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Harman International Industries Inc. (NYSE:HAR)

Q3 2006 Earnings Conference Call

April 26th 2006, 4:30 PM.

Executives:

Sidney Harman, Executive Chairman

Kevin Brown, Chief Financial Officer

Bernie Girod, Vice Chairman and Chief Executive Officer

Greg Henry, our Treasurer and Principal Officer for Officer Relations

Analysts:

Scott Merlis, Thomas Weisel Partners

Scot Ciccarelli, RBC Capital Markets

Peter Barry, Bear Stearns

Chris Ceraso, Credit Suisse First Boston

Ron Tadross, Banc of America Securities

Peter Friedland, Soleil Group

Jeffrey Kessler, Lehman Brothers

Steve Lidberg, Pacific Crest Securities

Peter Cyrus, Gorilla Capital

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Harman International Industries Third Quarter Fiscal 2006 Earnings Release Conference Call. Operator Instructions. And as a reminder, today's conference is being recorded.

If I may have your attention, certain statements made by the Company during this call are forward-looking statements. These statements include the Company's beliefs and expectations as to future events and trends affecting the Company's business and are subject to risk and uncertainties. Persons participating on the call today are advised to review the reports filed by the Harman International with the Securities and Exchange Commission regarding these risks and uncertainties.

Well, with that being said, here with our opening remarks is Harman International Industries’ Executive Chairman, Dr. Sidney Harman. Please go ahead.

Sidney Harman, Executive Chairman

Good afternoon. Joining me in Washington, D.C., are Bernie Girod, our CEO; Kevin Brown, our CFO; and Greg Henry, our Treasurer and Principal Officer for Officer Relations. We will report today on our third quarter results and we will provide perspective on the balance of the year and the years ahead. We had a strong third quarter.

Consolidated sales totaled $801.5 million, an 8% increase over the same quarter last year. Operating profit totaled $98.8 million equal to 12.3% of sales, and an increase of 11% above the third quarter last year. Earnings per share were $0.94 compared to $0.90 last year.

Those earnings were achieved despite unfavorable currency and restructuring charges which Kevin and Bernie will reveal and review in detail. As we begin the last quarter of the fiscal year, it is a good time to reflect on how our automotive OEM business has developed. We have been so occupied in designing the ship over the years that we run the risk of missing the fact that it is now built and launched and is under full sail.

Over the last seven years, we have been busy inventing this business and busy persuading the investment community of its legitimacy and its staying power even as we have promoted our leading role in it. We have established our capability, not only to design the systems, but to debug, integrate, and deliver them and we are in process of demonstrating that we can do all of that across the full range of automotive vehicles.

In addition to our previously announced '06 infotainment business, we have now won the award for the new BMW rear seat entertainment system. This system is the first application of our very important Qnet technology, which enables dual core operation between the head unit and the rear seat entertainment system. Its first application will be in the seven series. But we believe that it will be applied across the full range of BMW platforms.

The price for this initial 7 series award is $620 with a forecast of 20,000 units for fiscal 2009. Thus, an initial award of $12 million. We see the value in its full application at BMW running well in excess of $100 million annually. It is therefore a significant award and we anticipate adoption of its technology by other automakers. And we have just received a new award from Hyundai for its V-1 platform. This new vehicle will be positioned just above the BH, which was awarded to us 18 months ago, and has already substantially exceeded original estimates. It is Hyundai's expectation that the combination of these two big new offerings will establish it in the top rank of luxury vehicles. It is particularly meaningful, of course, in Asia.

This new award carries Harman content of approximately $2500 and represents volume of approximately $55 million annually beginning in 2009. We now have an automotive backlog in excess of $13 billion. And we forecast total OEM automotive sales next year, fiscal 2007 at $2.3 billion. We have that business in hand, although car model sales and installation rates may vary through the mix, we are confident that we will reach that level of sales and that we will generate 16% operating margin.

We now forecast total automotive OEM sales for fiscal 2008 at $2.8 billion and the total OEM sales in 2009 at $3.1 billion. We have that business in hand. The same variables apply to sales and take rates, and we expect 16% operating profit each year.

Now, a comment on opportunity. Our QNX operating system has proved itself the world's clear best choice for automotive applications. I am convinced that all other existing systems fall very short technically and that the development of a new system to compete with the elegance, sophistication, speed, and cost of QNX will represent a 5 to 8 year undertaking and an investment in the order of $1 billion. I therefore believe that our QNX operating system will be the unassailable standard and the key to the next generation of infotainment business across the automotive spectrum.

Within one year, we expect to unveil the most advanced multimedia system architecture for OEM and consumer applications this industry has seen. It will provide simultaneous and seamless transport of audio from hard disk, CD, and USB memory sticks from any computer to any other computer. It will accommodate several iPods, each playing music and displaying its playlist in less than one second. Similarly, the system will stream three DVDs across the network in real-time. We have conducted a series of exclusive presentations and focus groups to review and evaluate this new development. The unfailing reaction has been, “It knocked our socks off.”

In summary, we have brought our OEM business to a position of leadership and stability and readiness to move to another level. We see moderating sales in automotive and consumer in fiscal 2007 with renewed vigorous growth in fiscal 2008. Automotive vigor will be driven by an unusual level of all new model activity in '08 with a natural catching of industry breath in ‘07.

In consumer, the predictable transition from unbridled iPod enthusiasm to the new era of music-enabled phones now seems underway. iPod sales are softening. They declined 40% in the March-quarter, and iPod accessory sales naturally follow. We project a sales plateau in the fourth quarter, but the arrival of an array of new JBL multimedia products will energize fiscal '07 and the first significant expression of music phones in the United States will further stimulate fiscal '08.

Our professional business continues to impress. Sales in the third quarter were $127.3 million, an increase of 6% over the same quarter last year. Operating profit of $13.5 million displays a margin of 10.6% and an increase of 35% above last year. Our HiQnet protocol and associated programs are performing impressively. We have launched 57 HiQnet compatible products, of which 32 are now shipping. We have shipped 22,000 HiQnet compatible products and we are moving vigorously to add video capability to our standard. Busch Stadium, home of Major League Baseball St. Louis Cardinals, was a major project this quarter, as a very large HiQnet system was installed there.

We have become the world leader in professional audio and the opportunities to build on that position are substantial. With the continued enhancement of our professional business, and the growing capability of our consumer group, we are positioned to offer dependable guidance on performance this year and for fiscal '07 and fiscal '08. We reaffirm our expectation for the current year of $3.85 EPS. We are evaluating whether to retire our outstanding bonds before maturity, so as to reduce total interest expense. If we determine to do so, it will be done in the fourth quarter of this year, or the first quarter of fiscal '07. In either case, it will produce an after-tax charge of $0.04 a share. Our expectation for EPS in fiscal '07 is $4.35, and for fiscal '08 EPS of $5.25.

Finally, after a thorough search, at one time we had a roster of 60 candidates, we have chosen Bernie's successor. Subject to final Board approval, Doug Pertz will join us on May 1, as President and Chief Executive Officer. At 51 years of age, Doug has the combination of education and sophisticated manufacturing company experience we sought. A graduate of Purdue University with a BS in Mechanical Engineering, Doug's career is highlighted by years as Chairman and CEO of IMC Global, the New York Stock Exchange chemical producer, as President and CEO of Culligan Water and by Executive stints at Danaher and Cummins. He brings serious public company experience and a sophisticated understanding of technology, finance, and manufacturing.

Bernie Girod will continue as Vice Chairman of the Company until his retirement. The specific date of the retirement will be determined as he and I work with Doug to ensure the most effective seamless transition. Bernie will continue as consultant to the Company in his retirement. I now turn to Kevin Brown.

Kevin Brown, Chief Financial Officer

Thank you, Sidney. Net sales for the third quarter were 801.5 million, an increase of 8% compared to the same quarter last year. Gross profit margin was 35.1%, an improvement of 1.4 percentage point versus the prior year. Operating income was 98.8 million, an increase of 10 million or 11% from the third quarter of last year. Net income for the quarter was $64 million, earnings per diluted share were $0.94 compared to $0.90 in the prior year.

These results were achieved despite unfavorable foreign currency translation due to the strengthening of the U.S. dollar versus the euro. The dollar averaged $1.20 per euro during the quarter compared to $1.31 in the third quarter last year. More than 60% of the Company's sales and operating profits are generated outside of the United States with much of that coming from Europe. Therefore, reported earnings are significantly impacted by the U.S. dollar and euro exchange rates.

In the third quarter, foreign currency translation had a negative impact on sales of approximately $41 million. Exclusive of foreign currency translation, sales would have shown a year-to-year increase of 14%, compared to the 8% reported. The negative effect on net income from foreign currency translation was about $4.5 million or $0.07 per share. All three of our operating segments reported higher sales for the third quarter compared to the prior year.

Automotive sales were 567.3 million during the quarter, an increase of 9%. Excluding foreign currency translation, automotive sales improved 16%. Consumer sales grew 7% to 106.8 million. Professional sales were 127.3 million, 6% higher than last year. Automotive operating profit was 91 million in the quarter or 16% of sales, an increase of 8% from the third quarter fiscal year '05. Professional operating income was 13.5 million, or 10.6% of sales, up 35% from the prior year.

Consumer operating income was $5.2 million or 4.9% of sales. Consumer operating income was 27% lower than a year ago, primarily due to 2.1 million of increased investments in R&D for new multimedia products and the acquisition of PhatNoise.

R&D spending has increased to support the significant new automotive business awards and new product development. R&D spending in the third quarter was $73.7 million or 9.2% of sales, compared to 51.1 million or 6.9% of sales in the prior year. R&D spending increased in each of the operating groups with the largest increase in automotive. Automotive R&D spending increased 19.4 million in the quarter in support of development of the products for the $1.5 billion of new business that we have won in the past year.

During the quarter, management approved a plan to repatriate additional cash from our foreign subsidiaries under the American Jobs Creation Act of 2004. We previously repatriated $200 million and incurred a $1.1 million tax charge in the second quarter. We expect to repatriate an additional $300 million in the fourth quarter. That decision resulted in a $1.7 million tax charge in the third quarter. The third quarter tax rate was 33.3%, compared to 26.3% last year. Last year's third quarter tax rate was lower primarily due to one-time benefits related to the closing of prior year's federal tax audits. We presently expect the full-year tax rate to be between 32% and 33%.

Reported results for the third quarter include several one-time charges. In addition to the repatriation tax expense of 1.7 million, we incurred 2.6 million of restructuring expense principally at AKG. The AKG restructuring will continue in fiscal year '07 and will result in a vibrant worldwide microphone company. The combination of currency, repatriation tax, and restructuring lowered third-quarter reported results by $0.12 a share. Excluding these items, net income would have been $1.06 per share instead of the $0.94 reported. Cash flow from operations was approximately 38 million for the quarter.

Depreciation and Amortization was approximately 28 million and Capital Expenditures were approximately 30 million. Inventory was 337.7 million, and inventory turns were 6.1 compared to 5.7 last year. Accounts receivable were 440.2 million, and accounts payable were 243.4 million. The Company has expensed employee stock options since fiscal year 2003.

We expensed 3.8 million for stock options during the third quarter equivalent to $0.04 per share. Our cash and cash equivalents balance was 397.1 million at March 31, an increase of 114.4 million compared to last year. Our total debt was 326.8 million. Cash and cash equivalents exceeded debt by 70.3 million at March 31.

During the quarter, 172 million of debt moved from long-term to short-term on the balance sheet. This represents the 7.125% senior notes due in February of 2007. We believe that our current cash balance and ongoing cash from operations will be sufficient to retire this debt by the due date. I now turn the call to Bernie Girod.

Bernie Girod, Vice Chairman, Chief Executive Officer

Thank you very much, Kevin. Third quarter results were in line with our expectations. As you know, the comparison with last year's results is heavily influenced by currency and taxes. Adjusting for these two factors, sales were up 14% versus last year and EPS were up 25%. Absent the unusual factors reviewed by Kevin, earnings would have been even higher. Results from operations were therefore quite strong.

In the third quarter, consumer sales on earnings were somewhat below expectations, primarily because sales of iPod docking stations were lower than planned. Although sales of these products continue to grow, we expect moderating sales until the new music-enabled phones are firmly established. The balance of our consumer business was on track in the quarter. Automotive OEM sales grew 8.6% in the quarter, but more than 16% when adjusted for currency. Operating profit was 16% of sales, a very good quarter for the automotive group.

Professional posted record results. Sales grew 6.3% but operating income grew an impressive 35% to $13.5 million. We expect a similar pattern in the fourth quarter. Our earnings forecast continues to be $3.85 per share for the full year, suggesting fourth quarter EPS of $1.05, up 4% from last year's reported number, but up 17% when adjusted for currency and taxes. If we elect to repurchase our bonds, it will generate the charge of $0.04 in the quarter.

Looking at fiscal 2007, we expect sales to rise approximately 7%, first quarter earnings are expected to be flat with the prior year, given the exceptional strength of the first quarter of 2006 in which earnings were up 65%. We're talking about the first fiscal quarter of 2006. Earnings in the last nine months of fiscal '07 should be up approximately 15% at current exchange rates. As Sidney stated earlier, we expect EPS of $4.35 a share in fiscal '07.

Our fiscal '07 sales forecast reflects a more conservative estimate for multimedia products. As Sirius music enabled cell phone activity is not expected until fiscal '08. Although we continue to view the opportunity for the business as very attractive, this new market is difficult to predict in its early stages. Despite that caution, consumer sales are expected to grow nearly 15% and operating income should grow approximately 20%.

Automotive sales are expected to grow 5% in 2007. Principal areas of growth include the sale of additional audio systems to Hyundai/Kia, new PND devices, that's personal navigation devices, for the aftermarket, and Chrysler infotainment systems, which begin in the fourth quarter of next year. We expect automotive margins to hold at 16%. Professional sales are expected to grow approximately 7%, margins should continue to expand as we complete the turnaround of European operations, operating income is expected to grow 25% to 30%. Fiscal 2008 continues to look very attractive, with sales growing more than 15% fueled primarily by our new automotive contracts. Earnings are expected to grow more than 20%.

Now, if I may a personal note. After 20 years with this wonderful company, I welcome Doug Pertz as my successor. I will work with Doug and Sidney through much of the balance of this calendar year to ensure the smoothest possible transition, and I'm confident that the new team will lead our company to new heights. I wish Doug the very best. I treasure my 20 years of experience and friendship with Sidney, but take great pleasure and satisfaction in knowing that this company is in excellent shape today, and is poised for a very bright future. I'm hopeful that I will be helpful in the years ahead as consultant to management and the Board. It has been great to work with all of you, and I wish you all the very best, and we will now take your questions.

Question-and-Answer Session

Operator

Operator Instructions And our first question comes from the line of Scott Merlis from Thomas Weisel Partners. Please go ahead.

Q - Scott Merlis

Good afternoon everybody, how are you?

A - Berine Girod

Good Scott.

Q - Scott Merlis

Can we just take a deeper dive into the consumer business a little bit in the quarter. And just so we're on the same page, if you could just start by repeating the sales number and the operating income number, for consumer?

A - Berine Girod

Okay. Consumer, this is Bernie, sales of $106.8 million.

Q - Scott Merlis

Right.

A - Berine Girod

Operating income of $5.2 million, 4.9% of sales.

Q - Scott Merlis

And can you give any more granularity into mix and margin factors and iPod accessories versus other products and just a little bit more detail on what's going on there? Essentially as it relates to iPod accessories?

A - Berine Girod

Sure. iPod accessories slowed a bit in the quarter. They were more than $10 million in the quarter. But of course in the second quarter, sales were substantially higher, in large part due to seasonal factors due to Christmas season. Sales of iPod related devices were 17 million in the second fiscal quarter as compared to 10.6 in the third quarter.

A - Sidney Harman

Let me add to that, Scott. I think I said this in my opening remarks, not surprisingly at some point it has to happen. iPod sales have quieted down. As iPod sales have quieted down, competitive engagement in that field has ratcheted up. There are more players looking for some part of that action, included among them as you well know is Apple. In the face of the decline in the remarkable vigor of iPod sales, it is hardly surprising that it has been seen expressed in a decline or at least a less rapid growth of the iPod supporting products. We see that as continuing, that is that the iPod behavior will continue at about this level going forward, still quite a remarkable level of activity. In addition to that, we will be bringing onstream over the next several quarters, a quite impressive range of new iPod systems. That is, iPod adapter systems. We're pretty well convinced that that will add new energy. The big factor, of course, in all of this, if you like the elephant in the room, is the music-enabled cell phone and we can talk more about that as we go.

Q - Scott Merlis

Okay, so the EBIT margin was 4.9, is there any guidance on, I might have missed this, but I think any guidance on that margin, going forward or next year or whatever?

A - Sidney Harman

You're talking about consumer margin?

A - Berine Girod

Consumer margin should go up a fair amount in the fourth quarter for a variety of reasons. First, we're looking for fairly good sales forecast in the fourth quarter, largely due to the new products that Sidney was talking about. And the list is really quite impressive, plus there were a number of one-time events in the third quarter which negatively impacted the consumer business. So overall we're very pleased, we'll wind up the year with operating margin well in excess of 9% for the consumer group compared to 6.4% in the prior year. That's 300 basis points, nearly 300 basis points from year-to-year. And the outcome for next year is really quite good, as I stated earlier.

A - Sidney Harman

9% in consumer is actually stronger than we have in the past signaled. We thought the natural healthy percentage there might be, and moving very much in the direction of the corporate average.

Q - Scott Merlis

And lastly, just a bookkeeping item. Looking for an EPS effect on the two non-recurring items, the 1.7 million on the repatriation, plus the 2.6 million on the AKG restructuring gives you the 4.3 million pretax? Is that a pretax number? And to tax effect it, do we just use the 33% tax rate and that gives us kind of 2.8 million net?

A - Kevin Brown

Well, the repatriation expense is a tax expense so it's an after-tax.

Q - Scott Merlis

Right, right.

A - Kevin Brown

That's worth about $0.03 a share.

Q - Scott Merlis

Yeah.

A - Kevin Brown

The restructuring is worth about $0.02 a share so the two of those together about $0.05.

Q - Scott Merlis

Thank you very much.

A - Sidney Harman

Thank you, Scott.

Operator

Thank you, next, our question comes from the line of Scot Ciccarelli from RBC Capital Markets. Please go ahead.

A - Sidney Harman

This is Scot time.

Q - Scot Ciccarelli

Yeah, you get two in a row. Two questions, really. Just one more clarifying remark regarding consumer. So the '07 expectations are assuming how many new products? Is a series of new launches or is it just kind of --?

A - Sidney Harman

It's a series of new JBL launches. There are 8, 10, or 12, is a function of just how you count them.

Q - Scot Ciccarelli

All right. And then, is there anyway we can get better clarity on the rollout pattern of some of the new automotive contracts? I know you guys kind of talk in fiscal years and you have such and such contract, Chrysler when it's fully ramped up, 350 million, etc. Is there anyway you guys can give us a better feel for the timing of when some of these contracts land and how they're expected to roll out?

A - Sidney Harman

Sure. The Chrysler is the big one towards the end of next year. And you know that the total award for Chrysler, two parts, the one that kicks-in at the end of next year, when fully launched is worth 350 million and the one the following year is an additional $250 million year. So total of $600 million, it's a great opportunity but for '07, we're only looking at about $20 million in the fourth quarter. So it's a huge event. It does not come in until the latter part of the year. But it is still worth mentioning, Scot, that I spent a day at Chrysler a week ago. And I've not ever encountered the enthusiasm for new product there that I did last week. I think they are only now beginning to fully recognize the remarkable product that they're going to be launching. And so I am very optimistic about upcoming estimate, upcoming reality there.

Q - Scot Ciccarelli

Okay, great. So just clarify, 20 million starting in your fourth fiscal quarter of '07, and what models will that be launched on? Does it start with a single model and then get rolled out to a series?

A - Sidney Harman

We don't have that final definition from Chrysler.

Q - Scot Ciccarelli

Okay.

A - Sidney Harman

But I expect that it will be launched in several, not one.

Q - Scot Ciccarelli

Okay, great. Thanks a lot, guys.

A - Sidney Harman

You bet.

Operator

Next, we have a question from the line of Peter Barry from Bear Stearns. Please go ahead.

Q - Peter Barry

Gentlemen good afternoon. Sidney, you mentioned backlog totaling $13 billion and quick math in terms of revenue expectation, fiscal '07 through fiscal '09 adds to 8.2 billion. Obviously leaving 4.8 billion out there somewhere. Is that a number that takes us into the early part of the next decade?

A - Sidney Harman

Well, of course it does. And I don't really think of my leaving it out there. Rather, it is there and we have put our hands around it. It's the first time that I have thought it really truly relevant to count it all up and put it before you, Peter. That's an impressive number. But that's business we have in hand and you're correct, it suggests that beyond 2008 and '09, the order book is building as in fact it should.

Q - Peter Barry

Sidney, might I ask, how far out does that 4.8 billion of additional backlog go? Is it like 2012 or?

A - Kevin Brown

Peter, this is Kevin. It encompasses our seven-year business plan period which now runs through fiscal 2013.

A - Sidney Harman

You're pretty close, Peter.

Q - Peter Barry

I'm not sure who to address this to, but Sidney, probably you. Mr. Pertz, could you speak perhaps to those very unique specific skills that pushed him to the top of the heap of the selection list?

A - Sidney Harman

Yeah. I can and I am the guy to talk to, although as I think I have indicated, we vetted this guy quite thoroughly. He spent time with me. He spent time with Bernie, he spent time with Erich Geiger. We've had him pretty thoroughly worked over as indeed we had other candidates. We had a wonderful crop, came as no surprise to me, that we had a rich set of possible of candidates. The thing that I thought separated Doug from the rest was experience. This guy is at the right age, it seems to me, because at 51, he now has a significant body of experience, leading a public company, carrying forward an IPO, knowing the world in which you live, being able to deal with that material with the kind of comfort that experience only provides. We have a very interesting business. It is almost impossible to imagine finding a Chief Executive Officer with significant technical experience in the particular field of our engagement. And so what we look for is a literacy in that arena and we found it flourishing in Doug Pertz. The guy is as close to Bernie Girod and since he's in the room, to Kevin, as any executive I've talked to in terms of his grasp of the financial material of our business and the world in which we operate. When I put those elements together: experience, maturity, technical literacy, financial know-how, I say, we have found us a very unusual guy. We saw other more glamorous resumes, but we saw nobody I would suggest as ideally equipped to succeed Bernie as this man.

Q - Peter Barry

Sidney, I can't help but ask this question. Culligan as I recall used to be a part of the old Beatrice companies and I know that's where Bernie came from. Did they happen to cross paths during that period of time?

A - Berine Girod

No.

Q - Peter Barry

Much too young a man, obviously. A straight question to you, Sidney. The Chrysler order. Hasn't there been any slippage in delivery schedules?

A - Sidney Harman

Nope. These schedules vary, not just for Chrysler, for everybody. Some from month to month, sometimes you're ahead of the schedule. Sometimes you're behind. When you're behind, you work your fanny off to catch up. We're in good shape.

Q - Peter Barry

Anything new from the various folks in Japan? I think specifically of Toyota.

A - Sidney Harman

You think specifically of whom?

Q - Peter Barry

Toyota.

A - Sidney Harman

Not really, not I think in the sense that you're asking. I believe, Peter, we've made this sort of clear. We have a very heavy, a very substantial, a long-term investment at Toyota, not just in terms of relationship, but in terms of hard dollars that we have spent on the technical side. We are in there constantly. This is clearly the major automotive company likely in the world today. They are moving with remarkable care, slowly, from our point of view, down the path we think is inevitable. They have accepted the most our bus system as their standard and that represents a very important step forward. But it is one step after another. I do not think that other than the possibility of, what if you like might be characterized as a market exercise, that we are likely to see a definitive clarification of Toyota's position here through a couple of years or more.

Q - Peter Barry

And just to close, Bernie, good luck to you, godspeed and good sailing.

A - Berine Girod

Thanks very much, Peter.

Operator

Thank you, next we'll go to the line of Chris Ceraso with Credit Suisse. Please go ahead.

Q - Chris Ceraso

Thanks, good afternoon everyone.

A - Sidney Harman

Hi.

Q - Chris Ceraso

A few items, first, I guess back to one of the original comments about the BMW program. Can you just give us a quick explanation of what exactly the technology is that you're bringing to market here, how it's different and what it offers to consumers?

A - Berine Girod

This is a rear seat entertainment device. Traditionally rear seat entertainment devices have been standalone. There's an award made for the head unit and the award for the rear seat entertainment might go to a totally different manufacturer. It's a different, an additional DVD player screen, totally different software, and usually not even hooked up to the front, to the head unit. With this technology, we can now link the head unit with the rear seat entertainment, reduce the number of hardware devices, have full communication between front and rear seats, like you can display navigation, for example, in the rear seat. So make for some excellent back seat drivers. And you can play cartoons on the display in the front unit while you drive.

A - Sidney Harman

Let me just add that this dual core operation that we referred to has particular consequence in the whole area of latency. This stuff is immediate. It's real-time. That's not the state-of-the-art today. It will become state-of-the-art with this BMW system. And it is one software system. So the whole system is compatible, all the commands are compatible. So it reduces costs. It increases functionality. It's a very nice piece of technology.

Q - Chris Ceraso

Great. One other conceptual question. You mentioned, Dr. Harman, that QNX is proliferating across different makes. Would that include, I guess this ties into your previous comments about Toyota. Do you see down the road, Japanese makes adopting that operating system as well?

A - Sidney Harman

Well, I see it in terms of aspiration for sure. Perhaps there is some merit in looking at the development of our original bus system. MOST was not immediately adopted by the Japanese. Indeed, one or another of those companies made an effort to develop their own and determined over time that they were better served with MOST. I think we will see a similar process building around the QNX but I think that it is in one form or another inevitable.

Q - Chris Ceraso

Okay. And then just a couple of quick numbers, questions. The foreign exchange assumption in your '07 and '08 guidance, is that $1.20?

A - Berine Girod

It's $1.24.

Q - Chris Ceraso

$1.24, okay. And, I thought on the previous call when you had mapped out with less specificity the '07 and '08 expectation that you had talked about maybe 25% to 30% earnings growth in '08. It sounds like that's been dialed back a bit, is that correct?

A - Berine Girod

We talked about slightly higher numbers for '07. So the delta between '07 and '08 is still the same. We always talked about 20% or better for '08. The numbers for '07 are a bit lower than we had previously telegraphed. And the primary change as I indicated in my remarks is on the consumer side where we have somewhat lower expectations for some of the iPod devices and music-enabled cell phones. But nonetheless we feel very good about the consumer numbers for '07.

Q - Chris Ceraso

Great. Thank you very much, good luck, guys.

A - Berine Girod

Thank you.

Operator

Next we'll go to the line of Ron Tadross from Banc of America Securities. Please go ahead.

Q - Ronald Tadross

Good afternoon everyone. Can you hear me? Hi. I just wanted to focus on the infotainment segment for a little bit and the outlook. Can you give us an idea of your currency assumptions under the '07 through '09 revenue growth?

A - Berine Girod

Our currency assumptions, we don't make currency assumptions, we use current exchange rates and it appears that the euro and the euro is the primary currency that we're concerned about.

Q - Ronald Tadross

Right.

A - Berine Girod

The euro seems to have strengthened and all the indications we had. But it's going to stay where it is or in fact get stronger. And keep in mind that our budget for '07 is not nailed down yet. But as we look at it now, and we estimate our results for '07, we think that our number is somewhere around 123 to 125 is most likely.

Q - Ronald Tadross

Okay. And then, on the sales growth, if I look at just your revenue forecast, you're up about $900 million from roughly '06 through '09 that's your forecast. The last table you published, which was I think a month or two ago, showed that you guys had about 1.2 billion of new business that would be launched in the fiscal years '07, '08, '09. And so I'm wondering, is that $300 million difference, is that strictly timing? Or were there any reductions in your new business awards?

A - Berine Girod

There's absolutely no reductions. If any, there have been substantial increases. The way to read that table, you have to be a little careful with those numbers, it is the number of sales that we're going to have when all the vehicles are fully launched under that award. In some cases, it can take as many as three years before you get there. So it does not happen in the first year. There's a schedule. But what we tried to do with that schedule is to give you an indication of the total magnitude of the award after all the vehicles under that award are launched.

Q - Ronald Tadross

And why would it take three years to get up to that level?

A - Berine Girod

In some it's, when the vehicles are refreshed, is when the new technology is launched. And not all, take any car manufacturer, BMW, BMW doesn't launch the 7653 and 1 series in the same month of the same year. These are vehicles that are launched progressively, are refreshed over a period of years. So when the vehicles are refreshed, and updated, then the new technology is installed.

Q - Ronald Tadross

Okay. And so I guess it's fair to say then that 300 million doesn't represent one vehicle, there's a handful of vehicles that will overtime get up to the levels that you think they'll get up to?

A - Berine Girod

Well, of course.

Q - Ronald Tadross

Okay. And just one last thing on the margin, you're forecasting about 16% margin in your infotainment business.

A - Berine Girod

Right.

Q - Ronald Tadross

If I recall correct, you guys said that there's about 80% reuse in the software and also that R&D was falling, should fall in '08 '09 as a percent of sales, which led me to believe that there should be some operating margin leverage going forward. Can you just give us an idea of what's going on there, why we shouldn't expect any operating positive leverage on the upside from the margin standpoint?

A - Berine Girod

There may be some operating leverage. There's just so many factors that are happening. We're being a bit cautious about '08 because the year is so dynamic. We're looking for an increase in sales of $0.5 billion that year. That's big numbers for us. And the types of systems we're launching are very different from many that we have today. Some of them are mid levels or even a entry level vehicles. And at lower price points, some were lower margins. So you need to put all that mix together looking forward. There's a huge increase in not dollar sales, not only dollar sales, but in unit sales over that period. And you need to balance all that out. Yes it is true that overall our R&D percentage of sales should drop in '08 by nearly a full 100 basis points. But I think it's prudent to, at this point, as we do our planning, this far ahead of time, with a huge increase in sales with brand new systems coming on the market to make a forecast with our current automotive margin.

Q - Ronald Tadross

Okay. Thank you very much.

A - Berine Girod

You bet.

Operator

Next we'll go to the line of Peter Friedland from Soleil Group. Please go ahead.

Q - Makala Crauch

Hi, Makala Crauch (phonetic) for Peter, I was just hoping you could talk a little bit about your automotive revenue expectations for '07 and '08. It looks like you may have sort of pushed your expectations for each of those years forward one year out a year. Could you talk about what any sort of primary drivers for that would be?

A - Berine Girod

We haven't pushed anything in any direction. We gave you the specific forecast of sales for those three years. And we continued to have the same expectations that we always had. The only part of the business that has moderated somewhat is the aftermarket where if you go back to last year, for example, a large part of our sales was in what we call turn by turn navigation devices in the aftermarket.

A - Sidney Harman

In Europe.

A - Berine Girod

In Europe. And that business has just about disappeared. Or it's very low volume now and we have offset a part of that decline with these new PND devices. And by the way, we have a rather aggressive and a very interesting program with a series of PND offerings over the course of the next 12 to 18 months. That we think will pick up that volume.

A - Sidney Harman

And before we turn to the new question, I'd like to come back though to, to the question as you phrased it. Our job is not to push things forward or back. Our job is to reveal the reality as we know it. Now that reality can shift from time to time. One shift is in terms of currency. If the currency affects revenues, we recognize it. Another shift is in terms of success or lack of success of platforms on which we have been awarded the business. That mix moves and shifts over time, and the closer you get to the year the better visibility you have of it. Nothing has changed of any consequence. That I can identify in terms of awards we've made or the way in which we have given expression to those awards. There is that mix element in this stuff. The visibility becomes clearer as you get closer. We feel obliged to present it as we see it.

Q - Makala Crauch

Okay. And since you guys actually brought up PNDs, could you possibly disclose your unit sales of PNDs today or this quarter, even?

A - Kevin Brown

We sold about 30,000 PNDs in the year so far, running about 10,000 a quarter.

A - Berine Girod

Actually, in Q3 we sold 35,000 units. I think Kevin was referring to dollars, we sold about $30 million so far in 2006. But we sold 35,000 units in Q3. Our forecast for Q4 where we launch a new model, which should be out in the Street within a week is considerably more aggressive. We think that we could reach levels approaching two to three times the current level. And there are subsequent expressions of PNDs for future quarters. That's a very interesting program. We're just getting into it. But you'll hear more about our effort in PND over future quarters.

A - Sidney Harman

That's the point at which we should complete this question and turn to the next questioner. PND is a relatively new undertaking for us. Visibility will increase with every quarter. We'll be able to pin better numbers on it when we have a better sense, not only of how we're doing in Europe, where we begin this activity, but in the United States as it takes form. Can we hear the next question, please?

Operator

Thank you. The next question comes from the line of Jeff Kessler with Lehman Brothers. Please go ahead.

Q - Jeffrey Kessler

Thanks, I'm glad I was let on the call. Bernie, I've been bothering you for 15 of your 20 years at Harman. And you won't have me to bother anymore, but it's been great fun. And I wish you all the best.

A - Berine Girod

Thank you very much, Jeff.

Q - Jeffery Kessler

Any update, because the U.S. Market has some sensitivity to voice-activation, voice-activated controls to expand that market, and the willingness of the U.S. users to use the market? Any update on where you stand with voice activation?

A - Berine Girod

We have still the best technology as through Wavemakers and Temec of anybody out there. And in fact, we're in the process of trying to streamline our engineering to make communication a little more efficient. We have further opportunities. But clearly, and this is a very recent update, versus competition, we still have in our view, the best technology out there by a pretty good margin.

A - Sidney Harman

Jeff, let me add, we're improving that work all the time. We have a considerable investment in it. We know that business very, very well. But I would recommend to you to just to get a flavor for it, you get yourself into an S-class Mercedes and you will, if you haven't, I think you'll have your socks knocked off by the speed of the responsiveness, its ability to respond to, I think seven or eight different languages, enormous progress has been made and will continue to be made in voice recognition.

Q - Jeffery Kessler

Okay. Great. One other question on, with regard to -- on the margins with regard to consumer. Clearly we're in a phase now where you've gone from the bottom over a period of years to a point at which new product launches generate a sudden burst in the margin. And then as that product matures a little bit or it gets more competition, the margin comes down with more competition, more price competition as well. Can we expect to see on the consumer business, margins bouncing around, you're talking about averaging of hopefully, 8% or 9%. But are we expected to see these margins bouncing around somewhere between 5% and 15% over the course of the next several years?

A - Berine Girod

No. I think it's a fair question, Jeff. And I think it reflects the tradition of the broad consumer electronics business. Fortunately for us, a significant part of that business is in more legacy product, more new media server systems for the home, more custom installation. The area where your question might have more, its principal relevance, would be in devices to adapt for iPods and the new music phones. I think you do see if not volatility, a curve decline in margins over time in products such as that. The trick is to reinvigorate the product line, and very importantly I believe, you see a new era beginning to dawn as we see it late in '08 and very vigorously in '09 in music-enabled phones that have comparable facility, interface, storage capacity to the iPod. When that happens, you're going to see a period of sustained, solid margins, and then again a repetition of the variances that we have experienced in the current product line. But nothing remotely like the range you're talking about, I think the average that we've suggested within a point or so can be depended on.

Q - Jeffery Kessler

Okay. And again, once again, Bernie, I intend to talk to you before you leave. But again, it's been great, great deal with you over these years.

A - Sidney Harman

I intend to talk to him also before he leaves.

A - Berine Girod

Thanks, Jeff.

Q - Jeffery Kessler

Thank you guys.

Operator

Operator Instructions And we go to the line of Steve Lidberg from Pacific Crest Securities.

A - Sidney Harman

And Cynthia, we have time for one question beyond Steve's.

Operator

Okay, thank you. Mr. Lidberg, your line is open.

Q - Steve Lidberg

Good afternoon, guys. With regards to the iPod-related sales on the consumer side, obviously down basically 7 million sequentially, how much of that was strictly unit-driven and/or ASP driven? And then on the automotive side of the business, as you look at the introduction of dual core, how quickly can make your OEM customers make the decision to make a similar decision to BMW and roll that into their future lines? Thanks.

A - Sidney Harman

Well, let me try to answer both of them, perhaps Bernie would want to add to it. It's very difficult to predict how quickly others may respond. We think that there is that much merit in it, that once it's a reality, it will garner enormous amount of attention. Once that attention is generated, it isn't all that darn tough anymore. When is reality? There's a time, I suppose when and perhaps it's probably still true in the United States, reality dawned when there were wheels on the road. In Europe, I suggest there's a remarkable level of awareness on the part of all the manufacturers about what the other guys are doing. That's not the consequence of a looseness, it really reflects a different kind of collaboration that runs around the European automakers. So if it is as good as BMW thinks it is, if it's as good as we think it is, you may see a quick response. Once that determination is made, I think we and the automakers are much more able to give life to it more quickly now than used to be the case. As for the JBL products, the iPod related products, I'd say that principally what you've seen is decline in not selling price, there's been a certain amount of that. But really just in volumes. As you've seen it in iPod sales, they mirror each other.

A - Berine Girod

By the way, we should add that we are bullish. We continue to be bullish about iPod sales. Sidney said it earlier. It's worth reiterating as we've stated that, that sales are down in the third quarter versus a previous quarter. The seasonal factor is a very, very strong factor. But most important, we have a large number of new products coming on the market that we're very excited about. There's plenty of opportunity in this market. I think we'll see the numbers come back up in the fourth quarter and you'll see the numbers being up next year as well.

A - Sidney Harman

And we are watching very carefully the progress of the Sirius music-enabled phones. There's been a kind of hierarchy of these. The first ones have some music capability. That's not really the key. A music enabled phone that rivals the facility of iPod is the benchmark. You begin to see that in the Nokia N91, which has been launched in Europe. The response there has been very positive. Watching that stuff, staying very, very closely in touch with the manufacturers, with Nokia, with Motorola, with whom we have increasing arrangements for bundling our products with theirs, staying that carefully and thoroughly in touch on the engineering side is critical to this stuff. The music phone, the truly enabled music phone represents enormous opportunity. There's also enormous complexity, we've made that clear in the last two conference calls. There are infrastructure problems. There are technical questions, all of that will resolve in time. We see its first meaningful expression late in 2008. We see significant opportunity in 2009.

Q - Steve Lidberg

Thank you.

A - Sidney Harman

You bet.

Operator

And, ladies and gentlemen, our last question is from Peter Cyrus from Gorilla Capital. Please go ahead.

Q - Peter Cyrus

Hi, I just wanted to say something to Bernie, since Jeff Kessler said he's been on these calls for 15 years, I've been on them for 20. And also to you, Sidney, what I wanted to say is where you guys earned your salaries was a long, long time ago when you had one, in the days of Pile and Don Esthers and everything else, when you guys had the courage, when things were going badly, to come up with this dream and stick to it. And Bernie, I just want to tell you that it has been an honor, it was an honor being an analyst following your company and it's been an honor being a shareholder for all these years, I thank you.

A - Berine Girod

That's very kind of you and much appreciated, Peter. Thank you.

A - Sidney Harman

I think, Peter, that I will respond, too, and this since it will be my closing comment on the conference call. It was nice and even perhaps fortunate that an old hand closed up this particular conference call for us. Earlier questions about Bernie's successor justify my expressing my obvious admiration for this guy and for the wonderful experience we've developed together. I'm hopeful that we have communicated our professional regard for each other, our warm personal relationship to all the people of the Company, and Bernie was the benchmark as we saw his successor. One might argue that I had rainbows in mind or lightning in a bottle. It's up to Doug to show that Bernie and I and Erich Geiger knew what we were doing when we said, here's our boy. So I thank you all very much.

Operator

And, ladies and gentlemen, your host is making today's conference available for replay for one week. And by using web replay for 30 days, the digitized replay is available starting at 8:00 PM Eastern Time, April 26, 2006. Simply dial 1-800-475-6701 and at the voice prompt, enter today's conference access code: 826146. Alternatively, you may go to www.harman.com to listen to the web replay. You will need to enter the access code 826146. That does conclude our press release call for this quarter. Thank you very much for your participation as well as for using AT&T executive teleconference service. You may now disconnect.

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Source: Harman International Industries Inc. Q3 2006 Earnings Conference Call Transcript (HAR)
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