Harman International Industries, Inc. Earnings Call Nuggets: Contract Award, Gross Margin Levels

On Monday, Harman International Industries, Inc. (NYSE:HAR) reported its third quarter earnings and discussed the following topics in its earnings conference call. Here’s what executives shared with investors and analysts.

Contract Award

David Leiker – Robert W. Baird & Co.: Just two questions, numbers questions here and then a broader question. Herbert with the tax rate and the change in evaluation allowance where do you expect that to be going forward here.

Herbert K. Parker – EVP and CFO: What we expect David is pretty close to the 23% to 24% for the full year that we had guided you at. We could possibly come in around year-to-date rate which is 22% but for fiscal year ’13 and going forward we are still, striving to go for 28% which would still be lower than our structural rate.

A Closer Look: Harman Earnings Cheat Sheet>>

David Leiker – Robert W. Baird & Co.: Beyond the restructuring cost there are sometimes some other moving pieces and the R&D, royalty things like that anything of note there in the quarter.

Herbert K. Parker – EVP and CFO: We were normal, while the just for your information the R&D was about $59 million this quarter for infotainment it was $53 million for the same quarter of last year. So there’s nothing unusual.

David Leiker – Robert W. Baird & Co.: Then lastly you look at the $2 billion business here nice contract awards there. Can you give us some color in terms of Dinesh you had the follow-on contract how much of that is extension of existing business on next generation vehicles. How much might be incremental revenues and any color you could provide there.

Dinesh C. Paliwal – Chairman, President and CEO: This is pretty much a follow-on so it’s a replacement business the good thing is this business has been awarded to us which will not start shipping as a fully ramped up program until beginning of calendar year ’15 so that’s one color. Second color I give you this is based on current run rate of take rates and the customer and us we both feel the current technology we are going to deploy the take rates will significantly go with this, so this business is likely to grow and that might be incremental to what we have. So it’s a pretty much follow-on replacement business from like-to-like basis.

David Leiker – Robert W. Baird & Co.: Then, it doesn’t seem like you are updating your backlog here with these awards and business launches…

Dinesh C. Paliwal – Chairman, President and CEO: No we have not – backlog is on a quarterly basis. Frankly speaking, this award was confirmed to us on Friday afternoon. So we have not revised our backlog number, so you can add that for future perspective which will put our backlog if I say tentatively $14 billion plus $2 billion, so it’s a $16 billion our highest ever.

Gross Margin Levels

Christopher Ceraso – Credit Suisse: Just a follow-up on the contract award. I just wanted to double check. Are there any additional trend lines that you’ve picked up on this award? Has there been a consolidation maybe where Harman picked up additional responsibility relative to any of the junior suppliers that may also be on these programs?

Dinesh C. Paliwal – Chairman, President and CEO: A little of both to be honest with you as I said, but I’m not at a liberty to give those details, because customer would not allow. We intend to put out a press release hopefully with more details as soon as we are allowed to, but this has been our lead customer, very, very advanced technology customer. So, yeah, we are picking up some in trim line and also some on the expense of partners, but yeah, that’s all I’m allowed to say, Chris.

Christopher Ceraso – Credit Suisse: So, if I looked at it over the life of the program, is it safe to say that the $2 billion looking ahead is maybe a little bit bigger than the comparable period that you already were supplying? So, in other words, there’s a bit of a step up in your revenue base with this customer.

Dinesh C. Paliwal – Chairman, President and CEO: Absolutely correct, because I’ll give you an example. With the same customer, the original awards which we got, 2, 2.5 years ago that was just over a 1 billion and that’s already turning into much bigger award because the take rates are going up as more and more people worldwide are opting for embedded Infotainment system. So this award of $2 billion today is likely to grow bigger than that.

Christopher Ceraso – Credit Suisse: Next question, the margin in the Lifestyle business was a little bit weaker than we thought and I understand that seasonally the March quarter is not the best quarter for the consumer products within that division, but even on a year-over-year basis if I take seasonality out of it, it looks like margins were a little bit light even after taking into account the neodymium pass through that you mentioned. Is there anything underneath that, were there any events or investment or what caused the year-over-year decline above and beyond the neo issue?

Dinesh C. Paliwal – Chairman, President and CEO: Let’s talk about gross margin and we can also talk about operating margin. Herbert you want to handle that.

Herbert K. Parker – EVP and CFO: Yes. You are absolutely right, Chris. In the gross margin levels, you have mentioned – you heard Dinesh mention several investments we are doing in countries and in factories. So are about 200 basis points related to the investment in Dandong or let’s call it cost increases, Mexico and China. So we’ve been doing a lot there, in building up our channels. So that’s where most of it is coming from and there is a small point, a little small mix change of about 50 to 80 basis points.

Dinesh C. Paliwal – Chairman, President and CEO: And also per these as neodymium. Neodymium is about 230 basis point and half of 230 is coming from, just the (fact too), which adds up to the top line at zero margin and about half of the neo invest is a true cost invest. Chris since you do so detail analysis let me tell you the way it’s working. Neodymium, we are very happy to report that we have index in place which means we are able to pass on all the cost increases to our customers, but the way this index works, it could have worked positively for us, but it does work that we charge the customer at the time of shipping the spot price of the Neo and the Neo prices have been coming down. So if we bought something at a higher price we are giving it up at actually at a slightly lower price. So it’s a quarter impact, may be another quarter because you are going to be done with Neo by end of this fiscal year. So that’s why we probably have another 5 million of so to absorb in the fourth quarter. So that explains as Herbert said 2013 Neo and about 200 basis point in expanding channels, factories and training of personnel, adding dozens of sales folks and a little bit of a mix issue. That’s it. There is nothing unusual and we have also said in our press release we expect our coming quarters to have favorable margin development.

Christopher Ceraso – Credit Suisse: Just to check the China and Mexico the 200 basis points, we should assume that continues, right? Because you have just won a whole bunch of new business in China and you’re pushing hard to grow in these markets so there should be some ongoing investment level, is that a reasonable level?

Dinesh C. Paliwal – Chairman, President and CEO: No. What I meant to say, this is a duplication. We have a bunch of people from U.K., Europe and America helping us ramp up. So we have brought up a lot of SG&A costs right now, also lot of training going on, lot of simulation programs going on and also re-training and trainings of the new channels. So I call it almost a one-off because the rest we should be back on to the normal SG&A cost level. So this is a ramp up of Queretaro, in Mexico and Dandong in China.

Christopher Ceraso – Credit Suisse: Last one. Herbert, I know David asked about taxes but what about specifically in the fourth quarter as opposed to the full average, what do you expect in the Q4 fiscal 2012 tax rate to be?

Herbert K. Parker – EVP and CFO: Yes. The way we do it Chris, is the tax rates are always based on the full year. So if the full year is 22.1 we expect it around the 22 level but it could be 23 or 24 in that range.

Christopher Ceraso – Credit Suisse: Just to clarify you said for fiscal ’13 and beyond. You expected to be at 28 maybe a little bit lower is that right.

Herbert K. Parker – EVP and CFO: 28 is a pretty good solid number.