Harman Reports Strong 2Q - Analyst Blog

Harman International Industries Inc. (HAR), a developer of audio products and electronic systems, reported strong second quarter 2011 earnings, comprehensively beating the Zacks Consensus Estimate of 52 cents, by 27 cents.

Harman achieved impressive growth during the second quarter, primarily due to strong operating margin growth and stringent cost control.

Operating Performance

Pro forma earnings per share of 79 cents soared 118.4% year over year in the quarter. Net income was $56.3 million, up 120.3% year over year, with net margin expanding 310 basis points (bps) to 5.9% in the quarter.

Gross profit increased 6.0% year over year to $271.0 million, with gross margin expanding 90 bps to 28.3% in the second quarter of 2011. This growth was primarily driven by improved productivity and new product launches.

Segment wise, Automotive division gross margin decreased 20 bps to 25.2% in the second quarter. Consumer division gross margin expanded 230 bps and Professional division achieved a growth of 180 bps in the quarter.

Selling, general and administrative (SG&A) expense decreased 3.0% year over year to $198.0 million in the second quarter. Harman is on the verge of completing its scheduled $400.0 million cost savings program and achieved 98.3% of its target at the end of the quarter. We believe an improved cost structure will drive profitability over the long term.

Operating income was up 45.0% year over year to $73.0 million. Operating margin was 7.6% as compared with 5.4% in the prior-year quarter. The year-over-year growth was primarily attributed to higher sales, improved productivity and lower engineering costs.

Revenues

Revenues increased 3.0% year over year to $956.1 million in the second quarter of 2011. This was slightly below the Zacks Consensus Estimate of $957.0 million. Excluding foreign currency fluctuations, revenues increased 8.0% year over year in the quarter.

The year-over-year revenue growth was primarily driven by strong performance from the Consumer and Professional division, which fully offset the weak results from the Automotive division.

Sales from the Consumer division increased 10.0% year over year (16.0% excluding foreign currency effects) to $139.0 million, while Professional division achieved a growth of 14.0% year over year (15.0% excluding foreign currency effects) to reach $152.0 million in the second quarter.

The strong year-over-year growth in both the divisions was driven by increased penetration in the Asian and Latin American markets, further supported by Selenium acquisition in Brazil, which was completed in the first half of 2010.

However, Automotive declined 1.0% (up 5.0% excluding foreign currency effects) to $664.0 million. This decline was primarily credited to  an unfavorable foreign currency impact and divestment of the portable navigation devices business (PND). Including PND, revenue would have increased 6.0% in the quarter.

During the second quarter, Automotive received a significant contract from the Volkswagen Group worth $1.2 billion.  Harman also signed a new partnership with Sierra Wireless that will bring fourth generation (4G)/LTE connectivity to automobiles during the quarter. Automotive order backlog was $13.0 billion at the end of the quarter.

The Consumer division grew strongly in the emerging markets of Brazil, India and China, by 4 times over the prior year quarter. The Consumer division strengthened its presence in China by entering into a new partnership with China's leading consumer electronics distributor, Digital China during the quarter.

Harman remains focused on strengthening its footprint in China, the world's largest automotive market, which is expected to reach more than 30 million vehicles by 2015. Harman is in the process of developing a new R&D and manufacturing complex in the northern city of Dandong, in line with the company's existing facilities in Shanghai, Shenzen and Suzhou.

Harman continued to expand its presence in Hungary and Mexico. The company has decided to close its Washington, Missouri facility by 2012 and will shift some production to the Franklin, Kentucky plant.

Balance Sheet

As of December 31, 2010, cash and short-term investments were $731.5 million compared with $64.5 million as of September 30, 2010. Liquidity increased to $1.3 billion, including a $550.0 million credit facility.

Guidance

Harman remains focused on achieving profitable growth, both organic and inorganic, over the long term. Harman remains optimistic on a long-term basis based on increasing demand for its products, mainly in the emerging markets of Brazil, China, Russia and India. Harman expects to achieve $1.0 billion in revenue in China by 2015.

Our Take

We maintain a Neutral rating on a long-term basis (6-12 months). We believe that strong growth from the emerging markets, particularly China will drive top-line growth going forward.

Harman continues to face tough competition from Bose Corp., Boston Acoustics Inc., Pioneer Corp., Yamaha Corp., Rockford Corp. (ROFO), Panasonic Corp. (PC) and Sony Corp. (SNE), which may hurt its profitability going forward.

Currently, Harman has a Zacks #3 Rank, which implies a Hold rating on a short-term basis (1-3 months).