Harman Beats on Strong Sales - Analyst Blog

A developer of audio products and electronic systems, Harman International Industries Inc. (HAR) reported strong third quarter 2011 earnings, which comprehensively beat the Zacks Consensus Estimate of 46 cents by 14 cents.

Harman achieved impressive growth during the second quarter primarily due to strong sales and operating margin growth.

Operating Performance

Pro forma earnings per share (EPS) soared 122.2% year over year to 60 cents in the quarter. Net income was $43.0 million, up 129.0% year over year, with net margin expanding 310 basis points (bps) to 4.6% in the quarter.

Gross profit increased 14.5% year over year to $250.1 million, with gross margin improving 90 bps to 26.4% in the third quarter of 2011. This growth was primarily attributed to improved productivity and new product launches.

Segment wise, Automotive division gross margin spiked 20 bps to 23.3% in the third quarter. However, Consumer division and Professional division gross margins decreased 10 bps each in the reported quarter.

Selling, general and administrative (SG&A) expense climbed 9.4% year over year to $203.1 million in the third quarter. During the quarter, Harman exceeded its goal of $400 million in permanent cost and productivity savings under the company's STEP Change Cost Savings program and garnered $416.0 million in savings at the end of the third quarter.

The program included the closure or consolidation of 16 Harman facilities and 2250 lay offs in high-cost countries during the past three years. We believe an improved cost structure will drive profitability over the long term.

Operating income was up 93.0% year over year to $63.0 million. Operating margin was 6.6% compared with 3.9% in the prior-year quarter. The year-over-year growth was primarily attributed to higher sales, improved productivity and monetization of certain intellectual property rights.

Revenues

Revenues increased 13.0% year over year to $948.2 million in the third quarter of 2011. This was well above the Zacks Consensus Estimate of $897.0 million. Harman achieved strong growth across all its operational segments in the quarter.

Automotive increased 12.0% (up 13.0% excluding foreign currency effects) to $707.0 million. This year-over-year growth was driven by higher production volumes in the Automotive division and market share gains in the Infotainment business.

During the third quarter, Automotive won an additional contract from Volkswagen Group to provide premium high infotainment solutions for Volkswagen Group brands including Audi, SEAT, Skoda and Volkswagen for Asian markets beginning 2013. Automotive order backlog was $13.0 billion at the end of the quarter.

Earlier, in the second quarter, Harman received a $1.2 billion contract from the Volkswagen Group to provide high infotainment solutions for the Group's vehicles in the U.S and European markets. Including the new contract, total order value from the Volkswagen Group amounts to $1.6 billion.

Harman won significant contracts in China, which includes branded audio for a new electric vehicle by the BYD Daimler joint venture company, the Geely Motors Emgrand EC8 and the new BYD e6 electric vehicle.

Harman is collaborating with Sierra Wireless, a leading company in the high-speed mobile computing and wireless machine-to-machine communication space, to support fourth generation (4G)/LTE connectivity in automobiles.

Harman also showcased its broad range of connected infotainment solutions in the Rinspeed "BamBoo" concept car, which was hailed as the world's first social networking vehicle at the Geneva Auto Show.

Sales from the Consumer division increased 17.0% year over year (17.0% excluding foreign currency effects) to $95.0 million in the quarter, driven by higher market share in the Latin American and Asian markets.

Harman achieved strong growth from Brazil, China and India in the quarter based on strong market demand and increased penetration. Harman initiated operations in Russia during the reported quarter.

Harman launched 17 new products during the third quarter, which represented more than 25% of revenue. Harman launched JBL OnAir and OnBeat multimedia products, which are expected to drive higher penetration in Apple Inc. (AAPL) devices such as iPhone, iPod, iPad and also iPad 2, and into retailers such as Best Buy Co. Inc. (BBY) and Target Corp. (TGT).

The Professional division achieved a year-over-year growth of 16.0% (15.0% excluding foreign currency effects) to reach $146.0 million in the third quarter.

Balance Sheet

As of March 31, 2011, cash and short-term investments were $767.5 million compared with $731.5 million as of December 31, 2010. Liquidity increased to $1.3 billion, including a $550.0 million credit facility.

Outlook

Harman expects to expand its presence in the emerging markets of Brazil, Russia, India and China (BRIC) where the company aims to achieve $1.5 billion in revenues by 2015. Harman reports that its Dandong facility in China and Queretaro facility in Mexico are nearing completion. The Chinese facility is expected to be operational by July 2011.

Our Take

Harman is doubling its manufacturing capacity in Hungary, China and Mexico by fiscal 2011 and is expected to start five mega manufacturing plants by the summer of 2011. This will help Harman address the growing demand for Automotive and Professional products.

Harman boasts a solid product pipeline supported by more than 3500 patents, and the company intends to roll out new infotainment products in order to drive sales going forward.

Moreover, a huge backlog and new contract wins are the other key catalysts. We also believe that strong growth from emerging markets, particularly China will drive further top-line growth going forward.

Although Harman does not expect any material impact on its operations from the natural disaster in Japan, we believe automobile manufacturers are facing significant supply chain problems. This may hurt Harman's top-line growth in the near term, as its Automotive segment is a strong revenue driver (74.5% of the total revenue in the third quarter).

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.

We maintain our Neutral recommendation on a long-term basis (6-12 months). Currently, Harman has a Zacks #3 Rank, which implies a Hold rating on a short-term basis (1-3 months).