Harman Misses 4Q Estimates - Analyst Blog

A developer of audio products and electronic systems, Harman International Industries Inc. (HAR) reported fourth quarter 2011 earnings of 34 cents per share, which substantively missed the Zacks Consensus Estimate of 52 cents by 18 cents. Earnings per share (EPS) increased 13.3% year over year from 30 cents reported in the prior-year quarter.

Operating Performance

Gross profit increased 10.3% year over year to $247.0 million. However, gross margin declined 240 basis points (bps) to 23.9% in the quarter. The gross margin was primarily dragged down by the declining gross margin in the Automotive division, which fully offset the margin growth in the Consumer and Professional divisions.

The Automotive division gross margin decreased 360 bps to 20.1% in the fourth quarter. The tsunami and earthquake that struck Japan in March 2011 led to the decline in higher-margin branded auto sales to Japanese customers, which was the primary reason for the segment's declining margin.

Moreover, Harman incurred $3.7 million in expenses for a customer claim related to a software fix. The company failed to realize approximately $8.0 million of planned price reductions from suppliers due to tighter component supply and raw materials. Harman also incurred an additional $2.0 million in higher costs for neodymium magnets, a key high-performance speaker component.

However, the Consumer division and Professional division gross margins increased 150 bps each in the reported quarter.

Selling, general and administrative (SG&A) expense declined 9.3% year over year to $212.0 million in the fourth 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 $434.0 million in savings at the end of the fourth quarter.

Operating income was up 16.7% year over year to $35.0 million. Operating margin was 3.4% compared with 3.5% in the prior-year quarter. The weak gross margin in the quarter was a drag on results.

Net income was $24.0 million, up 14.3% year over year from $21.0 million reported in the prior-year quarter.

Revenue

Revenues increased 21.2% year over year to $1.03 billion in the fourth quarter of 2011. The strong year-over-year growth was driven by double-digit revenue growth in all the three divisions.

Automotive revenue increased 21.2% to $760.0 million. The Consumer division earned revenue of $100.0 million, up 23.5% year over year. The Professional division achieved a year-over-year growth of 20.4% to reach $171.0 million in the fourth quarter.

Automotive awarded business backlog reached $14.5 billion, while scalable platform reached $4.4 billion. The company launched several new products in fiscal 2011. New products represented more than 37.0% of revenues in the quarter.

Balance Sheet

As of June 30, 2011, cash and short-term investments were $603.9 million compared with $767.5 million as of March 31, 2011. Liquidity increased to $1.5 billion, including a $550.0 million credit facility.

Outlook

Harman expects robust operating margin growth going forward (2013-2014), based on strong performance from the infotainment business. Harman expects to outperform the overall automotive sector going forward, due to increasing adoption rate in the emerging markets of Brazil, Russia, India and China.

However, the company projects increasing cost of neodymium to scale up the gross cost by $85.0 million in fiscal 2012.

Recommendation

Harman is doubling its manufacturing capacity in Hungary, China and Mexico, which will help the company to address the growing demand for Automotive and Professional products.

Harman boasts a solid product pipeline that is 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.

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 #5 Rank, which implies a Strong Sell rating on a short-term basis (1-3 months).