Harman Profits but Misses - Analyst Blog

A developer of audio products and electronic systems, Harman International Industries Inc. (HAR) announced fourth quarter 2010 results. Earnings on a non-GAAP basis were a profit of 30 cents, significantly up from the loss of 43 cents record a year-earlier. However, earnings were two cents below the Zacks Consensus Estimate of 32 cents per share.

For fiscal 2010, earnings increased to 85 cents as compared with a loss of $1.23 cents in fiscal 2009.

Results improved for both the fourth quarter and fiscal year due to strong sales across all segments, gross margin expansion and higher cost savings.

Revenues

Revenues increased 29.0% year over year to $851.0 million in the quarter. This was in sync with the Zacks Consensus Estimate. Excluding foreign currency fluctuations, revenues increased 35.0% year over year in the quarter. The strong top-line growth was primarily driven by higher demand for Harman’s products.

Harman achieved significant growth across all its sectors, especially from the Automotive division. Automotive sales increased 35.0% year over year (43.0% excluding foreign currency effect) to $627.0 million in the quarter.

The remaining two segments also achieved strong growth. Sales from the Consumer division increased 15.0% year over year (20.0% excluding foreign currency effects) to $81.0 million, while Professional division achieved a growth of 15.0% year over year (16.0% excluding foreign currency effects) to reach $142.0 million in the fourth quarter.

During the fourth quarter, Automotive received significant contracts from a number of auto companies such as Chrysler Group, Fiat (combined worth more than $1.8 billion), Toyota Motor Corp. (TM) and BMW. Automotive order backlog increased from $8.8 billion to $12.2 billion at the end of fiscal year 2010.

The Consumer division introduced 88 new products throughout the fiscal year. The division launched a MS-8 digital processor from Jabil Circuit Inc. (JBL) during the quarter.

Harman acquired Selenium of Brazil in the quarter, which brings a network of 30 distributors across Latin America and two distribution centers in the U.S. to the Professional division.

In fiscal 2010, revenues increased 18.0% year over year to $3.4 billion. Excluding foreign currency effects, revenues increased 17.0% as compared with the prior year. Sales from BIC countries (Brazil, India and China) increased 330.0% year over year to $0.25 billion in the fiscal year.

Margins

Gross margin increased 550 basis points to 26.3% in the fourth quarter of 2010 and 350 basis points to 26.4% in the fiscal 2010. Higher sales based on improving factory utilization and productivity drove the results.

Selling, general and administrative (SG&A) expense increased 12.6% year over year to $194.1 million in the fourth quarter and inched up 2.7% year over year to $760.7 million in fiscal 2010. However, based on the STEP change permanent program that achieved $350.0 million of cost savings as of June 30, 2010, SG&A as a percentage of revenues decreased 330 basis points year over year in the fourth quarter as well as the fiscal year.

Harman remains well ahead of its scheduled $400.0 million in the STEP change permanent cost savings program and achieved 90.0% of it at the end of fiscal 2010. We believe an improved cost structure will drive profitability over the long term.

Operating income increased to $29.7 million in the fourth quarter as compared with a loss of $35.1 million in the prior-year quarter. Operating income increased significantly to $115.7 million as compared with a loss of $86.4 million at the end of fiscal 2009.

The year-over-year growth was primarily driven by higher gross margins and a lower level of operating costs.

On a segmental basis, Automotive's gross margin increased 690 basis points to 23.7% in the fourth quarter. The Consumer division’s gross margin expanded 280 basis points and the Professional division achieved a growth of 250 basis points in the quarter.

Automotive's operating income was $34.0 million as compared with a loss of $56.0 million in the prior-year quarter. Professional division’s operating income increased to $23.0 million from $8.0 million reported in the fourth quarter of 2009. However, Consumer division suffered another operating loss of $11.0 million as compared with the $15.0 million loss reported in the prior-year quarter.

Balance Sheet

As of June 30, 2010, cash and short-term investments were $646.0 million as compared with $424.0 million as of March 31, 2010.

Outlook

Harman remained optimistic on a long-term basis based on increasing demand for its products. Harman doubled its manufacturing capacity in Hungary and China and established research and development and engineering centers in China and India during fiscal 2010.

Harman expects to achieve $1.0 billion in sales from China by fiscal year 2015, up from current sales of around $199.0 million. Harman forecasts a double-digit operating margin based on profitable growth in developed and emerging markets and prudent cost management over the long term.

Recommendation

We maintain a Neutral rating on a long-term basis (6-12 months) based on Harman’s increasing footprint in the emerging markets such as China, Brazil and India. Moreover, the company has a solid product pipeline and strong balance sheet.

However, weak results from the Consumer division remain a concern. 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 of #3 Rank, which implies a Hold rating on a short-term basis (1-3 months).
 
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