Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations. Net sales for fiscal 2001 increased 2 percent to $1.717 billion, compared to $1.678 billion in fiscal 2000 and $1.500 billion in fiscal 1999. Fiscal 2001 sales increased due to higher audio system sales to automakers and strong demand for aftermarket car radio and navigation units. Sales of home speakers and electronics were down. Professional audio sales approximated last year’s levels. In fiscal 2000, sales growth was driven by higher audio system shipments to the automakers as well as strong sales to personal computer manufacturers. Continued weakness in European currencies reduced our reported sales as compared to prior year in both fiscal 2001 and fiscal 2000. Excluding currency effects, fiscal 2001 sales increased 8 percent over the prior year, and fiscal 2000 sales increased 17 percent over the prior year.

The Company experiences seasonal fluctuations in sales and earnings. The first fiscal quarter is the weakest due to automotive model changeovers and the July and August holidays in Europe. Variations in seasonal demands among end-user markets may also cause operating results to vary from quarter to quarter.

The Company’s businesses are organized by the end-user markets they serve. The Consumer Systems Group manufactures loudspeakers and electronics for high-fidelity audio reproduction in the home, in vehicles and with computers. The Professional Group manufactures loudspeakers and electronics used by audio professionals in concert hall, recording, broadcast and cinema applications.

Consumer Systems Group sales increased 3 percent to $1.267 billion in fiscal 2001, compared to $1.228 billion in fiscal 2000 and $1.091 billion in fiscal 1999. Exclusive of currency effects, the Group’s fiscal 2001 sales increased 9 percent over fiscal 2000. Sales to automobile manufacturers were higher by $64.9 million in fiscal 2001 due to increased audio system shipments to Toyota and higher shipments of radio and navigation units to Mercedes-Benz and the European aftermarket. Sales of home speakers and electronics were lower by $15.2 million due to economic conditions compared to fiscal 2000. Sales to personal computer manufacturers were lower by $10.4 million as the industry experienced substantial sales declines over the past year. Fiscal 2000 sales were higher than the previous year as a result of strong audio system sales to the automakers and growth in radio and navigation system shipments. In addition, sales to the personal computer manufacturers, principally Dell, Apple and Compaq, were strong.

Professional Group sales of $449.2 million in fiscal 2001 approximated fiscal 2000 sales of $449.7 million. Fiscal 1999 sales were $408.8 million. Excluding currency effects, sales were 4 percent higher in fiscal 2001 than in the previous year. Sales increased due to the acquisition of Crown and higher AKG microphone shipments to General Motors’ OnStar program. These increases were offset by lower sales to mobile phone manufacturers and the disposition of Orban in May 2000. Fiscal 2000 sales were higher versus the prior year as JBL Pro, Crown, Harman Music Group and AKG all performed well.

The Company reported a $36.3 million pretax charge for restructuring and other items in the third quarter ended March 31, 2001. This included non-cash charges of $18.5 million and cash charges of $17.8 million. The significant items included in the charge were provisions to terminate distributors in the U.K. and Germany, severance costs, write-off of impaired assets, factory closures in the U.K. and Argentina, and inventory write-downs at Studer and Consumer International.

The consolidated gross profit percentage was 26.1 percent in fiscal 2001, compared to 28.0 percent in fiscal 2000 and 26.5 percent in fiscal 1999. Fiscal 2001 gross profit was reduced by inventory write-downs totaling $8.6 million and other unusual charges of $5.3 million as discussed above. Excluding those charges, the fiscal 2001 gross profit percentage was 26.9 percent. Lower margins were realized for consumer audio products as the Company sought to decrease inventory levels while implementing a direct to retailer distribution system in Europe. The Professional Group experienced lower margins as well due to softness in the cinema business and inventory reduction initiatives at Studer. In fiscal 2000, the majority of the Consumer Systems Group and Professional Group companies reported a higher gross margin percentage than the prior year, but this was offset by lower margins on sales to international consumer audio dealers and distributors due to lower factory overhead absorption and other effects of the dealer destocking program. Fiscal 1999 gross profit included charges totaling $24.3 million to reduce the carrying value of inventories of discontinued product lines.

Selling, general and administrative expenses as a percentage of sales were 22.0 percent in fiscal 2001, compared to 20.7 percent in fiscal 2000 and 21.5 percent in fiscal 1999. In fiscal 2001, selling, general and administrative expenses included $22.4 million in unusual charges to terminate distributors in the U.K. and Germany, to cover severance costs for 250 employees, to write-off impaired assets, and to close factories in the U.K. and Argentina. Excluding these charges, selling, general and administrative expenses as a percentage of sales were 20.6 percent, approximately the same as last year. Higher selling costs and a $12.5 million increase in engineering and development expenses were partially offset by overhead cost reductions. Selling, general and administrative expenses as a percentage of sales decreased in fiscal 2000 compared to the prior year. The decrease was due to cost savings realized from the implementation of restructuring programs in fiscal 1999, partially offset by higher investments in business infrastructure but at a rate of increase lower than the sales growth rate.

In fiscal 1999, Harman reported plant closing and severance costs of $17.0 million, equal to 1.1 percent of sales, and asset impairment costs of $20.0 million, equal to 1.3 percent of sales. The plant closing and severance costs resulted from the closure of the El Paso, Texas, electronics plant, the closure of other smaller facilities and elimination of full-time positions in certain other locations. The asset impairment charge resulted from the write-down of tooling, factory equipment and other assets associated with discontinued product lines and other write-downs of assets that no longer provided economic benefit to the Company.

Fiscal 2001 operating income was 4.1 percent of sales, compared to 7.3 percent in fiscal 2000 and 2.6 percent in fiscal 1999. Excluding the charges for restructuring and other items totaling $36.3 million, fiscal 2001 operating income was 6.3 percent of sales. Consumer Systems Group operating income decreased primarily due to higher costs to implement changes in consumer international distribution and lower operating margins on sales to Chrysler in North America, partially offset by higher operating margins from domestic home speaker and electronic sales. Consumer International’s operating loss was $18.9 million before restructuring and other charges and $28.6 million after the charges. Professional Group operating income of $33.7 million, excluding unusual charges, approximated last year’s level. Operating income in fiscal 2000 increased over fiscal 1999 due to sales growth, higher margins and overhead reductions as a result of the fiscal 1999 restructuring program, partially offset by $21 million of losses incurred in sales to international dealers due to a destocking program.

Interest expense in fiscal 2001 was $25.0 million, compared to $18.5 million in fiscal 2000 and $23.6 million in fiscal 1999. Fiscal 2001 interest expense increased due to higher borrowings as a result of the Company’s share-repurchase program, higher working capital levels and increased interest rates. Capital expenditures of $88.1 million also contributed to the increase in borrowings in fiscal 2001. Fiscal 2000 interest expense was lower than the prior year due to strong operating cash flows used to reduce revolving credit facility borrowings.

The weighted average interest rate in fiscal 2001 was 6.3 percent, compared to 5.7 percent in fiscal 2000 and 6.0 percent in fiscal 1999. The increase in average interest rates in fiscal 2001 was due to a higher percentage of U.S. dollar-denominated borrowings versus Euro-denominated borrowings due to the conversion of a Deutschmark term loan to U.S. dollars. In fiscal 2000, average interest rates decreased due to a lower percentage of U.S. dollar denominated debt.

As a result, in fiscal 2001 the Company reported income before income taxes and minority interest of $45.1 million, or $81.4 million excluding restructuring and other charges, compared to $102.8 million in fiscal 2000, and $14.4 million in fiscal 1999, or $80.9 million before restructuring charges.

In fiscal 2001, the Company reported income tax expense of $12.7 million, an effective tax rate of 28.2 percent. This compares with income tax expense of $29.9 million and an effective tax rate of 29.1 percent in fiscal 2000. Fiscal 1999 income tax expense was $2.7 million with an effective tax rate of 18.7 percent. The effective tax rates for fiscal years 2001, 2000 and 1999 were below the U.S. statutory rate due to utilization of tax credits, realization of tax benefits for United States exports and the utilization of tax loss carryforwards at certain foreign subsidiaries. The effective tax rate for fiscal 1999 was significantly below the statutory rate because the above benefits offset a lower pretax income base.

Net income for fiscal 2001 was $32.4 million. Excluding restructuring and other charges, net income was $58.2 million compared with $72.8 million in fiscal 2000 and $11.7 million in fiscal 1999. Fiscal 1999 net income was $57.6 million excluding restructuring charges.

Liquidity and Capital Resources. Harman International primarily finances its working capital requirements through cash generated by operations, borrowings under a revolving credit facility and normal trade credit.

The Company and certain subsidiaries have a multi-currency revolving credit facility with a group of twelve banks committing $275 million to the Company for cash borrowings and letters of credit through September 30, 2002. The Company plans to refinance this agreement during the next fiscal year. At June 30, 2001, the Company had outstanding indebtedness under the revolving credit facility of $111.6 million, outstanding letters of credit of $7.3 million and unused credit thereunder of $156.1 million. The indebtedness at June 30, 2001, consists of committed rate loans, which bear interest at LIBOR plus 0.25 percent, and swing line borrowings, which bear interest at base rates.

The Company and certain subsidiaries have a term loan with a group of banks led by Commerzbank committing $73.4 million to the Company for cash borrowings through August 30, 2002. The variable rate loan bears interest at LIBOR plus 0.60, equal to 4.7 percent at June 30, 2001. In addition, at June 30, 2001, the Company’s international subsidiaries maintained unsecured short-term lines of credit of $23.2 million and had outstanding indebtedness thereunder of approximately $15.9 million.

Capital expenditures, net of lease financing, were $88.1 million in fiscal 2001, compared with $80.4 million in fiscal 2000 and $67.8 million in fiscal 1999. Expenditures in fiscals 2001, 2000 and 1999 were for equipment and facilities required to increase capacity and efficiency, primarily in our business supplying the automotive industry, and new product tooling.

The Company anticipates capital expenditures of approximately $120 to $130 million during the next fiscal year. Firm commitments for capital expenditures during fiscal 2002 of approximately $24.6 million existed as of June 30, 2001. The Company anticipates that a portion of these capital expenditures will be financed through operating lease arrangements.

Net working capital at June 30, 2001, was $358.7 million, compared with $309.6 million at June 30, 2000. The increase primarily results from higher inventories, reflecting lower than anticipated sales, and lower accounts payable due to timing of purchases and vendor payments.

Excess of cost over fair value of assets acquired was $145.3 million at June 30, 2001, compared with $166.6 million at June 30, 2000. The decrease was due to amortization and the effect of foreign currency translation.

Shareholders’ equity was $422.9 million at June 30, 2001, compared with $486.3 million at June 30, 2000, and $468.2 million at June 30, 1999. The decrease in fiscal 2001 resulted from net income offset by common stock repurchases totaling $67.0 million and negative foreign currency translation adjustments totaling $33.2 million due primarily to the weakening of the Euro against the U.S. dollar. Fiscal 2000 shareholders’ equity increased due to net income offset by $36.0 million of common stock repurchases and negative foreign currency translation of $17.2 million.

Harman’s Board of Directors has authorized the repurchase of 7.0 million shares. Through June 30, 2001, the Company has acquired and placed in treasury 5,689,300 shares of its common stock at a total cost of $137.0 million. Future repurchases are expected to be funded with operating cash flow.

Cash generated by operations and the unused credit available under the revolving credit facility should provide sufficient funds to meet the Company’s working capital, capital expenditure, dividend, debt service and share repurchase requirements in fiscal 2002.

The Company is subject to various risks, including dependence on key customers, economic conditions affecting disposable consumer income and fluctuations in currency exchange rates. A disruption in the operations of one of our key customers, such as an automotive strike, could have a material adverse effect on the Company.

Effects of Inflation and Currency Exchange Rates. The Company maintains significant operations in Germany, the United Kingdom, Denmark, France, Austria, Hungary, Switzerland, Mexico and Sweden. As a result, exposure to foreign currency gains and losses exists. A portion of foreign currency exposure is hedged by incurring liabilities, including bank debt, denominated in the local currency where subsidiaries are located.

The Company’s subsidiaries purchase products and parts in various currencies. As a result, the Company may be exposed to cost increases relative to local currencies in the markets to which it sells. To mitigate such adverse trends, the Company enters into foreign exchange contracts and other hedging activities. Also, foreign currency positions are partially offsetting and are netted against one another to reduce exposure.

Some products made in the U.S. are sold abroad. Sales of such products are affected by the value of the U.S. dollar relative to other currencies. Any long-term strengthening of the U.S. dollar could depress these sales.

Competitive conditions in the Company’s markets may limit its ability to increase product pricing in the face of adverse currency movements. However, due to the multiple currencies involved in the Company’s businesses and the netting effect of various simultaneous transactions, the Company’s foreign currency positions are partially offsetting.

Over the next several years Harman International expects significant revenue and earnings growth due to major new OEM automotive awards. The Company recently announced that it will supply all navigation systems for Mercedes-Benz vehicles beginning in fiscal 2003. The new awards are for integrated infotainment systems with display for E Class vehicles and for DVD navigation systems for S Class vehicles.

Recent Accounting Pronouncements. Recent accounting pronouncements SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets,” are discussed in footnote 1 to the consolidated financial statements, Summary of Significant Accounting Policies.