Harman International Industries, Incorporated Management Discusses Q3 2013 Results - Earnings Call Transcript

May. 2.13 | About: Harman International (HAR)

Harman International Industries, Incorporated (NYSE:HAR)

Q3 2013 Earnings Call

May 02, 2013 11:00 am ET

Executives

Sandy Rowland

Dinesh C. Paliwal - Chairman, Chief Executive Officer and President

Herbert K. Parker - Chief Financial Officer and Executive Vice President

Analysts

Ryan Brinkman - JP Morgan Chase & Co, Research Division

David H. Lim - Wells Fargo Securities, LLC, Research Division

Ravi Shanker - Morgan Stanley, Research Division

Christopher J. Ceraso - Crédit Suisse AG, Research Division

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Brian Arthur Johnson - Barclays Capital, Research Division

Matthew T. Stover - Guggenheim Securities, LLC, Research Division

Adam Brooks - Sidoti & Company, LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the HARMAN Fiscal 2013 Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Thursday, May 2, 2013. I would now like to turn the conference over to Sandy Rowland, Vice President of Investor Relations. Please go ahead, ma'am.

Sandy Rowland

Good morning, and thank you for joining the third quarter fiscal year 2013 investor and analyst call.

I'm joined in Stamford today by Dinesh Paliwal, our Chairman, President and Chief Executive Officer; and by Herbert Parker, our Chief Financial Officer.

If you haven't done so already, I invite you to visit the Investors section of our website where you can download copies of our earnings release and supporting slide presentation that we will be referencing today.

Before Dinesh and Herbert provide their remarks on the quarter, let me also address a quick housekeeping item. Certain statements during this conference call and question-and-answer session may be forward-looking statements as defined in the United States Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's beliefs, assumptions and current expectations. However, these forward-looking statements are subject to a number of important risk factors and uncertainties, which are fully described in our 10-Q and the press release that we issued this morning.

Now let me turn the call over to Dinesh.

Dinesh C. Paliwal

Thank you Sandy, and good morning, ladies and gentlemen.

On our last conference call, we stated that we expected our fiscal third quarter to be comparable with our fiscal second quarter. The results that we issued this morning were in line with that expectation from a top line perspective and more favorable on the bottom line as we successfully executed our operational and cost management programs.

As a result, sequentially, quarter-over-quarter, we improved EBITDA by 100 basis point to 9.2%, with all 3 divisions posting higher profitability quarter-over-quarter. Our EPS improved from $0.59 in Q2 to $0.79 in Q3 on a relatively flat sales.

We are raising our fiscal 2013 earnings per share guidance to $3 from our previous range of $2.70 to $2.90. To put this in perspective, our fiscal year 2012 EPS was $2.93 on higher sales.

We now expect revenue for fiscal 2013 to be at the mid-to-high end of our guidance range of $4,175,000,000 to $4,250,000,000. Additionally, we expect operating profit to meet the high end of our range of $265 million to $280 million. And EBITDA to meet the high end of our range, that is $385 million to $400 million.

The operating environment in Europe, particularly in the auto sector, remains challenging, and the recovery in this market will take some time. In its latest report, J.D. Power stated that auto production in Western Europe declined 12% compared to last year. However, I am encouraged by the double-digit growth during the quarter in our home and multimedia products in our Lifestyle Division. We carried the strong momentum that we had with our award-winning products during the holiday season into our third quarter and grew the revenues by 17% in this quarter. More importantly, our home and multimedia improvement constitutes profitable growth, as these products have generated high-single digit operating margins in the quarter as well as year-to-date. I am very pleased with this turnaround of the business.

As you can see on Slide 12, we have added a fifth pillar to our strategic plan. That is diversifying our portfolio. The Martin acquisition is a great example as it is not only expanding our Professional Division, but also further diversifies our portfolio outside of automotive. As I've said before, we will continue to pursue accretive bolt-on acquisitions that expands our market opportunities and expedite top line growth.

Let me update you on our Infotainment Service business, which we announced last quarter. The feedback from the discussions with several automakers has been very positive, and we are confident about the prospects of this new initiative. Although there is no third-party market data for services, we believe Infotainment Service is a highly profitable and more than $1 billion market opportunity.

Let me now take a closer look at our divisions and review some recent notable achievements. Let's start with our Infotainment Division, which is highlighted on Page 8 of your slide deck. HARMAN continues to be a global driving force for innovation in embedded infotainment systems. This month, we started production on the next-generation infotainment systems for Mercedes' flagship S-Class vehicles, which also include high-end 3D HARMAN navigation system. The premium system combine wireless connectivity with enhanced 3D navigation. It also includes the new multi-seat entertainment concept, which enables every passenger in the car to share personalized content. This system provides all seats with access to automotive-based apps. In addition, we expect that production for the higher volume C-Class vehicles, which will also include HARMAN Infotainment and HARMAN navigation, will start at the beginning of calendar year 2014. This hopefully will clarify a lot of inaccurate and misleading information of the press release from one of the competitor out of Kansas City put out. Hopefully that clears that.

During the quarter, we also expanded the production of our recently launched scalable Chrysler UConnect and BMW NBT systems. Following successful rollouts on the Dodge Ram and the SRT Viper, the UConnect system powered by HARMAN premiered in Jeep vehicles in the United States and Europe. Both of these platforms are ramping up, expanding cross-car line and gaining traction in the market.

Now turning to technology developments. As I've consistently said, our competitive advantage stems from our commitment to innovation. We are leading the industry with our cutting-edge connectivity and advanced safety solutions. In the first 9 months of this fiscal year, we have filed more than 300 new patents. That is a new company record. This brings our total patent count to more than 4,600.

At the Geneva Auto Show, HARMAN and Ferrari showcased the integration of Apple's Siri technology in the latest Ferrari FF model. It is another example of HARMAN partnering with Apple to bring innovative and easy-to-use solutions to consumers. Ferrari's limited edition hybrid sports car called LaFerrari also feature our embedded infotainment system.

As you are aware, at CES and at Geneva Auto Show, we showcased our vision for tomorrow's premium infotainment platform. Our next-generation systems feature interactive headset displays combined with smart connectivity, augmented navigation, gesture control, high-speed networking and advanced safety features. So a whole lot goes into infotainment system. And I'll reemphasize navigation is one of the several modules we use, and there's a whole lot of software, some 3.5 million, 4 million lines of code which we put in to make it a most complex yet user-friendly system.

In April, we acquired iOnRoad, an Israeli company, a recognized leader in the development of advanced safety vehicle solutions, including the iOnRoad augmented reality driving app. We successfully integrated iOnRoad technologies into our infotainment platforms at CES. The acquisition of iOnRoad will strengthen our leadership in global infotainment systems and services and will accelerate the rollout of new advanced safety functionalities on both scalable and custom platforms.

Now let's take a look at our Lifestyle Division. Highlights from the quarter are referenced on Slide 10 of your presentation. The Lifestyle division grew its car audio backlog as we secured several new awards from existing customers. Our car audio collaboration with Toyota, Kia, Ferrari and Maserati continues to expand as these long-term partners selected HARMAN's JBL, Infinity and JBL Professional branded audio systems for their vehicles.

During our fiscal third quarter, we launched a number of new systems, including a cutting-edge Mark Levinson system on all-new Lexus IS, a Harman/Kardon Logic7 system on the all-new Mercedes CLA and an Infinity premium sound system on the all-new Kia Soul. In addition, the company launched its first JBL system with the Chevrolet Malibu for the China market.

At the Geneva Auto Show, the company continued its world introduction of QuantumLogic Surround 3D, our proprietary technology that brings three-dimensional surround sound into HARMAN-equipped vehicles.

As I mentioned earlier, we continue to build momentum with our award-winning home and multimedia products. We're introducing innovative and easy-to-use products and expanding our distribution channels in both developed and emerging markets. To give you an example, right here at home, we are now using partnership with our provider, Sprint, with nearly 1,000 stores carrying HARMAN multimedia products and selling very well. And we are also entering in relationship with other providers like Verizon and AT&T, and that will just multiply our distribution channels and our touch points.

During the past 6 months, we have shipped over 1 million wireless portable audio products, again a new record in the industry and for HARMAN. Our focus on research and development and design is yielding positive results as we're delivering innovative products that are simply meeting or exceeding needs of today's consumers. For example, our recently launched JBL Flip was listed by The NPD Group as the top-selling portable audio product in the entire United States in this category.

Now turning to our Professional Division featured on Slide 11. We maintained our sector leadership and increased our penetration in the touring and installation markets during the quarter. In the developed markets, our Professional solutions were again featured at the most high-profile events including the U.S. Presidential Inauguration, the Super Bowl, the Grammys and the Oscars. We also won the business to outfit the American Idol set, Sports Authority Field at Mile High Stadium in Denver and Dodgers Stadium in Los Angeles.

Our focus on the emerging markets continues to yield results. In Mumbai, our solutions were installed at the Indian Institute of Technology and a full HARMAN solution was utilized to provide sound reinforcement at the Carnival in Rio de Janeiro in Brazil.

In China, we have recently entered the fast-growing premium KTV or Karaoke Television market. For those of you who are not aware, KTV is currently a $500 million market in China and growing rapidly. We expect to expand this category from 0. We already are in double-digit million dollar orders, and we expect a lot more to come.

We are also pleased to announce that we have been awarded 2 additional FIFA World Cup stadiums, bringing the HARMAN's total to 6 new stadiums in Brazil. The Arena de Amazonia and the Estadio Nacional will be fitted not only with our industry-leading audio products, but the stadium installations will also include our leading technology called IDX solution, which integrates audio and video.

As expected, we completed our acquisition of Martin in Denmark at the end of February and integration is well underway. This is our professional lighting business.

Looking ahead, we are taking the right actions to position the company for long-term top and bottom line growth. We are reducing cost, optimizing our global footprint, driving innovation and expanding our portfolio to continue delivering profitable growth. In addition, several of our higher-margin scalable infotainment platforms will be ramping up as well our Infotainment Services business. With many positive initiatives well underway, we are confident that fiscal 2014 and 2015 will be stronger years for HARMAN.

Now I thank you for your continued support, and I will ask Herbert to give you a closer look at our third quarter performance.

Herbert K. Parker

Thank you, Dinesh, and good morning. First of all, let me walk you through a few of our financial highlights from the quarter. As you know, most of my financial comments are provided on a non-GAAP basis, which basically excludes restructuring cost and other nonrecurring items. The reconciliation of our GAAP to non-GAAP results is included in the press release issued this morning.

Now starting with the top line. Our revenues in the quarter were $1,062,000,000, a decrease of 3% compared to the prior year. As Dinesh discussed earlier, revenues in our Infotainment Division and in our car audio products within the Lifestyle Division were adversely impacted by lower auto production in Western Europe as a result of the continued economic slowdown. These declines were partially offset by sales growth in our home and multimedia products within the Lifestyle Division and the acquisition of Martin in our Professional Division.

At the total company level, our gross profit in the quarter was 25.7% compared to 26.8% in the prior year. This reduction was primarily due to lower margins in our Infotainment Division, which were partially offset by stronger margins in our Lifestyle Division.

Our Infotainment Division's gross profit declined 370 basis points, primarily due to reduced operating leverage of fixed cost and higher warranty costs.

In the Lifestyle Division, gross profit margin improved 210 basis points compared to the prior year. This was primarily due to neodymium material cost impact in the prior year.

Our SG&A expense decreased 110 points, primarily due to higher recoveries of customer project engineering costs.

Our consolidated income on a non-GAAP basis was $66 million, essentially in line with the prior year.

Our net income was $55 million in the quarter or $0.79 per share compared to $53 million or $0.74 per share in the prior year.

Our effective tax rate during the quarter was 15%. This is lower than we had anticipated due to the reinstatement of the research and development tax credit and the related cumulative catch-up adjustment for this change in the law. We expect the Q4 tax rate of between 21% and 22%.

We continue to take actions that will shift our global footprint to best-cost countries, and I would take a couple of moments to provide a quick update on the restructuring program that we announced last quarter.

We recorded restructuring charge of $28 million this quarter. This restructuring program is on track to reduce 500 positions in high-cost countries and deliver $30 million to $35 million in annual savings starting in fiscal year 2014.

We also sold one of our manufacturing sites in Germany, and we would gradually transfer the production of our operations to Hungary. By the time this transfer is complete, we would have partly reduced our total headcount in Germany by 500 positions.

Thank you, and we are now ready to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Ryan Brinkman with JPMorgan.

Ryan Brinkman - JP Morgan Chase & Co, Research Division

There continue to be announcements regarding increased smartphone integration within automobiles, particularly as it relates to the iPhone, including this quarter. Some observers have painted this increased integration in a negative light as it relates to HARMAN, although you continue to highlight as an investment positive your work to integrate smartphones into the car. For example, you mentioned the integration of Siri technology into the Ferrari FF today. Now in the case of the Ferrari FF customer, there probably wouldn't be much debate even amongst the bears that this customer is not trying to save a few bucks by disintermediating the need for an embedded product, but is instead looking to enhance the experience of that embedded product. But can you maybe weight into the debate here a little bit when it comes to infotainment penetration in more mainstream vehicles and lay out your case as to why, if and indeed it is the case that smartphone proliferation is in fact a driver of embedded infotainment system penetration?

Dinesh C. Paliwal

Ryan, you couldn't be more eloquent, and I certainly would like to take part in this debate. I've been a very strong advocate over the last 4 years, 5 years and without getting any bragging about here, I think we turned out to be true so far. We said the future of P&A was dark, and it is turning out to be true. We said in terms -- that smartphones will create better awareness and better need creation inside the car for embedded experience; we are starting to see that. And we also said in 5 years from today that almost all cars rolling out of the production lines will have either some sort of a integration of smart devices or embedded infotainment system. And my take right now based on a lot of discussion I had with the industry champions in Germany and Asia and here in the United States is 50% embedded infotainment and 50% would be remaining cars, 50% of them will have some level of smartphone integration. Now let's define what that is. Smartphone integration can be as simple as having your phone in the car without you touching it, whether it's in your purse, or it's in your coat pocket, and you can make hands-free telephone. That's the number one thing. We are already doing it. In fact, we were the first one to launch that in BMW and other cars. Second would be your playlist, your address book, you should be able to do that. And a few other things which will be available. Now let's remind our listeners, car is a sacred place, which is absolutely for safety reasons will not be opened up to just about anybody. That's where HARMAN has carved out its niche. We get it. We understand the ecosystem. We understand the safety requirements. We have a record of rolling out systems. Therefore, when you talk about 100 or so live sensors in the car, when you talk about 6 to 8 subsystems in the car, we have the bus, which will interact with all the subsystems. We manipulate the license, the data. We do a lot of algorithms. We use cloud-based information, and we do a hell of a lot more in real time. So that is an experience. If price was not a prohibitive thing, everybody would like to have embedded infotainment in the car. Nobody would choose. Now the reality is somewhere in between. Not everybody can afford it, number one. Two, cost have yet to come down, and we are going to drive that, too. We started that with scalable platform. We brought it down by 1/2, and we're going to continue to do that. And we're going to help smartphone companies to do better integration and also share with them the knowledge of what should be the car-centric apps and how to write them. We will take the lead. We are doing it with BMW and Audi and Chrysler and Toyota. So I think this is a journey with which has begun, and it's actually a win-win for both. I've said that because car phones -- I'm a car phone user. Whether I have a car, rental car or a friend's car, I like to have a basic integration all the time. Yet, I don't want to be dealing with my phone while I'm driving. I want to have access to everything, whether it's the car diagnostics, whether my peer-to-peer communication, whether it's the connection to the cloud-based -- all the content out there. So my take and my advocacy has been very strong on that. We are at the cusp of major breakout in embedded infotainment journey. We are right now as an industry only 20% penetration. And we are looking at 50% or so penetration the next 5 years. Imagine the CAGR ahead of us. If we do it right, embed good technology, drive the cost down, and be there where customers are, not just be in 1 country and try to serve the whole world like some of the Japanese players have tried to do. We are doing all of those. Then, I think the future is fantastic for us. And so is for smartphone. That's my take, Ryan. I know I maybe gave a little long answer. But I'm very passionate about it, and I've been watching and learning this space quite well.

Ryan Brinkman - JP Morgan Chase & Co, Research Division

No, absolutely. I definitely appreciate that very thorough response. So my last question then is just, how would you paint the progress in customer product engineering cost recoveries during the quarter? To what extent does this simply reflect the stronger performance? To what extent does it just simply reflect a certain typical lumpiness here or is it instead maybe indicative of stronger execution via initiatives on your end to better recover those costs?

Dinesh C. Paliwal

Great. Ryan. You might have heard Herbert and I on the roadshow as well as in the calls that the business, the company we inherited was running a very different business model, that we expensed $60 million, $70 million, even $100 million on a large complex cost of development and then wait for unit prices to recover our cost. That's not acceptable to us. Certainly not. So we tried to change the culture. You don't change on the existing contract, but you can definitely do for the new contracts or do some sort of a hybrid agreement with your customers that, "Hey guys, I'm not going to wait for me to recover from the lifecycle. You got to start paying me on a regular basis." So that culture is starting to get hold. And we got recovery the quarter before. We got good recovery now, and we're going to continue to expect recovery to come in every quarter. And by the way, this is combined with change orders. We're getting a lot of change orders. And change order business, as we all know, is highly profitable. And you don't have to wait for 5 years to get recover. You do a change order, you get paid. So combined with recovery of past engineering we have incurred, we are recovering now, plus we're doing change orders. This will allow us to also take lumpiness or volatility away. But we're not there yet, Ryan. I want to caution us. We are pushing. We are winning. But this is a culture change, externally as well as internally. But I think you can count on one thing. I come from a culture where I always got engineering work done before and get paid before -- my former company, and that's where we're going.

Operator

Our next question comes from the line of David Lim with Wells Fargo Securities.

David H. Lim - Wells Fargo Securities, LLC, Research Division

So I have a question on neo cost in your third quarter. Can you sort of quantify that and will we see a tailwind in F Q4 as well?

Herbert K. Parker

This is Herbert. I'll take that question. The neo cost, what we had last year, as you know, we spoke last year and indicated that neo would not be an issue this year. But what we had for the Lifestyle Division was $3.5 million in the third quarter of 2012.

Dinesh C. Paliwal

So if you put things in perspective, David, last year, we had a gross impact of $78 million of neo and net was $24 million, which means we did a hell of a good job in terms of offsetting it or charging it back to our customers. So out of that $24 million net, we also promised you, you all, the investor community that you're not going to hear neo discussion in '13, and you're not going to hear and then you ask. And you're asking, it's actually minimal impact. The market has come down, the prices of neo has come down and our engineering and R&D team have done a good job in finding substitute and designing the products so that they are more efficient with less use of neo. So I think it's a nonissue for us.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Okay, so then I guess the question that I have is on next quarter, will we see a degree of a tailwind given that neo prices have come down on a year-over-year basis, will we realize in -- for your next quarter?

Dinesh C. Paliwal

As I said, we're not going to call out this particular item because we're not going to see exponential change from this quarter to next quarter. Prices have come down, but they're still pretty high compared to what they were 3 years ago. They shot up like 1,100%. So they've come down. They're still 500% high. So either we have designed it out or we have efficient design or we have done pricing agreement with our customers that we pass it through, so we don't allow this to affect us. So I would not say that Q4 would have any significance related to neo, David, if I may.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Got you. And then just to clarify a point, when you said 50% embedded infotainment and 50% on smartphone integration, those are 2 unique products. Did I understand you correctly on that?

Dinesh C. Paliwal

They are 2 unique, yet there's a lot of sort of gray area in between because you walk in a phone with any smart device. You're going to be actually using some feature functionality from the embedded infotainment if you want to have the really tight integration of smartphones in the car. If you have nothing in your car, then you will be restricted to some basic integration capability. So they are unique, yet there'll be some cooperation like I gave you an example of Siri, but there will be few more like that. But yes, there are too independent, and the way I see it, most of the people will have both. They will have embedded and they will have a smartphone of some degree. Mind it, we should also remind ourselves, a smartphone change every 9 months and embedded system you're putting in, we are designing it for the life of the car. And our challenge is to keep the software current and hardware should be so modular that you can swap out a chipset very easily at the dealer shop. You can't do that if you're going to rely on a smartphone for your complete connectivity in the car. And mind it, I heard someone was asking me earlier that somebody in China, a European automaker, has designed a cradle for iPhone 5. I say, well, thank you, that's a good thing. But you know what, you're not going to be selling cars just for iPhone 5. You're going to be selling it for 5, 6, 8 different smart devices. So we have to be careful that we are designing car together with automakers for 7, 9, 10 years, not for 9 months.

David H. Lim - Wells Fargo Securities, LLC, Research Division

So I just want to clarify, so the infotainment take rate, you see a ceiling on that at 50%. I'm assuming that the content on infotainment -- embedded infotainment is definitely higher in the smartphone integration. Would you term that as correct?

Dinesh C. Paliwal

Absolutely, correct. Absolutely. It's a exponential difference without a doubt here.

Operator

Our next question comes from the line of Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley, Research Division

First, a couple of follow-ups. On the customer engineering cost recoveries, can you quantify that for us? And also, how much it was compared to what a typical run rate would have been for this quarter?

Dinesh C. Paliwal

Well, it's in the low teens. I don't have the breakdown how much was that in our change orders, which is a continuation thing every quarter and how much was recovery. And by the way, Ravi, as I mentioned, our guys are not allowed to bring home some recovery and then they declare victory and stop. They constantly will be bringing home recovery from the previous jobs where we did not have upfront engineering reimbursement. So you should expect us to have some sort of a recovery in every quarter going forward.

Ravi Shanker - Morgan Stanley, Research Division

Okay. And I thought from your previous comment it sounded like this is a recovery that you would have traditionally got through the contract over time, but now you're getting it upfront. So does that mean it doesn't come through the contract, and it probably hurts margins in the future? Or is that not the right way of thinking about it?

Dinesh C. Paliwal

No, it does not hurt the margins in the future. As I also mentioned, it's both because we always have in the contract that so much they will do on milestone basis later in the product lifecycle and some will come through units. So unit prices are fixed for the life. I'll make it clear. So unit prices are never going to change. What we agree, we agree for the lifecycle. Plus the change order, software change orders is a new thing for our company. We never did it. And now, we're starting to do and getting paid, and that is going to be our push starting July 1 as separate business, which will have the full focus life on the asset base driven general manager, who will run P&L and drive change orders so that will bring a lot more engineering recovery on a quarterly basis.

Ravi Shanker - Morgan Stanley, Research Division

Got it. Can you remind us what Martin added to -- number this quarter and also for you full year guidance.

Dinesh C. Paliwal

Well, for your models, if you want to take it. I don't want to peel it up because this is a continuation, it's not a one-off. If it was one-off, I'll call it out. But if you want to use some number, it's a low teens.

Ravi Shanker - Morgan Stanley, Research Division

Low-teen dollar EBIT?

Dinesh C. Paliwal

Low-teen in dollar amount of recovery, yes. And you can also do the same on a like-to-like basis, yes.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And Martin wasn't in any of your previous guidance?

Herbert K. Parker

It was.

Dinesh C. Paliwal

Yes, of course, as I said, even what we have just guided for the full year, we have also included -- we will never call out separately how much recovery we will get.

Ravi Shanker - Morgan Stanley, Research Division

Got it. Also, your Lifestyle margin was pretty impressive. If you just look at the sequential walk there, was it all neo or what else was driving that improvement?

Dinesh C. Paliwal

It's not so must neo. It's the mix. Mix means not only car audio. Car audio always generated good profit and it still is. Where we used to have dilution, and we suffered from that last year and the year before, is our home and multimedia. Home and multimedia in our company, if you look back 5, 10 years, it has either been a loss maker or it has turned in at best low-single-digit margin. Now under the Lifestyle leadership, Sachin has done some incredible things in terms of product design and also product architecture changes. And we are now getting operating margin for the first 9 months of this year. We are at 8% level, just in home and multimedia, which is a record high. So that's what is helping margin improvement as the mix has changed, and you should continue to see that. It's not going to be a radical improvement, but even 50 basis points, 100 basis point year-over-year, that will be a great thing because nobody in the space makes money. Look at Bang & Olufsen, it's a loss company. Look at Sony, look at Denon, look at others. So it's us and Bose who are able to because we have a unique brand and unique design. So that's what it is. And going forward, since you asked that question, Ravi, we are also doing scalable audio approach just like infotainment. That way, we are bringing modularity and also pay-for-performance pricing scheme. So we will have a higher penetration and higher volume, and that will also improve our margin because car audio traditionally getting higher margin.

Operator

Our next question comes from the line of Chris Ceraso with Crédit Suisse.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

I was hoping we could spend a couple of minutes on the backlog just revisiting some of the underlying assumptions that support the numbers. So maybe just to start with the $16 billion. Can you just remind us how much of that is replacement of existing contracts? I have a number of 75% in my mind. So let's revisit that. And roughly the timeline over which the stuff comes on board, does it run roughly through the end of the decade? And then how much of that do you think will come on in 2014? And what portion of that represents scalable business?

Herbert K. Parker

Hello, Chris. This is Herbert. Let's start off with the part about scalable for '14.

Dinesh C. Paliwal

First of all, let's look at Slide #5 in your deck.

Herbert K. Parker

Yes, if you go to 5, you'll see where we had the scalable together with the higher-margin custom business. We're expecting close to 50%; what we have is 49% in the chart. So we're expecting that much up to be from the scalable and what we call the high-margin business defined as 9% to 11% EBIT. That is the plan for our fiscal year '14. So I think if you look at that Slide 5, it would give you the answer to the other information as you can see how much is replaceable versus the existing business -- versus new business.

Dinesh C. Paliwal

In replacement.

Herbert K. Parker

Replacement versus existing.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And then roughly the portion of the backlog that comes on in '14?

Herbert K. Parker

Yes, the portion of backlog that comes in '14 is roughly 50%, is in the scalable and higher-margin business.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

No, I'm sorry, in dollar terms, how much of the $16 billion is going to come on in 2014?

Herbert K. Parker

That, I just gave you the percentage of, Chris, because if I give you the volume, then I'm giving you guidance for '14. We will be happy to give you that when we have our year-end results in August.

Dinesh C. Paliwal

But I think it's safe to say, because we have said that before, that about half of our infotainment backlog is in infotainment, in scalable infotainment. So that -- if that's what you're looking, I will reinforce that. So half of our infotainment backlog is in high-margin, next-generation on scalable platform. That's the information you already have, Chris, on fiscal '14, where yellow bar is 51% and 49% is green. Green is the rich high-margin scalable plus high-margin custom.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. I guess I was trying to get to -- of the, let's call it, $4 billion of net new business that comes on between now and the end of the decade. How much of that shows up in '14?

Herbert K. Parker

Yes, just the question, I know, Chris, you've asked that before in several ways. Again, that will be just giving you guidance. So let's just -- if you can hold off to August, we'll give you that number.

Dinesh C. Paliwal

Well, Chris, if it helps, you know that when we win a job, whether it's a scalable or custom, it's about 2.5, 3 years from the day we win the job it converts into the revenues. Then you can also do the math because we have been pretty transparent when we book a business, we announce it, we announced 2 years ago the VW order. That was $1.6 billion scalable. We announced $1.2 billion Fiat/Chrysler business. That was scalable. We announced Toyota. That was scalable. So from the timing, the converting when we had SOP, they were all. So that's how we flow it in our revenue stream. I mean, we have all the granularity how we run it. We run it by cost per BUs. We run it by platform, by country. But from the disclosure point of view, if we go to that detail, I think that would be a bit confusing for us. So I think we'll leave it there.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And then maybe just on the same topic. Let's take one of these programs, for example, the $1.6 billion with VW or the $1.2 billion with Fiat, is there some underlying assumption that you and the customer have made about the take rates in the marketplace for the infotainment system and can you share with us what those assumptions are?

Dinesh C. Paliwal

I don't have in front of me by customer, but I can tell you in a broad framework. When we negotiate a job, we are negotiating a price per unit, first of all, and customer will make their best assessment what would be the take rate and what models they will be deploying this system. And based on that, they calculate number of units, and they tell us, and we multiply with them number of units times the unit price, and that makes the total award size. That's very clear. Now on an average, infotainment penetration for us is about 20%, 25%, and that varies. BMW 7 Series has 96%. Mercedes S-Class 96%, 97%, 100%. And then you go into the mid segment, they are lower. SUVs are very high. Entry cars are close to 0, and then geographically it varies. So we have all the data, but the data comes from customer, and we revise that data on an annual basis because we get update from them quarterly, but we upgrade -- update our data of backlog, that is, the number of unit changed for the remaining lifecycle of a program which we are already running. And I'll give you another good example of that. When we started Audi MIB, Audi was for a price for the number of units and then actually shot up so much, like almost 30% higher than they originally booked for. And we expect the same thing for BMW and same thing we expect for VW. And by the way, we are getting similar indications from Chrysler and Fiat that they will have much better penetration than they originally planned for. So we do not reflect that upside in our backlog until we hear from customer on an annual basis and will not reflect that for future years. We'll only reflect for the next year. Otherwise, we are taking risk, which we don't want to. Mind it, we have to negotiate our sourcing for $2 billion, $2.5 billion for long term. We have to be pretty precise what numbers we tell them. If we tell them a larger number, and we don't have the same numbers delivered, then we have a problem with our suppliers. So this is pretty complex thing, but we have been very good at it over the years, and I don't see that practice changing.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

So then just to clarify, the $16 billion, you've assumed on average then the 20% to 25% that you're currently experiencing? So there's room for that to grow higher if actual penetration rates are higher than that?

Dinesh C. Paliwal

Chris, you're absolutely right. And I have actually said that on my roadshow. Imagine if we had same backlog, $16 billion, and a penetration -- by the way, $16 billion includes car audio and infotainment. So if penetration goes up, just double it. Then your backlog is $16 billion x 2, $32 billion. That's exactly how it would be. And our profitability further improves because we're not increasing the cost base because we have the structured, what have you. But the answer is yes, based on penetration, this will change.

Operator

Our next question comes from the line of David Leiker with Baird.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Herbert, if I can get a couple of numbers from you first, R&D for the whole company in the quarter?

Herbert K. Parker

Okay. $63 million was the total for the company.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

And that includes the $15 million or so in reimbursement?

Herbert K. Parker

Infotainment was $39 million. Lifestyle, $14 million; Professional is $8 million. So that is a net number.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

That is a net number. And your normal reimbursement quarterly rate, is there any ballpark there, what that normally would run?

Herbert K. Parker

Several years ago, they were around 20% of the gross and then we were up to around 30%. Now we have been running around 40% the last few quarters. So we believe it's all going for the culture, but of course, there will be some volatility from quarter-to-quarter. But for modeling purposes, we've previously said that we were targeting 8% R&D on engineering on a company level. Now we believe we're going to be close to the 7% going forward in the next year. And on infotainment, we've been running around 9%, 9.5%. We believe that will be closer to 8% to 8.5%.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. So if we look at this $15 million in customer cost recoveries, if you normalize that, is it a $10 million number? Or what will that be if you didn't have...

Herbert K. Parker

David, I wouldn't look it that way because as Dinesh mentioned earlier, we have customer reimbursement, we have change orders. I think you more or less look at it as net engineering number going forward based on those percentages I gave you.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Because I think some people might look of that and take it out of the number as being unusual, but I think [indiscernible] is the normal run rate.

Dinesh C. Paliwal

David, that would be a mistake. That would be a mistake. I would not do it because this is an ongoing process. As I said, it's a culture. And I would expect from my divisions, particularly infotainment, to deliver that kind of a performance recovery on a quarterly basis. I won't mind if one quarter is $5 million and another quarter is $20 million or $15 million. But on an average, I would expect a decent recovery every quarter. And that expectation has been verified with my division president. So it's not one-off. It's a continuation.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Great. And then Herbert, in the gross profit, you talked about some warranty expense there. Can you talk about what that was, if it's unusual or what kind of magnitude there?

Herbert K. Parker

It wasn't really unusual. I think the main point is that we had a good quarter in the prior year, where the warranty was significantly lower than other quarters.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then one more number question here. If we look at your European business, is there a way that you could tell us what your revenue in Europe declined in the quarter in total?

Herbert K. Parker

I'd have to get that one for you, David. We normally don't run it that way, but I will certainly come back to you and get that one to see if there was a decline in Europe.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

And then one last item here then. If we look at scalable contract, you've been in production now with Toyota, 12, 13 months or something like that, where -- and then Chrysler here more recently. And if you look at the scalable products coming off your line, how would you say the profitability of those launches are relative to where you would have expected them to be at this time?

Dinesh C. Paliwal

It has exceeded our plan numbers.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

So where you thought before that, it was 9% or 10%, you think you're running at a pace higher than that?

Dinesh C. Paliwal

That is correct.

Operator

Our next question comes from the line of Brian Johnson with Barclays.

Brian Arthur Johnson - Barclays Capital, Research Division

Could you give us either a sequential in Lifestyle -- a sequential walk on the EBIT just in terms of, in particular, how much was driven out of the JBL Flip and the other home and Lifestyle products and how much came from the automotive sector?

Dinesh C. Paliwal

Brian, this is Dinesh. I don't think we ever gave out on a product or category basis any profitability numbers. But I think I gave you quite a bit of detail by saying, on a full year basis, I expect our home and multimedia business to be close to $600 million. And that year-to-date, we're running at 8% profitability. And I'm very pleased with it. So you can do your math out of Lifestyle. If you take out $600 million, this is 8%. The remaining is car audio. So that's the breakdown. We used to have consumer division separately, but now we run it is one because there's a lot of sort of synergy of R&D. But at some point in time, we will consider it, once home and multimedia business becomes close to $1 billion, we'll probably start giving that separate financials, too.

Brian Arthur Johnson - Barclays Capital, Research Division

Okay, and on the Infotainment Division, if you just took -- you were down 8% in terms of revenue. Europe was down 8-ish percent in terms of production, but then back to the discussion we were having earlier with the prior caller around the backlog, it would seem that if you took a few years ago incremental backlog divided by 7 and divided by 4, you should have seen some growth over and above global production in the quarter. And of course, you had the U.S. production up, Asia production up. So kind of, what were the real drivers there? Does it have to do with take rate? Does it have to do with additional price down pressures perhaps as these infotainment units become standard equipment? Or is it just specific program timing, e.g., the Mercedes launches?

Dinesh C. Paliwal

I'll let Herbert answer that, but let me make it very clear. There is no price down pressure. I said earlier and I repeat, once we have locked in price for the lifetime, we do not change price, unlike smartphones or P&D devices because they are commodities. Embedded infotainment is not a commodity, and it's a fixed price business for the life of it. We can talk about how much size in North America went up and what happened in Europe and what happened in terms of content or de-contenting, or what have you. Europe has and continues to play a big role for HARMAN. And Europe was down sequentially 12% and is expected, according to J.D. Power, another 10% drop in Q4, fiscal Q4 for us. And now they have also come out with Q1 of fiscal '14, another 10%. So that's the reality. I mean Dr. Martin Winterkorn, the Chairman and CEO of VW Group, yesterday said that this is an industry-wide problem, not anywhere near future we're going to get out of it. I had expected in January, by mid of this calendar year Europe would be bottling out and hopefully will start to pick up. Now I feel, based on what I've heard and listened, that we are in it for another couple of quarters and a recovery is not likely to happen until fourth calendar quarter in '13. And then North America, yes, North America had a great sales, and we have benefited from that when it comes to Audi, VW and BMW. But when it comes to a lot of Japanese selling a lot of cars, with the exception of Toyota, we don't benefit from that. A lot of Ford and GM cars, we don't benefit from that because we are not supplying much to them. Chrysler, yes, we benefit. So all in all, like anybody, we saw the numbers, what they are turning out to be. And we would like to see some improvement, and we are hoping that we will see later part of the calendar year. Anything else you want to add?

Herbert K. Parker

I'll just add to that. Sequentially, we did improve in our Infotainment Division. We grew 5%. So we're seeing good development in that area.

Operator

Our next question comes from the line of Matt Stover with Oppenheimer Funds.

Matthew T. Stover - Guggenheim Securities, LLC, Research Division

I'm sorry to beat a dead horse, I'd kind of want to go back to this engineering recoveries because I'm just trying to put some -- the number in perspective as we think about it going forward. If I look at the R&D as a percent of sales for the company, you registered about 5.9%, which would be the lowest quarter on record and below the trailing 4 quarter average of about 7.5% of sales. And if I think about the growth opportunities that are represented in your backlog, I'm trying to think about how I should think about that number. Are you telling me that that level of R&D as a percentage of sales is, in fact, durable? Or how should we think about that? And I have a follow-on question.

Dinesh C. Paliwal

Let me start, and then Herbert can jump in. As we said, for infotainment, about 8.5% is what we have given you to model. And for company, 7% is the number. And it might even go below 7% because we're going to do a lot of work out of best-cost countries, and we are doing it. Having said that, I would not pay much attention on a quarterly R&D percent or engineering percent because that number what we give you, as you know already, Matt, that is a combination of pure R&D and engineering, product engineering. So our R&D is not changing. Our R&Ds continue to be spent where we need to. It's the project is engineering cost recovery that you get, and I wish we could convince all the customers to pay us on a weekly, monthly basis on a regular stream that would be much better for us to present to you and for you to understand, but it is lumpy. And hopefully, once we have a good sort of a culture for the new products where we say, "Listen, guys, if it's going to cost $50 million to develop your program, we want it on a cost to completion basis or some sort of a milestone. Before we even start shipping you product, we'll recover all engineering." So we're not there yet. So we are still clearing some of the old backlog and some may continue with the old way of doing it, but we will continue to get recovery. So only thing I can reemphasize is, every quarter will not be that low. If that was the case, that means everybody would be paying us the next 4 or 5 quarters, and that will not happen.

Matthew T. Stover - Guggenheim Securities, LLC, Research Division

So we should assume that the variance basically from, say, 7%, 8-ish percent to 5.9% is the lumpiness of these recoveries?

Dinesh C. Paliwal

That is correct, Matt.

Matthew T. Stover - Guggenheim Securities, LLC, Research Division

Which sure describes to the low teens, okay. The second question then sort of gets to how we should think about that going forward, Dinesh, because you've taken the charges to sort of re-footprint ER&D, which is going to give you ER&D productivity going forward, and I imagine you're doing some things just at the corporate level to shave SG&A. But how should we think about that level going forward? Are we sort of -- is kind of the 20%-ish a reasonable level as a percent of sales? Or is there a possibility for that to go below?

Dinesh C. Paliwal

This is one area where I am going to be very focused because that is one thing we can control. And you can count on one thing that we're going to drive entire G&A like enemy. We attack that. Sales and marketing, I will not. I would like sales and marketing to go do their thing. In fact, I'm sitting here next to me a wonderful professional, chief marketing officer, who brings some 16 years of Pepsi marketing experience and then he was the head of marketing for Samsung America so we're going to have him do his magic and get us to the higher penetration level. So marketing and sales, expect high. G&A to be driven down, R&D to be driven down, engineering cost to be driven down. The number you should expect is in the high-teens. That's where we are targeting ourselves. And I'll give you some more color. Although this is not American company style, I mean European companies, the CEOs are giving 10-year outlook. The world will look very different in 10 years. But I can tell you in 5 years, our footprint is going to look very different because we are on a journey. We have done a lot. We started from 100% engineering and R&D done in high-cost country. Today, we have 40% of our workforce sitting outside of high cost. We started with 87% blue-collar manufacturing workforce in high-cost country. Today, only 45% of those people are in high-cost country. But this is nowhere close to where it should be. Look at the well-run companies, Emerson Electric or GE or ABB or Siemens or many others. That's experience I bring, and we're going to do it. So therefore, count on, in 5 years time where our growth as we grow, that growth of employee base will not be in high-cost countries. We're going to grow that base in Hungary, in Brazil, in China, in Russia, in India. So let's say from 13,000 today we go to 16,000. So we're adding another 3,000. The majority of that workforce will come outside of high-cost country. Therefore, a lot of engineering, a lot of manufacturing would come in this backlog from the lower cost base than it is today. When we booked it, we booked it based on the cost we had. So we have a lot of opportunities to improve. Roughly around $150 million to $200 million, which is, I would say, almost $3, $3 of EPS could come in next 5 years just from some of the actions we are working on footprint further in next 5 years.

Operator

Our next question comes from the line of Adam Brooks with Sidoti & Company.

Adam Brooks - Sidoti & Company, LLC

Just 2 quick ones here. You've had another quarter under your belt with Infotainment Services. Does that $500 million target in 5 years still hold? Can it get higher than that? And just maybe, just a little more update as far as what you're seeing, what's getting you excited there?

Dinesh C. Paliwal

Well, I wish I could say that changed, but no, not yet. Still very ambitious target. I say that. To go $500 million from about $100 million today we have is fivefold improvement. And we sort of getting used to making such decisions. We did that 4 years ago for emerging markets, and we are well underway. People didn't believe us at that time. So now $500 million for us is an achievable target. We're going to drive it. So $500 million business, the clock start ticking on July 1. Right now, we don't even run to service business as a separate P&L. Right now, it's all part of our systems activity. So July 1, there'll be a general manager who will be called Strategic Business Unit Manager Global, and he or she will be driving this business. And I will have reviews on a monthly basis of that business going forward. And the companies like iOnRoad and a lot of other things we are doing -- and by the way, the business is shifting, Adam, as you know well from good old hardware 75% to software. So you will watch what would unfold in coming months or quarters that some of the orders we might be getting, they will be more driven towards -- that we will make it a reference design hardware for you, but we're going to sell you software, and we're going to license you software. I think we are driving that way more and more. And that's what our R&D and our division presidents are tasked with.

Adam Brooks - Sidoti & Company, LLC

And just can you give us an update maybe on your thoughts on buybacks, given that you still are fairly underlevered?

Herbert K. Parker

Adam, that is certainly an area we are looking at keenly. And as you know, we do still have $70 million left on that, and we evaluate that with the board. And of course, we look at acquisitions as well. As you know, we just made the Martin acquisition that we're quite happy about. But I can only tell you that buyback is a big part of our strategic options that we will be looking at going forward. Obviously, I can't give you exactly what we would do, but we will announce it if we make a plan to do more.

Operator

Our next question is a follow up question from the line of David Leiker with Baird.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Just 2 additional things. Dinesh, at the Consumer Electronics Show, you had shown your next-generation premium system, your next-generation scalable and then the initial connected radio. Where are you today in booking orders for those 3 particular technologies?

Dinesh C. Paliwal

David, we are well underway. There are some discussions in fairly advanced stages with customers in all 3 major regions right here at home, in the United States, as well as in Europe and Asia. And I sure hope that in the next couple of quarters, we will have some news to share.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then the last item, I know you're going to give guidance 3 months from now. But we're 2 months away from your fiscal year starting. Is there a way we could -- you could help us frame some of those things in '14 that will be plus or minus versus '13? One of them being restructuring, these Audi volume losses that we had in the December quarter. Is there any color or help you can give us as we start to look at what '14 is going to look like?

Dinesh C. Paliwal

Sure. There are 3 things come to mind, which I can share without giving any guidance because we're not ready yet. By the way, if we had a number, I would have told you. So just for everybody's sake, this is actually a time when we are going through a process and collecting a lot of data from external sources, as well as from customers, account managers, and we have started to analyze it. In fact, we don't take our budget to our board until end of June. So I just don't have. But what I can do, I can give you a little guidance in the drivers. First of all is restructuring. We said that we are so brutal about meeting this deadline of 500 people out by June 30 because I want to book $30 million to $35 million of savings in fiscal '14, so that's one change. Mix of system business will change. Scalable will go up from 46% to 49%. That will change the margin mix. And the third, service business, although I have to be realistic that whoever is going to run this business for us that we don't kill this person by giving some unrealistic target in the first year. Because first year, he or she will be organizing, but we definitely will have better service revenue and better margin. And if everything works out as we all expect, if Europe start to get their act together, second half of '14 would be better than what we are in right now. That would help. China, and also I expect China to be performing better than China has performed as of 3 quarters this year. So those are the things we see. And then last but very important, we bought Martin light in Denmark. Right now, we're in integration phase. So '14, I expect Martin to also add to the EPS line a little bit. And definitely, because this business we bought based on clear promise that they're a world leader, and they're going to get to the pro level of profitability in few years time. So we're going to have that, too. So add it together, the 5 things I said: restructuring, scalable system mix, service, improvement in Europe and fifth was lighting business to be accretive to pro business.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

And then just one follow up on that. If we look at that restructuring savings of $30 million to $35 million, I think it's right around $0.30 to $0.35 a share. Is that something you expect to fall directly to the bottom line or is that designed to offset other cost in the business that the full amount doesn't really gets seen in EPS?

Dinesh C. Paliwal

Okay, let's make it clear first. That saving is permanent. That saving will be falling on the bottom line. However, there are other cost drivers, which will come and go. This is similar to what we did in STEP Change, that $450 million permanent savings are at the bottom line. Now there are things like annual price reductions. There are things like a big marketing expense that we want to put -- not that I'm approving any, but those are the kind of things -- unless, say, we decide to go in South Asia market, Indonesia, a lot of other things. We don't know what inflation would look like. So stuff like that we don't control. Those could be the cost drivers, David, but what we can be sure of, that you're going expect us to drop $30 million to $35 million to the bottom line.

Operator

Ladies and gentlemen, this concludes our Q&A session today. I would now like to turn the call back over to our presenters.

Dinesh C. Paliwal

Well, first of all, let me just say this was a very, very fruitful, very engaging session. Thank you for your time, and thank you for your interest. To all our owners who are listening and our analyst community, who does a great job in reading this industry and making sense out of every company.

In closing, I'll simply say we have 60 days left in our fiscal year, and I think we got a lot to do. We have given you EPS guidance, which is higher than last year, and last year was a fantastic year for HARMAN. So the $3 will beat last year's $2.93. We will work it out for that, so we're going to go to work, and we have a marketing leader now in place as he is going to start to help us in other areas. And that's about it. I think we want to start 2014 on sort of hit the ground running so we don't wait for anything, and we have a lot going on here.

So thank you again for your interest, and I remain very excited about our prospects in the future, and I think we are doing lots of right things here, and we're listening to all of you. With that, thanks again. Have a great day.

Operator

Ladies and gentlemen, this does conclude the conference for today. We thank you for your participation and ask that you please disconnect your lines.

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