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Harman International Industries, Incorporated (NYSE:HAR)

Q2 2014 Earnings Call

January 30, 2014 11:00 am ET

Executives

Sandra Rowland - Vice President of Investor Relations

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

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

Analysts

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Brian Arthur Johnson - Barclays Capital, Research Division

Ravi Shanker - Morgan Stanley, Research Division

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

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

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the HARMAN Fiscal 2014 Second Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded Thursday, January 30, 2014. I would now like to turn the conference over to Sandra Rowland, Vice President, Corporate Development and Investor Relations. Please go ahead, ma'am.

Sandra Rowland

Thank you. Good morning, and thank you for joining our Second Quarter Fiscal Year 2014 Investor 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.

Before Dinesh and Herbert provide their remarks on the quarter, let me remind you that certain statements during this conference call and question-and-answer session may be forward-looking in nature, as defined in the United States Private Securities Litigation Reform Act. These forward-looking statements are based on management's beliefs, assumptions and current expectations, and are subject to a number of important risk factors and uncertainties, which are fully described in the press release that we issued this morning. 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 the supporting slide presentation that we'll be referencing today.

Now let me turn the call over to Dinesh.

Dinesh C. Paliwal

Thank you, Sandy, and good morning, ladies and gentlemen. I'm extremely pleased to report that earlier this morning, we issued very strong second quarter results. Revenues in the quarter were $1,328,000,000. That's an increase of 26% as all 3 of our divisions once again reported double-digit growth. Our performance on the top line resulted in a strong bottom line as we finished the quarter with $139 million in EBITDA. That's an improvement of 61%. And earnings per share of $1.09, that's 85% improvement from the prior year.

The economic climate, particularly in the automotive sector, has improved compared to our expectations. More importantly, demand for a connected car is becoming more of a mainstream. And as a result, we have experienced higher take rates of our infotainment and car audio systems. We expect this positive development in the market to continue for the remainder of fiscal '14.

Therefore, we are increasing our outlook for the remainder of the year. We are now projecting that we will finish our current fiscal year 2014 with revenues of approximately $5.1 billion, which represents a growth of 19% compared to the prior year, and earnings per share of approximately $4.16. That's an improvement of 35% over last year.

Now let me 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.

During the quarter, we secured several new business awards, extended our recent platform launches across car lines and launched our next-generation scalable infotainment platform at Consumer Electronics Show in Las Vegas. We secured new awards close to $700 million in the quarter with new and existing customers, including Volkswagen Group, Changan and Geely. We made a significant breakthrough in Japan and won new business with Suzuki and Yamaha. The Suzuki award will make HARMAN the first non-Asian supplier to deliver an infotainment solution specifically designed for the Japanese market. We're extremely proud to win the trust of this important market and we will continue to look for opportunities to grow our business in Japan.

On top of that, we were awarded new Infotainment Services business from BMW, Jaguar and Land Rover. We will provide infotainment services for installed HARMAN systems. These solutions are designed to future-proof the infotainment systems, which is very important for today's drivers. Our award-winning Uconnect infotainment system, developed for Fiat/Chrysler and introduced last year, continues to expand across car lines and was launched on the Jeep Cherokee, Fiat 500L and Alfa Romeo models during the year or during the quarter.

We are also continuing to innovate and expand our technology leadership. At CES, we announced HARMAN's advanced solution for the connected car with our next-generation scalable infotainment. It addresses market demands for safety, cyber security and rapid application development, which can only be provided through in-car embedded solutions. I repeat, it can only be provided through in-car embedded solutions.

This next-generation platform is based on a proprietary system architecture that offers rapid development of connected car apps and integration of advanced safety features, while protecting the integrity of the system against cyber security threats. The new platform offers an HTML5-based application environment, which paves the way to an app ecosystem in the world of in-car embedded infotainment.

In addition, enhanced security is provided through a hypervisor-based domain separation, securing critical vehicle functions from errant and malicious software, which we all are aware of in our handset, everyday we face that. You can't afford to have sort of a problem in an embedded system, which is where HARMAN differentiates. The response from both current and prospective customers was very positive. This embedded in-car solution provides a foundation to support the future of autonomous driving. And once again, ladies and gentlemen, this is the first in the industry. Similar to what 4 years ago when we launched new scalable platform, this is another new.

Now turning to Lifestyle Division. Some of our recent notable achievements are highlighted on Page 9 of your slide deck. We continue to gain momentum with our award-winning home and multimedia and car audio solutions. During the quarter, we launched car audio systems in several vehicles, including a Lexicon system in Hyundai Genesis and a JBL system in Toyota Highlander. Furthermore, HARMAN secured several new scalable -- I say it because now we took the successful base from our infotainment and we launched our scalable audio solutions in this industry.

And we've got a bunch of awards in a fast-growing small car segment. Hyundai, Changan, Geely, SAIC and all selected -- and many others selected HARMAN scalable audio solutions. What that does actually, if you couldn't afford a high-end car audio system and you still wanted to have the iconic JBL or Harman Kardon or Infinity, now you can afford it because we have given them smaller configuration without compromising the sonic signature of these great, iconic world brands.

I would also like to highlight an order from Daimler for our innovative hands-free MEMS microphones across car lines. As cars become even more connected, voice control becomes increasingly important as a way for drivers to safely interact with in-vehicle systems. The MEMS microphones deliver the advantage of a small form factor and superior audio sensitivity.

Turning to our home and multimedia product line, which continue to delight me, we received 15 Red Star and 8 CES innovation and design awards, bringing the total number of awards to 62 over the past 18 months. This is certainly a record pace for our company. And I bet you and I dare you to check, it's also an industry benchmark.

In November, we launched our new flagship store on Madison Avenue in New York City. The HARMAN store is a customer experience center that transforms how consumers interact with audio products. The store showcases our home and multimedia, professional audio and our professional lighting products, along with our iconic home and car audio brands. Many of you who are based in New York City, please come in and experience first-hand all that HARMAN has to offer.

Along the same lines, we continue to escalate our brand awareness strategy through 360-degree marketing campaigns, including broadcast, print, social media, in-store and consumer promotions. At CES, we relaunched our Infinity brand to great reaction from our automotive customers and retail channel partners. I'm also pleased to mention that we have won our first award with mobile communications distribution partners to sell our award-winning portable audio products into several global markets where we had no access until now. We expect that this order will generate approximately $100 million in incremental revenue in second half of our fiscal year.

Now shifting to technology advancement in Lifestyle. At CES, the company introduced a proprietary software solution called Signal Doctor, I'd like to call it Sound Doctor, which automatically analyzes and improves the audio quality of all types of compressed, digitized and streaming music sources. There's an explosion of streaming. There's one going to be launched this Super Bowl. But they don't solve the problem that bring you a lot of garbage music in your ears. And this solution, which we're bringing, is again first in the industry. The technology leverages HARMAN's expertise in music recording, signal processing and psychoacoustics to restore the full sound that is forfeited in the compression process. Sound Doctor will be launched in a range of home and multimedia and automotive products fairly soon.

As a matter of fact, at CES, we were bombarded by the request from automotive companies how fast can we launch it in the cars where we have audio and in the cars where we have competitors' audio. And we will fulfill that demand. Furthermore, number of third parties have expressed an interest in incorporating this powerful technology as a licensed product, which we will also fulfill. You can imagine, I am very excited, so is my team, about the potential of this innovation. And again, another first for HARMAN.

Now turning to Professional Division, which is highlighted on Page 10 of slide deck. Our Professional Division continued to experience robust demand for its audio and lighting products for use at a wide range of live entertainment events and fixed-venue installations worldwide. You probably all witnessed what happened at GRAMMYs. That was 100% done by HARMAN technology, audio, lighting. And I was there to witness firsthand, and I was very proud of our team, what they did.

This quarter, our audio and lighting solutions were installed all around the globe at prestigious venues including BMW World Customer Center in Germany, King Abdullah Sports Center in Saudi Arabia, Salvador International Airport in Brazil and St. Louis Cardinals and San Diego Padres baseball parks, just to name a few. Our products are featured in numerous high-profile events, including the recent GRAMMYs I just mentioned, Grand Central Station's 100th Anniversary Celebration and the American and Country Music Awards. For the 12th consecutive year, this weekend, our audio and lighting systems will bring you the Super Bowl halftime show again to life.

I'm also extremely proud to report that HARMAN was awarded its third Technical GRAMMY Award. This Technical GRAMMY recognized Lexicon, which is our premier brand, contributions to the art and sciences of music recording and reproduction through innovation and excellence in product design. HARMAN is the only audio company in the world to earn multiple Technical GRAMMY Award. That doesn't surprise you or me. The company's AKG microphone and headphone brand and JBL brand were previously recognized by GRAMMY Recording Academy.

Overall, I'm very pleased with our performance in the quarter and the first half of the year. All 3 of our divisions are ahead of plan and we have improved our top and bottom line outlook for all 3 divisions. Our team is now focused on executing and delivering what we know best on our revised forecast.

Now I would take a little digression. Although my team might not be hearing, I want to give them a very, very deep word of thanks, what they have done. They've been working hard for many years. And finally, their efforts are showing up. My team and my all employees worldwide, they have done an absolutely outstanding job and differentiated HARMAN from anybody else in this industry. We're not there yet where we want to be, but we're well underway.

Now I will turn the call over to my colleague, Herbert Parker, who will give you additional color on our financial results.

Herbert K. Parker

Thank you, Dinesh, and good morning, everyone. Let me walk you through our financial results for the quarter and give you some commentary on our improved outlook for fiscal year 2014. As usual, most of our financial comments are provided on a non-GAAP basis, which basically excludes restructuring costs and other nonrecurring items. The reconciliation of our GAAP to non-GAAP results is included in the press release issued this morning.

This quarter, our revenues were $1,328,000,000, an increase of 26% compared to the prior year or 23% excluding the impact of foreign currency translation. We had double-digit revenue growth in all 3 of our divisions. Revenue in our Infotainment Division was up 28% year-over-year. The increase in sales is due to higher automotive production volumes, recent SOP launches and higher take rates. Revenue in our Lifestyle Division increased by 16% over the prior year and we continue to see strong sales growth in both our home and multimedia product lines and in our car audio business.

The double-digit growth was primarily due to new product introductions and the impact of our marketing initiatives in home and multimedia. The increase in car audio was primarily driven by automotive production volumes and increased take rates. Revenue in our Professional Division was up 45%. The increase is due to the expansion of our product portfolio into lighting, which was enabled by acquisition of Martin last February and due to strong global demand for our audio products.

Our gross margin improved 284 basis points to 28.7%. The improvement was primarily due to the impact of higher sales volume on fixed production cost, reduced cost due to our footprint migration initiatives and favorable product mix. And as we expected, the mix shift within infotainment to our higher-margin scalable solutions is also improving our profitability. Also I'd like to note that although we have increased our marketing investment, our SG&A expense, as a percentage of net sales, is basically in line with the prior year at 20.6%.

Our consolidated operating income on a non-GAAP basis was $108 million compared to $57 million in the prior year, an increase of 90%. Our net income was $76 million in the quarter or $1.96 per share compared to $41 million or $0.59 per share in the prior year, an 85% improvement on both metrics. And I would also like to highlight our cash performance during the quarter as we generated $120 million in cash from operating activities compared to $49 million in the prior year. The improvement is primarily driven by stronger operating results and more effective working capital management.

Okay. Let's turn to our updated forecast for fiscal year 2014. We are increasing our revenue outlook from approximately $4.7 billion to approximately $5.1 billion due to stronger demand in all 3 of our segments. In our Infotainment Division, our increased revenue forecast is primarily due to higher take rates and improved automotive production volumes. In our Lifestyle Division, our marketing investments are driving increased demand of our home and multimedia product lines and higher take rates in car audio. Also as Dinesh alluded to earlier, we have received our first order from a new mobile telecom partner, and we expect to recognize this revenue in the second half of this fiscal year. In our Professional Division, we are increasing our revenue forecast due to stronger demand for our audio and lighting products.

And finally, the euro is stronger than we had anticipated. And it is contributing almost $100 million through our original plan. The improvement in our top line is driving a stronger bottom line also across all 3 of our divisions. We are, however, investing some of these gains into our brand marketing initiatives, which are very important for our long-term growth of our home and multimedia and car audio products. We have assumed a tax rate of 25% and 70 million shares outstanding. Accordingly, we now expect earnings per share of approximately $4.16, an improvement of 35% compared to fiscal year 2013.

Overall, I'm very pleased with the results from the quarter and I am confident that we will deliver on our updated outlook. I thank you for your attention. And Dinesh and I are now ready to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Ryan Brinkman from JPMorgan.

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

My first question pertains to the profitability of scalable infotainment. So for a while now, you've been saying that the December 2013 end quarter would be when you launch a lot of these new higher-margin products. Now you've reported the quarter and there is even more of an improvement in margin than we'd thought. So I'm just curious whether the infotainment margin strength in the quarter was because you just shipped more of these systems, and so we're seeing the same margin benefit that you always expected, hit the book sooner, benefiting like FY '14 margin. Or was, in fact, like the per unit profitability higher-than-expected, such that there are positive ramifications for margin beyond FY '14?

Dinesh C. Paliwal

Ryan, it's a great question. And first of all, I'll answer it in 3 parts. Yes, it is true. We are seeing more of scalable in our revenue mix. So that's helping us. And as we have said, it's a double-digit profitable business so that definitely helps profitability. That's why we are in double-digit now. Second, as take rates are also starting to improve, which is also further validation of automotive and consumers' confidence in, in-car embedded systems, I think that's helping us getting more leverage. And third, we're not sitting idle. Even in scalable, our engineering teams continue to work towards taking cost out, adding more features. And of course, service business is also helping the division infotainment. As we grow that business, it'll improve the margin. So all in all, it's a mix. We are getting rid of lousy, low-margin business, which we inherited, and more and more the business, which we booked ourselves, where there's a custom, which is not high single-digit -- I mean, it's high single-digit but not double-digit, or more of a scalable, which is purely double-digit.

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Okay. That's helpful. Then just maybe one on the pace of new business awards. I guess, you've had about $1.8 billion now, I think, in FY '13 for Infotainment -- or FY '14, I should say. Last year for the whole -- you've got $2 billion this year. I think you had like $1.8 billion for all of last year. Obviously, there's certain lumpiness to it. But how should investors kind of look at this trend? Is there something unusual about the cadence? Or are you, in fact, like on track to double or at least very materially increase your new business this year?

Dinesh C. Paliwal

Well, we obviously don't know how the second half will look like. But we are pleased with the order intake in the first half, exactly what we wanted to win, we won. And we won happily both parties that we got the terms we wanted. And Japan is a new silver lining for us. We almost thought that we were totally shut out, but we never stopped knocking on that door. And we got a break in Suzuki. We got a break in Yamaha. And by the way, by no means, we're sitting quiet. You can count on it because both Sachin and Michael and myself have 2 different meetings. We're going to be in Japan because we see there's a lot of interest from other OEMs, especially they are seeing that HARMAN is the only company who's able to bridge the gap between Silicon Valley and the car companies and bringing whatever Google and Apple had to offer, bring them in an automotive eco-environment with safety security. So I think there's a lot more to come. Lumpiness, we can't control. But I remain positively disposed on the future quarters and years.

Ryan J. Brinkman - JP Morgan Chase & Co, Research Division

Okay. That's great. Just my last question then. You mentioned in the prepared remarks that emerging market sales were up 50% year-over-year, obviously a very strong number. Just so that we're correctly interpreting that, like how does that take into account, for example, if a German -- if you supply infotainment to a German luxury vehicle in Europe and it gets exported to China. Is that developed or emerging? And then just more broadly, there's been some recent increasing concern regarding macro trends in emerging markets. Can you just sort of remind us to which emerging markets you're most exposed, and then maybe provide an outlook on how you see your business there in light of some of the macro trends maybe over the near term?

Dinesh C. Paliwal

Sure. Ryan, 50% obviously is not sustainable, but we'll take it any quarter. That 50%, it includes -- because we always track numbers and we give you by destination, we call it demand-side P&L, or by supply side, where the purchase orders are written. So that 50%, as consistently we have talked all these years, is based on what ends up in BRIC markets, whether it was sold in the United States as a purchase order or in Germany. So if BMW, which just took over, and China became their #1 market, if BMW does well selling more in China, where the purchase orders were written in Germany, that would count China because the destination market. And that also proves the point that we were proactive enough to invest in research and development, engineering, manufacturing in China because as soon as these guys start to book more business, they expect us to ship everything and engineer everything in China. Third point you asked, which is the biggest market? Well, China, by far, the biggest market in BRIC markets. Brazil, to many companies, a disappointment, continues to be a shiny star for us. We have done very well there, whether it is FIFA or even automotive. We have won business there. That was almost a $0.5 billion business, which we will start to ship. In fact, we'll manufacture there. We already have the factory, so we don't have to worry about the CapEx. So all in all, year-to-date, I'll just also give you a number. We are 25% up for the first half in BRIC markets. And this is when India is really struggling. And hopefully, in calendar year second half, India will rebound. China was not so good last year and is starting to come slowly but nothing close to what it was 2 years ago. So I think, all in all, 25% for the first half is a good number. 50% in a quarter is an excellent number. We continue to drive towards -- 2 to 3x GDP is our goal, which will definitely mean continue to take market share away from the competition.

Operator

Our next question comes from Brian Johnson with Barclays.

Brian Arthur Johnson - Barclays Capital, Research Division

A couple of questions. First, kind of housekeeping one. In the infotainment margins this quarter or in audio, were there any kind of one-time or at least seasonally lumpy engineering or coverage or expenses in one way or another we ought to think about?

Herbert K. Parker

It's Herbert here. Actually, no, it's a very clean quarter. I mean, actually, we didn't recover as much engineering as we have in previous quarters. As an example, in infotainment, R&D expense was $61 million for the quarter, compared to only $44 million for the same quarter of last year.

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. So that's up. Second, if we think about the infotainment growth, how much is -- both in the sales and then in sort of your order and backlog, how much is increasing infotainment take rates? And could you maybe give an update on where those are year-over-year and where you see those going through the year in the next couple of years? And how much is consolidation of market share? And maybe to some extent, are the 2 sort of combined, if the take rates are higher on mid- and upper-range systems than on lower systems you're not on?

Dinesh C. Paliwal

Yes. So Brian, it's an excellent question. I'll give you the breakdown. If you see from quarter-over-quarter, we are $150 million up in Infotainment. And I'll break it down for you. So $60 million of that $150 million pretty much came from volume increase. So automakers are doing well, and we are benefiting for that. And then that $40 million came from pretty much the launch we have had, the SOPs. So our launch have done well. And in fact, our launch have gone on more cross-car line models than we anticipated. So that's a growth. Basically, it's a market share gain, we're replacing somebody. And the third piece, which is very important for me, is take rate. So take rate is about $50 million. So $50 million out of $150 million came from take rate. And I'll also give you a little matrix. About $75 million -- 1% take rate increase is about $75 million in revenue. And if you recall, when we guided you guys in August, we sort of said, "2013 was 17% global take rate and we expect 19% take rate to be in '14 and going all the way to 25% in 2016." We are actually -- we feel optimistic now that this year, we should finish 1% higher take rate than we guided you with. And so far, we are almost there. So if that continues, then we obviously, when the time comes a year from now, then we will also have some positive impact for '16. But right now, we're not able to actually diagnose the whole data because we're not even ready yet to see. But all in all, that's the breakdown. 1% take rate increase is $75 million for us. And that number can only increase. As the global production overall is increasing, 1% may mean $100 million in a couple of years' time.

Brian Arthur Johnson - Barclays Capital, Research Division

And as we kind of think about -- following up on Ryan's question on emerging markets, is that strong growth in infotainment, in audio or really in both?

Dinesh C. Paliwal

In both. But actually I wanted to add the fourth element in your first question, which I'll answer now. As you know, Brian, traditionally, HARMAN had a lock on luxury end of the market, and we did very well and we continue to do well, as BMW is expanding, Audi, expanding, Mercedes, Lexus. What we have seen very positive sort of development is mid-segment car, where if you look 5 -- 4, 5 years ago, we had hardly any presence. So the majority of our growth of 26%, what Sachin represented in the business, that came from mid-segment, which means Chrysler has done extremely well. Fiat has done well. VW has done well. And of course, the customers in China. So that's the mid-segment. So that's infotainment. Car audio, we also had very good development in car audio. First time in many years we've seen double-digit growth in car audio. And that's on the back of us getting creative in helping them design beautiful audio products, which will look nice in the car, and also creating a branding architecture. Almost every car company is now using 2 brands. One is the ultra-luxury audio brand and one is the mass car. So BMW, 100% is HARMAN. The high end is Bowers & Wilkins, which is our brand for automotive worldwide, and Harman Kardon for everything else. And third thing I would say for car audio, scalable solution is helping us sell more and penetrate more. And particularly in the emerging markets, we're seeing very good development of car audio and infotainment both. So they may be actually going towards faster rate achieving their goal than perhaps Europe did or even America did. So we'll watch in next 3 to 5 years. But I expect China, India, Brazil, they do very well in penetration, both infotainment and car audio.

Brian Arthur Johnson - Barclays Capital, Research Division

And just, I guess, final question and it kind of revolves around more of the qualitative thing of take rates. What about the argument that take rates should actually be heading down because smartphones can do most anything? A, what are you hearing from your OEMs? And b, I know you do customer search, what do you hear from customers on that issue?

Dinesh C. Paliwal

Well, Brian, first of all, recall our discussion at CES. We both agreed that the smartphone cannot really do almost anything. We wish. And I don't see that happening anywhere in near future, even 5 years. And I want to really give all the credit to Apple and Google or even Samsung and others. In fact, now Lenovo just bought Motorola. That's a good news for HARMAN. Because the more these guys do, more we have an opportunity to bring in that feature functionality in the car environment, integrate that. We are the super integrator. As I said, we are the bridge between -- and what makes me feel very good about, which people have missed, not you, but 1 or 2 you guys don't get it. But I'll tell you why. The consumer product business, particularly handsets, smartphones, the life cycle is 9 months. A car's life cycle is 9 years. Let's get it, number one. Number two, the development cycle for a smartphone is also 9 months or even shorter because I expect the next iPhone to come to me or next Samsung Galaxy 5 to come to me. But car companies will tell you it takes 3 years to develop. And also, I as a car company want to sell you a car, giving you a 100% confidence and guarantee that you own my car for 7, 8, 9 years, it's going to be kept alive. None of the silicon vendors or smartphone vendors can give you that guarantee ever that if you buy my smartphone, I'll keep you upgraded totally for 9 years. So that's our job, guys. And we do that very well. And that's why our order book is swelling and that's why our take rates are going up. So I'm actually more than ever confident that the direction of ours is going to further consolidate the large field of infotainment suppliers because they're not able to keep up with. And that's another reason why Japanese OEMs are turning to us because traditional infotainment players in Japan are not close to Bay Area. They don't understand what goes on. I have an office in Palo Alto for crying out loud. That's an investment we made. And that's where our global head of connectivity sits. And he gathers what goes on in the startups, not just the big boys of Google and Apple. So I think we are very pleased with the direction. And Sachin is leading the pack of this business, he himself is a software guru. And he's been called in by Apple and Google time and again. He spent a lot of personal time understanding what these guys are up to, how do we help them first bring in the car. So I remain very optimistic.

Brian Arthur Johnson - Barclays Capital, Research Division

Okay. That's sort of a description of you as a systems integrator.

Operator

Our next question comes from Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley, Research Division

Dinesh, I just wanted to clarify a couple of things. What was the percentage of scalable system shipments in the quarter?

Dinesh C. Paliwal

I think it's leading around 35%, and it's only growing. I don't think this time we added our chart, which we used have, the breakdown of revenue between scalable and custom. But this year, we're running about 35%. And next year, we expect it to go about 70% actually -- 60%, 70% scalable or high-margin. And then finally, in '16, which is where we have given guidance, 80% of our business would be scalable or a double-digit custom business.

Ravi Shanker - Morgan Stanley, Research Division

Got it. So you're still sticking with those numbers. I mean -- and upward pressure on that is what you're seeing?

Dinesh C. Paliwal

Absolutely because people are demanding more. Especially now, we've just launched, Ravi, the new scalable smart system, which will also bring cyber security and safety features, advanced driver safety features. I think that would allow mid-segment cars to be able to afford our system, which initially was not that easy. So I think we are very much mindful of that. If you buy a smartphone today without a 3-year contract, you have to pay $600. So my goal and Sachin's goal is to keep our fully embedded system right around or below that. That is intuitive. It's a no-brainer what I want. So long you give me full cloud connectivity and upgrade fast and almost give me future-proofing, I would love to have embedded. In addition, I also want to have a smartphone. So my take, Ravi, is as yours. People will actually be going in the direction that you will have multiple devices coming and going out of the car. But one thing will remain constant, that is a fully embedded, live, agile cloud connected system in the car.

Ravi Shanker - Morgan Stanley, Research Division

Got it. Just last question. The pro margin seemed to be a little softer than we expected. Anything in particular going on there? And then what's going to get that to really step up in the second half of the year?

Dinesh C. Paliwal

Sure. As we actually clarified to you on Investor Day in August and October as well, that we just acquired this Martin Lighting company. And it's about $150 million, $160 million annual basis revenue. And Martin, when they came in the group, they had lower margins than our professional audio. So if you did the pro forma at the time when we told you and now, so the weighted average margin has been pulled down a little bit. However, the full synergy has not been recognized. At the same time, if you go back and listen what Blake Augsburger and I actually said, we said in the next -- in 3 years' time, we'll actually bring the total margin to the same level as audio. So with that said, in fact, I'm happy to see the margin development in Martin Lighting is better than the business case presented to me. So I'm pleased with the development. Overall, it's very good business.

Ravi Shanker - Morgan Stanley, Research Division

Great. And then your guidance implies a step-up in pro margins of like 150, 200 bps in back half of the year. Is that seasonality? Is that something to do with synergy? Or what's driving that?

Dinesh C. Paliwal

It's always a combination. Synergies will continue to come another probably 6, 8 months. But lot of new products we just launched last week at the beginning of the NAMM, which is the biggest professional audio show. We launched almost 3, 4 dozen brand-new products in speakers, in sound mixing, in microphones and a bunch of other systems, networking, IDX, as you heard me say, there's a lot of the airports coming to us. So new products always start with high volume and high margin. So high margins will help us. And Q4 from the seasonality, Ravi, is always the strongest quarter for Professional Division. So if you put that all together and also restructuring we did in our professional business last year and first half, we expect to have all of that come in the second half. So put it all together, the math just adds up quite well.

Operator

Our next question comes from David Leiker with Baird.

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

Thanks for running through the upside as it related to the revenue drivers. What about on the margins? How much of that is the volumes coming in better-than-expected as opposed to mix or cost actions?

Dinesh C. Paliwal

Well, if I give you a little color on first half versus second half, first of all, the guidance we've given you, we expect better development of the top line. We finished the first half with $2.5 billion and second half, we are hoping to get $2.6 billion. However, there is more color to it. Infotainment, as you know, third quarter, our fiscal, which is first calendar quarter, we get annual price reductions hits us. So that would drive the margins down, which is nothing new this year. It's always the case. So third quarter will always get the biggest sort of punch. Even with that coming in, we are guiding -- first half EBITDA was 10.9% for infotainment. And now second half would be 10.8%. I think that's quite an achievement in spite of APR coming in because we'll have higher volume leverage coming in and also take rate improvement continuing. So that's infotainment. Then if you look at professional. Professional actually we're showing very good margin development. And that I already answered to you, that new products, restructuring cost savings and also strong fourth quarter every year. So that would help us get from 15.7% EBITDA in first half of professional, going to 18.2%, that's phenomenal, a very good development. Third division, that's Lifestyle. Lifestyle had 14.9% EBITDA, and we are driving down to 13.3%. That's pretty much because of $100 million of this portable speaker business we are booking. And as you know, home and multimedia business carries -- they're almost flirting with the idea of touching 10%, the whole business of home and multimedia, but they're not quite there yet, so it's a high single-digit. However, car audio business is mid-teens. So that second piece so that would have a little bit of a dilutive impact but very accretive for the earnings per share. And the third piece is, as you heard Herbert and you heard me, at CES, I got clear advice from our investors, "Hey, guys, enough of you being engineers, start investing a little bit more in marketing so that you can really let the world know how good HARMAN products are." So we're going to have another $20 million, $25 million incremental invest in marketing in second half. So if you actually add that $25 million in margin adjustment, in fact, Lifestyle Division is raking in pretty good margins and is still being very accretive to the EPS. So all in all, at the HARMAN level, we're holding EBITDA 10.5% first half, 10.5% second half in spite of APR and in spite of multimedia coming in, in spite of extra marketing, so -- and therefore, EPS, first half, is $2.04. Second half, EPS is $2.12. So all in all, I think second half right now is set up to be pretty good, but we still have to deliver.

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

Okay. And then if we look at the first and second quarter in infotainment, the margin performance there, is that coming because the launches are going more smoothly that you're hitting targeted margins higher, more quickly? Or is it because the inherent profitability of that business is proving to be better?

Dinesh C. Paliwal

I think SOPs have gone as expected. Nothing unusual, David, that got better or worse. I think we had our regular challenges when we had SOPs. That's why, typically, our warranty cost is always a little bit higher. It's primarily the leverage that the volume is giving and the scalable becoming bigger part every time. And of course, take rate, I mean, I'm very happy with take rate, too. So this is mainly volume.

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

Okay, great. And then if we look at, Herbert, the R&D numbers. Could you break those out for the balance of the segments and then also the total for us, please?

Herbert K. Parker

Yes. So total $91 million HARMAN this year versus $72 million last year. And for our Infotainment, as I said earlier, $61 million versus $44 million; Lifestyle, $17 million this year, $18 million last year; Professional, $10 million this year, $7 million last year; and the remainder, I think, is $2 million for corporate. $2 million or $3 million is the gap.

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

Okay, great. And then on the contract extension with Volkswagen here. Dinesh, can you talk about what's the scale of that? Does it include the Audi brand? Is it across more vehicles and regions, just any additional color you can offer there?

Dinesh C. Paliwal

Yes. It is actually an Audi brand extension, although we were told by the group that we don't go any further details. You know how it is. So it is extension of Audi brand. So it's not a net new business, it's basically replacement business.

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

And that extends it for 3 years or 6 years?

Dinesh C. Paliwal

It's 4 years.

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

4 years?

Dinesh C. Paliwal

Yes.

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

And then are you picking up vehicles that you didn't have before?

Dinesh C. Paliwal

It's basically the same cars we had before, which is good that they trusted us. But it would have a lot of new feature functionality, which we have launched in our new infotainment.

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

Is that the same system that Audi is launching in the A3 right now? Or is this the next-generation system?

Dinesh C. Paliwal

It is actually next-generation system, not quite what we launched at CES. That's more of a proof-of-concept. But something which is an enhanced scalable system is what they will launch with this extension for Audi.

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

And then the last -- one last comment is on the infotainment services. Can you -- any color on that, in particular, that you can share exactly what you're doing with BMW and JLR?

Dinesh C. Paliwal

Yes. Primarily, it's a combination of 3 things. So the map update, the map services, the additional engineering. You can call in change orders. Those are the 2 things for JLR. JLR is more of engineering services and BMW, more of a map services, because now we are starting to ramp up. So all in all, $100 million services order is very happy thing for us. And I'm glad that we sort of created this strategic business unit. And we're well underway. Since you have asked that question, David, I think we have announced it. But if not, I'm announcing it now. We have actually also formed a majority joint venture in China for our global car audio business that will also help us future-proofing and helping existing cars to bring in a very good voice and audio system so that they can take advantage of cloud-based services we're launching. So that is going parallel and infotainment service is going on other side. And they are baked in the division numbers as we go forward.

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

And I think you talked about this being $100 million business. Can you give us some order of magnitude of what this contributes to that revenue base?

Dinesh C. Paliwal

Revenue base, not so much. You can count on, it's like $25 million, $30 million a year because that's a multi-order -- a multi-year order, so 3, 4 years. So we have to start booking a lot of those. But we don't have to wait for $100 million. I would love to book $10 million, $5 million and book bunch of those orders. So you start to -- book and bill should be rather small in service business. Your backlog should not grow in that business because you ship as soon as you get and you actually take the profit and revenue. So this is new for HARMAN, as you know, David. This is a new culture. And this is an area you should expect us to even go ahead and make acquisition, to bring service mentality, service-minded, high-margin-minded engineers, high-margin-minded salespeople, who live and die with the very quick book and bill. So that's something we're looking at, quite a few good opportunities out there.

Operator

[Operator Instructions] And we have another question from David Lim with Wells Fargo Securities.

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

So I just wanted to clarify or just get your idea. The original guidance called for a 19% take rate, your longer term, 25%. Given what you know now, and I know that you've already caveated by saying it's too early, do you feel more comfortable hitting that 25% number? Or could there be potential -- the propensity for greater possibility for that number to go higher?

Dinesh C. Paliwal

That number will definitely go higher. That's very clear.

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

Got you. And then secondly, when it comes to the Suzuki and Yamaha business, can you sort of give us some color on the difficulties or some color on how that business was won? I know that it's difficult to crack the Japanese market. But I wanted to get a little bit more color on how that process went for you guys and the importance of it, given that once you've cracked in there, there definitely will be other Japanese OEMs that would greatly consider you guys more.

Dinesh C. Paliwal

Yes. That's a great question. Well, first of all, Japanese car companies have been watching what we have done for Toyota in North America and Toyota in Europe for infotainment. They have known us for audio because we do audio in Toyota. We also do audio in Subaru. But infotainment was a tough nut to crack because this is not about technology excellence in Japan. It was all about who knows who. So I think we worked hard on taking our technology lead. And also we brought something which no other OEM -- Tier 1 has ever exposed as a strength. We said to Japanese OEMs, "The technology is changing very rapidly. If you stay with 3-year development cycle, you're going to be doomed." And with our scalable approach, we are able to, from the purchase order today, in 18 months, we can start shipping. And that was a big differentiator for Suzuki in Japan, number one -- number two. Number three, I think understanding their unique requirements in navigation, unique requirements of their own safety-related aspects, they have certain standards, learning those and doing better than some of the Japanese companies do. And third aspect was how do we bring the best of the Google and best of Apple? I repeat, these are our partners. They're not adversaries. And we demonstrated that in prototypes that, "Look, this is the latest, the greatest, what we did first time for BMW and we are doing it for other companies, we can bring it in here." So we offered them a solution, which was so compelling that even some of the insiders, those who wanted to support the incumbent, they actually didn't have a whole lot to say. So Suzuki was not a huge, huge billion-dollar success. I would not go to the numbers yet because they didn't tell us -- they told us not to. But I think it's a massive success from the point of view of we have shaken up the Japanese environment for the big boys like DENSO and Aisin and Alpine and Clarion and Pioneers and Panasonic. So I think it's a good one for us.

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

Got you. Now the other question that I have is, speaking with people that we know in the industry, it seems like the impression that we're getting is the proliferation of smartphones is actually helping to drive infotainment take rates. Are you guys seeing the same thing?

Dinesh C. Paliwal

Absolutely. And by the way, this is not a surprise. I mean, if you go look back the transcripts for the past 3 years, consistently I've said that. And Sachin has been guiding and coaching a lot of people out there, explaining investors because this has been a traditional concern. That's why our company's beta has been high as it has been in the past. Hopefully, it's coming down. So we have been trying to explain. But we can only explain technologically. We can't take the psychology away from the people, and it takes time. And we are seeing that because we're hearing loud and clear from automotive companies, "Hey, guys, this is our baby. Giving them better system is ours. It's nothing to do with you or Google or what have you. We want to sell a car which works whether you buy a Samsung phone or Apple phone or Android phone or it's going to be a Lenovo phone soon." So they don't design cars for one phone. Let's say Apple says, "We're going to run the automotive." Are all cars going to run just Apple phone? No, they have to design for everything. So the best of the class would be a supplier who works very well with these people, as well as these people allow us to work and learn and bring the best of smartphones into the car and also simultaneously invest in cloud technology, invest in app development community, coach some development, write the standards, how should app developers write for automotive ecosystem. And we are in the middle of it very much. So with that said, I ask rather confidently that, yes, take rates would be higher because I'm already seeing it. I'm also hearing from automotive companies that take rates will only go higher. That doesn't mean it's a threat to smartphones. They will still sell a lot of smartphones. But all I'm saying, we're going to coexist in a big way. It's a huge industry going from 20% global take rates to 50%, 60%, it's going to be great news for investors and people like you, who are covering HARMON. Because we've got a huge runway and we've got a technology lead and we got momentum on our side.

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

And finally, a question for Herbert, just wanted to get an update on your thoughts on CapEx, as well as OCF, given the change to the guide?

Herbert K. Parker

Yes. We still plan to maintain our 2% to 2.5% of revenue as our CapEx. We think we've got the facilities in place in the various countries. The only time we'll open up any kind of a new facility is when we have a customer, where we have it sort of linked together that we need to have a local presence to operate. So recently, we opened a plant in India a couple of years ago. And we're thinking about one in Brazil now. So it should remain about the same. And as far as the cash, we still look at cash conversion from 90% to 100%. We think we can maintain that. And that's what we are seeing for this quarter. It's going in a positive direction.

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

So now [ph] 100% of net income as operating cash flow?

Herbert K. Parker

Yes.

Operator

We have no further phone questions at this time. I'll turn the call over back to you.

Dinesh C. Paliwal

I think we'll allow another minute or so for our listeners. If not, we'll wrap it up.

Operator

[Operator Instructions]

Dinesh C. Paliwal

Very well. First of all, I should say a very special thanks to our listeners. I can see on the screen, it's the largest ever participation from our investors, analyst community. Thank you very much for your interest. We really appreciate it. And we had a similar vote of confidence from most of you, who were with us at Consumer Electronics Show. And we'll be in Geneva beginning of March first week doing a lot of neat things in technology. But with that said, thank you for again joining for conference call for earnings release. Again, we are very, very pleased with the results that we issued today. It's a lot of hard work of many years, so we didn't get just lucky. And we know that's what will drive our execution going forward. We are even more excited about the future and our team is highly motivated than ever. We are focused on executing on our strategic pillars, which includes cost leadership. I remind all of you and my employee base that we will not be getting any complacent just because we're improving our profitability. Profitability improvement means we have to continue to drive best-in-class cost, and that you can count on me. And with that said, once again, thank you. And we will be on roadshow. We'll be meeting many of you in one-on-ones. So with that said, have a very good year going forward in 2014. And stay warm because it's damn cold here in New York. Thank you so much. Have a good day.

Operator

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

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