All improvement: Harman International Industries, Incorporated Management Discusses Q2 2014 Results

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

Harman International Industries, Incorporated (HAR) Q2 2014 Earnings Call January 30, 2014 11:00 AM ET

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 first Technical GRAMMY Award. This Technical GRAMMY recognized Lexicon's, 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 diversion. 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, whether it's 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've got a break in Suzuki. We've got a break in Yamaha. And by the way, by no means, we 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 the 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. Could you just look at if 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, whether 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 start 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, as 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% lower take rates 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. BMW has done well. And of course, the customers in China. So that's the mid-segment. So that's infotainment. Car audio, we also have 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 every thing 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're maybe actually going towards faster rate achieving their goal than perhaps Europe did or even America did. So we'll watch in that 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 almost anything? Well, 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 Motorola. That's a good news for HARMAN. Because more these guys do, more we have an opportunity to bring in that feature functionality in the car and integrate that. We are a super integrator. We are the bridge between -- and what makes me feel very good about, which people have messed, not you but 1 or 2 you guys have not 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, is 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 thing 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 will 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, light, agile cloud connected system in the car.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And then 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, and ours 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, with 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.