Motorcar Parts of America Inc (MPAA) 2019 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Motorcar Parts of America Fiscal 2019 Second Quarter Results. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Gary Maier, Investor Relations. You may begin.

Thank you. Thank you, all, for joining us for Motorcar Parts of America's fiscal 2019 second quarter conference call. Before we begin and I turn the call over to Selwyn Joffe, Chairman, President and Chief Executive Officer; and David Lee, the company's Chief Financial Officer, let me remind everyone of the safe harbor statement included in today's press release.

Private Securities Litigation Reform Act of 1995 provides a safe harbor for certain forward-looking statements, including statements made during today's conference call. Such forward-looking statements are based on the company's current expectations and beliefs concerning future developments and their potential effects on the company. There can be no assurance that future developments affecting the company will be those anticipated by Motorcar Parts of America.

Actual results may differ from those projected in these forward-looking statements. These forward-looking statements involve significant risks and uncertainties, some are -- some of which are beyond the control of the company and are subject to change based upon various factors. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

For a more detailed discussion of some of the ongoing risks and uncertainties of the company's business, please refer to the various filings with the Securities and Exchange Commission.

With that, I'd like to begin the call and turn it over to Selwyn Joffe.

All right. Thank you so much, Gary. I appreciate everyone joining us today. Firstly, we apologize for the delay in filing our financial statements, and appreciate your patience. The delay in our filing related to a change in way the company applies GAAP to the premium paid for -- paid or payable to customers for the core value in the finished good on the customer shelves related to new business.

The company previously recorded the full amount of the core buyback premiums as a reduction to revenue at the inception of a new customer relationship. This historical policy was concluded to be a misapplication of GAAP. The company has now revised the application of GAAP, resulting in amortization of the full amount of the premium costs over a period, typically ranging from 6 to 8 years. The company has revised its financial statements for each of the 3 years in the period ended March 31, 2018, and for the 3 months ended June 30, 2018.

As of June 30, 2018, the cumulative error for all periods previously reported was an understatement of reported net income of $2.9 million. This will be reflected in the Form 10-Q for September 30, 2018, which will be filed later today.

As of June 30, 2018, the cumulative impact to non-GAAP adjusted net income for all periods previously reported was again an understatement of $1.2 million. Our record sales for the quarter highlight the company's success and growing position within the $100 billion automotive hard parts aftermarket, and we continue to be busy. We are encouraged by exciting strategic and operational initiatives in many aspects of our business to drive significant growth to both the near and long-term in the following areas: We are ramping up production for new business wins; we're expanding our infrastructure to bolster our industry-leading customer support programs for our new business and products; we are expanding our footprint in both our Mexican and Malaysian facilities; in addition to our new 400,000 square foot distribution center in Mexico, we are in the process of expanding our global facilities with an additional approximately 350,000 square foot; we are launching our new brake program; we are increasing our diagnostic business for both internal combustion and electric vehicle applications.

As we announced last week, our acquisition of the E&M Power greatly enhances our presence in the electric motor space. While some of these initiatives involve upfront expenses, they pave the way for significant growth and enhancement of shareholder value. We have significant new business committed to us for next fiscal year and we remain cautiously optimistic about the vibrancy of the fundamental hard parts aftermarket, which should bode well for increasing replenishment orders for our business in general.

We have made considerable progress in all of the above-mentioned initiatives. Of particular note, we have completed the move of our rotating electrical distribution to our new, larger state-of-the-art distribution center in Mexico, and we are working diligently to get the remainder of our product lines transferred. This transition, once complete, will result in our ability to consolidate shipment of most of our product lines from one distribution warehouse, which will enhance our freight efficiencies. This will help mitigate significant increases in freight and labor costs, which are headwinds for everyone.

To highlight our positive outlook, I'll refer you to our investor presentation on our website, which show some macro industry charts, including a chart related to the expansion of the car park, sweet spot for repairs. We are now seeing the back end of lower new car sales from recession years and the prime parts replacement time frame. Essentially, the number of prime placement age vehicles is growing. These statistics further support our company's and industry's optimism for growth over the next several years.

Overall, we have opportunities to grow all of our product lines, including new product lines that will begin shipping in the new fiscal year. Our D&V Electronics subsidiary, which, as you know, offers rotating electrical and electric vehicle diagnostic products, is continuing to grow. Our alternator and starter diagnostic business is accelerating and shows great promise. We expect to see exciting growth from this business in the new fiscal year.

With respect to the D&V Electronics product lines that serve the electric vehicle market, we are experiencing nice traction. We have received a number of contracts for our products from industry-leading electrical vehicle OE customers. In short, D&V is an exciting part of our business and should be a major contributor to driving value for our shareholders.

I'll now turn the call over to David to review the results for the fiscal second quarter.

Thank you, Selwyn. To begin, I encourage everyone to read the 8-K filed this morning with respect to our September 30, 2018, earnings press release for more detailed explanations of the result, including reconciliation of GAAP to non-GAAP financial measures and the 10-Q which we'll file later today.

Let me take a moment to review the financial highlights for the fiscal 2019 second quarter, reflecting record sales for both the quarter and 6 months on a reported and adjusted basis. The results for the quarter and gross margin were impacted by a 3 items totaling $10.3 million as follows: Customer allowances related to new business of $2.2 million, consisting of upfront one-time cost of $1.2 million related to new business, core buyback premium amortization of $1 million related to new business, core buyback premium in amortization related to the refundable premium paid or payable to customers for the core value and finished goods on their shelves in connection with new business. As Selwyn noted earlier, the company previously recorded a full amount of the core buyback premiums as a reduction to revenue at the inception of a new customer relationship. This historical policy was concluded to be a misapplication of GAAP. The company has now revised the application of GAAP resulting in the amortization of the full amount of the premium cost over a period, typically ranging from 6 to 8 years.

The revaluation for core and on customer shelf resulted in a noncash write-down of $6.2 million, which does not affect the reimbursable amount for the full value of cores on the customer shelves should business with the customer be discontinued, and transition cost of $1.8 million associated with the expansion of manufacturing and distribution capacity to support increased demand for the company's existing pipeline and its recently announced new brake product lines.

Net sales for fiscal 2019 second quarter increased 16% to $127.9 million, from $110.3 million the same period a year earlier. Adjusted net sales for the fiscal 2019 second quarter increased 14.5% to $130.2 million from $113.7 million a year earlier. The adjusted net sales increase of approximately $16.5 million was due to the following: Rotating electrical net sales increased $17.3 million to $104.5 million for the second quarter from $87.2 million for the prior year; wheel hub assemblies and bearings net sales decreased $1.6 million, due in part to lower update orders, to $18.1 million for the second quarter from $19.7 million a year earlier; brake master cylinder net sales decreased $1.4 million to $2.3 million, from $3.8 million for the prior year, due in part to lower update orders.

Additionally, the combined net sales for the second quarter for brake power boosters, turbochargers and testers increased $2.2 million to $5.2 million, from $3 million in the prior year. Gross profit for the second quarter was $25.7 million compared with $26 million a year earlier. Gross profit as a percentage of net sales for the second quarter was 20.1% compared with 23.6% a year earlier. As I highlighted earlier, gross margin was impacted by customer allowances related to new business, transition expenses in connection with the expansion of our operations in Mexico, and noncash revaluation of cores that are part of finished goods on the customer shelf.

Adjusted gross profit for the second quarter was $36 million compared with $32 million a year earlier. Adjusted gross profit as a percentage of adjusted net sales for the second quarter was 27.6% compared with 28.2% for the prior year second quarter. The following items negatively impacted adjusted gross margins but have not been adjusted for increased stock -- customer stock adjustment of accruals in connection with larger future update orders and increased freight expenses related to external market rates. These 2 items resulted in a combined negative impact of 1.1% to adjusted gross margin.

Total operating expenses increased by $2 million to $15.3 million for the second quarter, from $13.3 million for the prior year. Our adjusted operating expenses increased by $2 million to $14.9 million for the second quarter, from $12.9 million for the prior year.

This increase in adjusted operating expenses was primarily due to personnel-related expenses to support our value-added customer service programs and growth, including sales, merchandising, marketing and engineering, and increase in reported operating expenses for D&V Electronics acquired in the prior year July 2017, reflecting a full quarter in the current second quarter compared to a partial quarter for the prior year second quarter, commissions due to the increased sales, Mexico-related expansion expenses and overall expense increases related to growth.

As mentioned previously, due primarily to customer allowances related to new business, transition expenses in connection with the expansion of our operations in Mexico and noncash revaluation of cores that are part of finished goods on the customer shelves, operating income was $10.4 million for the fiscal 2019 second quarter compared with $12.7 million for the prior year second quarter. Adjusted operating income was $21.1 million for the second quarter compared with $19.2 million for the prior year. Adjusted EBITDA was $22.5 million for the second quarter compared with $20.3 million for the period a year ago.

Depreciation and amortization expense was $1.6 million for the second quarter. Interest expense was $5.7 million for the second quarter compared with $3.5 million last year. The increase in interest expense was due primarily to an increase in the utilization of our accounts receivable discount program, increased average outstanding borrowings as we build our inventory levels to support higher sales and higher interest rates on our average outstanding borrowings under our credit facility and our accounts receivable discount program.

Interest expense for the second quarter was $1.2 million compared with $3.6 million for the prior year period. The new tax law resulted in lowering our total blended corporate tax rate from 39% to 25%, effective January 1, 2018.

Net income for the second quarter was $3.5 million or $0.18 per diluted share compared with $5.6 million or $0.29 per diluted share a year ago. Adjusted net income was $11.5 million or $0.60 per diluted share for the second quarter compared with $10.1 million or $0.52 per diluted share for the prior year.

Let me now discuss the results for the 6 months ended September 30, 2018. Net sales were $219.6 million compared with net sales of $205 million for the prior year 6 months. Adjusted net sales for the 6 months was $224 million compared with $209.2 million for last year.

Net loss for the 6-month period was $2 million or $0.10 per share compared with net income of $13.4 million or $0.69 a year ago. Adjusted net income for the 6 months was $14.6 million compared with $18.6 million for the prior year 6 months, and adjusted diluted earnings per share was $0.75 compared with $0.96 last year. Adjusted EBITDA was $32.8 million for the 6-month period, compared with $37.8 million a year earlier.

As of September 30, 2018, trailing 12 months adjusted EBITDA was $70.8 million, and the average equity and net debt balance was $340 million, resulting in a 20.8% return on invested capital on a pretax basis.

Our method of calculating ROIC is to divide trailing 12 months adjusted EBITDA by the average equity and net debt balance for the 12-month period. At September 30, 2018, we had net bank debt of approximately $76.4 million. Total cash availability on our revolver credit facility was approximately $153 million at September 30, 2018, based on a total $2 million revolver credit facility and subject to certain limitations.

At September 30, 2018, the company had approximately $584 million total assets. Current assets were $309 million, and current liability is worth $216 million. During the quarter ended September 30, 2018, the company repurchased 4.1 million of shares at an average price of $24.76. Under the share -- under the authorized share repurchase program as of September 30, 2018, $15.7 million of the $37 million common stock authorization has been purchased and $21.3 million is available to repurchase shares.

Net cash used in operating activities during the 3 months ended September 30, 2018, was $5.5 million. The $5.5 million cash used in operating activities reflects an increase in accounts receivable, with a record high sales during the second quarter, inventories for new business and $10.5 million refundable payments for purchases related to new business, partially offset by increase in accounts payable. Excluding the $10.5 million refundable payments for core purchases related to new business, cash flow provided by operating activities was $5 million for the second quarter.

For the reconciliation of non-GAAP financial measures, please refer to exhibits 1 through 7 in this morning's earnings press release.

Effective April 1, 2018, the company adopted accounting standards quantification topic 606, revenue from contracts with customers, using the full retrospective transition method. The company believes the effect on our income statement is not material. The effect on the balance sheet is to reclassify certain accounts. Additional information is available in the company's Form 10-Q filing later today.

As someone mentioned earlier, the company has revised its financial statements for each of the 3 years in the period ended March 31, 2018, and for the 3 months ended June 30, 2018. As of June 30, 2018, the cumulative error for all periods previous reported was an understatement of net income of $2,938,000. For further information, please see the company's September 30, 2018 Form 10-Q filed later today. As of June 30, 2018, the cumulative impact to non-GAAP adjusted net income for all periods previously reported was an understatement of $1,220,000.

I will now turn the call back to Selwyn.

Thanks, David. We're excited by expanding low-cost global footprint, including our impressive new facilities in Mexico and Malaysia, to enhance operating efficiencies that will help support our growth.

The foundation is being built to support a much larger company over the next 5 years. While the company still expects natural fluctuations in quarters as we grow, our record sales and adjusted results for the fiscal second quarter highlight our continued progress in the industry leadership position. We are reaffirming our annual adjusted sales guidance of between 6.5% and 8.5% growth year-over-year, with expectations of reaching the higher end. Adjusted gross margin for fiscal 2019 is now estimated to be at the lower end of our guidance of 27% to 30%, primarily due to 4 factors: Slow ramp up of higher margin new business; the effect of tariff costs relating to higher Chinese tariffs; timing of the planned transition of certain operations to our expanded Mexican facility; and wage inflation in Mexico.

Other than the Mexico wage inflation, these margin headwinds are expected to reverse in the next fiscal year. With respect to offshore wage inflation, we are evaluating alternative operating efficiencies and pricing strategies. In addition to the company's recent acquisition of E&M Power, we expect to close another strategic tuck-in acquisition this week, which enhances our existing product line offerings.

Let me emphasize. The company's momentum continues to be strong. The new business commitments are continuing. Our position in our base product lines and new product lines is robust, and we anticipate double-digit sales growth in fiscal 2020. We look forward to updating you on the significant opportunities as they evolve. We will now open the call for questions.

(Operator Instructions) And our first question comes from Matt Koranda with Roth Capital.

Just in terms of the revenue growth for the quarter, I mean, I understand that underlying industry growth rates have definitely picked up in the last couple of quarters, but roughly high-teens sort of year-over-year growth trends and your rotating electrical category is pretty impressive. I mean, how much of that can you kind of disentangle, what is new business versus replenishment versus stocking update? And maybe how did weather play into the growth rates that you saw during the quarter? I'd be curious to hear your thoughts there.

Yes, I can't give you the granular breakdown between all those categories, and then I will say that we're just starting to ramp up some new business in the rotating electrical. We do think that the fundamentals of the market played a role. Replenishment orders played a role in the revenue going up. Most of the update orders that we'll receive will come in the back end of the year. So overall, I would just say, in general, positive across-the-board. Certainly don't have the detail that I can give you by each of those categories. Weather helps certainly. It helps. I mean, we'll see how this winter ends up, but -- so the verdict is still out there as to how strong the winter will be. But to me, the most important metric is that the fundamental growth of the aged car population is starting to hit the prime replacement categories. And so just the statistics for the industry in general should be better as we go through the next few years.

Okay. And then, just in terms of the margin outlook. I wanted to see if we could get a little bit more color on your commentary that you'll be on the low end of the gross margin guidance range. I know you mentioned the 4 factors kind of at the end of the prepared remarks there. But in particular, I guess I was interested in understanding a little bit more about the lower mix of high-margin revenue in terms of timing. Could you talk a little bit about that? Are you referring to sort of rotating electrical ramping up a little bit further, and we're holding off on some update orders that come into play maybe at the end of this year or next? Would be helpful to get your thoughts there.

Yes. Look, I think that there's a new -- first of all, I'll start with when I think of the more permanent changes to the cost structure, which we need to figure out how to offset, and I think this is affecting the wage inflation in Mexico. This new administration there. Minimum wages have been statutory and have gone through statutory increases, and so that basically leads to flowing wage increases through the different levels of compensation. So the Mexico wage rates are definitely up. I think you'll see, in general, third world labor markets wage rates are generally going up right now, so it's -- I think it's not only Mexico, but certainly China is experiencing similar inflation. The other side of that is that as these Chinese tariffs are implemented, the demand for relocating or focusing growth into the Mexican market with the new Mexican trade agreement just accelerates the demand for labor, and so labor has become more competitive in Mexico, and certainly, that doesn't help with wage inflation. At the end of the day, again, I think, all of our competitors are affected by this, and there just needs to be some adjustment in the marketplace on pricing and production efficiencies that we can eliminate as much waste as possible from the metric. In terms of the other factors, we're suffering from our success a little bit, to be honest with you. We have just significant new business coming at us from all sides. We are in the middle. As that is happening, we're in the middle of transitioning our footprint from -- which is more than doubling on a global basis. And so we've had some acceleration of expenses as we ramp up our infrastructure, as we manage through meeting our customer's expectation with very high fill rates and high-quality product on an ongoing basis as we expand into sort of to what I think is a new inflection point across-the-board for our business. So I think those will settle down as we complete our transition into our expanded footprint and as we start digesting the new business opportunities that we have. So I think that those fundamentals will return to our gross margins. I think the tariff effect on our margins is temporary for now because, for the most part, we have been able to pass through our price increases related to tariffs, but we did -- we do have a small amount of tariff costs that are still in the tariff number that are affecting our margin. I think that's a couple of quarters of that and that will disappear into sort of the capitalization and to inventory and higher prices, which will ameliorate and offset that. So I think the big issue is wage inflation for us. And really, I think, we've made substantial progress in enhancing our infrastructure to offer and continue to offer what we think is industry-leading service levels in all aspects of our business to our customers, which is where we really, at the end of the day, we hang our hats in terms of what separates us from the pack. In addition to that, the opportunity in the electric vehicle space and the diagnostic space is now unfolding. It's been almost a year now, I think, since we've had that acquisition. And we are making significant progress, I would say. We just completed an acquisition that gives us, I think, a technology offering that's as competitive as anybody has in the world. We think that the unfolding electric vehicle space is going to accelerate. And so the margin structure of that business as it starts accumulating velocity and growth in its revenue base certainly will enhance our margins going forward. And then, in addition to that, I mean, the fundamentals of our internal combustion engine technology and our ability for diagnostics on the fundamental rotating electrical category, and then I think that the machinery and technology that D&V has is clearly industry-leading. And I think the customer base and really, quite frankly, everybody in the industry is using. So I think that's going to expand dramatically. So I think that's on a global basis as well. I mean, we're already starting to see inquiries come from outside of North America for our technology there. And so while today, it's a headwind, I mean, I think that headwind quickly turns to a tailwind over the next 12 to 18 months in a pretty significant way. So I mean, big changes. I mean, the changes again are coming from the problem of growth, which we find exactly in the target of what we wanted to get done. We think that this is going to enhance -- ultimately enhance our margins as we go through this transition. And certainly, we think that we're at an inflection point, heading towards the $1 billion mark revenue, which is really what we have as an internal guide in certainly the next 3 to 5 years. So we're on -- we're aggressively marching towards that order. And quite frankly, now that this financial restatement, which was painful for us as it was, I'm sure, for all of our shareholders, we think we can buckle down, focus on the execution that we have at hand right now, and we're excited, very excited about the outlook for our business.

Helpful color. Maybe just in terms of the pricing commentary that you made there. Curious, are you taking pricing to offset wage inflation? You mentioned -- you sort of alluded to that, but you also said that productivity improvements may also offset some of the wage inflation. Is it a combination of both? When do we see the pricing increases if you're taking pricing? What's the mechanism for that and timing?

Yes. That's a good question. I mean, we have not implemented any price increases for wage inflation. It's relatively new. I think we're waiting to see how our customer and competitive base responds to these statistics. I mean, I think, the new administration has just taken over, particularly in Mexico. But there, there is -- in my opinion, there will be price inflation, but I can't give you any more color as to exactly when. And I will also assure you that we are -- I don't even know the word to describe it, but aggressively pursuing, eliminating waste from all of our operating systems. And that's why you see this massive change in the way we're structuring the company towards future growth. And we're excited that we're ahead of the curve, and our technology, our management information systems and IT group is ahead, and we have infrastructure that's scalable. We don't need to change systems for the growth that we have on hand. We're just -- we're adding volume and we're adding the number of opportunities to grow our business. I mean, pricing, certainly, we want to protect our margins, and certainly, our customers will need to recognize, as tough as it is to get price increases, will need to realize that as infrastructure cost go up, it's important for them to have strong suppliers to embrace their initiatives and their suppliers have to make money. And so this is not just an isolated issue for us as an entity, but it's a global issue for the supply chain and the aftermarket in general. So I think we will see some inflation in pricing.

Okay. That's helpful. Last one real quick, and I'll jump back in queue. But just in terms of the buyback, I noticed there's still north of $20 million available on the repurchase as of September 30, I think. Were you guys able to take advantage during the dislocation in the stock back in November, December and buy more? Any additional color there would be appreciated.

Yes, unfortunately. Or I think the rules make sense, is that certainly we were blacked out. We understood the market reaction to the restatement of our financials, which took a significant hit to our valuation. But we were blacked out from buying any stock. And now, we're at the end of the quarter. We have not been able to buy additional stock. We're still committed to buying back our stock. We think that there's a great value in our stock price still. We intentionally have not adopted a planned buyback because we wanted to maintain flexibility in the allocation of capital. And it's not that we have a huge amount of excess capital, so we wanted to maintain our flexibility. And so the blackout periods have affected the buyback. I mean, we certainly intend to continue buybacks as appropriate, and believe that we're -- we believe we're a good buy.

And our next question comes from Christopher Van Horn with B. Riley FBR.

This is Dan Drawbaugh, on the line for Chris. So just to start, strong quarter, obviously. And looking ahead, can you talk a little bit about the kind of cadence you're looking at for the back half of the fiscal year? I know you've sort of reiterated the guidance range, talking towards the high end. But just given the strength that you saw in the second quarter, what's the prospect for upside to the back half of the year?

Well, I mean, again, we believe we'll see double-digit growth from the back end over the front end, certainly for the last 2 quarters over the first 2 quarters. So we're optimistic on that. We've got some timing issues that are out there with some significant update orders that involve some significant returns before you ship those update orders. So I think the back 6 months in total is going to be very good. We may have some variations in the quarter between the third and the fourth quarter. We're also, during the third and fourth quarter, ramping up some fairly significant incremental new business that we're involved in. So again, our guidance is at the upper end of the revenue. I think you'll start seeing, we -- I mentioned in the script and in my prepared remarks that we certainly expect double-digit growth for our next fiscal year. And so we think there's going to be more accelerated growth as we continue down the road. We do have commitments for new business, and we have a lot of new products that are launching and a lot of good things happening in the new fiscal year. As we go down -- and are happening now in the last 6 months. So I don't know if that answers your question.

Sure. Very helpful color. On the subject of new product introductions, brake pads and rotors, you guys recently announced you're rolling those out. Those are obviously pretty large market opportunities, just according to what you've kind of put out there and what we've kind of modeled. How big could those become in kind of, call it the fiscal '20, fiscal '21 time frame? I mean, how quickly can you ramp up those kind of new products?

Well, that's the question that you know that's hard to answer. I mean, the markets are huge and it just depends on how successful we are in getting traction in our customer base, and we think we have some great products. We think that there's definitely going to be some nice upside in there for our products. And we're receiving some positive -- some very positive responses to our products at this point. I can't give you how big can they be. I mean, these are certainly products that can be in the hundreds of millions of dollars. And so that's just -- right now, that's just a number. That's not based on anything now. So we certainly launch them, expecting to take our fair share of those categories. And so we don't go into a category and expect to be below the top 2 in terms of market share. So we're going to be aggressive. We're going to be offering great products and great customer service. And we'll see. Again, the outlook overall is, in general, positive.

Okay. Fair enough. And then, on the E&M Power acquisition, can you elaborate a little bit on what that -- what they look like in that $250 million market for active load emulator and DC emulator? I mean, is that a fragmented marketplace? Are they kind of one of many players? Is there like a leading player there? Can you help us understand sort of how big they are within that space?

Yes. They're still small in terms of their revenue, but in terms of their technology, I would have to say that if they're not the leader, they're certainly among a couple of leaders. Their technology on inverter, their inverter testing capabilities, their emulation capabilities, I mean, they're at -- the investment there was really as an enhancement to our technology base, and we think the combined technology with our current D&V platform will enable us to offer full platforms to the original equipment electric vehicle manufacturer, and that's a very fast-growing -- in total, that's a very fast-growing segment, and we think, now, we have an offering of technology. Again, I don't know whether we're the leader on our own in that space, but we're certainly in the lead row with not a lot of players able to offer what we can offer. In addition to that, besides the electric vehicle space, I would tell you that the interest in the aerospace industry for our technology is pretty significant as well. We're just beginning to look at that, but the whole electric vehicle is not only an electric motor -- an electric car opportunity. I mean, electric motors and electric emulation testing and inverter testing is -- goes to many different OE spaces. So very, very exciting for us. The founders of E&M are exceptional people. They have been, I think, limited by capital base of 2 individuals that have invented something. And I think having them as part of our new D&V organization and having their technology, I think we're going to be a real powerhouse in that space. Again, very small now, but with global positioning that I think is very, very significant for the future.

And our next question comes with Steve Dyer with Craig-Hallum.

Most of mine have been answered already. Just I was wondering if you could dig in a little bit. Rotating electrical was extremely strong in the quarter, and I'm wondering, was that driven largely by replenishment orders with really low inventory? Or was there some significant new business that was -- that had or was pulled forward? Any color around there, Selwyn?

Yes. I think replenishment was very strong. The market for our products, again, we've always talked about the statistics. Steve, I mean, for years we've been talking about it. I think the statistics is starting to play into just fundamental replenishment. So just our share helped significantly. We did have new business that's starting to ramp up, and we continue to have new business that's ramping up. So we should see more and more of it in that space. So I just think you have both. I mean, you have growth in new business, net new business, and net replenishment is up. And I think the update orders are going to be up. Unfortunately, we're seeing a fairly significant amount of adjustments to inventory, which, generally, we try and drive so we make sure our customers have the right mix. So I think, again, to summarize rotating electrical, it's all of the above, replenishment, updates, which haven't come yet. I mean, they're still to come. The updates have been pretty slow, but are still to come, and new businesses also is ramping up, slower than we expected. So -- but it's all coming. So the disappointment -- and I'm just going to jump to another sector, Steve, which may be just a sort of a natural add-on is we're disappointed in the wheel hub growth. Masters has more predictable. We've been waiting for the wheel hub. We have great market share in the wheel hub category. And so there's been some softness in the wheel hub industry in general, and we believe it has to turn. We believe our capabilities and our product is industry-leading. And we think that there is going to be a turn there. So I mean, we saw great growth just driven off a couple of product lines, but we didn't see all of our product lines really grow as much as we had liked to, and we certainly hope that's going to happen going forward, and we expect it to.

Got it. And then, I mean, the December quarter is already effectively behind you. Anything you can comment on there, just about in terms of continued trends or did things continue? Did you see any deviation? And then, again, maybe how we should think about the balance between Q3 and Q4 to kind of get to your year-end numbers?

Yes. I think, the -- again, with just -- we all finished the quarter, so it's a little tricky to talk about it. But I think the big news really for the back 6 months is that we certainly believe there's double-digit growth there. A lot of update orders have gone out in the third and fourth quarter. There is going to be an overlap between the third and fourth in terms of how revenue is recognized because a lot of the shipments went out towards the end of the third quarter. So I think the fourth quarter can be more -- certainly, we believe more vibrant, and we know will be more vibrant than the third, but the third is -- the shipments are already out the door in the third quarter and the revenue recognition would be in the fourth quarter. So -- but overall, again, we expect a strong back 6 months with a little bit south -- the third quarter being a little softer than the fourth.

Yes, okay. And then, lastly, just the accounting issues, are they -- I mean, is it safe to say they're in the past, E&Y sort of is on the same page? Or is there any more sort of potential for disagreement, anything going forward?

Yes. So the first thing I would say is there's no disagreement whatsoever between the auditors and MPA. So I'll make that clear there. Certainly, we picked up a very significant customer in the second quarter, which had a core buyback, and that stimulated reevaluation of the policies related to the core buyback. And while we, over the last 11 years, have been -- have taken the position that we should expense the premium portion of the buyback for the cores upfront, this was a much less conservative approach that we're now taking, and I think it's just the influence by more data that has come out in terms of interpreting revenue recognition and expense recognition. And so I don't believe -- we were surprised, to be honest with you, that we did -- that we had to change the application of GAAP, but I believe we -- I certainly believe that we have no disagreements between us and our auditors at all.

And our next question comes from Scott Stember with CL King.

Can you maybe talk about -- you talked about -- briefly about the wheel hubs and some industry weakness there. But in total, I would've thought that, that would have been doing better just given the winter that we had and with vehicles hitting a lot of potholes and so forth. Maybe just give us your view of why you think that, that market is soft as it is and what it could take for that to turn around?

Again, I just want to point out one thing. Unfortunately, I have to point this out. We're reporting very late for events that ended sort of before the winter began. So the results reflected in the September quarter are not indicative of what we've seen and potentially may see for the winter. So I hope you're right. I mean, we certainly, again, believe that the wheel hub business will accelerate. So it's -- and a lot of it is weather generated on the wheel hub side. Snow and salting of the roads and as we go through the winter on that and then we get through the winter, you generally see that in the January, February, March time frame, we'll have a much better feel as to what -- how the weather has affected the market right now. So I think, again, we anxiously await. I think the other side of that is it's the same as any other hard part that's out there that the car population for prime replacement age applies to wheel hubs as it applies to rotating electrical as it applies to all these other parts, and that just the fundamental statistics will ultimately change that wheel hub phenomenon to be back to its growth -- to having growth for us and for the entire industry. I don't know if Steve -- Scott, I'm not sure, did I -- was there a second part to the question?

No, that pretty much answers. I'm just trying to figure out what's going on there.

Yes. So we'll see. I mean, it's going to be fine. I mean, again, there's no fundamental change to where the market is not going to have replacement. That, I'm positive of.

Got it. And maybe talking about some of the newer products, like rotors and pads. And rotors in particular, how is that business going to, is that going to be a reman business or is that something you will be sourcing from China or other markets?

Yes. The rotors are not remanufacturable to the best of my knowledge. They are sometimes re-owned. But no, we'll be selling new units. There will be no call value to the rotors whatsoever. At this point in time, we have a key supplier or 2 and we'd be working with them really with their own specifications, their manufacturing capability to launch the products into the marketplace from them.

Got it. And just the last 2 questions. In the past, you've periodically sometimes given where you think the operating expenses for the full year will come in and interest expense. Are you in a position to give that out for the full year at this point?

This is David. So the first 2 quarters, we're averaging approximately $15 million in total operating expenses. With the sales growth we're anticipating, the back 2 quarters are going to average closer to $16 million per quarter. So that would get us closer to low $60 million for the full year.

And a lot of that is reflected in ramping up infrastructure for -- again, for significant new business that's coming on next year.

Correct.

And interest expense?

So we're looking at interest expense increasing. And that's going to be reflective also not only higher rates, but with higher sales, a lot of the customers offer vendor financing programs through the AR discount program. So for the year, we're probably going to be closer to 4.8% of sales. I think that's the easiest way to look at it as a percentage of sales.

And our next question comes from Brian Nagel with Oppenheimer.

So my question here, my first question and maybe a little repetitive to some of the prior questions, but in the second quarter, which now is free from the past, you had adjusted sales growth of over 14%, much stronger than you had in fiscal Q1, and above the rate at which you're guiding for year. How should we think about that 14%, I guess 14.5% to be specific in terms of a run rate for the business? I guess the question I'm asking is, within that, are there some oddities that we should not expect to continue? Or is that really reflective of where the business underlying trends were tracking?

I think, at the end of this fiscal year, we should be at a rate of around $500 million plus and fast ramping from there. So that's -- I mean, I think that's where we're headed.

Okay. Then maybe, I guess, a follow-up to that, so now with fiscal Q3 done, and I recognize you haven't reported that yet, but from a bigger picture, and Selwyn you talked a bit about just the overall improving environment in Q2, but the factors driving the improving environment, whether they be weather or the car park, did anything change significantly one way or the other as we went from Q2 to Q3?

I'm digesting that question. I mean, I don't think so. I think that the fundamentals are all there. I mean, obviously, the weather changes every day and so we don't know what this winter will end up being, and the rain patterns or whatever. But I mean, I think, if you'd just eliminate that, which, quite frankly, we have to because it's not a controllable, but fundamental -- the fundamentals of our industry, the fundamentals of our customers, the fundamentals of the car park and replacement rates, I don't see any real change in any of them. I think it's all -- and again, I would listen to all other people in the industry, I'm not the only one I would rely on, but certainly, when I listen and I read and I certainly look at the statistics, that they all seem to favor a very positive outlook over the next 3 to 5 years.

And my final question, just, I guess, is more from an expense standpoint. You discussed the build-out, if you will, the now the, I guess, the build-out towards the potential for higher capacity within your model. So 2 questions there. What type of sales now could be supported by your infrastructure? And then, second...

And that's it -- go ahead.

And then, second, how should we -- when we think -- look at the expense structure right now, what type of -- how should we think about the weight, if you will, or the drag is probably a better word, of having this excess capacity would not have any commensurate sales at this point?

Okay. So let me start with the first one. I mean, I believe the new footprint, as we complete it, will enable us to move closer to the $1 billion revenue mark, and we may not get all the way there, depending on how mix and how much is outsourced versus produced. But certainly, our immediate internal target is $1 billion in revenue. When I say immediate, that doesn't mean that's going to happen next year. I mean, that's sort of a 3- to 5-year outlook for us. I think that as we complete the new footprint, that the fundamentals of overhead absorption or the amount of revenue that's committed to us will keep us on par with existing overhead absorption. So we have a lot of new revenue that's going to fill up that space very quickly. And then, it's leveraging volume out of that space with multiple shifts and growth and things should get better from there. In the meantime, I think, we've probably got a 2 or 3-point margin drag until we get through that, and that's sort of indicated in our guidance on gross margins and we try and separate as much as possible. But we're just -- we're expanding. I mean, there's not a department in our organization that is not expanding. And so as you go through that inflection before that revenue comes on, there's going to be a little bit of a drag in gross margins. But as we start supplying that incremental volume that we've -- that's been committed to us, I think we get back to where we were in the sort of the higher ranges of our margin guidance, that 27% to 30% will be closer back to the 30% margins. And we go from there. So we see -- I don't know if that answered that, Brian. Does that answer your question?

Yes. That's very helpful.

And our next question comes from [Carl Egan].

I've been a long-term shareholder in the company and I appreciate you guys providing the color and the guidance on the $1 billion in revenues in 5 years. And for me, I think, that implies that you guys are going to do something like over 15% compounded annually from today's standpoint, and the stock trades somewhere 4.5x, 5x EBITDA. So my question is kind of what value do you see in being a public company, especially compared to going private, especially when I look at some of your competitors, especially like BBB, which has taken private 3x most recently in August. When I look at their moodys.com debt profile, it looks like they were taken out at 2x sales, 10x EBITDA and leverage 7.7x EBITDA, and you guys are trading at 4.5x. So just curious what value you guys see in remaining a public company as opposed to evaluating some strategic alternatives to drive shareholder value?

We're not getting into the pros and cons of public versus private, which I think most of us know the answers to that. But we are always looking at the ways to maximize value. Our time frame is not one moment in time. Our time frame is, how do we get to the maximum value we can in executing our 5-year plan? And we constantly evaluate whether we should be private, public and what the best alternatives are to maximize shareholder value. So at this point in time, we believe, with all the initiatives that have gone on, that we will get credit for it once we and if we execute appropriately, and we'll get that credit whether we be public or private. So I don't know.

I was curious, because looking at the stock over the last 5 years, the stock has gone from $25 a share 5 years ago to $21 today. So it's down like 20%, while the market is up over 50%, and you have a competitor, a direct competitor that does exactly the same thing that you guys do and that's been successfully taken private 3 times in a row. It just seems like value can be created by evaluating those options.

Yes. Well, your comments are certainly noted and nothing new to add to our understanding of the opportunities, but we appreciate your comments.

And our next question comes from Bill Dezellem with Tieton Capital.

A couple of questions. First of all, relative to the new brake product line, what's required to build that out?

The product lines that we've announced is mostly distribution space. Those are contract -- they're contracted out. So it's just distribution and engineering, our own specs, our customer service programs that relate to it, engineering, mostly -- again, distribution, along with all the infrastructure that we support all of our product lines with, which is market intelligence, engineering and all of the sort of EDI and IT infrastructure that you'd normally apply to any product.

Okay. And as you look at that business, is the value that you are bringing to your customer the engineering capability that you just referenced, or the ability to provide them with more products from a smaller number of suppliers?

I think it's both. I mean, I think, certainly, the engineering capability and the market intelligence that we bring to the support quotient of our offering is valued by the customer. And so I think that's a big part of it. It's a value add for them and certainly something that we need to get paid for. And then, the second thing is our fundamental footprint and logistical -- logistics capability that matches the needs of the customers in the marketplace that can make them more efficient is also valued. And so both of those add value. So it's the product as well as just how we go-to-market.

Great. And then, last question is that you've referenced new business that you've won for next fiscal year at one point in the call. And secondarily, I think, there was even a phrase something similar to new business coming at you from all sides. Would you talk about those 2 comments and try to put additional color around that for us?

Yes. Again, all of our categories, there's a lot of interest in new business and a lot of new business being evaluated and ramped up from all of our -- in all of our categories. In terms of where and what it's going to be at this point in time, we're not willing to talk about where and what. I'll give further color as we get down the road a little closer to launching that new business. But I would say that, again, every part of our hard parts business, we expect to get new share, and we expect share in our new product lines, and we expect share in our diagnostic businesses, both the EV and the internal combustion side of that business. And we expect, as I mentioned earlier, to open up some new technology available to some of our existing product lines by an acquisition that we expect to announce later this week. And so when I look down the road over the next 3 years, the number of opportunities for us to grow in has definitely grown, and the problems in terms of being able to grow any of those opportunities is not diminished anywhere. So multiple opportunities for growth in all the categories that we're in.

And you just referenced the acquisition that you anticipate closing later this week. I'll jump the gun and ask you to share whatever you can about that transaction.

Yes. I mean, there's very little we can share at this point because it's still private to the selling group and their employee base. So we have to respect that. But in general, it's going to add a piece of business opportunity to our existing product lines that we haven't really had in the past. And so while it's not a huge revenue, again, it's small, it is very significant and strategic for us in terms of opening up channels for us.

Ladies and gentlemen, that concludes our Q&A portion of today's call. I would now like to turn the call back over to your host, Gary Maier.

Great. I'll take it from here, this is Selwyn. Yes, again, we're happy to have the delay in our reporting behind us. And as always, I just want to thank our team members for their incredible commitment and, again, customer-centric focus on their service, for their exceptional pride in all the products we sell and the great customer services that we provide, which only they can make a reality for our customers. And we continuously get compliments about people that we have dealing with our customers, really, I would say, almost on a daily basis. Their commitment to the quality of our products and their service levels is also reflected in what we believe is important, the wonderful contributions they make to their communities and our society. And we appreciate their continued support, our investor base's continued support, and we thank you again for joining us on the call. And we look forward to speaking with you soon when we host our fiscal 2019 third quarter conference call in February. And we look forward to meeting you face-to-face at the various conferences in the future. And so thank you. That will end the call for now. Thank you very much.

Ladies and gentlemen, thank you for joining today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.