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Fuel Systems Solutions, Inc. (NASDAQ:FSYS)

Q4 2008 Earnings Call

March 6, 2009 1:00 pm ET

Executives

Mariano Costamagna – Chief Executive Officer

Matthew Beale – President

Bill Larkin – Chief Financial Officer

Analysts

Mark Siegel - Canaccord Adams

Robert Brown – Craig-Hallum Capital

Ronald Oster – Broadpoint AmTech

Graham Mattison – Lazard Capital Markets

Patrick McGlinchey – Sidoti and Company

John [Kardy] – Principal Global Investments

Unidentified Analyst

Jamie Lester – Soundpost Partners

[Adam Howe – Holden Capital]

John Quealy – Canaccord Adams

Operator

Welcome to the Fuel Systems Solutions’ fourth quarter and year end results conference call. (Operator Instructions). I will now hand the conference to Ms. Kirsten Chapman.

Cathy Mattison

Thank you for joining the call today. With me today from management are Mariano Costamagna, CEO, Matthew Beale, President, and Bill Larkin, CFO. Mariano will provide an overview, Matthew will review recent corporate events, Bill will follow with financial detail, and then Matthew will conclude with closing remarks and open the call for questions.

Before I turn the call over to the team, I would like to remind everyone of the Safe Harbor statement included in the earnings press release issued yesterday. If you have not received a copy of the release and would like one, please call Lippert/Heilshorn and Associates at 415-433-3777 and we will send one to you.

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for certain forward-looking statements including statements made during the course of today’s 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 Fuel Systems Solutions. Actual results may differ materially from those projected in the forward-looking statements. These forward-looking statements involve significant risks and uncertainties, some of which are beyond the control of the company and subject to change based upon various factors. For a more detailed discussion of some of the ongoing risks and uncertainties of the company’s business, I refer you to the company’s various filings with the Securities and Exchange Commission.

With that it is my pleasure to turn the call over to Mariano Costamagna.

Mariano Costamagna

Welcome to Fuel Systems Solutions 2008 fourth quarter and year end conference call. Thank you for joining us today. During our US automotive launch in Santa Ana in early February 2009, we stated Fuel Systems Solutions is dedicated to innovation, ingenuity, and inspiration. In 2008, we accomplished this again. We achieved critical mass and demonstrated the value of our business model as we optimized production across our broad spectrum.

Our strong 2008 revenue growth reflects our investment in our company combined with the increased demand for alternative fuel systems in the transportation sector outside of the US. As a result, we delivered record annual revenue of $382.7 million in 2008, an increase of 44% over last year’s revenues of $265.3 million, and in line with our annual guidance of approximately $385 million. In addition, in 2008, we made great strides in our plan to be the leader for the future.

I will turn the call over to Matthew Beale, our President, to review our accomplishments in detail.

Matthew Beale

Indeed 2008 has been a year of investments. We expanded Fuel Systems Solutions’ overall infrastructure to long term revenue growth by capacity expansion, acquisition, and new product line launches in transportation and industrials. We increased capacity to meet demand. In fact, in 2008, our production increased to approximately 800,000 systems annually. We focused on our delayed OEM business, increasing production at our Carrasco, Italy facility, and opening three new dedicated operations, one in Czakram, Poland, and two in Italy, Pisa and the port city of Livorno.

We began 2008 with annual DOEM installation capacity of 17,000 cars, and now that capacity exceeds 100,000 vehicles a year. As a result, the OEM segment now contributes a greater percentage of our transportation revenue than a year ago. Gaseous fuels remain one of the bright spots in the European OEM automotive sector as the market continues to grow and perform well.

In January 2009, we completed the acquisition of Distribuidora Shopping SA, or DS, based in Buenos Aires. DS reinforces our natural gas vehicle product line with the well-known Tomasetto Achille brand, diversifies our global manufacturing capacity, and expands our distribution footprint. DS also improves our position to serve the South American market, a region with significant natural gas reserves that offers long term growth potential for natural gas vehicles. The integration is progressing well. We are pleased with the management team and excited about the long term benefits of combining our production platform and creating purchasing and other synergies.

In February 2009, we formally launched our US automotive alternative fuels division at our Santa Ana IMPCO operations. Our technology and our US manufacturing facility provide Fuel Systems a strong and unique base to enter the US automotive market. Our strategy consists of two stages. First, we will target the fleet business. Fleets provide a ready market that often has refueling infrastructure. Second, we will take steps to bring technologies to the US consumer, a challenge we embrace based on our decades of success and the cumulative know-how in alternative fuel technology for transportation.

Penetration for gaseous fuel passenger vehicles in the US is less than one-half of 1%, whereas penetration rates are in excess of 20% passenger vehicles on the road in some Latin American and European countries. In many respects, the US is an emerging market for our products. Our bi-fuel vapor sequential fuel injection systems enables drivers to seamlessly transition between clean burning natural gas or propane and gasoline operation with the flick of a switch. This increases the consumer’s confidence as they can use natural gas or propane and still have gasoline operation available.

Around the world, we’ve witnessed a model for which bifuel systems actually encourage the development of an alternative fuels infrastructure because bifuel systems give gasoline station owners a market-driven reason to meet consumer demand by installing an alternative fuel pump or compressor. We’re working closely with the Propane Education and Research Council, PERC, and the Natural Gas Vehicle Association of America or NGV America, both of which offer support on many levels including assistance in bringing new products to market. Both groups recognize the connection between our success in selling equipment and their success in promoting the use of gaseous fuels, and certainly the stimulus package has been another positive for the industry.

Our US Automotive Alternative Fuels Division launch is in important step forward in proving the North American market with proven reliable alternative fuel vehicles that are part of a broader solution for reducing emissions, displacing petroleum, and promoting energy independence. Based on what has been achieved in some 70 countries internationally and growing support for alternative fuels at home, we are excited about reaching this significant milestone.

In addition, this week we announced our IMPCO investment in industrial engine dressing at our Sterling Heights, Michigan facility which houses our industrial market research and development activities. In 2008, IMPSO supplied over 100,000 fuel systems for a variety of industrial applications. Our next generation fuel injection industrial fuel system will be fitted and is certified to comply with the new 2010 emission standards. The investment includes mechanized production lines for engine builds and industrial mobile stationary and power generation applications and follows the successful implementation of a pilot program at our Santa Ana manufacturing plant.

Overall, our actions are driving synergies in production, engineering, and distribution. In combination, they further solidify Fuel Systems are the global leader in alternative fuel systems technology for industrial and transportation applications. We will continue to evaluate attractive acquisition opportunities to complement our organic activities.

Also in 2008, we successfully streamlined our corporate structure. We purchased a minority interest in our Australian and Dutch subsidiaries. We removed intercompany positions relating to the IMPCO-BRC transaction, and we established two credit facilities, one in the US and one in Italy.

Looking ahead, we believe there are significant long term market drivers in the alternative fuels sector. As we reduce emissions, displace petroleum, and generate savings, our market drivers include new actions such as the stimulus packages that are being implemented globally and ongoing factors such as certifications, fuel price differentials, and regulation. For example, in 2010, we will reach the next regulatory tier for indoor air emissions which will be required on many types of industrial equipment.

We have been leveraging our unique automotive injection technology to engineer attractive solutions that reduce emissions and improve efficiency, which translates to savings. We have also been leveraging our strong OEM relationships to secure orders for this phase of new equipment. We expect to start delivering this product to our OEMs in the fourth quarter of 2009, enabling our customers to incorporate this equipment into their 2010 product line.

In 2009, we intend to invest in our current product lines as well as use M&A as a tool to extend our technology platform to bolster and complete our solutions. We will evaluate additional opportunities that bring value to our customers.

With that, I’d like to turn the call over to Bill Larkin for a review of our financials.

Bill Larkin

I’ll begin with a review of the fourth quarter and year ended December 31, 2008. For the three months and one year periods ended December 31, 2008, our non-US operations accounted for approximately 85% of our revenue. The impact of changes in foreign currency when translating our foreign subsidiaries’ financial statements into US dollars resulted in a decrease of approximately 8% for the fourth quarter of 2008 and an increase of approximately 6% for the year ended December 31, 2008, when compared to the prior year periods.

Total revenue for the fourth quarter of 2008 was $84.3 million, up 5.7%. Transportation represented 82% of our revenues with a significant portion contributed from OEMs, and industrial represented 18% of revenues. This compares to fourth quarter 2007 of $79.7 million. The increase in revenue was primarily due to strong performance of the transportation business. However, it was a more moderate increase then recent periods due to the strengthening of the US dollar to the euro and lower industrial OEM sales.

Fourth quarter 2008 cost of revenue was $62.4 million, including a $2.1 million increase in our provision for excess and obsolete inventory compared to $59.6 million last year. Gross profit was $29.5 million or 26% of revenues for the fourth quarter of 2008, compared to $20.2 million or 25.3% of revenue a year ago, primarily reflecting the change in our product mix.

Fourth quarter 2008, SG&A expense was $14.6 million, which included expenses to support revenue growth and a $1.1 million increase in the provision to fully impair the loan receivables from the company’s unconsolidated WMTM joint venture, a $900,000 increase in our provision for accounts receivable, and $800,000 in expenses related to the acquisition of DS. This compares to $9.2 million in the year-ago quarter. R&D expense during the fourth quarter of 2008 was $2.8 million, up from $1.9 million in the fourth quarter of 2007.

Total operating expenses for the quarter were $17.6 million, or 20.8% of revenue, compared to $11.4 million or 13.9% in the fourth quarter of 2007, reflecting the increase in provisions and expenses to support higher revenue, investment in R&D, and the acquisitions.

Operating income for the fourth quarter of 2008 was $4.3 million, which included a total of $4.9 million in provisions and acquisition costs, compared to $9 million a year ago. Other expense increased to $1 million which primarily represents foreign currency exchange losses, up from $285,000 loss a year ago.

Income tax expense for the quarter was $3 million as compared to $3.3 million a year ago.

Our fourth quarter net income was $641,000 or $0.04 per diluted share, as compared to $4.8 million or $0.31 per diluted share in the 2007 fourth quarter.

For the year ended December 31, 2008, total revenue was $382.7 million as compared to $265.3 million for the full year of 2007, reflecting strong performance in the transportation business. Transportation represented 79% of revenues with the majority contributed from OEMs and industrial represented 21% of revenues. Gross profits in 2008 reached $108.6 million or 28.4% of revenues, compared to $64.1 million or 24.2% of revenues in 2007, primarily reflecting the change in our product mix.

Operating income for 2008 was $46.1 million or 12% of revenues, which included $8.8 million in charges recorded for noncash goodwill impairment in the second quarter and increase in provisions and acquisition costs in the fourth quarter. This is compared to $19.3 million or 7.3% of revenues in 2007.

Income tax expense for the year was $20.2 million, primarily representing foreign taxes at an affective rate of 46%, as compared to $9.2 million last year or 56%. The reduction in our effective tax rate is primarily due to the decrease in the statutory tax rates in Italy where we generate a substantial portion of our profits. Net income for 2008 was $23.3 million, compared to $5.9 million in 2007. Earnings per share for 2008 were $1.48 compared to $0.38 in the prior year.

On to the balance sheet, at December 31, 2008, our cash and cash equivalents balance was $26.5 million, compared to $26.8 million at December 31, 2007. Our year end working capital was $82.8 million compared to $70.6 million a year ago. Also in December, we strengthened our access to cash via a credit line for our IMPCO US operations for up to $13 million and a credit line for our MTM operations in Italy for up to $15 million euros or approximately $20 million US. In January 2009, we repaid $10.8 million in principal and unpaid interest to retire our intercompany loan we have referred to as MTM loan.

On to our financial guidance, while we believe the global economic slowdown will impact our 2009 sales, management is dedicated to building a strong financial foundation to fuel long term growth. As part of our overall goal of simplifying our corporation structure, we continue to evaluate manufacturing and G&A cost reductions as well as more effective means of managing inventories and accounts receivables.

Based on our current market outlook, we expect 2009 revenue to be between $330 million and $360 million, which assumes a stronger US dollar that is estimated to negatively impact 2009 annual revenue by approximately 12%. During 2008, the US dollar to euro exchange was approximately $1.5, while the exchange rate assumption used for our 2009 revenue estimate is $1.3.

We expect gross margins and operating margins to be impacted from the planned investment in our business. Therefore, we are targeting 2009 gross margins to be between 25% and 27%, and our operating margin to be between 10% and 12%. These reflect additional SG&A expense negotiated with our businesses. Regarding our income tax, we expect to continue to see anomalies due to the revenue mix between international and domestic sales as well as potential foreign exchanges gains or losses.

Now I’ll turn the call back to Matthew.

Matthew Beale

We are very proud of our successes in 2008, but we are more excited about 2009. We will be fuelling long term growth by our organic capacity increases, new product line launches, and acquisitions. Growth often lags the investment, and we expect our near term profitability to be impacted by the initiatives we are implementing. A stronger US dollar if sustained during 2009 will reduce foreign currency revenue expressed in US dollars; however, during these market conditions and during a year of investment, we still expect to deliver revenue between $330 and $360 million.

Much as our 2008 results validate our investments made in prior years, we expect our 2009 projects to contribute to sustaining our growth trajectory in the future. Our ultimate goal for 2009 is to invest in various paths that will begin to impact revenue in 2010, such as our newly launched US automotive business, our new technology for the next industrial regulatory tier, and potentially additional technologies that bolster our platform.

With that, I’d like to open up the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of John Quealy – Canaccord Adams.

Mark Siegel - Canaccord Adams

This is Mark Siegal for John. I was wondering if you guys might be able to talk a bit about your visibility in the transportation business, as to how you look at that both from the OEM and aftermarket perspective.

Matthew Beale

We’ve got management in different locations, so I’m going to kind of farm out the questions here, but as we look at visibility for the transportation business in general, we look at what we achieved in 2008, and really it was a transformation of our business and a shift in the mix from aftermarket to OEM supported by the expanded capacity from 17,000 to 100,000 system installations. In the third quarter, we had the first quarter of full blown exposure to the current economic cycle, but the OEM segment continued to perform strongly, and that is something that we factor in as we look forward in 2009 and the ability to leverage the increased capacity we have with the OEM segment through the new systems installation capacity.

Mark Siegel - Canaccord Adams

In terms of the revenue guidance, are there any built-in assumptions there regarding the price of oil going forwards or perhaps the achievement of certain vehicle sale milestones by any of the European OEMs?

Matthew Beale

No, it’s not linked certainly to any commodity price assumptions, which just as a reminder are relevant but less relevant certainly in the European market. I think the overriding point to make here as relates to the 2009 guidance here is that if you take away what we are making assumptions as it relates to foreign exchange, what we’re really saying is we’re targeting flat revenues, which quite honestly is an achievement in this environment.

Mark Siegel - Canaccord Adams

Bill, can you provide a little more color surrounding the uptick in inventories in the quarter?

Bill Larkin

As we mentioned in our prepared comments, we are starting to see a little bit of a slowdown in the pipeline of our industrial business and our aftermarket business, and it’s just the timing of the purchases that we had in the pipeline in the fourth quarter, and we’re keeping a close eye on that inventory to manage our purchases, our manufacturing capacity, and production in light of what we see as current trends in the pipeline.

Mark Siegel - Canaccord Adams

Matthew, could you perhaps build up on your comments regarding M&A? Are there particular technologies that are more attractive than others, or does geographical footprint factor into your considerations there as well? How do you think about things there?

Matthew Beale

We’re certainly opportunistic, and there is a lot of good technology out there which is floundering in a capital constrained environment. Any areas where we can add value is of interest to us. Any areas where we can increase what we’re doing with our OEM customers across the industrial and automotive side of the business is of interest to us, so there are plenty of opportunities, and I think that we’re looking to be somewhat opportunistic. In particular, on the industrial side of the business, we see a lot of attractive situations.

Operator

Your next question comes from the line of Robert Brown – Craig-Hallum.

Robert Brown – Craig-Hallum Capital

I think you just mentioned the organic growth net of FX in your transportation business will be 5 for 2009, is that right, and then how do we think about the split between OEM and retrofit? Should OEM be growing and retrofit declining, and then maybe reconcile the OEM growth in the phase of the automotive market?

Matthew Beale

In terms of growth, when we are targeting flat revenues leaving aside FX assumptions, we’re taking our best guess, but we don’t know what that’s going to be, but targeting flat revenues, that is really driven by continued growth in the OEM segment, in particular the DOEM segment where we’ve invested heavily, and we invested also in view of the pipeline that we perceived at least over the short term in that market segment, and that is offsetting what we expect to be, and this is our current vision, weakness in the aftermarket part of our transportation business as well as the industrial OEM business, so there’s a bit of an offsetting. We see growth in segment offsetting what is weakness in a couple of other distribution channels and product categories.

Robert Brown – Craig-Hallum Capital

Maybe you can help me understand how can the OEM business be growing in the face of declining automobile sales overall.

Matthew Beale

It is counterintuitive, isn’t it? But particularly in Europe, the gaseous fuels segment of the market and Italy is obviously a prime example continues to be robust. It’s one of the few areas that continues to grow and to perform, and our visibility on that and I know in the context of the broader global OEM situation it’s difficult to have, but as we work with OEMs in implementing new programs and the absorption of the capacity we’ve put in place, we short term were very encouraged by what we’re seeing.

Robert Brown – Craig-Hallum Capital

Maybe you could update us on when you’re investing for the US market growth how do you see that revenue starting to flow into your business, and at least a sense of when that could be. I think you mentioned 2010, but what do we see first in terms of programs announcements or when can we see revenue start to hit your business?

Matthew Beale

There are a lot of things that are happening in the US market right now that are very encouraging. The fact that there is a recovery act is kind of alarming, but the recovery act does hold a number of things that we think are very promising for the alternative fuel vehicle market generically in States. If you’ve been through the plan, Rob, you’ll see a couple of line items that are specifically addressed at our segment. You have $300 million set aside for the Department of Energy for the Federal Government to purchase alternative fuel vehicles. You have another $300 million for the Clean Cities program that they have in place. You have $2.5 billion for development and deployment activities which is likely to be pushed down to some of the states, so I think all of those things are very positive. It’s a fluid situation. Those things are helpful. We continue to work with a handful of what we consider to be flagship opportunities on pilot programs, but in terms of when this will trickle through, we would begin to expect to see the fruits of our labors in 2010. This is not a 2009 type of event.

Operator

Your next question comes from the line of Ronald Oster with Broadpoint AmTech.

Ronald Oster – Broadpoint AmTech

I wanted to dig in a little bit on the gross margin guidance of 25-27%. The low end of that is about a 400 basis point decline. That’s pretty surprising when throughout 2008, I thought the big driver for the improvement was economies of scale, and when we’re looking for revenues to be flat year over year, I have trouble reconciling how you see such a large decline in that gross margin.

Matthew Beale

The first point that I want to make is that if you look at the fourth quarter, which is the first quarter of full blown exposure to the current economic situation, if you adjust for some of the items, we’re still at that 28%. I think as we’re guiding to that 25-27 range, there’s a number of things at work. In 2009, there’ll be continued weakness in the industrial market. In 2009, we will be integrating Tomasetto Achille, and that’ll involve some investments in getting to the synergies that we’re looking for. We’re launching two new businesses, both the US automotive division as well as the industrial engine dressing business, and so these are some of the drivers that in our mind dictate short term caution as it relates to gross margin. Phil, do you have some additional color?

Bill Larkin

No. I think that summarizes how we’re looking at it in our forecast.

Ronald Oster – Broadpoint AmTech

You said you have capacity of 800,000 conversions annually. Can you put that in perspective for us and maybe give us what it was last year or the prior couple of years, just to illustrate what the growth looks like on a companywide basis?

Matthew Beale

I’m sure that Mariano will have a lot of comments on that as well. Mariano, if you want to kick that off for us?

Mariano Costamagna

Yes. We increased our capacity in 2008 because we built two new factories, one in Livorno at the beginning of the year or roughly April, another one in Pisa in October, and another one in November close to Varsavia, and this has increased our capacity in 2008, and now we’re in a good position to fulfill the requests of our clients.

Ronald Oster – Broadpoint AmTech

But can you tell me what the capacity was in 2007?

Mariano Costamagna

In 2007, it was just Carrasco, and the Carrasco plant’s maximum capacity we never reached, but it was 5000 cars per month. That was the maximum capacity in Carrasco in 2007, but we never reached this capacity because we implemented Carrasco capacity step by step. This is the data I can say.

Ronald Oster – Broadpoint AmTech

But relative to the 800,000, what was the 2007 number?

Mariano Costamagna

The 2007 number, roughly at the end of the year it was 35,000 cars in 2007. That was just in Carrasco

Ronald Oster – Broadpoint AmTech

But what about companywide basis? We could take this off line. On S&A, can you give me a run rate in terms of what you’re expecting in 2009, Bill, stripping out some of these worn-off items that we saw in the fourth quarter?

Bill Larkin

If you look at our historical quarterly run rate for SG&A, we’ve been roughly about in the $9 to $10 million range. If you take out the items that we called out, that run rate is right around about $11 million. In 2009, we expect that to uptick a little bit more, probably to the $12 to $13 million range because, number one, we’re going to take on additional G&A costs related to our newly acquired Argentine operations, so that’s going to increase our G&A, and then also, we’re going to be taking on additional headcount, investing in our operations to invest in our new businesses, so that’s also going to have an upward impact on our G&A. We’re probably looking at $12 to $13 million run rate on a quarterly basis for 2009.

Ronald Oster – Broadpoint AmTech

That’s excluding the R&D expenses?

Bill Larkin

Yes.

Ronald Oster – Broadpoint AmTech

On the industrial segment, revenues were down roughly 50% year over year. Is there visibility there in terms of that bottoming, or do we have continued downside to the industrial revenue number from fourth quarter levels?

Matthew Beale

I think that 2009 is going to continue to be weak. The mix there has changed, Ron, not surprisingly at all, but from an OEM driven revenue mix to much more sales and components and replacement parts in the aftermarket, so that shift has taken place. We expect continued weakness during 2009, but we’re optimistic about 2010 when there is a change in regulation. We’ve got a product that we’ll be launching that we think is perhaps the most advanced technology on the market employing injection technology for industrial applications, and so we don’t expect any real turnaround there, Ron, until 2010.

Operator

Your next question comes from the line of Graham Mattison with Lazard Capital Markets

Graham Mattison – Lazard Capital Markets

I was wondering if you could give us a breakdown on the revenues between the two segments and if you could just talk about the margins in those two segments in the quarter.

Bill Larkin

Our revenue breakdown was roughly about an 80:20 split between our industrial and transportation, with transportation being the 80%. Our margin mix between the two has not significantly changed on a consolidated basis, and also as we talked about, we’re going to have a change in the mix of business. The delayed OEM or the OEM business, the margins are a little bit better, but they’re marginal, so we would expect due to the change in the mix in the transportation business between the aftermarket and the OEM business to significantly change the in or out years, and we saw in our fourth quarter as well.

Graham Mattison – Lazard Capital Markets

On the inventory charge, was that for inventory on the industrial and transportation?

Bill Larkin

A significant portion was in the industrial business. We’ve got some unique products, and going through our year-end closed profits and analyzing reserves, there were some products that we just couldn’t rework and was going to put a provision on those products.

Graham Mattison – Lazard Capital Markets

In terms of the investment you’re making in the factor in Michigan, how much would that be, and what type of uptick will we see in R&D spending in 2009?

Matthew Beale

On the CapEx side, we’ve got a number of things going on. Historically, if you look at our financials, you’ll see that CapEx has been in the 8 to 10 range. I don’t know if that bears from your analysis, Graham, but going forward, this year is going to be a year of investment. It’s tough to put an exact number on it, but that number could be significantly higher. I would say at the far end, it could double, and that’s not limited to what we’re doing with our industrial business, but also our transportation and some of the other things and initiatives that we have underway in addition to trying to activate and crystallize some of the synergies across our manufacturing platform.

Graham Mattison – Lazard Capital Markets

If you could just talk about the competition you’re seeing in the market on the transportation side. Is that weighing on margins at all, or has there been the pricing competition that we’d seen previously or has that not materialized in this new current market dynamic?

Matthew Beale

Mariano, you’d be the best person I think to tackle this one.

Mariano Costamagna

Talking about competition, yes, there are a lot of competitors in the market as you know in our field. We have one strong competitor called [inaudible] and many other competitors in small dimension and more localized in several areas, but none with a worldwide market. Those are our competitors.

Graham Mattison – Lazard Capital Markets

But have you seen any increase in competition that has been weighing on your margin in the fourth quarter?

Mariano Costamagna

As far as I know, our competitors are at our level of margin and so on, and we expect to maintain this margin because the market is there, and we’re really strong in our position in our technologies.

Operator

Your next question comes from the line of Patrick McGlinchey with Sidoti and Company.

Patrick McGlinchey – Sidoti and Company

Can you give a little bit of a further breakdown of that revenue? I know you said it was 82:18 transportation and industrial, but on the transportation side, can you break out the difference between the OEM and the aftermarket, and I know you said that kit sales down, but sequentially what was the OEM demand like? Was that up, down, flat?

Bill Larkin

Yes. I can provide some color on that. Historically in our business and as we have talked about before it’s been roughly a 70:30 split, where 70% was our aftermarket business. Actually, with the investment in our OEM business and the expansion of our capacity, we are going to expect that mix to change, so what we are starting to see that spread between the two where it is starting to become more weighted towards the OEM business. I don’t have the exact percentages, but I would expect that it’s going to start getting to a 50:50 split between the OEM business and the aftermarket business.

Patrick McGlinchey – Sidoti and Company

Could you tell me if OEM was revenue up sequentially in the fourth quarter as compared to the third and again if you can then just talk about January and February, the momentum for the distribution channels?

Bill Larkin

I think from our OEM business, any increase is going to be a function of an increase in our capacity. In May, we opened up the facility in Livorno. In late October, we brought on the facility in Czakram, Poland, so that brought on incremental revenue, probably later in the fourth quarter, and then in the first part of December, we brought on the Pisa facility, so hopefully we are going to start seeing revenue contributions from the Pisa facility in the first quarter, so we would expect further increase in contribution from that business due to that capacity coming online.

Patrick McGlinchey – Sidoti and Company

I know you guys point out that gasoline prices and where oil is at doesn’t have much as much of an effect as you would expect in Europe, but is there more of an effect on the aftermarket than there is OEM, and if that’s the case, looking out to 2009, if we were to see rises in oil prices, would you expect aftermarket sales may be not fall off as much as you might have baked into your guidance numbers?

Matthew Beale

The aftermarket sales, much more beyond the pump prices, are really a factor of the current economic situation Patrick to be honest with you, and I think even if the economics of converting your vehicle continued to be compelling, it’s really just a capital constraint situation which makes it difficult. It’s an investment for private individuals. I think that, all things being equal, is the biggest factor that’s impacting the aftermarket. I think the price of crude does make an impact as well, but if you look at the aftermarket and you consider some of the incentives that are also available, it just shows you what a difficult situation we are in as it relates to the economy, and how it’s constraining people’s ability to spend.

Patrick McGlinchey – Sidoti and Company

Just in regards to the general comment, you had a lot of these one-time items in the accounting, and you are expecting these not to be recurring, with accounts receivable and the inventory and those types of things. Are those things you really don’t think that you’re going to expect to see again for the next 6-9 months or are those things that we might possibly see popping up again?

Bill Larkin

I would like to say that we don’t expect these to happen again. These are very difficult economic times. We are trying to manage. We’ve got processes and plans in place to effectively manage our inventory and our accounts receivables and look at the creditworthiness of our customers, so we can put processes in place to try to minimize the effect of changes in the economy.

Matthew Beale

The other thing that I would just add to that is that what happened in the fourth quarter are very situation-specific adjustments that were made. What we are not seeing in the fourth quarter is that we need to rethink our entire portfolio of receivables, and we are increasing a generic risk provision, and that is not in all the case. These were very situation specific events.

Patrick McGlinchey – Sidoti and Company

Are there any customers that you have out there at this point right now that do raise a red flag or cause for concern?

Matthew Beale

As of now, no.

Operator

(Operator Instructions). Your next question comes from the line John Roy.

John Roy

You mentioned a little bit on the subsidy situation. I was wondering if you could give us some more color on what are the key subsidies that you currently have and what are your expectations for any possible changes, particularly in the US for bifuel subsidies.

Matthew Beale

In the US, we are starting to the regulatory environment and some of the incentives a little bit more clearly. Clearly the recovery act or so-called the stimulus package offers some very high level packages for the federal government. It then through the Clean Cities program of the DOE, and will trickle down in the form of tax incentives. Those are the federal programs that are available. You’ll also see some very specific programs at the state level, which again administered in the form of tax credits, for the purchase of alternative fuel vehicles. There are a number of states that have very specific programs. You can look at Texas, Utah, Oklahoma which are incentivized in terms of individual, mainly it is a fleet driven issue right now, the purchase of alternative fuel vehicles.

John Roy

Historically, they haven’t really been kindly looking on bi-fuel vehicles. I wonder if going from mono-fuel subsidies to bi-fuel subsidies. Do you see that happening?

Matthew Beale

Yes. The jargon is dedicated systems if you read the literature that they talk about. Yes, the dedicated system particularly in a car context is one that is a challenge from a bi-fuel perspective, and then you get into what is the definition of dedicated. Is it starting on gasoline, does that continue to dedicated? At what level of gasoline operation is it dedicated? These are some of the regulatory challenges that we are working in, and part of what we are investing also in the states is to be sure that the education is there to understand, to put bi-fuel systems on the same footing as dedicated systems.

John Roy

But you have no ideas in your own mind of going to a dedicated system as if it were a mono-fuel type of technologies for yourself. You’re really going to stay a bi-fuel specialist.

Matthew Beale

We obviously have the technology to do a mono-fuel system. That’s not the question. The question is really where the demand is going to be. If there is no infrastructure, mono-fuel makes no sense, and the $300 million for federal vehicles or administered through the Clean Cities Program, they are going to find a hard time finding a home, so we really think that for this technology to take hold, we need to be at the forefront in pushing for putting dual-fuel or bi-fuel systems on the same footing as dedicated systems.

Operator

Your next question comes from the line John [Kardy] with Principal Global Investments.

John Kardy – Principal Global Investments

I wanted to get a little better understanding of the ramp up in the US operation this year and how much maybe you’re budgeting in terms of startup cost and get a little clarification on how that is going to impact gross margins as well as SG&A expense? I think you may have alluded to it on the SG&A ramping up from $9-$10 million to 12 or 13 and some of that includes the acquisition down in Argentina.

Matthew Beale

You could separate it. Just taking the US initiatives for the time being, I think if you look at the industrial issues we have, in order to absorb some of the manufacturing expenses and overhead that’s attributable to the cost of goods there, it’s going to take a while to ramp to the volumes that are going to make that happen, so that’s going to have an impact on cost of goods. A similar situation exists but to a lesser extent on the automotive side of things, and we are in penetration mode, we are in development mode, we are in pilot program mode, none of which are in an environment where you can get the most out from a gross profit perspective.

John Kardy – Principal Global Investments

Do you intend to have at least a pilot OEM facility operational in the US by the end of this year?

Matthew Beale

No. We hadn’t said that at all. The pilot is more pilot customers, but we are looking. I think as we look at the strategy, we talked a little bit about CapEx. There is a number of ways to approach the US markets, and we are trying to maintain maximum flexibility to execute the strategy based on the changing regulatory environment, and that could be an option as well.

John Kardy – Principal Global Investments

In terms of the tax rate, because of maybe increased losses or deceased profitability in the US side of the business, would we expect to see a tax rate on a consolidated basis for the company approximating 46% which you paid in 2008 or will it be higher than that?

Bill Larkin

That’s hard to say right now, just because we do have operations in various foreign tax jurisdictions and plus the net operating losses that we have in the US which definitely skew our tax rates. In 2009, it wouldn’t surprise us if we have some anomalies in our tax rates because of those facts.

John Kardy – Principal Global Investments

Why was the tax rate so high in the fourth quarter, nondeductibility of certain write off?

Bill Larkin

Well, we generated disproportionate profits over in Italy, reduction in pretax income in the US and our net operating losses and so all those factors combined resulted in the extremely high tax rate that we had during the fourth quarter.

Operator

Your next question comes from the line of Mark Rogers with [inaudible].

Unidentified Analyst

I just did some quick math. It looks like you had a 70:30 split on the aftermarket and the OEM. Since sales are going to be flat for ’09, to me it suggests that OEM sales are up 67% and aftermarket is down 30. Does that fit what you guys are seeing in the market?

Matthew Beale

I’m trying to redo your math here, but the first input that you gave, that’s not what we were saying in terms of the OEM and aftermarket. That’s what it had been traditionally. I think what we are saying is that that gap has narrowed. In fact, probably on the OEM side as it relates to transportation. The majority is probably coming from the OEM sector, so the math is flip flopped there.

Unidentified Analyst

If you are going from 30 to 70 to 50/50 and sales are flat. I realize the mix shift, but you are having to make up for the bigger piece, and the smaller pieces are making up for all that growth, right?

Matthew Beale

I would love to confirm or deny your math there, but I’ll have to do the calculation myself, but I think directionally what you are saying is correct that the OEM business continues to grow and to be strong, with this continued weakness in the aftermarket side of things.

Unidentified Analyst

I also noticed there are a couple of sell side surveys out that showed some of the aftermarket sales down as much as 50% in January and February in Italy. Are you seeing those trends around the rest of the regions or can you give some regional breakdown on the strength or the weakness in the sales by region?

Matthew Beale

Mariano, do you want to help us with the regional breakdown of the business on the transportation side?

Mariano Costamagna

Transportation side in Italy continues to be strong as you know, and we increased our capacity. That market continued to grow as you said Matthew on the OEM side and decreased a little bit in the aftermarket.

Unidentified Analyst

In terms of the trends you are seeing in January and February in your full year guidance, is that front or back loaded or are you assuming pretty even performance throughout the year? Basically what you’ve seen in January and February, is that pretty consistent with the full year numbers you have given?

Mariano Costamagna

Yes.

Unidentified Analyst

You confirm that January and February is inline with your full year guidance?

Mariano Costamagna

Yes.

Matthew Beale

Certainly as we look at the full year guidance with the benefit of everything that we are seeing and what we have put out there as it relates to the initial part of the first quarter, what we saw in December, and there are some anomalies in terms of seasonality, there is kind of an operating cycle, and December and January tend to be slightly weaker, but we are confirming the guidance that we put out there, if that’s the question.

Operator

Your next question comes from the line Jamie Lester with Soundpost Partners.

Jamie Lester – Soundpost Partners

I’m just wondering if you could give us a sense of what sort of visibility you do have. Obviously a lot of businesses don’t have very much visibility these days. I just want to get a sense for why you guys can put a number out there and how much confidence you have in that number?

Matthew Beale

I think strangely enough as the business becomes more OEM oriented and becomes more transportation driven, that actually helps us on the visibility. This is our best estimate of the business scenario that we operating in, and I think as we put in place these facilities, particularly as it relates to the OEM instillations, we have a much better feel for what things are likely to be, also as it relates to the programs we are putting in place and we are working, the models that we are conducting the engineering and certification work on, so that’s really what gets fed into it, and then of course you have other factors, like where is the aftermarket going to be, where is the economy going to be, where is the industrial market going to be, but all of those bits and pieces together are what is the formula for the guidance.

Operator

Your next question comes from the line [Adam Howe – Holden Capital].

Adam Howe – Holden Capital

I’m having trouble reconciling your comments on the OEM outlook with the industry sales trends and also with the comments of your competitors. Could you please identify some specific programs or partners that will allow you to achieve these sales goals in 2009?

Matthew Beale

Sure, and I don’t know who those comments to exactly, but on the OEM side, you have really particularly in Italy only two players which were one that are working in this segment, this so called delayed OEM segment. The OEMs that we work with are well known, from Ford to Hyundai-Kia, across the board, Chevrolet Europe, and there are a number of OEMs that we’re working with and those are a matter of public record. I think it is more difficult particularly as we sit here in the US to think about any growth in the OEM segment, but really it has been a bright spot in the OEM automotive for dual-fuel vehicles and that has been also helped, no doubt, by the subsidy program that is available in particular outside Italy.

Adam Howe – Holden Capital

Is there a particular product or technology launch in 2009 that you expect to drive your sales?

Matthew Beale

On the automotive side, it’s really ongoing, and we’re engineering the right product based on our OEM requirements. In 2009, at least on the industrial side, we referred to what we think is a very significant new product launch where we are applying our automotive fuel injection technology for an industrial application.

Operator

Your next question comes from the line of John Quealy with Canaccord Adams.

John Quealy – Canaccord Adams

Just a question about the outlook and the guidance. When you look in the transportation side of the business, specifically the OEM channel, obviously you’ve got some pretty big incentives kicking in Italy on February 7th. Does that change the seasonality or expected quarter by quarter performance of the transportation business as you move forward? Secondly, Matthew, thanks for the details on the mix shift within transportation on OEM and aftermarket or perhaps delayed OEM and aftermarket, but can you comment on how much do you think is cannibalization or just tough comps versus the economy we’re in?

Matthew Beale

Let’s take the last one, the cannibalization. These are very different segments. The aftermarket conversion segment and the OEM segment, and they have very different drivers, and if you look at the incentive programs which are extremely attractive, as you know John, you’ve done a lot of work on this, the subsidies, they’re very attractive for new vehicles in particular, and the subsidy program has allowed the manufacturers to put in the showroom a bifuel and a monofuel version of the same model and offer them at the same price. That’s a very compelling sale story, and part of the reason why this segment has been as strong as it has. There is not a lot of cannibalization between the two between who is in the market for a new vehicle and who is looking for a retrofit conversion to benefit from some of the economies. We don’t see a lot of cannibalization there, John, to answer your question.

John Quealy – Canaccord Adams

In terms of the sequence, if you will, of OEM sales, if they’re just getting restarted, at least what hear in February a little less negative from an OEM perspective, how do you model, if you will, as you look for the business? Is it going to be more seasonal do you think this year or not?

Matthew Beale

I think the weakness that we’ve had has traditionally been, and I’ll leave the summer months aside for a moment because they seem so far away, but as it relates to December and January, it has been weak, and that’s what we’ve noted on any kind of channel check that was done. February and March look good. We’d expect that to continue and not be quite as spiky as maybe it has been or as the aftermarket has been, if that’s helpful at all John.

Operator

Presenters, please proceed with your closing remarks.

Matthew Beale

Thanks to everyone for joining us today. We’ve long been a leader in alternative fuel technology. With continued advancements in regulation and certification, there is more demand than ever for efficient solutions. In 2009, we plan to invest further in our technology to capture opportunities of the future. We look forward to speaking with you next quarter.

Operator

This concludes today’s Fuel System Solutions’ fourth quarter and year end results conference call.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Fuel Systems Solutions, Inc. Q4 2008 Earnings Call Transcript
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