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Executives

Kirsten Chapman – Investor Relations

Mariano Costamagna – Chief Executive Officer

Matthew Beale – President and Chief Financial Officer

Michael Helfand – Chief Accounting Officer

Analysts

Robert Brown – Craig-Hallum Capital

Dilip Warrier – Thomas Weisel Partners

John Quealy – Canaccord Adams

John Roy – Janney Montgomery Scott

Ted Kuntz – Needham and Company

Patrick McGlinchey – Sidoti and Company

David Woodburn – Thinkequity

Eric Stein – Northland Securities

Graham Mattison – Lazard Capital Markets

George Furman – GunnAllen Financial

Louis Tomey – Delta Partners

Fuel Systems Solutions Inc. (FSYS) Q2 2009 Earnings Call August 7, 2009 11:00 AM ET

Operator

At this time, I would like to welcome everyone to the Fuel Systems Solutions second quarter 2009 results conference call. (Operator Instructions). Ms. Chapman, you may begin your conference.

Kirsten Chapman

Thank you all for joining us on the call today. With me from management are Mariano Costamagna, CEO, Matthew Beale, President and CFO and Mike Helfand, CAO. Today Mariano will provide an overview, Matthew will review operations and Mike will follow with the 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 the earnings press release issued yesterday. If you've not received a copy of the release and would like one, please call Lippert/Heilshorn & 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 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 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.

And now it is my pleasure to turn the call over to Mariano Costamagna, CEO. Please go ahead, Mariano.

Mariano Costamagna

Welcome to the Fuel Systems Solutions 2009 second quarter conference Call. We had a very successful quarter. We reported better than anticipated quarterly revenue of $92.3 million. The significant change in year-over-year euro to U.S. dollars exchange rate has reduced our revenues 10%. Without this impact our revenue would have been up slightly, even in this global recession.

Our revenue was solid due to the strong performance of our Delayed-Original Equipment Manufacturers transportation business, called DOEM. During the second quarter we achieved 37,000 DOEM system installations, up from 30,000 in the first quarter, plus 20%.

Our great volume is creating economies of scale and gross margins reached 31%. Coupled with a cost saving program, our operating margin also improved. And we delivered earning per share of $46.00. In addition, we advanced our strategies to acquire complementary technologies and product capability that enable us to future leverage our platform. In May we purchased certain assets from FuelMaker and this week we closed the Teleflex Power Systems acquisition we began during the quarter.

Now I will turn the call over to Matthew to provide an operational review.

Matthew Beale

Our investments thus far in 2009 mark our commitment to advancing fuel systems leadership position in the transportation and industrial alternative fuel systems markets. We intend to continue to identify opportunities that expand our capabilities and enable us to capitalize on the attractive medium term growth drivers in our chosen markets.

The completion of our acquisition of Teleflex's Power Systems business earlier this week, marks an important step forward in the execution of our growth strategy. The alternative fuel components and systems are highly complementary and assert our leadership positions in the transportation and industrial businesses.

The auxiliary power systems business produces anti-idling auxiliary power units that are used to generate power for operators of parts, Class A trucks and diesel locomotives. This business broadens our markets with diverse growth potential driven by regulatory and emissions standards.

Like our prior successful acquisitions we will be integrating operations and provide you with updates on the quarterly calls. While the acquired businesses delivered approximately $40 million in the first half 2009, current market conditions suggest a $60 million to $70 million annual run rate. We will own the business for almost five months in 2009.

We continue to expect this transaction to be mildly accretive in 2009 earnings and greater contributions beginning in 2010 when we expect to benefit from these synergies we create. We have updated our 2009 financial guidance to include this.

Next I'll provide an update on our transportation business which continues to be our strongest business. In Europe the demand for alternative fuel vehicles continues to be solid supported by attractive fuel price differentials, government incentives and a favorable regulatory environment. We are capturing the opportunities to supply the market with our broad offering of quality bi-fuel solutions through our key OEM relationships and expanded DOEM installation capacity.

In the second quarter, our DOEM business completed 37,000 installations, exceeding our first quarter 2009 rate of 30,000. We would like to remind you of our seasonality. Regarding DOEM conversions, we typically have greater volumes in the first half of the year due to the European summer and December holidays in the second half of the year.

Currently we are on track to exceed 120,000 conversions in 2009 up from nearly 58,000 in 2008. In the U.S. we are making progress executing our fleet strategy. To ensure breadth and longevity to serve the automotive market, we are building our EPA certification portfolio.

This quarter we earned six certifications for several Chevrolet and GM-branded vehicles including passenger cars, light duty class pickups, cargo vans and SUVs commonly used for fleet vehicles. In addition, we continue to work with industry advocacy organizations such as [NGDAmerica] and the Propane Education and Research Council that promote the use of natural gas and liquid propane gas vehicles in America.

While our OEM business is performing better than anticipated in the recession, we continue to experience softness in our aftermarket business. We believe this reflects mainly continued weakness in the global economy. Nonetheless, we are beginning to see preliminary signs of improvement in the aftermarket in some European markets.

In the U.S. automotive business we've begun to build out our distribution channels. In June we signed an agreement with CleanFUEL USA, an established player in the LPG alternative fuel vehicle market. CleanFUEL will distribute fuel systems EPA certified bi-fuel kits for conversion of light duty GM and Ford vehicles through its authorized installation network.

Regarding our Argentine subsidiary, DS, we are substantially completed with the integration and are now focused on improving efficiencies and allocating production across our manufacturing platform. In addition, we are updating our marketing strategy for our recent acquisitions including Teleflex Power Systems which adds brands to our BRC, [Dobaly] and Tomasetto Achille portfolio.

Lastly we are adapting our existing CNG refueling production to incorporate the assets and technology we acquired from FuelMaker. By blending our manufacturing expertise with the new product capabilities we can offer a complete range of refueling products for commercial, small to medium fleets and consumers in existing and developing markets. We believe that this expanded capability will be an asset as we roll out our North American automotive strategy.

In our industrial business, as anticipated, capital constraints and the slow economy continue to create a challenging market environment. As discussed on previous calls, while we are managing the current market we are focused on the future.

In our new industrial engine dressing facility we are providing a turnkey package that addresses the new 2010 emissions standards and we are well positioned to benefit when the global economic climate improves.

Regarding corporate events, in June we successfully raised $30 million in gross proceeds in a registered direct offering to fund growth initiatives as well as working capital needs. In May, we announced we are relocating our corporate headquarters to New York City to create a central base for managing operations in Europe, Latin America and the United States.

The move will be instrumental in streamlining our corporate offices and physically positions our team more centrally to improve global communication logistics. The move is expected to be completed by mid August.

In conjunction with the move we named Mike Helfand Senior Vice President of Finance and Chief Accounting Officer. Mike has been consulting with the company since the beginning of 2009. We are very excited to have him aboard permanently and he has joined me in our investor relations efforts.

Now I'd like to welcome Mike to the call and give him the floor for a review of the financials.

Michael Helfand

I'm going to begin with a review of the second quarter ended June 30, 2009. Our total revenue for the second quarter was $92.3 million compared to $98.3 million in the prior year. Our transportation segment represented 88% of those revenues with a significant portion contributed from the OEM and our industrial segment represented 12% of the revenue.

For the second quarter our non-U.S. operations accounted for approximately 91% of our revenue and the impact of foreign changes in currency when translating our foreign subsidiary financial statements which are predominantly euro into U.S. dollars resulted in a decrease of approximately 10% with $10.2 million for the second quarter of 2009 when compared to the prior period. So excluding the foreign currency exchange impact, second quarter revenue would have been up slightly compared to a year ago.

Gross profit for the quarter was $28.6 million with 31% of revenues for the second quarter of 2009 compared to a comparable $28.6 million or 29% of revenue a year ago. And this reflects that this quarter, the greater DOEM volume have reached a critical mass and delivered some economies of scale which helped improve those margins.

Second quarter 2009 SG&A expense was $12.7 million including approximately $1 million in costs related to acquisitions and our reorganization and move to New York as compared to $11.7 million in the year-ago quarter.

R&D expense during the second quarter 2009 was $3.3 million as compared to $2.7 million in the second quarter of 2008. And our total operating expenses for the quarter were $16.1 million or 17% of revenue and for the second quarter of 2008 total operating expenses were $18.4 million or 18.7% of revenue, and that included a non-cash $3.9 million goodwill impairment charge relating to our Australian operations.

Operating income for the second quarter of 2009 was $12.5 million or 14% of our revenue compared to $10.2 million or 10% of our revenue a year ago.

Our other income was $836,000 as compared to other expense of 43 a year ago which primarily represents net gains on foreign currency transactions and our income tax for the quarter was $5.6 million, primarily representing foreign taxes and an effective rate of 43.1 as compared to $4.9 million a year ago.

And our second quarter net income was $7.4 million or $0.46 per diluted share as compared to $4.6 million or $0.29 per diluted share in 2008 second quarter, which included that non-cash $3.9 million impairment charge or $0.25 per diluted share.

On to the six months ended June 2009, our total revenue for the first half of 2009 was $172.4 million as compared to $192.9 million for the first half of last year.

The impact of changes in foreign currency when translating the foreign subsidiary financial statements into U.S. dollars for the six months resulted in a comparable decrease of the quarter of approximately 10% or $19 million for the first half of 2009 when compared to the prior year period. And our net income for the first half of 2009 was $14.5 million as compared to $10.8 million in the same period last year.

EPS for the first half of 2009 was $0.90 per share and $0.69 per share in the year-ago period including that impairment charge.

Now I'd like to just take a couple of moments to talk about the balance sheet. At June 30, 2009 our cash and cash equivalent balance was $53.1 million compared to $26.5 million at December 31, 2008. During the quarter we received $30 million in gross proceeds from the sale of common stock in a registered direct offering.

Importantly, cash generated from operations during the second quarter was $21 million. At the end of second quarter working capital as $129.6 million compared to $82.8 million at December 31, 2008, and in the second quarter, we improved our net debt from a negative $28 million to a positive $11 million. And in addition, our efforts to better working capital were also successful as both inventory and accounts receivables have improved, excluding the effect of the acquisitions on the balance sheet.

Lastly, I'd like to talk about our financial guidance. As part of our overarching goal of simplifying our corporate structure, we continue to evaluate manufacturing and G&A cost reductions as well as a more effective means of managing inventories and receivables.

Today we are adjusting our 2009 annual guidance from the current market outlook, margin improvements and acquisitions, and we expect 2009 revenue to be between $370 million and $380 million. We are also targeting 2009 gross margins between 28% and 30% reflecting improved efficiencies resulting from greater DOEM volume. And we are targeting our 2009 operating margin to be between 11 and 13%.

Now I can turn the call back to Matt.

Matthew Beale

We continue to create opportunities to leverage our diversified platform and expand our engineering production and distribution capabilities. Our DOEM transportation businesses have remained strong even with the global recession, but we are positioning all of our businesses to capitalize on growth opportunities when the global economic climate improves.

We continue to further our leadership positions in industrial and transportation. The addition of Teleflex's power systems expands our global platform and broadens our target markets. With the addition of FuelMaker for fueling technology, we have capabilities from domestic and commercial to heavy duty for a complete refueling product line.

In summary we are excited about our leading position in the growing alternative fuel industry in our future prospects. We would now like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Rob Brown – Craig-Hallum Capital.

Robert Brown – Craig-Hallum Capital

Could you provide some more detail on the Teleflex acquisition? How long will it take you to kind of get this integrated and in general, do you think you can get that business up to the operating margins you see in your industrial business, which I think is low double digit operating margin?

Matthew Beale

As it relates to the business, we have – there's three market segments there. There's three business units if you will, two of which are businesses in which we currently participate and which are complementary. Having said that, we think that will obviously facilitate the integration, allow us to move forward quite quickly.

A third business line which as a manufacturing matter is very much akin to what we're doing in the compressor market, so we believe as a production question that is something that we'll be able to integrate as well quite quickly. We're looking – I think the time horizon we're looking at is around six months. Again we think that the transaction will contribute or make a positive contribution to the balance of the year, if to a lesser degree than in 2010. We hope to see the full benefits of the integration.

Robert Brown – Craig-Hallum Capital

On your FuelMaker, now that you've had some time to look it, could you give us some color on your strategy there. How do – do you know yet how you plan to go market and what should we look for for contribution? Is that a 2010 contribution?

Matthew Beale

Yes, I think it really is a 2010 contribution. Remember that there we acquired assets and technology not an existing operating business. So that there is a process of integrating those assets and technology with our existing facilities which we've made significant progress in doing.

In fact, we're – by the end of this quarter we'll have made very important strides in getting production up and running. We have integrated the main production parts with our existing compressor production facilities in Italy, and we also are maintaining and building upon what was a servicing infrastructure in North America.

So that's moving at a pace as much as we expected. I think towards the end of the year we'll feel that that integration in our go forward strategy have the ability to move forward. So it's really more of a 2010, I suspect, revenue type of question.

Our go forward strategy there is really to leverage some of the channels that are available to us through our OEM relationships and some of the commercial dialog we have as it relates to fleets for the domestic and commercial units.

Operator

Your next question comes from Dilip Warrier – Thomas Weisel Partners.

Dilip Warrier – Thomas Weisel Partners

I had a question on the Teleflex acquisition so it looks like revenue is going to fall off a little bit in the second half and I was wondering if that is also seasonal like your – like the main businesses, if it's the auxiliary power unit business that is going to see more weakness versus the complementary business?

Matthew Beale

I think the first half of the year there was – I think the business achieved or probably the businesses if you will achieved approximately $40 million in revenue. We're seeing a slight drop off. We think that was a strong first six months but as we look forward and we think about the business, we think the second half won't be quite, in volume terms, as strong as the first.

I think part of that also reflects the fact that this is a newly acquired business that we'll need to be integrating. We'll need to be looking at all of the markets in which we're operating. We'll need to be looking at overlapping relationships, what the go forward strategy is.

So I think as we look to the second half of the year, there is going to be some integration questions that we'll need to address. I don't think there's any particular weakness in any one business segment. I think it's really just a question of the global economy. It's not a particularly seasonal business. These are cyclical businesses however.

Dilip Warrier – Thomas Weisel Partners

Then on the transportation business, on the OEM partner that you worked with, are they already discussing 2010 outlook particularly in light of Italian incentives either being renewed or not being renewed and would you see yourself requiring to increase capacity in 2010?

Matthew Beale

Despite the OEM moniker the forward-looking tail on this business is quite short. I mean, the benefits of this strategy that we put in place is that we're able to help our OEM customers bring to market in a very short order a current model year vehicle.

So it is somewhat forward-looking but not quite that forward-looking out to 2010 and 2011. I think, as we discuss with our OEM partners and our view of the market, we look at the incentives programs and we really don't know. We have no certainty as to what will happen in 2010.

I think our view as we put forth in previous calls is that we believe that the program will continue in 2010, but we have no certainty that that will be the case.

Dilip Warrier – Thomas Weisel Partners

Just one last question on the SG&A expense line, there was a little bit of an uptick there at $12.7 million. I was just wondering if that was sort of one time based on some acquisition activity? I believe previous guidance or commentary was somewhere in the 11 to 12 range.

Mike Helfand

Yes, we definitely had about $1 million in transaction-related expenses and sort of the reorganization related expenses, so from a run rate standpoint we think we were pretty comparable to that 11.7 of last year.

The accounting rules have changed on the acquisition costs in 2009 where we use to be able to capitalize acquisition costs and being we were pretty active in the second quarter we, between attorney fees and consulting fees and things just to do acquisitions, we incurred between that and the reorganization about $1 million in those type of costs.

Operator

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

John Quealy – Canaccord Adams

First, Matthew, in terms of Teleflex a much bigger deal and acquisition than you folks have done in the past. You've been very bull, leveraging both the distribution in product capabilities but also the operating expenses. Can you talk about in broad terms expectations for leverage increase moving forward with Teleflex? Is it a different animal given the size or is it the same model applied to just a bigger number?

Matthew Beale

I think it is the same, well obviously, of course, I would point to the BRC transaction as being another pretty significant transaction, but I think the model really is the same, John, and the numbers are – I guess the revenue numbers are somewhat bigger than other recent transactions, but the model is very much the same.

We obviously see a lot of potential to improve margins in that business and integrating it with our existing IMPCO business. The transaction which really doubles the IMPCO business if you think of it that way and we would hope that the combined business, we'd be able as things improve here in the economy that we would be able to drive margins up to what we had traditionally achieved in our industrial operations.

John Quealy – Canaccord Adams

And then secondly, in the North American business with the new acquisitions and the platform broadening out, can you give us how you and the rest of the management is looking at tangible growth in the North American market? Is it primarily driven by legislation, infrastructure and then end market? How should we calibrate progress on the development of an alternative fuel marketplace and how Fuel System plays in that in North America?

Matthew Beale

Yes I think it's – as kind of an emerging market, if you will, there's two possible paths. One is the path that obviously we're pursuing, which is pursuing opportunities where we can and that's mainly in EPA states, states that have some measure of refueling infrastructure in place, states that have fleets that already are focused and accepting of alternative fuels, fleets that are in states where there's mandates that require a certain percentage of penetration of alternative fuel.

So that is a market and it's a market that requires work on the certification front. We've completed a lot of that this year with certifications we've put in place for the primary fleet vehicles. So that's a market. It's a market and it will develop. We would expect it to begin to contribute visible revenues if you will in 2010.

Regulatory changes are what could really make this market become significant very quickly. All eyes obviously are on this Nat Gas Act and what it could mean. The current language as we understand it with the specific reference to buy fuel technology is extremely significant, putting it on an even keel as dedicated system.

That type of legislation could change, we think, very significantly this marketplace. It's useless to have incentives, John, if you don't a have regulatory environment that supports the technology for which those incentives are available. So we think that's obviously very exciting but even without that, there is a market, an exciting and interesting market which we're pursuing.

John Quealy – Canaccord Adams

And my last question, more housekeeping, on the transportation business, the last couple of years Q3 has been resilient against what, at least from the outside, seems to be more of a slower period in the European market for consumer and capital transactions.

I realize you don't give near term guidance but in terms of things we should consider this year versus last, is there anything to suggest that that pastern of perhaps a more resilient Q3 in transportation wouldn't again repeat give the dynamics we're seeing with Cash for Clunkers and the low carbon fuel stuff over in Europe?

Matthew Beale

I don't know if they call it Cash for Clunkers, I do love the Cash for Clunkers, but I'm not sure they call it that. I think this seasonality pattern is always there. You do have those specific dates and for the summer holidays and the December holidays. We're not seeing anything that would suggest that past patterns would be altered significantly this year.

Operator

Our next question comes from John Roy – Janney Montgomery Scott.

John Roy – Janney Montgomery Scott

I know you don't give specifics but could you give any kind of color on the transportation in Europe in terms of percentages? In other words, how [high] was Italy and –

Matthew Beale

You cut off at the end, there John, do you mind repeating?

John Roy – Janney Montgomery Scott

Sure. What was Italy versus the other countries in terms of percentage of transportation or any kind of color you can give us on that?

Matthew Beale

What I can say is Italy and given the importance of the DOEM segment and a lot of our activity is in Italy with the DOEM market. In fact, most of it was our most important market, there's no question about it. And if you add in Europe overall, Europe was clearly our most significant geographic region.

John Roy – Janney Montgomery Scott

Right and second to that kind of as a follow on, I'm assuming we get the progress in the Nat Gas Act, which obviously as you said is a big deal. Do you think that this model could easily translate into the U.S. and are you already having discussions along that line?

Matthew Beale

Yes, it's something that we're seeing. There's a number of ways that this could pan out. I think that we obviously saw the opportunity on this model and it worked very well in Europe. It worked very well with auto importers and then also worked with local producers.

It's something that certainly could be pursued here. As a fleet vehicle matter, it probably wouldn't work quite in the same way in working with OEMs but it's clearly a channel and a possibility and we're keeping our options open there as we look at what the strategy will be. It really will depend on the behavior of OEM, of U.S. OEMs.

Operator

Our next question comes from Ted Kuntz – Needham and Company.

Ted Kuntz – Needham and Company

A couple of questions, first of all, Matthew, could you maybe go over the gross margin story a little bit more? Could you talk about obviously the gross margins were a lot higher than we all expected in this quarter, which was terrific. And you got it down a bit for them again and just kind of if you could give more color on that regarding how much of a lower estimate there is due from the Teleflex acquisition being included?

I assume they have lower gross margins that you do, maybe if you could clarify that a little bit for us. And how much is due to that versus maybe some conservatism on your part because your margins have been running ahead of your expectations?

Matthew Beale

Sure. Yes, I think as we look at the margins and having to – and first before we talk about Teleflex, I think what we've done is really guided up. We've adjusted our margins and we're where we sat about six months ago as we talked about gross margins, we had a significant shift in our business to a new type of segment.

There was a lot of uncertainty about where margins would lead. I think we have some quarters under our belt. In the meantime we've moved forward with trying to generate some of the efficiencies that our platform allows as it relates to critical mass.

I think we've been successful also in doing a bit of a better job as it relates to purchasing in certain aspects. So I think that a couple of things have happened is that we've been able to maintain margins in what has become a very significant business segment, at least for the time being and we've also at the same time gained some efficiencies. So that's what it's allowed us to achieve higher than expected margins and hence we have the comfort level of guiding a little bit further upward as it relates to gross margin.

I think for Teleflex, yes, that's correct that gross margins probably on the whole as a standalone business matter are lower than what we achieve. We would obviously be looking to work on gaining some kind of convergence with what we're able to do, that's a big part of the whole acquisition story and the upside and we're looking to do that.

Ted Kuntz – Needham and Company

Could you talk a little bit about the growth that you saw in the DOEM business? Could you be a little more specific as to where the growth actually came from? Was it mainly in Italy or Europe and maybe you could comment a bit on your Asia business as well?

Matthew Beale

Sure, as relates to the DOEM business, it's mainly in Italy as the programs have proceeded with a lot of the European OEMs as this technology gains traction. I think we've all now seen the statistics of one in four, one in five new vehicles that are sold in Italy are alternative fuels or bi-fuel, mainly propane but also natural gas vehicles. So and part of that is clearly the impact of the subsidy program, so growth continues the pace there in and Italy's been a very significant driver.

As relates to Asia, the Asian aftermarket businesses have been weak. We're very focused and we think of Asia in the broadest possible sense in looking at some of the OEM opportunities as well in Asia. And we've, specifically in India and Pakistan where we are investing and we see significant opportunities to partner with local OEMs and really providing complete systems.

It's not clear that this would involve a delayed OEM sense, probably not. But we are working with more as a true OEM type of market. So we see a lot of opportunity or growth there as we position ourselves as one of the leading suppliers to Asian OEMs.

Ted Kuntz – Needham and Company

And that you would expect to kick in more next year?

Matthew Beale – President

Yes, I think it's, we're beginning to see some success there, but I would expect it to kick in next year. At some point next year, we would also expect the global economy permitting, to some uptick also in the aftermarket. Again for the time being, it remains weak.

Ted Kuntz – Needham and Company

Great and maybe this is a question for you Matthew, or you Mariano, when do they review the subsidy programs in Italy again? When do you expect a decision about next year to have, to take place?

Mariano Costamagna

Ted, before the end of this year.

Ted Kuntz – Needham and Company

Okay, is that sometime, you would expect late in Q4, Mariano? Do you have any sense of when that could be? A little more specifically?

Mariano Costamagna

Yes, it's roughly before the end of this year. We expect these new rules before the end of this year. I don't know when in this moment, but we expect that before the end of this year.

Operator

Our next question comes from Patrick McGlinchey – Sidoti and Company.

Patrick McGlinchey – Sidoti and Company

In the past you've mentioned some emission mandates here in the States that you thought might help spur the recovery of IMPCO. Could you just refresh our memories on what may be coming up in 2010 to kind of kick that back in gear?

Matthew Beale

It's not really an emissions mandate; it's the normal regulatory cycle, which in 2010 a new regulatory regime as it relates to industrial equipment will be coming into play. So it's really about having a new product offering and a whole turnkey solution that helps our OEM partners to address the changing regulatory environment which will start from 2010.

So it's less of a mandate then just a shift in emission standards, much more stringent emission standards. And we've been partnering, obviously, during the last 18 months or so and also going forward with OEMs to get them a cost-effective solution that allows them to be at the cutting edge of regulatory standards.

Patrick McGlinchey – Sidoti and Company

And then just quickly on the transportation side over in Europe, is there a kind of a quarterly capacity ceiling you may be able to give us. Previously I thought the annual capacity was somewhere at 120,000 conversions, but obviously you look like you've surpassed that there. Could you just give us a number? Is it 45,000 is it 50,000?

Matthew Beale

As relates to, the important thing to note about this, what we are doing with OEMs in Europe and in specifically the delayed OEM segment is it's really not a capacity issue for us because just as a reminder, the facilities that we have, these are not capital intensive facilities that take a long time to set up and implement.

I am not undermining how difficult it is and our colleagues in Italy do an amazing job, but they're able to bring new capacity online very, very quickly. It's really a facility, a mechanized production line. Frankly, the bottleneck tends to be training and having personnel available to meet volumes. So it's something we can flex actually quite quickly, Patrick. So I wouldn't consider it a constraint, as such.

Operator

Our next question comes from David Woodburn – Thinkequity.

David Woodburn – Thinkequity

I just want to follow up on Patrick's questions regarding capacity. So with the DOEM facilities essentially being not capital intensive, does that sort of reinforce the comments that the upside in gross margin is more efficiency and sort of improving efficiency overall and it's not so much a case of reaching a point where you've surpassed most of the fixed cost and it all drops down then to the bottom line after that?

Mariano Costamagna

Of course efficiencies in volume, of course, are able also to do more and more and better and reach also a better result, as you know. And this is arguably more volume and more efficiencies and step-by-step we are working on this subject in order to review the cost, first, but obtain some benefit on the volume and, of course, the volume, of course.

David Woodburn – Thinkequity

And so then is it a case where, I guess I had been thinking previously that with the acquisitions that you've been entering into and pursuing, that that was sort of pursued instead of capacity increases in the DOEM channel. But it doesn't sound like they're mutually exclusive, that you can do both at the same time?

Matthew Beale

Absolutely David, we can and I think that the point is, as it relates to OEM decisions about the volume and models they want to bring to market in bi-fuel format. We can move quite quickly and we have the flexibility to move quite quickly to address that and in Italy our team has done just a fantastic job in doing that. And just being opportunistic and taking advantage of this opportunity. Acquisitions we consider to be a separate matter and it's certainly not in lieu of.

Operator

Our next question comes from Eric Stein – Northland Securities.

Eric Stein – Northland Securities

First Matthew, you mentioned at the start of the call that you were seeing some improvement in the aftermarket in some European countries. Can you talk about what those countries, or which countries those are and what's the reason behind that?

Matthew Beale

Yes, I wish I could answer the last part of your question. I think we're starting to see some very preliminary signs of awakening and I think throughout, the important thing to remember is throughout all of this the aftermarket in Italy has fared better than some of the others. Some of our other markets that are key markets in Europe there are some signs of preliminary reawakening.

I think there's markets such as Germany, Poland and Turkey that are real bellwether markets of what's happening in Europe and we're just starting to see some initial inklings. It's too early to call it a trend. We certainly would not suggest that what we're seeing is radically altering our perspective of the business scenario we're looking at for 2009. We can take that into account as we look at guidance as well.

Eric Stein – Northland Securities

Okay, so we should definitely think of that as a 2010 event. Just quick turning to Teleflex, can you just give us an idea of how we should think about the various operating expense lines going forward?

Matthew Beale

What's the impact? I think overall, and again, we just closed this week and so we're really rolling up our sleeves with our new colleagues and putting an integration plan in place and that will take a bit of time. I would say that we would expect a convergence of the metrics to what we've achieved historically, obviously in different kind of market times in our industrial business and that a really the goal and indeed looking to improve upon that. I mean, that sounds a bit of a cryptic answer, but I think that's the right way to look at it.

Eric Stein – Northland Securities

And as far as tax rate, any reason why that would be different than what your historical rate has been?

Michael Helfand

We've got a slightly lower rate right now in the second quarter and first half of this year. We have some good opportunities on the tax side. We have obviously historically been in the high 40s and sometimes the low 50% range. So we have some tax planning strategies that we've just started. We will maybe be able to take advantage of a couple of them later in this year and it will have a slightly positive result on our tax rate.

Right now we expect to be around 43% to 44% for the year. And that's assuming we can get a couple of these strategies in place. So that's a little bit of a benefit, but we think we have some good opportunities on the tax line as we put some of these strategies in place going forward.

Operator

Our next question comes from Graham Mattison – Lazard Capital Markets.

Graham Mattison – Lazard Capital Markets

A q Quick question I had here on the industrial business, you gave some sense of the revenues there. Can you give us some color on the margins in that business in the quarter?

Matthew Beale

Well, its margins there continue to suffer as relates to the overall scheme of things. They're much lower than where we want to be. You'll get a better feel for those things, when our Q comes out on Monday. But volumes are down and margins are down as a result, so it's not the kind of margins we'd like to be seeing right now, Graham. I hate to answer it like that, but we're at, in the second quarter, the business continues to be weak as it relates to the first quarter and we think that's going to continue out through the end of the year.

Graham Mattison – Lazard Capital Markets

And can you give a little more color as to what you're doing at the build-out of your dressing factory in Michigan?

Matthew Beale

Sure. I think that's part of what we've done and I guess what we probably don't emphasize enough, when we think about gross margins, I think the gross margins where we are as opposed to where we were about 12, 18 months ago reflects an emphasis on trying to put together solutions our turnkey solutions for our OEM, our industrial and transportation OEM customers.

And the Detroit facility or this engine dressing capability that we've invested in is part and parcel of that, as it relates to the industry business. It really allows us to offer that turnkey solution to industrial customers.

Now, with demand where it is right now, we're not deriving the benefits that we expect to see as the economy picks up and the industrial business picks up, as it inevitably will. So we've got the assets in place that allows us to really offer a turnkey solution for both industrial mobile OEM equipment manufacturers and some other more stationary type of applications, so we really think that that's the direction, that's what our customers are demanding. It's part of quality and warranty and so we really need to be able to offer this complete package, including the installation.

Graham Mattison – Lazard Capital Markets

And then a question on the delayed-OEM, are there other markets that you're looking to expand into that you can talk about, I mean outside of Italy or other parts out around the world or within Europe?

Matthew Beale

There are clearly opportunities, we think, to expand this internationally. We are exploring those. We wouldn't be over – it's difficult to be too specific. I think Poland obviously represents the first step in that direction. We see other opportunities in Europe, potentially Eastern Europe. Australia is another market where it's a market that is becoming very much an OEM market, and that's a market where we're already beginning to pursue this type of a strategy.

I think the thing to point out here, as this technology becomes so much more of a permanent part of the automotive landscape, it's going to become more and more of an OEM market and so we think that these types of opportunities, delayed-OEM approach or some variant thereof will offer a lot of opportunities internationally there.

Operator

Our next question comes from George Furman – GunnAllen Financial.

George Furman – GunnAllen Financial

Characterize for me your South American market, what kind of growth rates are you seeing there? You just acquired, I believe your Argentinean and Brazilian distributors.

Matthew Beale

Yes. We have had a long – our BRC operations have had a long and storied history in South America, and the key markets in South America clearly are Argentina and Brazil. It's a very significant importance and mature market. We acquired Tomasetto Achille. As you know our Distribuidora Shopping which operates under the Tomasetto Achille brand and now have a very important manufacturing capability in Argentina.

We bought out our minority interest of our partner, of our former JD partner in Brazil so we really have an opportunity to address what the very significant mature and, in many respects, has been an early adapter of this technology over the last several decades.

Growth rates, the market continues to be very weak in Latin America, Brazil I would say in particular. We don't see any near-term turn around there, but obviously think we're ideally positioned, when markets do begin to pick up there.

George Furman – GunnAllen Financial

And maybe the small acquisition that you made here, you bought I guess out of Chapter 11 some assets from FuelMaker. With the operations in Detroit and this acquisition, it looks like you are set to capture the explosive market when the recession passes here and in the United States.

Matthew Beale

We hope so. We think we are and it's very important to have that complementary refueling technology. Again, it's part of a conscious strategy to be able to offer kind of a turnkey or package solution. In our markets refueling is often just that, and particularly in a market where you don't have refueling infrastructure, you need to have the ability to offer, at least as it relates to fleets, a turnkey solution including a refueling capability.

George Furman – GunnAllen Financial

And you offer these retrofit gas station refueling systems in Italy, correct?

Matthew Beale

We have the ability, now with this recent acquisition, we have a complete line of refueling products from domestic refueling up through to the type of refueling equipment that would be required to operate with a commercial refueling station, so yes.

Operator

Our final question comes from Louis Tomey – Delta Partners.

Louis Tomey – Delta Partners

I was wondering if you break out the percentage of revenues that are from Italy for the quarter?

Mariano Costamagna

Matthew, would you answer?

Matthew Beale

We'll show our transportation and industrial. You'll see in the Q you'll get some granularity. It's just right now the Q will be coming out on Monday so you'll have a chance to take a look at that. What you'll see clearly is that Europe and Italy in particular continue to be, for the time being, the major portion of revenue.

Louis Tomey – Delta Partners

Right. Can you give us a sense for the mix, overall, for the OEM versus the aftermarket percentage?

Matthew Beale

Yes. This is something we've, it continues to be that we are – the OEM segment overall continues to really be about two-thirds of our business right now, as relates to aftermarket, almost a reversal of what it had been traditionally.

Louis Tomey – Delta Partners

And what is the differential in margins between the two pieces, OEM and aftermarket?

Matthew Beale

I think it's a tough comparison to make. I think I would say generically that as it relates specifically to this DOEM system installation type of strategy, you need to remember that that is truly a turnkey solution where we're providing some front-ended engineering and development.

We're producing, obviously, the equipment but we're going so far as to install them. So we're adding a lot more value so naturally the margins would be higher in that segment, as opposed to a situation where you're selling components or systems.

Louis Tomey – Delta Partners

And you're talking about on a gross or operating, because operating, it seems like you would have less sales and marketing type of expenses and it's mostly the dealer doing that. Is there a difference when you look at it on gross margins versus operating margins?

Matthew Beale

First, my reference actually was obviously to gross margins. I think when you think about how does the distribution work, I mean it's a very different – the aftermarket's a very different channel where we are managing our relationships with distributors. In some selected instances directly with installers, but to a much, much lesser degree, so it's really a distributor type of market. In the OEM segment, it's very different OEM relationship type of marketing, and we tend to have types of resources that handle that type of market segment.

Louis Tomey – Delta Partners

So your point is that the OEM, the margins are higher on both the gross and the operating basis, versus aftermarket?

Matthew Beale

Certainly on the gross basis. On the operating margin basis, again, we have some resources and we deploy them differently to be successful in that particular channel.

Operator

There are no further questions at this time. Do you have any closing remarks?

Matthew Beale

Okay, well, I'll just, to close out, thank everybody for joining us today. We're excited about our leading position in the growing alternative fuel industry and our future prospects. The U.S. team will be presenting at the following conferences: The Canaccord Adams 29th Annual Growth Conference in Boston on the 11th of August; the Sidoti Growth Conference in San Francisco on the 11th of September; and Thinkequity's 6th Annual Growth Conference in San Francisco on the 17th of September. We hope to see many of you there. Thank you very much.

Operator

This concludes today's conference call. You may now disconnect your line.

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Source: Fuel Systems Solutions Inc. Q2 2009 Earnings Call Transcript
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