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Executives

Leah Gibson – Director – IR

Steve Rhoades – President & CEO

Aaron Gomolak – CFO, EVP & Treasurer

Analysts

Ash Birla – Dougherty & Company

Dale Pfau – Cantor Fitzgerald

Adam Krop – Ardour Capital Investments

Carter Driscoll – CapStone Investments

Jeff Osborne – Stifel Nicolaus

Walter Ramsey – Walrus Partners

SatCon Technology Corporation (SATC) Q1 2012 Earnings Call May 9, 2012 5:00 PM ET

Operator

Good afternoon and welcome everyone to SatCon’s First Quarter 2012 Conference Call. (Operator Instructions). With us today are SatCon’s President and Chief Executive Officer Steve Rhoades, Executive Vice President and Chief Financial Officer, Aaron Gomolak and Director of Investor Relations, Leah Gibson.

At this time for opening remarks I would like to turn the call over to Ms. Gibson, please go ahead.

Leah Gibson

Thank you Roya and welcome to the call everyone. Before we begin please note that the comments made on this conference call today may include forward-looking statements that involve a number of risks and uncertainties. For this purpose any statements contained herein that are not statements of historical fact maybe deemed to be forward-looking statements and may include the words beliefs, anticipates, plans, expects, intends and similar expressions which are intended to identify forward-looking statements. And important factors that could cause actual results to differ materially from those inferred from such forward-looking statements or set forth under the caption risk factors and SatCon’s Form 10Q for the quarter ended March 31, 2012.

These factors are included there for reference. Once filed with the SEC copies of the 10Q will be available from SatCon upon request and will be posted to the company’s investor relations website at SatCon.com. In addition, today’s call is being recorded and a webcast replay will be available on the Investor Relations website.

This conference call and associated recordings belong to SatCon and appear for the benefit of our investors. With that I will turn the call over to our President and CEO.

Steve Rhoades

Thanks Leah. And good afternoon everyone, thanks for joining us today. Today I would like to take advantage of our time here to look back on the 2011 solar PV, inverter market, how it affected SatCon strategies and overall performance both last year and in the first quarter of 2012.

Then move on to our Q1, 2012, part of the metrics that we reported today. Then I will give you our look for the current Q2 outlook and in particular, this we have and are in the process of taking to put the company in a position to achieve success in the second half of this year and into 2013 and beyond and we will then take you through our detailed financials before we turn the call back over to the operator for our traditional live question and answer session with all of you attending the call today.

As we look back just over a year ago to the transition from 2010 and 2011 we can see the solar industry that started with all the expectation and fan fair associated with one of the fastest growing, most publicized industries we are planning, quickly becoming unpredictable and unstable.

We are at the 2010 our industry saw a hyper growth across all major solar market geographies and where SatCon is able to transition itself from a small technology led regional utility and commercial inverter player into a major global supplier across three continents. January, 2011 suddenly trust a solvent to a hyper competitive battle in every major solar market.

As an example under shifting government programs that once made large ground mount solar power plants in Europe extremely lucrative and opened up vast new opportunities for SatCon’s flagship utilities scale of power.

Policy change in early 2011 in several major countries made development of new utility scale systems firstly impossible to do profitably. This unexpected and severe change gigawatts of PV panel and inverter capacity and (inaudible). And prices subsequently plummeted as competition rose for the increasingly fewer new development staying content (ph).

While drastically lower panel prices across Europe created the economy that would post light commercial and residential solar to new heights, SatCon Solutions which had great success in Europe’s utility solar market segment in 2010 simply didn’t match the requirements of an industry that shifted its demand segment in a matter of months.

Asia, while still on a path of hyper growth for utility solar in 2011, our capacity rose and pricing fall faster than anyone in the world as low price Chinese inverter providers enter the market by dozen and local panel manufacturers looked to sell product locally does not finding demand in their traditional markets abroad.

This created a large volume market for panel and inverter manufactures in China many of them who are willing to operate at razor thin margins. But effectively close the Chinese market to more experienced western manufacturers to focus on long term product quality and services often price the amount of competition.

Despite this volatility abroad North America continued to demonstrate fairly consistent growth across all three major solar segments. Large commercial and utility solar grew in aggressive rate despite the fact that the Canadian solar market struggled to gain the momentum initially predicted after the announcement of their Ontario Feed-In-Tariff.

Looking forward our current U.S. pipeline data suggest continued growth in 10 plus megawatt solar power plant development over the next several years and further strengthening of the commercial rooftop market.

I have taken all of this into account, these quickly evolving market dynamics forced us to change course and strategy on many levels in the second half of 2011 and as I outlined further today. These dynamics will continue to affect our actions in the first half of 2012 as we position the company. As I outlined further today these dynamics will continue to affect our actions in the first half of 2012 as we position the company to take advantage of the strong back half of this year and in 2013.

We have outlined in last call several years of focus for lowering cost, increasing operational efficiencies, introducing leading technologies solutions and stream lining sales to be most effective in the areas of growth for SatCon.

Example of these efforts include lowering our headcount to that equal to where we in January of 2010, paying down over $55 million of debt over the last nine months. Closing our manufacturing facility in Burlington, Ontario as we move to an almost completely variable cost contracted manufacturing model. Introducing industry leading solutions for large scale medium voltage such as the Equinox Prism Platform and new technologies for light commercial solar with Equinox LC and finally moving to off payroll distribution sales models for territories such as China with our partner CEC Great Wall and in Europe, Middle East, and South Africa with our partner in Africa STL (ph) Solar.

While there is still more work today we are in a path of putting ourselves in the right position to be successful in the second half of this year and into the future.

This quarter’s numbers although not in-lined with our long term goals do show that while Q1 was a struggle and Q2 will only experience modest revenue growth, bookings have been well above historical numbers. Gross margins are increasing significantly and we are building a strong business for the second half of the year. Further revenue for the quarter in Q1 was $24.3 million in-line with our guidance for the quarter between 22 million and 25 million.

These revenues were lower than Q4, 2011 are not unexpected given the seasonality of the solar inverter market. Shipments totaled 98 megawatts with 96% of deliveries going into North America during the quarter. Our 500 kilowatt inverter solution continues to be our highest performing product segment, representing 32% of megawatt shift. Our medium voltage turnkey solution in Prism platforms represented 23% of total megawatt shift.

Totaling of over 50% of our revenue for the quarter our utility scale inverters continue to be our solutions in the highest demand in the market. Bookings for the first quarter 2012 were approximately $45.6 million, an increase of a 134% for the fourth quarter of 2011 and 29% over the first quarter of 2001.

These bookings included sales to settle large ground mount sites to be constructed in the second half of 2012, the most prominent being the sale of book Equinox and Solstice equipment, the GCL solar for the construction of a 60 plus megawatt site in North America over the course of Q3 and Q4 this year.

The first quarter of 2012 also marked the company’s most successful booking period in over a year, while the book to bill 1.9 to 1 demonstrating the strong demand for our industry leading solutions.

The majority of these shipments are planned for the second half of the year. In addition to the strength in the second half of the year in North America we see strong demand again in China through our newly signed contracts with CEC Great Wall technology a multi-billion dollar state owned entity in China who will build market, sell and serve on SatCon inverters for the Chinese market.

As I discussed earlier, the European solar market remains highly volatile and where we are at that success in some geographies our best long term strategy will be to focus on developing business through our well-developed partnership in Southern Europe with SDL Solar and through our international customers that have a global presence in this market. This strategy will allow us to take advantage of emerging markets there in the Middle-East and South Africa while still maintaining a presence to service both European market as well as European developers for projects worldwide.

Solution Innovation has consistently been a core strength of SatCon and remains essential to our strategy for the differentiation in the inverter market. In the first half of 2012 we have introduced the next in line of our industry leading Prism solutions the 1.5 megawatt Equinox Prism platform.

We also introduced a new cutting edge technology, the Equinox line of an LC line of inverters targeting the growing Light Commercial Rooftop Solar market.

We have already taken 50 megawatts of ores (ph) from the 1.5 megawatt Equinox platforms which will be in shipping in August. And the Equinox LC line is taking orders now begins shipping in June. As we look out in the second quarter 2012 we expect moderate revenue growth. As we look ahead into the second half of 2012, we expect revenue to grow sequentially and we expect to be EBITDA positive in both Q3 and Q4.

With that I will turn the call over to Aaron who will review our financial results.

Aaron Gomolak

Thanks Steve and good afternoon everybody. Revenue for the first quarter of 2012 was 24.3 million compared with 36 million in the fourth quarter of 2011. The decrease in Q1 revenues reflects expected seasonality the company experiences during the first part of the year. During the quarter we sold 98 megawatts of our inverter solutions as compared to a 147 megawatts in the fourth quarter of last year.

We maintained our overall revenue per watt for Q1, 2012 at $0.25 for the third quarter in a row due mainly to the adoption of our integrated medium voltage Prism platform solutions. Gross bookings for the first quarter of 2012 were 45.6 million as Steve mentioned earlier including 3.1 million in service and extended warranty.

Bookings for Q1, came mainly from North America. Our backlog which consists of a firm fixed purchase orders from our customers was 41.3 million as of March 31st, 2012. Gross margin for the first quarter of 2012 was 1% compared with negative 64% in Q4 of 2011.

The fourth quarter of 2011 contained $27 million in inventory charges whereas Q1 gross margin was weighted down by lower revenues and costs associated with transferring our remaining Canadian production to our contract manufacturers in China and in Canada.

Operating expenses for the quarter were 13.5 million, compared to operating expenses of 20 million in the fourth quarter of 2011. This includes approximately 10 million in SG&A, approximately 3.2 million in R&D and $300,000 in restructuring charges. The overall decrease and the restructuring charges are due to the company wide reorganization that was announced on January 4th. During Q1, the company recorded an operating loss of 13.3 million compared to an operating loss of 42.9 million in the fourth quarter of 2011.

As we have discussed in our previous conference calls management has made a commitment to lowering our EBITDA breakeven and achieving profitability and we made significant progress towards these efforts during the first quarter.

First, we've completed our extensive corporate reorganization focusing our design team and commercial sales and marketing teams on a best performing markets in North America and in Asia. This has resulted into an internal headcount reduction of over 50%. Next our cost reduction programs on central inverters and our medium and voltage Prism platforms are both on track. We continue to optimize the design of our Prism platforms for higher power levels recently announcing a 1.5 megawatt Equinox Prism platform and we are sourcing more subassemblies from Asia.

This will decrease the cost of these solutions by approximately 10% per quarter over the next two quarters. And finally we are nearly completed with the transition of the majority of our North American manufacturing to Sanmina. The Sanmina facility provides us with continued local manufacturing presence needed to qualify for Ontario’s local Feed-In-Tariff program.

The move to a majority outsourced manufacturing model through strong partners like Sanmina in Canada and Great Wall in China provides SatCon the variable cost structure that is much more capable of managing large shifts in our topline.

These cost cutting milestones have reset the expense structure of the company so that our EBITDA breakeven has further reduced to $32.5 million. Turning to the balance sheet, we continue to make progress, bringing down our working capital. Accounts receivable at the end of the first quarter were approximately 34.1 million down from 46.1 million in Q4. Inventory at quarter end was 46 million down from 49.9 million in Q4 of last year.

We are on track to generate over $25 million of cash through working capital reductions, throughout 2012. In addition, principal amounts owned on both our subordinated debt and convertible note are decreasing. When combined with trade payables and our bank line of credit we have reduced this outstanding debt of the company by $55 million in the past nine months and my team and I will continue our efforts to bring down debt throughout 2012.

In the second quarter of 2012 we expect revenues to be between $24 million and $28 million with gross margins in the mid to high teens. Q2 operating expenses will be in the $10 million to $10.5 million range. As we look ahead to the second half of 2012 we expect revenues to grow sequentially and expect to be EBITDA positive in both Q3 and in Q4.

With that I will turn it back to Steve for closing remarks.

Steve Rhoades

Actually with that I think operator we are going to go ahead and take questions right now. So let’s open up the lines for questions for folks in the call.

Question-and-Answer Session

Operator

(Operator Instructions). Thank you. Our first question comes from the line of Joe Maxa with Dougherty & Company. Please proceed with your question.

Ash Birla – Dougherty & Company

This is Ash for Joe. My first question was regarding gross margin, how much were the onetime items from closing the Canadian facility, because it looks like 0.7% was a bit lower.

Aaron Gomolak

I think obviously Ash the lower revenues impacted the gross margins more significantly than shutting down the Canadian facility. About $1 million of what I would consider non-recurring charges related to moving parts and cleaning up the facility that aren’t eligible for restructuring that we incurred in Q1.

Ash Birla – Dougherty & Company

Okay and where there similar 1 million plus in SG&A and in the OpEx line as well?

Aaron Gomolak

No I think most of the stuff that run through OpEx was what I would consider normal course of business type items there wasn’t really any outstanding items. We did record, if you notice on our balance sheet when you get the detail, you will notice a little bit of an increase in the bad debt reserve to the tune of about three quarters of a $1 million and that’s just been conservative. We had unfortunately in our industry as you know we had a lot of bankruptcies and just taking a little bit more conservative approach on our accounts receivable balance.

Steve Rhoades

But we are clearly moving quickly to move that number down further as we look in Q2. Aaron guided this quarter at 10 million to 10.5 million and as we look at it, the breakeven number bold 32.5 million in Q3 it will be 110 million.

Aaron Gomolak

Yes I would say 9.5 to 10 is a good OpEx range for Q3 as we look forward.

Ash Birla – Dougherty & Company

Sure. Can you give me the mallets book for the 42.5 million in product booking?

Leah Gibson

Looks like a 182.5.

Steve Rhoades

A 182.5 megawatts for that.

Ash Birla – Dougherty & Company

And like you said I believe you said all in North America and so nothing, none from China?

Steve Rhoades

There is a little bit from Asia and a little bit from Europe but the predominant is North America.

Aaron Gomolak

Yes, greater than 98% Ash, is North America.

Ash Birla – Dougherty & Company

Sure. I just have one more question, how much was your cash from ops?

Aaron Gomolak

I don’t have the cash flow in front of me Ash so I will get that over to you and Joe.

Operator

Thank you. Our next question comes from the line of Dale Pfau with Cantor Fitzgerald. Please proceed with your questions.

Dale Pfau – Cantor Fitzgerald

Could you just comment briefly about where you see market shares in the first half and where you see them going in the second half and then the next question, is did you say EBITDA positive in the second half or EBIT positive in the second half? Thanks.

Aaron Gomolak

So I will answer the second part of your question, Dale. We said EBITDA positive so depreciation, amortization if that’s 123 stock option expense excluded.

Steve Rhoades

As far as market share numbers for 2011 those aren’t out yet, we are actually expecting those pretty quickly in middle of May to be out from some of the services that we follow. I think we continue to hold our on in the utility section of the market. We have lost some market share in the commercial rooftop our products under 250. I think we lost some share there but our performance on the platform products. We’re very pleased with where this is going. I think we're still in that over 30%, between 30% and 35% that we've been seeing but that didn’t happen for a while for the utility scale solutions here in North America.

Operator

Thank you. Our next question comes from the line of Adam Krop, Ardour Capital. Please proceed with your question.

Adam Krop – Ardour Capital

Just to follow up on the gross margin question. I guess excluding the 1 million in one timers in the first quarter, you would have been at about 5% gross margin. To get to that mid-teens percentage in in the second quarter, what to the confidence you can do that and if you could highlight two to three main areas where you expect to get some cost leverage that would help us out. Thanks.

Aaron Gomolak

Let me clarify to you Adam. The 1 million is what I would consider kind of special one-time closure related into activities and that's exactly why Steve and I did not give gross margin guidance for Q1. You also have to remember too though that we had a Canadian facility the entire first quarter. So we had people, we had payroll, we had rents and that's not included in the $1 million number that I referenced. So, as that facility has pretty much been shut down now, we have I think two people left up in Canada, packing up parts and handling some of the clean-up and logistics activities. That's a very significant chunk of direct labor and overhead.

Steve Rhoades

It basically cuts duration half between Q1 and Q2.

Aaron Gomolak

So that was not included in my $1 million special charge comment earlier.

Adam Krop – Ardour Capital

Okay. And what about the leverage you are getting from the Great Wall partnership. How is that going to come into play on the gross margins? Is that going to be more of a second half thing?

Aaron Gomolak

Yes, I definitely would not model anything in the first half of the year. That would be the second half of the year royalty.

Steve Rhoades

We also, we have most of the revenue that we're projecting right now already in backlog and the mix that we've got for this quarter is a favorable mix while it is to Q1. It’s a higher margin product. So that BOA is coming down. Revenue is coming up a bit. We've got a better mix on product and…

Aaron Gomolak

And we're taking 10% per quarter out of the cost of these media voltage platforms continently.

Steve Rhoades

We're very, very confident in that number, mid to high teens of that revenue range.

Adam Krop – Ardour Capital

And then I guess that segues into my last question which is the mix that you're seeing in the new bookings. Maybe I missed it in your prepared remarks but what percentage is below 20kW level?

Steve Rhoades

Zero. We don't have a product at the moment that we're projecting revenue on for Q2. We introduced the products to Equinox LC, 24kW products at the beginning of March. We're going to begin shipping those in the second half of June. Remodel any revenue there but that's going to be at an increasing portion of our revenue going forward. The bulk of the shipment that we did for products that were booked in Q1 are larger central inventories and the sales hardware that we sold in to the auction day with GCL. So, that's the bulk of it right now for the revenue for Q2. As we look in the second half, almost all of it was in Prism platform. We've got a lot of Prism platforms that we booked over the last month.

Operator

Thank you. Our next comes from the line of Carter Driscoll with CapStone Investments. Please proceed with your question.

Carter Driscoll – CapStone Investments

I guess my first question is if you could just maybe talk about the financing environment for the US utility segment. We heard some noise that potentially finance became a little more difficult. That they ask you to share some of that burden and maybe how that may or may not impact your working cap reductions.

Steve Rhoades

I am not sure what you mean by sharing in the burden for the financing but I think that financing for large scale utility projects in the US and pretty much around the world is and has been as long as I have been in this business, challenging. It's difficult. But what we are seeing this year different from last year particularly in the North American market is more of the large scale projects that have big power purchasing into the utility that are well over 20MW. More of those are actually, they are moving, they are getting financing and they are actually buying equipments. So it's definitely different from last year in terms of some of the larger scale projects we see for North America.

Aaron Gomolak

Carter I mean certainly our customers always want longer payment terms. I think that was probably the second half of your question there but we've done a pretty good job of holding our own there. In fact some of these larger projects, we're actually getting down payments.

Steve Rhoades

And I also think that our DSO number is relatively stable.

Aaron Gomolak

Coming down slowly.

Steve Rhoades

Coming down slowly. So we haven't seen the large stretch out in the payment terms with our big customers.

Carter Driscoll – CapStone Investments

And then my other question really is on the backlog figure. Can you give us any color on whether you think that's all shippable this year, the majority of which, I guess I am trying to get a sense of your sequential growth in the back half of the year. How much of that is not currently in the ropes.

Aaron Gomolak

Yes, so the 41.3 million Carter is 100% shipping in 2012 and I would just at high level numbers, half of that is Q2 and half of that is Q3 or early Q4.

Steve Rhoades

And bookings have been, we don't give bookings guidance beyond what we have at the end of the quarter but bookings have remained strong as we've gone into indicate to for similar solutions for our platform solution.

Operator

Thank you. (Operator Instructions). Thank you. Our next question comes from the line of Jeff Osborne with Stifel Nicolaus. Please proceed with your question.

Jeff Osborne – Stifel Nicolaus

Most of my questions have been answered but Aaron I was wondering if you can update us on the financing arrangement that you had with Great Wall in terms of offloading some of the inventory that you folks had. I think it was up to 60MW by the end of April?

Aaron Gomolak

Yes, Jeff, we just completed the first shipment in the first quarter. So I think the first set of products went there in the middle to end of March that was approximately $2.4 million worth of hardware. I think we talked about this last quarter that we did not recognize that as revenue. It was offset to the cost of those products and we'll recognize revenue when those products ultimately are sold through by Great Wall into the Chinese market, we'll recognize the royalty revenue. So that's progressing as planned.

Jeff Osborne – Stifel Nicolaus

And then can you just update us on what that royalty revenue would look like? How do we think about that relative to your past dollar content for water?

Aaron Gomolak

I think what I would model is something around $0.02 of water, Jeff and I think we've been pretty consistent with telling people that. So it’s a function of how much they buy, it’s a function of power level but I think a really good average would be about $0.02 of water.

Steve Rhoades

And they are early in the market right now for solar but they've already identified over 100MW of near term opportunity that I think they are pursuing with reasonable chance. They quoted a lot more than that. There are a lot of big projects in China but in terms of where they are in their development of their pipeline, I am pretty pleased with the results given that we only signed this deal in February.

Jeff Osborne – Stifel Nicolaus

And then see if you happen to know if they are mainly focused on the Golden Sun program or some of the other more national programs, just given the Golden Sun program just reduced their tariff by I think it was 17%.

Steve Rhoades

They are going after Golden Sun project but the bulk of the revenue that I just mentioned is with the national tariff program.

Jeff Osborne – Stifel Nicolaus

And I haven't heard any comments on the call about the Indian market which has been pretty sporadic over the recent months but just what are you seeing in terms of pipeline there and maybe some of the other emerging markets that you've briefly talked about in the past whether its South Africa or Thailand, I think a few calls ago.

Steve Rhoades

Sure. I was just in India about six weeks ago and I think you know their buying pattern, they basically buy once a year in a big rush in Q3 and Q4 and they install into Q4 beginning in Q1 and when I talk with our partners and our customers in India, it looks like that same buying pattern is going to be here in 2012. Their people are going to get past the hot summer months, see how what they installed last year performs and then chose their vendors, chose their partners based on the performance here in the next few months.

Now we did quite well in the Indian market last year. Sold about 40MW worth of product. For an early market we were very pleased. We got strong partners there and I think it's going to be a good market, not a really big market but a good market as we look at it at the end of the year.

Slow to develop, looks like Thailand, but we've got quite a bit of pipeline in Thailand right now and I think we are going to start to see projects move at the end of Q2, beginning in Q3. South Africa is really just exploratory for us right now. We don't have significant pipeline there and we will be trying to find the same partner or strategy there that's been successful for us in some other markets.

Jeff Osborne – Stifel Nicolaus

Got you. And just a few quick housekeeping lines on the financials for Aaron, as you look at the EBITDA positive breakeven or breakeven level at 32.5 million for the second half, what are you thinking about with the gross margin level in terms of the current mix of backlog that you signed in your pipeline that converts. Is that the targeting mid to high 20s or…?

Aaron Gomolak

I think it's at a $32.5 million revenue level Jeff, we should be looking at gross margins at the low-to mid-20s, not mid to high 20s. But I think we've taken enough actions around our OpEx to get that number down. As mentioned, 9.5 million would be a good target for Q3. So that the math works out at those levels.

Jeff Osborne – Stifel Nicolaus

And then just for this most recent quarter, do you happen to have some of the cash flow metrics in terms of…

Aaron Gomolak

So CapEx for the quarter was $30,000 and yet again, I think the goal there was to try to keep CapEx at or around $1 million for the whole year. Stock based comp was approximately $1.3 million and depreciation was 558,000 for Q1.

Jeff Osborne – Stifel Nicolaus

Okay and in terms of share count over the next couple of quarters, nothing funky is going on in terms of any of the preferred you have or any of the other financial engineering you've done.

Aaron Gomolak

No we exited Q1 with a weighted average of 128 million shares outstanding. I am sure you saw that. We are monetizing and converting the convertible note into equity throughout Q1 and Q2. So in modeling I would use a share count of 142 to 144 million shares for Q2.

Jeff Osborne – Stifel Nicolaus

For Q2 and at similar level on the second half?

Aaron Gomolak

Yes, I don't see it changing much to second half, this indicates it released.

Operator

Thank you. Our next question comes from the line of Walter Ramsey with Walrus Partners. Please proceed with your question.

Walter Ramsey – Walrus Partners

Got a question about the gross margin. I mean everybody else is asking, now that the company is outsourced, at least most of its production, is the gross margin going to be pretty consistent at all the different sales levels?

Aaron Gomolak

Yes, I think that's one of the goals obviously of moving to a variable manufacturing model. It does provide a lot of cushion when times get tough and we have contraction in Q1 like we typically do. So yes, that obviously that's the intent. Our own internal cost structure above the line and cost to good sold is fairly minimal and we should see a more normalized pattern of gross margin.

Steve Rhoades

But working in to that mid-20 to high-20s level as we get revenues up to the high-30s low-40s. And I think that we still are working through some inventory that we had on hand at the beginning of last year, particularly for our CE markets and those deals are selling at lower margin. But on the flip side, as Aaron mentioned, we're aggressively pulling material cost out of our prison platforms and out of our standalone at worst. I think you've got to get it offset the large (inaudible) it will take for some of that older materials. So I think we're moving into a more stable region as we get here in to the second half of the year.

Walter Ramsey – Walrus Partners

Okay, so I was going to ask about that also, the engineering, what sort of potential do you guys think exists to improve the price performance of the products over the next well, whatever timeframe you can visualize?

Steve Rhoades

We have through the end of the year plan to take out on our larger standalones about 10% material cost per quarter for the largest standalone systems. For our smaller systems, we don't have as many programs in place but they represent a smaller portion of our revenue. But we expect to see a sequential decline in bond costs. One of the things about going to a contract manufacturing model is now DLOA that our contract manufacturer gets built into our material costs. So you actually see material costs go up a bit over the next quarter as our DLOAs for company comes down a lot so that our overall cost performance is better. But our bond costs we think we can pull out of our 10% a quarter as we look out over the next few quarters.

Walter Ramsey – Walrus Partners

That's the total cost of the product? How much is the material cost out of the whole cost?

Aaron Gomolak

It would trend similarly, 10% bond option should correlate to a 10% reduction in the pricing that we pay.

Steve Rhoades

Well, yes, in fact the way our contract manufacturing, contracts were is exactly that because they are based on the bond cost.

Aaron Gomolak

And most of that 10% that Steve alluded to, a lot of that is engineering led. So a lot of it's designed in engineering led cost reduction effort.

Walter Ramsey – Walrus Partners

Right, so how does that stack up to the competition? Can you compare it at all?

Steve Rhoades

I think our next generation of products will be both profitable and very competitive.

Walter Ramsey – Walrus Partners

So there is some opportunity to increase the gross margin over like the next couple of years?

Steve Rhoades

I think the industry is aggressive and we're all trying to drive towards great parity. But we do believe we have products that are going to be significantly lower in cost over time and that they are going to deliver high performance and that should allow us to grow margin.

Walter Ramsey – Walrus Partners

Okay. And just one last thing I guess. Most of the business right now is in the United States. Can you explain what's really driving that and how sustainable you think those factors are?

Steve Rhoades

Well what's happening in the US right now is that a lot of the large utility deals that have been announced over the last three years are actually being built. So that's driving a big business in the utility segment in the US. And we're also seeing very rapid growth for commercial recap because costs have come down so much that it's become much more economic to build, destroy the generation in commercial roof top. That we think over the longer term, over the next two to three years should be the best market that we've got and so both of those factors are driving the US to be our best market this year. Changes in government policy in Europe has made ground out very, very challenging in Europe. And the commercial rooftop market, I think it’s a good market in Europe, we just don't have the products right now to attack that market.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Steve Rhoades

Well I'd like to thank everyone for joining us today. With this ends today's call and we'll look forward to speaking to all of you again at next quarter's conference call. Thank you.

Aaron Gomolak

Thank you.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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