Solaredge Technologies, Inc. Q4 FY2021 Earnings Call

Welcome to the SolarEdge Conference Call for the Fourth Quarter and Full Year Ended December 31st 2021. This call is being webcast live on the company's website. This call is the sole property and copyright of SolarEdge with all rights reserved and any recording, reproduction, or transmission of this call without the expressed written consent of SolarEdge is prohibited. You may listen to a webcast replay of this call by visiting the Investor section of the company's website. I would now like to turn the call over to Ms. Erica Mannion at Sapphire Investor Relations for SolarEdge. Please go ahead, ma'am.

Good afternoon. Thank you for joining us to discuss SolarEdge's operating results for the fourth quarter and full year ended December 31, 2021, as well as the company's outlook for the first quarter of 2022. With me today are Zvi Lando, Chief Executive Officer; and Ronen Faier, Chief Financial Officer. Zvi will begin with a brief review of the results for the fourth quarter and full year ended December 31, 2021. Ronen will review the financial results for the fourth quarter and full year, followed by the company's outlook for the first quarter of 2022. We will then open the call for questions. Please note that this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to review the Safe Harbor statements contained in our press release and the slides published today for a more complete description. All material contained in the webcast is the sole property and copyright of SolarEdge Technologies with all rights reserved. Please note, this presentation describes certain non-GAAP measures, including non-GAAP net income and non-GAAP net diluted earnings per share, which are not measures prepared in accordance with US GAAP. The non-GAAP measures are presented in this presentation as we believe they provide investors with the means of evaluating and understanding how the company's management evaluates the company's operating performance. These non-GAAP measures should not be considered in isolation from, as substitutes for, or superior to financial measures prepared in accordance with US GAAP. Listeners who do not have a copy of the quarter ended September 30, 2021 press release or the supplemental materials, may obtain a copy by visiting the Investors section of the company's website. Now, I will turn the call over to Zvi.

Thank you, Erica. Good afternoon and thank you all for joining us on our conference call today. We are pleased to report that we have concluded the quarter with record revenues of $552 million and record revenues for the year 2021 of just below $2 billion. During 2021, we released and began to ramp several new products like our Energy Bank residential battery and higher power optimizers and inverters in our residential and commercial offerings. In recent months, we have experienced a surge in demand for these products, which we attribute to the positive reception of the technology in parallel to market growth, spurred by the increase in electrical power prices globally and the heightened governmental and corporate focus on sustainability and the use of renewable energy. We are excited about this rapidly growing opportunity and are intent on doing everything needed to capitalize on it. However, in the current challenging operational and supply chain environment, expanding infrastructure and ramping production to meet these higher demand levels is placing temporary pressure on our gross margins. In the call today, we will provide detail on all of these factors. I would like to start with a summary of 2021 and the main themes that shaped the year and how we expect them to impact our business moving forward. Total revenues in 2021 grew 35% over the previous year, and 32% in the Solar business. Growth in the solar business was across all segments and regions, and practically in every country in which we operate. The larger year-over-year growth from significant markets was in Italy, Germany, Taiwan, France, Poland, and Israel. While we usually focus our comments on North America and Europe, which grew substantially this year, 29% and 36%, respectively, I want to shed some light on the long-term growth opportunities in Southeast Asia and the Middle East. In these markets, we grew in 2021 by more than 43%, representing not only market share gains but also the high growth rate of these markets, which is expected to continue. In these countries, the market consists primarily of commercial installations, and our momentum here is indicative of our overall momentum in commercial, which I'll be discussing later. Other noteworthy dynamics of 2021 include a significant increase in battery attach rates in residential installations, which increased by more than 50%, most of which were third-party batteries sold by our partners, DC coupled to our inverters as our residential battery ramp was slower than we originally planned. Also, in residential, we are seeing growth in the average installation size and momentum in our sales of self-consumption devices such as EV chargers and smart water heaters, as consumers seek to optimize their home energy consumption and reduce their dependency on higher priced energy coming from the grid. In the area of grid services, we are now active in programs in 13 states across the United States, throughout Australia, and in some European countries. Additionally, in 2021, we saw a 70% increase in the use of our designer software, which enables full system design, including advanced features such as shade analysis, battery usage, consumption optimization, bill of materials generation, financial analysis, and automated creation of offers to the end customer. More than 1.1 million unique site designs were performed by installers on this platform last year. Overall, we are pleased with the growth we have seen in 2021 and the progress we made with our strategic initiatives. Now turning to the fourth quarter results. As mentioned, revenues for the fourth quarter were a record $552 million, driven by North America, where revenue grew quarter-over-quarter by 37%, due to higher battery sales, increased residential inverter sales, particularly of the higher-priced Energy Hub inverter, and the growth of sales to the commercial segment. Moving to our global residential business, we continue to see strong demand, healthy inventory in our channels, increasing sellout rates by our distributors, and a strong backlog of orders. In fact, we already have firm orders for delivery in 2022 of a megawatt volume that represents 60% of our megawatt residential shipments for the entire year of 2021, excluding batteries. In commercial, we are seeing a real shift in market momentum driven by several factors. The rising electricity crisis in Europe and other regions, along with the trend of corporations wishing to advance their ESG programs and offset their carbon emissions, together with a stable and favorable regulatory environment in many countries such as Germany, where the new government has announced aggressive growth plans for PV, lay the groundwork for an increase in demand in markets where SolarEdge already has a solid local presence and strong brand awareness. At the same time, we are seeing increased acceptance of our commercial product offering released last year, which includes the Synergy 120-kilowatt inverter and high-power optimizers, supporting the high-power bifacial modules now commonly used in commercial installations. Combined, these market and product dynamics are driving the record demand for our commercial solutions, where our current megawatt firm orders for delivery in 2022 are 143% of all commercial megawatts we shipped in 2021. While the increased backlog is partially related to longer lead times, the number of planned projects and the increase in design wins, including for ground-mount projects, demonstrates what we believe to be a true inflection point in the commercial market. Ramping production to meet this demand in the current supply chain and logistics environment is impacting our top and bottom line as we prioritize expedited shipments to meet customer schedules, sometimes at the expense of our gross margin. We expect this situation to last until the middle of the year as we adjust our infrastructure and ramp manufacturing capacity to this new level of demand. Moving on to product updates. In the residential segment, we released last quarter the 10- and 11.6-kilowatt Energy Hub inverter with 10-kilowatt backup power and a new 3-phase EV charger to complement the single-phase charger we have been shipping for a couple of years. We are seeing strong demand for the EV charging portfolio, driven by the growing adoption of electric vehicles, particularly in Europe. Our Energy Bank residential battery has now been installed in 11 countries. We are receiving positive customer feedback, particularly related to the ease of installation with the new Energy net wireless communication technology incorporated into our residential offering. Our battery manufacturing ramp has been slower than anticipated due to delayed supply of several components used in our DC to DC and BMS boards. For most of these components, we have already qualified additional sources and are working closely with suppliers to ensure timely and consistent supply for the remainder of the year. In the fourth quarter, we shipped 42.5 megawatt hours of batteries versus the 70 megawatt hour plan. We aim to close this gap already in Q1 of 2022, reaching a production run rate of 300 Energy Bank batteries per day by the end of the quarter, as we discussed in the last quarter's call. In Q1, we plan to ship between 100 to 120 megawatt hours of residential batteries. In the commercial and industrial segment, we continue to test our third 330-kilowatt large-scale inverter at sites in Israel and Europe. We are on track for ramp-up later this year, further strengthening our offering for ground mount installations. We will provide more details on our ground mount offering, as well as other new products and services in our Analyst Day scheduled for March 29. Moving to operational infrastructure and progress in that area. In Q1, we will begin to shift residential inverters and optimizers for the North American market from our new contract manufacturing facility in Mexico. We expect to be able to deliver practically all of the US residential demand from the Mexico factory by the end of the year. This will have a favorable effect on shipping costs, tariffs, working capital management, and timely meeting US demand and lead times. The commercial product manufacturing capacity will be expanded in two phases to meet the growing level of demand that I detailed earlier. We are increasing manufacturing capabilities in Vietnam for delivery of products to all regions, followed by additional manufacturing growth in Mexico to supply commercial products to the US market. The surge in demand is creating manufacturing capacity challenges and pressure across the supply chain, where we need our suppliers to allocate component quantities well above those supplied in previous years. We are working closely with our key suppliers who are supporting us in our usual growth, as they too see the value in this long-term opportunity. Moving to our non-solar businesses. 2021 was a record revenue year for our non-solar businesses, totaling $176 million, predominantly from our energy storage and e-Mobility division. Our energy storage division concluded the year with record revenues and was profitable for a second consecutive year. Sella 2 construction for the manufacturing of our own lithium-ion cells continues as planned and is expected to begin production ramp in the second quarter of 2022. In the e-Mobility division, we experienced some slowdown early in Q4 of 2021 due to our customers' temporary halt in production, which resumed normal levels by the end of the fourth quarter. We expect normal levels of delivery in the first quarter and through the year. In our Critical Power Division, we started first shipments of our three-phase UPS offering, which was designed and productized in-house since the acquisition. We will elaborate more about these segments in our Analyst Meeting in March. To summarize, we are facing an accelerated growth opportunity in a challenging operational environment. As we have proven in the past, I am confident that our global team will excel in execution, ensuring our customers have the benefit of our technology when and where they need it. And with this, I will turn the call over to Ronen.

Thank you, Zvi, and good afternoon, everyone. This financial review includes a GAAP and non-GAAP discussion. A full reconciliation of the pro forma to GAAP results discussed on this call is available on our website and in the press release issued today. Segment profit is comprised of gross profit for the segment, less operating expenses that do not include amortization, stock-based compensation expenses, and certain other items. Total revenues for the fourth quarter were a record $551.9 million, a 5% increase compared to $526.4 million last quarter, and a 54% increase compared to $358.1 million for the same quarter last year. Revenues from our solar segment were a record $502.7 million, a 5% increase compared to $476.8 million last quarter, and a 54% increase compared to $327.1 million for the same quarter last year. Overall, this quarter, we shipped approximately 5.1 million power optimizers, approximately 197,000 inverters, and 4,250 batteries, representing 42.5 megawatt hours. US solar revenues this quarter were a record $257.4 million, a 36.6% increase from the last quarter, and represented 51.2% of our solar revenues. Solar revenues from Europe were $193.2 million or 38.4% of our solar revenues, representing strong revenues in Germany, the Netherlands, Italy, and Poland. The rest of the world solar revenues were $52.1 million or 10.4% of our total solar revenues and included a record revenue quarter in Taiwan. On a megawatt basis, we shipped 751 megawatts to the United States, 752 megawatts to Europe, and 419 megawatts to the rest of the world. 45% of shipments were commercial products and the remaining 55% were residential. ASP per watt, excluding battery revenues this quarter was $0.253, a 0.8% decrease from $0.255 last quarter, resulting from a high volume of residential product shipments to North America, offset by an increased portion of large US customers who benefit from larger volume discounts within the overall mix and the weaker euro, which reduced our ASP on products sold in Europe. This quarter, two US customers accounted for more than 10% of our solar revenues. In light of the increased costs associated with the manufacturing of our products and the accelerated ramp-up costs related to meeting the surge in demand for our products, we initiated price increases in the fourth quarter of 2021 that will continue into the first half of 2022. These price increases vary among product lines and geographies, depending on the competitive environment, demand level, and specific cost increases related to specific products. The price increases aim to cover part of the component and manufacturing cost increases and are not focused on more temporary logistical expenses, which relate to timely meeting increased customer demand. We expect the full impact of these price increases to materialize in the third quarter of 2022. This quarter, revenues from our non-solar businesses were $49.1 million. Revenues of our energy storage division achieved record quarterly revenue, while our e-Mobility division revenues reflected lower delivery of powertrain units to the final customer, as explained by Zvi. Consolidated GAAP gross margin for the quarter was 29.1% compared to 32.8% in the prior quarter and 30.8% in the same quarter last year. Non-GAAP gross margin this quarter was 30.3%, compared to 34% in the prior quarter and 32.5% in the same quarter last year. Gross margin for the solar segment was 32.8% compared to 36.6% in the prior quarter. Gross margin within the solar segment is affected by various factors. The combination of the following factors contributed to this result. From a customer geography and product mix perspective, high volumes were shipped this quarter to large customers in the United States that benefit from volume discounts, which contributed to the lower margin. This was coupled with a weaker euro, which eroded our margins on sales in Europe since revenues are euro-denominated, while manufacturing expenses are stated in US dollars. Lastly, the growing share of battery shipments that are characterized with lower gross margins further contributed to this margin decrease. From an operational and supply chain perspective, our accelerated growth combined with the non-industry challenges of component shortages, limited manufacturing output, and a constrained and expensive shipment environment continued to adversely affect our margins this quarter, while we are still recovering from the first shutdown of our Vietnam facilities that returned to normal operations in mid-November. In a supply shortage period, component manufacturers tend to allocate goods among our customers based on past quantities. Given our current accelerated growth rate, some of our suppliers are having difficulties supplying sufficient component quantities in a timely manner. This has resulted in a need for expedited shipments to meet customer delivery times and, in certain cases, payment of unutilized capacity to our contract manufacturers. As Zvi mentioned, our battery manufacturing suffered this quarter due to delayed arrival of components, resulting in lower shipment volumes at a higher cost. Goods subject to tariffs, shifting to the United States from China accounted for 66% of our US shipments in Q4. To summarize the solar segment margin discussion, we view the impact on inverters and optimizers margin as transitory and expect to return to our normal level in the second half of 2022. Gross margin for our non-solar segment was 4.2% compared to 8.7% in the previous quarter, mostly related to reductions in e-Mobility revenues and margins. On a non-GAAP basis, operating expenses for the fourth quarter were $94.1 million or 17.1% of revenues compared to $83.8 million or 15.9% of revenues in the prior quarter and $72.9 million or 20.4% of revenues for the same quarter last year. This increase is mainly related to the fact that we reduced our hiring in the third quarter of 2021 and increased our headcount again in Q4, primarily in our R&D and sales and marketing groups worldwide. This quarter, we also experienced a gradual increase in sales and marketing activities as travel restrictions due to the pandemic began to ease and trade show activity, along with customer visits, returned to normal. Our solar segment operating expenses as a percentage of solar revenues were 15.8% compared to 14.6% last quarter. Non-GAAP operating income for the quarter was $72.9 million compared to $95.2 million in the previous quarter and $43.5 million for the same period last year. This quarter, the solar segment generated operating profit of $85.3 million compared to an operating profit of $104.9 million last quarter. The non-solar segment generated an operating loss of $12.4 million compared to an operating loss of $9.7 million in the previous quarter. Non-GAAP financial expense for the quarter was $2.2 million compared to a non-GAAP financial expense of $3 million in the previous quarter. Our non-GAAP tax expense was $7.9 million compared to $10.1 million in the previous quarter and $4.6 million for the same period last year. GAAP net income for the fourth quarter was $41 million compared to a GAAP net income of $53 million in the previous quarter and $17.7 million in the same quarter last year. Our non-GAAP net income was $62.8 million compared to a non-GAAP net income of $82.1 million in the previous quarter and $55.7 million in the same quarter last year. GAAP net diluted earnings per share was $0.74 for the fourth quarter compared to $0.96 in the previous quarter and $0.33 for the same quarter last year. Non-GAAP net diluted earnings per share was $1.10 compared to $1.45 in the previous quarter and $0.98 in the same quarter last year. Turning now to the balance sheet. As of December 31, 2021, cash, cash equivalent, bank deposits, restricted bank deposits, and investments were $1.2 billion. Net of debt, cash, cash equivalents, bank deposits, restricted bank deposits, and investments were $548 million. During the fourth quarter of 2021, we generated $89.6 million in cash from operations. Accounts receivable increased this quarter to $456.3 million compared to $416.2 million last quarter. As of December 31, 2021, our inventory level, net of reserve, was at $380.1 million compared to $304.7 million in the prior quarter. Most of this increase is related to increased raw materials, battery cells, and component inventory in our solar segment, while our finished goods inventory continued to decrease as a result of the growing demand and limited capacity. Our non-solar inventory level remained practically similar to the previous quarter. Let's move now to summarize the full year of 2021. Revenues for the year were $1.96 billion, a 34.6% increase from $1.46 billion in calendar 2020. Revenues related to the solar segment were $1.79 billion or a 32% increase compared to 2020. GAAP gross margin was 32% compared to 31.6% in the prior year. Non-GAAP gross margin was 33.5% compared to 33% in the prior year. GAAP net income for 2021 was $169.2 million, a 21% increase compared to $140.3 million in the previous year and GAAP diluted EPS of $3.06 compared to $2.66 in the prior year. Non-GAAP net income for 2021 was $272.9 million, a 22% increase compared to $224.4 million in 2020 and GAAP net diluted earnings per share of $4.81 compared to $4.11 in the prior year. This year, we generated $214.1 million of cash from operations. Turning to the guidance for the first quarter of 2022. The combination of strong demand for our products and the operational adjustments and efforts in fulfilling this growth within an environment of component constraints, fast manufacturing capacity expansion, which requires higher investment, logistical constraints, and high shipment charges, as well as the expanded rapid growth of our battery shipments that are characterized by lower gross margins, will have a positive effect on our revenue growth rate for the entire year and will continue to put pressure on our gross margin in the first half of 2022. We expect this impact to be temporary and will be mitigated upon the full ramp-up of our Mexico manufacturing, which is expected to be concluded by the end of the year. On an annual basis, we expect that revenue growth, as well as the operational expense leverage, will offset the temporary margin impact and will increase our overall expected profit levels. As such, for the first quarter of 2022, we are guiding revenues to be within the range of $615 million to $645 million. Revenues of the solar segment are expected to be within the range of $575 million and $595 million. We expect non-GAAP gross margin to be within the range of 28% to 30%. Gross margin of the solar segment is expected to be within the range of 30% to 32%. I will now turn the call over to the operator to open it up to questions. Operator, please?

Thank you, Mr. Speaker. We will take the first question from Mr. Mark Strouse from JPMorgan. Your line is open. Please go ahead.

Thank you for taking our questions. Zvi, I wanted to revisit your comments about a potential inflection point in the commercial market. Looking ahead beyond your guidance, do you believe 2022 could be the year when the commercial and industrial business starts to dominate your shipments? Also, could you remind us about the margin differences between the residential and commercial and industrial sectors?

Hey, Mark, I'll take the first part, and then I'll hand it to Ronen for the second part. I think the answer is, from a megawatt perspective, is likely. The demand is such and the rate of increase is such that it is likely that, from a megawatt shipment perspective, we will ship more commercial. And I think also the word commercial is becoming limiting because a significant part of this is already ground mount installations, in particular, in the US. So, generally, these larger installations will represent a larger portion of our megawatt shipments in 2022, I estimate at this point.

And Mark, with regards to the gross margins, I'll start with the qualitative and then I will move to the quantitative margin assumption. In general, you usually see that the gross margin for residential, I would say, is 200 to 500 basis points higher than what you see in commercial. And this is depending on, first of all, what is the residential offering? For example, is it an Energy Hub or is it a regular inverter? And also related to whether we are talking about large commercial or smaller systems. By definition here, the scenario very much changes, and this is before talking about geographical mix. So 200 to 500 basis points will be the quantitative answer. The qualitative answer, I think that what we need to understand is what is going to be the margin profile on our solar inverters and optimizers. And here, actually, we expect that towards the second half of the year, we will be back to our regular 35% to 37% gross margin for inverters and optimizers. Here, you actually see a little bit of this polarization. On one hand, we see residential, where the margin is expanding on the unit sale. At the same time, we see the increasing volume of commercial installations and products sold that are characterized by lower margins. But all in all, they are stabilizing to this 35% to 37% margin range. So this is basically a mix issue. But the important thing is that, in general, we continue to see the general model that we used to describe in the past.

Okay, that's very helpful. Thank you. And then if I can just squeeze in one more. You mentioned pricing increases in 4Q and continuing in the first half. Just any more color there where you think you have the most pricing power, least pricing power across products or geographies, whatever it might be?

I think the variation is by segment. And generally speaking, the commercial market is split to a large extent between lower-cost string inverters and our MLPE solution. And with the introduction of the larger inverters and the larger optimizers, we are able to bring the cost per watt on our MLPE configuration down a bit. And then it gives the people that still have the interest and motivation toward safety, module-level optimization, and monitoring the return on investment in order to prefer our solution over a string inverter. So, there the opportunities are relatively tight in terms of the ability to increase prices because it's a very cost-driven analysis and we are managing a defined gap and we are now at a point where we are able to, on large scale justify that gap, and that's what is increasing the demand. Generally, in residential, the opportunity is a bit bigger in that regard and even more in batteries under the current circumstances of shortages in the market and the favorable feedback that we're getting for our battery.

We will take the next question from Brian Lee from Goldman Sachs. Your line is open. Please go ahead, sir.

Yeah. Hey, guys. Good afternoon. Thanks for taking the questions. Maybe first one a follow-up on the gross margins. Just was wondering, Ronen, you're talking about getting back to 35% to 37% gross margin target for solar. Is that in the second half? Is that starting in Q3? Maybe if I could just clarify that. And then there's a roughly 500 basis point bridge between what you guided here for Q1 versus getting back to those targets. Can you kind of drill into some of the pieces? It sounds like freight, it sounds like some of the supply chain issues, but maybe give us the big pieces of that bridge, the 500 basis points between this quarter and a couple from now. And I have a follow-up. Thanks.

Yes, of course. And I would like even to clarify more of the question or my answer before I detail. What we discussed is returning to normal on the 35% to 37% on the inverters and optimizers and other batteries. Because if you remember, we discussed it, batteries will be approximately 25%. So let me, first of all, talk about the overall, I would call it, bridge to get back to the 35% to 37% on the optimizers and inverters, and I will then try to connect everything to the battery, okay? So in general, we see, I would say, five to six elements that will enable us to bridge from where we are today into Q3 and Q4. The first one is the fact that once we are increasing our manufacturing capacity, and this means that we're adding Mexico and expanding Vietnam. As Zvi mentioned before, we have much more capacity that can be placed on both and shipped and sent to the target without the need for expedited shipments, which are today extremely expensive, especially in the price environment that we see right now. So increased capacity means lower expedited shipments and much more regular shipments, this by itself contributes a few hundred basis points to the margin. The second one is Mexico as a site by itself because not only does it contribute to the additional capacity, it also means that now we can eliminate, first of all, increased tariffs that we pay today. As we said in the prepared commentary, 66% of the product that we brought to the US in Q4 were subject to tariffs, and this amount will be reduced as we are – as Vietnam is back, but most likely when Mexico is online. So this will dramatically reduce the expenses, plus the fact that we will not be needing the ocean freight, which is today, again, very expensive compared to land rates. The next thing will be the price increases that we have implemented. We usually implement price increases on new orders. And that means that most of the price increases we are implementing, because of the lengthening period, or a lead time period, are taking time until they kick into the system, and we expect to see all of them materializing in Q3. We also have a few more issues that will help in general. The first one is that today on the batteries, and this is already now related to the solar segment, not necessarily on inverters and optimizers, we're using the Samsung energy sales from our 1-gigawatt deal. Once we have Sella 2 towards the end of the year, sales that will be manufactured by our Korean part of the storage division will allow us to reduce this cost. The scale because of the very high revenue that we will see, our revenue growth that we will see, will effectively mean our fixed costs will become lower, and eventually, eventually, we will see, of course, a continued increase in the other non-solar segments that will actually push us again, which is not related to solar. So in the Analyst Day, we will basically layer all of this and we will provide how everything is impacting. But to summarize, yes, we will see solar inverters and optimizers go to 35%-37%. Batteries stay at about 25%. And now the portion of batteries to solar inverters and optimizers will very much determine the end result of the solar segment, and all of the other factors will increase margins in general for solar and non-solar. I hope that it answered your question, Brian.

Yes. That's super detailed and helpful context. I guess related to that last piece, the solar and the storage ratio. I know the battery ramp sounds like it's a little bit behind schedule, but there's a big acceleration here implied in Q1. Can you give us a sense of kind of what we should expect going forward in terms of the battery ramp? Because you got the SDI volume, but then you also have Sella 2 coming online in Q2 and I would expect that to add some volume in the back half of the year. So just any sense on the battery ramp we should expect off the Q1 acceleration? And then in terms of mix for batteries, US versus non-US, are you shipping it all into the channel, or are you seeing direct to on-demand, just any sense of kind of where you're seeing that $100 million to $120 million for Q1?

Okay. So first of all, from the revenues and the growth of battery sales, we need to remember that in 2021, we first of all utilized the Samsung deal that we have. And this means that, at least in the first quarter, as we mentioned, we already guided for 100 to 120 megawatts. By that, the end of this quarter, we will be at approximately 180-megawatt run rate per quarter. We will continue to ramp these manufacturing capabilities in Q2 where at the end of Q2, we would reach 250 megawatt hours per quarter. This is actually the run rate of sales that we have from Samsung, and we expect to run at this rate for Q3 and Q4. The sales from Kokam and the ramp-up of the manufacturing based on this one will be dependent on two major items. The first one is demand again that we will see in the market and assuming that, of course, it can consummate all of the 250 megawatt hours. And here, the second element will be really Sella 2 that will just start to ramp, as we said, with test runs in the second quarter, and in the second half, we will start to ramp up production. And here, I would say that the manufacturing pace will very much determine what will be the additional volume that we should bring. So play it safe, I would say, about 250 megawatts from Q3 and forward. There is an upside coming from the additional Sella 2, and this will guide, of course, as we will move and we'll have much more certainty regarding Sella 2. I'll move to Zvi for the second geographic mix.

Yes. Today, we're kind of shipping probably 50% to North America and to Europe, prioritizing customers that we believe have a potential for consistent large volumes over time. And while there's a huge opportunity also for retrofitting batteries on existing systems, we're making sure that the batteries that we're shipping today are such that they bring a full solar installation with them. And as capacity grows, we'll start making batteries available also for retrofit on existing systems.

All right. Thanks guys. I’ll pass it on.

Okay. Thank you.

Thank you.

We will take the next question from Mr. Stephen Byrd from Morgan Stanley. Your line is open, sir. Please go ahead.

Hey, thanks so much for taking my questions. A lot of my questions on the results have been addressed. I was thinking more about the evolution of your technology and developments around the integrated home and smart energy management. Are there technology developments that we should be thinking about in the future for you? Are there areas where you feel like you need to acquire capabilities outside of sort of organic capabilities there? I'm just curious if you could just speak a little bit more to the evolution on the technology side, especially sort of the idea around the integrated home and just continued evolution there?

Yes, it's a good question. And obviously, it would require a long answer, which we intend to at least try and give in the Analyst Day at the end of March. But that said, and maybe as an appetizer, we are focused on really expanding our technologies and capabilities that everything that has to do with generation, storage, and consumption of electrical power generated from renewable sources. So with that being the overriding vision, from a technology point of view, to deliver on that, there are technology areas where we are not our core strength today that we are gradually building capability in as well. But again, hopefully, in much more detail at the Analyst Day, we can share more on this topic.

It's a significant topic that would be better addressed at the Investor event. In terms of the overall perspective, demand for storage is clearly increasing globally, and your company is well positioned to meet that demand. You've mentioned expansion plans, and as we consider the long-term potential, what do you see as the best strategies for increasing your capacity? This could relate to geographic distribution or a balance between contracted capacity and in-house manufacturing. It appears there is considerable opportunity for growth, which also necessitates careful planning regarding capacity, especially given the challenging supply chain conditions. How do you envision your long-term growth strategy to accommodate this rapidly increasing demand for storage?

That’s a great question. I have a couple of comments. Firstly, in the residential sector, we are realizing that while there is much discussion about different batteries, the actual value for consumers is determined by system integration and performance. We anticipate an increase in storage attachment rates in the commercial sector as well, and we are already observing trends in Europe and North America. The key factors will include battery parameters like cost, cycles, and typical comparisons, but ultimately, what will provide value to users, whether residential or commercial, is how well the system is integrated and how it meets their needs, whether for backup power, self-consumption, or a combination of both. Our focus is on achieving a comprehensive solution from the cell technology to the entire system. This doesn't mean we will have the capacity to meet all demand in-house, but we will be able to provide an optimized complete solution and maintain flexibility to fulfill some or most of our capacity internally, potentially supplementing from external sources. That’s the high-level view we have, and I hope that clarifies things.

Yes, that’s helpful. Thank you very much.

The next question is from Julien Dumoulin-Smith from Bank of America. Your line is open, please go ahead.

Hey, good afternoon team. Thanks for the opportunity. Just going to pick up where we see left off here. Can you talk specifically about storage supply ramp going into 2023 here? Just as best I understand, as the Samsung deal is transient, how do you think about, not just complementing, but supplementing it and expanding that availability into 2023? You talked about a $250 million run rate here. What could that 2023 number look like? And how are you thinking about providing data points to ramp into that here?

I will break down the growth potential for 2023 into two parts. First, we have the capacity from Sella 2, which is initially designed for two gigawatt-hours annually. We can fully utilize this capacity for storage in 2023 if needed. Additionally, we can significantly increase Sella 2's capacity within a few months, potentially even doubling it. Once we gauge the consumption of Samsung SDI's capacity and determine a stable level of demand, we will decide whether to invest in Sella 2 ahead of 2023 to start the year with greater capacity. Secondly, our strategy has always been to avoid reliance on a single battery supplier. We can seek additional capacity from Samsung if the demand warrants a higher output. We'll aim to maximize capacity from Sella 2 first, considering both pricing and economies of scale. Overall, with some preparation, we believe achieving 500 megawatt-hours per quarter is relatively straightforward, and nearly doubling that is feasible with effort, as is obtaining more from Samsung.

Got it. So $500 is not the commitment on 2023, but that sounds like at least an outline of where you can go?

Yes.

Yeah.

Okay. Great. And then just related here to the component shortage, can you elaborate a little bit more on the strategy here? Just obviously, you had some very specific acute shortages in Q4. Sort of – strategy to address it broadly, if you can, 1Q specifically and onwards. I know, you addressed it somewhat in the call comments.

Yeah. I think if you recall, especially at the beginning of the season of shortages, we were – we were relatively in a very good position because we were prepared also with inventories and also with alternatives on most of the critical components that we were using, and that enabled us to execute with less constraint for the first three or four quarters of the period. We're now facing more constraints and a bigger challenge due primarily to the elevated volumes, and people tell us you're getting – your allocation is what it was or 1.5x what it was you should be happy. But that doesn't make us happy because we need 2 or 3x of the volumes that we consumed in the past. Now that's the challenging side. The positive side is that, we are becoming a much bigger portion of our suppliers' business, and we did – and we are consolidating into some specific larger component suppliers, such that on one end, we're more dependent on them. On the other hand, they are dependent or our business is more critical to them, and they are – and they are bigger and more reliable suppliers. So we're in the process of doing that, and in cooperation with some of these significant suppliers. And that's giving us reasonable visibility but not complete visibility, and there could be still hiccups along the way, and those hiccups usually translate into some type of expedited shipments in one form or another. But generally, we are consolidating into larger suppliers and being a bigger part of their business, and gradually, especially with the new products, also building the alternatives in order not to be dependent on any specific component in any of our products. But this is a process again, it will likely have some hiccups along the way.

Right. Hence, your comments for back half of the year to normalize, is that in line with the timing that you're thinking about there?

Again, hence, the...

For the back half of the year for margins to normalize, that assumes that those hiccups to get – to move past that, if you will, and to ramp with those larger suppliers?

Yeah, that's part of it. And for sure, the big suppliers that we're working with, we have their capacity plans and know when their new fabs are coming online, and that's aligned with that. But at the same time, we still have a lot of components coming from other manufacturers. And it's not that, I'm saying with full confidence that in the second half of the year, we won't be experiencing challenges and hiccups in these areas, it's just that the bigger portion of our component supply will be more secure in the second half of the year.

Thank you, guys.

Thank you.

Thank you.

The next question is from Mr. Philip Shen from Roth Capital Partners. Your line is open. Please go ahead.

Hi, everyone. Thanks for taking my questions. A follow-up on the storage megawatt hours. I think you talked about 42 megawatt hours recognized in Q4, or at least shipped. Can you talk to us about how many megawatt hours were recognized in revenue in Q4? And then of the 100 to 120 megawatt hours expected in Q1 shipped, how much do you think you could recognize in revenue in Q1? Thanks.

We generally do not give this data simply due to the fact that the shift to revenue may sometimes change based on the destination of where you're shipping. I would say that you should assume that generally, at this point of time, the majority of what you ship becomes revenue relatively quickly due to the fact that you either ship to Europe or you're trying to time the shipping in a way that shipping to the US will go out from European manufacturing at the beginning of the quarter. So, I would say that there is almost a similarity, although, of course, shipment is always larger than revenue. In the future and in Q1, we specifically cannot tell simply because of the fact that we do not know what will get to the customers as that at what point of time. So, it will be lower revenue than shipments, but I think that that's the most we can say right now.

Okay. Thanks for that. As it relates to the battery supply chain dynamics, as you ramp up to much larger numbers in the back half of the year, do you see any bottlenecks as it relates to lithium or any other raw materials? And if so, how are you addressing that? Thanks.

So let's divide between battery cells and the electronics around it. On battery cells, we are still very much secured, and Samsung is very organized and for its pricing on their supply of battery cells. So here, we don't see a major issue. I think that, as Zvi mentioned on the electronic components, here, we believe that we resolved, at least for the near future, the problem that we saw before, and we are in very good contact with the suppliers here. But again, sometimes simply, these kinds of delays are not in our hands, and we cannot actually forecast them. Hence, the miss in this 4Q; had we known that we would not even guide for the number that we had. So I think that we’re in good alignment with our vendors. But as Zvi mentioned, there are surprises that are happening from time to time. Sometimes the suppliers themselves do not control all of it.

Your next question is from Mr. Maheep Mandloi from Credit Suisse. Please go ahead, sir. Your line is open.

Hey thanks for taking those questions here. In terms of the Sella 2 expansion, can you just talk about how much of raw material supply visibility do you have for that? And specifically, just looking at the lithium carbonate and nickel prices kind of like increasing here versus last year. So I just wanted to understand your sourcing strategy for that. And how do you think about like expansion beyond '22 for Sella 2? Thanks.

So in general, first of all, the raw materials for battery manufacturing is a little bit more predictable than electronic components simply given the fact that once you have developed the battery cell and the underlying cathode, anode material and the electrolyte, you're basically locked. So in a sense, you do not even complete the development of a cell before you have a viable source and known source for all of this product, and this is the case of Sella 2. I would say that in Sella 2, we do not expect to see issues related to the quantities, which are there. Actually, most of the issues are related to pricing, because the price of all of these materials is related to the London Materials Index. And here, this is the place where you can see a little bit of variation. So, as long as we see and as in continuation to the answer to Julien, approximately 500 megawatt hours per quarter heading into 2023, this is something that we can cover with raw materials, and we believe that we can also cover the expansion that we said can be almost doubled within a period of time because you still need to invest a little bit in the factory itself.

Next question from Mr. Colin Rusch from Oppenheimer. Please go ahead, sir. Your line is open.

Thank you so much. Can you talk a little bit about the channel inventories and where you're at? And how you see that gain refills over the course of the year, I mean, just in terms of order of magnitude and cadence?

We heard the first part. Generally, I would distinguish inventory levels between residential and commercial products and consider regional differences. Inventory for residential products is relatively healthy in most areas within the channel, although it may be slightly lower than what distributors typically prefer, particularly concerning the newly released larger single-phase inverters. The 10 and 11-kilowatt inverters are likely below the normal inventory levels desired by distributors; however, we are not currently facing shortages in residential products in either Europe or the US. On the other hand, inventory levels for commercial products in the US are tight due to strong demand that exceeds our current capacity to fulfill it alongside inventory requirements based on project demand. As a result, we have increased shipments and airfreight, which are associated with large-volume products and contribute to higher costs. For commercial and industrial inventory, levels are low, and they are even lower in Europe, Asia, and Australia compared to the US, where conditions are somewhat better.

And that's awful. And then…

What was the second part?

It was just around the cadence of how the channel inventory gets refilled.

So, unfortunately, we're still in a bit of a non-smooth flow that started with the Vietnam shutdown and expanded into Chinese New Year for the last few weeks that obviously affects not only Chinese manufacturing but also Vietnam manufacturing. So the last few months have been more of a pulse supply and less of a continuous flow. Now, we hope that after factories are back to normal operation with the conclusion of Chinese New Year, that we don't have any more post events in the next few months and then flow is going to be much more smooth and simpler to forecast and manage inventories.

We'll take the next question from J.B. Lowe from Citi. Please go ahead, your line is open.

Good afternoon, Zvi, Ronen, Erica. I hope you're all doing well. My first question is about the Mexico contract manufacturing facility. You mentioned it would be operational by the end of the year, and I recall you initially said you could ship some of the first products from there in the first half. Is that still the case? My second question is regarding your bookings for 2022; I believe you mentioned they are over 130% of your 2021 shipments already. How much more can you book this year, and what is the timeframe for booking commercial products to ensure delivery before the end of 2022? Thank you.

Yes, to clarify the first part, we are starting to deliver products from Mexico to the US this quarter, Q1. By the end of the year, we aim for nearly all of the residential products used in the US market to be sourced from Mexico. This process is underway now and will be completed by year-end. During the first quarter, we expect significant shipments of inverters and optimizers from Mexico to the US. Regarding the second part of the question, we are currently accepting commercial orders for July, August, and beyond. The dynamics in commercial and industrial (C&I) are somewhat different. The design phase takes longer, which is why we are speeding up shipments. Customers have integrated our products into their designs a few months ago and now require the equipment to implement those projects. In many instances, this is their initial experience with our products after purchasing into the technology, which makes it critical for us to support them—even with the expedited shipments. The typical timeframe can span three to five months between the design stage and the actual product need. While the lead times we’re currently providing and the ongoing orders for July and August are a bit longer than the design cycle, they remain reasonable enough to assure customers that they can continue to incorporate our products at their recent pace.

We'll take the next question from Kasope Harrison from Piper Sandler. Your line is open, please go ahead.

Good afternoon. Thank you for taking my questions. So my questions are all on Sella 2. So with respect to the second half of the year, if for whatever reason, there's not enough demand on the residential side for Sella 2 – or for batteries powered by Sella 2, how easy is it? And is there enough demand for you to redirect that capacity to non-residential segments? And then, Ronen, I was just wondering if you could just help us think about the difference in returns associated with building capacity like you did with Sella 2 versus buying capacity like you did with Samsung SDI using whatever preferred metric you want to use? Thank you.

Okay. So I'll start with the capacity. So first of all, our storage division has sales of storage products that are independent of the solar residential battery, of course. So by definition, we can take – and by the way, we plan to take capacity from Sella 2 into this area as well. We simply, of course, prioritize the solar-related business rather than the non-related business, but we believe that the capacity is there, and it's enough. So yes, if we do not see that, there is enough capacity coming from Sella 2, first of all, we need – or for Sella 2, we need to consume the amount from Samsung, because this is a contractual obligation, and we will direct the excess capacity to the other sources. And here, we can actually either sell them as battery sales or as packed products. Our storage division has both and tech deliveries; we, of course, prefer to sell everything as a pack rather than in a cell because in this case, we have better margins. And, of course, we have a better ASP per watt hour. So in general, we can take this and we can divert, not maybe 100% of this capacity but still enough to make Sella 2 operate and able to grow. When it comes to the return on the investment, this is a little bit more tricky because, first of all, again, the question is what are you using the factory for? And whether you use it for more packs or more cells that you're selling? In general, I would say that the way the metric that we have used is returned on capital investment. And I can tell you that our return on investment on Sella 2 compared to the buy option, and this is before taking the fact that you get certainty on the number of cells that you can get and the capacity that you can get, was a multiple, I would say, single-digit – low single-digit years for return on the investment of Sella 2 compared to buying from other sources. So we view it as an extremely attractive ROI model.

We will take the next question from Biju Perincheril from Susquehanna. Your line is open, please go ahead.

Hi. Good afternoon. Thanks for taking my question. Maybe one more question on the long-term battery demand. As you sort of see the surge in commercial demand for inverters, what's the range you get from those customers for their appetite for storage products? Could this be an avenue for the additional capacity from Sella 2?

So I'll separate the answer into two, and I addressed it a bit earlier. We see the commercial storage dynamic repeating in the way the residential storage dynamic, just a few years later and maybe a slightly slower evolution. But we definitely expect it to come, and there are already early signs of it today. And for the same motivations and reasons, whether it is continuity of power supply in areas of grid instability, or controlling demand charges, or increasing self-consumption in order to save on the pricing coming from the grid. We have a large solar installation on the Sella 1 factory here in Israel, and we will put a large installation in Sella 2 and in both cases for economic reasons. When will we add storage? It's probably depending on the region, probably a couple of years out still before attach rates begin to be double-digit on commercial installations. And by that time, capacity from Sella 2 or by then from additional expansions that we will do is definitely what we have in mind and where we are aiming to go.

Your next question is from Mr. Michael Blum from Wells Fargo. Your line is open, please go ahead.

Thanks for taking my question. A little bit of a high-level question, I guess. I know NEM 3.0 in California is not finalized yet, but I wanted to get your views on how this and similar changes in other states here could impact demand of the US market? And how does that impact your long-term thinking on sales trends to the US versus Europe and rest of the world? Thanks.

Yes, I think the latter part of your question is very relevant to the first part. We have been operating in Europe and other parts of the world for a long time. In many European countries, the regulatory environment is quite similar to what was intended in the original NEM 3 proposal, evolving into a self-consumption market with much higher battery attachment rates. For example, in Germany, battery attachment rates are around 70% to 80%, alongside a stronger demand for self-consumption and enhanced components like solar-driven water heaters, EV chargers, and smart switches. This is already the situation we see in Germany and some other European nations. If California eventually adopts a similar direction, we believe the market will be close, possibly larger or smaller, but installations will remain complex and costly due to the potential returns from self-consumption. Overall, this will change the market's characteristics, but we do not expect it to eliminate the market. We actually believe that we are well-prepared and experienced for this type of environment when it arrives in the US.

The next question is from Mr. Ameet Thakkar from BMO Capital Markets. Please go ahead, sir. Your line is open.

Hi. Thank you for taking my questions. I just wanted to follow-up on the prior question real quick. And can you give us a sense for kind of the percentage of your 2021 revenues that were from California residential markets?

I don't have the exact numbers available. Typically, the US accounts for around 40% to 50% of our revenue. Within the US, our revenue comes from both residential and commercial sectors, with residential sales distributed across several states, California being the largest. I'd estimate that California's contribution is a significant figure in the double-digit range, likely on the lower end, since it's a part of our global business both geographically and by segment.

It appears that there are no further questions at this time. I'd like to turn the conference back to Mr. Zvi Lando for any additional or closing remarks. Please go ahead, sir.

Yes. Thank you. So in summary, we concluded an operationally challenging yet positive year on all fronts with record revenue, all of this while continuing to invest in laying the ground for future growth and expansion into adjacent markets, the first of which we are already beginning to see today. Thank you all for joining our call today, and have a good rest of the week.

This concludes today's call. Thank you for your participation. You may now disconnect.