Welcome to the SolarEdge conference call for the third quarter ended September 30, 2022. This call is being webcast live on the company's website at www.solaredge.com in the Investors section on the Event/Calendar page. 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 Event/Calendar page of the SolarEdge Investor website. I would now like to turn the call over to Erica Mannion at Sapphire Investor Relations, Investor Relations for SolarEdge.

Good afternoon. Thank you for joining us to discuss SolarEdge's operating results for the third quarter ended September 30, 2022, as well as the company's outlook for the fourth 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 third quarter ended September 30, 2022. Ronen will review the financial results for the third quarter, followed by the company's outlook for the fourth 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 and 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 U.S. GAAP. The non-GAAP measures are presented in this presentation as we believe that 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 U.S. GAAP. Listeners who do not have a copy of the quarter ended September 30, 2022, press release, or the supplemental material 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. This quarter, we saw record revenues for the company, led by record revenues from our global solar business driven by significant growth in Europe. In aggregate, we shipped this quarter a record 2.7 gigawatts of our DC-optimized inverter solution and 321 megawatt hours of residential batteries. This quarter, we shipped 6.1 million optimizers and 265,000 inverters, representing quarter-over-quarter growth of 16%. We're happy with this increased output from our factories following the COVID-related challenges we experienced in the first half of the year in Vietnam and China. However, the demand for our products still outpaces our production and supply chain capacity. We are working hard to close this gap through the further ramp of production in our new Mexico facility and capacity increases in other locations. On this note, in light of the recent IRA legislation and the increased demand from the U.S. market, we are aiming to establish manufacturing capability in the United States within 2023 and are in the active planning and site selection process. Our revenue growth this quarter is mostly driven by strong momentum in Europe, where revenues grew by 42% from last quarter and by 90% compared to the same quarter last year. In particular, growth was strong in the largest European market of Germany, where revenue grew by 125% quarter-over-quarter and in the Netherlands, France, and the U.K., all with record quarterly revenues. We expect the strong momentum in Europe to continue into 2023 and are seeing an elevated level of new orders coming from our channels to prepare and support this continued growth. In the third quarter, we prioritized shipments to Europe in light of the challenging winter expected there. This quarter, revenues in the U.S. were lower than the previous quarter. As given the constrained capacity environment, we prioritized the supply to the European residential market, as mentioned earlier. In the U.S. commercial segment, however, this was a record quarter of inverter and optimizer shipments with an increase of 10% from the last quarter. This is the fourth consecutive quarter of double-digit growth in our commercial megawatt shipments to the U.S., reflecting the market momentum and our position in this market. We expect this growth dynamic in the United States commercial market to continue into 2023. Outside of Europe and the United States, we also had record quarterly shipments in Taiwan and South Africa and good momentum in quarter-over-quarter growth in Australia. From a segment perspective, this was a record quarter for megawatt shift in both residential and commercial as well as megawatt hours of battery shipments. In the commercial segment, which grew 12% quarter-over-quarter in megawatts shipped, we are seeing growth of installations in an increasing number of diverse applications such as floating PV, where we commissioned this quarter several large projects in Israel and Taiwan, and the agro or agricultural PV application aimed at dual use of land for solar generation and growth of crops. We are engaged in several such projects in Europe and Asia and see this as a potential high-growth application for the future. Overall, our demand globally continues to be strong. Point-of-sale data from our distribution channels are at record levels and growing month-over-month, and our focus is to increase factory output to meet the demand efficiently and with less need for expedited shipments in order to continue the margin improvement we have seen this quarter. Shifting to products, our battery shipments grew this quarter in line with our plans and reached a record 321 megawatt hours, driven primarily by our shipments of the 3-phase battery that we announced last quarter. This demand is coming primarily from Germany and other 3-phase European countries, spurred by the increase in energy prices and the growing demand for backup and independence from the grids. For our single-phase battery, we are seeing good demand from Australia, South Africa, and the U.K., countering slower-than-projected growth of battery attach rates this quarter in the United States. That said, in this quarter, the amount of our single-phase batteries in the United States that were installed and connected to our monitoring portal was double that of the previous quarter. On the optimizer side, we recently announced the release of our new Sense Connect technology that detects temperature increase at the connector level to prevent potential electric arcs. By detecting and reacting to abnormal connector overheating that may happen due to faulty installations or connectors, our Sense Connect technology stops power flow before an arc can occur. With module level site visibility, operation and maintenance providers are informed of the pinpointed location of the connector, so repairs can be conducted swiftly and easily. This helps maximize system safety, uptime, and reduces operational costs. The Sense Connect technology is in addition to our wide range of safety features, among them the safe DC technology and rapid shutdown. Additionally, this quarter, we announced the release of our SolarEdge Home Load Controller. This is a wireless device that is designed to optimize energy consumption by controlling heavy loads home appliances. The Load Controller is easy to install, enabling remote and automatic control of home appliances such as heat pumps, EV chargers, pool and well pumps, HVAC, and others. This technology enables homeowners to increase their self-consumption by using excess energy that would otherwise be lost and extend their battery backup time during grid outages. Once installed, the Load Controller seamlessly integrates with our mySolarEdge app, enabling homeowners to control loads directly from their smartphone. For homeowners, this means that they can now schedule and track their solar energy production, battery storage level, grid services if they have connectivity, and solar cell consumption. The SolarEdge home operating system calculates energy usage and savings according to personal preferences while considering external factors such as weather events and utility rates. Also this quarter in grid services, we joined the Rocky Mountain Power Wattsmart program, making us one of the two battery suppliers selected thus far for this program. The program provides customers in Utah and Idaho, who enrolled with the SolarEdge home battery, a significant enrollment incentive and additional monthly incentives. We are already seeing positive interest among existing SolarEdge battery owners and new potential installations. Together with this program, we have to date more than 20,000 systems under various grid services and data programs globally. In this context, our financial results this quarter reflect the capital gain from a sale of shares from an investment we made about 18 months ago in a grid services company that materialized. Moving to our nonsolar business. In South Korea, the ramp of our Sella 2 factory is on schedule, and we began mass production and are shipping sales to customers in small quantities this quarter. Our e-Mobility revenues are at a steady but reduced rate, much in line with the overall automotive industry supply chain-related instability. And with this, I hand it over to Ronen, who will review our financial results.

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 comprises gross profit for the segment, less operating expenses that do not include amortization of purchased intangible assets, impairment of goodwill and intangible assets, stock-based compensation expenses, and certain other items. Total revenues for the third quarter were a record $836.7 million, a 15% increase compared to $727.8 million last quarter and a 59% increase compared to $526.4 million for the same quarter last year. Revenues from our solar segment, which includes the sales of residential batteries, were a record $788.6 million, a 15% increase compared to $687.6 million last quarter and a 65% increase compared to $476.8 million for the same quarter last year. This quarter, our shipments, while significantly higher than the last quarter, are still limited by manufacturing capacity rather than demand. As Zvi noted, we directed more residential products to Europe in anticipation of the energy issues expected there this winter. Consequently, the geographical mix presented may not fully reflect the demand we see in each region. As we continue to ramp up in Mexico, we expect to address the supply gap to the United States. Solar revenues from the United States this quarter were $251.6 million, a 19% decrease from the last quarter, representing 32% of our solar revenues. Solar revenues from Europe were a record $475.7 million, a 46% increase from the last quarter, accounting for 60% of our solar revenues. Sales in Europe are typically in euros, and thus the devaluation of the euro adversely affected our U.S. dollar revenues and gross margin. Specifically, the impact of the euro's devaluation compared to the average exchange rate of the last quarter resulted in a reduction of $31.7 million in revenues and a 360 basis points decline in gross margins. Over the last quarter, we raised our prices in Europe, and we continue to adjust prices in line with the devaluation of the euro. However, the effects of price increases usually take 1 to 2 quarters to materialize. Rest of the World solar revenues were $61.3 million, a 15% increase compared to the last quarter, representing 8% of our total solar revenues. On a megawatt basis, we shipped 859 megawatts to the United States, a record 1.4 gigawatts to Europe, and 470 megawatts to the rest of the world, slightly exceeding 2.7 gigawatts of quarterly product shipment. 52% of our megawatt shipments this quarter were commercial products, while the remaining 48% were residential. In the third quarter, we continued to see an increase in revenues related to our batteries. Of the 321 megawatt hours of batteries shipped this quarter, the majority were sent to Europe, driven by strong adoption of our 3-phase batteries. The average selling price per watt this quarter, excluding battery revenues, was $0.233, a 1% decrease from $0.236 in the last quarter. This decrease in ASP per watt is primarily due to the weaker euro and a greater share of commercial products in our mix. We anticipate an increase in ASP per watt in the next quarter, resulting from our price hikes in Europe and the United States. This quarter, 2 customers accounted for more than 10% of our solar revenues, one of whom is a European distributor. Overall, we observed a more balanced distribution among our top 10 customers in the last quarter. Revenues this quarter from our nonsolar business were $48 million. The consolidated GAAP gross margin for the quarter was 26.5%, up from 25.1% in the prior quarter and down from 32.8% in the same quarter last year. The non-GAAP gross margin this quarter was 27.3%, compared to 26.7% in the prior quarter and 34% in the same quarter last year. The gross margin for the solar segment was 28.3%, up from 28.1% in the prior quarter. Despite the 360 basis points negative impact of the euro's devaluation and the increased portion of batteries in our overall mix, this quarter-over-quarter increase in gross margin is attributed to the price increases we have implemented globally and our disciplined execution of operational activities. The increase in manufacturing capacity, coupled with a reduction in shipping prices, contributed 140 basis points of reduced shipping costs to our gross margin. Additionally, we witnessed a decrease in component and commodity prices this quarter, positively impacting our payments to contract manufacturers and vendors. Lastly, as our revenues continue to grow, we are observing efficiencies in our operations and support organizations due to economies of scale, which we expect to continue in the upcoming quarters. Goods subject to tariffs, excluding batteries, shifting to the United States from China accounted for 24% of our U.S. shipments this quarter, a decline from 31% in the last quarter, mainly due to the ramp-up of our manufacturing in Mexico. The gross margin of our nonsolar segment was 11.2%, compared to 2.7% in the previous quarter. On a non-GAAP basis, operating expenses for the third quarter were $108.3 million, or 12.9% of revenues, compared to $109.6 million, or 15.1% of revenues in the prior quarter, and $83.8 million, or 15.9% of revenues for the same quarter last year. The primary reason for this quarter-over-quarter decrease is the discontinuation of our Critical Power division operations, increased efficiencies in our e-Mobility division, and a favorable effect from the new Israeli shekel and other currencies against the U.S. dollar, which lowered our operating expenses since some of these are paid in those currencies. Our solar segment's operating expenses as a percentage of solar revenues were 12.2%, down from 13.7% last quarter. We anticipate further improvements in this ratio as our revenues grow at a faster pace than our expense base. Non-GAAP operating income for the quarter reached a record $120.2 million, compared to $84.7 million in the previous quarter and $95.2 million for the same period last year. This quarter, the solar segment generated a record operating profit of $126.7 million, compared to $99.2 million last quarter. The nonsolar segment recorded an operating loss of $6.5 million, an improvement from an operating loss of $14.6 million in the previous quarter. Non-GAAP financial expenses for the quarter were $31.6 million, up from a non-GAAP financial expense of $20.9 million in the previous quarter. $35.4 million resulted from foreign currency devaluation against the U.S. dollar, most of which are non-cash and non-realized expenses. For reference, euro cash balances and euro-denominated accounts receivable amounted to approximately EUR 300 million and EUR 500 million this quarter, respectively. This was partially offset by interest income from our investments. Our non-GAAP tax expense was $34.5 million, compared to $7 million in the previous quarter and $10.1 million for the same period last year. I would like to highlight our tax expenses and provide guidance for the upcoming quarters. Our corporate structure is such that the parent company of the group is a U.S. corporation, while most of our research and development activities occur outside the United States. According to new U.S. tax regulations, R&D expenses incurred outside the U.S. must be capitalized for tax purposes and recognized over 15 years rather than being expensed in the year incurred or over a 5-year period when expenses are within the U.S. The result being that of our $69.7 million in quarterly R&D expenses, approximately $64 million will not be recognized as an expense for U.S. tax purposes this year and will instead be amortized over 15 years. This shift in tax treatment will impose a tax burden on our financials that will diminish over time as a larger portion of our R&D expenses will become recognizable for tax purposes. Additionally, the impact of our lower stock price on our taxable income was reduced this quarter, as lower vested employee stock awards resulted in decreased tax expenses. Given the current stock price, we expect the effective tax rate for the following quarter to be marginally lower, and this rate is anticipated to decrease year-over-year as our overall income rises and a higher proportion of our research and development expenses are acknowledged for tax. GAAP net income for the third quarter was $24.7 million, compared to $15.1 million in the prior quarter and $53 million in the same quarter last year. Our non-GAAP net income was $54.1 million, compared to $56.7 million in the previous quarter and $82.1 million for the same quarter last year. GAAP net diluted earnings per share was $0.43 for the third quarter, compared to $0.26 in the previous quarter and $0.96 in the same quarter last year. Non-GAAP net diluted earnings per share was $0.91, compared to $0.95 in the previous quarter and $1.45 in the same quarter last year. The financial expenses related to foreign exchange negatively affected our non-GAAP EPS by approximately $0.37. Now, turning to the balance sheet. As of September 30, 2022, our cash, cash equivalents, bank deposits, restricted bank deposits, and investments totaled $1.6 billion. After accounting for debt, this amount is $937.6 million. Accounts receivable increased this quarter to $785.3 million, compared to $669.1 million last quarter. As of September 30, our inventory level, net of reserves, was $561.4 million, compared to $470.3 million in the prior quarter, primarily due to higher raw material levels, partly related to the ramp-up of our Sella 2 factory. Now, regarding our guidance for the fourth quarter of 2022, we anticipate revenues in the range of $855 million to $885 million. We expect non-GAAP gross margins to fall between 27% and 30%. Our non-GAAP operating profit is projected to be between $115 million and $135 million, with revenues from our solar segment expected in the range of $810 million to $840 million and gross margins for the solar segment anticipated to be between 28% and 31%. I will now hand the call over to the operator to open it up for questions.

I will begin by discussing margins, which have been a focal point for some time. It appears that gross margins have declined. Do you agree with that observation? Ronen, could you provide a detailed explanation of the 140 basis point benefit you mentioned? As we consider the guidance for the fourth quarter, it seems there is a slight improvement suggested. Could you elaborate on the factors driving that? Also, what else do you anticipate, whether additional drivers for the fourth quarter or new ones that may emerge after this quarter?

Thank you for the question, Brian. Generally, we believe that our gross margins are expected to improve moving forward. This improvement is primarily due to a reduction in gross margins, aside from the euro-related income from Europe, which is becoming a significant portion of our revenues. The decline in margin was largely driven by increased shipment costs resulting from disruptions we experienced in the previous year in Vietnam and with one of our vendors in China, which halted our factory operations for nearly three weeks. As a result of this demand surge, we had to quickly ship to customers using costly expedited services, alongside additional payments necessary for underutilization of our contract manufacturers. In Q3, we implemented disciplined operational strategies across all our factories, including a successful ramp-up in Mexico, leading to a 16% increase in production and shipments. This increase helped decrease the underutilization costs owed to our contract manufacturers. Additionally, we’ve observed a decline in regular shipping costs, and recently air freight prices have also started to drop. The combination of these lower costs and increased factory output enabled us to slightly reduce expedited shipments, thereby decreasing our shipping costs by about 140 basis points. We anticipate further improvements as we continue to boost production capacity in our factories, particularly in Mexico, where we expect to ship most residential products from there by the end of Q4. This will significantly reduce shipping times to the U.S. and lessen the reliance on expedited services. Furthermore, we are seeing enhanced efficiency in our other factories, allowing us to reduce the need for expedited shipments as well. As we grow our operations and support functions more slowly than revenue growth, this will also influence gross margins. In summary, we are focused on increasing capacity, cutting shipment costs, and managing vendor payments effectively. Regarding your question about next quarter, we have implemented price increases over the last three quarters, particularly in response to the currency fluctuations. Typically, there is a lag of one to two quarters for these price increases to fully take effect, and we expect the impact from the recent increases will be felt by Q1. Overall, we aim to be aligned with the guidance we provided during our Analyst Day last March by the end of Q2 2023.

I appreciate all that color. And my second question was going to be around the battery shipments. I thought last quarter, Ronen and Zvi, it sounded like you were implying more of a flattish sequential trend. So over 300-megawatt hours of volume seems quite high. Maybe talk to some of the near-term demand trends you're seeing for the battery segment? And then that transition, what that is looking like from your Korean supplier to Sella 2, maybe the timeline? And then what do you think it means for volumes and margins off of these levels?

So I think, as we alluded to, Brian, during the conversation, we introduced the 3-phase battery a quarter ago aimed for the European market, in particular, Germany, but not only as well as some of the other European 3-phase markets. And the demand there is obviously going up dramatically, and the batteries are typically going with inverters, either inverters that are already shipped and installed and we're waiting for batteries or new inverters that shipped this quarter. So with our ability also to increase the output of inverters that pulled with it additional volumes of batteries, beyond those that were targeted for inverters that were installed previously. So this double effect led to a very strong demand, which we were able to meet, and that's the result of the increase that you saw. And as we commented on the single phase, the rate of shipment with the main market over there is the United States. In the United States, the rate of shipment was slightly down, but that was partially covered by the fact that we introduced the single-phase battery also in some Rest of the World countries, the U.K., South Africa, and Australia, and we're seeing good acceptance there. So between those phenomena and the 2 types or the 2 families of batteries that we're offering, we saw the increase to this 320 megawatt hour. Obviously, none of these batteries today are using Sella 2 cells. We're just beginning the ramp right now and beginning to ship cells to some of our cell strictly so customers, not yet were still going into the early phases of qualification at the battery level. And we're still probably a few quarters away from a big portion of our battery shipments being based on our Sella 2 cells. But obviously, our long-term intent, as we've communicated all along, is to maximize usage of our own cells while continuing to maintain a certain portion and active relationships with other cell providers to give us the flexibility in volumes and technology that we're aiming for.

I wanted to revisit your comments about the potential establishment of U.S. manufacturing. I understand that plans are still being finalized, but could you provide more insight on this? Will it be for solar products or possibly storage as well? Are you waiting for specific guidelines from the treasury, or is there a chance we could see an announcement before those guidelines are set?

So I'm not sure we can provide much detail other than to say that we are working on both fronts simultaneously. Selecting a location and defining the processes takes time, and we are doing this based on preliminary assumptions regarding the regulations. However, since we know there may be significant changes to these regulations, we likely won't finalize any decisions related to production sites or plans until there's more clarity. We're actively pursuing both areas with urgency. As we gain more understanding from both sides, we will be able to provide a clearer picture. For now, we are tracking the regulations and moving forward with planning and site selection. Based on the current regulations, we expect to focus on inverters and optimizers in the initial phase, rather than batteries.

Okay. And then, Ronen, just real quick. I'm sorry if I missed this. The 4Q guidance, did you say what level of the euro you're baking in there?

The level of euro, we're basically looking at about $0.98 per euro.

Could you talk a little bit about the volume of energy storage products in the channel? And how much of what you shipped during the quarter was able to sell through during the quarter?

Yes. Unlike the inverter and optimizer, the channels are quite empty, and inventory levels are low. In terms of batteries, especially single phase, the channel is stronger and more stable. This is a key reason why there were fewer shipments this quarter compared to the 3-phase battery shipments, where the channel is still not fully filled.

Okay. That's helpful. And then in terms of the tax rate and how we should think about that going forward? You talked about a cadence of some step-downs, but you had pretty compelling tax rates historically. Could you talk a little bit about how we should be thinking about the step-down in tax expense, particularly as you have a little bit more robust operation in the U.S. here? Are you able to offset some of the net spending as U.S. R&D and any capacity to start lowering that tax rate?

Sure. To begin with, the main factor influencing our results this quarter was the new regulations regarding R&D performed outside the United States, which now require us to amortize those expenses over 15 years instead of recognizing them immediately. This regulation was established under the previous administration and was expected to change as part of the build-back-better plan, which has since been discontinued. Consequently, a significant portion of our R&D efforts, totaling around $240 million this year, is not contributing to taxable income. Additionally, we typically experience substantial expenses related to employee stock option vesting, particularly when stock prices rise. However, with our stock price about 30% lower than it was last quarter, this has resulted in decreased income and, consequently, a lower tax expense, which has led to a higher taxable income than anticipated. Moving forward, our tax rate will hinge on three key factors: the pace at which our operating income grows, the proportion of R&D expenses permitted for tax deductions, and fluctuations in our stock price. If we face a tax rate above 40% in the third quarter, we can expect it to fall between 30% and 35% in the subsequent quarter, contingent on the stock price. As we proceed, the tax rate should decline. While operations in the U.S. may not significantly contribute to lowering the tax rate, we must consider the uncertainties surrounding manufacturing tax benefits under the IRA, which may offer cash payments rather than just tax credits. Consequently, projections in this area remain uncertain. Generally, we anticipate a return to normalcy in the coming years, though it might take 6 to 7 years to reach around 20%. It's also important to note that starting next year, R&D conducted in the U.S. will be amortized over 5 years. Thus, the outcomes for our operations, both inside and outside the United States, are expected to become more comparable than they currently are.

First one to follow up on the U.S. manufacturing. I know you can't make any final decisions until we get clarity from the treasury department. But can you help us understand how much in terms of gigawatts for the inverters you might be contemplating? Are we talking about maybe 2 to 4 gigawatts of U.S. manufacturing? And then what's your latest view on the difference between the microinverter and the resi inverter credits, $0.11 versus the $0.065 per watt? What's the probability that you think you guys might be able to secure that $0.11 per watt?

I will begin with the first question, and Zvi will address the second. Generally, our plan is to meet U.S. demand from within the United States. As we've discussed before, we believe that over time, since our products are bulky and relatively heavy—especially batteries—it is ideal to establish manufacturing sites in our major markets or, if possible, in the largest countries where we operate. Thus, manufacturing in the U.S. for the U.S. is operationally advantageous. The delay in pursuing this has been due to economic factors, which are now changing with the introduction of the IRA. If the overall regulations allow for it, our goal is to produce all products destined for the U.S. in the U.S. This includes inverters and possibly optimizers, which would be our preferred approach. Zvi, could you please provide insights on the microinverters?

Yes, fairly. As you know, the act was passed through Congress quickly. And it's no secret that there are a lot of clarifications that are needed. And actually, even the technical definitions, as they are written right now, are not that clear cut in terms of their applicability to one technology versus the other. So together with many other companies, we're involved in reviewing and working with the relevant regulators for appropriate clarifications. And we are quite confident that it will end up being clear and consistent across the various technologies in terms of the way the regulations are applied.

We'll go through this one by one. First, in the quarterly report that will be filed over the next year or two, you'll see recognized revenues from batteries, which were approximately $167 million. Regarding interest expenses and finance expenses, it depends on how the euro behaves against the U.S. dollar. At the beginning of the last quarter, the euro sharply devaluated against the U.S. dollar. However, over the past two and a half months, we've observed relatively stable rates. As long as the euro stays within a range of $0.98 plus or minus, the impact on finance income or expenses should be minimal. If the euro strengthens against the U.S. dollar, we will benefit because we currently have over €800 million in euro-denominated balances on our balance sheet. You can calculate the impact by taking the difference for the quarter based on that amount. Conversely, if the euro declines, we will be adversely affected. At this point, considering the interest rates and comments from the Fed and the European Central Bank, the situation appears to be more stable. Therefore, when neutralizing foreign exchange impacts, we should see interest income from our investments, which generates several million dollars quarterly.

I wanted to go back to the cadence of gross margins over the next few quarters just to make sure I understand. And I just throw all my questions into one. Do you expect to still have paying expedited shipping costs in Q4? And if so, when do you think you'll no longer be paying those expedited shipping costs? And then on the batteries, I know, I think last quarter, you said the gross margins were somewhere around 15%. So I'm wondering where that stands right now? And when would you expect to get to that 25% target?

Thanks for the questions, Michael, and I'll go one by one. In general, expedited shipments are mainly a result of limitation of supply compared to the demand that we see. And we do expect them to diminish and be reduced towards the end of the second quarter of 2023, where the biggest issue there is actually the ramp-up of our Mexican facilities that will require less overseas shipments going into the United States and will also free the capacity that we have today in China, Vietnam, Israel, and Europe for shipments in Europe itself. So in general, we do expect those to reduce. I'm not sure that they will ever disappear completely because we need to understand that expedited shipments are sometimes even related to the needs of customers at that point. For example, at this point of time, and as Zvi mentioned, anyone talk about the expected winter in Europe. And when we see customers that are striving for products, we try to expedite shipments to them and also make sure that they're meeting the installation cycles that are very much reduced during the winter there. So I think the expedited shipments will always be there for sure not to the extent that they are today. And therefore, I believe that the relief will be gradual but ever-growing towards the second quarter of 2023. Just remind in one of the previous questions, we expected time to be within gross margins that we guided during the Analyst Day being the 28% to 30% on the corporate level and 30% to 32% on the solar level, and we keep feeling comfortable around this. So that's on expedited shipment. And please remind me the second one.

Gross margins of batteries.

Gross margin for batteries is currently targeted at 25%. Last quarter, it was 15%, but we're seeing growth in volumes, particularly with 3-phase batteries being sent to Europe, where pricing reflects improved margins. We're not at 25% yet, but we're on track. I also want to mention something related to expedited shipments. Assuming COVID is no longer an issue, we should see things improve. However, COVID remains a factor in China, where there are still strict measures and recent outbreaks have been reported. Thankfully, these have not affected us so far, but everything I mention is dependent on China continuing to operate normally.

So first one for me. How much capacity do you currently have on a megawatt basis? And how does that number change once the Mexico facility is fully online? And then I had a follow-up question.

Yes. So Kashy, thanks for the question. We don't give an exact number on that. But to be clear, the limitation is less capacity related and more supply chain related. So to be able to ramp some of our suppliers, in particular, on some of the components where we are competing with electrical vehicles, in most cases, that's where our limitations are and that is where we are working to qualify alternatives and to get larger allocations, and that was reflected in the growth that we saw this quarter and the growth that we're targeting for next quarter and beyond. It also involves increasing capacity and production lines and testing equipment. But at first approximation, the limitation is around component and component supply.

That's very helpful. And as my follow-up, I wanted to ask about cash flow from operations. Working capital has been a big use of cash year-to-date. And it looks like your cash conversion cycles are, I think, a bit higher than they were back in 2019 in the pre-COVID environment. And so just wondering, Ronen, as you look at this business moving forward, how are you thinking about cash conversion cycles, DSO, and so forth?

First of all, you're correct. This year, we are experiencing a slower cash conversion. There are two main reasons for this: first, we have seen an increase in our inventories, with tens of millions of dollars added this quarter. This is partly due to our commitment to avoid the golden screw—the critical part that we may lack, preventing us from completing a product. Therefore, we are building inventories to ensure stable manufacturing capacity. Additionally, we sold approximately $40 million more inventory related to materials for Sella 2 production this quarter. This is the primary driver of cash usage, along with our purchase of Samsung cells. Furthermore, some of our customers are facing longer shipping times from our factories, and in some instances, we've noticed extended inventory spending on shipments due to shipping times from China to the U.S. growing from 7 to 12 weeks. This is significantly lengthening the cash cycle. We anticipate improvement in 2023, as we expect relief on the components front and, as Zvi mentioned, we are stabilizing our manufacturing. Over time, we will build inventories at various locations, reducing working capital usage. In Mexico, for example, instead of spending up to 90 days on a boat, products will spend only 10 days on a truck. All these factors should return our cash generation to levels similar to non-GAAP profit by the end of 2023.

It's Alex Rebel on for Julian. Just one more, if I may, just to sort of like follow up or sort of close out this margin discussion. Ronen, I think in the past, you've been really open about sort of characterizing what the headwinds are today as far as logistics and expedited shipping base and kind of how you see those things rolling off? So with that in mind, I mean, looking at what you mentioned as far as your tariff volumes, it looks like Mexico is pretty early in the ramp stage. You're still targeting full volume or full residential volume from that facility by year-end. I'm wondering, looking at the next quarter and sort of the one after that, I mean, can you break that down again for us as far as roll-off, logistics expense and an ability to optimize around that as well as potential carry drag from the component space.

I'll try as much as I can with one correction, and this is the fact that Mexico has noted very early stages. This is actually the third quarter in a row that we are shipping products from Mexico in increasing volumes. And, by the way, as a result, as I mentioned in our prepared remarks, only 24% of the products that we brought to the U.S. were bearing Chinese tariffs. I would just remind everyone that it was close to 80% at the beginning of the year. So in that sense, Mexico is happening. It's on track, and this is definitely our aim to provide residential products at 100% from Mexico by the end of this year. And I think that we're on track. By the way, there are always certain flavors that you need to bring from other places because we have many flavors of inverters. So on that front, actually, Mexico is going as planned. From shipping costs and headwinds, we used to see in the past approximately a burden of 600 basis points compared to about a year ago. That was at the end of Q2. As we mentioned this quarter, about 140 basis points of this burden were taken away. And we believe that we can take until the end of the second quarter of '23, I wouldn't say all, but a substantial part of the remaining amount. This is a pure result of the fact that we do have more capacity, and we're able to basically have a more predictable manufacturing that allows us to better plan the capacity with our customers. So on that front, we definitely see an improvement. As it comes to the 301 tariffs, we mentioned before that, that's about 100 basis points load. Now it is going and diminishing. And it will not go to zero because today, some of our, at least commercial products, are still manufactured outside of the United States, but they will move also over time to other locations that are not bearing tariffs, and this will happen during 2023. I also mentioned in the past that there are 2 areas that we cannot control. One, of course, is the issue of foreign exchange rates. We do increase prices in order to overcome it. But sometimes, we see that there is a little bit of a lag here. And we cannot always control the mix of our products given the demand that we see. Again, reiterating my previous answers, we feel comfortable with the fact that we can get closer or to be at the Analyst Day guided margin by the end of the second quarter of '23.

Got it. Very helpful. Just one follow-up. Can you expand a little more on the demand trends you're observing between single-phase and three-phase? It seems you are one of the few in the U.S. market to indicate somewhat weaker demand trends. I'm curious if you can elaborate on what you're seeing and where you think those trends are headed from here?

Let's begin with a geographical overview. In the residential single-phase market, the largest is the U.S., followed by the Netherlands. Italy, most of Australia, and South Africa also have significant single-phase residential markets. For three-phase markets, Germany and its neighboring countries like Austria and Switzerland are the largest residential markets. The demand in these three-phase markets is exceptionally strong and necessary. Our market position is solid, and we believe our offering is well differentiated, as it combines both the battery and the inverter. We are confident about the anticipated growth and our capability to meet that demand, especially since attach rates in these regions are very high, with nearly every solar installation including a battery. In single-phase markets like Australia, South Africa, the U.K., and Italy, demand for batteries is robust yet smaller compared to the U.S. and Netherlands. The Netherlands is currently not a major battery market due to net metering and the lack of incentives for self-consumption. However, our installed base there is substantial, and we recently reported a record quarter. Over time, similar to other markets, a demand for batteries may arise, presenting a significant opportunity to retrofit our existing installations, though this is not expected in the short term. Turning to the United States, a key single-phase residential market, battery attach rates are indeed rising but not as quickly as many had anticipated. While our installation rates have doubled from one quarter to the next, the expected faster growth in battery attach rates has not materialized. Consequently, we have a bit more inventory of single-phase batteries in the U.S. right now. We believe this reflects the market's phase of learning about sales and installation, with prices stabilizing. We expect the battery attach rate in the U.S. to continue growing, and possibly even accelerate, particularly if any changes encourage self-consumption. Although attach rates are growing more slowly than projected, they still have the potential to increase quickly as we enter next year.

A couple of questions on my end. I was wondering, Zvi, if you can go over what lead times are for both residential and commercial products in the U.S. and Europe, that would be helpful to understand? As the capacity is ramping up, what's going on there?

Yes. So as reflected in your question, it varies a little bit by product, probably on optimizers and single-phase inverters that's in the range of 12 to 15 weeks or so. And on 3-phase commercial products, it is a little bit longer than that, probably 18 to 20 weeks, roughly in the commercial 3-phase inverters. I believe we've talked about this before. Many people have been anticipating the revival of the U.S. rooftop market for quite some time, which represents a significant untapped opportunity. While I'm not certain it has fully recovered, we are certainly observing growth. Predictions suggest further expansion next year. One of the key factors driving this is corporations making investments in solar energy for both environmental, social, and governance reasons, as well as due to high electricity costs. In this context, we are well-positioned as a cost-effective commercial solution that meets the safety standards required by these businesses. This trend benefits us. Furthermore, in recent quarters, we've launched product versions tailored for small ground mount community solar projects, and we are capturing market share in that area as well. Therefore, with the rooftop market growing alongside our increasing market presence there, and the expansion of community solar, we are clearly gaining traction since we had no market share before and are now supplying products to that segment. I believe we are effectively leveraging these opportunities.

Just to return to Europe, obviously, there's a significant disconnect between the megawatt growth and revenue growth, which I assume is mostly storage. I just wanted to check if that's correct or whether there's any ASP math going on the inverter side? And then just looking forward, wondering if we could continue to see that kind of disconnect in terms of storage driving growth in Europe well beyond what the megawatt volume on the inverters might suggest?

Yes, it's challenging to directly compare revenue to megawatts of shipments due to the influence of batteries. Additionally, Europe is a strong market for both residential and commercial applications. There can be significant variations from one quarter to another, which also affects average selling prices. However, the impact of batteries is likely a more significant factor going forward. We have previously reported that we are experiencing good commissioning times, thanks to our significant investment in training, which we see as an advantage for adoption rather than a limitation. Based on my discussions with customers, much of the progress will come from the entire channel learning how to effectively sell batteries and explain their benefits to consumers. Additionally, this will involve improvements in installation and simplicity. Currently, we have reasonable installation times, but we are focused on enhancing those aspects to streamline the process even further.

Just one quick one for me. You guys mentioned a couple of times that you expect to get back to that gross margin you displayed at the Analyst Day by the second quarter of '23. I was just kind of wondering, in terms of the trajectory for the operating profit margins you laid out, what's the trajectory for that? It looks like your 4Q guidance implies that that's going to be kind of flat, I guess, the third quarter, despite a little bit better outlook on gross margins.

In general, I'll begin with the overall trend and then discuss the fourth quarter. The trend indicates that we anticipate returning to the guided margins we previously outlined by the end of the second quarter of 2023. This expectation is based on projected revenue growth and improved margins, while expenses are not expected to rise at the same rate as revenues, leading to an increase in the overall operating margin. For the fourth quarter, the current guidance reflects the impact of reduced operating expenses in the third quarter, which were affected by the closure of some activities in our UPS division, Critical Power division, and e-Mobility sector. Additionally, we experienced a slight beneficial effect from currency fluctuations, though it is uncertain if this will persist in the fourth quarter. Consequently, operating expenses were lower than in the second quarter, despite ongoing headcount increases, but this trend is expected to reverse in Q4 as we return to growth. The key consideration, especially as we provide our guidance, is to carefully account for potential currency fluctuations that might slightly alter the results, factors beyond our control. Overall, the trend suggests that as we move towards a higher margin environment, we will also experience a decrease in operating expenses alongside revenue growth, resulting in higher operating margins.

Thank you. So in summary, we are pleased with the progress we made this quarter on all operational metrics and are looking forward to next quarter. And thank you all for joining us today. Have a great day.

This does conclude today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful evening.