Earnings Call
Solaredge Technologies, Inc. (SEDG)
Earnings Call Transcript - SEDG Q3 2023
Operator, Operator
Welcome to the SolarEdge Conference Call for the Third Quarter ended September 30, 2023. This call is being webcast live on the company's website at www.solaredge.com in the Investors section on the Events/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 express 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 J.B. Lowe, Head of Investor Relations for SolarEdge.
J.B. Lowe, Head of Investor Relations
Thank you, Leo, and good afternoon, everyone. Thank you for joining us to discuss SolarEdge's operating results for the third quarter ended September 30, 2023, as well as the company's outlook for the fourth quarter of 2023. 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, 2023. Ronen will then review the financial results for the third quarter, followed by the company's outlook for the fourth quarter of 2023. 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, the slides published today, and our filings with the SEC for a more complete description of such risks and uncertainties. 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 because 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, 2023 press release or the supplemental material may obtain a copy by visiting the Investor Relations section of the company's website. Now, I will turn the call over to Zvi.
Zvi Lando, CEO
Thank you, J.B. Good afternoon, and thank you all for joining us on our conference call today. As reflected in our preliminary announcement a few weeks ago and in the guidance we are giving today, we are going through challenging times in terms of general market dynamics and specific inventory trends related to our products. In the call today, we will share details of third quarter sales and megawatt sell-through data aggregated from distributors in some of the regions and our latest estimates of underlying business levels in the near future, and estimate how long it will take to reach the associated revenue level. Before getting into the regional picture, I want to start with high-level perspective. During 2022, and in particular the second half of 2022, our industry went through an unprecedented surge in demand, which we attributed to geopolitical and other reasons discussed in our prior call. Indicators in the beginning of 2023 were that demand would continue to increase this year, in particular in Europe. This led to a buildup of significant backlog for our products, in particular because at the time, we faced operational challenges to supply all the demand. Specifically, this was related to three-phase commercial inverters that were in high demand and low supply in the late part of 2022, and our supply improved dramatically in early 2023. Additionally, in early 2023, we released in Europe a differentiated three-phase residential offering of a backup inverter and battery, which our customers were waiting for and excited to adopt. As a result of these factors, our shipments in the first half of 2023 were at record levels, and we were in the process of increasing capacity to meet the elevated channel demand. However, market demand began to slow in the third quarter, and distributors began to experience financial challenges. As a result, we received a large amount of requests to cancel or push out orders. We should note that while these orders are technically binding on our distributors, the nature of our relationship with these customers assess that we accommodated most of these requests. As a result, our third quarter revenue and fourth quarter expected revenues are significantly lower than our run rate in recent quarters, while the infrastructure we built to support the anticipated sales growth has created a burden that is putting pressure on our margins in the near term. I will describe when and how we believe our revenue will reach a level that reflects stabilized market demand post inventory corrections. And Ronen would elaborate on the margin and financial infrastructure impact of the short-term actions we are taking. Now let's go over the highlights of our third quarter results. We concluded the quarter with revenues of approximately $725 million. Revenues from our solar business were $676 million, while revenues from our non-solar businesses were $49 million. This quarter, we shipped 3.3 million power optimizers and 274,000 inverters. Additionally, this quarter, we shipped 121 megawatt hours of residential batteries, down from 269 megawatt hours last quarter. Our solar business revenues declined quarter-over-quarter by 29% and by 14% year-over-year, driven by market slowdown and high inventory of our products in the channels. Moving now to market-by-market dynamics. Starting in Europe, as already described, during the second part of the third quarter, we experienced significant unexpected cancellations and push outs of existing backlog from our European distributors. Although the dynamics are consistent with what we cautioned during our second quarter earnings call, the magnitude grew much greater than we anticipated. We also note that the European market is a diverse one, and each country comes with its own regulatory environment and energy-related dynamics. I will give some color on what we see on a per-country basis in some of the top countries in which we operate. According to market reports, Germany, which is the largest rooftop solar market in Europe, is on track this year to connect to the grid more than 10 gigawatts of solar compared to 7.5 gigawatts in 2022. The government has announced the long-term goal to reach 215 gigawatts by 2030, which in order to be achieved would require annual installation of approximately 20 gigawatts per year, indicating the expected long-term strength of the German market. Consistent with this trend, our residential energy hub three-phase inverter introduced in April of this year and our three-phase battery are optimized for the German market. We continue to see good adoption of this solution. From a demand perspective, our sell-through in Germany in the third quarter was up 44% year-over-year and down 37% quarter-over-quarter from the peak levels typically seen in the second quarter. The Swiss and Austrian market, which revenue-wise are about a third of the size of our revenue in Germany, utilize the same portfolio of products as Germany, and similarly grew significantly so far in 2023, and are expected to continue to grow in 2024. In fact, Switzerland was a record revenue quarter for us in Q3, and we are well positioned to continue growth in these markets in 2024. Sell-through in these markets was up 213% year-over-year and up 42% quarter-over-quarter. Moving to the Netherlands. The market in the Netherlands is dramatically down from peak levels due to uncertainty around government policies and the phase-out of net metering, which may become clear after the elections in November. That said, there are several trends that we believe will work in our favor in the mid and long term in this market. The increased implementation of dynamic tariffs combined with the phase-out of net metering is likely to increase the number of full system installations with batteries, EV charging and advanced home energy management capabilities similar to the SolarEdge ONE platform that we launched at Intersolar in June. Additionally, depending on changes in regulation, the Netherlands could have a large potential for upsell and retrofit of existing installations with additional products, including batteries and EV chargers, as well as software capabilities, which is a great opportunity for SolarEdge given our market leadership and vast installed base in this country. Furthermore, there has been a push for new residential homes to be built with three-phase service in what has traditionally been a single-phase market. This will enable the use of our differentiated three-phase offering that we have been successful with in Germany, as described earlier. Sell-through of our products in the combined Belgian and Netherlands market were up 4% year-over-year and down 25% quarter-over-quarter. In Italy, the residential market has been sluggish since the Superbonus tax credit ended earlier this year. And we saw our point of sale of residential products in this market decline year-over-year by 48%. On the other hand, the commercial market has seen significant growth and has largely offset the decline in the residential market. Our point of sale data for commercial products in Italy was up 216% year-over-year in the third quarter. Overall, our megawatt filter in Italy was up to 85% year-over-year and down 6% quarter-over-quarter. All in all, the underlying demand in the European market was strong in the nine-month period ended September 30, although below the much elevated expectation heading into the year leading to the inventory buildup that I described earlier. On an aggregated basis in Europe, our sell-through in the third quarter was up 34% year-over-year and down 22% quarter-over-quarter. Moving to the U.S. We have not seen a significant change in market dynamics since our second quarter call. The market is still being adversely impacted by high interest rates and uncertainties around the pace of adoption of NIM 3.0 systems in California. In commercial, we are seeing a slight improvement as projects that were on hold appear to be moving forward, possibly related to availability of low-priced modules. In our data, sell-through in the third quarter for residential was down 13% quarter-over-quarter, and commercial was up 8% quarter-over-quarter. Battery sell-through was up 31% quarter-over-quarter. We expect these market dynamics to continue without significant change in the coming quarters. In the rest of the world, our third quarter revenues were relatively stable and we do not see dramatic shifts in overall revenue over the next several quarters. The rest of the world markets are largely dominated by commercial installations, which are impacted by the higher interest rate environment. Local dynamics in specific countries are largely offsetting each other. Taking into account these market dynamics, we use the demand patterns represented by the sell-through data discussed above to model the time we think it will take to run down the inventory level and have estimated a normalized level of revenue and margin following the inventory corrections. We used our sell-through data for the third quarter of 2023 as a baseline, and did not include potential additional revenue from new products that we will discuss separately, or market share improvements that we are working on and for which we see positive signs. This modeling currently indicates in a non-inventory challenged environment, a revenue run rate of approximately $600 million to $700 million per quarter. Using this model and looking at inventory data that we received from our distributors, we estimate the correction could take two to three quarters of gradual improvement quarter-over-quarter. Moving to the operational side. We are, of course, already taking measures to adjust our cost base to this projected level of business. To align with reduced demand, we have discontinued the manufacturing of our products in Mexico and reduced capacity in China. In parallel, we are ramping up manufacturing in our U.S. facility, where we expect to ship 12,000 energy hub inverters in the fourth quarter ramping to a run rate of 50,000 units per quarter. Additionally, we are targeting for a second site to begin producing commercial inverters and optimizers by the second quarter of 2024. An additional step of cost reduction is our decision to discontinue our light commercial vehicle e-Mobility activity, which we consider non-core. And as such, we delivered the final kits to Stellantis in October. We intend to continue making adjustments to achieve the levels of profitability at the revenue run rate discussed earlier, which Ronen will elaborate on in his comments. Moving on to products. We recently installed our first 330 kilowatt inverter in the U.S. following similar installations that have been running for some time in Europe and Asia. This product is specifically targeting community solar and Agri PV applications. We will be ramping production in the fourth quarter for further deliveries globally in 2024. This will expand our offering for these ground mount applications beyond the tracker product that we released a few months ago. This quarter, we are also announcing the approval by our Board of Directors of a share repurchase program, which reflects our confidence in the future growth of our company. The plan authorizes the repurchase of up to $300 million of the company's stock through 2024. I would like now to address the ongoing situation in Israel and how it is affecting our company. We have seen no disruption to our ability to manufacture and deliver products and services to our customers. Approximately 11% of our Israel-based workforce, which is approximately 6% of our global workforce, has been called up for reserve duty and we are prioritizing and reallocating resources between projects to make sure that the impact on our business is minimized. To conclude my remarks, setting aside recent and upcoming inventory corrections, we believe the underlying demand for our products, while at a reduced level from the first half of 2023, is above our projected fourth quarter revenue and represents our strong position in the markets. On top of this, our global sales force is energized and focused on gaining market share, based on the products and improvements made to our core portfolio in the last 12 to 18 months. This together with the new products we have developed for the new segments we have entered should create an opportunity for incremental growth at a faster rate than the solar market in the coming year. I will now hand it over to Ronen.
Ronen Faier, CFO
Thank you, Zvi, and good afternoon, everyone. The financial review includes a GAAP and non-GAAP discussion. 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 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 $725.3 million, a 27% decrease compared to $991.3 million in the last quarter and a 13% decrease compared to $836.7 million for the same quarter last year. Revenues from our solar segment, which includes the sales of residential batteries and trackers, were $676.4 million, a 29% decrease compared to $947.4 million last quarter and a 14% decrease compared to $788.6 million for the same quarter last year. Total revenues from the United States this quarter were $195.7 million, similar to the last quarter and a 22% decrease from the same quarter last year, representing approximately 29% of our solar revenues. Total revenues from Europe were $419.2 million, a 39% decrease from the last quarter and a 12% increase from the same quarter last year, representing 62% of our solar revenues. In Europe, we saw a meaningful quarter-over-quarter revenue drop across the board with noticeable declines in Germany with a 43% decline, Netherlands with a 40% decline, UK with a 41% decline, and Poland with a 67% decline. On a positive side, revenues in Switzerland grew this quarter by 11%, reaching a record high. And in France, revenues grew by 37%. A significant portion of our revenue decline in Europe is attributed to lower sales of batteries or a combination of inventories in the beginning of the quarter and lower demand than anticipated by our customers led to an accumulation of large quantities in the channels. Rest of world solar revenues were $61.5 million, a 3% decrease compared to the last quarter and flat compared to the third quarter of last year, representing approximately 9% of our solar revenues. On a megawatt basis, we shipped 774 megawatts of inverters to the United States, 2.6 gigawatts to Europe, and 467 megawatts to the rest of the world, totaling 3.8 gigawatts of quarterly inverter shipments. During the quarter, we continued to ship a higher ratio of inverters related to optimizers in order to catch up with previous optimizer sales. During the quarter, 66% of our megawatt shipments were commercial products and the remaining 34% were residential. Just at the beginning of the year, we have shipped approximately 7.1 gigawatts of commercial products worldwide compared to the 5.2 gigawatts shipped in all of 2022. In the third quarter, we shipped 121 megawatt hours of our residential batteries, a decrease from 269 megawatt hours last quarter. While our battery sales in Europe decreased significantly, battery sales in the United States remained relatively stable, and we continue to see a steady increase in installation rates in the United States. Average selling price per watt this quarter, excluding battery revenues, was $0.164, a 13% decrease from $0.188 last quarter. This ASP per watt decrease is predominantly a result of a lower optimizer shipment mix during the quarter and increase in the weight of commercial inverters in our overall mix and the weaker euro. In general, our prices did not change this quarter. Our battery ASP per kilowatt hour was $475 slightly down from $479 last quarter, mostly a result of a weaker euro. Revenues this quarter from our non-solar segment were $48.7 million, an increase from $43.7 million last quarter. Consolidated GAAP gross margins for the quarter was 19.7%, down from 32% in the prior quarter and down from 26.5% in the same quarter last year. Non-GAAP gross margin this quarter was 20.8% compared to 32.7% in the prior quarter and 37.3% for the same quarter last year. Gross margin for the solar segment was 24% compared to 34.7% in the prior quarter and 28.3% in the same quarter last year. I would like now to address the decrease in our gross margins in the third quarter and provide color on the fourth quarter and the quarters ahead. Our cost of goods sold are comprised of variable costs that are correlated to the product mix and volume shipped, such as manufacturing costs, shipping and logistics expenses, etc. In addition, we have other indirect costs that are not volume or mix specific, such as warranty costs related to our existing and growing install base, contract manufacturer claims related to adjustments made to the manufacturing level and costs associated with our operation and support department, etc. These costs are not correlated to the volumes of product shipped and usually require some time to be adjusted to significant changes in revenues. Of the total quarter-over-quarter reduction of 1,070 basis points in the solar segment margins, approximately 160 basis points are attributed to a higher portion of commercial products and lower portion of optimizers within our product mix, customer mix and the devaluation of the euro against the U.S. dollar. The remaining 910 basis points decline are mostly related to the allocation of our indirect costs over a lower revenue base. Around a third of the 910 basis points are related to warranty and service costs across our existing and growing install base that do not change when revenues decline. Approximately 200 basis points are related to the allocation of our operations, quality and support organizations over lower revenues. The remaining amount is a result of a higher percentage of logistic costs due to increased storage expenses and underutilization costs to contract manufacturers. In the third quarter, we have also recorded a one-time expense related to the discontinuation of manufacturing in Mexico. These diseconomies of scale will persist and even worsen in the fourth quarter as revenues are abnormally low. Noteworthy is that these indirect costs were down quarter-over-quarter on an absolute basis. And due to the actions in process, we expect them to be significantly lower again in the fourth quarter in absolute value. We expect margins to gradually improve in the first and second quarters of next year as we will continue to reduce costs and as our revenues return to a more normalized level. Gross margin for our non-solar segment was minus 22.8% compared to minus 9.6% in the previous quarter. On a non-GAAP basis, operating expenses for the second quarter were $128 million, or 17.6% of revenues compared to $133.3 million, or 13.4% of revenues in the prior quarter and $108.3 million, or 12.9% of revenues for the same quarter last year. Non-GAAP operating income for the quarter was $23.1 million compared to $191 million in the previous quarter and $120.2 million for the same period last year. The solar segment generated operating income of $45.7 million this quarter, down from $207 million in the last quarter. The non-solar segment generated an operating loss of $22.6 million compared to an operating loss of $16.1 million in the previous quarter. Non-GAAP financial loss for the quarter was $7.4 million compared to a non-GAAP financial income of $4.4 million in the previous quarter. The loss was largely a result of a weaker euro during the quarter. Our non-GAAP tax expense was $46.6 million compared to $38 million in the previous quarter and $34.5 million for the same period last year. The unusual result is mostly due to the amortization of R&D expenses for tax purposes as well as temporarily higher tax rate related to the quarterly tax calculation methodology. We expect our annual non-GAAP tax rate for the entire 2023 to be within 22% to 24%. GAAP net loss for the third quarter was $61.2 million compared to a GAAP net income of $119.5 million in the previous quarter and GAAP net income of $24.7 million in the same quarter last year. Our non-GAAP net loss was $31 million compared to a non-GAAP net income of $157.4 million in the previous quarter, and a non-GAAP net income of $54.1 million in the same quarter last year. GAAP net diluted loss per share was $1.08 for the third quarter compared to a GAAP net diluted earnings per share of $2.03 in the previous quarter, and a GAAP net diluted earnings per share of $0.43 for the same quarter last year. Non-GAAP net diluted loss per share was $0.55 compared to a non-GAAP net diluted earnings per share of $2.62 in the previous quarter, and non-GAAP net diluted earnings per share of $0.91 in the same quarter last year. As mentioned by Zvi, we expect that the stabilized solar revenue levels after the inventory correction has run its course will be approximately $600 million to $700 million quarterly. Under this scenario, corporate non-GAAP gross margins are targeted to be 30% to 32%, including approximately 500 basis points of benefits from IRA manufacturing tax credit and operating profit margins are targeted to be at 11% to 14% after implementing cost reduction activities. I reiterate that this scenario is based on no improvement in demand from our third quarter sell-through levels and assumes no incremental revenues or margin from new products. Turning now to the balance sheet. As of September 30, 2023, cash, cash equivalents, bank deposits, restricted bank deposits, and investments were $1.5 billion. Net of debt, this amount is $831.4 million. This quarter, cash generated from operations was $40.6 million as a reduction in our receivables account and raw materials inventories were partially offset by an increase in finished goods inventories. As we had anticipated, we swung back to cash flow from operations generation in the third quarter and we expect to see greater cash flow from operations in the fourth quarter. Accounts receivable net decreased this quarter to $940 million compared to $1.15 billion last quarter, representing 149 days outstanding. This increase in customers' days sales outstanding resulted from extended payment terms provided to our customers, especially in Europe, in order to assist them handling with higher inventory levels than desired, as previously described. As of September 30, our inventory level net of reserves was at $1.2 billion compared to $984.2 million in the last quarter. The increase is solely attributed to higher finished goods inventories, a result of the abrupt slowdown in shipments offset by a decrease in raw material inventory. Turning to our guidance for the fourth quarter of 2023. We're guiding revenues to be within a range of $300 million to $350 million. We expect non-GAAP gross margin to be within a range of 5% to 8%, including approximately 130 basis points of net IRA manufacturing tax credit. We expect our non-GAAP operating expenses to be within the range of $126 million to $130 million. Revenues from the solar segment are expected to be within the range of $275 million to $320 million. Gross margin from our solar segment is expected to be within the range of 7% to 10%, including approximately 130 basis points of net IRA manufacturing tax credit.
Operator, Operator
We'll take our first question from Philip Shen of ROTH MKM.
Philip Shen, Analyst
Hi everyone. Thanks for taking my questions. I want to explore the correction cadence some more as it relates to Q4 of this $300 million to $350 million revenue range. And you talked about how things could grow gradually in the coming two to three quarters, or the subsequent two to three quarters. So can you quantify in any way Q1, Q2 and even Q3 is kind of a revenue number with either a three or four in front of it more reasonable? And then when we get back to Q4, once your post-correction, you jump right away to that $600 million to $700 million. And then as it relates to margins, could you do the same kind of sketch for that as well? You talked about things gradually improving. But the margin challenge this quarter was for the guide here in Q4 very much has to do with mix. Would you expect your mix to be very similar for Q1 through Q3 of next year as well? Thanks.
Ronen Faier, CFO
Thank you for the question. I hope to cover everything, but please correct me if needed. Forecasting market changes is particularly challenging at this time due to the rapid alterations we've observed. In our analysis of the markets across the U.S., Europe, and the rest of the world, we're looking at our overall shipments in relation to the sell-through data, which is around 50% of our normalized level. There are some differences between the U.S. and Europe regarding market corrections. Typically, we see that Q4 is lower than Q3 in Europe, and Q1 does not usually show an increase compared to Q4 due to seasonality, particularly influenced by winter. In Europe, we expect to see an increase in revenue in Q1. Our inventory consists of both commercial and residential products, which are not evenly distributed. This discrepancy suggests that some products, although they may currently show higher revenue, will need to catch up sooner with commercial supply. For example, we have shipped more inverters than optimizers in recent quarters, and optimizers may end up being lower in stock by the end of Q1. Consequently, we anticipate steady growth in Europe moving from this quarter into the second and third quarters, depending heavily on winter conditions. A lighter winter could accelerate growth from Q4 to Q1, whereas a harsher winter might result in slower growth initially but a stronger increase later. In the U.S., we do not foresee significant changes in revenue patterns, as this market is more predictable and has shown a more linear behavior. We expect revenues to remain comparable across quarters, with a potential slight decline in Q4 due to end-of-year factors. The rest of the world should mirror similar trends with modest growth. To summarize, we foresee the U.S. and the rest of the world remaining relatively stable, with a minor dip at the start of Q4 followed by steady growth leading from Q1 to Q3, where we anticipate reaching between $600 million and $700 million. If winter conditions turn out to be milder, we could see an earlier impact in Q1. From a margin perspective, we do not expect major changes over the next three quarters. The costs associated with our products will largely remain unchanged. Improvements in margins will more likely be influenced by non-variable costs rather than the variable ones. As we collaborate with our contract manufacturers who had expanded capacity anticipating growth that is no longer occurring, we will need to cover fixed costs when production levels drop. This situation is likely to affect our revenues in Q4 and Q1, especially since reduced revenues create challenges for adjusting capacity. By Q2, we expect these charges to significantly reduce. Moreover, while we aim to maintain our current support levels for our operations and existing fleet without cutting costs, a higher revenue volume will naturally lower the percentage of these fixed expenses. Overall, we expect to see a less linear trajectory in gross margin growth, with improvements leaning more towards the second and third quarters of 2024, partially due to the ramp-up of our U.S. factory and the benefits from the IRA. It’s a complex situation, but we anticipate a clear return in revenues and a more gradual improvement in gross margins.
Philip Shen, Analyst
Thank you for the detailed information, Ronen. Regarding cash flow and the balance sheet, I understand you have a significant amount of cash and marketable securities. Could you provide more insights into your expectations for cash flow in the upcoming quarters as you navigate this correction? Specifically, what do you anticipate for cash burn in Q4 and the third quarter of next year? Additionally, how do you foresee working capital evolving? I've noticed that inventory levels have increased significantly. When do you expect that to start normalizing? Thank you.
Ronen Faier, CFO
When a company is growing, it generally requires more working capital due to increased manufacturing and higher inventories, which can result in additional customer credits. This leads to a greater consumption of working capital. Regarding cash flow over the next three quarters, we're anticipating an increase in cash flow from operations, which currently stands at about $41 million this quarter. We expect a significantly higher figure in the fourth quarter, with continued growth into Q1 and Q2 due to sizeable customer balances from previous shipments. We've also extended payment terms for our European customers, so we'll see substantial collections in Q4 and Q1. Our inventory levels are currently high as we anticipated growth, and we plan to utilize this inventory over time, which will positively affect cash flow. Our payment to vendors correlates directly with manufacturing levels; as production decreases, we will be making smaller payments to our payables. We foresee increasing cash flow from operations in Q4 and Q1, and we hope revenue growth will start impacting cash flow by Q2 while still maintaining a positive cash position due to collections and inventory usage. To translate this into free cash flow, we are currently focused on reducing capital expenditures, which last year primarily aimed to enhance manufacturing capacity globally. This involved investing in automatic assembly lines and payments to contract manufacturers. Going forward, aside from our ongoing investments in U.S. manufacturing, we plan to significantly cut back on these expenditures. Additionally, we may invest somewhat in new or expanded labs during our growth phase. Consequently, we anticipate not only higher cash flow from operations but also lower investing cash flow, leading to an overall acceleration in cash growth.
Operator, Operator
We'll take our next question from Corinne Blanchard of Deutsche Bank.
Corinne Blanchard, Analyst
Hi, good afternoon. Thank you for taking my question. Could you provide more details about the U.S. market, possibly broken down by state? Which areas are experiencing strong demand and which ones are weaker, and how should we approach this as we look ahead to next year?
Zvi Lando, CEO
Yes. So, Corinne, referring to our data set that we use for this purpose is the installation rate that is the main indicator for us, our monitoring connections to our monitoring portal. So I can say that overall, on residential, the connection rates recently for the last, call it, 10, 12 weeks has been relatively flat. And when we break it down by states, it's showing a small decline in California and an increase in some of the other states, for instance, Puerto Rico and in other states around the nation. This is on the residential inverter point of view. For batteries, we're seeing a consistent increase in connection rate. And this is coming from California, because although installation rates are down, installation of batteries are up from the historical base, because whoever or many of those that are installing in California are installing with batteries. And we also see some increase in battery installations in other states. Again, Puerto Rico is an example. So this is the residential picture where California is slightly down and other states accumulated are slightly up. And overall, the rate of installation for residential in the U.S. is relatively flat. On commercial, as I mentioned also in the prepared remarks, we see on the installation the same type of pattern that we’re seeing on the sell-through data where after some period of installation rates of commercial being relatively flat, we’re seeing a gradual increase, not dramatic but still a positive trend on installation and connections of commercial projects. And as I mentioned, this is across the country specifically in the markets that are strong for commercial. And we believe it's projects that have been held for some time because of people waiting for clarity on the IRA or for understanding the interest rate dynamics and the fact that there are low-cost modules and people understand that they won’t be clarity on some of those elements for some time. So they’re moving ahead with the projects that were on hold. And we expect this trend to continue.
Corinne Blanchard, Analyst
All right. Thank you. And maybe for a follow-up, switching a little bit here, but could you talk about the competition that you're seeing in the U.S.? Tesla is coming out with new products. So what do you expect there and maybe what does that mean in terms of pricing pressure over the next three or four quarters?
Zvi Lando, CEO
We didn't discuss much about our products in this call, particularly regarding the single-phase portfolio. However, we are optimistic about our current offerings in that area. We have made some recent improvements and have received positive feedback regarding the reliability of our newest products, as well as the installation times and ease of installing both the inverters and batteries. We believe we are making good progress in increasing our market share in the U.S., particularly among mid-tier installers. While we have performed well with larger installations, we have been somewhat weaker with smaller ones, but we feel we are gaining ground in the mid-tier. These changes are incremental, and we do not anticipate a significant shift in trends. Consequently, we do not expect major price changes for our inverters in the U.S. market. The battery market, both domestically and overall, is experiencing an oversupply situation. We may lower battery prices occasionally to achieve volume targets, but we foresee price stability for inverters and optimizers going forward.
Corinne Blanchard, Analyst
Thank you.
Operator, Operator
We'll take our next question from Brian Lee of Goldman Sachs.
Brian Lee, Analyst
Hi everyone. Thank you for taking the questions. I have a couple here. Looking at the bigger picture, there are numerous moving parts and significant changes in numbers compared to the past few quarters. To start, you mentioned a normalized revenue level of $600 million to $700 million, with gross margins at 30 to 32 percent at that level, which includes 500 basis points. This suggests that the core business has a gross margin of around 25 to 27 percent. However, in 2022, you achieved that revenue level with higher gross margins, even without the IRA benefit. Back then, you faced challenges with the euro and some component issues, yet your gross margins remained above 25 to 27 percent. It seems like the margins are structurally lower now, even if you return to the $600 million to $700 million revenue range. What is driving this change? Could you help clarify this? Why can't more costs be eliminated from the system? It appears that the current margin target is lower than what you had before, especially since earlier you weren’t factoring in 500 basis points from the IRA.
Ronen Faier, CFO
Thank you for your question, Brian. Generally, I want to highlight two key areas. First, as we mentioned previously, our view of this normalized level is based on the point of sale data we observed in Q3. We are being cautious after the insights gained over the last month and a half. We are still assessing whether this normalized level will be the standard for several years or if it might need to be set a bit higher. Therefore, we will approach our expense adjustments carefully, ensuring all necessary cost reduction initiatives are taken while avoiding a return to a situation where we have to scramble for capacity again, especially during market fluctuations. From the outset, we adopted a cautious approach in modeling our expense base and operations, recognizing that the current level may not hold two or three quarters from now. This doesn't mean we won't exert effort to capitalize on every cost reduction opportunity; we simply wanted to be prudent in our modeling. Second, we see growth in the commercial segment of our portfolio. This quarter, 66% of the megawatts shipped were commercial products, a record high for us. Although there may be some skew towards commercial due to previous component shortages, we are strengthening our offerings and experiencing growth. Additionally, we anticipate further growth in other areas, particularly with new products. Though we prefer not to project revenue too aggressively, these new offerings typically start with lower margins. Overall, we aim to be conservative in our modeling while committing to adjusting to the new levels as they emerge. We plan to provide more insights on normalized levels in our next call, as we expect to gather additional information supporting our revenue base growth. Ultimately, our goal is to achieve the highest possible profitability and margins in the coming quarters.
Brian Lee, Analyst
Okay. I appreciate that additional context. And then just maybe kind of a follow up to some of the earlier questions, I could see investors growing concern that this is more than just an inventory correction given the magnitude and also the duration. Like, how do you think about the share position here, whether in U.S. or Europe or both? Like can you provide some evidence or data points or anything that gives you comfort that this is everyone going through the same correction versus maybe there is some share loss here that you guys are experiencing? And one of the things I guess we hear a lot about is there are two peers, like SMA and Sungrow, who have had recent updates that were relatively positive. I know they're not all positive in the universe space these days. But just maybe give us a sense of what you see out there data-wise, feedback-wise that gives you comfort it's not a share issue at all? Thank you.
Zvi Lando, CEO
Thank you, Brian. We closely monitor this situation. A key observation is that, although it's subjective, it's relevant to the markets we operate in. We don't cater to the utility market, so some of the companies you mentioned are affected by different market dynamics. Recently, we engaged with one of the largest European distributors and noticed that in late 2022, we were losing market share due to product availability issues. The demand for our products was robust, but we couldn't meet it, leading some long-time SolarEdge installers to try alternative products. We tracked this and, once our supply improved, systematically reached out to those installers to return to using SolarEdge. In our recent discussions with the distributor, they provided insights into inverter supplier market share. During shortages, suppliers tend to broaden their offerings to include more brands, but as conditions normalize, they typically streamline back. The distributor reported an increase in our market share for the first eight months of 2023 compared to the same period in 2022. We are analyzing this data in detail; while there are fluctuations and we haven't regained all of our lost share from late 2022, we are optimistic about the positive trends we've seen since the start of 2023 in recovering that share. This situation does not appear to be linked to the inventory challenges we previously outlined.
Brian Lee, Analyst
Okay, understood. I'll pass it on. Thanks, guys.
Ronen Faier, CFO
Thank you.
Operator, Operator
Our next question is from Colin Rusch of Oppenheimer.
Colin Rusch, Analyst
Thanks so much. Guys, can you talk a little bit about incremental geographies that you guys might be able to move into that are growing at a healthy rate, particularly in the rest of the world or other geographies that you’re ending up exiting out of here in this transition?
Zvi Lando, CEO
Yes, we discussed Europe, and there are emerging markets that we hadn't previously mentioned, such as Slovenia and Romania, which are influenced by nearby countries, mainly Italy. These markets are gradually evolving, and from our central position in Italy, we will engage in them as well. There are also markets that existed before but are gaining traction now, like Spain and Greece. Back in 2012, our market share in Greece was around 60% or 70%, but it quieted down for years, and now it's picking up again. We have a significant presence in Greece, and our growth in Spain is strong, albeit from a smaller base. Some countries are seeing a new dynamic, while others that were small are starting to grow more quickly. Outside of Europe, Brazil is attracting attention, and we have a positive momentum there. In Asia, markets like Thailand, Taiwan, and the Philippines are growing rapidly. However, we found that the Korean market did not meet our expectations, leading us to reduce our activity there. While there are opportunities in these regions, the current interest rate environment makes Europe and the U.S. more promising for share gains and demand improvements compared to the growth in some of these other markets.
Colin Rusch, Analyst
That's super helpful. And then the follow-up is really about the internal battery cell manufacturing and how that's ramping up and getting the sell-through on the batteries and some of the inventory that you're mentioning there, how you're dealing with and expecting to manage your third-party sell agreements along with that internal production?
Zvi Lando, CEO
Yes, I'll address this in two ways. Our current residential battery offering relies on third-party sales. We plan to increase factory production and eventually use the factory's output for these markets. Currently, the installation rates are rising but remain below our expectations. We do not anticipate this transition to occur in 2024, so our residential battery offerings will still depend on third-party sales that year. In the meantime, we will keep increasing factory output and serving our existing storage business customers, while also catering to new clients in non-solar energy storage and high-fee rate cell applications. Therefore, in 2024, our solar-attached single-phase batteries will continue to rely on the existing third-party cell supply.
Colin Rusch, Analyst
Okay. Thanks so much guys.
Operator, Operator
We'll take our next question from Mark Strouse of JPMorgan.
Mark Strouse, Analyst
Thank you for addressing our questions. I have two inquiries. Firstly, following up on Brian's question, it seems that the cancellation of distributor orders and delays intensified in the latter part of the quarter. Has this situation now stabilized? I would like to understand better; you mentioned some potential upside risks to the $600 million to $700 million range. What assurances do you have that there won't be any further downturn in that figure?
Zvi Lando, CEO
Yes, Mark, to address your first point, our highest ever sell-through month globally, and specifically in Europe, was June 2023. Our distributors achieved record sell-through of our products during that month. Although July saw a decline in sell-through, this is typical as it coincides with vacation time in Europe. The pattern shifted over the summer, and we gained clearer insights, which we communicated to our distributors, particularly in the latter half of the quarter. This period also marked the decline in installation rates. From a quarter-over-quarter viewpoint, the reduction from Q2 to Q3 in Europe was about 22%, though it remains higher than the same quarter last year. We are currently monitoring installation rates as they are a more immediate indicator of performance, though less accurate than sell-through figures, which we receive later after all distributors report their data. Recently, installation rates and connections for monitoring have improved in countries like Germany, Austria, and Switzerland, while we noted declines in the Netherlands. Overall, installation rates have remained relatively stable since the summer drop leading into the fourth quarter. However, we lack the absolute certainty regarding whether these rates will decline further or when they might begin to rise again. This data is forming the basis for our revenue projections moving forward.
Mark Strouse, Analyst
Thank you, Zvi. I would like to follow up on your willingness to utilize your balance sheet during this economic downturn. Given your strong balance sheet, you may have advantages that some competitors do not. Can you elaborate on your willingness to invest in research and development and possibly pursue mergers and acquisitions to enhance your competitive position as we emerge from this downturn?
Zvi Lando, CEO
So I'll use the opportunity, Mark, to give a broader perspective that it’s not directly related to the balance sheet, partially related to the balance sheet and partially related to the P&L. With all this going on, it's important to put in perspective that we are firm believers not only in the long term, but also the midterm trajectory of this market. And the core markets that we serve which are rooftop solar of residential and C&I. And not only in the long-term growth of these markets for PV and inverters and optimizers but also the evolution of the broader solutions that we're seeing that includes batteries, EV chargers, smart energy management, software to manage them, grid services, applications, cyber protection. So at the highest level for us in terms of priority is to continue and develop the portfolio of products that is going to serve these markets and put us in the leadership or keep us in the leadership position that we and we see this situation and the modeling that we give also as a transient that is not sure how long it will take and when it will happen, but in a market that is attractive, that has long-term value and that we are very well positioned to lead. And that includes the answer to the question that you have. Where we see the potential to strengthen, accelerate, or improve our differentiation along those surge markets, we will use also our balance sheet to do so, definitely.
Mark Strouse, Analyst
Thank you.
Operator, Operator
Our final question comes from Julien Dumoulin-Smith of Bank of America. Your line is open, sir.
Julien Dumoulin-Smith, Analyst
Thank you, operator. I appreciate it. Good afternoon, team. I’m grateful for this opportunity. Let’s revisit where we started. Can we go over the journey that brought us to this point? We are discussing the recovery trajectory specifically, but I think it’s important to take a step back and gain some perspective. You mentioned that June 23 was a high point, but there were some insider transactions during the summer, and then things quickly worsened. How can we be confident in the outlook from here? Could you guide us through a month-by-month overview from the June 23 high to our current situation throughout the year? Clearly, this will help us understand your confidence for the fourth quarter, but I'm curious about how everything deteriorated so fast. It seems like something significant was overlooked before it escalated. I want to emphasize how rapid these changes were and what lessons you might have learned from the recent events. Thank you for your insights on this matter.
Ronen Faier, CFO
Yes, Julien, thank you for your question. I'll start by reflecting on Q1, as it's important to recognize that the patterns we are observing follow the unusual circumstances of 2022, which was affected by COVID. When analyzing the business and its trajectory, we focus on three main data sets. First, we assess our shipping volume and destinations. Second, we look at the point of sale data from our distributors, which we track monthly. Lastly, we monitor inventory levels, which result from the first two data sets. Up until the beginning of Q1, we found a close correlation between our shipping rates and the point of sale data. This meant that there were very few inventory days in the channel. For instance, we observed near-zero inventory for three-phase products and one to one and a half months for single-phase products. As Q1 began, we noted a gradual improvement in our manufacturing capabilities for single-phase products, which only fully materialized in Q3 for three-phase commercial products. During Q1 through Q3, we experienced a return to a growing market pattern, where our shipments increased more than the actual point of sale data. Consequently, we found that overall days of inventory on hand ranged between 60 to 90 days, which is a typical level, though it varies by distributor. Better performing distributors tend to have tighter inventory levels. We noticed a significant increase in point of sale and sell-through data, which gave us confidence in our shipping numbers, and we consistently monitored inventory days. Typically, we receive reports monthly around the 20th of the following month. For example, on July 20, we received the June figures from Europe, which were record highs, leading to increased orders from customers who were managing a backlog. By the end of August, we received the July data, which was lower than June, which is typical due to vacation patterns in Europe, although the drop was minor. As we approached the end of September, we received August data showing it was down compared to July, but the decline wasn’t dramatic. However, at the end of September, our distributors began to notice that September was not shaping up as they had anticipated, deviating from the usual pattern of increased activity following the slower months of July and August. Our distributors had expected a strong September and made preparations accordingly, but as September progressed, we received reports during the last two weeks of the quarter indicating declining orders and increased pressure to postpone deliveries. When we received the September data in mid-October, we found that September figures were lower than August’s for the first time in many years, which was unexpected. This has impacted our Q4 outlook and guidance. We see that inventory levels are rising significantly, surpassing the usual 90-day threshold. By understanding these trends in coordination with our customers, it became evident that Q4 might not mirror Q3 due to the observed decrease. While we anticipate that October’s performance will be better than September, we do not have definitive data yet, which informs our cautious approach. This cycle’s rapid shift became apparent only in the last two to three weeks of September, leading to many cancellations and order delays at that time. I hope this answers your questions.
Zvi Lando, CEO
Maybe, Julien, regarding the topic, the dynamic is as Ronen described, but we need to learn from it. One significant aspect we are discussing with our distributors is the visibility into the inventory levels at the installers. This dynamic arose from an unprecedented surge in demand and a lack of availability, which led everyone, including installers who typically do not hold inventory, to build up their stock, especially of the products they prefer to install. When the demand slowed, their orders decreased, but they still had inventory on hand, which was not visible to us. Therefore, in addition to the data we usually track regarding installation rates and inventory levels at our distributors, we need to consider the inventory levels at our large installers. This will provide better clarity during fluctuations, particularly in extreme cases.
Operator, Operator
We'll take our next question from Jeff Osborne of TD Cowen.
Jeff Osborne, Analyst
Great. Good evening. Two quick questions on my side. Ronen, what demand levels were assumed when you talked about a normalization of revenue at $600 million to $700 million? Is that sort of flat with current levels? That was part one of the question. And part two is just as the industry normalizes whenever that is next summer, why wouldn't there be a knife fight in terms of pricing? I know you said there was a sort of stable outlook in the quarter and in the near term, and payment terms were more important to distributors. But it looks like it’s a tech industry with no excess capacity. Obviously, you're rationalizing capacity. I'm not sure others will. But why wouldn't pricing go down meaningfully in the second half of the year?
Ronen Faier, CFO
Okay. So first of all, I'll start by saying that yes, as you mentioned, the way that we modeled the normalized level is taking the point of sale data for the last three months as it is, and therefore yes, if there's going to be recovery in this, then we can see a higher number. I would say that we do take in our numbers also an assumption about changes in pricing. As you have mentioned, right now, we did not change our prices within Q3. And I’m not sure that we will do anything on the inverter side at least in Q4, given the fact that we believe that with inventory levels that you see right now, there is almost zero impact on changing pricing. First of all, because nobody is taking orders. So if they’re taking very little orders, no reason to change your pricing because everyone is selling the inventory that they have, plus we do not see that it can actually change the behavior along the elasticity of demand curves. So I must say that moving forward, we do assume that prices will have to be adjusted in some places. It is going to be very much related to the offering that we see. For example, the more markets are moving to dynamic rates, these are going actually to products that are a little bit maybe more expensive, because of the fact that they’re allowing better capabilities. We do believe that maybe in batteries, we will have to adjust down prices. Because when we look at the competition today, yes, our prices I would say are not the cheapest that you see in the market. And I can tell you that in our stabilization number, there is a baked in assumption on possible price adjustment that we will need or may need to implement. The reason that we put in there, even if we’re not sure if we’ll have to take them, is as I mentioned in my answer to Brian, after this unprecedented event that we’re missing a quarter never happened in this company history, we wanted also to be very cautious in the way that we’re modeling.
Operator, Operator
We'll take our next question from Jonathan Kees of Daiwa Capital Markets. Your line is open.
Jonathan Kees, Analyst
Thanks for taking my questions and fitting me in. I wanted to ask about the call-up in Israel. You mentioned it involves about 11% of your staff there and 6% globally. That seems quite significant, though maybe not material. I'm curious if the call-up is widespread or primarily affecting those in Israel. Is it mostly impacting your business professionals and engineers, particularly those under 40, or is it more evenly spread across different occupations and professional levels? I'll leave it at that and take the rest of my questions offline. Thank you.
Zvi Lando, CEO
So a quick correction, it's male and female. It's even in that regard. Our manufacturing and business activities are primarily conducted outside of Israel and are not reliant on anything significant in Israel, neither the infrastructure nor the people, which is why this does not affect our execution toward our customers. From a research and development perspective, there is an impact, as I mentioned. The call-up is fairly evenly distributed across the different departments, allowing us to reallocate and adjust personnel to ensure that the main projects are adequately staffed to move them forward. This approach aligns with our business discussions to focus on identifying the key drivers of the business and deploying the appropriate quantity and quality of personnel to address them. That’s our strategy for both reasons. Thus, we are in a position to execute in the business and can support operations without interruption.
Operator, Operator
And this does conclude today's question-and-answer session as well as our call for this afternoon. You may now disconnect your lines and everyone, have a great day.
Zvi Lando, CEO
Thank you.