SolarEdge Technologies, Inc. (SEDG) Earnings Call Transcript & Summary

All right. Good morning, everyone. I think we'll get started here. My name is Brian Lee. I head up the CleanTech Research Team here at Goldman for those of you that I haven't had the chance to meet. Thank you for joining us for this morning session. We have, to my left, CFO of SolarEdge, Ronen Faier. I'm sure many of you know Ronen. He's been a mainstay at this conference for the past few years. I think actually right around this time, first day of the conference last year, he was one of the first speakers and had some interesting comments that I think a lot of people took away from last year's event around the market. So with that as an introduction, I wanted to maybe just start right there.

Ronen, you've got one of the more dynamic diversified portfolios across the space. You've got U.S., Europe resi, commercial. Given the new year, maybe we can go around the horn a little bit and just kind of hear your thoughts around each of the markets. I really wanted to start with the U.S. though, because I know there's a lot of focus. Last year was tough. You were one of the first to call out that it was going to be tough. Where are we now in the cycle? What do you think '24 growth looks like? And are we in store for any kind of positive growth inflection in the U.S.?

Sure. So first of all, thank you very much for having me. Always happy to be here. In general, I think that next year, the view is going to be determined whether you look at it as a whole year or quarter by quarter. I think that there's a -- as a whole year, it's going to be, we believe, lower than 2023. But I think that we've bottomed in the last 2 quarters the, I would call it, demand reduction here in the United States. So I think that quarter-over-quarter, you should start to see an improvement. And still it will not be able to compensate for the beginning of 2023. So year-over-year, you're going to see a little bit of a reduction. The reason for our belief is, I would say, twofold. One is that the economics that very much deteriorated the situation for payback periods in solar are at least expected to improve. There is an expectation that interest rates will start to go down. I think that we're hearing about at least 5 notches of interest rates going down over 2024. I believe that we already witnessed that electricity prices start to go up, and this is something that, of course, moves the payback period to a shorter position. And this is something that's needed. The second thing, I believe, is the fact that the impacts of the IRA and California are already here, and they start to be digested by the market. So on one hand, you see that on California, our NEM 3.0 installers selling companies are polishing over time their selling points. I think that they start to get the reasoning behind it and they start to get the information behind it. I think that the fact that equipment prices go down a little bit helps them in this regard. I think that in other markets, the IRA impact that maybe sold the market because why would you install something if you know that the benefit is going to be here for the next 10 years. Now it's going to be 9 years, then you already see that a combination of the macroeconomics that are improving, plus the IRA will start to play a little bit of better -- in a better way. So I think that we're all -- all in all, we've bottomed. We're going to start increasing right now, but not yet to compensate for what we saw at the beginning of '23.

Maybe just to drill down on that a bit. So there's a lot of -- just like last year, a lot of uncertainty heading into this year. I think there's certain market fundings calling for down 20% resi growth in the U.S. Some people are a bit more bullish saying it could be flat to down a little bit. It sounds like you're saying it's still down. Do you think it's down in that kind of double-digit range when we tally up the year? And then when you talk about -- it's always hard to call the bottom, but Q-on-Q improvement, is that 2Q volume trends already improving off the 1Q? Can you kind of drill into what timing you're looking at?

Sure. So first of all, seasonality always plays a major effect in this market. Once winter is going away, at least when it comes to the Northeast, you start to see those markets behaving a little bit better. And still absent of California, the North is still a relatively relevant market. So I don't know if I can call it the bottom. Again, this is our belief or understanding. Because as long as you believe that consumers are logical, nothing -- we do not believe that we see anything bad happening other than maybe, again, macroeconomics going -- sliding into a bigger recession or something like this. But I think that from all the economic reasons, there is nothing that should deteriorate. And because of the fact that I believe that the interest impact will come over time and because of the fact that I believe that electricity prices will go over time, this is why we feel comfortable to see this gradual growth. I would more expect things to improve towards the second quarter because of seasonality, though.

Fair enough. I'm going to shift gears to Europe, which has obviously become a big part of your mix over the past couple of years. Started off '23 very strong. Ended the year sort of seemingly entering a downturn later than the U.S. So kind of maybe set the stage for us in terms of Europe as you look at where we're in the cycle there heading into the new year. And then just like we had California in the U.S., a big kind of political/regulatory pivot midyear. It seems like Europe has a few countries that are going through that as we speak. So if you could kind of walk us through the moving pieces there.

Sure. So I'll start by -- I'll start with data because I think that the only way to judge a region, especially a region that is so complex like Europe because of the fact that there are many countries with different policies and sometimes different dynamics. When you look at the aggregate data, with the exception of the very last weeks of 2023, almost every week throughout the year, when we look at installation rates, these are the amount of units that are being connected to our monitoring portal. We've seen general in Europe that other than in the last few weeks, every week in '23 was better than it was in '22. And we did see deterioration towards the end of the year compared to last year. One reason was, by the way, that last year, the war with Ukraine was much more pronounced than the fear of lack of electricity. Of course, electricity prices were much higher. Today, they're lower. And therefore, we saw that all in all Europe, at the last few weeks was lower in '23 compared to '22, but '22 was a little bit of an outlier as well. So we still attribute it mostly towards the seasonal impact of winter. When you start breaking Europe into countries, then you start to see a little bit of a more interesting trends. So the first one is I'll start with the positive, places like Germany. Germany was expected to install this year around 12 gigawatts of solar energy -- new solar energy. The desire is to go towards 20 gigawatts annually. That's a market that's bound to grow. And we believe that it has all of the reasons to grow. First of all, electricity prices went down, but they're expected to increase over the next few weeks or months. The cost of the carbon tax is going up by about 30%. The subsidy that existed on electricity prices, subsidy that was given in the midst of the war in 2022, elapsed. There were not many subsidies in general to solar in Germany. None of them was taken away. You do not pay VAT. From all good reasons, economics are supporting in Germany. Continued installation. Germany today, by the way, is bigger than the U.S., at least in the relevant market for us. And this is something that we expect to continue. Will it grow 50% year-over-year like we saw in '22 or maybe at the beginning of '23? That's most likely not the situation, but we do expect to see a growth there. When we go to look at Austria or Switzerland, countries that are following the same dynamics, I think that, again, combination of electricity prices, plus VAT cuts in Austria, are expected to grow this market in '24 compared to '23. On the other side, there is a lot of uncertainty in the Netherlands. The Netherlands is a country that used to be one of the major markets for solar. There's a new government there -- sorry, there's a new elected party that's supposed to form a government that was not formed yet. The system there is that this party will have to form a coalition. The policy around solar is unclear there. We believe that whatever the result is going to be, the market is going to be a positive market. If the government in Netherlands is not going to support solar, most likely that you'll see the Dutch markets becoming a battery market, which is a good market because you see less installations, but much higher revenue. If it's going to be a government that will support solar, you will not see batteries, but you will continue to see very strong market. The problem right now, uncertainty. You don't know what system would you like to install right now. So we do see a decrease there. And in between, you see a variety of countries, U.K., Belgium, even Italy, by the way, were interesting enough, the cancellation of the benefits called the Ecobonus at the beginning of '23 didn't change the market dramatically on a megawatt basis, you simply see less batteries in this market. Our expectation is to see a growth in Europe, a mild growth. It's not going to be a big growth in the overall Europe. We believe that you'll see colors among the various countries, but we expect to see a growth here.

And commercial is big for you in Europe. So can you kind of delineate between what you're expecting in Europe resi versus Europe commercial? When you say mild growth overall, does that apply to both end markets?

So I think that yes, but we believe that commercial has a bigger potential of growth because of the ESG trends and also the impact. Again, if carbon tax is increasing, of course, industrial companies will need to put more solar and to offset a little bit more of their carbon footprint. So it will follow, again, to our view, the same dynamics, I think that it's going to be a little bit better than the residential though.

And then the channel inventory situation, and you talked about U.S., it feels like we've been bottoming here. So outside of normal seasonality, maybe we'll get better Q-on-Q trends into the second quarter. Is it a similar cadence that you're expecting in Europe? And then also, can you talk about specifically what you're seeing in terms of inventory in both markets?

So expectation is similar, but I will say with all cautiousness that it is an expectation because there is one major player in this equilibrium, and this is winter. And we do not know how it is going to play out yet, at least for this year. The beginning was not very promising. You saw snowstorms in Germany in the beginning of December. This is something that we didn't experience last year, at least. Maybe there is a climate change eventually. But in essence, we do believe that we'll see similar trends. What we do see right now, though, is that the inventory levels are decreasing on an absolute level, but also the point of sale is decreasing, either because of seasonality or because of the fact that there is a cleansing in the, what we call underlying channels below. So I wouldn't say that it's better or worse than what we expected, it's within the ranges of our expectations. But I think that we'll have a much better view into February, March once we'll see the end of the winter.

Okay. Fair enough. Maybe just wrapping up this discussion around demand trends and the growth outlook. Battery is also a big product category for you guys that has been seeing a lot of growth, but did slow down here in '23 alongside [Audio Gap] seem to be some regulatory changes like in California that are supporting battery growth. So what's your general view on battery growth and demand as you head into the new year?

Sure. So first of all, by the way, the demand in 2022, at least in the beginning, was also skewed a little bit upwards because of the fact that everyone wanted to have batteries. At that time, it was relatively hard to get batteries. So I think that there is a big difference between purchase of batteries from us compared to the installation. When we review installation rates of batteries week-over-week, and we do review it weekly, we see an upward trend. By the way, both in Europe and in the United States. I do think that there is -- just like in inverters and optimizers, there is a large inventory of batteries in the channels, and they need to clear out again. The phenomena that we expect to see -- and again, I think that is already supported is -- first of all, the fact that yes, you'll see more batteries and better attachment rates -- attach rates. California, of course, is a great example, and I think that you'll see much more. If you look at reports coming from Bloomberg or other companies, they do expect to see continued growth in the U.S. from about 15%, 20% attach rate to about 40%. So we share the same view. In Europe, the attachment rate is already relatively high. If you're 80% to 90% in Germany, you cannot go much higher than this. So I think that you just need to see the overall inventory clearing out. The other thing that we do see, though, is that at least in the U.S., our own batteries sales -- when we look at installations of solar equipment with batteries, a lot of our equipment is installed with Tesla, a lot of our batteries are installed with the LG batteries and a lot of our inverters are installed with SolarEdge batteries. We do see constant improvement in the ratio of our batteries installed with our systems. And this is something that I think comes from starting to understand the benefits of the DC coupled advantages, plus the fact that, again, it's a system that was built to work together. And the easy installation and the fast commissioning is something that starts to play a very nice role in this trend.

So when you think about all these moving pieces, you talked about kind of U.S. is probably still down for the year, mild growth in Europe and then batteries sound like they could be growthy again in '24. How would you kind of force rank across those 3 broad buckets in terms of what you see fastest growth in volume-wise and what you see slowest growth entering the new year?

Again, it's hard for me to say simply because of the fact that there is an unknown of the level of inventories that we see at least in the subchannels. And I don't know how much will be sold. I think that it is clear that the expectation is that 2024 will be lower year in revenues for us compared to 2023, of course. So that's something that's easy to see based on even the stabilization levels of sales that we saw in the past. I'm not sure that I can bet on which one will go faster. I would say that I would expect to see all markets at about the same improvement and at least, again, happening towards the second or the later part of the year. I'm not sure that I can call one area that I see is growing much faster than the other.

Okay. I wanted to touch on pricing margins competition. Obviously, in this uncertain demand backdrop, there's some implications for what you're doing strategically there. And you have had some margin setbacks here recently. So I wanted to maybe focus on that first. You called out last quarter a path to get back to, I think, 25% to 27% non-GAAP gross margins ex the IRA credit, which we'll get to in a little bit. But that's lower than the margins you've historically targeted if we looked at the past Analyst Days. And so big picture question, kind of what's changed structurally? And then in terms of these new margin targets, there's a long path to get there. I know you haven't set out the exact time frame, but can you talk about some of the specific pieces and maybe quantify how you build back to that 25% to 27% level?

Sure. So the first thing to changes, I would say, our level of cautiousness. With -- in the third quarter for the first time for SolarEdge ever, in fact, career, we missed the quarter. And when this is something that happens, you don't want to make it into a habit. So by definition, you become a little bit more cautious in your projections. But if you look into the drivers of gross margins, the main difference is that, first of all, you'll see more batteries in the overall mix, and batteries are carrying lower gross margins. When we did the Analyst Day in 2022, the battery ratio of our sales and even expectations was lower, and this is something that is going to impact, plus the fact is that what we call the stabilized level of revenues of $600 million to $700 million that we called most likely for Q3, this is not the level that we expect moving forward. We do believe that the amount of inventories and the way that the market behave, we'll see higher growth in 2025 than in '24. And that means that we need to preserve capabilities that are of an access of what we need in 2024. And this creates a drag on your margin. For years, and you know us really from the very beginning of our life as a traded company, we've been fighting air shipments for a very, very long time. And the main reason was because growth was always exceeding our ability to build capacity. Now we have capacity. So the question is I need much less capacity in '24 than I needed in '23. And by the way, most likely less than I will need in '25, maintaining manufacturing capacity costs money. And especially when your revenues are lower than there used to be, that's a bigger drag on your gross margin. So I think that the combination of the fact that we do have these economies of scale related to the fact that our revenues are lower, we do not want to reduce the level of our service to our customers. Service is given to your past installed base. We cannot really reduce dramatically the amount of people that we're using in our call centers. By the way, we're improving processes. You'll see cost improvements across the line, by the way, in SolarEdge. But in general, you cannot cut below a certain level. You do not want to cut manufacturing capacity. And all of it is creating a kind of a toll, a kind of, I call it, a call option that we pay in gross margin in order to make sure that if it is a market that's growing in 2025, I don't have to sit here next year and explain why we airship products.

I guess as a follow-up to that, is there -- what I'm hearing is there's a lot more fixed cost in the business than there were historically and then you've got the battery mix shift, which is dragging on margins....