SolarEdge Technologies, Inc. (NASDAQ:SEDG) Oppenheimer’s 25th Annual Technology, Internet & Communications Conference August 10, 2022 12:25 PM ET
Company Participants
Lior Danziger – VP of FP&A and IR
Conference Call Participants
Colin Rusch – Oppenheimer & Co.
Colin Rusch
Hi, everyone. This is Colin Rusch. I’m the Head of Sustainable Growth and Resource Optimization here at Oppenheimer. And we are very pleased to have Lior Danziger, who’s the VP of FP&A and IR at SolarEdge. We’ve done the company now, I guess, dating back to 2009 and so have been tracking them, working with them for a very long time here and thrilled to be able to welcome them here with us today. So Lior, thanks so much for being here.
Question-and-Answer Session
Q – Colin Rusch
First, can we talk around demand, right? I mean this is one area where I feel like there is some understanding, but like a misunderstanding around the order of magnitude with demand. So can you just start out with what you’re seeing right now from your customers and from the broader landscape around the demand profile?
Lior Danziger
Sure, sure. So first, thank you very much for having me and having us and giving us the opportunity to give our story. So in terms of demand, I think we’ve been very fortunate to be at the right industry at the right time. I think solar — the demand for solar products has been booming, at least for us. And if we look across all the geographies, all the segments, we see accelerated growth, accelerated demand, and we’re very excited to see that.
If you think about the U.S. residential market, it’s been growing very nicely. We’ve had a record quarter in the U.S. commercial segment. So the demand there is definitely picking up. I think it’s very known that maybe right now, the highest growth rate and the most accelerated demand is being demonstrated in Europe actually, and we’ve seen accelerated growth over there, had a record quarter in both residential and commercial segments over there in 14 countries in a record quarter.
And also in those geographies that we like to call the rest of the world, everything outside the U.S. and Europe, where it is mostly C&I business for us, commercial and industrial, we’re also observing a very healthy growth rate. So all in all, in terms of demand, I think we’ve been very fortunate to absorb very healthy demand. We have a very healthy backlog. And I think challenges at the moment are mostly on the supply side.
Colin Rusch
Okay. Excellent. And so one of the things that we’ve talked about just on this demand side is the need to grow the industry as much as 4 to 5x from where it’s at right now to meet many of the mandates that countries are laying out for 0 emissions. I guess as you look at that sort of projection, can you talk a little bit about the customer relationships that you’re developing to meet that — I think that’s something that is important to understand the ability to scale with your customers. So I guess if you could dig into that a little bit.
Lior Danziger
Sure. So in the U.S., I would say, first, we are mostly using distributors and to some extent, we’re also selling directly to installers. But the vast majority is through distribution. And generally speaking, these are relationships that have been going on for many years now. And by the way, you have gone through also many cycles similar to what we’re seeing today of component shortages that was there 4, 5 years ago, exchange rate fluctuations. So in many ways, this type of relationships have already went through some hurdles in the past, similar to some of the things that we’re going through today.
In the U.S., I would say, it’s somewhat common knowledge that we are maybe more present with the Tier 1 and Tier 2 customers or players installers in the residential space, but that is not to say that we’re not present with the long tail as well.
In Europe, actually, where you don’t see the Sunrun and Sunnovas and those large players, it’s mostly all long tail. And we know how to do that very well. The European market is very fragmented, a lot of different markets, a lot of different distribution channels. But we’ve been successful to be a leading player in pretty much every country that we operate there. We will probably be either #1, #2 or #3 on both residential and commercial. So this is how we try to maintain our relationship. I would even say and add that throughout the 1.5 years, everything really went wild around the supply chain, and we had to do price increases. We try to do it in a very transparent, fair type of way as we see them mostly as our partners. And this is how we approach that. And I think, overall, we’re getting very good feedback.
Colin Rusch
Okay. That’s helpful. And I think it leads into my next question. As we think about the landscape of players and some of those larger centralized players have a more sophisticated technology position and can manage their portfolios with an overlay of controls beyond what you guys offer, right? But as we look at the growth of electrification, not only in the transportation sector, but also in the heating environment as a real key driver of some of the consistent demand, particularly in the wintertime in certain countries. Can you talk about how important the control functionality is of your technology in terms of optimizing resource performance and the broader grid? It’s certainly a transformation, and it seems to me that the inverter companies are very much at the heart of some of the functionality that is really critical here going forward.
Lior Danziger
Yes. First, I fully agree with that. And I think it’s an evolving creature that we’re looking at right now in that sense in terms of where the capabilities are today and what they are being utilized for and where we find that 5, 10 years from now. So I think the control functionality is extremely important and is at the heart of what we try to do. And sometimes, we try to relate to that maybe from different angles and different terminology, but it goes back to that control functionality. So if today or if in the visionary world of tomorrow, a homeowner or even an apartment owner, by the way, doesn’t have to have a roof anymore to put a solar system or a mall or a factory, there will probably be some combination of energy resources. So it could be the grid. It could be the solar panels on the roof. It could be a battery that is connected to the system. It could be a generator. And all of these together in our view should be looked at as one energy system or that is running together and should be harmonized. And this is where the control functionality kicks in.
And in many ways, I think we’ve already seen some of that taking place to some extent. We announced our home management system. So basically, you have a control functionality in place there about optimizing generation, optimizing storage, optimizing your consumption need and then also learning that behavior continuously — to continuously optimize that. But in the future, where we will have more and more energy sources connected to one system, as I mentioned, whether it’s grid storage, generator or what have you, the ability to reach access and manage and optimize — continuously optimize each and every element in that system is where we want to be. I think in that sense, the inverter really becomes the brain of such a system. And we think we’re very well positioned to be there. And this is where we’re also aiming some of our development efforts, and we’re very much excited with the opportunity that this space offers.
Colin Rusch
Yes. And I think that’s been our thesis back to 2009, 2010 and investing and coverage of the inverter space that we need the brands of the operation, right? And it’s the point at which the systems really engaged — the solar systems really engage with the broader electrical infrastructure. And so with that in mind, can you talk a little bit around some of your core efforts in the R&D space around simplification, cost reduction, increased platform flexibility so that you can serve those functions in a real serious way?
Lior Danziger
Yes. Sure. So I think even before I do that, and given the world that we’re living in today, I think it’s also worthwhile to mention that, actually, right now, most of R&D focus is around components, qualifying new components. I think — and we had to do that, by the way, given our footprint. So once you’re present in so many countries and you have so many different products and flavors and grids that you need to know, and at the same time, growing so fast. So we had to change some of that, and there’s a lot of R&D effort going into those areas today is of qualifying new components and qualifying new vendors to make sure that we can continue and support all of the different grids and markets and localities. So this is one area that the R&D is very much focused on. But at the same time, we are definitely focused on the simplification, as you mentioned. I would even connect it to the next generation of products that we’re putting out, whether it’s inverters or optimizers. So in the past, if you had to go — if you wanted to have, for example, a solar and storage system back in 2017, 2018, using all inverter architecture, you would have to have an HD Wave, but then you will have to have a few additional boxes that will connect you to the storage. And this will have to be paved through the walls. And it’s not a very simple installation to do, and it’s not a very esthetical one. So some of the efforts are definitely on that on the simplification of those devices. And then that also results in a better commissioning time and ease of installation and a much better experience for the installer.
So there are a lot of R&D efforts going into that direction as well. And I think that on top of that, what we also try to do is we continuously — and this is something that we try to do with every generation that we put out there. We want to reach a better LCOE, levelized cost of energy. We can do that by either try to consistently increase the bandwidth of the hardware of the device, which is something that we do. And at the same time, we also try to reduce the cost, to reduce the component count, to try and replace hardware — software and computing power. And this is something that drives innovation.
And I think maybe worthwhile to mention on top of all of this is that we see more and more R&D efforts around software because similar to what you mentioned in control functionalities, the systems as well as the inverter and optimizer architecture are becoming more and more sophisticated, and they should be able to accommodate more and more appliances or self-consumption appliances and needs. And that usually requires more and more software capabilities. So we are seeing more and more of our R&D focused on software areas as well.
Colin Rusch
Okay. I think that’s important because the next question is really around the leverage on those software efforts, right? I mean as we see the hardware get simplified, you get more bandwidth for management from the software level. There’s significant debate around SolarEdge’s focus. The company has made some very large investments in a variety of other sectors that are adjacent to solar and building a battery factory, buying a battery company is one element that people had some questions about, certainly moving into the medium-duty space with the pack management has brought up some questions around focus and effort.
And so I guess as we think about the leverage of software and controls expertise, can you talk a little bit about the portfolio of efforts that you guys are working on and the synergies that you see amongst each of those business lines?
Lior Danziger
Sure. So as you mentioned, we did a few acquisitions in the last few years that were mostly adjacent. And I would actually start with the one that is no longer there. So we had the experience with the Critical Power Division that we just announced. We’re discontinuing its operation on a stand-alone basis, and we’re going to try and utilize this type of capabilities into the solar space actually. And I think the other 2 are actually more closely tied to our core business.
So I think you mentioned Qualcomm and you mentioned the storage piece. I think there’s very clear tie here. When we wanted to have our own battery and when we engaged all of them back in 2015, 2016, all of the large players of battery cells and battery packs, no one was willing to commit on volumes and to go into a binding agreement simply because the EV space is so much more attractive, is many times bigger. And for them, it makes more sense to focus there. That was the main motivation to go and do that acquisition, which is what we did.
And now we have captive supply. And now we’re no longer hostages of anyone’s consideration, whether they want to supply or not. And at the same time, we think that we can also direct good R&D and innovation efforts into the chemistry itself. So the chemistry — most of the chemistry is used today, maybe on a tailor-made specifically to storage needs. We think we have some value that we can add there as well, simply because we’re focused on those areas. And as a leading player in that space, we think we also have the responsibility to do so. And this is how I would look at that acquisition, and I think the synergy is very clear.
In the EV one, for e-Mobility division, so if you think about what we deliver, the powertrain kits, again, the elements themselves invite a lot of synergies. There’s inverters inside or batteries, those onboard chargers. A lot of the things that we already have good knowledge, very high level of expertise, and we’re probably only learning more. And I think it’s a very clear, I would call it, element of the energy transformation era that we definitely want to be a part of.
So we are looking to exploit those synergies. We’re building Sella 2 that we just finished to construct. That’s a 2-gigawatt hour of a factory that will help us improve our battery margins, but at the same time — and we were just referring to simplification. It is the case that when you connect our battery — using our battery cell and our electronics and mechanics that is packing the battery together with a whole system that includes our inverter and architecture and optimizer, it will probably have the best results on a system level. So this also ties to the system level point of view that we’re trying to work on and be the basis of the innovation that we do.
Colin Rusch
That’s super helpful. I mean I think as we see battery chemistries evolve, like some of that flexibility in terms of the platform and managing the actual performance of the materials in the battery ends up being — it has a couple of things: one, you maximize performance short term; but also a lifetime of those materials long term. And so the deeper understanding around basic material performance under — what actually is a very harsh environment inside a battery cell, I think is crucial to understand.
So I guess, the next set of this in terms of the flexibility and the understanding of the actual hardware performance and the controls is really about some of the geographic differences that you guys are seeing in terms of some of the needs because certainly, the grid is different no matter where you go. The weather is different. And being able to accommodate a quickly changing environment around not only the weather and the climate, but the infrastructure, that’s very much in process.
It’s something that I think a lot of us just don’t think about the grid as a dynamic environment, but it very much is a work in progress on an ongoing basis. So I was wondering if you could talk about your flexibility to address some of those needs and what you’re seeing in terms of some larger trends around some of those geographic differences?
Lior Danziger
Sure. And that’s a very good question because I think sometimes people tend to maybe underestimate what it takes to understand so many grids, the different localities and to realize that it’s simply not the same grid and the same infrastructure in different places. So I think let me maybe exemplify and use one country from each geographic that we operate in. So I think maybe the clearest one to relate to would be the U.S., and the U.S. is maybe the geography that most of our investor community is familiar with.
And we all know what the U.S. residential market looks like. And I think the reason it looks like it it’s because of the dynamics that are very much specific to the U.S. market. The rapid charging regulation that ended up in a duopoly and created that space. And this is a dynamic that you’re only seeing in the U.S., and we are looking at the Biden Administration and the infrastructure bill that we had before. And we see the discussions around NEM 3 in California, speaking about the tension between utility companies and solar system homeowners and about transmission and infrastructure investments.
And this is all a dynamic that is particular to the U.S., and we tackle it. We have good product out of the shelf that meets such a regulation that is very unique and very local one. And the fact that we have the right innovation, the right technology, helped us prevail and take over the vast majority or half of the U.S. residential space in the U.S. I think a very interesting market to look at that is acting somewhat different, but it could be the case that one day, the U.S. will be similar is the German market. Germany is probably the most sophisticated solar market in the world. It’s the most saturated one for sure. And really, what you saw there is maybe the evolution that you would expect to see in some of the other solar markets. So solar was strongly adopted, strongly incentivized and encouraged and more and more installations took place. Feed-in tariffs went down, and we ended up at a stage where you can no longer push solar electricity into the grid in Germany simply because it’s actually creating grid instability.
So it was no longer the case that they needed solar electricity to be pushed into the grid. So that dynamic and that specific locality created a market that is now very much identified as high attach rate market for storage. We’re probably talking about 80%, 90% of storage rate. And that is also characterized with high self-consumption trends. So if you’re a German homeowner, what you want to do right now is you probably want to connect more than one battery to your system simply because you want to be able to utilize as much as energy as you can out of your system and you probably want to connect a couple of self-consumption devices like an EV charger or a heat pump.
And what does all of that translate into for us is that we have to have a good MLPE solution that can support all of that with that particular locality. So this is what we do in Germany, and we have — we recently announced that we have 3-phase batteries specifically for that market. And we have some other elements that are specific for that market. And this is the way we try to adjust ourselves. And I think — maybe another worthwhile of example would be 2 fairly big markets in Asia that we recently started to grow very nicely, which are Korea and Japan.
These are 2 very big markets, 2 to 3 gigawatts on residential side, characterized with very high customer loyalty. And also requires a very strict certification in order to be able to sell our inverter in. And for example, in Japan, the grid and the local regulation requires you to have what is called back up from the sun. So when the grid is down, you must have the ability to have an AC socket that can work directly from the energy that is generated on the PV panels.
So basically, this is a type of technology and a feature that if you want to be able to sell your inverters in Japan, you must be able to demonstrate your ability to do that and do that well so that your product will also be certified but will also generate demand and will actually be considered as a good product. And we did that. And basically, it’s a feature that we only provide in Japan. So I think all of those together — and these are just 3 countries that I mentioned, we have installations in 130 different countries. So it requires a lot. It takes a lot for the company to be able to do that. And I think sometimes we’re maybe underestimated for the fact that we’ve been able to do so for many years.
Colin Rusch
That’s super helpful. I mean I think one of the things that we think is really important is the diversity of that end market and the learnings that you take from individual markets into the collective hole in terms of the functionality. There’s an enormous amount of efficiency from an R&D perspective there. I want to be a little attentive to time here and get through a couple more questions before we wrap up. Obviously, the investor community is extremely concerned about gross margins.
Having gone through a few cycles with you guys in terms of some of the waxing and waning around some of the things that kind of pile up on top of each other, certainly, it looks to us and we’re in print saying this, that there’s at least 400 to 500 basis points of margin improvement to be had. The reality is, it may be substantially more than that, given what you guys have from currency headwinds, some underutilization, pricing dynamics that you can roll through. I guess, can you talk through each of the individual areas of improvement that you guys are seeing in kind of order of magnitude and how we should think about that?
Lior Danziger
Sure. So let me put, for a second, the exchange rate effect aside, and I’ll get back to it. I think — because we were already starting to lay out how we’re going to do it previous quarter. And by the way, I fully agree also on the quantification. It’s probably in the neighborhood of hundreds of basis points that we can gradually grab back. And we mentioned 3 pillars that will help us get there: one is price increases, and this is something that we’ve been doing. Actually, we’ve already had 3 or 4 cycles of that in 2022.
And the way we do it is as follows: First, again, and going back to what we just discussed, because we have such a diverse footprint, it’s a fairly complex process for us. We’re not a single market, single segment type of company with a single product. So you should really try and imagine this complex matrix of geography, segment, product that we try to analyze, understand what the competition looks like, when we will see a pushback if we want to increase price and to what extent we can actually increase the price.
So once all of these have been evaluated and judged, this is when we decide on the price increase itself, and we’ll roll it out. And then what we try to do: first, we honor all the orders that we already received. So we try not to change prices on already received and booked orders that are in our backlog. It’s not to say that it’s 100% that case. We do have some cases that we’re also doing that. We prefer not to, but sometimes we don’t have a choice. And what we do all forward is everything that has to do with increased cost.
So materials prices went up, we rolled that forward. Components prices went up, we rolled that forward. The RMI index or the LME Index for measures that are in the lithium-ion batteries has gone up. That was all forward as well. What we do not roll forward to our customers is growth things. So underutilization is ramping up fees. When you ramp up, you’re still not at your optimized cost structure, we will not roll it forward ramp-up cost. We’re not rolling forward expedited shipment costs because I had a lockdown in Shanghai to one of my vendors and that created slowness of getting the components. So these are the type of things that we do not roll forward, but we did the price increases, and we said this will be fully materialized. So you didn’t see the full effect yet in Q2.
The second pillar that we mentioned, and I think this is maybe just as important as the price increases, maybe even more is actually the ramp-up of the Mexico facility. So the Mexico facility is supposed to serve 100% of the U.S. residential demand by the end of this year. Just to give a sense, U.S. is probably 45% of our business these days and 85% of it is probably residential.
So it’s a significant volume of our business, and it will all be served by Mexico by the end of this year. And here, you have 3 very straightforward and clear gains: one, you have another side that is not tariff. In previous quarter, we had 31% of goods coming into the U.S. that are still bearing tariff. We can cut that dramatically, not 0, by the way, but very significantly. At the same time, what we can do is we can have shorter lead routes coming into Mexico because we don’t need to use 4 to 6 weeks on a boat anymore. We can use 6 to 7, 8 days on the truck. And that is also a less expensive shipment method. So these are the 3 benefits that we will gain from Mexico, and it will be a gradual ramp up. It’s going as planned. And it will be similar benefits, not to the same extent, but we will also gain on the other side that we’re clearing capacity from and moving that capacity into Mexico. So now the Chinese and Vietnamese sides and the Israeli one and the Hungary one can serve newer markets as well. So that is important.
The third pillar, which is maybe less on our control, but it is something that we’re also starting to observe is that we are seeing some normalization going back into the supply chain, both on components availability as more and more capacity has been built, especially in Asia. And we do expect some relief on that in 2023. And when I say relief, I take into account that we’re growing very fast. So it’s not a relief of getting the same quantity of component, it’s a relief of getting components while growing very fast.
And what we’ve also seen in parallel is, I would say, the beginning — a slow beginning of a reduction in freight costs, both ocean and air. So if you take all of these 3 elements together, even with the current exchange rate, there are still hundreds of basis points that we can gain back. And if on top of that, we will have a better exchange rate, then we can probably be in a good place.
Colin Rusch
Excellent. And I think just in the interest of time, this will be the last question. So it looks to us like there’s an awful lot of operating leverage for you guys right? So obviously, there’s some manufacturing leverage, but the ability to incrementally drop more cash to the bottom line as you grow the top line, seems really substantial. Can you talk about how SolarEdge thinks about that and thinks about maintaining their overhead to support the growth in a way that does lead to cash? Because you guys have a long history of being very attentive to cash and very effective in your cash management.
Lior Danziger
Yes. So first, you’re right. I think there’s still a lot of room for operational leverage to kick in. And I think that also if you look at the long-term targets that we laid out in the Analyst Day, it’s clear that we still have some room to go. And I think it comes from various elements. One, as batteries portion, we increase, it’s pretty much using the same OpEx base, right? But it’s a numbers game. The price of a battery is 4, 5x the price of the inverter. It’s the same sales force that is running both sales.
So that can definitely help and improve the operational leverage. And this is also, in many ways, the case when you’re talking about commercial installations. So often times commercial might have a lower gross margin, but they actually might have better or just the same operational profitability. So as we scale, as we grow, there’s still room for better operational profitability. We think that as we ramp up Mexico as the gross margin also normalizes back, we would probably be able to get there. And I think that we will probably be able to exit in 2022 to show a much healthier operational leverage that will start to converge with our long-term targets.
Colin Rusch
Perfect. Well, is there anything else that you’d like to address before we sign off here? Very much appreciate you taking the time, and I feel very enthusiastic around where you guys are sitting right now in the broader scheme of things.
Lior Danziger
Not really. Just — so thank you, and thank you again for having us and for this discussion and look forward to our next discussion.
Colin Rusch
Excellent. Thank you so much. Enjoy the evening in Israel. Thanks so much for being with us. Take care. Bye.
Lior Danziger
Bye, bye, Colin. Bye.
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