SolarEdge Technologies (SEDG) Q2 2022 Earnings Call Transcript – The Motley Fool

Logo of jester cap with thought bubble.

Image source: The Motley Fool.

SolarEdge Technologies (SEDG 1.90%)
Q2 2022 Earnings Call
Aug 02, 2022, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the SolarEdge conference call for the second quarter ended June 30, 2022. This call is being webcast live on the company’s website at www.solaredge.com in the Investors section on the Events and 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.

[Operator instructions] I would now like to turn the call over to Ms. Erica Mannion of Sapphire Investor Relations, investor relations for SolarEdge.

Erica MannionInvestor Relations

Thank you. Good afternoon. Thank you for joining us to discuss SolarEdge’s operating results for the second quarter ended June 30, 2022, as well as the company’s outlook for the third quarter of 2020. 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 second quarter ended June 30, 2022. Ronen will review the financial results for the second quarter, followed by the company’s outlook for the third quarter of 2022. We will then open the call for questions. Please note that this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from management’s current expectations.

We encourage you to review the safe harbor statements contained in our press release and the slides published today for a more complete description. All material contained in the webcast is a sole property and copyright of SolarEdge Technologies with all rights reserved. Please note, this presentation describes certain non-GAAP measures, including non-GAAP net income and non-GAAP net diluted earnings per share, which are not measures prepared in accordance with U.S. GAAP.

The non-GAAP measures are presented in this presentation as we believe 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 June 30, 2022 press release or the supplemental material may obtain a copy by visiting the Investors section of the company’s website.

Now I will turn the call over to Zvi.

Zvi LandoChief Executive Officer

Thank you, Erica. Good afternoon, and thank you, all, for joining us on our conference call. This quarter, once again, we saw record revenues for the company, led by record revenues from our solar business in the United States and Europe. Our growth in the United States reflects record megawatt ships of commercial inverters, which is more than double from the previous quarter.

This is a result of the strong commercial and community solar momentum in the U.S., where we are well-positioned. We expect this market to continue to grow, especially in light of the most recently proposed bill and its favorable terms for commercial and community solar projects. Additionally, this quarter, we saw a 12% quarter-over-quarter increase in residential inverter megawatt ships to the United States. In Europe, we hit record megawatt shipments of both commercial and residential inverters this quarter.

The strength in Europe is led by record revenues in 14 countries, most notably in Italy and in Germany. Outside of Europe and the United States, we are seeing particularly positive momentum in Brazil, Australia, South Africa, and India. While our shipment rate continues to increase, channel inventory remains low due to the very high rate of installations of our product. During this quarter, more than 160,000 new sites were added to our monitoring platform, bringing us to a total of more than 2.8 million monitored sites around the world.

For clarification purposes, a single site can be anywhere from a residential home installation of 2.5 kilowatts to a 77-megawatt sites like the one we discussed last quarter in Taiwan, that was recently commissioned. The importance of this indicator and of getting these sites installed sometimes at the cost of expedited shipments, is that many of these sites are potential for follow-on revenue in the future as we expand our portfolio and offering of commercial storage, residential and commercial EV chargers and other hardware and software products and services. Overall, this quarter, we shipped 5.2 million power optimizers and approximately 230,000 inverters, both below our original plan for the quarter. The main cause for this was the extended lockdown in Shanghai, impacting a supplier’s back-end manufacturing facility of a set of components used in our inverters and optimizers.

The lockdown created discontinuity in our manufacturing. And when the facility finally opened, we expedited shipments of the components to our manufacturing facilities and the finished goods to our customers. Additionally, the event impacted our opening inventory for the third quarter. And as such, we will need to expedite some shipments this quarter as well to enable our customer installations to take place as planned.

Our battery shipments grew this quarter in line with our plans and reached 251-megawatt hour, more than doubling shipments from last quarter. We are receiving positive feedback on our battery, in particular, relating to ease of installation and commissioning time. This quarter, we released a new software version that focuses on these elements and we have heard from installers about installation times in the range of 10 to 15 minutes. Note that our average installation time is currently around half an hour, and we continue to roll out the new software and training to enable improved experience and installation times across the installer base.

At the core of this simplified installation process is our SolarEdge home network, wireless technology that links the inverter, the battery and all of the related components in a seamless way, eliminating the need to physically connect the various system elements with cables and connectors. Also related to our battery offering at Intersolar in Munich in May, we highlighted our SolarEdge home residential portfolio, which includes our newly introduced three-phase SolarEdge home battery designed for the German and other three-phase European markets. We began shipments of this new battery this quarter. With the high attach rate for batteries in Germany, we anticipate healthy demand.

The three-phase battery also includes the SolarEdge home network wireless technology discussed before. More on the product side. In residential, in addition to the battery focus that I discussed, we are working on releasing higher power inverters to address the global trends we are seeing for large-sized installations, in particular, in self-consumption driven markets. In the U.S., we are ramping the 11.4-kilowatt inverter released a couple of quarters ago.

And this quarter, we released a 10-kilowatt inverter designated for the Australian market. We expect the segments of large residential system where we are particularly strong due to the favorable economics of our DC architecture to continue to grow with a relatively high attach rate of batteries. In commercial, we began initial installations of our new S-1400 power optimizer, which enables connection of two high-powered G12 modules to a single optimizer, thus significantly reducing system cost per watt while ensuring full harvest of the power generated by the modules. Also in commercial, we recently commissioned a 13-megawatt floating system in Taiwan.

As we discussed at the analyst day, the strength of our architecture is the adaptability to the different applications of the commercial market, one of which is the growing floating solar application, where in many cases, the practices to apply rapid shutdown safety protection, even in countries where it is not a regulatory requirements. Moving to our nonsolar business. Our revenues from e-Mobility declined this quarter relative to last quarter, due to reduced demand from our customer, which is in line with the overall automotive industry supply chain-related instability. Considering the continued lack of visibility in this space, we believe that revenues for this project this year will be lower than originally expected.

Moving to critical power. This quarter, we made and implemented a decision to discontinue our stand-alone UPS market-related activities. At the time of acquisition four years ago, we saw this market as an additional pillar for the growth of the company expecting a potential inflection point in the UPS market. At this time, however, considering the rapid growth and magnitude of the opportunities we face in our core solar market, and as we believe that parts of the UPS market will eventually converge with the solar plus backup market, we judge that both the technology we developed and the teams we built are best utilized within our solar organization.

As such, we are discontinuing the development of UPS-specific products and commercial operations in the stand-alone UPS market and the already developed technologies will be integrated in solar products as uninterrupted power supply becomes required or relevant. In this and in recent earnings calls, we have discussed the increase in demand we are seeing globally triggered by elevated power prices and general transition toward renewable energy by corporations, businesses, and individuals. Notably, over the last few weeks, multiple governments around the world have implemented or announced their intent to implement new policies aimed to accelerate installations of PV as part of their energy independence and climate control initiatives. This reiterates the exciting opportunities that lay ahead for us and for our industry as a whole.

And with this, I hand it over to Ronen, who will review our financial results. Ronen?

Ronen FaierChief Financial Officer

Thank you, Zvi, and good afternoon, everyone. This 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 purchase intangible assets, impairments of goodwill and intangible assets, stock-based compensation expenses and certain other items.

Total revenues for the second quarter of 2022 were a record $727.8 million, an 11% increase, compared to $655.1 million last quarter and a 52% increase compared to $480.1 million for the same quarter last year. Revenues from our solar segment, which includes the sales of residential batteries were a record $687.6 million, a 13% increase, compared to $608 million in the last quarter and a 59% increase compared to $431.5 million in the same quarter last year. Solar revenues from the United States this quarter were a record $309.8 million, a 17% increase from the last quarter and represented 45% of our solar revenues. Solar revenues from Europe were a record $324.7 million, a 14% increase from the last quarter and represented 47% of our solar revenues.

Sales in Europe are typically denominated in euros, and therefore, the devaluation of the euro negatively impacted our U.S. dollar-denominated revenues and gross margin. Specifically, the impact of the euro devaluation between last quarter and this one translated into a reduction of $18 million in revenues and 240 basis points of gross margin. Rest of the world solar revenues were $53.1 million, a 7% decrease compared to the last quarter and represented 8% of our solar revenues.

On a megawatt basis, we shipped a record 936 megawatts to the United States, a record 1.2 gigawatts to Europe and 357 megawatts to the rest of the world, surpassing for the first time, 2.5 gigawatts of quarterly product shipments. 51% of the megawatts shipped this quarter were commercial products and the remaining 49% were residential. This quarter, we also continued to see an increase in revenues related to our batteries that are currently sold in 12 countries. Of the batteries we shipped this quarter, 75% were shipped to Europe, 21% to the United States and 4% to the rest of the world with first shipments and installations in South Africa.

ASP per watt, excluding battery revenues, this quarter, was $0.236, a 12% decrease from $0.269 per watt last quarter. This ASP per-watt decrease is a result of a growing portion of commercial product in our mix and the geographical mix that leaned toward Europe where — which was subject to currency rate erosion of the euro against the U.S. dollar. This ASP erosion was partially offset by price increases implemented in Q2 that will be fully materialized in Q3.

This quarter, one U.S. customer accounted for more than 10% of our solar revenues. Revenues from our nonsolar businesses were $40 million, most of which came from our e-Mobility division. Consolidated GAAP gross margins for the quarter was 25.1%, compared to 27.3% in the prior quarter and 32.5% in the same quarter last year.

Non-GAAP gross margin this quarter was 26.7%, compared to 28.4% in the prior quarter and 33.9% in the same quarter last year. Gross margin for the solar segment was 28.1%, compared to 30.2% in the prior quarter. The quarter-over-quarter decline in gross margin is the result of a few factors. More battery revenues in our overall product mix, euro to dollar erosion, as discussed above, a higher portion of commercial sales and expedited shipments related mostly to the supply chain issues discussed by Zvi.

The decline in margin was lower than the accumulated impact of all of these factors, thanks to price increases implemented in prior quarters. Heading into the third quarter, the current USD-to-euro rate — exchange rate will offset the price increases that we have implemented in Europe. Goods subject to tariffs, excluding batteries shipped to the United States from China accounted for 31% of our U.S. shipments this quarter.

This is a slight decrease compared to 32% in the last quarter and is mainly a result of increased supply to the U.S. market from our manufacturing facility in Mexico where ramp-up continues as planned. Gross margin for our nonsolar segment was 2.7%, compared to 5.6% in the previous quarter mostly driven by high margins in the storage division and lower margin in the e-Mobility business, a result of lower volumes. Our GAAP gross margin included a write-down of $4.3 million this quarter as a result of the discontinuation of critical power division-related activities.

On a non-GAAP basis, operating expenses for the second quarter were $109.6 million or 15.1% of revenues, compared to $98.9 million or 15.1% of revenues in the prior quarter and $81.5 million or 17% of revenues for the same quarter last year. The main reason for this increase compared to the previous quarter is the annual merit increase to our employees’ salaries and its impact on vacation accruals, as well as the pickup in marketing activities and travel. Our solar segment operating expenses as a percentage of solar revenues were 13.7%, compared to 13.9% last quarter, representing an improved operating leverage as our revenues continue to expand. Our GAAP operating expenses this quarter included a $4 million write-down of goodwill and intangible assets related to the discontinuation of the critical power segment activities.

Non-GAAP operating income for the quarter was $84.7 million, compared to $87.2 million in the previous quarter and $81.3 million for the same period last year. This quarter, the solar segment generated operating profit of $99.2 million, compared to an operating profit of $98.7 million last quarter. The nonsolar segment generated an operating loss of $14.6 million, compared to an operating loss of $11.5 million in the previous quarter. Non-GAAP financial expense for the quarter was $20.9 million, compared to a non-GAAP financial expense of $4.9 million in the previous quarter, a result of the erosion of euro-denominated cash balances and euro-denominated accounts receivable balances that amounted to EUR 239.7 million and EUR 354.3 million, respectively.

Our non-GAAP tax expense was EUR 7 million this quarter, compared to EUR 13.5 million in the previous quarter and EUR 10.5 million for the same period last year. GAAP net income for the second quarter was $15.1 million, compared to a GAAP net income of $33.1 million in the previous quarter and $45.1 million for the same quarter last year. Our non-GAAP net income was $56.7 million, compared to a non-GAAP net income of $68.8 million in the previous quarter and $72.5 million in the same quarter last year. GAAP net diluted earnings per share was $0.26 for the second quarter, compared to $0.60 in the previous quarter and $0.82 for the same quarter last year.

Non-GAAP net diluted EPS was $0.95, compared to $1.20 in the previous quarter and $1.28 in the same quarter last year. The unrealized financial expenses related to foreign exchange had a negative impact of $0.25 on our non-GAAP EPS. Turning now to the balance sheet. As of June 30, 2022, cash, cash equivalents, bank deposits, restricted bank deposits and investments were $1.6 billion.

Net of debt, this amount is $973.3 million. During the second quarter of 2022, we generated $77.4 million of cash in operating activities, representing a return to cash generation after the last quarter cash consumption. AR net decreased this quarter to $669.1 million, compared to $676.8 million last quarter. As of June 30, 2022, our inventory level, net of reserve, was at $470.3 million, compared to $432.5 million in the prior quarter.

This entire increase is related to increased level of raw materials, battery cells and component inventory in the solar segment while our finished goods inventory continued to decrease as a result of growing demand to our products. Turning now to our guidance for the third quarter of 2022. We’re guiding revenues to be within the range of $810 million to $840 million. We expect non-GAAP gross margin to be within the range of 26% to 29%.

We expect non-GAAP operating profit to be within the range of $90 million to $110 million. Revenues from the solar segment are expected to be within the range of $765 million and $795 million. Gross margins from the solar segment is expected to be within the range of 27% to 30%, mostly impacted by the euro-dollar exchange rate and amplified by anticipated increase in European revenues within our overall mix. I will now turn the call over to the operator to open it up for questions.

Operator, please.

Questions & Answers:

Operator

Thank you. [Operator instructions] We will now take our first question from Stephen Byrd from Morgan Stanley. Your line is open. Please go ahead.

Stephen ByrdMorgan Stanley — Analyst

Great. Thank you very much. I wondered if you could just speak to your thoughts on the draft legislation in the United States. And just I want to make sure just at a high level that we’re thinking through all the potential elements that could benefit you? What you — I know there’s a lot to digest in the language.

But just as you look at the support that could be coming in the U.S., how you think about the potential impacts?

Zvi LandoChief Executive Officer

So obviously, it is a positive even before discussing the content itself just for the fact that it gives stability and visibility to the overall industry. Then looking at the content itself, it has favorable acts in many of the segments that we serve. As I mentioned, there was a focus on commercial in general and community solar in particular, which is a segment that we’ve been having good progress in the last 12 months or so, as well as for — obviously, for residential and for storage. So we feel that it has a potential positive impact across all of our business lines.

And we’re studying the other elements related to a potential benefit for local manufacturing and elements like this. Now as I mentioned in my remarks, this is on the heels of — similar, although in a very different type of incentives and policies announced in various countries recently in Germany. There was a significant or a meaningful update to the feed-in tariff on top of the very aggressive plans that were introduced a couple of months ago. In Italy, there were some very strong government commitments and incentives presented for growth in the agricultural photovoltaic segment, which is a subset of the commercial segment where we have and we believe, a good offering.

So overall, it’s very evident that there is a very strong drive globally. And here in the U.S., the recent or the intended bill comes — is the North American share in that momentum. And of course, we are — we see it positively and are excited about it.

Stephen ByrdMorgan Stanley — Analyst

Thank you. And if possible, I just wanted to follow up on a remark you made about pricing that you see the ability to increase price and help offset some of the headwinds on margin and things like exchange rate. The — more broadly, just given the magnitude of demand, I guess we’re hearing some commentary from a number of companies that, with kind of just what you just said that the demand is so strong in places like Europe and the United States that — and also the clean energy looks so much cheaper than sort of conventional energy. Do you see that sort of pricing power extended beyond just the next quarter? Do you see some ability for margins to expand given that clean energy does look so much more attractive and that demand is just so incredibly strong.

In other words, how persistent might your ability to extract better margins over time via pricing as a result of all these dynamics we’ve been talking about.

Zvi LandoChief Executive Officer

Maybe try to divide the answer to two and Ronen will back me up with additional information. Our approach has been to increase prices to compensate for the increase of costs related to raw materials and all other standard elements of doing business. And we’ve been implementing those price increases gradually over the last two or three quarters. We, as a policy, tend not to implement it on existing backlog for the most part and implement it on orders going forward.

So that’s why it takes a little bit longer to affect our ASPs and resulting bottom line. What we did not do, and we don’t intend to do is where there are onetime or which we call transitionary challenges, like factories, clothing, and then the need to expedite and things like that. Those type of costs, we typically incur and don’t automatically move them on to the customers. In terms of looking forward, I think the opportunity is more in the fact that the systems are becoming larger, more complex and include more elements like batteries and accessories, all of which give an opportunity to improve margin.

And that comes back to what I commented also about the larger inverters and the larger systems and EV chargers and such elements. That is where we see good opportunity to improve margin. And we are also seeing I would say our early signs of some improvement in the cost structure around logistic costs that are beginning to go the other direction, some raw material costs that are showing signs of — first signs of decline, etc. So we think that there is definitely a potential for gradual margin improvement in the coming quarters, not necessarily from direct price increases on existing products.

Ronen FaierChief Financial Officer

And if I may add one more thing, and this is a little bit related to the international, I would call it, aspect of our business. If you take, for example, Europe, the average exchange rate, for example, for us during Q1 was approximately EUR 1.9 per euro — $1.09 per euro. During Q2, the average was about $1.06. And by the way, right now, we see that every euro is $1.02.

And that means that if you take the overall price increases that we did and you reflected in the specific market, you see that in Europe, our customers saw a real increase and a relatively large increase in prices because they pay in euro, and they make money in euro, while in our case, this increase was not really translated into gross margin simply because of the erosion of the euro against the U.S. dollar. So I think that here, this time, it is working against us in other places where the euro will move more favorably. It can help us, but not every price increase or price change is directly impacting our gross margin immediately in the same direction that we’ve actually implemented it.

Stephen ByrdMorgan Stanley — Analyst

Thank you very much.

Operator

We’ll take the next question from Brian Lee from Goldman Sachs. Your line is open. Please go ahead.

Brian LeeGoldman Sachs — Analyst

Hey, guys. Good afternoon. Thanks for taking the questions. I had two here.

First one was — can you provide a bit more color on the China back-end issue, which components specifically are you referencing were impacted. And do you have any mitigation strategies in place besides the expedited shipments, any new suppliers you’re working with or inventory build? Just anything else planned there to kind of get you over the hump from that impact? And then I had a follow-up.

Zvi LandoChief Executive Officer

So without getting to be too specific, it was about three or four components. And as I said, also for inverters and also for optimizers and the lockdown was extended. We actually were able, at least for some of them, to qualify alternatives in a reasonable amount of time and start to replace. And that’s why the hit was less than it could have — potentially have been.

And that’s an effort that is going on across the board of making sure that we have alternatives available to the critical components that we use. But I think the caveat is that the rate that our manufacture — or capacity and demand is growing. It’s not only about qualifying an alternative, it also sometimes the suppliers need to add additional lines and capacity to meet our elevated demand. So right now, for this specific event, we were — it’s behind us.

And as I said, it was less — it impacted us, but to a lesser extent than it could have, thanks to qualifying components to the ones that we were short on in this case.

Brian LeeGoldman Sachs — Analyst

OK. Fair enough. And just my follow-up was with respect to the margin guidance, I guess I’m sort of surprised — margin guide for the solar segment is down a bit for 3Q from 2Q. Maybe talk to some of the dynamics there.

I know you quantified, Zvi and Ronen, the dynamics for 2Q with forex and expedited shipments. But I guess as we think about the 3Q guide here, how much additional headwind from forex are you embedding? What’s the expedite cost impact? And then just any other puts and takes, if you can quantify into sort of a basis of gross margin impact you’re seeing? And then also maybe within the context of that, prior 35% to 37% gross margin target on optimizers and inverters you’ve talked about for the second half. I’m not sure if that’s still intact. But maybe sort of help us bridge the gap here? That would be helpful.

Thank you.

Ronen FaierChief Financial Officer

Sure. So first of all, the main — or I would say the only impact actually on Q3 margin is foreign exchange rate changes. In general, in the volumes that we see going to Europe into Q3, every cent difference or every lower euro against dollar rate by $0.01 is impacting our margins by 50 basis points. And in general, what we see and what we have planned for this quarter at least is compared to approximately, as I mentioned, if our average U.S.

dollar to euro ratio in Q2 was $1.06 per euro. We’re now looking at USD 1.01 to euro. And of course, the time that you’re making the shipment very much changes as you know because if you do more shipments toward the end of the quarter, where we don’t know what is the exchange rates, this may change a little bit. So in essence, if you take only this, we’re talking about 250 basis points that we expect this quarter to be impacted only by gross margin.

Now it’s important to say that exchange rate, sorry. And it’s important to say — the other thing and this is that when we discuss gross margin, there are always those elements that are within our control. We are continuing to increase the manufacturing in Mexico. And this is something that is happening in line with our plans.

This quarter already, we saw that we shipped although the percentage was slightly lower, but since the revenues that we ship to the U.S. were record revenues and record megawatts, that means that higher portion of units came from Mexico. This is something that we do and we were able to do to enjoy. From a logistics point of view, we do see a little bit of an easing in what we see in prices for contracts at least for the next few quarters.

Here, the lockdown that Zvi mentioned in Shanghai, not only create a situation where we paid a little bit more in Q2, it actually took away three weeks of manufacturing during the quarter that we now need to expedite through Q3. But still, by the way, even had it been for the regular exchange rate, we would see our gross margins going up. So to summarize it, everything that is within our control is happening exactly as planned, and everything related to the underlying permanent costs that we see for our product is actually improving, including some components price reductions that we are now already starting to hear from vendors for the next quarters. This is a pure game of FX rates, at least in this quarter, the fact that this quarter will be much more heavy on sales to Europe in the overall mix makes it a little bit more tough in this sense.

And this is why when we’re looking at — and we know that currencies are moving in a cyclical, I would call it, trends, we still believe that had it been for $1.07, $1.08 per euro and not to talk about higher rates, the 35% to 37% on optimizers and inverters is definitely a rate that we see feasible because all of the underlying costs are actually allowing it to do it and the pricing environment is allowing us to do this.

Brian LeeGoldman Sachs — Analyst

OK. Thanks a lot. I appreciate all the color.

Operator

We’ll take the next question from Philip Shen from ROTH Capital. Your line is open. Please go ahead.

Philip ShenROTH Capital Partners — Analyst

Hey, guys. Thanks for taking my questions. Just as a follow-up on the margin theme. I know you haven’t provided Q4 guidance.

But in the past, you’ve talked about healthy margin expansion in the back half. And now with Q3 margins flat quarter over quarter. I was wondering if you might be able to help us understand the trend in margins in Q4 and Q1 specifically? And then also coming back to the topic of the long-term 35% margin target, as you see the commercial mix growing much more, is that as realistic of a target or because of mix alone, it may not be as achievable? Thanks.

Ronen FaierChief Financial Officer

OK. So again, I’ll start, and again, of course, we do not guide for Q4 and Q1, but we do see the direction. And I would like to go back to what we have discussed in the previous calls. When we discussed the margin expansion or return to levels that we were, we said that there are several elements that can get us there.

The first one is to increase the amount of products that we’re manufacturing in Mexico that will allow us to reduce the tariffs and will allow us to reduce the ocean freight costs and costs of taking these products and the associated supply chain from China to the United States. This remains intact for Q4 as well, we continue to see the ramp. We’ve said in the past that we expect Mexico to be 100% run rate at the end of Q4 of everything that goes to residential U.S. This is something that we still have on site.

And this is a claim that is still valid. The other issue we discussed is related to prices of components. And this is actually again happening. We already start to see that material prices related to aluminum and copper are decreasing.

They are far from the level that they used to be in the past, but they are decreasing, and this is something that we continue to see. And the same apply, by the way, for some of the components because we do see and we do talk to our vendors, and then we see that some, I would call it, capacity that they put online is materializing, which will allow us not only, of course, to get the products at a lower cost, but it will also be in a more constant manner. So this is something that we expect into Q4 as well. The next one is actually continuity of the supply.

And when you have more capacity and when you have your lines working at full pace without being halted for a few weeks or days because of lack of shipments, you’re not paying to your contract manufacturers, what we call unutilized capacity charges that are going as charges to your gross margin. And again, you are missing the output there. All of these impacts are happening exactly as we have planned and as we have thought we will — the biggest change here is the exchange rate because when we were standing in Carnegie Hall just about like — I think it was four months ago, exchange rates was $1.09 per EUR 1. At that level, the 36% plus/minus 1%, even including commercial, is holding.

And if you remember, we even discussed it in my part that since we see that our residential products at that rate is about a 40% gross margin. Then we said that whatever we do in commercial is basically taking the margin down to this 35% to 37%. So in that sense, and we could have been — if the euro rate was $1 plus, we were standing here saying how smart we are simply because we did everything. But the fact is that from all perspective, this is a foreign currency game more than anything else.

And under, I would call it, again, normalize $1.10 or $1.09 to euro. This is definitely a target that we see visible.

Philip ShenROTH Capital Partners — Analyst

OK. Thank you for that. And then as it relates to Biden’s trip to Saudi Arabia recently, Zvi. I think you guys may have been one of the beneficiaries of that Mid-East trip.

Can you talk about your recent trip there and share some more details on the agreement that you put in place? Thanks.

Zvi LandoChief Executive Officer

Yeah. Thank you, Phil. Yeah, I’ll answer briefly. The topic of renewable energy and climate change is — has a lot of governments and leadership around the world busy.

And what’s interesting is that it’s also in countries that are strongly linked to fossil fuels like in the case of Saudi Arabia. There is a push from the leadership over there to implement renewable energies and solar, in particular, focusing on this new very modern city that they’re building and in — that is supposed to be net zero. And with that, we’ve been in a dialogue with local company and signed this MOU agreement to explore what are the opportunities related to the new city and related in general to the Saudi market and the — the nice thing was that this agreement was culminated and signed as part of the visit of President Biden to Saudi Arabia. So it was a very exciting and inspiring event.

It is not going to translate into any type of meaningful numbers anytime soon. But I think what we see as positive is that it’s an indication to the spread of the — of our industry globally and the interest in the topic all over the world. And it’s the interest and the fact that they reached out to us is an indicator to the position and reputation that we built in the market as a leader, not only in inverters, but in the energy transition as a whole. So that’s the background story behind this event.

Philip ShenROTH Capital Partners — Analyst

Great. Thanks, Zvi. I’ll pass it on.

Operator

We will now take the next question from Mark Strouse from J.P. Morgan. Your line is open. Please go ahead.

Mark StrouseJ.P. Morgan — Analyst

Yeah. Thanks very much for taking our questions. So completely understand there’s a lot of focus on FX on this call. Ronen, I’m curious, though, if you can talk about kind of the European gross margins excluding FX and how we should think about those compared to the U.S.

market. Is that still kind of a 300- to 400-basis-point differential or reason to think that that improves over time.

Ronen FaierChief Financial Officer

So the problem is that it’s very hard to relate European margins without looking at exchange rates because the basic fact is that we are selling in euros and we’re manufacturing in U.S. dollars. So by definition, the FX rate is embedded. Now the question of whether it is 2 to 3 basis points below, it very much depends to where you are compared to those margins.

Mark StrouseJ.P. Morgan — Analyst

OK. Yeah, that makes sense. OK.

Ronen FaierChief Financial Officer

And by the way, and just to add one more thing, and this is the fact that, again, it also relates to the mix of the products within this market. So for example, if you have battery, usually will be a little bit of a lower one. If it will be a residential system, then margins are a little bit higher. And sometimes you see a little bit of differences there.

But in general, I would say that FX is the most, I would say, determining factor.

Mark StrouseJ.P. Morgan — Analyst

OK. And then just a quick follow-up. I apologize if I missed it, but did you give a megawatt-hour shipments or revenue recognition target for the 3Q guide and just kind of generally how we should think about that over the coming quarters and years, if that has changed at all?

Ronen FaierChief Financial Officer

So actually, we didn’t give it, but I will just rely back to what we said in the previous quarters that we expected to grow to about 250-megawatt hour quarter and to stabilize there, we have reached this goal during Q2, and therefore, we expect to continue to be at that level. This quarter, specifically in Q2 and when the Q will be filed. Of course, it will be — you’ll be able to see, we recognized approximately $105 million of revenues, which is still lower than the number that — of revenues that we shipped and from next quarter, it’s going to be almost 1:1 what we shipped and what we recognize because we’re going to be at the same size of — or same volume of shipments.

Mark StrouseJ.P. Morgan — Analyst

Got it. Thank you very much.

Operator

Next up, we have Julien Dumoulin-Smith from Bank of America. Your line is open. Please go ahead.

Julien Dumoulin-SmithBank of America Merrill Lynch — Analyst

Yeah. Excellent. Thank you, team. Appreciate the time.

Let me just clean up here on a couple of questions. First off, just the forward trajectory with respect to the EU here. I understand the lithium, different headwinds, including FX. But how do you think about growth beyond just third quarter here compounding.

Obviously, your peers really talking it up and yourself quarter over quarter having a more modest trajectory here for the second quarter. If you can speak high level again, obviously, cognizant of the dynamics in third quarter, maybe even speaking fourth quarter and beyond, what the sort of normalized trajectory you would think for EU and your product.

Zvi LandoChief Executive Officer

And I’m not sure that we heard the question in full. In terms of the general dynamic in Europe, as reported, the market is very, very strong, driven from the high power prices, and we’re seeing this also in residential, also in commercial. And across practically every country in Europe, we are — our portfolio is very strong in Europe. We have close to 500 people in Europe.

We added the more specific European battery this quarter and we’ll be continuing to — we added EV charges for the European market a quarter or two ago, and we will to be adding solutions that are customized. We’re more specific for the European market. So — and you talk to anybody, no one is indicating any type of expectations for electrical power price reductions that would lead to the market cooling down. But obviously, that’s a — there are a lot of external factors that can impact that.

But for the foreseeable future and also based on announcements from various governments, we see this market continuing to grow at a high rate, and we are very confident in our position within this market that we built over the last 10 years or so.

Julien Dumoulin-SmithBank of America Merrill Lynch — Analyst

Got it. Fair enough. But I’m not prepared to share kind of a specific percentage growth target or something like that. And maybe related to that, if I can, just to talk about this.

I mean can you speak a little bit more about manufacturing trends and just the thought process here on committing to further expansion here. Obviously, Mexico underway, etc. But what about beyond that? I mean you talked about low inventory levels. You talked about being constrained.

Again, admittedly perhaps referencing the last question, the trajectory in the EU and U.S. How do you think about the continued ramp of the product again across your core business as well as storage.

Zvi LandoChief Executive Officer

Yeah. So first of all, we are definitely right now in a situation where we are capacity limited compared to the magnitude of the demand. And this is not only related to the events like in Shanghai, just in general, demand is progressing at a higher rate than we are able to add capacity. At the same time, we are pushing an added capacity as much as we can.

And with the long-term vision of having significant manufacturing capability in all of the main continents that we serve and building out also the rest of the supply chain to be able to supply this manufacturing capacity the immediate additional expansion that we are dealing with right now are the expansion of the factory in Mexico and also reaching target capacity levels in our Asian factories in Vietnam and in China. In the European factory, right now, we are increasing battery manufacturing capacity, but inverter and optimizer capacity will be increased in Europe in the second phase. So the long-term plan is to have significant volume manufacturing capability in each of the main continents, being Asia, Europe, and North America. And right now, we are working hard to increase the capacity in the existing factories to meet the elevated demand that we are seeing and similarly across the supply chain because as I said before, it’s also about the capability of the suppliers to meet the type of numbers that we need right now for transistors, magnetics, other components, it’s — these are very, very high numbers, but in some cases, require our suppliers to expand their factories, and that’s work in progress as well.

Operator

We will take the next question from Maheep Mandloi from Credit Suisse. Your line is open. Please go ahead.

Maheep MandloiCredit Suisse — Analyst

Hey, thanks for taking the question. Just switching away from FX. Just on the cash side, you have more than $1 billion of net cash right now. Can you talk about like what are the plans at this stage either on M&A or otherwise? Thanks.

Zvi LandoChief Executive Officer

Yes. Obviously, Maheep, we’re not going to discuss anything specific other than a little bit about what we are looking to do and a little bit about how we are doing it. So what we iterated also in the analyst day is that we are looking in terms of our strategy on technologies that help or deal and improved generation of renewable energy, storage of renewable energy and smart consumption of renewable energy. So we’re — and the software that controls all of these.

And we are looking at technologies in all of those elements, additional methods of generating clean power, additional technologies of an innovation in chemistry and packaging of batteries, expanding into additional means of energy consumption with EV chargers, we’re working on DC EV chargers, and we’re looking at advanced technologies in those areas. And a big element is looking at various types of software controls for energy management and all of the segments that we cover, residential, commercial, utility and expanding into various ways that people can benefit from these assets whether it’s energy management or trading or whatnot. And another element is in cyber. So especially as we go more into large commercial sites and utilities, we have some inherent strength for understandable reasons.

I think in cyber, we think that cyber will be important in the future for the growth of the industry, and we have access to innovative technologies, and we’re looking at those as well. And in terms of the how, we’ve added a group of professionals with a history of M&A and in our industry, so we are very comfortable with how we’re going about it right now and expect to take some actions in the coming future in these areas.

Maheep MandloiCredit Suisse — Analyst

Got you. And I look forward to those. And just one last one for me. On grid-forming inverters, your competitors are seeing some price premium.

Any plans of introducing that product. I know last time, you said you have those products in Japan, but any plans to introduce that in the U.S. markets.

Zvi LandoChief Executive Officer

If you’re referring to various ways of non-storage-based backup, as we said in the past, we see all over the world the focus on — I’ll call it proper backup at the — with the consistency and continuity needed and even, as I mentioned in my reference to the UPS backup, combined with ensuring smooth and continuous electrical power. We see that as the important technology for enabling this transition. And right now, we don’t see interest or demand to move out of Japan, the local non-storage-based backup capabilities.

Maheep MandloiCredit Suisse — Analyst

I appreciate the call. Thanks.

Operator

Next up, we have Colin Rusch from Oppenheimer. Your line is open. Please go ahead.

Colin RuschOppenheimer and Company — Analyst

Thanks so much, guys. Could you talk a little bit about the mix in Europe in 2Q and 3Q relative to residential, commercial, and utility scale, just to get a sense of how that’s breaking down for us.

Zvi LandoChief Executive Officer

So utility is a small — it’s a negligible part of what’s going on in general and what we are doing in Europe, although there have been some announcements that there’s going to be new government effort in some countries toward large projects as well, which were less common in Europe for the last for the last three or four — for the last three or four years. The demand is very strong in both — actually, what is affecting our mix right now is more related to supply than it is to demand. And our growth rates from the last quarter to this quarter has been pretty much the same in terms of residential versus commercial. But again, it’s not so much due to the demand necessarily being even.

I think that probably although residential is growing very fast — commercial is probably growing a bit faster for sure in megawatts just because of the dynamics that we mentioned before of companies looking at fitting out tens of factories with solar, also to compensate for the power for the increases in power prices and also for ESG needs. So when you have these large type of commercial installations going on, it covers a lot of megawatts and compared to the very strong growth in residential as well. So I would say that probably the demand growth in commercial is a little bit higher than that in residential in Europe, but the difference is not dramatic. And in our shipments, also there hasn’t been a significant change in pattern between the two.

Colin RuschOppenheimer and Company — Analyst

OK. That’s super helpful. And then you’ve had pretty significant operating leverage off the sales and marketing, as well as G&A. But R&D is kind of scaling with revenue.

I’m curious about, as you go forward, if there are going to be some optimizations around some of the efforts within that R&D spend in terms of some of the technology platforms and your ability to get a little bit of leverage out of that spending.

Zvi LandoChief Executive Officer

So the answer is — the answer is yes. But to be honest, it’s not our main focus. Our main focus is the opportunities that we have out there and expanding the portfolio. So — and in that regard, if we are looking through more R&D resources and actually, we are a bit optimistic that with some of the challenges that we’re seeing in other industries around us, we are seeing access to talent that maybe a few months ago would be more difficult to bring onboard.

So we’re focusing on efficiency, and we’re definitely leveraging, for instance, our capabilities in storage and sales from residential to commercial to utility and similarly in other areas, but really, we want to do more, and we want to do more in an efficient way and are not focusing right now or trying to do this.

Operator

Next up, we have Jeff Osborne from Cowen & Company. Your line is open. Please go ahead.

Jeff OsborneCowen and Company — Analyst

Good evening. Two quick ones. I was wondering, Ronen or Zvi, if you can touch on lead times and backlog visibility that you have in both the U.S. and Europe and then I had a follow-up for Ronen.

Ronen FaierChief Financial Officer

So from a lead time perspective, it is very much related to the product. And because in general, I can tell you that our lead time for residential products is a little bit shorter than the one for commercials. I relate results from component availability and manufacturing capacity. I would say that on the backlog that we’re sitting today, it’s a backlog that is good for two, three quarters at least that we already have.

And from a lead time CV, I would say a few weeks, like 12 weeks.

Zvi LandoChief Executive Officer

As Ronen said, in residential, it’s probably in the 12- to 14-week range. And in commercial, it’s a little bit longer. It varies — it varies a lot by product.

Jeff OsborneCowen and Company — Analyst

Got it. That’s helpful. And then, Ronen, just for you, why not hedge at all? Can you touch on your hedging cost.

Ronen FaierChief Financial Officer

So actually, we are hedging, but our hedging philosophy is that we’re hedging cash flows and not necessarily a balance sheet item. The main reason for this is that we have a very a fairly large balance sheet, I would call it, items, especially now with seeing the increase in Europe. And this can create a very large actual payments to the banks whenever you are closing a position. In our view, and we saw it, by the way, I saw it in 2015.

I saw it in 2018. The fact that we sit on a very large amount of cash allows us to benefit from the fact that we can wait and go through those cycles and when the gross margin — when the FX is changing, we’re able to enjoy converting those balances. In essence, I can tell you that we do not see any pressure in utilizing the euros. And we simply feel that seeing in this case, if we would hedge the balance sheet, we would have to pay cash $20 million this quarter only for hedging.

We simply believe that waiting and not spending this cash flow makes a little bit more sense in this sense — in this case, sorry.

Jeff OsborneCowen and Company — Analyst

Got it. Thank you. That’s all I had. Appreciate it.

Operator

We’ll take the next one from Michael Blum from Wells Fargo. Your line is open. Please go ahead.

Michael BlumWells Fargo Securities — Analyst

Thanks for taking my questions. My first question, I just want to talk about the battery shipments. You saw a really big — nice uptick in the second quarter. Wondering if you could just talk about attach rates where that sits today and where you see that heading over the next few years? And then how do you manage the impact to the overall gross margin?

Zvi LandoChief Executive Officer

So I’ll discuss the attach rate, and Ronen will talk about the gross margin. So attach rates are highest in Europe right now in a combination of the places where self-consumption is driving the attach rates. And typically, that’s the strongest driver. So wherever the policy is more toward selling consumption and power prices are increasing, that’s where the attach rate is the highest, and that’s why you see in Germany, attach rates of — today, on our systems, we might be seeing it at 60%, but that’s just as we’re ramping the new battery for the German market.

But generally speaking, attach rates in Germany can reach 80% and 90% and then similarly in Italy. And in some of the other European countries that are today on net metering as they gradually shift out of net metering like the Netherlands and the U.K., you will start seeing in the coming years, high battery attach rates over there. And that’s part of what we see as a very big opportunity because of the magnitude that I mentioned of our installed base in these type of countries. In the U.S.

and Australia, the attach rate is significantly lower. It’s — it can range in the 10%, 15% or so depending on period and depending on an area and the increase in attach rate is gradual. It is not — I don’t think it’s going to reach a 50% attach rate across all of the U.S. in a matter of a year or so.

It’s going to take longer, but the attach rates are going to gradually increase also in the U.S. and also in Australia. And all of this is residential and commercial storage is probably two steps behind with global attach rates today in the low single-digit percentages, but definitely a trend toward a slow trend of increase, and it will follow what is happening in residential in the coming years — in the coming years as well.

Ronen FaierChief Financial Officer

And just to conclude on the margin side. The way that we look at it is that we prefer managing the operating profit margins rather than the gross margin. And the reason is that batteries will always be product with a lower gross margin. But still, this is a project that adds to the — product that adds very much to the overall profitability of the company of the EPS.

So if I have, let’s say, a very big demand for batteries, let’s say, a 15% gross margin. And the alternative is either not to sell them and not make 15% profit or to sell them and erode gross margins, we would prefer to erode gross margins and count the 15% net profit in our EPS. So I think that we don’t manage in this case, at least gross margins, but rather operating profit margins.

Zvi LandoChief Executive Officer

And maybe adding on to that point, one quick point also is the ratio of batteries per installation is also going up. So the amount of kilowatt hours per site is increasing together with the amount of kilowatt peak per site. And this is increasing consistently one quarter after another. We’re averaging today, I think, somewhere between 1.1 to 1.2 batteries per site.

And that also improves the revenue and the economics because all of this is sitting on the same infrastructure of sales, service, and G&A.

Michael BlumWells Fargo Securities — Analyst

Great. Thanks for that. I guess another kind of just high-level question for you. We’ve got high interest rates, inflation, potential recession and yet it doesn’t seem like there’s really been any slowdown in solar demand.

So I’m wondering if that’s from your perspective, an accurate assessment. And if you have any view of why solar demand is seemingly not impacted by any of these macro factors? Or is it just too early to say that. Thanks.

Zvi LandoChief Executive Officer

I think using Europe as an example, the return on investment for solar installation in Germany was cut by half, more or less over the last 10 months. So in an inflationary and price increase environment, it’s going — it’s already a very — it’s a financial investment in order not to deal with the very high power prices. And I think that that’s also part of what’s driving the business here in the U.S. on top of the incentive is the expectation that over time, there is a certain likelihood that power prices are going up.

So people who view it right now as the combination of the financial investment and resilience and choosing — again, in the cases that they choose to spend their money in this way. And it’s the same for — at the residential level and at the commercial level. So I — from everyone I spoke to about this, especially like I say, in Europe, that’s where the thinking is. This is a wise financial decision in an unstable financial environment.

Operator

Next up, we have Joseph Osha from Guggenheim. Your line is open. Please go ahead.

Joseph OshaGuggenheim Securities — Analyst

Hello, everyone. I’m not going to ask about foreign exchange anymore. I am curious, given all the opportunities you have in your core markets and I think what we just learned about UPS and the fact that you are taking some gross margin dilution and some of your other businesses, not to put too fine a point on it, why are we still in this e-Mobility business? And why would it not make sense at this point to just kind of fold the tent there and focus on the many core opportunities that you have?

Zvi LandoChief Executive Officer

So it’s a valid question, but there are actually very few similarities between the e-Mobility market and critical power and UPS and the way we are active within these two markets. E-Mobility is a huge — it’s a rapidly growing market with a lot of paths in which is evolving and opportunities, well beyond what’s usually spoken about of passenger cars and trucks that are moving to EVs. The opportunities are in areas like construction, agriculture and others that are going through electrification. And these are very — very closely linked to the need for distributed renewable energy on the site where the electrical vehicle is charging.

And we also said this in the analyst day, we’re focused and interested in this high-growth area. However, we are shifting our focus from where we started off as a tier 1 component supplier to mainstream OEMs and are evaluating where we can have a system architecture that gives benefit between the — and link the generation from the solar system to the mobility system that requires and needs this energy. And we’re seeing some good traction in that area, and we think that in the long term, it is the right investment for the company. But we are taking it in a slightly different path than the one that we originally intended to.

Ronen FaierChief Financial Officer

And just one addition, by the way, which will be a little bit of a technical, but as part of our accounting treatment of this specific area, we’re reviewing every year some accounting balances related to intangible assets related to this. And this is something that we will view this year. Whatever we do here is more accounting or the checking is more of an accounting from a, I would call it, business perspective, we’re staying equally interested and we live in this business.

Joseph OshaGuggenheim Securities — Analyst

OK. Is that — before I go away a diplomatic way of saying we might see you write down part of that investment?

Ronen FaierChief Financial Officer

No, just saying that we will need to evaluate it at the end of the year as we do with all of the other investments.

Joseph OshaGuggenheim Securities — Analyst

OK. All right. Thank you, Ronen.

Operator

Next up, we have Kasope Harrison from Piper Sandler. Your line is open. Please go ahead.

Kasope HarrisonPiper Sandler — Analyst

Hi, good afternoon, and thanks for taking the questions. So just one quick question, Ronen. Just looking at the operating profit guidance for 3Q, I think, it implies another decent increase in operating expenses. And I was wondering if you could just maybe — just speak some more about what’s driving that increase? And then how you think about the trajectory of operating expense leverage moving forward? And then I have a follow-up.

Thank you.

Ronen FaierChief Financial Officer

So in this case, I can already tell you that actually, what you see there is not a result of the — of an increase that we plan in the expenses, but rather being a little bit more cautious on the FX side and its impact. In general, I can tell you that when we plan the operating expenses for the remaining part of the year, it is going to be a relatively small. But in the environment that we’re now acting and we see so many movements and the base of the expenses is denominated in many cases, not in U.S. dollars.

But for example, the Israeli shekels related to our R&D people, we simply prefer to be more cautious. From a realistic point of view, the level of increase, again, had we had FX fixed, you will see a relatively small increase.

Kasope HarrisonPiper Sandler — Analyst

OK. And then a quick clarification question on the component issue you had in China. With the Mexico facility ramping up, does your risk go to zero from another lockdown in China? Or would that potential risk still exist? And then if it does, just maybe some thoughts on how you think about just general mitigation, given that China’s view on zero COVID and the high probability of another lockdown over the next 12 to 24 months?

Zvi LandoChief Executive Officer

So the answer is no and just to clarify. The event in China was not a lockdown of our factory. It was a back-end facility of a component manufacturer. And as a result of that, we could not get components into our manufacturing lines anywhere for that matter, China, or Mexico.

And as Ronen said, it has a double impact or literally a triple impact. We didn’t produce as much as we wanted. We — when we — what we were able to produce and when we were able to resume on some of the lines. We had to expedite the shipments.

And in some cases, our actual contract manufacturing sites, we had to participate with the contract manufacturer in some of the cost of the line standing either waiting for components. So this event was in our supply chain, not in our CM manufacturing facility. On the CM side, so the fact that Mexico ramps is very favorable, as Ronen mentioned, for tariffs and for shipping time, etc., but it doesn’t compensate for the volume that we produce in Asia. On the contrary, because of the very strong demand, we’re ramping capacity everywhere.

So if, for whatever reason, a factory of ours would be shut down due to COVID, it would have a significant impact on the output — our overall output of the company.

Kasope HarrisonPiper Sandler — Analyst

Thank you.

Operator

Next up, we have Biju Perincheril from Susquehanna. Your line is open. Please go ahead.

Biju PerincherilSusquehanna International Group — Analyst

Hi. Thanks. Thanks for taking my question. I had a quick follow-up on the battery attach rates for residential, are you still seeing some third-party batteries being used both SolarEdge and batteries? Or has it all switched over to your batteries now? And if you can quantify that that would be great, too.

Zvi LandoChief Executive Officer

Yeah, we are seeing a meaningful portion of use of third-party batteries and attaching to our systems in particular in areas like in Europe or three phase, where, until recently, we didn’t have a battery of our own and in some cases, also with single phase for various reasons. Also, we don’t always know because a lot of people are still doing AC cupping of the battery. So our system is a big advantage and the architecture that fits our batteries, the DC company, but you can still attach batteries in an AC cupping structure and it doesn’t necessarily — we don’t necessarily have visibility to it, but we do see a lot of reports and pictures and images of people attaching different types of batteries in an AC-coupled manner to our inverters. It would be hard for me to say the ratio on a single phase, I would probably guess that right now the ratio is in the range of 50-50 to 50% with our battery and 50% like third party.

On three phase in Europe, right now, it’s all third party just until recently when we began — people began installing our batteries as well.

Biju PerincherilSusquehanna International Group — Analyst

OK. And then if you look at a few quarters, do you have an expectation where that 50-50 could move to?

Zvi LandoChief Executive Officer

Yeah. We definitely think that the ideal architecture is the one that is based on our battery in a DC cupping and with the seamless integration. And the trend is definitely in that direction that a higher percentage will be attaching — will be attaching our battery.

Operator

Next up, we have Ameet Thakkar from BMO Capital Markets. Your line is open. Please go ahead.

Ameet ThakkarBMO Capital Markets — Analyst

Hi, good evening. Thanks for squeezing me in. I just wanted to ask, I guess, a couple of quick follow-up questions on kind of — on how the mix is kind of translating into what you’re seeing in operating income margins since that’s kind of, I guess, the metric that you’re kind of working for. So like the lead times are higher on the commercial side versus the residential side.

It looks like the gross margins are a little bit lower. So are you guys saying that you still haven’t seen kind of any dilutive impact from kind of the, I guess, the four consecutive quarters on growth in commercial versus residential and operating income margins. And then, I guess, the second question to that is, — how quickly can you pivot your contract manufacturing lines to produce more residential versus commercial, if lead times or margins kind of diverge from your expectations going forward for those two segments?

Zvi LandoChief Executive Officer

Yeah. I’ll start with the second that relates to the production line. So it’s actually the differentiating factor is more single phase versus three phase. So because a lot of Europe residential is three phases.

So we have flexibility to shift our three-phase production from residential phase to commercial in three phase and back and forth, depending on the demand. We have good flexibility in that regard. Right now, demand is super, super strong for both of those. And then the rest of the residential world is single phase, we don’t have very good flexibility to move capacity from single phase to three phase.

We have ability to move within these specific lines and adjust if there is a need to adjust from a demand perspective or if from a supply chain point of view, we have available more components and elements for one versus the other, we can adjust production. So I hope that’s answered the question in terms of the dilution effect of gross margin of commercial, I think Ronen answered before, but he can clarify more.

Ronen FaierChief Financial Officer

Yeah. And here, I think on the heel of EVs answer, when it comes to the operating margin, the difference is not very large between residential and commercial because on one hand, the residential, on a, let’s say, kilowatt basis, enjoys a better gross margin but requires a little bit more of a high-touch sales or high touch, I would call it, usage of operating expenses, while at the same time, when you’re selling — when you’re making one sale of commercial system, the ASP per watt is smaller, but in essence, the opex associated with it is also relatively small simply because it’s a single deal. So we don’t see a very big difference on the operating margin level between residential and commercial. And right now, and especially in the market situation that we see, it’s hard for me to say that we’re even planning it or trying to optimize it.

We simply try to manufacture and provide as much as possible for customers that are striving to get products and to install them rather than optimizing. We do sometimes a little bit of I would call it marginal optimization because we are, for example, sometimes deciding to prioritize areas or regions with higher gross margins of specific products compared to regions that the same products will bear a little bit of lower gross margin, which is, of course, lower operating margin. But I would say that right now, we simply try to manufacture and to sell as much as possible rather than to optimize mix.

Ameet ThakkarBMO Capital Markets — Analyst

Thank you.

Operator

It looks like there are no more questions at this time. I would like to turn the call back to over Mr. Zvi Lando for any additional or closing remarks.

Zvi LandoChief Executive Officer

Thank you very much. We will end here, and thank you, all, for joining us on our call today. Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Erica MannionInvestor Relations

Zvi LandoChief Executive Officer

Ronen FaierChief Financial Officer

Stephen ByrdMorgan Stanley — Analyst

Brian LeeGoldman Sachs — Analyst

Philip ShenROTH Capital Partners — Analyst

Mark StrouseJ.P. Morgan — Analyst

Julien Dumoulin-SmithBank of America Merrill Lynch — Analyst

Maheep MandloiCredit Suisse — Analyst

Colin RuschOppenheimer and Company — Analyst

Jeff OsborneCowen and Company — Analyst

Michael BlumWells Fargo Securities — Analyst

Joseph OshaGuggenheim Securities — Analyst

Kasope HarrisonPiper Sandler — Analyst

Biju PerincherilSusquehanna International Group — Analyst

Ameet ThakkarBMO Capital Markets — Analyst

More SEDG analysis

All earnings call transcripts

Spread the love

Leave a Reply

Your email address will not be published.