Hello, and welcome to the SolarEdge conference call for the first quarter ended March 31, 2024. This call is being webcast live on the company's website at www.solaredge.com in the Investors section on the Event Calendar page. This call is the sole property and copyright of SolarEdge with all rights reserved, and any recording, reproduction or transmission of this call without the expressed written consent of SolarEdge is prohibited. You may listen to a webcast replay of this call by visiting the Event Calendar page of the SolarEdge Investor website. I would now like to turn the call over to J.B. Lowe, Head of Investor Relations for SolarEdge. Please begin.

Thank you, Chloe, and good afternoon, everyone. Thank you for joining us to discuss SolarEdge's operating results for the first quarter ended March 31, 2024, as well as the company's outlook for the second quarter of 2024. 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 first quarter ended March 31, 2024. Ronen will review the financial results for the first quarter, followed by the company's outlook for the second quarter of 2024. We will then open the call for questions. Please note that this call will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from management's current expectations. We encourage you to review the safe harbor statements contained in our press release, the slides posted on our website ahead of this call today and our filings with the SEC for a more complete description of such risks and uncertainties. Please note this presentation describes certain non-GAAP measures, including non-GAAP net income and non-GAAP net diluted earnings per share, which are not measures prepared in accordance with U.S. GAAP. The non-GAAP measures are presented in this presentation because we believe that they provide investors with the means of evaluating and understanding how the company's management evaluates the company's operating performance. Reconciliation of these measures can be found in our earnings release, presentation and SEC filings. 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 March 31, 2024, press release or the supplemental material may obtain a copy by visiting the Investor Relations section of the company's website. And I will now turn the call over to Zvi.

Thank you, J.B. Good afternoon, and thank you all for joining us on our conference call. Starting with highlights of our first quarter results, we concluded the quarter with approximately $204 million in revenue. Revenues from our solar business were approximately $190 million, while revenues from our nonsolar businesses were approximately $14 million. This quarter, we shipped 1.1 million power optimizers, 69,000 inverters and 128-megawatt hour of batteries. As we have done on previous calls, I will start with the market dynamics we see in the various regions and end markets, our underlying demand in these markets and the implications on sell-through and inventory cleanup. Starting with the U.S. residential segment, as we commented last quarter, we did not expect significant changes in this market as long as interest rates and electricity prices remain at recent levels. As a result, our first quarter results largely reflect traditional seasonality with inverter and optimizer sell-through down 19% quarter-over-quarter. However, we have seen continued strength in the uptake of our single-phase battery product in the U.S. market, and sell-through of our battery product was up 26% quarter-over-quarter. This strength is coming from California with the accelerating adoption of battery-tied NEM 3.0 systems, as well as Puerto Rico where customers need full backup capability. Our DC coupled solution is particularly well suited for these applications given the incremental energy that is generated when compared with many alternative products. Moving to U.S. commercial. Sell-through was down 22% from a record fourth quarter, largely due to seasonality. We are encouraged by the trajectory of this market, which is expected to grow this year due, among other reasons, to the continued demand from large enterprise customers who want to standardize their global portfolios on our product. On a year-over-year basis, sell-through of our commercial inverters was up…

Thank you, Zvi. Good afternoon, everyone. Total revenues for the first quarter were $204.4 million. Revenues from our solar segment, which includes the sales of PV attached residential and commercial batteries, were $190.1 million. Total revenues from the United States this quarter were $65.3 million, representing 34% of our solar revenues. Solar revenues from Europe were $85.7 million, representing 45% of our solar revenues. Rest of the world solar revenues were $39.1 million, representing 21% of our total solar revenues. On a megawatt basis, we shipped 226 megawatts to the United States, 443 megawatts to Europe and 276 megawatts to the rest of the world for just under 950 megawatts of total shipments. As in the fourth quarter of 2023, this quarter, the geographical mix of our revenues is mainly a result of the inventory situation in the channel and is not necessarily representing the installation rates, competitive environment or long-term trends. 68% of the megawatt shipments this quarter were commercial products and the remaining 32% were residential. In the first quarter, we shipped 128-megawatt hour of our residential batteries, with the majority shipped to the United States where we see steady growth in installation rates. Similar to last quarter, there was a large portion of shipments of single-phase batteries that are manufactured using our inventory of higher cost sales that carries significantly lower gross margins. In the first quarter, due to the continued inventory imbalances in the distribution channels, we shipped a higher ratio of inverters to optimizers. As a result, average selling price per watt this quarter, excluding battery revenues, was $0.172, a 27% decrease from $0.236 last quarter. While the typical ratio of inverters to optimizers is 1 to 24 -- 1 inverter to 24 optimizers, the ratio this quarter was 1 inverter to 16 optimizers. This…

[Operator Instructions] And we'll move first to Andrew Percoco with Morgan Stanley.

I guess just to start out here on margin guidance, obviously, a lot to unpack. But if I just look at the first quarter, your revenue actually was somewhat in line with your guidance, but margins missed. And my understanding is it was mostly related to mix shift, I guess, a lack of reversal in mix shift that you were expecting following the fourth quarter. So can you just give us a sense for what you're expecting for the remainder of 2024 beyond just the second quarter and whether or not you're comfortable in your prior guidance in terms of your ability to get back to the 30% range by the end of the year?

Sure, Andrew, and thank you for the question. So I'll start by saying that we're still playing the rule of small numbers relatively. And just to explain it a little bit, in general, the amount of batteries that we planned when we guided for our gross margin was a certain level that was exceeded by approximately $15 million of additional battery sales that we did not anticipate just given the fact that the demand for our battery -- single-phase batteries in the United States is better than we expected. And the entire result is actually related to the difference of the margin of having more batteries at a very low margin compared to where we planned it. Had it been a regular quarter at the regular business level, this would be very minimal effect. But at this revenue level, it's relatively large. Now in essence, it's a little bit of a zero-sum game because all of these batteries are based on battery cells that we've already acquired, are already in our inventory, and it's just a question of how quickly we consume it. So by definition, if we sell a lot of more of them right now, we will sell less of them next year when we're going to basically consume all of them. So it's just a shift of the margin. In general, what we are doing, and this is already baked into the second quarter gross margin guidance, we are assuming a slightly higher battery sales than we initially anticipated when we started the year. So for -- at the beginning, it's already there. And the second thing is, of course, that given the very small revenues that we have and we assume that they will grow towards the end of the year, we assume that any impact in that size of difference in mix will be very, very minimal. So no change in our, I would call it, stabilized margin projection.

Understood. Okay, that's helpful. But I guess as a follow-up to that, can you maybe bridge that to cash flow expectations for the year and maybe how you're thinking about liability management? I think you have a debt maturity next year to think about. So how are you thinking about that as it relates to cash flow expectations this year and liability management?

Sure. So of course, cash is, especially in these times of very low revenue, is one of the major items that we're keeping our eyes on. And as I mentioned in my prepared remarks, we expect this quarter to be actually the lowest cash point for the year. The main reason for the position that we're here right now is the fact that, well, we did see the revenues declining already when we guided for Q4. And then for Q1, you still have commitments for inventory procurement and also for manufacturing towards your contract manufacturers. And that means that during the first quarter, we still manufactured more than we actually sold. And this, of course, results in the fact that we are -- we had to pay for the inventory and we had to pay our vendors. What happens in the second quarter is that this phenomenon is actually reversing. We are going to start selling more than our actual manufacturing. And actually, we're going to utilize the inventory that is just $1.55 billion of cash sitting in the form of products. And once we're going to start reversing those, we expect the gross -- the cash to start to be generated again. So we already expect to see cash generation in Q2. And we're going to see intensified generation into Q3 and Q4, where not just that we will have higher revenues, we will also have higher utilization of the inventory. And one -- by the way, just to complete on the convertible bond, currently, of course, these amounts, we treat them as debt, they're out of the money. We treat them as debt. We take -- we work under the assumption that these are moneys that will have to be refunded to the debt holders. And as such, we simply make sure that all of our cash positions are not taking them into account and something that we can use.

And we'll take our next question from Brian Lee with Goldman Sachs.

I jumped on the call late, so I apologize if you already addressed this, Ronen, but can you update us on sort of what you're seeing in the pricing environment? Are you taking any new actions in the U.S.? I know in the past, you've been saying the U.S. pricing situation is pretty stable. And then in Europe, in the past, you said mid- to high-single-digit price declines are what you're planning to implement. Have you implemented those already? Do you see any more actions potentially being needed in terms of pricing in Europe given the market dynamics out there? And then I have a follow-up.

Sure, Brian, and thanks for the question. So actually, we have already started to implement price reductions in various forms this quarter. I would divide them to 2. The first one are price reductions that we've implemented to our batteries, and this is something that is done across the board and across the products. And this just simply means that you buy today batteries at a lower price than you used to. In other regions, what we're trying to do is actually to make our price reductions a little bit more effective in the way that they help our customers because we need to remember that some of our customers are sitting on a large amount of inventories. And sometimes if you are reducing prices, those loyal customers of yours or channels that have a lot of inventory are in an inferior position to someone that's just entering the market or has less inventory and, therefore, being a little bit damaged by this. And this is something that, of course, we don't want to do. So what we are doing is that we are trying to match various price reductions or initiatives to help those -- for example, in Europe today, we see that we have lower ratio of optimizers in the channel compared to inverters. That means that our channels will have to buy more optimizers. What we basically did is that we have temporarily reduced the price of our optimizers in those regions in order to make sure that when our distributor is buying those optimizers, he basically gets them at the lower price. He can sell, by the way, the entire system at the lower price. And this is -- we are not just allowing them to get a better pricing, we also help them to get rid of some of the inventory that they have. And by this, we are accelerating the inventory clearing. So we definitely do this. We're very flexible in the way that we do it. We put a lot of thought about how to not just use -- have the reduction amount, but how to use it properly. And yes, we're doing it in every region separately. In the U.S., I must say that we don't see a lot of this right now because as we mentioned before, again, the environment is relatively stable.

Okay. That's helpful. And then I know there's been a lot of focus on the gross margins here. I guess I'm a little surprised that with revenue pickup in 2Q, the gross margin guidance isn't improving a bit more. I know there's a lot of like volume and fixed cost drivers or absorption drivers that ultimately are going to be a big part of the gross margin ramp back up. So I guess 2 questions here. What actions are you taking to kind of get back to that target of 25 to 27 ex IRA, if that's still the appropriate target? And is there anything that maybe you've been surprised by or is more challenging than you thought and isn't getting you maybe a gross margin uplift on better volumes here in the very near term?

Sure. So first of all, no surprises here from our side given the fact that we still expect to see gross margins where we said all along they will be towards the end of the year. So we don't see change in the end target. The 2 main differences that you see right now compared to maybe a quarter ago is that, one, the rate of selling our residential batteries in the U.S. is a little bit quicker than we thought. And again, when you have relatively limited revenues, you just dilute the margins by very low-margin products, and that's the result here. By the way, again, it's a zero-sum game because the quicker we are consuming them, that means that margin will recover in '25 when we completely get rid of those batteries. So that's the easier part. The second part is actually related to regular seasonal effect that we see every year. Usually, in the second and third quarter, because of summer, we see a little bit of a higher spending on actual warranty expenses. You see more, first of all, replacement of units. It's easier to go on the roof to replace units, and sometimes you see a little bit of a higher failure rate during the summer. So here, really, it's a combination of faster battery sales and no surprises with the overall OCOGS, again, our target -- long-term target remains exactly the same.

And we'll move next to Philip Shen with ROTH Capital Partners.

The first one is a follow-up on pricing. Ronen, our checks suggest you guys may be launching or may have launched recently a new promotion in the European resi segment, which is to buy -- when you buy a kilowatt, you get an optimizer free. So wondering if you could comment on the specifics around that promotion. Our sense is it's across Europe. Our sense is it's -- it will last from May 1 to September 1. And so just curious if you can talk about the dynamics there. And then from an inventory standpoint, it seems like there might be still a year left of inventory for the European resi segment. This might slow things down from a channel clearing standpoint because the distributors will get a coupon to then have to buy more optimizers or at least more product. And so given that dynamic, when do you think the European channel can clear and if you agree that it might be a little bit slower now?

So first of all, the initiative that you mentioned, Phil, is exactly to my last answer is exactly one of the tools that we're taking. What we basically saw here is that we see higher ratio of inverters to optimizers within our channels in Europe. A result of the fact that at the very beginning of '23, we had the problem to provide inverters. Everyone ordered so many and then the slowdown in the market came in. And what we have identified is that whether they like it or not, a lot of the distributors will have to buy quite a lot of optimizers. This will be a necessity for them. And had we just decided to reduce prices across the board of all of our products, that means that they would not really benefit from this price decrease given the fact that what they need is optimizers. So the initiative around optimizers was very easy, let's help our distributors exactly where they need it because they will have to buy. And by allowing them to buy cheaper optimizers because basically giving one on every kilowatt under this initiative means that they need, I don't know, like 4 instead of 5, but that basically means that now they can sell a full system with an inverter that they have a little bit quicker. So these kind of initiatives are simply helping to clear the inventory a little bit faster. As of the time and time to clear, this is very much different between various distributors. And actually, it's also very much different sometimes between various products with those distributors. I can tell you that some of the distributors, for example, that ordered a lot of commercial inverters, just given the fact that we didn't have enough in '23, have many -- maybe too many of them. And one other distributor that didn't order so much have a little bit of lack of those inverters. In average, what we do see, we see a much long -- lower, sorry, inventory levels that reflect 1 year. And we believe that as the year will continue, we will see gradual runoff of some of the products from the shelves. And not just that one day across the board, all products will be finished. So we will continue to see gradual increase in revenues, gradual increase in shipment and gradual clearing of the inventories. But again, we do not expect, in most of the cases, to see a year worth of inventory in total on the shelves in Europe.

Okay. Shifting over to a housekeeping question here on the Q2 guide. Can you talk to us about what you expect the ratio of inverters and optimizers to be in Q2?

So we do not give it yet simply because of the fact that, again, we haven't shipped in. And in those numbers, every small difference is -- or shipment is making a big difference. In general, we do expect to see a higher ratio of optimizers to inverters this quarter and, I would say, even in the upcoming quarters. So I would say that we expect it to be higher than the normal 1 to 24. But again, it's a very volatile environment, so I will not be surprised that there is a little bit of diversion here. But directionally, more than 1 to 24 or 24 to 1.

We'll move next to Mark Strouse with JPMorgan.

So outside of the pandemic years, just kind of looking back over your history, we've kind of thought about your ability to bring down your cost per watt kind of in the mid- to high-single digits or so. Looking forward to learning more about the new products you have coming out. But just kind of curious, if you can talk generally, should we expect the efficiency improvements, the cost declines to kind of be in line with that versus kind of a step-function change that you can talk about?

Yes, Mark, thanks for the question. And I think you gave the answer yourself. So typically, in the -- over the life of a product or generation of a product, we are able to reduce costs roughly at the rate that average prices decline in the market, so kind of a 10% per year. And then we're able to take a larger step cost reductions when we move to new generations. And especially when we're moving to higher-capacity generations because one of the advantages of our architecture is that on the module-level electronics, the cost per watt is kind of fixed, but on the inverter side, we're able to reduce the cost per watt with larger inverters. And when the market goes to larger systems, that enables a cost reduction. So generally speaking, at a very high level, if you look at our next-generation 3-phase inverter that I was discussing, that will enable a step-function reduction in cost per watt compared to the current generation inverter for that size of an installation in the range of 30% to 50% in the shift between generations compared to the annual rate, if you will, of about 10%. Is that clear enough, Mark?

Yes. Yes, that's very helpful. Look forward to seeing that. And then just a quick follow-up, Ronen. Just going back to the low-margin, single-phase batteries, are you able to quantify what that inventory looks like? You said 2025 clearing a couple of times now. I'm just curious, I mean with the crystal ball you have now, do you think that it's [ in '25 ] or later in the years? Any color you have there would be great.

Thanks, Mark. And first of all, by the way, looking at the industry performance in the last few quarters, crystal balls are not easy here. But in general, the way that we look at it is this is basically a product that is based on around 1 gigawatt that we acquired from Samsung. And here, actually, we expected it always to be basically ending, if you remember in the history, around the end of this year. Now of course that, all in all, the industry is a little bit slower than it used to be, we believe that we will enter this market with this inventory into 2025, and that will be the year that we believe that we'll see some replacement with our new products. Now the question here is going to be a combination of 2 things. One is, again, to continue to see how the market adopts the product. And second will be when do we expect the product to be ready, and Zvi will talk about it in the next call. But we will make sure that we're basically continuing with this product as much as needed in order to make sure that we have no product gap. The one thing I would say is that right now, it's not just the fact that we're selling these batteries a little bit faster than the others, it's also the fact that the 3-phase batteries that are enjoying much better margins in Europe, right now, the sales for them are relatively low given the situation in Europe. So when we look at the improvement of gross margins related to batteries into the end of this year and beginning of next year, it's not just how quickly we're clearing this, which is, of course, an important factor, but it's also what portion of these batteries are within the overall residential batteries we sell. Right now, this portion is very high. So all in all, middle of '25, we believe that will be gone with this inventory.

And we'll take our next question from Colin Rusch from Oppenheimer.

With the product redesigns and evolution, can you give us a sense of how much cost you feel like you could take out? And how important is that to the margin trajectory that you guys are talking about getting back to a normalized level?

Yes, Colin, thanks for the question. I think first, the -- and Ronen will correct me, the margin projections that Ronen was discussing before were not dependent on the new product that we will be releasing because the volumes, when we're looking at the rest of this year, the volumes of the new products will not be impacting dramatically the financials. As I was alluding before, it varies from one -- from different products. You take a battery, the cost is very strongly dominated by the cells. So when you move from a current generation to a next generation, you're dependent on cell prices, you can become more efficient on the mechanics and the power electronics, but your potential for cost reduction is, at the end of the day, limited. When you're talking about the next generation of inverter, new components and efficiencies, the potential for step-function reduction in cost is much more significant. So as I was referring before to the new 3-phase inverter, taking into account when looking at the installation size that we're targeting for that inverter, so the segment of a large residential installation, we will be able to serve with a solution that is probably in the range of about 50% lower cost per watt of the inverter compared to serving that application with current generation inverters. That is not necessarily the cost reduction that will be achieved for every size of installation, but for the target -- and that's how we do the design, for a target size and application that we think is going to be the main driver in the market. And for that point, we optimize the cost. And like I say on the power electronics and the generational move, we can be in the range of reducing the cost per watt of 30% to 50%.

That's helpful, guys. And with the emergence of virtual power plants, both at the residential level, but more importantly at the commercial level, and some of the software investments that you guys have made, can you talk a little bit about your ability to monetize that and how quickly the evolution of those offerings are -- what the cadence of that evolution is and your ability to really get it embedded in with some of your customers, particularly on the commercial level?

So I would separate indeed between the -- VPP or virtual power plant is one application of grid services that is today more prevalent in residential than it is in commercial. And we are able to monetize a subscription as long as the VPP program is active. I don't remember off the top of my head the number of batteries or residential systems that we have today under some form of a VPP. It is not huge. Otherwise, we would have probably been able to report a much better margin because of 100% margin flow of cash. But VPP is growing. The growth rate is not huge. And when it happens, we can generate revenue from it. The other software capabilities that we enable in residential, for the most part, are not generating any type of revenue. Commercial is a different story. What we are offering there is much, much broader than a virtual power plant. It provides more value, and it's a wide range of capabilities from energy efficiency, load management, et cetera. And there, we expect to be able to have a higher ratio of -- or a high -- relatively high ratio of software services and recurring revenue generation, but it will be a process. It's something that we'll be rolling out gradually, and it will grow gradually. So again, I don't see it having a big impact on our numbers in the next 24 months, but it is something that in the long run will be a source of high-margin revenue.

We'll move next to Austin Moeller with Canaccord.

Just my first question here, do you see any potential changes to tariffs or legislation coming that could benefit U.S.-made inverters and batteries similar to the recent change for bifacial panels?

Beyond the IRA, if you can help clarify the question?

The recent change was with tariff rules.

Yes, we're not aware of anything. I think that said, the adoption of -- an increased use of bifacial panels is a good thing for module-level power electronics providers because the incremental added harvest by module-level power electronics from a bifacial panel is more significant than from a regular panel, but that's completely a sidenote related to that regulation. We're not aware of anything cooking of a similar nature in the space that we operate in.

Okay. And just given that interest rates remain high, what trends have you started to see in core U.S. markets like California around leasing arrangements for rooftop solar?

So I think the general expectation for increase of lease versus loan is evident in the market. Again, it's not a black and white in a complete switch, but we see that dynamic ourselves as well, as well as the entrance of new lease providers because of that trend and because of the tendency or the benefits that the IRA creates for third-party ownership. So that is definitely evident, and it is more evident in the battery markets like California and Puerto Rico.

And we'll take our next question from Kashy Harrison with Piper Sandler.

And apologies if this was covered as I joined late, but I was wondering if you could just share your thoughts on the forward trajectory of the nonsolar business? It looks like you lost roughly $12 million in Q1, I believe, or just under $50 million annualized. Cell manufacturing is becoming a little bit more competitive. And so I'm just wondering how you think about the path to either getting towards breakeven operating income or selling the business or shutting it down and just focusing on the core solar business.

Sure, Kashy, and thanks for the question. So in general, I'll start by maybe a little bit of dynamics, but then go into the heart of the question itself. From a dynamic point of view, usually, the storage market, especially the market in which our storage division is active, is very much been back of the year loaded with revenues. And that means that, usually, you see very low Q1 and relatively strong Q4. And in general, we do expect to see growth in the revenues and activity of this segment. So therefore, at least directionally, losses related to the storage division should go down as we move forward towards the second half of the year, not a lot in the first half, but more in the second half. Now directionally about the segment itself, I think that there are 2 areas of the segment that we need to look at. The first one is having a segment that is concentrated in making storage weather control collected to solar or not. And this is something that we see very great advantage of having these kind of capabilities. Even if we're selling batteries that are not collected to PV, the knowledge, the development and the technology that we're developing there is helpful for us. And we will continue to see multiple applications where you see storage without solar. By the way, just as an anecdote, we sell today sometimes residential batteries without a PV just for backup. So in general, having this kind of an asset is something that we see a great value in. And here, we invest. It's basically a segment that is developing product. And like every developing product, it takes a while. The second part of the segment is actually owning the cell manufacturing that we have…

I appreciate that, Ronen. Very helpful. And then just a quick follow-up. I think you mentioned $950 million of cash as the low point for the year. Can you just walk us through some of the drivers to increasing that cash balance for the rest of the year given that operating income should be negative still?

Of course. I think that the main reason for where we are today is the fact that it takes a while -- when you are a manufacturer, at least large volumes, it takes a while to stop manufacturing and to adjust it to the levels of selling that you see; by the way, as it's painfully hard to grow the manufacturing capabilities into where you want them to be. And that means that over the fourth and the first quarter -- fourth quarter of '23 and first quarter of '24, we -- it took us a while to break this train of manufacturing and to basically adjust the manufacturing layers other than what happens in the U.S. because in the U.S., we'll manufacture as much as we can to the level of inventory. But this is something that already ended. So we manufactured more than we sold. That means that we need to pay to our vendors for either component or for the manufacturing itself. And this is something that continued into Q1 and will, by the way, continue slightly into Q2. What happens in the meantime? First of all, we are collecting on our customer balances, and we did a very good quarter when it comes to collection. We will continue to do this in Q2. And now most of the new sales that we're doing outside of the United States are going to be revenues coming from inventories that we already have and already paid for. And this is the thing that will start to turn the cash flow to be positive. Since in Q2, we will still see some payments related to the manufacturing in Q1, we will see cash generation that will be in Q2 lower than in Q3. And from Q3, Q4, we expect to be in a relatively strong cash flow generation both, by the way, on the operating, but also much less spending on CapEx or anything else.

[Operator Instructions] We'll move next to Jordan Levy with Truist.

It's Henry on for Jordan here. Just to start, can you just dig a little bit deeper into the -- some of the pacing we can expect to see around the inventory reduction kind of over the next few quarters?

Can you just -- I didn't hear it will well, sorry?

Yes. Can you hear me?

Yes, now I do.

Yes. Just to start, can you give a little more into some of the pacing we can expect around the inventory reduction over the next few quarters?

Sure. So in general, and I think it also relates to how we see the inventory clearing over time, it's actually [ anticipating ], but it's also the ratio of how much of the inventory we're using. Because right now, first of all, in the last 2 quarters, our sales into the United States were higher compared to the rate of sales into Europe over the last few quarters, again, because of the channel inventory there. So that means that if we are manufacturing in the United States almost everything that we sell in the United States, the pacing of the inventory clearing is a little bit slower. Once we will start to see Europe growing again and because of the fact that most of the European inventory is already manufactured, the pace is going to grow. When it comes to the pace itself of finishing this kind of inventory, I would assume that of the finished good inventory that we started the year with, approximately 2/3 will be cleared towards the end of the year. And of course, here, the pace is going to be dependent on how quickly the market recovers. But of what we had at the end of the year as finished goods, about 2/3 will be clearing this year. And you can linearly take it from like Q2 towards the end of the year in order to get there because this is the assumption that we take.

Awesome. And then just a quick follow-up from me. Outside of California and Puerto Rico, which you all had mentioned, were there any other main U.S. regions that stood out to you all from a demand perspective on battery sales this quarter? Or has demand been relatively steady state in the rest of the country?

Yes, there wasn't -- other than Hawaii, but Hawaii is a different story, I can't think of a state that has as high an attach rate as the 2 states that you mentioned. But there is definitely an increase at some level of battery take-up also in Arizona and also, to some extent, in Texas probably.

We'll take our next question from Vikram Bagri with Citi.

I just wanted to follow up on the sell-through guidance that you gave for second quarter. I believe you said 15% to 20% up in 2Q. We're in the middle of the quarter, I was wondering like if you can highlight some markets where you're seeing the strength. I imagine some markets are growing faster than that rate and some markets are sort of underperforming relative to that rate. If you can identify markets where you're seeing that level of strength and some markets where you're not seeing the impact of the promotions and price reductions that you've implemented?

Yes, thanks for the question. First of all, it's very multidimensional because we're talking about the split between geographies as well as between segments. Now added onto that, really, sell-through by our distributors is not online data. So the fact that we're into the quarter, it doesn't mean we have that much information in front of us. It gets accumulated a bit later. I can say that there are some countries in Europe that are showing faster growth rates right now, Italy, Switzerland. As I mentioned before, Germany was a bit slow. The expectation is that it will begin to pick up because this legislation went through just a week ago, and those are probably just from specific data that I've seen. I would say that Italy and Switzerland stand out a bit. And probably also commercial is showing, in some cases, faster growth in -- and this data is a combination of how we track the installation rate and sell-through. So although it's -- we're a little bit more than 1 month into the quarter, I don't think there's a lot of definitive information that we can give on this topic probably other than what I mentioned that is more evident is -- are the countries that I referred to.

Great. And on a related note, Zvi, you mentioned gaining market share through more innovation and more features in SolarEdge ONE software, particularly in C&I side and also on residential side going forward. We only see that R&D line item, which is $300 million on an annual basis. Could you talk about how you plan on gaining market share going forward, both in U.S. and Europe? Is the strategy to be differentiated on software side? Or there are more innovations on the hardware side that are upcoming that we don't fully appreciate?

No, thanks for the question. And hardware has been our bread and butter for years, and our expertise or the expertise of our R&D team in power electronics is a significant differentiator for the company. So it's definitely a core priority for us. And as I mentioned, I gave the example in my prepared remarks of the next-generation 3-phase large inverter for the European market that is targeting a growing segment. And there, we definitely plan and are in route to differentiation on the basis of hardware with the traditional factors in mind of efficiency, cost and the -- all of the capabilities around the interaction between the battery and the inverter. So that and a lot of the things that I didn't refer to in this conversation around safety that is coming from the optimizers where we are constantly introducing more unique safety features and, again, completely on the basis of our hardware infrastructure and capability. That said, and when you refer to the R&D investments, definitely, the ratio of software to hardware investment today is different than it was 4 or 5 years ago. And software takes a bigger portion because it is much more important to the customers from a world that used to be based on feed-in tariff where it just mattered how much you -- electricity you deliver into the grid to a world today that is much more complex and self-consumption-oriented, which creates again another opportunity for differentiation, which we are focused on. So we are definitely taking a balanced approach between the 2. But in historical perspective, it means that we're doing more in software today than we did in the past because we were always very heavily invested on the hardware side.

We'll take our next question from Christine Cho with Barclays.

I just had one question. Last quarter, with respect to gross margins, you mentioned batteries were -- the single-phase batteries were a reason for the drag on gross margin similar to this quarter. But you had also mentioned that you had a higher percentage of customers with discounts and that you expected for it to revert back. You didn't mention anything about customer mix this quarter. So just curious if you did see it revert back or was it pretty consistent with what you saw in 1Q -- or I'm sorry, last quarter.

No, it's actually -- Christine, thank you for your question. It's actually, I mentioned in my prepared remarks, we did see that we saw lower ratio of customers that are -- that enjoy the volume discounts, and this was actually offsetting -- this benefit was offsetting of the additional batteries that we shipped above what we actually planned. So definitely, yes, this was the case. The surprise here actually was not the change in mix that we did not anticipate. We anticipated this one. Surprise was actually simply selling more batteries, which I think was a little bit of a good thing, at least commercially.

Do you expect continued improvement on the percent -- the customer mix or no, it's back to normal in 1Q?

I would say that it's relatively normal. The only thing I would say is, again, it's a very -- a small numbers game. And everyone that will give us a surprising -- a large customer that will come with the surprising order simply because he needs something may change it a little bit in those numbers. But in general, we do expect that the ratio that we see right now is the more normal compared to what we saw before.

And it does appear that there are no further questions at this time. I would now like to turn it back to Zvi for any closing remarks.

Thank you, operator. And thank you, everyone, for joining us on our call today. Have a good evening. Thank you.

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