SOLAREDGE TECHNOLOGIES, INC. 10-K

ITEM 7 . MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section of this Annual Report on Form 10-K captioned “Business” and our consolidated financial statements and the related notes to those statements included elsewhere in this Form 10-K. In addition to historical financial information, the following discussion and analysis contains forward looking statements that involve risks, uncertainties, and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward looking statements as a result of many factors, including those discussed under the sections of this Annual Report captioned “Special Note Regarding Forward Looking Statements” and “Risk Factors”. F or discussion related to changes in financial condition and the results of operations for the year ended December 31, 2021, refer to Item 7- Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 22 , 2022. Overview We develop, manufacture and sell products that address a broad range of energy market segments through our diversified product offering, including residential, commercial and large scale photovoltaic or PV, energy storage and backup solutions, electric vehicle or EV charging capabilities, home energy management, grid services and virtual power plants, as well as products in our non-solar businesses which address e-Mobility ("e-Mobility"), automation machines ("Automation Machines") and lithium-ion batteries ("Storage"). Further information regarding our business is provided in “Part I, Item 1. Business” of this Annual Report. In the year ended December 31, 2022 , one customer accounted for 18.5% of our revenues and our top three customers (all distributors) together represented 34.8% of our revenues. Our revenues were $3,110.3 million and $1,963.9 million for fiscal 2022 and fiscal 2021 , respectively. Gross margins were 27.2% and 32.0% for fiscal 2022 and fiscal 2021 , respectively. Net income was $93.8 million and $169.2 million for fiscal 2022 and fiscal 2021 , respectively. Performance Measures In managing our business and assessing financial performance, we supplement the information provided by the financial statements with other operating metrics. These operating metrics are utilized by our management to evaluate our business, measure our performance, identify trends affecting our business and formulate projections. We use metrics relating to shipments of inverters, power optimizers and megawatts to evaluate our sales performance and to track market acceptance of our products. We use metrics relating to monitoring (systems monitored) to evaluate market acceptance of our products and usage of our solution. We provide the “megawatts shipped” and "megawatts hour shipped" metrics, which are calculated based on inverter or battery nameplate capacity shipped respectively, to show adoption of our system on a nameplate capacity basis . Nameplate capacity shipped is the maximum rated power output capacity of an inverter or battery, and corresponds to our financial results in that higher total nameplate capacities shipped are generally associated with higher total revenues. However, revenues may increase in a non-correlated manner to the "megawatt shipped" metric since other products such as Power Optimizers, are not accounted for in this metric. 40 Year ended December 31, 2022 2021 Inverters shipped 1,019,307 789,565 Power optimizers shipped 23,736,368 18,568,297 Megawatts shipped 1 10,491 7,159 Megawatts hour shipped - residential batteries 889 53 1 Excluding residential batteries, based on the aggregate nameplate capacity of inverters shipped during the applicable period. Nameplate capacity is the maximum rated power output capacity of an inverter as specified by the manufacturer. Global Circumstances Influencing our Business and Operations Covid-19 Impact & Response Covid-19 continued to present challenges to our operations and business in 2022, primarily, operational challenges, which we reported on continuously in our quarterly reports throughout the year, but to a lesser extent than in 2021. Due to the worldwide growing trend in availability and administration of vaccines against Covid-19, many restrictions that were placed during the pandemic were gradually lifted by governments across the globe. However, the future impact of the Covid-19 pandemic remains highly uncertain. Resurgences of Covid-19 cases and the emergence of new variants may adversely impact our results of operations. For example, in the second quarter of 2022, the mandatory government shutdowns resulting from the increase in Covid-19 cases in Shanghai, that were eased in the beginning of the third quarter of 2022, led to delays in our scheduled shipments from the Shanghai port. Our first priority continues to be to protect and support our employees while maintaining company operations and support of our customers with as few disruptions as possible. W e follow the guidance issued by applicable local authorities and health officials in each region in which we do business, including in our headquarters located in Israel. While we have not experienced any new disruptions resulting directly from Covid-19 in the fourth quarter of 2022, the pandemic and general global economic conditions continue to present challenges to our operations and business. In the fourth quarter of 2022, we began to witness a decrease in shipment prices and transit times, both however are still not at their pre-Covid-19 levels. In fiscal 2022 as a whole and the fourth quarter of 2022 specifically, the industry-wide component shortages which originated from Covid-19 and amplified by the increase in demand for our products, as well as other manufacturers who are competing for the same components, continued to impact our ability to accurately plan and forecast the delivery of our products to customers and have also increased cost of ocean and air freight for components and finished goods. To mitigate the impact of these disruptions on our supply chain, we extended shipment terms that differ from our standard terms in certain transactions including Free-Carrier and Ex-works (INCOTERMS, 2020) delivery from our manufacturing facilities. This change was implemented as part of our ongoing efforts to expedite shipments to our customers and improve visibility throughout our supply chain. Moreover, industry-wide component shortages require our R&D teams to focus their attention on manufacturing and production design workarounds solutions, which can impact our ability to meet our plans to roll out new innovative products and services. Our operation team is working tirelessly to mitigate the impact of the disruptions described above. 41 Impact of Ukraine’s Conflict on the Energy Landscape The conflict between Ukraine and Russia, which started in early 2022, and the sanctions and other measures imposed in response to this conflict, have increased the level of economic and political uncertainty. While we do not have any meaningful business in Russia or Ukraine and we do not have physical assets in these countries, this conflict has, and is likely to continue to have, a multidimensional impact on the global economy, the energy landscape in general and the global supply chain. On one hand, in 2022, rising global interest in becoming less dependent on gas and oil led to higher demand for our products. On the other hand, the conflict further adversely affected the prices of raw materials arriving from Eastern Asia and resulted in an increase in gas and oil prices. Furthermore, various shipment routes were adversely impacted by the conflict resulting in increased shipment lead times and shipping costs for our products. While the impact of this conflict cannot be predicted at this time, the circumstances described above may have an adverse effect on our business and results of operations. Inflation Reduction Act In August 2022, the U.S. government enacted the Inflation Reduction Act of 2022 (the “IRA”), which includes several incentives intended to promote clean energy, battery and energy storage, electrical vehicles, and other solar products and is expected to impact our business and operations. As part of such incentives, the IRA, will among other things, extend the investment tax credit (“ITC”) through 2034 and is therefore expected to increase the demand for solar products. The IRA is expected to further incentivize residential and commercial solar customers and developers due to the inclusion of a tax credit for qualifying energy projects of up to 30%. Since these regulations are new and are still pending administrative guidance from the Internal Revenue Service and U.S. Treasury Department, we will be examining the benefits that may be available to us, such as the availability of tax credits for domestic manufacturers, in the coming months. To the extent that tax benefits or credits may be available to competing technology and not to our technology, our business could be adversely disadvantaged. 42 Key Components of Our Results of Operations The following discussion describes certain line items in our Consolidated Statements of Operations. Revenues We generate revenues from the sale of DC optimized inverter systems for solar PV installations which include power optimizers, inverters, storage and backup so lutions, EV chargers, smart energy devices , our cloud-based monitoring platform as well as grid services. Our customer base mainly includes distributors, large solar installers, wholesalers, EPCs, and PV module manufacturers. In addition, we also generate revenues from the sale of lithium-ion cells, batteries and energy storage solutions, automation machines and EV powertrain solutions for electric vehicles. Our revenues from the sale of solar-related products are affected by changes in the volume and average selling prices of our DC optimized inverter systems. The volume and average selling price of our systems is driven by the supply and demand for our products, changes in the product mix between our residential and commercial products, the customer mix between large and small customers, the geographical mix of our sales, sales incentives, end user government incentives, seasonality, and competitive product offerings. Revenues from the sale of energy storage system or ESS products, are affected by the type of product sold (cell, battery or system) and the type of the battery that is sold. Revenues from the sale of SolarEdge Automation Machines and SolarEdge e-Mobility products are affected by the changes in the volumes, customers’ size and average selling prices of the p roducts we sell. Our revenue growth is dependent on our ability to expand our market share in each of the geographies in which we compete, expand our global footprint to new evolving markets, grow our production capabilities to meet demand, continue to develop and introduce new and innovative products that address the changing technology and performance requirements of our customers and expansion of the new businesses we acquired. In the year ended December 31, 2022 , 54.3% of our revenues were generated from Europe, 36.5% of our revenues were generated from the United States and 9.2% of our revenues were generated from ROW. In the year ended December 31, 2021 , 45.4% of our revenues were generated from Europe, 40.0% of our revenues were from the United States and 14.6% of our revenues were generated from ROW. Cost of Revenues and Gross Profit Cost of revenues consists primarily of product costs, including purchases from our contract manufacturers and other suppliers, as well as costs related to shipping, customer support, product warranty, personnel, depreciation of testing and manufacturing equipment, provision for losses related to slow moving and dead inventory, hosting services for our cloud based monitoring platform, and other logistics services. Our product costs are affected by technological innovations, such as advances in semiconductor integration and new product introductions, economies of scale resulting in lower component costs and improvements in production processes and automation. Some of these costs, primarily personnel and depreciation of testing and manufacturing equipment, are not directly affected by sales volume. With respect to ESS, Automation Machines and e-Mobility products ("Non-Solar") cost of revenues, consists primarily of materials costs, labor costs associated with the manufacturing, variable utility, and operational costs related to the manufacturing factories, depreciation of testing and manufacturing equipment, amortization of intangible assets and other fixed costs. Except for the manufacturing and assembly activities related to our Non-Solar businesses and the manufacturing of solar products at Sella 1, our manufacturing facility in the North of Israel, we outsource our manufacturing to third-party manufacturers and negotiate product pricing on a quarterly basis. 43 During 2022 , supply chain and operational challenges coupled with an increase in demand for our products, resulted in increased use of expedited ocean freight as well as air freight to deliver our products to our customers in a timely manner. At the beginning of 2022, a high portion of our products manufactured in non-tariff countries imported into the U.S. resulted in lower custom tariff charges. As a result of the operational challenges we faced during 2022, the levels of our finished goods inventories required to support our growth were reduced. While we are seeing an improvement in supply chain disruptions and component constraints towards the end of 2022, we expect to continue to deliver our products through expedited ocean freight and air freight. To the extent that production in our Mexican manufacturing facility ramps and production in Sella 1 is expanded as anticipated, we expect inventory levels to return to those required to support our growing business, the reduction in expedited shipments and air freight usage during the third quarter of 2023. We continue to develop our own manufacturing capabilities. For example, we have developed our own proprietary automated assembly lines for our power optimizers, manufacture sub-assemblies such as cables and magnetic, and own large amounts of equipment in connection with such manufacturing activities. In 2022, we developed and commenced manufacturing from our first partially automated inverter assembly line which began production in our Sella 1 manufacturing site. We expect to continue to invest in additional automated assembly lines in the future. We have designed and are responsible for funding all of the capital expenses associated with existing and planned automated assembly lines. The current and expected capital expenses associated with these automated assembly lines will be funded out of our current cash and cash equivalents, available-for-sale marketable securities and cash flows generation. Additionally, we continue to develop our own manufacturing capabilities in Sella 2, our Li-Ion battery factory in Korea. We expect Sella 2 to continue to incur costs and expenses as it ramps. We also intend to expand the manufacturing capabilities of Sella 2 in fiscal years 2023 and 2024 which will result in additional expenses. We intend to use our available cash balances for this expansion. Key components of our logistics supply channel consist of third party distribution centers in the U.S., Europe, Au stralia, and Japan . Finished goods are either shipped to our customers directly from our contract manufacturers or shipped to third-party distribution centers and then, finally, shipped to our customers. Cost of revenues also includes our operations, production and support departments’ costs. The operations and production departments are responsible for production management such as planning, procurement, supply chain, production methodologies and machinery planning, logistics management and manufacturing support to our contract manufacturers, as well as the quality assurance of our products. Our support department provides customer and technical support at various levels through our call centers around the world as well as second and third-level support services, which are provided by support personnel located in our headquarters. Our employees headcount in our operations, production and support departments has grown from 2,052 as of December 31, 2021 to 2,383 as of December 31, 2022 . Gross profit may vary from quarter to quarter and is primarily affected by our average selling prices, product costs, manufacturing ramp-up costs, product mix, customer mix, geographical mix, shipping method, warranty costs, exchange rates and seasonality. Operating Expenses Operating expenses consist of research and development, sales and marketing, general and administrative, goodwill impairment and other operating expenses, net. Personnel related costs are the most significant component of each of these expense categories and include salaries, benefits, payroll taxes, commissions and stock-based compensation. Our employees headcount in our research and development, sales and marketing and general and administrative departments, has grown from 1,912 as of December 31, 2021 to 2,543 as of December 31, 2022 . We expect to continue to hire significant numbers of new employees to support our growth . The timing of these additional hires could materially affect our operating expenses in any particular period, both in absolute dollars and as a percentage of revenue. We expect to continue to invest substantial resources to support our growth and anticipate that each of the following categories of operating expenses will increase in absolute dollar amounts for the foreseeable future. 44 Research and development expenses Research and development expenses include personnel-related expenses such as salaries, benefits, stock-based compensation and payroll taxes. Our research and development employees are engaged in the design and development of power electronics, semiconductors, software, power-line communications, networking and chemistry . Our research and development expenses also include third-party design and consulting costs, materials for testing and evaluation, ASIC development and licensing costs, depreciation and amortization expenses, and other indirect costs. We devote substantial resources to ongoing research and development programs that focus on enhancements to, and cost efficiencies in, our existing products and timely development of new products that utilize technological innovation, thereby maintaining our competitive position. Sales and marketing expenses Sales and marketing expenses consist primarily of personnel-related expenses such as salaries, sales commissions, benefits, payroll taxes, and stock-based compensation. These expenses also include travel, fees of independent consultants, trade shows, marketing, costs associated with the operation of our sales offices and other indirect costs. We currently have a sales presence in many countries worldwide and intend to continue to expand our sales presence to additional regions. General and administrative expenses General and administrative expenses consist primarily of salaries, employee benefits and stock-based compensation related to our executives, finance, human resources, information technology, and legal organizations, travel expenses, facilities costs, fees for professional services, and registration fees related to being a publicly-traded company. Professional services consist of audit and legal costs, remuneration to board members, insurance, information technology and other costs. General and administrative expenses also include expenses related to legal claims and allowance for doubtful accounts in the event of uncollectible account receivables balances. Goodwill impairment and other operating expenses, net Goodwill impairment and other operating expenses, net , consist primarily of impairment of goodwill, impairment of long-lived assets and certain other nonrecurring items. Non Operating Expenses Financial income (expense), net Financial income (expense), net, consists primarily of interest income, interest expense, gains or losses from foreign currency fluctuations and hedging transactions. Interest income consists of interest from our investment in available for sale marketable securities, deposits and accretion of discounts related to our investment in available for sale marketable securities. Interest expense consists of interest related to bank loans, advance payments received for performance obligations that extend for a period greater than one year, related to Accounting Standard Codification 606, “Revenue from Contracts with Customers” (ASC 606), interest related to Accounting Standard Codification 842, “Leases” (ASC 842), amortization of premium related to our investment in available for sale marketable securities and the accretion of the debt discount and amortization of debt issuance cost associated with our Notes due 2025. Our functional currency is the U.S. dollar. With respect to certain of our subsidiaries, the functional currency is the applicable local currency. Financial (expenses) income, net, also consists of gains or losses from foreign currency fluctuations primarily of the effect of foreign exchange differences between the U.S. dollar and the New Israeli Shekel, the Euro, the South Korean Won and other currencies related to our monetary assets and liabilities, the fair value remeasurement of hedging contracts not designated as cash flow hedge and bank charges. 45 Other income Other income consists primarily of realized and unrealized gains and losses on investments in privately-held companies. Income taxes We are subject to income taxes in the countries where we operate. In the year ended December 31, 2022 , we recorded a net income tax expense of $83.4 million , which consists of a $94.4 million current income tax expense and $11.0 million of deferred tax income . In the year ended December 31, 2021, we recorded a net income tax expense of $18.1 million, which consists of a $29.7 million current income tax expense and a $11.6 million deferred tax income. The increase in net income tax expense was mainly attributed to impairments that did not have a corresponding tax effect and the change to Section 174 of the U.S Internal Revenue Code, which became effective on January 1, 2022. The change eliminates the option to deduct research and development expenditures currently and requires taxpayers to amortize them over five years (if generated from a US entity) and fifteen years (if generated from non-U.S. entities).This change to Section 174, as well as lower tax benefits relating to stock-based compensation, resulted in an increase in the Company’s taxable income and Global Intangible Low Taxed Income (“GILTI”) tax. On December 22, 2017, the Tax Cuts and Jobs Act (the "Tax Act") was signed into law, making significant changes to U.S. income tax law. These changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years 2018 onwards and created new taxes on certain foreign-sourced earnings (including GILTI, as explained above) and certain related-party payments. Furthermore, the Tax Act required the Company to pay U.S. income taxes on accumulated foreign subsidiaries earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets, and 8% on the remaining earnings. The total tax liability will be paid over the eight-year period provided in the Tax Act (ending 2024). SolarEdge Technologies Ltd., our Israeli subsidiary, is taxed under Israeli law. Income not eligible for benefits under the Investments Law is taxed at the corporate tax rate. The Israeli corporate tax rate is 23%. Our Israeli subsidiary elected tax year 2012 as a ”Year of Election” for “Benefited Enterprise” under the Israeli Investments Law, which provides certain benefits, including tax exemptions and reduced tax rates. Upon meeting the requirements under the Israeli Investments Law, the two-year tax exemption has ended on December 31, 2018. The Investment Law was amended in 2005 and was further amended as of January 1, 2011 and in August 2013 (the “2011 Amendment”). The 2011 Amendment canceled the availability of the benefits granted in accordance with the provisions of the Investments Law prior to 2011 and, instead, introduced new benefits for income generated by a “Preferred Company” through its “Preferred Enterprise” (both as defined in the 2011 Amendment). Under the 2011 Amendment, income derived by Preferred Companies from Preferred Enterprise would be subject to a uniform rate of corporate tax. The tax rate applicable to such income, referred to as “Preferred Income”, would be 7.5% in areas in Israel that are designated as Development Zone A and 16% elsewhere in Israel starting in the year 2017 and thereafter. Our Israeli subsidiary has established its own manufacturing facility in Israel, located in a Development Zone A, therefore income from manufacturing attributed to that facility is subject to a 7.5% tax rate. 46 In December 2016, Amendment 73 to the Investments Law (the “2017 Amendment”) was published. According to the 2017 Amendment, special tax tracks for technological enterprises have been introduced, which are subject to rules that were issued by the Israeli Ministry of Finance. A Preferred Technological Enterprise (PTE), as defined in the 2017 Amendment, that is located in the central region of Israel, will be subject to a tax at a rate of 12% on profits deriving from intellectual property, or 6% if its annual revenues exceed New Israeli Shekel 10 billion. On June 14, 2017, the Encouragement of Capital Investments Regulations (Preferred Technological Income and Capital Gain for Technological Enterprise), 2017 (the “Regulations”) were published. The Regulations describe, inter alia, the mechanism used to determine the calculation of the benefits under the PTE regime. A company that complies with the terms under the PTE regime, may be entitled to certain tax benefits with respect to certain income generated during the company’s regular course of business and derived from the preferred intangible asset. As of January 2019, our Israeli subsidiary elected to implement the 2011 and 2017 Amendments starting as of tax year 2019 and as a result, under the PTE regime with respect to our business activities in Israel. Our PTE income was subject to a 12% tax rate in Israel in the years 2019-2021, and in 2022 to a 6% tax rate as we surpassed 10 billion New Israeli Shekel revenues threshold. The Law for the Encouragement of Industry (Taxes), 1969, (the “Industry Encouragement Law”), provides certain tax benefits for an ‘Industrial Company’ as such term is defined in the Industry Encouragement Law. An Industrial Company is entitled to certain tax benefits including, inter alia, amortization over an eight-year period of the cost of purchased know-how, patents and accelerated depreciation rates on equipment and buildings. Results of Operations The following tables set forth our consolidated statements of income for the years ended December 31, 2022 and 2021 . We have derived this data from our consolidated financial statements included elsewhere in this Annual Report. This information should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report. The results of historical periods are not necessarily indicative of the results of operations for any future period. 47 Comparison of year ended December 31, 2022 and year ended December 31, 2021 Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Revenues $ 3,110,279 $ 1,963,865 $ 1,146,414 $ 58.4 % Cost of revenues 2,265,631 1,334,547 931,084 69.8 % Gross profit 844,648 629,318 215,330 34.2 % Operating expenses: Research and development 289,814 219,633 70,181 32.0 % Sales and marketing 159,680 119,000 40,680 34.2 % General and administrative 112,496 82,196 30,300 36.9 % Goodwill impairment and other operating expenses, net 116,538 1,350 115,188 8,532.4 % Total operating expenses 678,528 422,179 256,349 60.7 % Operating income 166,120 207,139 (41,019 ) (19.8 ) % Financial income (expense), net 3,316 (19,915 ) 23,231 (116.7 )% Other income 7,719 — 7,719 100.0 % Income before income taxes 177,155 187,224 (10,069 ) (5.4 ) % Income taxes 83,376 18,054 65,322 361.8 % Net income $ 93,779 $ 169,170 $ (75,391 ) $ (44.6 ) % Revenues Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Revenues $ 3,110,279 $ 1,963,865 $ 1,146,414 58.4 % Revenues increased by $1,146.4 million, or 58.4%, in the year ended December 31, 2022, as compared to the year ended December 31, 2021, primarily due to (i) an increase of $615.5 million related to the number of inverters and power optimizers sold, with significant growth in revenues coming from Europe and the U.S.; and (ii) an increase of $409.6 million related to the number of residential batteries sold mainly in Europe and in the U.S. Revenues from outside of the U.S. comprised 63.5% of our revenues in the year ended December 31, 2022 as compared to 60.0% in the year ended December 31, 2021. The number of power optimizers recognized as revenues increased by approximately 5.1 million units, or 27.4%, from approximately 18.6 million units in 2021 to approximately 23.7 million units in 2022. The number of inverters recognized as revenues, increased by approximately 226.2 thousand units, or 28.7%, from approximately 788.4 thousand units in 2021 to approximately 1,014.6 thousand units in 2022 . Our blended Average Selling Price or ASP per watt for solar products excluding residential batteries is calculated by dividing solar revenues, excluding revenues from the sale of residential batteries, by the nameplate capacity of inverters shipped. Our blended ASP per watt for solar products shipped decreased by 0.008 , or 3.3% , in 2022 as compared to 2021 . The decrease in blended ASP per watt is mainly attributed to the depreciation of the Euro and other currencies against the U.S. Dollar, which, coupled with our increased sales in Europe, accelerated this effect, as well as the increase in the sale of commercial products in Europe and the U.S., out of our total solar product mix that is characterized with lower ASP per watt. This decrease in blended ASP per watt was partially offset by price increases that went into effect gradually during the second half of 2021 and continued in 2022, as well as a relatively higher number of other solar products shipped compared to the number of inverters shipped, which increased our total solar revenues, but did not impact the watt amount used for calculating the ASP per watt. Our blended ASP per hour watt for residential batteries is calculated by dividing residential batteries revenues, by the nameplate capacity of residential batteries shipped. Our blended ASP per watt for residential batteries in 2022 was 0.479. 48 Cost of Revenues and Gross Profit Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Cost of revenues $ 2,265,631 $ 1,334,547 $ 931,084 69.8 % Gross profit $ 844,648 $ 629,318 $ 215,330 34.2 % Cost of revenues increased by $931.1 million , or 69.8% , in 2022 as compared to 2021 , primarily due to: • an increase in the volume of products sold and the increase in the cost of components used in the manufacturing of our products; • a significant increase in shipment and logistic costs in an aggregate amount of $124.0 million due to (i) an increase in volume shipped; (ii) an increase in air and expedited shipments; and (iii) an increase in the shipment rates throughout 2022 that was partially offset by a decrease in shipment rates which began in the fourth quarter of 2022; • an increase in other production costs of $89.0 million, which is mainly attributed to charges from our contract manufacturers, due to manufacturing disruptions related to global supply constraints, increased logistics costs resulting from transportation disruptions, mobilization of components between our different manufacturing sites in order to allow for continuous manufacturing, as well as ramp up costs associated with our new contract manufacturing site in Mexico and Sella 2, our Li-Ion battery cell manufacturing facility located in South Korea; • an increase in warranty expenses and warranty accruals of $88.6 million . associated primarily with an increased number of products in our install base, as well as an increase in costs related to the different elements of our warranty expenses, which include the cost of the products, shipment and other related expenses; • an increase in personnel-related costs of $22.4 million , related to the expansion of our production, operations, and support headcount, which grew in parallel to our growing install base worldwide, our new contract manufacturing site in Mexico and the completion of our lithium-ion cell and battery factory in Korea, known as "Sella 2"; and • an increase in customs duties of $17.2 million attributed to the increase in volumes of products manufactured in China for the U.S. market. 49 Gross profit as a percentage of revenue decreased from 32.0% in 2021 to 27.2% in 2022 , as a result of the above detailed analysis. Operating Expenses: Research and Development Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Research and development $ 289,814 $ 219,633 $ 70,181 32.0 % Research and development costs increased by $70.2 million or 32.0% , in 2022 compared to 2021 , primarily due to: • an increase in personnel-related costs of $53.0 million resulting from an increase in our research and development headcount, as well as salary expenses associated with annual merit increases and em ployee stock-based compensation. The increase in headcount reflects our continuing investment in enhancements of existing products, as well as research and development expenses associated with bringing new products to the market; • an increase in expenses related to overhead costs in the amount of $6.6 million ; • an increase in depreciation expenses of property and equipment in the amount of $4.2 million ; • a decrease in reimbursement of costs, in the amount of $4.2 million , related to the research and development activities performed by SolarEdge e-Mobility; and • an increase in expenses related to material consumption in the manufacturing of prototypes during our development process in the amount of $2.4 million . These increases were partially offset by a decrease in expenses related to consultants and sub-contractors in the amount of $3.7 million. Sales and Marketing Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Sales and marketing $ 159,680 $ 119,000 $ 40,680 34.2 % Sales and marketing expenses increased by $40.7 million , or 34.2% , in 2022 compared to 2021 , primarily due to: • an increase in personnel-related costs of $28.6 million, as a result of an increase in headcount supporting our growth in all geographies, as well as salary expenses associated with annual merit increases and employee stock-based compensation; • an increase in expenses related to marketing activities of $4.8 million; and • an increase in expenses related to travel in the amount of $2.7 million. 50 General and Administrative Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) General and administrative $ 112,496 $ 82,196 $ 30,300 36.9 % General and administrative expenses increased by $30.3 million , or 36.9% , in 2022 compared to 2021 , primarily due to: • an increase in personnel-related costs of $22.7 million resulting from an increase in our general and administrative headcount, as well as salary expenses associated with annual merit increases and employee stock-based compensation; • an increase in expenses related to consultants and sub-contractors in the amount of $7.3 million; and • an increase in expenses related to overhead costs in the amount of $2.4 million. These increases were partially offset by a decrease of $5.6 million related to a provision for legal claims. Goodwill impairment and other operating expenses, net Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Goodwill impairment and other operating expenses, net $ 116,538 $ 1,350 $ 115,188 8,532.4 % Goodwill impairment and other operating expenses, net were $116.5 million in 2022, compared to $1.4 million in 2021, primarily due to: • an increase in the amount of $90.1 million attributed to a goodwill impairment charge related to three reporting units: e-Mobility, Automation Machines and Critical Power ; and • an increase of $28.4 million attributed to the impairment of intangible assets, mainly related to the technology of the e-Mobility asset group, as well as the impairment of the related intangible assets of the Critical Power asset group, due to the discontinuation of its activities. These were partially offset by an increase of $2.6 million in income related to selling of Critical Power assets and property, plant and equipment. 51 Financial income (expenses), net Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Financial income (expense), net $ 3,316 $ (19,915 ) $ 23,231 (116.7 )% Financial income, net was $3.3 million in 2022 compared to financial expenses, net of $19.9 million in 2021, primarily due to: • a decrease of $20.9 million in financial expenses resulted from foreign exchange fluctuations, mainly between each of the Euro, the New Israeli Shekel and the South Korean Won against the U.S. dollar; and • an increase of $7.6 million in interest income and accretion (amortization) of discount (premium) on marketable securities. These were partially offset by a decrease of $4.7 million in financial income related to hedging transactions. Other income Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Other income $ 7,719 $ — $ 7,719 100.0 % Other income increased by $7.7 million , or 100.0% , in 2022 compared to 2021 due to the sale of our investment in a privately-held company. Income taxes Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Income taxes $ 83,376 $ 18,054 $ 65,322 361.8 % Income taxes increased by $65.3 million , or 361.8% , in 2022 as compared to 2021 , primarily due to: • an increase of $51.4 million of current tax expenses mainly attributed to the change to Section 174 of the U.S Internal Revenue Code, as well as impairment of goodwill and intangible assets, higher non-deductible expenses and lower tax benefits relating to stock-based compensation. The change to Section 174, which became effective on January 1, 2022, eliminates the option to deduct research and development expenditures as expensed and requires taxpayers to amortize them over five years (if generated from a U.S. entity) and fifteen years (if generated from non-U.S. entities). • an increase of $13.3 million in prior years taxes income; and • a decrease of $0.6 million in deferred tax income. 52 Net Income Year ended December 31, 2021 to 2022 2022 2021 Change (In thousands) Net income $ 93,779 $ 169,170 $ (75,391 ) (44.6 ) % As a result of the factors discussed above, net income decreased by $75.4 million , or 44.6 % in 2022 as compared to 2021 . Liquidity and Capital Resources The following table shows our cash flows from operating activities, investing activities, and financing activities for the stated periods : Year ended December 31, 2022 2021 (In thousands) Net cash provided by operating activities $ 31,284 $ 214,129 Net cash used in investing activities (417,044 ) (484,211 ) Net cash provided by (used in) financing activities 654,607 (15,178 ) Increase (decrease) in cash, cash equivalents and restricted cash $ 268,847 $ (285,260 ) As of December 31, 2022, our cash and cash equivalents were $783.1 million. This amount does not include $886.6 million invested in available for sale marketable securities, $0.5 million invested in short-term restricted bank deposits and $1.4 million invested in long-term restricted bank deposits. Our principal uses of cash are for funding our operations, capital expenditures, other working capital requirements and other investments. As of December 31, 2022, we have open commitments for capital expenditures in the amount of approximately $74.0 million. These commitments reflect purchases of automated assembly lines and other machinery related to our manufacturing operations. We also have purchase obligations in the amount of $1,590.2 million related to raw materials and commitments for the future manufacturing of our products. We believe that cash provided by operating activities, as well as our cash and cash equivalents and available for sale marketable securities, will be sufficient to meet our anticipated cash needs for at least the next 12 months as well as in the longer term, including the self-funding of our capital expenditure and operational commitments. 53 Operating Activities Cash provided by operating activities consists of net income adjusted for certain non-cash items and changes in assets and liabilities. Cash provided by operating activities decreased by $182.8 million in 2022 as compared to 2021 , mainly due to unfavorable changes in working capital and lower net income in 2022 compared to the prior year . Investing Activities Investing cash flows consist primarily of capital expenditures, investment in, sales and maturities of available for sale marketable securities, investment and withdrawal of bank deposits and restricted bank deposits, cash used for acquisitions and cash provided by the sale of equity investments . Cash used for investing activities decreased by $67.2 million in 2022 as compared to 2021 , primarily driven by a $72.2 million decrease in purchases of available-for-sale debt investments, an increase of $29.0 million in sales and maturities of available-for-sale debt investments, $16.6 million decrease in an investment in a privately-held company and $24.4 million increase from sale of an investment in a privately-held company. This increase was partially offset by a $61.1 million decrease in cash provided by bank deposits and restricted bank deposits and an increase of $20.1 million in capital expenditures. Financing Activities Financing cash flows consisted primarily of the issuance and repayment of short-term and long-term debt , proceeds from the sale of shares of common stock in a public offering and employee equity incentive plans . Cash provided by financing activities in 2022 was $654.6 million compared to $15.2 million cash used in financing activities in 2021 , primarily due to a $650.5 million increase in cash provided by the issuance of common stock, net through a secondary public offering, and a decrease of $15.9 million in repayment of bank loans. Convertible Senior Note On September 25, 2020, we issued $632.5 million aggregate principal amount of our Convertible Senior Notes or Notes in a transaction exempt from registration pursuant to Rule 144A and Regulation S under the Securities Act. Net proceeds from the offering, after underwriters’ discount and commissions and offering expenses, was $617.9 million. We intend to use the proceeds of the Notes for general corporate purposes (see Note 16 to our annual financial statements for more information). Secondary public offering On March 17, 2022, we offered and sold 2,300,000 shares of the Company’s common stock at a public offering price of $295.00 per share. The net proceeds to the Company after underwriters' discounts and commissions and offering costs were $650,526. We intend to use the proceeds from the public offering for general corporate purposes, which may include acquisitions (see Note 18b to our consolidated financial statements for more information). Critical Accounting Policies and Significant Management Estimates We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the U.S. (“GAAP”). The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain (see Note 2 to our annual financial statements for more information). 54 Revenue Recognition We generate revenues from the sale of DC optimized inverter systems for solar PV installations which include our power optimizers, inverters, and cloud-based monitoring platform as well as other solar related products, Lithium-ion cells, batteries, energy storage solutions, EV powertrain solutions and machinery. Our worldwide customer base includes large solar installers, distributors, EPCs, PV module manufacturers, utility companies and other customers. Our products are fully functional at the time of shipment to the customer and do not require production, modification, or customization with the exception of some ESS systems that require installation and commissioning. We recognize revenue under the core principle that transfer of control to the customers should be depicted in an amount reflecting the consideration we expect to receive in revenue. In order to achieve that core principle, we apply the following five-step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when a performance obligation is satisfied. Provisions for rebates, sales incentives, and discounts to customers are accounted for as reductions in revenue in the same period that the related sales are recorded. We generally sell our products to our customers pursuant to a customer’s standard purchase order and our customary terms and conditions. We do not offer rights to return our products other than for normal warranty conditions, and as such, revenue is recognized based on the transfer of control, which includes but is not limited to, the agreed International Commercial terms. We evaluate the creditworthiness of our customers to determine that appropriate credit limits are established prior to the acceptance and shipment of an order. We provide our full web-based monitoring platform for our solar products free of charge and revenues associated with the service since that date are being recognized ratably over 25 years. In the absence of third party comparable pricing for such service, management determines the revenue levels of this service based on the costs associated with providing the service plus appropriate margins that reflect management’s best estimate of the selling price. These revenues are minimal and we do not expect this to become a significant source of revenue in the near future. We recognize financing component expenses in our consolidated statement of income in relation to advance payments for performance obligations that extend for a period greater than one year. These financing component expenses are reflected in our deferred revenues balance. Such performance obligations are those that include a financing component, specifically: (i) warranty extension services, (ii) cloud-based monitoring, and (iii) communication services. See Notes 2 u and 14 to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to revenue recognition. Product Warranty We provide a standard limited product warranty for our solar products against defects in materials and workmanship under normal use and service conditions. Our standard warranty period is 25 years for our power optimizers, 12 years for our inverters, 10 years for our storage interface and a 10-year limited warranty for our residential batteries . Other products are sold with standard limited warranties that typically range in duration from one to ten years, and in some cases for a longer period. In certain cases, customers can purchase an extended warranty for our battery storage products that extend the standard warranty period. In addition, customers can purchase extended warranties for inverters that extend the warranty period to up to 25 years. 55 Our products are designed to meet the warranty periods and our reliability procedures cover component selection, design, accelerated life cycle tests, and end-of-manufacturing line testing. However, since our history in selling power optimizers and inverters i s shorter than the warranty period , the calculation of warranty provisions is inherently uncertain. We accrue for estimated warranty costs at the time of sale based on anticipated warranty claims and actual historical warranty claims experience. Warranty provisions, computed on a per-unit sold basis, are based on our best estimate of such costs and are included in our cost of revenues. The warranty obligation is determined based on actual and predicted failure rates of the products, cost of replacement and service and delivery costs incurred to correct a product failure. Our warranty obligation requires management to make assumptions regarding estimated failure rates and replacement costs. In order to predict the failure rate of each of our products, we have established a reliability model based on the estimated mean time between failures (“MTBF”). The MTBF represents the average elapsed time predicted for each product unit between failures during operation. Applying the MTBF failure rate over our install base for each product type and generation allows us to predict the number of failed units over the warranty period and estimates the costs associated with the product warranty. Predicted failure rates are updated periodically based on data returned from the field and new product versions, as are replacement costs which are updated to reflect changes in our actual production costs for our products, subcontractors’ labor costs, and actual logistics costs. Since the MTBF model does not take into account additional non-systematic failures, such as failures caused by workmanship or manufacturing or design-related issues, and since warranty claims are at times opened for cases in which the error has been triggered by an improper installation, we have developed a supplemental model to predict such cases and recognize the associated expenses ratably over the expected claim period. This model, which is based on actual root cause analysis of returned products, identification of the causes of claims and time until each identified problem is revealed, allows us to better predict actual warranty expenses and is updated periodically based on our experience, taking into account the installed base of approximately 107.5 million power optimizers and approximately 4.5 million inverters as of December 31, 2022 . If actual warranty costs differ significantly from these estimates, adjustments may be required in the future, which could adversely affect our gross profit and results of operations. Warranty obligations are classified as short-term and long-term warranty obligations, based on the period in which the warranty is expected to be claimed. The warranty provision (short and long-term) was $385.1 million and $265.2 million , in the year ended December 31, 2022 and 2021 , respectively. See Notes 2 w and 13 "Warranty obligations" to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to product warranty. Inventory Valuation Our inventories comprise sellable finished goods, raw materials bought for own manufacturing or on behalf of our contract manufacturers, and faulty units returned under our warranty policy. Sellable finished goods and raw material inventories are valued at the lower of cost or net realizable value, based on the moving average cost method. Certain factors could affect the realizable value of our inventories, including market and economic conditions, technological changes, existing product changes (mainly due to cost reduction activities) and new product introductions. We consider historic usage, expected demand, anticipated sales price, the effect of new product introductions, product obsolescence, product merchantability, and other factors when evaluating the net realizable value of inventories. Inventory write-downs are equal to the difference between the cost of inventories and their estimated net realizable value. Inventory write-downs are recorded as cost of revenues in the accompanying statements of income and were $10.2 million and $7.1 million , in the year ended December 31, 2022 and 2021, respectively . 56 Faulty products returned under our warranty policy are often refurbished and used as replacement units. Such products are written off upon receipt. We do not believe that there is a reasonable likelihood that there will be a material change in future estimates or assumptions that we use to record inventory at the lower of cost or net realizable value. However, if estimates regarding customer demand are inaccurate or changes in technology affect demand for certain products in an unforeseen manner, we may be exposed to losses that could be material. See Notes 2 j and Note 4 to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to inventory valuation. Business Combination We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair value. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require our management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired technology and other intangible assets, their useful lives and discount rates. Our management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. See Note 2 n "Business Combination" to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to business combination. Intangible and other long-lived assets We evaluate the recoverability of finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. During the year ended December 31, 2022, we recorded impairment charge of $28.4 million mainly related to technology within the e-Mobility asset group and intangible assets within the Critical Power asset group. Acquired identifiable finite-lived intangible assets are amortized on a straight-line basis or accelerated method over the estimated useful lives of the assets. We believe the basis of amortization approximates the pattern in which the assets are utilized, over their estimated useful lives. We routinely review the remaining estimated useful lives of finite-lived intangible assets. In case we reduce the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. See Notes 2. o and 8 to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to intangible assets. 57 Goodwill Goodwill reflects the excess of the consideration transferred, including the fair value of any contingent consideration and any non-controlling interest in the acquiree, over the assigned fair values of the identifiable net assets acquired. Goodwill is not amortized, and is assigned to reporting units and tested for impairment at least on an annual basis. The goodwill impairment test is performed according to the following principles: (1) An initial qualitative assessment may be performed to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. (2) If the Company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying mount, a quantitative fair value test is performed. An impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value is recognized. We complete the required annual testing of goodwill impairment for the reporting units in the fourth quarter of each year and accordingly, determines whether goodwill should be impaired. The Company recorded impairment charges of goodwill during the year 2022 in the amount of $90,104 , related to the e-Mobility, Automation Machines and Critical Power reporting units. See Notes 2 q and 9 to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to goodwill. Income taxes We account for income taxes in accordance with ASC 740, “Income Taxes.” ASC 740, which prescribes the use of the liability method, whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and tax basis of assets and liabilities, and are measured using the enacted tax rates that will be in effect when the differences are expected to reverse. We account for uncertain tax positions in accordance with ASC 740-10 two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% (cumulative probability) likely to be realized upon ultimate settlement. See Note 2 af to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to income taxes.