The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the sections of this Annual Report on Form 10-K captioned "Selected Financial Data" and "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 forwardlooking statements that involve risks, uncertainties, and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forwardlooking statements as a result of many factors, including those discussed under the sections of this Annual Report captioned "Special Note Regarding ForwardLooking Statements" and "Risk Factors".
Overview
Established in 2006, we developed a DC optimized inverter solution that changed the way power is harvested and managed in photovoltaic, known as PV systems. Our direct current, or DC optimized inverter system maximizes power generation while lowering the cost of energy produced by the PV system, for improved return on investment, or RoI. Additional benefits of the DC optimized inverter system include providing comprehensive and advanced safety features, improved design flexibility, and improved operating and maintenance, or O&M with module-level and remote monitoring. The typicalSolarEdge optimized inverter system consists of our inverters, power optimizers, a communication device which enables access to a cloud based monitoring platform and in many cases, additional smart energy management solutions. Our solutions address a broad range of solar market segments, from residential solar installations to commercial and small utilityscale solar installations. Since we began commercial shipments in 2010, we have shipped approximately 16.2 gigawatts ("GW") of our DC optimized inverter systems and our products have been installed in solar PV systems in 133 countries. Since introducing the optimized inverter solution in 2010,SolarEdge has expanded its activity to other areas of smart energy technology, both through organic growth and through acquisitions. By leveraging world-class engineering capabilities and with a relentless focus on innovation,SolarEdge now offers energy solutions which include not only residential, commercial and large scale PV systems but also product offerings in the areas of energy storage systems, or ESS, and backup, electric vehicle, or EV components and charging capabilities, home energy management, grid services and virtual power plants, lithium-ion batteries and uninterrupted power supply, known asUPS solutions. We are a leader in the global module-level power electronics market according to IHS and as ofDecember 31, 2019 , we have shipped approximately 49.9 million power optimizers and 2.1 million inverters. More than 1.38 million installations, many of which may include multiple inverters, are currently connected to, and monitored through, our cloudbased monitoring platform. As ofDecember 31, 2019 , we have shipped approximately 16.2 GW of our DC optimized inverter systems. We primarily sell our products directly to large solar installers, EPCs, and indirectly to thousands of smaller solar installers through large distributors and electrical equipment wholesalers. Our sales strategy focuses on toptier customers in markets where electricity prices, irradiance (amount of sunlight), and government policies make solar PV installations economically viable. We also sell our power optimizers to several PV module manufacturers that offer PV modules with our power optimizer physically embedded into their modules. In the year endedDecember 31, 2019 , one customer accounted for 20.4% of our revenues and our top three customers (all distributors) together represented 35.4% of our revenues. Today, we address a broad range of energy market segments through our diversified product offering, including residential, commercial and large scale PV, energy storage and backup solutions, e-Mobility, home energy management, grid services and virtual power plants, batteries and uninterrupted power supply (UPS) solutions.
Our revenues were
We continue to focus on our longterm growth and profitability. We believe that our market opportunity is large and that the transition from traditional inverter architecture to DC optimized inverter architecture will continue as the architecture of choice for distributed solar installations globally. We believe that we are well positioned to benefit from this market trend. Additionally, we are expanding our offering with products such as storage inverters for increased self-consumption and backup, EV-charging inverters, smart meters, smart energy devices (sockets, water heater controllers, wireless relay), aimed to increase our average revenue per installation (ARPI). We intend to continue to invest in sales and marketing to acquire new customers in our existing markets and in adjacent markets, grow internationally and drive additional revenue. We aim to increase market share in the C&I segment and penetrate the utility segment through specialized product development. We expect to continue to invest in research and development to enhance our product offerings and develop new, cost-effective solutions. We believe that our strategy for continued growth in the solar market results in an efficient operating base with relatively low expenses that will enable profitability on lower revenues relative to our competitors. We believe that our sales and marketing, research and development, and general and administrative costs will decrease as a percentage of revenue in the longterm as we continue to grow due to economies of scale. With this increased operating leverage, we expect our gross and operating margins to increase in the long-term. With respect to our penetration of non-solar businesses in which we have invested, we expect that we will need to make significant research and development, sales and marketing investments before making those businesses profitable.
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 yearly shipments (inverters shipped, power optimizers shipped, and megawatts shipped) to evaluate our sales performance and to track market acceptance of our products from year to year. We use metrics relating to monitoring (systems monitored and megawatts monitored) to evaluate market acceptance of our products and usage of our solution. 35
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We provide the "megawatts shipped" metric, which is calculated based on nameplate capacity shipped, to show adoption of our system on a nameplate capacity basis. Nameplate capacity shipped is the maximum rated power output capacity of an inverter and corresponds to our financial results in that higher total capacities shipped are generally associated with higher total revenues. However, revenues increase with each additional unit, not necessarily each additional MW of capacity, sold. Accordingly, we also provide the "inverters shipped" and "power optimizers shipped" operating metrics.
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, EV chargers, smart energy devices, our cloudbased monitoring platform as well as grid services. Our customer base mainly includes distributors, large solar installers, wholesalers, EPCs, and PV module manufacturers. In addition, following our recent acquisitions, we also generate revenues from the sale of lithium-ion cells, batteries and energy storage solutions,UPS systems, machinery 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, enduser government incentives, seasonality, and competitive product offerings. Revenues from the sale of Kokam's 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 ofUPS products and SMRE products are affected by the changes in the volumes, customers' size and average selling prices of the products 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.
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 test and manufacturing equipment, hosting services for our cloudbased 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 test and manufacturing equipment, are not directly affected by sales volume.
With respect to Li-Ion batteries, cost of revenues consists primarily of materials costs, labor costs associated with the manufacturing, variable utility, and operational costs related to the cell and battery factories, depreciation and other fixed costs.
Except for the manufacturing and assembly activities related to our newly acquired businesses, we outsource our manufacturing to thirdparty manufacturers and negotiate product pricing on a quarterly basis. Our thirdparty manufacturers are responsible for funding the capital expenses incurred in connection with the manufacture of our products, except with regard to end-of-line testing equipment and the automated assembly lines for our power optimizers and the equipment for the manufacturing of sub-assemblies, as further described below (which resulted in capital expenditures of$13.6 million ,$9.0 million and$23.2 million for the year endedDecember 31, 2017 , the year endedDecember 31, 2018 , and the year endedDecember 31, 2019 respectively). We expect to continue this funding arrangement in the future, with respect to any expansions to such existing lines. We also procure strategic and critical components from various approved vendors on behalf of our contract manufacturers. In fiscal 2019, higher than anticipated demand for our solar products has exceeded the production capacities of these manufacturers and we were required to use air freight, rather than less expensive ocean freight, to deliver the majority of our products. The expansion of current manufacturing sites by our contract manufacturers as well as our own manufacturing site, is anticipated to allow us to reduce these expenses in 2020 as well as to build sufficient inventory to continue our growth without the need to ship substantial amounts of products by air. 36
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In 2017, 2018 and 2019 global shortages in power components used in our products and in other industries, such as electrical motor drives and uninterrupted power systems (UPS) caused disruptions to our ongoing manufacturing. This phenomenon combined with increased demand for our products required us to use expensive air shipments in order to meet our delivery schedule, which negatively affected our gross profit. We expect component shortages to continue to affect us in upcoming quarters, a combination of increased component safety stocks, qualification of additional suppliers, and increased capacity of our existing vendors coupled with continued expansion of the current manufacturing sites by our contract manufacturers, and the development and deployment of our proprietary automated assembly line (described below), will provide sufficient manufacturing capacity to meet our forecasted demands with lower shipment volumes of products by air freight. We completed development and manufacturing our proprietary automated assembly lines for our power optimizers. Additionally, we manufacture sub-assemblies such as cables, and magnetics and own significant amounts of equipment in connection with such manufacturing activities. 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 future automated assembly lines. The current and expected capital expenses associated with these automated assembly lines will be funded out of our cash flows generation. Key components of our logistics supply channel consist of third party distribution centers in theU.S. ,Europe ,Australia , andJapan . 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 and support department costs. The operations department is 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 fulltime employee headcount in our operations, production and support departments has grown from 348 as ofDecember 31, 2017 to 663 as ofDecember 31, 2018 and to 1,031 as ofDecember 31, 2019 .
Part of the increase in our cost of revenues is derived from an increase in
tariffs on Chinese made products sold in the
Gross profit may vary from quarter to quarter and is primarily affected by our average selling prices, product costs, product mix, customer mix, geographical mix, shipping method, warranty costs, and seasonality.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, general and administrative and other expenses. Personnelrelated costs are the most significant component of each of these expense categories and include salaries, benefits, payroll taxes, commissions and stockbased compensation. Our fulltime employee headcount in our research and development, sales and marketing, and general and administrative departments has grown from 660 as ofDecember 31, 2017 to 1,074 to as ofDecember 31, 2018 and to 1,400 as ofDecember 31, 2019 . 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.
Research and development expenses
Research and development expenses include personnelrelated expenses such as salaries, benefits, stockbased 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 thirdparty design and consulting costs, materials for testing and evaluation, ASIC development and licensing costs, depreciation expense, 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. 37
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Sales and marketing expenses
Sales and marketing expenses consist primarily of personnelrelated expenses such as salaries, sales commissions, benefits, payroll taxes, and stockbased 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. The expected increase in sales and marketing expenses is due to an expected increase in the number of sales and marketing personnel and the expansion of our global sales and marketing footprint, enabling us to increase our penetration of new markets. In the year endedDecember 31, 2019 , 38.2% of our revenues were generated fromEurope , 47.6% of our revenues are generated from theUSA and 14.2% of our revenues are generated from ROW. In the year endedDecember 31, 2018 , 32% of our revenues were generated fromEurope , 53.9% of our revenues are generated from theUSA and 14.1% of our revenues were generated from ROW. In the year endedDecember 31, 2017 , 32.7% of our revenues were generated fromEurope , 57.5% of our revenues were generated from theUSA and 9.8% of our revenues were generated from ROW. We currently have a sales presence in theU.S. ,Canada ,France ,Germany ,Italy ,the Netherlands , theUnited Kingdom ,Israel ,Turkey ,Japan ,Australia ,China ,Sweden ,Poland ,India ,Belgium ,Korea ,Brazil andTaiwan . We intend to continue to expand our sales presence to additional countries.
General and administrative expenses
General and administrative expenses consist primarily of salaries, employee benefits, and stockbased 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 allowance for doubtful accounts in the event of uncollectable account receivables balances.
Other expenses
Other expenses consist primarily of losses related to the sale of an SMRE subsidiary originally acquired as part of the SMRE Acquisition, stockbased compensation related to the untimely death of Mr.Guy Sella , our Founder, who had served as CEO and Chairman of the Board of Directors until shortly before his passing OnAugust 25, 2019 , modification of PSUs terms originally granted as part of the SMRE Acquisition and a legal claim acquired as part of the Kokam Acquisition which was settled in arbitration.
Non-Operating Expenses
Financial income (expenses)
Financial income (expenses) 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.
Interest expense consists of interest related to loans taken by Kokam and SMRE, advance payments received for performance obligations that extend for a period greater than one year, as part of the adoption of Accounting Standard Codification 606, "Revenue from Contracts with Customers" (ASC 606) and interest related to the adoption of Accounting Standard Codification 842, "Leases" (ASC 842). Our functional currency is theU.S. Dollar. With respect to certain of our subsidiaries, the functional currency is the applicable local currency. Financial expenses, net is net of financial income which consists primarily of the effect of foreign exchange differences between theU.S. Dollar and the New Israeli Shekel, the Euro, the Korean Won and other currencies, related to our monetary assets and liabilities, and the realization of gain from hedging transactions.
Taxes on income
We are subject to income taxes in the countries where we operate.
In the year endedDecember 31, 2017 , we recorded net income tax expenses of$19.8 million for federal and state tax in theU.S. , which consists of$19.9 million current income tax expenses and$0.1 million deferred tax. In the year endedDecember 31, 2018 , we recorded net income tax expenses of$12.6 million for federal and state tax in theU.S. , which consists of$13.9 million current income tax expenses and$1.3 million deferred tax benefit. In the year endedDecember 31, 2019 , we recorded net income tax expenses of$6.7 million for federal and state tax in theU.S. , which consists of$10.1 million current income tax expenses and$3.4 million deferred tax benefit. 38
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OnDecember 22, 2017 , the Tax Cuts and Jobs Act (the "Tax Act") was signed into law making significant changes toU.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, created new taxes on certain foreign-sourced earnings and certain related-party payments. Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our consolidated financial statements as ofDecember 31, 2017 . As we collected and prepared necessary data, and interpreted the additional guidance issued by theU.S. Treasury Department , theIRS , and other standard-setting bodies, we made adjustments, over the course of 2018, to the provisional amounts including refinements to deferred taxes. The accounting for the tax effects of the Tax Act was completed as ofDecember 31, 2018 . The Tax Act required us to payU.S. income taxes on accumulated foreign subsidiary earnings not previously subject toU.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 Company has elected to pay its transition tax over an eight-year period as provided in the Tax Act.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. Amendments of the Israeli Income Tax Ordinance (New Version), 1961 (the "Tax Ordinance") decreased the corporate tax rate to 23% command 24% startingJanuary 1, 2018 . 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. Income not eligible for Benefited Enterprise benefits is taxed at the then prevailing regular corporate tax rate. Upon meeting the requirements under the Israeli Investments Law, income derived from productive activity under the Benefited Enterprise status, would subject to certain terms and limits, will be exempt from tax for two years from the year in which the Israeli subsidiary first generated taxable income. BecauseSolarEdge Technologies Ltd. utilized all of its losses carryforwards in the six months ended inDecember 31, 2016 , and as it was granted an approval by the Israeli Tax Authorities ("ITA") in this regard, the two-year tax exemption has ended onDecember 31, 2018 . The Investment Law was amended in 2005 and was further amended as ofJanuary 1, 2011 and inAugust 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 for an unlimited period as opposed to the incentives prior to the 2011 Amendment that were limited to income from Approved or Benefited Enterprise during the respective benefits period. According to the 2011 Amendment (considering the rates as amended in the 2017 Amendment as defined herein), the tax rate applicable to such income, referred to as "Preferred Income", would be 7.5% in areas inIsrael that are designated as Development Zone A and 16% elsewhere inIsrael in the year 2017 and thereafter. Under the transitional provisions of the 2011 Amendment, companies may elect to irrevocably implement the 2011 Amendment while waiving benefits provided under the legislation prior to the 2011 Amendment or keep implementing the legislation prior to the 2011 Amendment. InDecember 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 theIsraeli Ministry of Finance . A Technological Preferred Enterprise, as defined in the 2017 Amendment, that is located in the central region ofIsrael , will be subject to tax at a rate of 12% on profits deriving from intellectual property (in Development Zone A - a tax rate of 7.5%). 39
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OnJune 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 and determine certain requirements relating to documentation of intellectual property for the purpose of the PTE. According to these provisions, 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 determined in the Investments Law), excluding certain portion of income as prescribed therein. As ofJanuary 2019 ,SolarEdge Technologies Ltd. elected to implement the 2011 and 2017 Amendments, starting as of tax year 2019. Under the PTE regime with respect to our business activities inIsrael we expect thatSolarEdge Technologies Ltd. will be entitled to an effective tax at a rate of 12.3%.
Our production facilities in
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. AnIndustrial Company is entitled to certain tax benefits including, inter alia: (i) amortization over an eight-year period of the cost of purchased know-how and patents and rights to use a patent and know-how which are used for the development or advancement of the company; and (ii) accelerated depreciation rates on equipment and buildings. Eligibility for benefits under the Industry Encouragement Law is not subject to receipt of prior approval from any governmental authority. We believe that our Israeli subsidiary currently qualifies as anIndustrial Company ; however, there can be no assurance that it will continue to so qualify or that the benefits described above will be available to it in the future. Furthermore, the ITA may determine that we do not qualify as anIndustrial Company , which could entail a loss of the benefits that relate to that status. Israeli tax law (Section 20A of the Tax Ordinance) allows, under certain conditions, a tax deduction for certain research and development expenses as prescribed in the Tax Ordinance for the year in which they are paid, subject to appropriate approval by the relevant Israeli government ministry, determined by the field of research. Expenses incurred in scientific research that are not approved by the relevant Israeli government ministry will be deductible over a three-year period commencing from the tax year in which they are paid. Our Israeli subsidiary did not obtain to date such approval.
Results of Operations
The following tables set forth our consolidated statements of operations for the years endedDecember 31, 2017 , 2018 and 2019. 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 this Annual Report. The results of historical periods are not necessarily indicative of the results of operations for any future period.
Comparison of year ended
Year ended December 31, 2018 to 2019 2018 2019 Change (In thousands) Revenues$ 937,237 $ 1,425,660 $ 488,423 52.1 % Cost of revenues 618,001 946,322 328,321 53.1 % Gross profit 319,236 479,338 160,102 50.2 % Operating expenses: Research and development 82,245 121,351 39,106 47.5 % Sales and marketing 68,307 87,984 19,677 28.8 % General and administrative 29,264 49,361 20,097 68.7 % Other operating expenses - 30,696 30,696 N/A Total operating expenses 179,816 289,392 109,576 60.9 % Operating income 139,420 189,946 50,526 36.2 % Financial expenses 2,297 11,343 9,046 393.8 % Income before taxes on income 137,123 178,603 41,480 30.3 % Taxes on income 9,077 33,646 24,569 270.7 % Net income$ 128,046 $ 144,957 $ 16,911 13.2 % Net loss attributable to Non-controlling interests 787 1,592 805 102.3 % Net income attributable to SolarEdge Technologies Inc.$ 128,833 $ 146,549 $ 17,716 13.8 % 40
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Revenues Year Ended December 31, 2018 to 2019 2018 2019 Change (In thousands) Revenues$ 937,237 $ 1,425,660 $ 488,423 52.1 % Revenues increased by$488.4 million , or 52.1%, in 2019 as compared to 2018 primarily due to (i) an increase in the number of inverters and power optimizers sold, with significant growth in revenues coming fromEurope , theU.S. andIsrael ; (ii) price increases on products sold in theU.S. intended to offset the newly imposed tariffs onChina made products; and (iii) revenues from the new businesses we acquired, which includes sales ofUPS units, batteries, storage systems, and products sold by SMRE, in an aggregate amount of$89.0 million in the year endedDecember 31, 2019 , compared to$23.0 million in the year endedDecember 31, 2018 . Revenues from outside of theU.S. comprised 52.4% of our revenues in 2019 as compared to 46.1% in 2018. The number of power optimizers sold increased by approximately 4.3 million units, or 38.2%, from approximately 11.4 million units in 2018 to approximately 15.7 million units in 2019. The number of inverters sold increased by approximately 210,000 units, or 46.3%, from approximately 454,000 units in 2018 to approximately 664,000 units in 2019. In addition, we increased prices in theU.S. in 2019, in order to offset the impact of the increase in tariffs on goods made inChina that became effectiveJune 1, 2019 . This increase in selling prices was partially offset by the devaluation of the Euro and the Australian Dollar compared to theU.S. Dollar, negatively impacting ourU.S. Dollar denominated average selling price ("ASP"). Overall, and primarily due to the factors detailed above, our ASP per watt for units shipped increased by$0.005 , or 2.3%, in 2019 compared to 2018.
Cost of Revenues and Gross Profit
Year Ended December 31, 2018 to 2019 2018 2019 Change (In thousands) Cost of revenues$ 618,001 $ 946,322 $ 328,321 53.1 % Gross profit$ 319,236 $ 479,338 $ 160,102 50.2 % 41
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Cost of revenues increased by
•
an increase in the volume of products sold;
•
increased customs tariffs, shipment and logistics costs of$67.7 million attributed to the change in tariff rates on Chinese made products imported into theU.S. from 10% to 25% as well as an increase in air shipments due to increased product demand which required us to increase manufacturing capacity and expedite shipments for timely delivery;
•
an increase in warranty expenses and warranty accruals of$24.3 million associated primarily with the rapid increase of products in our install base; this increase was partially offset by various cost reductions on the different elements of our warranty expenses which include the cost of the products, shipment and other related expenses;
•
inclusion of variable costs related to the assembly ofUPS products, manufacturing of Kokam and SMRE products in an aggregate amount of$56.9 million in 2019, compared to$19.7 million for 2018 asGamatronic and Kokam were partially represented in our results for the year endedDecember 31, 2018 and SMRE was acquired in January of 2019;
•
an increase in personnel-related costs of$20.4 million related to the expansion of our operations and support headcount which is growing in parallel to our growing install base worldwide and in connection with entering into theUPS , storage, machinery and integrated powertrain technology businesses; and
•
an increase in amortization of intangible assets and cost of product adjustment of$8.3 million related to the Gamatronic Acquisition, the Kokam Acquisition and the SMRE Acquisition;
Gross profit as a percentage of revenue decreased from 34.1% in 2018 to 33.6% in 2019, primarily due to:
• increased shipment and logistics costs resulted from our expedited growth and heavy reliance on air-shipments, new customs tariff rules in theU.S. and an increase in air shipments; • the arithmetic effect from the increase in selling prices in theU.S. intended to offset the increase in tariffs on Chinese made products and the same increase in cost of goods sold as a result of the increased tariffs;
•
lower gross profit from our
•
increased actual support costs related to our warranty obligations; and
•
amortization of intangible assets and cost of product adjustment related to the Gamatronic Acquisition, the Kokam Acquisition and the SMRE Acquisition;
These were partially offset by:
•
general economies of scale in our personnel-related costs and other costs associated with our support and operations departments.
•
increased profit on the units sold due to a combination of stable average selling prices and cost reductions in the manufacturing process of these products; and
•
decreased warranty accruals due to various cost reductions on the different elements of our warranty expenses which include the cost of the products, shipment and other related expenses;
Operating Expenses: Research and Development Year Ended December 31 2018 to 2019 2018 2019 Change (In thousands)
Research and development
Research and development increased by
•
increased personnel-related costs of$31.0 million resulting from an increase in our research and development headcount as well as salary expenses associated with employee equity-based compensation. The increase in headcount reflects the inclusion of personnel costs from acquired businesses as well as our continued investment in enhancements of existing products and research and development expenses associated with bringing new products to the market;
•
increased expenses related to consultants and subcontractors in an amount of
•
increased expenses related to material consumption costs in an amount of
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•
increased expenses related to other overhead costs and other expenses in an
amount of
•
increased expenses related to amortization and depreciation expenses
Sales and Marketing
Year Ended December 31, 2018 to 2019 2018 2019 Change (In thousands) Sales and marketing$ 68,307 $ 87,984 $ 19,677 28.8 %
Sales and marketing expenses increased by
•
increased personnel-related costs of$15.4 million as a result of the inclusion of personnel costs from acquired businesses and an increase in headcount supporting our growth in theU.S. ,Europe andAsia , as well as salary expenses associated with employee equity-based compensation;
•
increased expenses related to other overhead costs and travel expenses in an
amount of
•
increased expenses related to amortization and depreciation expenses in an
amount of
•
increased expenses related to marketing activity in an amount of
•
increased expenses related to external consultants and sub-contractors, material
consumption costs and other expenses in an amount of
General and Administrative
Year Ended December 31, 2018 to 2019 2018 2019 Change (In thousands)
General and administrative
General and administrative expenses increased by
•
increased personnel costs of$10.8 million related to (i) increased headcount resulting from the acquisitions ofGamatronic , Kokam and SMRE and the expansion of our legal, finance, human resources and information technology departments; and (ii) increased expenses related to equity-based compensation and changes in management compensation; •
increased expenses related to consultants and subcontractors in an amount of
•
increased expenses related to other overhead costs, other expenses and travel
costs in an amount of
•
increased expenses related to depreciation expenses and public company related
expenses in an amount of
•
increased expenses related to doubtful debt in an amount of
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Other operating expenses Year Ended December 31, 2018 to 2019 2018 2019 Change (in thousands) Other operating expenses -$ 30,696 $ 30,696 N/A
Other expenses increased by
For the year endedDecember 31, 2019 , we recognized compensation expenses resulting from a modification in PSU terms originally granted as part of the SMRE Acquisition in an amount of$12.2 million . This modification was part of a separation agreement with a former SMRE executive as further detailed in Item 5 - "Purchases ofEquity Securities by the Issuer and Affiliated Purchases". In addition, we recognized the following (i)$8.3 million expense related to payroll, bonus and employees equity-based compensation acceleration related to the untimely passing of Mr.Guy Sella , our founder, Chairman and CEO, (ii)$5.3 million loss related to the sale of an SMRE subsidiary originally acquired as part of the SMRE acquisition and (iii)$4.9 million expenses related to an acquired legal claim under the Kokam Acquisition which was settled in arbitration. Financial expenses, net Year Ended December 31, 2018 to 2019 2018 2019 Change (In thousands)
Financial expenses, net
Financial expenses were
•
an increase of$3.0 million in foreign exchange fluctuations, mainly between the Euro, the New Israeli Shekel, the Australian Dollar and the South Korean Won against theU.S. Dollar; •
an increase of
•
an increase of$1.7 million in interest expenses related to advance payments received for performance obligations that extend for a period greater than one year, as part of the adoption of ASC 606;
•
an increase of
•
a decrease of
•
an increase of
The increase in these expenses was partially offset by an increase of
Taxes on Income Year Ended December 31, 2018 to 2019 2018 2019 Change (In thousands) Taxes on income$ 9,077 $ 33,646 $ 24,569 270.7 %
Tax on income increased by
•
an increase of$26.2 million of current tax in 2019 as compared to 2018 related to the entitlement ofSolarEdge Technologies Ltd. to a preferred effective tax rate of 12.3% under the PTE, ;
•
an increase of
•
an increase of
These taxes on income were offset by:
•
a decrease of$8.8 million in Global Intangible Low Taxed Income or GILTI and E&P taxes Net Income Year EndedDecember 31, 2018 to 2019
2018 2019 Change (In thousands) Net income$ 128,046 $ 144,957 $ 16,911 13.2 %
As a result of the factors discussed above, net income increased by
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Comparison of year ended
Year ended December 31, 2017 to 2018 2017 2018 Change (In thousands) Revenues$ 607,045 $ 937,237 $ 330,192 54.4 % Cost of revenues 392,279 618,001 225,722 57.5 % Gross profit 214,766 319,236 104,470 48.6 % Operating expenses: Research and development 54,966 82,245 27,279 49.6 % Sales and marketing 50,032 68,307 18,275 36.5 % General and administrative 18,682 29,264 10,582 56.6 % Total operating expenses 123,680 179,816 56,136 45.4 % Operating income 91,086 139,420 48,334 53.1 % Financial income (expenses) 9,158 (2,297 ) 11,455 N/A Income before taxes on income 100,244 137,123 36,879 36.8 % Taxes on income 16,072 9,077 (6,995 ) (43.5 )% Net income$ 84,172 $ 128,046 $ 43,874 52.1 % Net loss attributable to Non-controlling interests - 787 787 N/A Net income attributable to SolarEdge Technologies Inc.$ 84,172 $ 128,833 $ 44,661 53.1 % Revenues Year Ended December 31, 2017 to 2018 2017 2018 Change (In thousands) Revenues$ 607,045 $ 937,237 $ 330,192 54.4 % Revenues increased by$330.2 million , or 54.4%, in 2018 as compared to 2017, primarily due to an increase in the number of systems sold, with significant growth in revenues coming fromthe United States ,Europe ,Australia ,Japan andIsrael . Non-U.S. revenues comprised 46.1% of our revenues in 2018 as compared to 42.5% in 2017. In addition, the Gamatronic Acquisition and the Kokam Acquisition increased our revenues over the last months of 2018, which included sales ofUPS units, batteries and storage systems in the aggregate amount of$23.0 million . The number of power optimizers sold increased by approximately 4.0 million units, or 54.1%, from approximately 7.4 million units in 2017 to approximately 11.4 million units in 2018. The number of inverters sold increased by approximately 139,000 units, or 43.7%, from approximately 317,000 units in 2017 to approximately 456,000 units in 2018. Overall, our blended ASP of solar products per watt decreased by$0.018 , or 6.8%, in 2018 as compared to 2017, primarily due to: •
a change in the mix of products, yielding a higher portion of sales of commercial products that are characterized with lower ASP per Watt in comparison to residential products;
•
we initiated price reductions of our commercial products in order to increase market share in this segment;
•
the introduction of new commercial products with higher capacity which carry a lower ASP per watt; and
•
selective price decreases of our residential products
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Cost of Revenues and Gross Profit
Year Ended December 31, 2017 to 2018 2017 2018 Change (In thousands)
Cost of revenues
Cost of revenues increased by
•
an increase in the volume of products sold;
•
increased warranty expenses of
• increased shipment and logistical costs of$16.1 million attributed, in part, to the growth in volumes shipped, an increase of customs tariff in the US and an increase in air shipments due to power component shortages;
•
increased fixed and variable costs related to the manufacturing of Kokam related
products and the assembly of
•
increased personnel-related costs of$13.1 million related to the expansion of our operations and support headcount which is growing in parallel to our growing install base worldwide and as result of the acquisition of ourUPS and battery divisions ;
Gross profit as a percentage of revenue decreased from 35.4% in 2017 to 34.1% in 2018, primarily due to:
•
increased warranty and support services expenses and accruals;
•
price reduction to customers at a rate higher than our cost reduction;
•
lower gross profit onUPS and battery products due to underutilization of production facilities, as well as certain transactions for the sale of batteries with low gross profit, which had been entered into prior to closing the Kokam Acquisition; and •
amortization of intangible assets and cost of product adjustment related to the
These were partially offset by:
•
reductions in per-unit production costs that exceeded price erosion of our products;
•
increased efficiency in our supply chain; and
•
general economies of scale in our personnel-related costs and other costs associated with our support and operations departments.
Operating Expenses:
Research and Development, Net
Year Ended December 31 2017 to 2018 2017 2018 Change (In thousands)
Research and development
Research and development increased by
•
an increase in personnel-related costs of
•
depreciation expenses related to lab equipment and amortization expenses related
to intangible assets increased by
•
materials consumption for development increased by
•
expenses related to other directly related overhead costs that increased by
•
expenses related to consultants and subcontractors that increased by
•
Other expenses, including travel expenses increased by
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Sales and Marketing
Year Ended December 31, 2017 to 2018 2017 2018 Change (In thousands) Sales and marketing$ 50,032 $ 68,307 $ 18,275 36.5 %
Sales and marketing expenses increased by
•
an increase in personnel-related costs of$14.6 million as a result of (i) an increase in headcount supporting our growth in theU.S. , Europe Asia and the rest of the world, (ii) salary expenses associated with employee equity compensation resulting from the impact of the increase in our stock price affecting the fair value of any share award, and (iii) hiringGamatronic's employees and the consolidation of Kokam's employees;
•
expenses related to travel increased by
•
expenses related to trade shows and marketing activities increased by
•
expenses related to other overhead costs increased by
•
depreciation expenses related to tangible assets and amortization expenses
related to intangible assets increased by
•
expenses related to consultants and subcontractors increased by
General and Administrative
Year Ended December 31, 2017 to 2018 2017 2018 Change (In thousands)
General and administrative
General and administrative expenses increased by
•
an increase in personnel-related costs of$5.8 million related to (i) higher headcount in the legal, finance, human resources, and information technology department, functions required of a fast-growing public company, (ii) changes in management compensation and increased expenses related to equity-based compensation resulting from the impact of the increase in our stock price affecting the fair value of any share award and (iii) hiringGamatronic's employees and the consolidation of Kokam's employees;
•
expenses related to external consultants and sub-contractors increased by$3.9 million due to legal proceedings initiated by us and other consulting expenses in relation to the Gamatronic Acquisition and the Kokam Acquisition;
•
expenses related to other overhead costs increased by
•
expenses related to travel increased by
•
increase of
•
depreciation expenses increased by
This increase was offset by a decrease in costs related to the accrual of
doubtful and bad debts of
Financial Income (Expenses) Year Ended December 31, 2017 to 2018 2017 2018 Change (In thousands) Financial Income (Expenses)$ 9,158 $ (2,297 ) $ (11,455 ) N/A
Financial income was
•
an increase of
•
an increase of$2.4 million in interest expenses, mainly related to advance payments received for performance obligations that extend for a period greater than one year, as part of the adoption of Accounting Standards Codification 606, Revenue from Contracts with Customers (ASC 606).
These increases in financial expenses were offset by:
•
an increase of
•
a decrease of
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Taxes on Income Year Ended December 31, 2017 to 2018 2017 2018 Change (In thousands) Taxes on income$ 16,072 $ 9,077 $ (6,995 ) (43.5 )%
Tax on income decreased by
• a one-time transition tax net decrease of$1.3 million in 2018 as compared to an increase of$18.7 million in 2017 on the federal mandatory deemed repatriation of cumulative foreign earnings; and
•
a decrease of
These taxes on income were offset by:
•
a tax provision of
•
an increase of
•
an increase of
Net Income
Year Ended December 31, 2017 to 2018 2017 2018 Change (In thousands) Net income$ 84,172 $ 128,046 $ 43,874 52.1 %
As a result of the factors discussed above, net income increased by
Liquidity and Capital Resources
The following table shows our cash flows from operating activities, investing activities, and financing activities for the stated periods:
Fiscal Year ended December 31, 2017 2018 2019 (In thousands) Net cash provided by operating activities$ 136,665 $ 189,079 $ 259,000 Net cash used in investing activities (85,407 ) (156,609 ) (152,853 ) Net cash provided by (used in) financing activities 7,240 (7,955 ) (73,021 ) Increase (decrease) in cash, cash equivalents and restricted cash$ 58,498 $ 24,515 $ 33,126 48
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As ofDecember 31, 2019 , our cash, cash equivalents and restricted cash were$223.9 million . This amount does not include$211.0 million invested in available for sale marketable securities,$27.6 million invested in restricted bank deposits and$5.0 million invested in short-term bank deposits. Our principal uses of cash are funding our operations and other working capital requirements. As ofDecember 31, 2019 , we have open commitments for capital expenditures in an amount of approximately$60.6 million . These commitments reflect purchases of automated assembly lines and other machinery related to our manufacturing. We believe that cash provided by operating activities as well as our cash and cash equivalents will be sufficient to meet our anticipated cash needs for at least the next 12 months and to fund our capital expenditure commitments.
Operating Activities
During 2019, cash provided by operating activities was$259.0 million derived mainly from net income of$145.0 million that included$87.3 million of non-cash expenses. An increase of$50.8 million in warranty obligations,$83.1 million in deferred revenues,$47.8 million in trade payables,$38.1 in accrued expenses and other accounts payable,$18.6 million accruals for employees and$2.2 million in operating lease liabilities. This was offset by an increase of$124.1 million in trade receivables,$22.5 million in inventories and$67.3 million in prepaid expenses and other accounts receivable. During 2018, cash provided by operating activities was$189.1 million derived mainly from net income of$128.0 million that included$38.0 million of non-cash expenses. An increase of$41.9 million warranty obligations,$37.0 million in deferred revenues,$31.5 million in trade payables and$4.6 million accruals for employees. This was offset by an increase of$60.5 million in trade receivables,$20.2 million in inventories,$2.7 million in prepaid expenses and other accounts receivable and a decrease of$8.5 in accrued expenses and other accounts payable. During 2017, cash provided by operating activities was$136.7 million derived mainly from net income of$84.2 million that included$21.3 million of non-cash expenses. An increase of$63.0 million in trade payables and other accounts payable,$20.4 million warranty obligations,$14.1 million in deferred revenues and$9.4 million accruals for employees. This was offset by an increase of$38.1 million in trade receivables,$21.9 million in prepaid expenses and other accounts receivable and$15.7 million in inventories. 49
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Investing Activities
During 2019, net cash used in investing activities was$152.9 million , of which$160.1 million was invested in available-for-sale marketable securities,$38.4 million was utilized for the SMRE Acquisition,$72.6 million related to capital investments in laboratory equipment, end of line testing equipment, automated assembly lines, manufacturing tools and leasehold improvements,$26.1 million was invested in restricted bank deposits and$3.3 million were decreased in relation to the sale of an SMRE subsidiary originally acquired as part of the SMRE Acquisition. This was offset by$142.7 million from sales and maturities of available-for-sale marketable securities and$4.9 million decrease in short-term bank deposits. During 2018, net cash used in investing activities was$156.6 million , of which$142.6 million was invested in available-for-sale marketable securities,$94.7 million was utilized for the acquisitions of the assets ofGamatronic and the Kokam Acquisition,$38.6 million related to capital investments in laboratory equipment, end of line testing equipment, automated assembly lines, manufacturing tools and leasehold improvements and$10.0 million was invested in bank deposits. This was offset by$129.3 million from sales and maturities of available-for-sale marketable securities. During 2017, net cash used in investing activities was$85.4 million , of which$143.7 million was invested in available-for-sale marketable securities,$21.4 million related to capital investments in laboratory equipment, end of line testing equipment, automated assembly lines, manufacturing tools and leasehold improvements and$0.6 million related to an increase in restricted cash. This was offset by$80.3 million from the maturities of available-for-sale marketable securities. Financing Activities During 2019, net cash used in financing activities was$73.0 million , of which$71.5 million was related to the purchase of non-controlling interests,$9.2 million was used for repayment of loans we acquired as part of the Kokam Acquisition and the SMRE Acquisition and$1.4 million related to the purchase of land and building formerly leased under a financial lease. This was offset by$9.1 million attributed to cash received from the exercise of employee and non-employee stock-base awards. During 2018, net cash used in financing activities was$8.0 million , of which$14.2 million related to the purchase of non-controlling interests and$3.8 million was used for repayment of loans we acquired as part of Kokam's Acquisition. This was offset by$10.0 million attributed to cash received from the exercise of employee and non-employee stock-base awards.
During 2017, net cash provided by financing activities was
Debt Obligations
InOctober 2018 , as part of the Kokam Acquisition, we acquired a number of bank loan obligations in an aggregate amount of$20.1 million (the "Kokam Loans"). The Kokam Loans mature in various installments throughMay 2021 and their annual interest rates are variable. As ofDecember 31, 2019 , the interest rates on the Kokam Loans ranged from 2.7% to 3.4% and the aggregate outstanding Kokam Loans were$15.7 million . InJanuary 2019 , as part of the SMRE Acquisition, we acquired a number of bank loans in an aggregate amount of$7.2 million (the "SMRE Loans"). The SMRE Loans mature in various installments throughJune 2026 and their annual interest rates are variable. As ofDecember 31, 2019 , the interest rates on the SMRE Loans ranged from 2.6% to 3.5% and the aggregate outstanding SMRE Loans were$0.1 million . 50
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Contractual Obligations
The following table summarizes our outstanding contractual obligations as ofDecember 31, 2019 : Payment Due By Period Less Than More Than Total 1 Year 1 - 3 Years 4 - 5 Years 5 Years (In thousands) Operating and finance leases(1)$ 44,666 $ 10,839 $ 25,464 $ 4,317 $ 4,046 Purchase commitments under agreements(2)$ 472,086 $ 472,086 - - - Capital expenditures(3)$ 60,634 $ 60,634 - - - Total$ 577,386 $ 543,582 $ 25,464 $ 4,317 $ 4,046
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(1) Represents future minimum lease commitments under noncancellable operating
lease agreements through which we lease our operating facilities. (2) Represents noncancelable amounts associated with our manufacturing contracts. Such purchase commitments are based on our forecasted
manufacturing requirements and typically provide for fulfillment within
agreedupon or commercially standard leadtimes for the particular part or
product. The timing and amounts of payments represent our best estimates and
may change due to business needs and other factors.
(3) Represents noncancelable amounts associated with purchases of automated
assembly lines and other machinery related to our manufacturing.
OffBalance Sheet Arrangements
We did not have any offbalance sheet arrangements in the year ended
Critical Accounting Policies and Significant Management Estimates
We prepare our consolidated financial statements in accordance with generally accepted accounting principles in theU.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. Revenue Recognition EffectiveJanuary 1, 2018 , we adopted the Accounting Standards Codification 606, Revenue from Contracts with Customers (ASC 606) using the modified retrospective method applied to those contracts which were not substantially completed as ofJanuary 1, 2018 . As a result of this adoption, we revised our accounting policy for revenue recognition as detailed below. We generate revenues from the sale of DC optimized inverter systems for solar PV installations which include our power optimizers, inverters, and cloudbased monitoring platform as well as other solar related products,UPS systems, 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 someUPS and 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 recorded upon shipment of products to customers and transfer of title and risk of loss under standard 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 webbased 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.
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The most significant impact of the standard on our financial statements relates to advance payments received for performance obligations that extend for a period greater than one year. Applying the new standard, such performance obligations are those that include a financing component, specifically: (i) warranty extension services, (ii) cloud-based monitoring, and (iii) communication services.
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. The cumulative adjustments have decreased the retained earnings by$3.9 million while increasing the deferred revenues by the same amount.
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, and 10 years for our storage interface. 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 forUPS products and our battery storage products that exceed the standard warranty period. In addition, customers can purchase extended warranties for inverters that increase the warranty period to up to 25 years. 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 is substantially 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 perunit 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 nonsystematic failures such as failures caused by workmanship or manufacturing or designrelated 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 49.8 million power optimizers and approximately 2.1 million inverters as ofDecember 31, 2019 . 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$78.8 million as ofDecember 31, 2017 ,$121.8 million as ofDecember 31, 2018 and$172.6 million as ofDecember 31, 2019 .
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 market, 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 value of inventories. Inventory writedowns are equal to the difference between the cost of inventories and their estimated fair market value. Inventory writedowns are recorded as cost of revenues in the accompanying statements of operations and were$1.4 million ,$0.9 million and$4.5 million , in the year endedDecember 31, 2017 , 2018 and 2019, respectively. 52
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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 market. 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. 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.
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. We have not recorded any impairment charges during the year endedDecember 31, 2019 . 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.
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, in the fourth quarter of the fiscal year.
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 for impairment for the reporting unit onOctober 1 of each year and accordingly, determines whether goodwill should be impaired. As ofDecember 31, 2019 , no impairment of goodwill has been identified. 53
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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. ASC 740-10 contains a 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.
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