Earnings Call: Q3 2018

Oct 24, 2018

Good day, ladies and gentlemen, and welcome to the Tesla Q3 2018 Financial Results and Q&A webcast. I would now like to introduce your host for today's conference, Mr. Martin Viecha, Senior Director of Investor Relations. Mr. Viecha, you may begin. Thank you, Shirley. Good afternoon, everyone. Welcome to Tesla's third quarter 2018 Q&A webcast. I'm joined today by Elon Musk, J.B. Straubel, Deepak Ahuja, and a number of other executives. Our Q3 results were announced at about 1:00 P.M. Pacific Time in the update letter we published at the same link as this webcast. During this call, we will discuss our business outlook and make forward-looking statements. These comments are based on our predictions and expectations as of today. Actual events or results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent filings with the SEC. During the question and answer portions of today's call, please limit yourself to 1 question and 1 follow-up. Please press star one now if you would like to join the question queue. Before we jump into Q&A, Elon has some opening remarks. Elon? Thanks, Martin. I'll make some opening remarks, and then we're gonna talk about vehicle safety, Autopilot and factory safety. We have a number of people from Tesla here to elaborate on that. I think there's just a lot going on that you would find interesting. I wanna start by thanking all of our customers, employees and shareholders. This was an incredibly historic quarter for Tesla. Model 3 production stabilized. We delivered a total of 84,000 vehicles globally, which is more than 80% of the vehicles that we delivered in all of 2017. In fact, we delivered more cars in this quarter than we did in all of 2016 in a single quarter. Model 3 became the best-selling car in the U.S. in terms of revenue and the fifth best-selling car in terms of volume. We saw higher revenues and significantly better profitability in our energy business. In fact, I think for solar, it may have been the best quarter ever for solar. We achieved GAAP net income of over $300 million, increased cash and equivalents by $731 million, and achieved a greater than 20% gross margin of the Model 3. Moreover, we expect to again have positive net income and cash flow in Q4. I believe our aspiration certainly will be for all quarters going forward. You know, I think we can actually be positive cash flow and profitable for all quarters going forward, leaving aside quarters where we may need to do a significant repayment. For example, in Q1 next year. I think even in Q1, I think we can be approximately flat in cash flow by end of quarter. This quarter was made possible by the incredible execution of our employees across the board from sales, production, delivery, service, energy, engineering, finance, and all of our G&A teams. Really every part of the business executed incredibly well. I wanna thank everyone again for their incredibly hard work. I especially wanna thank customers who help. It's like I've never even heard of this. Maybe this has happened before, I've never heard of a case where a company's customers actually cared about the future of the company so much that they volunteered their time to help the company succeed. I think that's amazing. Just don't see that anywhere. it's like really makes me choked me up actually. This quarter we started rolling out version 9 of our software, which is the biggest software upgrade in 2 years, and Model 3 received a 5-star safety rating in every category and subcategory. It got the lowest probability of injury of any car that the U.S. government's ever tested. Looking ahead, we expect to produce and sell even more Model 3s in Q4, and expect that trend to continue into Q1. We're excited to bring Model 3 to Europe and China early next year, given that the market for midsize premium sedans in those regions is even larger than in North America. I've said before that we must prove that Tesla can be sustainably profitable. This quarter was an important step towards that, and I'm incredibly excited about what lies ahead. This is so proud of the Tesla team, our customers, really appreciate the support of our long-term shareholders. I just wanna say on behalf of the Tesla team, we're just super appreciative of your support through, towards what's obviously been a very difficult time. All right. Now let's start off with vehicle safety. Madan, who's kind of a lead vehicle safety engineer, been with the company for a long time. Madan, how many years has it been that we've been working together? Ten years. 10 years. Wow. Yeah, I've been working with Madan for 10 years. We've had so many conversations on vehicle safety. Wow. You know what? We really go, try to go the extra mile with vehicle safety. You know, not just like there's a series of government-mandated tests. You know, what some companies do is they game the system. They know where the side pole impact's gonna be. They strengthen it right in that position. At Tesla, we're like, "Okay, what is the weakest point in the car? Let us test it at that position." The actual safety is not fully captured in the tests because we anti-game the system. Madan, please. Thank you, Elon. Just want to give you a very quick background about myself. Yeah. Like I said, joined Tesla 10 years. I'm extremely very happy to mention I'm working with extraordinary set of very passionate and very hardworking individuals, and that essentially shows in our product. That's very important for us and also important is our principal mission statement on safety. What we want to do is, safety is probably the important factor for our vehicle. It's not just for electric vehicle, any vehicle, period. Yeah. That's where fundamentally difference differentiates us. Which essentially helps us to keep adding new features and new safety, technology, and that's very important and that shows in Model 3. -latest two things that we have. The fact that we have electric vehicle, the design and architecture gives us a fundamental benefit over traditional vehicles. That takes care of, for example, whether you have a block of engine in the front where we can work with using a pretty much open architecture in the front and the whole fact that you have all the electrical and high voltage and motors and all of that almost below the center of gravity of the vehicle. Right use the lowest probability of reduced rollover risk. Yeah. That is significantly benefit. I think architecturally, we have Newton on our side. Correct. Having Isaac Newton on your side is definitely the way to go. Right. Exactly. In the later series of tests, I would like to specifically talk about Model 3. NHTSA did a series of tests, actually 4 tests for 1 frontal, 2 side, and 1 rollover test. If you look at, we have been calculating how can we distinguish within the 5-star. There are so many vehicles that already gets 5-star. Yeah. If you look at within the five star. They're still all the same. Yeah. All the same. Exactly. If you look at there is a metric we came up with, which is a part of U.S. NCAP rating itself, has the lowest probability of injury, and Model 3 has the lowest. Just to give you a context, there are total of 900 plus vehicles since 2011 which have been rated. The fact that Model 3 is the best among all the 943 to be exact. Right. That speaks to volume and I'm very happy to say that, Model 3 has achieved. We are not stopping right now. Yeah. What we would like to do is next is how we can make use of the active safety and Autopilot features. make it even more improvement. The next area that we're focusing on, how to integrate active and passive safety. That's our next area of challenge, which we will improve for sure. Yeah. It's worth noting that the safety extends to not just people in the car, but also pedestrians. Correct. Yeah. Not having a big engine block in the front of the car is really helpful. Because if the car were to hit a pedestrian, and we'll get to active safety next. The best thing is not, obviously, not to hit a car or pedestrian. The fact that the hood can dent so far in is really helpful. Yeah 'cause it ends up being like sort of like it have. Under- -sort of like a, like a, uh, like a trampoline- Under- Like a You just not you don't have a rock underneath it. It's very helpful. It's helpful for pedestrian safety and for the safety of people in the car. Yeah. Even if you have like a head-on collision with another car, the extended sort of crumple zone of a Tesla Model S, X, or 3 is helpful to the people in the Tesla and the people in the other car. That's interesting. It's not just, you know, the people in the car. I'd like to add one item, which is essentially how we look at the real world safety, which has always been an important element for Elon. If you look at our blog post, we showed how we handle the center pole impact in the front here. By the way, that's not part of NCAP rating. It is just to show how we go over and above the NCAP rating to make sure it's real world safety. Yes. That's very important for us. Exactly. That's what I mean by like anti-game the system. Yeah. Like say, what is the worst way that the car could be hit? Yeah. Not just sort of strengthen where we know the test will happen and that kind of thing. Obviously we're all in these cars. Our friends are in these cars, family's in the cars, so we care a great deal about safety. A lot of people think safety is boring, but not at Tesla. Thanks, Madan. Thank you. Thank you for your decade of hard work and the rest of the Tesla safety team. You know, with that, let's move on to the Autopilot. If you guys could just give an update on sort of Autopilot software, AI, and hardware. Yeah. That's great. This is Stuart Bowers. We'll soon begin to roll out the team's most advanced Autopilot feature ever, Navigate on Autopilot. In our last release, we launched a new set of neural networks that combine together, provide a view of everything happening around the car. With Navigate on Autopilot, we'll use information to understand exactly where the car is on the highway system and to automatically change lanes, handle forks, and take high curvature exits to follow a nav route. Initially, it will require drivers to confirm lane changes using the turn signal before the car moves into an adjacent lane. Future versions will allow customers to waive the confirmation requirement if they choose to. One area that I'm personally really excited to build on this improvement is active safety. With the advancement of neural networks covering 360 degrees of view around our car, we can provide a level of constant vigilance that humans just can't. Ultimately, this should allow us to warn, even intervene for an enormous percentage of modern accidents and to ship these improvements as software upgrades to our existing customers. we have a lot of Like we see this all the time in the. in the data where the car will do an automatic braking event and save a pedestrian or a, you know, another car from impact. This happens all the time. All the time. Yeah, all the time. Yeah, and I think it's- Every day. Usually every day. It's, like, pretty crazy. Yeah. Yeah, the team's done incredible work here, and by bringing up more of the cameras around the car, we can detect things as they come toward us, not just directly in front of us. Yeah. Pete. Hi, this is Pete Bannon. The Hardware 3 design is continuing to move along. Over the last quarter, we've completed qualification of the silicon, qualification of the board. We started a manufacturing line and qualification of the manufacturing line. We've been validating the provisioning flows in the factory. We've built test versions of Model S, X, and 3 in the factory to validate all the fit and finish of the parts and all the provisioning flows. We still have a lot of work to do, and the team's doing a great job, and we're still on track to have it ready to go by the end of Q1. Great. That, that'll be at roughly 1,000% increase in processing capability compared to the current hardware. It's obviously a giant improvement despite it costs about the same. Cost volume and power consumption are approximately the same as the current hardware but is a tenfold improvement in frames per second. That's right. Yeah. Improved redundancy as well. Very importantly, it's very important to emphasize is that the only thing that needs to change between a car that's produced today and a car that's, say, produced in the second quarter of next year, is swapping out the Autopilot computer. Right. This is a simple change that takes less than half an hour in service to upgrade the computer. Anyone will be able to upgrade their computer to Full Self-Driving capability or upgrade their car to Full Self-Driving capability with a simple service visit. We expect all cars with the Hardware 2 sensor suite, basically anything made in the last roughly 2 years, will be upgradable to Full Self-Driving. Yep. Yeah. In fact, a lot of the cars we're using for testing today have in fact been upgraded from Hardware 2. Right. It's very important to emphasize, like, It's likely to say that people would wanna wait until that comes out, but there's no need to wait till that comes out, because it's just a very simple plug-and-play change to get to Full Self-Driving. And anyone who's paid for the Full Self-Driving option will just get it done for free. And anyone who still wants to order Full Self-Driving at this point, it's just an off-menu item. You can still order it. We took it off the order of menu just because there it was really creating a lot of friction in the sales process, and people didn't understand the difference between enhanced Autopilot and Full Self-Driving. Just to simplify the order process, we took that off. Anyone who asks for it can certainly get it and it really ends up being a discount on future capability. To be clear, there's definitely no need to wait until Q2 to order a car. We wanna make it just a completely seamless process. There's no advantage to ordering now versus Q2. Andre, do you wanna? Yes. Okay. Hi, everyone. My name is Andrej Karpathy. I'm the Director of AI here at Tesla, and my team trains all of the neural networks that analyze the images streaming in from all of the cameras for the Autopilot. For example, these neural networks identify cars, lane lines, traffic signs, and so on. The team is incredibly excited about the upcoming upgrade for the Autopilot computer, which Pete briefly talked about. This upgrade allows us to not just run the current neural networks faster, but more importantly, it will allow us to deploy much larger computationally more expensive networks to the fleet. The reason this is important is that it is a common finding in the industry, and we see this as well, is that as you make the networks bigger by adding more neurons, the accuracy of all their predictions increases with the added capacity. In other words, we are currently at a place where we've trained large neural networks that work very well, but we are not able to deploy them to the fleet due to computational constraints. All of this will change with the next generation of the hardware, and it's a massive step improvement in the compute capability, and the team is incredibly excited to get these networks out there. Great. Thank you. I should I said this before, but I'd like just to talk a bit about the kind of long-term future. We absolutely see the future as kind of, as sort of a shared electric autonomy, so that you'll be able to do ride-hailing or share your car in any way. In a sort of, long-term model that's some combination of, like, Uber, Lyft, and Airbnb. In other words, there'll be Tesla-dedicated cars for ride-hailing, and there'll be, and any customer will be able to share their car at will, just like you share your house on a Airbnb. It's a combination of those two models, I think is pretty obviously the, where things are headed long term. The advantage that Tesla will have is that we'll have millions of cars in the field with full autonomy capability. No one else will have that. I think that will end up putting us in the strongest competitive position long term. Lori, can you finish it off with, let's talk about factory safety and thank you for the hard work of you and your team. I think we've made great strides. Please go ahead. Yeah, thanks. Yeah, we have the safest cars made by the safest people. Yeah. It's exciting time here at Tesla. All car and manufacturing factories have injuries. At Tesla, we have a commitment to zero injuries, and our target is actually on good reporting. We have good reporting of injuries, good reporting of near misses, good observations, and lots of improvements. To be the safest company in the world, we have to be committed to that, and everybody here is. We're actually steadily getting there, and we're not gonna stop till we're there. Absolutely. So one- I'm mentioning, like, for example, like, we have had, like, some, you know, sort of for example, like, we do get these, like, quite unfair, you know, accusations. For example, one of them was, like, that we were underreporting injuries. Correct. It's worth noting that OSHA completed their investigation and concluded that we had not been doing anything of the sort. Correct. Correct. The factory here had a four-month long Cal/OSHA investigation, and it basically proved that we are recording properly and doing as we should be. It's much different than what you would read about in the press. Yeah. This is true. Yeah. I'm very proud of the team for that. It's 1 point I think people don't know is I've been here about a year now, time flies, and you're having so much fun. It was like 12 years. I know. When I joined, Our injury rate was a fraction of what it had been when Toyota and GM ran the factory in the NUMMI days. What we're all about is really continuing to make improvements from there. You know, what's also important is not to have serious injuries. That's extremely rare here at Tesla. We have really strong focus on prevention and also using mitigating controls so these types of injuries don't occur. I mean, most of the injuries that we have are muscular sprains and things like that. Yes. Essentially it's muscle strain and getting scratched. Exactly. That's most injuries, yeah. Yeah. Hand and finger cuts- Yeah. Yeah. and sprains. Yep. I kinda just wanna break down a few things that, you know, my team has been working on along with all the leaders here. You know, first it's people and engagement. One of the first things is, you know, meeting with you, Elon. Yeah. I meet with you on a regular basis. We meet with all the production leaders, it's full on engagement on improving safety. We have built a really strong EHS team, the best and the brightest. And our EHS team is actually embedded into the line on the factory because we learn the process and we learn the people. You don't know how to improve unless you're out there on the line, on the process, engaging with the associates, listening and learning from our associates. We have really strong engagement, health and safety committees. We do find it, fix it walks. Our leaders are out there walking and also looking for improvements. Actually just this quarter, we had over 15,000 improvements. I mean, that's, like, amazing. Very, very exciting about that. We also look at risk reduction and in human performance. You know, people are gonna make mistakes, so we're gonna design in so we fail safely. We have an early symptom intervention program. This is where we have industrial athletes go out on the line and work with our associates before anything happens. Like, if you have a pain, you know, let's work it out, let's strengthen and really get our employees fit. We're doing that. We've also just opened a new and improved health clinic. When injuries do occur, we get the absolute best care. for our associates. It's actually overseen by one of California's leading orthopedic surgeons. We did that because most of our injuries, like we said, like 80%-85% are those sprains and strains. Now they get that best care here on site. We have 24/7 care. Actually staffed by three full-time doctors and nurses, and I'm really super happy with the care they're giving, I think the employees are as well. Yeah. We're gonna expand on that. Yes The, yeah, the Tesla sort of health clinic, both at Fremont and at Giga, so that we have a really immediate, first-class, healthcare available right, you know, right on the spot when people need it. This is not just for workplace, this is for workplace and non-workplace. I know. That's super exciting. Yeah. We're leading the world. If you become injured at all for any reason, then there's healthcare immediately on site. That's where we plan to give. Exactly. Finally, just being proactive, 'cause that's what we're about, innovation and proactive. I mean, we've joined national safety organizations. We partner with many leading universities, including UC Berkeley, Center for Occupational and Environmental Health. We do presentations there. We work with the automotive industry and do benchmarking all the time. We're always looking and bringing people in to look for things that we can do better and for new technology and innovations in safety. With all of that, you know, we have made improvements in our injury rate. We are more than 10% better year-over-year in our lost workdays and our days away. The most important thing is we're also getting all those good engagement observations. They're moving up. Injuries down, observations, engagement up. All right. Awesome. So- Thanks, Laurie. Thank you. Thanks, Laurie. We'll provide regular updates on workplace safety. Our goal is unequivocally to have the safest factories in the world where people look forward to coming to work in the morning. That's our goal. All right. With that, we can move to questions. Cool. Well, thank you very much. Shirley, let's go to the first question, please. Thank you. Our first question comes from Dan Galves with Wolfe Research. Hey, thanks for taking my questions. Congratulations on the quarter. It's really amazing to see this landmark quarter, after covering the company for so long. Thanks for bringing some of your team onto the call. It's very interesting. My question is about cell supply. There's been some noise about tight cell supply and Sparks and tight labor supply. Like, in the short term, could you just talk about whether demand is outpacing supply of battery cells and kinda what's your plan for long-term expansion, including cell supply in China? JB. Sure. I can speak to that. This is JB. We have had a period where the supply was fairly tight for Model 3, but it did not really constrain the Model 3 production in a significant way. Well, like for a week. Yeah. Yeah. Maybe for a few days. Yeah. Yeah, the impact was larger felt on the energy products. Yeah. You know, that still is somewhat tight, but we do, as we pointed out in previous, you know, discussions, we do have third-party supplies of energy cells. That production, you know, can continue, even independently of the Panasonic supply and Sparks. That's been very helpful. That is expanding in future quarters. The Panasonic supply is expanding. You know, the productivity of existing lines is continuing to improve with a lot of hard work from the engineering teams and just operational stability. We continue to bring online new production lines. Even just in the last several weeks, we've started up, you know, yet another cell production line with Panasonic and through the end of the year, there's another another line coming on and then one shortly after that. There's a steady increase in the total supply that should keep us ahead of, you know, even Model 3 growth and also should let us, you know, have a larger percentage of energy supply be sourced from Giga locally. Yeah. We are making a pretty nutty amount of the world's lithium ion batteries. Martin, like, I think we're, what, at 60% or something? Yeah. At the moment, if you look at, for example, for Q3, all electric vehicles made around the world, their total battery capacity was about 20 or 19 gigawatt hours. What we produced in Q3 was about the same or a little bit higher. Okay. About half of world's batteries, basically. Is that because we also source cells from Japan and elsewhere? Is that you two or just Giga? Yeah. Just the Giga itself is about $20, and on top of that, S and X is, I don't know, another $4 or $5. Yeah. Got it. No, it's a huge advantage. Is there plans that you can talk about for cell supply in China? Will that be produced in China? I'm assuming so. Long term, it would be produced in China. Short term, we're not certain of the short-term situation, but long term, certainly. Got it. Okay. Thanks very much. Thank you. Let's go to the next question, please. Thank you. Our next question comes from Pierre Ferragu with New Street Research. Hey, thank you for taking my question. I was very surprised in the numbers you reported today by your gross margin performance on the Model 3. If I remember correctly, you were expecting more of a 15% type of margin for this quarter, and you actually did better than 20%. Can you take us through what improved, like, faster and better than you had initially anticipated in the manufacturing line and where these improvements came from? Deepak here, and, Jerome and others, please, feel free to join. Our improvements on the cost side were in every aspect of cost. Clearly, our manufacturing labor hours improved significantly. Our overall manufacturing costs had dropped almost 30% sequentially Q2 to Q3. We produced more volume, so we had better fixed cost absorption. We had far less scrap. Our yield on each of the lines across both factories improved significantly. As we look forward, we see even more opportunities. We are going through this phase where we are now stabilizing production and the team can now intensely focus on cost optimization, and that trend will just continue in Q4. I think we're also being relatively, like, on the conservative side when we predicted or said, like, 15 lower range. Right. Our expectation was we would do better. Yeah. We wanted to be conservative. You're right. Yeah. In terms of our guidance that we gave, for Q three. Yeah. Okay, thanks. That's great. Then on, as a quick follow-up, you've announced over the weekend, like a mid-range car with a smaller battery pack. I was wondering as you're looking at expanding production of the Model 3, I think about it as you had two options. One was to go abroad and to keep producing a higher end, higher SV car, and the other one was to go for a lower cost car and stick to the U.S. How did you decide the sequencing of these two things? Why is lower car now and going abroad only early next year? Well, we're trying to provide the most affordable electric car options that we can. Since we just don't have the ability to get to the $35,000 car right away, we thought this might be a way to offer it as an intermediate step. That's really it. We expect to start producing a significant volume for Europe in January. Obviously it takes some time to ship. Deliveries, you know, probably pretty significant deliveries in Europe, kind of in the late February, March timeframe, because cars have to get all the way from California to a customer in Europe. You know, for us, a car is only counts as delivered if it's, reaches the end customer, and all the paperwork is completed correctly. It's the highest possible standard for considering a sale a sale. Also to APAC, you start delivering cars. Yeah. We may or may not deliver cars in APAC in Q1, but certainly in Q2. It'll be kind of borderline as to whether a car is delivered in APAC by the end of Q1, so I can't say that for certain. They're definitely in Europe, but they're definitely in APAC in Q2. Yeah. Okay, let's go to the next question, please. Thank you. Our next question comes from Romit Shah with Nomura Instinet. Yes, thank you. I guess just along those lines, you know, you indicated that, you're going to bring Model 3 to Europe, early next year. Where would you like to see, production, in order to support that ramp overseas? Well, initially, production will occur, I mean, at least the next several months, all vehicle production will take place at our car plant in California. Sorry, I meant to ask, where would you like to see the production rate on a weekly basis go to in order to support that ramp? Yeah, it's hard to predict with accuracy. there's also, you know, like the tariff wars and everything. you know, long term, like you say, we're not talking about like next quarter. like what is likely global demand for Model 3? It's on probably on the order of anywhere from 500,000 to 1 million cars a year, let's say, global demand for Model 3. If you look at something like, say, the 3 Series, one, that's around half a million. $half a million. The BMW 3 Series is about half a million units a year. globally. Generally we find that we outcompete the BMW 3 Series, quite well. We, it seems, like, logical therefore that we will long-term have a higher production or higher demand, you know. Maybe it's somewhere in between the kind of the BMW 3 Series and the Volkswagen Golf, which is about 1 million units a year. Yeah, that's why I say anywhere from 500,000 to 1 million units a year long term. Do you have to add new lines to support that or are you just gonna continue to remove bottlenecks in the existing lines? We're definitely gonna do local production in China. We're moving rapidly on that. We're aiming to have Model 3 production for the China market or the Greater China market active certainly next year. It will be happening next year. It will be done with a very capital-efficient manner, much more akin to the way we did general assembly line 4 versus general assembly line 3. We'll also have a factory in Europe long term 'cause it's pretty silly to make cars in California and ship them all the way to Europe. That's far. Especially in high volumes. Yeah, exactly. Especially if I'm not talking about the S and X, I'm just talking about the Three. S and X will continue to be made in California, I think probably exclusively here, before for cars where we're trying to maximize affordability, it makes a lot of sense to produce those cars at least on the continents where they are, where they are consumed or bought. Okay, let's go to the next question, please. Thank you. Our next question comes from George Galliers with Evercore. Thank you. Maybe just following up on the previous question, is the target still to produce 10,000 Model 3s a week in Fremont? I think you mentioned in the past that once you got to a run rate of around 5,000, you'd be better placed to assess what CapEx is required to get there. As of today, do you have a better idea of what CapEx is required to get to that kind of level at Fremont? I think we're not prepared to speak to that right now, except that it will be considerably less than money that we've spent to get to 5,000 in the first place. Like quite, I think quite dramatically less. I would say I probably see a path to like 7,000 units a week for Model 3 with really minimal CapEx. Very minimal. Yeah. Jerome, yeah. With very minimal to get to 7,000. Yeah a week. I mean, that's really just basically solving, improving the uptime of the existing lines. Uptime We can do 7,000 a week. Exactly. Exactly, yeah. It gets a little harder as you start to go above 7,000. We would need to at least bring lines down in Fremont for significant upgrades to get to 10K, but also just not, we're not talking about massive amounts of CapEx. You know, if it's, say, like long term, it's Again, you know, long term, it's something if predicting these on a quarter-by-quarter basis is very difficult because, when you have an exponential growth rate like we do, I mean, if you, if you look at Tesla cumulative deliveries over time, that's like the cleanest exponential curve fit that I've ever seen. Small movements in calendar time can look like a very large hit or miss one way or the other because it's such a steep curve. That's why it's always tricky to predict things on a quarterly basis. A lot easier if you go out, you know, a year or so. I mean, it's, you know, probably long term, it's at least sort of 7,000-10,000 cars from Fremont of Model 3. I don't know, 5,000-8,000 in the rest of the world, something like that. This is a guess. Okay, thank you. Just as a follow-up, in the letter you do point out that the size of the European market for premium mid-size sedans is roughly twice that of the U.S. Could you also maybe just comment to what your expectations are for mix in Europe based off Model S and Model X? Do you expect richer mix in Europe versus the U.S., or is it fairly similar? We've given that zero thought. I mean, this is like, there's not I have no idea. I don't know. Martin, do you have any idea? Yeah, I, like all I'm aware of is that, you know, because of cold weather and probably all-wheel drive and long, battery range will be highly demanded in Europe. Apart from that, I mean, we ultimately have to start selling the car to see what the demand is. Yeah. I mean, it seems like it's likely to be comparable to- It's like- If pre-mid, mid-size sedans market is like twice as big in Europe, then it's likely to be at least as much demand in Europe as is in North America. That's a pretty safe bet. Our goal really is to make electric cars that everyone can afford, not to sort of mine high, you know, high option value cars. It's like if we could produce a $35,000 car today, we would do it. You know, we need more work. We need more work. There's more work to do before we can make a $35,000 car and have it be positive gross margin. Not, you know, we're probably less than 6 months from that, but that's our mission. Great. Let's go to the next question, please. Our next question comes from Maynard Um with Macquarie. Hi. Thank you. Congratulations on a great turning point for Tesla. As you continue to scale the business, can you talk about how we should think about how you balance profits versus reinvestments? You're targeting sustainable GAAP profitability and cash flow, I'm curious if there's a level of GAAP profitability or GAAP operating margin or cash flow you wanna hold and then take the excess to fund new growth or accelerate opportunities. Sure. I mean, maybe to If, if to characterize that question, it would be like, you know, are we starving new vehicle development in order to achieve GAAP profitability and cash flow positive? Would that be inaccurate? Is that what essentially Like, the answer is no. We've made significant progress on the Model Y. You know, in fact, I've approved the prototype to go into production recently. You know, it'll be 2020 before that's in volume production, but we made great progress there. Also continue to make progress on the Semi and the newer Tesla Roadster. Actually the product I'm personally most excited about is the Tesla pickup truck. It's like, I think that's gonna be some next level, next level stuff there. Then also, I should not forget to mention the solar tile roof. We'll also start getting into volume production of the solar tile roof next year. You know, that's quite a long development cycle, because anything that's a roof has got to last 30 years. Even if you do accelerate life testing as fast as possible, there's still minimum amount of time required to do that. And there's a lot of engineering that goes into how do you put on the solar tile roof, with and not be really labor-intensive in doing so. There's a lot of engineering, not just in the tile, but in the way it's done. We've got, you know, continued improvements to Powerwall, Powerpack, other energy products. I think we've got the most exciting product roadmap of any company on Earth by far. I'm not even sure, like probably twice. I don't even know which company would have a better product roadmap or even close. Yeah, maybe they do, but I don't know about them. Great. When you talk about Tesla having its own, you know, ridesharing fleet or giving people the ability to loan out their car like an Airbnb model, I'm curious if your long-term plan is to build a platform that's going to enable companies to write applications to turn the car directly into an application. Can you also maybe just talk about that business model? Is that, should we be thinking more about like a revenue-sharing model, sort of like how Apple takes piece of revenue generated for applications from iPhones? Thanks. I don't know about turning the car into an application exactly, but I mean, maybe. We'll try to do the thing that maximizes usefulness. If there's a way we can think of where third parties could do something, then that could make sense. I do know for sure that Tesla will operate its own ride-hailing, ride, you know, its own ride-hailing service. We'll compete directly with Uber and Lyft, obviously. Also have the ability for customers to offer their car, and add or subtract their car to the fleet at will. There'll be a company-owned fleet and the company-owned fleet will just be where there aren't enough customer cars to be lent out. If we find in a particular metro, there aren't enough customers who are willing to add their car to the shared fleet, then that's where we'll supplement it with a Tesla-owned fleet. That's why it's a sort of combination of the Uber and Lyft thing and Airbnb. We would charge, you know, something probably comparable to how, let's say, the App Store works where, I don't know, we charge 30% or something in order for somebody to add the car to the fleet. I think that's like a pretty sensible way to go. Great. Let's go to the next question, please. Thank you. Our next question comes from Adam Jonas with Morgan Stanley. Thanks, everyone. First question is on governance. As the company conducts its search for a new chairman, what are the attributes and experiences of that person that you think would be a best fit or best value for Tesla? Actually, on this call, we're gonna restrict questions to operational topics. Do you have any- No problem. Yes, I do. Can you tell us about the folks who are taking deliveries of Model 3? What are the top cars, car models or brands that they're trading in or switching out of? How many are new to the brand? Anything you're prepared to share, and then I have a follow-up. Sure. Absolutely. Hey, this is Martin. I've done the analysis of all the trade-ins that we've received. Really the only pattern that I've seen is that it's sort of all across the board and the vast majority is non-premium brands. I think that is the number 1 message is just that more than half of the trade-ins we received were priced at below $35,000 when new. Other than that, there's no real pattern. I, you know, I haven't noticed anything worth highlighting other than it's just a lot of people upgrading their cars quite dramatically. Which is a huge upgrade. Yeah. -from- For most people. Maybe for most, but for many people, it is the most expensive car they've ever bought. They're clearly demonstrating with their money that they're willing to spend extra money to get a Tesla. you know, like, Tesla is, it's like mass market premium. Yeah. The price walk is way beyond the federal tax credit. Yeah. There's value. To the product that they are perceiving, whether it's cost of ownership, whether it's sustainability, whether it's the brand or the safety. Safety. The safety. All of the above is making a large number of customers jump up significantly in their purchase price. Yeah, I mean, really, like, honestly, like, the top reason to refer a friend to buy a Tesla is it's gonna keep your friend safe. Mm-hmm. That's a good reason. If I can just squeeze in, since I couldn't ask the first one that you could answer, do you think that the third quarter is a milestone, Elon, where you think Tesla becomes sustainably self-funding and perhaps not in need of outside capital? Thanks. Yeah, that's, that is our goal. We do not intend to raise equity or debt. At least that's not our intention right now. You know, that may change in the future, but the current operating plan is to pay off our debts, and not to refinance them, but to pay them off, and reduce the debt load and overall leverage of the company. Oh, and I, actually almost forgot one quite important thing. This is quite helpful. Well, it's helpful to have these sort of crisis situations, with logistics, for example. As I dug into the inventory, like basically finished part inventory, from factory to the customer, I was quite surprised to see how long that took, and that it was quite expensive in a lot of cases to get cars to customers. This was something I didn't fully appreciate before. We really have a major initiative at Tesla to get the average time from a car exiting the factory to receiving a check from the customer or being in the customer's hands, if we could really get the check when we get the car to the customer. Getting a car from factory to customer to get that to be as short as possible. In August, the average time in North America to get a car from the factory to a customer was 30 days, which is embarrassingly long. By the end of the quarter, we reduced it to around 20 days, and our goal in Q4, this is a goal, not a promise, but our goal is to get the average time of a car from factory to customer under 10 days. This is a giant improvement in the capital efficiency of the company, because we're making on the order of $75 million worth of products per day, of cars per day. Every day, every day it requires $75 million worth of capital. Every 10 days is $750 million. We obviously have a loan from the bank that we can make use of. The banks will only loan us 85% of the cost of the vehicle, which translates to about 70% of the price of the vehicle. And then we've got this loan outstanding, which effectively increases the COGS of the car. And then dilutes the company to the tune of 30% of what of the inventory of the finished goods in transit is. This is really like tightening that and getting that below 10 days in North America and then also improving dramatically the time, the transit time to Europe and Asia. This is where like having local factories is actually very important for the capital efficiency of the overall system. Because I think over time, we want to get the time from a car going from factory to customer under 7 days, worldwide. The terms that we have from our suppliers are on average just over 60 days. Our, our parts inventory management also is, there's a lot of room for improvement there. We'll probably cut that down to, you know, a few hundred million dollars or so, you know, Deepak something like that, maybe $200 million or $300 million of parts at the factory. effectively, what we're gonna do is reverse the working capital requirements of the company quite dramatically to the point where the faster we grow, the more capital we have. This is incredibly important for capital efficiency of the company. It's night and day. Deepak, is there anything you'd like to? No, I think you are totally, you know, we're reducing our raw material inventory on one hand, by keeping the production stable, finding efficiencies in warehouse management and supply chain, and at the same time, reducing the time to deliver the car and convert that car into a cash, and that significantly improves working capital needs. Yeah, it's really quite dramatic. Yeah, I think this sort of profoundly changes the financial effectiveness of Tesla. Yeah. Yeah, we reduced our inventory in Q3, which helped. Although we had higher payables, sorry, higher receivables because the quarter ended on a weekend, we won't have that in Q4. All of this should continue to help us in Q4 and beyond the working capital gain. Yeah, I mean, it occurs to me that even if the only thing, like even if this was the only thing that Tesla did different was to shorten the time from factory to the end customer, any given company that did that would outcompete all other companies over time. It would not be a contest. Great. Thank you very much. Let's go to the next question, please. Thank you. Our next question comes from Toni Sacconaghi with Bernstein. Yes, thank you. I have one for Deepak and then a follow-up, please. Deepak, the OpEx expense management was very strong in the quarter. I think it was down 13% sequentially, and OpEx was only up 5% year-over-year, despite revenue growing 71%. So on that front, I mean, in hindsight, did you get too bloated and needed to get more right-sized? Looking forward, how do we think about OpEx growth versus revenue growth on kind of a more normalized basis? Toni, excluding one-time items, our OpEx decreased sequentially by 5%, to just clarify that, first of all. A lot of that was driven by the actions we took in Q2 to be more efficient with our employee headcount. We benefited from that in Q3. We were really careful in terms of all of our spending. The other piece that helped us is a lot of our Model 3 spending on expense term, sort of R&D is reducing because Model 3 is going into production. Q2 to Q3, we saw a reduction there. It just gives you the sense of the leverage of operating expenses can have while our revenue is growing dramatically. Our OpEx will increase in the future, but at a far slower rate, and we will continue to be really careful about the spending. I think there are actually more efficiencies that we can find. We are going to find them, absolutely. Right. We'll continue down that path. Definitely. Okay. Thank you for that. To follow up, I was just wondering if you could help us a little bit back to the gross margin on Model 3 and the $35,000 car. You know, this quarter, you know, I impute that Model 3 ASPs were maybe $59,000, that might suggest that gross margins on a $35,000 Model 3 might be about zero. Elon, I think you alluded to the fact that, you know, the goal is really to get positive gross margins on a $35,000 car before shipping. Are those all fair assessments? I guess the question is, where would a Model 3, $35,000 Model 3 be in terms of gross margins today, and where does it need to be before you wanna offer it broadly to consumers? Yeah, I mean, it's The challenge with asking questions of that nature and detail is that it is a rapidly changing situation. Like, literally, if you would ask this in a month, it would be different. In another month, it would be different. There's no question we need to get to a point where we can sell a $35,000 car and where the full accounted for COGS of the car is, let's say, on the order of $30,000 or slightly less than $30,000. Like, I think we'd wanna ideally get the COGS of the car, of that configuration car under $30,000. That would be that's our goal. That's what we're pushing very hard to achieve. Exactly. It's, it's a matter of time. It's, there's a significant material cost reduction that comes. You have a smaller battery pack, so you can have a fewer amount of cells. Yeah. It's not the same, cells that we have in the existing cars. Well, it's the same cell, but it's not the same. The same amount of cells, so cell cost. Fewer cells. Right. The non-cell portion of the pack is also cost reduced. Exactly. With the current mid-range pack, it still has basically about the same non-cell portion of the pack cost. Exactly. We are achieving massive reduction in all our manufacturing costs per car, which will continue. As volume grows, that also helps us with the fixed cost itself. It's the same factors that have helped us so far will continue to help us going forward to get us there. Anything you want to add, JB? No. Yeah. Great. Let's go to the next question, please. Thanks, Haley. Next question comes from Jamie Albertine with Consumer Edge. Great. Good afternoon, thanks for taking the question. Congratulations. Great. Wanted just a point of clarification. You know, Elon, you mentioned in August, you know, the time to get the car from a factory to a customer was 30 days down to 20 at the end of the quarter, and your goal's under 10 by the end of 4 Q. Where do we see that flow through from a COGS perspective? Is that in automotive gross margin, or is that in services and other at this point? It's all in automotive gross margin. Our logistics costs outbound. Outbound logistics, essentially. It's all in COGS and for automotive. Yeah, I think we'll see a reduction in inbound logistics as well as outbound logistics. What, maybe the question is like, for the debt that is carried for that period of time, is that coming into COGS or is that not? The interest expense. Yeah. of the debt, that's in the interest expense line. Okay. That is not in COGS. Okay. Yeah, that's why I do think that the definition of COGS should probably be broadened to include anything that's directly driven by volume, essentially, that affects the marginal cost of the vehicle. Although that is not officially in COGS, in my opinion, it probably should be, is to take the ABL interest expense and apply that effectively to the cost of the car. From a broader sense, you're looking at it as the cost of doing business, which can be avoided. Yeah. Just essentially cash flow ability increases quite dramatically. Dilution or leverage outside of the ABL line improves dramatically. The de facto cost, the effective cost of the car also reduces because you do not have the interest expense. If you have the interest expense over 20 days versus 10 days, this is a big difference. Yep. Understood, and I appreciate that clarification. You know, sort of was trying to get at, you've been running a negative gross margin in services and other for several quarters now and wanted to get a sense for, you know, when that could maybe drop and start to turn a corner and to generate some profit for you. I understand there's a lot of building out going on for sales, service, and charging infrastructure. But if you could give us some kinda clarification there, that would be, I think, helpful. And if you're willing maybe to provide an update on where you stand today in terms of battery costs, I know your goal about sort of parity with ICE vehicles, but maybe an update if you're willing to provide on where you stand in that trajectory. Thanks. I think, over time, every quarter progressively, we will see an improvement in the service and other business as our revenue continues to grow and, at the size of our fleet grows. It's as simple as that. Yeah. I would long term, I would expect service to be a significant revenue item, and to be a positive margin contributor. Yeah. It's gonna be a function of our fleet size. Age. Yeah, and age. Essentially, we're under warranty now. Exactly, we're under warranty. There's like a lot of stuff that's under warranty. As the, as the warranty expires, so there's like non-warranty items, then we would expect service to be positive gross margin. Okay. That also includes our used car sales. Yeah, a good point. Our used car sales is continuing to grow, and they have a healthy margin. That overall business, for mature companies is, in some cases, more profitable than new product sales. I'm not just talking about OEMs. Yeah car, auto OEMs. We are at the early stage of our growth here. As our fleet size grows, there are just so many opportunities in that business. It's a matter of time, I guess, simply said. Yeah. Okay. On the battery cost? That was the question. Well, that is a key sort of, like, competitive metric. I think it's safe to say we're much better than anyone else by a lot, but we prefer not to, give a precise number. Okay. Now let's go to the last question, please. Thank you. Our final question comes from Phil LeBeau with CNBC TV. Thank you, guys. Elon, quick question. In terms of as the federal tax credit starts to be phased out, as your sales cross over the threshold, what kind of an impact have you guys modeled into how much that might slow down potential sales? We don't expect this to result in. Yes, the sales tax or the tax incentive in the U.S. credit drops in half at the end of this quarter. We also start shipping to Europe and then start shipping to Asia. We certainly do not expect anything that would cause our production to drop below, let's say, a minimum of 5,000 cars a week. In terms of in the United States, do you expect that it'll slow down demand and sales within the U.S.? As we're able to offer lower cost versions of the car. Okay. We would expect demand to sustain in the U.S. I wanna be clear, like, it's not like we're holding back this lower cost version of the car intentionally. We're just like, "Is there anything we can do to provide a lower cost car now?" That's where we came up with the depopulated long range pack, just like basically taking, having a long range pack with fewer cells. Like, we really care about providing the end customer with the most affordable car that we can possibly produce, the best viability. If we could do the smaller pack now, we absolutely would. It's just gonna take us, I don't know, at least 3 months to get the production going, and then you gotta spool up production. That production's gotta go to, you know, we've gotta make the packs. Packs gotta go to the vehicle factory. The cars are going to get delivered to customers. That's why, you know, customers probably see the smaller battery pack on the order of like, you know, March or something, or February maybe. Something on that order. Okay. And, um- Thank you. You know, one thing, these do trigger kind of like maybe points that are worth bearing in mind. As our quarterly letter indicates, the Model 3 has the is the most efficient energy per mile electric vehicle out there 'cause it's got the best efficiency. We've got the best in terms of miles or kilometers per kilowatt hour, and we also have the lowest cost per kilowatt hour. This makes it very difficult for other companies to compete with Tesla because we are the most efficient car and the lowest cost batteries. I do encourage our competitors to really make a huge investment, and we've been saying that for a long time. They're only in this competitive disadvantage because, you know, we tried to help them as much as we could, and they didn't wanna take our help. They can use all our patents for free. They can use our Supercharger network if they can just have an adapter for our connector or something. We wanna be as helpful as possible to the rest of the industry. The fact of the matter is we made the investment in the Gigafactory and other companies didn't, and we put a lot of effort into having extremely efficient cars, which the other, you know, having the most efficient powertrains and the other companies didn't. You know, I'm sure they will over time, but that's what has put us in quite a strong competitive advantage, competitive position right now. Fantastic. I think that's all we have time for today. I just wanna add a comment. Sorry, go for it. In closing. Elon started with it, and I wanted to say that myself personally here. I wanna personally thank all the Tesla employees who worked incredibly hard this quarter and in prior quarters in each and every part of our business. Our results really are a reflection of the execution done in the company by the company and the passion that our employees have to deliver such results despite all odds. I also wanna thank all our customers and all our investors who have believed in us and our product and our vision of accelerating the world's transition to sustainable energy. Thank you from my side. Toni, anything? No, I'm good. All right. Anybody have any additional comments or anything? All right. Thanks, everyone. Yeah, look forward to the next call. Thanks. Thank you. Goodbye. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect, and have a wonderful day.