Good day, ladies and gentlemen, and welcome to the Tesla Inc. fourth quarter 2017 financial results Q&A conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. If anyone should require assistance during the conference, you may press star then zero on your touch-tone telephone. I would now like to turn the call over to Senior Director of Investor Relations, Mr. Martin Viecha. Please go ahead, sir.
Thank you, Andrew, and good afternoon, everyone. Welcome to Tesla's fourth quarter 2017 Q&A webcast. I am joined today by Elon Musk, JB Straubel, Deepak Ahuja, and Doug Field is on the line. Our 4Q 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 portion of today's call, please limit yourself to one question and one follow-up. Please press star one now, if you would like to join the question queue. Before we jump to Q&A, Elon would like to have some opening remarks. Elon?
All right. Thank you. 2017 was obviously a big year for Tesla. We launched the Model 3, which is our first mass production vehicle. It's a huge step change for Tesla. A lot of challenges, I think we made tremendous progress on that front. We also designed and installed and got into operation the world's largest battery in Australia's largest battery by a significant margin. That battery is exceeding its performance targets significantly. We also unveiled the Tesla Semi, which is a super heavy-duty truck, maximum load, semi-truck, and the next-gen Roadster, which we believe will exceed gasoline sports cars on every dimension. We also achieved record production and deliveries of Model S and X.
Overall, I think, while there were challenges associated with Model 3 ramp, you know, at the we're in a deep, we were in a deeper level of hell than we expected. Still a few levels deeper than we'd like to be, but swiftly exiting, I think. So it was really, I think, on balance, a phenomenal year. I'd like to thank everyone at Tesla who should be very proud of the work they've done. This is incredibly difficult. I'd like to thank everyone for their hard work and contribution to 2017 being a really great year for Tesla. I also wanna thank our suppliers, particularly those involved in Model 3, as they've shared the very difficult struggle we've had in ramping up production.
They've really spent the midnight oil, spent weekends and taken a lot of risks and suffered alongside us in the challenges associated with the ramp. I'd like to thank them for supporting us through this difficult time with Model 3. As well, our customers and Model 3 reservation holders, you're gonna love your cars, we'll work and get them to you as quickly as we possibly can. As for Model 3 production, we continue to make significant progress every day, we're targeting a weekly production rate of 2,500 vehicles by the end of March and 5,000 by the end of Q2. As we'll talk about or as you've seen in the letter, the quarter-over-quarter production of Model 3 is rising exponentially.
I'm hopeful that people think that if, you know, we can send a Roadster to the asteroid belt, we can probably solve Model 3 production. It's just a matter of time. And really the error bars on the timing are really quite small in the grand scheme of things. It's 2018 is likely to be a very big year for us. At some point in 2018, we expect to begin generating positive quarterly operating income on a sustained basis, after hitting 5,000 per week of Model 3 production. I'm cautiously optimistic that we will be GAAP profitable. It's not certain, but I'm cautiously optimistic that we will actually be GAAP profitable with no asterisk.
Thank you, Elon. Andrew, let's go to the first question.
Certainly. I'm showing we have a question from the line of Rod Lache with Deutsche Bank. Your line is now open.
Hi, everybody. Thanks for taking my question. Congratulations on the launch yesterday. Wanted to just ask a couple questions. One is just to get a little bit more color from you on Model 3, what the production run rate is at the moment? Maybe if you can just provide us with a little bit more color on where the challenges are at this point? On the last call, you talked about, I think two of the four zones at Gigafactory that were still, you know, kind of an issue and manual operation. Have those been resolved? Once you get to 2,500, is the ramp to 5,000, is that just merely involve increasing line speeds?
Sure. I'll try to give as much color as possible. You know, I'm reminded of, I think it may have been Churchill's line about sausage. If you like sausage and respect the lawyer, you should watch neither being made. And to some degree, that is true of a production ramp. You know, there's I wouldn't read too much into the day-to-day battles of this or that, but I'll give you the color, but don't like, don't read too much into it. Yes, there are four zones in module production. Module production is fundamentally the limiting factor on Model 3 output, which is ironic since battery modules really should be the thing we're best at.
I think in part we were probably a little overconfident, a little complacent in thinking that this is something we know and understand and put a lot of attention on other things and just got too comfortable with our ability to do battery modules since we've been doing that since the start of the company. Of the four zones, two of them, which was subcontracted to the production systems was subcontracted to other companies, flat out didn't work it turns out. Like, I mean, we were promised they would work. They and they just didn't work.
We had to do what would normally be maybe an 18-month development cycle for a production system of that scale and complexity, and try to do that in basically six months, or maybe a little six to nine months. And we've tackled that on multiple levels. We, we have a design that is nearing completion for a new automated system for zone one and two that is being led by a Tesla-grown team. It's an excellent design. All the other work that they've done has been, has performed to spec. And we expect a single Tesla-grown line to be equivalent to three if not four of the current lines that we have, and be smaller, which has made it kind of amazing.
Then we have what we call a semi-automatic line, which is a series of small automated stations manned by people. They've actually been remarkably effective. It's actually, to some degree, renewed my faith in humanity, that the rapid evolution of progress and the ability of people to adapt rapidly has is quite remarkable. Our semi-automatic, our sort of semi-manual, semi-automatic line is exceeding all three of the automatic lines right now. That is something that we're able to scale quite rapidly. I mean, JB, is there additional color you'd like to fill in there?
Sure. That's a, that's a great summary of it. I think much has been made about the manual production of modules, it's really not very accurate. These are, as Elon said, semi-auto lines where we have people that are, you know, moving materials perhaps between the machines that are actually performing the operations. There is still a degree of automation doing the operation.
Right. It's not artisanal.
Exactly. You know, this is what has been ramping, you know, quite effectively in the last, first part of this year.
Yeah.
You know, we're continuing to expand that, those semi-auto lines and, you know, that is effectively bridging the gap as we redesign the full automation and bring that online.
Yeah.
And-
It's quite a sort of, actually, I think it's probably worth providing some tours for investors that are interested so you can actually see firsthand. I think a lot of it is like if you see it firsthand, you will understand exactly what's going on. I think let's arrange for some new tours for investors that are interested, because I think you can really get a feel for what it is. Otherwise, it's just some words that are kind of hard to put, hard to imagine.
I also just wanna add, I think it's fair to say that, you know, this maybe degree of, you know, complacency that happened at the end of last year has been pretty thoroughly replaced by an intense focus from a huge portion of the Tesla team. There are a lot of different initiatives and teams, whole teams, you know, targeted at this area. I mean, as Elon opened with, it's not a question of if we will get to the production rate, it's just a question of the matter of time.
Yeah. Absolutely.
If I could just clarify, what's the run rate now with semi-automation, and when are you expecting the fully automated line to come on?
Well, it's probably a level of granularity that is not productive to dive into in terms of exactly what is coming from which operation. We do expect the new automated lines to be landing and starting up at the Gigafactory in just the next, you know, well, you know, landing in site within this quarter.
Yeah.
Okay.
We expect the new automated lines to arrive next month in March.
Yep.
It's working in Germany. It's got to be disassembled, brought over to the Gigafactory and reassembled and brought into operation at the Gigafactory. It's not a question of whether it works or not, it's just a question of disassembly, transport and reassembly.
Exactly.
That's, you know, yeah, we expect to alleviate that constraint, with alleviating that constraint, that's what gets us to roughly 2,000- 2,500 units per week production rate. The next constraint would be material conveyance at our Fremont vehicle plant. And there's a very sophisticated automated parts conveyance system that we think is probably the most sophisticated in the world, or at least we're not aware of one that is more so. And the software for that is quite complex. That would be the next constraint on production to get to 5,000, is the conveyance system in Fremont. That also appears to be on track. You know, we feel like the error bars around the unit volume predictions are getting [smaller] with each passing week.
Okay, Andrew.
All right. Our next question comes from the line of Adam Jonas with Morgan Stanley. Your line is now open.
Thanks everyone. I also wanna add my congrats for the launch yesterday. That Twin Falcon landing was probably the sickest thing I've ever seen in my life.
Thanks.
First question is for Deepak. Yeah, it was just nutty. Totally nutty.
Nutty. Yeah.
Deepak, a question for you. Given the negative trade cycle, your negative working cap, you know, some of the modeling analysts are doing, kind of simulating when you get to 2,500 or 5,000 or maybe somewhere in between that some of the arrangements you made with your suppliers who have been very helpful, that you might temporarily run enough negative working cap to even have operating cash flow exceed CapEx. Is that something that's possible? Again, I know there's execution behind that clearly, but is that something out of question? Temporarily even?
I mean, we gotta look at it from a full quarter perspective. The negative working cycle is amplified by the rate at which we ramp our production. Given our present plans of getting to 5,000 by end of Q2, it's a fairly gradual, it's exponential from where we started, but it's not gonna create a situation where our cash flow from operations will exceed CapEx.
Okay. Thanks for confirming that. Just as a follow-up, Elon, your kinda compensation, long-term compensation plan obviously got a lot of attention and raised some questions, however long-term from now on succession. Just wanted to ask you, do you see your successor as CEO of Tesla, someone currently within the company right now or from outside the company, kinda how do you see that? Thanks.
Well, I mean, there's no active search going on or there's not even or passive. There's active or passive search going on for a new CEO of Tesla. I expect to remain CEO for the foreseeable future. At some point, if there's somebody really spectacular inside or outside the company who could take on that role and for, you know, who'd want to, you know, have that title and that role, that would, that'll be fine with me and I would focus on product development, which is, you know, design and engineering, which is what I like doing best. There are no plans to make a change at this time.
Okay. Next question please.
Thanks.
All right. Our next question comes from the line of Tyler Frank with Baird. Your line is now open, sir.
Hi, thank you. Thanks for taking the question, guys. I guess, Elon, bigger picture and looking out a few years, you had mentioned a couple quarters ago that the 1 million unit target for 2020 was still there, and that you would need to introduce the Model Y by then. How do we connect from where we are today to getting to 1 million units a year? What should we look for this year in terms of ramping production or, you know, building a facility for the Model Y?
We are going to make some capital investments towards the end of this year related to Model Y. I don't wanna [drop the gun] on those, but I think we've got a good plan. I'm pretty excited about the how we're designing Model Y. It's really taking a lot of lessons learned from Model 3 and saying, "How do we design something to be easy to manufacture instead of difficult, really," you know? I really think it's gonna be pretty great and pretty scalable for Model Y. Yeah, we are gonna, as you suspect, need to make some capital investments in the second half of this year, really late Q3, Q4 for Model Y. I think we wanna wait until, you know, wait probably three to six months before announcing any definitive plans on production location, and the details associated with that.
Is that million unit target still in play?
Yes.
Perfect. Just one quick follow-up. How should we think about the Tesla Semi and investments needed there and what do you guys think you can hit from an annual run rate, you know, in the next, let's say two to four years?
Well, there's a big difference between two and four years. You know, at Tesla, you know, I've said, I think even a few years ago, I think Tesla's gonna kind of grow at an average of roughly 50% a year, which is a crazy average growth rate for a company manufacturing a complex product at scale. Two versus four is a huge difference.
If you say, it's much easier to predict, especially these production curves, they look like an S curve, where you have an initial exponential, which, you know, the exponential appears If since people naturally tend to extrapolate on a straight line basis, an exponential always appears, the predictions are conservative in the beginning, and then the exponential takes off, then it becomes linear, and then it becomes logarithmic. It's easier to predict, well, far easier to predict the endpoint, or the steady state of the S curve than anywhere on that exponential or log curve. If you say four years, I think 100,000 units a year is a reasonable expectation. Maybe more, but that's the right, roughly the right number, I think.
For the Tesla Semi?
Yeah.
Perfect.
I think we might be able to exceed the specs that we unveiled last year, too, which is pretty exciting. I know there's, like, speculation that we might not meet them. I think we're going to exceed them. You know, I made this comment before. It's like [cruel things like loss] over these comments, but I would really take these to heart. The competitive strength of Tesla long term is not gonna be the car. It's gonna be the factory. We're gonna productize the factory. Really, this is a lesson that is kind of obvious in history because the Model T wasn't the product, it was River Rouge. The Model T was a very simple car. Anybody could have made that car.
Not anyone could make Rouge River. That's really what will be Tesla's long-term competitive advantage. We will, you know, we'll have a great product, so a great design, a great engineering the product itself in the vehicles, and, you know, autonomy and all that sort of stuff. It's the factory is gonna be the product that has the long-term sustained competitive advantage, in my opinion.
Okay. Next question, please.
Our next question comes from the line of David Tamberrino with Goldman Sachs. Your line is now open.
Great. Thank you. Elon, on your autonomous vehicle strategy, why do you believe that your current hardware set of only camera plus radar is gonna be able to get you to fully validated autonomous vehicle system? Almost every competitor has noted that they need the redundancy from lidar hardware given the robustness of the 3D point cloud and the data it's generated. What are they missing in their software stack and their algorithms that Tesla is able to obtain from just a camera and plus radar? Further, what would be your response if the regulatory bodies required that level of redundancy and is really needed from an incremental lidar hardware?
Yeah. Well, first of all, I should say, you know, there's actually three sensor systems. There are cameras, clearly redundant forward cameras. There's the forward radar and there are the ultrasonics for near field. Third is also, the third set is also important for near field stuff, just as it is for humans. I think it's pretty obvious that the road system is geared towards passive optical. We have to solve passive optical in image recognition extremely well in order to be able to drive in any given environment and a changing environment. We must solve passive optical image recognition. We must solve it extremely well.
At the point at which you have solved it extremely well, what is the point in having active optical, meaning lidar, which cannot read signs? It's just giving you a. In my view, it is a crutch that will drive companies to a local maximum that they will find very difficult to get out of. If you take the hard path of a sophisticated neural net that's capable of advanced image recognition, then I think you achieve the global maximum. We combine that with increasingly sophisticated radar. If you're gonna pick active photon generator, doing so in 400- 700, you know, nanometer wavelength is pretty silly since you're getting that passively.
You would want to do active photon generation in the radar frequencies of approximately around 4 mm because that is occlusion penetrating. And you can essentially see through snow or rain, dust, fog, anything. It's just, I find it quite puzzling that companies would choose to do an active photon system in the wrong wavelength. They're gonna get a whole bunch of expensive equipment which makes the car sort of expensive, ugly, and unnecessary. I think they will find themselves at a competitive disadvantage. Now, perhaps I am wrong, in which case I'll look like a fool. I am quite certain that I'm not.
Understood. As a follow-up, if I may, can we talk about the trajectory for the Model S and X margins [3 Q] 2017, I think the company was saying you're in the low 20% range. I think it took another step down per the report today. I'm assuming it's probably at 20%. What's the path to recovery from here? Can you frame us through how you're gonna get to that margin expansion?
Yeah, we feel very good about the recovery of S and X gross margin, to, in 2018 to a level which we have seen in the past. It's a combination of a variety of things. It's increasing the mix of the larger batteries, the higher option content, and then also we have a very good and a robust, manufacturing cost reduction roadmap. We will achieve a lot of manufacturing efficiencies which continue to occur on S and X, so we feel really good about it.
Our internal plan, you know, whether we meet this or not, I don't know, but I think we will. Internal plan calls for somewhere around a 30%-32% cash gross margin on S and X by the end of the year and probably 25%, maybe 26% GAAP gross margin on S and X towards the end of this year. Model 3, maybe not by the end of this year, but not far behind it.
Right. This is, as Elon said, internal roadmap, an internal plan. Things sometimes get delayed, they don't work out exactly, but I think you get a sense that we feel really good about the improvement that's ahead.
Yeah. We have a clear path to that goal.
Yeah.
Yeah.
Okay. Next question, please.
Our next question comes from the line of Romit Shah with Nomura. Your line is now open.
Yes, thank you. It sounds like from the letter that you could do more than 100,000 S and X in 2018, but you're constrained by the 18650s. I'm just curious, you know, what would it take to see the 2170 cells in these vehicles?
Well, this is JB. It's, it's something we've of course contemplated, but it's quite a large change to the architecture of the module and the battery pack overall. You know, while the 18650 supply, you know, is, somewhat of a cap at about 100,000 units per year, you know, even just a few months ago, you know, we didn't feel that expanding and making some long-term bets on expanding that supply with Panasonic in Japan was really the right, the right risk. It's something we could consider, but right now, you know, we're pretty happy with that balance, and it matches our other production capabilities and our other investments.
Yeah. It's also like for any given a complex manufacturer item, in order to go past the target capacity, you really need to move the whole supply chain in cadence.
Exactly.
You really have to then shift everything to say, okay, if you want to make 20% more, S and X, everyone has to make 20% more. There have to be investments in new lines, or it's gonna require over time, which negatively affects gross margins. You kind of design the manufacturing machine for a particular rate, and then you either have to redesign the machine or go redline. I think we feel pretty good about the 100,000 a year, for S and X. We wanna focus on just improving the efficiency of production.
Okay. Okay. Yeah, makes sense. Go ahead.
Of course, on Model 3, I mean, that's really where.
Yeah, exactly.
The majority of the effort is.
Okay. The other thing you guys mentioned was upcoming autonomous coast drive, which we're really looking forward to. Could you give a little bit more color on timeframe when something like that would be available for customers?
Yeah. We actually, I mean to address this, 'cause obviously I missed the mark on that front. Our focus was very much on Model 3 production, so everything else kind of took a second place to that. We could have done the coast-to-coast drive, but it would have required too much specialized code to effectively game it.
Make it somewhat brittle in that it would work for one particular route but not be a general solution. Other people would be able to repeat it, but just not any other route, which is not really a true solution. I am pretty excited about how much progress we're making on the neural net front. It's also one of those things that's kind of exponential, where the progress doesn't seem like much progress, then suddenly, wow. That's been my observation generally with AI stuff.
You look at, say, something like what Google's DeepMind did with AlphaGo, went from not being able to beat even a pretty good Go player, to suddenly it could beat the European champion, then it could beat the world champion, then it could thrash the world champion. It could then thrash everyone simultaneously. They made AlphaZero, which could thrash AlphaGo and where just learning against itself was better than all the world's human experts. It's gonna kind of be like that for self-driving. It'll see like, well, this is a lame driver. Like, okay, that's a pretty good driver. Like, holy cow, this driver's good. It'll be like that. I mean, timing wise, I think we could probably do a coast-to-coast drive in three months, six months at the outside.
Is it available for customers immediately, or is there a lag?
Yeah, that would be something that's available for customers.
Okay. Thank you.
We're going to experiment or do testing.
Yeah, sure.
Yeah.
Okay.
Thank you very much. Question, please.
Thanks.
Our next question comes from the line of Ryan Brinkman with JP Morgan. Your line is now open.
Hi, good afternoon. Thanks for taking my question. You know, as you put solutions in place one by one to unclog Model 3 production bottlenecks in Fremont or at the battery module line in Reno, are you finding that the ultimate solution is more or less expensive to implement than your original plans, you know, which called for a 25% gross margin on the vehicle? Do you feel any differently now about the cost to manufacture the Model 3 or its gross margin potential versus, you know, prior to the start of production last July?
I think and we feel good about that. I think, like, I think we're probably able to exceed that next year. Probably. A bit, let me put it like, our understanding of manufacturing has improved dramatically. We can think of a huge number of ways to make it far better, far more efficient. I'm really excited about how much we're learning about manufacturing. That's why I said I think long-term strength Tesla will be the manufacturing by essentially productizing the Gigafactory, which is like the world's biggest product, basically. Make it like a nuclear aircraft carrier look pretty small by comparison.
Maybe just to add to that. I mean, the product bill of materials cost and the, you know, embedded labor cost is, I think that's where there's opportunities. We are simplifying, and we're finding ways to improve the design incrementally as we go through the ramp. You know, if there's some small increases in CapEx, you know, that doesn't, you know, directly, you know, it will be overwhelmed by the improvements in simplicity and some cost savings in the product itself.
Yeah, I think-
Okay.
Bottom line is we feel really optimistic about the long-term potential for gross margin on Model 3, and especially Model Y.
Yeah, we haven't seen anything to suddenly change our view.
That's very helpful. Thank you.
Yeah.
And then just for Yeah.
Yeah.
For my follow-up, you know, I see the guidance in the letter about the quarterly operating income turning positive at some point in 2018. That's great. I'm just curious what your thoughts are with regard to when you also might generate free cash flow. Is that less of a medium-term focus, you know, as you prefer to invest operating cash flows from the Model 3 into the Tesla [truck], the Roadster, and Model Y?
Yeah. We could be positive cash flow, like, I think pretty significant positive cash flow probably in like third quarter. You know, which is like four or five months from now. We think it makes sense to invest in Model Y. Yeah.
Future growth of our energy products.
Energy products, yeah.
Model 3, future growth of that.
Yeah, the opportunities we see are just-
Yeah.
We see really good opportunities there.
Exactly.
Um-
Yeah. Makes good business case and business sense to invest.
Yeah. Super bullish on manufacturing. Can't emphasize it enough. What I find sort of interesting is that, like, the, our competitors, like, well, the car industry thinks they're really good at manufacturing, and actually they are quite good at manufacturing, but they just don't realize just how much potential there is for improvement. It's way more than they think. I went through this math, I think, on a prior earnings call, but like, it sounds like some of the, like the fastest car factories produce a car maybe every 25 seconds.
It sounds fast, but if you think of a five-meter long car including gap, a 4.5 meter car with a half meter gap or something, that's only 0.2 meters per second. Like grandma with a walker can exceed the speed of the fastest production line on Earth. Really not that fast. Walking speed is 1 meter per second, so 5 x faster than the fastest production line on Earth.
That's interesting.
Why should at least be jogging speed?
I mean, in the limit, companies should start caring about the aero drag in the factory, which, you know, that's maybe around 20 or 30 mi an hour, or to quote 30 km an hour, 40 km an hour. It's like, stuff should be moving at fast speed.
Okay, thank you very much.
Thank you.
Let's go to the next question.
All right. Our next question comes from the line of Toni Sacconaghi with Bernstein. Your line is now open.
Yes, thank you. You commented in the shareholder letter that capital expenditures for 2018 were expected to be a bit higher than 2017. I'm wondering if you could tell us what exactly is in that, call it, roughly $3.5 billion. Are you gonna get to full like 10,000 car per week capacity? Is that in the $3.5 billion? What will Gigafactory production be? In the slightly more than $3.4 billion, is that also including the investments, Elon, that you mentioned on Model Y? Where exactly is this level of capital spending going to take us in 2018? I have a follow-up, please.
Sure. I mean, our biggest, a very high level sort of, breakdown. Our biggest investment is obviously in the Model 3. That includes completion of the payments that we still have to make on the capacity we are putting in place now, as well as significant investment in required upfront for the next phase of Model 3 production to 10,000 + per week. That's, I would say overall.
Yeah.
More than 50%.
Yeah, yeah.
Way more than 50% is Model 3. The rest is all the many other things we talked about, whether it's energy storage.
Primarily Y and energy storage.
Right. Then our infrastructure spend, superchargers, stores, service centers. We wanna significantly increase the service capacity. We're gonna significantly increase our Supercharging capacity.
Yeah.
All of those pieces then add up to the total spend.
The, you know, just to give some sort of flavor for optimism on Model Y front, I mean, I think, you know, Model Y, I think we might aim for something like maybe capacity of 1 million units a year, something like that, just for Model Y alone. I think we'll be able to do that for CapEx that is less than the Model 3 CapEx at the $500,000 million . Probably I think we can probably improve CapEx by a factor of two. It's not a promise, but that's my gut feel on Model Y CapEx. Just give you a flavor for my level of optimism on improvements to the manufacturing front.
Thank you. That's helpful. Is the $3.5 billion and the greater than 50% to Model 3, is that gonna complete all the required equipment to get us to 10,000 a week at the end of the year? Are we still gonna have incremental capital expenditures? Separately, on my second question, around Model 3 gross margins, I think you had said that you expected them to be breakeven this quarter. Obviously, volume was lower, and so you didn't get there.
For next quarter, you're suggesting that they're gonna be negative again, despite the fact that I think Q1 volumes are much higher than what you would have anticipated originally for Q4 when you thought that margins would be breakeven. Can you help reconcile the apparent enthusiasm you have about the gross margin trajectory with the fact that your guidance around gross margins in the near term actually appears more cautious than it was, [90 days ago]?
Did we just lose the line?
Can you hear us?
Hello?
Yes. I can hear you. Thank you.
No worries. To sort of finish off your first part of the question, we will still have further investments in 10,000 per week capacity of Model 3 happening next year as all of that will be concluded next year. There's always a lag in our, you know, cash outflow and while we continue to test the equipment and verify it. That'll continue in 2018, in 2019. In terms of the Model 3 gross margin, our expectations earlier were of a much steeper ramp than what we are projecting here.
You know, we were, you know, we were targeting, as you well know, at one point hitting 5,000 by the end of 2017, and now that's six months later. With that slower ramp, we just know we'll have inefficiencies. We have the full capacity for the depreciation of all that equipment and the operating costs are hitting while we're not producing as many cars. It's actually pretty simple.
Yeah. Okay.
In that sense. It's only temporary.
Yeah.
It doesn't imply anything fundamental.
Yeah, exactly. The problem is like when you've got a machine where most of that machine, I mean, the overall production and supply chain machine, is at a 5,000 unit capacity, but then 10% or 15% of it isn't, then you've got this massive load on a way smaller production volume. As you fix the remaining 10% [or 15%] of the production machine, you're able to get to product production, and then things improve dramatically.
Right.
You know, it's sort of like having a car that's operating at a fraction of its. You know, let's use a gasoline analogy. If you've got a four-cylinder car operating on one cylinder, it's like, okay, cylinders are great. Once all four cylinders are good, then it's just like a big machine, essentially.
Okay, thank you very much. Let's go to the next question.
Our next question comes from the line of Philippe Houchois with Jefferies. Your line is now open.
Yes. Good afternoon. Thanks for taking the question. I have a slightly non-related to earnings, about the electric truck, the Semi. In the past, Mr. Musk, you have spoken about a super capacitors as a way of generating energy or storing energy, and particularly in the application of heavy trucks, I would expect that the surge of energy in slowing down or braking in a truck would be too much for a battery to absorb. Are you considering super capacitors as an application for the Semi, or what is your kind of general thought on that technology and the implications to make that industrially viable?
Yeah, I mean, ages ago, I was gonna do, basically, applied physical control science degree, a PhD in capacitors. I'm a big fan of capacitors. I think that the lithium-ion chemistry is so good at this point that capacitors will not be needed. There's a certain power to energy ratio, and once you have a huge amount of energy which is needed for range, then you automatically have the power you need for absorbing, for being able to do rapid acceleration and braking.
Yeah, it's maybe not intuitive, this is JB, but the power to energy demand on the battery in the heavy truck is actually, you know, generally less than.
Yeah
I.n our, you know, sort of performance vehicles. It's definitely less also in most cases than even the high rate of discharge energy products.
Yeah.
As Elon said, you have a lot of energy, so you end up with a lot of power, actually more than you need.
The way the chemistry works is that you're able to actually extract, for short periods of time, very high power from lithium-ion cells as you sort of have ionic migration right on the surface. The sustained power for lithium-ion is considerably less than the power over, say, the course of several seconds or a minute. The several seconds power for lithium-ion is remarkably good because you're essentially using ion migration from the outer surface. It's like if you have a parking lot, all the cars in the front of the parking lot can just exit. Once you start getting cars from deep in the parking lot, it takes a while for them to wind their way out.
Thank you.
Thank you very much. Let's go to the next question.
Our next question comes from the line of Brian Johnson with Barclays. Your line is now open.
Yes, I'd like to talk, follow up a little bit on the first question around some of the manufacturing roadblocks, as well as the comment about building a machine to build a machine, which I believe was the title of a 1990 MIT book about Toyota. Could you maybe give us some more discussion really on the managerial culture, the process level, you know, how you would benchmark yourself, for example, against a Toyota factory, which seems to be able to launch a new product in about three or four months to ramp up? Or, you know, at the other extreme, 'cause I know Mr. Field came from there, kind of what Foxconn does and its goal to replace humans. In particular, talk about the managerial processes, not so much the robots you're putting into place.
I'm pretty sure Toyota cannot ramp up a new product in three months. In fact, that's 100% certain about that. You know, Deepak spent many years at Ford before joining Tesla.
Yeah, I mean, generally, companies including Toyota take anywhere from 6 months to 1 year when they come up with an all-new product.
All new is like, that's a, like they're still, it's not really the amount of technology that changes from not that much.
It's a major platform.
Yeah.
It's not all new as a Model S or a Model X could be done. It is longer.
Right. They're not fundamentally new technologies.
Yep.
Okay, within that, what are the differences though in the way you're gonna be managing the factory?
The most fundamental difference is thinking about the factory as really as a product, as a quite vertically integrated product.
It's treating it as more of an engineering and a technical problem as well.
Yeah.
Instead of.
Right, which is the Toyota Production System.
Yeah, we don't think so.
I think that generally it's treating it as more of an optimized operational problem.
Yeah.
Being extremely lean and really managing the flows of materials and the supply chain and, you know, they're great at it. This is, I think, a different approach, looking at it really from a deep technical lens in terms of, you know, automation, robotics, process.
Yeah. Imagine like if the Model S was a, the way you design a Model S, design a factory like it's a car. You still have a lot of workers, you still have a lot of people. I mean, just like with Model S, say we have a large service organization. You get the scheduled maintenance. There's things that break. There are crashes that need to be repaired. There are technology upgrades. You don't actually ship people with the Model S. That would be weird. You know, there are not like tiny people in the car. We expect that the Tesla factory really has people, a lot of people around the factory, but very few people in it.
I also think that, the degree with which we have, this is Doug, the degree with which we have product development and manufacturing development integrated is unique. Model 3 already is a dramatically simpler car to build than the Model S. Even many people in operations who have worked their career in volume manufacturers say the Model 3 is a huge step forward from anything that they've built. As we go forward, Elon mentioned Model Y, the a big part of our manufacturing capability is gonna come from how simple we make our products.
You, you may want to-
How do you manage the people in the interim?
Yeah, yeah, Doug, you come from Foxconn. Yeah, you were at Apple and then Ford and then Apple. Yeah.
The model at Foxconn was very different, where very quick product ramps and very high scale was achieved through manual processing of also what is fundamentally a product whose simplicity is orders of magnitude below ours. An iPad is less complicated than our center screen in many ways. It's a very different order of magnitude in terms of the kind of product you're building, and it's extremely manual because that is the way that you have to ramp very quickly and then end the life of a product and bring up a new one.
Okay, thanks.
Actually, you know, one thing we forgot to mention is Jon McNeill, who was heading up our sales and service group, is departing the company. We wish him well in his future career. Going forward, I will be having the sales and service report directly to me. There are no plans to search for a replacement.
Okay, let's go to the next question.
Our next question comes from the line of John Murphy with Bank of America. Your line is now open.
Good afternoon. Shockingly, I want to follow up on the production of the Model 3. Seems like that's going to remain the hot topic here. You know, do you have enough experience with production of the Model 3 outside of the issues you're facing in the Gigafactory that you're confident once those problems are solved, you can get up and running?
Is there sort of a contingency here that once you get that worked out, you'll be ramping up in Fremont and there might be some other hurdles that are discovered? I'm just trying to understand if there's some incremental kinks that might come in the production process as you ramp up. Also, as we think about the step from 5,000 - 10,000, you know, is that something that can be done inside the Fremont factory? It sounds like you're confident that.
Yeah.
Your density is much higher than what even Toyota and GM were producing out there potentially on capacity. Just curious on those two terms.
There are only two things that I'm aware of that are constraints in production of any significance. The module being the most significant, and then the parts conveyance, basically the automated conveyance system that brings parts to the line. The way the Fremont factory is set up is that there's actually On the ground floor, we actually created two levels. The bottom level is all parts conveyance.
Parts coming from a warehouse where the parts are sort of automatically stored, and then are transferred through an automated conveyance system, all the way to the line, on the conveyance system being on the ground floor and then raised up to the line, which is actually on kind of a artificial mezzanine.
I think we can get 10,000 vehicles a week out of Fremont without a significant without creating really any new buildings of significance in the existing space. We will need to bring up the south paint shop, which is what we actually were using for S and X paint, until we upgraded north paint to do S, X, and 3. With relatively small CapEx of like way less than we spend on north paint, we're confident we can bring south paint up to achieve the approximately 600,000 vehicle per year rate to combine, you know, 100,000 S and X, 500,000 3, which would be 20%-30% more than Toyota and GM produced in the same facilities. We're a lot more vertically integrated as well.
Literally and figuratively, right?
Yeah.
Um, a-a-a- and, um-
Definitely.
Just as we think about that though, Elon, is that sort of an asymptotic limit in that plant? Based on what you're really talking about here, you know, could you get more out of that plant? As we look at the Model Y and there's a 1 million units capacity, we're definitively looking at a new facility?
You know, I'm pretty excited about the Model Y stuff, and I think I wanna present that in a more cohesive fashion. It's probably not the next earnings call, but call it six months from now. I'm really excited about Model Y manufacturing and the design for manufacturing. Like, essentially, how do we design out all the pain that we're currently going through? We do not wanna experience it again. This is really a lot of pain. The pain level is extremely high. I mean, I was in the factory, I was in the [Gigafactory] on Thanksgiving Day, as were many other Tesla people. It's like it's hardcore, okay? Seven days a week. There aren't vacations. We don't wanna repeat that.
Okay. And then-
Maybe one-
Is there?
The material flow delivery that Elon mentioned, as we develop very high density and velocity lines, the limit starts to become how we get material to that line. We'll solve that for the Model 3 line, but eventually, within Fremont, the limit to production may be how many trucks we can get in, how quickly.
Yeah.
In order to build cars.
That's it. You could use Hyperloop for that.
Yeah. Actually, you know, funny enough, we are looking at building tunnels using The Boring Company or something. Because we have, for example, our seats production is at a separate building on [Page Avenue]. We have a bunch of trucks moving seats back and forth between the primary Fremont production and the seat factory. We actually get constrained on how many trucks can we dock and undock at the seat factory, which is only, I don't know, 0.5 mi or 1 mi away from the vehicle plant. It'd be pretty easy to just have a tunnel do an automated conveyance from seats to the factory.
I mean, there are things we can do where we can build subsystems and then transport subsystems to Fremont. These things get increasingly difficult, but they're all doable. I can see a path where we get to, say, 600,000 Model 3 production, and 100,000 S and X, so maybe 700,000, which would be, like, almost 50% more than GM and Toyota got out of the plant. I mean, that seems achievable.
Surprise. Can I just sneak one in for Deepak? I apologize, [Steve]. You did a great job with working capital in the quarter. I mean, I think, you know, some of us might kind of throw stones and say it might not be repeatable. You did it and you got the cash, you know, in the door. It's done, and it was like just some pretty good work here. How repeatable do you think the benefit from working capital is, you know, going forward? I mean, is this really just the benefit of negative working capital and as you ramp up, you'll get this cash inflow? Also, as we look at the customer deposits and the ZEV credits, you know, those were two, I think, apparently large, you know, cash inflows. I mean, how repeatable do you think those are in the future as well?
Yeah, some of those are not repeatable. We significantly reduced the finished goods inventory of S and X in Q4, which will not repeat itself going forward, and that was a huge impact to our working capital. Customer deposits may not be as well, as you pointed out. As the Model 3 ramp continues, the negative working capital needs for that, which essentially creates extra cash for us, will be repeatable. We'll continue to keep very tight controls on our accounts, receivables, and everything else we do to manage cash to make sure we are being efficient.
Okay. Thank you very much.
Thank you very much. Unfortunately, we're not gonna be able to get to everybody, but maybe one last question, please.
Our last question comes from the line of James Albertine with Consumer Edge. Your line is now open.
Great. Thank you, and appreciate you sneaking me in. A topic doesn't get asked, I think, a lot, or as much as it should, you know, we believe is maybe one of the reasons why the Model S and X demand remains so high after many years of production is sort of the over-the-air update ability of these vehicles. I'm just wondering, you know, it had been several quarters ago, kind of pre-Model 3 questions. We are hearing more about, you know, software you were rolling out to existing customers. Just wondering if you can give us some color on what level of uptake you're seeing.
And, you know, I would imagine we're not seeing that in the upfront Model S and X margins, but potentially there's some sort of, you know, those are vehicles that are earning assets for you in the future of, you know, sort of the customer ownership. If you could kind of talk a little bit about what trends you're seeing there or elaborate a little bit on that would be helpful.
Yeah, I think, I think the, probably the biggest item is, as we get the software right, people upgrading to, you know, Full Self-Driving capability of the S and X. Anything with Hardware 2, which is like, you know, the eight cameras, more advanced ultrasonics and improved compute capability, I think we'll be capable of the Full Self-Driving. The Full Self-Driving, the Hardware 2 stack is also capable of doing easy swap out of the computer.
It turns out we need additional computing capability to meet the regulatory standards for, you know, for self-driving, for particularly if it's Like, we think with the current compute hardware, we can get to better than human, but the standard for regulators may be that you need to be, you know, 5x better than human or something like that. We believe that is solvable purely with compute hardware. And it would be a relatively minor expense to do that. I think probably that's the biggest opportunity.
Along the same lines, not all customers take our enhanced Autopilot too.
Yeah.
People hear more, we can see an uptick on that. It's all around Autopilot, to your point.
Yeah, exactly. And that's some of the sort of semi-automated driving definitely doesn't require any hardware upgrades, and that's, you know, $5,000. That's essentially a software product with zero cost, zero module cost and so it's 100% margin. When Full Self-Driving is available, we think probably that's more than a $3,000 increment.
Yeah.
That's maybe $5,000 increment or something like that.
Is there any data you can provide us though today in terms of the percentage of consumers that are upgrading or opting in, you know, just to get a sense of kind of the order of magnitude what that business could look like over time?
Yeah. That's Well...
Not many people are opting in at this time.
For the Full Self-Driving, since it doesn't actually work, essentially people are buying an option on it, on it working in the future.
Right.
That's a very interesting advantages or [very like trailer].
Right.
There's also the, you know, as I mentioned prior, things that we expect to operate kind of a shared autonomy fleet, where, you know, Tesla's like kinda like a combination of Uber or Lyft and Airbnb, I guess, where you can opt to have your car enter a shared fleet or not. Tesla can also operate its own fleet in places where there's not enough people sharing their vehicles. That, that's, you know, that's a pretty significant opportunity.
Understood. Thank you again.
Okay. I think that's unfortunately all the time we have today. Appreciate all your great questions. We look forward to talking to you in the next quarter. Thank you very much and goodbye.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.