Earnings Call: Q3 2017

Nov 1, 2017

Good day, ladies and gentlemen, and thank you for your patience. You've joined the Tesla Motors Third Quarter 2017 Financial Results Q and 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. As a reminder, this conference may be recorded. I would now like to turn the call over to your host, VP of Investor Relations, Mr. Jeff Evanson. Sir, you may begin. Thank you, Latif, and good afternoon, everyone. Welcome to Tesla's Q3 2017 Q and A webcast. I'm joined today by Elon Musk, JB Straubel, Deepak Ahuja and John McNeil. Our 3rd quarter results were previously announced 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 yourselves to one question and one follow-up, so we can get to everybody in the queue. Before we jump into the Q and A, Elon has some opening remarks. A bit of a cold. So that's the end. Actually, we're doing this cold from the Gigafactory because that's where the production constraint is for Model 3s and the most important thing for the company. And I always move my desk to wherever well, not everybody has a desk, actually. I move myself to wherever the biggest problem is in Tesla. So I really believe that one should lead from the front lines, and that's why I'm here. I'll go into some of the Gig factory issues later in the call, but I'd like to start off by acknowledging some, I think, pretty amazing milestones for Tesla. One thing that I thought was really profound was that we surpassed cumulative deliveries of vehicles. We surpassed a quarter 1000000 cumulative deliveries since the company's inception and had record Model S and X net orders and deliveries last quarter. So things are really going quite well. To put that into perspective, 5 years ago, we had only delivered 2,500 cars. So our the Tesla fleet has grown by a factor of 100 in 5 years. I would expect 5 years from now to be at least an order of magnitude beyond where we are right now and possibly even close to 2 orders of magnitude. But for the skeptics out there, I'd like to say, ask them, which one of you predicted that Tesla would go from 2,500 units delivered to 250,000 units delivered now? I suspect the answer is 0. So consider your assumptions for the future and whether they are valid or perhaps pessimistic. So for Model 3, we continue to make significant progress each week. We've seen no fundamental problems with our supply chain or any of our production processes. Obviously, there are bottlenecks. There are thousands of processes in creating Model 3, and we'll move as fast as the slowest and least lucky process among those 1,000. In fact, there's 10,000 unique parts. So where I could say there are tens of thousands of processes necessary to produce the car, we will move as fast as the least competent and least lucky elements of that mixture. So while the vast majority are doing incredibly well, there are some problem areas. And after I give the business overview, I'll do a deep dive into the biggest problem area. So based on what we know now as we've gotten really into the details of some of the worst bottlenecks, We expect to achieve a price rate of 5,000 Model 3 vehicles per week by late Q1 2018, so probably sometime in March. This I mean, think in the grand scheme of things, this is a relatively small shift. The Model 3 is a 10 year program, and so we're talking about a few months out of a 10 year program. It's in the grand scheme of things, so Lake Point is doing net print value calculation. This is immaterial. And we have a clear path to that. We understand the bottlenecks. It's difficult to fully understand these things as we actually try to do them. And it's worth noting that some of our manufacturing areas, we're actually seeing capabilities that are, we estimate, in the 6000 to 7000 unit per week capability, well in excess of the 5,000 unit capability. So and we're optimistic with further optimization that many of our production processes will need very little, in some cases, no so not saying no, but almost no CapEx to reach something close to 10,000 units a week. It's remarkable how much can be done by just speeding up robots, shortening the path, densifying the factory, adding additional robots to choke points and just making lines go really, really fast. Speed is the ultimate weapon. And our the design intent of the Model 3 being that it's designed to make accessibility is going to have to be accurate. It's far easier to build this car than a Model S and vastly easier than a Model X. The primary production constraint really by far is in battery module assembly. So this is so I'll just do a little bit of a deep dive on that. There are 4 zones to module manufacturing that goes through 4 major production zones. The zones 34 are in good shape. Zones 12 are not. Zone 2, in particular, we had a subcontractor, systems integration subcontractor that unfortunately really dropped the ball, and we did not realize the degree to which the ball was dropped until quite recently. And we had to this is a very complex manufacturing area. We had to rewrite all of the software from scratch and redo many of the mechanical and electrical elements of Zone 2 of module production. We've managed to rewrite what was about 20 to 30 manures of software in 4 weeks. But there's still a long way to go. It's because the software work can be fast with the electromechanical elements that need to be fabricated and installed and that getting those atoms in place and rebuilt is, unfortunately, a lot longer and has far more external constraints than software. This is what I spent money late night on the Gig factory working on JV spend here constantly, and we've reallocated many of our best engineers to fundamentally fixing Zone 2 of the module line. And then what's behind that is Zone 1. On the plus side, we now have a very detailed understanding of what is necessary to fix zone 1 and zone 2. We also have a new design for zone 1 and 2 that is about 3 times more effective than the current design. So when we put in and there are 3 lines of module production. Lines 1, 2 and 3 are essentially identical. Line 4, which will have will be linked to the new design, where we have triple the effectiveness of or will be as good as the other three lines combined. So we're very confident about a future path of having incredibly efficient production of modules and that this will not be a constraint in the future. But unfortunately, it does take some amount of time. This is like moving like lightning compared to what is normal in the automotive industry. There's still some finite amount of time necessary to fix something that we thought was in good shape. We were told by our supplier, it was in good shape, but was really not. So this has now been a title by Tesla's internal automation group in the U. S. And Tesla Automation U. S. And Tesla Grommen from Germany. We have a large team from Tesla Grommen also working this year and looking to very rapid progress. And like I said, I am personally on that line in that machine, Translarna's personally where I can. And JV is basically spending his life at the Gigafactory. See, that's the sort of detail on that front. One thing I want to mention that there are a lot of articles about Tesla firing employees and layoffs and lots of stuff. These are really ridiculous. And like anyone, any journalist who have written articles for this effect should be ashamed of themselves for lack of journalistic integrity. Every company in the world does annual performance reviews. In our annual performance review, despite Tesla having an extremely high standard, a standard far higher than other car companies which we need to have in order to survive against much larger car companies. You can't be a little guy and have equal levels of skill as the big guy. If you have 2 boxes of equal ability and one's much smaller, the big guy is going to crush the little guy, obviously. So the little guy better have heck of a lot more skill. And that is why we're just going to get covered. So that is why our standards are high. They're not high because we believe in being mean to people. They're high because if they're not high, we will die. Despite that, in our annual performance reviews, only 2% of people didn't make the grade. So it's about 700 people out of 33,000. So this is a very low percentage. GE, I don't know if they still do, but they certainly for a long time had a policy of firing 10% of their employees' performance every year, no matter what. If you were to stack Tesla's performance related releases compared to other companies, the number would be low. So the only reason these articles had any play whatsoever is because journalists and editors with low integrity don't provide any context for where they stood because the actual article would have read Tesla fires 2% of its employee base for performance based reasons, a remarkably low number compared to other companies. But of course, that would be a meaningless article, so they forget to include that. Shame. And then also what was not reported is that several 1,000 employees were promoted and almost half those promotions were in manufacturing. I think let's switch to questions. Okay, Latif. Let's go to the question queue, please. You. Our first question comes from the line of James Aubertin of Consumer Edge. Your line is open. Great. Thank you and good afternoon everyone. Wanted to ask with respect to and Elon, thank you for doing the deeper dive into the zones and the bottlenecks. How does this change the trajectory or does it change the trajectory from a margin perspective on the Model 3? And then maybe as an aside, can you tell us where you are today on a production per week basis and where you expect to be by the end of 2017, just so we can get an idea of the ramp? Thanks. I don't want to go into like the week by week stuff. The reason it's tricky is because people just read too much into it. The RAM curve is a step exponential. It means as you alleviate a constraint, the production suddenly jumps to a much higher number. And so although it looks a little staggered, if you sort of zoom out, that production ramp is an exponential with giant week over week increases. I'd like to state a number at the end of Q4, but there's too much uncertainty right now to give that with any precision. I do feel confident about end of Q1, maybe sooner. But really, it's like we're like in a vertical client here, so it's really hard to say. And also to your earlier point, Deepak here, it does not change any of our projections in terms of the long term target gross margin. These are all short term issues. I mean, I can certainly say by the end of the year, it will be in the thousands. It's well up here. Yes. Yes. I'm sorry. Well into the 1,000 per week. In the 1,000 by the end of the year. But where exactly, it's hard to say. And literally, if you move the calendar by like 2 or 3 weeks, you would see giant changes. So it's like the date the quarter to date will fall somewhat sort of arbitrarily in that exponential curve. So even a matter of a few weeks, which show a very different number, People tend to extrapolate on a linear basis instead of an exponential. In fact, most people don't know what an exponential is. So human intuition tends to be a straight line extrapolation, but we're really on a very steep exponential. So it's really an S curve. So it starts off really slow and it ramps very rapidly on an exponential basis, it does start to go sort of linear right in the middle and then it sort of asymptotes off at the target production capacity. Really target a whole supply chain in a factory for a given production capacity and, yes, try to get this as possible. We're highly confident of the long term margin number of coming back sooner or higher for Model 3? You talked to me. Yes. None of our projections in terms of material cost or manufacturing, labor and overhead or depreciation of the other elements have changed as a result of these last few months to modify that target. Okay. All right. We have a lot of people in queue. So let's move on to the next question, please. Thank you. Our next question comes from Adam Jonas of Morgan Stanley. Your line is open. Thanks everybody. Just one question and one follow-up. Elon, you described Model 3 the Model 3 launch as production hell. How I mean, you have a cold, but how hot is it in hell right now? And is it getting hotter or less hot? I mean, are we solving more problems that are coming up? I mean, this is sort of imprecise. I'm not sure what each level means really, but let's say level 9 is the worst. We were in level 9. We're now in level 8. I think we're close to exiting level 8. I thought we would probably be more like in level 7 by now, but it's and I have to tell you, I was really depressed about 3 or 4 weeks ago when I realized that we were kind of in level 9, then we got to level 8. Now I can see sort of a clear path to sunshine. And so I feel really pretty optimistic. Right now, if you talked to me 2 weeks ago, I would have been quite pessimistic and I was sort of quite down in those. But it's very obvious what we need to do. It's just a matter of work to get there. We're working 7 days a week to do it. That person even here on Zone 2 module line at 2 a. M. On a Sunday morning helping diagnose robot calibration issues. So I'm doing everything I can. Jason, everything I can. The whole team is on it. We're on it. And we're on it. We got it covered. It's just going to take us a few months longer than we expected. Got it. Just one follow-up for Deepak. On the secured bonds due 2025, the issuance from last August, was this meant to be a permanent part of the cap structure? Or is it more of a bridge loan to help fund some of the near term cash absorption issues related to the Model 3 delay and things of that nature? Yes. It is it's an 8 year tenure on that debt offering. And to give us that cap rate for that timeframe. The next question comes from Tyler Frank of Baird. Your line is open. Hey, it's Ben Kallo for Baird. Elon, you guys talk a lot about the 3 being easier to manufacture than the S and the X. Could you just give us a sense about the difference in manufacturing the volume of the 3 compared to basically 10 times the volume that you're trying to get to in the near term? And then I have a follow-up. Yes. There's vastly more automation with Model 3. Now the tricky thing is that when one doesn't work, it's way harder to make up for it with main labor. So with Esarex, because a lot less of it was automated, we could scale up labor hours and achieve a high level of production. With Model 3, that's like tends to be either the machine works or it doesn't or it's limping along and we get sharp quite severely on output. So yes, I mean, J. B, do you want to add? Yes. I think that's spot on. The design on whole is much easier to build. Yes, by a lot. But it's also intensely automated, which is part of what lets us realize the margin and the cost targets, but that does become difficult to bring that automation online. That's where we are. Yes. And Doug is on the line. Perhaps he can add some on his of manufacturing quality. Doug, do you want to maybe start to dive for example? Sure. The number of actual, what we call a pitch, which is a station for a robot to work on the car in general assembly, is about onefour of the typical industry average for number of stations that use to build a car. So the way we do sub assemblies and the care we've taken in design for manufacturing engineering to make it work. I guess my follow ups on that point. So in the battery assembly and automation things that you're working through and the software for configuring the robots, how I'm thinking of this, Is it a certain number of man hours that have to go into this and that's fixed? Or like you know the fix or what are you throwing at it right now? Is it people or is it time required to or all of the above? Yes. We're throwing a huge amount of people at fixing the machines. And then occasionally, there's like some part of production manufacturing process where the machine is finally broken and then we have to have a bypass to a manual operation. Yes, totally fixed automation. But that's really it's really inefficient because the system is really not designed for a manual bypass to your broken machine or machine when software is not right or whatever the case may be. It's just an extremely complicated machine with combined electrical, mechanical and software challenges. It's not that different than what we do bringing up a brand new car. And a lot of the It is harder to supplement with manual than S or X because the system is designed as a very tightly integrated automated system. So it's very unwieldy to try to supplement or make up for a machine not working with manual activity. So we think it's like a if you had a spreadsheet and a couple of cells in the spreadsheet were manually calculated, well, yes, you could still do your spreadsheet stuff, but it's going to be a lot slower until the last cell is automated and then it's going to be super fast. All right. Got it. Thank you, guys. Our next question comes from Ramin Shah of Nomura Instinet. Your line is open. Great. Thank you and congratulations on the milestone. The competitiveness of autopilot is something that's come up a lot recently and I just wanted to ask about your hardware capabilities. We're actually at a technology conference today hosted by NVIDIA and their newest autonomous solution according to NVIDIA is 10x more powerful than the version that Tesla is using. And they're saying we can get you to level 5 autonomy. And so along those lines, the year over year improvement in the NVIDIA board just seems really significant. And I was curious, Elon, if you could just talk about what you think you need to do from a hardware perspective to advance autopilot? Well, first of all, I think that we'd be able to achieve full autonomy with the current hardware. The question is, it's not just full autonomy, but full autonomy with what level of reliability and what will be acceptable to regulators. But I feel quite confident that we can achieve human level approximately human level autonomy with the current computing hardware. Now regulators may require some significant margin above human capability in order for a full time to be engaged. They may say it needs to be 2% safer, how much is safer, 1,000 percent safer, I don't know. I'm not sure they know either. But I think I'm confident that we can get to approximately human level with our current hardware. And yes, we'll have more to say on the hardware front soon. We're just not don't get ready to say anything now. But I feel very optimistic on that front. For customers that have signed up for full sub credit rating capability or purchase that option, If it does turn out that a computer upgrade is necessary in order to meet the regulatory requirements in their area. We will replace their computer with something with greater power. It's just sort of unplug the old one, plug the new one in. But we feel confident of the competitiveness of our hardware strategy. I would say that we are certain that our hardware strategy is present any other option by a lot. Okay. Great. And then if I could ask, you said that the deposit balance for Model 3 strengthened. Can you give us what that actual balance was? We don't give specific balance for deposits by Caroline. We just give the combined number, which you can see on our balance sheet with customer deposits. Our next question comes from John Murphy of Bank of America Merrill Lynch. Your question please. Good afternoon. Just a question on core cash flow for the Q4 and the Q1. I mean, it sounds like, obviously, there's some delays here in the Model 3, which is understandable given the complexity. I'm just curious as we think about cash flow for the next two quarters, would we think about them relatively similarly to what we just saw in the Q3 plus what you would whatever you would sell out of inventory, so it might be a bit better? I'm just trying to understand Deepak, how much of that $2,500,000,000 inventory is finished goods that you might be able to sell out of in the 4th quarter? Well, firstly, as we continue to ramp up Model 3, our cash flow from operations is going to increase over the next few quarters. And this is the positive virtuous cycle of cash flow or working capital that Model 3 provides us because we effectively pay our suppliers later than we collect from our customers. And also over these quarters, our CapEx payments will start to decline as we pay off over the next couple of quarters. All the remaining Model 3 related CapEx. So there should be an improving trend over the next 2, 3 quarters. But to be fair Deepak, I mean, it sounds like this is a little bit more uncertain than you thought before as far as production and delivery. So I'm just trying to understand what kind of cash you can generate out of the inventory that you hold right now? Yes. So firstly, our inventory is going to come down on S and X and also what's important is, it is given these short term delays, we have to be prudent in how we spend our money. And so we are managing our CapEx and OpEx growth to be in line with the growth of our fleet. And so for example, CapEx related to our stores or service centers or superchargers, we are slowing that down to be in line and that's logical with our growth of our fleet. So all those actions will come through in terms of helping us conserve cash. Okay. I'll follow-up with detail later. Thank you. Thank you. Our next question comes from Ryan Brinkman of JPMorgan. Your line is open. Great. Thanks for taking my question. Just with regard to the ramp up of the Model 3 production, I can see what's happening with the 5,000 per week target from 1Q to 4Q or from now it's 1Q versus 4Q. But I think it's less clear from reading the letter, what's happening with the previous guidance of the 10,000 units per week at some point in 2018? Is that now like beyond 2018? I think before investors were estimating that if you could hit it at the end of 2018, you do over 250,000 vehicles. If you could hit it more toward the middle, you do over 325,000. But what now would be a reasonable expectation based upon what you know for the amount of Model 3s that do get built in 2018? It's a bit too early to make an exact number, but I mean if you extrapolate from $5,000 towards the end of Q1, we do want to hold up on significant CapEx until we are confident about cash flow on Model 3. So then that's a question of how it takes to implement having necessary to get to 10,000 units a week for Model 3, which is a number we are confident can be sustained from a demand standpoint. And we want to figure out how much we can push the 5,000 up from the existing equipment. And then learn from those and figure out how do we redesign whatever we do for the next bit and spend more efficiently our CapEx. So it's the right thing to do. Yes, exactly. As I mentioned earlier, we're finding out some faster line, very clearly, a people of 6 or 7,000 units a week and maybe more than that just by shortening path length, speeding up robots, adding some robots where the turn points exist, simplifying some of the processes and a few minor pot redesigns it's remarkable how much you can improve cycle time. Okay. I see. That's helpful. Maybe just as a follow-up go ahead, yes. Go ahead. No, go ahead. I was just going to say, is the gross margin discussion also related to this at all? I mean, I see the reduced outlook for 4Q, but do you feel any differently about, for example, the ability to do 25% margin when you're doing kind of 250,000 run rate? And as long as the production is going to be restrained, do you have any ability to continue to preference for longer maybe the higher margin, higher trim level variance of the Model 3 to help with that? We can fine tune those things when we get there. But overall, our and I'm reinforcing this again, these are all short term issues and it doesn't change over long term prognosis on Model 3 gross margin. Okay. All right. Latif, let's go to the next questioner, please. Our next question comes from Alex Potter of Piper Jaffray. Your question, please. Yes. Thanks very much. I was wondering I guess to the extent that these production bottlenecks are ultimately somebody else's fall, is it worth your time trying to claw back some of the costs that you're presumably incurring due to the subcontractor, I guess, dropping the ball, as you put it? Yes. I think, first of all, I think at the end of the day, everything is our fault and my fault, most of all. If we pick the wrong subcontractor, we're the fault. So I don't want this to be sort of an externalizing responsibility. Really, it's helpful before picking the wrong supplier and then not realizing it until way late in the game. We will be able to call back some amounts, but it certainly will not make up for the lost revenue, the lost free cash flow. So it's not enough, yes. But it's going to matter that much. The goal is right now to fix Raman. Yes, exactly. Okay. Fair enough. I guess one other issue. You referenced a gross margin headwind on the S and X due to trim and mix. I was wondering if you could talk maybe a little bit more explicitly about what that was and then what the corrective measures you're taking to address that? Yes, it's John. I can address a piece of this. So a large chunk of it was discontinued trims. We've introduced the 100 kilowatt battery pack, which has a 3 35 mile range in Model S. And as a result of that, we discontinued the 90 kilowatt pack. And as those cars were in inventory, we reduced price to move them out. And so that was a piece of the gross margin headwind that won't repeat as we go forward. And in addition to that, the mix did shift. We sold more 100 kilowatt cars, actually than we predicted we would, but order rate went up for the 75s even faster. And so we sold more 75 kilowatt cars in the mix than we predicted and that had a gross margin impact as well. Given demand is it continues to increase with 100 kilowatt pack and the mix shift is occurring more towards that product. We'll see, as we indicated in the letter, increasing margins as we roll into Q4 and then into Q1. So this is the heart of the discontinuation really was the success of us debottlenecking the 100 kilowatt production we talked about in Q2 and really rolling that into strong demand in Q3. Yes. We also just increased the amount of value that's in a Model S In an X. Yes, in an X, but particularly Model S, because we felt there need to be greater differentiation between the S and Model 3. So the base cost the fundamental cost of a Model S increased because of more included content. So the full Model S has had air suspension, for example. Much of the premium elements were included by default. Just felt you need to be clear the reason for people to buy a Model S over Model 3. And the market responded really strongly to that in terms of demand. So in Q3, the Model S in the U. S. Outsold the Mercedes S Class by 2 times, over 2 times actually. And if you added up the sales of Audi A7, A8, the BMW 7 Series and the Porsche Panamera, we outsold all those combined. So the market really did respond to the increased value. Yes. Yes. And our deliveries to in terms of our market share in the U. S. Did went up in Q3 for S and X. S and X both. Yes, that's right. Compared to Q2. And I saw some of the articles from our quarterly earnings that are about sort of that's your question kind of S and X, why we reduced production on S and X. We didn't reduce it very much. It's just sort of from about 2,000 each week to 18 100. And we did then note to break down inventory. So finished goods inventory was too high. We also just needed a bunch of people on Model 3 line. So we thought, well, we'll take the 3rd shift from Model S and X and apply it to Model 3. Because really running out of out of Liverpool, honestly, it's like we're sucking Liverpool dry, both in the Gigafactory and in Fremont. And so it's like, yes, there's just only so many people that can make it to the factory. And then we are finding that we're able to improve the efficiency of production of PS and X. So previously it required 3 ships to do 2,000 units a week. And it's important to appreciate, like the whole supply chain and everything, it's all sized to 2,000 units a week. So like I said, why can't you just spontaneously make 2,500 units a week? Because the entire supply chain, all the parts, everything has got to go to 2,500 and that requires a bunch of CapEx. Then you got to match sort of increased stores. Like everything's got a significant cadence. So sort of like deciding what seems like the right number. So the right number is about 100,000 units a year combined S and X and we size the supply chain accordingly. But we expect to continue making production improvements on the S and X line and be able to take it up from up 1800 units a week to 2,000 units a week in probably early next year and still be on 2 shifts, which means that our labor hours are reducing per vehicle. And that gets us to our sort of roughly 1,000 year cadence. And we can work on supply chain efficiencies and all that. But we do expect to important point, we expect to sell more cars in Q4. Than we did in Q3. Than Q3. So we expect sales and deliveries to be higher in Q4 than Q3. But to reduce model S and X inventory to achieve that. Okay, next question, please. Next question comes from Rod Lache of Deutsche Bank. Your line is open. Hi, everybody. Just had a question about how we should be thinking about capital spending maybe at a high level next year. It sounds like you are going to be deploying some capital to increase to 10,000 units per week. And obviously, there have also been some reports about you investing in another assembly facility in China. So is your CapEx still expected to be lower in 2018 versus 2017? So, Rod, in terms of the China Patriot, I'll leave for Ynon to make comments on that. But I think maybe better if we hold on broadly speaking to that question to the next quarter when we provide full 2018 guidance and give you better clarity on our capital spend for the different elements in our plan. I suspect it's comparable, similar, obviously, to 2017. We have some obviously, some it's a sort of strategic choice. Do we have higher CapEx and higher growth or lower CapEx and lower growth? Yes. So it's but we can move that lever wherever it makes sense where it makes sense to do so. As mentioned earlier, though, we want to make sure we know what to scale before we spend money on it. So the Model 3, figuring out which production lines can be simply accelerated and which production lines need to be duplicated. We'd far rather accelerate the production line than duplicate it. If we were to make those CapEx decisions right now, we'd be making them kind of shooting in the dark. Yes. But with respect to China, I wouldn't expect any significant CapEx on China until 2019. It won't be material in 20 8. The China plan is sort of maybe something like this is just a like don't say you're watched by this, but we it's sort of a rough target of startup production in about 3 years. And it would be serving the China market and perhaps some other countries in the region. And that's really its intent just to be able to provide Model 3 and Model Y. We're not making Model S and X, but we're making probably Model 3, probably Model Y primarily for the mobile trans market. And it's really the only way to make the cars affordable in China. But it's 3 years out. And just to clarify two points, is your objective to have something that's kind of Fremont sized in China? And I wanted to also clarify your earlier comment about when exactly the production of Model 3 goes exponential. Were you suggesting that that It's exponential right now. Yes. Well, I guess, yes, off of a low number. But are you getting to a few 1,000 per week already by the end of this year? Or did you mean to say that you'll have a few 1,000 produced in total No, no. Again, it's really tricky because of that being exponential. If you had to move the calendar date by plus or minus a few weeks, you'd see gigantic differences in weekly output. But what I meant was in something like a few 1,000 units per week at the end of Q4. But there's like if you said, okay, what about a few weeks after Q4? I'd say, yes, definitely. So it's just going to be very, very sharp rising very, very sharply at that time. To be clear, you're not talking to provide guidance. He's just giving you're giving us all the time. Exactly. I mean, it will be like a fighter jet in vertical climb here. It's like from one moment to the next, it sounds very different. Yes. It sounds like you'll be able to provide some pretty high confidence update on the Q4 earnings call. Yes. For sure. Yes, absolutely. Even with the deliveries announcement, we'll have some feedback for you, as we mentioned in the letter. Yes. I would have, I think, very we'll have a very good understanding and high clarity on the Q4 earnings call. Okay. And then the China size, is this a Fremont type of project? I mean, it's something in the hundreds of thousands of vehicles per year. I'm not sure where it is exactly in the at least a couple 100000 vehicles a year, maybe more. Okay. All right. That's all I can get out of them. Thanks. Next question, please. Our next question comes from Tony Sacconaghi of Bernstein. Your line is open. Yes, thank you. I have a question, a follow-up please. Elon, you just talked about sort of this trade off between growth and capital spending. And quite frankly, I think it's really the first time that I've heard you talk about that potential trade off. Usually, Tesla has been all about doing as much as quickly as possible to lead the move to electrification to establish a 1st mover advantage, etcetera. So is the hesitancy in going all out growth, is that a concern that you might run out of cash and have to raise more cash? Is that a bandwidth concern for the organization in terms of trying to do too much too quickly? Is that a concern about using capital effectively? What's at the root of that decision? And why isn't the why is there even a decision, I guess, is the question? I mean, I would say it's probably a bit of all. I mean, it's prudent for us to think through all of that as we are continuing to grow. Certainly, we want to be there's a certain sense of fiduciary responsibility that we have in addition to just growing like crazy. These are mad percentage growth rates for the auto industry. Now I think some comparison of Tesla's growth rate relative to Ford in the Model T era. Are We're talking about a rate of growth faster than the Model T, which is the fastest in history. So these are nutty growth rates. Exactly. It's certainly not the first time we've thought about this. Yes, we have talked about that. Growth rate, I don't recall the exact numbers, but I think it's been in the 70%, 80% every year and next year. Even with 5,000, it will be like crazy compared to this year. So growth rate continues to be extraordinary. Yes. If our growth rate continues at anything like that in the coming years, I mean, if it continues to be something like that, Tesla will be the largest car company in the world by volume as well. Tony, it may be helpful. It accelerates with new product introductions too. Model X reached Model S demand rates in half the time. So at twice the rate of demand build. So not only are we growing, but we're accelerating as we grow. Yes, exactly. Model 3 will be, yes, call it, 5 times will be 5 times Model S. Yes. Correct. And if you look at the timing, it is order of magnitude downward. Yes. Yes. I guess the question is I don't know. Looks like. But really perhaps to punctuate a little bit more, you've talked about pretty soon you're going to be close to cash flow generative once you get the volume on the Model 3. And so I'm just surprised why you're actually not trying to step on that as quickly as possible because ostensibly once you get to that level, then cash flow really doesn't become a problem. And so is there any difference in that view? Otherwise, I'm just struggling to sort of reconcile why you don't want to get to scale, get to volume, get to positive operating cash flow as quickly as possible. Listen, just to be clear, we are trying to get as fast as we can to $5,000 and then we will work as fast as we can to get to 10,000. Yes. I don't think we were saying we wouldn't do it. We were just saying we would think through it and make the strategic trade offs in terms of timing, but we'd think through it. Yes. I mean, we should like to move back to it. Like what people have different interpretations of timescales. For us, it's like, well, should we have the growth of 10,000 be take 9 months, 12 months or 15 months? Okay, fair enough. These are like flashing the pan timescales for other manufacturers, right? Okay. If I could just follow-up on a separate topic. On the S and X gross margins, they look like they must have fallen materially unless Model 3 gross margins were worse than minus 1,000%. So maybe you can help us understand what S and X margins, gross margins were this quarter? And given most of the one time stuff is gone and the mix shift is favorable, why wouldn't they snap back to be similar or better next quarter? And do you think that the promotional activity helped drive volume for SNX this quarter? Yes, I mean, firstly, your analysis is completely off from what we see internally. And the mix shift that we saw, part of that continues in Q4. And Largely because we're custom we're largely custom orders. So there orders were already placed in Q3 that we will ship in Q4. And then as we achieve continue to achieve efficiencies and also work on that mix shift, which takes time, we will continue to see improvement and our full confidence in S and X gross margin. Yes. The chunk of the cars being sold in Q4 are inventory burn down and some including older models, the service loaners, and those go for slightly lower average selling price than a custom motor vehicle. That has maybe a point or 2 effect on gross margin. But yes, I mean, it should get back into the mid-20s essentially in Q4. Okay. Thank you. Next question, please. Our next question comes from Brian Johnson of Barclays. Your line is open. Yes. Thank you. I want to just drill down on the service revenue and expenses line. That's something we often talk about, but a lot of the other questions have been asked. It looks like year over year revenues were up $180,000,000 costs were up $247,000,000 Could you just talk about the drivers of that change between what's left of the drivetrain outsourced business, the CPO business, the service loaner actual vehicles expense and then the cost of the PP and E for the actual people and service infrastructure? Yes. So I think what you see there is the increase in PP and E for the service infrastructure. We wanted to get out in front of demand as we're increasing both S and X fleet size and also Model 3. So we opened a location just about every 4 days in Q3. And to get ahead of that demand, you probably saw that we put 180 mobile vehicles on the road and we plan to double that this quarter. And so a lot of that what you see is PP and E. In terms of the drivetrain issue that you mentioned, that's mostly behind us. In fact, we see very little of that now. The reliability for S and X continues to improve. And you asked about the CPO business. The CPO business for us last year or last quarter was about $238,000,000 revenue business. We expect that to grow to $1,000,000,000 run rate or a $1,000,000,000 business for all of 2017. And so that business is growing rapidly at the same time. And we're running those we do our own CPO refurbishment. We do that in the same service infrastructure that we're servicing the cars. So you see a little bit of that cost into that line as well. Okay. And my follow on for Deepak probably is, can you walk us through the depreciation when you produce, for example, in the Q2, those 100 P100D cars Mr. Musk talked about going into the loaner fleet. Where do those how do those get depreciated while they're in the loaner fleet? And when they're transferred to be sold, what's the accounting on that? Yes. They are capitalized as inventory because these cars are salable. And when these cars get sold, the depreciation related to those cars gets recognized in cards. Okay. So it's not in the cost of the service centers? No. Okay. Thanks. Next question, please. Next question comes from Joseph Spak of RBC Capital Markets. Your question please. Hi, thank you. You also mentioned some constraints in body shop welding and final assembly and final assembly obviously makes sense given constraints elsewhere. I was wondering if you could talk a little bit about welding. And then as you get to your year end run rates, is there still going to be a discrepancy between sort of different parts of the entire line? Or do you think everything's going to be roughly at the same level? Doug, would you like to take that on? Well, with respect to welding, the rate is controlled by are you specifically asking about the video? Or do you have another Sorry, in the letter it said body shop building listed as a constraint. Yes. It was listed as a constraint. Yes. It's not the same level of constraint as the Gigafactory, but it is one of the more complex parts of the overall assembly line. So to reach our overall production goals, that has to ramp significantly. But again, it's not at the same level of constraint as modules. And it's really driven just by the sheer number of robots in the body shop. It's the highest concentration of robots anywhere in our overall production line. But it is coming up well. The bodies that we're building are of excellent quality. We've had fantastic crash results in testing them, and we're building more and more every day. We're ahead of the rest of the production curve. Okay. And then as a follow-up on the capital question, Ilan, I think a year ago on this call you said to go from 5 to 10 was would require a fair amount of capital, but you were confident that would be less than going from 0 to 5. And now that you have some real world experience with the ramp, I'm wondering if you have any different views there, if you could put a little bit of a finer point on that comment. Yes, I don't think we actually feel even more strongly that our efficiency of CapEx on the next phase will be significant compared to the 1st phase. Yes, absolutely. Some elements will require almost no CapEx. It's really come to realize that the you really want to make the factory grow incredibly fast. I think I think speed is the ultimate weapon when it comes to innovation or production. And we're pushing robots to the limit in terms of the speed that they can operate at and asking suppliers to make robots go way faster. And they've been a shock because nobody's ever asked them that question before. It's like, if you can see the robot move, it's too slow. We should be caring about air friction, like things going so fast. You should need a strobe light to see it. And that's incredibly critical to CapEx efficiency. And obviously, we're going to be designing a lot of the robotic elements and automation elements internally. So yes, because front of suppliers are just too slow to respond in some cases. Okay. We have 10 more questions in the queue, so we're obviously not going to get to everybody. Elon, you want to take just a couple more? Sure. Okay. Next question please, Latif. Next question comes from Colin Rusch of Oppenheimer. Your line is open. Thanks so much. Could you talk about the percentage of sales that are coming from these loaners to the fleet vehicles? We're trying to reconcile the MSRP declines that you implemented and what it looks like is a little bit more severe ASP decline? And then also if you could talk a little bit about why you felt it was necessary to add value to the Model S and Model X while lowering price? It seems like you should be able to drive volumes with 1 or the other. Yes, I think to the first question, I would say roughly about 5%. Yes, very low single digits in terms of service loaner sales as a percentage of total units. Yes. As far as the prices, it was Model X was always it was really the one that saw more price reductions and other things, and then the 100 kilowatt hour pack, which was 100 kilowatt pack cars was artificially priced high because we were production like really blocking constraint on that pack. It was never our intention to set some price quite that high, so we reduced a little bit. And then added some content as default. So we're just sort of split it between some price reductions where we thought things were a little overpriced and then added some content just to have a clear differentiation. We weren't quite sure what the response would be to Mol 3. So maybe we might have overcorrected a little bit, but that's kind of where it is. Okay. And then just moving to the China strategy, obviously with the permanent magnet requirements for the DC motor for the Model 3 and what we've seen historically with export restrictions in China and improved environmental enforcement in terms of mining practices. How important is that to the strategy of moving into China and maintaining your supply lines for the growth of the Model 3? I think we think about China more from a demand side than anything. We're building complete cars and shipping them across the ocean and into the largest electric vehicle market in the world. So what really pulls us into China primarily is to be able to supply that market and to make the cars more affordable, as Elon said, so that we're not forcing consumers to experience tariffs as we put those cars in. That's a much bigger impact than any supply chain or sourcing materials issue. Okay. Next question? Next question comes from Rob Sear of Guggenheim. Your line is open. Great. Thank you very much. I recognize it's not the biggest focus right now, but just curious on solar declining as you expected. But just wondering when you think that can start growing again? Is that a function of solar roof? Or is that sort of moving past your sales changes? And then I guess similarly on energy storage, the ramp looking sort of exiting this year into 2018, is that constrained by Model 3 or is that on its own separate track? Thanks. Yes. We do expect that solar demand to rebound as we move solar sales into all of our stores, which is a much more efficient channel for demand generation. And that's just sort of conventional solar. The solar roof stuff, we expect, is going to be well, we're confident it's going to have extremely high demand. And we're just going through the validation process for the solar roof tiles. It does and they're working right now, I should point out. So I have the silver tiles on my house. So and I didn't even notice that they're there. They've landed so well. So they look really good, but a roof is expected to last a long time, so at least 25, 30 years. And so there's a certain rate at which we can do accelerated live testing on all the various components so we can maybe try to accelerate live testing on a 30 year roof in sort of 6 months, but it's hard to do it in less than about 6 months. So and then we're going to fact that into the production process. So I have no doubt that this will be a very significant part of the business down the road. It just takes a little while to get this behemoth rolling. But once it gets rolling, it's going to be a behemoth. Yes. We continue to install pilot engineering early customer homes. We continue the cadence of that. Yes. So JBS still have one and quite a few others at this point, more than 10. And we still are on track to turn on some most of the production line in Buffalo at the end of this year to start ramping final actual production versus this in the final factory. Yes. And maybe to your point about the separation from Model 3, those production areas are largely separate. That's right for the pack side. Yes, storage. Pack side. Storage versus vehicles. The energy storage production is actually going at a really actually it's doing really well by our ability to complete the South Australia project or be on track to complete that. That's Puerto Rico. Yes, as well as the deployments Puerto Rico and elsewhere in the Caribbean. That's been running at nominal rate and doing quite well. So those are quite separate. Thank you. Yes. Down the road, there will be some sale conflict. I think if you so fast forward a year or 2, we really need to think about cell production as being a constraint and some of the oil change going into self production. So if you go a couple of years out, making sure that we have secure supplies of lithium hydroxide, cobalt. There's actually a small amount of cobalt. I'm going to say nickel. Nickel, graphite, copper, aluminum, separator, like the line. The module lines that we're operating to assemble the cells into modules are totally separate. So that's the Model 3 module line that we are focused on right now and improving quickly. But the energy module line in the same building, coincidentally, is a totally separate line. Okay. I think that's unfortunately all the time we have today. Appreciate all your great questions and we look forward to talking to you next quarter. Goodbye. Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.