Good day, ladies and gentlemen. Thank you for your patience. You've joined the Tesla, Inc. third 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. Should you require any additional assistance during the call, please press star then zero on your touchtone telephone. 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 third quarter 2017 Q&A webcast. I'm joined today by Elon Musk, JB Straubel, Deepak Ahuja, and Jon McNeill. Our third 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. Please press star one now if you would like to join the question queue. Before we jump into the Q&A, Elon has some opening remarks.
Elon?
Sorry. I have a bit of a cold, so. Let's see. We're doing this call from the Gigafactory, because that's where the production constraint is for Model 3, the most important thing for the company. I always move my desk to wherever Well, I don't even have a desk, actually. I move myself to wherever the biggest problem is in Tesla. I really believe that one should lead from the front lines, and that's why I'm here. I was going to some of the Gigafactory 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 million cumulative deliveries since the company's inception, and had record Model S and X net orders and deliveries last quarter. Things are really going quite well. To put that into perspective, five years ago, we had only delivered 2,500 cars. The Tesla fleet has grown by a factor of 100 in five years. I would expect five years from now to be at least an order of magnitude beyond where we are right now, and possibly even close to two orders of magnitude. 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 zero.
Right.
Consider your assumptions for the future, and whether they're valid or perhaps pessimistic. 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 thousands. In fact, there's 10,000 unique parts. More accurately, 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. While the vast majority are going incredibly well, there are some problem areas, and after I give just this overview, I'll do a deep dive into the biggest problem area.
Based on what we know now, as we've gotten really into the details of some of the worst bottlenecks, we expect to achieve approximate 5,000 Model 3 vehicles per week by late Q1 2018, probably sometime in March. In the grand scheme of things, this is a relatively small shift. The Model 3 is a 10-year program. We're talking about a few months out of a 10-year program. In the grand scheme of things, certainly if one is doing net present value calculation, this is immaterial. We have a clear path to that. We understand the bottlenecks. It's difficult to fully understand these things until you actually try to do them. It's worth noting that some of our manufacturing areas, we're actually seeing capabilities that we estimate in the 6,000 to 7,000 unit per week capability, well in excess of the 5,000 unit capability.
We're optimistic with further optimization that many of our production processes will need very little, in some cases no, I'm 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 fast. Speed is the ultimate weapon. The design intent of the Model 3 being that it's designed for manufacturability is turning out to be accurate. It's far easier to build this car than a Model S, and vastly easier than a Model X. Okay. The primary production constraint, really by far, is in battery module assembly. I'll just do a little bit of a deep dive on that. There are four zones to module manufacturing.
It goes through four major production zones. The zones three and four are in good shape. Zones one and two are not. Zone two in particular, we had a systems integration subcontract that unfortunately really dropped the ball and we did not realize the degree to which the ball was dropped until quite recently. 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 two of module production. We've managed to rewrite what was about 20 to 30 man-years of software in four weeks. There's still a long way to go. The software work can be fast, but the electromechanical elements need to be fabricated and installed, and getting those atoms in place and rebuilt is, unfortunately, a lot longer and has far more external constraints than software.
This is what I've spent many a late night on the Gigafactory working on. JB's been here constantly. We've reallocated many of our best engineers to fundamentally fixing zone 2 of the module line. Then right behind that is zone 1. 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 three times more effective than the current design. There are three lines of module production. Lines 1, 2, and 3 are essentially identical. Line 4, which will be the new design, will be triple the effectiveness of, well, will be as good as the other 3 lines combined.
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. Unfortunately, it does take some amount of time. This is 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. This has now been tackled by Tesla's internal automation group and Tesla Automation US and Tesla Grohmann from Germany. We have a large team from Tesla Grohmann also working the issue and making very rapid progress. Like I said, I am personally on that line in that machine, trying to solve problems personally where I can. JB's basically spending his life at the Gigafactory.
See, that's the sort of deep dive on that front. One thing I want to mention, that there are a lot of articles about Tesla firing employees and layoffs and all that sort of stuff. Its reasons are really ridiculous. Any journalists who've written articles to this effect should be ashamed of themselves for lacking 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's going to crush the little guy, obviously.
The little guy better have a heck of a lot more skill, or he's going to get clobbered. 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. This is about 700 people out of 33,000. 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 later releases compared to other companies, the number would be low.
The only reason these articles had any play whatsoever is because journalists and editors with low integrity failed to provide any context for where this stood. 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." Of course, that would be a meaningless article, so they forget to include that. Shame. Also what was not reported is that several thousand employees were promoted and almost half those promotions were in manufacturing. All right. I think let's switch to questions.
Okay, Latif, let's go to the question queue, please.
Yes, sir. Ladies and gentlemen, if you have a question, please press star then one on your touch-tone telephone. Again, that's star then one on your touch-tone telephone to ask a question. To prevent any background noise, we ask that you place your line mute once your question has been stated. Our first question comes from the line of Jamie Albertine of Consumer Edge. Your line is open.
Great. Thank you, 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? Does it change the trajectory from a margin perspective on the Model 3? 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 the week-by-week stuff. The reason it's tricky is because people just read too much into it. The ramp curve is a stepped exponential. It means as you alleviate a constraint, the production suddenly jumps to a much higher number. 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. Really, we're in a vertical climb here, so it's really hard to say. Yeah.
Also to your earlier point, Deepak here, it does not change any of our projections in terms of the long-term-
Yeah
target gross margin from-
Right
these are all short-term issues.
I can certainly say by the end of the year, it will be in the thousands. Well, yeah. Yeah.
I'm sorry. Well into the thousands per week?
We should be in the thousands by the end of the year. Where exactly, it's hard to say. Literally, if you move the calendar by two or three weeks, you would see giant changes. It's like the quarter date will fall somewhat sort of arbitrarily in that exponential curve. Even a matter of a few weeks, would show a very different number. The problem is that people tend to extrapolate on a linear basis instead of an exponential. In fact, most people don't even know what an exponential is. The human intuition tends to be a straight line extrapolation, but really on a very steep exponential. It's really an S-curve. It starts off really slow, and then 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. You really target a whole supply chain or factory for a given production capacity, and yeah, try to get that as soon as possible. We're highly confident of the long-term margin number of 25% or higher for Model 3. Deepak?
Yeah. None of our projections in terms of our material cost or manufacturing labor and overhead or depreciation or the other elements have changed.
Yeah
As a result of these last few months to modify that target.
Yeah.
Okay?
Yep.
All right. We have a lot of people in queue. 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, one follow-up. Elon, you described the Model 3 launch as production hell. How hot is it in hell right now? Is it getting hotter or less hot?
Yeah.
Are we solving more problems than are coming up?
This is sort of imprecise. I'm not sure what each level means, really. Let's say level 9 is the worst, okay? We were in level 9. We're now in level 8, and I think we're close to exiting level 8. I thought we would probably be more like in level 7 by now. I have to tell you, I was really depressed about three or four 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. I feel really pretty optimistic right now. If you talked to me two weeks ago, I would've been quite pessimistic, and I was sort of quite down in the dumps. Now it's pretty obvious what we need to do.
It's just a matter of work to get there. We're working seven days a week to do it. I've personally been here on zone 2 of the module line at 2:00 A.M. on a Sunday morning, helping diagnose robot calibration issues. I'm doing everything I can. J.B.'s doing everything he can. The whole team's on it. 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? Thanks.
Yeah, it's an eight-year tenure on that offering designed to give us that capital for that time frame.
All right, Latif, let's go to the next question, please.
The next question comes from Tyler Frank of Baird. Your line is open.
Hey, it's Ben Kallo from 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, though, 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? I have a follow-up.
Yeah. There's vastly more automation with Model 3. The tricky thing is that when one element of that automation doesn't work, it's way harder to make up for it with manual labor. With the S or X, because a lot less of it was automated, we could scale up labor hours and achieve a high level of production. With Model 3, it has to be either the machine works or it doesn't, or it's limping along, and we get choked quite severely on output. Yeah, JB, do you want to add?
Yeah, I think that's spot on.
Go ahead.
The design on whole is much easier to build.
Yeah, by a lot
It's also intensely automated, which is part of what lets us realize the margin and the cost targets. That does become difficult to bring that automation online. That's where we are.
Yeah.
Doug is on the line, perhaps he can add some on ease of manufacturability.
Mm-hmm. Doug, do you want to maybe touch base, 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 one-fourth of the typical industry average for number of stations it used to build a car. The way we do sub-assemblies and the care we've taken in design for manufacturing does make it much simpler. As JB said, each of those stations is fairly automated and requires time and engineering to make it work.
I guess my follow-up's on that point. In the battery assembly and automation things that you're working through and the software for that, 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 then it's fixed or you know the fix or what are you throwing at it right now? Is it people or is it a time requirement too, or all of the above?
Yeah. We're throwing a huge amount of people at fixing the machines. Occasionally, there's some part of a production manufacturing process where the machine is permanently broken and then we have to have a bypass to a manual operation.
Until we fix the automation.
Yeah, until we fix the automation. It's really inefficient, because the system's really not designed for a manual bypass to your broken machine or a machine when the software's not right or whatever the case may be.
It's just.
Got it.
extremely complicated machine.
Yeah.
Combined electrical, mechanical, and software challenges. It's not that different than what we do bringing up a brand-new car.
Yeah.
And a lot of the-
It is harder to supplement with manual than S or X because-
Yeah
The system is designed as a very tightly integrated automated system. It's very unwieldy to try to supplement or make up for a machine not working with manual activity. To be clear, if you had a spreadsheet and a couple of the cells in the spreadsheet were manually calculated, well, yeah, 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. Let's-
Got it. Thank you, guys
go to the next question, please.
Our next question comes from Romit Shah of Nomura Instinet. Your line is open.
Great. Thank you. 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. They're saying it can get you to level 5 autonomy. 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 will 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? What will be acceptable to regulators? I feel quite confident that we can achieve approximately human-level autonomy with the current computing hardware. Now, regulators may require some significant margin above human capability in order for full autonomy to be engaged. They may say it needs to be 50% safer, 100% safer, 1,000% safer, I don't know. I'm not sure they know either. I think I'm confident that we can get to approximately human level with our current hardware. We'll have more to say on the hardware front soon. We're just not ready to say anything now. I feel very optimistic on that front.
For customers that have signed up for full self-driving capability or purchased 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.
Yeah.
We feel confident of the competitiveness of our hardware strategy. I would say that we are certain that our hardware strategy is better than any other option, by a lot.
Okay, great. 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 car line. We just give the combined number, which you can see on our balance sheet for customer deposits.
Yep. Okay. Latif, let's go to the next question, please.
Yes, sir. 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 fourth quarter and the first quarter. 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 third quarter? plus 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 $2.5 billion in inventory is finished goods that you might be able to sell out of in the fourth quarter.
Well, firstly, as we continue to ramp up Model 3, our cash flow from operations is going to increase or improve significantly over the next few quarters. 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. 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. There should be an improving trend over the next two, three quarters.
To be fair, Deepak, it sounds like this is a little bit more uncertain than you thought before as far as production and delivery. I'm just trying to understand, what kind of cash you can generate out of the inventory that you hold right now.
Yeah. Firstly, our inventory is going to come down on S and X. Also what's important is, given these short-term delays, we have to be prudent in how we spend our money. We are managing our CapEx and OpEx growth to be in line with the growth of our fleet. For example, CapEx related to our stores or service centers or Superchargers, we are slowing that down to be in line, that's logical with our growth of our fleet. 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 J.P. Morgan. 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. 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 beyond 2018? I think before investors were estimating that if you could hit it at the end of 2018, you'd do over 250,000 vehicles. If you could hit it more toward the middle, you'd do over 325,000. 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. I think you can extrapolate from 5,000 towards the end of Q1. We do want to hold off on significant CapEx until we are confident about cash flow on Model 3. That's a question of how long it takes to implement everything 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.
We want to figure out how much we can push the 5,000 up from the existing equation.
Yeah, that's true.
Learn from those and figure out how do we redesign whatever we do for the next bit and spend more efficiently on CapEx.
Yeah.
It's the right thing to do.
Yeah, exactly. As I mentioned earlier, we're finding at some parts of the line we're very clearly capable of 6,000 or 7,000 units a week. Maybe more than that just by shortening path length, speeding up the robots, adding some robots where the choke points exist, simplifying some of the processes, and a few minor part redesigns. It's remarkable how much you can improve cycle time.
Okay, I see. That's helpful.
Yeah.
Maybe just as a follow-up. Go ahead, yeah.
Go ahead. No, go ahead.
I was just going to say, is the gross margin discussion also related to this at all? I see the reduced outlook for 4Q, do you feel any differently about, for example, the ability to do 25% margin when you're doing 250,000 run rate? 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 variants 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 our 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.
Yep. Thanks very much. Was wondering, I guess to the extent that these production bottlenecks are ultimately somebody else's fault, is it worth your time trying to claw back some of the costs that you're presumably incurring due to this subcontractor, I guess, dropping the ball, as you put it?
Yeah, I think first of all, I think at the end of the day, everything is our fault and my fault, first of all. If we pick the wrong subcontractor, we're the fool. I don't want this to be put up as externalizing responsibility. It really is our fault for 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 or lost free cash flow. Some amount, yeah. It's not going to matter that much.
The goal is right now to fix rather than-
Yeah, exactly.
Yeah.
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 what the corrective measures you're taking to address that.
Yeah, Jon.
Yeah, this is Jon. I can address a piece of this. A large chunk of it was discontinued trims. We've introduced the 100 kilowatt battery pack, which has a 335-mile range in Model S. 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. That was a piece of the gross margin headwind that won't repeat as we go forward. In addition to that, the mix did shift. We sold more 100 kilowatt cars actually than we predicted we would, order rate went up for the 75s even faster. We sold more 75 kilowatt cars in the mix than we predicted and that had a gross margin impact as well.
Given demand, it continues to increase for the 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. The heart of the discontinuation really was the success of us de-bottlenecking the 100 kilowatt production that we talked about in Q2 and really rolling that into strong demand in Q3.
Yeah. We also just increased the amount of value that's in a Model S.
Model X.
Yeah, Model X, particularly Model S because we felt there need to be greater differentiation between the S and the Model 3. The fundamental cost of a Model S increased because of more included content. The four Model S's have air suspension, for example. Much of the premium elements were included by default. We just felt there needed to be a clear reason for people to buy a Model S over a Model 3.
The market responded really strongly to that in terms of demand. In Q3, the Model S in the U.S. outsold the Mercedes-Benz S-Class by 2 times, over 2 times actually. If you added up the sales of Audi A7, A8, the BMW 7 Series, and the Porsche Panamera, we outsold all those combined.
Yeah.
The market really did respond to the increased value.
Yeah.
Yeah, a lot of our deliveries too, in terms of our market share in the U.S., it went up in Q3 for S and X.
S and X both.
Yeah.
That's right.
Yeah. Compared to Q2.
I saw some of the articles from our quarterly earnings letter about sort of back to your question, kind of S and X, why we would reduce production on S and X. We didn't reduce it very much. It's just sort of from about 2,000 units a week to 1,800. We did that in order to burn down inventory. First because inventory was too high. We also just needed a bunch of people on Model 3 line. We thought, well, we'll take the third shift from Model S and X and apply it to Model 3. We're really running out of labor pool, honestly. It's like we're sucking labor pool dry both in Gigafactory and in Fremont. It's like, there's only so many people that can make it to the factory.
We're also finding that we're able to improve the efficiency of production of the S and X. Previously, it required three shifts to do 2,000 units a week. It's important to appreciate, the whole supply chain and everything, it's all sized to 2,000 units a week. People are like, "Say, why can't you just spontaneously make 2,500 units a week?" It's because the entire supply chain, all the parts, everything's got to go to 2,500, and that requires a bunch of CapEx. You have to match sort of increased storage. Everything's got to move in cadence. You sort of decide on what seems like the right number. We think the right number is about 100,000 units a year, combined S and X, and we size the supply chain accordingly.
We expect to continue making production efficiency improvements on the S and X line and be able to take it up from roughly 1,800 units a week to 2,000 units a week.
Yeah
We expect this to be in probably early next year and still be on two shifts.
Yeah.
Which means that our labor hours obviously are reducing per vehicle. That gets us to our sort of roughly 100,000 units a year cadence and we can work on supply chain efficiencies and all that. We do expect to, important point, we expect to sell more cars in Q4.
Correct.
This is more than we did in Q3.
Than Q3. Expect sales and deliveries to be higher in Q4 than Q3. To reduce Model S, X inventory to achieve that.
Copy.
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're 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. Is your CapEx still expected to be lower in 2018 versus 2017?
Rod, in terms of the China factory, I'll leave for Elon to make comments on that. 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 and similar, honestly, to 2017. We have obviously some sort of strategic choice. Do we have higher CapEx and higher growth or lower CapEx and lower growth? Yeah. We can move that lever 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. For 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, we'd be kind of shooting in the dark.
Yeah.
Yeah.
In respect to China, I wouldn't expect any significant CapEx on China until 2019. It won't be material in 2020.
Okay.
The China plan is sort of maybe something like, [I don't say watch by this], but it's sort of a rough target of start of production in about three years. It would be serving the China market and perhaps some other countries in the region. That's really, it's the intent, is to be able to provide Model 3 and Model Y. We won't be making Model S and X, but we'll be making probably Model 3, probably Model Y, primarily for the local Chinese market, and it's really the only way to make the cars affordable in China. It's three years out, so.
Just to clarify two points, is your objective to have something that's kind of Fremont sized in China? I wanted to also clarify your earlier comment about when exactly the production of Model 3 goes exponential. Were you suggesting that-
Exponential right now.
Well, I guess, yeah, off of a low number. Are you getting to a few thousand per week already by the end of this year, or did you mean to say that you'll have a few thousand produced in total by the end of this year?
No. It's really tricky because of that being an exponential. If you were to move the calendar date by plus or minus a few weeks, you'd see gigantic differences in weekly output. What I meant was in something like a few thousand units per week at the end of Q4.
Okay.
If you said, okay, what about a few weeks after Q4? I'd say yes, definitely.
It's just going to be rising very sharply at that time.
To be clear, Elon's not going to provide guidance. He's just giving-
Just my guess.
Exactly.
It'll be like a fighter jet in vertical climb here. It's like from one moment to the next, very different.
Yeah. It sounds like you'll be able to provide some pretty high confidence update on the fourth quarter earnings call.
Yes.
Oh, for sure.
Yes, absolutely.
Yeah.
Even with the deliveries announcement, we'll have some feedback for you, as we mentioned in the letter.
Okay. Great.
Yeah. We'll have a very good understanding and high clarity on the Q4 earnings call.
Okay. Then the China size, is this a Fremont type of project?
It's something in the hundreds of thousands of vehicles per year. I'm not sure where it is exactly. It's at least a couple hundred thousand vehicles a year, maybe more.
Okay.
All right.
Great. Thank you.
That's all you get out of him. Thanks. Next question, please.
Our next question comes from Toni Sacconaghi of Bernstein. Your line is open.
Yes, thank you. I have a question to 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's been all about doing as much as quickly as possible to lead the move to electrification, to establish a first-mover advantage, et cetera. 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 is there even a decision, I guess, is the question?
I would say it's probably a bit of all. It's prudent for us to think through all of that as we are continuing to grow. Certainly, we want to be in a certain sense of fiduciary responsibility that we have in addition to just growing like crazy.
These are mad % growth rates for the auto industry. I think somebody did some comparison of Tesla's growth rate relative to Ford in the Model T era. We're talking about a rate of growth faster than the Model T, which is the fastest in history. These are nutty growth rates.
It's certainly not the first time we've thought about this.
Yeah, we have talked about that. Our growth rate, I don't recall the exact numbers, but I think it's been in the 70, 80% every year. Next year, even with 5,000, it'll be crazy compared to this year.
Our growth rate continues to be extraordinary.
Yeah. If our growth rate continues at anything like that in coming years, if it continues to be something like that, Tesla will be the largest car company in the world by volume as well.
Toni, it may be helpful. It accelerates with new product introductions, too. Model X reached Model S demand rates in half the time. At twice the rate of demand build. Not only are we growing, but we're accelerating as we grow.
Yeah, exactly. Model 3 will be, call it five times, well, it'll be five times Model S.
Yes.
Correct.
If you look at the timing, it is order of magnitude shifts.
Yeah
downward. Yeah.
Yeah.
I guess the question is.
Yeah.
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 to volume on the Model 3. 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. 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.
Just to be clear, we are trying to get as fast as we can to 5,000, we will work as fast as we can to get to 10,000.
Yeah.
Yeah, 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-off in terms of timing, we'd think through it.
Yeah. We can talk about what people have different interpretations of timescales. For us, it's like, well, should we have the growth to 10,000 take nine months, 12 months, or 15 months?
Okay. Fair enough.
These are like flash in 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%. Maybe you can help us understand what S and X gross margins were this quarter. 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? Do you think that the promotional activity helped drive volume for S and X this quarter?
firstly, your analysis is completely off from what we see internally. The mix shift that we saw, part of that continues in Q4.
Largely because we're largely custom orders.
Correct
Those orders placed in Q3 that we will ship in Q4.
As we continue to achieve efficiencies and also work on that mix shift, which takes time, we will continue to see improvement and I have full confidence in S and X gross margin.
Yeah. The chunk of the cars being sold in Q4 are inventory rundown, including older models.
Service loaners.
The service loaners. Those go for slightly lower average selling price than a customer vehicle. That has maybe a point or two effect on gross margins. Yeah, it should get back to the mid 20s essentially.
Right
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. A lot of the other questions have been asked.
Yeah.
It looks like year-over-year revenues were up $180 million, costs were up $247 million. Could you just talk about the drivers of that change between what's left of the drivetrain outsource business, the CPO business, the service loaner, actual vehicles-
Sure
expense, the cost of the PP&E for the actual people and service infrastructure.
Yeah. I think what you see there is the increase in PP&E for the service infrastructure. We wanted to get out in front of demand as we're increasing both S and X fleet size, also Model 3. We opened a location just about every four days in Q3. To get ahead of that demand, you probably saw that we put 180 mobile vehicles on the road, we plan to double that this quarter. A lot of that, what you see is PP&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. You asked about the CPO business. The CPO business for us last year or last quarter was about a $238 million revenue business.
We expect that to grow to a billion-dollar run rate or a billion-dollar business for all of 2017. That business is growing rapidly at the same time. We do our own CPO refurbishment. We do that in the same service infrastructure that we're servicing the cars. You see a little bit of that cost into that line as well.
Okay, my follow on for Deepak probably is, can you walk us through the depreciation when you produce, for example, in the second quarter, those 100 P100D cars Mr. Musk talked about going into the loaner fleet. 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?
Yeah. They are capitalized as inventory because these cars are saleable. When these cars get sold, the depreciation related to those cars gets recognized in COGS.
Okay, it's not in the cost of the service centers.
No.
Right. Okay, thanks.
Next question, please.
The 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 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 welding elicited as a constraint.
Yeah.
Yeah, it wasn't listed as a constraint.
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. To reach our overall production goals, that has to ramp significantly. Again, it's not at the same level of constraint as modules. 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, as a follow-up on the capital question. Elon, I think a year ago on this call, you said to go from 5-10 would require a fair amount of capital, but you were confident that'd be less than going from 0-5. 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.
Yeah, we actually feel even more strongly that our efficiency of CapEx on the next phase will be significant compared to the first phase.
Yeah, absolutely. Some elements will require almost no CapEx. Really come to realize that you really want to make the factory go incredibly fast. I think speed is the ultimate weapon when it comes to innovation or production. We're pushing robots to the limit in terms of the speed that they can operate at and asking our suppliers to make robots go way faster. They're shocked because nobody's ever asked them that question. It's like, if you can see the robot move, it's too slow. We should be caring about air friction, things moving so fast. You should need a strobe light to see it. That's incredibly critical to CapEx efficiency. Obviously, we're going to be designing a lot of the robotic elements and automated elements internally. Yeah, because final suppliers are just too slow to respond in some cases.
Okay, we have 10 more questions in the queue, 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 % of sales that are coming from these loaners of 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. 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 one or the other.
Yeah, I think to the first question, I would say roughly about 5%.
Very low single digits in terms of the service loaner sales as a % of total units.
Yeah.
As far as the prices with the Model X was always really the one that saw more of a price reduction than other things. The 100 kilowatt-hour pack. 100 kilowatt-hour pack car was artificially priced high, because we were really production constrained on that pack. It was never our intention to price it quite that high, so we reduced a little bit. Added some content as default. We 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 Model 3. Maybe we might have overcorrected a little bit, but that's kind of where it is.
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 is, 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. 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 bring these cars in. That's a much bigger impact than any of the supply chain or sourcing materials issue.
Okay, next question.
Next question comes from Rob Cihra 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? 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.
Yeah. We do expect the solar demand to rebound as we move solar sales into all of our stores, which is a much more efficient channel for demand generation. 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. We're just going through the validation process for the solar trials. They're working right now, I should point out. I have the Solar Roof tiles on my house. I don't even notice that they're there. They blend in so well. They look really good, but a roof is expected to last a long time, so at least 25, 30 years. There's some rate at which we can do accelerated life testing on all the various components.
We can maybe try to accelerate life testing on a 30-year roof in sort of six months, but it's hard to do it in less than about six months. Then we've got to pack that into the production process. 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. Once it gets rolling, it's going to be a behemoth.
Yeah. We continue to install pilot engineering in early customer homes. We've continued the cadence of that.
Yeah. You have one in your house in the works.
Yeah. This is JB, I still have one, and quite a few others at this point, more than 10. We still are on track to turn on most of the production line in Buffalo at the end of this year to start ramping final actual production versions of this in the final factory.
Yeah.
maybe to your point about the separation from Model 3, those production areas are largely separate.
That's for the pack side.
Yeah. Storage.
Pack storage.
energy storage versus vehicles. The energy storage production is actually doing really well by our ability to complete the South Australia project or be on track to complete that. That's.
Puerto Rico.
Yeah, as well as the deployments in Puerto Rico and elsewhere in the Caribbean. That's been running at nominal rate and doing quite well. Those are quite separate.
Great. Thank you.
Yeah. Down the road, there will be some cell conflict. I think if you fast-forward a year or two, we really need to think about cell production as being a constraint and some of the raw materials going into cell production, certainly 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 meant to say nickel.
Nickel, graphite.
Yeah.
Copper, aluminum.
Yep. Separator, electrolyte.
The module lines that we're operating to assemble the cells into modules are totally separate.
Yeah.
It's this Model 3 module line that we're focused on right now and improving quickly. The energy module line is in the same building, coincidentally, but a totally separate line.
Yeah.
Okay, I think that's unfortunately all the time we have today. Appreciate all your great questions, and we'll 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.