Good day, ladies and gentlemen. Thank you for your patience. You've joined Tesla Motors, Inc. fourth quarter 2015 financial results Q&A conference call. At this time, all participants are in a listen-only mode. Should you require any additional assistance during the call, please press star then zero on your touch-tone telephone. I would now like to turn the call over to your host, Mr. Jeff Evanson. Sir, you may begin.
Thank you, Latif. Good afternoon, everyone. Welcome to Tesla's fourth quarter and full year 2015 Q&A webcast. I'm joined today by Elon Musk, Tesla Chairman and CEO, JB Straubel, our CTO, CFO Jason Wheeler, and Jon McNeill, President of Global Sales, Service, and Delivery. Our Q4 results are announced in the update letter at the same link as this webcast. As usual, this letter includes GAAP and non-GAAP financial information and reconciliations between the two. During our call, we will discuss our business outlook and make forward-looking statements. These 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 Form 10-Q filed with the SEC.
We're going to start today's call with some comments by Elon and then Jason, and then we'll go into the Q&A session. I would ask everyone that during the Q&A session, you try to constrain yourselves to one question and one follow-up so we can give everyone fair time on the call. Before we go to Elon, you might as well go ahead and press star one to get into the queue to ask your question. With that, I'll turn it over to you, Elon.
Thank you. I think the newsletter largely speaks for itself, but I'll add some commentary on some of the lead points. Obviously, we had a huge increase in Model S deliveries year-on-year in Q4 last year, going up 76%. We had a huge change in our core operational cash flow, which you can really see in the chart. It's really quite dramatic. That's why I think it's interesting to look at in chart form. It goes from negative to significantly positive in Q4 last year. Then we made modest improvements in Model S gross margin, getting to about 25%, excluding one-time items. I feel pretty good about where we're tracking to probably get close to 30% by Q4 this year.
Something I'm personally quite excited about is that we expect to be positive cash flow starting next month, continuing on into Q2 and beyond. There's one caveat there, that's including the asset-backed line. The asset-backed line is that's just funding for cars that are en route to customers. Particularly as our sales to international markets increases, there's more finished goods inventory on its way to customers. Inclusive of the asset-backed line, which really I think is most accurately regarded as a slight decrease in the gross margin of the car by about roughly 0.1% or thereabouts. Apart from that, we're positive cash flow. We're expecting to be profitable for 2016 on a non-GAAP basis. I personally think that that is actually the correct way to think, to look at it, because of the way that GAAP treats lease accounting.
Nonetheless, despite the lease accounting stuff, we anticipate being profitable by GAAP standards in Q4 of this year. We're really looking forward to the unveiling of the Model 3 at the end of next month. I think this is going to be really well-received, getting into production and delivery at the end of next year. Touching on a few things that are in the bulk of the newsletter, I think the chart on vehicle demand is really interesting. To the degree that this represents a microcosm of how Tesla vehicles will be received in other vehicle segments, it augurs extremely well for the future. The Model S was the best-selling premium sedan in the U.S. last year of any kind. Our sales actually increased by 51%, whereas everybody else's sales declined. The overall market segment declined by about 1%.
I think it's really rare to see situations like this. I think this is despite us being really quite under-penetrated in the Northeast. I think there's a lot of room for growth in the Northeast particularly of the U.S. and in international markets in general. Essentially, getting to 25% market share of all premium sedans in the U.S. is, I think, a great achievement of the Tesla team. I think it's also great for the world because it means it's 25,000 fewer gas guzzlers that are on the road. I'd like to thank all the customers that went out and bought that car because I think they're making a difference for the environment. Of course, they're helping pay for the future development of the Model 3, which is the more affordable mass-market car.
That's where we put all of the revenue we receive from the Model S and Model X. It's always important to bear that in mind, that Model S and Model X are what pay for the Model 3. Perhaps one additional note is that Tesla, we don't pay for any endorsements. We do not discount our cars for anyone, including me. I pay full retail price. All of our competitors take those actions. That's, I think, quite interesting. We also have far fewer sales outlets than our competitors. Essentially, there's a lot of degrees of freedom that we are not exercising that we could, in theory, exercise. If you look at the text, it's worth noting that this is not just uniquely true in the U.S.
In Switzerland, the Model S outsold the Mercedes-Benz S-Class, the BMW 7 Series, Porsche Panamera, and the Audi A8 combined, and also outsold the Mercedes-Benz E-Class. In Germany, we outsold the Porsche Panamera. I think these are pretty good situations. This is even in places that have no incentives. Obviously, incentives are certainly helpful. They're a catalyst for sales. Tesla always appreciates the incentives, and I think they make a difference in accelerating the advent of electric vehicles. Sometimes incentives are characterized as it's sort of all about incentives or not at all about incentives. It's really important to appreciate that incentives are an accelerant. That's the reality of them. Jason, do you want to add anything?
Sure, absolutely. Thanks, Elon. First of all, look forward to working with everybody. I'm super excited to be here, as excited as I was on the first day I walked through the door. Just three quick things I want to touch on real quick. Number 1, gross margin. Lots of moving parts this quarter. Let me walk you guys through it a little bit. We had over $67 million in Model X ramp-up costs and non-recurring items in the quarter, as Elon mentioned. Correcting for these items, automotive gross margin, excluding ZEV credits, would have been 25%. First thing, the major component here is labor and overhead and depreciation related to the Model X launch. The way for you all to think about this is towards the end of Q3 and into Q4, we had to bring the workforce into the factory to build these wonderful vehicles.
Also, as soon as production starts, the clock starts hitting on depreciation as well. That's what's going on there. We also had some asset impairments, one with our old paint shop, and we've now got a state-of-the-art paint shop in place, which is going to give us the capacity that we need all the way through Model 3.
Yeah, that's 10,000 cars a week, too.
Yep, 10,000 cars a week. This is a good story. These are assets that we had purchased, go all the way back to the NUMMI days. We got every bit of life out of those assets as we possibly could. The other big piece here is we had an E&O write-off, excess and obsolescence. This is a result of better production control and inventory management systems that we put in place. The place is moving really fast, and we took some time. Elon talked about this in Q2 on the earnings call during the shutdown, putting better systems in place to track this stuff. We're moving to a place where we're tracking E&O on a real-time basis and bringing those facts to the table when we're making decisions. We shouldn't be in this position again.
Next thing I wanted to talk about, just real quickly, was cash flow. Elon covered this, and I think the chart on the face of the shareholder letter really gets there. We were within striking distance of positive operating cash flow this quarter. When you add back the leasing proceeds that we get of $209 million, it's a great step change in the right direction to getting us to net cash flow positive. Also, CapEx, we guided at $500 million last quarter on the call, and we closed out at $411 million for the quarter. That all resulted in ending cash balance being at $1.2 billion, which I think showcases our strong improvement in cash management and discipline of the company. Finally, really quickly, talk about capital structure. We closed the warehouse line that we previously had before and opened the ABL, as Elon mentioned.
Think of this as a shift to lower-cost financing. We've got a better deal on this line, I think it's a better way to think about that. Intended uses, one, we'll continue to monetize our direct leases as we did with the warehouse line, but it also creates an option for us to finance our ramp in FGI as the Model X hits full production scale. I'll just close by saying, my mandate from Elon is clear: Cash is king. There's some real steps that we're taking as a company to get ourselves to net cash flow positive for the year.
Profitability.
Profitability. One more, it's just capital efficiency in CapEx. CapEx in 2016, as we've said in the past, will be less than it was in 2015. We've started to see some of this in Q4. It will continue. We're also getting to a point where we have operating leverage in the business. We'll continue to aggressively manage our growth and expenses. I walk around and I'm on this every day, it's a relentless focus on automotive unit cost reductions. That's my mandate. Again, I'm happy to be here. Elon, if you've got nothing else, we can go to Q&A.
I guess one other point that's interesting to note is that Tesla is approximately doubling its cumulative sales every year. I'm not sure if this has happened in the car industry for maybe a century. We started at the beginning of last year with 50,000 cars on the road, then we ended with 100,000 this year. We're maybe 60%-80%, so we're at the high end of that range. Again, potentially double the size of the fleet. I just think that's pretty exciting and unusual. Thank you. We can go to Q&A.
Latif, let's take the first question, please.
Yes, sir. Our first question comes from the line of Brian Johnson of Barclays.
Welcome, Jason. Just want to ask a couple questions revolving around the cash flow. I'm sure other people will go into some of the Model X ramp and delivery numbers. First, you produced about 14,000, you delivered 17,000 vehicles. That would imply 3,443 reduction in finished goods, at least as inventory, which could generate $250 million. Yet your inventory is roughly flat quarter-over-quarter. What, before we get the 10-K and the 10-Q, are the puts and takes there?
I think you touched on it. We managed to do a really nice job selling inventory cars at the end of the year.
On the balance sheet, the inventory number in cash and inventory stayed about the same.
There's a couple things going on in there. One is the finished goods, doing a nice job on the finished goods inventory, but also just the ramp up of the parts that we need to get full production with Model X.
It's sort of the work in process on the Model X. Second, can you kind of just refresh, can you kind of update us, given the change from the revolver to the ABL? What is currently drawn on the ABL? What's the available borrowing base? How much of that is, as you think about next year, going to be used to support increased on-balance sheet leasing versus increases in finished goods inventory? What's your remaining, if the banks were to come and kind of borrowing base, that would be left unpledged?
Yeah, sure. On where we closed Q4 at, I think we're $135 million fully drawn on it. In terms of the borrowing base, there's a lot of detailed numbers behind that. I think the most important thing to point out here is the increase to $1 billion that we did with our banking partners. Then there's some restrictions there, and we don't want to max that out, so we're going to monitor it carefully and just make sure we do the things to do. We don't want to live on this crutch.
Yeah. We have a collection of lenders, so it's like, hypothetically one lender were to decide not to support the ABL, then it's distributed. It's not a single dependency. We found that the appetite with lenders is very strong for the ABL because it's a finished product that's going to a known customer. There's no channel to stuff because there isn't a channel. It's just stuff in transit to customers primarily overseas.
Yep. It grows with the inventory balance.
Yeah
Against cars that have orders placed against them.
It sounds like you could draw it even if finished inventory was flat. Could you still draw on it, or does it have to track to a direct increase in finished goods inventory?
Yep. Yes.
Yes. It does track to finished goods inventories. Basically, it's a finished goods loan.
Okay, thanks.
No problem. Thanks for the question.
Thank you. Our next question comes from the line of Colin Rusch of Oppenheimer. Your line is open.
Thanks so much. You're coming to, in the next couple of quarters, to the end of some of the initial leases on the Model S's. Can you talk a little bit about your preparations for that and your expectations as we move throughout this year on what will happen with those cars and how many of them are actually going to get returned?
Sure. Jon, do you want to talk about that?
Sure. We actually started on that early and launched a campaign in the second half of 2015 to reach out to folks who had cars coming off lease. One of the attractive things to those folks who are coming off a lease is to have a car that's equipped with Autopilot. Autopilot is certainly one of the core stories of what's going on here at Tesla. It's really exciting. We're finding that folks are willing to upgrade their Tesla as part of this campaign. We've got a full-on program where we're really providing a smooth transition period for these cars.
In addition to that, we're finding there's a very healthy aftermarket for these cars, and the trading values in the market are significantly above our residual reserves on the cars, which is giving us some flexibility in terms of our financing partners offering very attractive monthly payments and loan terms because the Teslas are holding value at a much higher rate than we thought. I think the short answer is we're out ahead of it, and we're getting really good reception and conversion from customers, who are excited about the next generation of Tesla, which is an Autopilot-equipped car.
Okay, great. Just the follow-up, there's some pretty significant legislation updating the Toxic Substances Control Act that passed through Congress in December. As you guys look at a lot of the details in terms of ramping the Gigafactory, can you talk a little bit about what you're seeing as the impact so far with the updated substances and how they might be treated as we go forward here?
This is JB. I can jump in there. We haven't seen any immediate impacts from those results or changes. The materials we're using at the Gigafactory are not particularly toxic substances.
Yeah, the Gigafactory has zero toxic output.
Yeah. In terms of large industrial factories, it's an incredibly clean one. There's really no air emissions, and the raw materials are largely base metals and things like that.
Okay, great. I'll follow up offline. Thanks, guys.
Thank you. Our next question comes from Adam Jonas of Morgan Stanley. Your question please.
Hey, everybody. Two quick ones. First, can you confirm reports that Jim Keller, kind of a legend in the microprocessor world, has joined the company that had some hardware engineering at Tesla and Autopilot? If that's correct, does that signal that Tesla might be moving to design some of their own silicon?
Well, I think it's public knowledge that Jim Keller has joined. We have a lot of talented people that join Tesla all the time. Jim is indicative of that. Just some people get a bit more press than others, but I think the talent level that's joining Tesla is really incredible. With regard to the latter part of your question, no comment. Yeah.
Okay. Just to follow up on test drives, outside of company-sponsored events, kind of surprised we haven't seen any full, comprehensive, independent test drives from the major magazines. Is there anything kind of preventing, and I think people on the call can understand if there would be of the earlier-produced units that maybe you wouldn't want released quite yet, but is there anything preventing the magazines from gaining access to the early vehicles, the Model Xs, and conducting a full road test of the vehicle? If there is, when could we expect some of the first reviews, you think? Thanks.
Well, I guess we've not provided cars to the media, largely because to the degree that we could suppress demand for the X, we did. We took basically every action we could to suppress demand for the X, because we need to get production up. There's no point in amplifying demand if production cannot meet that demand. We did our best to really suppress demand or certainly not encourage demand. That'll obviously change in the balance this year as we get cars to stores, because there've been no Model Xs at stores, no Model Xs available for test drives. In the coming months, I think probably next month, you'll start seeing some reviews in magazines and whatnot. The feedback from customers we've gotten has been very positive.
Thanks, Elon.
Thank you. Our next question comes from Emmanuel Rosner of CLSA. Your line is open.
Hi, good afternoon. Wanted to ask you first, can you give us a little more color on what exactly happened with the Q4 launch? In the letter, you sort of implied that it sort of took maybe a little bit longer than expected. What sort of issues have you encountered, and what have you learned that sort of gives you confidence that in your next launch, maybe the Model 3, you can actually ramp that up significantly quicker?
Yeah, I think that's a great question. I think the mistake we made with the Model X, which I really think we've taken to heart at Tesla, is that we put too many new features and technologies, too many great things all at once into a product. In retrospect, it would've been a better decision to do fewer things with the first version of the Model X and then roll in the capabilities and features, new technologies over time in subsequent years. I do think that there was some hubris there with the X. The net result, however, is that I think the Model X is an amazing car. I honestly think it's the best car ever. I'm not sure anyone's going to make a car like this again. I'm not sure Tesla would make a car like this again.
I'd be surprised if somebody buys the X, particularly as the software gets refined, if it's not the product they love more than any product they've ever bought, I would be surprised.
Yeah. Maybe it's worth also just commenting that even some of the most innovative features on X that caused some challenges in Q4 have really been largely overcome today.
Yeah, that's true.
The operation of the Falcon Door, the sourcing and supply of the large glass windscreen. These things are working very well and are not a bottleneck at this point.
Exactly. Some of the things that cause us issues are somewhat counterintuitive. They're not the obvious things. For at least a few weeks, maybe three or four weeks actually, the constraint was the chrome finish on the bright work around the front window. Okay, you think, how on earth could that be the constraint? It was.
Seals.
Seals, yeah. Yeah, the seals have been a huge pain. Essentially, the seals had to be redesigned. Then the seals that we did have had to be reworked by hand in order to fit correctly. Yeah, seals are a bane. We had a lot of issues with obviously second row seat, we've now in-sourced that capability. Yeah, we really don't see any fundamental issues.
Okay. Yeah, it sounds like it's basically mostly behind you. As we move forward into the year, you're talking about this Model X production rate of 1,000 vehicles a week in Q2. Is that an exit rate or is that an average for Q2? Can you just more generally give us how you see the overall mix for the year of S versus X play out in terms of deliveries?
Some of the stuff is, you have as good a crystal ball as we do. Let's see, 1,000 a week would probably be a peak production week in Q2. I don't know what the average is going to be exactly, but maybe 700 or 800, something like that. I think we feel confident hitting 1,000 a week, certainly towards the mid to end of Q2. For the exact mix, I think we need to see how customers react when both cars are in the showrooms. We'll adjust accordingly. We expect a combined delivery number average over the year of 1,600 to 1,800 per week.
Perfect.
Yeah.
Thank you very much.
Yeah.
Thank you. Our next question comes from the line of Colin Langan of UBS. Your line is open.
Thanks for taking my question. Can you just kind of walk through what are the key short-term drivers? You're still off cash flow, sorry, kind of still burning $200 million this quarter. Is it just really all volume to get to cash flow positive by Q2? You also touch on CapEx. You're saying it's going to be flat to down, seems like there's an awful lot of work going on in the company. How do you keep CapEx down as you have all these growth plans?
Yeah, sure. The key drivers on cash flow positive. As I said in my earlier comments, it was a great step in that the operations, the business of selling cars and energy products is now producing enough cash for us to start to pay for our investments. If you look at the Q4 dynamics, that cash flow from core operations, as we're calling it, produced 40%-45% of the cash that we needed for the CapEx in the quarter. That is certainly a big piece of it too. Another piece of it, as I mentioned, is just going to be operating leverage. We need to be very diligent about how we grow operating costs, certainly. The other big element to it is certainly continuing to drive cost downs on the vehicles, and there's lots of ways to do that.
We're getting better at our manufacturing processes. We're reducing scrap. We're reducing excess and obsolescence. As we talk about in the letter, the car continues to be more and more reliable. That reduces our warranty, and that actually has a cash impact when the cars show up less at the service centers.
Yeah. In fact, I'd just like to reemphasize that. We're seeing dramatic improvements in reliability and reductions in servicing needs. This is important. Sorry, go on.
Yep, yep. No, absolutely. The other piece, you talk about CapEx and how can it be down? Well, we made a bulk of the investments that we need for Model X in 2015. In 2016, we're going to continue to invest, but we'll really, towards the back half of the year, start to see some initial investment in Model 3. We'll continue to invest in the Gigafactory to get to where we want to be with production there. We'll continue to expand the service center, the retail locations, and the Supercharger network as well. There's a lot of the big pieces that we needed to spend in CapEx to get to where we are today were spent in the past. Yep.
Yeah. I think it's just important to bear in mind that the overall market for SUVs and sedans is roughly the same. Roughly it's split almost 50/50. The X is kind of half of our volume. If you set a company up to produce X. Let me just use the variable X. If you set a company up to produce a certain amount of revenue, and then it produces maybe just over half that amount of revenue, but has the cost base associated with it, then obviously the things will not be pretty from a cash flow and profitability standpoint, necessarily. Going to be true. As the X production rises, then that changes and then we achieve the target revenue with a reasonable cost basis and the whole picture changes dramatically for profitability and cash flow.
Absolutely. The only other last thing I would add, too, is we've had a significant run-up investment over the last couple of years. Now it's time to absorb that and look for just greater capital efficiency.
Got it. Just one final question. Could you just remind us, are you still on track for storage of $4 to $500 million this year and $2 to $5 next year, or is that still on track?
JB, do you want to comment on that? One thing I'd say with respect to energy, we do see this being a very enormous market, but it's an exponential growth market, exactly where the calendar falls on that sort of S-curve exponential makes quite a big difference on revenue. It will be heavily weighted to the fourth quarter, Jay, do you want to add anything?
Yeah, that's exactly right. It's not a linear extrapolation throughout this year at all. I think we're being fairly cautious and trying to make sure that we don't overpromise here, and understand what's going to happen in Q4. It's a little bit tricky to know how that will grow. Production is on track. We feel really good about that. Production started off as planned in the Gigafactory in Q4. Deliveries are on track. We're starting shipments of Powerwall and Powerpack worldwide. We're growing out the sales operations and sales teams around the world. From an execution point of view, I think we feel really good with where we're at. It's early days to predict how exactly that exponential growth is going to really integrate.
Okay. All right. Thank you very much.
Thank you. Our next question comes from the line of Patrick Archambault of Goldman Sachs. Your line is open.
Okay. Yeah, thanks. Good afternoon and I guess good evening from our end. Wanted to build just on Emmanuel's question. Can you just tell us what is the current run rate of X production, where we stand today towards the middle of February? Can we talk a little bit about how you get to that ramp? It sounds like 1,000 is the target that would obviously mathematically get you to think about half your production, so that's pretty much full ramp. It seems like that's a pretty big distance from where you are now, and maybe we can walk through the pieces that get you there, in terms of training employees, getting the supply base in order, getting some of the quality issues resolved. That would be my first question.
I don't think we want to comment with that level of granularity, because unless people actually understand how our production works, they will reach incorrect conclusions. We want to stick to what our projections are and leave it at that.
Okay. I guess, just in terms of another ramp-oriented question, if I may. It does seem that, given the forecast that you have for, I think, 16,000 deliveries this year.
This quarter
for this quarter, excuse me, getting to 80-90 would imply a run rate that's about 40% higher than where you are in Q1. You also made a comment that inventories, that a lot of that's going to be international and there may be some in-process inventory being built out to service that, maybe we can talk a little bit about that ramp.
Yeah. The international stuff is mostly Q2. That's really where the international ramp starts. There's still inventory in-process for, of course, North America, because it takes longer to get a car to the East Coast, particularly if we have a blizzard or something. That's certainly a factor in finished goods, finished goods necessarily ramps as we fill the pipeline for overseas sales, which is next quarter.
Okay. Thank you.
Thank you. Our next question comes from Dan Galves of Credit Suisse. Your line is open.
Thanks for taking my questions. First one has to do with operating expenses. Hopefully I'm not getting the numbers wrong, it seems like 20% growth in 2016 versus 2015 implies relatively flat versus the Q4 run rate. Is that achievable to essentially keep the operating expenses pretty consistent throughout 2016?
Certainly. This is Jason. We definitely believe that we can do that. There was a bit of a dog's breakfast in Q4. We had some things in there. I'll just give you a couple of examples. We had some aged receivables from some service revenues in Europe that we ended up having to write off. That was one thing. We had some R&D tooling that had come to the end of its useful life, and we had to write off as well. There's some noise in the Q4 number for sure, but I'm very confident in the projection and the forecast that we've given for 2016 relative to 2015.
Okay, great. No problem. One other, if I could. There's been a lot of negative chatter about Gigafactory related to signing up of other partners, precursor partners, supply agreements for access to raw materials, and just kind of the general size of the plant. I was wondering if you could give us an update on where you stand and if you see any challenges to get up to the 35 gigawatt hours of cell production by 2020, 50 of packs.
Sure. On general, relative to the initial forecasts and timelines, we feel pretty comfortable on where we're at. I think there has been a lot of drama and a lot of negativity in the reporting on this, and some around the headcount recently that I think a lot of people picked up on. Maybe just to talk about that one in particular, that recent sort of hiring headcount discussion queued off of numbers that we reported that were effective essentially in the middle of 2015. Those were essentially compared against where we had predicted to be at the end of 2015. They weren't even really apples to apples.
In our very most recent report that we made with the Nevada Governor's Office of Economic Development, we had reported, I think, around 272 net hires for the year at the end of 2015 against what we had a target of 300. The general plan is executing actually quite closely to what we had laid out back in 2014. I think because of the fast growth, we have to be really careful at what snapshot in time you actually look at and what you compare that against. We still have the same confidence. We're still on track to produce 15 gigawatt hours of cells and, I'm sorry, 35 gigawatt hours of cells and 50 gigawatt hours of packs. 15 of that going to Tesla Energy, the rest going to Model 3 and vehicles.
That still is on track, and we're on track to start cell production toward the end of this year.
Okay. Thanks very much.
Basically, to the best of our knowledge, you should not worry about the Gigafactory as a constraint on Model 3.
Yeah.
That does not appear to be anywhere near the critical path for Model 3. If I can just maybe say a few words about the Gigafactory in Nevada and the incentives and all that. One of the most bothersome things that I see in the media is sort of overrepresentation of the Nevada incentives. The thing to bear in mind for the $1.3 billion in incentives for Nevada is that in order for us to achieve that, we have to develop about $100 billion in revenue from the Gigafactory. Those incentives occur over 20 years, representing approximately a 1% discount on the cost of the Gigafactory. The reason it's a big number, I should say it is a big number in the absolute terms, but it is disproportionately small relative to incentives that, say, Boeing would receive for keeping an aircraft factory in Washington.
The reason it's this big is because the Gigafactory will be the largest footprint building in the world when it is done. Our Tesla Fremont factory is currently number 2, and if you're curious, number 1 is a flower auction house in the Netherlands. You can look this up on Wikipedia. It sort of makes sense that if something is kind of like the biggest thing on Earth, it's probably going to have incentives that are big in the absolute, but small in relative terms.
Yeah.
The fundamental driver of the decision, not the exclusive driver, but the primary driver of the decision, was pace of execution for the Gigafactory. That was the primary reason for Nevada over other options. I believe that this decision is bearing fruit because we are seeing it move at a very good pace.
Okay, thanks, guys. Welcome, Jason. Sorry.
All of those incentives are also performance-based.
Yeah, exactly.
We don't receive them unless we execute along the path toward the milestones.
Right. Even some of the ones we do receive have fallback provisions.
Exactly.
Essentially, I wrote a blog about this. There is no way for Nevada to lose. The way that Nevada set up the incentive structure is a no-lose proposition for them. They did an awesome job on behalf of the state. You can read the blog that I wrote called "The House Always Wins," which is true. Anyway, it's just really annoying to see this stuff misrepresented in the press.
Got it. Thank you.
All right, Latif, next question, please.
Yes, sir. Our next question comes from the line of John Murphy of Bank of America Merrill Lynch. Your line is open.
Good afternoon, guys. Just a first question. Elon, you made a very interesting comment about the Model X being the best car ever produced, it sounds like you think it might be better than the Model S. As you get
Maybe I'm biased, obviously.
Well, it's your newest car, it makes sense. Newest vehicle, I should say, it makes sense. As you look at getting that production ramped up and availability out there to consumers, what would the selling point be on the Model S then? Could you get this mix significantly above 50% crossovers or Model X, because the price premium is really not that great. Why wouldn't you sell a whole lot more Model X than Model S, could you?
Yes, I think this is a question of owner preference. I personally still prefer to drive the Model S over the X, because I like the lower position of a sedan. The S, in terms of performance, is about 10% better in acceleration, through handling and whatnot, than the X. It really depends on owner optimization. If you like a high seating position, an amazing amount of room, and functionality, and just a feeling of high visibility. Because one of the best features, maybe the best feature of the X, is the cockpit-style front windshield, which gives you this amazing panoramic view as you're driving. A lot of people like that in an SUV, that's the reason that they buy that.
I think it really depends on personal preference, we'll see what the results are once we actually put the vehicle in stores and people take test drives.
When you think about all the content that you're putting in the X and the upgradability of the S and the X over time, how do you think about planned obsolescence, which is a real necessary part of almost any business to generate incremental sales from your existing customer base?
We don't plan to obsolete things. We just relentlessly make things better. For example, for the S, there's an average of 20 improvements per week. Most of these are little, tiny nuance things that most people wouldn't notice. It is a continuous improvement process. That's why when people say, "Well, when should they buy a Model S?" Like, what model year? We don't really have model years. We keep improving the car. If you want to wait until the car stops improving, you'll be waiting forever.
Just one follow-up just on the cash flow for 2016. Obviously, a lot of progress has been made more recently. As we think about the positive net cash flow and the increase in the cash balance on a year-over-year basis, will that include, I'm just trying to be clearer, the potential draw on the ABL over time as that's needed to run the business? Does that net cash increase not include whatever draw that happens on the ABL in 2016?
That includes the draw on the ABL to finance finished goods.
Okay. Thank you very much.
Thank you. Our next question comes from Jamie Albertine of Stifel. Your question please.
Great. Thanks for taking the question. On the Model 3, if I may, just I think a lot of folks are trying to do work as it relates on the margin trajectory over time, and it's clearly going to be volume dependent and timing around the launch. I was wondering if you could help us understand, just given that it's a third of the transaction price of roughly your initial Model X deliveries, what are some of the efficiencies you're hoping that you can draw upon, maybe beyond just battery cost reductions? What are you leveraging in the Model 3 from investments you've already made and the knowledge you have around initial launch costs and the higher priced vehicles at this point?
Yeah. I think the way to think of the cost services is really that the Model 3 being a sedan, is about 20% lighter and actually quite a bit less complex to manufacture than the S. The S was really the first car we ever made ourselves. So we were designing to make it work as opposed to designing it from ease of manufacturing, whereas the 3 is really designed for ease of manufacturing. Then we expect through economies of scale and just general design improvements to get another 30% improvement. So that's where the 50% improvement comes relative to the S. So, $35K versus $70K, 3 versus S is the way to think about the difference.
And our default plan, as we've done in the past, is that the initial sales are relatively highly optioned versions of the car, because obviously we've got to pay back the investment of all the tooling and everything, so that sort of makes sense to have the higher optioned versions first. That's what we did with the S and obviously, again, with the X. Although it was sort of unfortunate that the way the X pricing got reported, they reported the sort of fully optioned Signature Series as though it was the base price volume number in some publications. So this was just a misunderstanding of how things work. And I think it's also normal to do this in many other industries.
Like for if Intel comes out with a new CPU or faster CPU, or NVIDIA comes out with a new graphics card, in the beginning it's a lot more expensive, and then over time the price drops.
Just a clarification, Elon, on the economies of scale. Should I think about that in the running through the paint shop as an example, given you said the 10,000 unit per week goal there? And then separately, when should we expect to start hearing about the Model 3 production line? Where do you, within the facility plan to build it? At what point? Is it going to be the same lead time as we saw with the Model X? Thanks.
There will be a production ramp for the Model 3. It's always been tricky in the past to predict those production ramps. Anything you guys want to add?
Well, I think in the development plan that we have now, we have substantially more time and placeholder put into the schedule to really refine the product ahead of the production ramp. To a question that came earlier, I think that's something we've really taken to heart in the launch of the Model X. As we look to higher volumes and what we hope will be a steeper ramp with Model 3, I think we've learned some important lessons on how to do that well and having a really robust pilot build in the plant and enforcing rigorous numbers there.
Okay, great. Thank you guys so much.
Thank you. Our next question comes from Andrea James of Dougherty & Company. Your line is open.
Thanks for taking my questions and welcome, Jason. Just a practical one about the factory. You have different choke points at different points in time. It's been general assembly, it's been the cells. At last count, it was body lines 1 and 2. I'm just asking about the status of body line 2 and when you hope to migrate maybe Model S production onto that body line.
I think we're getting a bit too much into the internal decisions of Tesla. If we say something that's related to an internal decision at Tesla, then it can overconstrain our decisions. We need to have some flexibility there. We prefer not to comment on the details of when different production lines are moving around.
Okay. Maybe longer term then, what is your updated thinking on your cost per kilowatt hour by the end of the decade, especially as you source your raw materials at the Gigafactory?
That's quite a sensitive number. It's less than what we see most people estimating. We see most people overestimating cost per kilowatt hour. That is a proprietary number.
I think in the past you've said you'd be disappointed if it was not below $100.
Yeah. In the long term. Yeah.
Thank you for taking my questions.
All right, thanks.
Thank you. Our next question comes from Ryan Brinkman of J.P. Morgan. Your question, please.
Yes, thanks for taking my call. Question for Jason, probably. Other automakers sometimes talk about what they call minimum cash, the amount of cash that they need to end a quarter with in order to fund inter-quarter working capital swings, even in the event total change in working capital during the quarter were negligible. I'm curious what you think your minimum cash needs are, and if that's something you can share with the investment community. Just more broadly, what total amount of cash or gross liquidity do you prefer to run the business with? Thanks.
Yeah, sure. We don't go over the inner workings of how we do those calculations internally, but $1 billion is a nice comfort level. You see we're starting to make the moves on the ABL and et cetera to give ourselves more flexibility there. To just reiterate a comment I made at the very beginning, cash is king, and I'm walking around collecting it.
Okay, great. Just last question on the Gigafactory. You've already given some updates, but maybe you could just talk about how much of the planned CapEx for 2016 relates to the Gigafactory? Maybe an update on the relationship with your partners there, maybe Panasonic or any others, how those relationships are progressing relative to their expected future contributions. Thanks.
Sure. It's a great question. Like I said, we're really excited about the Gigafactory, and things are on schedule. We're not at this time going to break out the detailed CapEx plans. I gave it to you thematically earlier. Certainly Gigafactory towards the end of the year, we'll start to see some Model 3 investment, and then throughout the year, we'll see investment in sales, service, and the Supercharger network.
Great. Thanks.
Maybe just quickly on the Panasonic piece.
Yeah.
They continue to be an excellent partner in the project, I think you've seen probably in the recent months some additional statements from them, with ongoing capital commitments to the project, as planned. Those are happening in the right sequence. They've also started hiring for the project and training people. Things are going as well as we could hope there.
Perfect. Thanks.
Thank you. Our next question comes from Ben Kallo of Robert W. Baird. Your line is open.
Hi, guys. Tyler Frank on for Ben. Can you comment on the overall expectations for deliveries throughout the year? If we back out the 16,000 of the Q1, it looks like about 23,000 first quarter for Q2 through Q4, which seems like you should be there with production given the Model X expectations and the Model S production expectations as well.
Like I said, I know you'd love to have more granularity, but it's difficult for us to give you granularity that we ourselves don't have. That's excessive precision. I don't want to give false precision. We feel good about the overall number, but it might move around as to how it gets to that overall number. There's always unforeseen things that occur, so that's why we need some flexibility, so we don't provide false precision and then people hold us to false precision.
Okay. Thank you. Can you comment on what you're seeing for overall demand in the China market, what markets do you expect to move into next, and how that ramp will go?
Yeah. China is not a huge market for us and it hasn't been historically. It is something we expect in the long term will be a big market and ultimately probably our biggest market. I think there's a lot of long-term opportunity there. It's difficult to say what's going to happen with China in the short term, except that it doesn't really have a big effect on Tesla yet. Long term it will be. In terms of new markets, I'm really excited to launch in Mexico this year. I'll be heading out to Mexico City. I think there's actually quite a bit of opportunity there. We actually do have customers in Mexico already, but having a significant presence there I think is going to be great. Some of our most supportive customers are actually in Mexico.
Good. Thanks. A quick follow-up. There's been some rumors and commentary that the Model 3 launch may not be an actual full vehicle. Can you just talk about what we should expect at the launch event at the end of March?
Yeah. We're trying to decide whether we should show all the cards or keep a few cards close to the vest. Haven't made the decision yet.
Great. Thank you.
Thank you. Our next question comes from Rod Lache of Deutsche Bank. Your question please.
Hi, everybody. You commented earlier, Elon, on the Model S versus the Model X demand being personal preference on passenger car versus SUV. I was just wondering if you have any thoughts on whether Model S demand would or could be affected once the Model 3 is revealed. Do you think that those vehicles ultimately go to different customers, or is there a plan to avoid cannibalization there?
Yeah. I think they are different market segments. Much as, say, the BMW 7 Series and 5 Series and 6 are different market segments from the 3 Series. You should think of the Model 3 as really competing in the BMW 3 Series or Audi A4 market. If you want the ultimate machine, you'd really want to get the Model S. The Model 3 will be a great car.
Yeah. Maybe also just as an anecdote, there was a lot of similar concern when we launched the Model X about cannibalization of Model S demand, and we actually saw just the opposite, which was the increased interest and awareness and just customer engagement actually drove higher Model S sales, even as the Model X was launched. Those are actually much closer in terms of vehicle capability as we just talked about.
Yeah. It makes sense. I was hoping just on the financial side, can you give us just a little bit of a sense of how challenging it will be to get to that 25% Model X gross margin? Can you comment at all on how you're expecting for the overall company gross margins would look this year? Are you expecting them to be able to stay above 25% even with the Model X ramping?
Sure. As we said in the letter, 25% by the end of the year for Model X. I'm sorry, I'm a little under the weather. 30% for the Model S. You can do the math on what the blended rate will look like. In terms of getting to 25% for Model X, the way you have to think about it is we've got many years of history with the Model S right now, and that is learning that can certainly be applied to what we're doing with Model X. We're comfortable that we're going to be able to drive gross margin in the right direction with Model X significantly throughout the year.
Yeah. In the long run, we expect the gross margins of the S and X to converge around the 30% number. They should, in the long run, both be around 30%. That's our target. It's just as Jason was saying, because the X is a newer vehicle, we're just earlier on the learning curve for the X than the S.
It sounds like you're benefiting from some learning curves, the margins even initially could be. North of the 20% range, is that a reasonable expectation, ramping up to that level? Is it a more challenging kind of ramp?
I really look at it, where does it end up, as opposed to what happens in the very near term. It's hard for us to predict exactly where it is in the near term. Just think of that S-curve and say, where are you on the S-curve? If you have a rapidly changing slope on a curve, it's really hard to say, let's take a date, because you could move that date by a week and have a huge difference.
Right.
That's why it's hard for us to give you an exact number. We kind of know where the S-curve will end up, as it starts to asymptote, it gets much more predictable.
Okay, great. Thank you.
Thank you. Our next question comes from Dana Hull of Bloomberg News. Your line is open.
Yeah, hi. Thanks so much. As you think out four to five years to 2020 when you want to produce 500,000 cars each year, can you get there without building another assembly plant or a second Gigafactory?
Yes. Specifically, the Fremont plant, in fact, historically has produced almost 500,000 cars a year. Sorry, we can hear your keys quite loudly. When it was a Toyota GM plant, it produced almost 500,000 cars a year. We're comfortable that it can get back to that level. The Gigafactory is designed to support 500,000 cars a year worth of batteries, plus have 15 gigawatt hours left over for stationary storage.
Okay. No need for a second Gigafactory.
Correct. No need for a Gigafactory. Correct.
Okay. For Jason, the shareholder letter says you plan to open about 80 retail locations and service centers and energize about 300 new Supercharger locations. Can you give us some commentary on where exactly those new service centers and retail locations might be? Is it mostly the Northeast of the U.S. or also globally?
That's what I said.
Sure. I think the general theme is two-pronged. We're densifying in markets where we already exist, and where demand has increased significantly, we've got to put service centers. We try to actually predict ahead of that, where we're going to need those. As Elon referenced, we are opening new markets this year. I think in general, we're going deeper in markets where we are. In addition, we're opening a significant number of stores in China and in the Northeast of the U.S. as we increase our awareness and our share in those markets. You'll see service centers and retail locations opening across all of our markets, including Europe.
All right. Why don't we go to the next question?
Thank you. Our next question comes from Mike Ramsey of The Wall Street Journal. Your line is open.
Hi. I guess I was hoping maybe you could give me an encapsulating feeling on the quarter. It's sort of a mixed bag from an outsider's perspective. The losses were pretty high and maybe higher than what some people expected, you're giving a very aggressive forecast. Do you feel like the company is on the right track and that you're past some of your hiccups? I guess I'm looking for a 40,000-foot analysis.
Yeah, I feel very good about things right now. The last several months have been quite excruciating, I'd say. Many late nights and weekends. I think we're through the worst of it at this point.
Okay. I had wanted to ask a little bit about also your plans for consolidation. Dana asked about whether the Gigafactory could handle the Model 3. I'm curious, I haven't been there. There's so many folks working over there now that aren't even building cars. You have engineers and stuff there. Can you give me a little idea about whether and when you might have to think about consolidating your operations in the Bay Area? Excuse me, I'm a little under the weather as well.
I'm not sure what you mean by consolidating. We are kind of spread out because in addition to Fremont, the Fremont factory complex and our headquarters in Palo Alto, we do have a number of other facilities in the Bay Area. Man, I'm not sure how we'd consolidate.
Yeah.
We'd have to build a real big facility for that.
You might just keep taking over buildings all around. Okay. All right. Thanks a lot. Appreciate it.
Yeah, I think, man, it's probably 7 million sq ft of real estate at this point around the Bay Area.
Yeah.
Something like that.
Yeah. We've seen the Gigafactory actually being a helpful pressure outlet for some things in the Bay Area.
Plus expansion in the Lathrop Stockton area.
Yeah. We're going the other way.
Alright, Latif, next question, please.
Yes, sir. Next question comes from Dee-Ann Durbin of Associated Press. Your line is open.
Hi. Thanks for taking the call. Considering now that the Chevy Volt is going to go on sale at the end of this year, so that'll be a full year that it's on sale before Model 3 arrive. Has it taken any wind out of your sails, or do you think, again, that these are very different customers? If you're comparing to an Audi A4, for example, are people still going to be attracted to the Model 3, even though they'll have that option on the market quite a while before the Model 3 arrives?
Well, I would point you to the market share of large luxury vehicles or large premium sedan sales in the U.S. that I talked about earlier in the call. We currently outsell everyone in that category and had a 51% market growth last year, where everyone else declined and the market as a whole declined. If Model 3 is at all similar in its market segment, it doesn't seem like we're going to be demand-constrained.
Okay. I know you don't do any marketing, but I'm wondering if you would ever possibly reconsider that. It struck me when you were saying that you aren't where you could be on the East Coast, and that may be because people need some more educating about how the car performs in the snow or whatever. Do you think there's ever a point at which you might reconsider and do some very targeted marketing in places where you think you could do better?
Yeah. I don't think we'd do that in the near term. In the long term, I think I could see us doing advertising where that advertising was interesting, entertaining, and people don't regret seeing it. Which, unfortunately, is not the case for most advertising. If there's something interesting and artistic, or it's entertaining, it's like we don't waste people's time if they saw it. Also, I think we need to have a more affordable high-volume car before that makes sense, like the Model 3.
It's more accessible. If we do mass media, then it's more likely that somebody could buy the car. That's when it would be something we'd consider.
Okay. Thank you very much.
All right.
Thank you. Our next question comes from the line of Phil LeBeau of CNBC. Your line is open.
Thank you. Elon, I'm curious if you are noticing any impact in terms of reservations, orders, in terms of the market volatility that we're seeing, the growing questions about instability in our economy, elsewhere, fall-off in the wealth effect, if you will. Are you guys noticing any slowdown in the pace of orders?
Jon, do you want to?
Yeah. Phil, it's a great question. Actually, the answer is no. The demand is very strong. We're up significantly over 2014 in the same period for S and X. Both the order rate on S and the conversion rate to orders on X has been very strong. We're not seeing that impact at this point in time across really all of our markets, both domestic and international.
Yeah. That said, we don't want to be complacent about demand generation. As we mentioned, there's a bunch of stores opening in markets where we really haven't had a store or any kind of meaningful store. Our store in Manhattan, you basically need to be Sherlock Holmes to find it. Unless you hunt us down you won't find the store.
Right.
I think we also need to change that and put stores where people are likely to encounter them. It's kind of like a fishing boat or something. It's like you want to be where the fish are. It's like not in some sort of random barren location. That's kind of what we're doing. We're not complacent about demand, and just in case we see things take a turn for the worst, we want to overshoot on demand generation via our stores.
Thank you.
All right, everyone. That concludes the Q&A session of the call. Thank you so much for joining us today, and we look forward to seeing you all in the future.
Yeah. Thanks, everyone.
Ladies and gentlemen, you may disconnect your lines at this time. That does conclude your call. Have a great day.