Good day, ladies and gentlemen, and welcome to the Tesla Motors Second Quarter 2014 financial results. At this time, all participants are in a listen-only mode. Later, we will conduct our Q&A session and instructions will follow at that time. Now I'd like to turn the call over to your host, Jeff Evanson. Please go ahead.
Thank you, Patrick. Good afternoon, everybody. Welcome to Tesla's second quarter financial results Q&A webcast. I'm joined today by Elon Musk, Tesla Chairman and CEO, JB Straubel, Tesla Chief Technology Officer, and Deepak Ahuja, Tesla's Chief Financial Officer. We announce second quarter results today in our quarterly shareholder letter. The letter is available at this time as a link to our website at ir.tesla.com. There will also be a replay of this webcast available later today at the same link. Please note that certain financial measures used in this call, such as revenue and income, are expressed on a non-GAAP basis and have been adjusted to exclude the effects of lease accounting used on Model S sales with a residual value guarantee and charges related to stock-based compensation. Our GAAP results and reconciliations to non-GAAP measures can be found in the shareholder letter.
During this call, we may discuss our business outlook and make other forward-looking statements. Such statements are predictions based on management's 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. If you would like to ask a question, please press star one at this time. Patrick, why don't we turn it on over to the first question, please?
First question comes from Adam Jonas with Morgan Stanley. Your line is open.
Hey, everybody. First I had a question on your forward-year guidance of 100,000 unit run rate by the end of 2015. Can you give us some sense of how much of that's coming from China? We understand that demand for your products in China is off the charts strong, but we're a little concerned about your ability to deliver and service the volume while focusing 100% on the quality and building the brand authenticity. Maybe how many China stores or service centers would you need by this time next year that might be commensurate with that volume target?
Sure. Well, just to sort of give you rough guesses on the 100K run rates at the end of next year, which I think is arguably one of the most interesting things in our newsletter, which you picked up on. We're expecting that to be sort of roughly split between X and S. We're talking, it's roughly 1,000 units a week of each.
When you look at the market demand for SUVs and sedans, that's about the split. It's almost exactly 50/50.
In fact, I think recently, SUVs might have slightly edged ahead of sedans. It's reasonable to expect that I'll address the demand and then the servicing side of things. It's reasonable to expect that if we see a comfortable 1,000 unit demand on the sedan side, well, probably we should expect that similar number on the SUV side. My guess is we'll actually see slightly higher on the SUV side. I think the Model X is going to be a phenomenal car. On the service front, we are spending a lot of money on service expansion. That's our primary expenditure, in the sort of sales and service arena, it's primarily service. An overwhelming majority is service-related.
Mm-hmm. Good.
It's not really— Our concern is not demand generation, but how do we make sure that that demand is well served? In terms of number of stores by the end of next year, or number of service centers, I should say, by the end of next year, actually, I don't have that offhand, but it's probably on the order of 100 in China alone, I'm guessing, by the end of next year.
Probably worldwide, it's on the order of 300. I'm speaking off the cuff here.
Sure.
Probably north of 300 worldwide. I have to say, I've been very impressed with the Tesla China team and the quality of people that we're attracting in China. I think the China team is smart, and they work super hard. The pace of progress is just amazing. I feel pretty comfortable about being able to do good service in China, or great service, actually. In fact, the key metric we measure in service is the percentage of customers that are delighted, which is a 10 out of 10 score. That's the primary thing we look at. Domestically, I believe we're actually— In the U.S., we're about 70% of customers who experience service rate it as perfect, or yeah, 10 out of 10, essentially.
Another key metric we measure is the average time to service something. Our average is less than a day. In most cases, we can actually pick up your car, fix anything that's wrong with it and give it back to you without you even knowing it was gone. You just tell us, "Look, my car is at my office, and this is where it is," and we'll pick up the car, fix it, and get it back to you before you finish work.
Wow.
Our goal with service is sort of invisible up, which is, it's like magic, it's like El's service journey. You don't even see it.
It happens so fast. When it's done, you love it. I think there's an interesting opportunity to revolutionize service as well. It's not just like, oh, just do the same thing as before. There's a lot of lessons to be learned from the Formula One pit crew approach. Because we're not trying to serve most customers for the most amount of money possible in a service, which is typical of the conventional auto industry, we want to get the job done super fast and then also make sure that we want to anticipate issues so you don't have to come back again. We actually bring the car in, and we kind of hit it with a pit crew, like a Formula One pit crew. Instead of having one person per bay, the car gets slowly worked on over several days.
It actually comes in and a team attacks it, and we're constantly improving the tools and the metrics to say, "How can we get the car perfect as fast as possible?
We're actually bringing in people from Formula One to help with the training on this. I think there's a real opportunity there to revolutionize the way service works.
That's great color, Elon. Can I just ask a follow-up? Outside of BMW, any other parties, can you say any other parties that have expressed interest in your patent-sharing gesture? I'm curious to think why you think the industry is moving towards hydrogen in this, or so much of the industry seems to be pushing hydrogen like crazy in the past few months. Is this just some bullshit move to kind of get CARB to rewrite the rules on EVs, or do you think they actually believe this stuff? Just finally, can you confirm the rumor that Mr. Burns tries to kill you by running you over in an i8? Thanks.
He does attempt to kill me in "The Simpsons." Not in an i8.
Maybe a Volt.
Well, as you know, I'm not the biggest proponent of hydrogen. Our view, JB and my view, and the rest of the team at Tesla is that really, if you take a theoretically optimal fuel cell car and compare that to a current in-production battery electric car on key metrics of mass, volume, complexity, cost, refueling infrastructure, it's a loss. If the best case, in our opinion, the best case fuel cell car, and obviously the current fuel cell cars are far from best case, cannot beat the current case electric car, well, why even try? That just makes no sense. Success is not one of the possible outcomes. Right, JB, anything you'd want to elaborate on that?
I think that really is pretty clear. The only real benefits that get touted for fuel cell and hydrogen vehicles are potentially range and refuel time, both of those are not sustained benefits when you look at where battery technology is today and certainly where it's going in a few years. I think people make a mistake of comparing today's technology with future potential technology instead of two technologies at the same point in time.
Like I said, even if you take a theoretical optimal, theoretically perfect fuel cell car, I just don't think you still do.
JB, why are they doing this? That's why I ask if it's BS. Is this just kind of a diversionary tactic, or do you think they're just not on What's up?
We're quite confused about this.
Yeah. It does not make a lot of sense. We didn't even touch on the infrastructure challenges that hydrogen brings, but building out that infrastructure is substantially more expensive than building out any electric vehicle infrastructure, and there's almost none of it today.
Yeah. Also, I don't think people understand, hydrogen is an energy carrier, not an energy source.
Yeah.
You have to create the hydrogen, which is really inefficient because you either have to crack a hydrocarbon or electrolyze water.
If you want to do it renewably, the water electrolysis route is really the only path.
Yeah, which is super inefficient. Yeah. Hydrogen has very low density. If you're going to pick a chemical energy storage mechanism, hydrogen's a terrible choice. At least do methane, CH4. Lock up the hydrogen with one carbon atom or something. Anyway.
That answers the question.
It doesn't make a lot of sense.
Yeah.
All right. Thanks a lot, Adam. We should get to the next caller, please.
Our next question comes from Andrea James with Dougherty & Company. Your line is open.
Thanks for taking my questions. First one's, I guess, about quality control. Can you talk about the improvements you've made in quality control and where you think it needs to go, maybe with a nod toward what's going on with the drivetrain systems?
Sure. We definitely had some quality issues in the beginning for the early serial number cars, because we were just basically figuring out how to make the Model S. I think we've addressed almost all of those for current production cars. Not all, but the vast majority have been addressed in cars that are being produced today. We're also getting better at diagnosing what's wrong. Because in some cases, particularly with respect to the drive unit, we would think that something's wrong with the drive unit, but it's actually something wrong with another part of the car. Then we'd replace the drive unit, and that wouldn't solve the problem because the drive unit was not the problem.
We had one particular case where there was a vibration. It was due to a cable detaching itself, touching the drive unit assembly and causing vibration to be transmitted to the body of the car. It was somewhat pernicious because if the cable moved a little bit, that it didn't provide a conductive path, then the vibration would go away. You'd replace the drive unit, you'd temporarily tuck the cable back and think the problem was solved, the cable would vibrate itself down and transmit the energy. The cable thing takes us like It's nothing to fix it. Literally it's like a $3 cable tie to solve it. There's a bunch of things like that, which are just misdiagnosis of problems that we've obviously addressed.
There are a few items that a fair number of drivetrains will need to be serviced. One in particular is related to the differential. We need to shim the differential. It doesn't require a drive unit replacement. It just requires a technician to insert a shim. We're going to have to do that on a fair number of cars. That's like a $0.50 shim. I wouldn't assume that there's going to be some vast number of drivetrains that will need to be replaced. There's several service bulletins that we'll be instituting, many of which we already have instituted to address the issue. Every week, I have a product excellence meeting, which is a cross-functional group.
We've got engineering, service, production, we go over all the issues that customers are reporting with the car, develop action items that have to be addressed to get the car ultimately to the platonic ideal of the perfect car. That's what we're aiming for. Although I think we've got great service, the best service is no service. That's really what we want, is a car that never needs to be serviced. I think we're getting there quite rapidly.
Would you say you're satisfied or more so with the quality control function and team you have in place?
We've got an excellent quality control team. We weren't there in the beginning, but I'm confident that we're there now. Our aspiration is sort of an order of magnitude better quality than any other car. We will keep at it unrelentingly until we get there.
Just to flip over to the Gigafactory, it says in the shareholder letter you've broken ground in Nevada, I guess it's out there in the blogosphere that construction's paused. I guess my question is, why slow it down? Do you have a drop-dead date for when you really need to make sure you're really up and going?
Yeah. We've essentially completed the creating of the pad, the construction pad for the Gigafactory in Nevada. In terms of creating a flat pad and getting the rocky foundation, that is substantially complete. There's still a little bit of work ongoing. We're going to be doing something similar in one or two other states, which is something I previously said we'd do, because I think it makes sense to have multiple things going in parallel. Before we actually go to the next stage of pouring a lot of concrete, though, we want to make sure we have things sorted out at the sort of state level, the incentives are there that make sense and are fair to the state and Tesla. I do want to emphasize, Tesla is not going to go for a deal that is unfair to the state or unfair to Tesla.
We want to make sure it's compelling for all parties. I think on the Nevada side, at this point, the ball is in the court of the governor and the state legislature.
Is Panasonic having any input into the site selection process?
We're keeping them closely informed, so that they're aware of all the details. They haven't volunteered advice necessarily. We'd certainly listen to their advice if they provided it, but they seem to be in accordance with our very own location.
Yeah. Tesla is managing all of the utilities and infrastructure at the Gigafactory sites. In that regard, Tesla is basically aggregating the inputs and requirements from not just Panasonic, but other potential partners as well. It's primarily Tesla's role to be evaluating those sites.
Appreciate it. Thank you so much.
Our next question comes from Ryan Brinkman with JPMorgan. Your line is open.
Good afternoon. Thanks for taking my question. Earlier in the year, you had discussed a potential, I think, $4 billion-$5 billion investment in the Gigafactory through 2020. Is that still the number that you're working with? I think, too, you had planned for the CapEx to be shared by the Gigafactory partners. In your press release this morning, you mentioned that Panasonic will provide equipment, you the buildings, utilities, et cetera. Do you think you're on track to sign suppliers on to provide $2 billion-$3 billion of investment? Over what rough timeframe might we expect you to announce those partners and their respective investment commitments?
Sure. That $4 billion-$5 billion number is, I think, we think probably accurate. Particularly through 2020, I think it'll be maybe closer to $4 billion, maybe slightly less than that, before we get to initial high-volume production. As we do continued investments to improve output and improve the technology, the pack, it's probably closer to the $5 billion over the 2020 timeframe, but probably less than four to get up to serious production. Of that number, we see Tesla probably providing 40%-50% of the total. Panasonic probably about 30%-40%, the state maybe 10%, and other industrial partners about 10%, maybe 15%-20%, depending on how vertical we go with the factory.
With having signed the contract with Panasonic, I think, well, it was never really something that was in doubt from my standpoint. I think sometimes people take things that Panasonic says. They're going to be fairly conservative in their words, but I think the actions are really what matter. Panasonic has always taken the actions of an excellent partner. We feel confident that there will be the amount of money needed to reach the 35-gigawatt-hour level at the cell level and 50-gigawatt-hour at the module and pack level. The module and pack stuff is all Tesla internal. We're expecting suppliers of the precursor materials from the anode, cathode, separator, maybe the electrolyte, to be also present in the factory.
Great. That's extremely helpful and reassuring, too. Switching gears, last question. Is there anything you can say at all on the trend to Model X orders? I know that you don't disclose backlog, but perhaps you could speak qualitatively to it, maybe how it compares to when you first started taking Model S orders, or how many are maybe returning customers? Is there any difference geographically, and who is preferring an SUV versus sedan, where the orders are coming from, et cetera?
Sure. Well, first of all, it's important to appreciate for the X that, just to put the orders in context, there are no cars available for a test drive. There is no information about the cars in our stores because we're only selling the S. In fact, if somebody comes in and wants to buy the X, we try to convince them to buy the S. We anti-sell it. We don't really provide all that much information or details about the car or provide a really definitive date on when you can get it. Despite all that, there's huge demand from all around the world for the X. I think that actually people are right even though they don't really have enough information to know they're right, but they are.
Great. Thank you.
Yeah. Our issue is we will not have a demand issue. Yeah.
Thanks.
Our next question comes from Colin Langan with UBS. Your line is open.
Oh, great, thanks for taking my questions. Just on the 100,000 exit rate in 2025, I guess that implies that the battery constraints will be limited. At what point should we think of the battery constraint limiting you until the Gigafactory comes online?
Sure. We see a path to potentially 150,000 cars a year, maybe if you really push it, 200,000 cars a year without the Gigafactory. The Gigafactory is needed for that incremental 300,000 cars. I would guess that probably it could be pushed to a couple hundred thousand cars a year without the Gigafactory. That's probably a good guess. Yeah, we'll sort of see where that leads.
On the Gigafactory, is the chemistry going to be the same battery chemistry that you're currently using, or is that part of the discussions that are going on with Panasonic?
There are improvements to the chemistry, as well as improvements to the geometry of the cell. We would expect to see an energy density improvement, and of course, a significant cost improvement. JB, do you want to go that way?
Yeah. The cathode and anode materials themselves are next generation. We're seeing improvements in the maybe 10%-15% range on the chemistry itself.
Yeah, in terms of energy density.
Energy density. We're also customizing the cell shape and size to further improve the cost efficiency of the cell and packaging efficiency.
Right. We've done a lot of modeling of trying to figure out what's the optimal cell size. It's really not a lot different from where we are right now, but we're sort of in a roughly 10% more diameter, maybe 10% more height. Since it's a cubic function, it effectively ends up being, just from a geometry standpoint, probably a third more energy per cell. Well, maybe 30%-ish. The actual energy density per unit mass increases.
Yeah. Fundamentally, the chemistry of what's inside is what really defines the cost position, though. It's often debated what's shape and size. At this point, we're developing basically what we feel is the optimum shape and size for the best cost efficiency for an automotive cell.
Yeah.
The chemical formula would be the same, it's just shaped differently, or?
No.
It's a different formula.
Yeah.
Okay. Just one last question. It sounds like the Gigafactory might be very vertically integrated. How do you think about that for the assembly of a Model 3? Do you need to be highly vertically integrated, or do you think you'll probably outsource more of that to reduce the cost of that model?
I don't think outsourcing decreases the cost. It tends to increase the cost, in our experience. The reason we outsource stuff is just because we've got too many fish to fry otherwise. It's almost always the case that when we've insourced something, it got cheaper. Yeah. The thing that makes it really efficient for any given technology level is to say, how far did that molecule move? If the molecule's taking several round trips around the world, that's expensive. If it's just moving from one station to the next, then that's obviously lower cost. The vertical integration just means that the molecule doesn't move as much. It's not being put in a box and then put in a truck and then on a boat and then going through customs and stuff like that.
I think that's generally true, that vertical integration and doing things at large scale results in cost reductions. I feel very confident about a 30% cost reduction per unit of energy. We're obviously going to target something higher than that.
Okay. All right, thank you very much.
Our next question comes from Brian Johnson with Barclays. Your line is open.
Yes, thank you. Could you maybe help us understand how you think about the gap or how we ought to think about the gaps between production and deliveries? It looks like typically production's been running 900-1,200 units in recent quarters ahead of deliveries. Your 4Q guide would actually imply deliveries roughly equal or actually a little bit higher than production. Can you help us kind of think through that?
No. Production in Q4 will significantly exceed deliveries. The time from when a car is produced to when it is delivered, it depends on the mix of domestic versus international, because when cars are sent to Europe or China, they've got to obviously get on a boat, they've got to go through customs. It's sort of a more lengthy process. Our average time for delivery of a car in North America is about two weeks-ish there. For international deliveries, you've got to add probably another three to four weeks on top of that. We're trying to tighten that down a little bit. If you blend the two, then maybe it's an average delivery time of four or five weeks. For cars made in October, they would all be delivered in Q4.
Okay. I think that's been what hurts too. Go ahead.
As we increase our overall production, there are two factors that drive that gap. One is the ramp of production increase, the other one is the mix of international markets.
Right.
Even if the mix is the same, but we're increasing production, it creates a bigger gap each quarter. Clearly, as we are shipping more to right-hand drive markets into China, our international mix is increasing, too. Each quarter, it's a slightly different story, but certainly there will be a gap as we continue.
Okay. The implication of that, though, is your production rate in 4Q would be not slightly higher than 1,000 a week, but more than slightly higher than 1,000 a week.
Sufficiently higher.
Yeah. It'll be sufficiently high that we can still deliver to our expectations of slightly over 35,000 cars this year.
Yeah. At 1,000 cars a week, steady state implies a 50,000, roughly, delivery number in steady state. It doesn't really need to be all that much beyond 1,000 to achieve our goal on average for the Q4.
Okay. If you think about the difference between the roughly five to 600 deliveries per week this quarter and the 1,000 a week rate you're talking about, how would you waterfall the step up in terms of the contribution of the three key geographies, Europe, China, and obviously Hong Kong as part of that, and then North America?
Long term, I'd say it's a-- Well, this is not just China and Asia, of course. I think long term, we're probably looking at, and this is just a guess, but it's maybe 40% Asia, 40% North America, 20% Europe, as a rough guess. Asia is more than China, for sure. We think we'll do reasonably well in Japan, and we'll at some point go into Korea.
Hong Kong.
Hong Kong being sort of China. It's part of China, of course. A special administrative zone, I guess. Australia and New Zealand and that kind of thing. It's probably 40% Asia Pacific region. We tend to do very well in our home markets in North America, hence the 40% there. Europe, the demand is just not generally as strong in Europe. It's hard to say. I mean, Europe could end up being 25% or 30% of the mix. This is just a rough guess.
Okay, thank you.
Our next question comes from Rod Lache with Deutsche Bank. Your line is open.
Hi, everybody. You brought up a few times the future case electric car, and you also mentioned that you're comfortable even in the near term with a 30% reduction in cost for batteries for packs. Most of what you said is logistics. I wanted to ask you two things on that. One is that additional 10%-15% that you talked about related to anode and cathode chemistry and geometry, is that incremental to the 30%? If you took a step back and thought about the trajectory for this in the next 10 years rather than the next three years, what do you see on the horizon? Is there a case for $100 per kilowatt-hour pack in 10 years?
I would be disappointed if it took us 10 years to get to a $100 kilowatt-hour pack.
Basically, you're saying that within that time frame, you would expect electric vehicles to reach cost parity and maybe even improve upon the cost of an internal combustion vehicle?
Yeah.
Mm-hmm. That's interesting. Now, that's a pretty big statement to make.
Pretty big statement to me. I just want to correct something. In your question, something should be corrected. The 30% savings is not just due to logistics. The logistics is a big factor. We are-
Not even the biggest, though.
Yeah. Logistics, if you consider the fact that it's just going from one station to the next instead of going from multiple entities to multiple entities and- When you get to the economies of scale that we're talking about, you really get to design custom equipment that's much better at processing each step. You really get to design the machine that makes the machine, not just do so with off-the-shelf equipment. Just everything about it is going to get a whole lot better. That's why we think the 30% number when the Gigafactory is at full production is a conservative number. Yeah. Then, yeah.
To get to those kind of targets beyond the 30%, is there some kind of breakthrough anode chemistries or things that you're looking at that you think are highly probable that are needed, or is it just a bunch of incremental steps that you see kind of playing out over the next years?
We're tracking things that have a whole range of different horizons for implementation. To realize the Gigafactory and those cost targets, we don't need some fundamental breakthrough in chemistry or material science. Those things are pretty well understood and in front of us. In the long term, there are a lot of very interesting, long term being the 10 years perhaps you mentioned or more. There's many very interesting things on the horizon with reducing probabilities as you go further out.
Absolutely. It's heading to a place of no contest with respect to gasoline, we're trying to make it go there as fast as possible because time is important here.
The sooner this can be done, the sooner we can reduce carbon output and reduce the probability of a catastrophe. Yeah. In the absence of the Gigafactory, this progress would be much slower.
Just wanted to ask a quick kind of nearer term question. Now that it sounds like you're buttoning down a lot of things with regard to the Gigafactory and expansion of service centers and things like this, can you share any kind of high level thoughts on how we should be expecting the trajectory of your CapEx, R&D, and SG&A as we look beyond this year? Just maybe some kind of broad ranges into next year.
Rod, we can share more details towards the end of the year as we look further out. Clearly, given the huge ramp up in our deliveries and consequently our revenue, we should see a significant improvement in our operating expenses as a percentage of revenue-
Right.
-as we go forward. We can provide you a little bit more granular guidance as we go further out.
Yeah. I should also say, in the past, Tesla, we've shown all of our cards. People have kind of gotten used to us showing all of our cards. We're not currently showing all our cards.
Okay. All right. Well, thank you.
Our next question comes from Patrick Archambault with Goldman Sachs. Your line is open.
Hi. Yeah, thank you very much. Just a question on the cadence of sales. With the guide for deliveries of 78 for next quarter, it does appear that you are going to be starving some demand there certainly, which is going to clearly get allocated into the following quarter once the changeover is done. I guess, how do you think about just the risks of kind of associated with hitting that target? I guess if the math is right, I think you go from 78 to 13,000. It just seems like an awful big ramp. Maybe not in absolute units, but certainly, kind of you think about it almost doubling. How should we think about that and managing that?
Sure. I agree. It does seem like a sort of a crazy leap, we try to address that by pointing out that there's two weeks missing in Q3 because of the factory retooling, and those are two weeks at fairly high production. You can add almost 2,000 units to what Q3 really would be if we didn't have that two-week interruption. It would actually be more like 9,500 units or something like that in terms of Q3 deliveries. Then it's like, oh, okay, it's much more of. You can see how we get from sort of 7,500 to 9,500 to 12,000, 13,000, whatever the case may be. The progression is much more sensible in that context, I think.
Yeah. It certainly helps us understand in terms of kind of the underlying cadence of purchases, if you will. I suppose, even though we're talking about deliveries. I guess the one question I would have is how about in terms of Of service centers and just the logistics of actually being able to physically deliver these cars. Is that a constraint or a risk in any way, I suppose?
No, because we actually will be delivering at the 1,000 to 1,000 plus per week rate at the end of Q3.
Okay, understood. Then I guess another related question, if you have any color on this is, if you just go through what you've laid out there and hold the regional delivery rates constant with where they came in in Q2. Most people sort of have those through various sources. It does imply, again, that clearly you're starving one or more regions in Q3 in terms of demand that they'd want, but can't get. For Asia, it implies something like maybe 5,000 to 6,000 units of deliveries, at least on our preliminary math. I guess that's a similar number that you did initially in the U.S. when you launched. Is that something that you've got a backlog for already? I'm imagining the answer is yes, but was just kind of curious.
Demand will not be a problem. Yeah. There's an interesting little item, like how many stores are we building? Wow, we're building hardly any. Building lots of service centers. We can drive demand up at will. If we drive it up too much, then people get upset with us because they wait too long for their car. One guy in China got so upset that when he got his car, he bashed it, which seems self-defeating, but his stated reason for bashing the car was that we took too long to deliver it to him. I'm like, "Okay." When I was visiting China, the only unhappiness I saw was because customers were upset about waiting too long for their car. It's like, boy, we better not stoke demand in that situation.
Sales per square foot on our stores, I believe Apple's normally the leader on sales per square foot. Our sales per square foot are double that of Apple's.
Thank you. That's helpful perspective. If I could just ask one more, just building on Rod's question. As you think about OpEx, I know you're not giving guidance for next year, Deepak, but clearly what you've laid out for your expansion of service and distribution, obviously that's an expense that we expect to increase in a fairly steady way. How do we think about just R&D in the shorter term? Obviously it's fairly elevated. I think the math implies more than $400 million this year, if I'm doing it right. Is that something that takes a little bit of a breather in terms of the growth rate, or just given the significant product ramp you've got, it's something we should look to continue to increase in short order?
We are doing a lot of product-related actions at this point, and that is creating an artificial bump, and especially with Model X and other activities that are going on. That will sort of slow down, but then we want to work on so many exciting things. I don't want to just suggest that R&D will slow down. I think if there is one place you want to spend money, it's there, and do more exciting stuff. I think we'll just provide information as appropriate further on. Yeah. In other words, our CapEx and R&D numbers are better than they appear because there are things you don't know about.
Well, okay. A lot of interesting stuff to look ahead to. Thanks for the color, guys.
You're welcome, Patrick.
Our next question comes from John Lovallo with Merrill Lynch. Your line is open.
Hey, guys. Thanks a lot for taking my call here. First question is, there's clearly a lot of excitement and anticipation about China. It just seems that the Chinese government is doing just about everything in their power to kind of favor the domestic OEs. Whether it's the 10% purchase tax avoidance that won't apply to imports, the charging station standards that, at this point, don't seem to be compatible with Tesla's technology. Even they're allowing or thinking of allowing non-OEs to have licenses to produce autos, including the owner of Fisker and A123, who might be in that race. I guess the question is how do you see this kind of environment developing? Do you think there's going to be just increasing pressure from the Chinese government to kind of favor the domestic guys?
Actually, I've been pretty impressed with the Chinese government at all levels, the city level and the national level. They have done some protectional actions, certainly maybe quite a bit in the past. I don't think that's going to be the path going forward for them. Actually for the sales tax exemption, it does actually apply to non-Chinese cars. I think you may be misinformed there. We have to adhere to Chinese charging standards. We are going to do so. The challenge was that those standards weren't defined until about a month ago.
It's a little tricky to adhere to something that has not yet definitively been announced. Now that it has, we're committed to meet those standards, and we expect to fit within the sales tax exemption. Yeah.
Yeah. It's actually a very relatively simple matter to meet the Chinese standards. They're very familiar and quite close to the European standard.
Right. Yeah, exactly. We already meet the European standard. We kind of serve the U.S. standard, the European standard, and then we'll be serving the China standard, which is, as JB said, very similar to Europe.
Okay. That's very helpful. Sorry, go ahead.
Yeah, in Shanghai, we've got the exemption on the license plate fees, which is on an imported EV. It's not just for local EVs that those policies are being applied, we are having discussions in other cities where that's a possibility, too. I think so far, it's been overall a positive reception that we have received. It's been good.
Yeah. They're genuinely committed to electric cars.
Right.
It's not just about favoring local manufacturers. Yeah.
Okay. That's helpful. I guess the second question would be, recently, Edmunds put out a report on I guess their first year with the Model S, and obviously everyone has their own opinion on this, but there's been a lot of talk about quality on the call, and what Edmunds was saying, and you may have read it, is that there were something like 28-30 service campaigns that were not part of the regular scheduled maintenance, and because of that, they couldn't recommend the car. Yeah, I just was curious how you guys might respond to that.
Well, there's definitely some genuine issues in the Edmunds car, but they had one of our early production units. In fact, most of the problems that they've encountered there are not present in current cars. We also, I think this maybe ended up being counterproductive, but the service team was ultra proactive with the Edmunds car. They were doing their best to make Edmunds happy, and I think unfortunately, that resulted in them changing things out that, just on the off chance something might go wrong. That drive unit issue that I mentioned earlier where the drive unit was sometimes replaced, even though it wasn't a drive unit problem, that happened with them twice. It's an unfortunate sort of case, but I don't think it's broadly correct. It's definitely not correct for cars made in the past year.
Yeah. If I might add one thing on the drive unit replacements as well. I think it's important to note that the drive unit is a very complicated sort of assembly of different components and the pieces that have needed service and have failed internal to the drive unit are relatively not very expensive. They're being replaced in order for expedience and to get the car back on the road for the customer-
Yeah
in the minimum time.
Yeah.
Going forward, we're looking at ways to repair them and give people back their same drive unit very quickly, in about the same amount of time. If you had to replace your internal combustion engine every time something small went wrong with it-
Yeah, if you needed a gasket or something.
That would scale.
It's literally like the sort of small shim that I was mentioning is equivalent to replacing a minor gasket on an internal combustion engine.
Right.
Normally, you wouldn't give someone a new engine for that, but our optimization was customer happiness. Until we knew exactly what to do, we just wanted to give people back their car right away.
Yep.
Yeah. Thanks a lot, guys.
Next question.
Yeah. Just to add from a cost perspective, since these are not significant, the overall impact on our warranty reserves has not been significant.
Right. We're going to be at it hardcore until our car is 10x better than any other car on the road.
Thank you. Our next question comes from Ben Kallo with Robert W. Baird. Your line is open.
Thanks for taking my question. As we look ahead to next year and the 100,000 unit by the end of next year, is the biggest production increase happening right now over these two weeks? Is there some other step that has to take place next year to get you to that level?
Well, there is a big step that's expected to occur in Q1 next year, which is the bring up of the body line, the S/X body line. What we did the past two weeks is the assembly line, where it's basically the bits get put together, the body line is where the body itself is welded and bonded together. In fact, the core skeleton of the car is created. You can anticipate probably Well, I'm not sure. It may or may not be. Actually, it may. I take that back. We're going to bring the body line up in parallel with the current line.
Yes.
Unlike this case with the assembly, we couldn't have two complete assembly lines. We had to stop and retool. In the case of the new S/X body line, which is a line that's designed to be capable of 2,500 units a week, maybe more than that, conservatively 2,500 units a week, at a lower cost point. We should be able to do that in parallel.
Got it.
I should say, sorry, another thing that's going to be a big upgrade, really big upgrade, is the paint shop. There are a few cases where advanced CapEx spending makes sense, even though it's going to pay off in two to three years. It's just such a big improvement that you kind of want to do it even at a high discount rate. Our paint shop is being upgraded. It's going to be the most advanced automotive paint shop in the world.
Got it.
It's expensive to do that.
We like watching Halle Berry every week, can you give us any details on when we can see the Model X? There's slightly different language about the alpha and beta that I think is new. Could you just tell us the difference between the alpha model and the beta model?
Yeah. The Model X that was produced, the sort of the show car or advanced prototype, is sort of a pre-alpha. The alpha itself is the production. It's basically production design. We're going to move very quickly from alpha to beta. In this case, like for the Model S, the alpha was a lot more primitive than the Model X will be because, of course, for the Model X, we've got all this chassis and powertrain stuff that's been done for the Model S that we can build upon. In the Model S case, we didn't have that. It's really a very advanced alpha car that we're producing through the Model X. We'll move to beta within three months. It's a real fast alpha to beta.
You can expect to see production cars, not in customer hands, but kind of on the road doing tests and validation in Q1 next year. We'll have quite a few of those.
Great. Thanks so much.
Our next question comes-
Something I do want to emphasize with the Model X is because we're moving very quickly into a high production mode as opposed to the Model S. The Model S had a long production slope. Starting off very slowly and then taking kind of 6 months to reach the 400-unit per week level. In the case of the Model X, we're going to try to move to sort of a several hundred units a week within 3 months of production. It's like half, maybe less than half the length. Because of that, we really want to do serious validation on the car, test the heck out of it before going into volume production.
Thank you. Our next question comes from Colin Rusch from Northland Capital Markets. Your line is open.
Thanks so much, guys. I just wanted to make sure I heard these numbers right. We're going from 1,000 to 2,000 cars a week in 2015. If I take the mid-range of that- about 1,500 cars a week or production levels of 78,000 cars per year. If I heard correct on the delivery time frames, you're about 2 weeks in North America and something like 5 to 6 weeks overseas, which you're trying to shorten up. We'd be thinking about works in progress of roughly 10%. Are those numbers right in terms of how I'm thinking about kind of targets for you guys for next year?
It's difficult for us to predict the slope of next year. What is the exact curve of the production rise look like next year? We feel confident of exiting next year at 2,000 units a week of production and demand, absent some macroeconomic shock. It's hard to say exactly what the area under the curve looks like. It's certainly more than 60,000, I would think.
Okay. That's perfect. Can you talk about the weight reduction efforts that you've got going on right now with the vehicles, and how should we think about the cadence of pulling weight out of the vehicle and potential translation of that into extended range?
Well, the partial on weight versus range, it's not super strong. There is an improvement, but it's not a huge improvement. The Model S has gotten steadily lighter over time. It's really like a quarter pound here, half pound there. The Model S in production today is at least a few hundred pounds less than that that's in the starter production. We'll continue to see improvements over time. To get to a step change, there's so many pieces in the car. You've got the battery pack, the motor, the transmission or the gearbox, the tires and wheels, the seats. If you had a big improvement in any one of those items, maybe with the exception of the battery pack, it only changes the weight of the car by 1%, 2% or something.
These are all good things, but there's not one big block of lead sitting in the car that one can remove. It requires whittling away at a whole bunch of things.
The range impact is, weight is one fraction of impact on range, so it's even smaller than the direct % of weight reduction.
Yes. It is getting slightly better over time. It is hard for people to perceive it from one month to the next, but if you look at it over the course of a year, you would notice.
Great. Thank you.
Our next question comes from Andrea James with Dougherty & Company. Your line is open.
Patrick, I should have mentioned that we probably need to cut the call off after this question, so have this be the last question, please. Go ahead, Andrea. Sorry.
Please check your mute button. Andrea James, your line is open.
She dropped off then? We can move to a different question, I guess.
I guess she's no longer in queue. With that, I guess we'll call it a day. Thank you, everyone, for joining the call, and we look forward to talking with you for our third quarter earnings release. Goodbye.
Thanks.
Ladies and gentlemen, thank you for participating in today's program. This concludes the program. You may all disconnect.