Good day, ladies and gentlemen. Welcome to the Tesla Motors Second Quarter 2013 Financial Earnings Results Call. At this time, all participants are in listen only mode. Later, we will conduct a question and answer session. Instructions will follow at that time. I would like to turn the call over to your host, Jeff Evanson. Please go ahead.
Thank you, Patrick. Good afternoon, everyone. Welcome to our second quarter financial results Q&A webcast and conference call. I am joined today by Elon Musk, Tesla's Chairman and CEO, and Deepak Ahuja, Tesla's Chief Financial Officer. We announced our financial results for the second quarter shortly after the close of trading today. The shareholder letter, financial results, webcast of this Q&A session are all available at our investor relations website at ir.teslamotors.com. Today's webcast is for your questions. I thank you for primarily using webcast. That helps save us some money. Thank you. We are going to conduct this Q&A session live. Please press star one now if you would like to ask a question. We do plan to end this call in 45 minutes as always. During the course of this discussion, we may talk about our business outlook and make forward-looking statements.
Such statements are predictions based on management's current expectations. Actual events or results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent 10-Q filed with the SEC. Such forward-looking statements represent our views as of today and should not be relied upon after today. We also disclaim any obligation to update these forward-looking statements. Now, Patrick, could we please have the first question?
Our first question comes from Patrick Archambault with Goldman Sachs. Your line is open.
Oh, yes. Thank you very much, guys. Congratulations on a good quarter. I think obviously the execution looked great. My one question would be just can you help us walk a little bit from, I think your margin is adjusted 10% ZEV credits. It sounds like you still have some levers to pull to get to the 25%. Can you just go through those with us?
Well, I think, Patrick, it's Deepak here. Our automotive gross margin, excluding ZEV credits, is closer to 13%. Maybe we can walk you through that later on to clarify. I know this is a confusing quarter with significant accounting numbers here. We'll just help you with that. We see clearly a path that gets us to 25%, excluding ZEV credits given the actions that are underway and have been underway for a while. These relate to on the cost reduction aspects with our part cost reduction roadmap, the efficiencies we have in our manufacturing and supply chain that are happening over the second half, as well as a combination of the new options that we have put in the marketplace and the margin enhancement we get from there. I'm sure Elon has more to add.
Right. Well, just in summary, we're about 12 points away from getting to the 25% gross margin target without ZEV credits. If you look at, say, Q1 to Q2, we increased eight points. Obviously on average between Q3 and Q4, we need to do six points per quarter. We don't need to make as quite as big an improvement as we did Q1 to Q2. Obviously, still a significant hill to climb and huge amount of work. We feel pretty confident about the 25% number. It's important to note that we have visibility into these numbers within reason ahead of time. The things that affect the gross margin, in order for them to affect the fourth quarter, really need to be in place or substantially in place about a month before the fourth quarter.
Otherwise, the parts that go into the car will not contain the cost savings that are necessary. Essentially, things need to be in place next month, and so that's not very far away. That's why we felt confident enough to reaffirm the 25% gross margin guidance, absence of credits for the fourth quarter. Obviously, there could be a force majeure event or something, some really big unexpected thing. As long as there's nothing really unusual that happens, then that should meet that target.
Okay, great. I guess we haven't had an update on the X and when that's likely to. We understand that obviously, the variants of the S are what's taking a lot of engineering resources in the near term. Deepak, maybe in terms of the X timing, is it still towards the end of next year when you're thinking about it? When do those engineering resources come to bear on your capital budget? Thanks.
Sure. I'll maybe do part of the answer and then hand it over to Deepak. We're hard at work on the Model X, refining the design. We expect to be in limited volume to deliver a small number of units at the end of next year, and then volume production would only occur in 2015. In terms of if you're trying to model it financially, I'd model it more in 2015 than in 2014. Although we're on track to deliver units to customers at the end of next year. From a product standpoint, the Model X is our primary focus, obviously, at this point. Most of our resources are spending a lot of time personally on the Model X and trying to get the details right.
I think there are some things we can do to improve the Model X over the early demonstration prototype that people have seen. I think there's room to make it better. We're going to push pretty hard to make it better than what people have seen. I think there's some exciting features that I love. Hopefully other people like them, too.
Yeah. I think Elon's covered the key points. A lot of the resources required for Model X is in our plan in terms of expenditures, and that's one of the contributors for the increase in the expenses as we go forward.
Okay. Thanks a lot, guys. I'll get back in the queue.
Our next question comes from Andrea James with Dougherty & Company. Your line is open.
Hi, thank you for taking my questions.
Sure.
I guess I imagine you have several options available to you now. From investing in the Model S capacity, which you mentioned in your letter, to finishing up the Model X, then to engineering the next generation of vehicle. I was wondering if you could just weight your priorities and tell us how you're thinking about it, both from factory investment and also from your R&D.
Okay. Well, it depends on how one says weight with those things. In terms of our expenditures, we're still more on Model S than anything else on every front, including R&D. Bear in mind, we've got a right-hand drive that's coming out in the spring. Then there's the China version and obviously we've got the European version that's going in and there are a number of nuances in the various European countries that require work to ensure the car operates smoothly. There's the Japan right-hand drive version. There's a lot of versions, and individually maybe not so huge, but you add them up and they amount to a fair bit of spending. In terms of executive time, I think the Model X is swiftly rising to become the main priority. It's not quite there yet, but it will be soon.
I'm allocating an increasing portion of my time to that every week. Probably in the fourth quarter, it becomes the top item. I guess these are somewhat qualitative statements, but yeah.
Yeah, the capital expenditure for Model X will primarily kick in next year as we start to get some of the tooling in place. Right now.
Yeah, that's true.
It's more of the human resource expenditure and some of the-
It's design and engineering, not a lot of tooling. It's a lot of lab work and design work, not a lot of hard tooling or anything. Yeah, there'll be a fairly big chunk of that in the second and third quarter and fourth quarter next year.
When does the next generation of vehicles move up? Is it a timing thing? Is it a cost of the battery pack thing, that resources-
Oh, you mean our high-volume, affordable car?
That's right.
Right. There's a couple interesting, as we think ahead to that vehicle, we're allocating a little bit of time to some of that advanced planning. It's only maybe less than 5% a week, but of our planning activity. When you do the math on saying, okay, how many batteries do you need for, like what's the cell fabrication capability, the raw materials, all the elements? It's really quite a large number in order to ultimately, say, feed a factory that's producing half a million vehicles a year. We start exceeding the entire laptop industry by a decent margin. Clearly, new cell factories need to be built. We need to be smarter about the raw materials going into the pack. I certainly see a clear path.
I not only do not see obstacles, I see a fairly clear path to that vehicle. I have high confidence that we can create a compelling $35,000. Compelling meaning a 200-mile range. Of course, a lot of the other features that people have come to expect from Model S. A few things would be default features. Yeah, I feel pretty good about it. This is a huge amount of work, but no miracles required.
Are Tesla shareholders going to see any benefit from the Hyperloop?
I don't know. I think it's not out of the question, but I think I kind of shot myself in the foot by even mentioning the Hyperloop because I'm too strung out. Obviously, I have to focus on core Tesla business and SpaceX business, and that's more than enough. I did commit to publishing a design and provide quite a detailed design, I think, on Monday. Then invite critical feedback and see if people can find ways to improve it, and then it can just be out there as kind of like an open-source design that maybe people can keep improving. I don't have any plans to execute it because I must remain focused on SpaceX and Tesla.
If nothing happens for a few years with that, maybe it could make sense to make the Hyperloop happen with Tesla involvement, but that I would say is extremely speculative.
Finally, just for Deepak. What were the other regulatory credits in the quarter, and does your GM assumption include those in the long term?
Yeah. Our gross margin for automotive does include the other regulatory credits because we have good visibility of those, and they're locked in for us over a longer term. ZEV credits are the ones which are not predictable in terms of recognizing sales and revenue by quarter. Given their unpredictability, we have deliberately kept that aside in our own projections. In this quarter, in Q2, those were roughly $18 million.
Can you just, the visibility is better than the ZEV credits because why exactly? I'll hop off. Thank you.
We have longer-term contracts with certain car makers to sell those credits.
Thank you so much.
Our next question comes from Adam Jonas with Morgan Stanley. Your line is open.
Hey, everybody. Okay, Elon, I'm not going to ask you any questions about a cap raise this time. I don't think we need to go there.
Uh-uh.
First question on the 40,000 unit annualized sales comment you made by late 2014 as a potential. What metric were you using when you were extrapolating that for Asia? Is that something like on a sales per store or percentage of addressable market?
Actually, it's just based on what we kind of see the demand as. Right now, obviously, we're selling in North America at about 20,000 units a year. Europe is a similar-sized market to North America. China is actually bigger, that doesn't include the rest of Asia-Pacific, South America, South Africa, Australia. It seems like that's a pretty safe number to assume. I think we've probably got some potential upside from that number.
Okay. That's clear. Just next one now. Can you elaborate a bit on the nature of the supplier bottlenecks that you mentioned? Is it related to homologation for some of the exotic, either European or right-hand drive type deliveries? Is it a new issue or is it a lingering legacy issue? Any update on when this could be resolved?
This is an important point that our production is, we are production constrained, not demand constrained. Very often, people suggest all sorts of marketing ideas and this, that, and the other thing. Obviously, our time is spent trying to figure out how to make more cars. The things that prevent us from doing that are supplier parts, essentially. We've got 90% of our suppliers are able to ramp up, and 5% have some difficulty, and 4% have a lot of difficulty, and 1% just can't. We've got to replace those or in-source those items because you can't give people a car that's 99% complete, unfortunately. There's several thousand unique parts in the car.
That's what we're really spending our time on, is clearing out those production bottlenecks or supply chain bottlenecks. I think we should have probably cleared most of them out in the next six months. I think by maybe into Q1, Q2, we should, certainly by Q2, I think, unlock a fair bit more production potential. We'll obviously see what the demand looks like at that point, but we're striving to become demand limited as opposed to production limited.
I feel like we're actually able to attract more the A team on suppliers, whereas previously we had some trouble attracting the A team from suppliers. They thought we wouldn't be around long-term, and we had that issue where IHS had predicted that Tesla would only ever sell 3,000 cars lifetime of the Model S. Then we sold that in basically the first quarter of production. The tricky thing was that many of our suppliers had taken the IHS number or taken historical electric vehicle numbers and maybe given us a little bit of credit for our projections, but not much. They didn't tool up for the production that we actually experienced.
They were scrambling to make up for it. Yeah, they just didn't believe it, so it takes some time to tool up and do it. Then some suppliers, just a small number, they're just not set up for volume production, so we've got to switch them out or in-source it.
That's clear, Elon. Thanks. This is my last question. I think many people on this call might be interested in your views on the BMW i3. That's it. Thanks. What do you think?
Well, I'm glad to see that BMW's bringing an electric car to market. That's cool. I think there's room to improve on the i3, and I hope that they do.
Sorry.
Cute.
Yeah.
Yeah. Anyway, I feel the key point I'm going to make is I really do encourage other manufacturers to bring electric cars to market because this is a good thing, and they need to bring it to market and then keep iterating and improving and making better and better electric cars. That's what's going to result in humanity achieving a sustainable transport future. Kind of wish it was going faster than it is.
Yeah. Thank you for that, Elon. Good answer.
You're welcome.
Our next question comes from Brian Johnson with Barclays. Your line is open.
Yes, good afternoon. Two questions, one for Deepak, probably, and one for Elon on Gen3. For Deepak, the first question asks you to bridge on gross margin through the end of the year. Could you just maybe give us, on the bridge of improvement from one Q to two Q, the big chunks of things that contributed to that margin increase, X reg credits?
Sure. I would say the biggest pieces there were part cost reduction as we continue to get more efficient at our suppliers as well as some of the design changes we made to make the design efficient while not taking anything away from a consumer point of view. We also had improvements in our labor and overhead and our freight costs. All of those, in fact, were partially offset by the mix. We had a poor mix in Q2 since we sold the 40 kilowatt-hour cars that had the 60 kilowatt-hour battery pack.
Which essentially sold at a loss, right?
Right. Which had, from an average gross margin perspective, a negative impact. I think what I'm sharing with you is no different than what we have shared before. It's those same levers, part cost is our biggest lever that helps to drive these improvements.
Parts, labor. Parts, labor, it's parts and labor. That's what cars are made of. Maybe another way to characterize it is in the fourth quarter of last year, we were extremely dumb at making cars. In the first quarter, we were maybe still pretty dumb. We're slightly dumb in the second quarter, hopefully, by the fourth quarter, we will at least not be dumb. That's the way to think about it.
I'll figure out how to quantify that.
This is not some super how do we get so super good? It's like, how do we stop being so stupid?
Second question, Gen 3. Two questions underneath. The $35,000 price point, is that before or after consumer credits and tax credits? Second, as you think of Gen 3 and making money at it, some talk I've heard that maybe small format batteries aren't the right way to go, but large format. Just maybe reiterate, I kind of think the former, small format, kind of where you are on those and how that gives you some comfort in getting to the price point on the Gen 3.
Sure. Yeah, the $35,000 assumes that the $7,500 federal tax credit is no longer available. There may be other sort of state-level tax credits or maybe other things, but we're assuming that the $35,000 is without any subsidy.
Right.
It's always helpful to have some subsidy, but we're not counting on it. Yeah. In terms of the cell format, for us, when we talk to our key cell suppliers and we ask them to give us, say, at the cell level, what is the best energy density, so watt-hours per kilogram, and what is the best price in sort of $ per watt hour, invariably, the 18650 format is the best, usually by a pretty decent margin. That's an 18 mm by 65 mm cylinder. That's the format that seems to be the best. It has advantages. I think if you say, well, why does it cost less? I think you're able to kind of pack, and then why does it have that energy density? You're able to compress and pack in quite a bit of electrode and electrolyte in that cylinder.
That's why consumer-grade batteries, there's like cylinder, double A, triple A, and that kind of thing. You can pack more in there. It just happens to be a fairly efficient manufacturing process in almost every way, relative to the sort of prismatic approach. Also, as you make the cell bigger, you have to say that the reject rate for the cell is going to increase. If you think of maybe an analogy to the silicon wafer fab and say, what would be cheaper, having a whole bunch of, say, 6-inch wafers or one 12-inch wafer? Actually, it's the lower diameter wafer that is cheaper because with the silicon, as with electrode area, you have to reject anything that's got a flaw. The reject rate, and it's also helpful to think of things in the limit.
Say in the limit where the whole battery is one cell, the reject rate would be virtually 100%. Then as you make the cell smaller and smaller, the reject rate will reduce. At the 18650 format, the reject rate is very low. You have very good statistical reliability. I'm sort of giving long-winded answers here.
Shorthand, could we call it a server rack versus a mainframe strategy?
Yeah, sure.
Okay. In terms of how you're managing the load, are there advantages to having several thousand, I've heard numbers as high as 8,000 cells versus a smaller number? Again, kind of thinking about the statistics behind it.
Well, I think we're at around the 7,000-cell number for the 85 kilowatt-hour pack. If you say, well, what's the ideal cell number, if we were to do a whole new cell, like a whole new sort of cell plant, I think we might drop the cell number in half, but probably not less than that. Another thing that cells give you is that for long-term life of the pack, if you have a large number of cells, then losing a cell actually has a very small impact on the total capacity of the pack. Whereas if you have a small number of cells, then losing a cell has a big impact on the capacity of the pack. There are some advantages for life as well and for reliability.
Okay, thanks.
Our next question comes from Dan Galves with Deutsche Bank. Your line is open.
Okay, thanks. Just wanted to follow up on the 40,000 units per year by late 2014 comment in the shareholder letter. Can you tell us what North American order flow is on an annualized basis right now, and what type of order rate are you seeing in Europe currently, and what's been the trajectory of that?
Yeah. I don't want to get too specific, but in terms of net orders, weekly net orders, so new orders, net of cancellations, it fluctuates a little bit from week to week, but it's around 20,000 right now for North America. We're not trying to push it higher than that because it's pointless to push volume when you don't have the production to meet it. I think there's potential there for once we have service centers in more parts of the country and maybe more stores out there and more word of mouth and more Supercharger stations, and there's an argument that the long-term demand in North America is greater than 20,000 units a year since we lack those things today and have that approximate demand.
In Europe, also in Europe, we're actually not trying to push the sales very hard because if you order a car in Europe, you're going to get it in maybe November. Improve our production. We need to make sure that the entry of the car into Europe is smooth, that people have a good experience with the car, that all the service centers are there, that the people are well-trained. These are the really important things. Like I said, I think if you look at sedan demand, the sort of EU or greater EU area is actually higher than North America in general sedan demand. If you say how many premium sedans are sold, more are sold in the greater EU area than in North America.
To the degree that we achieve a similar percentage in Europe, and maybe it's a bit less because our car costs a bit more because it's got to come from the U.S., and there's increased logistics costs and some import duties and that thing. Maybe that's why we're not going to say assume it's just going to be as good as North America, but it's probably at least half as good as North America. Maybe it is ultimately as good as North America, but our conservative estimate would say it's half as good. China and the rest of Asia and other countries, well, if they can be half as good as North America, then we're at the 40,000 unit number. That all seems pretty reasonable to me.
That makes sense. In terms of capacity to build, I think your current line is set up for maybe 40,000 to 50,000 units on two shifts. I guess two questions. When do you think you can get to that number in terms of production rate, and what is the decision-making process in terms of potentially adding more capacity, if you're going to fill that up with just the Model S?
Right. As I said earlier, while we have the ability to produce at the 40,000 unit level, all of our suppliers must also have that ability. That's the thing that's holding us back. I think there's certainly room to grow beyond that. We have a big factory. Yeah, we'll have to see how demand settles out. As I mentioned, we want to get to being demand constrained as soon as possible. Hopefully, we'll get there next year. That's our goal. At least by the end of next year. Then, of course, we'll bring the Model X online in limited numbers end of next year and then in bigger numbers in 2015. The potential is obviously very significant. I don't want to overpromise. I think there's a lot of potential, but we'll have to see how it turns out.
Great. One last question. You mentioned that the changes to options and pricing that went in maybe a week ago was going to be a benefit to margin in the back half. Do you have any sense of how much it would've benefited margins in this quarter, or do you have a projection for how much of an increase you'll see from that action?
We're really not sure because we only introduced them less than a week ago, like four days ago, five days ago. We don't know what the take rate's going to be. We've got some guesses, but I think there's no need to guess because in let's say a few weeks' time, we'll have a pretty good sense for what the option mix is in reality, as opposed to just a guess. What we did with the options is we obviously unbundled a bunch of things. We added some additional options that weren't there before, like parking sensors and improved interior trim options and a number of other things that people had been asking for. There's a Sub-Zero Weather Package . There's improved tires, which come as default on the 85 and are an option on the 60. There's a whole bunch of cool things, actually.
New wheels.
Oh, yeah, new wheels. The Aero Wheels, which improve range and give us actually by far the lowest drag coefficient of any car in production. There's a whole bunch of cool stuff. We, like I say, we unbundled some things like the Performance Package, which required you to buy a whole bunch of things in addition to just the zero to 60 time. Now you essentially can buy just the power and then decide if you want the other options. We slightly lowered the price of the Technology Package. To be clear, the base price stayed the same. The Technology Package dropped. The Cold Weather Package, we also dropped in deference to our customers in Norway, because I think the Sub-Zero Package you kind of need if you're in Norway. We actually dropped the cost of that a fair bit.
We made Xenon headlights and the high-definition backup camera, we made that standard equipment on all cars. Essentially, I think the value for money is actually better. We did increase the price on some of the optional, the extras. We'll actually make more margin on some of the things out there, like for example, the third-row seats And those were a fairly low margin item, and so we increased the price to make it more of a better margin item for us.
Okay, great. Thanks.
Okay.
The next question comes from Colin Rusch with Northland Capital Markets. Your line is open.
Great. Can you guys talk a little bit about the introduction of new generations of batteries into the battery pack? How much testing do they need to go through, and how much impact do you think that can be on the cost structure over the next several quarters?
We're not planning on making a significant fundamental technology change at the cell level. We are making a number of improvements at the pack level, and in the electronics and packaging and all that stuff that surrounds the pack. There's the cell and the non-cell portion of the cost. To get the cell cost lower, we're working with our main cell supplier, which is Panasonic, and working with them to improve the cost of the cell. Obviously, more volume there helps. We're quite optimistic about that relationship. It's going really well. They're a great partner to have, actually. Yeah, I'm not quite fully answering your question, but we feel good about where things are and where they're headed on both the cell and non-cell portion of the battery pack cost.
Okay, perfect. Then, with the purchase of the additional land around your current facility, pie in the sky, how much capacity would that potentially give you if you build out all that area?
It's worth noting that piece of land adjacent to the factory was originally part of the NUMMI facility. When we bought the factory, it was actually divided into the center parcel and then a north parcel that was mostly just land, and a south parcel that was mostly land. When we bought NUMMI, we bought essentially the factory and the main parcel of land, but there were these two little sort of satellite parcels. What we did was we bought about half, I guess, of the south land parcel. NUMMI as a whole, as a factory, had about half million unit capacity. We'd actually need to be slightly more space efficient than them to achieve the 500K number or buy some, maybe some more land. I don't think buying that land puts us above the 500K number.
It just makes it easier for us to achieve the 500K number.
Excellent. Thank you so much.
Our next question comes from John Lovallo with Bank of America Merrill Lynch. Your line is open.
Hey, guys. Thanks for taking the call. First question would be on what you're expecting in terms of the ramp in R&D and SG&A in the back half of the year.
I think you want to-
Can you hear me okay?
I think, yeah. R&D and SG&A, right?
Yeah, right. I think, certainly, it's going to be fairly significant. I want to be careful about how much I quote in terms of %, but I think it's more important to understand the physicals, as we have indicated in the shareholder letter, that overall, given the continued emphasis on multiple product programs that we have, we will see an increase in R&D. On the sales and SG&A side, overall, we are strengthening our infrastructure globally on a variety of fronts. From a trend perspective, the % increase would be higher than what you've seen in the last couple of quarters.
Okay. That's helpful. If we think about cash flow for a minute, I think if you look at just free cash flow was a use of about $79 million in the quarter, and I think if you make the adjustments that you guys had talked about, I think $11 million for the DOE payments and the $67 million increase in receivables, that may not recur. That looks like about a use of $1 million. You have CapEx ramping up in the back half of the year. How are you thinking about just kind of free cash flow generation through the remainder of the year and into 2014?
As we've said in the shareholder letter, that we clearly intend to generate cash flow from operations. You're right in pointing out that some of that will be offset by our capital expenditures. We want to be very careful about burning cash. We want to be sure we are as close as possible to a free cash flow position, but that's something that we don't want to necessarily guide to. We're going to manage it, but we are going to be still judicious and spend the CapEx where we need to in order to make sure that we're growing at the right pace.
Yeah. We are aspiring to make slight improvements to our cash position quarter-over-quarter. That's our aspiration.
Okay, that's very helpful again. The final question would be, just looking at the typical ramp curve of a vehicle after launch, generally speaking, and I don't want to put you guys in a category with any other vehicle, but generally speaking, volumes tend to peak, call it seven, eight quarters out. Sorry?
I don't think that's going to be the case for the Model S.
Okay. That was the question. In North America, you would say that you have not seen any signs of a slowdown in new orders?
No.
Yeah, the traditional model doesn't apply for Tesla because that assumes that you have a network which is already present not only in the U.S. but globally.
Right. Exactly.
We just don't have that presence. We are starting here essentially from scratch and slowly increasing our presence and making consumers feel comfortable about what EVs are.
Exactly. Yeah, I think there's a pretty long way to go.
Yeah, that's right. Go ahead. Sorry.
It's sort of like an S-curve of technology adoption. There's the really early adopters, but for the mainstream audience, they need to really see a lot of cars on the road for a long time to really feel comfortable buying it, particularly when it's a new technology like an electric car, as people say.
Okay. Thanks very much, guys.
Our next question comes from Craig Irwin with Wedbush. Your line is open.
Evening, gentlemen. Congratulations on the solid progress.
Thanks.
Thanks.
First question I wanted to ask was about the Tilburg plant capacity. What sort of capacity have you put into that plant, and what sort of capital investment will be needed there as far as expanding finishing capacity? Can you sort of sketch this out for us a little bit?
Yeah, I really don't think that that's going to be in any way a limitation on our progress. Typically, it's a final assembly plant, so we're not dependent on parts from suppliers or anything. Generally, when we haven't had an external dependency, we've been able to get the job done. Once fate is in the hands of others, that makes it a lot more difficult. Fate is not in the hands of others in the case of the Tilburg plant.
Great. Progress in China. Obviously, the Chinese market is a huge market. There's a lot of enthusiasm over there for electric cars. Can you share with us where you stand on your order rate out of China, what you think we're likely to see over the course of the next couple quarters, and if maybe you could update us on your store plan for China?
Sure. I wouldn't say that this is quite the quarter to talk about China. I think we might want to talk about it probably at the next earnings call in more depth. As you say, China is a huge market. It's the world's biggest market for premium sedans. If you take something like, say, the Mercedes-Benz S-Class, they sell approximately half of all of their worldwide production in China. Obviously, if we were to have a similar ratio, that would be a pretty amazing outcome for Tesla. We're not counting on anything remotely like that. Quite the opposite. There could be a positive upside surprise there. You just never know.
We have one store in Beijing that we're probably open later this year. I'm going to visit China, obviously, and really try to understand the market and make sure we're doing the right things for Chinese consumers and the buyers over there, because not every market wants exactly the same thing. We've got to make sure that our product is properly tailored to the desires of consumers in every market, in Europe, North America or China or Japan or anywhere else. We're doing a few things, especially for the China market, for example, improving the comfort level of the rear seat because it's common for people in China to be driven rather than drive themselves. When we first designed the Model S, we designed it to be the perfect driver's car, really.
It's like, how do we make the driver fall in love with the car? Obviously, if people are being driven around, then we need to make sure that the back seat is optimized. We're working on an executive back seat that's more comfortable than what we have right now, which is kind of like the family back seat. Anyway, those sort of things. It's a little difficult to predict. This is not the quarter to talk about China. Maybe at the next earnings call, and certainly at the earnings call about Q4, we'll be talking quite a bit about it at that point, I think.
Great. Last one, if I may. Got a pretty interesting trajectory on battery cost over the next few years. Can you share with us philosophically whether or not you might use the reduction in battery pack costs as a way to sort of neutralize the impact of the federal tax credit rolling off for your customers, or do you see this possibly extending out beyond the timeframe where that would have the necessary benefit?
Well, you see, the $7,500 federal tax credit is limited to the first 200,000 cars from any manufacturer. Between Model S and X, we think probably that's going to get exhausted in the next several years. That's why we think it probably won't apply to the third generation, kind of the affordable car. At that point, if it's possible for us to maintain high margin and utilize the loss of the tax credit, I think I'd probably like to do that rather than have a higher margin car. Yeah.
Good. Thanks again for taking my questions.
Okay, we're running about five minutes over, everyone. We want to make sure that we get to all the questions in the queue, we have a couple more left. If we can keep the questions brief, we'll wrap this up as quickly as we can.
Our next question comes from Aditya Satghare with Lazard Capital Markets. Your line is open.
Oh, thank you. I had two questions. Firstly, just a follow-up on the 40,000 unit target. How many different versions of the Model S and how many different countries do you plan to sell into to get to that 40,000 unit target?
In terms of actually number of countries, it's quite a large number of countries because of the EU, which is, I'm not sure the exact number of countries in the EU, but like 14 or 15 or something like that. Of course, there's Norway and Switzerland, which are not in the EU. Right there you're approaching, and taking Canada and the U.S. into account, you're talking about 20 countries right there. You've got China, Japan. Japan's a very important market for us, by the way. We're going to take the Japan market very seriously. I know that a lot of American companies, they don't take the Japan market really seriously, I think we're going to do that. The Japanese market's very discerning, actually, I would consider it a great honor if the Japanese were to actually buy our car.
Got it. Okay. The second question was on the U.S. market. Could you give us a little bit more color about your buyer base here, what kind of potential brands do you think your customers are swapping out, who do you think you're grabbing share from?
We have some pretty good numbers for that. It's a really broad mix of cars. It's not just premium sedans. In fact, I think we.
I believe we used some of that.
Yeah
in our last earnings call where we shared-
At the Capital Raise, I think it was.
Probably. That's right.
If you go back and look at our Capital Raise presentation, when do we have them in it?
It's not in the slideshow, go ahead and just talk about some of the cars you're replacing.
Yeah. It's a wide range of cars. It's not like you can say, oh, it's a BMW 5 Series or something like that. Yeah, in fact, we're just pulling up a pie chart right now. Next slide. This is from an ALG overview, taking data from Polk. They're showing essentially it's like the premium sedans and hybrids are the big ones. It's interesting, the largest one here is on the order of 10, 11%. A lot of people are buying our car instead of the Prius, but that's 10%. There's obviously things like the E-Class. People are buying our car instead of the LEAF, or coming from the Sorry, these are the cars they're coming from. It's like E-Class, Prius, LEAF, the Highlander, BMW 5 Series, Honda Odyssey. It's like just 4% is a Honda Odyssey going for Model S. Volvo XC90 is 4%.
Volkswagen Jetta is 4%.
Interesting.
Pretty broad mix overall.
Honda Civic is 3%. It's really a pretty broad range.
Got it.
It's not just from the premium sedan segment.
Got it. No, that's helpful, and congratulations on good execution this quarter.
Oh, thank you.
Okay, we have time for one last question, please.
Our last question comes from Elaine Kwei, from Jefferies. Your line is open.
Hi, everyone. Thanks for squeezing me in. Now that you're beginning to ship internationally, could you talk a little bit about the thinking behind the pricing strategy for Europe and Asia? Are there any adjustments based on local incentives? Is it based on what the local market can bear? Would you expect margins to vary compared to the U.S.? I'll just throw the second part in there with the Supercharger network has really overcome the infrastructure obstacles for long-distance driving. Does Tesla have any strategy for addressing the challenges for urban dwellers, especially in international markets, where that might be more common? Thanks so much.
Sure. The Tesla policy is to try to make the same amount of money on a car in any given market. This is not a policy. In fact, we may be unique in this. I'm not sure if there's another automaker that does this, but we don't want to make more money off of someone just because they're in another country. I don't think that's the right thing to do. For example, in China, it's quite common for manufacturers to mark up the cars in a pretty huge way. We will not be doing that. We'll also try to be extremely transparent about pricing. You can take the U.S. price, and you can factor in logistics and any import taxes.
There's maybe a 3% allowable for exchange rate movements and then some incremental for any extra costs of doing business in that country that increase our overhead. We try to be really transparent about that and keep trying to improve those costs over time. I guess the overarching principle here is we don't want to rip anyone off. You should assume the same margin in every country.
That's great. Are there any thoughts behind addressing the challenges for folks living in apartments or condos where you might not have a personal garage? I could see this.
Oh, yeah
being an issue for the Gen 3 buyers especially.
Yeah, absolutely. It's not a huge percentage of the market that has this issue, but it is something we need to address. The biggest, the toughest one is street parking. A lot of cities and municipalities are putting in charging infrastructure on the street. We're working with them to get more of that established. For apartments and condos for the garages there, we're forming, or we actually have sort of loosely formed a group within our sales and service operations team that is able to work with whoever's running the condo or apartment building and tell them what they need to do to install sockets. I think that's going to be important long term is the ability to sort of load level or limit total electricity power load in an apartment building.
If there's a lot of cars, you don't want to exceed the total power going to that building at any one time. It's just kind of a peak power limiter that's able to communicate between the cars that are getting charged. There are a few companies we're working with in that regard to deal with that peak power load in apartment buildings. It really hasn't been, thus far, a constraint on our growth. It's occupied a little bit of our attention. Next year, perhaps it will become a constraint on our growth, then it's going to be more centrally in our attention.
That's great to hear on the international and infrastructure front. Thank you so much, Elon.
Welcome.
Okay, thank you everyone for joining us today. We look forward to seeing you over the next quarter. In fact, we'll be at Jefferies Industrial Growth Conference in Manhattan next Monday. On Tuesday, also in Manhattan, we'll be at J.P. Morgan's Auto Conference. Hope to see you all out on the road, and happy driving.
Okay.
Ladies and gentlemen, thanks for participating in today's program. This concludes the program. You may all disconnect.