Earnings Call: Q1 2013

May 8, 2013

Good day, ladies and gentlemen, and welcome to the Tesla Motors First Quarter 2013 Financial Results Q and A Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Jeff Evanston from Investor Relations. Please go ahead. Thank you, Patrick, and good afternoon, everyone. Welcome to our Q1 financial results question and answer conference call. I'm 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 Q1 shortly after the close of trading today. The shareholder letter, financial results and webcast of this Q and A session are all available at our Investor Relations website at ir. Teslamotors.com. Today's call is for your questions and we will conduct the Q and A session live. Like last quarter, we will limit this call to 45 minutes. During the course of this call, we may discuss our business outlook and make forward looking statements. Such statements are predictions based on management's current expectations. Actual results or events could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent 10 ks filed with the SEC. Such forward looking statements represent our views as of today should not be relied upon after today. We also disclaim any obligation to update these forward looking statements. And now Patrick, could we please have the first question? Our first question comes from Ben Shuman from Congratulations on the great deliveries and results in the quarter. My first question is around the ZEV credits. You disclosed the amount of revenue in Q1. Can you say how much is implied in Q2 gross margin guidance? And kind of as part of that, what are some of the big gross margin drivers to get from that 5% level now excluding the ZEV revenue to 25%? And do you expect that 25% also without whatever positive impact from the lease accounting that you might see. Okay. There's a few questions left in there. Yes, so we are expecting a decline in ZEV credit revenue for Q2 and then probably fairly significant decline in Q3. And as I said, right now, we're not expecting anything in Q4. That's not to say that I mean, there might be some self credit revenue in Q4, but we're not counting on it. I don't know, I can't give any more precision than that at this time. Okay. So a bigger decline in Q3 than in Q2. Is it fair to say that? Sure, of course, yes. Okay. And then just one more for me. The $200,000,000 in CapEx, can you talk about just what that's going to exactly? Maybe how much of the gross margin improvement might be tied to additional capital expenditures? Ben, Deepak here. Clearly, some of the CapEx is related to improvements we are making in house by bringing more equipment in and automating our processes that results in gross margin improvement. And a portion of that is also new product development and then another portion is the infrastructure development of our service centers, our stores and the supercharger network. Yes. I mean, it's worth noting that we're profitable in Q1 despite actually spending quite a lot of money on new service centers, expanding the supercharger network stores and other things that obviously won't we won't need to keep doing. I mean, that's not something that's going to need to occur on an ongoing basis. But we need to establish a service network, let me take that for example. Great. Thanks a lot. The next question comes from Dan Galves with Deutsche Bank. Your line is open. Thanks for taking my questions. First one, again, kind of regarding the gross margin. I did this, I think, the same simple math that Ben did to get to somewhere in the 5% to 6% gross margin, automotive gross margin, excluding the ZEV credits, if that's in the ballpark, it seems like you need to increase gross profit per unit by something in the $17,000 to $19,000 per unit by the end of the year. Wondering if you could give us kind of the big buckets that you're targeting for that improvement? And how much is within your control? And how might be you might need price concessions from your suppliers, if any? Sure. Well, first, it's worth noting that when you see the gross margin for Q1, we're giving you the obviously, the gross margin average over the quarter. And so the gross margin at the end of Q1 was significantly better than at the beginning of Q1. You may sort of think, oh, we're starting from a base of 5% or 6%, but actually we're starting from a base that's a bit better than that. And then in terms of where the additional cost savings are coming from, It's a wide range of activities. Most of these have been put in place either in Q4 last year or in Q1, but it takes time for those actions to bear fruit that don't happen instantly. And it's like this wide range, it's improving at the cost of our logistics, improving getting better deals from suppliers, design improvements. Design improvements are the ones that take the longest to come to fruition, which is why we're only confident of the 25% gross margin number in Q4 and not sooner is because there are a number of improvements that are design related. So you've got to finish the design, you've got to validate it and then put it into production. So And I'll add to that, manufacturing process improvements both in house and at our suppliers. Yes. It takes cost out. Yes. I mean, a number of our suppliers have really done some impressive work on cost reduction. And for some others, they just didn't believe that we'd do these numbers. So they didn't quite tool up for this level of production because their internal predictions were that we would do in some cases 3,000 over the entire lifetime of the product. We're like, yes, we did that last quarter. So they sort of come to believe that those things that these projections are real, then they actually tool up and are able to deliver significant cost savings for parts supply. Okay. Got you. So just a follow-up. The suppliers are cooperating with you in terms of reducing. So I guess, are you still experiencing a lot of premium freight from suppliers that weren't ready to produce at volume? Are they cooperating with you in terms of the design improvements and kind of redesigning the component? And then my second question relates to cash flow. What is what's causing the decline from $65,000,000 of OCF in Q1 to the guidance of neutral in Q2 and if you could remind us of your minimum cash level? And thanks. So to answer your first question, our expedited freight is continuing to reduce every month that goes by as both our suppliers have additional capacity to meet our needs and our production schedule is becoming much more stable. So it's all trending in the right direction. And then to that same point of Elon, where we ended with our freight costs at the end of Q1 was better than the average for the quarter. So it gives us comfort that or confidence that we'll continue to reduce our costs. And then in terms of our cash flows, we are mindful of the volumes. As you can see, we are projecting lower deliveries in North America since we have quite a few cars on the board being shipped to Europe. And that's a that consumes some degree of working capital, which becomes a part of our cash flow from operations and that's a significant number. So when you combine the lower deliveries because we're producing for Europe and the fact that we have these cars on the board, that has an impact. Okay, perfect. Thanks a lot. Our next question comes from Aditya Sadgari with Lazard Capital Markets. Your line is open. At 2, first is on the manufacturing process. You talked about the number of manufacturing hours being reduced by 40%. Can you give us a sense of how much more room is there to go and where does that stand in relation to your target? And then I have a follow-up. I think there's clearly room to go further and there are a lot of activities in our manufacturing organization that's continuing in that direction. And then towards the second half of the year, as we start to increase our production rate slightly further than our present levels, that will further add to the labor reduction on a per unit basis. Got it. Second question on demand. When you talk about the 15,000 units per year, does that include both sort of cash and lease demand? And could you also give us some more color on when we think about the 15,000 non U. S. Units, what geographies do you expect that demand to come from? And maybe a little bit more color on the buyer base of sort of who potentially could be buying these cars? Yes. We actually expect probably most of our purchases long term will be financed purchases, which is actually normal for premium sedans. They're majority financed. And in fact, in our case, it might end up being a super majority because I think that the best way to appreciate the savings you get from gasoline is to look at it on a monthly basis. In the U. S, you maybe save $200 to $300 a month in gasoline relative to electricity costs if it's your daily driver. In Europe, obviously, that number can be double. It can be maybe $500 a month if you're driving Europe because the cost of gasoline is twice as much. So I think given that, I think we'll see over time, my guess is that it will be a super majority financed in one form or another. And then I believe that also opens up the potential the affordability of the car to a much broader a much larger number of people. And I think if our car was exclusively available for purchase and not run by a financing, I think that's maybe accessible to 1% or roughly 1,000,000 U. S. Households. As a finance product with the right financing, sort of fully optimized financing product, I think it's probably accessible to the top 10,000,000 households. And then, of course, it depends on what percentage of those households will want to buy our car versus somebody else's. But I do think that it's long term, it's primarily a finance product. And could you touch on sort of non U. S. Demand in terms of the geographical mix and where it comes from? Yes. Sure. Well, I think we'll see probably at least 10,000 units a year from demand in Europe. And then at least 5,000 in Asia. But I mean, that could be obviously a much bigger number. China is kind of a wild card here. It's worth noting that all of the cards, all the sales to date, including all the way through end of Q2, is 100% North American. Great. Thank you. Our next question comes from Adam Jonas with Morgan Stanley. Your line is open. I know I've asked you a version of this question before, and you guys have done a phenomenal job building what appears to be a viable business and a thriving business, although still early and at a risky part of the life cycle of the company. So to kind of when you look at where your share price is and is likely to be tomorrow and you think about the factors that are outside of your control to kind of make sure that all this great work your team has done doesn't go to waste potentially for those factors outside of your control. Can you share your thoughts on potentially stocking in, padding the balance sheet a bit more with a capital increase that could further improve your chances to keep investing in the business and focusing on the product and not the economic cycle? Sure. Well, we don't have any plans right now to raise funding. Potentially, we're we expect to be we were positive cash flow in Q1 and we expect to be relatively sort of neutral on cash flow in Q2. But it's always possible that we could be optimistic about raising a round. But there's no we spent no time on that at all. So if we were to do a round, it would be for the reasons that you mentioned, which is to ensure that there was some unexpected supply interruption, some sort of Risk of measure event. Yes. To potentially protect against the force of measure event that there could be some merit to doing around. Okay. That's very clear, Elon. Thank you. And just a follow-up to an earlier question about the geographic split. Don't know if you can give any color of the 21,000 that you expect this year, how much by order of magnitude could come from Europe confirm whether there'd be any Asian numbers in that in this year's figure? Thank you. Well, I mean obviously given that the first half of the year is entirely in North America, that obviously puts a floor of 10,000. If we stop shipping to North America on July 1st, then we would still have something like 10,000 North American cars. So we're not obviously not going to do that. So we're it's probably but do not take these numbers as final in any way, but you just have if I'm asked to sort of speculate, I mean, it's probably something like 15,000 in North America and 5,000 in Europe and 1,000 in Asia. But this is don't hold me to these numbers. So I was wondering when I say stuff, I want to bracket it with the appropriate confidence interval. That's my best guess. Those numbers could be different. Understood, Elon. Thank you very much. The next question comes from Patrick Archambault with Goldman Sachs. Your line is open. Yes, great. Thank you very much. And yes, congratulations on a good quarter. Just on the sales number, I mean, if you are selling, as you say, above the 20,000 per year mark right now, that kind of implies about at least 55 a day While we were still able to get kind of the sequenced reservation data in February, I believe that fell as low as the mid-30s. So it's come up quite a bit, which is obviously great. I was hoping you could put a little bit more color on that. How much of that is how much of an impact have you seen since the introduction of the new finance product? I'm sure there's some seasonality that we need to think about. And what's the contribution to some of the international sales in this acceleration? Yes. I mean, our focus has been sort of more on just operating efficiently as a company and building cars that and consistently improving the gross margin as well as ensuring we have really good service, got to be an okay service. We're working hard on making it on making service great. I think we haven't really tried to push volume super hard yet because I think you need to make sure that the house is in order and the car is being made as efficiently as it can be made before you try to push volume. So that's why we haven't tried to do that. I think there's potential for next year fairly significant increase in volume as we really sort of test the depth of the demand that's out there. I think it's probably quite a bit higher than we'd originally thought. But like I said, we don't want to just ramp volume and even but not have taken care of gross margin or have bad service and just dump a ton of product on the market. I don't think that's sort of the wise course of action. But we'll still exceed, I think, what most people are expecting us to do. Okay. And if I can just one quick follow-up on that. I mean, did you I know it's still early, but have you seen a pretty good pickup from the introduction of the new finance product? Yes. We've definitely seen a meaningful improvement in demand as a result of the financing product. I think that's had quite an effect on people. I mentioned sort of in some prior talks I've given that like at SolarCity, we saw just a monster increase in demand when we went from selling people solar systems as a purchase product versus a finance product. It was really an order of magnitude difference in demand as a finance product versus purchased. I'm not saying we'll see anything on that scale at Tesla, but I do think it's going to be pretty significant in its effect. That's helpful. If I can just squeeze one more, if that's okay. Just I know your guidance for the 25% doesn't include ZEV credits for the Q4, but I don't know can you help us just bracket that possibility that there might be some Are you in talks with I mean, clearly, you have the volume to have furthers out of credits, obviously. Are you in talks with other manufacturers for these kinds of credits? I mean, is there any kind of feeling of probability that you can give us that would allow us to sort of handicap that? I mean, I think I would realistically handicap it at 0 for the 4th quarter, which is not I mean, we'll sell it if we can, but honestly, we'd anticipate saturating demand for presumed credits probably in the Q3. So maybe that's not true, but I wouldn't for purposes of modeling our financials, I think I would recommend assuming 0% for their credits in Q4. Okay, great. Thanks a lot guys. Our next question comes from Brian Johnson from Barclays. Your line is open. Two topics. Your customer segmentation, but before that just some more data points if you can provide them on the factory. Can you give us a sense of what the overtime hours or temp labor hours were say run rate exiting December versus run rate March? I noticed your inventory was flat even though, obviously, revenue was way up. What you're doing in inventory? And then how does that kind of lead to some of the gross margin improvement you're talking about? Sure. Well, people were working really at the sort of 78 hour week level in at the end of Q4. Now they're sort of down under 50 hours a week. And we've also been able to release a lot of the temp labor that we'd added to deal with manufacturing efficiency. And Deepak, do you want to add something on the inventory front? Yes. Just to clarify, Brian, that our inventory was down by $30,000,000 compared to end of the year despite the fact that our production rate was significantly up. And that's clearly as a result of us better managing our inventory and our production processes. And on the marketing side, do you have a sense yet or data around what the other cars in your customers' garage are or sort of what the other automakers would call conquests, what they owned before versus what they're buying and trade in if any associated with the Tesla? I know you don't do formal trade ins, but just what are the other cars that your customers typically own? Pretty wide range. Yes. We haven't got a formal study across all of our customers, but we saw some study over a narrow time period and it was very interesting to see that it was literally across the entire gamut of price points and brands. So we feel pretty good about that. Okay. Thanks. Yes. It just seems to be based on fundamental affordability rather than any particular prior car that they have. Our next question comes from Elaine Kuei with Jefferies. Your line is open. Hi, guys. Congratulations on the great progress there. I was actually wondering how development on the Model X is progressing at this point. If any of that $200,000,000 CapEx is going to the X and if any R and D is there as well and is the launch still for early 2014? Well, we certainly are making progress on the Model X. Our focus in the Q2 is to finalize the design, so the internal economics and the shape of the car. It isn't yet our top focus because our top focus is on improving the efficiency of Model S production and service. But it will become our top focus towards the end of this year. We are expecting to start production of Model X towards the end of next year rather than the beginning. But I think we've already stated that a few times. That's right. So I don't think that's just for everyone else listening, that's not new news. Right. All right. That's right. And actually on the production efficiencies with the raw material decline in the quarter, how much of that was volume versus just better purchasing strategies or negotiating with suppliers or benefit from lower commodities and how much more benefit do you think there'd be to be gained there? Well, I think the biggest chunk was volume. Clearly, as our cost per unit goes down, the absolute amount of inventory we carry for the same number of cars is coming down. But I think it was primarily us managing our inventory better and that was contributing towards our lower working capital and improvement in our cash flows. Okay, great. And just, I guess, last one real quick. What does the do you have a picture of what the 60 kilowatt hour mix looks like at this point? And are most people taking the supercharger option on that? Thank you. Well, we do think that the mix of 60 kilowatt hour is going to increase. We think more people will buy. And I mean, long term, I think it might be a majority of people buy the 60 kilowatt hour version. But thus far, it's been sort of more like at the kind of 35% level on the 60 kilowatt hour car. But I think that's going to increase. And I think it's roughly half of people are enabling supercharger at the time of purchase. But I think that number is likely to I think that may increase in the future. And certainly, you can enable the supercharger at any time after buying the car for a slightly higher amount. So I think over time, most 60 kilowatt hour cars will enable will have the supercharger enabled either by the initial buyer or a future buyer. Great. Thank you so much. Our next question comes from Andrea James with Dougherty and Company. Your line is open. Just to kind of follow-up a little bit. You sort of put aside the Model X and the Gen 3, you're focusing your resources on getting the Model S right and taking the cost out. And I guess, what metrics do you look at internally where you can say, okay, this progress is satisfactory, let's start diverting more resources on to the next stage of Tesla. We're already doing that. We're actually already diverting resources onto the next stage. So that will keep increasing through this quarter and next and probably by sometime next quarter, middle or end of next quarter, our future products will be our priority because we'll be where we need to be or at least we'll have done the things we need to do in order for the in order to achieve our gross margin numbers. And then once we once because of the time taken from when the parts are ordered to arriving to being put in a car, car gets built, load to a customer and we receive a check. There's kind of a couple of months in there. So even when we've made a cost improvement, it takes, call it, 6 to 8 weeks for that cost improvement to actually show up in our quarterly in our financials. So even though you'd see that unless we really screw the pooch, you'll see the 25 percent gross margin number in Q4. The actions necessary to take that will actually have been completed in Q3, which means that we will in Q3, have turned to Model X and other things as our priority. No, thanks. That's helpful. And it does give us a sense of where the confidence is coming from. And just on the lease accounting and on the financing program, can you give us a sense of maybe you can update your GAAP guidance and what sort of the take rate that you're expecting on the financing program? So far, we are seeing about 25% take rate. But as Elon said, we'll continue to see an increase in the take rate. Yes, actually, there's a difference between our financing program and financing in general because a lot of customers will finance through an institution that's not us. I mean, I think our the total number of percentage of cost being financed is probably half ish, of which half of those are through the Tesla financing program in partnership with Wells Fargo and U. S. Bank. So that's, I guess, the way to think about it. But like I said, I do think that the percentage of finance purchases will increase, both Tesla Finance and 3rd party finance. Okay. Thank you. And then just one more. Does the word cancellation mean anything anymore now that you're changing how you do your reservation? Are you still taking a down payment and then locking them in? Can you just talk a little bit about how that's changed? Yes. So now we've changed the buy flow because previously it was kind of an arduous buy flow. We were making it hard for people to buy the car. You put down a $5,000 reservation without actually configuring the car or knowing how much it costs. And then a lot of people would kind of get shocked by if you have all options you want, it's more expensive than you think, so then they cancel. So now we don't do that. And since April 2, we've you do not order the car with the configuration that you want. You've got 2 weeks to change that configuration or cancel. And then after 2 weeks, the deposit becomes nonrefundable and the configuration is locked. So that's sort of how things are working now. And deposit is still I should mention, we are thinking of reducing the initial deposit number because we don't really need the cash at this point. And when somebody puts down $5,000 they we've got to pay credit card processing fees on that. So it's kind of an unnecessary cost. So we are thinking about reducing it from $5,000 to some lower number. We haven't made a final decision on that, but I think it probably makes sense just in terms of cost reduction. That's helpful. Thank you. Our next question comes from John Lovallo with Merrill Lynch. Your line is open. Hey, guys. Thanks for taking the call. First question would be, I guess, on lease accounting. Can you help us understand the potential effect on margins? And also, I think you mentioned that there would be no cash flow impact on that. But I mean, wouldn't receivables naturally increase with this? Can you just help me understand that? Yes. So, no, receivables wouldn't increase because this is a retail sale. We get the full cash for selling this car upfront. This is not a lease sale per se. The reason we are taking lease accounting is because we are offering this resale value guarantee at the end of it and for the price that are technically Yes, it's a pseudo lease. It's not a Yes. Yes. So yes, our receivables don't go up on our balance sheet. Our income statement is affected because we have to amortize our revenue and the cost over a period, the 36 months in this case for retail value guarantee. So the interesting thing is from a margin point of view as a percentage, there's really not a significant impact, but obviously the absolute dollar amount of the margin is lower since you're not recognizing the entire income upfront? Yes. Actually, I mean, our margins slightly improved with financing versus a purchase because we share in the interest revenue that's generated by the Tesla partner, Tesla Finance Partners. So yes. Okay, great. Yes. But we will get the full cash upfront as well. We get like we see slightly more cash than it was a purchase. Okay. And then in terms of the 25% gross margin target in the 4th quarter, now was this always kind of an exit rate to 25%? Or is this kind of a change in stance? No, no change really. I mean, I'd say we're we think we'll be at 25% on average for all of Q4. I'm like I'm fairly certain we'll be at 25% before the end of Q4, and I think it's likely that we'll be at 25% on average in Q4. Okay. Thanks very much guys. Patrick, unfortunately, we probably only have time for one more questioner. Our next question comes from Ryan Brinkman with JPMorgan. Your line is open. Hi, this is actually Amy Carroll for Ryan Brinkman. Good quarter. I just had a quick question regarding foot traffic in stores. Just wondering what you guys are seeing and if you could kind of help us think about when these people come to the stores, what you're seeing in percentage of conversion rate. Also, I think in the Q1, you mentioned that some of the higher cost was related to not things not going out perfectly through the door, if you're still seeing that and I know your servicing business is kind of still early, but what are you seeing in terms of like usage and kind of just giving us a little bit more color on that, that'd be appreciated. Okay. I'm not sure I totally understand the question, but The first question was just basically like when somebody comes to the door, how through your stores, like what you're converting in terms of like actual sales? Well, we have a huge number of people come through our stores. I mean Usually in excess of a 1000000 people per quarter. That's where our new design stores that we have. So I mean our stores are in high density. It's a low percentage conversion, yes. I mean in terms of bring a lot of people in and educate them about Tesla and the brand and the EVs. So that's our marketing strategy, which is different from a typical car company. And so just the typical metric of conversion of foot traffic is not exactly applicable. I mean, there's a lot of people that buy a T shirt. I mean, our apparel sales are actually not bad. I think we could actually do a lot more on that front. We actually have 1,000,000 of dollars in apparel sales, but without really trying hard. I think probably a better metric would be conversion after of a qualified lead after a test drive. We're seeing something like a 25% conversion after a test drive, which is quite, quite high. That's a good point. After a test drive, yes. Okay. And then just like on the service front, if you're seeing like what percentage of people using it, what are some of the more common issues on that? Yes. Well, I said, we're at the service announcement. Our service has been okay, but not great. But I think it's improving swiftly with each passing week. And we did have some issues there with we've got quite a fancy door handle and occasionally the sensor would malfunction on the door handle. So you'd pull on the door handle and it wouldn't open. Obviously, it's quite taxing for a customer. But we've addressed that at root cause. And so essentially, the door handle incidents have gone to virtually 0 since we introduced the kind of new version of the door handle. And then we're attractively addressing door handle issues or addressing for the fleets that's in the road, we're kind of fixing the door handles, which in a lot of cases just can be done with a remote firmware update. So I mean, I think the door handle has been an issue. We've actually ironically had an issue with the 12 volt lead acid battery. There's a little 12 volt lead acid auxiliary battery that we bought from quite a reputable supplier, American company, who then outsourced it to China, who then outsourced it to Vietnam. And so we thought we were getting fairly good battery, but by the time it had been outsourced to multiple levels, it turned out to be not so great. And so we had to a number of those batteries have had a much shorter life than expected. So that caused some customer happiness. We've since implemented a few months ago a much better screening of the battery packs and now have a substantially improved pack going into cars. Great. Thank you. This concludes our Q and A session. I will turn it back to Jeff Evenson for closing remarks. All right, Patrick. Well, I don't have much to say, but thank you everyone for joining us today and look forward to talking with you next quarter. Bye bye. Ladies and gentlemen, thanks for participating in today's program. This concludes the program. You may all disconnect.