Good day, ladies and gentlemen, and welcome to the Tesla Motors first quarter 2013 financial results Q&A conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will 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 Evanson from Investor Relations. Please go ahead.
Thank you, Patrick, and good afternoon, everyone. Welcome to our first quarter financial results question and answer 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 first quarter shortly after the close of trading today. The shareholder letter, financial results, and webcast of this Q&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&A session live, so please press star one now if you would like to ask a question. 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-K 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 Benjamin Schuman from Pacific Crest Securities. Your line is open.
Hey, guys. Thanks for taking the call. Congratulations on the great deliveries and results in the quarter.
Thanks.
I guess my first question is around the ZEV credits. You disclosed the amount of revenue in Q1. Can you say how much is implied in the Q2 gross margin guidance? 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%? Do you expect that 25% also without whatever positive impact from the lease accounting that you might see?
Okay, there was a few questions nested in there. Yeah. We are expecting a decline in ZEV credit revenue for Q2 and then probably a fairly significant decline in Q3. As I said, right now we're not expecting anything in Q4. That's not to say there might be some ZEV 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. A bigger decline in Q3 than in Q2. Is it fair to say that?
Oh, sure. Of course. Yeah.
Okay. Then just one more from me. The $200 million 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're making in-house by bringing more equipment in and automating our processes that results in gross margin improvement. A portion of that is also new product development, another portion is the infrastructure development of our service centers, our stores, and the Supercharger network.
Yeah. It's worth noting that we were profitable at Q1 despite actually spending quite a lot of money on new service centers, expanding the Supercharger network, stores, and other things that obviously we won't need to keep doing. That's not something that's going to need to occur on an ongoing basis, but we need to establish a service network, in particular, for example.
Great. Thanks a lot.
Great.
Our next question comes from Dan Galves with Deutsche Bank. Your line is open.
Thanks for taking my questions. First one, again, regarding the gross margin. I did this, I think the same simple math that Ben did to get to somewhere in the 5%-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-$19,000 per unit by the end of the year. Wondering if you could give us the big buckets that you're targeting for that improvement and how much is within your control and how much 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 obviously the gross margin average over the quarter. The gross margin at the end of Q1 was significantly better than at the beginning of Q1. You may think, oh, we're starting from a base of 5% or 6%, but actually we're starting from a base that's a fair bit better than that. 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. They don't happen instantly. It's like this [Y rate], it's improving at the cost of our logistics, 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.
I'll add to that, manufacturing process improvements both in-house and at our suppliers.
Yeah
to take cost out.
Yeah. A number of our suppliers have really done some impressive work on cost reduction. 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 own internal predictions were that we would do, in some cases, 3,000 over the entire lifetime of the product. We're like, "Yeah, we did that last quarter." They sort of come to believe that these projections are real, then they actually tool up and are able to deliver significant cost savings for parts supply.
Just to follow up, the suppliers are cooperating with you, in terms of reducing. 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? My second question relates to cash flow. What's causing the decline from $65 million of OCF in Q1 to the guidance of neutral in Q2? If you could remind us of your minimum cash level. Thanks.
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. It's all trending in the right direction. 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. It gives us comfort that, or confidence that we'll continue to reduce our costs. 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. That consumes some degree of working capital, which becomes a part of our cash flow from operations.
That's a significant number. When you combine the lower deliveries, because you'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 Satghare with Lazard Capital Markets. Your line is open.
[Aju] , first 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? Then I have a follow-up.
I think there's clearly room to go further. There are a lot of activities in our manufacturing organization that are continuing in that direction. Then towards the second half of the year, as we start to increase our production rate slightly further than our present levels, that'll 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? 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? Maybe a little bit more color on the buyer base of sort of who potentially could be buying these cars.
Yeah. 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. 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-$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 in Europe, because the cost of gasoline is twice as much. I think, given that, I think we'll see over time, my guess is that it'll be a super majority financed in one form or another.
I believe that also opens up the potential, the affordability of the car to a much broader, a much larger number of people. I think if our car was exclusively available for purchase and not by financing, I think that's maybe accessible to 1% or roughly 1 million U.S. households. As a financed product with the right financing, sort of fully optimized financing product, I think it's probably accessible to the top 10 million households. Of course, it depends on what percentage of those households will want to buy our car versus somebody else's.
Got it.
I do think that long-term, it's primarily a finance product.
Could you touch on non-U.S. demand in terms of geographical mix and where it comes from?
Yeah, sure. Well, I think we'll see probably at least 10,000 units a year from demand in Europe. Then at least 5,000 in Asia, but that could be, obviously, a much bigger number. China's kind of a wild card here. It's worth noting that all of the cars, 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.
Elon, I know I've asked you versions of this question before, 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. When you look at where your share price is and is likely to be tomorrow, you think about the factors that are outside of your control, to 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 socking 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 were positive cash flow in Q1, and we expect to be relatively neutral on cash flow in Q2. It's always possible that we could be opportunistic about raising a round. We've spent no time on that at all. If we were to do a round, it would be for the reasons that you mentioned, which is to ensure that if there was some unexpected supply interruption, some sort of-
Risk measure
force majeure event. Yeah. To essentially protect against a force majeure event, that there could be some merit to doing a round.
Okay. That's very clear, Elon. Thank you. 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, and to confirm whether there'd be any Asian numbers in this year's figure. Thank you.
Well, obviously, given that the first half of the year is entirely North America, that obviously puts a floor of 10,000. If we stop shipping to North America on July 1st, we would still have something like 10,000 North American cars. Do not take these numbers as final in any way, if I'm asked to speculate, to me, it's probably something like 15,000 in North America, 5,000 in Europe and 1,000 in Asia. Don't hold me to these numbers.
Right.
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.
All right.
The next question comes from Patrick Archambault with Goldman Sachs. Your line is open.
Great. Thank you very much. Congratulations on a good quarter.
Thanks.
Just on the sales number, 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 the sequenced reservation data in February, I believe that fell as low as the mid-30s. 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 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? Thanks.
Yeah. Our focus has been more on just operating efficiently as a company and building cars and consistently improving the gross margin, as well as ensuring we have really good service. We had an okay service. We're working hard on making service great. I think we haven't really tried to push volume super hard yet. 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. That's why we haven't tried to do that. I think there's potential for, in next year, a fairly significant increase in volume as we really test the depth of the demand that's out there.
I think it's probably quite a bit higher than we'd originally thought. We don't want to just ramp volume and 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 the wisest course of action. We'll still exceed, I think, what most people are expecting us to do.
Okay. If I can, just one quick follow-up on that. I know it's still early, but have you seen a pretty good pickup from the introduction of the new finance product?
Yeah. 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 gave, at SolarCity, we saw just a monster increase in demand when we went from selling people solar systems as a purchase product versus as 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. I know your guidance for the 25% doesn't include ZEV credits for the fourth quarter, but can you help us just bracket that possibility that there might be some? Clearly you have the volume to have further ZEV credits, obviously. Are you in talks with other manufacturers for these kinds of credits? Is there any kind of feeling of probability that you can give us that would allow us to sort of handicap that?
I think I would realistically handicap it at zero for the fourth quarter.
Okay.
We'll sell them if we can. Honestly, we'd anticipate saturating demand for ZEV credits probably in the third quarter. Maybe that's not true, but for purposes of modeling our financials, I think I would recommend assuming zero for ZEV credits in Q4.
Okay, great. Thanks a lot, guys.
All right. Our next question comes from Brian Johnson from Barclays. Your line is open.
Two topics. Your customer segmentation. 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. How does that kind of lead to some of the gross margin improvement you're talking about?
Sure. People were working really at the sort of 78-hour-a-week level at the end of Q4. Now they're sort of down under 50 hours a week. We've also been able to release a lot of the temp labor that we'd added to deal with manufacturing efficiencies. Deepak, do you want to add something on the inventory front?
Yeah, just to clarify, Brian, that our inventory was down by $30 million compared to end of the year, despite the fact that our production rate was significantly up. That's clearly as a result of us better managing our inventory and our production processes.
On the marketing side, do you have a sense yet or data around what the other cars in your customer's garage are, or sort of what the other automakers would call conquests, what they owned before versus what they're buying, 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.
Yeah, we haven't got a formal study across all our customers, but we saw some study over a narrow time period, and it was very interesting to see there was literally across the entire gamut of price points and brands. We feel pretty good about that.
Okay, thanks.
Yeah, it just seems to be based on fundamental affordability rather than any particular prior car that they had.
Our next question comes from Elaine Kwei 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 million CapEx is going to the X and if any R&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 second quarter is to finalize the design, so the internal ergonomics 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. 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. I think we've already stated that a few times.
That's right.
I don't think that's just for everyone else listening, that's not new news.
Right.
That's right. 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?
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. 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. Just, I guess, last one real quick. 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 it and long-term, I think it might be a majority of people buy the 60 kilowatt hour version. Thus far it's been more like at the kind of the 35% level on the 60 kilowatt hour car. Like I said, I think that's going to increase. I think it's roughly half of people are enabling Supercharger at the time of purchase, but I think that may increase in the future. Certainly, you can enable the Supercharger at any time after buying the car for a slightly higher amount. I think over time, most 60 kilowatt hour cars will have the Supercharger enabled either by the initial buyer or a future buyer.
Great. Thank you so much.
Okay.
Our next question comes from Andrea James with Dougherty & Company. Your line is open.
Just to kind of follow up a little bit. You've 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. I guess, what metrics do you look at internally, where you can say, okay, this progress is satisfactory, let's start diverting more resources onto the next stage of Tesla?
Well, we're already doing that. We're actually already diverting resources onto the next stage. That'll 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 to achieve our gross margin numbers. Then, because of the time taken from when the parts are ordered to arriving to being put in a car gets built, delivered to a customer, we receive a check. There's kind of a couple of months in there. Even when we've made a cost improvement, it takes, call it six to eight weeks for that cost improvement to actually show up in our financials.
Even though you'd see that, unless we really screw the pooch, you'll see the 25% 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. Sorry.
No, thank you. That's helpful, it does give us a sense of where the confidence is coming from. Just on the lease accounting and on the financing program, can you give us a sense of maybe, are you going to update your GAAP guidance and what's the take rate that you're expecting on the financing program?
We are seeing about 25% take rate, but as Elon said, we'll continue to see an increase in the take rate at a time.
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 think the total number, percentage of cars 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. That's, I guess, the way to think about it. Like I said, I do think that the percentage of financed purchases will increase both Tesla finance and third-party finance.
Okay, thank you. 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?
Yeah. 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, a lot of people would kind of get shocked by, oh, if you add all the options you want, it's more expensive than you think, they cancel. Now we don't do that. Since April 2nd, if you now order the car with the configuration that you want, you've got two weeks to change that configuration or cancel, after two weeks, the deposit becomes non-refundable and the configuration's locked. That's sort of how things are working now.
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. When somebody puts down $5,000, we've got to pay credit card processing fees on that. It's kind of an unnecessary cost. 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? I think you mentioned that there would be no cash flow impact on that. Wouldn't receivables naturally increase with this? Can you just help me understand that?
Yeah. No receivables would increase because this is a retail sale. We get the full cash for selling this car up front. This is not a lease sale per se. The reason we are taking lease accounting is because we're offering this resale value guarantee at the end of it.
Yeah. It's a pseudo lease.
Yeah.
Yeah.
Yeah, 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, 36 months in this case, for resale value guarantee. 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 up front.
Yeah. Actually, our margins slightly improve with financing versus a purchase, because we share in the interest revenue that's generated by the Tesla finance partners. Yeah.
Okay, great.
Yeah. We get the full cash up front as well.
Okay
because likely, there'll actually be slightly more cash than if it was a purchase.
Okay. In terms of the 25% gross margin target in the fourth quarter, was this always kind of an exit rate to 25%, or is this kind of a change in stance?
No change, really. I'd say we think we'll be at 25% on average for all of Q4. 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.
Okay.
Patrick, unfortunately, we probably only have time for one more questioner.
Our next question comes from Ryan Brinkman with J.P. Morgan. 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 the stores. Just wondering what you guys are seeing and if you could kind of help us think about when these people come through the stores, what you're seeing in percentage of conversion rate. Also, I think in the first quarter, you mentioned that some of the higher cost was related to things not going out perfectly through the door, if you're still seeing that and I know your servicing business is still early, but, what are you seeing in terms of usage and just giving us a little bit more color on that'd be appreciated.
Okay. I'm not sure I totally understand the question.
The first question was just basically when somebody comes through the door.
Yeah
through your stores, what you're converting in terms of actual sales.
Well, we have a huge number of people come through our stores.
Usually in excess of a million people per quarter.
Yeah.
That's for our new design stores that we have. Our stores are in high-end.
It's a low % conversion, yeah.
These are to bring a lot of people in and educate them about Tesla and the brand and the EVs.
Yeah.
That's our marketing strategy, which is different from a typical car company, just the typical metric of conversion of foot traffic is not exactly applicable.
There's a lot of people that buy a T-shirt. Our apparel sales are actually not bad. I think we could actually do a lot more on that front. We actually have millions of dollars in apparel sales, without really trying hard. I think probably a better metric would be conversion of a qualified lead after a test drive. We're seeing something like 25% conversion after a test drive, which is quite high.
That's helpful.
Of qualified lead after a test drive. Yeah.
Okay. Then just on the service front, if you're seeing what % of people using it and what are some of the more common issues on that?
Yeah. Like I said, we're going to do the service announcement. Our service has been okay, but not great. I think it's improving swiftly with each passing week. 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 vexing for a customer. We've addressed that at root cause, essentially the door handle incidents have gone to virtually zero since we introduced the new version of the door handle. Then we're retroactively addressing door handle issues, or addressing for the fleet that's on the road, we're fixing the door handles, which in a lot of cases just can be done with a remote firmware update. I think the door handle's 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, an American company, who then outsourced it to China, who then outsourced it to Vietnam. We thought we were getting a fairly good battery, but by the time it had been outsourced to multiple levels, it turned out not so great. A number of those batteries have had a much shorter life than expected, so that's caused some customer unhappiness. 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&A session. I will turn it back to Jeff Evanson for closing remarks.
All right, Patrick. Well, I don't have much to say, but thank you everyone for joining us today, and we look forward to talking with you next quarter. Bye-bye.
Ladies and gentlemen, thank you for participating in today's program. This concludes the program. You may all disconnect.