After market close yesterday, Tesla Motors (TSLA) released its Q4 earnings and discussed projections for the next quarters. After the report, shares of Tesla tumbled 6.1% after hours, and are continuing to fall during early hours of the trading day. Company executives expressed in the conference call that they are expecting to generate positive earnings in Q1, but how valid is this projection?
Tesla missed earnings per share expectations at (-.65) while consensus was at (-.53), but revenue increased significantly to $306.3 million, beating consensus in that category. Still, Tesla Motors has increased its net loss to $89.9 million from $81.5 million.
Tesla Motors was founded in 2003 with the aim of convincing the public that electric vehicles are not only possible but popular by designing, patenting, and then creating electric vehicles for consumer consumption. Furthermore, Tesla Motors provides consultation, service, and sales of electric powertrain components to other automotive manufacturers such as Daimler AG.
Tesla manufactures, sells, and distributes its vehicles without third party assistance. This ownership of the entire process from the factory to the customer is highly intrinsic to the TSLA business strategy. The company maintains low stock of vehicles in order to limit floor space necessary to display the products in an effort to reduce cost and limit supply.
In 2008, Tesla released to market its first EV (electric vehicle) called the Roadster, and as of today, there are 2,300 sold in 37 different countries, which equates to an average of 575 Roadsters sold per year. At a base cost of $109,000, Tesla Motors generated over roughly $62 million dollars in revenue from sales alone. With the high cost of the Roadster, Tesla Motors aimed to limit the first model to high-end enthusiasts willing and able to afford the vehicle, and then gradually reduce the price for the masses to participate. This is a similar business model adopted for use by other technology companies such as Apple (APPL), which did this with its initial product releases.
The more recent Model S Sedan is designed to target a wider base of customers, as the starting price for a Model S Sedan starts at $52,400 dollars. The Model S is not by any chance a middle class vehicle, but it is 50% the price of the original Tesla Roadster. As of the Q4 conference call, customers interested in purchasing the Model S this year have to put down a "reservation" fee of $5,000 to put themselves in line for the next available model. According to CEO Elon Musk: "I do emphasize where we are not demand constraint. We are intentionally production constraint."
In my opinion, this is a smart strategy and good call by the executives at Tesla for a number of reasons. 1) By maintaining greater demand than supply, Tesla has greater reign over profit margins and can generate consumer hype without even delivering a product. 2) Musk also stated that Tesla is intentionally not demand constrained because this allows for the company to ensure that every product produced is perfect and exactly as the customer wants it to be. With methodical production, Tesla ensures product quality. 3) Tesla is in a good position right now, as it has opportunity to increase production rates by improving production efficiency rather than simply churning out more units with raw increase in capital and labor. With intelligent leadership, Tesla has the chance to impress investors and satisfy consumers with increased production efficiency and decrease its operating costs at the same time.
On the other hand, the major downside to a lopsided supply-demand scenario is that some customers are getting so frustrated with the wait and the high down payment that they are backing out of the reservations all together. According to a Tesla spokeswoman, 1,500 Model S reservations were cancelled in Q4. The challenge for Q1 is to increase production for highly coveted models without compromising on the quality of each individual unit. CEO Elon Musk said on the conference call that the company expects 4,500 additional units to be produced in Q1. Tesla has targets of delivering 20,000 new vehicles in 2013, and it received 15,000 new reservations in 2012. So if Tesla can achieve the 4,500 guidance for Q1, and continually increase production efficiency for the continuing quarters, it could achieve positive EPS and operating margins by the end of 2013 or the beginning of 2014.
2,400 Model S cars were delivered in Q4, and Tesla generated $12 million from servicing the Mercedes-Benz EV Program, which encompasses 4% of the total revenue. As mentioned earlier, a huge increase in gross revenue occurred from Q3 to Q4 to $306 million. Additionally, the company reports that it aims to reduce production inefficiencies and costs, and sport a 25% continued growth in revenue for next quarter. Research and Development spending in Q4 was $69 million based on GAAP, but the company expects Q1 R&D to decline 15%, as a significant portion of Q4 R&D was meant for product design, engineering, and testing of the vehicle that has all been completed in Q4. Selling and General Expenses totaled $46 million in Q4, and these costs are expected to increase in Q1 as the company strives to increase production and sales of its Model S vehicle. According to the company's balance sheet, sales generated total revenue of $371.6 million, while the cost of revenue for 2012 totaled $383.2 million dollars. Currently, the cost of the Model S is significantly priced, and if it increases the price any higher, the demand would plummet, as customers are already revoking their reservations under the current prices. Thus, Tesla needs to develop a more efficient and streamlined production in order to decrease the cost of revenue, as that is the major hindrance from a positive operating margin.
Tesla expects Q1 production to yield 4,500 vehicles, sales to increase along with production, and a break even or positive operating margin -- something that the company has not been able to manage thus far. The guidance and expectations for Tesla (as created by the executives themselves) are not an easy task, especially for a company within an industry that is not yet fully mainstream. There are, no doubt, very neat features for the Model S, including a battery that can charge overnight, aerodynamic door handles, automatic ignition with a buckled seat belt, and state of the art interior electronics. However, many of these features can be found in more traditional luxury cars and sedans that run on gasoline. In the future, if Tesla successfully convinces the masses that the savings in gasoline will compensate for the higher base price of the model S, then I see great success for the future of this company. As of now, I am worried about its balance sheet. Out of the money calls for June 2013 are down a few percentage points, so if there appears to be any headwind in TSLA stock in the near future, purchasing a few of these babies may not be a bad idea.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.