Tesla Q2 Results: Elon May Be Growing Up A Bit

| About: Tesla Motors (TSLA)

Summary

Q2 results below expectations but company has worked hard on Model X production problems.

Delivery guidance for second half of 2016 unchanged but projected gross margin improvement below expectations.

Musk’s tone on the call seemed to be different and possibly with a more realistic view of the environment in which Tesla operates.

Introduction

There isn't really a lot to say about Tesla's Q2 results announcement (NASDAQ: TSLA) as an "earnings report" as the losses were a lot larger than the brilliant sell-side analysts were forecasting but I felt there was a new sense of reality from comments made on the conference call. That sense of reality didn't completely extend to standard accounting metrics, as there were comments such as:

  • We would be profitable in Q3 and Q4 without the Model 3 CapEx

And so all Musk may really need at this point is an accounting course! (Well plus another $5 billion in capital over the next three years).

All silly jokes aside, the actual Tesla situation at this point is: everything now depends on the Model 3 ramp. The issue for investors is that the Model 3 ramp will really have no visibility over at least the next 12 months, other than some comments on quarterly conference calls every three months over the next four quarters.

Additional Model 3 comments on the conference call

The most notable thing on the call today was that there does appear to be a firm goal of July 1, 2017 for "volume production" on the Model 3. That could mean many things given the inconsistent roll out of the Model X but another notable item on today's call was a comment that a majority of the CapEx planned for the second half of 2016 would be to support Model 3 production capabilities. I would then assume that the first half of 2017 would also continue to be another period of very heavy capital spending (probably another $2 billion in that six-month period).

What that means is that "something" will probably be able to be produced in July 2017 but I would guess with an initial production ramp similar to the Model X. Given that the Model X then took another nine months to achieve what Tesla calls "volume production" my own prediction currently would be 5,000 Model 3s in Q3 2017 and 20,000 in Q4 2017. Assuming that demand is real for the Model 3, that production could probably then increase to a level of 50,000 to 60,000 Model 3 units a quarter throughout 2018 - which is only slightly below my previously published unit forecast in 2017 of 250,000 Model 3 units delivered that year.

Some of Musk's specific comments are as follows about the Model 3:

  • no standout issues for a July 1 Model 3 production ramp but we don't expect to be in volume production on July 1
  • suppliers that fall short will be cut out of the picture
  • internal teams not performing well be reorganized
  • in a real world, our Model 3 development would be confidential but Tesla scrutinizes results in news about everything

I've already commented about my views of the initial production ramp that some initial Model 3s can probably be produced next July but the additional bullet points above do suggest to me that there are still a lot of moving parts to a planned July 1 production start date. Suppliers "falling short" being "cut out of the picture" could add another six months to a production ramp and "internal teams not performing" being "reorganized" would probably also result in internal delays of between two and three months.

There is another interesting context to Musk's remarks about the planned Model 3 schedule as in another section of the call, he described the Model X production ramp during the first half of this year as "going through hell" and that people were "burnt out" and that a reasonable number of people had "left the company." I think what is happening here is that Silicon Valley drive and energy is meeting head on with the realities of heavy manufacturing where complex manufacturing processes don't always go according to plan.

Burning people out with a much smaller production ramp for the Model X would be an additional risk factor for a much larger planned production ramp for the Model 3 if a similar management approach is taken for the Model 3 introduction.

There are some other interesting comments in the Shareholder Letter that suggest there may be some other "moving parts" and risk factors as well concerning the Model 3 production ramp. We've previously heard Musk's comments about developing new manufacturing paradigms and processes, and apparently, the company is going all in on that theme with planned Model 3 production processes. Included below are some comments that I think are interesting from the Shareholder Letter:

"We have completed the design phase of Model 3 and released Model 3 for tooling, production planning and validation. The Model 3 capacity expansion will reflect our initial efforts to apply our "machine that makes the machine" philosophy to vehicle manufacturing, and demonstrates our intense focus on volumetric and capital efficiency. Some Model 3 production equipment is already on line, including initial capacity in our stamping and paint centers. Later this year, we plan to begin construction of new Model 3 body and general assembly centers."

Effectively, what we are being told is that a lot of new approaches to manufacturing are being planned and so investors need to decide their confidence level about such new processes. On a somewhat amusing note about the new Model 3 production process, Musk described the new procedures as "alien dreadnought version 0.5 and a year later will be version 1.0." That sort of reminded me of the silly Fred Couples advertisement for Mitsubishi Electric where he is talking about "Zombaliens"!

One final comment about the Model 3 is that if anyone was hoping for an update about the reservation number currently, the company wasn't willing to disclose that as they answered the question by just citing the 373,000 number in the Q1 10-Q filing. There was a comment, however, that some Model S 60 purchasers had been Model 3 reservation holders and so the number of Model 3 reservations could be dropping a bit.

Additional Model S and Model X details

Model X was described as having an ASP 15 percent higher than the Model S and that is in line with the projected price difference in my financial model that was published about a month ago. There were a number of almost disconnected comments about Model S 60 gross margins but general comments were that base model Model S 60 gross margins were in "the 15 to 20 percent" range, which is at least five points below the overall gross margin reported for the quarter. Musk then did add that they had been surprised, however, that many of the 60 version purchasers were adding on a lot of options, which then resulted in many 60 version models having gross margins in the 30 percent range.

Additional comments about gross margins were that the company expected them to improve by "two to three percent" for the rest of the year. In response to analyst questions about that level of improvement being below expectations, the answer was that previous comments were before the lower margin 60 version had been introduced.

As for possible current Model X demand, there was an interesting comment that the company expected Model X and Model S deliveries to be "comparable" during the third quarter. My Q3 delivery forecast is for 21,000 units and so that would possibly project to being 10,000 Model Xs during Q3 and 11,000 Model Ss during Q3. That would still seem to be below expectations for the Model S, however, if my projections are reasonable. There was another unquantifiable "order number" mentioned in the Shareholder Letter, which was:

"Model S orders increased year over year. With the addition of Model X orders, total Q2 net new vehicle orders rose 67% from a year ago."

But that also doesn't really square with the possible relatively flat Model S delivery numbers described above.

Tesla Energy comments

Answers on the conference call about Tesla Energy seemed to sort of go off grid in my opinion as I was left with the impression that almost nothing was really being shipped at all. There was an interesting number in the income statement, which supports such speculation, which is that "Services and Other Revenues" (which includes any Tesla Energy revenues) dropped from $120MM in Q1 to $88MM in Q2.

In true Muskian form when there were additional questions about a likely ramp for Tesla Energy revenues, various answers were:

  • "stationary energy is going through heavy engineering but will be really robust in Q4"
  • "depends on production ramp in second half of year and finishing engineering"
  • "next generation of stationary storage head and shoulders above anything else"
  • "have to scale up production"
  • "production is a hard thing particularly with new technology"
  • "design the machine that makes the machine"
  • "our plans are better than what I've heard anyone announce"

I don't think any of those comments added any visibility at all to Tesla Energy and so I'm going to not assume any revenue build from that this year.

Autonomous driving comments

With recent publicity about Tesla's Autopilot feature and other automated functions, I might have thought that Tesla might be pretty low key at this point about future product plans. Musk, however, took the offensive about these topics with comments such as:

  • "full autonomy will come a hell of a lot faster than anyone thinks and full development will come a lot faster than anyone thinks"
  • "we will have a solution that is far superior than our previous approach working with an outside vendor"

When questioned about a schedule for future Autopilot features or internally developed solutions, Musk then responded, however, by saying that an earnings conference call wasn't the place for such an announcement.

Future Product Plans

In another sign of possible discipline, Musk did say that there will be no future products until the Model 3 is in full production ramp and that seemed to imply at least until 2019. The next model appears to probably be the "Model Y" (the rumored compact SUV) which Musk said would sell between 500K and 1 million units a year. There were a couple of comments about the Tesla Semi and "Minibus" but which suggested that they were far into the future in terms of actual production. There was an additional comment, however, that there could be an "unveiling" for both of those products within the next year.

At the end of the call, Musk did describe that he did understand the trade-off between growth and "dilution" and so maybe there is now a broader perspective about the financial effects of Tesla's plans. Still, a lot of how the company fares financially will be based on what actual Model 3 gross margins may be and that is something that we will not know until full volume production is reached two years from now.

Additional Financial Details

A very interesting detail mentioned in the Shareholder Letter was the following about Tesla's external vehicle financing programs:

"We anticipate that direct leasing will rise from 8% of deliveries in Q2 to about 15% of deliveries in Q3, as we have reached our funding limit with a banking partner. We anticipate adding new partners that will allow us to fund our planned growth in the future."

I have already mentioned in previous articles that one of the reasons for Tesla ending the U.S. Resale Value Guarantees was that they were getting pushback from bank lending partners about providing segregated accounts to back up the guarantees and "reaching our funding limit with a banking partner" suggests that may be the case. "Anticipating adding new partners" also implies that such new partners are not yet in place, which could, on the margin, have some effect on deliveries without the previous array of financing options.

One of my favorite parts of Tesla financial statements is the completely unanalyzable "Customer Deposits" account as the company lumps into that account the value of trade-in vehicles, which they may own at any given time. Still, however, it is notable that the current balance of $680 million is an increase of $290 million from the end of Q1. Supposedly around $150 million had been booked in that account in Q1 for the one day of March 31 reservations for the Model 3 in Q1 and so that would imply based on the 373,000 number of Model 3 reservations that we last knew about that the additional Model 3 reservations would have added another $225 million to that balance. But, since the account went up another $65 million of top of that, it is anybody's guess what is really happening with that account. That is a lot of free cash being held by the company, however, which will eventually have to be applied against customer deliveries of vehicles.

Conclusion

I thought I heard a new and different tone on this conference call where Musk is now more aware of the environment that Tesla is operating in and a possible new sense of focus about making the company's plans and activities more realistic relative to external expectations. Still, for my very fundamental way of looking at things, there are just too many "ifs" and too many variables to not still be concerned about the many risks of the company's goals over the next two years.

I don't really think that near term "earnings estimates" really matter either but with the latest quarter's financial results and lower than expected guidance for gross margin improvement, sell-side analyst earnings estimates will be decreasing. With the additional disclosure about reaching "bank funding limits" in their external vehicle loan program, that is another item to watch too as that is the first possible signal that there is possibly some stress with external lending partners.

Overall, however, I feel like giving the company an "A" for effort with how they have apparently now worked through a lot of operations problems in the first half of 2016. I still think the projected Model 3 ramp is very aggressive, however, and so that also makes me concerned about the risk of possible disappointments with such plans.

Disclosure: I am/we are short TSLA.

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