Tesla's Q1 Revenue Beat Driven Largely By Accounting Changes, Model 3 Currently Loses $8K Per Unit

Summary

• In a previous analysis, we correctly projected costs for Tesla'a Auto segment but widely missed on revenue.
• Upon investigation, average sale price (ASP) of $105K across S/X volume proved reasonable, but the volume of units accounted for as non-leased revenue was wide of the mark for S/X.
• The reason? A recent FASB rule change entering into effect, with Tesla interpreting the rule in such a manner that lease-accounted units fell to only 8% of deliveries.
• A quick analysis of gross margins revealed Model 3 COGS are currently $58-60K per unit, though per unit costs will fall as production rates improve.
• We continue to doubt that Tesla will be able to sufficiently increase production and lower costs to generate a net profit by Q3.

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Introduction

In our previous analysis, we estimated Tesla's Q1 2018 Auto revenue at $2.167B; we, along with many other analysts, were surprised to see Tesla reported $2.562B in Auto revenue for the quarter. This was well above general expectations, and contributed heavily toward more acceptable gross margins for the segment, rather than the feared low double digits or even single digit margins for the segment.

The proportion of revenue in this division attributable to the Model 3 is fairly easy to determine. With Tesla delivering 8,180 Model 3s in Q1 and the possible price range (after delivery) spanning $45K to $58K (a relatively small breadth), an ASP of $50-52K may be interpolated. This in turn yields a revenue figure of approximately $410-425M from Model 3 in the quarter (even if all vehicles sold were at the $58K price point, which we have no reason to believe this is anywhere close to the reality, Model 3 revenue would still be less than $475M). This results in $2.152B of revenue assigned to S/X deliveries. In the previous quarter, 77% of S/X deliveries were for sold units. With approximately 21,815 units of the two legacy models delivered in the quarter, this would have equated to roughly 16,800 units accounted for in this division if the proportion of 77% had held constant, implying an ASP of unprecedented levels, at $128K per unit (over the previous 4 quarters, the S/X ASP ranged from approximately $101K to $113K). If Tesla had achieved a massive ASP improvement to offset a decline in S/X volume, this would have a significant, positive impact on the outlook for the stock. As we discuss below, while ASP moved up slightly, the beat is driven not by some fundamental improvement in the company, but primarily by an accounting change.

FASB to the rescue!

Buried as a note to the revenue and gross margin section was the following excerpt:

"With the adoption of the new revenue recognition standard starting January 1, 2018, lease accounting generally applies only to vehicles directly leased by us without using bank partners. As a result of this change, only 8% of our deliveries in Q1 were subject to lease accounting."

This is a fairly significant change for Tesla (a summary of the FASB change can be found here). A minority of the units leased by Tesla are done directly from the company, which means Tesla is now recognizing revenue on non-lease accounting terms for units leased through third parties (representing a majority of all leased units). In other words, 92% of the 21,815 S/X units delivered were recognized as revenue within the Auto segment, or approximately 20,100 units. With this new volume, the ASP nets out to $107K per unit, in line with the normal range for the S/X volume. This represents an approximately 2% increase in ASP sequentially.

The upshot is that revenue from leasing fell $129M sequentially, but Auto revenue rose $153M sequentially. The 2% rise in ASP sequentially yielded less than $50M in incremental revenue, meaning that the vast majority of the variance was due to accounting changes (we will not delve into the issue of whether or not Tesla's interpretation of the new rule is consistent with FASB's intent). Under these new rules, Tesla's revenue moving forward will need to be analyzed more carefully, with 3rd party leased units now buried in the accounting for the Auto segment.

The bright side of cannibalization?

The impact of the Model 3's entry is ultimately two-fold, reducing demand for S/X units (as indicated in our previous analysis, in roughly equal measure) but also improving the ASP for the two legacy models (as the Model 3 may compete clearly with the Model S 75, but it is a very different appeal than the P 100D). This will likely lift gross margins for the S/X units sold in the future. Obliquely, we expect this to be a talking point from management in coming months. A question not directly answered by Tesla, but now discernible given their statements, is the current gross margin of the Model 3.

And one more thing

Within the recent shareholder's letter, Tesla asserted that S/X GM was approximately 25%. Given that we know S/X revenue was approximately $2.152B for Q1, this means the legacy units generated $538M in gross profit under the new accounting. Compared against the $470.5M in gross profit reported for the quarter, the Model 3 generated approximately $68M in negative gross profit (or -$8.1K per unit) on its $410-425M in estimated sales, for an estimated COGS of $58-60K per unit. This approximates to a gross margin of -15% to -16%. COGS will improve significantly as volume shifts, as direct labor does not comprise a particularly large portion of COGS when producing at scale. However, the current negative gross margin underscores how vulnerable Tesla's cash flow (and immediate company health) is to a significant and sustainable ramp of the Model 3. The high COGS also illustrates future challenges in profitably producing the bare-bones, $35K version of the Model 3.

Summary

While a portion of Tesla's revenue and earnings beat is due to better-than-expected performance in the Energy segment, this is a relatively minor driver of the financials. Rather, much of the company's apparent success from the last quarter, delivering "record" revenues, is driven by an accounting change. S/X ASP has improved slightly to $107K, likely due to cannibalization of lower-valued models by the Model 3. Based off information provided by Tesla, the Model 3 currently has a negative gross margin, at approximately -15%. Per car COGS sit at $58-60K, with per car gross losses of around $8K. Given the accounting changes and the continued Model 3 production ramp, we expect Q2 automotive revenue to exceed $3B and for total company revenue to beat the $4.16B average analyst projections; however, we anticipate overall losses to improve only slightly in Q2 and for automotive gross margin to fall as Model 3 volume overtakes S/X volume in the next 1-2 quarters. Tesla has shown modest (but essential) discipline in OPEX and will need to expand cost-control efforts to have any hope at achieving Q3/Q4 profitability, even while hitting their stated production targets.

Analyst’s Disclosure: I am/we are short TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

One or more of the author(s) is short TSLA via long-dated options. One or more of the author(s) is a Model 3 reservation holder.