Tesla: 10-Q Paints Worse Picture

Summary

• The accounting change had some major impacts.
• More credits sold than previously disclosed.
• Customer deposits jump not what it seemed.
• Language regarding production ramp changes.

Early Monday morning, we received the 10-Q filing from Tesla (NASDAQ:TSLA) after the company reported earnings last week. Many were curious to see this document, especially as it related to a major accounting change adopted during Q1 from the company. Unfortunately, now that we have the document in front of us, the situation looks even worse for Tesla.

It would take a while to discuss every single impact of the new accounting change involving revenue from customers with contracts. I pasted the portions of the balance sheet below to show all the changes. Perhaps the most important one is that customer deposits jumped by $56 million in the Q4 period, and $58 million in the Q1 period.

(Source: 10-Q filing linked above)

This is primarily because customer deposits now include "prepayments on contracts that can be cancelled without significant penalties, such as vehicle maintenance plans". These have been reclassified from deferred revenue to customer deposits. So for all those bulls that thought the $130 million jump in deposits during Q1 was bullish, almost half of it was due to the accounting change.

The change also had a decent size impact on the income statement. First, a little more than $130 million in extra revenues were reported, with a cost of revenues of $95 million, meaning around a 27% above average gross margin on the increased revenue. This change also added $36 million to the bottom line, reducing the net loss by more than 4.4%, of which almost 90% was applied to common stockholders.

The second major item is that Tesla disclosed regulatory credit sales of $80.3 million. There's nothing wrong with this, as we've seen the company sell hundreds in millions in credits over the years. The main issue is that in the investor letter, they only detailed $50.3 million in ZEV credit sales, as seen in the image below. The 10-Q adds another $30 million of these high margin sales, meaning the gross margin improvement we saw in Q1 was partially because of credit sales not mentioned in the quarterly report.

(Source: Tesla Q4 2018 investor letter)

The company also quietly added an update to its credit agreement, this being the 9th amendment. The major changes can be seen below, primarily the update about the borrowing base now including the Fremont factory.

On May 3, 2018, the Company and its subsidiary Tesla Motors Netherlands B.V. entered into the Ninth Amendment (the “Ninth Amendment”) to the Credit Agreement. The Ninth Amendment amended the Credit Agreement to permit Tesla to include in its discretion: (i) the Fremont Factory facilities in the U.S. borrowing base and/or (ii) vehicles in and in-transit to Belgium in the Dutch borrowing base.

Now you may remember an article I had published back in March relating to Tesla borrowing. It discussed the impact of rising 3-month LIBOR rates on many of Tesla's debt instruments. The key rate is now up to nearly 2.37%, which is up 175 basis points as seen in the chart below from when Tesla unveiled the Model 3.

(Chart from St. Louis Fed. 3-mo. LIBOR page. Check current rates here)

As expected, the rise in LIBOR meant increased interest rates for some of Tesla's borrowing facilities. For instance, the term loans due December 2018 and January 2021 went from rates of 4.8% and 4.9%, respectively, to 5.2% and 5.3%. A few other credit facilities saw a rise in rates, and with further increases in LIBOR (and potentially Treasury rates), the situation will only be worse with Tesla's rising debt pile.

Finally, although it was a small change, Tesla has played around a bit with the wording of its target for Model 3 production of 5,000 units per week. I've talked about this previously regarding statements of "approximately 5,000" along with "about two months" (from early May), but now we have an official statement in the SEC filing. Take a look at what was said in comparison to the 10-K filing from a few months ago. Bulls will argue that this is just semantics, but there definitely is new wording (important part in bold).

10-K: Based on our current progress, we are targeting a production rate of 2,500 Model 3 vehicles per week by the end of the first quarter of 2018 and 5,000 Model 3 vehicles per week by the end of the second quarter.

10-Q: We continue to target Model 3 production of approximately 5,000 per week around the beginning of July 2018.

In the end, the situation with Tesla looks even worse after a quick read through the 10-Q filing. The accounting change boosted revenues a bit at a high margin, while reducing the company's loss by more than $30 million, as well as boosting customer deposits by more than $58 million. Additionally, an extra $30 million of credit sales were disclosed, which also inflated gross margins a bit. Finally, the rise in rates is definitely hurting, causing interest expenses to rise even overall debt hadn't increased. It looks even more difficult now for the company to be profitable later this year, which adds to the pressure Elon Musk and Tesla is facing. Tesla also tried to get the 10-Q filed late on Friday to try to bury it during the weekend, but as one user pointed out on Twitter, they missed the deadline and so it came out this morning. I've shown numerous examples in the past of Tesla trying to bury bad news late on a Friday.

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