# How Tesla Makes A Profit This Quarter

## Summary

- I build a model of Tesla's third quarter.
- Tesla has only two quarters of profitability in the past decade.
- If Model 3 gross margins can approach 15%, this could be its third profitable quarter.
- Profits are not impossible, but margins are razor-thin.

Over the past decade, Tesla (NASDAQ:TSLA) has generated revenue of over $36 billion and watched its market cap soar from under $2B in 2010 to over $50B today.

The company has amassed its fair share of critics along the way as well. One reason for this is that Tesla has made a profit in only two quarters (Q3/16 and Q1/13). Since 2009, Tesla has amassed cumulative net losses of over $6B. That could be about to change.

"Yeah, I'd say highly confident of being cash flow positive and being GAAP profitable in Q3."Elon Musk, Q2/18 CC

Last quarter, Tesla lost $718M. Could it really make a profit in Q3/18? Inspired by an article at Alphaville (with a hat tip to Seeking Alpha reader cabaretvoltaire), let's do a little modeling of Tesla's possible third-quarter results to find out. Everything herein is merely an estimate and I welcome all constructive feedback on this model.

Tesla can make a profit in Q3/18. This is an exercise in modeling that shows one way that Tesla could walk away with its third quarterly profit in 10 years.

### A Blank Income Statement

The task here is simple. Let's fill out this chart for Q3/18 (ending Sept. 30, 2018):

(*Based on company filings*)

Or, to format the same information in more convenient format, let's fill out this chart:

Let's get the uninteresting items out of the way first.

For energy generation and services, let's just use the company's results last quarter. Last quarter, Tesla generated $645M in revenue with gross margins of -11%, resulting in a gross loss of $72M. Gross profits from these two segments (combined) have been ~constant over the past three quarters despite significant variability in revenue growth and margins, so this simplifying assumption is unlikely to be significantly off. This is worse than Tesla forecasts:

"We are expecting that the negative margin of our Services and Other business will narrow by the end of this year. As we generate more revenue from used car sales, merchandise & accessory sales, body shop and other paid repairs, we expect revenue to grow significantly. Used car sales in particular are growing rapidly and are becoming more profitable."- Q2/18 Update

Similarly, let's assume that interest income/expenses, other income, and net losses to non-controlling interests remain the same as last quarter, resulting in a net $82M in non-operating costs after non-controlling interests.

Tesla has offered some guidance on operating costs:

"[O]ur OpEx is staying essentially flat, so massive leverage in the business." -Deepak Ahuja, Tesla CFO, Q2/18 CC

Tesla expects operating expenses to stay essentially flat. Excluding one-time restructuring costs related to June layoffs, operating costs increased 8% sequentially last quarter and an average of 4% sequentially over the last five quarters. Given Tesla's belt-tightening, let's assume that operating costs increase 4% sequentially excluding the one-time restructuring costs - in line with the past five quarters. This results in operating costs of $1.18B, up from $1.14B (ex one-time costs) last quarter and $985M one year ago.

Putting that back into our second chart, we now have:

Without producing any cars, Tesla is losing ~$1.35B in the third quarter. But onto the interesting bit: the cars.

### Forecasting Vehicle Deliveries

Data points: *(If you have more suggestions, message me)*

- Tesla's past deliveries and other statements in the quarterly updates: Q2/18, Q1/18, Q4/17, Q3/17, Q2/17, Q1/17, Q4/16, Q3/16.
- Inside EVs Monthly Plug-in Sales Scorecard (US-only sales, monthly)
- Bloomberg Tesla Model 3 Tracker (Model 3 production estimates, daily)

Tesla combines the Model S and Model X deliveries information in its quarterly updates, so I will do the same here. In the first half of 2018, Tesla delivered 44,134 Model S/X vehicles, and offered guidance on the second half of the year:

"Model S and Model X deliveries should accelerate in the second half of this year as we have now finished realigning our delivery process. While historically most deliveries were made towards the end of each quarter, our delivery pattern should smooth out in the next two quarters. Our target of delivering 100,000 Model S and Model X vehicles this year remains unchanged." -Q2/18 Update

"We continue to expect Model S and Model X deliveries to be approximately 100,000 in total in 2018, constrained by the total available supply of cells with the 18650 form factor used in those vehicles." -Tesla Q2/18 10-Q

Inside EVs reports that Tesla sold 1,200 Model S vehicles and 1,325 Model X vehicles in the United States in July. Over the first two quarters this year, first-month US sales accounted for ~7% and ~10% of total quarterly deliveries. This is well less than 33% due to the "delivery pattern" Tesla mentioned and due to international sales (which aren't included in Inside EVs' totals).

Based on past ratios of US first-month-sales to total-quarterly-sales, this would imply deliveries of ~29,600 Model S/X vehicles in Q3/18:

(Inside EV Sales) | Q1/18 | 1/18 | % | Q2/18 | 4/18 | % | 7/18 | Q3/18? |

Model S/X | 21,815 | 1,500 | 7% | 22,319 | 2,275 | 10% | 2,525 | 29,586 |

Model 3 | 8,182 | 1,875 | 23% | 18,449 | 3,750 | 20% | 14,250 | 65,907 |

(*Author based on Tesla sales data from company filings and Inside EVs.*)

However, Tesla noted that it expects to see changes in the monthly seasonality - "*our delivery pattern should smooth out in the next two quarters*" - which would imply fewer end-of-quarter deliveries. Meanwhile, Tesla's target of 100,000 Model S/X vehicles would leave ~55,866 vehicles left to deliver in 2H/18 or ~27,933 vehicles in Q3/18.

For the sake of modeling, let's say that Tesla hits its 100,000 vehicle target and **delivers 28,000 Model S/X vehicles** in the third quarter. Tesla skeptics are sure to disagree with this assumption: Tesla has a history of not fulfilling its promises (Bloomberg used to maintain an Elon Musk promise tracker. Suffice to say, most promises were delivered late if at all). So far, though, Tesla's monthly sales imply it can hit this target.

As shown above, the same Inside EVs sales figures and monthly trends would imply sales of ~65,900 Model 3s in Q3/18. They are better than Tesla forecasts:

"Now that we have reached a production rate of 5,000 Model 3 vehicles per week, we are focused on further ramping production, and achieving profitability and continuous cost efficiencies. We expect to- Q2/18 Updateproduce 50,000 to 55,000 Model 3vehicles in Q3, which will represent an increase of 75% to 92% from the prior quarter.Deliveries should outpace production in Q3as our delivery system stabilizes."

Based on data from Bloomberg's Tesla Model 3 Tracker, Tesla is on pace to exceed its Model 3 production estimates. As of August 19, 2018, Tesla has produced ~71,005 Model 3s and is producing at a rate of 5,942/week. Prior to this quarter, the company had produced 41,030 vehicles. Thus, Tesla has already produced ~29,975 Model 3s this quarter. If it continues its current rate of production, it will produce over 65,600 Model 3s in Q3/18.

(Bloomberg Model 3 Tracker) | Model 3s | Per week | Weeks |

June 30, 2018 | 41,030 | 4,197 | 7.1 |

August 19, 2018 | 71,005 | 5,942 | |

September 30, 2018 | 106,657 | 5,942 | 6.0 |

Q3/18 Production: | 65,627 | 4,993 | 13.1 |

(*Author based on Bloomberg Model 3 Tracker*)

If Bloomberg's data is correct and if Tesla can continue its current production rate, the company would exceed its Model 3 production estimate by over 10,000 vehicles. To hit the midpoint of Tesla's guided production range, Tesla would only need to produce ~3,750 Model 3s/week - only ~63% of its current production rate.

Putting the data points together, Tesla's July US sales imply ~65,900 deliveries in Q3. Tesla's production-to-date implies ~65,600 vehicles produced in Q3. Tesla's guidance is that "*Deliveries should outpace production in Q3*," although that statement was made in reference to a target of 50,000 to 55,000 vehicles. For the sake of modeling, let's say that Tesla's delivery patterns smooth out (so it delivers fewer than ~65,900) and **Tesla delivers 60,000 Model 3s** in Q3.

Our model thus looks like this:

### Estimating Vehicle Prices

Data points:

- Tesla's production and deliveries: Q2/18, Q1/18, Q2/17, Q1/17, Q4/16, Q3/16.
- Tesla's past deliveries and automotive revenue in the quarterly updates, especially in Q2/18, Q1/18, Q4/17, Q3/17, Q2/17, Q1/17, Q4/16, Q3/16.
- Inside EVs Monthly Plug-in Sales Scorecard (US-only sales, monthly)
- Bloomberg Tesla Model 3 Tracker (Model 3 production estimates, daily)

Tesla does not release information on the average sales prices of any of its vehicles. Instead, we must piece together data from past quarters.

The last quarter in which Tesla did not deliver any Model 3s was Q2/17, which makes that quarter useful for estimating average prices of Model S/X vehicles.

(Financials in $000) | Q3/16 | Q4/16 | Q1/17 | Q2/17 |

Automobile Revenue | 2,148,727 | 1,994,123 | 2,289,600 | 2,286,616 |

ZEV Credits | 138,541 | 19,840 | 0 | 100,000 |

Model S/X Deliveries | 24,821 | 22,252 | 25,051 | 22,026 |

Model S % | 65% | 57% | 54% | 55% |

Model S/X Price | $80,987 | $88,724 | $91,398 | $99,274 |

(*Author based on company filings*)

Prices rose consistently through this period as Tesla discontinued lower-priced models:

- In October 2016, Tesla made smart air suspension standard on the Model X, upping the retail price of the cheapest model to $76,500.
- In March 2017, it discontinued the Model S 60 and 60 D meaning customers had to buy the 75 kWh models or above.
- In September 2017 (after Q2/17), Tesla discontinued the Model S 75, leaving the $74,500 Model S 75D as the cheapest model.

Note that the Model X is more expensive than the Model S, so changes in the mix between the two can significantly impact average sales prices. In the first half of 2018, the Model X is outselling the Model S: the Model S represents 48% of Model S/X sales (see Q1/18 and Q2/18 production and deliveries).

Because of the Model X sales pulling ahead of the Model S and the discontinuation of the Model S 75 in September 2017, I believe it's appropriate to use a price a bit higher than $99,274 for the Model S/X sales price. Let's use a **Model S/X average sales price of $102,000** for the past two quarters and for Q3/18. Tesla noted that sales prices of the Model S/X were ~constant in 1H/18:

"Gross margin of Model S and Model X improved sequentially in spite of changes in FX rates. WhileQ2/18 Updateaverage selling price of Model S and Model X remained flat sequentially, we achieved significant efficiencies in material cost and other manufacturing costs." -

At this price, this would infer that the average price of the Model 3 in 1H/18 is ~$57,900:

(Financials in $000) | Q1/18 | Q2/18 | 1H/18 |

Automobile Revenue | 2,735,317 | 3,357,681 | 6,092,998 |

ZEV Credits | 50,314 | 0 | 50,314 |

Model S/X Deliveries | 21,815 | 22,319 | 44,134 |

Model S/X ASP | $102,000 | $102,000 | $102,000 |

Model S/X Revenue | 2,225,130 | 2,276,538 | 4,501,668 |

Model 3 Revenue | 459,873 | 1,081,143 | 1,541,016 |

Model 3 Deliveries | 8,180 | 18,440 | 26,620 |

Model 3 ASP | $56,219 | $58,630 | $57,889 |

(*Author's estimates based on data company filings*)

Given that this price appears reasonable, let's use a **Model 3 average sales price of $58,000**. These prices will increase when Tesla begins delivering Model 3 Performance and All-Wheel-Drive models: The AWD upgrade will cost $5,000 and the performance model will cost $78,000.

With sales of 60,000 Model 3s and 28,000 Model S/Xs at prices of $58,000 and $102,000 respectively, Tesla will generate ~$6.3B in automotive revenue and $7.0B in total revenue - up 74% q/q and 134% y/y.

### Predicting Gross Margins

Now for one last step: gross margins. I expect this to be the most controversial step in the process, for the Model 3, as there is very little to go on except past margins (3% and under) and Tesla's guidance:

"Model 3 gross margin should grow significantly to- Q2/18 Updateapproximately 15% in Q3and to approximately 20% in Q4 predominantly due to continued reduction in manufacturing costs and to some extent an improving mix. Average selling price will remain high for several quarters as we expect a richer mix in the initial wave of Model 3 deliveries to Europe and APAC. We believe future Model 3 cost savings will more than offset the normalization of the Model 3 average selling price in the second half of 2019, resulting in improving gross margins and stable gross profit per vehicle."

Before wading into the quagmire of Model 3 gross margin arguments, let's estimate gross margins for the Model S/X vehicles which will still represent ~44% of Tesla's automobile revenue.

In the year prior to the introduction of the Model 3, Tesla's automotive gross margins averaged 27.7% with the most recent quarter having 29.2% gross margins excluding the impact of ZEV credits:

(Financials in $000) | Q3/16 | Q4/16 | Q1/17 | Q2/17 | Total |

Automobile Revenue | 2,148,727 | 1,994,123 | 2,289,600 | 2,286,616 | 8,719,066 |

Auto Cost of Revenue | 1,517,061 | 1,544,422 | 1,662,675 | 1,648,011 | 6,372,169 |

ZEV Credits | 138,541 | 19,840 | 0 | 100,000 | 258,381 |

Auto GM % ex-ZEV | 31.4% | 22.8% | 27.4% | 29.2% | 27.7% |

(*Based on data company filings*)

It is possible to determine Model S/X gross margins in Q2/18 as well, using our previous estimates of average sales prices for Q2/18 and using some guesses about Model 3 gross margins:

"Model 3 gross margin turnedslightly positive in Q2even though we were still ramping production and did not yet deliver any All-Wheel-Drive or performance models." - Q2/18 Update

"And then, more importantly, it looks like you're calling for Model 3 gross margins to go from about maybe 3% this quarter to 15% next quarter."Antonio M. Sacconaghi, Sr. Analyst at Bernstein, Q2/18 CC

Based on price points of $102,000 for the Model S/X, $58,600 for the Model 3, and ~3% gross margins on the Model 3, this would imply gross margins on Model S/X vehicles were ~28.9%.

(Financials in $000) | Q2/18 |

Auto Revenue ex-ZEV | 3,357,681 |

Auto Gross Profit ex-ZEV | 691,027 |

Est. Model 3 Revenue (18,440 @ $58,630) | 1,081,143 |

Est. Model 3 Gross Margin % | 3% |

Est. Model S/X Revenue (22,319 @ $102,000) | 2,276,538 |

Implied Model S/X Q2/18 Gross Margin % | 28.9% |

(*Based on data company filings and Bernstein 3% GM% estimate)*

This falls within the range of gross margins from Q3/16 to Q2/17, so appears to be a reasonable gross margin to me. Thus, let's use a **28.9% gross margin** for the Model S and X vehicles for Q3/18.

### Model 3 Gross Margins

Based on everything above, Tesla would need to make a gross profit of $510M on $3.5B of Model 3 sales to make a profit in Q3/18 (excluding tax and ZEV credit sales).

A gross profit of $510M on $3.5B in sales requires gross margins of 14.5% or higher. Excluding the impact of ZEV and income tax, Tesla would be break-even at 14.7% gross margins, and each 1% gross margin move (in either direction) would add or remove $35M in profit.

"Model 3 gross margin should grow significantly to approximately 15% in Q3 and to approximately 20% in Q4 predominantly due to continued reduction in manufacturing costs and to some extent an improving mix." - Q2/18 Update

Last quarter, Model 3 gross margins were "slightly positive," perhaps at ~3%. Some observers are doubtful that Tesla can achieve 15% gross margins on the Model 3 in Q3/18:

"Last quarter the Model 3 recorded gross margins of around 3 per cent. Before non-cash items, this number was negative, according to the second quarter's press release. So it's hard to justify keying in 15 per cent gross margins for the Model 3 this quarter, particularly as 19 per cent of the deliveries in our model happened at the end of June.

But we are a generous bunch here at Alphaville. So we're going to tentatively wave our flag in the air with anFinancial Times Alphaville11 per cent gross margin. -

"I think Tesla can achieve 15% GM on the Model 3 once they reach 5,000/week sustained production. However, they're starting the quarter with more than 11,000 cars built at Q2 margins. I think a GM ofCoverDrive in "12.5% is reasonable."For Tesla, Time Has Come Today"

As for me, I'll just wave my hand and defer to Tesla's guidance of ~15% gross margins in Q3/18. Using that 15% figure, we end up with:

### Loose Ends (ZEV Credits and Tax)

There are two loose ends remaining: ZEV credits and income tax.

Income taxes will be minimal, due to minimal profits and years of offsetting losses. Over the past four quarters, Tesla has paid a net of $9.9M in income tax (with two of those quarters having negative tax). For the sake of simplicity, I'll assume taxes will just be the average of the last four quarters, or $2.5M in tax paid.

In the last 10 quarters, Tesla has made $546M selling ZEV credits, or $54.6M/quarter. Significantly, Tesla did not sell any of these credits last quarter - it will have more credits to sell this quarter if the company needs to bolster its revenue and profits. Let's assume that Tesla can match its average revenue from ZEV credits and generate $54.6M selling these credits (These credits are included in automobile revenue on Tesla's income statement).

### The Finished Product

Putting everything together, we end up with this:

(*Note that this includes ZEV below operating income while they're actually included in automotive revenue on Tesla's income statement*).

Tesla's income statement, meanwhile, might look a bit like this:

### Discussion

The biggest question marks in this analysis will be Tesla's Model S, X, and 3 deliveries in the third quarter and Tesla's margins on the Model 3. Each of those estimates is quite speculative. Model S/X sales could be much lower than my 28,000 vehicle estimate. Model 3 sales could fall within a wide range. The same can be said for Model 3 margins or even average sales prices.

Varying any of those data points can have a big impact on Tesla's bottom line, especially when profit margins are so razor-thin - Tesla has a net margin of 0.91% in this model. Every percentage point of change in Tesla's Model 3 margins causes $35M in change to its bottom line: If Tesla's Model 3 gross margins are below 13.2%, the company will not be profitable in this model.

With that said, it is possible that Tesla makes a profit in the third quarter, according to this model.

For other perspectives on what Tesla's third quarter might look like, I encourage readers to read the works of CoverDrive such as "*For Tesla, Time Has Come Today*" and the model at FT Alphaville. Both authors present entirely plausible models which call for Q3/18 losses of $236M and $209M, respectively.

I welcome reader comments in the comment section below, especially constructive feedback related to this modeling.

Happy investing!

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**Disclosure:** I am/we are long 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.