When Tesla (TSLA) reported its “pie-in-the-face” Q3 earnings report, the market responded with all the jubilance one would expect from a big beat. But soon after, the excitement began to ebb as analysts dug deeper into the financials, especially once the actual 10-Q was filed with the SEC.
Despite the forensic analysis of Tesla’s earnings report and quarterly filing, one mystery has persisted: a strange spike in Accounts Receivable.
Several theories have been mooted to explain the phenomenon, but a recent statement by Tesla may have finally answered the question. In examining the mystery of the Q3 Accounts Receivable, we find yet another effort by Tesla to bolster its apparent financial strength that is unsustainable, and arguably a bit shady.
A Gimmicky Quarter
We will not be diving into the many other issues with Tesla’s latest financial disclosures that have been dredged up by the eagle-eyed analysts. The important thing to understand is that the Accounts Receivable mystery is one part of a broader analysis of Tesla’s “pie-in-the-face” quarter. Fundamentally, the whole quarter was engineered to create the illusion of a profit, as has been addressed in detail by a number of authors, including a few on Seeking Alpha.
As Anton Wahlman discussed, a number of one-off gimmicks may have turned a real loss into a paper profit:
Let’s add it up: From $312 million profit to…
Tesla reported a $312 million profit for Q3 2018 on October 24. Now, thanks to the 10-Q filed on November 1, we find out that:
1. Not only $52 million in ZEV credits, but an additional $137 million, came from non-ZEV credits. That’s a total of $189 million.
2. At a minimum, $115 million (but could be a lot more!) of Tesla’s accounts receivable comes from a single entity. Until we know exactly how much, and what the nature of this accounting entry represented, we can’t say for sure, but it seems like it could be a highly engineered goosing of the health of the income statement and balance sheet alike.
Adding up $189 million ($137 million of which was non-ZEV credits not reported until the 10-Q) and anywhere from $115 million and up, you can see that it all adds up to something that could very meaningfully reduce the $312 million reported profit from the perspective of “ongoing operations” as opposed to a couple of accounting gimmicks. From this perspective, did Tesla really make a profit at all in Q3?
While Wahlman offers a good backward-looking explanation of chicanery, jaberwock provides a solid primer on why Q3 margins were unsustainably high, and why this means profit deterioration going forward:
Tesla has taken a calculated risk by overloading the delivery and service centers and cutting back on service in Q3. As the North American orders backlog is depleted and overseas deliveries start, those delivery centers will revert to a more normal workload. The problems should decrease but the North American component of the SG&A costs will be spread over a smaller number of cars. However, the European delivery and service network will have to be ramped up to accommodate sales of the Model 3, so it is reasonable to expect overall SG&A costs to increase significantly in Q1 and Q2 of 2019.
I expect US sales to take a big hit from the phase out of the FIT credit, so we could see as much as 80% of Model 3 sales going for export in Q1. Deliveries will lag production because of the extra transit time required for export. “In transit” Model 3s during Q1 could be as high as 30,000 (20,000 higher than the end of Q3). That is equivalent to a $1+ billion drop in revenue in Q1.
With all these gimmicks and one-off moves in place, it is thus unsurprising that a spike in Accounts Receivable, a big deviation from previous patterns, would also deserve a deeper explanation.
The Accounts Receivable Mystery
This brings us to our part of the strange tale of Tesla’s Q3 earnings. Accounts Receivable shot up to a whopping $1.16 billion, up from $569.87 million the previous quarter.
That huge move demanded explanation, and Tesla CFO Deepak Ahuja tried to offer one on the earnings call:
Yeah, we reduced our inventory in Q3, which helped. And then, although we had higher payables because - sorry, higher receivables, because the quarter end, the weekend, we won't have that in Q4, so all of this should continue to help us in Q4 and beyond, the working capital again.
So we are meant to believe that this stratospheric rise in receivables was simply the product of the quarter ending on a weekend. Given the sheer scale of the Accounts Receivable figure, that does not pass the smell test for starters. And if we dig a little deeper, we can see that there have been no similar spikes in prior quarters that ended on weekends. So we can conclude with a fair amount of confidence on that information alone that there must be more to the story than Deepak or CEO Elon Musk were willing to say.
The plot thickened further once the 10-Q was finally filed. Tesla made a revealing disclosure in the filing, adding a new entry on Credit Risk:
Financial instruments that potentially subject us to a concentration of credit risk consist of cash, cash equivalents, restricted cash, accounts receivable and interest rate swaps. Our cash balances are primarily invested in money market funds or on deposit at high credit quality financial institutions in the U.S. These deposits are typically in excess of insured limits. As of September 30, 2018, one entity represented 10% or more of our total accounts receivable balance. As of December 31, 2017, no entity represented 10% of our total accounts receivable balance. The risk of concentration for our interest rate swaps is mitigated by transacting with several highly-rated multinational banks.
So it turns out it was not merely a matter of the quarter ending on a weekend at all. Instead, it was the result in substantial part of a single entity responsible for more than 10% of those receivables that materialized on the balance sheet seemingly out of nowhere. A November 2nd article in the LA Times highlighted the mystery quite well:
Analysts scratched their heads when they saw the increase in Tesla’s accounts receivable, which is money owed to the company. That balance sheet line nearly doubled, to $1.1 billion. Receivables go up with increased production. And on the Oct. 24 conference call with stock analysts, Chief Financial Officer Deepak Ahuja explained the quarter ended on a weekend, so many car payments were delayed. But a note in the 10-Q report put forth another reason: “One entity represented 10% or more of our total accounts receivable.”
Who the entity is and how much more than 10% of the total it represents was left unstated. Earlier this year Tesla had asked suppliers for discounts and rebates. Could a major supplier such as battery-cell maker Panasonic be the 10% entity? Or some other supplier or customer?
The 10-Q, which many hoped would resolve the Accounts Receivable mystery, only served to stoke further head scratching.
Solving the Mystery
A flurry of theories have been bandied about since the 10-Q was filed to explain the Accounts Receivable spike and what entity could be responsible for 10% or more of the total. The top two making the rounds were that they represented either retroactive supplier rebates or a big fleet sale to a rental car company. Both theories have played out on Twitter and elsewhere, but in the absence of facts and Tesla keeping mum, it has been hard to come to any solid conclusion.
The LA Times was able to offer a bit more clarity. An updated version of the previously cited article cites a statement from Tesla in response to queries on the mystery:
On Saturday, Nov. 3, a Tesla spokesman told The Times that a large receivable from one of its partner banks for loans issued to US customers is the 10% entity noted in the 10-Q, and almost all of this receivable was cleared in the first few days of Q4.
So what does this mean? Well, Twitter’s HeadbutterBot actually offers a fairly concise account of things. In essence, if Tesla’s statement is true, then the 10% institution must be a lease partner to which Tesla is providing residual value guarantees on leased vehicles. That would mean that the Accounts Receivable spike is the result of Tesla receiving returned Model S and Model X leased vehicles. The implications of this are spelled out quite clearly:
We now know what drove the spike in AR, but we can also infer why finished goods did NOT go down despite selling far more cars than produced in the quarter. Tesla INCLUDES used vehicles in finished goods. Boom! They are now sitting on a bigger pile of used Model S and X.
The bank either took the cars to sell on their own, or more likely, stuck Tesla with the cars. Either way, once the decision is made, the AR would be "settled". If Tesla gets stuck with the cars, we'd never know and losses on those sales likely get booked in Services segment.
Why did Tesla choose to book these sales in 3Q?? It seems that the accounts were not settled, cash had not been delivered (may never be actually); wouldn't it make more sense to wait for 4Q? But shorts must be punished, so into 3Q it goes....
We find this explanation rather compelling for a number of reasons. First, it explains the mystery of the Accounts Receivable spike, as well as how it could be resolved quickly in the beginning of Q4 as Tesla claims has occurred. It also fits with the short-sighted behavior on the part of Tesla management in a desperate effort to pad out its cash position and show a profit, i.e., if Tesla waited until Q4 to address this, it would not have been able to bring in the cash piece of the transaction from customers turning in their leased vehicles. Finally, it also deals with the issue of how finished goods value could rise even as inventory dropped. Other explanations such as a fleet sale would not be so easy to square with that last fact.
Investor’s Eye View
All of this matters for two reasons. First, it is yet another indication of a totally unsustainable financial model in which juicing Q3 was the only priority, even at the expense of future performance. Second, it shows the continued willingness of Tesla to rely on half-truths and misdirection to evade showing its true financial health.
All things considered, it seems impossible that Tesla could pull off a similar quarter in future. It has engineered a profitable quarter once before. The hangover the next quarter was very painful. It could be even worse this time, given the sheer scale of the effort to create an artificially positive Q3.
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.