Tesla, Inc.

Q3 2018 Earnings Conference Call

10/24/2018

spk11: Good day, ladies and gentlemen, and welcome to the TESLA Q3 2018 Financial Results and Q&A Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Martin Vieca. Senior Director of Investor Relations. Mr. Rieke, you may begin.
spk04: Thank you, Sherry, and good afternoon, everyone. Welcome to Tesla's third quarter 2018 Q&A webcast. I'm joined today by Elon Musk, J.B. Straubel, Deepak Ahuja, and a number of other executives. Our Q3 results were announced at about 1 p.m. Pacific time in the update letter we published at the same link as this webcast. During this call, we will discuss our business outlook and make forward-looking statements. These comments are based on our predictions and expectations as of today. Actual events or results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent filings with the SEC. During the question and answer portions of today's call, please limit yourself to one question and one follow-up. Please press star 1 now if you would like to join the question queue. But before we jump into Q&A, Elon has some opening remarks. Elon?
spk02: Thanks, Martin. So I'll make some opening remarks, and then we're going to talk about vehicle safety, autopilot, and factory safety. And we have a number of people from Tesla here to elaborate on that. So I think there's just a lot going on that people would find interesting. But I want to start by thanking all of our customers, employees, and shareholders. This was an incredibly historic quarter for Tesla. Model 3 production stabilized. We delivered a total of 84,000 vehicles globally, which is more than 80% of the vehicles that we delivered in all of 2017. In fact, we delivered more cars in this quarter than we did in all of 2016 in a single quarter. Model 3 became the best-selling car in the US in terms of revenue and the fifth best-selling car in terms of volume. We saw higher revenues and significantly better profitability in our energy business. In fact, I think for solar, it may have been the best quarter ever for solar. We achieved GAAP net income of over $300 million, increased cash and equivalents by $731 million, and achieved a greater than 20% gross margin for Model 3. Moreover, we expect to again have a positive net income and cash flow in Q4, and I believe our aspiration certainly will be for all courses going forward. I think we can actually be positive cash flow and profitable for all quarters going forward, leaving aside quarters where we may need to do a significant repayment, for example, in Q1 next year. But I think even in Q1, I think we can be approximately flat in cash flow by end of quarter. This quarter was made possible by the incredible execution of our employees across the board from sales, production, delivery, service, energy, engineering, finance, and all of our G&A teams. really every part of the business executed incredibly well. I want to thank everyone again for the incredibly hard work. I especially want to thank customers who helped. It's like I've never even heard of this. Maybe this has happened before, but I've never heard of a case where a company's customers actually cared about the future of the company so much that they volunteered their time to help a company succeed. I think that's... That's amazing. Just don't see that anywhere. So, yeah, it really chokes me up, actually. This quarter, we started rolling out version 9 of our software, which is our biggest software upgrade in two years, and Model 3 received a five-star safety rating in every category and subcategory. It got the lowest probability of injury of any car that the U.S. government has ever tested. Looking ahead, we expect to produce and sell even more Model 3s in Q4 and expect that trend to continue into Q1. And we're excited to bring Model 3 to Europe and China early next year, given that the market for midsize premium sedans in those regions is even larger than in North America. I've said before that we must prove that Tesla can be sustainably profitable. This quarter was an important step towards that, and I'm incredibly excited about what lies ahead. So this is, yeah, just so proud of the Tesla team, our customers, really appreciate the support of our long-term shareholders. And yeah, I just want to say on behalf of the Tesla team, we're just super appreciative of your support through what has obviously been a very difficult time. All right, now let's move to, let's start off with vehicle safety. Madan, who's a lead vehicle safety engineer. Been with the company for a long time. I don't know how many years has it been that we've been working together.
spk18: Ten years.
spk02: Ten years. Wow. So, yeah, I've been working with Madan for ten years. We've had so many conversations on vehicle safety. Wow. And, you know what, we're really going to try to go the extra way extra mile with vehicle safety. There's a series of government-mandated tests, but what some companies do is they game the system. They know where the side pole impact is going to be. They strengthen it right in that position. At Tesla, we're like, okay, what is the weakest point in the car? Let us test it at that position. The actual safety is not fully captured in the tests because we anti-game the system.
spk18: Thank you, Ila. Just want to give you a very quick background about myself. Like I said, joined Tesla 10 years. I'm extremely very happy to mention I'm working with an extraordinary set of very passionate and very hardworking individuals. And that essentially shows in our product. So that's very important for us. And also important is our principal mission statement on safety. Because what we want to do is safety has been probably the important factor for our vehicle. It's not just for electric vehicle, any vehicle period. And that fundamentally differentiates us. So which essentially helps us to keep adding new features and new safety technology. And that's very important and that shows in Model 3, the latest two things that we have. Also, the fact that we have an electric vehicle The design and architecture gives us a fundamental benefit over traditional vehicles. And that takes care of, for example, whether you have a block of engine in the front, where we can work with using a pretty much open architecture in the front. And the whole fact that you have all the electrical and high voltage and motors and all of that, almost below the center gravity of the vehicle, you say lowest probability of reduced all over risk. And that significantly benefits.
spk02: I think architecturally, we have Newton on our side. And having Isaac Newton on your side is definitely the way to go.
spk18: Exactly. So in the latest series of tests, I would like to specifically talk about Model 3. NHTSA did a series of tests, actually four tests for one frontal, two sides, and one rollover test. And if you look at, we have been calculating how can we distinguish Within the five-star, there are so many vehicles that already get five-star. And if you look at within the five-star, there is something. So it's not all the same. Yeah, exactly. So if you look at there, there is a matrix we came up with, which is a part of USN cap rating itself as the lowest probability of injury. And Model 3 has the lowest. And just to give you a context, there are a total of 900-plus vehicles since 2011 which have been rated. So the fact that Model 3 is the best among all the 943 to be exact. So that speaks the volume. And I'm very happy to say that Model 3 has achieved. We are not stopping right now. What we would like to do next is how we can make use of the active safety and autopilot features and make it even more improvement. So the next area that we're focusing on, how to integrate active and passive safety. That's our next area of challenge, which we will improve for sure.
spk02: Yeah, it's worth noting that the safety extends to not just people in the car, but also pedestrians. Yeah, so not having a big engine block in front of the car is really helpful because if the car were to hit a pedestrian, we'll get to active safety next because the best thing is obviously not to hit a car or pedestrian. The fact that the hood can condense so far in is really helpful because it ends up being sort of like a trampoline. You don't have a rock underneath it. It's very helpful. So it's helpful for pedestrian safety and for the safety of people in the car. Even if you have like a head-on collision with another car, the extended sort of crumple zone of a Tesla Model SX03 is helpful to the people in the Tesla and the people in the other car.
spk18: So it's not just the people in the car. I'd like to add one item, which is essentially how we look at the real world safety, which has always been an important element for Elon. So if you look at our blog post, we showed how we handle the center pole impact in the front end. By the way, that's not part of N-CAP rating. This is just to show how we go over and above the N-CAP rating to make sure it's real world safety. Yes. That's very important for us.
spk02: Exactly. That's what I mean by like anti-gamma system. What is the worst way that the car could be hit? Not just sort of strengthen where we know the test will happen and that kind of thing. Obviously, we're all in these cars. Our friends are in these cars, families in the cars, so we care a great deal about safety. A lot of people think safety is boring, but not at Tesla. So thanks, Milan. Thank you for your decade of hard work and the rest of the Tesla safety team. And with that, let's move on to autopilot. And if you guys could just give an update on autopilot software, AI, and hardware.
spk08: Yeah. That's great. This is Stuart Bowers. We'll soon begin to roll out the team's most advanced autopilot feature ever, Navigate on Autopilot. In our last release, we launched a new set of neural networks that combined together provide a view of everything happening around the car. With Navigate on Autopilot, we'll use information to understand exactly where the car is on the highway system and to automatically change lanes, handle forks, and take high curvature exits to follow a nav route. Initially, it will require drivers to confirm lane changes using the turn signal before the car moves into an adjacent lane. Future versions will allow customers to waive the confirmation requirement if they choose to. One area that I'm personally really excited to build on this improvement is active safety. With the advancement in neural networks covering 360 degrees of view around our car, we can provide a level of constant vigilance that humans just can't. Ultimately, this should allow us to warn and even intervene for an enormous percentage of modern accidents and to ship these improvements as software upgrades to our existing customers.
spk02: We see this all the time in the data where the car will do an automatic braking event and save a pedestrian or another car from the impact. This happens all the time. All the time. Yeah, all the time. Simply every day. It's pretty crazy.
spk08: Yeah, the team has done incredible work here, and by bringing up more of the cameras around the car, we can detect things as they come toward us, not just directly in front of us. Yeah.
spk06: Pete? Hi, this is Pete Bannon. The hardware 3 design is continuing to move along. Over the last quarter, we've Completed qualification of the silicon, qualification of the board. We started the manufacturing line and qualification of the manufacturing line. We've been validating the provisioning flows in the factory. We've built test versions of Model S, X, and 3 in the factory to validate all the fit and finish of the parts and all the provisioning flows. So we still have a lot of work to do, and the team's doing a great job, and we're still on track to have it ready to go by the end of Q1.
spk02: Great. And that'll be roughly a 1,000% increase in processing capability compared to the current hardware. And so it's obviously a giant improvement despite being about the cost about the same. Cost volume and power consumption are approximately the same as the current hardware, but it's a tenfold improvement in frames per second. That's right. Yeah. and improve redundancy as well. But very importantly, we're going to emphasize is that the only thing that needs to change between a car that's produced today and a car that's been produced in the second quarter of next year is swapping out the water pilot computer. And this is a simple change that takes less than half an hour in service to upgrade the computer. And so anyone will be able to upgrade their computer to full self-driving capability or upgrade their car to full self-driving capability with a simple service visit. So we expect all cars with the hardware 2 sensor suite, basically anything made in the last roughly two years, will be upgradable to full self-driving.
spk06: Yep. In fact, a lot of the cars we're using for testing today have, in fact, been upgraded from hardware 2.
spk02: Right. So it's very important to emphasize that people shouldn't We're slightly concerned that people would want to wait until that comes out, but there's no need to wait until that comes out because it's just a very simple plug-and-play change to get to the full self-driving. And anyone who's paid for the full self-driving option will just get it done for free. And anyone who still wants to order full self-driving at this point, it's just an off-menu item. You can still order it, but we... We took it off the order of menu just because it was really creating a lot of friction in the sales process, and people didn't understand the difference between enhanced autopilot and full self-driving. So just to simplify the order process, we took that off. But anyone who asks for it can certainly get it, and it really ends up being a discount on future capability. But to be clear, there's definitely no need to wait until Q2 to order a car. We want to make it just a completely seamless process. So there's no advantage to ordering now versus Q2. Andre, do you want to?
spk07: Yes, OK. Hi, everyone. My name is Andre Karpathy. I'm the director of AI here at Tesla. And my team trains all the neural networks that analyze the images streaming in from all the cameras for the autopilot. For example, these neural networks identify cars, lane lines, traffic signs, and so on. The team is incredibly excited about the upcoming upgrade for the autopilot computer, which Pete briefly talked about. This upgrade allows us to not just run the current neural networks faster, but more importantly, it will allow us to deploy much larger, computationally more expensive networks to the fleet. The reason this is important is that it is a common finding in the industry, and we see this as well, is that as you make the networks bigger by adding more neurons, the accuracy of all their predictions increases with the added capacity. So in other words, we are currently at a place where we've trained large neural networks that work very well, but we are not able to deploy them to the fleet due to computational constraints. So all of this will change with the next iteration of the hardware, and it's a massive step improvement in the compute capability, and the team is incredibly excited to get these networks out there. Great, thank you.
spk02: And I've said this before, but I think, let's talk a bit about the kind of long-term future. We absolutely see the future as kind of as, sort of a shared electric autonomy so that you'll be able to do ride hailing or share your car in any way. You know, sort of a long-term model that's probably some combination of like Uber, Lyft, and Airbnb. There'll be Tesla-dedicated cars for ride hailing, and any customer will be able to share their car at will, just like you'd share your house in an Airbnb. So it's a combination of those two models I think is pretty obviously where things are headed long term. The advantage that Tesla will have is that we'll have millions of cars in the field with full autonomy capability, and no one else will have that. So I think that will end up putting us in the strongest competitive position long term. And then, Lori, can you finish off with a talk about factory safety? And thank you for the hard work of you and your team. I think we've made great strides. Yeah, please go ahead.
spk10: Yeah, thanks. We have the safest cars made by the safest people. So it's an exciting time here at Tesla. All car and manufacturing factories have injuries. At Tesla, we have a commitment to zero injuries, and our target is actually on good reporting. So we have good reporting of injuries, good reporting of near misses, good observations, and lots of improvements. to be the safest company in the world, we have to be committed to that, and everybody here is. So we're actually steadily getting there, and we're not gonna stop till we're there.
spk02: Absolutely. Yeah, so you were mentioning, for example, we have had some, for example, we do get these quite unfair accusations, for example, one of them was that we were under-reporting injuries, and it's worth noting that OSHA completed our investigation and concluded that we had not been doing anything of the sort.
spk10: Correct, correct. The factory here had a four-month-long CalOSHA investigation, and it basically proved that we are recording properly and doing as we should be. So it's much different than what you would read about in the press.
spk02: Yeah, those are true.
spk10: Yeah, yeah, I'm very proud of the team for that. Now, one point I think people don't know is I've been here about a year now. Time flies when you're having so much fun.
spk02: It's like 12 years.
spk10: I know. But when I joined, we were already really a fraction. Our injury rate was a fraction of what it had been when Toyota and GM ran the factory in the new me days. So what we're all about is really continuing to make improvements from there. And, you know, what's also important is, not to have serious injuries. And that's extremely rare here at Tesla. We have really strong focus on prevention and also using mitigating controls so that these types of injuries don't occur. I mean, most of the injuries that we have are muscular sprains and things like that.
spk02: Yes, essentially it's a muscle strain and getting scratched.
spk10: Exactly.
spk02: That's most injuries, yeah.
spk10: Hand and finger cuts. and sprains. So I kind of just want to break down a few things that, you know, my team has been working on along with all the leaders here. You know, first it's people and engagement. So one of the first things is, you know, meeting with you, Elon. We meet with you on a regular basis. We meet with all the production leaders. So it's full-on engagement on improving safety. We have built a really strong EHS team, the best and the brightest. And our EHS team is actually embedded into the line on the factory because we learn to process and we learn to people. You don't know how to improve unless you're out there on the line, on the process, engaging with the associates, listening and learning from our associates. So we have really strong engagement, health and safety committees. We do find it, fix it walks. Our leaders are out there walking and also looking for improvements. And actually just this quarter, we had over 15,000 improvements. I mean, that's like amazing. So very, very exciting about that. We also look at risk reduction and in human performance. You know, people are gonna make mistakes, so we're gonna design in so we fail safely. We have an early symptom intervention program. This is where we have industrial athletes go out on the line and work with our associates before anything happens. Like if you have a pain, You know, let's work it out. Let's strengthen and really get our employees fit. So we're doing that. We've also just opened a new and improved health clinic. So when injuries do occur, we get the absolute best care for our associates. And it's actually overseen by one of California's leading orthopedic surgeons. And we did that because most of our injuries, like we said, like 80%, 85% are those sprains and strains. So now they get that best care here on site. And we have 24-7 care. It's actually staffed by three full-time doctors and nurses. And I'm really super happy with the care they're giving, and I think the employees are as well.
spk02: And the third... We're going to expand on that.
spk10: Yes.
spk02: So, yeah, the Tesla sort of health clinic, both at Fremont and at Giga, is that we have a really immediate... first-class health care available right on the spot when people need it. And this is not just for workplace. This is for workplace and non-workplace.
spk10: I know. That's super exciting.
spk02: Yeah. If you become injured or ill for any reason, then there's health care immediately on site.
spk10: That's where we plan to go. Exactly. And then finally, just being proactive, because that's what we're about, innovation and proactive. I mean, we've joined national safety organizations We partner with many leading universities, including California Berkeley Center for Occupational and Environmental Health. We do presentations there. We work with the automotive industry and do benchmarking all the time. We're always looking and bringing people in to look for things that we can do better and for new technology and innovations in safety. And with all of that, you know, we have made improvements in our injury rates. We are more than 10% better year over year in our lost work days and our days away. But the most important thing is we're also getting all those good engagement observations. They're moving up. So injuries down, observations, engagement up.
spk02: All right. Awesome. Thanks, Laura.
spk10: Thank you.
spk02: Thanks, Laura. And we'll provide regular updates on workplace safety and information Our goal is unequivocally to have the safest factories in the world where people look forward to coming to work in the morning. So it's like, yeah, that's our goal. All right. With that, we can move to questions.
spk04: Cool. Well, thank you very much. Cherie, let's go to the first question, please.
spk11: Thank you. Our first question comes from Dan Galvis with Wolf Research.
spk14: Hey, thanks for taking my questions. Congratulations on the quarter. It's really amazing to see this landmark quarter after covering the company for so long. And thanks for bringing some of your team onto the call. It's very interesting. My question is about cell supply. There's been some noise about tight cell supply and sparks and tight labor supply. In the short term, could you just talk about whether demand is outpacing supply of battery cells and kind of what's your plan for long-term expansion, including cell supply in China?
spk05: JB, do you want to? Sure, I can speak to that. This is JB. We have had a period where the supply was fairly tight for Model 3, but it did not really constrain the Model 3 production in any significant way. Well, like for a week. Yeah, maybe for a few days. Yeah. You know, the impact was larger felt on the energy products. Yeah. And, you know, that still is somewhat tight. But we do, as we pointed out in previous, you know, discussions, we do have third-party supplies of energy cells. So that production, you know, can continue even independently of the Panasonic supply in SPARCs. So that's been very helpful. And that is expanding in future quarters. And also the Panasonic supply is expanding. The productivity of existing lines is continuing to improve with a lot of hard work from the engineering teams and just operational stability. And we continue to bring online new production lines. So even just in the last several weeks, we've started up yet another cell production line with Panasonic. And through the end of the year, there's another line coming on and then one shortly after that. So there's a steady increase in the total supply that should keep us ahead of even Model 3 growth and also should let us have a larger percentage of energy supply be sourced from Giga locally.
spk02: Yeah, we are making a pretty nutty amount of the world's lithium-ion batteries. And Martin, I think we're, what, 60% or something?
spk04: Yeah, so at the moment, if you look at, for example, for Q3, all electric vehicles made around the world, their total battery capacity was about... 20 or 19 gigawatt hours, and what we produced in Q3 was about the same or a little bit higher. Okay. So about half of the world's batteries, basically.
spk02: Well, is that because we also source cells from Japan and elsewhere. Is that you talking about just a gigawatt or?
spk04: So, yeah. So just a gigawatt itself is about 20, and on top of that, that's an excess, I don't know, another four or five. Yeah.
spk14: Got it. Now it's a huge advantage. Is there plans that you can talk about for self-supply in China? Will that be produced in China? I'm assuming so.
spk02: Long-term, it will be produced in China. Short-term, we're not certain of the short-term situation, but long-term, certainly.
spk14: Got it. Okay. Thanks very much.
spk04: Thank you. Let's go to the next question, please.
spk11: Thank you. Our next question comes from Pierre Ferragu with New Street Research.
spk03: Hey, thank you for taking my question. I was very surprised in the numbers you reported today by your gross margin performance on the Model 3. So if I remember correctly, you were expecting more of a 15% type of margin for this quarter, and you actually did better than 20%. Can you take us through what improved faster and better than you had initially anticipated in the manufacturing line and where these improvements came from?
spk19: Deepak here and Jerome and others, please feel free to join. Our improvements on the cost side were in every aspect of cost. Clearly, our manufacturing Labor hours improved significantly. Our overall manufacturing costs dropped almost 30% sequentially, Q2 to Q3. We produced more volume, so we had better fixed cost absorption. We had far less crap. Our yield on each of the lines across both factories improved significantly. And as we look forward, we see even more opportunities. We are going through this phase where we are now stabilizing production and the team can now intensely focus on cost optimization. And that trend will just continue in Q4.
spk02: Yeah, I think we're also being relatively on the conservative side when we predicted. We said like 15, so we're being... Right.
spk19: Our expectation was we would do better, but we wanted to be conservative. You're right. In terms of our guidance that we gave for Q3. Yeah.
spk03: Okay, thanks. That's great. And then on... As a quick follow-up, you've announced over the weekend a mid-range car with a smaller battery pack. I was wondering, as you're looking at expanding production of the Model 3, I think about it as you had two options. One was to go abroad and to keep producing higher-end, higher-ASP cars, and the other one was to go for a lower-cost car and stick to the US. How did you decide the sequencing of these two things? Why is a lower car now and going abroad early next year?
spk02: Well, we're trying to provide the most affordable electric car options that we can. And since we just don't have the ability to get to the $35,000 car right away, we thought this might be a way to offer it as an intermediate step. And that's really it. You know, we expect to start producing a significant volume for Europe in January, and obviously it takes some time to ship, so deliveries, you know, probably pretty significant deliveries in Europe, kind of in the late February, March timeframe, because cars have to get away from California to a customer in Europe. And, you know, for us, a CARS only counts as delivered if it reaches the end customer and all the paperwork is completed correctly. So it's the highest possible standard for considering a sale at sale. Yeah.
spk19: And also to APAC, you start delivering CARS.
spk02: Yeah. We may or may not deliver CARS in APAC use. in Q1, but certainly in Q2. It'll be kind of borderline as to whether a car is delivered in APAC by the end of Q1. So I can't say for certain. But definitely in Europe, and then definitely in APAC in Q2.
spk04: Okay, let's go to the next question, please.
spk11: Thank you. Our next question comes from Romit Shah with Nomura Instant.
spk00: Yes, thank you. I guess just along those lines, you indicated that you're going to bring Model 3 to Europe early next year. Where would you like to see production in order to support that ramp overseas?
spk02: Well, initially, production will occur. I mean, at least the last several months, oil production is vehicle production will take place at our car plant in California.
spk00: Sorry, I meant to ask, where would you like to see the production rate on a weekly basis go to in order to support that ramp?
spk02: Yeah, it's hard to predict with accuracy. And there's also, you know, like all the tariff wars and everything. So, you know, long-term... Like you say, without talking about like next quarter, so like what is likely global demand for Model 3? It's probably on the order of anywhere from 500,000 to a million cars a year, let's say, for global demand for Model 3. If you look at something like, say, the 3 Series, that's around half a million. The BMW 3 Series is about half a million a year globally. And generally, we find that we out-compete the BMW 3 Series quite well. So, it seems like logical, therefore, that we would want to have a higher production or higher demand, you know. They made it somewhere between the kind of the BMW 3 Series and the Volkswagen Golf, which is about a million units a year. So, yeah, that's why I say anywhere from 500,000 to a million units a year long term.
spk00: And do you have to add new lines to support that, or are you just going to continue to remove bottlenecks in the existing lines?
spk02: No, we're definitely going to do local production in China. We're moving rapidly on that. So we're aiming to have Model 3 production for the China market or the greater China market active certainly next year. It will be happening next year. But it will be done in a very capital-efficient manner, much more akin to the way we did General Assembly Line 4 versus General Assembly Line 3. And then we'll also have a factory in Europe long-term because it's pretty silly to make cars in California and ship them all the way to Europe as far.
spk19: Especially in high volumes.
spk02: Yeah, exactly. Especially if it's a – I'm not talking about the S and X. I'm just talking about the three. So S and X will continue to be made in California, I think probably exclusively here. But for cars where we're trying to maximize affordability, it makes a lot of sense to produce those cars, at least on the continents where they are consumed or ported in.
spk04: Okay, let's go to the next question, please.
spk11: Thank you. Our next question comes from George Galliers with Evercore.
spk17: Thank you. Maybe just following up on the previous question, is the target still to produce 10,000 Model 3s a week in Fremont? And I think you mentioned in the past that once you got to a run rate of around 5,000, you'd be better placed to assess what CapEx is required to get there. So, As of today, do you have a better idea of what capex is required to get to that kind of level at Fremont?
spk02: I think we're not prepared to speak to that right now, except that it will be considerably less than money that we've spent to get to $5,000 in the first place. I think quite dramatically less. I said I could probably see a path to like 7,000 units a week for Model 3 with really minimal capex. Very minimal. Yeah, drum, yeah. Very minimal to get to 7,000 a week. And then, I mean, that's really just basically solving, improving the uptime of the existing lines, and we can do 7,000 a week. Exactly. Exactly, yeah. So... And then it gets a little harder as you start to go above 7,000. We would need to at least bring lines down in Fremont for significant upgrades to get to 10K, but also just not, we're not talking about massive amounts of capex. But, you know, if it's, say, like, long-term, it's, again, you know, long-term, it's, if predicting things on a quarter-by-quarter basis is very difficult because, when you have an exponential growth rate like we do. If you look at Tesla cumulative deliveries over time, it's like the cleanest exponential COVID that I've ever seen. But small movements in calendar time can look like a very large hit or miss one way or the other because it's such a steep curve. That's why it's always tricky to predict things on a quarterly basis, but a lot easier if you go out a year or so Yeah, I mean, probably long-term it's at least sort of 7,000 to 10,000 cars per month of Model 3. And then, I don't know, 5,000 to 8,000 in the rest of the world, something like that. This is a guess.
spk17: Okay, thank you. And then just as a follow-up, in the letter you do point out that the size of the European market for premium midsize sedans is roughly twice that of the U.S. Could you also maybe just comment to what your expectations are for mix in Europe? Based off Model S and Model X, do you expect richer mix in Europe versus the U.S., or is it fairly similar?
spk02: We've given that zero thought. I don't know, Martin, do you have an idea?
spk04: All I'm aware of is that because of cold weather, probably all-wheel drive and long battery range will be highly demanded in Europe. But apart from that, we ultimately have to start selling the car to see what the demand is.
spk02: Yeah, I mean, it seems like it's likely to be comparable to... If free midsize sands market is like twice as big in Europe, then, well, it's likely to be at least as much demand in Europe as there is in North America. Like that's a pretty safe bet. But our goal really is to make electric cars that everyone can afford, not to sort of mine high option value cars. It's like if we could produce a $35,000 car today, we would do it. You know, we need more work. There's more work to do before we can make a $35 car and have it be positive response. You know, we're probably less than six months from that, but that's our mission.
spk04: Great. Let's go to the next question, please.
spk11: Thank you. Again, ladies and gentlemen, if you'd like to ask a question at this time, please press star then 1. Our next question comes from Maynard Um with Macquarie.
spk15: Hi, thank you. Congratulations on a great turning point for Tesla. As you continue to scale the business, can you talk about how we should think about how you balance profits versus reinvestments? You're targeting sustainable gap profitability and cash flow, but I'm curious if there's a level of gap profitability or gap operating margin or cash flow you want to hold and then take the access to fund new growth or accelerate opportunities?
spk02: Sure. Maybe to characterize that question, it would be like... Are we starving new vehicle development in order to achieve gap profitability and cash flow positive? Would that be inaccurate? The answer is no. We've made significant progress on the Model Y. In fact, I approved the prototype to go into production recently. It'll be 2020 before that's in volume production, but we made great progress there. We'll also continue to make progress on the Semi and the newer Tesla Roadster. And then actually the product I'm personally most excited about is the Tesla pickup truck. So I think that's going to be some next level stuff there. And I should not forget to mention the solar tile roof will also start getting into volume production of the solar tile roof next year. That's quite a long development cycle because anything that's a roof is going to last 30 years. So even if you do accelerate life testing as fast as possible, there's still a minimum amount of time required to do that. And there's a lot of engineering that goes into how do you put on the solar tile roof and not be really labor-intensive in doing so. So there's a lot of engineering, not just in the tile, but in the way it's done. And then we've got continued improvements in Powerwall, Powerpack, other energy products. I think we've got the most exciting product roadmap of any company on Earth by far. I'm not even sure, like probably twice. I don't even know. who would have, which company would have a better product or even close. Yeah. Maybe they do, but I don't know about them.
spk15: Great. And, and when you talk about Tesla having its own, you know, ride sharing fleet or giving the ability people, the ability to loan out their car, like an Airbnb model, I'm curious if your long-term plan is to build a platform that's going to enable companies to write applications, um, to turn the car directly into an application. And then can you also maybe just talk about that business model? Should we be thinking more about like a revenue sharing model, sort of like how Apple takes a piece of revenue generated for applications from iPhones? Thanks.
spk02: I don't know about turning the cards on application exactly, but I mean, maybe. We'll try to do the thing that maximizes usefulness. And so if there's a way we can think of where third parties could do something, then that could make sense. But I do know for sure that Tesla will operate its own Ride hailing right right, you know its own ride hailing service will compete directly with your brain left obviously and You know and but then also have the ability for customers to offer their car Get an ad that add or subtract their car to the fleet at will there'll be a company-owned fleet and And the company-owned fleet will just be where there aren't enough customer cars to be lent out. So if we find, like, in a particular metro, there aren't enough customers who are willing to add their car to the shared fleet, then that's where we'll supplement it with a Tesla-owned fleet. So that's why it's sort of a combination of the Uber Lyft thing and Airbnb. And then we would charge, you know, something probably comparable to, yeah, to how they say the App Store works, where, I don't know, we charge 30% or something. in order for somebody to add the car to the fleet. I think that's a pretty sensible way to go.
spk04: Great. Let's go to the next question, please.
spk11: Thank you. Our next question comes from Adam Jonas with Morgan Stanley.
spk12: Thanks, everyone. First question is on governance. As the company conducts its search for a new chairman, what are the attributes and experiences of that person that you think would be a best fit or best value for Tesla.
spk02: Actually, on this call, we're going to restrict questions to operational topics.
spk12: Do you have another question? No problem. Yes, I do. Can you tell us about the folks who are taking deliveries of Model 3? What are the top cars, car models, or brands that they're trading in or switching out of? How many are new to the brand? Anything you're prepared to share, and then I have a follow-up. Absolutely.
spk04: Hey, this is Martin. So I've done the analysis of all the trade-ins that we've received, and really the only pattern that I've seen is that it's sort of all across the board, and the vast majority is non-premium brands. I think that is the number one message. It's just that more than half of the trade-ins we received were priced at below $35,000 when new. But other than that, there's no real pattern. I you know, I haven't noticed anything worth highlighting other than it's just a lot of people upgrading their cars quite dramatically.
spk19: Which is a huge upgrade.
spk02: Yeah. For many people, it is the most expensive car they've ever bought. So they're clearly demonstrating with their money that they're willing to spend extra money to get a Tesla. So You know, it has a sense like mass market premium.
spk19: The price walk is way beyond the federal tax credit. So clearly there is value that they are perceiving, whether it's cost of ownership, whether it's sustainability, whether it's the brand or the product. And the safety. All of the above is making a large number of customers jump up significantly in their purchase price.
spk02: Yeah, I mean, really, honestly, the top reason to refer a friend to buy a Tesla is it's going to keep your friend safe.
spk12: That's a good reason. If I can just squeeze in, since I couldn't ask the first one that you could answer, do you think that the third quarter is a milestone, Elon, where you think Tesla becomes sustainably self-funding and perhaps not in need of outside capital? Thanks. Thanks.
spk02: Yeah, that is our goal. We do not intend to raise equity or debt. At least that is not our intention right now. That may change in the future, but the current operating plan is to pay off our debts, not to refinance them, but to pay them off and reduce the debt load and overall leverage of the company. Oh, and I actually almost forgot one quite important thing. And this is quite helpful, why it's helpful to have these sort of crisis situations with logistics, for example. As I dug into the inventory, like basically finished product inventory from factory to the customer, I was quite surprised to see how long that took and that it was quite expensive in a lot of cases to get cars to customers This was something I didn't fully appreciate before. And we really have a major initiative at Tesla to get the average time from a car exiting the factory to receiving a check from the customer, being in the customer's hands. We only get the check when we get the car to the customer. So getting a car from factory to customer, to get that to be as short as possible, In August, the average time in North America to get a car from the factory to a customer was 30 days, which is embarrassingly long. By the end of the quarter, we reduced it to around 20 days. And our goal in Q4, this is a goal, not a promise, but our goal is to get the average time of a car from a factory to a customer under 10 days. This is a giant improvement in the capital efficiency of the company. Because we're making on the order of $75 million worth of products per day, of cars per day. So every day it requires $75 million worth of capital. So every 10 days is $750 million. And obviously we have a loan from the bank that we can make use of. But the banks will only loan us 85% of the cost of the vehicle, which translates to about 70% of the price of the vehicle. And then we've got this loan outstanding, which effectively increases the cogs of the car. And it dilutes the company to the tune of 30% of what the finished goods in transit is. So this is really like tightening that Again, getting that below 10 days in North America and then also improving dramatically the transit time to Europe and Asia. This is where having local factories is actually very important for the capital efficiency of the overall system because I think over time we want to get the time from a car going from factory to customer under seven days worldwide. the terms that we have from our suppliers are, on average, just over 60 days. Now, our parts inventory management also is, there's a lot of room for improvement there. I think we'll probably cut that down to, you know, a few hundred million dollars or so of, you know, something like that, maybe $300 million of parts at the factory. So then, effectively, what we're going to do is reverse the working capital requirements of the company quite dramatically to the point where the faster we grow, the more capital we have. This is incredibly important for capital efficiency of the company. It's night and day.
spk19: Deepak, is there anything you'd like to? No, I think you are totally, you know, we're reducing our raw material inventory on one hand by keeping the production stable, finding efficiencies in warehouse management and supply chain, and at the same time reducing the time to deliver the car and convert that car into a cash. And that significantly improves working capital needs.
spk02: Yeah, it's really quite dramatic. So, yeah, I think there's sort of profoundly changes the financial effectiveness of Tesla.
spk19: Yeah, we reduced our inventory in Q3, which helped. Although we had higher receivables because the quarter ended on the weekend, we won't have that in Q4. So all of this should continue to help us in Q4 and the working capital gains.
spk02: Yeah, I mean, it occurs to me that even if the only thing, like even if this was the only thing that tells it different was to shorten the time from factory to the end customer, in any given company that did that would outcompete all other companies over time. It would not be a contest.
spk04: Great, thank you very much. Let's go to the next question, please.
spk11: Thank you. Our next question comes from Tony Sakonaji with Bernstein.
spk13: Yes, thank you. I have one for Deepak and then a follow-up, please. Deepak, the OPEX expense management was very strong in the quarter. I think it was down 13% sequentially, and OPEX was only up 5% year over year despite revenue growing 71%. So on that front, I mean, in hindsight, did you get too bloated and needed to get more right-sized? And looking forward, how do we think about OPEX growth versus revenue growth on kind of a more normalized basis?
spk19: Yeah, Tony, so excluding one-time items, our OPEX decreased sequentially by 5%, to just clarify that, first of all. And a lot of that was driven by the actions we took in Q2 to be more efficient with our employee headcount. We benefited from that in Q3. And we were really careful in terms of all of our spending. The other piece that helped us is a lot of our Model 3 spending on expensed R&D is reducing because Model 3 is going into production. So Q2 to Q3, we saw a reduction there. And It just gives you the sense of the leverage our operating expenses can have while our revenue is growing dramatically. So our OPEX will increase in the future, but at a far slower rate, and we will continue to be really, really careful about the spending. And I think there are actually more efficiencies that we can find. We are going to find them, absolutely. So we'll continue down that path, definitely.
spk13: Okay. And then to – thank you for that. And then to follow up – I was just wondering if you could help us a little bit back to the gross margin on Model 3 and the $35,000 car. So, you know, this quarter, you know, I impute that Model 3 ASPs were maybe 59,000, and that might suggest that gross margins on a $35,000 Model 3 might be about zero. And, Elon, I think you alluded to the fact that, you know, the goal is really to get positive gross margins on a $35,000 car before shipping. Are those all fair assessments? And I guess the question is, Where would a Model 3, $35,000 Model 3 be in terms of gross margins today, and where does it need to be before you want to offer it broadly to consumers?
spk02: Yeah, I mean, the challenge with asking questions of that nature and detail is that it is a rapidly changing situation. So, like, literally, if you would ask this in a month, it would be different. In another month, it would be different. There's no question we need to get to the point where we can sell a $35,000 car and where the full accountable cost of the car is, let's say, on the order of $30,000 or slightly less than $30,000. I think we'd want to ideally get the cogs of that configuration of the car under 30,000. That's our goal. That's what we're pushing very hard to achieve.
spk19: Exactly. And it's a matter of time. There's a significant material cost reduction that comes. You have a smaller battery pack, so a fewer amount of cells. It's not the same cells that we have in the existing cars.
spk02: But it's the same cell, but it's not the same amount.
spk19: It's the same amount of cells, so cell cost.
spk02: It's fewer cells, and then the non-cell portion of the pack is also cost-reduced. Exactly. With the current mid-range pack, it still has basically about the same non-cell portion of the pack's cost.
spk19: Exactly. And we are achieving massive reduction in all our manufacturing costs per car, which will continue, and as volume grows, that also helps us fix cost and selection. So it's the same factors that have helped us so far will continue to help us going forward to get a sale. Anything you want to add, Jamie? Yeah.
spk04: Great. Let's go to the next question, please.
spk11: Thank you. The next question comes from James Albertine with Consumer Edge.
spk01: Great. Good afternoon, and thanks for taking the question. Congratulations.
spk09: Great.
spk01: I wanted just to point a clarification. Elon, you mentioned in August the time to get the car from a factory to a customer was 30 days down to 20 at the end of the quarter, and your goal is under 10 by the end of 4Q. Where do we see that flow through from a COGS perspective? Is that an automotive gross margin or is that in services and other at this point?
spk19: It's all an automotive gross margin or logistics costs outbound. Outbound logistics. COGS and COGS.
spk02: Yeah, I think it's a reduction in inbound logistics as well as outbound logistics. Maybe a question like for the debt that is carried for that period of time, is that given to COGS or is that not?
spk19: The interest expense, that's in the interest expense line, but that is not in COGS.
spk02: Okay, yeah, that's right. I do think the definition of COGS should probably be important to include anything that's directly driven by volume, essentially, that affects the marginal cost of the vehicle. So, although that is not officially in COGS, in my opinion, it probably should be, is to take the ABL interest expense and apply that effectively to the cost of the car.
spk19: And from a broader sense, you're looking at it as the cost of doing business, which can be avoided.
spk02: Yeah. Essentially, cash availability increases quite dramatically. Dilution or leverage outside of the ABL line improves dramatically. And then the effective cost of the car also reduces because you do not have the interest expense. If you have the interest expense over 20 days versus 10 days, this is a big difference. Yep.
spk01: Understood, and I appreciate that clarification. You know, sort of was trying to get at, you've been running a negative gross margin in services and other for several quarters now, and wanted to get a sense for, you know, when that could maybe drop and start to turn a corner and to generate some profit for you. I understand there's a lot of building out going on for sales, service, and charging infrastructure. But if you could give us some kind of clarification there, that would be, I think, helpful. And if you're willing maybe to provide an update, on where you stand today in terms of battery costs. I know your goal of a sort of parity with ICE vehicles, but maybe an update if you're willing to provide on where you stand in that trajectory. Thanks.
spk19: I think over time, every quarter progressively, we will see an improvement in the service and other business as our revenue continues to grow and the size of our fleet grows. It's as simple as that. Yeah.
spk02: Long-term, I would expect service to be a significant revenue item and to be a positive margin contributor. And it's going to be a function of our fleet size and age. Yeah. We're under warranty now. Yeah, exactly. We're under warranty. There's like a lot of stuff that's under warranty. But as the warranty expires, so there's like non-warranty items, then we expect service to be positive gross margin.
spk19: And that also includes our used car sales.
spk02: Yeah.
spk19: And our used car sales is continuing to grow, and they have a healthy margin. And so that overall business for mature companies is, in some cases, more profitable. than new products. I'm not just talking about OEMs. And we are at the early stage of our growth here, and as our fleet size grows, there are just so many opportunities in that business. But it's a matter of time, as I said, simply said. Yeah. Okay.
spk04: And on the battery cost?
spk02: There was a question. Well, that is a key sort of competitive metric. So I think it's safe to say we're much better than anyone else by a lot, but we prefer not to give a precise number.
spk04: Okay, and now let's go to the last question, please.
spk11: Thank you. Our final question comes from Phil LeBeau with CNBC-TV.
spk16: Thank you, guys. Elon, quick question. In terms of as the federal tax credit starts to be phased out, as your sales cross over the threshold, What kind of an impact have you guys modeled into how much that might slow down potential sales?
spk02: We don't expect this to result in – yes, the sales tax or the tax incentive in the U.S. drops in half at the end of this quarter, but then we also start shipping to Europe and then start shipping to Asia – and we certainly do not expect anything that would cause our production to drop below, let's say, a minimum of 5,000 cars a week.
spk16: But in terms of in the United States, do you expect that it will slow down demand and sales within the U.S.?
spk02: I think that as we're able to offer lower-cost versions of the car, that we would expect demand to sustain in the U.S., But I want to be clear, like, it's not like we're holding back this lower cost version of the car intentionally. Just like with, like, we're just like, is there anything we can do to provide a lower cost car now? And that's where we came up with the depopulated long-range pack, just like basically taking, having a long-range pack with fewer sales. Like, we really care about providing the end customer with the most affordable car that we could possibly produce, so that's viability. And if we could do the smaller pack now, we absolutely would. It's just going to take us, I don't know, at least three months to get the production going, and then you've got to spool up production, and that production is going to go to make the packs. The packs are going to go to the vehicle factory. The cars are going to get delivered to customers. So that's why, you know, customers probably see the smaller factory pack on the order of, like, you know, March or something, or February maybe. It's something on that order. Okay. Thank you. You know, one thing, these do trigger kind of like maybe points that are worth bearing in mind. As our quarterly letter indicates, the Model 3 is the most efficient energy per mile electric vehicle out there. It's got the best efficiency. So we've got the best in terms of miles or kilometers per per kilowatt hour, and we also have the lowest cost per kilowatt hour. This makes it very difficult for other companies to compete with Tesla, because we have the most efficient car and the lowest cost batteries. So I do encourage our competitors to really make a huge investment, and we've been saying that for a long time. And then they're only in this competitive disadvantage because they didn't, you know, we tried to help them as much as we could, and they didn't They didn't want to take our help. So they can use all our patents for free. They can use our supercharger network if they can just have an adapter for our connector or something. We want to be as helpful as possible to the rest of the industry. But the fact of the matter is we made the investment in the Gigafactory and other companies didn't. And we put a lot of effort into having extremely efficient cars, which the other, you know, having most efficient powertrains, and the other companies didn't. But, you know, I'm sure they will over time, but that's what has put us in quite a strong competitive position right now.
spk04: Fantastic. I think that's all we have time for today.
spk19: I just want to add a comment in closing, and Elon started with it, and I wanted to say that for myself personally here. I want to personally thank all the Tesla employees who worked incredibly hard this quarter and in prior quarters in each and every part of our business. Our results really are a reflection of the execution done by the company and the passion that our employees have to deliver such results despite all odds. And I also want to thank all our customers and all our investors who have believed in us and our product and our vision of accelerating the world's transition to sustainable energy. So thank you from my side.
spk02: Anybody have any additional comments or anything? All right. Thanks, everyone. And, yeah, I look forward to the next call. Thanks. Thank you. Goodbye.
spk11: Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect and have a wonderful day.
Disclaimer

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