Earnings Review: Inefficiencies in Transition to New Assembly Line Force Tesla to Revise Outlook

Tesla Motors (NYSE:TSLA) did not disappoint investors as it delivered yet another set of solid results. During the quarter, the company’s revenues stood at $849 million, up from $768 million in the second quarter of fiscal 2014. The net income stood at ~-$75 million, or a loss of 60 cents a share. The automaker delivered a record 7,785 vehicles this quarter, but production fell down to 7,200 vehicles this quarter, as the shutdown of the Fremont factory resulting from a shift to a new assembly line and production system hurt production more than expected. As a result, the company had to sell cars off showroom floors and testers in order to meet as much demand as it could. Citing the production deficit, Tesla cut down guidance for deliveries in fiscal 2014 down to 33,000 from 35,000.

Tesla had introduced a new lease program earlier in 2013. GAAP requires Tesla to spread out the revenues of the cars sold through this program over the lease tenure (i.e. treating these revenues as deferred revenues). Therefore, a better method to gauge the automaker’s performance is to analyze the non-GAAP figures. On a non-GAAP basis, Tesla’s revenues were $932 million, up 55% compared to a year ago. The net income stood at $3 million, or 2 cents a share. ^[1]

We have a price estimate of $150 for Tesla, which is about 40% below the current market price. We are in the process of revising our estimates to incorporate the latest earnings.

Revised Outlook

In 2014, the automaker expected to sell 35,000 Model S cars, helped by higher production rates and expansion into new markets. The third quarter’s 7,200 vehicles produced means that Tesla had to revise its full-year guidance of 35,000 down to 33,000. Meanwhile, the company has also been working on making its assembly line efficient enough to be able to improve the production rate to 1,000 vehicles a week by the end of this year and 2,000 vehicles by the end of next year. ^[1]

In order to meet its year end targets, Tesla will have to deliver more than 10,000 vehicles in the fourth quarter, representing an increase of over 30% in the fourth quarter. The Silicon Valley based company increased its production rate by about 16% over the second quarter but was not be able to continue accelerating at the same rate because of a planned two-week shutdown of its factory to allow the transition of the manufacturing process to a new assembly line. To meet its 2015 targets, Tesla will have to increase its delivery rate by about 25% for each quarter compared to the rate this year. The planned introduction of the Model X by the middle of 2015 should help the company in attaining that target but a lot of it will rely on how quickly it is able to reach the production rate target of 2,000. By our estimates, just about 1,200 of the cars produced in the second quarter were only delivered this quarter, which meant that the lag time between production and delivery came down considerably for this quarter, as over 90% of the cars produced this quarter were delivered. However, this reduction is perhaps artificial, as the company sold cars off its shop floors and gave away testers to meet its demand. The company said that it expects the quarterly gap between vehicles produced and vehicles delivered to decline in the future quarters. This is important as some customers, especially in China, have expressed disappointment at the time lag between time of order and time of delivery.  ^[1]

Average Revenue Per Vehicle Corrects

During the quarter, the average revenue per vehicle stood at ~$109,000, implying an increase of about  8% compared to the second quarter. During the first quarter of 2013, the average revenue per vehicle went as high as $115,000, buoyed by sales of ZEV credits, to the tune of $60 million. Another reason why the figure was higher during the start of 2013 was because Tesla had primarily delivered its high-end versions first. As the automaker eventually delivered its lower priced options, the average revenue per vehicle witnessed a correction.

The revenue during the third quarter includes the revenue generated from the sales of power trains to Daimler and BMW. Tesla has signed a deal with Daimler for the supply of power trains to be used in the production of Mercedes-Benz B Class Electric Drive. During the quarter, Tesla also announced a new leasing arrangement that it signed with U.S. Bank. Currently, Tesla offers a leasing package that allows consumers to purchase a Tesla Model S, which sells at a base price of $71,000, for installments between $800 and $1,300 a month, depending on options. This follows an initial down payment of $6,500. Tesla’s revenue recognition for this leasing program differs from that of other car companies: it will recognize revenue generated from leasing only over the term of the lease unlike other companies which record the full value of the car as revenue because they sell their cars to independent dealers, who in turn lease these cars out to commercial ventures. Tesla sells its cars directly to end customers and hence bears the risk of defaults on these loans directly. Tesla’s Elon Musk announced a new agreement with U.S. Bank which could allow consumers to purchase the Model S on a lease that could be 25% cheaper than the lease program currently offered by the company. The option will allow consumers to return the vehicle in case they do not like it, while also getting their lease obligation waived off. Considering the fact that the cost of ownership of a Tesla Model S is already lower than most cars in its class, a cheaper lease program should make the car even more attractive to potential buyers.

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Impressive Margin Expansion

The automaker’s gross margins declined by 400 basis points to 22.6% compared to 26.9% on account of manufacturing inefficiencies associated with the transition to a new assembly line and the impact of a strong U.S. dollar on international revenues. On a non-GAAP basis, gross margin stood at 23%. Tesla’s gross margins had improved from 17.1% in the first quarter of 2013 to 26.9% in the second quarter, helped by higher volumes and operational efficiencies. However, the company thinks there is room to further improve margins. Tesla is targeting gross margins of 28% by Q4 2014. ^[2] Auto companies, in their definition of cost of goods, usually include some fixed cost components like labor costs, plant operational expenses etc. Therefore, as volumes increase, the additional revenues often result in improved gross margins.

However, Tesla also cautioned that administrative and capital expenses will rise significantly as the company scales up its customer support to keep pace with the growing global demand for its products. The company stated that it plans to accelerate the rate at which it opens stores and service centers. The plan is to increase the number of company operated stores to about 300. Additionally, the company plans to install more than 200 superchargers globally by then end of this year. Superchargers are charging stations installed by Tesla for its customers to charge their car batteries for free. ^[1]

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1. Tesla 8-K, Tesla Investor Relations [↩] [↩] [↩] [↩]
2. Tesla Motors Management Discusses Q4 2013 Results, Seeking Alpha, February 2014 [↩]