- GAAP profitable even without the benefit of a one-time gain
- Cash balance increased, despite making DOE loan payment
- Record sales of $562 million, up 83% from last quarter
- 4,900 vehicles delivered
- Gross margin doubled from last quarter to 17%
- U.S. demand expected to exceed 15,000/year; global demand likely above 30,000/year
May 8, 2013
Dear Fellow Shareholders:
Tesla reached profitability in the first quarter of 2013 for the first time in our ten year history. We exceeded our own targets for deliveries, significantly expanded gross margin, and improved execution throughout the company. Excluding non-cash warrant and stock option items, we generated a profit of $15 million. Including those factors, our GAAP profit was $11 million. Importantly, we achieved profitability despite the benefit of a one-time accounting gain related to the DOE warrant.
Production & Deliveries Up Over 80%, Exceeding Targets
During Q1, we consistently produced 400 or more Model S vehicles per week, for a total of over 5,000 during the quarter. We recognized 4,900 vehicles as revenue, exceeding our initial Q1 guidance of 4,500, despite physically delivering a higher number of vehicles, as the standard for revenue recognition was extremely high. Even if a car was received, fully paid for and signed off as good by a customer, we did not recognize the revenue if the paperwork was incorrect.
As our manufacturing processes stabilized and our supply chain continued to mature, we turned our attention to improving execution. In the process, we reduced the hours required to build a car by almost 40% from December to March. We also improved our inventory management. During Q1, raw materials declined by almost 26%, while unit production increased 80%. Better inventory management contributed over $30 million in cash and reduced our logistics costs during the quarter.
Financing Product Expands Model S Market
Our goal has always been to make electric vehicles affordable to the mass market. The Model S is priced substantially lower than the Roadster and our third generation vehicle will again be priced much lower than the Model S. However, in the near term, we believe that the right financing product can make a significant difference to the affordability of the Model S.
Working with US Bank and Wells Fargo, we are able to offer many customers the ability to buy a Model S with no money down (net of reimbursement from federal & state incentives) and an effective cost as low as $580 per month, taking into account savings from not using gasoline.
When purchased for business use, the depreciation benefit reduces the effective monthly cost even further to as low as $350. Moreover, Tesla guarantees a resale price in three years that is the highest of any premium sedan brand made in volume. We believe that this has the potential to make the Model S accessible to a much larger customer base.
Growing Rate of Worldwide Orders
We are pleased with the strong global demand for Model S and are currently receiving orders at a rate greater than 20,000 per year worldwide. Importantly, we are seeing orders in a particular region increase proportionate to the number of deliveries, which means that customers are selling other customers on the car. Given that we have not yet delivered any customer cars outside of North America, there would appear to be significant upside potential in Europe and Asia.
We continue to modify our sales processes to simplify and enhance the customer experience. As vehicle production became more reliable during Q1, we realized that the reservation process was cumbersome and therefore eliminated it. Customers in North America now order their customized Model S online in a simple three step process, rather than placing a generic reservation in a queue. As a result, quarter-end reservation data is no longer a meaningful metric, nor is it comparable to prior quarters.
Going forward, we believe that the accepted automotive industry approach of focusing on margin improvement, profitability and deliveries are the more meaningful metrics for measuring progress.
Building the Best Ownership Experience
The ideal service experience is, of course, never to need service, but when necessary, we now offer top of the line Tesla vehicles as loaner cars. Through our valet service, which will be rolled out over the next three months, we deliver another Model S to the customer at their choice of location and pick up their car. Since we also plan to offer these loaner cars for sale at a discount according to age and miles driven, the loaner fleet is constantly refreshed, resulting in the loaner cars usually being newer and with more options than the customer car in service. For some additional fun, customers in most markets can opt to receive a Tesla Roadster while their Model S is in for service. Also, while we do recommend an annual checkup for optimal performance, Model S will also now no longer require an annual service contract to maintain the vehicle warranty.
Moreover, for customer peace of mind, the battery pack now comes with a “no fault” warranty. Even if a customer never reads or follows the manual, the Model S battery pack is always covered by Tesla.
Finally, to support the growing fleet of customer cars, in Q1 we opened 12 new service locations, bringing our total network to 41 locations. We remain on plan to add approximately 30 service locations in total in 2013.
Model S in the Alps
The expansion of our store and gallery network is also continuing on plan. At quarter end, we had 34 stores and galleries around the world, and plan to open about 15 more stores and galleries this year with about half the openings in Europe and Asia. This year we have already opened a gallery in Austin, Texas, and stores in Century City, California, and Frankfurt, Germany. We also moved our location at Santana Row, California to a new, larger store to accommodate stronger than expected visitor traffic levels. Global store and gallery visitor traffic has remained very strong.
We have been hard at work on improving our Supercharger technology and in building out new Supercharger stations, with a major announcement expected within the next few weeks. As always, Tesla Supercharging is fast, convenient and free forever.
Improving the Car of the Year
Like we did with the Roadster, we continue to improve Model S for both new and existing customers. We recently introduced a lower cost, 60 kWh battery pack for Model S. This Model S has outstanding 0-60 mph acceleration and an EPA certified range of 208 miles on a single charge.
We also introduced a Performance Plus option for our 85 kWh cars. Using a combination of wider tires and enhanced suspension components, we were able to improve dynamic handling and ride quality while extending range by about ten miles. During Q1, we also started delivery of cars with standard coil suspension (in addition to active air suspension), and in April, we introduced a new, red paint.
We remotely pushed software updates to our customer fleet, adding incremental functionality such as voice activation of the infotainment system. By holding down the voice button and saying “Play XX song by YY artist”, you can play almost any song in the world on demand.
Quarterly Results
Total revenues for Q1 rose 83% from Q4 to $562 million, a new record for Tesla. In addition to record Model S deliveries in Q1, we continued to supply full electric powertrains and battery packs at a steady pace to Toyota for their RAV4 EV program. We also completed various deliverables under the Mercedes Benz B-Class EV program which contributed to total development services revenue of almost $7 million.
From Q4 to Q1, total gross margin rose from 8% to 17%, as a result of a higher Model S production rate, manufacturing efficiencies, part cost reductions and regulatory credit sales. Zero emission vehicle (ZEV) credits sold to other automakers amounted to approximately $68 million or 12% of revenues. We expect this to decline significantly in future quarters, as ZEV credits will only apply to about 1/6 of worldwide deliveries, versus roughly half of US deliveries, and the price per credit has declined. However, an important point for investors to note is that we are reaffirming our prior guidance of a gross margin of 25% in Q4 2013, assuming zero ZEV credit revenue. This may turn out to be greater than zero, but we are not counting on it.
What really matters is improving fundamental automotive gross margin, excluding regulatory credits. On this front, Tesla improved nine percentage points from the prior quarter and continues to improve every month.
Research and development (R&D) expenses were $47 million on a non-GAAP basis and $55 million on a GAAP basis. R&D spending declined by 23% from Q4 on a non-GAAP basis, as very high expenses associated with the Model S launch declined substantially. Increasing production by over 3000% from Roadster to Model S was extremely difficult and many mistakes were made, but now we are starting to get the hang of things.
Selling, general and administrative (SG&A) expenses were $41 million on a non-GAAP basis and $47 million on a GAAP basis, up slightly from Q4. The increase was driven primarily by additional selling expenses related to the expansion of our store network and service infrastructure, and by increased information technology costs.
Q1 non-GAAP net income was $15 million, and $11.2 million on a GAAP basis. Non-GAAP basic EPS was $0.13 and $0.10 on a GAAP basis, using 114.7 million weighted shares outstanding. On a fully diluted basis, non-GAAP EPS was $0.12. GAAP diluted EPS was $0.00, as net income has been adjusted to exclude the one-time non-cash gain of $10.7 million from the elimination of our Department of Energy (DoE) warrant liability as required under GAAP.
Our total cash was $231 million at quarter end, an increase of $10 million from last quarter, despite making the second quarterly principal repayment of almost $13 million on our DoE loan. Total cash includes short term restricted cash set aside primarily for the next DoE loan payment due in June 2013, and excludes noncurrent restricted cash.
Outlook
While we expect to build about 5,000 Model S vehicles in Q2, some cars will be in transit to Europe for start of deliveries in Q3. As a result, we expect to deliver slightly over 4,500 vehicles during Q2, all in North America. For the full year of 2013, we expect to exceed our prior target of 20,000 worldwide deliveries and feel comfortable raising guidance to about 21,000 deliveries. Obviously, there is a huge amount of work ahead to improve the gross margin of Model S, but we have a clear roadmap to achieve component cost reductions, as well as achieve additional manufacturing and logistics efficiencies. As a result, we expect to achieve gross margin in the high teens in Q2. Importantly, this expectation includes the impact from lower ZEV credit sales, a lower average selling price due to a higher mix of 60 kWh cars, as well as limited sales of the now discontinued 40 kWh cars, which will have a range-limited 60 kWh battery pack.
As mentioned above, we expect that our gross margin will continue to rise into the second half of the year to our target of 25%, assuming no contribution from ZEV credits. The lease accounting treatment for cars sold through our new financing plan will have no impact on our cash flows, and we expect to be roughly breakeven on cash flow from operations in Q2, despite launch costs in Europe and a huge increase in service centers, stores and Supercharger stations.
However, the deferred revenue recognition required by GAAP for lease accounting will lead to a net loss on paper in Q2. We plan to provide information so that investors can evaluate our results both with and without the impact of lease accounting, as we believe the actual effect on Tesla is positive.
Operating expenses are expected to increase moderately in Q2. R&D expenses are expected to increase slightly from Q1 as the pace of product development starts to pick up. SG&A expenses will continue to rise moderately, primarily due to the growth in our stores and service centers.
We plan to spend about $200 million on capital expenditures in 2013, as we conclude the majority of our investment in the Tesla Factory and Model S tooling. Capital spending also includes the expansion of our service, store and Supercharger networks and new product development. 2013 is off to a strong start, and we look forward to seeing more of you on the road in a Model S this year.
Elon Musk, Chairman & CEO
Deepak Ahuja, Chief Financial Officer
