Tesla’s [TSLA] Q2 May Be Very Profitable

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Now that we’ve seen Tesla’s actual Q2 2020 production and delivery numbers, the next thing Tesla bears and bulls turn their attention to is trying to determine what the financial impact will look like, and will Tesla make money.

Something that needs to be pointed out — estimates based on assumptions end up building in a ton of risk to the numbers, similar to how I recently illustrated the potential difference between a theoretical capacity or a roller coaster, and how seemingly small adjustments to a few assumptions can lead to massive differences in the end result. Bringing this up is also a good excuse to share another photo of a roller coaster, so here’s one with a legacy automaker dinosaur:

Being aware of the problem that can cause, I’m going to instead point out just a few areas where I expect changes, and the impact those changes could achieve. I’ll leave it to you to decide which assumptions may impact actual margins.

I’m going to pull the majority of these numbers from the Tesla Q1 2020 Update, which can be found here, so if I don’t reference where I got the number from, it’s probably that document.

Operating Expenses

In Q1 of 2020, Tesla spent $951 million on its operating expenses, which are made up of both research and development as well as selling, general and administrative accounts. In Q4 of 2019, Tesla spent $1.032 billion, and in Q3 2019 the number was $930 million.  The number moves around a bit, but it’s reasonable to assume the increase in Q4 may have been due to the start of production at the Shanghai Gigafactory.

For Q2 2020, Tesla had the majority of its US operations shuttered for almost half of this quarter. This unavoidable event would have decreased spending, probably by a noticeable amount. While it is true that in Q1 of 2020, Shanghai would have been closed for a period of time, potentially decreasing the operating expense by a small amount, Q2 was a more sustained closing period in the larger, more established Fremont Gigafactory, as well as Tesla’s battery production factory in Nevada and solar production facility in New York.

Additionally, in early April we know that Tesla reduced pay for its salaried employees based in the US by 30% for Vice Presidents and above, 20% for directors and above, and 10% for all other employees. It was announced these cuts would happen in similar ways in other countries too. Tesla also furloughed its factory employees who could not work from home for the majority of April. Salaries were announced to return to normal at the end of Q2, but the combination of all this could lead to a significant savings.

If we use the higher Q4 2019 number as our baseline ($1.032 billion), a reduction in overall spend of 10% would cut that number down by $103 million to $929 million, a savings of $22 million from Tesla’s Q1 2020 number. A 15% reduction in spend would mean a spend of $877 million, a savings of $74 million. You can play with this number to make your own estimate by knowing that each 1% reduction is a savings of about $5 million.

Deferred Revenue for FSD

When a company sells a product which it needs to deliver on over time, it is not allowed to recognize the full amount of the revenue until it has completed the delivery of that product. Therefore, according to Tesla CFO Zachary Kirkhorn on the Q1 2020 Tesla Earnings Call, Tesla has only recognized about half of the revenue it has taken in for this Full Self Driving (FSD). He stated at the time that deferred revenue continues to grow, and was a little over $600 million at that time. Whenever Tesla adds a feature to the FSD suite, it can recognize a bit more of that revenue.

I believe that Kirkhorn was identifying the entirety of the $600 million deferred revenue stream as that of FSD, as the company’s deferred revenue line from its Q1 2020 10Q actually stood at $1.186 billion.

In late April, Tesla turned on the ability for cars with FSD enabled to see and react to stop signs and traffic lights. Elon confirmed Zach’s rumor that Tesla would additionally drop green light confirmation, and that update was pushed out before the end of the quarter.

Here’s where this becomes a lot of guessing. It’s up to Tesla to decide how much of the revenue to book as earnings now. After Smart Summon was rolled out, Tesla used it to claim $30 million in revenue for its Q3 2019 results. Assuming Tesla views stoplight and stop sign recognition as equal to Smart Summon in value, the company could easily recognize another $30 million. If we assume that Tesla’s team sees this as more crucial for the overall development of FSD — a viewpoint I could see them reasonably taking — they could claim an even higher amount if they chose to.

Since they recognize half of FSD currently as revenue, $30 million of a $600 million account would mean stoplight and stop sign recognition would only be recognized at about 2.5% of the overall self driving package. If you want to adjust for your own numbers, for every 1% of additional importance you give this functionality, assign another $10 million in revenue.

This also doesn’t take into account new FSD revenue recognition, which could have significant upside in both the US, where the price increase could have boosted end-of-quarter sales, as well as in China, where Tesla offered the package with a three-year, 0% interest loan.

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Regulatory Credits

Tesla sells regulatory credits from its auto sales to other manufacturers. If you follow the company, this shouldn’t be a surprise. Often, bears cite this as a negative — if regulatory credits didn’t exist, Tesla would go out of business!

The problem with that line of thinking is these are not Tesla-specific regulatory credits. These are regulatory credits which any company can claim, so long as their product or products meet the criteria. In Tesla’s case, it sells things like ZEV credits (or “zero emission vehicle”) credits in states which require zero-emission vehicles to be part of the mix. Automakers that don’t sell enough zero emission vehicles purchase these credits from Tesla at a price point cheaper than what their fines would be.

In other words, it’s a choice that these automakers are making to pay Tesla instead of make compelling vehicles for which they can get the same credits, in which case Tesla’s credits would become worthless. Any criticism of Tesla selling these credits comes from someone who I feel doesn’t understand how the system works.

Tesla’s competitors see it as more valuable to hand Tesla massive amounts of cash than to meet the regulations themselves. Tesla in turn uses that money to further its operations and get more zero-emissions vehicles on the road. It’s a win/win unless you think that there should be no regulatory credits at all, in which case I will simply point out this sort of thing is done with all sorts of industries everywhere, so cherry picking Tesla as a problem is stupid. How stupid would Tesla be if it chose to instead not sell the credits?

Anyway, there was some consternation in Q1 that Tesla recognized $354 million in credits, more than a $200 million increase over the previous quarters. This may have been largely due to the partnership with Fiat Chrysler that may essentially fund Tesla’s German Gigafactory. If this is the case, this is repeatable. If not, and if regulatory credits drop to $100 million, Tesla will have a $254 shortfall to make up.

Honestly, this one is impossible to predict, but even if we’re looking to make up $200 million, there is at least one spot we should be able to do so easily. …

Auto Deliveries

Tesla delivered 8,378 vehicles more than it produced this quarter. Considering Tesla produced more than 14,000 additional vehicles it couldn’t deliver last quarter, if anything, I’m surprised Tesla didn’t deliver more of these vehicles.

In the Q1 2020 earnings call, Kirkhorn noted that this disparity was a headwind to free cash flows in Q1, but would be helpful in Q2.

Of the 8,378 vehicle difference, 4,104 of those vehicles were Model 3 or Ys. If we assume that all of these vehicles were white Standard Range Plus variations sold in the US without any upgrades — the cheapest version of the car that isn’t “off menu” — this gives Tesla an extra $155,910,960 of revenue to recognize from just the additional Model 3/Y deliveries.

But wait! 4,274 of these vehicles were Model S and X! The cheapest versions of those vehicles is the white Model S Long Range Plus, starting at $74,990. Using these numbers, this gives Tesla an additional $320,507,260 of revenue to recognize.

Model S and X deliveries were down 12,200 to 10,600 quarter over quarter, so there would be a potential decrease of 1,600 sales. Assuming that all 1,600 of these sales were white performance Model Xs at $99,990 prices, this would decrease our revenue by only $159,984,000, meaning that the combined revenue from the above three things — taking the absolutely worst-case average sale price for additional sales while recognizing an absurdly high average sales price for the decrease in sales, this gives us a total of an additional $316,434,220 in revenue thanks to this difference.

Conclusion

Adding up what I came up with above, if we save $22 million from operating expenses, recognize $30 million from stoplight and stop sign recognition in the FSD package, assume a $254 million decrease in regulatory credit sales, and recognize an additional $316 million in revenue from selling cars that were made but not delivered in Q1 2020, we start with $114 million of additional revenue for the quarter, working toward making Q2 2020 profitable.

Again, this is all highly speculative, and small adjustments can drastically change the outcome. However, I feel like I was extremely conservative in all of these estimates. On top of that, there are other levers that Tesla could easily decide to pull, including another one I believe is worth hundreds of millions of dollars that I’ll share in an upcoming article. [Editor’s note: It’s extremely unlikely you’ll guess this one, but give it a shot!]

Regardless, the more I dig into this quarter, the less that I see a way that it won’t be a massive financial success, too.

Disclaimer

I am a Tesla [NASDAQ:TSLA] shareholder who has purchased shares within the preceding 12 months. Research I do for articles, including this article, may compel me to increase or decrease stock positions. However, I will not do so within 48 hours after any article is published in which I discuss matters that I feel may materially affect stock price. I do not believe that my voice could or should influence stock price by itself, and I strongly caution anyone against using my work as your sole data point to choose to invest or divest in any company. My articles are my opinion, which was formulated using research based on publicly available data. However, my research or conclusions may be incorrect.