Tesla: Confidently Selling Cars at Zero Profit with Autonomous Driving Reaping Benefits.

Below are the key information of Tesla's Q1 earnings call. For the interpretation of financial report, please refer to Tesla: It's not easy to say I love you in the year of setting targets high.

I. Core data of Q1 report vs Market expectation

1. Revenue: $23.33 billion, YoY +24.4%, basically in line with expectations (-0.2% inline).

2. Gross margin: 19.3%, YoY -9.8ppt, lower than market expectations (-2ppt miss).

3. Automotive business:

(1) Sales: 423,000 vehicles, YoY +36.4%.

(2) Revenue per vehicle: $48,400, QoQ - $4,800, slightly higher than market expectations (+$300).

II. Full text of earnings call

(I) Management remarks

【1】1Q23 Review

Elon Musk

1. Sales volume: Despite many challenges in production and delivery, Model Y continues to be the best-selling car in Europe and the best-selling non-pickup truck in the United States.

2. The impact of price reduction on profit margin: Although the price was significantly lowered in early Q1, the operating profit margin still leads the industry.

The company believes that driving higher sales and a larger fleet is the right choice compared to lower sales and higher profit margins. However, as time goes on, it is expected that vehicles will be able to generate considerable profits through autonomous driving. Therefore, the foundation is being laid now to deliver a large number of cars at lower profit margins and to reap huge profits when fully autonomous driving is achieved in the future.

3. Cybertruck: Continues to manufacture the Alpha version of the Cybertruck on the pilot line for testing; the installation of the mass production line at the Texas factory is being completed, and deliveries are expected to begin in 3Q23.

Like all new products, the Cybertruck will follow an S-curve—starting production slowly and then accelerating. Obviously, there is a lot of demand for this product. And this is a magical product that can enter the hall of fame of products. However, like all new products, it takes time to get the production line going. And this is indeed a very radical product that is not made like other cars.

4. Megapack: In Q1 2023, energy storage deployment reached nearly 40GWh, the strongest quarter to date, thanks to the ramp of the large factory in Lathrop, California. There is still a way to go to achieve a speed of 400GWh per year. In addition, it was recently announced that a new super factory for large commercial energy storage batteries, Megapack, will be built in Shanghai. Therefore, as expected, the growth of fixed storage space will actually greatly exceed the growth of vehicles.

5. Autopilot (AP) & Full Self-Driving (FSD): has now driven over 150 million miles through FSD testing, a number that is exponentially growing and a unique advantage for Tesla's data.

The company is very focused on improving its neural network training capability, one of the main limiting factors for achieving fully autonomous driving. Therefore, it will continue to purchase a large number of NVIDIA GPUs and invest heavily in Dojo, which could significantly increase training costs.

In addition, Dojo also has the potential to become a sellable service to other companies.

In summary, Tesla will continue to manufacture and sell as many cars as possible. Although the macro environment is uncertain, now is a good time to further increase its competitive advantage and continue to invest in growth as quickly as possible.

[2] 1Q23 Performance Review

1. Profit Margin: Although the automotive gross margin and operating profit margin decreased quarter-on-quarter, but both remained at a healthy level.

Automotive gross margin was affected by the Q1 price reduction of vehicles and one-time items (especially the adjustment of S and X old-model warranty and the deferred revenue of automatic driving during the technology transition period).

In Q1, progress continued to be made in reducing vehicle costs, mainly due to substantial improvements in logistics and some declines in commodity costs.

Driven by record sales, the unit costs of the Austin and Berlin factories have also improved. However, these factories are still producing obstacles in terms of profit, which will continue until the expected stable production is achieved.

Q1 23 is the third quarter of the transition to a more regionally balanced production and delivery mix plan, resulting in a quarter-on-quarter decline in deliveries and production due to an increase in on-the-way cars at the end of the quarter, which had an impact on the free cash flow at the end of the quarter. This effect was particularly common in S and X cars as international deliveries began.

2. Energy Storage Business: After years of investment, it has begun to take shape. The share of revenue from this business is growing and reached its highest level to date in Q1, driven by the increased delivery rate of Megapack products. Profitability has also made progress, creating the highest gross profit so far this quarter.

3. Business Philosophy for 2023: Increase sales of cars and energy businesses as soon as possible. Continue to invest heavily in future plans, including the Cybertruck next-generation platform, self-developed battery production, energy storage business, and autonomous driving and artificial intelligence products; while maintaining financial health and industry-leading position. To achieve this goal, focus on cost efficiency and operational capital, especially to deal with strategic inventory backlog left by the pandemic.

(II) Q&A Session

Q: Steps, relevant variables, and frequency of adjusting car prices

A: Make the best effort to evaluate the production situation and macroeconomic conditions, and then make a decision. The team conducts a weekly review of the company's global situation, and some members of the team make decisions.

Q: Will the energy storage business surpass the automotive business, and when will Metapack and overall energy storage performance guidance be provided?

A: (1) Energy storage vs. Automotive

From the perspective of installed capacity (GWh), energy storage will surpass automotive, but automotive revenue will be higher, and energy storage growth will be faster.

(2) Energy storage performance guidance

Currently, the energy storage business (Metapack & Powerwall) still accounts for a small proportion, mainly due to its small scale and diverse customer base, resulting in significant volatility. It is estimated that after several quarters, the energy storage business will become stable, and its sales volume will be included in the production and delivery announcement and timely provide performance guidance.

In addition, the gross profit margin of the energy storage business is expected to be similar to that of the automobile, which is approximately mid-20% (mid-20% is the gross profit margin target for any project launched); we hope to achieve this gross profit margin level by the end of the year, but we cannot guarantee it.

Q: Progress of 4680 battery

A: Battery Day outlined the cost reduction roadmap until 2026, including battery design, anode and cathode materials, structure packaging, and battery factories, which are currently being promoted plan and made good progress in all-round.

- Battery factory: The Texas 4680 factory has completed some construction and commissioning. When the ramp-up is completed, its capital expenditure per GWh is 70% lower than that of a normal full-production battery factory. In future factory construction, further opportunities for intensification and reducing investment will be sought, such as in Nevada.

- Battery Design: Not only is the first-generation flat-panel battery launched on Battery Day being produced but the Texas factory is also producing a second-generation version that is easier to mass-produce.

- Cathode Materials: In terms of lithium, the Corpus Christi lithium smelting plant will break ground in May this year and aims to start trial production of some facilities by the end of this year. The smelting plant adopts a lithium spodumene refining process without sulfate, reducing process costs, without acid or corrosive reagents, and reducing implied energy. It also produces a beneficial by-product, which can be reused for building materials.

The low-cost and zero-wastewater cathode precursor process has been successfully proven in laboratory and pilot-scale, and is in the detailed design stage of incorporating this technology into the Austin cathode facility front end.

Fifty percent of the equipment and 75% of the public facilities have been installed in the new cathode factory in Austin, and the goal is to start wet and dry commissioning this quarter and next quarter and produce the first batch of cathode materials by the end of the year.

- Structural Packaging: The 4680 battery and structural battery pack concept bring significant improvements to battery pack manufacturing-under the same annual gigawatt-hour output, capital expenditure reduced by 50%, and factory scale reduced by 66%. Structural is a better concept, and it is simpler. It will continue to load batteries structurally and make battery packs the floor of vehicles, while iterating designs in future projects to make the execution of this grade-A architecture closer to grade B. 1Q23, the focus of the 4680 team is cost and quality. Texas output increased by 50% QoQ, with a 12% yield improvement; cathode peak rate up by 20%, with a 20% increase in output quality. Overall, the team achieved a 25% COGS reduction this quarter and is expected to achieve steady-state cost goals in the next 12 months. For the rest of this year and before the Cybertruck increases production, priority will be given to cost issues for the 4680 project.

Q: Automotive gross margin expectation excluding carbon emissions allowances in 2023 based on current pricing levels?

A: There is a great deal of uncertainty in the macro environment; some costs are controllable, while others are constrained by the macro environment.

Controllable parts: Accelerate production ramp at the Austin factory and optimize costs. Once the expected production volume is reached, cost optimization will continue from other angles; 4680 is an important part of Austin's factory COGS, and with the progress of the 4680 corresponding plan, the entire operation of the factory will be optimized accordingly. Berlin factory is also reducing costs, and with the increase of production, localization continues to advance, and cost is reduced.

Uncontrollable parts: Logistics and bulk commodities.

Logistics are developing in a positive direction for the company, and the supply chain team is doing well in logistics optimization and making the best use of reduced spot prices.

For the past two years, bulk commodities have been a key factor in cost structure; it peaked in the second half of last year and began to decline, with some easing in 1Q this year and even more in 2Q. Lithium prices have fallen substantially. Bulk commodity prices are expected to fall and have a more significant impact in the second half of this year.

Q: Global order status after price reduction

A: Overall, orders exceed production.

Q: Cybertruck progress and pricing

A: It will be unveiled at 3Q delivery.

Q: Progress of ramping up production capacity of Las Lomas energy storage plant

A: Capital expenditure is divided into two phases, assembly of facility components, and cooperation with the seller and power supplier. Progress of these investments will be seen in the second half of this year. Thus, the entire facility is phased, and the capital expenditure for the second phase will come online at the end of this year.

Q: Ability and related planning to serve markets outside Shanghai

A: There are indeed many places in the world where the company has not yet provided services, especially in the automotive industry, so it really hopes to open up new markets around the world.

Q: FSD subscription rate and whether FSD subscription price will be reduced

A: There are no details on subscription rate for now.

In terms of pricing, the value of autonomous driving cars is immense, and the current price is the option value of autonomous driving cars. FSD beta users can feel that the improvement is significant. The trend towards fully autonomous driving is very clear, and Tesla will achieve it this year.

Q: Did the price changes of bulk commodities of electric vehicles reflect overcapacity in the mining and smelting fields or global electric vehicle demand? And what is the expected price trend of bulk commodities for the next few quarters?

A: The prices of bulk commodities related to electric vehicles reflect overcapacity in mining and smelting fields, as well as global electric vehicle demand. The expected price of bulk commodities in the next few quarters is likely to decline. Q: uncertain period

A: Currently, we are in an uncertain period. Musk personally speculates that macro pressures may last for about 12 months, and good changes are expected next spring if there are no major geopolitical surprises.

Electric vehicle materials prices have been changing but within 10%, and many market transactions are carried out at the spot level. In terms of energy storage, there is a small supply and demand mismatch in the short term, and prices may fluctuate in the short term. However, the company does not want to get caught up in short-term price fluctuations. Six months ago, the price of lithium carbonate was about 85,000 USD/ton, and now the spot price is only 26% of this price. We hope to lock in prices through fixed-price contracts to obtain better profits. In the next 10 years, we will pay attention to whether the supply of materials meets demand. Fixed price contracts have been signed, and the company will continue to study other related measures.

The company has begun to deploy mining and smelting capabilities. Actually, there are plenty of lithium reserves on earth. Lithium is one of the most common elements in the world, and timely mining is very important. It requires a certain smelting capability to ensure the supply of lithium materials needed for batteries.

Q: Profit model of Robotaxi

A: Robotaxi is the general term for the next generation platform models. All models that have HW3, which is most of the current models, have the ability to achieve fully automatic driving.

Q: Has there been any change to the 20% gross margin floor?

A: The reason for the lower-than-expected gross margin in the first quarter is that the price was reduced. In the second quarter, we reduced the price again, so you can also assume that the 20% gross margin floor previously guided needs to be adjusted downward. Another part is the impact of non-recurring items.

In addition, two macro factors have an impact. The biggest factor is interest rates, which make cars more difficult for consumers to afford. Second, as long as there is economic uncertainty, consumers will delay large expenditures.

Q: Priority of other business lines

A: Dojo is a very visionary bet by the company, which may bring returns of tens of billions of dollars.

The company has excellent heat pump technology and believes that heat pumps have value in both home and commercial scenarios. However, it is still a backup/minor project.

The company's focus is on cars, autonomous driving, and static storage (compared to automotive batteries, which belong to mobile storage), solving sustainable energy and autonomous driving problems. In terms of autonomous driving, if the software update value of a fleet of millions of cars is several times its original value, this will be the largest asset value increase in history.

Q: The pricing of cars or electric vehicles and its impact on market share

A: Unlike other car companies with lagging data, Tesla can know the previous day's orders and production in real time, and integrate data from all aspects for comprehensive analysis, making price adjustment decisions every 7 days on average. Generally, the company team's decisions are better than those of other companies in the industry.

Furthermore, it is reiterated that Volkswagen's focus is on electric vehicle market share, but Tesla regards it as the car market, not the electric vehicle market, and Tesla's mission is to convert gasoline cars to electric cars. It can no longer be viewed as an electric vehicle market. All cars will be electric cars. Q：What percentage of the cost of a car is variable and what is the range of lithium costs?

A: Depending on the time scale in question, most of the costs associated with a car are variable. Improvements in supplier costs are critical for the company.

Previously, it was anticipated that lithium prices would plummet, but some of this has already flowed into the cost of batteries through the use of lithium carbonate. The same thing is also happening with lithium hydroxide.

Because we are discussing something very upstream, the length of the supply chain is also very important.

However, in addition to commodity pricing, other indicators that make production effective are also very important. For example, the situation of delays and detention in air transport. The company's urgent air freight costs have dropped by 90%, and detention and detention ratios have dropped by 93% compared to the peak period, which can also save costs.

Q: There are many people waiting for global energy storage to be connected to the grid, and how many of them are being converted into actual sales?

A: The company does not participate in grid connection. It focuses on quickly and effectively improving Megapack, has visibility into pipelines for various renewable energy and pure fixed storage developers, and is developing its own projects. We are selectively selecting products and choosing projects that are most suitable for our own tasks and goals.

Improvements are being made in many areas, including Megapack, some of which will increase the speed at which Megapack is connected to the grid.

Q: Is 2 million vehicles still an optimistic scenario for this year’s sales, and are the constraints for reaching 1.8 or 2 million vehicles this year in the supply chain or demand?

A: From a production standpoint, if everything goes smoothly, there is a chance to produce 2 million cars this year, but this is an optimistic scenario. The neutral expectation is 1.8 million vehicles, depending on progress this year.

Q: What is the feedback from Tesla owners and non-Tesla owners about the open charging network?

A: 1Q opened the first V4 charging station in Europe and the Magic Dock charging station in North America, indicating that the company's direction is that all vehicles can be universally compatible regardless of the charging port's location. In all major markets, these improved products will continue to be launched as new stations are established.

The company has always balanced the ability to provide services to its customers with the ability to provide services to new customers, and can now achieve this balance very well. For example, in Europe, 50% of all supercharging stations are open to all electric vehicles, and no one's wait time has increased. Therefore, we will continue to take similar approaches and promote them in North America and China in the next few quarters.

Q: What is the cost floor and the latest profit margin expectations for cars?

A: Profit margins depend on the macroeconomic environment. If the Federal Reserve lowers interest rates, this will boost demand. If interest rates are raised, it will only increase the interest costs buyers must pay for purchasing cars, reduce affordability, and thus reduce demand. Unless there are significant geopolitical accidents, we are very optimistic about the mid and year-end of next year.

For the company this year, apart from managing day-to-day business, it is really important to invest. It is crucial for the company to use the cash generated from product sales for reinvestment. Changes in profit margins over the next few quarters will only affect the company's ability to reinvest in 2024 and 2025. Before re-evaluating the investment plan, there is plenty of space to keep the business healthy. However, it is worth noting that recent events do not need to be over-interpreted. Tesla is highly focused on ensuring it lands in the best way possible when it exits this macroeconomic situation.

Q: Thoughts on demand elasticity

A: "Can they afford it?" is the main focus, and at this stage, loan difficulties have increased. For Tesla, it is in a unique and advantageous position where it can temporarily sell cars at zero profit and earn substantial returns in the future.

Q: Will American auto history repeat itself?

A: Pricing is not intended to undermine competitors, as Tesla does not really consider them. Its primary concern is how to make products and services better and more affordable to the general public.

Tesla has a unique strategic advantage – if its self-driving technology is successful, the asset's future value will be higher than its present value. Thus, while it is sold at zero profit, the net present value of future cash flows related to that asset remains very high. Moreover, services, charging, and other revenue streams such as insurance that other companies do not have are still available.

Tesla hopes that all electric cars will be successful and does not intend to maliciously attack other companies. For instance, opening Supercharger stations is a patent-free service.

In conclusion, it is not about destroying competitors but rather trying to help them do better.

Q: Is production continuing at maximum capacity under supply constraints (excluding broader economic conditions)?

A: Yes, production will continue to grow rapidly without any apparent macro shocks that may cause people to stop buying cars.

Q: Profit margins of the Austin and Berlin factories compared to the Shanghai factory

A: It is possible to have a structure that is as effective as Shanghai's. Shanghai has an efficient cost structure that is apparently the world's lowest. However, Tesla is hoping to make significant progress in Austin and Berlin and continue making progress in Fremont.

Efforts have been increased in localization, which will reduce lead times and demand backlog. There has already been a 10% MoM growth in lead times and inventory. Therefore, localization work will continue.

Q: Limitations of the direct sales model

A: So far, the model has been running well. The direct sales model helps form a closed feedback loop in service, which dealership models rely on service revenue, which is not advantageous to customers.

Q: Many traditional competitors derive a considerable amount of profit from selling parts and services, whereas Tesla does not. Is the company aware of this situation relative to its peers?

A: For a long time, the main antiforecast for Tesla has been the company's lack of an existing fleet. The primary reason why incumbents succeed and newcomers fail in the automotive industry is that incumbents have a sizable fleet that allows them to sell new cars at near-zero profit margins, then sell parts at very high-profit margins, much like a "razor-and-blades" situation. Therefore, the only way for newcomers to succeed is to have a compelling product that people are willing to pay more for than existing products. Without electrification and self-driving, newcomers are unlikely to succeed.