One month after Tesla surprised markets with an unexpectedly low production output of its much anticipated Model 3, delivering just 260 cars far below the 1,500 expected, which according to a follow up report from the WSJ was due to parts of the car actually being made by hand, investors were fearfully looking forward to today's Q3 earnings report despite Elon Musk's assurance that Tesla had its "all-time best quarter" for Model S and X deliveries. Those fears were justified when moments ago Tesla reported an adjusted, non-GAAP loss of ($2.92), far worse than the expected loss of ($2.27), which was more than double the ($1.33) loss in Q2.
The silver lining is that in the third quarter, Tesla generated revenue of $2.98 billion, slightly better than the $2.93 billion expected, but this was more than offset by the plunge in the Automotive gross margin, which in Q3 was 18.7 non-GAAP, far below the 25.0% in the previous quarter, and worse than expected.
It was all downhill from there, however, and in what has become the most sensitive topic for the EV maker, Tesla continued to burn epic amounts of cash, outdoing itself in Q3 with a record cash burn of $1.4 billion - or roughly $16 million per day: an unprecedented amount. This was higher than the $1.2 billion consensus forecast. In Q3, Tesla's CapEx was $1.116 billion, a number which is set to continue pressuring its balance sheet as the company continues to ramp up Model 3 production. Indeed, Tesla announced that capital expenditures are expected to be approximately $1 billion in Q4, "driven largely by milestone payments on Model 3 production equipment, as well as Gigafactory 1, and further expansion of stores, service centers, delivery hubs and the Supercharger network."
Understandably, the cash burning behemoth was proud to announce that it had $3.5 billion in cash on hand at the end of Q3. There is just one problem, and this wasn't announced in the letter: Tesla also had $3.9 billion in accounts payable and accrued liabilities, a number that was unchanged from the previous quarter, as the company drains all net working capital sources of cash it can find.
In terms of deliveries, there were no surprises: as the company disclosed previously, it delivered 25,915 Model S and Model X vehicles and just 222 Model 3 vehicles, for a total of 26,137 deliveries. Combined Model S and Model X deliveries in Q3 grew 18% globally compared to Q2 and 4.5% versus the same quarter one year ago.
And this is where the trouble started, because looking into the future, Tesla revealed an even scarier picture, warning that due to the the nature of manufacturing challenges during a ramp such as this "makes it difficult to predict exactly how long it will take for all bottlenecks to be cleared or when new ones will appear."
The result: the company now anticipates hitting a production rate of 5,000 Model 3s not by December as it said previously, but some time in late Q1:
Based on what we know now, we currently expect to achieve a production rate of 5,000 Model 3 vehicles per week by late Q1 2018, recognizing that our production growth rate is like a stepped exponential, so there can be large forward jumps from one week to the next."
Additionally, Musk did not say when he expects production to hit 10,000 per week:
We will provide an update when we announce Q4 production and delivery numbers in the first few days of January. With respect to the timing for producing 10,000 units per week, it has always been our intention to implement that capacity addition after we have achieved a 5,000 per week run rate. That will enable us to make the next generation of automation even better while making our capex spend significantly more efficient.
Musk was quick to blame suppliers for again having to push back the delivery schedule, saying that "to date, our primary production constraint has been in the battery module assembly line at Gigafactory 1, where cells are packaged into modules. Four modules are packaged into an aluminum case to form a Model 3 battery pack. The combined complexity of module design and its automated manufacturing process has taken this line longer to ramp than expected. The biggest challenge is that the first two zones of a four zone process, key elements of which were done by manufacturing systems suppliers, had to be taken over and significantly redesigned by Tesla."
The company then promised that it has "redirected our best engineering talent to fine-tune the automated processes and related robotic programming, and we are confident that throughput will increase substantially in upcoming weeks and ultimately be capable of production rates significantly greater than the original specification." Which is bizarre in light of all the recent mass terminations from its Fremont facility.
Kicking the can yet again, TSLA said it will provide an update when it announces 4Q production and delivery numbers in the first few days of January.
Musk also said that between cash on hand, future cash flows and available lines of credit, believes TSLA says it is well capitalized to accommodate the revised ramp of Model 3 production to 5,000 per week... assuming it ever gets there of course.
Some more on the outlook:
Based on the recent acceleration in order growth, we now expect that Model S and Model X are on pace for about 100,000 deliveries in 2017, an increase of 30% compared to 2016. Notwithstanding these increased deliveries, we plan to produce about 10% fewer Model S and Model X in Q4 compared to Q3 because of the reallocation of some of the manufacturing workforce towards Model 3 production. As a result, inventory level of finished Model S and X vehicles should continue to decline.
We expect Model 3 non-GAAP gross margin to reach breakeven by end of Q4, because of increased capacity utilization, and it should improve rapidly in 2018 to our target of 25%. Our recent production challenges may affect short-term costs, but they have no impact on our 25% gross margin target, since there has been no change to our projections for material, labor and overhead costs per vehicle
Finally, some more bad news:
Due to a higher mix of temporarily lower margin Model 3 deliveries in Q4 compared to Q3, we expect non-GAAP automotive gross margin to temporarily decline slightly in Q4 to about 15% and then recover starting in Q1. Gross profit is expected to grow more than operating costs in Q4 compared to Q3, while operating costs are expected to be flat to up slightly in Q4. Between cash on hand, future cash flows and available lines of credit, we believe that we are well capitalized to accommodate the revised ramp of Model 3 production to 5,000 per week. Upon achieving this production level, we expect to generate significant cash flows from operating activities.
Capital expenditures are expected to be approximately $1 billion in Q4, driven largely by milestone payments on Model 3 production equipment, as well as Gigafactory 1, and further expansion of stores, service centers, delivery hubs and the Supercharger network.
The worst news, however, is that investors may finally be losing patience and the stock was down as much as 5% after hours, a rare adverse reaction to the company's increasingly shaky - if extremely ambitious - growth plan coupled with a cash burn that puts even Netflix to shame.
As for Tesla's bondholders, judging by the steep price drop after hours as holders flee from what is an increasingly obvious "melting ice cube", the company may have trouble finding willing buyers the next time it decides to issue debt.