Tesla

When it comes to describing its situation, not even Bob Ross could paint a prettier picture than Tesla Motors. The California automaker has had a good few months and announced today that it delivered 7,579 Model S EVs in the second quarter of 2014. That's the most the company has ever delivered in a three-month period, reflecting an expanded market that now spans new countries in Asia and Europe. Tesla also built 8,763 vehicles in that time frame, another record, thanks to getting more cells from battery supplier Panasonic, and says it remains "on track for more than 35,000 deliveries in 2014."

Alongside the earlier announcement about the official Gigafactory announcement with Panasonic, the automaker also said today that it has broken ground on a "potential" location in Reno, NV, – validating earlier speculation – while it is still looking at locations in Arizona, California, New Mexico and Texas. Work at the site has mostly stopped for now, however, as the company doesn't want to begin pouring cement until state incentives are in place and a "compelling deal for all parties" has been struck. The ball in Nevada, according to CEO Elon Musk, is now in the hands of the state's governor and legislature.

The 7,579 vehicles delivered last quarter continue an upward-moving trend line. In all of 2012, Tesla sold 2,650 Model S EVs. For 2013, the company delivered 4,900 vehicles in Q1, 5,150 in Q2, 5,500 in Q3 and 6,892 in Q4. In 2014, Tesla sold 7,535 Model S EVs in Q1. Add in the 7,579 from Q2 this year, and you've got 15,100 or so, meaning that Tesla needs the next two quarters to average out at around 10,000 each in order to hit the 35,000-vehicle goal. Tesla expects 2015 to be even better, saying that the rate at which its expanding means that its, "annualized delivery rate should exceed 100,000 units by the end of next year." In other words, deliveries for Q4 2015 should be around 25,000 EVs.

A few other tidbits from the shareholder letter and today's conference call:
  • Tesla had a loss of $62 million last quarter.
  • The company's Fremont, CA factory is being upgraded to make the Model S and X on the same line and will be up and running next week.
  • Speaking of next week, the first operational Model X Alpha prototypes should be ready by next week.
  • Tesla expects North America to continue to contribute strong demand for its EVs, despite the Model S being available here for several years now. The company says, "we believe [North America and Europe] remain under-penetrated. We expect demand to continue to increase worldwide as we continue to grow our customer support infrastructure and broaden the appeal of our products, and as consumer awareness improves."
  • Model S drivers have driven 394 million miles in their fancy EVs so far.
  • Musk addressed the issue of drivetrain replacement, saying many early swaps were a result of problem misdiagnosis, including a couple performed on the vehicle belonging to Edmunds. A problem in some early drive units are being fixed with a 50-cent shim. Chief Financial Officer Deepak Ahuja said that from a cost perspective, "impact on warranty reserves have not been significant."
  • A couple of times during the call with financial analysts, allusions were made to developments that are currently not on the radar. Apparently, Tesla is "not showing all our cards" and capital expenditures and R&D numbers are better than appear because "there are things you don't know about." Hmm.
Read more below or click through our gallery of the actual letter.
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Tesla Motors, Inc. – Second Quarter 2014 Shareholder Letter

• Tesla and Panasonic announce Gigafactory agreement
• Site preparation started in June for a potential Gigafactory location
• Record Q2 Model S deliveries of 7,579 vehicles
• Record Q2 Model S production of 8,763 vehicles
• Net income of $16M and $0.11 EPS (non-GAAP), loss of $62M and $(0.50) EPS (GAAP)
• New Model S/Model X assembly line planned to begin operation next week
• On track for more than 35,000 deliveries in 2014

July 31, 2014

Dear Fellow Shareholders:

We have had an active first half of 2014, and the rest of the year is expected to be even busier. The development of our large-scale battery manufacturing facility, known as the Tesla Gigafactory, is proceeding well. We have formalized our agreement with Panasonic for cell manufacturing at the Gigafactory and remain on track with the site selection process. In addition, we are adding new production capacity at our Fremont factory that will allow us to meet the growing worldwide demand for our vehicles. The speed at which we are executing this capacity upgrade will allow us to exceed 35,000 Model S deliveries this year. Provided that we execute well and there are no serious macroeconomic shocks, Tesla's annualized delivery rate should exceed 100,000 units by the end of next year.

Laying the Groundwork for Future Growth

Earlier today, Panasonic and Tesla entered into a formal agreement to partner on the Gigafactory. Panasonic will invest in production equipment that it will use to manufacture and supply Tesla with battery cells. Tesla will prepare and provide the land, buildings and utilities for the Gigafactory, invest in production equipment for battery module and pack production, and be responsible for the overall management of the Gigafactory. Additional Gigafactory partners for production of cell precursor materials will be announced in the coming months to create a fully integrated industrial complex. Processed ore from mines will enter by railcar on one side and finished battery packs will exit on the other.

In June, we broke ground just outside Reno, Nevada on a site that could potentially be the location for the Gigafactory. Consistent with our strategy to identify and break ground on multiple sites, we continue to evaluate other locations in Arizona, California, New Mexico and Texas. The final site for the first Gigafactory will be determined in the next few months, once we have full visibility and agreement on the relevant incentives and processes for enabling the Gigafactory to be fully operational to meet the timing for Model 3. We see these concurrent efforts as prudent. This vehicle will be our third-generation product and will substantially broaden the addressable market for Tesla, helping to accelerate the transition towards sustainable transportation. Any potentially duplicative investments are minor compared to the revenue that could be lost if the launch of Model 3 were affected by any delays at our primary Gigafactory site.

At the Fremont factory, we set a new record for vehicles produced this quarter, which came in tandem with substantial efforts underway to increase the factory's capacity. Factory production reached 8,763 Model S vehicles during the quarter, up 16% from Q1. Recently, we have been producing about 800 cars per week. Panasonic's increased cell production capacity in Japan has begun to reduce this critical constraint on vehicle production.

To increase manufacturing capacity further, we are building a new final assembly line and adding more automation to our body shop. With advancements in automation and efficiency, our new assembly line has the capacity to produce more than 1,000 vehicles per week and the flexibility to build both Model S and Model X. Production on the new line begins next week after a shutdown for the transition. As planned, the transition will result in about 2,000 fewer units being produced in Q3, while having no significant impact on scheduled customer deliveries. After a short ramp up period in Q3, we foresee average Q4 production of slightly more than 1,000 cars per week, enabling us to meet our 2014 delivery guidance of more than 35,000 vehicles.

Model S/Model X Final Assembly Line – Fremont

Expanding Model S Demand

At Tesla, we see a clear distinction between demand and deliveries. We measure demand by the number of cars that have been ordered. An order occurs when a customer selects their vehicle configuration and pays the nonrefundable cash deposit. Deliveries, on the other hand, are the fulfillment of those orders. The number of deliveries in a quarter is influenced by three main factors: our ability to increase production; the allocation of that production among our North American, European and Asian markets; and the need to fill the in-transit pipeline for future deliveries in each region. This quarter, for example, we delivered 7,579 Model S vehicles, slightly ahead of guidance and up by more than 17% sequentially. However, even though we increased both production and deliveries, average global delivery wait times increased because our production growth was unable to keep pace with increased demand.

Model S orders, and thus demand, continue to grow even in our most established markets. In both North America and Europe, Q2 Model S orders increased sequentially at a much faster rate than for the rest of the automotive industry. Accordingly, we believe these markets remain under-penetrated. We expect demand to continue to increase worldwide as we continue to grow our customer support infrastructure and broaden the appeal of our products, and as consumer awareness improves.

This year, we are doubling our total global addressable market by entering China and right hand drive (RHD) markets. Model S is off to a very encouraging start in China, especially considering that we are delivering cars only in the areas around Beijing, Shanghai, Shenzhen and recently Hangzhou where we can assure customers of service coverage. We are planning to launch service and deliveries in many additional cities in the upcoming months, including Chengdu and Guangzhou. China has almost 10 times as many

cities with more than 1 million people compared to the United States, so we believe the opportunity is substantial.

RHD Model S is also being well received in the United Kingdom where it launched in June and in Hong Kong where it launched last week. Hong Kong is a unique market because Model S is exempt from registration tax that nearly doubles the cost of a comparable luxury car. We plan to begin RHD Model S deliveries in Japan and Australia later this year. Our customers have now driven the Model S for 394 million miles globally, saving nearly 18 million gallons of gasoline.

RHD Model S – United Kingdom

We continue to open stores and service centers worldwide to support our global expansion. For the rest of 2014, the rate of location openings will be fastest in China, followed by Europe, and then North America. We also continue to expand our Supercharging network, with the introduction of our Superchargers in Canada and a substantial increase in the rate of deployment in Europe and China. Globally, we just energized our 156th Supercharger, which makes our network both the largest and the most rapidly growing fast charging network in the world. We measure the network's

Q2 Results

RHD Model S – Hong Kong

size by charging capacity because it represents the ability to displace petrol-powered with electricity powered miles. In June alone, the Supercharger network passed a milestone, delivering more than 1 GWh of energy to Model S vehicles in the month, representing 2.7 million miles of driving. Since inception, our customers have driven for free nearly 32 million Supercharged miles, the same distance as traveling to the moon and back, sixty-five times!

Development efforts remain on track for production of Model X in the spring of 2015. We anticipate having operational Alpha prototypes ready by next week in order to confirm design intent and Beta prototypes to be ready later this year.

As usual, this letter includes both GAAP and non-GAAP financial information because we plan and manage our business using such non-GAAP information. Non-GAAP financials exclude stock-based compensation and non-cash interest expense, while adding back the deferred revenue and related costs for cars sold with a residual value guarantee or similar buy-back terms.

Non-GAAP revenue was $858 million for the quarter, up 55% from a year ago, while GAAP revenue was $769 million. Compared to Q1, the average selling price of Model S was stable. Automotive revenue for Q2 includes $23 million of powertrain sales to Daimler and Toyota, reflecting the start of production deliveries to Daimler for the Mercedes-Benz B Class Electric Drive and the wind down of sales to Toyota for the RAV4 EV.

This quarter, we started business leasing for Model S in the United States. We recognize revenue for leased vehicles over the term of the lease in both our GAAP and non-GAAP financials. By contrast, other automotive manufacturers recognize full revenue for the price of the vehicle even if that vehicle is eventually leased, because the vehicle is first sold to an independent dealer. To facilitate comparisons with other automakers, we have disclosed in our supplemental tables below that $16 million of aggregate sales value was related to the 158 vehicles leased to business customers in Q2. We expect to recognize this amount in revenues over the next few years. Additionally, our balance sheet disclosures summarize the cost of these operating lease vehicles, which we expect to recognize as cost of revenues over the same period.

During Q2, we achieved a non-GAAP automotive gross margin of 26.8%, and 26.9% on a GAAP basis. These results represent a 140 basis point improvement in non-GAAP automotive gross margin sequentially, excluding ZEV credits, and our warranty reserves are generally consistent with the prior quarter.

Research and development (R&D) expenses were $93 million on a non-GAAP basis and $108 million on a GAAP basis. Non-GAAP R&D expenses were up 37% from Q1 as Model X engineering work continues to accelerate and as we develop processes for capacity expansion.

Selling, general and administrative (SG&A) expenses were $117 million on a non-GAAP basis and $134 million on a GAAP basis. The 20% sequential increase in non-GAAP SG&A expenses was driven by the rapid pace of our global growth and by the expansion of our customer support infrastructure.

Q2 non-GAAP net income was $16 million, or $0.11 per share based on 140.9 million diluted shares, while Q2 GAAP net loss was $62 million or $(0.50) per share.

We had a $2 million net cash outflow from operations in Q2 primarily due to an $82 million increase in finished goods inventory from cars in transit to Europe and China, and $15 million of cash used for leasing vehicles. Capital expenditures in the quarter totaled $176 million.

Cash at quarter end, including cash equivalents, increased to almost $2.7 billion, in part because our underwriters exercised the overallotment option on the Q1 convertible note financing, contributing an additional $267 million of cash in Q2.

Q3 & 2014 Outlook

We plan to produce about 9,000 cars in Q3. This target takes into account the effect of the two-week production shutdown related to the transition to the new final assembly line at the Fremont factory. If we had been able to avoid this production down time, we would have been able to forecast Q3 quarterly production at about 11,000 units. After considering our planned production and the need to have more vehicles in transit (including the new RHD models), we expect to be able to deliver about 7,800 Model S vehicles in Q3. Without the planned factory retooling shutdown, Q3 delivery expectations would have been approximately 9,500 vehicles.

We expect non-GAAP automotive gross margin in Q3 to be about consistent with the prior quarter. As manufacturing efficiencies and part costs continue to improve, we continue to anticipate a 28% non-GAAP automotive gross margin, excluding ZEV credits, by Q4 of this year. We expect to lease about 300 cars in North America during Q3, and much more in Q4.

Q3 operating expenses are expected to grow sequentially by about 20% for R&D and 15% for SG&A. Despite a higher count of leased vehicles, investments in R&D, and geographic expansion, we expect to be marginally profitable in Q3 on a non-GAAP basis. Based on our current stock price, we project between 141 million and 143 million diluted shares outstanding in Q3.

We plan to invest between $750 million and $950 million in 2014, an increase of $100 million from prior guidance. We continue to invest in additional production capacity, continued Model X and Model S development, Gigafactory construction, and further expansion of our sales, service, and Supercharger footprints. We have also chosen to slightly accelerate our investments in production capacity and the Gigafactory.

It will indeed be a busy second half of the year as we execute on the opportunities ahead.

Elon Musk, Chairman & CEO Deepak Ahuja, Chief Financial Officer