Deepak Ahuja: "Our expectation is that we will establish shop via warehouse line ....

[Benz]

During Conference Call ER Q4 2014 (on February 11th, 2015):

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Andrea James - Dougherty & Company LLC
Hi, thanks for taking my questions and congratulations on the rocket launch.

Elon Musk - Chairman, Product Architect and Chief Executive Officer
Thank you.

Andrea James - Dougherty & Company LLC
So just quickly can you help me get to a free cash flow for your, looks like you can do $1.5 billion in CapEx, but what’s going to be the operating cash flow to offset that?

Deepak Ahuja - Chief Financial Officer
Yes, we will have clearly significant - Deepak here, hi Andrea.

Andrea James - Dougherty & Company LLC
Hi.

Deepak Ahuja - Chief Financial Officer
We would have significant positive operating cash flow, obviously as our business, our volume gross and our gross margin continues to improve. We’ll also have some cash used on our direct leasing program. Our expectation is that we will establish shop via warehouse line for leasing cars and that will continue to grow and fund the big portion for leasing funding required. So overall, we feel pretty comfortable where we are in terms of our 2015 look from a cash flow perspective.

Andrea James - Dougherty & Company LLC
So maybe about $1 billion is that about inline cash burn?

Deepak Ahuja - Chief Financial Officer
Should be less than that.

Andrea James - Dougherty & Company LLC
Okay.

Deepak Ahuja - Chief Financial Officer
Yes, considering that we will have a lease warehouse line which continues to expand.
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I don't think that I completely understood the point about this "lease warehouse line".

Peolple in certain states of the US can already lease a Tesla Model S, either direct via Tesla Motors or not.

What is so new about this "lease warehouse line"?

Is this something that is pretty normal in the US?

 

[flankspeed8]

I may be wrong but I think he was implying that they could monetize by securitization these assets to turn into FCF?

 

[hockeythug]

I may be wrong but I think he was implying that they could monetize by securitization these assets to turn into FCF?

Correct.

 

[Benz]

I may be wrong but I think he was implying that they could monetize by securitization these assets to turn into FCF?

Can you please explain that for me a little bit?

 

[uselesslogin]

Oh, I feel much better reading this. This letter made me nervous because I realized how critical the X launch is now and how making Model 3 "less adventurous" is also very important. But knowing at least that they have a source of credit to help them absorb setbacks helps. I'll feel far better if they beat Q1 guidance by a good margin.

 

[flankspeed8]

Think of it in the context of a home mortgage. If Citibank lends you $500,000 to buy you a house, they get interest income at the speed at which you are repaying it. All the appreciation in price goes to you, the owner so they really don't have much of an upside. Instead, they decide that they have a better use for that money, they will sell off your original loan to another company who will pay them a premium (hopefully) for it. That frees up Citibank to use that money for another loan or other use.

All of these leases and CPO cars are sitting on Tesla's balance sheet but are not bringing them much income in the short term. So, they decide to sell these off to another company and receive cash in return that they can reinvest into the company. It frees up more cash for them to use.

 

[adiggs]

Think of it in the context of a home mortgage. If Citibank lends you $500,000 to buy you a house, they get interest income at the speed at which you are repaying it. All the appreciation in price goes to you, the owner so they really don't have much of an upside. Instead, they decide that they have a better use for that money, they will sell off your original loan to another company who will pay them a premium (hopefully) for it. That frees up Citibank to use that money for another loan or other use.

All of these leases and CPO cars are sitting on Tesla's balance sheet but are not bringing them much income in the short term. So, they decide to sell these off to another company and receive cash in return that they can reinvest into the company. It frees up more cash for them to use.

To build on this - Tesla is choosing to carry those self-leases on their own books right now as they have plenty of cash to fund them, and the interest that cash is earning sitting in a bank account is low. If that changed, or they needed to free the cash up to pay for the next round of Gigafactory build (for example), Deepak's point was those leases that are on the books and providing a monthly payment stream can be converted into cash for the full amount trivially. Today, it's a better economic choice for Tesla to carry the monthly payment streams as they cash won't be used for other purposes and they can earn a few % on those sums instead of 0.1%.

 

[FrozenCanuck]

To build on this - Tesla is choosing to carry those self-leases on their own books right now as they have plenty of cash to fund them, and the interest that cash is earning sitting in a bank account is low. If that changed, or they needed to free the cash up to pay for the next round of Gigafactory build (for example), Deepak's point was those leases that are on the books and providing a monthly payment stream can be converted into cash for the full amount trivially. Today, it's a better economic choice for Tesla to carry the monthly payment streams as they cash won't be used for other purposes and they can earn a few % on those sums instead of 0.1%.

Wonderful explanation. I believe this is what many of the bears over at SA do not quite understand, but I haven't yet compared some of their arguments to the actual financials to see if I'm right that they are misundersanding this. Regardless, it's clear that Tesla has cash available to them, and it's clear that if they wanted to they could easily use a third party to finance the leases such that cash flow improves tremendously.

 

[Benz]

Think of it in the context of a home mortgage. If Citibank lends you $500,000 to buy you a house, they get interest income at the speed at which you are repaying it. All the appreciation in price goes to you, the owner so they really don't have much of an upside. Instead, they decide that they have a better use for that money, they will sell off your original loan to another company who will pay them a premium (hopefully) for it. That frees up Citibank to use that money for another loan or other use.

All of these leases and CPO cars are sitting on Tesla's balance sheet but are not bringing them much income in the short term. So, they decide to sell these off to another company and receive cash in return that they can reinvest into the company. It frees up more cash for them to use.

OK, thanks.

- - - Updated - - -

To build on this - Tesla is choosing to carry those self-leases on their own books right now as they have plenty of cash to fund them, and the interest that cash is earning sitting in a bank account is low. If that changed, or they needed to free the cash up to pay for the next round of Gigafactory build (for example), Deepak's point was those leases that are on the books and providing a monthly payment stream can be converted into cash for the full amount trivially. Today, it's a better economic choice for Tesla to carry the monthly payment streams as they cash won't be used for other purposes and they can earn a few % on those sums instead of 0.1%.

OK, thanks.

The direct leasing from Tesla Motors means that there is no third party (like a bank) involved in this lease construction, right?

Meaning that the customer only has an obligation towards Tesla Motors for providing the money to finance the lease, right?

That's actually a brilliant construction. Specially the fact that there is no third party involved.

Or dit I not understand this correctly?

 

[svp6]

I thought the leases go through US Bank now, as they had better terms for the private lease. Mine is through US Bank, and I was not given an option to decide between a Tesla and a US Bank lease. I have no idea how this works for business leases.

 

[CHGolferJim]

I believe the securitization/monetization of leases (sale to a third party, possibly even to a related company) would also lead to an immediate recognition of the revenue amounts not yet captured at the sales line (reducing or eliminating the balance sheet item "deferred lease income", or whatever it's called). Depending on how they do the accounting, this might be net positive for gp ratio.

 

[adiggs]

I believe the securitization/monetization of leases (sale to a third party, possibly even to a related company) would also lead to an immediate recognition of the revenue amounts not yet captured at the sales line (reducing or eliminating the balance sheet item "deferred lease income", or whatever it's called). Depending on how they do the accounting, this might be net positive for gp ratio.

There are apparently 2 kinds of leases that Tesla is engaged in. The first kind involving US Bank or whoever is a big reason why we get the non-GAAP financials. In that lease, it's the bank that owns the car / lease, and receives the lease payments. Tesla receives cash for the car at the time of delivery.

As of this conference call, it sounds like Tesla also has a program (maybe for businesses, or some other segment?) in which Tesla leases the car directly to the consumer. In this case, the cash flow to Tesla is in the form of a monthly payment, and that's how Tesla is recognizing that income in the financials - both GAAP and non-GAAP. Going back to Deepak's point, for the money in that category that is owed but not yet paid, Tesla can bundle those together and sell them to another investor and convert them into cash (with the other investor exchanging cash for the monthly payment stream and the few % interest).

 

[uselesslogin]

As of this conference call, it sounds like Tesla also has a program (maybe for businesses, or some other segment?) in which Tesla leases the car directly to the consumer. In this case, the cash flow to Tesla is in the form of a monthly payment, and that's how Tesla is recognizing that income in the financials - both GAAP and non-GAAP. Going back to Deepak's point, for the money in that category that is owed but not yet paid, Tesla can bundle those together and sell them to another investor and convert them into cash (with the other investor exchanging cash for the monthly payment stream and the few % interest).

Actually the business leasing came first and US Bank second. I now remember they mentioned the warehouse line of credit back then as well. I don't know if it was Q1 or Q2 last year.

 

[CHGolferJim]

Deepak Ahuja's bio (from Forbes)

7/2008 - Present. CFO, Tesla
7/06 - 7/08. Vehicle Line Controller, Small Cars Product Development, Ford
2/03 - 6/06. CFO, Ford South Africa
9/00 - 2/03. CFO, Auto Alliance International, Ford/Mazda JV
9/93 - 9/00. Various, Ford

MBA, Carnegie Mellon
MS, Materials Engineering, Northwestern
BS, Ceramic Engineering, Banaras Hindu University

 

[Benz]

There are apparently 2 kinds of leases that Tesla is engaged in. The first kind involving US Bank or whoever is a big reason why we get the non-GAAP financials. In that lease, it's the bank that owns the car / lease, and receives the lease payments. Tesla receives cash for the car at the time of delivery.

As of this conference call, it sounds like Tesla also has a program (maybe for businesses, or some other segment?) in which Tesla leases the car directly to the consumer. In this case, the cash flow to Tesla is in the form of a monthly payment, and that's how Tesla is recognizing that income in the financials - both GAAP and non-GAAP. Going back to Deepak's point, for the money in that category that is owed but not yet paid, Tesla can bundle those together and sell them to another investor and convert them into cash (with the other investor exchanging cash for the monthly payment stream and the few % interest).

Wouldn't it be obvious for customers to choose the direct lease instead of the lease where a third party (a bank) is involved?

 

[HansWurst]

Wouldn't it be obvious for customers to choose the direct lease instead of the lease where a third party (a bank) is involved?

I guess that the bank can offer more attractive rates to Teslas customers than Tesla itself can. Thus I don't think the decision would obviously be towards a lease through Tesla.

 

[Benz]

I guess that the bank can offer more attractive rates to Teslas customers than Tesla itself can. Thus I don't think the decision would obviously be towards a lease through Tesla.

I think that I disagree with you on this matter.

This is what Elon Musk said on the Earnings Conference Call

From the transcript of the Earnings Conference Call
Elon Musk:
"So yes, and then even for leases that we do ourselves, we can securitize those leases whenever we want. So, we can take those leases, fund them and put them into a securitization program or just get a warehouse loan to recover the capital. The reason we’re using our existing capital is just basically common sense, because we’ve got a big bank balance that’s earning a 0.1% or basically nothing, actually minus whatever the inflation rate is. And so, it makes more sense for us to put that capital to work with consumer leases and current 2% to 3% that’s basically what it amounts to, but whenever we want to recover that capital we can do so through warehouse balance securitization. Yes."

 

[jhm]

I think that I disagree with you on this matter.

This is what Elon Musk said on the Earnings Conference Call

From the transcript of the Earnings Conference Call
Elon Musk:
"So yes, and then even for leases that we do ourselves, we can securitize those leases whenever we want. So, we can take those leases, fund them and put them into a securitization program or just get a warehouse loan to recover the capital. The reason we’re using our existing capital is just basically common sense, because we’ve got a big bank balance that’s earning a 0.1% or basically nothing, actually minus whatever the inflation rate is. And so, it makes more sense for us to put that capital to work with consumer leases and current 2% to 3% that’s basically what it amounts to, but whenever we want to recover that capital we can do so through warehouse balance securitization. Yes."

Yeah, this quote is very important for investors to understand. Tesla is sitting on about $1.9 B in cash which was raised primarily to build the Gigafactory. They will draw it down as needed to build the factory and for other capital projects. This is also called "cash burn," which in some circles has a bad connotation. But in the meantime, just holding this cash in bank accounts returns nothing on this capital. So the thing to do is find temporary uses for this cash to generate a little return while granting Tesla the liquidity to fund capital projects. So basically there is a capital cost to burning cash too slowly, and using cash for direct leasing is one way to reduce this capital cost. So while Tesla has surplus liquidity, it makes sense to deploy that cash as direct leases. Once the $1.9B is drawn down past a certain level, if they need more liquidity, they can securitize the leases. I expect they won't need to do so for the Gigafactory, but when they are opening new plants in Europe and Asia, this securitization option may become a handy way to avoid having to raise capital in a potentially dilutive way.

Investors who may be concerned about dilutive capital raises should take heart that Tesla does not need to securitize leases at this point. Those leases represent an asset which can be deployed at a future time to raise capital in a nondilutive way. So it is ironic that by not being GAAP profitable at an earlier stage, due to direct leasing, that Tesla is building up an asset which can hedge against dilutive capital raises and secure funding for longterm growth. The GAAP fisted pounding is totally ignorant.

 

[BornToFly]

Great explanation jhm!
I loving learning about how Tesla is always maximizing its long term financial outlook. Good stuff....

 

[HansWurst]

Yep Benz you are right, he did say that. As I said, I don't no either, I was just speculating. However, his statement doesn't say that the bank isn't offering cheaper rates (again, no knowledge, just speculation)
Another possibility:
They only offer direct leases to business customers and private leases are handled by their bank partner. This is a possible explanation why there are customers going with the bank lease.

I think that I disagree with you on this matter.

This is what Elon Musk said on the Earnings Conference Call

From the transcript of the Earnings Conference Call
Elon Musk:
"So yes, and then even for leases that we do ourselves, we can securitize those leases whenever we want. So, we can take those leases, fund them and put them into a securitization program or just get a warehouse loan to recover the capital. The reason we’re using our existing capital is just basically common sense, because we’ve got a big bank balance that’s earning a 0.1% or basically nothing, actually minus whatever the inflation rate is. And so, it makes more sense for us to put that capital to work with consumer leases and current 2% to 3% that’s basically what it amounts to, but whenever we want to recover that capital we can do so through warehouse balance securitization. Yes."