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Tesla's new 8-year drivetrain warranty impact on Q3 2014 earnings

Discussion in 'TSLA Investor Discussions' started by DaveT, Aug 15, 2014.

  1. DaveT

    DaveT Searcher of green pastures

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    #1 DaveT, Aug 15, 2014
    Last edited: Aug 19, 2014
    Elon announced a new 8-year drive train warranty applied retroactively to all Model S vehicles ever produced:
    "The Tesla Model S drive unit warranty has been increased to match that of the battery pack. That means the 85 kWh Model S, our most popular model by far, now has an 8 year, infinite mile warranty on both the battery pack and drive unit. There is also no limit on the number of owners during the warranty period.

    Moreover, the warranty extension will apply retroactively to all Model S vehicles ever produced. In hindsight, this should have been our policy from the beginning of the Model S program. If we truly believe that electric motors are fundamentally more reliable than gasoline engines, with far fewer moving parts and no oily residue or combustion byproducts to gum up the works, then our warranty policy should reflect that.

    To investors in Tesla, I must acknowledge that this will have a moderately negative effect on Tesla earnings in the short term, as our warranty reserves will necessarily have to increase above current levels. This is amplified by the fact that we are doing so retroactively, not just for new customers. However, by doing the right thing for Tesla vehicle owners at this early stage of our company, I am confident that it will work out well in the long term."​

    First, I applaud this decision as I think it's not only increases owner loyalty but also increases the appeal of the car, which increases demand. I also think the long-term expenses will be minimal for Tesla. However, there will be other posts to discuss this newly updated warranty in general.

    The purpose of this post is to specifically discuss the new drive train warranty's impact on next quarter (Q3) earnings:
    - What's Tesla's current warranty reserve per vehicle, and how much will that increase due to this warranty?
    - How much money will Tesla need to put into warranty reserves due to this new warranty applied retroactively?
    - How will the warranty expense for past cars be recorded? How does this affect Q3 earnings?

    I haven't done the research on this yet, as I'd like to crowdsource this and see if folks can pitch in to nail down some numbers. But for the sake of keeping this thread manageable, let's not post opinions about the warranty in general but rather focus in on real numbers and research into the warranty reserves. And if you don't have hard data/facts/figures, then let's give room to those who will put in the research to post what they've found out.

    8/19/14 Update:
    I asked Tesla Investor Relations the following question and got the following response this afternoon.

    Q: Can you shed any light on how much the extended drive train warranty will cost Tesla as a one-time expenses in Q3?

    A: We have not provided any estimate of those costs. Analysts are generally estimating a 1-2% of revenue charge in Q3 for past vehicles and an ongoing 25-50 basis points (a quarter to half a percent) ongoing cost in future quarters.All of this will pass through cost of goods sold and lower gross margin.

    ---------------------------

    Here are my personal thoughts on Tesla's response.

    1. It appears that they haven't given guidance regarding the impact of the drive train warranties yet.

    2. They've shared some analysts estimates, and this helps us form a rough range (although it might not be accurate).

    3. "1-2% of revenue charge in Q3" - I'm personally forecasting about $880M in non-GAAP revenue for Q3, so 1% expense would be about $9M and a 2% expense would be $16M. There were about 40k cars sold prior to Q3 2014. So a one time $9M warranty charge would be $225/car. A one-time $18M warranty charge would be $450/car. This isn't too far off from my original estimates several days ago (I estimated about $400/car).

    4. An "ongoing 25 to 50 basis points" works out to be roughly $250-500 per new car (ie., if ASP is around $100k). This hits gross margin about .25 to .50%. This might make it difficult to hit the 28% gross margin target by the end of the year.

    Overall, if analysts estimates are correct then the drive train warranty will not add a huge expense to Q3 and it's impact to gross margin is minimal. However, it still might be difficult for Tesla to be non-GAAP profitable in Q3 unless they sell ZEV credits or they sell more cars than guidance.

    However, in the bigger picture being slightly non-GAAP not-profitable in Q3 is not a big deal as long as Tesla continues to execute and continues to ramp production successfully to meet growing demand.
     
  2. TD1

    TD1 Member

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    I see a pattern here:
    When there were a lot of talks about the uncertainty of the resale value of the Model S, Elon announced the buyback guarantee.

    Now there seems to be worries among the customers about the durability of the drive unit, so Elon announces an 8 year guarantee on that.

    So I see it like just the way that these guarantees will lower the margin per car, but also will increase the demand and the image of Tesla.
    Demand is not an issue as of right now, but Tesla wont stay for ever supply constrained.

    Angry customers complaining about an expensive Drive Unit replacement is something that needs to be avoided.
    Tesla is here in its own League since people are cautious about this "new" technology.

    In my personal conversations with people, the point of reliability of EVs came up more frequent then I would have thought.
     
  3. FANGO

    FANGO Active Member

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    A friend of mine brought something up - if the drivetrains so far have all been replaced under warranty (a few are probably over 50k, but not many), does this still mean that Tesla has to put aside money for warranty obligations now, or can they wait until later? I presume there's a law which exists and requires them to hold a certain amount of money at the start of the warranty, but will we end up seeing a big increase in warranty reserves, or just a pittance? Especially considering the battery is far more expensive than the drive unit anyway, and if they all already have long warranties, then this should be somewhat of a drop in the bucket...

    Also, will this count as a "one-time expenditure" where they can say they have .xx EPS discounting one-time expenditures? Or will they have to account for it? I suppose that would all be GAAP, and we're more interested in non-GAAP anyway (where I'm sure they will make note of this as a one-time expenditure, and correct for that), but just wondering if anyone knows the rules on that.
     
  4. Topspin

    Topspin Member

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    #4 Topspin, Aug 16, 2014
    Last edited: Aug 16, 2014
    They
     
  5. RationalOptimist

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    Here's one way to sketch out the impact.

    1. Total cars sold before the problem largely addressed. (guess: 10k)

    2. Percentage of those cars which will make warranty claim in years 4-8: (guess: 10%. Many more than that will make the claim in first 4 years, but that shd already be accounted for.)

    3. Total cars sold after problem largely addressed (30k).

    4. Percentage of those more recent sales who will make warranty claim in years 4-8 (guess: 3%. Again, the majority of any probs likely taken care of years 1-4)

    5. Average cost to Tesla to remove, fix, and replace drive train. (guess: $2k)

    Those assumptions would generate a one-time warranty reserve increase of just under $4m. That would be consistent with 'moderate'. But the assumptions may be way off.
     
  6. Chickenlittle

    Chickenlittle Active Member

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    I don't believe they have to wait 8 yrs. if warrantee costs less than expected they can reduce the reserve before then
     
  7. DaveT

    DaveT Searcher of green pastures

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    Topspin - in the original post I specifically asked people stick with the topic of warranty reserves impact on Q3. I don't appreciate it how you diverted this thread into an argument about Tesla's overall valuation. That can/should be done in another thread.

    Mod - please move these posts (starting from #6) to long-term fundamentals or another thread.
     
  8. anticitizen13.7

    anticitizen13.7 Enemy of the Status Quo

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    It will depend on the amount of warranty reserve that has to be increased, so there is no way for us to know right now.

    We know from Elon's statements during the Q2 conference call that motor replacements due to noise were caused by either loose wires that could easily be tied down, or a shim of marginal cost. These problems are easily repaired and easy to prevent during manufacturing, so going forward, I don't expect to see many issues where the motor is concerned.
     
  9. Ampster

    Ampster Member

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    #9 Ampster, Aug 16, 2014
    Last edited: Aug 16, 2014
    Yes, the reserve would probably be based on aggregate experience not on a per car experience. I would guess that a per car reserve number would be included in costs and the size of the balance sheet reserve number would be expected to grow until the first cars hit the 8 year mark. I would also guess that warranty cost would be applied against that reserve and the adequacy of the reserve would be evaluated quarterly.
     
  10. tomas

    tomas Traded in 9 rep bars for M3, used to be somebody!

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    I've stayed out of investor threads, but gotta say this: in order to achieve transformation mission and grow into lofty valuation, tesla motors needs to continue to think big. R&D, new products, new product lines, new markets, golden customer service and brand loyalty/identity. Rushing to quarterly profits would ironically negate probabity of achieving mission and shareholder return. Google knew this, I remember all the years of carping about lack of profit and high valuation - until they created/cornered the page view advertising market, or whatever you call it. Keep eye on the prize! Drivetrain move excellent loyalty and image move at minimal cost. People sweating Q3 or any other quarter are in wrong stock!
     
  11. NigelM

    NigelM Recovering Member

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    Mod Note: posts moved to Bubbles and Billionaires. Dave is right, please stay on topic folks.

    - - - Updated - - -

    On topic: I don't have any good numbers but it does occur to me that extending the warranty will help maintain resale prices which may in turn reduce Tesla's liability wrt to resale guarantee; that could be a nice little back-door benefit.
     
  12. kalikgod

    kalikgod Member

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    DaveT, thanks for starting this thread (and keeping it focused), I had the same curiosities.

    I took a shot a putting together some data on the warranty costs from the 10Q filings since the Model S went on sale. I am more looking for a worst case scenario on what could hit in Q3. I will try to paste my summary results in here. I am also providing the link the the Google Sheet I put together on it. Sorry for the poor plots in there, my Sheets plotting skills are terrible.

    TSLA Warranty Reserves - Google Sheets

    ----

    Ok, I give up on the table paste. You will have to follow the link, sorry.
     
  13. Chickenlittle

    Chickenlittle Active Member

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    I hope you realized that the first 4 years of drive train warrantee is already in current reserves. Second I would suspect that the last 4 years would be lower than the first 4 years since drive trains already proved good or fixed, hopefully permanently
     
  14. kalikgod

    kalikgod Member

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    #14 kalikgod, Aug 16, 2014
    Last edited: Aug 16, 2014
    I do realize that. What I am not sure of is what percentage of the 4 year warranty cost was originally portioned for the drivetrain. That is why I took a shot at 50% and 25%. It may be even lower as the supposed cost of a brand new drivetrain is ~15% of the ASP.

    These numbers are conservative to prepare for a worst case scenario in the Q3 report. The warranty cost data isn't showing anything scary so far, so I think this issue is definitely overblown. Tesla is also probably making the repairs more cost effective than a typical automaker.
     
  15. AudubonB

    AudubonB Mild-mannered Moderator Lord Vetinari*

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    I applaud your bringing up a worthwhile topic, Dave - even if I poo-poo any particular quarter's results, a wise old amoeba once told me that quarter by quarter, eventually that adds up to long-term.....

    My thoughts run similarly to Anticitizens's. First, while we cannot be privy to the amount they will set aside, we should assume that will be a number appropriate to that which would take care of the number of S85's produced to date, times the fraction TM determines may present a problem, times the cost of repair. You have the first number (oops - I don't. What is it? 28,000 now???); I would try to be cautious with the second and call it 25 percent, and the last number is the killer-or-saviour. IF we take Mr. Musk's 2Q results words at their face value, then we're looking at a nickel or so of direct costs, plus appropriately amortized shop-time costs, to handle what I will suggest to be 98 percent of that fraction. In other words, 2/3s of 3/8s of f----all. Zilch-o. A sneeze.
    That leaves 2 percent or so of vehicles to demonstrate a "real" drivetrain problem, and I may be overstating that by fifty percent. An electric motor really does not run into problems! It's simple stuff!

    But - I also am going to suggest that 3Q's reserve number instantly will be the most looked-for datum of the Oct 30th-or-so press release. For me, it will demonstrate conclusively what TM believes to be the 'problem factor' of its motor &c. Neat stuff!
     
  16. DaveT

    DaveT Searcher of green pastures

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    Thanks kalikgod for the spreadsheet. Going off of your numbers it appears that Tesla is setting aside roughly $2800 per new vehicle (though varies) for warranty reserves.

    The question is how much will they add to warranty reserves for an extra 4 year drive train warranty?

    My rough guess would be $400. Most of the faulty drive trains from earlier VINs will be replaced within the first few years, so warrant years 5-8 will likely be minor fixes.

    If that's the case, and they delivered 40k Model S's through end of Q2 and maybe 1.5k in first several weeks of Q3 (since factory was shut down), then that would mean 41.5k x $400 = $16.6 million.

    So, I'm estimating a one-time expense of $16.6 million. Overall, I think it's a nominal amount, but it will make it difficult to be profitable non-GAAP in Q3 unless they sell a lot more cars than forecasted or they sell a lot of ZEV credits.
     
  17. Cattledog

    Cattledog Active Member

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    While the issue may have popped up at HQ in the last 3 weeks, I am imagining that they were already deep into the decision making process on it by the earnings call. So I imagine some thought about its cost impact is baked into the Q3 numbers.
     
  18. schonelucht

    schonelucht Active Member

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    Interesting spreadsheet from kalidgod. Thanks for running the numbers. Warranty expenses are fairly constant at slightly less than $300 per car, per quarter. Over 4 years, costs would be $4800 per car which is higher than the number they are setting aside. It seems like Tesla is counting on many drivers hitting the 50k miles limit first instead of the 4 years, which may be a good bet. Still, by only setting aside slightly less than $3000, that would mean on average funding for 10 quarters of warranty expenses. Honestly this seems a little low. I would not be surprised if the additions to warranty reserves are going to come in higher than most posters here expect to offset this potential shortfall without having to go to the markets with additional negative information.

    I also had expected the warranty expenses to trend downwards more aggressively than they do due to the factory getting better at manufacturing defect free cars. It will be interesting to see if the coming quarters confirm the modest downward trend.

    Btw can someone explain why the number they set aside with each new sale varies so wildly?
     
  19. kalikgod

    kalikgod Member

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    Thanks for the comments on the spreadsheet.

    This calculation was very conservative. Remember there are still roadster warranties active right now. All the CPOs came with new full warranties. I think those are disproportionately more expensive to service than Model S.

    I also think there will be a lag effect on new vehicle quality helping the per car cost of the warranty. If the cost per car each quarter keeps trending down, I think they will be very close to the $2800 target in the original terms.

    The real question is how much of the original $2800 was for the drivetrain? Since that number was determined before the issues appeared, we should be doubling that portion of the cost. 15% of the warranty would be $420. I think that is the realistic min they would need to add to each future (and retroactive warranty). 47000 * 420 ~= $20 million. I think that is the lowest adjustment we see on Q3.

    It is better for them to set aside a chunk of money now while they have a pile of cash. Cash burn is going to go up significantly once GF is under real construction.
     
  20. schonelucht

    schonelucht Active Member

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    Good point about the Roadsters. But if they are significantly more expensive to provide warranty for than a model S, wouldn't we actually expect the expenses per car to go down even more aggressively? Given that in 2012 the impact of the cost to repair Roadsters would be proportionally much higer than in 2014 when 1) many CPO Roadsters are now out of their 3 year warranty period) and 2) much more model S's make them proportionally more important. Still if we look at per car expenses for the first half of 2013 (the numbers suggest part of the warranty costs for Q2 were shifted to Q1) we are at $527 while the corresponding period in 2014 it was $530.

    Wrt to the widely differing reserves set aside per car for future warranty expenses, maybe the right divisor isn't number of sales, but number of cars produced?
     

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