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

[kalikgod]

wouldn't we actually expect the expenses per car to go down even more aggressively?

Tesla didn't start the CPO program until after the Model S went on sale, IIRC. By the end of this year I would expect the Roadster to be less than 2% of the data we are seeing. I am just warning people to not read the 2012 or 2013 numbers as purely Model S. There was $869k and $813k in 2012 warrant cost in Q1 and Q2 respectively. I think you could attribute that 100% to Roadsters. Figuring out the exact warranty mix for 2012 and 2013, or when the Roadsters will be off warranty, will be really difficult.

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?

Excellent point. I do not have any idea whether the reserve is tied to production or sale. I will try to add that metric to the sheet later tonight.

I don't think the reserve per car is a fixed number either. I would imagine that the number would evolve over time as they get more data on the warranty claims.


I am looking closer at this category now: Changes in liability for pre-existing warranties, including expirations.

It looks like the Q1 2014 has a big number for the new battery shields. I can't really make sense of the 2013 numbers. Anyone have ideas?

 

[eepic]

Here is Forbes' analysis of the warranty change, for what it's worth. Decent article relative to a lot of mainstream media blunders when it comes to reporting on Tesla.

How Much Could Tesla's Cost The Company? - Forbes

 

[DaveT]

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.

 

[kalikgod]

I asked Tesla Investor Relations the following question and got the following response this afternoon.

Thanks for reaching out to them. That is in the ballpark of the numbers I was guessing at also. None of these numbers look like they effect any company prospects.

I have a feeling Tesla will just manage the spending to take this hit into account. A long time ago, I remember EM saying that they would be managing to be cash flow neutral while growing the business.

The only exception I see, is once concrete starts hitting the GigaFactory, we should start seeing some of the $2 billion in cash start to burn.

 

[TSLAopt]

I have a feeling Tesla will just manage the spending to take this hit into account. A long time ago, I remember EM saying that they would be managing to be cash flow neutral while growing the business.

The only exception I see, is once concrete starts hitting the GigaFactory, we should start seeing some of the $2 billion in cash start to burn.

Great investigative work DaveT as always and thanks for sharing. as for the point above, I agree and think the timing of this announcement could speak about the success of the new line's efficiency...I would speculate that EM wanted to wait to be sure that this new line would give them efficiency improvements enough in production (GM and capacity) to where he felt comfortable taking on this one time charge....and after two weeks of the new line running to plan he felt comfortable enough to know they could still be cash flow neutral for the quarter while taking on this charge.

 

[mershaw2001]

Great investigative work DaveT as always and thanks for sharing. as for the point above, I agree and think the timing of this announcement could speak about the success of the new line's efficiency...I would speculate that EM wanted to wait to be sure that this new line would give them efficiency improvements enough in production (GM and capacity) to where he felt comfortable taking on this one time charge....and after two weeks of the new line running to plan he felt comfortable enough to know they could still be cash flow neutral for the quarter while taking on this charge.

Or, the quarter is going to be a loss so they might as well add this loss onto the existing loss and throw all the bad things in at once. Or use this accounting for drive trains to obscure the actual loss.

 

[stoebs]

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?

I think you also need to take into account the mix of MS 60s and MS 85s. All the reporting I've seen focuses on EM's blog post about an infinite mile warranty. If you read carefully, he only writes that the drivetrain warranty is being extended to match the battery warranty. Don't forget that the unlimited mileage aspect of the battery/drivetrain warranty only applies to the 85 kWh models. The 60 kWh cars still have a 125k mile limit on their warranties. I would expect that the warranty reserve wouldn't need to be as high for the 60s that are out there; since it's probable that many of the 60s will exceed their mileage limit before the 8 year warranty period is up.

 

[Cobos]

I've had my S60 now for about 11 months and a few days and I guess my yearly milage will be 10k miles more or less. I guess that will be good for the years going forward, so after 8 years I'v still got around 40k miles left but I run out of years. Most that buy the S60 drive shorter trips, that's why they thought the S60 was enough. I figure the extra years for the drivetrain warranty even for the S60 should be enough for most owners. So in other words I would not count on much savings compared to 8 years duration.

Cobos

 

[vgrinshpun]

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.

My feeling is that we will be in the lower part of the range hinted by Tesla. I've felt this way for a while, thinking along the lines of low hundreds per car (Drive train replacements (results/share_impact)? - Page 3).

The interesting point to consider is that in spite of a promise of inherently higher dependability of electric platform, Tesla Motors reserves for warranty per car are actually higher then it's peers. According to Deutsche Bank note on impact of the warranty extension, as quoted by Streetinsider.com, TM allocations as of Q2 were $2,661/car, while luxury OEM peers average is $1,600/car.

One conclusion from this is that bear's screaming about Tesla being reckless by not allocating sufficient reserves for warranty is a plain lie - as it is obvious that they act very responsibly and actually allocated more than peers, although EV technology's promise is lower repair costs.

Another conclusion is that TM warranty reserves will tend to go lower from the current $2,661/car as volume increases and design of the cars matures via constant improvements based on real world experience of the growing fleet of cars in the wild. As a minimum this lowering of warranty expenses and the corresponding allocation will probably gravitate toward the aforementioned $1,600/car or lower. So impact of this warranty extension going forward will be shrinking as time goes by - another reason, in addition to ones highlighted by DaveT, that long term shareholders should be very happy about this decision by the company.

Deutsche Bank maintained a Buy rating on Tesla Motors (NASDAQ: TSLA) with a price target of $310. Comments follow changes to its Model S warranty. Despite the update and potential impact on earnings, analyst Rod Lache thinks costs will decline, and he recommends buying any related weakness.
"Tesla announced that they are expanding the warranty on the 85 kWh version of their Model S to 8-years and unlimited miles from 4 years or 50,000 miles. This change is likely in response to widely reported reviews from Edmunds and Consumer Reports, which identified a number of powertrain issues during long term tests of the Model S. The Edmunds test vehicle reportedly had 4 powertrain replacements over the course of 30,000 miles (based on comments on the Tesla Owners Blog, it appears that the Edmunds experience was not unique; several powertrains were replaced under warranty due to “milling” or knocking sounds that developed over time). While Edmunds still described the Model S as an exceptionally good vehicle, reports such as these clearly influence consumers, and Tesla appears to be responding with damage control (an 8 year unlimited mile warranty should satisfy most buyers that the vehicle will be covered throughout their ownership)," said Lache.
"We believe that 100% of the 39,000 units produced to date will ultimately receive modifications, likely at <$200/vehicle (i.e. $7.8 MM). We are adjusting our 3Q estimate for this. We also expect slightly higher warranty accruals for new vehicles produced during Q3. Importantly, Tesla appears to be making significant gains in quality such that their warranty accrual per unit will likely decline throughout 2015 despite the upgraded (longer duration) coverage. We’d note that as of Q2, Tesla’s warranty accruals were $2,661 per unit. This compares with accruals in the $1600 range for luxury OEM peers. Over time, Tesla believes that electric powertrains will prove to be more reliable than internal combustion powertrains. While this has yet to be proven, we believe that warranty represents a significant opportunity for cost improvement. We’d buy TSLA on any weakness associated with this story," he added.
For an analyst ratings summary and ratings history on Tesla Motors click here. For more ratings news on Tesla Motors click here.
Shares of Tesla Motors closed at $262.01 yesterday.

 

[FluxCap]

Great analysis here Dave and vgrin. I concur completely with you both, but would add that I see this as yet another shrewd "we don't have a marketing budget" stealth marketing expenditure meant to lift overall public perception of electric vehicles in anticipation of Model 3 ramp-up. This is a shrewd, cost-effective move with a trivial impact on margins in the near term, but a HUGE potential positive impact in the medium to longer term. Hyundai disrupted the sleeping Japanese compact economy car market when it stunned the world with its 10-year warranty, and this is an order of magnitude more important, I think.

Hard to argue with the physics of it as well -- electric motors are superior in almost every meaningful way (efficiency, torque, longevity, reliability, simplicity, flexibility)...but the public has no idea about this yet. They will know one day, and this move helps pave the road for that awareness.

 

[schonelucht]

The interesting point to consider is that in spite of a promise of inherently higher dependability of electric platform, Tesla Motors reserves for warranty per car are actually higher then it's peers. According to Deutsche Bank note on impact of the warranty extension, as quoted by Streetinsider.com, TM allocations as of Q2 were $2,661/car, while luxury OEM peers average is $1,600/car.

One conclusion from this is that bear's screaming about Tesla being reckless by not allocating sufficient reserves for warranty is a plain lie - as it is obvious that they act very responsibly and actually allocated more than peers, although EV technology's promise is lower repair costs.

Well, a real bear will tell you something different : that Tesla's inherently higher dependability (and consequently lower maintenance costs) is a promise that they cannot actually fulfill on the cars they are selling today.

 

[FANGO]

Vgrin: another reason for higher warranty reserves is because tesla has a much higher ASP than luxury peers. BMW sells the 3 and 1 series, Mercedes the c class. Tesla does not have these models. I suspect if you looked at only the warranty reserves of directly competing models they would be higher than 1600

 

[vgrinshpun]

Vgrin: another reason for higher warranty reserves is because tesla has a much higher ASP than luxury peers. BMW sells the 3 and 1 series, Mercedes the c class. Tesla does not have these models. I suspect if you looked at only the warranty reserves of directly competing models they would be higher than 1600

While I agree with your general point, I think that you might be misreading Deutsche Bank's term "luxury OEM peers" to mean average warranty outlays for the brand as a whole, while I think that they used word peers to indicate that the number they used is an average for comparably priced cars from luxury OEMs.

- - - Updated - - -

Well, a real bear will tell you something different : that Tesla's inherently higher dependability (and consequently lower maintenance costs) is a promise that they cannot actually fulfill on the cars they are selling today.

Well, the real (ostensibly smarter) bears that you mention in your post no less shortsighted then the less smart, garden variety bears I was mentioning in mine. Instead of looking at a snap shot in time, I would advise them to look at the trend, which clearly shows that Tesla inherently higher dependability is the promise that is getting closer with every passing day as they are solving initial problems by improving QC and tweaking the manufacturing process.

 

[dalalsid]

Also what needs to be noted is that the length of the warranty for the "luxury peers" is half that of Tesla i.e. they are designed to be problem free for the warranty period . If you consider this, the warranty reserves are lower. Imagine if BMW needed to double the length of its warranty. The costs would increase more than double.

 

[AudubonB]

Do you suppose that some of the reason other manufacturers' warranty reserves are at the level they are not solely because of manufacturing or design flaws, but because they perforce have to work through those ferschliggina dealer networks!!!!​ and the very, very expensive rates these "independents" are endlessly happy to foist back on to the auto company?

 

[schonelucht]

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

Just one other remark. To calculate total warranty costs per car, you need to also add the warranty costs associated with cars sold through the resale guarantee program. Those warranty costs are not covered by accrued warranty reserves, but expensed as they occur. Warranty expenses related to this program are quite substantial (20% for the last quarter). Redoing the numbers, I find that the warranty expenses per car in the last quarter was $282 instead of $236. Rounded to the significant digit, the series of quarterly warranty expenses per car starting Q4 2012 is (difference to your number) : $300 / $410 / $160(+$30) / $390(+$40) / $340(+$20) / $330(+$40) / $280(+$50)

 

[Chickenlittle]

Just one other remark. To calculate total warranty costs per car, you need to also add the warranty costs associated with cars sold through the resale guarantee program. Those warranty costs are not covered by accrued warranty reserves, but expensed as they occur. Warranty expenses related to this program are quite substantial (20% for the last quarter). Redoing the numbers, I find that the warranty expenses per car in the last quarter was $282 instead of $236. Rounded to the significant digit, the series of quarterly warranty expenses per car starting Q4 2012 is (difference to your number) : $300 / $410 / $160(+$30) / $390(+$40) / $340(+$20) / $330(+$40) / $280(+$50)

Wrong. In process of buy per owned roadster. The cars are new enough that the warrantee of 37 months is just continuation until the regular warrantee over. A 2010 roadster has three years left on warrantee that is transferable anyway and so no additional set aside. BTW they do not come cheap tesla doing very well with these and they get snatched up even before inspected/repaired

 

[schonelucht]

Wrong. In process of buy per owned roadster. The cars are new enough that the warrantee of 37 months is just continuation until the regular warrantee over. A 2010 roadster has three years left on warrantee that is transferable anyway and so no additional set aside. BTW they do not come cheap tesla doing very well with these and they get snatched up even before inspected/repaired

I think you are confusing two issues? This has nothing to due with pre owned Roadsters. It's about the Model S's sold to customers with the guaranteed resale value ('Tesla financing'). Warranty expenses for those cars do not come from the accrued reserves as tabled in the quarterlies where Kaligod copied them from but are mentioned in a different paragraph. Here is the wording from the latest report

Our warranty reserves do not include projected warranty costs associated with our resale value guarantee vehicles as such actual warranty costs are expensed as incurred. For the three and six months ended June 30, 2014, warranty costs incurred for our resale value guarantee vehicles were $1.8 million and $3.0 million, respectively.

That $1.8M is an expense obviously related to Model S warranties, not Roadsters.

 

[kalikgod]

Just one other remark. To calculate total warranty costs per car, you need to also add the warranty costs associated with cars sold through the resale guarantee program. Those warranty costs are not covered by accrued warranty reserves, but expensed as they occur. Warranty expenses related to this program are quite substantial (20% for the last quarter). Redoing the numbers, I find that the warranty expenses per car in the last quarter was $282 instead of $236. Rounded to the significant digit, the series of quarterly warranty expenses per car starting Q4 2012 is (difference to your number) : $300 / $410 / $160(+$30) / $390(+$40) / $340(+$20) / $330(+$40) / $280(+$50)

Great work. Thanks for pointing this out.

This is exactly why I shared my Sheet with people to get input from people that know these calculations better than I.

 

[FANGO]

Wrong. In process of buy per owned roadster. The cars are new enough that the warrantee of 37 months is just continuation until the regular warrantee over. A 2010 roadster has three years left on warrantee that is transferable anyway and so no additional set aside. BTW they do not come cheap tesla doing very well with these and they get snatched up even before inspected/repaired

Roadsters originally had a 3 year warranty, so a 2010 would have run out by now unless the owner bought the extended warranty when new.

Congrats on your car though, love mine except that it just had a suspension problem three days out of warranty, and a week after I had it in for the annual/end of warranty service (which included suspension work), and tesla is not clear about whether they're going to cover it or not...