Tesla Inc (TSLA) — Q4 2018 Earnings Call Transcript

Thank you, Sherry, and good afternoon, everyone. Welcome to Tesla's fourth quarter 2018 Q&A webcast. I'm joined today by Elon Musk, J.B. Straubel, Deepak Ahuja and a number of other executives. Our Q4 results were announced at about 1 p.m. Pacific Time in the update letter we published at the same link as this webcast. During this call, we will discuss our business outlook and make forward-looking statements. These comments are based on our predictions and expectations as of today. Actual events or results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent filings with the SEC. But before we jump into Q&A, Elon has some opening remarks. Elon?

Thanks, Martin. Last year was definitely the most challenging year in Tesla history, but also the most successful. Thanks to the incredible work of the Tesla team, Model 3 became the best-selling premium vehicle in the U.S. for 2018. And in fact, when considering battery electric vehicles, Tesla achieved an 80% market share of U.S. sales in the last year. I think this point is perhaps not well appreciated. All other electric vehicles combined were 20% of sales in the U.S. in the last year. So I think that's not so bad. We also delivered as many vehicles last year as we did in all prior years combined, which is a tremendous achievement by the Tesla team. If you track Tesla vehicle production year-over-year, cumulative sales and deliveries year-over-year, it is about the cleanest exponential I've ever seen. We've basically almost doubled our fleet every year. Every year, we make as many cars as we did in all prior years. So this is a very unusual thing to see for a large, complex manufactured object; I think it may be the fastest that a complex manufactured object like a car has grown in history, or at least I'm not aware of anything that has grown faster. Martin, are you in agreement?

I'm not sure. I think Model T was a little bit slower, but I'm not 100% sure.

Okay. And we expect that exponential to continue. So with the deliveries this year being... even in the face of a global recession, we're expecting deliveries this year to be about 50% higher than last year. And it could be a lot more than that. But even with tough economic times, to see 50% growth is pretty significant. For Q4, we achieved GAAP profitability, the second quarter for the first time in the company's history, and we increased our cash on hand by more than $700 million, even after paying debt, with a total of $3.7 billion in cash. This means we have enough cash to settle our convertible bond that will mature in March. In addition, our operating margin remains strong at 5.7%. Operating margins in the fourth quarter are usually lower in the automotive industry, but this was not the case with Tesla. 2019 is going to be an amazing year for Tesla. As I mentioned, we are expecting to increase sales by 50%. It could potentially be a lot more than 50%, but I think 50% is a very reasonable number. But that's crazy growth for the automotive industry. I want to note that one of our major priorities this quarter is improving service operations. So really, from my standpoint, when I think about what my priorities are this quarter, it's improving service in North America. That's number one. And I think we have very exciting advancements that we're going to roll out and implement. We're going to get cars to China and Europe and make sure that we have good logistics for the whole delivery process, from factory gate to the customer. That's obviously quite far from California to get to Europe and China and to get the car to customers. So we're working on every aspect of that logistics chain, and I think we've made significant progress. I'd say at this point, I'm optimistic about being profitable in Q1. Not by a lot, but I'm optimistic about being profitable in Q1 and for all quarters going forward. So let's see, we've opened 27 new store and service locations, bringing our total locations worldwide to 378. And we increased our Mobile Service fleet to 411 vehicles. The Mobile Service fleet is something we can scale up very rapidly, because we don't need bricks and mortar. We can get more vehicles, hire people, and deploy rapidly. It also results in higher customer satisfaction because we can actually send one of our service vans to your work or home and fix the car without you having to bring it into the service center or do any paperwork. It's really seamless and invisible. The customers love it. And we're also increasing the functionality of the Tesla App for service, so that instead of having to make an appointment, you just open your Tesla App, say you want to make a service appointment, and select from the top 10 most frequently requested service items. With a couple of taps, you've made yourself an appointment. And we're going to make it easier for the car to be picked up and dropped off as well. So if you prefer not coming to the service center at all, you can just request that the car be picked up and delivered. That's something that we rolled out two or three weeks ago, and I think it's going to significantly improve customer satisfaction. The next feature we're going to add is, if a car detects something wrong, like a flat tire or a drive unit failure, that before the car has even come to a halt, there is already a tow truck and a service loader on the way. The car has already notified Tesla emergency services, and a service loader or tow truck are on their way before your car has even come to a stop. I think this will be immense in improving customer happiness. We're also improving parts distribution. I think we made a strategic error in the past about not having service parts located at our service centers. We had them in parts distribution warehouses, which made it impossible to achieve a fast turnaround on servicing a car because the car would come in, and then the parts would be requested to come to the service center, which could take days. So we're going to stock all common parts at the service centers to enable a turnaround time of 20 minutes or even 15 minutes for common repairs. It should be like lightning-fast. For new products, with Model Y, we've completed the engineering of Model Y and the parts are on track for Model Y production. Three-quarters of the Model Y is common with the Model 3, so it requires much lower CapEx per vehicle than Model 3. And the risk is also quite low. This is in contrast to Model S versus Model X where the theory was that Model X was going to be like the Fabergé egg of cars. It's an incredible vehicle and nothing like it will probably be made again, and maybe it shouldn't. But it is a work of art. However, the commonality with the Model S is limited, only about maybe 30% in common with the Model S, whereas Model Y is about 76% in common with the Model 3. We're most likely going to put Model Y production right next to the Gigafactory in Nevada, which reduces our risk of execution and the cost of transporting parts. I would expect Model Y production to be potentially 50% higher than Model 3. As I understand it, the midsized SUV segment is the most popular type of vehicle worldwide, so we'll probably see a higher volume of Y than 3. Earlier this month, we saw the construction of our Gigafactory in Shanghai. By the end of this year, we expect to be producing Model 3s using a complete vehicle production line. This includes body paint, final assembly, general assembly, and module production. It will be extremely fast. I get daily updates on the progress of the Shanghai Gigafactory; those factories are going to go up like lightning. We feel quite confident that we can achieve volume production in Shanghai by the end of the year, and that should allow us to get to the 10,000 vehicles a week rate or very close to it by the end of the year.

Okay, great. So we're going to take the first questions from our retail investors who have been submitting their questions. The first question is about service, which I think you already spoke at length about. The second question would be, how are you feeling about demand right now across the product line? Is 500,000 to 700,000 units at a $42,000 ASP still a realistic annual target for Model 3, even considering Model Y and its impact on demand? And do you continue to see S and X demand of 100,000 annually?

I mean, my best guess, this is just a guess, my best guess for demand of Model 3 worldwide is something in a strong economy, it's something on the order of 700,000 to 800,000 units a year. That's my best guess for demand of Model 3 in a strong economy. If the economy goes into a recession, then I think that could be something under 40% less. But I think even in a recession, worldwide demand is still something in the order of 500,000 for Model 3. For S and X, we did eliminate the 75 kilowatt-hour version of S and X, and with the product differentiation relative to 3 and Y. I think we could see a slight decline in total vehicles, but I think the net cash flow from S and X is likely to be very similar, so probably no major change in net cash flow for S and X.

Okay. The next question from Alex is, can you please share an update on full self-driving and Tesla Network development? When will customers start to see full self-driving features? What's the best-case timeline for a Tesla Network to go live?

Sure. We have already full self-driving capability on the highway. So from highway on-ramp to highway exit, including passing cars and going from one highway interchange to another, full self-driving capability is there. In a few weeks, we'll be pushing an update that will allow the option of removing stock confirmation in markets where regulators approve it, which we believe will be the case in the U.S., for example. Over time, we think probably all regulators will approve it, but we keep talking about it just to make sure we take care of any strange corner cases. It’s really quite profound to have that experience. The next part of full self-driving will really be traffic lights. It's hard. Stop signs are pretty easy because we can essentially geocode those and recognize them at all times. Traffic lights and intersections will be the next tricky aspect, and then navigating complex parking lots, like if you're underground in a mall parking lot with a lot of traffic and pedestrians and it's on multiple levels—that's where it gets tricky. With the release of enhanced or advanced Summon, you'll see the first indications of the car being able to navigate complex parking lots. That's also coming up fairly soon, probably next month. In development mode, the car does all the things that I just mentioned. It recognizes traffic lights and stop signs and basically has all the functionality in development mode. It’s really just a question of getting the reliability of recognizing traffic lights up, which is at about 98% good right now. But we need it to be like 99.999%, really extremely reliable. So we think it’s probably towards the end of this year when we will consider it safe for full self-driving; then it's up to regulators to decide when they want to approve that.

Okay. Let's go to the next question, which is, if and when will Tesla switch Model S and X to 2170 battery cells? What percent range improvement do you expect?

We have no plans to switch S and X to 2170 and can't comment on huge product developments.

Okay. So maybe we'll take the last question from retail investors, which was, where will Tesla Semi and Model Y be produced? Can you share a timeline on expected production ramp of these products?

As I mentioned earlier, the Model Y will most likely be produced at Gigafactory; that's the default plan we’re proceeding toward unless we encounter some obstacle. It's fast, low-risk, and low CapEx. In terms of the initial production of Model Y, a very low volume, probably next year. But it always takes time to ramp up any production system. So it’s difficult to predict the shape of that S-curve. We feel confident in saying there will be production volume of Model Y by the end of next year, but between the beginning of next year with low volume and then growing exponentially from the beginning to the end of next year. So that’s our expectation for Model Y. For Semi, the first units will be for our own usage, to move parts and vehicles in different locations, and then we will start delivering to outside customers. Yes, that’s right. And for the Tesla pickup truck, we might be ready to unveil that this summer. It will be something quite unique, unlike anything else.

Okay. Fantastic. So operator, we can start taking questions from participants on the call.

Thanks for taking my question. I think—the amount that you've spent on lands for Gigafactory Shanghai in the classification operating cash flows, is there any guidance you can provide us in terms of how to think about CapEx for this facility going forward? And can you discuss the source of funds for the project? I think you've spoken in the past about the potential to raise that locally in China. Is that still your thinking? And what kind of terms might you be able to raise that capital?

Yes, Deepak here. You're right. The purchase of the land is a 50-year lease with the government of China. So it's not CapEx, but it's an operating lease that shows up as cash flow from operations. However, the CapEx that we will invest is for our equipment, and we fully own it. So that will show up as capital expenditures. The plan, as we have indicated in the letter, is still to get funding for the majority of that capital spending from local China banks, and we expect pretty attractive rates based on the dialogue we've had. There’s a lot of interest, and we hope to finalize that and then share the details at that point.

Yes. I mean, as a ballpark figure, probably it's something in the order of $0.5 billion in CapEx to get to the 3,000 vehicle rates in Shanghai, ballpark figure. And as Deepak was saying, there is very competitive debt financing in China, with extremely compelling interest rates, and we do not expect that to be a capital drain on the company.

Yes. These are the biggest banks in the world, and for them, $500 million is not a large amount of money in the scheme of things.

Sorry, perhaps if you're in the automotive industry, you’ll understand how significant this is, but maybe it's not as obvious to everyone: Tesla has the first wholly-owned manufacturing facility in China of any automotive company. So this is profound, and we're very appreciative of the Chinese government allowing us to do this. I think it is symbolic of greater openness to the market. A lot of appreciation for the Chinese government in allowing us to do that; it's a very significant thing.

The question I have is related to Waymo and the autonomous driving opportunity. Morgan Stanley recently valued Waymo at $175 billion. And my question is, what do they have that you don't have? And separately, how important is timing in the Tesla story longer term? Is this just a nice-to-have? Is it really about EVs and renewable energy? Or is autonomy kind of one of the foundational parts of the story long-term?

The relevance of Tesla comes down to two things: the acceleration of sustainable energy and autonomy. The acceleration of sustainable energy is absolutely fundamental because this is the next potential risk for humanity. So actually, that is, by far and away, the most important thing. But also, very important is autonomy. This has the potential to save millions of lives and tens of millions of serious public injuries, allowing people to spend time doing things they enjoy instead of being in terrible traffic. It’s extremely important. We feel confident about our technical strategy, and I think we have an advantage that no one else has. We have, at this point, somewhere around 300,000 vehicles on the road with a 360-degree camera sensor suite, radar, ultrasonics; always connected uploads, especially video clips from the customer when there is an intervention. So effectively, we have a massive training fleet. The amount of training we have—if you add everyone else combined, they’re probably 5%—I'm being generous—of the miles that Tesla has. This difference is increasing. A year from now, we’ll probably have 1 million vehicles on the road, and every time the customers drive the car, they’re training the systems to be better. I'm just not sure how anyone competes with that.

Sorry, do you have a follow-up question? Okay, no follow-up question. Let's go to the next participant.

Thanks so much. Can you talk a little about the geographic dispersion for the guidance for 2019, where you're expecting the Model 3s to sell through as well as the other models?

Well, I think we did actually. Yes, it's clear in our letter.

We indicated in Q1 we will start delivering Model 3s in Europe and China. We also shared a chart showing the potential market size for midsized premium sedans in North America, Europe, and Asia, suggesting those markets could be even bigger. So I think that gives a good sense of where we'll be. And we'll launch the right-hand drive version at some point to go to other markets.

Yes. Maybe around 350,000 to 500,000 Model 3s, something like that this year.

Okay. And then just in terms of the cost reduction roadmap and rework post-factory, can you talk a little bit about your expectation for reducing that in the next couple of quarters and what the order of magnitude is on that in your model internally?

Jerome, do you want to answer that?

This is Jerome. Our manufacturing is improving quarter-over-quarter and actually week-over-week. We take fewer hours, both here in Fremont or at the Gigafactory, to assemble the Model 3 and S and X as well. We track quality very closely. We review that carefully with the engineers and the supply chain and manufacturing team. The quality in the field and the number of incidents is also improving week-over-week, every week. So there are fewer and fewer need for cars to be in service, and we’ll keep going. There’s no end in sight. We’ll make sure the car never breaks down.

Yes, I think there's some confusion about rectification. For us to drive the Model 3s that come off the line, all that happens is some slight adjustment of drawer gaps and panel gaps and that kind of thing, and that's all that's done. There's nothing more than that.

Thanks for taking my question. Just a follow-up on the comments around you saying about 700,000 to 800,000 you think is the normal demand. I mean, any color on what price you're expecting that to be? Because I think there's a lot of chatter that demand is already weak in—of the midrange, at least, already in January. I don't know if that's true as well.

Yes. I mean, there are multiple factors at play here. First of all, there’s a lot of seasonality to automotive purchases. Most people do not buy a new car in the middle of a blizzard. So January and February tend to be seasonally low and then pick up significantly around early to mid-March. In the U.S., we obviously have a pull forward of demand from the tax credit. So there are all those factors. But I feel very confident about Model 3 demand. The customer happiness level with the car is incredible and probably the highest of any car in the world right now. So you can tell basically, nobody wants to sell their car.

But the target price point is, I think, in the past, you mentioned mid-$40,000. Is that where we're thinking or a long-term range?

Yes, this is really just a guess. So it's not like I have some huge crystal ball or something. But at volume, I would expect this, just an estimate, probably an average of $42,000 at that volume level. I'm not certain on it.

And just as a follow-up. You commented that you expect China to be online by the end of the year, but there are a lot of articles that your battery supplier—you're looking at different battery suppliers. But do you have a battery supplier? Because it seems kind of close to when production is supposed to start.

Well, there are really three things: the cell, the module, and the pack. We will be making the module and the pack. So it’s really just a question of cell supply. We can essentially use any high-density 2170 chemistry. We expect a combination of cells produced at our Gigafactory in Nevada, cells produced in Japan and cells produced locally in China. We feel confident to have a sufficient supply to hit the 3,000 units.

First, I wanted to ask you about the short-range Model 3. What are your latest thoughts in terms of timing of introduction? I think at some point, you had in mind to do it maybe in the first half of this year. And just to clarify, when you're talking about the outlook for 2019, the number of deliveries up 50% and then the margin target for Model 3 to get to 25%, does that assume that you're introducing a lower range, the short-range Model 3 at some point during the year?

Well, you could call it the standard range, but it's maybe short by Tesla's standards, but it’s long range by other manufacturers' standards. But yes, we expect to introduce the standard range Model 3 sometime—probably the middle of this year is a rough guess. And we’re working hard to improve our costs of production, our overhead costs, our fixed costs, just costs in general. This past year, while extremely difficult, has driven us to a high level of financial discipline. We're getting smarter about how we spend money, and we're getting better with each passing week.

And so to be clear, you expect to reach at some point this year—or you're targeting at some point this year 25% gross margins on Model 3, and that's despite the introduction of the lower-end or standard range Model 3. Is that correct?

Yes.

Okay. And, I guess, my follow-up would be on the demand side. So you're talking about a 50% increase this year. You said a few times that it could be higher than this. I think you just mentioned in the previous question 350,000 to 500,000, if I understood well. So what drives the cautious outlook that’s in your letter? Because it feels like it’s basically four times the fourth quarter run rate, which would imply sort of 50% for the full year but not really a lot of growth compared to what you just accomplished. So how do we think about the total demand for 2019, especially if you introduce the cheaper version?

Well, we need to bring the Shanghai factory online. I think that's the biggest driver for getting to 500K plus a year. Our car is just very expensive going into China. We’ve got import duties, transport costs, higher-cost labor here, and we've never been eligible for any of the EV tax credits. A lot of people depend on incentives, and we have the least access to them. It’s pretty crazy because there are many companies and countries that have put price caps on the EV incentive, which affects Tesla. And in China, which is the biggest market for EVs, we've never had subsidies or tax incentives for vehicles. So it's—it is eligible for that, but it sounds like that’s going to be reducing in China in the coming years. Bottom line, we need the Shanghai factory to achieve that 10K rate and make cars more affordable. The demand for Model 3 is incredibly high; the inhibitor is affordability. People literally don’t have the money to buy the car—it’s not about desire.

So, Deepak, I was wondering, as we get to 2019, we’re all concerned about the potential recession. I was wondering how you think about it and what you would tell us about how we should expect Tesla to react to a recession in 2019. How do you manage your volume plan? How do you manage your pricing? How do you present cash? How do you manage your CapEx if things turn south in 2019? And then I have a follow-up on gross margin for Jerome.

Yes, it’s a very broad question, which is not really just for me to answer. But I think at the highest level, the way we are trying to be prepared for any kind of contingency is to just continue focusing on cost. And the theme of our conversations here is, how do we reduce costs all the time? And how do we run our business with a very high level of financial discipline? Elon alluded to that, and so did Jerome. If we do that, we believe that even in scenarios of lower volumes and tight pricing, we do have a good chance and a good shot of being profitable and generate free cash flow. So that’s the best way to manage the business—be frugal.

Yes, I don't want to be a broken record about this—it's costs, costs, costs—because reducing our costs—by the way, while making improvements to Model 3, I want to emphasize, the product is getting better by slight degrees despite lower costs in hundreds of small ways. But you actually wouldn't notice explicitly, but they would appreciate subconsciously. And getting those costs down—variable and fixed costs—is what allows us to lower the price and be financially sustainable and achieve our mission of environmental sustainability. We have to be absolutely clear about this—there's no question.

The other aspect of this, Elon, which we've been doing extremely well, is capital efficiency. We have dramatically cut back on capital expenses. We are spending it in a very efficient manner. We talked about it in the letter regarding Model 3 and Gigafactory Shanghai, and we talked about it for Model Y. There are many learnings we're incorporating, and we just want to beat what we did with Model 3 and the kind of spending we had for the returns we got.

Absolutely. We're confident that our CapEx per unit of production for the Shanghai factory and for Model Y will be less than half of what we did for Model 3. Internally, we think it might be a quarter, but that’s probably too good to believe; it’s definitely less than half.

The first thing I want to just understand is what you're seeing from European orders and China orders so far. There are some numbers that get thrown around, but you guys are obviously taking a look at it. How is that order profile shaping up relative to what you saw in the U.S. with the launch of the Model 3?

I think it seems good. I mean, our share, actually within Europe and China, is how do we get the cars made on a boat such that they reach customers before the end of the quarter? We don’t want to have a massive number of cars on the water; that's our biggest challenge—not demand. It’s how do we get the cars there fast enough.

So like orders above, I think I’ve seen like 20,000 orders for Europe and single-digit thousands for China. Is it better than that, Elon?

Yes, absolutely. I mean, we’re not even really trying; I should point out. Our factory is right now only making cars for China and Europe; that’s all it’s doing with respect to Model 3. Our focus is on how do we get those cars manufactured, get them on a ship as fast as possible, get the ship as fast as possible to Zeebrugge in Belgium, then get them over to Drammen in Norway, and get those cars to customers as fast as possible. We’re doing the same in China. We hope the trade negotiations go well, but it’s not clear. But we need to get them there while there’s sort of a truce on the tariff war. The demand generation is really not one of the things we’re thinking about.

Okay. Then just lastly on this demand thread, customer deposits came in again over $100 million. Is it possible to give us an update? I know you don't think it’s really a relevant number, but I do want to know. Explain why on the reservation count, where you were 450,000—you started delivering. And I ask this because I think we’re all trying to understand how much incremental demand you think there is based on what you see at that lower price point if, say, there’s over half of those people that are still waiting for that 75k base model to come out. That would be interesting, and I think that's what you’re seeing but I just want to confirm that.

So Deepak, do you want to address...

Yes, I mean, I think reservations are not relevant for us. We are really focused on orders. We do have a large reservations backlog still, which tells us that a lot of customers are still waiting for those cars, but I don't think it's appropriate to share the reservations number.

Reservations are just like preorders; it’s like for a video game coming out. Once you start shipping the game or product, that stops being important. So yes, as I said earlier, I think my guess is demand is somewhere on the order of 700,000 to 800,000 units a year for Model 3, and even in a recession, it’s probably around half a million.

So my question is around Europe. Obviously, with deliveries coming onboard in the first quarter. Maybe what surprised you in terms of your demand looks strong but in terms of what you’re seeing at the region, is it stronger than you expected in certain countries? What do you think is driving that? And maybe you can just talk about the opportunities and challenges in Europe, especially from a delivery logistics perspective.

Well, like I said, we’re thinking about demand almost zero right now. It’s really getting the product there on time and not having a ton of cars on the water in a quarter and for China getting cars there before there’s a potential rise in tariffs. That’s really put very front of mind the cost reduction and then improving service in North America.

And just maybe a quick follow-up on can you just talk about—when we look at the Gigafactory build-out in China and obviously how important that is, can you maybe just fast forward, let’s say, 18 to 24 months? I mean, how do you envision that as just a competitive advantage versus other automakers that will be trying to go in your tracks?

I think it will be quite a significant advantage; it’s quite fundamental to the future of Tesla. I expect to make several trips to China this year. I’m working very closely with the team building the factory. I literally get daily updates. It’s a super, big deal, and we’re only just talking about Phase 1 here. Phase 1 is about 10% of what we think the Gigafactory will ultimately be. So it’s a major, major deal.

You've talked repeatedly about the need to drive down costs, which in turn drives the elasticity of demand for cars. I’m wondering if you can talk about how much of a price differential between the $50,000 Model 3 and the $35,000 Model 3 is structural, meaning that powertrain costs for EVs are just structurally higher than they are for internal combustion engine cars. And where do you think that difference is today, and when do you see that being no longer a factor?

It's both—it's both the vehicle and the powertrain. I split my time half and half between the Gigafactory and here, and there are opportunities in both.

But I think the bigger point is that there are cost reduction opportunities out there; the bigger point is that our cost is not higher than a gas-powered or an internal combustion engine.

I think what Toni meant is with the battery pack, as in battery pack as well as the powertrain together, are more expensive than an engine.

That's true.

And how big do you think that delta is today? And when do you think of it as being kind of $10,000, $11,000 for that pack plus powertrain for an electric vehicle and maybe $5,000 or $6,000 for an internal combustion engine car? And is that sort of the order of magnitude? And where do you see those getting much more aligned just sort of given the lives of where you think cell and pack costs are going?

Well, the biggest part to bear in mind is because of electricity, it’s quite a bit less than the cost of gasoline, especially in Europe or California or China—basically almost everywhere except, say, the middle of the United States, where gasoline is expensive and electricity is far cheaper. The cost of ownership pretty significantly factors in to the cost of an electric car versus a gasoline car. It's around $50 to $100 a month depending on how much someone drives. So that’s very important to consider. That said, in terms of initial cost of acquisition, I think it’s probably on the order of $7,000 but trending towards $4,000 or $5,000; this is just off the top of my head.

Okay. And as you think about 2019, you talked about scenarios for demand and how you plan to roll out the intermediate range and then ultimately the standard range. What is—if you have to make a trade-off on volume or profitability during the year, meaning if you have to get the volume you need, you have to go to lower margins, or vice versa, where’s the trade-off? Are units produced most important to you, or is delivering the 25% gross margin more important? If you have a chance to deliver 450,000 or 500,000 cars, but they’ll be more standard editions, and gross margins will end at 20%, are you willing to make that trade-off?

My guess is it ends up being about the same—if there's a given amount of free cash flow, you sort of decide to achieve that with a smaller production or smaller volume of cars at a higher margin or larger volume cars at a smaller margin. I think we're already towards the second. We're going to make more cars at a lower margin, but I think it’s more or less a flat rate.

Can you just update us on where battery costs are now and where you anticipate they'll be by year-end? I'm just trying to gauge how much of a factor this is to lowering costs and sustaining profitability.

That's a highly proprietary number. We cannot give it out, but I’d like to tell you, but no. We do think we have the best costs in the world. To the best of our knowledge, our costs are lower than anyone else right now, and they’re improving.

And maybe talk about your expectations with the Panasonic-Toyota JV and how it might impact you. Was this something that you were made aware of?

I spoke directly with Tsuga-san about this, the head of Panasonic, and he assured me this will have no impact on Tesla.

Do you plan to offer a U.S. lease product for Model 3 in the U.S.? When can we expect it? And can you talk about what percentage of S and X have historically been leased in the U.S.?

Well, we've been reluctant to introduce leasing on Model 3 because of how it affects our GAAP financials. It is worth noting that demand to date is without leasing, so obviously, leasing is a way to improve demand, but it makes our financials look worse. So we don't want to introduce that right away. I mean, we'll probably introduce it sometime later this year.

It's around 20%, low 20s, and it has stayed stable at that level for many quarters, which seems like the natural demand because we don't do anything artificially to bump it up.

Yes, exactly. Our leases are legitimate. The tax write-off is important for leasing.

Okay. And then I have just, like, two quick housekeeping questions. One, is there a restructuring charge that you expect in the first quarter? How much is it? And is it included in your expectation of a small profit?

Yes, it is included in that. It's difficult to say exactly what that is at this point. Let’s say, roughly around $40 million, but that number can vary slightly.

Okay. And then just the last one is...

Sorry, go ahead.

Yes, the last one is, this change in your service parts structure to make things more distributed rather than in the parts warehouse—is that going to be a meaningful working capital drag? What's the cash impact of that?

No, it's actually—we’ve just been very foolish about where we store our parts. So it's actually going to be no change in working capital, or it's not something you would even notice in the financials. It's just being smarter about sending parts directly to service centers, either directly from our factory here or from our suppliers and just shipping them directly. We think it’s going to significantly improve our service costs and customer happiness worldwide.

I have one question, and it’s got four parts. Happy New Year, Elon. So the first part is—our Street numbers, like consensus, we've gotten everything wrong for six or seven years since you went public, and there are about $6 in earnings. Talk to us about that if you can. Number two, Elon, could you talk about—I hear you cut some workforce at SpaceX and there at Tesla. Can you talk to us about how you feel about that with your guidance in order—in the same order. And then can we talk about, maybe sort of third thing, for JV? No one’s ever going to talk about stationary storage, but we had a whole page on that with a pretty good speech, and what should we be focusing on that? And what can that add to the bottom line on top of that $6 this next year?

I mean, we can't really, Ben, talk about consensus and what that means. I think the—maybe the better approach is we are providing certain guidance here, and you and the other analysts need to reflect that in your modeling. That’s the best indication from the company of our projections.

Yes. J.B., is there anything you'd like to add?

I think the letter outlines the predicted growth in the battery storage business, the stationary storage business pretty clearly, and that should be included in the projections as well. So we’re excited about it but I can’t say much more detail.

I mean, our internal projections for stationary storage are closer to 3 gigawatt-hours, but some of it is kind of lumpy and may not be completed this year. We would have done more in stationary storage last year except we were so strong for vehicle production. We had to convert a bunch of stationary storage lines to vehicle battery lines. Otherwise, we would have done quite a bit more in stationary storage. I expect that to grow, probably twice as fast as automotive for a long time.

We continue to set production records basically every month. So that’s growing.

And the profitability of the storage business continues to improve as we keep ramping up production and scale.

It's going to be a gigantic business down the road.

And the last question was about the economy and the global economy.

Sure. I mean, I do think that the economy moves in cycles, and there's a fairly significant risk of a recession over the next 12 to 18 months, but I’m confident that Tesla will remain at least slightly profitable even with a significant recession. We will be all the stronger for it when there’s a recession. We have to be relentless about cost to make affordable cars and not go back up. That's what our headcount reduction is about. Yes, we have to be super disciplined about this; it's the only way to make affordable cars. On the SpaceX side, the cost reduction was for a different reason unrelated to Tesla. SpaceX has really two absolutely insane projects that would normally bankrupt a company—Starship and Starlink—so SpaceX has to be incredibly spartan with expenditures until those programs reach fruition.

Okay, great. I think that's all we have time for today. Thank you very much for your questions, and Elon would like to have some closing remarks.

Yes. So let's see. Deepak is going to be retiring.

Again.

Deepak, I think it’s now been—you first started with Tesla about 11 years ago, right?

Close to that, yes.

Yes, almost 11 years. Thank you for your tremendous contribution to Tesla. He's announcing retirement, but the retirement will not be immediate, but Deepak will continue to be at Tesla for a few more months and will continue to serve as a senior adviser to Tesla for probably years to come hopefully. We thought long and hard about who the right person is to take over from Deepak, and that’s Zach. Zach has been with Tesla for now nine years.

Nine years.

Yes. Zach, you had management and technology at Wharton undergrad and then worked at Tesla and then spent a couple of years at Harvard Business School, which I actually don't think was necessary, by the way.

You told me that when I came back.

Yes, exactly. Zach's incredibly talented, has made a huge contribution to Tesla over the years and is a very well-known figure to the whole team and has the respect of everyone. Zach, I don’t know if you'd like to say a few words?

Yes, I will.

Sure, okay. Thank you, yes. First, Elon, thank you very much for the opportunity to be here for a second time. I've learned a lot from you and have always been inspired by you, and very much inspired by the Tesla team, who are incredibly brilliant, very passionate, and just amazingly perseverant—the best team I could imagine. So thank you, everybody, for that. There is no good time to make this change. We felt strongly this was a good time—a new chapter, a new year. Tesla has had two great quarters of profitability, cash flow, so now we have a really solid foundation. I feel really good about Zach taking over as the CFO. He's proven himself with his many years of experience and many tough challenges that he’s worked on, and I’m really excited to have Zach take on this role. I’ll be here to support him and make sure we are all successful as a company.

My name is Zach Kirkhorn. Just a brief background on myself. I joined Tesla just under nine years ago when it was a super small company with a lot of potential ahead of us, and I was attracted to the mission and the vision of the company. Over this time, I’ve been deeply involved in the operations of every major program of the company—from the Roadster to Model S and X, Model 3, scaling our Energy business, and more things to come which we've talked about on this call. I feel we're starting 2019 with a very strong financial foundation. We have enough cash to continue launching new programs and developing new technologies, and we’re able to service upcoming debt obligations with our forecasted cash flows. My focus, alongside the talented and passionately-driven team at Tesla, is to ensure we continue the terrific momentum on cost management and operational efficiency, which will enable us to provide more access to our products around the world, which is key to achieving the mission of the company. On a personal note, Deepak, a huge thank you to you for your leadership, mentorship, and support. I very much look forward to discussing our progress on future earnings calls.

Great.

Great. Thank you very much. We will speak to you in three months.

Thanks, guys.