Amid feverish leaks, trial balloons and media reports that Tesla will finally report a profit as production of the Model 3 electric sedan finally took off, following efforts to minimize spending and maximize revenue, coupled with an ongoing mass exodus of senior executives, and Elon Musk's promise (first made in May) to be cash flow positive, not to mention yesterday's surprising reversal by noted short-seller Citron who turned tactically bullish on the stock prompting a massive short squeeze, and of course Musk's well-known problems with keeping his mouth shut on Twitter and his recent settlement with the SEC over Tesla's "funding secured" going private transaction, it is safe to say that Tesla's earnings were the most hotly expected numbers of the week, if not the quarter.

So, with all that in mind, moments ago Tesla reported what Bloomberg dubbed a "historic" quarter because not only did Q3 revenue and earnings soar, smashing expectations, but the company reported an unprecedented $881 million and positive Free Cash Flow, over $600 million more than the $280 million expected.

  • Revenue: $6.824BN, smashing consensus expectations of $6.3 billion
  • Net income: $312MM, also beating consensus expectations of a -$49.6MM loss
  • Adj. EPS: $2.90, a huge beat to consensus of a 15 cent loss
  • GAAP Gross margin 25.8%, up from 18.3% Y/Y
  • Free cash flow: $881 million, slamming consensus expectations of $280 million
  • Cash position increased by $731MM to $3.0BN

Here are the production highlights from the report:

  • At long last, Tesla reported positive free cash flow of $881 million, smashing expectations of a $280 million cash burn. In fact this was the most cash Tesla has made in one quarter in history.
  • Tesla produced 5,300 Model 3s in the last week of Q3.
  • The Model 3 outsold all but four sedans in the U.S. last quarter.
  • Model 3 GAAP and non-GAAP gross margin > 20% in Q3
  • Reaffirmed its forecast for profit and positive free cash flow in the fourth quarter, adding credibility to Musk’s prediction a quarter ago that the company will make those feats routine going forward
  • Reported over $900 million in Q3 customer deposits, a small decline from Q2; Musk said that Model 3 is starting to get customers who trade in non-luxury cars, suggesting that the car can tap into a deeper well of consumer interest.
  • Managed to get the all-wheel drive Model 3 into production, which Musk said the company did without disrupting the assembly line.
  • Even though the average for the quarter was 4,300 Model 3's a week, the company got to 5,300 in the last week of the quarter.
  • Production "hell" is over: labor hours on the Model 3 fell 30% from Q2 with Tesla noting that the Model 3 production system has "stabilized" in Q3.
  • $3.0 billion in cash and cash equivalents, up $731 million in Q3

This is what revenue looks like:

And earnings, both adjusted and GAAP:

Tesla's GAAP automotive gross margin jumped to 25.8% in Q3 from 20.6% in Q2, while non-GAAP Automotive gross margin improved to 25.5% in Q3 as compared to 21.0% in Q2.

Tesla now has $3 billion of cash on hand and $2.2 billion in debt obligations coming due by November 2019. Assuming it can sustain this kind of cash flow, it might be able to squeak by without a capital raise as Musk has promised.

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As regards to auto production and deliveries, we already knew what Q3 looked like: Tesla reported that it produced 80,142 vehicles in Q3, of which 53,239 Model 3s and delivered 14,470 Model S and 13,190 Model X vehicles as well as 55,840 Model 3 cars, totaling 83,500 deliveries.

Commenting on Model 3 production, Tesla said that it "went from a steep S-curve to more gradual monthly improvements" as it "made the changes necessary to enable production of an All-Wheel Drive (AWD) version of Model 3, and we did this without disrupting our production rate."

Tesla writes that "it started the quarter producing only Rear Wheel Drive (RWD) Model 3s and ended the quarter producing almost entirely AWD cars. Even though AWD cars are significantly more complex to build, we produced 5,300 Model 3s in the last week of Q3."

Tesla also notes that labor hours per Model 3 decreased by more than 30% from Q2 to Q3, falling for the first time below the level for Model S and X, and looking ahead says that in Q4, it "will focus even further on cost improvements while continuing to increase our production rate."

Investors were also curious about Tesla's "delivery hell", and Musk address this saying that "vehicle delivery and logistics were our main challenges in Q3 as our delivery system went through a similar “ramp” to what our production system went through in Q2." The good news for Musk is that "these challenges are easier to solve than vehicle manufacturing, and we made improvements through the quarter" noting that one of the most significant improvements was the expansion of direct deliveries where Tesla employees delivers the car wherever the customer would like.

Also in this context, Tesla said that more than half of Model 3 buyers traded in cars that were under $35,000 when they were new. That's even though the starting price on Model 3 was $49,000, while Musk has been inching closer towards his goal of bringing down the price.

As part of the closely followed mix transition, Tesla expects the average selling price of its cards to gradually decline as lower priced variants are introduced, it does not expect this to impact profitability. Whether or not Tesla succeeds in this transition will determine whether it will be able to remain profitable.

Tesla also notes that it stopped taking Model 3 reservations in North America in early July 2018 when its moved to a direct order system. Of the 455,000 net reservations that it reported in August 2017, less than 20% have cancelled, and the company expects most of the remaining reservations to gradually convert to orders.

Additionally, according to Musk's letter, in order to increase the affordability of Model 3, the company decided to accelerate its manufacturing timeline in China, and is now "aiming to bring portions of its Model 3 production to China during 2019 and to progressively increase the level of localization through local sourcing and manufacturing. Production in China will be designated only for local customers."

One key aspect of the business that investors were looking at was Tesla's cash burn, which in Q3 smashed expectations, and Tesla actually generated positive cash of $881 million, better than the estimated $280 cash burn, with CapEx shrinking to $510MM from $610MM in Q2.

Telsa also reported that customer deposits decreased for the second quarter in a row, and dropped to $906 million in Q3 compared to $942 million in Q2; the decline took place as Tesla "continues to work through our Model 3 backlog."

As usual, Tesla continued to use working capital as a source of cash, with total payables rising $741MM to $5.6 billion.

Now the outlook:

Tesla said Model 3 quarterly production and deliveries should continue to increase in Q4 compared to Q3, while its target of delivering 100,000 Model S and X vehicles this year remains unchanged.

The company expects gross margin for Model 3 to remain stable in Q4 as manufacturing efficiencies and fixed cost absorption offset a slightly lower trim mix and the negative impact of tariffs from Chinese sourced components. Gross margin for Model S and X will likely decline slightly in Q4, as Tesla expects that the sequential increase in tariffs in Q4 from Chinese sourced components will be only partially offset by increased manufacturing cost efficiencies. For all three vehicles, additional tariffs in Q4 on parts sourced from China will impact our gross profit negatively by roughly $50 million.

The company reaffirmed prior guidance to achieve positive GAAP net income in Q4. It also expects to continue to generate positive cash from operating cash flows in Q4 net of capital expenditures, as well as the normal inflow of cash received from non-recourse financing activities on leased vehicles and solar products.

Tesla expects its cash position will remain at least flat in spite of our plan to repay $230 million of convertible notes in cash during Q4.

Tesla expects total 2018 capex, to be slightly below $2.5 billion, consistent with prior guidance. Q4 capex projection includes the purchase of land in China and initial design and other expenditures for Gigafactory 3.

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The market reaction was euphoric, and the stock is now over 12% higher after hours, rising to $323 as a result of smashing revenue, profit and cash flow expectations, a strong Model 3 production pipeline, expectations of continued profitability and cash flow generation in Q4, a drop in projected CapEx, and no discernible concerns about liquidity.