Tesla (TSLA) Q2 2020 Earnings Call Transcript: Announce Austin Gigafactory, Beat Forecasts

Martin Eberhard: (00:00) Elon? Elon Musk: (00:01) Thank you. First of all, I'd like to thank the Tesla team for exceptional execution in the second quarter. Despite tremendous difficulties, they've done an incredible job and it's an honor to work with such a great team. I mean, there were so many challenges, too numerous to name, but they got it done. And it just what a great group to work with. Like I said, it's just an honor to work such a great team. So as a result, we were able to achieve a fourth consecutive profitable quarter. And although the automotive industry was down about 30% year over year in the first half of the year, we managed to grow deliveries in the first half of the year. So despite that massive industry decline, we actually went up. Elon Musk: (00:53) We're also very excited to announce that we're going to be building our next Gigafactory in Texas. It's going to be a right near Austin. It'll be about ... I'll go into better detail on this and I'm sure there will be a lot of questions. But the location is five minutes from Austin International Airport and 15 minutes from downtown Austin. It's about 2000 acres and we're going to make it a factory that it's going to be stunning. It's right on the Colorado River. So we're going to have a boardwalk where there'll be a hiking, biking trail. It's going to basically be an ecological paradise. Birds in the trees, butterflies, fish in the stream. And it will be open to the public as well so not closed and only Tesla. So if anyone's interested in working at Giga Texas, engineering, production, whatever the case may be, please let us know. We're going to be doing a major, major factory there. And it's also where we'll be doing cyber truck there, the Tesla semi, and we'll be doing Model 3 and Y for the Eastern half of North America. Elon Musk: (02:18) Now at the same time, I want to say we will continue to grow in California, but we expect California to do Model S and X for worldwide consumption and 3 and Y for the Western half of North America. And then we think probably also the Tesla Roadster, a future program, would also makes sense in California. So I think this is a nice split between Texas and California and just emphasize we'll continue to grow in California, but we'll be creating a massive factory and cyber truck and semi programs in Texas. And I also want to just do a shout out to Tulsa and just say thank you very much to the Tulsa team, economic development team and the Governor, really I was super impressed. The Tesla team was super impressed, and we will for sure strongly consider Tulsa for a future expansion of Tesla down the road. Let's see. Is there anything more you want to say about? This is a lot of information, so. Anything else, guys? All right. Well, I'm sure there will be lots of questions. We've already started work on the facility so some initial construction work it's already underway out of this weekend. Elon Musk: (03:46) Let's see. Moving on to other subjects. Solar, we recently adjusted the pricing about retrofit solar. So Tesla solar is the lowest cost solar in the United States. And we added a lowest cost guarantee and a money back guarantee. So we're very confident that people will love our solar product, whether it's this whole retrofit or solar roof. Our solar is now 30% cheaper than the U.S. average. After the federal tax credit, Tesla Solar now costs $1.49 per watt, and it's a very simple, highly automated single click experience. So definitely think about a Tesla, whether you want a new roof, Tesla solar roof, or you want solar on your existing roof. Either way, we're the company to go to. Elon Musk: (04:37) And then you can also get a power wall and have energy independence and be your own utility. So I think that product is really coming together and it's only going to get better later this year. So just very excited about that business potential. On the additional technology stuff, we introduced the first production car with more than 400 miles range. So the current Tesla Model S now has an EPA certified range of 402 miles. I mean, basically you can drive from LA to San Francisco nonstop and still have some miles left over when you arrived and this was at highway speeds. So you don't have to do anything, drive slowly or anything. You just drive it. You can just drive normally and go very long distances. Elon Musk: (05:36) And then for full self driving, we launched traffic lights and stop signs, and we're continuing to improve that to make them more robust. And we're currently testing also driving software for intersections and city streets and narrow streets. So I personally test the latest [inaudible 00:05:54] of full self driving software when I drive my car. And it is really, I think, profoundly better than people realize. Yeah, really profoundly better. It's amazing. So it's almost getting to the point where I can go from my house to work with no interventions, despite going through construction and widely varying situations. So this is why I am very confident about full self driving, the functionality being complete by the end of this year, because I'm literally driving it. Elon Musk: (06:40) In conclusion, I'd like to again say thanks for all the hard work of the Tesla team achieving our first four year of profitability in the company history. It was incredibly difficult and just as a result of the hard work of a lot of people from Tesla worldwide. And yeah, just think about the next 12 to 18 months, we'll have three new factories in place. Things are looking great with a Giga Berlin and we'll have cyber truck, semi, Roadster, full self driving. There's so much to be excited about. It's really hard to kind of put into this call, but the sheer amount of hardcore engineering, especially on the autonomy and the manufacturing engineering front is mindblowing. Elon Musk: (07:39) And then of course, there's [inaudible 00:07:40] Day, which is coming up pretty soon. And I think that's really going to surprise people by just how much there is to see. So with that, thanks again for your support in our long term mission. And we're looking forward to having a great journey with you to create amazing products and continue scaling it. And yeah, I think I've never been more optimistic or excited about the future of Tesla and then the history of the company. Thank you. Martin Eberhard: (08:20) Thank you very much. And I think our CFO Zachary Kirkhorn has some remarks as well. Zach Kirkhorn: (08:25) Yeah. Thanks, Martin. I want to start by thanking our employees, customers, and suppliers for your support over the last quarter. In particular to the Tesla team. I couldn't be more impressed with the hard work and the resiliency that you all have shown. In net income overall, as Elon mentioned, we achieved our fourth sequential quarter of profitability. This is despite a significant impact to our financials as a result of suspended operations of our U.S. factories and field operations around the world. To ensure the business remained healthy, we took temporary action to reduce costs, including expenses related to personnel and noncritical path projects. The direct cost savings or the direct cost impact of the temporary shutdown was largely offset by these cost savings actions although the costs were concentrated in cogs and the cost reductions were on both cogs and operating expenses. Zach Kirkhorn: (09:17) On automotive gross margin, excluding regulatory credits, this reduced sequentially from 20% to 18.7%. This sequential reduction is fully attributed to idle capacity charges and lower operational efficiency due to the various shutdowns. Despite these charges, we continue to make progress reducing our costs, particularly on Model Y in Fremont and Model 3 in Shanghai. Given the global macro economic context, we made the decision in Q2 to pass through savings to customers around the world on some of our products. With the release of stoplight and stop sign recognition and response, we recognized 48 million of deferred revenue in the period. The full profit impact on our P&L is less than half of this due to cost associated with FSD computer retrofits in the field. Regulatory credit revenue increased sequentially to 428 million. While difficult to forecast precisely, our best estimate of 2020 credit revenue is roughly double that of 2019 services. Zach Kirkhorn: (10:20) Services and other margin improved yet again, marking the fifth sequential quarter of improvement. In the energy business, our Megapack product achieved its first quarterly profit. We remain production constrained in this business and are continuing to work towards building additional capacity. And our solar installation business was impacted by permit office closures, limiting installation volume. Stock-based comp increased from Q1 to Q2. This is driven almost entirely by an expense related to the next traunch of the CEO grant, as well as early vesting of the first traunch, which is reflected in SGNA within operating expenses. On cashflows, our cash balance increased to our highest level yet of 8.6 billion, which included free cash flows of over 400 million. This is a strong result on its own, despite an increase in capital expenses associated with Shanghai and Berlin, as well as movements in working capital. Zach Kirkhorn: (11:14) A few things to note on working capital, particularly accounts receivables. While our AR balance is usually about 20% of revenue, it can fluctuate depending upon a number of factors. First, overall less than 30% of our receivables is associated with new car sales. Second, due to payment terms associated with financing and enterprise customers, settlement timelines for certain methods of cash payments and geographic mix of our deliveries, our cash balance and associated receivables are impacted significantly by how many cars are delivered in the final weeks and days of the quarter. Third, roughly 40% of the balance is attributed payment terms on regulatory credit sales and statutory incentive programs, both of which have been increasing. Customer deposits reduced slightly as well. Note that as we transitioned to lower order fees across the world, the average deposit per order will continue to reduce, driving down this balance. As we look forward, Tesla was able to navigate through Q2 due to our agile and dynamic culture. We will continue to appropriately manage our cash flows through cost optimization and close working capital management. This is key as we remain focused on expanding production, scaling our operations, and preparing for the launch of three new factories over the next year and a half. Martin Eberhard: (12:34) Thank you very much. Let's go to questions from institutional investors first. The question number one is, as Tesla continues its journey towards the longterm goal of selling 20 million units per year, what are the most important vehicle programs that will drive volume growth over the next three to five years beyond Model 3, Y and the cyber truck? Cheaper, smaller versions of 3 and Y or region specific vehicles or anything else? Elon Musk: (13:02) Well, I don't think we can comment on our detailed product roadmap beyond what's announced because I think we want to reserve that for product launches. It would be reasonable to assume that we would make a compact vehicle of some kind and probably a higher capacity passenger vehicle of some kind. These are likely things at some point, but I do think there's a long way to go with 3 and Y and with cyber truck and semi. It's a long way to go with those. I think we'll do the obvious things. Martin Eberhard: (13:52) Okay. The second question from institutional is, what is your vision for self-drive Tesla? What opportunities do you see for monetizing the installed base other than by FST? Elon Musk: (14:14) Right now I thought FST as just overwhelmingly the most important thing. I think the upgrading of the fleet to full self driving, especially with an over the air software update, may go down as the biggest asset value increase in history as a step change. Maybe there's something bigger, but it certainly would be one of the biggest. I can't think of anything bigger. So overnight, a million depending exactly when it happens and when it's allowed in various regulatory jurisdictions. Elon Musk: (15:02) ... regulatory jurisdictions you'd have like, I don't know, at least a few million cars suddenly becoming five times more valuable or something like that. So like five times higher utility to go from like 12 hours a week of utility, something like that. That's how many hours they used, 260, something like that. Everything else is pretty small by comparison. Now, when things do become full self-driving, so what are people going to do in the car? Well, I guess they're probably going to do productivity and entertainment of some kind, watch movies, play games, and do work. That's in the future. We're already putting some games and stuff on the car just for fun. Speaker 1: (16:04) Yeah. We have been experimenting on that. FSD remains by far and away the biggest opportunity in the near term, but we're putting the plumbing in place to be ready to scale other areas when the time is right. So premium connectivity subscription is something that we put in place and the ability to upgrade your vehicle through the app, for example, on acceleration boost or upgrading a standard range Model 3 to a Standard Plus, adding rear heated seats. These are things that we have, and we're continuing to get feedback from the field on other things that we can launch, and we'll trickle those in with time. Elon Musk: (16:40) Yeah. But they're all very tiny compared with... The step change to full self driving depending upon high calculated is probably worth at least a hundred thousand dollars per car. That's a lot of software you have to sell in the app store or whatever. Moderator: (17:04) Thank you. The third question is also about autopilot. What are the most important upcoming self-driving milestones, and how do you think about timing? Elon Musk: (17:19) Well, the actual major milestone that's happening right now is really transition of the autonomy system of the cars like AI, if you will, from thinking about things in like two and a half D. It's basically taking isolated pictures and doing image recognition on pictures that are partially correlated in time but not very well. And transitioning to kind of a 4D, which is video essentially. You're thinking about the world in three dimensions and the fourth dimension being time. So that architectural change, which has been underway for some time but has not really been rolled out to anyone in the production fleet is what really matters for full self driving. Elon Musk: (18:23) What we've been doing thus far is really just going with 2D, mostly 2D, and like I said, not well correlated in time. So it's just hard to convey just how much better a fully 4D system does work. It's capable of things that if you're just looking at things as individual pictures as opposed to video, basically you go from like individual pictures to a surround video. This is fundamental. The car will seem to have just like a giant improvement. We'll probably roll it out later this year, but be able to do your traffic lights, stop, turns, everything pretty much. Elon Musk: (19:38) Then it will be a long March of Nines, essentially. How many nines of reliability are okay? So it's definitely way better than human, but how much better than human does it need to be? That's actually going to be the real work. There's just a massive amount of work with each kind of order of magnitude of reliability. You'll see a [inaudible 00:20:12] happen and if you plot the points on a curve, it'll be kind of obvious where it's headed. AI in general, I think is something... I've been banging this AI drum for a decade, we should be concerned about where AI is going. The people I see being the most wrong about AI are the ones who are very smart because they can't imagine that a computer could be way smarter than them. That's the flow in their logic. They're just way dumber than they think they are. Moderator: (20:51) Thank you. The next question from this additional investor is, please may you update us on alien dreadnought? How has your thinking evolved, and what is needed in order to get closer to fundamental physical limits? Elon Musk: (21:06) A massive amount of effort into manufacturing engineering, the machine that makes the machine is probably a 1000%, maybe 10000% more engineering required for the factory than for the product itself. So we're certainly making progress. I mean, battery and powertrain Gigafactory in Nevada is on an alien dreadnought version 0.5, something like that. Starting to approach version one. We're getting way better at making cars. You can see that in Giga Shanghai. You'll see that even more with Berlin and we're really changing the design of the car in order to make it more manufacturable. The fundamental architecture of Model Y will be different in Berlin. It may look the same, but the internals will be quite different and fundamentally more efficient architecturally than what we've done to date. Drew, would you like to add to that? Drew: (22:30) Yeah, I was going to expand on that thought. I think part of the alien dreadnought concept is not just automation, but minimizing the number of process steps and complexity involved in the manufacturing system, which involves really integrating design and manufacturing across when the raw materials enter the factory to the finished goods exit. We're learning so much through doing that. Elon Musk: (22:56) Yeah. Vertical integration is extremely important for this. But the supply chain, if you put a GPS tracker on a molecule from when it got mined to when it was in a usable product, it would look insane. It would be like, wow, it went around the world like six times. With vertical integration, maybe you can only go around the world once. It's a huge improvement. I think if we could get vertical integration, we could probably get you an order magnitude improvement. Yeah. [inaudible 00:08:29]. Speaker 2: (23:28) Yeah. I think the focus for us is increasing CapEx efficiency. This is something that we've been working very hard for the past three years. You can see that we can build new factories for less amount of money and much faster. Elon Musk: (23:51) Yeah. Speaker 2: (23:52) Those things work together. Elon Musk: (23:54) It's a better factory for less money and less time. Speaker 2: (23:56) Yeah, less money means less time. So that's a great advantage. We're also reducing, and this still is a lot, the amount of inefficiencies. We want every operation to add value to the vehicle, value meaning moving the atoms closer to the final state. So we do not want any robot that just moves things. Elon Musk: (24:19) Yes. [crosstalk 00:09:21]. In fact, it's like we want to be super respectful of people's labor. If we're asking somebody to do something, are we sure it's useful? Are we asking them to spend their time in a way that is respectful of their time? But it's like, wow, the potential for improvement is just tremendous. I just want to be clear, here at Tesla, we love manufacturing. It's awesome. I really think more smart people should be working on manufacturing. It's like- Speaker 2: (24:49) We want more people. Elon Musk: (24:50) Yes. We love it. We do. Speaker 2: (24:52) If people are interested in designing new lines and trying to do things different, Tesla has got a job for you. Now we've got jobs everywhere. It's not only in California. We got jobs in China, in Berlin, in Austin, Texas, and in California. So there's plenty of exciting places and all these places will do original work and challenging and meaningful work. Elon Musk: (25:18) Absolutely. It's actually extremely exciting and fulfilling to design new production systems. I think that for some reason I kind of got a bad rap, especially in the US for a long time. I think people don't think that manufacture... They thought of manufacturing as like, "Oh, it's just some boring, just making copies or whatever." But actually there's far more opportunity for innovation in manufacturing than in the product itself. Order magnitude. If there's one thing that comes out of this call, it's like, "Hey, if you want to help us invent amazing manufacturing techniques and have them put into the product itself." It's not like you just get tossed the product and say, "Hey, make this product." And it's kind of a lousy design. If you're a manufacturer, you get to change the product design and say, "Hey, this product you're asking me to manufacturer is dumb." They're like, "Great, let's fix it." Elon Musk: (26:21) So at Tesla, if you work on manufacturing and engineering, you don't just get forced [inaudible 00:11:28]. You get to change the product design. So it's super exciting. And we evolved [Alliance 00:26:37] even after their book, this rapid evolution of the production system. Drew: (26:43) And there's nothing more rewarding than going from zero cars an hour to 5,000 cars a week or a thousand cars a day. Elon Musk: (26:50) Yeah. So the long term sustainable advantage of Tesla, I think will be manufacturing. Moderator: (27:01) Thank you very much. The last question from institutional investor is, how many vehicles can Tesla produce in Texas? Elon Musk: (27:09) Well, right now, zero. But longterm, a lot. Speaker 2: (27:17) Our biggest property. Elon Musk: (27:18) Yeah. It's the biggest property. True. Moderator: (27:21) Okay. Now we can shift to retail investor questions on Say.com. The first one is, Tesla energy seems widely ignored by Wall Street despite Elon's comments about growth rate exceeding automotive. Could Tesla share more detail on current their plan projects to help investors better understand the business outlook? How disruptive is this Autobidder technology? Elon Musk: (27:46) Yeah, I can't emphasize enough. I think long term, Tesla energy will be roughly the same size as Tesla automotive. I mean the energy business collectively is bigger than the automotive business. So you say like, how big is the energy sector? Bigger than automotive. In order to achieve a sustainable energy future, we have to have sustainable energy generation, which I think is going to be primarily solar and by wind and those are intermittent. So you need to have a lot of batteries to store the energy because the wind doesn't always blow and the sun doesn't always shine. There's like three elements of the sustainable energy future, wind and solar, sustainable energy generation, battery storage, and electric transport. Those three things. The mission of Tesla is to accelerate sustainable energy. I can't emphasize enough the... Yeah. Battery and solar will both be enormous and they kind of have to be in order for us to have a sustainable future. We've got a great product roadmap on that front as well. [inaudible 00:29:09] the Megapack is very well received. Yeah, if you want to talk about that. Drew: (29:17) Yeah. I think the Megapack has represented itself and is an integrated rapidly deployable grid type storage battery of megawatt hour scale. We're working with utilities large and small, not just utilities, but also just micro grid and project developers of all types and building our own projects where it makes sense. There's a lot of demand for the product and we're growing the production rates as fast as we can for that product. Then on Autobidder, Autobidder is basically autopilot for grid tied batteries. It's an autonomous energy market participation system that does high frequency trading and ensures- Elon Musk: (30:01) That's a bad word. Drew: (30:02) Sorry. Sorry. Speaker 3: (30:03) ... frequency trading- Elon Musk: (30:03) That's a bad word. Speaker 3: (30:03) Sorry, sorry. Elon Musk: (30:03) High frequency trading should be called front running. We're not doing that. Speaker 3: (30:06) We're not doing anything like that. No, it's ensuring that the battery is doing everything it can to manage the [crosstalk 00:30:12] of the renewables, and just grid intermittency of all kinds. I mean, people turn their lights on and off. Power plants turn on and off. Factories ramp up and down, and batteries are great to solve those problems. Elon Musk: (30:25) Yeah, it's just grid stabilization at the millisecond level. Speaker 3: (30:29) Exactly. Elon Musk: (30:29) So it just ensures that things are super smooth. It's like UPS, an uninterruptible power supply, of a normal size. But just ensures that the grid has smooth sailing, and the batteries, the computers won't interact with each other, and make sure that they're working together to make the grid as smooth. And this can be done with the Power Walls and the Megapacks and the Power Packs all working together, and interacting with third party systems as well. Speaker 3: (31:06) Yeah, centrally or distributed, it does both. Elon Musk: (31:08) Yeah. Speaker 3: (31:11) Yeah, I mean, yeah. Elon Musk: (31:13) It's necessary in order to solve the sustainable energy problem. Speaker 3: (31:17) Yeah, you can't plan power plants on the hourly scale in a renewable world. You need to optimize them on a minute-by-minute scale and that's what we're doing. Elon Musk: (31:27) Yeah, the real limitation on Tesla growth is cell production at affordable price. That's a real limit. So, that's where... We can talk a little more about this on Battery Day, because this is the fundamental scaling constraint. And any part of that supply chain or processing at the cell level will be the limiting factor. So, whatever it may be, anywhere from mining to refining. There's many steps, in refining, to cathode and anode formation, cell formation, whatever the trouble point is, that will set the growth rate. Elon Musk: (32:17) And so, we expect to expand our business with Panasonic, with CATL, with LG, possibly with others. And there's a lot more to say on that front on Battery Day. Speaker 4: (32:34) Thank you. The second question is, now that it's time to bring the Tesla semi to volume production, can you share more detail on production plans? What weekly production rate is considered volume production, and when does Tesla expect to reach that rate? Speaker 5: (32:51) Yeah, so we'll start production next year as we announce before. I personally very care about the project. I can't wait. We do have a few trucks that keep driving around, and keep delivering cars. But we're going to accelerate that. I want to be clear that the first few units, we will use ourselves at Tesla to carry our own freight. Probably mostly between Fremont and Reno, which is a fantastic test route. We're going to prove that we have really good reliability. Speaker 5: (33:22) So far the early units do have it, but we'll develop them larger scale. And we have also promised some early units to some long term, very patient and supportive customers, and we'll do that. And we will have more sales coming up in next year, as Elon just pointed out. So we can increase the diversity of the portfolio. Speaker 5: (33:47) It didn't make sense up to now to do it, but we'll be ready, and that's... Maybe a little biased, but I'm very excited about this. We have a lot of very unique technology that we're always dreaming about that we will be putting in to that semi. It will be just awesome. Elon Musk: (34:07) Yeah. And just, there's two general classes of cell. There's iron phosphate and then the nickel-based. The nickel-based cells have higher energy density, so longer range. Obviously those are needed for something like the semi, where every unit of mass that you add in battery pack you have to subtract in cargo. Elon Musk: (34:28) So it's very important to have mass-efficient and long range pack for batteries. However, what we're seeing with our passenger vehicles is our power train efficiency, tire efficiency, drag coefficient... If all of the things, HVAC, going into a heat pump, [inaudible 00:34:55] our total vehicle efficiency has gotten good enough with Model 3, for example, that we actually are comfortable having an iron phosphate battery pack in Model 3 in China. And that'll be in volume production later this year. Elon Musk: (35:11) So we think that getting a range that is in the high 200's... Basically, but we think, probably get a range of almost 300 miles with an iron phosphate pack, taking into a whole bunch of power train and other vehicle efficiencies. And that frees up a lot of capacity for things like the Tesla Semi and other projects that require higher energy density. So, yeah, [inaudible 00:35:49] two supply chains that you can tap into, iron phosphate or nickel. Elon Musk: (35:55) We use very little cobalt in our system already, and that may trend to zero [inaudible 00:36:03]. So it's really about nickel. Speaker 4: (36:07) Thank you. And the next question is, Tesla recently decided not to produce standard range version of Model Y. No longer offers a standard range S or X, and has announced ramping of the semi. Does this shift from smaller pack vehicle suggest that Tesla is not battery-constrained as in the past? What are the biggest constraints now? Elon Musk: (36:30) Well, I'd just like to re-emphasize [inaudible 00:36:32], any mining companies out there, please mine more nickel. Okay? Wherever you are in the world, please mine more nickel, and don't wait for nickel to go back to some high point that you experienced some five years ago, whatever. Go for efficient, as environmentally friendly nickel mining, at high volume. Tesla will give you a giant contract for a long period of time if you mine nickel efficiently and in an environmentally sensitive way. So, hopefully this message goes out to all mining companies. Please get nickel. Elon Musk: (37:17) With regard to passenger vehicles, I think the new normal for range is going to be, just in U.S. EPA terms, approximately 300 miles. So I think people will really come to expect that, as some number close to 300 miles, as normal. That's a standard expectation. Elon Musk: (37:46) Because you do need to take into account, is it very hot outside? Or very cold? Or are you driving up a tall mountain with a full load? And it's... People don't want to get to a destination with like 10 miles range. They want some reasonable margin. Elon Musk: (38:11) So, I think 300 is going to be really... or close to 300 is going to be a new normal. Call it 500 kilometers, basically. Roughly. Speaker 4: (38:22) Thank you. The next question on insurance. What is the holdup on Tesla Insurance outside of California? Will you release numbers from that part of the business? Will Tesla Insurance be required to participate in the Tesla ride hailing network as a driver? Elon Musk: (38:36) Sure. Zach Kirkhorn: (38:38) Yeah. We were joking before the call that we get the quarterly insurance question that pops up on [inaudible 00:38:44] dot com here. We are working super hard on insurance. I'll go into a little bit more detail than I have in the past. Zach Kirkhorn: (38:51) Currently, we have a product in California, as I've described before, it's been quite well received. And I would largely describe it as a fairly standard insurance product with elements of it that are unique to our cars. So you can think of it as a Version 1 of Tesla Insurance. Elon Musk: (39:10) Version 0.9 [inaudible 00:39:13] at least. Zach Kirkhorn: (39:13) 0.9. But what we're working on now is, we can call it Version 2 or the first version of our telematics product. And so really, ultimately where we want to get to with Tesla Insurance is to be able to use the data that's captured in the car, in the driving profile of the person in the car, to be able to assess correlations and probabilities of crash, and to be able, then, to assess a premium on a monthly basis for that customer. Zach Kirkhorn: (39:40) And what makes this very exciting for us is, the amount of data that is available with the customer's permission to use, is not available in any other product or any other vehicle in the world. So this gives us a unique advantage in terms of information. Zach Kirkhorn: (39:58) And we had a decision point here, where we could take the California product and replicate that into other states, or we could delay going into additional states, and instead put more effort into the telematics side of this. And we chose the latter. And where we are now is, nearly complete with the risk and cost analysis associated with the first version of the telematics product. We hope to be filing that in a handful of states, with regulators, very shortly. Zach Kirkhorn: (40:32) And assuming that regulatory approvals go smoothly, we hope to have this in a handful of states by the end of the year. And then we'll continue to file for approval in additional states. With regulatory approval there, we'll continue to roll this out nationwide as quickly as we can. Zach Kirkhorn: (40:52) And then that product, as we continue to collect more data, and we iterate on it, there will be Version 2, Version 3, et cetera, as we continue to refine that. Elon Musk: (41:00) Yeah, I mean, at the heart of being competitive with insurance is, what is the accuracy of your information? Are you dealing with... Are you forced to assess people statistically, looking in the rear view mirror? Or can you assess people individually, looking ahead with smart projections? And inform the driver of how they may reduce their... what actions they can take to reduce their insurance, as Zack was alluding to. It's like, okay, you're driving too fast. You're doing this or that or the other thing. It's like, if you want to pay more for insurance you can, but if you want to pay less, then please don't drive so crazy. Elon Musk: (41:45) And people can make a choice. Okay, they want to drive aggressively. In that case it will be higher insurance. They want to be more careful in their driving, it'll be pay less. It's just also actually very helpful for us to have a feedback loop to see what is driving insurance expense. A lot of it is just, you have like a little fender bender, and the next fender bender, because of the way that the body or collision repair is being done, costs $15,000 or something crazy. We can actually adjust the design of the car, and adjust how the repair is done, to actually have the fundamental cost of solving that problem be less. Elon Musk: (42:34) So this has helped us unearthed a bunch of silly things we were doing, basically. Without realizing it. This is a problem in general with insurance. It's like, if insurance is like, all you can eat, then the feedback loop for improvement is weak. Elon Musk: (42:50) So this gives us a great feedback loop for improvement. It gives us basically a fundamentally better insurance product. Elon Musk: (42:57) I'd also like to say, in the spirit of recruiting, if there's one thing I'd like to come out of this call, it's that a lot of great people want to join Tesla. That's the number one thing I'd like out of this call. And on the insurance front, I want to be clear, we're building a great, major insurance company. If you're interested in revolutionary insurance, please join Tesla. I would love to have some high energy actuaries, especially. I have great respect for the actuarial profession. You guys are great at math. Please join Tesla. Especially if you want to change things, and you're annoyed by how slow the industry is. This is the place to be. We want revolutionary actuaries. Speaker 4: (43:47) Okay, thank you very much [crosstalk 00:43:49]. Zach Kirkhorn: (43:50) Sorry, there was a second part of this question. Will Tesla insurance be required to participate in the Tesla ride hailing network? Zach Kirkhorn: (43:55) And so, I think I've answered this before in prior calls, but by the time the ride hailing network is available, we will, Tesla insurance will be provided for folks who are in this network. It's a different type of insurance because of the use of the car. It's not decided whether third party insurance versus Tesla insurance will be required. There might be some things we need to think through there, but Tesla Insurance at least will be working, working for the ride hailing network. Speaker 4: (44:25) Thank you very much. And in the interest of time, let's go to the Q&A of analysts online. Speaker 6: (44:31) Thank you. Our first question will come from Dan [Levy 00:44:34] from Credit Suisse. Please go ahead. Dan Levy: (44:37) High. Good afternoon, thank you. I'll ask a question on the quarter, and a question more broadly on strategy. Just on the quarter, if you could give us an update on gross margin with China [inaudible 00:44:53] gross margin in the second quarter, and give us an idea of how far off Model Y gross margin was versus Fremont Model 3, and just more broadly on strategy. It seems like your approach- Speaker 7: (45:03) ... and then just more broadly on strategy. It seems like your approach to insourcing is varying by region. You're insourcing a lot more in Fremont, but you're relying a lot more on the supply chain in Shanghai. What do you expect your approach to be on insourcing when you eventually opened up Berlin? And what's your Texas factory is going to be? Thank you. Speaker 8: (45:21) Yeah. Just to start with the gross margin questions. We did see progress on gross margins in China, and that was despite pricing action that was taken. The factory is still not running at full capacity yet as it continues to ramp. So we think there's continued opportunity to optimize the cost structure there. Model Y. As we mentioned last quarter, was profitable in its first quarter of production. And despite the inefficiencies that we had due to the shutdown, we did see a pretty substantial improvement in the Model Y margin. And as we said before, the Model Y cost structure and Model 3 cost structure will converge. They're not quite there, Model Y still slightly more expensive than Model 3. And it's not yet at full production. And with Model Y carrying a slightly higher price point, you can back into the math there on the relative gross margins. Speaker 9: (46:14) Yeah and the Shanghai factory is a pretty big factory. It's continuing to do more and more internally. The thing that's really helping is there were previously a ton of parts that were made in other parts of the world that were being shipped to Shanghai from every part of the world. And just locally sourcing those components makes a massive difference to the cost of the vehicle. The proportion of local sourcing has literally been rising at five to 10% a month. It was 40% at the beginning of this year getting or something like that. It will be 80%, by the end of this year, maybe more. Speaker 10: (47:02) Varied. Also a lot of very strong, very component and very eager suppliers around the factory in Shanghai. Speaker 9: (47:09) Yeah. I've seen the suppliers in China have been extremely competitive, possibly the most competitive in the world. Speaker 10: (47:16) And so far we're in negotiations for Berlin and we'll go where there is a lot of business. Also a lot of suppliers in Germany or the rest of Europe, they are eager to support the factory [inaudible 00:47:30] . Yeah. Speaker 9: (47:31) Yeah. Well obviously Germany has a great automotive industry and supply chain. So actually a ton of our suppliers are in Germany within a few hundred kilometers of the factory. Speaker 11: (47:45) Thank you very much. Let's go to the next question please. Speaker 12: (47:47) My next question will come from Tony [Sakanagi 00:47:52] with Bernstein. Please go ahead. Tony Sakanagi: (47:54) Yes. Thank you. You mentioned in the slide deck a couple of times That you were pleased with gross margin with PTI March in progress, and you expect it to achieve industry leading operating margins over time. Maybe you could shed a little light on that. Industry leading for luxury vendors is eight to 10% PTI for Porsche who's smaller it's 17, for mass market vendors it's five to eight. What do we think about and how much ultimately do you believe that EV credits will contribute to that margin? Because I know your margin has been 5% over the last 12 months, but it's actually less than 1% excluding EV credits. So it's a four point contribution right now. How do we think about ultimately what industry leading margins are? And how much of that you think is coming from EV credits, regulatory credits? And I have a follow up please. Speaker 8: (48:58) Sure. I've mentioned this before in terms of regulatory credits. We manage the business, said differently we don't manage the business with the assumption that regulatory credits will contribute in a significant way to the future I do expect regulatory credit and revenue to double in 2020 relative to 2019. And it'll continue for some period of time, but eventually the stream of regulatory credits will reduce. Speaker 9: (49:25) Yes. It's worth noting that buyers of our car in the US receive zero federal tax credit. Whereas many of our competitors, they get a $7,500 tax credit. And yet not sales have continued to do well. Speaker 8: (49:44) Yep. And so what we see is a continued decline in the cost to produce, manufacture, and distribute our cars. That cost of, even for mature products like the S and the X continues to come down as we do work on that. Model 3, which is our second most mature product that continues to come down. You then layer on top of that, as Elan was discussing earlier, the potential for software based revenue, particularly full self driving. There's the revenue recognition portion of that that we have today. And that will expand as we release more features. And then you can layer on top of that in the future, our revenue from a ride hailing network. Speaker 8: (50:24) Operating expenses continue to come down and become more efficient as a percentage of revenue. There's still incredible opportunity there that we we're working on. Particularly on how customers interact with the company from sales, and service and what their flow is, and how we get cars to them. So we continue to see efficiencies there. So in the medium term here, what our modeling shows is in the low teams operating margin level. And I think there continues the opportunity to drive that up. I hear your point on the 5% and the 1%. We're on a bit of a journey here and we're continuing to be partners. Tony Sakanagi: (51:09) Thank you. And if I could just follow up Elan, you've talked a lot about the mission of the company and really trying to drive EV adoption globally. So how do you think about that trade off between driving towards industry leading profitability yet trying to make your cars more affordable and broader? It feels like historically you've always picked the path of, "I'd rather drive more growth and more adoption because ultimately that's the mission of the company." And we even saw it a little bit this quarter with price reductions. You could have probably kept price where it is sold some units and had better profits, but that's been an ongoing choice that Tesla as a company has made. So how do you personally think about that trade off, even if you were to get to industry leading margins, wouldn't you be inclined to give more of that back to drive a greater adoption more quickly? Elon Musk: (52:21) Well, I think we actually achieve both when you factor in autonomy. I think we can go way beyond industry margins and have the car be affordable to more and more people and potentially almost everyone when factoring in autonomy. But that was really a mega game-changer, [inaudible 00:52:42] changer. Elon Musk: (52:45) Yeah. It is important for people to distinguish between two things. There's value for money that a product has, and then there's affordability. And even if you rail value for money and have value for money, infinite. If people do not have enough money in the bank account to buy the car, they simply cannot. So then you just have this awesome thing and nobody can buy. so it is important to make the car affordable. We will not succeed in our mission if we do not make cars affordable. Elon Musk: (53:23) The thing that bugs me the most about where we are right now is that our cars are not affordable enough. We need me to fix that. So we're all making progress in that regard, just steadily making progress. So we need to not go bankrupt, obviously that's important because that will fail in our mission. But we're not trying to be super profitable either. Obviously profitability is like one or 2%. It's not crazy. Last quarter was only 0.1%. So we want to be profitable. I think just, we want to be like slightly profitable and maximize growth and make the cars as affordable as possible. That's what we're trying to achieve. Speaker 11: (54:22) Thank you. Let's go to the next question please. Speaker 12: (54:25) Our next question will come from Emmanuel [Rossmore 00:54:28] with Deutsche Bank. Please. Go ahead. Emmanuel Rossmore: (54:31) Hi, good afternoon. Could you please characterize the current near term demand environment for your vehicles? These obviously unusual times, I think back in Q1 you had indicated direct [inaudible 00:54:43] backlog I guess at the beginning of this past quarter. I haven't seen any specific comments about new orders as a backlog and then release today. So can you give us some color? Elon Musk: (54:55) Demand is not our problem. Definitely not. We do have some production supply chain challenges we're trying to solve right now. For example, the Model Y rear body casting, obviously, because it's new technology, it's been tricky to maintain rate and keep growing the rate for Model Y casting. Which it's a two piece casting and there's about half a dozen other parts that are added on that will transition to a one piece casting. If I can predict super excited about this. We're going to have the world's biggest casting press is getting assembled right now actually in Fremont for the Model Y rear body casting. It's enormous and it looks awesome. So the things that are troubling us right now are not demand that they are just a bunch of fire fighting on supply chain and production issues. Emmanuel Rossmore: (55:59) Okay two part [crosstalk 00:56:03]. Elon Musk: (56:01) Sorry. Yeah, don't worry about demand. That's not the issue. Emmanuel Rossmore: (56:07) Okay. So when you're saying achieving 500,000 deliveries has become more difficult was it's really just a function of the recent shutdown and some of these supply dynamics? Elon Musk: (56:18) Yeah. It's not [inaudible 00:56:21] demand it's really just a production issue. It's pretty hard when you've got a global supply chain and it's whatever the most effective part of that global supply chain is, that sets your rate. So the number of rabbits we've had to pull out of hat for supply chain is insane. Team's done an amazing job. So I think it also some of our server costs were related to having to use a lot of airplanes to get parts around because of parts shortages. So hopefully get use for your airplanes, that will improve our costs. But it's a dramatic feed supply right now. That's where we are now. Speaker 11: (57:16) Thank you very much. And the last question, please Speaker 12: (57:19) Our last question today, we'll [Phillipe Hoofweiss 00:57:21] with Jefferies. Please go ahead. Phillipe: (57:26) Good afternoon. And thank you. You mentioned a few times to us the constraint to growth fees is vary capacity still. And I was hoping you could clarify the scope of the Berlin plants we're building right now. Will there be the battery capacity consistence with the amount of assembly volume you expect to come out of Berlin? And if not, will you be able to source your battery requirements out of Europe? Or would you have to import batteries from outside of Europe to ensure production and building? Elon Musk: (58:02) Okay, well, we can't say too much about this, except that there will be local cell production. And that will serve the needs of the Berlin factory. [inaudible 00:13:19]. Speaker 13: (58:20) No, that's straightforward enough. I think just adding to what you said earlier about talent and people. Elon Musk: (58:26) Yeah. Speaker 13: (58:28) The same goes in all areas of cell. Elon Musk: (58:30) Yes. Speaker 13: (58:30) Supply chain, manufacturing, materials, design. We are solving this problem. And we're treating it like any other problems that we have solved. We will solve this problem and want talented people to join us as we solve these problems. Speaker 9: (58:46) Yes. To my biggest concern for getting talented people is just probably Berlin because labor mobility in Europe is not as low. I would recommend changing this. If somebody wants to leave and join another company, sometimes they have to spend six months on garden leave it's called hang out in the garden basically. And this is not a good use of people's time. If they want us to hang out in the garden, that's fine, but they shouldn't have to. Speaker 11: (59:22) Thank you. Elon Musk: (59:23) Those who know Europe will know what I'm talking about. Speaker 11: (59:25) Okay. Phillip did we have a follow up question? Phillipe: (59:33) No, that's fine. Thank you very much. Speaker 11: (59:35) Okay. Thank you very much for everyone for joining this call and thank you for all your good questions. And we'll speak to you again in about three months. Elon Musk: (59:43) Yeah. Have you seen her with [inaudible 00:14:46]. Speaker 9: (59:46) Thanks.