TESLA, INC. The following discussion and analysis should be read in conjunction with the consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q.
Overview
Our mission is to accelerate the world's transition to sustainable energy. We design, develop, manufacture, lease and sell high-performance fully electric vehicles, solar energy generation systems and energy storage products. We also offer maintenance, installation, operation, financial and other services related to our products. Automotive In the first half of 2020, we produced 184,944 vehicles and delivered 179,387 vehicles, including our one millionth cumulatively delivered vehicle in the second quarter. We remain focused on ramping our existing products, including Model Y, and constructing additional and diversified manufacturing capabilities while incrementally improving our processes and reducing costs.
Energy Generation and Storage
In the first half of 2020, we deployed 679 MWh of energy storage products, driven by our Powerwall system and the ongoing rollout of our popular Megapack system, and 62 MW of solar energy systems. In the second quarter of 2020, we further streamlined our retrofit solar processes to allow us to offer a better product at improved pricing. We continue to focus on increasing our Solar Roof deployments and installation capabilities.
Management Opportunities, Challenges and Risks
Impact of Current Macroeconomic Factors
We achieved a strong second quarter of 2020 in spite of the continuing widespread worldwide impact from the COVID-19 pandemic. We had temporarily suspended operations at each of our manufacturing facilities worldwide at some point during the first half of 2020 as a result of government requirements or to accommodate related challenges for our employees, their families and our suppliers. Certain of our suppliers and partners, including Panasonic, our partner that manufactures lithium-ion battery cells for our products at our Gigafactory Nevada, also experienced such temporary suspensions. We had also instituted temporary labor cost reduction measures by furloughing certain of our hourly employees, reducing most salaried employees' base salaries globally and reducing our bonus and commission structures while ourU.S. operations were scaled back. Exiting the second quarter of 2020, however, we have resumed operations at all of our manufacturing facilities, continue to increase our output and add additional capacity, and are working with each of our suppliers and government agencies on meeting, ramping and sustaining our production. Our ability to manufacture, deliver and install our products, increase our infrastructure, and plan and invest in our future roadmap during difficult external circumstances has been tested, and thus far we have met the challenge. On the other hand, certain government regulations and public advisories, as well as shifting social behaviors, that have temporarily or sporadically limited or closed non-essential transportation, government functions, business activities and person-to-person interactions remain in place. In some cases, the relaxation of such trends has been followed by a return to stringent restrictions. We cannot predict the duration or direction of such trends, which have also adversely affected and may in the future affect our operations. For example, reduced operations or closures at motor vehicle departments, vehicle auction houses and municipal and utility company inspectors resulted in certain challenges in or postponements for our new vehicle deliveries, used vehicle sales, and energy product deployments in the first half of 2020. We may also be affected by global macroeconomic conditions and changing levels of consumer comfort and spend in the future, which could further impact demand in the worldwide transportation and automotive industries and for construction projects such as the addition of solar energy systems. Likewise, our ability to sustain our production trajectory depends on the ongoing status of various government regulations regarding manufacturing operations, the readiness and solvency of our suppliers and vendors, and a stable and motivated production workforce. Government-imposed travel or visa restrictions may also prevent personnel employed by us or our vendors from traveling to our sites to work on key projects, which may delay their progress. 36 -------------------------------------------------------------------------------- Ultimately, we have always monitored macroeconomic conditions to remain flexible and optimize and evolve our business as appropriate, and we will continue to do so as we did in the first half of 2020. Because the impact of current conditions on a sustained basis is yet largely unknown, is rapidly evolving, and has been varied across geographic regions, this ongoing assessment will be particularly critical to allow us to accurately project demand and infrastructure requirements globally and deploy our production, workforce, and other resources accordingly. Automotive-Production We continued the ramp of Model Y at theFremont Factory during the second quarter of 2020, and after only four cumulative months of production in the first half of the year primarily due to manufacturing suspensions, we exited the quarter at a weekly production rate comparable to that of Model 3 more than nine months into its ramp. We intend to add additional manufacturing capacity for Model 3 and Model Y at theFremont Factory in the second half of 2020 as previously planned. At Gigafactory Shanghai, we have continued to ramp our installed Model 3 capacity, and construction of the next phase to add Model Y manufacturing capacity remains on track. We are also continuing the construction of Gigafactory Berlin, where a localized version of Model Y will be the first vehicle we produce. Finally, we recently purchased a site nearAustin, Texas for our Gigafactory Texas, where we expect to manufacture Model Y and Cybertruck. We have seen the early benefits of diversifying and localizing manufacturing facilities, including during the current COVID-19 pandemic, and our goal is to further improve our manufacturing resilience, efficiency, costs and technology with the development of each new factory. However, the construction of and ramp at these factories are subject to a number of uncertainties inherent in all new manufacturing operations, including ongoing compliance with regulatory requirements, maintenance of operational licenses and approvals for additional expansion, potential supply chain constraints, hiring, training and retention of qualified employees, and the pace of bringing production equipment and processes online with the capability to manufacture high-quality units at scale, and it is not yet certain whether and to what extent the COVID-19 pandemic may further affect such uncertainties and our projected timelines for completion.
Automotive-Demand and Sales
In the second quarter of 2020, the maturity and adaptability of our business model, together with the advanced technology in our vehicles that enabled options for touchless test drives and deliveries, continued to allow us to market and deliver vehicles notwithstanding challenges impacting the automotive industry as a whole. We are adding to this advantage as we ramp and expand new offerings such as Model Y, and continuously update and improve our vehicles' functionality and features based on user feedback. Recently, we further improved our stop sign and traffic light recognition system for applicable FSD-optioned users and increased the EPA-tested maximum range of Model S to 402 miles. We also expect our international manufacturing expansion to continue to drive demand. For example, Model 3 was the best-selling electric vehicle during the second quarter of 2020 inChina , where Gigafactory Shanghai allows us to offer locally-produced Model 3 vehicles with industry-leading standard equipment at a lower price point than competing mid-sized premium sedans even before the impact of government or tax incentives. Moreover,Germany is now among our largest European vehicle markets, which we believe bodes well for future manufacturing at Gigafactory Berlin. While we cannot predict the magnitude or duration of current macroeconomic conditions, we believe that we have actually gained key advantages with the flexibility and momentum we have shown in the first half of 2020, and we are also hopeful that the demonstrably positive environmental impact from the recent worldwide reduction in the transportation-related consumption of fossil fuels will facilitate greater awareness for the importance of sustainable energy and related products. As is inherent in the automotive industry, we may be impacted by trade and environmental policies, political uncertainty and economic cycles involving geographic regions where we have significant operations, which are inherently unpredictable. We may also make certain adjustments to our prices from time to time in the ordinary course of business, including as we introduce new vehicles and variants and optimize the pricing among them and for affordability, and we made such adjustments in the second quarter of 2020 and more recently for ModelY. Such pricing changes may impact our vehicles' resale values, and in turn our operating results. 37
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Automotive-Deliveries and Customer Infrastructure
We continue to optimize our vehicle manufacturing and logistics patterns to deliver our vehicles efficiently worldwide. Unusual logistical challenges such as those related to the COVID-19 pandemic may strain such delivery patterns, which in the second quarter of 2020 resulted in a heavy volume of deliveries towards the end of the quarter. While we have historically experienced planning and logistics challenges related to concentrated production, GigafactoryShanghai is becoming an increasingly larger contributor to our overall production and we expect to ultimately alleviate such challenges through increased local production, including at Gigafactory Berlin and at GigafactoryTexas . We also continue to expand and invest in our servicing and charging locations and capabilities to keep pace with our customer vehicle fleet and ensure a convenient and efficient customer experience, marked by our expansion of the Supercharger network to over 2,000 stations at the end of the second quarter of 2020. However, if our customer vehicles, particularly in the rapidly growing Model 3 fleet and newly launched Model Y fleet, experience unexpected reliability issues, it could outpace and overburden our servicing capabilities and parts inventory.
Energy Generation and Storage Demand, Production and Deployment
In the second quarter of 2020, we further increased the value proposition of our retrofit solar systems by improving the efficiency of our panels, additionally streamlining our ordering and contracting processes and passing on the savings to our customers, backed by lowest-price and money-back guarantees. We have also continued to expand our Solar Roof deployments and increase our installation capacity. Megapack, our up to 3 MWh energy storage system for commercial, industrial and utility and energy generation customers, remains a popular offering as we expand its production and rollout. Together with the international expansion of Autobidder, our proprietary real-time energy trading platform for our customers' utility-scale systems, and the continuing expansion of our other systems such as Powerwall, we believe our energy storage business is well-positioned for further growth. InApril 2020 , the government agency overseeing our agreement with theSUNY Foundation for the construction and use of Gigafactory New York issued guidance that all obligations relating to investment and employment targets under certain of its projects, including our obligation to be compliant with our applicable targets under such agreement onApril 30, 2020 , may be deferred for a one-year period upon such agency's approval of an application for relief by the obligor. As we temporarily suspended most of our manufacturing operations (including of Solar Roof) at Gigafactory New York pursuant to aNew York State executive order issued inMarch 2020 as a result of the COVID-19 pandemic, we were granted such deferral, which was memorialized in an amendment to our agreement with theSUNY Foundation inJuly 2020 . Moreover, as we had exceeded our investment and employment obligations under this agreement prior to such mandated reduction of operations, we do not currently expect any issues meeting all applicable future obligations under this agreement. However, if our expectations set forth above or as to the costs and timelines of our investment and operations at Buffalo or our production ramp of the Solar Roof prove incorrect, we may incur additional expenses or substantial payments to theSUNY Foundation .
Trends in Cash Flow, Capital Expenditures and Operating Expenses
Our capital expenditures are typically difficult to project beyond the short
term given the number and breadth of our core projects at any given time, and
uncertainties in future global market conditions resulting from the COVID-19
pandemic currently makes projections more challenging. For example, the curve of
any new product ramp, such as for Model Y and the Solar Roof, or the
construction of new large-scale operations, such as Gigafactory Berlin and
Gigafactory Texas, is inherently subject to uncertainty of timing, and if we are
able to meet various milestones more quickly than expected, our related capital
expenditures may be accelerated. We also continuously evaluate and may adjust
our capital expenditures based on, among other things: our manufacturing plans
for our various products, which we may rebalance from time to time based on the
mix of demand among them and other contingent factors; the pace and
prioritization of current projects under development; and the addition of any
new projects. Moreover, we are generally increasing the capital efficiency of
our projects with experience, and we may find that our actual capital
expenditures on new projects are different than previously expected.
38
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Subject to the above, considering the expected pace of the manufacturing ramps
for our products, construction and expansion of our factories, and pipeline of
announced projects under development, and consistent with our current strategy
of using partners to manufacture battery cells, as well as considering all other
infrastructure growth, we currently expect our average annual capital
expenditures in 2020 and the two succeeding fiscal years to be $2.5 billion to
$3.5 billion .
In March 2018 , our stockholders approved the 2018 CEO Performance Award, with
vesting contingent on our Board of Directors' certification of the achievement
of specified market capitalization and operational milestones. We will incur
significant non-cash stock-based compensation expense for each tranche under
this award after the related operational milestone initially becomes probable of
being met, and if later than the grant date, we will also have to record a
cumulative catch-up expense at such time. Such catch-up expense may be material
depending on the length of time elapsed from the grant date. Moreover, as the
expense for a tranche is recorded over the longer of (i) the expected
achievement period of the relevant operational milestone and (ii) only if the
related market capitalization milestone has not been achieved, its expected
achievement period, the achievement of a market capitalization milestone earlier
than expected may accelerate the rate at which such expense is recognized. Upon
vesting of a tranche, all remaining associated expense will be recognized
immediately. As of the date of this filing, three operational milestones and two
market capitalization milestones have been achieved, of which two operational
milestones and two market capitalization milestones have also been certified by
our Board of Directors. Consequently, two of the 12 tranches under this award
have vested and become exercisable, subject to our CEO's payment of the exercise
price of $350.02 per share and the minimum five-year holding period generally
applicable to any shares he acquires upon exercise.
During the second quarter of 2020, an operational milestone under the 2018 CEO
Performance Award of Adjusted EBITDA of $4.5 billion became probable of being
met and consequently, we recognized a catch-up expense of $79 million in such
quarter. During the third quarter of 2020, the second tranche vested and
therefore the remaining unamortized expense of $95 million associated with such
tranche, which was previously expected to be recognized ratably in future
quarters through the first quarter of 2022 as determined on the grant date, will
be accelerated into the third quarter of 2020. In addition, if the value of
Tesla's closing stock price continues near or higher than the levels seen in
late July 2020 , the third market capitalization milestone of $200.0 billion is
expected to be met during the third quarter of 2020, meaning that the third
tranche under the 2018 CEO Performance Award would vest upon certification by
our Board of Directors. In such case, the remaining unamortized expense of $118
million for that tranche, which is currently expected to be recognized ratably
in future quarters through the first quarter of 2023 as determined on the grant
date, would be accelerated into the third quarter of 2020. See Note 11, Equity
Incentive Plans-2018 CEO Performance Award, to the consolidated financial
statements included elsewhere in this Quarterly Report on Form 10-Q for further
details regarding the stock-based compensation relating to the 2018 CEO
Performance Award.
Excluding the impact of non-cash stock compensation expense from additional
operational milestones and/or tranches under the 2018 CEO Performance Award
becoming, as applicable, probable of being met or vested earlier than expected,
and as long as macroeconomic factors facilitate increases in overall revenues
from expanding sales, we expect operating expenses as a percentage of revenue to
continue to decrease in the future as we focus on increasing operational
efficiency and process automation.
Critical Accounting Policies and Estimates
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in theU.S. ("GAAP"). The preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience, as appropriate, and on various other assumptions that we believe to be reasonable under the circumstances. Changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. We evaluate our estimates and assumptions on an ongoing basis. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows may be affected. 39 -------------------------------------------------------------------------------- Due to the COVID-19 pandemic, there has been uncertainty and disruption in the global economy and financial markets. The estimates used for, but not limited to, determining significant economic incentive for residual value guarantee arrangements, sales return reserves, the collectability of accounts receivable, inventory valuation, fair value of long-lived assets, goodwill, fair value of financial instruments, fair value and residual value of operating lease vehicles and solar energy systems subject to leases could be impacted. We have assessed the impact and are not aware of any specific events or circumstances that required an update to our estimates and assumptions or materially affected the carrying value of our assets or liabilities as of the date of issuance of this Quarterly Report on Form 10-Q. These estimates may change as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions. For a description of our critical accounting policies and estimates, refer to Part II, Item 7, Critical Accounting Policies and Estimates in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . There have been no material changes to our critical accounting policies and estimates since our Annual Report on Form 10-K for the year endedDecember 31, 2019 .
Recent Accounting Pronouncements
See Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
Results of Operations Effects of COVID-19
The COVID-19 pandemic impacted our business and financial results in the first half of 2020.
The temporary suspension of production at our factories during the six months endedJune 30, 2020 had caused production limitations that negatively impacted our deliveries for the first half of 2020. While we have resumed operations at all of our factories worldwide, our temporary suspension at our factories resulted in idle capacity charges as we still incurred fixed costs such as depreciation, certain payroll related expenses, and property taxes. As part of our response strategy to the business disruptions and uncertainty around macroeconomic conditions caused by the COVID-19 pandemic, we had instituted cost reduction initiatives across our business globally to be commensurate to the scope of our operations while they were scaled back. This included temporary labor cost reduction measures such as furloughing certain of our hourly employees, reducing most salaries employees' base salaries, and reducing our bonus and commission structures. Additionally, we suspended non-critical operating spend and opportunistically renegotiated supplier and vendor arrangements. As part of various governmental responses to the pandemic granted to companies globally, we received certain payroll related benefits which helped to reduce the impact of the COVID-19 pandemic on our financial results. Such payroll related benefits related to our direct headcount have been primarily netted against our idle capacity charges disclosed as well as marginally reduced our operating expenses. The impact of the idle capacity charges incurred in the current period were almost entirely offset by our cost savings initiatives and payroll related benefits. Revenues Three Months Ended June 30, Change Six Months Ended June 30, Change (Dollars in millions) 2020 2019 $ % 2020 2019 $ % Automotive sales$ 4,911 $ 5,168 $ (257 ) -5 %$ 9,804 $ 8,677 $ 1,127 13 % Automotive leasing 268 208 60 29 % 507 423 84 20 % Total automotive revenues 5,179 5,376 (197 ) -4 % 10,311 9,100 1,211 13 % Services and other 487 605 (118 ) -20 % 1,047 1,098 (51 ) -5 % Total automotive & services and other segment revenue 5,666 5,981 (315 ) -5 % 11,358 10,198 1,160 11 % Energy generation and storage segment revenue 370 369 1 0 % 663 693 (30 ) -4 % Total revenues$ 6,036 $ 6,350 $ (314 ) -5 %$ 12,021 $ 10,891 $ 1,130 10 % 40
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Automotive & Services and Other Segment
Automotive sales revenue includes revenues related to cash deliveries of new Model S, Model X, Model 3 and Model Y vehicles, including access to our Supercharger network, internet connectivity, FSD features and over-the-air software updates, as well as sales of regulatory credits to other automotive manufacturers. Cash deliveries are vehicles that are not subject to lease accounting. Our revenue from regulatory credits fluctuates by quarter depending on when a contract is executed with a buyer and when the credits are delivered. For example, our revenue from regulatory credit sales in the three months endedJune 30, 2019 was$111 million while it was$428 million in the three months endedJune 30, 2020 . Automotive leasing revenue includes the amortization of revenue for Model S, Model X and Model 3 vehicles under direct lease agreements as well as those sold with resale value guarantees accounted for as operating leases under lease accounting. We began offering direct leasing for Model 3 vehicles in the second quarter of 2019 and we began offering direct leasing for Model Y vehicles in the third quarter of 2020.
Services and other revenue consists of non-warranty after-sales vehicle services, sales of used vehicles, retail merchandise, sales by our acquired subsidiaries to third party customers, and vehicle insurance revenue.
Automotive sales revenue decreased$257 million , or 5%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 , primarily due to a decrease of 6,807 Model S and Model X cash deliveries and a decrease in the average selling price of Model 3 from a higher sales mix of lower end trims in the three months endedJune 30, 2020 compared to the same period in the prior year as we began deliveringStandard Range variants internationally inJune 2019 . These decreases were partially offset by an increase of$317 million from additional sales of regulatory credits to$428 million in the three months endedJune 30, 2020 and an increase of 3,691 Model 3 and Model Y cash deliveries despite production limitations as a result of temporary suspension of production at theFremont Factory during the first half of 2020. We were able to increase deliveries year over year from additional Model 3 production capacity at Gigafactory Shanghai. Automotive sales revenue increased$1.13 billion , or 13%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 , primarily due to an increase of 24,865 Model 3 and Model Y cash deliveries despite production limitations as a result of temporary suspension of production at theFremont Factory during the first half of 2020. We were able to increase deliveries year over year from additional Model 3 production capacity at Gigafactory Shanghai. Additionally, due to pricing adjustments we made to our vehicle offerings in the six months endedJune 30, 2019 , we estimated that there was a greater likelihood that customers would exercise their buyback options and adjusted our sales return reserve on vehicles previously sold under our buyback options program which resulted in a reduction of automotive sales revenue of$565 million . During the six months endedJune 30, 2020 , we made further pricing adjustments that similarly resulted in a reduction of automotive sales revenue of$60 million . There was also an increase of$455 million from additional sales of regulatory credits to$782 million in the six months endedJune 30, 2020 . The increases in automotive sales revenue were partially offset by a decrease in the average selling price of Model 3 from a higher sales mix of lower end trims as we began deliveringStandard Range variants internationally inJune 2019 and a decrease of 7,245 Model S and Model X cash deliveries in the six months endedJune 30, 2020 compared to the same period in the prior year. Automotive leasing revenue increased$60 million , or 29%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 . Automotive leasing revenue increased$84 million , or 20%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 . The increases in the three and six months endedJune 30, 2020 compared to the same periods in the prior year were primarily due to an increase in cumulative vehicles under our direct vehicle leasing program and an increase in the number of vehicles under leasing programs where our counterparty has retained ownership of the vehicle during or at the end of the guarantee period. When our counterparty retains ownership, any remaining deferred revenue and resale value guarantee liabilities are released to automotive leasing revenue. These increases were partially offset by a decrease in cumulative vehicles under our resale value guarantee leasing programs which are accounted for as operating leases. 41
-------------------------------------------------------------------------------- Services and other revenue decreased$118 million , or 20%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 . Services and other revenue decreased$51 million , or 5%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 . These decreases were primarily due to a decrease in the volume of used vehicle sales, offset by an increase in average selling prices for traded-inTesla vehicles. Additionally, there was an increase in non-warranty maintenance services revenue as our fleet continues to grow and an increase in sales by our acquired subsidiaries to third party customers.
Energy Generation and Storage Segment
Energy generation and storage revenue includes sales and leasing of solar energy generation and energy storage products, services related to such products, and sales of solar energy systems incentives. Energy generation and storage revenue increased by$1 million , or 0%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 . Energy generation and storage revenue decreased by$30 million , or 4%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 , primarily due to a decrease in deployments of solar cash and loan jobs.
Cost of Revenues and Gross Margin
Three Months Ended June 30, Change Six Months Ended June 30, Change
(Dollars in millions) 2020 2019 $ % 2020 2019 $ %
Cost of revenues
Automotive sales $ 3,714 $ 4,254 $ (540 ) -13 % $ 7,413 $ 7,110 $ 303 4 %
Automotive leasing 148 106 42 40 % 270 223 47 21 %
Total automotive cost
of revenues 3,862 4,360 (498 ) -11 % 7,683 7,333 350 5 %
Services and other 558 743 (185 ) -25 % 1,206 1,429 (223 ) -16 %
Total automotive &
services and other
segment cost of
revenues 4,420 5,103 (683 ) -13 % 8,889 8,762 127 1 %
Energy generation and
storage segment 349 326 23 7 % 631 642 (11 ) -2 %
Total cost of revenues $ 4,769 $ 5,429 $ (660 ) -12 % $ 9,520 $ 9,404 $ 116 1 %
Gross profit total automotive
$ 2,628 $ 1,767 Gross margin total automotive 25 % 19 % 25 % 19 %
Gross profit total automotive &
services and other segment
$ 2,469 $ 1,436
Gross margin total automotive &
services and other segment 22 % 15 % 22 % 14 %
Gross profit energy generation
and storage segment $ 21 $ 43 $ 32 $ 51
Gross margin energy generation
and storage segment 6 % 12 % 5 % 7 % Total gross profit$ 1,267 $ 921$ 2,501 $ 1,487 Total gross margin 21 % 15 % 21 % 14 % 42
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Automotive & Services and Other Segment
Cost of automotive sales revenue includes direct parts, material and labor costs, manufacturing overhead, including depreciation costs of tooling and machinery, shipping and logistic costs, vehicle connectivity costs, allocations of electricity and infrastructure costs related to our Supercharger network, and reserves for estimated warranty expenses. Cost of automotive sales revenues also includes adjustments to warranty expense and charges to write down the carrying value of our inventory when it exceeds its estimated net realizable value and to provide for obsolete and on-hand inventory in excess of forecasted demand. Cost of automotive leasing revenue includes the amortization of operating lease vehicles over the lease term, as well as warranty expenses recognized as incurred. Cost of automotive leasing revenue also includes vehicle connectivity costs and allocations of electricity and infrastructure costs related to our Supercharger network for vehicles under our leasing programs. Costs of services and other revenue includes costs associated with providing non-warranty after-sales services, costs to acquire and certify used vehicles, costs for retail merchandise, and costs to provide vehicle insurance. Cost of services and other revenue also includes direct parts, material and labor costs, manufacturing overhead associated with the sales by our acquired subsidiaries to third party customers. Cost of automotive sales revenue decreased$540 million , or 13%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 , primarily due to a decrease of 6,807 Model S and Model X cash deliveries and a decrease in average Model 3 costs per unit due to a higher sales mix of lower end trims, lower freight and duty costs from local production inChina , and additional manufacturing efficiencies in the production of Model 3 in ourFremont Factory . The decrease in cost of automotive sales revenue was partially offset by idle capacity charges of$189 million as a result of temporary suspension of production at theFremont Factory and Gigafactory Nevada during the three months endedJune 30, 2020 and an increase of 3,691 Model 3 and Model Y cash deliveries. Cost of automotive sales revenue increased$303 million , or 4%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 , primarily due to a decrease in average Model 3 costs per unit due to a higher sales mix of lower end trims, lower freight and duty costs from local production inChina , and additional manufacturing efficiencies in the production of Model 3 in ourFremont Factory . There was also a decrease of 7,245 Model S and Model X cash deliveries in the six months endedJune 30, 2020 compared to the same period in the prior year at lower costs per unit due to lower freight and duties from regional sales mix. The decreases in cost of automotive sales revenue were partially offset by an increase of 24,865 Model 3 and Model Y cash deliveries. Due to pricing adjustments we made to our vehicle offerings in the six months endedJune 30, 2019 , we estimated that there was a greater likelihood that customers would exercise their buyback options and if customers elect to exercise the buyback option, we expect to be able to subsequently resell the returned vehicles, which resulted in a reduction of cost of automotive sales revenue of$458 million . During the six months endedJune 30, 2020 , we made further pricing adjustments that similarly resulted in a reduction of cost of automotive sales revenue of$37 million . Additionally, there was an increase to cost of automotive sales revenue from idle capacity charges of$213 million as a result of temporary suspension of production at theFremont Factory and Gigafactory Nevada during the six months endedJune 30, 2020 . Cost of automotive leasing revenue increased$42 million , or 40%, in the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 . Cost of automotive leasing revenue increased$47 million , or 21%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 . The increases in the three and six months endedJune 30, 2020 compared to the same periods in the prior year were primarily due to an increase in cumulative vehicles under our direct vehicle leasing program and an increase in the number of vehicles under leasing programs where our counterparty has retained ownership of the vehicle during or at the end of the guarantee period. When our counterparty retains ownership, the net book value of the leased vehicle of the lease vehicle is expensed to cost of automotive leasing revenue. These increases were partially offset by a decrease in cumulative vehicles under our resale value guarantee leasing programs which are accounted for as operating leases. 43 -------------------------------------------------------------------------------- Cost of services and other revenue decreased$185 million , or 25%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 . Cost of services and other revenue decreased$223 million , or 16%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 . The decreases were primarily due to decreased costs of used vehicle sales from lower sales volume and decreased costs of non-warranty maintenance services as a result of additional operational efficiencies. These decreases were partially offset by an increase in cost of sales by our acquired subsidiaries to third party customers in line with the increase in revenue. Gross margin for total automotive increased from 19% to 25% in the three and six months endedJune 30, 2020 as compared to the three and six months endedJune 30, 2019 , primarily due an increase of$317 million and$455 million , respectively, in sales of regulatory credits and an improvement of Model 3 gross margin primarily from lower freight and duty costs from local production inChina and additional manufacturing efficiencies in the production of Model 3 in ourFremont Factory . Additionally, improvement of Model S and Model X gross margin from lower freight and duties from regional sales mix helped contribute to higher total automotive gross margin. The increases were partially offset by idle capacity charges of$189 million and$213 million as a result of temporary suspension of production at theFremont Factory during the three and six months endedJune 30, 2020 , respectively. Gross margin for total automotive & services and other segment increased from 15% to 22% in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 . Gross margin for total automotive & services and other segment increased from 14% to 22% in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 . The increases to gross margin in the three and six months endedJune 30, 2020 compared to the same periods in the prior year were primarily due to the automotive gross margin impacts discussed above and improved services and other gross margin from increased operational efficiencies in our non-warranty maintenance services business and improved used vehicle sales margins. Additionally, there was an increase due to a lower proportion of services and other within the segment in the three and six months endedJune 30, 2020 , which operates at a lower gross margin than our automotive business.
Energy Generation and Storage Segment
Cost of energy generation and storage revenue includes direct and indirect material and labor costs, warehouse rent, freight, warranty expense, other overhead costs and amortization of certain acquired intangible assets. In addition, where arrangements are accounted for as operating leases, the cost of revenue is primarily comprised of depreciation of the cost of leased solar energy systems, maintenance costs associated with those systems and amortization of any initial direct costs. Cost of energy generation and storage revenue increased by$23 million , or 7%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 , primarily due to higher costs from temporary manufacturing utilization of our Solar Roof ramp and idle capacity charges of$20 million as a result of temporary suspension of production at Gigafactory New York during the three months endedJune 30, 2020 , partially offset by a decrease in deployments of solar cash and loan jobs. Cost of energy generation and storage revenue decreased by$11 million , or 37%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 , primarily due to a decrease in deployments of solar cash and loan jobs and lower material costs per unit for storage products, offset by higher costs from temporary manufacturing utilization of our Solar Roof ramp and idle capacity charges of$20 million as a result of temporary suspension of production at Gigafactory New York during the six months endedJune 30, 2020 . Gross margin for energy generation and storage decreased from 12% to 6% in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 , primarily due to idle capacity charges of$20 million as a result of temporary suspension of production at Gigafactory New York during the three months endedJune 30, 2020 . Gross margin for energy generation and storage decreased from 7% to 5% in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 , primarily due to idle capacity charges of$20 million as a result of temporary suspension of production at Gigafactory New York during the six months endedJune 30, 2020 . This decrease is partially offset by an improvement in our energy storage gross margin as a result of lower materials costs. 44 --------------------------------------------------------------------------------
Research and Development Expense
Three Months Ended June 30, Change Six Months Ended June 30, Change
(Dollars in millions) 2020 2019 $ % 2020 2019 $ %
Research and development $ 279 $ 324 $ (45 ) -14 % $ 603 $ 664 $ (61 ) -9 %
As a percentage of revenues 5 % 5 % 5 % 6 %
Research and development ("R&D") expenses consist primarily of personnel costs
for our teams in engineering and research, manufacturing engineering and
manufacturing test organizations, prototyping expense, contract and professional
services and amortized equipment expense.
R&D expenses decreased $45 million , or 14%, in the three months ended June 30,
2020 compared to the three months ended June 30, 2019 . The decrease was
primarily due to a $27 million decrease in employee and labor related expenses,
an $11 million decrease in professional and outside service expenses and a $4
million decrease in expensed materials. The decreases observed were driven by
our continued focus on increasing operational efficiency and process automation
and from our cost savings initiatives as part of our COVID-19 response strategy
as discussed above.
R&D expenses as a percentage of revenue decreased from 5.1% to 4.6% in the three
months ended June 30, 2020 as compared to the three months ended June 30, 2019 .
The decrease is primarily from a decrease in our R&D expenses as detailed above,
offset by a decrease in total revenues as a result of temporary suspension of
our factories during the first half of 2020.
R&D expenses decreased $61 million , or 9%, in the six months ended June 30, 2020
as compared to the six months ended June 30, 2019 . The decrease was primarily
due to a $49 million decrease in employee and labor related expenses and a $9
million decrease in professional and outside service expenses, partially offset
by an $8 million increase in facilities, freight and depreciation expenses. The
decreases observed were driven by our continued focus on increasing operational
efficiency and process automation and from our cost savings initiatives as part
of our COVID-19 response strategy as discussed above.
R&D expenses as a percentage of revenue decreased from 6% to 5% in the six
months ended June 30, 2020 as compared to the six months ended June 30, 2019 .
The decrease is primarily from a decrease in our R&D expenses as detailed above
and an increase in total revenues from expanding sales.
Selling, General and Administrative Expense
Three Months Ended June 30, Change Six Months Ended June 30, Change
(Dollars in millions) 2020 2019 $ % 2020 2019 $ %Selling, general and administrative $ 661 $ 647
$ 14 2 %$ 1,288 $ 1,351 $ (63 ) -5 % As a percentage of revenues 11 % 10 % 11 % 12 %
Selling, general and administrative ("SG&A") expenses generally consist of personnel and facilities costs related to our stores, marketing, sales, executive, finance, human resources, information technology and legal organizations, as well as fees for professional and contract services and litigation settlements.
45
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SG&A expenses increased $14 million , or 2%, in the three months ended June 30,
2020 as compared to the three months ended June 30, 2019 . The increase was
primarily due to an increase of $119 million in stock-based compensation
expense, of which $111 million was attributable to the 2018 CEO Performance
Award. We had recorded a $79 million cumulative catch-up expense for the service
provided from the grant date when an additional operational milestone was
considered probable of being met in the second quarter of 2020 and the remaining
unamortized expense of $22 million for the first tranche was recognized in the
second quarter of 2020 upon vesting as the first market capitalization milestone
was achieved (see Note 11, Equity Incentive Plans, to the consolidated financial
statements included elsewhere in this Quarterly Report on Form 10-Q). The
remainder of the increase in SG&A expense from the 2018 CEO Performance Award is
attributed to the additional performance milestone that was deemed probable in
the fourth quarter of 2019. The increase was partially offset by a decrease of
$74 million in employee and labor related expenses and a $46 million decrease in
office, information technology and facilities-related expenses and sales and
marketing activities. The decreases observed were driven by our continued focus
on increasing operational efficiency and process automation and from our cost
savings initiatives as part of our COVID-19 response strategy as discussed
above.
SG&A expenses as a percentage of revenue increased from 10% to 11% in the three
months ended June 30, 2020 as compared to the three months ended June 30, 2019 .
The increase is primarily from a decrease in total revenues as a result of
temporary suspension of our factories during the first half of 2020 and an
increase in our SG&A expenses as detailed above.
SG&A expenses decreased $63 million , or 5%, in the six months ended June 30,
2020 as compared to the six months ended June 30, 2019 The decrease is primarily
due to a $123 million decrease in employee and labor related expenses and $64
million decrease in office, information technology and facilities-related
expenses and sales and marketing activities. The decreases observed were driven
by our continued focus on increasing operational efficiency and process
automation and from our cost savings initiatives as part of our COVID-19
response strategy as discussed above. The decreases were partially offset by an
increase of $125 million in stock-based compensation expense, of which $122
million was attributable to the 2018 CEO Performance Award. We had recorded a
$79 million cumulative catch-up expense for the service provided from the grant
date when an additional operational milestone was considered probable of being
met in the second quarter of 2020 and the remaining unamortized expense of $22
million for the first tranche was recognized in the second quarter of 2020 upon
vesting as the first market capitalization milestone was achieved (see Note 11,
Equity Incentive Plans, to the consolidated financial statements included
elsewhere in this Quarterly Report on Form 10-Q). The remainder of the increase
in SG&A expense from the 2018 CEO Performance Award is attributed to the
additional performance milestone that was deemed probable in the fourth quarter
of 2019.
SG&A expenses as a percentage of revenue decreased from 12% to 11% in the six
months ended June 30, 2020 as compared to the six months ended June 30, 2019 .
The decrease is primarily from a decrease in our SG&A expenses as detailed above
and an increase in total revenues from expanding sales.
Restructuring and other
Three Months Ended June 30, Change Six Months Ended June 30, Change
(Dollars in millions) 2020 2019 $ % 2020 2019 $ %
Restructuring and other $ - $ 117 $ (117 ) -100 % $ - $ 161 $ (161 ) -100%
As a percentage of revenues 0 % 2 % 0 % 1 %
During the first half of 2019, we carried out certain restructuring actions in
order to reduce costs and improve efficiency. As a result, we recognized $50
million of costs primarily related to employee termination expenses and losses
from closing certain stores. These costs were substantially paid by the end of
second quarter of 2019. During the second quarter of 2019, we recognized $47
million in impairment related to IPR&D as we abandoned further development
efforts and $15 million for the related equipment. We also incurred a loss of
$49 million for closing certain facilities. There were no restructuring actions
in the three and six months ended June 30, 2020 .
46
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Interest Expense
Three Months Ended June 30, Change Six Months Ended June 30, Change
(Dollars in millions) 2020 2019 $ % 2020 2019 $ %
Interest expense $ 170 $ 172 $ (2 ) -1 % $ 339 $ 330 $ 9 3 %
As a percentage of revenues 3 % 3 % 3 % 3 %
Interest expense decreased by
Interest expense increased by$9 million , or 3%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 , primarily due to an increase in our average outstanding indebtedness as compared to the six months endedJune 30, 2019 . Other Income (Expense), Net Three Months Ended June 30, Change Six Months Ended June 30, Change (Dollars in millions) 2020 2019 $ % 2020 2019 $ % Other expense, net $ (15 ) $ (41 )$ 26
-63 %
0 % -1 % -1 % 0 %
Other income (expense), net, consists primarily of foreign exchange gains and
losses related to our foreign currency-denominated monetary assets and
liabilities and changes in the fair values of our fixed-for-floating interest
rate swaps. We expect our foreign exchange gains and losses will vary depending
upon movements in the underlying exchange rates.
Other expense, net, changed favorably by $26 million , in the three months ended
June 30, 2020 as compared to the three months ended June 30, 2019 . The change
was primarily due to a decrease in losses from interest rate swaps related to
our debt facilities year-over-year and favorable fluctuations in foreign
currency exchange rates compared to the three months ended June 30, 2019 .
Other expense, net, changed unfavorably by $54 million , in the six months ended
June 30, 2020 as compared to the six months ended June 30, 2019 . The change was
primarily due to unfavorable fluctuations in foreign currency exchange rates
compared to the six months ended June 30, 2019 .
Provision for Income Taxes
Three Months Ended June 30, Change Six Months Ended June 30, Change
(Dollars in millions) 2020 2019 $ % 2020 2019 $ %Provision for income taxes $ 21 $ 19$ 2 11 % $ 23$ 42 $ (19 ) -45 % Effective tax rate 14 % -5 % 10 % -4 % Our provision for income taxes increased by$2 million , or 11%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 . The increase is primarily due to an increase in discrete tax expense in the current period related to foreign return-to-provision items, partially offset by reduced taxable profits within certain foreign jurisdictions compared to the same period in the prior year. Our provision for income taxes decreased by$19 million , or 45%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 . The decrease was primarily due to reduced taxable profits within certain foreign jurisdictions, partially offset by an increase in discrete tax expense in the current period related to foreign return-to-provision items compared to the same period in the prior year. 47
-------------------------------------------------------------------------------- Our effective tax rate increased from -5% to 14% in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 . Our effective tax rate increased from -4% to 10% in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2020 . The increases were primarily due to being in a pre-tax earnings position in the three and six months endedJune 30, 2020 as compared to a pre-tax loss position for the same periods in the prior year. Net Income Attributable to Noncontrolling Interests and Redeemable Noncontrolling Interests Three Months Ended June 30, Change Six Months Ended June 30, Change (Dollars in millions) 2020 2019 $ % 2020 2019 $ % Net income attributable to noncontrolling interests and redeemable noncontrolling interests in subsidiaries $ 25 $ 19$ 6 32 % $ 77$ 53 $ 24 45%
Our net income attributable to noncontrolling interests and redeemable noncontrolling interests was related to financing fund arrangements.
Net income attributable to noncontrolling interests and redeemable noncontrolling interests increased by$6 million , or 32%, in the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 . Net income attributable to noncontrolling interests and redeemable noncontrolling interests increased by$24 million , or 45%, in the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 . The increases were primarily due to lower activities from new financing fund arrangements.
Liquidity and Capital Resources
As ofJune 30, 2020 , we had$8.62 billion of cash and cash equivalents. Balances held in foreign currencies had aU.S. dollar equivalent of$3.60 billion and consisted primarily of Chinese yuan, euros and Canadian dollars. Our sources of cash are predominantly from our deliveries of vehicles, sales and installations of our energy storage products and solar energy systems, proceeds from debt facilities, proceeds from financing funds and proceeds from equity offerings. Our sources of liquidity and cash flows enable us to fund ongoing operations, research and development projects for new products, establishment and/or increases of Model 3 and Model Y production capacity at theFremont Factory and at Gigafactory Shanghai, the continued expansion of Gigafactory Nevada, the construction of Gigafactory Berlin and Gigafactory Texas, the manufacturing ramp of the Solar Roof at Gigafactory New York, and the continued expansion of our retail and service locations, body shops, Mobile Service fleet and Supercharger network. As discussed in and subject to the considerations referenced in Part I, Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations-Management Opportunities, Challenges and Risks-Trends in Cash Flow, Capital Expenditures and Operating Expenses in this Quarterly Report on Form 10-Q, considering the expected pace of the manufacturing ramps for our products, construction and expansion of our factories, and pipeline of projects under development, and consistent with our current strategy of using a partner to manufacture battery cells, as well as considering all other infrastructure growth, we currently expect our average annual capital expenditures in 2020 and the two succeeding fiscal years to be$2.5 billion to$3.5 billion . We expect that the cash we generate from our core operations will generally be sufficient to cover our future capital expenditures and to pay down our near-term debt obligations, although we may choose to seek alternative financing sources. For example, we expect that much of our investment in GigafactoryShanghai will continue to be funded through indebtedness arranged through local financial institutions inChina , such as theRMB 9.0 billion (or the equivalent amount inU.S. dollars) fixed asset term facility andRMB 2.25 billion (or the equivalent amount inU.S. dollars) working capital revolving facility that our local subsidiary entered into inDecember 2019 , and we expect the same with respect to Gigafactory Berlin. As always, we continually evaluate our capital expenditure needs and may decide it is best to raise additional capital to fund the rapid growth of our business. 48
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We have an agreement to spend or incur$5.0 billion in combined capital, operational expenses, costs of goods sold and other costs in theState of New York during the 10-year period beginningApril 30, 2018 . InApril 2020 , the government agency overseeing this agreement issued guidance that all obligations relating to investment and employment targets under certain of its projects, including our obligation to be compliant with our applicable targets under such agreement onApril 30, 2020 , may be deferred for a one-year period upon such agency's approval of an application for relief by the obligor. As we temporarily suspended most of our manufacturing operations at Gigafactory New York pursuant to aNew York State executive order issued inMarch 2020 as a result of the COVID-19 pandemic, we were granted such deferral, which was memorialized in an amendment to this agreement inJuly 2020 . Moreover, as we had exceeded our investment and employment obligations under this agreement prior to such mandated reduction of operations, we do not currently expect any issues meeting all applicable future obligations under this agreement, and we do not believe that we face a significant risk of default. We expect that our current sources of liquidity together with our projection of cash flows from operating activities will provide us with adequate liquidity over at least the next 12 months. A large portion of our future expenditures is to fund our growth, and we can adjust our capital and operating expenditures by operating segment, including future expansion of our product offerings, retail and service locations, body shops, Mobile Service fleet, and Supercharger network. For example, if our near-term manufacturing operations are at a smaller scale or ramp more slowly than expected, including due to global economic conditions and levels of consumer comfort and spend impacting demand in the worldwide transportation, automotive and energy product industries, the pace of our capital expenditures may be correspondingly slowed. We may need or want to raise additional funds in the future, and these funds may not be available to us when we need or want them, or at all. If we cannot raise additional funds when we need or want them, our operations and prospects could be negatively affected. In addition, we had$1.83 billion of unused committed amounts under our credit facilities and financing funds as ofJune 30, 2020 , some of which are subject to satisfying specified conditions prior to draw-down (such as pledging to our lenders sufficient amounts of qualified receivables, inventories, leased vehicles and our interests in those leases, solar energy systems and the associated customer contracts, our interests in financing funds or various other assets; and contributing or selling qualified solar energy systems and the associated customer contracts or qualified leased vehicles and our interests in those leases into the financing funds). For details regarding our indebtedness and financing funds, refer to Note 10, Debt, and Note 13, Variable Interest Entity Arrangements, to the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
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