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TESLA MOTORS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the related notes that appear elsewhere in this Form 10-Q. These discussions contain forward-looking statements reflecting our current expectations that involve risks and uncertainties. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, expectations regarding demand and acceptance for our technologies, growth opportunities and trends in the market in which we operate, prospects plans and objectives of management and the statements made below under the heading "Management Opportunities, Challenges and Risks." The words "anticipates", "believes", "estimates", "expects", "intends", "may", "plans", "projects", "will", "would" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A, "Risk Factors" in this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission. We do not assume any obligation to update any forward-looking statements. Overview and Quarter Highlights We design, develop, manufacture and sell high-performance fully electric vehicles and advanced electric vehicle powertrain components. We own our sales and service network, and market and sell our vehicles directly to consumers via the phone and internet, in-person at our corporate events and through our network of Tesla stores. We were incorporated in Delaware in July 2003, opened our first store in Los Angeles, California in May 2008, and introduced our first vehicle, the Tesla Roadster, in early 2008. In July 2009, we introduced a new Roadster model, the Tesla Roadster 2, and its higher performance option package Roadster Sport, as well as launched the Tesla Roadster in Europe. On July 1, 2010, we introduced the Roadster 2.5, with new styling and an upgraded interior. We are designing our second vehicle, the Model S, for a significantly broader customer base than the Tesla Roadster and plan to manufacture the Model S in higher volumes than our current volumes for the Tesla Roadster. During the three months ended June 30, 2011, total revenues were $58.2 million, an increase of 105% over total revenues of $28.4 million for the three months ended June 30, 2010. Automotive sales revenues increased 63% from the three months ended June 30, 2010, driven by strong customer demand for the Roadster globally and significantly higher deliveries of battery packs and chargers to Daimler AG (Daimler). During the three months ended June 30, 2011, we continued to support sales of the Tesla Roadster with increased sales and marketing activities as compared to the three months ended June 30, 2010. During the three months ended June 30, 2011, we opened new Tesla stores on Santana Row in San Jose, California and in Park Meadows near Denver, Colorado. The opening of these Tesla stores launched what we believe to be a new retail experience designed to engage and inform potential customers about electric vehicles in general and the advantages of the Tesla experience in particular. The concept and layout of these new stores, which are located in high profile retail centers, is different than what has previously been used in automotive sales. At our new stores, Tesla customers can learn about electric vehicles, explore Tesla's innovations, and configure their cars through hands-on interactive touchscreens. Given the success of our two new stores, we plan to introduce this retail strategy more broadly. We plan to open several more stores by year end, mostly in the United States. Some of these new stores will replace existing stores which we plan to continue using as service locations. 19 -------------------------------------------------------------------------------- Table of Contents Development services revenue increased to $19.1 million for the three months ended June 30, 2011 from $4.4 million during the three months ended June 30, 2010, due primarily to our development activities for the Toyota Motor Corporation (Toyota) RAV4 EV program. We completed various planned milestones and deliveries of samples and prototype vehicles to Toyota, and we currently expect to complete our remaining development services milestones pursuant to our agreements with Toyota by the first quarter of 2012. In July 2011, we entered into a supply and services agreement with Toyota for the supply of a validated electric powertrain system, including a battery, charging system, inverter, motor, gearbox and associated software, which will be integrated into an electric vehicle version of the Toyota RAV4. Additionally, we will provide Toyota with certain services related to the supply of these components. Pursuant to the agreement, Toyota will pay us approximately $100 million from 2012 through 2014 based on our delivery of these components to Toyota for the RAV4 EV. The Model S program remains on track for planned customer deliveries beginning in mid-2012. During the three months ended June 30, 2011, we continued to put our Model S alpha prototypes through numerous rounds of testing. Detailed testing of systems integration, performance and safety, including cold weather braking, steering and suspension testing, all of which are ongoing, has provided us with significant reliability and systems integration data and we expect that our iterative alpha testing will continue to influence our final parts designs. While testing of our Model S alpha prototypes continues, we also initiated the beta phase of our Model S development, which will allow us to further refine the overall design of the Model S and its constituent parts as well as the production and assembly process to manufacture the vehicles. Almost all of the critical parts have been sourced, resulting in further visibility of material costs and supplier availability of the Model S production parts. During the beta phase, we will use an increasing level of production parts and tooling in the build of the Model S beta prototypes as well as employing manufacturing processes that will increasingly approximate the actual processes to be used in Model S vehicle production. As a result of expenses related to continued validation and testing of the Model S alpha prototype fleet, research and development expenses increased to $52.5 million for the three months ended June 30, 2011 from $15.4 million for the three months ended June 30, 2010. Research and development expenses included expenses related to the start of the Model S beta prototype build, development of our Model S manufacturing facility, significant engineering, design and testing work being undertaken at several of our suppliers to support Model S readiness, and other research and development activities. We anticipate that the level of research and development spending will increase moderately from the current level for the remainder of 2011 as we continue with the engineering and testing of Model S, prepare our manufacturing facility for production of the Model S next year, accelerate the advanced engineering work on Model X, and pursue additional strategic projects. In addition to Model S engineering and manufacturing engineering development, we also experienced significant activity at our Fremont manufacturing facility, where we intend to produce our Model S and future vehicles, including our Model X crossover vehicles. Significant construction continues to take place and detailed manufacturing readiness plans are being executed. Almost all of the Model S vehicle manufacturing equipment has now been specified and ordered and some equipment has already arrived and is being installed, especially in the stamping, plastics and paint shops. As a result of investments being made in our manufacturing and powertrain facilities and related in-house and supplier tooling for the Model S, capital expenditures increased to $54.3 million for the three months ended June 30, 2011, compared to $9.8 million for the three months ended June 30, 2010. We will continue to seek opportunities to limit our capital expenditures and anticipate our aggregate capital expenditures for 2011 to be in the range of $220 million and $245 million, primarily focused on vehicle development and manufacturing activities for Model S and Model X. 20-------------------------------------------------------------------------------- Table of Contents Our Model S, Model X and powertrain development activities, as well as our capital investments in manufacturing infrastructure, continued to be supported by draw-downs under our Department of Energy Loan Facility (DOE Loan Facility) and other sources of cash including cash from the sales of the Tesla Roadster, cash from the provision of development services and sales of powertrain components, cash received from refundable reservation payments for our Model S and cash received in our public offerings and private placements. During the three months ended June 30, 2011, we received $31.7 million in draw-downs under the DOE Loan Facility bringing our total long-term debt under the facility to $134.2 million. As we continue to progress on our Model S and powertrain activities, we expect to continue making draw-downs under the DOE Loan Facility. In June 2011, we completed a follow-on offering of common stock in which a total of 6,095,000 shares of our common stock were sold, and received cash proceeds of $172.7 million, net of underwriting discounts. Concurrent with this offering, we also sold 1,416,000 shares of common stock to Elon Musk, our Chief Executive Officer and 637,475 shares of common stock to Blackstar Investco LLC, an affiliate of Daimler and received total cash proceeds of $59.1 million in these private placements. No underwriting discounts or commissions were paid in connection with these private placements. As of June 30, 2011, we had $661.5 million in principal sources of liquidity available from our cash and cash equivalents, cash held in our dedicated DOE account and the remaining amounts available under the DOE Loan Facility. This includes our cash and cash equivalents in the amount of $319.4 million which includes investments in money market funds, cash of $11.3 million deposited in a dedicated DOE account in accordance with the requirements of our DOE Loan Facility, and $330.8 million available under the DOE Loan Facility. Management Opportunities, Challenges and Risks Our principal focus for the remainder of 2011 continues to be on the disciplined development of the Model S so that we can achieve our plan of customer deliveries beginning in mid-2012. We are also focused on continued sales of the Tesla Roadster and powertrain components, development services activities with our strategic partners, advanced engineering work on the planned Model X and pursuing new electric powertrain opportunities with automobile manufacturers. In June 2011, we entered into an amendment to our supply agreement with Lotus Cars Limited (Lotus) to increase our purchase from 2,400 Tesla Roadster vehicles or gliders to 2,500 vehicles or gliders. Through June 30, 2011, we have delivered approximately 1,840 vehicles to customers. We currently intend to manufacture at Lotus our current generation Tesla Roadster through January 2012. We plan to sell the last of the North American Roadsters by early next year and continue selling in Europe and Asia until inventory is fully depleted in 2012. As we have a limited number of the Tesla Roadsters left for sale, we anticipate our automotive sales may decline, potentially significantly, just prior to the planned launch of our Model S. The launch of our Model S could be delayed for a number of reasons and any such delays may be significant and would extend the period in which we would generate limited revenues from sales of our electric vehicles. As a result of our electric powertrain supply and development services activities with Toyota under the Toyota RAV4 EV program and with Daimler under the Smart fortwo and A-Class EV programs, we will have significant deliveries and milestones to achieve in 2011. Although our current agreement with Daimler provides us with increased revenue potential in 2011 compared to 2010 from powertrain-related activities, we do not have any agreement with Daimler for sales or services beyond 2011. We expect that the Toyota RAV4 EV development program, and the associated development services revenues, will be completed by early 2012. Thereafter, we plan to begin shipping RAV4 EV production powertrain systems to Toyota consistent with Toyota's announced plan to produce the RAV4 EV for sale in 2012. 21 -------------------------------------------------------------------------------- Table of Contents We anticipate that we will place greater sales emphasis on the generation of Model S reservations during the second half of 2011 as we work towards the launch of our Model S in mid-2012. Preparations for the Model S beta prototype build in our Fremont facility later this year are underway and we are working closely with suppliers to design, develop and test components that will meet our anticipated production design specifications and schedule. Ensuring that our design, engineering, operations and manufacturing engineering teams, and our suppliers, execute on all significant activities will be critical to a timely launch of customer deliveries of our Model S beginning in mid-2012. Our progress towards our beta prototype activities, our continuing negotiations with suppliers, and our manufacturing capabilities will influence our ability to achieve the cost per unit that we are currently projecting. Our plan to begin production of the Model S in mid-2012 is dependent upon the timely availability of funds from the DOE Loan Facility, upon our finalizing the related design, engineering, component procurement, testing, build out and manufacturing plans in a timely manner and upon our ability to execute these plans within the current timeline. In 2011, we publicly announced the Tesla Model X as the first vehicle derivative we intend to develop by leveraging the Model S platform. We are designing the Model X as a crossover vehicle. We currently plan to reveal a prototype of the Model X crossover by the end of 2011 followed by the anticipated commercial introduction of this vehicle in the fourth quarter of 2013. Our operating expenses are expected to increase year-over-year for the remainder of 2011 as we continue to execute on the Model S program, systematically and strategically expand our sales and marketing activities globally to support the launch of the Model S as well as pursue additional strategic projects. As we continue to make significant investments in research and development and our infrastructure to launch the Model S as well as incur costs for the development of the Model X, we expect to continue generating a net loss despite anticipated year-over-year growth in revenues. Capital spending for the Model S program is anticipated to be at its highest level in 2011, as we plan to purchase much of the tooling and manufacturing equipment required for production. We anticipate that most of the capital expenditures on the Model S will be funded by the DOE Loan Facility. We will continue to seek opportunities to limit our capital expenditures and anticipate our aggregate capital expenditures for 2011 to be in the range of $220 million and $245 million, primarily focused on vehicle development and manufacturing activities for Model S and Model X. We have also elected to invest incrementally in new technologies and additional plant automation to efficiently produce vehicles at high quality and at an affordable cost. Most of the Model S related capital investments should be reimbursable under the terms of our DOE Loan Facility. All depreciation of our capital expenditures related to the Fremont facility will begin with the start of Model S production. See Part II - Item 1A - "Risk Factors" for a further discussion of risks associated with our business, including additional risks related to Model S and Model X. Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed 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 will be affected. 22-------------------------------------------------------------------------------- Table of Contents For a description of our critical accounting policies and estimates, please refer to the "Critical Accounting Policies and Estimates" section of our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission (SEC). In addition, please refer to Note 2, "Summary of Significant Accounting Policies," of our condensed consolidated financial statements in Item 1, Part I of this Quarterly Report on Form 10-Q, which is incorporated herein by reference. For revenue arrangements that were entered into or materially modified after January 1, 2011, implementation of new revenue accounting guidance had no material impact on our reported revenue for the three and six months ended June 30, 2011 as compared to revenue that would have been reported if the related arrangements were subject to the accounting requirements in effect in the prior year. Results of Operations The following table sets forth our condensed consolidated statements of operations data for the periods indicated (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Revenues Automotive sales $ 39,028 $ 23,971 $ 72,656 $ 44,556 Development services 19,143 4,434 34,545 4,661 Total revenues 58,171 28,405 107,201 49,217 Cost of revenues Automotive sales 30,528 20,266 57,489 37,124 Development services 9,135 1,878 13,176 1,980 Total cost of revenues 39,663 22,144 70,665 39,104 Gross profit 18,508 6,261 36,536 10,113 Operating expenses Research and development 52,531 15,416 93,693 28,681 Selling, general and administrative 24,716 22,207 48,928 38,792 Total operating expenses 77,247 37,623 142,621 67,473 Loss from operations (58,739 ) (31,362 ) (106,085 ) (57,360 ) Interest income 46 47 86 95 Interest expense - (464 ) - (694 ) Other expense, net (71 ) (6,729 ) (1,556 ) (9,950 ) Loss before income taxes (58,764 ) (38,508 ) (107,555 ) (67,909 ) Provision for income taxes 139 9 289 127 Net loss $ (58,903 ) $ (38,517 ) $ (107,844 ) $ (68,036 ) Revenues Automotive Sales Automotive sales, which include vehicle, options and related sales, and powertrain component and related sales, consisted of the following for the periods presented (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Vehicle, options and related sales $ 27,573 $ 19,136 $ 48,040 $ 37,231 Powertrain component and related sales 11,455 4,835 24,616 7,325 Total automotive sales $ 39,028 $ 23,971 $ 72,656 $ 44,556 23 -------------------------------------------------------------------------------- Table of Contents Automotive sales during the three and six months ended June 30, 2011 were $39.0 million and $72.7 million, respectively, an increase from $24.0 million and $44.6 million during the three and six months ended June 30, 2010, respectively. Vehicle, options and related sales represent sales of the Tesla Roadster, including vehicle options, accessories and destination charges, vehicle service and sales of zero emission vehicle credits. Powertrain component and related sales represent the sales of electric vehicle powertrain components, such as battery packs and battery chargers, to other manufacturers. Vehicle, options and related sales during the three and six months ended June 30, 2011 were $27.6 million and $48.0 million, respectively, an increase from $19.1 million and $37.2 million for the three and six months ended June 30, 2010, respectively. The increase in vehicle, options and related sales was primarily attributable to an increase in the number of Tesla Roadsters that we sold, particularly in North America and Asia, coupled with slightly higher average selling prices. The increase was also attributable to an increase of the cumulative number of vehicles under our leasing programs, which we introduced in 2010. Powertrain component and related sales for the three and six months ended June 30, 2011 were $11.5 million and $24.6 million, respectively, an increase from $4.8 million and $7.3 million for the three and six months ended June 30, 2010, respectively. The increase in powertrain component and related sales was primarily due to significant shipments of battery packs and chargers to Daimler. We began delivering battery packs and chargers for the Daimler Smart fortwo EV program during the first quarter of 2010, and the first quarter of 2011 represented the first full quarter of shipments of battery packs and chargers for the Daimler A-Class EV program. Production for both the Smart fortwo and A-Class EV program is expected to continue through 2011. In response to the strong demand for the Roadster, in June 2011, we entered into an amendment to our supply agreement with Lotus to increase our purchase from 2,400 Tesla Roadster vehicles or gliders to 2,500 vehicles or gliders over the term of the amended agreement, which ends on January 31, 2012. We plan to sell the last of the North American Roadsters by early next year and continue selling in Europe and Asia until inventory is fully depleted in 2012. Development Services Development services represent arrangements where we develop electric vehicle powertrain components for other automobile manufacturers, including the design and development of battery packs and chargers to meet customer's specifications. Development services revenue during the three and six months ended June 30, 2011 was $19.1 million and $34.5 million, respectively, an increase from $4.4 million and $4.7 million during the three and six months ended June 30, 2010, respectively. In July 2010, we entered into an agreement with Toyota to initiate development of an electric powertrain for the Toyota RAV4. Under this Phase 0 development agreement, prototypes were made by us by combining the Toyota RAV4 model with a Tesla electric powertrain. In October 2010, we also entered into a Phase 1 contract services agreement with Toyota for the development of a validated powertrain system, including a battery, power electronics module, motor, gearbox and associated 24 -------------------------------------------------------------------------------- Table of Contents software, which will be integrated into an electric vehicle version of the Toyota RAV4. During the three months ended June 30, 2011, we completed two milestones and delivered several samples under the Phase 1 agreement and delivered all remaining prototype vehicles under the Phase 0 agreement. Development services revenue under these arrangements with Toyota for the three months ended June 30, 2011 was $19.1 million. During the six months ended June 30, 2011, we completed various milestones and delivered several samples under the Phase 1 agreement and delivered all remaining prototype vehicles under the Phase 0 agreement. Development services revenue under these arrangements with Toyota for the six months ended June 30, 2011 was $34.5 million. Through June 30, 2011, we had delivered all development services under the Phase 0 contract services agreement. We expect that the Phase 1 agreement, and the associated development services revenues, will be completed by early 2012. We intend to grow our development services revenue over time by establishing additional commercial arrangements with other automobile manufacturers. We do not, however, have agreements for significant development services after completing the remaining development services for Toyota under the Phase 1 agreement. Additionally, we expect our development services revenue may fluctuate in future periods based on the timing of our delivery of milestones and samples, as well as the timing of meeting revenue recognition criteria. Cost of Revenues and Gross Profit Cost of revenues includes cost of automotive sales and cost of revenues related to our development services. Cost of revenues during the three and six months ended June 30, 2011 was $39.7 million and $70.7 million, respectively, an increase from $22.1 million and $39.1 million during the three and six months ended June 30, 2010, respectively. The increase in cost of automotive sales for the three and six months ended June 30, 2011 was driven primarily by an increase in the number of vehicles that we sold and the significant shipments of battery packs and chargers to Daimler. We began delivering battery packs and chargers for the Daimler Smart fortwo EV program during the first quarter of 2010, and the first quarter of 2011 represented the first full quarter of shipments of battery packs and chargers for the Daimler A-Class EV program. Cost of development services includes engineering support and testing, direct parts, material and labor costs, manufacturing overhead, including amortized tooling costs, shipping and logistic costs and other development expenses that we incur in the performance of our services under development agreements. The increase in cost of development services was driven primarily by our activities for the Toyota RAV4 EV program which began in the second half of 2010. Gross profit for the three and six months ended June 30, 2011 was $18.5 million and $36.5 million, respectively, an increase from $6.3 million and $10.1 million for the three and six months ended June 30, 2010, respectively. The increase was driven primarily by the gross profit contributed by our development services revenues which we substantively began to recognize in the second quarter of 2010 as well as a significant increase in Tesla Roadster sales coupled with slightly higher average selling prices and ongoing cost improvement programs on the Roadster. We expect our development services gross profit and gross margin may fluctuate in future periods as the timing of revenue recognition may not coincide with the period in which the corresponding cost of revenues is recognized. 25-------------------------------------------------------------------------------- Table of Contents Research and Development Expenses Research and development expenses consist primarily of personnel costs for our teams in engineering and research, supply chain, quality, manufacturing engineering and manufacturing test organizations, prototyping expense, contract and professional services and amortized equipment expense. Also included in research and development expenses are development services costs that we incur, if any, prior to the finalization of agreements with our development services customers as reaching a final agreement and revenue recognition is not assured. Development services costs incurred after the finalization of an agreement are recorded in cost of revenues. Research and development expenses during the three months ended June 30, 2011 were $52.5 million, an increase from $15.4 million during the three months ended June 30, 2010. The $37.1 million increase in research and development expenses during the three months ended June 30, 2011 consisted primarily of a $15.6 million increase in costs related to Model S engineering, design and testing activities incurred by our suppliers, a $9.5 million increase in materials and prototyping expenses primarily to support our Model S alpha build as well as powertrain development activities, an $8.1 million increase in employee compensation expenses from higher headcount, a $2.6 million increase in stock-based compensation expense related to a larger number of outstanding equity awards and generally an increasing common stock valuation applied to new grants, and a $1.9 million increase in office, information technology and facilities-related costs to support the growth of our business. Research and development expenses during the six months ended June 30, 2011 were $93.7 million, an increase from $28.7 million during the six months ended June 30, 2010. The $65.0 million increase in research and development expenses during the six months ended June 30, 2011 consisted primarily of a $26.3 million increase in costs related to Model S engineering, design and testing activities incurred by our suppliers, a $17.5 million increase in materials and prototyping expenses primarily to support our Model S alpha build as well as powertrain development activities, a $13.2 million increase in employee compensation expenses from higher headcount, a $4.7 million increase in stock-based compensation expense related to a larger number of outstanding equity awards and generally a higher common stock valuation applied to new grants and a $3.3 million increase in office, information technology and facilities-related costs to support the growth of our business. We have significantly increased our research and development efforts for the Model S in recent quarters, which has resulted in an increase in our research and development expenses. We anticipate that our research and development expenses will rise moderately from our current level in the second half of 2011 as we incur additional costs to further develop the Model S, to develop the Model X and to operate our Model S manufacturing facility in Fremont, California prior to the start of Model S production, and work on strategic projects. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of personnel and facilities costs related to our Tesla stores, marketing, sales, executive, finance, human resources, information technology and legal organizations, as well as litigation settlements and fees for professional and contract services. Selling, general and administrative expenses during the three months ended June 30, 2011 were $24.7 million, an increase from $22.2 million during the three months ended June 30, 2010. The $2.5 million increase in our selling, general and administrative expenses during the three months ended June 30, 2011 consisted primarily of a $3.0 million increase in employee compensation expenses related to higher sales and marketing headcount to support sales activities worldwide and higher general and administrative headcount to support the expansion of the business and a $1.0 million increase in costs principally related to our planned increase in the number of Tesla stores. The increase is also attributable 26 -------------------------------------------------------------------------------- Table of Contents to a $0.6 million increase in stock-based compensation expense related to a larger number of outstanding equity awards and generally an increasing common stock valuation applied to new grants and a $0.6 million increase in office, information technology and facilities-related costs to support the growth of our business. The increase for the three months ended June 30, 2011 was partially offset by a one time charge of $2.4 million in stock-based compensation expense. In the fourth quarter of 2009, we granted certain stock options for which a portion of the grant was immediately vested. We erroneously accounted for the expense on a straight-line basis over the term of the award, while expense recognition should always be at least commensurate with the number of awards vesting during the period. To correct this error, we recorded additional stock-based compensation of $2.4 million in the three months ended June 30, 2010. Selling, general and administrative expenses during the six months ended June 30, 2011 were $48.9 million, an increase from $38.8 million during the six months ended June 30, 2010. The $10.1 million increase in our selling, general and administrative expenses during the six months ended June 30, 2011 consisted primarily of a $6.5 million increase in employee compensation expenses related to higher sales and marketing headcount to support sales activities worldwide and higher general and administrative headcount to support the expansion of the business and a $1.8 million increase in costs principally related to our planned increase in the number of Tesla stores. The increase is also attributable to a $1.5 million increase in office, information technology and facilities-related costs to support the growth of our business, a $1.2 million increase in professional and outside services costs and a $1.0 million increase in stock-based compensation expense related to a larger number of outstanding equity awards and generally an increasing common stock valuation applied to new grants. The increase for the six months ended June 30, 2011 was partially offset by a one time charge of $2.4 million in stock-based compensation expense as described above. We expect selling, general and administrative expenses to increase both in aggregate dollar amounts and as a percentage of revenue in future periods as we continue to grow and expand our operations, and increase our sales and marketing activities to handle our expanding market presence and prepare for the planned Model S commercial launch in mid-2012. We also expect an increase in our selling, general and administrative expenses as a result of our planned increase in the number of Tesla stores. As of June 30, 2011, we had opened 18 Tesla stores in the United States, Europe and Japan. We plan to open additional stores during 2011, mostly in the United States, and some of these stores will replace existing stores, which we may continue to use as service locations. Interest Expense Our interest expense is primarily due to our loans under the DOE Loan Facility which we began accessing in 2010. During the three and six months ended June 30, 2011, we capitalized $1.0 million and $1.7 million, respectively, of interest expense to construction in progress. Although interest expense will increase as we continue to draw down on the DOE Loan Facility to fund our Model S and powertrain activities, we expect to capitalize this interest to construction in progress through 2011. Other Expense, Net Other expense, net consists primarily of the change in the fair value of our warrant liabilities and transaction gains and losses on our foreign currency-denominated assets and liabilities. We expect our transaction gains and losses will vary depending upon movements in the underlying exchange rates. Income or charges resulting from the change in the fair value of our stock warrant liability, excluding the DOE warrant liability, was eliminated after July 2, 2010, as these warrants were net exercised at the completion of our IPO. The DOE convertible preferred stock warrant became a common stock warrant on July 2, 2010 and is carried at its estimated fair value with changes in its fair value continuing to be reflected in other expense, net, until its expiration or vesting. 27 -------------------------------------------------------------------------------- Table of Contents Other expense, net, during the three and six months ended June 30, 2011 was $71,000 and $1.6 million, respectively, a decrease in expense compared to other expense, net, of $6.7 million and $10.0 million during the three and six months ended June 30, 2010, respectively. The decrease in other expense, net, for the three and six months ended June 30, 2011 was primarily due to the elimination of warrant liabilities, excluding the DOE warrant liability, after the completion of our IPO, partially offset by a higher charge from the fair value change in our DOE warrant liability during the three and six months ended June 30, 2011 resulting from a higher stock price. Provision for Income Taxes Our provision for income taxes during the three and six months ended June 30, 2011 was $140,000 and $290,000, respectively, compared to $9,000 and $127,000 during the three and six months ended June 30, 2010, respectively. The increase for the three and six months ended June 30, 2011 was due primarily to the increase in taxable income in our international jurisdictions. Liquidity and Capital Resources Since inception and through the three and six months ended June 30, 2011, we had accumulated net losses of $522.8 million and have used $396.4 million of cash in operations. As of June 30, 2011, we had approximately $661.5 million in principal sources of liquidity available from our cash and cash equivalents, cash held in our dedicated DOE account and the remaining amounts available under the DOE Loan Facility. This includes our cash and cash equivalents in the amount of $319.4 million which included investments in money market funds, cash of $11.3 million deposited in a dedicated DOE account in accordance with the requirements of our DOE Loan Facility, and $330.8 million available under the DOE Loan Facility, which is primarily intended to cover spending related to the development of the Model S and our powertrain activities. Other sources of cash also include cash from the sales of the Tesla Roadster, cash from the provision of development services, sales of powertrain components and refundable reservation payments for our Model S. We expect that our current sources of liquidity, including cash, cash equivalents, cash held in our dedicated DOE account and the remaining amounts available under the DOE Loan Facility, together with our anticipated cash from operating activities will be sufficient to develop the Model S and Model X based on our current plans. This capital will fund our ongoing operations, continue research and development projects, establish sales and service centers, improve infrastructure such as expanded battery assembly facilities, and to make the investments in tooling and manufacturing capital required to introduce the Model S and to continue development of the Model X. The acceleration of the development of future vehicles, investments in new technologies, increased in-sourcing of manufacturing capabilities, investments to expand our powertrain activities or further expand our sales and service network, may require us to raise additional funds through the issuance of equity, equity-related or debt securities or through obtaining credit. We may also choose to opportunistically raise additional funds if market conditions are favorable. We cannot be certain that additional funds will be available to us on favorable terms when required, or at all. DOE Loan Facility On January 20, 2010, we entered into a loan facility with the Federal Financing Bank (FFB), and the Department of Energy (DOE), pursuant to the Advanced Technology Vehicles Manufacturing (ATVM) Incentive Program (the DOE Loan Facility). Under the DOE Loan Facility, the FFB has made available to us two multi-draw term loan facilities in an aggregate principal amount of up to $465.0 million, which will be available to finance up to 80% of the costs eligible for funding for the powertrain 28 -------------------------------------------------------------------------------- Table of Contents engineering and the build out of a facility to design and manufacture lithium-ion battery packs, electric motors and electric components and the development of, and to build out the manufacturing facility for, our Model S sedan (the Model S Facility). Under the DOE Loan Facility, we are responsible for the remaining 20% of the costs eligible for funding under the ATVM Program for the projects as well as any cost overruns for each project. Loans may be requested under the facilities until January 22, 2013, and we have committed to complete the projects being financed prior to such date. The following table summarizes our DOE Loan Facility draw-down activities (in thousands): Loan Facility Available for Future Draw-downs Interest rates Beginning Balance, January, 2010 $ 465,048 Draw-downs received during the three months ended March 31, 2010 (29,920 ) 2.9% - 3.4% Draw-downs received during the three months ended June 30, 2010 (15,499 ) 2.5% - 3.4% Draw-downs received during the three months ended September 30, 2010 (11,138 ) 1.7% - 2.6% Draw-downs received during the three months ended December 31, 2010 (15,271 ) 1.7% - 2.8% Remaining Balance, December 31, 2010 393,220 Draw-downs received during the three months ended March 31, 2011 (30,656 ) 2.1% - 3.0% Draw-downs received during the three months ended June 30, 2011 (31,693 ) 1.8% - 2.7% Remaining Balance, June 30, 2011 $ 330,871 The DOE Loan Facility contains customary operational and financial covenants with which we must comply, and impose restrictions on, among other things, additional indebtedness, liens, various fundamental changes to our business (including mergers and acquisitions), payments, expenditures, investments, transactions with affiliates, and other aspects regarding the management of our finances. We are currently in compliance with these covenants. In addition to our obligation to fund a portion of the project costs as described above, we agreed to, and upon completion of our IPO, set aside $100 million to fund a separate dedicated account under our DOE Loan Facility. This dedicated account can be used by us to fund any cost overruns for our powertrain and Model S manufacturing facility projects and is used as a mechanism to defer advances under the DOE Loan Facility. This will not affect our ability to draw down the full amount of the DOE loans, but will require us to use the dedicated account to fund certain project costs up front, which costs may then be reimbursed by loans under the DOE Loan Facility once the dedicated account is depleted, or as part of the final advance for the applicable project. We will be required to deposit a portion of these reimbursements into the dedicated account, in an amount equal to up to 30% of the remaining project costs for the applicable project, and these amounts may similarly be used by us to fund project costs and cost overruns and will similarly be eligible for reimbursement by the draw-down of additional loans under the DOE Loan Facility once used in full, or as part of the final advance for the applicable project. Through June 30, 2011, we have transferred $88.7 million from the dedicated account to our operating cash accounts in accordance with the provisions of the DOE Loan Facility. As of June 30, 2011 and December 31, 2010, $11.3 million and $73.6 million remained in the dedicated account, respectively. As we expect to transfer the remainder of this balance within one year, we have classified such cash as current restricted cash on the condensed consolidated balance sheets. Pursuant to our DOE Loan Facility, we were not required to hold any portion of the net proceeds from the public offering and the concurrent private placements completed in June 2011 in a separate dedicated account. Leasing Activities In February 2010, we began offering a leasing program to qualified customers in the United States for the Tesla Roadster. Through our wholly owned subsidiary, Tesla Motors Leasing, Inc., qualifying customers are permitted to lease the Tesla Roadster for 36 months, after which time they have the option of either returning the vehicle to us or purchasing it for a pre-determined residual value. When compared to our sales of vehicles, our leasing activities will spread the cash inflows that we would otherwise receive upon the sale of a vehicle, over the lease term and final disposition of the leased vehicle. As such, our cash and working capital requirements will be directly impacted and if leasing volume increases significantly, the impact may be material. However, after taking into consideration our current and planned sources of operating cash, our ability to monitor and prospectively 29 -------------------------------------------------------------------------------- Table of Contents adjust our leasing activity, as well as our intent to collect nonrefundable deposits for leased vehicles that are manufactured to specification, we do not believe that our planned leasing operations will materially adversely impact our ability to meet our commitments and obligations as they become due. As we will also be exposed to credit risk related to the timely collection of lease payments from our customers, we intend to utilize our credit approval and ongoing review processes in order to minimize any credit losses that could occur and which could adversely affect our financial condition and results of operations. We intend to require deposits from customers electing a lease option for vehicles built to a customer's specifications on the same timeframe and under the same circumstances as from customers purchasing our vehicles outright. During the three and six months ended June 30, 2011, approximately 10% and 9%, respectively, of the vehicles delivered during these periods were under operating leases. As of June 30, 2011, we had deferred revenues of $1.4 million of down payments which will be recognized over the term of the individual leases. Through June 30, 2011, our leasing activity has not had a significant adverse impact on our liquidity. Reservations Payments A source of our cash flows from operations has been through our receipt of reservation payments from our customers. Reservation payments consist of reservation payments that allow potential customers to hold a reservation for the future purchase of a Tesla Roadster or Model S. We are not currently accepting reservation payments for our Model X crossover vehicle. For our Tesla Roadsters manufactured to specification, our current purchase agreement requires the payment of an initial nonrefundable deposit which varies based on the country of purchase. For the Model S, we require an initial reservation payment of at least $5,000. For Tesla Roadsters purchased directly from our showrooms, no deposit is required. Prior to the second quarter of 2010, our reservation policy was to accept reservation payments from all customers who wished to purchase a Tesla Roadster and require full payment of the purchase price of the vehicle at the time the customer selected their vehicle specifications. During the second quarter of 2010, we changed our policy to require nonrefundable deposits for Tesla Roadsters manufactured to specification at the time a customer enters into a purchase agreement. However, we also occasionally accept reservation payments for the Tesla Roadster if a customer is interested in purchasing a vehicle but not yet prepared to select the vehicle specifications. For customers who have placed a reservation payment with us, the reservation payment becomes a nonrefundable deposit once the customer has selected the vehicle specifications and enters into a purchase agreement. The full payment of the purchase price of the vehicle is required only upon delivery of the vehicle to the customer. Reservation payments for a vehicle are recorded as a current liability when received. No later than upon the delivery of a vehicle, the reservation payments collected on a customer's account are applied against the total purchase price of the vehicle. Reservation payments are expected to fluctuate as the number of reservation holders on the Tesla Roadster reservation list decreases, while the number of reservation holders on the Model S reservation list increases. |