TMCnet News
TESLA MOTORS INC - 10-K - 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 consolidated financial statements and the related notes that appear elsewhere in this Annual Report on Form 10-K. Overview and 2012 Highlights We design, develop, manufacture and sell high-performance fully electric vehicles and advanced electric vehicle powertrain components. We introduced our first vehicle, the Tesla Roadster, in early 2008. The Roadster's proprietary electric vehicle powertrain system is the foundation of our powertrain technology and, with design enhancements, forms the basis for our Model S sedan, our Model X crossover and other future vehicles. We are targeting our second vehicle, the Model S sedan, for a significantly broader customer base than the Tesla Roadster and are manufacturing Model S in significantly higher volumes than those for the Tesla Roadster. We commenced deliveries of Model S in June 2012 and increased production to an annualized rate of 20,000 per year by the end of 2012. In February 2012, we revealed an early prototype of the Model X crossover, a vehicle based on the Model S platform. We plan to start Model X production in late 2014. We sell our vehicles through our own our sales and service network. During the year ended December 31, 2012, we recognized total revenues of $413.3 million, an increase of 102% over total revenues of $204.2 million for the year ended December 31, 2011. Automotive sales revenue of $385.7 million increased 160% from the year ended December 31, 2011, driven by commencement of Model S deliveries in North America, regulatory credit sales and customer demand for our remaining Tesla Roadsters internationally, partially offset by lower powertrain component sales. Lower powertrain component sales resulted from the completion of the Daimler AG (Daimler) Smart fortwo and A-Class EV programs at the end of 2011, partially offset by powertrain systems that we began to sell to Toyota for the Toyota RAV4 EV in 2012. Development services revenue decreased to $27.6 million for the year ended December 31, 2012 from $55.7 million for the year ended December 31, 2011, due primarily to the completion of our development activities for the Toyota RAV4 EV program during the first quarter of 2012. In 2012, we began work on a full electric powertrain under the Mercedes-Benz B-Class EV program. The majority of our 2012 development services revenue was from the achievement of milestones and deliveries of prototype samples to Daimler under this program. In June 2012, we commenced deliveries of Model S to customers in the United States. Our timely launch of Model S represented an important milestone, transitioning us from significant activities in Model S development and our preparation for vehicle manufacturing at the Tesla Factory, to the process of ramping up for volume production in the months that followed. Gross margin for the year ended December 31, 2012 was 7.3%. Although we produced over 3,100 Model S vehicles during the year, we still experienced significant early-stage higher per unit costs inefficiencies during the production ramp from June to December as a result of lower fixed cost absorption, manufacturing inefficiencies associated with the initial production ramp and higher logistics costs as our supply chain processes continued to mature. We also had higher component prices as many vendors were supplying parts at production prices later than planned due to their own manufacturing inefficiencies. Research and development (R&D) expenses included expenses related to our Model S pre-production activities, including manufacturing preparedness, process validation, prototype builds and extensive testing at both the vehicle and component levels; development of the Tesla Factory; development and testing of Model S, including activities to homologate Model S for the rest of the world and to introduce the 60 kWh and 40 kWh battery pack options; development, design and engineering activities related to Model X; and other research and development activities. Research and development expenses for the year ended December 31, 2012 were $274.0 million, compared to $209.0 million for the year ended December 31, 2011. As the Model S production in the Tesla Factory became fully operational in 2012, Model S related manufacturing costs, including direct parts, material and labor costs, manufacturing overhead and amortized tooling, and logistics, were no longer captured in R&D expenses but instead fully reflected in cost of automotive sales. 66-------------------------------------------------------------------------------- Table of Contents Significant construction activity took place in 2012 as we readied the Tesla Factory to begin production of the Model S. During the first half of the year, we completed the installation of Model S manufacturing equipment, tested and qualified our manufacturing equipment, and continued to fine-tune our production processes while incorporating a higher percentage of production-intent components into Model S vehicles. By mid-year, a significant portion of our Model S manufacturing-related assets were ready for their intended use and we began to depreciate these assets. As a result of investments made in the Tesla Factory and related supplier tooling for Model S, capital expenditures increased to $239.2 million for the year ended December 31, 2012, compared to $184.2 million for the year ended December 31, 2011. During the year, we further expanded our company-owned retail network with the opening of several more stores and service centers, primarily in the United States. At year end, we had 32 stores and galleries around the world. We also successfully launched our Supercharger network in California as well as our first two Superchargers on the east coast. With the higher expenses associated with the expansion of our store network and service infrastructure as well as the growth of our business in general, we incurred selling, general and administrative expenses of $150.4 million for the year ended December 31, 2012, compared to $104.1 million for the year ended December 31, 2011. We ended the year with $221.0 million in cash and cash equivalents, and current restricted cash. In addition to cash received from our revenue generating and reservation-taking activities, we funded our operations in 2012 primarily from the proceeds of our follow-on offering, fully drawing down our Department of Energy Loan Facility (DOE Loan Facility) as well as careful working capital management. In October 2012, we completed a follow-on offering of 7,964,601 shares of our common stock and received cash proceeds of $222.1 million from this transaction, net of underwriting discounts (which included 35,398 shares sold to Elon Musk, our Chief Executive Officer and cofounder, for an aggregate amount of $1.0 million). During the year ended December 31, 2012, we received $188.8 million in draw-downs under the DOE Loan Facility, which completed our draw down of the $465.0 million facility. During the fourth quarter, we made the first quarterly principal payment of $12.7 million to repay the loans to the DOE on schedule. Additionally, we had set aside $14.6 million for our second quarterly DOE payment, which is due in March 2013 and is classified in current restricted cash. In March 2013, we entered into a fourth amendment of our DOE Loan Facility. For more information, see Note 8 to our Consolidated Financial Statements included in this Annual Report on Form 10-K under Item 8. Financial Statements and Supplemental Data. We expect that our current sources of liquidity together with our current projections of cash flow from operating activities, will provide us adequate liquidity as we attempt to reach profitability in 2013, based on our current plans. Additionally, we currently expect to be near break-even on cash flow from operations during the first quarter of 2013. Management Opportunities, Challenges and Risks Our principal focus in 2012 was on completing the development of Model S, establishing our manufacturing capabilities at the Tesla Factory, launching Model S and ramping up the production rate. While we successfully commenced deliveries of Model S to customers in the United States in June 2012, our attention during the second half of 2012 switched to the continued refinement of our manufacturing and supply chain processes to enable high volume production at the Tesla Factory while maintaining high quality standards. By year end, we had successfully increased production volume to over 400 vehicles per week for three consecutive weeks in December. This established a production level that will allow us to achieve our goal of 20,000 Model S deliveries in 2013, provided that we also ramp deliveries to the same rate. Having achieved our steady-state production level in 2012, we expect automotive sales to increase significantly in 2013 as compared with 2012. We plan to start European deliveries of the Model S this summer 67-------------------------------------------------------------------------------- Table of Contents and Asian deliveries later in 2013. In addition, we have now started delivering Model S with the 60 kWh battery pack and delivery of cars with the 40 kWh battery pack is expected to begin this summer. We offer a variety of methods by which customers can take delivery of their Model S, including delivery at home or at the Tesla Factory. In order to ramp deliveries of Model S to meet our forecasted sales, we have made and will continue to make enhancements to the delivery process. Should these delivery process enhancements not achieve our objectives, the timing of automotive sales recognition will be delayed and will have a significant impact on the projected growth in our revenues. In addition to sales of Model S, we will continue to recognize automotive sales from our supply of powertrain components and systems to Toyota for the Toyota RAV4 EV, and to a lesser extent, sales of the Tesla Roadster. During the first quarter of 2012, we began shipping powertrain systems to Toyota under a supply and services agreement for the Toyota RAV4 EV. Pursuant to the agreement, Toyota will pay us approximately $100 million from 2012 through 2014 based on our delivery of the powertrain systems for the Toyota RAV4 EV. In January 2012, we concluded the production run of our current generation Tesla Roadster at 2,500 vehicles. As of December 31, 2012, we had sold most of our remaining Roadsters. In 2012, we began work on a full electric powertrain under the Mercedes-Benz B-Class EV program. Under this program, we will continue to provide development services and deliver prototype samples in 2013. Similar to our previous development services agreements, due to timing differences that may arise between the recognition of milestone revenues and the underlying costs of development services, the gross margin from our development services activities may vary from period to period. Although we produced over 3,100 Model S vehicles in 2012, we still experienced higher per unit costs during the latter part of the year as a result of lower fixed cost absorption, manufacturing inefficiencies associated with the initial production ramp and higher logistics costs as our supply chain processes continued to mature. We also had higher component prices as many vendors supplied parts at production prices later than planned due to their own manufacturing inefficiencies. As we enter 2013, production efficiency on a per vehicle basis is improving substantially as we continue to stabilize and improve our production processes, as further cost reduction efforts are undertaken by both us and our suppliers and as we continue to sell regulatory credits. We expect first quarter material, labor and overhead costs to be substantially lower than the fourth quarter of 2012, and for this trend to continue throughout 2013. We expect our gross margin in the first quarter of 2013 to exceed that in the fourth quarter of 2012 and to continue to rise to our target of 25% in the second half of 2013, despite an anticipated decrease in Model S average selling prices resulting from the introduction of lower priced Model S battery variants and a much lower contribution from regulatory credit sales, partially offset by higher average selling prices on international sales that begin in the second half and increase into the fourth quarter of 2013. There is no guarantee that we will be able to achieve the planned cost reductions from our various cost savings initiatives, which would negatively affect our ability to reach our gross margin goals. Longer term, regulatory credit revenue should decline relative to our automotive sales as we grow our sales outside the United States and earn fewer credits on the lower priced Model S battery variants While we will pursue opportunities to monetize the credits we earn from the sales of our vehicles, we do not plan to rely on such sales to be a significant contributor to gross margin, and our business model is not predicated on such regulatory credits. However, if we are unable to sell regulatory credits in the short term, our revenues, gross margin and profitability would be negatively impacted. In February 2012, we revealed an early prototype of the Model X crossover as the first vehicle we intend to develop by leveraging the Model S platform. We currently plan to start production of Model X in late 2014. Our ability to develop and introduce the Model X in this timeframe is based partially on our expectations of 68 -------------------------------------------------------------------------------- Table of Contents leveraging the Model S platform. If there is a lower level of commonality between Model S and Model X than anticipated, our future development and tooling costs may exceed expectations. At year end, we had 32 stores and galleries around the world. We plan to open 15 to 20 more stores and galleries in 2013 with about half the openings in Europe and Asia to support our expansion into these regions during the second half of 2013. Notably, we have already started construction of our first store in Beijing, China in preparation for its planned opening this spring. At the end of 2012, we also had 29 service locations around the world. We plan to double this number by the end of 2013 to keep pace with the growing fleet of customer cars. In 2012, we invited a large number of reservation holders to configure their cars. Converting these reservations to firm, non-refundable orders increased cancellations, as expected. After deliveries and cancellations, our net reservations as of December 31, 2012, were over 15,000. New reservations continue at a steady, although slower pace in the first quarter of 2013, as compared to December 2012, due in part to the pull ahead of reservations into 2012 by customers seeking to avoid our announced 2013 price increase. First quarter 2013 cancellations are likely to remain elevated as the remaining older reservation holders are invited to configure their vehicles within a set timeframe or pay the higher price just like new reservation holders. In 2012, we successfully launched Superchargers in California, and on the east coast of the United States. Construction planning is underway to install additional Superchargers in 2013. Our plan is to expand coverage on the U.S. west and east coasts, and around the rest of the country. Through the combination of improved gross margin, lower research and development expenses, as well as measured spending to support the expansion of our sales and service infrastructure and the general growth of the business, we expect to be profitable in the first quarter of 2013 and experience breakeven cash flow from operations. The achievement of operational and manufacturing efficiencies will drive some adjustments in our personnel, primarily affecting contractor and temporary employees. At the same time, we are continuing to hire and convert to full-time key talent where required. In 2013, we plan to spend significantly less on capital expenditures than we did in 2012, as we have concluded the majority of our investment in the Tesla Factory and Model S tooling. This reduction will be partially offset by expenditures related to expanding our service and store network, investing in new capital equipment and tooling to reduce variable costs and new product development. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these 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. We believe that the following critical accounting policies involve a greater degree of judgment and complexity than our other accounting policies. Accordingly, these are the policies we believe are the most critical to understanding and evaluating our consolidated financial condition and results of operations. Revenue Recognition Automotive Sales We recognize automotive sales revenue from sales of Model S and the Tesla Roadster, including vehicle options, accessories and destination charges, vehicle service and sales of regulatory credits, such as zero emission vehicle(ZEV) and greenhouse gas emission (GHG) credits. We also recognize automotive sales revenue from the sales of electric vehicle powertrain components and systems, such as battery packs and drive units, to other manufacturers. We recognize revenue when (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred and there are no uncertainties regarding customer acceptance; (iii) fees are fixed or determinable; and (iv) collection is reasonably assured. 69-------------------------------------------------------------------------------- Table of Contents Automotive sales consist primarily of revenue earned from the sale of vehicles. Sales or other amounts collected in advance of meeting all of the revenue recognition criteria are not recognized in the consolidated statements of operations and are instead recorded as deferred revenue on our consolidated balance sheets. Prior to February 2010, we did not provide direct financing for the purchase of the Tesla Roadster although a third-party lender has provided financing arrangements to our customers in the United States. Under these arrangements we have been paid in full by the customer at the time of purchase. Starting in February 2010, we began offering a Tesla Roadster leasing program to qualified customers in the United States. Automotive sales also consist of revenue earned from the sales of vehicle options, accessories and destination charges. While these sales may take place separately from a vehicle sale, they are often part of one vehicle sale agreement resulting in multiple element arrangements. To determine the appropriate accounting for recognition of our revenue, we consider whether the deliverables specified in the multiple element arrangement should be treated as separate units of accounting, and, if so, how the price should be allocated among the elements, when to recognize revenue for each element, and the period over which revenue should be recognized. We also evaluate whether a delivered item has value on a stand-alone basis prior to delivery of the remaining items by determining whether we have made separate sales of such items or whether the undelivered items are essential to the functionality of the delivered items. Further, we assess whether we know the fair value of the undelivered items, determined by reference to stand-alone sales of such items. To date, we have been able to establish the fair value for each of the deliverables within these multiple element arrangements because we sell each of the vehicles, vehicle accessories and options separately, outside of any multiple element arrangements. As each of these items has stand alone value to the customer, revenue from sales of vehicle accessories and options are recognized when those specific items are delivered to the customer. Increased complexity to our sales agreements or changes in our judgments and estimates regarding application of these revenue recognition guidelines could result in a change in the timing or amount of revenue recognized in future periods. For multiple deliverable revenue arrangements, we allocate revenue to each element based on a selling price hierarchy. The selling price for a deliverable is based on its vendor specific objective evidence (VSOE) if available, third party evidence (TPE) if VSOE is not available, or estimated selling price if neither VSOE nor TPE is available. To date, we have been able to establish the fair value for each of the deliverables within the multiple element arrangements because we sell each of the vehicles, vehicles accessories and options separately, outside of any multiple element arrangements. Therefore, there were no material differences between total revenue reported and pro forma total revenues that would have been reported during the year ended December 31, 2011, if the transactions entered into or materially modified after January 1, 2011 were subject to previous accounting guidance. Regulatory Credit Sales California and certain other states have laws in place requiring vehicle manufacturers to ensure that a portion of the vehicles delivered for sale in that state during each model year are zero emission vehicles. These laws and regulations provide that a manufacturer of zero emission vehicles may earn regulatory credits, and may sell excess credits to other manufacturers who apply such credits to comply with these regulatory requirements. Similar regulations exist at the federal level which require compliance related to greenhouse gas (GHG) emissions and also allow for the sale of excess credits by one manufacturer to other manufacturers. As a manufacturer solely of zero emission vehicles, we have earned regulatory credits, such as ZEV and GHG credits on vehicles, and we expect to continue to earn these credits in the future. Since our commercial vehicles are electric, we do not receive any compliance benefit from the generation of these credits, and accordingly look to sell them to other vehicle manufacturers. In order to facilitate the sale of these credits, we enter into contractual agreements with third parties requiring them to purchase our regulatory credits at pre-determined prices. We recognize revenue on the sale of these credits at the time legal title to the credits are transferred to the purchasing party by the governmental agency issuing these credits. 70-------------------------------------------------------------------------------- Table of Contents Development Services Revenue from development services arrangements consist of revenue earned from the development of electric vehicle powertrain components and systems for other automobile manufacturers, including the design and development of battery packs, drive units and sample vehicles to meet a customer's specifications. Revenue is recognized as a development arrangement is finalized, the performance requirements of each development arrangement are met and collection is reasonably assured. Where development arrangements include substantive at-risk milestones, revenue is recognized based upon the achievement of the contractually-defined milestones. Amounts collected in advance of meeting all of the revenue recognition criteria are not recognized in the consolidated statement of operations and are instead recorded as deferred revenue on the consolidated balance sheet. Increased complexity to our development agreements or changes in our judgments and estimates regarding application of these revenue recognition guidelines could result in a change in the timing or amount of revenue recognized in future periods. Costs of development services are expensed as incurred. Costs of development services incurred in periods prior to the finalization of an agreement are recorded as research and development expenses; once an agreement is finalized, these costs are recorded in cost of development services. Marketable Securities Marketable securities consist of commercial paper and corporate debt and are designated as available-for-sale and reported at estimated fair value, with unrealized gains and losses recorded in accumulated other comprehensive loss which is included within stockholders' equity. Realized gains and losses on the sale of available-for-sale marketable securities are recorded in other expense, net. The cost of available-for-sale marketable securities sold is based on the specific identification method. Interest, dividends, amortization and accretion of purchase premiums and discounts on our marketable securities are included in other expense, net. Available-for-sale marketable securities with maturities greater than three months at the date of purchase and remaining maturities of one year or less are classified as short-term marketable securities. Where temporary declines in fair value exist, we have the ability and the intent to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value. We regularly review all of our marketable securities for other-than-temporary declines in fair value. The review includes but is not limited to (i) the consideration of the cause of the impairment, (ii) the creditworthiness of the security issuers, (iii) the length of time a security is in an unrealized loss position, and (iv) our ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Inventory Valuation We value our inventories at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis. We record inventory write-downs for estimated obsolescence or unmarketable inventories based upon assumptions about future demand forecasts. If our inventory on hand is in excess of our future demand forecast, the excess amounts are written off. We also review inventory to determine whether its carrying value exceeds the net amount realizable upon the ultimate sale of the inventory. This requires us to determine the estimated selling price of our vehicles less the estimated cost to convert inventory on hand into a finished product. Once inventory is written-down, a new, lower-cost basis for that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. During the years ended December 31, 2012, 2011 and 2010, we recorded write-downs of $5.0 million, $1.8 million and $1.0 million, in cost of automotive sales, respectively. 71 -------------------------------------------------------------------------------- Table of Contents The inventory amounts are based on our current estimates of demand, selling prices and production costs. Should our estimates of future selling prices or production costs change, material changes to these reserves may be required. Further, a small change in our estimates may result in a material charge to our reported financial results. Warranties We accrue warranty reserves at the time a vehicle or powertrain component has associated revenue recognized. Warranty reserves include management's best estimate of the projected costs to repair or to replace any items under warranty, based on actual warranty experience as it becomes available and other known factors that may impact our evaluation of historical data. We review our reserves at least quarterly to ensure that our accruals are adequate in meeting expected future warranty obligations, and we will adjust our estimates as needed. Initial warranty data can be limited early in the launch of a new vehicle or powertrain component and accordingly, the adjustments that we record may be material. As of December 31, 2012, 2011 and 2010, we had $13.0 million, $6.3 million and $5.4 million in warranty reserves, respectively. Adjustments to warranty reserves are recorded in cost of automotive sales. It is likely that as we sell additional vehicles and powertrain components and as we repair or replace items under warranty, we will acquire additional information on the projected costs to service work under warranty and may need to make additional adjustments. Further, a small change in our warranty estimates may result in a material charge to our reported financial results. Valuation of Stock-Based Awards, Common Stock and Warrants Stock-Based Compensation We use the fair value method of accounting for our stock options granted to employees and Employee Stock Purchase Plan (ESPP) which require us to measure the cost of employee services received in exchange for the stock-based awards, based on the grant date fair value of the awards. The fair value of the awards is estimated using the Black-Scholes option-pricing model. The resulting cost is recognized over the period during which an employee is required to provide service in exchange for the awards, usually the vesting period which is generally four years for stock options and six months for the ESPP. Stock-based compensation expense is recognized on a straight-line basis, net of forfeitures. The fair value of each stock-based award was estimated on the grant date for the periods below using the Black-Scholes option-pricing model. Year Ended December 31, 2012 2011 2010 Risk-free interest rate: Stock options 1.0 % 2.0 % 2.0 % ESPP 0.2 % 0.2 % - Expected term (in years): Stock options 5.9 6.0 5.3 ESPP 0.5 0.5 - Expected volatility: Stock options 63 % 70 % 71 % ESPP 51 % 59 % - Dividend yield: Stock options 0.0 % 0.0 % 0.0 % ESPP 0.0 % 0.0 % - 72 -------------------------------------------------------------------------------- Table of Contents If in the future we determine that another method for calculating the fair value of our stock-based awards is more reasonable, or if another method for calculating the above input assumptions is prescribed by authoritative guidance, the fair value calculated for our stock-based awards could change significantly. The Black-Scholes option-pricing model requires inputs such as the risk-free interest rate, expected term and expected volatility. Further, the forfeiture rate also affects the amount of aggregate compensation. These inputs are subjective and generally require significant judgment. The risk-free interest rate that we use is based on the United States Treasury yield in effect at the time of grant for zero coupon United States Treasury notes with maturities approximating each grant's expected life. Given our limited history with employee grants, we use the "simplified" method in estimating the expected term for our employee grants. The "simplified" method, as permitted by the SEC, is calculated as the average of the time-to-vesting and the contractual life of the options. Our expected volatility is derived from our implied volatility and the historical volatilities of several unrelated public companies within industries related to our business, including the automotive OEM, automotive retail, automotive parts and battery technology industries, because we have limited trading history on our common stock. When making the selections of our peer companies within industries related to our business to be used in the volatility calculation, we also considered the stage of development, size and financial leverage of potential comparable companies. Our historical volatility and implied volatility are weighted based on certain qualitative factors and combined to produce a single volatility factor. We estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior and other factors. Quarterly changes in the estimated forfeiture rate can have a significant effect on reported stock-based compensation expense, as the cumulative effect of adjusting the rate for all expense amortization is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the stock-based compensation expense recognized in the consolidated financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the stock-based compensation expense recognized in the consolidated financial statements. As we accumulate additional employee stock-based awards data over time and as we incorporate market data related to our common stock, we may calculate significantly different volatilities, expected lives and forfeiture rates, which could materially impact the valuation of our stock-based awards and the stock-based compensation expense that we will recognize in future periods. Stock-based compensation expense is recorded in our cost of revenues, research and development expenses, and selling, general and administrative expenses. In August 2012, to create incentives for continued long term success beyond the Model S program and to closely align executive pay with increases in stockholder value, our Board of Directors granted 5,274,901 stock options to our CEO (CEO Grant). The CEO Grant consists of ten vesting tranches with a vesting schedule based entirely on the attainment of both performance conditions and market conditions, assuming continued employment and service to us through each vesting date. Each of the following ten vesting tranches requires a combination of one of the performance achievements outlined below and an incremental increase in our market capitalization of $4.0 billion, as compared to the initial market capitalization of $3.2 billion. • Successful completion of the Model X Engineering Prototype (Alpha); • Successful completion of the Model X Vehicle Prototype (Beta); • Completion of the first Model X Production Vehicle; 73 -------------------------------------------------------------------------------- Table of Contents • Successful completion of the Gen III Engineering Prototype (Alpha); • Successful completion of the Gen III Vehicle Prototype (Beta); • Completion of the first Gen III Production Vehicle; • Gross margin of 30% or more for four consecutive quarters; • Aggregate vehicle production of 100,000 vehicles; • Aggregate vehicle production of 200,000 vehicles; and • Aggregate vehicle production of 300,000 vehicles. The term of the CEO Grant will be ten years, so that if any vesting tranches remain unvested after expiration of the CEO Grant, they will be forfeited. In addition, our CEO will forfeit any unvested options if he is terminated as CEO of the Company, whether for cause or otherwise. Stock-based compensation expense associated with the CEO Grant is recognized for each performance condition over the vesting period beginning at the point in time that the relevant performance condition is considered probable of being met, regardless as to whether the related market condition is ever met (though meeting the market condition would also be required in order for the related options to ultimately vest). We measured the fair value of the CEO Grant using a Monte Carlo simulation approach with the following assumptions: risk-free interest rate of 1.65%, expected term of ten years, expected volatility of 55% and dividend yield of 0%. Unadjusted Error in 2009 In June 2010, we identified an error related to the understatement in stock-based compensation expense subsequent to the issuance of the consolidated financial statements for the year ended December 31, 2009. 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. As a result, selling, general and administrative expenses and net loss for the year ended December 31, 2009 were understated by $2.7 million. The error did not have an effect on the valuation of the stock options. As stock-based compensation expense is a non-cash item, there was no impact on net cash used in operating activities for the year ended December 31, 2009. To correct this error, we recorded additional stock-based compensation of $2.4 million during the three months ended June 30, 2010. We considered the impact of the error on reported operating expenses and trends in operating results and determined that the impact of the error was not material to previously reported financial information as well as those related to the three months ended June 30, 2010. Common Stock Valuation Since the completion of our IPO on July 2, 2010, for purposes of option pricing and valuations, our common stock has been valued by reference to its publicly traded price. Prior to the IPO, we historically granted stock options with exercise prices equal to the fair value of our common stock as determined at the date of grant by our Board of Directors. Because there was no public market for our common stock, our Board of Directors determined the fair value of our common stock by considering a number of objective and subjective factors, including the following: • our sales of convertible preferred stock to unrelated third parties; • our operating and financial performance; 74 -------------------------------------------------------------------------------- Table of Contents • the lack of liquidity of our capital stock; • trends in our industry; • arm's length, third-party sales of our stock; and • contemporaneous valuations performed by an unrelated third-party. There is inherent uncertainty in these estimates and if we had made different assumptions than those used, the amount of our stock-based compensation expense, net loss and net loss per share amounts could have been significantly different. The following table summarizes, by grant date, the number of stock options granted during the six months prior to the completion of our IPO on July 2, 2010, and the associated per share exercise price, which equaled the fair value of our common stock for each of these grants. Exercise Price and Fair Value Number of per Share of Options Common Grant Date Granted Stock March 3, 2010 402,660 9.96 April 28, 2010 256,320 13.23 June 12, 2010 1,135,710 14.17 Included in the December 4, 2009 awards, were 6,711,972 stock options granted to our Chief Executive Officer (CEO) comprised of two grants. In recognition of his and our company's achievements and to create incentives for future success, the Board of Directors approved an option grant representing 4% of our fully-diluted share base prior to such grant as of December 4, 2009, or 3,355,986 stock options, with 1/4th of the shares vesting immediately, and 1/36th of the remaining shares scheduled to vest each month over three years, assuming continued employment through each vesting date. In addition, to create incentives for the attainment of clear performance objectives around a key element of our current business plan-the successful launch and commercialization of Model S-the Board of Directors approved additional options totaling an additional 4% of our fully-diluted shares prior to such grant as of December 4, 2009, with a vesting schedule based entirely on the attainment of performance objectives as follows, assuming Mr. Musk's continued service to us through each vesting date: • 1/4th of the shares subject to the option are scheduled to vest upon the successful completion of Model S Engineering Prototype; • 1/4th of the shares subject to the option are scheduled to vest upon the successful completion of Model S Validation Prototype; • 1/4th of the shares subject to the option are scheduled to vest upon the completion of the first Model S Production Vehicle; and • 1/4th of the shares subject to the option are scheduled to vest upon the completion of the 10,000th Model S Production Vehicle. If Mr. Musk does not meet one or more of the above milestones prior to the fourth anniversary of the date of grant, he will forfeit his right to the unvested portion of the grant. Due to the significant number of stock options granted to our CEO, we valued these December 2009 grants by using the following grant-specific Black-Scholes assumptions: risk-free interest rate of 1.7%, expected term of 4.1 years, expected volatility of 70% and dividend yield of 0%. Included in our June and September 2010 stock option grants were 666,300 and 20,000 stock options granted respectively, to various members of our senior management with a vesting schedule based entirely on the attainment of the same performance objectives as those outlined for Mr. Musk above. 75-------------------------------------------------------------------------------- Table of Contents Warrants We have accounted for our freestanding warrants to purchase shares of our convertible preferred stock as liabilities at fair value upon issuance. We have recorded the warrants as a liability because the underlying shares of convertible preferred stock are contingently redeemable and, therefore, may obligate us to transfer assets at some point in the future. The warrants are subject to re-measurement to fair value at each balance sheet date and any change in fair value is recognized as a component of other expense, net, on the consolidated statements of operations. We have issued a warrant to the DOE to purchase shares of our common stock at an exercise price of $7.54 per share and a warrant to purchase up to 5,100 shares of our common stock at an exercise price of $8.94 per share. Beginning on December 15, 2018 and until December 14, 2022, the shares subject to purchase under these warrants will become exercisable in quarterly amounts depending on the average outstanding balance of the DOE Loan Facility during the prior quarter. The warrants may be exercised until December 15, 2023. If we prepay the DOE Loan Facility in part or in full, the total amount of shares exercisable under the warrants will be reduced. Since the number of shares of common stock ultimately issuable under the warrants will vary, these warrants will be carried at their estimated fair value with changes in their fair value reflected in other expense, net, until their expiration or vesting. Since the number of shares ultimately issuable under the DOE warrants will vary depending on the average outstanding balance of the loan during the contractual vesting period, and decisions to prepay would be influenced by our future stock price as well as the interest rates on our loans in relation to market interest rates, we measured the fair value of the DOE warrant using a Monte Carlo simulation approach. The Monte Carlo approach simulates various scenarios and captures the optimal decisions to be made between prepaying the DOE loan and the cancellation of the DOE warrant over the expected term of the DOE Loan Facility of 13 years. For the purposes of the simulation, the optimal decision represents the scenario with the lowest economic cost to us. The total warrant value would then be calculated as the average warrant payoff across all simulated paths discounted to our valuation date. The significant assumptions that we use in the valuation of the DOE warrant include similar assumptions used in the valuation of otherwise featureless stock warrants at various simulated stock prices, as well as the interest rate differential between the interest rates under our DOE Loan Facility and market interest rates for companies comparable to us. The estimated value of our stock warrant requires us to use a Black-Scholes option-pricing model, which incorporates several assumptions that are subject to significant management judgment as is the case for stock-based compensation discussed above. The differential between the interest rates under our DOE Loan Facility and market interest rates is derived from the credit spread data of several unrelated public companies within industries related to our business. As the average simulated value of our stock warrant increases relative to the credit spread of our comparator companies, the fair value of our DOE warrant decreases since the economic cost of prepaying our outstanding loans under the DOE Loan Facility and replacing the funds with market interest rate debt, would be lower than the economic cost associated with the dilution caused by the vesting of warrants. Similarly, as the credit spread of our comparator companies increases relative to the average simulated value of our stock warrant, the fair value of our DOE warrant increases since the economic cost associated with prepaying our outstanding loans under the DOE Loan Facility and replacing the funds with market interest rate debt is higher than the economic cost associated with the dilution caused by the vesting of warrants, and therefore, we would not prepay our outstanding DOE debt and we would allow a higher number of warrants to vest. Prior to completion of our IPO, the fair value of the DOE warrant was included within the convertible preferred stock warrant liability on the consolidated balance sheet. Upon the completion of our IPO on July 2, 2010, this warrant was reclassified on our consolidated balance sheet from convertible preferred stock warrant liability to common stock warrant liability. The DOE warrant will continue to be recorded at its estimated fair value with changes in the fair value reflected in other expense, net, as the number of shares of common stock ultimately issuable under the warrant is variable until its expiration or vesting. The relative 76 -------------------------------------------------------------------------------- Table of Contents movements in our stock price as compared to the credit spread of our comparator companies will result in fair value changes being recorded in other expense, net, in future periods which may be significant. Excluding the warrant issued to the DOE in January 2010, we estimated the fair value of other pre-IPO convertible preferred stock warrants using a Black-Scholes option-pricing model which used several assumptions that were subject to significant management judgment as is the case for stock-based compensation as discussed above. Upon the completion of our IPO in July 2010, these convertible preferred stock warrants outstanding as of June 30, 2010, were re-valued with changes in value being charged to income, and the warrants were net exercised and the related convertible preferred stock warrant liability was settled and recorded in shareholders' equity. Income Taxes We record our provision for income taxes in our consolidated statements of operations by estimating our taxes in each of the jurisdictions in which we operate. We estimate our actual current tax exposure together with assessing temporary differences arising from differing treatment of items recognized for financial reporting versus tax return purposes. In general, deferred tax assets represent future tax benefits to be received when certain expenses previously recognized in our consolidated statements of operations become deductible expenses under applicable income tax laws, or loss or credit carryforwards are utilized. Valuation allowances are recorded when necessary to reduce deferred tax assets to the amount expected to be realized. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We make these estimates and judgments about our future taxable income that are based on assumptions that are consistent with our future plans. As of December 31, 2012, we had recorded a full valuation allowance on our net deferred tax assets because we expect that it is more likely than not that our deferred tax assets will not be realized in the foreseeable future. Should the actual amounts differ from our estimates, the amount of our valuation allowance could be materially impacted. Furthermore, significant judgment is required in evaluating our tax positions. In the ordinary course of business, there are many transactions and calculations for which the ultimate tax settlement is uncertain. As a result, we recognize the effect of this uncertainty on our tax attributes based on our estimates of the eventual outcome. These effects are recognized when, despite our belief that our tax return positions are supportable, we believe that it is more likely than not that those positions may not be fully sustained upon review by tax authorities. We are required to file income tax returns in the United States and various foreign jurisdictions, which requires us to interpret the applicable tax laws and regulations in effect in such jurisdictions. Such returns are subject to audit by the various federal, state and foreign taxing authorities, who may disagree with respect to our tax positions. We believe that our accounting consideration is adequate for all open audit years based on our assessment of many factors, including past experience and interpretations of tax law. We review and update our estimates in light of changing facts and circumstances, such as the closing of a tax audit, the lapse of a statute of limitations or a material change in estimate. To the extent that the final tax outcome of these matters differs from our expectations, such differences may impact income tax expense in the period in which such determination is made. The eventual impact on our income tax expense depends in part if we still have a valuation allowance recorded against our deferred tax assets in the period that such determination is made. 77 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth our consolidated statements of operations data for the periods presented (in thousands, except per share data): Year Ended December 31, 2012 2011 2010 Revenues Automotive sales $ 385,699 $ 148,568 $ 97,078 Development services 27,557 55,674 19,666 Total revenues 413,256 204,242 116,744 Cost of revenues Automotive sales 371,658 115,482 79,982 Development services 11,531 27,165 6,031 Total cost of revenues 383,189 142,647 86,013 Gross profit 30,067 61,595 30,731 Operating expenses Research and development 273,978 208,981 92,996 Selling, general and administrative 150,372 104,102 84,573 Total operating expenses 424,350 313,083 177,569 Loss from operations (394,283 ) (251,488 ) (146,838 ) Interest income 288 255 258 Interest expense (254 ) (43 ) (992 ) Other expense, net (1,828 ) (2,646 ) (6,583 ) Loss before income taxes (396,077 ) (253,922 ) (154,155 ) Provision for income taxes 136 489 173 Net loss $ (396,213 ) $ (254,411 ) $ (154,328 ) 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): Year Ended December 31, 2012 2011 2010 Vehicle, options and related sales $ 354,344 $ 101,708 $ 75,459 Powertrain component and related sales 31,355 46,860 21,619 Total automotive sales $ 385,699 $ 148,568 $ 97,078 Automotive sales for the year ended December 31, 2012 were $385.7 million, an increase from $148.6 million for the year ended December 31, 2011. Vehicle, options and related sales represent sales of Model S and the Tesla Roadster, including vehicle options, accessories and destination charges, vehicle service and sales of zero emission vehicle and greenhouse gas emission regulatory credits to other automotive manufacturers. Powertrain component and related sales represent the sales of electric vehicle powertrain components and systems, such as battery packs and drive units, to other manufacturers. Vehicle, options and related sales for the year ended December 31, 2012 were $354.3 million, an increase from $101.7 million for the year ended December 31, 2011. The increase in vehicle, options and related sales 78-------------------------------------------------------------------------------- Table of Contents was primarily attributable to the commencement of Model S customer deliveries in June 2012 and subsequent ramp as well as sales of regulatory credits, partially offset by a decrease in the number of Tesla Roadsters sold as we completed production of the Tesla Roadster in January 2012 and have been selling our remaining inventory primarily in Europe and Asia. Vehicle, options and related sales for the year ended December 31, 2012 included regulatory credit sales of $40.5 million compared to regulatory credit sales of $2.7 million for the year ended December 31, 2011. The significant increase in production and delivery of vehicles in the United States allowed us to sell more regulatory credits to other automotive manufacturers. Powertrain component and related sales for the year ended December 31, 2012 were $31.4 million, a decrease from $46.9 million for the year ended December 31, 2011. The decrease in powertrain component and related sales was primarily due to fewer shipments of battery packs and chargers to Daimler. Production for both the Daimler Smart fortwo and A-Class EV programs was substantially completed as of December 31, 2011. During the three months ended March 31, 2012, we began supplying powertrain systems to Toyota under the RAV4 EV supply and services agreement and recognized $29.1 million for the year ended December 31, 2012. Automotive sales for the year ended December 31, 2011 were $148.6 million, an increase from $97.1 million for the year ended December 31, 2010. Vehicle, options and related sales for the year ended December 31, 2011 were $101.7 million, an increase from $75.5 million for the year ended December 31, 2010. 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. Under our supply agreement with Lotus, we have built 2,500 Roadster gliders. 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, 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. We account for these leasing transactions as operating leases and accordingly, we recognize leasing revenues on a straight-line basis over the term of the individual leases. Lease revenues are recorded in vehicle, options and related sales within automotive sales revenue and for the years ended December 31, 2011 and 2010, we recognized $3.0 million and $0.8 million, respectively. During the years ended December 31, 2011 and 2010, approximately 6% and 14% of the vehicles delivered during those years were under operating leases. Powertrain component and related sales for the year ended December 31, 2011 were $46.9 million, an increase from $21.6 million for the year ended December 31, 2010. 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 at the end of 2009, and for the Daimler A-Class EV program late in the fourth quarter of 2010. Production for both the Smart fortwo and A-Class EV programs was completed as of December 31, 2011. Development Services Development services represent arrangements where we develop electric vehicle powertrain components and systems for other automobile manufacturers, including the design and development of battery packs, drive units and chargers to meet customer's specifications. Development services revenue for the year ended December 31, 2012 was $27.6 million, a decrease from $55.7 million for the year ended December 31, 2011. During the fourth quarter of 2011, Daimler engaged us to assist with the development of a full electric powertrain for a Daimler Mercedes-Benz B-Class EV vehicle. In 2012, we received two purchase orders from Daimler to begin 79-------------------------------------------------------------------------------- Table of Contents development work and also entered into a separate development agreement under which we would complete various milestones and deliver prototype samples. During the year ended December 31, 2012, we recognized a total $15.9 million in development services revenue related to the Mercedes-Benz B-Class EV program. 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 software, which would be integrated into an electric vehicle version of the Toyota RAV4. During the year ended December 31, 2011, we completed various milestones and delivered several samples under the Phase 1 agreement and we also delivered all development services under the Phase 0 agreement. Development services revenue under these arrangements with Toyota for the year ended December 31, 2011 was $55.0 million. During the three months ended March 31, 2012, we completed our remaining milestones and delivered samples under the Phase 1 agreement and recognized $10.7 million in development services revenue. Development services revenue for the year ended December 31, 2011 was $55.7 million, an increase from $19.7 million for the year ended December 31, 2010. During the first quarter of 2010, Daimler engaged us to assist with the development and production of a battery pack and charger for a pilot fleet of its A-Class electric vehicles to be introduced in Europe during 2011. We began providing development services for this program during the first quarter of 2010 and had received an aggregate of $5.5 million in payments; however, as we had not executed a final agreement related to this program as of March 31, 2010, we deferred the $5.5 million of payments that had been received from Daimler to that point. In May 2010, we executed a final agreement under which Daimler would make additional payments to us for the successful completion of certain development milestones and the delivery of prototype samples. As of December 31, 2010, we had completed our deliverables under this agreement and for the year ended December 31, 2010, we recognized $14.4 million in development services revenue. In July 2010, we entered into an agreement with Toyota to initiate development of an electric powertrain for the Toyota RAV4 EV. Under this Phase 0 development agreement, prototypes would be made by us by combining the Toyota RAV4 model with a Tesla electric powertrain. Through June 30, 2011, we had completed all prototype vehicles under the Phase 0 agreement and for the years ended December 31, 2011 and 2010, we recognized $7.6 million and $1.3 million in development service revenue, respectively. 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 pack, power electronics module, motor, gearbox and associated software, which will be integrated into an electric vehicle version of the Toyota RAV4. Pursuant to this agreement, Toyota would pay us up to $60.0 million for the anticipated development services to be provided by us over the expected term of our performance, including a $5.0 million upfront payment that we received upon the execution of the agreement. During the year ended December 31, 2011 and 2010, we completed various milestones and delivered samples under the Phase 1 agreement. Including the amortization of our upfront payment, for the years ended December 31, 2011 and 2010, we recognized $47.4 million and $3.3 million in development services revenue, respectively, under the Phase 1 agreement. 80-------------------------------------------------------------------------------- Table of Contents Cost of Revenues and Gross Profit Cost of revenues includes cost of automotive sales and costs related to our development services. Cost of automotive sales for the year ended December 31, 2012 was $371.7 million, an increase from $115.5 million for the year ended December 31, 2011. Cost of automotive sales includes direct parts, material and labor costs, manufacturing overhead, including amortized tooling costs, royalty fees, shipping and logistic costs and reserves for estimated warranty expenses. Cost of automotive sales 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. We also recognize charges through cost of automotive sales to provide for non-cancellable purchase orders for inventory deemed to be obsolete or in excess of net realizable value. The increase in cost of automotive sales was driven primarily by the commencement of Model S deliveries in June 2012 as well as electric powertrain component and systems sales to Toyota as we began to deliver under the Toyota RAV4 EV supply and services agreement, partially offset by a decrease in the number of Roadster deliveries and battery packs and chargers delivered to Daimler. Cost of development services for the year ended December 31, 2012 was $11.5 million, a decrease from $27.2 million for the year ended December 31, 2011. 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 decrease in cost of development services was driven primarily by our activities for the Toyota RAV4 EV program which we substantially completed during the three months ended March 31, 2012, partially offset by costs associated with development activities related to the Mercedes-Benz B-Class EV program which we commenced in 2012. Gross profit for the year ended December 31, 2012 was $30.1 million, a decrease from $61.6 million for the year ended December 31, 2011. The decrease for the year ended December 31, 2012, compared to the year ended December 31, 2011, was driven primarily by the commencement of Model S deliveries and the associated early stage cost inefficiencies including lower fixed cost absorption, manufacturing inefficiencies related to production ramp, higher initial parts costs and higher logistics costs as our supply chain took time to mature as well as lower sales of the Tesla Roadster, partially offset by the sales of regulatory credits which carry no associated cost of revenues. Cost of revenues for the year ended December 31, 2011 was $142.6 million, an increase from $86.0 million for the year ended December 31, 2010. The increase in cost of automotive sales for the year ended December 31, 2011 was driven primarily by an increase in the number of vehicles that we sold and the increased shipments of battery packs and chargers to Daimler. We began delivering battery packs and chargers for the Daimler Smart fortwo EV program at the end of 2009 and for the Daimler A-Class EV program at the end of 2010. 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 year ended December 31, 2011 was $61.6 million, an increase from $30.7 million for the year ended December 31, 2010. The increase was driven primarily by higher sales of the Tesla Roadster coupled with higher average selling prices and ongoing cost improvement program on the Roadster, increased shipments of battery packs and chargers to Daimler, as well as gross profit from our development services activities which we expanded in the latter half of 2010 with the Toyota RAV4 EV program. 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 81-------------------------------------------------------------------------------- Table of Contents expense, contract and professional services and amortized equipment expense. Overhead costs related to the Tesla Factory prior to the start of production of Model S are also included in research and development expenses. 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 for the year ended December 31, 2012 were $274.0 million, an increase from $209.0 million for the year ended December 31, 2011. The $65.0 million increase in research and development expenses during the year ended December 31, 2012 consisted primarily of a $54.3 million increase in employee compensation expenses from higher headcount, a $23.1 million increase in office, information technology and facilities-related costs to support the growth of our business, a $15.1 million increase in stock-based compensation expense related to a larger number of outstanding equity awards due to additional headcount and generally an increasing common stock valuation applied to new grants, and a $3.3 million increase in shipping charges for prototype materials incurred in the first half of 2012. The increase was partially offset by a $30.9 million decrease in materials and prototyping expenses primarily to support our Model S beta and release candidate builds as well as powertrain development activities. Research and development expenses for the year ended December 31, 2011 were $209.0 million, an increase from $93.0 million for the year ended December 31, 2010. The $116.0 million increase in research and development expenses during the year ended December 31, 2011 consisted primarily of a $38.1 million increase in materials and prototyping expenses primarily to support our Model S alpha and beta builds, overhead costs related to the Tesla Factory, powertrain development activities, a $30.9 million increase in costs related to Model S and Model X engineering, design and testing activities incurred by our suppliers, a $30.4 million increase in employee compensation expenses from higher headcount, a $9.7 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 $7.0 million increase in office, information technology and facilities-related costs to support the growth of our business. 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 for the year ended December 31, 2012 were $150.4 million, an increase from $104.1 million for the year ended December 31, 2011. The $46.3 million increase in our selling, general and administrative expenses during the year ended December 31, 2012 consisted primarily of a $24.3 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, a $9.4 million increase in office, information technology and facilities-related costs to support an expanded store and service network and the growth of our business in general, a $6.0 million increase in stock-based compensation expense related to a larger number of outstanding equity awards due to additional headcount and generally an increasing common stock valuation applied to new grants, and a $6.0 million increase in professional and outside services costs. Selling, general and administrative expenses for the year ended December 31, 2011 were $104.1 million, an increase from $84.6 million for the year ended December 31, 2010. The $19.5 million increase in our selling, general and administrative expenses during the year ended December 31, 2011 consisted primarily of a $12.3 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, a $4.1 million increase in office, information technology and facilities-related costs to support the 82-------------------------------------------------------------------------------- Table of Contents growth of our business, a $2.4 million increase in professional and outside services costs, and a $1.7 million increase in costs principally related to our Tesla store and gallery openings. The increase is also attributable to 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 year ended December 31, 2011 was partially offset by an additional stock-based compensation charge of $2.4 million recognized during the year ended December 31, 2010, which reflected a correction of stock-based compensation expense that should have been recorded during the year ended December 31, 2009. Interest Expense Interest expense is incurred primarily from our loans under the DOE Loan Facility to fund our Model S and powertrain activities, and as of August 2012, we have fully drawn down on the DOE Loan Facility. Interest expense for the year ended December 31, 2012 and 2011 was $7.9 million and $5.1 million, respectively. We have historically capitalized this interest to construction in progress while the Tesla Factory and our manufacturing assets for Model S and future vehicles were being constructed for their intended use. During the years ended December 31, 2012 and 2011, we capitalized $7.6 million and $5.1 million of interest expense to construction in progress, respectively. Interest expense for the year ended December 31, 2010 was $1.0 million. As significant construction of the Tesla Factory and our Model S manufacturing assets had not yet begun, less interest was capitalized to construction in progress in 2010. 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. The DOE common stock warrant liability 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. Other expense, net, for the year ended December 31, 2012 was $1.8 million, a decrease in expense compared to other expense, net, of $2.6 million for the year ended December 31, 2011. The decrease in expense for the year ended December 31, 2012 was primarily due to a favorable foreign currency exchange impact from our foreign currency-denominated liabilities, partially offset by the fair value change in our common stock warrant liability during the year ended December 31, 2012 resulting from a higher stock price. Other expense, net, for the year ended December 31, 2011 was $2.6 million, a decrease from other expense, net, of $6.6 million for the year ended December 31, 2010. The decrease in expense for the year ended December 31, 2011 was primarily due to the elimination of warrant liabilities, excluding the DOE warrant liability, upon the completion of our IPO in July 2010. Provision for Income Taxes Our provision for income taxes for the year ended December 31, 2012 was $0.1 million, a decrease from $0.5 million for the year ended December 31, 2011. The decrease was due primarily to the decrease in taxable income in our international jurisdictions as we were concluding sales of the Tesla Roadster. Our provision for income taxes for the year ended December 31, 2011 was $0.5 million, an increase from $0.2 million for the year ended December 31, 2010. The increase was due primarily to the increase in taxable income in our international jurisdictions. Liquidity and Capital Resources Since inception and through the year ended December 31, 2012, we had accumulated net operating losses of $1.07 billion and have used $709.2 million of cash in operations. As of December 31, 2012, we had $221.0 million 83-------------------------------------------------------------------------------- Table of Contents in principal sources of liquidity available from our cash and cash equivalents in the amount of $201.9 million which included investments in money market funds, and cash of $14.9 million deposited in a dedicated DOE account in accordance with the requirements of our DOE Loan Facility to pre-fund our quarterly DOE loan repayment of principal and interest that will come due on March 15, 2013. Other sources of cash include cash from the sales of Model S, refundable reservation payments for Model S and Model X, sales of regulatory credits, cash from the provision of development services and sales of powertrain components and systems. In February 2013, we made a pre-funding payment of $14.6 million for principal and interest that will come due on June 15, 2013 into a dedicated debt service reserve account in accordance with the pre-funding requirements under the DOE Loan Facility. We expect that our current sources of liquidity, including cash, cash equivalents, cash held in our dedicated DOE account, together with our current projections of cash flow from operating activities, will provide us adequate liquidity until we reach expected profitability in 2013, based on our current plans. These capital sources will enable us to fund our ongoing operations, continue research and development projects, including those for our planned Model X crossover, establish sales and service centers and to make the investments in tooling and manufacturing capital required to introduce Model X. As of August 31, 2012, we have fully drawn down the remaining funds available under the DOE Loan Facility. These funds have been used to develop and produce Model S, grow our powertrain capabilities and develop the Tesla Factory. The development of future vehicles, investments in new technologies, increased in-sourcing of manufacturing capabilities, investments to expand our powertrain activities or investments to 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. Also, should prevailing economic conditions and/or financial, business or other factors adversely affect the estimates of our future cash requirements, we could be required to fund our cash requirements through additional or alternative sources of financing. 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 DOE, pursuant to the ATVM Incentive Program. We refer to the loan facility with the DOE, as amended, as the DOE Loan Facility. The DOE Loan Facility requires, among other things, that we comply with certain financial covenants and fund a debt service account. The financial covenants include a minimum current ratio, which is a ratio of our current assets to our current liabilities (taking into account certain categorical exclusions); a minimum fixed charge coverage ratio, which is a ratio of consolidated adjusted EBITDA to consolidated fixed charges; and a maximum ratio of total liabilities to stockholder equity. The DOE Loan Facility was amended in June 2011 to expand our cash investment options, in February 2012 to modify the timing of certain future financial covenants and funding of the debt service reserve account, in June and December 2012 to allow us to effect certain initiatives in our business plan. In September 2012, we entered into an amendment with the DOE that: (i) removed our obligation to comply with the current ratio financial covenant for the third quarter of 2012; (ii) amended our funding requirements for the dedicated debt service reserve account to (a) postpone until February 15, 2013, $14.6 million of the $28.8 million pre-funding payment originally due on October 15, 2012; and (b) make additional pre-funding payments, beginning June 15, 2013, of between $14.2 million to $14.5 million each quarter to pre-fund the quarterly principal and interest payments due from September 15, 2013 through December 15, 2014; and (iii) added a covenant requiring us to work in good faith with the DOE to develop an early repayment plan for our outstanding DOE Loan Facility on terms satisfactory to the DOE. We entered into another amendment with the DOE in March 2013 that, among other things: (i) modified certain future financial covenants; (ii) accelerated the maturity date of the DOE Loan Facility to December 15, 2017; (iii) created an obligation to repay approximately 1.0% of the outstanding principal under the DOE Loan Facility on or before June 15, 2013; and (iv) created additional contingent obligations based on excess cash flow that may result in accelerated repayment of the DOE Loan Facility starting in 2015. The original amortization schedule for the DOE Loan Facility is not affected by this recent amendment, and so the debt service payments remain the same until the new maturity date when all outstanding loans under the DOE Loan Facility are to be repaid. 84 -------------------------------------------------------------------------------- Table of Contents As of August 31, 2012, we have fully drawn down the aforementioned facilities. Our DOE Loan Facility draw-downs were as follows (in thousands): Loan Facility Available for Future Draw-downs Interest rates Beginning balance, January 20, 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 % Draw-downs received during the three months ended September 30, 2011 (90,822 ) 1.0% -1.4 % Draw-downs received during the three months ended December 31, 2011 (51,252 ) 1.0% -1.5 % Remaining balance, December 31, 2011 188,797 Draw-downs received during the three months ended March 31, 2012 (84,267 ) 0.9% -1.6 % Draw-downs received during the three months ended June 30, 2012 (71,274 ) 1.0% -1.3 % Draw-downs received during the three months ended September 30, 2012 (33,256 ) 1.0% -1.2 % Remaining balance, December 31, 2012 $ - In December 2012, we paid $14.6 million including the first quarterly principal payment of $12.7 million in accordance with the repayment schedule under the DOE Loan Facility. In February 2013, we pre-funded $14.6 million for all principal and interest that will come due on June 15, 2013 into a dedicated debt service reserve account in accordance with the pre-funding requirement under the DOE Loan Facility. For more information on the DOE Loan Facility, see Note 8 to our Consolidated Financial Statements included in this Annual Report on Form 10-K under Item 8. Financial Statements and Supplementary Data. Follow-on Offering and Concurrent Private Placements In June 2011, we completed a follow-on offering of common stock in which we sold a total of 6,095,000 shares of our common stock and received cash proceeds of $172.7 million from this transaction, net of underwriting discounts. Concurrent with our June 2011 follow-on offering, we also sold 1,416,000 shares of our common stock to Elon Musk, our Chief Executive Officer (CEO) and cofounder, and 637,475 shares of our common stock to Blackstar InvestCo LLC, an affiliate of Daimler, and received total cash proceeds of $59.1 million in the private placements. No underwriting discounts or commissions were paid in connection with these private placements. In October 2012, we completed a follow-on offering of common stock in which we sold a total of 7,964,601shares of our common stock and received cash proceeds of $222.1 million from this transaction, net of underwriting discounts (which includes 35,398 shares or $1.0 million sold to Elon Musk, our CEO and cofounder). 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, qualifying customers are permitted to lease the Tesla 85-------------------------------------------------------------------------------- Table of Contents 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 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 leasing operations 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 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 years ended December 31, 2011 and 2010, approximately 6% and 14% of the vehicles delivered during these periods were under operating leases, respectively. As we had substantially completed sales of the Tesla Roadster in North America in early 2012, we did not enter into any new leasing arrangements during the year ended December 31, 2012. As of December 31, 2012 and 2011, we had deferred revenues of $0.7 million and $0.8 million of down payments which will be recognized over the term of the individual leases. Through December 31, 2012, our leasing activity has not had a significant adverse impact on our liquidity. Reservation Payments Reservation payments consist of fully refundable payments that allow potential customers to hold a reservation for the future purchase of a Model S or Model X. We require an initial refundable reservation payment of at least $5,000 and these amounts are recorded as current liabilities until the vehicle is delivered. The reservation payment becomes a nonrefundable deposit once the customer has selected the vehicle specifications and enters into a purchase agreement. We require full payment of the purchase price of the vehicle only upon delivery of the vehicle to the customer. Amounts received by us as reservation payments are generally not restricted as to their use by us. Upon delivery of the vehicle, the related reservation payments are applied against the customer's total purchase price for the vehicle and recognized in automotive sales as part of the respective vehicle sale. As of December 31, 2012, we held reservation payments for undelivered vehicles in an aggregate amount of $138.8 million. Summary of Cash Flows Year Ended December 31, 2012 2011 2010 Net cash used in operating activities $ (266,081 ) $ (128,034 ) $ (127,817 ) Net cash used in investing activities (206,930 ) (162,258 ) (180,297 ) Net cash provided by financing activities 419,635 446,000 338,045 Revision of Prior Year Amounts We have revised our consolidated statement of cash flows for the year ended December 31, 2011 to correct an immaterial error. Amounts related to purchases of property and equipment during 2011 that were not paid at December 31, 2011 were erroneously included as cash outflows from investing activities and cash inflows from operating activities in our previously issued financial statements. This revision resulted in a $13.7 million decrease in purchases of property and equipment included in cash flows used in investing activities and a 86-------------------------------------------------------------------------------- Table of Contents corresponding increase in the change in accounts payable resulting in an increase in cash flows used in operating activities. There was no impact on previously reported total cash and cash equivalents, consolidated balance sheets or consolidated statements of operations for any of these periods. See Notes 1 and 17 to our Consolidated Financial Statements included in this Annual Report on Form 10-K under Item 8. Financial Statements and Supplementary Data. Cash Flows from Operating Activities We continue to experience negative cash flows from operations as we expand our business and build our infrastructure both in the United States and internationally. Our cash flows from operating activities are significantly affected by our cash investments to support the growth of our business in areas such as research and development and selling, general and administrative. Our operating cash flows are also affected by our working capital needs to support growth and fluctuations in inventory, personnel related expenditures, accounts payable and other current assets and liabilities. We currently expect our cash flow from operations in the first quarter of 2013 to be near breakeven as we continue to improve gross margin and incur lower research and development expenses. Net cash used in operating activities was $266.1 million during the year ended December 31, 2012. The largest component of our cash used during this period related to our net loss of $396.2 million, which included non-cash charges of $50.1 million related to stock-based compensation expense, $28.8 million related to depreciation and amortization and $4.9 million related to inventory write-downs and adverse purchase commitments. Significant operating cash outflows were primarily related to $424.4 million of operating expenses, a $194.7 million increase in inventory and operating lease vehicles and $383.2 million of cost of revenues, partially offset by a $197.4 million increase in accounts payable and accrued liabilities, and a $1.1 million decrease in prepaid expenses and other current assets. Inventory increased to meet our planned production requirements for Model S and powertrain component and system sales while the net increase in accounts payable and accrued liabilities was due to both the growth of our business and the timing of vendor payments. Significant operating cash inflows for the year ended December 31, 2012 were comprised primarily of automotive sales of $385.7 million, a $47.1 million net increase in reservation payments and $27.6 million of development services revenue. Net cash used in operating activities was $128.0 million for the year ended December 31, 2011. The largest component of our cash used during this period related to our net loss of $254.4 million, which included non-cash charges of $29.4 million related to stock-based compensation expense, $16.9 million related to depreciation and amortization and $2.8 million related to the fair value change in our warrant liability. Significant operating cash outflows were primarily related to $313.1 million of operating expenses, $142.6 million of cost of revenues and a $13.6 million increase in inventory and operating lease vehicles, partially offset by a $30.5 million increase in accounts payable and accrued liabilities, and a $2.6 million increase in other long-term liabilities. Inventory increased to meet our production requirements for the Tesla Roadster as we planned for the final production of the Tesla Roadster and powertrain component sales as well as leasing activities. The increase in accounts payable and accrued liabilities was due to both the growth of our business and the timing of vendor payments. Significant operating cash inflows during the year ended December 31, 2011 were comprised primarily of automotive sales of $148.6 million, $55.7 million of development services revenue and a $61.0 million net increase in reservation payments, partially offset by a $2.8 million increase in accounts receivable and a $1.9 million decrease in deferred revenue. The increase in accounts receivable was related primarily to receivables from Toyota for shipments of powertrain components under the Toyota RAV4 EV Phase 1 contract services agreement and shipments of battery packs and chargers to Daimler under the Daimler Smart fortwo and A-Class EV programs. 87-------------------------------------------------------------------------------- Table of Contents Net cash used in operating activities was $127.8 million during the year ended December 31, 2010. The largest component of our cash used during this period related to our net loss of $154.3 million, which included non-cash charges of $21.2 million related to stock-based compensation expense, $10.6 million related to depreciation and amortization and $5.0 million related to the fair value change in our warrant liabilities. Significant operating cash outflows were primarily related to $177.6 million of operating expenses, $86.0 million of cost of revenues, a $28.5 million increase in inventory and operating lease vehicles, and a $5.0 million increase in prepaid expenses and other current assets, partially offset by a $13.3 million increase in accrued liabilities and a $3.5 million increase in other long-term liabilities. Inventory increased to meet our production requirements for the Tesla Roadster and powertrain component sales while the increase in prepaid expenses and other current assets and accrued liabilities was due to both the growth of our business, as well as our increased manufacturing and Model S development activities. Operating lease vehicles increased with the introduction of our leasing program in 2010. Other long-term liabilities increased as a result of higher warranty liability from sales of the Tesla Roadster. Significant operating cash inflows during the year ended December 31, 2010 were derived primarily from automotive sales of $97.1 million, $19.7 million of development services revenue, a $4.8 million increase in deferred revenues and a $4.7 million increase in reservation payments, partially offset by a $3.2 million increase in accounts receivable. In October 2010, we entered into a Phase 1 contract services agreement with Toyota for the development of a validated powertrain system, including a battery pack, power electronics module, motor, gearbox and associated software, to be integrated into an electric vehicle version of the Toyota RAV4. Upon execution of the agreement, we received a $5.0 million upfront payment for which revenue is being recognized over the expected term of our performance. Deferred revenues also increased from our vehicle leasing activities as lease down-payments are recognized over the term of the operating leases. The increase in accounts receivable was related primarily to powertrain component sales in relation to Daimler's Smart fortwo EV program as well as $2.3 million receivable from Toyota for the achievement of the first milestone under the Phase 1 contract services agreement. During the year ended December 31, 2010, we received $10.4 million of net new reservation payments for Model S while reservation payments for the Tesla Roadster decreased by $5.7 million. Cash Flows from Investing Activities Cash flows from investing activities primarily relate to capital expenditures to support our growth in operations, including investments in Model S manufacturing, as well as restricted cash that we must maintain in relation to our DOE Loan Facility, facility lease agreements, equipment financing, and certain vendor credit policies. We currently expect our capital expenditures in the fiscal 2013 to be significantly less than those of fiscal 2012, as we have concluded the majority of our investment in the Tesla Factory and Model S tooling. This reduction will be partially offset by expenditures related to expanding our service and store network, investing in new capital equipment and tooling to reduce variable costs and new product development. Net cash used in investing activities was $206.9 million during the year ended December 31, 2012 primarily related to $239.2 million in purchases of capital equipment and tooling, partially offset by a $25.0 million in maturities of short-term marketable securities and an $8.6 million net transfer of cash out of our dedicated DOE account in accordance with the provisions of the DOE Loan Facility. Net cash used in investing activities was $162.3 million during the year ended December 31, 2011 primarily related to $184.2 million in purchases of capital equipment and $65.0 million in purchases of short-term marketable securities, partially offset by $50.1 million of net transfers out of our dedicated DOE account in accordance with the provisions of the DOE Loan Facility and $40.0 million from the maturity of short-term marketable securities. The increase in capital purchases was primarily due to significant development and construction activities at the Tesla Factory as well as purchases of Model S related manufacturing equipment and tooling. Net cash used in investing activities was $180.3 million during the year ended December 31, 2010 primarily related to capital purchases of $105.4 million and a net increase in restricted cash of $74.9 million. The increase 88-------------------------------------------------------------------------------- Table of Contents in capital purchases was driven primarily by $65.2 million of payments made in relation to our purchase of our Tesla Factory located in Fremont, California from NUMMI, and certain manufacturing assets located thereon to be used for our Model S manufacturing, as well as $40.2 million primarily related to other Model S capital expenditures, our transition to and build out of our powertrain manufacturing facility and corporate headquarters in Palo Alto, California, and purchases of manufacturing equipment. Our purchase transactions with NUMMI were completed in October 2010. The increase in restricted cash was primarily related to $100.0 million of net proceeds from our IPO and concurrent Toyota private placement that we transferred to a dedicated account as required by our DOE Loan Facility, partially offset by $26.4 million that was transferred out of the dedicated account during the third and fourth quarters of 2010 in accordance with the provisions of the DOE Loan Facility. Cash Flows from Financing Activities We have financed our operations primarily with proceeds from loans under the DOE Loan Facility beginning in 2010 and the net proceeds from our public offerings and private placements of common stock. Net cash provided by financing activities was $419.6 million during the year ended December 31, 2012 and was comprised primarily of $221.5 million received from our follow-on public offering completed in October 2012, $188.8 million received from our draw-downs under the DOE Loan Facility and $24.9 million received from the exercise of common stock options by employees and the purchase of common stock under our employee stock purchase plan, partially offset by $12.7 million related to our first quarterly repayment of principal related to our loans under the DOE Loan Facility, and $2.8 million related to principal repayments on capital leases. Net cash provided by financing activities was $446.0 million during the year ended December 31, 2011 and was comprised primarily of $231.5 million received from our follow-on public offering and concurrent private placements completed in June 2011, $204.4 million received from our draw-downs under the DOE Loan Facility and $10.5 million received from the exercise of common stock options by employees and the purchase of common stock under our employee stock purchase plan. Cash provided by financing activities was $338.0 million during the year ended December 31, 2010 comprised primarily of $188.8 million in proceeds from our IPO, $71.8 million we received from our loans under the DOE Loan Facility, $50.0 million in proceeds from the Toyota private placement, $30.0 million in proceeds from the Panasonic private placement, partially offset by $3.7 million of issuance costs we incurred in relation to our DOE Loan Facility and our IPO. Contractual Obligations The following table sets forth, as of December 31, 2012 certain significant cash obligations that will affect our future liquidity (in thousands): Year Ended December 31, 2018 and Total 2013 2014 2015 2016 2017 thereafter Operating lease obligations $ 92,639 $ 13,866 $ 14,298 $ 13,692 $ 19,967 $ 8,103 $ 22,713 Capital lease obligations 15,364 5,646 5,199 3,566 923 30 - Long-term debt 487,551 58,068 57,216 56,378 55,535 54,666 205,688 Total $ 595,554 $ 77,580 $ 76,713 $ 73,636 $ 76,425 $ 62,799 $ 228,401 In October 2010, we completed the purchase of our Tesla Factory located in Fremont, California from NUMMI. NUMMI has previously identified environmental conditions at the Fremont site which affect soil and groundwater, and is currently undertaking efforts to address these conditions. Although we have been advised by NUMMI that it has documented and managed the environmental issues, we cannot determine with certainty the potential costs to remediate any pre-existing contamination. Based on management's best estimate, we estimated 89 -------------------------------------------------------------------------------- Table of Contents the fair value of the environmental liabilities that we assumed to be $5.3 million, which is not reflected in the table above as the timing of any potential payments cannot be reasonably determined at this time. As NUMMI continues with its decommissioning activities and as we continue with our construction and operating activities, it is reasonably possible that our estimate of environmental liabilities may change materially. We have reached an agreement with NUMMI under which, over a ten year period, we will pay the first $15.0 million of any costs of any governmentally-required remediation activities for contamination that existed prior to the completion of the facility and land purchase for any known or unknown environmental conditions, and NUMMI has agreed to pay the next $15.0 million for such remediation activities. Our agreement provides, in part, that NUMMI will pay up to the first $15.0 million on our behalf if such expenses are incurred in the first four years of our agreement, subject to our reimbursement of such costs on the fourth anniversary date of the closing. On the ten-year anniversary of the closing or whenever $30.0 million has been spent on the remediation activities, whichever comes first, NUMMI's liability to us with respect to remediation activities ceases, and we are responsible for any and all environmental conditions at the Fremont site. At that point in time, we have agreed to indemnify, defend, and hold harmless NUMMI from all liability and we have released NUMMI for any known or unknown claims except for NUMMI's obligations for representations and warranties under the agreement. As of December 31, 2012 and 2011, we held reservation payments of $138.8 million and $91.8 million from potential customers, respectively, which are not reflected in the table above. In order to convert the reservation payments into revenue, we will need to sell vehicles to these customers. All reservation payments for Model S are fully refundable until such time that a customer enters into a purchase agreement. Off-Balance Sheet Arrangements During the periods presented, we did not have relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. |