All seemed well with Tesla’s second-quarter earnings results released Wednesday night. The headlines, again, glowed — Tesla reported yet another positive GAAP earnings number, $400m of free cash flow and a slight dip in revenues when every other auto manufacturer has been crushed by coronavirus.
So was this the time the company proved the doubters wrong and delivered another clean profit from its automotive business to the market?
Well, not quite. Over 100 per cent of Tesla’s $327m operating profit in the quarter came from the sale of $428m of regulatory credits. As a reminder, these are the credits Tesla earns from the state incentive schemes when it sells electric cars, which it then flips to other auto manufacturers who need them to meet emissions standards. Without this windfall, Tesla’s core business of shifting souped-up go-karts to 1 percenters would have made a loss.
It wasn’t the only accounting funny. Morgan Stanley’s Adam Jonas, perhaps with a knowing smile, ran through a few more:
In our opinion, bears really would have to nit pick at the release to construct a materially negative narrative here. One could point to the unsustainable cuts to fixed costs during the quarter (ie. labour) that will not last, lower sequential ASPs [average sale prices], lower volume ex-China, help from software revenue (which btw — is that a bad thing?) or how regulatory credits accounted for roughly 400 per cent of 2Q GAAP profit, etc. We’re not suggesting these aren’t issues worth considering, but we don’t think they materially hit the quality of the quarter.
You’re right Adam, one could point to all these issues — but who cares with the stock taking on a life of its own?
That being said, we did get some clarity on one topic that has had Alphaville puzzled for some time now: Tesla’s accounts receivables balance.
You might recall that Greenlight Capital’s David Einhorn had a very public swing at Tesla back in December, and one of his bug bears was Tesla’s cash-to-be-collected.
Einhorn’s argument was simple. Tesla mainly receives cash from its customers when it delivers a vehicle to them. Therefore there shouldn’t be a significant amount of time between the revenue being recognised, and the cash arriving in Tesla’s coffers.
Yet, this doesn’t seem to be the case for Elon Musk’s company. Tesla has regularly run a net accounts receivable’s balance at around 20 per cent of revenues going back all the way to 2014:
In 2020’s second quarter, this figure was the second highest in the past six years — at 25 per cent of revenues, versus 21 and 18 per cent for the previous two quarters.
You’d expect to see accounts receivables scale with revenue growth, but this wasn’t the case. Tesla’s top line declined 5 per cent year-on-year, while its accounts receivables grew 30 per cent.
Despite being a classic red flag in accounting — as it suggests an aggressive approach to recognising revenues — a high accounts receivables balance isn’t, in and of itself, a problem if the company’s explanation is reasonable.
Yet Tesla’s explanations for the balance have changed more times than Thom Yorke’s haircut. In 2018’s third quarter, it was blamed on the period ending on a weekend. Then, in 2019’s third quarter, the finger was pointed at European banks being slow to transfer customer funds. Which, as we suggested at the time, didn’t make much sense.
In 2020’s first quarter, however, we got some further clarity from Tesla’s 10-Q:
As of March 31, 2020, one entity represented 10 per cent or more of our total accounts receivable balance, which was related to sales of regulatory credits.
So those pure profit regulatory credits that powered the second quarter’s earnings were at least part of the issue. But not all of it.
Helpfully though, we got some more colour from chief financial officer Zachary Kirkhorn on Wednesday evening’s conference call. From the transcript (provided by Sentieo):
A few things to note on working capital, particularly accounts receivable. While our AR balance is usually about 20 per cent of revenue, it can fluctuate depending upon a number of factors. First, overall, less than 30 per cent of our receivables is associated with new car sales. Second, due to payment terms associated with financing and enterprise customers, settlement times for certain methods of cash payments and geographic mix of our deliveries, our cash balance and associated receivables are impacted significantly by how many cars are delivered in the final weeks and days of the quarter. Third, roughly 40 per cent of the balance is attributed to payment terms on regulatory credit sales and statutory EV incentive programs, both of which have been increasing.
Mystery solved: “less than 30 per cent” of $1.5bn of receivables was related to car sales. Yet $500m — or 8 per cent of sales — still seems like a lot for a cash upfront business.
As for who owes the rest of the balance, especially with regards to the regulatory credits, we’re none the wiser. Hopefully we’ll find out when the 10-Q drops over the next fortnight.