What Caused Tesla’s Gross Margins to Decline in 1Q16?
Tesla’s 1Q16 Earnings Results: The Big Bet on Model 3
Tesla’s gross margins
In 1Q16, Tesla Motors (TSLA) reported a gross margin of 22% on a GAAP (generally accepted accounting principles) basis and 21.7% on a non-GAAP basis. This was much lower than 27.7% GAAP and 28.2% non-GAAP gross margins in 1Q15. In this part of the series, we’ll see why Tesla’s gross margins declined in 1Q16.
Margins decline
According to the company, 1Q16 gross margins declined “due to an increase in delivery mix of Model X, which carries a lower margin during its ongoing production ramp phase.”
Notably, in the last several quarters, Tesla’s gross margins have declined due to a stronger US dollar and product mix. Moreover, Tesla’s average selling price has declined. The company’s product mix was unfavorable because it increased deliveries of low-priced 70 kWh (kilowatt hour) variations of the Model S.
Tesla’s gross margins are still higher than those of other automakers (RWL) such as Ford (F), General Motors (GM), and Fiat Chrysler (FCAU).
Tesla’s expectations
Tesla suggested that its gross margin should increase in the coming quarters. According to the company, “Model S cost reductions and improving Model X manufacturing efficiency should cause automotive gross margin to increase.”
With this, Tesla’s management reiterated the company’s plan to achieve higher margins in the coming year. In its 1Q16 letter to shareholders, the company said, “We are on plan for Model S non-GAAP gross margin to approach 30% and Model X non-GAAP gross margin of about 25% by year-end, with higher Model X gross margin in 2017.”
Approaching higher margins?
Despite management’s reassurance, uncertainty continues for Tesla’s gross margin expansion plan. It’s not going to be an easy task, especially at a time when the company’s gross margin has been in a declining trend for the last several quarters, as you can see in the above graph.
To achieve 25% gross margins on Model X, Tesla needs to significantly reduce related fixed costs. It will be interesting to see if the company can make these changes and demonstrate its potential to expand gross margins in the coming quarters.
In the next part of this series, we’ll see how Tesla is preparing to deliver its Model 3 on time.
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