In last week’s earnings release, Elon Musk made the claim in the headline release that Tesla generated $614 million of “free cash flow,” which he defined as “operating cash flow less capex.” Additionally, in the 2nd paragraph of the earnings release Musk states that, “As a result of this growth and operational improvements, we generated $614 million of free cash flow (operating cash flow less capex) in Q2.”
Notwithstanding that fact that Tesla has slashed its capex spending to what appears to be the bare minimum, and setting aside Musk’s claim of “operational improvements,” a careful dissection of the cash flow statement, balance sheet and footnote disclosures calls into question Musk’s assertion that the Company generated $614 million of “free cash flow.”
The graphic above is from the operating cash flow section of Tesla’s cash statement. I use the earnings release version to make comparisons YoY for Q2 and Q1 2019 easier (the 10Q only shows the YTD 6-month numbers in the cash flow statement). You’ll note that Tesla’s capex was $30 million less than Q1 2019 and 59% below the capex spent in Q2 2018. Strange for an automotive OEM that is building a factory in Shanghai, developing a new model (the Model Y), reconfiguring its OEM facility in the U.S. to accommodate the new model and planning an OEM facility in Europe.
However, the big source of Musk’s alledged “free cash flow” comes from the “changes in operating assets and liabilities.” The netted number shows $287 million provided by changes in the various balance sheet accounts. But a detailed analysis of the accounts that provided this “cash flow” would call into question the reliability of Musk’s assertion. In fact, most of the cash was generated from “accumulator” sub-accounts that can be found in the footnote disclosures. These accumulator accounts are liability accounts which account for near-term cash payment obligations which would have used up all of that “free cash flow” had Musk signed the checks to make the payments by June 30th.
The graphic above shows the liability section of Tesla’s balance sheet. I’ve highlighted the liability accounts in question. The “accrued liabilities and other” account increased from Q1 2019 by $346 million, meaning that it contributed $346 million in cash to the “changes in operating assets/liabilities” number in the cash flow statement. Most of this is a “current liability” for which Musk is obligated to make payments in the near term. Tesla does not disclose the breakdown of “accrued liabilities” in its 10-Q, but it shows the contents of this account in the 10-K. In 2018, the two biggest items were payroll and taxes payable, which represented 21.4% and 16.6% of accrued current liabilities.
The second largest contributor to the “free cash flow” calculation was the change in “other long term liabilities” from Q1. The details of this account are disclosed in Note 9 of the 10-Q. This account contains longer term cash payment obligations like “accrued warranty reserve” and “sales return reserve.” Again, this is an “accumulator” account that accumulates future payment obligations. This account increased by $180 million from end of March, meaning the accumulation of cash payment obligations contributed $180 million to the “change in operating assets/liabilities” account in the cash flow statement.
Finally, there’s “deferred revenue.” Deferred revenue for Tesla is derived from the portion of the revenue for each vehicle sold which is attributable to access to the supercharger network, internet connectivity, autopilot (LOL), full self-driving (LOL) and software updates. In other words it represents some portion of the revenue which is paid up-front which is contingent on Tesla delivering performance obligations. It’s revenue received but not earned. It also means that Tesla did not recognize the corresponding expense that needs to “amortized” against this revenue source. Thus, it’s a source of cash. This contributed $121 million in “cash flow” to Tesla’s Q2 “free cash flow.” But in reality it’s not free cash flow.
The point of this analysis is that Telsa is on the hook to make cash payments on obligations and liabilities incurred well in excess of the amount to which Musk refers as “$614 million of operating cash flow less capex.” Most of the money – payroll, taxes, facility lease payments – will be due on or before the end of July. Some of it will have be paid out of Tesla’s cash balance over the course of the next several months. But to make the claim that Tesla generated $614 million of “free cash flow” is highly deceptive.