Tag Archives: Musk

AMZN’s Free Cash Flow And Profitability Myth

Jeff Bezos was a master at GAAP accounting manipulation back when Elon Musk thought that “GAAP” was a clothing store chain. AMZN’s numbers are just as manipulated as Tesla’s. But the difference between Jeff Bezos and Elon Musk is that, whereas Musk is a pure caveman with his fraud, Bezos is clever about disguising and hiding the accounting manipulation. About six years ago I spent a considerable amount of time deep-diving into AMZN’s financials going back to 2004, which is when AMZN’s business really began to takeoff. After about two weeks of tedious but intensive study of the footnotes in 10Q’s and K’s, I pieced together a lot of the GAAP manipulation tools embedded in AMZN’s financials.

I will note that in 2018 Amazon denied a request from the SEC for more information about the Prime business, including disclosing in its financials the amount of sales attributable to Prime members. I’m certain Bezos rejected this request because Prime is a money-losing proposition and does not want to provide the evidence of that by breaking out the numbers. I recall sometime around 2013 or 2014 Bezos admitted in an interview with Bloomberg that Prime lost a couple billion per year.

AMZN pulled a lot of of the usual GAAP tricks to generate this quarter’s net income “beat.” Bezos slashed marketing expenses by a considerable amount as a percentage of revenue, as the marketing expense was essentially flat vs Q2 2019. Historically the marketing expense has grown YoY at a healthy rate. He may have just figured out a way to justify capitalizing some that expense – i.e. throwing some amount of the marketing expense into an asset account and amortizing it over time. This would reduce the amount of marketing expense shown in the income statement, thereby increasing operating and net income. Too be sure during Q2 a lot of companies cut back on web-based advertising, but if this was the case with AMZN, the cost-improvement is one-time, non-recurring.

Though AMZN reported EPS of $10.50 vs. $5.32 in Q2/19, several red flags for me point to the improbability of net income nearly doubling YoY. The operating income margin in the North America product segment (e-commerce + whole foods + sundry other small businesses) declined again to 3.7% from 4.1% in Q2/19. For the first time he showed a tiny operating profit in the International e-commerce business. I’m certain there were accounting games to accomplish this but I can’t prove it with just the publicly available numbers.

AWS (the cloud business) continues to experience slowing sales growth and declining margins. AWS contributed to 59% of the Q2 operating income but just 12.1% of the total revenues. And the percentage of revenues represented by AWS sales declined.

AMZN’s overall operating margin was 6.5% but the Products (online + WF) operating margin was just 3.1% vs 4.9% in Q2/19. This decline is attributable I believe to declining margins in the Whole Foods business. Again, AMZN offers fat discount specials to Prime members on many products at WF, which drives sales growth at the expense of profitability. Unfortunately, AMZN does not break out the sales and income attributable to the WF business – yet another layer of opacity on AMZN’s financials. I predicted when AMZN acquired WF in mid-2017 (at the time WF was 5% operating margin business being folded into a 3% operating margin business) that Bezos would drive margins lower at WF in an effort to generate revenue growth.

The cost of fulfillment rose – again – to 26% of product sales vs 25.6% last year. The Company generates sales by subsidizing the selling price of online products with 2-day free
delivery for Prime members. This is a money losing proposition and it enables predatory
pricing to drive out competition. Bezos is being grilled by Congress about the possible use of predatory pricing strategies to drive out competition, along other anti-trust issues. Rest soundly that this is nothing more than political theatre and nothing will be done to curtail AMZN’s effort to put the competition out of business.

AMZN’s debt increased again to $33 billion (41%) in Q2 but the Company is not using the funds to buyback shares. If the business really is generating free cash flow, why issue more debt? AMZN has to issue debt from time to time to fund cash needs. Without going into the complicated calculus here, AMZN’s free cash flow claim is an accounting mirage. At the end of Q2 2012, AMZN had zero debt. It had $24 billion in debt after closing the WF’s deal. Now it has $33 billion in long term debt. To my knowledge, unlike most other big companies that issue debt for the sole purpose of buying back shares, AMZN has rarely if ever repurchased shares. This is because it needs the debt funding to cover expenses.

Finally, AMZN used to disclose the amount of cash it spends every quarter for operating and finance leases plus that amount cash used to acquire PP&E under operating and finance leases at the bottom of the State of Cash Flows. No more. Now it discloses this information in the footnotes in a section titled “Supplemental Cash Flow Information.” This may sound trivial but the cash used for the PP&E purchases is not included in Bezos’ definition of free cash flow. In addition, very few analysts and investors ever bother to look at the footnotes.

Bottom line: If I gross up the the first 6 months of 2020 operating income and add a couple billion for growth, I get full-year estimated operating income of $20 billion. This stock is trading at 80x estimated operating income for a business that generates a 6.5% operating margin and said margin declines almost every quarter. 88% of the business model generates just a 3% margin and that margin is declining. Right now it doesn’t matter. The stock algos, Chinese retail gunslingers and Robinhood idiots will chase anything that moves. You make a dead skunk carcass move and the Robinhood morons will chase it.

Will Tesla Ever Generate A Real Profit?

The only part of Tesla’s business model that generates profitability – gross, operating and net – is the sale of greenhouse gas credits to other OEM manufactures and tax subsidies.  Neither of those sources of profitability is sustainable.

The GAAP net income of $105mm in Q4 was 17% below the consensus of $126mm. Regarding net income, Tesla generated $133mm of income from selling Zero Emission/Greenhouse Gas credits to the big OEMs who need them – for now – to remain in compliance with environmental regulations. Net of these credits, Tesla lost $28 million in the quarter (before the fraudulent accounting manipulation). Subtracting these credits from the full-year loss, Tesla’s 2019 net loss attributable to shareholders is $1.5 billion.

The problem with this reliance on the sale of these credits to generate income is that, starting this year, the buyers of these credits (GM, Audi, Chrysler, etc) will soon be selling more than enough EVs and hybrids to remain in compliance. This source of income for Tesla will thus eventually be non-recurring.

With subsidies disappearing and an onslaught of competition,  2020 could be a bloodbath for Tesla in terms of deliveries. Not only is the global auto market contracting, but the much larger, better funded and operationally credible OEMs will be flooding the market with competitive EVs that will significantly cannibalize Tesla’s market share.

There’s just no telling when this Electric Tulip will inevitably crash. But, like with any investment bubble,  the popping will happen suddenly and unexpectedly, when the bulls are convinced that the upside is limitless and the bears are in a state of terror

Tesla, Gold And Coronavirus – Fraud And Global Depression

To say the current stock market is in a bubble is an insult to the word “bubble.” Tesla experienced an insanely idiotic stock price move after reporting “shock and awe” headline numbers for revenue and EPS which “beat” estimates – estimates that had been lowered by analysts throughout 2019. But as always there’s plenty of dirt in the details which point to a reality that is far different than is represented by headline numbers and Tesla’s highly orchestrated earnings presentation.

There’s just no telling when this Electric Tulip will inevitably crash. But, as with any investment bubble the popping will happen suddenly and unexpectedly, when the bulls are convinced that the upside is limitless and the bears are in a state of terror.

Meanwhile, the physical gold market which underlies the complicated web of paper gold derivatives continues to push the gold price higher despite aggressive efforts by the western Central Bank and bullion bank price management team. In fact, data from the BIS indicates that the BIS had a heavy hand in the effort to cap the price-rise of gold during January using its physical gold swap and leasing transactions.

Paul at Silver Doctors invited me onto its podcast to discuss these issues

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The Telsla CyberTruck Event: Elon Musk’s Travelling Burlesque Show

As many of you are aware by now, Tesla’s roll-out of its Cybertruck, an event which pushed the stock price irrationally higher ahead of time, was a complete disaster. The vehicle itself, which one commentator said “looks like the product of a DeLorean that had sex with a triangle,” was visually quite unappealing. Morgan Stanley conducted a snap poll of its email distribution list to determine viewers’ impression of the Cybertruck.  Zero percent (0%) of those surveyed thought the truck would be a success.

Whether or not the claims by Musk & Co are true that over 250k people have plunked down a $C-note to “reserve” a Cybertruck, at this point it’s unclear whether not the vehicle will ever make it to production. Notwithstanding inconvenient realities, Musk fraudulently refers to the refundable reservations as “orders.”  Electrek.co and Musk’s Twitter pimps behave as if Tesla has already pre-booked $10 billion in revenues.

But Tesla has several hurdles to overcome before this electrified Lego block on wheels ever rolls off the production line, not the least of which includes addressing a technically insolvent balance sheet and raising the $100’s of millions of capex required. Notwithstanding this, the entire auto industry, including Tesla, faces gale force economic headwinds as the sector globally plunges into recession.

Based on YTD sales through October – plus estimates for November and December – data published by EV-Volumes, a service that provides a database of sales statistics for EVs, shows that total EV sales in the U.S. will decline 4% from 2018. After 10 years of EV availability, the market penetration rate for EVs is just 2% – and ex-California it’s 1%. Think about this in the context that the Government has provided enormous subsidies for EV/hybrids, thereby lowering the all-in cost for the buyer. As the largest EV seller in the U.S. (currently but not for long), Tesla is by far the most affected by the negative trend in EV sales.

Finally, because of plunging EV sales (along with plunging sales for the entire Chinese auto market), the Chinese Government is implementing major cuts to its EV sales subsidy program. The Chinese Association of Automobile Manufactures said that weak demand for the vehicles is one of the reasons for the pullback in the subsidy program.

Eric Peter’s Autos blog captured the essence of Musk’s farcical CyberTruck burlesque show:

Thousands of affluent marks have already put down deposits, unsightliness seen. And in spite of one of Elon’s many promises about the Cybertruck revealed to be a blatant lie right in front of their very eyes – the “shatterproof” door glass that wasn’t. It’s wondrous, baffling. Elon’s mesmeritic powers are so puissant he could probably get his followers – this includes the press – to bark like dogs if he asked them to.

You can read Peter’s entire commentary here:    And So They Drooled

More Evidence Tesla Is In A Death Spiral

Reuters  report in which the news service discovered that almost all of the solar cell production at Tesla’s solar factory in Buffalo, New York is being sold overseas, primarily to a large Asian buyer.  Tesla’s Solar City business was given $750 million in State subsidies to build the plant in NY in exchange for employing at least 1,460 people and spending $500 million per yer in the State over 10 years.

The factory employs far less than the 1,460 required and the State has no hope of ever seeing the $500 million per year. The factory has become little more than a solar cell production facility for Panasonic paid for by U.S. taxpayers.

Panasonic produces the solar cells in the factory that were supposed to be used in Solar City’s solar panels.  The problem is that Solar City’s sales are approaching zero.  In California only 21 Solar City roof systems are connected to the State’s three investor-owned utilities as the end of February.  Panasonic is seeking to use the Buffalo plant to fulfill demand for U.S. made solar sales from foreign buyers (foreign solar manufactures can then export the solar panels back the use duty-free).

Earlier this year Panasonic announced that it was suspending plans to expand capacity at Tesla’s Gigafactory. It also suspended planned investment in Tesla’s Shanghai Gigafactory. The decision to curtail investment in Tesla’s U.S. Gigafactory was based on declining sales in the Models S and X and on Model 3 sales which are running below plan.   Panasonic’s Tesla EV battery business had losses exceeding $181  million in its fiscal year that ended in March.  Panasonic was likely not interested in repeating that experience as a “partner” in Tesla’s Shanghai operations.

What’s interesting about the two situations described above is that, more than anyone outside of Tesla’s corporate suite, Panasonic has an up close inside look at the truth behind Tesla’s operations and financials.  It’s quite clear that Panasonic is in financial loss containment mode with respect to its relationship with Tesla.  In this regard, Panasonic is signaling that Tesla is in deep trouble operationally and financially.

Panasonic’s withdrawal from its relationship with Tesla reflects the same critical information about Telsa as the steady stream of high level executive departures over the last year, the rate of which accelerated over the last 4-6 months.  Clearly the message is that Tesla is now in an irreversible death spiral.

Just for the record, I believe that Goldman Sachs and Morgan Stanley used the recent stock and convertible bond offering to suck fees out the deal that would help offset the likely losses the two banks will incur when Musk inevitably defaults on loans he owes to both firms.  It cost Tesla $300 million to purchase derivative protection against the potential shareholder dilution affect if Tesla’s stock were to rise the conversion price of $309 in the new converts.

But those two firms know that Tesla is going to hit the wall and that the stock has no chance of sniffing anywhere close to $309 from now to eternity. It’s highly likely that Goldman and Morgan Stanley forced this hedge structure on Tesla to rake in the $10 to $20 million in fees skimmed on the derivatives used for the hedge.  It was nothing more than vultures who are closest to the carcass grabbing the choicest cuts of meat.

Ironically, Morgan Stanley’s analyst issued a ”worst case” $10 valuation on Tesla. Unless the analyst is a complete idiot with little experience in distressed situations – which is possible – the $10 dollar valuation is Morgan Stanley’s “code” for, “the stock is worthless if Tesla has to file” (which it will sooner or later).

Put A Fork In Tesla – It’s Done

Tesla has been “done” for awhile but many of the Wall Street and investor “uber” bulls are finally starting to see this reality.  Amusingly, Wedbush’s Dan Ives issued a report in which he lowered his price target on Tesla stock from $270 to $235.   He refers to Tesla’s situation as a “code red situation.”  Quite frankly, a “code red situation” with regard to a company and its stock price should be regarded as, “sell your shares if you’re long and get out of the way.”

How someone with the credentials to occupy a stock analyst’s seat at a stock brokerage – even if it is just Wedbush, a retail pump and dump mill – can truly believe that Tesla stock is worth the $40 billion market cap at $230/share is truly mind-blowing.  As an example, consider just a basic valuation metric.  The average automotive car OEM trades at an enterprise to revenue ratio of 0.2x revenues.  At the high-end Toyota trades at 0.6x revenues. That’s because Toyota sports a 7.5% operating margin.  Tesla’s market cap plus debt is 2.6x revenues, or 13x greater than the industry mean.

It would be useful to use other valuation metrics but Tesla does not generate any profits beyond its highly suspicious gross profit as shown in its SEC filings. It would also be useful to know if Dan Ives owns any Tesla shares. Does he really put his money where is mouth is?

That aside, Tesla shares are going to zero. Tesla stock broke down last week, closing at its lowest price since December 21, 2016. The stock is down $44 (17.5%) since May 6th, when it closed at $255 after completing the stock/convertible deal. It’s down 43% from its $370 close after the “funding secured” incident (August 8, 2018). Today the shares traded as low as $195 before a dead-cat short-cover bounce that has lifted the shares back over $200.

Tesla has likely entered into an irreversible death spiral. The only question at this point is how long it will take for the stock to head below $10 and how long the Company can stay solvent. There are scattered reports that the latest price cuts have stimulated a brief increase in sales of the Model S and X, but nothing has been verified. To be sure, sales of the Model 3 have fallen off a cliff in Europe and China, as an increasing number of potential buyers are made aware of the poor quality and follow-up service of this vehicle.

At TSLA’s current cash-burn rate, it won’t make it until the end of the year without a sales turnaround miracle on par with Moses seeing God in a burning bush. I doubt the Company will ever be able to raise money again. The stock does not have value as an acquisition because I highly doubt any potential acquirer would pay an amount that would cover Tesla’s debt load plus other fixed obligations.

In my 34+ years of experience in the financial markets, I’ve witnessed several Pied Piper types who have led their faithful  off the cliff.  Elon Musk for my money is the greatest purveyor of cult of personality that I’ve observed in my lifetime.  I don’t know how else to explain, at least for myself, how so many seemingly intelligent people continue to support Musk’s glaringly indisputable fraud.

The Wheels Are Coming Off Musk And Tesla

Literally, the wheels are coming off. Panasonic, which supplies batteries that it manufactures for Tesla at the Gigafactory in Nevada announced that it was cutting back on its plans to expand production capacity at the plant. It also announced that it was suspending plans to produce batteries at Tesla’s planned Shanghai Gigafactory. In an article in a Japanese business publication, Panasonic had less than flattering things to say about working with Tesla. The move by Panasonic at the Nevada Gigafactory likely reflects concern over the falling demand for Teslas.

Tesla is sticking by its guidance to produce and deliver 360-400k vehicles in 2019. In Q1, Tesla delivered 63k vehicles – a 252k annualized rate. David Einhorn, the proprietor of the high profile Greenlight Capital hedge fund, is vocally short Tesla. His team believes Tesla will deliver less than 250k vehicles in 2019. Q1 and Q2 will likely have higher deliveries than Q3 and Q4 because of the temporary “bump” in demand from rolling out the Model 3 in Europe and China in Q1. I believe there’s a chance that deliveries in 2019 are closer to 200k than 250k.

This graphic shows the demand drop for the Models S&X combined in, Norway, one of Tesla’s largest markets (visit @teslacharts to see more well-produced analytic charts like this):

That chart looks similar or worse in all of Tesla’s markets, including the U.S. After a brief bump in deliveries from the effect from the start of delivering the Model 3 to Europe’s and China’s “must-have the latest tech device” crowd, the Model 3 chart will soon look like the delivery chart for the S/X. European’s are already complaining about the poor reliability and service on the Model 3.

Tesla also rolled out its leasing program, which left most analysts, including me, thoroughly baffled. The lease program ostensibly is primarily to boost demand for the Model 3. But Tesla does not offer a lease for the basic $35,000 Model 3. It also announced that the basic Model 3 would only be offered for online purchase. The lease for the Standard Range-plus Model 3 is structured such that the lessee will need to put down roughly $4k upfront. The lowest monthly payment option is $504 and there’s no purchase option at the end of the lease. I won’t go into Musk’s rationale for this because it would be a waste of your time to read about it. In short, the ill-conceived lease program will likely have a minimal effect on unit deliveries.

There’s three primary reasons Tesla’s sales are falling rapidly: 1) the 50% drop in the tax credit (which drops even lower to $1875 starting July 1st this year and goes away completely after December 31st);   2) Tesla’s growing reputation for poor reliability and even worse service;   3) Growing competition in the luxury EV space.

With each passing week, the operational decisions and musings of Musk become more bizarre. The growth narrative is over. The Company is shrinking its service centers and delivery infrastructure in order to cut costs. Senior employees are leaving pretty much on a weekly basis. In fact, last week the senior manager who was responsible for building Tesla’s lithium ion battery supply chain from May 2017 to April 2019 left the Company. Perhaps more troubling, Tesla’s Director of Global Treasury also left recently. This function of this position is to oversee the Company’s worldwide cash management and liquidity activities. It’s likely this person, Pedro Glaser, was not interested in sticking around until the cash runs out.

The Company continues to spiral downward in a toxic cloud of operational dysfunction, financial deterioration, decaying auto industry fundamentals and growing fraud. It remains a mystery to anyone who examines Tesla closely how the stock manages to remain at a level that assigns a $47 billion market cap to the Company. I suspect there’s a continuous short squeeze on the shares because the short-interest is quiet high and the “free” float of shares is low relative to the overall short-interest. Ultimately the shorts will prevail – of that I’m 100% confident.

In my view, Tesla continues to circle the drain. The stock is down nearly 20% YTD in the context of one of the most torrid upside moves in the overall stock market in history. The stock appears ready to test the $250 level again. If it drops below that, it could fall below $200 quickly.

Elon Musk’s Legacy Of Unchecked Fraud Continues

At 5:15 p.m. on February 19th, Elon Musk tweeted that Tesla would produce 500,000 cars on 2019.  The headline hit news terminals globally. The stock jumped over $1 in after hours trading.  Four hours later Musk tweeted that he meant Tesla would be producing cars at an annualized rate of 500,000 by the end of 2019.  After-hours trading was closed when that “correction” hit Twitter.

The next morning the Wall Journal reports that Tesla’s General Counsel, Dane Butswinkas, is quitting Tesla to return to his law practice in DC – two months after he took the job. Butswinkas’ role at  was widely regarded to be Musk’s highly compensated Twitter babysitter per the terms of Musk’s SEC settlement related to Musk’s securities fraud “420 secured” tweet.

Tesla will rival Enron as the biggest stock fraud in this century, if not U.S. financial history.  To be sure it sells cars that generate revenues.  But the alleged profitability shown in Q3 and Q4 financials is likely nothing more that the product of GAAP accounting manipulation.  Elon Musk has been making promises and performance projections which fall miserably short of reality for several years.  He overtly violated securities laws with the $420 secured” tweet, which cost investors $10’s of millions of dollars – longs and shorts.

Tesla stock jumped on Monday, February 11th after analysts from Canaccord and Wedbush issued strong buys based on “strong demand for the Model 3,” putting absurd price targets on the stock. While both analysts’ analysis and opinions can be summarily dismissed based on gross negligence in presenting facts, you should be aware that the Canaccord analyst had a buy recommendation on Solar City stock from $53 in February 2015 all the way down to down $19.60 in May 2016. Tesla acquired Solar City in the summer of 2016 in a highly controversial deal,  likely fraudulent,  that has turned out to be an unmitigated  disaster.

I suspect the motive for both analysts’ arguably fraudulent stock reports is to generate demand for Telsa shares that can be used to unload shares on behalf of a large seller through both brokerage firms’ retail stock distribution network (brokers and investment advisors). T Rowe Price, formerly the largest shareholder outside of Musk,  cut its position in half during Q4, unloading 8.4 million shares. Insiders have been unloading shares non-stop, with not one insider purchase in the last 3 months.  Two of the most respected investors on Wall Street – Stanley Drukenmiller and Jim Chanos – are short Tesla.

With the tax credit cut in half January 1st and a growing reputation for poor quality control and even worse service, Tesla’s deliveries of all three models have literally plunged off a cliff since Q4. Officially Model 3 sales have dropped 60% for Q4. But sources that keep track of the numbers separately from the Company show a steeper drop-off in sales. As an example, the Marina Del Rey service center previously had been Tesla’s premier delivery center. But deliveries have dropped from average of 16 deliveries per day in Q4 to less than 1 per day in February through February 11th (2.1 deliveries per day in January). Sales in China and Europe have also fallen off a cliff, as superior competing EVs are becoming available.

The latest “500,000 production in 2019” tweet is the just latest in a long list of stunts pulled by Musk in an attempt to pump up the stock price. The departure of the General Counsel is one of many high level executive departures to leave in the last two years after spending just a brief tenure at the Company. Remarkably, the main stream financial media has little to no interest in investigating the nature of the circumstances of the executive departures or the unwillingness of regulators to keep Musk in check.

Tesla is perhaps the most egregious fraud in U.S. financial history.  It has been allowed to unfold out in the open, enabled by the complete lack of regulatory enforcement. Tesla and Elon Musk are emblematic of the unmitigated corruption that has engulfed the U.S. political, financial and economic system. Tesla’s saga represents the Government’s total disregard for Rule of Law. The message sent is that it is now open season for any person or entity with enough money to buy political protection to grab as much wealth as possible before the system collapses

Tesla’s Q3 GAAP “Net Income:” Manipulation If Not Outright Fraud

I perused Tesla’s Q3 10-Q and scrutinized the footnotes to figure out, to the extent possible, where Tesla manipulated GAAP accounting standards and outright “cooked” its numbers. Before I had a chance to analyze the 10-Q, others had already posted their findings on Twitter or in Seeking Alpha articles. In the analysis below, I’ve double-checked and confirmed the findings presented by others. In addition, where appropriate, I’ve added my findings to the previous work of others and explained how and why Tesla’s numbers are highly misleading, if not outright fraudulent.

Net income – Tesla reported GAAP income of $311.5 million. But what it did not disclose when it released its earnings report was that $189 million of that income was generated from selling regulatory credits – Greenhouse Gas (GHG) credits and ZEV (Zero Emission Vehicle) credits. Automakers in 10 States are required to sell a specified number of electric or hybrid vehicles within the State. Credits are earned for the number of emission-friendly vehicles sold. Automakers are required to maintain a level of credits based on each automaker’s overall vehicle sales volume within the State. GHG credits function in a similar way at the Federal level.

Some companies, like Tesla, generate more GHG and ZEV credits than required to be in compliance with the law. Companies with excess credits are allowed to sell their excess credits to car manufactures and other companies that manufacture carbon-emission equipment and do not generate enough credits to be in compliance with the regulation. Selling excess credits over the past few years has been a significant source of cash flow generation for Tesla. The money raised by selling these credits is accounted for as income under GAAP.

The problem is that, in its presentation of its Q3 earnings, Elon Musk and the CFO did not disclose that nearly 61% of its GAAP net income was derived from selling these credits. While Tesla referenced that $52 million was generated from ZEV credit sales in Q3, they did not disclose the $137 million GHG credit sales in the earnings press release or the analyst conference call. Rather, they postured as if the net income was generated thru cost-efficiencies and sales volume. The $137 million in GHG credit sales was buried in the 10-Q.

In the chart above, you can see that TSLA’s use of GHG credit sales has been inconsistent over time. In all probability, Musk chooses the timing and quantity of the credit sales based on when he needs to generate cash. It’s pretty obvious that he decided to unload a massive quantity in Q3 in order to help generate the GAAP net income and positive cash flow he had been promising for months.

Technically, the manner in which Musk utilized,and disclosed the use of, ZEV/GHG credits to manufacture income, is highly deceptive. Selling regulatory-derived environmental credits is a low-quality, unreliable source of income. As Tesla’s competition ramps up production and sales of EV’s, the supply of credits will escalate rapidly. This will drive down the resale value of these credits toward zero. And there’s always the possibility that regulatory requirements will be rolled back. Over time, this source of income and cash will disappear.

Warranty Provision – Every quarter companies that issue warranties have to take a warranty expense provision, which is an estimate of the quarterly expense that will be incurred under warranties on products sold by the company. The warranty provision hits the income statement as an expense. The idea is to match estimated quarterly warranty costs that will be incurred from selling products covered by the warranty each quarter. Warranty expense is part of the cost of goods sold. The information on warranty expenses is found in the footnotes (this is standard).

In Q3 this year, Tesla expensed $187.8 million, or $2,249 per car delivered, vs $118.6 million, or $2,913 per car delivered in Q3 2017. If Tesla had kept the cost per vehicle delivered constant, the provision for warranty expense in Q3 would have been $243.2 million, or $55.4 million higher than was expensed in Q3. In this case, Tesla’s cost of goods sold would have been $55.4 million higher and the gross profit would have been $55.4 million lower. This is part of the reason Tesla’s gross profit margin was much higher than anyone expected. It also translates into a $55.4 million net income benefit.

In Q3 2108, Tesla sold a little more than double the number of vehicles sold in Q3 2017. At the very least, and to be prudent, in Q3 this year Tesla should have at used at least double the warranty provision it used in Q3 2017. This is especially true since the Model 3 is in its debut model year and will likely require higher than expected warranty-based repairs. The probability of greater than expected warranty repairs for cars sold during Q3 is even higher when taking into account the high number of production difficulties the Company encountered – and about which Musk whined publicly.

Using a warranty expense estimation method simply based on doubling the warranty provision taken in Q3 2017 – given that Tesla sold more than double number vehicles, Tesla’s warranty provision expense would have been $237.2 million in Q3 rather than the $187.8 million recorded, which would have reduced net income by $49.4 million.

To be sure, the warranty expense provision can be adjusted based on using the actual amount of warranty costs incurred over time. But given the limited history of Tesla, and given that the Model 3 is a 1st-year production automobile with noted production and quality control issues, Tesla probably should have used a warranty provision that was higher on a per car delivered basis than the number used in Q3 2017. But, then again, Musk and his CFO were goal-seeking positive net income and thus likely decided to reduce the provision per vehicle delivered by nearly 23% and pray that they figure out a way to bury an increase in the actual amount spent on warranty repairs in future quarters.

Inventory Write-Down – An inventory write-down is recorded as an expense in the quarter in which it is taken. For a company like TSLA, an inventory write-down occurs for excess or obsolete inventories (unsalable cars, worthless parts and supplies) or when the carrying value of certain cars held in inventory is greater than the realizable value. The latter would primarily apply to cars taken back by Tesla under lease guarantees (keep this tidbit in mind for reference below) or cars held in inventory deemed unsalable because the cost of fixing manufacturing defects is greater than the gross margin generated from selling the car.

Over the last six quarters, Tesla’s inventory write-down as a percentage of total inventory has averaged 1.4%. In Q3 2017, the write-down was 1.1% of inventory; in Q2 2018 it was 0.9%). However, in Q3 Tesla’s inventory write-down was 0.4% of inventory. In terms of numbers, Tesla’s inventory expense in Q3 was $12.4 million vs $26.2 million in Q3 2017 and $24.6 million in Q2 2018. This chart shows the degree to which it appears as if Tesla purposely minimized the inventory write-down expense in Q3 2018:

(Kudos to @TeslaCharts for the charts he created illustrating the extreme inconsistencies in Tesla’s Q3 financial statements)

The effect of taking an inventory write-down that is far lower than the historical average reduces the cost of sales and thereby increases the gross, operating and net profits. If TSLA had used the historical average of 1.4%, the expense taken for the Q3 inventory write-down would have been $46.2 million, or $33.8 million more than the $12.4 million used. The reduced write-down had the effect of reducing cost of sales by $33.8 million and increasing gross profit and net income by $33.8. This also contributed to the large increase in the gross profit margin in Q3 vs historical quarters.

The inventory write-down charge was clearly an extreme outlier in relation to the historical application of this write-down over the previous six quarters. Make no mistake, the minimization of the inventory write-down expense in Q3 was a blatant effort to exploit accounting standards for the purpose of reducing GAAP expenses and thereby increasing GAAP income. The discrepancy between the Q3 charge vs historicals predictably was not addressed by the CFO or by analysts in the Q3 earnings conference call.

Tesla’s Actual Net Income? Telsa reported $311 million of GAAP net income. Of this, $83.2 million represents the highly questionable reduction in costs attributable to lower than usual warranty and inventory write-down expenses. Tesla also sold an unusually high amount of GHG/ZEV credits, which boosted net income by $189 million. While this is a source of actual cash income, it’s not a long-term sustainable source of income. Combined, these items accounted for $272 million – or 87.5% – Tesla’s GAAP net income in Q3.

In addition to the items presented above, Tesla “achieved” significant and highly questionable reductions in the expenses taken for R&D and SG&A. In Q3 Tesla recorded $350 million for R&D and $729 million for SG&A – $1.079 billion combined. In Q2 Tesla recorded $386 million for R&D and $750 million for SG&A – $1.36 billion combined. Tesla wants the market to believe that R&D and SG&A expense declined by $290 million from Q2 to Q3, despite the fact that Tesla’s overall operations were expanded to accommodate a large increase in vehicles sold in Q3 vs Q2. On average, over the last six quarters, R&D plus SG&A has been running at 39.5% of revenues. In Q2 2018, these charges were 33.84% of revenues. But in Q3 2018, R&D and SG&A dropped to 17.7% of revenues.

To be sure, there are “economies of scale” with respect to R&D and SG&A expenditures as revenues grow. But for R&D and SG&A to decline nearly 50% as a percentage of revenues from Q2 is simply not credible, unless Tesla intentionally drastically cut back on R&D and administrative/sales functions in Q3. Without question, Musk and his CFO played games with the R&D and SG&A expense accounts in order to reduce the charges expensed for these categories in Q3 vs the previous six quarters and especially vs Q2 2018.

It’s quite possible that Tesla loaded R&D and SG&A expenses into Q2 that technically belonged in Q3 knowing that it was going to report a big loss in Q2 ($717 million loss in Q2) anyway and had promised profitability in Q3. But it’s impossible to know if this occurred without having access to the inside books and bank statements. The stunning plunge as a percentage of revenues for these items in Q3 vs Q2 is the equivalent of asking us to believe in the existence of Santa Clause.

If we give the Company the highly doubtful benefit of synergies which reduced R&D and SG&A to just 20% of revenues – despite the fact that it has been running nearly double 20% over the last six quarters – the combined charge for these accounts would have been $1.219 billion rather than the $1.079 billion used by Tesla (note, at the very least it would have been reasonable to assume that the expense level at a minimum stayed flat vs Q2, meaning I’m being overly generous in my assumption). Under this scenario, Tesla’s operating expenses would have been higher by $140 million.

Adding this $140 million in incremental expense to the $49.4 million warranty expense manipulation and $33.8 million inventory write-down manipulation implies that Tesla’s GAAP net income was overstated by $223 million. Using the historical experience for these expense accounts, including an overly generous benefit in the assumption I use for “normalized” R&D/SG&A, Tesla’s GAAP income as reported would have been $88 million instead of $311 million. Tesla’s $88 of net income as adjusted less the $189 million in income attributable to GHG/ZEV sales turns the $311 net income reported as net income into a $101 million loss.

In addition to the questionable accounting used by Tesla to generate $311 million of GAAP “net income,” Tesla engaged in questionable, if not problematic, balance sheet maneuvers to boost the level of cash presented at the end of Q3. The purpose of this was to create the illusion of solvency. In the Q3 10-Q, Tesla shows a cash balance of $2.96 billion. At the end of Q2 Tesla had $3.11 billion.

Tesla’s accounts payable jumped jumped by $566 million from Q2 to Q3. Companies will stretch out their bills in order to conserve cash. Tesla has made a habit out of dragging its feet on paying vendors, suppliers and service providers as evidenced by the large number of court filings from smaller vendors who are forced to get a court order for payment. The same dynamic applies to “other accrued liabilities,” which contains other short term liabilities for which payment has not been made (payroll, taxes, interest and smallish items).

While accounts payable and other accrued liablities will naturally rise with the organic growth of a company, the rise in Tesla’s payables year over year is nothing short of extraordinary. Through the first nine months of 2018, per the statement of cash flows, Tesla generated $1.6 billion in cash “financing” from “stretching out” its payables vs $170 million in the first nine months of 2017. While Tesla’s revenues nearly doubled over the same period, this amount of unpaid bills has a reason behind it.  The net effect of withholding payment of its bills longer than necessary is that it makes the cash on Tesla’s balance sheet appear larger than otherwise. Accrued payables and other short term liabilities are the equivalent of a short term loan to a company. These liabilities should be treated as a form of short term debt.

Subtracting current liabilities ($9.78 billion) from current assets ($7.92 billion) shows that Tesla has negative working capital of $1.86 billion. Technically Tesla is insolvent, which explains the games the Company plays with its supplier/vendors.

Another curiosity on Tesla’s balance sheet was accounts receivable, which more than doubled, from $569 billon to $1.155 billion. In the footnotes under “credit risk,” Tesla disclosed that “one entity represented 10% or more of our total accounts receivable balance” at the end of Q3, whereas previously no entity represented 10% of receivables. In other words, one entity owed Tesla at least $115 million.

When asked about the big jump in A/R during the earnings conference call, the CFO dismissed it by claiming that the quarter ended on a Sunday. It’s beyond absurd that the analysts on the call accepted this answer without further interrogation. Subsequent to the release of the 10Q, a company spokesman told a reporter from the L.A. Times who had inquired about the 10% disclosure that the receivable was attributable to a large partner bank for car loans issued to U.S. customers. The spokesman said that “all of this receivable was cleared in the first few days of Q4.”

The inference was that Tesla sold $115 million or more worth of cars after 5 p.m. on Friday and over the last weekend of its quarter financed by one bank that could not be processed by the banking system. If this were truly the case, why not just state this as fact openly rather than leaving the market guessing what might have happened? 10% of $1.155 billion is considered “meaningful” under strict GAAP, which means this issue requires more detailed disclosure. The CFO’s vague response to the question about the issue reflects intentional obfuscation of the matter.

Unfortunately, we may or may not be able to figure out exactly what happened when the 10-K is released. I’m not optimistic that the Company will come clean. However, an analyst posted an assessment on Twitter (@4xRevenue) which seems to be a very reasonable explanation to this mystery. This analyst believes that the 10% receivable is from a lease partner (a bank) who has underwritten leases that contain Residual Value Guarantees from Tesla.

Tesla had been offering Residual Value Guarantees (RVG) on leases as an incentive to generate sales. The RVG is a guarantee from Tesla on the value of the car at the end of a lease. In order to stimulate lease-based sales, auto companies will guarantee the lease-end value of car at a level that is typically above the market value for that car at the end of the lease. It’s a “back-door” mechanism used to lower the monthly cost of a lease to the lessee.

If the receivable in question is from a bank that financed Model S&X leases, it means that a large number of vehicles came off lease at the end of Q3 and the bank was returning these cars to Tesla. The “receivable” is the guaranteed residualy value of these vehicles. It also means that Tesla likely will have a large cash payment (at least $115 million) to make to the bank that would be connected to the RVG. Based on actual market data, that the resale value of used Tesla’s has been declining rapidly. This being the case, Tesla has a large make-whole payment to make to the bank who represents at least 10% of the receivable. Tesla will then look to unload these used Teslas and recoup as much as possible, though it will be substantially less than the guaranteed make-whole made by Tesla.

This analysis would explain why Tesla’s payables and receivables were unusually high at the end of Q3. If this transaction had been processed before the end of Q3, Tesla’s accounts receivable would have been lower by the value of the cars being returned to Tesla under the RVG. The accounts payable would have lower by the amount Tesla owes to the bank. Tesla’s cash balance would have been lower by the amount that Tesla paid to the bank under RVG.

Recall that the Tesla spokesman said that this specific A/R was “cleared” in the first few days of Q4. Holding off on processing this transaction until after the quarter ended enabled Tesla to show a higher cash balance than it would have otherwise. It also kept the used Teslas out of Tesla’s inventory, which further enabled Tesla to manipulate the inventory write-down by taking a much lower write-down than historical write-downs. This is because the market value of the used  Teslas received is lower than the amount Tesla paid under the RVG. This would have required Tesla to write-down the value of the used Teslas, thereby increasing the inventory write-down charge, increasing cost of goods sold, lowering the gross margin and lowering the amount GAAP “net income” reported.

This also explains why Tesla moved $73 million worth of cars out of finished inventory and into the PP&E account on the balance sheet. Tesla accounts for vehicles used as service loaners as part of PP&E. I don’t have a problem with that. But moving $73 million of these vehicles allowed Tesla to avoid including those vehicles as part of its inventory write-down expense. It also allowed Tesla to move the cars taken back under the RVG transaction described above without causing an unusual change in inventory that required explanation. In other words, it’s entirely possible, if not probable, that Tesla wanted to “make room” for the used Teslas.

The bottom line – Tesla pulled out every accounting manipulation available to it in order to produce the promised positive GAAP net income, positive cash flow, extraordinarily high gross profit margins and a higher quarter-end cash balance. It was accounting deception, and in some areas probable fraud, at its finest. The Wall Street ass-kissing analysts did nothing other than cheer the results and lob easy questions at management on the conference call. Many of them are likely clueless about the degree to which Tesla manipulated reality.

It will be very interesting to see how Q4 turns out for Tesla. Based on reports from China and Europe, car sales have fallen off a cliff in October. Norway reported the first week of EV sales, which showed that Jaguar i-Pace deliveries, new to the market, were 44 vehicles vs. just 11 for the Tesla models S&X combined (the Model 3 has not been approved for sale yet in the EU). In October the i-Pace sold 441 units vs 201 for the Tesla S&X. This gives us a valuable glimpse at the effect competition will have on Tesla’s sales. Soon the Audi e-Tron will be available. It will likely smother any demand for Teslas.

Tesla had to make a $230 million convertible bond maturity payment in a couple weeks. It then has to start figuring out how to generate enough cash to make another $930 billion convertible bond maturity payment in March. On the assumption that Tesla’s sales are highly negatively affected by competition and the economy, Tesla will have a hard time raising the money needed to refinance the March convertible bond payment. Accounts payable will also become a problem, especially if Tesla is unable to raise more cash selling ZEV and GHG credits. On top of this, the tax-credit that Tesla car buyers receive from buying a Tesla EV will soon run out. This will make buying a Tesla more expensive.

The above analysis is from my Short Seller’s Journal from November 11th.  I also provided some ideas for shorting Tesla using short term and long term puts.  You can learn more about this newsletter here:  Short Seller’s Journal information.  Note:  one of my subscribers emailed me this morning that he just took $3500 in profits on January KB Home (KBH) puts that I recommended a few months ago.

Upper Management Exodus At Tesla Continues – Why?

Phil Rothenberg, VP of Legal at Tesla, is leaving the company.  He’s been at Tesla for nearly 8 years; previously worked at the SEC.  I assume Phil has a lot of stock and a lot of stock options, having been at the Company for eight years, including a nice chunk of options he’s leaving on the table because they will never vest.  If everything at the Company was as amazing as presented by Musk and his meat-puppet CFO in the 3rd quarter earnings report, why leave now?

Apparently Phil, trained in securities law,  would have been the designee of reviewing and monitoring Musk’s Tweets and other social media venues per the terms of the SEC settlement.   Jonathan Chang, the other VP-level lawyer at TSLA, was not a trained securities lawyer.  I have to believe that the potential legal liabilities connected to being legally responsible for overseeing the manner in which Musk operates as his own PR organization weighed heavily on Phil’s decision to flee Telsa’s corporate Sodom and Gomorrah.

Although the SEC, for whatever reason, let Musk and Tesla off the hook on a slam-dunk securities fraud case with a mere wrist-slap, the provisions of the settlement will likely create a sticky legal spider web that can be utilized to snare Musk and those around him at the Company on several counts down the road.  I am certain a desire to legally disconnect from Tesla/Musk  explains the sudden exodus of high-level executives in the past 12 months.

After Tesla’s post-earnings price spike, the torrid stock market run-up that started October 30th played a major role in keeping Tesla’s stock propped up over the last two weeks. At the beginning of the week after Tesla reported (Monday, October 29th) Tesla’s stock was about to sell-off. But the major stock market indices began to shoot up, keeping Tesla’s stock supported. Today’s action in Tesla stock reinforces this theory, as TSLA plunged 5.5% while the SPX dropped just under 2%. Tesla’s stock is going lower – a lot lower.

Tesla will eventually implode – all Ponzi schemes fail. But Musk has proven to be adept at kicking the can down the road. In the analysis I did of Tesla’s Q3 10-Q that I presented to my Short Seller’s Journal on Sunday evening, I didn’t drill down into the 10Q as thoroughly as I could have because of lack of time. But I’ve never seen this degree of manipulation in the numbers from a company the size and profile of Tesla. Bernie Madoff’s company was private so there were never publicly available numbers to scrutinize. Tesla’s operations will eventually collapse under the weight of liabilities and a collapse in auto sales related to the economy and competition.