Two Tesla 10-K Topics - Part 1
When Tesla filed its 10-K, its recognition of revenue in the 4th quarter for "Full-Self-Driving" functionality and its adjustment of its deferred tax asset valuation allowance piqued my interest
There is always something going on at Tesla and I like to use “ripped-from-the-headlines” examples in my financial accounting classes at Wharton. Tesla’s interesting and always changing revenue streams and its status as a former chronic loser with, until 2021, a huge accumulated deficit and full deferred tax asset valuation allowance provide high wire examples of the concepts I teach.
The first Tesla 2022 10-K issue everyone was talking about on Twitter was the surprise recognition of some revenue related to “Full-Service-Driving” or FSD functionality. I first heard about this when short-seller Jim Chanos tweeted out some Gross Margin statistics for Tesla that mentioned FSD recognition:
Bloomberg reported that Tesla’s fourth-quarter revenue rose to $24.32 billion, but “narrowly beat” expectations. Automotive gross margins, however, dipped to 25.9%, below analysts’ average estimate of 28.4% and down from 30.6% a year earlier.”
The estimate for revenue for the 4th quarter was $24.16 billion, per Refinitiv.
So the beat on revenue for the 4th quarter was only about $160 million. Hold that thought…
Tesla’s 10-K wasn’t filed yet so I looked at the earnings press release presentation deck that was filed that day, Jan. 25. Tesla had reported a 37% YOY 4th Quarter revenue growth. The explanation for this result was:
The mention of the FSD revenue recognition was, curiously, provided in the profitability section, not the revenue section, and was footnoted:
Yeah, that footnote is kind of faint in the report, too. It says, “(2) This pertains to wide release of FSD Beta in the US and Canada during the period. Additionally we expect to recognize nearly $1 billion of deferred revenue that remains for such customers over time as software updates are delivered.”
What does this all mean in terms of customer access to this functionality?
Tesla tells us that, over the years, approximately 400,000 customers bought and paid for FSD and are now just getting access to “FSD Beta”. Going forward every customer that purchases this “subscription” will get access immediately to “AI-powered autonomy”. Tesla has not yet recognized all of the revenue for funds collected from customers over the years for this functionality, nearly $1 billion more, just a portion since the status of the software is still “FSD Beta”. This revenue is expected to be recognized over time, “as software updates are delivered”.
I went back in time to confirm that this was the first time any revenue was recognized for all these FSD nuts that are squirreled away. How long has this been going on?
In its 2018 10-K, Tesla provided a nice description of its existing “advanced driver assist system” called Autopilot and the functionality it is driving towards: “full self-driving” or FSD (although the acronym is not yet used).
Self-Driving Development
We have expertise in developing self-driving systems, and currently offer in our vehicles an advanced driver assist system that we refer to as Autopilot, including auto-steering, traffic aware cruise control, automated lane changing, automated parking, Summon and driver warning systems.
In October 2016, we began equipping all Tesla vehicles with hardware needed for full self-driving capability, including cameras that provide 360 degree visibility, updated ultrasonic sensors for object detection, a forward-facing radar with enhanced processing, and a powerful new onboard computer. Our Autopilot systems relieve our drivers of the most tedious and potentially dangerous aspects of road travel. Although, at present, the driver is ultimately responsible for controlling the vehicle, our system provides safety and convenience functionality that allows our customers to rely on it much like the system that airplane pilots use when conditions permit. This hardware suite, along with over-the-air firmware updates and field data feedback loops from the onboard camera, radar, ultrasonics, and GPS, enables the system to continually learn and improve its performance.
Additionally, we continue to make significant advancements in the development of fully self-driving technologies.
When the 2022 10-K was filed with the SEC on Jan. 31, I was able to review Tesla’s revenue recognition policies, in general, and its policy with regard to FSD and other non-auto revenue streams in light of the decision to start recognizing FSD revenue in the 4th quarter of 2022, in particular. (I have bolded and italicized some key phrases.)
Automotive Sales
Automotive sales revenue includes revenues related to cash and financing deliveries of new vehicles, and specific other features and services that meet the definition of a performance obligation under Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”), including access to our FSD features, internet connectivity, Supercharger network and over-the-air software updates.
We recognize revenue on automotive sales upon delivery to the customer, which is when the control of a vehicle transfers. Payments are typically received at the point control transfers or in accordance with payment terms customary to the business, except sales we finance for which payments are collected over the contractual loan term. We also recognize a sales return reserve based on historical experience plus consideration for expected future market values, when we offer resale value guarantees or similar buyback terms.
Other features and services such as access to our internet connectivity, legacy programs offering unlimited free Supercharging and over-the-air software updates are provisioned upon control transfer of a vehicle and recognized over time on a straight-line basis as we have a stand-ready obligation to deliver such services to the customer. Other limited free Supercharging incentives are recognized based on actual usage or expiration, whichever is earlier. We recognize revenue related to these other features and services over the performance period, which is generally the expected ownership life of the vehicle.
Revenue related to FSD is recognized when functionality is delivered to the customer and the portion related to software updates is recognized over time. For our obligations related to automotive sales, we estimate standalone selling price by considering costs used to develop and deliver the service, third-party pricing of similar options and other information that may be available.
When I teach revenue recognition, in particular Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”) which was effective for annual reporting periods beginning after December 15, 2017, I use this slide to explain the high-level thought process that goes into determining if revenue can be recognized under Generally Accepted Accounting Principles, or GAAP:
Deferred revenue, or unearned revenue, is not revenue yet but instead a liability on the balance sheet:
Tesla’s deferred revenue account is divided between an amount allocated to the current liabilities section of the balance sheet and the portion that is not current, “Deferred revenue, net of current portion” that represents an amount that will not be recognized in the next twelve months or business cycle.
Tesla’s overall deferred revenue balance has grown substantially over the years since it first started producing cars, tracking the phenomenal growth of its production and deliveries. That’s because Tesla has a nice little business model where people pay in advance for their cars, sometimes well, well in advance of delivery.
Recall that in the Earnings Press Release powerpoint presentation, Tesla said that “over the years approximately 400,000 customers bought and paid for FSD” and are just now getting access to FSD Beta in the US and Canada. Tesla has not yet recognized all of the revenue for funds collected from these customers over the years for this functionality, or it says nearly $1 billion more. This revenue is expected to be recognized over time, “as software updates are delivered”.
The Tesla 10-K was filed on Jan. 31 and had more specific information about the FSD revenue recognition.
Deferred revenue related to the access to our FSD features, internet connectivity, free Supercharging programs and over-the-air software updates primarily on automotive sales consisted of the following (in millions):
Deferred revenue is equivalent to the total transaction price allocated to the performance obligations that are unsatisfied, or partially unsatisfied, as of the balance sheet date.
Revenue recognized from the deferred revenue balance as of December 31, 2021 was $472 million as of December 31, 2022, primarily related to the general FSD feature release in North America in the fourth quarter of 2022. We had recognized revenue of $312 million from the deferred revenue balance as of December 31, 2020, for the year ended December 31, 2021. Of the total deferred revenue balance as of December 31, 2022, we expect to recognize $639 million of revenue in the next 12 months. The remaining balance will be recognized at the time of transfer of control of the product or over the performance period as discussed above in Automotive Sales.
So, without this $472 million of FSD revenue recognized for 4th quarter, Tesla would not have beat the Refinitiv estimate. I suspect that the FSD revenue is booked at nearly 100% gross margin so, even with this boost, gross margins are still lagging. Who knows what the impact on GAAP EPS would have been without it?
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