The operating expenses of a company relate to all the overheads such as rentals, maintenance, payroll, marketing, advertising and all sorts of other costs that the company incurs in order to run its business. No matter what, some of the operating expenses are necessary and unavoidable even if the company does not have any sales or revenue.
As a result, the operating expenses are worth examining especially for a company like Tesla (NASDQG:TSLA) where its operating costs not only take up a large portion of its revenue but also has increased significantly over the last few years (shown in a chart below).
From the company quarterly and annual filings, Tesla total operating expenses are made up of the following 3 major components:
1. Research and development expenses
2. Selling, general and administrative expenses
3. Restructuring and others
In this article, we will look at Tesla’s cost of doing business and where the company spends its money. Besides, it’s important to analyze these costs over a period of time, preferably for a few years, to find out the respective trend and how that trend relates to revenue.
(Note: operating expenses and operating costs refer to the same thing in this article and are used interchangeably.)
Research and Development Expenses (R&D)
Based on the company 4Q19 annual statement, research and development expenses consist primarily of personnel costs for teams in engineering and research, manufacturing engineering and manufacturing test organizations, prototyping expenses, contract and professional services and amortized equipment expenses.
Selling, General and Administrative Expenses (SGA)
Based on the company 4Q19 annual statement, selling, general and administrative expenses primarily consist of personnel and facilities costs related to stores, marketing, sales, executive, finances, human resources, information technology and legal organizations as well as fees for professional and contract services and litigation settlements.
Restructuring and Others
Restructuring and other expenses are related to the following items:
1. Employee termination expenses
2. Losses from sub-leasing a facility
3. Disposal of tangible assets
4. Shortening of the useful life of a trade name intangible asset
5. Impairment losses
6. Court settlement fees
Restructuring costs have only appeared in recent quarters in 2018 and 2019 when Tesla carried out certain restructuring actions such as closing certain stores to reduce cost and improve efficiency.
Chart of Tesla Total Operating Expenses
The graph above shows Tesla quarterly operating expenses for the past 5 years from 2015 to 2019.
According to the chart, we can see that major increases of Tesla total operating expenses, roughly 3X increment, occurred in the early years of 2015, 2016 and 2017. The figure reached record high at more than $1.2 billion in 2Q 2018 before slowing down in 2019 and onward. Since 2018, Tesla operating expenses have fluctuated at the $1 billion per quarter level.
As of 4Q 2019, Tesla operating expenses was slightly over $1 billion, representing a year over year growth rate of only 1% compared to the same quarter a year ago.
The significant increase of operating costs in the early years show that Tesla was going through a major expansion which required significant working capital during those periods. Before long, the company realized that it was burning roughly $1 billion per quarter during 2018.
At a burn rate of over $1 billion per quarter in operating costs, Tesla was basically consuming as much as 50% or more of its current assets in the entire year of 2018 which at that time was valued at only $6 and $8 billion.
At this rate, Tesla would use up its capital reserve in no time. To make matter worse, the company has not made any profit all the while. As a result, Tesla has decided to embark on a cost saving initiative which mainly focused on automation and stores closure to cut cost and improved efficiency. The approach was effective as seen from its stagnating or even declining operating expenses in 2019.
While there is a lot of information which we can uncover by just looking at the operating expenses chart above, it’s still far from over. As such, we will subsequently look at more charts below to dig into detail of the company operating expenses and its relationship with respect to revenue.
Chart of Tesla Operating Expenses Components
The plot above shows the breakdown of quarterly operating expenses into components from 2015 to 2019. These components have been briefly mentioned at the start of this article.
As seen from the chart, Selling, General and Administrative (SGA) expenses make up the biggest part of operating cost in most quarters, accounting for over two third of total operating expenses. This is followed by research and development (R&D) expenses which roughly accounted for the remaining one third of total operating cost.
Restructuring and Other expenses existed in only a few quarters in 2018 and 2019 which has been insignificant. According to Tesla’s financials, restructuring and other expenses were primarily due to one-time employee termination fees, losses from sub-leasing facility, disposal of certain tangible assets and contract termination carried out to reduce costs and improve efficiency.
Over the 5-year period, SGA expenses grew the fastest compared to other operating expenses. From 1Q15 to 2Q18, the respective SGA expenses has grown more than 3X from $200 million to a little over $700 million whereas during the same period, R&D expenses has only increased slightly over 2X from about $180 million to $390 million.
As of 4Q 2019, SGA expenses has grown 5% year over year to $700 million while R&D expenses has actually declined by -3% to $356 million from a year ago.
Both SGA and R&D expenses are pretty much fixed costs that Tesla will incur no matter how many cars the company delivers or how much storage the company installs. These costs are relatively difficult to get rid of since they are related to engineering personnel and buildings. The reason is that these are important assets to the company which need to be continuously maintained. The restructuring plan that the company has carried out was meant to reduce some of these costs.
In addition, the analysis of the chart shows that Tesla has been quite conservative in research and development spending. For instance, Tesla has spent twice as much SGA expenses as R&D expenses since 2017. Back in 2015, both expenses were roughly on the same level but SGA expenses have outgrown R&D expenses starting 2016.
As of 4Q 2019, SGA expenses was $700 million whereas R&D expenses was only $345 million. This shows that Tesla has been careful in R&D spending but not in SGA spending. This scenario was reflected in the latest quarter of 4Q 2019 when SGA expenses shot up significantly to $700 million from $600 million in the prior quarter which represents a quarterly growth rate of as much as 17%!
While SGA expenses are a must, R&D expenses are much more important and will give Tesla the competitive advantages the company needs in order to win the all-electric race.
Ratio of Tesla Operating Expenses to Revenue
The plot above shows the ratio of Tesla operating expenses with respect to total revenue from 2015 to 2019.
The ratio measures the amount of operating costs expressed in percentage with respect to total revenue. For example, a ratio of 40% means that operating costs has consumed 40% of total revenue.
From the chart, it is quite obvious that the percentage of operating costs with respect to total revenue has declined over the 5-year period. The quarterly ratio was in the range of 40% back in 2015 but has since declined steadily and hit the lowest at roughly 15% in both 3Q and 4Q 2018. The ratio surged to 25% when revenue declined in 1Q 2019 but came back down to the 15% range in 4Q 2019.
The declining trend can be interpreted as a good development for the company. First, it means that Tesla has successfully controlled its expenses especially from 2018 to 2019 when the plot declined the most. Secondly, the declining trend also means that revenue has gone up significantly with respect to costs and this has caused the ratio to decline even further.
Subsequently, the combination of costs controlled and revenue growth has made the ratio to plunge to its lowest figure of 15% in 4Q 2019.
At only 15% of revenue, Tesla operating expenses are considerably low. However, the ratio needs to be compared with the industry standard to arrive at a more conclusive result.
In short, a declining expense coupled with a growing revenue is basically what most investors want to see. Effectively, Tesla has managed to fix its operating cost and at the same time grow its revenue.
Chart of Tesla Revenue and Operating Costs Comparison
The chart above shows the comparison between revenue and operating costs on a dollar to dollar basis. You can see how much revenue has grown with respect to operating costs over the previous 5 years.
The plot of revenue has grown exponentially since 2018 when Model 3 delivery was at full ramp. During the same period, Tesla operating expenses has remained fixed at the $1 billion range while quarterly revenue has surged past the $7 billion mark in 4Q 2019, resulting in a huge gap between operating expenses and total revenue.
Ratio of Tesla R&D Expenses and SGA Expenses to Revenue
The graph above is similar to the previous one which shows the operating expenses to total revenue ratio in percentage. In the current chart, I have broken down total expenses into SGA and R&D respectively and measure their respective ratio with respect to total revenue.
The chart above shows that both expenses as a percentage of revenue have trended down over the 5-year period which is similar to the one we saw previously. The trend is actually in line with the total expenses to revenue ratio which has trended down as well.
As of Q4 2019, both ratios have declined to their lowest level at 10% and 5% for SGA and R&D respectively.
Again, research and development costs declined the fastest over the 5-year period, plunging more than 300% from 18% in 1Q 2015 to its lowest level in 4Q 2019 at only 5% of revenue. During the same period, SGA costs declined roughly 210% from 21% of revenue to only 10% of revenue in the latest quarter of 4Q 2019.
From this analysis, it looks like Tesla has reduced R&D expenses faster than SGA expenses which I think should have been the other way around since R&D produces intellectual property such as patents that give competitive advantage to the company.
Moreover, it doesn’t make sense when R&D expenses with respect to revenue have to go down together with SGA expenses since both are separate expenses and not related to each other. My opinion is that Tesla needs to maintain the R&D ratio at 10% of revenue instead of letting it to slide even further to only 5% of revenue.
Nevertheless, the trend in the current chart reinforced the idea that Tesla’s revenue has outgrown operating costs by a very large milestones. While revenue has surged past $7 billion in 4Q 2019, Tesla has managed to maintain its operating costs and achieved a cost to revenue ratio that was well below its historical values.
Tesla operating expenses are divided into two major components: (a) SGA expenses and (b) R&D costs.
Total operating expenses have surged significantly over the past 5 years, with most of the growth occurring from 2015 to 2017 before gradually narrowing to $1 billion per quarter in subsequent years. As of Q4 2019, comparable operating expenses rose slightly higher to $1 billion, representing a year on year growth rate of only 1%.
Tesla has tried to maintain its operating costs at roughly $1 billion per quarter by implementing automation and stores closure which was part of its restructuring plan.
SGA expenses made up the largest part of the company’s total costs and this was followed by R&D expenses at roughly 30% of total costs. As of Q4 2019, SGA expenses was $700 million which was twice as much as that of R&D expenses.
In addition, over the 5-year period from 2015 to 2019, SGA expenses grew the fastest at slightly more than 300% whereas R&D expenses grew only 200% during the same period.
In terms of operating expenses to revenue ratio, the plot shows that the long-term trend has been declining over the 5-year period and reached only 15% of revenue in 4Q 2019. The declining trend represents a surging revenue and a flattening operating cost which should be viewed as a positive development for Tesla.
When we further broke down the total operating costs into individual components, we saw that Tesla SGA expenses was only 10% of revenue in 4Q 2019 which was the lowest compared to historical figures. Similarly, R&D expenses relative to revenue was only 5% in 4Q 2019, also the lowest compared to historical figures.
References and Credits
1. All financial figures were obtained from Tesla Stock Information.
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