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’s quarterly and annual filings, Tesla’s 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.
Tesla’s Operating Expenses (Quarterly)
The graph above shows Tesla’s quarterly operating expenses for the past 5 years from 2015 to 2020.
According to the chart, Tesla’s operating expenses increased significantly from 2015 to 2017, roughly a 3X increment in the same period. The figure reached a record high at more than $1.2 billion in 2Q 2018 before slowing down in 2019 and onward. Since 2018, Tesla operating expenses have stayed at roughly $1 billion per quarter.
In 2Q 2020, Tesla’s operating expenses were down slightly to $940 million, representing a year over year decline of 13%.
The significant increase in operating costs in the early years shows that Tesla went through a major expansion that required significant working capital during those years.
At over $1 billion per quarter or $4 billion per annum, Tesla incurred an operating cost that equals to 50% of its current assets in 2018 which at that time was valued at about $8 billion.
At this rate, Tesla would use up its capital reserve in no time. To make matter worse, the company did not make any profits. 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 the leveling or even declining operating expense since 2019.
Breakdown of Tesla’s Operating Expenses
The plot above shows the breakdown of quarterly operating expenses into components from 2015 to 2020. These components have been briefly mentioned at the start of this article.
As seen from the chart, Selling, General and Administrative or SGA expense made up the biggest part of Tesla’s operating cost in most quarters, accounting for over 2/3 of total operating expense. Research and development or R&D expense ranks 2nd and accounted for about 1/3 of total operating cost.
Restructuring and Other expenses existed in only a few quarters in 2018 and 2019 and have 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 last 5 years, SGA expense grew the fastest compared to other operating expenses.
Between 2015 and 2019, Tesla’s SGA expense grew more than 3X from $200 million to a little over $700 million per quarter. During the same period, Tesla’s R&D expense increased only 2X from about $180 million to $390 million.
In 2Q 2020, Tesla incurred an SGA expense of $660 million compared to R&D expense of only $279 million in the same quarter.
Both SGA and R&D expenses are fixed costs that Tesla will incur no matter how many cars the company delivers or how many batteries the company installs. These costs are relatively difficult to get rid of since they are related to engineering personnel and buildings as well as equipment maintenance.
These are important assets to the company which need to be maintained from time to time. The restructuring plan that the company has carried out was meant to reduce some of these costs.
In terms of R&D, Tesla has been quite conservative in the expense. For instance, Tesla’s R&D costs have actually declined and dropped below the $300 million levels in 2Q20, representing a YoY decline of 14%.
While SGA expenses are a must, R&D expenses are much more important and will give Tesla the competitive advantages the company needs to win in the all-electric race.
Chart of Tesla Revenue and Operating Costs Comparison
The chart above shows the comparison between revenue and operating expense from a trailing 12-months (TTM) basis. You can see how much revenue has grown with respect to operating costs over the previous 5 years.
The chart shows that Tesla’s revenue has already surpassed $25 billion on a TTM basis as of 2Q20 while the operating cost has remained below the $5 billion levels and remained flat for the past several years, suggesting that Tesla has managed to successfully control its operating expenses.
Ratio of Tesla’s Operating Expenses to Revenue (Quarterly)
The operating expense to revenue ratio measures the changes in operating costs with respect to total revenue expressed in percentage over a period of time.
From the chart, the trend is quite clear that the ratio has declined over the last 5 years.
The quarterly ratio was 40% in 2015 but has since declined steadily and hit the lowest at only 15% in 2Q 2020.
The declining trend indicates both a leveling operating expense and a surging revenue, which bodes well for Tesla’s investors.
At only 15% revenue, Tesla’s operating expense was the lowest with respect to revenue in 2020 Q2.
Ratio of Tesla’s Operating Expenses to Revenue (TTM)
To smooth out the curve, I created the TTM (trailing 12-months) chart which is shown above.
The downtrend is even more obvious in the current chart.
On a TTM basis, the ratio of Tesla’s operating cost to sales was at the lowest at 15% in 2Q20.
Ratio of Tesla’s R&D Expenses and SGA Expenses to Revenue
The current chart shows Tesla’s SGA and R&D expenses with respect to total revenue. Again, the chart is plotted on a TTM basis.
The downtrend for both expenses, R&D and SGA, is also quite clear in the current chart.
As of 2020 Q2, both ratios have declined to their lowest level at 10% and 5% for SGA and R&D costs, respectively.
Both ratios seem to be declining at about the same rate.
Nevertheless, the trend in the current chart reinforced the idea that Tesla’s revenue has outgrown operating costs by a very large milestone.
While revenue has surged past $25 billion in Q2 2020 on a TTM basis, Tesla’s operating costs have remained unchanged at $5 billion.
The gap between revenue and operating expense was at a historical high of $20 billion in 2Q20.
Tesla has successfully maintained its operating expense at slightly below $1 billion per quarter or $5 billion on TTM in the last several quarters.
At the same time, the company has successfully grown its revenue that surpassed $25 billion on a TTM basis in 2Q20.
In short, Tesla is reaping the results of the investments that were done in the past as reflected in the surging revenue but leveling operating cost.
References and Credits
1. All financial figures in the charts in this article were obtained and referenced from quarterly and annual filings available in Tesla Stock Information.
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