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Tesla (NASDAQ:TSLA)
Q4 2018 Earnings Conference Call
Jan. 30, 2019 5:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen. And welcome to the Tesla, Inc. Q4 2018 financial results and Q&A webcast. [Operator instructions] As a reminder, this conference is being recorded.

I would like to introduce your host for today's call, Mr. Martin Viecha, senior director of investor relations. Mr. Viecha, you may begin.

Martin Viecha -- Senior Director of Investor Relations

Thank you, Sheri, and good afternoon, everyone. Welcome to Tesla's fourth-quarter 2018 Q&A webcast. I'm joined today by Elon Musk, JB Straubel, Deepak Ahuja, and a number of other executives. Our Q4 results were announced at about 1 p.m.

Pacific Time in the update letter we published at the same link as this webcast. During this call, we will discuss our business outlook and make forward-looking statements. These comments are based on our predictions and expectations as of today. Actual events or results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent filings with the SEC.

[Operator instructions]But before we jump into Q&A, Elon has some opening remarks. Elon?

Elon Musk -- Co-Founder and Chief Executive Officer

Thanks, Martin. Last year was definitely the most challenging year in Tesla history, but also the most successful. Thanks to the incredible work of the Tesla team, Model 3 became the best-selling premium vehicle in the U.S. for 2018.

And in fact, when considering battery electric vehicles, we -- Tesla achieved an 80% market share of U.S. sales in the last year. I think this point is perhaps not well appreciated. All other electric vehicles combined were 20% of sales in the U.S.

in the last year. So I think that's not so bad. We also delivered -- also made vehicles last year as we did in all prior years combined, which is a tremendous achievement by the Tesla team. The -- if you track Tesla vehicle production year over year, cumulative sales deliveries year over year, it is about the cleanest exponential I've ever seen.

We've basically almost doubled our fleet in every year. Every year, we make as many cars as we did in all prior years. So, this is a very unusual thing to see for -- especially for a large complex manufactured object. I think maybe the fastest that a complex manufactured object is -- like a car has grown in history or at least I'm not aware of anything that is faster.

Martin, are you?

Martin Viecha -- Senior Director of Investor Relations

I'm not sure. I think Model T was a little bit slower, but I'm not 100% sure.

Elon Musk -- Co-Founder and Chief Executive Officer

OK. And we expect that exponential to continue. So, with the deliveries this year being -- even in the face of -- if there's a global recession -- even if there's a global recession, we're expecting deliveries this year to be about 50% higher than last year. And this -- it could be a lot more than that.

But even with tough economic times, to receive 50% growth is pretty nutty. For Q4, we achieved GAAP profitability, for the second quarter for the first time in the company history, and we increased our cash on hand by more than $700 million, even after paying debt in EMEA with a total of $3.7 billion of cash. This means we have enough cash to settle our convertible bond that will mature in March. In addition, our operating margin remains strong at 5.7%.

Operating margins in the fourth quarter are usually lower in the automotive history, but this was not the case for Tesla. 2019 is going to be an amazing year for Tesla. As I mentioned, we're expecting to increase sales by 50%. And perhaps could be a lot more than 50%, but I think 50% is a very reasonable number.

But that's crazy growth for the automotive industry. I want to note that one of our major priorities this quarter is improving service operations. So really, from my standpoint, when I think about what my priorities are this quarter, it's improving service in North America. That's No.

1. And I think [Inaudible] very exciting [Inaudible] have been -- to roll out with the Tesla App. We're going to get cars to China and Europe and make sure that we have good logistics for the whole delivery process, from factory gate to the customer. That's obviously pretty far from California to get to Europe and China and make it to, again, our two customers.

So, we're working every aspect of that logistics chain. And I think we've -- I think it's going to be good. I would say at this point, I'm optimistic about being profitable in Q1. Not by a lot, but I'm optimistic about being profitable in Q1 and for all quarters going forward.

So let's see, we've opened 27 new store and service locations, bringing out our total locations worldwide to 378. And we increased our Mobile Service fleet to 411 vehicles. Mobile Service fleet is something we can scale up very rapidly because we don't need bricks and mortar. We can get more vehicles, hire people, and deploy rapidly.

It also actually results from higher customer satisfaction because we can actually send one of our service vans to your work or home and fix the car without you having to bring it into the service center or do any paperwork or anything like that. It's really seamless and visible. The customers love it. And we're also increasing the functionality of the Tesla App for service, so that instead of having to make an appointment -- to call and make an appointment, you can just open your Tesla App, say you want to make a service appointment, and it was the top 10 most frequently requested service item.

And you can -- with a couple of taps, you've made yourself an appointment. And we're going to make it easier for the car to be picked up and dropped off as well. So if you want -- if you prefer not coming to the service center at all, you can just request that the car be picked up and delivered. That's something that we'll be -- so that's already -- we're going to roll that out and have a big improvement to customer satisfaction.

It rolled out two or three weeks ago. But the next thing we're going to add is, if a car detects something wrong, like a flat tire or a drive unit failure, that before the car has even come to a halt, there is a tow truck and a service loader on the way. The car has already notified Tesla emergency services, and a service loader, a tow truck, are on their way before your car has even come to a stop. Now this will be immense in improving customer happiness.

Virtually, you just call it and you have to tap the service ring to cancel it. So, you can cancel it if you want. You just have to -- it's not automatically going to happen. You just press cancel.

We're also improving product distribution. So, I think we made a strategic error in the past about not having service parts located at our service centers. We had them in product distribution warehouses, which basically meant it was impossible to have a fast turnaround on servicing a car because the car would come in, then the parts will be requested. They come to the service center, this would basically -- even if they're very simple, repair could take days.

So we're not -- we're going to be able to stock in all common parts at the service centers, so that it's possible to -- and first, we'll have -- get your car serviced in 20 minutes or 15 minutes, even if it's a simple matter. I mean, it should be like Jiffy Lube, like eight minutes or whatever, 8.5. It should be like lightning fast. But in order to -- that we have to have the parts located at our service centers.

Also, it's going to make sense for our service centers to do basic body work or essentially if [Inaudible] replaced a front or rear [Inaudible], it makes sense to just prestock the front and rear [Inaudible] in the common colors. So, unless you have an unusual color, we can literally replace your [Inaudible] in 15, 20 minutes. And it's not like a suite body shop stuff. Let's see, in terms of the new products, with Model Y, we've completed ensuring of ensign of Model Y, and the parts are [Inaudible] going up for production Model Y.

Three quarters of the Model Y is common with the Model 3, so it's a much lower CAPEX per vehicle than Model 3, and the rest is also quite low. This is in contrast to Model S versus Model X, where the theory was -- in Model X, we just -- it's like -- it's sort of Model X to be like the sort of the Fabergé egg of cars. It's a fast -- it's an incredible vehicle and probably one -- probably nothing like it will ever be made again, and maybe it shouldn't but it is a work of art. It's a special work of art.

But the commonality with the Model S is limited. It was only about maybe 30% in common with the Model S, whereas Model Y is, I think, 76% was when it got in common with the Model 3. And we're most likely going to put Model Y production right next to -- in fact, it's part of our main Gigafactory in Nevada. So, it will just be right there.

Batteries and powertrains will come out and go straight into the vehicle. So that also reduces our risk of execution and reduces the cost of having to transfer parts from California to Nevada. It's not a for sure thing, but it's quite likely, and it's our default plan. I would expect Model Y will probably be -- the thematic Model Y will be maybe 50% higher than Model 3, could be even double.

The -- as I understand it, the midsized SUV segment is the -- worldwide is the most popular type of vehicle. So we'll probably see a higher volume of Y than 3. And earlier this month, we saw the construction of Gigafactory in Shanghai, and by the end of this year, we expect to be producing Model 3s using a complete vehicle production line. That's body paint, final assembly, general assembly and module production.

So it basically would be -- this will be extremely fast. I get like daily updates of progress of the Shanghai Gigafactory, and those factories are going to go up like lightning. So, we do feel quite confident at this point, at least for the factories that are in our control, that we can achieve volume production in Shanghai by the end of the year. And that should allow us to get to the 10,000 vehicles a week rate or very close to it by the end of the year.

And yes, I think that's it.

Martin Viecha -- Senior Director of Investor Relations

OK. Great. So, we're going to take the first questions from our retail investors who have been submitting their questions on say.com. So, the question that has been submitted has been about service, which I think you already spoke at length about.

So let's go to the second question. The second question would be: how are you feeling about demand right now across the product line? Is 500 to 700 units -- 500,000 to 700,000 units at 42,000 ASP still a realistic annual target for Model 3, even considering Model Y and its impact on demand? And do you continue to see S and X demand of 100,000 annually?

Elon Musk -- Co-Founder and Chief Executive Officer

I mean, my best guess, this is just a guess, my best guess for demand of Model 3 worldwide is something -- in a strong economy, it's something on the order of 700,000 or 800,000 units a year. That's my best guess for demand of Model 3 in a strong economy. If the economy goes into a recession, then I think that could be something under 40% less. But I think even in a recession, worldwide demand is still something in the order of 500,000 for Model 3.

For S and X, we did eliminate the 75 [Indiscernible] version of S and X and it provided more differentiation relative to 3 and then Y that's coming out. I think we could see a slight decline in total vehicles, but I think the net cash flow from S and X is likely to be very similar. So probably no major change in net cash flow for S and X.

Martin Viecha -- Senior Director of Investor Relations

OK. The next question from Alex is, can you please share an update on full self-driving and Tesla network development? When will customers start to see full self-driving features? What's the best case time line for a Tesla network to go live?

Elon Musk -- Co-Founder and Chief Executive Officer

Sure. We have -- we already have full self-driving capability on highway. So from highway on ramp to highway exit, including passing cars and going from one highway interchange to another, full self-driving capability is there. In a few weeks, we'll be pushing update that will allow the option of removing stock confirmed in markets where regulators approve it, which we think that will be the case in the U.S., for example.

And over time, we think probably all regulators will approve it. But we kept talking from there just to make sure that we took care of like -- of any strange corner cases. And it's really quite sublime if you have stock confirm of and like the car goes from highway on ramp, passes slower cars, change -- takes an interchange and then takes the exit and then comes to a stop after the exit. So that it's really quite profound to have that experience.

And the next part of full self-driving will really be to -- is traffic lights. It's hard. So stop streets are pretty easy because you can essentially geocode those and is recognized at all times. Traffic lights and intersections will be the next really tricky one, and then navigating complex parking lots and like -- so like if you're underground in a mall parking lot with a lot of traffic and pedestrians and it's on multiple levels, that kind of thing is when things get tricky.

With the release of enhanced or advanced Summon, you'll see the first indications of the car being able to navigate complex parking lots. And that's also coming up fairly soon, probably next month. And in development mode, the car does all of the things that I just mentioned in development mode. It recognizes traffic lights and stop signs and you can -- basically has all the functionality in development mode.

It's really just a question of getting the reliability of recognizing traffic lights to several names. So it's maybe like, I don't know, 98% good right now, but we need it to be like 99.999%, really extremely reliable. So I mean [Inaudible] I think the capability will be there for -- when will we think it's safe for full self-driving? It's probably toward the end of this year, and then it's up to regulators to decide when they want to approve that.

Martin Viecha -- Senior Director of Investor Relations

OK. Now let's go to the next question, which is, if and when will Tesla switch Model S and X to 2170 battery cells, what percent range improvement do you expect?

Elon Musk -- Co-Founder and Chief Executive Officer

We have no plans to switch S and X to 2170, and can't comment on huge product developments.

Martin Viecha -- Senior Director of Investor Relations

OK . So maybe we'll take the last question from retail investors, which was, where will Tesla Semi and Model Y be produced? Can you share a time line on expected production ramp of these products?

Elon Musk -- Co-Founder and Chief Executive Officer

As I mentioned earlier, the Model Y, we think, most likely will be produced at Gigafactory, but that's -- unless we encounter some obstacle -- that's the default plan that we're proceeding toward. And it's fast, low risk, and relatively low CAPEX. In terms of the -- I mean, probably there's like initial production of Model Y and probably low volume, probably next year. But then it always takes time to ramp up any production system, and that's difficult to predict, the shape of that S-curve.

So we feel confident in saying there will be production volume of Model Y by the end of next year, but in between beginning of next year with low volume, it always starts with very low and then it grows exponentially -- from beginning of last year to end of next year, it's difficult to break that ramp. So that's our expectation for Y. For Semi, we're -- I don't know if you want to comment on that, Jerome.

Jerome Guillen -- President

I want to start next year as well.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes.

Jerome Guillen -- President

But the first units will be -- this is Jerome. Well, first units will be for our own usage. So depends how many trucks we'll use for our own usage to move the parts and the vehicle in different location, and then we'll start delivering to outside customers.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, that's good. And then the Tesla pickup truck, we might be ready to unveil that this summer. It will be something quite unique, unlike anything else.

Martin Viecha -- Senior Director of Investor Relations

OK. Fantastic. So, operator, we can start taking questions from participants on the call. 

Questions and Answers:

Operator

Thank you. Our first question comes from Ryan Brinkman with J.P. Morgan.

Ryan Brinkman -- J.P. Morgan -- Analyst

Great. Thanks for taking my question. I think -- the amount that you've spent on lands for Gigafactory Shanghai in the classification operating cash flows, is there any guidance you can provide us in terms of how to think about CAPEX for this facility going forward? And can you discuss the source of funds for the project? I think you've spoken in the past about the potential to raise that locally in China. Is that still your thinking? And in what kind of terms might you be able to raise that capital? Thanks.

Deepak Ahuja -- Chief Financial Officer

Yes, Deepak here. You're right. The purchase of the land is a 50-year lease with the government of China. So it's not CAPEX , but it's operating lease.

That shows up as cash flow from operations. However, the CAPEX that we will invest is our equipment, and we fully own it. So that will show up as capital expenditures. The plan, as we have indicated in the letter, is still to get funding for majority of that capital spending from local China banks.

And we expect very attractive rates based on the dialogue we've had, and there's a lot of interest. And we hope to finalize that and then share the details at that point.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes. I mean, as a ballpark figure, probably it's something about -- something in the order of $0.5 billion in CAPEX to get to the 3,000 vehicle rates in Shanghai, ballpark figure. And as Deepak was saying, [Inaudible] very competitive debt financing in China, really extremely compelling interest rates, and we do not expect that to be a capital drain on the company.

Deepak Ahuja -- Chief Financial Officer

Yes. These are the biggest banks in the world. And for them, $500 million is not a large amount of money on the scheme of things.

Operator

Thank you. Our next question comes from Gene Munster with Loup Ventures.

Elon Musk -- Co-Founder and Chief Executive Officer

Sorry perhaps -- if you're in the automotive industry you'll understand how significant this is but maybe it's not as obvious to everyone is Tesla has the first wholly owned manufacturing facility in China for any -- of any automotive company. So this is profound, and we're very appreciative of the Chinese government allowing us to do this. I think it is symbolic of they wanting to open the market. And if I -- and [Inaudible] to everyone, I would just like say a note of appreciation for the Chinese government in allowing us to do that.

It's a very significant thing.

Gene Munster -- Loup Ventures -- Analyst

Good afternoon. The question I have is related to Waymo and the autonomous driving opportunity. Morgan Stanley recently valued Waymo at $175 billion. And my question is, what do they have that you don't have? And separately -- so what do they have that you don't have? And then separately, how important is the timing in the Tesla story longer term? Is this nice to have? Is it really about EVs and renewable energy? Or is the autonomy kind of one of the foundational parts of the story longer term?

Elon Musk -- Co-Founder and Chief Executive Officer

I think the [Inaudible] goodness of Tesla, yes, so like the why of Tesla, the relevance, what's the point of Tesla, comes down to two things: acceleration of sustainable energy and autonomy. The acceleration of sustainable energy is absolutely fundamental because this is the next potential risk for humanity. So obviously that is, by far and away, the most important thing. But also, very important is autonomy.

This has the potential to save millions of lives, tens of millions of serious public injuries and give people their time back, so that they don't have to drive, they can -- if you're on the road, you can spend time doing things that you enjoy instead of being in terrible traffic. So it's extremely important. We feel confident about our technical strategy, and I think we have an advantage that no one else has, which is, that we have, at this point, somewhere in the order of 300,000 vehicles on the road, with a 360-degree camera sensor suite, radar, ultrasonics, always connected uploads, especially video clips with the customer submission when there is intervention. So effectively, we have a massive, massive training fleet.

Our -- the amount of training that we have -- if you add everyone else up combined, they're probably 5%, I'm being generous, of the miles that Tesla has. And this difference is increasing. A year from now, we'll probably go -- certainly from 18 months from now, we'll probably have 1 million vehicles on the road with -- that are -- and every time the customers drive the car, they're training the systems to be better. I'm just not sure how anyone competes with that.

Operator

Thank you. Our next question...

Martin Viecha -- Senior Director of Investor Relations

Sorry, Gene, do you have a follow-up question? OK. No follow-up question. OK. Let's go to the next participant.

Operator

Our next question is from Colin Rusch with Oppenheimer.

Colin Rusch -- Oppenheimer & Co. Inc. -- Analyst

Thanks very much. Can you talk a little bit about the geographic dispersion for the guidance for 2019, where you're expecting the Model 3s to sell through as well as the other models?

Elon Musk -- Co-Founder and Chief Executive Officer

Well, I think we did, actually. Yes, it's clear in our letter.

Deepak Ahuja -- Chief Financial Officer

Correct. We indicated in Q1, we will start delivering Model 3s in Europe and China. And we also shared a chart showing the potential market size for mid-sized premium sedans in North America, Europe and Asia, suggesting those markets could be even bigger. So I think that gives a good sense of where we'll be.

And we'll launch the right-hand drive version at some point to go to the other markets.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, maybe in the order of 350,000 to 500,000 Model 3s, I mean, like that this year.

Deepak Ahuja -- Chief Financial Officer

OK?

Colin Rusch -- Oppenheimer & Co. Inc. -- Analyst

OK. Thanks, guys. And then just in terms of the cost reduction road map and rework postfactory, can you talk a little bit about your expectation for reducing that in the next couple of quarters and what the order of magnitude is on that in your model internally?

Deepak Ahuja -- Chief Financial Officer

Jerome, do you want to answer that?

Jerome Guillen -- President

This is Jerome. Well, our manufacturing is improving quarter over quarter, actually, week over week. We take fewer hours, both here in Fremont or at the Gigafactory, to assemble the Model 3 and S and X as well. And then we track the quality very closely.

We review that carefully with the engineers and the supply chain and the manufacturing chains. And the quality in the field and the number of incidents is also improving week over week, every week. So there are fewer and fewer need for cars to be in service, yes. So we'll keep going.

There's no end in sight and we'll try to make sure that the car never breaks down.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, I think there's like some confusion about rectification. Like I said -- like -- for us to drive the Model 3s that come off the line, when that happens is like some slight adjustment of door gaps and panel gaps and that kind of thing. And that's all that's done. There's nothing more than that.

Martin Viecha -- Senior Director of Investor Relations

OK. Let's go to the next question please.

Operator

Thank you. Our next question comes from Colin Langan with UBS.

Colin Langan -- UBS -- Analyst

Great. Thanks for taking my question. Just a follow-up on the comments around you said about 700,000 to 800,000, you think, is the normal demand. I mean, any color on what price you're expecting that to be? Because I think there's a lot of chatter that demand is already weak in -- of the midrange, at least, already in January.

I don't know if that's true as well.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes. I mean, it's more like there are multiple factors at play here. First of all, there's a lot of seasonality to automotive purchases. First of all, do not buy a new car in the middle of a blizzard.

So January and February tends to be seasonally low and then picks up significantly around the early to mid-March time frame. In the U.S., we obviously have a pull forward of demand from the tax credit. And yes, there's -- so there's all those factors. But I feel very confident about Model 3 demand.

The customer happiness level with the car is incredible and I think probably the highest of any car in the world right now, I think. And so you can tell like, basically, nobody wants to sell a car. So --

Colin Langan -- UBS -- Analyst

But the target price point is, I think, in the past, you mentioned mid-$40,000. Is that where we're thinking? Or is that the long-term range?

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, this is really just a guess. So it's not like it's I have some huge crystal ball or something. But at volume, I would expect, this is totally a guess, I want to be clear. Probably an average of $42,000, probably at that volume level.

I'm not certain, but again -- OK.

Colin Langan -- UBS -- Analyst

And just as a follow-up. You commented that you expect China to be online by the end of the year, but there's a lot of articles that the battery supplier -- you're looking at different battery suppliers. But, I mean, do you have a battery supplier? Because it seems kind of close to when production is supposed to start.

Elon Musk -- Co-Founder and Chief Executive Officer

Well, there's really three things: the cell, the module and the pack. We will be making the module and the pack. So, it's really just a question of cell supply. And we can essentially use any high energy.

That's the 2170 chemistry. And we expect to be a combination of cells produced at our Gigafactory in Nevada and cells produced in Japan and cells produced locally in China. And we feel confident to have a sufficient supply to hit the 3,000 units suite.

Martin Viecha -- Senior Director of Investor Relations

OK. Let's go to the next question please.

Emmanuel Rosner -- Deutsche Bank -- Analyst

Hi. Good evening, everybody. First, I wanted to ask you about the short-range Model 3. What are your latest thoughts in terms of timing of introduction? I think at some point, you had in mind to do it in the -- maybe the first half of this year.

And just to clarify, when you're sort of talking about the outlook for 2019, the number of deliveries, up 50%, and then the margin target for Model 3 to get to 25%, does that assume that you're introducing a lower range -- the short-range Model 3 at some point during the year?

Elon Musk -- Co-Founder and Chief Executive Officer

Well, you could call it the standard range, but it's maybe short by Tesla's standards, but it's long range by other manufacturers' standards. So -- yes, we expect to introduce the standard range Model 3 sometime probably the middle of this year is a rough guess. And we're working hard to improve our costs of production, our overhead costs, our fixed costs, just costs in general. I think this past year, while extremely difficult, has driven us to a high level of financial discipline.

I think we're way smarter about how we spend money, and we're getting better with each passing week. We -- yes.

Emmanuel Rosner -- Deutsche Bank -- Analyst

And so to be clear, the -- you expect to reach at some point this year -- or you're targeting at some point this year 25% gross margins on Model 3, and that's despite introducing the lower-end -- or just the standard range Model 3. Is that correct?

Elon Musk -- Co-Founder and Chief Executive Officer

Yes.

Emmanuel Rosner -- Deutsche Bank -- Analyst

OK. And I guess, my follow-up would be on the demand side. So, you're talking about 50% increase this year. You said a few times that it could be higher than this.

I think you just mentioned in the previous question 350,000 to 500,000, if I understood well. So, what is sort of like what drives the cautious outlook that's in your letter? Because it feels like it's the -- it's just basically four times the fourth quarter run rate, which would imply sort of 50% for the full year but not really a lot of growth versus what you just accomplished. So, I guess, how do we think about the total demand for 2019, especially if you introduced this -- the cheaper version?

Elon Musk -- Co-Founder and Chief Executive Officer

Well, we need to bring the Shanghai factory online. I think that's the biggest driver for getting to 500K plus a year. Our car is just very expensive going into China. We've got import duties.

We've got transport costs. We've got higher-cost labor here. And we've never been eligible for any of the EV tax credits. A lot of people [Inaudible] sort of dependent on incentives.

In fact, we are [Inaudible] EVs, we have the least access to incentives. It's pretty crazy because there's so many companies that -- countries that have put price caps on the EV incentive, which differentially affects Tesla. And in China, which is the biggest market for EVs, we've never had any subsidies or tax incentives for vehicles. So it's difficult.

If [Inaudible] it is eligible for that although it sounds like that's going to be reducing in China in the coming years. But really, bottom line is, we need the Shanghai factory to achieve that 10k rate and other cars be affordable. The demand for -- it's important to appreciate that the demand for Model 3 is insanely high. The inhibitor is affordability.

It's just like people literally don't have the money to buy the car. It's got nothing to do with desire. They just don't have enough money in their bank account. If the car can be made more affordable, the demand is extraordinary.

Martin Viecha -- Senior Director of Investor Relations

OK. Thank you. Let's go to the next question please.

Operator

Our next question comes from Pierre Ferragu with New Street Research.

Pierre Ferragu -- New Street Research -- Analyst

Hey. Thank you for taking my question. So, Deepak, I was wondering, so as you get to 2019, we're all concerned about the potential recession, and I was wondering how you think about it and what you would tell us about what we should expect -- how we should expect Tesla to react to recession in 2019. How do you manage your volume ramp? How do you manage your pricing? How do you present cash? How do you manage your CAPEX if things turn south in 2019? And then I have a follow-up on gross margin for Jerome.

Deepak Ahuja -- Chief Financial Officer

Yes, it's a very broad question, which is not really just for me to answer. But I think at the highest level, the way we are trying to be prepared for any kind of contingency here is to just continue focusing on cost. And the theme of our conversations here is, how do we reduce cost all the time and how do we run our business with a very high level of financial discipline? And Elon alluded to that and so did Jerome, I think. That if we do that, we believe that even in some of the scenarios of lower volumes and pricing -- tight pricing, we do have a good chance and a good shot of being profitable and generate free cash flow.

So that's the best way to manage the business, be frugal.

Pierre Ferragu -- New Street Research -- Analyst

Yes, thanks.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, I don't want to be a broken record about this. It's costs, costs, costs, because reducing our costs. By the way, while making improvements to Model 3, I want to emphasize, the product is getting better by slight degrees despite lower costs in hundreds of small ways but you actually wouldn't notice explicitly, but that you would appreciate subconsciously. But getting those costs down, variable costs and fixed costs, is what allows us to lower the price and be financially sustainable and achieve our mission of environmental sustainability.

So we have to be absolute zealots about this. There's no question.

Deepak Ahuja -- Chief Financial Officer

The other aspect of this, Elon, which we've been doing extremely well, is capital efficiency. We have dramatically cut back on capital expense, and we are spending it in a very efficient manner. We talked about it in the letter on Model 3 and Gigafactory Shanghai. We talked about it for Model Y.

There are just so many learnings that we are incorporating, and we just want to beat what we did with Model 3 and the kind of spending we had for the returns we got.

Elon Musk -- Co-Founder and Chief Executive Officer

Absolutely. I mean, we're confident that our CAPEX per unit of production for Shanghai factory and for Model Y will be less than half of what we did for Model 3. Internally, we think it might be a quarter but that's probably too good to believe, but it's definitely less than half.

Deepak Ahuja -- Chief Financial Officer

Yes.

Martin Viecha -- Senior Director of Investor Relations

Great. Let's go to the next question please.

Pierre Ferragu -- New Street Research -- Analyst

Thanks.

Operator

Thank you. Our next question comes from David Tamberrino with Goldman Sachs.

David Tamberrino -- Goldman Sachs -- Analyst

Great. Thanks for taking the questions tonight. First thing I want to just understand is on what you're seeing from European orders and China orders so far. There are some numbers that get thrown around, but you guys are obviously taking a look at it.

How is that order profile shaping up relative to what you saw in the U.S. with the launch of the 3?

Elon Musk -- Co-Founder and Chief Executive Officer

I think it seems good. I mean, our share actually with Europe and China is, how do we get the cars made and on a boat as such that it reaches customers before end of quarter and we don't have a massive number of cars on the water. That's our biggest challenge. It's not demand.

It's how do we get the cars there fast enough.

David Tamberrino -- Goldman Sachs -- Analyst

So like orders above, I think I've seen like 20,000 order levels for Europe and single-digit thousands for China. Is it better than that, Elon?

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, absolutely.

David Tamberrino -- Goldman Sachs -- Analyst

OK.

Elon Musk -- Co-Founder and Chief Executive Officer

The -- and we're not even really trying, I should point out. I guess it's -- we -- our factory is like, right now, only making cars for China and Europe. That's all it's doing for -- with respect to Model 3. And our whole focus is, OK, how do we get those cars made, get them on a ship as fast as possible, get the ship as fast as possible to Zeebrugge in Belgium then get them over to Drammen in Norway and get those cars to customers as fast as possible.

We get them to China as fast as possible. In China, we were also -- yes, we don't what's going to happen with the trade negotiations. So that's very important to get those cars especially to China as soon as possible. We hope the trade negotiations go well, but it's not clear.

But we need to get them there while there's sort of a de facto -- sort of a truce on the tariff war. And the demand gen is really not one of the things we're thinking about.

David Tamberrino -- Goldman Sachs -- Analyst

OK. Then just lastly on this demand thread, customer deposit came in again over $100 million. Is it possible to give us an update? I know you don't think it's really a relevant number but I do want to know. Explain why on the reservation count, where you were 450,000, you started delivering -- and I ask this because I think we're just all trying to understand how much incremental demand you think there is based on what you see at that lower price point if, say, there's over half of those people that are still waiting for that 75k base model to come out.

That would be interesting, and I think that's what you're seeing but I just want to confirm that.

Elon Musk -- Co-Founder and Chief Executive Officer

So, Deepak, do you want to...

Deepak Ahuja -- Chief Financial Officer

Yes, I mean, I think reservations are not relevant for us. We are really focused on orders. Now we do have a large reservations backlog still, which tells us that a lot of customers are still waiting for those cars, but I don't think it's appropriate to share the reservations number.

Elon Musk -- Co-Founder and Chief Executive Officer

Reservations are just like preorders. It's like here -- like some video game come out and there's like a preorder number, then that's like -- stops being important once you start shipping the game or product. So yes, as I said earlier, I think -- my guess is demand is somewhere on the order -- in a strong economy is on the order of 700,000 or 800,000 units a year for Model 3 and even in a recession is probably on the order of 0.5 million.

Martin Viecha -- Senior Director of Investor Relations

OK. Let's go to the next question please.

Operator

Thank you. Our next question comes from Daniel Ives with Wedbush Securities.

Daniel Ives -- Wedbush Securities -- Analyst

Yes, thanks for taking my question. So my question is around Europe. Obviously, with deliveries coming onboard in the first quarter, maybe what surprised you in terms of -- your demand looks strong, but in terms of what you're seeing at the region, is it stronger than you expected in certain countries? What do you think is driving that? And maybe you can just talk about the opportunities and challenges in Europe especially from a delivery logistics perspective.

Elon Musk -- Co-Founder and Chief Executive Officer

Well, like I said, we're thinking about demand almost 0 right now. It's really getting the product there in time and not having a ton of cars on the water and in a quarter and then for China getting cars there before there's a potential rise in tariffs. That's really -- put really at front of mind that cost reduction and then improving service in North America, and -- yes.

Daniel Ives -- Wedbush Securities -- Analyst

And just maybe a quick follow-up on -- can you just talk about -- when we look at the Gigafactory buildout in China and obviously how important that is, can you maybe just fast forward, let's say, 18, 24 months? I mean, how do you envision that as just a competitive advantage versus maybe some other automakers that will be trying to go in your tracks? Thanks.

Elon Musk -- Co-Founder and Chief Executive Officer

I think it will be quite a significant advantage, a really good -- it's quite fundamental to the future of Tesla, and I expect to make several trips to China this year. And I'm working very closely with the team building the factory. I literally get daily updates. So, it's a super big deal and we're only just talking about Phase 1 here.

Phase 1 is about 10% of what we think the Gigafactory will ultimately be. So, it's a major, major, major deal. And we're getting a lot of support from the Shanghai government, which we're very appreciative of, and the national government.

Martin Viecha -- Senior Director of Investor Relations

OK. Let's go to the next question please.

Operator

Thank you. Our next question comes from Toni Sacconaghi with Bernstein.

Toni Sacconaghi -- Sanford C. Bernstein -- Analyst

Yes. Thank you. You've talked repeatedly about the need to drive down costs, which, in turn, drives the elasticity of demand for cars. And I'm wondering if you can talk about how much of a price differential between the $50,000 Model 3 and the $35,000 Model 3 is structural, meaning that powertrain costs for EVs are just structurally higher than they are for internal combustion engine cars and where you think that difference is today and when that is no longer a factor? So is -- or maybe said another way, is the bigger driver in getting to lower costs and lower -- and more affordability on the Model 3, is it really around the powertrain and getting that at parity? Or is it everything else about Tesla not being as efficient as other manufacturers that is causing the higher price right now? And have I follow-up, please.

Jerome Guillen -- President

It's both. It's both, the vehicle and both the powertrain. So I split my time half and half between the Gigafactory and here, and there is opportunities in both, yes.

Deepak Ahuja -- Chief Financial Officer

But I think the bigger point is that, yes, there is cost reduction opportunities out, but the bigger point is it's not that our cost is higher than a gas-powered or an internal combustion engine.

Martin Viecha -- Senior Director of Investor Relations

I think what Toni meant is with the battery pack, as in battery pack as well as the powertrain together, are more expensive than an engine.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes. That's true.

Toni Sacconaghi -- Sanford C. Bernstein -- Analyst

And how big do you think that delta is today? And when it's -- do you think of it as being kind of $10,000, $11,000 for that pack plus powertrain for an electric vehicle and maybe $5,000 or $6,000 for an internal combustion engine car? And is that sort of the order of magnitude? And where do you see those getting much more aligned just sort of given the lives of where you think cell and pack costs are going?

Elon Musk -- Co-Founder and Chief Executive Officer

Well, the -- I think it's important to bear in mind is because of electricity is quite a bit less than the cost of gasoline, especially in Europe or in California or China, basically almost everywhere except, say, the middle of the United States, where the cost of gasoline is very expensive and electricity is far cheaper. The -- so that factors in to the cost of ownership pretty significantly. It's on -- sort of going on the order of $50 to $100 a month depending upon how much somebody drives. So that's a very important thing to consider for an electric car versus a gasoline car.

The -- that said, in terms of initial cost of acquisition, I think it's probably -- this is just off the top of my head, not a calculated number, probably on the order of 7k but trending toward 4k or 5k. It's off the top of my head.

Toni Sacconaghi -- Sanford C. Bernstein -- Analyst

OK. OK. And as you think about 2019, you talked about sort of scenarios for demand and how you plan to roll out the intermediate range and then ultimately the standard range. What is -- if you do have to make a trade-off on volume or profitability during the course of the year, meaning to get the volume you need or you think you can deliver, you have to go to lower margins or vice versa, where's the trade-off? Is -- are units produced most important to you? Or is delivering the 25% gross margin more important? So if you have a chance to deliver 450,000 or 500,000 cars but they'll be more standard editions and gross margins will end the year at 20%, is that -- are you willing to make that trade-off?

Elon Musk -- Co-Founder and Chief Executive Officer

My guess is it ends up being sort of about the six and one-half [Inaudible] where if there's a given amount of free cash flow, you sort of decide-you decide to achieve that with a smaller production or smaller volume of cars or at a higher margin or large volume cars at a smaller margin. I think we're already toward the second. We'd rather make more cars at a lower margin, but I think it's more or less a flat rate.

Martin Viecha -- Senior Director of Investor Relations

OK. Let's go to the next question please.

Operator

Thank you. Our next question comes from Maynard Um with Macquarie.

Maynard Um -- Macquarie Group -- Analyst

Hi. Thank you. Can you just update us on where battery costs are now and where you anticipate they'll be by year-end? I'm just trying to gauge how much of a factor this is to lowering costs and sustaining profitability.

Elon Musk -- Co-Founder and Chief Executive Officer

That's a highly proprietary number. We cannot give it out, but I'd like to tell you but no. We do think we have the best costs in the world. We're -- to the best of our knowledge, our costs are lower than anyone else right now and they're improving.

Maynard Um -- Macquarie Group -- Analyst

OK. And maybe talk about your expectations with the Panasonic-Toyota JV and how it might impact you. Was this something that you were made aware of?

Elon Musk -- Co-Founder and Chief Executive Officer

I spoke directly with Tsuga-san about this, the Head of Panasonic, and he assured me this will have no impact on Tesla.

Martin Viecha -- Senior Director of Investor Relations

OK. Thank you very much. Let's go to the next question please.

Operator

Thank you. Our next question comes from Dan Galves with Wolfe Research.

Dan Galves -- Wolfe Research, LLC -- Analyst

Hey, guys. Thanks a lot. Do you plan to offer a U.S. lease product for Model 3 in the U.S.? When can we expect it? And can you talk about what percentage of S and X have historically been leased in the U.S.?

Elon Musk -- Co-Founder and Chief Executive Officer

Well, we've been reluctant to introduce the leasing on Model 3 because of how -- of its effect on GAAP financials. So, it is worth noting that demand to date is with 0 leasing. So obviously, leasing is a way to improve demand but it has -- it makes our financials looks worse. So we're -- we don't want to introduce that right away.

I mean, we'll introduce it sometime later this year probably. What -- I'm not sure the percentage of lease is for S and X right now.

Deepak Ahuja -- Chief Financial Officer

It's around 20%, low 20s, and it stayed stable at that level for many, many quarters, which is -- it seems like the natural demand because we don't do sub-invention or artificially pump up --

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, exactly. Our leases are legit. The -- it usually expects a small business. Tax write-off is important for the -- for leasing.

Dan Galves -- Wolfe Research, LLC -- Analyst

OK. OK. Thanks. And then I have just, like, two quick housekeeping questions.

One, is there a restructuring charge that you expect in the first quarter? How much is it? And is it included in your expectation of a small profit?

Deepak Ahuja -- Chief Financial Officer

Yes, it is included in that. It's difficult to say exactly what that is. At this point, it's, let's say, roughly around $40 million, but that number can vary slightly.

Dan Galves -- Wolfe Research, LLC -- Analyst

OK. Thanks. And then just the last one is...

Deepak Ahuja -- Chief Financial Officer

Sorry, go ahead.

Dan Galves -- Wolfe Research, LLC -- Analyst

Yes, the last one is, this change in your service parts structure to make things more distributed rather than in the parts warehouse is. Would that be like a meaningful working capital drag? What's the cash impact of that?

Elon Musk -- Co-Founder and Chief Executive Officer

No, it's actually -- we've just been very silly about where we store our parts. So, it's actually going to be no change in sort of working capital or not something you would even notice in the financials. It's just being smarter about sending parts directly to service centers. In fact either directly from our factory here or from our suppliers and just ship and direct to the service center.

Right now, actually, our costs will improve, I think, actually quite a lot, because there's been -- actually quite -- they're kind of persistent. It's quite boneheaded, actually speaking self-referentially. So just being -- so stopping doing the foolish things will massively improve our service costs, will massively improve customer happiness around the world, and it's just fundamentally better all around. I mean, there are some pretty -- we've been just like super dumb in some of the things we've done, where -- like in one of my trips to China last year, as I always ask, "OK, what are we doing wrong? What can we fix?" And then like our China team is great always.

They're like, "Well, do you think we could have spare parts that are made in China just sent directly to China service centers? Because currently, there's a bunch of parts that are made in China then sent to a warehouse in New Jersey and then sent back to China." Literally, what was happening. It's super nut stuff. So, it's going to get way better. And yes, it's very queer.

Martin Viecha -- Senior Director of Investor Relations

OK. Let's go to the next question please.

Operator

Thank you. Our next question comes from Ben Kallo with Baird.

Ben Kallo -- Robert W. Baird & Co. -- Analyst

Hey. Great, guys. I have one question and it's got four parts to it. Happy new year, Elon.

So the first part is -- so our Street numbers, like consensus, we've got everything wrong for six years or seven years since you went public, in thereabouts $6 in earnings. Talk to us about that, if you can. Number two, Elon, could you talk to us about -- you talked about -- I hear you cut some workforce at SpaceX business there at Tesla. I feel that you have a worry about global economy.

Can you talk to us about how you feel about that with your guidance in order -- in the same order? And then can we talk about, maybe sort of third thing, for JV? No one's ever going to talk about stationary storage, but we had a whole page on that with pretty good speech, and why should we be focusing on that? And what can that add to the bottom line on top of that $6 this next year? Thank you.

Deepak Ahuja -- Chief Financial Officer

I mean, we can't really, Ben, talk about consensus and what that means. I think the -- maybe the better approach is we are providing certain guidance here and you and the other analysts need to reflect that in your modeling. And that's the best indication from the company of our projections. In all fairness, that's the best way I can think of answering your question here.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes. J.B., is there anything...

Jeffrey Straubel -- Chief Technical Officer -- Analyst

I mean, I think the letter outlines the predicted growth in the battery storage business, the stationary storage business pretty clearly, and that should be included in the projections as well. So I mean, we're excited about it but I can't say much more detail.

Elon Musk -- Co-Founder and Chief Executive Officer

I mean, our internal projections for stationary storage are closer to 3 gigawatt hours. But some of it is kind of lumpy and may not be completed this year. We would have done more in stationary storage last year except we were cell-starved for vehicle production. So we had to convert a bunch of stationary storage lines, battery lines, to vehicle battery lines.

Otherwise, we would have done quite a bit more in stationary storage. I expect that to grow, I mean, probably twice as fast as automotive for short -- a long time.

Jeffrey Straubel -- Chief Technical Officer -- Analyst

We continue to set production records basically every month. So that's growing.

Deepak Ahuja -- Chief Financial Officer

And the profitability of the storage business and the gross margin continue to improve as we keep ramping up production and scale.

Elon Musk -- Co-Founder and Chief Executive Officer

It's going to be a gigantic business down the road.

Martin Viecha -- Senior Director of Investor Relations

And the last question was about economy, global economy.

Elon Musk -- Co-Founder and Chief Executive Officer

Sure. I mean, I do think that the economy moves in cycles and there's fairly a significant risk of a recession over the next 12 to 18 months, but I'm confident that Tesla will remain at least slightly profitable even with -- even if there is a significant recession. And then when -- and be all the stronger for it when there's recession. And the -- we have to be relentless about cost in order to make affordable cars and not go back up.

That's what our headcount reduction is about, yes, yes. I think we have to -- it's -- we have to be super hardcore about it. It's the only way to make affordable cars. The -- on the SpaceX side, the cost reduction was for a different reason unrelated to -- it was --SpaceX has really -- SpaceX has two absolutely insane projects that would normally bankrupt a company, Starship and Starlink.

And so SpaceX has to be incredibly spartan with expenditures until those programs reach fruition.

Martin Viecha -- Senior Director of Investor Relations

OK. Great. I think that's all we have time for our -- today. Thank you very much for your questions, and Elon would like to have some closing remarks.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes. So let's see. The -- so Deepak is -- well, I'd like you to make the announcement, but Deepak is going to be retiring.

Deepak Ahuja -- Chief Financial Officer

Again.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, from Tesla.

Deepak Ahuja -- Chief Financial Officer

Yes.

Elon Musk -- Co-Founder and Chief Executive Officer

Deepak, I think it's now been -- you first started with Tesla about 11 years ago, right?

Deepak Ahuja -- Chief Financial Officer

When -- close to that, yes.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, almost 11 years. Thank you for your tremendous contribution to Tesla. And he's announcing retirement but the retirement will not be immediate, but Deepak will continue to be at Tesla for a few more months and will continue to serve as a senior advisor to Tesla for probably years to come hopefully. And we thought long and hard about who the right person is to take over from Deepak, and that's Zach.

And Zach has been with Tesla now for nine years...

Zach Kirkhorn -- Vice President, Finance

Nine years.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes. So Zach, you had management and technology at Wharton undergrad and then worked at Tesla and then spent a couple of years at Harvard Business School, which I actually don't think was necessary, by the way.

Zach Kirkhorn -- Vice President, Finance

You told me that when I came back.

Elon Musk -- Co-Founder and Chief Executive Officer

Yes, exactly. So Zach's incredibly talented, has made a huge contribution to Tesla over the years, and obviously a very well-known quality to the whole team and has the respect of the whole team. And Zach, I don't know if you'd like to say a few words?

Zach Kirkhorn -- Vice President, Finance

Yes, I will.

Elon Musk -- Co-Founder and Chief Executive Officer

OK. Or do you want, Deepak, to save you?

Zach Kirkhorn -- Vice President, Finance

Deepak?

Deepak Ahuja -- Chief Financial Officer

Sure. OK. Thank you. Yes -- no.

Well, first of all, Elon, thank you very much for the opportunity for me to be here and be here again a second time. I've learned a lot from you and I've been always inspired by you, and I've been also very inspired by the team at Tesla, who are incredibly brilliant, very passionate and just amazingly perseverant, the best team I could imagine. So thank you everybody for that. There is no good time to make this change.

We felt generally this was a good time. It's a new chapter, a new year. Tesla has had two great quarters of profitability, cash flow, so now a really solid foundation. And I feel really good about Zach taking over as the CFO.

He's proven himself with his many years of experience and many tough challenges that he's worked on and really excited to have Zach take on this role, and I'll be here to support him and make sure we are all successful as a company.

Zach Kirkhorn -- Vice President, Finance

Yes, well, thank you, Deepak. Thank you, Elon. So my name is Zach Kirkhorn. Just a brief background on myself.

So, I joined Tesla just under nine years ago when it's a super small company with a lot of potential ahead of us and I was attracted to the mission and the vision of the company. Throughout that time, I've been deep in the operations of every major program of the company, from the Roadster to Model S and X, Model 3, scaling our energy business and more things to come, which we've talked about on the call. I feel we're starting 2019 with a very strong financial foundation. We have enough cash to continue launching new programs and developing new technologies, and we're able to service upcoming debt obligations with our forecasted cash flows.

My focus, alongside the talented and amazingly passionate team at Tesla, is to ensure we continue the terrific momentum on cost management and operational efficiency, which will enable us more -- enable more access to our products around the world, which is key to achieving the mission of the company. On a personal note, Deepak, a huge thank you to you for your leadership, mentorship, and support and very much looking forward to discussing our progress on future earnings calls.

Elon Musk -- Co-Founder and Chief Executive Officer

Great.

Martin Viecha -- Senior Director of Investor Relations

Great. Thank you very much. We will speak to you in three months.

Elon Musk -- Co-Founder and Chief Executive Officer

Thanks, guys.

Operator

[Operator signoff]

Duration: 69 minutes

Call Participants:

Martin Viecha -- Senior Director of Investor Relations

Elon Musk -- Co-Founder and Chief Executive Officer

Jerome Guillen -- President

Ryan Brinkman -- J.P. Morgan -- Analyst

Deepak Ahuja -- Chief Financial Officer

Gene Munster -- Loup Ventures -- Analyst

Colin Rusch -- Oppenheimer & Co. Inc. -- Analyst

Colin Langan -- UBS -- Analyst

Emmanuel Rosner -- Deutsche Bank -- Analyst

Pierre Ferragu -- New Street Research -- Analyst

David Tamberrino -- Goldman Sachs -- Analyst

Daniel Ives -- Wedbush Securities -- Analyst

Toni Sacconaghi -- Sanford C. Bernstein -- Analyst

Maynard Um -- Macquarie Group -- Analyst

Dan Galves -- Wolfe Research, LLC -- Analyst

Ben Kallo -- Robert W. Baird & Co. -- Analyst

Jeffrey Straubel -- Chief Technical Officer -- Analyst

Zach Kirkhorn -- Vice President, Finance

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