In this MarketFoolery podcast, host Chris Hill and David Kretzmann of Motley Fool Rule Breakers and Supernova discuss Tesla's (NASDAQ:TSLA) first quarter -- yes, Model 3 production is still lagging -- and Elon Musk's odd behavior on the company's conference call; Spotify's (NYSE:SPOT) first post-IPO quarterly report, which was a reminder of how hard it can be in tech to transition into the harsh glare of the public markets; and the future of struggling wearables icon Fitbit (NYSE:FIT)

A full transcript follows the video.

This video was recorded on May 3, 2018.

Chris Hill: It's Thursday, May 3rd. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio today, it's David Kretzmann. Thanks for being here!

David Kretzmann: Thanks for having me! I'm glad to be here!

Hill: It's earnings season.

Kretzmann: It sure is. Full steam ahead.

Hill: It is full steam ahead. We're going to talk tech. We have Spotify earnings, we have Fitbit earnings. We have to start, though, with Tesla for a couple of reasons. We'll get to the conference call in a second, because right now, on CNBC's website, the top five trending stories in tech news are all about Tesla's conference call.

Kretzmann: I think something happened there.

Hill: [laughs] Yeah. We'll get to the conference call in a second. Let's start with the actual quarter. The first quarter results, Tesla lost a record amount of money in the first quarter, and yet somehow, that was still better than expected. When you looked at the quarter, what stood out to you besides their historic loss?

Kretzmann: I think the story with Tesla continues to be scaling production of the Model 3. They produced a little under 10,000 Model 3 vehicles this quarter. They produced about 25,000 Model S and Model X vehicles, but they're still well behind the pace where they wanted to be with Model 3 production. I think by the end of last year, they wanted to be producing somewhere in the neighborhood of 5,000 vehicles a week. Right now, they just peaked out at about 2,300 vehicles per week. They're trying to revamp automation within the factories, revamp the whole manufacturing process to get that number up to 5,000 vehicles a week. I think by July is when they're targeting. And then, they're even talking about different ideas to get it up to 10,000 vehicles a week down the road. But, the theme here with Elon Musk continues to be over-promising, under-delivering, and hopefully there's intersection of those two things. But for now, I think all eyes continue to be on the Model 3.

Hill: Musk staunchly says, "There's no way we're going to raise money this year. We don't need to raise money." When you look at their business right now, do you think they're going to raise money this year?

Kretzmann: They're saying that they'll be profitable in the third and fourth quarter this year. So, next quarter will continue to be unprofitable, but they're saying they will bounce back to profitability. And not just non-GAAP profitability or adjusted profitability, but GAAP profitability. 

I wouldn't necessarily bet on that. If you look at the state of the company now, it's hard for me to see them making it the rest of the year without needing to raise capital somehow. They have $2.7 billion in cash on the balance sheet. Their net debt position is over $8 billion. And their cash burn right now is $4.4 billion. So, at the rate they're burning cash right now, they won't make it another year without raising more cash. Unless there's a dramatic improvement by the third quarter this year, they're going to have to issue equity or debt, one of those two. Given how the conference call went, I'm not sure if they'll necessarily get very favorable terms with the cash they're probably going to need to raise later this year.

Hill: And I think the conference call, as much as anything, is the reason that shares of Tesla are down today. Again, yes, they lost all this money, but it was actually better than expected. But the conference call just went off the rails, because you had analysts who were asking questions that didn't strike me as overly pointed or overly personal, and they were asking about things like, are they going to need to raise capital, in terms of production for the Model 3, which is really the most important thing from a business standpoint that has to happen for Tesla, is to get these cars out of the factory and into the hands of the people who have actually made reservations for them. 

And at some point, Musk literally said, "You guys are killing me. These questions are so boring, they're so dry, I'm going to take questions from YouTube." And he essentially shut down the analysts and said, "I'm just going to take questions from Tesla owners on YouTube." And, I don't know, I just thought, maybe you should consider, stop doing conference calls, because there's no requirement that they do conference calls, or that the CEO be the one on the call. I don't know. When you saw this unfolding, what went through your mind?

Kretzmann: Given the state of Tesla's financials, like I said, unless they have a dramatic improvement in their cash situation, there's no way around it, they're going to need to raise money. So, you don't want to get on the bad side of Wall Street, because you need them to finance the company's growth at this point. And, yeah, it might be best for Elon Musk to stick to Twitter and avoid the conference calls. A Wall Street analyst asked where the company will be in terms of capital requirement as they scale up Model 3 production, and a direct quote from Elon Musk, he said, "Excuse me, next, next, boring butthead questions are not cool. Next." It's like, that's an important question that's really underlying the thesis for Tesla here. 

There is one aspect of this that I do think is kind of interesting or worth praising. I do like the fact that they brought in a retail investor from YouTube, a writer who covers Tesla on Seeking Alpha and YouTube. I like that they brought a retail investor onto the conference call to ask questions. That's something you don't typically see in the U.S. In other countries like Australia, we have Motley Fool analysts who will actually participate on the conference calls and have that presence, and it's not just limited to the investment banks. So, I do like that aspect of it. 

But, really, putting the middle finger toward Wall Street and then going to the questions from this retail investor on YouTube, which, we're talking about autonomous vehicles down the road, talking about the Supercharger network, questions that are really more outside of the central investing thesis and the issues that Tesla is going through. And it sounds like Musk would rather talk about those things. But when you need Wall Street on your side, this wasn't Elon Musk's greatest performance. I think that could bite the company in six months or so, if they need to raise more money.

Hill: And I understand and appreciate the comments that he made regarding short-term traders vs. long-term investors. I totally understand that, I applaud that, I appreciate that. That being said, he didn't just stop there. Again, the questions that were being asked actually went to -- whether they went to short-term trading or not -- they went to the short-term financial situation of the company, which you talked about. 

Yesterday, I taped an interview with Becky Quick from CNBC. This weekend is the Berkshire Hathaway annual meeting. She's going to be going out to be one of the moderators for the marathon Q&A session that Buffett and Charlie Munger do that goes for five or six hours. That interview is going to be on Motley Fool Money tomorrow. I'll just give you one snippet of that interview, because one of the things I said to her was, I can't imagine anyone else doing what Buffett and Munger are doing and having people care. Even people who love Amazon, Facebook and Disney, if Jeff Bezos, Mark Zuckerberg or Bob Iger said, "At our annual meeting, I'm going to sit up on a stage for five hours and I'm going to take any question you want." I don't think people would care, particularly. 

And she said, "You know what? I'm going to disagree with you." Because, Buffett and Munger, it's unscripted. They'll take any question. It's basically like, "Ask us anything you want." A lot of the questions are about the business of Berkshire Hathaway. Some of them are just like, "What book would you recommend," that kind of thing, they're more personal in nature. I don't think Elon Musk would last 10 minutes in that type of setting. That was one of the things that went through my mind. At one end of the spectrum, in terms of public company CEOs, we have Warren Buffett, who once a year says, "Bring it on! Ask me anything you want, and I'll answer it." And, again, Musk should really consider just taking a page out of Buffett's book, in terms of the quarterly approach, because Buffett doesn't do quarterly conference calls. He just does once a year. So, if part of Musk's thinking is, "No, I want to encourage long-term thinking," then maybe just ditch these calls altogether, because this was not good.

Kretzmann: Yeah. I just don't see what you accomplish by having this attitude on a conference call. If you're notably hating the process of talking to Wall Street and answering key questions that any sensible analyst would be asking at this point, then, yeah, it's probably better to either take Musk off the calls or just avoid the calls altogether and control the narrative through Twitter or other means. 

I do think, the one thing that Tesla continues to have going for it, you have to remember, this is a company that's not spending a dime on marketing. So, if they can produce the vehicles, people are going to buy them. Even if there are some people who reserved a Model 3 over a year ago and canceled their reservation, there's probably still well over 200,000 reservations. It's probably still closer to that original 400,000 mark. People want these cars. Tesla's issue is not creating interest for the product. It's actually now manufacturing and delivering the product. 

And I suppose an optimist might look at what Elon Musk did on this call, and maybe he is so confident that the company doesn't need to raise money this year -- which is something he has reiterated over the past several months -- maybe he's so confident that they will actually hit those production targets this summer, and they will be dramatically reducing their cash burn. 

So, that isn't impossible. But, given the track record of Tesla and Musk, I don't think it's a given that they will hit 5,000 or 10,000 vehicles a week by the summer. If they do, then potentially, the financial situation is OK. But this doesn't give them a whole lot of flexibility when it comes to raising money from Wall Street.

Hill: Happy first earnings report ever to Spotify. Spotify's first quarter wasn't great. [laughs] But, they have 170 million users. They have 75 million people who are paid subscribers. When you looked at the quarter, what stood out to you?

Kretzmann: They continue to grow both their free ad-supported users and those premium subscribers, like you mentioned. They have 75 million premium subscribers. That still puts them soundly in the No. 1 position in that streaming music space. Apple (NASDAQ:AAPL), in their quarter earlier this week, they reported that they have over 40 million paid subscribers with Apple Music. So, Spotify has almost twice the number of paid subscribers as the No. 2 player there. Their leadership position is impressive. They're guiding to hit somewhere between 92-96 million paid subscribers in 2018. 

So, when I look at Spotify, I think the near-term outlook over the next one or two years is pretty bright, because they really have a nice funnel with their 170 million monthly active users, a lot of people who are their ad-supported users, so they're not paying anything for the platform. But, that's a nice funnel to potentially upgrade those people to the premium subscription. That gives them a nice tailwind or runway for growth over the next one or two years.

I think the longer-term question, or the clouds hanging over the business, people might be having a harder time figuring out, where does Spotify go from here? If Apple, Amazon, Google, YouTube are rolling into the streaming music space, what can Spotify do to create some sort of sustainable differentiator from those other services? I think the challenging thing with the music category, to have a music streaming service, you can't just have a small selection of songs. You need to have basically every song that's out there and more. And that "and more" piece is, I think, what people are waiting for. Do they go into exclusive contracts with artists, do they have original music? I think right now, if you're an artist or a label, you don't necessarily want to limit yourself to one platform. At this point, you want to be on as many platforms as you can. 

But, the ultimate question here is, can Spotify get to a point where they have more leverage in that relationship, and they're the one place where artists or labels want to go to? I think, if you're thinking about buying Spotify, you really have to believe that they can get to that point.

Hill: This quarter wasn't really all that much of a surprise in the sense that we've seen this from a lot of companies, particularly in the tech space, where, they go public, and that first quarterly report just isn't all that great. And as we've said many, many times, it's so much more challenging to be a public company than it is to be a private company. 

That being said, I think that one of the advantages Spotify now has as a public company is, it's very easy to compare them side-by-side with Pandora (NYSE:P). Because, for the longest time, if you heard one name, the other name followed immediately, and those were the two comparisons. Now that Spotify is a public company, and you can compare it to others, you can just look at it and say, "Oh, no! Spotify is so much bigger than Pandora."

Kretzmann: Bigger and better. [laughs] 

Hill: Bigger and better. It's a $30 billion company. Pandora is not even a $2 billion company. So, I think, in terms of the narrative, and to your point about musical talent and what they are considering, Pandora is way off to the side, and it's really much more about Apple Music, Spotify, and you could probably throw Amazon Music in there as well, although that's just kind of an add-on with Prime.

Kretzmann: And supposedly, Amazon Music has tens of millions of users. I think that's the latest number that Bezos and Amazon put out. So, they might be a No. 3 or No. 4 player. There's no doubt that Pandora dropped the ball when it came to launching an on-demand subscription package. For such a long time, Pandora was just dependent on that ad-supported platform, and I think they're still below 10 million premium subscribers -- well behind Spotify, Apple, Amazon. 

Spotify, compared to Pandora, is in a far better situation. Pandora, I don't think, has ever been profitable or free cash flow positive. They continue to burn cash and mount up some pretty substantial losses. Spotify is free cash flow positive. They have no debt, over $500 million in cash, which is why they were able to do this direct IPO where the company itself wasn't actually raising money when it went public, it was just giving liquidity to insiders and shareholders. 

So, Spotify has flexibility here. It's not like they need to scramble for a solution. But I think, for Spotify, they need to figure out over the next three years or so how they can differentiate themselves, and that's really the question I think investors or potential investors should be watching.

Hill: Fitbit's first quarter loss was smaller than Wall Street was expecting. Revenue in the quarter would have been more of a bright spot if they didn't immediately follow it up by saying, "Oh, yeah, we have to lower guidance for the current quarter."

Kretzmann: [laughs] And if revenue wasn't actually dropping. Beating estimates for revenue when revenue is dropping -- I think it dropped 15% or 17% this quarter, it's hard to get excited about that. Beating low expectations isn't something to be extremely proud of. In this case, the number of devices that Fitbit sold dropped 27% to 2.2 million down from three million last year. 

A stat that Fitbit puts out there, and I think they put it out there as a positive thing, but I look at it in kind of a different light, 38% of activations of the devices that they sold this quarter -- so, 38% of the devices that were activated this quarter -- came from repeat users. And half of those repeat users were people who were previously inactive with their Fitbit for 90 days or more. I think that just reinforces the issue that Fitbit has. I think a lot of people will buy these devices, whether it's a fitness tracker or a smartwatch, and you might use it for a few months, but then you get to a point where it's just kind of a nuisance, you forget about it, and it's just not a seamless thing to integrate into your daily life. 

And Fitbit is in the midst of trying to pivot to becoming more of a software and services company, where they're tracking this health data that could work with employers for corporate wellness programs, or work with hospitals and doctors, where you can easily sync up and access a patient's data and health tracking. But the problem with that strategy is, the software and the services will only be valuable if people are using the devices, and Fitbit, up to this point, has not proven that people are actually using these devices on a regular basis. 

And you might push back on that by saying, maybe it's the category as a whole, wearables just aren't as flashy or sexy as they were a couple of years ago when it was all the rage. But Apple, again, in the quarter that they just reported, they said Apple Watch sales grew in the double digits. It was a record for Apple Watch in the March quarter. So, Apple Watch is gaining market share, and Fitbit's revenue and their device sales are dropping, so this isn't just an industry problem. This is very much a Fitbit problem.

Hill: Part of me wonders if -- because, you and I were talking earlier today, and I was just trying to wrap my head around, not even what is the bull case for Fitbit, but, what's the thesis for buying this stock today? They have some amount of brand cachet. It's a decent brand. The ease of use of the device is there, and I think that's an important thing. I've talked before about Venmo. The brilliance of Venmo is that people who are not smart about technology, like me, are able to use it. Whoever designed Venmo, kudos, because they nailed that. 

So, there are some positives there. But, ultimately, the thing I keep coming back to is, yeah, that gets them to the point where someone buys them. I still don't see them as a stand-alone company three to five years from now. Is that really the bull case right now? The thesis for this stock is, there's value there, someone is going to buy them?

Kretzmann: I think that's a big part of the bull thesis here. Someone might look at it and have some optimism with that software and services piece, but right now, management still says that's immaterial to their overall revenue, and I don't see that changing anytime soon. Again, if people aren't really using the devices on a regular basis and aren't regularly engaging with those devices, I don't think many organizations or individuals will find it appealing to pay for some sort of monthly premium Fitbit package. Maybe down the road at some point. 

Another issue with Fitbit is, new devices they released over the past year makes up a third of their total revenue. So, this is a company that constantly has to reinvent its products. And I think they launched three new products within the past year. You compare that to Apple Watch, which is like, ever year, 18 months, they upgrade the Apple Watch, and it's selling like gangbusters. So again, this isn't just an industry issue, this is a Fitbit issue.

Another bright spot for the company -- obviously, a lot of things going poorly. They're projecting revenue to continue dropping through the rest of the year. But, half of their market cap today is in cash. The company has over $650 million in cash, no debt. The market cap is about $1.2 billion. So, you look at that, and that does provide some cushion for the market value of the company, and by extension, for the stock. 

They are burning cash. They've burned somewhere in the neighborhood of $80 million over the past year, because they've been making acquisitions, and free cash flow has been pressured. But, they are expecting for 2018 to actually break even on a cash flow basis. So, you look at it, and if the company gets to a point where it's not burning cash, or not bringing cash to a great degree, and you have over $650 million in cash and no debt in the bank, that does give them a cushion and a lot of flexibility to figure things out. 

I think, in the meantime, the stock doesn't really look that appealing to me. But, I think you could look at that and say, well, sure, things aren't going great, but the downside might be minimal, just given that hefty cash pile.

Hill: I can't decide if it would have been helpful for them if, remember when Under Armour bought MyFitnessPal for $700 million or whatever they shelled out for it?

Kretzmann: Hefty price tag.

Hill: Hefty price tag, and that did not work out. I can't decide if that actually would have been helpful for Fitbit's current situation -- if Under Armour was able to make that work, that more people, bigger companies, would be looking at Fitbit and saying, "Maybe we should think about kicking the tires on Fitbit." Or, if, ultimately, that was just a completely separate situation because Under Armour couldn't figure out a way to make that work.

Kretzmann: It's an interesting category, because it seems inevitable that we will get to a point where we're more proactive in tracking our health, and that there will be some solution where our doctors can have access to our health data. It just makes sense that the world is going in that direction. And I don't think any company has really cracked that code. 

I think the advantage for Apple is obviously the brand cachet that they have. The Apple Watch ties in very nicely with the entire iPhone ecosystem. And, I think the Apple Watch is far and away a better product compared to the smartwatches that Fitbit or Fossil are putting out, because the Apple Watch has GPS, it has the built-in cellular technology, so it's becoming a more and more powerful stand-alone device on its own. 

In the case of Fitbit, they continually have to reinvent themselves when it comes to the hardware. Then, they're trying to create and develop and acquire this software and services side of the business. But, it's like, if you're buying a device for the software and the services, you're probably going to stick with Apple Watch, which is part of that Apple platform and software ecosystem. 

It's going to be an uphill battle for Fitbit, I could see them maybe plugging into a larger player, somehow. They do have a partnership with Google, so maybe that turns into a potential acquisition opportunity, or maybe that helps jump-start the software and services piece. But, in the meantime, they need to prove that people are actually engaging with these devices more than three or six months, because without that, then it's going to continue to be an uphill battle for them.

Hill: David Kretzmann, thanks for being here!

Kretzmann: Thanks for having me!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you on Monday!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Chris Hill owns shares of Amazon, Under Armour (A Shares), Under Armour (C Shares), and Walt Disney. David Kretzmann owns shares of Alphabet (C shares), Amazon, Berkshire Hathaway (B shares), Facebook, Tesla, Twitter, Under Armour (A Shares), Under Armour (C Shares), and Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Berkshire Hathaway (B shares), Facebook, Fitbit, Pandora Media, Tesla, Twitter, Under Armour (A Shares), Under Armour (C Shares), and Walt Disney. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Fossil Group. The Motley Fool has a disclosure policy.