Tesla, Inc. (TSLA) Q1 2021 Earnings Call Transcript

Tesla, Inc. (NASDAQ: TSLA) Q1 2021 earnings call dated Apr. 26, 2021

Corporate Participants:

Martin Viecha — Senior Director of Investor Relations

Elon Musk — Chief Executive Officer

Zach Kirkhorn — Chief Financial Officer

Analysts:

Pierre Ferragu — New Street Research — Analyst

Rod Lache — Wolfe Research. — Analyst

Dan Levy — Credit Suisse — Analyst

Presentation:

Operator

Good day, ladies and gentlemen, and thank you for standing by and welcome to the Tesla First Quarter 2021 Results and Q&A webcast. [Operator Instructions]

I will now hand the conference over to your speaker today Martin Viecha, Senior Director of Investor Relations.

Martin Viecha — Senior Director of Investor Relations

Thank you, Carmen and good afternoon everyone and welcome to Tesla’s first quarter 2021 Q&A webcast. I’m joined today by Elon Musk, Zachary Kirkhorn and a number of other executives. Our Q1 results were announced at about 1:00 PM Pacific Time in the update deck 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. During the question-and-answer portion of today’s call, please limit yourself to one question and one follow-up. [Operator Instructions]

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

Elon Musk — Chief Executive Officer

Great. Thank you. So Q1 2021 was a record quarter on many levels as Tesla achieved record production, deliveries and surpassed $1 billion in non-GAAP net income for the first time. We’ve seen a real shift in customer perception of electric vehicles and our demand is the best we’ve ever seen. So this is, we talked about — we’re used to seeing a reduction in demand in the first quarter and we saw an increase in demand. So that exceeded the normal seasonal reduction in demand in Q1.

So Model 3 became the best-selling mid-size premium sedan in the world. In fact, I should say, the best-selling luxury sedan of any kind in the world. The BMW 3 Series was for the longest time the best-selling premium sedan. It’s been exceeded by the Tesla Model 3. And this is only 3.5 years into production and with just two factories. For Model 3 to be outselling its combustion engine competitors I think is quite remarkable. In the past couple of quarters we delivered roughly 0.25 million Model 3s, so that — which translates to an annualized rate of 0.5 million per year.

When it comes to Model Y, we think Model Y will be the best-selling car or vehicle of any kind in the world and — probably next year. So — I am not 100% certain next year, but I think it’s quite likely. I’d say more likely than not that in 2022 Model Y is the best-selling car or truck of any kind in the world.

Then with regard to Full Self-Driving. Full Self-Driving team [Phonetic] continues to make great progress. But this is definitely one of the — I think, one of the hardest technical problems that exists, that maybe ever existed. And really in order to solve it, we basically need to solve a pretty significant part of artificial intelligence, specifically real-world artificial intelligence. And that sort of AI, the neural net needs to be compressed into a fairly small computer and a very efficient computer that we’ve designed but nonetheless a small computer that’s using on the order of 70 or 80 watts. So this is a much harder problem than if you, what do you say, 10,000 computers in a server or something like that. This has got to fit into a smallest brain.

And this — I think with the elimination of radar, we’re finally getting rid of one of the last crushes. Radar was really — it was making up for some of the shortfalls of vision, but this is not good. You actually just need vision to work and when vision works, it works — it works better than the best human. It’s like having eight cameras, it’s like having eyes in the back of your head, sides of your head and has three eyes with different focal distances looking forward. This is — yeah, and processing it at a speed that is superhuman. There is no question that with a clear vision solution, we can make a car that is dramatically safer than the average person. So — but it is a hard problem because we are actually solving something quite fundamental about artificial intelligence where we basically have to solve real-world vision, AI. And we are — and key to solving this is also having some massive dataset. So just having well over 1 million cars on the road that are collecting data from very sort of corner case rare situations sort of like so many wearied things in the world like coming back on like a truck carrying a truck or a car with a — one example is, a car — an actual example, a car with a kayak on the roof where the kayak has a little weight dangling from the front of the kayak in front of the car and the car must ignore this and just look at the road. So, it’s really quite tricky, but I am highly confident that we will get this done.

So, yes — this quarter and I think we’ll continue to see that a little bit in Q2 and Q3. So, Q1 was — had some of the most difficult supply chain challenges that we’ve ever experienced in the like of Tesla. And same difficulties with supply chain, with parts of the whole range of parts, obviously we’ve heard about the chip shortage. This is a huge problem.

But then in addition to that, for example, we had quite of a difficulty scaling, driving our production in China because we were unable to get critical engineers there because of COVID quarantine restrictions. So — which meant that Tesla worldwide was dependent upon driving units made at our factory in Nevada, Giga Nevada. So that was a very challenging situation. I think we are mostly out of that particular problem. That’s just — those were just two of many challenges. So team is really good. Done an incredible job dealing with really severe supply chain shortages.

So with respect to Model S and X, there were more challenges than expected in developing the Plaid Model S or what’s called the Palladium Program which is the new version of Model S and X which has revised interior and new battery pack and new drive units and new internal electronics and has reasonable PlayStation 5 level infotainment system.

There’s just a lot of issues accounted ensuring that the new factory [Technical Issues]. So it took quite a bit of development to ensure that the battery of new SX is safe. And we’re trying to get all [Technical Issues] car slowly for the past few months. But we’re just backing them up in the yard and just making refinements to the cars that we built. But we do expect to ramp Model S production and start delivering probably next month. So — and then to be in sort of fairly high-volume production for the S in Q3 and to start delivering the Model X in Q3 as well.

So I think as we ramp, I think probably the demand for the new S/X will be quite high. So soon there is going to be a question of ramping supply chain and internal production processes. So probably — like we’re going to aim to produce over 2,000 S/X per week, perhaps, if we get lucky, upwards of 2,400 or 2,500. This again is contingent on global supply chain issues, which there is a lot of factors that’s out of our control here. But I do think these things will get solved, it’s just a matter of time and then we’ll be doing well with 2,000 S/X per week. It’s a great car. It actually costs us less to produce, a little bit less to produce, but it is a superior product.

So in conclusion there is a lot to be excited about in 2021 and ’22. We’re building factories as quickly as we can. Both Texas and Berlin are progressing well. And we expect to have initial limited production from those factories this year and volume production from Texas and Berlin next year. At this time we are continuing to ramp production of Model Y in Fremont and Shanghai.

In the background, we’re continuing the work — development work on the semi Cybertruck, the Roadster and other products.

Thanks to everyone at Tesla who made this year a huge success. Now on to questions.

Martin Viecha — Senior Director of Investor Relations

Thank you very much. We have some remarks from Zachary Kirkhorn as well.

Elon Musk — Chief Executive Officer

Okay.

Zach Kirkhorn — Chief Financial Officer

Yeah. Thanks, Martin. Thanks, Elon. So congratulations to the Tesla team on breaking multiple records in the first quarter of ’21 as Elon had mentioned, which is typically the most difficult of the year for many reasons.

To summarize the quarter, I think it’s best understood by three key items. First, we successfully launched and began the ramp of Model Y in Shanghai, achieving positive gross margin in the first quarter of production and receiving a great reception from the market.

Second, as Elon mentioned, although we began the production process for the Model S during the quarter, we have not yet begun customer deliveries. The reduction in Model S and X deliveries from Q4 to Q1 were a meaningful headwind to free cash flows and profit generation. For example, we incurred an estimated $200 million of direct P&L impact relating to this program in Q1, the majority of which is reflected in COGS. And that’s before even considering the impact of lost revenue and profits as a result of the transition. And as Elon mentioned, we expect the first deliveries to begin shortly.

Third, as we continue to work through the instability of the global supply chain, particularly around semiconductors and port capacities and while the Tesla team in partnership with our suppliers did tremendous work keeping our factories running, we did experience high expedite costs in the quarter and they were also higher than they were in Q4 with some minor interruptions to production over the course of the quarter. But we believe that this landscape is improving but it does remain difficult and it’s an evolving situation.

If we double click within net income, auto gross margin excluding credits improved sequentially and year-over-year. This is in spite of the cost mentioned for S and X and expedites and a reduction in global ASPs as our cost structure as a company is reducing at an even faster pace. So as we look out over the course of the year, we feel optimistic about our gross margin strength, particularly as some of these headwinds we’re experiencing start to be resolved.

On services and other margins, these have recovered and are trending towards profitability, aided by strength in the used car business, operational improvements in service and additional service revenue opportunities that help absorb fixed overheads.

On energy gross margins, these remained negative for the second quarter. This is driven by Solar Roof related ramp costs and winter seasonality in the lease PPA business. We continue to manage through a multi-quarter backlog on Powerwall. We’re working as fast as we can to increase production and this will aid in profitability of this business as test volumes increase.

On operating expenses, these increased for Q1, which is driven by our investments in technology and growth. In particular for R&D this includes the structural battery pack and 4680 cells, investments in the new S and X and our neural net and silicon investments.

On the SG&A side, we’re setting up infrastructure and support for both China and EMEA in anticipation of volume to come there. And as I said before, our plans show that we remain on track for sustained industry-leading operating margins.

Double clicking on cash flows, we continue to generate positive free cash flows and this was despite the significant working capital headwinds from S and X. Additionally, we are making progress reducing various forms of debt. We also invested $1.5 billion in bitcoin during the quarter, then trimmed our position by 10%, which contributed to a small gain in our Q1 financials. Taking a step back, we’ve generated $8 billion in operating cash flows and $4 billion in free cash flows over the past four quarters.

As we look forward, our plans remain unchanged for long-term growth of 50% annually and we believe we’re on track to exceed that this year as we guided to last quarter. Global demand remains meaningfully higher than production levels. And so we’re driving as fast as we can to increase our production rates. As we think about Q2 and Q3, these quarters should largely be driven by execution on S and X as we’ve discussed, continued ramp of Model Y in Shanghai and the associated cost reductions of these programs. And we expect profitability and cash generation to evolve over the course of the year in line with those improvements. And then as we get towards the end of the year, our story will pivot towards the launch and ramp of our newest factories in Austin and Berlin. So there is certainly no shortage of exciting things for us to work on and look forward to.

Thank you. And we’ll open it up for questions.

Questions and Answers:

Martin Viecha — Senior Director of Investor Relations

Thank you very much. We’ll first take retail questions from SAY website. The first question is how is Dojo coming along? Could Dojo unlock an AWS like business line for Tesla over the next few years?

Zach Kirkhorn — Chief Financial Officer

Yeah, I’ll jump in here. So with respect to Dojo —

Elon Musk — Chief Executive Officer

Sorry, Zach. My pleasure. I was on mute.

Zach Kirkhorn — Chief Financial Officer

Okay. Go ahead, Elon.

Elon Musk — Chief Executive Officer

So. Yes it’s basically saying that although like right now people think of Tesla as electric — I think Tesla as a car company or powertrain and energy company. I think long term people will think of Tesla as much as an AI robotics company as we are a car company or an energy company. I think we are developing one of the strongest hardware and software AI teams in the world, something we appear to be able to do things with full self-driving that others cannot.

So — and if you look at the evolution of what technologies we developed, we develop them in order to solve problems of self-driving. So we can find a powerful-enough neural nets a computer so we designed and built our own. The software out there was really quite primitive for this task. And so we built the team from scratch and have been developing what we think is probably the most advanced real-world AI in the world.

And then it’s sort of makes sense this is kind of what needs to happen because the road system is designed for a neural net computer, our brain. Our brain is a neural net computer and it’s — the entire road system is designed for vision with neural net computer which is — because it’s designed for eyes and their brain. And so if you have a system which has very good eyes, you can see all directions at once, you can see three focal points ahead or forward, it never gets tired, it’s never sort of texting, it has redundancy and its reaction time is superhuman. Then it seems pretty obvious that such a system would achieve an extremely high level of safety far in excess of the average person. So that’s — that’s what we’re doing.

Then Dojo is kind of the training part of that. So — because we have over a million cars and perhaps next year we’ll have 2 million cars in active use providing vast amounts of video training data that then needs to be digested by a very powerful training system. And currently, we use Tesla training software. So, we develop a lot of training software, a lot of labeling software to do — to be able to do surround video labeling which is quite tricky. This means all eight cameras simultaneously at 36 frames a second per camera, labeling video over time. There wasn’t any tool that existed before this. So, we developed our own labeling tool.

Then taking it a step further, obviously, the Holy Grail is auto labeling. So, now we’re getting quite good at auto labeling where we do — the trainers train the training system and then the system auto labels the data and then the human labelers just need to look at the labeling to confirm that it is correct and perhaps make edits. And then every time an edit is made, that further trains the system. So, it’s kind of like a flywheel that’s just spinning up and really the only way to do this with vast amounts of video data. So, then we need to train this efficiently. So Dojo is really a — it is a supercomputer optimized for neural net training. We think Dojo will be probably in order of magnitude more efficient on say — I ‘m not sure the exact right metric is, but it’s a per frame of video.

We think it will be an order of magnitude more cost efficient in hardware and in energy usage for a frame of video compared to a GPU-based solution or compared to the next best solution that we’re aware. So, then possibly that could be used by others. It does seem as though over time, I mean, just an observation — I think it is the fact that neural net based computing or AI-based computing, it is a more and more of the compute stack. Conventional computing heuristics based computing is — sure going to be important — sure going to be very important that it will become — neural net will become a big and bigger portion of compute. So, all right, that’s a long story, but I think probably as this roll and use it to and will make it available.

Martin Viecha — Senior Director of Investor Relations

Thank you very much. Let’s go through the second question from retail investors. The recent price changes on Solar Roof have been discouraging for customers and investors. Could just like to share more about Solar Roof challenges and if the outlook has changed at all i.e., 1,000 roofs per week?

Elon Musk — Chief Executive Officer

Yeah. First of all, I should say that the demand for the Solar Roof remains strong. So, despite raising the price, the demand is so significantly in excess of our ability to — to meet the demand to install the Solar Roofs. So production is going fine, but we are choked at the installation point. We did find that we’ve basically made some significant mistakes in assessing the difficulty of certain roofs, but the complexity of roofs varies dramatically.

Some roofs are to be literally two or three times easier than other roofs. So you just can’t have a one size fits all situation. If a roof has lateral protuberances or if the roof sort of the core structure of the roof is rotted out or is not strong enough to hold the Solar Roof, then the cost can be double, sometimes 3 times what we — what our initial quotes were. So in those cases what we obviously have to do is to refund customers their deposit and — what we cannot do is go and just lose an absolute amount of money, we just got to provide a refund of the deposit. But that’s what is I think most important about the solar situation, which I tweeted about past week is that we are shifting the whole — the whole sort of solar situation. So the Solar Powerwall basically solar plus battery situation to — there is only one product basically or there’s only one — one configuration, every house — we will not sell a house solar without a Powerwall.

That solar could either be solar retrofit — what’s conventional panels put on a roof or it can be the Tesla Solar Glass Roof. But in all cases, it will have the Powerwall tool technically, but this is actually Powerwall 2 plus if you will. And the plus opposed to a higher peak power capability. So, basically all Powerwall has made since roughly in November of last year, have a lot more peak power capability than the specification on the website. It’s never about twice — the power capability roughly. it’s not how you count power, but it’s about twice the peak power and about arguably twice the steady state power of the specification of the website.

The energy is same, but the power is roughly double. And old installations — so old installations will have the Powerwall and the difficulty of the installation will dramatically include — the difficulty of the installation will be — will be much less, it will be much easier because the the power from this — from the Solar Roof — Solar Glass Roof or the the solar panels will only ever go directly into the Powerwall. And the Powerwall will only ever go between the utility mains — between the utility and the the main power panel of house, which means you never need to touch the main circuit breakers of the house. You never need to touch the house circuit breakers.

Effectively almost every house therefore, looks the same electrically. Instead of being a unique work of art and requiring exceptional ability to rewire the main panel. So this is extremely important for scalability, it is the only way to do it really. And this also means that every solar Powerwall installation that the house or whatever the case may be will be its own utility. And so even if all lights go off in the neighborhood, you will still have power. So that gives people energy security. And we can also in working with the utilities, use the Powerwall to stabilize the overall grid. So let’s say if there is a blackout that was in Texas, there was a peak power demand and the peak power demand because the grid lacked the ability to buffer the power, they had to shut down power.

There is no power storage — no good point of power source. However, with how much of Powerwall in houses, we can actually buffer the power. So if the grid needs more power, we can actually with the consent obviously of the homeowner and partnership with utility, we can then actually release power onto the grid to take care of peak power demand. So effectively the Powerwalls can operate as a giant distributed utility. This is profound. I’m not sure how you will actually understand this but it is extremely profound and necessary because we are headed towards a world where, as we were just talking about earlier, where people are moving towards electric vehicles. This will mean that the power needs at homes and businesses will increase significantly.

We will — there will need to be a bunch more electricity coming from somewhere. In fact, if you go to full renewable electricity, we need about three times as much electricity as we currently have. So these are rough numbers, but roughly need twice — roughly need twice much electricity if all transport goes electric and you need three times as much electricity if all heating goes electric. So basically this is a prosperous future both for Tesla and for the utilities because — and in fact I guess this will be very — if this is not done, the utilities will fail to serve their customers. They won’t be able to do it, they won’t be able to act faster and we’re going to see more and more of what we see.

I think in California and Texas people seeing brownouts and blackouts and utilities not being able to respond, because it is a massive change going on with the transition to electric transport and we’re seeing more extreme weather events. This is a rescue for its assay [Phonetic]. So it was very important to have solar and batteries at the local level of the house.

In addition, it is important to have large battery storage at the utility level so that solar and wind, which are the main forms of renewable electricity can be — that electricity can be stored because sometimes the wind doesn’t blow, sometimes blows a lot, sometimes blows too much, at times it doesn’t blow enough. But if you have a battery you can store the energy and provide the energy to the grid as needed. The same goes for solar because obviously the sun does not shine at night and sometimes it is very cloudy. And so by having battery storage paired with solar and wind, this is the long-term solution to a sustainable energy future.

And as I said especially these are both at the local level and at the utility level. If it doesn’t work currently at local level what will actually be required is a massive increase in power lines, in power plants, long distance and local power lines all over the place, they will have to increase the size of the substations, it’s a nightmare. This must occur. There must be solar plus battery, it’s the only way. So, yeah.

Martin Viecha — Senior Director of Investor Relations

Thank you very much. And the next retail question is Master of Coin, can you tell us anything about Tesla’s future plans in digital currency space or when any such major developments might be revealed?

Zach Kirkhorn — Chief Financial Officer

Sure. Thanks, Martin. So, as I noted in our opening remarks and we’ve announced previously, so, Tesla did invest $1.5 billion into bitcoin in Q1 and then we subsequently sold a 10% stake in that. We also allow customers to make the vehicle deposits and final vehicle purchases using bitcoin. And so where our bitcoin story began, maybe just to share a little of the context here, Elon and I were looking for a place to store cash that wasn’t being immediately used trying to get some level of return on this, but also preserve liquidity, particularly as we look forward to the launch of Austin and Berlin and uncertainty that’s happening with semiconductors and port capacity being able to access our cash very quickly is super important to us right now.

And there aren’t many traditional opportunities to do this or at least that we found and then talking to others that we could get good feedback on, particularly with yields being so low and without taking on additional risk or sacrificing liquidity. And bitcoin seemed at the time and so far has proven to be a good decision, a good place to place some of our cash that’s not immediately being used for daily operations or maybe not needed till the end of the year and be able to get some return on that.

And I think one of the key points that I want to make about our experiences in the digital currency space is that there is a lot of reasons to be optimistic here. We’re certainly watching it very closely at Tesla and watching how the market develops listening to what our customers are saying, but thinking about it from a corporate treasury perspective, we’ve been quite pleased with how much liquidity there is in the bitcoin market. So our ability to build our first position happened very quickly. When we did the sale later in March, we also were able to execute on that very quickly.

And so as we think about kind of global liquidity for the business and risk management, being able to get cash in and out of the markets is something that I think is exceptionally important for us. So we do believe long term in the value of bitcoin. So it is our intent to hold what we have long term and continue to accumulate bitcoin from transactions from our customers as they purchase vehicles.

Specifically with respect to things we may do there are things that we’re constantly discussing. We’re not planning to make any announcements here and we’re watching this space closely. So when we’re ready to make an announcement on this front, if there’s one to come, we’ll certainly let you all know.

Martin Viecha — Senior Director of Investor Relations

Thank you. And the fourth question from retail investors is does Tesla have any proactive plans to tackle mainstream media’s imminent massive and deceptive clickbait headline campaigns on the safety of Autopilot or FSD? Perhaps a specialty PR job of some sort?

Zach Kirkhorn — Chief Financial Officer

Well, I’ll take this one, guys. From the safety side, I continue to say everyone that [Technical Issues] driving point and — go ahead Elon.

Elon Musk — Chief Executive Officer

I think — please go ahead. I think it’s just worth just going through the facts of the — what — specifically there was an article regarding a tragedy where there was a high-speed accident in a Tesla and there was really just extremely deceptive media practices where it was claimed to be autopilot when this is completely false and those journalists should be ashamed of themselves. Please go ahead, Zach.

Zach Kirkhorn — Chief Financial Officer

Yeah. Thanks, Elon. So I was just saying we’re committed to the safety in all our designs, and that’s number one in what we do here. Regarding the crash in Houston specifically, we worked directly with the local authorities and GSP and so wherever applicable and whenever they reach out to us for help directly on the engineering level and whatever else we can support. In that vein, we did a study with them over the past week to understand what happened in that particular crash and what we’ve learned from that effort was it auto steer did not and could not engage on the road condition that — as it was designed. Our adaptive cruise control only engage when the driver was buckled and above 5 miles per hour and it only accelerated to 30 miles per hour with the distance before the car crashed. As well adaptive cruise control dis-engage the car slowly to complete to stop when the driver’s seat belt was unbuckled.

Though further investigation of the vehicle and accident remains, we inspected the car with NTSB, NHTSA and local police and we were able to find that the steering wheel was indeed deformed. So there must — leading to the likelihood that someone was in the driver seat at the time of the crash and all seatbelts post crash were found to be unbuckled.

We were unable to recover the data from the SD card at the time of impact but the local authorities are working on doing that and we await their report. As I said, we continue to hold safety in a high regard and look to improve our products in the future through this kind of data and other information from the field.

Martin Viecha — Senior Director of Investor Relations

Okay. Thank you very much. Let’s go to the next question from institutional investors. The first question is proponents of alternative grid storage technologies claim that lithium-ion is unsuited for long-term storage at scale due to vampire drain. Could 4680 cells address this limitation? Is the limitations even more for charging the energy equation?

Zach Kirkhorn — Chief Financial Officer

Yeah, just let me jump in on the vampire drain.

Elon Musk — Chief Executive Officer

Yeah.

Zach Kirkhorn — Chief Financial Officer

That’s definitely not the issue. Good lithium-ion cell self discharges less than 0.001% of its energy per day. So the vampire drain is maybe [Indecipherable].

Elon Musk — Chief Executive Officer

As mythical as vampires.

Zach Kirkhorn — Chief Financial Officer

Yeah. I think the challenge with seasonal storage is your value proposition drops from hundreds of useful cycles per day — per year to less than maybe 10 or maybe less than five cycles per year. So it’s just a different type of technology altogether that would make sense given that it’s more than order of magnitude different use case.

Elon Musk — Chief Executive Officer

Yeah. We’ve got a long way to go before we’re dealing with seasonal technology issues, but certainly a way to deal with seasonal technology would be to have wind and solar side program side of more sub-lease [Phonetic] latitudes and put them across a variety of magnitude. So essentially let’s say in the US for example if there was — I’m not sure people understands that you’ve actually power in the entire United States with just sort of 100 — roughly a 100 mile by 100 mile grid of solar.

So I know if you don’t quite understand like how much solar is needed for United States. Almost nothing of the [Technical Issues] of almost any country in the world. The solar incident is a gigawatt per square-kilometer. This is insane. In fact, if you took the clear area, just the area, say, for nuclear power plants, the area that is considered not usable because a neutral power plant is there in most cases if you just put solar there, it would generate more power than in the nuclear plant because they typically have pretty wide clear areas.

So it really — if you have say 25% efficiency solar panels and then those are 80% efficient in how they are laid out, you’re going to do about 200 megawatts per square-kilometer. This is therefore [Indecipherable] which might be a typical sort of power plant. It’s really not much area at all. And a lot of places can have wind and solar in place.

So — anyway it’s entirely possible to power all of earth with a small percentage of earth’s area. And then to transmit that power through high-voltage DC lines, no new technology, no, no — you don’t need like room temperature superconductors, this is another myth. Room temperature superconductors almost irrelevant in my opinion, almost irrelevant.

Low-cost, long distance power lines using copper or aluminum are very important. So heating is I squared R. So that’s current squared times resistance. So as you increase voltage, you can drop the current dramatically and drop the heating dramatically to the point where it is of minor relevance, but maybe you lose 5% to 7% with a high-voltage DC power, something like that.

So I wanted to be clear. No [Technical Issues] no new material is necessary. We just need to scale this thing up. We have — the technology exists today to solve renewable energy and it sounds cool as it’s what we do it, that’s because the energy basis of the earth is gigantic, super mega, insanely gigantic. So you can’t just go and do 1 zillion terawatts overnight. You’ve got to build the production capacity for the cells, for the battery cells, for solar cells, you’ve got to put that into vehicles, you got to put that into stationary storage packs, you’ve got put that into solar panels and solar glass roofs and you got to deploy all the thing, all the stuff.

But it was certainly the case that we can accelerate this and we should try to accelerate it. And the right thing to do, I think from an economic standpoint, I think most economists would agree, is to have a carbon tax, just as we have a tax on cigarettes and alcohol which we think are more likely to do bad than good and we tend to tax fruit and vegetables less where the same should be true. We should tax energy that we think is probably bad and support energy, I think it’s probably good, just like cigarettes and alcohol versus fruits and vegetables. It’s just cognizant.

And — but I just — on the plus side, I not suggesting anyone be complacent, but sustainable energy, renewable energy will be sold, it is being sold, but it matters how fast we solve this. And if we solve it faster, that’s better for the world.

Martin Viecha — Senior Director of Investor Relations

Thank you very much.

Elon Musk — Chief Executive Officer

There is no question in my mind whatsoever that the energy storage problem can be solved with lithium-ion batteries. Zero, I want to be clear, zero. I think the bias will tend to be towards iron based lithium-ion cells. Let’s say, lithium-ion, people think lithium must be a big constituent of cells. It’s more like 1% to 2% of the cell is lithium. But the main part of the cell is the cathode. The main mass and cost in the cell is the cathode. For high energy cells, like for example what we use in most — most types have nickel based lithium-ion cells, which have higher energy density, longer range than iron based cells.

However, stationary storage, the energy to SC is not as important because just saying on the ground. And so I think the vast majority of stationary storage will be iron based lithium-ion cells, iron phosphate cathode technically. But in the phosphate part is unnecessarily through iron ore nickel, unnecessary is the terminology. It’s just typical iron and nickel and same amount of iron in the world, more iron than we could possibly use and it’s also more lithium than we could possibly use. Basically there is no shortage of anything whatsoever in iron plus based lithium-ion cells.

Martin Viecha — Senior Director of Investor Relations

Tank you very much. Let’s go to the next question from institutional investors which is you’ve suggested that between a five times to time times improvement is achievable in the automotive production versus the first Model 3 line on the first principles physics analysis. Where does Berlin fit — where does Berlin fit relative to that limit?

Elon Musk — Chief Executive Officer

I think we are so quite far away from it. I mean the thing to bear in mind with production is for those who have not — who have never done production they just don’t understand how insanely hard production is. I want to really be very, very emphatic here, prototypes are trivial, their trials play, production is hard, it is very hard.

Now you say production at large scale with high reliability and low cost, insanely difficult. But what has achieved on the automotive side was not to create an electric car. The truly profound thing on the car side is that Tesla was the first American car company to achieve volume production of a car in 100 years and not go bankrupt.

So this is this — basically myself and many others at Tesla basically have several aneurysms to get this done. It was so hard to know so — and the thing about making a large complex manufacture object is let’s say you have first order approximation 10,000 unique items, even one of those items is slow, that’s set to wait, just one, doesn’t matter how, so trivial.

We’ve had production stop because of carpet in the trunk, we had production stop because of a USB cable. At one point for Model S we literally rated every electronics store in the Bay Area for a few days there nobody could buy a USB cable in the Bay Area because we went bought them all to put them in the car literally. And there is like hundreds of stories like that. So anyway, solving that — those constraints and a logistics problem that makes World War II look trivial. I’m not kidding, like the scale is insane. We’re talking to millions of cars some massive global supply chain, 50 countries, dozens of regulatory regimes, it’s insane [Phonetic]. So — yeah.

Martin Viecha — Senior Director of Investor Relations

Thank you. And last question from institutional investor is Master Plan Part II talks about an urban transport vehicle that is smaller than traditional bus with greater aerial density achieved by removing the central aisle. Do you have any updates to share on this goal?

Elon Musk — Chief Executive Officer

Not at this time.

Martin Viecha — Senior Director of Investor Relations

Okay. Thank you very much. So let’s move to analyst Q&A.

Operator

Thank you. First question is from Pierre Ferragu with New Street Research. Your line is open.

Pierre Ferragu — New Street Research — Analyst

Hi, guys. Thanks very much for taking my question. I’d love to get actually an update on what you presented on the Battery Day. In the last six, seven months, I was wondering how much progress you’ve made on that front, first in terms of process development. So how are things coming together on your pilot line. Are you getting to the kind of production throughputs you are aiming for?

And second is actually on your production ramps. So I was wondering in which sites you’re ramping production capacity for the 4680 cell and where you stand on ramping up that capacity as well? And I have a quick follow-up on energy as well if that’s possible.

Elon Musk — Chief Executive Officer

So we have the [Technical Issues] but we have the small solar powered plant, which is still big by all standards, expected to have like a 10 gigawatt hour per year capability in Fremont, California. And we’ve made quite a few cells. We’re not quite yet at the point where we think the cells are reliable enough to be shipped in cars, but we’re getting close to that point. And then we’ve already ordered first equipment for battery production in Berlin and then battery in Austin as well. So we really don’t like the nitty-gritty elements but overall, I think we still feel quite optimistic about achieving volume production of 4680 next year.

Zach Kirkhorn — Chief Financial Officer

Yeah, I think just one thing I would add is, there’s been a lot of questions about yields. Actually I noticed people asking about that and the yield progress has been really strong every day and we were really still in commissioning phase. We were really still in commissioning phase with most of the tools to the point we’re confident that the yield trajectory aligns with our internal cost projections. We did talk about yield also at Battery Day which is one of the reasons why it’s useful to check in on that. It takes a while as Elon just mentioned to go from prototype to production and it’s not just parts, it’s processes, it’s equipment, but as we’ve matured those fit the process equipment we’ve gotten to where we need to be on the yield side.

Elon Musk — Chief Executive Officer

Yeah. And basically this is just a guess because we don’t know for sure, but it appears as though we are about 12 to probably not more than 18 months away from volume production of 4680. Now at the same time, we are actually trying to have our cell supply partners ramp up their supply as much as possible. So this is not something that is to the exclusion of suppliers. It is in conjunction with suppliers. So we want to be super clear about that. This is not about replacing suppliers, it is about supplementing suppliers.

So we have very strong partnership with CATL, with Panasonic and LG and we would — our request to our strategic partners who are cells supply is please make us — please supply us with as much as you possibly can, provided with prices affordable we will buy everything that they can make.

Zach Kirkhorn — Chief Financial Officer

Yeah. And specific to that we are on track to more than double the supplier capacity over next 18. [Phonetic]

Elon Musk — Chief Executive Officer

Yeah. Exactly. We do expect from suppliers willing to receive double the cell output next year versus this year.

Zach Kirkhorn — Chief Financial Officer

Yeah.

Pierre Ferragu — New Street Research — Analyst

Okay. And I had a quick follow-up on maybe Zach for you on your energy business. So I understand, like when I get to gross margin with Solar Roof ramp, but I was wondering what do gross margin look like there when you look at the storage business?

And where are you, what’s your ambition in terms of gross margin in that business? I guess it’s going to grow in the mix in coming years. So it’s very important for long-term modeling.

Zach Kirkhorn — Chief Financial Officer

Yeah, we’re seeing a lot of — I think for comparable margins in storage, as in vehicle but it is important to bear in mind that vehicle is more mature than the storage. So we already are at good margins with the Powerwall, but some additional work is needed to put the Megapack to achieve good margins.

Operator

Thank you.

Zach Kirkhorn — Chief Financial Officer

Yes, sorry just jumping in. Absolutely agree. Powerwall is mature. We’ve been producing Powerwall 2 for three years now and we’re at good margins there but Megapack has more room to go to achieve our target.

Elon Musk — Chief Executive Officer

We have a — we have a clear runway for improving the cost per the megawatt hour of the Megapack. Absolutely, yes, we do.

Martin Viecha — Senior Director of Investor Relations

Thank you. Let’s go to the next question please.

Operator

From Rod Lache with Wolfe Research. Please go ahead.

Rod Lache — Wolfe Research. — Analyst

Hi, everybody. I was hoping maybe just first you could talk a little bit about how you’re thinking about the rollout of Version 9 of FSD and the transition to subscription model. It sounds like some of this is about to roll out next month. I’m not sure if that’s a subscription model. But maybe you could just spend a little time talking about how impactful you expect that to be.

Elon Musk — Chief Executive Officer

Zachary, go ahead.

Zach Kirkhorn — Chief Financial Officer

Yeah. We’re working on getting FSD subscription out and there is a couple of internal technical dependencies but from a business model perspective that’s aligned and we’re hoping to roll that out soon. The key thing that I say here, there is a lot of potential for recurring revenue based on FSD subscription. If you look at the size of our fleet and you look at the number of customers who did not purchase FSD upfront or on a lease and maybe want to experiment with FSD this is a great option for them.

One of the things we’ll need to keep an eye on is a potential transition from cash purchases of FSD subscription over to — cash purchases of FSD who may move over to FSD subscription. And so there could be a period of time in which cash reduces in the near term and then as the portfolio of subscription customers built up then that becomes a pretty strong business for us over time. But we’re hoping to get this launch pretty soon and see what the responses to it.

Rod Lache — Wolfe Research. — Analyst

Okay, great. And I was hoping, Zach, maybe you can just talk a little bit about opex. I think it was a noticeable increase even excluding SBC. Obviously, a lot going on this quarter. But can you maybe just talk a little bit about how we should be thinking about that going forward?

Zach Kirkhorn — Chief Financial Officer

Sure. On the R&D side what we’re seeing, as I mentioned in my opening remarks, is kind of a convergence of a series of programs that are happening. And our R&D opex spend correlates to where we are in the product lifecycle on different programs. And so we’re kind of at the tail end of investments in, what we call internally, palladium which is the new Model S and Model X. And so we expect that to decrease over time, but it was high in Q1 for a lot of the reasons that Elon has mentioned.

We’re also getting very heavy into 4680 development that Drew and team are working on in the associated structural battery pack that goes along with that. And so these are new technologies, not only new to Tesla but new to the industry. So we’re investing heavily there and in R&D side to work out those kinks. And spend along — in those areas should continue over time as we continue to work through the development cycle of those.

And then I also mentioned — Elon talked a bit about Dojo and the potential there. So from neural net investments and custom silicon investments these continue to be areas that we spend on and make investments.

On the SG&A side, the business is pivoting very quickly to be global and China is ramping quite quickly and we’re trying to make sure that we are staying ahead of the volume so that we have the right sales capacity, store capacity there, local investments in IT and others to manage the growth such that as the growth comes the execution challenges are smaller than maybe in similar periods of growth that we’ve seen in the past. And so we’re making investments there ahead of the growth and overall as we look at opex as a percentage of revenue over the course of the year we do expect to see a substantial drop from 2020 to 2021 as the volumes in the latter part of the year pick up.

Martin Viecha — Senior Director of Investor Relations

Thank you. Let’s go to the next question please.

Operator

Thank you. From Dan Levy with Credit Suisse. Your line is open.

Dan Levy — Credit Suisse — Analyst

Hi. Good evening. Thanks. Two questions. One is on COGS. I think we’ve gotten from Battery Day a pretty good feel about the potential for COGS reduction related to powertrain. But I’d like to get a sense of the path to reducing COGS ex Powertrain, you still need a meaningful reduction on that front to make the math work on a $25,000 vehicle. So, what levers do you have to reduce in your cost ex Powertrain? Is just more scale, better supplier pricing or is it just based on ongoing cost reduction?

Elon Musk — Chief Executive Officer

[Indecipherable]

Zach Kirkhorn — Chief Financial Officer

Yeah, I mean on the vehicle side there is plenty of opportunity as well. Obviously building a car like Model S is quite complex and has various moving parts. Model 3 and Model Y were steps of improvement in that. But when you look at some of the other advancements that we’re including in the Model Y factories into Austin and Berlin, we reduced the body pound by as much 60% in the product cost money. So we continue to find optimizations there as well as we get economies of scale when we start to talk about the volumes we’re considering worldwide with four factories building the same vehicle. So both of those things on the vehicle side will improve our COGS as well and the Powertrain continues to be integrated into that.

Dan Levy — Credit Suisse — Analyst

Great. And then just related as we see Berlin and Austin ramp, I’d like to just get a sense on the comparison of Fremont versus the new capacity. Obviously Fremont non -optimized because you bought the old NUMMI facility. You had to retrofit that to your need. So maybe you can give us a sense of how your new capacity is going to differ versus Fremont? What are the areas that you have efficiencies that you previously didn’t have, maybe how much does that add up to improved COGS over time to help you achieve that $25,000 vehicle?

Elon Musk — Chief Executive Officer

Yeah, I think we never to talk too much about future product development. The earnings call is not the right place for — to make major product announcement. So, yeah, we’ll get there. We will provide it later.

Martin Viecha — Senior Director of Investor Relations

All right. Thank you very much. Unfortunately, this is all the time we have for today. Thank you very much for dialing in and for listening and we’ll speak to you again in about three months. Thank you.

Elon Musk — Chief Executive Officer

Thanks, everyone.

Operator

[Operator Closing Remarks]