tesla motors, inc. - kyle holloway -...

Running Head: TESLA MOTORS, INC. 1

Tesla Motors, IncorporatedAn Audit Risk Assessment

Kyle HollowaySpring Hill College

TESLA MOTORS, INC. 2

Tesla Motors, Incorporated is an automotive company that focuses on the design,

development, manufacturing and selling of high-performance fully electric vehicles and

advanced electric vehicle powertrain components. Tesla’s main products include: The Tesla

Roadster, the Model S, Model X, Powertrain Development and Sales, Battery Packs, Power

Electronics, Motors, Gearboxes, and Control Software. The company uses various raw materials

to produce the previously mentioned products, mostly metals – such as aluminum, steel, nickel

and copper.

Tesla Motors is a relatively small automotive company compared to most other

companies within the industry with a staff size of only 1,417 employees. In 2011, Tesla Motors

saw a considerable amount of growth in sales, increasing from $116,744 in 2010 to $204,242.

The company also has assets totally $713,448 as of 2011. Tesla Motors is head-quartered in Palo

Alto, California and also has other locations in Hawthorne, California and Maidenhead, United

Kingdom.

Tesla Motors has close ties to a few different companies, particularly companies related

to the electric vehicle industry. Beginning in 2008, Tesla Motors has entered into close relations

with the Daimler AG, to perform specific research and development services for the

development of a battery pack and charger for Daimler’s Smart fortwo electric drive. In May

2010, Tesla announced their intentions to cooperate with Toyota on the development of electric

vehicles, and for Tesla to receive Toyota’s support with sourcing parts and production and

engineering expertise for Model S. Tesla Motors also announced a collaborative effort with

Panasonic on the development of next-generation electric vehicle cells based on the 18650 form

factor and nickel based lithium ion chemistry.


There are some very key economic factors in the automotive industry in general that

directly affect Tesla Motors. These factors include: positive image, distribution network,

compliance, and flexibility. An automotive company needs to maintain a positive image for their

company as consumers have many different options and may purchase a competitor’s product

based solely off of a single negative event. A company in the automotive industry is directly tied

to their distribution network; if it is hard for a consumer to purchase a vehicle they are more

likely to turn to a competitor. The automotive industry is also straddled by compliance issue.

Companies, like Tesla Motors, have to meet very specific and strict guidelines and compliances

relating to efficiency, emissions, safety, etc. The automotive industry also demands flexibility in

their products; consumers want customization and updates to models very frequently and if a

company is not flexible in their product designs and creations consumers are likely to go to a

competitor.

As Tesla Motors, Inc. was only formed in 2003 it is a relatively new company. They only

began producing a product, their Tesla Roadster, in 2008 and as of year-end 2011 Tesla only sold

approximately 2,150 Roadsters. They are starting to diversify their product line by introducing

the Model S, and plans for the Model X vehicles. The company is operating at a loss, relying on

governmental subsidies for Zero Emissions Vehicles (ZEV) and deals with Daimler AG and

Toyota Motor Corporation for compensation relating to research and development work relating

to a full electric powertrain. The diversification of their product line and subsidies should help

Tesla Motors, Inc. move out of the early stages of their life-cycle and into a more stable portion

of their life-cycle.

Tesla Motors, Inc. faces some interesting and critical factors in the Electric Automobile

industry that they have to address in order to succeed. The success of the company is based


almost directly on the rise of gasoline and oil prices, as the prices climb the demand for

alternative fuel vehicles – like the Tesla Model S – also increases. This dependency makes for a

very instable demand which can be affected materially without notice. Tesla Motors also has to

work around competition, both domestically and internationally. The rise of hybrid and more

fuel efficient combustion based vehicles directly harm the demand for electric vehicles. Another

factor that Tesla Motors has to address is the perception of electric vehicles by the average

consumer. The average consumer views electric vehicles as expensive, they worry about the

range of the vehicle on a single charge, the accessibility of charging stations, the deterioration of

the battery life over time and regular maintenance of the vehicle.

Tesla Motors stands in shaky grounds when it comes to these factors, but as a relatively

new company they still have ample opportunity to address them and stand on more firm basis

when it comes to these factors. There is little a single company, especially one as small as Tesla

Motors, Inc. can do to affect the prices of gasoline and oil. They are hedging their success on the

rise of gasoline and oil prices, which seems to be the right move in the long term. Tesla is

marketing their vehicle as a ZEV to help stabilize demand by tapping into the environmentally

conscious consumers. It also targets the early adopters and wealthy consumers looking for

something unique and luxurious with their Model S and Model X vehicles. They are doing little

to help change the perception of electric vehicles by the average consumer, although they do

address it. It seems they are working on fixing issues that average consumer worries about but

are not helping to educate. This seems to be an issue they are tabling until they achieve a greater

level of success.

Some legal and regulatory issues that Tesla Motors faces are typical automotive industry

standards concerning safety and emissions. These are standard for every automotive


manufacturer. A legal issue that is unique to Tesla Motors and other electric vehicle

manufacturers is a minimum noise level for vehicles driving at low speeds. Electric engines

make less noise than standard combustion engines and safety issues concerning people not being

able to hear the vehicles approaching have arisen. Aside from these issues, Tesla is subject to

various legal proceedings that arise from the normal course of business activities. In addition,

from time to time, third parties may assert intellectual property infringement claims against Tesla

Motors. An unfavorable ruling in these cases may result in a material adverse impact on the

results of operations, cash flows, financial position and brand.

Tesla Motors, Inc. is particularly involved with social matters concerning the rise of

alternative fuel vehicles (AFV) and the fluctuation of gasoline and oil prices. They hope to profit

off of these matters, while providing consumers a more stable source of power for their vehicle.

The prices of electricity are more stable than gasoline/oil currently, which allows consumers to

effectively plan and budget cost concerning fuel for their vehicle more accurately. The company

is also involved with pollution and emissions released by standard combustion vehicles. They

address this social matter by making a Zero Emissions Vehicle which releases fewer pollutants

and emissions into the atmosphere and appeals to environmentally conscious consumers.

Every major automotive manufacturer is a competitor to Tesla Motors. Their competitors

have every different type of vehicle to attract consumers away from Tesla Motors, Inc, except

the type of vehicle that Tesla manufactures. Tesla Motors focuses on manufacturing luxury Zero

Emissions Vehicles based off of electricity. While there are companies who make fuel

efficient/hybrid luxury vehicles – like the Mercedes-Benz S-Class Hybrid, and companies who

make zero emission vehicles based off of other fuel sources – like the Fiat Multipla that runs on

compressed natural gas, and even companies who manufacture electric vehicles – like the Nissan


Leaf, there is no company that manufactures luxury, electricity based, zero emissions vehicles

like the Tesla Model S and Tesla Roadster. This not only gives Tesla Motors the exclusive

market for the automotive they manufacture, it also allows them to grow their market share

rapidly before competitors start to enter into the market – an advantage critical in the highly

competitive automotive industry.

Tesla Motors is an interesting company to research for an analytical review. While they

have been increasing revenue every year since they went public, they also have been operating at

a loss the entire time they have been public. Their revenue has increased from $15 million in

2008 to $117 million in 2010 and up to $204 million in 2011. In contrast, they have been

decreasing their operating income each year, going down from $-147 million in 2010 to $-251

million in 2011. However, expenses related to the development of the Model S and design and

engineering activities related to the Model X mounted in 2011. These are one-time expenses that

have amounted to $209 million, an increase of 224.73% over the previous year’s research and

development expenses. This puts investors in an interesting position, while the company has

been showing growth when it comes to sales and revenue; they have also been showing an

increasing loss each year. They have very poor profitability ratios – posting a -31.83% return on

assets, a -49.69% return on capital, and an astonishing -291.29% return on equity. Tesla also has

not posted stellar growth over prior year numbers, including a -27.27% for total revenue, and a

-78.42% for gross profit. These numbers indicate that Tesla Motors, Inc. is not a healthy

company, but a 1.3x inventory turnover ratio and a 223.16% increase in inventory over the prior

year show the potential for profitability in the future for Tesla Motors and it seems to be on the

rise.


Tesla Motors garners capital in both typical and atypical manners. They have revenue

from sales and various projects, $204 million, and they have $3.8 billion in market capital. They

also gather capital from the Department of Energy Loan Facility (DOE Loan Facility) that has

totaled $276.3 million. The capital market has responded positively to Tesla Motors, as it has

shown a positive growth in stock price over the company’s lifetime. Despite its favorable market

response, Tesla’s earnings have been relatively poor. They currently, as of November 28th, 2012,

are posting $-2.21 earnings per share, however that is an increase over their 2011 EPS of $-2.53.

This EPS is below industry average; however this is expected for a newer company.

PricewaterhouseCoopers is the audit firm who reviewed Tesla Motors, Inc. for the 2011

year. They also did all the previous audits of Tesla Motors after they went public. They have

released unqualified opinions each time. They have not noted any material misstatements or

failures in their internal controls.

Tesla Motors is perceived very positively by their financial statement user community.

NASDAQ has the community sentiment listed as Bullish; Wall St. Recommendations have Tesla

as 4.0 on a 5.0-1.0 scale (with 5.0 being buy and 1.0 being sell). The consensus is that Tesla is on

the rise and investors should look to buy this stock. Early estimates for 2013 revenues are listed

at $1.7 billion consensus, a drastic increase from the current revenue estimates for 2012 year-

end, which are around $409 million. If Tesla meets the estimates for 2013 revenues they are

looking at a positive EPS for the first time, with estimates hovering $0.06.

There are numerous material transactions between Tesla Motors and Toyota Motors,

particularly involving the development of a powertrain for use by Toyota vehicles. There are also

the loans given by the DOE Loan Facility. Since the demand for Model S vehicles surpass the


production rate, Tesla Motors transaction cycle for the sale of the Model S vehicle involves

selling their entire inventory of the Model S to reservations almost immediately. This prevents

them from stockpiling inventory.

Tesla Motors, Inc. operates almost exclusively in high-risk areas. They rely heavily on

the expectations that electricity powered vehicles will be adopted wide-spread. They can be

materially affected by developments in other alternative fuel sources, efficiencies in combustion

based engines, and the price of oil/gasoline. They also are using a new, highly risky distribution

model that involves company owned dealerships, rather than the independently owned dealership

that dominate the distribution model for automobiles currently.

The management and audit committee appear to strive for perfection and complete

integrity when it comes to their internal controls over their internal controls, particularly when it

comes to financial reporting. However, with huge expectations in revenue increases for 2013,

along with going concern issues, and a lack of profitability to date, there is a massive amount of

pressure that could lead to fraud. The company has shown no issues with integrity and or reports

of fraud to date, which leads to me to believe that it would be appropriate to select the client with

the expectation of an increased amount of scrutiny. Since, the client is located mainly in

California, with a minor branch in the UK; the audit effort should be allocated with the focus on

the US branches, particularly the Palo Alto headquarters, with sufficient focus on the other

locations. With the success of the internal controls to date, there would be a strong use of the

internal audits, with minor sample based testing to verify the accuracy. The audit plan should be

plan accordingly for outside specialists, which will allow them to come into the audit and

complete their tasks with little disturbance. Auditors with expertise in the automotive

manufacturing industry would have an important place in this audit, as a newer, more risky


company would require auditors with more experience in the field. I would expect an unqualified

audit report to be issued, much like the previous years.


Mr. John Smith, CPA Managing PartnerSmith, Black, & Edwards110 Laughing Tree Ct.Fountain In, SC 29644

Dear Mr. Smith,

Upon reviewing the financial statements, annual report and Form 10-K for the company Tesla Motors, Incorporated I have come to the conclusion that initially Tesla Motors, Inc. may appear to be a risky company that will require large amounts of planned audit risk. However, I believe that based on the strength of their internal controls, along with previously successful audits that resulted in no findings of material misstatements that Tesla Motors, Inc. will provide roughly the same amount of risk as the industry standard. However, since Tesla Motors, Inc. is a relatively new company, facing multiple years of operating losses and an upcoming year, in 2013, of estimated operating revenue for the first time that auditors with expertise in the automotive manufacturing industry be large involved with the audit. It is my belief that their expertise will not only help detect any material misstatements, but also help Tesla Motors, Inc. in their continued growth and managing upcoming expectations. I believe that the main focus of the audit should be centered around Tesla Motors, Inc.’s headquarters based in Palo Alto, California with secondary focus placed on the locations in Hawthorne, California and Maidenhead, United Kingdom. I believe that with the proper auditors and a well formulated audit plan, the audit of Tesla Motors, Incorporated will be a success.

Sincerely,

Kyle P. Holloway, CPASenior AccountantSmith, Black, & Edwards110 Laughing Tree Ct.Fountain In, SC 29644

tesla motors, inc. - kyle holloway -...

Documents