On the 4Q 2016 financial results conference call in February, Tesla (NASDAQ:TSLA) confirmed what I had been saying for some time about the first Model 3 units going to Tesla’s own employees: here.

From the transcript:

“The initial cars, sort of Founder Series, actually go to company employees, because I think it’s important for us to have a good feedback loop on the product that we’re making. And if there are any issues, bugs or things that need to be addressed that we can address those before customers experience them.”

A little later in the transcript:

“Probably going to be pretty close to production. We’ll open it internally. So, the first cars will go to Tesla employees and investors and whatnot and so forth so that we can experience any challenges before our customers do. So we’ll obviously do it internally sooner than we would do it externally. So I think it’s probably three months or four months away.”

Basically, the first so-and-so many Model 3 units will be going to Tesla’s own employees. Seeing as Tesla says deliveries will begin in July, how many units are we talking about, that will be going to the employees first?

Tesla wrote in its 4Q 2016 investor letter that it will exceed 5,000 per week some time in the fourth quarter of 2017: here.

Assuming 12 weeks per quarter, the production ceiling is therefore somewhere in the ballpark of 60,000 units per quarter as a run-rate starting some time in the fourth quarter of 2017. The reality before then will naturally be dramatically less, and Tesla doesn’t have 60,000 employees anyway. Then again, each Tesla employee could get more than one car as a Guinea pig. Spread the risk inside the family!

Before we go any further, let’s examine what Tesla said about Model 3 for 2017 less than a year ago, on the 1Q 2016 earnings call here.

“So as a rough guess, I would say we would aim to produce 100,000 to 200,000 Model 3s in the second half of next year. That’s my expectation right now. Yeah, so that’s the thing.”

Does anyone believe that that’s still the thing? Does anyone believe that Tesla will come even close to the lower end of that range – 100,000 units of the Model 3 – before the end of 2017?

For purposes of this discussion it doesn’t matter whether it will be 3,000 or 15,000 Tesla employees who will be testing the Model 3 until it is deemed good enough for outsider-civilians to take delivery of this otherwise untested rocket on four wheels. Remember what Elon said in the quote above: “…experience any challenges before our customers do.”

There are so many issues with this methodology: Are these Tesla employees qualified to be test pilots? If you’re working in the accounting department? Marketing? Janitorial services? On the assembly line?

Besides, Elon said that this group wouldn’t include just employees. It would also include “investors and whatnot.”

Seriously, are investors qualified to evaluate cars that are not yet deemed good enough to sell to the general public? Which other automaker does this? Why do you suppose that is?

And would it be too much for Tesla to clarify who is included in this “whatnot” category? Are automotive journalists part of “whatnot?” Inquiring minds want to know.

Actually, automotive journalists may just be more qualified to evaluate these things than almost anyone else in society. Who else spends the year driving 100 other new cars? It would seem reasonable that if Tesla actually wanted some qualified feedback, that it should send the first 300 or so cars off the line to the top journalists in the country.

Who are we kidding? That probably won’t happen.

Instead, the more qualified people are apparently those who don’t spend the year evaluating all new cars in the market – such as the random Tesla in-house bureaucrat, line worker, “investor” and “whatnot.” One supposes that Tesla should mix it up a little internally more often just to test its own products and other functions: Swap the assembly line worker with the accountant, from time to time. It would make just as much sense.

Per definition, these cars aren’t good enough to sell to the general public — that’s their whole justification for doing this in the first place (see the quote from the transcript above) – so what are the dangers to which these testers (including investors and “whatnot”) will be exposed? Anything safety-related? Wheels falling off? Cars stalling on the freeway because of battery connector issues? (here)

That does pose an interesting liability question: What happens if the Tesla janitor or assembly line worker takes his family out for Sunday brunch or church in one of these cars not yet deemed suitable for regular customers, and something goes wrong? How do you even insure a test car that is a test car precisely for the reason that it has not yet been deemed worthy of sale to the general public? Why would an insurance company want to touch a car like that?

In any case, this leads us to the arrangement in which Tesla’s employees will be driving these cars – whether 3,000 of them or any other number. Will they be sold outright, in a manner no different than a Tesla Model S or X is sold to a regular customer today? Or will they be leased?

Whether sold or leased, two questions immediately arise: Will there be a discount, and will there be return rights?

As pre-production test cars, these cannot – per definition – be of the same quality as the cars that will be sold once the testing period is over, and the Model 3 has been deemed worthy of being delivered to regular non-employee customers. We know this from the Models S and X, of course – the first several thousand units, arguably even more than that, are widely deemed to have been of inferior quality compared to those that are being produced right now.

If you are going to take delivery of an inferior product, presumably you should get a discount, no? And seeing as this is a highly unusual – unprecedented – case of an automaker distributing test cars to people who are not professional test drivers, what about outright return rights? Will the employees be able to hand them back in some form, if something is discovered during the testing period and therefore doesn’t turn out flawlessly? Will they be able to trade them in on favorable terms?

This all goes to the accounting question: Are these “sales” (or leases) of Model 3 test cars actually “sales” from an accounting perspective? I don’t have the answer, but I have not yet seen anyone else asking the question, so I’m asking it now!

Federal and state tax credits: Why applied to test cars?

Are Tesla’s own employees expecting to take advantage of the $7,500 federal tax credit while employed in the task of being part of Tesla’s new car testing regime? Why should the U.S. taxpayer subsidize company employees testing a new car? Do other automakers get this kind of subsidy for testing their electric cars as well? If you can find any such example, please let me know. I’m not aware of any other automaker being able to bill the U.S. taxpayer $7,500 for each electric test car.

And if there are return rights or significant discounts to these test cars as a result of them being pre-production test cars, should someone be able to collect $7,500 from the U.S. Treasury for each of those potentially thousands of units as well?

The fundamental dilemma: Tesla can’t have the cake and eat it too

Either a car is a test car and it’s not sold to, or driven by, civilians: There is no revenue from it, and it’s crushed upon the conclusion of the testing period. The car does not count as a sale. No $7,500 per electric car subsidy is collected as a result of being part of a testing program among company employees. These cars carry manufacturer’s license plates.

That’s how all other automakers do it, as far as I know. Is Nissan an exception? Is Hyundai? Is Ford (NYSE:F)? Is General Motors (NYSE:GM)? You tell me. I can’t find an exception.

Alternatively, a car is not a test car if it’s delivered to everyone. At that point, the car doesn’t come with “test car status discount” or special return rights for being a test car. It’s the way any car is sold to the general public by any other automaker – Chrysler (NYSE:FCAU), Toyota (NYSE:TM), BMW, anyone. You can take the federal electric car tax credit, and there are no return rights for being a pre-production tester.

Basically, you don’t co-mingle the two groups described above. You complete the testing period using professional test drivers. These cars are not sold, no federal electric car tax credit is collected, they carry manufacturer’s license plates, and in the end these cars are crushed.

Then, once that process has been completed – and that can take well over a year – you can sell cars to the public.

It seems to me that Tesla is basically trying to co-mingle these two groups here. It wants the benefit of counting these cars as “sales” and potentially for the employees to collect the $7,500 per car Federal electric car tax credit — but without the liabilities that go along with having professional test car drivers ringing out the issues before proper serial production starts, and crushing those cars in the end.

To be clear: Tesla is engaging in conventional automotive testing – right now – with professional test drivers, cars that have manufacturer license plates, etc. We have all seen the spy photos. This process looks to have started around the second week of March 2017. The point is that a normal automaker normally doesn’t take anywhere near four months to conduct this sort of testing, they don’t do it mostly in California’s flawless climate. This sort of testing would take dramatically longer and include very rigorous and extended testing in some of the harshest places on earth.

Tesla: Well, it looks to be handing over this process after only four months, to “employees, investors and whatnot.” Therein resides the difference compared to all the other automakers.

It all boils down to this:

If the Model 3 is good enough to be sold/delivered to Tesla’s own employees, investors and “whatnot” – it is also good enough to be sold/delivered to the general public. And if the Model 3 is NOT good enough for the general public, then it’s a pre-production test car, and should be treated as such from an accounting, insurance, licensing, and tax credit perspective.

Disclosure: I am/we are long F, GM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: At the time of submitting this article for publication, the author was long GOOGL, GM and F. However, positions can change at any time. The author regularly attends new vehicle launches, press conferences and equivalent, hosted by most major automakers.

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