Re: Tesla [TSLA] Has A Warranty Accounting Mystery — Exploring The Goodwill Theory

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My recent article on “Tesla’s Warranty Accounting Mystery” got a lot of comments, and to reply correctly, I feel as if I should share some further research. In this article, I’m going to specifically discuss the “goodwill” warranty claims that keep coming up, what I know about them, and what I think I think about them. I’ll return with another article soon addressing some of the other questions and comments people had.

If you haven’t read that article above (or my original warranty accounting mystery article published in January), you should probably start there, as it will give you background on some of what I’m going to cover within this one.

“Goodwill” Repairs

The first thing that needs to be defined is what is a “goodwill” warranty repair. Simply put, it’s a repair the company providing the warranty does to provide “goodwill” to the customer, that otherwise would not fall under the standard warranty. For instance, if a company repairs something for free just beyond the warranty expiration date, or if the damage repaired was due to something not covered by the warranty, like neglect or abuse. Eric Arnum from WarrantyWeek.com used this example as we discussed this topic recently:

“Goodwill is simply giving the customer the benefit of the doubt to keep them happy and loyal. It’s a bit like giving 13 donuts in a dozen. You don’t then write one off as employee theft. You call it customer goodwill and you hope they come back soon for more.”

There is a belief, started originally by a noted Tesla short seller, but then bolstered by a series of articles on a site that generally writes positively about EVs, that Tesla is using the goodwill classification regularly to avoid … something. The shorts believed it was a way to unfairly reduce warranty costs, and therefore not put enough money into its warranty accounts, thus increasing profits. The EV site hypothesized it may be trying to avoid the “lemon law” or maybe avoid NHTSA oversight.

I’ve got a number of problems with this thought, so let’s walk through them. It’s worth pointing out, however, that making assumptions about goodwill is sort of building assumptions on assumptions, and as I’ve illustrated before, small changes can make big impacts. Draw your own conclusions — or better yet, show me how I’m wrong — in the comments.

Is Mislabeling Widespread?

The first issue I have is that I can find scant actual evidence of this being a widespread problem. The site which reported it found a Model X owner who took his car in for repair due to a leaky windshield. The owner of the Model X informed Tesla that the window leaked when they drove through puddles. Although the windshield may have had an issue at the factory when it was installed, it was labeled as “goodwill” on that particular owner’s bill.

Was that the right classification? If the window leaked when it rained, as the article claims, it probably was. But, if the owner told Tesla it was only an issue when driving through puddles, as the article implied, I can fully understand the service center wondering if you’re purposefully hitting standing water to make big splashes, and deciding if it’s only leaking when you do that, it’s goodwill — not your “basic warranty.”

From my own experience, Tesla labels everything as “Basic Vehicle Limited Warranty.” I have one of the early dual motor Model 3’s without the badging on it. In my most recent warranty visit, getting the dual motor badge was labeled as “Basic Vehicle Limited Warranty.” If Tesla is actively trying to relabel things to avoid claiming them as warranty expenses, this seems like a perfect candidate to legitimately bury somewhere else, but they didn’t bury it.

But it’s worth highlighting that looking at any individual claims doesn’t tell you much. As Arnum notes:

“I never get that deep into the guts of the individual claims, because none of that is public and only half of it is true. And you don’t know which half.”

To be clear, Tesla doesn’t publish individual warranty stats, but if it was widespread, we should be able to find lots of examples online, right? After hours of my own research looking through various Tesla forums and owner groups, I did not find a single example — including this windshield — where I felt the label was clearly improper. I did find a number of times Tesla replaced or fixed issues under goodwill after owners had their warranties expire.

This isn’t to say that I found everything, and since humans are human, I’m sure that there are at least a few issues out there where legitimate warranty issues were mislabeled as “goodwill,” but if it was as widespread as some people believe, I feel like it would be easy to find multiple examples.

Does Mislabeling Avoid Lemon Laws?

Lemon Laws vary by state, but they generally give the vehicle manufacturer a certain number of times to attempt repair of a certain part before it gets classified as a lemon, or gives them a certain number of days in which the vehicle is unusable due to repairs. The way these laws are set up, I don’t see a benefit Tesla would receive for labeling them as goodwill.

The items I found labeled as goodwill while the warranty was still active were generally things like fixing rubber seals or cleaning stains off the seat (supposedly left by the service center). These are repairs that won’t lead to lemon law scrutiny.

All of the issues for things that could be lemon law related — like drivetrain replacement — seemed to be correctly labeled as warranty work. If Tesla was trying to avoid lemon laws, why would it hide repairs that wouldn’t count toward the lemon law as “goodwill” by classifying actual issues properly? That doesn’t make sense to me.

Does Mislabeling Avoid NHTSA Scrutiny?

Could Tesla avoid NHTSA scrutiny because it doesn’t need to report “goodwill” repairs to the organization? I think this is doubtful, too. I was told by the technician that my control arm issue was a regular occurrence with early Model 3s. Looking into it, I easily found dozens of other owners with the same issue. And the few who posted their service records all showed that these control arms were repaired under the “basic warranty”

It’s definitely more of a safety issue than a leaky windshield. If there was a coverup, wouldn’t this be the issue to cover up?

Besides that, Tesla seems to get investigated by the NHTSA constantly. Just this year alone, the NHTSA has investigated Tesla for unintended acceleration, Model S infotainment screens, and early Model S battery packs. If the goal is to avoid NHTSA scrutiny, it’s clearly not working.

Is it possible that there is some sort of coordinated attempt to mislabel certain repair work as “goodwill” for some nefarious reason? Sure! It’s also possible that my Model 3 is really a Transformer in disguise. I just don’t think it’s very probable.

But It Could Helps Tesla Show Profit, Right?

The math doesn’t add up. Tesla could decide to put the cost of “goodwill” claims against either their warranty account, or against a different account. In one of our email exchanges, Arnum made this point about the theory that Tesla would be hiding out-of-warranty repairs as goodwill against it’s warranty account:

“So let’s assume their theory is correct. If Tesla hides out-of-warranty repairs as goodwill, why is its claims rate so low? Tesla was at 1.2% last year. Ford 3.3%, GM 2.5%, VW 4.4%, Toyota 1.8%. That’s math, not opinion. They say the math is a fraud? That’s also an opinion.

“Conversely, if you want to run the conspiracy backwards, if Tesla hides its warranty work as out-of-warranty repairs and calls it goodwill, why keep so much in the warranty reserve fund? Why accrue $555 million and spend only $250 million? Why not accrue just $250 million instead, and boost net income by $305 million?

“The shorts would say, that’s exactly what Tesla is doing! Look at the fourth quarter of 2019, when they took $37 million out of the warranty reserve to boost earnings! But they fail to point out that in the first quarter of 2019, Tesla added an extra $37.75 million to the same reserve fund, thus impacting earnings, and helping the shorts make their case last May. Truth is, they make adjustments. Sometimes those adjustments are up; sometimes they are down. And as you wrote in your story, someday they could make a half-billion adjustment without unduly impacting the resilience of their reserve fund. The shorts will shout!”

The math doesn’t add up there. Instead, the argument seems to have changed to Tesla is shifting its warranty expenses to other accounts such as “Services and Other.” The problem is this does nothing to help Tesla’s bottom line, as Arnum points out:

“And this new conspiracy theory, where Tesla is allegedly burying some warranty claims in the ‘Services and Other’ segment, again, why bother? You can also mis-classify all warranty work as interest payments. But what do you gain if you do that? An expense is still an expense, even if it’s blatantly mis-classified. And given how closely scrutinized Tesla is – I mean, NHTSA is investigating its touchscreens, for chrissakes – why risk it?”

In my previous articles, I’ve mentioned Tesla accrues far more than other manufacturers on a per-vehicle basis. Look at Figure 5 in this article from Warranty Week to see how off the charts Tesla’s warranty accruals have been compared to the rest of the industry. Tesla was putting aside more than 5 times as much for warranty work than anyone else, and while it has lowered that as the Model 3 has become a larger portion of the product mix, it is still booking $1,510 per unit as of this year. Ford is booking $591.

The original theory was that Tesla was mislabeling things so it could claim more of the sale price of a car as revenue, reduce its warranty coverage, and turn a quicker profit. The problem is we can clearly see that Tesla has accrued a massive warranty war chest — the largest in the industry based on both per-vehicle accrual and claims capacity — so the entire theory that Tesla is abusing goodwill to accrue less, therefore inflating profits, is clearly incorrect.

Is there the possibility that there is something weird still going on? Sure, there always could be. As Arnum points out:

“Then again, in defense of the conspiracy theorists, I’d ask the same question of VW, which cheated on its diesel tests until 2015 and spent $20 billion fixing it after getting caught by some students. Was it worth it? I mean, if you’re going to embark on a massive fraud, you have to figure either you’ll never get caught, or you’ll eventually get caught and it will cost you less than not cheating. Anything else is irrational. So what were they thinking?”

Herein lies the entire problem for me with any of this. Tesla has been heavily scrutinized by seemingly everyone who matters in the past few years — TSLA short sellers, the NHTSA, the SEC, and investors like me who started out skeptical. If Tesla was committing a massive fraud, for absolutely no discernible reason, why isn’t it at least reaping some of the benefits from this by doing something like making a massive reduction in its current warranty reserves?

Conclusion

Ultimately, math doesn’t lie. If we are going to find fraud, the math should add up to at least justify the reason for the fraud. As far as I can tell, and as far as a warranty expert can tell, Tesla’s numbers don’t support the company doing any sort of fraud with this. I cannot find proof of the supposed “widespread” issue of repairs being mislabeled as goodwill. And the only things I can seem to find that are even questionable wouldn’t have a benefit from a safety standpoint, thus not lending credence to the theory that Tesla is avoiding NHTSA scrutiny.

Arnum had a better conclusion than I did, however, so I’ll let him end this:

“Oh, I know, Tesla is all part of a big conspiracy, involving the freemasons, the Queen of England, Kanye West and Bill Gates, to make us give up on gasoline and lose our freedom because we have to wear masks. Or maybe, just maybe, some of these shorts have lost their shirts, pants, shoes and socks, and now they’re looking for someone to blame. Will they blame you and me? Undoubtedly. But if I say to them how does your conspiracy theory explain away this basic math, and they say the numbers aren’t real, then we really have nothing to discuss. 2 + 2 = fraud? So I would say, prove the fraud, expose the cabal, or shut the eff up.”

Special Thanks

Again, a huge thanks to Eric Arnum of WarrantyWeek.com, as his expertise has proven invaluable for this deep dive. I feel it’s also worth pointing out Mr. Arnum is not a Tesla shareholder.

If you’re interested in further clean technology warranty information, I’d like to direct you to Warranty Week’s recent Solar & EV Warranty Report, a great dive into recent warranty claims by Tesla, BYD, and others in the genre of, well, solar and EVs.

Disclaimer

I am a Tesla [NASDAQ:TSLA] shareholder who has purchased shares within the preceding 12 months. Research I do for articles, including this article, may compel me to increase or decrease stock positions. However, I will not do so within 48 hours after any article is published in which I discuss matters that I feel may materially affect stock price. I do not believe that my voice could or should influence stock price by itself, and I strongly caution anyone against using my work as your sole data point to choose to invest or divest in any company. My articles are my opinion, which was formulated using research based on publicly available data. However, my research or conclusions may be incorrect.