Xos Inc (XOS) 2022 Q4 法說會逐字稿

Greetings, and welcome to the Xos Inc.'s Fourth Quarter and Full Year 2022 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. At this time, I would like to turn the conference over to General Counsel of Xos, Christen Romero. Thank you. You may begin.

Thank you, operator, and thank you, everyone, for joining us today.

Hosting the call with me today are Chief Executive Officer, Dakota Semler; Chief Operating Officer, Giordano Sordoni; chief Financial Officer, Kingsley Afemikhe; and our Head of Engineering, Scott Zion.

Ahead of this call, Xos issued its fourth quarter and full year 2022 earnings press release, which we will reference during this call. This can be found on the Investor Relations section of our website at investor.xostrucks.com.

On this call, management will be making forward-looking statements based on current expectations and assumptions, which are subject to risks and uncertainties. Actual results could differ materially from our forward-looking statements if any of our key assumptions are incorrect because of factors discussed in today's earnings news release, during this conference call or in our latest reports and filings with the Securities and Exchange Commission. These documents can be found on our website at investors.xostrucks.com. We do not undertake any duty to update any forward-looking statements.

Today's presentation also includes references to non-GAAP financial measures and performance metrics. Please refer to the information contained in the company's fourth quarter and full year 2022 earnings press release for definitional information and reconciliations of historical non-GAAP measures to the comparable GAAP financial measures. Participants should be cautioned not to put undue reliance on any forward-looking statements. With that, I'll turn it over to Dakota.

Thanks, Christen. And good afternoon to everyone joining our call today to discuss the strategic milestones and successes of 2022 and the key initiatives that better position Xos for significant growth in 2023 and going forward.

On the call, our COO, Gio Sordoni, who will offer insights into the steps we are taking to deliver gross margin positive units later this year. Next, our Head of Engineering, Scott Zion, will provide an update on the cost reduction and performance upgrades of the 2023 Step van. Followed by CFO, Kingsley Afemikhe, who will share the company's fourth quarter financial performance and expectations for 2023. I will provide an overview of projected milestones over the upcoming year as well as an update on the commercial traction we are seeing with customers in the field and will detail our progress on the deployment of charging infrastructure.

We have created a strategy that is based on 3 core tenets to build and sustain a high-growth enterprise. These tenets are: first, grow demand and deliveries of our products; second, improve gross margin; and third, maintain healthy access to capital to ensure we are strongly positioned to fund and scale the business. I will begin by sharing an update on what we are seeing with customers as the demand for commercial electric vehicles continues to grow.

There are 3 primary factors that drive demand for Xos products and solutions. Number one, fleet replacement levels; number two, strong interest from a broad set of customers; and number three, the supportive regulatory environments.

First, we will discuss fleet replacement levels. Industry wide supply chain constraints and delayed vehicle production over the past 3 years resulted in many fleets being unable to maintain their normal fleet replacement cycles. As a result, there is pent-up demand for new vehicles as many potential customers with designated vehicle purchase allocations have yet to fulfill such targets. Older vehicles remain in operation beyond typical maintenance thresholds for fleets or in certain cases, are noncompliant with newer emissions regulations and this places further incentive for fleet operators to acquire new commercial vehicles.

Second, we are experiencing strong demand as a result of the diversification of the wide appeal of our product line to a diverse set of customers, including many large national customers across multiple industries. While Step vans are most associated with parcel delivery with Xos serving independent service providers of 2 of the largest parcel delivery companies in the world, we also now serve 4 of the top uniform rental fleets as well as 2 of the largest U.S.-based beverage fleets in the country.

This adoption rate amongst the leaders in their respective segments underscores the value customers see and excess products. We are also seeing additional opportunities with new customers in armored transport, beverage delivery, food delivery, uniform rental and ancillary fleet services. In 2022, we added over 800 signed Step van orders to our backlog including a 30-unit order from uniform rental provider Alsco.

Subsequent to year-end, we received a 150-unit order from cash transport service provider, Loomis, another large-scale multinational customer with hundreds of locations across the U.S. We recently unveiled the 2023 model year Xos Step van and have secured multiple orders with delivery set to take place mid-2023. These orders serve as proof points for the wide appeal and application of our product line and over time, the diversification of end market customers will allow us to capture more of the market and better manage seasonal cycles.

With strong demand for our Step van, we're seeing growing demand for Xos Energy Solutions, our suite of comprehensive charging infrastructure and services. We recently wrapped up a charging infrastructure installation with our chargers for Loomis at their Montebello, California location and an infrastructure location with our chargers for UniFirst in Boston. Currently, our Energy Solutions team has multiple installation projects in the works for FedEx Ground operators across the United States.

Relatedly, we have achieved an incredible milestone in the first quarter of 2023 and delivered our first Xos Hub prototype to one of our Fortune 100 customers, where it is already in use serving a partial delivery fleet and collecting real-world usage and reliability data. The Xos Hub is our rapidly deployable mobile DC fast charging solution. A single Xos Hub is capable of charging up to 5 vehicles in one location and requires minimal to no upgrades to the charging site. We are confident it will alleviate certain infrastructure delays we hear from our customers.

We currently have engineering builds underway to begin a comprehensive durability test plan for the hub where we will cycle the charging and discharging the system as well as test and validate the hub's ability to perform reliably in the harsh environments that a trailer-mounted mobile charger is likely to endure. We expect the Hub to begin scaling production by the third quarter of this year and continue to believe that mobile flexible methods of charging like the Hub will play a key role in accelerating fleet electrification.

Third, regulations are playing a significant role in driving demand for commercial electric vehicles. Last year, California passed the Advanced Clean Fleet Rule, one of the many examples of a rapidly changing regulatory landscape that commercial fleets will need to adapt to in coming years. Beginning in 2024, under the Advanced Clean Fleet rule, several of our customers will be required to remove all internal combustion vehicles from their California fleet at the end of their useful lives and replace 100% of their California-based medium- and heavy-duty units with zero emissions vehicles by 2027.

Additionally, commercial EV ownership requirements will increase to 100% between 2035 and 2042, depending on the vehicle type. As a result, we anticipate a sustainable increase in demand and purchase volumes in the short and long term. Regulatory incentives encouraging electric vehicle adoption amongst commercial fleets expand beyond California. Xos vehicles are approved for incentive programs in several other attractive markets, including Colorado, Massachusetts, New Jersey, New York, Pennsylvania and Texas. We are already seeing customers across the nation qualify for and receive millions of dollars in state-level incentives.

On the federal level, the Inflation Reduction Act, or IRA, passed in late 2022 offers companies a tax credit of up to $40,000 for the purchase of commercial electric vehicles. Under the current regulations, all of Xos' vehicle models are eligible for the IRA tax credit. We believe that our attractive products and strong customer relationships, combined with supportive regulatory tailwinds, can drive continued growth for the company and the customers we proudly serve.

That said, from our perspective, the truest pulse of our industry is one-on-one conversations with the customers served by our vehicle products. I spent the month of January and February this year on the road visiting over 30 current and prospective customers with members of our business development team. Our customers confirmed our expectations that critical fleet replacement needs, a diversified customer mix and new EV-friendly regulations will continue to drive demand for the foreseeable future.

Now I would like to walk through how that growth and demand translated into deliveries for 2022. During the second half of 2022, we delivered 146 units to customers. While Xos had ample demand to support our forecasted volumes, transitioning orders to the new Step van model, infrastructure delays and seasonality in parcel delivery resulted in falling short of our delivery guidance. However, Xos did meet revenue projections with $19.6 million in revenue for the second half.

In total, Xos achieved full year unit deliveries of 275 units and $36.4 million in revenue, a substantial increase of 525% in vehicle deliveries and a 620% increase in top line revenue from 2021. Our positive growth in services revenue underscores the continued diversification of our product lines and the growing importance of generalized revenue rather than vehicle sales revenue alone as an indicator of our success.

With that, I would now like to turn the call over to our COO, Gio Sordoni, who will share an operational update.

Thanks, Dakota. Xos' operational focus remains on achieving our goal to begin shipping gross margin positive units near the end of the second quarter. Through a dedicated cost reduction task force at Xos, we've taken multiple steps over the past year, position ourselves to achieve this target in areas such as manufacturing, supply chain management, and the procurement of parts, charging infrastructure and our systems.

As we mentioned during our third quarter call, we've streamlined our manufacturing operations and focused our production at the Byrdstown, Tennessee facility. As a result, we've been able to eliminate unnecessary freight costs and strengthen our inventory management practices. The Byrdstown facility also provides us with the manufacturing capacity to meet our customer needs to continue to grow our business.

Our recently introduced Next-Generation 2023 Step van includes several design improvements that Scott will describe in greater detail shortly. These design changes and more focused production plan will have the potential to reduce material and direct labor costs by about $15,000 per Step van with more cost reductions planned in the future. Part of these savings will come from our diversified battery strategy that includes the lithium iron phosphate cell chemistry. We continue to invest in our in-house developed battery management and control systems, which integrate the battery into the vehicle. Our in-house battery and software teams helped us react nimbly to a rapidly evolving battery market.

I look forward to sharing more details over the coming quarters as we scale our platform and continue our cost-saving efforts. As for the supply chain, we've continued to work in tandem with our engineers and vendors on cost reduction efforts and procurement and logistics of key parts of our products. Our growing scale and brand are helping us achieve better terms as we become stronger partners with these suppliers. We're also benefiting from lower logistics costs as the cost of moving container from China to North America has fallen sharply over the past year. That said, we are still seeing some delays in the sourcing of certain parts, such as high-voltage cables and low-voltage wiring harnesses.

With the volume of unit deliveries increased significantly in 2022, we encountered delays in the deployment of charging infrastructure that prevented customers from taking additional vehicle deliveries as Dakota previously mentioned. Infrastructure remains a challenge for the industry. However, we're pleased to see increased attention and investment from vehicle OEMs, regulators and municipalities to overcome this infrastructure hurdle. At Xos, we're seeing a growing uptake in demand for our charging hardware and project management services. Fleet operators are recognizing the value of OEM level support and expertise when planning charger layouts, incentive capture, permitting and utility upgrades.

Though infrastructure factors will likely continue to constrain the commercial EV market, we expect that the impact to our business will improve over the coming year. State level and federal incentives for charging infrastructure enacted in 2023 will play a large role. Currently, 36 states offer tax credits or rebates for charging infrastructure, which can be with a 6% tax credit of up to $100,000 per item of equipment for new charger installations included in the Inflation Reduction Act.

As part of Xos Energy Solutions, we have a dedicated in-house team focused on helping our customers uncover the best-fit incentives and credits available to them, no matter where they live.

Finally, we've continued to take steps to advance our internal systems and improve the accuracy of our data to help scale our business responsibly. Specifically, we have invested in better tools and processes for inventory management, releasing new designs to manufacture and production planning.

Overall, we're proud of what the team has been able to accomplish over the last year. The opportunity for clean fleet and logistics solutions in both the public and private sector remains immense, and we expect to continue to benefit from a secular shift with net 0 carbon economy.

Now I'll turn it over to Scott Zion, Head of Engineering, to provide an update on his areas of oversight, which include engineering development, product testing, validation and new product lines.

Thanks, Gio. As mentioned earlier, we recently introduced our Next-Generation 2023 model year Step van, which includes major cost optimization and technology upgrades to our latest generation vehicle. Particularly proud of the design improvements for the 2023 Step van that will deliver the important manufacturing cost reductions that Gio already mentioned. Savings will come mainly from design and sourcing improvements in our battery system, our voltage distribution equipment and simplified cable routing with additional optimizations to come as we continue to scale production.

Beyond the efforts of the cost optimization team, we were also pleased to release this generation of Step van with greater connectivity, longer range and a higher payload capacity. Compared to the prior generation, we expect the 2023 Step van to provide customers with a higher performance vehicle, while also reducing the cost to manufacture and services.

Regarding connectivity, the 2023 Stepvan features an enhanced telematics module and over-the-air software capabilities. The updated telematics module enables advanced remote diagnostics for customers with an Xosphere subscription and provides our engineering and service teams with better insight into the real-world performance of our vehicles. The addition of the over-the-air software updates will reduce the service visits and vehicle downtime experienced by our customers, while also reducing the cost of rolling out new features and important software updates.

Going forward, our service team will be able to push software updates to all new Step vans remotely without requiring a visit to a service center.

When it comes to range, the 2023 Step van launched with 2 battery options, a 100-mile usable range specifications for customers operating shorter routes and looking for the most cost-efficient option and a 200-mile option for applications serving larger routes. The 200-mile Step van is already expanding our customer mix to include more cash in transit, uniform and linen rentals, and food and beverage fleets that service routes beyond the range of our previous vehicles.

In its long-range configuration, the 2023 Step van offers a usable range among the best available in a comparable commercial EV.

In order to support the larger battery of the 200-mile option without sacrificing payload capacity for our customers, all 2023 Step vans are rated for a gross vehicle weight of 26,000 pounds up from 23,000 in previous models. In addition, several structural changes were made to the chassis to reduce the curb weight of the vehicle, enabling greater payloads and creating a more efficient vehicle. We have packaged the standard batteries and all high voltage and current lines within the frame rails, improving the safety of our vehicle. We also revised the packaging of the high-voltage power electronics into a more compact form factor that allows for the chassis to be used with a wider range of body configuration.

We also centralized the thermal management system and deepened our partnerships with one of our critical suppliers to develop and validate that system. These improvements mean that even for vehicles with the increased weight from the larger, longer-range battery pack, the payload in that Step van will be able to handle them not be reduced.

In conclusion, we are very excited about the recent advancements we've made to our technology, and we continue to make improvements as we look to provide more efficient, high-quality vehicles to our customers.

I'll now pass this over to our CFO, Kingsley Afemikhe.

Thank you, Scott, and good afternoon, everyone.

As previously noted, we are making great strides in our paths to becoming gross margin positive at the unit level by the second quarter -- the end of the second quarter 2023, whilst also ensuring we need the strong demand for our products and solutions. I'll now review our financial performance for the quarter and for the full year 2022.

For the full year, revenue grew significantly to $36.4 million from $5 million in the prior year. Revenue was supported by both higher deliveries and average selling prices of our Step vans. We increased the average selling price of our Step van units by close to 20% over the fourth quarter which reflects changes in our channel mix and the effects of the price actions we took last year. We expect this trend to continue as we add higher ASP units into our backlog and flow them into deliveries.

For 2022, our cost of goods sold was $66.4 million, up from $7.4 million in 2021. Gross margin during 2022 was a loss of $30 million compared to a loss of $2.4 million in 2021. Non-GAAP gross margin loss for the year was $16.4 million compared to $1.4 million in 2021.

Looking at the fourth quarter specifically, our revenue was $8.6 million compared to $11 million in the third quarter, which is in line with our expectations and reflects the seasonality we noted in our third quarter call due to the busy holiday season for the last-mile delivery sector.

Our cost of goods sold during the quarter decreased to $16.5 million compared to $21.8 million in the previous quarter. Gross margin during the quarter was a loss of $8 million compared to a loss of $10.8 million in the third quarter.

As a team, we continue to strive for gross margin positive on a unit basis led by cost optimization steps, including a bespoke devoted team working across the company to achieve this. The team's efforts are primarily focused in 3 areas: first, as mentioned earlier, we have implemented strategic pricing action to address ongoing inflation in the cost of building a vehicle. Over the past 2 years, costs have risen sharply due to increases in raw materials, logistics and tariff costs as well as higher labor costs, similar batteries and vehicles.

As a growing company, we elected to build customer goodwill by honoring pricing with minimal material surcharges being passed on to our customers in 2022. This decision helped drive follow-on customer orders and increase our customer loyalty. We have since taken price action to ensure that our sales prices enable us to reach our goals whilst continuing to maintain the loyalty of our customers.

Secondly, as Scott outlined, the launch of our 2023 Step van brings with it a number of design improvements that will meaningfully reduce the direct material costs and the cost of manufacturing the units. There are immediate cost optimizations of over $15,000 per 2023 Step van as a first step in further material cost reductions, which we will deliver over the rest of 2023 and into early 2024.

These efforts have constituted the bulk of our R&D spending for 2022.

Finally, the steps we took last year in centralizing manufacturing in Tennessee will materially reduce our overhead costs as we ramp throughout this year. These costs include taxes, freight, indirect labor, production supplies. Over 2022, these costs made up roughly 15% of our cost of goods sold and we expect these to reduce -- to refocus manufacturing on our centrally located and highly operationally cost competitive plant in East Tennessee.

We believe our continued laser focus on expanding margins will position a strong position going forward and demonstrates Xos' unique ability, the innovates across engineering, supply chain management and sales to achieve success in this rapidly growing and expanding industry. In part, due to the release of our new Step van, we expect deliveries to be weighted towards the second half of 2023 so as to maximize the effects of our steps.

Turning now to expenses. Our fourth quarter operating expenses fell to $17.9 million from $20.4 million in the third quarter, and this was driven by a reduction in our R&D expenses to $6.2 million versus $8.6 million in the third quarter and lower sales and marketing expenses of $1.7 million compared to $2.3 million. These lower expenses were partially offset by higher general and administrative expenses of $10.1 million compared to $9.5 million in the third quarter.

Our non-GAAP operating loss for the second half of the year was $44.1 million, which is near the bottom end of our guidance range. We expect to continue to have a very strong expenditure discipline over 2023 and see operating expenses reducing further over the year.

We closed the quarter with cash, cash and equivalents and marketable debt securities available for sale of $89.3 million, which includes $3 million of restricted cash. Compared to 2021, inventories increased, and we recorded a net inventory position of $57.5 million versus $30.9 million at the end of the fourth quarter of 2021. On a quarter-by-quarter basis, inventories declined during the quarter from $62 million at the end of the third quarter. We expect inventory levels to remain at or below the current level for the first and second quarters as we see supply chain disruptions continue to ease.

As expected, total use of cash, cash used in operating activities plus CapEx, improved to $18.3 million for the quarter versus $32.2 million in the third quarter. We closed the quarter with ample liquidity to scale our operations. We are confident as we grow volumes and get to positive gross margins, we'll have options to raise additional capital.

Finally, wrapping up with our business outlook for 2023. We expect to deliver between 450 and 600 units. We expect to generate between $58.5 million and $84 million in revenue and we forecast an operating loss of between $52.8 million and $80 million for the year.

With that, I'll now turn the call back to Dakota to wrap up. Thank you.

Thanks, Kingsley. While much has been accomplished, we continue to remain on track for long-term success as we continue to focus on helping commercial fleets seamlessly deploy EVs across their operations. As I mentioned earlier, our strong customer relationships, combined with supportive regulatory tailwinds, are expected to continue to drive growth for Xos. We've positioned ourselves for continued sustainable growth in parallel with achieving our goal of becoming gross margin positive at a unit level by streamlining our manufacturing operations, taking strategic pricing actions and launching our Next-generation Step van.

As a company, we remain focused on our singular objective, electrifying commercial fleets. We believe our continued mission focus and dedication to fiscally responsible product development will translate to a commercial success. Fleets work with Xos because they see a critical differentiator. They understand we are dedicated to creating the most customer-oriented product on the market and that Xos is building a company to service their needs for the long term.

With that, we'd like to now open the line for questions. Operator?

Kingsley here. Apologies, I wanted to note that I misspoke earlier on total use of cash, cash used in operating activities plus CapEx, was $24.6 million over the quarter.

(Operator Instructions) And our first question will come from Mike Shlisky of D.A. Davidson.

That's -- can you maybe just start off, maybe try to spare us the drama here in the first quarter, going to end in 2 days. Anything as to how business went here in the first quarter deliveries, revenues, operating expenses, et cetera? Anything you can give us here now that we're basically at the end of the quarter would be appreciated.

Yes. Certainly, Mike. We can absolutely give a little bit of context, and thank you for joining the call today. As we've continued delivering vehicles through the quarter, we've continued to face infrastructure hurdles that have plagued some of our larger customers, and that has pushed back some deliveries, but we still have made progress in the quarter in getting trucks out to customers, some of which we've actually spoken about publicly, like our delivery to Alsco as well as some additional deliveries that took place during the quarter.

What we see for the year, as Kingsley alluded to, is the deliveries are going to be back-end weighted. So the first quarters and -- first and second quarter should be less than the second half of the year, much like we saw in 2022, but ultimately continuing to make progress and as we shared it with the backlog, continuing to see increasing growth in demand for the products.

Okay. Okay. And then maybe just a follow-up on that backlog comment you just made there, Dakota. You had units during 2022, another 150 at least has publicly announced here in the first part of '23. Can you maybe tell us what number of backlogs you have -- what number of units are in the backlog today? And I guess, you already feel good about 2024, assuming that the supply chain cooperates given what might be in backlog already.

Yes. So I'll just clarify, the 800 units for -- that we added to the backlog for last year are exclusively Step vans. We do have other products that are customers are demanding and wanting those products, we won't be delivering this year, but we've continued to grow the backlog on those vehicles as well, those products as well. When we talk about overall backlog, we don't guide to that metric, but we have seen it sales and demand for the products continue to grow really quarter-over-quarter and year-over-year, and we don't anticipate that to slow down this year.

The one thing I will say regarding the Step van product is that you're seeing several customers responding to a lot of the regulations that are taking place that I spoke about like the Advanced Clean Fleet rule. Some of these fleets have thousands of trucks just in California, and so hitting those percentage thresholds is going to be critical, particularly when we're one of the few suppliers that's providing an electric Step van that will meet the needs of those fleet operators in the state.

Great. And just to follow up on that last point about the non-Step van products. I guess, first, can you tell us a little about how it's going with the MDXT and HDXT products? Is any of that in the sales outlook for 2023? And the same question for the Powertrain business, was that any part of the mix in the fourth quarter? And is there any part of the mix you have here in the 2023 outlook? That will be appreciated.

Yes. So when we talk about the other products like MD and HDXT and powertrain, those are not factored into the backlog for 2023. We do have orders that are factored into our outlook for the full year revenue guidance that we've discussed previously in this call. And then as we're looking to -- back to Q4, I'll let Kingsley speak directly to those 2 business units.

So when you look at our forecasting units for this year, that number includes Step vans, powertrains and also a number of hubs. Primarily the numbers -- the vast majority of it is Step vans. In addition, on the backlog number, backlog additions that we had last year, that number is the net addition of net of cancellations and also net of deliveries over the year.

Just wanted to add one more point. As we've continued to focus on cost reduction of our platform, we also want to make sure that most of the vehicles we're delivering this year are gross margin positive and at a point where we're actually generating contribution margin for the business. And so when we look at even back at Q4, we were profitable on a direct material basis with those vehicles, and we're continuing to see improvement there that we shared in some of the detail in the call and anticipate further improvement in the quarters to come.

Got it. Maybe one last one for me. And maybe just taking a big step back, Dakota. Some of the comments you made here in your prepared comments kind of suggest that at this point with certain customers, you're already beyond the testing phase. In other words, that you've gone through the 2-unit test, you've then gone through a second 10-unit to 20-unit test. And now customers are coming in and saying, you are an official supplier of our company. I have not heard that anywhere else in the EV truck space, I think off the top of my head ever.

So can you comment as to are customers now calling you just a supplier and not just a test program or experiment at this point? And what number of customers are considering you that? And can you get a feel for how many you might convert into that in 2023?

Yes, absolutely. Mike, you hit the nail on the head in that commercial fleets and large national fleets have a very risk-averse process to procuring equipment. And that starts with a small demonstration, scales up to a slightly larger one in the low tens of units and then scales to hundreds of units. I think Loomis is one of the examples that we can actually publicly talk about that's done exactly that over the past few years, but we have several other customers that really are coming into that phase of the relationship where they're planning to order into the low hundreds of units and following on in their -- either their first or second order.

We don't guide to the specific number of customers that are there, but many of them are recognizable Fortune businesses that have sophisticated fleet operations with thousands of vehicles in them. So I would say that that's one of our proof points as we've talked about creating value for customers. We need to ultimately deliver on a TCO promise, deliver on a reliability promise, which is why they test the vehicles in small scale to start and then ultimately show them that these unit economics scale across their fleet operations, and we're doing it every day.

Our next question comes from Jerry Revich of Goldman Sachs.

This is Adam Davis on for Jerry today. Just wondering -- hey, when you talk about gross profit on a unit level turning positive, can you clarify, does that mean you expect gross profit for the total company to be positive in mid-2023 or are you maybe excluding overhead in that number? And then just wondering how gross profitability could be tracking as we exit the year?

Yes, absolutely. I can take that. When we talk about on a unit basis, what we're including there is the direct material costs, so that's the cost of the chassis, the part of the bodies and also the battery systems we have on the also the direct labor costs and all the indirect costs as well that are linked to the units. So freight, taxes, rent, depreciation, all that you would expect. What you're basically flushing out the inventory through.

Over and above that, when you talk about a unit level, you are also a number of other accounting adjustments, often there are reserves for particular reasons, including an NRV reserve or an E&O reserve, which you then see recognize on a GAAP basis in your financial statements. And so what we've guided to is being positive on a gross -- on a unit basis by the end of the second quarter, inclusive of those indirect costs that I mentioned.

Following up on that, just talking a bit about how we were trending in Q4, as Dakota mentioned, when you look at pure direct material costs as well as direct labor costs, we're about breakeven on the units, the Step van units we delivered in Q4 and the steps that we've mentioned today, the 15,000 that we've identified, this is really the first step in a number of other improvements in the direct material costs and the labor cost, manufacturing time that we expect to bake in over the course of 2023 and into 2024.

And so where we think about it is achieving gross margin positive is the station on the journey to being cash flow positive, which is our focus as a company in the coming years.

Great. That's helpful. And can we shift to cash flow for a second. So wondering how you're thinking about cash burn through 2023 and your capital position today?

Yes. No, absolutely. When I look at -- when we look at our operations this year, there are really 3 lags, as I mentioned, costs in the direct material costs, the overhead costs and also the pricing action that we've taken. We expect overall as we go towards the journey being gross margin positive as well as being really, really capital disciplined on our operating expenditures. The operating office expenditures will come down significantly this year. We feel pleased that we have ample liquidity to fund operations to 2023 to 2024, and we're scaling as you've guided to.

The next question comes from Michael Ward of Benchmark.

I wonder if I could just dig into the production numbers a little bit more. I think you entered 2022 with a significant backlog. And 1 thing I'm curious about is, is the current backlog on the Stepvans shifted entirely to the next generation to the '23 model?

Yes, Mike. That's a great question. The entire backlog has not shifted to that model. But as we've started to move customers over to the new model, they've been increasingly interested in it. So I would say that when we go to those customers, we're giving them a vehicle that's a similar ASP with better performance and better maintenance performance. And so when you go to a customer offering them something for the same price, but ultimately going to save them more money and better actual real-world driving performance and range, most of them are not turning it down.

This is -- sorry to interrupt here, this is Gio. The only thing I'd add to that is with this new model, the 2023 version of the Step van, we're also offering a 200-mile range version of the step van, and that's gotten some customers really excited. We have diversified the customer mix away from just parcel delivery folks, who are typically only looking for 100 miles to folks in other industries like uniform services that might be interested in heavier duty Step van for longer ranges that might require more kilowatt hours on board, and that's something this new version of Step van enables us to do, and that's something we're really excited about.

And as you look at the production ramp, you had a sharp falloff there in the fourth quarter. And was that an additional supply issue? Or I think you mentioned in the release that it had somewhat to do with switching over production to the '23 version. And so is that the -- are those the reasons -- maybe it's both, as we accelerate production in 2023. And it sounds like you're looking at a similar level of deliveries in Q1 and Q2 that we saw in the fourth quarter.

What are the things limiting that delivery? Because it sounds like you're going to have a substantial backlog as you exit 2023 and so there's always a risk that customers are going to pull away. So I'm just wondering what you're going to do to accelerate production, accelerate deliveries?

Yes. Happy to address that, Mike. So I would say one thing that is common across the entire last mile logistics industry with Q4 is that it is the peak season in the year. So some of our customers like FedEx Ground, they'll go for moving 10 million packages the week before Thanksgiving to 20 million packages the following week. And so with such an uptick in their operations, it becomes difficult to really do anything else in the business like onboarding new vehicles, training drivers on those new vehicles. They really are focused on getting packages delivered to customers.

So when we look at that, really, Q4 is the first 6 to 7 weeks or 6 to 8 weeks of the quarter where we can make deliveries to customers. After that, it becomes incredibly busy to try and get vehicles delivered to those customers, along with all of the holiday days, which folks are either traveling or out of the office. So it can make it difficult to get the same number of vehicles delivered. So that's one seasonal factor that always hits during Q4.

And by having a diverse -- a more diverse customer mix, we actually are able to mitigate that. Some customers like a uniform rental or mobile fleet maintenance company, they aren't going to see that same seasonal peak in Q4. And so we try to slot body builds and vehicle builds for those customers into that vacancy and really gives us -- it will give us a little bit of a smoother ramp, but we do anticipate that the seasonal trend will always continue.

The second factor I'd talk about is charging infrastructure. The same reason it's difficult to deliver vehicles in Q4, we also see similar obstacles in getting charging infrastructure delivered. So offices are shut down for permit approvals or utility interconnect studies and ultimately for construction. People are just working less through that quarter. And so when we talk about commissioning and turning on charging infrastructure for our customers, we generally see less there. So that was one the obstacles we face. And there's a little bit of a lag time that goes into Q1 on that seasonal impact.

So that's where we see it in Q1. Ultimately, the backlog was -- is really growing through those quarters. We're continuing to make sales and seeing sales growth through Q4 and Q1, but we aren't seeing many cancellations. Folks still need to transition to zero emissions vehicles because of the regulatory environment. And also, they're seeing the incentives of operating the Zero emission fleet and how it's reducing their overall maintenance costs and their overall energy costs.

Okay. So some of that are the industry growing pains? Because I assume if the charging structure is in place next year or the year after that, that won't be as big an issue.

Absolutely. One of the things we talk about is infrastructure is an issue that we're readily solving today and introducing solutions like the Hub, but we believe this problem will continue to expand into the next 5 and even 10 years. The reason being, fleets never convert 100% of their fleet today. And so they're not going to build up 100% of that charging infrastructure today. They're going to build it up incrementally year-over-year. We always expect there to be some delay, but the more flexible, adaptable mobile solutions like the Hub we can offer, the more we'll be able to smooth that gap and really get trucks delivered per their original plans.

And Kingsley, you mentioned in the release that you had a range of options for raising capital. Can you discuss any of those?

Sure, absolutely. If you look at our business as we're scaling, we're investing in operations and also in assets like our inventory and our receivables. We are in a range of discussions with debt providers underpinned by those assets. We want to make sure that we get the right partner for us as we grow and we scale. Over and above that, we still have our equity line of purchase agreements with Yorkville, which is largely untapped. We have some access to capital that we can access.

So the capital is there. And operationally, we're really, really focused on growing deliveries, getting positive gross margin and also making sure we are stewards of the capital as you grow.

Yes, Mike, the only thing I would add to that is that we have several customers, who are large strategic customers. And in many cases, when we take on new product specifications or configurations that we might not already be building, we generally ask those customers to share in some of the expense and bringing those customers on board. And so that also helps. It's not nearly the contribution that any kind of asset-backed financing or our equity line will enable us to tap into.

But it certainly does help accelerate those commercial conversations and offset some of the initial engineering costs that goes into those new platforms.

The next question comes from Donovan Schafer of Northland Capital Markets.

I apologize if there's any background noise. We've got some renovations going on right now, hammering or something else. But -- okay. So for my first question, I want to ask, with the new Stepvan model, I saw the mentions of having the centralized liquid cooling system and I'm just curious, is this the reversal of the kind of prior approach where it was like, I'm kind of assuming the cooling you're talking about here is for the battery, but maybe I'm wrong on that. So maybe it was always liquid cooling for the engine or something like that.

So is it kind of a reversal from -- on the battery side, from air to liquid? I guess that just as a starting point there.

Yes. This is Scott. We are transitioning to liquid cooled batteries. Historically, all of our Step vans did have liquid cooling for like the power electronics that are in the vehicle. So we basically have 3 separate cooling loops now. We have a power electronics cooling loop. We also have the battery heating and cooling loop and then the heating and cooling loop of the cabin. So that is a big transition from our previous models.

Okay. And then I think Gio made a comment about now you have the 200-mile range. And so -- because as I understand it, part of the doing air cooling on the battery before was realizing, the duty cycle of a part of delivery vehicle, UPS or FedEx Ground was quite light. You didn't have aggressive acceleration and deceleration and other things like that, which is what made it kind of appropriate to not do liquid cooling.

So I guess my question is, is it about the kind of change in duty cycle that's leading to liquid cooling on the batteries? Or is there anything you were seeing with the older generation of Step vans or maybe you weren't getting as much life and performance out of them using the air cooling on those prior models?

Yes. Happy to provide a bit more context, Donovan. So on the air cooling modules, they actually did really service the use case of parcel delivery quite well, and we continue to deliver vehicles as well as powertrain systems with those batteries and that forced air cooling design. One of the things that our design did in order to achieve the air cooling performance was we actually spaced out the cells. And that gave us a lower volumetric performance relative to some of the liquid cooled options.

So what this enables us to do is get a higher volumetric performance to enable packaging more vehicle -- more battery onto the vehicle, improve the overall gravimetric performance because of the way we mount the system now and ultimately deliver on a platform that now has a broader range of use cases, but if somebody does want to run the vehicle on a dual shift, they can now with the liquid cooling performance that the system offers.

Okay. Great. That's helpful. And then I was looking into the New Jersey VIP program on their website. And it was interesting to see that you -- I think it must be part of the paperwork and everything that's involved in being included in that program, where you actually had -- you have MSRPs for the vehicles up there on the website. That's not something included in the catalog on like the California HVIP program.

So I just kind of want to double check here. Am I going to leave myself astray if I take the MSRPs from the New Jersey ZIP program from their website and apply that more broadly? Or is there something -- are there -- does the MSRP kind of vary by state and maybe there's markup there where you're kind of capturing half of whatever the incentive is? Just curious if there's any -- if you can give any clarification there.

Absolutely. So in most of these incentive programs, they want to have a standard price level, so that folks aren't taking advantage of the program. But as we think about ASPs on the vehicle, there are multiple different factors not just the acquisition cost of the vehicle, but there are delivery fees, tax fees, servicing fees that all go into the end cost of the vehicle. And there are also factors in terms of our large customers where we may offer price competitive discounts that ultimately get them to a more competitive price level.

I would say when the best information to rely on when it comes to ASPs is the ASP guidance that we provided quarterly are the actual reporting. So if you look back at Q4, you saw ASP performance went up significantly because of the price action we took. And I think that's a good indicator, along with the guidance we provided for the full year for 2023 as to where the vehicles will land and where they end up getting net price to a customer.

Okay. That's helpful. And then with the production facility in Tennessee and kind of doing the new version of the Step van and then also talking about maybe doing some more excess Hub -- Hub trailers. Is that something where you do -- like you do it in batches and you kind of overhaul the line? I mean I can imagine something like even going from the old version to the new version for the Step van, having the structural changes so that everything is in between the chassis rails, that may involve moving some equipment around or training -- training the laborers to say, okay, we did 20 vehicles this way. Now we're going to switch over and do 20 this other way.

Is that kind of how it's done? Or do you run line simultaneously? And then there's there like a switching cost? Or does that impact kind of economics and maybe it leads to a few days of reduced production as you're switching things over? Just kind of conceptually trying to think through how you manage the different product lines.

Yes. This is Gio here. As far as the Step van goes, the different options in the Step van, the 100-mile and the 200-mile versions are really similar platforms. The 200-mile just has some extra batteries on board, so those can actually run on the same line. We do try to batch build as much as we can. Then a given week, we try to build all of the same (inaudible) vehicle. But having to switch throughout the week isn't the biggest cost is something that we can handle.

As far as the Hub goes, that's built separately. It's quite a different design, and that's built separately but also in Tennessee.

Okay. And then if I could just get one last question and just because people -- there's the financial turmoil and all that stuff and people are trying to understand if there's a tightening of the credit market and how that would flow through to anything. So I'm just curious with selling Step vans, your primary products and your customer base and everything, what kind of financing is involved in these Step van purchases?

I mean, I imagine most of them aren't just sitting on large checking account balances or something. And I assume there's a certain amount of financing to purchase Step vans. And then do those get turned into commercial vehicle asset-backed securitizations or something, like who are kind of the main lenders to help facilitate that? And any changes have we seen a flow through in interest rates in that space?

Yes, a really, really thoughtful question, Donovan. So I'll break it into 2 different ways. The first way is financing is offered to our customers. As we announced a couple of years ago, we work with, amongst others, DLL, which is one of the largest asset-backed finances, part of Rabobank, that's to offer financing to our customers. We also work with a range of other -- range of other providers as well. We have seen a slight increase in the rates charged. But for most of our customers, who are acquiring the fleets with financing, this trusted financing, they're acquiring an asset that's a very critical part of their fleet, right? It's a very critical part of their transportation of the assets. And say even if, there's a couple of percentage increases there in rates, they are actually going to execute the purchase.

In many cases, we get a slight financing fee on that. So we talked about it in our deck when we went public. And separate to that, what I was talking about is the potential to finance the assets in our balance sheet, which includes kind of raw materials, WIP and some components of finished goods. We want to make sure that we get the right partner there, right? So there are a number of different funds, usually nonbanking, institutions as well as some bank institutions that play in that space, and we have been in discussions there to find partners that work best for us.

Ultimately, when you look at -- when we look at 2023, there a couple of things that are really, really clear. First of all, we expect inventory levels to fall definitely relative to revenue over the next couple of quarters. We're seeing supply chain challenges ease, and so that was a very significant use of capital for us in 2022, and that's going to reduce a lot this year. In addition, when you look at operating expenditure as well, we are being laser-focused on cost there, and we've already guided in the quarter, we would expect those levels to come down as well.

Donovan, I would just add that as we talk about customer financing, one thing you have to consider is the diversifying mix of customers that we're seeing this year. When we talk about large national fleets, many of them are businesses that utilize their fleet as a delivery service for their own products at their manufacturing. Many of them, multi, multibillion-dollar companies have access to capital, either through their own lines of credit or their own credit facilities that are well below the equipment lines that are publicly available to smaller and medium-sized fleets.

And many of them have structures or facilities in place with large FMCs or fleet management companies or banks that specifically focus on equipment financing, such as Wells Fargo. And so those customers rarely have access to credit issues where they can't already access credit that's either below market. And in many cases, some of these customers will even finance it off their own balance sheet. So it's not an issue as our customers continue to diversify to those larger national accounts.

These are all the questions that we have today. Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines, and have a wonderful day.