Earnings Call Transcript - XOS Q4 2022

Operator, Operator

Greetings and welcome to Xos Inc.'s Fourth Quarter and Full Year 2022 Earnings Call. All participants are currently in a listen-only mode. This conference is being recorded. I will now hand it over to Christen Romero, the General Counsel of Xos. Thank you, you may proceed.

Christen Romero, General Counsel

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 investors.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 investor.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.

Dakota Semler, CEO

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, 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 three core tenets to build and sustain a high growth enterprise. These tenets are; first, grow demand and deliveries of our products; second, improve gross margins; 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 three 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 three 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 non-compliant 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 two of the largest parcel delivery companies in the world, we also now serve four of the top uniform rental fleets as well as two of the largest US-based beverage fleets in the country. This adoption rate amongst the leaders in their respective segments underscores the value customers see in Xos 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 transport service provider Loomis, another large-scale multinational customer with hundreds of locations across the US. 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 parcel 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 five 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 in 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 topline 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.

Giordano Sordoni, COO

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 and 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-ion 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 help 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 as key parts of our product. 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 containers 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 charger 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 on 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 structures, which can be stacked 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 for 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 sectors remains immense and we expect to continue to benefit from a secular shift towards a net-zero 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.

Scott Zion, Head of Engineering

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, high-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 service it. Regarding connectivity, the 2023 Step Van 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 offers two battery options, a 100-mile usable range specification for customers operating shorter routes and looking for the most cost-efficient option and the 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 pounds 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 on all high-voltage and coolant 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 increased weight from the larger, longer-range battery pack, the payload in that step van will be able to handle will 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.

Kingsley Afemikhe, CFO

Thank you, Scott, and good afternoon everyone. We've made significant progress towards achieving gross margin positivity at the unit level by the end of the second quarter of 2023, while also responding to the strong demand for our products and solutions. I'll now discuss our financial performance for the quarter and the full year of 2022. For the full year, revenue jumped to $36.4 million, up from $5 million the previous year. This revenue increase was driven by higher deliveries and average selling prices of our step vans. We raised the average selling price of our step van units by nearly 20% from the fourth quarter, reflecting our channel mix changes and the pricing strategies implemented last year. We anticipate this trend will persist as we introduce higher ASP units into our backlog and promote them into deliveries. In 2022, our cost of goods sold reached $66.4 million, compared to $7.4 million in 2021. The gross margin for 2022 showed a loss of $30 million, compared to a loss of $2.4 million in 2021. The non-GAAP gross margin loss for the year was $16.4 million, versus $1.4 million in 2021. Focusing on the fourth quarter, our revenue amounted to $8.6 million, down from $11 million in the prior quarter, which aligns with our expectations and reflects the seasonality discussed in our third quarter call due to the busy holiday period for last-mile delivery. Our cost of goods sold in the fourth quarter decreased to $16.5 million compared to $21.8 million in the previous quarter. The gross margin for the quarter was a loss of $8 million, improved from a loss of $10.8 million in the third quarter. Our team remains committed to achieving gross margin positivity on a unit basis through cost optimization efforts, supported by a dedicated team working across the company. Our focus is primarily on three areas: First, we've implemented strategic pricing actions to combat ongoing inflation and increased vehicle production costs. We've absorbed some price increases in recent years due to rising raw materials, logistics, tariffs, and assembly labor costs for our batteries and vehicles in order to foster customer loyalty. We have since adjusted our pricing strategies to ensure our sales prices help us achieve our gross margin objectives while maintaining customer loyalty. Second, the launch of our 2023 step van includes design improvements that will significantly lower direct material and manufacturing costs, with initial cost optimizations exceeding $15,000 per unit, marking the first step toward further material cost reductions throughout 2023 and early 2024. These initiatives comprised the majority of our R&D spending in 2022. Finally, the manufacturing centralization in Tennessee will considerably cut our overhead costs as operations ramp up this year, covering expenses such as taxes, freight, indirect labor, and production supplies. In 2022, these costs represented about 15% of our total cost of goods sold, and we expect significant reductions as we concentrate manufacturing in our cost-efficient East Tennessee facilities. Maintaining a strong focus on expanding margins will strengthen our position moving forward and showcase Xos' capability to innovate across engineering, supply chain management, and sales in this rapidly evolving industry. With the launch of our new step van, we expect deliveries to be concentrated in the second half of 2023 to optimize the outcomes from our strategies. Now turning to expenses, our operating expenses in the fourth quarter decreased to $17.9 million from $20.4 million in the third quarter, primarily due to a drop in R&D expenses to $6.2 million from $8.6 million and lower sales and marketing expenses of $1.7 million, compared to $2.3 million previously. These savings were slightly offset by increased general and administrative expenses of $10.1 million compared to $9.5 million in the third quarter. Our non-GAAP operating loss for the latter half of the year was $44.1 million, falling near the low end of our guidance range. We plan to maintain strict expenditure discipline throughout 2023 and expect to see further reductions in operating expenses. We finished the quarter with cash and cash equivalents and marketable debt securities totaling $89.3 million, which includes $3 million in restricted cash. In comparison to 2021, inventories have risen, with a net inventory of $57.5 million, compared to $30.9 million by the end of the fourth quarter of 2021. On a sequential basis, inventories decreased from $62 million at the close of the third quarter. We expect inventory levels to stabilize at or below current levels for the first two quarters as supply chain disruptions continue to lessen. Our total user cash flow, comprising cash used in operating activities and CapEx, improved to $18.3 million for the quarter from $32.2 million in the third quarter. We have sufficient liquidity to expand our operations, and as we scale up production and achieve positive gross margins, we will explore opportunities for raising additional capital. In conclusion, for 2023, we anticipate delivering between 450 and 600 units, generating revenue between $58.5 million and $84 million, and forecasting an operating loss between $52.2 million and $80 million for the year. Now I will hand it back to Dakota to wrap up. Thank you.

Dakota Semler, CEO

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 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 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 Afemikhe, CFO

Hello, it's Kingsley here, apologies. I wanted to note that I misspoke earlier; total cash used in operating activities, plus CapEx was $24.6 million over the quarter. Thank you.

Operator, Operator

We will now open the question-and-answer session. Our first question will come from Mike Shlisky of D.A. Davidson. Please proceed.

Michael Shlisky, Analyst

Good afternoon and thank you for taking my question. To start off, could you share how the business performed in terms of first quarter deliveries, revenues, and operating expenses? It would be helpful to have this information as we approach the end of the quarter.

Dakota Semler, CEO

Yes, absolutely, Mike. Thank you for joining the call today. Throughout the quarter, we have continued to deliver vehicles, though we faced some infrastructure challenges affecting our larger customers, which have delayed some deliveries. However, we have made progress in getting trucks to customers, including deliveries to Alsco and others during the quarter. Looking at the year ahead, as Kingsley mentioned, we expect deliveries to be weighted toward the backend. Therefore, the first and second quarters are likely to see lower figures compared to the second half of the year, similar to what we observed in 2022. Overall, we are making progress, and with our current backlog, we are seeing increasing demand for our products.

Michael Shlisky, Analyst

Okay. Regarding your comment on backlog, Dakota, you mentioned adding units in 2022 to the 150 that were publicly announced at the beginning of 2023. Can you provide the current number of units in the backlog? Also, do you have a positive outlook for 2024, assuming the supply chain performs well, given the existing backlog?

Dakota Semler, CEO

Yes. To clarify, the 800 units we added to the backlog last year are solely step vans. We do have other products that our customers are interested in, but we won't be delivering them this year. However, we are still increasing the backlog for those vehicles. While we don't provide guidance on overall backlog, we have noticed that sales and demand for our products have been consistently rising quarter over quarter and year over year, and we expect this trend to continue this year. Regarding the step van product, many customers are responding to various regulations, such as the Advanced Clean Fleet rule. Some fleets, particularly in California, have thousands of trucks, and meeting these percentage thresholds is crucial, especially since we are one of the few suppliers offering an electric step van that fulfills the requirements of those fleet operators in the state.

Michael Shlisky, Analyst

Great. To follow up on the last point about the non-step van products, can you share how the MDH, MDXT, and HDXT products are performing? Is any of that included in the sales outlook for 2023? Similarly, regarding the powertrain business, was it part of the mix in the fourth quarter? Do you expect it to be included in the 2023 outlook? I would appreciate your insights on this.

Dakota Semler, CEO

Yes. So, when we talk about the other products like MD and HDXT and powertrains, 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 at Q4, I'll let Kingsley speak directly to those two business units.

Kingsley Afemikhe, CFO

Hey Mike, how are you? When you look at our forecast for this year, that number includes step vans, powertrains, and a number of hubs. The vast majority of it is step vans. Additionally, the backlog number reflects net additions, accounting for both cancellations and deliveries over the year.

Dakota Semler, CEO

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 improvements there that we shared in some of the detail in the call and anticipate further improvement in the quarters to come.

Michael Shlisky, Analyst

Got it. Maybe one last one for me and maybe just taking a big step back, Dakota. Some of the comments that 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 two unit tests, you've then gone through second 10 units, 20 units test and now customers are coming in saying you are an official supplier of our company. I haven't heard anywhere else in the EV truck space. I don't think it's 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 a fund those experiment at this point? And what number of customers are considering you that and you get a feel for how many might convert to that in 2023?

Dakota Semler, CEO

Yes, absolutely. Mike, you hit the nail on the head. 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 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 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.

Michael Shlisky, Analyst

Okay. That's great color. I'll pass along. Thank you.

Dakota Semler, CEO

Thanks Mike.

Operator, Operator

Our next question comes from Jerry Revich of Goldman Sachs. Please go ahead.

Adam Bubes, Analyst

Hi. This is Adam Bubes on for Jerry today.

Dakota Semler, CEO

Hi there Adam.

Adam Bubes, Analyst

When you mention gross profit on a unit level becoming positive, could you clarify if that indicates you expect the overall company's gross profit to be positive in mid-2023, or are you perhaps excluding overhead from that figure? Additionally, how do you anticipate gross profitability will be tracking as we approach the end of the year?

Kingsley Afemikhe, CFO

Yes, I can address that. On a unit basis, we are including direct material costs such as the chassis, bodies, and battery systems, as well as direct labor costs and all relevant indirect costs like freight, taxes, rent, and depreciation. Essentially, this is how we account for inventory. Additionally, there are accounting adjustments at the unit level, including reserves for various reasons like NRV or E&O reserves, which are reflected in our GAAP financial statements. We expect to be positive on a gross basis per unit by the end of the second quarter, including those indirect costs. In Q4, as Dakota mentioned, when analyzing direct material and labor costs alone, we were breakeven on the step van units delivered. The $15,000 improvements we've identified are just the first steps toward further enhancements in direct material costs and labor manufacturing times, which we anticipate implementing throughout 2023 and into 2024. Ultimately, we see achieving a positive gross margin as a step toward becoming cash flow positive, which is our primary goal as a company in the coming years.

Adam Bubes, Analyst

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

Kingsley Afemikhe, CFO

Yes, absolutely. When we examine our operations this year, there are really three key components: direct material costs, overhead costs, and the pricing actions we’ve implemented. We anticipate that as we progress, we will achieve gross margin positivity while maintaining strict discipline over our operating expenditures, which we expect to significantly reduce this year. We are pleased to have sufficient liquidity to support our operations through 2023 into 2024, and we are scaling as we have outlined.

Adam Bubes, Analyst

Thanks so much.

Dakota Semler, CEO

Thanks Adam.

Operator, Operator

The next question comes from Michael Ward of Benchmark. Please go ahead.

Michael Ward, Analyst

Thanks. Thank you. Good afternoon everyone. 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 one thing I'm curious about is, is the current backlog on the step vans shifted entirely to the next-generation to the 2023 model?

Dakota Semler, CEO

Yes, Mike. Good afternoon. 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.

Giordano Sordoni, COO

And Mike, this is Gio. I just wanted to add that with the new model, the 2023 version of the step van, we are also offering a 200-mile range option, which has generated a lot of excitement among customers. We have diversified our customer base beyond just parcel delivery, who typically only require 100 miles. Other industries, such as uniform services, may be interested in heavier-duty step vans or longer ranges that need more kilowatt-hours on board. The new version of the step van allows us to meet these needs, and we are really excited about it.

Michael Ward, Analyst

Thank you. As you examine the production ramp, there was a significant decline in the fourth quarter. Was that due to an additional supply issue, or as mentioned in the release, was it related to the transition to the 2023 version? Are those the reasons, or could it be both, as we ramp up production in 2023? It appears you're expecting similar delivery levels in the first and second quarters as seen in the fourth quarter. What factors are limiting those deliveries? It seems you will have a considerable backlog as you end 2023, which presents a risk of customers potentially pulling away. What steps will you take to accelerate production and deliveries?

Dakota Semler, CEO

Yes, I'm glad to address that, Mike. One common aspect across the entire last-mile logistics industry in Q4 is that it marks the peak season of the year. For instance, some of our customers, like FedEx Ground, may increase their package volume from 10 million the week before Thanksgiving to 20 million the following week. With such a surge in activity, it becomes challenging for them to focus on other business operations, such as onboarding new vehicles or training drivers; their main priority becomes delivering packages to customers. Therefore, we recognize that the first six to eight weeks of Q4 are the only time we can effectively make deliveries. After that, it becomes extremely busy to arrange vehicle deliveries, especially with holiday closures when people are either traveling or out of the office. This creates seasonal challenges during Q4. However, having a more diverse customer base helps us mitigate these issues. Some customers, such as those in uniform rental or mobile fleet maintenance, do not experience the same seasonal peak in Q4, allowing us to schedule vehicle builds for them during that slower period. This approach provides us with a smoother ramp, although we do expect the seasonal trend to persist. Another factor worth discussing is the charging infrastructure. Similar to vehicle deliveries, we encounter challenges related to the delivery of charging infrastructure in Q4, including office closures that affect permit approvals, utility interconnect studies, and construction efforts. Since people tend to work less during that quarter, we generally see reduced progress in commissioning and activating charging stations for our customers. Consequently, there is a lag effect extending into Q1. Despite these seasonal impacts, our backlog is steadily increasing, and we continue to experience sales growth into Q4 and Q1, with very few cancellations. Businesses still need to transition to zero-emissions vehicles due to regulatory pressures, and they are also recognizing the benefits, such as reduced maintenance and energy costs associated with operating a zero-emission fleet.

Michael Ward, Analyst

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

Dakota Semler, CEO

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 five 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.

Michael Ward, Analyst

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

Kingsley Afemikhe, CFO

Sure, absolutely. If you look on 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. It has 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 to grow.

Dakota Semler, CEO

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 an 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.

Michael Ward, Analyst

Thank you very much.

Operator, Operator

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

Donovan Schafer, Analyst

Thank you for taking my questions, and I apologize for any background noise from the renovations happening here. For my first question, I wanted to ask about the new step van model. I noticed the mention of a centralized liquid cooling system and I'm curious if this represents a shift from the previous approach. I’m assuming the cooling system you referred to is for the battery, but I could be mistaken. Is this a switch from air cooling to liquid cooling for the battery?

Scott Zion, Head of Engineering

Yes. Hi, this is Scott. We are transitioning to liquid-cooled batteries. Historically, all of our step vans did have liquid cooling for the power electronics that are on the vehicle. So, we basically have three separate cooling loops. Now, we have our electronic 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.

Donovan Schafer, Analyst

Okay. Gio mentioned that now you have a 200-mile range. From my understanding, previously, air cooling on the battery was a decision based on the light duty cycle of parcel delivery vehicles like those from UPS or FedEx Ground. Since there wasn't much aggressive acceleration or deceleration, liquid cooling didn't seem necessary. My question is whether the shift in duty cycle is what prompted the move to liquid cooling for the batteries, or were there issues with the older generation of step vans, perhaps in terms of lifespan and performance when using their cooling systems?

Giordano Sordoni, COO

Yes. I'm happy to provide more context, Donovan. The air cooling modules effectively supported the use case of parcel delivery, and we continued to supply vehicles along with powertrain systems that use those batteries and the forced air cooling design. To enhance the air cooling performance, we spaced out the cells, which resulted in better volume metric performance compared to some liquid-cooled alternatives. This design allows us to achieve greater volumetric performance, enabling us to fit more battery onto the vehicle and improve the overall gravimetric performance due to our new mounting system. Ultimately, this leads to a platform with a wider range of use cases. Additionally, for those who wish to operate the vehicle on a dual shift, the liquid cooling performance of the system makes that possible.

Donovan Schafer, Analyst

Okay, great. Thanks, that's helpful. I was looking into the New Jersey VIP Program on their website, and I found it interesting that the program includes MSRPs for the vehicles listed online. This is different from what I see in the California HVIP Program catalog. I want to confirm whether I would be mistaken to take the MSRPs from the New Jersey VIP Program and apply them more broadly. Does the MSRP vary by state, or is there a markup that affects the incentives? I would appreciate any clarification you can provide.

Giordano Sordoni, COO

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 the best information to rely on when it comes to ASPs is the ASP guidance that we provide quarterly or 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.

Donovan Schafer, Analyst

Okay. That's helpful. With the production facility in Tennessee and the development of the new version of the step van, along with the possibility of producing more Xos hub trailers, I’m curious if the production is done in batches where you overhaul the line. I imagine transitioning from the old version to the new step van, with the required structural changes, might necessitate rearranging some equipment or training workers. For example, after building 20 vehicles one way, do you then switch to producing 20 in a different manner? Is that how it operates? Or do you run the lines at the same time? Are there switching costs involved, and do those affect the economics, potentially leading to a few days of reduced production during the transition? I’m trying to conceptually understand how you manage the differing product lines.

Giordano Sordoni, COO

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 in a given week, we try to build all of the same spec vehicle, but having to switch throughout the week isn't the biggest cost that's 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.

Donovan Schafer, Analyst

Okay. If I could ask one last question, especially with the current financial turmoil and the tightening of the credit market, I’m curious about the financing involved in purchasing step vans, your main products. I assume most customers don't have large checking account balances and likely require financing for these purchases. Do those purchases get turned into commercial vehicle asset-backed securitizations? Who are the primary lenders facilitating this, and have we noticed any impact from interest rate changes in that sector?

Kingsley Afemikhe, CFO

Yes. And a really, really thoughtful question, Donovan. So, I'll break it into two different ways. The first way is financing is offered to our customers. As we announced a couple of years ago, we work with, among others, DLL, which is one of the largest asset-backed financers, part of Rabobank, to offer financing to our customers. We also work with a 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, the structured 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 their assets. As evidenced, there's a couple of percent of increases there in rates that are going to execute the purchase. In many cases, we get a slight financing fee on that. We talked about it in our backlog went public. And the separate to that, what I was talking about is the potential to finance the assets in our balance sheet, which include kind of raw materials with 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 using non-banking 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 2023, 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 expect these levels to come down as well.

Dakota Semler, CEO

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 with their manufacturing. Many of them multi-billion 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. 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.

Donovan Schafer, Analyst

Okay. Thank you. That's very helpful. I'll take the rest of my questions offline.

Dakota Semler, CEO

Thank you.

Operator, Operator

Those 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.