Yahoo Finance Eos Energy Enterprises, Inc. (NASDAQ:EOSE) Q4 2023 Earnings Call Transcript
Eos Energy Enterprises, Inc. (NASDAQ:EOSE) Q4 2023 Earnings Call Transcript March 5, 2024
Eos Energy Enterprises, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, and welcome to Eos Energy Enterprises Fourth Quarter and Full Year 2023 Conference Call. As a reminder, today's call is being recorded and your participation implies consent to such recording. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. With that, I would like to turn the call over to Liz Higley, Director of Investor Relations. You may begin.
Liz Higley: Good morning, everyone, and thank you for joining us for Eos's financial results and conference call for the fourth quarter and full year 2023. On the call today we have Eos’s CEO, Joe Mastrangelo; and CFO, Nathan Kroeker. Before we begin, allow me to provide a disclaimer regarding forward-looking statements. This call, including the Q&A portion of the call, may include forward-looking statements, including, but not limited to current expectations with respect to future results and outlook for our company and statements regarding our ability to secure final approval of a loan from the Department of Energy, LPO, or our anticipated use of proceeds from any loan facility provided by the U.S. Department of Energy which are subject to certain risks, uncertainties, and assumptions.
Should any of these risks materialize or should our assumptions prove to be incorrect, our actual results may differ materially from our expectation or those implied by these forward-looking statements. The risks and uncertainties that forward-looking statements are subject to are described in our SEC filings. Forward-looking statements represent our beliefs and assumptions only as the date such statements are made. We undertake no obligation to update any forward-looking statements made during this call to reflect events or circumstances after today, or to reflect new information or the occurrence of unanticipated events, except as required by law. This conference call will be available for replay via webcast through Eos's investor relations website at investors.eose.com.
Joe and Nathan will walk you through the company highlights, financial results, and business priorities before we proceed to Q&A. With that, I'll now turn the call over to Eos CEO, Joe Mastrangelo.
Joseph Mastrangelo: Thanks Liz, and welcome, everybody. Great to have everyone on the call here this morning. Let's jump right to Page 3 and go through some highlights from last year. First, I think the first place I’d start off is just the improvement that we've seen on gross margins as we've launched the Z3 product. Now year-over-year, we see a 41% improvement in the fourth quarter alone, when we really saw production of the Z3 ramp, we had a 66% gross margin improvement versus the prior year period. It just goes to show all the things that we've been saying about the Z3 are starting to show themselves in the financials as we move forward and start putting product out into the field. When you look at the year in and of itself, it was kind of a bookend year where Q1 was our last full quarter of Gen 2.3 production and in Q4 was our first quarter of Z3 production.
Those are our two highest quarters in revenue for the company. I think when you look at how Nathan will talk about the year, I think you're going to see some similar dynamics when you look at 2024, just because, as we do the transition to some cost out and also the new state-of-the-art manufacturing line. I think you're going to see a similar quarterly profile as you move forward throughout the year, and I think what the Z3 is showing is, the ability to generate revenue off of the semi-automated line, drive down cost, and improve gross margins, just show why we've been so positive about getting the Z3 out to customers. Also, I think one of the major accomplishments for the team was being the first non-lithium-ion battery company to qualify for a Title 17 loan with the Department of Energy.
Nathan will talk about where we are in that process, but we continue to feel like we're on track to closing that loan as we work through and get the first automated line up and running here in the second quarter of 2024. Also, we've designed and are developing that state-of-the-art line up in Wisconsin with our automation partner, ACRO Automation. We feel really good about what -- how the line looks when you go actually see it. I've been up there a couple times to watch the work being done. It is a well-done line with great craftsmanship. And it's actually pretty emotional when you start seeing the robots actually moving and you start to see the vision of how we wanted to build the Z3 take shape. So a lot in 2023 to be proud of, continue to have to work and close that gap on profitability and that's -- as we talked about back in December, that's the main focus here as we look at 2024.
If we go to Page 4, just some quick operating highlights, continue to see growth in our opportunity pipeline, up 77% at $13 billion. I think one of the biggest things in 2023, when you look at where we came in, we came in lower than our order target. And I'll talk a little bit about the dynamics that we see within the pipeline and why we feel like we're building a stronger pipeline that's going to lead to orders growth as the Z3 gets out in the field. Notwithstanding that, our backlog was still up 15% year-over-year, which in a normal operating circumstances with that type of orders growth, you'd be pretty proud of it. But looking at the opportunity, the secular shift in the industry, we know that line has to grow faster and the team is focused on bringing in the opportunities and finding as long duration of your storage becomes more critical, finding those opportunities with key customers, and I'll also talk a little bit in the commercial section about planting those seeds for future growth.
Our discharge energy is up at 1.8 gigawatt hours, 1.4 of those gigawatt hours out in the field. Every cycle that we run is a learning for us. It helps us make the software better. It helps us understand how the customer derives revenue off of our product. It's the best laboratory actually out in the field, not actually in a laboratory. Revenue for 2023, Nathan will walk through the comparisons of this, $16.4 million, down slightly versus prior year, but again, executing the transition to the Z3, while working through the DOE loan, while timing all that with capital raises to effectively get the company through the year is something that I think we feel proud of and feel like it's a foundation we can build off of here in 2024. Cash on hand, we landed with $69.5 million, not including $15 million in restricted cash, which we have for the loan that we have with Atlas.
Again, the team is laser focused on making every dollar count. I've always said every employee has stock in the company, so every employee thinks and acts like owners. We are committed to be able to work through and really navigate through this part of going from truly a R&D company into a full-fledged profitable operating company as we approach year-end 2024. Let's move to Page 5. Just a quick update on the Z3, I've talked a little bit about it. If we start off on the left-hand side of the page, on the commercial dynamics, we have 1.9 gigawatt hours, almost the same size of our backlog, what I would call late-stage opportunities. These are opportunities where customers are either getting approval, they're waiting for permits, they're waiting for grants from the Department of Energy that really make us feel good about the selection of the technology and the customers that we're working with.
The focus here going forward is really converting this great pipeline number into a great orders backlog and orders number. Semi-automated manufacturing line, we went from 10 minutes of cycle time at launch to three minutes. We hit about 3% scrap when you normalize for run rate. When you look at where we are as we get into Q1 and Q2, there's going to be a little bit lower utilization on the line versus what we saw in Q4, and that's basically about the transition to lower cost raw materials and starting to implement the line here in Turtle Creek. We achieved power on status in all motion systems in the line. This is back mid-February with the state-of-the-art line one. We're gearing up now for the FAT in Milwaukee at ACRO and the SAT coming up in Q2 in Turtle Creek.
We feel really good about the plan that we laid out. Having the line in Milwaukee and ACRO allows us to leverage their technical expertise real time and bring people on the floor to troubleshoot and work through the critical elements of debugging and finalizing mechanical completion. It's been a good partnership and we feel really good about where we are right now. On our cost roadmap, I'll talk a little bit about this on the other side of the page, but we achieved 30% of the plan that we laid out on December 12th as far as taking out costs. We see additional cost out benefits coming in in Q1 and then continuing as we go through 2024 to culminate in being contribution margin positive at the end of the year. We've shipped Z3 cubes to four customers.
Many of those are going to be starting installation here as we're talking now. And then the biggest thing from that is, taking those installations, generating the field data to show what we're seeing in every factory acceptance test that we do and every test cycle that we run in Edison that the product performs and meets the specifications that are on the field. Our container performance, right now -- we've always talked about depending on duration you get different output on a container and that's for every technology, not just our technology. If you do short duration right now with shipping is a 600 kilowatt hour container. If you do longer duration, it's 695 kilowatt hours. That will improve throughout the year to where we'll culminate in Q4 with an 800 kilowatt hour container with a lot of the work that the R&D and engineering teams are doing right now.
Finally, product certifications, we are UL 1973 approved and at the same time we're NDAA compliant, which is very important when you look at the energy storage and the energy industry in general in the United States. I think it's important to note that our product is already compliant and puts aside, not only do you get the non-flammability, the flexibility and performance, the recyclability, the safety factor. You also get security around our product. We are sourcing key components from here in the United States. Although on a part basis it may cost more, at the same time it gives you the security of knowing that this product can be on the grid and de-risks the energy security that we're all worried about. If we go over to the right-hand side of the page, I want to start with the upper right.
This is an update of the cost out walk that we laid out in our strategic outlook back in December. When you look at it in the beginning, you see like we started off at 100%, we're now down at 71%, so 30% -- 29%, 30% cost out of the product. A lot of that has to do with ramping up the line. It also has to do with the material cost out. The Z3 product is a simple product. It's a simple product that really has a good bill of material cost position. We now need to continue to ramp that product. So when you look at the biggest things, so when you tell people we want to get down to Z3 at scale at 20% of what it was at launch, you have to consider like how our factory works and where this comes in as far as what we need to do. And I want to go down to the bottom of the page and talk about the Q4 2023 cost makeup.
So when you look at COGS, you start to take out that, 11% of that COGS number was building spares for the Gen 2.3. Another 4% was Z3 launch costs. These are the costs of tuning the line, running material through the line as we start to figure out how to balance, not normal run rate. Now, the good news around that 4%, it's lower than what we initially had planned for, and one of the reasons why, when we talk about the Z3 launch and the state-of-the-art line, we think the overall program costs will come in below budget, because we were able to ramp up the semi-automated line, learn from that and apply it to the state-of-the-art line. Then you have -- a 25% of this is labor and overhead under absorption. So why do we say that? Well, think about our factory, right?
The factory that we're in or the footprint that we have for manufacturing is essentially three locations of approximately 50,000 square feet. One of those locations does containerization. Another of those locations houses the semi-automated line, and the third one was where the Gen 2.3 line was located and is where the state-of-the-art line will go into when we ship it from ACRO into Eos. That -- one-third of that line was basically idle as we went through. So when you think about how we're going to take cost out of the product going forward, it's truly getting better labor and overhead utilization on a per unit basis as you ramp manufacturing. This is not invention, this is not complex material science, this is executing on a plan to deliver volume.
Now, what I feel really good about is, as we're going through and looking at the cost out roadmap, this is going to continue. It's not going to stop at this 20% of the launch cost. We are already starting to refresh the cost out pipeline and start looking to what that will look like beyond 2024. So in an early stage product like the Z3, there's significant work that we can still do to continue to take cost out, but the initial progress and performance in the first quarter of really producing the product shows that the thesis that we had around what the product can do will hold. Now it's a matter of scaling and utilizing our cost profile to better take down unit costs and drive profitability into the organization. Transitioning over to the commercial opportunity pipeline orders backlog.
Let's just go to the classic Slide on Page 7 to talk about some of the dynamics that we're seeing. We saw a drop year-over-year in lead generation. What I'd like everyone to know about is, like, I'm not concerned about that just in the sense that we saw an increase in what I would call solid projects. So we have less people coming to us with ideas and more people coming to us with solid opportunities. So seeing that number go down is not concerning to me, and we always talked about there being breakage of each one of these buckets as you transition. You're hoping to transition probably 30% of it to the next bucket to come up with the numbers that you want to have when you're operating at scale. We saw a significant increase in both the active proposals and the LOI firm commitments.
We've got to really work on that LOI firm commitment to transition those opportunities over into active backlog with down payments. The team is working on this. What I would say is, no one is satisfied with the performance that we've had on delivering orders here as we went through last year. What I do feel good about are the conversations that we're having with customers, where we're positioning the company to grow for the future, and how customers are really saying, we like the Z3 product, we have a project, work through me, work with me to get through closure of these projects to get the technology out in the field. And that's that 1.9 gigawatt hour that I talked about earlier. So this is an area where we're focused on it, we need to improve our performance, we will improve our performance over time, but feel really good about the initial interest and how customers are approaching the Z3.
And where they are doing that lays out on Page 8. I want to talk about what I would say are the four main areas of growth. I talked earlier in the US around this national security concerns, shift to more domestic content. We're seeing longer duration energy storage opportunities coming through and also started to see interest from high energy consumption applications like data centers and how our product can match up with either wind or solar or on a standalone basis to help meet those energy needs. When you look at the opportunity, look, the US government banned the Defense Department from procuring batteries produced by four specific Chinese companies. We sit here, and as I said earlier, that's where NDAA compliance comes in. And we also sit here and say to the market, here is an alternative that is invented in the US, manufactured in the US, with US materials on US manufacturing equipment.
It meets that need and allays the concern around national security as you think about our grid. Next one, when you look at Italy, Italy recently got an incentive program approved to fund 9 gigawatt, 71 gigawatt hours of energy storage. They'll be implemented out until 2030. We're very excited. I mean, recently shipped one Eos Z3 tube to Sicily to start use case testing with a key customer. That's going to lay the foundation for when the auction happens and we're starting to see this auction also call for 10% of that auction being non-lithium-ion technology. It doesn't stop at 10% but it gives it a four and that's why we're excited and focused to get that project up and running in Sicily and then from there look at how we expand going forward.
Australia, another core market as you see growth, when you look at their market size, it's very big. We, given the size of the company, need to do this in partnership with someone. We're working with a couple of different companies down there, we're working to find an initial commercial pilot, and commercial pilot meaning multiple megawatt -- multiple megawatt hours, like you've seen us talk about with companies like Dominion and Duke here in the United States. But to really be able to do that with a core, large natural resource company to be able to figure out how we're going to grow in Australia and grow the right way in Australia because of the distances here. We have to do this right and be thoughtful about it, but great opportunity as we look forward.
The fourth one being India. India is targeting a 500 gigawatt hour renewable energy target by 2030. The interesting thing around India is, they're coming up and bidding projects where they're talking about 24-hour renewables. That becomes a mix of solar, wind, and energy storage. What we're working with two large Indian corporations is understanding how having it in an asset like the Z3 Cube in that 24-hour energy mix allows you to better balance when wind isn't there, a better balance the solar demand and come up with a more profitable project. It's initial work that we're going through, but we feel really good about where we're headed and we'll keep everyone updated on this. So when you really think about this, the US is where we're shipping the majority of our product.
We have a pilot going to Italy to position ourselves for long term out there. We're working with partners for Australia and India to access those markets and as we move forward, we'll keep everybody posted on the progress here, but we're seeing more and more opportunities where people are starting to see having a flexible, safe, secure. And another really -- thing that we've never really talked about, we've been too quiet about is the fact that the Z3 is also silent. It doesn't make any noise because it doesn't have any HVAC systems. And that's also important when you think about citing these things in urban areas. No one wants to have a lot of noise around it and our product actually doesn't make any noise. In fact we had a customer once tell us, we don't know when we're using your product because you don't consume any power and you don't make any noise.
Those are strengths as you start thinking about how the market is going to evolve in the future. Now let's look at operational scale and building capacity for the company. Let's go to Page 10 for an update on the state-of-the-art manufacturing line. We have a highly efficient capital model for building out capacity. And you're starting to see that more and more as we are building out our line compared to what you hear around lithium-ion manufacturing. We believe it's $30 million CapEx for 1 gigawatt hour compared to $85 million for 1 gigawatt hour of lithium-ion, knowing that we can become profitable at that 1 gigawatt hour, whereas much larger factories are required to get the economies of scale to hit profitability with lithium-ion. Currently we're on budget for the plan.
As I said, there's some recent pictures from ACRO as the line is being tuned. It is one of those moments where you stand and you watch this and you think about where the company has come from in the past five years and how this positions us for future growth. Having a full line assembled on the ACRO floor, seeing the power on, seeing the robots moving, seeing our raw materials move across the line, it just goes to show the opportunity that we have and working with ACRO, it's actually, helps me sleep well at night, because they look at what we're trying to do and they kind of give you a shrug of the shoulders and say we've been here before, this is what our expertise is, we're going to build you a great product, and so far that's what's been happening.
As you look at where we're headed, we are doing the system integration and the final debugging of the line. At the same time, we've also come up with this concept of A and B teams rotating in and out of ACRO on a bi-weekly basis. What that means is that, we have people going up to ACRO helping to assemble a line, so the maintenance teams are there helping assemble a line, and then we're also going to start sending operators up, start getting trained on the line, so that when it hits the floor in Turtle Creek, we're all familiar with it, we know how this works. We're currently on schedule for the installation and commissioning in Q2, and we'll keep everyone updated on the progress, but it really is something to see when you see it live. Going to Page 11.
Look, the picture on the left really shows the simplicity of the product. We're now positioning this product to take out the volatility around raw materials. We signed a long-term agreement with both TETRA and SABIC. TETRA for our electrolytes, SABIC for our conductive polymers. The same time we're doing work to get graphitized felt, what we've done on our supply chain is, we moved from China to Asia and now looking at balancing out Asia with a move into the US. We're starting to build this out. This is a somewhat complex supply chain when you look at it wing-to-wing. So it's where do you get your pan fiber from, how do you needle that pan fiber or actually turn pan fiber into felt, and then how you graphitized that. The good news is that, we're finding US-based suppliers that are interested in working with us.
We'll keep everyone updated on that, but we really feel good about the work that we're doing there and the cost position that it's driving for us as we move forward. And then just on core plastic, the tub and the lid for the battery, we buy 100% in the US from multiple suppliers and we're expanding capacity and introducing redundancy to get protection around the market. But the goal here is to just drive that battery cost down. For us, where comparison points get difficult, is when people talk about lithium-ion cells being at a certain cost point, we don't actually manufacture cells, we build modules. What you look at there is 20 cells that make up a module. And what we see as we look forward going back to that cost walk I talked about earlier is a product that will be very competitive on a per unit basis as we move forward just as we continue to drive simplicity and focus and partner with large strategic companies to build our product.
If we go to Page 12, just a quick update, really think on two programs that were critical and part of the cutover that we're going to be doing here in the first quarter. On the left-hand side, if you look at the details there, what you see on the left-hand side is, our old three bipolar and the new one, basically what you see is you see less white plastic, more black area. Having more black area means you have more surface area to generate energy out of. That both takes cost out of the product and improves performance. And that's where we start talking about getting the fourth quarter and having an 800 kilowatt hour cube performance. That's where a lot of that performance comes from. And at the same time, when you look in the middle here, we've replaced titanium with conductive plastic.
That new piece there is significantly less expensive to produce than the old one. When you think about it, it's 65% lower and it simplifies our manufacturing process and that's what drives up our performance to the 695 kilowatt hour, and then eventually to the 800 kilowatt hour as we get to year end. As I talked about before, we've hit 30% of our plan that we've laid out in 12/12. We've got additional cost out improvements coming for late Q1 2024. We schedule and get the state-of-the-art line up and running in Q2, and then hit the energy density in Q4, and the company and the product is operating at scale. It's pretty exciting and when I look back on this, I know some people would say, why did you just go to Z3 in the beginning? If we hadn't done the Gen 2.3, we would have never learned the valuable lessons on how to manufacture that led to the Z3.
I think when we were looking at the Gen 2.3 and the Z3, there were a lot of unknowns around this concept of doing a tub insertion assembly design. And actually by manufacturing the Gen 2.3, we learned a lot that led to where the Z3 now is and the fact that we were able to launch it the way that we did in Q4. So more to come as we move forward. We want to thank everybody for listening. I'll turn it over to Nathan. Thank you.
Nathan Kroeker: Thanks, Joe. And thanks, everyone, for joining us this morning. Let me start with an update on cash. We ended 2023 with $69.5 million in cash on the balance sheet. And since year end, we have collected some customer deposits and milestone payments and we have current line of sight to collecting on three or four significant customer payments in the next couple of months as we continue to work towards getting the first advance on the DOE loan. We are also in the process of finalizing negotiations with the expectation to monetize our 2023 production tax credits in the coming weeks, and we also expect to monetize our 24 credits on a monthly or quarterly basis going forward. Consistent with previously announced transactions in the market, we anticipate there to be a 5% to 10% discount on these credits upon monetization, with the economics improving as the size of the credits increases over time.
With that, let's get to our financial results. Turning to the next few slides, I will walk through the fourth quarter and full-year financial performance along with an outlook for 2024. Now for the fourth quarter, revenue in the quarter was $6.6 million, up 148% compared to revenue of $2.7 million in Q4 of 2022, and up 866% compared to revenue of $0.7 million in Q3 of 2023. The year-over-year growth in revenue was a result of our transition from Gen 2.3 to the Eos Z3 Cube, while the sequential quarterly growth was driven by higher production volumes off the semi-automated manufacturing line as we ramped up production. We shipped our first Eos Z3 cubes at the end of September to two different customers and we are in the process of delivering a much larger project in Orchard, Texas to a key customer owned by a large North American infrastructure fund, which is scheduled to be completed in the next few weeks.
Cost of goods sold for the quarter was $30.4 million, a 1% decrease versus prior year despite higher production volumes, resulting in a 66% gross margin improvement year-over-year, primarily attributable to better unit economics of Z3. During the quarter, we saw a decrease of approximately 30% in costs as a result of improved labor and overhead absorption, in addition to bill of material cost reductions. These reductions were partially offset by increased scrap costs from process control changes. Fourth quarter operating expenses were $18.5 million, a 10% decrease from the prior year period, primarily attributable to there being no write-off of assets this quarter and partially offset by an increase in payroll-related expenses such as stock-based compensation in the quarter.
Total operating expenses of $18.5 million included $4.1 million of non-cash items, including stock-based compensation, depreciation, and amortization. The resulting operating loss for the quarter was $42.2 million, or $35.8 million, when you exclude non-cash items such as stock-based compensation, depreciation, and amortization, and a net loss of $41.2 million. This compares to an operating loss of $48.6 million and a net loss of $56.6 million in the fourth quarter of 2022, despite 2022 having lower production volumes. So as Joe highlighted earlier, you can see all of our hard work beginning to pay off. Now turning to slide 15 to review 2023 full year performance. Revenue for the full year 2023 was $16.4 million, a slight decrease compared to revenue of $17.9 million for full year 2022 as we concluded our Gen 2.3 production in the first half of 2023 and stood up the Z3 manufacturing processes in an effort to launch production at the end of the third quarter.
Cost of goods sold was $89.8 million, a $63.5 million decrease compared to the prior year, delivering an improvement of 41% in gross margins year-over-year, driven by lower input costs combined with improved Z3 manufacturability. During the year, we recognized $3.3 million in production tax credits, net of the anticipated monetization discount. We are now recognizing both the 45x and the 10% electrode active material credits. And we are working towards monetizing both the 2023 and 2024 tax credits at a small discount, as we discussed earlier. We invested $18.7 million in research and development in 2023, of which $2.3 million was related to non-cash items, such as stock-based compensation, depreciation, and amortization. This was in line with what we discussed on December the 12th and we believe this is a good run rate for R&D on a go-forward basis.
We continue to invest in our Z3 battery technology, optimize our BMS system, and identify various initiatives to reduce battery and system costs. SG&A for the year was $53.7 million, a 12% decrease compared to $60.6 million in 2022 as we worked on tighter cost control and reducing outside services. Full year SG&A included $12.3 million, or approximately 23% of non-cash items, including stock compensation, depreciation, and amortization. Total operating expense for the year was $79.5 million, a 7% decrease versus prior year, of which $14.7 million or approximately 20% was non-cash related and $7.2 million was related to asset write-offs as we transitioned manufacturing to Z3. Full year operating loss was $152.9 million with a net loss of $229.5 million or $145.3 million excluding non-cash items including the fair value treatment of our derivative liabilities, non-cash interest expense, stock-based compensation, depreciation and amortization.
A 30% year-over-year improvement. Now moving to slide 16, I want to spend some time looking at our past production and what we should expect going forward as we get into the expected financial performance for 2024. As you can see on the left-hand side of the page, Q4 revenues increased 866% over Q4 of this year and 148% over Q4 of last year as we significantly increased production volumes off the semi-automated line. As discussed earlier, we shipped our first Z3 cubes at the end of September and then ramped up production in Q4, while still producing well below capacity on the semi-automated manufacturing line. While this resulted in us coming in below our initial 2023 revenue guidance, we made the decision to balance factory output with critical customer commitments.
We expect to continue making these trade-offs as we prioritize working capital conservation ahead of securing our long-term financing. We continue to work alongside our customers to understand delivery timelines based on their site readiness and aligning these obligations with our cost out roadmap. As a result, we currently expect production rates for the first half of the year to be similar or slightly above what we saw in Q4 of 2023. Before we conclude, we want to initiate guidance for 2024 on both revenue and profitability. Regarding our revenue estimates for 2024, we expect to be between $60 million and $90 million based on our current production schedule and anticipated customer delivery schedules, which includes us running the semi-automated line for the first part of the year and then transitioning to initial production of batteries on the new state-of-the-art line before the end of the second quarter.
As we have discussed in the past, we have a list of customer projects scheduled that supports this revenue plan, and we are continuously working with customers to finalize delivery dates based on their site readiness. From a profitability perspective, we expect to achieve positive contribution margin in the fourth quarter. Positive contribution margin is defined as revenue, less direct labor, and direct materials, also taking into account the benefit of the production tax credits. As discussed on December the 12th and as Joe detailed earlier, we have a roadmap to reduce material and labor costs, while increasing energy density that is expected to result in an 80% reduction in overall product costs on a dollar per kilowatt hour basis from initial launch to scale, currently anticipated in early 2025.
In calendar 2024, we expect to reduce costs by approximately 76% from initial commercial launch, with further cost out to be achieved when we increase our capacity in the beginning of 2025. Once we achieve positive contribution margin, we intend to increase our production significantly, now that every incremental unit that we produce helps to cover our fixed costs. Since the Z3 launch in mid-2023, we have achieved approximately 30% of the total expected cost reductions with additional initiatives to begin cutting in by the end of the first quarter. So as we move into 2024, we expect to continue balancing key customer schedules with necessary workforce development, product design enhancements, and cost out, up until the critical point at which each individual battery module we build contributes to our bottom line.
We believe this disciplined manufacturing approach will allow us to conserve capital as we work on closing the DOE loan and lead to positive contribution margins in Q4 of this year. With that, I want to thank everybody for their time and for listening today. I would now like to turn it over to the operator for questions. Operator?
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