Hyster-Yale, Inc. Q2 FY2022 Earnings Call

Hello, and welcome to the Hyster-Yale Q2 2022 Earnings Conference Call. My name is Alex. I'll be coordinating the call today. I will now hand over to your host, Christina Kmetko of Investor Relations. Christina, over to you.

Good morning, everyone, and thanks for joining us today. Welcome to our 2022 second quarter earnings call. I am Christina Kmetko, and I am responsible for Investor Relations at Hyster-Yale. Joining me on today's call are Al Rankin, Chairman and Chief Executive Officer; Rajiv Prasad, President; and Ken Schilling, our Senior Vice President, Chief Financial Officer and Treasurer. Yesterday evening, we published our 2022 second quarter results and filed our 10-Q, both of which are available on our website. Today's call is being recorded and webcast. The webcast will be on our website later this afternoon and available for approximately 12 months. Our remarks that follow, including answers to your questions, contain forward-looking statements. These statements are subject to several risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements made here today. These risks include, among others, matters that we have described in our earnings release issued last night and in our 10-Q and other filings with the SEC. We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly earnings conference call, if at all. In a moment, I'll discuss our current quarter results. But first, let me turn the call over to our Chairman and CEO, Al Rankin, for some opening remarks. Al?

Thanks, Christie, and good morning, everyone. Overall, our second quarter results are directionally where we expected them to be as we continue to face near-term supply chain constraints and inflation challenges as many other companies do. Despite these headwinds and while still reporting a substantial consolidated operating and net loss, our results for the quarters were substantially better than we anticipated in our first quarter earnings release with all three segments, particularly the Lift Truck business reporting better-than-expected results. These more favorable results were due to higher-than-anticipated gross margins and lower operating expenses. Nevertheless, supply chain availability prevented our forklift truck business from achieving production levels we would have preferred in the second quarter. Lift Truck gross margins decreased modestly from gross margins in the first quarter of 2022 due to additional commodity inflation resulting from the Russia-Ukraine conflict and adverse product mix. End-market booking demand appears to be moderating, but the market is still strong, and we continue to have healthy order rates and a robust backlog. Nevertheless, shortages of certain critical components are continuing to disrupt our production levels. And the Lift Truck business has reduced future production levels planned for the back half of 2022 and 2023 to help ensure parts availability. We remain laser-focused on mitigating the impacts of the supply chain constraints, and our teams continue to work closely with suppliers to obtain the components we need for production. Given the high backlog levels, the Lift Truck business will further increase production as supply chain bottlenecks are resolved. We have also continued to raise prices in the current inflationary environment to increase margins, both in our backlog and particularly for new orders. While these challenges have affected our outlook for the back half of the year, we remain confident that they will subside over time. Rajiv and Ken will provide more specifics on these topics. Now I'll turn the call back over to Christie to review the financial results for the quarter. Christie?

Thank you, Al. I'll start with high-level comments about the consolidated operations and then provide some perspective on the individual segments. In the second quarter, our consolidated revenues increased 17% to $895.4 million from $765.6 million last year because of improved pricing in our Lift Truck and Bolzoni businesses and higher unit and parts volumes in the Americas and EMEA. These improvements were partially offset by unfavorable currency movements from the strengthening U.S. dollar. Shipments for the quarter were 25,300 units, an increase of 11.5% over the prior year second quarter. However, as Al mentioned, while the Lift Truck market continues to be healthy, it has shown signs of moderating. As a result of this and other factors Rajiv will discuss in a moment, we saw a significant decrease in bookings in the second quarter compared with the prior year second quarter and the first quarter of 2022. We ended the second quarter with approximately 112,000 units in backlog, still very high, but down modestly from the historically high level at the end of the first quarter. Despite the increased shipments and higher revenues, the company reported an operating loss of $15.7 million compared with operating profit of $5.9 million in the prior year, which included $6.3 million of income associated with a favorable court ruling. We also reported a consolidated net loss of $19.4 million for the second quarter of 2022 compared with net income of $1.9 million last year. The decline in profitability was mainly due to significant material and freight cost inflation and manufacturing inefficiencies, primarily in the Americas and EMEA, totaling $85.9 million. These unfavorable variances more than offset the favorable impact of improved pricing of $59.9 million and higher unit and parts volumes. Looking at the individual segment results, our Lift Truck business generated an operating loss of $11.7 million in the 2022 second quarter compared with operating profit of $15.4 million in the prior year, primarily due to a decrease in gross profit in all three geographic segments, but most significantly in EMEA as well as higher operating expenses in the Americas. The decline resulted from the specific factors I mentioned in the discussion of our consolidated results. While all three of the geographic Lift Truck segments were affected by higher costs and production delays, EMEA was affected the most. The Americas was able to fully offset the increase in material costs with price improvements, whereas EMEA pricing did not fully cover cost increases. EMEA and JAPIC also experienced significant unfavorable currency movements and JAPIC generated lower margins because of a shift in mix to lower-margin products. Bolzoni's second quarter revenues increased modestly and operating profit improved to $3.4 million from an operating loss of $400,000 last year. These improvements were primarily due to a 19.6% improvement in gross profit and a substantial increase in gross margin resulting from a shift in sales mix to higher margin products and benefits from price increases, net of material and freight cost inflation as well as lower operating expenses. Finally, at Nuvera, revenue of $300,000 was comparable to the prior year second quarter and the operating loss decreased to $7.9 million from $9 million in the prior year. The lower operating loss was due to improved margins from lower production costs in 2022. That completes the update of our financial results for the quarter. Now let me turn to Rajiv, who will provide an overview of our operations and our strategic projects.

Thank you, Christie. The global Lift Truck market grew in the first quarter of 2022, but as Al indicated, appears to decline significantly in the second quarter compared to the high levels of both the second quarter of 2021 and the first quarter of 2022. As a result of the market decline as well as our focus on accepting only orders with expected sound margins, bookings in the second quarter of 2022 decreased substantially from the robust levels of the 2022 first quarter and 2021 second quarter. However, the average booking sales price per unit increased 23.8% in the 2022 second quarter over the first quarter and 43.6% over the prior year quarter because of price increases, a shift in sales mix and our focus on accepting only orders with expected sound margins. Over the remainder of 2022, we expect the global Lift Truck market to continue to decline from historical highs of 2021, but remains above pre-pandemic levels. As a result of this market outlook and the depression we have, we're using in order acceptance, we anticipate a substantial decrease in bookings during the second half of 2022 compared with the second half of 2021, particularly in the Americas. Despite the ongoing parts shortage and supply chain disruptions which continue to constrain production of our Lift Trucks in the second quarter, we experienced higher shipment levels than in the prior year second quarter and 2022 first quarter because an increase in production rate over prior period levels was facilitated by a moderately reduced impact of component shortages. Nevertheless, with higher shipments and lower bookings than in 2022 first quarter, our high backlog levels with its delivery lead times that remain well above historic norms began to decrease in the second quarter of 2022 for the first time since the beginning of the pandemic. Some moderation in the number of suppliers with shortages occurred in the first half of this year. The shortages are anticipated to continue through the remainder of 2022 and then decline in 2023. However, that could change based on China lockdowns and Russia-Ukraine conflict developments. As a result, we have reduced our planned production schedule for the second half of 2022 and in 2023 from what we expected at the time of last quarter's earnings release. We continue to focus on managing margins in our backlog and especially on new orders. As a result of the Ukraine-Russia conflict, material costs continued to increase in the second quarter. However, recent signs have suggested some relief from additional material and freight cost inflation in the second half of this year. As a result of the cost inflation that has already occurred and what is expected over the remainder of 2022, we have implemented several price increases, both last year and in the first six months of this year. But many of the orders in the backlog slotted for production in the third and fourth quarters do not reflect the full effect of it. On the other hand, our sales team is pricing new bookings at close to target margin based on anticipated future costs at the time of production. Further, the renewal of tariff exclusion is expected to partly offset the anticipated higher material cost inflation in the backlog over the remainder of 2022. Due to the lag between when unit price increases go into effect and when revenue is realized as the units are shipped as we work through our low-margin backlog in the second half of 2022 and in early 2023, we expect margins to improve, specifically in the 2022 fourth quarter when the higher-margin already booked trucks are expected to be produced and shipped. We continue to focus on our strategic initiatives, which are laid out in more detail in our earnings release. The Lift Truck business' primary focus continues to be on introducing new modular scalable products and transforming our sales approach by using an industry-based approach to meet our customer needs. Bolzoni continues to work on streamlining and strengthening its operations while increasing its Americas business and expanding its industry sales, marketing and other product capabilities and Nuvera continues to focus on ramping up demonstrations, quotes and bookings of its 45 and 60-kilowatt engines. Overall, we continue to believe we have the right strategies in place with sound long-term financial results once we can achieve resolution of component shortages and relative stabilization and then decline in material and freight costs. I'll now turn the call over to Ken for an update on future quarters and liquidity.

Thanks, Rajiv. As you've heard from both Al and Rajiv, significant supply chain disruptions continue despite relentless engagement with our supply base. These disruptions are reducing our production plans and shipment levels substantially lower than what we would like and increasing manufacturing inefficiencies. We have also been faced with higher material and freight costs. All these factors are having an impact on our expectations for the second half of 2022 and into 2023. However, given our robust backlog and actions put in place to mitigate the impact of supply chain constraints and shortages, we still expect full year 2022 shipments to increase over 2021 despite the normal third quarter plant shutdowns. Of course, this is all with the expectation that supplies of components or commodities are not further constrained. We are hopeful that availability will improve, and consequentially, production can increase over our current forecast for the remainder of 2022 and into 2023's production schedules. As Rajiv discussed, we are focusing on pricing new bookings closer to target margins based upon anticipated costs at the time of expected production. These increased prices have translated into a substantial increase in the current average sales price per unit within our backlog. Over time, we expect improved margins as prices and costs come into line. In the meantime, we continue to work aggressively to manage component availability to increase production rates and continue to adjust prices as costs change. As a result of these factors, along with our core strategies, increased shipment volume potential of our current backlog and expected bookings during the remainder of 2022 and enhanced prices and the renewal of tariff exclusions, we expect the Lift Truck business to move from a significant operating loss in the first half of 2022 to an operating profit in the fourth quarter. Because of manufacturing and inefficiencies expected in the third quarter due to our normal seasonal plant shutdowns and reductions in production volumes resulting from the continued supply chain constraints as well as unfavorable currency effects, we expect a significant operating loss at the Lift Truck business in the third quarter that is higher than the operating loss in the prior year third quarter. Then an increase in substantial operating profit is expected in the fourth quarter, but one that is lower than was anticipated at the time of the 2022 first quarter earnings release. The anticipated operating loss in the second half of 2022 at the Lift Truck business is expected to be significantly lower than the operating loss in the first half, mainly driven by strong operating profits in the fourth quarter of 2022 in the Americas segment. Over the second half of 2022, we are projecting the stabilization of product and transportation costs and continued improvement in component and logistics availability. Although this could change if the availability of commodities and/or components continues to be seriously affected by various market forces, including a potential economic recession, the lockdowns in China, and the ongoing Russia-Ukraine conflict. We are also anticipating the continued introduction of additional modular and scalable product families and the continued implementation of cost-saving initiatives over this period and into the longer term. As a result of lower sales and inefficiencies expected from the normal third quarter seasonal plant shutdowns, reduced demand for legacy components for the Lift Truck business and additional material inflation caused by the Russia-Ukraine conflict, we expect Bolzoni to achieve near breakeven results in the third quarter of 2022 with a return to profitability in the fourth quarter as component shortages moderate, efficiencies return and benefits are realized from pricing actions. We expect solid operating profit at Bolzoni in the second half of 2022 compared with an operating loss in the second half of 2021. However, operating profit in the second half of this year is expected to be significantly lower than it was in the first half of 2022. Excluding the impact of the inventory valuation and fixed asset impairment charges taken last year, we expect moderately reduced losses at Nuvera in 2022 because of enhanced fuel cell shipments and expected lower production costs. Although losses in the second half of 2022 are expected to be higher than in the first half as a result of higher operating expenses. On a consolidated basis, we expect a larger net loss in the third quarter of 2022 than previously projected, but a return to net income in the fourth quarter of 2022. However, I would note that the fourth quarter net income is not expected to offset the losses generated in the first nine months. Generally, results in the second half of the year are expected to be lower than anticipated when the 2022 first quarter earnings release was issued mainly due to the adjustments we made to our production schedule because of continued supply chain constraints. Current expectations are based on the anticipated reasonable resolution of component shortages and relative stabilization of material and freight cost. Our expectations could be lower if supply chain and inflation conditions worsen or if conditions improve. We continue to monitor the factors contributing to our revised outlook for the year, and we'll provide an update on our next earnings call. We carefully manage our capital expenditures, our operating expenses and our production plan for 2022 in a manner designed to protect liquidity. We have implemented a program of strict controls over operating expenses to reduce cash outflow, including delays in the timing of certain of our strategic program investments. While we expect over time to make these capital expenditures and investments in the business, maintaining liquidity will continue to be a priority. During 2021 and the first half of 2022, our ability to build and ship trucks was significantly constrained by part shortages of certain critical components, while the remaining components needed to build trucks were received and added to inventory, causing inventory levels to increase substantially. We expect to reduce inventory substantially by using current inventory to build trucks for which production has been significantly delayed due to critical part shortages and receiving components as they are needed for production. That process has resulted in reduced inventory over the last two months with further reductions expected monthly. At June 30, 2022, we had cash on hand of $75.6 million and debt of $580.6 million compared with cash on hand of $65.1 million and debt of $479 million at March of 31, 2022, and cash on hand of $65.5 million and debt of $518.5 million at December 31, 2021. As of June 30, 2022, we had unused borrowing capacity of approximately $156 million under our revolving credit facilities compared with $218 million at March 31. I'll now return the call back to Al.

As we look to the remainder of 2022, we are continuing to focus on managing effectively in this challenging environment. While we're facing near-term supply chain challenges, market dynamics remain strong. We've taken numerous pricing actions to recover margins. Additionally, we've updated our production plans to better match the current environment in terms of supply of components and believe we have a realistic outlook for the back half of 2022. We have innovative products, and we're implementing the right programs in this highly inflationary environment. We remain confident that the actions we are taking will enable us to return to profitability in the fourth quarter of 2022 and in 2023. Further, we continue to execute our midterm and long-term strategies. Our strategy for the longer term is clear and transformative. Our key projects as well as the explicit objectives for the Lift Truck, Bolzoni and Nuvera businesses support this long-term strategy. We will now turn to any questions you may have.

Our first question for today comes from Steve Ferazani from Sidoti.

Great. I appreciate all the detail on the call. There's a lot there. So I just want to start out by congratulating you on the increase in deliveries this quarter, especially given all the volatility; it was impressive and certainly exceeded our expectations for shipments and deliveries. Regarding your outlook for the second half of the year, are you observing that component shortages in the near term have worsened compared to three months ago? For your guidance for at least the third quarter, is it more related to the usual European slowdown and higher material costs, or is there a significant impact due to honing shortages?

Let me ask Rajiv to address your question in a moment, but I want to first emphasize that our goal has been to boost our production compared to previous levels. We have a backlog that we are eager to address. There is growing demand for our products, along with issues regarding component availability to sustain current production levels. With that context, I'll turn it over to Rajiv for a more detailed response.

Yes, sure. Thank you, Al, for the question. What we see right now is some variation between the two regions. In North America, we are noticing improvement. The number of delayed shipments from our suppliers has certainly decreased from the first quarter to the second quarter. We expect this trend to continue improving, although it won't be perfect. We will still need to work diligently with our buyers to meet their delivery targets. In Europe, however, the situation is more challenging due to the Russia-Ukraine conflict and the summer shutdown period in August. While there is some improvement in Europe, it is not to the same extent as what we're seeing in North America. Therefore, it remains more difficult to secure our parts in Europe. I hope that provides some clarity.

Okay. Appreciate that.

What this means is that, as clearly stated in the earnings release, we are aligning our planned production levels with our suppliers' capabilities at this stage. We will not assume that we can increase production as much as we would like and had initially expected. While our suppliers might be able to ramp up, we will wait for solid evidence that they can do so before we adjust our production plan beyond the moderate increases we currently have in place. We aim to be cautious in our planning and production levels, along with the resulting inventory. However, if conditions improve, we certainly have the backlog to take advantage of that improved availability if it arises.

When I look at bookings and backlog dollars per unit, it's hard to figure out how much of that's mix versus how much it's just straight pricing? And also, as I look at the dollars per unit in backlog, how much of that have you moved a significant portion now of the older price backlog, and that is going to help you moving forward. If you can sort of help out with the sort of the per unit dollar amount in both bookings and backlog. And if I can throw one other piece into that is when we see the bookings coming down, how much of that's demand versus you being very strongly holding the line on pricing and willing to give up business to make sure you get the margins you want into next year?

Maybe Rajiv starts and then turn it to Ken.

Yes, thank you, Al. Regarding our backlog, it includes various factors related to pricing and inflation. We are currently addressing the lower-margin trucks in our backlog, which we processed in the first half of the year, and we still have some remaining. This is an important aspect. Concerning pricing, we've shared the percentage of price increases from the last 18 months, and these figures are notable. This undoubtedly affects the prices of the trucks we are booking now. The model mix has a small impact; in the first half, we shipped more Class 3 trucks, which are our smaller warehouse trucks, leading to a slight decrease in that backlog compared to other trucks. However, the primary factor remains shipping the lower-priced, lower-margin trucks while booking higher-priced ones. As for market dynamics, we've observed a slight moderation this quarter, aligning with our expectations. We consider ourselves price leaders, maintaining our pricing strategy not based on current products but on what we project for future shipments. Given our backlog, some lead times approach a year, so we are forecasting to understand future shipment inflation and adjusting our pricing accordingly. Not all competitors are utilizing these strategies, which positions us as a price leader in the market and has influenced our bookings.

Yes, I'd agree with Rajiv's comment. We ship lower-priced layers out of the backlog in the second quarter production. We booked trucks at higher prices during the second quarter as well. And Steve, you're doing the math based upon the backlog and the backlog values. And you've seen that we grew by about $3,700 on the average truck between March 31 and June 30 in terms of average sales value of the trucks. Now some of that was an increase in price. Some of it was the shipping of the lower-priced trucks. But also there is a bit of mix. But you also have to consider that trucks that we sell overseas now stated in U.S. dollar value have actually gone down. So in some ways, the backlog is now not even showing all of the increase that we have because those foreign book sales in non-U.S. currency are typically being translated at unfavorable conversion rate in the U.S. dollars. So I guess that's kind of how you add up the bits and pieces.

That's helpful. That's helpful. If I could get one last one in. Obviously, you've really held the line on OpEx. How well can you do that as you start picking up production, hopefully, over the next few quarters and you're getting those stronger margins? What are you thinking about OpEx? Because obviously, you've done a great job here over the last couple of quarters.

Rajiv?

Yes. As you mentioned, we have maintained a tight control on operating expenses, which has led to a slowdown in some of our key initiatives. However, the critical projects are still ongoing and funded. With the reduced production rates planned for the second half of the year, we expect to continue managing operating expenses carefully, though we might have some flexibility with certain next-tier programs. Additionally, we aim to gradually return to normal levels for some of our other programs in 2023.

It's useful to just keep in mind that there is some inflationary backlog or inflationary impact that's occurring in SG&A as well as other as well as in the components that we buy. And I'm sure you're seeing that in other companies, but our outsourced services and certain kinds of expenses are continuing to move up. So there's an inflationary aspect that is apart from sort of the substantive question of when do we begin to undertake some of the projects that we've been deferring for a relatively short period, but nevertheless deferring.

Our next question comes from Chip Moore of EF Hutton.

Let us follow-up on the reduced production schedules for the back half of the year and into next year. Can you give us a sense maybe of your ability to flex those schedules up if you do see some improvement on supply chain shortages? How quickly do you think you could react?

Our typical lead time for our highly engineered components is around 12 to 13 weeks, which is about 3 months. We are using internal metrics to monitor how well we are receiving material, and that is the primary variable. We have the manufacturing capacity to build the trucks, so that is not an issue. As our metrics indicate an improvement in supply security, we can start to ramp up production approximately 3 to 4 months ahead for some of our larger trucks.

I'd add to that that the sort of metrics we're using internally are very much focused on the levels of inventory that we have available to build trucks for the next four days or so and whether we have all the components in hand, and we also track very carefully the components that are available for the next 30-day build and our judgment as to the reliability of the supplier forecast of what they're going to ship to us. So when those metrics start to improve, that will be a real indicator that we can look forward in the way that Rajiv was describing. But in the meantime, we're going to be carefully controlled because it's just not breaking open in terms of the supply availability as we had hoped at money.

Got it. That's very helpful. If I could ask another question regarding being a price leader and taking a more selective approach to upfront bookings, that makes a lot of sense given the backlog position. Do you have any insights on the competitive dynamics that might be allowing some of your competitors to be more aggressive on pricing, or any concerns regarding fairness? Or is your primary focus really on your strong backlog?

We have implemented an excellent set of share-based programs, and our market share position in 2021 was very robust, with these programs yielding positive results. We believe that as costs decrease due to easing commodity prices over the next few months, we will be able to lower our prices while still achieving our target margins. Additionally, it appears our competitors were slower to adjust their pricing in response to increased inflation costs. This creates a situation where both sides are catching up, which we expect will help us remain competitive based on our backlogs, which we are closely monitoring on a product-by-product basis. The backlog levels vary by truck type, with some being much more extensive than others. Therefore, as our backlogs align to more competitive levels, we anticipate being competitive with our pricing while currently following the outlined approach.

I would just add that we are working very closely with our customers and dealers. We have kept them informed about our actions and the reasons behind them, and we've engaged in extensive discussions with them. These relationships will remain strong throughout this process.

And then remember that inflation is not just in the components that we buy, the shipping costs, both internationally and domestically have been very elevated. There is some sign of moderation in both of those, and we're hopeful that that will continue and come back down to far more normal levels.

Yes. That's a very helpful perspective. I appreciate that. But maybe just one more kind of longer-term update on Nuvera sort of pipeline and progress and maybe how to think about some of the potential regulatory drivers there, whether I think California right is talking about phasing out some of the bigger trucks, spark-ignited trucks. Obviously, Europe has many initiatives underway. Just kind of an update on how you're thinking about the opportunity.

Rajiv.

Sure. We have certainly seen increased activity, primarily in Europe, due to the challenges arising from Russia that have prompted Europe to explore alternative fuel sources extensively, with hydrogen being a significant focus. Activity in Europe has accelerated, and we are also observing similar trends in India. China has experienced a slowdown due to lockdown measures, but we anticipate a strong rebound. We are beginning to see early signs of similar developments in North America, particularly starting with California. We believe that if California moves in this direction, other progressive states will likely follow. The activity level at Nuvera remains high. As discussed in previous calls, Nuvera is analyzing the market to identify which types of vehicles could benefit the most from fuel cells as a green solution compared to batteries. They are concentrating on specific market segments and collaborating with key original equipment manufacturers in those areas. It has become clear that the essential component for the industrialization of fuel cells involves going through a demonstration and development phase. Internally at Hyster-Yale, we recently introduced our first port equipment in California, which arrived last weekend and will be tested with a key customer at the L.A. port. Later in the year, we plan to do the same in Valencia with another piece of port equipment. We are beginning to deploy our products while also working with a significant number of customers across various segments who are earlier in their development stages but are going through similar processes starting with demonstration units.

I think our terminal tractor venture is going very well. We'll have I believe, Rajiv, fuel cell terminal tractors up and running very shortly in August, actually is the plan. And I think the overall perspective, if you want to back away from the details is that the high gasoline prices and diesel fuel prices and the shortage of natural gas have really significantly accelerated the focus in development perspective that both we and, I think, more generally, the industry have on prospects over the next few years. So I think the overall perspective is a good one, but we are clearly focusing on the segments as Rajiv said, where we expect early adoption because batteries alone will not get the job done in the heavy-duty applications that we're focusing on.

Our next question comes from Brett Kearney from Gabelli Funds.

Obviously, you've heard from a lot of companies about the further stress, particularly in China lockdowns, war in Ukraine, putting on supply networks. Curious, your factories today and your inventories, kind of what are the few critical components most holding things up at this point? And obviously understanding it's never a shifting list, but is it wire harnesses, electronics still two of the larger bottlenecks?

They are. Yes. So you picked the two top ones. But then the strange stuff like hoses and sometimes I'm surprised at the things that we get shortages on. And when we deep-dive what the root causes is typically some sort of material availability. And in some cases, it has been COVID that a plant got impacted by COVID, but that's starting to be a rare case now. It's mostly raw material at a think with what people had expected and the longer-term thinking supply seem to be doing better and the ones who are much more reactive suppliers are the ones that struggle.

I wanted to add that part of the issue relates to the types of suppliers you inquired about. We're also encountering random shortages of smaller parts periodically. We've implemented new processes to address this sporadic unavailability because it only takes one missing part to complete a truck. It's not just the large parts that are affected; often, it's the smaller, seemingly less critical components that are unavailable due to our suppliers not receiving what they need from their own sources. There's a lot of unpredictability in our supply chain, which is why we emphasize ensuring we have the necessary parts for the next four days of truck production. When we improve this process, it will boost our confidence in our ability to manufacture efficiently, as running an effective operation is challenging without a reliable supply chain.

Yes. Okay. All right. That's very helpful. And then I guess, with some of the geopolitical dislocations we've seen Eastern Europe, potentially also evolving now in Asia. I know you all have obviously done a tremendous amount of work really the past two years managing through this challenging supply environment. I guess longer term and structurally, do you think there's any adjustments coming out of this you might contemplate on some of your component sourcing or in finished products shipped out of China and other areas?

I'm going to ask Rajiv to address that question, but let me introduce it by just saying that we have a lot of discussion with our Board of Directors about that particular issue. And the general perspective is that we need to have backup plans for all the components and some of the assembly operations that we have around the world in those areas that are likely to have more political stress or issues potentially. So this is an area of considerable focus in which our Board is taking a lot of interest in as a general backup plan and risk management plan. With that backdrop, I may turn the question over to Rajiv.

Yes, thank you, Al, and thank you for the question, Brett. What I wanted to mention is that even prior to the recent geopolitical challenges, we recognized the need for a more resilient supply chain. This initiative began alongside our development of the AN series trucks, which are modular and scalable. We refer to our key suppliers as "center of gravity suppliers." Currently, we engage with over 700 suppliers, but we've integrated a smaller selection into Iris. These suppliers are large, highly capable, and have a diverse geographic presence. For instance, a supplier can manufacture a part in Asia, Europe, or the Americas. We believe this diversity will significantly enhance our resiliency, and we are also actively developing additional suppliers in various Asian countries as a contingency to China.

Our next question comes from Benjamin Thelen of Arosa Capital Management.

I just had a question as it relates to your working capital. So it looks like this quarter, we saw a pretty sizable decrease in your payables, but also a subsequent increase in our receivables. I'm wondering what you can do better to manage your working capital overall. Is there anything you can do to accelerate receiving your receivables from customers or extending your payment cycle? And then also on the inventory side, you did a nice job using up some inventory this quarter, but how should we think about that going forward?

Let me just give you an overview of our receivables generally are managed very tightly and we feel pretty good about the receivables process that we have in place. Our real focus is on inventory. And with the production schedules we've put in place, we believe that we can better match the inventory to the production levels that we have. And the focus is on decreasing inventory in a significant way. Rajiv, would you like to expand on that?

Sure. Part of stabilizing our production plan involved reducing fluctuations in working capital, which are challenging for us as well as our customers and suppliers. We have just completed this process, and our main focus is now on reducing inventory. There are two key elements to this. First, we are working with our suppliers to eliminate unnecessary inventory as we decrease our production rate. The second element is that building a truck we have planned is straightforward. The entire organization is dedicated to this initiative, and we are increasing our efforts. Regarding payables, we are actively managing them and collaborating with suppliers to extend payment terms as necessary. Overall, we are concentrating on reducing inventory.

Yes. And maybe I...

Let me elaborate on the inventory. It's made up of two components that Rajiv mentioned. One is what we currently have on hand. We have many of the components needed for our planned production over the next several months, and we received them much earlier than usual because our production goals were higher than previously established. So, that's one part of it—managing the inventory we possess. The second part is ensuring that we do not receive any unnecessary shipments that do not align with the trucks currently in our production schedule, which Rajiv is focused on. We see a significant opportunity to reduce working capital by prioritizing inventory, as Rajiv highlighted.

Following Al's comment, the effort to reduce inventory is going to lead us to order less in the current period. This will result in a decrease in our payables as we lower our inventory levels and buy fewer parts needed for truck production. Payables are decreasing as we adjust our inventory to more appropriate levels due to excess inventory resulting from a lack of critical components for building trucks. On the receivables side, we experienced some linearity as we shipped more trucks towards the end of the quarter, which influenced an increase in receivables. Additionally, we saw higher sales and increased sales values due to rising unit prices during this price increase cycle. As prices rise, even if we sell the same number of trucks, a 15% increase in selling price means a 15% increase in receivables. These are some of the key factors at play. We have programs in place to manage receivables effectively, for instance, through dealer floor planning, and depending on the mix of customers, there may be different payment terms. Overall, we have an active approach to managing receivables, as Alan noted.

In terms of timeline, we expect our inventory reduction programs and overall working capital to decline significantly over the remainder of 2022.

Could you provide any details on that? In the last quarter, it seems you released approximately $35 million of inventory, which is impressive. Should we anticipate that pace continuing? Additionally, how should we consider a normalized inventory level in relation to days of inventory outstanding or in terms of total dollar amount? Historically, your inventory has been around $500 million to $600 million. Should we expect another $290 million of inventory to be released during the timeframe you mentioned?

I believe there's a lot to discuss regarding that. Ken, could you provide more details? Is that appropriate?

Yes. Obviously, we're living in unique times with the critical component availability challenges causing us to not have inventory at the time we need it. But our goal, of course, is to return back to more normal levels of receivable days, inventory days and payable days. And I think if you go back and look at our history, you'll see what we're targeting. Now we don't believe we're going to achieve all that this year, but we'll achieve quite a bit of that, at least that's what we expect and that's what we're working towards. And of course, as the supply chain evens out in 2023, we're going to task our businesses to get back on to our targeted days of working capital in each of those categories.

I would add too that we have more and more of the new scalable modular and scalable products that the inventory carrying characteristics of those are significantly different from the products that we have today. So there are longer-term and increasingly significant results that will come from that as well as we push forward.

Our next question comes from .

Could you discuss in the advanced trucks in hydrogen fuel cells and so on, your ability or your marketing strategy, when folks like Amazon and Walmart are getting warrants from various suppliers? How do you deal with that?

Rajiv, do you want to comment on that?

Sure. I mean, I think it's difficult to comment on how and why others are doing what they're doing. I mean, I think our strategy for marketing and developing this market is to work very closely with key customers because it's not just about the solution, you need the infrastructure that goes along with it, not just the truck, the hydrogen, but then you need very skilled service capability, service and support capability. So we're kind of moving ahead, and our customers who have really tough through this process understand it. And so we're engaged with them, and we will be following a normal kind of the way we interact with the market approach. And obviously, some of the venture companies are doing some unusual stuff, which we're unlikely to do.

Our final question for today comes from William Nicklin of Circle N Advisors.

In line with the previous comments from Nuvera and what you just mentioned, I observed that the Inflation Reduction Act of 2022, released last week, includes a section called the Energy Security and Climate Act. This section outlines $3 billion in grants aimed at reducing air pollution at ports to support the purchase and installation of zero-emission equipment and technology, as well as $1 billion for clean heavy-duty vehicles like school buses, transit buses, and garbage trucks. It appears to me that if you have strong lobbyists or good fortune to have this included, could you share your thoughts on the potential impacts of this? Additionally, could you address the new act, previously known as Build Back Better, which discusses a $3 per kilogram credit for hydrogen production?

We'll have to see. We'll have to see how all that plays out in final legislation. But I would say that the general overview we have is that the kinds of things that you were talking about are playing to our strengths. We said earlier in this discussion that our focus is in applications where batteries alone really are not suitable for having a productive application for the end customer. That's particularly true in ports. You heard Rajiv comment about specific ports that we're working with. And I think there are others in Germany, including Hamburg and that we're working very closely with. And I think that's going to be a key area in heavier-duty vehicles, whether they're garbage trucks or to some degree, school buses and others are certainly areas where our technology and our product applications and where our focus on both marketing and product capabilities is strongest. So we consider all those things positive, and we'll be working to understand the details of any legislation that comes along to try to take advantage of national government policies, whether they're here in the United States or perhaps in even a greater degree in Europe as well. Rajiv, do you want to add anything to that?

No, I think that covers it. As you can imagine, those are target areas for both our customers and us, with port being the number one focus due to the intense attention there. This movement toward zero-emission vehicles is crucial globally, not just in North America. Additionally, the heavier-duty vehicles are key segments for us. We understand the rationale behind this approach, as it addresses the highest needs and the toughest applications. Once we can find solutions for those, it will naturally extend to other applications as costs decrease.

It is important to emphasize Rajiv's earlier point that this is not just about providing a product. There is a comprehensive support system that must accompany these products, which includes developing the application itself in the vehicle from an overall engineering perspective. This process is quite complex, and we believe it aligns with our strengths and capabilities. For many years, we have been building a large engineering team, particularly in our Nijmegen plant, focusing on heavy-duty trucks and port equipment. We possess extensive skills in this area, and we will leverage them to help end-users effectively address their real needs.

Thank you, Bill. With that, we'll conclude our Q&A session. Thank you to everyone for joining us. I'll close with just a few final reminders. A replay of our call will be available online later this morning. We'll also post a transcript on the Investor Relations website when it becomes available. If you have any questions, please reach out to me. You can reach me at the phone number on the press release. I hope you enjoy the rest of your day. And now I'll turn it back to Alex, our operator, to conclude the call.

Thank you. A telephone replay will be available until Wednesday, August 10. If you're in the U.S. and you'd like to dial in, you can dial 1866-813-9403 and use the access code 149 747. Thank you for joining today's call. You may now disconnect your lines.