Good morning, and welcome to PACCAR's Second Quarter 2021 Earnings Conference Call. All lines will be in a listen-only mode until the question-and-answer session. Today's call is being recorded. And if anyone has an objection, they should disconnect at this time. I would now like to introduce Mr. Ken Hastings, PACCAR's Director of Investor Relations. Mr. Hastings, please go ahead.

Good morning. We welcome those listening by phone and those on the webcast. My name is Ken Hastings, PACCAR's Director of Investor Relations. Joining me this morning are Preston Feight, Chief Executive Officer; Harrie Schippers, President and Chief Financial Officer; and Michael Barkley, Senior Vice President and Controller. As with prior conference calls, we ask that any members of the media on the line participate in a listen-only mode. Certain information presented today will be forward-looking and involve risks and uncertainties, including general economic and competitive conditions that may affect expected results. For additional information, please see our SEC filings and the Investor Relations page at paccar.com. I would now like to introduce Preston Feight.

Hello, everyone. It's good to be on the call with all of you. Harrie Schippers, Michael Barkley and I will update you on our second quarter results and business highlights. First and foremost, I appreciate our outstanding employees around the world for providing excellent trucks and transportation solutions to our customers. I'd also like to thank PACCAR's fantastic dealers and suppliers for their support. PACCAR achieved very good quarterly revenues and net income in the second quarter of 2021. PACCAR's results reflect quarterly sales and profit records at PACCAR Parts and PACCAR Financial Services. The economies in freight markets continue to be robust in all of PACCAR's geographic markets. Demand for PACCAR's premium trucks is strong. PACCAR's second quarter sales and Financial Services revenues were $5.8 billion and second quarter net income was $493 million. PACCAR Parts achieved record quarterly revenues of $1.2 billion and record pretax profits of $266 million. PACCAR Financial achieved record pretax income of $107 million. I’d just like to take a moment to recognize these wonderful achievements by our great team. So looking at product, 2021 is the biggest year of new truck introductions in PACCAR's history. The most recent truck introduction was in June, when DAF launched the XF, XG and XG+. These DAF trucks are game-changing. DAF is the first manufacturer to utilize the new European regulations allowing for a longer cab and the regulations enabled DAF's engineers to design an aerodynamically optimized truck that provides up to 10% greater fuel efficiency and an equal reduction in greenhouse gas emissions. Technology enhancements include a new powertrain, new digital mirrors, digital dash displays and a full suite of advanced driver-assistance systems. The new models provide drivers a new level of luxury and comfort and there is great customer excitement for the new trucks, and this is being reflected in strong orders. Production starts in October. The next-generation Peterbilt 579 and Kenworth T680 began production in May. These new trucks feature enhanced aerodynamics and powertrains that deliver up to 7% higher fuel efficiency, industry-leading LED headlights, advanced driver-assistance systems and a state-of-the-art interior with a configurable digital display. In addition to launching the new Class 8 trucks, this month Kenworth and Peterbilt began production of their new medium-duty truck lineup. These vehicles have an 8-inch wider cab, best-in-class visibility for enhanced safety and a premium interior with configurable dash displays. The new medium-duty trucks feature the PACCAR 8-speed automatic transmission and we are seeing excellent customer demand for these new Peterbilt and Kenworth vehicles. PACCAR's industry-leading zero emissions battery electric trucks are now in production, with 60 vehicles in customer operations in Europe and North America. And we've received orders for over 450 battery electric trucks and are working closely with our customers and our dealers, as we move forward with these exciting zero emissions product offerings. During the second quarter, PACCAR enhanced its autonomous truck development partnership with Aurora by becoming a minority investor in their planned public offering. The PACCAR, Aurora partnership continues to make progress in developing a Level 4 autonomous solution. Now looking at the truck markets, U.S. and Canada Class 8 industry retail sales are estimated to be in a range of 260,000 to 280,000 vehicles. Kenworth and Peterbilt market share was 29.4% in the first half. In Europe, truck industry registrations in the above 16-ton market are estimated to be in a range of 270,000 to 290,000 vehicles and DAF's year-to-date market share is 15.7%. The South American above 16-ton market is projected to be in a range of 100,000 to 110,000 trucks and DAF Brazil is about 16-ton market share through June was 5.7%. As has been discussed in recent months, industry truck production has been tempered by the under-supply of semiconductor chips. Kenworth, Peterbilt and DAF had a good quarter and delivered 40,100 trucks with an additional 6,500 awaiting key components. While it's very dynamic, we currently anticipate supplier constraints improving toward the end of this year. PACCAR continues to advance its industry-leading environmental focus with our products and in our factories. PACCAR is committed to achieving science-based carbon reduction targets and PACCAR continues to receive high rankings for its environmental leadership. These are really exciting times for PACCAR as we create our future. And Harrie Schippers will now provide an update on PACCAR Parts, PACCAR Financial Services and other business highlights. Thank you.

Thanks, Preston. PACCAR Parts had another outstanding quarter, achieving record revenues of $1.2 billion compared to $823 million for the second quarter of last year. Parts pretax profits were a record $266 million compared to $152 million in the same period last year. Parts gross margins grew a robust 28.2%. PACCAR Parts benefited from strong freight demand and truck utilization, investments in e-commerce technology and distribution capacity. Strategically located PDCs reduced delivery times and increased customer uptime. E-commerce part sales increased 56% in the second quarter compared to the same quarter last year. PACCAR is continuing its investments in world-class distribution by opening a new distribution center in Louisville, Kentucky next year. We expect third quarter part sales to be similar to the strong second quarter. PACCAR Financial Services earned record pretax income of $107 million, reflecting strong portfolio performance and robust used truck demand. We expect third quarter PACCAR Financial results to be in line with the excellent second quarter. PACCAR Financial is increasing its retail used truck center capacity worldwide, which enhances margins. A new PACCAR Financial used truck facility is under construction in Madrid, Spain. Kenworth and Peterbilt truck resale values command a 10% to 20% premium over competitors' trucks. PACCAR has invested $7.3 billion in new vehicle programs, enhanced facilities and new technologies during the past decade. This includes the investment of $1 billion for the new DAF truck range and expanding its factories. Capital expenditures for the year are projected to be $550 million to $600 million and research and development expenses are estimated to be $340 million to $360 million. PACCAR is investing in zero emissions and ultra-clean diesel powertrains, advanced driver assistance and autonomous driving systems, connected vehicle services and enhanced production and distribution facilities. Second quarter truck, parts and other gross margins were 13.5%. Customer demand is strong and DAF, Kenworth, and Peterbilt are sold out for the year. Depending on the supply of materials, third quarter global truck production and gross margins could be similar to the second quarter. The recently introduced DAF, Kenworth, and Peterbilt truck models provide PACCAR the newest and most exciting product lineup in Company history. These new trucks will support our customers, dealers, and our success in the coming years. Thank you. We'd be pleased to answer your questions.

Operator?

Your first question will come from Jerry Revich with Goldman Sachs. Please proceed.

Yes, hi. Good morning, everyone. I'm wondering if you could just talk about with the new product lineup that you have rolled out globally. Do you have a higher proportion of common platforms and core components in the platform today compared to what we would have been looking at under prior generation products? And if you could just talk about the implications of product development going forward given the timing overlap of the product rollouts globally this year? Thanks.

Hey, Jerry, that is a fun question. We can talk a long time about it, but I'll keep it brief for you. Yes. We have been able to globally make sure that we're leveraging our core competencies in software development and in some of the electronics capabilities for the vehicles around the world. So between DAF, Kenworth and Peterbilt, we take the best approaches and apply them, and that shows up in the way some of the vehicle functionality is, which is just – I got to tell you, it's really fun. I was able to drive the new DAF a few weeks ago, it was over in Europe, and the truck is amazing. And I think, obviously, I'm subjectively biased but we had a bunch of our dealers in it. They got to see it and everybody is just thrilled with it. So we're seeing just a beautiful new truck there in Europe and the same can be said for the trucks in North America. There's more commonality between the Kenworth and a Peterbilt in terms of the chassis design there. So we use best practices to make sure we provide the best ride and capabilities, and those trucks are equally just fantastic to be in. So yes, we're using our best practices and getting global leverage as we do our designs.

Terrific. And then you're off to strong bookings for your electric vehicles. I'm wondering if you could just talk about, over what time frame do you plan to produce the electric vehicles you spoke about in backlog? And can you just quantify, to what extent you've been successful in layering on charging stations and other expanded services? Is there a revenue number associated with the unit number that you might be willing to share with us?

Well, I would say that the orders are coming in. I mean, the 450 is just a moment in time. We're getting new orders every day. We had a good order from Amazon yesterday, a couple of days ago in Europe for battery electric vehicles that we've used in the UK. So we're getting us around the world and they'll be built as the orders come in. Some of the orders are multi-year. They could take a few years, because there's high quantities. But we anticipate the market just continuing to evolve, grow over the years. So it starts in the hundreds, as we've shared before, and we see it moving to the thousands, as that happens. And our team at PACCAR Parts is doing a great job of rolling out charging stations and being supportive to our customers and our dealers with the infrastructure needs that they have. So we've taken a holistic approach there and see these as good opportunities for PACCAR to grow this business beyond just the provision of product.

Okay. And lastly, Harrie, you spoke about expectations for similar production and gross margins in the third quarter. Can you talk about how you expect the supply chain to look into the fourth quarter? What are you hearing from the supply base that far out? Do you think our inventory of uncompleted trucks declines as we go through the year?

Yes. Like we said, Jerry, there was a lot of uncertainty around the supply base and the deliveries in the third quarter and beyond, a lot of that will depend on the ability of the supply base to deliver, especially in the semiconductor area.

Okay. I appreciate the discussion. Thanks.

You bet. Have a good day.

Your next question will come from Ann Duignan with JPMorgan.

Hi. Thank you. If you could expand on those last comments a little bit? I think we depreciated the puts and takes on the gross margin going into Q3. Seasonally Q3 will be weaker than Q2 just on plant shutdowns, et cetera, in Europe. However, you've got all this inventory build and should you be able to receive components – perhaps deliveries are higher. So we don’t get the absorption because they're already built. So I'm trying to really understand the puts and takes because you seem kind of hesitant when you said that gross margins and performance might be similar in Q3 to Q2. So please expand on that in any way, shape or form that you can?

Thanks. Sure. Ann, happy to take a swing at that for you. You understand the market really well and we have excellent demand, as we said, we're sold out through the year in all our markets. So with this great demand, great market, need for trucks around the world really, customers are looking for trucks as quickly as they can get them. And we're building this as quickly as we can get them. And so, we had a good second quarter in our deliveries at 40,000. Obviously, you can do the math, there's several thousand sitting there that are waiting a component. And as we get the components, which is unclear in the semiconductor front we complete the trucks and get them to our customers. So wish we could give you more clarity on how that semiconductor supply is going to proceed through the third and fourth quarters, but we just don't have any more than that right now.

But just for clarification, when you ship those trucks after you get the semiconductor, you've already gotten the absorption of building those products. They're just sitting at the end of the line waiting for semiconductors and...

That is correct, Ann. Of course, the absorption has already taken, and when we deliver and ship the truck, that's when we record the gross margin on the truck.

Right, exactly. And then on the parts and the finco businesses, you had given us the full-year guide for Parts and you had expect it to be up about 15% to 18%. I'm assuming with your revision today, or you're calling for more like 18% to 20% now for the full-year. And finco, you said, performance would be similar in Q3 to Q2. Is there any reason to believe that the finco couldn't continue to perform at this level into year-end also?

So the parts, we're expecting the full-year to be an increase about 20% to 22%.

And for the finance company, the $107 million in the second quarter was a record outstanding result. If we look at the current market dynamics with strong used truck markets and excellent payment behavior by all our customers, strong portfolio, we expect that business to run at that level for the next quarter. And that's a pretty good run rate now.

It is a good run rate. I'm just trying to figure out the model. And just real – finally, a real quick just dealer inventories right now versus where they ought to be?

Well, the dealer inventories are limited, which will extend the market also, we have about 1.6 months of inventory at the dealers. And I think the industry is 1.9 or 2, so it's – we'd like it to be, of course, but that does bode well for a strong extended demand cycle.

Okay. Thank you. I'll get back in line. Appreciate it.

You bet.

Your next question will come from Stephen Volkmann with Jefferies. Please proceed.

Hi. Good afternoon here. Good morning there, guys.

Hello, Steve.

Hi. So a couple of quick ones. Preston, does your industry commentary, does that factor in the supply chain issues and that's kind of your best guess? Or is that more of a number that would be kind of a high side and then supplier issues might cause it to be lower than that?

I would say that we try to factor in everything into those numbers. So that 260,000 to 280,000 in North America. The reason it shifts down a little bit is because of the supply side provision with the demand that we have. It's really what the throttle is on the business right now.

Okay. Super. And then with respect to all these new truck launches that you kind of went through, I guess the bottom line question is do you expect these products to be kind of higher margin than the products that they're replacing?

Well, we think that we set out design products that are great for our customers and with the kind of fuel efficiency, the driver comforts, the feature capabilities that they all provide to the customers, we think they want to buy them. And that should be good for PACCAR and good for the customers.

All right. Maybe the final quick one. Just any commentary on pricing. I mean, I know things are sort of sold out. When do you start taking orders for 2022? And is there any reason not to assume that that pricing wouldn't be more robust as you start to do that?

We are taking pricing for 2022, and if you just look at our – our order intake has been very strong. And so we're seeing how that's progressing through the market, working on raw materials pricing into those models and just moving forward thoughtfully into 2022 as we take those orders. And we do expect the new trucks to be a bigger percentage of our build in the next year, and that'll be good for everyone.

Got it. Thank you.

You bet.

Your next question will come from David Raso with Evercore.

Hi. Thank you.

Hey, David.

I was thinking about pricing for the rest of the year. When you mentioned you're sold out for the rest of the year, does that speak to them pricing is pretty well set on your deliveries for the rest of the year? Or is there an ability to adjust pricing for any further shipments this year?

So it's largely set. But I would tell you that these have been unusual times, and so we've adjusted pricing as necessary to match into raw materials pricing. And that's kind of the way we've approached the market.

Okay. So still some flexibility despite the backlog sort of spoken for the rest of the year, but limited versus historically. You wouldn't usually adjust the backlog historically.

Yes. What I would say is we're working really closely with the customers to get them the trucks they need as quickly as we can. And I think they understand, we understand that that's taking extra efforts right now and so we're applying those efforts.

And when it comes to the 6,500 red-tagged trucks waiting for component, of those, do you expect those to ship? A large majority of those would ship in the third quarter or because that's the greatest pinch point, when we think about say potentially flat deliveries 2Q to 3Q, they might not include a lot of those 6,500. I think we're all just trying to get a feel for some of the overhead absorption issues with shipping already built trucks or not in the near-term?

Yes. I would tell you that that's a constant dynamic there. We've had some trucks that we build minus component and we received a batch of components for those and have shipped those out only to find ourselves in different circumstances like a COVID outbreak, which then causes a constraint of a different component. So it's pretty dynamic and hard to really talk about which truck ships when…

All right. Thank you very much. Appreciate it.

Sure. You bet. Have a good day.

Your next question will come from Nicole DeBlase with Deutsche Bank.

Yes. Thanks. Hi, guys.

Hey, Nicole.

Maybe just a clarification on the third quarter production guidance. So have you guys – do you plan on taking your usual plant shutdowns seasonally in Europe? And I'm just trying to think through like q-on-q production by region?

So we do plan to take our European shutdown, in fact we're in the midst of it now.

It started this week.

And I don't know if there's anything else you want to add thinking about regionally?

No.

I don't think there is any other regional vagarities that I'd add into it.

Okay. So Europe is down q-on-q and maybe the other two regions up a little bit q-on-q to compensate for that to get you to flat overall?

I would say it's really more about which components we get when, and that's really what's driving those deliveries by region.

Okay. Understood. And then maybe just to elaborate a little bit on David's point. So if you think about the pricing that you guys realized in the quarter, which I know we'll all see when the 10-Q is filed. But did you have a pinch at the margin line from price costs and what is the expectation for how that progresses into 3Q?

When you see the 10-Q, Nicole, you'll see that pricing was up 2% to 3% compared to last year. And then, of course, that resulted in margin improvement compared to last year. But if you look at it more on a sequential basis, then I would say that, yes, we've been able to increase prices to cover cost increases. And I think that's what gives us the margins as we know them in the second quarter, and that’s a similar assumption if we look at the third quarter.

Got it. Okay. That's really helpful. And then I'll just squeeze one more in. Could you just comment a little bit on what you're seeing with respect to used truck pricing, like the magnitude of the growth?

Well, I mean, it's grown quite a bit, obviously in the year-over-year and North America has grown in the 40-something percent and Europe has grown double-digits also. And so we've had great growth in our used truck pricing. There's a limited supply of used trucks. I mean, obviously the PACCAR products command a premium in that space, and it's an even more precious premium right now. So we think that as long as supply is limited, then there'll be a good opportunity for our team selling used trucks, getting customers the ability to move the freight.

Your next question will come from Joel Tiss with BMO. Please proceed.

Hey guys. How is it going?

Really good, Joel. How are you doing?

I’m hanging in there. Is this automated cab factory in Europe, is that a new template for what you can do around the world? Or is that more just building on what you already have in place in terms of the footprint?

Well, Joel, it really is a new approach. It's an evolutionary approach, but it's a new approach. The factory is amazing. We hope to get you over there soon to be able to see it. We were just there a few weeks ago. And all I can say is, wow. When you look at the level of robotics that we've applied to bring the highest degrees of quality and capability in putting those trucks together, it's really fantastic state-of-the-art factory and it brings a new level of, I'd say, competence into our manufacturing operations.

And I think what everyone's asking and I'm wondering too. Can you give us some of the pieces to raise your kind of structural incremental margins? They've been kind of stuck in this 12% to 14% range for a while. And I just wondered, everyone keeps asking, maybe it's electric, maybe it's automation, maybe it's pricing. Can you give us a little sense of maybe just some of the things you're thinking about internally that that could structurally push those margins higher in the next five years?

Yes, sure. Happy to. If you look at the Parts business and again, that team is just doing a fantastic job and the focus there is to continue growing and they're able to do that because they really think about what the customers needs are and what the dealers needs are. So they're putting systems in place that enable a really world-class delivery of parts in same-day more and more frequently. And so that's an area of growth opportunity as we look at it. The finance company is a great foundational growth opportunity for us as well. The new trucks, we'd be really remiss to not talk about how the new trucks are going to help to grow the business over time. You mentioned other things like alternative powertrain, zero emissions vehicles, that's a great opportunity for PACCAR. We're already – put yourselves in a leadership position in terms of order intake. And so that not just the sale of the trucks, but the support of the trucks in the field, battery electric charging stations, battery energy management, fleet management help, those are skills that we can provide. We see embedded software and connected trucks being an opportunity for growth in the future. Obviously, we have this relationship with the autonomous vehicle producers and namely Aurora, that's an opportunity as we go forward and increasing utilization of safety systems like that. So there is a whole plethora of great opportunities for PACCAR to grow as we move forward in the future.

That's excellent. Thank you so much.

Yes. You bet.

Your next question will come from Rob Wertheimer with Melius Research.

Hey. Good morning, everyone.

Hey, Rob.

My question, I guess, I think I have two on electric. One is, you obviously noted your three competitors announced an alignment on charging in Europe and I don't know whether you specifically comment on your thoughts on doing that with that alliance. But maybe more broadly, what is the role for an OEM in trying to prep if any, the prep infrastructure for some of these changes that are coming in the infrastructure is necessarily there?

Okay. That's good line of thinking there. They did make that announcement, we are rolling out our infrastructure system. And so basically what everybody is trying to do in the all OEMs car and truck are trying to create an infrastructure that's usable by each other and that's what theirs would be. So usable by all our products. At the same time, we're also rolling out our capabilities into the dealers and with the customers, obviously, with each electric vehicle in the early phases before ranges unlimited. They're going to be largely used in a return to base kind of an operating style, which means when you buy a truck you're probably looking at a charging station also and the integration of the truck and the charging station how those – how that system works together is a core competency that we bring to our customers and we'll share with our customers. So we see that is kind of an avenue forward. So there's some symbiotic relationship with all the OEMs, but there's also this unique capability that PACCAR has in bringing the right battery energy management and the right kind of system to a customer.

That's a very helpful answer. So you're not kind of sitting passively by letting others do this. You're involving yourselves in a different way where you think it's more viable. Okay. That's very helpful.

Yes, exactly.

Yes. On your electric truck orders, are those mostly in medium-duty or is there heavy? And can you say anything about the – you mentioned return to base, anything about the routes or the base or the duty cycles the vehicle configuration that is currently attracting attention? And I will stop there. Thank you

Yes, sure. The orders have been spread out. There have been medium-duty orders, been heavy-duty orders in the kind of the pickup and delivery space and there has also been refuse kinds of trucks that we've taken good orders from. So again, anywhere where urban applications or you're running 200 miles and you're coming back at night, we have time to recharge. Those are the right spots for the battery electric systems today and we're doing that in Europe and in North America.

Thank you.

You bet. Have a good day.

Your next question will come from Jamie Cook with Credit Suisse. Please proceed.

Hi. Good afternoon or good morning to you. I guess, a couple of questions. One, I've been – while the truck margins are coming in a little lower because of the supply chain inefficiencies, the Parts margins have continued to progress and seem like this year will be at a record new level. So I'm wondering if gross margin structurally in Parts can be higher and that's what we're missing. And how much runway you have to go there? And then my second question is, understanding you probably don't want to talk about next year, but as you think about the order book and then some of the inefficiencies that we're seeing in 2021, do you think there is a set up for next year for incremental margins if the industry forecasts are right to potentially be better in 2022 versus in 2021?

Jamie, I'll let Michael talk about the first part of it and I'll kind of come into the second.

The margins are benefiting from higher volume we get to spread that over the fixed cost base, if you will. So we get volume leverage out of the much higher volume that we're enjoying right now, and plus, there has been decent pricing because there has been strong demand that's been able to at least keep pace with the cost increases that we're seeing on the raw material side.

Yes. And then as we look at 2022, we see that as this operations can flow steadily, put it that way, then that should be a great opportunity for us as well. Right? The production efficiencies return at higher levels, we expect the market will be strong next year, and that should be good for PACCAR.

Okay. And then, sorry, one last follow-up question. It sounds like from your prepared remarks, you guys were having good success with the automatic – with the transmission with ZF, your new partnership there. So can you just give a little more color there? What you're seeing on adoption rates with the ZF transmission? And how you think penetration – how to think about penetration, I guess, over the next 12 months and over the longer-term with that product line? Thank you.

I don't know the exact number of percentage take rates on it. I know it's been pretty high and growing as people get the experience with it. So I can't give you a numeric answer. I can just tell you that in being in the vehicle a lot and driving it and talking to customers about it, it's working really, really well, and we expect that just to continue to increase.

Okay. Thank you.

You bet. Have a good day.

Your next question will come from Chad Dillard with Bernstein.

Hi. Good morning, guys.

Good morning, afternoon.

So I just wanted to go back to supply chain challenges. So can you just give a little bit more color? Beyond semis, can you talk about where the components are in short supply, has the breadth of the component shortage grown? And if you can just talk about like the month-over-month cadence? Are things – do things get better or worse as we progress through the second quarter?

Chad, I love to be able to give you more, but we've given you just about everything we can on explaining where we're at with the supply base and that there is a degree of uncertainty that you can see in every manufacturer's report write-ups and we have that same kind of uncertainty working through our system. And if I could tell you more and more, I would. But we're going to continue to operate this business in a world-class fashion. And as we get the parts, we put them in the trucks and get them to the customers as quickly as we can.

Got it. And maybe you can just give us a sense for how much less you need to spend on promotional discounting, just given the really strong environment? Are you at 50% of typical spend levels, 20%? Just trying to think through, if the environment – the demand environment remains strong, can you actually pull up a little bit more of that marketing expense?

Well, we don't really have a marketing expense associated with promotional discounting in the way we build a order. And I think that our products do a great job of selling themselves. And I don't know if you have anything else to that?

Our sales expenses are part of our SG&A. And as you've been able to see, our SG&A has been pretty stable going from the first to the second quarter. And that's the kind of level we expect that SG&A to stay in. We got the tight cost controls, good budget discipline and we'll continue to do so.

Okay. Great. Thanks. I'll pass it on.

All right.

Your next question will come from Ross Gilardi with Bank of America.

Hi there. Thanks for taking my questions.

Hey, Ross.

Have you guys disclosed how big your Aurora stake is? I mean, if it's been out in articles and your filings, I missed it. I apologize, but do you have any with there?

No, Ross, we haven't disclosed that. This is Ken. And Aurora hasn't either. I don't think any of the pipe investors have disclosed the amounts.

Our thinking around it was to make sure that we just had a strong partnership with them, and the real focus is are developing in PACCAR-specific autonomous vehicle platform that will work with Aurora that can also work with others. And that's where our focus has been and they've turned into a great partner. We've been riding around in the autonomous trucks with them and there is great progress being made on that – on the development of an L-4 system.

And then, sorry for another price cost question, but I'm just trying to think this more at a high level. I mean, cost push aside, recognizing that you're raising prices to offset cost inflation and over time you're probably successful doing that. Just why doesn't there seem to be more, if any, structural pricing power in the commercial vehicle industry when you have all of these new products, you have all this new technology, it creates enormous cost and productivity benefits for the fleet, you have a tight used equipment market, you're sold out. Why can't the industry? And you probably don't want to speak for the industry, but let's just say why can't PACCAR just steadily raise prices 2% to 3%, whatever the number is, every year regardless of what is happening with costs, given the amount of value that your new products are bringing?

I guess, I think you're right, we wouldn't want to talk for the industry and to tell you that we are constantly working on providing industry-leading margins. And we do that. And I think our results show that and we're going to keep doing that in a good way. And as we bring out these new products, we do expect that they will provide again benefits to the customer and PACCAR and that's kind of the model we work with is to stay as the best company there is.

But, I mean, are you just pushing more to just take market share, grow the installed base and therefore, you see improved margins via the Parts business because you're selling more content in the aftermarket or there's going to be some type of strategy there? It just seems like that the focus is much more on driving volumes and share than on pricing itself realizing, I guess, that you have the best margins in the industry. But it would just seem that, maybe this is more of a comment than a question, and welcome your further thoughts. Just why you can't raise prices?

Yes. I think you said it right, you said, we have the best margins in the industry and we do and we continue to work on that and we continue to grow our business around the world geographically. We continue to make these great investments, which are good for our customers, you continue to see the growth that comes along with it through the Parts business, the finance company. I mean, PACCAR is really doing a great job and we're going to keep doing that.

All right. Preston, then just the last part of it, just pricing for your EVs in the broad spectrum of – you got all these new entrants in the market, you got a lot of new vehicles that are coming out. You're one of the first, if not, the first, but where are you on pricing relative to everyone? And can you comment at all, what do you think happens to pricing for some of your core vehicles over the next three to five years as penetration really starts to grow?

Our margins for the EVs are kind of comparable to diesel powertrain margins. So those are looking really good. The markets obviously a market that's emerging. It's not mature, so there's a lot of dynamics around battery cost continue to come down. There's government grants and subsidies that come along with some of these projects, be they battery electric or hydrogen fuel cell. So it's a pretty dynamic world and we're focuses on achieving high quality margins and high quality trucks for our customers in the zero emissions space.

Okay. Thanks very much.

You bet. Have a good day.

Your next question will come from Felix Boeschen with Raymond James.

Hey. Good morning, everybody.

Howdy. How are you doing?

Good. Hey. I was hoping to touch on the new product launches for just a quick second. Correct me if I'm wrong, but I think you mentioned about 10% fuel efficiency improvement in Europe. That should start production a couple of months. And then I think I heard 7% on Peterbilt and Kenworth. Can you help us understand how good that is from an upgrade perspective maybe versus prior fuel efficiency increases in sort of historical model changes?

Sure. That's a good way to think of it. The first thing is double-digit changes in Europe where speeds are more like a 100 kilometers an hour, 80 kilometers an hour for trucks is wow. I mean, getting that kind of improvement is just amazing and the DAF team did such a fantastic job. And one of the reasons they were able to do such a good job is they work closely with the government there in defining what the shape of a vehicle can be and so the government allowed a different shape of the vehicle and DAF is the first OEM and the only one that's announced to do so, so far of being able to bring out a cab that meets this new shape, which is more aerodynamic. So just fantastic effort by the team at DAF in bringing that truck out, and it doesn't just create aerodynamic benefit, but the interior and the visibility of those trucks are just amazing. And I would also say that from being a user of the truck, if you get in the truck and you're driving it, just the way it feels, it's really, really quiet, like I would say quieter than a 5 Series BMW when you're running down the highway. It's just fantastic. And then if you use a sleeper compartment of it, it's got all kinds of creature comforts and luxury for the drivers. And so it's just a beautiful product that delivers this double-digit fuel economy. And in characterizing it against other programs, you might think 5% is a lot, that's how we would look at it. So a 5% change in fuel economy is a big change in fuel economy. So for them to get 10% just amazing and same thing for the Kenworth and the Peterbilt teams getting 7% on these next-generation 579s and 680s. They just had a great job of bringing everything they could to the table. And that's obviously got a big impact on lowering operating costs for our customers. So these trucks are going to set the mark for the industry.

Yes. And I appreciate that and that's kind of where I was trying to go with it. From an OpEx perspective, 10% improvement year-over-year feels like a very big deal. If you could indulge me maybe characterize how you think this would impact multi-year truck demand if indeed upgrade features are maybe higher? And then in that same vein, I guess, where I'm coming from, I understand the near-term focus on margins, given all of the temporary noise in the numbers. But if demand does stay elevated for longer, is there anything structural in the model why margins should not move sort of in tandem with that prolonged demand? Any color kind of would be appreciated.

Well, I think your second comment is right, they should move in tandem with it. And I would say that you're right in the new products coming out that make the operating costs lower for a customer is cycle independent, they want to lower their operating cost is what they used to be competitive, so buying new DAFs, Peterbilts and Kenworths is how they win that game. That's how they keep their drivers most happy. And so, yes, that's good for the business and that will extend the cycle for them.

Yes. The biggest cost to operator truck is the driver. The fuel is a good second and if you can cut the fuel bill by 7% or 10%, that's huge. I think 10% is the highest reduction that DAF has seen in its entire history. And reducing that, like I said, the fuel bill by 10% makes any of our customers a lot more competitive. So they are looking forward to getting those new trucks.

Appreciate the help. I'll leave it there.

Great.

Your next question will come from Matt Elkott with Cowen. Please proceed.

Hello. Thank you for taking my question. My first question just a quick one, you guys are now the only U.S.-based Class 8 truck manufacturer. Do you think this could in any way help you competitively in the U.S. Class 8 market longer-term?

I don't know. We're proud of who we are, and we're proud to be a great company. We love our Kenworth and Peterbilt operations here in Mexico, our DAF in Europe, our DAF in Brazil. So we feel like we represent the markets where we operate really well, have great relationships with our customers and dealers in those markets and that's how we think about the world.

Okay. Got it. And then my next question is more on the vertical integration front, with next year looking like a strong production year, and with you guys and other OEMs allocating investment dollars along a whole host of new technologies, as well as core operations, do you think you might do less vertical integration of engines at least next year?

I don't think of it that way at all. No, I think that we're making the investments where they make sense on a volume standpoint. We're continuing to grow our PACCAR Engine business, obviously, 60% of our sales are powertrains or our engine around the world and we continue to just making the right investments to bring the best products to the customer. I mean, it's elegant and it's simple. We just want the best things for our customers that will be good for PACCAR. And so our R&D and our thinking is to vertically integrate where it makes sense, partner with others where it makes sense, and make sure that brings the best products out to our people using them.

Great. Thank you very much.

You bet.

Your next question will come from Jeff Kauffman with Vertical Research Partners. Please proceed with your question.

Thank you very much and congratulations on the quarter.

Thank you.

A big topic out there is raw material parts inflation and I think we've talked about some of the challenges on the chip side and the supply chain and getting the trucks out. But I was really kind of impressed that the gross margins were what they were this quarter. And could you give us a feel for, are you seeing inflation in the – in your supply chain kind of when will that start to hit and flow through? And are we offsetting that with price? Are we offsetting that with anything? I just kind of want to get a sense because some of the other OEMs we've spoken to were kind of citing that but I didn't see it in your numbers.

Yes. We are seeing inflation, of course, and raw material costs have gone up. But we're baking that into our pricing when we price new trucks to our customers and that's how we deal with that.

Okay. So now you wouldn't tell us brace for gross margins to come down a little on inflation in the second half. You feel like you're containing it in terms of what you're seeing in the market right now?

Yes. That's probably the best way to think about it.

Okay, great. Well, congratulations. Thank you.

Your next question is a follow-up from David Raso with Evercore. Please proceed.

Hi. Thank you. My question is on the duration of the cycle. I mean, given this is a pretty unique supply constraint moment, your conversations with some of your largest customers, the larger fleets. What are they laying out for you when you try to look out a year or two thinking about potential growth or not beyond 2022 and maybe different conversation in Europe than in North America? I'm just trying to digest you're having to go back to key customers and understandably you maybe can't provide them everything they want today. How is that impacting their thought on their truck needs over the next, call it, 18 to 30 months?

Sure. I think one of the things to think about is trucks are, as we talked about a lot in this call, becoming more and more efficient. And so I think their percentage of how they'll haul freight in the future beyond 18 and 30 months even is that they will continue to take a vast majority of the freight hauled around Europe, North America, around the world actually. So trucking is in a really good position for the world. Our customers are doing a fantastic job of becoming more efficient, but the demand is really, really high. And so, we and they, I'd say, expect that there'll be a strong market certainly through next year, which tied you to the 18 months. Beyond that, it's hard to say. But in essence, they're doing really well right now. They have all the freight that they can haul and the business is doing really well. So together everybody is doing fine.

And when you think of the capacity in the industry, I mean, there's pinch points today but when folks start to think about how much the industry could build next year and then obviously that sets the bogey up for, can you grow off of that in 2023. I mean, understanding it's hard to analyze exactly, some of the chip issues when those will be resolved and so forth. But just as a framework, how do you think about build capacity for next year versus this year, just so we have a sense of – if you served all of the demand, how much could demand production grow next year?

Sure. I don't want to kind of comment on other people's capacities. But I'll tell you is that, we have sufficient capacity in all of our markets to go up substantially and to meet the demand as needed. And so, we're looking forward to that as we get through this supply base issues, then we just look forward to the operation running really smoothly and build a lot of trucks next year.

And last quick one on 3Q versus 2Q. The shutdowns that you would normally take in 3Q, given the dynamics out there, are those shutdowns still intended to take place?

The shutdown we take in Europe is taking place indeed.

Okay. Thank you very much. Appreciate the time.

You bet. Have a good day.

Your next question is also a follow-up from Ann Duignan with JPMorgan.

Yes. Just building on David's question a little bit. We felt cancellations spike last month, maybe an industry problem or whatever, but can you talk a little bit about what you're seeing in terms of cancellations out there? And is there any risk that customers just say, too late or too expensive or whatever, I've decided, I don't need my trucks after all? If you could just give us some color on what you're seeing on the cancellation side, I'd appreciate it.

Yes. Ann, I can't speak well to the industry. We are not seeing that. I can tell you that our order board has been solid. We aren't seeing cancellations. I think that probably has to do with the great products we're putting out. But there is really not – that's not a factor right now. We're seeing excellent demand and really, really strong request for more and more product from us.

But on the other hand, you do like to tell us what your share of orders was last quarter or at least in the first half of the year and what's your share backlog is? So maybe we could get at least that from you?

Sure. Happily. We had 42% of the orders in the first half of the year.

And what's your share of the backlog then?

The share of the backlog at the end of June was 36%.

Okay. Great. Thank you.

Yes. You bet. Have a good day Ann.

At this time, there are no other questions in queue. Are there any additional remarks from the company?

Sure. Just like to close by thanking everyone for the discussion today. I might think that the key points for us as we look at the business is, there is really strong demand in order intake as we just covered. We have fantastic new trucks all around the world. The finance team is setting records and has great momentum in their business. The Parts team is just killing it. It is an industry-leading team. They're bringing in new technology and customer focus and they really are going to keep driving record success. And so I'm just so proud of everyone at PACCAR and the great work they're doing. And we look forward to talking to all of you soon. And with that, we'll conclude and say thank you.

Ladies and gentlemen, this concludes PACCAR’s earnings call. Thank you for participating. You may now disconnect.