Good morning, and welcome to PACCAR’s Second Quarter 2022 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 would like to welcome those listening by phone and those on the webcast. My name is Ken Hastings, PACCAR’s Director of Investor Relations. And joining me this morning are Preston Feight, Chief Executive Officer; Harry 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 of paccar.com. I would now like to introduce Preston Feight.

Good morning. Harry Schippers, Michael Barkley and I will update you on our second quarter results and business highlights. I truly appreciate PACCAR’s outstanding employees around the world, who continue to deliver excellent results in the highest quality trucks and transportation solutions. PACCAR achieved record revenues and net income in the second quarter. PACCAR’s revenues increased 23% to $7,160,000,000. Net income increased 45% to $720 million. PACCAR Parts second quarter revenues increased by 18% to a record $1.43 billion. Parts pre-tax profits were record $353 million, 32% higher than the same period last year. Truck parts and other gross margins expanded to 14.4% in the second quarter compared to 13.5% in the second quarter of last year. PACCAR’s increased vehicle production, new lineup of premium trucks and strong after-market Parts business drove the higher gross margins. PACCAR Financial had an excellent quarter increasing year-over-year pre-tax income by 36% to $144 million due to its high-quality portfolio and strong used truck results. PACCAR is an industry leader in diesel and zero emissions powertrains, autonomous trucks and next generation connected services. PACCAR’s best-in-class new trucks, its new clean diesel and electric powertrain lineup, and its ongoing research and development programs provide our customers with the right products and technology to help them optimize their operations. The entire PACCAR team has done an excellent job of working with our suppliers to manage supply base shortages, and we have been able to gradually increase daily truck production. In the U.S. economy, unemployment remains low. GDP is estimated to grow and industrial production is projected to expand. Based on this favorable operating environment, we estimate the U.S. and Canadian Class 8 market to be in the range of 260,000 to 290,000 trucks. The European and U.K. economies are also growing with Eurozone unemployment at low levels. The 2022 European truck market is expected to be in the range of 270,000 to 300,000 trucks. Looking at PACCAR’s operating environment, our new generation of trucks in Europe and North America are providing our customers the benefit of owning the most desirable and most efficient trucks in the industry. Freight tonnage remains at great levels; we are sold out for the year, and the first quarter is beginning to fill-in nicely. With fleet age up and truck utilization high, we anticipate continued strong demand for PACCAR Parts, Trucks and Financial Services. Thank you. Harry Schippers will now provide an update on PACCAR Parts, PACCAR Financial Services and other business highlights.

Thanks, Preston. PACCAR delivered 47,000 trucks during the second quarter, a 9% increase over the first quarter. We estimate third quarter deliveries to be in the range of 44,000 to 48,000 trucks. As higher daily build rates will be offset by the normal summer shutdown at DAF in Europe. Truck Parts and other gross margins increased to 14.4% in the second quarter. We anticipate third quarter gross margins to be in the 14.5% to 15% range, reflecting a continued strong performance of PACCAR Parts and a favorable mix of new truck models in production. PACCAR Parts had an outstanding second quarter with Parts gross margins of 30%. Customers increased truck utilization and higher average fleet age have contributed to PACCAR Parts' record results. PACCAR Parts' outstanding performance is driven by an expanding network of 18 parts distribution centers, 2,200 dealer locations, and 250 independent TRP stores, as well as technologies like managed dealer inventory and innovative e-commerce systems. PACCAR is continuing its investments in the Parts business by opening a new distribution center in Louisville, Kentucky this quarter. PACCAR Financial Services benefited in the second quarter from high used truck prices and excellent portfolio quality. Revenues were $373 million in the second quarter. Pre-tax income was $144 million, 36% higher than last year. Demand continues to be strong for PACCAR pre-owned vehicles as customers appreciate and are willing to pay a premium for superior reliability and durability. PACCAR Financial has been increasing its network of retail used truck centers and is opening a used truck retail center in Madrid, Spain this year. These facilities sell used trucks at retail prices, which contributes to higher profits. PACCAR has invested $7.3 billion in new and expanded facilities, innovative products and new technologies during the past decade. These investments have created the newest and most impressive lineup of trucks in the industry and will contribute to excellent shareholder returns for many years. PACCAR’s after-tax return on invested capital improved to an industry-leading 23% in the first half of this year. Capital expenditures are projected to be $425 million to $475 million this year, and research and development expenses are estimated to be $330 million to $350 million. PACCAR’s exciting new line of trucks and transportation solutions, efficient R&D and capital investments, strong after-market parts and financial services business, and flexible operating structure position the company for a bright future. Thank you. We will be pleased to answer your questions.

Thank you. We will take a moment to allow everyone to signal. Our first question comes from a caller; your line is open, please ensure your mute button is checked.

Hi, this is Chad Dillard from Bernstein. First question for you, just on your gross margin trajectory. If I look cycle, last time, we had around 1,000 builds versus 2014 and I think you guys are doing margins; if we fast forward to where we are today, it looks like we’re heading for a 14.5% run rate. I'm quite curious about the cycle-over-cycle durability. And then secondly, just how to think about the evolution of margins as we go through the backend of the year and any early comments you can give on your thoughts at least going to Q1, given that you are taking orders right now?

Sure, I’d be happy to take the question. I feel like things are going really well for the company. As we shared in the commentary, the new trucks are performing really well in the market in Europe and North America. That performance is helping our customers perform better, finding excellent fuel economy for them. The result of that is an improvement in margins. That is really the fundamental underlying principle for the increase in truck margins. I’ve also shared that our Parts team is doing a great job and set another record in the first quarter. We expect continued strong performance throughout the year for them, because fleets have aged and utilizations are at high levels, which is driving Parts performance. So we do expect to see continued improvement in margins for some time.

And then just second question on Parts. Just how to think about a year-on-year growth, as well as margins on that?

Harrie, do you want to offer commentary?

Sure. We expect Parts sales to continue to be strong in the third quarter, probably similar to the second quarter, which would be up 12% to 14% from the third quarter last year.

We’ll move on to our next question.

Good morning, everybody. It’s Robert Wertheimer from Melius Research.

Good morning.

Are you guys there? Yes, great.

We’re here.

So two quick questions. One is just, could you update, I mean, that the results were great, the margins look very strong, obviously some tailwind from Parts as you noted. Could you update us on where you stand on price versus inflation? Is there continued catch up from price? And I don’t know if you make any comments on Truck pricing, how far it was up for you guys in the quarter?

Michael, you want to share any thoughts on that?

Yes, we had good price realization during the quarter that kept pace, a little bit more than kept pace with our cost increases.

And the second one, a little bit bigger picture, Europe, if you’re a customer in Europe, I suppose you have a lot of different things you could choose to worry about with energy security and so forth. And I’m curious whether knowing maybe your orders are kept by the supply chain or whatever, just what your mood from your customers in Europe is? And is there any sign of impending downturn there? Thank you.

You bet. Well, our European business is doing fantastic right now. The new trucks that we introduced are really delivering for our customers. They are an increasing percentage of our build, roughly 50% in the second quarter, and increasing in the third quarter. Demand is exceptionally strong for those products, the only trucks that meet the new masses and dimensions regulations in Europe, which provides great driver comfort. They operate in a premium position in the market. And they’re doing a fantastic job. So I think that what we see is continued strong demand in Europe. Freight is moving effectively, and we think it will continue to do so.

We’ll move on to our next caller.

Hi, good morning, Jamie Cook. Can you hear me?

Hey, Jamie, we can hear you.

Hi, I guess two questions. First of all, great performance in the quarter. You talked about the new products being about 50% of build in the second quarter, I think that was specific to Europe. Can you comment on where those build rates are in terms of new products for the U.S.? I guess that’s my first question. And then my second question, just given the deflationary pressures that could be facing us in the back half of the year into 2023, your confidence level in being able to maintain the pricing levels that you have today, just given your new product introductions, do you think you can maintain the list price increases that you have out there?

Well, let’s start with the first one, which is new North American products, the medium-duty product that was on a brand new platform and the heavy-duty product for the new 579 and T680. We’ve completed those transitions in North America now. And you’re right to note that it’s a European product that’s continuing to increase. So that’s good news for all of us as we’ll take build rates up to the new products continually through being exceptionally well-received by our customers. As far as commentary on pricing, we feel like because we’ve got the right products in the marketplace, and that the best products are delivering thousands of dollars per truck per year in fuel economy savings, that our customers will continue to want to buy those trucks from us. So we think that the pricing model will stay intact.

I guess, in a follow-up question, if I could, again, just given the new product introductions, and just performance from your perspective, what do we need to see in the market to get your truck gross profit margin sort of back to the pre-COVID 11% to 12% margin?

I think every market stands on its own, as you would be well aware and know, and we’ve talked about in the past. There have been supply challenges, and we’ve prioritized getting the most trucks out for our customers that we could. That has been a thing that we’ve dealt with really effectively. Great congratulations to our team and our suppliers for working through that and continuing to work through that. But our focus has been on getting the right trucks out to our customers and making the transition to the new products. We think that looking forward, we’ll see continued growth, as Harrie noted in the comments.

We’ll take our next question.

Yes, hi, good morning and good afternoon. This is Jerry Revich from Goldman Sachs.

Hi, Jerry.

Hi, your Parts business is really interesting. Over the past five years, you folks have taken up margins by over a point per year. I’m wondering as we look at the Parts business over the next couple of years, as your engine field population grows, is that level of margin expansion sustainable two, three, four years out? Can you just talk about the moving pieces in there, if you don’t mind?

Like you said, Jerry, that Parts margins have improved very nicely at record levels of around 30% now. A lot of that is driven by the increasing success of the PACCAR Engine. As the population grows and the engines get older, they get into more maintenance work, which should be a tailwind for Parts margin in the future as well.

Yes, I think that’s what Harrie said. It makes complete sense. I would just add to it the opportunity of what the Parts team is doing from a technology standpoint and how effective they are at capturing an increasing percentage of the market is also helpful to us improving margins, so the systems they’re employing and the technology they’re employing put us at the top of the class in terms of how we support customers.

And then, just to follow up to Jamie’s question in terms of labor hours per unit on trucks. Now that you’ve dealt with the toughest part of the supply chain challenges, are you back on trend line levels of labor hours per unit or is there more efficiency gains on that normalization in the next couple of quarters for us to think about?

I think that it’s a great comment. What we’ve seen is, again, the focus on getting trucks through to our customers. That continues to be our focus. We are not back to our optimized efficiencies, but we are very efficient from a standpoint of how we’re producing the new trucks and what they’re bringing. We’re going to continue to make sure we build as many trucks as we can, and that’s really our first priority.

And lastly, obviously Europe is a big region, can you just talk about differences in order trends by your major countries, anything that you would point out in terms of any differences in order intake rates over the past couple of months?

Yes, maybe Harrie, you want to offer something on that?

Yes, sure. As we noted in the press release, market share in Europe has grown to 17.5%. A lot of those gains have come out of the bigger markets like Germany, France, and Spain, where we had the opportunity to grow. It’s really exciting to see that in the first half year those countries came through. That has been a big part of the success.

And we’ll move on to our next caller.

Thanks. Good morning. It’s Steven Fisher from UBS. Curious how you’re thinking about the seasonality. Good morning. Curious how you’re thinking about the seasonality of EPS this year. Typically, Q3 would be lower than Q2 due to those European shutdowns and then Q4 picks up again. Do you think Q2 was sort of the typical peak of EPS for the year or do you think there’s enough pent-up production and mix benefits and Parts strength that we could see something even better than this as we get towards the end part of the year?

Yes, I think that we feel like the business is running really well. The teams have done a great job in the second quarter. We look forward to the third quarter as Harrie talked about, we think Truck, Parts and other margins are going to increase in the third quarter. You noted the fewer build days in the third quarter in Europe. All in all, we feel like the business is running quite well and will do so in the third quarter as well.

And then looking out to 2023, how are you deciding kind of when to fully open up the order books and how far out are you comfortable with pricing decisions at this point?

So as you said, and what we shared with you, we have begun to fill our orders for the first quarter of next year. Some of those end up being four-year contracts. We see really strong interest from the customers. We're having good progress in order intake. I’d say that as I think a bit more macroscopically, as we shared, fleet ages up 10% or 15%. Truck utilization is very high. Freight tonnage and volumes are at very high levels. We think that setup the market for a strong future for truck sales.

And we’ll move to our next question.

Good morning. This is Matt Elkott from Cowen. I think the inventory only grew $10 million sequentially in the quarter, which is way less than the increases of the last few quarters. Is this mainly a result of a lot fewer trucks waiting for parts? And do you think this whole red tag truck issue is largely behind us as the trip footage eases and the supply chain improves?

Hi Michael, you want to share some thoughts on that?

Well, we did experience a reduction in the number of trucks that were offline during the quarter. So we had good sequential improvement in that. The currency weakness also had an impact on reducing our inventories, which we’ll see how that goes as the year progresses, but that’s another factor to think about.

And then any supply chain update would be helpful?

Sure, as we mentioned, the supply chain and our team have done a fantastic job really of finding solutions and enabling us to increase our daily build rate through the last quarter. While we’re not complete and through the supply chain limitations, we think that that probably contributes to a strong truck cycle for a long period.

Right. Thank you very much.

Thank you. We’ll move on to our next question.

Hi, Steve Volkmann from Jefferies.

Good morning.

Good morning, good afternoon. So just a couple of quick follow-ups, if I may. What was the currency impact on the second quarter maybe on sales?

Yes, the impact on sales was about $270 million negative. The impact on net income was about $25 million compared to last year for the quarter.

And then maybe similarly, I think Harrie, you mentioned in your comments that high used truck prices were a benefit for FinCo income, how much was that kind of gain on sale stuff? How much did that contribute?

I don’t have the numbers readily available, Steve, but it was a nice benefit to the results of the finance company, both in the first and second quarter. We expect the used truck market to remain strong and finance company also to perform very, very solid in the third quarter.

I guess where I’m going with that is, at some point, I suppose used truck prices will normalize, but at the same time, you guys are doing a lot to improve your used truck marketing and so forth. And I’m just curious, maybe as we think out into ‘23, when and if used truck prices normalize, would that be a bit of a headwind for you, or do you think you’ll be able to kind of keep this higher level of sales because of the way you’re marketing the used trucks?

The used truck facilities that we’ve added, Steve, will definitely benefit the finance company next year and many years thereafter. It allows us to sell more trucks at retail prices to end customers, which is good for the finance company’s profitability.

And we’ll take our next question.

Greg, Good morning, guys. This is Dylan Guggenheim from Morgan Stanley. Just wanted to ask first on R&D, are you guys took that back a bit this quarter? I was just curious if that was more reflective of your ability to spend the money in terms of any kind of supply chain issues, or if that was a more conscious pullback on your side?

No, it’s not necessarily a pullback on the R&D. If you look at the second quarter, the lower R&D, I would say that the majority of that is, again, due to currency, a weaker euro. Our outlook for the year means that we’re going to be spending R&D at record levels. We feel very good about the money we’re spending, the projects we’re developing, and the technologies that will be coming to customers.

Got it, thanks, Harrie. Then maybe one on the battery electric side. I mean, you guys have been planning to take up production as you’re kind of progressed. I’d be curious if you can kind of give an update around the supply chain situation on the battery side, and whether or not procurement of pack cells, etc., has kind of improved for the year, or is any kind of color you can give on how that build rates path has progressed?

You bet. I think that where we sit with that, as we have seven truck models in production now around the world that are battery electric and zero emissions product lines, which is fantastic. We’ve secured supply for the batteries and systems we need, specifically batteries for the coming years. We continue to work with our partners as we ramp up our production. We’re seeing that growth quarter-over-quarter. As we’ve shared a few times, we expect that this year will be in the hundreds of units and then over the coming years, that will grow to the thousands of units, and we see just a steady progression there as our technology comes to market.

And we’ll take our next question.

Hi, this is from Bank of America. I have two quick questions. During your Investor Day, you mentioned that we should anticipate order rates to be limited in the upcoming months as OEMs manage production closely. Traditionally, the benchmark is around 250,000, which represents the replacement level of demand for trucks, and that's roughly where orders have been over the past year. Do you believe orders will weaken in the next few months before they recover? Additionally, regarding that replacement level demand, do you think it has increased compared to the past?

First, I think this has been an uncommon couple of years. Trying to put too much math into order intakes is a difficult thing to get accurate. What I would talk about is that the year is sold out; there was obviously some pause for everyone in terms of strong order intake because everyone wanted to see what the market was going to be and what the supply of capabilities were going to be. We’re now closer to 2023. We have opened new order books to more fully, and we're taking orders and demand is strong for that. I would expect to see order intake increase now for the coming time.

I recognize that the spot market is not the entire freight market. If there are worries with spot freight rates down on a year-over-year basis because of the impact on future trucker profitability, how should we view that weakness in spot? Is that not an accurate portrayal of the U.S. Truck market in your view? Do you feel like it’s misleading given the strength you pointed to and other data points? Just love to get PACCAR’s view on how we should interpret some of the weakness in the last few months on the spot freight market. Thank you.

Sure, great question. I think that we probably overemphasize the significance of the spot market; it’s 10% to 20% of the total market in range. It’s really the part that deals with the tips of anything. It’s a good leading indicator maybe, but what I would suggest is that spot contracts are quite robust. Spot rates are down from extremely high levels, but normal contracts and truckload contracts are doing very well, and rates are actually increasing in that area. Combine all those factors with the strong freight tonnage and you should expect to see a good Truck market for some time.

We’ll move on to our next question.

Hey, thanks. It’s [Indiscernible] from Wolfe Research. I just want to follow up on a couple of points. I’m not clear if you still believe it’s necessary to limit orders for 2023.

No, I wouldn’t think of us as being limited in orders for 2023. I think that there’s a normal cadence to how fleets buy and how the market goes, so it’s really just the start of that season. That’s what you’re kind of seeing, an uptick in order intake as we move through the calendar year.

And then I just want to ask a bigger picture question. So you guys are talking about gross margins of 14.5% to 15%. We haven’t been above 15% since 2016. So as you think about price and costs and units and just your crystal ball, does this third quarter feel like it’s about as good as it gets from a gross margin standpoint, or do you think you could build on that into next year?

I would say that we’ve had a fantastic team of people working really hard around the business to deliver great results, as we shared. We think the third quarter looks fantastic as well, and we think there’s a great business going forward.

And then if I can just one last follow-up with that. The last time you guys were at high 14%, kind of gross margins, margins for Truck were right around 11%. Next time you get back to high teens or high 14%, 15% gross margin, do you think that the operating margins EBIT margins should be better, worse, or similar to that 11% you had last time?

Yes, we will continue to deliver good margins. I think the outlook for the company is excellent. Demand is strong; the new products are doing well. We’re in an excellent position to deliver this very, very good margin for next quarter and going forward.

We’ll take our next question.

There are no further questions. I’ll turn it back to our presenters for any additional or closing comments.

I’d like to thank everyone for joining the call. And thank you, operator.

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