PACCAR Q2 2022 Earnings Call Transcript

Participants

Corporate Executives

• Ken Hastings, Director of Investor Relations
• Preston R. Feight, Chief Executive Officer & Director
• Harrie C. Schippers, President & Chief Financial Officer

Analysts

• Bernstein, Chad Dillard
• Robert Wertheimer, Melius Research
• Michael Barkley, PACCAR
• Jamie Cook, Credit Suisse Group AG
• Jerry Revich, The Goldman Sachs Group, Inc.
• Steve Fisher, UBS Group AG
• Matthew Elkott, Cowen Inc
• Stephen Volkmann, Jefferies Financial Group Inc.
• Dillon Cumming, Morgan Stanley
• Mike Feniger, Bank of America Co.
• Scott Group, Wolfe Research
• Nicole DeBlase, Deutsche Bank Aktiengesellschaft
• Jeffrey Kauffman, Vertical Research Partners
• Tami Zakaria, J.P. Morgan
• Timothy Thein, Smith Barney Citigroup
• John, Bank of Montreal
• Felix Boeschen, Raymond James
• David Raso, Evercore ISI

Presentation

[Operator]

Good morning, and welcome to PACCAR's Second Quarter 2022 Earnings Conference Call. [Operator Instructions]. 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.

Mr. Hastings, please go ahead.

[Ken Hastings, Director of Investor Relations at PACCAR]

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; 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 of paccar.com. I would now like to introduce Preston Feight.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Good morning. Harrie Schippers, Michael Barkley and I will update you on our first quarter results and business highlights. I truly appreciate PACCAR's outstanding employees around the world who continue to delivery excellent results and the highest quality trucks and transportation solutions.

PACCAR achieved record revenues and net income in the second quarter. PACCAR's revenue increased 23% to $7.160 dollars. Net income increased 45% to $720 million. PACCAR Parts second quarter revenue has increased by 18% to a record $1.43 billion. PACCAR Parts pretax 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 with 13.5% in the second quarter of last year. PACCAR's increased vehicle production, new line of premium trucks and strong aftermarket parts business drove the higher gross margins.

PACCAR Financial had an excellent quarter, increasing year-over-year pretax 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, it's 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 272,000 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're 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. Harrie Schippers will now provide an update on PACCAR Parts, PACCAR Financial Services and other business highlights. Harrie?

[Harrie C. Schippers, President & Chief Financial Officer at PACCAR]

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 has 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, 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. Pretax 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 the 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 aftermarket parts and Financial Services business and flexible operating structure positioned the company for a bright future. Thank you. We'll be pleased to answer your questions.

Questions and Answers

[Operator]

Thank you. [Operator Instructions]. We'll take our first question. Caller, your line is open. If you would please check your mute button.

[Bernstein, Analyst at Chad Dillard]

Hi, this is Bernstein. First question for you is just on your gross margin trajectory. If I look in a cycle, the last time we had like [Technical Issues] build whereas 2014 and I think you guys were doing around I guess 13% [Phonetic] margins, and if we fast forward where we are today, it looks like we're heading forward like a 14.5% run rate. I kind of quite curious about just like the cycle over cycle durability.

And then secondly, just like how to think about the evolution of margins as we go through the back end of the year and any early comments you can give on your thoughts, I would say going to 1Q given that you are taking orders right now.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Sure, I would be happy to take the questions. 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 in North America. That performance is helping our customers perform better, finding excellent fuel economy for them and the result of that is an improvement in margins. That is really the fundamental underlying principle for increase in truck margins.

I'd also share that our parts team is doing a great job, set another record in the first quarter. We expect continued strong performance in the second quarter, I should say. 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.

[Bernstein, Analyst at Chad Dillard]

And then just second question on parts, just how to think about the year-on-year growth rate here, as well as just how to think about margins on that?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Harrie, do you want to offer commentary?

[Harrie C. Schippers, President & Chief Financial Officer at PACCAR]

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.

[Bernstein, Analyst at Chad Dillard]

Thank you.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

You bet.

[Operator]

We'll move on to our next question.

[Robert Wertheimer, Analyst at Melius Research]

Hi, good morning everybody. It's Robert Wertheimer from Melius Research.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Good morning.

[Robert Wertheimer, Analyst at Melius Research]

Are you guys there? Yeah, great.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

We're here.

[Robert Wertheimer, Analyst at Melius Research]

So, quick questions. Thanks. 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 comment on truck pricing -- how far it was up for you guys in the quarter?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Michael, you want to share any thoughts on that?

[Michael Barkley, Senior Vice President and Controller at PACCAR]

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

[Robert Wertheimer, Analyst at Melius Research]

Okay, perfect. 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 or capitalized 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.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

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. They are roughly 50% in the second quarter and increasing in the third quarter. Demand is exceptionally strong for those products. Those are the only trucks that meet the new masses and dimensions and regulations in Europe, which provides great driver comfort. They operate at 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.

[Michael Barkley, Senior Vice President and Controller at PACCAR]

Thank you.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

You bet.

[Operator]

We'll move on to our next caller.

[Jamie Cook, Analyst at Credit Suisse Group]

Hi, good morning Jamie Cook, can you hear me?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Hi, Jamie. We can hear you.

[Jamie Cook, Analyst at Credit Suisse Group]

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 lowest price increases that you have out there?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Let's start with the first one, which is North America and new products. The medium-duty product was on a brand-new platform and heavy-duty product for the new 579 and T680 and 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 it will take build rates up of the new products continually. They are being exceptionally well-received by our customers.

And then as far as a commentary on pricing is, we feel like because we've got the right products in the marketplace and those are the best products delivering thousands of dollars per truck per year and fuel economy savings, that our customers will continue to want to buy those trucks from us. And so, we think that the pricing model stay intact.

[Jamie Cook, Analyst at Credit Suisse Group]

I guess in a follow-up question, if I could, again just given the new product introductions and you know, 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-sort of COVID 11-ish 11% and 12% margin?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

I think every market stands on its own as you would be well aware and know and we've talked about in the past, right? There have been supply challenges and we've put a priority on making sure that we get the most trucks out for our customers that we could. So that has been the 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, and we think that looking forward, we'll see continued growth as Harrie noted in the comments.

[Jamie Cook, Analyst at Credit Suisse Group]

Thank you.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

You bet.

[Operator]

We'll take our next question.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Yeah, hi, good morning and good afternoon. This is Jerry Revich of Goldman Sachs.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Hi, Jerry.

[Jerry Revich, Analyst at The Goldman Sachs Group]

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

[Harrie C. Schippers, President & Chief Financial Officer at PACCAR]

Yeah, like you said, Jerry, the 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 and as that population grows and the engine get older and get into more maintenance work, that should be a tailwind for Parts margin in the future as well.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

I think what Harry said makes complete sense. And 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. It is also helpful to us improving margin. So the systems they're employing, the technologies they're employing put us at the top of the class in terms of how we support customers.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Super. And then just a 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.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

I think it's a great comment and I think what we've seen is again the focus on getting trucks through to our customers and that continues to be our focus. We are not back to our optimized efficiencies, but very darn efficient I think 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 what really our first priority.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Okay. 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?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

May be Harrie want to offer something on that?

[Harrie C. Schippers, President & Chief Financial Officer at PACCAR]

Yeah, sure. As we noted in the press release, our market share in Europe has grown to 17.5%. A lot of those gains have come out of the, let's say, bigger markets like Germany, France and Spain, where we have opportunity to grow and it's really, really, exciting to see that in the first half year, those countries came through and that has done really well in those markets. So that's been a lot of big part of the success.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Perfect, thanks.

[Operator]

We'll move on to our next caller.

[Steve Fisher, Analyst at UBS Group]

Thanks, good morning. It's Steve Fisher from UBS. Curious how you're thinking about seasonality. Good morning. Curious how you're thinking about the seasonality of EPS this year? It is 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 is enough pent-up production and mix benefits in Parts strength that we could see something even better than this as we get towards the end part of the year.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Yeah, I think that we feel like the business is running really well, that 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 part and other margins are going to increase in the third quarter. You noted fewer build days in the third quarter in Europe, but all in all, feel like the business is running quite well and will do so in the third quarter as well.

[Steve Fisher, Analyst at UBS Group]

Okay. 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?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

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

[Steve Fisher, Analyst at UBS Group]

Okay, thank you very much.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

You bet.

[Operator]

And we'll move to our next question.

[Matthew Elkott, Analyst at Cowen]

Good morning. This is Matthew Elkott from Cowen. I think, you guys -- I think the inventory only grew $10 million sequentially in the quarter, which is way less than the increases over the last two 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 chip shortage eases and the supply chain improves?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

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

[Michael Barkley, Senior Vice President and Controller at PACCAR]

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. We also -- the currency weakness also had an impact on reducing our inventories, which we'll see how that goes as the year progresses. But there is that impact as well to think about.

[Matthew Elkott, Analyst at Cowen]

Okay. And then any supply chain update would be helpful.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Sure, I'd say, 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. And so while we're not complete and through the supply chain limitations, we think that that probably actually contributes to a strong truck cycle for a long period of time.

[Matthew Elkott, Analyst at Cowen]

Thank you very much.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

You bet.

[Operator]

Thank you. And we'll move on to our next question.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Hi, Stephen Volkmann from Jefferies.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Good morning.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

You guys hear me? 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?

[Michael Barkley, Senior Vice President and Controller at PACCAR]

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

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Great. Thanks. And then maybe similarly, I think, Harry, 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?

[Harrie C. Schippers, President & Chief Financial Officer at PACCAR]

I don't have the number readily available Steve, but it was a nice benefit to the results of the finance company, both in the first and second quarter. And we expect the used truck market remains strong and the finance company also to perform very-very solid in the third quarter.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Okay. I guess where I'm going with that is at some point I suppose used truck prices will kind of 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 2023, when and if used truck prices kind of 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.

[Michael Barkley, Senior Vice President and Controller at PACCAR]

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

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Great. Okay, thank you.

[Operator]

And we'll take our next question.

[Dillon Cumming, Analyst at Morgan Stanley]

Great. Good morning, guys. This is Dillon Cumming from Morgan Stanley. I just wanted to ask first on R&D. You guys took that back a bit this quarter. I was just curious if that was more reflective of your ability to actually spend the money in terms of any kind of supply chain issues? If that was a more conscious pull back on your side?

[Harrie C. Schippers, President & Chief Financial Officer at PACCAR]

No, it's not necessarily a pull back on the R&D. If you look at the second quarter, the lower R&D, I would say, 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. So, we feel very good about the money we're spending, the projects we're developing, and the technologies that will be coming to customers.

[Dillon Cumming, Analyst at Morgan Stanley]

Got it. Thanks, Harrie. And then maybe just one on the battery electric side. I mean you guys have been playing to take a production. As the year gotten progressed, I would just be curious if you can kind of give an update around the supply chain situation on the battery side? Whether or not procurement of pack cells, etc. has kind of improved through the year or is there any kind of color you can give on how that build rate path progressed?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

You bet. I think that where we sit with that is 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, battery specifically for the coming years and we continue to work with our partners as we ramp up our production. So, we're seeing that growth quarter-over-quarter and as we've shared a few times, we expect that this year will be in the hundreds of units and then in the coming years, that will grow into the thousands of units and we see just a steady progression there as our technology comes to market.

[Dillon Cumming, Analyst at Morgan Stanley]

Got you. Thank you.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

You bet.

[Operator]

And we'll take our next question.

[Mike Feniger, Analyst at Bank of America]

Yeah, hi, this is Mike Feniger from Bank of America. Just two quick questions. At your Investor Day, you flagged, we should expect order rates to be constrained over the next few months as OEMs are managing production closely and the old rule of thumb is that 250K [Indecipherable] is kind of like the replacement level demand for trucks, and that's kind of where orders have been if you look at the last 12 months.

Do you think orders would get weaker in the next few months before they get stronger and is that rule of thumb that replacement level demand, do you feel like that's added date [Phonetic]. Do you think that's moving now higher than it was in the past?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

First, I think this has been an uncommon couple of years and I think trying to put too much math into order intakes is a difficult thing to get accurate. What I would talk about is at the year sold out, there was obviously some pause for everyone In terms of strong order intake because everyone want to see what the market was going to be and what the supply of capabilities were going to be. We now are closer to 2023 and so we're taking, we've opened the order books 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.

[Mike Feniger, Analyst at Bank of America]

Great. And 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, potential impact on future truck trucker profitability on that, how should we view that weakness in spot? Is that an accurate portrayal of the U.S. truck market in your view? Do you feel like it's misleading given the strength you point to and other data points? Just love to get PACCAR's view on how we should kind of interpret some of the weakness in the last few months on the spot freight market? Thank you.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Sure, great question. I think that we probably overemphasized the significant to the spot market. It's 10% to 20% of the total market in range and 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 and normal contracts, truckload contracts and other are doing very well and that rates are actually increasing in that area. Combine all those factors with strong freight tonnage and you should expect to see a good truck market for some time.

[Operator]

We'll move on to our next question.

[Scott Group, Analyst at Wolfe Research]

Hi, thanks. It's Scott Group from Wolfe Research. Couple of things just want to follow up on. It wasn't clear to me if you feel like you still need to be limiting orders for 2023. And you had a comment that your used truck is still really good and don't expect any impact on the finco results. Are you not seeing any sort of pressure in used truck like the overall market is starting to see in the last couple of months, you wouldn't expect to see any sort of sequential drop off?

[Harrie C. Schippers, President & Chief Financial Officer at PACCAR]

Yeah, we did see that used truck prices came down a little bit in the second quarter compared to the first quarter in North America, that is. But used truck prices are still up more than 60% compared to the same quarter of the last year. So that's what we call a really strong used truck market for us.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

And did you have a first question, Scott.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

Yeah, hi, guys. Nicole DeBlase from Deutsche Bank.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Hi, Nicole.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

Hello, maybe just going back to the question asked earlier on the red tagged inventory to kind of tie things up there. I think last quarter when we were on this earnings call, you guys said the red tagged trucks were kind of in the low 3,000 range. When we talk about sequential improvement like to what extent have they improved, like how close are we to getting that number towards zero?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Good question. And the number will never go to zero because there always trucks that are being final delivery, I would say. So we will never look for the number to be zero. But what we have seen is an improvement from the 3000 into the high 2000s and so we see that sequential improvement and we hope that that sequential improvement will continue.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

Okay, got it. That's helpful and then we've gotten through a lot of the questions here. Talked a lot about the U.S. and Europe, but I guess what are you seeing with respect to order rates in the rest of world. Any change in the trend that you had been seeing things kind of pretty strong over the past few quarters?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Quite sure that if you look at South America, our team down there has done a really great job in South America and specifically in Brazil. We've grown market share considerably. We've had strong order intake. The trucks are performing very well for the customers. We've established ourselves as a premium brand in Brazil and it feels like a great market for us. In Mexico, we're doing well also. So Europe, North America South America. Australia is doing well, having a fantastic year there as well.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

Thanks, I'll pass it on.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

You bet.

[Operator]

Thank you. And we'll go to our next question.

[Jeffrey Kauffman, Analyst at Vertical Research Partners]

Hi, everybody is Jeffrey Kauffman of Vertical Research Partners. Good afternoon.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Hello, Jeff.

[Jeffrey Kauffman, Analyst at Vertical Research Partners]

Hi, a quick question on raw materials and raw material costs pretty inflated in the second quarter, still somewhat inflated but steel, aluminum almost any raw material you look at has been coming down pretty sharp over the last four to six weeks. Could you remind us kind of how long it takes raw materials to work through inventory and become part of the P&L, and I guess kind of the costs you're running through your P&L when were those raw materials acquired and what we're seeing now in terms of the change in the markets? Is that something that's going to be more of an early 2023 change in cost of goods sold? Is it probably a little later this year? I just love a little insight on that.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

But, we don't really break the model out that way to think about it in terms of sequential timing of that. It obviously depends on which materials in the trucks. You bring up the comment of which is we have seen in the last several weeks some softening in materials prices but from very, very high levels and so we continue to include that in our conversations with customers as we price the trucks.

[Harrie C. Schippers, President & Chief Financial Officer at PACCAR]

It's one of the elements that goes into the cost of a truck like labor is and efficiency is and the new truck models are so. There's many elements that go into the pricing for trucks.

[Jeffrey Kauffman, Analyst at Vertical Research Partners]

So I should think about it as the pricing will follow the cost.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

It's a good -- that's a good general rule, Jeff. We agree.

[Jeffrey Kauffman, Analyst at Vertical Research Partners]

In general, wonderful. That's my question. Thank you, guys.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Alright.

[Operator]

Thank you. And we'll move to our next question.

[Tami Zakaria, Analyst at J.P. Morgan]

Hi, thank you so much. This is Tami Zakaria from J.P. Morgan. Thanks for taking my questions. I have a couple of quick ones. So my first question is, is there any risk to production in the third or fourth quarter given what we are hearing about a potential gas shortage in Europe, are you preparing for any disruptions should there be any?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Well, on that topic, Tami. I would say that those conversations are always ongoing. What we've seen in the last five months since Ukraine conflict started is that the countries have done a great job of continuing to have supply. PACCAR has done very well in that time frame. And we think that it will continue to do well as we look forward.

[Tami Zakaria, Analyst at J.P. Morgan]

Got it. Super helpful. And so this is -- my second question is more of a macro question, so I think Preston, you just mentioned contract freight market is actually increasing. But what we are hearing from retailers is that there is an inventory overhang and growing consumer demand. So what do you think is really driving the contracts freight market that it's going up now?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

I think that the most fundamental thing is the economy is very large and at a very large level and it's probably going to continue to be. So I think that anything that 75% of what is delivered in this country is done through trucks and ours are the most desirable trucks. So I kind of expect that as the car market is strong, as housing is strong, as consumer goods even if it moderates is at high levels, then there's a lot of freight that's going to need to be hold and so that creates a strong market dynamic for us.

[Tami Zakaria, Analyst at J.P. Morgan]

Got it. Thank you so much.

[Operator]

We'll take our next question. Caller, your line is open, please check your mute button.

[Timothy Thein, Analyst at Smith Barney Citigroup]

All right. Tim Thein here from Citi. Sorry about the clunky exchange. Preston, the first question I had was just with respect to the from a truck perspective, the margins and we talked a lot about price versus material costs, but is there a way to quantify what sort of impact you've experienced just from the standpoint from factory efficiency or I guess in this case inefficiencies over the last several quarters from more of a stop-start or and-or a slower-than-normal build rate? Is there a way to kind of quantify what that drag has been and then presumably that becomes a more of a tailwind in 2023?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Well, I think, no, there is not really an easy way to do that or necessary way to do that. I think what we look at is the improvement in margins that we've realized year-over-year and sequentially and the continued improvement in margin that we're forecasting out into the future. I think that kind of takes the whole macro picture of pricing cost and efficiency into play and shows you that we see things going in the right direction.

[Timothy Thein, Analyst at Smith Barney Citigroup]

All right. And then back to the comment on foreign exchange. If we just used where the dollar settled at the start of the quarter, is there a way, maybe Michael can help just a ballpark figure. I know there is multiple cross currency impacts, but just dollar-euro or what we should think about from the standpoint of second half headwind, either top end or bottom line, just if the dollar stayed at current levels.

[Michael Barkley, Senior Vice President and Controller at PACCAR]

Yeah, I mean I think what happened in Q2 is probably it would be a similar effect that what you see in Q3 and Q4. Kind of last year's currency was already drop in Q3 and Q4 last year. So there's multiple cross currents there. But directionally, it would be similar probably to Q2.

[Timothy Thein, Analyst at Smith Barney Citigroup]

Okay, understood. Thank you.

[Operator]

We'll take our next question.

[John, Analyst at Bank of Montreal]

Hi, this is John with the Bank of Montreal.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Hello.

[John, Analyst at Bank of Montreal]

Hi, so, and maybe you touched on this already, but you've done an excellent job of controlling I guess equipment-related SG&A dollars, particularly in light of the strong sales. So I guess what has been driving your success here?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

So, I have to give all the credit in the world to the entire team of PACCAR and we have a focus on excellence and focus on efficiency and operating well and they have delivered fantastic performance in that area.

[John, Analyst at Bank of Montreal]

Okay, thank you. And then, maybe just one more on the -- on your outlook kind of maybe if you can talk about beyond this year or at least give some at least directionally in terms of capital expenditures. I mean do you anticipate those picking up or staying at similar levels or maybe even declining from here. I would assume that you would you would be continually investing back into the businesses and really with new technologies and such, but if you could give any color there, that would be helpful.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Sure. We've obviously last year into the start of this year been introducing new products. At the same time, we're working on some really exciting new technology projects in both the battery electric space, hydrogen fuel cell space, connected vehicle space and autonomous space. So, we see that we have a great future set of product portfolios that we are working on that will deliver continued great results for the future.

[John, Analyst at Bank of Montreal]

Okay, fantastic. Thank you so much. Okay.

[Operator]

We will take our next question.

[Felix Boeschen, Analyst at Raymond James]

Hi, this is Felix Boeschen from Raymond James.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Hi, Felix.

[Felix Boeschen, Analyst at Raymond James]

I just have one question, I guess two parts, but you mentioned earlier in the call that the new model transition in North America is largely complete. I'm curious if you could talk about the uptake on the PACCAR transmission for the medium-duty lineup, maybe what percent of bills have them. And then similarly, if you could update us on what percentage of your heavy-duty builds in North America now carrying MX engine. That's really it for me.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Sure thing. As we think about it, we have been able to grow over the years, our proprietary powertrain. That continues to grow. Our MX engine performance or percentages in the U.S. is now right around 40% in the low 40% is what we'd expect to see through the year. And the transmission that we introduced in the medium-duty, the automated PACCAR transmission has done a great job. I don't have the numbers in front of you in terms of me in terms of percentages, but it is definitely growing.

[Operator]

We'll move on next caller.

[David Raso, Analyst at Evercore ISI]

David Raso from Evercore ISI. I was curious with the new models and assume the majority of Europe is new model, what is the margin differential with the new models out in the US-Canada versus your European business? Thank you.

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Hi, David. We don't break that out. We think that what we've been able to do this transition off Kenworth and Peterbilt brands to these new models and we definitely see that as an advantage for our customers as we said, each of those -- each truck and save them several thousand dollars per year in operating cost. And then of course as we mentioned, that's really good for the company. But we have a differentiated those margins.

[David Raso, Analyst at Evercore ISI]

Could you at least answer has the GAAP changed with the new models?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

Well, I mean I think, yes, it has, right. We've seen improved margin from them because they're delivering benefit to our customers. And so it's a win-win situation.

[David Raso, Analyst at Evercore ISI]

I meant the gap between U.S., Canada and Europe, has it changed with the new models out?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

I think that I think there is a several factors that go into that. And one of those is market strength. And we have seen increasingly strong markets in Europe. So that's to an advantage. And then the new trucks are definitely performing really well. So I would directionally the margin question of Europe improving, yeah, great margins in Europe.

[David Raso, Analyst at Evercore ISI]

Thank you very much I appreciate it.

[Operator]

[Operator Instructions]. We will take our next question.

[Scott Group, Analyst at Wolfe Research]

Hi, it's Scott Group from Wolfe again. I don't know what happened. Can you guys hear me now?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

We sure can.

[Scott Group, Analyst at Wolfe Research]

Okay, great. So, I had -- one of my followups was just it wasn't clear to me if you guys are still in a place where you need to be limiting orders for 2023?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

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

[Scott Group, Analyst at Wolfe Research]

Okay. 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 cost and units and just your crystal balls, does 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?

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

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

[Scott Group, Analyst at Wolfe Research]

Okay. And then if I can, just one last followup with that. So 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 a high teens -- sorry high 14%, 15% gross margin, do you think that the operating margins, EBIT margins should be better, worse or similar with that 11% that you had last time.

[Michael Barkley, Senior Vice President and Controller at PACCAR]

I think like Preston said 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 very, very good margins for next quarter and going forward.

[Scott Group, Analyst at Wolfe Research]

Okay, all right, thank you guys.

[Operator]

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

[Preston R. Feight, Chief Executive Officer & Director at PACCAR]

I'd like to thank everyone for joining the call and thank you, operator.

[Operator]

[Operator Closing Remarks].