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PACCAR (NASDAQ:PCAR)

Q2 2012 Earnings Call

July 24, 2012 12:00 pm ET

Executives

Robin E. Easton - Treasurer

Mark C. Pigott - Chairman, Chief Executive Officer and Chairman of Executive Committee

Michael T. Barkley - Principal Accounting Officer, Vice President and Controller

Analysts

J. B. Groh - D.A. Davidson & Co., Research Division

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Andy Kaplowitz - Barclays Capital, Research Division

Seth Weber - RBC Capital Markets, LLC, Research Division

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Jerry Revich - Goldman Sachs Group Inc., Research Division

Henry Kirn - UBS Investment Bank, Research Division

Jamie L. Cook - Crédit Suisse AG, Research Division

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Timothy J. Denoyer - Wolfe Trahan & Co.

Robert Wertheimer - Vertical Research Partners Inc.

Adam William Uhlman - Cleveland Research Company

Patrick Nolan - Deutsche Bank AG, Research Division

Basili Alukos - Morningstar Inc., Research Division

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

David Raso - ISI Group Inc., Research Division

Mark Rogers

Operator

Good morning and welcome to PACCAR's Second Quarter 2012 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. Robin Easton, PACCAR's Treasurer. Mr. Easton, please go ahead.

Robin E. Easton

Good morning. We would like to welcome those listening by phone and those on the webcast. My name is Robin Easton, Treasurer of PACCAR. And joining me this morning are Mark Pigott, Chairman and Chief Executive Officer; Ron Armstrong, President; and Michael Barkley, Vice President, Controller.

As with prior conference calls, if there are members of the media participating, we request that they 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.

I would now like to introduce Mark Pigott.

Mark C. Pigott

Good morning. PACCAR reported increased revenues and net income for the second quarter of 2012 compared with the second quarter last year. PACCAR's second quarter sales and Financial Services revenue were $4.46 billion, up 13% compared to $3.96 billion in the second quarter of last year. Quarterly net income increased to $297 million, a 24% increase versus the $240 million earned a year ago.

Increased truck deliveries in North and South America and a growing Financial Services business contributed to PACCAR's increased profits.

For the first half, revenues were a record $9.2 billion, and net income was $624 million. In addition, PACCAR's dividend increased 60% compared to a year ago. I'm very proud of our 23,000 employees who have delivered industry-leading products and services to our customers worldwide.

Our customers in North America are benefiting from increased freight tonnage, improved fleet utilization rates and lower fuel prices. In Europe, freight transportation on German highways continues at good levels, comparable to last year. European transporters have also benefited from lower fuel prices in recent months.

Due to the uncertain global economy, some of our customers are not expanding their fleets at this time and are focused primarily on truck replacement. PACCAR delivered 37,700 trucks during the second quarter, about 10% higher than the same period last year, but down 5% from the first quarter of 2012. Peterbilt, Kenworth and DAF grew their market share as customers recognized the benefits of our high-quality and efficient trucks. PACCAR's retail share of the U.S. and Canadian Class 8 truck market was 29.9% for the first half.

DAF's share of truck registrations in Europe above 16-tonne reached 16%. Kenworth and DAF truck deliveries in the Andean region of South America, that is the region outside of Mercosur, increased by about 75% in the first half of this year compared to the same period last year.

Looking forward, PACCAR expects to deliver about 10% fewer trucks in the third quarter compared to the second quarter due to the weak economic growth in the United States, coupled with the ongoing uncertainty in the Eurozone.

Looking at the broader market, U.S. and Canadian Class 8 industry retail sales are estimated to improve this year to a range of 210,000 to 230,000 units, up 12% at the midpoint from 197,000 units last year. In Europe, the greater-than-16-tonne truck market is also anticipated to be in the range of 210,000 to 230,000 units, down slightly from the 241,000 units last year.

PACCAR's business initiatives worldwide are progressing well. Capital spending is estimated to be $450 million to $550 million, with research and development at $275 million to $300 million. Construction of our new DAF assembly factory in Ponta Grossa, Brazil, is progressing, and we plan to be building DAF Trucks in Brazil next year.

We're also very pleased with the excellent customer response to the launch of the new Kenworth T680 and the Peterbilt Model 579, both very exciting trucks. During the second quarter, Kenworth and Peterbilt began limited production of these exciting new models, and they will gradually increase their production in the third and fourth quarters.

PACCAR is enhancing its network of 15 parts distribution centers. We're building a new 280,000 square foot distribution center in Eindhoven, the Netherlands, and our distribution centers in Madrid, Spain, and Lancaster, Pennsylvania, are increasing their capacity to meet the demands of our customers and dealers.

PACCAR Financial Services revenue were $266 million in the second quarter compared to $258 million last year. PACCAR Financials second quarter pre-tax income jumped to a quarterly record $77 million compared to $57 million earned in the second quarter last year. The excellent results benefited from growth in portfolio balances and a lower provision for credit losses. PACCAR Financial, with its strong A+ credit rating, has excellent access to the commercial paper and medium-term note markets. In the second quarter, PACCAR Financial sold over $900 million in 2- and 3-year notes in the U.S. and Europe. PACCAR also completed the renewal of its $2 billion credit line.

Overall, PACCAR is well-positioned to further enhance its competitive position in the global truck market due to the strength of our dealers worldwide, a robust finance company and the highest-quality products in the industry.

Thank you. I'd be pleased to answer your questions

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of J. B. Groh of D.A. Davidson.

J. B. Groh - D.A. Davidson & Co., Research Division

I just wasn't writing fast enough, I guess. On your comments about 10% sequential decline, is that your North American, U.S., Canada? Or is that global or Europe or what?

Mark C. Pigott

It's primarily in the U.S. and Canada.

J. B. Groh - D.A. Davidson & Co., Research Division

Okay. So Europe…

Mark C. Pigott

Europe is fairly steady.

J. B. Groh - D.A. Davidson & Co., Research Division

But I noticed you didn't really change the outlook on North America, and given that the orders have been a little underwhelming, so to speak, can you sort of talk about that against that backdrop?

Mark C. Pigott

Well, we adjusted the high end of the range.

J. B. Groh - D.A. Davidson & Co., Research Division

Right. Okay. You brought that down a little bit, okay.

Mark C. Pigott

Right. And you're right. We probably have been in times where there had been stronger order intake for the industry, and I think that's why we're looking at the moderate production decrease.

J. B. Groh - D.A. Davidson & Co., Research Division

And then the incremental margins looked pretty strong in the quarter. Can you explain that? Is it new models? Are you just managing things better, supply chain? Where is it coming from?

Mark C. Pigott

Well, I certainly think the team is doing a very good job of managing, as they do in every different type of economic market. I think, overall, we're getting good cooperation with our suppliers. The material side is in good shape. We've introduced some new models, but the models that we have had are in a good place in terms of production efficiency. The customers are interested in purchasing our vehicles. And so that has some positive impact on the margins. So overall, I think, just kind of managing the business, as you've indicated, in a good, professional manner.

Operator

Your next question comes from the line of Andy Casey of Wells Fargo Securities.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Can you kind of help us understand current -- we all have our own opinions -- but when you talk about the current fleet fundamentals been pretty good, trucks are old, yet the truck buyers are kind of slightly ordering below typical replacement demand. What do you think is going on? Is it just hesitation because of look-forward or government policy or something else?

Mark C. Pigott

That is a very topical question that has a lot of discussion in many companies around the industry, Andy. A couple of things: One, just to reiterate, I think for a number of years, most of the industry would expect that the replacement size is approximately 225,000 units a year, give or take, but in that range. So as you've noted, orders had been below that for a number of years. The other thing is we do have an older fleet, but when you look into that fleet, what you're going to find is a number of very good customers don't have too many miles on their vehicles. So they may be, let's call it, chronologically old, but when you look at it, they're not doing 125,000, 150,000 miles a year. So they're still in good shape. And so that's having an impact. Our customers, and many of them are publicly traded, so you can see their results, they're making good profits. They have survived a challenging 10 years with a couple of different recessions in there. So they're managing their business very well. The trucks are performing well, and I think, as we talk with our customers and we're out all the time, they're saying "We'll just run these a little bit longer. They're in good shape." Obviously, there's some benefit for parts and service, but the trucks are just made well and performing well. So I think it's -- you see a term in most of the periodicals industry, sort of in a pause or sort of in a reflective mode. There's lots of different terms out there. I think people are saying, "I'm running a fleet. I've got 100, 200, 500, 1,000 trucks. They're good. I'm getting great service from whatever dealer is providing that. I've got good freight rates. Fuel's manageable. There is a lot of freight. Let's just run them and kind of see what happens over the next 6 months."

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. And to support the anticipated level of production in Q3 from Q2, which you said is primarily North America, does anything have to happen in the orders? Or is that sized to your current order flow?

Mark C. Pigott

I think that reflects the order flow versus production levels, yes.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. And then...

Mark C. Pigott

Good question. It's an interesting discussion, and we're all discussing it.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

If I can fit one other in. You've, I'm sure, noticed that one of your competitors had a pretty sizable engine strategy shift. And I was wondering if you would expect any near-term share gains or any other impact on just general market conditions because of that.

Mark C. Pigott

Well, PACCAR, our focus is, a couple of things: One is providing return for our shareholders. Two, we do that by designing, selling and servicing the best products in the industry, and that's been guiding our company for 107 years. So competitors are always evaluating different strategies. I can't really comment on that. I know what we do, and hopefully, we share that with you and your colleagues and we keep a pretty steady course.

Operator

Your next question comes from the line of Andrew Kaplowitz of Barclays Capital.

Andy Kaplowitz - Barclays Capital, Research Division

Mark, given the age of the fleet and that the customers are running the fleet for longer, do you think that the aftermarket opportunities that you have, both in the U.S. and in Europe, will just be better over the next 6 months, year, 18 months, better than even the historic run rate that you've had?

Mark C. Pigott

So, what you're asking, do we think that there will be a time when customers say, “It probably is a good time to replace my fleet”? Is that what you're essentially asking?

Andy Kaplowitz - Barclays Capital, Research Division

No, what I'm saying is that the parts business could actually have higher growth now because you're -- these customers are running the trucks for longer than they have before.

Mark C. Pigott

Well, that has a, I think, probably a slight impact, but I would give the aftermarket group some praise in that they're developing a lot of new programs. There is a lot of e-commerce activity ongoing. We're reaching out to many more customers who might not necessarily actually operate our vehicles. They're also looking at different industries, not necessarily truck-related. So they have a pretty comprehensive, thorough plan to grow aftermarket services, and I'm also including Financial Services, sort of in line but a little bit independent of just the Truck business.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. That's fair. And Mark, how does -- I know you’ve talked about this before, but it does seem like one bright spot in the U.S. is housing starts, and they are continuing to improve. How do we factor in the upside from housing and its impact on trucks going forward? Do we need just a better U.S. economy? Or can we have real upside from housing?

Mark C. Pigott

Housing, as you've indicated, there is some little sunnier climate out there, talking about housing starts, maybe perhaps over 700,000 units this year, and that's a welcome relief for many industries. And I think when you look at the range of industries, whether it's the construction side with wood, concrete, timber, then the furnishings, that all is brought to the site by trucks. So the average, certainly over the last 10, 15, 20 years, for housing starts is about 1.2 million. I think when it gets closer to that level, then you'll see some impact, and I'm not talking about a lot but, certainly, a couple of percent impact to the vocational markets, whether it's the dump truck or the flatbed or the steel hauler, all great customers of ours and certainly companies that have had a slow patch for a number of years. So right now, it's just starting to improve -- let's see how it progresses over the next couple of years.

Operator

Your next question comes from the line of Seth Weber of RBC.

Seth Weber - RBC Capital Markets, LLC, Research Division

So margins were better than what we were expecting for the quarter. So nice job there. I'm wondering if you have another 10% sequentially down quarter here in the third quarter, can you give us your view on the sustainability of the margins?

Mark C. Pigott

Well, the margins obviously reflect our market demand and production capacity and utilization. So I think as you look at the lower production levels, there will be some impact on the second -- on the third quarter margin attainment. But we'll continue to focus and run our business to optimize our returns.

Seth Weber - RBC Capital Markets, LLC, Research Division

Okay. If I could ask a housekeeping question, could you give us the aftermarket, the parts revenue and the margin numbers?

Mark C. Pigott

Yes, we can. It's coming up.

Seth Weber - RBC Capital Markets, LLC, Research Division

I guess maybe in the meantime, Mark, can you talk about...

Mark C. Pigott

I got it here. For the second quarter, aftermarket parts revenues were $666 million, and the aftermarket parts margin was 34.3%.

Seth Weber - RBC Capital Markets, LLC, Research Division

Great. And then lastly, can you comment -- have you seen any change in used truck inventories or used truck pricing?

Mark C. Pigott

Used truck pricing continues to be very good, particularly for our vehicles. We're actually seeing a little bit of an uptick on used truck values across-the-board. So that's good. We're feeling pretty good about that. In Europe, used trucks are kind of holding their own.

Seth Weber - RBC Capital Markets, LLC, Research Division

Okay. And no issue with inventories at dealers or anything like that?

Mark C. Pigott

No, dealer inventory is very healthy, very healthy. Yes, we're in good shape.

Operator

Your next question comes from the line of Ann Duignan of JPMorgan.

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Your SG&A was down a little bit sequentially, not that much, but it was down a little, and we've been hearing through the quarter that you've cut back on things like advertising spending in Europe. Can you talk a little bit about what kind of cost reduction activity might be going on in Europe in anticipation of potentially slower growth? I mean, are you guys considering pulling out of IAA or anything like that? Or are you comfortable that you've got the right sized organization there already?

Mark C. Pigott

I need to get your contacts.

Ann P. Duignan - JP Morgan Chase & Co, Research Division

I can tell you exactly which magazines you can pull that out of.

Mark C. Pigott

No, Ann, you've been around. Don't read -- don't believe everything you read. You know that. No, we're in good shape. In fact, I'm going to be in Hanover. So I hope to see you and your colleagues there. Always an excellent show, and it's -- no, we're -- we manage our business to reflect whatever the industry is. We've done it for decades, as you know. So we showed at the -- earlier this year, the Euro 6 engine that DAF is developing. So, we're out there -- regional shows, at vocational shows, just very normal. Very normal. And you enjoyed the Mid-America show a few months ago here in Louisville?

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Yes, but you did pull out of that a few years ago, which was a big...

Mark C. Pigott

Well, that -- 2008 -- let's move forward here.

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Exactly. And then curious also, second question, CNG LNG related, just -- we understand that at least on the LNG trucks that those are being leased. Can you talk a little bit about why the Financial Services business would want to take on the risk of leasing LNG trucks when there's no history for residual values or just curious a little bit on what's going on?

Mark C. Pigott

Ann, I have no idea what you're talking about. We sell our trucks. The natural gas market certainly gets a lot of press from different corners of the business arena. We're very proud that PACCAR is one of the leaders, if not the leader, in the natural gas market. It's a market that's only 1% to 2% of the total truck market. So I think we need to put it in context. The CNG is used actively, particularly in the ports in California, but we offer both, and we're going to be increasing our product offering with a 12-liter next year. So we're very pleased with where we are. If the market increases, and certainly, there's plenty of rhetoric in the newspapers and by political speakers, we're ready for it. We embrace it, and we're proud to supply those products to the industry.

Ann P. Duignan - JP Morgan Chase & Co, Research Division

Okay. I'll take my LNG-specific question off-line and follow up with Robin afterwards.

Mark C. Pigott

You might want to ask me now.

Operator

Your next question comes from the line of Jerry Revich of Goldman Sachs.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Mark, I'm wondering if you could talk about over what time horizon you expect the business in Brazil to get to company average returns or now that you're building out the dealer network. Just give us an update, if you would, on how you view the path to the build-out and, ultimately, whether we can expect the same level of lean inventories, et cetera, that we're used to seeing in your other businesses.

Mark C. Pigott

Well, first of all, great question. And I am really looking forward to being able to invite many of our wonderful analysts to the factory when we get it up and running. Because what you'll see, as you've seen at all the factories, whether it's Mississippi or DAF, or St. Therese, or Chillicothe, it'll be exactly the same format and mode of operation. It'll be sparkling clean. It will be high technology. It'll be lean. It'll be motivated workforce and very high-quality products. In terms of returns, it will take 3 to 5 years. Obviously, it has something to do with the market. As you've indicated, we are beginning the process of appointing dealers, and those dealers will be independent dealers. They'll be building their dealerships around the country. We have a very steady program under way of building the factories. So that's on track. We're getting great cooperation and partnership with many of our suppliers that we work with around the world who are already in Brazil. And I think from the customers -- of course, we don't sell any trucks in Brazil at this time. But potential customers are very positive and excited about DAF coming in. They know the reputation of the product from around the world. They've contacted many customers in Europe,who they might have a relationship with. And they're really looking forward to the great product, great support and high-quality residuals and low operating cost. So it's going to be good. But it takes time to increase the business.

Jerry Revich - Goldman Sachs Group Inc., Research Division

And Mark, you mentioned a medium-term share target of about 10% for that market. I'm wondering if you could care to comment on what kind of market share level would the operation be profitable for you. Can you lay that out for us?

Mark C. Pigott

We tend not to break that out. But as you know in PACCAR, we like every group to be profitable.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Okay. And you saw very good deliveries out of your legacy South American business this quarter as you pointed out. Can you just talk about the order trends and visibility? How far out is your visibility in that part of the business? And is that what's offsetting what we might expect to be bigger production cuts in the U.S.?

Mark C. Pigott

Well, Mexico, in particular, continues to be strong. We have approximately 50% market share. We've been there since the late '50s, so we have a strong legacy and strong position within the Mexican market. And many of the trucks we're selling in South America are manufactured in Mexico. Colombia has been a particularly strong country, particularly for oil transport. But Chile, Peru are other countries that are doing reasonably well. And it's not huge numbers, but they're steady, they're growing. We did open up a distribution, parts distribution center, in Santiago, over a year ago, I guess. And that's providing some very good aftermarket service. We're appointing some new dealers in the region. They're enthusiastic in making investments in their own businesses. So it's all coming together in a very orderly, straightforward manner. We're encouraged by it.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Excellent. And on the U.S. side, to get to the production reduction you're talking about for the third quarter, can you just give us a sense, is that for additional holiday shutdowns or the mechanism by which you're cutting production?

Mark C. Pigott

Well, we don't usually break that out. But we do all of the above as appropriate.

Operator

Your next question comes from the line of Henry Kirn of UBS.

Henry Kirn - UBS Investment Bank, Research Division

Some of the recent checks we've done have indicated that credit may actually be easing for truckers in North America. Could you talk about credit availability in general and then, maybe more specifically, your appetite to grow PACCAR Financial?

Mark C. Pigott

Credit has been very good, very normal for -- certainly, for us and for our customers. We've seen some new entrants into the industry. Obviously, a number exited during the recession. Some have kind of come back in, dipped their toe in the marketplace. But for our customers who are usually very well financed and capitalized, we're seeing very normal, steady business. In terms of PACCAR Financial, of course, it's very much linked with our production side, and it's one of our aftermarket services that we are able to offer to our customers and our dealers. So I think the growth sort of is in line with our overall production.

Henry Kirn - UBS Investment Bank, Research Division

That's helpful. And with the choppy environment, is there any changes -- are there any changes to the way that truckers are spec-ing trucks, maybe if they're higher end or lower end then, more specifically, 13- versus 15-liter?

Mark C. Pigott

Well, that's a great question, and probably choppy is an appropriate term on certain aspects of the business. I think the 13-liter versus 15-liter is a multiple chapter book that we are beginning to delve into. You do see on some measurements that 13-liter is outselling the 15-liter. That tends to have a little bit of to and fro depending on what fuel prices actually are and what our customers perceive them to be in the future. But nevertheless, I think the 13-liter and the 15-liter both have strong positions to play, at least in the short term. As you know in the markets outside of the U.S. and Canada, 13-liter tends to be the largest engine size that you would see in Europe or South America, Asia. And I would think over time, that will probably be the way that the North American market will trend.

Operator

Your next question comes from the line of Joel Tiss [ph] of Bank of Montréal.

Unknown Analyst

Can you give us any insight into the age of the fleet in Europe? And I'm just trying to get any sense if we're getting to the point where we could see some pent-up demand and need for a replacement cycle as we move past 2013.

Mark C. Pigott

No, the fleet in Europe is probably 1 to 2 years younger than North America, sort of 5, 5 to 6 years. And some of the fleets don't travel quite as many miles as their counterparts would in North America. So I don't think there's that pressure for customers to necessarily say, I need to replace large segments of their fleets at this time. I think just normal replacement to take advantage of ongoing technology improvements. As you may know, DAF introduced recently their ATe, advanced technology, let's call it, fuel efficiency improvements. So that's causing a number of our good customers to say, "Wow, that could really be a benefit for me if I turn in some of my trucks." But overall, I think we were just in Europe a few weeks ago. And we traveled from Ireland, the U.K., Holland, Belgium through Germany all the way to Hungary. And I'd say, for the most part, customers were reasonable in terms of their outlook. They were feeling that business was pretty good. It wasn't just booming, but it was pretty good. And the dealers, many of our dealers, were -- say, "Inventory is in great shape." They're seeing some good aftermarket business. Used trucks are holding their value. So it's just -- if you read the paper or read the Internet, it causes you to think, “What's going on?” But when we really talk at the ground-level to the people hauling freight, there's business out there, people are buying. Not every industry or, certainly, not in every market, but it's reasonable.

Unknown Analyst

And then just trying to get at the margins a little bit. Can you talk about some end markets -- is energy still strong? Is that helping your mix? What's happening with your share in Class 6 and 7, just some of the factors that might also feed [ph] into the mix.

Mark C. Pigott

Well, the oil and gas, I think it's still good. It might've slowed down a little bit, but it's going at a pretty strong rate. Medium-duty is doing okay, particularly in Europe, over 10% share. And in fact, I think a few months, it actually bumped 11%. So that's probably pretty close to a record or might be a record for us. And we keep working it.

Operator

Your next question comes from the line of Jamie Cook of Crédit Suisse.

Jamie L. Cook - Crédit Suisse AG, Research Division

A couple of questions. One, can you talk about -- one of the suppliers in the market came out with a 2013 forecast, I think, calling for build rates of 260 to 280, relative to their forecast of 280 this year. So it's the first sort of truck supplier that I’ve heard talking to a potentially down year. So can you talk about sort of your comments on that or what you would need to see to get that, I guess, to get that bearish. My second question, can you talk about your strategy to gain market share given the dislocation in the market with Navistar and whether you or anyone else is -- how sensitive, I guess, the customers are to price and given the market dynamics? And then third, what are your assumptions for build rates for Q3 and Q4 relative to Q2 in the U.S., specifically?

Mark C. Pigott

Sure. Okay. Well, production in Q3, as we said, will be down about 10%.

Jamie L. Cook - Crédit Suisse AG, Research Division

In Q4?

Mark C. Pigott

In Q4, we didn't put a number out there yet.

Jamie L. Cook - Crédit Suisse AG, Research Division

Do you want to?

Mark C. Pigott

Not at this time. So that's one item. Two, in terms of market dislocation, as you so kindly indicated, we're not driving to get to a particular share. Over the last 30, 40 years, by building great trucks, our share has steadily increased. But there's always competitors who have a share target, and they'll use typically price to achieve whatever that number is, we don't do that. So share will bounce around, and it always has, for all the competitors in all the markets. But our strategy is, quite simply, we're going to build the best products in the market and give our customers the lowest operating cost. And share will, in a sense, take care of itself. And so that's really all I can make on that point. In terms of any supplier forecast for 2013, probably a little bit premature to talk about that.

Jamie L. Cook - Crédit Suisse AG, Research Division

But I mean, you must have -- Mark, you've been in this business for quite some period of time, and no more than us. So I guess I was surprised by 2 things: One, I was struck that you didn't lower U.S. forecasts more; and I think the market is viewing a potential down year next year or a flat year. Just what you would need to see to get to that level of the market. I mean, where would orders have to trend, I mean, or handicap the probability that you think we could have a flat to down year? I mean, I'm assuming...

Mark C. Pigott

Well, I think it's really going to depend, Jamie, on the general economy, and you can start with the elections in November, you can talk about tax policy, you can talk about general confidence of the consumers, we can talk about the overall housing industry, which, as we talked a little bit earlier in the call, has had some uptick. But you know what? I've seen it before. And then it can go another way. So there's a lot of macro elements that are going to influence what our excellent customers finally do. If several of those line up in, what I would call, a positive pro-business alignment, truck business will be pretty good. But, as you say, I have been doing this, and the whole PACCAR team has been doing this for a long, long time. Will it be as good as this year? Or will it be better? I would say that if we get a little bit more of a pro-business attitude and it impacts several key industries, it could be reasonable next year. If that doesn't happen, it could be comparable to this year, which -- this year, we're saying it's going to be slightly better than last year. It's not at replacement cycle. Certainly, eventually, you're going to have the impact of trucks that were built in '05, '06, '07 that will need to get replaced, and there are a lot of trucks built in that cycle. That was a very strong, call it, irrational exuberance in many industries. So those trucks will eventually have to come into the marketplace, and that'll be good for truck builders like us. So all in all, 2013, it's got a lot of variables that need to be finalized before we can see how it's going to shake out.

Jamie L. Cook - Crédit Suisse AG, Research Division

Can I ask one more question, if possible? I was surprised in the quarter that your bad debt expense came down to 1.9% in the quarter. Just given everything that's going on in the macro, I would think this would go the other way. So can you just talk about that, please?

Mark C. Pigott

Sure, absolutely. In kind of tying in with, I think, Joel's or Henry's question, our customers are in good shape, and our dealers are in good shape. And as they say, if you don't read the paper, you don't read Internet and you just get out and go to the towns and cities around North American and Europe, these people are saying, “Is it booming? No. But is it reasonable? Yes.” So the customers that we're financing have got good balance sheets. They're making money. They've got great customers that they're taking care of. They've sized their fleets according to the demand from their customers. So I think it's a good question you're asking, and people tend to sort of say well, "Is the world like Greece?" No, it's not. There are a lot of great companies out there that we're proud to partner with that are doing very, very well.

Operator

Your next question comes from the line of Steve Volkmann with Jefferies.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Given the pullback, I forgot exactly what words you used, Mark, but the consolidation that we're seeing in orders, can you just let us know if you're seeing anything with respect to price cutting in the market?

Mark C. Pigott

Well, I would say in the 35 years I've been in this business, there's always price cutting somewhere in the market. So that's not really a big indicator. It depends what competitive strategies our competitors are employing at the time. I think as you see a market go down, and we have a cycle every 3 to 5 years in a down market, margins are impacted because customers are going to take advantage of the economics of time.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Is that happening now? Or is that not the market we're in?

Mark C. Pigott

I think there is a -- there's certainly some of that going on.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Okay. And then I'm curious about your 680, 579 launch, which you mentioned at the outset here. Can you give us a sense of sort of what percent of orders that might be, if it's meaningful, and where you might think it would be, say, 12 months from now?

Mark C. Pigott

Well, it's right on schedule in terms of our very gradual introduction. These are really very wonderful products, and they're a great complement to our existing products. We've installed a lot of new machinery in our factories, which are undergoing their final evaluations, and that's all on track and on schedule and looking good. So it's early days now. Over the next 12 months, we will see a gradual ramp-up. We're getting good orders. People are saying, "I'd like to order these products when they're available." And one year from now, I’d be hard-pressed to tell you what exactly that number is going to be, but it will be making a contribution.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Could it be 20% of volume in a year?

Mark C. Pigott

It's possible, yes. Sure.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

I guess the reason I'm asking is because I'm thinking based on your conversation that you just had and some other things that we've talked about, that the margin on that product should be probably better than your corporate average.

Mark C. Pigott

Oh, I see. That's a good analysis, and it -- yes, there are some benefits to the product in terms of the margin. I think let's talk about it as the quarters go on. We'll give you a little bit more clarity.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

All right, appreciate that. And then the tax rate was a little higher than I expected in the quarter. Do we have a forecast for the year?

Michael T. Barkley

Yes, the forecast for the year will still be in the 32.5% to 33% range. The tax rate for the quarter reflects the mix of U.S. versus foreign income and the higher U.S. rates that we have.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Okay. And then just -- if you don't mind, can you give us just a broad sense of maybe production at the engine facility here in the U.S.? Maybe something in the line of sort of engines per day that we have now and where you think that might exit the year?

Mark C. Pigott

Yes, the engine production has increased at a steady pace throughout the year. We're, say, as indicated, 25% to 30% of our production. So those going into Kenworth and Peterbilt trucks, and that seems to be a good pace at this time, I think it will increase over time. But we continue to add machining capabilities and become more and more efficient as we increase the utilization of the factories. So I think it's making a great contribution, not only on the production side and the integration of our powertrain, but we're also seeing some benefits in the aftermarket side.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Okay. But just so I'm clear, would we be expecting higher production levels by year-end than we have right now?

Mark C. Pigott

I think reflecting the slower production rates that are in the truck side, probably the engine side will be pretty level.

Operator

Your next question comes from the line of Tim Denoyer of Wolfe Trahan.

Timothy J. Denoyer - Wolfe Trahan & Co.

A couple of questions on Europe. Can you talk about the order rate in the quarter, maybe just directionally, was it up or down from the first quarter? And specifically, if you could comment on pricing in Europe and how that might compare to other markets? And I believe it was Volvo this morning said that France had weakened a little bit in the second quarter, and I believe that's a pretty important market for DAF, and I was wondering if you could comment on what you're seeing there.

Mark C. Pigott

The order rate has been pretty constant through most of the year for us in Europe. France, like every country, is an important market and a little factoid for you is that DAF is either #1 or #2 in every country, with the exception of Germany, where we're #3 in terms of share. Obviously, each country has a different sized market. But the good thing, DAF is in all the markets, and it's also grown and is the market leader in Central Europe and is growing its business in the Middle East, Africa and Russia. So that's a nice addendum to our business in Western Europe.

Timothy J. Denoyer - Wolfe Trahan & Co.

And one other just sort of question about the potential for a prebuy ahead of the Euro 6 standards, are you seeing any demand for build slots in the fourth quarter of '13?

Mark C. Pigott

Not at this time. A number of our competitors introduced 1 or 2 models that were Euro 6 ready. They did that earlier this year. But if you're talking to a customer to talk about what are you going to buy 2 years out, is usually a little bit of a stretch.

Timothy J. Denoyer - Wolfe Trahan & Co.

Yes, sure. And then if I could just throw one more in back about the North America construction cycle and replacement there. I mean, we usually talk about 3 or 4 years as the early end of the truckload replacement cycle. Can you give us a sense of what that is for customers that are hauling -- using mixers and dump trucks and those kind of things, the real construction-intensive trucks?

Mark C. Pigott

Yes, those trucks, because they do significantly less miles, they can be 7, 8 years, easily.

Timothy J. Denoyer - Wolfe Trahan & Co.

Yes. So we still could have a few more years before that replacement cycle kicks in?

Mark C. Pigott

Actually, I think that's a very insightful point you're making.

Operator

Your next question comes from the line of Rob Wertheimer of Vertical Research Partners.

Robert Wertheimer - Vertical Research Partners Inc.

One quick question. So industry build rates in the first half have been a little bit interesting in North America, and obviously, you guys have taken some very appropriate cuts, and I'm not sure the industry has followed. So if you're willing to answer a general question, does that have necessarily a pricing impact? Or do those trucks somehow they already had orders attached, so it's not a pricing risk? And if that's too general, maybe if you could tell us what percentage...

Mark C. Pigott

Happy to jump in on that one. Excellent question, Rob. I think what you'll probably find, and in fact, I think it's been in a few of our competitors' quarterly filings, is that you'll probably be seeing some production adjustments from the industry as a whole. And sometimes, that's not spelled out completely clearly, but it may be shutdown days. It may be just reducing build rate while maintaining the same number of employees. It may be actually reducing build rate. So I think everybody is facing the same demand.

Robert Wertheimer - Vertical Research Partners Inc.

Now that's helpful. And I guess I was wondering if those trucks that were already sort of built and sitting around were a price risk for the industry and/or if you could say what portion of your mix in North America is sort of spec-ed out specific for a fleet and if over-built trucks really are a risk or most of them are spec-ed out?

Mark C. Pigott

Actually, I think the industry inventory is in very good shape. So I think we need to sort of put a stopper in the bottle on that one. The inventory is in good shape, particularly at our dealers. And our philosophy has always been to build to a customer specification. So if we've got an order, we're happy to build your truck, but we really don't build a spec truck. Some of the competitors may do that. I'm not sure how they're doing.

Robert Wertheimer - Vertical Research Partners Inc.

Okay, that's great. And then if I could ask one small follow-up, are you able to say when you would need to see orders in North America again pick up to hit the higher end of your estimated range for the year?

Mark C. Pigott

Any time would be good.

Operator

Your next question comes from the line of Adam Uhlman of Cleveland Research.

Adam William Uhlman - Cleveland Research Company

I guess the first question, maybe just a follow-up on the inventory question. PACCAR's own inventories stepped up from the first quarter, although the sales were down from the first quarter level. And I was wondering if you could help us understand better why that is.

Mark C. Pigott

I think inventory levels are pretty consistent. Are you talking about PACCAR?

Adam William Uhlman - Cleveland Research Company

Yes.

Mark C. Pigott

Yes, so I think that's just a reflection of timing of production schedules and build rates. So, it's all -- the inventory is in good shape and balanced with our production needs.

Adam William Uhlman - Cleveland Research Company

Okay. And then could you talk about -- I guess, you commented about the Europe orders, recently had been somewhat steady through the year. What do your North America orders look like relative to what we saw in the first quarter?

Mark C. Pigott

Well, as I indicated, we'll be looking at a 10% fewer trucks primarily in the U.S. and Canadian market in the third quarter versus the second quarter. And Europe is pretty steady.

Adam William Uhlman - Cleveland Research Company

Okay. Got it. And then on -- can you talk about what price realization was for this quarter? I think, last quarter, you had roughly a $157 million of price and maybe 4% to sales, and I'm wondering how that played out this quarter, if you have that figure handy.

Mark C. Pigott

Okay. Just a moment.

Michael T. Barkley

If you're talking about the contribution to margin from truck sales prices, that's $66 million in the second quarter.

Adam William Uhlman - Cleveland Research Company

Okay. And then was there any impact from currency to -- or could you talk about the magnitude of the impact to sales and income?

Michael T. Barkley

Yes, the overall impact on currencies was a reduction compared to the prior year of $139 million in revenue and $4 million in pretax profit.

Operator

Your next question comes from the line of Patrick Nolan of Deutsche Bank.

Patrick Nolan - Deutsche Bank AG, Research Division

Mark, thanks for your commentary on the North American pricing. That was very helpful. Can you just comment what you're seeing as far as industry trends and any competitive movements on the European side of the business as far as pricing?

Mark C. Pigott

In Europe primarily, Patrick?

Patrick Nolan - Deutsche Bank AG, Research Division

Yes. I mean I think you spoke at length to North America.

Mark C. Pigott

Okay. I think in Europe -- are you based in Europe?

Patrick Nolan - Deutsche Bank AG, Research Division

No, I'm based in New York.

Mark C. Pigott

Okay. Well, as you travel around in Europe, it's obviously, many different scenarios being played out in different countries. So you have to be mindful of that. I think several of our competitors who are perhaps more focused on Southern Europe are feeling the negative impact much more than certainly others are. And that probably will have an impact on their pricing. In terms of what we're seeing is pretty steady. Obviously, the market is slightly lower than last year, but reasonable. And we’ve gained some share as people like the products that we're building, and where the economies are a little bit stronger, we tend to be the leader in those markets. So that for DAF is a positive scenario. I think everybody in our industry would like to see an increased market size, and that's probably not in the cards in the near future, but eventually, it will be.

Patrick Nolan - Deutsche Bank AG, Research Division

Okay. That's helpful. And can I just sneak one more in? Just to clarify the Q3 production outlook. So overall, PACCAR production down 10% with Europe flattish. That implies U.S. and Canada is going to be down in the range of 15% to 20%, sequentially?

Mark C. Pigott

I think that's probably in the ballpark.

Operator

Your next question comes from the line of Basili Alukos of Morningstar.

Basili Alukos - Morningstar Inc., Research Division

I guess, one question. Going back to the engine penetration, I was wondering if you could bifurcate that 20% to 25%, or 25% to 30% of the internal production between your current run rate of -- or at least normalized business on the U.S. side, call that, your 25% traditional market share versus the about 4% or 5% of the market share that you’ve picked up over the last year.

Mark C. Pigott

Well, we kind of look at it that we've really picked up 25% to 30% over the last year or 2, since that's when we started our factory up.

Basili Alukos - Morningstar Inc., Research Division

Yes, sorry, maybe, like the 25% of your current business on the truck side, what percentage of the MX engines are on those versus the, call it, the 5 percentage points of market share you've gained on the North American Class 8 truck share? Just trying to get a sense of on those new customers…

Mark C. Pigott

Oh, I see. I think it's probably in line. Probably about 25%, which has added up to, let's say, 30%. Yes, if that's answering your question.

Basili Alukos - Morningstar Inc., Research Division

Great. Yes, I was just try to get a sense of, obviously, with what's happening with your...

Mark C. Pigott

I think broadly, the engine is doing well. We're having a lot of good response from our customers across different industries and different locales who are seeing improved fuel economy. It's very quiet. It's an easy engine to operate. And once again, it's been in the marketplace for, let's call it, 1.5 years, and we're starting to get some good endorsements, which is causing other great customers to say, "It's been out for 1.5 years. Let me try some of those." So it's positive.

Basili Alukos - Morningstar Inc., Research Division

So do you think maybe you're winning new business due to the engine or just due to the quality of the truck?

Mark C. Pigott

Both.

Basili Alukos - Morningstar Inc., Research Division

Great. And then just following up on your 10-Q have called out the formal investigation with SEC. I'm just wondering if you could provide us with any follow-up.

Mark C. Pigott

No, I think it's all on track.

Operator

Your next question comes from the line of Jeff Kauffman of Sterne Agee.

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

I'd like to follow-up on the ForEx question a little bit. Could you possibly -- would you be willing to give us an idea for how much of that ForEx impact was more of a European-base versus, say, rest of the world? Because the real is down almost 20% against the dollar. The peso is down. I just kind of want get a sense for how that's affecting things. And then, kind of secondly, when you're looking at these capital investments you're making in Brazil and around the world, I would guess it just got a little cheaper for you. So could you discuss kind of the benefits you might be seeing in terms of capital allocation?

Michael T. Barkley

Okay. So the ForEx impacts that we're talking about are primarily the movements of the euro versus the U.S. dollar, which is down about 7% compared to the prior year on average. And certainly, as the real declines, it does reduce the dollar impact of the capital that we were investing there at the moment. And so that's why we have a range because we don't know exactly what's going to happen to currencies going forward.

Mark C. Pigott

And I think picking up on that good comment that...

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

All right. And one last follow-up. Cost of goods sold. Raw material costs are starting to come down. Is -- can you talk about where you're seeing the impact of, let's say, raw material costs coming down? And are you able to keep a fair amount of that internally?

Mark C. Pigott

Well, you're correct. Raw material is coming down, I think with the exception of probably copper and natural rubber. And this is obviously reflective of what's going on in the global business markets. We have -- over 75% of our components are covered by long-term agreements. And those long-term agreements, I think, are really an excellent tool for both us and our suppliers. So there are some mechanisms that will reflect lower commodity prices. But they're not just instantaneous. So, it will go down, but can you tell me in 3 months, are they going to go back up? Well, there might be some slight improvement, but overall, the good news is our suppliers are in good shape. They are making investments. They see that some of the markets are a little slower. But they're getting ready for when they do improve, and they're able to improve their quality and their capacity, and that's healthy for the whole industry. So overall, it's pretty steady.

Operator

Our next question comes from the line of David Leiker of Baird.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Two questions for you. On the 13-liter that you're building here in the U.S. right now, how much of that supply chain and material production do you have now domiciled here in the U.S. versus bringing it over from Europe?

Mark C. Pigott

Well, I would say that it's -- I don't have the exact percent, but it's increasing in terms of the local content. And it will continue to increase. Obviously, we started out 1.5 year ago, importing key components from our DAF factory, but as we ramped up in production and brought on suppliers, we're shifting that on a pretty steady basis over to North American suppliers.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then as the euro goes lower, at what point does it make sense to continue to bring that from Europe?

Mark C. Pigott

Well, we plan to eventually have the majority of the components in North America because we're not really doing this for an exchange rate hedge. We like to source in local currency. Yes, you can get an advantage, but you can also get a disadvantage. And our focus is on the highest-quality products at the lowest overall manufacturing cost because the exchange rate is good, but then you also have the longer time and the freight cost. So we're going to move it higher and higher to be in North America.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

We might have -- this might have come up earlier, and I had to jump off for a little bit, but 6 months ago or so, there was a lot of discussion around the industry of the cumulative increased cost of emissions and the inability to recoup that in the marketplace. Where do you think you’re at or the industry is at right now in terms of being able to recoup those emission costs?

Mark C. Pigott

I'd say over the last 6 months, there's been some positive movement but, certainly, have not recouped the costs. And looking out to the future, it's going to take a very strong market to make a sizable dent on those costs.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. Do you think that the transition that Navistar is going helps alleviate some of that, and everyone’s able to recoup some more of those costs?

Mark C. Pigott

I'm not sure what they're doing.

Operator

Your next question comes from the line of David Raso of ISI Group.

David Raso - ISI Group Inc., Research Division

One quick question. The targeted U.S. Canada build schedule. I want to try to think about the build schedule beyond 3Q. Did you target a build schedule that's consistent with the recent order pattern that we've seen, or if the orders stay the same as we've seen, is that up or down for the fourth quarter versus third quarter? I’m just trying to get a feel for how much you cut the third quarter relative to the recent order patterns.

Mark C. Pigott

I think that question was pretty well answered earlier on, that 15% or so cuts in U.S. and Canada.

David Raso - ISI Group Inc., Research Division

Well, that's not my question. My question is that cut, are we then at a level that's consistent with the recent orders, thus say, if orders pick up, your build schedule goes up in the fourth quarter or if the orders stay the same? I'm just trying to get a feel, looking at the orders…

Mark C. Pigott

I think -- no. I mean, the way we operate, we try to have our production rate reflect incoming orders at a reasonable backlog, and that's what we're doing. And so if the orders come in at the rate they've been coming in for the last couple of months, then the production rate will be held pretty steady. If they increase, we will very gladly increase production.

David Raso - ISI Group Inc., Research Division

Okay. So the third quarter reflects the recent order activity. So any movement from that level should flow right into your build…

Mark C. Pigott

That's accurate.

Operator

Your next question comes from the line of Mark Rogers of Gagnon Securities.

Mark Rogers

I want to make sure I understood what your, I guess, strategy is for internally sourcing engines. And if you could frame that with respect to the LNG and CNG opportunity, I'd appreciate it.

Mark C. Pigott

Well, those are a little bit -- 2 different elements. But our strategy is to continue to grow our PACCAR branded engine in Kenworth and Peterbilt. If you go to Europe, I'm sure you have, you'll see that all engines in our DAF lineup: LF, CF, XF; are PACCAR branded. That is our strategy here. So we're making good strategy on that. In terms of LNG, CNG...

Mark Rogers

Okay. And then, is the plan going forward to continue sourcing your LNG engines from your partners, such as Cummins, or do you eventually plan on being able to do this in-house?

Mark C. Pigott

No, we work with Westport and Cummins, both excellent companies. And at this time, it's a very good partnership and seems to work well and provide our customers with a very high-quality, efficient solution in the natural gas markets.

Mark Rogers

Great. And then if I could, you are introducing that 12-liter Cummins-Westport branded engine. And I was wondering if you could just give a high level commentary on the anticipated demand for this engine platform.

Mark C. Pigott

Well we have the 9 and the 15, so I think the 12 will provide a nice middle point for customers. But I think as I indicated earlier, it's a market that's only 1% to 2% of the total truck market. So we'll see what happens.

Operator

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

Robin E. Easton

I'd like to thank everyone for their excellent questions, and thank you, operator.

Operator

Ladies and gentlemen, this concludes PACCAR's Earnings Call. Thank you for participating. You may now disconnect.

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