PACCAR INC (PCAR) FY 2023 MD&A

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW:

PACCAR is a global technology company whose Truck segment includes the design and manufacture of high-quality light-, medium- and heavy-duty commercial trucks. In North America, trucks are sold under the Kenworth and Peterbilt nameplates, in Europe, under the DAF nameplate and in Australia and South America, under the Kenworth and DAF nameplates. The Parts segment includes the distribution of aftermarket parts for trucks and related commercial vehicles. The Company’s Financial Services segment derives its earnings primarily from financing or leasing PACCAR products in North America, Europe, Australia and South America. The Company’s Other business includes the manufacturing and marketing of industrial winches.

2023 Financial Highlights

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Worldwide net sales and revenues were $35.13 billion in 2023 compared to $28.82 billion in 2022, primarily due to higher truck and parts revenues.

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Truck sales were $26.85 billion in 2023 compared to $21.49 billion in 2022, primarily due to higher truck deliveries and price realization in all markets.

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Parts sales were $6.41 billion in 2023 compared to $5.76 billion in 2022 reflecting higher price realization in all markets.

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Financial Services revenues were $1.81 billion in 2023 compared to $1.51 billion in 2022, primarily due to portfolio growth and higher portfolio yields.

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In 2023, PACCAR earned net income for the 85th consecutive year. Net income was $4.60 billion ($8.76 per diluted share) in 2023 compared to $3.01 billion ($5.75 per diluted share) in 2022 reflecting higher Truck and Parts operating results.

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Adjusted net income (non-GAAP), excluding a $446.4 million after-tax non-recurring charge related to civil litigation in Europe was $5.05 billion ($9.61 per diluted share). After-tax return on beginning equity (ROE) was 34.9% in 2023, which includes the $446.4 million after-tax non-recurring charge related to civil litigation in Europe in the first quarter of this year. Excluding the one-time charge, adjusted ROE (non-GAAP) was 38.3%. This compares to an ROE of 26.0% in 2022. See Reconciliation of GAAP to Non-GAAP Financial Measures on page 30.

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Capital investments were $698.3 million in 2023 compared to $505.0 million in 2022.

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Research and development (R&D) expenses were $410.9 million in 2023 compared to $341.2 million in 2022.

PACCAR has begun construction of a new 240,000 square-foot PACCAR Parts Distribution Center (PDC) to be opened in Massbach, Germany, in 2024. This PDC will improve parts delivery to dealers and customers in the region.

PACCAR, Cummins, Daimler Trucks and EVE Energy are partnering to create state-of-the-art commercial vehicle battery cell production. The joint venture partners expect growing demand for zero emissions vehicles throughout the decade. The planned factory in Marshall County, Mississippi, will provide cost effective scale and industry leading battery cell technology, which will benefit our commercial vehicle customers. The total investment is expected to be in the range of $2-3 billion, with PACCAR, Cummins and Daimler Truck each owning 30% of the joint venture and EVE Energy having 10% ownership and contributing its industry leading battery cell design and manufacturing expertise. Subject to regulatory approval, the 21-gigawatt hour (GWh) factory is expected to begin producing battery cells in 2027.

The PACCAR Financial Services (PFS) group of companies has operations covering four continents and 26 countries. The global breadth of PFS and its rigorous credit application process support a portfolio of loans and leases with total assets of $20.96 billion. PFS issued $2.91 billion in medium-term notes during 2023 to support new business volume and repay maturing debt.

Truck Outlook

Heavy-duty truck industry retail sales in the U.S. and Canada in 2024 are expected to be 260,000 to 300,000 units compared to 297,000 in 2023. In Europe, the 2024 truck industry registrations for over 16-tonne vehicles are expected to be 260,000 to 300,000 units compared to 343,300 in 2023. In South America, heavy-duty truck industry registrations in 2024 are projected to be 105,000 to 115,000 compared to 105,000 in 2023.

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Parts Outlook

In 2024, PACCAR Parts sales are expected to increase 4-8% compared to 2023 levels reflecting strong freight demand. If economic conditions were to worsen, lower freight volumes could reduce the demand for replacement parts, resulting in lower parts revenues and operating results.

Financial Services Outlook

In 2024, average earning assets are expected to increase 3-5% compared to 2023. If current freight transportation conditions decline due to weaker economic conditions, then past due accounts, truck repossessions and credit losses would likely increase from the current low levels and new business volume would likely decline.

Capital Spending and R&D Outlook

Capital investments in 2024 are expected to be $700 to $750 million, and R&D is expected to be $460 to $500 million. The Company is increasing its investment in fuel efficient diesel and electric powertrain technologies, connected vehicle services, and next-generation manufacturing and parts distribution capabilities.

See the Forward-Looking Statements section of Management’s Discussion and Analysis for factors that may affect these outlooks.

RESULTS OF OPERATIONS:

The Company’s results of operations for the years ended December 31, 2023 and 2022 are presented below. For information on the year ended December 31, 2021, refer to Part II, Item 7 in the 2022 Annual Report on Form 10-K.

* In 2023, Other includes a $600.0 million non-recurring charge related to civil litigation in Europe (EC-related claims) in the first quarter 2023.

The following provides an analysis of the results of operations for the Company’s three reportable segments - Truck, Parts and Financial Services. Where possible, the Company has quantified the impact of factors identified in the following discussion and analysis. In cases where it is not possible to quantify the impact of factors, the Company lists them in estimated order of importance. Factors for which the Company is unable to specifically quantify the impact include market demand, fuel prices, freight tonnage and economic conditions affecting the Company’s results of operations.

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2023 Compared to 2022:

Truck

The Company’s Truck segment accounted for 77% of revenues in 2023 compared to 75% in 2022.

The Company’s new truck deliveries are summarized below:

The increase in new truck deliveries worldwide in 2023 compared to 2022 was driven by higher build rates and increased demand in all major markets.

Market share data discussed below is provided by third-party sources and is measured by either retail sales or registrations for the Company’s dealer network as a percentage of total retail sales or registrations depending on the geographic market. In the U.S. and Canada, market share is based on retail sales. In Europe, market share is based on registrations.

In 2023, industry retail sales in the heavy-duty market in the U.S. and Canada increased to 297,000 units from 283,500 units in 2022. The Company’s heavy-duty truck retail market share was 29.5% in 2023 compared to 29.8% in 2022. The medium-duty market was 105,300 units in 2023 compared to 88,300 units in 2022. The Company’s medium-duty market share was 14.5% in 2023 compared to 10.9% in 2022.

The over 16‑tonne truck market in Europe in 2023 increased to 343,300 units from 297,500 units in 2022, and DAF’s market share was 15.6% in 2023 compared to 17.3% in 2022. The 6 to 16‑tonne market was 46,800 units in 2023 and 38,800 units in 2022. DAF’s market share in the 6 to 16-tonne market in 2023 was 9.1% compared to 9.7% in 2022.

The over 16‑tonne truck market in Brasil in 2023 decreased to 82,100 units from 97,900 units in 2022, and DAF Brasil achieved a record 10.2% market share in 2023 compared to 6.9% in 2022.

The Company’s worldwide truck net sales and revenues are summarized below:

The Company’s worldwide truck net sales and revenues increased to $26.85 billion in 2023 from $21.49 billion in 2022 primarily due to higher truck unit deliveries, improved price realization in all markets and favorable currency translation effects, primarily the euro. Truck segment income before income taxes and pretax return on revenues reflect the impact of higher truck unit deliveries and improved margins.

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The major factors for the Truck segment changes in net sales and revenues, cost of sales and revenues and gross margin between 2023 and 2022 are as follows:

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Truck sales volume reflects higher truck deliveries in all major markets.

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Average truck sales prices increased sales by $2.79 billion, primarily due to higher price realization worldwide reflecting the positive effect of new truck models as well as inflationary cost increases.

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Average cost per truck increased cost of sales by $916.7 million, primarily reflecting higher raw material, labor and product support costs, mainly warranty expense.

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Factory overhead and other indirect costs increased $204.3 million, primarily due to higher labor costs, maintenance, depreciation and utilities.

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Extended warranties, operating leases and other increased revenues by $40.5 million and increased cost of sales by $134.2 million. The increase in cost of sales was primarily due to higher costs from extended warranty and service contracts.

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The currency translation effect on sales and cost of sales reflects an increase in the value of the euro and Brazilian real relative to the U.S. dollar, partially offset by the decrease in the value of the Canadian dollar and Australian dollar relative to the U.S. dollar.

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Truck gross margin was 16.4% in 2023 compared to 10.6% in 2022 due to the factors noted above.

Truck selling, general and administrative expenses (SG&A) in 2023 decreased to $278.5 million from $280.0 million in 2022. The decrease was primarily due to lower professional expenses, and lower sales and marketing expenses, offset by higher salaries and travel related costs. As a percentage of sales, Truck SG&A was 1.0% in 2023 and 1.3% in 2022.

Parts

The Company’s Parts segment accounted for 18% of revenues in 2023 compared to 20% in 2022.

The Company’s worldwide parts net sales and revenues increased to $6.41 billion in 2023 from $5.76 billion in 2022 primarily due to higher price realization in all markets. The increase in Parts segment income before income taxes and pre-tax return on revenues was primarily due to higher price realization in all markets.

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The major factors for the Parts segment changes in net sales and revenues, cost of sales and revenues and gross margin between 2023 and 2022 are as follows:

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Aftermarket parts sales volume increased by $22.5 million and related cost of sales increased by $9.2 million primarily reflecting higher sales volume in Brasil, Australia and Europe, partially offset by lower sales volume in the U.S.

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Average aftermarket parts sales prices increased sales by $614.2 million primarily due to higher price realization in North America and Europe.

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Average aftermarket parts direct costs increased $297.6 million due to higher material costs, primarily in the U.S. and Europe.

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Warehouse and other indirect costs increased $44.8 million primarily due to higher salaries and related expenses and costs of supplies.

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The currency translation effect on sales and cost of sales primarily reflects an increase in the value of the euro relative to the U.S. dollar, partially offset by a decrease in the value of the Australian dollar and the Canadian dollar relative to the U.S. dollar.

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Parts gross margin was 31.9% in 2023 compared to 30.4% in 2022 due to the factors noted above.

Parts SG&A expense in 2023 increased to $238.0 million from $216.3 million in 2022. The increase was primarily due to higher salaries and related expenses, partially offset by lower sales and marketing costs. As a percentage of sales, Parts SG&A was 3.7% in 2023 and 3.8% in 2022.

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Financial Services

The Company’s Financial Services segment accounted for 5% of revenues in 2023 and 2022.

New loan and lease volume increased to $7.21 billion in 2023 from $6.22 billion in 2022. The increase in new loan and finance lease volume reflected higher retail sales of PACCAR trucks and a higher amount financed per truck in all major markets. The decrease in equipment on operating leases new business volume reflected lower market demand, partially offset by a higher amount financed per truck in all major markets. The effect of currency translation increased new loan and lease volume by $98.7 million, primarily due to the stronger Mexican peso and euro relative to the U.S. dollar. PFS finance market share of new PACCAR truck sales was 24.0% in 2023 compared to 25.6% in 2022.

PFS revenues increased to $1.81 billion in 2023 from $1.51 billion in 2022. The increase was primarily due to higher interest and fee income driven by portfolio growth and higher portfolio yields. The effects of currency translation increased PFS revenues by $40.8 million in 2023, primarily due to a stronger Mexican peso and euro relative to the U.S. dollar.

PFS income before income taxes decreased to $540.3 million in 2023 from $588.9 million in 2022, primarily due to lower operating lease margins, reflecting lower results on returned lease assets, partially offset by higher finance margins. The effect of currency translation increased PFS income before income taxes by $15.0 million in 2023, primarily due to a stronger Mexican peso and euro relative to the U.S. dollar.

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Included in Financial Services “Other Assets” on the Company’s Consolidated Balance Sheets are used trucks held for sale, net of impairments, of $309.8 million at December 31, 2023 and $141.7 million at December 31, 2022. These trucks are primarily units returned from matured operating leases in the ordinary course of business, and also include trucks acquired from repossessions, through acquisitions of used trucks in trades related to new truck sales and trucks returned from residual value guarantees (RVGs).

The Company recognized gains on used trucks, excluding repossessions, of $43.5 million in 2023 compared to $140.1 million in 2022, including losses on multiple unit transactions of $12.3 million in 2023 compared to $.8 million in 2022. Used truck losses related to repossessions, which are recognized as credit losses, in 2023 were $4.6 million and were insignificant in 2022.

The major factors for the changes in interest and fees, interest and other borrowing expenses and finance margin between 2023 and 2022 are outlined below:

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Average finance receivables increased $2.77 billion (excluding foreign exchange effects) in 2023 primarily due to higher average loan, finance lease and dealer wholesale balances.

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Average debt balances increased $1.91 billion (excluding foreign exchange effects) in 2023, reflecting higher funding requirements for the portfolio, which includes loans, finance leases, dealer wholesale and equipment on operating lease.

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Higher portfolio yields (6.7% in 2023 compared to 5.1% in 2022) increased interest and fees by $177.7 million. The higher portfolio yields were primarily due to higher market rates in all markets.

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Higher borrowing rates (3.9% in 2023 compared to 2.0% in 2022) were primarily due to higher debt market rates in all markets.

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The currency translation effects reflect a increase in the value of foreign currencies relative to the U.S. dollar, primarily the Mexican peso, Brazilian real and euro.

The following table summarizes operating lease, rental and other revenues and depreciation and other expenses:

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The major factors for the changes in operating lease, rental and other revenues, depreciation and other expenses and lease margin between 2023 and 2022 are outlined below:

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Lower sales volume and lower market prices of used truck on trade, primarily in Europe, decreased revenues by $27.8 million and related depreciation and other expenses by $25.6 million.

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Results on returned lease assets increased depreciation and other expenses by $107.6 million primarily due to lower gains on sales of returned lease units as a result of lower used truck market values.

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Average operating lease assets decreased $280.7 million (excluding foreign exchange effects), which decreased revenues by $129.4 million and related depreciation and other expenses by $110.3 million.

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Revenue per asset increased $53.1 million primarily due to higher lease rates reflecting higher average truck value financed and higher market rates. Cost per asset increased $42.1 million due to higher depreciation and operating expenses.

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The currency translation effects reflect an increase in the value of foreign currencies relative to the U.S. dollar, primarily the Mexican peso and euro.

Financial Services SG&A expense increased to $149.0 million in 2023 from $133.9 million in 2022. The increase was primarily due to higher salaries and related expenses, higher travel costs and unfavorable currency translation effects, primarily the Mexican peso and euro. As a percentage of average earning assets, Financial Services SG&A was .8% in 2023 and .9% in 2022.

The following table summarizes the provision for losses on receivables and net charge-offs:

The provision for losses on receivables increased to $31.3 million in 2023 from $5.5 million in 2022, primarily driven by higher charge-offs, portfolio growth and higher past due balances in 2023.

The Company modifies loans and finance leases as a normal part of its Financial Services operations. The Company may modify loans and finance leases for commercial reasons or for credit reasons. Modifications for commercial reasons are changes to contract terms for customers that are not considered to be in financial difficulty. Insignificant delays are modifications extending terms up to three months for customers experiencing some short-term financial stress, but not considered to be in financial difficulty. Modifications for credit reasons are changes to contract terms for customers considered to be in financial difficulty. The Company’s modifications typically result in granting more time to pay the contractual amounts owed and charging a fee and interest for the term of the modification. When considering whether to modify customer accounts for credit reasons, the Company evaluates the creditworthiness of the customers and modifies those accounts that the Company considers likely to perform under the modified terms.

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The post-modification balances of accounts modified during the years ended December 31, 2023 and 2022 are summarized below:

* Amortized cost basis immediately after modification as a percentage of the year-end retail portfolio balance.

Modification activity increased to $487.8 in 2023 from $364.5 in 2022. The decrease in modifications for commercial reasons primarily reflects lower volumes of refinancing. The increase related to Insignificant Delay reflects an increase in customers requesting payment relief for up to three months, primarily in the U.S. The decrease in Credit modifications reflects lower volumes of contract modifications and requests for payment relief, primarily in Brasil, partially offset by higher volumes of credit modifications in Europe.

The following table summarizes the Company’s 30+ days past due accounts:

Accounts 30+ days past due increased to 1.0% at December 31, 2023 from .4% at December 31, 2022. The Company continues to focus on maintaining low past due balances.

When the Company modifies a 30+ days past due account, the customer is then generally considered current under the revised contractual terms. The Company modified $35.0 million, primarily in Europe, and $8.9 million of accounts worldwide during the fourth quarter of 2023 and the fourth quarter of 2022, respectively, which were 30+ days past due and became current at the time of modification. Had these accounts not been modified and continued to not make payments, the pro forma percentage of retail loan and lease accounts 30+ days past due would have been as follows:

Modifications of accounts in prior quarters that were more than 30 days past due at the time of modification are included in past dues if they were not performing under the modified terms at December 31, 2023 and 2022. The effect on the allowance for credit losses from such modifications was not significant at December 31, 2023 and 2022.

The Company’s annualized pre-tax return on average total assets for Financial Services was 2.9% in 2023 compared to 3.7% in 2022, respectively.

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Other

Other includes the winch business as well as sales, income and expenses not attributable to a reportable segment. Other also includes non-service cost components of pension expense and a portion of corporate expense. Other sales represent less than 1% of consolidated net sales and revenues for 2023 and 2022. Other SG&A decreased to $87.8 million in 2023 from $96.1 million in 2022 primarily due to lower corporate expenses.

Other loss before tax was $616.8 million in 2023 compared to $1.1 million in 2022. The increase was primarily due to the EC-related charge in the first quarter 2023 which is discussed in Note L of the consolidated financial statements.

Investment income increased to $292.2 million in 2023 from $61.0 million in 2022, primarily due to higher market interest rates in all regions, as well as higher investment balances.

Income Taxes

In 2023, the effective tax rate was 19.5% compared to 21.8% in 2022. The lower effective tax rate in 2023 was primarily due to a $119.7 million discrete tax benefit for the release of a valuation allowance on deferred tax assets in Brasil, and the change in mix of income generated in jurisdictions with lower tax rates in 2023 as compared to 2022.

In 2023, both domestic and foreign income before income taxes and domestic pre-tax return on revenues increased primarily due to the improved results from Truck and Parts operations. In 2023, foreign income before income taxes and pre-tax return on revenues includes a one-time expense for the EC-related charge of $600.0 million in the first quarter 2023.

LIQUIDITY AND CAPITAL RESOURCES:

The Company’s total cash and marketable securities at December 31, 2023, increased $2.70 billion from the balances at December 31, 2022. Total cash and marketable securities are primarily intended to provide liquidity while preserving capital.

The change in cash and cash equivalents is summarized below:

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Operating activities: Cash provided by operations increased by $1.16 billion to $4.19 billion in 2023 from $3.03 billion in 2022. Higher operating cash flows reflect higher net income of $1,589.2 million and higher accruals of $750.7 million, including EC-related charge and product support liabilities. The higher operating cash flows were partially offset by lower accruals in 2023 compared to 2022 of $464.5 million for accounts payable and current accrued expenses. Additionally, there were higher cash outflows for income taxes of $567.2 million and higher cash used of $331.0 million for wholesale receivables.

Investing activities: Cash used in investing activities increased by $838.0 million to $2.87 billion in 2023 from $2.03 billion in 2022. Higher net cash used in investing activities primarily reflects higher net originations for retail loans and financing leases of $877.1 million and higher cash used in the acquisition of property, plant and equipment of $170.0 million. The higher net cash usage was partially offset by lower acquisitions of equipment for operating leases of $298.0 million.

Financing activities: Cash provided by financing activities was $1.10 billion in 2023 compared to $304.9 million in 2022. The Company paid $1.52 billion in dividends in 2023 compared to $1.00 billion in 2022, primarily due to a higher year-end dividend paid in January 2023. Cash provided from net borrowing activities was $2.57 billion, $1.30 billion higher than the cash provided by net borrowing activities of $1.28 billion in 2022 reflecting higher funding to support financial services portfolio growth.

The Company expects to continue paying dividends, although there is no assurance as to future dividends because they are dependent upon future earnings, capital requirements and financial conditions. Cash dividends declared for the last two years were as follows:

* The sum of quarterly per share amounts do not equal per share amounts reported for the full year due to rounding.

Credit Lines and Other:

The Company has line of credit arrangements of $4.20 billion, of which $3.66 billion were unused at December 31, 2023. Included in these arrangements are $3.00 billion of committed bank facilities, of which $1.00 billion expires in June 2024, $1.00 billion expires in June 2026 and $1.00 billion expires in June 2028. The Company intends to extend or replace these credit facilities on or before expiration to maintain facilities of similar amounts and duration. These credit facilities are maintained primarily to provide backup liquidity for commercial paper borrowings and maturing medium-term notes. There were no borrowings under the committed bank facilities for the year ended December 31, 2023.

On December 4, 2018, PACCAR’s Board of Directors approved the repurchase of up to $500.0 million of the Company’s outstanding common stock without an expiration. The objective of the repurchase plan is to return value to PACCAR shareholders. As of December 31, 2023, the Company has repurchased $110.0 million of shares under this plan. There were no repurchases made under this plan during the year ended December 31, 2023.

Truck, Parts and Other

The Company provides funding for working capital, capital expenditures, R&D, dividends, stock repurchases and other business initiatives and commitments primarily from cash provided by operations. Management expects this method of funding to continue in the future.

Investments for manufacturing property, plant and equipment in 2023 were $679.4 million compared to $491.2 million in 2022. Over the past decade, the Company’s combined investments in worldwide capital projects and R&D totaled $7.68 billion and have significantly increased the operating capacity and efficiency of its facilities and enhanced the quality and operating efficiency of the Company’s premium products.

Capital investments in 2024 are expected to be $700 to $750 million, and R&D is expected to be $460 to $500 million. The Company is increasing its investment in fuel efficient diesel and electric powertrain technologies, connected vehicle services, and next-generation manufacturing and parts distribution capabilities.

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PACCAR, Cummins, Daimler Trucks and EVE Energy are partnering to produce state of the art commercial vehicle batteries in a factory in Marshall County, Mississippi. The total investment is expected to be in the range of $2-3 billion, of which PACCAR’s share is 30%. The 21-gigawatt hour (GWh) factory is expected to begin producing batteries in 2027, subject to regulatory approval.

Financial Services

The Company funds its financial services activities primarily from collections on existing finance receivables and borrowings in the capital markets. The primary sources of borrowings in the capital markets are commercial paper and medium-term notes issued in the public markets and, to a lesser extent, bank loans.

In November 2021, the Company’s U.S. finance subsidiary, PACCAR Financial Corp. (PFC), filed a shelf registration under the Securities Act of 1933. The total amount of medium-term notes outstanding for PFC as of December 31, 2023 was $6.10 billion. In January 2024, PFC issued $600.0 million of medium-term notes under this registration. The registration expires in November 2024 and does not limit the principal amount of debt securities that may be issued during that period.

As of December 31, 2023, the Company’s European finance subsidiary, PACCAR Financial Europe, had €911.7 million available for issuance under a €2.50 billion medium-term note program listed on the Euro MTF Market of the Luxembourg Stock Exchange. This program renews annually and expires in September 2024.

In August 2021, PACCAR Financial Mexico registered a 10.00 billion Mexican peso program with the Comision Nacional Bancaria y de Valores to issue medium-term notes and commercial paper. The registration expires in August 2026 and limits the amount of commercial paper (up to one year) to 5.00 billion Mexican pesos. At December 31, 2023, 6.32 billion Mexican pesos were available for issuance.

In August 2018, the Company’s Australian subsidiary, PACCAR Financial Pty. Ltd. (PFPL Australia), registered a medium-term note program. The program does not limit the principal amount of debt securities that may be issued under the program. The total amount of medium-term notes outstanding for PFPL Australia as of December 31, 2023 was 850.0 million Australian dollars.

In May 2021, the Company’s Canadian subsidiary, PACCAR Financial Ltd. (PFL Canada), established a medium-term note program. The program does not limit the principal amount of debt securities that may be issued under the program. The total amount of medium-term notes outstanding for PFL Canada as of December 31, 2023 was 150.0 million Canadian dollars.

The Company’s Brazilian subsidiary, Banco PACCAR S.A., established a lending program in December 2021 with the local development bank, Banco Nacional de Desenvolvimento Economico e Social (BNDES) for qualified customers to receive preferential conditions and generally market interest rates. This program is limited to 1.15 billion Brazilian reais and has 775.5 million Brazilian reais outstanding as of December 31, 2023.

The Company believes its cash balances and investments, collections on existing finance receivables, committed bank facilities, and current investment-grade credit ratings of A+/A1 will continue to provide it with sufficient resources and access to capital markets at competitive interest rates and therefore contribute to the Company maintaining its liquidity and financial stability. In the event of a decrease in the Company’s credit ratings or a disruption in the financial markets, the Company may not be able to refinance its maturing debt in the financial markets. In such circumstances, the Company would be exposed to liquidity risk to the degree that the timing of debt maturities differs from the timing of receivable collections from customers. The Company believes its various sources of liquidity, including committed bank facilities, would continue to provide it with sufficient funding resources to service its maturing debt obligations.

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Commitments

The following summarizes the Company’s contractual cash commitments at December 31, 2023:

* Commercial paper included in borrowings is at par value.

** Interest on floating-rate debt is based on the applicable market rates at December 31, 2023.

Total cash commitments for borrowings and interest on term debt were $14.94 billion and were related to the Financial Services segment. As described in Note J of the consolidated financial statements, borrowings consist primarily of term notes and commercial paper issued by the Financial Services segment. The Company expects to fund its maturing Financial Services debt obligations principally from funds provided by collections from customers on loans and lease contracts, as well as from the proceeds of commercial paper and medium-term note borrowings. Purchase obligations are the Company’s contractual commitments to acquire future production inventory and capital equipment. Other obligations primarily include commitments to commodities.

The Company’s other commitments include the following at December 31, 2023:

Loan and lease commitments are for funding new retail loan and lease contracts. Residual value guarantees represent the Company’s commitment to acquire trucks at a guaranteed value if the customer decides to return the truck at a specified date in the future.

IMPACT OF ENVIRONMENTAL MATTERS:

The Company, its competitors and industry in general are subject to various domestic and foreign requirements relating to the environment and greenhouse gases. The statutory and regulatory requirements governing greenhouse gas and non-greenhouse gas emissions are included in Item 1A, “Risk Factors – Emissions Requirements and Reduction Targets.” The Company believes its policies, practices and procedures are designed to prevent unreasonable risk of environmental damage and that its handling, use and disposal of hazardous or toxic substances have been in accordance with environmental laws and regulations in effect at the time such use and disposal occurred.

The Company is involved in various stages of investigations and cleanup actions in different countries related to environmental matters. In certain of these matters, the Company has been designated as a “potentially responsible party” by domestic and foreign environmental agencies. The Company has accrued the estimated costs to investigate and complete cleanup actions where it is probable that the Company will incur such costs in the future. Expenditures related to environmental activities in the years ended December 31, 2023 and 2022 were $3.0 million and $4.6 million, respectively. While the timing and amount of the ultimate costs associated with future environmental cleanup cannot be determined, management expects that these matters will not have a significant effect on the Company’s consolidated cash flow, liquidity or financial condition.

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RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES:

This Form 10-K includes “adjusted net income (non-GAAP)” and “adjusted net income per diluted share (non-GAAP)”, which are financial measures that are not in accordance with U.S. generally accepted accounting principles (“GAAP”), since they exclude a charge for EC-related claims. These measures differ from the most directly comparable measures calculated in accordance with GAAP and may not be comparable to similarly titled non-GAAP financial measures used by other companies. In addition, the Form 10-K includes the financial ratios noted below calculated on non-GAAP measures.

Adjustment for the EC-related claims relates to a pre-tax charge of $600.0 million ($446.4 million after-tax) for estimable total costs recorded in Interest and other expenses (income), net in the year ended December 31, 2023 (recorded in the first quarter 2023).

Management utilizes these non-GAAP measures to evaluate the Company’s performance and believes these measures allow investors and management to evaluate operating trends by excluding a significant non-recurring charge that is not representative of underlying operating trends.

Reconciliations from the most directly comparable GAAP measures to adjusted net income (non-GAAP) and adjusted net income per diluted shares (non-GAAP) are as follows:

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CRITICAL ACCOUNTING POLICIES:

The Company’s significant accounting policies are disclosed in Note A of the consolidated financial statements. In the preparation of the Company’s financial statements, in accordance with U.S. generally accepted accounting principles, management uses estimates and makes judgments and assumptions that affect asset and liability values and the amounts reported as income and expense during the periods presented. The following are accounting policies which, in the opinion of management, are particularly sensitive and which, if actual results are different from estimates used by management, may have a material impact on the financial statements.

Operating Leases

Trucks sold pursuant to agreements accounted for as operating leases are disclosed in Note F of the consolidated financial statements. In determining its estimate of the residual value of such vehicles, the Company considers the length of the lease term, the truck model, the expected usage of the truck and anticipated market demand. Operating lease terms generally range from three to five years. The resulting residual values on operating leases generally range between 30% and 70% of the original equipment cost. If the sales price of a truck at the end of the term of the agreement differs from the Company’s estimated residual value, a gain or loss will result.

Future market conditions, changes in government regulations and other factors outside the Company’s control could impact the ultimate sales price of trucks returned under these contracts. Residual values are reviewed regularly and adjusted if market conditions warrant. A decrease in the estimated equipment residual values would increase annual depreciation expense over the remaining lease term.

During 2023, market values on equipment returning upon operating lease maturity were generally higher than the residual values on the equipment, resulting in a decrease in depreciation expense of $63.8 million.

At December 31, 2023, the aggregate residual value of equipment on operating leases in the Financial Services segment and residual value guarantee on trucks accounted for as operating leases in the Truck segment was $1.49 billion. A 10% decrease in used truck values worldwide, if expected to persist over the remaining maturities of the Company’s operating leases, would reduce residual value estimates and result in the Company recording additional depreciation expense of approximately $73.6 million in 2024, $34.8 million in 2025, $20.5 million in 2026, $13.1 million in 2027, $6.8 million in 2028 and thereafter.

Allowance for Credit Losses

The allowance for credit losses related to the Company’s loans and finance leases is disclosed in Note E of the consolidated financial statements. The Company has developed a systematic methodology for determining the allowance for credit losses for its two portfolio segments, retail and wholesale. The retail segment consists of retail loans and sales-type finance leases, net of unearned interest. The wholesale segment consists of truck inventory financing loans to dealers that are collateralized by trucks and other collateral. The wholesale segment generally has less risk than the retail segment. Wholesale receivables generally are shorter in duration than retail receivables, and the Company requires periodic reporting of the wholesale dealer’s financial condition, conducts periodic audits of the trucks being financed and in many cases, obtains guarantees or other security such as dealership assets. In determining the allowance for credit losses, retail loans and finance leases are evaluated together since they relate to a similar customer base, their contractual terms require regular payment of principal and interest, generally over three to five years, and they are secured by the same type of collateral. The allowance for credit losses consists of both specific and general reserves.

The Company individually evaluates certain finance receivables for expected credit losses. Finance receivables that are evaluated individually consist of all wholesale accounts and certain large retail accounts with past due balances or otherwise determined to be at a higher risk of loss. In general, finance receivables that are 90 days past due are placed on non-accrual status. Finance receivables on non-accrual status which have been performing for 90 consecutive days are placed on accrual status if it is deemed probable that the Company will collect all principal and interest payments.

Individually evaluated receivables on non-accrual status are generally considered collateral dependent. Large balance retail and all wholesale receivables on non-accrual status are individually evaluated to determine the appropriate reserve for losses. The determination of reserves for large balance receivables on non-accrual status considers the fair value of the associated collateral. When the underlying collateral fair value exceeds the Company’s amortized cost basis, no reserve is recorded. Small balance receivables on non-accrual status with similar risk characteristics are evaluated as a separate pool to determine the appropriate reserve for losses using the historical loss information discussed below.

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The Company evaluates finance receivables that are not individually evaluated and share similar risk characteristics on a collective basis and determines the general allowance for credit losses for both retail and wholesale receivables based on historical loss information, using past due account data, current market conditions, and expected changes in future macroeconomic conditions that affect collectability. Historical credit loss data provides relevant information of expected credit losses. The historical information used includes assumptions regarding the likelihood of collecting current and past due accounts, repossession rates, and the recovery rate on the underlying collateral based on used truck values and other pledged collateral or recourse.

The Company has developed a range of loss estimates for each of its country portfolios based on historical experience, taking into account loss frequency and severity in both strong and weak truck market conditions. A projection is made of the range of estimated credit losses inherent in the portfolio from which an amount is determined based on current market conditions and other factors impacting the creditworthiness of the Company’s borrowers and their ability to repay. Adjustments to historical loss information are made for changes in forecasted economic conditions that are specific to the industry and markets in which the Company conducts business. The Company utilizes economic forecasts from third party sources and determines expected losses based on historical experience under similar market conditions. After determining the appropriate level of the allowance for credit losses, a provision for losses on finance receivables is charged to income as necessary to reflect management’s estimate of expected credit losses, net of recoveries, inherent in the portfolio.

The adequacy of the allowance is evaluated quarterly based on the most recent past due account information and current and future market conditions. As accounts become past due, the likelihood that they will not be fully collected increases. The Company’s experience indicates the probability of not fully collecting past due accounts ranges between 10% and 70%. Over the past two years, the Company’s year-end 30+ days past due accounts have ranged between .4% and 1.0% of loan and lease receivables. Historically, a 100 basis point increase in the 30+ days past due percentage has resulted in an increase in credit losses of 2 to 25 basis points of receivables. At December 31, 2023, 30+ days past dues were 1.0%. If past dues were 100 basis points higher or 2.0% as of December 31, 2023, the Company’s estimate of credit losses would likely have increased by a range of $2 to $35 million depending on the extent of the past dues, the estimated value of the collateral as compared to amounts owed and general economic factors.

Product Warranty

Product warranty, including changes in estimates for pre-existing warranties, is disclosed in Note I of the consolidated financial statements. The expenses related to product warranty are estimated and recorded at the time products are sold based on historical and current data and reasonable expectations for the future regarding the frequency and cost of warranty claims, net of recoveries. Estimates consider product type, geographical differences, labor rates, and any other known factors affecting the number or amount of expected claim payments. For new products with no historical experience, reference to similar products is utilized. Management takes actions to minimize warranty costs through quality-improvement programs; however, actual claim costs incurred could materially differ from the estimated amounts and require adjustments to the reserve. Historically those adjustments have not been material. Over the past two years, warranty expense as a percentage of Truck, Parts and Other net sales and revenues has ranged between 1.9% and 2.9%. If the 2023 warranty expense had been .2% higher as a percentage of net sales and revenues in 2023, warranty expense would have increased by approximately $67 million.

FORWARD-LOOKING STATEMENTS:

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements relating to future results of operations or financial position and any other statement that does not relate to any historical or current fact. Such statements are based on currently available operating, financial and other information and are subject to risks and uncertainties that may affect actual results. Risks and uncertainties include, but are not limited to: a significant decline in industry sales; competitive pressures; reduced market share; reduced availability of or higher prices for fuel; increased safety, emissions, or other regulations or tariffs resulting in higher costs and/or sales restrictions; currency or commodity price fluctuations; lower used truck prices; insufficient or under-utilization of manufacturing capacity; supplier interruptions; insufficient liquidity in the capital markets; fluctuations in interest rates; changes in the levels of the Financial Services segment new business volume due to unit fluctuations in new PACCAR truck sales or reduced market shares; changes affecting the profitability of truck owners and operators; price changes impacting truck sales prices and residual values; insufficient supplier capacity or access to raw materials and components, including semiconductors; labor disruptions; shortages of commercial truck drivers; increased warranty costs; cybersecurity risks to the Company’s information technology systems; pandemics; climate-related risks; global conflicts; litigation, including European Commission (EC) settlement-related claims; or legislative and governmental regulations. A more detailed description of these and other risks is included under the heading Part I, Item 1A, “Risk Factors” and in Note L in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.

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