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PACCAR, Inc. (NASDAQ:PCAR)

Q3 FY08 Earnings Call

October 21, 2008, 12:00 PM ET

Executives

Robin Easton - Treasurer

Mark C. Pigott - Chairman and CEO

Ronald E. Armstrong - Sr. VP and Executive Operations Officer

Michael T. Barkley - VP, Controller

Analysts

J.B. Groh - D. A. Davidson & Co.

Joel Tiss - Buckingham Research

Ann Duignan - JPMorgan

Jamie Cook - Credit Suisse

Andrew Casey - Wachovia Capital Markets

Henry Kirn - UBS

Peter Jacobs - Ragen MacKenzie

Kristine Kubacki - Avondale Partners

Operator

Good morning and welcome to PACCAR's Third Quarter 2008 Earnings Conference Call. All lines will be in a listen-only mode until the question-and-answer session. Today's call is being recorded and if anyone has an objection, they should disconnect at this time.

I would now like to introduce Mr. Robin Easton, PACCAR's Treasurer. Mr. Easton, please go ahead.

Robin Easton - Treasurer

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; Mike Tembreull, Vice Chairman; Ron Armstrong, Senior Vice President and Michael Barkley, Vice President and 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 - Chairman and Chief Executive Officer

Good morning. First of all, I'd like to start off by saying I'm very proud of PACCAR's 20,000 employees who have delivered excellent financial results. In fact, its our tenth best quarter in company history. A number of PACCAR divisions are performing very well, specifically PACCAR Parts, PACCAR Lease, PACCAR Financial Europe and our Winch Group and DAF.

The recession in North America and Europe has impacted the truck markets and we're responding accordingly. As in previous cycles, the company is rigorously aligning operating costs, expenses and capital budgets with current market conditions.

When we compare the third quarter 2008 to the fourth quarter, we expect industry bill rate reductions are 20% to 30% in Europe, Mexico and Australia. This action, coupled with continued softness in the U.S. and Canadian truck market, and the effect of a strengthening U.S. dollar, will have an impact on fourth quarter financial results. I think that's been outlined quite clearly in the press release.

PACCAR is in excellent position, because of its dedicated employees, the most experienced management team in the industry, high-quality products, world-class technology, modern factories and the ongoing benefit of capital investments in every facet of the business.

Looking at the third quarter, PACCAR's sales and service revenues were $4 billion. Net income was $299 million, which was comparable to a year ago and earnings per share at $0.82 per share is actually a $0.01 better than a year ago.

For the nine months, net sales and service revenues were $12.1 billion with net income of $905 million and earnings per share at $247 million. PACCAR's after-tax return on sale was 7.5% for the quarter and it's year-to-date after-tax return on beginning equity was 24.1%.

Diving a little bit deeper, gross margins are up, operating margins are up and SG&A is down, all good indicators. PACCAR Financial Service revenues of $323 million increased in the third quarter compared to $313 million a year ago. Pre-tax income was $45.5 million in the third quarter compared to $73.4 million earned a year ago.

Most of the lower profit is due to provisions for loan losses in the U.S. and Canada. And as we know, loan losses normally increase at this point in the economic cycle, which our industry typically experiences every five years. Our finance team is proactively engaged with our dealers and customers to manage through the market. PACCAR Financial opened a truck center in South Carolina and it's making an excellent contribution to our used truck distribution program.

PACCAR's strong balance sheet and conservative approach to business has enabled it navigate the financial turbulence caused by the global credit crisis. PACCAR's AA minus credit rating promotes good access to the capital markets. Like other highly rated U.S. companies, PACCAR plans to utilize the Fed's commercial paper funding facility to complement our current commercial paper programs. In addition, PACCAR is utilizing a portion of its excess manufacturing cash to supplement short-term financial services funding requirements in our foreign markets.

Moving to operations, the reduction in many commodity prices, with the exception of steel should be a benefit to PACCAR and other manufacturers in 2009. However, commodity prices still need to decline another 20% to 40% to equal the cost levels of 2006.

But, there's other good news. The dollar per gallon decline in the price of diesel fuel since July is benefiting our customers, as fuel is about 25% of their operating costs. Freight is up in each of the last 10 months year-on-year in North America. In fact, a number of our customers are reporting increased earnings in the third quarter. And finally, there may be some small impact from a pre-buy due to 2010 engine emission regulations.

When you wrap all that up, we estimate that truck orders in the U.S. and Canada could be up next year at 170,000 to 210,000 units. If achieved, this would be the best year for orders since 2006.

I think what we all need to recognize is for the trucking industry, we've been in a down market since really the middle of 2007. Trucks do wear out and with strong freight and about 4% less trucks operating in U.S. and Canada, our good customers are making money with good freight and are looking to purchase next year for the first time in about three years.

Moving on to our capital, we continue to actively review our capital budgets to determine which have the best, short, medium and long-term benefits. We are maintaining capital investments on important projects that will deliver increased profitability and superior customer benefits such as the construction of our new engine facility in Columbus, Mississippi.

And by the way, for the first time, I'd just like to report that field trials of the PACCAR engine in Kenworth and Peterbilt fleets are achieving excellent results.

Looking at other investments, Kenworth and Peterbilt have recently completed investments in their robotic paint booths to improve quality and productivity and our technical center is increasing its testing capability by 30%, which will accelerate new product development, once again benefiting our customers.

Over the last decade, PACCAR has invested $2.6 billion, and those investments are delivering excellent financial results. As an example, Kenworth, Peterbilt and DAF now built a truck in half the hours it took to build a truck 10 years ago, and the quality is 500% better. As someone mentioned to me what was the quality like 10 years ago? It was excellent. Now it is incredibly excellent. We are proud to be the highest quality, most efficient manufacturer. Our truck divisions have earned 26 J.D. Power customer satisfaction awards compared to only nine for the next competitor. That's a bottom line advantage to our customers.

In summary, our investments have delivered new products, strengthened our dealer network and made us an industry leader in information technology. In taking a little longer historical perspective, PACCAR's outstanding growth after the last recession of 2001 and 2002 is an excellent indicator of the benefits of our quality product focus and continuous improvement philosophy. PACCAR is working hard to deliver outstanding results in all phases of the market cycle.

Thank you. I look forward to your questions.

Question And Answer

Operator

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

J.B. Groh - D. A. Davidson & Co.

Good morning Mark, can you hear me?

Mark C. Pigott - Chairman and Chief Executive Officer

Yes, you bet, good morning.

J.B. Groh - D. A. Davidson & Co.

How are you doing?

Mark C. Pigott - Chairman and Chief Executive Officer

Fine.

J.B. Groh - D. A. Davidson & Co.

Just aquestion on your outlook for U.S., Canada and Europe. Can you maybe discuss the swing factors that put you towards, in your opinion, the top end or the bottom end of those ranges? I'm assuming the factors are different for Europe than they would be for U.S. and Canada.

Mark C. Pigott - Chairman and Chief Executive Officer

Sure, you bet. U.S. and Canada, and of course you have been following the industry and the company for a while, I think one point I'd just make is, and I've mentioned it briefly in the comments is that for the U.S. and Canada, we've been in the down part of this cycle for coming up about a year and a half. And every five years we go through some sort of cyclical adjustment. So that's why we pointed out some of the reasons that we think there could be an improvement next year.

Obviously, the macro economy is probably 6 to 12 months behind the leading indicator of truck production and freight. That's going to have an impact perhaps on a negative view point. On the positive, a lot of our customers have not purchased for two to three years. They are still doing 200,000, 250,000 miles a year. They're now getting these vehicles up to 600,000 to 800,000 miles. And frankly, that's typically the time when they turn it in to continue to maximize their, let's call it, or minimize their operating costs. So that would be really that the range is how many of the customers will be trading in and purchasing new vehicles.

In Europe, which is probably 6 to 12 months behind the U.S. in terms of the truck economic cycle. And I guess I keep emphasizing that because it is a little bit different than just a general economic cycle. If we... you've got the positive impact of Central Europe, which has certainly cooled down, but is still estimated to have GDP growth of 2% to 4% next year, you compare that to Western Europe of, let's say, 0% to 1%. But with about 60,000 to 70,000 in Central Europe, which we did not have even six, seven years ago, that's going to be a certain buoyant effect.

So Western Europe will slow down because of the 0% to 1% GDP growth. Some of that will be offset with the newly invigorated Central European markets. So that's how you get your range.

J.B. Groh - D. A. Davidson & Co.

Okay. And then it looked obviously the provision for loss in the financial subsidiary popped up a little bit there understandably. If you look at past cycles and then look back, but sort of where does that peak out at? I mean is 10% kind of dire circumstances or can it get worse from here? Where do you see that going?

Mark C. Pigott - Chairman and Chief Executive Officer

Let me just start it off and then turn it over to Ron Armstrong. But our losses in terms of dollars are really comparable to 2001, 2002. Of course, the good news is our asset base, the portfolio is at least twice as big. So on dollars, it's comparable to the last recession but on a much larger asset base. Ron?

Ronald E. Armstrong - Senior Vice President and Executive Operations Officer

Yes, I would say our loss ratio in the last downturn was up close to 180 basis points. We don't expect anywhere near that, and roughly have that based on the size of our portfolio. So portfolio performing well as Mark mentioned. We are proactively engage with our dealers and customers, helping them work through whatever challenges they might encounter. And we expect the portfolio to perform well as we go forward.

J.B. Groh - D. A. Davidson & Co.

Okay. Thanks for you time.

Mark C. Pigott - Chairman and Chief Executive Officer

You bet. Thank you.

J.B. Groh - D. A. Davidson & Co.

Bye bye.

Operator

Your next question will come from the line of Joel Tiss with Buckingham Research.

Joel Tiss - Buckingham Research

Good morning. How is it going?

Mark C. Pigott - Chairman and Chief Executive Officer

Good morning, Joel. Good to have you back.

Joel Tiss - Buckingham Research

Thanks. I wasn't gone long, only three weeks. I've been looking through the dictionary trying to find what incredibly excellent means, but I'm still having trouble on that. You'll have to explain that to me.

Mark C. Pigott - Chairman and Chief Executive Officer

Come out again. We'll give you a tour of the truck factory. We'll show you up close and personal.

Joel Tiss - Buckingham Research

Okay. Can you talk a little bit about your European forecast? Is that industry or for you specifically, because it seems a little bit more negative than what we're hearing from some of the other MAN and Volvo and some of the other guys?

Mark C. Pigott - Chairman and Chief Executive Officer

Well, I'd say it's an interpretation of the industry forecast. It's a little harder to get a true industry forecast in Europe because you've got so many countries that are trying to compile their own home truck manufacturer. It's not quite as easy as we do it here with the American Trucking Association. So I think it's in the range of what our competitors are saying. Everybody's being affected by the same macroeconomic slowdown, and we try to be conservative, which is the way we run the company. So if it's better, well, that's a good thing. Of course, one thing I just touched on is that DAF has done a great job of continuously growing market share 0.5 to 0.2 a year, and we will be looking to continue to do that next year, even with a slower market.

Joel Tiss - Buckingham Research

Okay and then just a quick follow up, I know that historically you've tried to help your customers' transition into higher prices as new emission standards come out. Can you just talk a little about what kind of discussions you're having with the customers and the dealers, and if there is a chance to get a little bit of pricing in 2009, or is it just going to be difficult?

Mark C. Pigott - Chairman and Chief Executive Officer

Well I think it's a great question, certainly a one that everyone in the industry is working very hard on. It's still a little bit early, I mean here we are October 2008 and this... the emissions will go in January 1, 2010. But, we are talking with some of our leading major customers about it and I think the realization has sort off dawned on most of the customers that every three-four years we're going through on emission change, which typically means higher costs and higher price, because of the add-on equipment to meet the emission regulations.

There's always a little bit of a fear about what will that do to fuel economy and just operating efficiency. What we have found little over the last 10 or 15 years and I think we've had four emission changes over the last 15 years is that, the fuel economy usually is about the same. The dire forecasts never come true. Yes, there are increased costs which ultimately get passed through to the end customer. But I think people have wised up after 2002, 2004 that there will be some pre-buy and yes, there will be some higher prices, but it's a little disrupted to the customer. Because if they buy 30% more than they typically buy, then they need to get the drivers, they need to get the service contracts, they need to get additional business. And so, it's more of a challenge for them. So I think we'll perhaps some pre-buy but it will be more on the smaller scale.

Joel Tiss - Buckingham Research

Okay. Thank you very much.

Mark C. Pigott - Chairman and Chief Executive Officer

You bet. Thank you.

Operator

Your next question will come from the line of Ann Duignan with JPMorgan.

Mark C. Pigott - Chairman and Chief Executive Officer

Good morning, Ann.

Ann Duignan - JPMorgan

Hi, good morning everybody. Can we step back and look at Europe again and could you give us your best thoughts on decremental profits, just given how quickly that markets slowed over the last quarter and it's slowing as we go forward. Coupled with the fact that in Europe we don't tend to see too much cyclicality; plus or minus 5% is where we usually forecast. But it certainly looks like this downturn could be worst for Europe. Could you just talk about how you would expect decremental profits to rollout over the next several quarters?

Mark C. Pigott - Chairman and Chief Executive Officer

All I can share and I can add to that the profit, we can talk about the market. First, we're such an experienced team. We've been around for 30 years, so we've seen the ups and downs of these markets. And if you look at Western Europe, let's call it in the 260-280 range this year, that's '08 and Central Eastern Europe, 60 to 80. What is of course different and I'd mentioned this earlier is that even in the year 2000, Central Eastern Europe really wasn't much of a factor. So you got that as a positive. Western Europe is certainly running into the same economic issues that while the rest of the world is now certainly in; North America, Australia.

So we see that there will be a more of slowdown in Western Europe than in Central Europe, just in terms of truck demand. But the quantity... you're talking about a market is four almost five times larger in Western Europe than Central Europe, so it's still going to be a good market. I think, if you go back, it might be in a market of a size in Western Europe that you're seeing sort of 2003. Still five years ago, which... I was there in 2003, it was a good market and you put the advantage or the benefit of the Central European and it's still a good market. It's not a record market like we're experiencing this year around a long time, it's hard to have a record here every year.

Ann Duignan - JPMorgan

But is it... should we also expect that with volumes slowing somewhat, that you would deliver, somewhat normal decremental profits of somewhere between 20% and 30%? Just on lower volume in Western Europe or is there something that might be different?

Mark C. Pigott - Chairman and Chief Executive Officer

Yes, probably. Yes, I think most of our competitors would probably agree with that.

Ann Duignan - JPMorgan

And then as you expect...

Mark C. Pigott - Chairman and Chief Executive Officer

Let's say Europe. That's just Europe. Europe's only a portion of our overall business as you know.

Ann Duignan - JPMorgan

Right. But you also have the flexibility of taking cost out faster than maybe some of your competitors there?

Mark C. Pigott - Chairman and Chief Executive Officer

And that's a very good point which really has not been brought up and that I think PACCAR's for a 100 years has been a real leader on being able to take cost out throughout the company. And of course, the Kenwood and Peterbilt teams have done that over the last year and a half and the DAF teams we're all working together, have learned from that.

Ann Duignan - JPMorgan

Okay. And my follow-up question is on Financial Services side. Are you seeing any increase in loan losses or delinquencies in your Europe yet, and we just were on the Caterpillar call and they mentioned that they are beginning to see delinquencies rise a little late in Europe. Are you guys seeing any of that yet and would you expect to see going forward, just again given how quickly and how aggressively the market has fallen off?

Mark C. Pigott - Chairman and Chief Executive Officer

No. I think we have seen a rise... I call it, a little bit. But the portfolio, passed dues and losses are still at historically low averages and performing well.

Ann Duignan - JPMorgan

So would you expect Europe delinquencies to grow up from here?

Mark C. Pigott - Chairman and Chief Executive Officer

I mean that's tough to tell, you know what, how the things will progress. So our team is proactively engaged with our dealers and our customers and working through it. So we are seeing a little bit of uptick so far, but the guys will manage that very prudently.

Ann Duignan - JPMorgan

Okay, thank you.

Mark C. Pigott - Chairman and Chief Executive Officer

Thank you very much.

Operator

Your next question will come on the line of Jamie Cook with Credit Suisse.

Mark C. Pigott - Chairman and Chief Executive Officer

Good morning Jamie.

Jamie Cook - Credit Suisse

Hi good morning. My first question; can you guy just talk about the order book in Europe? I think on your last conference call, you mentioned it without overseas, without about a year and I'm just wondering whether you saw any cancellations in that market? And I have a follow-up question after that.

Mark C. Pigott - Chairman and Chief Executive Officer

Yes, looking at Europe, the order book has declined and...

Jamie Cook - Credit Suisse

Can you comment how much?

Mark C. Pigott - Chairman and Chief Executive Officer

I think it's down to probably more historical levels normal levels.

Jamie Cook - Credit Suisse

Which would be?

Mark C. Pigott - Chairman and Chief Executive Officer

I'd say it's probably down, as we said it was out a year. I think where you look at sort of backlog in total probably about half a year, but that has different frequencies. So I think we are looking at four to eight weeks of bill which we typically look for around the world and then some people will have orders slated in the first and second quarter.

Jamie Cook - Credit Suisse

Okay. And then I guess my second question because you did answer Ann's questions on decrementals which I think were for Europe. On the flip side, I was more thinking about North America, because you're less vertically integrated there. Should we think about the incremental uptick being more in the teens range. And then a follow up, I am surprised... on your U.S. retail sales forecast, how aggressive or positive it is, I guess when do you anticipate us starting to see the orders improve and at what point in '09?

Mark C. Pigott - Chairman and Chief Executive Officer

Well, for 150-ish, this year to even get to 170. It won't take too much in terms of somebody's good customers that will need to replenish their stock as their vehicles are achieving good mileage. So it'll probably be the second half of the year.

Jamie Cook - Credit Suisse

And then trying to answer the question on incrementals in North America, because the concern is Western Europe being down, haven't [ph] hit your earnings just because you're more vertically integrated there. Or is it the gap between North America and Western Europe now because of any internal things that PACCAR shows. Anyway you could provide color will be appreciated.

Mark C. Pigott - Chairman and Chief Executive Officer

Yes.I think there will be some impact from the lower build rates in Europe, which will be more than any offsetting improvement in North America.

Jamie Cook - Credit Suisse

Is... the teens, is that a fair way to think about incremental?

Mark C. Pigott - Chairman and Chief Executive Officer

Let me get back to you on that one. I'll make sure that we give you a right answer. I'm not sure that we can say that right now.

Jamie Cook - Credit Suisse

All right, I appreciate it. Thank you.

Mark C. Pigott - Chairman and Chief Executive Officer

Thank you.

Operator

Your next question will come from the line of Andy Casey with Wachovia Securities.

Mark C. Pigott - Chairman and Chief Executive Officer

Good morning Andy.

Andrew Casey - Wachovia Capital Markets

Hey good morning, Mark, everybody. In North America, you mentioned the field test for the new engines, for the 2010 engines. Can you comment on incremental fuel economy benefits versus your currently installed 13 liter?

Mark C. Pigott - Chairman and Chief Executive Officer

Well, I mean I think it's probably a little too early to issue that specific information. I'll just say we've got probably 30 million miles of engine operation, and they're performing very well. And it's still over a year away before we'll get our factory up and running. So it's going well. I just wanted to kind of give you a little bit of color because we really haven't mentioned it before.

Andrew Casey - Wachovia Capital Markets

Okay. And then thanks for that. On the two different technologies that are still being pursued, your side kind of family SCR.

Mark C. Pigott - Chairman and Chief Executive Officer

They got the whole industry is SCR now.

Andrew Casey - Wachovia Capital Markets

With the exception of one, who has been --

Mark C. Pigott - Chairman and Chief Executive Officer

Well, I can't comment on that. I got... let's call it the vast majority are SCR around the world.

Andrew Casey - Wachovia Capital Markets

Okay. I'm just wondering if you would care to give your view on the differences from your competitors as an example [ph].

Mark C. Pigott - Chairman and Chief Executive Officer

We're 100% SCR and so is pretty much everybody in Europe and pretty much everybody here with maybe one exception. I mean SCR's... if it was a Presidential vote, we'd call it a landslide.

Andrew Casey - Wachovia Capital Markets

Okay. Thank you. On both the North American and Europe markets, it's a little bit different than the question that Joel asked. Are you seeing any short-term change in new equipment pricing dynamics against the weakening market demand conditions?

Mark C. Pigott - Chairman and Chief Executive Officer

I think it's pretty normal in the cycles. As you know every three, four or five years and have been going on for the last 100 years. And typically, when the market slows down, manufacturers like to keep their production facilities operating at an optimum level and customers are a very smart group. That's why we like working with them. And they will try to take advantage of the changing market dynamics. So it swings round about. So yes, I think you can say that everybody in every down cycle will typically see something... some impact on the margin side and then on the upcycle, you see the flip side.

Andrew Casey - Wachovia Capital Markets

Okay. Is there, on a qualitative basis, is there any difference between North America and Europe? Is it more pervasive in North America at this point than Europe?

Mark C. Pigott - Chairman and Chief Executive Officer

It's like when I talk with our 1800 dealers around the world, every one is unique and we love everyone. But their grades [ph], they are very similar around the world. And I would say that these truck markets follow the same dynamics, whether it is Asia, North America, Europe in terms of the customer dealer manufacturer relationship. They are all the same.

Andrew Casey - Wachovia Capital Markets

Okay. And then on Europe specifically, you're seeing some consolidation of competitors. The last time that happened, it seemed beneficial for your market share and dealer density increase. How are you looking at the longer term potential for PACCAR with the marriage of the two Germans and the one on Scania?

Mark C. Pigott - Chairman and Chief Executive Officer

Outstanding, great news. The two elements we're talking about. One is the... in Europe, with the German consolidation, we're already having many dealer contact us about can they represent our product? Typically, our dealers make quite a bit more margin and have higher profitability. So that's positive. And something that wasn't brought up, we can just mention it briefly is of course the announcement that Sterling is exiting the market. We've... phones have been ringing off the hook with their dealers saying we'd like to work with a company that allows a dealer to make a good margin and we'll see how that plays out. So lots of opportunities as a result of that.

Andrew Casey - Wachovia Capital Markets

Okay. Thanks a lot.

Mark C. Pigott - Chairman and Chief Executive Officer

Thank you.

Operator

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

Henry Kirn - UBS

Hi guys.

Mark C. Pigott - Chairman and Chief Executive Officer

Good morning Henry.

Henry Kirn - UBS

Wondering if you can talk a little bit about the funding strategy for financial services and how you match maturities, the liabilities with the asset profile and maybe a little bit how much duration risk is there if the credit markets were to shut down here for some period of time.

Mark C. Pigott - Chairman and Chief Executive Officer

Okay. Well we're very fortunate that we have a very strong balance sheet. We have excellent AA minus credit rating that allows PACCAR continue to support the sale of new and used PACCAR products. We have followed an approach of funding our portfolio with a mix of medium-term notes and commercial paper. We have issued medium-term notes in the U.S. and Europe in the second quarter, Mexico in the third quarter and we just completed a medium-term funding in Australia earlier this month. Commercial paper markets continue to provide good liquidity, mostly in the U.S. and around the world. So we're 100% match funded. We match the interest rate characteristics of our debt with the interest rate characteristics of our portfolio to not expose this to interest rate risk in our P&L.

Henry Kirn - UBS

Okay.

Mark C. Pigott - Chairman and Chief Executive Officer

And have been doing it for 30 years I guess. And it's definitely a unique market as you've heard from about every other company. But got a great team and good position.

Henry Kirn - UBS

Okay. And the residual value guarantee liability that you reported in the 10-Qs, is it possible to give the number as of the end of the third quarter and then maybe a little color around how we should look at that in this market of potential challenges in the used market?

Mark C. Pigott - Chairman and Chief Executive Officer

We will be having our third quarter 10-Q out of the next week or two. Just normal filing, and I think probably a little bit premature to sort of say what's in the 10-Q.

Henry Kirn - UBS

Okay. But is there a way to discuss how we should think about that liability if used prices are starting to decline because of challenges in the market?

Mark C. Pigott - Chairman and Chief Executive Officer

Well I think... you're talking about used truck prices?

Henry Kirn - UBS

Right?

Mark C. Pigott - Chairman and Chief Executive Officer

Yes, I'll make a comment and Ron might have something else to add. But for U.S. and Canada, used truck prices seem to be stabilizing, which is good. Obviously, they're down from say a year ago, but as I say, we've been in a down cycle since the middle of '07. So they're stabilizing and we have an active program selling used vehicles as they come off lease or repossessed. They seem to be generating some very good results and our residual values versus what we're selling in marketplace seem to be matching up very, very well. I don't know, Ron, you have any other --

Ronald E. Armstrong - Senior Vice President and Executive Operations Officer

Yes,I just would add that we do follow a conservative approach to setting our residual values and that's served us very well and we don't see any particular issues as we go forward.

Henry Kirn - UBS

How conservative is it as you discuss those issues back [ph]. Is there a way to give a metric on that?

Mark C. Pigott - Chairman and Chief Executive Officer

Probably not, although we do have monthly used truck sales. We'd love to have you come by and... but I think it's... we've got a very experienced team. And the good news is the used truck values for the Kenworth, Peterbilt and

DAF products continue to command a 15% to 25% premium over the competitors, which is of course a very important part of our low-cost of operation strategy.

Henry Kirn - UBS

Okay. Thanks a lot.

Mark C. Pigott - Chairman and Chief Executive Officer

Good. Thank you.

Operator

Your next question will come from the line of Peter Jacobs with Ragen MacKenzie.

Mark C. Pigott - Chairman and Chief Executive Officer

Good morning Peter.

Peter Jacobs - Ragen MacKenzie

Gentlemen, good morning. First question either for Mark or Ron. Can you give us the loan loss ratio, the loan losses that were in current percentage of assets this quarter on an annualized basis and how to compare that with the provision that you are taking relative to the assets?

Mark C. Pigott - Chairman and Chief Executive Officer

All I would say is that the provision for losses is primary driven by our actual credit losses. We have the reserve percentages roughly up just a bit from where it has been. Our loss ratio year-to-date is roughly just over 1%. And as I mentioned, before the last ratio in the last cycle in 2001 was 1.8% and we do not see that getting close to those levels.

Peter Jacobs - Ragen MacKenzie

Okay. And then your reserves as a percentage of assets then that would be comparable with that 1% level then right now?

Mark C. Pigott - Chairman and Chief Executive Officer

No. As a percentage of assets, we are over 2%.

Peter Jacobs - Ragen MacKenzie

Reserved?

Mark C. Pigott - Chairman and Chief Executive Officer

Yes.

Peter Jacobs - Ragen MacKenzie

Okay.

Mark C. Pigott - Chairman and Chief Executive Officer

And we keep that... that has been that way for a decades.

Peter Jacobs - Ragen MacKenzie

Okay, great. And then, two other questions. Mark, I don't think you talked about this and if you did, I apologize but I look for R&D spending in 2009. Can you give any color around that? Has there been any changes since you wrote a letter to shareholders back in, I guess it was March or April?

Mark C. Pigott - Chairman and Chief Executive Officer

Let me have Michael start with that.

Michael T. Barkley - Vice President, Controller

Yes, this is Michael Barkley. The R&D spending is going to continue at higher level than maybe what you saw three or four or five years ago. But it is going to be at level I would say with what was seen in 2008.

Peter Jacobs - Ragen MacKenzie

Okay. So if I guess this may continue through on the rate you have been spending on R&D, that gets me to about $350 million in 2008 and you'd think that it could be about that level then in 2009.

Michael T. Barkley - Vice President, Controller

It would be probably somewhat about that level maybe a little lower.

Peter Jacobs - Ragen MacKenzie

And then is it fair to think that R&D ranks would come down in 2010? I'm just trying to think about how you'd be spending money with some of the new facilities in the engine plant coming on. Can you help me out on you're thinking about that and how we should be thinking about that?

Michael T. Barkley - Vice President, Controller

I think that's a fair observation. Some major development programs will be coming to a conclusion, including engine development and others that will probably result in some tail off to that number.

Peter Jacobs - Ragen MacKenzie

And then a similar then question on capital spending; how should we be thinking about that. Is there any changes there that have... that has come about based on with the current economic outlook?

Michael T. Barkley - Vice President, Controller

Well as Mark mentioned, we're continuing to invest in our factory and other key programs, but we've completed a lot of very important projects and those projects will benefit the company going forward, but they're done and so spending again for those things should tail off.

Peter Jacobs - Ragen MacKenzie

In 2000. And so this we should start to see that tail off in 2009 then?

Michael T. Barkley - Vice President, Controller

Yes.

Peter Jacobs - Ragen MacKenzie

Okay terrific. Thank you very much and that's all I have.

Mark C. Pigott - Chairman and Chief Executive Officer

Good questions. Thank you.

Operator

Your next question will come from the line of Kristine Kubacki with Avondale Partners.

Mark C. Pigott - Chairman and Chief Executive Officer

Good morning Kristine.

Kristine Kubacki - Avondale Partners

Good morning gentlemen. Just a couple of quick questions, as most of my questions have been answered. But one of the higher repossessions this is, you'd also mentioned this in the second quarter. I was just kind of wondering how that's trended in terms of North America. Did you see it really accelerate in September or did things drop off later in the quarter?

Mark C. Pigott - Chairman and Chief Executive Officer

I think repossessions I think are actually slowing down. I answered your question?

Kristine Kubacki - Avondale Partners

Did it come down from the second quarter rates?

Mark C. Pigott - Chairman and Chief Executive Officer

No.

Kristine Kubacki - Avondale Partners

Okay. And then just a housekeeping question. Again the cash flow, I see that wholesale credit receivable has kind a took a big swing in the quarter, kind of a $400 million plus. Can you provide some color there and does this concern you in anyway on maybe looking forward on credit losses?

Mark C. Pigott - Chairman and Chief Executive Officer

Not that the increase... that's a year-to-date increase since the end of last year. So it's really three elements there. One, we've had increased billed rates during the course of the year in Europe, Mexico and Australia. And as at year end, the factories are shutdown for the December holiday period. And so that provides a lower level of wholesale flowing at the end of the year and that's been... and then the third thing, there has been some delays in customers taking trucks. But our dealers are working closely with our customers and we'll likely see some reduction, as we go forward.

Kristine Kubacki - Avondale Partners

Okay. And then just a follow up and make sure I understand, did you mention that you talked a little bit about watching Europe, you're seeing that down but as for Central Europe, is your forecast for it to increase next year or be slightly down?

Mark C. Pigott - Chairman and Chief Executive Officer

I think Central Europe will probably slowdown also and there has been a lot of infrastructure building, some of that is still ongoing. I'm sure you see the press about the different countries in Central Europe and some are in better position than others. But they're still trying to catch up highways, factories, center towns, distributions centers there's a lot being built there.

We just opened up a new facility outside of the Budapest and it is going well as it serves Slovenia and Slovakia and Poland and others. So I think that'll slowdown and they are having their own credit issues at the national... country level. But I think they're committed to continue to grow which is driving freight. So and lot of the... not a lot but some of the freight companies in Western Europe have moved to Central Europe, whether it's for better access to more drivers or lower cost of doing business. So, that's also stimulating demand for trucks. But I think no part of the world is immune to the slower economy. So, I think you'll see some slow down, but still compared to eight years ago, there was no market there.

Kristine Kubacki - Avondale Partners

Okay. Well thank you very much.

Mark C. Pigott - Chairman and Chief Executive Officer

Thank you.

Operator

[Operator Instructions]. Your next question is a follow up question from the line of Ann Duignan with JPMorgan.

Mark C. Pigott - Chairman and Chief Executive Officer

Hello again Ann.

Ann Duignan - JPMorgan

Hi guys. I wonder if you could just give us a little bit more color on the comments you made about using the manufacturing cash for commercial paper for the Financial Services business. How should we think about that, and how should we think about capital allocation going forward? Does it change any of the capital allocation decisions?

Mark C. Pigott - Chairman and Chief Executive Officer

No. I think that's a temporary situation that we exercise from time to time. We had roughly $150 million of manufacturing cash that we'd utilized this September 30 and that goes... that's...we don't see any significant change as we go forward in how we fund the finance company.

Ann Duignan - JPMorgan

So you see that as small of a temporary item.

Mark C. Pigott - Chairman and Chief Executive Officer

Yes.

Ann Duignan - JPMorgan

Not a long term?

Mark C. Pigott - Chairman and Chief Executive Officer

No.

Ann Duignan - JPMorgan

Okay. That was just what I needed to know.

Mark C. Pigott - Chairman and Chief Executive Officer

Good question. Thank you.

Ann Duignan - JPMorgan

Thank you.

Operator

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

Mark C. Pigott - Chairman and Chief Executive Officer

I just want to thank everyone for their excellent questions and thank you operator.

Operator

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

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Source: Paccar Inc. Q3 2008 Earnings Conference Call Transcript
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