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PACCAR, Inc. (NASDAQ:PCAR)

Q4 2008 Earnings Call

January 30, 2009 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

Andrew Casey - Wachovia Capital Markets

Joel Tiss - Buckingham Research

Ann Duignan - J.P. Morgan

Jamie Cook - Credit Suisse

Adam Uhlman - Cleveland Research Company

Henry Kirn - UBS

Andrew Obin - BAS-ML

Kristine Kubacki - Avondale Partners

Declan Carlin - BlueBay Asset Management

[David Rosso] - ISI

[Vicus Tannen] - BTIG

Peter Nesvold - Lazard

[Daniel Johansen] - NBIM

Operator

Good morning and welcome to PACCAR's fourth quarter 2008 earnings conference call. (Operator Instructions)

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

Robin 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, Senior Vice 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 earned it's fourth highest annual net income in its 103year history in 2008 and has delivered a remarkable 70 consecutive years of net profit to its shareholders. PACCAR's financial results reflect the benefits of the company's quality products and services, geographic diversification, excellent aftermarket revenues and financial services income.

I'm very proud of our 18,000 employees, who have delivered exceptional performance to our shareholders and customers, especially in today's very difficult business conditions.

PACCAR's excellent balance sheet and strong cash flow have enabled ongoing investments in capital projects such as diesel engines, new vehicles and factory productivity improvements. These projects position the company to achieve its long-term growth objectives.

However, as we all know, the severe recession is affecting our business in North America and Europe. Our fourth quarter 2008 financial results were negatively impacted by reduced gross margins, lower build rates and temporary plant shutdowns. These challenges are increasing in the first quarter of 2009, but just as with previous cycles, PACCAR is rigorously reducing operating expenses and capital expenditures to align the business with the slower markets.

When we compare the fourth quarter 2008 to the first quarter 2009, we expect build rate reductions of 40% in Europe, coupled with 10% lower truck production in the U.S. and Canada. At this time it appears that 2009 will be very similar to 2001 in terms of business conditions. It will be a challenging year for all industries.

The good news - and there is plenty of good news - is that PACCAR's revenue is 2.5 times higher today than it was in 2001. A population of Kenworth, Peterbilt and DAF trucks is 40% larger. We have 150 more dealer locations. PACCAR Parts sales have doubled, and PACCAR Financial has twice as many assets. Our manufacturing facilities are 100% more efficient than five years ago and product quality is 500% better than five years ago. A number of PACCAR divisions are performing very well - PACCAR Financial, PACCAR Parts, PacLease, and our Winch group. And finally, we have essentially the same experienced management team in place today as we did in 2001.

PACCAR's fourth quarter sales and financial services revenue were $2.9 billion. Net income was $113 million. For the year, net sales and financial services revenues were $15 billion, with net income of $1.02 billion and earnings per share of $2.78.

PACCAR Financial Services revenues of $292 million in the fourth quarter compared to $327 million a year ago.

Pre-tax income was $45.4 million in the fourth quarter compared to $76.2 million earned a year ago. Most of the decline is due to the higher provision for loan losses.

One more piece of good news - loan losses actually decreased in the fourth quarter compared to the third quarter, primarily due to fewer repossessions in the U.S. and Canada.

Used truck values are about 10% lower than three months ago, but may be close to the bottom.

PACCAR's strong balance sheet and conservative approach to business has enabled it to navigate the financial turbulence caused by the global credit crisis. PACCAR's AA- credit rating promotes good access to the capital markets. Like other highly rated U.S. companies, PACCAR utilizes the Fed's commercial paper funding facility to complement our commercial paper and term debt programs. In addition, PACCAR has substantial manufacturing cash to supplement short-term financial services funding requirements.

Reviewing the general market and our customers, the reduction in many commodity prices should be a benefit to PACCAR and all manufacturers in 2009. However, commodity prices still need to decline another 20% to 40% to equal the cost levels of 2004.

Other good news is that the $2.40 per gallon decline in the price of diesel fuel since last July is benefiting our customers. In fact, most of our customers continue to be profitable and a few have increased their profits quarter to quarter.

In summary, PACCAR's investment of $3.5 billion in the last decade to enhance its operating efficiency, develop new products, strengthen its dealer network and become an industry information technology leader has generated excellent results for our shareholders, employees, customers, dealers and suppliers.

PACCAR recognizes the very difficult challenges facing our industry worldwide. Our balanced approach in all phases of the business cycle position us to generate good results when the global economy recovers.

Thank you and I look forward to your questions.

Robin Easton

Operator, we'd be happy to take questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Andrew Casey - Wachovia Capital Markets, LLC.

Andrew Casey - Wachovia Capital Markets, LLC

First, on the capital investment guidance, if I take the midpoint, $175 million, how should we view the implied 62% reduction from '08? Is it really that you've come to the end of your expansion cycle for now or is it more that you're being prudent in the event that what we're in lasts a little bit longer?

Mark C. Pigott

Well, Andy, I think we're always prudent. We pride ourselves on being conservative, as you well know.

We have had a lot of excellent investments with terrific ROIs throughout the company and capital investments for any industry have a bit of a cycle. I think we're just sort of at the end of one cycle, and I'm sure in the future we'll be investing larger amounts for different products.

But our factories are in great shape, our vehicles are in great shape, systems are in great shape, and now we're going to enjoy the benefits of all those investments.

Andrew Casey - Wachovia Capital Markets, LLC

Then on the startup cadence of the new engine plant in the U.S., the implied pushout which has kind of been in the press for awhile, is that mainly a reflection of lower assumed volume and you want to maximize existing capacity utilization before bringing new capacity online or is there another reason you'd like to offer?

Mark C. Pigott

No, I think we obviously have capacity in Europe with the slowdown there. We're going to utilize that. What sometimes doesn't make the headlines is that we essentially have a new engine factory in Europe that was built about four years ago, state of the art, and so we'll manufacture there. The buildings in Mississippi are essentially complete, and it is a first class facility that, when the market recovers, we look forward to utilizing.

Andrew Casey - Wachovia Capital Markets, LLC

Then a few on the near term. We're pretty much in the teeth of what we're in. Can you talk about the European used truck pricing trends, any signs of industry discounting either in the U.S. or Europe?

Mark C. Pigott

You know, when the market slows down - and I can't think of any market that hasn't slowed down in any industry - pricing is affected. On the used truck pricing, particularly in the U.S. and Canada, we're finding that our pricing is pretty much in line with what we're selling the units for. So I think that's good news. We've taken a very proactive approach over the last two years and it seems to be paying dividends.

The good news is that the Kenworth, Peterbilt, DAF products still have a 15% to 25% advantage on used truck pricing, and that's very healthy for our customers and our dealers.

Andrew Casey - Wachovia Capital Markets, LLC

If I could follow up a little bit. You alluded to 2001 being a pretty similar environment to what you expect in 2009. If I go back in time in that 2001 range, we saw a lot of discounting, not necessarily from you, but some of your competitors. Have you seen any of that in the industry yet?

Mark C. Pigott

Well, you know, every company has their own approach to the market and certainly a number of our competitors, that would tend to be their favorite approach in trying to secure orders.

For the commercial vehicle market in the U.S. and Canada - and to some extent Mexico  we've been in a recession since the middle of '07, so we're coming up on two years. So we're pretty experienced on what's going on and, as you know, we're the leading indicator going down and we're the leading indicator going up. So, you know, when things are more challenging, people resort to whatever tools they've got at their hand, so I'm sure that competitor's pricing the normal trend.

Operator

Your next question comes from Joel Tiss - Buckingham Research.

Joel Tiss - Buckingham Research

In the aftermarket business, can you just give us a sense what the growth was in 2008 versus '07 and the outlook for '09?

Mark C. Pigott

The growth was essentially flat '08 to '07, which could be a win if you take a look at it that way. In '09 we expect to see some growth.

Joel Tiss - Buckingham Research

And then you guys think you're going to be able to stay profitable in the fourth quarter of 2009 given all the stress?

Mark C. Pigott

That's always our intention - always our intention.

Joel Tiss - Buckingham Research

You think it's going to be close?

Mark C. Pigott

We don't give guidance. You know that.

Joel Tiss - Buckingham Research

And then your production, all the shutdowns, do you think that's going to last through February? Are you seeing the channels clearing out or do you think you're going to need to keep the shutdowns going a little bit longer through February?

Mark C. Pigott

Well, all of our factories are building that are planned to building. And obviously build rates have adjusted over the last two years, and we've shared with you what we think the build rates will be vis-à-vis the fourth quarter of '08. But we want our factories operating. That's good for everybody. It's good for our employees, our customers, and obviously good for the business. It's something that we review on a daily, weekly, monthly basis.

Operator

Your next question comes from Ann Duignan - J.P. Morgan.

Ann Duignan - J.P. Morgan

Can we talk about PACCAR Financial? That's where we've been getting all the questions all morning, and I suppose what surprised us a little bit is your provision for loan losses on receivables. We understand that they're up 80% year-over-year, but they were down sequentially. Is that a function of lower diesel prices and correlated with the fact that you mentioned that losses are actually down and that your customers are actually making money? Or is it just we've reached such a low level that there just aren't many more customers to go bankrupt out there?

Mark C. Pigott

Well, let me address part of that, and I know Ron will have any more specifics you want.

Most of the trucking companies are making money, so let's get that out there. And you've seen their results over the last week from certainly the major ones that report publicly. So I think that's important. I know that it's not a popular trend in the world today to talk about good news, but there is plenty of good news. And so most of our customers are making money and a number have actually increased profits.

And why? They manage their business well. Fuel, which is about 25% to 30% of their business has come down by $2 plus per gallon. And you have to calculate that most of them buy about 20,000 gallons per truck per year of fuel, so you can do the math on the benefit of that, at least on a cash flow basis. Driver turnover is coming way down because essentially the housing market is slow and people are saying well, I want to keep my job and I don't have any houses to build, so I'm going to keep driving my truck, so that's saving them hundreds of thousands of dollars. They're getting attractive pricing on trucks and freight is down, but it's still, let's call it, 2000  2001 levels. So even though 5% of the capacity of the industry has been taken out, the 95% that's left are doing reasonably well.

So that's kind of the market overview, and Ron might have some thoughts on any financial questions you've got.

Ann Duignan - J.P. Morgan

Yes, if you could just comment on your outlook for loan loss provisions as we go into '09. Should we look at Q4 as being a run rate or do you anticipate that with your falling off a cliff that we've yet to see the impact of those customers going out of business or under financial stress? If you could just help us understand what you're looking at going into '09 for financial services.

Ronald E. Armstrong

We continue to monitor the portfolio and it's performing well, and we don't see any particular trends one way or another. We're working with customers as needed to support their business and we'll continue to do that throughout the coming year.

Ann Duignan - J.P. Morgan

And how much manufacturing cash are you now using to fund PACCAR Financial?

Ronald E. Armstrong

Minimal.

Ann Duignan - J.P. Morgan

Can I switch back to the manufacturing side? Can you talk a little bit more about the launch of the new engines and your new manufacturing facility? We'd heard some scuttle out there that maybe there were some startup problems or some issues out there - and I know it's scuttle.

Mark C. Pigott

Ann, you're a seasoned person. Don't waste your time listening to that stuff. Give us a call. We'll let you know.

Ann Duignan - J.P. Morgan

So can you talk about any contingency plans you might have if there should be any problems and if engines are not ready on 1/1/2010 or just give us an update on what's going on.

Mark C. Pigott

I don't know who you've been talking to. Things are going great. I think in our press release and in my comments we talked about 40 million miles these engines have run, which is about three times more than any other manufacturer has ever run their engines before its launched.

The factory itself - I was just there two weeks ago - it is fantastic. We've got great employees. And, as I think Andy mentioned or asked earlier, we've got some capacity in our facility in Eindhoven which we're going to use, which makes sense, certainly, from a business standpoint. And as the market recovers, we look forward to utilizing a wonderful new factory in Mississippi.

So it's all green light here.

Operator

Your next question comes from Jamie Cook - Credit Suisse.

Jamie Cook - Credit Suisse

On the engine side, can you just talk about what you're hearing from your customers in the U.S. in terms of the adoption of the engine for 2009 because from our perspective we're going to have to start to model that in.

And then I guess just my second question, a little more color or granularity when we think about Western and Central Europe by country or even the emerging markets, just sort of what you're seeing, the magnitude of the decline that you're seeing.

Mark C. Pigott

Well, I think there won't be a lot of modeling necessary in terms of the engine. This would be a gradual phase in, which is very typical of how we introduce our products around the world and have for decades, so I'm not sure that's going to have any real impact on your modeling. I'm trying to help you out here.

It's going great. People are excited about it, obviously. Just one more piece of the business that customers, dealers, our own people enjoy. We've been building engines for 50 years, so it's pretty much business as normal.

And in looking at Europe, it's a little hard to give a country-by-country because, first of all, they don't usually issue information for about six months on a country-by-country basis.

Jamie Cook - Credit Suisse

But I'm assuming you're talking to your customers.

Mark C. Pigott

Europe has slowed down, as has the rest of the world. We've given you some indications of what we think at this point, the end of January, that 2009 will look like. And we're building trucks every day, continue to win all the quality awards in whatever market we're competing in, and it's going to be an exciting year and we're looking forward to it.

Operator

Your next question comes from Adam Uhlman - Cleveland Research Company.

Adam Uhlman - Cleveland Research Company

Related to these new engines that are coming out in 2010, how much is PACCAR going to be raising prices in 2010 in the U.S.?

Mark C. Pigott

We like to look at it as raising value, but I think the range that you'll hear from everybody in the industry is $5,000 to $10,000. It's a pretty broad range and obviously it depends on horsepower and application, but I think that's the general industry range. And, of course, we've been around a long time, so '94, '98, 2002, 2004, 2007, now 2010, and about every three years we see it.

And, of course, the good news is it continues to be great for the environment, which we're proud to be a leader on, and also the fuel economy for the most part continues to improve, which lowers the cost for our customers.

Adam Uhlman - Cleveland Research Company

And then regarding the outlook for research and development expenses this year, how would you think that that would unfold through the quarters? Should we expecting kind of an expense evenly spread across the quarters or more of a gradual reduction through the year?

Mark C. Pigott

I think pretty constant, yes, pretty steady. I think the earlier question addressed a little bit about that. We're in the best shape in our history. We're in our 104th year, which is a major accomplishment, and we're going to enjoy and benefit from all these excellent investments across the board. So right now it's a little bit of a lull period, but pretty constant across the quarters.

Adam Uhlman - Cleveland Research Company

What was the impact to revenue and earnings from currency in the fourth quarter?

Michael T. Barkley

For the quarter, comparing against the last quarter of '07, the impact on all currencies was a reduction of net income by $20 million and a reduction of revenues by about $220 million.

Operator

Your next question comes from Henry Kirn - UBS.

Henry Kirn - UBS

A question about the age of the fleet in Europe today and maybe some color around what you think normalized replacement demand would be there.

Mark C. Pigott

Well, the age of the fleet in Europe is younger than North America, one of the key reasons being, as I mentioned earlier, that North America's recession started about the middle of '07 and let's say the recession in Europe started about September of last year, so they have about two more years of new vehicles and a lot more new vehicles coming in.

So if the average age in North America is six to seven, probably in Europe it's four-ish, four or five.

Henry Kirn - UBS

And with the rest of the world, what are the trends that you're seeing and what do you watch for to see when things could pick back up?

Mark C. Pigott

Well, I think two key indicators for, let's call it, the commercial vehicle industrial world are construction. You have obviously residential and commercial. You also have some of the primary industries such as steel manufacturing and auto manufacturing are big drivers. So industries that utilize a lot of transport tend to be very good indicators for the requirement to buy trucks.

Henry Kirn - UBS

I'll save you the embarrassment from having to answer why you swung to a loss 71 years ago.

Mark C. Pigott

Well, you know, the good thing is you've given me a segue as about half our management team has been here for about half of that 70 years, so we've got a pretty experienced team. We've seen the ups and downs and it's been fantastic.

Operator

Your next question comes from Andrew Obin - BAS-ML.

Andrew Obin - BAS-ML

I think it's the first time I've heard anybody talk about the cost of the new trucks going into 2010, and so the question I have, how much pre-buy - and I apologize if I missed a little bit of it  how much of a pre-buy do you have in your forecast for North America for '09?

Mark C. Pigott

Well, first of all, I think in terms of the - you're talking about the engine pricing for 2010, the $5,000 to $10,000? I think that's been sort of discussed over the last half a year.

Andrew Obin - BAS-ML

Sure.

Mark C. Pigott

The pre-buy, there might be some, but obviously it's going to be impacted by the general economy. When things are really strong with the general economy, the pre-buy has typically been pretty substantial, so I think there's some influence there.

But also, to be fair, I think many, many of our customers and the industry associations are very experienced with new engine technology. As I indicated earlier, it's about every three years now. So I think some of the thoughts about well, what's the impact going to be of this new technology are really diminishing. People are saying you know, the engines are going to be fine. Yes, they're going to cost more because there's more environmental componentry on the engines, but everybody's in the same boat so you just kind of get on with it and do it.

So there's really no mystery about it anymore. The industry has adopted SCR as the standard, same as in Europe, so everybody's comfortable with it.

Andrew Obin - BAS-ML

And would you by any chance share with us your GDP assumption for U.S. in '09? Is that something you would disclose?

Mark C. Pigott

Not typically. I'm sure we always hope it's better than other people might think it is.

Andrew Obin - BAS-ML

Just going to the Finance sub and sources of [inaudible] Finance sub, I'm a little bit  it's a twopart question - I am a little bit surprised just by how little, I guess, in terms of debt you've issued, particularly compared to peers like CAT and Deere given your reliance on [inaudible] financing in your sub versus [inaudible] year, if you'd comment on that.

And part two of the question, could you tell us where you are in terms of renegotiating your credit facility that backs up your commercial paper issuance, which I believe expires some time in the summer.

Mark C. Pigott

Well, okay, and Ron will cover that. We've got, on the backup facilities, there's a couple of those over this year and next year.

Ronald E. Armstrong

Yes. We have a $2 billion backup facility that comes due in June and we're in the process of very initial discussions with some of the banks. And we expect to renew that for the appropriate amount based on our debt position and asset size.

The first part of your question?

Andrew Obin - BAS-ML

The first part, I guess it goes to the same question, the fact that you are not issuing as much debt as some of your peers because it seems some people are sort of more worried about credit environment going into '09 and just trying to issue as much debt as they can when they can. Yet if I look at your debt issuance, I guess you said it was less than $200 million in 4Q.

Now I understand that your financial position is much stronger than that of your peers, but having said that, how good an asset is truck, particularly in Europe, and do you truly really have a positive view for recovery for North America in '09 that you don't feel the urgent need to refinance a lot of your paper or to back up your credit lines as soon as you can?

Ronald E. Armstrong

We have a continuing approach to the market to have commercial paper and medium-term notes as our primary funding source. Over the last four quarters, the second quarter of last year issued in Europe, the third quarter we issued in Mexico, the fourth quarter we did some term debt in Australia, and so far this year we've done the $178 million term note in the U.S. So we're very comfortable with our funding approach and our access to the debt markets at this point.

Andrew Obin - BAS-ML

So I guess it's fair to say that you'll stick to the same sort of short-term debt versus medium-term debt, that you're not likely to change the composition in terms of how you raise the money for the business?

Ronald E. Armstrong

No, it's always a balance, and we monitor that on an ongoing basis.

Mark C. Pigott

And I think, picking up on Ron's comments, on the medium-term, we'll go into that market on a very regular basis, as we've done over the last 18 months, and going forward do the same thing.

Andrew Obin - BAS-ML

Do you have an explicit expectation of significant improvement in U.S. credit markets in the second half of '09?

Mark C. Pigott

I wish we knew the answer to that, Andrew.

Ronald E. Armstrong

Can't really comment on that one.

Operator

Your next question comes from Kristine Kubacki - Avondale Partners LLC.

Kristine Kubacki - Avondale Partners LLC

Just a bigger picture question. We all know the current freight trends and the impact on truck demand at this point. My question is concerning a structural change with the U.S. fleet that's been emerging as the truckers have reported. Truck fleets are shedding trucks and have made comments that they're not going to bring the size of their fleets back - this regards shorter length of haul, the cost of new trucks - and they're also elongating their trade cycles. How do you see this recovery, as we think about moving through '09 and '10 versus prior cycles and could a normal replacement cycle be lower going forward from here?

Mark C. Pigott

I think that's a good question, a good macro question. We've been in business a long time. I think what happens is that when things are going good, many companies, many industries say, well, they're always going to go good. And when things turn around and aren't going as good, then everybody says, gee, this is never going to get better. So I think one of the strengths of PACCAR is we have a long-term view.

So is there a structural shift? I don't think we can say that there is. Are people concerned about the economy? Definitely and rightfully so. It is challenging times, as we've said in our press release, and many other industries have commented.

A year ago some very, very bright people in New York and around the world said that oil was going to be hundreds of dollars and now it's less and who knows what's going to happen, so I'm not sure anybody's crystal ball is absolutely sparkling right now.

Our goal is produce the highest-quality product in all the industries we compete and that's what we do every day. And if there is any sort of evolution, we'll be in good shape to meet it.

Kristine Kubacki - Avondale Partners LLC

Your industry outlook in North America and Europe - I should preface that with a trend not too different from any other industrial company at this point - has been revised lower a few times over the last few months. What's your confidence going forward in your forecasts and do you view them as conservative at this point and perhaps you'll be at the high side of those ranges?

Mark C. Pigott

Well, we just give a range and, honestly, through the year we get smarter and smarter as the year goes on. So we feel good about the range right now and when we chat in three months we'll be that much smarter, but it seems to be reflective of what's going on in the world right now.

Kristine Kubacki - Avondale Partners LLC

It's been in the press that you guys have pulled out of the Mid-America Truck Show. It caught me a little wide-eyed and I was just wondering what the strategy behind that was?

Mark C. Pigott

Well, as you may know - and I know you've been tracking the industry for awhile - most of the trade shows have been canceled in Europe because they're expensive and may not be the best way to reach our customers. They're certainly fun, but just like any other trade show, boat show, RV show, cooking show, home improvement show, sometimes in interesting times it's good to stand back and say what is the real return for the companies and for the industry?

So, as I say, I think every major show has been canceled in Europe and we're proactive on that and we're going to be actually having more of our customers visit us at our factories, at our technical centers, at our regional office. In fact, that'll probably be a record for us this year in terms of great customers who're spending real quality time, you know? In the future, we'll look at shows again, but I think PACCAR is, again, a leader in setting the quality standard in reaching our customers.

Operator

Your next question comes from Ann Duignan - J.P. Morgan.

Ann Duignan - J.P. Morgan

I just wanted to circle back on financial services again. It looks to us actually like your leverage went up, not down, in the quarter, and equity actually went down in financial services and on the manufacturing side. Can you just walk us through what's going on just from a modeling standpoint so that we understand what all the moving parts are in financial services and manufacturing.

Mark C. Pigott

Sure. Let me start out, and then Ron will give you a little more color on it.

As you know, in any type of industry where you've got a financial component, as production goes down, as the market eases back, that has an effect on the financials. Same with us, so it tracks. If things are slower, our assets are going to be lower, we're going to do less financing. When things improve, more people want to do the financing and that'll go up. So I think that's sort of the 30,000-foot level.

For more specifics, over to Ron.

Ronald E. Armstrong

Just a further comment on the asset side, we saw lower dealer inventories as the dealers managed through their inventory. They made some nice reductions and were able to manage their positions better during the quarter, and I think we'll continue to see that. And on the debt side, it reflects the lower asset balances and just normal activity with our manufacturing cash flows.

Ann Duignan - J.P. Morgan

And the lower equity on the manufacturing side, what was that driven by?

Ronald E. Armstrong

The equity on the manufacturing side?

Ann Duignan - J.P. Morgan

Yes.

Michael T. Barkley

Yes, the equity on the manufacturing side during the quarter was impacted by two main things. One is we had currencies went down during the quarter and so we had a currency translation effect. And we had, you know, our pension balances went down and so we had an equity impact from a pension funding standpoint.

Ann Duignan - J.P. Morgan

And are you contributing to your pension in 2009?

Michael T. Barkley

Yes.

Mark C. Pigott

We do that on a regular basis.

Ann Duignan - J.P. Morgan

Do we know how much?

Michael T. Barkley

Well, it'll depend on the markets. It'll depend on our views of what our funding requirements are from our pension trustees.

Mark C. Pigott

It'll probably be in line with last year. If you tell us what's happening with the stock markets, Ann, we'll all do well.

Ann Duignan - J.P. Morgan

I appreciate that, but we shouldn't expect it to be too dissimilar to last year?

Mark C. Pigott

Just normal, very normal.

Michael T. Barkley

It'll be a similar pattern to last year.

Ann Duignan - J.P. Morgan

And that does bring up just my final follow up and that's on the working capital side. Your days of inventories went up slightly year-over-year, they were down sequentially; same with days sales outstanding. How should we think about working capital management, particularly in Q1?

Mark C. Pigott

Well, I think you should think good about it. You know, a couple of little factoids that are interesting are dealers - and we actually put in our press release a section on our dealers because we think that's important - but our dealers' inventory, I'll just make a note, is probably at a four to five-year low. Our dealers are doing very well and all credit to them and obviously with our teams that are working with them. So I think that's important just in terms of managing the business.

Ann Duignan - J.P. Morgan

Will working capital be a source or a user of cash in Q1?

Michael T. Barkley

I'm sorry, repeat that question?

Ann Duignan - J.P. Morgan

Will working capital be a source of cash or a user of cash in the first quarter? I'm just thinking how quickly Europe has slowed and the manufacturing you're going to do but thought you'd probably have a lot of the inventories in house, so my question is really around what's the operating cash flow going to look like in Q1?

Michael T. Barkley

We expect to generate positive operating cash flow in Q1.

Operator

Your next question comes from Declan Carlin - BlueBay Asset Management.

Declan Carlin - BlueBay Asset Management

The first question is on the truck gross margin. In the quarter it came in at 10.7%, and in that quarter European sales were down about 25%. Looking ahead, given the Q1 guidance and given the full year guidance for Europe, should we expect margins for the full year to come in below 10.7%?

Mark C. Pigott

Well, I think we've given some indications that the production is going down and typically there's some tracking of margins and production, so there'll be some impact.

Declan Carlin - BlueBay Asset Management

Okay, so we should expect margins lower than the 10.7%, just for our modeling purposes?

Mark C. Pigott

I think that's probably a fair assessment.

Ronald E. Armstrong

If we end up producing at the lower end of our range, the margins will probably be lower and at the higher range, they might be better.

Mark C. Pigott

And as I say, it really follows. The more you can move through your factory, your margins tend to be better.

Declan Carlin - BlueBay Asset Management

Within your financial services assets, could you tell us if you have any exposure within that to Eastern Europe and could you quantify what the exposure is?

Mark C. Pigott

Eastern Europe?

Declan Carlin - BlueBay Asset Management

Yes.

Mark C. Pigott

No, we have no exposure.

Operator

Your next question comes from David Rosso - ISI.

David Rosso - ISI

Historically your trucks have had a premium resale value.

Mark C. Pigott

And they still do.

David Rosso - ISI

Well, I was just curious, with CAT's decision to exit the truck engine business and the majority of your trucks three to four years ago were powered by CAT engines - and particularly, of course, the Peterbilt brand - how would you characterize your dealers' appetites right now for tradein values? I know the CAT dealer network is supposed to support and service the installed base, but obviously the exiting of the business could raise some customers' desire to buy a CATpowered truck. Can you articulate kind of what you're seeing from your dealers on tradeins?

Mark C. Pigott

Let me rephrase that for you. It's a Kenworth and Peterbilt with a CAT engine. That's where your resale is.

David Rosso - ISI

Obviously, the drive train isn't just the engine, but obviously the drive train's - the critical aspect's the engine.

Mark C. Pigott

Just one small part of it. It's a vehicle, so I'd say minimal impact.

It's still a Kenworth, it's still a Peterbilt, it's still a DAF, and it's still the best.

David Rosso - ISI

So it may be on the margin a little, but you're not -

Mark C. Pigott

[inaudible] resale and durability and reliability.

David Rosso - ISI

On the margin, a little impact, but you're not seeing any notable change on a dealer's willingness to take that trade-in at the old, let's say, a three, four-year-old trade-in value?

Mark C. Pigott

You're still getting a fantastic vehicle that's worth 25% more than any competitor out there in the world.

Operator

Your next question comes from [Vicus Tannen] - BTIG.

Vicus Tannen - BTIG

I just want to circle, make sure I got some data right, and ask a question. The indication was that Q4 '08 versus Q1 '09 builds were down 40% in Europe. Is that correct?

Mark C. Pigott

In Q1 '09 we expect them to be down Q4, that's correct.

Vicus Tannen - BTIG

What would that translate to on a year-over-year versus Q1 '08, just out of curiosity?

Mark C. Pigott

Well, let's see if we have that data.

Vicus Tannen - BTIG

And I guess the question would be, I'm assuming that the year-over-year data would be a larger decline, obviously, since Q4 '08 already had some slowdown in it, obviously. The overall annual guidance is for 200,000 to 240,000, so picking the midpoint of 220,000. The overall industry guidance that you guys had in the press release was for a 33% decline in Europe, so are you expecting the second half of the year to be better and the decline not to be as strong? Because I'm just trying to reconcile kind of, you know, a 40% plus drop, let's say, in the first quarter with annual guidance of a 33% drop.

Mark C. Pigott

I think you've got a lot of percents there. Let's go back to the first part of you question and that is Q1 '09 versus Q1 '08 on build rates in Europe will be probably half. And, of course - you've kind of lost me with all those percents. What's your question?

Vicus Tannen - BTIG

I guess basically if we're down 50% year-over-year, let's say Q1 '08 versus Q1 '09, the guidance for at least the industry that you put in the press release was for more like a 30% decline, so if we're down 50% in the first quarter.

Mark C. Pigott

Of course, we're looking to continue to grow some market share as, you know, DAF's picked up about a point of market share per year over the last six or seven years. And, you know, they've got the best product out there. And so, you know, that's going to be an important part. I think our dealers in Europe are in good shape, very good shape most of them. And we still only have 14% share and our goal is to get to 20%, so a lot of our competitors are struggling and there's some opportunities.

Vicus Tannen - BTIG

So it's not based on a thought of macroeconomic trends in Europe, that there'll be some rebound in the second half of the year?

Mark C. Pigott

Well, you know, possibly way out there at the higher end. But, yes, I think pretty steady right now.

Vicus Tannen - BTIG

Just looking at the impact currency translation has on the business with the strengthening dollar, is there any guidance you can give for sort of how much, if the current spot rate on, let's say, the euro persisted for the entire year kind of what the impact year-over-year on profitability would be?

Mark C. Pigott

You guys are asking some questions. You know, if we had answers like this, we'd all probably be on the Fed board or something. I don't think anybody knows what's going to happen with currency or exchange rates and certainly interest rates don't have a lot further to go down. So we're just like everybody else, we're just responding to what's going on out there.

Vicus Tannen - BTIG

No, understood, but I guess just if currency rates stayed kind of where they are right now, have you guys looked at what the impact on profitability would be? And I'm not asking you what you think currency rates are going to do.

Mark C. Pigott

Yes. I mean, we do different scenarios, but I'm not sure what the - yes.

Operator

Your next question comes from Peter Nesvold - Lazard

Peter Nesvold - Lazard

Ron, just a point of clarification. On the lower loan loss reserves, is there a relationship between that and the fact that you shrunk the book, the finance book, during the quarter?

Ronald E. Armstrong

It's mostly driven by lower losses.

Mark C. Pigott

Which means our customers are doing better than you might expect.

Peter Nesvold - Lazard

So how would the accrual compare today versus where it was a quarter ago, two quarters ago?

Mark C. Pigott

Our reserve percentage is relatively static. It's about 2.1% and very conservative.

Operator

Your next question comes from [Daniel Johansen] - NBIM.

Daniel Johansen - NBIM

I was wondering, you referred to this year becoming like an '01 type of year, and if I look back at history and see, you know, in '01 you did some 255 in terms of pre-tax profit.

Mark C. Pigott

Oh, we only look at net income.

Daniel Johansen - NBIM

Yes, but the way you have showed it in your 10-Ks. And anyway, the distribution of that pretax profit was that you were roughly breakeven in North America - or in the U.S., I should say - and you did some $1 billion less than I estimate that you did last year in Europe. And if I think about this year, why should the profits go down less in Europe than a billion if you are back to the same kind of levels?

Mark C. Pigott

We shared that the general world and our industry, we should be thinking about 2001 just in terms of the challenges out there. When we look at what we did in 2001 versus, say, 2008 and you can extrapolate some of that to 2009, we're a significantly larger, more diversified company. We're just saying it's going to be challenging like 2001. And, of course, we all were here in 2001 managing it and I think the team did a great job and, once again, it was a good profit year in 2001. We're looking forward to a reasonable year this year, but it's going to be challenging. That's really the guiding force between that analogy to 2001.

Daniel Johansen - NBIM

But in essence, if you are a larger company and have more installed base and you have less volume or the same volume as you had then, isn't that -

Mark C. Pigott

We're got more parts business. We've got more finance business. We've got more winch business. And our market share is a lot higher, and we're a lot stronger in all different parts of the world. PacLease is doing very well. And the vehicles that we do make, as I said, they're 100% more efficient in terms of the factory utilization than certainly six, seven years ago. Well, that's all good.

Daniel Johansen - NBIM

Secondly, if I may, I might ask on DAF, the market share gains we've seen, obviously you have had a pretty beneficial mix in terms of geographies in Europe where U.K. accounts for some 20% of our DAF deliveries, I guess, and the Benelux countries is another 15% - 20%.

Mark C. Pigott

And moving into Scandinavia in a big way.

Daniel Johansen - NBIM

Yes. And both these markets, I mean, they were increasing nicely, I guess, in '08. Will this work as a headwind for you going forward more than the industry as a whole or how to think about that?

Mark C. Pigott

Well, if you look back at 2001 in the U.K. - of course, we've been the market share leader in the U.K. for 10-plus years. We had about 23% - 24% share. We have now 33% share, so we've gotten a bigger chunk of that. Obviously, you know, if the markets are shrinking, which they are, it has an effect on us and it has an effect on everybody. But the good news is that we are one of the largest players in the largest market versus being a small player in a big market or a big player in a small market.

So I think DAF's got great product, probably the healthiest dealer network - in fact, one of the few independently owned dealer networks versus a number of the competitors out there, so that's a real benefit. Well, I think it's a challenging market, but we're in good shape.

Daniel Johansen - NBIM

But may I also ask, maybe, how much of your trucks you sell in the U.K. do you import from Holland or wherever in Europe?

Mark C. Pigott

Not too many. We just build them up at Leyland.

Operator

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

Robin Easton

I'd like 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. Q4 2008 Earnings Call Transcript
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