PACCAR Management Discusses Q1 2013 Results - Earnings Call Transcript

Apr.23.13 | About: PACCAR Inc. (PCAR)

PACCAR (NASDAQ:PCAR)

Q1 2013 Earnings Call

April 23, 2013 12:00 pm ET

Executives

Robin E. Easton - Treasurer

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

Ronald E. Armstrong - President

Robert J. Christensen - Chief Financial Officer and Executive Vice President

Analysts

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

Ross P. Gilardi - BofA Merrill Lynch, Research Division

Andy Kaplowitz - Barclays Capital, Research Division

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

Jerry Revich - Goldman Sachs Group Inc., Research Division

Joel Gifford Tiss - BMO Capital Markets U.S.

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

Jamie L. Cook - Crédit Suisse AG, Research Division

Eric Crawford - UBS Investment Bank, Research Division

Seth Weber - RBC Capital Markets, LLC, Research Division

Alexander E. Potter - Piper Jaffray Companies, Research Division

Robert Wertheimer - Vertical Research Partners, LLC

Timothy J. Denoyer - Wolfe Trahan & Co.

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

Brian Sponheimer - Gabelli & Company, Inc.

Operator

Good morning, and welcome to PACCAR's First Quarter 2013 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. And if anyone has an objection, they should disconnect at this time. I would now like to introduce Mr. Robin Easton, PACCAR's Treasurer. Mr. Easton, please go ahead.

Robin E. Easton

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

[Operator Instructions] Certain information presented today will be forward-looking and involve risks and uncertainties, including general economic and competitive conditions that may affect expected results.

I would now like to introduce Mark Pigott.

Mark C. Pigott

Good morning. PACCAR reported good revenues and net income for the first quarter of 2013. PACCAR's first quarter sales and Financial Services revenues were $3.9 billion and quarterly net income was $236 million, an after-tax return on revenues of 6%.

I'm proud of our 21,700 employees, who have delivered industry-leading products and services to our customers worldwide. PACCAR's first quarter truck segment results reflect lower industry truck sales in North America due to slower economic growth. Class 8 industry retail sales in the U.S. and Canada were 45,000 units in the first quarter this year compared to 54,000 in the first quarter last year.

Customer truck purchases are focused primarily on replacement vehicles for their fleets. PACCAR delivered 30,500 trucks during the quarter, in line with our projections. PACCAR generated steady aftermarket parts and service revenues and strong PACCAR Financial results during the first quarter. The U.S. and Canadian Class 8 industry retail sales are estimated to be in the range of 210,000 to 240,000 units this year. In Europe, the greater than 16-tonne truck market is projected to be in the range of 210,000 to 235,000 units compared to 222,000 units sold last year.

Looking forward, PACCAR truck deliveries in the second quarter are expected to increase 5% to 10% compared to the first quarter. Second quarter gross margins should be similar to the first quarter. It's encouraging to note that housing starts in the U.S. are projected to be over 1 million units this year and there is some growth in nonresidential construction. Other good economic news is that North American auto production is expected to be 15 million vehicles or higher this year. These positive trends should benefit truck demand. In fact, freight tonnage in the U.S. is at the highest level in 10 years. That's good news. These indicators have translated into many dealers and customers earning record results in 2012.

Turning to Europe. Freight in Germany, as measured by truck miles driven, continued at levels comparable to last year. DAF truck orders in Europe have increased 29% compared to a year ago. And we're beginning to have some customers, particularly in the U.K., accelerate purchases of Euro 5 vehicles ahead of the introduction of Euro 6 emission requirements next year.

PACCAR's strong balance sheet and positive cash flow have enabled the company to invest over $1.5 billion in new products and services in the last 2 years. Last year, PACCAR launched the Kenworth T680, the Peterbilt Model 579 and the DAF XF Euro 6. These new products have received excellent reviews from customers, dealers and industry experts for their innovative design, high quality and fuel efficiency. This year, PACCAR has complemented these on-highway trucks by launching new vocational trucks: the Kenworth T880, the Peterbilt Model 567 and the DAF CF and LF Euro 6. And I think it's important to note that PACCAR has the newest and most modern vehicle range in the industry.

I think all of these new products will certainly benefit our customers; fuel-efficient, ergonomic vehicles begin to go into production. Very exciting. In addition, PACCAR has expanded its range of proprietary engines with the introduction of the updated PACCAR MX-13 and the new PACCAR MX-11 engine. The PACCAR MX-11 engine will begin production at DAF in the fall of this year and is planned to be available in Kenworth and Peterbilt vehicles in 2015.

PACCAR's global business initiatives are making excellent progress. Capital spending this year is estimated to be $400 million to $500 million and research and development expenses are estimated to be $250 million to $275 million. Construction of the new DAF assembly factory in Ponta Grossa, Brazil is on schedule and is expected to begin production in late 2013.

PACCAR Financial Services revenue were $293 million in the first quarter compared to $261 million in the prior year. PACCAR Financial's first quarter pretax income was $80 million compared to $71 million earned last year. This is the best first quarter in PACCAR Financial history and the second-best quarter ever for PACCAR Financial. The excellent results benefited from growth in portfolio balances, lower borrowing cost and used truck prices that have increased 75% in the last 3 years.

In summary, PACCAR is enhancing its leadership position in the global truck market by launching the highest-quality products and services in the industry and by investing in new geographic regions. Thank you. And I'll be pleased to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Andy Casey with Wells Fargo.

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

I was intrigued by the up 5% to 10% quarter-over-quarter delivery comment that you made. Could you update us on the European market conditions, especially related to orders? Current market condition is obviously a little rough. But one of your competitors talked about a low double-digit order improvement in the first quarter. Have you seen something like that?

Mark C. Pigott

You bet. DAF continues to do very, very well. We've seen orders year-on-year in Europe, up about 29% in Europe. I think some of our competitors may have had some numbers that reflect some increased orders, but those might be worldwide numbers. So the numbers for DAF are Europe.

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

That's great to hear. And then a few questions on the R&D expense. The 2013 outlook increased modestly obviously. What drove the increase? And then secondly, given that you realized about 30% of the new expense range midpoint in the first quarter, how do you anticipate the R&D is going to be allocated by quarter? Is it evenly? Or does it progressively get lower as the year goes along?

Mark C. Pigott

Yes. That's a good question. We're very excited and our customers and dealers are excited about all the new products. The biggest product launch, I think, in our history if you go back over the last few years, so there was a lot of R&D associated with that. And we still have plenty of R&D with new engines that are being launched and still some new options and variations on the new products that are being launched. But I think over the course of this year, R&D will gradually tail off.

Operator

Your next question comes from the line of Ross Gilardi from Bank of America Merrill Lynch.

Ross P. Gilardi - BofA Merrill Lynch, Research Division

Just back on Europe. So you've seen a nice uptick in orders, it sounds like, but you've taken your industry forecast down a little bit this year. So could you just talk about the dynamic there a bit?

Mark C. Pigott

Right. Well, we've got some orders coming in. I mentioned briefly that we're starting to see some Euro 5, I guess, you could call it prebuy orders. There's many countries have different cutover dates in terms of being able to purchase or produce Euro 5 versus Euro 6. We just had a very successful show in Birmingham, the U.K., where we launched the new CF and LF and that generated a lot of interest and a lot of orders from our customers there. We'll just have to see what happens as the year progresses. But I think customers are starting to realize that there are some benefits to Euro 6, but it will be at a higher cost of EUR 10,000 to EUR 15,000. So some of them are saying it might be worthwhile purchasing Euro 5 vehicles this year, and that's -- now we're coming up to May. People are saying, "I need to start making those decisions." So I think for the total year, Europe has obviously got some challenges, just as a general eurozone economy. But I think if it's comparable to last year, it would be a pretty good year in Europe.

Ross P. Gilardi - BofA Merrill Lynch, Research Division

Great. And then the detail you provided on parts versus trucks, and so forth was very helpful in your parts margins, I think you came in around 14.3%. Can you talk a little bit about where that has been historically and where you think it can go? And do you see any revenue acceleration or cost impact in the parts business as you open up your new Parts Distribution Centers in several locations?

Mark C. Pigott

Yes. Well, we appreciate it. We're trying to keep giving the good information so that you and your peers can make good decisions, so thanks for the feedback. I think parts margins have probably improved a little bit as we've gotten more proprietary products out there. And certainly, we're pushing that in North America. And Europe's probably had more proprietary with their own axle and engine for many more years. But I think in terms of products that we're bringing to the market for our customers, we're trying to do a better job of sourcing. I think margins are going to be sort of in line with where they are now. Certainly, as we add new distribution centers, we're looking for some growth in our sales, particularly as we get into new markets, like South America. But just continue to achieve some improved efficiencies in the way we're processing the logistics of the orders of the entire parts operations. So we've got a very talented team in Parts, keep coming up with new ideas and new products to sell and new services to offer our customers. So I think it looks very bright, very good future.

Operator

Your next question comes from the line of Andy Kaplowitz from Barclays.

Andy Kaplowitz - Barclays Capital, Research Division

So Mark, PACCAR at Mid-America talked about a pickup in vocational trucks, which do tend to carry higher margins. Maybe you can update us on that improvement. Have you seen it continue? You mentioned a little bit in your release. But do you expect that improvement to be reflected in your margins? Is it already? Or is it coming still?

Mark C. Pigott

Well, the Kenworth and Peterbilt team, I think, have done a very good job. The new products they just introduced with the 880 and 567 seemed to be timed pretty well as we see that the housing starts, particularly in the U.S., increasing, getting back to some, let's call it, closer to replacement levels on housing starts. Peterbilt and Kenworth have over 40% market share of the vocational market, which is good. And vocational is probably about 20%, 25%, maybe 30% of the total market. That could improve as we see more construction going on. It does tend to have a little bit better margin. I don't think it's going to have a significant impact on this year. But I think certainly the Kenworth and Peterbilt team are well poised with their new products to continue to do very well in that marketplace.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. Mark, that's very helpful. And then let me just shift gears. One of the biggest deltas, at least versus our expectations, continues to be in the regions outside of North America and Europe. So maybe you could talk about when we might see stabilization. You talked a little bit last quarter about countries like Colombia, Mexico, Australia. What are we seeing in these regions? And are we going to stabilize in these regions?

Mark C. Pigott

The Mexico market is actually reasonably steady. Colombia had a large infrastructure investment with their pipelines that's been completed. But they're now looking at other infrastructure development. Of course, the big area that we're focused on is getting our plant in Brazil up and running. I was just there a week or so ago with the team and very encouraged. We're planning to be building DAF Trucks there later this year. And Brazil, as we've talked I think in previous calls, continues to have very good margins for manufacturers. And many of our competitors generate a sizable portion of their profits from Brazil. I think maybe 1 or 2, that's the only place they make money. So we're looking forward to being in that marketplace. We're coming in as a premium product. Certainly, everybody knows what we offer. We have a great range of DAF Trucks. We've got many dealers that are investing in new facilities, and it's very exciting. But it'll take time. We're just starting out this year slowly, and we'll grow over time. So I think that'll be a good benefit for PACCAR. Australia is an important market, it's a smaller market. And we tend to be the market leader there. It's been fairly, fairly stable. And then over to Asia, big markets but not a lot of money being made there, but important markets.

Operator

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

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

Talking about Brazil, can you talk a little bit, Mark, about what you would expect the competition to do? I mean, the competition is just not going to allow DAF to come along and take market share away, particularly given the sizable margins in the region. How have you seen the competition react previously when you've brought out new products or tried to gain share? I know Brazil is unique. But maybe you could talk about what the competitive reaction might be.

Mark C. Pigott

We compete against an excellent group of competitors in the marketplace. I'm sure that they're having their own calls. And I know that you're very thorough, so I'm sure you're asking them those very same questions. So I don't want to jump ahead of what they're saying. I think the good news for the Brazil market is that DAF is the premium-value, high-quality product. All of our competitors know that. It's a relatively small world that we compete in. We know the competitors, they know us. And unlike some new competitors under Brazil, who are very interested in just gaining share and getting a foothold at a very low price, we're going to come in and offer our customers a wonderful value with a great product that's going to deliver for them in terms of efficiency and helping their operations be profitable. So I'm sure that the competitors are continuing to make their investments in their facilities, in their products, in their dealerships just as we are also. So it's pretty similar anywhere in the world. But I think, Ann, to your point that what we're going -- we're coming in as the premium, and that's what we've done over 108 years now around the world. So I think that is probably relatively good news for our competitors.

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

Okay. I do appreciate the color. And then back to Europe -- Euro 5, Euro 6. I mean, in a way, the worst thing we could see this year is prebuying because it will just come out of next year. Can you talk a little bit, Mark, about -- are your dealers tempted to prebuy also and store some of these or carry an inventory of some of these Euro 5s as well as your end fleet customers? Can you just talk about the mix there a little bit?

Mark C. Pigott

Yes. First of all, of course, like everybody, we have dealer meetings on an ongoing basis, and our dealers are probably in the best shape they've been in for my 35 years. They are great facilities. They're making excellent returns. They've got strong teams. And of course, as an OEM, we're supplying them with wonderful new trucks and services and Financial Services. So the dealers are doing well, their inventory, I think, generally is probably at the mid- to the low state. So they're in great shape that way. In terms of Euro 5, there are different guidelines by country, so dealers are not really able to store vehicles. They have to abide by the requirements of each country. So I think it's really going to be driven more by the customers. The customers know that they either have to put in service or have to purchase Euro 5 vehicles by a certain time and each country has their own guidelines on that. So dealers are doing well.

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

And what about used equipment when we switch to Euro 6? I mean, I've heard some dealers talk about the fact that 50% of their used equipment goes to regions of the world where ultra-low sulfur diesel is not available. Would that be similar for DAF dealers, that a significant number of used trucks end up in countries where no ultra-low sulfur diesel is available?

Mark C. Pigott

I think a few years ago, there's probably more of a trend towards that. But you look at countries, like Russia. They want to have good, new products operating, meeting whatever their latest Euro emission requirements are. So I think Used Trucks will be good if you -- next year, if you want to buy a truck and there's a Euro 5, that's going to command a pretty good price. So used trucks really have had a strong growth over the last 3 years, as I mentioned in my comments. And we're producing the best trucks we've ever had in our history. So I think the customers and the dealers really appreciate that. Used trucks is a very, very good business right now, very good.

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

I bet, if it's a Euro 5.

Operator

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

Jerry Revich - Goldman Sachs Group Inc., Research Division

I'm wondering if you'd just talk about the plan for PACCAR Financial in Brazil. At which point do you ramp up the Financial Services subsidiary in the region?

Ronald E. Armstrong

Sure, you bet. Just as we do around the world, Jerry, as our volumes grow in various markets, we make decisions at various points in time to supplement our business with a finance operation, and we'll follow that same practice in Brazil. As the volumes grow, we'll decide at the appropriate point where there's enough volume to support a standalone finance operation. And we'll work closely with banks in Brazil to support our operations and make sure that our customers have the best financing options available.

Mark C. Pigott

And I think picking up on that, Brazil has some guidelines in terms of local content, in terms of weight and value, about 60%, that allows you to qualify for some national financing programs. And most of our competitors do that. We certainly plan to be part of that program, which is a good advantage for our customers and our dealers. So that's what we'll be doing. As Ron mentioned, working with -- there's a couple of major banks in Brazil. They're very good banks. We'll work with them and structure a program to enable our customers to have a competitive financing program just like the competitors have.

Jerry Revich - Goldman Sachs Group Inc., Research Division

And switching gears to Europe market, can you just put the order growth comment into perspective for us? Can you talk about what the book-to-bill was in the quarter for DAF in Europe or talk about how much the backlog grew in the quarter?

Mark C. Pigott

I think that the -- well, the backlog year-on-year is about the same for DAF. And we're finding pretty steady order intake right now, which allows us to have pretty steady production. As I mentioned, we're starting to see the early signs of -- I call it -- you can call it a prebuy or just people buying more trucks is another way of looking at it, starting in the U.K. That may, over the next few months, begin to filter out to different countries on the continent. So I think we're in pretty good shape.

Jerry Revich - Goldman Sachs Group Inc., Research Division

And in terms of what you're hearing on the incentives side to, I guess, mute the impact of prebuy, it sounds like Germany and Poland are considering some toll road incentives there. Can you just talk about what you're seeing across the region and how you think that plays out?

Mark C. Pigott

Yes. Well, I think each country is evaluating whether there is an incentive to purchase Euro 6, whether it's a straight-out incentive or a lower tax or something on the toll road. So there's a lot of different ways to approach it, and each country has their own guideline and their own governing body that's going to determine that. And that's beginning to take shape. But I think it's still going to be a couple more months before we really get it clarified for all of Europe. But I think Europe, probably more than North America, tries to have incentives to direct customers to partake of the latest environmental-improved vehicles. We see that. We've seen that a number of times, whether it's Euro 4, Euro 5 and now Euro 6.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Okay. And lastly, I'm wondering if you could talk about pricing conditions on order activity today compared to what you're shipping out of backlog in North America and Europe. Any meaningful changes in the landscape?

Mark C. Pigott

No, I think pricing has been pretty steady over the last 3 to 6 months. Obviously, we're very excited about these new products that we're launching and the new engines we're launching that hopefully will continue to contribute to good margins and maybe even slightly enhanced margins.

Operator

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

Joel Gifford Tiss - BMO Capital Markets U.S.

Can you talk about why the penetration in the U.S. with the PACCAR engine is still kind of low? I know that when you first introduced it, you were hoping to get it up to 50-50 over a reasonable period of time. And it still seems kind of below that.

Mark C. Pigott

Well, it's at 30%, and we're seeing some good, particularly good growth this year. I think what we've been able to do and dealers are very excited about it, is we launched these new truck products, and there's been a lot of it, you've seen it in the press release, a number of those truck models are tailored to have the PACCAR engine in it, which I think the customers will find very advantageous. So we're excited about it. Yes, we're at 30% share, and we feel very confident that, that will grow and perhaps even accelerate over the near and medium term as these new truck models come out that have been designed for the PACCAR engine. So a lot of good work being done by our engineering teams.

Joel Gifford Tiss - BMO Capital Markets U.S.

Okay. And can you give us some -- a little bit of a framework on margin impact from all the initiatives you've had? Launching new products is obviously very expensive and opening your factory in Brazil. So as we go into '14 and '15, can you give us a sense of how much drag there has been on the operating margins in the last 2 years from all these initiatives?

Mark C. Pigott

I mean, I think that the ramp-up, we've continued to add additional people in Brazil as we've started factory construction. We just added our first line supervisors to our team. We've had the executive team in place for quite some time. So we'll continue to see that as -- build as it gets closer to building our first trucks in the fourth quarter. So it's been a negative effect. But I wouldn't say it's a sizable impact on our operation.

Robert J. Christensen

I would say the same thing for the introduction of the new product. You see some small increase in our R&D levels, which we expect to plateau and go down during the course of the year. But it's rather small in terms of impact on margins.

Operator

Your next question comes from the line of Stephen Volkmann from Jefferies.

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

Just a little bit of a clarification, I guess. Mark, you had mentioned sequentially, you thought production could be up 5% to 10%, and then I think you said gross margins, essentially flat. And I guess, I would expect some sort of volume benefit in your gross margin, if you had that much sequential increase in production. So I'm wondering, is there sort of an offset there we should be thinking about? Or are you being perhaps a bit conservative? What's the right way to look at that?

Mark C. Pigott

No, I think we're being -- that's the way we look at it. Obviously, we've got a -- we take on some people as we increase production, working with some of our suppliers to make sure that everybody can increase their production. I think there continues to be, just in the marketplace, people are looking for the best package they can get in terms of pricing. Our customers, as I mentioned, are doing well. But they're not expanding their fleets. It's more of a replacement. So everybody is still very conservative and cautious in terms of the amount of pricing that they're willing to allow an OEM to increase. The marketplace, as I've shared, is similar to last year. Last year was a good year for PACCAR. But our customers, our dealers are saying, "Okay, we're seeing some good things, but every day, there's sort of challenges out there." So I think we'll produce more and we're looking forward to that. But I don't think the margins that we're selling to our customers is necessarily going up at the same rate.

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

Okay. Understood. And then maybe just quickly on the MX-11 engine, can you sort of lay out your expectations for that product over the next year or 2 in terms of, I don't know, volumes or penetration? Or how should we think about that opportunity?

Mark C. Pigott

Yes, sure. That's a good question. Of course, the MX-11 is really going to be going into our DAF product first, and we'll bring it into North America in 2015, which is a number of years from now. And we look for the MX-11 over time to be 20%, 30% of our volume in Europe. It's a very exciting product. It's got great torque and great horsepower in a smaller package, which is really the trend we're seeing around the world. And of course, in North America, as we've talked over the last 12, 18 months, the 13-liter is essentially the same volume now as the 15-liter on a general industry level. And the 11-liter in Europe will probably take some of the business from the 13-liter in Europe, as people are saying, "I can get 400 horsepower and strong torque, and that's all I need to move my products around." So we're excited about it. It's one of the first all-new engines that have been unveiled to the industry by any competitor for a long time. So it's very exciting.

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

And can you make that product in Mississippi as well?

Mark C. Pigott

In fact, we're making about 1/2 of it in Mississippi. So between our 2 engine factories in Holland and Mississippi, there's a great collaboration and sort of best practices as we do a lot of benchmarking. So they make about 1/2 of it there and ship it to Holland.

Operator

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

Jamie L. Cook - Crédit Suisse AG, Research Division

A couple of quick questions. At Mid-America Truck Show, it was mentioned that some of the dealers, I think, in particular Peterbilt dealers, inventory levels were cited in some instances as too low. Can you talk about how you're feeling about dealer inventory levels both at Peterbilt and Kenworth? And then I guess, my second question, on the margin side, I think last quarter, you said for the full year you expect margins to be about flat. Is that still your expectation with R&D coming up modestly? And then my third question, I guess, is you've done an impressive job gaining market share in North America. I mean, do you assume you can hold that share this year just with sort of the competitive dynamics changing a little that we could take a step backward before we move forward or hold share?

Mark C. Pigott

Three great questions. First, it was a good show at Mid-America. And the dealers' inventory is in terrific shape if you're a dealer. They're doing well. I think that they recognize that the market, particularly for vocational, we're seeing a bump in that. They'll probably bring some more stock on. But dealer inventory, as I say, is probably in the best shape it's been for years. So they're very comfortable. And I think they'll begin to increase their inventory modestly. In terms of margins, yes, we still expect it to be relatively comparable to last year. I don't see a lot of changes on that. R&D will begin to decline, as I mentioned earlier. We've got -- we've come out with a lot of new products and a lot of those programs are starting to wrap up. Obviously, some new programs will take their place. But I think you'll see that decline. And then in terms of market share, it was a record market share last year. We've never been market share-driven. We think the market share will probably be comparable to last year. But what we're excited about is coming out with all these new products and just enhancing our dealers' and our customers' business with great new products. So market share; different competitors are at different cycles in their business. We've seen that for many, many decades. And I think our market share will be sort of in line with last year.

Operator

Your next question comes from the line of Eric Crawford from UBS.

Eric Crawford - UBS Investment Bank, Research Division

Not to beat a dead horse, but I'm still trying to understand the lower outlook in Europe. What drove the reduction? And I'm curious, actually you mentioned steady order intake right now. But I'm curious how the cadence of orders trended for DAF in the quarter.

Mark C. Pigott

Well, I think the cadence was pretty steady. As I say, we had a good show in Birmingham. I don't know if you were there or not. But of course, launching of the new products and with some of the U.K. regulations and guidelines on Euro 5, Euro 6 that got people's attention. And DAF in the U.K. has been the market share leader. We've got a great team there. So that's generating a lot of very positive business for us. I think in Europe, you read the press as well as we do, it's just -- many countries are in a recession. There's certainly challenges. Freight overall is flat, certainly in Germany, which has a very good program in terms of being able to track freight. You compare that to the freight in North America, which is at a 10-year high, a big difference. Obviously, customers carry the freight. That's what drives their business. And I think there could be -- if there's a prebuy, that may be good for the first 3 quarters or so, but there might be a slowing in the fourth quarter. So I think it's just being conservative and trying to reflect the ongoing eurozone business conditions is really what we're looking at.

Eric Crawford - UBS Investment Bank, Research Division

Okay. That's helpful. Assuming retail sales do come in at the middle of that range, flat year-over-year, what kind of delta should we expect in terms of your production? Are you going to be overproducing, underproducing?

Mark C. Pigott

You're talking about for Europe now?

Eric Crawford - UBS Investment Bank, Research Division

Yes.

Mark C. Pigott

Well, of course, one of the great things about working for PACCAR is we only produce what we have orders for. So I never really think of it any other way. So we vary our production levels to reflect incoming order rates. And right now, DAF's been pretty steady on their build rates for about 17, 18 months now. And we've got a very good team out there getting the orders. And market share is pretty much in line with what it was last year. So we'll see what happens.

Operator

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

Seth Weber - RBC Capital Markets, LLC, Research Division

Just going back to the second quarter delivery target, up 5% to 10% sequentially, can you give us any more details on how that breaks down U.S. versus Europe?

Mark C. Pigott

You bet. I think it'll probably be about 2/3 in North America and about 1/3 in Europe.

Seth Weber - RBC Capital Markets, LLC, Research Division

Okay. And then on the 29% increase in orders for DAF year-over-year, can you give us any color on what that did sequentially? I mean, was there something unusually soft in the prior year quarter?

Mark C. Pigott

No, I think a year ago, the orders were actually pretty good. And what I see is we've been able to benefit this quarter, the first quarter of 2013 with some strong order intake, particularly in the U.K., really surrounding the exciting launch of the new CF and LF at the Birmingham show. I think that stimulated some good orders in the last month or so.

Seth Weber - RBC Capital Markets, LLC, Research Division

Okay. So orders were up from the fourth quarter to the first quarter then?

Mark C. Pigott

Yes. They were -- well, they were actually -- they were up a little bit on sort of the medium side and relatively flat on the heavies.

Seth Weber - RBC Capital Markets, LLC, Research Division

Okay. And then just lastly, I was surprised to see the Parts sales number down for the quarter year-over-year. Is that -- is there something going on there? I mean, I think it was up 3%, 4% or so last year. Is this just kind of a hiccup here?

Mark C. Pigott

Well, they've been on a -- Parts has just done a marvelous job. They've had such strong growth over the last 10 years that I think people are just having a little bit of a breather. They keep coming out with wonderful, new programs. And we just had dealer meetings in the last month or so. They're still excited about it. I think most of that, probably the parts impact was in Europe. The dealers being just a little bit conservative about the parts and obviously a little bit of maybe slower servicing side also at the dealerships. And servicing is usually the biggest customer of Parts for either business. So just once again, Europe, just a little bit conservative that way, a little bit slower.

Operator

Your next question comes from the line of Alex Potter from Piper Jaffray.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Let's see here. So I was wondering if -- you talked a lot about the vertical integration and the integration of the MX engine obviously into your products. I was wondering if it's possible to quantify a fuel economy benefit that you might be able to articulate to customers when you're pitching that as kind of a packaged product as opposed to using outside engines.

Mark C. Pigott

Well, we have several benefits using our engine. Typically, they have a couple percent improvement on fuel economy, but they're also lighter. And as I say with the new products, we've been able to package them in a smaller hood. So you have a little lower profile of the vehicle. And of course, we're excited about our own engine. We think it's got great reliability. It's very quiet, easy to drive. And so it's something that we've been working on for 50 years, great driving experience. And I think that really sort of sums it up.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Okay. Then there's, I guess, one other question. I was wondering just in terms of the long-term direction, obviously you've been spending a lot on new products. At the end of this year, Brazil will be in production. I was wondering kind of what the next big thing is. Have you guys thought of, I don't know, maybe going to China? I guess, what is the next big strategic initiative?

Mark C. Pigott

Well, we have a lot of initiatives around the world. Speaking of China, we do sell into China. We've been proud to be selling into China for many, many decades. It's small numbers, but we'd look to grow there. And we're starting to get a foothold in India, which is also very exciting for us. And I think really Brazil is not just sort of a open the door, and then it's over. We're there for 50, 100 years. And so we want to grow that and bring the same sort of great service and great products that we bring to our customers in North America and Europe. And of course, there's always opportunities in growing in the Middle East and Africa, so there's a lot of things going on.

Alexander E. Potter - Piper Jaffray Companies, Research Division

But not necessarily an appetite to replicate the Brazil approach in some of these other big, developing markets?

Mark C. Pigott

Well, I don't think I can really comment on that at this time.

Operator

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

Robert Wertheimer - Vertical Research Partners, LLC

So just wanted to follow up on the 11-liter. Out of curiosity, was any of the R&D increase this quarter and this year related to any final work on that and/or the decision to go to the U.S. in 2015? And just wanted to ask the decision to go later [ph] in Peterbilt and Kenworth, was that product fit-related or just because the market is not as big for the 11-liter here in the U.S.?

Mark C. Pigott

Yes. I think the 11-liter -- yes, obviously there has been R&D and capital investment for the 11-liter in terms of the manufacturing side of our business, but also just supporting it and getting our dealers ready for it. The 11-liter is a smaller market size at this time in North America. And I just thought it made more sense to begin in Europe, where really we only have PACCAR engines in our DAF products. And we have the 9.2-liter at DAF. And this is a nice, new product to, let's call it, transition from the 9-liter to the 11-liter. So that's really the reasoning.

Robert Wertheimer - Vertical Research Partners, LLC

Great. And are you seeing any increase in mid-size fleets in the U.S.? Credit availability, I guess, you can see. Is that continuing to be okay? And are you seeing the mid-size fleets sort of step up? And then if I could just sneak in my last one, have you announced any production timing changeover for Euro 6 when you stop making the Euro 5?

Mark C. Pigott

Yes. I think the -- I'd say all fleets, small, medium, large that are operating today are very experienced. They've been through some challenging times over the last decade and they're doing well. I can't say that one is stepping up versus the other. I think they each take a look at their own customers and see how they're doing. Obviously, there's been a lot of discussion recently about housing starts and, of course, housing starts also translates into white goods and carpets. And the car business is strong right now, so there's some benefit for steel and glass and aluminum and electrics, electronics. So if you're a trucking company that works for that industry, you're thinking things are pretty darn good.

Robert Wertheimer - Vertical Research Partners, LLC

Got you. And the changeover for the Euro 6, Euro 5?

Mark C. Pigott

It really -- the deadline is January 1, 2014, but the transitions are occurring now. We're selling Euro 6 XF vehicles today out of DAF. And we'll be introducing the CF and the LF as we progress through the middle and the latter part of this year. And so a customer can have a Euro 6 vehicle or they can have a Euro 5 vehicle up to January 1, 2014, if they're driving in the eurozone. But we'll continue to offer Euro 5 vehicles outside of the eurozone.

Robert J. Christensen

Next year, absolutely.

Operator

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

Timothy J. Denoyer - Wolfe Trahan & Co.

Question on your North American outlook. It seems to imply that truck orders rise into the second quarter from the first quarter after running at sort of a 180,000 kind of a rate for the first quarter sales, where they usually kind of take a small seasonal step-down. Can you talk about quoting activity and what you're seeing that would support an improvement in orders from here? And how long does it usually take for the bidding activity that you've been seeing, I think, since January to translate into orders?

Mark C. Pigott

Yes. We are certainly thinking, and along with our entire industry, that there should be a pickup in the second half. We're not the only industry that's saying that. As you read the financial press, there are many industries that are talking about it. I think for the general U.S. economy, they're certainly hoping for an improvement in the second half. So certainly, our industry is in line with that. In terms of seasonality, typically, we don't see a lot of seasonality. Yes, there are people who buy different -- for different sectors of trucking, but that tend to be evenly spaced throughout the year. So I don't really see much seasonality on that. We're starting to see some customers are interested in replacing more vehicles, say, coming out of the Mid-America Show, where Kenworth and Peterbilt launched a lot of new products. There was a lot of interest. The dealers were in great shape, having a little bit of improvement in their stocking. So we're seeing people there say, "Hey, it seems like a good time. I'm getting more of a positive feeling for the general economy. But it's not just booming, but getting a better feeling." So that's positive right now. And in terms of the amount of time it takes to -- for the customer to think about an order, to placing an order, it really depends on that customer. I can't really say much more than that.

Timothy J. Denoyer - Wolfe Trahan & Co.

Can you just give us a sense of just historically, if you saw an increase in quoting activity? Is it 60 or 90 days later, where you'd see orders start to pick up?

Mark C. Pigott

Oh, I see what you're saying. Okay. All right. Yes, it's hard to say. But I'd say probably in, let's call it, 30 to 90 days because some customers are ready to move quicker than others, but it's -- there's a range like that.

Operator

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

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

Two quick questions. When I'm out talking to truck fleets manufacturers, they're telling me how raw material costs are coming down. And I was just wondering what you're experiencing and if that's a factor in the second half if current trends continue.

Mark C. Pigott

Yes. I think you and I talked, maybe a couple of years ago, raw material probably had more of an impact. We're seeing because of lower demand on a global basis, some decline in raw materials. Some of it has picked back up a little bit. Let's say with the car guys, we're seeing steel was way down, and now it's come back a little bit, rubber coming back a little bit. But in general, the global demand has slowed. It's not way down. I mean, you've got major countries, China, India, that still have very strong GDP growth, although it may be lower than it was a few years ago. Typically, with our long-term contracts, which probably cover over 70% of all the product we purchase from suppliers, that tends to be sort of flattened out.

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

Okay. And then one follow-up. I know you -- I saw you took the top end of some of your forecast for this year down slightly, yet in your annual report, you said Financial Services assets should increase at about a 5% to 10% rate this year. Are you holding to that Financial Services asset forecast or might that come down a little bit with your kind of global vehicle forecast?

Mark C. Pigott

The annual report is written the end of last year. So that's now 4 or 5 months behind us, and lots of things have happened. I mean, based on the truck forecast ranges that we've talked about, 210,000 to 240,000 and 210,000 to 235,000 in Europe, I think we'll continue to see growth in the portfolio assets because what -- the collections that we're collecting today are originations in 2008, '09 and '10, when portfolio growth was smaller. So we'll still see some modest growth.

Operator

Your last question comes from the line of Brian Sponheimer from Gabelli.

Brian Sponheimer - Gabelli & Company, Inc.

Going back to just the previous question about vehicle age and what you're seeing come back to you, we had a very large year for U.S. sales Class 8 trucks in 2006 ahead of 2007 EPA. What sense or what kind of data are you seeing with the trucks that are coming back to you now for fleet replacement? Is that '06? Or I guess, it would be the '07 model year all the way through the system. Or could this be a real opportunity for increased sales and production for the next 18 months?

Mark C. Pigott

In a normal market, a vehicle that's 5, 6 years old will certainly be into its second owner and have pretty high mileage. You could take a look at anywhere from 500,000 to 1 million miles on those vehicles. But with the recession of, let's call it, '09, '10 and part of '11, the mileage on a lot of these vehicles was substantially decreased. They may have been parked, they just may have had less business. So we're finding that those vehicles actually are in great demand because they have typically lower mileage than you would normally associate with a vehicle 5, 6 years old. And so we do talk about an older vehicle fleet age of 7, 8 years old. But if you have a truck that's 7 years old but only has 500,000 miles, it's in pretty good shape versus one that has 1 million miles. So you kind of have to read between the lines on what these vehicles are actually bringing to the party. Right now, those vehicles on the used market are really doing well.

Brian Sponheimer - Gabelli & Company, Inc.

Right. Well, I guess, I mean, if you were able to define any sort of forecast for your own fleet customers who are potentially selling some of those vehicles on to their second owners right now and getting some pretty substantial markups on the used side, do you think that there's any opportunity for you over the next 18 months or so because of this dynamic? Or has that ship sailed?

Mark C. Pigott

We have a portfolio of trucks that we have on operating lease in our finance operation and in Europe as well. And so we have a constant inflow of used trucks coming back to us. It's not a huge number, several hundred trucks each month in both North America and Europe. And yes, we're able to pass those on based on the market values at the time, which -- we put the values on them at inception based on the strong residual values that the PACCAR products realize in the second-hand market.

Operator

You have another question from the line of Tim Denoyer from Wolfe Trahan.

Timothy J. Denoyer - Wolfe Trahan & Co.

Just a quick follow-up to my earlier question. You were saying that it typically takes 30 to 90 days from the increase in quoting to orders. And I was just checking my notes from the call 3 months ago, and you had said that, I think, it was mid-January that quoting activity had picked up. So 90 days later, are you seeing an increase in order activity at the moment?

Mark C. Pigott

Well, the good news is we're increasing our production hopefully 5% to 10%, so we're seeing a little bit.

Operator

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

Robin E. Easton

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

Operator

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

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