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PACCAR Inc. (NASDAQ:PCAR)

Q4 2009 Earnings Call

January 29, 2009 12:00 pm ET

Executives

Mark Pigott - Chairman & Chief Executive Officer

Ron Armstrong - Senior Vice President

Michael Barkley - Vice President & Controller

Robin Easton - Treasurer

Analysts

Meredith Taylor - Barclays Capital

Jamie Cook - Credit Suisse

Joel Tiss - Buckingham Research

J.B. Groh - D.A. Davidson

Henry Kirn - UBS

Adam Uhlman - Cleveland Research

Steve Volkmann - Jefferies

Mike Rourke - McAdams

Andrew Obin - Banc of America/Merrill Lynch

Kristine Kubacki - Avondale Partners

Jerry Revich - Goldman Sachs

Patrick Nolan - Deutsche Bank

Ann Duignan - JP Morgan

Ben Elias - Sterne, Agee

Andrew Obin - Bank of America-Merrill Lynch

David Raso - ISI

Garrett Stevens - Giovine Capital

Operator

Good morning and welcome to PACCAR’s fourth quarter 2009 earnings conference call. All lines will be in a listen-only mode until the question-and-answer session. Today’s call is being recorded and if anyone has an objection they should disconnect at this time. I would now like to introduce Mr. Robin Easton, PACCAR’s Treasurer. Mr. Easton, please go ahead.

Robin Easton

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 Barclay, Vice President & Controller.

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

Good morning. I’m very pleased to share the news that PACCAR has earned a net profit for the 71 consecutive year. This remarkable achievement has been attained due to the hard work and dedication of our 15,000 outstanding employees who have delivered the highest quality products and services in our history against a back drop of a very difficult recession.

I’m very proud of their performance as it shines a light on the consistent proactive approach that has enabled PACCAR to achieve the best shareholder performance in our industry worldwide. On that note, I’d like to personally thank our long term shareholders including the Pigott family for their support and encouragement during the challenging times of 2009. As has been done and other lien years, I and some of the senior executive team did not earn an annual bonus last year due to the effects of the recession.

Looking at 2010, the year ahead will continue to be challenging for many businesses. The economy is still in the middle of a recession. As long as unemployment is at levels close to 10%, and housing starts are at 50 year lows, freight growth will be muted and truck sales will only gradually increase.

The good news is that PACCAR’s fourth quarter results were our best profit quarter in 2009. PACCAR earned $46.1 million in the fourth quarter 2009, compared to $113.1 million in the prior years fourth quarter. fourth quarter 2009 results include a onetime expense of $11.4 million resulting from the retroactive effects of a New Mexican Corporate Income Tax Law enacted in December 2009.

Fourth quarter net sales and financial service revenues were $2.2 billion, compared to $2.9 billion reported for the comparable period in 2008. Regular dividends of $0.54 per share were declared during 2009, and as many of you know, PACCAR has paid a dividend every year since 1941. It’s a long time.

During the last decade, PACCAR’s regular dividends have increased by 240% and PACCAR’s average annual shareholder return is 19.1% for the last 10 years compared to the S&P 500’s return of a negative 1% annually. Reviewing our business, there may be a small improvement in truck and aftermarket sales driven primarily by the industries need to begin replacing an aging national truck fleet.

PACCAR is in excellent position to grow due to the strength of our dealers worldwide, a robust finance company the most seasoned and experienced management team in the business and the highest quality products in the industry. As I enter my 32 year at PACCAR, this promises to be one of the most exciting years. As we begin the installation of the PACCAR MX Engine into Kenworth and Peterbilt trucks this summer.

The PACCAR Engine successfully completed a grueling 50 million mile test schedule and is ready for the North American market. Of course, as many of you know, PACCAR through our DAF truck group has been designing and building engines for 50 years, so the entry into North America is a logical step. We’re pleased that our PACCAR Engines continue to earn industry quality awards.

Speaking of quality, PACCAR reinforced its industry leading quality and resale value in 2009. Kenworth trucks were again ranked highest by the J.D. Power Heavy Duty Customer Satisfaction surveys and the over the road, pick up and delivery and dealer service segments.

Peterbilt was also ranked highest in the conventional medium duty truck segment. PACCAR was honored earlier this year by earning the J.D. Power Founders award for our 25 years of quality leadership and DAF earned the U.K.’s Motor Transport Award for Fleet Truck of the Year for the ninth time.

Looking at the markets, the 15-ton plus truck market in Europe is estimated to be between 150,000 and 180,000 units this year compared to 168,000 last year. U.S. and Canadian retail truck sales are estimated to improve to be in the range of 110,000 to 140,000 units this year compared to 108,000 in 2009.

Now, even though first quarter 2010 industry sales will be helped somewhat by the demand for trucks with 2009 engines, it’s estimated that first quarter truck production will be 5% to 10% lower than the fourth quarter as customers adjust to the $8,000 to $10,000 price increase for 2010 EPA emission engines.

Once again, the good news is that PACCAR’s strong performance places the company in a leading position when industry demand improves to a more normal replacement range of 225,000 to 250,000 units in the U.S. and Canada and the same levels in Europe.

Looking elsewhere in our business, PACCAR continues to invest in its factories, and we appreciate that many of the analysts on this call have toured our facilities and have seen firsthand the superb quality that is represented in every facet of the operations and we thank you for taking the time to do that.

PACCAR’s excellent balance sheet and strong operating cash flow of over $1.3 billion have enabled ongoing investments in projects such as new diesel engines, expanded vehicle ranges, and annual factory efficiency improvements of 5% to 7%, and finally, PACCAR’s finance companies have demonstrated remarkable resiliency due to the rigoroused customer credit reviews, proactive management of challenging accounts, and good access to the capital markets. We look forward to 2010 and the opportunities to grow the company.

Thank you and look forward to your questions.

Mark Pigott

Operator, we’ll take questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Meredith Taylor - Barclays Capital.

Meredith Taylor - Barclays Capital

I’m hoping we can talk a little bit about the trends that you saw in Europe. Clearly we saw nice sequential bounce there. Can you speak a little bit about how much of that was driven by underlying end market momentum versus the dealer network, having worked inventories down such that your revenues more closely matched end market trends?

Mark Pigott

In terms of incoming orders, we’ve seen pretty much the same amounts in the last two quarters so there isn’t much of a story there. I think as we look at 2010 with the very positive progress that our dealers have made in selling their new truck inventory, if we retail the same amount as we did last year, we should see an improvement in truck orders coming into the factory.

Meredith Taylor - Barclays Capital

So as I think about then your outlook for Europe specifically of 150 to 180, I mean what would that assume on a year-over-year change for your retail sales in Europe?

Mark Pigott

I’ll say just a record of 14.8% and obviously…

Meredith Taylor - Barclays Capital

I was talking assuming flat share?

Mark Pigott

That’s our share on retail sales, correct.

Meredith Taylor - Barclays Capital

If I were to assume flat retail share, what would that mean in terms of your actual retail sales changes in your end market outlook?

Mark Pigott

I think our retail sales would be comparable to last year, but we would just be building more trucks coming out of the factory versus selling them out of our dealer inventory. So that’s a positive for DAF and for PACCAR.

Meredith Taylor - Barclays Capital

Then maybe just one last related question and I’ll pass it along. Can you define kind of the macro assumptions that under lie the low end and the high end of your growth outlook for Europe?

Mark Pigott

I think the low end would be continued economic challenges, many of the countries are having mixed results, some are still deeply in a recession, some are posting some positive GDP, but if there’s a double dip or whatever letter of the alphabet the economists are assigning now days that will obviously have an impact on the lower end. On the upper end, the economy continues to gather a little bit of momentum and we would benefit from that very much country-by-country and the challenges that many of them face.

Operator

Your next question comes from Jamie Cook - Credit Suisse.

Jamie Cook - Credit Suisse

Just my first question, Mark your prepared remarks I think you talked about production being up first quarter relative to fourth quarter, I think 5% to 10% or so?

Mark Pigott

I said down.

Jamie Cook - Credit Suisse

Was that for the industry, when you’re talking is that for the industry or for PACCAR just to be clear?

Mark Pigott

That’s for PACCAR.

Jamie Cook - Credit Suisse

Just wanted to make sure I heard it correctly.

Mark Pigott

It may also be the industry though.

Jamie Cook - Credit Suisse

A lot of times you do better than the industry. That’s why I’m asking the question. Just the margins in the fourth quarter were impressive across most levels. Was there anything unusual in the quarter? Can you talk about in the fourth quarter, did you see any benefit from lower input costs and how we think about that into 2010?

Mark Pigott

There was the fourth quarter at PACCAR like the industry benefited from a very slight pre-buy if you will, and so you get higher demand. We were able to run our factories at five day work weeks versus something lower and you get the operating leverage coming from that.

We also had some benefit from lower commodity costs which I think you’re calling input costs, but as I mentioned in the prepared remarks, the customers are now coming to grips that the new EPA engines will be $8,000 to $10,000 more for the industry and our job will be to see if we can pass that along and they will get a benefit of better fuel economy, so that’s the challenge the whole industry has right now.

Jamie Cook - Credit Suisse

Then can you just talk about you also mentioned R&D for 2010 was going to be up. Last quarter when you talked about R&D you said when we see that ramp it’s a sign that we see the economy improving. I mean the R&D, is it specific to a particular program? Is it related to the engine side if you could just give more color on that or just a more bullish tone on the economy?

Mark Pigott

Well hopefully the economy is going to get a little bit better. I think we’re being conservative is our way but PACCAR continues to generate good cash flow. We’re continuing to work on developing new products. The engine program, which I mentioned is very exciting. That will continue to have some investment and then just the introduction of more and exciting new products trucks around the world we’re starting to invest more on that front also.

Jamie Cook - Credit Suisse

To be clear, some of it is going towards the engine. Is the R&D investment related to the engine what you thought or are you having to spend more?

Mark Pigott

No, it’s very much in line. That project is really proceeding well.

Operator

Your next question comes from Andy Casey - Wells Fargo.

Andy Casey - Wells Fargo

Just on the R&D question, should we expect it to re-approach 2008 levels or is it just somewhere between ‘09 and ‘08 when you raise it in 2010?

Mark Pigott

I think we’ve given you a little bit of guidance on what we’re looking to spend on R&D and also capital so it will be more than last year and probably not as much as 2008, and a lot of exciting products and got a great team working on them.

Andy Casey - Wells Fargo

When you look at the acceptance of the new technology and the pricing, are you seeing what you would have thought in orders looking at this time period maybe six months ago, or is it a little bit stalled out, because the economy is taken a little bit longer to get going?

Mark Pigott

The economy, I think it’s actually probably tracking about where we thought it could be I think 2010, will still be very challenging for many, many industries. So we thought that was going to happen and it certainly is playing out that way. In terms of just the pricing and our customers, many of our customers are doing well. Many of them are publicly traded and you can see their results and that’s fantastic they’re doing an excellent job of running their companies.

$8,000 to $10,000 is a significant amount of money, but there are benefits in terms of cleaner power and better fuel economy, so that will take some time just to work through the market, but within the next quarter or two, that’s the only engine that’s going to be available from anybody and if you’re in the transportation industry, that’s what you’re going to be looking at.

Operator

Your next question comes from Joel Tiss - Buckingham Research.

Joel Tiss - Buckingham Research

Are you going to help your customers’ transition into the new pricing levels starting in the first quarter of 2010?

Mark Pigott

By offering them the best highest quality J.D. Power Award Winning Trucks, you bet.

Joel Tiss - Buckingham Research

Even on the models with ‘09 engines, right it would be a good customer service to be able to help ease them into that the new pricing?

Mark Pigott

Well, most of the industry within the next month or two probably won’t have many ‘09 engines left and so, I think we’re starting to see people place orders for 2010 and move on from there. Every few years as you know, Joel, the industry goes through this and the customers have a very good appreciation of the technology typically is beneficial and is nothing new.

Joel Tiss - Buckingham Research

You also mentioned that you’re not going to be putting your own engines into the trucks until the middle of 2010.

Mark Pigott

Yes, this summer.

Joel Tiss - Buckingham Research

Is that a comment on the order board for the 2010 products?

Mark Pigott

No, that’s just a plan that’s been in place for a number of years and we have put out a press release earlier this week announcing the introduction of the MX engine. That seems to be very well received. We’ve got a lot of positive comments from the dealers and customers throughout North America and that’s all on track for the summer. Hope you get you down to the factory. I think you’d enjoy it.

Joel Tiss - Buckingham Research

Then just lastly, a little bit of color because you guys know as much or more than anybody else. Can you talk a little bit about what’s happened to the number of parked trucks out there and sort of your guess at what the real average age of the fleet that’s in North America?

Mark Pigott

Yes, that’s a great question. I think average age is probably six to seven years, but you know I’ve seen eight years on some studies. It’s certainly at the high end for the last couple of decades. I think that’s a fair assessment, which means as business improves, the economy generates some strength. You’ll see better parts and service business particularly at the dealerships and eventually you’re going to have many of the fleets wanting to replace those vehicles and get lower operating cost product running.

I think the industry is in good shape. There’s been a little bit of a shake out over the last couple of years, but compared to the number of fleets that went out of business in ‘01 and ‘02 it’s about half that level. So transportation particularly in North America, but also Europe is in good shape.

Joel Tiss - Buckingham Research

Number of parked trucks out there has it come down significantly?

Mark Pigott

Yes, it has. Absolutely, I don’t have a firm number for you, but as we do our channel checks and work with our dealers and the used truck groups, it’s come down significantly.

Operator

Your next question comes from J.B. Groh - D.A. Davidson.

J.B. Groh - D.A. Davidson

I had a question on the good margin performance in Q4, is there a way to break that down between pricing and operations? My guess is it’s not a lot of pricing power up there, so is it basically just blocking and tackling on your part?

Mark Pigott

Absolutely, its operating leverage, you get more products going through the factory, a little bit lower commodity, but our guys in the factories and logistics are doing a fantastic job and of course we keep improving the efficiency 5% to 7% a year and that has a benefit over time.

J.B. Groh - D.A. Davidson

I may have missed this, but the currency impacts in the quarter?

Mark Pigott

The currency impacts in the quarter were actually fairly negligible.

J.B. Groh - D.A. Davidson

Then maybe you could comment on how the credit quality in the portfolios changed over the last 90 days, what are your thoughts there?

Mark Pigott

The past due percentage for our over 30 day past due was 4.4% at September 30 and that’s down to 3.8% at year end, so we continue to see a steady progression have improvement in the performance of our overall portfolio.

Operator

Your next question comes from Henry Kirn - UBS.

Henry Kirn - UBS

Question I guess to get back to Meredith’s question, if retail sales were stable in Europe is there anyway to quantify how much your production would be up?

Mark Pigott

Yes, there is. It would be up probably 10%, 15%.

Henry Kirn - UBS

Thank you, that’s helpful.

Mark Pigott

We’re hoping that comes true.

Henry Kirn - UBS

I hope so too. In the parts business, could you talk about the trends you’re seeing today and what we might be able to expect in 2010?

Mark Pigott

Parts is obviously a function of a couple things, general economy, do fleets feel a need to have regular maintenance or can they cannibalize trucks that are parked, the age of the overall fleet, the amount of freight being transported, but also just the general economic health of the dealers and when you look at all of that, there’s actually a lot of positive trends going on.

You’ve got an older fleet, customers that are still running are doing fairly well, they see the advantage of repairing and replacing their vehicles and the dealers, our dealers in particular are on very strong position. Their inventory on new trucks has come down significantly in Europe, in North America; their inventory is at probably five to six year lows.

So they’ve got the operating cash and the where with all to focus on the parts and service, so I think we’re looking at some improvement on parts business. Obviously, if something negative happened to the general economy, that would have an impact, but if there’s some improvement in the general economy we would see a little bit improvement on the parts business.

Operator

Your next question is from the line Adam Uhlman - Cleveland Research.

Adam Uhlman - Cleveland Research

Mark I was wondering if you could talk about your operating costs as we look out into 2010. R&D is going to be going up and DAF benefited from some of these short time our support from the government, various governments in Europe this past year and I bet your team is probably shooting for some bonuses this year, so how should we think about cost growth in 2010 and modest market growth?

Mark Pigott

Well let’s take one of the larger elements you’ve brought up, and that’s the part-time employment programs, particularly in the Netherlands and Belgium that is an important government program and DAF and many industrial companies like many companies period benefited from those, I call it farsighted approach by the government. Those programs currently are set to expire in the summer of this year, but there’s a lot of discussion by many industries to recommend that the part-time programs are extended.

I think that’s still being discussed at governmental levels, but I think it would be good for those countries in general, for all industries if they were extended. So that’s an important consideration, but in terms of just the overall business, I think DAF is in good shape. It continues to grow. It’s got a great recognition as being the quality leader and here in North America, I think we’re in very good shape attaining record market levels in the medium duty product and close to industry leadership in terms of the market on the heavy duty and I think everybody is poised to really generate some good results if the economy can cooperate with us.

Adam Uhlman - Cleveland Research

Mark, could you put the part-time hour benefit into dollars for us perspective to better understand what the benefit has been this year so that, we can understand if those programs are allowed to expire what the cost creep back would be?

Mark Pigott

Well I don’t have it right here, but the way the program typically is set up is that, if an employee is furloughed or has a part-time working, the government would pay a 70% of an agreed wage and then the company would pay 30% of an agreed wage. There’s some discussion within the European industry is that, by the time these programs may expire in the summer, perhaps the orders and the demand for truck starts to increase.

So it sort of seamlessly moves back to a situation where you don’t need to have part-time unemployment and the underlying demand will, necessitate keeping all of the employees working full-time, so that’s kind of the thinking right now.

Adam Uhlman - Cleveland Research

Secondly, unrelated, could you talk about the leasing business, what you’re seeing there in terms of demand and rates?

Mark Pigott

The leasing business, early 2009 was challenged with lower freight levels and that depressed some of the rental utilization, but in the latter part of the year second half of the year particularly fourth quarter, we saw improved rental utilization and we enter 2010 with a bit stronger position.

Operator

Your next question comes from Steve Volkmann - Jefferies.

Steve Volkmann - Jefferies

Most of mine have been answered, but I was just thinking about your finance company and looking at my model, which actually goes back to 86 and I’ve noticed that almost always your first quarter is pretty similar to your fourth quarter in terms of finance company income. I’m just wondering if there would be any reason that that shouldn’t be the case this year.

Mark Pigott

As we talked the portfolio has shown steady progression improvement during the course of 2009. Freight is still challenged but we see that the portfolio performing relatively consistent with how it did in the fourth.

Steve Volkmann - Jefferies

Then Mark, you said you would expect part sales to be the first to ramp up as we start to come out of this thing, assuming we are at some point. I didn’t quite get it. Is that happening already?

Mark Pigott

Not to a significant extent, no. We’re still in the middle of a recession. As we touch many industries around the world, I think that gets transported by truck, we’re involved with and as you see a lot of industries report their results, maybe they’ve had slightly better financials, but the underlying demand is still pretty low.

As I indicated in the press release, they’re saving their money and kind of worrying am I going to have a job and what the general economy is going to do. So the part side is still, some improvement because they’ve got great programs and we keep adding new stores but it’s still early days.

Steve Volkmann - Jefferies

Then I’m wondering if you just have any insights, there’s been some discussion in some industry sources that Eastern Europe maybe coming out of the depth of its funk there and maybe a little more availability of credit and so forth. Do you have anything to add to that discussion?

Mark Pigott

I think you’re probably hearing it somewhat accurately. I think in terms of our business, DAF, I don’t know if you realize it, but we just took market leadership in Hungary, and we’re one of the leaders in Poland and the Czech Republic, so Eastern Europe is important, Central Europe is important for us. They’ve got some call it currency issues, obviously have some trade, issues and just general economic issues and it’s going to take time to work through that. I think we’re looking for Western Europe and maybe even more specifically Northern Europe to lead the recovery.

Operator

Your next question comes from Mike Rourke - McAdams

Mike Rourke – McAdams

I had a question just a few here. First on the MX engine, can you specify at this point how many orders you’ve received for the new engine in North America?

Mark Pigott

No. We haven’t launched it officially so we’ve got 50 million miles of experience on it and it goes into production this summer so it’s still building anticipation.

Mike Rourke – McAdams

So have you received any orders though?

Mark Pigott

Yes, we’ve got many people who are excited about getting it when we go into production, definitely. It’s an exciting engine and obviously has a wonderful track record in all of our DAF trucks around the world.

Mike Rourke – McAdams

Okay, and then at the outset, how are the logistics of the engine going to work in terms of production? Are you going to be turning on the Mississippi plant or is there going to be some importing taking place?

Mark Pigott

For most of 2010, the program will be that will do the majority of the machining and assembly in Eindhoven in Holland and ship it to Mississippi for the final specification fit out and then it will be sent to our Kenworth and Peterbilt factories.

Mike Rourke – McAdams

Okay, also on the Kenworth plant side, are there any plans right now to kind of turn the Renton facility back on for Class 8 production?

Mark Pigott

That would be fantastic. The team there has done a wonderful job. Have you visited Renton?

Mike Rourke – McAdams

Oh, yes.

Mark Pigott

It’s doing great and obviously as orders pick up, and the industry returns we look forward to Renton making many more Kenworth trucks.

Mike Rourke – McAdams

Then just one last one if I could. I heard you say the 30 day past due percentage for the entire finance portfolio is 3.8%, but would you be able to break that down by geography, U.S. and Canada and Europe?

Mark Pigott

U.S. and Canada is 2.5 and Europe was 4.4%.

Mike Rourke – McAdams

Then also Mexico and Australia if you could?

Mark Pigott

Mexico is, I don’t have the specific number, but it’s closer to 10% and Australia is 2%.

Operator

Your next question comes from Andrew Obin - Banc of America/Merrill Lynch.

Andrew Obin - Banc of America/Merrill Lynch

Just a question, could you give us some more color on used equipment truck market by region, U.S. versus Europe and, if we are seeing trends in this market bottoming yet?

Mark Pigott

I think we have seen the bottom, in fact in the fourth quarter slight improvement in some models and some markets, so we’re encouraged by what we saw in the fourth quarter and as we head into 2010.

Andrew Obin - Banc of America/Merrill Lynch

Any color on what’s happening in Western Europe on used equipment pricing?

Mark Pigott

Yes, I’d say that comment really was both the U.S. and Canadian market as well as Europe. We did see some firming of prices and in fact some slight improvement on the DAF recognition really of the quality product that they have.

Operator

Your next question comes from Kristine Kubacki - Avondale Partners.

Kristine Kubacki - Avondale Partners

My question is around the financial portfolio. Our firms trucking industry bankruptcy data suggest that things could get a little bit worse before it gets better in terms of repositions, which is ultimately should be better for the trucking industry down the road as you lose some weaker players. Do you think that your portfolio could see a little bit of a hit as we roll through 2010 from some of that repossessions and bankruptcies from some of the weaker players?

Mark Pigott

Let me address that and then, Ron will have some specifics, because I think that’s a very perceptive question. As we look at the number of bankruptcies for fleets, which we typically look at as companies have five and more trucks for this recession which has been a tough one as we all know. We’ve got about 6,000 companies go into bankruptcy or leave the industry.

When you look at the recession in ‘01 and ‘02 there was 12,000 companies that went into bankruptcy. So what that tells you on a macro level is that, a lot of the weak players have obviously exited and here we are in a recessions that probably 10 times as worse of the one in ‘01-’02, but you only have half as many companies going into bankruptcy, which lets you know that to the people who are here are better financed, better capitalized, probably have better customers paying their bills on time.

So that’s the good news for our industry that the people operating are doing better, they’re managing their companies in a very excellent fashion, which is good for us and obviously has an impact on repossessions. Ron has got some additional color on repossessions.

Ron Armstrong

I think we seen from the peak in U.S. and Canada was in the second and third quarter of 2008, when fuel prices escalated. Fuel prices are steady. Driver availability is good and turnover is low. So there are some very positive things, but still a challenging environment and we work with our customers very closely to make sure that they continue in business and we continue to get paid.

Mark Pigott

We’re still in a recession. It’s getting a little bit better but we’re still in one.

Kristine Kubacki - Avondale Partners

Do you think arguably, if we were to lose some of the smaller players in the industry and you get some of the pricing power concentrated among the larger fleets? Do you think that the pricing could be a little bit different this cycle as we edge out? Do you think it could be more difficult given that some of the pricing power is going to be so concentrated with the large fleet type trucking companies?

Mark Pigott

You’ve seen that over the last 20 years. As I say, I’m in my 32 year, so I’ve seen the remember and flow of the industry over many, many cycles and today, what you consider the smaller operator is more than likely a line with a larger company and of course the benefits of that are a little bit more consistency and the number of halls they get, they might have a healthcare program, and they might have other benefits, they maybe able to get better pricing on their vehicles themselves.

So the old days of owner operators although it’s romantic, I think it’s pretty much gone away over the last decade. Doesn’t mean there aren’t companies with smaller fleets or just a few numbers of vehicles, but more times than not they’re inline with a larger company. So I don’t see it changing, I think we’ve already absorbed that change over the last decade.

Operator

Your next question comes from Jerry Revich - Goldman Sachs.

Jerry Revich - Goldman Sachs

You had a nice sequential pickup in sales in Europe in what’s typically a seasonally weaker quarter. Can you just talk about how much of that was better end customer orders versus just a bit of a pick up in dealer activity?

Mark Pigott

For Europe, you say?

Jerry Revich - Goldman Sachs

Yes.

Mark Pigott

I think that was pretty consistent. We continued to reduce the amount of inventory at our dealers. So some of the dealers began to order some for stock, which is healthy. I think that’s really primarily the main change. We had a number of summer shutdowns to balance incoming orders with demand and so if you’re producing five days a week versus four versus three you’re going to see more trucks coming out so I think between some reduction in inventory that’s benefited the dealers and moving from the summer shut downs which obviously had a big impact on the third quarter, we seen some improvement, but not much.

Jerry Revich - Goldman Sachs

In which countries have you seen the most significant improvement or the most positive signs from dealers?

Mark Pigott

Well I think in general pricing Northern Europe, the UK. Southern Europe, Spain, Italy, obviously got impacted on a macroeconomic level the most, particularly Spain with the construction and that has had a tough impact and you could see the unemployment in Spain is bouncing between 15% and 20%, the same with Italy so that’s a bit of a depressing effect on all industries on total GDP, but Northern Europe and the U.K. seem to be responding the best.

Jerry Revich - Goldman Sachs

In the U.S., you’ve typically been the first OEM to rollout new emissions products. Can you talk about whether you’re producing the new emissions products and full production now or that going to be later in the quarter?

Mark Pigott

It’s later in the quarter and once again we will be the first. We pride ourselves on being the environmental leader and our customers appreciate that and we’ve had a lot of good feedback from our customers about the new engines and those will be rolling out later this quarter.

Jerry Revich - Goldman Sachs

That going to be closer to February or is it going to be later than that?

Mark Pigott

It will be March.

Operator

Your next question comes from Patrick Nolan - Deutsche Bank.

Patrick Nolan - Deutsche Bank

Just most of my questions have been answered so I just had a quick couple of follow up questions. First provisioning came down sequentially. Can you give us some color on what charge-offs were in the quarter versus provisioning?

Ron Armstrong

Yes, the charge-offs came down consistent with the amount of provision reduction.

Patrick Nolan - Deutsche Bank

Was the allowance up or down sequentially?

Ron Armstrong

Allowance is down a bit reflecting lower portfolio balances but we maintain a very conservative reserve relationship to our asset balance so we’re well positioned as we go into 2010.

Patrick Nolan - Deutsche Bank

Just a follow up to that versus the previous question, so you’re comfortable with that allowance going into what could possibly be a tick up in the bankruptcies in Q1?

Ron Armstrong

Well we’re comfortable with the allowance for sure.

Patrick Nolan - Deutsche Bank

Just my last question is on, you were asked the question about the headwind of the return to the full work week in Europe, but can you give us some numbers around what the headwind will be as far as bonuses next year versus this year?

Mark Pigott

Well as you know, a lot of us were getting no bonuses and that’s the way it should be so, we’re very happy and comfortable with that. Bonuses within PACCAR don’t really have much impact on financial results for our shareholders.

Patrick Nolan - Deutsche Bank

So would you think the SG&A run rate you’re at the fourth quarter that’s fair to be using for next year?

Mark Pigott

Yes, yes, absolutely.

Operator

Your next question comes from Ann Duignan - JP Morgan.

Ann Duignan - JP Morgan

I’m not sure what the crack on JP Morgan was there, but that’s okay.

Mark Pigott

On bonuses.

Ann Duignan - JP Morgan

I wanted to take a step back and talk about the DAF Engines. You seem to emphasize over and over that these engines have 50 million miles on them. Can you talk a little bit about the engine development process and how important is it to have 50 million miles, how long does that takes, or how many engines? Does it take to generate that much experience and then thus the confidence that customers can have in the new engines?

Mark Pigott

Typically, as we look back over the last 20 years at the new engine introductions by our competitors and suppliers, it’s usually in the 10 million to 15 million mile test cycle, which is fine and obviously, particularly for our suppliers has worked out well. I can’t really comment on our competitors. I think the point that we wanted to ensure is that, these are the highest quality engines in the world, obviously we’ve got a great track record with DAF and they’re running in DAF’s everyday as you know around the world.

The first time we’ve introduced our own engine into Kenworth and Peterbilt products as is PACCAR style, we wanted to go the extra mile literally and so 10 million 15 million was what the norm was for the industry. We said well why don’t we look at 300% better, which would be 50 million and so those have been running in hundreds of vehicles for the last number of years and all types of terrain and temperatures and applications and we’re the quality leader.

Certainly, quality has been a topical note in the newspapers regarding the automotive industry, certainly in the last month or so, and we’re the quality leader every year and that applies to the power train in the engines so that’s why we set those targets at 50 million miles.

Ann Duignan - JP Morgan

Can you just remind us if those engines are indeed certified to 0.2?

Mark Pigott

The certification with the EPA is ongoing right now and we’re confident that it will be achieved the time we go into production.

Ann Duignan - JP Morgan

Just on the production side and this is my final question, you noted that you expect your production in North America or in the U.S. to be down 5% to 10% sequentially from Q4. Can you just walk us through the three other quarters then? Should we expect another line in Q2 just because you changed over the product lines and the assembly lines and then quite a steep ramp maybe above retail in Q3 as you fill the channel with trucks with new engines?

Mark Pigott

That’s a great question, Ann. Of course we don’t really change over production lines. It’s not like the car industry. We kind of gotten beyond that so that doesn’t have an impact. The second quarter for the entire industry will be an interesting one because that will be the quarter that you’ll be really focused on selling pretty much exclusively 2010 emission engines.

With an $8,000 to $10,000 price point increase, the industry has to get used to that. I’m sure they will. They have every other time, every three years we have a new emission standard. So the second quarter for the industry will be, I think challenging and interesting and then as the general economy improves which we hope it will. The third quarter people are used to the price of the engines. We should get back to business as normal.

Ann Duignan - JP Morgan

Would you anticipate any channel filling just to get these new products out to your dealers and get some on the lot so customers can get comfortable with it?

Mark Pigott

I think what many customers have seen the product running. We don’t do channel filling. Our products are built to order. So I think that’s the normal way that we approach. Some of our competitors may do some channel filling, but that’s not what we do.

Ann Duignan - JP Morgan

So you wouldn’t anticipate any building above whatever retail it is as you go through the year?

Mark Pigott

That’s not our approach. We always meet demand.

Ann Duignan - JP Morgan

Just as a final follow-up, you talked about the benefits you received from Belgium and the Netherlands. What percent of your European employees benefit from that?

Mark Pigott

I’d say probably at least half.

Operator

Your next question comes from Ben Elias - Sterne, Agee.

Ben Elias - Sterne, Agee

Just wanted to circle back on the margins especially the cost cutting, I was just interested if there was any other additional structural adjustments in the fourth quarter when I look at your costs as a percentage of sales, it was down about 400 basis points compared to the third quarter and then when I look historically it seems like you have another 300 to 400 basis points to go and now does that just simply come back for higher volume?

Mark Pigott

Yes, kind of a two part answer, one, PACCAR prices itself on being the low cost manufacturer in every marketplace in which we compete and I think we were achieving that because of great employees or taking a lot of good steps and benefited by programs such as Six Sigma throughout our company, so we are the low cost producer. Nothing unusual in the fourth quarter and I think to the second point as volume does increase, we do get some very excellent operating leverage and we look forward to that hopefully taking place later this year.

Ben Elias - Sterne, Agee

So what we saw in the fourth quarter is that sustainable through the low point the first half of 2010, how should we look at that going forward, when do we begin to see more of a return to what you’ve done historically?

Mark Pigott

I think in terms of the first and second quarter as production in the first quarter will be 5% to10% lower that will probably have some impact on the margin because you’ve got lower operating leverage and the second quarter will be as I say the most interesting as the industry transitions to 2010 engines, but you get back to a normalized marketplace, we certainly look forward to returning to those excellent margins.

Ben Elias - Sterne, Agee

Second question I just wanted to once again follow up. I know these questions have been asked before but truck pricing in Europe, you are seeing evidence of better used truck pricing now. Are you seeing a good pull through from some of the emerging economies, Eastern European economies because from what I recall a couple years ago, they really pulled out a lot of the three, four, and five year trucks out of Western Europe? Are we beginning to see evidence that that’s starting up again and what are we seeing over there?

Mark Pigott

Well I think in Eastern and central Europe you’re seeing slight improvement but they still have a lot of macroeconomic challenges so they’ve replaced as you indicated a lot of their older trucks, but that was several years ago so no, in a sense, Central Europe in particular is very similar to Western Europe, so I don’t see any major pull through impact.

Operator

Your next question comes from Basili Alukos – Morningstar.

Basili Alukos – Morningstar

I was wondering if you could talk a little bit about your relationship with some of the bigger fleets.

Mark Pigott

Great, great relationship.

Basili Alukos – Morningstar

I guess maybe my misconception is that PACCAR, I was more geared towards the owner operators as you mentioned. Looking at the last two recessions, there’s been about 18,000 bankruptcies in kind of the smaller owner operator space, but yet the market share of PACCAR has maintained relatively…?

Mark Pigott

Maintained and grown.

Basili Alukos – Morningstar

Actually, grown so I wonder if you could just comment on that?

Mark Pigott

I’m not sure what your background is with the industry, but we’re the longest serving company in our industry. People that buy our products and we have about 25%, 26% share in the U.S. and Canada and 40%, 50% share of Mexico and 15% in Europe and on and on. People love our products. They have low operating cost, great resale, high quality and so that’s all ranges of customers from the very, very biggest fleets to the smallest of companies, and that’s certainly the way it’s been for well forever, but certainly over the last decade as the industry continues to consolidate.

Basili Alukos – Morningstar

I asked, because there’s kind of been a shift in the concentration of truck purchasers with like kind of the top calls it 30 truckers out there and I was just wondering how going forward if that were to play out…?

Mark Pigott

Yes, I think that’s actually a benefit for PACCAR, because you’re going from certainly there’s always an emotional attachment and this is a beautiful piece of art that’s moving along the highway it has our named on it and as the customers names on it, but as you do more and more financial analysis, it just shows hands down that whether it’s a Kenworth, Peterbilt or DAF, that’s the product to have and it’s the low operating cost through its life cycle is our product and that’s been proven time and time again, so we’re finding a wonderful response.

Basili Alukos – Morningstar

A follow-up if I might kind of on a bigger picture. Recently, Caterpillar kind of in their earnings release talked about housing starts in the million for this year and you seen kind of increases in truck sales and assuming that an increase in sales will lead to more production. I’m wondering how an increase in potential call for housing starts as well as auto production could lead to even more growth during for 2010 considering that truckers tend to ship a good portion of housing related and car related products versus other forms of transportation?

Mark Pigott

I hope that housing starts reaches $1 million. I’m not sure I’ve seen that particular study, but that would be good. Our 10 year average is probably about $1.2 million or $1.3 million. You can see different forecasts from 600,000 to 800,000, but that has a big impact on transport and freight because everything does get moved by truck that goes into a house, so that improves. We’re going to be benefiting from it.

Operator

Your next question comes from Andrew Obin - Bank of America-Merrill Lynch.

Andrew Obin - Bank of America-Merrill Lynch

Just a follow-up question, one of your competitors has been sort of stating that “People of SCR in terms might have difficulty running them in extreme conditions i.e., too cold or too hot.” Could you just provide us what have you guys observed as you’ve put the miles on your engines? What have you experienced then was running them under these extreme conditions? Thank you.

Mark Pigott

The whole world has adopted SCR. So there really isn’t any credible competitor that is making those claims that we know. SCR is the industry standard. So that’s it and they run from the Arctic to the Mojave Desert and they do great. So everyone in the industry has adopted it. All of the support programs are either in place or being put in place. It’s actually a non-event now.

Operator

Your next question comes from David Raso - ISI.

David Raso - ISI

I was just wondering if we take the midpoint of your sales forecast for North America the 125,000 and for simplicity maintain your share of 25%, you’re looking to sell roughly 31,000 trucks in North America in ‘10. What percent of those trucks do you think will have ‘09 engines and then obviously what percent ‘10?

Mark Pigott

I would say that probably 75% would have ‘10.

David Raso - ISI

So I’m trying to square that up assuming you’re going to work through your ‘09 engines a large percent in the first quarter and the new engines won’t be available until the summer…?

Mark Pigott

That’s our new engine.

David Raso - ISI

So they come in 15 liters, mostly what’s going to makeup your second quarter or say early summer sales…?

Mark Pigott

That’s correct. The whole range, we’re their largest customer. They’re an excellent partner.

Operator

Your final question comes from Garrett Stevens - Giovine Capital.

Garrett Stevens - Giovine Capital

So, just to a follow up on the Mississippi plant once again. Presumably you’ll produce the engines in Europe to begin with because there’s too much excess capacity currently. What sort of demand level would you need to justify starting up the plans in Mississippi?

Mark Pigott

Well, let me clarify. The Mississippi plant is starting up and will be assembling the final specs of the engine and we are currently installing the machining capital equipment and that will be ready to go in 2011.

Garrett Stevens - Giovine Capital

What sort of demand level would you need to justify doing the machining at that facility then?

Mark Pigott

Well, we look to meet the demand for our 13 liter engines from that factory so it’s going to start up next year.

Garrett Stevens - Giovine Capital

Okay and then on the finance side if I could very quickly, it seems like you’ve been taking share. Is that continue in the fourth quarter and do you think you can sustain that once the credit market is normalized?

Ron Armstrong

PACCAR Financial and PACCAR Leasing we’ve got excellent access to the credit markets and we’ve been there to support our dealers and customers throughout the challenges and I think the dealers and customers appreciate the level of customer services that we can provide and we look to continue to build on that as we go forward in 2010.

Mark Pigott

I think just picking up on that good comment from Ron, you’ve seen several large third party financing companies withdraw from the market or severely curtail their approach to the market and then you’ve got the ongoing overhang of the commercial real estate that’s having a real dramatic impact particularly on local and regional maybe even super regional banks that typically might have been working with the transportation industry so that’s being impacted and as a result, PACCAR financial is there through great times, through lien times and we keep adding to our team, introducing easier to use retail tools and the teams just done a fantastic job and the same in Europe.

Garrett Stevens - Giovine Capital

So will we start raising financing at the sub level in 2010 again? Will you start raising financing at the subsidiary level in 2010 again instead of doing it at the parent?

Mark Pigott

Yes, we’ve borrowed both during 2009 out of our finance subsidiaries as well as out of PACCAR Inc, and we’ll continue to do that during the course of 2010 will be a balance as well as commercial paper borrowings.

Operator

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

Robin Easton

I’d just like to thank everyone for their excellent questions and thank you Operator.

Operator

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

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Source: PACCAR Inc. Q4 2009 Earnings Call Transcript
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