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PACCAR Inc (NASDAQ:PCAR)

Q1 2010 Earnings Call Transcript

April 20, 2010 11:00 am ET

Executives

Robin Easton – Treasurer

Mark Pigott – Chairman and CEO

Ron Armstrong – SVP

Michael Barkley – VP and Controller

Analysts

Henry Kirn – UBS

Meredith Taylor – Barclays Capital

Jamie Cook – Credit Suisse

Andy Casey – Wells Fargo

Joel Tiss – Buckingham Research

Adam Uhlman – Cleveland Research

Steve Volkmann – Jefferies & Company

Mike Roarke – McAdams Wright Ragen

Kristine Kubacki – Avondale Partners

Jerry Revich – Goldman Sachs

Patrick Nolan – Deutsche Bank

Ann Duignan – JPMorgan

Keith Schicker – Robert W. Baird

Basili Alukos – Morningstar

Tim Denoyer – Wolf Trahan

Operator

Good morning and welcome to PACCAR’s first quarter 2010 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 Barkley, Vice President, Controller.

As with prior conference calls, if 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. PACCAR today reported improved revenues and net income for the first quarter of 2010. PACCAR’s first quarter sales and financial services revenue were $2.2 billion compared to $1.99 billion in the first quarter last year.

Net income was $68 million compared to $26 million a year ago. PACCAR’s financial results reflect the benefits of higher truck deliveries in North America and an improvement in aftermarket part sales and financial services worldwide. PACCAR results for the first quarter benefited from a small pre-buy in the US and Canadian markets as customers took delivery of new vehicles with pre-EPA 2010 engines.

As I have mentioned in previous calls, I am very proud of our 15,000 employees who have delivered outstanding performance to our shareholders and customers in a very challenging recession. PACCAR’s strong balance sheet and positive cash flow have enabled the company to continuously reinvest in the business, enhance operating efficiency, and introduce new products such as the PACCAR MX engine, which will be installed in Kenworth and Peterbilt trucks this summer.

And on a personal note, I appreciate that many analysts on this call were able to view our many new products at the Mid-America Truck Show last month. I am pleased to share with you that we received over 1,500 orders for MX engines to be installed in Kenworth and Peterbilt trucks. We expect PACCAR’s build rate in the second quarter to be comparable to the first quarter. DAF production may increase slightly, while Kenworth and Peterbilt production will be lower as the North American truck industry adjusts to the new more expensive EPA 2010 engines.

PACCAR Financial Services revenue was $246 million in the first quarter compared to $255 million a year ago. PACCAR Financial’s first quarter pretax income was $28 million compared to $15 million earned in Q1 2009, primarily due to better financed margins and a reduction in the provision for credit losses. The credit loss provision for the first quarter of 2010 was $21.7 million compared to $25 million in 2009. Just as a reminder, there was an $11 million reduction in finance margin in the first quarter of 2009, due to the adjustment from mark-to-market effects on derivative contracts.

Other news in the market, used truck values in North America have increased by approximately $2,500 per vehicle for one-to-two year-old trucks, especially Kenworth and Peterbilt. PACCAR’s conservative approach to business complemented by an AA minus credit rating enables PACCAR Financial to offer competitive financing to Kenworth, Peterbilt and DAF dealers and customers around the world. As you are aware, some of our competitors have exited the finance business or formed financing partnerships due to their weakening market positions.

PACCAR Financial on the other hand has excellent access to the medium term note markets. In March of this year, PACCAR Financial sold a three-year $300 million floating rate note with an equivalent fixed rate of 2.17%. More good news, PACCAR’s quarterly aftermarket parts revenue of $505 million was the highest since the fourth quarter of 2008, as our dealers have more customers increasing their service business.

Reviewing our dealers and customers, our 1,900 Kenworth, Peterbilt, and DAF dealer locations are leading the commercial vehicle industry in customer service, and many of our customers are benefiting from reasonable diesel prices, low driver turnover, and year-on-year increases in freight tonnage, even though freight rates continue to be low.

Looking at the truck markets around the world, we expect a 15-ton plus market in Europe to be between 150,000 to 180,000 units this year comparable to the 168,000 in 2009. Some of you may know that DAF is currently the Number 2 truck manufacturer in Europe with over 16% profitable market share. Let’s see how that goes as the year progresses.

US and Canadian industry retail truck sales are estimated to improve to the range of 110,000 to 140,000 units this year compared to 108,000 last year. As you know, the industry US and Canada received about 20,000 orders in the first quarter, so it ought to be a slightly stronger second half. PACCAR’s investment of $3.8 billion in the last decade has enabled the company to enhance its operating efficiency, develop new products, strengthen its dealer network, become an industry leader in information technology, and deliver shareholder equity of over $5 billion.

Even with of that, there continues to be many challenges facing the transportation industry worldwide, impacted by high unemployment and low home construction and car production. The good news is that PACCAR’s balanced approach in all phases of the business cycle positioned us to generate improving results as the global economy recovers.

Thank you and we look forward to your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Henry Kirn with UBS.

Henry Kirn – UBS

Hi, good morning guys.

Mark Pigott

Good morning Henry.

Henry Kirn – UBS

Wondering if you could chat a little bit about what you are seeing in the European trucking end market, freight looks a little bit better, what do you think it’s going to take that to translate to better retail demand?

Mark Pigott

Well, Europe, you know is just having lots of different types of challenges, whether it’s some issues in Greece or just a simple thing like the volcano on Iceland or there is lots of ongoing economic challenges, particularly in southern Europe. And there might be some increase in freight rates at this time, but you know, we look at car production to be down throughout Europe this year, which has an impact on the amount of freight being hauled around Europe. So, I think it’s just going to continue to sort of be a market very similar to last year in terms of truck orders.

Henry Kirn – UBS

Thank you. And you mentioned on the aftermarket side, things look a little bit better. Could you talk about your expectations where aftermarket demand as we go through the year, and is this somewhat of a precursor to improved new demand?

Mark Pigott

Yes, I think, Henry, it’s a good point. You know, we look at the typical cycle and we have all been through many, many cycles in our careers. I usually see about a three-step process. One, is to see some improvement in the parts and services, customers go back to the dealerships to, you know, repair their existing vehicles. And as freight increases, you see some increased demand in values on used trucks and we are starting to see that, which is positive. And then finally, as used truck values increased to a point where customers are saying, you know, there may be some advantages to buying a new truck and there is enough freight to justify that, you see the new truck orders start to tick in. So, it’s really, you know, a pretty normal three-step process. We have seen it for decades, and right now, we are seeing our customers having a little better freight, which means, we are now taking the vehicles in to get the maintenance done, which is improving parts sales.

I mentioned in my comments that used truck values have gone up about $2,500 per vehicle over the last year or two, particularly for late model vehicles, we still have ways to go on that. And then, you know, sometime in the medium-term future, we hope to see new truck orders improving. The general economy is still, there are a lot of challenges out there.

Henry Kirn – UBS

That’s helpful. Thanks a lot.

Mark Pigott

Thank you. Good question.

Operator

Your next question comes from the line of Meredith Taylor with Barclays Capital.

Meredith Taylor – Barclays Capital

Hi good morning.

Mark Pigott

Good morning Meredith.

Meredith Taylor – Barclays Capital

I am hoping to sort out, you can give us a little bit more color on the sequential production rates in the second quarter. You talked rather broadly about Europe up slightly with the US down, but can you give us a little more granularity there?

Mark Pigott

You know, I think what we laid out in the comments in the press release is that we look forward to be comparable to the first quarter. US and Canada, you know, for our Peterbilt and Kenworth groups, it’s slower as we essentially have gone through all the ’09 engines and customers are adapting and starting to understand that there is a $8,000 to $10,000 price impact on buying a new vehicle. That’s slowed things down, and I think it will continue to be slow for the second quarter. In Europe, our dealers are in good shape. They have low new truck inventory compared to a year or so ago. So, they are now looking to purchase some stock units, and we are seeing some improvement in market share with DAF. So, that’s translating to a little bit more production at our DAF company.

Meredith Taylor – Barclays Capital

Okay. Great. And then, you know, in Europe, last quarter, you talked about production being up 10% to 15% in a flat full-year market, can you talk a little bit about what you saw in the first quarter and then how you expect this to evolve over the balance of the year?

Mark Pigott

Yes, for DAF, as I said, because our dealers new truck inventory has been brought down to pretty much couple of year low levels, so they are in very good shape. We expect some improvement in year-on-year production at DAF and first quarter was comparable to a year ago, but we are starting to gather some momentum now. So, we think we will be maybe 10% up for the year.

Meredith Taylor – Barclays Capital

Okay. Great. And then just one last question, in Europe, can you talk a little bit about what your expectations are for the extension of temporary unemployment programs there?

Mark Pigott

That’s a great question. I think, well it’s by country-by-country. I think the Netherlands program, which obviously has a major impact on our facility in Eindhoven will expire at the end of June, and as you probably know, there is going to be a new government in place in the Netherlands. So, I think with some of the economic challenges and the new government, it’s unlikely that the part-time unemployment will be extended. In Belgium, it has a longer duration to run, and other countries, we really don’t have any manufacturing undertaking in slightly different approach. So, based on an excellent program, I complement the governments and agencies involved with it, came at a critical time for the industry and I think it has served its purpose.

Meredith Taylor – Barclays Capital

Can you quantify then, assuming that it does not get extended in the Netherlands, and then can you quantify what the impact will be for you?

Mark Pigott

I think the impact is very, very minimal. As we increase production, it will be pretty seamless.

Meredith Taylor – Barclays Capital

Okay. Thank you.

Mark Pigott

Good. Thank you.

Operator

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

Mark Pigott

Good morning Jamie.

Jamie Cook – Credit Suisse

Hi, good morning. Couple of questions, one on the gross margin front, we saw another nice sort of sequential improvement, any color you can give on that front? And then my next question relates to, you know, you talked about Q2 in the US production being down because we won’t have any more transition engines, again is that – I guess can you just comment more specifically? I mean, I thought you guys did have some more Caterpillar engines and that you were running out of Cummins engines. So, if you could just comment on sort of that term, because I thought we had enough Cat engines anyway to get it through the end of the quarter, so that just sort of confuses me relative to 40% [ph].

Mark Pigott

Gross margin first?

Jamie Cook – Credit Suisse

Yes.

Ron Armstrong

Now, gross margins as a percentage of sales for parts in Q1 of ’10 was 33.7%, which compares to 32.7% in Q4 of ’09 and truck margins were 3% compared to 2.4% in Q4.

Jamie Cook – Credit Suisse

But on the truck side, are you seeing, was there any material cost benefit there, I am just trying to get more color within trucks specifically, too?

Mark Pigott

For Q1?

Jamie Cook – Credit Suisse

Yes.

Mark Pigott

I think the margins were up slightly on trucks in North America. Yes, of course you are now seeing the increase in commodity prices around the world, which will have an effect on any manufacturer that makes anything if you see, copper and others really start to increase after some lows in last year. So, it’s ongoing challenges, but our team is doing a great job in managing through the cost elements. On the engines and transition in Q1 and Q2, you know, for most of the industry, the vast majority of the engines and trucks built in Q1 in US and Canada were pre-2010 engines. That’s the same with us. PACCAR as we have done in every other engine transition, we adopt a new technology, we are the leader on that. So, we will have a minority of engines in Q2 being the, let’s call it, pre-2010 engines. And we are going to be putting in more of their Cummins 2010 engines. And maybe even a few PACCAR engines.

Jamie Cook – Credit Suisse

Okay. But, so there will be no – so you don’t have any leftover Caterpillar ’09 engines?

Mark Pigott

You know, there will be handful of it, but it’s a minority.

Jamie Cook – Credit Suisse

Okay. And then just last question, you know, on the SG&A front, it’s you know, been increasing little over the past three quarters and this is the first quarter we saw a year-over-year increase. I guess, just Ron, how you are thinking about, you know, SG&A in dollars for the year, if you could give any color?

Mark Pigott

Okay.

Ron Armstrong

(inaudible) SG&A, the run rate that we currently have is pretty indicative of what we expect for the rest of the year against Q1 of ’09, about $4 million of that increase is due to currency. So, really pretty flat.

Jamie Cook – Credit Suisse

Okay. Great. I will get back in queue.

Mark Pigott

Good questions. Thank you.

Operator

Your next question comes from the line of Andy Casey with Wells Fargo.

Mark Pigott

Good morning Andy.

Andy Casey – Wells Fargo

Good morning Mark, good morning everyone. Question on the financial services, given that you are seeing, I think you said, used equipment prices starting to go up, should we see the provisions start to go down more dramatically than they really did in the quarter if we compare to the fourth quarter?

Mark Pigott

I think we have seen, you know, gradual improvement over the last year in terms of past dues and credit losses, and I think that has proved that gradual improvement is what we see as we go forward. You know, there is still a difficult operating environment and I think we will see that gradual improvement as we move forward.

Andy Casey – Wells Fargo

Okay. Thanks. And then a little bit back on your comment Mark, on commodity costs being a little bit of a hurdle that you have to get over on the margin side. Given that you have already seen kind of the US and Canadian industry pushback on some of the emissions pricing, is it reasonable to assume that you should be able to get pricing to offset that, or is that something you really have to do on a productivity basis?

Mark Pigott

I think productivity will have an important element of that. They say we are pretty much the first in the industry to have the majority of our vehicles now being equipped with 2010 engines, and you know, frankly customers appreciative of some of the benefits of the new engine, but there is a real world price hurdle that they have to get used to. They will, they are very flexible and proactive customer base. It seems that every three to four years, we are about 20 years. So, they understand how it works, but you know, for the interim, let’s say for this year, it will probably have some impact on some of the margins and then you throw in the commodity price increases and that’s just business. That’s what we do every day.

Andy Casey – Wells Fargo

Okay. Thank you for that. And then a little bit longer term, I mean, given that freight demand and used equipment pricing and all that in US and Canada seems to be improving, you know, and there is this hesitance out there, are you without giving quantified 2011 outlook, are you looking for kind of a normal cyclical recovery or one that is exaggerated upfront, and if so, how are you looking to support the supply chain’s ability to really ramp up quickly?

Mark Pigott

Okay, that is a fantastic question. Well, first of all, on the freight, it’s up about 10% from its low, but it’s still down about 10% year-on-year. So, we have to get the general economy going, and I am not talking about the financial sector, which is the basic blocking and tackling of people making things in this country to get freight really going again. There is some improvement, and I think over the course of the year, we hope to see more of that. Obviously the housing industry is a big factor in terms of freight movement and that’s still a 50-year low on home construction. So, that’s going to take a couple of years to come back. So, I am not sure what the normal cycle recovery is out of worst recession 50 years, but there is some positive signs to say, used trucks are looking good.

Our suppliers are really in good shape. We have an excellent collaborative partnership. We train our suppliers in Six Sigma, we are one of the few companies in the industry that actually will purchase major capital pieces of equipment and install them in our suppliers to help them improve quality and improve capacity and reduce their costs. We retain ownership on this piece of equipment, but so suppliers overall are in very good shape and our team has done a fantastic job around the world. So, the good thing is when suppliers have ideas and have many great ideas, PACCAR is the first place they call, because it truly is a partnership. We want our suppliers to make money, and I am not sure others, other manufacturers are of that same mind. So, it will recover and PACCAR is in good shape to take advantage of it when it does.

Andy Casey – Wells Fargo

Thank you very much.

Mark Pigott

You bet.

Operator

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

Mark Pigott

Good morning Joel.

Joel Tiss – Buckingham Research

How are you?

Mark Pigott

Good. Did you get an MX pad in a calendar?

Joel Tiss – Buckingham Research

No, no, but I got stung well by all your dealers. So, you guys did a good job.

Mark Pigott

They are probably checking credits.

Joel Tiss – Buckingham Research

Yes, yes. Can you talk a little bit about the California port issue? You know, there was a lot of people that were all over the place talking about, you know, the 100,000 trucks that have to be, that are going to come out of there, and some people talking about 150,000, can you just give us a sense of the impact of that and the size maybe on the industry?

Mark Pigott

Sure. I think particularly our Kenworth team have done a very good job on being one of the leaders in terms of supplying alternate fuel vehicles down in the port of LA, Long Beach, and I think right now, it’s a little bit confused by what the federal authority say is possible versus what the state authority say versus what the local authority say, and then unfortunately you have got the trucker caught in the middle. The good news is we have got a product that people like that is – that’s endorsed by the major ports, but there’s still some sort of interdepartmental agency discussions that need to be settled out. We are not involved with that, that really at a political level.

So, the size, you know, the size is a little bit variable and it will be interesting to see what happens when the Panama Canal is enlarged and more freight is brought to the East Coast and what effect that’s going to have on the ports of the West Coast. So, there’s a few interesting variables going on, but we are in good shape. When they do figure it out, and we got the product the customers seem to want.

Joel Tiss – Buckingham Research

All right. And just last, can you talk a little bit about some of the guide posts that we should be watching out for to gauge the amount of margin efficiency or operating efficiency that you built into the company during this downturn, you know, on less volume in this coming cycle, can you achieve the same or better operating margins, you know, just trying to get a sense?

Mark Pigott

You know, the operating margin, we always pride ourselves in delivering a good margin. As you know, we even made money last year when most of the industry did not, but the volumes are a third of what they were when things were really strong, and that does have an impact on your operating efficiency. Even with that, we continue to be more efficient in our factories and quality continues to improve and we won the JD Power Awards, which we are very proud of, but to tell you, you know, get your volume up to probably 60%, 70%, 80% of what we were when things were really strong, overall it’s going to have an impact on your margins.

Joel Tiss – Buckingham Research

So, you are not going to know until the volume comes back to more normalized level?

Mark Pigott

Yes, exactly. It’s that simple. I mean, we are getting good margins on the volume we have now, but you know, you have to go back a decade to find comparable volumes. So, we made a lot of improvement on the operating efficiency within the factory and so it’s fantastic.

Joel Tiss – Buckingham Research

Okay, all right. Thank you very much.

Mark Pigott

You bet, good question.

Operator

Your next question comes from the line of Adam Uhlman with Cleveland Research.

Mark Pigott

Good morning Adam.

Adam Uhlman – Cleveland Research

Hi, good morning. I was wondering if you could talk a little bit about the parts business, the trend of demand between the US and Europe, is Europe also seeing improved parts activity yet?

Mark Pigott

Okay, the answer is yes. Europe is seeing improvement in their parts business, which is very good. As I say, the dealers, the DAF dealers throughout Europe are in good shape, and they are starting to see customers coming into the shops for normal maintenance. And the same is true with the Kenworth and Peterbilt dealers throughout North America. So, the parts business is, you know, starting to improve.

Adam Uhlman – Cleveland Research

Good. Okay. And then just a couple of clarifications. Could you help us with an impact to sales and earnings from currency, and then I might have missed it, but what the past dues were in the quarter?

Mark Pigott

Okay, let’s do currency.

Ron Armstrong

Yes, I guess prior year of the impact on currency was about $110 million to increase revenue and about $10 million to increase pretax income.

Mark Pigott

And on the past due side, past dues at March 31 are comparable to the December 31 levels, where the slight improvement in US and Canada offset by a slight and higher percentages in our other markets. So, overall 4% at March 31 versus 3.8% at December 31.

Adam Uhlman – Cleveland Research

Great, thank you.

Mark Pigott

Good, thank you.

Operator

Your next question comes from the line of Steve Volkmann with Jefferies & Company.

Mark Pigott

Good morning Steve.

Steve Volkmann – Jefferies & Company

Good morning. Just a couple of quick follow-ups for you.

Mark Pigott

Good.

Steve Volkmann – Jefferies & Company

I was a little surprised to see the finance down sequentially even though the credit quality seemed a little bit better, are we just sort of working down the portfolio here, or how should we think about that?

Mark Pigott

Good question.

Michael Barkley

Yes, I think the biggest thing is the reduction in the asset base, and the impact that had on finance margins and there are a couple of fewer days in the first quarter versus the fourth quarter. So, those are primarily in the finance margin line.

Steve Volkmann – Jefferies & Company

Okay, great. That’s helpful. And the market share of potential deals that you are financing internally, have that changed much in the past?

Ron Armstrong

The first quarter was right in line with our full year, last year. The first quarter typically is a little bit lower, but we were able to achieve 26%, the same as our full year last year.

Steve Volkmann – Jefferies & Company

Super, that’s helpful. And I am also wondering, you know, as you start to put orders for your 2010 compliant engines on the books here, have you seen any kind of a shift with respect to engine size? You know, some people in the industry are sort of pushing away from 15 later into the lower side, is that happening with you or is that kind of status quo?

Mark Pigott

I think there is more discussion about that and perhaps it’s actually happening, but it’s certainly a topic that people are looking at, with you know, fuel prices even though they are attractive, they have gone up over the last year, 18 months. And the 13-liter engines are performing very well. They deliver excellent torque and horsepower. So, that’s what the rest of the world uses and I think overtime, North America will probably become a little bit more aligned with the rest of the world.

Steve Volkmann – Jefferies & Company

Thanks. That’s all I have. Thanks very much.

Mark Pigott

Good questions.

Operator

Your next question is from the line of Mike Roarke with McAdams Wright Ragen.

Mark Pigott

Good morning Mike.

Mike Roarke – McAdams Wright Ragen

Hi good morning. Just two short ones here, what’s the value of the used equipment currently being held for sale on your balance sheet please?

Ron Armstrong

We don’t have that number.

Mark Pigott

Used equipment?

Ron Armstrong

Readily available.

Mike Roarke – McAdams Wright Ragen

Used trucks held for sale, no?

Ron Armstrong

I don’t have that, I can get you the numbers.

Mark Pigott

We will get you.

Mike Roarke – McAdams Wright Ragen

Okay. Also just another quick question, what was the level of charge-offs in the finance portfolio in the first quarter please?

Ron Armstrong

So, the actual charge-offs were $26 million.

Mike Roarke – McAdams Wright Ragen

Okay. Versus the 21.8 provision?

Ron Armstrong

Yes.

Mark Pigott

Yes, that’s correct.

Ron Armstrong

Yes.

Mike Roarke – McAdams Wright Ragen

Okay. So, in terms of thinking about that –?

Mark Pigott

We don’t have a lot of used trucks.

Mike Roarke – McAdams Wright Ragen

Pardon?

Mark Pigott

But if you want a deal, we can probably talk to you.

Mike Roarke – McAdams Wright Ragen

Okay. So, just a bigger picture, allowing the charge-off to move at a rate that’s greater than the provision, how should we kind of be thinking about that going forward?

Ron Armstrong

Actually, you know, the provision or the reserve that we have in the balance sheet as compared to our asset base is actually picked up a little bit, progressively each quarter just to maintain our conservative reserve position as we always do. So, we are efficiently 2.5% of our asset base in the first quarter.

Mike Roarke – McAdams Wright Ragen

Okay. Great. Thank you for taking the question.

Mark Pigott

You bet, thank you.

Operator

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

Mark Pigott

Good morning Kristine.

Kristine Kubacki – Avondale Partners

Good morning. My question is a little bit more color on the new engine production. I know you said this summer, but I was wondering if you could give us a little bit more detail about the process of bringing up production and where you are now in terms of ramp-up, and then you mentioned a 1,500 orders, I was kind of wondering just over the longer term, where the mix of your volume is going to come more of a 13-liter versus 15-liter, kind of what’s your goal mix?

Mark Pigott

Well, you know, certainly for the foreseeable future, we will be selling more 15-liters with our excellent partner Cummins. We only have a 9-liter and a 13-liter in-house. So, that’s what we will sell. And in terms of the ramp-up, you know the summer is the timeframe that we are aiming for, and I think overtime, we will see a good balance between the 13-liter PACCAR engine and the 15-liter Cummins engine. It will serve the whole market, customers will get the benefit.

Kristine Kubacki – Avondale Partners

In terms of summer, would that be late summer or more mid or early summer?

Mark Pigott

I would say in the middle of the summer.

Kristine Kubacki – Avondale Partners

Okay. And then I wanted to ask a question about the pricing, maybe a little bit differently. We have been hearing the same things on pricing especially on the 2010 engines, coming under a little bit of pressure, I wanted to get your sense on what are you seeing competitors doing at this time? I realize there is pretty low volumes that’s pretty hard to make, you know, kinds of long range forecast based on this, but what are you seeing some competitors and do you think that the industry will be able to hold the line on the pricing, or do you think that as volume improves, we will start to see the industry pushing back on trucking companies with that pricing?

Mark Pigott

I think it’s a very normal process. Most of our competitors are still trying to sell pre-2010 engines, to say we are the leader on selling the 2010 engine. Overtime, most of the pricing will be passed through as our customers pass through the additional cost to their customers, that’s a pretty normal way the market works. But you know, that will take some time, it will certainly take all of this year to work through particularly since we are introducing higher price, but more efficient product in an ongoing recession. You know, if it was boom times, it would be a slightly different economic scenario, but we are coming out of a very challenging recession, and the customers and their customers are more wary and more conscious of cost and what they can or cannot pass through.

Kristine Kubacki – Avondale Partners

A short-term question, you mentioned that your competitors have more 2009 engines available, do you think you will see market share shift here in the short term, is there running nose out and you may see a lower production?

Mark Pigott

I think that’s pretty normal. You know, number of our competitors are interested in market share usually at the detriment of their shareholders I find. But that’s pretty normal than the aftertime, all balances out.

Kristine Kubacki – Avondale Partners

Great. Thank you for your time. I appreciate it.

Mark Pigott

You bet. Good questions.

Operator

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

Mark Pigott

Good morning Jerry.

Jerry Revich – Goldman Sachs

Good morning. Mark, you always lean of an inventory supply chain as anyone, I am wondering if you can talk about how you see the freight situation in Europe playing out for truckers, how much higher have spot truck freights moved and you know, over what time period do you think that situation is resolved if aerospace opens up for the next couple of days?

Mark Pigott

Well, I don’t have sort of what the freight spot has done just over the last four days, because of the Icelandic volcano, but you know, the vast majority of freight does get moved by truck as you know. So, there might have been a momentary one week upward movement. I think that will settle back down. So, we are starting to see freight rates slightly improved, but I would say slightly in Europe. And there’s still a lot of economic challenges, and you have got a number of countries that have elections going on, the UK, the Netherlands coming to mind, and then you have Spain, Portugal and Italy that probably having a little more serious economic challenges and essentially Europe is sort of being impacted in a negative way. So, there’s lot of things going on there that’s going to take some time to settle out. You know, the good news is that people love the DAF trucks and they are buying those, but certainly not at the levels we saw two or three years ago.

Jerry Revich – Goldman Sachs

And Mark, in terms of the parts of Europe or countries that you are more optimistic on this year, can you talk about which countries are at the top of that list?

Mark Pigott

I think primarily Northern and Western Europe. So, France, Germany, Netherlands, Belgium, you know, would be some of our strongest markets.

Jerry Revich – Goldman Sachs

And Mark, the order trends that you are seeing in the European market, obviously it’s a great time that you are taking up production rates, can you just talk about where orders cracked in, in the first quarter, perhaps relative to sales?

Mark Pigott

Well, the orders have improved. We are taking some share away from probably one of our German competitors who seems to be in a little bit of disarray, but having been on this business for many decades, what will probably happen is, once our competitors figure out their internal business systems, they will aggressively come out with low prices to regain or regain some of the shares that they lost and you know, we will go back to the steady progress that DAF made over the last almost 15 years of, you know, few tenths, or half a tenth or half a point of share increase every year. So, I think, you know, at the time what we are seeing right now in Europe.

Jerry Revich – Goldman Sachs

And Mark, lastly, just a clarifying question, your earlier comment that commodity costs inflation, you would have to offset through internal initiatives, does that apply to both US and European market or is there a chance that your European competitors might push prices with the raw materials move?

Mark Pigott

Well, the commodities are worldwide. So, we are, you know, everybody who manufactures anywhere in the world will be impacted by the base commodity increases. Europe doesn’t have the 2010 engine increase, but I think the competitors will probably keep their pricing at relatively low levels who maintain whatever share they have got, and they have had several years of losses and I think they are probably comfortable to have several more years of losses as long as they can keep some share going. So, you know, it’s pretty normal in many ways.

Jerry Revich – Goldman Sachs

Thank you very much.

Mark Pigott

Good questions.

Operator

Your next question comes from the line of Patrick Nolan with Deutsche Bank.

Mark Pigott

Good morning Patrick.

Patrick Nolan – Deutsche Bank

Good morning everyone. Good morning Mark. A couple of questions, most of it have been answered. When I look at your R&D and your CapEx spending in the quarter, I would have thought they would have been a little bit more front-end loaded given the ramp-up to launching the ’10 engines in midyear?

Mark Pigott

Well, lot of the expense and capital and R&D for the engines has been in the previous couple of years, in the previous three, four, five years. What is now shifting because we are in very good shape in terms of 2010 engines is the ongoing development of just new vehicle products. So, we are actually sort of in a bit of a transition right now. I think you saw some of that at the Mid-America Show. So, the engine expenditures has really been dialed down. We have done the work.

Patrick Nolan – Deutsche Bank

And how is your thinking about, I mean, you know, now it looks like production is increasing in Europe pretty steady to increasing in North America, you are still generating cash now $2 billion [ph] on the balance sheet, how will you think about what you are going to do with your cash and relative to your additional dividend last year, I know that’s a Board decision, but what are the priorities for cash going forward?

Mark Pigott

Well, I think just first point on the production as was indicated, North America, Kenworth and Peterbilt production most likely to be down this year. So, that’s an important factor to take into account. Yes, we have got a very strong balance sheet, which is really one of the major factors that’s contributed to us being able to make any money last year, and being able to borrow money for our finance companies and the treasury team has done an outstanding job on that. The dividend is something that we continue to review with the Board, and we made that difficult decision a year ago and as the business improves, we certainly would like to take a serious look at improving the divided. We are looking at opportunities in South America, we are looking at opportunities in Asia, and we also have got a pretty active new product development program that will use some of that cash. So, plenty of opportunities to invest.

Patrick Nolan – Deutsche Bank

And just the last question, so we should not expect any benefit of utilization rates in Europe from the North American engine in the second quarter, if that’s more mid to somewhere at the end of the summer, so that’s really going to be Q3 and beyond, right?

Mark Pigott

For engines?

Patrick Nolan – Deutsche Bank

Yes, as far as improved utilization rates in European?

Mark Pigott

Yes, certainly, DAF has an excellent engine factory, but they are relatively low production compared to the capacity of our engine factories. So, it will be a minor enhancement to utilization and efficiency.

Patrick Nolan – Deutsche Bank

Okay, thank you very much.

Mark Pigott

Good. Good questions.

Operator

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

Mark Pigott

Good morning Ann.

Ann Duignan – JPMorgan

Hi, good morning guys. Mark, I am just a little bit confused, the outlook for Q2 North America production, you said that you are in fact almost out of 2009 engines, however your 2010 MX engines have nothing certified yet. So, can you help clarify, you know, what will you be building, will you be building uncertified –?

Mark Pigott

No, but we just love your questions, you know. We are Cummins’ largest customer. We have a great strong partnership. We will be selling a lot of Cummins engines.

Ann Duignan – JPMorgan

So, not just 15-liter?

Mark Pigott

No, Cummins has a whole range of engines.

Ann Duignan – JPMorgan

I know, but that’s helpful to clarify that.

Mark Pigott

Yes.

Ann Duignan – JPMorgan

So, you will not be assembling PACCAR trucks, Kenworth and Peterbilt trucks with MX engines until they are certified, I was just kind of wondering if it could still be maintained in the inventory?

Mark Pigott

Obviously, the EPA certification is a very normal two-step process. The first step is complete, past grade, and we are in process on the second step and we look for certification in May.

Ann Duignan – JPMorgan

In May? Okay, that’s helpful. And then the 1,500 orders for 2010 engines, can you talk just a little bit about what your expectations might have been? You know, is this in line with what your expectations might have been, is it below, or is it above, you know what –?

Mark Pigott

I think it’s in line, these are 1,500 MX engine orders.

Ann Duignan – JPMorgan

Yes.

Mark Pigott

And I think it’s in line and you know, we look for a few more thousand as we go through over the next several months, and obviously it’s an engine that’s had very good results in all the rigorous testing we have done, I think you have picked up that, 50 million miles of testing, and you know, so we are excited about getting them out into the field, and having our customers enjoy the benefits.

Ann Duignan – JPMorgan

So, you are reiterating that miles tested is an important criteria?

Mark Pigott

I think everybody in the automotive industry would corroborate that.

Ann Duignan – JPMorgan

And then just finally, just a data, the slip-in in North America then as you transition out of ’09 engines and into 2010 engines in Q2 versus maybe a slight pickup in Europe, net-net if you look at the net impact, would you expect revenues sequentially to be down or flat in Q2?

Mark Pigott

I would say flat to maybe slightly up.

Ann Duignan – JPMorgan

Flat to slightly up overall?

Mark Pigott

Yes.

Ann Duignan – JPMorgan

Okay, that’s all I have. Thank you.

Mark Pigott

Good questions, thank you.

Operator

Your next question comes from the line of David Leiker with Robert W. Baird.

Mark Pigott

Good morning David.

Keith Schicker – Robert W. Baird

Hi, good morning. It’s actually Keith Schicker calling for David.

Mark Pigott

Good morning Keith.

Keith Schicker – Robert W. Baird

I wanted to touch on used truck prices. Prices are rising in the US, could you comment on the used truck environment in Europe, and then also we saw as your sharp prices were depressed, that potentially some vendors were a little reluctant to repossess trucks, could you comment on how that looks right now and what sort of impact that could have on capacity going forward?

Ron Armstrong

Yes, I think as we look at Europe, I think we are seeing the same trends in Europe as we are seeing in the US that late model used equipment is up 5% or so year-over-year. So, very similar trends. In terms of repossessions, I can only comment, we have seen gradual improvement in the performance of our portfolio. We evaluate and want to work with our customers to achieve full payout, but if the situation is not possible, then we try and find a quicker solution to it, for best economic results.

Mark Pigott

I don’t think it has really any effect on production or what we are doing. I think it’s just small part of the business.

Keith Schicker – Robert W. Baird

Okay. And then, you outlined a pretty good three-step process here out of recovery. It sounds like in America, North America, the US, we are kind of barely in step two, maybe can you just give your perspective on when you think things shipped over into step three and then maybe some perspective on where do you think Europe is along that timeline?

Mark Pigott

Well, I think in terms of the pretty normal three-step process we have here, it’s all going to be later this year, and you know, it’s hard to pinpoint. Obviously there’s lots of economic inputs that have to be factored in and things are changing every week in many different industries as you know. In Europe, I would say they are probably a little bit behind where North America is right now, but then I would also just add that they don’t have the impact of transitioning from one engine model to another. So, that could be a positive in the European market. So, probably slightly behind, but they are both moving forward on the three-step process.

Keith Schicker – Robert W. Baird

Okay. Do you still get a sense of there is a greater overcapacity situation in Europe to work through relative to the US?

Mark Pigott

Well, there hasn’t been too many factories decommissioned. As you know, we permanently shut our Nashville factory in the US, but in Europe, everybody still has factories in place, certainly employees have been let go, but structurally the industry is probably pretty much the same as it was a couple of years ago.

Keith Schicker – Robert W. Baird

Okay. And then if you look that from a trucker freight hauling capacity, you get a sense of there is more of a surplus in Europe than the US, or closer to equilibrium there?

Mark Pigott

Yes, I would agree. I think the US, North America is probably a little bit better shape. You know, Canada is in good shape economically. Mexico starting to recover although, you know different things are going on, but – and Europe plunged much more dramatically into recession and that was a real shock to the system that are now coming out of.

Keith Schicker – Robert W. Baird

Okay. Thank you very much.

Mark Pigott

Good questions.

Operator

Your next question comes from the line of Basili Alukos with Morningstar.

Mark Pigott

Hi, is this Bas?

Basili Alukos – Morningstar

Basili.

Mark Pigott

Basili?

Basili Alukos – Morningstar

Yes, the family members are getting wrong, so I am not going to.

Mark Pigott

I want to get it right though.

Basili Alukos – Morningstar

I appreciate it. Kind of going back to an earlier question, maybe asked a little bit, you mentioned a 1,500 MX engine orders, can you talk about I guess what timeframe are those engines are? Basically what I am trying to get is kind of what percentage of your total truck purchases that represent?

Mark Pigott

Yes, those are over 12 months in terms of with the customers where they lay them out on a monthly basis, and you know, of course, that’s starting this summer, so this summer to next summer, the way I realistically look at it. You know, at this time, it’s closing in on 5% of our orders, and hopefully that will increase.

Basili Alukos – Morningstar

Okay. And I guess correct me if I am wrong, I heard something that maybe the company is about 50% is kind of a goal, ultimately they have –?

Mark Pigott

Yes, overtime.

Basili Alukos – Morningstar

Okay.

Mark Pigott

Absolutely. And I think to look at the industry as a barometer, you can see what the competitor is out, they all have their own in-house engines and a number that is still purchased, third-party engines, and you can see what their percentages are.

Basili Alukos – Morningstar

Right. I was just trying to get a sense of kind of where it is now versus kind of the longer –?

Mark Pigott

Early days, it’s a very exciting journey, but it’s early days.

Basili Alukos – Morningstar

Understandable. And kind of second question that you talked about kind of your three tier curve around I guess or how the trucking industry goes, how close would you follow the truck tonnage index, as I have heard the next review is from, you know, different carriers themselves kind of just to the validity of the –?

Mark Pigott

That’s a great question and it’s certainly one input, the way I put it.

Basili Alukos – Morningstar

Okay, but it’s not something that you know, you kind of obsess over.

Mark Pigott

We try not to obsess over anything except outstanding product quality and shareholder return.

Basili Alukos – Morningstar

Great. And then kind of one last question follow-up, back on the 13-liter engine, from what I understand, 13-liter engines are more fuel efficient and one of the reasons that they really taken whole of the Europe is just doing what the geography, it’s a lot smaller, in the US, there is kind of more open road, 15-liter engine is more desirable because of the power. At what point do you have a sense of what price per gallon of diesel? I know we recently approached $3, but at what price do you think the market shifts there, preferences to a more fuel-efficient engine?

Mark Pigott

Well, if you look at the pricing per gallon, you obviously have to translate that from leaders and kilometers to miles, but in Europe, you can have anywhere from literally $5 to $10 per gallon depending on where you are travelling, that will have an impact. And we have a wonderfully attractive low price for a gallon of diesel in North America. How long that will last is obviously open to much discussion, but overtime it will most likely go up and there will be more interest in 13-liter engines.

Basili Alukos – Morningstar

Great. Those are my questions. Good time guys.

Mark Pigott

Good questions.

Operator

Your next question is from the line of Tim Denoyer with Wolf Trahan.

Mark Pigott

Good morning Tim.

Tim Denoyer – Wolf Trahan

Good morning. Quick question, not to deliver the order level point, but in terms of the number of orders that you had of, of ’09 engines, can you specify a little bit more in terms of March versus how many you have left over going into April?

Mark Pigott

Well, it’s a minority now in terms of our production, and you know, it’s winnowing down every week.

Tim Denoyer – Wolf Trahan

Okay. Tell me about the $2,500 per truck increase in used truck prices that you mentioned, can you just say the sources of that data point?

Mark Pigott

We have a very active used truck centers around the country that our teams operate, and of course we are also involved with independent auctions. We have many hundreds of excellent dealers who tell us what’s going on, on a daily and weekly basis in terms of the valuation of our products and our competitors. We are also involved every day on talking with our customers about trading packages. So, we take all those inputs and we have for years and years and it’s quickly apparent as the value of a T-800 going up or going down and how is it speck-for-speck year-on-year. So, it’s pretty straight forward.

Tim Denoyer – Wolf Trahan

But it’s weighted towards Peterbilt and Kenworth.

Mark Pigott

It’s weighted that way because they have the best resale value, up to 25% compared to the competitors, but we fairly track with the competitors’ vehicles are doing.

Tim Denoyer – Wolf Trahan

Okay. And then just one broader question, you mentioned a few industries. I know you have great exposure to lots of different end markets. You mentioned that European auto sales are or production is fairly weak and I am guessing that in the US, it’s fairly strong, but the housing market is not great. Are there other –?

Mark Pigott

I would say is that our production is not fairly strong, it’s slightly better coming off a 20-year low in North America.

Tim Denoyer – Wolf Trahan

Okay. But my question is more on, are there any other industries where you are seeing particular strength or weakness, you know, US or Europe, just going to –?

Mark Pigott

Commercial real estate, commercial construction is challenging right now. Retail sales, people going to shopping malls, you know, has improved over the last year. The home repair market has seen some improvement, but not back to the glory days. You know, you track anything that gets moved by truck and as you know, over 70% of all freight is moved by truck in North America. So, it catches every industry.

Tim Denoyer – Wolf Trahan

Yes, absolutely. And then just one very long-term, do you have any expectations on the next emissions regulations on a timing, I know you are participating in a super truck program and just what types of technologies might be back-to-back?

Mark Pigott

Well, we are looking at a whole host of technologies and that’s – lot of exciting opportunities out there, and you know, what would be fun if you and your team would like to come out and visit our technical center, we could talk in more detail about that.

Tim Denoyer – Wolf Trahan

We would love to. That’s all the questions I had. Thank you very much.

Mark Pigott

Good. Thank you.

Operator

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

Robin Easton

I would like to thank everyone for the excellent questions, and thank you operator.

Operator

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

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Source: PACCAR Inc Q1 2010 Earnings Call Transcript
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