PACCAR Q2 2010 Earnings Call Transcript

| About: PACCAR Inc. (PCAR)

PACCAR (NASDAQ:PCAR)

Q2 2010 Earnings Call

July 27, 2010 12:00 pm ET

Executives

Robin Easton - CFO

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

Thomas Plimpton - Vice Chairman and Principal Financial Officer

Analysts

Jerry Revich - Goldman Sachs Group Inc.

Tim Denoyer - Wolf Trahan

Ann Duignan - JP Morgan Chase & Co

David Leiker - Robert W. Baird & Co. Incorporated

Stephen Volkmann - Jefferies & Company, Inc.

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

Henry Kirn - UBS Investment Bank

Andrew Casey - Wells Fargo Securities, LLC

Kristine Kubacki - Avondale Partners LLC

Chase Becker - Credit Suisse

Ben Elias - Sterne Agee & Leach Inc.

Mike Roarke - McAdams Wright Ragen, Inc.

Patrick Nolan - Deutsche Bank AG

Meredith Taylor - Barclays Capital

Adam Uhlman - Cleveland Research

Timothy Thein - Citigroup Inc

Joel Tiss - Lehman Brothers

Operator

Good morning and welcome to PACCAR's Second Quarter 2010 Earnings Conference Call. [Operator Instructions] 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 that they participate in a listen-only mode. Certain information presented today will be forward-looking and involve risks and uncertainties, including general economic and competitive conditions that may affect expected results.

I would now like to introduce Mark Pigott.

Mark Pigott

Good morning. PACCAR today reported improved revenues and net income for the second quarter of 2010. PACCAR's second quarter sales and Financial Services revenue were $2.46 billion compared to $1.85 billion in the second quarter of 2009, a 33% improvement. Net income improved to $99 million compared to $26 million a year ago. I'm very proud of our 16,000 employees who have delivered outstanding performance to our shareholders and customers in an uneven and unsettled global economy. PACCAR's financial results reflect the benefits of higher truck deliveries worldwide and a continued improvement in aftermarket parts sales and Financial Services results. However, the North American and European truck markets remained at historically low levels. In the U.S. and Canada, our customers are starting to adjust to the higher- priced vehicles that have resulted from the EPA 2010 emission change. The European truck registrations for the second quarter improved 17% compared to the first, but despite that favorable increase, the European truck market year-over-year is still down.

We expect the 15-ton market registrations in Europe to be between 160,000 units and 170,000 units this year, comparable to the 168,000 units last year. U.S. and Canadian retail truck sales are estimated to improve to a range of 110,000 to 130,000 units this year compared to 108,000 last year. While the global economic outlook is still uneven, the truck market is stabilizing. PACCAR truck build in the third quarter is expected to be slightly better than the second quarter. I would note that production at our DAF factories in Europe will have their regularly scheduled two-week summer shutdown.

We discussed during the analyst call in April the three-step process that the truck industry usually progresses as it recovers from a recession. First is improvement in parts and service, second in used truck values and third is more truck orders. In the U.S. and Canada, parts sales were up 10% to 15%, and used truck pricing increased 10%. The good news is that industry new truck orders for the first six months compared to a year ago are up 30%. Many of the orders are for production during the next six to 12 months. In Europe, a similar situation with parts business and used truck pricing improving by 10% to 15%. In Europe, as I previously noted, new truck sales are 15% lower than last year due to a slow first quarter, but the second half of the year should be up 20% compared to 2009.

More good news is that DAF is the leader in the European market for on-highway tractor sales and has now achieved a record overall market share of 16.3%, the second highest market share in Europe. It's been a wonderful success story over the last decade for DAF.

DAF is steadily progressing toward its medium-term goal of 20% market share in Europe. DAF heavy truck production is up 25% from first to second quarter this year and we expect that their production will be up 25% for the remainder of the year. Kenworth and Peterbilt build rates will be up 10% to 15% from the second to the third quarter.

Our customers are benefiting from a 7% year-on-year improvement in freight volumes, higher freight rates and stable diesel prices. They continue to increase the utilization of their fleets, which in turn is driving increased aftermarket parts and service business for our dealers. PACCAR's aftermarket parts sales increased to $538 million for the second quarter, the highest level since the third quarter of 2008.

Turning to margins, margins for trucks was primarily driven by higher pricing due to improved demand. PACCAR's strong balance sheet and positive cash flow have enabled the company to continuously reinvest in the business, enhance operating efficiency and develop innovative new products such as the PACCAR MX diesel engine. I'm pleased to note that we're now installing the MX engine in approximately 15% of Kenworth and Peterbilt vehicles. Assembly of the PACCAR MX engines began last month at our industry-leading manufacturing facility in Columbus, Mississippi. Early feedback from our customers of the PACCAR MX engine has been excellent. On a broader scale in the U.S. and Canada, the substantial majority of Kenworth and Peterbilt trucks are being produced with the EPA 2010 engines. I know a number of you are interested in it, but there appears to be about a 5% shift to 13-liter engines year-on-year.

PACCAR Financial Services revenues were $239 million in the second quarter compared to $247 million a year ago, reflecting a lower level of assets. PACCAR's Financial second quarter pretax income was $34 million, more than double the $16 million earned in Q2 of 2009. This was achieved due to better finance margins and a reduction in the provision for credit losses. The credit loss provision for the second quarter 2010 was $20.2 million compared to $29.1 million in 2009.

PACCAR's conservative approach to business complimented by its excellent credit ratings enables PACCAR Financial to offer competitive financing to Kenworth, Peterbilt and DAF dealers and customers. The ongoing turmoil in the commercial real estate market is impacting regional banks in the U.S. which limits their ability to offer financing to truck customers, good news for PACCAR Financial. PACCAR Financial has excellent access to commercial paper and the medium-term note markets. Last month, PACCAR Financial sold a three-year $250 million fixed rate note at a rate of 2.1%. Also during the quarter, PACCAR completed the renewal of a $2 billion credit facility.

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 and become an industry leader in information technology. As we all can see, from our iPads and newspapers and television every day, there continue to be many challenges facing the world economies. The global economic environment is still unsettled. However, PACCAR's balanced approach in all phases of the business cycle positions us to generate improving results for our shareholders as the global economy recovers. Thank you. Look forward to your questions.

Robin Easton

We'd be happy to take questions now.

Question-and-Answer Session

Operator

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

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

The thing that pops out immediately is the real strong gross margin performance in the quarter. Can you maybe help us understand, attribute that? I’m sure part of it's driven by better volumes, but is there input cost benefits in there or anything else that you can point to that drove that good margin?

Mark Pigott

Well, we commented in the opening statement gross margin was really driven primarily by some increased volume and better pricing, particularly as there’s been increased demand throughout the marketplace.

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

Are you able to get margin on some of the higher-priced trucks with the new engines? I know that the cost has been passed through, but is there any margin, whatever it is, $8,000 to $10,000 increase?

Mark Pigott

Yes, it's an $8,000 to $10,000 increase. We're starting to see slightly improved margins as the overall market is getting a little bit stronger. It's still a challenge for many of our customers to recognize that $8,000 to $10,000 price increase, but as the freight business improves, as their freight rates are increasing, as there's a little bit more business for our customers, they’re starting to see the benefits of it.

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

And I noticed a top headline today in one of the trade rags about fleets raising driver pay and I know in the past, you guys have talked about your premium brands being sort of a driver retention tool, which I guess when turnover was pretty low, that wasn't probably as attractive a prospect. But now it looks that things are kind of turning the other way. Can you maybe address that?

Mark Pigott

Yes. A number of our customers are increasing their pay somewhat, although there are still a fair number of potential candidates out there, particularly as the housing/construction market is at 50-year lows. But all these fleets want the best drivers that are available in the marketplace and using a Kenworth, Peterbilt or DAF product as an inducement to join their fleet is always a great idea and we encourage it.

Operator

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

Joel Tiss - Lehman Brothers

Have you sold through all your Cat engines?

Mark Pigott

They will be pretty much gone this quarter.

Joel Tiss - Lehman Brothers

Can you give us any sort of an idea how many trucks you shipped in the second quarter in the U.S. and Europe versus the first quarter?

Mark Pigott

We typically aren't breaking that out too much, but we shipped a comparable number between second and first quarter for the U.S. The first quarter, as you may recall, still has some carry over 2009 engines. The second quarter was really the customers adjusting to the 2010 pricing.

Joel Tiss - Lehman Brothers

And then your comment on the 13-liter mix, is that saying that now 13-liter’s about 40% of the total mix?

Mark Pigott

Not for us, it's not. Obviously, in Europe, it's the entire mix. But in North America, it's still probably more in the 20% range, but improving.

Joel Tiss - Lehman Brothers

Can you comment a little bit on the inventory levels of your dealers?

Mark Pigott

They’re at about five- or six-year lows, so our dealers are in great shape making strong profits as the Parts & Service business returns, used truck pricing is improving and they're in, very, very good shape financially.

Operator

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

Chase Becker - Credit Suisse

It’s Chase Becker in for Jamie. Just a bigger-picture question on the announcement of DAF in South America, I know obviously this is probably not a huge near-term impact, but was wondering kind of if you could speak to longer-term strategy and kind of the investments that you feel that you need to make to be a meaningful player in that market?

Mark Pigott

That’s a great question. I’m glad you brought it up. As you've seen from the reports, DAF has really become one of the major leaders in the European market, Western and Central Europe, now over 16% market share; great product, great dealers and really a terrific company. So as we are more comfortable with the strengths of what's going on in Europe, we're taking a look at South America. And we've sold in South America particularly with our Kenworth brand for many decades, but in America Sur region, which is most of the product being sold in South America, we've only sold in very limited numbers. So recently in the last few years as we evaluate growth opportunities, that seems to be a very strong candidate. Most likely, we'll take a manufacturing facility in order to meet local content regulations and also to qualify for some of the national finance programs that are available to customers in Brazil and Argentina. And as you've heard from many of our competitors, they seem to be gaining most of their profitability from the strong South American market. We compete against these same competitors around the world and do very well. So I think over time, we should have a very strong, profitable and growing presence in South America.

Chase Becker - Credit Suisse

Did you care to touch on the potential timing of a manufacturing facility?

Mark Pigott

They usually take a couple of years to get up and running and in place, but we will see what happens.

Chase Becker - Credit Suisse

Just on the material cost side, sounds like not seeing much headwinds right now, but wondering what your expectations are for the back half of the year. One of your suppliers was talking about it this morning?

Mark Pigott

Well, we track all of the major commodities around the world and obviously, now things have slowed. We have very good relations with all of our suppliers, dealing with commodity pricing. We have long-term agreements with them that hopefully will minimize the impact of the pricing swings. So at this time, minimal impact, but you can never tell as the world may go on a different tangent.

Operator

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

Henry Kirn - UBS Investment Bank

Could you chat about how Europe trended through the quarter? If you saw improvements as the quarter went on?

Mark Pigott

Sure. Europe started out slow for the whole industry in the first quarter. The second quarter definitely gained some momentum. As I said, it's up 17% second quarter to first. And orders continue to be good. Obviously, some countries are stronger than others. Some of the southern countries, Spain and Italy, are still challenged, but a little more confidence among our customers. Our dealers, once again, are in very good shape in Europe as they are in North America. So they're continuing to invest and add new service facilities, which help to grow our business. And I think as I shared with you, our DAF production is up about 25%. Some of that is obviously gaining market share as people really enjoy the DAF product. And I think the European market is steadily improving, but even with that, we're looking for the number of registrations this year to be comparable, maybe a little bit more than last year, but 2011 could be better again.

Henry Kirn - UBS Investment Bank

Is there anything you can highlight for either a segment of the market or a geography where you're gaining some of the share?

Mark Pigott

Well, we are now number one in Europe in the On-highway Tractor segment, so that's the vehicles that you see up and down the motorways. That's been a very excellent result and a very long process of developing the right product for our customers. A growth opportunity for us is continuing to grow in the Off-highway or Construction segment. That tends to be a little bit more regionalized. Certainly the biggest market would be Germany and I think we still have a few competitors in Germany that seem to have a strong presence there. But overall, Northern Europe, DAF is doing well in every country. If we're not number one, most likely we're number two. So we see continued growth opportunities as we add more service facilities. We continue to invest in new products. We've got Euro 6 coming up in 2013. It’s going to be another exciting inflection point for our industry. So just good, steady progress. Excellent team.

Operator

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

Stephen Volkmann - Jefferies & Company, Inc.

You provided some helpful detail here, Mark, overall, but also I'm going to ask with respect to your production volumes as we go forward, I think you mentioned Kenworth and Peterbilt would be up 10% to 15% in the third quarter. You reminded us about the DAF shutdown. Should I read that to be DAF is maybe flattish in the third quarter?

Mark Pigott

I think that's an excellent assessment.

Stephen Volkmann - Jefferies & Company, Inc.

So is there any reason not to think that the fourth quarter sequentially should continue to improve over the third quarter, with respect to production for the overall company?

Mark Pigott

I think that's another excellent assessment.

Stephen Volkmann - Jefferies & Company, Inc.

Is there any reason on the margin side, and I would agree, good job on the margin this quarter, any costs that we should be aware of that kind of start to ramp up in the second half as volume comes up. Are there any costs that need to be brought back that would lead us to be a little more cautious on margins in the second half?

Mark Pigott

No. It's a good question. I mean, obviously, we touched on this a little bit with some of the commodity pricing, which is still very variable around the world, depending on major macro influences. But I would just say on the margin -- and we have to take a look at a 20-year horizon. When you look at that, the U.S. and Canadian and European truck markets are still down at those 20-year lows. So the volumes overall for the entire industry are improving, but they're still at a very low level. And I think in order to get solid margin enhancement, we need to get back to not the heyday of 2006, but certainly '04, '05 and maybe even 2007. So that's going to have a big influence on the margin growth.

Stephen Volkmann - Jefferies & Company, Inc.

On your MX engine, 15% of your Kenworth and Peterbilt vehicles would be MX now. What's the overall target for that over whatever time period you choose? And what's the outlook for actually kind of full production rather than just assembly here in the U.S.?

Mark Pigott

Well, as the market improves, we're looking for further growth. Obviously, the template that we've designed the MX engine on is based on the success of the engine in the DAF product. And as you know, we're standard and essentially exclusive with our own product, as many of the other competitors are. But it’s going to take some time to ramp up. We certainly will be expecting to get well over half our products. We'll have our engine as we continue to grow our business, but that's what going to take some time. The other element that was not really addressed is that we're seeing some real success in selling our powertrain around the world to independent manufacturers. And that still small numbers but starting to gather some traction.

Operator

Your next question comes from the line of Tim Thein of Citigroup.

Timothy Thein - Citigroup Inc

First on the PACCAR Financial Services, I'm wondering if you could comment -- one of your competitors had noted some higher increased competition from some of the bank and leasing companies in certain Western European markets. And I'm curious if you can comment in terms of the financing landscape in your key Western, especially Northwestern European markets, as well as what the penetration rate in the quarter for the Financial Services business in Europe was?

Mark Pigott

I think the competition levels are comparable to what we've seen historically. Banks are always going to be there and offering competitive rates and we try to show we're the best in terms of providing the service to support the customers long term. In terms of penetration, we were at 25% for the first half, consistent with where we've been historically.

Timothy Thein - Citigroup Inc

And in terms of the production schedule for the back half of this year, how many -- in terms of the dealer inventory levels, where are they versus where they were a year ago? I'm just getting at if you have a kind of a flattish retail market, why you wouldn't see production rise more than what you're kind of suggesting in your commentary?

Mark Pigott

Well, taking a look at Europe, which is a little bit behind, a little bit ahead depending on how you look at the markets and the economic cycle, our dealer inventory for DAF products is probably half of what it was a year ago. So they're in great shape and we are seeing an increase in production. And as I mentioned, DAF production is up about 25% year-on-year, so that's significant and we expect that will run out at that same rate during the rest of the year, recognizing we do have a normally scheduled two-week summer shutdown that will affect DAF production. And in North America, once again, the dealer new truck inventory is five- to six-year lows, so they're in great shape. And Kenworth and Peterbilt production will improve. It had a good first quarter. Things slowed down the second quarter and we look for some improvement on the second half.

Operator

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

Adam Uhlman - Cleveland Research

Mark, I think you mentioned that 15% of your trucks were now taking a MX engine and then you had also mentioned 20% later. Is the difference the C13 engine from Caterpillar?

Mark Pigott

Yes, that's correct.

Adam Uhlman - Cleveland Research

Could you talk about what the impact was from currency to sales and earnings this quarter?

Thomas Plimpton

That impact on earnings for the quarter was fairly modest. It was about $4 million and most of that came from in the Australian dollar. And the impact in the first half is about $14 million. A lot of that was in the first quarter and had to do again with the Australian and Canadian dollar movements.

Adam Uhlman - Cleveland Research

Could you talk about the demand trends that you're seeing in Eastern Europe?

Mark Pigott

You bet. Breaking out, let's call it Central, Eastern Europe versus Western Europe, it's kind of interesting because year-on-year, that's the first six months, Central, Eastern Europe is up about 20%; Western Europe -- these are registrations I'm talking about, 15-ton higher -- Western Europe is down about 20% for the first six months. So you blend those together and they’re down about 17%. So Eastern Europe, even though there's plenty of challenges and you see those in the paper, those economies are still chugging along and people are interested in doing business there. They typically have low corporate tax rates. They have attractive business programs to invite new businesses to settle into their countries. So we're seeing some growth, but Central Europe total market is about 12%, 14% of the Western European market, so it's still a lot smaller.

Operator

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

Meredith Taylor - Barclays Capital

I'm hoping that you can address your end market outlook, both for North America and for Europe. I noted that you took the high end of both of the ranges down. Can you talk a little bit about in both regions the scenarios that would have defined at the high end of the range and what you haven't seen take shape that caused you to take the high end of the range down?

Mark Pigott

Well, as we've been doing this for a long time, as we progress through the year, obviously, we got a little bit smarter on what the total market is doing. But looking at Europe first, we have a range of 160 to 170. That's strictly a range. Things can happen that will have an effect on that, but looking at the order input for the entire industry, and obviously, what we're getting at DAF and any of changes in market share between the competitors, it seemed to be probably close to 170,000, which is, as I mentioned earlier, comparable to last year, which is 168,000. 2011 could be better market if some of the momentum continues. In North America, we have a range of 110,000 to 130,000 units, which is up from 108,000. In fact, if you went to 130,000, it's up about roughly 20%. So we're seeing that in terms of the incoming order rate. Hopefully that's the first step in the trend to get back to the replacement demand, which we calculate is about 225,000 to 250,000 units for the U.S. and Canadian market.

Meredith Taylor - Barclays Capital

Well, it sounds like as you talk about Europe, then the base case is closer to 170 than 160. Is the 160 still on the table in the event that you see some measurable slowing in Europe or what really defines the low end?

Mark Pigott

Six months ago, we're talking about the euro dollar exchange rate. There were a lot of people thinking, well, it's going to go 150, 160. Three months ago, they’re talking about one to one. Now they’re saying, well, it’s 130. I mean, a lot of things can still unravel in Europe that many economists can't even foresee. So we just give a range.

Meredith Taylor - Barclays Capital

Can you walk us through the delinquency rates on a region-by-region basis in the quarter?

Mark Pigott

So overall past dues for the Financial Services segment were flat with slightly higher in U.S. and Canada and Europe and offset by a reduction in our Mexican and Australian portfolios. We do continue to see gradual improvement in the portfolio and customers are continuing to work through the rehabilitation process, if you will.

Operator

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

Andrew Casey - Wells Fargo Securities, LLC

First on the South American growth opportunity, would you be entering with a full line or more on the tractor area? And then also are you expecting to support that production with engines or components from the Mississippi plant?

Mark Pigott

We'd be looking at a full line. Primarily, it's the DAF product. Most of South America prefers the cabover version and we're very pleased that we have the global leader in cabovers with the DAF, LF, CF and XF. In terms of the powertrain, that's a very important part of growing in South America. We have some very good suppliers there that can furnish us with componentry. And some of the product may come from Mississippi or may come from Eindhoven, just depending on what makes the best economical sense. Very exciting opportunity for us over time.

Andrew Casey - Wells Fargo Securities, LLC

Dialing it back to the near-term, around the production projections, Q3 versus Q2, the 10% to 15% increase for Peterbilt, Kenworth, is that related mainly to the availability of the MX engine?

Mark Pigott

No. It's just markets perhaps getting a little bit stronger. If people want the MX, we are happy to provide it.

Andrew Casey - Wells Fargo Securities, LLC

And then in Europe, this may have already been announced, but I may have missed it, the market’s improving, but still weak with some macro concerns overlaying. Is the government labor cost assistance still being eliminated or is that still up?

Mark Pigott

That’s a great question. I just want to say that, that program for the industry was very well thought out and very well instituted and really achieved its target of maintaining a reasonable level of employment, of giving some assurance and hope to many workers and many industries and also basically allowing companies to do some forward planning. That was a really excellent program. The program, the part-time unemployment has now expired in the Netherlands, but it continues in Belgium and in other countries. The good news is the markets are starting to improve and we're able to start hiring back some of our employees. So I think the programs were excellent for their time and now they’ll just be gradually phased out.

Andrew Casey - Wells Fargo Securities, LLC

Pricing in the U.S. and Canadian market, clearly, you benefited in the second quarter from better pricing. What are you seeing, generally, from competitors as they go after some of these larger orders? Is it getting more competitive as you go forward or is it pretty much static?

Mark Pigott

I think there is many consistent themes in our industry as I'm entering my 33 year. One is PACCAR will produce the highest quality products in the industry. Second, most of our competitors will sell one thing -- cheap pricing. I think that's all I can really comment.

Operator

[Operator Instructions] Your next question comes from the line of Ann Duignan of JP Morgan.

Ann Duignan - JP Morgan Chase & Co

Well, I suppose I'd be remiss given all the discussion you've just had about how great your products are and the great share you gained in Europe. I was hoping that you would comment on Navistar's recent release that their product is 1% to 2.5% more fuel efficient than your wonderful T660 with an ISX 15-liter. Would you comment on just fuel efficiency overall, what you're finding out there and just what your reaction was to that press release?

Mark Pigott

Haven't seen the press release. All I know is what our customers tell us. They love our product.

Ann Duignan - JP Morgan Chase & Co

And what are they saying about fuel efficiency?

Mark Pigott

Yes. We're the leader, continue to be the leader and there's always somebody that will say something, but let's let the market decide.

Ann Duignan - JP Morgan Chase & Co

You haven't done any testing yourselves in terms of your engine?

Mark Pigott

We've done plenty of testing. You know that and you've been here. We’re the leaders in testing. 50 million miles for our engine. We test extensively. We have a very sophisticated testing. But at the end of the day, let's just let the customers decide. As I go to these used truck auctions and that would be probably fun for you to do sometime because you can really see the real world there and the Kenworth, Peterbilt and DAFs are getting 20% to 25% more for a comparable aged, spec’d vehicle. That's what's defining our product worth.

Ann Duignan - JP Morgan Chase & Co

So you're products are holding up better in the used market? Is that what you're saying?

Mark Pigott

They have, they always will and that's a very important part of how we develop our product.

Ann Duignan - JP Morgan Chase & Co

Just kind of conceptually also, can you talk a little bit about why you chose Brazil as kind of your next region of expansion and not Asia? Just conceptually or strategically?

Mark Pigott

Well, actually, we’re in both areas. We've been in China for 100 years. So we certainly know that market. It's a huge market, as you're aware. It's got some different kinds of challenges in terms of the ownership capability for Western companies. There's still been no certifiable Western truck manufacturer that's ever made any money in China in a partnership. Now that's a challenge. But we are pleased after four years in a row, the PACCAR engine has been named the diesel bus Engine of the Year in China. We're selling a lot of our product in China. Brazil, America Sur, South America is a market, once again, that we've been in for over 50 years. We're the market share leader in a number of the countries. Columbia comes to mind. And it's a market that is in a slightly different place in terms of its evolution of owner operators, medium- and large-sized fleets. There still seems to be the opportunity to gain significant gross margins on vehicle sales, as you've seen over your years of covering the industry. Any of our competitors that are in South America, particularly Brazil, which is the largest market in South America, seemed to gain an inordinate amount of their net income from those markets when it's going well. We're a leader in every market we’re in and we think the product will be very well accepted. And we're looking forward to growing in South America.

Operator

Your next question is a follow-up from the line of Joel Tiss of Buckingham Research.

Unidentified Analyst

This is Alex in for Joel actually. I was just hoping you could talk about how many parked trucks are there in the U.S. right now?

Mark Pigott

I don't think anybody knows exactly how many parked trucks. I think the best comment would be there's a lot less than there was a year ago and many of our customers have no truck parked.

Operator

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

Patrick Nolan - Deutsche Bank AG

On the 13-liter shift, the 5% shift, was that you or the industry?

Mark Pigott

I say it's both.

Patrick Nolan - Deutsche Bank AG

And is it a matter of who's buying trucks or is it really customers shifting down from 15s to 13s.

Mark Pigott

I don't think there's any shifting down. The 13-liter is the preferred engine throughout the world. And I think there’s just a growing realization of the benefits of the 13-liter in terms of fuel economy, light weight, ease of maintenance and certainly, it will deliver comparable torque and horsepower. No, I think it’s just people coming to grips that the U.S. and Canadian market really cannot be an island in the global truck world, recognizing that this is what the vast majority of people use for power in their vehicles worldwide.

Patrick Nolan - Deutsche Bank AG

And when you look at your share in the second quarter, were you supply constrained? I know you guys were doing the changeover quicker than most in the industry. Was there a supply issue that your share was a little weaker in the second quarter versus the first?

Mark Pigott

No, I think the main impact was that we made the shift to 2010 engines, as we always make the shift to new technology faster than any of our competitors, and thus, there was a price differential as we were passing along the 2010 pricing versus the old 2009 pricing.

Patrick Nolan - Deutsche Bank AG

Do you expect the share to come back some in the…

Mark Pigott

I'm sure it will over time. It always does.

Patrick Nolan - Deutsche Bank AG

And just more of a detail question, can you give us an idea of what financials you both did quarter-over-quarter in the Finance business?

Mark Pigott

Can you repeat that? I didn't quite hear that.

Patrick Nolan - Deutsche Bank AG

The balance of the [indiscernible] (48:00) receivables on the balance sheet, what they did quarter-over-quarter?

Thomas Plimpton

I think we were down $400 million to $500 million in the quarter. Part of that was currency and part of that’s just lower level of truck sales that we continue to see in the markets.

Mark Pigott

You’re talking receivables?

Patrick Nolan - Deutsche Bank AG

Right.

Mark Pigott

Yes, the asset base is getting a little bit smaller. The good news is that probably getting close to the bottom, and as our customers see improved business and start purchasing more, that we'll see Finance Company assets growing and our total Finance Company will grow.

Operator

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

Tim Denoyer - Wolf Trahan

Can you give a little more color on the margin impacts that the increase in parts and service had or was that material enough?

Mark Pigott

No, the margins for parts and service was pretty comparable to what we've seen before. Parts business is improving as we mentioned, as more customers are fixing up their trucks and they're seeing some freight growth and taking trucks off the parked status. But margins for parts is comparable to what we've seen.

Tim Denoyer - Wolf Trahan

Can you give a little more color on South America and the strong result that you posted geographically outside of the U.S. and Europe, in terms of was that being driven by mostly South America or were there other markets involved?

Mark Pigott

Our two primary markets would be Mexico where we are celebrating our 51st year and we're also celebrating probably over 50% market share. So that's going well. Australia is also a very strong market. We're the market leader there and Australia did a very good job of navigating the difficult economic times over the last few years and seems to be in a pretty steady recovery area.

Operator

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

Jerry Revich - Goldman Sachs Group Inc.

Mark, when we've seen successful new product cycles for your business in the past, we saw the momentum on share gains continue really for a couple of years. Do you see potential for your European share gain in the back half of the year to improve further from here based on your order share? Do you have any visibility there?

Mark Pigott

Well, we do have great products and I appreciate your support of that. Of course, Kenworth, the T700 is really doing well. Peterbilt's got some exciting new products themselves. We continue to be recognized by many of the industry groups, such as the American Truck Dealers as the Peterbilt 384. Right now, when you look at the U.S. and Canadian market, whether it's 110,000, 120,000 units, it's still at about a 20-year low. So it's still at the bottom now. It's improving, so that's the good news. Our share will improve over time, but there's a number of competitors that still are actively selling engines that were built last year. There's certainly a price differential on that. So this year is certainly a year of flux as customers are working their way between what engine do they buy, how is the economy generally recovering. But then you've got the countervailing concerns about housing build, 50-year low, car production, 20-year low. I mean, these are major drivers for freight movement in our country and also have a big effect on what our customers see. So 2010 is certainly a better year than 2009, but it's still a very challenging year.

Jerry Revich - Goldman Sachs Group Inc.

And Mark, today, can you address the same question for the European business? So my question is considering the share gains you delivered in the first quarter and based on what you're seeing out of your order share, do you think your retail share will be higher in the back half of '10 than the first half? Looks like customers are clearly voting with their wallets. Question is, is there further momentum on this product cycle for you in Europe?

Mark Pigott

Great question. In Europe, I think the share will be sort of comparable to what we have now. There's certainly a range that will fluctuate in between. We continue to add service points and the customers love the DAF product. Our share in Europe is lower than it is in the U.S. and Canada. So there's still some opportunity. But there's also different dynamics. There's a little different economic headwinds you run into in Europe. Every country has a slightly different challenge and different opportunity. Also a number of our competitors in Europe are not present in North America and some of those competitors have their own unique challenges. So it's a different market.

Jerry Revich - Goldman Sachs Group Inc.

Mark, you mentioned an improvement in pricing, which was great to hear. Is that centered more in the U.S. and Europe or is that pretty broad-based?

Mark Pigott

I think the improvement in pricing we're seeing in most of our markets is just early days coming out of a very tough recession and still in a challenging year. So I think I’m proud of the team for getting improved margins, but it's going to take a number of more successful quarters and a much stronger economy in Europe and in North America to continue to get margin enhancement.

Operator

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

David Leiker - Robert W. Baird & Co. Incorporated

Mark, I don't think I heard you talk about this, but in the North American market, over the last couple quarters, there's been a disparity of different segments of the market and how they're recovering. Have those started to recover a little bit more in line or is there still some lagging areas?

Mark Pigott

No, there's definitely some lagging areas. Anything to do with construction, the commercial or residential or let's call it manufacturing, are down. Whether it's a five-year, 10-year, 20-year or 50-year low, they're down. Now some of the retail main street may be seeing some improvements although a number of the big chains are pretty flat year-on-year. So there's definitely some unevenness, as we've said in our press release.

David Leiker - Robert W. Baird & Co. Incorporated

But what about within the Truck segment, the severe service versus on-highway versus truckload? Is there any…

Mark Pigott

There is some and it would take most of the day to go through it all. But certain of our customers focus on different segments. Some are doing very well. You've seen many of the financial reports from the publicly-traded truckload carriers. Some of them are seeing some good improvement. Others are maybe struggling a little bit more because the segment that they're focused on hasn't recovered too much of an extent. And some of the customers have a, let's call it a mix of customer base, and so their results may be a little bit more on the flat end. But all in all, the good news is freight has improved. It's still about 10 points lower than it was at its peak two years ago. Diesel fuel is relatively stable. Freight rates, as some of our customers are starting to see a little bit of improvement in freight rates. But a lot of the customers are still holding on to their older equipment because they just want to see does this "recovery" really have any legs or will next month bring some other challenge.

David Leiker - Robert W. Baird & Co. Incorporated

As you look at volume and recovery, can you walk us through what your strategy plans are for ramping production back up?

Mark Pigott

It's a very straightforward strategy, one we've had for 105 years. And that is, if you want our product, we will build it for you in a very reasonable amount of time. We have a lot of flexibility in our factory. We have the most efficient and productive truck manufacturing factories in the world. And so as volume increases and we get more orders, we'll increase our production.

Operator

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

Mike Roarke - McAdams Wright Ragen, Inc.

What percentage of loans are 30 days past due in the Finance portfolio, please?

Mark Pigott

That was – you heard 4%.

Mike Roarke - McAdams Wright Ragen, Inc.

Okay 4%, so about flat. And then what is the amount of used equipment on the balance sheet right now?

Thomas Plimpton

We've made significant strides in reducing our level of used equipment and we’re down to between 1,500 and 2,000 units.

Mike Roarke - McAdams Wright Ragen, Inc.

And do you have a dollar value assigned to that, please?

Thomas Plimpton

I don't have it offhand. It's probably $75 million or so.

Mark Pigott

We can send that out to you.

Mike Roarke - McAdams Wright Ragen, Inc.

I think I heard on the manufacturing breakout that $538 million was attributable to aftermarket parts?

Mark Pigott

That's correct.

Mike Roarke - McAdams Wright Ragen, Inc.

What was the gross margin on that $538 million, kind of like you do in the 10-Q, if you could?

Thomas Plimpton

For the quarter, the aftermarket parts margin was 33.8%, which compares to 32.5% in the prior year's quarter…And then 33.7% for the six months and it's 33.8% for the six months last year, so it's comparable.

Mark Pigott

So we’ve had some improvement there.

Mike Roarke - McAdams Wright Ragen, Inc.

And then what was the gross margin in 2Q for the trucks, please?

Thomas Plimpton

The truck gross margin was 5% in Q2.

Mark Pigott

Good questions.

Operator

Your next question comes from the line of Ben Elias of Sterne Agee.

Ben Elias - Sterne Agee & Leach Inc.

I was wondering if you could spend a couple of minutes talking about the capacity utilization in Europe. I think people, I guess, have moved from the argument that the fleet is kind of young and are thinking about the lack of capacity or the impending lack of capacity. What are you hearing from your dealers?

Mark Pigott

I'm not sure which capacity utilization are you talking about?

Ben Elias - Sterne Agee & Leach Inc.

The fleets, the number of trucks in the road and freight capacity?

Mark Pigott

I think there is good fleet capacity. Our dealers, that's not an issue for our dealers and our customers seem to be in good shape and if they need more capacity, they are purchasing trucks and the good news is DAF production is up about 25% year-on-year.

Ben Elias - Sterne Agee & Leach Inc.

Okay, so you haven't heard anything from your customers that they need additional trucks in a shorter period of time?

Mark Pigott

Well, they're purchasing more trucks than they did a year ago. Of course, a year ago was in the middle of a very tough recession. So I think we are in good shape.

Operator

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

Kristine Kubacki - Avondale Partners LLC

I want to frame up a question that was kind of asked earlier. We've seen some rather lofty increases in the forecast for the next year, but understanding that the supply chain and your manufacturing can react only so fast thinking about it quarter to quarter, if we see demand really surge, kind of like what's the availability? Like could the supply chain react with a 50% increase? 100% increases? I mean, this is some of the forecast that we've seen the year-on-year.

Mark Pigott

You haven't seen those forecasts from us… I don't think so. I'm not sure who's forecasting that, but that would be quite an increase. I'm not sure a number of our competitors could meet that. Someone's talking about 100% improvement in the market size?

Kristine Kubacki - Avondale Partners LLC

They’re out there…There's some forecasts that are pretty lofty out there for next year.

Mark Pigott

Maybe those are people who are actually not building trucks for a living so they're just forecasting. I can't really comment on that. We've got a great supply chain. Obviously, it's been through a tough couple of years with the recession. Once again, the good news, and this doesn't get a lot of press, is that PACCAR's really the only OEM that continues to invest in our suppliers, particularly on capacity and quality enhancement where we will put in multi-million dollar machinery to improve our suppliers. So our suppliers are in good shape and they relish the opportunity to produce more.

Kristine Kubacki - Avondale Partners LLC

Then changing directions a little bit, out of the EPA CARE workshop last week, it sounds like the EPA is going to make some changes to the FCR guidance after a comment period here in August. Do you expect any impact to adhering to these changes? Will there be any R&D investments or anything that we should look out for?

Mark Pigott

Well, we continue to work with the EPA and all the relevant environmental groups around the world. I think whatever changes are promulgated, we've had an opportunity to have some input to them and we will be a leader on meeting them. And as you know, everybody in the world, all major competitors, have aligned themselves on one environmental strategy and practice. So I think we're in good shape.

Operator

Your next question is a follow-up from the line of Tim Denoyer of Wolfe Trahan.

Tim Denoyer - Wolf Trahan

On used truck prices, you noted a pretty strong improvement in the first quarter and we’ve heard anecdotally that things continued to pick up in the second quarter, but I was wondering if you're seeing that as well?

Mark Pigott

Yes we are. Used trucks are having good improvement and we look forward to that improvement continuing through the year and into next year, particularly as the market ramps up and people need trucks to haul their increased freight. So the good news is that all of our trucks, Kenworth, Peterbilt and DAF are still getting a 20% to 25% residual value greater than any other competitors.

Tim Denoyer - Wolf Trahan

Are there any specific segments of the market? I mean, I would guess that obviously, that the younger trucks where there's less supply are having the biggest price increases. But are you seeing any differences in mixes as you go older?

Thomas Plimpton

Yes, I think that is true. The late-model used vehicles have seen better appreciation because there is a lot of good miles left in those trucks and good demand for those.

Mark Pigott

I think we're seeing some on the day cabs. They seem to be strong.

Operator

Your next question comes from the line of Stuart Herzanski [ph] of Vanguard.

Unidentified Analyst

In your release, you mentioned that your CapEx for the year, you're expecting I think around $175 million or so. I think for the first six months of the year, you were a little bit below $50 million. So is it fair to say that the second half of the year, you're going to be at about $125 million to $150 million?

Mark Pigott

That is correct. Yes. We got a lot of exciting projects we're working on and we are ramping up on them.

Unidentified Analyst

So could you provide any more color on that?

Mark Pigott

Not at this time. But it's a great question.

Operator

There are no other questions in the 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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