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PACCAR Inc. (NASDAQ:PCAR)

Q1 FY08 Earnings Call

April 22, 2008, 11:00 AM ET

Executives

Kenneth R. Gangl - VP and Treasurer

Mark C. Pigott - Chairman of the Board, CEO

Michael T. Barkley - VP, Controller

Analysts

Peter Nesvold - Bear Stearns

J.B. Groh - D.A. Davidson

Jonathan Steinmetz - Morgan Stanley

Andrew Casey - Wachovia Securities

Michael Regan - Janus Capital

Operator

Good morning and welcome to PACCAR's First Quarter 2008 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. Ken Gangl, PACCAR's Vice President and Treasurer. Mr. Gangl, please go ahead.

Kenneth R. Gangl - Vice President and Treasurer

Thank you and good morning. We would like to welcome those listening by phone and those on the web cast. My name is Ken Gangl, Vice President and Treasurer of PACCAR and joining me this morning are Mark Pigott, Chairman and Chief Executive Officer; Ron Armstrong, Senior Vice President, Financial Services; and Michael Barkley, Vice President and 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 risk and uncertainties including general economic and competitive conditions that may affect expected results. I would like to now introduce Mark Pigott.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Good morning. PACCAR is pleased to be one of the industry leaders for financial performance, product quality, and applied technology. As many of you know, PACCAR is in its 103rd year [ph] and recognizes that while the U.S. and Canadian truck market is currently challenging there will be brighter days.

PACCAR today announced good earnings for the first quarter of 2008. The company's performance reflects the company's global diversification, world-class technology, and a growing after-market and financial services business. PACCAR's strong balance sheet and outstanding cash flow have allowed the company to increase its capital investments in new products, enhance facility efficiency, and increase after-market capacity. We invested over $169 million in capital projects and R&D during the quarter. PACCAR's net sales and financial services revenue were $3.94 billion for the quarter, net income was $292.3 million compared to $365.6 million last year. On a per share basis, earnings were $0.79. PACCAR's after-tax return on revenue during the quarter was 7.4%.

PACCAR has certainly benefited from having 60% of its business outside the United States. We delivered increased revenues and profits from commercial vehicle sales in Europe, Mexico, and Australia. Europe truck sales are robust due to the growth in Central Europe as countries invest in their infrastructure. Revenue and profits in PACCAR's after-market parts business continues to grow.

The financial services business is expanding as total assets reached $10.8 billion and pre-tax profits were a first-quarter record of $67.3 million. The healthy performance of our finance and after-market segments has complemented the manufacturing business. In the U.S. and Canada, truck sales have been negatively impacted by higher diesel prices, lower freight demand, and a weaker economy. The good news is that customers are working through the higher diesel prices as many medium and large customers are beginning to discuss new truck purchases as many of them have not purchased for 12 to 15 months. We have lowered our 2008 retail truck sales forecast for the U.S. and Canada to reflect market uncertainties.

On a longer-term basis, over the past ten years, PACCAR has invested over $3 billion in products, infrastructure, and technology to develop and produce the industry's highest quality vehicles and services. As part of this ongoing investment program, PACCAR's $400 million world-class engine facility is progressing on schedule and is due to be completed in late 2009. This investment complements the company's state-of-the-art engine factory in the Netherlands and will enable the company to manufacture 12.9 and 9.2-liter engines for use in Kenworth, Peterbilt, and DAF vehicles worldwide.

Additionally, DAF will soon begin construction of a new 135,000 square foot cab paint facility in Westerlo, Belgium. This project will utilize leading-edge technology and will ensure that the Westerlo paint facility is a leader in being environmentally friendly. The new cab paint facility will increase DAF's manufacturing capacity by 20% and is expected to commence operations in 2010.

PACCAR Parts continues to expand capacity to serve the worldwide commercial vehicle markets. The construction of a 260,000-square foot distribution center in Budapest, Hungary is nearing completion. The facility will serve DAF dealers and customers in Central and Eastern Europe. At the same time, a 45,000 square foot expansion of our distribution center in San Luis Potosí, Mexico is nearing completion and will enhance service to our Kenworth dealers in Mexico.

Switching gears, PACCAR is proud to be an environmental leader as we celebrate first day today. Kenworth, Peterbilt, and DAF were at the forefront of hybrid technology development. Kenworth and Peterbilt medium-duty trucks utilizing an advanced diesel electric drive system that targets 30% fuel efficiency improvement are scheduled to go onto production this summer. Kenworth will begin its presence in the production of Class 8 vehicles for the liquefied natural gas market in 2009 under an agreement with Westport Innovations. And I think even more importantly, all of our manufacturing facilities worldwide have earned ISO 14001 environmental certification, a terrific achievement.

Asia continues to be a point of focus for PACCAR. Our new office in Shanghai is increasing the sourcing of parts and the sale of DAF power train components. I am pleased to note that PACCAR was named the best engine supplier for 2008 at the Shanghai Bus Show.

PACCAR plans to further expand its presence internationally with the opening of a major engineering, purchasing, information technology, and sales office in India later this year.

PACCAR's conservative credit practices have certainly benefited the company and its customers. PACCAR Financial Services continues its global expansion as the European portfolio now exceeds $3.1 billion or approximately 28% of the worldwide business. Portfolio quality remains good with past dues accounts increasing only slightly to 2.2% at the end of March.

As I mentioned earlier, PACCAR Financials had a new pre-tax record for the first quarter, even including credit losses in the quarter of $15.3 million versus $9.4 million in fourth quarter of last year. The losses were primarily due to the repossessions in the U.S. and Canada.

Once again on the good news, the resale value of PACCAR products continues to generate a premium versus the competition in all of the markets we serve.

Looking at the global truck markets for 2008, there continues to be positive economic growth in Europe. We expect the European over 15-ton truck market to range between 340,000 to 360,000 units. DAF is planning to increase production in the near future, approximately 5%. The U.S. and Canadian retail truck market should be in the range of 165,000 units to 185,000 units comparable to last year, reflecting the slower economy and impact of increased diesel fuel prices.

During the first quarter, PACCAR repurchased approximately 2.45 million of its common shares for an investment of $110 million. Over the last six months, PACCAR has bought 3.73 million shares, split adjusted for a total investment of over $172 million. PACCAR has achieved an average annual total shareholder return for the last ten years of 18.9% compared to the 3.5% for the S&P 500 Index.

Thank you. We look forward to your questions.

Question and Answer

Operator

[Operator Instructions] Your first question comes from Peter Nesvold with Bear Stearns.

Peter Nesvold - Bear Stearns

Happy Earth Day, Mark.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Good morning, Peter.

Peter Nesvold - Bear Stearns

Don't expect me to sing. Can you go into some detail on what's happening on material costs? I mean steel, copper prices it has been extra ordinary, the run that they have year-to-date and whatever detail you can provide about... what are you under contract for in terms of your purchasing, are you hedged, is that how you are handling it? Are you able to pass it through? What kind of price increases are you getting through the retail channel right now, etcetera?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Excellent question. Certainly one that many companies and many industries are grappling with around the world. We've seen an increase in steel really begin to have an impact a few years ago, certainly with the increase in petroleum, it’s affecting rubber products, tires etcetera. But, I would say over the last few years it has been a several thousand-dollar impact on materials, $1,000 to $2,000, which we tried to pass as much of it along as we can. We have the majority of our supplier partners under long-term contract. We've a great relationship with our suppliers, but that's kind of the way the world right now. Obviously it is happening for many reasons, but some of it you pass along and some of it, because of our investment in our facilities we try to compensate by improved efficiency.

Peter Nesvold - Bear Stearns

Well, you mentioned that you are under a long-term contract with these suppliers and I am just curious, I mean, if I am a tier two or three supplier, I am the living definition of stag [ph] inflation right now where there’s just no demand and my material costs are just going to the roof. So, if you are under long-term contracts, but are you giving them relief? I mean how much of their increases are you taking off their shoulders because it would seem to be the longer we stay down at these levels, the more risk there is the supply chain isn't there in '09 to handle whatever pre-buy might emerge.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Well, PACCAR and I’m really proud of the purchasing and supply development and Six Sigma teams. We have a very different approach than many OEMs and that is we actively invest in our suppliers. May tens of millions of dollars on an annual basis to allow them to become more efficient to increase their capacity and even more importantly to improve their profitability. And this is a program that we started probably five, six years ago. We also go in and teach them six Sigma analysis techniques. So all of these activities have been able to improve the financial viability of our suppliers and we pride ourselves on having suppliers that make money. We want them to make money, we want them to increase their profitability, and we are putting our money where our intensions are by investing in them, by allowing them to buy sophisticated machinery, whether it's robotics or process machinery, and as a result, the suppliers that we work with are doing, for the most part, very well. We absorb quite a bit of the material cost and in fact we work together to improve their profitability and make sure that we produce the finest products for our end customers.

Peter Nesvold - Bear Stearns

And last quick one, I will jump back in queue. When I look at the provision for loan losses, certainly did take a bigger than expected uptick here, but still only about 5.5% the financial services revenue, and when I look at sort of the worst case scenario back in '01 that was 19% of revenue, do you... what's the risk that we start to rival that that kind of scenario that we were feeling back in '01?

Peter Nesvold - Bear Stearns

Let me just start off and then we’ll turn it over to Ron Armstrong. Obviously compared to the '01, '02, our asset base is more than twice as large, we are much more internationally spread out. We've got a lot more customers and a lot more countries. We are more sophisticated in our credit analysis and evaluation techniques. So, I think your questions are good one but I think we are very, very conservative as you well know and seem to be well positioned. Obviously, we are not immune to the challenging times in certain countries around the world, but we are taking the appropriate steps to keep the business moving forward and really proud of the team. We are generating a first record profit and I would say it's a first quarter profit. Let me turn it over to Ron for a little bit more information.

Ronald E. Armstrong – Senior Vice President

I would just echo Mark's comments. I think the diversification, the conservative approach to our credit underwriting are key to the portfolio performance and we continue to work very closely with our customers on a day in day out basis to help work through the challenge to satisfactory solution. So, actively engaged and continue to see the portfolio perform well.

Peter Nesvold - Bear Stearns

Okay, thanks guys.

Ronald E. Armstrong – Senior Vice President

Thank you.

Operator

[Operator Instructions]. Your next question comes from J.B. Groh with D.A. Davidson.

J.B. Groh - D.A. Davidson

Good morning, guys.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Good morning.

J.B. Groh - D.A. Davidson

Couple of questions on the R&D, can you sort of give us clues to win that peaks and what are the big drivers, I'm assuming your new plant is part of it as well, some of these hybrid vehicles, and I mean how should we look at that kind of as a percentage of sales are in absolute level recognizing, but you don't want give guidance, I appreciate that. But I'm just trying to get a clue as to where that goes and when it kind of peaks out?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Yes, excellent question and we appreciate your support and many other who cover us in terms of our expanded coverage of R&D. So, thanks for the input on that. Throughout the company, we have many initiatives, you mentioned a couple, the new engine factory and the hybrids, but we're also have a very active program to design, develop, and introduce entire new range of products in every product range, that would be Kenworth, Peterbilt, and DAF. So, that's a... those are typically five to six-year programs. We are expanding our parts after market distribution center capacity, we are doing a lot of engine development besides just building a new engine factory expanding financial services. So, I would say that the rate you see now will probably be a normal run rate for the foreseeable future.

J.B. Groh - D.A. Davidson

In terms of dollars or percentage of sales or--?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

I think the dollar side would be what I focus on.

J.B. Groh - D.A. Davidson

Okay. Great. And then on the premium vehicles, you're probably going to able to charge a premium, so I would guess given the fuel economy that they are going to --?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

On the… yes, on the high bridge?

J.B. Groh - D.A. Davidson

Yes.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Yes. In fact, we will be showing a few of them to our shareholders this morning at our meeting. But typically how it's going to work is, yes if there is a premium for it, many of the customers will be eligible to get some sort of relief from the government if they qualify under certain specifications, and, but the main driver will be the 30% estimated fuel economy improvement, which sort of a strange way of world as the fuel price goes up, there's more money that we're going to save. So, it's going to be, I think a terrific product and we're getting a lot of real, strong interest. People like Coca-Cola and others are already ordering these trucks because their customers are interested in being associated with so-called green companies.

J.B. Groh - D.A. Davidson

So, can we assume that contribution margin of hybrid trucks better than on standard truck?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Well, I don't know if I want to say that. It's going to be decent but recognize it's still a very, very small part of our business.

J.B. Groh - D.A. Davidson

Right, right.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Hopefully over time, it will grow, but it's early days.

J.B. Groh - D.A. Davidson

Right. Absolutely. Okay, thanks for your time, Mark.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Thank you.

Operator

Your next question comes from Jonathan Steinmetz with Morgan Stanley.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Hi, Jonathan.

Jonathan Steinmetz – Morgan Stanley

Hi, how are you?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Fine. Thank you.

Jonathan Steinmetz – Morgan Stanley

So, just a few follow-ups here. I just wanted to go a little deeper on Peter's initial question on the raw material side. I’m sort of trying to understand whether you think that there were a number of increases in steel and another commodity, [inaudible] based commodity etcetera that you didn't really feel in the first quarter because you have some longer-term contracts, but then as these expire will begin to feel them or do you feel like you saw real time in your ability to have productivity and some pricing is offsetting?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

That's a great question. I think, we sort of pride ourselves on real-time analysis and real-time recognition of price increases whatever facet of the business they happen to surface in. So this has been going on for many industries, as you are aware for a number of years. So the first quarter is nothing unusual, I think, it probably might have been highlighted in the popular press because of the dramatic increase in diesel. That's certainly is very topical and very important to our industry and our customers. But I think, on the manufacturing side, the steady increase in prices has been going on for at least three years.

Jonathan Steinmetz – Morgan Stanley

Okay. So, I guess, that would suggest you'd continue to have productivity and pricing you think compensate for, we don't see some spike --?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

I think that's a good assessment.

Jonathan Steinmetz – Morgan Stanley

Okay. Let me ask you on the rest of world revenue, I know it's a topic that doesn't come up a lot given the focus on Europe and the U.S. but most of that, I think is Mexico and Australia. Can you just talk a little bit about what you foresee in the back half of the year there, some of these initial changes are finished?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Yes. You're right. It is primarily Mexico and Australia. Each of those countries has their own time schedule in terms of the emission implementation. Mexico would be coming up in the middle of this year, and I think, if history is any guy which sometimes it is, we would expect some sort of increased interest in purchases, I mean, every country has its own story. Mexico just implemented a, let's call it an inventory valuation tax program early in the year, which is still being, work through by many companies and many industries. So that's unsettled the market. Australia has seen some slowdown, but now it seems to be rebounding. So, I think both have certainly grown tremendously for us in the last five to six years and are making an excellent contribution. So, I see steady progress there.

Jonathan Steinmetz – Morgan Stanley

Okay. And lastly, just a housekeeping item, can you give the... for the total company the impact of currency translation year-on-year on both revenue and either EBIT or EPS?

Michael T. Barkley - Vice President, Controller

Yes, this is Michael Barkley. The impact of all currencies on the revenues for the quarter compared to the last quarter of '07... first quarter of '07 was $247 million on revenues and $23 million on net income.

Jonathan Steinmetz – Morgan Stanley

Great, thank you.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Thank you.

Operator

Your next question comes from Andy Casey with Wachovia Securities.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Good morning, Andy.

Andrew Casey - Wachovia Securities

Good morning, Mark. Good morning, everybody. I was wondering if you guys could talk about industry pricing trends in the U.S. and Canada for both new and used trucks, especially in light of the sequential increase in the provision for losses and the finance up.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Are you talking about transaction prices for new and used trucks?

Andrew Casey - Wachovia Securities

Yes.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Well, I always wish I could say they keep going up. I think the good news is that on the used truck side, we continue to enjoy a 15% to 25% premium over all of our competition as we have for probably many decades and if anything is probably widening as we come out with newer exciting models, I think used truck pricing is probably slightly down compared to a year ago, but for us still good, very good. And what you're seeing is a shift more towards the aerodynamic models, which make sense considering diesel prices. On the new trucks, I think the... I don't think there has been any noticeable change in transaction pricing over the last six months. I think the market has been fairly steady as you can see by industry build rates and order income and retail sales. Obviously, compared to the strong market of 2006 they've come down, but I think they've reached a reasonable plateau and as the market improves over time, and I can't tell you specifically when that's going to happen, I think pricing will improve.

Andrew Casey - Wachovia Securities

Thanks. Could you also talk about what not necessarily PACCAR, but what you may be seeing in the industry overall in terms of potential discounting on some of your competitors’ part to grab some large orders to fill up their capacity?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Well, I don't think anybody has filled up their capacity, I am sure everybody would like to. As I mentioned in my opening comments, we are seeing medium and large customers, well managed, well financed, leads starting to engage in discussion process saying we really haven't purchased for 12 to 15 months. There is a normal replacement cycle that they run their businesses on and they are saying, yes, the economy may be slow but freight is still about a 2005 level. I think that's an important point to make, is it down, yes, it is down from a record level. But we were around in 2005 and I think everybody thought, well that rate was pretty good. Well, we are back down to that level. Freight is good. So as maybe some of the smaller operators are deciding that they are going to try a different business, a lot of that freight is absorbed by medium and large customers, and I think there will be a brighter day in the future.

Andrew Casey - Wachovia Securities

Okay. And I mean, I was just asking, I know it's a quick turnaround, but some of your competitors made some highly interesting hires, recently?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Well, I can't track all of that, but I just know that we've got the best team, and I'm obviously proud of the PACCAR team.

Andrew Casey - Wachovia Securities

Thank you very much.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Thank you.

Operator

Your next question comes from Michael Regan with Janus Capital.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Good morning, Michael.

Michael Regan - Janus Capital

Good morning, Mark. Thanks.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Thank you.

Michael Regan - Janus Capital

First, just a clarification, the translation number you gave on both sales and profits, was that on pre-tax profits?

Michael T. Barkley - Vice President, Controller

That was net income.

Michael Regan - Janus Capital

Net income. Okay. Got you. And then, Mark, if I could ask after making significant share gains in Europe for the last couple of years against an admirable target, shares slowed a little bit in '07. Is that mostly capacity and sort of the rate of capacity you are bringing on as opposed to where your competition is?

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

That is a great question, yes, we are--

Michael Regan - Janus Capital

I started the ones I know you will answer and then I will follow-up with ones I know you won't.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

The DAF has done a remarkable job as you are aware and winning the Truck of the Year three times and we’re the only OEM to do that. So we are continuing and have invested several billion euros since we acquired DAF, well 12 years ago now, and as I've mentioned in my comments and in the press release, we're increasing capacity another 20%, particularly in the cab paint area, which will have a positive impact throughout the entire DAF organization and that will allow us to obviously increase the number of vehicles we deliver. So right now we are sort of bumping the factory capacity limit, although through investment and efficiency gains, we are able to increase that slightly. This would be a significant enhancement in 2010, and I think we will continue the steady progress towards our target of 20% share.

Michael Regan - Janus Capital

Great. Thanks, Mark.

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

Thank you.

Operator

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

Mark C. Pigott - Chairman of the Board, Chief Executive Officer

No, 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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