帕卡 (PCAR) 2010 Q4 法說會逐字稿

Good morning and welcome to PACCAR's fourth-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.

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; Tom Plimpton, Vice Chairman; and Michael Barkley, Vice President, Controller. As with prior conference calls, if there are members of the media participating we request 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.

Good morning. PACCAR reported improved revenues and net income for the fourth quarter of 2010. PACCAR's fourth-quarter sales and financial services revenue were $3 billion compared to $2.2 billion in the fourth quarter of 2009. Quarterly net income increased to $170 million compared to $46 million a year ago, a 370% improvement. PACCAR's 2010 yearly net income of $458 million is the Company's 72nd consecutive year of net profit -- quite an achievement.

I'm very proud of our 17,700 employees who have delivered outstanding performance to our shareholders and customers in a global economy which is beginning to emerge from recession. PACCAR's results reflect the benefits of higher truck deliveries, particularly in Europe and Mexico, and a continued improvement in aftermarket parts sales and financial services worldwide. In the US and Canada, industry orders in the fourth quarter of 2010 increased by 100% compared to the third quarter. US and Canadian retail truck sales are estimated to improve in 2011 to a range of 180,000 to 200,000 units, an increase from the 126,000 units last year. This is still below replacement demand of 225,000 vehicles.

European truck registrations for the fourth quarter improved by 19% compared to the third quarter. As a result, we expect the greater than 15-ton truck market to be between 220,000 to 240,000 units this year, up from 183,000 units last year.

The improving global economy is benefiting the truck market, no doubt about it. PACCAR delivered 20% more trucks in the fourth quarter than the third quarter of 2010, and truck production is expected to increase this year.

However, recent commodity price increases, particularly steel, aluminum and copper and the added cost of installing engine emission equipment over the last three years, particularly the 2007 to 2010 EPA cycles, added costs of about $15,000, which will likely impact PACCAR's operating margins as compared to prior cycles.

On recent calls I've talked about the three-step process that the truck industry progresses through as it recovers from a recession. First is an improvement in parts and service, second is an increase in use truck prices, and third is new truck orders improving. Well, the good news is that PACCAR Parts delivered record quarterly revenues due to the highest average age in recent history in the US truck fleet. Used truck prices in North America are up 10% to 15% from their lows, and used truck prices in Europe are up 20% from their lows.

Finally, year-on-year quarterly industry truck orders in the US and Canada increased by 63% and in Europe by 86%. Our customers are benefiting from improved freight volumes, which are up 4% from a year ago and higher freight rates, which are up approximately 5%. They continue to increase the utilization of their fleets, which is, in turn, driving increased aftermarket parts and service business for our dealers.

PACCAR's strong balance sheet and positive operating cash flow of $1.5 billion last year have allowed the Company to accelerate its investment in the business, enhance operating efficiency and develop innovative new products, such as the PACCAR MX diesel engine. We have now received over 10,000 orders for the MX engine. The engine is being installed in 25% of Kenworth and Peterbilt trucks, and the feedback from our customers has been excellent.

PACCAR Financial Services' revenue were $244 million in the fourth quarter compared to $255 million a year ago. PACCAR Financial's fourth-quarter pre-tax income improved to $50 million compared to $36 million earned in Q4 2009. This was due to better finance margins and a reduction in the provision for credit losses. The credit loss provisions for the fourth quarter of 2010 were $12.6 million compared to $23.7 million a year ago.

2010 in many ways was an excellent year for new PACCAR product introductions. The success of the Kenworth T700 and the Peterbilt model 587 and the complete line of DAF vocational vehicles enhances our quality leadership as well as delivering low cost of ownership for our customers.

In 2011 PACCAR will more than double capital expenditures. The Company will focus on new vehicle development, customer service initiatives, meeting the Euro 6 and EPA 2013 emission requirements and global business opportunities. One of the primary areas we will focus this year is initiating construction of our DAF factory in Brazil. Our long-term goal is DAF achieving a 20% share of the Brazilian medium- and heavy-duty truck market.

A lot of exciting opportunities. PACCAR will incur some increased expenses due to these business initiatives; but, as we all know, that's normal considering the benefits of growing in the global markets. It looks like a good year, and I look forward to your questions. Thank you.

(Operator instructions) Rob Wertheimer, Morgan Stanley.

A couple questions on the awards data that just came out -- and I know the monthly stuff is highly variable, but your vertical integration had slipped just a bit. I wanted to see what the 1513 leader was trending like and whether you feel like that's continuing, going to continue to move your way.

Well, it's hard to talk about the whole industry, but I can tell you, the customers and the dealers certainly love the MX engine. And we are getting anywhere from 25% to 30% order intake on that, and right now we have about 25% production. So it looks very good -- 13 liters, the most popular configuration in the rest of the world. 15 liter, with our great partner, Cummins Engine, continues to be a strong player. But I think, over time, you'll see a little bit more 13 liter activity.

Perfect. That was helpful, on the order. And then the second question would just be on the margin front. With the 2010 trucks, I understand the increased cost of the emissions, but there's also pricing that went up. Has pricing become more of an issue? And can you quantify how much of a margin headwind is -- is splitting up commodities for a second, just the emissions side is?

Well, the commodities -- and obviously, that's in the paper, and many industries are running into that. And obviously, PACCAR prides itself on being the most efficient and low-cost manufacturer in every market in which we participate. And so you work with your suppliers and try to minimize the impact of the commodities, and over time, hopefully you're able to do that.

But in recent three to six months, it has had an impact to some amount. I think more important is the impact on the emission requirements. And once again, that's a regulatory requirement which we all meet in the industry, and 2007 and 2010 added about $15,000 of cost. And I think you'll find any OEM saying about that same figure. The market happened to be in a recession the last few years, so it's very difficult to pass that through.

I think on the supplier side, they've had a little more success passing it through to the OEM, but when we deal with the end customer, who have had some difficult times, whether because their business is down or freight rates are down, it's just much more difficult to pass that $15,000 through.

Do you think that pass-through could get easier throughout the year as the economy continues to recover and you see an upswing, a continued upswing, let's say, in orders? Or, do you think you're waiting -- you're done on pricing for the year?

Well, never say never, and we obviously look forward to improved economy in many markets. But that's quite a bit to try to pass through. I think it's going to take time, and that could be -- and it could be several years.

I'll stop there, thank you.

Ann Duignan, JP Morgan.

I just wanted to touch on the emissions costs also, but more thinking about the upcoming costs for Euro 6. Could you comment a little bit on -- you mentioned that costs will be going up to contend with that. Can you talk about the expense costs, the R&D costs, the CapEx costs, just the different kind of cost elements that we're going to see to meet Euro 6?

Well, Euro 6 -- we have been working on that, obviously, for a couple of years, and that's coming in, in a few years. We are increasing our R&D and the CapEx to meet some of the requirements to meet Euro 6, as well as EPA 2013.

It's a little tough to qualify. I think in Europe, we have a little more flexibility in terms of some price movement, which tends to cover a little bit more of those cost increases. But in the US, with a little bit more rapid introduction cycles, it's been just a little harder to pass through those costs.

Okay, that's good color, actually, on the difference in Europe and North America. And then, on the Brazil strategy, can you talk a little bit about what your strategy is for distribution? We think about building manufacturing plants. Great, but it's all about distribution. What is your plan for distribution in Brazil?

Right. Well, we've gone public with the announcement that we are going to be putting in a factory. And I would tend to agree with you that people can build factories pretty straightforward. We pride ourselves on building great factories. The distribution is a several-pronged approach. First of all, we've had quite a few independent inquiries from different groups, whether they are currently representing a competitor of ours in the marketplace or they are in a related field, say agricultural, or maybe new entrants from other parts of South America, Mexico and even Europe who have said, you know, we recognize the advantages of having a DAF franchise. It's a very profitable franchise. We make a lot of investments for our dealers which benefit our dealers.

So we're finding much more broad-based support from different constituents in helping us put distribution into place in Brazil. It's very encouraging.

And so the key take-away, I think, of what you're saying is that your long-term market share target of 20% is long-term? That's fair to say?

Yes, it's long-term, just like we've talked about in Europe, and now we are up to 15.2%. So that's the goal.

But you did acquire some of that share in Europe, as opposed to (multiple speakers)?

Probably about 6% of it.

Yes. And just real quick, you mentioned how customers and dealers love the new MX engines. Can you talk about any feedback you're getting on fuel efficiency versus the '07?

Yes. I think the fuel efficiency is anywhere from 3% to 5% on the '07, so it's positive. And of course, we also have the benefit of great reliability. Very quiet, as I think you found when you drove it a few months ago at our tech center.

Indeed.

Easy to operate, so it's really going well.

Easy to operate would be the --

That's your main take-away.

That would be my take-away, exactly. I'll leave it there, guys. Thanks very much.

Jerry Revich, Goldman Sachs.

Mark, you highlighted rising material costs in your prepared remarks, but can you touch on the pricing landscape? I guess, considering how much used equipment values have recovered in both North America and Europe, I would think the pricing discussion should be relatively easy for you, relative to your customers. Can you give us an update on what kind of pricing actions you are seeing in the marketplace out of your competitors, and are you optimistic that you can push the recent raw material inflation through on the pricing side? Thanks.

Yes, you bet, good question. I think you've summed it up, actually, pretty well, that we are seeing some price improvement, I'd say generally, although on any particular deal, there's always a lot of to-ing and fro-ing. Over the course of the year, we hope to be able to recover material price increases, whether it's through efficiency in our factory -- we've got a lot of Six Sigma projects going on -- or, through general improvement in pricing, which I think every competitor would like to see some improvement.

And as you ramp up production in the Mississippi plant, as we think about the cost savings on the content, should we just think of the, call it 5% to 8% logistics cost savings as the biggest opportunity there? Or, are there any absorption benefits that we would be losing in Europe that we should be thinking about as we try to quantify the margin rate for that business going forward?

I think, of course, Europe continues to be a supplier to Mississippi, although that over time will diminish. So I don't think there's any -- there's no negative impact in terms of the absorption in Europe. Yes, it's getting more efficient in Mississippi. We would love to show you around, if you get a chance to get down there.

And, of course, the real benefit is reduced cost of installing the engine. You have more of an integrated powertrain. That helps our manufacturing efficiency. You also have the back end with the parts and service, so that helps our dealers and our parts business. And also, maybe even gets a little bit of a finer point when we are out on leasing deals in terms of residual values and the value of operating the vehicle. So I think that's the real benefit. There's some logistics benefit, but I think that's just one of many.

And, lastly, can you give us an update on your backlog in Europe at the end of the quarter? And also, you picked up some share over the course of 2010, so should we look for your build rates for DAF to be higher than your guidance for the industry in 2011?

Well, of course, the build rate at DAF over the last year is up, gosh, almost 100%. That's a pretty significant increase. Obviously, the market is stronger, the share has increased and we're looking to have some steady share increase during this year in a rising market. Everybody's out grabbing share as fast as they can, but we continue to have strong dealers, appoint a few more dealers. And I think DAF will obviously build a lot more trucks this year than they did last year, but [maybe] some moderate share increase at DAF is the plan.

Thank you.

J.B. Groh, D.A. Davidson.

A couple of questions -- you talked about commodity pricing, touched on that a little bit. Is there any way to defend yourself, or what sort of hedging mechanisms do you have in place to stem the rise in some of these oil-based products?

That's a great question. I think, like most companies, you take a look at what you can hedge. We tend to focus more on having over 70% of our suppliers on long-term agreements so that there's some hedging built into those agreements in terms of cost sharing and efficiency. And I think, as I've mentioned over the last number of years, we actually go out and work with our suppliers on trying to help make them more efficient, whether it's installing capital equipment, which we retain ownership of, in their factories, doing Six Sigma programs with them. And they are trying to offset some of the costs that even our suppliers aren't able to control.

So it's a teamwork approach, and I think over time, it has worked very, very well.

So there's nothing explicit in place; it's more of a PSA -- pain-sharing agreement?

I have not heard that particular term. We look at it as a productivity-sharing agreement.

Okay, fair enough. And then a lot of talk on this CSA 2010 and hours of service agreements and those sorts of things. What are your customers saying about that, and sort of thoughts on how that impacts their buying patterns and, eventually, your business?

Yes; I don't -- it's a good long-term question. I'm not sure it's having any impact right now, in terms of more regulations impacting drivers, type of drivers, the background of the drivers. I think overall it's going to be positive for the industry. There's, once again, some fleets or some areas may have a little bit more up-and-down than others, but it's a great industry. Sometimes it's difficult to be on the road a long time; that's why we want to make a great product.

I think we are working with ATA and other groups on making sure that there are fair, thoughtful industry changes to the regulations, and I think it will all turn out okay.

I guess, in the past you've mentioned your premium brands as a driver retention tool. And I'm just thinking of driver shortages and that sort of impact and how you (multiple speakers) --

I think that's a good point. Of course, with all the new products that we introduced in the last year, including our own engine, we are seeing, I guess, a renewed driver retention tool. And people love our products and are very supportive of the products. I think, for the whole industry in general, we'll get to an equilibrium because you've got to move the freight, and either we will have to pay the drivers more or maybe people will have to buy more PACCAR product to entice the drivers to come back into the industry. But either way, we'll work through it.

Okay, great, thanks for your time, Mark.

Henry Kirn, UBS.

Since you called out some headwinds from emissions costs over the next cycle compared with last cycle, how should we be thinking about achievable margins this time around?

Excellent question, Henry. Well, I think, just looking at this year, 2011, in terms of margins, I think they will be probably comparable to fourth quarter of 2010, give or take. Obviously, we work hard to keep trying to improve the margins. Over time, we do, but as we've talked on some of the earlier questions, these are real cost impacts that we're still not just a booming economy, particularly in North America. And customers are thinking about, how can we get even better value, how can we keep the pricing down when we purchase new equipment. They love our equipment, but they can't pass that through to their end customer. So it's just a little bit slower process. We're probably not in a recession, but you've got 9.4% or 9.6% unemployment and housing at a 50-year low and cars improving, but still at a 20-year low -- there are some challenges out there for many industries.

And as far as parts, what do you expect in your parts business in 2011?

We're looking to grow our parts business around the world. I think there was a nice picture in the press release of our new facility we have in Santiago, Chile. So that's providing our customers and dealers an even better service. I think our parts business should have some improvement. We've got the highest field population of PACCAR trucks in our history. We've got great dealers who are profitable and investing in new stores and new technologies.

So I don't have a specific number, but I think that's some improvement.

And one final housekeeping one, if I may.

Please.

How should we think about the tax rate as we go into 2011?

You should anticipate the tax rate to be in the 31%-32% range for the year.

Thanks a lot.

Andy Casey, Wells Fargo Securities.

I guess it kind of dovetails with Henry's question on the margins. You gave granularity on R&D. Can you talk about any incremental administrative expense related to the global growth initiatives vis-a-vis the past cycles? And is that material at all during 2011?

I'd say, not so much, in terms of -- we'll add some expenses. We're going to be hiring people because we have these different global initiatives on SG&A. And we're also ramping up. We have a lot of exciting new projects we are working on, so that takes some more people, whether they are new people or hiring people back that we've had to let go in the last few years. So it has some impact, but I wouldn't read too much into that.

Okay, thanks on that. And then on the incremental costs related to installing the internally produced engines, is that primarily warranty accrual expense? And if so, does that go down as a percent of total revenue during the year, not volume adjusted but it's kind of flattish?

I'm not sure I understood that, but if I did understand it, the cost to install our engine is -- it's less expensive to install our engine than a third-party engine.

I understood. In the release, you call out some incremental costs associated with that related to moderation on the overall margins. I'm just wondering where that is coming from.

Yes; that was related to primarily the cost to purchase the componentry to meet the emissions regulations, so the [defs] and the bracketry and just the myriad of equipment that needs to go on to the engine to meet the EPA regulations. Yes, there's a little bit of additional costs to install it, but the vast majority is the equipment itself, the aftertreatment, things like that.

Okay, got it, thank you very much.

Adam Uhlman, Cleveland Research.

Mark, just a clarification on Henry's question earlier about margins in 2011. Were you speaking to gross margins or operating margin or incremental margin being similar to the fourth quarter? Which one?

I think we're talking about the gross margin line would be comparable to the fourth quarter.

Okay, great, thanks, that's helpful. And then, could you also talk about with bills expected to ramp up pretty materially here in North America in 2011, are you seeing any indications from your suppliers that they might have problems meeting that increased demand?

We're looking at 2011 production, you know it's 5%, 10% improvement in first quarter versus the fourth quarter. And we stay very close to our suppliers; we have about 800 total global suppliers. I'd say, generally, they're reading the tea leaves as well as we are, and they are hiring people and increasing their capacity or maybe getting their capacity back on stream, which they might have reduced during the recession. Every day, there's something that keeps our production people busy in terms of suppliers, but generally great suppliers and everybody recognizes an opportunity to improve business. So they are making the investment to do that. Right now, I think it's steady as she goes.

Great, thank you.

Steve Volkmann, Jefferies & Co.

I'm wondering if we can talk just for a minute about the finance business, which was better than what I was expecting on the quarter. You mentioned margins were a little better.

Yes.

Is there a change happening there that we should think about that as a better business going forward, or was there something temporary there?

I think the finance business has always been a very steady business for PACCAR. Obviously, as our customers see improved business conditions, they are getting a little bit more margin. A number of our customers are obviously publicly traded transport companies, and you can see that their margins are improving, their profits are improving -- perhaps not to the record levels that any of us saw three, four years ago, but steady business. The general economy, GDP growth 2%, 3%, that's good for them.

So I think in terms of any of the down sides of the finance business, obviously there will always be some customers that might get into difficulty. But our reserves are good, and I think we're seeing some improvement overall -- more business. In fact, the assets are growing in the finance business.

Would you expect margins in that business to be better in 2011 than they were in 2010?

I think they are -- let's say they're going to be maybe comparable, maybe slightly better, but yes. I think the big improvement is obviously less losses, credit issues, and growing business. As the economy is improving -- during the recession we saw a number of competitors in the finance world exit. Some of them are now dipping their toe back in, and you've got more competitors. Some of them come in at some lower rates, so that's always a challenge.

But of course, another benefit is we've seen good improvement in used trucks. In fact, speaking of that, it wasn't in our press release, but we are building our third used truck center in Salt Lake, working through the snow, but that's going to be very good, and I think PACCAR has been a real technology innovator in terms of the used truck programs online, and that has really added to the breadth of what our dealers can offer to our end customers. And that's very exciting.

So the finance business is a very good business. Lease business, very good. We're even seeing a good improvement in Europe for our lease and finance business.

Okay, thanks for that. And it seems like you still probably have more cash on your balance sheet then you need to run the business. Any evolution in your thinking about what you ultimately do with that?

Boy, that question didn't come up the last two years, when people didn't have any cash. We've got just the right amount. Obviously, we have a program of steadily increasing our dividends, which you've seen, and we've got a lot of new product development programs. We are doubling the CapEx, we're going into Brazil. And if there's an opportunity on the M&A side, we'll always take a look at it. So I think we are well-positioned.

Thank you very much.

Jamie Cook, Credit Suisse.

Believe it or not, another question on margins, but it's longer-term. I appreciate the margin headwinds in the short term, but as you -- historically, PACCAR has been a company that has already improved their margins peak to peak. As you look at the headwinds this cycle, when we think about the material costs, when we think about emissions and the cost that you are going to have to grow globally, and you offset that with efficiencies in the engine and higher service after market, do you think that you will still be able to surpass prior peak margins, like we have done every other cycle? Or, is there something different this cycle that would suggest that's not achievable anymore?

Our goal is, obviously, to set records. And certainly, our goal is to achieve higher margins. And we are putting many elements of business in place to do that. I think you have accurately summarized that there will be some additional costs, but there will also be some additional business profit and margin opportunities. So, certainly, our goal is to continue to improve, and we've achieved that for 105 years and we're going to keep doing that going forward.

Just on a simple note, and I think we talked about this a few months ago, Brazil, which is a good market, and obviously we know South America, although we don't have a presence as such in Brazil, is typically regarded as the highest margins in the world for the truck business. And as you follow a number of our competitors, you will see that called out or you can deduce that very clearly, that that's where they get the majority of their profit and, in some cases, the only place they get their profit.

So I think that will have some benefit.

And then next question -- I'm sorry; what do you assume your adoption rate for the MX engine is next year? How should we think about that relative to this year?

Well, we've got, as I indicated earlier, we are getting 25% to 35% share. It varies by month, depending on fleets we get. But we are looking, over time, to get that up towards 50%. It's going to take a year or two or three, but that's certainly the goal. And we are way ahead of our schedule. And, as I said, the customers and the dealers love it.

So the high end of the 25% to 35% probably isn't unreasonable in 2011?

Well, you know, we've only been in the business out of Mississippi since last summer. So (multiple speakers)

But you guys are PACCAR, you can do anything.

-- Six months of history and try to overlay it. But certainly, 25% to 30% is a reasonable expectation.

All right, I'll get back in queue, thanks.

Patrick Nolan, Deutsche Bank.

Just a couple of quick ones -- I apologize if I missed this first one, but can you give us the regional change in production in the fourth quarter?

The regional? Okay. Well, let's see. North America -- you're talking about fourth-quarter to third quarter, is that kind of what you are looking at?

Whatever you guys have.

Well, I'd say fourth quarter to third quarter for North America was flattish, and in Europe it was up by about 30%, 40%. That's the fourth to third.

Got it. And also it's been very helpful that you guys have been giving detail on how the parts business has been tracking when you break down the margins. What was the parts business margin in the quarter, and what was the year-over-year change in revenue?

Let us get back to you off-line on that and we'll give you the numbers on that. Okay?

And just -- my last question is more the longer-term question. When you think about -- you guys have historically been able to price your products, arguably, better than your competitors.

Yes.

And you've had a pricing premium because of that.

Because we have deliver a better product.

Yes, absolutely. But when you think about your comment that margins may not exceed the previous peak or may not even reach that level --

I didn't say that. I said that we are hoping they will.

So is your assumption, then, that your pricing premium will hold?

I think our pricing premium will improve because we now have our own engine, which is a big contributor. We also have a broader range of products, we're coming out with new products faster than our competitors.

When you think about the incremental margin in the fourth quarter, it's a little bit lower than it was in the third. Is that mainly because the raw material started hitting you, and there's more of the EPA 2010 costs coming through in the fourth quarter as you are completely 2010 engines by that point?

Yes, there might be an element of that.

Okay, thank you very much.

Tim Denoyer, Wolfe Trahan.

A question on the parts segment -- kind of following up, I was wondering if you wanted to just give the revenue off-line? Can you give us the fourth-quarter revenue?

Fourth-quarter revenue, $597 million. That's fourth quarter 2010.

Yes, and in terms of the gross margin?

34%, a little over 34%.

Within parts, how does it break down geographically? Is it similar to the truck business mix, or is there more in one region of the world? I'm wondering what's growing faster and if there is any impact, potentially, from CSA 2010, which seems to be driving some maintenance.

Well, it's reflective of the amount of product we have out there. It's a complicated question. We have the benefit in Europe of having perhaps higher margins because they've had more of a vertically integrated approach. We have the PACCAR engine and the PACCAR axle, so there's a benefit there. On the other side, you've got probably more Kenworth and Peterbilt trucks around. It's an older fleet in North America, so there's a benefit there.

But I'd say they're -- both are strong markets for us.

Okay, in proportion to the truck revenue, though, would you say that there's more parts revenue in the US and Canada, just because that's a more established market?

Yes, definitely (multiple speakers) there's more trucks running around, too.

And one more question, just in terms of the sequential production -- it seems like Europe ramped up in the quarter a lot more than North America. Do you expect that to reverse going into the first quarter, and North America to pick up -- I think maybe you said maybe you said 5% pickup?

Yes, about 5% to 10%, 5% to 10% (multiple speakers) I think North America, on a percentage term, probably may pick up a little bit more than Europe, but we see Europe improving also. There will be some interesting stories written about the recovery, comparing Europe to North America, in many industries because, obviously, both got hit by a pretty difficult recession. But we've just seen a lot faster ramp up in the truck industry in Europe than in North America. Part of it was, didn't have the housing bubble, part of it was different governments had incentive programs to keep their economies going. So Europe has had a little faster recovery than North America.

Got you, thank you very much.

Andrew Obin, Banc of America/Merrill Lynch.

Just a question on your comments regarding gross margin throughout 2011 being similar to Q4. Assuming that we are going to start raising North American production sometime in the spring, why would gross margin not benefit from improved absorption? And also, to that, I'll throw in -- you guys cut a ton of cost during the downturn. You shut down a big facility. You are vertically integrated in North America, so you are definitely getting the benefit from capacity absorption in Europe. How does it work that margins will be flat throughout the year? I'm just not exactly sure how the math works.

Well, one thing to keep in mind is that the incremental margin on truck sales is lower than that of parts sales, and the growth is going to be on the truck sales side. So you are going to have a weighting effect because of the relative margins between truck and parts, so that comes into play. So, while truck margins are going to be going up as a percentage of the total, the overall margin is going to be on the flat side as a percentage. Margin dollars will grow, of course, as sales go up.

And I think also, on the other points you've indicated, obviously we are the low cost, we are getting the benefits of integrated. There are more -- maybe we'll get some pricing improvement as the economy improves across a wide range of industries. So our goal is to keep improving margins. We're just trying to share with you what's going on.

Okay, so should we -- okay. And would you quantify, just for Q4 -- and I know you didn't, but revenue went up $500 million and profitability only went up by $50 million. Can we assume that between $50 million to $100 million of raw materials drag in the quarter?

No, no. Didn't have that much of an impact -- it had a slight impact, but --

So why was there no operating leverage in the quarter, then, if it wasn't raw material prices?

Well, we had an excellent quarter. I'm not quite sure of the question because we had great quarter-on-quarter, year-on-year improvement in income.

Oh, no, no, no; I understand. But if I go and I look at the second quarter and if I look at third quarter, and that is a metric we use and I understand that's not how you run the Company. But we had incremental margins of 22% and 27%, showing very strong operating leverage as volumes kept improving. And I'm not saying that there's anything wrong with this quarter, but it's obviously where our expectations are. I'm just trying to understand, given that your penetration of your truck engine has improved, why -- and you are now saying that there wasn't that much raw material drag. Why wasn't there more bang for the buck, speaking about it on volume increases in Europe, in particular? That's the question.

I think what you're seeing is the impact of pricing in the market. It is taking a while for pricing to roll through the market, and as orders get placed and delivered, it takes a while for them -- the improved pricing to run through the bottom line.

Yes, we had great improvement and excellent leverage. But just because the market goes up doesn't mean you're going to get more money for your vehicles, either. It takes some time. We're still in a very tough marketplace, but we thought we did very well. Good leverage.

As Jamie said, you're PACCAR; we expect perfection from you. Thank you very much.

We expect perfection from ourselves. We appreciate the support.

Basili Alukos, Morningstar.

Thank you for taking my questions; just two, the first one -- kind of anecdotally, I'm hearing that the current freight rates aren't high enough to support the increase in truck purchases for the smaller owner/operators. And historically, you guys have had a big percentage -- or maybe not big, but a percentage of exposure to them. I'm wondering if you can talk about the conversations that are happening and if you're seeing the owner/operators decide more to refab old trucks and buy used. I know this has been, obviously, happening for a while, but now how that has changed versus actually being able to afford the new trucks with the higher ticket price.

It's a good question. I think you have to be a little bit careful on the anecdotal. I think some of the smaller operators that have very good customers that allow them to purchase new trucks are able to do that. Some are, perhaps, extending the life of their trucks another year or two in hopes that the economy will improve. And some are aligning themselves, as they have for the last 10-plus years, with larger companies to take advantage of some economies of scale in purchasing.

So there has been, certainly, a trend towards more medium and large-sized fleets in North America and in Europe. I think we'll see that trend continue. But the good news is that more and more large fleets love our product, and they can do the math and understand that the low operating costs of running a PACCAR product is a real financial benefit. So we're still seeing a number of our smaller customers buy product. But it's still -- it's early days.

So it's not a material change, I guess, this time around versus previous price increases on trucks? I guess, given how many bankruptcies there have been, it seems like there's a lot of talk that the owner-operator is dead. And, like you said, it's not good to go based on anecdotes, but you've got to start somewhere (multiple speakers).

Right. Certainly there was, what, 12,000-14,000 bankruptcies eight years ago? In the previous recession, there was probably 3000, 4000 or 5000. So the people who are still operating are actually very efficient. They've been through two tough, tough recessions. And if you are a small operator and you are still operating, you've got some great customers, you know how to control your costs, you understand the cost of product and when you need to trade it in. So this is a pretty seasoned, experienced group. So I think they will be purchasing when it makes sense for them.

Fair enough. And then one more question, dealing with the market share on your 13-liter engines. I was impressed that it's running so high.

Thank you.

From what I understand, historically the 15-liter engine has been substantially heavier than the 13-liter engine. And obviously, that's a drag on fuel efficiency. But now, as those 15-liter engines have become lighter, the fuel efficiency difference has shrunken. And obviously, the larger the engine, the more powerful. And I'm just wondering -- and there has been a lot of talk that the industry is going to shift to 13. And I'm just wondering how that has actually played out versus the fuel efficiency of the two engines, the differential is shrinking, as well as the weight of the 15-liter engine and how that has played out with your customers, now that you obviously have your own 13-liter engine (multiple speakers).

Right. That's a good question. There's still about a 400-pound differential between a 13- and a 15-liter. I don't think that's shrinking. Everybody is trying to become more weight-sensitive, if you will, on their power train. So if there's weight reduction on a 15-liter, there's weight reduction on a 13, 10, 8, 6, whatever. Everybody is trying to reduce the weight.

But it's still 400 pounds, and a little bit more fuel-efficient on a 13-liter. So there are some real benefits to a 13-liter. And it's less expensive to purchase.

Fair enough. I guess what I was referring to is maybe 15 years ago, the differential was 1000 pounds, and fuel --

I'm not sure that's correct.

Okay. But as far as your customers, the big question is -- and I think you mentioned this last call. In Europe, diesel prices are the equivalent of $8, and that's for a 13-liter engine or the 13-liter equivalent is predominantly used. But in the US, there still isn't -- while diesel prices are higher, it's not that great. And I'm just wondering if the improvements in the fuel economy and also the power on the 13-liter engines, specifically yours, if that is offsetting the need for having a larger engine, to a substantial degree that you might see the 13-liter engine take over in the next few years.

Well, there's a lot of advantages to the 13-liter in terms of the fuel efficiency, and also the power, horsepower ratings, the ability to have an excellent lifecycle. It's comparable to a 15-liter. As you've indicated, 13-liters are used all around the world to hauling through deserts and over mountains, and for million-mile engines. That's certainly what we are selling.

So North America is a little bit of a unique market. There are still a lot of people who enjoy the 15-liter, and we are proud to partner with Cummins making an excellent 15-liter. And the good thing is, we offer both of them, so our customers are happy either way.

Great, thank you.

Seth Weber, RBC Capital Markets.

Mark, just going back to your comments on the strength in Europe, have you noticed any improvement in the vocational market share? I know that has been an area that you have been relatively weaker.

That is a great question, Seth, thank you very much for asking that. Our entire focus at the Hanover show last September was on vocational. We are battling for the number-one position in the tractor on-highway segment, but we are only about fifth in the vocational. We're going to increase that. We've established partnerships with the major bodybuilders, vocational segment leaders throughout Europe, and that's starting to percolate out to the industry through many different countries. And our dealers are excited about it. We're establishing good customer contacts with people in the vocational.

So we're seeing some improvement. It will take time. We just really put this as a major agenda item for our product development last September. So we are five, six months into it, but certainly people are aware of us offering or DAF offering the full line, and it's a very exciting future.

Okay, and do you think that that would be -- would we notice any change there in 2011, in that business, or is it just too small to matter at this point?

I think it's too small, and it's a much stronger market overall. But it's something that we are focused on and we keep working at.

And then just a separate question -- given the strength of the balance sheet, would you undertake concurrent initiatives, like while you're doing South America, to also go and expand your presence in Russia or Turkey or things that you've talked about? As far as a return, would you accelerate any of that?

Sure, so we've been in Russia. We put that in the press release. We've been in Russia for decades. We are expanding our sales office. It's a good market. We know the market well. We're adding dealers in Russia.

So yes; we are looking all around the world. But we want to make sure we do -- everything we do, we want it to be, obviously, high quality and, as Andrew said, strive for perfection if we can. So we want to make sure we really focus on a few items and do them very, very well.

Sure, okay, thanks very much, guys.

Ben Elias, Sterne Agee.

I just want to pick up on an earlier theme that you have, the CSA and driver retention. And I was just wondering what else you are offering in terms of product. I know SCR is standard and everyone is -- it's the industry standard and a requirement. But are you offering things like disc brakes and things like that? Are they not optional? Are you just trying to push that through to attract drivers, maybe get better safety scores?

Well, our Peterbilt group was really the first in the industry to make disc brakes standard on a number of their models. I applaud them for that. Obviously, disc brakes in many parts of the world are standard; in fact, they are pretty much all you can get unless you are into an off-road or vocational application. Our cabs, the chassis exceed all of the global safety standards.

But I think the real benefit for our customers are the low cost of operation, the quality, the pride of all of our product. And that's what draws people to a Kenworth, a Peterbilt or a DAF. And they get all of that and great service, incredible residual value. We love seeing these used truck prices going up. And many, many auctions, we're finding our products are worth 25% more than the competitors' on a like-for-like basis, and that's a real contributor to the economic decision when you purchase a PACCAR product.

So from what I understand in the US, there's a great emphasis or a greater use of drum brakes. So what you're saying is people are moving to disc brakes? Certainly, you are offering it as standard equipment. But are you -- now that freight rates are up and the economy is improving and I think truck purchases are improving and your core segment's coming back, are you seeing more discretionary spending on some of these add-ons? I mean, if we sort of continue that theme, maybe just safety products, are you seeing more of these components being installed? Or how do we understand (multiple speakers) higher margin?

Obviously, we are seeing our parts business improve, and a lot of that is being driven by an older population of vehicles out there, but there is some improvement in discretionary. Some of it is safety-related, some of it is feature and benefit, some of it is just luxury-related. Some people just say, I want a little more comfortable; maybe I will add a few more gauges or have some more pieces of chrome to highlight my vehicle, make it distinctive. So we're seeing some of that.

But I think people are still recognizing that we're still in some challenging times, so people are thinking about it before they are purchasing.

And does safety come back before luxury, or how does it generally work?

I think there have probably been libraries written on that. The good news is that we like to be a leader on both.

Okay, thank you.

Kristine Kubacki, Avondale Partners.

Just a quick question -- North American production, I guess, isn't up as much as I would have thought in the first quarter. Can I infer, then, that the order strength that we've seen in the last few months, are those being spotted for later in the year? And is this normal behavioral for fleets at this point to spread the orders over 2011?

I'd say yes to all your questions. We are going to be increasing production, and we're saying 5% to 10%. It might be a little more than that. Certainly, it could be 15% plus in North America over the first quarter. But a lot of the fleets are spreading it out over 2011. They can only absorb so much new product, and they may have a used truck trade-in package that may be financing related, but whatever their business model is, so I think it's very, very normal. It has been going on for 70-80 years, I bet.

And then I guess, on the pricing side, is the pricing a little bit weaker now, or it's still coming off the bottom? And is it just the general lag in the market with capacity and demand, or are there specific actions by any of your competitors to drive maybe market share that we are seeing pricing being a little bit weaker than we would expect at this point in the cycle, given the order rates?

The pricing, I think, is actually probably pretty much in line with coming out of a recession. Everybody is trying to grab what they think is their fair share, whatever that might be. Certainly, a number of our competitors are always very excited about saying what their market share goal is, and then you all hold their feet to the fire, so now they have got to go get that. And profit isn't so important to them.

But we're coming out of a recession. I think we are out of the recession, but we are not in a boom economy, by any means. So people are -- customers are cautious. They are evaluating how they can get the best price, and there are always people in any industry who will drop the price, for whatever reason. So you need to work through that, too.

Okay, thank you very much for the color, I appreciate it.

Andrew Obin, Banc of America/Merrill Lynch.

Just two follow-up questions -- on your order rates, did you say a number in terms of your order book? Did you quote a specific number on that in terms of your backlog, or you didn't?

No, we did not.

And the second question -- if, let's say, demand for your engines was running ahead of 25% to 30%, if you are experiencing now, would you be able to satisfy if it was more like 40% to 50%? Do you have the capacity to do it in 2011?

Yes, yes, we do. And if you would place a lot of large orders, we would try to accommodate you, Andrew.

I'll try, thank you very much.

Ann Duignan.

Just one that I thought somebody might ask along the way, but it didn't get asked. Can you just give us a little bit of color on -- SG&A was significantly higher than we had forecast. It was higher than last year as well and higher than last quarter. Was there anything in there, like variable comp? What kind of a run rate should we assume going into 2011?

Great question. We were hoping you would ask that, Ann. I think the run rate will be comparable to fourth quarter of 2010; yes, be comparable.

Okay, so there was no one-off --

No; we are just ramping up business, you know -- people, expenses, growing the business.

Okay, that's good color, thank you; that's all I needed.

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

Yes. I would just like to thank everyone for their excellent questions and thank you, operator.

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