Ken Hastings - PACCAR, Inc. Ronald E. Armstrong - PACCAR, Inc..

Jerry Revich - Goldman Sachs & Co. Emily McLaughlin - RBC Capital Markets LLC Timothy W. Thein - Citigroup Investment Research Ross P. Gilardi - Bank of America Merrill Lynch Joe D. Vruwink - Robert W. Baird & Co., Inc. Cleve Rueckert - UBS Securities LLC John Joyner - BMO Capital Markets (United States) Michael J.

Baudendistel - Stifel, Nicolaus & Co., Inc. Barry George Haimes - Sage Asset Management LP Alexander Eugene Potter - Piper Jaffray & Co. Faheem F. Sabeiha - Longbow Research LLC.

Good morning, and welcome to PACCAR's First Quarter 2017 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 Hastings, PACCAR's Director of Investor Relations. Mr.

Hastings, please go ahead..

Good morning. We would like to welcome those listening by phone and those on the webcast. My name is Ken Hastings, PACCAR's Director of Investor Relations.

And joining me this morning are Ron Armstrong, Chief Executive Officer; Harrie Schippers, Executive Vice President and Chief Financial Officer; and Michael Barkley, Senior Vice President and Controller. As with prior conference calls, if there are members of the media on the line, we ask 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 Ron Armstrong..

Good morning. PACCAR reported good revenues and net income for the first quarter of 2017. PACCAR's first quarter sales and financial services revenues were $4.2 billion, and first quarter net income was $310 million, a 7.3% after-tax return on revenues. PACCAR Parts achieved record quarterly pre-tax profits of $152 million.

PACCAR achieved excellent Truck, Parts and Other gross margins of 14.1%, helped by the strong European truck market and growth in PACCAR Part sales. I'm very proud of our 23,000 employees. We have delivered industry-leading products and services to our customers worldwide. PACCAR delivered 35,000 trucks during the first quarter.

Peterbilt and Kenworth raised build rates during the quarter in response to robust order intake. Looking ahead, we expect a 10% increase in deliveries in the second quarter compared to the first quarter due to higher build rates in North America and Australia.

Second quarter gross margins are projected to be slightly higher than first quarter margins, reflecting the operational benefits of higher build rates. PACCAR's forecast for Europe's greater than 16-tonne market has been increased to a range of 270,000 to 300,000 units, reflecting strong demand and the steady economic outlook.

Europe's GDP growth expectations for this year are 1.6% in the UK and on the continent. Freight transport activity on German highways in the first quarter was at record levels and up 3% compared to the same period last year. Year-to-date, DAF has achieved a 15.7% share of European heavy truck market registrations. The economic picture in the U.S.

is also positive with GDP forecast to grow 2.2% this year. Housing starts are projected to grow 9% to 1.3 million units and the automotive industry is expected to deliver 17.3 million vehicles. Industrial production is estimated to grow 1.7% this year due to stronger manufacturing and mining output.

This will be the first year of industrial production expansion since 2014. We estimate U.S. and Canadian Class 8 truck industry retail sales will be in a range of 190,000 to 220,000 units this year. The economy's steady growth is supportive of healthy freight levels. The ATA Tonnage Index continues at high levels.

Peterbilt and Kenworth's share of industry Class 8 orders so far this year is strong at 32% as customers appreciate the benefits of Kenworth and Peterbilt's reliable and fuel-efficient trucks and industry-leading resale values. PACCAR Parts quarterly pre-tax income was a record $152 million, 13% higher than a year ago.

Pre-tax return on revenue was an excellent 19.3%. PACCAR Parts business generated quarterly revenues of $787 million, 9% higher than in the same quarter of last year. These results were driven by the growing number of PACCAR trucks and engines in operation and the many innovative products and services offered by PACCAR Parts and our dealers.

PACCAR's dealers worldwide have invested over $1 billion over the last five years to open 200 new dealer locations in North America and Europe. PACCAR's new truck models and expanded powertrain have created a tremendous business opportunity for PACCAR and our dealers.

These dealer network investments support PACCAR's continued growth in truck market share and aftermarket sales. PACCAR Financial Services first quarter pre-tax income was $57 million, compared to $80 million earned a year ago. Excellent portfolio performance was partly offset by the effects of the industry's lower used truck values in the U.S.

and Canada. PACCAR Financial continued to invest in the remarketing of PACCAR trucks by opening its third truck remarketing center near Chicago. These truck centers further enhance Kenworth and Peterbilt residual values which command a 10% to 20% premium over competitors' trucks.

PACCAR's strong balance sheet and positive cash flow have enabled the company to invest over $3 billion in new products and facilities in the last five years.

This year, capital expenditures of $375 million to $425 million and research and development expenses of $250 million to $280 million are targeted for truck and powertrain product development, enhanced manufacturing and parts distribution facilities, and aftermarket support programs.

PACCAR continues to enhance its leadership position in the global truck market by delivering the highest quality products and services in the industry. Thank you. I'd be pleased to answer your questions..

Your first question will come from the line of Jerry Revich of Goldman Sachs..

Hi. Good morning, everyone..

Good morning, Jerry..

Can you talk about which regions drove the acceleration in the part sales in this quarter, how broad-based is it, and it sounds like the inventory destock that we saw parts of last year has played out already.

To what extent is that a contributing factor?.

Yeah. I'd say that the greater share of the increase comes from North America, but we also saw growth in our Europe business as well..

Okay.

And can you say more about the used truck headwind in the quarter, was that mark-to-market on outstanding lease residual values, can you just flesh that out for us in terms of is there a risk of additional charges on the outstanding lease book?.

Yeah, that primary relates to trucks that we sell, the good news is there was better demand for trucks. Unfortunately the prices are dampened because of the high quantities of used trucks that are in inventories, we're seeing from several of our competitors and that's dampening the prices.

And so, I don't – we've not seen any further deterioration in prices, but we haven't seen an increase either..

And what about the operating leases that you folks have outstanding, can you remind us when do you do the impairment test on whether the market value is below the residual value that's recorded for FinCo..

Yeah. We review those every quarter, Jerry. And we mark those to, and we adjust the residual values and depreciation accordingly..

Okay.

And there was no adjustment related to the operating lease for this quarter at all?.

I don't – I think there was probably a small amount that was included in the first quarter results..

Okay. All right. I appreciate the color. Thank you..

You bet..

Your next question will come from the line of George (9:00) of Wells Fargo..

Hey, good morning.

Could you provide us a little bit more color of what you're seeing in regional truck trends and in South America, first outside of Brazil and then inside of Brazil? I know, (9:15) commented that it thought that it was seeing a bottom, I'm wondering if you agree?.

Well, the – I think the South American market will be comparable this year to what we saw last year.

So, we would hope that as Brazil sells some of its economic challenges that we'll see return to growth in that business and a lot of the – the rest of the South America will be dependent on how the mining and commodities develop, so I think there is some positive trends in that arena..

Sounds great.

I know you commented on improved strength in the North American Canadian market, are you – that you didn't move your forecast at all, are you expecting the strength to kind of maintain itself throughout the year or you feel like it will subside in anyway?.

I think when we had discussion in January, our market range was probably above the average of other estimators and as time has gone on, they have increased their market size estimates to be closer to ours. So, we feel pretty comfortable with our range and if orders continue at the pace, we could be at the mid to upper portion of the range..

That sounds great. Thank you very much..

You bet..

Your next question will come from the line of Ann Duignan of JPMorgan..

Hi, this is Kristy (11:04) on for Ann Duignan.

Can you guys describe the environment by end market in North America, and where you're seeing orders coming from? Is it, say, oil and gas over the long-haul? And can you describe by region in the EU and how sustainably you think current orders rates are into the second half of 2017?.

I'd say we're seeing good broad-based order intake across all segments, the vocational segment has been steady for several years now, and we're seeing good order intake from the long-haul side in Europe.

The Western Europe continues to be strong, Central Europe as well, and we're seeing some recovery and order intake from the Russian market as we begin this year..

Okay. Thank you. I will get back in queue..

Your next question will come from the line of Seth Weber of RBC Capital Markets..

Hi this is Emily McLaughlin on for Seth.

I'm just wondering, do you think that the 32% you reported for the Class 8 order share is sustainable, and is there anything you can point to specifically than if you'd be driving the share gains?.

Our Kenworth and Peterbilt's retail sales share in the second half of last year was roughly 30%, 31%. And so I think that order intake share is in line with that, the retail sale share in the first quarter was 28.2%. And so, we hope to see that continue at that level or increase as we progress through the year..

Great. And then, one more.

I'm just wondering if you're seeing any notable change in order mix in terms of smaller owner operator versus larger fleets for their Class 8 segment?.

No, I think it's pretty consistent with what we've been seeing now for the last year or so..

Okay. Great. Thanks. That's all I had..

Thank you..

Your next question will come from the line of Tim Thein of Citigroup..

Great. Thein, this is Tim. Yeah, good morning, Ron. How you're doing..

Good morning, Tim..

Good, good. Hey, just coming back to the first question on the financial services. I'm trying to kind of get a better understanding in terms of the increase that call at $35 million increase in net interest and other line year-over-year.

How much of that with is, I guess I'm getting out, was this a kind of more one-time impairment or is this – will there be an ongoing impact from higher depreciation or combination of both? Maybe just a little bit more clarity on that would be helpful?.

Yeah. So, one of the things that's caused – impacting revenues and interest in other is the fact that the mix of our portfolio is a little bit more tilted towards operating leases, which have higher revenue and expense per truck associated with them. And then we did have on some bulk sales of used trucks in the first quarter.

That's where we saw the losses that we incurred on some of those sales. And so we'll see how pricing develops, but, as I can say, demand has increased and we'll monitor prices very closely to see if we can get some better price realization as we go forward..

Okay, okay.

And are you able to – I mean, at this point, maybe provide some more color in terms of the amount of lease returns in your North American financing business in the quarter, do you have that?.

Yeah. That will be in our 10-Q when we publish that..

Yeah?.

Yeah..

Okay, okay.

And then, I guess, maybe just a last one on Parts, obviously off to a strong start in 1Q, are you still expecting to be in that kind of plus 2% to 4% range or is it – has the thought process changed in terms of full-year revenue for Parts?.

Yeah. I think, based on the first quarter results, probably 3% to 5% would be our estimate of how we would see the year progress for Parts..

Okay, okay. Understood.

And just close it up on gross margin expectations, obviously, above the midpoint here in 1Q with – and you're talking about deliveries going up, are we still thinking it kind of mid-14% range at the higher end or for the year?.

Yeah. I think in the 14% to 14.5% range for the year would be the way to think about the rest of the year for us..

Got it. Understood. I appreciate it. Thanks a lot..

Thank you..

Your next question will come from the line of Ross Gilardi of Bank of America Merrill Lynch..

Hey. Good morning, guys..

Good morning, Ross..

Sorry to harp on the FinCo questions, but just I guess to expand on what Tim was asking, I mean in a flattish used truck pricing environment is that $57 million in FinCo pre-tax earnings kind of the inappropriate run rate or should this kind of bounce back to more in line with year ago levels?.

I think once we get through the used truck, I think we'll see recovery, assume all other things being equal, assuming similar interest rate environment, et cetera..

Okay. So in order to see sort of a step up, you've actually got to see a change in earnings for the FinCo. You've got to see a change in market conditions, from the sounds of it..

Yeah. I think that's fair and as we continue to work with our used truck inventories, and we'll see hopefully that progress as we go through the rest of this year in a positive way..

Got it. Thanks. And then, maybe you could talk just about the truck margin itself as the parts margin was very strong, the truck margin was a little bit soft.

Could you help us maybe bridge the year-on-year, and maybe just include some comments on sort of pricing and raw material costs?.

So, when you look at the incremental margin from the fourth quarter, incremental margin was 18%, which is basically in line with how we would think about how incremental margins would move quarter-to-quarter in the 15% to 20% range. So, right in line with how we anticipated it would develop..

And in terms of pricing versus raw material costs, was there anything notable from the UK or with all the currency movements or anything like that which you would highlight?.

The pound euro exchange rate continues to be – I guess, I would call it a bit of a headwind, but we're working through that as time goes on. And the U.S. and Canadian market, as we progressed through last year, the orders and the retail sales decline.

And so we ended last year in a more competitive position and we're still in that same situation as we began the year this year..

Got it. Thank you..

Thank you..

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

Hey, guys. This is Joe Vruwink for David..

Good morning..

Sorry to do this one, quick one on used price dynamics.

Any impact from mix of what was sold in the quarter? You're seeing, I would say, much more pressure on the sleepers in the market, less so on the day cabs, did that factor in to what you saw?.

I think it's pretty, pretty evenly across the market. I don't think there is any particular impact with sleepers versus day cabs..

Okay. And used prices being weak isn't really a new issue for the industry. So, I guess I'm struggling a bit with why this is really the first quarter PACCAR has had an issue.

Just any idea why it's popping up for you where your peers have been dealing with it for a while now?.

I think it's just because of the volume of used trucks. We did have increased used truck sales in the quarter. And so higher trucks, higher used truck sales is the reason it's, I guess, it's slightly bigger impact than it has been..

Okay. Okay. Shifting to the new market, so you've obviously gained a lot of share at the trough of this recent correction. It looks like we have an upcycle on the horizon, looks like with that upcycle in play, Q1 market share in terms of the order book is normalizing a little bit.

Can you maybe help us frame, I don't know a peak-to-peak market share is the right way to look at it, but what's sort of market share PACCAR would expect as we may be an inch back closer to 300,000 unit markets?.

That's – our guys are working hard to – like our customers, the best trucks and satisfy their needs and we have great products, we have great support services and we think that over time, that will lead to share improvement as it has for the last 20 years.

So, being able to predict how that's going to progress quarter-to-quarter or year-to-year is a bit challenging..

Maybe on Q1 itself, so the whole 32% and I think we can call Q1 a recovery corridor in order intake, is holding 32% doable, because that obviously would represent market share relative to where you have been?.

It's just dependent on how things develop. There's no – we would hope that that 32% continues, but we have competitors in the market and everybody works hard to keep their business moving forward. So, we'll see how it develops as we progress through the year..

Okay. Very good. Thank you..

Thank you..

Your next question will come from the line of Steven Fisher of UBS..

Hey, guys. Good morning, it's Cleve Rueckert on for Steve..

Good morning..

Just a follow-up on the Q1 orders strength.

Do you guys have a color on how that developed from a customer perspective, I mean how much was energy versus construction versus over the road? Is there any shift going on there?.

Probably, the – the biggest increase was probably the over the road. Like I said, vocational has been pretty steady. We did see some improvement in vocational. But as a percent of total, the increase in orders, I think, comes a lot from the on highway customers.

And we are seeing some, some recovery in the energy segment, but it's pretty early days for that..

Okay. That's helpful, thanks.

And then just a quick one, can you reconcile the lower European revenues with the higher volumes, say, on a year-over-year basis, what's driving that small divergence there?.

There is a couple of factors on that one. One, as we have – when we do residual value, it guarantees in Europe, we account for those as operating leases, so we differ the revenues.

So there is a truck delivery, but the revenue gets deferred and amortized over time and we had a higher number of those operating lease activities in Europe during the quarter, compared to last quarter. So that accounted for about $40 million or so of the difference, plus the pound and the euro were both lower against the U.S.

dollar compared to last year..

Okay. So it's nothing to do with pricing there..

No..

No, actually pricing was up a bit as some prices were increased to reflect the effective pound versus the euro in UK..

Okay. That's it from me. Thanks very much..

Thank you..

Your next question will come from the line of Joel Tiss of Bank of Montreal..

Hey. This is John Joyner in for Joel..

Good morning..

So, I guess you're getting – good morning. A lot of B teams today.

So, just real quick on FinCo again and I know this amount is, absolutely dollar amount is not big, but when you look at the provision for losses, I wonder that I guess nearly double from a year ago?.

I mean the provision for loss is at historically low levels. I think last year, if you look at the elements of the change in the reserve, the level of credit losses is very similar. This year, we had an increase in the provision. Last year, we had a decrease in the provision.

And that just reflects movements in portfolios in the various geographies, and as you said, it's a relatively small impact. And so, if the portfolio continues to perform very well, past dues had been at below 1% for almost four or five years now. So, it's purely just small numbers..

Got it.

And just maybe one more, I mean, can you talk a little bit about your products? I know over the past couple of years, you and another of your competitors have been rolling out new products and kind of a refresh of the portfolio, and can you maybe talk about any traction that's being gained or where you see strong customer uptake versus your competitors, because kind of all you hear is that, oh, every product is gaining share and obviously that can't necessarily be the case?.

Well, we have great product, and we've launched the 2.1 meter products here in North America, that percentage of build has continued to increase.

And currently, we're at about 75% of Kenworth and Peterbilt heavy duty truck build or the newer models, very well received, performing excellently, we launched and we included the update to the 2017 MX engine in those trucks at the beginning of this year, adding another 3% to 4% of fuel efficiency.

So, the trucks are performing great and very well received by the customers.

And just this morning, our DAF team launched their newest XF model at the Birmingham truck show, which basically incorporates all the engine enhancements that we adopted here in North America into the DAF product as well as some additional chassis and cab changes that improved aerodynamics and fuel efficiency up to about a 7% improvement.

So, we just continue to move the needle forward on our products, and customers really appreciate the lowest total cost of ownership. When you combine the low operating costs with the strong residual values it makes for a good value proposition for our customers..

Okay. Thank you very much..

Thank you..

Your next question will come from the line of Mike Baudendistel from Stifel..

Hey, thank you. Thank you. Just wanted to ask you on the Parts segment, I think you said you have 17 existing parts distribution facilities and you're opening a couple more that are 100,000 or 170,000.

Can you just frame that for us as what percentage increase in parts distribution capacity that represents?.

So, I think we roughly have about $2.2 million of square feet in parts distribution center space around the world.

So, we're going to increase the – we increased the distribution capacity here in Washington at our Renton facility by about 80,000 square feet, and we're going to increase the distribution capacity in Toronto by another 100,000 square feet when we finish construction of that next year.

So, as we look forward, our parts team has really clear view of continuing to increment that capacity as the parts business grows. And so, that kind of pace per year, I think you'll see going forward..

Okay. And your forecast for growth in Parts of 3% to 5% this year, if you view that as a normalized rate or somewhat of a muted rate, given the environment that you think will accelerate back to the prior growth rate of 7% or 8%..

I think that's what we're expecting at this point, whether that's – just how we see the development of the market for us globally..

Okay. And also just want to ask you on one of the topics of the hour. There was a lot of media attention given to a certain tweet about from a certain company that does electric vehicles that they're planning to have a prototype out of a semi-electric semi-truck this fall.

And wanted to ask you since you occupy sort of the premium end of the marketplace on Class 8 trucks.

Do you view an electric truck as a credible threat longer-term if we were to think out 10 years?.

Yeah, longer-term, 10 years, I think that's the kind of timeframe and we're working on electric trucks, hybrid electric, hydrogen fuel-cell, natural gas. I mean, we're investing in all alternative fuel strategies to be prepared for what may come. So, nobody is standing still and everybody's – I can't say everybody I guess.

We're certainly focused on being prepared for market dynamics and market transitions as they occur..

Sounds great. Thanks very much..

Thank you..

Your next question will come from the line of Barry Haimes of Sage Asset..

Thanks very much. Yeah, I have one follow-up on the financial services.

So, if you're marketing used trucks to market every quarter and if used truck prices stayed flat sequentially, why wouldn't the financial services profit move up sequentially as well, as opposed to it seemed like you indicated that it would be sort of a gradual improvement as we went through the year.

But why wouldn't you see that improvement sequentially right away?.

In the accounting rules the mark-to-market is based on a one-truck transaction and we sell used trucks and typically multiples of that, and so a larger sale typically has some discounting pricing that goes with that..

Okay. Thanks. And then one question on another topic. The Class 8 orders, I think by most accounts have come in better than folks expected over the last several months, and in spite of the fact that truckload rates has been pretty soft. So, I'm wondering if you have any thoughts as to why you think the orders have been better.

Is it that the few economy gap is so large or are there some other factors that might account for the better tone and in spite of the fact that truckload profitability isn't so great? Thanks so much..

Net truck load profitability, I mean, it's down from maybe the peak, but it's still pretty good. And we see that in our finance portfolio, customers have no problem servicing their truck payments. So I think there is – as is in any year, we're starting to see the age of the fleet creep-up a bit.

And so there are just more customers who are probably getting to the point where it makes sense to take advantage of the additional investment to fuel efficiency that comes with the latest versions of heavy-duty trucks..

Thank you..

Thank you..

Your next question will come from the line of Alex Potter of Piper Jaffray..

Hi, guys. Just wanted to ask another maybe a longer term thematic strategic question. This time regarding self-driving vehicles, obviously it's another area of intense media interest recently, just wondering if you could give an update on what your strategy is there, if it's changed at all over the last 6 months to 12 months.

And I don't know, if you would consider acquisitions, partnerships, organic development.

Just any color you can provide will be helpful?.

One of the things that we've done and we've seen over the last 12 months, really 24 months is the software controls that are in our vehicles are becoming ever more important and we've increased our engineering resources, particularly in the software area.

And so, I think we'll continue to see that as we progress over the coming years and with some of those resources dedicated to developing autonomous vehicle technologies. There is a lot of things that have to happen for autonomous trucks to become a reality, but we've had platooning demonstrations, we've had autonomous truck demonstrations.

So, we're involved and engaged in that in a big way and we'll continue to make investments in that arena as we go through this year and for the next five years, 10 years. So, we're working closely with a lot of different parties in the industry and so we'll continue to develop our capability..

Okay, great. And then one last question, you had mentioned earlier, the impact of the pound moving around and the OEMs having to increase pricing in the UK in order to make up for that.

Just wondering, if you've seen any pushback or if the market seems capable of absorbing that increase in pricing?.

I'd say it's a gradual process, it just takes time and we've been – we've done this before and it just takes a while for it to work its way through the system..

Okay. Good to hear. Thanks..

Thank you..

Your next question will come from the line of Neil Frohnapple of Longbow Research..

Sorry. Hi. Good morning. This is actually Faheem on the line for Neil.

And I'm just wondering, what's your – what was the MX installation rate in the quarter, in the Kenworth and Peterbilt trucks in North America?.

I believe it's 46% for the first quarter, yes..

Okay, sounds great.

And can you remind what's your outlook is for the MX market share in 2017?.

I think, look, we were 47% last year, our target is to be at 50% or so this year..

Okay.

And as far as the bulk used truck sales that you mentioned in the first quarter, were those to like a particular dealer group or were those to fleets?.

Sum of both..

Both?.

Yeah..

Okay.

And as far as the Class 8 order increase in the first quarter, I mean, was that a little more to end users or did you see an increase in dealer stock orders?.

No. Most of it was the customers, end users..

Customers?.

Yeah..

Okay. All right. Thank you..

Thank you..

There are no other questions in the queue at this time.

Are there any additional remarks from the company?.

We would like to thank everyone for their participation, and thank you, operator..

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