Good morning, and welcome to PACCAR's Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions] 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, President and Chief Financial Officer; and Michael Barkley, Senior Vice President and Controller. As with prior conference calls, we ask that any members of the media on the line 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. Thanks to the accomplishment of PACCAR's 25,000 outstanding employees around the world. 2017 was an excellent year for the company. PACCAR achieved record revenues of $19.5 billion and net income for $1.68 billion. Net income includes a $173 million onetime benefit from the new U.S. tax law. Excluding the onetime tax benefit, PACCAR reported annual adjusted net income of $1.5 billion, the second highest in the company's history. 2017 was PACCAR's 79th consecutive year of generating positive earnings. Last year's results reflect record heavy duty truck market share in the U.S. and Canada, record worldwide after-market parts results and a strong European truck market. PACCAR celebrated many important achievements in 2017. DAF XF and CF trucks earned a prestigious international truck of the year award. Kenworth and Peterbilt achieved record U.S. and Canada Class 8 retail market share of 30.7%. Kenworth and Peterbilt also launched the new PACCAR front and rear axles and the PACCAR automated transmission in North America. The PACCAR engine factory in Mississippi earned the 2017 plant of the year honor from quality magazine. The PACCAR Innovation Center opened in Silicon Valley. PACCAR parts opened new distribution centers in Brisbane, Australia and Panama City, Panama; and is constructing a new PDC in Toronto. DAF was honored as truck brand of the year in Brazil for the second year in a row. PACCAR's fourth quarter sales and financial services revenues were a quarterly record, $5.45 billion and quarterly net income was $589 million including the $173 million onetime tax benefit. Quarterly adjusted net income excluding the onetime tax benefit was $416 million. PACCAR delivered a record 44,300 trucks during the fourth quarter, 10% higher than third quarter deliveries. PACCAR increased its regular quarterly dividend in April last year and declared total annual cash dividends of $2.19…

[Operator Instructions] Your first question comes from Steve Volkmann with Jefferies. Your line is open. And your next question comes from Steven Fisher with UBS. Your line is open.

Can you give us maybe what the year-over-year contribution was for volume and currency and the quarter on revenue and gross margin? And maybe how you're thinking about the components of what gets you that 50 basis point margin improvement over the course of 2018?

So let's talk about -- I'll let Michael talk about the revenues and the currency effects but I'll just address the margins. As we look at the first quarter -- the fourth quarter because of the holiday period in North America, Peterbilt and Kenworth have fewer production days, so that had more production days and we have a bit higher margins in North America compared to Europe and so that mix is bit of a unfavorable effect in the fourth quarter and now will be favorable in the first quarter and just other expenses and sort of the customer and product mix in the first quarter is more favorable than what we saw in the fourth quarter.

The overall currency effects for the fourth quarter were $142 million, additive to revenue and about $8 million to pretax income.

That was foreign currency you said?

Yes.

And then, I wondered if you could talk about the supply chain here; how is it managing the increased demand for trucks and where are the tightest points that you're seeing at this point? Is it able to meet the wrap up here?

As we do in our wrap ups, we always work very closely with our suppliers, given a lot of forewarning about our plans and so at this point we don't see any particular challenges in working with suppliers to achieve the market demands that we currently see.

Your next question comes from Stephen Volkmann with Jefferies. Your line is open.

I just wanted to make sure I understand Ron when you're talking about the margins in the first quarter and for the full year; are you talking EBITDA or gross margin?

I'm talking about gross margin.

And then what's discussed just a little on SG&A; should we think about that being sort of flat in dollar terms or will you spend a little bit more there as well -- just your thinking there?

So if you look at the fourth quarter, that's probably fairly indicative of what our run rate will be for 2018, probably with a little bit of upward pressure because of exchange rates. Year-to-date, exchange rates will be higher in 2018 as they were in 2017.

And then you talked about sort of spending a little bit more on some drive train integration, electric and all that; how should we think about this kind of longer term over the next kind of three to five years? Are you going to have to sort of spend increasingly larger amounts of R&D and CapEx to kind of get ready for whatever the future looks like I heavy truck or is this sort of a sustainable kind of rate?

I'd say it's more sustainable. This is with 2021 greenhouse gas submissions, on the horizon, we're investing now for that; so I think we have a pretty clear view of -- this level is probably kind of the sustainable level for the next foreseeable few years.

Do you have a targeted year for when you think you will have an electric vehicle of any sort ready for the market?

We'll have it ready when the customer demand is there to support that. We're obviously investing like a lot of companies are in zero emission technologies and as the world evolves and as those vehicles become economical to the customers, that's the point at which we will definitely have a product in the market.

Your next question comes from Jerry Revich with Goldman Sachs. Your line is open.

I'm wondering if you can update us on factory overhead performance in the quarter over the year. You folks have had cost rising to support the production ramp and I'm just wondering how did that evolve for the fourth quarter?

Yes, it was very normal, reflected our billed rates. We got good operating leverage on our factory operations, so I would say it's very normal.

And in terms of the drag from that factory overhead ramp, how does that evolve as we think about '18? Is it any easier to ramp from here or where we're thinking about similar drag in terms of factory overhead cost growth in '18 as we saw in '17?

I think we'll see again, very normal progression, factory overhead will go up as we incremental build rates or come down as we decrement build rates and so all very normal, so I don't have anything else to add to there.

And can you talk about the parts business, the price cost dynamic was a headwind on a year-over-year basis for the past few quarters; could you folks turn the corner -- in the fourth quarter you can just talk about the strategy there in terms of why pricing has lagged inflation for parts for you?

I don't think it's pricing, there are -- we have incentives and because of the great volume, the great programs that our PACCAR parts teams provides, the dealers earned some higher incentive levels that they haven't earned before; so that's reflected but that also is reflected in the fact that we achieved record sales and record profit.

And lastly, in terms of the new tax structure; does that impact your thinking in terms of how much excess cash you need on the balance sheets and now you don't have unremitted foreign earnings the way you did under the prior tax jurisdiction; any change to how you're thinking about target levels of cash?

Yes, we'll progress as we progress through this year, we'll become much more smarter each quarter about how this progresses but we do see definitely a favorable benefit. So we'll be thinking about our capital allocation strategy as we go forward.

Your next question comes from Joel Tiss with BMO. Your line is now open.

So I'm just wondering if you can give us some of the factors like what held back the incremental margins in 2017; just some of the things is it -- have you pretty much optimized all your production or is there something else in there?

No, the single biggest item Joel was just material cost movement. In 2016 we had a very -- nice favorable material cost movements, 2017 was just the opposite. So they went in different directions year-over-year and so that was probably the single biggest item. And then we launched some new products that had a lot of renewable elements to it so as we launched those products we put our initial accrual rates for warranty and some of the other costs that have slightly higher rates, just to be conservative. Products are performing excellently in the market, so we'll see some benefit of that as we go forward.

And I didn't see in the press release here, your market share when you're up; can you give us a sense of what it was?

Yes, 15.3% for the full year and 15.7% in the fourth quarter.

And then just last, on the AMT product; is that a PACCAR product or do you buy it from someone else and rebrand it?

It's rebranded but I would say Joel, it is customized to mesh with our actuals and our MX engines. So it's a unique configuration for our vehicles.

Your next question comes from Ross Gilardi with Bank of America. Your line is open.

Ron, I was just curios what you're seeing in and with huge stock pricing are you seeing any recovery there, and if so was it translating at all into better new truck pricing?

I would say it's stable, the used truck prices have been fairly stable during the second half of the year and as we start into 2018 and I would say that -- I would say the same thing for new truck pricing that is relatively stable.

And any thoughts on the FIMCO [ph], how that would shake out? I mean you got off to -- in 2018 you got off to a weaker start in early 2017 and that was partly due to the weakness in new truck pricing. Should -- do you think you get a little bit of a bump there until we kind of consider this Q4 run rate for earnings kind of -- what we use that for 2018?

Yes, I think -- probably, if you pick an average of the full year, divide that by full year last year and divide that by four, that's probably a fairly indicative run rate, plus or minus for developments during the course of the year.

And then, just start from -- like the state of the UK market, I mean, the UK registrations have been soft, so it's hard to know if that's really indicative of what you guys are experiencing. So did you see a tailing off of momentum or absolute declines in your UK business as the year closed out and expectations the UK for 2018?

Our team there did a great job, they finished -- when you look at the combined -- above 16 ton and 6 to 16 ton market, they -- for the second year in a row were over 30% share of that market; so our teams do a great job there and we're working closely with our customers for negotiating orders for 2018 and so we expect as the year progresses that the UK market by the time we get through the year will be similar to 2017 levels.

Your next question comes from Jamie Cook with Crédit Suisse. Your line is open.

Two questions; one, on the margin commentary for 2018. You're tweaking your margins down or maybe splitting here as essentially flat versus what you said last quarter for '18 but your industry retail sales forecasts were up so I'm just wondering sort of what's changed; is it just material cost, is it market share -- if you could just talk through why wouldn't the operating leverage be better on higher sales and maybe if you hit the high end of your forecast, how to think about margins? And then my second question; some people are increasingly concerned that as the U.S. truck market continues to be stronger, we continue to raise 2018 industry forecast if that takes away from '19; are you getting more concerned that sort of '18 is the peak of the cycle just given the strength that we're seeing? Thank you.

No, we were not concerned about the peak, we're obviously working closely with our customers to meet their needs today, tomorrow and whatever those needs are we will be working closely with them to make sure that we meet those and we'll flex to adjust whatever the market demands are and it's a real strength of our company. As we think about margins, there is a lot of factors that can impact 2018 margins, material costs, other factors as we progress through the year; so it's early days, we feel pretty good about the first quarter and we'll see how things develop for the full year.

Your next question comes from Ann Duignan with JP Morgan. Your line is open.

Can you just talk about what kind of impact to expect changes in the U.S. [indiscernible] having your capital allocation strategy? And would you expect to make any changes on your dividend payout which is currently on 50% of net income?

No, I don't foresee any particular change, obviously that will be a matter for discussion with the board as we discuss things during 2018 but I don't see us making radical changes in our capital allocation approach in our dividend practices.

Your next question comes from Tim [ph] with Citigroup. Your line is open.

I just wanted to circle back with your comments earlier on pricing; maybe you can just talk a little bit more about the outlook in terms of what you're assuming here in '18 and both in the U.S. and Europe? And I guess somewhat related to that, I'm just thinking from an industry standpoint, here we're approaching 2.5 -- kind of 3 plus year highs in terms of quarterly projected build rates. I'm just curious, what do you think another some changes in terms of potential ownership dissimilar to what we saw in Europe I guess a couple of years back but maybe just what do you think the dynamic is holding back or dynamics that are holding back the pricing opportunity in North America and I guess lesser in Europe? So maybe just some comments there.

Maybe Tim [ph] can you clarify for me for what you talked about changes in potential ownership. What…

Yes, just some potential consolidation. You had some ownership change a couple of years ago in Europe by another [indiscernible]. I'm just wondering if there is similar kind of overlay here and potentially North America without naming obvious companies.

Sure. I mean there is consolidation that goes on sort of continuously in the transportation industry and we work very closely with the predecessor and the successor companies to try and maintain strong relationships and as you know, this is an industry that's built a lot on personal relationships and that's important for us and our teams. As we think about pricing, it's just a competitive market and we price -- believe our customer's needs, we have great trucks that have earned a premium in the marketplace and we work closely to earn our share of the market and we're all about profitable market share and that's our focus and we'll continue to do that. So the competitive environment will dictate what the pricing opportunities will be or not be.

Your next question comes from Seth Weber with RBC Capital Markets. Your line is open.

I wanted to ask about the strength in the part sales again; I mean is there anything that you could call out there with respect to whether it's the MX engine starting to kick in and just -- is it mid to high single-digit growth rate, the right way to think about this business now going forward is my first question.

In parts, I think it's a combination of higher truck populations and certainly the increased engine population with MX engines in North America now. The programs that the teams have put together with fleet services, billings, the e-commerce capabilities that we have we're now upto over 130 TRP stores around the globe, the TRP brand; so all those things are elements that contribute to -- I would say above industry growth levels in the parts business and sure we'd hope to be able to continue to build on those but we're focused on continuing to build that business during the course of this year.

And then just one the -- I think I heard delivery is flat sequentially, 4Q to 1Q; is there any regional color that you could give us there to help?

Yes, I think just because of the workday adjustments there will be slightly higher North America deliveries in the first quarter and slightly lower European deliveries in the first quarter.

Your next question comes from David Leiker with Baird. Your line is open.

I enjoyed your booth, so it was good to see a truck company at a talk show [ph].

Harrie was there. Harrie, what's your comments about that.

Well, we had the nice hydrogen truck there, then our autonomous trucks and -- yes, it got a lot of attraction, lot of positive feedback from everybody who was at the show.

So I actually wanted to ask about the zero emission truck because it's obviously not new for PACCAR, you've had vehicles imports I think for several years now. What are some of the challenges in getting the existing electric platforms into higher volume applications at existing fleets?

I think the major thing we needed is a breakthrough in battery technology for electric trucks to really scale, really be significant for heavy commercial trucks.

And then when you think about fuel cell trucks, there is a lot of infrastructure that has to -- hydrogen fuel cell, that has to be developed to support fuel cell technology but all things that we're working with our truck divisions and with some of our suppliers on developing the capabilities to be ready when the demand is right.

And when we think about breakthroughs in battery technology, is that energy density, is it packaging, is it thermal on a heavy duty application? There is obviously very aggressive forecast for automotive lithium-ion battery technology, what are some of the limitations in taking that into a heavy duty application?

For the heavy duty applications it's way [ph] important because a truck carries lot more than a person, like a passenger car does. And the cost and the range that the truck can operate, those are three things that are much more important for heavy trucks than they are for a car.

And the packaging on the chassis and on the truck. So I think there is a lot of things that will matter as that technology gets closer to the market.

It will see applications in the smaller trucks for us and it will make its way in the coming years.

And if you have your crystal ball in the room, five years from now, what sort of value might this be commanding of PACCAR overall?

That crystal ball is little bit dim right now.

Your next question comes from Nicole DeBlase with Deutsche Bank. Your line is open.

I guess on the truck segment, last quarter you guys did 1% positive pricing; did that continue onto 4Q?

I assume you're getting that from the 10-K or 10-Q.

That was from the queue, yes.

I just -- there is a lot of dynamics in those individual line items that impact -- whether it's heavy duty mix, medium duty mix, customer mix; so you've got to look at that total table as one, so it's a little bit difficult to parse into any individual line item.

So we should just want for that I guess. And then, I guess on what you guys have seen internally with respect to order activity in fourth quarter, so it's been really strong for the whole industry. Just curious about mix, so anything interesting that you're seeing with respect to like day cabs versus sleepers versus vocational vehicles, etcetera?

No, I think the demand is up in really all segments. I would say that they are probably in terms of percentage growth, maybe a little bit higher demand on the day cab side and we're seeing some of that in the used truck market where the used day cabs have a bit of a benefit compared to what they had been say six months, nine months ago.

Your next question comes from Andy Casey with Wells Fargo. Your line is open.

Ron, I'm wondering somebody -- could you please discuss how Q4 gross margin performed versus whatever the embedded expectation was in the Q3 call when you gave volume growth, it ended up being a little bit higher; I'm wondering if the margin was a little bit lower and if so, was that -- well, was it lower?

I don't remember exactly what we said but as you look at third quarter versus fourth quarter, part of what we saw was the fact that fourth quarter had higher deliveries in Europe versus North America which again a bit of a dampening effect on overall margins. And there were some impacts of customer and model mix in terms of the products that got sold, the customers that we sold to, and we talked a little bit about the fact that fourth quarter was a record sales period for the parts business and the good news is we had to pay slightly higher incentives but that -- the incentives really helped spur on the additional volume and profitability.

And then I guess a pretty step back from the shorter term; I'm wondering if the company has changed how it balances kind of short-term truck margin versus longer term total margin growth or profit growth potential -- that could be driven by increased engine population in the field that could sport higher after-market sales in the future?

I don't think there is anything fundamentally that's changed about how we think about operating leverage and margin enhancement, some years, quarters, things go your way like material costs, sometimes they don't. So -- but I think long-term we still have a similar perspective on how we thought about margins and operating leverage overtime.

And then, I know you suggested no new pricing right now is pretty stable at North America; I'm just wondering if you're seeing any of the typical forward signals that could suggest pricing could start to improve during 2018?

As we sit here today, pricing is fairly stable.

Your next question comes from David Raso with Evercore ISI. Your line is open.

The margins -- I'm just trying to get a feel for the fourth quarter, the price cost that was incurred and what's your price cost assumption for 2018? I mean, when you pull up a currency, the gross margin was 14 -- a year ago you pull out currency, the gross margins are 14.7. So just to see the gross margins down even ex-currency, in North America it's 51% of deliveries this quarter, a year ago fourth quarter they were only 42; so I thought that would be a positive mix. So I'm just trying to digest; A) how painful was the price cost in the fourth quarter and what are you expecting for the next year to kind of come up from this level and then maintain?

So as I mentioned before, the key differences are the mix between Europe and North America in terms of volume.

And I apologize, I'm talking year-over-year; year-over-year North America deliveries were 51% of the total, they were only 42% a year ago. So the mix is positive year-over-year but the margins ex-currency was down, that's all, it's a plain cost issue, I'm just trying to reconcile.

I don't know what currency numbers you're using and how you're getting those. All I can just tell us is that when you look at fourth quarter '17 versus fourth quarter '16, you have the effects of material cost movements with the single biggest factor beneficial in '16, challenging in '17, the parts incentives had a bit of an impact and those are sort of the two biggest factors and as you look forward into next year, those sort of tend to reverse and you've got the European and North American mix favorable as we get into the first quarter.

And just to be clear, maybe I misheard you. I thought early you did give us the currency impact for the quarter, it was $142 million for revs and $8 million for profit. So…

And that's for the total company, total revenues, total profitability, truck parts, finance, etcetera.

But again, just on clear price cost next year, what's the basis, is it neutral after this year negative or '17 a negative; just to make sure we understand the puts and takes.

Yes, say at this point we're probably thinking about it neutrally.

Your next question comes from the Mike [ph] with Seaport Global.

I wanted to touch on the used truck market again, it's certainly great of course that your brands have good value retention overtime and get solid pricing but if [indiscernible] 2018 for new truck sales, there is a risk that the supply of trading's from the -- on the used side rises as we go through 2018 and that pricing could come down a bit? And can you give us little more color as to what PACCAR has done trying to work with their dealers since the last time we had high inventories on the used side to kind of keep the impact small going forward?

As we think about used trucks I mean we're seeing good demand from used trucks as we sit here today. And no reason to indicate that no reason to indicate that that's not going to continue for the near-term. We've done a lot of things to support our ability to handle greater volumes of used trucks, we built a new used truck center in Chicago area that's been open now just about a year, we're just opening another used truck facility in the Los Angeles area, in Montana. So we continue to enhance our internal abilities and obviously, we've always worked very closely with our dealers on the distribution of used trucks through the market; so we've done a lot of things to enhance our capabilities over the last several years.

And then secondly, just on parts; can you tell us how many TRP part store is open during the quarter and how far along are you to fill buildout to what you're hoping to do globally?

I don't know how many during the quarter, I know we finished over 120 at year end and we're over 130 as we sit here today. I don't think we have a view of what full population is and just as we continue to add dealer locations for Peterbilt, Kenworth, DAF; we'll add locations for TRP to meet market demands as they develop. So there is no end number or end game in sight, it's just continue to take advantage of distributing parts to all the areas that we can support our customers.

Can I understand -- I mean, is that a big piece of the 5% to 8% growth you've got planned for parts in 2018? Are there additional locations planned with first stock ups coming here or is it -- is the best start for your growth for ;18 organic parts growth?

I'd say it's a combination of both. I think it's the programs, it's the population of vehicles and it's TRP expansion.

Your next question comes from Michael Baudendistel with Stifel. Your line is open.

I just wanted to ask you if you have any preliminary expectations for Class 8 market share in 2018; I mean does the decline from where it was in 2017, if there is a big shift from vocational trucks to sales to large fleet?

Our teams will -- they have worked very hard over the years to develop the market share. When I started with the company 24 years ago, Peterbilt and Kenworth had a combined share of 21% and over the 24 years they've been able to increment that to 25%, 28% and now they have 30%. And so our view is to continue to develop the best trucks in the market, provide the best value for our customers and organically grow our share profitably and our primary markets, so that will be our focus for 2018 as well.

And I also wanted to ask you is there anything we should be thinking about in terms of the mix impact of TRP, I mean if TRP consists of a larger portion of your total parts business that's add a drag on margins and parts at all?

No, it's -- in terms of the percentage it's in the 10% to 15% of total sales range and so I don't see it being a major factor in parts margins.

Your next question comes from Joe [ph] with Vertical Research. Your line is open.

First question is just on build rates, and are you currently building to the kind of volumes that you expect in 2018 or do you think that there is still some upward move in where you build this to -- kind of a midpoint of your expectations?

As we have progressed into 2018, we have taken some additional build rate increases, both in North America and Europe to support demand and so we'll maintain that as long as the demand is there.

And then a quarter ago you talked about this sort of 14% to 15% gross margin range, it looks like initial expectations for '18 or that kind of be in the middle of that range. There are industry forecasts out there with volumes, particularly North America well above where it were you or currently. If we think about the market may be turning closer to those expectations versus yours, how do you think about the operating leverage on that? Would that mean gross margin closer to the higher end of the range or there are reasons why we shouldn't anticipate some leverage on that?

As I mentioned, earlier there is a lot of factors that impact that overall margin outcome and we feel really good about what we're seeing and expecting for the first quarter, the rest of year -- there could be opportunities, we'll just have to see how the year develops.

Your next question comes from Neil Frohnapple with Buckingham Research. Your line is open.

Ron, can you give us more granularity on the outlook for the European above 16 ton market for this year? What are the drivers that get you kind of the higher end of the range and then conversely the lower end? And as a follow-up, can you share anything regarding the trends in your order for DAF, like you've done in prior quarters?

Yes, orders for DAF have been very strong. We look at fourth quarter compared to the second or fourth quarter, I think they are up about 27%. So as I mentioned, we've taken some additional plans to increase our build rate this quarter and so it's going to be dependent on the market, you look at the freight activity in Germany; in the month of December I think the activity was up 6%, and for the full year up about 4%, so we enter the beginning of this year with strong freight activity. DAF obviously has a great product, just won truck of the year in the fourth quarter and those products provide upto 7% improved fuel efficiency, so it's a great value proposition for the customers if the customers haven't bought trucks for four or five years, today's trucks is double-digit improvement in terms of operating efficiency. So there is a lot of reason for customers to purchase new vehicles, take advantage of the lower operating cost.

And then Ron, given the outlook for North America heavy duty industry production that continue to increase this year and it sounds like you guys have already increased your daily build rate; as we begin to close in on the recent peak 2015 levels does PACCAR have enough capacity in its factories to support this level of demand or if the market continues to in fact higher considering where your market share is today versus just a few years ago?

Yes, we definitely do and we continue to monitor that and make the investments. As you know, we completed the West [ph] paint facility in Europe last year which basically increased the capacity of our paint operations in Europe by about 50% and we continue to monitor those capacity factors and make the investments. So in our capital plans this year or next year, we'll continue to look at that not just for our factories but obviously we're looking at that for our parts distribution activities as well, we're building the new PDC in Toronto and we're looking at some additional investments on the parts side to continue to support our customers with their truck up time.

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

Yes, we'd like to thank everyone for their participation, and thank you, operator.