Covers_cvo223 2.23.05 2:08 AM Page 1 2 0 0 4 A N N U A L R E P O R T Covers_cvo223 2.23.05 12:58 AM Page 2 S T A T E M E N T O F C O M P A N Y B U S I N E S S S T A T E M E N T O F C O M P A N Y B U S I N E S S S T O C K H O L D E R S ’ I N F O R M A T I O N As a multinational technology company, PACCAR manufactures heavy-duty, As a diversified, multinational technology company, PACCAR manufactures heavy- on- and off-road Class 8 trucks sold around the world under the Kenworth, duty, on- and off-road Class 8 trucks sold around the world under the Kenworth, Peterbilt, DAF and Foden nameplates. The company competes in the North American Peterbilt, DAF and Foden nameplates. The company competes in the North American Class 6-7 market with its medium-duty models assembled in North America and Class 6-7 market with its medium-duty models assembled in North America and sold under the Peterbilt and Kenworth nameplates. In addition, DAF manufactures sold under the Peterbilt and Kenworth nameplates. In addition, DAF manufactures Class 6-7 trucks in the Netherlands and Belgium for sale throughout Europe, the Class 6-7 trucks in the Netherlands and Belgium for sale throughout Europe, the Middle East and Africa and distributes Class 4-7 t r u c k s i n E u r o p e manufactured Middle East and Africa and distributes Class 4-7 t r u c k s i n E u r o p e manufactured by Leyland Trucks (UK). • PACCAR manufactures and markets industrial winches by Leyland Trucks (UK). • PACCAR manufactures and markets industrial winches under the Braden, Gearmatic and Carco nameplates and competes in the truck under the Braden, Gearmatic and Carco nameplates and competes in the truck parts aftermarket through its dealer network. • Finance and Leasing subsidiaries parts aftermarket through its dealer network. • Finance and Leasing subsidiaries facilitate the sale of PACCAR products in many countries worldwide. Significant facilitate the sale of PACCAR products in many countries worldwide. Significant company assets are employed in financial services activities. • PACCAR company assets are employed in financial services activities. • PACCAR maintains exceptionally high standards of quality for all of its products: they maintains exceptionally high standards of quality for all of its products: they are are well-engineered, are highly customized for specific applications and sell in the well-engineered, are highly customized for specific applications and sell in the premium segments of their markets, where they have a reputation for superior premium segments of their markets, where they have a reputation for superior performance and pride of ownership. performance and pride of ownership. C O N T E N T S C O N T E N T S Financial Highlights Message to Shareholders PACCAR Operations Financial Charts Management’s Discussion and Analysis Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Stockholders’ Equity Consolidated Statements of Comprehensive Income Notes to Consolidated Financial Statements Management’s Report on Internal Control Over Financial Reporting Financial Charts Internal Controls Financial Highlights Message to Shareholders Report of Independent Registered Public PACCAR Operations Accounting Firm on the Company’s Consolidated Financial Statements Report of Independent Registered Public Accounting Firm on the Company’s Management’s Discussion and Analysis Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Selected Financial Data Consolidated Statements of Stockholders’ Equity Common Stock Market Prices and Dividends Consolidated Statements of Comprehensive Income Quarterly Results Notes to Consolidated Financial Statements Market Risks and Derivative Instruments Auditor’s Report Officers and Directors Selected Financial Data Divisions and Subsidiaries Quarterly Results Common Stock Market Prices and Dividends Market Risks and Derivative Instruments Officers and Directors Divisions and Subsidiaries Corporate Offices PACCAR Building 777 106th Avenue N.E. Bellevue, Washington 98004 Mailing Address P.O. Box 1518 Bellevue, Washington 98009 Telephone 425.468.7400 Facsimile 425.468.8216 Homepage http://www.paccar.com Stock Transfer and Dividend Dispersing Agent Wells Fargo Bank Minnesota, N.A. Shareowner Services P.O. Box 64854 St. Paul, Minnesota 55164-0854 800.468.9716 www.wellsfargo.com/ shareownerservices PACCAR’s transfer agent maintains the company’s shareholder records, issues stock certificates and distributes dividends and IRS Form 1099. Requests concerning these matters should be directed to Wells Fargo. Online Deliver y of Annual Report and Proxy Statement PACCAR’s 2004 Annual Report and the 2005 Proxy Statement are available on PACCAR’s Web site at www. paccar.com/financials.asp Registered stockholders can sign up to receive future proxy statements and annual reports in electronic format, instead of receiving paper documents, by visiting www.econsent.com/pcar/ Stockholders who hold PACCAR stock in street name may inquire of their bank or broker about the availability of electronic delivery of annual meeting documents. Braden, Carco, DAF, Dynacraft, Foden, Gearmatic, Kenworth, Leyland, PACCAR, PacLease and Peterbilt are trademarks owned by PACCAR Inc and its subsidiaries. Independent Auditors Ernst & Young LLP Seattle, Washington SEC Form 10-K PACCAR’s annual report to the Securities and Exchange Commission will be furnished to stockholders on request to the Corporate Secretary, PACCAR Inc, P.O. Box 1518, Bellevue, Washington 98009. It is also available online at www.paccar.com/ financials.asp, under SEC Filings. Annual Stockholders’ Meeting April 26, 2005, 10:30 a.m. Meydenbauer Center 11100 N.E. Sixth Street Bellevue, Washington 98004 An Equal Opportunity Employer This report was printed on recycled paper. 01-22_Narratives_cvo225 3.1.05 12:28 AM Page 1 F I N A N C I A L H I G H L I G H T S Truck and Other Net Sales and Revenues Financial Services Revenues Total Revenues Net Income Total Assets: Truck and Other Financial Services Truck and Other Long-Term Debt Financial Services Debt Stockholders’ Equity Per Common Share: Net Income: Basic Diluted Cash Dividends Declared 2004 2003 (millions except per share data) $10,833.7 562.6 11,396.3 $ 7,721.1 473.8 8,194.9 906.8 526.5 5,247.9 6,980.1 27.8 4,788.6 3,762.4 4,334.2 5,605.4 33.7 3,786.1 3,246.4 $ 5.19 5.16 2.75 $ 3.01 2.99 1.37 R E V E N U E S billions of dollars N E T I N C O M E billions of dollars S T O C K H O L D E R S ’ E Q U I T Y billions of dollars 12.5 10.0 7.5 5.0 2.5 0.0 1.0 4.0 0.8 3.2 0.6 2.4 0.4 1.6 0.2 0.8 0.0 0.0 35% 28% 21% 14% 7% 0% 95 96 97 98 99 00 01 02 03 04 95 96 97 98 99 00 01 02 03 04 95 96 97 98 99 00 01 02 03 04 Return on Equity (percent) PACCAR Inc and Subsidiaries 01-22_Narratives_cvo225 2/25/05 6:48 AM Page 2 T O O U R S H A R E H O L D E R S PACCAR had a record year in 2004 due to its superior vehicle quality, growth in its primary truck markets and strong results from aftermarket parts and financial services. PACCAR increased its share to record levels in the European and North American heavy-duty truck markets. Medium-duty truck share was strong in both markets. Customers benefited from PACCAR’s ongoing investments in technology, which enhanced manufacturing efficiency, extensive support programs and new product development. PACCAR delivered a record 124,000 trucks and sold more than $1.4 billion of aftermarket parts and services during the year. Net income of $906.8 million was the highest earnings in the company’s 99-year history, and revenues of $11.4 billion were 39 percent higher than in the previous year. Dividends of $2.75 per share were declared during the year, including a special dividend of $2.00. PACCAR declared a 50 percent stock dividend, effective February 2004, and increased its regular quarterly dividend, effective March 2004. The North American truck market in 2004 grew 39 performance for commercial vehicle manufacturers percent from the previous year, as a stronger economy worldwide. After-tax return on beginning shareholder generated increased freight tonnage and transport equity (ROE) was 27.9 percent in 2004, compared to companies increased their fleet sizes. The Class 8 truck 20.2 percent in 2003. The company’s 2004 after-tax market in North America, including Mexico, was return on sales (ROS) was a record 8.4 percent, 248,000 vehicles, compared to 178,000 last year. The compared to 6.8 percent a year earlier. Sales and profits European heavy truck market in 2004 was 239,000 were driven by record truck and parts deliveries and vehicles, compared to 218,000 in 2003, as the euro zone origination of new finance contracts for over 42,000 economy improved slightly. units. Results were also positively impacted by the Truck competitors experienced improved results weakness of the U.S. dollar versus the euro and other due to the stronger market, though their high operating foreign currencies. PACCAR shareholder equity more costs, including the burden of expensive and than tripled over the last decade, to $3.76 billion, as a underfunded pension plans and post-retirement result of strong earnings. PACCAR’s total shareholder health-care programs, continue to negatively impact return in 2004 was 47 percent and has again exceeded their performance. There was limited activity in terms the Standard & Poor’s 500 Index return for the previous of joint ventures, design collaboration and mergers in one-, five- and ten-year periods. the industry. INVESTING FOR THE FUTURE — PACCAR’s record PACCAR continued to set the standard for financial profits, excellent balance sheet, and intense focus on 01-22_Narratives_cvo225 2/25/05 6:48 AM Page 3 quality, technology and cost control have enabled the software and hardware that will enhance the quality company to consistently invest in its products and and efficiency of all operations throughout the processes during all phases of the business cycle. company, including the seamless integration of Productivity, efficiency and capacity improvements suppliers, dealers and customers into its interactive continue to be implemented in all manufacturing and operating metrics. parts facilities. Many of PACCAR’s facilities established One of the major successes that ITD achieved during new production records during the year in terms of the year was the implementation of PACCAR’s new quality metrics, inventory turns and assembly hours. industry-leading purchasing system. The sophisticated PACCAR is recognized as one of the leading logistic platform links engineering, purchasing and technology companies in the world, and innovation suppliers into a cohesive information loop and provides continues to be a cornerstone of PACCAR’s success. real-time data to production and materials personnel. PACCAR has integrated new technology to profitably Other major accomplishments include increased support its own business, as well as its dealers and activities at the Electronic Dealerships in Renton and customers. Ninety-seven new dealer locations were Eindhoven. Over 8,800 dealers, customers, suppliers opened worldwide, and more are planned to enhance and employees have experienced the interactive PACCAR’s distribution network in Europe and demonstration modules showing the application of North America. automated sales and service kiosks, tablet PCs and Major capital projects during the year included the Radio Frequency Identification (RFID). New features completion of the state-of-the-art Kenworth Research include wireless shopping carts and voice-recognition & Development Center, new North American truck software for dealer service applications. interiors, the launch of the fuel-efficient PACCAR In 2004, ITD also led the launch of the Call Center’s MX 12.9-liter engine, installation of paint robotics in new customer-tracking software, the implementation of manufacturing facilities, new engine machining and an electronic transportation system for PACCAR Parts, assembly transfer lines, and the commissioning of the introduction of new Web-based sales catalogs, Engine Development and Test Center. upgrading of the mainframe, and installation of over SIX SIGMA — Six Sigma is integrated into all business 3,600 new personal computers. activities at PACCAR and has been assimilated into 150 TRUCKS — U.S. and Canadian Class 8 retail sales in of the company’s suppliers and many of the company’s 2004 were 233,000 units, and the Mexican market dealers. Its statistical methodology is critical in the totaled 15,000. Western Europe heavy truck sales were development of new product designs and 239,000 units. manufacturing processes. In addition, the company PACCAR’s Class 8 retail sales market share in the introduced “High Impact Kaizen Events” (HIKE), which U.S. and Canada was a record 24.6 percent in 2004. leverage Six Sigma’s methods with production flow DAF’s heavy-duty truck market share in Europe improvement concepts. The HIKE projects conducted increased to a record 12.8 percent. Industry Class 6 in 2004 were instrumental in delivering improved and 7 registrations in the U.S. and Canada numbered performance across the company. Over 7,000 employees 98,000 units, a 29 percent increase from the previous have been trained in Six Sigma and 4,000 projects have year. In Europe, the 6- to 15-tonne market was 75,000 been implemented since its inception. Six Sigma, in units, an 8 percent increase from 2003. PACCAR conjunction with Supplier Quality, has been increased its North American and European market instrumental in delivering improved performance by share in the medium-duty truck segment, as the the company’s suppliers and contributed to PACCAR’s company delivered over 22,000 medium-duty trucks steady production flow last year. and tractors in 2004. INFORMATION TECHNOLOGY — PACCAR’s One of the major challenges facing the commercial Information Technology Division (ITD) is an important vehicle industry in 2004 was the negative cost effect of competitive asset for the company. PACCAR’s use of escalating commodity prices and the hesitancy of information technology is centered on developing suppliers to rapidly expand capacity to meet demand. 01-22_Narratives_cvo225 2/25/05 6:49 AM Page 4 In addition, there was a shortage of steel, which PACCAR International, responsible for exporting impacted many industries, upsetting materials- trucks and parts to over 100 countries, had another planning horizons. PACCAR’s excellent long-term record year due to strong sales in South Africa and supplier partnerships enabled increased production to Latin America. be met, due to the tremendous team effort of its AFTERMARKET TRUCK PARTS — PACCAR Parts had purchasing, materials and production personnel. an excellent year in 2004 as it earned its 12th A highlight in 2004 was PACCAR’s product quality, consecutive year of record profits. With sales of more which continued to be recognized as the leader in the than $1.4 billion, the PACCAR Parts aftermarket industry. Kenworth, Peterbilt and DAF earned industry business is the primary source for replacement parts for recognition as quality leaders in the Class 6, 7 and 8 PACCAR products, and supplies parts for other truck markets, both on-highway and vocational. brands to PACCAR’s dealer networks in many regions Other North American PACCAR truck plant of the world. accomplishments include the installation of additional Over 5 million Class 8 trucks are operating in North paint robotics systems in the Peterbilt Nashville, America and Europe, and the average age of these Tennessee, Kenworth Renton, Washington, and vehicles is estimated to be over six years. These trucks PACCAR Ste-Thérèse, Québec, factories. A new five- create an excellent platform for future parts and service year labor contract at PACCAR’s Ste-Thérèse factory business, provided by a growing number of Kenworth, was ratified in December 2004. Peterbilt, DAF and Foden service facilities. Over 50 percent of PACCAR’s business is generated PACCAR Parts continues to lead the industry with outside the United States, and the company is realizing technology that offers competitive advantages at excellent synergies globally in product development, PACCAR dealerships. Managed Dealer Inventory sales and finance activities, and manufacturing. DAF (MDI) is now installed at over 700 PACCAR dealers Trucks achieved record truck production, sales and worldwide. MDI utilizes proprietary software profits, while increasing its market share for the fifth technology to determine parts-replenishment consecutive year. DAF also introduced the new schedules. Significant investments were also made PACCAR MX engine. in Call Center technology to improve the customer Leyland Trucks, the United Kingdom’s leading experience with its 24-hour/365-day-a-year roadside truck manufacturer, completed significant facility assistance centers. PACCAR Parts enhanced its Connect restructuring, which increased capacity, improved program, a software application for fleet-maintenance quality and enhanced efficiency. Foden Trucks management. The program is a Web-based application broadened its product line with the launch of several providing fleets the opportunity to better manage new product features and aftermarket services. vehicle operating costs. PACCAR Mexico (KENMEX) had another record FINANCIAL SERVICES — At year-end, the PACCAR profit year as the Mexican economy grew steadily. Financial Services (PFS) group of companies had KENMEX recorded gains in plant efficiencies as operations covering three continents and 15 countries. production reached an all-time high. As a result of The global breadth of PFS has enabled the portfolio to capital investments, production capacity will be further grow to more than 128,000 trucks and trailers, with enhanced due to a planned factory expansion project. total assets exceeding $6.9 billion. PFS is the preferred PACCAR Australia set new records for profit, sales funding source in North America for Peterbilt and and market share in 2004, supported by the highest Kenworth trucks, financing over 26 percent of dealer production rates in the company’s history. The sales in 2004. introduction of new Kenworth models and expansion of PACCAR Financial Corp.’s (PFC) conservative the DAF product range led to increased market share in business approach, coupled with PACCAR’s strong S&P vocational and urban applications. Aftermarket parts credit rating of AA- and complemented by the strength sales delivered another year of record performance. of the dealer network, enabled PFC to earn a record 01-22_Narratives_cvo225 3.1.05 12:29 AM Page 5 profit in 2004. PFC recorded increased finance volume facets of its business, strengthening its competitive in 2004 by offering a comprehensive array of finance, advantage. Other fundamental elements contributing lease and insurance products. PFC enhanced its credit- to the exciting prospects of this vibrant, dynamic analysis program, Online Transportation Information company are geographic diversification, with over 50 System (OTIS), by extending the system to Canadian percent of revenues generated outside the U.S., modern customers and dealers. manufacturing and parts-distribution facilities, PACCAR Financial Europe (PFE) completed its leading-edge and innovative information technology, third year of operations and increased profits as it conservative and comprehensive financial services, served DAF dealers in 11 Western European countries. enthusiastic employees and the best distribution PFE provides wholesale and retail financing for DAF networks in the industry. and Foden dealers and customers and finances 16 As PACCAR enters its 100th year, a notable percent of DAF’s dealer sales. milestone among many celebratory moments in its PACCAR Leasing (PacLease) earned its 11th history, the company and its employees are focused on consecutive year of record operating profits and placed strong, quality growth. The embedded principles of in service over 5,000 vehicles in 2004, a new record. premium products, innovative technology and superior The PacLease fleet grew to more than 20,000 vehicles aftermarket support continue to define the course in as 17 percent of the North American Class 6-8 market PACCAR’s daily operations. We are thankful for the chose full-service leasing to satisfy their equipment solid foundation of integrity, honesty and fiscal needs. PacLease substantially strengthened its market discipline that was established during PACCAR’s presence in 2004, increasing the network to over 200 founding year — 1905. William Pigott, Paul Pigott, outlets, and represents one of the largest full-service Charles Pigott and the talented group of employees, truck rental and leasing operations in North America. directors and dealers, in tandem with legions of A LOOK AHEAD — PACCAR had its best financial year suppliers, have defined its unwavering quality approach in the company’s history in 2004, with most operating to business and community involvement. The future is divisions achieving record results. PACCAR’s 20,500 bright, and though each generation will face its share employees enabled the company to distinguish itself of challenges, PACCAR is in an excellent position to as a global leader in the commercial vehicle, finance, enhance its stellar reputation as a leading technology full-service leasing and aftermarket parts businesses. company in the capital goods and finance business. Superior product quality, consistent profitability and steady regular dividend growth are three key operating characteristics that define PACCAR’s business philosophy. In North America, improved economic growth is driving freight shipments and tonnage to record levels. These market indicators should have a positive impact on the truck market in 2005. Euro zone GDP is improving, which, in combination with a strong vehicle-replacement cycle and the increased movement of goods throughout the expanded European Union, is generating increased demand for trucks. The company continues to take aggressive steps to manage production rates and operating costs, consistent with its goal of achieving profitable market share growth. M A R K C . P I G O T T PACCAR’s excellent balance sheet ensures that the C h a i r m a n a n d C h i e f E x e c u t i v e O f f i c e r company is well positioned to continually invest in all Fe b r u a r y 2 5 , 2 0 0 5 01-22_Narratives_cvo225 2/25/05 6:52 AM Page 6 01-22_Narratives_cvo225 2/25/05 6:53 AM Page 7 D A F T R U C K S DAF increased its presence in the growing European market and established records in sales, profit and production in 2004. DAF is the product-quality a n d r e s a l e - v a l u e l e a d e r i n E u r o p e a n d i m p r o v e d i t s m a r k e t s h a r e i n t h e over-15-tonne and 6- to 15-tonne segments. DAF unveiled an entirely new generation of PACCAR MX 12.9-liter engines in 2004. The MX engine employs a sophisticated design and utilizes high-tech materials — including Compact Graphite Iron (CGI) — for the cylinder block and head. This leading technology results in increased performance, reliability, durability and fuel economy. The PACCAR MX engine will initially be available in the DAF XF with power outputs of 410 hp, 460 hp and 510 hp. Additional versions are planned to include engine ratings of 560 hp for the XF and 360 hp for the CF Series. DAF delivered the first phase of a significant order for articulated, heavy transport vehicles to the Royal Dutch Army in 2004. Based on DAF’s XF model, the vehicles were designed for the rugged operating environment, with an enhanced Space Cab module, a superior 6x6 drivetrain and an automated gearbox. The units are equipped with 13-tonne or 24-tonne PACCAR winches for loading and unloading of armored vehicles. The articulated vehicles will transport loads of over 100 tonnes GCW. DAF continued to strengthen its vast distribution network of more than 1,000 dealer and service points throughout Europe. The introduction of the Electronic Dealership tools, aligned with innovative order processing and electronic credit analysis, enhances the customer’s sales experience. PACCAR Financial Europe strengthened its position as a leading financial partner for DAF dealers. The DAF CF85, Britain’s most popular tractor model, earned “Fleet Truck of the Year” from readers of Motor Transport magazine for the third time in four years — an unprecedented achievement. For the fourth consecutive year, the DAF LF was named “Best 7.5-Tonne Truck in the Import Category” in Germany, reinforcing the superior reputation of DAF vehicles. DAF made significant capital investments in its new world-class engine transfer lines and automated assembly facility in Eindhoven. The new 8,000-square-foot anechoic chamber being built at Eindhoven will enable full- size trucks to be evaluated for sound compliance. At the Westerlo facility, the implementation of robotic axle welding and machining centers further improved quality and efficiency. DAF’s XF long-haul flagship delivers exceptional customer value, offering superior reliability, reduced operating expenses, high residual value and luxurious interior appointments — attributes that have propelled record gains in sales and market share. 01-22_Narratives_cvo225 2/25/05 6:54 AM Page 8 01-22_Narratives_cvo225 2/25/05 6:56 AM Page 9 P E T E R B I L T M O T O R S C O M P A N Y Peterbilt combined excellent product quality, high vehicle resale value and classic styling to increase market share in the heavy-duty segment. Peterbilt earned the J.D. Power and Associates 2004 award for Highest in Customer Satisfaction Among Conventional Medium-Duty Trucks.* Peterbilt’s new medium-duty Model 335 sets a higher quality standard in life-cycle value for Class 6/7 vehicles. Enhanced serviceability features and plush interior are combined in a modern, distinctively Peterbilt design. The sloping, aerodynamically styled hood — constructed of a state-of-the-art composite material — is lighter and improves visibility. An advanced forward lighting system provides 40 percent better down-road coverage than conventional lighting designs. New features include a chromed grille crown, a stamped-steel bumper and an ergonomic interior. Peterbilt options introduced on select models include air disc brakes on front axles, higher-horsepower engines for long- and heavy-haul operations, premium stainless-steel air cleaners and keyless entry security systems. Peterbilt’s aftermarket TruckCare Services were expanded with a new Value Preventive Maintenance option and online chassis and parts catalogs. Peterbilt implemented new manufacturing systems in its factories, such as Web Trap, which replaces build paper with computerized tracking of truck chassis throughout the assembly process. Radio Frequency Identification (RFID) is being used to monitor chassis in the factories and to assist PACCAR Financial in monthly vehicle performance metrics. Designated product quality audit areas were constructed at both plants to showcase Peterbilt’s quality commitment to customers and visitors. Peterbilt invested in new cab paint robotics at its Nashville facility to enhance industry leading paint quality. The Nashville plant replaced its 350,000-square-foot roof and reconfigured many of its assembly stations for efficiency improvements. RoadStar magazine honored Peterbilt’s special edition Model 379X conventional with its Most Valuable Product (MVP) award in recognition of the vehicle’s innovation and owner/operator appeal. Heavy Duty Trucking magazine highlighted the visibility upgrades to many Peterbilt models, which include new side windows and optional rear corner windows, as one of its Nifty Fifty best new product introductions of the year. Reflecting a higher quality standard for medium-duty conventionals, the new Model 335 combines enhanced serviceability features, advanced ergonomics and improved visibility with a contemporary exterior that is distinctively Peterbilt. * J.D. Power and Associates 2004 Medium Duty Truck Customer Satisfaction StudySM. Medium Duty Truck defined as Gross Vehicle Weight Class 5, 6 or 7 truck. www.jdpower.com 01-22_Narratives_cvo225 3.1.05 1:17 AM Page 10 01-22_Narratives_cvo225 3.1.05 12:35 AM Page 11 K E N W O R T H T R U C K C O M P A N Y Kenworth earned the 2004 J.D. Power and Associates Award for Highest in Customer Satisfaction Among Vocational Segment Class 8 Trucks* and Medium-Duty Truck Dealer Service.** Product introductions and factory enhancements by “The World’s Best” emphasized its reputation as a technology leader in the trucking industry. Kenworth market share for Class 8 and Class 6/7 products increased in 2004, reflecting a vigorous brand and exceptional life-cycle value. A series of new, innovative products enhanced driver comfort, reduced operating expenses and bolstered already superior resale value. Kenworth added two new AeroCab Diamond sleeper models to the product range. The 86-inch and 72-inch configurations offer a 42-by-80-inch lower bunk with an optional upper bunk; up to an additional 69 cubic feet of storage room; and a weight savings of 150 pounds. T2000 enhancements increased aerodynamic performance and enhanced driver amenities. Increased driver space provided a roomier cab. A reconfigured front bumper makes repairs more cost-effective, while a new steel subframe helps protect the radiator from road impacts. The Kenworth T300 Class 6/7 conventional is increasing its market share. Fresh styling enhancements include a new grille and complex reflector headlamps that increase illumination by 50 percent, as well as an optional one-piece stainless-steel-clad aluminum bumper. Corner windows, a driver workstation and Australian burl wood paneling extend the list of custom options. Kenworth opened its new Research & Development Center in 2004 to remain at the forefront of innovative truck design. The 24,000-square-foot facility houses leading-edge technologies such as a 3D design wall, laser-aided coordinate mapping tools and sophisticated five-axis computerized modeling capability. Kenworth captured several other prestigious honors in 2004. Assembly magazine named the Renton, Washington, factory Assembly Plant of the Year, an outstanding tribute to Kenworth’s production and engineering excellence. The Ste-Thérèse plant received the Government of Québec’s and the Québec Quality Society’s top award — The Grand Prix Québec Quality Award for 2004. The Kenworth Diamond Sleeper was recognized as one of the Most Valuable Products of 2004 by RoadStar magazine, and Heavy Duty Trucking magazine selected the Kenworth External Temperature Gauge as one of its Nifty Fifty new products of the year. The strong Kenworth dealer network operates 282 locations in the U.S. and Canada. Kenworth introduced two PremierCare inventory-management programs — Connect Professional for small- to medium-sized fleets and Connect Enterprise for large fleets. Popular with fleets and owner/operators alike, Kenworth’s T2000 aerodynamic long-haul conventional continues to evolve. Enhancements in 2004 increase aerodynamic performance, improve driver comfort in cab and sleeper areas, and reduce operating costs. * J.D. Power and Associates 2004 Heavy Duty Truck StudySM. Study based on 1,596 responses from principal maintainers of heavy duty trucks. Segment is defined as vehicles which operate in specifically rugged vocations. www.jdpower.com ** J.D. Power and Associates 2004 Medium-Duty Truck Customer Satisfaction StudySM. Medium-Duty Truck defined as Gross Vehicle Weight Class 5, 6 or 7 Truck. www.jdpower.com 01-22_Narratives_cvo225 3.1.05 1:23 AM Page 12 P A C C A R A U S T R A L I A PACCAR Australia dominated the robust heavy-duty truck market in 2004, exceeding previous records in profit, sales, market share and production volume. Kenworth remained the overwhelming choice among long-distance operators who require custom-built, quality vehicles of superior reliability. The Australian economy remained strong in 2004. PACCAR Australia, the continent’s leading producer of heavy commercial vehicles, increased its market share to 24.6 percent. In the high-horsepower end of the market, where trucks haul loads of 200 tonnes over rugged terrain, Kenworth’s share soared to an unprecedented 60 percent. PACCAR Australia enhanced its share of short-haul B-Double and vocational segments with the introduction of the Kenworth T404SAR (Short, Australian, Right-Hand Drive) conventional. This popular new model provides customers a significant advantage by carrying up to a half tonne more per trip versus competitive trucks. DAF Australia increased its share of the medium-duty cabover market, especially in metropolitan applications, where the LF series is well suited. The DAF product range is providing PACCAR Australia dealers with a proprietary engine and suspension for the Australian environment. Specially engineered for Australia’s challenging B-Double and vocational applications, the Kenworth T404SAR conventional provides customers with higher carrying capacities and, therefore, more profit potential than competitive trucks. 01-22_Narratives_cvo225 3.1.05 1:25 AM Page 13 P A C C A R M E X I C O PACCAR Mexico (KENMEX) captured more than 52 percent of heavy-duty tractor sales in the Mexican market during 2004. Higher export volume plus substantial growth in medium-duty and construction vehicles contributed to record production levels. Over the past 10 years, Kenworth’s T300 has become increasingly popular for urban and regional distribution applications in Mexico and Latin America. This model features many new styling enhancements such as an advanced headlight system, 35 percent increased window areas and a comfortable, modern cab interior. KENMEX unveiled the Class 6-8 KW45 and KW55 — based on the versatile DAF LF series— to serve Mexico’s extensive in-city delivery requirements. These widely acclaimed vehicles offer superior maneuverability, visibility and ergonomic design — significant advantages in congested metropolitan areas. KENMEX also introduced a new low-cab-forward Kenworth L700. With its strong chassis, tight turning circle, excellent visibility and spacious interior, this model is especially well-suited for the harsh demands of waste disposal and specialty construction markets. KENMEX celebrated its 45th anniversary and production of its 100,000th truck — a T800 Aerocab — with Mexico’s President Vicente Fox attending the festive occasion. The Kenworth insignia is synonymous with heavy-duty trucking throughout Mexico, prized for the superior product quality, dealer network, financial services and aftermarket support it represents. 01-22_Narratives_cvo225 2/25/05 7:14 AM Page 14 L E Y L A N D T R U C K S Leyland, the United Kingdom’s leading truck manufacturer, delivered a record 15,000 quality vehicles to customers throughout Europe in 2004. Leyland increased production capacity substantially to satisfy demand for DAF and Foden vehicles. In its world-class 600,000-square-foot manufacturing facility, Leyland produces a highly complex mix of vehicles: the entire Foden product line, DAF CF65, right-hand-drive CF75 and 85 Series, and the DAF LF range for urban applications. During 2004, Leyland employed 3D manufacturing simulation software to plan the largest assembly process redesign in the plant’s 25-year history. Engineers created a detailed model of the streamlined production flow to help optimize the logistics and manufacturing processes. Leyland, in conjunction with PACCAR Parts, successfully concluded an early termination agreement regarding the Leyland aftermarket parts distribution contract for its dealer network. The new Leyland Parts Distribution Center completed its first full year of operation and processed over 1.5 million lines of parts orders. The Leyland facility won the prestigious U.K. Manufacturing Excellence Awards for Financial Performance and Process Innovation, in addition to earning the Barclays Award for Best Financial Performance in the Institute of Mechanical Engineers’ Manufacturing Excellence Awards. Leyland expanded its production capacity substantially in 2004 to accommodate increased demand for popular DAF and Foden vehicles. A thorough assembly process redesign increased volume capacity, enhanced build quality and set new standards for efficiency. 01-22_Narratives_cvo225 2/25/05 7:15 AM Page 15 F O D E N T R U C K S Foden, one of the most respected nameplates in the United Kingdom, extended its customer-support network by adding new sales and service outlets. Export sales of Foden’s Alpha range nearly doubled in 2004. Foden’s celebrated Alpha range offers many advanced features that enhance the drivability, productivity and profitability of heavy-duty trucks. During 2004, Foden broadened its appeal to fleets with the addition of the AS-Tronic automatic-shift gearbox as an option on most models. Updates to the product, including options to suit a range of telecommunications needs and safety features to suit U.K. fleet-safety programs, enhanced Foden’s market presence. Strengthening its aftermarket service capability, Foden launched Managed Dealer Inventory (MDI) throughout its dealer network. PACCAR’s state-of-the-art dealer parts-replenishment system electronically manages dealer inventories and parts availability — improving customer satisfaction. Foden claimed top honors during Truck magazine’s prestigious annual multiaxle Tip-In event, in which all makes of trucks are evaluated for performance, drivability and productivity in quarry operations. The eight- wheeled Alpha chassis was highlighted for its product quality and earning capability. Foden’s Alpha range — exemplified by this multi-axle rigid model — has achieved wide recognition for rugged- duty reliability, operating efficiency, enhanced productivity and driver satisfaction. 01-22_Narratives_cvo225 2/25/05 7:16 AM Page 16 P A C C A R I N T E R N A T I O N A L PACCAR International, a leader in marketing trucks for specialized applications around the world, posted solid gains in sales and profits during 2004. An improved global economy spurred demand for proven, premium-quality PACCAR vehicles. PACCAR International delivered vehicles to more than 40 countries in 2004, responding to an increased demand for custom-built transportation solutions. South African sales of locally assembled DAF trucks increased to record levels. PACCAR International delivered the 200th DAF truck to one of the largest logistics and transport companies in sub-Saharan Africa. Sales of medium-duty trucks and conquest sales in Latin America also contributed to the higher volume. Robust demand for commodities — coal, copper and especially oil — stimulated sales for PACCAR off- highway products such as the proven Kenworth C540 and Kenworth Super 953. PACCAR International strengthened its presence in world markets, appointing new dealers in Latin America, Indonesia and Singapore. Dealer access to the latest in communication, diagnostic and Web-based aftermarket application tools continues to expand through DealerNet — PACCAR’s Internet portal. PACCAR International facilitates the sale of PACCAR vehicles for use in a myriad of challenging applications worldwide. This massive and maneuverable Kenworth Super 953 is destined for Middle East oilfields. 01-22_Narratives_cvo225 2/25/05 7:17 AM Page 17 A F T E R M A R K E T T R U C K P A R T S PACCAR Parts celebrated its 12th consecutive year of record sales and profits in 2004 — a remarkable achievement that reflects innovative use of advanced technology and unrivaled aftermarket customer services. The introduction of private-branded products, which allow dealers and fleets to obtain PACCAR-quality parts for their all-makes vehicles, contributed to the strong result. Direct-mail and electronic-mail marketing highlighted new product offerings and promoted PACCAR Parts’ wide variety of premium parts and services. Each month, more than 200,000 customers received information about parts and service promotions. In 2004, PACCAR Customer Call Centers integrated new technology, including three-screen computer consoles and call-handling software. The Call Centers offer 24/7 roadside assistance support to truck drivers throughout North America and Europe and manage over 1.6 million telephone calls annually. Additionally, the newly installed Advance Inventory Management system in North America improved logistics management and product availability to customers. In Europe, PACCAR Parts introduced new Web-based parts and service information catalogs that provide DAF and Foden dealership technicians with current chassis-specific parts and repair times and an electronic pricing guide. Utilizing a global network of highly sophisticated distribution centers, PACCAR Parts supplies Kenworth, Peterbilt, DAF and Foden dealers with parts for all makes of medium- and heavy-duty trucks. 01-22_Narratives_cvo225 2/25/05 7:18 AM Page 18 P A C C A R F I N A N C I A L S E R V I C E S PACCAR’s Financial Services Companies (PFS), which support the sale of PACCAR trucks worldwide, achieved record income in 2004. PFS portfolios are comprised of more than 128,000 trucks and trailers, with total assets surpassing $6.9 billion. The preferred source of financing for Kenworth and Peterbilt trucks for more than 40 years, PACCAR Financial Corp. (PFC) recorded increased finance volumes and strong market share in 2004. Higher freight levels and improved profitability for many fleet operators spurred demand for new vehicles and PFC’s industry- leading lease, insurance and financial products. PFC launched a successful series of innovative financial products, which include new software programs addressing specific requirements of vocational buyers. The programs electronically calculate monthly finance rates, extended terms and seasonal payments. PFC further enhanced loan-processing efficiency and responsiveness by extending its Web-based Online Transportation Information System (OTIS) to Canadian customers and dealers. PACCAR Financial Europe (PFE) has over $1.6 billion in assets and provides financial services to DAF and Foden dealers and customers in 11 Western European countries. PACCAR Financial utilizes state-of-the-art information technology to streamline communication, credit application and contract preparation for PACCAR dealers and their customers worldwide. 01-22_Narratives_cvo225 2/25/05 7:20 AM Page 19 P A C C A R L E A S I N G C O M P A N Y PACCAR Leasing achieved record profits for the 11th consecutive year during 2004 and delivered a record number of new Kenworth and Peterbilt trucks throughout its North American network. The PacLease fleet consists of over 20,000 units. In 2004, more than 17 percent of all Class 6, 7 and 8 vehicles produced were delivered to the full-service leasing industry — reflecting solid demand for outsourced transport services. PacLease is one of the largest full-service truck rental and leasing operations in North America. The company provides national distribution fleets with proactive solutions to meet their daily transport challenges such as increased government regulation, sophisticated maintenance requirements and driver retention. PACCAR Leasing’s competitive advantages: custom-built, premium-quality Kenworth and Peterbilt vehicles with strong residual value and lower operating expenses, and a large — and growing — network of responsive franchises, provide customers with a full spectrum of value-added transportation services. PACCAR Leasing substantially strengthened its market presence in 2004, increasing the network to more than 200 outlets and utilizing company region managers to buttress major accounts. PACCAR Leasing expanded its fleet nearly 20 percent in 2004 and increased its share of the medium-duty market with a greater number of premium-quality Class 6-7 trucks, such as this new Peterbilt Model 335. 01-22_Narratives_cvo225 2/25/05 7:21 AM Page 20 P A C C A R T E C H N I C A L C E N T E R S PACCAR Technical Centers in Europe and the United States provide testing for the design and production of PACCAR’s quality products. PACCAR’s technical expertise worldwide has dramatically accelerated product development programs. The commissioning of PACCAR’s state-of-the-art engine development and test center began in 2004. The expanded capabilities of the test facilities, utilizing sophisticated computational fluid dynamics (CFD) and Six Sigma for design techniques, allow PACCAR to integrate independent powertrain suppliers’ components in meeting emission standards. The addition of an advanced rapid prototyping machine — only the second of its type delivered in the U.S. — enables engineers to iteratively process full-sized computerized models and prototype parts of one cubic meter in size and construct the scale model 10 times faster than with previous methods. A new supercomputer dramatically increases the speed of finite element analysis. PACCAR Technical Centers were instrumental in the development, testing and validation of the new PACCAR MX engine, which incorporates groundbreaking technologies that improve reliability, durability and fuel economy. 01-22_Narratives_cvo225 2/25/05 7:22 AM Page 21 I N F O R M A T I O N T E C H N O L O G Y D I V I S I O N PACCAR’s Information Technology Division (ITD) leads the industry in the innovative application of technology to enhance competitiveness, manufacturing efficiency, productivity, product quality, customer service and profitability. An important reason for PACCAR’s success in recent years has been the integration of a strong Information Technology Division. PACCAR’s implementation of a global knowledge network seamlessly links employees with standard systems worldwide for e-mail, purchasing, engineering design, aftermarket parts and customer support. The Worldwide Operations Support Center provides around-the-clock monitoring of business-critical PACCAR systems and was recognized by Computerworld magazine for its best practices in enterprise management. ITD’s innovative use of technology provides a secure infrastructure whereby its worldwide dealers, customers and suppliers work together utilizing PACCAR electronic systems. In conjunction with primary IT partners, such as Microsoft and Dell, new software and hardware platforms are evaluated in a variety of real-world applications for efficiency and competitive advantage. PACCAR’s technological leadership is exemplified by the deployment of tablet PCs in its “wired for wireless” offices and factories. PACCAR ITD’s award-winning Global Operations Support Center provides 24/7 monitoring of PACCAR systems worldwide. The Center lowers cost and improves customer satisfaction through tracking of key system parameters on a real time basis. 01-22_Narratives_cvo225 3/2/05 3:42 PM Page 22 F I N A N C I A L C H A R T S EARNINGS & DIVIDENDS PER SHARE dollars U . S . A N D C A N A D A C L A S S 8 T R U C K M A R K E T S H A R E retail sales 5.50 4.40 300 240 3.30 180 2.20 120 1.10 0.00 60 0 50% 40% 30% 20% 10% 0% 95 96 97 98 99 00 01 02 03 04 95 96 97 98 99 00 01 02 03 04 ■ Diluted Earnings per Share ■ Dividends per Share Total U.S. and Canada Class 8 Units excluding PACCAR (in thousands) PACCAR Units (in thousands) PACCAR Market Share (percent) T O TA L A S S E T S billions of dollars G E O G R A P H I C R E V E N U E billions of dollars 12.5 10.0 7.5 5.0 2.5 0.0 95 96 97 98 99 00 01 02 03 04 Truck and Other Financial Services 12.5 10.0 7.5 5.0 2.5 0.0 95 96 97 98 99 00 01 02 03 04 ■ United States ■ Outside U.S. ■ ■ ■ ■ 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 23 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F R E S U L T S O F O P E R A T I O N S A N D F I N A N C I A L C O N D I T I O N (tables in millions, except per share data) R E S U LT S O F O P E R AT I O N S : Net sales and revenues: 2004 2003 2002 Truck and Other Financial Services $10,833.7 $7,721.1 $6,786.0 562.6 $11,396.3 473.8 $8,194.9 432.6 $7,218.6 Income before taxes: Truck and Other Financial Services Investment Income Income taxes Net income Diluted earnings per share $ 1,139.9 $ 640.6 $ 473.4 168.4 123.6 72.2 59.9 (461.4) 906.8 41.3 (279.0) $ 526.5 28.5 (202.1) $ 372.0 5.16 $ 2.99 $ 2.13 $ $ Overview: PACCAR is a multinational company whose princi- pal businesses include the design, manufacture and distribution of high-quality, light-, medium- and heavy-duty commercial trucks and related aftermar- ket parts. A portion of the Company’s revenues and income is derived from the financing and leasing of its trucks and related equipment. The Company also manufactures and markets industrial winches. In 2004, heavy-duty truck industry retail sales in the U.S. and Canada increased 42% to 233,000 units. Peterbilt and Kenworth achieved a record 24.6% combined market share compared to 23.5% in 2003. In Europe, PACCAR’s other major market, DAF and Foden truck sales and revenues improved 31% over the prior year due to an increase in customer demand for DAF’s industry-leading products and a positive impact from the increase in the value of the euro versus the U.S. dollar. PACCAR’s DAF truck brand increased its share of the 15 tonne and above market to 12.8% from 12.7% in 2003. PACCAR’s net income in 2004 was a record $906.8 million ($5.16 per diluted share), on record revenues of $11.40 billion. This compares to 2003 net income of $526.5 million ($2.99 per diluted share) on revenues of $8.19 billion. Net income increased in 2004 primarily due to improved truck and aftermarket parts sales and margins in the Company’s primary markets due to increased demand and an improvement in Financial Services pre-tax income. Selling, general and administrative (SG&A) expense for Truck and Other increased to $390.4 million in 2004 compared to $345.0 million in 2003. However, as a percent of sales, SG&A expense decreased to a record low of 3.6% in 2004 from 4.5% in 2003. SG&A increased to support higher production levels and technology investments. In addition, the weaker U.S. dollar had the effect of increasing SG&A by approximately $18 million. Financial Services revenues increased 19% to $562.6 million in 2004. Financial Services income before taxes increased to a record $168.4 million compared to $123.6 million in 2003 as a result of strong asset growth, lower credit losses and excellent finance margins. Investment income of $59.9 million in 2004 was $18.6 million higher than the prior year due to higher cash and marketable debt securities balances and gains of $14.1 million from the sale of equity securities. Income taxes as a percentage of pretax income were 33.7% in 2004 compared to 34.6% in 2003. The lower effective tax rate in 2004 was primarily due to a $9.5 million benefit arising from higher expected utilization of NOL carryforwards acquired in 1998 at a United Kingdom subsidiary. Truck PACCAR’s truck segment, which includes the manu- facture and distribution of trucks and related after- market parts, accounted for 94% of revenues in 2004 and 93% of revenues in 2003 and 2002. In North America, trucks are sold under the Kenworth and Peterbilt nameplates and, in Europe, under the DAF and Foden nameplates. 2004 2003 2002 Truck net sales and revenues $10,762.3 $7,661.2 $6,733.2 Truck income before taxes $ 1,145.0 $ 655.4 $ 482.5 PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 24 2004 Compared to 2003: PACCAR’s worldwide truck sales and revenues increased $3.10 billion to $10.76 billion in 2004 pri- marily due to higher demand for heavy-duty trucks in all of the Company’s primary markets and a $330.3 million impact due to the weaker U.S. dollar. Worldwide truck deliveries were 124,100 units, com- pared to 93,000 units in 2003. Truck income before taxes was $1.14 billion com- pared to $655.4 million in 2003. The increase from the prior year was the result of higher production rates, aftermarket parts sales volume and truck mar- gins, as well as a $52.9 million favorable impact of the weaker U.S. dollar. Retail sales of new Class 8 trucks in the U.S. and Canada totaled 233,000 units in 2004, an increase of 42% from the 2003 level of 164,000. PACCAR’s Class 8 market share in the U.S. and Canada increased to 24.6% in 2004. Kenworth and Peterbilt improved their share of the U.S. and Canada Class 6 and 7 truck market in 2004 to 9.7%. The European 15 tonne and above truck market improved to 239,000 units. DAF Trucks increased its share of the European heavy-duty market to 12.8% from 12.7% in 2003. DAF market share also increased to 8.9% from 8.7% in the 6 to 15 tonne market. Sales in Europe represented approximately 34% of PACCAR’s total Truck and Other net sales and revenue in 2004, compared to 35% in 2003. PACCAR also has a significant market presence in Mexico and Australia. Combined sales and profits of Mexico and Australia were higher by 33% and 46%, respectively, in 2004 compared to 2003. These mar- kets represented approximately 11% of sales and 15% of profits during 2004, compared to 11% of sales and 18% of profits in 2003. Sales and profits from trucks sold to export customers in South America, Africa and Asia also improved in 2004 versus 2003. PACCAR’s worldwide aftermarket parts revenues of $1.47 billion increased in 2004 compared to 2003. Parts operations in North America and Europe bene- fited from a growing truck population and the fur- ther integration of PACCAR technology with dealer business systems to improve responsiveness to cus- tomer needs. In November 2004, PACCAR concluded an early termination agreement with the RAC plc regarding the distribution of Leyland aftermarket parts to DAF dealers and customers in the United Kingdom. PACCAR’s 2004 Truck segment results include a $33.3 million pretax charge for costs associated with the agreement. Effective October 1, 2005, the related parts will be stored and distributed from the Company’s new parts distribution center at Leyland. Research and development expense totaled $103.2 million in 2004, an increase of $22.1 million from 2003, reflecting additional projects focused on new truck designs, technological innovations and contin- ued improvement in industry-leading product quality. 2003 Compared to 2002: PACCAR’s worldwide truck sales and revenues increased $928.0 million to $7.66 billion in 2003 primarily due to higher truck sales in Europe and a $485 million positive impact from the increase in the value of the euro versus the U.S. dollar. Truck income before taxes was $655.4 million compared to $482.5 million in 2002. The increase from the prior year was the result of higher margins, ongoing cost-reduction programs and a $55 million favorable impact of the weaker U.S. dollar. Retail sales of new Class 8 trucks in the U.S. and Canada totaled 164,000 units in 2003, comparable to the 2002 level of 166,000. PACCAR’s Class 8 market share in the U.S. and Canada was also similar to 2002. The European 15 tonne and above truck market decreased slightly to 218,000 units. DAF Trucks increased its share of the European heavy-duty market to 12.7% from 12.0% in 2002. Sales in Europe represented approximately 35% of PACCAR’s total Truck and Other net sales and revenue in 2003, compared to 31% in 2002. PACCAR’s worldwide aftermarket parts revenues increased in 2003 compared to 2002. Parts opera- tions in North America and Europe benefited from a growing truck population, the addition of a parts warehouse in the U.K. and successful integration of PACCAR technology with dealer business systems to improve parts availability. Truck Outlook Demand for heavy-duty trucks in the U.S. and Canada is expected to improve 15% to 20% in 2005, with industry retail sales expected to be 270,000 - 280,000 trucks. European heavy-duty registrations for 2005 are projected to be up slightly from 2004 at 240,000 - 250,000 units. Financial Services The Financial Services segment, which includes wholly owned subsidiaries in the United States, Canada, Mexico, Australia and Europe, derives its earnings primarily from financing or leasing PACCAR products. The Company’s 49% joint venture investment in DAF Financial Services was sold in 2004 for $39.8 million, which approximated book value. 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 25 Financial Services: Average earning assets Revenues Income before 2004 2003 2002 $5,945.0 562.6 $5,139.0 473.8 $4,670.0 432.6 taxes 168.4 123.6 72.2 2004 Compared to 2003: Financial Services revenues increased 19% to $562.6 million in 2004 compared to the prior year due to higher asset levels in the Company’s primary oper- ating markets. New business volume was $3.12 bil- lion, up 38%, reflecting higher truck sales and improved leasing market share. Assets in Europe continued to grow in PACCAR Financial Europe’s third full year of operation. Income before taxes increased 36% to a record $168.4 million in 2004 compared to $123.6 million in 2003. The improvement was primarily due to higher finance margins in the U.S., Canada and Europe and lower credit losses in the U.S. and Canada. Credit losses for the Financial Services segment were $12.2 million in 2004, compared to $24.2 in 2003. The lower credit losses reflect fewer truck repossessions and higher used truck prices. The increase in finance margins in the U.S. and Canada was due to higher earning assets and a lower cost of funds, partially offset by a lower yield. The increase in finance margins in Europe was due to an increase in earning assets. 2003 Compared to 2002: Financial Services revenues increased 10% to $473.8 million in 2003 compared to the prior year due to higher assets, primarily in Europe. Income before taxes increased 71% to $123.6 million in 2003 compared to $72.2 million in 2002. The improvement was primarily due to higher finance margins in the U.S., Canada and Europe and lower credit losses in the U.S. and Canada. Financial Services Outlook The outlook for the Financial Services segment is principally dependent on the generation of new business and the level of credit losses experienced. Asset growth is likely in Europe, the U.S. and Canada, consistent with the anticipated improve- ment in the truck markets and the resulting increase in truck sales. The segment continues to be exposed to the risks that economic weakness, as well as higher fuel, interest rates and insurance costs, could exert pressure on the profit margins of truck opera- tors and result in higher past-due accounts and repossessions. Other Business Included in Truck and Other is the Company’s winch manufacturing business. Sales from this business represent less than 1% of net sales for 2004, 2003 and 2002. L I Q U I D I T Y A N D C A P I TA L R E S O U R C E S : Cash and cash equivalents Marketable debt securities 2004 2003 2002 $1,614.7 $1,347.0 $ 773.0 604.8 $2,219.5 377.1 535.3 $1,724.1 $1,308.3 As more fully explained in Note B of the consoli- dated financial statements, the Company changed its presentation of some lending activities on new trucks in its consolidated statement of cash flows in 2004. These lending activities were reclassified from investing to operating cash flows. Prior year cash flows were reclassified to conform to the current year presentation. The change had no impact on the Company’s net income, total cash flows or the cash and liquidity position of the Company. The Company’s total cash and marketable debt securities increased $495.4 million over 2003. The higher balances result from cash inflows from opera- tions, a portion of which was used to pay dividends, make capital additions, and repurchase PACCAR stock. The Company has $1.5 billion in multiyear bank facilities available. The credit facilities, $750 million of which matures in 2005 and another $750 million of which matures in 2006, are primarily used to provide backup liquidity for the Financial Services commercial paper program. The Company’s strong liquidity position and AA- investment grade credit rating continue to provide financial stability and access to capital markets at competitive interest rates. PACCAR Inc and Subsidiaries PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 26 Truck and Other The Company provides funding for working capital, capital expenditures, research and development, dividends and other business initiatives and com- mitments primarily from cash provided by opera- tions. Management expects this method of funding to continue in the future. Long-term debt and commercial paper were $36.2 million as of December 31, 2004, and con- sisted of fixed and floating rate Canadian dollar debt for the construction of the Company’s truck assembly facility in Quebec in 1999. Expenditures for property, plant and equipment in 2004 totaled $231 million as compared to $111 million in 2003. Over the last five years, the Com- pany’s worldwide capital spending, excluding the Financial Services segment, totaled $643 million. Spending for capital investments in 2005, includ- ing new product development, is expected to in- crease from 2004 levels. PACCAR is investing in state-of-the-art technology to improve product design and quality, increase capacity, achieve effi- ciencies in business processes and enhance the distribution network, as well as develop new manufacturing tooling to support product development plans. The American Jobs Creation Act (the AJCA), which was signed into law on October 22, 2004, cre- ated a special one-time 85% tax deduction for cer- tain repatriated foreign earnings that are reinvested in qualifying domestic activities, as defined in the AJCA. The Company may elect to apply this provi- sion to qualifying earnings repatriations in the year ending December 31, 2005. The Company is in the process of evaluating the effects of the repatriation provision and expects to complete its evaluation after its assessment of clarifying guidance published by Congress or the Treasury Department. The maxi- mum amount the Company is eligible to repatriate under the AJCA is approximately $1.5 billion. The estimated tax provision that would be required on this amount would be approximately $70 million. If any amount is repatriated, it would likely be less than the maximum with a proportional reduction in the estimated provision for income taxes. Financial Services The Company funded its financial services activi- ties primarily from collections on existing finance receivables and borrowings in the capital markets. An additional source of funds was loans from other PACCAR companies in the Truck segment. The primary sources of borrowings in the capital market are commercial paper and publicly issued medium-term notes and, to a lesser extent, bank loans. The majority of the medium-term notes are issued by PACCAR’s largest financial services subsidiary, PACCAR Financial Corp. (PFC). PFC periodically files a shelf registration under the Securities Act of 1933. On December 31, 2004, $1.85 billion of such securities remained available for issuance. In September 2004, PACCAR’s European finance subsidiary, PACCAR Financial Europe, registered a €750 million Euro Medium Term Note Program with the Luxembourg Exchange. On December 31, 2004, €450 million remained available for issuance. This program is renewable annually through the filing of a new prospectus. To reduce exposure to fluctuations in interest rates, the Financial Services companies pursue a policy of structuring borrowings with interest-rate characteristics similar to the assets being funded. As part of this policy, the companies use interest-rate contracts. The permitted types of interest-rate con- tracts and transaction limits have been established by the Company’s senior management, who receive periodic reports on the contracts outstanding. PACCAR believes its Financial Services compa- nies will be able to continue funding receivables and servicing debt through internally generated funds, lines of credit and access to public and private debt markets. 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 27 Commitments The following summarizes the Company’s contrac- tual cash commitments at December 31, 2004: represent the Company’s commitment to acquire trucks at a guaranteed value if the customer decides to return the truck at a specified date in the future. Maturity Within More than One Year One Year $1,707.7 $3,117.1 54.4 31.0 83.7 80.0 $1,845.8 $3,228.1 Total $4,824.8 85.4 163.7 $5,073.9 Borrowings Operating leases Other obligations Total At the end of 2004, the Company had approxi- mately $5.1 billion of cash commitments, including $3.2 billion maturing within one year. As described in Note L of the consolidated financial statements, borrowings consist primarily of term debt and com- mercial paper of the Financial Services segment. Approximately $4.8 billion of the cash commitments were related to the Financial Services segment. The Company expects to fund its maturing Financial Ser- vices debt obligations principally from funds pro- vided by collections from customers on loans and lease contracts, as well as from the proceeds of com- mercial paper and medium-term note borrowings. Other obligations include deferred cash compensa- tion and the Company’s contractual commitment to acquire future production inventory. The Company’s other commitments include the following at December 31, 2004: Commitment Expiration Within More than One Year One Year $ 1.2 5.9 $ 21.9 Letters of credit Loan guarantees Loan and lease commitments 289.9 Total $ 23.1 5.9 289.9 Equipment acquisition commitments Residual value guarantees Total 30.4 23.0 53.4 128.4 $470.6 206.3 $236.4 334.7 $707.0 Loan guarantees consist of guarantees of the bor- rowings of certain PACCAR dealers. Loan and lease commitments are to fund new retail loan and lease contracts. Equipment acquisition commitments require the Company, under specified circumstances, to purchase equipment. Residual value guarantees I M PA C T O F E N V I R O N M E N TA L M AT T E R S : The Company, its competitors and industry in gen- eral are subject to various domestic and foreign requirements relating to the environment. The Company believes its policies, practices and proce- dures are designed to prevent unreasonable risk of environmental damage and that its handling, use and disposal of hazardous or toxic substances have been in accordance with environmental laws and regulations enacted at the time such use and dis- posal occurred. Expenditures related to environmental activities were $2.4 million in 2004, $1.2 million in 2003 and $1.9 million in 2002. The Company is involved in various stages of investigations and cleanup actions in different countries related to environmental matters. In certain of these matters, the Company has been designated as a “potentially responsible party” by domestic and foreign environmental agencies. The Company has provided for the estimated costs to investigate and complete cleanup actions where it is probable that the Company will incur such costs in the future. The Company’s estimated range of reasonably possible costs to complete cleanup actions, where it is probable that the Company will incur such costs and where such amounts can be reasonably estimated, is between $21.0 million and $49.8 million. The Company has established a reserve to provide for estimated future environmental cleanup costs. While the timing and amount of the ultimate costs associated with environmental cleanup matters cannot be determined, management does not expect that these matters will have a material adverse effect on the Company’s consolidated cash flow, liquidity or financial condition. PACCAR Inc and Subsidiaries PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 28 C R I T I C A L A C C O U N T I N G P O L I C I E S : In the preparation of the Company’s financial state- ments, in accordance with Accounting Principles Generally Accepted in the United States, manage- ment uses estimates and makes judgments and assumptions that affect asset and liability values and the amounts reported as income and expense during the periods presented. The following are accounting policies which, in the opinion of management, are particularly sensitive and which, if actual results are different, may have a material impact on the finan- cial statements. Operating Leases The accounting for trucks sold pursuant to agree- ments accounted for as operating leases is discussed in Notes A and G of the consolidated financial state- ments. In determining its estimate of the residual value of such vehicles, the Company considers the length of the lease term, the truck model and antici- pated market demand and the expected usage of the truck. If the sales price of the trucks at the end of the term of the agreement differs significantly from the Company’s estimate, a gain or loss will result. The Company believes its residual-setting policies are appropriate; however, future market conditions, changes in government regulations and other factors outside the Company’s control can impact the ulti- mate sales price of trucks returned under these con- tracts. Residual values are reviewed regularly and adjusted downward if market conditions warrant. Allowance for Credit Losses The establishment of credit loss reserves on finan- cial services receivables is dependent on estimates, including assumptions regarding collectibility of past due accounts, repossession rates and the recov- ery rate on the underlying collateral. The Company believes its reserve-setting policies adequately take into account the known risks inherent in the finan- cial services portfolio. If there are significant varia- tions in the actual results from those estimates, the provision for credit losses and operating earnings may be adversely impacted. Product Warranty The expenses related to product warranty are esti- mated and recorded at the time products are sold based on historical data regarding the source, fre- quency, and cost of warranty claims. Management believes that the warranty reserve is appropriate and takes actions to minimize warranty costs through quality-improvement programs; however, actual claims incurred could differ from the original estimates, requiring adjustments to the reserve. Pension and Other Postretirement Benefits The Company’s accounting for employee pension and other postretirement benefit costs and obliga- tions is governed by the pronouncements of the Financial Accounting Standards Board. Under these rules, management determines appropriate assump- tions about the future, which are used by actuaries to estimate net costs and liabilities. These assump- tions include discount rates, health care cost trends, inflation rates, long-term rates of return on plan assets, retirement rates, mortality rates and other factors. Management bases these assumptions on historical results, the current environment and rea- sonable expectations of future events. Actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect expense in such future periods. While management believes that the assumptions used are appropriate, significant differences in actual experience or significant changes in assump- tions would affect pension and other postretirement benefit costs and obligations. See Note M of the Financial Statements for more information regard- ing costs and assumptions for employee benefit plans. F O R WA R D - L O O K I N G S TAT E M E N T S : Certain information presented in this report con- tains forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995, which are subject to risks and uncertainties that may affect actual results. Risks and uncertainties include, but are not limited to: a significant decline in industry sales; competitive pressures; reduced market share; reduced availability of or higher prices for fuel; increased safety, emissions, or other regulations resulting in higher costs and/or sales restrictions; currency or commodity price fluctua- tions; insufficient or under-utilization of manufac- turing capacity; supplier interruptions; insufficient supplier capacity or access to raw materials; shortages of commercial truck drivers; increased warranty costs or litigation; or legislative and governmental regulations. 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 29 C O N S O L I D A T E D S T A T E M E N T S O F I N C O M E Year Ended December 31 T R U C K A N D O T H E R : Net sales and revenues Cost of sales and revenues Selling, general and administrative Interest and other expense, net Truck and Other Income Before Income Taxes F I N A N C I A L S E RV I C E S : Revenues Interest and other Selling, general and administrative Provision for losses on receivables Financial Services Income Before Income Taxes Investment income Total Income Before Income Taxes Income taxes Net Income Net Income Per Share Basic Diluted Weighted Average Number of Common Shares Outstanding Basic Diluted See notes to consolidated financial statements. 2004 2003 2002 (millions except per share data) $10,833.7 $ 7,721.1 $ 6,786.0 9,268.6 390.4 34.8 9,693.8 1,139.9 562.6 296.1 80.0 18.1 394.2 168.4 59.9 1,368.2 461.4 906.8 6,732.0 345.0 3.5 7,080.5 640.6 473.8 248.7 72.9 28.6 350.2 123.6 41.3 805.5 279.0 $ 526.5 5,947.2 354.5 10.9 6,312.6 473.4 432.6 237.7 69.5 53.2 360.4 72.2 28.5 574.1 202.1 $ 372.0 5.19 5.16 $ $ 3.01 2.99 $ $ 2.15 2.13 174.6 175.7 174.8 176.1 173.3 174.6 $ $ $ PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 30 C O N S O L I D A T E D B A L A N C E S H E E T S A S S E T S December 31 T R U C K A N D O T H E R : Current Assets Cash and cash equivalents Trade and other receivables, net of allowance for losses (2004 - $12.7 and 2003 - $14.9) Marketable debt securities Inventories Deferred taxes and other current assets Total Truck and Other Current Assets Equipment on operating leases, net Property, plant and equipment, net Other noncurrent assets Total Truck and Other Assets F I N A N C I A L S E RV I C E S : Cash and cash equivalents Finance and other receivables, net of allowance for losses (2004 - $127.4 and 2003 - $119.2) Equipment on operating leases, net Other assets Total Financial Services Assets 2004 2003 (millions of dollars) $ 1,579.3 $ 1,323.2 538.7 604.8 495.6 113.3 3,331.7 472.1 1,037.8 406.3 5,247.9 479.1 377.1 334.5 85.0 2,598.9 494.8 893.4 347.1 4,334.2 35.4 23.8 6,106.1 716.4 122.2 6,980.1 $12,228.0 4,994.9 471.0 115.7 5,605.4 $ 9,939.6 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 31 L I A B I L I T I E S A N D S T O C K H O L D E R S ’ E Q U I T Y December 31 T R U C K A N D O T H E R : Current Liabilities Accounts payable and accrued expenses Current portion of long-term debt and commercial paper Dividend payable Total Truck and Other Current Liabilities Long-term debt and commercial paper Residual value guarantees and deferred revenues Deferred taxes and other liabilities Total Truck and Other Liabilities F I N A N C I A L S E RV I C E S : Accounts payable, accrued expenses and other Commercial paper and bank loans Term debt Deferred taxes and other liabilities Total Financial Services Liabilities S T O C K H O L D E R S ’ E Q U I T Y Preferred stock, no par value – authorized 1.0 million shares, none issued Common stock, $1 par value – authorized 400.0 million shares, 173.9 million shares issued and outstanding Additional paid-in capital Retained earnings Accumulated other comprehensive income Total Stockholders’ Equity See notes to consolidated financial statements. 2004 2003 (millions of dollars) $ 1,794.4 8.4 347.8 2,150.6 27.8 526.2 372.9 3,077.5 148.8 2,502.0 2,286.6 450.7 5,388.1 173.9 450.5 2,826.9 311.1 3,762.4 $ 12,228.0 $1,334.4 7.8 140.1 1,482.3 33.7 560.4 330.5 2,406.9 126.8 2,263.0 1,523.1 373.4 4,286.3 175.1 524.2 2,399.2 147.9 3,246.4 $9,939.6 PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 32 C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S 2004 2003 2002 (millions of dollars) $ 906.8 $ 526.5 $ 372.0 Year Ended December 31 O P E R AT I N G A C T I V I T I E S : Net income Items included in net income not affecting cash: Depreciation and amortization: Property, plant and equipment Equipment on operating leases and other Provision for losses on financial services receivables Other, net Change in operating assets and liabilities: (Increase) Decrease in assets other than cash and equivalents: Receivables: Trade and other Wholesale receivables on new trucks Sales-type finance leases and dealer direct loans on new trucks Inventories Other Increase (Decrease) in liabilities: Accounts payable and accrued expenses Deferred lease revenues Other Net Cash Provided by Operating Activities I N V E S T I N G A C T I V I T I E S : 122.0 193.0 18.1 19.4 (53.0) (298.4) (164.0) (142.1) (30.2) 409.7 (69.5) (20.8) 891.0 Retail loans and direct financing leases originated Collections on retail loans and direct financing leases Net decrease (increase) in wholesale receivables on used equipment Marketable securities purchases Marketable securities sales and maturities Acquisition of property, plant and equipment Acquisition of equipment for operating leases Proceeds from asset disposals Other, net Net Cash Used in Investing Activities (2,333.1) 1,816.0 7.1 (876.3) 710.5 (231.9) (401.6) 103.2 (1,206.1) 116.1 151.4 28.6 21.7 (32.8) (29.7) (10.7) 23.6 (57.3) 57.5 (55.3) 38.7 778.3 (1,829.4) 1,822.4 1.9 (945.6) 1,097.9 (111.2) (258.1) 30.9 (7.7) (198.9) 118.0 100.2 53.2 49.4 39.3 (202.3) (5.0) (15.9) (36.3) 82.5 32.7 .3 588.1 (1,752.1) 1,797.5 (2.8) (659.3) 537.1 (78.8) (261.4) 28.5 5.6 (385.7) F I N A N C I N G A C T I V I T I E S : Cash dividends paid Purchase of treasury stock Stock option transactions Net increase in commercial paper and bank loans Proceeds from long-term debt Payments on long-term debt Net Cash Provided by (Used in) Financing Activities Effect of exchange rate changes on cash Net Increase in Cash and Cash Equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year See notes to consolidated financial statements. (270.9) (107.7) 15.7 148.2 1,588.6 (857.6) 516.3 66.5 267.7 1,347.0 $ 1,614.7 (171.9) (123.0) 23.8 20.2 659.2 (662.0) (130.7) 125.3 574.0 773.0 $ 1,347.0 22.4 12.7 867.4 (938.6) (159.1) 74.5 117.8 655.2 773.0 $ 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 33 C O N S O L I D A T E D S T A T E M E N T S O F S T O C K H O L D E R S ’ E Q U I T Y December 31 C O M M O N S T O C K , $ 1 PA R VA L U E : Balance at beginning of year Treasury stock retirement 50% stock dividend Stock options exercised and other stock compensation Balance at end of year A D D I T I O N A L PA I D - I N C A P I TA L : Balance at beginning of year Treasury stock retirement 50% stock dividend Stock options exercised and tax benefit Other stock compensation Balance at end of year R E TA I N E D E A R N I N G S : Balance at beginning of year Net income Cash dividends declared on common stock, per share: 2004-$2.75; 2003-$1.37; 2002-$1.00 Balance at end of year T R E A S U RY S T O C K AT C O S T: Balance at beginning of year Purchases Retirements Balance at end of year A C C U M U L AT E D O T H E R C O M P R E H E N S I V E I N C O M E ( L O S S ) : N E T U N R E A L I Z E D I N V E S T M E N T G A I N S ( L O S S E S ) : Balance at beginning of year (Decrease) Increase Balance at end of year M I N I M U M P E N S I O N L I A B I L I T Y: Balance at beginning of year (Increase) Decrease Balance at end of year D E R I VAT I V E C O N T R A C T S : Balance at beginning of year Increase (Decrease) Balance at end of year C U R R E N C Y T R A N S L AT I O N : Balance at beginning of year Translation gains Balance at end of year Total accumulated other comprehensive income (loss) Total Stockholders’ Equity See notes to consolidated financial statements. 2004 2003 2002 (millions of dollars except per share data) $ 175.1 (2.0) $ 115.9 $ .8 173.9 524.2 (105.7) 25.6 6.4 450.5 2,399.2 906.8 (479.1) 2,826.9 (107.7) 107.7 $ 9.5 (9.2) .3 (3.2) (5.3) (8.5) (15.1) 11.0 (4.1) 156.7 166.7 323.4 $ 311.1 $ 3,762.4 58.4 .8 175.1 545.8 (58.4) 32.9 3.9 524.2 2,113.3 526.5 (240.6) 2,399.2 79.2 (2.4) 38.6 .5 115.9 658.1 (103.4) (38.6) 25.3 4.4 545.8 1,916.5 372.0 ( 175.2) 2,113.3 (105.8) 105.8 $ 7.4 2.1 9.5 $ (2.4) 9.8 7.4 (20.3) 17.1 (3.2) (39.7) 24.6 (15.1) (121.7) 278.4 156.7 $ 147.9 $3,246.4 (8.8) (11.5) ( 20.3) (37.3) ( 2.4) ( 39.7) ( 246.9) 125.2 ( 121.7) $ ( 174.3) $2,600.7 PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 34 C O N S O L I D A T E D S T A T E M E N T S O F C O M P R E H E N S I V E I N C O M E December 31 2004 2003 2002 Net income Other comprehensive income (loss), net of tax: Marketable securities (decrease) increase Minimum pension liability (increase) decrease Derivative contracts increase (decrease) Foreign currency translation gains Net other comprehensive income Comprehensive Income See notes to consolidated financial statements. $ 906.8 (9.2) (5.3) 11.0 166.7 163.2 $1,070.0 (millions of dollars) $ 526.5 2.1 17.1 24.6 278.4 322.2 $ 848.7 $ 372.0 9.8 (11.5) (2.4) 125.2 121.1 $ 493.1 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) A . S I G N I F I C A N T A C C O U N T I N G P O L I C I E S Description of Operations: PACCAR Inc (the Company or PACCAR) is a multinational company operating in two segments: (1) the manufacture and distribution of light-, medium- and heavy-duty commercial trucks and related aftermarket parts and (2) finance and leasing products and services pro- vided to customers and dealers. PACCAR’s sales and revenues are derived primarily from North America and Europe. The Company also operates in Australia and sells trucks and parts outside its primary mar- kets to customers in Asia, Africa and South America. Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned domestic and foreign subsidiaries. All significant intercompany accounts and transactions are eliminated in consoli- dation. The equity method of accounting is used for investments in companies where PACCAR has a 20% to 50% non-controlling ownership interest. Change in Presentation of the Consolidated Statement of Cash Flows: As more fully explained in Note B, the Company changed its presentation of some lending activities on new trucks in its consoli- dated statement of cash flows in 2004. Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents: Cash equivalents con- sist of short-term liquid investments with a matu- rity at date of purchase of three months or less. Long-lived Assets, Goodwill and Other Intangible Assets: The Company evaluates the carrying value of long-lived assets (including property and equip- ment, goodwill and other intangible assets) when events and circumstances warrant such a review. Goodwill is also reviewed for impairment on an annual basis. There were no impairment charges for the three years ended December 31, 2004. Revenue Recognition: Substantially all sales and revenues of trucks and related aftermarket parts are recorded by the Company when products are shipped to dealers or customers, except for certain truck shipments that are subject to a residual value guarantee to the customer. Revenues related to these shipments are recognized on a straight-line basis over the guarantee period (see Note G). Interest income from finance and other receiv- ables is recognized using the interest method. Certain loan origination costs are deferred and amortized to interest income. For operating leases, rental revenue is recognized on a straight-line basis over the lease term. Recognition of interest income and rental revenue are suspended when manage- ment determines that collection is not probable (generally after 90 days past the contractual due date). Recognition is resumed if the receivable becomes contractually current and the collection of amounts is again considered probable. Foreign Currency Translation: For most of PACCAR’s foreign subsidiaries, the local currency is the functional currency. All assets and liabilities are translated at year-end exchange rates and all income statement amounts are translated at the weighted average rates for the period. Adjustments resulting from this translation are recorded in other 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 35 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions except per share amounts) comprehensive income (loss), a component of stockholders’ equity. At December 31, 2004, the value of the U.S. dollar was lower than the euro and other primary functional currencies of the Company at December 31, 2003. This had the effect of increasing stock- holders’ equity by $166.7. PACCAR uses the U.S. dollar as the functional currency for its Mexican subsidiaries. In addition, the Company’s Netherlands subsidiaries generally use the euro as the functional currency for their subsidiaries. Accordingly, for these subsidiaries, inventories, cost of sales, property, plant and equipment, and depreciation were translated at historical rates. Resulting gains and losses are included in net income. Research and Development: Research and develop- ment costs are expensed as incurred and included as a component of cost of sales in the accompanying consolidated statements of income. Amounts charged against income were $103.2 in 2004, $81.1 in 2003 and $56.0 in 2002. Earnings per Share: Diluted earnings per share are based on the weighted average number of basic shares outstanding during the year adjusted for the dilutive effect of stock options under the treasury stock method. Stock-Based Compensation: Effective January 1, 2003, PACCAR prospectively adopted FAS No. 123, Accounting for Stock-Based Compensation, for all new employee stock option awards. As the expense of stock options is recognized over the vesting period, amounts included in net income in 2004 and 2003 are less than if the fair value method had been applied retroactively. Through the end of 2002, PACCAR used the intrinsic value method of accounting for its stock compensation plans. Under the intrinsic value method, when the exercise price of option grants equals the market value of the underlying common stock at the date of grant, no compensation expense is reflected in the Company’s net income. The estimated fair value of stock options granted during 2004, 2003 and 2002 was $18.87, $9.82 and $9.31 per share. These amounts were determined using the Black-Scholes-Merton option-pricing model, which values options based on the stock price at the grant date, and the following assumptions: 2004 3.11% 2003 2002 3.21% 4.50% Risk-free interest rate Expected volatility of common stock 45% 3.0% Dividend yield Expected life of options 5 years 48% 4.4% 5 years 48% 4.4% 5 years The following table illustrates the effect on net income and earnings per share if PACCAR had retroactively recorded compensation expense for the fair value of stock options under the provisions of FAS No. 123: 2004 2003 2002 Net income, as reported Add: Stock-based compensation included in net income, net of related tax effects Deduct: Fair value of stock compensation, net of tax Pro forma net income $906.8 $ 526.5 $ 372.0 2.8 1.7 (4.0) $905.6 (4.7) $ 523.5 (5.5) $ 366.5 Earnings per share: Basic–as reported Basic–pro forma $ Diluted–as reported Diluted–pro forma 5.19 5.19 5.16 5.15 $ 3.01 $ 2.99 2.99 2.97 2.15 2.11 2.13 2.10 In December 2004, the Financial Accounting Standards Board issued FAS No. 123R, Share-Based Payment. The standard is effective beginning with the first interim or annual reporting period ending after June 15, 2005. Since the Company has already adopted the expensing provisions of FAS 123, the adoption of FAS 123R is not expected to have a sig- nificant impact on the Company’s consolidated results of operations or financial position. See Note R for a description of PACCAR’s stock compensation plans. Reclassifications: Certain prior-year amounts have been reclassified to conform to the 2004 presentation. B . C H A N G E I N P R E S E N TAT I O N O F T H E S TAT E M E N T O F C A S H F L O W S After review of concerns recently expressed by the staff of the U.S. Securities and Exchange Commission regarding the cash flow presentation of lending activities of companies with captive finance subsidiaries, such as PACCAR, the Company has decided to change the classification of the cash flow effects of some lending activities in the consolidated statement of cash flows in 2004 as follows: 1) Dealer wholesale financing for the payment of a substantial portion of trade receivables is provided by the Company’s finance subsidiaries. Previously, the net change in wholesale loans on new trucks was shown as an investing activity while the change in PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 36 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S INVESTING ACTIVITIES 2003 2002 As reclassified: Retail loans and direct financing leases originated Collections on retail loans $ (1,829.4) $(1,752.1) and direct financing leases 1,822.4 1,797.5 Net decrease (increase) in wholesale receivables on used equipment Net Cash Used in Investing 1.9 (2.8) Activities $ (198.9) $ (385.7) C . I N V E S T M E N T S I N M A R K E TA B L E S E C U R I T I E S The Company’s investments in marketable securities are classified as available-for-sale. These investments are stated at fair value with any unrealized holding gains or losses, net of tax, included as a component of stockholders’ equity until realized. Gross realized gains and losses on marketable debt securities were $5.1 and $.7 for the year ended December 31, 2003. Gross realized gains and losses on marketable debt securities were not significant in 2004 or 2002. Unrealized losses are charged against net earnings when a decline in fair value is determined to be other than temporary. Gross unrealized losses at December 31, 2004 and 2003, were not significant. The cost of debt securities available-for-sale is adjusted for amortization of premiums and accre- tion of discounts to maturity. Amortization of pre- miums, accretion of discounts, interest and dividend income and realized gains and losses are included in investment income. The cost of securities sold is based on the specific identification method. Marketable debt securities at December 31, 2004, were as follows: AMORTIZED COST U.S. tax-exempt securities $ 194.8 187.3 Corporate securities Non U.S. government securities 203.0 19.1 Other debt securities $ 604.2 FAIR VALUE $ 195.4 187.4 202.9 19.1 $ 604.8 December 31, 2004, 2003 and 2002 (currencies in millions) the related trade receivables was shown in the oper- ating section even though on a consolidated basis, cash is not received on the related sale until pay- ment is received on the wholesale balance. This had the effect of presenting an operating cash flow as an investing cash flow. The net changes in new truck wholesale financing have been reclassified from the investing to the operating section of the cash flow statement to eliminate the effects of intercompany transactions in arriving at operating cash flows. 2) Certain dealers enter into long-term leases of PACCAR trucks with their customers and fund these activities by entering into a corresponding loan or sales-type lease with the Company’s finance sub- sidiaries. Previously these transactions were treated as a payment of the trade receivable in the operating section and as a component of finance receivables originated in the investing section. The subsequent receipts were shown as a component of collections on finance receivables in the investing section. Since on a consolidated basis, cash on the original sale is received by PACCAR when payments are received on these loans and sales-type leases, the related origi- nations and the collections have been removed from the investing section of the cash flow statement. The net change in sales-type finance leases and dealer direct loans on new trucks is now shown in the operating section. The statements of cash flows for 2003 and 2002 have been reclassified consistent with the 2004 pre- sentation as follows: 2003 2002 $ 818.7 $ 795.4 (29.7) (202.3) (10.7) (5.0) $ 778.3 $ 588.1 OPERATING ACTIVITIES As previously reported: Net Cash Provided by Operating Activities As reclassified: Wholesale receivables on new trucks Sales-type finance leases and dealer direct loans on new trucks Net Cash Provided by Operating Activities INVESTING ACTIVITIES As previously reported: Finance receivables originated $ (1,928.2) $(1,829.3) Collections on finance receivables Net increase in wholesale 1,910.5 1,869.7 receivables (27.8) (205.1) Net Cash Used in Investing Activities $ (239.3) $ (593.0) 2003 2002 were as follows: Marketable debt securities at December 31, 2003, U.S. government securities U.S. tax-exempt securities AMORTIZED COST $ 24.2 347.8 $ 372.0 FAIR VALUE $ 24.5 352.6 $ 377.1 23-54_Financials-cvo225.qxd 3.1.05 1:52 AM Page 37 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) The contractual maturities of debt securities at December 31, 2004, were as follows: Maturities: Within one year One to five years AMORTIZED COST $ 122.7 481.5 $ 604.2 FAIR VALUE $ 122.7 482.1 $ 604.8 The Company had no investments in marketable equity securities at December 31, 2004. Investments in marketable equity securities were included in “Other noncurrent assets” at December 31, 2003. The cost and fair value of marketable equity securi- ties totaled $4.9 and $15.1 at December 31, 2003. Gross realized gains on marketable equity securities were $14.1 and $.7 for the years ended December 31, 2004 and 2003. Gross realized losses were $9.3 for the year ended December 31, 2002. D . I N V E N T O R I E S Inventories at cost: Finished products Work in process and raw materials Less LIFO reserve 2004 2003 $ 270.6 $ 247.9 353.1 623.7 (128.1) $ 495.6 213.3 461.2 (126.7) $ 334.5 Inventories are stated at the lower of cost or market. Cost of inventories in the United States is deter- mined principally by the last-in, first-out (LIFO) method. Cost of all other inventories is determined principally by the first-in, first-out (FIFO) method. Inventories valued using the LIFO method com- prised 50% and 39% of consolidated inventories before deducting the LIFO reserve at December 31, 2004 and 2003. E . F I N A N C E A N D O T H E R R E C E I VA B L E S Finance and other receivables are as follows: Loans Retail direct financing leases Sales-type finance leases Dealer wholesale financing Interest and other receivables Less allowance for losses Unearned interest: Loans Finance leases 2004 2003 $3,306.1 1,635.7 497.5 1,061.0 73.0 6,573.3 (127.4) 6,445.9 $ 2,901.1 1,343.3 352.2 727.4 71.2 5,395.2 (119.2) 5,276.0 (100.6) (239.2) (339.8) $6,106.1 (91.7) (189.4) (281.1) $ 4,994.9 The majority of the Company’s customers are located in the United States, which represented 56% of total receivables at December 31, 2004, and 60% at December 31, 2003. Terms for substantially all finance and other receivables range up to 60 months. Repayment experience indicates some receivables will be paid prior to contract maturity, while some others will be extended or renewed. Included in Loans are dealer direct loans on the sale of new trucks of $124.2 and $82.4 as of December 31, 2004, and December 31, 2003. The cash flow effects of sales-type leases, dealer direct loans and wholesale financing of new trucks are shown as operating cash flows in the consoli- dated statement of cash flows since they finance the sale of company inventory. Annual payments due on loans beginning January 1, 2005, are $1,215.4, $891.1, $652.3, $370.6, $158.0 and $18.7 thereafter. Annual minimum lease payments due on finance leases beginning January 1, 2005, are $610.7, $513.0, $389.9, $259.5, $147.2 and $75.0 thereafter. Estimated residual values included with finance leases amounted to $137.9 in 2004 and $129.6 in 2003. F. A L L O WA N C E F O R L O S S E S The provision for losses on finance, trade and other receivables is charged to income in an amount sufficient to maintain the allowance for losses at a level considered adequate to cover estimated credit losses. Receivables are charged to this allowance when, in the judgment of management, they are deemed uncollectible (generally upon repossession of the collateral). The allowance for losses on Truck and Other and Financial Services receivables is summarized as follows: TRUCK AND OTHER FINANCIAL SERVICES $ 104.7 Balance, December 31, 2001 53.2 Provision for losses (51.1) Net losses 2.3 Translation 109.1 Balance, December 31, 2002 28.6 Provision for losses (24.2) Net losses 5.7 Translation 119.2 Balance, December 31, 2003 18.1 Provision for losses (12.2) Net losses Translation 2.3 Balance, December 31, 2004 $ 12.7 $ 127.4 $ 21.7 2.1 (.3) 2.4 25.9 (8.6) (4.8) 2.4 14.9 (2.2) (1.0) 1.0 PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 38 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) The Company’s customers are principally con- centrated in the transportation industry in North America and Europe. There are no significant concentrations of credit risk in terms of a single customer. Generally, Financial Services and trade receivables are collateralized by financed equipment. G . E Q U I P M E N T O N O P E R AT I N G L E A S E S Truck and Other: Certain equipment sold to customers in Europe sub- ject to a residual value guarantee (RVG) is recorded at cost and amortized on the straight-line basis to its guaranteed residual value. Guarantee periods generally range from three to seven years. The Company reviews residual values periodically to determine that recorded amounts are appropriate. Equipment on operating leases is shown net of accumulated depreciation: 2004 2003 Equipment on lease $ 649.0 Less allowance for depreciation (176.9) $ 472.1 $ 668.7 (173.9) $ 494.8 When the equipment is sold subject to an RVG, the full sales price is received from the customer. A liability is established for the residual value obliga- tion with the remainder of the proceeds recorded as deferred lease revenue. These amounts are summa- rized below: Deferred lease revenues Residual value guarantee 2004 $ 191.5 334.7 $ 526.2 2003 $ 193.0 367.4 $ 560.4 The deferred lease revenue is amortized on a straight-line basis over the RVG contract period. At December 31, 2004, the annual amortization of deferred revenue beginning January 1, 2005, is $82.9, $54.2, $34.0, $14.2, $5.1 and $1.1 thereafter. Annual maturities of the residual value guarantees beginning January 1, 2005, are $128.4, $71.7, $77.0, $36.3, $17.4 and $3.9 thereafter. Financial Services: Equipment leased to customers under operating leases is recorded at cost and is depreciated on the straight-line basis to its estimated residual value. Estimated useful lives range from five to ten years. 2004 2003 Transportation equipment $ 930.4 Less allowance for depreciation (214.0) $ 716.4 $ 607.8 (136.8) $ 471.0 Original terms of operating leases generally aver- age four years. Annual minimum lease payments due on operating leases beginning January 1, 2005, are $193.5, $129.2, $88.2, $41.7, $6.0 and $.9 thereafter. H . P R O P E R T Y, P L A N T A N D E Q U I P M E N T Property, plant and equipment include the following: Land Buildings Machinery and equipment Less allowance for depreciation 2004 $ 105.6 625.4 1,477.1 2,208.1 $ 2003 92.7 580.1 1,273.0 1,945.8 (1,170.3) $1,037.8 (1,052.4) $ 893.4 Property, plant and equipment are stated at cost. Depreciation is computed principally by the straight-line method based upon the estimated useful lives of the various classes of assets, which range as follows: Buildings Machinery and equipment 30-40 years 5-12 years I . A C C O U N T S PAYA B L E A N D A C C R U E D E X P E N S E S Accounts payable and accrued expenses include the following: Truck and Other: Accounts payable Salaries and wages Product support reserves Other 2004 2003 $ 964.0 130.0 247.0 453.4 $1,794.4 $ 662.6 118.0 216.4 337.4 $ 1,334.4 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 39 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) J . P R O D U C T S U P P O R T R E S E R V E S Product support reserves include warranty reserves related to new products sales, as well as reserves related to optional extended warranties and repair and maintenance (R&M) contracts. The Company generally offers one-year warranties covering most of its vehicles and related aftermarket parts. Specific terms and conditions vary depending on the prod- uct and the country of sale. Optional extended war- ranty and R&M contracts can be purchased for periods which generally range up to five years. Warranty expenses and reserves are estimated and recorded at the time products or contracts are sold based on historical data regarding the source, fre- quency and cost of claims. PACCAR periodically assesses the adequacy of its recorded liabilities and adjusts the reserves as appropriate to reflect actual experience. Changes in warranty and R&M reserves are sum- marized as follows: Beginning balance Reductions from payments Increases to reserves Translation 2004 2003 $ 300.5 (218.6) 246.9 20.0 $ 348.8 $ 273.4 (159.2) 153.3 33.0 $ 300.5 Warranty and R&M reserves are included in the accompanying consolidated balance sheets as follows: 2004 2003 Truck and Other: Accounts payable and accrued expenses $ 247.0 $ 216.4 Deferred taxes and other liabilities Financial Services: Deferred taxes and other liabilities K . L E A S E S 32.5 28.7 69.3 $ 348.8 55.4 $ 300.5 The Company leases aircraft, computer equipment and office space under operating leases. Leases expire at various dates through the year 2019. Annual minimum rental payments due under non-cancellable operating leases beginning January 1, 2005, are $31.0, $18.3, $11.1, $6.9, $5.0 and $13.1 thereafter. Total rental expenses under all leases for the three years ended December 31, 2004, were $34.3, $29.9 and $28.5. L . B O R R O W I N G S A N D C R E D I T A R R A N G E M E N T S Borrowings include the following: EFFECTIVE RATE 2004 2003 Truck and Other: Long-term debt: Commercial paper 5.7% Noninterest-bearing notes Less current portion 5.7% $ 16.7 $ 23.3 19.5 36.2 (8.4) $ 27.8 18.2 41.5 (7.8) $ 33.7 Interest expense amounted to $3.0, $3.4 and $5.3 for 2004, 2003 and 2002. Commercial paper classified as long-term debt is based on management’s ability and intent to main- tain these borrowings on a long-term basis. Annual maturities of long-term debt are $8.4 for 2005 and $8.3 for 2006, and $19.5 matures in 2011. Financial Services: Commercial paper Bank loans Term debt: Fixed rate Floating rate EFFECTIVE RATE 2004 2003 3.4% 4.7% 6.2% 2.9% $2,480.0 22.0 $2,502.0 $2,231.6 31.4 $2,263.0 $ 100.5 2,186.1 $2,286.6 $ 94.6 1,428.5 $1,523.1 The effective rate is the weighted average rate as of December 31, 2004, and includes the effects of interest-rate agreements. Annual maturities of term debt beginning January 1, 2005, are $606.7, $1,671.4, $6.7, $1.5 and $.3. Consolidated: Interest paid on consolidated borrowings was $134.4, $137.9 and $168.3 in 2004, 2003 and 2002. The weighted average interest rate on consoli- dated commercial paper and bank loans was 3.4%, 3.5% and 4.0% at December 31, 2004, 2003 and 2002. The primary sources of borrowings in the capital market are commercial paper and publicly issued medium-term notes. The medium-term notes are PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 40 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) issued by PACCAR Financial Corp. (PFC) and PACCAR Financial Europe (PFE). PFC periodically files a shelf registration under the Securities Act of 1933. PFC filed a $3,000.0 shelf registration that became effective in January of 2004. On December 31, 2004, $1,850.0 of such securities remained avail- able for issuance. In September 2004, PFE registered a €750.0 Euro Medium Term Note Program with the Luxembourg Exchange that provides for the issuance of senior debt securities with maturities of up to five years. On December 31, 2004, €450.0 of such securi- ties remained available under the program. The Company has line of credit arrangements of $1,760.9, most of which are reviewed annually for renewal. The unused portion of these credit lines was $1,704.6 at December 31, 2004, of which the major- ity is maintained to support commercial paper and other short-term borrowings of the financial services companies. Compensating balances are not required on the lines, and service fees are immaterial. M . E M P L O Y E E B E N E F I T P L A N S PACCAR has several defined benefit pension plans, which cover a majority of its employees. The Company evaluates its actuarial assumptions on an annual basis and considers changes based upon market conditions and other factors. The Company funds its pensions in accordance with applicable employee benefit and tax laws. The Company elected to contribute $58.4 to its pension plans in 2004 and $75.8 in 2003. The Company expects to contribute in the range of $25.0 to $60.0 to its pension plans in 2005, of which $12.0 is esti- mated to satisfy minimum funding requirements. Annual benefits expected to be paid beginning January 1, 2005, are $29.1, $32.4, $33.3, $38.1, $41.2, and for the five years thereafter, a total of $269.5. Plan assets are invested in a diversified mix of equity and debt securities through professional investment managers with the objective to achieve targeted risk adjusted returns and maintain liquidity sufficient to fund current benefit payments. Allocation of plan assets may change over time based upon investment manager determination of the relative attractiveness of equity and debt securi- ties. The Company periodically assesses allocation of plan assets by investment type and evaluates external sources of information regarding the long- term historical returns and expected future returns for each investment type. The following information details the allocation of plan assets by investment type: Target 2004 2003 Actual Plan assets allocation as of December 31: Equity securities Debt securities Total 57 - 67% 62.9% 59.9% 33 - 43% 37.1 40.1 100.0% 100.0% The following additional data relate to all pension plans of the Company, except for certain multi-employer and foreign-insured plans: 2004 2003 Weighted Average Assumptions as of December 31: Discount rate Rate of increase in future compensation levels Assumed long-term rate of return on plan assets 4.2% 5.7% 7.4% 6.1% 4.2% 7.4% Change in Projected Benefit Obligation: Benefit obligation at January 1 Service cost Interest cost Benefits paid Actuarial loss Foreign currency translation Participant contributions Plan amendment Settlements and other Projected benefit obligation $799.3 32.2 48.4 (33.0) 64.8 16.7 3.8 3.0 $ 673.0 27.0 44.2 (26.1) 50.2 24.0 3.2 6.2 (2.4) at December 31 $935.2 $ 799.3 Change in Plan Assets: Fair value of plan assets at January 1 Employer contributions Actual return on plan assets Benefits paid Foreign currency translation Participant contributions Settlements Fair value of plan assets at $763.9 58.4 77.5 (33.0) 9.7 3.8 $ 577.1 75.8 113.9 (26.1) 22.3 3.2 (2.3) December 31 $880.3 $ 763.9 Funded Status at December 31: Funded status Unrecognized actuarial loss Unrecognized prior service cost Unrecognized net initial obligation Prepaid benefit $ (54.9) $ (35.4) 136.8 21.0 184.1 21.0 2.2 $ 152.4 2.4 $124.8 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 41 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) Details of Prepaid Benefit: Prepaid benefit costs Accrued benefit liability Intangible asset Accumulated other comprehensive loss Prepaid benefit 2004 2003 $ 171.0 $ 148.0 (28.2) (39.9) 8.3 13.0 5.0 $ 152.4 $ 124.8 Included in the projected benefit obligation above are $33.3 at December 31, 2004, and $34.6 at December 31, 2003, related to an unfunded supple- mental plan. The accumulated benefit obligation for all pen- sion plans of the Company, except for certain multi- employer and foreign-insured plans, was $806.8 for 2004 and $684.9 for 2003. 2004 2003 2002 Components of Pension Expense: Service cost Interest on projected benefit obligation Expected return on assets Amortization of prior 48.5 (59.5) $ 32.2 $ 27.0 $ 24.9 44.2 (48.5) 40.3 (41.7) service costs Recognized actuarial loss Other Net pension expense 3.4 3.8 .2 $ 28.6 2.9 4.1 .3 2.8 .8 .8 $ 30.0 $ 27.9 Pension expense for multi-employer and foreign- insured plans was $24.9, $19.3 and $15.4 in 2004, 2003 and 2002. The Company has certain defined contribution benefit plans whereby it generally matches employee contributions of 2% to 5% of base wages. The majority of participants in these plans are non- union employees located in the United States. Expenses for these plans were $18.5, $16.1 and $15.0 in 2004, 2003 and 2002. In addition, the Company maintains postretire- ment medical and life insurance plans covering the majority of its U.S. employees. The medical and life insurance plans generally reimburse those employ- ees from retirement until age 65 for approximately 50% of their medical costs and provide a nominal death benefit. The following data relate to unfunded postretire- ment medical and life insurance plans: 2004 2003 Unfunded Status at December 31: Unfunded status Unrecognized actuarial loss Unrecognized prior service cost Unrecognized net initial obligation Accrued postretirement benefits $(69.3) 18.5 .8 3.2 $(46.8) Change in Projected Benefit Obligation: Benefit obligation at January 1 Service cost Interest cost Benefits paid Actuarial loss Projected benefit obligation $ 51.2 2.6 3.7 (1.9) 13.7 $(51.2) 5.5 .9 3.7 $(41.1) $ 44.2 1.7 2.9 (1.0) 3.4 at December 31 $ 69.3 $ 51.2 2004 2003 2002 Components of Retiree Expense: Service cost Interest cost Recognized actuarial loss Recognized prior service $2.6 3.7 .7 $1.7 2.9 $1.6 2.7 cost Recognized net initial obligation Net retiree expense .1 .1 .1 .5 $7.6 .5 $5.2 .5 $4.9 The discount rate used for calculating the accu- mulated plan benefits was 5.8% for 2004 and 6.3% for 2003. The long-term medical inflation rate used was 7.0% for 2004 and 2003 and is projected to remain the same in the future. Annual benefits expected to be paid beginning January 1, 2005, are $2.2, $2.6, $3.0, $3.5, $4.1 and for the five years thereafter, a total of $30.2. Assumed health care cost trends have an effect on the amounts reported for the postretirement health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1% INCREASE 1% DECREASE Effect on annual total of service and interest cost components Effect on accumulated postretirement benefit obligation $ .8 $ (.7) $6.8 $(6.0) PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 42 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) N . I N C O M E TA X E S 2004 2003 2002 Income Before Income Taxes: Domestic Foreign $ 643.5 724.7 $ 1,368.2 Provision for Income Taxes: Current provision: $ Domestic Foreign 162.0 251.4 413.4 Deferred provision (benefit): 71.4 (23.4) 48.0 461.4 Domestic Foreign $ $ 273.6 531.9 $ 805.5 $ 242.3 331.8 $ 574.1 $ 67.0 195.8 262.8 33.4 (17.2) 16.2 $ 279.0 $ 44.5 106.3 150.8 41.9 9.4 51.3 $ 202.1 Reconciliation of Statutory U.S. Federal Tax to Actual Provision: Statutory rate Statutory tax Effect of: 35% $ 478.9 35% $ 281.9 35% $ 200.9 State income taxes Other, net 18.7 (36.2) $ 461.4 8.7 (11.6) $ 279.0 7.4 (6.2) $ 202.1 At December 31: 2004 2003 Components of Deferred Tax Assets (Liabilities): Assets: Provisions for accrued expenses Net operating loss carryforwards Allowance for losses on receivables Other Valuation reserve Liabilities: Financial Services leasing activities Depreciation and amortization Other Net deferred tax liability $ 239.7 $ 211.5 81.5 84.0 43.2 32.8 397.2 (56.0) 341.2 41.8 36.4 373.7 (68.0) 305.7 (338.4) (257.6) (85.4) (99.0) (522.8) (89.3) (96.2) (443.1) $ (181.6) $ (137.4) At December 31: 2004 2003 Classification of Deferred Tax Assets (Liabilities): Truck and Other: Deferred taxes and other current assets Other noncurrent assets Deferred taxes and other liabilities Financial Services: Other assets Deferred taxes $ 82.4 59.5 $ 53.6 38.2 (35.5) (19.4) 28.3 23.6 and other liabilities Net deferred tax liability (316.3) $ (181.6) (233.4) $ (137.4) At December 31, 2004, the Company’s net tax operating loss carryforwards were $272.0. Substantially all of the loss carryforwards are in for- eign subsidiaries and carry forward indefinitely, subject to certain limitations under applicable laws. The future tax benefits of net operating loss carry- forwards are evaluated on an ongoing basis, includ- ing a review of historical and projected operating results. The Company’s evaluation in 2004 resulted in a $9.5 reduction in the valuation reserve related to net operating loss carryforwards at its subsidiary Leyland Trucks Ltd. in the United Kingdom. United States income taxes and foreign withhold- ing taxes are not provided on undistributed earn- ings of the Company’s foreign subsidiaries because of the intent to reinvest these earnings. The amount of undistributed earnings, which are considered to be indefinitely reinvested, is approximately $2,708.5 at December 31, 2004. The American Jobs Creation Act (the AJCA), which was signed into law on October 22, 2004, cre- ated a special one-time 85% tax deduction for cer- tain repatriated foreign earnings that are reinvested in qualifying domestic activities, as defined in the AJCA. The Company may elect to apply this provi- sion to qualifying earnings repatriations in the year ending December 31, 2005. The Company is in the process of evaluating the effects of the repatriation provision and expects to complete its evaluation after its assessment of clarifying guidance published by Congress or the Treasury Department. The maxi- mum amount the Company is eligible to repatriate under the AJCA is approximately $1,500. The esti- mated tax provision that would be required on this amount would be approximately $70. If any amount is repatriated, it would likely be less than the maxi- mum, with a proportional reduction in the estimated provision for income taxes. Cash paid for income taxes was $418.7, $246.0 and $114.6 in 2004, 2003 and 2002. 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 43 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) O . FA I R VA L U E S O F F I N A N C I A L I N S T R U M E N T S The following methods and assumptions were used by the Company in determining its fair value disclo- sures for financial instruments: Cash and Equivalents: The carrying amount reported in the balance sheet is stated at fair value. Marketable Debt and Equity Securities: Amounts are carried at fair value. Fair values are based on quoted market prices (see Note C). Financial Services Net Receivables: For floating- rate loans and wholesale financings, fair values are based on carrying values. For fixed-rate loans, fair values are estimated using discounted cash flow analysis based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest and other receivables approximates its fair value. Finance lease receivables and the related loss provisions have been excluded from the accompanying table. Short- and Long-term Debt: The carrying amount of the Company’s commercial paper and short-term bank borrowings and floating-rate long-term debt approximates its fair value. The fair value of the Company’s fixed-rate long-term debt is estimated using discounted cash flow analysis, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. Derivative Instruments: Derivative instruments are carried at fair value. Fair values for the Com- pany’s interest-rate contracts are based on costs that would be incurred to terminate existing agreements and enter into new agreements with similar notional amounts, maturity dates and counterparties’ credit standing at current market interest rates (see Note Q). The fair value of foreign exchange contracts is the amount the Company would receive or pay to terminate the contracts. This amount is calculated using quoted market rates (see Market Risks and Derivative Instruments). Trade Receivables and Payables: Carrying amounts approximate fair value. Balance sheet captions, which include financial instruments of the Company where the recorded carrying amount is not at fair value, are as follows: 2004 Truck and Other: Long-term debt Financial Services: Net receivables Long-term debt CARRYING AMOUNT FAIR VALUE $ 36.2 $ 34.6 4,185.1 2,286.6 4,172.0 2,286.5 2003 Truck and Other: Long-term debt Financial Services: Net receivables Long-term debt CARRYING AMOUNT FAIR VALUE $ 41.5 $ 39.8 3,454.7 1,523.1 3,470.6 1,524.7 P. C O M M I T M E N T S A N D C O N T I N G E N C I E S The Company is involved in various stages of inves- tigations and cleanup actions in different countries related to environmental matters. In certain of these matters, the Company has been designated as a “potentially responsible party” by domestic and foreign environmental agencies. The Company has provided for the estimated costs to investigate and complete cleanup actions where it is probable that the Company will incur such costs in the future. While neither the timing nor the amount of the ultimate costs associated with future environmental cleanup can be determined, management does not expect that those matters will have a material ad- verse effect on the Company’s consolidated financial position. Expenditures related to environmental activities were $2.4 in 2004, $1.2 in 2003 and $1.9 in 2002. The Company’s estimated range of reasonably possible costs to complete cleanup actions, where it is proba- ble that the Company will incur such costs and where such amounts can be reasonably estimated, is between $21.0 and $49.8. The Company has estab- lished a reserve to provide for estimated future environmental cleanup costs. At December 31, 2004, PACCAR had standby letters of credit of $23.1, which guarantee various insurance and financing activities. PACCAR had also guaranteed $5.9 in borrowings of certain indepen- dent dealers. The guarantees expire between March 2006 and March 2008. The maximum potential amount of future payments PACCAR could be re- quired to make under the guarantees is $5.9. As of December 31, 2004, PACCAR had recorded a liability of $.2 for outstanding guarantees. The Company is committed, under specific circumstances, to purchase equipment at a cost of $30.4 in 2005, $14.9 in 2006 and $8.1 in 2007. At December 31, 2004, PACCAR’s Financial Services companies, in the normal course of business, had outstanding commitments to fund new loan and lease transactions amounting to $289.9. PACCAR Inc and Subsidiaries PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 44 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) The commitments generally expire in 90 days. The Company had commitments to purchase primarily production inventory amounting to $77.4 in 2005, $10.6 annually from 2006 to 2010 and $2.7 in 2011. In November 2004, the Company concluded an early termination agreement with the RAC plc regarding the distribution of Leyland aftermarket parts to DAF dealers and customers in the United Kingdom. Accordingly, PACCAR’s 2004 consolidated results of operations include a $33.3 pretax charge for costs associated with the agreement. The Company’s liabil- ity for future payments related to the termination amounted to $25.9 at December 31, 2004. PACCAR is a defendant in various legal proceed- ings and, in addition, there are various other con- tingent liabilities arising in the normal course of business. After consultation with legal counsel, management does not anticipate that disposition of these proceedings and contingent liabilities will have a material effect on the consolidated financial statements. Q . D E R I VAT I V E F I N A N C I A L I N S T R U M E N T S The Company does not engage in derivatives trad- ing, market-making or other speculative activities. Derivative financial agreements are used as hedges to manage exposures to fluctuations in interest rates and foreign currency exchange rates. The Company documents its risk management strategy and hedge effectiveness at the inception of and during the term of each hedge. Minimum credit ratings of the coun- terparties to these agreements are established and the Company limits its exposure to any single coun- terparty. At December 31, 2004, the Company had no material exposure to loss in the event of counter- party default. Interest-Rate Contracts: The Company enters into various interest-rate contracts, including interest- rate and currency swap, cap and forward-rate agree- ments. Interest-rate contracts generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying principal. These contracts are used to manage exposures to fluctuations in interest rates. Net amounts paid or received are reflected as adjustments to interest expense. At December 31, 2004, the Company had 278 interest-rate contracts outstanding with other financial institutions. The notional amount of these contracts totaled $3,125.2, with amounts expiring annually over the next five years. The notional amount is used to measure the volume of these contracts and does not represent exposure to credit loss. In the event of default by a counterparty, the risk in these transactions is the cost of replacing the interest-rate contract at current market rates. The total fair value of all interest-rate contracts amounted to an asset of $16.2 and a liability of $34.6 at December 31, 2004. Fair values at December 31, 2003, amounted to an asset of $5.8 and a liability of $50.9. Floating to fixed rate swaps effectively convert an equivalent amount of commercial paper and other variable rate debt to fixed rates. Notional maturities for the five years beginning January 1, 2005, are $1,109.4, $987.4, $717.2, $229.2 and $82.0. The weighted average pay rate of 3.47% approximates the Company’s net cost of funds. The weighted aver- age receive rate of 2.57% offsets rates on associated debt obligations. Foreign Currency Exchange Contracts: PACCAR enters into foreign currency exchange contracts to hedge certain anticipated transactions denominated in foreign currencies. PACCAR has currency ex- change exposure for the value of the U.S. dollar compared to the Canadian dollar, the euro and the British pound. With respect to Europe, PACCAR has currency exposure for the value of the euro compared to the British pound and other national currencies in Europe. As a matter of policy, the Company does not engage in currency speculation. Foreign exchange contracts mature within one year. The maximum amount of loss that could be incurred associated with foreign exchange purchase contracts is equal to the fair value of the contracts ($9.3 at December 31, 2004). PACCAR had net foreign exchange purchase contracts outstanding amounting to $399.6 and $327.2 U.S. dollars at December 31, 2004 and 2003. Derivative assets are included in the accompany- ing consolidated balance sheets, in Truck and Other “Deferred taxes and other current assets” and Finan- cial Services “Other assets.” Derivative liabilities are included in Truck and Other “Accounts payable and accrued expenses” and “Deferred taxes and other liabilities” and in Financial Services “Accounts payable, accrued expenses and other.” Gains or losses on the effective portion of deriva- tives designated and qualifying as cash flow hedges that arise from changes in fair value are initially reported in other comprehensive income. The remaining gain or loss, if any, is recognized cur- rently in earnings. Hedge ineffectiveness was immaterial. Amounts in accumulated other comprehensive income are reclassified into net income in the same period in which the hedged forecasted transaction affects earnings. Net realized gains and losses from foreign exchange contracts are recognized as an adjustment to cost of sales. Net 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 45 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions except share and per share amounts) realized gains and losses from interest-rate contracts are recognized as an adjustment to interest expense. Of the accumulated net loss included in other com- prehensive income as of December 31, 2004, $10.6 is expected to be reclassified to interest expense in 2005. The fixed interest earned on finance receiv- ables will offset the amount recognized in interest expense, resulting in a stable interest margin consis- tent with the Company’s interest-rate risk manage- ment strategy. R . S T O C K C O M P E N S AT I O N P L A N S PACCAR has certain plans under which officers and key employees may be granted options to purchase shares of the Company’s authorized but unissued common stock. Non-employee directors may be granted restricted shares of the Company’s common stock. The maximum number of shares of the Company’s common stock available for issuance under these plans is 20.7 million. As of December 31, 2004, the maximum number of shares available for future grants under these plans is 9.9 million. Op- tions currently outstanding under these plans were granted with exercise prices equal to the fair market value of the Company’s common stock at the date of grant. Options currently expire no later than 10 years from the grant date and generally vest within three years. Stock option activity is as follows: Outstanding at 12/31/01 Granted Exercised Cancelled Outstanding at 12/31/02 Granted Exercised Cancelled Outstanding at 12/31/03 Granted Exercised Cancelled Outstanding at 12/31/04 NUMBER OF SHARES 4,738,200 989,300 (1,055,300) (148,900) 4,523,300 864,100 (1,267,600) (229,600) 3,890,200 457,600 (736,100) (270,400) 3,341,300 AVERAGE EXERCISE PRICE* $20.50 28.21 21.63 21.75 21.88 31.40 19.31 26.45 24.56 56.95 20.78 32.66 $29.18 The following tables summarize information about stock options outstanding and exercisable at December 31, 2004: Stock Options Outstanding: RANGE OF EXERCISE PRICES NUMBER OF SHARES REMAINING CONTRACTUAL LIFE IN YEARS $ 9.67-11.00 16.28-18.56 22.94-23.90 28.20-31.40 56.95-56.95 156,800 390,900 904,000 1,461,300 428,300 3,341,300 Stock Options Exercisable: 1.0 4.1 5.4 7.5 9.0 6.4 AVERAGE EXERCISE PRICE* $10.56 17.75 23.26 29.75 56.95 $29.18 RANGE OF EXERCISE PRICES $ 9.67-11.00 16.28-18.56 22.94-23.90 NUMBER OF SHARES 156,800 390,900 904,000 1,451,700 AVERAGE EXERCISE PRICE* $10.56 17.75 23.26 $20.40 *Weighted Average See Note A for additional information regarding estimated fair values, Black-Scholes-Merton option pricing assumptions and pro forma net income and earnings per share amounts. Diluted Earnings Per Share: The following table shows the additional shares added to weighted aver- age basic shares outstanding to calculate diluted earnings per share. These amounts primarily repre- sent the dilutive effect of stock options. Options outstanding at each year-end with exercise prices in excess of the respective year’s average common stock market price have been excluded from the amounts shown in the table. 2004 2003 2002 Additional shares 1,188,600 1,218,600 1,235,700 Excluded antidilutive shares 428,300 – – PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 3.2.05 1:56 AM Page 46 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions except share amounts) S . S T O C K H O L D E R S ’ E Q U I T Y Stockholder Rights Plan: The plan provides one right for each share of PACCAR common stock outstand- ing. Rights become exercisable if a person publicly announces the intention to acquire 15% or more of PACCAR’s common stock or if a person (Acquiror) acquires such amount of common stock. In all cases, rights held by the Acquiror are not exercisable. When exercisable, each right entitles the holder to purchase for two hundred dollars a fractional share of Series A Junior Participating Preferred Stock. Each fractional preferred share has dividend, liquidation and voting rights which are no less than those for a share of common stock. Under certain circumstances, the rights may become exercisable for shares of PACCAR common stock or common stock of the Acquiror having a market value equal to twice the exercise price of the right. Also under certain circumstances, the Board of Directors may exchange exercisable rights, in whole or in part, for one share of PACCAR common stock per right. The rights, which expire in the year 2009, may be redeemed at one cent per right, subject to certain conditions. For this plan, 50,000 preferred shares are reserved for issuance. No shares have been issued. Other Comprehensive Income: Following are the items in other comprehensive income and the related tax effects including reclassification adjustments to net income: PRETAX AMOUNT TAX EFFECT NET AMOUNT 2004 Marketable securities: Net holding loss Reclassification adjustment Net decrease Minimum pension liability increase Derivative contracts: Net holding loss Reclassification adjustment Net increase Currency translation $ (1.2) $ .4 $ (.8) (13.6) (14.8) 5.2 5.6 (8.4) (9.2) (8.0) 2.7 (5.3) (11.9) 3.8 (8.1) 31.4 19.5 (12.3) (8.5) 19.1 11.0 gain 166.7 166.7 Total other comprehensive income $163.4 $ (.2) $163.2 2003 Marketable securities: Net holding gain Reclassification adjustment Net increase Minimum pension liability decrease Derivative contracts: Net holding loss Reclassification adjustment Net increase Currency translation PRETAX AMOUNT TAX EFFECT NET AMOUNT $ 9.1 $ (3.5) $ 5.6 (5.7) 3.4 2.2 (1.3) (3.5) 2.1 25.8 (8.7) 17.1 (12.4) 5.6 (6.8) 50.6 38.2 (19.2) (13.6) 31.4 24.6 gain 278.4 278.4 Total other comprehensive income $345.8 $ (23.6) $322.2 2002 Marketable securities: Net holding gain Reclassification adjustment Net increase Minimum pension liability increase Derivative contracts: Net holding loss Reclassification adjustment Net decrease Currency translation $ 7.0 $ (2.5) $ 4.5 8.6 15.6 (3.3) (5.8) 5.3 9.8 (17.5) 6.0 (11.5) (57.7) 20.5 (37.2) (20.5) 55.3 (2.4) 34.8 (2.4) gain 125.2 125.2 Total other comprehensive income $120.9 $ .2 $121.1 Stock Dividend: On December 9, 2003, the Board of Directors declared a 50% common stock dividend payable on February 5, 2004, to stockholders of record on January 19, 2004, with fractional shares to be paid in cash. This resulted in the issuance of 58,398,302 additional shares and 583 fractional shares paid in cash. 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 47 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2004, 2003 and 2002 (currencies in millions) T. S E G M E N T A N D R E L AT E D I N F O R M AT I O N Geographic Area Data 2004 2003 2002 PACCAR operates in two principal segments, Truck and Financial Services. The Truck segment includes the manufacture of trucks and the distribution of related aftermarket parts, both of which are sold through a network of company-appointed dealers. This segment derives a large proportion of its revenues and operating profits from operations in the United States and Europe. The Financial Services segment is composed of finance and leasing products and services provided to truck customers and dealers. Revenues are pri- marily generated from operations in the United States and Europe. Included in All Other is PACCAR’s industrial winch manufacturing business. Also within this category are other sales, income and expense not attributable to a reportable segment, including a portion of corporate expense. Intercompany interest income on cash advances to the financial services companies is included in All Other and was $10.8, $9.3 and $9.2 for 2004, 2003 and 2002. Geographic revenues from external customers are presented based on the country of the customer. PACCAR evaluates the performance of its Truck segment based on operating profits, which excludes investment income, other income and expense and income taxes. The Financial Services segment’s performance is evaluated based on income before income taxes. Geographic Area Data 2004 2003 2002 Revenues: United States Continental Europe United Kingdom Other $ 5,414.2 $ 3,653.9 $3,689.5 2,498.9 1,201.5 2,281.7 1,928.3 872.3 1,740.4 $ 11,396.3 $ 8,194.9 1,519.1 607.3 1,402.7 $7,218.6 Long-lived assets: Property, plant and equipment, net United States $ The Netherlands Other 424.7 $ 371.8 217.5 276.8 304.1 336.3 $ 1,037.8 $ 893.4 Goodwill and other intangibles, net The Netherlands $ Other 1.3 122.7 $ 121.2 1.2 124.0 $ 122.4 $ $ 369.2 192.6 256.6 $ 818.4 $ $ 94.8 1.0 95.8 Equipment on operating leases, net United Kingdom $ France United States Other 278.8 $ 301.8 155.3 157.0 198.7 340.9 310.0 411.8 $ 1,188.5 $ 965.8 $ 256.6 122.5 122.3 256.8 $ 758.2 Business Segment Data Net sales and revenues: Truck Total Less intersegment (319.5) $11,081.8 $7,894.3 (233.1) $6,910.1 (176.9) External customers All Other Financial Services 10,762.3 71.4 10,833.7 562.6 7,661.2 59.9 7,721.1 473.8 $11,396.3 $8,194.9 Income before income taxes: Truck All Other Financial Services Investment income $ 1,145.0 $ 655.4 (14.8) 640.6 123.6 41.3 $ 1,368.2 $ 805.5 (5.1) 1,139.9 168.4 59.9 6,733.2 52.8 6,786.0 432.6 $7,218.6 $ 482.5 (9.1) 473.4 72.2 28.5 $ 574.1 Depreciation and amortization: $ Truck Financial Services All Other $ 182.1 $ 174.1 83.3 124.0 10.1 8.9 315.0 $ 267.5 $ 155.7 49.1 13.4 $ 218.2 Expenditures for long-lived assets: Truck $ Financial Services Other $ 222.7 $ 127.2 228.1 386.1 14.0 24.7 633.5 $ 369.3 $ 162.8 183.5 8.0 $ 354.3 Segment assets: Truck Other Cash and marketable $ 2,889.3 $2,470.6 163.3 174.5 securities 2,184.1 5,247.9 Financial Services 6,980.1 1,700.3 4,334.2 5,605.4 $12,228.0 $9,939.6 $2,211.7 105.1 1,273.4 3,590.2 5,112.3 $8,702.5 PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 48 M A N A G E M E N T ’ S R E P O R T O N I N T E R N A L C O N T R O L O V E R F I N A N C I A L R E P O R T I N G The management of PACCAR Inc (the Company) is responsible for establishing and maintaining satisfactory internal control over financial reporting. Internal control over financial reporting is a process designed to pro- vide reasonable assurance regarding the reliability of financial reporting and the preparation of financial state- ments for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. Management assessed the Company’s internal control over financial reporting as of December 31, 2004, based on criteria for effective internal control over financial reporting described in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, we concluded that the Company maintained effective internal control over financial reporting as of December 31, 2004. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting has been audited by Ernst & Young LLP, an Independent Registered Public Accounting Firm, as stated in their report. Mark C. Pigott Chairman and Chief Executive Officer R E P O R T O F I N D E P E N D E N T R E G I S T E R E D P U B L I C A C C O U N T I N G F I R M O N T H E C O M P A N Y ’ S C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Board of Directors and Stockholders PACCAR Inc We have audited the accompanying consolidated balance sheets of PACCAR Inc as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assur- ance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consoli- dated financial position of PACCAR Inc at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of PACCAR Inc’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 23, 2005, expressed an unqualified opinion thereon. Seattle, Washington February 23, 2005 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 49 R E P O R T O F I N D E P E N D E N T R E G I S T E R E D P U B L I C A C C O U N T I N G F I R M O N T H E C O M P A N Y ’ S I N T E R N A L C O N T R O L S Board of Directors and Stockholders PACCAR Inc We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that PACCAR Inc maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). PACCAR Inc’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assur- ance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating man- agement’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external pur- poses in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reason- able detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) pro- vide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the com- pany; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisi- tion, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect mis- statements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that PACCAR Inc maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO crite- ria. Also, in our opinion, PACCAR Inc maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of PACCAR Inc as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2004, of PACCAR Inc, and our report dated February 23, 2005, expressed an unqualified opinion thereon. Seattle, Washington February 23, 2005 PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 50 S E L E C T E D F I N A N C I A L D A T A 50 2004 2003 2002 2001 2000 Truck and Other Net Sales and Revenues $ 10,833.7 $ 7,721.1 $ 6,786.0 $ 5,641.7 $ 7,457.4 Financial Services Revenues 562.6 473.8 432.6 458.8 479.1 (millions except per share data) Total Revenues Net Income Net Income Per Share: Basic Diluted Cash Dividends Declared Total Assets: Truck and Other Financial Services Truck and Other Long-Term Debt Financial Services Debt Stockholders’ Equity $ 11,396.3 $ 8,194.9 $ 7,218.6 $ 6,100.5 $ 7,936.5 $ 906.8 $ 526.5 $ 372.0 $ 173.6 $ 441.8 5.19 5.16 2.75 5,247.9 6,980.1 27.8 4,788.6 3,762.4 3.01 2.99 1.37 4,334.2 5,605.4 33.7 3,786.1 3,246.4 2.15 2.13 1.00 3,590.2 5,112.3 33.9 3,527.6 2,600.7 1.01 1.00 .64 3,155.4 4,758.5 40.7 3,426.2 2,252.6 2.56 2.55 .98 3,156.7 5,114.2 124.7 3,803.9 2,249.1 All per share amounts have been restated to give effect to a 50% stock dividend effective in February 2004. C O M M O N S T O C K M A R K E T P R I C E S A N D D I V I D E N D S Common stock of the Company is traded on the Nasdaq National Market under the symbol PCAR. The table below reflects the range of trading prices as reported by Nasdaq and cash dividends declared. All amounts have been restated to give effect to a 50% stock dividend effective in February 2004. There were 2,235 record holders of the common stock at December 31, 2004. 2004 QUARTER CASH DIVIDENDS DECLARED STOCK PRICE HIGH LOW 2003 QUARTER CASH DIVIDENDS DECLARED* STOCK PRICE HIGH LOW First Second Third Fourth Year-End Extra $ .15 .20 .20 .20 2.00 $59.82 60.70 69.25 81.42 $49.61 51.00 52.95 62.00 First Second Third Fourth Year-End Extra $ .133 .147 .147 .147 .80 $34.95 48.30 58.00 57.24 $28.39 33.73 45.06 49.27 The Company expects to continue paying regular cash dividends, although there is no assurance as to future dividends because they are dependent upon future earnings, capital requirements and financial conditions. * The sum of quarterly per share amounts does not equal per share amounts reported for year-to-date periods due to rounding. 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 51 Q U A R T E R L Y R E S U L T S ( U N A U D I T E D ) FIRST SECOND THIRD FOURTH QUARTER 51 2004 Truck and Other Net Sales and Revenues Truck and Other Gross Profit (Before SG&A and Interest) Financial Services Revenues Financial Services Gross Profit (Before SG&A) Net Income (1) Net Income Per Share (2): Basic Diluted $2,374.3 330.8 127.0 59.6 182.2 (millions except per share data) $2,653.4 $2,774.7 $3,031.3 398.2 133.4 64.4 236.5 395.8 143.1 69.0 246.7 440.3 159.1 73.5 241.4 $ 1.04 1.03 $ 1.35 1.34 $ 1.42 1.41 $ 1.39 1.38 2003 Truck and Other Net Sales and Revenues $1,803.2 (millions except per share data) $1,895.1 $1,940.2 $2,082.6 Truck and Other Gross Profit (Before SG&A and Interest) Financial Services Revenues Financial Services Gross Profit (Before SG&A) Net Income Net Income Per Share (2): 225.2 113.6 52.4 110.8 238.7 117.1 55.0 124.1 244.3 118.3 58.4 132.5 Basic Diluted Net income per share amounts have been restated to give effect to a 50% stock dividend effective in February 2004. .64 .63 .71 .71 .76 .75 $ $ $ 280.9 124.8 59.3 159.1 $ .91 .90 (1) Third quarter net income includes a $9.5 tax benefit related to higher expected utilization of net operating loss carryforwards in the United Kingdom. Fourth quarter net income includes $23.3 for costs associated with the termination of an agreement regarding distribution of Leyland parts in the U.K. and $5.4 for a gain on the sale of real estate. (2) The sum of quarterly per share amounts may not equal per share amounts reported for year-to-date periods. This is due to changes in the number of weighted shares outstanding and the effects of rounding for each period. PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 52 M A R K E T R I S K S A N D D E R I V A T I V E I N S T R U M E N T S (currencies in millions) Interest Rate Risks - See Note Q for a description of the Company’s exposure to interest rate risks. The following is a sensitivity analysis for the Company’s derivatives and other financial instruments which have interest rate risk. These instruments are held for other than trading purposes. The Company measures its interest rate risk by esti- mating the amount by which the fair value of interest rate sensitive assets and liabilities would change assuming an immediate 100 basis point increase across the yield curve as shown in the following table: Fair Value Gains (Losses) C O N S O L I D AT E D : Assets Cash equivalents and marketable securities T R U C K A N D O T H E R : Liabilities Borrowings and related swaps: 2004 2003 $ (9.9) $ (7.0) Long-term debt Interest rate swaps related to commercial paper classified as long-term debt .7 0.2 .9 .3 F I N A N C I A L S E R V I C E S : Assets Loans and wholesale financing, net of unearned interest, less allowance for losses Liabilities Debt Interest rate swaps related to financial services debt Total (40.2) (35.5) .9 45.0 $ (3.3) 1.1 37.9 $ (2.3) Currency Risks - See Note Q for a description of the Company’s exposure to currency risks. The following foreign exchange forward contracts were held by the Company related to certain currency exposures. All contracts have maturity dates of less than one year. The notional amounts and fair values follow: AVERAGE CONTRACTUAL RATE* NOTIONAL AMOUNT FAIR VALUE GAINS (LOSSES) December 31, 2004 Buy Euro / Sell British Pound Buy Euro / Sell Swiss Franc Buy Euro / Sell Czech Koruna Buy Euro / Sell Hungarian Forint Buy Euro / Sell Polish Zloty Buy Swiss Franc / Sell Euro Buy Czech Koruna / Sell Euro Buy Hungarian Forint / Sell Euro Buy U.S. Dollar / Sell Euro Buy Norwegian Kroner / Sell Euro Buy U.S. Dollar / Sell British Pound Buy U.S. Dollar / Sell Canadian Dollar Total December 31, 2003 Buy Euro / Sell British Pound Buy Euro / Sell Swiss Franc Buy Euro / Sell Czech Koruna Buy Euro / Sell Hungarian Forint Buy Euro / Sell Polish Zloty Buy British Pound / Sell Euro Buy U.S. Dollar / Sell Euro Buy U.S. Dollar / Sell British Pound Buy U.S. Dollar / Sell Canadian Dollar Total *Stated in terms of selling currency .697 1.525 30.730 247.349 4.208 .649 .033 .004 .753 .121 .556 1.263 .697 1.555 32.175 266.229 4.643 1.421 .840 .580 1.319 $ 145.2 2.4 3.8 1.6 7.1 .1 1.7 .4 26.2 .1 3.5 207.5 $ 399.6 $ 87.3 2.1 8.8 4.3 10.7 11.5 45.5 111.0 46.0 $ 327.2 $ 1.5 (.2) (.5) (.2) (9.9) $ (9.3) $ 1.1 0.1 (.1) .2 (2.6) (3.8) (.9) $ (6.0) 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 53 O F F I C E R S A N D D I R E C T O R S Dav id C. Anderson Vice President and General Counsel Richard E. Bangert, II Vice President Robert J. Christensen Vice President Aad Goudriaan Vice President Timothy M. Henebr y Vice President William D. Jackson Vice President Thomas A. Lundahl Vice President Helene N. Mawyer Vice President Janice B. Skredsv ig Vice President and Chief Information Officer Daniel D. Sobic Vice President George E. West, Jr. Vice President Andrew J. Wold Treasurer Janice M. D’Amato Secretary Stephen F. Page Retired Vice Chairman and Chief Financial Officer United Technologies Corporation (1) William G. Reed, Jr. Retired Chairman Simpson Investment Company (1,3) Robert T. Parr y Retired President and Chief Executive Officer Federal Reserve Bank of San Francisco (2) James C. Pigott President Pigott Enterprises, Inc. (3,4) Harr y C. Stonecipher President and Chief Executive Officer The Boeing Company (1,4) Michael A. Tembreull Vice Chairman PACCAR Inc Harold A. Wagner Retired Chairman Air Products and Chemicals, Inc. (1) O F F I C E R S Mark C. Pigott Chairman and Chief Executive Officer Michael A. Tembreull Vice Chairman Thomas E. Plimpton President James G. Cardillo Senior Vice President Kenneth R. Gangl Vice President Ronald E. Armstrong Vice President and Controller D I R E C T O R S Mark C. Pigott Chairman and Chief Executive Officer PACCAR Inc (3) John M. Fluke, Jr. Chairman Fluke Capital Management, L.P. (1,2) Gerald Grinstein Chief Executive Officer Delta Air Lines, Inc. (2,4) Dav id K. Newbigging OBE Chairman Friends Provident Plc (2,4) C O M M I T T E E S O F T H E B O A R D ( 1 ) A U D I T C O M M I T T E E ( 2 ) C O M P E N S A T I O N C O M M I T T E E ( 3 ) E X E C U T I V E C O M M I T T E E ( 4 ) N O M I N A T I N G C O M M I T T E E PACCAR Inc and Subsidiaries 23-54_Financials-cvo225.qxd 2/25/05 5:40 AM Page 54 D I V I S I O N S A N D S U B S I D I A R I E S T R U C K S Kenworth Truck Company Division Headquarters: 10630 N.E. 38th Place Kirkland, Washington 98033 Factories: Chillicothe, Ohio Renton, Washington Peterbilt Motors Company Division Headquarters: 1700 Woodbrook Street Denton, Texas 76205 Factories: Denton, Texas Madison, Tennessee PACCAR of Canada Ltd. Markborough Place 6711 Mississauga Road N. Mississauga, Ontario L5N 4J8 Canada Factory: Ste-Thérèse, Quebec Canadian Kenworth Company Division Headquarters: Markborough Place 6711 Mississauga Road N. Mississauga, Ontario L5N 4J8 Canada Peterbilt of Canada Division Headquarters: 108 Summerlea Road Brampton, Ontario L6T 4X3 Canada DAF Trucks N.V. Hugo van der Goeslaan 1 P.O. Box 90065 5600 PT Eindhoven The Netherlands Factories: Eindhoven, The Netherlands Westerlo, Belgium Leyland Trucks Ltd. Croston Road Leyland, Preston Lancs PR26 6LZ United Kingdom Factory: Leyland, Lancashire Kenworth Méxicana, S.A. de C.V. Kilometro 10.5 Carretera a San Luis Mexicali, Baja California Mexico Factory: Mexicali, Baja California PACCAR Australia Pty. Ltd. Kenworth Trucks 64 Canterbury Road Bayswater, Victoria 3153 Australia Factory: Bayswater, Victoria PACCAR U.K. Ltd. Foden Trucks Moss Lane, Sandbach Cheshire CW11 3YW United Kingdom T R U C K P A R T S A N D S U P P L I E S PACCAR Parts Division Headquarters: 750 Houser Way N. Renton, Washington 98055 Dynacraft Division Headquarters: 650 Milwaukee Avenue N. Algona, Washington 98001 W I N C H E S PACCAR Winch Div ision Division Headquarters: 800 E. Dallas Street Broken Arrow, Oklahoma 74012 Factories: Broken Arrow, Oklahoma Okmulgee, Oklahoma P R O D U C T T E S T I N G , R E S E A R C H A N D D E V E L O P M E N T PACCAR Technical Center Division Headquarters: 12479 Farm to Market Road Mount Vernon, Washington 98273 DAF Trucks Test Center Weverspad 2 5491 RL St. Oedenrode The Netherlands P A C C A R F I N A N C I A L S E R V I C E S G R O U P PACCAR Financial Corp. PACCAR Building 777 106th Avenue N.E. Bellevue, Washington 98004 PACCAR Financial Europe B.V. Hugo van der Goeslaan 1 P.O. Box 90065 5600 PT Eindhoven The Netherlands PACCAR Capital México S.A. de C.V. Kilometro 10.5 Carretera a San Luis Mexicali, Baja California Mexico PacLease Méxicana S.A. de C.V. Kilometro 10.5 Carretera a San Luis Mexicali, Baja California Mexico PACCAR Financial Ser v ices Ltd. Markborough Place 6711 Mississauga Road N. Mississauga, Ontario L5N 4J8 Canada PACCAR Financial Pty. Ltd. 64 Canterbury Road Bayswater, Victoria 3153 Australia PACCAR Leasing Company Division of PACCAR Financial Corp. PACCAR Building 777 106th Avenue N.E. Bellevue, Washington 98004 E X P O R T S A L E S PACCAR International Division Headquarters: PACCAR Building 777 106th Avenue N.E. Bellevue, Washington 98004 Offices: Beijing, People’s Republic of China Jakarta, Indonesia Manama, Bahrain Miami, Florida Sandbach, United Kingdom Covers_cvo223 2.23.05 12:58 AM Page 2 S T A T E M E N T O F C O M P A N Y B U S I N E S S S T A T E M E N T O F C O M P A N Y B U S I N E S S S T O C K H O L D E R S ’ I N F O R M A T I O N As a multinational technology company, PACCAR manufactures heavy-duty, As a diversified, multinational technology company, PACCAR manufactures heavy- on- and off-road Class 8 trucks sold around the world under the Kenworth, duty, on- and off-road Class 8 trucks sold around the world under the Kenworth, Peterbilt, DAF and Foden nameplates. The company competes in the North American Peterbilt, DAF and Foden nameplates. The company competes in the North American Class 6-7 market with its medium-duty models assembled in North America and Class 6-7 market with its medium-duty models assembled in North America and sold under the Peterbilt and Kenworth nameplates. In addition, DAF manufactures sold under the Peterbilt and Kenworth nameplates. In addition, DAF manufactures Class 6-7 trucks in the Netherlands and Belgium for sale throughout Europe, the Class 6-7 trucks in the Netherlands and Belgium for sale throughout Europe, the Middle East and Africa and distributes Class 4-7 t r u c k s i n E u r o p e manufactured Middle East and Africa and distributes Class 4-7 t r u c k s i n E u r o p e manufactured by Leyland Trucks (UK). • PACCAR manufactures and markets industrial winches by Leyland Trucks (UK). • PACCAR manufactures and markets industrial winches under the Braden, Gearmatic and Carco nameplates and competes in the truck under the Braden, Gearmatic and Carco nameplates and competes in the truck parts aftermarket through its dealer network. • Finance and Leasing subsidiaries parts aftermarket through its dealer network. • Finance and Leasing subsidiaries facilitate the sale of PACCAR products in many countries worldwide. Significant facilitate the sale of PACCAR products in many countries worldwide. Significant company assets are employed in financial services activities. • PACCAR company assets are employed in financial services activities. • PACCAR maintains exceptionally high standards of quality for all of its products: they maintains exceptionally high standards of quality for all of its products: they are are well-engineered, are highly customized for specific applications and sell in the well-engineered, are highly customized for specific applications and sell in the premium segments of their markets, where they have a reputation for superior premium segments of their markets, where they have a reputation for superior performance and pride of ownership. performance and pride of ownership. C O N T E N T S C O N T E N T S Financial Highlights Message to Shareholders PACCAR Operations Financial Charts Management’s Discussion and Analysis Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Stockholders’ Equity Consolidated Statements of Comprehensive Income Notes to Consolidated Financial Statements Management’s Report on Internal Control Over Financial Reporting Financial Charts Internal Controls Financial Highlights Message to Shareholders Report of Independent Registered Public PACCAR Operations Accounting Firm on the Company’s Consolidated Financial Statements Report of Independent Registered Public Accounting Firm on the Company’s Management’s Discussion and Analysis Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Selected Financial Data Consolidated Statements of Stockholders’ Equity Common Stock Market Prices and Dividends Consolidated Statements of Comprehensive Income Quarterly Results Notes to Consolidated Financial Statements Market Risks and Derivative Instruments Auditor’s Report Officers and Directors Selected Financial Data Divisions and Subsidiaries Quarterly Results Common Stock Market Prices and Dividends Market Risks and Derivative Instruments Officers and Directors Divisions and Subsidiaries Corporate Offices PACCAR Building 777 106th Avenue N.E. Bellevue, Washington 98004 Mailing Address P.O. Box 1518 Bellevue, Washington 98009 Telephone 425.468.7400 Facsimile 425.468.8216 Homepage http://www.paccar.com Stock Transfer and Dividend Dispersing Agent Wells Fargo Bank Minnesota, N.A. Shareowner Services P.O. Box 64854 St. Paul, Minnesota 55164-0854 800.468.9716 www.wellsfargo.com/ shareownerservices PACCAR’s transfer agent maintains the company’s shareholder records, issues stock certificates and distributes dividends and IRS Form 1099. Requests concerning these matters should be directed to Wells Fargo. Online Deliver y of Annual Report and Proxy Statement PACCAR’s 2004 Annual Report and the 2005 Proxy Statement are available on PACCAR’s Web site at www. paccar.com/financials.asp Registered stockholders can sign up to receive future proxy statements and annual reports in electronic format, instead of receiving paper documents, by visiting www.econsent.com/pcar/ Stockholders who hold PACCAR stock in street name may inquire of their bank or broker about the availability of electronic delivery of annual meeting documents. Braden, Carco, DAF, Dynacraft, Foden, Gearmatic, Kenworth, Leyland, PACCAR, PacLease and Peterbilt are trademarks owned by PACCAR Inc and its subsidiaries. Independent Auditors Ernst & Young LLP Seattle, Washington SEC Form 10-K PACCAR’s annual report to the Securities and Exchange Commission will be furnished to stockholders on request to the Corporate Secretary, PACCAR Inc, P.O. Box 1518, Bellevue, Washington 98009. It is also available online at www.paccar.com/ financials.asp, under SEC Filings. Annual Stockholders’ Meeting April 26, 2005, 10:30 a.m. Meydenbauer Center 11100 N.E. Sixth Street Bellevue, Washington 98004 An Equal Opportunity Employer This report was printed on recycled paper. Covers_cvo223 2.23.05 2:08 AM Page 1 2 0 0 4 A N N U A L R E P O R T