Paccar
Annual Report 2005

Plain-text annual report

2 0 0 5 A N N U A L R E P O R T 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, on- and off-road Class 8 trucks sold around the world under the Kenworth, Peterbilt and DAF nameplates. The company competes in the North American 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 Class 6-7 trucks in the Netherlands and Belgium for sale throughout Europe, the Middle East and Africa and distributes Class 4-7 trucks in Europe manufactured by Leyland Trucks (UK). PACCAR manufactures and markets industrial winches under the Braden, Gearmatic and Carco nameplates and competes in the truck parts aftermarket through its dealer network. Finance and Leasing subsidiaries facilitate the sale of PACCAR products in many countries worldwide. Significant company assets are employed in financial services activities. PACCAR maintains exceptionally high standards of quality for all of its products: they are well-engineered, are highly customized for specific applications and sell in the premium segments of their markets, where they have a reputation for superior performance and pride of ownership. C O N T E N T S 1 Financial Highlights 2 Message to Shareholders 6 PACCAR Operations 22 Financial Charts 23 Management’s Discussion and Analysis 31 Consolidated Statements of Income 32 Consolidated Balance Sheets 34 Consolidated Statements of Cash Flows 35 Consolidated Statements of Stockholders’ Equity 36 Consolidated Statements of Comprehensive Income 36 Notes to Consolidated Financial Statements 50 Management’s Report on Internal Control Over Financial Reporting 50 Report of Independent Registered Public Accounting Firm on the Company’s Consolidated Financial Statements 51 Report of Independent Registered Public Accounting Firm on the Company’s Internal Controls Selected Financial Data 52 52 Common Stock Market Prices and Dividends 53 Quarterly Results 54 Market Risks and Derivative Instruments 55 Officers and Directors 56 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 Delivery of Annual Report and Proxy Statement PACCAR’s 2005 Annual Report and the 2006 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, INLINE, Kenworth, Leyland, MIRREX, PACCAR, PacLease, Peterbilt and ROADLEVELER 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 25, 2006, 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. 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 $13,298.4 $10,833.7 2005 2004 (millions except per share data) 1 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 759.0 14,057.4 1,133.2 5,359.5 8,355.9 20.2 6,226.1 3,901.1 562.6 11,396.3 906.8 5,247.9 6,980.1 27.8 4,788.6 3,762.4 $ 6.60 $ $ 6.56 2.87 5.19 5.16 2.75 R E V E N U E S (cid:70) billions of dollars N E T I N C O M E billions of dollars (cid:17)(cid:21) (cid:17)(cid:18) (cid:25) (cid:22) (cid:19) (cid:16) S T O C K H O L D E R S ’ E Q U I T Y billions of dollars (cid:17)(cid:14)(cid:18)(cid:21) (cid:20)(cid:14)(cid:16) (cid:17)(cid:14)(cid:16)(cid:16) (cid:19)(cid:14)(cid:18) (cid:16)(cid:14)(cid:23)(cid:21) (cid:18)(cid:14)(cid:20) (cid:16)(cid:14)(cid:21)(cid:16) (cid:17)(cid:14)(cid:22) (cid:16)(cid:14)(cid:18)(cid:21) (cid:16)(cid:14)(cid:24) (cid:16)(cid:14)(cid:16)(cid:16) (cid:16)(cid:14)(cid:16) (cid:19)(cid:21)(cid:5) (cid:18)(cid:24)(cid:5) (cid:18)(cid:17)(cid:5) (cid:17)(cid:20)(cid:5) (cid:23)(cid:5) (cid:16)(cid:5) (cid:25)(cid:22) (cid:25)(cid:23) (cid:25)(cid:24) (cid:25)(cid:25) (cid:16)(cid:16) (cid:16)(cid:17) (cid:16)(cid:18) (cid:16)(cid:19) (cid:16)(cid:20) (cid:16)(cid:21) (cid:25)(cid:22) (cid:25)(cid:23) (cid:25)(cid:24) (cid:25)(cid:25) (cid:16)(cid:16) (cid:16)(cid:17) (cid:16)(cid:18) (cid:16)(cid:19) (cid:16)(cid:20) (cid:16)(cid:21) (cid:25)(cid:22) (cid:25)(cid:23) (cid:25)(cid:24) (cid:25)(cid:25) (cid:16)(cid:16) (cid:16)(cid:17) (cid:16)(cid:18) (cid:16)(cid:19) (cid:16)(cid:20) (cid:16)(cid:21) Return on Equity (percent) PACCAR Inc and Subsidiaries T O O U R S H A R E H O L D E R S PACCAR had a record year in 2005 due to its superior product quality, strong 2 markets, technology-led process efficiency and excellent results from aftermarket parts and financial services. PACCAR increased its share to record levels in the European heavy- and medium-duty truck markets. Market share was strong in North America, with record truck deliveries in both the heavy- and medium-duty segments. Customers benefited from PACCAR’s ongoing investments in technology, which enhanced manufacturing efficiency, extensive support programs and new product development. PACCAR delivered a record 148,500 trucks and sold nearly $1.7 billion of aftermarket parts and services. Net income of $1.13 billion was the highest in the company’s 100-year history, and revenues of $14.06 billion were 23 percent higher than in the previous year. Dividends of $2.87 per share were declared during the year, including a special dividend of $2.00. PACCAR increased its regular quarterly dividend twice during the year, raising its quarterly payout by 25 percent, and has increased its dividend 345 percent in the last four years. The North American truck market in 2005 grew 24 percent performance for capital goods companies worldwide. from the previous year, as a strong economy generated After-tax return on beginning shareholder equity (ROE) increased freight tonnage and transport companies was 30.1 percent in 2005, compared to 27.9 percent in increased their fleet sizes. The Class 8 truck market in 2004. The company’s 2005 after-tax return on revenues North America, including Mexico, was 307,000 vehicles, (ROR) was 8.1 percent, a new record. Excluding the compared to 248,000 last year. The European heavy truck $64.0 million one-time tax charge in 2005 for the market in 2005 was a record 259,000 vehicles, compared repatriation of foreign earnings, ROE was 31.8 percent to 238,000 in 2004, as customer demand remained strong and ROR was 8.5 percent. Sales and profits were driven in spite of slow growth in the euro zone economy. by strong truck and parts margins and new finance Competitors experienced improved results due to contracts for over 44,000 units. PACCAR shareholder the stronger market, though their high operating costs, equity tripled over the last decade, to $3.90 billion, as a including the burden of expensive and underfunded result of strong earnings. PACCAR’s total shareholder pension plans and post-retirement health-care programs, return averaged 27 percent per year, versus 9 percent continue to negatively impact their performance. annual return for the Standard & Poor’s 500 Index, over PACCAR continued to set the standard for financial that same ten-year period. INVESTING FOR THE FUTURE — PACCAR’s record projects have been implemented since its inception. Six profits, excellent balance sheet, and intense focus on Sigma, in conjunction with Supplier Quality, has been quality, technology and productivity enhancements have instrumental in delivering improved logistic performance enabled the company to consistently invest in its by the company’s suppliers. products and processes during all phases of the business INFORMATION TECHNOLOGY — PACCAR’s 3 cycle. Productivity, efficiency and capacity improvements Information Technology Division (ITD) is an important continue to be implemented in all manufacturing and competitive asset for the company. PACCAR’s use of parts facilities. Many of PACCAR’s facilities established information technology is centered on developing and new production records during the year in terms of quality integrating software and hardware that will enhance the metrics, inventory turns and assembly hours. PACCAR is quality and efficiency of all operations throughout the recognized as one of the leading technology companies in company, including the seamless integration of suppliers, the world, and innovation continues to be a cornerstone dealers and customers. of PACCAR’s success. PACCAR has integrated new One of the major successes that ITD and Purchasing technology to profitably support its own business, as well achieved during the year was the construction and as its dealers, customers and suppliers. One hundred inauguration of the North American Transportation and thirty new dealer locations were opened worldwide, Center. The Center utilizes a sophisticated logistic and more are planned to enhance PACCAR’s global platform to track, real-time, supplier parts shipment to distribution network. PACCAR facilities, resulting in world-class just-in-time Capital investments reached $300 million for the first inventory deliveries. Other major accomplishments time in the company’s history. Major capital projects include increased activities at the Electronic Dealerships in during the year included construction of a state-of-the- Renton and Eindhoven. Over 11,000 dealers, customers, art Kenworth manufacturing facility in Mexico, the launch suppliers and employees have experienced the interactive of the DAF XF105 and the fuel-efficient PACCAR MX demonstration modules showing the application of 12.9-liter engine, the introduction of the aerodynamic automated sales and service kiosks, tablet PCs and Radio Peterbilt 386, installation of additional paint robotics in Frequency Identification (RFID). New features include manufacturing facilities, including robotic chassis paint, an electronic sales and finance office and an electronic the opening of the new North American Transportation service analyst. Center and the start of construction of a new PACCAR In 2005, ITD provided breakthrough advancements Parts Distribution Center. in paint robotics software, wireless vehicle diagnostic PACCAR is judiciously examining business solutions, infrastructure capacity upgrades and opportunities in Asia, with the primary focus being installation of over 3,600 new personal computers. China and India. The company has sold product in TRUCKS — U.S. and Canadian Class 8 retail sales in 2005 China since 1908, and is cognizant of the benefits of a were 287,000 units, and the Mexican market totaled 20,000. long-term planning horizon for the region. Western Europe heavy truck sales were 259,000 units. SIX SIGMA — Six Sigma is integrated into all business PACCAR’s Class 8 retail sales market share in the U.S. activities at PACCAR and has been adopted at 150 of the and Canada was a strong 23.1 percent in 2005. DAF’s company’s suppliers and many of the company’s dealers. heavy-duty truck market share in Europe increased to Its statistical methodology is critical in the development a record 13.7 percent. Industry Class 6 and 7 truck of new product designs and manufacturing processes. In registrations in the U.S. and Canada numbered 101,000 addition, the company introduced “High Impact Kaizen units, a 5 percent increase from the previous year. In Events” (HIKE), which leverage Six Sigma methods with Europe, the 6- to 15-tonne market was 77,000 units, a production flow improvement concepts. The HIKE 3 percent increase from 2004. PACCAR’s North American projects conducted in 2005 were instrumental in delivering and European market shares in the medium-duty truck improved performance across the company. Over 8,000 segment both exceeded 9 percent, as the company delivered employees have been trained in Six Sigma and 5,200 a record 25,000 medium-duty trucks and tractors in 2005.  The capital goods and financial services industries introduction of new Kenworth models and expansion of were impacted in 2005 by the negative cost effect of the DAF product range led to a 24 percent heavy-duty rapidly escalating commodity prices, especially steel and market share in 2005. Aftermarket parts sales delivered 4 oil, higher interest rates and two devastating hurricanes. another year of record performance. However, PACCAR’s excellent pricing stability and long- PACCAR International, responsible for exporting trucks term supplier partnerships enabled increased production and parts to over 100 countries, had another record year and profits to be realized, facilitated by the tremendous due to strong sales in South Africa and Latin America. team effort of the company’s purchasing, materials and AFTERMARKET TRUCK PARTS — PACCAR Parts had production personnel. an excellent year in 2005 as it earned its 13th consecutive Another highlight in 2005 was PACCAR’s product year of record profits. With sales of nearly $1.7 billion, quality, which continued to be recognized as the leader the PACCAR Parts aftermarket business is the primary in the industry. Kenworth, Peterbilt and DAF earned source for replacement parts for PACCAR products, and industry awards as quality leaders in the Class 6, 7 and supplies parts for other truck brands to PACCAR’s dealer 8 markets. networks in many regions of the world. Other North American PACCAR truck plant Over five million Class 8 trucks are operating in North accomplishments include the completion of the company’s America and Europe, and the average age of these new Kenworth Mexico facility, installation of robotic cab vehicles is estimated to be over six years. These trucks paint systems in all factories and the attainment of record create an excellent platform for future parts and service production levels in five of six plants. business provided by a growing number of Kenworth, Almost 50 percent of PACCAR’s business is generated Peterbilt and DAF service facilities. outside the United States, and the company is realizing PACCAR Parts continues to lead the industry with excellent synergies globally in product development, sales technology that offers competitive advantages at PACCAR and finance activities and manufacturing. DAF Trucks dealerships. Managed Dealer Inventory (MDI) is now achieved record truck production, sales and profits, while installed at over 800 PACCAR dealers worldwide. MDI increasing its market share for the sixth consecutive year. utilizes proprietary software technology to determine DAF introduced its new XF105 and the PACCAR MX parts-replenishment schedules. Significant investments engine to excellent reviews. were also made in Call Center technology to improve the Leyland Trucks, the United Kingdom’s leading truck customer experience with its 24-hour/365-day-a-year manufacturer, completed significant facility restructuring, roadside assistance centers. PACCAR Parts enhanced such as installing an industry-first robotic chassis paint its Connect program, a software application for fleet- line, which increased capacity, improved quality and maintenance management. The enhanced program is a enhanced efficiency. Foden Trucks announced that it Web-based application providing fleets the opportunity would be retiring vehicle production in mid-2006, after to better manage vehicle operating costs. 150 years of industry leadership. FINANCIAL SERVICES — At year-end, the PACCAR PACCAR Mexico (KENMEX) had another record Financial Services (PFS) group of companies had profit year as the Mexican economy grew and truck operations covering three continents and 15 countries. fleets were renewed. KENMEX recorded gains in plant The global breadth of PFS has enabled the portfolio to efficiencies as production reached an all-time high. The grow to more than 144,000 trucks and trailers, with total largest capital investment in KENMEX history doubled assets exceeding $8.3 billion. PFS is the preferred funding production capacity, consolidated support services and source in North America for Peterbilt and Kenworth built a new fabrication center. trucks, financing 25 percent of dealer sales in 2005. PACCAR Australia achieved excellent profit, sales and PACCAR Financial Corp.’s (PFC) conservative business market share in 2005, supported by the second-highest approach, coupled with PACCAR’s strong S&P credit production level in the company’s history. The rating of AA- and complemented by the strength of the dealer network, enabled PFC to earn a record continually invest in all facets of its business, strengthening profit in 2005. PFC recorded increased finance volume in its competitive advantage. Other fundamental elements 2005 by offering a comprehensive array of finance, lease contributing to the exciting prospects of this vibrant, and insurance products. PFC enhanced its credit-analysis dynamic company are geographic diversification, with 5 program, Online Transportation Information System almost 50 percent of revenues generated outside the U.S., (OTIS), by extending the system to Canadian customers modern manufacturing and parts-distribution facilities, and dealers. leading-edge and innovative information technology, PACCAR Financial Europe (PFE) completed its fourth conservative and comprehensive financial services, year of operations and increased profits as it served DAF enthusiastic employees and the best distribution networks dealers in 11 Western European countries. PFE provides in the industry. wholesale and retail financing for DAF dealers and As PACCAR enters its second century, the company customers and finances almost 20 percent of DAF’s and its employees are focused on strong, quality growth. dealer sales. The embedded principles of integrity, quality and PACCAR Leasing (PacLease) earned its 12th consecutive consistency of purpose continue to define the course in year of record operating profits and placed in service PACCAR’s daily operations. PACCAR has successfully over 5,700 vehicles in 2005, a new record. The PacLease evolved as a leader in several industries since its founding fleet grew to 23,500 vehicles as 17 percent of the North in 1905. The proven business strategy — delivering American Class 6-8 market chose full-service leasing to technologically advanced, premium products and an satisfy their equipment needs. PacLease substantially extensive array of tailored aftermarket customer services strengthened its market presence in 2005, increasing utilizing an independent global distribution channel — the network to 245 outlets, and represents one of the enables PACCAR to achieve strong earnings growth. The largest full-service truck rental and leasing operations strength of the business foundation provides a platform in North America. to examine growth opportunities in complementary A LOOK AHEAD — PACCAR celebrated its Centennial business segments worldwide. PACCAR is enhancing its year by earning record financial results — the best year stellar reputation as a leading technology company in the in its 100-year history. PACCAR’s 22,000 employees capital goods and finance businesses. enabled the company to distinguish itself as a global leader in the technology, capital goods, financial services and aftermarket parts businesses. Superior product quality, technological innovation and balanced global diversification are three key operating characteristics that define PACCAR’s business philosophy. In North America, strong economic growth is driving freight shipments and tonnage to record levels. These market indicators should continue to have a positive impact on the truck market in 2006. 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 M A R K C . P I G O T T operating costs, consistent with its goal of achieving profitable market share growth. PACCAR’s excellent balance sheet ensures that the company is well positioned to Chairman and Chief Executive Officer Februar y 20, 2006 F I N A N C I A L C H A R T S D A F T R U C K S DAF vaulted to new sales, profit and production records in 2005, strengthening its competitive position with strong market-share gains in the over 15 tonne and 6-15 tonne 7 segments. This outstanding achievement reflects the success of its new highly efficient, captivating products and comprehensive customer support network. DAF introduced a new flagship model, the XF105, to its comprehensive product range during 2005, reinforcing its reputation as Europe’s commercial vehicle quality and resale-value leader. The XF105 presents a dazzling exterior that complements the characteristic aerodynamic elements of the widely acclaimed XF95. The vehicle offers a new interior and a completely restyled exterior, including a new upper and lower grille and a newly designed steel front bumper. It also features optional xenon headlights with clear Lexan glass, cat-eye combi- lights in the bumper and unique integrated spotlights in the Super Space Cab roof. Inside, the XF105 sets best-of-class standards in ergonomics, productivity and comfort — enhancing DAF’s industry-leading position for luxury that has long been defined by its cab interiors. From the stylish new door panels to the high-tech instrument panel and dashboard layout to the sumptuous sleeping compartment, uncompromising quality is the vehicle’s hallmark. The XF105 is powered by the new PACCAR MX engine, also introduced this year, with power outputs of 410 hp, 460 hp and 510 hp. An innovative new chassis layout repositions air tanks and other components inside frame rails to maximize fuel tank capacity. DAF unveiled a tractor unit variant of its CF85 series that offers an ultra-low fifth-wheel setting for customers who want to maximize payload in large-volume transport applications. Trailers with an interior height of three meters can haul more volume per journey — up to 100 cubic meters — while remaining within Europe’s legal maximum height of four meters and maximum trailer length of 13.65 meters. The highly successful Leyland-built CF65 distribution truck has earned a reputation for class-leading payloads. The new CF65 delivers a payload of almost 13.5 tonnes at 19 tonnes GVW. By making use of the innovative chassis frame and design attributes of the LF55 series, the chassis weight of the CF65 has been further enhanced to increase customer profit potential. DAF continued to strengthen its extensive distribution network of over 1,000 dealer and service points and is completing construction of its new full-service dealership in Frankfurt, Germany. DAF has more than doubled its market share in Germany — Europe’s largest truck market — since 1996. DAF constructed a new engine machining factory and substantially upgraded its manufacturing facilities in Eindhoven and Westerlo. Capitalizing on market momentum, DAF unveiled a new flagship model: the XF105. From its striking exterior to its luxurious interior appointments, the XF105 presents new benchmarks in reliability, operating efficiency and driver comfort for long-haul operators. F I N A N C I A L C H A R T S P E T E R B I L T M O T O R S C O M P A N Y Peterbilt sales of both heavy- and medium-duty trucks set new company standards in 2005. Outstanding product quality, superior vehicle resale value and innovative styling 9 continue to reflect Peterbilt’s well-deserved reputation as the “Class” of the industry. In one of the most significant new product introductions in the company’s history, Peterbilt unveiled its 2006 lineup of Class 8 conventional trucks and tractors: Models 379, 386, 385, 378 and 357. All the vehicles incorporate new technologies that improve performance, reliability and serviceability, and redesigned operating environments that optimize driver productivity, ergonomics and comfort. The new lineup of trucks offers best-in-class cab interiors with unparalleled fit and finish and driver amenities that rival luxury automotive quality. Three new interior trim levels meet a full range of market requirements. State-of-the-art multiplexed instrumentation enhances reliability and enables efficient analysis by technicians via PACCAR’s new wireless Electronic Service Analyst (ESA) tool. Restyled driver- and passenger-side doors improve ground visibility by 17 percent, enhancing the driver’s field of vision. A new heating and air conditioning (HVAC) system boosts airflow by 20 percent and delivers precise climate control throughout the vehicle. The sleek new aerodynamic Model 386, with a full range of detachable sleepers, expands Peterbilt’s offering of premium aerodynamic trucks — complementing the Model 387, with its spacious, integrated sleeper — and provides customers with fuel-efficient operation in all applications. The new vehicle design features a contoured sunvisor, side chassis fairings, dramatically sloped hood, integrated headlamps, swept-back fender design and form-fitted bumper — elements that together improve aerodynamic efficiency by 10 percent. Peterbilt expanded its market share in vocational and construction industries. The Model 357 offers over 300 new options designed specifically for construction, gravel and off-road applications. Peterbilt’s Denton, Texas, manufacturing facility celebrated its 25th anniversary in 2005 and became the first North American truck plant to install advanced, fully integrated robotic cells to weld aluminum fuel tanks. The Peterbilt dealer network reached a record level with 220 locations throughout the U.S. and Canada. Peterbilt’s TruckCare services program also expanded, serving more customers with complimentary roadside assistance and service scheduling, TruckCare Services Cards and QuickCare preventive maintenance. Peterbilt’s TruckCare Maintenance Manager updates service bulletins electronically and provides a reminder for vehicles within 1,000 miles of factory-recommended routine service intervals. Peterbilt’s sleek new aerodynamic Model 386 debuted in 2005, offering customers another premium choice for improved fuel economy, increased productivity, optimum serviceability, greater resale value and industry-leading ergonomics. F I N A N C I A L C H A R T S K E N W O R T H T R U C K C O M P A N Y Kenworth performed superbly in 2005 by earning five J.D. Power and Associates Awards in Customer Satisfaction for its Class 8 and Class 7 vehicles and outstanding dealer 11 service.* “The World’s Best” introduced many new product designs and achieved record profits, sales and production. Kenworth sales of Class 8 and Class 6/7 vehicles increased to record levels in 2005, reflecting enhanced product functionality, excellent operating efficiency and strong driver preference for the complete range of vehicles. Two significant production milestones were celebrated by Kenworth in 2005. Kenworth marked the production of its 700,000th truck in its 61-year history, and recognized the Chillicothe, Ohio, plant’s production of its 250,000th truck since the plant’s opening in 1974. Kenworth demonstrated its leadership in technology and innovation with the introduction of its new Class 8 models. A new cab interior with world-class automotive quality, multiplexed electronic instrumentation and increased driver comfort enhances the productive Kenworth experience on and off highway. The state-of-the-art instrument panel significantly enhances reliability and functionality. Servicing has also become easier with the newly launched Electronic Service Analyst (ESA), a wireless, computer-based diagnostics tool that helps technicians quickly and efficiently verify instrument functions. New options introduced on select Kenworth models include a factory-installed collision-avoidance system, electronic vehicle-stability control, a keyless-entry security system and adaptive cruise control. Kenworth made significant capital investments in its factories, adding robotic base-coat and clear-coat paint at the Chillicothe, Ohio, plant for enhanced quality and productivity. More than 1,600 computers and tablet PCs are in service at Kenworth manufacturing facilities, making each plant a wireless network able to access data in real time. Kenworth added Class 8 production to its medium-duty vehicle assembly facility in Ste. Thérèse, Quebec. Kenworth’s Six Sigma tools compressed the time required to design and introduce new products, improved production efficiency and capacity, and generated numerous quality enhancements. Heavy Duty Trucking magazine selected Kenworth’s factory-installed exhaust system that recirculates heat into dump truck bodies in cold climates as one of its Nifty Fifty best new product introductions of the year. RoadStar magazine honored Kenworth’s eCommerce effort in merchandising with its Most Valuable Product (MVP) award. The strong Kenworth dealer network operates 284 locations in the U.S. and Canada. Kenworth’s PremierCare® program expanded in 2005, serving more customers with roadside assistance, preventive maintenance, express services, fleet card and electronic parts inventory management. Kenworth’s reputation for manufacturing premium-quality trucks that satisfy both owners and drivers is reflected in the many coveted industry awards the company has earned in the last few years. This T800, popular with fleets and owner/operators alike, combines an extraordinarily durable, lightweight chassis design with advanced truck technologies to minimize operating expenses. * “Highest in Customer Satisfaction with Heavy-Duty Truck Dealer Service,” “Highest in Customer Satisfaction among Pickup & Delivery Segment Class 8 Trucks” and “Highest in Customer Satisfaction among Over the Road Segment Class 8 Trucks.” J.D. Power and Associates 2005 U.S. Heavy-Duty Truck Customer Satisfaction StudySM. “Highest in Customer Satisfaction among Conventional Medium-Duty Trucks” and “Highest in Customer Satisfaction with Medium-Duty Truck Dealer Service.” J.D. Power and Associates 2005 Medium- Duty Truck Customer Satisfaction StudySM. www.jdpower.com P A C C A R A U S T R A L I A PACCAR Australia dominated the Australian heavy-duty truck market again in 2005, 12 with excellent profits, sales, market share and production. Kenworth defines trucking in Australia, delivering custom-built quality with superior reliability. PACCAR Australia, the continent’s leading producer of a complete range of commercial vehicles, strengthened its position in the high-horsepower segment with more than 61 percent of the market in 2005. Kenworth posted strong gains in sales to vocational applications, where its new products — such as the T604 — have proven to deliver significant productivity enhancements. PACCAR Australia reached an important milestone in 2005, delivering its 30,000th Kenworth truck since it began production in 1971. The T650 livestock hauler, rated at 140 tonnes GCM and configured as a triple road train, will operate in some of the roughest environments in Australia. In 2005, PACCAR Australia introduced the T350 Agitator, a lightweight yet heavy-duty cement mixer model that provides a half tonne more payload than competitive trucks. An agile and versatile performer, the T350 offers all the maintenance advantages of a conventional plus the maneuverability and visibility of a cab-over — ideal for negotiating metropolitan streets and construction sites. PACCAR Australia unveiled the Kenworth T350 Agitator in 2005, a cement mixer capable of carrying an extra half tonne of payload per trip compared to competitive vehicles — an immediate productivity gain and significant cost benefit over the life of the truck. P A C C A R M E X I C O PACCAR Mexico (KENMEX) enhanced its leadership in the competitive Mexican market — accounting for more than 53 percent of heavy-duty tractor sales — and extended a 13 tradition that has made Kenworth the most revered nameplate for over 45 years. KENMEX set new records for sales, profits and production levels in 2005, strengthening its positions in over-the-road and medium-duty markets. KENMEX also set new standards for driver comfort when it unveiled Kenworth’s exciting world-class interior enhancements for its T600, T800, T2000 and W900 Class 8 models. Kenworth’s new Class 6/7 KW45 and KW55 — based on the versatile DAF LF series — are becoming increasingly popular in metropolitan delivery applications, where their excellent maneuverability, visibility and ergonomics offer significant productivity advantages. KENMEX completed the largest capital investment program in its history with a $70 million expansion of its truck factory. The state-of-the-art production facility doubles in size to 508,000 square feet and incorporates leading manufacturing technology — including paint robotics and production-line information systems — to increase assembly capacity by 50 percent. KENMEX also increased the country’s most extensive parts and service network to 102 dealer facilities nationwide. This medium-duty Kenworth KW45 serves Mexico’s extensive in-city delivery requirements, offering excellent maneuverability, visibility and ergonomic design. L E Y L A N D T R U C K S Leyland, the United Kingdom’s leading truck manufacturer, delivered a record 17,000 14 vehicles to customers throughout Europe in 2005. The innovative application of industry- leading technology helped Leyland substantially increase production capacity. Leyland produces a highly complex mix of vehicles in its state-of-the-art manufacturing plant, delivering a range of DAF and Foden trucks. In 2005, Leyland expanded production capacity considerably with the addition of a remarkable new robotic chassis paint facility — a world first in the commercial vehicle industry. Engineers employed a detailed visioneering model to optimize and speed installation of the groundbreaking project. Leyland worked with other PACCAR divisions worldwide to develop a patent-pending software program that enables the robotic spraying process to handle an enormous variety of truck configurations. Leyland has earned much industry recognition over the years for the high quality, efficiency and safety standards achieved at its world-class 607,000-square-foot manufacturing facility. In 2005, Leyland was presented with the President’s Prize by the Royal Society for the Prevention of Accidents (RoSPA) in recognition for earning RoSPA’s Gold Award ten years in a row. A world first in the commercial vehicle industry, Leyland added an innovative new robotic chassis paint facility in 2005 that helped boost capacity and achieve record production levels for DAF and Foden trucks. P A C C A R I N T E R N A T I O N A L PACCAR International, a leader in delivering Kenworth, Peterbilt and DAF trucks to customers worldwide, posted record sales and profits during 2005. A buoyant global 15 economy increased demand for premium-quality PACCAR vehicles. Worldwide demand for PACCAR’s custom-built transportation solutions continued to grow in 2005. PACCAR International delivered its 1,000th locally assembled DAF unit to South Africa, a market recognizing the benefits of PACCAR’s vehicle reliability. Latin America’s economic recovery spurred growth in sales for on- highway, vocational and medium-duty trucks. Customers in Colombia purchased record numbers of Kenworth trucks in 2005. Higher oil prices energized the oilfield servicing industry and resulted in greater truck demand. PACCAR off-highway products such as the Kenworth Super 953 and the Kenworth C500 delivered excellent performance in rugged and remote locales while serving the logging and mining markets. PACCAR International strengthened its market presence in 2005, expanding its dealer network in China, Taiwan, and Central and South America. Customers in over 100 countries benefit from the durability and reliability of PACCAR trucks and on-time delivery of parts and service. PACCAR International serves customers worldwide, merging PACCAR’s manufacturing expertise with the specialized knowledge of its global dealer network to solve transportation challenges. This huge Kenworth C540, destined for Middle East oilfields, reflects decades of successful experience serving remote locations. A F T E R M A R K E T T R U C K P A R T S PACCAR Parts achieved record sales and profits for the 13th consecutive year in 2005, 16 substantially increasing business in every market worldwide. The results included a strong demand for the comprehensive PACCAR-branded aftermarket product line. PACCAR Parts celebrated its best year in 2005, shipping 11.2 million order lines throughout the world for all makes of trucks. Innovative efforts in marketing, sales, customer service and information technology contributed to a surge in sales. PACCAR Parts U.K. assumed distribution of Leyland parts from a third-party distributor in 2005, and a new 72,000-square-foot facility at Leyland was completed to meet increased customer demand for DAF parts in the European market. Popular PACCAR branded All-Makes parts lines — such as INLINE, DYNACRAFT, MIRREX and ROADLEVELER, which include brakes, accessories, fenders, batteries and air and electrical components — expanded in 2005 and posted dramatic volume increases. PACCAR Parts also introduced an extension of its popular Connect program called WebConnect, a comprehensive vehicle-maintenance and parts-inventory system for small fleets. The superlative PACCAR Customer Call Centers offer 24/7 roadside support to truck drivers throughout North America and Europe, managing 1.7 million telephone calls annually. PACCAR Parts employs industry-leading technologies to heighten competitive advantage throughout its distribution system. Preventive Maintenance Automation, for example, enables dealership technicians to streamline maintenance inspections, customer communication and payment processing. P A C C A R W I N C H PACCAR Winch Division is the premier full-line producer of industrial winches in the world. Robust global demand for products in every segment propelled PACCAR Winch 17 to new records in sales, profits and market share in 2005. Braden recovery winches, hoists and drives, Gearmatic planetary hoists and Carco tractor winches are renowned for their engineering excellence, dependability and precise handling characteristics in challenging environments. The Winch Division reinforced its industry-leading reputation for innovation by introducing Electronic Winch Monitoring (EWM), a patent-pending new technology that electronically senses winch performance and automatically applies an auxiliary brake to assist in stopping the load in emergencies. Another industry first, the Electronic Maintenance Module (EMM), detects the direction of winch rotation, remaining wire rope capacity, load and speed and electronically logs critical operating history for improved maintenance. PACCAR Winch expanded its extensive product line in 2005, introducing the BA series of air-driven winch models engineered specifically to suit oil and gas drilling and mining industries. The division also unveiled a series of compact winches featuring higher line pull, superior quality and longevity for the growing service body crane market. PACCAR Winch launched a new line of air-driven winches specifically engineered for offshore oil and gas markets. Each model features an internal multi-disc brake and an overrunning clutch for superior load control. P A C C A R F I N A N C I A L S E R V I C E S PACCAR Financial Services Companies (PFS), which support the sale of PACCAR trucks 18 worldwide, achieved record income in 2005. PFS portfolios are comprised of more than 144,000 trucks and trailers, with total assets surpassing $8.3 billion. PACCAR Financial Corp. (PFC), the preferred source of financing for Kenworth and Peterbilt trucks in North America, set new records for finance volume in 2005. PFC’s innovative financial and insurance products generated increased demand in all market segments. Six Sigma driven process and technology investments enabled PFC to reduce credit application processing time by 50 percent. An updated pre-owned equipment Web site, the introduction of tablet PCs for field sales teams and new capabilities for PFC’s Web-based Online Transportation Information System (OTIS) dramatically improved loan-processing efficiency and responsiveness. PFC introduced Retail Manager, an initiative designed to streamline service to owner-operators. PACCAR Financial Europe (PFE) achieved a record $1.85 billion in assets in 2005, and provides financial services to DAF dealers and customers in 11 Western European countries. PFE is the market-share leader in financing DAF products in Europe. PACCAR Financial Services Companies facilitate the sale of PACCAR products throughout the world, utilizing information technology in innovative ways to streamline credit processing and communication for customers and dealers. P A C C A R L E A S I N G C O M P A N Y Celebrating its 25th anniversary, PACCAR Leasing achieved record profits for the 12th consecutive year in 2005 and delivered a record number of new Kenworth and 19 Peterbilt trucks throughout its North American network. The PacLease fleet contains 23,500 units — including 1,900 leased vehicles serving Mexico. PacLease, one of the largest full-service truck rental and leasing networks in North America, provides customers with complete and reliable daily transportation solutions. In 2005, PacLease inaugurated a new full-service lease program geared to the exacting requirements of vocational operators, a growing segment of the lease industry. During 2005, more than 17 percent of all Class 6, 7 and 8 vehicles manufactured were delivered to the full-service leasing industry. Driver and technician shortages, rising fuel costs and sophisticated maintenance requirements for truck systems have created a flourishing market for outsourced transport services such as leasing. PACCAR Leasing offers significant competitive advantages: custom-built, premium-quality PACCAR trucks with exceptional residual value, low operating expenses, an expansive network of 245 responsive franchises and company locations, and a full spectrum of value-added transportation services. PACCAR Leasing expanded its fleet by 20 percent in 2005 and increased its share of the medium-duty market with a greater number of premium-quality Class 6-7 trucks, such as this popular Peterbilt Model 335. 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 North America ensure that new product 20 designs perform to PACCAR’s rigorous quality standards. Increasing use of advanced simulation techniques and sophisticated information technology systems has leveraged worldwide engineering resources. PACCAR Technical Centers are world-class facilities with state-of-the-art product test and validation capabilities. At the U.S. Technical Center, engineers use high-speed computing clusters to model, test and validate designs up to 10 times faster than with previous methods. The new Electronics Integration Center uses hardware-in-the- loop technology to simulate and validate next-generation electronics systems in a laboratory environment. The engine test laboratory simulates the demanding performance required in a million-mile powertrain. In Europe, PACCAR’s Technical Center was instrumental in the development, testing and field validation phases of DAF’s new XF105 model and low-deck CF85 tractor and the PACCAR MX engine. DAF opened its new 8,000-square-meter semi-anechoic chamber, unique in the truck manufacturing industry, to evaluate vehicle sound compliance. PACCAR Technical Centers, in the Netherlands and in Washington State, employ highly sophisticated engineering analysis, simulation and rapid prototyping technologies to accelerate the development of world-class components and designs. 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) is an industry leader in the innovative application of software and hardware technology. ITD provides PACCAR a competitive 21 advantage at every stage of the product life cycle, including R&D, sales, manufacturing, financial services and aftermarket support. PACCAR earned the top position in InformationWeek magazine’s ranking of companies in the automotive sector during 2005 for the use of information technology. Kenworth and Peterbilt launched product enhancements that include advanced vehicle electronics and networked dashboard instrumentation developed by ITD. The Electronic Service Analyst (ESA), a new wireless tool for North American factories, dealers and call centers to enhance vehicle programming and diagnostics, also was designed by the Information Technology Division. In 2005, ITD’s 700 employees’ expertise in software and hardware development contributed to achieving record results for many PACCAR divisions. An updated Manufacturing Execution System (MES), for example, includes enhancements that enable PACCAR’s production facilities to electronically track each vehicle chassis location, monitor quality check status and interface with material and engineering personnel on design and parts queries. Utilizing the ITD-developed PACCAR Transportation System, planners at PACCAR’s new state-of-the-art Logistics Center manage the movement of inbound freight traffic to PACCAR factories and parts distribution centers throughout North America. F I N A N C I A L C H A R T S F I N A N C I A L C H A R T S 22 EARNINGS & DIVIDENDS PER SHARE U.S. AND CANADA CLASS 8 TRUCK MARKET SHARE dollars (cid:23)(cid:14)(cid:16)(cid:16) (cid:19)(cid:16)(cid:16) retail sales (cid:21)(cid:14)(cid:22)(cid:16) (cid:18)(cid:20)(cid:16) (cid:20)(cid:14)(cid:18)(cid:16) (cid:17)(cid:24)(cid:16) (cid:18)(cid:14)(cid:24)(cid:16) (cid:17)(cid:18)(cid:16) (cid:17)(cid:14)(cid:20)(cid:16) (cid:16)(cid:14)(cid:16)(cid:16) (cid:22)(cid:16) (cid:16) (cid:21)(cid:16)(cid:5) (cid:20)(cid:16)(cid:5) (cid:19)(cid:16)(cid:5) (cid:18)(cid:16)(cid:5) (cid:17)(cid:16)(cid:5) (cid:16)(cid:5) (cid:25)(cid:22) (cid:25)(cid:23) (cid:25)(cid:24) (cid:25)(cid:25) (cid:16)(cid:16) (cid:16)(cid:17) (cid:16)(cid:18) (cid:16)(cid:19) (cid:16)(cid:20) (cid:16)(cid:21) (cid:25)(cid:22) (cid:25)(cid:23) (cid:25)(cid:24) (cid:25)(cid:25) (cid:16)(cid:16) (cid:16)(cid:17) (cid:16)(cid:18) (cid:16)(cid:19) (cid:16)(cid:20) (cid:16)(cid:21) ■ 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 GEOGRAPHIC REVENUE billions of dollars (cid:17)(cid:21) (cid:17)(cid:18) (cid:25) (cid:22) (cid:19) (cid:16) (cid:17)(cid:21) (cid:17)(cid:18) (cid:25) (cid:22) (cid:19) (cid:16) (cid:25)(cid:22) (cid:25)(cid:23) (cid:25)(cid:24) (cid:25)(cid:25) (cid:16)(cid:16) (cid:16)(cid:17) (cid:16)(cid:18) (cid:16)(cid:19) (cid:16)(cid:20) (cid:16)(cid:21) (cid:25)(cid:22) (cid:25)(cid:23) (cid:25)(cid:24) (cid:25)(cid:25) (cid:16)(cid:16) (cid:16)(cid:17) (cid:16)(cid:18) (cid:16)(cid:19) (cid:16)(cid:20) (cid:16)(cid:21) ■ Truck and Other ■ Financial Services ■ United States ■ Outside U.S. 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 F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S (tables in millions, except truck unit and per share data) R E S U LT S O F O P E R AT I O N S : Selling, general and administrative (SG&A) expense 23 2005 2004 2003 Net sales and revenues: Truck and Other Financial Services $13,298.4 759.0 $14,057.4 $10,833.7 $7,721.1 562.6 $11,396.3 473.8 $8,194.9 Income before taxes: Truck and Other Financial Services Investment Income Income taxes Net Income Diluted earnings per share $ 1,516.8 $ 1,139.9 $ 640.6 199.9 168.4 123.6 56.9 (640.4) $ 1,133.2 59.9 (461.4) $ 906.8 41.3 (279.0) $ 526.5 $ 6.56 $ 5.16 $ 2.99 Overview: PACCAR is a multinational company whose principal businesses include the design, manufacture and distribu tion of high-quality, light-, medium- and heavy-duty commercial trucks and related aftermarket parts and the financing and leasing of its trucks and related equipment. The Company also manufactures and markets industrial winches. Consolidated net sales and revenue increased 23% to a record $14.06 billion from $11.40 billion in 2004 due to strong global demand for the Company’s high-quality trucks, aftermarket parts and financial services. Financial Services revenues increased 35% to $759.0 million in 2005. PACCAR achieved record net income in 2005 of $1,133.2 million ($6.56 per diluted share), which was an increase of 25% over 2004 net income of $906.8 million ($5.16 per diluted share). Excellent results were achieved in the Truck and Other businesses due to the strong revenue growth, increased margins and continued cost control. Financial Services income before taxes increased 19% to a record $199.9 million compared to $168.4 million in 2004 as a result of robust asset growth, low credit losses and excellent finance margins. for Truck and Other increased to $429.9 million in 2005 compared to $390.4 million in 2004. SG&A increased to support higher production levels, expanded sales initiatives and technology invest- ments. However, as a percent of revenues, SG&A expense decreased to a record low of 3.2% in 2005 from 3.6% in 2004 as the Company benefited from Six Sigma initiatives and process improvements driven by technology investments. Investment income of $56.9 million in 2005 compares to $59.9 million in 2004, which included a one-time gain of $14.1 million from the sale of equity securities. Excluding the gain in 2004, invest- ment income was higher in 2005 due to higher average interest rates earned on cash and marketable debt securities. The 2005 income tax provision includes a one- time charge of $64.0 million ($.37 per share) related to repatriation of $1.5 billion of foreign earnings. Excluding the tax charge on repatriated earnings, the effective rate was 32.5% in 2005 compared to 33.7% in 2004. The lower effective tax rate in 2005 was primarily due to lower tax rates in the Netherlands and Mexico. The Company’s return on revenues was a record 8.1% (8.5% excluding the one-time tax charge) compared to 8.0% in 2004. Truck PACCAR’s truck segment, which includes the manufac ture and distribution of trucks and related aftermarket parts, accounted for 94% of revenues in 2005 and 2004 and 93% of revenues in 2003. In North America, trucks are sold under the Kenworth and Peterbilt nameplates and, in Europe, under the DAF nameplate. 2005 2004 2003 Truck net sales and revenues $13,196.1 $10,762.3 $7,661.2 Truck income before taxes $ 1,520.2 $ 1,145.0 $ 655.4 PACCAR Inc and Subsidiaries 24 The Company achieved record new truck deliveries in 2005, summarized as follows: United States Canada U.S. and Canada Europe Mexico, Australia and other Total units 2005 71,900 10,900 82,800 52,200 2004 59,200 9,100 68,300 45,300 13,500 148,500 10,500 124,100 2003 39,000 6,600 45,600 38,600 8,800 93,000 2005 Compared to 2004: PACCAR’s worldwide truck sales and revenues increased 23% to $13.20 billion in 2005 due to continued high demand for the Company’s trucks and related aftermarket parts around the world. Truck income before taxes was $1.52 billion compared to $1.14 billion in 2004. The increase from the prior year is due to higher production rates, growing aftermarket part sales and improved truck margins. The impact of exchange rate movements was not significant to either revenues or profit in 2005. Peterbilt and Kenworth delivered 82,800 medium and heavy trucks in the U.S. and Canada during 2005, an increase of 21% over 2004 with heavy-duty (Class 8) deliveries up 23% and medium-duty (Class 6 and 7) deliveries up 12%. The increased deliveries reflect overall market growth. The Class 8 market increased to 287,500 units in 2005 from 233,000 in 2004. The medium-duty market increased 5% to 100,700 units. New truck deliveries in Europe increased 15% to a record 52,200 units. The 15 tonne and above truck market improved to a record 259,000 units, a 9% increase from 2004 levels. PACCAR’s DAF truck brand increased its share of the 15 tonne and above market for the sixth year in a row. DAF market share in the 6 to 15 tonne market also increased. Truck and parts sales in Europe represented 31% of PACCAR’s total truck segment net sales and revenues in 2005, compared to 34% in 2004. Truck unit deliveries in Mexico, Australia and other countries outside the Company’s primary markets increased 29%. Deliveries outside the primary markets to customers in Africa, Asia and South America are sold through PACCAR International, the Company’s international sales division. Combined truck and parts sales in these markets accounted for 10% of total truck segment sales and 11% of truck segment profit in 2005. PACCAR’s worldwide aftermarket parts revenues were $1.68 billion, an increase of 15% compared to $1.46 billion in 2004. Parts operations in North America and Europe benefited from a growing truck population and the further integration of PACCAR technology with dealer business systems to improve responsiveness to customer needs. Truck segment gross margin as a percentage of net sales and revenues improved to 14.5% in 2005 from 14.3% in 2004 as a result of higher operating efficiencies and strong demand for the Company’s products. Higher material costs from suppliers due to increases in steel, aluminum, crude oil and other commodities have generally been reflected in new truck sales prices. 25 Truck Outlook Demand for heavy-duty trucks in the U.S. and Canada is currently forecasted to increase approximately 5% in 2006, with industry retail sales expected to be 290,000–310,000 trucks. European heavy-duty regis- trations for 2006 are projected to be similar to 2005 at 245,000–265,000 units. Both markets will be affected by engine emissions regulations. In Europe, effective October 1, 2006, all new truck registrations will be required to comply with Euro 4 emissions standards. In the U.S., effective January 1, 2007, all new diesel engines manufactured will be required to comply with EPA 2007 engine emissions standards. In both markets, conversion to the new engine emissions standards will increase the end user vehicle cost. Customers may adopt strategies to mitigate the cost impact by accelerating purchases of trucks before the new standards take effect. This could result in a “pull forward” of vehicle sales in Europe in the first three quarters of 2006 and in the U.S. prior to the January 1, 2007 deadline. 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 increase due to the weaker U.S. dollar. 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. New trucks delivered in the U.S. and Canada were 68,300, an increase of 50% from 2003. Industry 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. Kenworth and Peterbilt improved their share of the U.S. and Canada Class 6 and 7 truck market in 2004, contributing to the increased deliveries. In 2004, new trucks delivered in Europe totaled 45,300 units, an increase of 17%. The European 15 tonne and above truck market improved by 20,000 to 238,000 units. DAF Trucks increased its share of both the European heavy-duty (above 15 tonne) market and the 6 to 15 tonne market. Sales in Europe repre sented approximately 34% of PACCAR’s total truck segment net sales and revenue in 2004, compared to 35% in 2003. Truck unit deliveries in Mexico, Australia and other countries increased 19%, primarily due to larger markets in Mexico and Australia. Combined results in these countries were 10% of total truck segment sales and 14% of profit in 2004. PACCAR’s worldwide aftermarket parts revenues of $1.46 billion increased in 2004 compared to 2003 due to a larger truck population and improved market penetration. 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. PACCAR Inc and Subsidiaries 26 Financial Services The Financial Services segment, which includes wholly owned subsidiaries in North America, Europe and Australia, derives its earnings primarily from financing or leasing PACCAR products. Financial Services: Average earning assets Revenues Income before taxes 2005 2004 2003 $7,389.0 759.0 $5,945.0 562.6 $5,139.0 473.8 199.9 168.4 123.6 2005 Compared to 2004: PACCAR Financial Services (PFS) revenues increased 35% to $759.0 million due to higher earning assets worldwide and, to a lesser extent, higher interest rates in the U.S. New business volume was $3.73 billion, up 20% from 2004 on higher truck sales levels and strong market share. PFS provided loan and lease financing for over 27% of PACCAR new trucks delivered in 2005. Income before taxes increased 19% to a record $199.9 million from $168.4 million in 2004. This improvement was primarily due to higher finance margins, partly offset by a higher provision for losses on receivables related to growing earning asset bal- ances. The increase in finance margins was due to higher earning asset levels and higher yield rates on assets, offset partly by a higher cost of funds. Net portfolio charge-offs were $19.3 million compared to $12.2 million in 2004 and represented .26% and .21% of average earning assets, respectively. At December 31, 2005, the earning asset portfolio was performing well with the percentage of accounts 30+ days past due at 1.2% compared to 1.1% at the end of 2004. 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 operat- ing markets. New business volume was $3.12 billion, up 38%, reflect ing higher truck sales and improved leasing market share. Income before taxes increased 36% to $168.4 million in 2004 compared to $123.6 million in 2003. The improvement was primarily due to higher finance margins and lower credit losses. Credit losses for the Financial Services segment were $12.2 million in 2004, compared to $24.2 million in 2003. The lower credit losses reflect fewer truck repossessions and higher used truck prices. The increase in finance margins was due to higher earning assets and a lower cost of funds, partially offset by a lower interest yield on assets. Financial Services Outlook The outlook for the Financial Services segment is principally dependent on the generation of new business volume and the related spread between the asset yields and the borrowing costs on new business, as well as the level of credit losses experienced. Asset growth is likely in North America and Europe, con- sistent with the anticipated strong truck markets. The segment continues to be exposed to the risk that economic weakness, as well as higher interest rates and fuel and insurance costs, could exert pressure on the profit margins of truck operators 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 2005, 2004 and 2003. 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 2005 2004 2003 $1,698.9 $1,614.7 $1,347.0 591.4 $2,290.3 604.8 $2,219.5 377.1 $1,724.1 The Company’s total cash and marketable debt securities increased $70.8 million in 2005. Cash provided by operations of $986.8 million was used primarily to pay dividends of $496.9 million, make capital additions totaling $300.4 million and repur- chase PACCAR stock for $367.2 million. Cash required to originate new loans and leases was funded by repayments of existing loans and leases as well as Financial Services borrowings. The Company has line of credit arrangements of $1.70 billion. The unused portion of these credit lines was $1.62 billion at December 31, 2005 and is primarily maintained to provide backup liquidity for commercial paper borrowings of the financial services companies. Included in these arrangements is a $1.5 billion bank facility, of which $.5 billion matures in 2006 and $1.0 billion matures in 2010. 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. Truck and Other The Company provides funding for working capital, capital expenditures, research and development, dividends and other business initiatives and commit- ments primarily from cash provided by operations. Management expects this method of funding to continue in the future. Long-term debt and commercial paper were $28.8 million as of December 31, 2005. 27 Expenditures for property, plant and equipment in 2005 totaled $299 million compared to $231 million in 2004. Major capital projects included a new engine factory at DAF to manufacture the new Euro 4/5 compliant PACCAR MX 12.9 liter engine for the European market and a significantly expanded Kenworth truck factory in Mexico. In addition, the Company invested in robotics and other quality- enhancing innovations in all of its truck factories. Over the last five years, the Company’s worldwide capital spending totaled $800 million. Spending for capital investments in 2006, including new product development, is expected to increase from 2005 levels. PACCAR is investing in state-of- the-art tech nology to improve product design and quality, increase capacity, achieve efficiencies in business processes and enhance the distribution network, as well as develop new manufacturing tooling to support product development plans. As previously announced, during the second quarter of 2005, PACCAR’s Board of Directors authorized the Company to repatriate $1.5 billion of foreign earnings under the provisions of The American Jobs Creation Act. This repatriation was completed by the end of 2005. In accordance with FASB Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004, a provision of $64.0 million for the repatriation of foreign earnings was recorded as income tax expense in the second quarter of 2005. U.S. income taxes are not provided on any remaining undistributed earnings of the Company’s foreign subsidiaries because of the intent to reinvest these earnings indefinitely. PACCAR Inc and Subsidiaries 28 Financial Services The Company funds its financial services activities primarily from collections on existing finance receivables and borrowings in the capital markets. An additional source of funds is loans from other PACCAR companies in the truck segment. The primary sources of borrowings in the capital market are commercial paper and medium-term notes issued in the public markets 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. At December 31, 2005, $1.3 billion of such securities remained available for issuance. In September 2005, PACCAR’s European finance subsidiary, PACCAR Financial Europe, registered a €1 billion euro medium-term note program with the London Stock Exchange. On December 31, 2005, €341 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 companies 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. Commitments The following summarizes the Company’s contrac- tual cash commitments at December 31, 2005: Maturity Within More than One Year One Year $ 935.5 $5,319.4 49.8 32.1 68.6 15.2 $1,053.9 $5,366.7 Total $6,254.9 81.9 83.8 $6,420.6 Borrowings Operating leases Other obligations Total At the end of 2005, the Company had $6.42 billion of cash commitments, including $5.37 billion maturing within one year. Of the cash commitments, $6.23 billion were related to the Financial Services segment. As described in Note K of the consolidated financial statements, borrowings consist primarily of term debt and commercial paper of the Financial Services segment. The Company expects to fund its maturing Financial Services debt obligations princi- pally from funds provided by collections from customers on loans and lease contracts, as well as from the proceeds of commercial paper and medium- term note borrowings. Other obliga tions include deferred cash compensation and the Company’s contractual commitment to acquire future production inventory. The Company’s other commitments include the following at December 31, 2005: Commitment Expiration Within More than One Year One Year $ 15.0 $ 16.3 291.4 Total $ 31.3 291.4 14.9 38.2 53.1 71.4 $394.0 175.6 $228.8 247.0 $622.8 Letters of credit Loan and lease commitments Equipment acquisition commitments Residual value guarantees Total 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 represent the Company’s commit- ment to acquire trucks at a guaranteed value if the customer decides to return the truck at a specified date in the future. 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 general are subject to various domestic and foreign require- ments relating to the environment. The Company believes its policies, practices and procedures are designed to prevent unreasonable risk of environ- mental 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 disposal occurred. Expenditures related to environmental activities were $1.2 million in 2005, $2.4 million in 2004 and $1.2 million in 2003. The Company is involved in various stages of inves tigations and cleanup actions in different coun- tries 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 $19.2 million and $44.2 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 Com pany’s consolidated cash flow, liquidity or financial condition. 29 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 U.S. generally accepted accounting principles, management 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 financial 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 deter mining its estimate of the residual value of such vehicles, the Company considers the length of the lease term, the truck model and anticipated 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 poli cies are appropriate; however, future market conditions, changes in government regulations and other factors outside the Company’s control can impact the ultimate sales price of trucks returned under these contracts. Residual values are reviewed regularly and adjusted downward if market conditions warrant. Allowance for Credit Losses The Company determines the allowance for credit losses on financial services receivables based on a combination of historical information and current market conditions. This determination is dependent on estimates, including assumptions regarding the likelihood of collecting current and past-due accounts, repossession rates and the recovery rate on the under- lying collateral based on used truck values and other pledged collateral or recourse. The Company believes its reserve-setting policies adequately take into account the known risks inherent in the financial services portfolio. If there are significant variations in the actual results from those estimates, the provision for credit losses and operating earnings may be adversely impacted. PACCAR Inc and Subsidiaries F O RWA R D - L O O K I N G S TAT E M E N T S : Certain information presented in this report contains 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 fluctuations; lower used truck prices; insufficient or under-utilization of manufacturing capacity; supplier interruptions; insufficient supplier capacity or access to raw materials; labor disruptions; shortages of commercial truck drivers; increased warranty costs or litigation; or legis lative and governmental regulations. 30 Product Warranty The expenses related to product warranty are estimated and recorded at the time products are sold based on his torical data regarding the source, frequency, 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 obligations is governed by the pronouncements of the Financial Accounting Standards Board. Under these rules, manage ment determines appropriate assumptions about the future, which are used by actuaries to estimate net costs and liabilities. These assumptions include discount rates, health care cost trends, infla- tion 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 reasonable expectations of future events. The discount rate for each plan is based on market interest rates of high- quality corporate bonds with a maturity profile that matches the timing of the projected benefit payments of the plans. The long-term rate of return on plan assets is based on projected returns for each asset class and the projected relative weighting of those asset classes in the plans. Actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect expense in such future periods. Changes in the discount rate also affect the valuation of the plan benefits obligation. While management believes that the assumptions used are appropriate, significant differences in actual experience or significant changes in assumptions would affect pension and other post- retirement benefit costs and obligations. See Note L of the consolidated financial statements for more information regarding costs and assumptions for employee benefit plans. 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 TRUCK AND OTHER: 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 FINANCIAL SERVICES: 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. 2005 2004 2003 31 (millions except per share data) $13,298.4 $ 10,833.7 $ 7,721.1 11,340.5 429.9 11.2 11,781.6 1,516.8 9,268.6 390.4 34.8 9,693.8 1,139.9 6,732.0 345.0 3.5 7,080.5 640.6 759.0 433.8 84.9 40.4 559.1 199.9 562.6 296.1 80.0 18.1 394.2 168.4 473.8 248.7 72.9 28.6 350.2 123.6 56.9 1,773.6 640.4 $ 1,133.2 59.9 1,368.2 461.4 906.8 $ 41.3 805.5 279.0 $ 526.5 $ $ 6.60 6.56 $ $ 5.19 5.16 $ $ 3.01 2.99 171.7 172.8 174.6 175.7 174.8 176.1 PACCAR Inc and Subsidiaries 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 32 A S S E T S December 31 TRUCK AND OTHER: Current Assets Cash and cash equivalents Trade and other receivables, net 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 FINANCIAL SERVICES: Cash and cash equivalents Finance and other receivables, net Equipment on operating leases, net Other assets Total Financial Services Assets 2005 2004 (millions of dollars) $ 1,624.4 582.2 591.4 495.5 214.9 3,508.4 361.0 1,143.0 347.1 5,359.5 $ 1,579.3 538.7 604.8 495.6 113.3 3,331.7 472.1 1,037.8 406.3 5,247.9 74.5 7,262.5 845.9 173.0 8,355.9 $13,715.4 35.4 6,106.1 716.4 122.2 6,980.1 $12,228.0 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 33 December 31 TRUCK AND OTHER: 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 FINANCIAL SERVICES: 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; issued 169.4 million and 173.9 million shares Additional paid-in capital Treasury stock – at cost – .5 million shares Retained earnings Accumulated other comprehensive income Total Stockholders’ Equity See notes to consolidated financial statements. 2005 2004 (millions of dollars) $ 1,834.9 8.6 338.7 2,182.2 20.2 410.4 344.0 2,956.8 168.9 3,568.6 2,657.5 462.5 6,857.5 169.4 140.6 (35.1) 3,471.5 154.7 3,901.1 $13,715.4 $ 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 PACCAR Inc and Subsidiaries 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 34 Year Ended December 31 OPERATING ACTIVITIES: 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, net Increase (decrease) in liabilities: Accounts payable and accrued expenses Residual value guarantees and deferred revenues Other, net Net Cash Provided by Operating Activities INVESTING ACTIVITIES: Retail loans and direct financing leases originated Collections on retail loans and direct financing leases Net (increase) decrease 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 FINANCING ACTIVITIES: 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. 2005 2004 2003 (millions of dollars) $ 1,133.2 $ 906.8 $ 526.5 133.3 236.8 40.4 (19.8) (80.1) (398.9) (194.3) (30.1) (37.5) 147.1 45.5 11.2 986.8 (2,946.4) 2,202.5 (15.5) (1,172.4) 1,135.1 (300.4) (548.1) 96.1 46.5 (1,502.6) (496.9) (367.2) 11.9 1,148.4 1,016.9 (592.1) 721.0 (121.0) 84.2 1,614.7 $ 1,698.9 122.0 193.0 18.1 19.4 (53.0) (298.4) (164.0) (142.1) (30.2) 409.7 (69.5) (20.8) 891.0 (2,333.1) 1,816.0 7.1 (876.3) 710.5 (231.9) (401.6) 103.2 (1,206.1) (270.9) (107.7) 15.7 148.2 1,588.6 (857.6) 516.3 66.5 267.7 1,347.0 $ 1,614.7 116.1 151.4 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) (171.9) 23.8 20.2 659.2 (662.0) (130.7) 125.3 574.0 773.0 $ 1,347.0 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 COMMON STOCK, $1 PAR VALUE: Balance at beginning of year Treasury stock retirement 50% stock dividend Stock options exercised and other stock compensation Balance at end of year ADDITIONAL PAID-IN CAPITAL: 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 TREASURY STOCK, AT COST: Balance at beginning of year Purchases Retirements Balance at end of year RETAINED EARNINGS: Balance at beginning of year Net income Cash dividends declared on common stock, per share: 2005-$2.87; 2004-$2.75; 2003-$1.37 Balance at end of year ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS): Balance at beginning of year Other comprehensive (loss) income Balance at end of year Total Stockholders’ Equity See notes to consolidated financial statements. 2005 2004 2003 35 (millions of dollars except per share data) $ 173.9 (5.0) $ 175.1 (2.0) $ 115.9 58.4 .8 175.1 545.8 (58.4) 32.9 3.9 524.2 .5 169.4 450.5 (338.4) 27.0 1.5 140.6 (378.5) 343.4 (35.1) .8 173.9 524.2 (105.7) 25.6 6.4 450.5 (107.7) 107.7 2,826.9 1,133.2 2,399.2 906.8 (488.6) 3,471.5 (479.1) 2,826.9 311.1 (156.4) 154.7 $ 3,901.1 147.9 163.2 311.1 $ 3,762.4 2,113.3 526.5 (240.6) 2,399.2 (174.3) 322.2 147.9 $ 3,246.4 PACCAR Inc and Subsidiaries 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 36 Year Ended December 31 Net income Other comprehensive (loss) income: Unrealized gains (losses) on investments Net holding (loss) gain Tax effect Reclassification adjustment Tax benefit Minimum pension liability adjustment Tax effect Unrealized gains (losses) on derivative contracts Gains (losses) arising during the period Tax effect Reclassification adjustment Tax effect Foreign currency translation (losses) gains Net other comprehensive (loss) income Comprehensive Income See notes to consolidated financial statements. 2005 2004 2003 (millions of dollars) $1,133.2 $ 906.8 $526.5 (1.6) .6 (.5) .2 (1.3) (20.2) 7.9 (12.3) 28.5 (10.5) 9.6 (2.8) 24.8 (167.6) (156.4) $ 976.8 (1.2) .4 (13.6) 5.2 (9.2) (8.0) 2.7 (5.3) (11.9) 3.8 31.4 (12.3) 11.0 166.7 163.2 $1,070.0 9.1 (3.5) (5.7) 2.2 2.1 25.8 (8.7) 17.1 (12.4) 5.6 50.6 (19.2) 24.6 278.4 322.2 $848.7 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, 2005, 2004 and 2003 (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 provided 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 markets 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 consolidation. 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 consist of short-term liquid investments with a maturity 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 equipment, 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 during the three years ended December 31, 2005. Revenue Recognition: Substantially all sales and revenues of trucks and related aftermarket parts are 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, 2005, 2004 and 2003 (currencies in millions except per share amounts) recorded by the Company when products are shipped to dealers or customers, except for certain truck ship- ments 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). At the time certain truck and parts sales to a dealer are recognized, the Company records an estimate of the future sales incentive costs related to such sales. The estimate is based on historical data and announced incentive programs. Interest income from finance and other receivables is recognized using the interest method. Certain loan origination costs are deferred and amortized to inter- est income. For operating leases, rental revenue is recog nized on a straight-line basis over the lease term. Recog nition of interest income and rental revenue is suspend ed when management determines that collec- tion 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 accu- mulated other compre hensive income (loss), a compo- nent of stockholders’ equity. During 2005 the Company entered into forward currency contracts to hedge its net investment in for- eign subsidiaries. The gain, net of tax effects, of $45.3 on the hedges was recorded as an adjustment to the foreign currency translation component of other comprehensive income. PACCAR uses the U.S. dollar as the functional currency for its Mexican subsidiaries. Accordingly, inventories, cost of sales, property, plant and equip- ment, 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 consoli dated statements of income. Amounts charged against income were $117.8 in 2005, $103.2 in 2004 and $81.1 in 2003. 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. 37 Stock-Based Compensation: Effective January 1, 2003, PACCAR began to recognize compensation expense on all new employee stock option awards over the option vesting period, generally three years. In December 2004, the Financial Accounting Stan- dards Board issued FAS No. 123(R), Share-Based Pay- ment, which requires the expensing of all share-based payment transactions, including stock option awards. FAS No. 123(R) also requires that certain tax benefits from stock options be classified as financing rather than operating cash flows. PACCAR will apply FAS No. 123(R) on a modified prospective basis, effective January 1, 2006. The Company does not expect the adoption of FAS No. 123(R) to have a significant effect on its consolidated financial statements. Stock-based employee compensation expense (net of related tax effects) included in net income amounted to $4.4 in 2005. The following table illustrates the effect on net income and earnings per share as if the expensing of stock options had been applied to all outstanding and unvested shares in 2004 and 2003: 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 Earnings per share: Basic–as reported Basic–pro forma Diluted–as reported Diluted–pro forma 2004 $ 906.8 2003 $ 526.5 2.8 1.7 (4.0) $ 905.6 (4.7) $ 523.5 $ 5.19 5.19 5.16 5.15 $ 3.01 2.99 2.99 2.97 The estimated fair value of stock options granted during 2005, 2004 and 2003 was $21.25, $18.87 and $9.82 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: 2005 3.73% 2004 3.11% 2003 3.21% Risk-free interest rate Expected volatility of common stock 39% 3.2% Dividend yield Expected life of options 5 years 45% 3.0% 5 years 48% 4.4% 5 years See Note Q for a description of PACCAR’s stock compensation plans. PACCAR Inc and Subsidiaries 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 38 December 31, 2005, 2004 and 2003 (currencies in millions) New Accounting Pronouncements: In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (FIN 47). FIN 47 is an interpretation of FAS No. 143, Asset Retirement Obligations, and relates to the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The adoption of FIN 47, effective December 31, 2005, did not have an effect on the Company’s consolidated results of operations or financial position. Reclassifications: Certain prior-year amounts have been reclassified to conform to the 2005 presentation. B . 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 accumulated other comprehensive income until real- ized. Gross realized gains on marketable debt securities were $3.5 in 2005, not significant in 2004 and $5.1 in 2003. Gross realized losses and gross unrealized gains and losses were not significant for any of the three years ended December 31, 2005. The cost of debt securities available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity. Amortization of premiums, accretion of discounts, interest and dividend income and realized gains and losses are included in invest- ment income. The cost of securities sold is based on the specific identification method. Marketable debt securities at December 31, 2005, were as follows: U.S. tax-exempt securities Non U.S. government securities amortized cost $ 553.6 39.3 $ 592.9 fair value $ 552.7 38.7 $ 591.4 Marketable debt securities at December 31, 2004, were as follows: U.S. tax-exempt securities Corporate securities Non U.S. government securities Other debt securities amortized cost $ 194.8 187.3 203.0 19.1 $ 604.2 fair value $ 195.4 187.4 202.9 19.1 $ 604.8 The contractual maturities of debt securities at December 31, 2005, were as follows: Maturities: Within one year One to five years Five to ten years 10 or more years amortized cost $ 78.6 196.7 14.7 302.9 $ 592.9 fair value $ 78.5 195.3 14.7 302.9 $ 591.4 Marketable debt securities include $342.3 of variable rate demand obligations (VRDOs). VRDOs are debt instruments with long-term scheduled maturities which have interest rates that periodically reset through an auction process. The Company had no investments in marketable equity securities at either December 31, 2005 or 2004. Gross realized gains on marketable equity securities were $14.1 and $.7 for the years ended December 31, 2004 and 2003. C . I N V E N T O R I E S Inventories include the following: Finished products Work in process and raw materials Less LIFO reserve 2005 $ 299.3 2004 $ 270.6 330.1 629.4 (133.9) $ 495.5 353.1 623.7 (128.1) $ 495.6 Inventories are stated at the lower of cost or market. Cost of inventories in the United States is determined 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 comprised 49% and 50% of consolidated inventories before deducting the LIFO reserve at December 31, 2005 and 2004. 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, 2005, 2004 and 2003 (currencies in millions) D . 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 Unearned interest: Loans Finance leases Less allowance for losses 2005 2004 $ 3,745.9 $ 3,306.1 1,881.8 1,635.7 701.2 497.5 1,402.8 1,061.0 86.6 73.0 (103.6) (307.0) 7,407.7 (145.2) (100.6) (239.2) 6,233.5 (127.4) $ 7,262.5 $ 6,106.1 The majority of the Company’s customers are located in the United States, which represented 58% of total receivables at December 31, 2005, and 56% at December 31, 2004. Terms for substantially all finance and other receivables range up to 60 months. Repayment experience indicates that 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 $155.8 and $124.2 as of December 31, 2005, and December 31, 2004. 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 consolidated statement of cash flows since they finance the sale of company inventory. Annual payments due on loans beginning January 1, 2006, are $1,372.8, $981.9, $728.7, $456.3, $184.1 and $22.1 thereafter. Annual minimum lease payments due on finance leases beginning January 1, 2006, are $718.2, $595.4, $474.9, $362.9, $193.1 and $89.3 thereafter. Estimated residual values included with finance leases amounted to $134.4 in 2005 and $120.1 in 2004. E . 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 re ceivables is charged to income in an amount suffi- cient 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 uncollect- ible (generally upon repossession of the collateral). The allowance for losses on Truck and Other and Financial Services receivables is summarized as follows: financial services truck and other 39 Balance, December 31, 2002 Provision for losses Net losses Currency translation Balance, December 31, 2003 Provision for losses Net losses Currency translation Balance, December 31, 2004 Provision for losses Net losses Currency translation Balance, December 31, 2005 $ $ 25.9 $ 109.1 28.6 (8.6) (24.2) (4.8) 5.7 2.4 119.2 14.9 18.1 (2.2) (12.2) (1.0) 2.3 1.0 127.4 12.7 40.4 .3 (19.3) (.5) (3.3) (1.6) 10.9 $ 145.2 The Company’s customers are principally concen- trated 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 collateral- ized by the related equipment and parts. F. P R O P E RT 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 2005 2004 $ 123.6 $ 105.6 625.4 1,477.1 2,208.1 633.3 1,569.7 2,326.6 (1,183.6) (1,170.3) $ 1,143.0 $ 1,037.8 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 PACCAR Inc and Subsidiaries 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, 2005, 2004 and 2003 (currencies in millions) 40 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 The Company leases equipment under operating leases to customers in the financial services segment. In addition, in the truck segment, equipment sold to customers in Europe subject to a residual value guar- antee (RVG) is accounted for as operating leases. Equipment is recorded at cost and is depreciated on the straight-line basis to the lower of the estimated residual value or guarantee value. Lease and guarantee periods generally range from three to seven years. Estimated useful lives of the equipment range from five to ten years. The Company reviews residual values of equip- ment on operating leases periodically to determine that recorded amounts are appropriate. Truck and Other: Equipment on operating leases is as follows: Equipment on lease Less allowance for depreciation 2005 $ 493.4 (132.4) $ 361.0 2004 $ 649.0 (176.9) $ 472.1 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 obligation with the remainder of the proceeds recorded as deferred lease revenue. These amounts are summarized below: Deferred lease revenues Residual value guarantee 2005 $ 163.4 247.0 $ 410.4 2004 $ 191.5 334.7 $ 526.2 The deferred lease revenue is amortized on a straight-line basis over the RVG contract period. At December 31, 2005, the annual amortization of deferred revenue beginning January 1, 2006, is $68.1, $48.5, $28.0, $12.6, $5.2 and $1.0 there- after. Annual maturities of the residual value guarantees beginning January 1, 2006, are $71.4, $72.6, $56.8, $27.1, $16.6 and $2.5 thereafter. Financial Services: Equipment on operating leases is as follows: Transportation equipment Less allowance for depreciation 2005 2004 $ 1,130.7 $ 930.4 (214.0) $ 845.9 $ 716.4 (284.8) Annual minimum lease payments due on operating leases beginning January 1, 2006, are $225.3, $142.9, $92.4, $39.5, $11.8 and $.8 thereafter. H . 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 2005 2004 $ 983.2 $ 964.0 130.0 247.0 453.4 $ 1,834.9 $ 1,794.4 137.2 253.3 461.2 I . P R O D U C T S U P P O RT R E S E RV 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 product and the country of sale. Optional extended warranty 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 his- torical data regarding the source, frequency 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 summa- rized as follows: Beginning balance Cost accruals and revenue deferrals Payments and revenue recognized Currency translation 2005 2004 $ 348.8 $ 300.5 268.4 246.9 (228.0) (30.3) (218.6) 20.0 $ 358.9 $ 348.8 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, 2005, 2004 and 2003 (currencies in millions) Warranty and R&M reserves are included in the accompanying consolidated balance sheets as follows: Truck and Other: Accounts payable and accrued expenses Deferred taxes and other liabilities Financial Services: Deferred taxes and other liabilities 2005 2004 $ 253.3 $ 247.0 34.3 32.5 71.3 69.3 $ 358.9 $ 348.8 J . L E A S E S The Company leases certain facilities, computer equip- ment and aircraft under operating leases. Leases expire at various dates through the year 2019. Annual minimum rent payments under non-cancel- able operating leases having initial or remaining terms in excess of one year at January 1, 2006, are $32.1, $20.5, $12.5, $5.9, $3.4 and $7.5 thereafter. Total rental expenses under all leases amounted to $42.3, $34.3 and $29.9 for 2005, 2004 and 2003. K . 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 2005 2004 Truck and Other: Long-term debt: Commercial paper 5.7% $ Noninterest bearing notes Less current portion 5.7% $ 8.6 $ 16.7 20.2 28.8 (8.6) 20.2 $ 19.5 36.2 (8.4) 27.8 Long-term debt of $8.6 matures in 2006 and $20.2 matures in 2011. effective rate 2005 2004 Financial Services: Commercial paper Bank loans Term debt: Fixed rate Floating rate 4.0% $ 3,566.3 $ 2,480.0 22.0 5.0% $ 3,568.6 $ 2,502.0 2.3 7.0% $ 127.3 $ 100.5 2,530.2 2,186.1 3.6% $ 2,657.5 $ 2,286.6 41 The effective rate is the weighted average rate as of December 31, 2005, and includes the effects of interest- rate agreements. Annual maturities of term debt beginning January 1, 2006, are $1,742.2, $393.4, $388.9, $132.0 and $1.0. Maturities for 2006 include $100.0 of floating rate exten dible notes, which were issued in 2005. The extendible notes have an initial maturity of 13 months, which can be extended at the investor’s option to a final maturity of five years. Consolidated: Interest paid on consolidated borrowings was $204.0, $134.4 and $137.9 in 2005, 2004 and 2003. The weighted average interest rate on consolidated commercial paper and bank loans was 4.0%, 3.4% and 3.5% at December 31, 2005, 2004 and 2003. The primary sources of borrowings are commercial paper and medium-term notes issued in the public markets. The medium-term notes are 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 2004. On December 31, 2005, $1,300.0 of debt remained available for issuance. In September 2005, PFE registered a €1,000.0 euro medium-term note program with the London Stock Exchange. On December 31, 2005, €341.1 of such securities remained available under the program. The Company has line of credit arrangements of $1,695.1. Included in these arrangements is a $1,500 bank facility, of which $500 matures in 2006 and $1,000 matures in 2010. The unused portion of these credit lines was $1,615.2 at December 31, 2005, of which the majority is maintained to provide backup liquidity for commercial paper borrowings of the financial services companies. Compensating balances are not required on the lines, and service fees are immaterial. PACCAR Inc and Subsidiaries 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, 2005, 2004 and 2003 (currencies in millions) 42 L . E M P L O Y E E B E N E F I T P L A N S 2005 2004 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 contributed $63.7 to its pension plans in 2005 and $58.4 in 2004. The Company expects to contribute in the range of $30.0 to $70.0 to its pension plans in 2006, of which $13.5 is estimated to satisfy minimum funding require ments. Annual benefits expected to be paid beginning January 1, 2006, are $32.6, $33.0, $37.3, $40.4, $44.1, and for the five years thereafter, a total of $286.7. Plan assets are invested in a diversified mix of equity and debt securities through professional invest- ment 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 securities. The Company periodi- cally 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 Actual 2005 2004 Plan assets allocation as of December 31: Equity securities Debt securities Total 55 - 65% 35 - 45% 62.9% 37.1 63.9% 36.1 100.0% 100.0% The following additional data relate to all pension plans of the Company, except for certain multi-employer and foreign-insured plans: 2005 2004 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% 5.5% 7.4% 5.7% 4.2% 7.4% Change in Projected Benefit Obligation: Benefit obligation at January 1 Service cost Interest cost Benefits paid Actuarial loss Currency translation Participant contributions Plan amendment Projected benefit obligation at December 31 $ 935.2 40.8 52.8 (29.4) 61.0 (19.7) 3.9 $ 1,044.6 $ 799.3 32.2 48.4 (33.0) 64.8 16.7 3.8 3.0 $ 935.2 Change in Plan Assets: Fair value of plan assets at January 1 Employer contributions Actual return on plan assets Benefits paid Currency translation Participant contributions Fair value of plan assets at December 31 $ 880.3 63.7 75.4 (29.4) (20.2) 3.9 $ 763.9 58.4 77.5 (33.0) 9.7 3.8 $ 973.7 $ 880.3 Funded Status at December 31: Funded status Unrecognized actuarial loss Unrecognized prior service cost Unrecognized net initial obligation Net pension asset $ (70.9) 220.1 17.7 $ (54.9) 184.1 21.0 2.2 $ 169.1 2.2 $ 152.4 Amounts Recorded in Balance Sheet: Prepaid benefit Accrued benefit liability Intangible asset Accumulated other $ 160.3 (30.9) 6.5 $ 171.0 (39.9) 8.3 comprehensive loss Net pension asset 33.2 $ 169.1 13.0 $ 152.4 The projected benefit obligation includes $38.6 at December 31, 2005, and $33.3 at December 31, 2004, related to an unfunded supplemental plan. The accumulated benefit obligation for all pension plans of the Company, except for certain multi- employer and foreign-insured plans, was $904.9 at December 31, 2005, and $806.8 at December 31, 2004. 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, 2005, 2004 and 2003 (currencies in millions) 2005 Components of Pension Expense: $ 40.8 Service cost Interest on projected 52.8 benefit obligation Expected return on assets (64.1) Amortization of prior 2004 2003 $ 32.2 $ 27.0 48.5 (59.5) 44.2 (48.5) service costs Recognized actuarial loss Other Net pension expense 3.6 3.4 2.9 9.2 .1 $ 42.4 3.8 .2 $ 28.6 4.1 .3 $ 30.0 Pension expense for multi-employer and foreign- insured plans was $29.0, $24.9 and $19.3 in 2005, 2004 and 2003. 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 $20.6, $18.5 and $16.1 in 2005, 2004 and 2003. The Company also provides coverage of approxi- mately 50% of medical costs for the majority of its U.S. employees from retirement until age 65 as well as a nominal death benefit. The following data relate to unfunded postretirement medical and life insurance plans: Unfunded Status at December 31: Unfunded status Unrecognized actuarial loss Unrecognized prior service cost Unrecognized net initial obligation Accrued postretirement benefits 2005 2004 $ (76.7) 19.8 .6 2.8 $ (53.5) $ (69.3) 18.5 .8 3.2 $ (46.8) 2005 2004 43 Change in Projected Benefit Obligation: Benefit obligation at January 1 Service cost Interest cost Benefits paid Actuarial loss Projected benefit obligation at December 31 $ 69.3 3.6 4.2 (1.4) 1.0 $ 76.7 $ 51.2 2.6 3.7 (1.9) 13.7 $ 69.3 2005 2004 2003 Components of Retiree Expense: Service cost Interest cost Recognized actuarial loss Recognized prior service $ 3.6 4.2 1.5 $ 2.6 3.7 .7 $ 1.7 2.9 cost Recognized net initial obligation Net retiree expense .2 .1 .1 .4 $ 9.9 .5 $ 7.6 .5 $ 5.2 The discount rate used for calculating the accumu- lated plan benefits was 5.6% for 2005 and 5.8% for 2004. In 2005 the assumed long-term medical inflation rate was 12% declining to 6% over six years. In 2004 the rate assumption was 7% for all future years. Annual benefits expected to be paid beginning January 1, 2006, are $2.8, $3.2, $3.7, $4.3, $5.0 and for the five years thereafter, a total of $35.5. 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% 1% increase decrease Effect on annual total of service and interest cost components Effect on accumulated postretirement benefit obligation $ 1.0 $ (.8) $ 7.6 $ (6.6) PACCAR Inc and Subsidiaries 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, 2005, 2004 and 2003 (currencies in millions) 44 M . I N C O M E TA X E S 2005 2004 2003 Income Before Income Taxes: Domestic Foreign $ 960.3 $ 643.5 724.7 $ 1,773.6 $ 1,368.2 813.3 Provision for Income Taxes: Current provision: Federal State Repatriated earnings Foreign $ 330.7 $ 139.9 22.1 41.9 64.0 257.7 694.3 251.4 413.4 Deferred (benefit) provision: Federal State Foreign (35.7) .4 (18.6) (53.9) 64.7 6.7 (23.4) 48.0 $ 640.4 $ 461.4 $ 273.6 531.9 $ 805.5 $ 53.6 13.4 195.8 262.8 33.4 (17.2) 16.2 $ 279.0 35% 35% $ 620.8 $ 478.9 Reconciliation of Statutory U.S. Federal Tax to Actual Provision: Statutory rate Statutory tax Effect of: State income taxes Repatriated earnings Foreign income taxes Other, net 27.5 64.0 (45.3) (26.6) 18.7 35% $ 281.9 8.7 (25.7) (10.5) $ 640.4 $ 461.4 (4.6) (7.0) $ 279.0 The American Jobs Creation Act of 2004 (AJCA) created a special 85% tax deduction available during 2005 for certain repatriated foreign earnings that are reinvested in qualifying domestic activities, as defined in the AJCA. PACCAR repatriated $1.5 billion of foreign earnings in 2005. In accordance with FASB Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Pro- vision within the AJCA, a provision of $64.0 for the repatriation of foreign earnings was recorded as current income tax expense during the second quarter of 2005. United States income taxes are not provided on any remaining undistributed earnings of the Company’s foreign subsidiaries because of the intent to reinvest these earnings indefinitely. The amount of undistrib- uted earnings, which are considered to be indefinitely reinvested, is $1.68 billion at December 31, 2005. During 2005, the Company generated $50.0 in U.S. foreign tax credit carryforwards, which expire in 2015. The Company does not expect to utilize these credits, and accordingly, recorded a valuation reserve for the full amount in 2005. At December 31, 2005, the Company’s net tax operating loss carryforwards were $221.2. Substantially all of the loss carryforwards are in foreign subsidiaries and carry forward indefinitely, subject to certain limita- tions under applicable laws. The future tax benefits of net operating loss carryforwards are evaluated on an ongoing basis, including a review of historical and pro- jected operating results. During 2004, the Company’s evaluation resulted in a $9.5 reduction in the valuation reserve related to net operating loss carryforwards at its sub sidiary Leyland Trucks Ltd. in the United Kingdom. At December 31: Components of Deferred Tax Assets (Liabilities): Assets: Provisions for accrued 2005 2004 expenses Net operating loss carryforwards Allowance for losses on receivables U.S. foreign tax credit carryforward Foreign product development costs Other Valuation reserve $ 232.3 $ 210.9 64.5 81.5 50.8 43.2 50.0 41.1 71.7 510.4 (95.5) 414.9 36.3 25.3 397.2 (56.0) 341.2 Liabilities: Financial Services leasing depreciation Depreciation and amortization Pension Other Net deferred tax liability (343.9) (338.4) (91.5) (85.4) (56.2) (42.2) (68.2) (56.8) (559.8) (522.8) $ (144.9) $ (181.6) At December 31: Classification of Deferred Tax Assets (Liabilities): Truck and Other: Deferred taxes and 2005 2004 other current assets Other noncurrent assets Deferred taxes and other liabilities Financial Services: Other assets Deferred taxes and other liabilities Net deferred tax liability $ 132.4 43.6 $ 82.4 59.5 (22.1) (35.5) 27.8 28.3 (326.6) (316.3) $ (144.9) $ (181.6) Cash paid for income taxes was $722.0, $418.7 and $246.0 in 2005, 2004 and 2003. 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, 2005, 2004 and 2003 (currencies in millions) N . 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 O . 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 45 The following methods and assumptions were used by the Company in determining its fair value disclosures 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, based on quoted market prices (see Note B). Financial Services Net Receivables: For floating-rate loans and wholesale financings, fair values approximate 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 commercial paper and short-term bank borrowings and floating-rate, long-term debt approximates fair value. The fair value of fixed-rate, long-term debt is estimated using discounted cash flow analysis, based on current rates for similar types and maturities of debt. Derivative Instruments: Derivative instruments are carried at fair value. Fair values for interest-rate contracts are based on amounts that would be paid or received to terminate agreements outstanding at December 31, 2005 (see Note P). The fair value of outstanding foreign exchange contracts is the amount the Company would receive or pay to terminate the contracts. This amount is calculated using quoted market rates. Trade Receivables and Payables: Carrying amounts approximate fair value. Balance sheet captions, which include financial instruments that are not carried at fair value, are as follows: 2005 Truck and Other: Long-term debt Financial Services: Net receivables Term debt 2004 Truck and Other: Long-term debt Financial Services: Net receivables Term debt carrying amount fair value $ 28.8 $ 26.8 4,954.5 2,657.5 4,909.4 2,657.3 $ 36.2 $ 34.6 4,185.1 2,286.6 4,172.0 2,286.5 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 “poten- tially responsible party” by domestic and foreign en vironmental 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 ulti mate costs associated with future environmental cleanup can be determined, management does not expect that those matters will have a material adverse effect on the Company’s consolidated financial position. Expenditures related to environmental activities were $1.2 in 2005, $2.4 in 2004 and $1.2 in 2003. 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 $19.2 and $44.2. The Company has established a reserve to provide for estimated future environmental cleanup costs. At December 31, 2005, PACCAR had standby letters of credit of $31.3, which guarantee various insurance and financing activities. The Company is committed, under specific circumstances, to purchase equipment at a cost of $14.9 in 2006, $8.1 in 2007 and $30.1 in 2008. At December 31, 2005, PACCAR’s financial services companies, in the normal course of business, had outstanding commitments to fund new loan and lease transactions amounting to $291.4. The commitments generally expire in 90 days. The Company had other commitments, primarily to purchase production inventory amounting to $11.2 in 2006, $9.3 annually from 2007 to 2010 and $2.2 in 2011. PACCAR is a defendant in various legal proceedings and, in addition, there are various other contingent lia bilities 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. PACCAR Inc and Subsidiaries 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, 2005, 2004 and 2003 (currencies in millions) 46 P. 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 Deriva tive financial instruments are used as hedges to manage exposures to fluctuations in interest rates and foreign currency exchange rates. PACCAR’s policies prohibit the use of derivatives for speculation or trading. The Company documents its hedge objectives, proce dures and accounting treatment at the inception of and during the term of each hedge. Exposure limits and minimum credit ratings are used to minimize the risks of counterparty default, and the Company had no material exposures to default at December 31, 2005. Interest-Rate Contracts: The Company enters into various interest-rate contracts, including interest-rate and basis swaps and cap agreements. Interest-rate contracts generally involve the exchange of fixed and floating rate interest payments. 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, 2005, the Company had 401 interest-rate contracts outstand- ing. The notional amount of these contracts totaled $3,927.7, with amounts expiring annually over the next six 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 con tracts amounted to an asset of $38.0 and a liability of $9.7 at December 31, 2005. Fair values at December 31, 2004, amounted to an asset of $16.2 and a liability of $34.6. Notional maturities for all interest-rate contracts for the six years beginning January 1, 2006, are $1,306.7, $1,234.9, $914.3, $352.9, $106.9 and $12.0. The majority of these contracts are floating to fixed swaps that effectively convert an equivalent amount of commercial paper and other variable rate debt to fixed rates. The weighted average pay rate of 3.76% for the fixed rate swaps approximates the Company’s net cost of funds. The weighted average receive rate of 4.10% for fixed rate swaps offsets rates on associated debt obligations. In addition, cross currency interest-rate swaps with a notional amount of $100.3 are used to hedge both the interest rate risk and the foreign exchange risk of Mexican peso-denominated debt. Foreign Currency Exchange Contracts: PACCAR enters into foreign currency exchange contracts to hedge certain anticipated transactions denominated in foreign currencies, particularly the Canadian dollar, the euro, the British pound and the Mexican peso. Foreign exchange contracts mature within one year. PACCAR had net foreign exchange purchase contracts outstanding amounting to $321.1 and $399.6 U.S. dollars at December 31, 2005 and 2004. The fair value of these foreign exchange contracts was a liability of $.7 and an asset of $9.3 at December 31, 2005 and 2004. Derivative assets are included in the accompanying consolidated balance sheets, in Truck and Other “Deferred taxes and other current assets” and Financial 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.” Substantially all of the Company’s interest-rate contracts and all of its foreign currency exchange contracts have been designated as cash flow hedges. Gains or losses on the effective portion of derivatives designated and qualifying as cash flow hedges that arise from changes in fair value are initially reported in other comprehensive income. Gains or losses on the ineffective portion of cash flow hedges are recognized currently in earnings and were immaterial for each of the three years ended December 31, 2005. 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 or to financial services interest expense, consistent with the hedged transaction. Net realized gains and losses from interest-rate contracts are recognized as an adjustment to interest expense. Of the accumulated net gain included in other comprehensive income as of December 31, 2005, $12.3 is expected to be reclassified to interest expense in 2006. The fixed interest earned on finance receivables will offset the amount recognized in interest expense, resulting in a stable interest margin consistent with the Company’s interest-rate risk manage ment strategy. In 2005, the Company entered into cross currency interest-rate swaps in connection with its financing operations in Mexico. These instruments have been designated and accounted for as fair value hedges. Unrealized gains and losses related to these interest- rate swaps, together with changes in the fair value of the underlying debt, are recognized and recorded as an adjustment to interest expense. Ineffectiveness from these hedges was immaterial during the year ended December 31, 2005. 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, 2005, 2004 and 2003 Q . S T O C K C O M P E N S AT I O N P L A N S Stock Options Exercisable: 47 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 authorized for issuance under these plans is 20.7 million. As of December 31, 2005, the maximum number of shares available for future grants under these plans is 9.5 million. Options currently outstand- ing 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 12/31/02 Granted Exercised Cancelled Outstanding at 12/31/03 Granted Exercised Cancelled Outstanding at 12/31/04 Granted Exercised Cancelled Outstanding at 12/31/05 number of shares 4,523,300 864,100 (1,267,600) (229,600) 3,890,200 457,600 (736,100) (270,400) 3,341,300 414,600 (484,400) (101,900) 3,169,600 average exercise price* $21.88 31.40 19.31 26.45 24.56 56.95 20.78 32.66 29.18 72.25 23.59 44.05 $35.19 The following tables summarize information about stock options outstanding and exercisable at December 31, 2005: Stock Options Outstanding: range of exercise prices $11.00-18.56 22.94-23.90 28.20-31.40 56.95 72.25 number of shares 463,500 725,300 1,181,400 396,300 403,100 3,169,600 remaining contractual life in years 2.5 4.2 6.5 8.0 9.0 5.9 average exercise price* $16.28 23.29 29.96 56.95 72.25 $35.19 range of exercise prices $11.00-18.56 22.94-23.90 28.20 *Weighted Average number of shares 463,500 725,300 531,300 1,720,100 average exercise price* $16.28 23.29 28.20 $22.92 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 average basic shares outstanding to calculate diluted earnings per share. These amounts primarily represent the dilutive effect of stock options. Additional shares 2005 2003 1,103,500 1,188,600 1,218,600 2004 Options outstanding at each year-end with exercise prices in excess of the respective year’s average common stock market price (antidilutive options) have been excluded from the diluted earnings per share calculation. Antidilutive options amounted to 403,100 in 2005, 428,300 in 2004 and none in 2003. PACCAR Inc and Subsidiaries 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, 2005, 2004 and 2003 (currencies in millions except share amounts) 48 R . 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. Accumulated Other Comprehensive Income: Following are the components of accumulated other comprehensive income: Minimum pension liability adjustment Deferred tax asset Unrealized gain (loss) on derivative contracts Deferred tax (liability) asset Unrealized (loss) gain on investments Deferred tax asset (liability) Currency translation adjustment Accumulated other comprehensive income 2005 2004 2003 $ (33.2) 12.4 (20.8) $ (13.0) 4.5 (8.5) $ (5.0) 1.8 (3.2) 32.7 (5.4) (24.9) (12.0) 20.7 1.3 (4.1) 9.8 (15.1) (1.6) .5 15.3 .6 (1.0) (.2) .3 (5.8) 9.5 155.8 323.4 156.7 $ 154.7 $ 311.1 $ 147.9 Other Capital Stock Changes: During 2005 the Company acquired 5.5 million of its common shares, of which five million were retired. In 2004, the Company acquired and retired two million of its outstanding common shares. 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 paid in cash. This resulted in the issuance of 58,398,302 additional shares and 583 fractional shares paid in cash. 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, 2005, 2004 and 2003 (currencies in millions) S . 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 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 propor tion of its revenues and operating profits from operations in North America and Europe. The Financial Services segment is composed of finance and leasing products and services provided to truck customers and dealers. Revenues are primarily generated from operations in North America and Europe. Included in All Other is PACCAR’s industrial winch manufacturing business. Also within this category are other sales, income and expenses 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 $15.7, $10.8 and $9.3 for 2005, 2004 and 2003. 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. 2003 2005 2004 Geographic Area Data Revenues: $ 7,161.8 $ 5,414.2 $ 3,653.9 United States Continental Europe 2,889.5 1,928.3 1,206.7 872.3 United Kingdom 2,799.4 1,740.4 Other $ 14,057.4 $ 11,396.3 $ 8,194.9 2,640.3 1,085.6 2,256.2 Long-lived assets: Property, plant and equipment, net United States The Netherlands Other $ 443.0 $ 424.7 $ 371.8 217.5 304.1 $ 1,143.0 $ 1,037.8 $ 893.4 276.8 336.3 308.4 391.6 Goodwill and other intangibles, net The Netherlands $ 105.7 $ Other 1.3 $ 107.0 $ 122.7 $ 121.2 1.2 124.0 $ 122.4 1.3 Geographic Area Data Equipment on operating leases, net 2005 2004 2003 49 United States United Kingdom France Other $ 400.7 $ 340.9 $ 198.7 301.8 155.3 310.0 $ 1,206.9 $ 1,188.5 $ 965.8 278.8 157.0 411.8 206.6 130.7 468.9 Business Segment Data Net sales and revenues: Truck Total Less intersegment (363.3) External customers 13,196.1 102.3 All Other 13,298.4 759.0 Financial Services $ 13,559.4 $ 11,081.8 $ 7,894.3 (233.1) 7,661.2 59.9 7,721.1 473.8 $ 14,057.4 $ 11,396.3 $ 8,194.9 (319.5) 10,762.3 71.4 10,833.7 562.6 Income before income taxes: Truck All Other Financial Services Investment income (3.4) 1,516.8 199.9 56.9 $ 1,520.2 $ 1,145.0 $ 655.4 (14.8) 640.6 123.6 41.3 $ 1,773.6 $ 1,368.2 $ 805.5 (5.1) 1,139.9 168.4 59.9 Depreciation and amortization: Truck Financial Services All Other $ 190.3 $ 182.1 $ 174.1 83.3 10.1 $ 370.1 $ 315.0 $ 267.5 124.0 8.9 166.6 13.2 Expenditures for long-lived assets: Truck Financial Services Other $ 419.3 $ 222.7 $ 127.2 228.1 14.0 $ 848.5 $ 633.5 $ 369.3 386.1 24.7 413.7 15.5 Segment assets: Truck Other Cash and marketable $ 2,955.8 $ 2,889.3 $ 2,470.6 163.3 174.5 187.9 securities Financial Services 2,215.8 1,700.3 5,359.5 4,334.2 8,355.9 5,605.4 $ 13,715.4 $ 12,228.0 $ 9,939.6 2,184.1 5,247.9 6,980.1 PACCAR Inc and Subsidiaries 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 50 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 provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements 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, 2005, 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, 2005. 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, 2005 and 2004, 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, 2005. 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, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, 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, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Or ganizations of the Treadway Commission, and our report dated February 17, 2006, expressed an unqualified opinion thereon. Seattle, Washington February 17, 2006 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 51 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, 2005, 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 assurance 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 management’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 purposes 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 reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide 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 company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, 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 misstatements. 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, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, PACCAR Inc maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, 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, 2005 and 2004, 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, 2005, of PACCAR Inc, and our report dated February 17, 2006, expressed an unqualified opinion thereon. Seattle, Washington February 17, 2006 PACCAR Inc and Subsidiaries S E L E C T E D F I N A N C I A L D A T A 52 2005 2004 2003 2002 2001 Truck and Other Net Sales and Revenues $ 13,298.4 $ 10,833.7 $ 7,721.1 $ 6,786.0 $ 5,641.7 Financial Services Revenues 759.0 562.6 473.8 432.6 458.8 (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 $ 14,057.4 $ 11,396.3 $ 8,194.9 $ 1,133.2 $ 906.8 $ 526.5 $ 7,218.6 $ 372.0 $ 6,100.5 $ 173.6 6.60 6.56 2.87 5,359.5 8,355.9 20.2 6,226.1 3,901.1 5.19 5.16 2.75 3.01 2.99 1.37 2.15 2.13 1.00 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 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 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 be low reflects the range of trading prices as reported by NASDAQ and cash dividends declared. There were 2,187 record holders of the common stock at December 31, 2005. quarter First Second Third Fourth Year-End Extra cash dividends declared $ .20 .21 .21 .25 2.00 2005 stock price high $81.38 74.04 76.61 73.59 low $68.50 63.84 66.21 63.30 cash dividends declared $ .15 .20 .20 .20 2.00 2004 stock price high $59.82 60.70 69.25 81.42 low $49.61 51.00 52.95 62.00 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. 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 ) 2005 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 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 (3) Net Income Per Share (2): Basic Diluted first second third fourth 53 quarter (millions except per share data) $3,154.6 $3,372.9 $3,345.4 $3,425.5 464.9 171.4 75.1 274.0 496.5 182.5 80.0 241.5 502.9 195.6 83.2 304.8 493.6 209.5 86.9 312.9 $ 1.57 1.56 $ 1.40 1.39 $ 1.79 1.78 $ 1.85 1.83 $2,374.3 $2,653.4 $2,774.7 $3,031.3 330.8 127.0 59.6 182.2 398.2 133.4 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 (1) Second quarter net income includes a $64.0 income tax provision for repatriation of foreign earnings. (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. (3) Fourth quarter net income includes $23.3 for costs associated with the termination of an agreement regarding distribution of Leyland parts in the United Kingdom and $5.4 for a gain on the sale of real estate. Third quarter net income includes a $9.5 tax benefit related to higher expected utilization of net operating loss carryforwards in the United Kingdom. PACCAR Inc and Subsidiaries 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) 54 Interest Rate Risks – See Note P for a description of the Company’s hedging programs and exposure to interest rate fluctuations. The Company measures its interest rate risk by estimating the amount by which the fair value of interest rate sensitive assets and liabilities, including derivative financial instruments, 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: 2005 2004 $ (6.1) $ (9.9) Long-term debt Interest rate swaps related to commercial paper classified as long-term debt .6 (0.1) .7 .2 F I N A N C I A L S E RV I C E S : Assets Loans and wholesale financing, net of unearned interest, less allowance for losses Liabilities Term debt Interest rate swaps related to financial services debt Total (46.7) (40.2) .9 54.6 $ 3.2 .9 45.0 $ (3.3) Currency Risks – The Company enters into foreign exchange forward contracts to hedge its exposure to exchange rate fluctuations of foreign currencies, particularly the Canadian dollar, the euro, the British pound and the Mexican peso (See Note P for additional information concerning these hedges). The Company uses a sensitivity anal- ysis to evaluate its exposure to foreign currency exchange rate fluctuations. This analysis measures the potential gain or loss in the fair value of forward contracts based on a percentage increase or decrease in exchange rates relative to the U.S. dollar. A hypothetical 10% weakening of the U.S. dollar relative to all other currencies would result in a potential unrealized loss of $31.3 related to contracts outstanding at December 31, 2005, compared to $17.9 at December 31, 2004. These amounts would be largely offset by changes in the values of the underlying hedged exposures. O F F I C E R S A N D D I R E C T O R S 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 Senior Vice President Ronald E. Armstrong Vice President and Controller David C. Anderson Vice President and General Counsel Richard E. Bangert, II Vice President Robert J. Christensen Vice President Aad Goudriaan Vice President Timothy M. Henebry Vice President William D. Jackson Vice President 55 Thomas A. Lundahl Vice President Helene N. Mawyer Vice President Janice B. Skredsvig 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 D I R E C T O R S Mark C. Pigott Chairman and Chief Executive Officer PACCAR Inc (3) Alison J. Carnwath Chairman, Management Board ISIS Equity Partners, LLP (2) John M. Fluke, Jr. Chairman Fluke Capital Management, L.P. (1,2) David K. Newbigging OBE Chairman Talbot Holdings Limited (2,4) James C. Pigott President Pigott Enterprises, Inc. (3,4) Stephen F. Page Retired Vice Chairman and Chief Financial Officer United Technologies Corporation (1,4) Robert T. Parry Retired President and Chief Executive Officer Federal Reserve Bank of San Francisco (2) William G. Reed, Jr. Retired Chairman Simpson Investment Company (1,3) Michael A. Tembreull Vice Chairman PACCAR Inc Harold A. Wagner Retired Chairman Air Products and Chemicals, Inc. (1) 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 D I V I S I O N S A N D S U B S I D I A R I E S 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 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 PacLease Méxicana S.A. de C.V. Kilometro 10.5 Carretera a San Luis Mexicali, Baja California Mexico PACCAR Financial Services Ltd. Markborough Place I 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 W I N C H E S PACCAR Winch Division 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 56 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 I 6711 Mississauga Road N. Mississauga, Ontario L5N 4J8 Canada Factory: Ste-Thérèse, Quebec Canadian Kenworth Company Division Headquarters: Markborough Place I 6711 Mississauga Road N. Mississauga, Ontario L5N 4J8 Canada Peterbilt of Canada Division Headquarters: Markborough Place I 6711 Mississauga Road N. Mississauga, Ontario L5N 4J8 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 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, on- and off-road Class 8 trucks sold around the world under the Kenworth, Peterbilt and DAF nameplates. The company competes in the North American 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 Class 6-7 trucks in the Netherlands and Belgium for sale throughout Europe, the Middle East and Africa and distributes Class 4-7 trucks in Europe manufactured by Leyland Trucks (UK). PACCAR manufactures and markets industrial winches under the Braden, Gearmatic and Carco nameplates and competes in the truck parts aftermarket through its dealer network. Finance and Leasing subsidiaries facilitate the sale of PACCAR products in many countries worldwide. Significant company assets are employed in financial services activities. PACCAR maintains exceptionally high standards of quality for all of its products: they are well-engineered, are highly customized for specific applications and sell in the premium segments of their markets, where they have a reputation for superior performance and pride of ownership. C O N T E N T S 1 Financial Highlights 2 Message to Shareholders 6 PACCAR Operations 22 Financial Charts 23 Management’s Discussion and Analysis 31 Consolidated Statements of Income 32 Consolidated Balance Sheets 34 Consolidated Statements of Cash Flows 35 Consolidated Statements of Stockholders’ Equity 36 Consolidated Statements of Comprehensive Income 36 Notes to Consolidated Financial Statements 50 Management’s Report on Internal Control Over Financial Reporting 50 Report of Independent Registered Public Accounting Firm on the Company’s Consolidated Financial Statements 51 Report of Independent Registered Public Accounting Firm on the Company’s Internal Controls Selected Financial Data 52 52 Common Stock Market Prices and Dividends 53 Quarterly Results 54 Market Risks and Derivative Instruments 55 Officers and Directors 56 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 Delivery of Annual Report and Proxy Statement PACCAR’s 2005 Annual Report and the 2006 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, INLINE, Kenworth, Leyland, MIRREX, PACCAR, PacLease, Peterbilt and ROADLEVELER 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 25, 2006, 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. 2 0 0 5 A N N U A L R E P O R T 

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