Earnings Call: Q3 2013

Oct 29, 2013

Summary

Q3 net income rose 32% YoY to $309M, while Parts and Financial Services delivered record results. Q4 deliveries were expected to rise ~5%, led by Europe’s regulatory pre-buy, with higher production supporting gross-margin improvement.

Good morning, and welcome to Paccar's third quarter 2013 earnings conference call. All lines will be in a listen-only mode until the question and answer session. Today's call is being recorded, and if anyone has an objection, they should disconnect at this time. I would now like to introduce Mr. Robin Easton, Paccar's Treasurer. Mr. Easton, please go ahead. Good morning. We would like to welcome those listening by phone and those on the webcast. My name is Robin Easton, Treasurer of Paccar. Joining me this morning are Mark Pigott, Chairman and Chief Executive Officer, Ron Armstrong, President, Bob Christensen, Chief Financial Officer and Executive Vice President, and Michael Barkley, Vice President Controller. As with prior conference calls, if there are members of the media participating, we request that they participate in a listen-only mode. Certain information presented today will be forward-looking and involve risks and uncertainties, including general economic and competitive conditions that may affect expected results. I would now like to introduce Mark Pigott. Good morning. Paccar reported good revenues and net income for the third quarter of 2013. Paccar's third quarter sales and financial services revenue were $4.3 billion, and quarterly net income was $309 million, an after-tax return on revenues of 7.2%. This is the best after-tax return on revenue in five years. Net income increased 32% compared to the results generated in the third quarter last year. I am very proud of our 22,700 employees who have delivered industry-leading products and services to our customers worldwide. Paccar's third quarter truck results reflect improved industry truck sales in North America and Europe compared to the third quarter last year. Paccar is in the final stages of the largest new truck and engine family launch in our history. In the next six weeks, we will begin production of our new vocational vehicles, the Peterbilt Model 567, the Kenworth T880, and the DAF CF Euro 6. In addition, we will begin production of our new MX-11 diesel engine for Europe. Our new assembly plant in Brazil began producing DAF trucks in early October and will gradually increase production over the next 18 to 24 months. The Brazil truck market greater than six tons for next year is estimated to be approximately 150,000 units. I am also pleased to note that Paccar is manufacturing trucks on every continent except Antarctica. Our customers and dealers are very excited about the many new vehicles and services that Paccar is delivering to the market. Paccar delivered 35,400 trucks during the third quarter, a 2% increase versus the second quarter and in line with our projections. The U.S. and Canadian Class 8 industry truck retail sales are estimated to be in the range of 205,000 to 215,000 units this year. The U.S. and Canadian Class 8 industry truck sales next year are expected to improve to be in the range of 210,000 to 240,000 units, reflecting ongoing replacement demand and some expansion of industry fleet capacity. European truck orders jumped in the third quarter as customers purchased trucks ahead of the January 1, 2014, implementation of the Euro 6 environmental regulations. Third quarter DAF truck orders increased by 70% compared to a year ago and were up 16% compared to the second quarter. In Europe, the greater than 16-ton truck market is projected to be in the range of 215,000 to 225,000 units this year. DAF deliveries in the fourth quarter will benefit from the pre-buy. I'd also like to note that DAF's new Euro 6 vehicles are receiving very good industry reviews, and customers are pleased with the new products. Looking at the industry, it's anticipated that the greater than 16-ton European truck market next year will be in the range of 200,000 to 230,000 vehicles. Paccar's truck deliveries worldwide in the fourth quarter are expected to increase by about 5% compared to the third quarter. Fourth quarter gross margins should improve compared to the third quarter, reflecting higher truck production. There are also a number of encouraging economic indicators in North America that should benefit truck demand. First, residential and commercial construction activity is improving. Housing starts in the U.S. are projected to be approximately 900,000 units this year. Second, North American auto production is expected to be over 15 million vehicles this year. Third, freight tonnage in the U.S. is at a seasonally adjusted record level. These economic improvements have enabled our dealers and customers to generate strong results. Paccar Parts business generated record quarterly revenues of $715 million, an increase of 10% compared to $650 million in the same quarter last year. Paccar Parts quarterly pre-tax income was $107 million, an increase of 20% compared to $89 million earned in the third quarter last year. The excellent results were driven by strong freight tonnage and improved fleet utilization. Paccar Financial Services revenue were $294 million in the third quarter, compared to $274 million in the third quarter last year. Paccar Financial third-quarter pre-tax income was a record $88 million, compared to $80 million earned last year. The excellent results benefited from growth in asset balances and the continuing strong portfolio performance. Paccar's capital spending is estimated to be $425 million to $475 million this year. In 2014, capital investment is estimated to be $350 million to $400 million. Research and development expenses this year are estimated to be $250 million to $260 million, while next year R&D will be in the range of $225 million to $275 million. The positive contribution of all of the company segments has enabled Paccar to attain the highest operating margins in our industry, and to deliver excellent shareholder returns while investing during all phases of the business cycle. Paccar's average annual shareholder return over the last decade was 13.1%. Shareholder return is 24.5% through September this year. Paccar continues to enhance its leadership position in the global truck market by launching many new products and services, and by continuing to invest in new geographic regions. Thank you. I'd be pleased to answer your questions. At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Your first question comes from the line of Jamie Cook from Credit Suisse. Morning, Jamie. Hello. His question has been withdrawn. Your next question comes from the line of Stephen Volkmann from Jefferies. Morning, Steve. Hi, Mark. Okay. I know you are. Was wondering if we could dig into the margins a little bit. Versus my model, they were a little better than I expected, which is great, obviously. Good news. Yeah, of course. Was curious if you might be able to bucket for us what's starting to go right on the margin front, and how sustainable we think this is going to be. Well, we indicated that we estimate the margins in the fourth quarter should be a little bit better than the third quarter. We have come out with a lot of new products this year, as you're aware, and we're starting to see some benefit from that. Also, our customers over the last few years have done pretty well, so there might be a slight improvement in industry pricing. Working with our suppliers on reducing some supplier costs is having a benefit. So I think all in all, those are probably three primary reasons. Is there any reason that any of those things should not continue to sort of improve as we get into 2014? I think we're working hard on all three of those main avenues to continue that positive trend. Okay, great. Can I just ask you your view on what's happening in Europe, and I guess specifically, obviously sort of some eye-popping numbers on the DAF orders this quarter. Do we pay all that back in the first quarter next year, or how do you think that unfolds? I think that order intake, we obviously have had some very good success, as I think the entire industry has in terms of the pre-buy. There's a couple other elements to consider. One, we're still waiting, as the whole industry is, for Germany to share their thoughts on any Maut discount. So they look at that as a bit of an incentive to purchase Euro 6. We expect that in the next month or so. So that'll be a benefit for the industry. I think in terms of orders, we're finding very good success with our customers on acceptance of the Euro 6 vehicles. They perform well, they have good fuel economy, they're attractive and continue to lower the cost of operation for our customers. So we take that as a good sign. You have to overlay that with what's happening throughout the Eurozone and some of the challenges ongoing. The U.K. is having a remarkable uptick in their economic performance, and that's a strong market for DAF. We're looking forward to next year. We've got great products. We continue to add dealers. We're growing in Central Europe, we're growing in Russia, we're growing in Turkey. So there's a lot of positive momentum for DAF. So just to be clear on that, you're saying you have some reasonable orders for Euro 6 trucks already? Yes, we do. Yes. Great. Absolutely. Appreciate it. Good questions. Your next question comes from the line of Jamie Cook from Credit Suisse. Hi, can you hear me this time? Welcome back. Oh, thank you. Just a clarification. When I think about your margin performance in the quarter, your operating margins improved sequentially. Your gross profit improved, I think, year-over-year, but sequentially, it was just sort of flat. When you think about where we should see the margin improvement, do you see going forward it improving more on sort of the gross profit or margin line or on the operating margin line or both? Then I just guess my second question, on the pricing environment as we look to 2014, do you think you will be able to pass through the full cost of the Euro VI price increase? Then also your view on your ability to hold price and market share with Navistar, with the Cummins engine back in the market. Thanks. Okay. Well, with respect to the question about gross profit, when we talked about margins in the opening comments, we were talking about the gross profit will benefit in the fourth quarter from the higher production levels. Okay. That will pass through to the operating profit line. With respect to Euro VI, Euro VI does have a cost uptick, and we're working with our customers and trying to realize the potential of the product. The product is great. The customers have received it very well, and we're excited about being able to offer that in the European market as we begin next year. Then your final question about market share. Of course, we're, and have been for 108 years, are focused on high quality and great returns to our shareholders. There's always competitors. Each of them have their own unique approach to the marketplace. They come, they go. Sometimes they even come back, when you think they're gone. I'm sure that we'll continue to have good share and great support from our customers. Okay, thanks. I'll get back in queue. Thanks, Jamie. Your next question comes from the line of Andy Casey from Wells Fargo. Morning, Andy. Morning, Mark, everybody. Couple questions. In the North American market, I am trying to reconcile the difference between what we are seeing in some of the very strong indicators and industry orders up through September. We are hearing a lot of mixed signals from some of your North American customers. I am just wondering if the normal order acceleration took hold so far in October. We are seeing some improvement in October. I think you have accurately summarized the economic environment in, let us call it, the U.S. and Canada. I think Mexico is a separate market again. There is a lot of different types of signals facing our customers and their end customers. We are looking for some general economic growth to kick in, and that is more than just the trucking industry. We are seeing some improvement in orders. Once again, we have got a whole new range of Kenworth and Peterbilt products that have been well-received, and our Paccar engine is doing well. Our customers are making money. Some of them are not making as much money as they did a year ago. There are different industry factors affecting that. Overall, if we have some positive GDP growth, which we are this year, and we hope to have an improved GDP next year, it should benefit all of us. Okay. Thanks, Mark. You bet. Flipping over to Europe, if I could. The orders, as Steve had said in a prior question, quite impressive. Did you continue to see most of the Euro V pre-buy, meaning against the Euro VI standard next year, happening in the U.K., or did that spread out into some other regions? No, it was throughout Europe. Okay. Absolutely. Okay. Thank you very much. Good. Thank you. Appreciate it, Andy. Your next question comes from the line of Ross Gilardi from Bank of America. Hi, Ross. Yeah, good morning. Thank you. Could you just talk a little bit more about your expectation for Q4, I think for sales to be up 5%, how that would split out between the U.S. and Europe? Well, I think on the truck side, I think we'll see most of the improvement will be in Europe because of the benefits from the, let's call it, the pre-buy. U.S. and Canada would be sort of in line with what's been going on. There's a few less production days during the quarter. Then, of course, we have the parts and finance business, which continue to perform well and are achieving many record levels, and they're working hard to keep that going. When you think about a 70% increase in orders, which is just a staggering number in Q3 for DAF, I mean, how are you positioned from a capacity perspective to fulfill those orders by the end of the year? Can you actually deliver some of those orders in 2014? Well, we have increased our production rates about four times in the last two months, to meet that increased demand. Even at the production rates we're at now, they're still a little bit lower than we were back in 2007, 2008. So we do have the capacity infrastructure. Obviously, it takes a lot of coordination, working with our suppliers, very good suppliers. Because they've got to ramp up, recognizing that The first quarter next year will return to more normal levels. There is very much of an integrated logistics approach here. I guess what I am getting at is could some of that 70% increase in order intake spill over into the 2014 year? Not per the guidelines that each of the countries have. The good news is that we are getting a very good response on the Euro VI vehicles, and that is certainly the focus now of our customers and our dealers who have been processing, as you have indicated, a lot of Euro V, and that has pretty much come to a conclusion, and now people are saying, "Hey, I love these DAF Euro VI vehicles, and let's start selling those and getting those in the factory." We are filling up the first quarter with Euro VI. Also, the Euro V will continue to be a factor outside of Western Europe. Russia, Turkey, Middle East, Africa, Australia, China, Taiwan. That will still be an ongoing contribution to our production through next year and actually for probably two or three years. Okay. Thank you. Then just lastly on Brazil, how are you progressing with assembling your dealer network, and do you feel, obviously, the long-term opportunity is enormous, but do you feel like the mood has changed at all given some of the concerns on the Brazilian economy? No, we don't feel that the mood has changed at all. In fact, the heavier side of the Brazilian business is actually performing quite well. We're very encouraged with the way things are developing on our project in Brazil. The dealer body is very active constructing their new facilities, training their people. This week, all of our dealers are participating in the Fenatran Show in South America, and we expect to gradually improve our deliveries in Brazil over the next 12 months. Yeah, it's exciting times, and truck market in Brazil is continuing to grow. We registered our first group of DAF trucks a month or so ago, so that was a memorable highlight. The factory is good. I think there's videos and pictures on the internet. So it's going very well, and we'll be there next 50, 100 years. We're looking forward to it. Thanks very much. Best of luck. Thanks, Ross. Your next question comes from the line of Andrew Kaplowitz from Barclays. Good morning there. Hi, Andrew. How you doing? Pretty good. Mark, in the first half of the year, you guys saw a decent pickup in vocational truck activity. Can you talk about whether you've seen follow-through in that activity or maybe any fall off, that construction maybe was a little bit soft in the summer? Yeah, vocational, as you indicated, we have seen some improvement, and we're also very excited about launching our new vocational products here in the next six weeks, Kenworth, Peterbilt, and DAF, which I think will give us a nice boost, and certainly our dealers and customers are looking forward to it. There has been a little bit of slowdown in some of the vocational markets, but there's still a lot more demand than there was a year ago, so we're taking advantage of that. When we go to the vocational shows, we talk with our end customers. They haven't been purchasing for a number of years, so they're excited to be back in the market, and they're very excited by the new products that we're launching. Okay, Mark, that's helpful. Maybe just a follow-up on other previous questions. How do you plan for production in the E.U., given the spike you're seeing here, and then next year you're forecasting relatively flattish market. Does that mean that the second half of this year is somewhat flat with the first half of next year, but you'll have lumpiness within that production? Do you understand what I'm saying? I do. It's a great question. First of all, well, you plan it as far in advance as you can, and it's obviously an integrated program with our suppliers, as I mentioned earlier. In terms of the production for the second half versus the first half, I think the second half will be higher production than the first half. I don't know, I wouldn't consider it lumpiness. I consider it an opportunity to make more trucks. I think that's helpful. Yeah. Thank you. Good. Thanks. Good question. Your next question comes from the line of Ann Duignan from J.P. Morgan. Anne, good afternoon. Good afternoon. Hey. Just to be clear, I know this question's gotten asked 100 times different ways, but from everything you've said, Mark, we should be putting +70% in our models for DAF for fourth quarter. Is that correct? No. No, that is not correct. It is a nice thought. No, we are talking about overall 5% for the company. That is our shared guidance. Right. DAF specifically, you are saying orders are up 70%, and they have to be delivered before year-end. They are up compared to a year ago. Exactly. We have also increased through this year, so you have to take a look at the increase from the second quarter of DAF, which were up 16%. Then obviously the rest of the world, some are going up, some are going down. So overall for Paccar, it is 5%, which is a very good, robust number, I believe. Oh, okay. It seems a little conservative. Then just the cynic in me wants to say, if customers are so excited about the Euro 6, why are we seeing any pre-buying at all? You've been in this industry quite a long time. It's just the industrial pre-buy psychology. That's what people do. Obviously, there is a price increase in the marketplace of between 10,000 and EUR 15,000. So if you're a customer and that's a major consideration, you have to make the best business case for your own business. That's typically why we see a pre-buy. Yeah. Okay. I was being cynical. Your dealers in Europe, can you talk a little bit about, where do the used trucks go? I've heard some dealers in Europe articulate some concern that once these Euro 6 trucks roll out and come back to the dealers, they lose a lot of their potential used equipment sales markets, because a lot of European used equipment goes to Eastern Europe, goes to Africa, places that don't have ultra-low sulfur diesel. Are your dealers talking about that at all as a potential issue three, four years down the road? There's some very minor discussion, but I think as you pointed out, it is three, four, five, six years down the road. Each country, and we're in 100 countries around the world, is proactively trying to meet North American and European environmental regulations. So I would expect that a number of years down the road, there'll be more regions of the country that are adopting almost a global environmental standard. I think that the used trucks will have many happy homes wherever they go. Okay. Just finally, real quick, in Brazil, are you hearing anything about higher interest rates or the potential for no FINAME next year, given the fact that we have an election and interest rates are rising? What are you guys hearing from feet on the street down there on FINAME? We're expecting the program to continue into 2014, but perhaps at slightly higher rates. Okay. That was easy. Thank you, guys. I'll get back in line. Thank you. Your next question comes from the line of Seth Weber from RBC Capital Markets. Good morning, Seth. Hey, good morning. How are you? Pretty good. Hope you're doing fine. Doing fine. Thank you. Just going back to the Europe production ramp in the fourth quarter. How do you address that? Will you be hiring temporary employees? How should we think about the expenses related to managing that production? Yeah, we do flex our employment rate, utilizing some temporary workers. That's a pretty common industry practice, and been going on for quite a few years. It works well for everybody. As I've indicated, the production increase from, let's call it second to third quarter, it's probably 5%-7% for DAF, and then we'll continue to increase that. So I think the 70%, we're very pleased to get the number of orders, but I don't think that should be taken as a standalone number in terms of production increase. Sure. No, I understand. I'm just trying to understand if your expenses may flex up here in the fourth quarter, do they then come back down in the first quarter? Well, they move sort of in sync with our truck production. Obviously, we're selling more trucks, we're manufacturing more trucks, and Sure you need more material and labor in order to produce those trucks. It moves in sync and don't take it anything. It's very normal. It's not out of bounds with the normal. Very normal. Okay. Then just on Brazil, can you just remind us maybe what your market share targets are for that market over maybe 2014 and over the next couple of years? Over the next couple of years, as I shared in my opening comments, we are just looking for steady gradual growth, sort of 18 to 24 months. Longer term, as we have said in a number of press releases, we would like to achieve 20% share, which is our target in all of our markets. But it is early days. We are pleased to beginning the production of DAF Trucks, and we are just beginning the whole process, so steady as she goes. Okay, fair enough. Thank you very much. Thanks, Seth. Your next question comes from the line of Jerry Revich from Goldman Sachs. Morning, Jerry. Good morning, good afternoon. Good afternoon. Mark, can you talk about your parts business really strong acceleration this quarter on a year-over-year basis, excellent performance. Can you just give us some context, which regions were up more than others? How broad-based is that? Sure. I think the parts team have done a remarkable job, and you look at a couple of things of why they've been able to achieve that. First, we have the largest population of Paccar vehicles in our history out running around between 1.5 and 2 million vehicles, Kenworth, Peterbilt, and DAF trucks. Second, we've got the most dealers in our history. Third, we've increased share over the last number of years from, let's call it, 22% to almost 30% in North America, and in Europe from, well, certainly 10% to 16%. You just have a lot more activity out in the marketplace. Complementing that, the parts group has been very innovative in developing their TRP, their all-makes brand. They're also working with customers you typically wouldn't think of, whether it's the bus market or gen sets or industrial equipment who need parts. They really had a broad approach to the parts marketplace. We continue to add our distribution centers. I know a number of companies seem to get a lot of press when they add distribution centers. Well, we're adding distribution centers. Just opened up our largest one in the last year in Eindhoven, 280,000 sq ft. We just opened up a new one in Brazil. We just doubled the size of one in Lancaster, Pennsylvania. So if you take all of those very positive investments and approaches, and the result is you've got a parts business that is continuing to grow and generate good returns. And just using it as a proxy to understand where your customers are doing better than in other regions, is it stronger in Europe versus North America? Is it possible to break that out on a year-over-year basis? I think North America is a little bit stronger. Europe is improving, but it has a little bit of the flavor of some economic challenge. But it's good all the way around the world. Mark, in North America, can you talk about, based on your conversations with customers, how you expect the order cadence to play out over the next couple of quarters? I know you folks are the first to adjust your build rates to any changes in customer demand trends. I am wondering, how do you see beyond 4Q, based on your customer conversations, how are the discussions going relative to your planned 4Q build rates? Sure. In North America, the discussions are going very well. As Mark indicated, generally our customers, their utilization rates are high. Rates are maybe not as great as they would like, but they are definitely looking at replacing the fleet and looking for some growth with economic growth. Okay. Lastly, Mark, you mentioned about the ramp hire in Europe that you are executing here. How difficult is it to transition into the first quarter? I know you folks have done it countless times, but just help us understand how complex is that process and how challenging will the margin profile be in the first quarter if it will be challenging. Well, I think the teams are very used to the ebb and flow of the industry and do it very, very well. We have a lot of great people working in. Obviously, we also have a lot of good systems, whether it is the Paccar production system, and we are also a leader on Six Sigma. So I think in just terms of building more trucks or building less trucks, that is part of what our team does. I think the first quarter will probably be more in line with the rest of the year, excluding the pre-buy. So we are looking for a reasonable quarter. Thank you very much. Thank you. Good question, Jerry. Your next question comes from the line of Joel Tiss from Bank of Montreal. Hi, Joel. How's it going? Pretty good. I've been wondering why your stock's down all day, but now I know you don't make any trucks in Antarctica. There's an opportunity there, Joel. Yeah. I just wonder if you could give us a sense of the cost that you spent throughout 2013 on your expansion that might be going away as we go into 2014. Well, we've kind of shared the R&D and the CapEx, and I think that shows a slight reduction, which reflects a lot of these projects coming to fruition. I think the other one is, as we begin to ramp up Brazil, there should be some benefit from the reduction or the elimination of startup and construction costs. We've got a great factory there, and it's starting to build trucks, so I think that'll have some benefits for the company. As you look out, say, over the next couple of years, you still have quite a bit of cash. You're generating a lot of free cash flow. You've done your Brazilian project. Can you give us a sense of what's in the planning stages, or what are you thinking about over the next 5 years areas to expand into? Well, we want to obviously keep all of our products leading edge. So that's an ongoing program for any company in the automotive industry. We also want to continue to expand our services. We've got great success with our finance and lease operations, which we see has more opportunities. Then you've got all of Asia, which we've had good success. We've been there for many decades, but it's still a relatively small contributor to our overall profits and sales. So that's got to be an area and a region that has a lot of potential, if we can do it in a correct manner, and we've had a lot of time to study it. That is for sure. All right, thank you very much. Thank you, Joel. Your next question comes from the line of Steven Fisher from UBS. Good morning, Stephen. Hi, good morning. Regionally, the other category in the quarter, I think it was down about 20% year-over-year. Can you just talk about what drove that? Okay, you bet. Most of that was currency movements. Okay, so the underlying organic, was that up? Our winch business was down a bit. Okay. Then, I guess separately, can you just give us a sense of how many weeks of production you have in backlog today? Then should we expect that that would come down as you deliver the European pre-buy over the course of the quarter? We don't typically break out weeks of production. But I think in line with the rest of the European industry, we're essentially sold out in Europe through the end of the year. The rest of our production backlog is in line with what's going on in the industry. Okay. Then maybe lastly, can you just remind us how many units you expect to ship out of Brazil in the fourth quarter? I don't think we've actually ever broken that out. It's just early days. It's just ramping up the factory at this time. I thought the number was somewhere around like a few hundred. Does that sound order of magnitude? Oh, I think it's in that range, yes. Okay. Good. Great. Thank you. Thank you, Stephen. Your next question comes from the line of Rob Wertheimer from Vertical Research. Good morning. Good morning, everybody. Just a quick question on R&D. I know we asked you this, Mark, on last call, and you said you might get some small benefit. We've had two quarters of decently low R&D. Are you going to be in a mode where you're able to harvest a lot of the good investment you've made over the past couple of years and stay at this level, or will it bounce back up? Well, we've indicated for next year that we see R&D and CapEx will be slightly lower than what we're doing this year. But it's a very exciting industry. You've got to keep investing. There's always opportunities to come out with new products. We also have different regulatory programs that we're working with in different parts of the world. Greenhouse gas comes to mind, new engine, and powertrain regulations. So that all takes certainly a fair amount of capital and R&D. So I think in terms of harvesting, we look for these wonderful new products and services to generate good returns for our customers, our dealers, and ourselves. That'll be the harvest, the bountiful harvest. Thank you. Just one minor one. Did turning on the Brazil plant make any impact on gross margin either this quarter or will it next? No, not really, no. I invite you to tour the plant. It is up and running. It is really looking good. Excellent. Would love to. Thank you. Thank you. Your next question comes from the line of Alex Potter from Piper Jaffray. Good morning, Alex. Hi, guys. How are you? Pretty good. I was wondering if you could break out the percent of your production in Q4 that you think is going to be Euro 6 compliant versus Euro 5. Well, it'll be a portion. We probably won't break that out, but we are making Euro 6 product in Q4, and it's going well. Okay. It's a minority. Sure. Right. Okay. Fair enough. I was just wondering also, kind of a philosophical question, on 15 liter versus 13 liter in the North America, I guess Yes trucking market in general. Not just for your company specifically. I know that you guys are making your vertically integrated with regard to the 13. So trying to push production of the 13 or sales of the 13, you have an incentive to do that. But industry-wide, do you think you're seeing a shift, I guess, more regionalization among trucking companies and more preference as a result for the 13 liter? That's a great topic. I'm glad you raised that. Right now, and we've seen this trend over the last five years, the 13 liter is about the same as the 15 liter in terms of industry market share. That's for the whole industry. It's interesting that there have been more new 13-liter engines introduced over the last two years than 15-liter from anybody in the industry. As people and our customers certainly become aware that 13-liter has a lot of benefits. The fuel economy is very good, a little lighter weight. It has the same durability, reliability, a little lower cost. Essentially, it's the engine that is the high-end engine around the world in any region you go to from Asia to Europe to Africa, South America. We just introduced our 11-liter, which we're beginning production and will be installed in the DAF product this year. We are even hearing now from customers that for vocational, the 11-liter may be the engine of choice for that application, where you are driving within a 50-mile radius from your home, your base. It has got a lot of power, a lot of torque, and once again, it is a little lighter weight, a little lower cost, and it could be the solution that a lot of our customers are looking for. I think like you see in the whole automotive industry, including cars, you are getting more power density, and you see the car guys are now coming out with even one liter engines and two and three liter engines, whereas 10 years ago, 15 years ago, those were five and six and seven liter engines. We see that same thing going on in the commercial vehicles. Any willingness, I guess, to take a stab at what that 50/50 breakdown might be in 2014, 2015? How quickly do you think the 15-liter share deteriorates? Well, I look at it on the positive side is how fast the 13-liter can grow. But I think if you look at five years, I think the 13-liter will continue to increase its share. Okay. Thanks very much, guys. Thanks, Alex. Your next question comes from the line of Adam Uhlman from Cleveland Research. Morning, Adam. Hi, good morning. Mark, I was wondering if you could remind us what proportion of DAF builds would be outside of the Euro 6 standards for next year. I would say as we go forward, it is probably in the 15%-20% range would be Euro 5 product, and the remainder would be Euro 6 product. Okay, got it. Thank you. Was there any impact to currency on earnings this quarter? Also, how are you thinking about the tax rate going? Yeah, the impact on currencies was fairly muted. We got some benefit from the higher EUR on revenues and a bit on income. The tax rate we expect for the full year to be around 31%. Great. Thank you. Your next question comes from the line of Ted Grace from Susquehanna International. All right, Ted. Hey, guys. How you doing? Pretty good. Great. I was just wondering if you could maybe give us a little more perspective on how sentiment feels among your North American clients, starting with kind of the owner-operators versus small fleets, mid-size, larger, and then the private guys. I mean, are there discernible differences in how they're looking at 2014 and how much you characterize those? Of course, the owner-operator market as we know it, essentially has been amalgamated into fleets. You're really talking about fleets, so whether they're small, medium, or large. We've had different regulations and different federal guidelines that have been implemented in the last 12 months that they're now taking on board, whether it's hours of operation or just how the vehicle's going to be performing. It's a very resilient, dynamic industry, great fleet operators, great fleet owners. They've been around through a couple of pretty serious downturns over the last decade, and I think they're doing well. They're excited about the new products. They're seeing some general growth in the economy. We've got the vocational side starting to improve. Consumer side seems to be reasonable. So I think for North America or U.S. and Canada, I think it should be a good year. Would you see any distinction between long haul and regional guys or shorter haul customers? I think you could say there might be some distinction between truckload versus less than truckload, but I think that's been in play for the last decade or so. I think the customers that we typically work with across the board are in good shape. Okay. The second thing I was hoping to ask you is, we saw the pre-tax margins for both trucks and parts. Could you give us a sense for what the gross margins look like for both of those businesses? Typically don't disclose. We don't break that out. Gross margins by segment. We don't break it out. You don't. Okay, great. Well, thanks a lot, guys. Good luck this quarter. All right, Ted. Thank you. You have a follow-up question from the line of Joel Tiss from Bank of Montreal. Joel is back. Hi, apologize. Yeah, I know you thought you were done with me. No, we want you here. Just one quick one there. Daimler's had a lot of success with this AMT transmission rollout. Can you just talk about, you mentioned that as one of your longer-term investment priorities. Can you just give us an update of what's going on in the market and how you think about being able to compete with that product longer term? We've got two excellent transmission or gearbox suppliers, Eaton and ZF. Each of them has slightly different, although there is some overlap in their approach to the marketplace. ZF is our primary supplier for the DAF product in Europe and wherever else we sell DAF, and then Eaton would be primarily for Kenworth and Peterbilt. They've got product that competes very well against all of our competitors, and everybody's working on the same engineering premise in terms of making it truly an integrated powertrain from the engine all the way back to the rear axles. I think the success that we're getting with the Paccar engine, integrated with the ZF or Eaton, is standing up very well, and we continue to have very good share, so we're having good success. Every automotive supplier is certainly evaluating their approach to powertrain and seeing if they can get a benefit for their customer. Okay, thanks very much. Thanks, Joel. Your next question comes from the line of Neil Frohnapple from Longbow Research. Hi, Neil. Hi, good morning, guys. What was the MX engine penetration rate in North America in the third quarter for Kenworth and Peterbilt trucks? 35%. Oh, it picked up from the second quarter? Yeah. Very exciting, and we keep working on it. Every year we have certain goals, and if you haven't had a chance to go down to the Mississippi factory, I encourage you to. It's a beautiful facility. Great. Then along those lines, what percent of your North American production in the third quarter were for the new products? I think you had mentioned 30% in the second quarter. Did that tick up also? Yeah, it did. It is probably about 35%-40%. Great. Thanks very much, guys. Thank you, Neil. You have a follow-up question from the line of Ann Duignan from J.P. Morgan. Hi, guys. Hi, Anne. I forgot to ask about natural gas. In the context of your MX penetration on the 13-liter, we're hearing some very positive things about customers wanting to at least try out the 12-liter nat gas, the Cummins Westport. Can you talk about if that engine is successful, does that displace your 13-liter MX? Just talk about the dynamics there. Are Kenworth and Peterbilt still even offering a 15-liter HPDI? Yes, we are. We continue to have about 40% share in the natural gas industry, so we are very excited about that. As that market grows, we expect to grow with it. Natural gas is about 1% of the total marketplace. Customers are starting to invest. The infrastructure is in the early stages of being built out, so we see that as an alternative fuel for customers that it makes sense for. We are right there with it, and in fact, leading the way. But you did not answer my question, Mark. If the 12-liter Cummins Westport is the offering that customers are leaning towards, does that displace a 13-liter MX? Yeah. It is a good engine. Cummins continues to be a major supplier to us, a major partner, and we offer a variety of engines, but I think in the big scheme of things, everybody happily coexists. If that end market took off, would you consider developing your own spark-ignited 13-liter? There is always the opportunity to develop a whole new range of engines, absolutely. Okay, I will leave it there. Thanks, guys. Thank you, Ann. Your next question comes from the line of Daniel Johansen from UBS O'Connor. Morning, Daniel. Hey, how are you doing? Thanks a lot for taking my question. Absolutely. I was wondering, on the order intake, the DAF order intake being up 70%, did you say what the book to bill was? What is our production versus that? Yeah, exactly. What you produced in the quarter and how the orders relate to that. You bet. Well, we're talking about globally that Paccar will increase its production by about 5% with slightly improved margins in the fourth quarter. We're seeing an increase in production at DAF. We will complete building all of our Euro 5 vehicles for Western Europe this year but continue building Euro 5 vehicles for the rest of the world for at least the next few years. Did DAF get more orders in the third quarter than they produced? Yes. Some of those orders were also for Euro 6, which we are producing now and in the first quarter also. A big portion of DAF is U.K., I think around 20%. I believe U.K. has September 30, not December 31 as a deadline, right? That is correct. We've essentially built all those vehicles for the U.K. Okay. There's still some, a little bit of a derogation. We continue to build trucks for the U.K. with Euro 5 and Euro 6 in the fourth quarter. It's ongoing. Okay. Very good. And in terms of your dealers, in general, they are independent, right? That is correct. And what is the normal lag between a registration and when you ship to your dealers? It depends if it is for on-highway or if it is for vocational and they need to get a body. So if a dealer gets a vehicle, day one, if for on-highway, it can be registered into the customer's hands within a week or two. If it is for a body, it can be anywhere from four to 12 weeks, depending on the backlog at the body manufacturer. If we talk about the 2014 outlook, we are 2%-3% down on midpoint, I believe. That is the registration number. Yes, that is correct. In Europe, it is registrations. Correct. Okay. Thank you very much. Thank you very much, Daniel. Appreciate it. Your next question comes from the line of Jeff Kauffman from Buckingham Research. Thank you very much. Congratulations. Hey, guys. Thank you very much. Great quarter. Great quarter. A couple questions. A few have been asked on the R&D, but that range is so big I might be able to squeeze a Peterbilt in between there. Well, these are very slim Peterbilts, so you could probably get a couple in there. Can you give me an idea of what set of circumstances gives you a number closer to the $225 million end of the range versus the $275 million end of the range? I think as most companies do, when you're looking out over the next 14 months- we like to have a range that provides for a lot of different eventualities, but I would think that the range would probably be on the lower half of that. Okay. The tax rate, 31%, I think was the guidance for the year. Correct. I'm assuming that's based on your mix of global profits. Should I be thinking about, as I look forward, a different tax rate, 32%, 32.5%, or is 31% kind of the range you think I should be thinking about, given what you see right now? Given our mix of global earnings, 31% is pretty close for this year, 31%-32% next year, I think would be a good way to think about it, depending on global earnings. Okay, what is driving that down? It is just a higher mix of European and maybe Brazilian earnings? Yeah, the tax rate in Europe is in the low 20s, so that is a mix. Okay, then just one final follow-up. Let me go away from that. Now that the Brazil plant is open, you did say it was going to be a ramp. You said no gross margin impact, but how should I think about the Brazilian plant impacting SG&A over the next few quarters as you do build up production? I think as we look forward, we have had our dealer development people, we have got salespeople in place, so we will see some slight increase, but it is not going to be a major factor. All right. Well, congratulations. Most of my other questions have been answered. Thank you, guys. Appreciate that. There are no other questions in the queue at this time. Are there any additional remarks from the company? I'd like to thank everyone for their excellent questions, and thank you, operator. Ladies and gentlemen, this concludes Paccar's earnings call. Thank you for participating. You may now disconnect.