PACCAR Inc.

Good morning and welcome to PACR's fourth quarter 2020 earnings conference call. All lines will be in the listen-only mode until the question and answer session. Today's call is being recorded and if anyone has an objection, they should disconnect at this time. I would now like to introduce Mr. Ken Hastings, PACR's Director of Investor Relations. Mr. Hastings, please go ahead.

Good morning. We would like to welcome those listening by phone and those on the webcast. My name is Ken Hastings, PACR's Director of Investor Relations. And joining me this morning are Preston Fite, Chief Executive Officer, Harry Skippers, President and Chief Financial Officer, and Michael Barkley, Senior Vice President and Controller. As with prior conference calls, we ask that any members of the media on the line participate in a listen-only mode. Certain information presented today will be forward-looking and involve risks and uncertainties. including general economic and competitive conditions that may affect expected results. For additional information, please see our SEC filings on the Investor Relations page of Packard.com. I would now like to introduce Preston Feith. Hey, good morning, everyone.

Harry Skippers, Michael Barkley, and I will update you on our good fourth quarter and full year 2020 results, as well as provide you an update on other business highlights. First, I really appreciate our outstanding PACCAR employees around the world. Their focus on safety and health throughout the pandemic continues to be outstanding as they deliver the highest quality trucks and transportation solutions to our customers. In 2020, PACCAR achieved annual revenues of $18.7 billion and good net income of $1.3 billion. PACCAR's performance benefited from a recovery in truck demand to normal levels in the second half of the year, and strong performance from our trucks, parts, and financial services divisions. PACCAR has achieved 82 consecutive years of net income. The company has paid a dividend every year since 1941 and has delivered annual dividends of approximately half of net income for many years. In 2020, PACCAR declared dividends of $1.98 per share. Packard's fourth quarter revenues were $5.6 billion and fourth quarter net income increased to $406 million. Packard parts achieved fourth quarter revenues of $1.7 billion and record pre-tax profits of $223 million, which was an 8% increase compared to the same period last year. Packard delivered 40,700 trucks during the fourth quarter compared to 36,000 in the third quarter. In the first quarter of 2021, we expect deliveries to be 10% higher than the fourth quarter due to stronger markets and higher customer demand for Kenworth, Peterbilt, and Doss grade trucks. In 2020, U.S. and Canadian Class 8 truck retail sales were 216,500 units. Kenworth and Peterbilt's combined Class 8 market share increased to 30.1%, and medium duty share increased to a record 22.6%. For 2021, the U.S. economy and industrial production are projected to expand by about 4%. The strengthening economy, low fuel prices, and high volumes of freight are good for the truck industry. We estimate the 2021 U.S. and Canada Class A truck market to increase to a range of 250,000 to 280,000 vehicles. The European above-16-ton truck registrations were 230,500 last year, and DOF achieved strong market share of 16.3%. In 2021, the European economies are projected to continue growing, and we expect the above-16-ton truck registrations to increase to a range of 250,000 to 280,000. The South American above-16-ton truck industry registrations were 93,000 last year. In Brazil, DOF increased its share of the greater-than-16-ton market from 4.3 to a record 5.7%. In 2021, the South American market is expected to increase to a range of 100,000 to 110,000 units. Truck and parts gross margins were 12.6% in the fourth quarter. We estimate first quarter truck and parts gross margins to increase to around 13.5%. Packard takes a rigorous approach to controlling costs throughout all phases of the business cycle and continues to deliver industry-leading margins. Last week, we announced a strategic partnership with Aurora, a leader in autonomous driving technology. This partnership will integrate Packard's autonomously-enabled truck platform with the Aurora self-driving sensor and software system. The goal of this collaboration is to create a commercially viable autonomous truck that enhances safety and operational efficiency for PACCAR's customers. PACCAR's zero-emissions vehicles continue to lead the industry. Our zero-emissions vehicles have accumulated nearly 500,000 miles. Peterbilt, Kenworth, and Doth battery electric trucks are beginning production in the second quarter of this year. and we're continuing in the development of hydrogen fuel cell-powered zero-emissions vehicles. Last year, PACCAR was again recognized as a global leader in environmental practices by the reporting firm CDP, which places PACCAR in the top 15% of over 9,500 reporting companies. And the Women in Trucking organization awarded our PACCAR corporate office, Peterbilt, Kenworth, PACCAR Parts, and Dynacraft as a top place for women to work. Kenworth and Peterbilt received a total of five Manufacturing Leadership Awards from the National Association of Manufacturers, and the DOCXF earned the Fleet Truck of the Year 2020 Award in the United Kingdom. There are a multitude of exciting things happening around PACCAR, and Harry Skippers will now provide an update on PACCAR parts, PACCAR financial services, and PACCAR's investments in future growth. Harry?

Thanks, Preston. In 2020, Packer Parts generated excellent annual revenues of more than $3.9 billion, an annual pre-tax profit of $799 million. Fourth quarter parts revenues were a record $1.7 billion, and quarterly pre-tax profit was a record $223 million. One of the great things about Packer Parts that it provides steady profitability through all phases of the business cycle. Becker has increased market shares over the years, resulting in a greater number of truck and powertrain parts opportunities. Becker Parts' excellent long-term growth reflects investments in distribution and technology. Becker Parts has expanded its global network to 18 distribution centers, and is currently constructing another facility in Louisville, Kentucky. Becker Parts' investment and leadership in e-commerce technologies proved valuable last year, as e-commerce retail sales increased by 25%. In 2021, we estimate part sales to grow by 7-9%. Becker Financial Services achieved 2020 annual revenues of $1.57 billion, annual pre-tax income of $223 million, and portfolio assets of $15.8 billion. The percentage of Pega truck sales financed by Pega Financial Services increased from 25% to 28% last year. The portfolio continues to perform well with low bond dues and low credit losses. Pre-tax finance income increased from $55 million in the third quarter to $64 million in the fourth quarter. Pekka Financial added used truck centers in Denton, Texas, Lyon, France, and Prague, Czech Republic last year, and will open a new used truck center in Madrid, Spain this year. Across Pekka, last year we invested $570 million in capital, and $274 million in R&D. In 2021, we're planning to increase capital investments to the range of $575 to $625 million, and R&D expenses will grow to be in the range of $350 to $375 million. These capital and R&D projects will develop the next generation of fuel-efficient diesel powertrains, zero emissions vehicles, as well as advanced driver assistance systems, autonomous vehicles, connected services, and cutting-edge manufacturing capabilities. Dakar has started 2021 with strong momentum. The truck and parts businesses are growing. Kenworth, Peterbilt, and Dove market share is increasing, and we're investing in new trucks and technologies that will deliver enhanced operational efficiency safety, and environmental benefits to our customers. Thank you. We'd be pleased to answer your questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster. And our first question comes from Joel Tiss with BMO. Your line is now open.

Wow, I don't think I've ever been first for anything in my life. I guess maybe to get fired.

You are today, Joel. Glad to talk to you.

Yeah, I still got to work on that. Can you talk a little bit about, I think your European market share hit 17% at some point, and now it's a little more than 15%. Can you just talk about what's going on there?

Sure. The record we've had in Europe was 16.7%. This is actually our second best year in our history. So that's up a tenth from last year, and we have strong momentum as we enter into the 2021 timeframe. So it's really a good year for the European team in market share, and we have market leadership in a number of countries, including Great Britain, a lot of countries in Eastern Europe, and we grew share in principal markets like France as well.

All right. And I have a lot of questions, so maybe I'll just try to glue two together to cheat a little bit here. The size of the – can you talk a little bit about the size of the EV market, you know, today and maybe in 2025 or a couple of years down the road? And what are examples of next-gen manufacturing and distribution? I was trying to think of what you meant there, but I couldn't figure it out. And then I'll leave it to everyone else. Thank you.

Thanks. Well, let's talk about the electric vehicles or zero emissions vehicles first. If we look at the world around us right now, the most important thing that we're doing at PACCAR is having the right technologies in place. So we've spent a considerable amount of time and energy bringing to market battery electric vehicles that fit the zero emissions class, both in Europe and North America, both for our medium-duty and our heavy-duty products. And the key there is making sure we have the right technology and the right leverage for those products as we move forward. So we've done a good job with that. As we shared last time, we'd announced the sale of the product, and now we're going to production with those trucks beginning in the second quarter. As far as volumes go, as we shared last time, we expect that the industry will have volumes in the hundreds in the coming year or two. And then as we get to the 2025 timeframe like you referenced, that might grow into the thousands. And we would expect that we'll have a good market share representation as the industry comes along. The most important thing, again, right now is making sure we have great technology, and I've got to say I'm really excited about the products we're bringing to market. So on the second point of advanced manufacturing, what we're really talking about there is how we have a connected factory. So if we look at how the factory works together, what kind of data analytics we're sharing within the factories, how the robotics work together, and making sure that we just enhance to an even higher degree our already excellent quality.

And I think just to add to that, Mark, Our new paint shop in Chillicothe, Ohio, that will open this year, is a excellent example of that. So on top of the things that Preston said, it also will be a lot more environmental friendly. It will be the most modern campaign facility in the industry.

All right. Great. Thank you very much.

Yes. Have a good day, Joel.

Our next question comes from Rob Wertheimer with Milius Research. Your line is now open.

Yeah, hi. My question is on gross margin, and thank you for the outlook in the 1Q. You know, you're improving from the 3Q, 4Q levels in the 1Q. Can you describe what the dynamic is? Is that maybe there's quantifiable COVID, you know, supply chain or otherwise costs that are fading? Maybe it's mixed. Maybe it's pricing. You know, what was weighing on the last half of 20, and what's getting better? Thank you.

You know, sure, I'm happy to take that. The biggest thing that's affecting gross margins is being in this global pandemic. and the fact that we have made sure rigorously that safety of our employees is the most important priority for ourselves. That's number one, number two, and number three. So there is additional costs associated with that for us, but not just for us. It also goes along with the supply base. So that has obviously had some margin impact to us. There is raw material pricing effects that we're seeing as we see the economies recover on a global level. And, you know, we're at a different point in the cycle than we have been. We're just starting to see the truck market recovery. And so that has an impact as well.

And Harry?

Sorry, please. Yeah, so we're improving to 13.5% in the first quarter. It's a nice improvement. And it's been where we continue to achieve the highest margins in the industry. Okay.

And is there anything from the COVID that you've got straightened out? I mean, obviously, in six months, hopefully this is irrelevant. I understand that. But, I mean, I'm just a little bit curious if there's anything sort of driving the sequential, and I'll stop there. Thank you.

Figured out, again, the most important thing is safety. And so we have figured that out. We've been able to provide a great, safe environment for our people. And that's been the most important priority for us.

Okay. Thank you, gentlemen.

You bet. Have a good day.

Our next question comes from Tim Dine with Citigroup. Your line is now open.

Great. Thanks. Good morning. Just maybe to take that gross margin question a step further in thinking beyond the first quarter, you know, typically there can be impacts, I think, especially at kind of early stages of an upcycle like this where you have some some customer mix impacts in the first quarter, whether it's, you know, dealers placing more stock orders and maybe you get a little bit heavier small customer sales flowing into that first quarter, whereas you get, you know, some of the larger fleets start to take delivery in the spring. So is that – would you expect that to be a – just as we think about, you know, first quarter impacts – potentially moving beyond. Is it meaningful or is it just kind of gets washed out?

I think there's a lot of factors that play into what the second, third, fourth quarter will be. It'll depend on the strength of recovery and how the market continues. You mentioned some good points. Those are true things that mix can have an effect on things. We've also seen some of the larger customers be the people that continued buying in the fourth quarter and through the first quarter. So there's offsetting factors in that.

OK, good question. I was interested to see that maybe you've disclosed it before, but the comment that you included in the in the relief on the T680, the fuel cell electric having a 350 mile range and I'm just curious and obviously I would assume that you would expect that overtime to probably not stay at that level and potentially increase, but. I guess the question is, do you have a sense for maybe what percentage of either your truckload or, I don't know, that potentially LTL customer base is, you know, what could that be relevant to in terms of, you know, just obviously the trend over time has been towards more of a shorter length of haul. So I guess I'm just curious, what percent of the customer set do you think a 350-mile range vehicle could be relevant to?

Yeah, what I would say is that the technologies that are being evaluated right now, batteries and fuel cells, both have capacity to expand range. It just takes more batteries or it takes more fuel cells. So range is really about how much space you take up on the truck. And the energy density at this point in time is higher for fuel cells, for hydrogen fuel cells. So that's an advantage they have. Of course, both types of solutions – infrastructure development and infrastructural development and how close charging stations are for either system will decide how much range you need on the vehicle. So I think it's a little early to tell what's going to happen and which technology will play out in which markets.

Okay. All right. Thanks for the time. Take care.

Sure. You bet.

All right. Next question comes from the line of Nicole DeBlaze with Deutsche Bank. Your line is now open.

Yeah, thanks. Good morning, guys. Good morning. Maybe just starting with a little bit more detail around the commentary on 1Q, the 10%, you know, forecasted increase in production. Can you guys just talk about, you know, is that kind of across geographies, any comment you have on U.S. versus Europe versus rest of the world?

Sure, good question, and it kind of is across geographies. We see increases in the North American market. Cambridge and Peterborough are doing really well, have strong order intake, and the same is true in Doff. Both economies have strong freight activity, trucks are moving, and there's good order intake right now.

Okay, got it. And then just on the parts business, pleasantly surprised by the acceleration there into the fourth quarter on the top line. Can you just talk a little bit about sustainability, about strength into next year, or, you know, some sense of what you guys are thinking for, you know, parts revenue growth in 2021?

Yeah, I think that if you look at our parts, they just did a fantastic job in the past year, and for the past several years, really, of not just serving our customers but creating creative solutions for our customers. One of the things we talked about and mentioned was e-commerce. They've created a state-of-the-art system where you can go online and get your parts. It makes it a lot easier. They've made investments in the distribution network so that the next-day delivery and even same-day delivery of parts has increased in the percentages. And they just do a fantastic job of taking care of all the different kinds of customers and meeting their needs, which is bringing business to them. So we do think that growth will continue in the coming years for our parts team at kind of a similar rate.

Got it. Thanks. I'll pass it on.

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

Great. Good morning, guys. Just a quick follow-up on that one. Should we also expect gross margins in that parts business to continue to expand as well in this scenario?

Well, I think the gross margins we enjoy in parts are very high, and we'd expect them to continue to be very high, Steve. So we'll look for that to continue certainly through the quarter and year.

Okay, and then kind of my broader question, Preston, is just about how you guys are looking at the year. I'm assuming that the first quarter will be sort of the low delivery quarter of the year, and things will sort of slowly grow as the year progresses to kind of hit your industry targets. Please disagree if that's not the way you're thinking about it. But I'm curious if we should also think about the first quarter as kind of the low gross margin quarter as well in the truck business.

I think we're at the beginning of the cycle right now, you know, where you look at where we're coming out of and where we're going to, and obviously have better clarity on the first quarter than we do the second, third, and fourth quarter. So right now, the quarter's full and built. We have great visibility in the second quarter. As it stands, we'd expect three and four to go that way, but there's a lot of time between now and then. So maybe your modeling is right, but I think it's a little early to kind of call the latter part of the year.

Okay. Maybe just conceptually then a different way. You know, you guys have done quite a bit of work on the parts business and on the cost structure to some extent. I guess I'm just curious if you running the company kind of expect – overall margins to be higher this cycle than they were in the previous cycle?

Well, I think, you know, we've made some good investments. We have some great things happening right now. So I think the recovery in gross margins at 13.5 that we're saying will be around in the first quarter is good progress. And then I'd share with you that this is going to be a really exciting year for PACCAR in terms of new product introductions. So in the coming months, both in the United States and Canada, as well as in Europe, We have some big introductions that we think will be really helpful to our company's growth.

Great. Super. Thank you, guys.

Our next question comes from Jamie Cook with Credit Suisse. Your line is now open.

Hi. Good morning. I guess a couple questions. One, on the fourth quarter, can you just provide any granularity on sort of pricing or mixed dynamics in the quarter? I think pricing was slightly negative last quarter. So if you could help us out on that front. So I guess I'll start with that, and then I'll ask my follow-up.

Pricing was very stable, maybe slightly down in the fourth quarter, but pretty normal for where we are in the cycle right now.

Okay. And was there anything else, like, related to mix or anything besides the pricing commentary that impacted the fourth quarter? And then I guess my follow-up question, just as I have you, is, just any additional color you can provide on the R&D increase, you know, where the spend is going, how much of that can be, you know, attributed to the recent announcement with Aurora on the autonomous side. Thanks.

Yeah. Jamie, thanks for the questions. On the pricing side, you know, you look at just a little bit of it as cycle timing and just where we're at and how much backlog there has been, and so we're seeing – Improvement in that as we go through this year now, I would say there has been commodity cost increases, which has had some impact. And obviously, the effects of managing the pandemic has had some effects. So those are kind of the key factors you look at in pricing. As we progress, we see some opportunities in that. We look forward to those opportunities. And then, you know, in terms of your second question, can you repeat what you were specifically looking for?

My question was, yeah, just any additional color you can provide on the R&D spend. I know we increased it a little from what we said. Last quarter and how much of that, if any, is attributed to Aurora or any color you can provide on that? Thanks.

Sure. I would share kind of the same thought I shared with Steve is that we have a lot of great things happening right now in the company in terms of new product introductions that we'll see this year and some of that R&D spending is in support of those really exciting products that you'll get to hear about shortly. And also, we have a great focus on technology. We mentioned it in the comments for our factories, but also in the space of zero emissions vehicles and connected services and autonomous vehicle development and ADOS Level 2 projects. So we have a lot of great things going on that build for a strong future.

Okay. Thank you.

You bet.

Our next question comes from the line of Ann Dagen with J.P. Morgan. Your line is now open.

Hi. Good morning, everybody.

Morning, Ann.

Morning. Maybe you could give us some color on your outlook for both regions, you know, what you think the biggest drivers are going to be, whether it's line haul in the U.S., whether it's, you know, severe service, just some color on both North America and Europe, maybe Europe by region also, as well as mix. Thank you.

Sure, let's just start with the U.S.-Canada markets and say that we have good housing starts. The auto industry is performing well, expected to perform even better in 2021, so those are both good for our businesses. People continue to live their daily lives as they need to, so the refrigerated carriers and protein haulers are doing a good job as well. Basically, the truck industry is doing pretty well, and I don't expect that to change. Truck utilization is high, and so I think that We're even starting to see signs of green shoots in the oil and gas industry. So all of that combined points to a good year for us in the U.S. and Canada. And I don't think it's very dissimilar in Europe.

I don't know if you can do that, Harry. The Europe transport activity remains strong as well. We just got the German mug statistic in. That's the number of miles for which trucks have to pay toll in Germany. That was up more than 4% in December. after a 4% increase in November, so that just shows that trucks are driving, our customers are doing well. In terms of regional, I probably would expect Central and Eastern Europe to do a little bit better than the U.K. maybe, but it's a trend we see across Europe.

Okay, thank you. I appreciate that. And then with the R&D spend increase and the number of new products that you're launching that you've alluded to, Should we anticipate that SG&A will be higher also in maybe second, third quarter as you launch all these products and, you know, you increase your marketing, you increase your spend, you know, above and beyond maybe any impact it might have on manufacturing and gross margins as you launch these products?

No, I don't think so. I think as you look at, you know, last year, we had improvements, reductions in our SG&A for the full year and also even in the fourth quarter. And we'd expect kind of the fourth quarter to be at a run rate for 2021. So, you know, the effect of last year and trimming things in the business will continue. We always want to make sure that we're diligent in providing the lowest fixed costs that we can to our shareholders.

Okay, and no incremental costs from commodity prices, steel prices, or anything? I know you're more of an assembler, so the impact on you will be muted, but are you anticipating any kind of supply shortages, supply chain issues related to lack of availability of steel or anything like that?

We have a great team in our materials teams and purchasing teams around the world, and while there's much been written about supply shortages, They have done a fantastic job of making sure we have all the parts we need to put the trucks together and create our products, and we don't anticipate anything significant in the first quarter. It's tight for the whole world, but they are just doing a really good job, and one of the reasons we're able to do that is they do a good job of forecasting out to our supply base what our schedules are, and I think that's much appreciated. It allows our suppliers to be successful, and it allows our company to be successful.

Okay. I appreciate that. I'll get back in line.

Thank you. Our next question comes from Stephen Fisher with UBS. Your line is now open.

Thanks. Good morning. Good morning. Curious about how your order share in Q4 trended. Was it higher or lower than your retail share in Q4 as an indicator of where market share might be going in the relative near term and Just curious how that looked in North America versus Europe.

Sure. If you look at our order share, and I think it's easier to look at it in bigger chunks because there's cyclicality in that, our order share grew in 2020 as a percentage of the industry. So that's a positive thing. And obviously we grew our market share a little bit, and we feel well-positioned to continue growing in 2021.

Okay. And then I know it's still just very early days on this, but curious how the orders on the electric trucks looked in Q4 and if you're seeing any just momentum building on that in Q1.

There is definitely momentum building. Good question. There's momentum building, but it's momentum building from kind of a very, very low level. And now I think people are interested in trying a truck or two or tens. And so that's kind of the scale you're talking about in terms of the industry right now for zero emissions vehicles. It does still depend heavily on government subsidies to make it an economically workable solution. So, again, I'd emphasize that I expect the industry will see hundreds of units in sales this year and that we'll get a good percentage of those.

Terrific. Thank you.

Our next question comes from David Rosso with Evercore. Your line is now open.

Hi, thank you. So on the gross margins, I'm just trying to think about every year there's always a lot of investment in products, initiatives that are clearly not in full production. But just given the technology push that we're seeing right now across a variety of drive trains and autonomous and so forth, is there any level of cost that you would call out that's incremental this year than normal. These, again, the first quarter gross margins are pretty impressive. I mean, it implies like a 25% incremental sequentially. And I'm just trying to think through, are maybe some of those new costs, you know, not going up that much year over year, so the volume really gets levered more than normal? I'm just trying to think through, there's got to be some costs that are above normal. And again, it makes the gross margin guide a little more impressive. I'm just trying to sanity check it. And then I had a quick follow-up related to the factories.

I would start by saying that, you know, if you look at the gross margin effects of it, it has a lot more to do with the COVID and global pandemic than it has to do with the R&D that we're doing. I don't really think of those relatively. And I would just say that we are seeing a pretty good improvement coming for the first quarter in gross margin with that 12.6 turning towards around 13.5 level. and feel good about the growth we're getting. And again, it's tied to the place we are in the market and the market's improvement. More about that in the gross margin to me than the R&D spending. The R&D spending is going to be great because we're bringing out these fantastic new products, and that should be helpful to us in gross margin.

But beyond the R&D, are there any incremental costs for products that are not providing much of any revenue, let alone profits, than you would normally see in a cycle? No. I mean, again, the R&D is not an immaterial number, but I'm just trying to think through the ramp in cost given it's a bit of a unique time and the technology rollout in the industry. Are you saying you wouldn't describe this as any more abnormal than, yeah, maybe the R&D is up a bit given the new product rollout? You would not describe this as a bit abnormal?

No, I think R&D spending is an increase that's – on the product we're introducing, and it's on the technology we're introducing, but we continue to have R&D's percentage of sales at the lowest levels of anybody. We do a great job, our engineering teams do a fantastic job of working with partners and having those partnerships so that we bring great technology to our customers, but we co-develop, and that seems to be a great model, and it's part of the story around Aurora is we pick industry leaders like them that are fantastic with technology, and And we're fantastic in developing an autonomously-enabled truck, and together that becomes an efficient way to bring an industry-leading solution to the market at a reasonable cost.

And then when it comes to my factory question, where are the factories? I mean, the real core ones like Denton and Chillicothe and embracing the cycle in the sense of adding the extra shift, adding a skeleton third shift. I'm just trying to get a sense of where are you in balancing adding the capacity and which if the order book is very strong, it's not necessarily risky, but just the idea of where are you adding that in the confidence in the order book. And second, of course, there's always that balance of adding capacity versus pricing. Where are those shifts running right now?

So the truck factories have done a fantastic job of managing the increases that we've seen over the last quarter. They've just done a beautiful job of keeping people safe. I just want to keep emphasizing that because that's our most important priority is our employees. And they've done a great job of being able to increase build while protecting people and giving them a safe working environment. And we don't see any limitations to that. We see the ability to keep increasing build rate as we need in the factories to support the market. Really not any limitation on that. So they're not operating at near max capacity at this point.

Are they all on second shift, full second, or is it skeleton? I mean, there's always those inflection points in the cycle where you have to, you know, make that jump. You're right, David.

There always are. And some of them, as appropriate, would be on second shifts, and some of them are not as appropriate. And so each factory is in its own balance right now.

All right. I appreciate the time. Thank you.

Yeah, you bet. Have a great day.

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

Yes, hi. Good morning and good afternoon.

Hey, how are you, Jerry?

Doing well, thanks. And you?

We're all staying healthy out here. Hope you are too.

Absolutely. Preston, I'm wondering if you could just expand on your comments about expectations of very good market share on truck and hydrogen vehicles. You know, what's your win rate now out of what's been, you know, bid for delivery over the next year? You mentioned industry size of a couple hundred units and, you know, I'm just curious, what are you folks seeing in terms of your success rate on those bids?

Our success rate tends to be pretty good, and we obviously have a strong relationship with our existing customers, provide them great products, low operating costs, and the repeat of that is at extremely high levels, and our win rate continues to be high, where we go out and are able to show people Kenworth, Peterwolf, and DOP trucks that have never tried them before. When they get to experience them, I think they're impressed also, and that's the reason we've been Growing our market share, the reason we expect to keep growing our market share.

And, you know, part of the reason why you folks have higher market share and heavy duty than medium duty is because you get paid for the higher features and higher spec trucks. And, you know, in an EV world, obviously the per truck costs are higher. I'm just wondering, is that a tailwind that you're seeing? Is that what you're coming to lose to? Some customers that would be more value focused are now trying – your trucks in medium duty, so this dynamic could potentially be a market share tailwind for you folks. Am I understanding you right?

I think it could be. I think Kenworth, Cedarville, and Duff have been real leaders in customization and giving customers exactly the trucks the way they want them and how they want them. And with electrification, that's probably even more important, that we just configure the truck exactly to their needs, their transport tasks, and make sure the weight and the charging and all of that is optimized for their requirements.

To add on to that, it kind of brings a more integrated experience for the user because you've got to think about how much time you need to charge it, and that's why one of the reasons we're selling charging stations through Packard Parts is, you know, we think that whole energy management opportunity is good for our customers and should be good for Packard.

And lastly, I'm wondering if you can provide an update on your telematics and how that you have even more data with more trucks in the field. Is there anything that you're able to offer customers or anything that you can do incrementally within your operations to increase efficiency building on that growing data set?

That is a fun topic. We could spend all day talking about it. Maybe when we get back together live, we'll spend a lot more time on it, but in brevity, I would say that our connected services business really is a growth opportunity. All our trucks in North America come from the factory connected. A vast majority in Europe come connected as well. And so we collect a lot of data from them, which we share with the customers. It's their data. We share that with the customers and talk about how to improve their operating efficiency and talk about how the vehicle is performing. That involves our great distribution network as well. So our dealers are looking at that data, and they know how to take care of the customer as well. We have service event management capabilities, so we understand where vehicles are in the network, how to take care of them better. So it's really kind of all about optimizing our customer's experience, and that obviously can be good for PACCAR as well.

Okay. I appreciate the discussion. Thank you.

You bet. Have a good day.

Our next question comes from Chad Dillard with Bernstein. Your line is now open.

Hi. Good morning. Good afternoon, guys. Hey, Chad. So you guys are guided to a pretty solid start to the first quarter on trucks. And I was just curious on how you're thinking about the first half versus second half seasonality and cadence. And we're recognizing it's still early, but I'd love to get a sense behind you guys are thinking about it.

Sure. I think the way we're looking at the world right now is that it's the beginning of an improvement towards replacement level, and that as we trend towards replacement level – we'll see where the market goes. If we're saying the midpoint is 265,000, both Europe and in North America, that's a healthy market. And it feels like it's a sustainable market for a while. But obviously, it depends a lot on the economy and generally happening.

And can you talk about your approach to building your autonomous platform? Will it be more like open source? I know many digital drivers like, you know, Aurora can interface with it or... Aurora will be a little bit more exclusive and maybe could walk through your thought process behind making that decision.

Sure. The way we're looking at this right now is this is a nascent technology that has a lot of development, and it's going to take several years to do, as we shared in our announcement. Aurora is a great company with a lot of really skilled people. They're a very impressive group of people, and our team that's working on autonomously-enabled trucks is also skilled. And we think that the best approach to bring something robust, safe, secure to market is to work together, our leadership with their leadership, to create a capable level four autonomous vehicle. And we'll do a lot of testing on that. And we'll have the end game be to provide our customers a safe, efficient vehicle. It takes several years to do that. Thank you. You bet.

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

Good morning, guys. Thank you. Hey, Ross. Preston, maybe you can just elaborate a little bit more on Aurora since you're just on the topic and anything incremental that you can provide just to help us think about it a little bit more, whether it's the economics of the collaboration, How do you think about it in terms of your competitive position? Is it something that's going to drive the fastest speed to market for PACCAR with Level 4 autonomy? And do you think that you'll experience a meaningful increase in pricing power as you do that?

Well, I think that Aurora is a really good company. We chose them because of our working relationship with them. I think that what you'll see is as we develop capable systems that have redundancy in steering, braking, power systems, control, software, and they develop the autonomous driver with sensors and software stacks that are integrated into that, that integration will be important. I think it will provide a good strength for our customers. It will be obviously advantageous for Aurora and Packer will benefit because we'll have this autonomous-enabled platform integrated which will be a value to our customers, and it'll use our distribution system. It'll make their operations potentially more efficient, and it should be one of those situations in life that creates a win for us, a win for Aurora, and a win for our customers.

And any particular milestones we should just think about? Obviously, it's a great, great opportunity and should give you guys an advantage, but You know, what's to look out for? Is this just, you know, something that, like, over the next three years we'll just get, you know, occasional updates? Or is there anything you could point to as kind of the next key milestone to look for for Aurora?

I think that we'll be conservative in our milestones, and we're definitely making some interesting progress right now. It's really exciting inside. But as far as laying out milestones, I think we probably not want to do that right now.

Okay. And then just the last thing I want to ask you, you know, I realize you've gotten a lot of questions on gross margin already. I'm sorry to dwell on it. But I'm just looking, you know, for the first quarter, your implied truck deliveries seem to put you on a level of deliveries that were similar to the first quarter of 18. And the first quarter of 18, your gross margin was 14.8. And now you're saying it's going to be about 13.5. And I understand that the you've invested in safety and so forth, and you've got some inefficiencies in the supply chain and whatnot. But is it possible to say how much of that difference is really tied to what you think are sort of COVID-19-related inefficiencies? And more importantly, is there any reason to expect lower gross margins through the next cycle versus prior cycles?

Yeah, I would estimate that the – The cost associated with increased safety, higher absenteeism, and over time as a result of the safety measures we've taken would be around 40 basis points maybe for us. So that's a little bit of a drag, but yeah, despite that COVID impact, we still see margins nicely improved to 13.5%. And like I said before, that's probably the highest margin in the industry.

Okay, thanks. All right.

We keep thinking about this, right, is we are going to continue rigorously focused on providing the industry's highest gross margins. And we do that. And we expect to continue doing that. So it's kind of a pretty happy with the margins being industry leading.

But to the fact that they already are industry leading, do you feel like there's a ceiling on them at this point and that you're going to potentially drift lower? Just because where you are saying you're going to be in the first quarter, and I guess this is a very odd cycle, what we're going through, to say the least. It just seems like you're on just a lower level at the beginning of the year relative to where you were on a similar amount of delivery several years ago.

Yeah, I think you said it well in saying it's an odd cycle, and we'll see how the year develops on that cycle.

Okay, fair enough. Thank you, Gus.

My next question comes from Matt Alcon with Cohen. Your line is now open.

Thank you. Good morning. Good afternoon. If we take a very long, say, you know, 10 year view, do you guys have any broad vision or, you know, high level opinion of what percentage of your truck production might be level four and level five autonomous? And basically, same question by energy type, what percentage might be anything other than conventional diesel in 10 years?

Wow, Matt, that is asking us to prognosticate out there at the decade level. And what I would share with you is the way we think about that question, which we obviously do, is we want to make sure we have the right capabilities for what the customer's needs are. So in autonomy, if there was the right operating environment for level four, level five autonomy, we want to have the right products there for our customers as soon as that makes sense to. And that's why we took the step we did. And similarly on zero emissions vehicles, there is going to at some point be an economic payback for them. And so that's why we keep being invested in all the different battery electric and hydrogen fuel cell hybrid capabilities so that when the market chooses, PACCAR is there for the product that they want. And we kind of think of ourselves as a powertrain agnostic and want to make sure that we can provide the customers the product they need. But in summary, we do think diesel engines will be a primary mode of power for the current timeframe up to the next decade.

Got it. That's very helpful. And if I may ask just one more, you know, intermediate term question here. You mentioned that the truck market has been very strong, but the driver market has gotten tighter in TL specifically. Do you see any signs that the Class 8 orders that you're getting for growth, may begin to moderate as carriers worry about seeding trucks? And if so, do you think, you know, you know, whatever replacement demand is last will be enough to keep the order momentum going this year?

Well, I don't, we don't see, simply we don't see any moderation order intake. There's strong demand for Dock, Peterhold, and Kenworth trucks right now, and we expect that would continue as the cycle goes. So,

Things feel good. Backpacks are very reasonable. Lead times are competitive. If customers want to have trucks in the second quarter, we can provide them and make sure they get what they need.

Got it. Thank you very much. Appreciate it.

Yeah, you bet. Have a good day.

Our next question comes from Brett Lindsey with Vertical Research Partners. Your line is now open.

Hi. Good morning. Just one for me and back to the parts distribution strategy. You know, 18 currently. I think you said you're going to add another one this year. What is the right investment to support that strategy? And are you budgeting, you know, continued upward move, you know, in investment related to distribution? And then just as a follow-up, could you just talk about in the second half of 20 how the e-commerce retail sales trended versus fleet billings versus engine parts as the markets recovered?

Thanks. All right. If I think about parts distribution strategy, our goal is to make sure that we service our customers as effectively and efficiently as possible, which is getting parts to them same day and next day with expertise, that being a critical part of it, and to make sure that we're supporting their organizations through not just a part but also technical knowledge and interface with our fantastic dealer networks around the world as well. So the distribution strategy as to how to optimize that, and one part of that is bricks and mortar. Like you mentioned, the 18 distribution centers and the Louisville Center that will be working on this year and opening next year. So that's an addition. And then as we look forward to it, you know, we'll add the bricks and mortar we need, but there's going to continue to be a key focus on technology so that we can continue to expand the service excellence we provide to the customers. And as far as the other part of the question, I'm sorry, do you have any thoughts?

Yeah, sure. E-commerce, of course, has been the fastest growing segment within agri-farts, 25%, like you said. And engine power is at a good second with a 13% growth year over year. I think those are trends that we expect to continue going forward.

Okay, great. And just to follow up on R&D, obviously, you know, sort of a snapback here off a pandemic low in 2020, but it was up, or at least the expectation for 2021 is up about 10% off the 2019 base. What is the right incremental jump we should see over the next, you know, two to three years? Is it, you know, 10% plus, or do you think you're at a good level? Any color you can give us?

We feel like we're going to be at a good level with this number, and one of the things we always do is if there's great projects for us to work on, we work on them. You know, we have a really strong balance sheet, a lot of cash, and we deploy it wisely to the benefit of our shareholders.

Okay, got it. I'll leave it there. Thanks for the questions.

Awesome. Have a good day.

Our next question comes from Adam Allman with Cleveland Research. Your line is now open.

Hey, guys. Good morning. Good afternoon. Hey, Adam. I wanted to start with I appreciate you sharing your expectations for, you know, industry truck sales and the parts business. I'm wondering if you could do the same for the finance subsidiary. Any thoughts on sales and earnings this year?

Yeah, finance companies saw a nice improvement in profit from the third to the fourth quarter. And if you look at the profit level in the fourth quarter of $64 million with low past dues, good performing portfolio, strong credit qualities, that's the kind of level that we would anticipate for the coming quarters as a range.

Okay. And it seems like used truck valuations have moved quite a bit higher recently. What are you seeing in the market and is there any chance that positively benefits your business?

Used trucks have seen positive momentum both in Europe and North America. Europe probably bottoming out right now, but North America has seen a nice improvement, about 10-12%. So that's a really nice trend. At the same time, Our used truck groups have sold a high number of used trucks, and as a result, our inventories right now have come down very nicely to very healthy levels.

Can I just add that our teams have done a great job in Europe and North America in establishing these retail centers that we've added, both in France and Prague in the Czech Republic, the one we're creating in Madrid, Spain, in Denton, Texas. So that really strengthens our ability to provide customers great used trucks

help their operations too absolutely okay and then just a clarification could you um update us on your mx engine penetration here recently and any plans or goals for penetration rates in 2021 yeah like over the years we've seen steady growth in the mx engine and we expect that growth to continue and we think about the things we're talking about is if we had

Ten years ago, to estimate our proprietary engine share, it was probably 30%. And now it's 60%, and it continues to grow. And each year is a different story depending on who's buying trucks and what parts of the market are alive. But we do expect steady growth on MX engines.

Okay. Thank you.

You bet. Our next question comes from Rob Salmon with Wolf Research. Your line is now open.

Hey, good morning, guys, and thanks for taking the questions. A few follow-ups with regard to Aurora. Could you give us a sense with this partnership, if you guys are taking a stake in Aurora and kind of big picture, how did the economics look for PACCAR? Obviously, you'd be selling a higher spec truck. We're curious if there's any sort of revenue you'd be getting on a mileage base or anything along those lines.

Yeah. You know, the team down there led by Chris and Sterling, are great in terms of technology. Their understanding what the model might be going forward and our understanding of the model might be going forward looks the same in that we would distribute trucks through our network. Obviously providing a driver, an autonomous driver for them, is something that would have lots of updates and lots of engagement with. It's not a sell and forget thing. It's a sell and engage and maintain and update. So that would be, I'm sure, part of their model. And for us, a similar thing, right? The truck will need updates. It will be really important that the trucks that the industry uses for the autonomous are the highest quality, highest reliability, safest product, which is what Packard provides. So that puts us in a strong position. They'll rely on having a great distribution network of dealers, which we do, to take care of those trucks because that will still be a need. And you'd expect that there will be an engagement of software and updates and how the truck performs. And so that will provide opportunity for Packard on a steady basis as well as just a one-time sale.

And Preston, do you have a sense, I know you've talked about kind of looking out a few years where this penetration goes that you guys are currently thinking about from an AV?

I think it's a little bit early to make that call. I think people have tried to make that call in the car industry a few years ago and found that that was a difficult decision. And I think the most important thing is to make sure that it's completely safe and completely reliable, and that's where our focus is.

Got it. Appreciate the time, guys.

Yeah, you bet.

As a reminder, ladies and gentlemen, please press star 1 on your telephone to ask a question. Our next question comes from Courtney Iacovonis with Morgan Stanley. Your line is open. Hi. Good morning. Good afternoon, guys.

Just wanted to follow up on the conversation on used truck pricing. You mentioned that, you know, the Finco margins had improved. I think last quarter you talked about those, you know, trucks really pulling through at no margin. But just wanted to understand, you know, has the used inventory been kind of entirely worked through at this point? And then what are the implications then when you think about new pricing for next year? Because I think you had mentioned that new pricing was about flat in the quarter. So how we should be thinking about the impact to your new pricing?

If you look at the used truck inventory, that has come down nicely. It's not that we don't have any used trucks anymore. We continue to have used trucks, but it's like 16% lower than it was at the beginning of the quarter. It's lower than what it was at the beginning of the year. We continue to sell those trucks to our used truck center, like Preston said. We sell them at those used truck centers. Typically, we would get a premium of around $5,000 per truck. So that will support margins. Yeah, and better used trucks, of course, provide better trading values for our customers and will be a good thing for them, too.

And then just any thoughts on new truck pricing for this year? And then I guess, you know, especially with respect to some of the comments that you've made on, you know, commodity price pressure, can you just, you know, give us a sense of how much steel and aluminum could be impacting your margins this year and what you're thinking about as it relates to price cost.

I don't think there's anything specific we'd say about that. I mean, we're working with our customers on the trucks they need from the big to the small, vocational to the on-highway, and we have a strong relationship with the dealers as we do that and make sure we provide the best parts, trucks, finances, all together for our customers.

working with the supply base, of course. Typically, we have long-term agreements with our suppliers that allow a speed of six months between the raw materials go up and that the prices for those components would go up. So, that gives us enough lead time to price it into a truck, into our trucks, even when needed. So, that's very normal.

Okay, gotcha. And then, just lastly, You mentioned your parts growth expectation for next year. I think, you know, coming out of 3Q, you talked about the acceleration that you saw in parts growth. Have we seen parts growth largely stabilize at this high solution level, or was it actually in the quarter much higher and have kind of continued to grow throughout the quarter?

I think the parts team showed their real strength and capability by having a record quarter. You know, their fourth quarter was an all-time record. So that's steady, strong growth for them. They did a great job, and we expect to see that continue through the year.

Okay, great. Thanks.

You bet. Have a good day, Courtney.

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

We'd like to thank everyone for joining the call, and thank you, operator.

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