帕卡 (PCAR) 2014 Q3 法說會逐字稿

Good morning and welcome to PACCAR's third-quarter 2014 earnings conference call.

(Operator Instructions)

Today's call is being recorded. If anyone has an objection, they should disconnect at this time.

I would now like to introduce Mr. Ken Hastings, PACCAR's Director of Investor Relations.

Mr. Hastings, please go ahead.

Good morning. We would like to welcome those listening by phone and those on the webcast. My name is Ken Hastings, PACCAR's Director of Investor Relations. And joining me this morning are Ron Armstrong, Chief Executive Officer; Bob Christensen, President and Chief Financial Officer; and Michael Barkley, Vice President, Controller.

As with prior conference calls, if there are members of the media participating, we ask 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 Ron Armstrong.

Good morning. PACCAR reported record quarterly revenues and increased net income for the third quarter of 2014. PACCAR's third-quarter sales and financial services revenues were $4.9 billion, and net income was $371 million, an aftertax return on revenues of 7.5%. Revenues were up 15%, and net income increased 20% compared to the results generated in the third quarter last year.

These excellent results reflect increased truck deliveries in North America, and records for quarterly sales of PACCAR Parts and quarterly pretax profits at PACCAR Financial Services. I am very proud of our 23,400 employees who have delivered industry-leading products and services to our customers worldwide. During the third quarter, PACCAR repurchased 581,000 shares of stock for $34.1 million. Under the current Board authorization of $300 million, PACCAR has repurchased 5.6 million shares for $226 million.

PACCAR delivered 37,400 trucks during the quarter, an 11% increase versus the second quarter of this year and 6% higher than the third quarter last year. This growth reflects increased truck deliveries in the US and Canada, due to many customers expanding their fleets and the ongoing replacement of older trucks. Industry orders for Class 8 trucks in the US and Canada for the first nine months of this year were over 220,000 trucks, a 38% increase over the comparable period last year.

Our customers are benefiting from positive economic trends that are generating record freight tonnage and higher fleet utilization. US auto sales are projected to be over 16 million vehicles, and housing starts over 1 million units this year. Other good economic news is that the US unemployment gains this year have averaged 227,000 jobs per month, and lower fuel prices are benefiting our customers' operating costs.

In Europe, it is encouraging that the UK economy, which is PACCAR's largest market in the region, is expected to grow by about 3% this year. The Eurozone economies are projected to grow more modestly, at around 1%. Year to date through September, freight in Germany, as measured by the Maut toll system, was 3% higher than the same period last year. During the third quarter, market registrations of Euro 6 vehicles continued to increase and were estimated to be about 85% to 90% of the industry. As a result, DAF's market share increased to over 15% for the third quarter.

Looking to the fourth quarter, we expect to increase global truck deliveries by 5% to 7% compared to the third quarter, reflecting an increased number of work days in Europe and the continued strength of the North American Class 8 market. Fourth-quarter truck gross margins should be slightly higher than the third quarter, reflecting the benefits of higher production levels.

US and Canadian Class 8 industry retail sales are estimated to be in a range of 245,000 to 255,000 trucks this year, the highest level since 2006. The 2015 estimate for the US and Canada Class 8 market is 240,000 to 270,000 trucks. For 2014, Europe's greater than 16-ton market is projected to be in a range of 210,000 to 220,000 trucks, with our 2005 estimate at 200,000 to 240,000 trucks. Production of DAF trucks in Brazil is steady, with build rates expected to increase gradually in 2015.

PACCAR's Parts business generated record quarterly revenues of $784 million. PACCAR Parts quarterly pretax income was $128 million, an increase of 20% compared to a year ago. The strong results were driven by improved fleet utilization and the many innovative products and services offered by PACCAR Parts.

PACCAR Financial Services revenues were $306 million in the quarter. PACCAR Financial's pretax income was a quarterly record $97 million, compared to $88 million earned last year. The improved results benefited from growth in asset balances and strong portfolio performance. PACCAR's strong balance sheet and positive cash flow have enabled the Company to invest over $2 billion in new products and facilities in the last three years.

In the third quarter, DAF introduced many exciting new products at the Hanover Truck Show, including the new DAF CF and XF Low Deck tractors, and DAF CF and XF trucks with predictive cruise control. Kenworth and Peterbilt launched innovative additions to their product lineups, including natural gas versions of the Kenworth T680 and T880, and the Peterbilt models 579 and 567. Capital expenditures for 2015 are projected to be $325 million to $375 million. And research and development expenses are estimated to be $200 million to $250 million. The investments will enhance our global product ranges, aftermarket support, and manufacturing facilities.

PACCAR continues to enhance its leadership position in the global truck market by developing the highest-quality products and services in the industry, investing in new geographic regions, and providing excellent returns to our shareholders.

I'd be pleased to answer your questions.

(Operator Instructions)

The first question comes from the line of Steven Fisher from UBS.

You were just talking about some of the CapEx trends there. I'm wondering, where are we in the investment cycle for parts distribution centers?

And then how should we think about how much it would cost to expand into some of the newer regions that you've discussed? I'm just wondering against that $2 billion you spent the last few years, are there any particularly big CapEx programs we should be expecting in the next couple?

I think capital expenditures next year, if you look back at our average spending levels, we've been in the $300 million to $400 million level on average. And I think next year will be a typical year, with continued investment in parts distribution centers. We're going to build a new parts distribution center in Renton, here in the Seattle area. We'll continue to invest in new products and continue to invest in improving the efficiency of our manufacturing facilities around the world. One of the things that we'll be doing next year is investing in a new paint facility at our Westerlo plant in Belgium.

Okay. That's helpful.

And then in terms of fleet expansion at your customers, you seem to be calling out a little bit more clearly this quarter. What have you heard from end customers that may be different at this point?

I think that the fleets have taken some actions to attract more drivers through increasing pay rates and other activities. And so I think they're feeling better about being able to keep their trucks utilized. And, of course, freight tonnage is at an all-time high. So the demand is there. And we're starting to see a little bit more willingness to make that fleet expansion.

Okay. Great. Thank you.

The next question comes from the line of Nicole DeBlase with Morgan Stanley.

Thanks, good morning.

My first question is around build rates. So you've been stepping up your build rates at your North American facilities. I'm just curious, today, where are we from a plant capacity utilization perspective? How does that compare to prior peak levels? And is there scope to take up your build rates further?

We're in good shape from a capacity standpoint. We have a fair amount of capacity remaining in several of our plants in North America. So we don't see capacity being a limiting factor for our operations in the near term. In Europe, obviously, I think we're in good shape capacity-wise as well. So we feel good about our capacity really in all of our markets around the world.

Okay. Got it. That's helpful. Thanks.

And then maybe the second one around pricing. How was truck pricing for you during the quarter? And what's your view on pricing as we move into next year? Because as build rates increase, there could be the scope for pricing to improve in the industry. I'm just curious on your thoughts around that.

Pricing has been pretty steady for us in the last 12 months. We talked about, with Euro 6 coming on board in early part of 2014, the market still remains at a relatively low level compared to some of the peak levels. So pricing continues to be steady. And if there's some opportunity for market improvement as we go forward, there may be some opportunity for price realization. I'd say steady is how we're thinking about pricing as we go forward.

Okay. Thanks. I'll pass it on.

The next question comes from the line of Steve Volkmann with Jefferies.

Good morning. How are you?

I'm well, thank you for asking. I hope everybody's good there.

Great.

Curious about maybe another way to think about this pricing thing. How far out are your delivery slots in North America these days, roughly?

We're pretty full for the rest of this year and then starting to add to our backlog for next year.

And did you have a normal price increase associated with 2015? I assume you do that every year.

There are typical adjustments, effective with the model year change. And so when that happens next year, there will probably be a list price adjustment that goes with that.

Okay. Fair enough.

And then are you seeing anything on the supplier side, with respect to costs or tighter schedules, as things ramp up? Are they able to keep up with you? And is that having any impact on your costs?

The suppliers did a great job of supporting our build rate ramp-up during the third quarter. And everything is running very smoothly at this point, and we see no particular challenges with them being able to continue to support that. And commodity prices are relatively stable, so that's obviously allowing us a stable cost situation.

Great. Thank you very much. I'll pass it on.

The next question comes from the line of Jamie Cook with Credit Suisse.

Couple of questions. As we think about 2014, you have had nice margin improvement on the operating margin line, based on how we'll trend for the year. The gross margins look like they'll probably be more flattish for the year. As we look ahead, do you see further opportunities on the SG&A and R&D side to get operating margin leverage? Or going forward, does operating margin leverage really need to come more from the gross profit side or gross margin side? Can you talk about your comfort level there?

And then my other question is just on the markets. Can you talk about the vocational side of the markets -- how much that was up year over year and sequentially? Thanks.

Well, on the cost side, SG&A -- I think we'll continue to see comparable levels next year to what we've seen this year. If there are higher revenues, that provides some leverage; but spending levels will remain relatively constant.

In R&D, we talked about for next year our range being in the $200 million to $250 million range as we continue to invest in new products, engine efficiency, and other product enhancements. That spending level will be in that range somewhere. So again, the leverage will depend on whether we have increased revenues or not that go with that.

From a factory standpoint, to the extent that build rates increase, we'll see some operating leverage as a result of that. So I'd say pretty typical operating leverage, as we've seen, over the years.

What was the --?

The second question. So you feel comfortable you could get gross margin improvement next year?

I think it really depends on the volumes that we see. I think we see pricing as being pretty steady. And there's opportunity to get additional operating leverage with additional volume.

Okay. And sorry, the last question was just color on the vocational markets -- what you're seeing sequentially and year over year? Thanks.

PACCAR does a great job with the vocational business. The vocational market in the North American continent is on order of 25% to 30% of the total market, probably up 5% to 10% year on year. And our market share is in the 45% to 50% range. So it's a good, solid, steady market for PACCAR. And in Europe, the guys are working really hard to capture a larger share of the rigid or vocational business in Europe. And certainly it's an opportunity for us there.

All right. Thanks. I'll get back in queue.

Next question comes from the line of Andy Casey with Wells Fargo.

If I missed it, I apologize. Could you highlight what the truck shipments were in the quarter, and then maybe by two of the regions?

Total deliveries were 37,400. I don't know if -- we'll get the information by region. In fact, I have it here, 37,400 So in the US and Canada, 23,500; Europe, 9,200; and the rest Mexico, South America, Australia and other.

Okay. Great.

And then on the 2015 industry sales outlook, I know it's the initial view. But between the two primary regions, US/Canada and then Europe, which region do you think has the highest likelihood for upside risk at this point?

Upside risk. I mean, I guess we feel good about the ranges that we've provided, Andy. If US and Canada continue at third- and fourth-quarter pace, it would be probably towards the higher end of that range. And Europe, a lot depends on how things develop in the economy over the coming months. I don't have a comment which was, say, more risky than the other. I think we feel good about our ranges at this point.

Okay, thanks.

One last one, and it's along the same lines. If you look at the midpoint, it's low-single-digit growth in both primary regions. And if you assume no dramatic market share shift anywhere for you folks, does the modest sales growth suggest modest production growth? And the reason I'm asking is, you've increased production pretty much sequentially for most of the year; so the first part should have pretty good growth.

I think we're at a production level to support the current market conditions in US and Canada. So assuming the market is within our range, I think we'll see fairly steady production levels through next year. In Europe, orders have been relatively steady; and we've with been producing at a pretty steady pace there. And so we'll see how things develop as we enter 2015. But our perspective is that the markets will be similar to up, depending on how the economic conditions develop.

Okay. Thank you very much.

The next question comes from Andrew Kaplowitz with Barclays.

Nice quarter.

Ron, so maybe we could talk a little bit more about the European truck market. If you look at the data available for the important countries for you, like the UK that you mentioned and Germany, they do look still somewhat weak -- but maybe stable at a low level is more accurate. September did appear a bit better than July from the data that I see. Maybe you could talk about your order boards and inventory levels in the major European markets for you?

Orders have been pretty steady the last couple of quarters and supporting our current build rates. I don't see anything that's going to cause that to change in the short term.

What was the rest of your question, Andy?

Inventory, your 2005--

Inventories, both for our truck operations and our dealers, are in great shape. Dealers have reasonable levels that are consistent with the current market conditions. I'd say that's true not only in Europe, but also in North America. And if anything, dealers could probably use maybe a little bit more inventory in some of our North American activities.

Okay. That's helpful, Ron.

You talked about your Parts-related growth for this year to be in the 5% to 8% range. It continues to pretty consistently be around 10%. Besides more difficult comparisons, as your fleet in service continues to get larger, why wouldn't Parts continue to grow -- at least on the higher end of your previous range?

Now we're to the point in the year, where we're 10% up year on year. So I think for the full year, we'll be at the higher end of that range,.

As we look into 2015, Ron, again, you're going to put in new distribution. And it still seems like it's pretty consistent growth there, especially with the bigger fleet. Can we expect still at least mid-single-digit growth?

I would expect -- our Parts team does a great job of putting together innovative programs and services to support our dealers and customers around the world. So I would think we would see some continued growth in the Parts business as we progress into 2015.

All right. I tried. Thanks, Ron.

The next question comes from the line of Ann Duignan with JPMorgan.

Maybe you could take a step back. You noted that the vocational market is up about 5% year to date. Could you just break that down and give us some more color in terms of construction end markets versus oil and gas? And then, what you're seeing in other applications -- like long haul versus big cab, short haul? Just a little bit more color on where you're seeing the strength in demand.

I would say that in the oil and gas area, activity is steady, probably is the best way to say that, year on year. Probably have a little bit more growth in residential and commercial construction applications. In the current environment, we would think that would be the trend moving forward as well, that construction activity would continue to lead the vocational market until oil and gas pricing really recovers from its current level.

Okay. And perhaps just the same question around fleet expansion. What kind of fleets are expanding? Is there any commonality, either geographically or tied to oil and gas, or not?

No, Ann, I --

Rail capacity or --

I would say the economy is in the midst of a long, slow economic recovery. And it's all of the segments of the Class 8 business: long haul, short haul, day cab, sleepers. They're all responding within the same solid range of growth.

Okay. So no one end market or applications specific to expansion of fleets?

Which is great for PACCAR because we've got a very diverse product lineup. We're strong in all of those segments.

Indeed. Indeed.

And then just finally on Brazil, you normally tell us how many trucks per day you're building. Where are we today? Where are we going? The market doesn't look great down there. So maybe talk about, are you going to continue to proceed ramping up? Or would you consider curtailing production in the region?

It's early days for us, Ann. And our build rates are steady, and we anticipate being able to gradually ramp up build rates. As we start into 2015, our dealers get more of their final facilities in place and operational, and we get contact with more and more customers. We have lots of demo trucks that are out with customers that they're testing, and we're getting traction really as we continue to go week by week, month by month.

So the team is doing a great job, and we've got a great long-term opportunity in Brazil. So the short-term situation in Brazil doesn't really impact us.

I think you were at about three trucks per day at the end of last quarter. Where are you right now?

We're in the two- to three-truck range.

Okay. I'll leave it there. Thanks. Thanks for the color.

Next question comes from the line of Jerry Revich with Goldman Sachs.

I'm wondering if you could talk about how the warranty performance is tracking on the new products in Europe. And I think the industry was just working through some electronics issues on engines in the US. Can you talk about how the quality performance has trended since the last time you spoke on the call?

Products are great. The Euro 6 products are being very well-received by our customers. Obviously, we continue to increase the penetration of engines in North America, 35%, 40%. So I think we have 65,000 engines in the field these days. And so the feedback on the engines, all of our truck models around the world is excellent; and warranty performance is just normal. So products are doing great.

And I know you're counting is deliberately conservative on the warranty side. Can you talk about over what time period you would expect the accrual rates to come down to match the quality performance? At least as of last quarter, it looked like you were running 80 basis points plus above normal accrual rates following the new introductions.

Warranty, as I said, it's very normal. There's nothing unusual about our warranty rates. And so I think we'll see steady warranty as we go.

Steady improvement.

Yes.

And in Europe, can you just calibrate us since this was just a transition year. How much this year are your retail sales higher than your production rates on the numbers you shared with us year to date? How much higher would the retail sales for your dealers have been?

One more time, Jerry?

Sure. Retail sales for your dealers, I'm assuming, were higher than your production this year in Europe, given the transition to Euro 6. Can you just talk about how significant that gap was for your dealers? How much did they bring down inventories post the Euro 6 transition?

I think retail sales were pretty consistent with our production levels. Probably maybe 1,000 trucks or so from the beginning of the year dealer inventory down to where we're at today. But it's nothing of significance.

Okay.

And lastly, you spoke about the CapEx and SG&A outlook. I'm wondering if you could just touch on R&D heading into next year. You're coming off a couple of really significant new product cycles. Is there an opportunity for R&D to move lower in 2015 and maybe 2016?

I think as we put our range for next year, we think will be $200 million to $250 million -- somewhere very comparable to what we saw this year as we continue to invest in our new product lineups and engine efficiency, facility enhancements, new systems to support continuing to improve our business efficiency. So I think R&D will be in that comparable level as we look at 2015.

Okay. Thank you.

Next question comes from Joel Tiss of Bank of Montreal.

I think a lot of the operating stuff has been asked already. But I just wanted to ask a little bit about the philosophy of your cash pile and the buildup. You've got a little less than $3 billion right now. And between 2015 and 2016, you could easily generate another $2.5 billion of free cash flow.

And I just wondered if the number and the size of the projects that you already have on your plate, plus your special dividend, is enough to deal with that? Or is there any reason to do some new thinking about where you are and where we are in the cycle?

We're talking about capital expenditures for next year in the $325 million to $375 million range. We've got a $0.22-per-quarter regular dividend. And we'll take a look at what the year end might bring with respect to potential special dividend payments. The Board will evaluate that and make a decision.

And we continue to -- it's a cyclical business. Having a strong cash position is healthy for our Company and in our industry. And we'll continue to look at alternative uses. And, obviously, having a strong cash position and strong cash flow gives us a lot of flexibility to take advantage of situations that might arise.

And we periodically, from time to time, will go in the open market and repurchase shares. So that's always an option for us. So that will be our plan as we continue forward.

All right. Thank you.

The next question comes from Patrick Nolan of Deutsche Bank.

Most of my questions have been answered. But I wanted to follow back up on the earlier pricing discussion to see if you would expand on particularly what you're seeing in pricing in Europe. Have we seen prices move up sequentially? Are you capturing more of the Euro 6 costs than you were earlier this year?

No, I think pricing is pretty constant. We have a great product lineup. We have a broad Euro 6 product offering. And so the customers are very appreciative of the great products. And so pricing has been, I'd say, fairly constant as we've moved throughout this year for our Euro 6 products.

And your statement about pricing next year of relatively confident as well -- that applies to Europe as well?

I think it will depend a lot on market demand and what the market size potential may be. So at this point, I don't see any significant ups or downs in price expectations for 2015.

Thanks.

And I just had one follow-up on the Q4 shipments. I apologize if I missed it. Can you just discuss how you see the shipments materializing for each region sequentially going into Q4?

We talked about a 5% to 7% increase in our fourth-quarter deliveries, with the majority of that coming from just increased workdays in Europe. Our European business has their traditional summer shutdown period during the third quarter, so that gives us more workdays in the fourth quarter. And then we continue to see the benefits of the strong North American market.

Thanks very much.

The next question comes from the line of David Leiker with Robert W. Baird.

I wanted to try and dig through two items here. First, on Brazil, where are you on coming up the profit curve and breakeven in the region?

That's a long-term proposition for us. We do expect to ramp up our build rate in 2015. It's held steady. Market conditions are -- it's a challenging market, but the opportunity for DAF to continue to gain traction and build its place in the market is great.

And so we look for continued improvement in 2015 and beyond. And we'll get to that breakeven point in the near term.

Is anything, as you ramp, though, is that a drag on the numbers might become larger before it gets better? Or are we over the hump on that?

No, I don't think so.

Great.

And then just a little bit more color, if the we could, on capacity utilization. Where are you in terms of shifts that you're running in your plants and build rates and things like that? Anything you can share?

We're producing at record build rates in our Chillicothe and Denton factories. We still have lots of opportunity to build more trucks in our Renton factory; in Sainte-Therese in Canada; our Mexico factory obviously has some additional capacity; and in Europe, we're in great shape capacity-wise. So good shape really in all of our geographic areas.

Are you running overtime anywhere?

No, no scheduled overtime. So we're in good shape. And all the capacity investments that we've made over the last five years have really positioned our facilities to be in great shape to support current market conditions, as well as reasonable growth prospects that may come.

Okay. Great. Thank you very much.

The next question comes from the line of Rob Wertheimer with Vertical Research.

One quick one on Europe. I'm just trying to sort through the pre buy. And I would have thought that you would have had a deeper overhang, just given the geography of where you sell. And therefore your 1Q might have been worse; and it would have come up 2Q and 3Q, despite 3Q maybe some production shutdowns in August and all that stuff.

I'm just curious if you see Europe trending a little bit worse because that overhang was there in 1Q and it hasn't gotten better or if you see it steady? Maybe I'm misunderstanding how the overhang works.

I'm not clear on what you mean by the overhang.

So 9,300 deliveries in 1Q, 9,200 in 3Q. And I would have thought that 1Q would have been the most depressed, just given the pre buy before that.

I think as we look at -- build rates have been reasonably steady. We took the build rates up in third quarter and fourth quarter of 2013 to support the demand for the Euro 5 pre buy. As we reduced that back down at the beginning of 2014, that build rate has been relatively steady at that level through the course of the year.

Okay. That answers it.

One other question. I'm not sure you'll be able to address it, but I'm just curious. Given the strong success of your engine, 13-liter in North America, did it come with any launch? It's been launched a while back now, I guess. But any initial hesitation from customers that would have caused you to have a pricing strategy that was less aggressive? And as it proves out to be seemingly really high-quality and working well, is there any opportunity to move the margin up on it?

We had a well-thought-out pricing strategy with our engine when we launched it four years ago in 2010. We've stayed pretty consistent with our approach. And think the engine, obviously, provides great value for our customers. It provides a great option for them. It's light weight, fuel efficient, and reliable and durable.

So great engine. Like I said, 65,000 engines in the field currently. And so I think that's, again, a pretty stable outlook on what we see as pricing and value for our customers.

Thank you.

Next question comes from the line of David Raso with ISI.

Thinking of the build schedule for Europe, I know with the days it's not the cleanest analysis. But I'm just trying to think about the builds for fourth quarter versus third quarter. It would appear you'll be over roughly 10,000 units. Is that the right way to think about the sequential?

That's fair.

So with that, when I think of the first half of 2015 -- and I guess really if you're thinking your build schedule being steady -- is there any reason to think, from what you see in your order book right now, that we can't take that fourth-quarter build schedule and think of it as, at a minimum, sequentially flat? Obviously that puts the first couple quarters of next year with pretty healthy year-over-year growth in Europe.

Our current thoughts are that the market will be comparable to this year and that we hope to improve our share of that market as we look to 2015. And so I think we'll enter next year at rates comparable to where we're at currently.

That's what I was getting to. Your industry outlook is midpoint, I know it's a wide range, but up 2.3%. But just taking your prior answer, again, if you run that build schedule from fourth quarter out, you're up a lot more than that. Should we take that to mean some implicit thought about market share? Or, again, it's a wide range; it's an early look.

When I say build schedule I'm thinking about the daily build rate. And again, our daily build rate has been pretty steady throughout 2014. What has been a difference is the number of workdays in the fourth quarter relative to the third quarter.

Okay. Last question.

Gross margins, a little stronger than you had forecasted at the end of last quarter. What would be driving that in particular? Was there any change on the build schedules versus what you thought with a particularly good mix? It just doesn't sound like pricing is necessarily giving it to you. Is it cost? Just trying to understand where that gross margin upside came from and how to think about that moving forward.

Primarily it was the benefits of operating leverage. We're 11% up in terms of delivered volumes during the quarter, and so it really was the benefits of operating leverage.

More specifically, it's a North American production upside. Europe builds were generally as you thought?

Yes. Europe was -- it was really the ability of the suppliers and our facilities to deliver the ramp-up plans very efficiently and very effectively.

Okay. I appreciate it. Thank you.

Next question comes from Scott Group of Wolfe Research.

So I wanted to ask, on the engine side, as you start doing orders for next year, are you seeing any further maybe material pick-up in engine share on your side? Do you think that can get to the 50% penetration number next year? And how should that impact the gross margin?

Well, I think we've continued to see the increased penetration of our engines over time. In the third quarter, we were in the 35% to 40% range. I think you'll continue to see a steady progression as time goes on.

And so 50% at some point in the near term is certainly achievable. And as we increase the utilization of our factory, there are some operating leverage benefits that come with that.

And how long after you sell a truck with a PACCAR engine does the aftermarket opportunity on that come through?

Well, it starts when the engine gets put in service; but that ramps up over time. And so as we increase the number of engines in the field, that aftermarket benefit really starts to kick in after two, three, four years.

The Parts stream has a little bit longer tail. The service opportunities, because it's a captive engine and will be serviced at Kenworth and Peterbilt dealer, provides good near-term opportunity for our Parts organization to sell parts that are also installed in different service intervals. And so the service captivity is an important piece of the engine strategy.

Okay.

And then last one for you, Bob. Not a big deal, I don't think. But any preliminary thought on pension as a potential headwind for next year?

I would just say that our pensions are fully funded, and the contribution rates are steady. And we don't really expect too much of a change from that.

I was just thinking on the expense side with the lower discount rate, but you're saying nothing material?

No.

Thank you.

The next question is from Alex Potter with Piper Jaffray.

This is actually Winnie in for Alex.

The first question is on margins in the Financial Services segment. We saw an improved margin in Q3. Can you maybe talk about how sustainable those margins are on a go-forward basis?

How are you measuring margins?

We're taking the -- one second here. We're taking the gross profit by the revenue.

So the --

Gross profit margin.

Revenues minus the cost. Part of that is obviously we're an A-plus rated borrower. And so we are able to borrow at very competitive rates. And we are able to support our dealers and our customers, for them at very cost effective rates, to support our business.

Part of the reason for that improved margin is the fact that market rates are trending down. And so the revenue number and the cost number both are going down. And so it creates a higher margin percentage just because of market rate movements.

Okay. Got it. Thank you.

And then just another question on the outlook in Europe. Last week, WABCO also reported they expect flattish demand and growth in Europe. But the production forecast was about up 3% to 8% for 2015. I was wondering if you can maybe talk about what your 2015 outlook implies in terms of production growth?

I think our market estimate for Europe, we're talking about 210,000 to 220,000 this year; next year, 200,000 to 240,000. We would expect DAF to earn its typical share of that market, and so that will be indicative of production. So I don't think there's any big difference between market registrations and our production for either year.

Okay. Thank you very much.

Next question comes from the line of Adam Uhlman with Cleveland Research.

I was wondering if you could talk about what you're seeing in Eastern Europe and Russia?

Our deliveries in Russia this year will be lower than last year, an effect of some of the uncertainty that exists in that region. But we continue to sell trucks. Got a great and growing dealer network in Russia, and so we see it as a great long-term market for us.

But certainly impacted this year by what's gone on in the region. And you see that in some of the other areas, the other areas of Eastern Europe. We continue to grow our business there and, again, see that whole region as a great long-term opportunity for DAF.

Okay. And then what proportion of your DAF volume is going to be non-Euro 6 for the year, do you think?

It's probably in the 10% to 20% range for the year for Euro 5 and other emissions levels.

Great. Thank you.

Next question comes from the line of Neil Frohnapple with Longbow Research.

Congrats.

Regarding used truck pricing in North America, what are you seeing in the market? And do you think we're peaking? And just any other color you can add there on how that will potentially impact the new truck side?

Well, the used market has been very good throughout this year, up 5% to 10% year on year. And so there are no signs of that being significantly different in the near term. Used truck prices are near all-time highs, and we're benefiting from that in our finance operations.

And then can you speak to any early signs on the 11-liter MX engine launch in Europe? And wondering if you can just update us on your plans for the timing of the launch in North America?

The plans for launching in North America are early 2016. The feedback in Europe has been excellent. I was in Europe in September and met with some customers and dealers. And the benefits that engine provides in terms of payload, capacity, the weight, the efficiency of the engine in terms of improved fuel efficiency, it's great for a lot of customer applications.

And so as we see down-sizing becoming a growing trend in Europe, the MX11 is being very well-received. And we'll have a launch here in 2016, and we think that will be a nice addition to our engine offerings in North America as well.

Great. Thank you very much.

Next question comes from the line of Ted Grace with Susquehanna Financial.

I was hoping to follow up on David's question on Europe. And I know the range you gave was down -- call it down mid single to up high singles. Could you maybe speak to your key markets in Europe and whether you expect those to outgrow, and that might help bridge your build rate, versus what you jump into next year with versus year to date?

The UK, the Netherlands, Belgium, our home markets, if you will, got impacted a fair amount by the Euro 5 pull-forward. And the Netherlands and UK had unique transition rules, so those markets are down quite a bit this year compared to 2013. And the expectation for next year is that those markets will see some growth, which will benefit DAF both in terms of production volumes and share position.

We're very strong in the Central European countries, a market leader in Central Europe. And so I think we'll continue to see reasonable growth in Central Europe as we go forward.

So I feel DAF, again, the DAF Euro 6 product has been very well-received. The MX11 engine has been very well-received. The product lineup is as broad as it ever has been. So DAF's well-positioned to continue their march towards 20% market share in the midterm.

Okay. So when you overlay your footprint and those dynamics relative to your plus 2% market growth, you should outgrow the market by a meaningful portion, correct?

There's potential there, for sure.

Okay.

And then the second thing I wanted to asks was on the US outlook. You've got the midpoint up 2% next year. Could you just maybe talk about how you're thinking about the on-highway market versus the vocational, the relative growth rates? Which would be above 2%, which would be below 2% in your forecast?

We haven't gotten that precise with our outlook. I'd say that we expect both markets to continue to grow in the short term. Obviously, the long term, we'll see I think develop.

Right now I think we see, as Bob mentioned earlier, the improving construction market conditions will support vocational growth in the short term. And record freight tonnage obviously supports the long haul and less than truckload business, as well as in the short term.

But the freight side is facing tougher comps. So just intuitively, it would make sense to think vocational should grow at a faster rate. Would that be a fair assumption?

Again, we haven't thought that precisely about the growth expectations.

Okay. Thank you very much. Good luck this quarter.

Next question is from the Seth Weber with RBC.

Just a couple of quick tie-up questions. Just going back to Brazil, have you heard anything about the government subsidies -- what their plan is there, I guess, post election or how that's looking for 2015?

Well, obviously, with the Rousseff administration continuing, we expect that those subsidy arrangements will continue. I think there will be some discussions in the coming weeks and months about what exactly those terms and conditions will be. But our expectation is that those will continue in at least a similar form or fashion as to what they have currently.

We expect to hear the details of the new program in December.

In December. Okay. So you don't anticipate any interruption into next year?

We don't think so.

Okay.

And then just on the FinCo, given the low interest rate environment, are a larger percentage of customers relative to history using the FinCo? And how do you handicap what would happen in that business if rates did go higher?

Over time, the market share penetration -- the percentage of PACCAR trucks that are financed in leasing companies -- support have been in the 28% to 30% range. And so I think we would continue to expect to see it in that range. Our team provides really strong customer service. We're dedicated to the transport industry.

So the increased level of customer service and technology that we have to support the business is beyond what others can offer. So I think we'll continue to see it in that range.

Okay. That's all I had. Thank you very much.

The final question comes from the line of Jeff Kauffman with Buckingham Research.

Thank you very much. Congratulations. Terrific quarter.

A lot of my questions have been answered at this point. So let me just ask a softer one here. In terms of the ASP and the improvement you're seeing there, how much of that is coming from customers coming to you saying -- Listen, I just want different specs on my truck. And here's how I want it specced. And maybe look at what your heavy-duty buyers are asking for versus medium-duty. And I know there are a lot of different kinds of markets there -- versus you going out there and saying, look, the base truck is just X percent more?

When you say ASP, you're talking about average selling price? Just to make sure we're --

Right. And I understand that's a residual fallout between revenues you're generating and units you're selling.

Our discussions with our customers are all based on the value that we provide to them to meet their needs. And each customer is different, and their expectations and demands may change over time. It's a very dynamic pricing environment. And we price our product to earn a fair return and provide them a great product that they can have at the lowest lifetime operating costs for their operation.

All right. Let me follow up a different way.

At the dealership level, with the Parts and Service business being so strong, how are the absorption rates at your dealer levels trending right now? And where do you think you're going to be in terms of dealer inventory?

Absorption rates are trending up. Our dealers are performing excellently and taking advantage of the high freight levels; and providing great service; extending their hours of service; opening new facilities. So you see the benefits of that in their business. Their inventories are in great shape. And, as I mentioned earlier, in fact, maybe they're a bit too low from where maybe the optimum situation might be. But dealers are doing very well in North America, as well as in Europe.

Okay. The big questions have been answered. Thank you for the follow-ups.

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.