Paccar Inc (PCAR) — Q3 2017 Earnings Call Transcript

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; Harrie Schippers, Executive Vice 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. I would now like to introduce Ron Armstrong.

Good morning. PACCAR achieved excellent revenues and earnings for the third quarter of 2017. PACCAR's third quarter sales and Financial Services revenues were $5.1 billion, and third quarter net income was $403 million, a strong 8% after-tax return on revenues. PACCAR achieved excellent Truck, Parts and Other gross margins of 14.5%, driven by growing Kenworth and Peterbilt market share in North America, a robust European truck market and record aftermarket parts results. Kenworth and Peterbilt's year-to-date Class 8 market share in the U.S. and Canada was 30.1%, more than 2 percentage points higher than in the same period last year. DAF is currently producing trucks at record build rates in its Eindhoven factory. I'm very proud of our 25,000 employees who have delivered the world's highest quality trucks, parts and financial services to our customers worldwide. PACCAR delivered 40,200 trucks during the third quarter, 2% higher than the second quarter. Increased build rates in North America, Australia and Brazil were partially offset by fewer build days in Europe due to the regular summer shutdown. Next quarter, we're expecting 7% to 9% higher deliveries compared to the third quarter due to increased production in Europe. Deliveries will be slightly lower in North America due to regularly scheduled holidays. Truck, Parts and Other gross margins in the fourth quarter are forecast to be down slightly from the third quarter due to a higher mix of truck sales compared to parts. The U.S. economy is expanding 2% to 2.5% this year. We expect U.S. housing starts will grow to 1.2 million units, and the automotive industry will deliver nearly 17 million vehicles. We've raised our estimate of retail sales for this year's U.S. and Canadian Class 8 truck market to a range of 210,000 to 220,000 units. For 2018, economists are forecasting continued GDP growth of 2% to 3%, an increase in housing starts of 7% and another strong year of auto sales. Industrial production is also expected to expand 2% to 3% next year. We head toward 2018 with positive momentum in the U.S. economy and the truck industry. We estimate U.S. and Canadian Class 8 truck industry retail sales will increase to a range of 220,000 to 250,000 units in 2018. We've raised our 2017 forecast for Europe's greater than 16-tonne market to a range of 300,000 to 310,000 units, reflecting continued strong demand and a growing economy. The eurozone's GDP growth expectation for this year is 2.1%, with 2018 projected at a similar level. Freight transport activity on German highways is at record levels, up 4% this year. We expect that 2018 European heavy truck market to have another excellent year in a range of 280,000 to 310,000 units. PACCAR's Parts business generated record quarterly revenues of $840 million. Parts quarterly pretax income was a record $153 million, with an excellent pretax return on revenue of 18.2%. The growing number of PACCAR trucks and engines in operation and increased sales of TRP All Makes parts drove these results. We're pleased to have opened the 100th TRP store during the quarter. TRP stores expand PACCAR's aftermarket opportunity by selling more parts to the second and third owners of All Makes of trucks. PACCAR Financial Services third quarter pretax income increased 13% to $71 million compared to $63 million in the second quarter this year. The portfolio, which was a record $13.1 billion this quarter, continued to perform very well. U.S. Class 8 industry used truck sales volumes increased during the quarter. Kenworth and Peterbilt truck resale values continue to command a 10% to 20% premium over competitors' vehicles. PACCAR is increasing its investments in delivering new products and technologies as reflected in the recent introduction of the new PACCAR automated transmission, the new DAF XF and CF vocational trucks and new DAF LF vehicles. We estimate capital spending of $400 million to $450 million and R&D expenses of $260 million to $270 million this year. In 2018, we're planning for increased capital investments of $425 million to $475 million and increased R&D expenses of $270 million to $300 million. These investments will enhance PACCAR's integrated powertrain, deliver advanced driver assistance and truck connectivity technologies and add additional capacity and efficiency to the company's manufacturing and parts distribution facilities. To expand our technology and industry leadership, PACCAR is investing in technologies that may take several years to commercialize. A current example of our advanced driver assistance systems investments is a truck platooning trial that begins early next year in the U.K. PACCAR is also a leader in alternative powertrains. Kenworth and Peterbilt are market leaders in the North American natural gas truck segment, and we're currently testing electric powertrains in PACCAR trucks as well. While we think it will be some time before electric trucks become a sizable segment of annual industry sales, there could be an opportunity in certain applications in the medium term. PACCAR knows from experience that customers adopt technology when it provides a financial return for their businesses or is mandated by government regulations. Our focus is to always offer transportation solutions with industry-leading technologies that maximize our customers' operating efficiency. Thank you. I'd be pleased to answer your questions.

I'm wondering if you could talk about the expanded product lineup that you folks are delivering in Europe. How should we think about the production learning curve for you folks? Any productivity changes that we should be thinking about? And the overall margin profile of the product line as you ramp it through the factories, anything we should keep in mind for the sequential margin outlook?

No. The transition of production to the new CF, XF and soon the LF vehicles, that's all gone very well. So production ramp-up has gone without any challenges. And so we're moving into the next phase with the vocational trucks and getting ready to transition with the new LFs. So all that has gone very well. Yes, Harrie has some thoughts here. Just a second.

The production started already in June. And like Ron said, the ramp-up had been pretty smooth. The trucks offer 7% better fuel economy and lots of other benefits for our customers and have been extremely well received.

Yes.

Okay. And normally, when you folks do a new product rollout, there's typically a higher level of automation. And is that the case here as well from a manhours-per-unit standpoint that we should keep in mind?

I think one of the great things that is just coming online is not necessarily tied to the launch of the new products, is the Westerlo cab paint shop, which does have the latest state-of-the-art paint robotic applications in the industry. So it's a fantastic plant. If you ever get a chance to go to Europe and visit DAF's facilities, that would be certainly be a stop because it does have state-of-the-art robotics and the quality and the finish of the products is great.

And Ron, at the end of your prepared remarks, you mentioned electric truck is coming into focus for select applications. Can you talk about how we should be thinking about the margin profile for you folks on electric trucks versus diesel-powered trucks? Anything we should keep in mind? And then from a parts standpoint, I guess there's concern about wider maintenance intervals. And I'm wondering how are you folks thinking about possible offsets. And appreciating that it's a small market subset where that product would make sense, but just conceptually, if you could touch on that.

Yes, Jerry. As I mentioned, I believe that the commercialization of this technology is still a number of years away, likely beyond any reasonable planning period for significant adoption. Battery packs remain large, heavy, and costly. While we need to prepare for this technology, its commercial viability still has a long way to go. Therefore, I don't anticipate that it will influence our thoughts on margins or similar concerns in the near future. I see it as a midterm technology that we may start to see in vehicles, particularly smaller ones or those not typically mainstream, such as port applications or refuse trucks.

I have a couple of questions. You mentioned that PACCAR has historically invested in technology for its customers, and you provided your R&D and CapEx outlook for 2018. However, considering the changes in the truck industry, such as electric vehicles, platooning, and automation, could these developments pose a potential challenge to margins? Should we not expect you to deliver what we would consider a normalized incremental margin in the near term, particularly within the next 12 to 24 months? Additionally, could you elaborate on what that normalized incremental margin might be? My second question is regarding your perception of the market; there seems to be some concern entering 2018 about whether the larger fleets will actually begin to place orders. Can you share your thoughts on whether the customer base for 2018 will primarily consist of large fleets or will it be more diverse, including vocational, small, and large businesses? What feedback are you receiving from customers in the U.S.?

Let's discuss technology. We have recently opened our office in Silicon Valley and already have established many relationships prior to this opening. We plan to continue developing relationships focused on future technologies such as connectivity, advanced driver assistance systems including autonomy, and electrification. These areas are currently our focus and will remain so. While we anticipate an increase in our research and development spending next year, I don't believe it will significantly affect our gross margins in the short term. On the customer front, feedback from discussions has been quite optimistic regarding their outlook, particularly in terms of demand and some recent improvements in freight pricing. Overall, our customers report positive sentiments, with order levels matching those of last year. The on-highway fleet segment will likely continue to dominate, but vocational markets are also performing well, especially in regions with significant construction activity. If an infrastructure plan is enacted, it will likely enhance demand for vocational trucks as we move into the next year.

Okay. So just to be clear though, the investment will not impact our thinking on normalized incremental margins for PACCAR going forward?

Yes.

Just a couple of questions. First, just on the finco and how it relates to used truck prices. I mean, used pricing seems to be firming a little bit. Do you think that translates into higher new equipment pricing anytime soon? I mean, there seems to be a lot of competition on new products out there. Or do we just sort of meander around this flattish pricing environment for new trucks for a while?

What we've seen is relatively steady pricing. And at this market level, I think that's what we're anticipating from a pricing standpoint. You're correct about the used truck market there. Prices are firming. And I think most of our guys and the folks we talk with feel like that used truck prices have bottomed and are stabilizing and have some upside. On the used truck side, we're starting now to see more of our newer model trucks being returned off lease, so that's a positive sign that we'll see over the next 12 to 18 months.

Got it. And then just on Parts, I mean, your longer-term growth rate, I think you would agree, is closer to kind of mid-single digits, maybe 6%. And you've clearly been running well ahead of that this year. Do you think you see a slowdown in 2018? Or does it feel like this above-trend growth in Parts will continue for at least a couple more quarters?

For now, we're thinking that next year is somewhere in the 3% to 5% range for Parts revenue growth for next year, but we'll see how it develops. Obviously, the demand is there. We're continuing to add dealer locations. Our team has got great programs and really making it easier all the time for our dealers and customers to do business with PACCAR Parts. We're adding distribution capability. We're just starting the construction of a new facility in Toronto, and we'll continue to increment our distribution capability in the coming months and years. So we feel good about the prospects. And right now, 3% to 5% is our thinking about next year globally.

Just can we go back to pricing for a second? I mean, I'm curious because, historically, once we get above sort of mid-cycle in the U.S., we start to think about maybe having a little bit of opportunity to get a little price. And I guess I'm just not sure with all the new products and the competition and so forth. Do we still think that's potentially possible? Or is that not so much on the table?

I think as we sit here today, I mean, it's a great product to offer, but we have competitors in the market. And so we're going to be able to earn what the customer is willing to pay. And so at this point, pricing feels like it's a pretty steady proposition in both Europe and North America.

Okay, good. And then I think you mentioned gross margin's down slightly in the fourth quarter. Historically, if you look back, the SG&A sort of kicks up a little bit in the fourth quarter. I guess there's some year-end true-up things or not. Should we expect that this year as well? Is there any trend there to call out just as we think about the fourth quarter?

I think we're pretty sort of focused on the dollars. And so I would think the dollars will be pretty comparable to third quarter levels. So I don't see any significant increase in the fourth quarter.

Can you talk a little bit about 2018, your guidance? Can you just break out maybe the segments, the sleeper segment versus the Class 8 straight versus day cabs? Anything different by any segment that you're anticipating for 2018 versus '17?

No, I'd say segment-wise, I think we anticipate similar mix of our sales to what we've seen in 2017, which is in Europe, DAF continues to be an industry leader in the tractor segment, continues to focus on growing their vocational volumes. And the new trucks that they've just launched will enhance their capability in that arena. And in North America, I think we anticipate that the growth in the market will come in really all segments, both the on-highway as well as some vocational. So I don't see any particular segment mix or customer mix sort of affecting our sales next year.

Okay. I appreciate the color. That's helpful. And then you forecast U.S., Canada. Any difference U.S. versus Canada? And then do you have an outlook for Mexico so we can kind of square back to NAFTA?

Yes. So I think if you look at this year, U.S. is probably flat to maybe a little bit down year-over-year, but Canada has bounced back. The Canadian market this year is stronger than it was in 2016. I think next year, I think, we expect the U.S. will be the area where a lot of the growth will occur for U.S. and Canada. And Mexico, it should be another good year in Mexico, expect the market to be comparable. Election years in Mexico sometimes have a little bit of an uptick because of some of the stimulus that gets added to the economy. So that could be a potential upside for Mexico next year.

Unless NAFTA is cancelled, I presume?

Excuse me?

Unless NAFTA is cancelled?

Yes. Yes, I don't have any perspective on that, and I don't think that makes any sense, but...

Agreed. Regarding the same mix discussion, U.K. registrations fell significantly this past month. Is there any change in the mix? Are there any concerns about market share loss for DAF? The U.K. market is slowing, and it's an important market for DAF. Any comments on that for 2018 would be appreciated.

Yes. Harrie's got some thoughts on that.

So Ann, if we look at the U.K. market for us, registrations year-to-date are exactly the same as they were last year. Market share is up 0.1%. We're above 30% market share, still continue to be market leaders in the U.K. And also orders year-to-date are at the same level as they were last year. So we haven't seen that softening in the U.K. that some people talked about.

So orders flat year-to-date despite just last month's anomaly, then registration is down 20%?

Yes, it is flat. In the month of September, it was a little bit lower, but year-to-date, it's at the same level as it was last year. So September is always a big month with new license plates, so we got some fluctuations in that month typically. But year-to-date, we're at the same level.

I have a question similar to Ann's. I'm trying to understand how you arrived at the 7% to 9% sequential delivery growth from the fourth quarter compared to the third quarter. It suggests a significant increase in Europe. Are there market share gains included in that figure for the fourth quarter relative to the third? I'm trying to determine how to reach that 7% to 9% sequential growth.

Yes, Seth. The main point is that DAF will have a two-week shutdown during the third quarter, and they will be operating on a single shift for a couple of weeks before and after that shutdown. They are producing about 1,000 trucks a week, which is a significant factor. DAF has also increased their production slightly for the fourth quarter. Therefore, the key impact will come from the lack of shutdown days in the third quarter.

But it looks like it's going to be up year-over-year as well pretty nicely.

Yes, I think it will be. Probably 10% or so would be my guess.

Right, okay. And is that share gains? I mean I don't think the market is up that much though, right?

Yes. So one of the things that has been beneficial for DAF is the fact that there's more sales this year outside of Europe, the European truck registration market. So you look at what we're selling into Russia, selling into the Indian region and South America, into Australia, into Africa, so all those things have supplemented DAF's build rate during the course of this year.

Okay, that's helpful. I appreciate that. And then just a follow-up question. I think people are trying to kind of get at this, but maybe just coupling together some of the questions that have been asked about for next year for pricing and mix and whatnot, incremental margins. I mean, in this area where volumes are up next year, would you expect gross margin to be up next year?

Right now, I guess I would say I expect gross margin for next year to be comparable to what we're seeing in 2017 at the market size estimates we've provided. I would say that if you look at the build rates for DAF and Peterbilt and Kenworth where they're currently at, if those build rates were able to be sustained for all of next year, the markets would probably be at the upper end of our estimates that we've provided for 2018.

Okay. So something in the kind of mid-14%, I think your...

Yes, mid-14%, yes, plus or minus.

I wonder, maybe you can fuss it up for the whole industry. But is there expected to be another increment to fuel efficiency as we go into 2019?

Well, I think a big increase in fuel efficiency came with the engines that were launched this year. So DAF, 7% was a combination of fuel efficiency gains from the engine as well as aerodynamics of the enhanced vehicle features. And Peterbilt and Kenworth had a 4%, 5% increase at the beginning of this year with the model year '17 engine. So the next big increment, I think, will be in the 2020, 2021 time frame as we continue on the path of working on the 2021 greenhouse gas regulations. But there'll be ongoing increments each year as we have to get certified each year and we continue to make investments in the capability of our hardware. But even more importantly is the capability of our software. So we're investing a lot more in our company today in software capability, software development for engine programming, truck control units and the integration of all that into a solid system. So that's where you're going to see some of the gains in the coming years, is that continuous improvement in the integration of all elements of the truck and the powertrain.

And then your market share of orders seems to be running noticeably ahead of your reported market share, your market share of deliveries. And I guess that's not enough to get you to be a little closer to where kind of industry forecasts are for 2018. Do you still think it's prudent to be on the conservative side?

Yes. I think we're reasonably conservative at this point. And we haven't started the year and we're trying to predict what next year is going to be. I think we feel confident it will be a better year. And we'll see, as the year goes on, how it progresses.

So my first question is just around Brazil, what you're seeing there and I guess the expectation for that region as we move into 2018.

Well, our team was just at the Fenatran truck show last week. And I would say the optimism of the industry and our team is good as we enter 2018. We've seen an increased quoting activity in the market. We've increased our build rates as we've progressed through this year, and we'll start next year at even higher build rates. So the market is recovering. We just launched a new truck for heavy haul applications in the agricultural industry. And so that is going to give us some additional product capability in the market. So we're pretty bullish about what the near term looks like for Brazil in terms of being on the road to recovery and taking advantage of that and continuing to grow our share in that market.

Okay. That's helpful. And then just thinking about material costs. How much of a headwind was that to your truck margins this quarter? And how do you think about the headwind to material costs into next year since commodity costs have continued to move higher?

Yes, it has presented some challenges. Last year, we experienced some advantages, but this year has been more difficult. However, I believe next year won't see a significant impact. We have long-term agreements with our suppliers that enable us to incorporate those changes gradually into our pricing. Therefore, I don't expect it to be a major concern as we move into next year.

Can you talk about the engine penetration in North America? Did that remain stable? Or did it improve?

It's actually down just slightly. And when you compare our penetration this year to last year, we offer our customers the PACCAR option and the Cummins option. Cummins is a great, great partner of ours. And so it really depends a lot on who's ordering at a particular given time, but we continue to enjoy great success with the engine. It's very well received by the customers, and we continue to work on getting increased penetration. So I'd say just down slightly a little bit this year compared to last year.

Okay. And then within the Financial Services segment, provisions appeared to come down a little bit sequentially, and that's good. I'm just wondering what drove the improvement. And was there any regional concentration behind that?

Andy, that portfolio is performing great and has for really post 2010. And so any movement in those provisions typically has to do with the amount of the assets that we have. But the amount of actual credit losses that we're seeing are pretty isolated. And there's no indication that the customers' ability to pay is going to be affected anytime soon with pretty robust transportation markets in all the markets where we're doing financing at this point.

Okay, Ron. And then just an industry question specific to North America. I'm just wondering if you've seen any irrational price discounting going on given one of your competitors has a stated goal of trying to recover some share that they've lost over the years.

No, I don't think we've seen that. We've been able to offer a great value proposition for our customers through our products, aftermarket support, parts, and ensuring the uptime of our customers with strong financing options. Overall, I believe the total package allows us to maintain a premium due to the quality of our offerings. We haven't noticed any significant issues; there may be isolated instances or deals where you question the pricing, but there's no general trend.

I have a quick question. I understand that you don't manage the company with a focus on the stock, and the stock has recently moved from the 60s to the 70s. However, I'm trying to understand if we can expect no operating leverage next year. With the earnings potential, the expectation is that as we progress further in the cycle, you would benefit from some price-cost dynamics and leverage, potentially reaching $5 in earnings next year, possibly exceeding $5.50 later on. But if there's no operating leverage, it raises concerns for the U.S. and Canadian markets, especially considering that the European market is at a historically high level. I want to ensure that we leave this call with clarity on whether you're confident that next year’s gross margins will be similar to this year’s. Why is there no operating leverage in your model? Is it due to rising costs for technology, among other factors? I'm a bit disappointed to hear that your gross margins next year are expected to be similar to this year’s.

Yes, that's our current assessment. There's definitely some upside potential as we move through the year, and we'll see how that unfolds. Right now, we're estimating around 14.5%, give or take. We've made substantial investments in the factories, which are running very efficiently. We'll monitor how pricing evolves throughout the year. Overall, we expect things to fall within the 14% to 15% range as we continue.

I mean, given the lead times and so forth. And look I appreciate competitive dynamics. But in your backlog today, how far does your U.S., Canadian business project out orders already on hand? How many months into next year? And is the pricing better in that backlog than we were shipping over the last, say, 6 months?

No. Typically, the extended backlog is longer-term buyers, fleet buyers. And so what fills in, in the shorter term is the stocking trucks, the smaller customers. And the margins in the backlog are generally consistent with what we're building currently.

I had another question about gross profit margin, but from a different angle. You mentioned earlier about the gross profit margin in Q3. I'm curious about the revenue increases you experienced this quarter and whether they had any effect on improving gross margin profit.

So you're talking about compared to the third quarter of last year?

Last year, yes. Revenues are up 20%, and gross profit's down 20 basis points.

Yes. The higher mix of trucks contributed to this situation. We are facing some material cost challenges, and there are ongoing currency impacts from the British pound relative to the euro and the Mexican peso. These factors are influencing our margins, but we are actively addressing them. We remain optimistic about our ability to grow the business and deliver strong returns for our shareholders, which aligns with our historical incremental margin performance.

Yes. I knew you mentioned it earlier. I've missed it so thanks for catching me up on that. On the aftermarket, with the TRP brand, obviously, you're growing faster there than what the market's growing. Where do you think those share gains are coming from?

I would guess they're coming from warehouse distributors, would be where I would think we get most of our upside with our TRP brand and the ability to service and have greater access to second and third owners of really All Makes of trucks.

And do you think those are coming from other private labels or from branded products?

I mean, obviously, whatever the warehouse distributor is distributing, there are some private labels and vendor products. We are gaining better access to that customer base than we had previously when we were only going through the Peterbilt, Kenworth, or DAF dealer network.

Yes. And just one last question. Thank you for the insights regarding next year. The market has been quite strong and we’ve seen high volumes. What signs are you observing that indicate this market may be reaching its peak, prompting you to prepare for potential challenges ahead? What indicators would you be looking for?

Well, I mean, just ongoing discussions with customers, with dealers and order activity is the sign that tells us how things are going. And so order activity is aligned with the market estimates that we've provided.

Could you just give us some color on levels of used inventories on the PACCAR lots or stores that were opened in last year or so to deal with the excess used inventories that we're starting to build up?

Yes. So our used truck inventory has declined progressively throughout this year. And so as we end the third quarter, we're at our lowest level of used trucks that we've had. So we're well positioned with a good level of inventory to sell into the market, both out of our retail sales locations as well as through our dealers. So we're right where we feel we need to be with respect to used truck inventories.

Okay, great. And then can you just talk some more about the mix in parts margin this quarter? I would have thought that the margins would have been helped by the volumes that you had. I don't know if there's any particular drag from opening more stores and if you get a better margin once you have that expansion.

No, I think parts margins are typically influenced by the mix of product lines sold during any given period, such as proprietary products versus vendor items versus TRP and PACCAR genuine parts. There are various levels of parts, and usually, the movement in margins is impacted more by this mix than by changes in sales prices or material costs.

So how is your mix this quarter relative to what it's been?

I don't have those figures in front of me, I'm sorry.

I have a question. I agree with your views on the timeline for the electrification of trucks, which will clearly take several years. I'm interested in what your customers are saying. As you conduct research and determine how urgently you need to develop products, are there specific segments showing interest? Is it just medium-duty customers or only ports with emissions restrictions? The long-haul aspect seems less relevant to me, but perhaps you're receiving feedback from them. I'd like to know which segments of your customers are truly interested in these developments.

I believe all segments are interested. However, when considering the economic reality, smaller vehicles are more likely to benefit from the technology. It will take some time, as we need a breakthrough in battery technology for it to be commercially viable, especially in the higher end of the truck market. Everyone is curious about what we're doing, and we have many areas we're exploring. But in terms of economic viability, it appears to be more of a midterm issue than a near-term one.

Okay. And then could you give a quick update on Russia, which has been boom and bust and where you've had success in previous years?

Good market. This year, DAF has been able to increase its share up on the 15% range from 11% or 12% in some of the prior years. We have good dealer representation, good support for the product. So it's a good market and one that we're taking advantage of as it currently sits.

Is there a possibility that the volatility could persist for another two to three years? Are there any indications of market saturation? More generally, what is the situation in Europe regarding used trucks and their availability, considering the trade cycles vary? Does the market still appear healthy, especially in the Eastern regions where some trucks are directed?

The market in Russia is significantly stronger this year compared to last year. However, historically, it remains at a relatively low level and has not yet returned to the figures seen several years ago. This is a market for Euro 5 trucks, and our DAF trucks have performed exceptionally well there. Customers appreciate the quality and fuel efficiency, and our market share has increased to approximately 15% year-to-date. Overall, we have a very positive outlook for DAF in Russia.

Great. And any comment at all on just how you think about, I guess it was asked before, cycle indicators on used trucks in Europe, whether we can stay up here at these levels for a while longer, whether there's any hint of saturation in trucks being absorbed by the second buyers wherever they are?

I mean, used truck market is pretty steady, I guess I'd say. Again, one of the positive aspects that DAF and PACCAR Financial in Europe will experience is the fact that starting next year and on for the coming years, that there'll be more and more of the Euro 6 product that will be coming back off lease, coming in on trades. And we'll have the newer models to sell in the used truck market. So overall demand at this point and pricing seems to be pretty steady.

With regard to your outlook for North America in 2018 and beyond, how do your thoughts on electronic logging device mandate play into that?

At this point, it's a lot more talk than there is actual impact, what we're seeing in the market. So that obviously goes into play in December. And so we'll see how it develops. But right now, it doesn't feel like it's a significant element in truck orders and truck buying decisions.

Great. That's helpful. And then just one on Europe. It looks like the bottom end of your range for next year is below this year. I mean, it didn't seem like you've said anything that's negative about Europe so far in this call. I mean, what areas could concern you that could make Europe be down next year?

There's no real areas of concern. I'd say, at this point, that the bottom end of our range is conservatism. As I mentioned previously, if we continued with our build rates as they currently sit at DAF and Peterbilt and Kenworth, the markets would be at the upper end of our estimate. So the lower end just really reflects some conservatism.

I think there was an earlier question on SG&A for the fourth quarter. But can you provide any granularity on the SG&A expense outlook for 2018 like you guys have done for R&D?

I think if you look at the second half run rate for SG&A, some of the effect in the second half has been due to stronger currencies, particularly the euro. Therefore, the second half run rate of SG&A is likely indicative of what we would expect for the full year 2018 in terms of absolute dollars.

Got it, okay. And then could you talk about what drove the acceleration of PACCAR Financial Services revenue growth in the quarter? And I guess as a follow-up to that, is that also good run rate views for 4Q and 2018?

So the revenue is just we have a bit of an increasing interest rate environment, we have higher assets and we had the higher mix of operating leases in our portfolio. So there's several things that impact that. As we think about next year, right now, we anticipate that the portfolio will continue to perform well, that our customers will have good economic conditions in which to operate. And so credit losses will continue to be muted. Used truck values seem to have stabilized, and so I don't think we'll see any challenges on the used truck side. So as it sits here today, we feel good about our prospects for 2018 in the Financial Services arena.

Just wanted to clarify one thing. Would your operating leverage be more evident at the gross profit level or at the pretax profit level?

Probably at the pretax profit level because we sort of manage our R&D and SG&A more to a fixed cost.

Right. So to kind of frame it as there's no operating leverage in the model as we think about next year, maybe more appropriate to think about the pretax level no matter how much fixed costs you have in your gross profit, but ...

It's going to depend on how the year progresses and how material costs develop. And we're well positioned. And at this point, again, I think margins would be in that 14% to 15%. And whether they're at the upper end or lower end of that range depends on a lot of factors that are to be determined.

We'd like to thank everyone for their participation, and thank you, operator.