Good morning, and welcome to PACCAR's Fourth Quarter 2020 Earnings Conference Call. All lines will be in the listen-only mode until the question-and-answer session. [Operator Instructions]. 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 Preston Feight, Chief Executive Officer; Harrie Schippers, 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 expect -- may affect expected results. For additional information, please see our SEC filings on the Investor Relations page of paccar.com. I would now like to introduce Preston Feight.

Hey, good morning, everyone. Harry Schippers, 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. PACCAR's fourth quarter revenues were $5.6 billion, and fourth quarter net income increased to $406 million. PACCAR Parts achieved fourth quarter revenues of $1.70 billion and record pre-tax profits of $223 million, which was an 8% increase compared to the same period last year. PACCAR 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 DAF 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,…

Thanks, Preston. In 2020, PACCAR Parts generated excellent annual revenues of more than $3.9 billion and annual pretax profit of $799 million. Fourth quarter Parts revenues were a record $1.70 billion, and quarterly pre-tax profit was a record $223 million. One of the great things about PACCAR Parts is that it provides steady profitability through all phases of the business cycle. PACCAR has increased market shares over the years resulting in a greater number of truck and powertrain parts opportunities. PACCAR Parts' excellent long-term growth reflects investments in distribution and technology. PACCAR Parts has expanded its global network to 18 distribution centers and is currently constructing another facility in Louisville, Kentucky. PACCAR Parts' investment and leadership and 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% to 9%. PACCAR 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 PACCAR truck sales financed by PACCAR Financial Services increased from 25% to 28% last year. The portfolio continues to perform well with low past dues and low credit losses. Pre-tax finance income increased from $55 million in the third quarter to $64 million in the fourth quarter. PACCAR Financial added used truck centers in Denton, Texas; Lyon, France and Prague, Czech Republic last year. And we'll open a new used truck center in Madrid, Spain this year. Across PACCAR, 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 million to $625 million, and R&D expenses will grow to be in the range of $350 million 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. PACCAR has started 2021 with strong momentum. The truck and parts businesses are growing. Kenworth, Peterbilt and 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.

[Operator Instructions] And our first question comes from Joel Tiss with BMO.

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 2 together to cheat a little bit here. The size of the -- can you talk a little bit about the size of the EV market 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.

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 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 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 of those, as we shared last time, we expect that the industry will have volumes in the hundreds in the coming year or 2 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 make sure we have great technology. And I 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 -- in the factories, how the robotics work together and making sure that we just enhance to an even higher degree already excellent quality.

And I think just to add to that, our new paint shop in Chillicothe, Ohio that will open this year is an 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.

Our next question comes from Rob Wertheimer with Melius Research.

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

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, it’s number one, number 2 and number 3. 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 we're at this 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. Harrie anything to add?

Yes. So we're improving to 13.5% in the first quarter is a nice improvement. And it's been -- we continue to achieve the highest margin in the industry.

And is there anything from the COVID that you've got straightened out? I mean, obviously, in 6 months, hopefully, this is relevant, 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?

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.

Our next question comes from Tim Thein with Citigroup.

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

Okay. Good. Preston, I was interested to see the -- maybe you've disclosed it before, but the comment that you included in the release on the T680, fuel cell electric, having 350 mile range. And I'm just curious, and obviously, I would assume that you would expect that over time to probably not stay at that level and potentially increase. But I guess the question is, what -- do you have a sense for what -- maybe what percentage of either your truckload or -- I don't know, that potentially LTL customer base is -- what could that be relevant to in terms of 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?

Yes. What I would say is that the technologies that are being evaluated right now, batteries and fuel cell, both have capacity to expand range, just takes more batteries or 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 advantage they have, of course both types of solutions need the 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.

Our next question comes from the line of Nicole DeBlase with Deutsche Bank.

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

Sure. Good question, and it kind of is across geographies. We see increases in the North American market. Kenworth and Peterbilt are doing really well, have strong order intake, and the same is true and off. Both economies have strong freight activity. Trucks are moving and is 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 some sort of sense of what you guys are thinking for Parts revenue growth in 2021?

Yes. 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. We made investments in the distribution network so that next-day delivery and even same-day delivery parts has increased in the percentages. And they just do a fantastic job of taking care of all the different kinds of customers, 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.

Our next question comes from Stephen Volkmann with Jefferies.

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 through -- certainly through the quarter and year.

Okay. And then kind of my broader question, Preston, is just about how you as 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, where you look at where we're coming out of and where we're going to, obviously, we have better clarity on the first quarter than we do the second, third and fourth quarter. So right now, the quarter is full and bill. We have great visibility in the second quarter. As it stands, we'd expect 3 and 4 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 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 we've made some good investments. We have some great things happening right now. So I think the recovery in gross margins of 13.5% that we're seeing 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 growth.

Our next question comes from Jamie Cook with Credit Suisse.

I guess a couple of questions. One on the fourth quarter. Can you just provide any granularity on sort of pricing or mix 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, 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, where the spend is going, how much of that can be attributed to the recent announcement with Aurora on the autonomous side?

Yes. Jamie, thanks for the question. On the pricing side, you look at just a little bit of it is 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 effect. So those are kind of the key factors you look at pricing. As we see some opportunities in that, we look forward to those opportunities. And then in terms of your second question, can you repeat what you're specifically looking for there?

My question was -- yes. Just adding 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? Any color you can provide on that?

Sure. I would share kind of the same thought I should receive 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 in the comments for our factories, but also in the space of zero-emissions vehicles and connected services and autonomous vehicle development and ADAS Level 2 projects. So we have a lot of great things going on that, that build for a strong future.

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

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

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. And basically, the truck industry is kind of 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 anything you would add, Harrie?

No, the Europe transport activity remained strong as well. We just got the German Maut statistic in, that's the number of miles of 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 UK maybe, but it's a trend we see across Europe.

And then with the R&D spend increase in 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 increase your marketing, and you increase your spend. 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 we look at last year, we had reductions in our SG&A and 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 the effective 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 cost that we can to be to our shareholders.

Okay. And no incremental cost 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 and our materials teams and purchasing teams around the world. And while there's much been written about on 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.

Our next question comes from Steven Fisher with UBS.

Just 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 it 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, 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 into -- in Q1?

There is definitely momentum building, good question. There's momentum building, but it's momentum building from a kind of a very, very low level. And now I think people are interested in trying a truck or 2 or 10. 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 would 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.

Our next question comes from David Raso with Evercore.

So on the gross margins, I'm just trying to think about every year, there's always a lot of investment and 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 drivetrains and autonomous and so forth. Is there any level of cost that you would call out that's incremental this year than normal? 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 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 if you look at the gross margin effects of it, it's -- 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 up 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? 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 unique time in the technology rollout in the industry. Are you saying you wouldn't describe this as any more abnormal than 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 our R&D spending is an increase. That's on the products we're introducing, and it's on the technology we're introducing, but we continue to have R&D as a 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 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, which of 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. Are those ships 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 make that jump.

Some of them as appropriate, would be on second shifts, and some of them are not as appropriate. So each factory is in its own balanced right now.

Our next question comes from Jerry Revich with Goldman Sachs.

Preston, I'm wondering if you could just expand on your comments about expectations of very good market share on truck and hydrogen vehicles. What's your win rate now out of what's been bid for delivery over the next year? You mentioned the industry size of a couple of hundred units. And 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, Peterbilt and DAF trucks that have never tried them before and they get to experience them. I think they're impressed also. And that's the reason we've been growing our market share and the reason we expect to keep growing our market share.

And part of the reason why you folks have higher market share in heavy duty than medium-duty is because you get paid for the higher features of higher spec trucks. And 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 come to allude 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, but Harrie, do you want to?

I think Kenworth, Peterbilt and DAF 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 task 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 got to think about how much time do you need to charge it. And that's why one of the reasons we're selling charging stations through PACCAR Parts is we think that whole energy management opportunity is good for our customers and should be good for PACCAR.

Okay. And lastly, I'm wondering if you can provide an update on your telematics, so now 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, and we could spend all day talking about it. Maybe when you get back to the other 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 majority, 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 is 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 customers as well. We have event managed 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 customers' experience, and that obviously can be good for PACCAR as well.

Our next question comes from Chad Dillard with Bernstein.

So you guys guided to 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 recognizing it's still early, but relative to this, how 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? It will be more like open source, so many digital drivers like overall interface with it? Or will be a little bit more exclusive? And maybe you 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 are 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 4 autonomous vehicle. And then we'll do a lot of testing on that. And we'll -- at the end we need to provide our customers a safe, efficient vehicle. It takes several years to do that.

Our next question comes from the line of Ross Gilardi with Bank of America.

First, 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 should we 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. And 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 PACCAR will benefit because we'll have this autonomously enabled platform, which will be a value to our customers. And it will go -- it will use our distribution system. It will make their operations potentially more efficient, and it should be one of the 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 what's to look out for? Is this just something that, like over the next 3 years? We'll just get of occasional updates? Or is there anything you could point to as kind of the next key milestone I look forward for Aurora?

I think that we'll be conservative in our milestones, and we 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. And 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, 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. In 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 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, what you think or just 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?

Yes. I would estimate that 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 yes, we -- despite that COVID impact, we still see margins nicely improve to 13.5%. And like I said before, that's probably the highest margin in the industry.

I think that's one of the things 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 is 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, but we're going through, to say the least, it just seems like you're on a just a lower level at the beginning of the year relative to where you were on a similar amount of delivery several years ago?

I think you have to -- I think you said it well and saying it's an odd cycle, and then we’ll see how the year develops on that cycle.

Our next question comes from Matt Elkott with Cowen.

If we take a very long, say, 10-year view, do you guys have any broad vision or high level opinion of what percentage of your truck production might be Level 4 and Level 5 autonomous? And basically same question by energy type, what percentage might be anything other than conventional diesel in 10 years?

Well, 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 customers' needs are. So in autonomy, if there was the right operating environment for Level 4, Level 5 autonomy, we want to have the right products there for our customers as soon as that makes sense, too. 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 hydro fuel cell and 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 timeframe up to the next decade.

Got it. That's very helpful. And if I may ask just one more 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 seating trucks? And if so, do you think whatever replacement demand is left 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 with the strong demand for DAF, Peterbilt and Kenworth trucks right now. And we expect that would continue as the cycle goes. So things feel good.

Trucks 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.

Our next question comes from Brett Linzey with vertical Research Partners.

Just one for me. And back to the parts distribution strategy. 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 continued upward move 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 fleet billings versus engine parts as the markets recovered?

Well, if I think about parts distribution strategy, it's -- 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 is 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 we'll be working on this year and opening next year. So that's an addition. And then as we look forward to it, 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, Harrie, do you have any thoughts?

Yes, sure. E-commerce, of course, has been the fastest-growing segment within PACCAR Parts, 25%, like we said. And Parts is a good segment with a 13% growth year-over-year. I think those are trends that we expect to continue going forward.

Okay. Great. And just a follow-up on R&D. Obviously, sort of a snapback here of a pandemic low in 2020, but it was up -- or at least the expectation for '21 is up about 10% of the 2019 base. What is the right incremental jump we should see over the next 2 to 3 years? Is it 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 that there's great projects for us to work on. We work on them. We have a really strong balance sheet, a lot of cash and we deploy it wisely to benefit of our shareholders.

Our next question comes from Adam Uhlman with Cleveland Research.

I wanted to start with -- I appreciate you sharing your expectations for industry truck sales and the parts business. I'm wondering if you could do the same for the finance subsidiary, any thoughts on sales or earnings this year?

Yes, finance companies saw a nice improvement in profit from the third to the fourth or 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. Could you -- what are you seeing in the market? And is there any chance that positively benefits your business?

Yes. 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 high number of used trucks. And as a result, our inventories right now have come down very nicely to very healthy levels.

I would 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 the Lyon, 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 that help their operations, too.

Absolutely.

Okay. And then just a clarification. Could you update us on your MX engine penetration here recently and any plans or goals for penetration rates in 2021?

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 10 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 is buying trucks and what parts of the market are alive, but we do expect steady growth on MX engines.

Our next question comes from Rob Salmon with Wolfe Research.

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 do the economics look for PACCAR? Obviously, you'd be selling a higher spec truck. But curious if there's any sort of revenue you'd be getting on a mileage base or anything along those lines?

Yes. 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 and 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 forgetting. It's a sell and engage and maintain an 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 these -- that the trucks of the industry uses for the autonomous are the highest quality, highest reliability, safest product, which is what PACCAR provides. So it puts us in a strong position. They rely on having a great distribution network of dealers, which we do to take care of those trucks. So that will still be a need. And you'd expect that there'll be an engagement of software and updates and how the truck performs. And so that will provide opportunity for PACCAR and an 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 EV?

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.

[Operator Instructions] Our next question comes from Courtney Yakavonis with Morgan Stanley.

Just wanted to follow-up on the conversation on used truck pricing. You mentioned that the margins had improved. I think last quarter, you talked about those trucks really flowing through at no margin. But just wanted to understand, has the used inventory been kind of entirely worked through at this point. And then what are the implications 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?

So 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 can 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. And we continue to sell those trucks through 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. 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, especially with respect to some of the comments that you've made on commodity price pressure. Can you just 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 locational 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.

We’re working with the supply base, of course. Typically, we have long-term agreements with our suppliers. That allow us 3 to 6 months between that 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 if and when needed. So that's very normal.

Okay. Got you. And then just lastly, you mentioned your Parts growth expectation for next year. I think 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 single digit level? Or was it exiting 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. Their fourth quarter was an all-time record for them. So that's steady, strong growth for them. They did a great job, and we expect to see that continue through the year.

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 PACCAR's earnings call. Thank you for participating. You may now disconnect.