Good morning, and welcome to PACCAR's Third Quarter 2021 Earnings Conference Call. All lines will be in a listen-only mode until the question-and-answer session. Today's call is being recorded. [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 affect expected results.

For additional information, please see our SEC filings and the Investor Relations page of paccar.com. I would now like to introduce Preston Feight..

Good morning. Thank you all for joining the call. Harrie Schippers, Michael Barkley and I will update you on our good third quarter results and business highlights.

I appreciate our outstanding employees around the world, who are managing through the supply-based constraints to deliver the highest quality trucks, parts and financial services solutions to our customers. And I'd also like to thank PACCAR's dealers and suppliers for their contributions and support during these dynamic times.

PACCAR's good quarterly revenues and net income in the third quarter reflects sales and profit records at PACCAR Parts and PACCAR Financial Services. The economies and freight markets continue to be robust in all of PACCAR's geographic markets.

PACCAR is having a tremendous year of new product introductions and demand for the new Kenworth, Peterbilt and DAF trucks is excellent. PACCAR's third quarter sales and Financial Services revenues were $5.2 billion, and third quarter net income was $378 million.

PACCAR Parts achieved record quarterly revenues of $1.26 billion and record pretax profits of $281 million. PACCAR Financial achieved record pretax income of $120 million. The record-setting Parts and Financial Services results illustrate the strength of PACCAR's businesses.

With the strong order backlog, growth in the truck divisions will accelerate as the supply of semiconductors improves. We estimate Class 8 industry retail sales in the U.S. and Canada to be in a range of 230,000 to 250,000 trucks this year. Peterbilt and Kenworth have achieved 29.6% market share through September.

Although build is still expected to be limited by semiconductor supply in the fourth quarter, the good news is that we're starting to see improvements in the supply chain. We forecast the 2022 U.S. and Canadian Class 8 truck market to be in the range of 250,000 to 290,000 vehicles.

In Europe, this year's truck industry registrations in the above 16-tonne market are estimated to be in a range of 260,000 to 280,000 vehicles. DAF's year-to-date market share is 15.8%. The 2022 market is expected to be in the range of 260,000 to 300,000 trucks.

The South American above 16-tonne market is projected to be in the range of 120,000 to 130,000 trucks this year. DAF Brazil's above 16-tonne market share through September was 5.6%. The South American above 16-tonne truck market is estimated to be in a range of 130,000 to 140,000 trucks next year.

The new Kenworth T680 and Peterbilt 579 trucks that began production in the third quarter are being well received by our customers. These trucks feature new styling, configurable digital instrumentation, advanced aerodynamics, distinctive LED forward lighting and they provide up to 7% greater fuel efficiency.

The new Kenworth and Peterbilt medium-duty trucks that also began production in the third quarter, provide features that customers appreciate such as a wider cab with 3-person seating, lower cap heights for easier entry and new digital instrumentation.

The exciting new DAF XF, XG and XG+ lineup feature luxurious interiors and beautiful exteriors that provide 10% greater fuel efficiency. The new DAF offers unsurpassed performance and value. DAF is the first truck manufacturer in the industry to have taken full advantage of Europe's new regulations governing truck design.

And the new DAF trucks began production earlier this month. All of these new trucks position PACCAR very well for the future. PACCAR leads the industry with 7 battery electric vehicle models now available. Kenworth, Peterbilt and DAF have orders for several hundred zero-emissions vehicles and have 90 trucks operating with customers.

These include Kenworth T680 fuel cell trucks, Peterbilt battery electric model 579s and DAF medium-duty battery electric trucks. PACCAR has advanced its autonomous truck program by working with its partners, Aurora and FedEx, to launch a commercial pilot of autonomous vehicles into linehaul operations.

The PACCAR trucks are operating autonomously with a backup driver for safety as they haul freight on 500-mile route between Dallas and Houston. PACCAR has launched an advanced global connected truck platform.

Customers will benefit from the systems enhanced truck data security, advanced over-the-air software updates, elimination of the need for third-party hardware modules and an open platform that supports existing fleet management systems.

PACCAR's new proprietary connect system increases customer value, increases PACCAR's recurring revenue and as part of PACCAR's digital transformation. We're pleased to share that PACCAR was recently recognized as a 2021 top company for women to work for in transportation by the Women in Trucking Association.

We were honored for our excellent working environment and company culture that supports gender diversity. PACCAR is committed to hiring and promoting the most talented people in the world, and we know that the best people represent the diversity present in the global community. PACCAR continues to be an environmental leader.

PACCAR is working with the science-based targets initiative and is committed to 2030 carbon reduction goals. PACCAR earned a CDP Climate Change score of A minus, placing PACCAR in the top 15% of over 9,500 companies that publish reports to the CDP.

100% of PACCAR's manufacturing locations globally have environmental management programs certified under ISO 14001. Harrie Schippers will now provide an update on PACCAR Parts, PACCAR Financial Services and other business highlights. Thank you. Harrie, over to you..

Thanks, Preston. Kenworth, Peterbilt and DAF delivered 32,800 trucks in the third quarter, with truck, Parts and other gross margins of 11.8%. Third quarter volumes and margins reflect manufacturing inefficiencies associated with limited microchip supplies.

Depending on the supply of materials, fourth quarter PACCAR global truck deliveries should increase into the low 40,000s with gross margins improving to approximately 12.5%.

Customer demand is strong and DAF, Kenworth and Peterbilt are well positioned for sales growth and margin expansion as the new truck models are now in production, and when semiconductor vendor supply issues are resolved.

PACCAR Parts had another outstanding quarter, achieving record revenues of $1.26 billion up 24% compared to the third quarter of last year. Parts pretax profits were a record $281 million, up 34% from last year.

PACCAR Parts benefited from strong freight demand and truck utilization, world-class supply chain management and logistics, and increased distribution capacity. In the first 9 months of this year, overall part sales increased 28% with e-commerce parts sales increasing 37%.

PACCAR continues to invest in its Parts business, and is building a new distribution center in Louisville, Kentucky that will open next year. We currently expect fourth quarter part sales to be similar to the strong third quarter.

PACCAR Financial Services earned record pretax income of $120 million, reflecting strong portfolio performance, a robust used truck demand. We expect fourth quarter PACCAR Financial results to be in line with the excellent third quarter. PACCAR Financial is increasing its retail used truck center capacity worldwide, which enhances used truck margins.

The latest PACCAR Financial used truck facility is under construction in Madrid, Spain. Kenworth and Peterbilt truck resale values deliver a 10% to 20% premium over competitive strikes. PACCAR has invested $7.3 billion in new vehicle programs, enhanced facilities and new technologies during the past decade.

This includes the investment of $1 billion for the new DAF truck range and its expanded factories. Capital expenditures for 2021 are projected to be $525 million to $550 million. Next year, we plan to invest $425 million to $475 million in capital projects as we've just completed the launch of our exciting new truck platforms.

Research and development expenses are estimated to be $320 million to $330 million this year, an increase to $350 million to $400 million next year. Next year's increased R&D spending will support our clean diesel, zero- emissions, autonomous and connected truck programs.

These programs, along with the strong performance of Parts and Financial Services, will ensure PACCAR's ongoing success. Thank you. We'd be pleased to answer your questions..

[Operator Instructions]. Your first question will come from Stephen Volkmann with Jefferies..

I'm hoping to talk a little bit about just the kind of impact of the quarter. I guess the preannouncement that you put out a few weeks ago talked about 7,000 trucks that you were unable to ship. I assume that means those trucks are largely completed and awaiting whatever part would allow you to ship them.

Is that correct?.

That's partially correct is what I'd say, Stephen. The way I'd look at it is, through the course of the third quarter, supplier constraints remained, that caused us to have 7,000 fewer deliveries from us. That was a combination of build rate adjustments as well as trucks that are almost complete, as you referenced them.

So that's what put us in that position. So right now, with the 32,800 trucks in the third quarter, there's about 10,000 trucks offline. And that's how you match that up..

Okay. And then I assume as we go forward, and ultimately, you will ship those trucks when the parts are available, in whatever quarter that happens, then you'll have much better absorption, in fact, better than normal absorption, I guess, and your margin should be kind of higher than normal.

Am I thinking about that right?.

I think about it this way, is that what we think is with the trucks that are offline, those are just missing a component or 2 or 3. And so as those trucks deliver, that's going to be good for us in terms of getting the truck to the customer.

That's the most important thing and that’s where our focus really was in the third quarter is to get as many trucks prepared as we could. So we'll see that improve market share positions, et cetera, around the world. We also think that as we get additional supply of semiconductors, then that will allow us to go up in build rate.

And we think those things will happen concurrent with one another, so….

But there's not a big absorption impact 1 way or the other from building but not shipping?.

No, as Preston mentioned, Steve, those trucks were largely completed in prior quarters. So that's why we incurred overhead and labor and the absorption as well. So once those trucks get delivered, we'll record the margin on the truck, but not the absorption anymore..

Understood. Okay. And then the final one, I'll pass it on.

Just was -- given all of your product launches here, heavy-duty, medium-duty, DAF, does that sort of imply there was more than normal start-up costs associated with these launches in the quarter?.

It does. Yes. In the course of the third quarter, there was more than normal start-up and that's a percentage of what was going on as well. And I think that what we're seeing now is those new 579, new T680 and medium-duty products starting to see them on the road. And we're hearing a lot of positive feedback from our customers.

So the team did a great job on those. The new DAF just went into production. And it's just fantastic..

Your next question will come from the line of Ann Duignan with JPMorgan..

Maybe just a few. As we think about gross margins going into 2022 on the back of kind of Steve's question, I totally appreciate that you've built the trucks that are offline. You got the absorption already, so you don't get the margin when you record the sales.

But as you roll into 2022, and you look at the potential for gross margins, could you talk about some of the pluses and minuses that we should contemplate when we're looking at our model pricing in the backlog, inefficiencies you incurred this quarter because of startup and our components? If you could quantify any of those, that will be helpful so that we can think more carefully about our gross margin assumptions for 2022?.

Absolutely. So as we think about the fourth quarter, what I mentioned in the commentary is that we've started to see some good news, working with the supply base. Our teams here in purchasing materials operations have done just a fantastic job working suppliers, suppliers working with us.

partnerships, we've now started to come up with the either reengineered solutions or alternate chips or brokered chips that allows us to start to recover some of the trucks in the fourth quarter. And we think that, that will continue, it's likely to continue.

And then as we get into 2022, as we have steady production, which is what we'd anticipate, albeit at probably some still constrained level that will allow our margins to improve kind of to more normal high margins..

Can you talk about pricing specifically for new models? Can you talk about material inflation versus some of the supply chain constraints you've had? And then are you anticipating outproducing retail sales next year as you rebuild dealer inventories? Maybe you could just remind us what your dealer inventories were at the end of the quarter..

Sure, Ann. First of all, we had price realization of 4% in the third quarter. And so that has matched up with the materials. We think into 2022, we should have continued price realization for these great new products. I mean, if you just think about the kind of product performance they're delivering for our customers, and we're seeing that.

So that's good news for us. And then as you mentioned, our inventory is about 1.4 months compared to the industry of 1.9 or 2 months, which allows us to also think that we'll build more. And really 2022 as we look at it, will be probably constrained only by supply of components, certainly true for the first half..

Your next question will come from the line of David Raso with Evercore..

To continue the conversation on pricing.

When you just said, continued price realization, should we expect that to mean running above the 4% that you got in the third quarter and maybe try to think through how used prices, the strength there is influencing how you're thinking about pricing for '22?.

Yes. As Preston mentioned, we've increased prices on average 4% in the third quarter, David. If we look into the fourth quarter next year, that is obviously going to continue. We're going to recover material cost increases and price for those and hopefully a little bit more in a strong market that we're in today..

And then when it comes to the supply chain improvement, is there anything that you're seeing that suggests -- it looks like the fourth quarter, there is some modest improvement. The deliveries step up significantly because the -- you have a lot of trucks that are just waiting for a few parts.

But is there anything you're seeing about 1Q or 2Q where you can give us some sense of magnitude of the improvement in the supply chain? I'm not necessarily saying there's a hockey stick out there, but just a better sense if you can expand upon a little bit that comment about seeing an improving supply chain..

Yes. I think as we look at it, it's really been just recently that we've seen a stabilization in the supply base, the semiconductors from the work the teams are doing. And so that's the good news that we see.

And in this work with our second, third, fourth tier suppliers, and we have good supply base, and they're all communicating really well with us right now, that we would expect that there'll be gradual rather than a hockey stick as you mentioned. How far that goes and where that bounds out at, we don't know that.

We'll have to see how that looks in the course of the year, which actually could be play into a good market for next year and in a good market in the year after that. So that's the positives there. And then just to add on to what Harrie was talking about in price realization.

One of the things that we do see with the new DAF trucks, we have over 10,000 orders for the new DAFs in Europe. And as we mentioned briefly, it's the only truck in Europe that meets the new regulations for truck design, the only truck and customers are amazingly excited about it, and it's going to make a big difference for us. So that's a positive..

That's helpful. So just to wrap up on the sequential.

And it feels like these low 40,000 deliveries in 4Q, even though you do have a lot of trucks partially built that enables maybe a quicker delivery than having to build from scratch, can we take the supply chain comments as base case builds increase sequentially from this fourth quarter level just as we think through the beginning of next year?.

See, that's our hope right now. And so what we hope to have happened.

Harrie?.

Yes, a little bit will depend on the supply base, David. I think our teams have done an amazing job in redesigning modules, components to work with alternative chips and other solutions that although the semiconductor situation is still constrained. And we found some alternative solutions to keep production going with good solutions.

And I think that supports our optimism a little bit..

I appreciate that. Just because if you do that, and you run the rest of the year out that way, it looks like your deliveries are running ahead of the initial ‘22 industry guidances. And I guess that goes back to your comment, it looks like you'll build more than the industry sales next year. I'm just kind of trying to square that circle a little bit.

Is that the right way to think about it?.

I think that's probably true. That's really 1 of the things we focused on in the course of the quarter or 2 as there's a tremendous amount of customer demand for the Kenworth, Peterbilt and DAF trucks out there.

And so our focus has been around getting as many prepared for delivery as we can, building and just shy of component to satisfy that market demand for these great trucks..

Your next question will come from the line of Steven Fisher with UBS..

It seems like you would be delivering some of your backlog that you have today, you've taken orders on 2021 models, delivering them into 2022.

So I'm just curious when will your delivery switch over from '21 model years to '22 model years? And what impact will that have on pricing and margins?.

Well, as you know, every time there's a model year, there's an increase in how that works, and that will happen in the first part of 2022 and just the normal cadence..

The change in model year is relevant that it changed from the old to the new model. So the new DAF, the new T680, the new 579, the new medium duty those have a much bigger impact than the model year change this year..

Okay. That's helpful. And then just a bigger picture technology question. You've talked about the ramp on the EV market over the next few years.

What's your expectation on industry and PACCAR ramp on autonomous vehicles by 2025 and with this relationship with Aurora?.

Well, we're in this test right now with FedEx and Aurora calling freight. It's the first time we've been participating in an actual freight-hauling exercise. We've got lots of trucks running around, different autonomous start-ups and that's going well. But it's pretty early days.

And I think that making a prediction for how quick that market is going to develop is going to depend on how robust the technology becomes, and that's what we're learning about right now. So I think we should be just patient to see how quickly it develops and when it's really ready to scale..

Your next question will come from the line of Joel Tiss from BMO..

I just wondered, I'm following up on the end of Steven's question.

What kind of barriers do you think are out there for more like the insurance side or is it from the DOT or is it just having enough models out there, like just some of the things you guys have led?.

Joel, we had a really hard time hearing you there. I didn't come through very clear.

Could you try the question again?.

Yes. Sorry, we just moved to a new office.

Anyway, what the -- what you're seeing is sort of like the roadblocks to expand that technology adopt by 2025? Is it DOT or through miles?.

I think I got the gist of your question is the roadblocks for implementation 2025 on autonomy. And I would say that the technology is incredibly involved. And so if you think about the edge cases that exist, that's what's being sorted out right now. Most of the operation can be done running down the highway.

But now it's about the edge cases of those unique boundary conditions. So we're working through those.

The other part of it is we're developing a proprietary PACCAR autonomous vehicle poor, which has all the redundancies involved in it, which is -- should be ready in the next couple of years here, and that will be a huge advantage for PACCAR in working with companies like Aurora, like our partner, Aurora because it will let us have this really robust platform to build upon.

And then we think probably the things that cause it to be constrained for ‘25 or again technology. There'll be a societal element to it as well and then company adoption. So I think it will start with certain lanes and evolve from there..

All right. I'm going to try 1 more question. Just to ask a little bit more, instead of about the quarter, I want to ask like on a 3- to 5-year basis, the structure of the margins.

Do you think like all these different autonomous and electric vehicles and everything else you're working on and plus new products is enough to really drive your margins to new record levels.

Or do you think that there might be some need to use some of your balance sheet to buy something or to expand into something that could really drive those margins to a new higher level?.

Joel, I absolutely believe that the new products, the autonomy that connected the electrification, those efforts that we have on will drive our margins to very, very high levels. And I think then there is just other opportunities incremental to that. So the future looks very good..

Your next question will come from the line of Rob Wertheimer from Melius Research..

Just a couple of questions on -- you mentioned some of the supply chain things getting better.

I'm a little bit curious on whether semis are the only real hold up, maybe that's not that's domestic way to phrase it, whether you're just kind of outhustling, I don't know if you're reprogramming like Tesla did or finding new sources and how long you sort of have some certainty on that? And then more generally, when do you see the whole situation with semis getting better? Is that visible to you yet from your conversation with suppliers?.

Well, I think it's a matter of degree. I think our teams are doing mentioned before. It's worth mentioning are doing a fantastic job of hustling as you put it. They are reengineering different chips. They're taking places where maybe 2 chips were required and reengineering them into require only 1 chip.

We're working with semiconductor manufacturers themselves in our second, third, fourth tier to come up with good solutions that are robust and high the team has done a fantastic job on that. And I think that's why we're starting to see this improvement because hats off to all their efforts.

And I would say that we see, again, a gradual improvement over time as far as the final conclusion. I think it's going to take some time. So gains next year are positive for us. And then again, that might make it for a very strong 2022, and lead to a strong 2023..

Okay. And then if I could also do a bigger picture one.

I mean just early experience on your -- with your customers on electric and hydrogen, when do you think those orders sort of start to convert to from what I assume is testing orders to volume? And then when you talk about the autonomous truck platform that you're developing for -- I guess, for redundancy for sensors for everything else to go into.

Similarly, that comes at an additional content last price point for you. And I wonder if you have any thoughts on quantification.

It seems like your future revenue curve is a little bit better in the past as you layer in more technology?.

All right. Let's try and take the first one, which is on order size of EVs. We have some orders that are not in the ones anymore. We're starting to see that shift into tens and even hundreds for some of our orders where customers are saying, “Have tried it. I've been around you guys for a little while now. I believe in what you're doing.

And I think I can put 10 in operation or more.” So that's kind of the transitional phase that we're in right now, realize it's still limited by the infrastructure requirements that are around out there, some numbers of chargers and putting that together.

So it's really still a return to base kind of model adoption, and it probably will be for a few years. So that's a positive thing. We're selling our chargers. PACCAR Parts is doing a good job of that. Our teams are doing a good job working together with customers to make sure they have the balance of truck and infrastructure.

So it will just continue to progress over the coming years. From an autonomous standpoint, yes, you're right, that autonomous vehicle platform that you mentioned will have additional componentry on it. It's a very tech solution. And PACCAR be the leader in that area. So that will be helpful to margin.

We also expect that services will grow on autonomous vehicles because now our dealers and their involvement will be significant as well, and it should be good for the total business..

Your next question will come from the line of Chad Dillard from Bernstein..

So to what extent are you seeing share gains related to your new product introductions for '22 in your backlog? Maybe you could talk about what your backlog and market share today is versus a year ago or even your current backlog market share versus shipment market share? Just trying to get a sense for to what extent you can outperform the broader industry going into '22?.

Yes. I would say that when I look at share, it's a really interesting time with build really industry build being constrained by the number of components that are out there.

And what I would say is that we feel like we're in a good position right now with the share we have in Europe and North America, Brazil, Australia and I would expect that we'll see growth in chair because of the trucks that we've built and we'll be delivering.

So it feels pretty positive looking forward, which would be great for the parts business and the finance company business as we look forward..

And the new truck models on top of that will support market share growth as well..

Great point, Harrie..

Great. And then just on my calculations, it looks like you have about 140 basis point gap between actual gross margins this quarter. And I was just hoping maybe you could kind of break down that shortfall, so we can just model it as we go into '22. How much comes from just like absorption versus price cost versus logistics? That would be great..

I'm sorry, Chad, I don't recognize the numbers that you just quoted..

Okay. So I'm just looking at -- yes, I'm just looking at the margins that you did -- the gross margins that you did, compared to that to what you’d do if you got your typical 20% incrementals and I got kind of like 140 basis points gap. So that's what I'm trying to bridge between..

Incremental margins typically have been in that 15% to 20% range, and nothing has changed about the company-wide, that wouldn’t -- that continue to occur going forward. And like we said, we expect margins to improve in the fourth quarter to 12.5%.

And as we work through the semiconductor issues and with the new work models in place, margins should improve significantly going into next year..

Yes, I'd just add to what Harrie's saying there's probably more factors affecting margin than just typical. So it makes it more complicated, right? We mentioned the new product introductions, the supply issues and the dynamics of that factoring into it and obviously, pricing factoring in. So it's -- but it does look really good with the new trucks.

And as we get stability, we feel like the gains will be significant, the incrementals will be significant..

Your next question will come from the line of Jerry Revich from Goldman Sachs..

I'm wondering if you could just talk about the zero emissions vehicles. So last quarter, I think you had mentioned to date orders of 450.

Can you just give us an update on where that stands now? And if you could just give us a flavor for what the regional mix looks like, what the mix versus medium and heavy duty looks like, if you don't mind?.

Sure. The orders continue to grow, and I would suggest that as I mentioned a little bit earlier, they're coming in now, I'd say, initially, it came in, in the 1s. Now they're coming in more like in the 10s and even in the hundreds, we've had some orders for. From a standpoint of where they are geographically, it's mixed.

I mean Europe is seeing order intake for the trucks and build for the trucks and delivery to the customer, same in North America. It's medium-duty and heavy-duty split the key probably point to all of it is that it's return to base applications.

So whether heavy-duty or medium duty, the adoption is going to be urban areas where people are coming back and can plug into a charger at night, we see the initial start to that.

And I think as we've articulated before, expect that orders and build will be in the hundreds in the coming year or 2, and then transition to the thousands pretty quickly in the next 3 years, let's say..

Terrific.

And then on the new product lineup across the board, can you just talk about what -- can you talk about what proportion of your production you expect to come from the new models in the fourth quarter? And what's that mix ramp-up looks like as we head into 2022? And if you are willing to quantify, you deliver labor hours reductions on new models typically.

I'm wondering if you're willing to quantify what that looks like here..

So I would say that in North America for the new trucks, they'll become a majority of the trucks in the fourth quarter, and in Europe, we just launched this month for the new DAF and so it will be a minority of the trucks. And as we head into the next year, then it will grow into being roughly half of the trucks.

And Harrie, you got detail on the top builds for next year?.

No. We will end this year, approximately 30% of our heavy trucks being the new model, and January will be similar than I would say, as of March, it should be 50% and continue to grow from there..

And then to the second part of your question, where you're thinking about the benefits of the truck, the trucks are amazing as far as how they build.

We got to get you guys over to the factories in Belgium and the Netherlands because it's just a beautiful factory and the trucks are performing in terms of their fuel economy and their driver comforts and conveniences and how they work and safety features and their Level 2 autonomous capability.

So all of that together is a great benefit to the customers, and that's why it will be impactful to our margins..

Invitation accepted. And on the autonomous trials, not just FedEx, but what you've done across the board, can you just talk about the benefits that you're finding in terms of fuel economy improvements accident avoidance outside of the potential elimination of labor longer term.

Can you just talk about the -- and quantify the other benefits that you're seeing in the trials?.

Yes, I think that's the real -- part of the real opportunity of this is as these trucks become mature, then they will be very safe, and it will bring an efficiency to freight that's a huge impact to the country and world. And so we're looking forward to being leaders with that effort and are in that position right now.

So we'll continue to progress that. I think it's hard to quantify those values, but you can intuitively understand how it could be safer and more efficient and good for the operating environment..

Your next question will come from the line of Ross Gilardi from Bank of America..

I was just wondering if you could comment on the capital spending outlook for next year. I mean, it's down by almost $100 million. And I'm just a little surprised by that given the trend of the outlook and all the production constraints and so forth.

And just what are your latest thoughts on incremental integration it might pursue given the supply chain situation?.

No big changes in vertical integration, Ross. But we did just complete the launch of the biggest product renewal programs in the new medium duties, the new T680 and the new 579. So we're now in that phase the R&D go up a little bit more as we focus our efforts to autonomous electrification, connectivity, those kind of technologies.

And in that phase, there's just more R&D going on and capital spending will come later..

And then can you talk a little bit more about Europe? I mean, I'm surprised your demand outlook for next year is barely up. And it just seems like a lot of backlog just globally is getting pushed out further and further.

So why is the demand outlook not up that much next year? Are you seeing any areas of softness? Or are you just taking a conservative approach out of the gate?.

Ross, let me take a swing at that, and maybe Harrie will add something into it is I'd say that it's not a demand feature. It's a demand is extremely strong right now. Order backlog is very good, and it's really a supply issue still that has us throttling the market. So our market size assumptions are based upon assumptions of what we can get supplied..

And a range of 260,000 to 300,000 at the high end of that range, a 300,000 truck market for Europe, that's a pretty good market. So let's not forget that..

Oh, for sure. I'm not debating that Harrie. You're coming off a year with pretty significant constraints where you're still playing a lot of catch-up. Maybe that's more of a production comment than it is a retail sales comment. But -- that's why I was asking.

And then just lastly, can you just talk about unions at all? I mean what percentage of your production workforce globally is unionized these days? And do you have any union contract negotiations coming up. Obviously, that's topical these days around the industry. So I haven't asked that in a while..

Sure. Very small percentage of our team in North America is unionized and a great relationship with them, and those are actually quite positive ways of working with each other. In Europe, it's a union environment..

Yes. But same thing, excellent relationships with the unions..

Yes. It's green -- one of the things as we travel around in this dynamic environment and go out and meeting on floor with people, it's a great place to work. And we have some fantastic people, and I couldn't be more proud and humbled to get to work with all of them..

Your next question will come from the line of Jamie Cook from Credit Suisse..

I guess 2 questions. One, obviously, the Parts performance this quarter was very strong. I guess it will be throughout the whole year.

Do you think there's an opportunity for you guys to outgrow the market on the Parts side? And then I'm just wondering on the margin front, what you're seeing on pricing for Parts? And is there an opportunity for gross margins in Parts to move structurally higher with share, with scale and as some of these investments sort of wear off? And then just my follow-up question is just can you just remind me what you said about production in the fourth North America versus Europe?.

So on the Parts business, Jamie, I would suggest that our teams are doing a fantastic job applying technology. Again, part of our digital transformation as the team at Parts is really leading it and getting data from trucks, from customers, from the dealers and synthesizing that into value-added services. So just top to our performance there.

I think that leads to growth in the business by all of them. And I think that does present margin opportunities for us in the future as we look out. So great job for all of them in that area. And then as far as the split of Europe and North America, your -- second part of your question, I'd say that we'd expect growth in both markets.

And you just have to remember that in the fourth quarter, we'll see more build days in Europe than we had in the third quarter, right, just by holiday schedules and shutdowns. So you'll probably see increases at a higher degree in Europe..

Okay. And sorry, just on Parts, can you talk about what you're seeing from the pricing front? I know you talked about 4% price. I think that was specific to trucks..

Yes. Parts has been a little bit higher even than 4%. I would think it's 6%....

It's about 5%..

5% in the third quarter, Jamie..

Your next question will come from the line of Nicole DeBlase from Deutsche Bank..

We've been through a lot here, but I guess we haven't really talked a whole lot about South America. And I noticed that you guys did take up your full year '21 guidance for the market there. So I would love to hear what's going on in South America..

You bet. We did take the market up a little bit there. What we've seen in South America is our dealers are doing a fantastic job down there. We have the new DAF that we introduced last year. Customers are in love with that truck. It's performing at the top of them, so our premium reputation is established in South America and Brazil.

We've grown in the Andean region as well. And so South America is a strong point for PACCAR, and we've had the strategy to grow there and it's been successful..

Got it.

And when we think about like how you guys are booking orders into 2022, I guess, how far out are you booking orders at this point? And I know that that's probably like a bit of a flux with what's going on with the supply chain? And how does that compare to what's normal at this point in the year?.

Well, I don't -- normal is a funny word, but I would say that in a strong market, which is what I would treat this as a very strong market, we're likely to have significant order backlog, a few months of order backlog. We have every bit of that and more. And so we're working with the customers now as we fill in the 2022 market.

But obviously, it's going to be, as we said before, constrained by the number of parts we get. So we'll see improvement, and we're trying to make sure we get all the customers, the trucks that they want..

Your next question will come from the line of Tim Thein from Citigroup..

The first question was just on the Parts business and just thinking from a high level as to the growth potential in '22. You talked earlier about the potential for truck sales potentially to run ahead of retail, just as you potentially see some dealer stocking.

Is there a -- do you think there's a similar potential on the Parts side? And I just say that we're just seeing and hearing more about certain parts being tight from dealers.

So is there a potential for sort of a restock in '22, do you think?.

I think the way I think about that is that there's tons of freight volume out there, and people are running their trucks fully right now. And so because there's a constraint on new trucks industry-wide, it's meaning that the repairs are going up on the trucks are existing.

And so that's also being a great opportunity for the Parts market, and that seems likely to continue into next year..

Okay. So I actually could potentially go the other way. If you do start to see new truck supply ease up, maybe that tempers the growth in Parts a bit..

Yes, but I wouldn't look that....

Yes. Okay. All right. And then just on the Financial Services.

I mean, just such a big quarter from a -- on a margin percentage basis, is there anything, Harrie, that we should think about a lot that runs through that and that we can't necessarily see on the face of the release in terms of gains on used sales or changes from the operating lease assumptions or anything more I guess, onetime in nature that just as we think about a similar profitability in the fourth quarter, is that fair all else equal, if we had a similar strong truck market with strong residuals? Can we kind of run rate that into '22? Or is there, again, just something we should think about that potentially impacts the back half of this year that may not recur next year?.

Yes. Tim, the finance company has had a stellar quarter. The portfolio is of excellent quality. Customers continue to pay on time. Past dues were less than 0.5%. And on top of that, we see strong demand for used trucks. All the investments we've made in the used truck centers over the years, we get the dividends out of that now.

And you see that back in that strong profitability, $120 million, a record for the finance company. And we expect that performance to continue, let's say, into next year it's difficult to say what's going to happen in the second half of next year. But for the foreseeable future, the finance company in the future is bright..

Your next question will come from the line of Courtney Yakavonis from Morgan Stanley..

If we could just talk a little bit about R&D. I know you mentioned the step-up that's going to support clean diesel and some of the autonomous programs as well as the connected truck platform. Historically, you've talked about obviously investing mostly in the diesel. You've done your new truck launches.

Just curious if the buckets for R&D have changed over time.

And also, as we think about the investments that you're making in autonomous versus clean diesel, anything that you can just help guide us as to where the increase is primarily coming from and how it compares to the breakdown in prior year?.

Sure. Let me take a swing at that for you, and then Harrie, maybe has something to add. I would say that there is a shift going on. We have a lot of great diesel programs coming along. When you think about 2024 emissions, 2027 emissions, our team did a great job of meeting that with clean diesel.

So that's continuing as that will likely be the dominant powertrain offering for the next 5 to 10 years, at least.

And then I would suggest that beyond that, we have put more money into the electric vehicle programs as we develop our own capabilities there and develop our own software solutions and control algorithms and same with autonomous, with the autonomous vehicle platform and then the investments we're making in connected services and this digital transformation so that we're providing value to customers in those areas.

All of those are the shifts that are ongoing right now. As Harrie said, we've just completed the best launch of new trucks we've had in our history. And so that foundation is built, and we're moving to other areas..

Great. That's helpful. And then just a little bit more on the 4Q margin comments. Can you just help us understand -- I know you made the comments about absorption.

But just in terms of the additional availability via reengineered chips and some of the brokered chips, any guidelines you can give us on just how much more expensive those are versus procuring them through normal channels just when we're thinking about the margin impact that we have to 4Q versus thinking about 2022 when things normalize a little more?.

Yes. Courtney, of course, those alternative chips can be more expensive and often are more expensive but it doesn't have a material impact on our gross margin percentages for now..

Your next question will come from the line of Matt Elkott from Cowen..

So you guys are doing a good on the autonomy front and a good deal electrification.

Can you talk about if you see an overlap of the 2 technologies as a growth area, electric autonomous trucks? And if there are any manufacturing processes advantages to try and to merge the 2 technologies or limitations?.

I wouldn't think of them quite as linked like that. I think that initially, autonomy is going to have a great role to play when it becomes commercialized in the long haul are principally to begin with. And that isn't something that lends up well to battery electric vehicles.

It might with hydrogen fuel cell, which is 1 of the other technologies we're leading in. So I think that we look at them as developing in parallel, they will merge at some point, but I don't think that they happy linked like that..

And then my second question is on the cycle. I know the base case scenario here, our assumption is that supply chain disruptions will slowly and gradually.

But if they ease more quickly and somewhat abruptly, are you guys able to ramp up production on a sequential basis next year? Maybe what a step function material increase if the chip shortages are out of the way?.

Matt, indeed, we could. We’ve prepared ourselves for it. We have great operations teams, and we would be prepared that step up..

Next question will come from the line of Jeff Kauffman from Vertical Research..

I almost feel bad coming back to autonomous, but I think it's just such an interesting opportunity. So I'd love to ask you 2 questions on this.

Number one, is there going to be any ability for you to utilize the platform across markets, so let's say, Europe, where is the thermometer on autonomy out there and what's going on? And then the second question, you kind of answered a little bit, but you're building a platform for it. So it's not something you're dabbling in.

I mean this is something you believe in and you're going to commit to.

What have you learned so far whether it's the way the trucks were whether what things maybe are you learning that you didn't expect in terms of fuel economy? I know it's early stage in its early innings, but I'm just kind of curious because you're 1 of the few companies that's really being proactive in terms of building a platform and testing vehicles..

You bet. I'll try to take both those questions for you. As far as platform, this autonomous vehicle platform we're building, indeed it does have application across markets, across brands. So we are investing in the knowledge centers and software capabilities that develop a vehicle as well as the hardware systems onboard the trucks.

So that those integrate well with the autonomous driver with companies like Aurora that are creating the driver itself, integrates well to our platform and then our platform could be used with another autonomous driver as well. So that’s why we are making those big investments.

I’d also continue to say that lessons learned are that the drivers are going to around for a long time that this is not something that we will step-in in three years and displace drivers. This was a gradual introduction, it will be certain routes. It will take weather conditions, and those will slowly get sorted out.

So I would say that the other key learning is that the support required for an autonomous vehicle is pretty high and having a strong global presence like PACCAR does, help success occur for autonomous vehicle operations because you need a good dealer network.

You need to be able to understand what's happening on board the vehicle through connected services and you be able to reach out and get to that truck and work with our customers to make sure that they're operating well and then repair the truck when something happens. So it really is an -- autonomy is a great opportunity for PACCAR in the world..

Your next question will come from the line of Felix Boeschen from Raymond of James..

I just wanted to follow up on the comments on the Parts business. Clearly, the backdrop just from an industry-wide truck utilization standpoint is obviously very favorable today and probably for the foreseeable future.

But I'm just curious if you could talk through some of the company-specific drivers in that business and really the sustainability of those cycles even if, say, the truck market were to loosen.

I'm trying to think through MX engine parts, the e-commerce business, TRP and the new distribution center? And any sort of quantification on those would be helpful..

Yes. You made great comments. To answer your question, those are all exactly right. I mean the TRP growth is strong. We are seeing continued strong growth, 37% in the e-commerce business. So that's fantastic. The engine business parts are growing as well.

And then I really think we need to make sure we emphasize the fact that through the digital transformation that the Parts team has embarked on in knowing how to connect with the customer, with the dealer and then meet those needs. Our Parts team is doing a fantastic job of doing that, and that's what kind of grows the business in the longer term.

So really positive things to look forward to..

Got it. And then just quickly on the margins, they've obviously been strong. I'm curious if there's anything in those numbers from a supply chain headwind perspective? Or have you been sort of isolated or covering your costs with that? Just to kind of try think to the puts and takes as we head into 2022..

For Parts, Felix, it's very easy to -- whenever there are cost increases, do have price increases at the same time, there is no backlog for Parts. So the Parts orders that come in today, they're going to be shipped to their same day or tomorrow. So that's very easy to get pricing there in line or better than the cost increases..

At this time, there are no further questions in queue.

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..