PACCAR Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 25, 2021

Key Takeaways

  • PACCAR reported record Q3 results in its Parts and Financial Services divisions with total revenues of $5.2 billion and net income of $378 million.
  • Semiconductor shortages and other supply-chain constraints reduced Q3 truck deliveries by 7,000 units, leaving about 10,000 trucks awaiting parts; management sees gradual improvements in Q4 as chip supplies recover.
  • Demand remains robust for PACCAR’s new Kenworth, Peterbilt and DAF models, which feature up to 10% greater fuel efficiency, advanced aerodynamics, digital instrumentation and growing EV and autonomous vehicle order pipelines.
  • PACCAR maintained 2021 retail sales guidance for U.S. and Canadian Class 8 trucks at 230,000–250,000 units and forecast 2022 sales of 250,000–290,000, while estimating European >16 ton registrations of 260,000–280,000 in 2021 and 260,000–300,000 in 2022.
  • The company plans capital expenditures of $525–550 million in 2021 and $425–475 million in 2022, and expects R&D spending to rise from $320–330 million this year to $350–400 million next year to support emissions, electric, autonomous and connected-truck programs.
AI Generated. May Contain Errors.
Earnings Conference Call
PACCAR Q3 2021
00:00 / 00:00

There are 19 speakers on the call.

Operator

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 and if anyone has an objection, they should disconnect at this time. I would now like to introduce Mr. Ken Hastings, PACCAR's Director of Investor Relations.

Operator

Mr. Hastings, please go ahead.

Speaker 1

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 Feit, Chief Executive Officer Terry 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.

Speaker 1

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 Feit. Good morning.

Speaker 2

Thank you all for joining the call. Harry Skippers, Michael Barclay and I will update you on our good third quarter results and business highlights. I appreciate our outstanding employees around the world We're 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 3rd quarter reflect sales and profit records at PACCAR Parts and PACCAR Financial Services.

Speaker 2

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 3rd quarter sales and financial services revenues were $5,200,000,000 and 3rd quarter net income was 378,000,000 PACCAR Parts achieved record quarterly revenues of $1,260,000,000 and record pre tax profits of 281,000,000 PACCAR Financial achieved record pre tax income of $120,000,000 The record setting parts And Financial Services results illustrate the strength of PACCAR's businesses. With the strong order backlogs, Growth in the truck divisions will accelerate as supply of semiconductors improves. We To make Class 8 industry retail sales in the U.

Speaker 2

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 Q4, the good news is that we're starting to see improvements in the supply chain. We forecast the 2022 U.

Speaker 2

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 ton market are estimated to be in a range of 260,000 to 280,000 vehicles. Soft 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.

Speaker 2

The South American above 16 ton market is projected to be in a range of 120,000 to 130,000 trucks this year. South Brazil's above 16 ton market share through September was 5.6%. The South American above 16 ton 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 3rd 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.

Speaker 2

The new Kenworth and Peterbilt medium duty trucks that also began production in the Q3 provide features that customers appreciate, Such as a wider cab with 3 person seating, lower cab heights for easier entry and exit and new digital instrumentation. Exciting new DAF XF, XG and XG Plus lineup feature luxurious interiors and beautiful exteriors That provides 10% greater fuel efficiency. The new DAF offers unsurpassed performance and value. DAF is the 1st 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.

Speaker 2

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 100zero 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 Commercial pilot of autonomous vehicles into line haul operations.

Speaker 2

The PACCAR trucks are operating autonomously with a backup driver for safety SA haul freight on 500 mile route between Dallas and Houston. PACCAR has launched an advanced global connected truck platform. Customers will benefit from the system's enhanced truck data security, advanced over the air software updates, elimination of the need for 3rd 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 is 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.

Speaker 2

We were honored for 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 2,030 carbon reduction goals. PACCAR earned a CDP climate change score of A- placing PACCAR in the top 15% of over 9,500 companies that publish reports 100 percent of PACCAR's manufacturing locations globally have environmental management programs certified under ISO 14,001.

Speaker 2

Harry Skippers will now provide an update on PACCAR Parts, PACCAR Financial Services and other business highlights. Thank you. Harry, over to

Speaker 3

you. Thanks, Preston. Kenworth, Peterbilt and DAF delivered 32,800 trucks in the Q3, with truck, parts and other gross margins up 11.8%. 3rd quarter volumes and margins reflect manufacturing inefficiencies associated with limited microchip supplies. Depending on the supply of materials, Q4 PACCAR Global Truck deliveries should increase into the low 40000s

Speaker 4

With gross

Speaker 3

margins improving to approximately 12.5%. Customer demand is strong And Duff, Genworth and Peterbilt are well positioned for sales growth and margin expansion as the new truck models are now in production And when semiconductor endosupply issues are resolved. Becker Parts had another outstanding quarter, achieving record revenues of $1,260,000,000 up 24% compared to the Q3 of last year. Parts pre tax profits were on record $281,000,000 up 34% from last year. Becker Parts benefited from strong freight demand and truck utilization, world class supply chain management and logistics And increased distribution capacity.

Speaker 3

In the 1st 9 months of this year, overall part sales increased 28%, With e commerce parts sales increasing 37%. Pega 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 4th quarter part sales To be similar to the strong Q3. PACCAR Financial Services earned record pre tax income of $120,000,000 reflecting strong portfolio performance and robust used truck demand. We expect Q4 PACCAR Financial results to be in line with the excellent Q3.

Speaker 3

Becker Financial is increasing its retail used truck center capacity worldwide, which enhances used truck margins. The latest Pekka Financial used truck facility is under construction in Madrid, Spain. Kenworth and Peterbilt truck resale values Deliver a 10% to 20% premium over competitors' trucks. Pega has invested $7,300,000,000 in new vehicle programs, enhanced facilities and new technologies during the past decade. This includes the investment of $1,000,000,000 for the new DAF truck range and its expanded factories.

Speaker 3

Capital expenditures for 2021 are projected to be 525 to $550,000,000 Next year, we plan to invest 425,000,000 to 475,000,000 The capital projects, as we've just completed the launch of our exciting new drug platforms. Research and development expenses are estimated to be $320,000,000 to $330,000,000 this year And increase to $350,000,000 to $400,000,000 next year. Next year's increased R and D spending We'll support our clean diesel, 0 emissions, autonomous and connected truck programs. These programs along with the strong performance of parts and financial services will ensure Pegaard's ongoing success. Thank you.

Speaker 3

We'd be pleased to answer your questions.

Operator

Your first question will come from Steven Volkmann with Jefferies. Please proceed with your question.

Speaker 5

Hello. Good morning out there guys. Thanks, Steven. I'm hoping to talk a little bit about just the kind of impact of the quarter. I guess The pre announcement that you put out a few weeks ago talked about 7,000 trucks that you were unable to ship.

Speaker 5

I assume that means those trucks are largely completed and awaiting whatever part would allow you to ship them. Is that correct?

Speaker 2

So that's partially correct is what I'd say, Stephen. The way I'd look at it is through the course of the Q3 supply based 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 into that position.

Speaker 2

So right now with the 32,800 trucks in the 3rd quarter, There's about 10,000 trucks offline and that's how you match that up.

Speaker 5

Okay. And then I assume as we go forward and ultimately you will Chip 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?

Speaker 2

I think about it this way. So 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 trucks to the customers, that's the most important thing. And that's where our focus really was in the Q3 is to get as many trucks prepared as we could. So we'll see that improve market share positions, etcetera, around the world.

Speaker 2

We also think that as we get additional supply Semiconductors then that will allow us to go up and build rate and we think those things will happen concurrent with one another. So

Speaker 5

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

Speaker 3

As Preston mentioned, Steve, those trucks were largely completed in prior quarters. So that's when we Incurred overhead and labor and the absorption as well. So once these trucks get delivered, we'll record the margin on the truck, but not the absorption anymore.

Speaker 5

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 startup costs associated with these launches in the quarter?

Speaker 2

It does. Yes. In the course of Q3, 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 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.

Speaker 2

The new DAFs just went into production and it's just fantastic.

Speaker 3

Okay. Thank you. I'll pass it on.

Speaker 2

All right.

Operator

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

Speaker 6

Yes. Good afternoon, everybody. Good morning. Maybe just a few. As we think about gross margins going into 22 on the back of kind of Steve's question.

Speaker 6

I totally appreciate that you've built the trucks that are offline. You got the absorption already. You won'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 modeling of 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 2020 2. Thank you.

Speaker 2

Absolutely. So as we think about the Q4, 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 with suppliers, Suppliers working with us and through those strategic partnerships, we've now started to come up with either re engineered solutions or alternate chips or brokered chips that allows us to start to Recover some of the trucks in the Q4 and we think 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.

Speaker 6

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 out producing retail sales next year as you refill Dealer inventories, maybe you could just remind us what your dealer inventories were at the end of the quarter?

Speaker 2

Sure, Ann. First of all, we had price realization of 4% in the Q3. 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, we're seeing that. So that's good news for us.

Speaker 2

And then as you mentioned, Our inventory is about 1.4 months compared to 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, We'll be probably constrained only by supply of components. Certainly true for the first half.

Speaker 6

Okay. I'll leave it there and get back in line. Thank you. Appreciate the color.

Speaker 2

All right. Good.

Operator

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

Speaker 7

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 Q3 and maybe try to think through how used prices, the strength there is influencing How are you thinking about pricing for 2022?

Speaker 3

Yes. As Preston mentioned, we've increased prices on average 4% in the Q3, David. If we look into the Q4 and next year, that is obviously going to continue. We're going to recover material cost increases I'm pleased for those and hopefully a little bit more in a strong market that we're in today.

Speaker 7

And then when it comes to the Supply chain improvement. Is there anything that you're saying that suggests it looks like the Q4 there is some modest improvement. The deliveries You know, 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 We 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.

Speaker 2

Yes. I think as we look at it, It's really been just recently that we've seen the stabilization in the supply base, the semiconductors from the work the teams are doing. And so that's the goodness that we see. And in this work with our second, 3rd, 4th tier suppliers, we have good supply base and they're all communicating really well with us right now, We would expect that there'll be gradual and steady improvement rather than a hockey stick as you mentioned. How far that goes and where that bounds out at?

Speaker 2

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 then good market in the year after that. So that's the positives there. And then just to add on to what Harry was talking about in price realization, one of the things that we do see with the new DOP 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.

Speaker 7

That's helpful. So just to wrap up on the sequential, 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 Q4 level, just as we think through the beginning of next

Speaker 2

year. See, that's our hope right now. So that's what we hope to have happen. Harry?

Speaker 3

Yes. A lot of it 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 Although the semiconductor situation is still constrained, we found some alternative solutions to keep production going with good solutions. And I think that supports our optimism a little bit.

Speaker 7

I appreciate that. Just because if you do, 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.

Speaker 7

So I think that's

Speaker 2

probably true. That's really one of the things we focused on in the course of the quarter or 2 is there's a tremendous amount of customer demand for the Kenworth, Peterbilt and DOF trucks out there. And so our focus has been around getting as many prepared for delivery as we can, building and being just shy of component to satisfy that market demand for these great drugs.

Speaker 7

All right. Thank you very much. I appreciate it.

Operator

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

Speaker 4

Great, thanks. Good morning, guys. It seems like you'd 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 deliveries switch over from 2021 model years to 2022 model years? And what impact will that have on pricing and margins?

Speaker 2

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 1st part of 2022 and just a normal cadence.

Speaker 3

The change in model year is less relevant than the change from the old to the new models. 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.

Speaker 4

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.

Speaker 2

Well, we're in this test right now with FedEx and or hauling freight. It's the first time we've been participating in an actual freight hauling exercise. We've got lots Truck is running around different autonomous startups 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.

Speaker 4

Okay. Thanks very much.

Speaker 2

You bet.

Operator

Your next question will come from the line of Joel Tiss from BMO. Please proceed with your question.

Speaker 1

How's it

Speaker 3

going guys?

Speaker 1

Hi, Joel.

Speaker 8

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 the insurance side

Speaker 9

or is

Speaker 8

it from the DOT Or is it just having enough error be modeled out there? Like just some of the things you guys have learned.

Speaker 2

Hey, Joel, we had a really hard time hearing you there. Didn't come through very clear. Could you try the question again?

Speaker 8

Yes, sorry, we just moved to the new office. Anyway, what you're seeing is sort of like The roadblocks to having that technology adopted by 2025, is it in IoT or free miles?

Speaker 2

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.

Speaker 2

So we're working through those. The other part of it is we're developing a proprietary PACCAR Autonomous vehicle platform, 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 are again technology. There will 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.

Speaker 8

All right. I'm going to try one more question.

Speaker 6

Thanks for it.

Speaker 8

To ask a little bit more, instead of about Quarter, I want to ask like on 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.

Speaker 2

Yes. Joel, I absolutely believe that the new products, the autonomy, the 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.

Speaker 8

Okay. Thank you. That's awesome.

Speaker 2

You bet.

Operator

Your next question will come from the line of Rob Wertheimer from Melius Research. Please proceed with your question.

Speaker 10

Hello, everybody. Thank you. 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 holdup. Maybe that's not maybe that's too optimistic a way to phrase it.

Speaker 10

Whether you're just kind of out hustling, I don't know if you're reprogramming like Tesla did or finding new sources, and how long you sort of 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?

Speaker 2

Well, I think it's a matter of degrees. I think our teams are doing, as I mentioned before, it's worth mentioning, are doing a fantastic job of hustling as you put it. They are reengineering different chips or taking places where maybe 2 chips were required and reengineering them into requiring 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 quality. So the team has done a fantastic job on that.

Speaker 2

And I think that's why we're starting to see this improvement. Just 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 of it. I think it's going to take some time. So Gains next year are positive for us.

Speaker 2

And then again, that might make it for a very strong 2022 and lead to a strong 2023.

Speaker 10

Okay, perfect. 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 I guess for redundancy for sensors for everything else to go into. Assuming that comes at additional contentprice point And I wonder if you have any thoughts on quantification. It seems like your future revenue curve is a little better than the past as you layer in more technology.

Speaker 10

I will stop there. Thank you.

Speaker 2

All right. Let's try to 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 the Tens and even 100 for some of our orders where customers are saying, hey, I've tried it. I've been around you guys for a little while now.

Speaker 2

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. So numbers of chargers and putting that together.

Speaker 2

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. Packer parts is doing 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.

Speaker 2

From an autonomous standpoint, yes, you're right that autonomous vehicle platform that you mentioned We'll have additional componentry on it. It's a very tech solution and PACCAR will be the leader in that area. So that will be helpful to margin. We also expect that services will grow on autonomous Because now our dealers and their involvement will be significant as well and it should be good for the total business.

Speaker 10

Thank you.

Speaker 2

You bet.

Operator

Your next question will come from the line of Chad Dillard from Bernstein. Please proceed with your question.

Speaker 4

Hi, good morning guys.

Speaker 3

Hello.

Speaker 4

So to what extent are you seeing share gains related to your new Maybe you can talk about what your backlog 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 2022?

Speaker 2

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 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 share Because of the trucks that we've built and we'll be delivering. So it feels pretty positive looking forward, which will be great for the parts business and the finance company business as we look forward.

Speaker 3

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

Speaker 4

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 just hoping maybe you could kind of break down that shortfall, so we can just model it as we go into 2022. How much comes from just like absorption

Speaker 3

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

Speaker 4

Okay. So I'm just looking at

Speaker 3

Sorry, go ahead.

Speaker 4

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

Speaker 3

Yes. Our incremental margins typically have been in that 15% to 20% range and Nothing has changed about the company wide. That wouldn't continue to occur going forward. And Like we said, we expect margins to improve in the Q4 to 12.5%. And as we work through the semiconductor issues And with the new truck models in place, margin should improve significantly going into next year.

Speaker 2

Yes. I'd just add to what Harry was saying, there's probably more factors affecting margin than It's 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.

Speaker 4

Thanks. I'll pass it on.

Speaker 2

You bet.

Operator

Your next question will come from the line of Jerry Revich from Goldman Sachs. Please proceed with your question.

Speaker 11

Yes. Hi. Good morning and good afternoon, everyone.

Speaker 2

Hey, Jerry.

Speaker 11

I'm wondering if you could just talk about the 0 emissions vehicles. So last quarter, I think you had mentioned to date orders of 450. Can you What the mix versus medium and heavy duty looks like, if you don't mind?

Speaker 2

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 they came in, in the ones. Now they're coming in more like in the tens 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.

Speaker 2

It's medium duty and heavy duty split. The key probably point to all of it is that it's return to base Application. 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. That's what we see the initial start And I think as we've articulated before, expect that orders and build will be in the 100 in the coming year or 2 And then transition to the 1,000 pretty quickly in the next 2 to 3 years, let's

Speaker 11

say. Terrific. And then on the new product lineup Across the board, can you just talk about what proportion of your production you expect to come from The new models in the Q4 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.

Speaker 2

So I would say that in North America for the new trucks that they'll become a majority of the trucks in the Q4. And in Europe, we just launched this month 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 Harry, detail on the DAF builds for next year?

Speaker 3

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

Speaker 2

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 Conveniences and how they work and safety features and their level 2 autonomous capabilities. So all of that together is a great benefit to the customers and that's why it will be Impactful to our margins.

Speaker 11

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 Accident avoidance outside of the potential elimination of labor longer term. Can you just talk about and quantify the other benefits that you're seeing in the trials?

Speaker 2

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 can be safer and more efficient And good for the operating environment.

Speaker 11

Okay. I appreciate the discussion. Thanks.

Speaker 2

You bet. Have a good day.

Operator

Your next question will come from the line of Ross Gilardi from Bank of America. Please proceed with your question.

Speaker 12

Thank you. Good morning, everybody. Raj? I was just wondering if you could comment on the capital spending outlook for next year. I mean, it's down by almost $100,000,000 and I'm just a little surprised by that given the strength of the outlook and all the production constraints and so forth.

Speaker 12

And Just what are your latest thoughts on incremental vertical integration you might pursue given the supply chain situation?

Speaker 3

No big changes in vertical integration, Ross. But we did just complete the launch Of the biggest product renewal programs in the history of the company with the new DAF, the new medium duties, the new T680 And the new 579, so we're now in that phase that you see R and D go up a little bit more as we focus our efforts To autonomous, electrification, connectivity, those kind of technologies. And in that space, there's just more R and D going on And capital spending will come later.

Speaker 12

Okay, got it. Thanks Harry. 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.

Speaker 12

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 like out of the gate?

Speaker 2

Hey, Ross, let me take a swing at that and maybe Harry will add something into it. I'd say that it's not a demand feature. I'd say 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

Speaker 3

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, Rob, so let's not forget that.

Speaker 12

For sure. I'm not debating that, Ari. It's just 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. Thank you.

Speaker 12

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 Yes, union contract negotiations coming up. Obviously, that's topical these days around the industry. So Haven't asked that in a while.

Speaker 2

Sure. Very small percentage of our team in North America is unionized and we have 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. It's a GreenOak.

Speaker 2

One of the things as we travel around in this dynamic environment and go out and meet in the 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.

Speaker 12

Okay, great. Thanks very much guys.

Operator

Your next question will come from the line of Jamie Cook from Credit Suisse. Please proceed with your question.

Speaker 13

Hi, good morning. I guess two questions. 1, 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?

Speaker 13

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 Q4 North America versus Europe? Thanks.

Speaker 2

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 is the team at parts Really leading it and getting data from trucks, from customers, from the dealers and then synthesizing that into value added services. So just Talked 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.

Speaker 2

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 We expect growth in both markets and you just have to remember that in the Q4, we'll see more build days in Europe than we had in North in Q3, right, just by holiday schedules and shutdowns. So you'll probably see increases at a higher degree in Europe.

Speaker 13

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

Speaker 3

Yes. Parts has been a little bit higher even than 4%. I would think it's 6%, it's about 5%. 5% in the Q3, Jamie.

Speaker 13

Okay, great. Thank you.

Speaker 11

You bet.

Operator

Your next question will come from the line of Nicole DeBlase from Deutsche Bank. Please proceed with your question.

Speaker 14

Yes. Thanks, guys. Good morning.

Speaker 2

Hello, Nicole.

Speaker 14

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 2021 guidance for the market there. So we'd love to hear what's going on in South America.

Speaker 2

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.

Speaker 2

It's performing at the top of the mark. 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.

Speaker 14

Got it. Thanks. And when we think about like how you guys are booking orders into 2022, I guess how far 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?

Speaker 2

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 are likely to have Significant order backlog, 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.

Speaker 14

Okay, perfect. Thank you. I'll pass it on. Okay, great.

Operator

Your next question will come from the line of Tim Dine from Citigroup. Please proceed with your question.

Speaker 15

Great. Thank you. Good morning. The first question was just On the parts business and just thinking from a high level as to the growth potential in 'twenty 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.

Speaker 15

So is there a potential Sort of a restock in 2022, do you think?

Speaker 2

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 And so because there's a constraint on new trucks industry wide, it's meaning that the repairs are going up on the trucks that are existing. And so that's also creating great opportunity for the parts market and that seems likely to continue into next year.

Speaker 15

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.

Speaker 2

Yes, but I wouldn't look at that anytime soon.

Speaker 15

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 Harry that we should think about? There are a lot that runs through that and that we can't necessarily In the face of the release in terms of gains on used sales or changes from the operating lease assumptions or anything More, I guess, one time in nature that just as we think about similar profitability in the 4th 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 2022 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?

Speaker 15

Thank you.

Speaker 3

Tim, the finance company has had a stellar quarter. The portfolio is of excellent quality. Customers continue to pay on time. Past used were less than 0.5%. And on top of that, We see strong demand for used trucks.

Speaker 3

We 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, dollars 120,000,000 a record for the finance company. And yes, 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, the future is bright.

Speaker 15

All right. Very good. Thank you.

Operator

Your next question will come from the line Courtney Yakavonis from Morgan Stanley, please proceed with your question. Hi, good afternoon guys.

Speaker 16

If we could just talk a little bit about R and 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 and 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 years.

Speaker 2

Sure. Let me take a swing at that for you and then Mary maybe has something to add. As 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, 20 20 Our team is doing a great job of meeting that with clean diesel.

Speaker 2

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, 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 Are the shifts that are ongoing right now? As Harry 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.

Speaker 16

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 and just how much more expensive those are versus Procuring them through normal channels, just when we're thinking about the margin impact that would have to 4Q versus thinking about 2022 when things normalize a little more.

Speaker 3

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.

Speaker 16

Okay, that's helpful. Thanks.

Operator

Your next question will come from the line of Matt Elkott from Cowen. Please proceed with your question.

Speaker 17

Good morning. Thank you for taking my question. So you guys are doing a good deal on the autonomy front and a good deal on 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?

Speaker 2

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 market, Principally to begin with and that isn't something that lends itself well to battery electric vehicles. It might with hydrogen fuel cell, which is one 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 have to be linked like that.

Speaker 17

Got it. And then my second question is on the cycle. I know the base case scenario here or assumption is that supply chain disruptions You 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 like a step function Material increase, if the chip shortages are out of the way?

Speaker 2

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

Speaker 17

Got it. Thank you very much.

Speaker 2

You bet.

Operator

Your next question will come from the line of Jeff Kauffman from Vertical Research. Please proceed with your question.

Speaker 18

Thank you very much and congratulations on a tough environment. 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 Two questions on this. Number 1, is there going to be any ability for you to utilize the platform across Market, 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.

Speaker 18

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 wear, whether what things maybe are you learning that you didn't expect in terms of fuel economy? I know it's early stages and it's early innings, but I'm just kind of curious because you're one of the few companies that's really being proactive in terms of building a

Speaker 2

You bet. Let me try to take both those questions for you. As far as the platform, this autonomous vehicle platform we're building indeed, it does have Application cross markets, cross brands. So we are investing in the knowledge centers and software capabilities that develop the vehicle as well as the hardware Systems on board the trucks so that those integrate well with the autonomous driver, the 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're making those big investments.

Speaker 2

I would also kind of continue to say that the lessons learned The drivers are going to be around for a long time, that this is not something that will step in 3 years and displace drivers. This is 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 helps success occur for autonomous vehicle operation 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 need to 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.

Speaker 2

So it really is a it's going to be a great opportunity for PACCAR to grow in the world.

Speaker 18

Okay. That's fantastic. Again, congratulations on the quarter and thank you for your answer.

Speaker 2

All right. Thank you very much.

Operator

Your next question will come from the line of Felix Boschian from Raymond James. Please proceed with your question.

Speaker 9

Hey, good morning, everybody.

Speaker 2

Hello.

Speaker 9

Hey, I just wanted to follow-up on the comments on the parts business. Clearly, the backdrop just from an industry wide truck utilization standpoint It's 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 The sustainability of those through cycles even if say the truck market were to loosen. I'm trying to think through MX Engine Parts, the e commerce business, TRP at the new distribution center, any sort of quantification on those would be helpful.

Speaker 2

Yes, yes, you made great comments. So 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. Engine business parts are growing as well.

Speaker 2

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 and 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.

Speaker 9

Got it. And then just quickly on the margins, they've obviously been 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 kind of trying to think through the puts and takes as we head into 2022.

Speaker 3

For parts, Felix, it's very easy to whenever there are cost increases To 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 today or Same day or tomorrow. But that's very easy to get pricing there in line or better than the cost increases.

Speaker 9

Got it. I appreciate it, Harry.

Operator

At this time, there are no further questions in Are there any additional remarks from the company?

Speaker 1

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

Operator

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

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