PACCAR Q3 2021 Earnings Call Transcript

Participants

Corporate Executives

• Ken Hastings, Director of Investor Relations
• R. Preston Feight, Chief Executive Officer
• Harrie C.A.M. Schippers, President and Chief Financial Officer

Analysts

• Stephen Volkmann, Jefferies Financial Group Inc.
• Ann Duignan, JPMorgan Chase & Co.
• David Raso, Evercore ISI
• Steven Fisher, UBS Group AG
• Joel Tiss, BMO Capital Markets
• Rob Wertheimer, Melius Research
• Chad Dillard, Sanford C. Bernstein
• Jerry Revich, The Goldman Sachs Group, Inc.
• Ross Gilardi, Bank of America Co.
• Jamie Cook, Credit Suisse Group AG
• Nicole DeBlase, Deutsche Bank Aktiengesellschaft
• Tim Thein, Smith Barney Citigroup
• Courtney Yakavonis, Morgan Stanley
• Matt Elkott, Cowen Inc
• Jeff Kauffman, Vertical Research
• Felix Boeschen, Raymond James

Presentation

[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, Mr. Hastings, please go ahead.

[Ken Hastings, Director of Investor Relations at PACCAR]

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.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 base 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 reflect sales and profit records at PACCAR Parts and PACCAR Financial Services. 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. 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 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 a range of 120,000 to 130,000 trucks this year. DAF Brasil'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 three-person seating, lower cab heights for easier entry and exit, and new digital instrumentation.

The exciting new DAF XF, XG and XG+ plus 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, who have taken full advantage of Europe's new regulations governing truck design. 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 seven 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 in the linehaul operations. The PACCAR trucks are operating autonomously with the backup driver for safety as they haul greater than 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 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 and Trucking Association. 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 2030 carbon reduction goals. PACCAR earned CDP Climate Change score of A-, placing PACCAR in the top 15% over 9,500 companies that published reports to the CDP. 100% of PACCAR's manufacturing locations globally have environmental management program 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.

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

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 under 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 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 nine months of this year, overall part sales increased 28%, with e-commerce part 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 and 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 delivered a 10% to 20% premium over competitor's trucks. PACCAR has invested $7.3 billion in new vehicle programs, enhance facilities and new technologies during the past decade. This includes the investment of $1 billion for the new DAF Truck range and it's 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 and increased 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.

Questions and Answers

[Operator]

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

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Hello, good morning out there, guys, 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. I assume that means those trucks are largely completed and awaiting whatever part would allow you to ship them. Is that correct?

[R. Preston Feight, Chief Executive Officer at PACCAR]

So that's partially correct is what I'd say, Stephen. The way to look at it is through the course of the third quarter, supply base 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 do reference them. So that's what put us in that position. So right now with 32,800 trucks in the third quarter, there's about 10,000 trucks offline and that's how you match that up.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

I think about it this way, is what we think is with the trucks that are offline, those are just missing a component or two or three and so as those trucks delivered that's going to be good for us in terms of getting the trust of the customers, that's the most important thing and that's where our focus really was in the third quarter as to get as many trucks prepared as we could. So, we'll see that improve market share positions etc., 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.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

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

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

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 those trucks get delivered, we'll record the margin on the truck, but not the absorption anymore.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

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, 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.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Okay, thank you. I'll pass it on.

[R. Preston Feight, Chief Executive Officer at PACCAR]

All right.

[Operator]

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

[Ann Duignan, Analyst at JPMorgan Chase & Co.]

Yes, good afternoon everybody. 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 won't get the margin when you record the sales. But as you roll into 2022, when 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 and the backlog inefficiencies you incurred this quarter because of start up and our components here. 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? Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Absolutely. So, as we think about the fourth quarter, what I mentioned in the commentary is that we're starting 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 fourth quarter 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.

[Ann Duignan, Analyst at JPMorgan Chase & Co.]

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 producing 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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 the great new products. I mean if you just think about the kind of product performance we'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 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.

[Ann Duignan, Analyst at JPMorgan Chase & Co.]

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

[R. Preston Feight, Chief Executive Officer at PACCAR]

All right, good.

[Operator]

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

[David Raso, Analyst at Evercore ISI]

Hi, thank you. 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've got in the third quarter and maybe try to think through how used prices the strength there is influencing? How are you thinking about pricing for '22.

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

Yes. As Preston mentioned, we've increased prices on average 4% in the third quarter, David. If we look into the fourth quarter to 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.

[David Raso, Analyst at Evercore ISI]

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's 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 or you can give us some sense of magnitude of the improvement in the supply chain? Not necessarily, same as a hockey stick out there, but just a better sense if you can expand upon a little bit that comment about seeing an improvement in supply chain?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes, I think as we look at it, it's really been -- just recently that we've seen a stabilization in the supply base is semiconductors from the work the teams are doing. So that's the goodness that we see and in this work with our second, third, fourth Tier suppliers, we have good supply base and they're all communicating really well this right now, but we would expect that there will be gradual and steady improvement rather than a hockey stick as you mentioned. How far that goes and where that balance 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 then 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, only truck and customers are amazingly excited about it and it's going to be a big difference for us. So that's a positive.

[David Raso, Analyst at Evercore ISI]

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 it 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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

See that's our hope right now. Since we hope to have happen, Harrie, 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 will go to -- semiconductor situation is still constrained and we find some alternative solutions to keep production going with good solutions and I think that supports our optimism a little bit.

[David Raso, Analyst at Evercore ISI]

I appreciate that. Just 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 guidance 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 bit. So that's right way of thinking about it?

[R. Preston Feight, Chief Executive Officer at PACCAR]

I think that's probably true. That's really one of the things we focused on in the course of the quarter or two, 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 being just shy a component to satisfy that market demand for these great trucks.

[David Raso, Analyst at Evercore ISI]

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.

[Steven Fisher, Analyst at UBS Group]

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 switchover from '21 model years to '22 model years and what impact will that have on pricing and margins?

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

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

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 does have a much bigger impact on the model year change this year.

[Steven Fisher, Analyst at UBS Group]

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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Well, we're in this test right now with FedEx and we're hauling freights. 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 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.

[Steven Fisher, Analyst at UBS Group]

Okay, thanks very much.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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

[Joel Tiss, Analyst at BMO Capital Markets]

How is it going, guys?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hi, Joel.

[Joel Tiss, Analyst at BMO Capital Markets]

I just wondered, I'm following up on the end of Steven's question there. What kind of barriers do you think are out there for [Technical Issues] more like the insurance side or is it from the [Technical Issue] or is it just having enough [Technical Issues] demand was out there, like, just some of that things you guys have learnt?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hey, Joel. We had a really hard time hearing you there, didn't come through very clear, could you try the question again?

[Joel Tiss, Analyst at BMO Capital Markets]

Yes, sorry. We just moved to new office. Anyway, what you're seeing as sort of like the roadblocks to have that technology adopt by 2025 EOG, is it [Technical Issues].

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 evolved 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 platform, which has all the redundancies involved in it, which is -- should be ready in the next couple of years here and that would be a a huge advantage for PACCAR and 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.

[Joel Tiss, Analyst at BMO Capital Markets]

All right I'm going to try one more question. [Speech Overlap] to ask a little bit more -- instead of about the quarter. I want to ask like on the 3 to 5-year basis, the structure of the margins, do you think like all these different [Technical Issues] autonomous and electric vehicles and everything else you're working on and plus new product is enough to really drive your margins to a 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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. Joel, I absolutely believe that the new products, the economy that connected to 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.

[Joel Tiss, Analyst at BMO Capital Markets]

Okay. Thank you. That's awesome.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

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

[Rob Wertheimer, Analyst at Melius Research]

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 semi's are the only real hold up, maybe that's not and that's too optimistic of way to phrase it, 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 have some certainty on that? And then more generally when do you see the whole situation with semi's getting better? Is that visible to you yet from your conversation with suppliers?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Well, I think it's a matter of degrees. I think our teams are doing, as I mentioned before, it's worth mentioning and are doing a fantastic job of hustling as you put it. They are re-engineering different chips. They are taking places where maybe two chips were required and reengineering them to require only one chip and 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 teams are doing a fantastic job on that. 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. And then that -- again that might make it for a very strong 2022 and lead to a strong 2023.

[Rob Wertheimer, Analyst at Melius Research]

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 for redundancy, for sensors, for everything else to go into; similarly that comes at an additional content/price point for you and I wonder if you have any thoughts on quantification? It seems like your future revenue curve is a bit better in the past as you layer in more technology. I will stop there. Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 the 10s and even 100s for some of our orders where customers are saying they have tried it, have 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. So 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 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 will be the leader in that area. So that will be helpful to margin. We would 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.

[Rob Wertheimer, Analyst at Melius Research]

Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

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

[Chad Dillard, Analyst at Sanford C. Bernstein]

Hi, good morning guys. So, to what are you seeing share gains related to your new product introductions for '22 in your backlog, 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 '22?

[R. Preston Feight, Chief Executive Officer at PACCAR]

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: Europe, North America, Brasil, Australia and I would expect that we'll see growth in share because of the trucks that we've built and will be delivering. So it feels pretty positive looking forward, which would be great for the parts business and finance company business as we look forward.

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

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

[R. Preston Feight, Chief Executive Officer at PACCAR]

Great point, Harrie.

[Chad Dillard, Analyst at Sanford C. Bernstein]

Great. And then just on my calculations it looks like you have about 140 basis point gap between actual and 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? Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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

[Chad Dillard, Analyst at Sanford C. Bernstein]

Okay. So I'm just looking at...

[R. Preston Feight, Chief Executive Officer at PACCAR]

Sorry, go ahead.

[Chad Dillard, Analyst at Sanford C. Bernstein]

Yes, I'm just looking at 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 like cover the 140 basis points gap? So that's just what I'm trying to the bridge between.

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

Our incremental margins typically have been in that 15% to 20% range and nothing has changed about the company wide that continue to curve 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 truck models in place, margins should improve significantly going into next year.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes, I'd just add to what Harrie is saying is probably more factors affecting margin than is typical, so 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, incrementals will be significant.

[Chad Dillard, Analyst at Sanford C. Bernstein]

Thanks, I'll pass it on.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

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

[Jerry Revich, Analyst at The Goldman Sachs Group]

Yes, hi, good morning and good afternoon everyone.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hey, Jerry.

[Jerry Revich, Analyst at The Goldman Sachs Group]

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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Sure. The orders continue to grow and I would suggest that, as I mentioned little bit earlier, they're coming in now -- I'd say initially it came in the ones. Now they're coming in more like in the 10s and even in the 100s 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. That's what we see the initial start to that. And I think as we've articulated before, we expect that orders and build will be in the 100s in the coming year or two and then transition to the 1000s pretty quickly in the next two to three years let's say.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Terrific. And then on the new product lineup across the board. Can you just talk about what -- could you talk about what proportion of your production do 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 or reductions on new models typically, I'm wondering if you're willing to quantify what that looks like here?

[R. Preston Feight, Chief Executive Officer at PACCAR]

So I would say that in North America for the new trucks that will 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're having detail on the DAF builds for next year?

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

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.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 the factories in Belgium and in 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.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Good. 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 that and quantify the other benefits that you're seeing in the trials?

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 of 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.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Okay. I appreciate the discussion. Thanks.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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.

[Ross Gilardi, Analyst at Bank of America]

Thank you. Good morning, everybody.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hi, Ross.

[Ross Gilardi, Analyst at 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 strength of the outlook and all the production constraints and so forth. And just what are your latest thoughts on incremental vertical integration you might pursue given that supply chain situation?

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

No big changes om 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 duty, the new T680 and a new 579. So we're now in that phase that you see R&D go up a little bit more as we focus our efforts to autonomous, electrification, connectivity and those kinds of technologies and that's phased us just more R&D going on and capital spending will come later.

[Ross Gilardi, Analyst at Bank of America]

Okay, got it. Thanks, Harrie. And then could you talk a 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. It just across -- global its 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, like out of the gate?

[R. Preston Feight, Chief Executive Officer at PACCAR]

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

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

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

[Ross Gilardi, Analyst at Bank of America]

Oh, for sure, I'm not abating that, Harrie, it's just you're coming off a year with pretty significant constraints where you're still plan, 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. All right. Thank you. And then just lastly, can you just talk about unions at all? 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 haven't asked that in a while.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

Yes, but the same thing. Excellent relationships with the unions.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes, it's a [Indecipherable], one of the things as we travel around in this dynamic environment and go out and meet on 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 in humbled to get to work with all of them.

[Ross Gilardi, Analyst at Bank of America]

Okay, great, thanks very much guys.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

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

[Jamie Cook, Analyst at Credit Suisse Group]

Hi, good morning. I guess two questions. One, obviously the parts performance this quarter was very strong, I guess it will be throughout the whole year. Do you think there is 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 if 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 quarter in North America versus Europe? Thanks.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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. The team of parts is really leading it and getting data from trucks, from customers, from the dealers and then synthesizing that into value-added services. So just talk 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, 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 North -- in the third quarter, right, just by holiday schedules and shutdowns. So you'll probably see increases at a higher degree in Europe.

[Jamie Cook, Analyst at Credit Suisse Group]

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 DAF.

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

Parts has been a little bit higher even than 4%, I think its about 5% in the third quarter, Jamie.

[Jamie Cook, Analyst at Credit Suisse Group]

Okay, great. Thank you.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

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

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

Yes, thanks, guys, good morning.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Hello, Nicole.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

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 would love to hear what's going on in South America.

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 the mark. So our premium reputation is established in South America and Brasil. 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 has been successful.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

Got it, thanks. 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's probably like a bit of a flux with what's going on with the supply chain and how does that compare to what the normal at this point in the year?

[R. Preston Feight, Chief Executive Officer at PACCAR]

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, 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.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

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

[R. Preston Feight, Chief Executive Officer at PACCAR]

Okay, great.

[Operator]

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

[Tim Thein, Analyst at Smith Barney Citigroup]

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 '22, you've 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 is a similar potential on the parts side? And I just say that as we're just seeing and hearing more about certain parts being tight from dealers. So, is there a potential for a sort of a re-stock in '22, do you think?

[R. Preston Feight, Chief Executive Officer at PACCAR]

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 that are existing. And so that's also creating great opportunity for the parts market and that seems likely to continue into next year.

[Tim Thein, Analyst at Smith Barney Citigroup]

Okay. So actually could potentially go the other way if you do start to see new truck supply? Maybe that tempers the growth in parts of it?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes, but I wouldn't look [Speech Overlap]

[Tim Thein, Analyst at Smith Barney Citigroup]

Yes. Okay, all right and then just on the Financial Services. I mean just such a big quarter from -- 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 from the face of the release in terms of gains on new sales or changes from the operating lease assumptions or anything more, well I guess one-time in nature that just as we think about 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? Thank you.

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

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. 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 $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 future is bright.

[Tim Thein, Analyst at Smith Barney Citigroup]

All right, very good. Thank you.

[Operator]

Your next question will come from the line of Courtney Yakavonis from Morgan Stanley. Please proceed with your question. Hi, good afternoon, guys. 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 in making 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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Sure. Let me take a swing at that for you and then Harrie maybe have 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 doing 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 five 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 the 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.

[Courtney Yakavonis, Analyst at Morgan Stanley]

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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes, Courtney, of course 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.

[Courtney Yakavonis, Analyst at Morgan Stanley]

Okay, that's helpful, thanks.

[Operator]

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

[Matt Elkott, Analyst at Cowen]

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 two technologies as a growth area: electric, autonomous trucks and if there are any manufacturing processes, advantages to trying to merge the two technologies or limitations?

[R. Preston Feight, Chief Executive Officer at PACCAR]

I wouldn't think of them quite as linked like that. I think that initially, Tom 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 lenses up 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.

[Matt Elkott, Analyst at Cowen]

Got it. And then my second question is on the cycle. I know the base case scenario here our assumption is that supply chain disruptions will reduce slowly and gradually, but if they -- but if it is 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?

[R. Preston Feight, Chief Executive Officer at PACCAR]

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

[Matt Elkott, Analyst at Cowen]

Got it. Thank you very much.

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet.

[Operator]

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

[Jeff Kauffman, Analyst at Vertical Research]

Thank you very much and congratulations in 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 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 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 its 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 platform and testing vehicles?

[R. Preston Feight, Chief Executive Officer at PACCAR]

You bet. Let me try to take both those questions for you. As far as a 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 the vehicle as well as the hardware systems onboard the trucks. So that those integrate well with the autonomous driver, 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.

I would also kind of continue to say that the lessons learned are that the drivers are going to be around for a long time, that this is not something that will step in three years and displace drivers, is that this is a gradual introduction, there will be certain routes that 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 operation because you need a good dealer network, you need to be able to understand what's happening onboard 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 are operating well and then repair the truck when something happens. So, it really is a -- autonomy is a great opportunity for PACCAR to grow in the world.

[Jeff Kauffman, Analyst at Vertical Research]

Okay. That's fantastic. Again, congratulations on the quarter. And thank you for your answer. All right, thank you very much.

[Operator]

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

[Felix Boeschen, Analyst at Raymond James]

Hey, good morning everybody. 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 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 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 as a new distribution center? And any sort of quantification of those would be helpful.

[R. Preston Feight, Chief Executive Officer at PACCAR]

Yes. You made great comments, but 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. 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.

[Felix Boeschen, Analyst at Raymond James]

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 cost with that? Just a potential I think to the puts and takes as we head into 2022.

[Harrie C.A.M. Schippers, President and Chief Financial Officer at PACCAR]

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 -- same day or tomorrow, but it's very easy to get pricing there in line or better than the cost increases.

[Felix Boeschen, Analyst at Raymond James]

Got it. I appreciate Harrie.

[Operator]

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

[Ken Hastings, Director of Investor Relations at PACCAR]

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

[Operator]

[Operator Closing Remarks]