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. I would now like to introduce Mr. Ken Hastings, PACCAR's Director of Investor Relations. Mr. Hastings, please go ahead.

Good morning. We would like to welcome those listening by phone and those on the webcast. My name is Ken Hastings, PACCAR's Director of Investor Relations. And joining me this morning are Preston Feight, Chief Executive Officer; Harrie Schippers, President and Chief Financial Officer; and Michael Barkley, Senior Vice President and Controller. As with prior conference calls, we ask that any members of the media on the line participate in a listen-only mode. Certain information presented today will be forward-looking and involve risks and uncertainties, including general economic and competitive conditions that may affect expected results. For additional information, please see our SEC filings and the Investor Relations page of paccar.com. I would now like to introduce Preston Feight.

Good morning. Thank you all for joining the call. Harrie Schippers, Michael Barkley and I will update you on our good third quarter results and business highlights. I appreciate our outstanding employees around the world, who are managing through the supply-based constraints to deliver the highest quality trucks, parts and financial services solutions to our customers. And I'd also like to thank PACCAR's dealers and suppliers for their contributions and support during these dynamic times. PACCAR's good quarterly revenues and net income in the third quarter reflects sales and profit records at PACCAR Parts and PACCAR Financial Services. The economies and freight markets continue to be robust in all of PACCAR's geographic markets. PACCAR is having a tremendous year of new product introductions and demand for the new Kenworth, Peterbilt and DAF trucks is excellent. PACCAR's third quarter sales and Financial Services revenues were $5.2 billion, and third quarter net income was $378 million. PACCAR Parts achieved record quarterly revenues of $1.26 billion and record pretax profits of $281 million. PACCAR Financial achieved record pretax income of $120 million. The record-setting Parts and Financial Services results illustrate the strength of PACCAR's businesses. With the strong order backlog, growth in the truck divisions will accelerate as the supply of semiconductors improves. We estimate Class 8 industry retail sales in the U.S. and Canada to be in a range of 230,000 to 250,000 trucks this year. Peterbilt and Kenworth have achieved 29.6% market share through September. Although build is still expected to be limited by semiconductor supply in the fourth quarter, the good news is that we're starting to see improvements in the supply chain. We forecast the 2022 U.S. and Canadian Class 8 truck market to be in the range of 250,000 to 290,000 vehicles. In Europe, this year's truck industry registrations in the above 16-tonne market are estimated to be in a range of 260,000 to 280,000 vehicles. DAF's year-to-date market share is 15.8%. The 2022 market is expected to be in the range of 260,000 to 300,000 trucks. The South American above 16-tonne market is projected to be in the range of 120,000 to 130,000 trucks this year. DAF Brazil's above 16-tonne market share through September was 5.6%. The new Kenworth T680 and Peterbilt 579 trucks that began production in the third quarter are being well received by our customers. These trucks feature new styling, configurable digital instrumentation, advanced aerodynamics, distinctive LED forward lighting and they provide up to 7% greater fuel efficiency. The new Kenworth and Peterbilt medium-duty trucks that also began production in the third quarter, provide features that customers appreciate such as a wider cab with 3-person seating, lower cab heights for easier entry and new digital instrumentation. The exciting new DAF XF, XG and XG+ lineup feature luxurious interiors and beautiful exteriors that provide 10% greater fuel efficiency. The new DAF offers unsurpassed performance and value. DAF is the first truck manufacturer in the industry to have taken full advantage of Europe's new regulations governing truck design. And the new DAF trucks began production earlier this month. All of these new trucks position PACCAR very well for the future. PACCAR leads the industry with 7 battery electric vehicle models now available. Kenworth, Peterbilt and DAF have orders for several hundred zero-emissions vehicles and have 90 trucks operating with customers. These include Kenworth T680 fuel cell trucks, Peterbilt battery electric model 579s and DAF medium-duty battery electric trucks. PACCAR has advanced its autonomous truck program by working with its partners, Aurora and FedEx, to launch a commercial pilot of autonomous vehicles into linehaul operations. The PACCAR trucks are operating autonomously with a backup driver for safety as they haul freight on a 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 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 in Trucking Association. We were honored for our excellent working environment and company culture that supports gender diversity. PACCAR is committed to hiring and promoting the most talented people in the world, and we know that the best people represent the diversity present in the global community. PACCAR continues to be an environmental leader. PACCAR is working with the science-based targets initiative and is committed to 2030 carbon reduction goals. PACCAR earned a CDP Climate Change score of A minus, placing PACCAR in the top 15% of over 9,500 companies that publish reports to the CDP. 100% of PACCAR's manufacturing locations globally have environmental management programs certified under ISO 14001. Harrie Schippers will now provide an update on PACCAR Parts, PACCAR Financial Services and other business highlights. Thank you. Harrie, over to you.

Thanks, Preston. Kenworth, Peterbilt and DAF delivered 32,800 trucks in the third quarter, with truck, Parts and other gross margins of 11.8%. Third quarter volumes and margins reflect manufacturing inefficiencies associated with limited microchip supplies. Depending on the supply of materials, fourth quarter PACCAR global truck deliveries should increase into the low 40,000s, with gross margins improving to approximately 12.5%. Customer demand is strong and DAF, Kenworth and Peterbilt are well-positioned for sales growth and margin expansion as the new truck models are now in production, and when semiconductor vendor supply issues are resolved. PACCAR Parts had another outstanding quarter, achieving record revenues of $1.26 billion, up 24% compared to the third quarter of last year. Parts pretax profits were a record $281 million, up 34% from last year. PACCAR Parts benefited from strong freight demand and truck utilization, world-class supply chain management and logistics, and increased distribution capacity. In the first 9 months of this year, overall part sales increased 28%, with e-commerce parts sales increasing 37%. PACCAR continues to invest in its Parts business and is building a new distribution center in Louisville, Kentucky, that will open next year. We currently expect fourth quarter part sales to be similar to the strong third quarter. PACCAR Financial Services earned record pretax income of $120 million, reflecting strong portfolio performance 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 deliver a 10% to 20% premium over competitive brands. PACCAR has invested $7.3 billion in new vehicle programs, enhanced facilities and new technologies during the past decade. This includes the investment of $1 billion for the new DAF truck range and its expanded factories. Capital expenditures for 2021 are projected to be $525 million to $550 million. Next year, we plan to invest $425 million to $475 million in capital projects as we've just completed the launch of our exciting new truck platforms. Research and development expenses are estimated to be $320 million to $330 million this year, increasing 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.

Your first question will come from Stephen Volkmann with Jefferies.

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

That's partially correct is what I'd say, Stephen. The way I'd look at it is, through the course of the third quarter, supplier constraints remained, that caused us to have 7,000 fewer deliveries from us. That was a combination of build rate adjustments as well as trucks that are almost complete, as you referenced them. So that's what put us in that position. So right now, with the 32,800 trucks in the third quarter, there's about 10,000 trucks offline. And that's how you match that up.

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

I think about it this way: what we think is with the trucks that are offline, those are just missing a component or 2 or 3. And so as those trucks deliver, that's going to be good for us in terms of getting the truck to the customer. That's the most important thing, and that’s where our focus really was in the third quarter is to get as many trucks prepared as we could. So we'll see that improve market share positions, et cetera, around the world. We also think that as we get additional supply of semiconductors, then that will allow us to go up in build rate. And we think those things will happen concurrently with one another, so…

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

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

Understood. Okay. And then the final question, I'll pass it on. Given your recent product launches, including heavy-duty, medium-duty, and DAF, does that suggest that you experienced higher-than-usual start-up costs related to these launches in the quarter?

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

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

Maybe just a few. As we think about gross margins going into 2022 on the back of kind of Steve's question, I totally appreciate that you've built the trucks that are offline. You got the absorption already, so you don't get the margin when you record the sales. But as you roll into 2022, and you look at the potential for gross margins, could you talk about some of the pluses and minuses that we should contemplate when we're looking at our model pricing in the backlog, inefficiencies you incurred this quarter because of startup and our components? If you could quantify any of those, that will be helpful so that we can think more carefully about our gross margin assumptions for 2022?

Absolutely. So as we think about the fourth quarter, what I mentioned in the commentary is that we've started to see some good news, working with the supply base. Our teams here in purchasing materials operations have done a fantastic job working suppliers, suppliers working with us. We’ve now started to come up with either reengineered solutions or alternative chips or brokered chips that allows us to start to recover some of the trucks in the fourth quarter. And we think that, that will continue, it's likely to continue. And then as we get into 2022, as we have steady production, which is what we'd anticipate, albeit at probably some still constrained level, that will allow our margins to improve kind of to more normal high margins.

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

Sure, Ann. First of all, we had price realization of 4% in the third quarter. And so that has matched up with the materials. We think into 2022, we should have continued price realization for these great new products. I mean, if you just think about the kind of product performance they're delivering for our customers, and we're seeing that. So that's good news for us. And then as you mentioned, our inventory is about 1.4 months compared to the industry of 1.9 or 2 months, which allows us to also think that we'll build more. And really 2022 as we look at it, will be probably constrained only by the supply of components, certainly true for the first half.

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

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

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

Regarding supply chain improvements, are you observing any signs of progress? It seems there is a slight enhancement in the fourth quarter, as deliveries are rising significantly due to many trucks waiting for a few parts. Can you provide any insights into the first or second quarter that might give us a clearer picture of the anticipated improvements in the supply chain? I'm not suggesting anything drastic, but any additional details you have on the situation would be appreciated.

Yes. I think as we look at it, it's really been just recently that we've seen a stabilization in the supply base, the semiconductors from the work the teams are doing. And so that's the good news that we see. And in this work with our second, third, fourth tier suppliers, we have a good supply base, and they're all communicating really well with us right now, that we would expect that there'll be gradual rather than a hockey stick as you mentioned. How far that goes and where that bounds out at, we don't know that. We'll have to see how that looks in the course of the year, which actually could play into a good market for next year and in a good market in the year after that. So that's the positives there. And then just to add on to what Harrie was talking about in price realization. One of the things that we do see with the new DAF trucks, we have over 10,000 orders for the new DAFs in Europe. And as we mentioned briefly, it's the only truck in Europe that meets the new regulations for truck design, the only truck, and customers are amazingly excited about it, and it's going to make a big difference for us. So that's a positive.

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

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

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

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

I think that's probably true. That's really 1 of the things we focused on in the course of the quarter or 2 as there's a tremendous amount of customer demand for the Kenworth, Peterbilt and DAF trucks out there. And so our focus has been around getting as many prepared for delivery as we can, building and just shy of component to satisfy that market demand for these great trucks.

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

It seems like you would be delivering some of your backlog that you have today, you've taken orders on 2021 models, delivering them into 2022. So I'm just curious when will your delivery switch over from '21 model years to '22 model years? And what impact will that have on pricing and margins?

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

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

Okay. That's helpful. And then just a bigger picture technology question. You've talked about the ramp on the EV market over the next few years. What's your expectation on industry and PACCAR ramp on autonomous vehicles by 2025 and with this relationship with Aurora?

Well, we're in this test right now with FedEx and Aurora calling freight. It's the first time we've been participating in an actual freight-hauling exercise. We've got lots of trucks running around, different autonomous start-ups and that's going well. But it's pretty early days. And I think that making a prediction for how quick that market is going to develop is going to depend on how robust the technology becomes, and that's what we're learning about right now. So I think we should be just patient to see how quickly it develops and when it's really ready to scale.

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

I just wondered, I'm following up on the end of Steven's question. What kind of barriers do you think are out there for more like the insurance side or is it from the DOT or is it just having enough models out there, like just some of the things you guys have led?

Joel, we had a really hard time hearing you there. I didn't come through very clear. Could you try the question again? Yes. Sorry, we just moved to a new office. Anyway, what you're seeing are the roadblocks to expanding technology adoption by 2025. Is it from the DOT or based on miles? I think I got the gist of your question is the roadblocks for implementation 2025 on autonomy. And I would say that the technology is incredibly involved. And so, if you think about the edge cases that exist, that's what's being sorted out right now. Most of the operation can be done running down the highway. But now it's about the edge cases of those unique boundary conditions. So we're working through those. The other part of it is we're developing a proprietary PACCAR autonomous vehicle platform, which has all the redundancies involved in it, which 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, because it will let us have this really robust platform to build upon. And then we think probably the things that cause it to be constrained for ‘25 or again technology. There'll be a societal element to it as well and then company adoption. So I think it will start with certain lanes and evolve from there.

All right. I'm going to try 1 more question. Just to ask a little bit more, instead of about the quarter, I want to ask like on a 3- to 5-year basis, the structure of the margins. Do you think like all these different autonomous and electric vehicles and everything else you're working on and plus new products is enough to really drive your margins to new record levels? Or do you think that there might be some need to use some of your balance sheet to buy something or to expand into something that could really drive those margins to a new higher level?

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

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

I have a couple of questions about the improvements you've mentioned in the supply chain. I'm curious if semiconductors are the main issue or if there are other factors at play. Are you finding new sources or adjusting your approach like Tesla did? How certain are you about the timeline for resolving these issues? Also, when do you anticipate that the semiconductor situation will improve? Do you have any insights from your discussions with suppliers?

Well, I think it's a matter of degree. I think our teams are doing, mentioned before, it's worth mentioning are doing a fantastic job of hustling as you put it. They are reengineering different chips. They're taking places where maybe 2 chips were required and reengineering them into just require only 1 chip. We're working with semiconductor manufacturers themselves in our second, third, fourth tier to come up with good solutions that are robust and high; the team has done a fantastic job on that. And I think that's why we're starting to see this improvement because hats off to all their efforts. And I would say that we see, again, a gradual improvement over time as far as the final conclusion. I think it's going to take some time. So gains next year are positive for us. And then again, that might make it for a very strong 2022, and lead to a strong 2023.

Okay. Regarding a broader perspective, I would like to know your early experiences with customers using electric and hydrogen. When do you anticipate those orders will transition from what I assume are testing orders to volume orders? Additionally, concerning the development of your autonomous truck platform, which focuses on redundancy for sensors and other components, this will likely result in an increased cost for you. I would appreciate your thoughts on quantifying this. It appears that your projected revenue growth looks more promising now as you integrate more advanced technology.

All right. Let's try and take the first one, which is on order size of EVs. We have some orders that are not in the ones anymore. We're starting to see that shift into tens and even hundreds for some of our orders where customers are saying, 'I've tried it. I've been around you guys for a little while now. I believe in what you're doing. And I think I can put 10 in operation or more.' So that's kind of the transitional phase that we're in right now, realize it's still limited by the infrastructure requirements that are around out there, some numbers of chargers and putting that together. So it's really still a return to base kind of model adoption, and it probably will be for a few years. So that's a positive thing. We're selling our chargers. PACCAR Parts is doing a good job of that. Our teams are doing a good job working together with customers to make sure they have the balance of truck and infrastructure. So it will just continue to progress over the coming years. From an autonomous standpoint, yes, you're right, that autonomous vehicle platform that you mentioned will have additional componentry on it. It's a very tech solution. And PACCAR will lead in that area. So that will be helpful to margin. We also expect that services will grow on autonomous vehicles because now our dealers and their involvement will be significant as well, and it should be good for the total business.

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

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

Yes. I would say that when I look at share, it's a really interesting time with build really industry build being constrained by the number of components that are out there. And what I would say is that we feel like we're in a good position right now with the share we have in Europe and North America, Brazil, Australia, and I would expect that we'll see growth in 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 the finance company business as we look forward.

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

Great point, Harrie.

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

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

Okay. I'm looking at the gross margins you achieved compared to what you would expect with your typical 20% incrementals, and I see a gap of about 140 basis points. I'm trying to understand that discrepancy.

Incremental margins have usually ranged from 15% to 20%, and that remains consistent across the company. We anticipate that margins will improve in the fourth quarter to 12.5%. As we address the semiconductor challenges and implement new work models, we expect a significant improvement in margins as we move into next year.

Yes, I would like to add to what Harrie mentioned. There are likely more factors influencing the margin than usual, making it more complex. We discussed the new product introductions, supply issues, and how these dynamics are impacting things, along with pricing considerations. However, the new trucks look very promising. As we achieve stability, we believe the gains will be substantial, and the incremental improvements will be significant.

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

I'm wondering if you could just talk about the zero emissions vehicles. So last quarter, I think you had mentioned to date orders of 450. Can you just give us an update on where that stands now? And if you could just give us a flavor for what the regional mix looks like, what the mix versus medium and heavy duty looks like, if you don't mind?

Sure. The orders continue to grow, and I would suggest that as I mentioned a little bit earlier, they're coming in now, I'd say, initially, it came in, in the 1s. Now they're coming in more like in the 10s and even in the hundreds, we've had some orders for. From a standpoint of where they are geographically, it's mixed. I mean, Europe is seeing order intake for the trucks and build for the trucks and delivery to the customer, same in North America. It's medium-duty and heavy-duty split; the key probably point to all of it is that it's return to base applications. So whether heavy-duty or medium-duty, the adoption is going to be urban areas where people are coming back and can plug into a charger at night, we see the initial start to that. And I think as we've articulated before, expect that orders and build will be in the hundreds in the coming year or 2, and then transition to the thousands pretty quickly in the next 3 years, let's say.

Can you discuss what proportion of your production you expect to come from the new models in the fourth quarter? Additionally, what does the mix ramp-up look like as we approach 2022? If possible, could you provide details on the labor hours reductions for the new models?

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

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

And then to the second part of your question, where you're thinking about the benefits of the truck, the trucks are amazing as far as how they build. We got to get you guys over to the factories in Belgium and the Netherlands because it's just a beautiful factory and the trucks are performing in terms of their fuel economy and their driver comforts and conveniences and how they work and safety features and their Level 2 autonomous capability. So all of that together is a great benefit to the customers, and that's why it will be impactful to our margins.

Invitation accepted. Can you discuss the benefits you've observed from the autonomous trials, not only with FedEx but across the board, particularly regarding fuel economy improvements and accident avoidance, aside from the long-term potential of reducing labor costs? Additionally, could you quantify the other benefits you've encountered during the trials?

Yes, I believe the key aspect of this opportunity is that as these trucks develop further, they will become very safe and contribute significant efficiency to freight, which will have a major impact on both the country and the world. We are eager to be leaders in this effort and are currently in a strong position. We will continue to make progress in this area. While it may be challenging to quantify these benefits, it's easy to see how they could lead to a safer, more efficient operation and improve the overall environment for operations.

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

I was just wondering if you could comment on the capital spending outlook for next year. I mean, it's down by almost $100 million. And I'm just a little surprised by that given the trend of the outlook and all the production constraints and so forth. And just what are your latest thoughts on incremental integration it might pursue given the supply chain situation?

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

And then can you talk a little bit more about Europe? I mean, I'm surprised your demand outlook for next year is barely up. And it just seems like a lot of backlog just globally is getting pushed out further and further. So why is the demand outlook not up that much next year? Are you seeing any areas of softness? Or are you just taking a conservative approach out of the gate?

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

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

Absolutely, I agree with you, Harrie. You're coming off a challenging year with significant constraints, and I understand that there is still a lot of catching up to do. Perhaps this is more relevant to production than to retail sales, which is why I was inquiring. Lastly, could you discuss the topic of unions? What percentage of your global production workforce is unionized today? Are there any upcoming union contract negotiations? This topic has become quite relevant in the industry lately, and it's been a while since I last asked about it.

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

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

Yes. It's a great place to work as we navigate this dynamic environment and engage with people on the ground. We have some fantastic individuals here, and I feel incredibly proud and humbled to be working alongside them.

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

I guess 2 questions. One, obviously, the Parts performance this quarter was very strong. I guess it will be throughout the whole year. Do you think there's an opportunity for you guys to outgrow the market on the Parts side? And then I'm just wondering on the margin front, what you're seeing on pricing for Parts? And is there an opportunity for gross margins in Parts to move structurally higher with share, with scale and as some of these investments sort of wear off? And then just my follow-up question is just can you just remind me what you said about production in the fourth North America versus Europe?

So regarding the Parts business, I believe our teams are excelling in applying technology. As part of our digital transformation, the Parts team is truly at the forefront, gathering data from trucks, customers, and dealers, and converting that into value-added services. This enhances our performance and I anticipate it will drive growth for the business overall. Additionally, I see potential for margin improvements in the future as we progress. Kudos to everyone involved in that area. As for the division between Europe and North America, we expect growth in both markets. It's important to note that in the fourth quarter, there will be more build days in Europe compared to the third quarter due to holiday schedules and shutdowns, so we can likely expect larger increases in Europe.

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

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

You bet. We did take the market up a little bit there. What we've seen in South America is our dealers are doing a fantastic job down there. We have the new DAF that we introduced last year. Customers are in love with that truck. It's performing at the top of them, so our premium reputation is established in South America and Brazil. We've grown in the Andean region as well. And so South America is a strong point for PACCAR, and we've had the strategy to grow there and it's been successful.

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

In a strong market, which I consider this to be, we are likely to have a significant order backlog spanning a few months. We have that and more. We are currently collaborating with customers as we approach the 2022 market. However, we will be limited by the availability of parts. We expect to see improvement and are working to ensure that customers receive the trucks they need.

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

The first question was about the Parts business and its growth potential in 2022. Earlier, you mentioned the possibility of truck sales outpacing retail due to dealer stocking. Do you think there is a similar opportunity for growth in the Parts area? We're hearing from dealers that certain parts are becoming scarce. Is there a chance for a restock in 2022?

I think the way I think about that is that there's tons of freight volume out there, and people are running their trucks fully right now. And so because there's a constraint on new trucks industry-wide, it's meaning that the repairs are going up on the trucks are existing. And so that's also being a great opportunity for the Parts market, and that seems likely to continue into next year.

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

Yes, but I wouldn’t look that...

Yes. And then regarding Financial Services, this quarter was significant in terms of margin percentage. Is there anything we should consider that may not be evident from the release, such as gains on used sales or changes in operating lease assumptions, or anything that is more of a one-time nature? As we think about maintaining similar profitability in the fourth quarter, if we have a strong truck market with good residual values, can we project that into 2022? Or is there something that might affect the latter half of this year that may not carry over into next year?

Yes. Tim, the finance company has had a stellar quarter. The portfolio is of excellent quality. Customers continue to pay on time. Past dues were less than 0.5%. And on top of that, we see strong demand for used trucks. All the investments we've made in the used truck centers over the years, we get the dividends out of that now. And you see that back in that strong profitability, $120 million, a record for the finance company. And we expect that performance to continue, let's say, into next year it’s difficult to say what's going to happen in the second half of next year. But for the foreseeable future, the finance company in the future is bright.

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

If we could just talk a little bit about R&D. I know you mentioned the step-up that's going to support clean diesel and some of the autonomous programs as well as the connected truck platform. Historically, you've talked about obviously investing mostly in the diesel. You've done your new truck launches. Just curious if the buckets for R&D have changed over time. And also, as we think about the investments that you're making in autonomous versus clean diesel, anything that you can just help guide us as to where the increase is primarily coming from and how it compares to the breakdown in prior year?

Sure. Let me take a swing at that for you, and then Harrie, maybe has something to add. I would say that there is a shift going on. We have a lot of great diesel programs coming along. When you think about 2024 emissions, 2027 emissions, our team did a great job of meeting that with clean diesel. So that's continuing as that will likely be the dominant powertrain offering for the next 5 to 10 years, at least. And then I would suggest that beyond that, we have put more money into the electric vehicle programs as we develop our own capabilities there and develop our own software solutions and control algorithms and same with autonomous, with the autonomous vehicle platform and then the investments we're making in connected services and this digital transformation so that we're providing value to customers in those areas. All of those are the shifts that are ongoing right now. As Harrie said, we've just completed the best launch of new trucks we've had in our history. And so that foundation is built, and we're moving to other areas.

Great. That's helpful. Can you provide more details on the fourth quarter margin comments? I understand you've mentioned absorption, but in terms of the additional availability through reengineered chips and some of the brokered chips, can you share any insights on how much more expensive those are compared to sourcing them through regular channels, particularly regarding the margin impact for the fourth quarter versus the situation in 2022 when things are expected to normalize a bit more?

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

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

So you guys are doing a good job on the autonomy front and a good deal 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 process advantages to try and merge the two technologies or limitations?

I wouldn't think of them quite as linked like that. I think that initially, autonomy is going to have a great role to play when it becomes commercialized in the long haul are principally to begin with. And that isn't something that lends up well to battery electric vehicles. It might with hydrogen fuel cell, which is 1 of the other technologies we're leading in. So I think that we look at them as developing in parallel, and they will merge at some point, but I don't think that they happen to be linked like that.

And then my second question is on the cycle. I know the base case scenario here, our assumption is that supply chain disruptions will slowly and gradually. But if they ease more quickly and somewhat abruptly, are you guys able to ramp up production on a sequential basis next year? Maybe what a step function material increase if the chip shortages are out of the way?

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

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

I almost feel bad coming back to autonomous, but I think it's just such an interesting opportunity. So I'd love to ask you 2 questions on this. Number one, is there going to be any ability for you to utilize the platform across markets, so let's say, Europe, where is the thermometer on autonomy out there and what's going on? And then the second question, you kind of answered a little bit, but you're building a platform for it. So it's not something you're dabbling in. I mean, this is something you believe in and you're going to commit to. What have you learned so far whether it's the way the trucks were whether what things maybe are you learning that you didn't expect in terms of fuel economy? I know it's early stage in its early innings, but I'm just kind of curious because you're 1 of the few companies that's really being proactive in terms of building a platform and testing vehicles.

Certainly. I'll address both of your questions. Regarding the platform we're developing for autonomous vehicles, it indeed applies across various markets and brands. We are investing in knowledge centers and software capabilities for vehicle development, as well as the onboard hardware systems in the trucks. This allows for seamless integration with the autonomous driver from companies like Aurora, ensuring compatibility with our platform, and our platform can also work with other autonomous drivers. This is why we are making significant investments. It's important to note that we have learned that drivers will remain necessary for quite some time; we won’t replace them in three years. The introduction of autonomous vehicles will be gradual and dependent on specific routes and weather conditions, which will take time to navigate. Another key insight is that the support needed for autonomous vehicles is substantial. Having a strong global presence, like PACCAR’s, is crucial for successful autonomous vehicle operations. This includes having a robust dealer network, the ability to monitor vehicle performance through connected services, and the capability to assist customers in maintaining their trucks when issues arise. Overall, autonomy presents a substantial opportunity for PACCAR in the industry.

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

I just wanted to follow up on the comments on the Parts business. Clearly, the backdrop just from an industry-wide truck utilization standpoint is obviously very favorable today and probably for the foreseeable future. But I'm just curious if you could talk through some of the company-specific drivers in that business and really the sustainability of those cycles even if, say, the truck market were to loosen. I'm trying to think through MX engine parts, the e-commerce business, TRP and the new distribution center? And any sort of quantification on those would be helpful.

Yes. You made great comments. To answer your question, those are all exactly right. I mean the TRP growth is strong. We are seeing continued strong growth, 37% in the e-commerce business. So that's fantastic. The engine business parts are growing as well. And then I really think we need to make sure we emphasize the fact that through the digital transformation that the Parts team has embarked on in knowing how to connect with the customer, with the dealer and then meet those needs. Our Parts team is doing a fantastic job of doing that, and that's what kind of grows the business in the longer term. So really positive things to look forward to.

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

For Parts, whenever there are cost increases, we also implement price increases simultaneously. We currently have no backlog for Parts. Orders that come in today will be shipped either the same day or the next day. This makes it straightforward to align pricing with or even exceed the cost increases.

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

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

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