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Edited Transcript of LNR.TO earnings conference call or presentation 6-Nov-19 10:00pm GMT

Q3 2019 Linamar Corp Earnings Call

GUELPH Nov 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Linamar Corp earnings conference call or presentation Wednesday, November 6, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dale Schneider

Linamar Corporation - CFO

* Jim Jarrell

Linamar Corporation - President & COO

* Linda S. Hasenfratz

Linamar Corporation - CEO & Non-Independent Director

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Conference Call Participants

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* Brian Morrison

TD Securities Equity Research - Research Analyst

* Kevin Chiang

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst

* Mark Neville

Scotiabank Global Banking and Markets, Research Division - Analyst

* Peter Sklar

BMO Capital Markets Equity Research - Analyst

* Raj Singla;Arrow Securities

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Presentation

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Operator [1]

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Good afternoon. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Linamar Third Quarter 2019 Earnings Conference Call. (Operator Instructions)

I would now like to turn the call over to Ms. Linda Hasenfratz. Please go ahead, ma'am.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [2]

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Thank you. Good afternoon, everyone, and welcome to our third quarter conference call. Joining me this afternoon are members of my executive team: Jim Jarrell, Dale Schneider, and Roger Fulton; and some members of our corporate marketing, finance and legal teams. Before I begin, I will draw your attention to the disclaimer currently being broadcast.

I will start off with sales, earnings and content. Sales for the quarter were $1.74 billion, down from last year, but again, meaningfully outperforming markets. Global vehicle markets were down 3.2%, and a key customer was on strike for 10 days, but despite such, our Transportation segment actually increased 0.5% in sales and boom sales again outperformed the strongly declining market in both North America and Europe by a significant factor. Top declines in the European and North American scissor market, well in the double digits, and declines as well in the North American combine market also put pressure on our top line, making a decline of 5.3%, actually quite good performance.

It is important to note that the combine market declines, in particular, are highly correlated to the trade and tariff war with China and in the event of such giving results, we would expect to see that market bounce back quite quickly based on the pent-up demand that we see out there.

Operating earnings were $139.2 million, normalized for balance sheet exchange impacts and any unusual items, down 18.9% over last year. A key fact to driving our performance in the quarter was our strong launches in the Transportation segment gaining traction and working through transition challenges.

A few factors were a challenge this quarter and hurt our results: First, lower sales at MacDon due to tariffs and trade issues, poor crop conditions, and staying of commodity prices and an unusually strong Q3 in 2018 as well as the timing of 2020 model year release, which has shifted from product sales into Q4; secondly, we saw Skyjack sales decline; third, we saw global market declines in the light vehicle segment, and of course, the first 10 days of the GM strike; and finally, we saw continued impact of launches, which although improved, are still suppressing margins as we were not yet at full volume on those programs. Normalized net earnings as a percent of sales in Q3 were 5.5%, down from last year due to those factors.

On the positive side, our overall normalized EBITDA performance remained strong at 14% of sales, strong performance in comparison to most of our peers. In North America, content per vehicle reached $165.88, down a little from last year in a flat market, marked by the GM strike, but up a little from what was reported last quarter. Q3 automotive sales in North America, as a result, were down slightly over Q3 last year at $691.9 million.

In Europe, content per vehicle for the quarter was $83.49, up a little over last year and up over last quarter as well, thanks to launching business in the region in a market that was up 0.9%. Q3 automotive sales in Europe, as a result, were up 1.1% over last year at $389.8 million.

In Asia Pacific, content per vehicle for the quarter was $10.06, up 6.9% from last year and up from last quarter on launching business. The market in Asia Pacific was down 4.5%, but content growth drove our Q3 automotive sales in Asia up 2.1% versus last year to reach $112.4 million. Asia will be a significant growth area for us over the next several years, with 50% growth over current sales levels booked already by 2023. Much of the growth is coming from electrified vehicle program launches as might be expected, given the strong focus for new energy vehicles in China. Already, 12% of booked business is for electrified vehicles in our China business and in some plants, reaches nearly 1/3 of their total book. Similarly, EV programs represented nearly 1/3 of our high potential business wins in the region.

It's great to see continued content-per-vehicle growth in the quarter in most regions, reflecting our increasing market share, thanks to large amounts of launching business. Market share growth is key to accelerating growth when volumes start to pick up.

Other automotive sales not captured in these content calculations were $97.3 million, up over last year due mainly to increased tooling sales. Commercial and Industrial sales were down 21.9% in the quarter at $448.6 million versus $574.1 million last year due to lower MacDon sales driven by, as noted, trade and tariff concerns and timing on new products launching this year and that very strong Q3 last year as well as lower sensor and foods sales at Skyjack, owing to market declines, partially offset by dual market share growth in North America and Europe. As mentioned, the timing of 2020 model year release has shifted some sales to Q4 from Q3 at MacDon this year, so expect a bit of an uptick on sales in Q4 from Q3, just for MacDon, which is not seasonably normal.

Investing in our future continues to be a priority for us at Linamar, but given economic uncertainties, we are using a very disciplined approach around capital expenditures. CapEx in the quarter was $158.5 million, but $122.4 million or 7% of sales, if I net out the purchases related to the dissolution of our Montupet JV in India. In the quarter, we came to an agreement with our JV partner in India to part ways, and in doing so, each take 1 of the 2 plants in the JV. We took over the Dewas plant, which is the newer of the 2 facilities, which require to top-up to our partner regarding recent capital expenditures. I removed it from both CapEx and our free cash flow calculations as it isn't normal operational CapEx. We still expect 2019 to see lower CapEx than 2018 and to be at the low end of our normal 6% to 8% range. 2020 will be a similar picture of spending at the low end of our normal range.

We had a good quarter in terms of adjusted free cash flow, was $90 million cash generative. Net debt stayed fairly steady to Q2 levels at $1.94 billion and our net debt-to-EBITDA at 1.75x due to cash spent on our buyback program, the takeover of the Dewas plant and dividends. We expect leverage to be under 1.5x by the end of the year, a little higher than our original target due to the -- to these same cash uses as well as continued cash impact of the GM strike in Q4. We expect to be under 1x next year based on continued strong and positive cash flows.

We have repaid $223 million of debt since our peak in Q1 of last year, despite soft markets. Great evidence, I think, of Linamar's excellent cash control. Leverage of under 1.5x EBITDA will be achieved, thanks to the continued excellent free cash flow we're expecting to generate through year-end. We continue to expect to generate between $500 million and $700 million of free cash flow this year, thanks to still strong earnings, lower CapEx and a focused noncash working capital improvement program. Noncash working capital, as a percent of sales, was up in Q3 as we normally see seasonally, we expect to see a significant decline in Q4.

Turning to our market outlook. We are seeing soft markets in most areas this year and next. Industry is predicting declining light vehicle volumes globally again this year to 16.3 million, 21.2 million and 46 million vehicles in North America, Europe and Asia, respectively. 2019 represents the second consecutive year of global vehicle volume declines and the third year of declines in North America. Next year, we'll see flat volumes of plus or minus 1% to 2%, depending on the region, resulting in global growth resuming.

Industry experts are predicting on-highway medium/heavy-truck volumes to be flat to moderately growing this year in North America and Europe at 2.6% and minus 1.4%, respectively, but declining in Asia. Next year, declines are expected in both North America and Asia, with Europe staying flat. Off-highway, medium-duty and heavy-duty volumes are in a bit of a holding pattern, thanks to trade issues and a holdup on the infrastructure spending bill in the U.S.

Turning to the access market, the industry is expecting mid-single-digit declines in core North American and European markets for aerial work platforms this year. Performance is being driven by declines in scissors and booms in both North America and Europe this year, offset by growth in the telehandler market. Industry consolidation, tariff-driven, higher construction costs, and uncertainties and Brexit issues in the key U.K. market are the key drivers of these forecasts. Next year, we will see continued declines in the scissor and boom market in both Europe and North America and some minor softness in telehandlers, resulting in high single-digit declines in the market overall for 2020. Skyjack's backlog is softer than last year as a result. Expect mid- to high single-digit declines for Skyjack this year and next.

Turning to the agricultural market. The industry expectation is for a decline in combined header market in the double digits this year in North America, thanks again to tariffs and political backlash hurting North American farmers, and therefore, dampening demand, particularly in soybean and canola and particularly in Canada. Europe, South America and Australia are also expected to decline in double digits this year. MacDon continues to build market share to offset market declines, but nevertheless, we will see sales down in low single digits for 2019 despite the extra month of sales and a similar performance for 2020, unless we see a speedy resolution to the political situation.

Lower light vehicle performance in the first half of the year has shifted to a flattening to prior year performance in Q3 in most market globally, but flat-to-down performance expected globally in Q4, most notably in North America, due mainly to the GM strike. Current forecasts show a global trough of production in 2019 and growth resuming in 2020 in most regions at this point. North American production is also now expected to be at its trough in 2019 and starting to grow in 2020.

In North America, down cycles have typically lasted 4 years on average, with declines of between 1% and 5% each year of that decline period. If IHS is correct, this will be a 3-year down cycle in North America, ending this year, with the trough 9% down from the last peak in 2016 and growth resuming in 2020. I think a key difference to prior cycle downs is that we did not get in with high interest rates and high unemployment, which is a positive and likely will mean a shallower trough than seen in the past as predicted. We continue to keep a close eye on these forecasts and we'll provide another mid-quarter update to you on our website in the coming months for the latest information.

Turning to an update on growth and outlet. We're seeing strong levels of new business wins and a strong book of business being quoted in our Transportation business. Q3 was another great quarter for us in terms of new business wins for our Transportation business, with quite a few notable strategic wins, driven by outsourcing of new electrified platforms and continued acceleration of powertrain outsourcing, which is very exciting. In fact, sales to electrified vehicles have grown between 2019 and 2023, a fantastic 10x for a compound annual growth rate of over 70%. Sales to these future-focused vehicles will be nearly $1.2 billion by that time, and in terms of content per vehicle, will already in 2023, be at the level we were at in internal combustion engine vehicles only a few years ago.

Our addressable market across a range of vehicle propulsion types continues to look excellent. Global vehicle growth is forecast to grow at a compound annual rate of 1% to 2% over the next 25 years. Each type of vehicle propulsion offers excellent and growing potential for us and our suite of products where each continues to develop and to grow. The total addressable market for us today is more than $120 billion, growing to more than $300 billion in the future, an increase of nearly 2.5x. We have 178 programs in launch at Linamar today. Look for ramping volumes on launching transmission, engine and driveline platform to reach 30% to 40% of mature levels this year. These programs will peak at more than $4.4 billion in sales.

We saw a shift of about $85 million of programs that moved from launch to production last quarter, which was more than offset by our new business wins. The programs shifted to production this year so far and have incremental growth compared to last year of about $55 million. That means total launches for this year will be in the $625 million to $675 million range. Next year, we will see growth in these programs of 60% to 70%, which means incremental sales from launches of more than $1 billion for 2020.

In addition, as noted, we are now looking at mid- to high single-digit declines at Skyjack this year and Mac. MacDon, as noted, will see low single-digit declines to sales unless we see a speedy resolution to the political situation. On a positive note, 2019 cornhead orders for North America have increased significantly since MacDon took over branding, sales and distribution of the OROS product. In fact, more than 4x, which is great to see as testament to the fantastic brand name and reputation that MacDon has developed here in North America.

We showed a tepid ag growth at the loss of business that naturally ends each year, noting to expect that at the high end of our normal range of 5% to 10%, both this year and next as well, of course, as normal productivity gets back.

So to summarize expectations for the top line this year, our strong backlog of launching business will offset market softness in both the Industrial and Transportation segments, resulting in flat to low single-digit declines in sales compared to last year. Next year, we'll see growth pick up, thanks to continued strong launches and more stable markets to see single-digit top line growth.

On the margin side, with pressures in both segments, we expect to see margin contraction in both, heading to mid to the low end of the range for both Industrial and Transportation. Next year, we will see margin expansion in the Transportation segment as we get to the other side of the transition to next-generation platforms and global growth of vehicles will resume. But Industrial will stay steady at the mid to low range in terms of margins. The GM strike and deterioration in industrial markets will push margins down a little further to a range of 6.25% to 6.75% for the year.

Flat sales and margin contraction, of course, are going to result in double-digit declines in normalized operating earnings this year, but single-digit declines in normalized EBITDA. Next year, we expect double-digit normalized operating earning and EBITDA growth, thanks to sales growth and margin expansion in the Transportation segment. Looking specifically at Q4, be sure to account for the 20 working days of GM strike in the quarter that will have a significant impact on the Transportation segment that otherwise you might expect to have a similar performance to Q3. Otherwise, we expect seasonal slowdowns at Skyjack, but a possible uptick in MacDon sales from new products, as noted earlier, that would temper the normal Q4 versus Q3 declines somewhat.

I'd like to highlight a couple of our more interesting business wins this quarter. First, we had another solid quarter in battery electric vehicle components in China. This type has several gearbox components. Start of production for most of these components is in 2023. Secondly, we are continuing to build strong partnerships with our Japanese customers, who are increasingly interested in a broader range of component supply from Linamar. This product is a front support for a transmission as cap and machine and is a new product for us with this customer. Start of production is in 2021.

We're starting to see some activity again in the Commercial Vehicle segment after several years of light business opportunities. We picked up several wins, representing an aggregate nearly $50 million in annual sales. We also saw several wins for structural components in the quarter, such as the land pictured here, slightly capped [threshold] parts are key elements of vehicle weight reduction, which is key to improving efficiency, particularly in electric vehicles.

Another exciting area of development over the last 6 months or so has been the evolution of takeover work from suppliers failing, mainly on the financial side. We're seeing stress in supply base, mainly in Europe, where volumes were hit hard a year ago, thanks to WLTP, and have not recovered and a difficult transition as well from diesel to gas vehicles. We have won, to date, more than $200 million in takeover work, all due to start-up in time in the next 12 months. Takeover work is the silver lining of industry downturns and one that Linamar has always been very successful at winning, thanks to our responsive, nimble approach to these opportunities. Business that we've won thus far includes balance shaft assemblies, connecting rods, heads, blocks and parking gears.

Turning to the innovation update, we continued to invest in innovation in each of our key businesses. First, I think, an area of development and design we're most proud of is our e-axle gearbox products. Our designs for these products are so critical -- that are so critical to the future of propulsion, has gone to a consistent level of evolution. We continually refine the designs and started to specialize the designs as well for particular applications. As an example, design evolution has allowed us to really push the limits of power density optimization, which was key in lining a factor of a pending production win for a high-performance vehicle application.

Other advanced features developed include park-lock systems, disconnect systems and multispeed gearboxes. We've also evolved our e-axle innovation to the commercial vehicle market. We've developed a series of products for a couple of high-profile test vehicle applications, from midsize as well as larger commercial vehicles. You could see a picture here. We've also been doing a lot of work in the area of additive manufacturing or 3D printing. Our focus is in 2 key areas: First, optimizing tooling and gauging functionality. As depicted here, printing tooling and gauging can offer unique opportunities in terms of tool function, cooling and strength, all of which improve throughput and quality of production. The second obvious application is in prototyping and rapid part development. To be able to rapidly create printed versions of part designs means we can move more quickly to test and optimize the design based on those results. And that means we can really accelerate the time to market for critical products such as our e-axle development.

Finally, we are nearing completion on our new innovation center, the iHub in Guelph, where we will be housing our new manufacturing partnerships and other longer-term innovation projects. We also continue to make considerable progress on our broad digitization initiative summarized on this slide. We are rapidly transforming our shop floor to be more efficient, more proactive and reactive, safer and more connected and in the progress, create more exciting career opportunities for our employees. And a huge amount of opportunity in these technologies to dramatically improve efficiencies of our operations, both on the shop floor as well as the back office, which we can deploy on a global basis.

In other areas of our operations, our plants continue to perform well, both on mature business metrics and in terms of launch. Our launch systems are excellent and plant control is world-class. In terms of new plants, we're making great progress on our 3 key expansion projects that are underway right now. Our new state-of-the-art facility in Hungary to have the significant e-axle gearbox program is complete. We started moving equipment into the facility to continue launch preparation. The project starts into production late next year. The expansion of our fabrication facility also agreed to accommodate growing [corner] sales and also to have the European requirements with Skyjack is also essentially complete. Expanding production of Skyjack to Europe is an important element in accelerating market share growth in the region.

Finally, the expansion of another facility in China is also complete. This facility will also take on a major e-axle program, which also launches next year. Just last week, we had a chance to visit China and celebrate with employees, customers and local officials. The official launch of both this facility and our new casting plant in the region. Also in the quarter, as mentioned earlier, we made a decision to dissolve our Indian JV partnership, Jaya Hind. Each partnership, 1 facility. We kept the newer facility, which is located in Dewas in Central India. We went from 50% of 2 plants to 100% of 1 plant. The financial implications of the transaction are not material to our P&L.

With that, I'm going to turn it over to our CFO, Dale Schneider, to lead us through a more in-depth financial review. Dale?

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Dale Schneider, Linamar Corporation - CFO [3]

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Thank you, Linda, and good afternoon, everyone. As Linda noted, Q3 was a great quarter for cash generation that led to significant debt repayment as we generated $90 million in free cash flow in the quarter. With global light vehicle market down 3.2%, the North America and Europe -- and European scissor boom markets down sharply, and the North American combine market down significantly as well, Linamar was able to outperform our markets with sales declines of only 5.3%. For the quarter, sales were $1.74 billion, down $97.3 million from $1.84 billion last year.

Normalized operating earnings for the quarter were $139.2 million. This compares to $171.6 million in Q3 last year, a decrease of $32.4 million or 18.9%. Earnings were normalized for FX losses related to the revaluation of the balance sheet and restructuring charges. These items impacted normalized EPS by $0.03 per share. Normalized net earnings decreased $24.9 million or 20.6% in the quarter to $96.2 million. As a result, fully diluted normalized EPS decreased by $0.36 or 19.7% to $1.47. Included in earnings for the quarter was a foreign exchange gain of $5.7 million, which related to a $6.2 million gain on the revaluation of operating balances and a $500,000 loss on the revaluation of our financing balances. The net FX loss impacted the quarter's EPS by $0.07. From a business segment perspective, the Q3 FX gain due to revaluations of operating balances of $6.2 million was a result of a $500,000 loss in Industrial and a $6.7 million gain in Transportation.

Further looking at the segments, Industrial sales decreased by 21.5% or $102 million -- $104.2 million to $380.6 million in the quarter. The sales decrease in the quarter was primarily due to the lower agricultural sales due to the poor crop conditions, the stagnant commodity prices and the ongoing trade dispute between the U.S. and China. It was also further reduced by lower volumes in access equipment in Europe and North America. A certain key customer has adjusted their 2019 capital spend in light of the uncertainty in the market.

Normalized Industrial operatings in the quarter decreased $45.5 million or 53.7% over last year. The primary drivers of the Industrial operating earnings results were the impact of the net lower volumes in both access and ag, as I just discussed.

Turning to the Transportation. Sales increased by $6.9 million over Q3 last year to reach $1.36 billion. The sales increase in the third quarter is primarily driven by the additional sales from launching programs, partially offset by lower volumes as a result of certain programs that are naturally coming to an end. The impact of the GM strike and unfavorable FX impacted the changes in FX rates since last year. Normalized operating earnings for transportation were higher by $13.1 million or 15.1% over last year. In the quarter, transportation earnings were impacted by the additional sales from launching programs, lower management costs and a favorable FX impact on operating expenses due to the changes in rates since last year. These were partially offset by lower volumes from ending programs, the impact of the GM strike and higher amortization on launching programs.

Returning to the overall Linamar results. The gross margin was $230.1 million, a decrease of $44.4 million due primarily due to the reduction in earnings related to the industrial volume and market declines, the additional amortization on launching programs, partially offset by the earnings impact of higher launches net of the GM strike and ending programs. COGS amortization expense for the third quarter was $99.1 million. COGS amortization, as a percent of sales, increased to 5.7%, mainly due to launching programs and the adoption of the new leasing standards in Q1.

SG&A cost decreased in the quarter to $94.3 million from $103 million. The decrease is mainly due to lower management costs and other restructuring costs that were incurred in the quarter. Financial expenses decreased $800,000 since last year, primarily due to the impact of the lower debt levels, the lower interest as a result of the cross-currency interest rate swaps on the euro-denominated debt, which was partially offset by lower interest on our cash, lower cash balances and lower long-term AR balances and the higher interest rate costs from the Bank of Canada rate hikes since Q3 2018. On a consolidated basis, the effective interest rate for Q3 decreased to 2.8%, primarily due to the lower debt levels and the interest rate swaps on the euro debt.

Effective tax for the third quarter increased to 23.8% compared to last year, which is mainly driven by the increase in nondeductible expenses, including 1x tax cost related to repatriation of earnings from our foreign subsidiaries. We are expecting the 2019 full year effective tax rate to remain at the high end of our range of 22% to 24%.

Linamar's cash position was $394.8 million on September 30, a decrease of $29.8 million compared to September last year. Third quarter generated $214.9 million in cash from operating activities, which is used mainly to fund CapEx, debt repayments and share buybacks. This resulted in free cash flow generation of $90 million in the quarter. Net debt-to-EBITDA increased to 1.75x in the quarter despite net debt improving by $129 million, which was a result of the lower EBITDA. We expect net debt-to-EBITDA to be under 1.5x by the end of 2019, due to the impact of the soft markets and the GM strike. The amount of our available credit on our credit facilities was $704 million at the end of the quarter.

To recap, Linamar had a great cash generation quarter and sales outperformed the declines in the light vehicles, scissor and combine markets that we serve. In the quarter, we generated $90 million of free cash flow, which was used to pay down debt and fund share buybacks. Linamar was able to maintain a strong normalized EBITDA margin of 14%, even with these tough market conditions.

That concludes my commentary, and I'd now like to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Your first question comes from the line of Kevin Chiang with CIBC.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [2]

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Maybe if I could just focus on the Industrial segment here. Obviously, a softer outlook based on what you've laid out. I think you generally have a view to grow your business ahead of the market. But wondering, are you seeing more price competition, given the softer outlook? And how do you look at that top line growth relative to protecting margins if you are facing more irrational competition, let's call it?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [3]

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Yes. I'll just make a few comments, and I'm going to hand it over to Jim to talk a little bit about pricing. But absolutely, the goal with both MacDon and Skyjack is to grow market share to offset market softness. And I think that is the strategy that we have very consistently executed on Skyjack. The booms, in particular, we continue to grow our market share in our core markets of North America and Europe, and that makes a big difference in offsetting. Obviously, it's not enough to offset the pretty significant double-digit declines that we're seeing, but it absolutely helps to temper that. And the good news is when volumes start to pick up, we'll have a stronger market share and that helps to accelerate the growth at that time.

Same thing at MacDon. I mean, we're seeing growth in market share in Europe, for instance, which is helping to offset the declines we're seeing in North America. But again, of course, not enough to fully offset them. Jim?

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Jim Jarrell, Linamar Corporation - President & COO [4]

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Yes. I would say, on the pricing side, it's very aggressive today. And I would think, overall, the market decrease, I think, came quicker than ourselves and probably our competitors, if you take a look at some of the competitor news as well that it sort of got fast forward. So the undercutting of pricing on different contract potential is certainly a huge thing that's going on today in Skyjack.

And I would say with Skyjack as well, we've got some really interesting and new launches that are coming out in regards to rough terrains and booms as well. So I think we're going to have a refreshed product line. From MacDon side, again, the launches that we have, we've got a couple of new things that are coming in the marketplace as well.

And certainly, I think some of the key issues Linda mentioned, is sort of the market uncertainties that are that are out there, for sure. I think the farmer sentiment right now is pretty low. And certainly, the weather has traded poor yield conditions in different regions.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [5]

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That's helpful. And maybe just following up on that. Given the outlook, it sounds like you're still investing in R&D and obviously, investing in your product line here. But is there an opportunity to throttle some of that back if the outlook is soft for the remainder of this year and into 2020? And then maybe pushing out some of that CapEx into maybe future years, when maybe demand looks a little bit better? Or are you committed to the investments that you decided to make a year ago at these lines?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [6]

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Certainly, we have reduced cost wherever we could. I mean, we've absolutely been doing that since we've started seeing the markets soften up. I think to dial back on important R&D expenditures, to drive innovation and market share is a mistake. I think that that's the kind of short-term folks that we try to avoid, that look at the long term. If we continue to invest, then we have better products, and that helps us to grow market share and I do think that is quite important to do.

We don't have a lot of capital expenditures at either MacDon or Skyjack. It's really more on the P&L in terms of R&D expenses that are not capitalized. So we're -- it's not like we're -- we've got a lot of CapEx going on that we can avoid.

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Jim Jarrell, Linamar Corporation - President & COO [7]

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Yes. I was going to say the same thing. The CapEx is fairly minimal. When you take a look at the overall Linamar markets you're in, we would invest into fixtures and paint cells and racks and things like that. We're pretty low on the total pull on CapEx. But certainly, I think without having these launches, I mean, every launch that we do at MacDon is all about improvement of yield for the farmer. So if we delay those, then you're either up against the competition that's always trying to go after that. And I would say the same on Skyjack, you've got to have that product ready in the marketplace. The whole NC launch is critical in the marketplace. That's a new specification that all aerial work platforms need to have. So you have to do those things.

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Dale Schneider, Linamar Corporation - CFO [8]

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Keep in mind that in the short run, our focus has been on controlling our variable costs and reducing those where we can. Given that the market softness is extending out longer, we are now looking at plans on how to reduce other fixed costs.

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Jim Jarrell, Linamar Corporation - President & COO [9]

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Yes.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [10]

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That's helpful. And just -- and maybe just last one for me. When I look at your outlook, you have pointed out to some deterioration in your earnings profile, but you kept your free cash flow guide of $500 million to $700 million. Just wondering how that flows through. If earnings are coming a little bit lower than you expected 3 months ago, what are the drivers that allow you to keep that free cash flow guidance static here?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [11]

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Yes. I mean, a big part of the improvement of the strong cash flow is coming out of noncash working capital, and we've got several key initiatives that we are in the process of executing on that we feel will be quite material in that regard.

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Jim Jarrell, Linamar Corporation - President & COO [12]

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And I think in addition is the CapEx side, as you referenced on the Transportation side, there's always opportunity there to push out CapEx and look at utilization if one line is down, and we can take a piece of equipment, we're going to micromanage that and use the equipment.

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Operator [13]

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Your next question comes from the line of Mark Neville with Scotiabank.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [14]

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Maybe just to stay on the free cash discussion. I just want to confirm. I guess, if my math is correct, it's -- it would imply with about $250 million of free cash flow in Q4. Is that right?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [15]

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We do have a significant expectation around cash flow generation. Certainly, I will point out that normally, Q4 does already have a seasonal strong cash flow compared in the Q3. Q3 noncash levels are typically higher, just given the dynamics of the quarter and Q4 normally already has an improvement. And then you layer on top of that some of these initiatives that we're talking about.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [16]

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And then these -- the working cap initiatives, these are sort of permanent structural changes, correct?

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Dale Schneider, Linamar Corporation - CFO [17]

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Yes, that is correct.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [18]

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Would this all be done by the end of '19? Or would there be more sort of working capital coming out next year? And if so, is it a material amount? Or sort of just...

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Dale Schneider, Linamar Corporation - CFO [19]

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Most of it will be implemented in 2019. We are looking at possible other initiatives for 2020 that might make further improvements, but nothing's been finalized on that yet.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [20]

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But nevertheless, we do still anticipate to, again, have very strong and positive free cash flow in 2020.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [21]

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Okay. Maybe just on the GM strike, again, it's about 20 days, I think, in Q4. I think you previously said about $1 million of earnings per day. But I'm just curious, is there any expectation that sort of some of the lost production from Q3 or Q4 gets made up in Q4 or even into Q1?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [22]

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Yes. I think that you shouldn't expect much to be made up in Q4. I mean, it take -- first of all, we were down for a whole month of Q4. And it's only really starting to get ramped back up. I mean, not everything is even back up yet. And furthermore, a lot of the key plants that we supply are already running 6 or 7 days. So -- at GM, I mean. So there isn't much chance of them catching up very quickly. So although they will be trying to catch up, I think it's unlikely that, that will happen in Q4 and more likely that we'll see it in the first half of next year.

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Jim Jarrell, Linamar Corporation - President & COO [23]

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Yes. And then also, not everything is all back up and running as of today. And there is, as Linda said, some talk about trying to catch up a little bit in Q1 next year.

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Dale Schneider, Linamar Corporation - CFO [24]

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And keep in mind, to Linda's comment, on timing for the rest of the quarter, you do have American Thanksgiving and Christmas break. So there really is only like 1.5-month left of the quarter.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [25]

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Great. Okay. And again, that would still be the -- in the $1 million roughly for days, as you previously called out. So could just use that as a ballpark number?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [26]

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Yes.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [27]

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Okay. Maybe just one last one. Just on the Industrial. Sales were down, I think, 20% this quarter EBITDA was down roughly 50%. I think next year, you're calling for sort of roughly mid-single-digit decline, sort of on a combined basis for Skyjack, MacDon but flat margin. I was just curious, just if you could speak to some of the levers you have at your disposal to sort of protect margins in Q4 and even into next year, I guess, over the longer-term versus what happened in Q3?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [28]

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Yes. So I mean, as noted earlier, we are actively looking to cost reduce where we can, both on the variable side and also to the extent that we can on the fixed side. So that will all help the picture for next year. We're expecting, as you mentioned, mid- to high single-digit declines at Skyjack, but low single-digit declines at MacDon. So it's -- MacDon should not be declining as steeply. But I mean, it's all obviously going to be dependent on what happens on the political front.

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Jim Jarrell, Linamar Corporation - President & COO [29]

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I think the other thing I would say is when we hit these volume issues that the natural action for us to rightsize our workforce and take fixed costs down. So that's the sort of the natural thing that we would do and the team has been focused on that since the volume reduction took place.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [30]

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All right. I guess, just -- I don't know if this is a tough one to answer, but if we did get a U.S.-China trade deal. And obviously, that was -- the core of that was around ag. Like how quickly would your demand pick back up? Just -- so I'm just not sure about the sales cycle and if we get something late this year or early next year. Would it actually help next year? Or would it be more 2021 sales line?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [31]

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I think it's -- I mean, it's obviously very difficult to predict, and it's all going to depend on the timing of when that resolution comes, and where does that fit in with the harvesting schedule and when farmers are out actively buying. So there's a lot of factors at play.

But what we do know is there's pent-up demands. I mean, we were just coming off of a cyclical low in the ag industry, and things were just starting to pick back up when the trade tariff situation evolved. So we know that pent-up demand in the industry and our sense is that there will be a pick up that should happen reasonably quickly.

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Operator [32]

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Your next question comes from the line of Peter Sklar with BMO Capital Markets.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [33]

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First, I have a question on Skyjack. I believe that you traditionally have provided financing for, I guess, it's more for the independent customers. What -- how is credit looking? And are you having any issues there?

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Dale Schneider, Linamar Corporation - CFO [34]

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No. So far, we haven't had any issues. But as you may remember Q3 last year, we put an AR financing deal in place. So all of our new sales are actually flowing through that financing deal rather than our balance sheet. So right now, we're focusing on, as you know, the -- those deals tend to be 3- to 5-year deals. So we are just draining our long-term AR as we're getting paid by our customers over the next number of years.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [35]

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But it does take time, obviously, to -- for that to play out because there is long-term AR that's in place from before that deal was put in.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [36]

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Right. And I -- and just to confirm, I believe there's no reserves established for the long-term AR.

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Dale Schneider, Linamar Corporation - CFO [37]

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No material reserves, that's for sure.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [38]

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Okay. The next thing is on this, I think it's $200 million of takeover work you announced. Like how does that work? Like do you have to inherit their tooling? Or do you have the opportunity to design and source your own tooling?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [39]

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It really depends on the situation. Sometimes, we take over equipment and/or tooling from the suppliers. Sometimes we tool it up totally on our own equipment that maybe we have available or that we're bringing in. So it really depends on the situation.

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Jim Jarrell, Linamar Corporation - President & COO [40]

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Yes. It depends on the OEM. If it's disclosed in the market. If it's a financial issue, usually, the OEM is actively involved with the supplier and then they would ask us to come in and look at, can they use the capital, pay for the capital? And as Linda said, it could be a blend. I mean, it could be a blend between our used equipment, Peter, and their equipment and new equipment because they're looking for the best price at that time.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [41]

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Right. Okay. And like on this takeover work, like, is it more that these other suppliers have become insolvent? Or is it their quality and delivery had deteriorated? Or is it all of the above?

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Jim Jarrell, Linamar Corporation - President & COO [42]

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Mainly financial, what we're seeing, and I would say, mainly from the region of Europe would be the major stuff we're seeing today. And it's pretty well around the financials. We do see, at times, a little bit on quality. But I'd say right now for most of this takeover work is based off the financials.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [43]

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Yes. Don't forget, Europe, it's been a tough slug in Europe over the last year. I mean, volumes really plummeted in Q3 of last year and basically, have not recovered. I mean, as you saw, volumes were fractionally up from last year in Europe this year when last year, it was faster from a volume perspective. So it's been a tough year. It's also, as I was mentioning, been a tough time in terms of transitioning from diesel vehicles to gas vehicles. So that's put pressure on some suppliers more so than others who were maybe a little more diesel focused than the next guy.

So -- and also, like I'd say, in general, European suppliers have had sort of a tougher last 6, 7 years than we've seen in North America because they've been a little up and down on the volume side. Volumes have been -- or rather, margins have been a little thinner, so they didn't have as much of a buffer to be able to withstand the kind of volatility that they've had to deal with in the last year. That's why we're seeing so many insolvencies in the region.

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Jim Jarrell, Linamar Corporation - President & COO [44]

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And at the sense, I think we're seeing today is that this may continue just based off some of the information that we're hearing and some of the things that we're seeing.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [45]

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Okay. And then my last question, I just wanted to address your global vehicle forecast for 2020. I believe you said in your introductory comments, Linda, that you're looking for 2019 to be the trough year. And then you're looking for back to global growth in 2020. I'm just wondering, where does that forecast come from? Is that the IHS forecast? Or do you have -- does Linamar have its own views?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [46]

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That's the IHS forecast. Yes. So I tend to quote industry expectations in my formal comments and that is what exactly what IHS is forecasting.

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Operator [47]

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Our next question comes from the line of Brian Morrison with TD Securities.

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Brian Morrison, TD Securities Equity Research - Research Analyst [48]

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I just want to follow that line. I wanted to ask the question in the industrial margins, but that was addressed, but going along the Transportation margins, your expectation for expansion in 2020. Can you maybe just talk about the key drivers? I assume it's unit volumes and lower launch costs and the maturing programs. But maybe you could just tell us in order of importance, how those rank? And then can you increase your margins in a declining unit volume environment?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [49]

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Yes. So we just did increase our margins in a declining unit environment. So yes, we can do that. Number 2, in terms of the increase next year, the primary source of that is launch is getting up to a higher level of utilization. So you're just climbing up that launch curve, getting through this transition time frame that I've been describing over the last few quarters, new programs not running at optimal levels and all programs not running at optimal levels, so we're seeing a little more better utilization of equipment, better levels of volume, and therefore, better margin on the launching programs. That's what drove margins and earnings up this quarter. I mean, Transportation segment earnings are up 15% in a down market. So that's a big driver, and that will continue to happen next year.

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Brian Morrison, TD Securities Equity Research - Research Analyst [50]

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To be fair, one quarter doesn't make a trend. On an annual basis, the margins are down, but I think your point is, you can increase margins next year in the declining unit volume environment.

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Jim Jarrell, Linamar Corporation - President & COO [51]

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Yes.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [52]

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Yes.

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Jim Jarrell, Linamar Corporation - President & COO [53]

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Yes. I think Linda's point is very valid on the launches, right? I mean, we've been sort of in a place of old technology that has been basically half the volume and now starting to go the other way with new technology programs are starting to ramp up higher. So the launch costs are reduced and the margins should be better on those.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [54]

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And still, so, yes. We've been talking for the last couple of quarters about the fact that we did expect to see the margins improving and the transportation segment improving in the back half of this year. So it's -- this transition is evolving as we have envisioned.

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Brian Morrison, TD Securities Equity Research - Research Analyst [55]

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Okay, fair enough. Just one housekeeping item, Dale. Your free cash flow to $90 million, I assume that you derive that by adding back $45 million from the JV dissolution?

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Dale Schneider, Linamar Corporation - CFO [56]

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Yes. It's calculated the offer balance sheet, when we adjust for day loss -- dissolution cost.

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Brian Morrison, TD Securities Equity Research - Research Analyst [57]

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And does that cash actually show up on your balance sheet or no?

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Dale Schneider, Linamar Corporation - CFO [58]

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Does the cash, you mean...

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Brian Morrison, TD Securities Equity Research - Research Analyst [59]

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The $45 million differential.

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Dale Schneider, Linamar Corporation - CFO [60]

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Well, there is a cash payment, yes, and that would have impacted our balance sheet.

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Brian Morrison, TD Securities Equity Research - Research Analyst [61]

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That's been received?

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Dale Schneider, Linamar Corporation - CFO [62]

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No. That was a payment. We paid our JV partner because we bought the newer plant and they got the older plant and the older equipment.

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Brian Morrison, TD Securities Equity Research - Research Analyst [63]

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Okay, okay. I don't see the free cash flow being in that calculation, but maybe we can talk about it offline.

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Operator [64]

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Your next question comes from the line of Raj Singla with Arrow Securities.

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Raj Singla;Arrow Securities, [65]

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I just want to ask a question regarding the share buyback. I actually haven't seen the MD&A. And in that, this year, you buyback is 715,000, but I was looking at the outstanding shares, it's -- they reduced by only 115,000. And my second question is regarding MacDon earning. And out of the $39 million updating earning, how much is related to MacDon earning?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [66]

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So on the second question, we don't provide a breakdown on the Industrial earnings as to what's Skyjack and what's MacDon. Second -- first question around the buyback, so we spent $20 million in the quarter on share buyback. But I didn't quite understand your question. You're -- There's you -- that you saw a discrepancy in the numbers? Or what was your question?

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Raj Singla;Arrow Securities, [67]

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So my question is regarding -- in the MD&A section, like you said, you have bought back 715,000 shares in the 9 months. So -- but I was looking at the outstanding shares, it has reduced by only 115,000. So where's that 600,000 shares (inaudible)

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [68]

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Yes. We -- yes, there was options exercised in the quarter and that's the difference.

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Raj Singla;Arrow Securities, [69]

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But there is no detail provided of that regarding the number of shares. Comment?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [70]

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The number of options?

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Raj Singla;Arrow Securities, [71]

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Yes, I mean, how much the (inaudible)

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Dale Schneider, Linamar Corporation - CFO [72]

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It should be in there.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [73]

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It should be in the details. May I suggest that you follow-up with Dale subsequent to the call, and he can help -- he can show you more specifically or hold on a second. I think I may have found it.

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Dale Schneider, Linamar Corporation - CFO [74]

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If you go to the outstanding shares detail on the MD&A, it's describes that.

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Raj Singla;Arrow Securities, [75]

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But it's on the described amount, but not in the number of shares. And just a follow-up on that, I mean, does what -- when we'll be able to see the net reduction in the outstanding shares? And like, it looks like you're buying only basically that to just mitigate the options, right? So -- but there is no significant reduction in the number of -- actual reduction in the number of shares.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [76]

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Well, in fact, that we were sort of cautiously setting out to only buy shares back to offset the options that just happened to happen at the same time. We actually set out to do -- to put a fair bit of money behind the buyback last quarter and went ahead and did so. So unfortunately, at the same time that we happened to have these options come to an end. And so they were recognized in the quarter. So unfortunate timing that it offset the buyback.

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Raj Singla;Arrow Securities, [77]

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Okay. And my last question is regarding the leverage. You're saying to get it back to 1x. So when you're expecting that it has -- that it will be to 1x? And then my -- the last question is that. So when it becomes down to 1x, so then you're expecting a significant upscale in the share buyback activity?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [78]

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We expect to be under 1x next year. And we will, at that time, assess what makes the most sense in terms of uses of cash. So whether it be growth in the business, obviously, is the priority that we always look at. We look at dividends. We look at buybacks. So I can't tell you right now that all of a sudden, we're going to shift to a big spend on buybacks. Those are decisions that we take on, on a quarterly basis with of -- with our Board of Directors.

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Raj Singla;Arrow Securities, [79]

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Okay. So it will be in the half -- in the first half year, the leverage will become back to 1x?

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [80]

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I did not specify that. I just said, by next year. We haven't been specific on when in the year, that will happen.

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Operator [81]

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And at this time, there are no further questions.

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Linda S. Hasenfratz, Linamar Corporation - CEO & Non-Independent Director [82]

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Okay. Thank you. Well, to conclude this evening, I'd like to leave you, as always, with 3 key messages: First, we are thrilled to report more than 15% growth in normalized earnings in our transportation segment despite tough markets, as sign, our launch transition is improving as expected; secondly, we're very pleased to again deliver solid adjusted free cash flow of $90 million in the quarter. Cash generation has been a key priority for us, and we are delivering on it. We continue to expect to see strong free cash flow for the year of $500 million to $700 million, which will further fortify our already strong balance sheet; and finally, we're pleased to see our business again outperforming markets on continued market share growth, driving at a solid business wins in many areas of our business, notably takeover business, which is the silver lining of weak markets.

Thanks very much, and have a great evening.

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Operator [83]

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This concludes today's conference. You may now disconnect.