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Edited Transcript of B earnings conference call or presentation 28-Apr-17 12:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Barnes Group Inc Earnings Call

BRISTOL May 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Barnes Group Inc earnings conference call or presentation Friday, April 28, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Stephens

Barnes Group Inc. - CFO and SVP of Finance

* Patrick J. Dempsey

Barnes Group Inc. - CEO, President and Director

* William Pitts

Barnes Group Inc. - Director of IR

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Conference Call Participants

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* Bhupender Singh Bohra

Jefferies LLC, Research Division - Equity Analyst

* Christopher D. Glynn

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Edward Marshall

Sidoti & Company, LLC - Research Analyst

* Kai Shun Chan

Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst

* Matt J. Summerville

Alembic Global Advisors - MD and Senior Analyst

* Michael Frank Ciarmoli

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Myles Alexander Walton

Deutsche Bank AG, Research Division - Director and Senior Research Analyst

* Peter John Skibitski

Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Christa, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Barnes Group Inc. First Quarter 2017 Earnings Conference Call and webcast. (Operator Instructions) William Pitts, Director of Investor Relations, you may begin your conference.

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William Pitts, Barnes Group Inc. - Director of IR [2]

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Good morning, and thank you for joining us for our First Quarter 2017 Earnings Call. With me are Barnes Group's President and CEO, Patrick Dempsey; and Senior Vice President of Finance and Chief Financial Officer, Chris Stephens.

If you have not received a copy of our earnings press release, you can find it on the Investor Relations section of our corporate website at bginc.com. During our call, we will be referring to the earnings release supplements slides, which are also posted on our website.

Our discussion today includes certain non-GAAP financial measures, which provide additional information we believe is helpful to investors. These measures have been reconciled to the related GAAP measures in accordance with SEC regulations. You will find a reconciliation table on our website as part of our press release in the Form 8-K submitted to the SEC.

Certain statements we make on today's call, both during the opening remarks and during the question-and-answer session, may be forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected. Please consider the risks and uncertainties that are mentioned in today's call and are described in our periodic filings with the Securities and Exchange Commission. These filings are available through the Investor Relations section of our corporate website at bginc.com.

We'll now open today's call in our usual fashion with remarks from Patrick, followed by a review of our first quarter results and our updated 2017 outlook from Chris. After that, we'll open up the call for question.

Patrick?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [3]

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Thanks, Bill, and good morning, everyone. Barnes Group had an excellent first quarter to open 2017, one that builds upon the momentum that began in mid-2016. We generated 15% organic sales growth with double-digit increases in each segment. Adjusted operating income grew 33% compared to a year ago, and adjusted operating margin increased 180 basis points to 16.5%. Adjusted diluted earnings per share were $0.71 in the quarter, up 31%.

This business performance isn't simply the result of 1 quarter's efforts. Moreover, it is the outcome of the profitable growth strategy we've been executing over the last several years: transforming our portfolio, expanding into new end markets and leveraging intellectual property as a core differentiator. The combination of these initiatives have led us to where we are today and will continue to serve us well as we move forward.

Supplementing these efforts are our 3 strategic enablers: the Barnes Enterprise System, innovation and talent management, which, in combination, drive a culture of high-performance that translates into operational and commercial excellence to meet the needs of our customers. And while we're happy with the progress today, we're just getting started.

Notwithstanding the exceptional performance this quarter, keep in mind that last year's first quarter wasn't particularly robust and that the comparables throughout the remainder of 2017 are more challenging. Nonetheless, we feel very good about our competitive positioning and the ability to execute our plan. And accordingly, our expectations for the full year have improved.

Now let's talk about our business segments in the quarter. The Industrial segment continues its track record of consecutive quarterly sales growth, now reaching 6 quarters, as sales increased 16% versus a year ago. Certainly, last year's FOBOHA acquisition contributes to this performance, but more impressive is organic sales growth of 11% this quarter.

As is the case for several quarters now, strength in many of the end markets served by our Molding Solutions and Nitrogen Gas Products continues while end markets for our engineered components business have generally improved. At Molding Solutions, sales increased 24% over last year's first quarter and organic sales grew 11%. Strength in our automotive hot runner business endures with orders and sales growth well into the double digits. Other hot runner markets, such as medical and personal care, are likewise favorable.

The sales challenge, and that's a relative comment, relates to our molds business, which fell short of plan in the quarter due to timing of projects. Our expectation, however, remains favorable as orders for this business line were pretty solid in the quarter as improving customer sentiment converted into projects being released. Much of the operational focus of Molding Solutions is directed towards the integration of our acquired businesses, including systems alignment, optimizing and leveraging the global sales organization and developing a higher level of aftermarket services. This is a great business for us, and we see significant opportunities for global growth. We continue to forecast sales growth in the double digits with organic sales in the mid to high single digits, an uptick from our prior expectation.

One final item with respect to Molding Solutions, in early April, we closed on the acquisition of Gammaflux, a leading supplier of hot runner temperature and sequential valve gate control systems to the plastics industry. Gammaflux provides temperature-controlled solutions for injection molding, extrusion, blow molding, thermoforming and other applications. While the acquisition is modest in terms of size and financial impact this year, it is an outstanding addition in terms of controls technology. This capability further enhances Barnes Group's unsurpassed technical offerings of high-quality hot runner products, complex molds and value-added services to our injection molding customers around the world.

At Nitrogen Gas Products, our business remains very strong. Tool and die end markets continue to be robust, generating organic orders and sales growth in the high double digits. Part of the order book for the quarter includes a large order into an adjacent market, heavy-duty suspensions. Please keep in mind that NGP commenced their business recovery in mid-2016, and as such, the first half of 2017 has easier comparables. Regardless, NGP delivered a record quarter for orders, sales and operating profit. Accordingly, we now anticipate growth in the mid-single digits, up from our prior outlook of low single-digit growth.

Our engineered components business also saw positive organic growth and orders, both up low single digits in the first quarter. In fact, engineered components booked its highest level of quarterly orders and sales relative to the last 6 quarters. End markets, such as heavy truck, construction and general industrial, showed good growth. Global automotive production remains positive, and the expectation for 2017 is for low single-digit growth. While we expect to see somewhat of a plateauing of U.S. production, we still anticipate auto-related volumes to remain at a high level. We now have a slightly more positive view for engineered components with organic sales growth in the low single digits for 2017.

At the segment level, our full year outlook is for total sales growth in the high single digits, in part due to the full year contribution of FOBOHA, while organic sales are anticipated to be in the mid-single digits, up slightly from our previous view. Forecasted operating margin at Industrial remains in the mid-teens.

Moving to Aerospace. First quarter total sales were up 23% compared to a year ago. The Aerospace team has worked extremely hard over the past 2 years to position Barnes Group to support the growth expected in our OEM business. OEM orders were very strong, leading to a further increase in backlog, and OEM sales increased by over 20%. Ramp in new engine programs, such as GE's LEAP A and Rolls-Royce's XWB, are driving the sales growth as we continue to power through our transition from legacy to new engine programs.

For Aerospace aftermarket, MRO sales increased 27% while spare parts were up 20% over the prior year quarter. In the aftermarket, the CFM56 engine is driving much of the growth, and our expectation is that sharp business for this engine family will continue to grow over the next several years. Adjusted operating margin improved 590 basis points to 19.5% as larger production volumes benefit our manufacturing operations and higher aftermarket margins flow through to operating profit.

For 2017, our Aerospace outlook is for total sales to be up mid to high single digits for the year with OEM, MRO and spare parts each exhibiting that level of growth. Our operating margin outlook is for mid-teens. Although as shown this quarter, that can range to the high teens with a high level of aftermarket demand.

In closing, I'm very happy with our performance to begin 2017. Our growth strategy is providing performance improvements we anticipate, and the competitive positioning of our businesses is enhanced by our 3 strategic enablers: the Barnes Enterprise System, innovation and talent management. While there's still much to do, we're more confident in our outlook for the full year and we see the opportunities before us to drive further improvement.

Let me now turn the call over to Chris.

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Christopher J. Stephens, Barnes Group Inc. - CFO and SVP of Finance [4]

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Thank you, Patrick, and good morning, everyone. I'll begin with highlights of our first quarter results on Slide 3 of our supplement and end with our updated 2017 outlook. First quarter sales of $342 million were up 19% from the prior year period, driven by strong 15% organic sales growth and $15 million or 5% from our FOBOHA acquisition. FX unfavorably impacted sales by $4 million or 1%. Net income in the quarter was $38.3 million or $0.70 per diluted share compared to $28.8 million or $0.53 a year ago. On an adjusted basis, EPS of $0.71 was up 31% from $0.54 last year. First quarter 2017 adjusted income excludes $0.01 of FOBOHA short-term purchase accounting adjustments in our Industrial segment and while last year's first quarter adjusted income excludes $0.01 of contract termination dispute charges in our Aerospace segment.

Now on to segment performance. Industrial's first quarter sales were $227.3 million, up 16% from a year ago. Organic sales grew 11%, driven by continued strength in Nitrogen Gas Products and Molding Solutions businesses. Unfavorable FX reduced sales by $4 million while the FOBOHA acquisition contributed $15 million, as previously noted by Patrick. Operating profit was $33.5 million, up 13% from the prior year period, driven by the profit impact of increased organic sales offset by lower productivity. Excluding $600,000 of FOBOHA short-term purchase accounting adjustments in the first quarter of 2017, adjusted operating margin -- adjusted operating profit increased 15% to $34.1 million, and adjusted operating margin was 15%, down 20 basis points.

Two contributing factors to this decline. First, FOBOHA margins have a dampening effect on Industrial's operating margin. You may recall at the time of acquisition, we said this would occur over the short term. We have plans in place to improve margins at FOBOHA, and they are being executed. Also, initial sales for this business are a bit behind plan as we now expect build to be between $65 million and $70 million for the year. However, as Patrick mentioned, orders in the quarter were solid, and we see this push to the right. Second, within engineered components, our Associated Spring business experienced some production delays, which resulted in increased costs and expedited freight charges. The team continues to work through this and have made steady progress in order to meet customers' requirements.

At Aerospace, first quarter sales were $114.5 million, up 23% from last year as OEM sales increased with higher volumes from new engine programs and aftermarket MRO and spare parts experienced considerable year-over-year sales growth. Operating profit in the quarter of -- was $22.3 million, up 76% from an adjusted $12.7 million in the prior year period, reflecting the profit impact from higher sales volumes across all businesses and favorable productivity. Operating margins improved 590 basis points to 19.5% from last year's adjusted operating margin of 13.6%. Aerospace backlog remained strong at $687 million, up 16% year-over-year and up 8% sequentially as compared to the December 2016 period end. Please note that a good portion of this increase relates to our customers providing a longer time horizon on their orders. Of the current backlog, we expect to ship just under 50% over the next 12 months.

Other items to note. Interest expense increased $400,000 to $3.3 million, primarily as a result of a higher effective average interest rate versus a year ago. Our effective tax rate for the quarter of 2017 was 26.9% compared to 24.7% in the comparable quarter last year and 25.7% for the full year of 2016.

With respect to share count, our first quarter average diluted shares outstanding were 54.7 million shares. During the quarter, we repurchased 107,000 shares at an average cost of approximately $50 per share. And at quarter-end, we had approximately 4.3 million shares available for repurchase under existing board authorizations.

Cash generation continues to be strong as first quarter cash provided by operating activities was $51.8 million versus $30.5 million last year. As a reminder, in 2016, we made a discretionary $15 million pension plan contribution that impacts the cash provided by operating activities for the prior year period. Free cash flow, which we define as operating cash flow less capital expenditures, was $40 million compared to $17 million last year.

With respect to our balance sheet, our debt to EBITDA ratio, as defined by our credit agreement, was 1.6x at quarter-end. Under our existing debt covenants, additional borrowings of approximately $510 million of senior debt would be allowed while $460 million remained available on our credit facility at quarter-end.

Turning now to our updated 2017 outlook on Slide 4 of our supplement. Given the strong first quarter and the end market dynamics discussed by Patrick, we now expect 2017 revenue growth of 8% to 9% with organic growth of 5% to 6% after consideration of negative FX of 1% and acquisition growth of about 4%. Our operating margin outlook remains in the range of 16% to 17%. GAAP net income is expected to be in the range of $2.65 to $2.75 per diluted share. Excluding $0.03 in FOBOHA short-term purchase accounting adjustments for the year, our adjusted 2017 EPS outlook is expected to be $2.68 to $2.78, up 6% to 10% from 2016 adjusted EPS of $2.53. At this point, given the strength of Q1, we now expect or anticipate adjusted EPS to be roughly a 50-50 split between first half and second half of the year. Our CapEx expectation remains at $55 million. Our 2017 effective tax rate is now approximately 27%. Average diluted shares outstanding for 2017 are anticipated to be approximately 54.5 million. And lastly, we now expect cash conversion to remain strong and exceed 100% of net income.

So in summary, an excellent start to the year. Our solid financial results and good cash flow provide a supportive balance sheet for further growth investments in organic projects and accretive M&A deals. Productivity initiatives, which drive margin expansion, and anticipated global growth should likewise provide financial benefits.

Operator, let's turn it over for some 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 Pete Skibitski with Drexel Hamilton.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [2]

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So organic growth in the quarter was 15%. It didn't seem like the year-over-year comp was particularly easy. So I'm wondering, considering you only raised the top line guidance by about 2%, if you're thinking that maybe sales got pulled forward from the rest of the year for some reason, whether it's in one segment or the other or if you're -- this earlier in the year, you're just being a bit conservative on the guidance.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [3]

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I think it's a combination of both, Pete. We're obviously extremely pleased with the quarter. Both Aerospace and Industrial teams had a tremendous quarter in terms of performance in total. We're looking -- we've clearly shaved $0.05 off the bottom and increased the midpoint by $0.04. The reason we took that approach was as we look out over the course of the year, it's not like -- the first quarter was linear. We did see some lumpiness in the quarter. And as we look out over the full year, whilst we remain positive in terms of each one of the businesses, each with their own set of challenges and not with 100% certainty, I think the guidance is prudent at this juncture.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [4]

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Okay, okay. And then -- I mean, obviously, backlog was up nicely in both segments. You mentioned customers kind of giving you better visibility, I think, longer-term type of backlog. Is that something radically new there? Or does that help give you some comfort level that there is, like you said, some challenges with some opportunities as well?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [5]

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Yes. Well, let me speak to both sides of the equation because you have the Industrial side and you have the Aerospace. A lot of the backlog -- a big piece of Aerospace's backlog was an extending of the window. So as you -- it's not uncommon as you move into these ramping programs that, depending on what the lead times are on materials, as the demand increases, the OEs will open up the window. It's not new work, so to speak. It's just a reflection of the fact that they've given you visibility to a greater outlook. And so of course, that, in turn, reflects into our backlog. I will highlight that there is the opposite of that, that can occur too. Once you come up to steady state and the supply chain normalizes, the OE can close that window and you could see a fall-off in backlog. So it works both ways. But clearly, the driver of our backlog in Q1 was the new programs, primarily the LEAP on the OE side of Aerospace. As you know, the aftermarket is short cycled so orders convert into sales in the same quarter many times. And on the Industrial side, backlog was extremely healthy, driven by just the demand that we're seeing in a number of the businesses. And for the most part, all of the Industrial is short cycle.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [6]

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Okay, that's great. That's great, very helpful. My last one, then I'll get back in queue. You kept the margin rate guidance intact. Are there any changes by segment? In other words, are you thinking Aerospace maybe could be a little bit higher than initially thought and maybe Industrial a little bit lower on some of the FOBOHA comments you made?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [7]

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No, we still see the year outlook in terms of both segments in the mid-teens. And I -- into the -- as I do every quarter, I think I introduced the caveat on the Aerospace side that if we have a strong aftermarket, then Aerospace will flex up to the high teens.

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Operator [8]

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And your next question comes from the line of Michael Ciarmoli with SunTrust.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [9]

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Maybe just to stay on that last question Pete was asking on the margins. I can't remember the last time you guys have put up a Aerospace segment margin this high to start off the year. I understand aftermarket's more short cycle, but maybe if you could comment what sort of visibility you might have in the aftermarket right now, if you think those trends can be sustained. I mean, you still have, I think, some pretty easy comps on aftermarket in the next quarter. But I mean, we're hearing a lot more airlines retiring -- or keeping older planes in service, retirement slowing. So maybe any additional color there.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [10]

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Absolutely. Well, Michael, we saw in the quarter very strong performance with our aftermarket, and it was driven -- as you know, our aftermarket is comprised of 2 elements, and it's a big contributor to the overall Aerospace margins. The 2 aspects of our aftermarket are the repair side and the spare parts. In both -- the common thread between both of those elements is the long-term life of program deals that we've entered into, primarily on the CFM56. We're also on the CF6 and the CF34, in CF34, on the repair side. The CF6 and the CFM are common for both the repair and the spare parts. But to your observation of aircraft staying in service longer, that is translate, and I believe, into performance we're seeing on the CF6. So the CF6, which is ultimately a declining program in that it's at the sunset side of its product life cycle, still continues to contribute nicely to both repairs and spare parts as it pertains to our business. Our team, both leadership and sales, are currently down in MRO Americas. I had spoke -- I've communicated with them yesterday, and they -- their feedback has been very positive in terms of the spirits at that particular show, and again, it's translating into what we're seeing. Our aftermarket business now, this quarter represents 5 quarters of sequential growth. Albeit that sequential growth has been modest, it nonetheless has been growth for 5 quarters.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [11]

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And what about any kind of visibility? I mean, I know it's sort of book, ship. But do you get the sense that you have better sort of maybe line of sight into maybe beyond what's normal? Or anything you could share on the visibility of the business there?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [12]

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Visibility-wise, I think we look to overall trends. We're obviously looking at all the fundamentals of the industry with regards to traffic -- passenger traffic, load rates and so forth. But then what is more important for us is we marry that with what our sales team on the ground is telling us in terms of what they're seeing from their visits to the overhaul shops, how are the over shop -- overhaul shops doing, what's their outlook in terms of future visibility. The airlines, of course, have the ability to flex both in terms of deferring maintenance and pulling it in. So the visibility within the industry is somewhat challenged over the long term -- in the short -- over the long term, I would say. But in the short term, again, all the feedback we're getting in terms of this year, there seems to be a high degree of optimism around aftermarket. Again, you temper that against the fact that we had a couple of false starts in the aftermarket over the last few years to where we thought it was going to become more robust over time and actually disappointed. So that said, I think the engines have to come in for overhaul eventually. [Light limited] parts are driving the engines in at the moment, and so again, maintenance is a necessity that has to come to bear.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [13]

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Got it. That's helpful. And then maybe just one last one on the Aero OE side. I think we heard one supplier this quarter talk about some destocking, maybe caught them off-guard on the 787. I mean, are you seeing anything with regards to the 787 that might indicate too much inventory in the channel or Boeing, perhaps, revisiting its rates from 14 to 12 to 10? Or what are you guys seeing there?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [14]

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But nothing, I think, significant reflected into our backlog. The 787 was -- it's an important program for us, isn't one of our bigger ones. Clearly, for us, we've been tracking the 777 much more closely because of its corresponding impact to Barnes Group. But in general, the 787, we've not seen anything that stands out that is concerning to us.

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Operator [15]

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And your next question comes from the line of Christopher Glynn with Oppenheimer.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [16]

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Just wondering how you're dealing with China and North America auto production in the outlook, just given the back half comps are tough. And especially with China, it can be a little whimsical, I think, around this inventive timing, and obviously, you're seeing some pretty good streak there.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [17]

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Yes. Well, as I mentioned in the prepared remarks, Chris, we believe that North America will plateau, but recognize it's plateauing at high levels. And that in terms of the full year, we just -- coupling the auto side with our general industrial into our engineering components business, as an example, we're feeling more optimistic upping our outlook into the low single digits from flat. As it pertains to China, last year, of course, there's some -- there was some reservation to the fact that tax incentives were driving volume or pulling forward volume out of 2017. With our businesses in China, for the most part, it's the model changes at Synventive, and we're seeing it at an elevated level in China. And so China's been a nice part of this growth story for us as it pertains to our automotive hot runners.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [18]

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Yet do you see signs that the model changes kind of continues at a good clip for the horizon?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [19]

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We see it in immediate short term. And in the context of what we see for the full year, we've reflected it into the guidance. But in general, we think that the model change activity right now is at elevated levels, and it was robust in Q1, and we've seen that continue into April.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [20]

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And now shifting gears, just wondering about your capital deployment pipeline and how you're looking at your current operational bandwidth to take on something material.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [21]

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Well, the team is doing a wonderful job on the Industrial side, which is where the heavy integration is occurring. On the Molding Solutions business, as you know, I -- we just announced the acquisition of Gammaflux I referenced earlier. That, I think, is just another great technology player. It's a smaller acquisition in the context to capital deployment, but very key in terms of the strategic aspects of where we want to build out a complete full-service offering to our injection molding customers. We -- we're continuing to look at potential targets. What's important for us is that we hold true and disciplined to the strategy we've used today, which has been our strategic criteria. And we have -- always with the M&A side of the equation, we have a lot of dry powder, as you see, with regards to the balance sheet. But actionability and timing and making sure that it meets our strategic screens is what's key.

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Operator [22]

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And your next question comes from the line of Myles Walton with Deutsche Bank.

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Myles Alexander Walton, Deutsche Bank AG, Research Division - Director and Senior Research Analyst [23]

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I was hoping to start on the EPS. On the top end, it looks like you lowered tax rate, which would account for most of the top-end raise of the EPS guidance, and then you had another 1 or 2 points of growth added in. So I'm just curious why that didn't add onto the top end even if it is earlier in the quarter? Just mathematically, it would seem like there would be some drop-through from the higher sales growth.

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Christopher J. Stephens, Barnes Group Inc. - CFO and SVP of Finance [24]

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Yes. Just as we look at the -- as Patrick kind of commented, most -- some of the movement on the shaving of the top line, maybe in the 8% to 9% growth is in our molds business, within Molding Solutions. So we're tempering that down somewhat in terms of our overall guidance. I feel gooding -- feel good about dropping the $0.05 to the bottom end and then adding $0.02 to each bottom and top. So the molds business, some of that's shifting to the right. It's impacting some of the bottom line profitability. And as a result, we're a little bit cautious as we look towards the second half of the year in our overall guidance, but obviously, coming off a terrific first quarter.

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Myles Alexander Walton, Deutsche Bank AG, Research Division - Director and Senior Research Analyst [25]

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Okay. And then the 777 in terms of what's flowing through on your OEM business and the rate there, I know -- I think the backlog, you've already got it stepped down to their -- the right level within the backlog. Is the sales run rate now getting towards the right level? Or do you have further step-downs there as well?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [26]

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Well, interesting in that, for us, on the backlog side of things, I think we've seen it almost half over the last 2 years. So that's not to be unexpected as it pertains to that program. The announced next production quota in August of down to 5 from 7, we believe that that's reflected into the backlog. What we have seen in this example -- unlike the LEAP, where with the 777, you see a more closely controlled window, because of course, the outlook is a little less predictable so subsequently -- and the supply chain is fully up to speed as it pertains to this program, so the window can close a little. So whether it's fully reflected into our backlog and then into our outlook, we think we've covered it for 2017. But how it's going to play out into 2018, I think, still is a little unclear.

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Myles Alexander Walton, Deutsche Bank AG, Research Division - Director and Senior Research Analyst [27]

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Okay. And then on the margin performance, obviously, really strong in Aero. I'm just curious -- obviously, helped by the aftermarket piece. But I wonder, have you also significantly improved the performance on some of the newer programs and their drop-through, which, I think if you look to last year, was more of a challenge for you? It seems like it must be going pretty well at this point.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [28]

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I would say that we're improving, but the challenge still remains quite considerable. So I would attribute most of the benefits in the quarter to the aftermarket side of the equation. We continue to absorb a lot of costs as it pertains to the newer programs because they're not running steady-state. They're ramping. They're still being learned out. So in general, a lot of costs is still being absorbed on the OE side of the equation.

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Operator [29]

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And your next question comes from the line of Edward Marshall with Sidoti & Company.

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Edward Marshall, Sidoti & Company, LLC - Research Analyst [30]

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So I wanted to go back to China, if I could. And you -- in your comments, you referred to model changes and how it reflects. I guess, you're speaking about Synventive. But I wanted to kind of further extrapolate that conversation, talk more about NGP. And I think that's where you've seen a lot of the tool and die growth coming out of China, in particular, for auto and the stamping businesses. Can you -- and you talked about pretty good backlog there. Can you kind of help me think that through a little bit and kind of talk about the remainder of the year and how you see that business shaping up?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [31]

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Yes. So within China, Ed, our business

(technical difficulty)

industry and the automotive hot runners business has been the 2 primary drivers. The tool and die industry continues at elevated levels. I mentioned that our NGP business achieved record order sales and profits in the quarter. And that was driven across all 3 regions, with China being the primary driver within the Asian region. The business has now -- as I've mentioned earlier, since mid-2016, we've seen consistent improvement within our Nitrogen Gas Products business. And in parallel, that improvement has occurred in China. So the tool and die industry out of China serves not only the local region, but the world's demand, in that a lot of tool and die products end up ultimately moving overseas. So it's a combination of all 3 regions, plus China continues to exhibit strength from our NGP or nitrogen gas springs business.

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Edward Marshall, Sidoti & Company, LLC - Research Analyst [32]

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Great. And you talked about -- all right, rather -- and you look at the model in the Industrial business, obviously, you had some pretty good organic growth. You talked about some of the impacts to the operating margin is coming in a little bit. When I think about mix and pricing, obviously, it wasn't volume, and I think you've already mentioned FOBOHA but -- unless there were significant losses there, I don't think that's big enough to drag the margin that much. What are some of the pressures to the margin on the Industrial side that weighed on it in the quarter?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [33]

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Well, we mentioned 2 items. One was the incremental sales of FOBOHA as what our lower margins and -- at the lower volumes in the quarter that had a corresponding impact on utilization within the shops. The second item we mentioned, which if I talk to the good news relative to the experience, which was how well the team learned in the quarter, how they should be ready to respond to any changes in demand within our engineered components businesses, we had one business within that particular segment or business -- SBU that experienced some operational issues in the quarter. And as such, we ended up having to react with additional resources, additional expediting, overtime and all that goes with meeting the needs of the customer as the ultimate goal. So with that, we -- it did have an impact on our margins. So if I look at -- if I take that out, I would've expected us to be a least 1 point higher to where we finished the quarter.

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Edward Marshall, Sidoti & Company, LLC - Research Analyst [34]

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And I'm sorry, the point higher, was that related to FOBOHA and the engineering components or you're referring to just the engineered components?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [35]

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Just the engineered components.

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Edward Marshall, Sidoti & Company, LLC - Research Analyst [36]

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You would be 1 point higher. Okay. And then anything to report on the LEAP B or the 777X?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [37]

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Well, we continue to work both programs and remain positive on them. But as I've mentioned a few times, most of our energy, as you can imagine, is on the ramp that's being driven against the LEAP B at the moment, and that's where we have the larger piece of content. And as such, the team is collectively focused on it. We are also developing the 777X product line. But in both instances, again, as I think I've indicated previously, neither the B or the 777X will be at the levels that we've enjoyed with the GE90 on the base 777 or on the LEAP B and C.

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Edward Marshall, Sidoti & Company, LLC - Research Analyst [38]

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The -- your -- the GE90, obviously, steps down in August to 5 from 7. And I'm curious, are you kind of in that sweet spot where you're benefiting still from a higher rate of GE90 as well as the incoming order from -- or the incoming demand from the LEAP A? Or did that -- did you already start to see the declines for the August shipments?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [39]

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So I believe we're seeing the declines for the GE90. And I'm not sure that they're all in there, in the sense of that -- we now got to a point where the GE90 is neutral. I think we're still absorbing. Some of the decline at the GE90 was -- were ramping on the LEAP. But net-net, as we give guidance to the OEM side of our business of mid to high single digits, it includes our assessment of both, all the moving parts within Aerospace.

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Operator [40]

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Your next question comes from the line of Bhupender Bohra with Jefferies.

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Bhupender Singh Bohra, Jefferies LLC, Research Division - Equity Analyst [41]

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Question, just some housekeeping question. I don't know if you already mentioned about the Aerospace OEM aftermarket, especially with the MRO and sales growth in the quarter, if we can get that.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [42]

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Yes. The sales growth on the OEM side of Aerospace was 20%, and the aftermarket side was 24%, which split 27% in MRO and 20% in spare parts.

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Bhupender Singh Bohra, Jefferies LLC, Research Division - Equity Analyst [43]

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Okay, got it. Yes. Got it. And let's talk about -- on the Industrial side. I think we focused too much on the Synventive side of the business. Give us some color on the Männer side. Some of the other end markets you talked about were kind of solid in the quarter. And how should we think about FOBOHA and how that integration is going on and what kind of focus (inaudible) you have with FOBOHA in the -- especially with the Männer business as you integrate?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [44]

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Right. So the Männer and FOBOHA teams continue to work extremely well together. And both of those businesses, as you just mentioned, have a lot of similarities. Clearly, the primary business is molds as opposed to hot runners, which are the primary of a -- Synventive, as an example. But also within that, clearly, Männer is also a industry-leading provider of the hot runner systems that it embeds into its own molds, and now going forward, we'll also look to do so into the FOBOHA molds. The two businesses, the primary end markets that they serve are personal care, medical devices and packaging. And those end markets have been very deliberate in terms of our strategic targeting as we've gone into this industry, because we believe, if you think about those 3 end markets, they're not necessarily going to be really high growth. But what they do offer is resilience in both the good and the bad times from an economic standpoint. So as we've looked at those businesses, in particular, not only were they complementary to the Molding Solutions' overall strategy, but also they provide some nice dampening effect and, I think, will have an ultimate impact on our performance as we go forward. As economy -- the economy turns at some point, they will provide a nice resilience to any particular downturn, given the end markets that they're serving. What we did see in the fourth quarter was a movement to the right of projects being released. And subsequently, what that means is that into the first quarter, it impacts shipments, first and second quarter. So that was something that we were looking closely and monitoring closely. The good news being that in the first quarter, we've seen customer sentiment improving and projects being released. So we've seen a nice uptick in our Mold business in the quarter in terms of orders. And in turn, because of the lead time that goes with the mold is why we subsequently tempered our outlook on the Männer and FOBOHA business for the full year, but that, again, is reflected in our guidance.

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Bhupender Singh Bohra, Jefferies LLC, Research Division - Equity Analyst [45]

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Okay, got it. On the Gammaflux now, can you -- I know it's a pretty small acquisition here. Where does it fit in and -- especially on the auto side? Or would that be -- even on the Männer side of the business?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [46]

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Well, when we look at our Molding Solutions business, we think of it in 3 ways. We think of the molds, the hot runner systems and the controls. And what Gammaflux brings, which is complementary to the other 2 elements -- so if you think of it as a three-legged stool within that overall SBU, Gammaflux is the electronic controls that have a great bearing on the hot runner system itself and the overall performance of the mold and operation. So if you couple that with our acquisition of Priamus Center Technologies (sic) [Priamus System Technologies] in 2015, we see the combination of these technologies being value-enhancing to the overall portfolio and a total service offering that we then bring into market for the plastic injection molding customers.

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Bhupender Singh Bohra, Jefferies LLC, Research Division - Equity Analyst [47]

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Okay. And lastly, I just want to -- I think it was mentioned, the second half of the earnings for this year is going to be equally weighted, 50-50 first half, second half. So does it seem like the second half, which was pretty nice last year -- while the quarters would be kind of a down quarter in terms of EPS? Or how should we think about -- especially the third and the fourth quarter, I think? Your earnings were pretty nice in the third quarter last year, so...

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Christopher J. Stephens, Barnes Group Inc. - CFO and SVP of Finance [48]

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Sure, Bhupender. Let me just highlight first. So let me just highlight, the third quarter last year, if you recall, there was -- we had a $0.03 benefit from a tax accounting change. And that represented $0.71, actually, on an adjusted basis for our third quarter last year. So we don't necessarily see that repeating. It can, and it's possible it would. But that would be the 1 quarter that we're looking at where, to your point, a little bit down as we think about our overall guidance on a year-over-year basis quarter-to-quarter.

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Operator [49]

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And your next question comes from the line of Matt Summerville with Alembic Global Advisors.

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Matt J. Summerville, Alembic Global Advisors - MD and Senior Analyst [50]

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With respect to the Industrial business, the issue you encountered at Associated Spring, can you get a little more granular on it? It sounded like it cost you a couple million dollars in OP during the quarter, which is not an income sequential amount.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [51]

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Yes, I wouldn't --- I think a couple is a little hefty, but it did cost us. And it cost us to the fact that I said it was 1 point -- it probably had an impact of 1 point on our margins. The good news, as I said again, is that I think for the most part, it's substantially behind us but -- and there was a number of lessons to be learned. But really, it was a case of where one of our businesses got behind the curve in terms of performance and then had to react. And react was what I -- the direction given to the business was that they have to meet the customers' requirements and that the issue was -- there were many reasons. It was important that we address it and address it with a sense of urgency. So it's been, as I said, materially taken care of. And whilst it might bleed over a little into Q2, again, I would indicate that the full year's guidance reflects it.

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Matt J. Summerville, Alembic Global Advisors - MD and Senior Analyst [52]

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And then where are you in terms of learning curve with some of the new programs you mentioned on the Aerospace business? You have been encountering some operating challenges, power quality metrics. Well, how -- to what degree have your quality metrics improved? And how far are you through? If you will, maybe using a baseball analogy, what inning are you in, in getting through these transitory challenges, if you will? How far up on the learning curve are you at this point, given the margin performance we're seeing in Aero?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [53]

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Yes. I think we're still in the early stages, Matt, as it pertains to these newer programs, because what you have is even as we enter -- as they ramp into production, there's a misconception sometimes that they have been locked in, in terms of their designs. In some instances, even as we are ramping on certain programs, we're also implementing engineering design changes to make the part better as we go. So they're still in -- I would argue, there's still a lot of efforts, engineering, design work, concurrent engineering as well as far from optimal movement at the parts to the shop that's causing incremental costs. So we're in the early innings. It's going to be -- a typical learning curve on these programs could be 1 year to 2 years. And it depends on the volume ramp, and it depends on -- the primary driver at the moment is meeting the production rates and ensuring that it's -- every part that ships is -- meets every requirement in terms of quality and performance. And unfortunately, in the early stages, that comes at a high cost.

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Matt J. Summerville, Alembic Global Advisors - MD and Senior Analyst [54]

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And then I think it was either in your response to a question or in your prepared remarks, but I -- I can't remember. But you mentioned that, I think speaking about the Industrial business, that you have not seen a lot of linearity or maybe you've seen a little bit more volatility than you would otherwise expect. And you provided some color on what you're seeing in Asia. Can you maybe talk about the Industrial businesses in the context of what you're seeing in North America and Europe as well please?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [55]

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Yes. North America, for us, we've seen a lot of goodness in the context of general industrial, albeit that it has been somewhat volatile or sporadic. The -- I mentioned that construction or heavy-duty trucks have seen some nice green shoots, if you like. And as we move forward, we're optimistic that the general improving industrial side of our engineered components business, as an example, can offset maybe some of the plateauing that's anticipated on the automotive side. Within Europe, Europe has been very strong for us this quarter, primarily coming out of, again, the automotive hot runner business as well as the Nitrogen Gas Products as being the 2 primary drivers.

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Operator [56]

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And your next question comes from the line of Josh Chan with Baird.

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Kai Shun Chan, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [57]

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Obviously, it was a very strong quarter. I was just wondering, relative to your own expectation as you look across the business, where were the areas of the biggest surprise to you within the quarter? And then also kind of looking ahead, you talked about trying to be prudent with your outlook, and you mentioned molds, as an example. I was just wondering if you're looking at any other areas where you're trying to be a little bit more cautious as well.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [58]

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Yes. We -- in the quarter, I think, where there was strength above what we had anticipated was in the short-cycle businesses. And the nature of those businesses, and where I give a tremendous amounts of credit to our team, is that when you have a surge in a short-cycle business, either you meet the demand or demand potentially goes somewhere else to a competitor or otherwise, what our team flags on the Industrial side within Nitrogen Gas Products and within the Molding Solutions side of the business was that they flexed with great agility to absorb that incremental demand. And by far, March was the strongest month of the quarter. So we had with -- even higher than I think we anticipated. The question is, as somebody mentioned earlier, is it -- does it represent a little bit of a pull-in from Q2 or Q3? I think that remains to be seen and, subsequently, why again we're a little bit more prudent on the outlook because that is yet to be determined. The Aerospace side of the business, also the aftermarket side, was stronger than we had anticipated. When originally we thought Aerospace was going to be in the mid-single digits, we're now providing an outlook of mid to high single digits based on the relative continued improvement in the aftermarket that we saw in Q1. And as I mentioned, that's 5 sequential quarters now of modest growth in aftermarket. But there seems to be momentum there that we believe will continue throughout 2017.

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Kai Shun Chan, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [59]

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Okay, that's good to hear. And then as your businesses continue to grow, how are you thinking about capacity across your portfolio? Any place where you're going to be bumping up into the need to add more capacity?

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [60]

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It's a great question, and I think it's something that we continue to monitor very closely. And one of the key elements of our overall strategy for -- as we continue to execute against the new strategy for Barnes -- as you know, there's been a few elements of this and transforming the portfolio has been at the heart of it, and that has primarily took place in terms of bricks and mortar on the Industrial side. And it took place on the Aerospace side in the form of moving on to the next generation of new aircraft. Each one of -- with that strategy, intellectual property has been at the cornerstone of it. And -- but an element that is also embedded in there terms of the overall go-forward strategy is global expansion. And that global expansion is twofold: one, to move into new markets; and second, to increase our capacity. Over the last couple of years, some of the capacity we've -- increases that we've made, we have advertised or publicized. Others, we've done almost as a -- just a part of normal business. So there, to give you some examples, a couple of years ago, we expanded almost like 50% our Nitrogen Gas Products business in anticipation of future growth, and that of course, has bore out very well for us. And as I mentioned, even in the quarter, Nitrogen Gas Products stepped up to the increased volume. On the Aerospace side, as we expanded into these new programs, we've also launched 2 greenfields over the last couple of years, one in Mexico to support our customers there and another in Singapore, both with a view to increasing capacity to support these new programs. So it's something we're monitoring closely, we continue to invest in. And that's, again, where -- as we talk about our capital investment budget for the year of $55 million this particular year, that is where we're making those investments on these growth programs.

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Operator [61]

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And your final question comes from the line of Pete Skibitski with Drexel Hamilton.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [62]

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We've been exploring it a little bit already, but I wanted to see if I can get some more color on this thesis of peak auto production. And Patrick, I'll leave it to you whether it's best to talk about it in terms of engineered components or Associated Spring, more specifically. But I'm wondering if -- how you think about managing that unit with peak auto in mind, if your idea of magic changes now in this environment. And I don't know if you've already seen pressures on auto production already or if you just see a flattening. But does cost control take on a bigger focus in this environment there or [IRAD]? Or are you going to change the way you manage that business in this environment? And I also want to get a sense of the mix in terms of if it's 50% auto production, 50% construction there and -- I just want to get a better feel for that as well.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [63]

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Absolutely. As it pertains to engineered components, that business, in its total, is a split between industrial and automotive. What's happened over the last couple of years is the shift has moved to a greater percentage and balance it with 50-50. Over the last couple of years, it shifted more to automotive, just given the strength in the auto industry. As it -- as you think about the outlook for automotive, in particular North America plateauing, the businesses continue -- their area of focus continues to drive optimum capacity, optimum efficiencies against the Barnes -- utilizing the Barnes Enterprise Systems as the mechanism by which we do that. What I would note is that the engineered components business also has done a really nice job over the last couple of years in terms of moving the mix of its components. So we have been focused on the 8 to 10 speed for the next generation of autos moving off of the traditional 6 speed. And so there's a conversion rate that's happening within our engineered components business that's helping as well. Also within engineered components, we've made reference to our Swiss operations and the GDI program, which, again, is a new technology being adopted by the industry. And so there's a conversion from the old port fuel injection systems to the GDI system. And again, what happens is it provides a dampening to the overall production volume.

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Peter John Skibitski, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [64]

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Okay, that's helpful. And on the construction exposure or the general industrial exposure, is there some Caterpillar exposure there? Because it seems like they're starting to turn, and I'm wondering if that's a good read-through for you guys or if you'd -- like something else.

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Patrick J. Dempsey, Barnes Group Inc. - CEO, President and Director [65]

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Yes. Caterpillar is a very strong customer of our engineered components business, and small in the scheme of things, but a strong relationship with that customer. And clearly, their recent earnings announcement was all good news. And as I mentioned in my prepared remarks, we've seen some green shoots in terms of our experience coming into the engineered components side of the business on the general industrial side.

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Operator [66]

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There are no further questions at this time. I'll turn the call back over to Mr. Pitts.

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William Pitts, Barnes Group Inc. - Director of IR [67]

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Great, thank you. We'd like to thank all of you for joining us this morning, and we look forward to speaking with you once again in July with our second quarter 2017 earnings call.

We will now conclude today's call. Thank you.

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Operator [68]

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