Carpenter Technology Corp (CRS) 2018 Q3 法說會逐字稿

Good morning, and welcome to the Carpenter Technology Corporation Third Quarter 2000 -- Fiscal Year 2018 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded.

And now, I would like to turn the conference over to Brad Edwards, Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to Carpenter's earnings conference call for the third quarter ended March 31, 2018. This call is also being broadcast over the Internet along with presentation slides. Please note, for those of you listening by phone, you may experience a time delay in slide movement.

Speakers on the call today are: Tony Thene, President and Chief Executive Officer; and Damon Audia, Senior Vice President and Chief Financial Officer.

Statements made by management during this earnings presentation that are forward-looking statements are based on current expectations. Risk factors that could cause actual results to differ materially from those forward-looking statements can be found in the Carpenter's most recent SEC filings, including the company's report on Form 10-K for the year-ended June 30, 2017, Form 10-Q for the quarters ended September 30, 2017 and December 31, 2017, and the exhibits attached to those filings.

Please also note that in the following discussion, unless otherwise noted, when management discusses sales or revenue, that reference excludes surcharge. When discussing operating income, that reference excludes pension earnings, interest and deferrals, or EID. When referring to operating margins, that is based on sales excluding surcharge and operating income excluding pension EID.

I will now turn the call over to Tony.

Thank you, Brad, and good morning to everyone on the call today. Let's start on Slide 4 and a review of our safety performance. Our total case incident rate is at 1.1 with the year-to-date fiscal year 2018. We continue to work diligently toward reaching our goal of a 0 injury workplace, and our performance to date keeps us on path to achieve our best fiscal year performance in Carpenter's history.

Last quarter, I mentioned our extensive human performance program that reinforces tools, practices and methods to reduce or eliminate errors in safety, quality and manufacturing. This program is focused on engaging the employee at the task level. For example, one of the concepts of human performance safety training is to empower employees to observe the environment around them. And when a potentially unsafe activity is observed, they are empowered to stop the activity by issuing a stop card. Every time a stop card is issued, a detailed action plan is assigned and tracked to closure to ensure this activity is corrected. This may seem basic, but I'm encouraged by the fact that to date, over 4,000 stop cards have been initiated. Also, by completing a certification process, multiple employees have become human performance advocates, who now train fellow employees in the principles of error reduction. That is true engagement in action. While we have made encouraging progress to date, there is much more work to be done and our commitment to this core value, a 0 injury workplace will not waiver.

Now let's turn to Slide 5 and a review of our third quarter highlights. The third quarter marked a continuation of the strong financial and operating performance we have delivered over the last several quarters. We are executing our commercial strategy and capitalizing on positive market trends as indicated by growing customer demand for our high-value solutions. We drove sequential sales growth across each of our end-use markets, including double-digit gains in Aerospace and Defense, Energy and Transportation. This is an outstanding team effort by both our commercial and manufacturing teams. Our manufacturing team has worked to unlock the additional capacity needed to produce higher volumes of complex materials, while maintaining our strict quality, environmental and safety standards.

In addition to posting volume gains, we are also steadily transitioning our product mix to higher margin applications, while consistently expanding our total backlog, which was up 13% on a sequential basis during the third quarter and up 27% compared to last year.

Total Aerospace and Defense sales were up 18% sequentially, driven by growth across every one of our submarkets, including engines, which increased 19% over the prior quarter. In addition, the third quarter marked the fifth consecutive quarter of year-over-year sales growth in Aerospace and Defense. We expect demand levels in this market to remain strong. At the end of the third quarter, backlog for Aerospace and Defense was up 9% sequentially, marking the seventh consecutive quarter of growth, and up 35% on a year-over-year basis.

In the Energy end-use market, revenue growth in our oil and gas submarket once again outpaced the increase in the North American directional and horizontal rig count. This performance speaks to the success we are having deepening our customer relationship and gaining market share. From a business segment perspective, SAO delivered its best third quarter performance since fiscal year 2013 and the fifth consecutive quarter of operating margins above 15%. We continued to drive a stronger product mix through SAO, while also actively managing our operating costs. Our PEP business delivered another solid quarter, paced by increased sales at Amega West, which delivered its third consecutive quarter of profitability since the beginning of the oil and gas turndown.

During the quarter, we continued to expand the Carpenter Operating Model. Unlocking incremental capacity in this high demand environment has become the critical focus of the Carpenter Operating Model for fiscal year 2018. On last quarter's call, I noted that we had submitted VAP qualification packages for our Athens facility to the major OEMs for engine disk and marine quality materials. We view this as well-timed, as it corresponds directly with the aggressive aero engine ramp up and tight supply chain. More specifically, lead times for nickel billet remain extended. As mentioned earlier, demand levels continue to increase as seen on our 19% sequential increase in engine sales and our Aerospace backlog continues to grow. And we continue to see and capitalize on expedite order requests from major Aerospace OEMs.

For this quarter's update, I am encouraged with the progress we continue to make on Athens qualifications. During the quarter, we received VAP approvals on 3 specific grades from 2 key OEMs. While the recent approvals are associated with smaller volumes, they are important steps as we progress towards approvals that support more meaningful volumes. We have significantly elevated the value we deliver to customers and are a critical partner to enabling their success. However, we know their needs, and our industry will see significant change in the future. As such, we know that we must strategically invest for the future and strengthen our position as a critical supply chain partner and solutions provider for our customers.

Our solid financial position and strong free cash flow generation enables us to make these critical strategic investments. Last quarter, I discussed the investment we are making in our soft magnetics capabilities and capacity. This is strategically important given our market leadership in auxiliary power units for Aerospace, increasing penetration on the high-value consumer electronics market and the tremendous disruptive potential of electric vehicles. And now, we have strengthened our solutions offering in the additive manufacturing space through the recent acquisition of CalRAM. The CalRAM business provides us with direct entry into the rapidly expanding part production segment of the additive manufacturing value chain. This moves us closer to customers across each of our end-use market and will enable us to deliver an additive manufacturing offering from powder to part. In addition, our value proposition in additive manufacturing was strengthened by our recent agreement for an exclusive license for an innovative meltless titanium powder manufacturing process. This provides Carpenter with the potential to produce low-cost titanium powder and maximize efficiencies across the entire additive manufacturing development and production chain. I will talk more about our strategy in this market in a few minutes.

Let's move to Slide 6, and the end-use market update. We'll begin with Aerospace and Defense, where sales increased 18% sequentially and 22% year-over-year. Sales increased sequentially across each of our submarkets led by engines, avionics and distribution. Also, our Aerospace and Defense backlog reached a record level this quarter, while our engine submarket booking eclipsed last quarter's record level by 12%. During the third quarter, engine submarket sales increased 19% sequentially and 32% compared to last year. We remain well positioned given our participation on the new engine platforms, and we expect continued solid growth in this submarket.

Moving on to our fastener submarket, where sales were up 9% sequentially, but down slightly compared to last year. The current fastener market shows pockets of demand, but forecasting long-term demand remains challenging as the supply chain continues to adjust to the platform ramps. Looking at the structural submarket, our growth continues to be driven by critical materials used on key programs, including the A320 and the 737. This is a submarket where we see an expanding number of market opportunities for our solutions, given the breadth of our offerings and our expanding additive capabilities. At a time when OEMs are showing increased interest in the potential benefits of additive manufactured structural components.

Performance in our aero distribution submarket remained strong, as the channels are restocking inventory despite price increases. This is yet another indicator of the strong underlying Aerospace demand, given the major OEMs backlog of over 14,000 aircraft. Finally, sales in our defense submarket increased both sequentially and year-over-year due to program-specific demand.

Moving to the Energy market and a review of our oil and gas and power generation submarkets. Total Energy sales increased 15% sequentially, due primarily to higher rental and replacement activity at Amega West. On a year-over-year basis, Energy sales declined 9%, as a 35% increase in oil and gas sales was more than offset by lower power generation sales. As previously mentioned, our oil and gas submarket sales are consistently outpacing the North American directional and horizontal rig count, and Amega West is capturing incremental market share as activity levels rise. While activity at Amega West remains more heavily weighted on the rental side, we are seeing signs of an increase in replacement activity of critical tools by service providers, which is a positive sign for the overall market.

Key contributors to our success in the oil and gas business, including our strong position in the Permian Basin, the strength of our horizontal drilling and artificial lift solutions and our deep relationships with major service providers. It's not surprising that certain production bottlenecks have arisen, given the concentrated drilling activity in the Permian Basin. Today, we are working closely with our customers to break those bottlenecks by improving the life of the tools we sell and rent and developing innovative solutions, including additive manufactured solutions.

Looking outside the Permian Basin, we remain well positioned to support our customers as activity increases in other key regions. Global conditions remain largely supportive of rising oil prices, while expected North American spending budgets remain healthy. Outside North America, conditions remain more subdued as higher crude oil prices need to be sustained before activity meaningfully accelerates.

Lastly, the power generation submarket remains at historic low levels due to industry-wide challenges in industrial gas turbines, or IGT. The replacement cycle for the current aging-turbine fleet has been delayed, which is impacting us and other industry participants. But keep in mind that power generation submarket currently accounts only 1% of our total net sales.

Transportation sales increased 14% sequentially as demand increased across multiple product applications for the North American light vehicle market and in heavy truck, where the recovery continues to strengthen. On a year-over-year basis, Transportation sales rose 8%. Compared to the same quarter last year, we are clearly seeing a favorable shift in product mix as sales of our high temp products have outpaced the lower-value materials. The expectation for North America light vehicle production in calendar year 2018 remains below prior year levels. However, Carpenter remains well positioned as we offer a broad suite of products addressing key OEM challenges, such as heat resistance, corrosion and light weighting. We are also well positioned in the light truck segment of the U.S. market, where sales are expected to outpace passenger sedans. Outside the U.S., we remain hard at work, increasing our penetration and market share in key regions, including Europe and China.

Moving on to the medical market. Sales were up 1% on a sequential basis and 19% compared to last year. Our sequential performance was impacted by the short-term disruption related to the fire at one of our Dynamet facilities. Excluding the impact of the Dynamet fire, we estimate medical sales would have been up 10% sequentially. Our sequential and year-over-year growth reflects ongoing strong demand for our titanium solutions as well as the impact of the notable share gains we have captured in the orthopedic and cardiology submarkets. We maintain strong relationships with our key medical distributors and are making further progress deepening our connections at the OEM level, given our diverse product portfolio.

In the industrial and consumer end-use market, sales were up 3% sequentially and 8% on a year-over-year basis. The increases were driven by higher demand for select industrial applications, partially offset by lower consumer sales.

Now I will turn it over to Damon for the financial review

Thank you, Tony. Good morning, everyone. Turning to Slide 8, in the income statement summary. We generated significant improvement in our operating results in our fiscal third quarter. We benefited from the successful execution of our commercial strategy, coupled with the improving market conditions as well as our focus on driving the improvements through the Carpenter Operating Model. The quarter marked our best third quarter operating income performance since fiscal year 2014.

We delivered year-over-year revenue growth in 4 of our 5 end-use markets. Although Energy was down, it is solely related to the industrial gas turbine industry and the corresponding adverse impact on the power generation submarket. Overall, we're capitalizing on strong demand trends across multiple end-use markets, building share through increased business among current customers while creating new relationships with companies that recognize the unique value proposition we offer.

Net sales in the third quarter were $572 million or $473 million, excluding surcharge. Sales, excluding surcharge, increased $57 million on a sequential basis on a 14% increase in volume. This increase reflects revenue growth across all our end-use markets as well as favorable mix. On a year-over-year basis, sales, excluding surcharge, increased 14% on a 9% gain in volume, led by a 22% increase in Aerospace and Defense and a 19% gain in medical.

SG&A expenses increased by $5.9 million on a sequential basis at $50.8 million, reflecting the timing of certain expenses. For the fourth quarter, we expect SG&A expense to be in the range of $47 million to $50 million. Operating income as a percent of sales was 9.7% in the quarter, excluding pension EID. This was effectively flat compared to the 9.9% in the second quarter and down slightly from 10% in the third quarter of fiscal year 2017. Operating income in the quarter was negatively impacted by the cost associated with the fire at our Dynamet facility in January. Excluding these costs of approximately $3 million, operating income as a percent of sales would have been over 10% and up both year-over-year as well as sequentially. In addition, given the increase in certain commodity costs, the headwinds related to the raw material surcharge lag continued for certain customers.

Our effective tax rate for the third quarter was 19.9%. The reported rate includes an income tax benefit of $1.6 million in the quarter, resulting from our continued assessment of the impact of U.S. Tax Reform that was enacted in December of 2017. Excluding the special tax item, our tax rate in the third quarter would have been 24.1%. For the fourth quarter, we expect our tax rate to be in the range of 26% to 28%. We reported net income of $30.2 million in the third quarter or $0.63 per share. Excluding the impact of the tax special item, adjusted diluted earnings per share would have been $0.60 for the quarter, which was up from $0.55 in the second quarter of fiscal year 2018 and $0.44 in the third quarter of last year.

Now turning to Slide 9. We generated free cash flow of $35 million in the third quarter, representing a notable improvement compared to the negative $11 million in the second quarter of 2018. Our free cash flow performance in the quarter is a result of our strong revenue performance. The shipment volume and ongoing work by the operations team drove a $41 million reduction inventory for the quarter. Regarding inventory, we currently expect to further reduce inventory by around $40 million in the fourth quarter, which would effectively keep inventory flat on a full year basis versus June 30, 2017 levels on a total company basis.

Within that guidance, we expect a reduction in SAO's inventory for a full year as a result of the increasing demand levels and ongoing efficiencies gained from the Carpenter Operating Model. However, given the strengthening demand in our Amega West business over the last few quarters and the correlating impact on its inventory, we expect this increase will largely offset the SAO inventory reduction. As we said in the past, we will continue to align our inventory levels with the opportunities and trends we see across our end-use markets. Also, during the quarter, we acquired CalRAM for approximately $13 million as part of our growth plans and additive manufacturing, which Tony will touch on in a moment.

Finishing up on free cash flow, we spent $25 million in capital expenditures during the quarter, essentially in line with the $27 million spent in the second quarter of fiscal year 2018. We continue to invest in core growth areas, including additive manufacturing and soft magnetics as we look to strengthen our long-term growth profile and become an increasingly critical solutions provider to our customers. For the year, we expect capital expenditures to be in the range of $130 million to $135 million.

Turning now to Slide 10, and a brief review of our capital structure. We remain committed to maintaining a strong liquidity position and healthy balance sheet. As of March 31, we had $441 million of total liquidity, including $47 million of cash and $394 million of availability under our credit facility. We have $55 million of long-term debt maturing in the upcoming fourth quarter that we currently expect to repay with cash. Beyond that maturity, we have no debt obligations until fiscal year 2022. We also have no significant required pension plan contributions until fiscal year 2022.

Our financial position remains solid. We are focused on leveraging our balance sheet and free cash flow generation, while investing in next-generation growth areas. We have the right strategy to capitalize on current conditions, improve our manufacturing operations, increase our capacity and strategically invest in our future, while still returning capital directly back to our shareholders.

Now turn to slide 11, and our SAO segment results. SAO delivered another solid quarter with net sales of $482.4 million or $381.3 million, excluding surcharge, representing an increase of $49.5 million or 15% on a sequential basis. On a year-over-year basis, sales, excluding surcharge, were up $59 million or 18%. This sequential increase was supported by the successful execution of our solutions-focused strategy and increased demand across our end-use markets. As Tony highlighted, our backlog increased on both the sequential and year-over-year basis.

Operating income was $58 million, up $8.2 million compared to the second quarter and up $6.1 million year-over-year. This quarter marked SAO's best third quarter operating income performance since fiscal year 2013. Operating margin was 15.2% compared to the operating margin of 15% in the second quarter and down from 16.1% in last year's third quarter. Operating margin performance was impacted by the timing of certain expenses in the quarter as well as the continued raw material surcharge lag, which, based on current commodity prices, will persist into the fourth quarter.

We continue to benefit from the Carpenter Operating Model as we capture manufacturing improvements and identify pathways to unlock capacity which is increasingly important given market conditions and increasing customer requirements. The Carpenter Operating Model allowed SAO to ship the most tons since Q3 of fiscal year 2015, but with a much richer and more complex mix as we focus on those customers who value the solutions we offer.

Looking to the fourth quarter, we continue to see healthy demand trends across most of our end-use markets as reflected in the notable growth in our backlog. As we continue to execute our solutions-driven commercial strategy and build share and extend the benefits of the Carpenter Operating Model, we currently expect SAO operating income to increase up to 10% on a sequential basis.

Now turning to Slide 12, and the PEP segment overview. On a year-over-year basis, PEP sales, excluding surcharge, increased 9% or $9 million to $107.5 million. On a sequential basis, sales rose approximately $3 million. This was PEP's sixth consecutive profitable quarter, while Amega West achieved its third consecutive profitable quarter. Operating income for the quarter was $5.4 million. The $5.4 million reflects the net impact of the strong underlying operating performance for the PEP businesses, coupled with a net cost related to the fire at one of our Dynamet facilities of approximately $3 million in the quarter.

Over the last several months, the team has done an exceptional job in both minimizing the impact to our customers and to Carpenter, while beginning the restoration process. More importantly, the teams has been able to accomplish these major tasks without any safety-related incidents. I want to thank everyone who's played a role in helping minimize the impact of this event for our customers as well as our associates. It's in these types of challenging times that you see people's true commitment and passion.

Looking at the fourth quarter, we expect to see strong demand for our titanium products and a further increase in activity levels at Amega West. We will, however, continue to deal with increased costs associated with the servicing of some of our customers, while we work on the restoration of the Dynamet facility. For the fourth quarter, we expect PEP operating income to increase approximately 55% to 60% versus the $5.4 million in Q3.

In summary, strong execution of our solutions-focused approach is driving revenue growth across our end-use markets and broadening the application areas for our products.

Now I'll turn the call back over to Tony.

Thank you, Damon. We firmly believe the future of our industry and that of our customers across every end-use market is going to be impacted in some form by additive manufacturing. Our strategy to be a leading solutions provider and an irreplaceable supply chain partner relies on our ability to evolve and best position Carpenter at the forefront of disruptive change. Customers across all of our end-use markets are actively exploring additive manufacturing, as they seek to elevate the performance of their products and meet ever-increasing design requirements for mission-critical applications.

A growing premium is being placed on characteristics, such as light weighting, corrosion resistance and a product's ability to withstand high temperature, stress and thermal variation. Today, we produce many power grades that we have engineered specifically for additive manufacturing, including Puris 5+, the world's first high-strength, low-oxygen titanium power solution. In fact, Puris 5+ exceeds standard grade 5 strength levels by nearly 18%, giving 3D part designers significantly more flexibility in their designs. We currently have an additive manufacturing R&D center that is focused on exploring and developing new and improved additive manufacturing alloys and qualified additive processes with the goal of creating better parts for our customers.

In addition, as we announced last quarter, we are finalizing plans to build an industry-leading emerging technology center, focused on key growth platforms, including additive manufacturing, where under one roof, we will have the capability to go from powder to part.

In February, we significantly enhanced our capabilities through the acquisition of CalRAM, a leader in power-bed fusion additive manufacturing metal printing services. CalRAM brings parts production to our existing capability, and it will allow us to create a turnkey additive manufacturing offering to a broad range of customers. This vertical integration positions Carpenter as a total solutions provider for customers in the rapidly expanding active manufacturing space by starting with our customers application requirements and providing solutions at each step of the additive manufacturing process. Immediately after the acquisition of CalRAM, we began hearing from customers in all of our end-use markets who clearly recognize the potential of combining our existing metallurgical processing expertise and additive manufacturing grade feedstock capabilities, with a leader in part production.

In addition, it is exciting to report that our position in additive manufacturing is also strengthened by an exclusive license agreement that we recently entered into for an innovative meltless titanium process. This innovative process has the capability to uniquely tailor titanium powder for additive manufacturing applications across multiple end-use markets. We believe that this capability, along with the potential for substantial cost reductions in the manufacture of titanium powder, will help unlock an expanding number of additive manufacturing opportunities and other high-performance application areas. Although commercialization of this process will take some time, we are excited about its prospects and its ability to further advance our competitive position.

Building a leadership position in additive manufacturing is a critical component of our long-term growth strategy. We remain focused on positioning Carpenter as an industry leader from feedstock development and part design to commercialization and final part supply. This total solutions approach can be a major competitive advantage at this crucial stage in the evolution and adoption of additive manufacturing.

Now let's turn to Slide 15, and my closing comments. During the third quarter, we built upon a fiscal year-to-date performance through strong commercial and operational execution. The transformation initiated several years ago is bearing fruit and is well timed given the robust demand environment in our key end-use markets. Our solutions approach is driving revenue growth across our end-use markets as we capture market share, expanding our customer relationships and consistently growing our backlog. The benefits of our diverse participation in Aerospace and Defense is clear, and Carpenter is well positioned as the engine ramp continues and the overall Aerospace cycle accelerates.

Activity levels in the oil and gas submarket are increasing, and we are focused on continuing to build upon our recent market share gains. Given the overall high demand environment, our implementation of the Carpenter Operating Model is increasingly focused on maximizing capacity across our facilities. This will allow us to capitalize on our strong commercial execution and the tailwinds we are experiencing across all our end-use markets.

During the quarter, we received VAP approvals on 3 specific grades from 2 key OEMs, a critical time for the Aerospace industry, with robust build rate and extended lead times. Our Athens facility will provide that much needed incremental state-of-the-art capacity for the industry.

Investing in the future of our industry will remain a critical element of our strategy. In the last year, we have secured immediate entry into the titanium power market with the Puris acquisition, announced a major investment in the high-growth, high-value soft magnetic space, launched our first additive manufacturing technology center, and announced plans for a new state-of-the-art emerging technology center, significantly enhanced our presence in the additive value chain through the acquisition of CalRAM and its additive manufacturing production capability, and secured an exclusive license for an innovative meltless titanium power technology that has the potential to transform the industry. We are making the strategic investments in core growth areas to position our ourselves for long-term sustainable growth and increasing value for shareholders. Carpenter today is a significantly stronger company in every way. Our customers recognize the value of our brand and view us as a critical supply chain partner.

Thank you for your attention, and I will turn it back to the operator to field your questions.

(Operator Instructions) And today's first question comes from Josh Sullivan with Seaport Global.

Just on the Aerospace side, Airbus has been making some comments about taking rates up on the A320, Boeing's indicated there's upward pressure on the 737. However, there were some other comments out of the engine supply chain suggesting that there's challenges getting to those elevated rates. How is Carpenter's capacity to potentially meet those elevated levels, either at SAO on any particular grade or even in PEP with the fastener facilities?

This is Tony. A couple points there. Number one, we've increased our capacity across our legacy assets over the last 12 months. So we've been able to step up and supply that demand, especially on the expedited orders that we've received over the last couple of quarters. That's number one. Number two, the biggest opportunity is we have Athens coming online. So we've received qualifications, as you know, for 3 specific grades for 2 OEMs, that will open up enormous capacity in the short term. And then specifically on Dynamet, we are investing in both of our facilities in Washington in PA, and in Clearwater, Florida.

Great. So if we did go to those levels, your capacity wouldn't be one of the issues?

Well, I think that when you look at specialty alloys, that is a tight market. And that's why I think Athens coming online right now is perfect timing. So we anticipate our ability to meet that demand.

Okay, great. And then just one on the medical side, should we expect to see the demand that was held back by the fire this quarter? How long do you think it's going to take for that demand to release over the next couple of quarters here?

Yes, Josh. So as we mentioned, that we're in the midst of the restoration process right now. As I mentioned last quarter, we've sort of looked at alternative sources to supply these customers, either working with other Carpenter facilities we're potentially outsourcing. The restoration process is going to probably take us at least another 1 to 2 quarters to get things back up and running to its normal run rate. But in the interim, we're working to service the customers in these alternative paths to sort of recover that volume, but again I think what you're going to see is the volume starts to come back over the next 2 to 3 quarters, but the cost of doing so will be somewhat elevated over the next 2 quarters.

Okay, great. And then just one last one. What's the time line of the soft magnetics investments? Is there any qualification time period that we should be thinking about? Or just how should we look at that investment?

It will take us about 2.5 years to bring that online. We like to do it sooner. The qualification cycle will be minimal.

And the next question comes from Chris Olin with Longbow Research.

Let me just start off by congratulating you on getting those approvals at Athens. I know it's been a long patient process, so good job.

Thank you.

Just in terms of Athens, can we get an update on where the operating rate is today, perhaps any guidance you can give? Or update in terms of what the EBIT impact on the quarter was? And how these approvals perhaps change your time line now?

Yes, these approvals do not change our time line at all because we expected them. You remember on the last call, I said that I thought we would have a couple by the end of our fiscal year, a couple of those have come in as we've reported. Keep in mind that those are on the smaller volume grade. That's a normal progression as we move the qualification cycle down the field. And I can tell you that, as we speak now from an incremental standpoint, which is -- when you think about utilization at Athens, it's important to say what's the incremental utilization. And that is about 10%, which it was last quarter as well.

And then any terms of how should I think about in terms of what the EBIT headwind is for that asset right now?

Well, Josh, what we've said is without any incremental, there's about $40 million of cost per year, about $20 million of that was depreciation and about $20 million of that was the cash costs. And when we were running at utilization rates at below 30s, call it 32, 33, we were sort of saying that none of that was really incremental. So you can sort of back in, as Tony gives you the utilization rates being up around 40 now. You can sort of back into sort of what that delta is or what that incremental component would be.

Okay. And then when I back into that number, it still seems like the margins maybe were a little bit light. And I know you referenced some early costs, I was wondering if you could be more specific in terms of what the impact was there?

Yes, I'll take that one. I think it's fair to say that Athens is not really contributing anything for margin expansion. I mean, Athens, even at these rates, is a drag on our overall margin expansion. So it's not a positive to this date. But it is a good question when you talk about the SAO margins and some we spent quite a bit of time on. I think it's important to remember, as you've noted already, just you take a step back, you had the SAO segment just delivered the best quarter since fiscal year 2013. But that said, certainly there's a lot of upside on the margin. Damon mentioned that we had the material -- raw material surcharge lag. We also had the timing of certain expenses as we get to the end of our fiscal year. And if you would just eliminate those 2, that would increase your margins by about 200 percentage points -- or basis points, sorry. That's puts you in the 17% range. We know that, to date, that our cost reduction efforts haven't been where we want them to be when we talk about 3% year-over-year, primarily because the mix has gotten richer, so the complexity has gotten tougher, and that we put a focus on increasing capacity and supplying every one of those expedited orders we get from our customer. So we are going to sacrifice cost in some ways to make sure we get that product out the door for customers when they need it, because they can't get it from another source. So if you take that into consideration and as Athens comes online, you can see a path to 20% and above fairly quickly.

Okay. That's very helpful. And the last question I had is, just looking at Dynamet specifically, has that company been affected by what looks like slower demand or destocking taking place on the fastener's side, especially in Europe? I guess, I'm not sure how to think about the leverage or the mix between Boeing and Airbus?

We see the normal patterns on the fastener business. Remember, we produce titanium and nickel, so over the last several quarters, there's not been any real difference. Dynamet, in fact, as you see in the numbers, is one of the main reasons why the PEP segment is doing so well. As I said, we're increasing capacity in both the Clearwater facility and the Washington facility, primarily on to serve the medical market, but Dynamet is on the rise right now, and we see good numbers coming out of them over the next couple of quarters.

(Operator Instructions) And the next question comes from Gautam Khanna with Cowen and Company.

Couple of questions. I think you mentioned, Tony, in your opening remarks that you're seeing expedited orders. And I was wondering if you could expand upon, in what product areas are you seeing those? And why you think you're seeing them? Is it just because the pace of demand is quickening? Or is it because some of the other suppliers that manufacture these products are coming up short? And in what product areas?

We're seeing that across many of the Aerospace submarkets, right? And it has to do with quality, with the extending lead times. And yes, there are some suppliers in the market that are not supplying as required. As I said, we take every one of those calls. We step up on every one of those requests. And as I said on the earlier question, we're willing to sacrifice some costs right now to manipulate our process flow and get them into the queue.

Okay. So when you say it's across all the subareas, you mean from fasteners to no product destined to jet engines to airframe, structural parts, everything?

Yes, but primarily...

Is it pronounced in -- yes?

Primarily on the engine, aero engine and aero structural side.

Okay. And then to follow up on your comments about the faster markets sort of, you said it was up sequentially. Could you quantify how much? And it sounded like in response to Chris' question, you were suggesting that it's going to accelerate over the next 2 quarters? I want to make sure, is that Aerospace fasteners? Or is that medical product out of Dynamet? What are you seeing in the fastener market?

Yes, good question. On aero fasteners specifically, we were up about 9% sequentially. We were down about 1% to 2% year-over-year. When I talk about -- and into the second part of your question, when I talk about Dynamet going forward, obviously, Aerospace fasteners is a solid business for us. But the majority of the growth that we see in Dynamet and primarily why we're investing capital is on the medical side.

Okay. Any explanation that you can come up with for why does aero fastener business on a year-on-year basis is a little bit more subdued?

I don't think there's anything specific there for us, Gautam, as far as the year-over-year.

Okay. And then another comment in your opening remarks about backlog being up 9% sequential. I wanted to clarify, was that for the entire company? Or was that at SAO? And related to that, normally we enter a seasonally strong June quarter, which you've guided to. But then it's usually followed by a pretty sharp reduction in the September quarter due to the normal seasonality in the industry. How should we think about your backlog comments, given -- it seems like it might portend a less seasonal kind of pattern this year in September and in separate quarters?

Yes. I talked about this briefly last quarter. I think, from a seasonality standpoint, it's all going to be about how many days are in that quarter, right? I understand that there's seasonality in Europe during the summer months. I understand that there's certain quarters where there might be shutdowns, but we're running as fast as we can. We're continually working to open up capacity. As I said, we continue to get expedited orders. So for us, seasonality means how many days are there in the quarter, and how does that differ from any other quarter.

And with that then, September, typically I don't remember the exact number, but it -- at times, it's around a 15% decline sequentially in terms of top line, and then the associated impacts on margin. Is it safe to say that this year, it will be less of a decline, because, I mean, it's not like the number of days are that dramatically different, September versus June in terms of your own -- Carpenter's ability to produce. So I'm just wondering, is that step down is going to be a lot less than what we've seen historically?

Yes. And for us, I think Tony alluded -- he's talked about the market impacts that we see sort of a reduced impact year-over-year as we go from Q4 to Q1. Remember, as we talked in the past, during our fourth quarter and into our fiscal first quarter, we do have some operational and some preventative maintenance that we go through. So as we go through that summer holiday, we go through a period of time where we're not really utilizing the assets. So even though there may be holidays, differences, we do have a period of downtime here, which usually increases the costs, and thus has a negative impact on the margin. But there's nothing unique to our first quarter beyond traditional first quarters other than we seen stronger market demand than what we did last year.

And Gautam...

And one last one...

Sorry, I wanted to answer your question before that. I omitted there. The backlog sequential growth, the 13% is on total Carpenter. And when I mentioned, just so you know, total Carpenter Aerospace is, the backlog is up 9% sequentially.

Okay. Last one, you alluded to the 20% SAO kind of bogey way out there. When do you think realistically is the soonest that's possible? In what quarter? I mean, because it seems like you're progressing well. You've kind of turned the corner. Demand's cooperating. I just wonder, are we 8 quarters away from that? 4 quarters away? What's your best guess with that, obviously? I'm not going to hold you do it. I'm just curious what you think is achievable?

I think it depends on Athens, right? So if we can get Athens to a reasonable level by the end of this calendar year, then I think you can be touching -- I think you can be bumping up against the 20%. I mean, I believe we're running in the 17% range right now. That's doable today, even with the Athens drag. So let's get Athens to a point that it's not a negative on the margin, and let's get back on track and get that 3% variable cost reduction. I think you're right at 20%.

And the next question comes from Phil Gibbs with KeyBanc Capital.

I had a question on the jet engine business, specifically. I think, you mentioned it was up pretty strongly quarter-on-quarter. But any color, Tony, on what that comparison was year-over-year?

I can tell you that, it was up 32% year-over-year. So 19% sequentially, 32% year-over-year.

Okay, perfect. And then also some of the commentary on the expedites. Where are you specifically seeing that? Because I know that on a lot of your products, you are qualified and probably you're most likely under contract. So help me understand in terms of why you would be seeing the level of expedites given the fact that a lot of your business is under contract and under program-based agreements?

Well, we sell, as you know, Phil, to all of those customers, we don't always have 100% share. So we're producing those products today when they have a shortfall in the market, whether it's due to quality or lead times, we're able to step in and effectively increase our market share in those areas.

Okay, perfect. And then any color outside of the fastener business on the structural side of Aerospace in terms of how that business is faring year-over-year?

On the structural side year-over-year -- I mean, if you take structural, fasteners and avionics and combine them together -- I'm just looking at the numbers real quick, I think, year-over-year, we are up 12%.

Okay, perfect. And then just to dig a little bit deeper on the Athens side. When you say 10% is incremental to Athens, do you mean 10% of the 40% capacity? Or do you mean 25% of the 40% capacity?

I mean 25% of the 40%.

Okay. And where is that -- where's most of the incremental coming from right now? Because I know when you were first getting that ramped up, it was -- a lot of that was tailored to oil and gas. But are you starting to texturize in the mix here?

Yes, we're making some Aerospace materials down there now that aren't on specific VAP or VAP approvals are not required, so we'll move back down to Athens. As we continue to pick up approvals, we'll -- we will move to Athens as well. So there is Aerospace material being run at Athens today.

Okay. I appreciate that. And last question on -- from me is on the oil and gas side. Clearly, seeing a pickup in rig count here domestically. I know your business can be a little bit more balanced between U.S. and international. So maybe some color in terms of what you're seeing here and abroad, and where should we see -- basically, where are we seeing the strength and perhaps less strength when you look at your entire basket. I'm not talking about PowerGen, just the oil and gas upon itself. And I think that's -- and then just a general comment maybe on what you see the inventory positioning out there from the customers?

Okay. Thank you, Phil. Yes, for us, I mean, Amega West is primarily a North American sales business, specifically the Permian Basin. So that is really what's been driving the growth. The international side, as I think I might said in my comments, are lagging a bit. I think you're going to have to see the oil price stay a bit more consistent to see any type of activity there. But right now, I can tell you, we're staying awfully busy just supplying to North American market. I'll let Damon take the inventory question.

Okay. I think the question is what we hear from -- so I think your question is more what do we see in the field for the customers' inventory levels. That's correct?

Yes, correct.

What we hear from -- at least from the Amega West side of the house, again, is that customers are starting to rebuild some of their inventory levels at a slow pace. I would tell you they're being cautious. But as you've heard us talk over the last couple of quarters, we are -- we've seen more activity on the rental side of Amega West versus the manufacturing and sales side over that -- over the last quarter-plus-or-so, we are seeing more demand coming in on the manufacturing side, which is what alluded to my comment about the inventory as do you have Amega West building more tools, not only the service on the rental side, but ultimately for the sales as they sell that into the marketplace. So market appears to be getting stronger, but at more of a cautious, cautious pace.

Is there any broad impact, positive or negative, from a lot of these geopolitical headlines we're seeing from the Russian situation? I know they do have some tentacles in the Aerospace supply chain and maybe some industrial titanium, but anything that you guys can point to in terms of disruptions or customer concerns or anything that you're seeing? I've -- I have heard that some certain off-contract titanium prices have gone up, but I know you're probably pretty hedged from that, but just anything that you can point to would be helpful?

Yes. Phil, nothing material to report from our side. I mean, obviously we monitor this issue -- the situation actively. And as you said, a lot of things going on out there, but no real direct impact to Carpenter, and we talk to our customers -- sorry to our suppliers. And again, as we ask the questions, most don't feel to be at disruption. If they do, they are contingency plans. They have already in place and have reviewed with us. So again, as we sit here today, we feel like -- we feel okay, so far.

And next, we have a follow-up from Josh Sullivan with Seaport Global.

Yes, I just had a question on -- have you seen any increased requirements on inspections at the manufacturing level? Are you seeing any increased ultrasonic or nondestructive testing just given what's happened with the CFM 56 engine recently or even on the supply chain with the next-generation engines?

Well, Josh, obviously, the industry is very strict today. But we have not seen any additional requirements come out of that specific incident. I think it's still very early days.

Thank you. And as there are no more questions at the present time, I would like to turn the call to Brad Edwards for any closing comments.

Thanks, Keith, and thanks everyone for joining us on our third quarter earnings conference call. We look forward to speaking with you all again on our fourth quarter call. Have a great day.

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.