Brad Edwards - IR Tony Thene - President & CEO Damon Audia - SVP & CFO.

Gautam Khanna - Cowen & Company Josh Sullivan - Seaport Global Phil Gibbs - KeyBanc Capital Markets.

Good day, and welcome to the Carpenter Technology Third Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note that this event is being recorded.

I would now like to turn the conference over to Brad Edwards of 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, 2017. 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 Carpenter's most recent SEC filings, including the Company's December 31, 2016 10-Q and the exhibits attached to that filing.

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, and special items.

When referring to operating margins, that is based on sales excluding surcharge, and operating income excluding pension, EID and special items. I will now turn the call over to Tony..

Thank you, Brad, and good morning to everyone. As always, I will start with a safety update on Slide #4. Year-to-date in fiscal year 2017, our total case incident rate, or TCIR, remains at the 2.0 level.

Our focus on safety includes many initiatives, the three most significant being hand safety programs, our leadership development program and human performance training. Our facilities continue to focus on leadership, systems and employee engagement.

We have ramped up our employee engagement efforts, launched enhanced safe teams at all of our operating facility. Employees are working to develop tools and methods to reduce hand and finger injuries, which account for about 40% of all reportable injuries.

Furthermore plant leadership is conducting one-on-one safety discussions with every employee to ensure they understand their role and accountability to work safely in collaboration with their colleagues to create an injury-free workplace.

We started the deployment of our Human Performance initiative, which is focused on improving our capabilities to recognize air traps and minimize the potential for deviation from standards that lead to injuries.

We continue to transition from a knowledge-based to a rules-based approach, and in time in interdependent state where employees work every day with the mindset of being responsible for their own safety as well as that of others. Our ultimate goal is clear and will never change, that is to become a zero injury workplace.

It's not a stretch target or an unattainable dream. We truly believe it is possible. In fact we have examples inside of company today. Earlier this week, our Athens, Alabama facility achieved a milestone of three years without a recordable injury, and our Hartsville, South Carolina facility has operated for more than 310 days without recordable injury.

Congratulations to both facilities. Turning to Slide #5, and a summary of our third quarter results.

We delivered a strong third quarter, driven by sequential revenue growth across all of our end-use markets, strong commercial execution and the benefit of additional cost efficiencies achieved through the ongoing implementation of the Carpenter operating model.

In our largest market, Aerospace and Defense, which accounts for over 50% of our sales year-to-date, we experienced an 8% sequential increase in sales. This is following a 15% sequential increase in the previous quarter.

The recovery in the oil and gas submarket remains in its early stages but we are encouraged of what we are seeing in the marketplace, including the North American directional and horizontal rig count exceeding 900 rigs, which represents the third consecutive sequential quarterly increase.

Our two business segments, SAO and PEP, both delivered notable milestones during the fiscal third quarter. At PEP, we generate positive operating income for the second consecutive quarter with improvements across every one of our businesses.

This includes Amega West, where increased rental activity and reduced cost base continues to result in improved results. Our Dynamet titanium business expanded its operating income as a result of strong demand for our titanium products and the early benefits of the Carpenter operating model.

I am pleased with the improvement in PEP but I know that this segment can deliver much more. I'm excited about the future, as our teams execute on the new market opportunities in front of them while also embracing the implementation of Carpenter operating model.

In SAO, the third quarter operating income was just shy of $52 million and margins increased to 16%, both the highest levels we have achieved in almost three years.

Again, this improvement is driven by strong commercial execution in terms of its solutions-based mentality as well as variable and fixed cost efficiencies achieved through the ongoing implementation as a Carpenter operating model.

I speak frequently about the Carpenter operating model because it is fundamentally changing the way we conduct business every day. Let me give you three recent examples.

In our billet conditioning department at Reading operations, we developed and trained to standardized work that provides training in terms of content, sequence, timing and expected outcomes, including key safety and quality points.

In addition, we implemented hour-by-hour boards that provide production requirements, current status to target, problems encountered and problem-solving via engagement with employees. Projected savings from yield and labor efficiency improvements to be realized through these actions could be as high as $3 million annually.

In our wire inspection area in Reading operations, we completed work center redesign and a waste elimination study. As a result, we eliminated non-value-added task and maximized product flows breaking the bottleneck and reducing excessive overtime.

The improvements increased capacity and has allowed us to compete for additional business, and if successful, could yield up to $4 million in additional operating profit on an annual basis. Our ultrasonic inspection station at Latrobe operations has long been a production constraint.

A three-day kaizen was conducted with a cross functional team including operators from our shifts. A total of 25 improvements were identified and prioritized throughout the week to reduced total setup time.

Immediate improvements reduced total setup time by approximately 25% and future planned improvements anticipated to reduce setup time by as much as 50%. Initial improvement will increase product flow and contribute up to $1 million of additional operating profit.

These are just a couple of examples to illustrate the impact that the Carpenter operating model is having on our operations. Moving onto our order backlog, we finished the third quarter with our backlog of 14% on a sequential basis, which is robust growth, given the 18% increase in backlog we generated in the previous quarter.

Our reformulated commercial strategy continues to deliver results and we are capturing market share gains across many of our end-use markets. We are focused on positioning ourselves to pursue a range of attractive growth opportunities by expanding our capability.

The strategic mandate is reflected in our recently completed titanium powder's acquisition. This transaction provides Carpenter with immediate entry into the titanium powder's market, strengthens our additive manufacturing presence and expands our capabilities as a solutions provider for our customers.

And lastly, we remain in a solid financial position.

We believe this is a clear strategic advantage and we are free to deploy our cash flow to the highest return projects with no major debt maturities until fiscal year 2022 and minimal required pension plan contributions for the next several years, we have significant flexibility to accelerate the growth of our business with strategic investments by the titanium powder's acquisition, by proactively improving our balance sheet like the $100 million voluntary pension plan contribution made last October or by deploying direct returns to our shareholders.

We will always remain balanced in our capital allocation with a goal to lock in or standing as an irreplaceable partner and maximize value for our shareholders. Let's move to Slide 6, the end-use market update. Starting with Aerospace and Defense, where sales ex-surcharge increased 8% sequentially and were up 3% compared to last year.

In the engine submarket, sales were down sequentially due to the impact of order timing from a key customer. Excluding this customer, the engine submarket was up double-digits sequentially and year-over-year, as it was in the previous quarter. We continue to see strong overall demand in the engine market as the new platforms ramp up.

Our engine bookings are up and our backlog is increasing. We currently expect to realize a sequential increase in our engine submarket sales in our fiscal fourth quarter. Our aerospace fasteners submarket delivered a strong sequential improvement, as we saw some customers rebuilding inventory during the quarter.

This was our second straight quarter sequential sales growth for fasteners, which is an encouraging sign, even though the submarket was down on a year-over-year basis.

Results in our aerospace structural and distribution submarket, was very strong on a sequential basis and up year-over-year, as we are seeing some of our distribution customers rebuild their inventory.

For visibility in this market is limited given the highly transactional nature of the business but we remain optimistic over the long-term given what we are hearing from the market. Lastly, our defense submarket revenues were up both sequentially and year-over-year due to increases in select programs.

Turning to our energy market, which consists of our oil and gas and power generation submarkets. Energy sales increased 35% on a sequential basis, driven by a 40% increase in oil and gas sales and a 28% increase in power generation sales. Energy sales were also up on a year-over-year basis driven by oil and gas.

We continue to see improving conditions in the oil and gas submarket, though the recovery remains in its early stages. The North American directional and horizontal rig count is up 34% sequentially and 51% year-over-year. This includes substantial activity in the Permian Basin, where we are well positioned, as well as other emerging regions.

The increase in directional drilling activity is driving continued improved rental in replacement order activity at Amega West. Importantly, we are also seeing capital spending increases in North America, largely concentrated in the Permian Basin.

During the recent downturn, we've placed strategic emphasis on connecting with our customers and strengthening our relationship. Those efforts along with our focus on managing our cost puts us in position to drive profitable growth and gain market share as overall volume levels increase.

In the power generation submarket, those were up sequentially but down year-over-year due to a large order we booked last year. As we look ahead, we continue to see opportunities in power generation given the replacement demand in the industrial gas turbine, or IGT market, but quarter-over-quarter comparisons could be mixed.

Moving now to transportation. On a sequential basis, sales were up 9% on the back of solid demand in the light vehicle segment. While we are seeing some declining production rates at select OEMs given high inventories at the dealership level, we are more than offsetting that headwind to share gain with other customers.

On a year-over-year basis, transportation revenues was down due to the cyclical downturn in the heavy-duty truck market. However on an optimistic note, heavy-duty truck production is beginning to rebound from its bottom.

We remain enthusiastic about our participation in this market, given the expected improvement in heavy-duty truck production as well as North American calendar year 2017 light vehicle production estimate remaining near record levels.

Today, Carpenter is one of the few exhaust material suppliers in this market and we have a product offering that is suited to help OEMs meet stringent performance requirements.

We generate a notable sales growth in our medical end-use market as strong demand for our titanium solutions and improving market condition help drive 26% sequential level in growth. We also continue to experience strong customer interest in our other high-end solutions, including our nickel and cobalt-based product offerings.

On a year-over-year basis, medical sales were up mainly due to a more stabilized supply chain at the distributor level. Overall, we are having success gaining share in the titanium market, while we also drive sales for our other differentiated high-end products.

It's worth noting that our acquisition of the titanium powder's business has resulted in a significant interest for our medical customers. In the industrial and consumer end-use market, sales were up 13% sequentially and 3% year-over-year with growth in both submarkets.

On the industrial side, sales were up versus both periods due to improvements across most of our product areas with distribution, oil and gas and semiconductor submarkets driving the majority of the growth.

In our consumer submarket, sales were up both sequentially and year-over-year, driven primarily by increased activity in electronics market ahead of new product introductions. Now I'll turn it over to Damon for the financial review..

Thank you, Tony. Good morning, everyone. Turning to Slide 8, and the income statement summary. We delivered a notable improvement in our financial results during our fiscal third quarter, highlighted by healthy sequential revenue gains across all our end-use markets, as Tony mentioned.

Overall net sales in the third quarter were $474 million, or $413 million excluding surcharge.

Sales excluding surcharge increased 13% sequentially, reflecting the 8% revenue gain in our Aerospace and Defense market, as well as the strong top line performance across all four remaining end-use markets, with three of the four delivering double-digit sequential revenue increases.

On a year-over-year basis, net sales excluding surcharge, increased $11 million, or 3%, on 3% higher volume.

This is the first quarterly year-over-year increase since the second quarter of fiscal year 2015, which is reflective of improving market conditions or diversified end-use markets and our actions of our commercial team to capture new market opportunities. SG&A expenses were essentially flat at $47 million on a sequential basis.

This was slightly above our expected run rate as we did recognize a couple of non-recurring charges in the quarter. Within the $47 million SG&A expense was a non-cash write-off of $1.3 million for the preliminary work associated with the preparation for the titanium powder investment we have been planning for our Athens, Alabama campus.

With the completion of our titanium powder acquisition, we no longer plan to proceed with the construction of that facility. In addition, we incurred some acquisition-related costs in the quarter, which in total kept SG&A flat sequentially.

Operating income as a percentage of sales when excluding pension, EID and special items, was 10% for the third quarter, up substantially from the 5.7% reported in the second quarter and the 8.7% reported in the third quarter of last year.

Our performance in the quarter represents our best operating margin in nine quarters and our best third quarter performance in three years. The improvements on our operating margins resulted from increased volumes, which was also influenced by our strategy to improve our sales mix in our end-use markets.

In addition, the margin improvements are further evidence of the results of the Carpenter operating model, which Tony mentioned earlier, continued to improve our profitability with improved manufacturing efficiencies.

Our effective tax rate for the third fiscal quarter was 28.9% compared to 15.7% in our second quarter and 27.6% in the last year's third fiscal quarter. We continued to expect our full-year tax rate excluding special items to be in the range to 28% to 30%.

We reported net income of almost $21 million in the third quarter, a $0.44 per share, up from $7 million or $0.15 per share in the second quarter. Now turning to Slide 9.

We delivered positive free cash flow of $6 million in the third quarter, which includes the impact of our titanium powder's acquisition of $35 million, which we closed on February 28. We increased inventory by $15 million in the quarter versus the traditional seasonal decline that we typically see in the second half of our fiscal year.

We currently expect to finish fiscal year 2017 with inventory $60 million to $70 million higher than a year ago versus our prior guidance of inventory being flat year-over-year.

The change in our guidance is due to the strong demand environment we are seeing across our end-use markets, increasing backlog, as well as our need to meet customer orders while executing our planned annual summer shutdowns.

Capital expenditures for the third quarter were $18 million as compared to $19 million in the second quarter and $17 million in the third quarter last year. As we enter the fourth quarter, we expect capital expenditures for fiscal year 2017 to be in the range of $90 million to $100 million versus our prior guidance of $100 million.

As our capital expenditures indicate, we remain disciplined in our approach in investing in our business as we seek to balance our maintenance capital needs against market conditions, while ensuring we are best positioned to capitalize on growth opportunities across our end-use markets. Turning to Slide 10.

We continue to maintain a healthy balance sheet and a strong liquidity position. As of March 31, we had $397 million of total liquidity including $17 million of cash and $380 million of availability under our credit facility.

During the quarter, we successful refinanced our credit facility through the completion of a new $400 million five-year syndicated credit facility with very similar terms for the previous facility. The new credit facility which is comprised of nine lenders was significantly oversubscribed prior to allocations.

With the extension of the credit facility, we have no significant debt maturities until fiscal year 2022, and currently have no significant recorded pension contributions until fiscal year 2020, which even then is only anticipated to be about $20 million.

Going forward, we remain well positioned to selectively explore strategic acquisitions, as well as invest in our internal capabilities as we continue to transition Carpenter into a complete solutions provider for our customers. In addition, we remain committed to delivering direct returns to our shareholders via our quarterly dividend program.

Our ability to deliver consistent positive free cash flow, combined with our emphasis on maintaining a strong liquidity position, represents key components of our strategy, as we seek to enhance shareholder value through a combination of strategic investments and consistent cash returns. Turning to Slide 11 and our SAO segment results.

Net sales excluding surcharge were $322 million, representing an increase of $34 million versus the second quarter, and a gain of $6 million compared to last year's third quarter. The sequential increase in sales reflected growth in volume across all our end-use markets.

The year-over-year increase, which is the first quarterly year-over-year increase since the third quarter of fiscal year 2015, reflects the improving market conditions and strong execution of our commercial team. Operating income was $52 million in the quarter, up $16 million sequentially and up $6 billion compared to last year's third quarter.

The $52 million was slightly better than we had anticipated due to the rate of factors including better market conditions, improved fixed cost absorption and lower employee benefit cost.

Operating margin was 16% in the quarter, which was up compared to the operating margin of 12.4% during the second quarter, and 14.4% in the year ago comparable period.

As Tony mentioned, this was the highest operating margin percentage in almost three fiscal years and speaks to the impact of the Carpenter operating model, as well as our high-end specialty alloy focus. Looking ahead, we expect to see continued improvement in the operating climate and subsequent volume increases.

The improving volumes, combined with our commitment to driving ongoing efficiency gains with the implementation of the Carpenter operating model, should allow us to drive sequential operating income growth of approximately 10% at SAO in our fiscal fourth quarter. Now turning to Slide 12 and the PEP segment overview.

We are pleased to deliver our second consecutive profitable quarter with all of our businesses achieving sequential increases in operating income. Our results reflect improving oil and gas environment and an increased demand for our titanium offerings, combined with early benefits of implementation of the Carpenter operating model in this segment.

On a year-over-year basis, PEP sales increased $7.3 million to $98.5 million, while sequential sales rose by $15.5 million, due primarily to increased rental activity in our Amega West business, as well as higher demand for our titanium products.

We remain encouraged by the early stage recovery in the oil and gas submarket, as well as the increased customer activity we are seeing in our Amega West business. Although still in an operating loss position, Amega West did deliver positive EBITDA in the quarter.

This is the first positive EBITDA quarter for this business since the third quarter of fiscal year 2015, when the average North American directional and horizontal rig count was approximately 1,460 rigs.

This improvement is a result of the aggressive cost-cutting by the team during the downturn, as well as the investment made to strengthen relationships and grow share with key customers. As the environment further improves, we remain well positioned to benefit from the decisions we have made over the last few years.

For the fiscal fourth quarter, we expect PEP to benefit from modest gains in rig counts and improved oil and gas activity levels, as well as increased demand for our titanium products. Overall we expect PEP operating income to improve approximately 10% sequentially.

We expect the underlying operating improvement to be better than the 10% but the improvement will be muted by the ramp-up costs related to our new titanium power's facility as we prepare it for full scale commercial use. Now I will turn the call back over to Tony..

Thank you, Damon. Moving to Slide #14. When I think about Carpenter and our future and why I'm excited about it, I start thinking about places where we are solving key problems because that is where our expertise shines through. That is where we can deliver value, and frankly, that is where we are rewarded the most by our customers.

The aerospace engine submarket is very strategic to Carpenter, as it represents approximately 24% of our year-to-date total sales. We participate on all the major new engine platforms and our content is greater on the new platforms versus the legacy platforms.

More importantly, we have increased our capacity through our investment in our Athens facility to support this growing market and we are working at the request of our customers on introducing higher temperature alloy and helping them explore and bring to scale production additive manufactured parts.

It is important to note that we are much more than a supplier to aerospace jet engine manufacturers. We have leading positions aerospace fasteners, avionics and structural applications.

For example, in aerospace structural, customers are increasingly asking us to help them lightweight their parts and figure out how to make parts which can't be made with old materials due to changing regulations. We see more and more designs exploring and adopting our advanced structural alloys, like our AerMet portfolio to solve these problems.

And outside of the aerospace market, we see the same trend. Our customers are facing more complex problems, prompting them to pursue Carpenter for more advanced solutions. In medical, implants like hips and shoulders are getting more advanced to provide patients greater longevity and freedom of movement.

New designs require more complicated and finer construction, and the instruments to support the surgery for these designs are also becoming more advanced. These instruments need to be tougher and stronger, and to get that, they can't use yesterday's materials.

That is leading more and more manufacturers to turn to our advanced and proprietary products, like Custom 465 and Custom 565. In consumer electronics, I think it is safe to say we all know what is happening with smartphones. Devices are getting smaller with longer battery life and more functions. Again, old materials don't work.

They don't provide as much magnetic shielding per area need to accommodate the device design. Carpenter has a broad breadth of solutions to these problems. Through our powder and industry-leading soft magnetic portfolio, we continue to introduce proprietary products such as our recently announced Hypocore product.

In transportation, new global emission standards require vehicle manufacturers to move to gasoline direct injection engines, many of which are turbocharged. These applications require higher temperature resistance and higher pressure capability.

We are continually discussing with our customers how to apply our high temperature products to turbocharger gaskets and bolts. In our industrial applications, for example, we are working with a large-scale manufacturing company whose production lines chain keep breaking. They were shutting down operation and causing significant cost challenges.

We are helping that organization explore opportunities to move to change made from our high-strength alloy, like AerMet 100, to eliminate breakage and to generate significant cost savings. As oil and gas recovers, our customers are drilling longer lateral oil wells in more corrosive environment.

The guide to drillbit directional sensors are housed in tools that if they fail cause the company non-productive time and millions in the replacement cost and the bottom-hole assembly. This is where our SCF-19 product is outperforming the incumbent material, lasting up to 3x as more. In short, the road is moving towards higher and higher performance.

While some of the examples I shared are not our largest project opportunities, they demonstrate our intrical role in driving mission-critical performance. Today, Carpenter is displaying and proving the range of our capability in advanced alloys across multiple markets.

The increasing connection to our customers and our broad and deep technical capability are reasons why we are excited about our future. Now let's turn to Slide 15 and my closing comments.

We had a strong third quarter, as improving market conditions combined with solid execution while our commercial and manufacturing teams continue to drive our results. I'm pleased with the efforts we are making to reinvigorate our commercial approach.

Our market focus strategy is delivering results through increased backlog, expanded customer relationships and share gains across several of our end-use markets. Our commercial approach is critical to capitalize on the improving conditions that we are seeing in our key end-use markets.

In Aerospace and Defense, we are seeing solid demand across all of our submarkets, while our broad product offering positions us well, given the projected airplane build range [ph]. The recovery in the oil and gas submarket remains in its early stages.

We really are encouraged by rising North American rig counts and the indication of increases in capital spending by the large oil service companies.

In terms of our manufacturing teams, I provided three examples of how the Carpenter operating model is delivering manufacturing and productivity gains that are reducing cost and freeing up capacity to enable us to capture incremental sales. The implementation of the Carpenter operating model is not a basic cost-cutting exercise.

It is a fundamental change in the way we do work. We have certainly delivered benefits to the bottom line to-date. We are in the very early stages of this transformation. That means there is significant more value we can drive to the bottom line as we continue this journey.

Today, Carpenter is a critical solutions provider to customers across multiple attractively end-use markets.

We believe the value we deliver today, coupled with our focus on expanding our capability in key areas, such as powder and additive manufacturing, positions us to generate long-term sustainable growth, and we have the financial flexibility needed to continue investing in our solutions and developing shared technology roadmap with our customers.

Thank you for your attention. And I'll turn it back to the operator to field your question..

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. At this time, we will pause for a moment to assemble our roster. Our first question comes from Gautam Khanna with Cowen & Company. Please go ahead..

Thanks. Good morning..

Good morning..

I was wondering, Tony, if you could expand on your comment about an engine order slipping.

Did that get caught up, and perhaps if you could quantify how large it was?.

Okay, Gautam, thanks for the question. Let me - as I said in my comments, this was due to timing of orders from a key customer. If you exclude this customer, this might be helpful. Aero engine sales were up double-digits sequentially as they were in the previous quarter. I don't think this is especially unusual.

The aerospace market doesn't always conform perfectly the quarterly reporting requirements. What I think is important is that we expect the fourth quarter to be sequentially up both for total aerospace and the aero engine submarkets.

I can also say that our aerospace defense market bookings were up sequentially more than 35% and our Aerospace and Defense market backlog increased 18% sequentially. So I still see that continue strengthen arrow engine, evidenced by lead times extending right now in the industry and the expectations of forward delivery.

So for me, this was a large order or a tiny, doesn't impact what we see going forward..

Okay.

What does actually caught up subsequent to the quarter and/or are you still waiting for that one, so that it could benefit fiscal Q1 of next year?.

It's just that we had the larger uptick in the previous quarter..

Okay. So it's more just the purpose [ph] of base comparison..

Yes..

Okay. And you mentioned normal seasonality typically allows for the first half of each fiscal year to be below that of the second half but we do have some ramping engine programs.

I just wondered if you could comment on what you think might happen to SAO in the third calendar quarter, in the fourth calendar quarter, given those program dynamics overlaid on those seasonal dynamic?.

Well, you're going out two or three quarters. Listen, I believe over the next three to four quarters, the aerospace as the last time you and I talked, I think aerospace can be in the high-single digits. That's where I would expect. I would expect the Carpenter operating model to continue to deliver results.

I would expect that the work we are doing on the commercial group as far as cultivating new sales and new applications, specifically in the consumer market and the medical market will continue, and I also would continue to expect that the improvement in PEP will continue.

So if you add all of that in, it's not necessarily going to be linear quarter-over-quarter. We normally have the seasonality but if you take a longer term, I think we are really starting to hit our stride and gain some momentum in what we can drive to the bottom line..

I hear you. I guess what I'm trying to ask is will we have more muted seasonality, if you will, because of the ramping….

I think that's - yes. Sorry, I think that's fair. Yes..

Okay. So the year-over-year increase in the first half of fiscal '18 could actually be more substantial than what otherwise be the case if it were just a normal seasonal year without [indiscernible] because you have energy coming back. You got a lot of things that are not....

Clearly that's fair, yes..

Okay. That's helpful. And then just wanted to ask again on the fastener side, so what are lead times right now and how have they changed over the last three to six months? Maybe if you can talk about the various products that you make and whether it be nickel alloys, bar, coil, wire, and then titanium as well.

Just what's happened with lead times in that market?.

Well, as you know, on the fastener market, on nickel and titanium, I would say the lead times are, for the most part, stable, going down a bit on titanium only because that's been a specific focus for us and the reason they are going down is because we've made improvement specifically in our Dynamet production flow.

So those lead times were unacceptably high. We've cut those in half over the last couple of months with an effort to drive them even further. I would tell you that the nickel side, the lead times have probably increased slightly over the last quarter..

Okay, thanks. I'll turn it over. Appreciate it..

Thank you..

Our next question comes from Josh Sullivan with Seaport Global. Please go ahead..

Good morning..

Good morning, Josh..

Good morning, Josh..

Can you give us an update on Athens, and maybe where you are in qualifications and what utilization currently looks like?.

Okay, Josh, I can take that one. Utilization in Athens is approximately 30% right now. That is not changed over the last couple of quarters. I will remind you that that is not all incremental to Carpenter, so we are moving products to Athens that benefit from that production flow.

From a qualification standpoint, I won't change much from what I said last quarter. As you know, we started this process about two years ago. Our goal really is to lock in the most efficient and reliable process. I would say that we've made good progress and we are basically on track.

Again, as I said last quarter, we plan - our expectation is to submit the desired VAP qualifications by the end of calendar year 2017.

I will remind you that that timing and pacing of the actual qualification will be dictated by our customers but I can say that we are actively involved with them, and I can also say that I'm pleased with the increase of customer connection and customer intensity over the last quarter..

Okay, great. And then just with the lead time questions, what do lead times look like at SAO? I think you said aerospace lead times are extending.

What about energy verticals and maybe just give us what lead times look like last quarter versus this quarter?.

Yes, on aerospace, the lead times are extending. I think that's across the industry, especially on the most advanced alloys, the high-temp alloys. I see - we see that extending and we think that's probably going to continue in the near-term. Energy, I think now those are just coming into play for us.

I don't see a specific issue for us right now but depending on where the market goes over the next couple of quarters, you could see that..

Okay. Thank you..

[Operator Instructions]. Our next question comes from Phil Gibbs with KeyBanc Capital Markets. Please go ahead..

Thanks very much. Good morning..

Good morning, Phil..

Had a question on the jet engine side.

Just curious if that business was up for you on a year-on-year basis?.

Yes, it is..

Any sense of a magnitude there, Tony?.

On the engine side, let me take a look at my notes right here. If you take away the one order, we're, I would say, in the high-teens 20% year-over-year increase..

Okay..

It's actually down slightly just because of the timing of that one order..

Okay.

So it was lumpy in terms of that, so that would be imply that we saw a pretty solid pickup year-over-year and either bought distribution or defense - is it more on the defense side?.

We had a nice pickup in defense, also structural and on fasteners as well..

Okay. What's the sense of the supply chain in terms of the mood with inventory positioning at this point? I think the conversation six to 12 months ago was the aerospace supply chain is in good shape. Momentum is continuing there. We've had some pockets of excess inventory and the structural supply chain.

What's that generic thought right now in terms of those buckets?.

I would say that from an overall standpoint, you see some increased restocking. We know our distributors are restocking their inventories. I would use the word that there is more tightness in the market what we are hearing from the customers as far as them getting in queue. Fasteners is a bit different.

Certainly today the signs are positive for us, more positive than negative but we are cautious, right, because we know how the fastener market can be and I think over the next couple of quarters you could see some inconsistencies there.

But on all the other submarkets, I think you're going to see continued growth over the next three or four quarters..

Okay, that's helpful.

And can you give us a sense on your energy business on the oil and gas side, how much of that is driven by onshore versus offshore historically and how much of your business there, roughly speaking, is North American versus international because obviously there is a lot of different dynamics going on right now?.

I can say the major is onshore and the majority is North America..

Okay. And then just last question I have is just on the inventory side. You brought up your target for the year in terms of building some inventory this year.

Just trying to understand really what changed there given that, I think, sales were at least in line with what we were expecting for the third quarter, so no big changes in terms of the momentum that we are anticipating and I know this is a longer term strategic imperative for you guys.

So I'm just trying to square up the market dynamics and the inventory positioning versus the long-term view of maybe some structural reduction. Thanks..

Okay. Thanks, Phil. It's a good question. Let me elaborate just a bit on that. You're right, inventory did increase about 2.5% sequentially, about 14% since the beginning of our fiscal year. We increased this inventory by design for specific product types.

And the inventory that we have is staged at the proper location in the production cycle, and from my viewpoint, the market is getting stronger, the Aerospace, Energy, Consumer, Medical. As I said, lead times are extending across the industry, especially on the aerospace side.

And I think just as importantly, our new commercial organization is out there gaining share. We are developing new customers. So we have a strong balance sheet. It gives me the flexibility to bill that inventory so I can maximize my revenue. And my focus now is I believe the market is coming to us. I'm going to run my equipment.

I'm going to put that strategic inventory in place. I'm going to go grow my base and I'm going to serve the customers. So I'm in a position where I'm not going to try to hit an inventory number that's going to sacrifice a growing market presence that I have over the next two or three quarters..

Thank you..

Thank you..

We now have a follow-up question from Josh Sullivan. Please go ahead..

Yes, just had one. You had mentioned the medical market is taking an interest in the new powder facility.

How large of an opportunity is that for your medical verticals? Do you think we could see a substantial increase in the contribution from medical over time?.

Absolutely, I think medical is a really a growth area for us, not only through the traditional means but through additive manufacturing and I think we play a great role there. We now have the titanium powder facility, also through our Dynamet facility and our titanium wire. That is another feedstock method into additive manufacturing.

All of the large medical OEMs are concentrated there. We have connections with all of them. And I think that is a meaningful growth opportunity for us going forward..

Okay. Thank you..

Thank you..

Thank you. This concludes our question-and-answer session. I would like to now turn the conference back over to Brad Edwards for any closing remarks..

Thanks Daniel. Thanks everyone for joining us today. We look forward to speaking with you again shortly. Thank you..

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