Carpenter Technology (CRS) Q3 2019 Earnings Call Transcript

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Carpenter Technology (NYSE: CRS)
Q3 2019 Earnings Call
April 25, 2019 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Carpenter Technology Corporation's third-quarter fiscal-year 2019 conference call. All participants will be in a listen-only mode. [Operator instructions] After today's presentation, there will be an opportunity to ask questions. [Operator instructions] Please note, this event is being recorded.

I would now like to turn the conference call over to Mr. Brad Edwards, investor relations. Mr. Edwards, the floor is yours, sir.

Brad Edwards -- Investor Relations

Thank you, operator. Good morning everyone, and welcome to Carpenter Technology's earnings conference call for the third quarter ended March 31, 2019. 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 Tim Lain, 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 Technology's most recent SEC filings, including the company's report on Form 10-K for the year ended June 30, 2018, Form 10-Q for the quarters ended September 30, 2018 and December 31, 2018 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.

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

Tony Thene -- President and Chief Executive Officer

Thank you, Brad; and good morning to everyone on the call today. I'll start on Slide 4 with an update of our safety performance. Through the third quarter, our total case incident rate, or TCIR, remains at 1.4, up from 1.2 during fiscal-year 2018. While some of our business units are operating at zero injuries for the year, clearly, we expect improvement.

We are placing additional focus on several key areas such as hand safety. Hand injuries currently represent 49% of our total recordable injuries, and we are intensifying our efforts in this area. Human performance, we continue to provide training to employees to recognize and stop unsafe work. Hazard elimination and action tracking team, which is focused on operator engagement for improvement plans and recommendations.

Leadership development initiatives centered on engaging our supervisors to drive accountability. And recently, we initiated a fork truck elimination initiative, where we identified immediate countermeasures to reduce injury risk of interacting with fork trucks. As always, our goal is a zero-injury workplace. Now let's turn to Slide 5 and a review of our third-quarter performance.

Overall, our third-quarter results reflect the ongoing momentum we are driving across all our core business as we generate strong operational results and delivered our ninth consecutive quarter of year-over-year earnings growth. We continue to capitalize on the solid demand patterns across our end-use markets by winning incremental market share and expanding our customer relationships. Our success drove year-over-year and sequential sales growth. In fact, it is also the ninth consecutive quarter of year-over-year sales growth.

In addition, our backlog increased for the 11th straight quarter, growing 9% sequentially and 44% compared to last year. In our largest end-use market, aerospace and defense, demand remains robust. And our submarket diversity continues to drive solid growth. Sales increased 17% sequentially and 5% year over year.

Backlog increased 12% sequentially. The results speak to the continued strong underlying demand and our established and diversified presence in the aerospace and defense end-use market. Obviously, the 737 MAX developments are important. We recognize this is a significant industry event and a dynamic situation.

We continue to engage directly with our customers on this issue. Each has affirmed to us that they have no current plans to reduce their production rates or alter their material needs. Accordingly, we have no planned changes to our production schedules. We will continue to monitor the situation, but at this time we do not expect a material adverse impact to Carpenter Technology.

Our medical end-use market is another meaningful source of sales growth, up 25% year over year and 23% sequentially. Backlog increased 5% sequentially. Growth within our medical end-use market is a result of two primary factors. One, our market-facing organization gaining share through meeting the needs of our medical OEMs, contract manufacturers and distributors.

These needs are successfully supported by Carpenter's leading portfolio of titanium, cobalt and stainless solutions for implantables and instrumentation. And second, the Carpenter operating model, increasing capacity, especially in our premium titanium bar products. We look forward to further improvements in titanium capacity, supported by a planned expansion of our Dynamet business unit within our next fiscal year. In terms of an update on the qualifications of our Athens facility, we continue to generate positive momentum.

And we received four additional specific aerospace VAP approvals during the third quarter. The Athens facility is well positioned to provide critical incremental capacity for the industry. To realize the full value of the facility, we must obtain the necessary aerospace VAP qualifications. As we have mentioned on previous calls, the qualification process is specific to each OEM and approval will be incremental, meaning the qualifications will be obtained one at a time.

For example, a specific diameter of a specific product type made across a specific set of assets. We are working closely with the business and technical teams of our customers as they work through their individual processes to obtain the necessary qualifications for the facility. A good indication of the progress we are making are the additional qualifications we received this quarter, combined with the long-term agreement we announced with Safran last quarter. As we stated on our last-quarter call, the bulk of the supply under that agreement will come from Athens, which we believe demonstrates our customer's confidence in the value and capabilities of the facility.

Earlier in my remarks, I mentioned the success we are having running our core business and generating consistent near-term earnings growth. We continued to balance that focus. We're strategically investing for the longer term and positioning Carpenter Technology for continued transformative growth. We believe these investments are necessary to ensure our position as a solutions provider for our customers and to strengthen our foundation for long-term sustainable growth.

With a focus on the longer term growth prospects, we have built a leading end-to-end additive manufacturing platform. In addition, we recognized the disruptive nature of electrification across multiple end-use markets. We see several attractive growth opportunities for our proprietary soft magnetics portfolio in high value areas, including electric vehicles, consumer electronics and auxiliary power units for aerospace. I'll speak more about these long-term strategic investments later in my remarks.

Lastly, we have no major pension contributions or debt maturities until fiscal-year 2022. Our financial position and flexibility are critical as we look to enhance our market position while also delivering direct returns to our shareholders via a quarterly dividend. Now let's move to Slide 6 and the end-use market update. Looking first to aerospace and defense, where sales were up 5% compared to last year and 17% on a sequential basis.

As I noted earlier, demand levels in the aerospace and defense end-use market remains strong, and we continue to benefit from our diverse solutions portfolio and leading presence across multiple attractive submarkets. In the engine submarket, demand remains high, and customers continue to seek long-term supply agreements to fill their material needs. While fastener demand increased in the current quarter, future demand signals remain mixed. Lastly, defense sales were up both year over year and sequentially, driven by program-specific demand.

Moving on to the medical market, where we generate strong sales growth on both a year-over-year and sequential basis. Sales increased 25% compared to last year and 23% sequentially. This solid performance was driven by steady demand in orthopedics and cardiology markets. Looking ahead, we see the potential for continued solid growth in medical given our high-value titanium products and the expected growth in the orthopedic and cardiology markets.

It's worth noting our medical backlog is up 50% year over year, which demonstrates solid forward demand for our solutions. Now moving to the energy market and our oil and gas and power generation submarkets. Total energy sales increased 23% year over year and 12% on a sequential basis. Oil price volatility continues to be a theme in the oil and gas submarket, with North America rig counts down 1% year over year and down 3% sequentially.

The reduced activity levels continue to intensify pricing pressures, especially in services and rentals. These market dynamics continue to impact neutral adoption rates at our Amega West business. Outside of North America, we are seeing an uptick in the international and offshore markets driving demand in the current quarter. In the power generation submarket, we continue to see signs of increasing activity, although off a low base.

In the transportation market, sales were down slightly year over year, mainly due to global macroeconomic and trade-related issues. On a sequential basis, transportation sales increased 14%, driven primarily by stronger mix and notable share gains in high temperature applications. Sales into the heavy duty truck market showed a healthy increase in the quarter, and we also made further inroads into attractive adjacent markets, including off road and marine. It's also worth noting we generate a healthy backlog growth in transportation during the third quarter via share gains with customers, primarily in North America in select high-value applications for high temp resistant alloys.

In the industrial and consumer end-use market, revenues were flat year over year and down 7% sequentially. This is mostly due to lower demand for selected industrial applications, as well as ongoing portfolio prioritization toward higher value products. Now I'll turn it over to Tim for the financial review.

Tim Lain -- Vice President and Chief Financial Officer

Thank you, Tony. Good morning, everyone. I'll start on Slide 8, the income statement summary. Our results for the quarter reflect continued momentum in our operations combined with strong market demand.

Net sales in the third quarter were $609.9 million, or $503 million excluding surcharge. Sales, excluding surcharge, increased 12% sequentially on 6% higher volume, with double-digit growth in all our end-use markets, except for industrial consumer, as Tony just covered. On a year-over-year basis, sales excluding surcharge increased 6% on 1% lower volume, driven by growth in several key end-use markets. As Tony mentioned, we continue to see solid demand across most of our end-use markets as evidenced by our growing backlog.

Our total backlog grew 9% sequentially and 44% year over year. Our current third-quarter gross profit includes an $11.4-million benefit related to an insurance recovery associated with a fire that occurred at our Dynamet operations in the third quarter of fiscal-year 2018. SG&A expenses decreased by $1.6 million on a sequential basis, mainly due to cost associated with the LPW acquisition that was completed in our second quarter. For the fourth quarter, we expect SG&A expense to be in the range of $50 million to $53 million.

Operating income as a percent of sales was 14.6% in the current quarter compared to 12.6% in Q2 of this fiscal year. When normalizing for the insurance recovery benefit in PEP's results in Q3 and the insurance recovery benefit in SAO's results in Q2, operating income margin improved by 80 basis points sequentially. Year over year, again normalizing for the insurance recovery benefit, operating income margin improved by 260 basis points. Our effective tax rate for the third quarter was 24.9%.

We expect our tax rate to be in the range of 24% to 26% for the fourth quarter. We reported net income of $51.1 million, or $1.5 per share. For clarity, $0.18 of EPS within the quarter is attributable to the insurance recovery benefit. Now turning to Slide 9 and a review of free cash flow.

Free cash flow in the third quarter was negative $37 million. During the current quarter, we increased inventory by $17 million. Over the last several quarters, we've generate a marked improvement in our primary operations, more specifically in areas such as melting due to focused efforts implementing the Carpenter operating model in these key operations. The increased throughput in our primary operations is critical to aligning our inventory levels with our increasing backlog.

However, this improvement has put pressure on our finishing operations, creating certain constraints. Using the concepts of the Carpenter operating model, our emphasis has shifted to key finishing operations where we believe there is a significant opportunity to alleviate current bottlenecks and improve productivity and throughput rates in these areas. We're seeing some early success with these efforts and have realized gains at certain key constraint work centers. There's still work to be done, but we view this as a significant opportunity to reduce inventory in the near term.

Working capital other than inventory increased by $53 million in a quarter, mostly related to an increase in accounts receivable driven by higher sales levels. We spent $49 million in capital expenditures in the current quarter and $131 million year to date, consistent with our expectation. As we've talked about in prior quarters, the capital spending in fiscal-year 2019 includes several large projects in our strategic growth areas of additive manufacturing and soft magnetics. The largest of these projects is the multi-year spend associated with our $100-million investment in a hot strip mill on our Reading campus.

We expect the fourth-quarter capital spending to be in line with the third quarter. Overall, our financial position remains solid with $286 million of total liquidity at the close of the quarter, including $19 million of cash and $267 million available under our credit facility. Our financial position is important as it allows us the flexibility to invest in our future growth. Now turning to Slide 10 and our SAO segment results.

SAO delivered another solid quarter with net sales of $498.3 million, or $393 million excluding surcharge. This represents an increase of $37 million, or 10% on a sequential basis on 6% higher shipment volume. On a year-over-year basis, sales excluding surcharge increased $12 million, or 3% on 2% lower shipment volumes. Both sequentially and year over year, the sales increased outpaced volume growth, which demonstrates the impacts of driving an improving product mix.

In addition, demand signals remain strong. As we have highlighted, our backlog increased on both a sequential and year-over-year basis. SAO operating income was $73.6 million, up $4.6 million compared to the second quarter and up $15.6 million year over year. The year-over-year improvement in operating income is primarily a result of the improving product mix.

As we pointed out last quarter, our recent second-quarter operating income results included a $4.7-million insurance recovery benefit related to a claim for a fire at an SAO facility during fiscal-year 2018. When excluding the insurance recovery in Q2, operating income improved $9.3 million sequentially. The sequential increase in operating income was primarily driven by the higher volumes and favorable product mix. SAO's reported operating income margin was 18.7%, which is up about 60 basis points sequentially when adjusting for the Q2 insurance recovery, and up 350 basis points relative to the same quarter last year.

This performance marks the highest third-quarter margin for SAO in the last seven years. We continue to benefit from the Carpenter operating model as we capture manufacturing improvements and identify opportunities to unlock capacity. This is becoming increasingly important, given current market conditions, our growing backlog and our strategic focus on a richer and more complex solutions portfolio. Looking ahead to Q4, we continue to see strong demand trends in most of our end-use markets.

We are currently expecting operating income to increase 5% to 10% sequentially from Q3 to Q4. Now turning to Slide 11 and our PEP segment results. Net sales, excluding surcharge, were $125.9 million, representing growth of 17% year over year and 15% on a sequential basis. Operating income for the quarter was $16.6 million, which again includes the $11.4 million insurance recovery related to our Dynamet business unit.

While increasing sequentially, again excluding the impacts of the insurance recovery, PEP's performance fell short of expectations due primarily to our Amega West business unit. Amega West continues to be challenged by lower-than-anticipated adoption rates for certain new tools that have been recently introduced to the market. As we've previously stated, service providers are looking for new technologies and solutions to improve efficiency and ultimately reduce their operating costs. We believe our differentiated products and services can help our customers achieve their goals.

We remain confident in the long-term growth potential for Amega West despite the recent short-term headwinds. It's important to note that the PEP segment includes the results of the recent investments we've made in additive manufacturing. Specifically, our powders, CalRAM and LPW business units. As we've said, these businesses represent investments in our long-term growth profile as the market for additive manufacturing is expected to grow significantly over the coming years, and we intend to maintain our growing leadership position in this area.

For the fourth quarter, we expect PEP operating income to be similar to the third quarter, excluding the insurance recovery, as we will continue to invest in our additive manufacturing platform and are currently expecting a more gradual progression in the adoption of the newer tools at Amega West. With that, I'll turn the call back over to Tony.

Tony Thene -- President and Chief Executive Officer

Thanks, Tim. As noted with our strong quarterly results, we are focused on delivering year-over-year earnings growth. In addition, we are identifying key trends on the horizon that have the potential to meaningfully impact our industry and our end-use markets. Positioning Carpenter Technology at the forefront of these trends requires investing in high-value market adjacencies, as well as building a leadership position in critical emerging technologies.

As you recall, in March of 2018 we announced the planned construction of a precision strip mill on our Reading campus to expand our soft magnetics production capabilities. Today, we are a leading supplier of soft magnetic alloys for the aerospace and consumer end-use markets. Electrification is becoming an increasingly critical area of focus, and investment for global automotive OEMs. Our projections might differ with respect to timing.

All expect a rapid increase in electric vehicle adoption over the coming years. This presents an attractive addressable market opportunity for our Hiperco and proprietary Hypocore soft magnetic alloys. Today, OEMs are facing performance and durability-related challenges, including range, battery life, weight, portability and charging times to name a few. Our soft magnetic solutions are among the highest induction alloys in the world, and we believe they can provide significant performance improvements compared to current applications.

At the same time, we will continue to expand our leadership in aerospace auxiliary power units, as well as to further penetrate the consumer electronics market via smartphones, smart watches and other applications. Our second long-term growth driver is building on our leadership position in additive manufacturing. Over the last several years, we have significantly expanded our additive manufacturing capabilities and today operate a leading end-to-end platform. Through a series of recent strategic acquisitions, we added titanium powder production, additive manufacturing part design and production capabilities, as well as powder lifecycle management to our existing metallurgical expertise and feedstock production.

Today, we can work alongside a customer starting from feedstock development, all the way through part design and production and support those efforts with critical powder reliability solutions. In addition, we've added significant additive manufacturing industry talent to our team. In the fall of this year, we expect to open our Emerging Technology Center on our Athens campus, where we will develop and implement future solutions for our customers, ranging from new alloys to 3D-printed parts. The dialog and conversations we are having with customers around additive manufacturing are increasing everyday and include customers across all of our end-use markets.

We are working alongside customers in process parameter development, characterization analysis, as well as the printing of numerous AEM parts. Our efforts in soft magnetics and additive manufacturing are consistent with our strategic mandate of being a complete solution provider for our customers, an irreplaceable supply chain partner and a trusted collaborator as they look to elevate their product and build their technology roadmaps for the future. Let's turn to Slide 14 and my closing comments. In closing, we are capitalizing on strong demand across our end-use markets, executing our strategy at a high level and delivering strong operational and financial results.

The third quarter marked our ninth consecutive quarter of year-over-year sales and earnings growth and our 11th straight quarter of total company backlog growth, which finished up 9% sequentially and 44% compared to last year. We offer a broad portfolio of leading solutions, and we are well positioned across attractive end-use markets. The aerospace and defense market continues to demonstrate fundamental long-term growth demand signals as our sales and backlog grew year over year and sequentially. We are an established supply chain partner in critical submarkets including engines, fasteners and structural.

Looking internally, we remain committed to the Carpenter operating model and unlocking incremental capacity, as well as securing operating efficiencies and reducing waste. The impressive growth we generated in the medical end-use market this past quarter speaks to the power of the Carpenter operating model and the transformational impact it can have on our work centers and facilities. We continue to make progress with aerospace VAP qualifications at Athens with four recent approvals. Customer engagement remains high, and we are working closely with them to bring a much needed incremental capacity for the industry.

We continue to successfully balance near-term earnings growth with a need to invest for the long term and secure a position at the forefront of transformative change facing our industry, specifically in additive manufacturing and electrification. We believe the end-to-end additive manufacturing platform that we have built is unmatched. This is evident as we continue to engage with customers across all of our end-use markets on strategy discussions in this space. Our soft magnetics investment remains on track, and we see an attractive and expansive addressable market for our proprietary soft magnetic solutions in applications such as electric vehicles, consumer electronics and aerospace.

Lastly, our financial position remains healthy and gives us the opportunity to build long-term value creation for Carpenter Technology. Thank you for your attention, and I'll turn it back to the operator to field your questions. 

Questions and Answers:

Operator

Thank you, sir. We will now begin the question-and-answer session. [Operator instructions] And the first question we have will come from Gautam Khanna of Cowen and Company. Please go ahead.

Gautam Khanna -- Cowen and Company -- Analyst

Yes, thank you guys.

Tony Thene -- President and Chief Executive Officer

Good morning, Gautam.

Gautam Khanna -- Cowen and Company -- Analyst

Good morning. Wondering if you could just expand upon the four additional Athens part qualifications. Where they with different OEMs and Safran? Anything you can characterize about the parts, if they're high volume, who they're with and what that might mean for the utilization of Athens and on what timeframe.

Tony Thene -- President and Chief Executive Officer

I can say, Gautam, they were significant approvals for us just in our, where we're at in the process. There were other OEMs other than Safran in those four.

Gautam Khanna -- Cowen and Company -- Analyst

And in terms of are they high-volume parts? And when do you anticipate, like where is Athens now in terms of kind of utilization? I know it's hard to measure depending on mix and what have you? And where do you anticipate it would be a year from now?

Tony Thene -- President and Chief Executive Officer

Tough question. I anticipate it being much stronger a year from now than it is now. As I said, I've kind of gotten away from saying what the utilization is of Athens just because we don't operate as a stand-alone middle. I will say these four are significant not just from a, we don't look just from a volume standpoint, excuse me, but from who we're working with and what that particular product was and the challenges that we overcame to get that qualified.

So those four are significant. They're very important to us. I think it's a major step forward.

Gautam Khanna -- Cowen and Company -- Analyst

And, Tony, one of your competitors has talked about challenges in the nickel powdered billet supply chain. I'm curious, are you guys working toward being part of the solution in that more challenged part of the supply chain?

Tony Thene -- President and Chief Executive Officer

Well, Gautam, as you might know, we're in the final stages of receiving qualification to produce and atomize this quality powder and sell that powder. And that's it, to sell the powder. We do not participate in the next steps of that specific supply chain, which is billetizing that powder and then ultimately forging that into a disk. We do not play in that piece of the supply chain.

Gautam Khanna -- Cowen and Company -- Analyst

Right. But ups in the powder you do, I'm just wondering, do you guys have an opportunity to pick up some market share with roles in that constrained part of the supply chain?

Tony Thene -- President and Chief Executive Officer

Well, if my understanding is right, the constrained piece isn't on the powder atomization.

Gautam Khanna -- Cowen and Company -- Analyst

OK, I think it was both, but maybe I'm wrong. And then the last one from me, just on cash flow. I know usually the second half of the fiscal year you guys generate cash as you work down some inventory. What do you anticipate happens in fiscal Q4, just given we're a little bit out of normal seasonality through the three quarters.

Tim Lain -- Vice President and Chief Financial Officer

Yes, Gautam, this is Tim. So as we talked about in our remarks, I think we've been pretty deliberate about managing our inventory in certain cases, building inventory to meet the growing backlog. But as I said, I think we've recognized inventory as a pretty significant opportunity for us to deliver some cash flow here in Q4 as we work through the constraints and get more out the back end of the mill. We've done some work in the front end of the operations, namely in melting and improving capacity and throughput and productivity there.

Now we're working through that in the back end of the facility in the finishing operations to get more out the door. So we view the inventory as a significant opportunity for cash flow in Q4.

Gautam Khanna -- Cowen and Company -- Analyst

Thanks, and great results.

Tim Lain -- Vice President and Chief Financial Officer

Thanks.

Operator

And next we have Josh Sullivan of Seaport Global.

Adam Friedman -- Seaport Global Securities -- Analyst

Hi guys, this is actually Adam Friedman on for Josh. Thank you so much for taking the time. Just assuming that Boeing eventually gets to the 57-per-month rate, either sort of late this year, early next year, how should we think about sort of the long-term margin potential for SAO? I guess just following on to that, do your long-term assumptions assume 57 per month in the 737 and on the A320 eventually getting to that 63-per-month rate?

Tony Thene -- President and Chief Executive Officer

Well, I mean your main question is where do we think SAO margins can go, and I've talked about this several times over the last couple of quarters. I believe we can do better than we are now. Think about being at 18.7. I think it's third time that we've, in the last four quarters that we've been above 18%.

The last time we're reaching 18% was back in fiscal-year 2014. But I can tell you, there's a lot more productivity that we can go achieve in our SAO facilities. And you see that quite frankly in some of the reasons for the inventory build. I think it's great internal competition that the front end of our process now has gained such significant productivity improvements that's putting pressure on the back end of our process now.

And they're up to the challenge to say we need to increase our rates as well so we can increase the overall shipments out of that facility. So I think SAO can do better than what they're doing now. Great performance this quarter and the last couple of quarters, but we still have much more in the tank when it comes to productivity.

Adam Friedman -- Seaport Global Securities -- Analyst

OK, great. Thanks for that. And then just given sort of the volatility that you talked about in the oil prices, I guess how are you thinking about the oil and gas business over the next, call it like three to four quarters or two to three quarters. Whatever sort of color you can give would be great.

Tim Lain -- Vice President and Chief Financial Officer

I think, Adam, we're cautiously optimistic. We talked about, we see the oil price volatility continue to play a factor in how companies are making decisions on where they're investing, I think this quarter we saw some uptick in activity internationally, which is kind of not been the case for the last several quarters. So I'd say it's fair to say we're cautiously optimistic. But I think it's going to be a rising water line as opposed to any big, big wins here in the next couple of quarters.

Adam Friedman -- Seaport Global Securities -- Analyst

OK, great. Thanks so much for the time guys. And I'll get back in the queue.

Operator

[Operator instructions] The next question we have will come from Chris Olin of Longbow Research. Please go ahead.

Chris Olin -- Longbow Research -- Analyst

Hey, good morning everybody.

Tim Lain -- Vice President and Chief Financial Officer

Good morning.

Tony Thene -- President and Chief Executive Officer

Good morning.

Chris Olin -- Longbow Research -- Analyst

My question is when companies within the industry, or even yourselves, talk about constrained capacity within the nickel-based alloy or call it the premium alloy markets, does that refer to the actual melting capacity? Call it like the VAR or VIM furnaces? Or does that refer to the limited, I guess, downstream supplies such as like the Athens forge?

Tim Lain -- Vice President and Chief Financial Officer

I think from our standpoint, when we speak about constrained capacity in the nickel billet area, it would include the primary and secondary melting, as well as the press or the forge operations.

Chris Olin -- Longbow Research -- Analyst

OK. I guess I was curious. So when you talk about applying the Carpenter operating model to downstream fabrication, is that what we're talking about here, as well as loosening up some volume on a go-forward basis? Or is that more of a cost item?

Tim Lain -- Vice President and Chief Financial Officer

Well, I think it's opening up volume. I mean, if you look at downstream for Carpenter or any comparable company, there's hundreds of work centers there. And right now, from a productivity standpoint, we've seen bigger increases in the upstream for us. That's good.

Those are the most recognizable constraints, and we're pushing that constraint downstream. That's good news for Carpenter, and that's good news for the industry.

Chris Olin -- Longbow Research -- Analyst

OK. And then just lastly, I want to make sure I understand the strategy here. When we see the approvals come in on the jet engine businesses, should I assume that that is volume that could already be done at Reading or maybe Latrobe that will ultimately be shifted to Athens so then you can have a more flexible mix at the legacy mills? Is that how you think about it?

Tony Thene -- President and Chief Executive Officer

Not 100%. I mean, it is true that the qualifications that we're receiving that we now produce those products at our existing facilities, but this market isn't about shifting a pound from Reading to Athens. As you well know, this is about making two pound instead of one. I mean, we're increasing the amount of engines that are being made, not keeping them flat.

So therefore, the premise that all of this is shifting from one plant to another isn't logical.

Chris Olin -- Longbow Research -- Analyst

OK. And just lastly before I forget too, your aerospace distribution business. I was curious approximately roughly how big that is. And could there be any risk that that part of the business gets weaker because of the uncertainty surrounding Boeing?

Tony Thene -- President and Chief Executive Officer

I think that's a great question. The distribution business is, for a total amount, is single digits. But I think if you saw any noise there, it would be across the distribution channel, as they're very focused on inventory turns. You could potentially see a pause there.

I don't think that will be an overall material impact of Carpenter, but I do think that that's where you would see some potential issue there.

Chris Olin -- Longbow Research -- Analyst

OK, thank you.

Tony Thene -- President and Chief Executive Officer

Yes.

Operator

And next, we have Phil Gibbs of KeyBanc Capital Markets.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Excellent. Thanks for taking my questions. Good morning.

Tim Lain -- Vice President and Chief Financial Officer

Good morning.

Tony Thene -- President and Chief Executive Officer

Good morning, Phil.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Hey, Tony, how did the -- I may have missed the comments early because I was jumping from the Reliance call, but excuse me not Reliance but the close call. But did you say what the engine subsegment did in terms of either quarter-over-quarter or year-over-year revenue growth?

Tony Thene -- President and Chief Executive Officer

Yes, sorry about that, Phil. I don't think I did mention that specifically. Engines quarter over quarter were up 15% from a sales standpoint.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

OK, perfect. And I think you talked a little bit about it just now, Tim, but you said international is showing some life, which we're hearing from others. But are you seeing a pickup in your order book on the oil and gas side moving forward given the improvement in pricing?

Tim Lain -- Vice President and Chief Financial Officer

Yes, I guess there, Phil, I may go back to saying we're cautiously optimistic. I mean, we would even say there's early signs of this international growth. We did see that demand pickup in the quarter, but in terms of outlook, I'm not sure that we're prepared to say anything more than that. Just being cautiously optimistic about that improvement.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Do you participate much in the offshore side?

Tim Lain -- Vice President and Chief Financial Officer

We do. I guess we're more concentrated in the Permian right now, but just because that's where all that activity is. But historically, we have participated in [Inaudible].

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

OK. And I think you all did better than your guidance in the third quarter in SAO on margins, at least relative to what we were thinking. But PEP was a little bit late, maybe by a couple of million dollars if you exclude the insurance gain. So what missed perhaps relative to your expectations there?

Tony Thene -- President and Chief Executive Officer

Yes, you're right. So that was a couple million dollars. So in the whole scheme of things, not that large compared -- you had almost $80 million in two segments combined. But I guess the positive to that is that I think it's very specific to our Amega West business primarily.

It's not a market issue. It's a specific new tool that we've developed and the adoption of that tool has not been what we would like it to be. So that's one specific, we had great expectations for that and we've fallen flat and we need to make that correction. But it's not a market issue.

And if you look at the other businesses inside of PEP, Dynamet quite frankly is doing very well. They did a great job recovering from the fire that we had. Did our best to take care of all of our customers, and I'm very proud of how they've done that. And now we're investing money in both of our Dynamet locations to increase capacity because of the share gains that we've added, particularly on the medical side.

So PEP is a pretty strong business for us, and we need to get after on the Amega West side those specific tools that we take to market and make sure we have the appropriate marketing plan to take advantage of their capabilities. And in this case here, we did not do it.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

OK, perfect. And one more question if I could, because I think it's important for what we're all seeing right now. Boeing has cut production, as everyone knows at this point in time. So is there any change in cadence that you're hearing from either the structural side or the engine side? Or is there any difference in terms of what you're hearing from both of those supply chains, meaning does one feel tighter or looser than another? Thanks.

Tony Thene -- President and Chief Executive Officer

Yes, thanks, Phil. We speak with all of our customers on a daily basis. We engage directly with all of them on this issue, and none of us, none of them have told us to slow down. So we are not changing any production plans at this time based on that specific incident with the 737 MAX.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Thanks, Tony. Appreciate it.

Tony Thene -- President and Chief Executive Officer

Yes. Thank you.

Operator

The next question will come from Jeremy Kliewer of Deutsche Bank.

Jeremy Kliewer -- Deutsche Bank -- Analyst

Hey, good morning. Regarding your soft magnetics program up at Reading, can you remind us how much of that is already contracted out with the new capacity that you'll add on there?

Tim Lain -- Vice President and Chief Financial Officer

Sorry, Jeremy repeat the question. We lost you.

Jeremy Kliewer -- Deutsche Bank -- Analyst

With the capacity addition up at Reading, how much of that is contracted, if any?

Tony Thene -- President and Chief Executive Officer

I would say none of it is actually under a long-term contract today. We supply into that industry now, so we have contracts in place across multiple customers. This piece of equipment is put in for two reasons. One, it's a significant cost saving because it brings the entire process in house.

So we're not as reliant on external support. And two, we see this as a significantly growing market that we will pick up that business as we go. So those contracts will come. Some existing customers, their demand will increase because it's much like the engine market.

As you see the electrification of the world increased, the demand is going to increase. So we built that facility based on a better cost base and on the fact that this is a market that we believe is going to grow significantly over the next couple of years.

Jeremy Kliewer -- Deutsche Bank -- Analyst

All right, thank you for that. And then regarding the SAO, you guys have about $3 million to $7 million bucks coming in 4Q compared to both 3Q and 4Q last year. How much of that is a market share gain versus just the overall markets in general increasing?

Tim Lain -- Vice President and Chief Financial Officer

Jeremy, can you ask that question again, please?

Jeremy Kliewer -- Deutsche Bank -- Analyst

So in your SAO, your guidance, you have a 5% to 10% growth coming in 4Q. That's roughly $3 million to $7 million bucks. How much of that is market share gains and clients coming to you for more product versus just the overall markets increasing production rates?

Tony Thene -- President and Chief Executive Officer

Well, I think it's a combination. I mean, I haven't broken that down specifically externally. But it's a combination of market share, of course. I think the market is going to continue to grow quarter over quarter as you see engine manufacturers increase their production schedules.

And we're going to continue to work on productivity. We'll take inventory out in the fourth quarter just because, from a sales standpoint, that's required. And that won't be a positive from an earnings standpoint. But I would say it's a combination of all of those that you mentioned.

Jeremy Kliewer -- Deutsche Bank -- Analyst

All right, thank you and good luck.

Brad Edwards -- Investor Relations

Thanks.

Operator

Next we have a follow up from Chris Olin, Longbow Research.

Chris Olin -- Longbow Research -- Analyst

Hello again. Question on medical. Actually, a couple of questions on medical. But my first one was any of the business you have today, would it be considered cobalt alloys? And was there any impact from the kind of surcharge movement?

Tony Thene -- President and Chief Executive Officer

The answer to the first question is yes, and the second part of your question, the answer is no.

Chris Olin -- Longbow Research -- Analyst

OK. And then I'm still trying to understand the strength in this business. It's been a strong grower for like four or five quarters now, and I was under the assumption there weren't very many competitors in, call it, titanium fabrication. I guess I'm just wondering, is there a way to look at what the underlying market is growing and how much is actually benefit from market share movement?

Tony Thene -- President and Chief Executive Officer

Well, I don't think there's a lot of players that do what we do from the titanium standpoint. Our big focus really is on orthopedic side and the cardiology side. And that is primarily the reason why we're expanding both of our Dynamet locations, is on the titanium side. I think you see a move from medical into additive manufacturing because it can improve patient outcomes, which is the ultimate goal.

So titanium wire becomes very attractive, that you turn that into a powder and then make the eventual part. So we see ourselves, they're growing with specific influential customers in that area.

Chris Olin -- Longbow Research -- Analyst

OK, but most of the growth came from another competitor?

Tony Thene -- President and Chief Executive Officer

When you say most of the growth came from another competitor, I don't--

Chris Olin -- Longbow Research -- Analyst

The volumes you want. It was a market share or contract movement basically.

Tony Thene -- President and Chief Executive Officer

Well, I think the market's getting larger. I think in medical, you see them moving more and more to additive manufacturing parts. I think they're on the front end of that. So it's a market that's getting larger as people have more procedures, just because the outcome of those procedures are much more positive because of the increase in technology.

Chris Olin -- Longbow Research -- Analyst

OK. And then just lastly, in that whole Dynamet environment, have we seen the full impact from Airbus canceling the A380. Is there any issues there.

Tony Thene -- President and Chief Executive Officer

Well, the A380 obviously is a large plane, so there's a lot of content on that. However, that's not going to change the overall planes that are manufactured over the next two, three, five years. So although that was a profitable plane for us, there's many other places where our material is going to go, and we don't see that being an adverse impact on us whatsoever.

Jeremy Kliewer -- Deutsche Bank -- Analyst

Thanks again.

Operator

Sir, no further questions. We will conclude our question-and-answer session. I would now like to turn the conference call back over to Brad Edwards of investor relations for any closing remarks. Sir?

Brad Edwards -- Investor Relations

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

Operator

[Operator signoff]

Duration: 54 minutes

Call Participants:

Brad Edwards -- Investor Relations

Tony Thene -- President and Chief Executive Officer

Tim Lain -- Vice President and Chief Financial Officer

Gautam Khanna -- Cowen and Company -- Analyst

Adam Friedman -- Seaport Global Securities -- Analyst

Chris Olin -- Longbow Research -- Analyst

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Jeremy Kliewer -- Deutsche Bank -- Analyst

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