Carpenter Technology Corp

NYSE:CRS

Q3-2025 Earnings Call

[Operator]

Thank you for standing by. My name is Karen, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Carpenter Technology Quarter 3 Fiscal Year 2025 Earnings Presentation. [Operator Instructions]

I will now turn the call over to John Huyette. Please go ahead.

[John Huyette, executive]

Thank you, operator. Good morning, everyone, and welcome to the Carpenter Technology earnings conference call for the fiscal 2025 third quarter ended March 31, 2025. This call is also being broadcast over the Internet, along with presentation slides. 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, 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 these 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, 2024, Form 10-Q for the fiscal quarter ended September 30, 2024 and December 31, 2024 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 referring to operating margins, that is based on adjusted operating income excluding special items, and sales excluding surcharge.

I will now turn the call over to Tony.

[Tony Thene, executive]

Thank you, John, and good morning to everyone. I will begin on Slide 4 with a review of our safety performance.

Through the third quarter of fiscal year 2025, our total case incident rate was 1.4. Our leaders are actively modeling safety-first behaviors and emphasizing hands-on scenario-based training to support our shop floor teams. We're also reinvigorating our daily safety routines to drive increased awareness and focus. We remain committed to our ultimate goal, a 0 injury workplace, driven by consistent action and continuous improvement.

Let's turn to Slide 5 for an overview of our third quarter performance. Our third quarter performance was exceptional, exceeding expectations and delivering the most profitable quarter on record. In the third quarter of fiscal year 2025, we generated $138 million in operating income, a 53% increase over our third quarter of fiscal year 2024 and 10% higher than our previous record in the fourth quarter of fiscal year 2024.

Our record third quarter performance was driven by our strong market position, broad solutions portfolio, with unique capabilities and focus on manufacturing execution.

Notably, the SAO segment continues to expand adjusted operating margins, reaching 29.1% in the quarter, compared to 21.4% a year ago and 28.3% in the prior quarter. The ongoing margin expansion is a result of continued improvement in productivity, product mix optimization and pricing actions. The SAO segment reached a record $151.4 million of operating income, an increase of 46% year-over-year.

With the strong earnings and disciplined working capital management, we generated $34 million in adjusted free cash flow during the quarter. And we continue to return cash to shareholders through our repurchase and dividend programs. We purchased 37.5 million of shares in the quarter, raising the total to 78 million for the year.

As we look ahead, our strong performance gives us confidence to again increase our guidance for the full fiscal year 2025. In the previous earnings call, we raised our fiscal year 2025 operating income guidance to a range of $500 million to $520 million. Now with a strong third quarter results and fourth quarter outlook, we are raising our guidance for the fiscal year to the range of $520 million to $527 million. This would represent a nearly 50% increase in earnings over fiscal year 2024.

Now let's turn to Slide 6 and take a closer look at our third quarter sales and market dynamics. In the third quarter of fiscal year 2025, sales increased 8% year-over-year and 9% sequentially. This was driven primarily by the aerospace and defense end-use market, which saw sales increase 12% sequentially on 6% higher volumes.

Within aerospace and defense, sales were notably up across engines, fasteners and defense. Our engine sales were up 16% sequentially. This was driven by increased shipments to many customers combined with higher pricing as we entered a new calendar year.

In general, our engine customers remain very busy with Airbus-related platforms and MRO demand and continue reporting strong pulls and a notion of being behind. They continue to look forward to ongoing build rate ramps in the industry and remain concerned about security of supply. As usual, we continue to be in discussions with multiple customers regarding long-term supply agreements. We recently concluded 2 LTAs that will provide significant benefit to our customers and corporate technology now and in the future. I will note that we also expect to conclude other LTA discussions over the coming quarter.

Aerospace OEMs continue to be very active across the supply chain and remain in strategic discussions with us, often on a weekly basis.

Our defense business remains strong, and we continue to see urgent requests for material across multiple applications. In the recent quarter, one notable area of increased sales was from a specific platform, where Carpenter Technology was asked directly by the Department of Defense to step in and provide emergency support. We continue to be proud of our role in supporting the defense community and will prioritize supply accordingly.

In the medical end-use market, our sales were essentially flat sequentially and down 14% compared to a record prior year quarter. Underlying demand in medical remains positive, with ongoing increases in patient procedures. Customers continue to discuss ongoing expectations for steady growth, and more and more are in discussions with us to ensure their supply is secured. While our medical sales have already grown substantially over the last several years, we continue to believe there is significant growth potential looking forward.

In the energy end-use market, sales were up 9% sequentially and 26% year-over-year, with significant increases in sales to our power generation customers. We are working closely with the power generation supply chain, from OEMs to parts manufacturers, to support their growth as this submarket has become a valuable strategic advantage for us.

Altogether, the near- and long-term demand outlook for Carpenter Technology remains very positive.

Moving to Slide 7, let's discuss the current tariff situation and how Carpenter Technology strategic position provides a solid foundation. We have been closely monitoring the evolving tariff news as well as engaging with our customers and suppliers to analyze how tariffs could impact our business.

I think the most relevant piece of information is that we as well as others in our industry have established long-standing surcharge mechanisms to pass through changing raw material prices to our customers. We expect to use these surcharge recognitions to pass through the impact of any incremental tariffs on our raw materials to our customers.

I will also say that not all of our input costs are subject to tariffs as currently proposed or enacted. For reference, nickel, our largest raw material input, is sourced primarily from Canada, and Canadian nickel is currently exempt from tariffs.

We have also evaluated how tariffs and, ultimately, global trade dynamics may impact demand in the near to medium term. Obviously, this is harder to predict as reactions and negotiations are happening in real time involving multiple countries. At a high level, based on what we know today, we anticipate limited impact.

First of all, most of our products are highly specialized, designed specifically for our customers' needs. In most cases, these products have undergone significant qualifications. This means that there are a few sources of these materials, in some cases, we are the only one, and often can only be sourced within the United States. Again, we will continue to monitor the tariff proposals and update our view as new information becomes available.

Moving on from tariffs, I think it is worthwhile to highlight a few points about Carpenter Technology that may be underappreciated. These past few years have included significant disruptions in the supply chains that we participate in, whether it's the tariffs and trade implications I just mentioned, ramping capacity and productivity across the broad aerospace manufacturing industry, airplane build rate changes or other manufacturing issues at specific OEMs, to name a few.

Despite all these disruptions, the team at Carpenter Technology has been solely focused on executing our strategy and consistently delivering record financial results. This is not a coincidence, and it is not luck. It is based on a specific strategy we set a decade ago and continue to execute against today.

Our consistent success demonstrates the advantage we have in serving customers across multiple applications and platforms. We are not tied to one single platform or alloy, but instead help a variety of customers solve their most challenging material needs. This includes meaningful content on all commercial aero engine platforms, whether it is considered legacy, next-gen, wide-body, narrow-body, OEM build or MRO. On these platforms, our material support applications from rings and discs, to gears, bearings, fasteners, avionics and structural.

There is not a single engine manufacturer in the aerospace industry that we do not count as a customer. And we are already looking ahead at the future generation of engine, still many years from industry adoption. In fact, we are actively working to support OEMs on these types of platforms with recent sales of advanced materials to be tested on these platforms. Our aerospace and defense end-use market accounts for approximately 60% of our revenue, but we also serve other very specialized markets that seek out Carpenter Technology's expertise for specialized alloys across a broad portfolio offering.

We are selective about which markets and industries we participate in. We focus on high-growth markets with customers who value precise metallurgical properties in their applications, like alloys used in medical implants, highly specialized materials used in the manufacture of semiconductors, and aerospace-like applications used in IGT to support power generation buildout, to name a few.

We have built a broad portfolio of highly specialized solutions in rapidly growing markets, supported by strong megatrends. With an impactful commercial strategy, a focus on manufacturing execution through rigorous quality standards and, above all else, a commitment to the safety of our employees.

Our solutions portfolio has provided the foundation that has enabled Carpenter Technology to navigate recent near-term challenges and short-term market disruptions. In fact, we have not only navigated the challenges, but we have also set new records for financial performance in the process.

Now I will turn it over to Tim for the financial summary.

[Timothy Lain, executive]

Thanks, Tony. Good morning, everyone. I'll start on Slide 9, the income statement summary.

Starting at the top, sales excluding surcharge increased 8% year-over-year on 7% lower volume. Sequentially, sales were up 9% on 1% higher volume. The year-over-year growth in net sales despite lower volume was driven by increasing productivity in key areas necessary to drive stronger product mix, as well as the realization of higher prices. The improving productivity, product mix and pricing are evident in our gross profit, which increased to $200.8 million in the current quarter, up 37% from the same quarter last year.

SG&A expenses were $63 million in the third quarter, which includes $24.4 million of corporate costs. For the upcoming fourth quarter of fiscal year 2025, we expect corporate costs to be in line with our recent third quarter of $24 million.

Adjusted operating income was $137.8 million in the current quarter, which is 53% higher than the $90 million in our third quarter of fiscal year 2024 and up 16% from our recent second quarter. As Tony mentioned earlier, this represents our best quarterly operating income result on record.

Moving on to our effective tax rate, which was 21.8% in the current quarter. This quarter's effective tax rate was slightly lower than our anticipated rate due to certain discrete tax benefits recorded in the current quarter associated with stock option exercises. For the upcoming fourth quarter of fiscal year 2025, we expect the effective tax rate to be more in line with our normalized rate of 23%.

In summary, the earnings per diluted share results for the quarter of $1.88 demonstrate ongoing solid execution against the goals we laid out for this quarter.

Now turning to Slide 10 and our SAO segment results. Net sales excluding surcharge for the third quarter were $519.4 million. On a year-over-year basis, sales were up 8% on 12% lower volume. Sequentially, sales were up 8% on similar volume. The increase in sales reflects the impacts of higher realized prices and increasing productivity at key work centers that enabled an improved product mix relative to a year ago.

Moving to operating results. SAO reported operating income of $151.4 million in the third quarter of fiscal year 2025. As Tony mentioned, the adjusted operating margin of 29.1% in the third quarter is a significant achievement. The continued margin expansion is a result of the SAO team's focus on reliably increasing production levels while closely managing operating costs, realizing higher selling prices and a richer product mix. These areas are as relevant as ever as we actively manage our production schedules to adjust to changing customer priorities and seek to increase our overall output.

Looking ahead to our upcoming fourth quarter of fiscal year 2025, we anticipate SAO would generate operating income in the range of $160 million to $165 million, which will represent another record level of profitability.

Now turning to Slide 11 and our PEP segment results. Net sales excluding surcharge in the third quarter of fiscal year 2025 were $96.8 million, up 2% from the same quarter a year ago and up 12% sequentially. In the current quarter, PEP reported operating income of $10.9 million, compared with $9.2 million in the same quarter a year ago and $7 million in the second quarter of fiscal year 2025.

The improvement in operating income in the current quarter was driven by our additive business. As we anticipated and discussed last quarter, our additive business experienced more normalized shipments to certain strategic customers that we expect to continue through the balance of this fiscal year.

As we look ahead, Dynamet is the driver of the PEP segment, representing a significant portion of PEP sales and even greater percentage of pest profitability. Dynamet's fundamentals are very comparable to SAO, including a strong market demand backdrop in the medical and aerospace end-use markets, which accounts for approximately 95% of Dynamet sales. Like SAO, the focus of Dynamet remains on improving productivity and expanding capacity to increase our output, which has driven improved results.

With that in mind, we currently anticipate the PEP segment will deliver operating income in the range of $10 million to $12 million in the upcoming fourth quarter of fiscal year 2025.

Now turning to Slide 12 to cover some of the highlights of liquidity and cash flow. In the current quarter, we generated $74 million of cash from operating activities and spent $40 million on capital expenditures, resulting in $34 million of adjusted free cash flow. The results were driven by improving profitability and our disciplined approach to working capital management.

I will note that the current quarter's cash flow results includes $38 million of discretionary pension contributions. This is incremental to the minimum required contributions and was made to maintain certain funded ratios for one of our plans. The pension plans remain well funded and no additional discretionary contributions above the modest minimum required contributions are planned at this time.

The cash generation in the current quarter is an important step towards delivering our full fiscal year 2025 adjusted free cash flow target of $250 million to $300 million, and executing our planned capital allocation priorities, namely taking a balanced capital allocation approach to return cash to shareholders and invest for growth.

In terms of returning cash to shareholders, we were active against our recently authorized share repurchase program. In the current quarter, we repurchased 37.5 million of our stock. Year-to-date, we have purchased 78 million of our stock against the $400 million authorization. The share repurchase program complements the long-standing quarterly dividend, which we continued this quarter.

From an investment perspective, we plan to spend $155 million to $160 million in capital expenditures in fiscal year 2025. This includes about $30 million of capital spend related to our recently announced brownfield expansion project.

Our liquidity remains healthy. We ended the third quarter of fiscal year 2025 with total liquidity of $500.4 million, which includes $151.5 million of cash and $348.9 million of available borrowings under our credit facility. Our leverage ratios remain at historic lows, ending our recent third quarter under 1x with no near-term debt maturities. And we remain confident that we can deliver our targeted adjusted free cash flow of $250 million to $300 million for fiscal year 2025.

With that, I will turn the call back to Tony.

[Tony Thene, executive]

Thanks, Tim. Carpenter Technology just completed another outstanding quarter, and I'd like to highlight the key points from today's call.

First, we delivered a record quarter with operating income of $138 million, up 53% from the third quarter a year ago. We increased adjusted operating margins in our SAO segment again, reaching 29.1%, another new record. We generated $34 million in adjusted free cash flow with improved earnings and working capital management. We continue to return cash to shareholders, purchasing 37.5 million of shares in the quarter. This raises the total share purchases to 78 million for the year against our $400 million share repurchase program. In addition, we continue our long-standing quarterly dividend.

As I highlighted earlier, we are well positioned to navigate the current environment with our strategic positioning, broad portfolio of products and focus on manufacturing excellence.

Finally, we're projecting a strong finish to our fiscal year 2025 with fourth quarter earnings expected to increase 6% to 11% over our record third quarter. As a result, we've increased our operating income guidance for fiscal year 2025 again to the range of $520 million to $527 million. And we remain on track to generate $250 million to $300 million of adjusted free cash flow in the fiscal year.

This financial performance will be a remarkable achievement at a time when the aerospace supply chain is transitioning and only at the beginning of its aggressive build rate ramp. We continue to believe we are in the early stages of our growth journey as demand for our material will only get stronger and our earnings growth potential will continue to expand.

Let me close by giving a reminder of our fiscal year 2027 earnings outlook on Slide 15. What an exciting time to be part of Carpenter Technology as we are delivering record profits while projecting a future of even higher earnings growth potential. As highlighted at our recent investor update, we have a compelling outlook for the company. We expect strong sustained earnings growth with operating income anticipated to reach $765 million to $800 million in fiscal year 2027. This would represent a 25% CAGR over the next 2 years, an earnings growth rate that we believe will outpace most of our peers.

We project fiscal year 2026 to be materially higher than fiscal year 2025. And we believe fiscal year 2027 is not the peak of our earnings growth trend, with volume, productivity and product mix all continuing to improve.

As with our previous targets, we have high confidence in our ability to achieve these numbers with opportunities to potentially exceed them. With our continued earnings growth and focus on disciplined management of our working capital, we expect our cash generation to accelerate. Specifically, we project significant free cash flow generation of $1 billion from fiscal year 2025 through fiscal year 2027, with an impressive 90% conversion rate. This is before considering the recently announced brownfield capacity expansion investment.

This is a meaningful amount of cash to drive shareholder value. As such, we will continue to take a disciplined, balanced approach. We will return cash to shareholders through our quarterly dividend. We will repurchase shares through our $400 million buyback program. And we will invest in long-term strategic profitable growth.

As we detailed in our investor update, we are in a unique position to bring on strategic capacity given our capabilities and unique collection of assets. The brownfield expansion will add high-purity primary and secondary melt capacity that will feed our existing downstream finishing assets. And while this brownfield investment will not materially impact the industry's current supply and demand imbalance, it most definitely provides an earnings accelerator to the company's already attractive earnings growth projections. We plan to fund this project through internal cash generation and anticipate an attractive return on capital of greater than 20%.

Altogether, I think you all will agree that Carpenter Technology is performing at a high level today and has a very bright future with sustained growth and value creation for our shareholders. Thank you for your attention. I will now turn the call back to the operator.

[Operator]

[Operator Instructions] The first question comes from Scott Deuschle from Deutsche Bank.

[Scott Deuschle, analyst]

Tony, can you further characterize the order trends you saw in the quarter? And then are you seeing any emergency orders coming in yet on the aerospace side as billings build rates gain some momentum here?

[Tony Thene, executive]

Scott, without getting into any of the specific figures on orders, I can tell you that they were up just a bit over 20% sequentially. So a really good order intake quarter.

Emergency orders, I can say that we still continue to have customers pushing to get their deliveries earlier than planned, whether that constitutes how you want to call it, emergency order or not, but we still have that quite frequently.

[Scott Deuschle, analyst]

Okay. And then can you give some updated color on leading-edge pricing? I mean obviously, we see in the results in a big way, but there's some lag there. And I think investors are a bit in the dark on what the current pricing environment looks like for what's going in the backlog today. So some clarity there, I think, would be helpful.

[Tony Thene, executive]

Well, I think, Scott, for me, it's -- I'm not going to talk specifically about pricing. What I did say in my prepared remarks is that we closed 2 LTAs in the quarter. And I think my words were I said they were a significant benefit or significant contribution. So I'll let you figure out what that means.

I can also point to the fact, back in the investor update that we gave a couple of months ago, we also said that we continue to see pricing actions continue to improve. And really, all that's based on is a supply and demand imbalance that's going to get significantly tighter going forward. So that's where the pricing is tied to. So I don't think that should be much of a surprise when we said in the investor update that we would anticipate that to continue.

[Scott Deuschle, analyst]

Okay. And then did you get much of the benefit from the LTA price increase in the quarter you just reported? Or is that still to come?

[Tony Thene, executive]

Well, not for this LTA that we just signed. Those will be in the future. But I think I did also mention in the call that in the quarter, because the calendar quarter, some of those new LTAs that we've negotiated 9, 10 months ago, then became effective on January 1.

[Scott Deuschle, analyst]

Right. Okay. Last question just high level, Tony, like a lot has happened since our February investor event. I guess, are you now more or less confident in the 2027 EBIT guide relative to your mindset 2 months ago?

[Tony Thene, executive]

Well, I'm more confident because things are in better shape than they were 2 months ago. I mean we stand now, just a couple of recent points, yesterday, Boeing has a very good call where they're continuing to make impressive improvements in their build rate production. GE Aerospace just reported MRO sustaining at high levels. Hopefully, we'll see some deescalation from the from the tariff situation. So I'm much more confident now than 2 months ago. We're in a much better spot.

And I really believe over the next 4, 5, 6 months, you're going to see a massive inflection point. And I know right now, we want to talk about is somebody destocking, is somebody -- did your backlog go down by 0.5%? I mean in the whole big scheme of things, we're in a much better spot now than we were 2 months ago. And I would tell you, we're talking a quarter or 2 from now, we're going to be right back to urgent demand across the board.

[Scott Deuschle, analyst]

Okay. Yes, I'm not too worried about the backlog going down 0.5%. But I appreciate it.

[Operator]

The next question comes from Josh Sullivan from The Benchmark Company.

[Joshua Sullivan, analyst]

Can you just update us on the lead times? And then is there any churn in that book? Or what does that look like? Any notable differences within end markets or products at this point?

[Tony Thene, executive]

On lead times, I will say that no change from before there. When we talk lead times, Josh, just to be clear, we're always talking about aerospace engine, that's the proxy for lead times. So I always like to say that just so everyone's clear with that. But we're still at up to 60 weeks for aerospace engine.

I don't see that changing, right? It's not going to get much shorter. And we cap our order book. So you're effectively capping lead times. So I think you're going to be in that up to 60-week lead time for aerospace engines. So no change.

[Joshua Sullivan, analyst]

And then just on the LTA discussions, and you mentioned in the remarks there, compared to last year or even earlier this year, how has the current environment leaked into those conversations? Or maybe it hasn't. Just curious if the short-term dynamics are influencing those LTA parameters at all.

[Tony Thene, executive]

They don't impact them at all. I mean you have very sophisticated customers that are sitting across the desk from you, right? They're not we're not negotiating a deal that's going to happen today for 10 tons. We're talking about a long-term supply agreement over the next 3, 5 plus years that's going to facilitate them making their product right? So that's what we're talking about.

And they know very well that supply and demand imbalance is only going to get tighter. So any disruptions in this near term actually have a 0% impact on current LTA discussions or negotiations.

[Joshua Sullivan, analyst]

And then maybe just on PEP, any impact from the SPS fire at this point? Or any dynamics there we should be thinking about medium term?

[Tony Thene, executive]

No, we didn't have any impact to our business on the SPS fire. I mean we remain -- we're in close coordination. We hate to see that happen to somebody, certainly in the industry. And we've done everything we can do to support them on any types of materials that we might have been holding. But no material impact to our business.

[Joshua Sullivan, analyst]

Okay. And then just one last one. Just at additive, can you just help us think about within PEP, the cyclicality within additive and then Dynamet ramping up, how should we think about that over the next 12 months or long term?

[Tony Thene, executive]

Well, you should think the Dynamet is by far the major player inside of PEP. And we have a good business with additive. We're always in the game. We have the opportunity to move inside of that industry if it picks up. But the real player inside of PEP is Dynamet.

[Operator]

The next question comes from Bennett Moore from JPMorgan.

[Bennett Moore, analyst]

Congrats on the quarter. Despite the greater shipping days, SAO volumes were relatively flat on a similar A&D and medical mix. Could you provide any additional color on the moving parts here and what we might expect to see those volumes trend consistently higher?

[Tony Thene, executive]

It's an interesting question, right? And it was really moved over the last couple of years. Remember, I'm -- we are really trying to optimize our business, not for volume. Because we're not a commodity business. We're trying to optimize for profitability. And as you see some of these products change, the processing times can be significant between. And when you're looking at an aerospace product, or let's just pick something out of the industrial segment, our transportation, one of our smaller end-use markets. What you're producing maybe in that other segment is significantly more volume at a lot less revenue.

So we're going to use our assets where we can, where there's any fungibility at all to use it on the higher-priced products. The result is you'll see your volume going down, but you see your revenue going up quite a bit. We believe that's an easy decision to make, right? So that's what we play to. We're going to play to profitability.

Now I will tell you, as you go forward over the next, let's say, 4 quarters or as we get into our FY '26 and beyond, you'll see volumes go up. You have to. You just spent the last 6 months where one of your large OEMs has effectively made no airplanes. So for sure, as you look forward over the next several quarters, volumes are going to go up, and that's just going to make the supply-demand picture even tighter.

[Bennett Moore, analyst]

And then just given the broader macro backdrop, I'm wondering if you're seeing any order deferrals or pockets forming for some of your more lower-margin GDP-levered markets.

[Tony Thene, executive]

Well, some of our more lower what you call lower-margin products aren't material, right, to the whole scheme of things. I mean I'd tell you we're moving towards aerospace and medical make up 75% of our revenue. And then if you add in IGT, which has aerospace-like margins, some of the semiconductor business, you're close to 80%. So that drives the story with us going forward.

[Operator]

The next question comes from Andre Madrid from BTIG.

[Andre Madrid, analyst]

Looking at the medical business, I know you said the backdrop remains strong, but down 14% year-over-year. I've heard some commentary from my industry contacts as well implying that this was a little bit weaker as of late. Could you maybe explain what's driving some of that a little bit further?

[Tony Thene, executive]

Well, I think you've had a little bit of destocking possibly in the medical end-use market. That happens, that's not overly surprising. Remember, last third quarter was, I think, our second highest medical sales quarter ever. So you've got a tough comparison.

To maybe give you a little bit of relief or a little bit of comfort, as we look forward next quarter to the fourth quarter, I usually don't project sales by end-use market, but medical, we project to be up quite a bit in the fourth quarter compared to Q3. So what we're hearing from customers, that any of that type of destocking, if you will, is largely behind us now. And our forecast supports that, and we see a big -- a pretty sizable increase in Q4.

[Andre Madrid, analyst]

Got it. Very helpful. And then going back to your comments around raw materials. I mean, you mentioned that most of the nickel you get from Canada. I mean maybe just overall, if you're looking at like all of your feedstock, how much is domestic versus international?

[Tony Thene, executive]

Well, our biggest input is nickel, and that comes from Canada and Norway specifically, right? So that's where that comes. That's going to go -- be managed through the established surcharge.

We did a pretty in-depth analysis on what all of the costs in our entire system could be impacted by tariffs. And we came to a very, very small number, very low single digits of our total spend would be impacted. And our plans would be to pass 100% of that through to our customers. Hopefully, that helps.

[Andre Madrid, analyst]

Definitely, definitely. And I guess just to follow up on that, you said though you can't control how that might impact demand further downstream. I mean could you share some more thoughts there?

[Tony Thene, executive]

You mean how it might impact our sales?

[Andre Madrid, analyst]

Yes, how it might impact demand downstream.

[Tony Thene, executive]

Yes. So the first part was input costs, which you just talked about. The second part, downstream. Right now we don't see that as being a big impact for us. Because like I said, given our unique portfolio of products that we manufacture, there's not another place to pick those up. So we don't see that being a major issue for us going forward.

[Operator]

The next question comes from Spencer Breitzke from TD Cowen.

[Spencer Breitzke, analyst]

I was wondering if you could provide some color on how fasteners and jet engine orders and sales were in the quarter?

[Tony Thene, executive]

Well, sales, I mentioned that in the remarks, they're up 16% sequentially, fasteners up 25% sequentially.

[Spencer Breitzke, analyst]

Okay. Great. And I was wondering do you have any sort of a view on maybe the upper limit of margins at SAO? I mean they've been so strong.

[Tony Thene, executive]

Well, Gautam must have given you that question. I'm sure he would have -- he was the one that asked a couple of quarters ago on whether -- where we could get to. And at the time, I said 30%. I think a lot of people thought that that wasn't really achievable in the amount of time that we stated, and we just achieved 29%. So really good performance by the commercial team and the operations team out on the floor.

And I think it's important, we get to this level of margin percentage expansion. I think that really pushes us to a higher, I would say, into another category in terms of valuation. I mean this is a really important point I think for any company to be able to perform at that type of level.

Now I mean, there's a lot -- I think, Spencer, important to keep in mind that there's a lot of factors that impact the margins and, in any given quarter, you could have some pluses and minuses, and certainly it depends on mix. So I'm not here to suggest to you that every quarter, it's going to be linear, right? But certainly, from our point of view, 30% not the limit, and we see opportunities that we could push past that number.

[Operator]

The next question comes from Philip Gibbs from KeyBanc Capital Markets.

[Philip Gibbs, analyst]

So Tony, I'm curious just from reading some of the tea leaves and being at a recent aerospace conference, if either you've received or you've given any of your customers any force majeure letters. Just what's the status of some of that within your own business and/or what you've seen or heard.

[Tony Thene, executive]

Well, Phil, I'm aware of what you're talking about. I think also you have to remember that there could be significant differences across the aerospace supply chain on where they source material, do they move material back and forth inside United States to produce that would cause them to do -- or they believe that they need to issue some type of letter. We have not done that. We don't see any need that we need to issue a force majeure letter due to tariffs. As I just said, any move on nickel price, which is the largest by far input to our cost, we have a mechanism to pass through. I just said that all those other costs, we've done a deep analysis. It's a very small amount, a small percentage amount of our overall spend. And we pass that 100% through.

So from our standpoint, we believe we have the mechanisms in place and don't feel like we need to do any type of force majeure letter.

[Philip Gibbs, analyst]

Tony, did you -- you also mentioned that a lot of your nickel imports are from Canada. Are those not being tariffed right now? I just wanted to be clear.

[Tony Thene, executive]

That's correct.

[Philip Gibbs, analyst]

Okay. And then I think you did mention earlier that backlog relatively flat. You said basically, what, down 0.5%. Was that theoretical or was that where you're at now?

[Tony Thene, executive]

No, that was theoretical, Phil. That was just, quite frankly, me showing some of my frustration with these small moves back and forth. I mean our backlog is at 2.5x, what it was pre-COVID. And at that time, it was considered strong. So you're going to have movement from -- in your backlog plus or minus from time to time, especially if you've got a fact that you've got one of the major OEMs not producing planes, you're able to pull forward for other customers to pull into that range.

So we still have a very healthy backlog, well over 2x what it was prior to COVID.

And keep in mind also, Phil, when we limit our order intake or close our order book, you're effectively putting a cap on your backlog. So I think it becomes a lot less effective metric to try to judge whether market demand is up or down.

[Philip Gibbs, analyst]

No. I think why we ask the question is just based on timing, right? So when does Boeing, for example, take their foot off the gas in terms of orders, feel like they have enough inventory and then we can see when they come back in, in a more meaningful way? So that's more of the question. Obviously, the pricing has been very good and will continue to be very good. But do you have that latest update, a number you could share?

[Tony Thene, executive]

We're within that plus or minus. I mean our backlog isn't moving that much at the high end now.

[Operator]

The next question comes from Scott Deuschle from Deutsche Bank.

[Scott Deuschle, analyst]

Tim, the inventory number as a percentage of sales was still pretty high this quarter. I guess, can you explain a bit more what's going on there with inventory? And should we still expect that to unwind in the fourth quarter?

[Timothy Lain, executive]

Yes, Scott, I mean, without getting into any specifics on what the number is going to be in the fourth quarter, we do tend to build in the first half and take it out in the second half. It wasn't quite the build that we had in Q2 and Q3. And then in the fourth quarter, we do expect inventory to come down. And that's a big driver of our confidence in the cash number for the full year, which obviously implies a big number for the fourth quarter. So inventory will come out in the fourth quarter.

[Scott Deuschle, analyst]

Okay. And is that building WIP as you do work to fulfill your existing order book? Or are you building finished goods and sitting on them?

[Timothy Lain, executive]

No, it's generally a story around WIP. I mean quarter-by-quarter, it may not work out that way. But generally, the focus all our efforts to bring inventory down is going to be on WIP, and that's what will play out in the fourth quarter when it comes down.

[Scott Deuschle, analyst]

Okay. And then, Tony, just to clarify, are the aerospace LTAs you're entering into, are they still of a shorter duration versus where they've historically been at?

[Tony Thene, executive]

Like we've said in the past, during that 3 to 5 in year range, we try to match up as close as we can to our customer needs. But you should think you're in that 3 to 5 as opposed to a 10. I think a 10-year contract in today's environment doesn't make any sense at all.

[Operator]

Your last question comes from Bennett Moore from JPMorgan.

[Bennett Moore, analyst]

I just wanted to ask real quick on the brownfield investment, specifically the equipment. What if any of this will face tariffs? And is that baked into the CapEx guidance?

[Timothy Lain, executive]

Yes, I'll take that. So yes, I mean the equipment we need is highly specialized, as we talked about before. There's a limited number of companies that can make the equipment we need. Those companies happen, at least for the critical pieces, tend to be in Europe. So we expect there will be tariffs associated with that.

I would say it's an overall small piece of the overall spend, because remember, we've got to do construction, we've got to install the equipment, so there's a lot of other pieces to the overall investment other than just the equipment. And then the other piece is, I mean, obviously, as you know, this is a moving target, and the tariffs really wouldn't come into play until the equipment gets delivered, which is some time out.

[Operator]

That concludes our Q&A session. I will now turn the call over to John Huyette for closing remarks.

[John Huyette, executive]

Thank you, Karen, and thank you, everyone, for joining us today for our fiscal year 2025 third quarter conference call. Have a great rest of your day.

[Operator]

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.