Earnings Call Transcript - WWD Q3 2023

Operator, Operator

Thank you for standing by. Welcome to the Woodward, Inc. Third Quarter Fiscal Year 2023 Earnings Call. At this time, I would like to inform you that the call is being recorded for rebroadcast and that all participants are in listen-only mode. Following the presentation, you are invited to participate in the question-and-answer session. Joining us today from the company are Chip Blankenship, Chairman and Chief Executive Officer; Bill Lacey, Chief Financial Officer; and Dan Provaznik, Director of Investor Relations. I would now like to turn the call over to Dan Provaznik. Please go ahead.

Dan Provaznik, Director of Investor Relations

Thank you, operator. We’d like to welcome all of you to Woodward’s third quarter fiscal year 2023 earnings call. In today’s call, Chip will comment on our strategies and related markets. Bill will then discuss our financial results as outlined in our earnings release. At the end of the presentation, we will take questions. For those who have not seen today’s earnings release, you can find it on our website at woodward.com. We have again included some presentation materials to go along with today’s call that are also accessible on our website. An audio replay of this call will be available by phone or on our website through August 14, 2023. The phone number for the audio replay is on the press release announcing this call as well as on our website and will be repeated by the operator at the end of the call. I would like to refer to and highlight our cautionary statement as shown on Slide 3. As always, elements of this presentation are forward-looking including our guidance and are based on our current outlook and assumptions for the global economy and our businesses more specifically. Those elements can and do frequently change. Our forward-looking statements are subject to a number of risks and uncertainties surrounding those elements, including the risks we identify in our filings. In addition, Woodward is providing certain non-US GAAP financial measures. We direct your attention to the reconciliations of non-US GAAP financial measures, which are included in today’s slide presentation and our earnings release and related schedules. We believe this additional financial information will help in understanding our results. Now I will turn the call over to Chip to comment further on our results, strategies and markets.

Chip Blankenship, CEO

Thank you, Dan, and good afternoon, everyone. We delivered strong sales growth in the third quarter, driven by robust demand and our improved ability to deliver products to our customers. We expanded margins through productivity improvements and price realization, partially offset by increased material and labor costs. We continue to make progress on our strategic initiatives focused on enhancing the customer experience, simplifying operations, and increasing profitability through improved execution. Output is increasing, pricing actions are yielding results, and we are seeing efficiency gains as our new members come up the learning curve and become more proficient in their job. We've seen improvement in our supply base performance; however, the environment remains challenging and we continue to actively manage and problem-solve with our suppliers. Our team has done a great job responding to the fluctuating delivery risk landscape. We remain focused on this work stream with significant resource allocation and the goal of identifying risks further upstream and launching countermeasures earlier in the process. Moving to our markets. In Aerospace, commercial airline utilization rates continue to rise with US, Europe, and China domestic passenger traffic now surpassing 2019 levels. In addition, international travel continues to improve, nearing 2019 levels. In Defense, due to geopolitical developments and government spending proposals, we expect R&D and procurement to increase, which bodes well for Woodward's future opportunities. In Industrial, demand for power generation remained strong, driven by growth in Asia, increases in aftermarket activity and continued demand for backup power. In Transportation, the global marine market remains healthy with increased ship build rates and higher utilization driving current and future aftermarket activity. Marine customers continue to launch more projects that incorporate alternative fuel capability in their specifications. This should drive expanded OEM and aftermarket opportunities as multi-fuel engines contain greater Woodward content. In addition, Chinese heavy-duty truck output increased significantly in February, as did the portion that is natural gas powered. The natural gas-powered production rate has been relatively stable since February but future demand remains uncertain. In Oil and Gas, global investment in LNG infrastructure development continues. Rig counts increased globally, though US activity declined year-over-year. In summary, the market signals we are receiving indicate continued strong demand. We remain focused on operational excellence, developing talent, and innovating for the future, which we believe will drive long-term sustainable growth and deliver enhanced value for shareholders. Before we move on to our financial results, I'd like to introduce Bill Lacey, who took the helm as CFO in May. Bill has a distinguished track record in financial operations and business leadership. With three months in role, Bill has integrated well into Woodward, and he is already contributing to the team. Bill, welcome to your first Woodward earnings call. I'll now turn it over to you to share our financial results.

Bill Lacey, CFO

Thank you, Chip. It's great to be here. Net sales for the third quarter of fiscal 2023 were $801 million, an increase of 30%. Aerospace segment sales for the third quarter of fiscal 2023 were $481 million compared to $402 million, an increase of 20%. Commercial OEM and aftermarket sales were up 41% and 28%, respectively, driven by higher OEM production rates, continuing recovery in both domestic and international passenger traffic, increasing aircraft utilization, and price realization. Defense OEM sales were down 12% in the quarter, primarily due to lower sales of guided weapons. Defense aftermarket sales were up 17%. Aerospace segment earnings for the third quarter of 2023 were $83 million or 17.3% of segment sales compared to $57 million or 14.1% of segment sales. The increase in segment earnings was primarily a result of price realization and higher commercial OEM and aftermarket volume, partially offset by higher annual incentive compensation. Turning to Industrial. Industrial segment sales for the third quarter of fiscal 2023 were $320 million compared to $213 million, an increase of 51%. The increase was driven by higher volumes across all markets as well as price realization. Industrial segment earnings for the third quarter of 2023 were $58 million or 18.2% of segment sales, compared to $21 million or 9.9% of segment sales. Industrial segment earnings increased due to higher sales volume, price realization, and favorable product mix, partially offset by higher annual incentive compensation. Industrial sales and earnings benefited from significantly increased on-highway natural gas truck production in China, although future demand beyond the fourth quarter remains uncertain. Non-segment expenses were $24 million for the third quarter of 2023 compared to $19 million. At the Woodward level, R&D for the third quarter of 2023 was $35 million or 4.4% of sales compared to $32 million or 5.2% of sales. SG&A for the third quarter of 2023 was $65 million compared to $46 million, primarily due to higher annual incentive compensation. The effective tax rate was 20% for the third quarter of 2023 compared to 21.6%. Looking at cash flows. Net cash provided by operating activities for the first nine months of fiscal 2023 was $156 million, compared to $86 million. Capital expenditures were $57 million for the first nine months of 2023, compared to $37 million. Free cash flow was $98 million for the first nine months of fiscal 2023, compared to $49 million. Adjusted free cash flow was $103 million for the first nine months of fiscal 2023, compared to $52 million. The increase in free cash flow and adjusted free cash flow was primarily due to increased earnings, partially offset by higher capital expenditures. Leverage was 1.7 times EBITDA at the end of the third quarter compared to two times EBITDA. During the first nine months of fiscal 2023, $64 million was returned to stockholders in the form of $38 million of dividends and $26 million of repurchased shares under a Board authorized share repurchase program. Lastly, turning to our fiscal 2023 outlook. We continue to expect year-over-year improvements in the fourth quarter of fiscal 2023. Due to the continued strong end-market demand and our improved ability to deliver for our customers, we are raising certain aspects of our full-year guidance. Total net sales for fiscal 2023 are now expected to be between $2.85 billion and $2.9 billion. Aerospace sales growth is now expected to be between 16% and 18%. Industrial sales growth is now expected to be between 28% and 30%. We now expect full-year price realization to be approximately 7% of prior year sales. Aerospace segment earnings as a percent of segment net sales are still expected to increase approximately 150 to 200 basis points. Industrial segment earnings as a percent of segment net sales are now expected to increase approximately 340 to 440 basis points. The adjusted effective tax rate is now expected to be approximately 18%. We still expect adjusted free cash flow to be between $200 million and $250 million, and capital expenditures to be approximately $80 million. Adjusted earnings per share is now expected to be between $4.05 and $4.25 based on approximately 61 million fully diluted weighted average shares outstanding. This concludes our comments on the business and results for the third quarter of 2023. Operator, we are now ready to open the call to questions.

Operator, Operator

The question-and-answer session will begin at this time. Our first question comes from the line of Robert Springarn of Melius Research. Please go ahead.

Robert Springarn, Analyst

Hey, everybody. Welcome, Bill.

William Lacey, CFO

Thank you, Robert.

Chip Blankenship, CEO

Good afternoon, Rob.

Robert Springarn, Analyst

Chip, these are very good numbers, clearly. I wanted to focus on the Industrial side, where some of these numbers are significantly higher than what we've seen on a quarterly basis. Just to understand, is this a new normal? Was there some pent-up inventory that was released? If you could walk us through the major business lines within Industrial and discuss where you stand in terms of a new normal or perhaps how it compares to the recovery versus 2019, that would be helpful. Especially since a quarter like this suggests that the fourth quarter for Industrial, or for the company, might be flat to down. I want to understand if you're being conservative and how we should frame this whole situation.

Chip Blankenship, CEO

Certainly, Rob. While we don’t typically disclose detailed numbers at the subunit product line level, I want to highlight that the Industrial performance has a significant contribution from China on-highway shipments. Regarding a new normal, we don't see this as a permanent shift, but we are currently experiencing strong demand from our customers in China for products where we had ample inventory, allowing us to respond quickly last quarter. Our supply chain and facilities in China performed exceptionally well, meeting customer needs this quarter. This line of business has been discussed previously and is challenging to forecast due to limited visibility on orders. When orders do come in, our strategy has been to maintain a strong inventory position with a flexible supply chain to respond effectively, and we are continuing with that approach. We have limited visibility for the fourth quarter, which has allowed us to feel confident in raising our guidance for China's on-highway volume, but we do not have sufficient visibility beyond that to make any predictions. For other lines of business, we observed sequential and year-over-year improvements in efficiency and product delivery. Our plants in Fort Collins and the L'Orange facilities in Germany have also seen advancement, focusing on lean manufacturing and the transformations we are implementing. Overall, we achieved positive results across the Industrial portfolio, but I would not consider this margin level to be a sustainable benchmark.

Robert Springarn, Analyst

Okay. And then if I could just follow-up on that, two quick things. One, is there a way to think about $320 million in Industrials and to allocate that across the businesses or to rank order, what's the biggest, what's the smallest? And then Bill, for you, just curious, it sounds like there's some moving pieces and maybe a little bit of conservatism, but why no increase in the cash flow guide?

Bill Lacey, CFO

Sure. To provide a bit more detail, as Chip mentioned, we usually do not disclose sales figures below the segment level. Regarding cash, we continue to see overall good improvement and maintain our guidance. We expect strong earnings delivery and further inventory efficiency improvements. We believe that the investments necessary for handling higher volumes are already factored in, and we anticipate achieving a solid cash figure.

Robert Springarn, Analyst

Okay. Thank you, both.

Chip Blankenship, CEO

You're welcome.

Operator, Operator

Thank you. Your next question comes from the line of Sheila Kahyaoglu of Jefferies. Please state your question.

Sheila Kahyaoglu, Analyst

Thank you, Bill, and hi, Chip, great quarter. Regarding the industrial business, we're not industrial analysts. What is your level of visibility? It seems your backlog is typically a third of your revenues. How much visibility do you have currently? How significant is the China business? I understand it used to be at a $100 million run rate. Are you on an annualized basis exceeding that?

Chip Blankenship, CEO

So, like Bill, and I said, Sheila, we're really not breaking out the business to those level of details underneath the Industrial segment. But I think it's fair to say that we enjoyed a strong quarter, and we don't have much visibility to China OH volumes post fourth quarter of this fiscal year. We sit back and we look at some pretty lagging indicators to tell us how that overall market is behaving, and we saw an uptick in February both in terms of the number of heavy-duty trucks being manufactured in China as well as the fraction of them that are natural gas powered versus diesel, and we can surmise a number of factors that might go into why that's happening post COVID and with natural gas availability. But really, we're just speculating a little bit on that. And we had that backward-looking explanation, but we don't have much forward visibility for China OH.

Sheila Kahyaoglu, Analyst

Okay. And then maybe if I could ask one on price, I think you raised your price assumption for the company from 5% prior to 7%. What drove that across the segments? And where are you sort of in the cycle of pricing increases flowing through?

Chip Blankenship, CEO

So on the price realization, we did raise the forecast for the total year. We had good performance of the escalation indices that drive most of our OEM contracts, and we worked through the spare parts pricing catalogs and our general catalogs for those not on long-term contracts. And we've been able to achieve those pricing targets that we laid down in the marketplace, and that result of that price realization is delivering the 7% versus the 5%.

Sheila Kahyaoglu, Analyst

So mostly Aerospace then?

Chip Blankenship, CEO

I think they're both kind of in line with that top level number.

Sheila Kahyaoglu, Analyst

Okay. Thank you.

Operator, Operator

Your next question comes from the line of Christopher Glynn of Oppenheimer. Please state your question.

Christopher Glynn, Analyst

Thanks. Good afternoon.

Chip Blankenship, CEO

Hey, Chris.

Christopher Glynn, Analyst

Hey, Chip. I think maybe another crack at Industrial. I think the press release kind of isolated the upside to the NG business. So I was wondering, versus your internal plan, did the natural gas China account for really all of the preponderance of the upside?

Chip Blankenship, CEO

While it was a large portion of the upside, like I was saying earlier with Sheila that all of our other product lines, be it the liquid fuel diesel products from Woodward L’Orange in Europe to the natural gas and actuation types of business units here in Fort Collins, all of our plants had increased output and we've improved efficiencies based on our supply chain performing better and having parts to the line on time, as well as our people just getting more proficient at their roles. We're also practicing continuous improvement processes that are delivering additional benefits in terms of both capacity and efficiency, so it's really across the board. It's not the case of one segment performing really well and masking malaise or poor performance in others. It's just that it's a little bit of an outsized performance from the China OH. But all product lines improved this quarter.

Christopher Glynn, Analyst

Okay. And last quarter, you commented that the Industrial sort of turnaround, so to speak, you weren't out of the woods. And it's impressive kind of top to bottom, look at all the operations and processes in Industrial, so I appreciate that. What's the status up to date in terms of in the woods, out of the woods?

Chip Blankenship, CEO

I appreciate the team's efforts in steering our product lines in the right direction and advancing our product rationalization. We are making continuous progress. Moving forward, our main focus will be on reducing inventory to better align with demand and meeting customer needs. Currently, we are enhancing our capacity in our planning; however, customer demand is even greater. To be confident that we've successfully turned things around, I need to see us fully meet that customer demand and lower our inventory levels further. Once we achieve those goals, I believe we will be in a strong position.

Christopher Glynn, Analyst

Great, I appreciate that update. And last one for me. You mentioned an expectation for R&D and procurement in the Defense sector to increase, which bodes well for Woodward. Could you elaborate on that? What kind of ramp curve do you envision? What sort of contours are you seeing reasonably take shape?

Chip Blankenship, CEO

In most Defense-related processes, the ramp is generally modest. We have been focusing our efforts on exploring and responding to opportunities, and lately, there have been more opportunities with a greater sense of urgency in addressing them. This gives us some confidence that opportunities will continue to develop, but these are not immediate opportunities that will significantly impact sales in the near future.

Christopher Glynn, Analyst

Okay. Thanks for that. Appreciate it.

Chip Blankenship, CEO

You bet.

Operator, Operator

Your next question comes from the line of Matt Akers of Wells Fargo. Please state your question.

Matt Akers, Analyst

Hey, good afternoon, guys. Thanks for the question. I wanted to kind of take a step back kind of on just earnings visibility broadly, right? I mean, so this quarter, relative to consensus, to a big positive surprise. I think last quarter, it was also a big positive surprise. Q1 was kind of a negative surprise. I guess you guys have been managing through supply chain uncertainty and uncertainty around China. So, I guess as we go forward, is there a point as we get into maybe next fiscal year that sort of settles down and we get a little bit more visibility or just sort of how you think about the outlook there?

Chip Blankenship, CEO

I believe the outlook is improving as we enhance our visibility regarding supply chain issues. We are better equipped to address these challenges and prevent disruptions to our operations or delays in customer shipments. Our forecasting capabilities for delivery models are getting stronger and should continue to improve as our suppliers and factories perform better. However, regarding customer-related issues in areas like China, where we have limited visibility, I do not anticipate any improvements, as we lack the necessary tools to address that. On the supply chain front, though, our visibility has significantly increased.

Matt Akers, Analyst

Yes. Okay. Thanks. And I guess just latest thoughts on the share repurchase? I think the plan at one point was to complete that authorization by January; is that still how you're thinking about it?

Chip Blankenship, CEO

We still have an open plan and we are evaluating opportunities for capital deployment with our Board, and we'll continue to go forward and do what's prudent.

Matt Akers, Analyst

Thank you.

Chip Blankenship, CEO

You bet.

Operator, Operator

Your next question comes from the line of Pete Skibitski of Alembic Global. Please state your question.

Pete Skibitski, Analyst

That’s a pretty impressive quarter, at least.

Chip Blankenship, CEO

Thanks, Pete.

Pete Skibitski, Analyst

I would like an update on the status of your various initiatives, particularly regarding in-sourcing. Is the in-sourcing effort complete? Has training for new employees been finished? Also, I recall you mentioning customer experience in your opening remarks, and I’m curious about that as well. Additionally, you had some insights regarding rationalization; could you clarify that for us? Thank you.

Chip Blankenship, CEO

Certainly. You need to remind me about a couple of the points you mentioned, but I'll address what I can. Regarding in-sourcing, we are still implementing several transfers between suppliers and in-sourcing to ensure we have enough flexibility and sourcing options to meet customer needs. Currently, as we did last quarter, we are dealing with different parts; over 1,000 parts are undergoing transitions, either between suppliers or through in-sourcing. We have produced 16,000 parts through our rapid response machining centers, and all necessary equipment is already set up at those locations. This activity is very much ongoing and will likely continue for several years as we work on simplifying and strengthening our supply chain by establishing multiple sources where necessary while reducing the total number of sources. In line with SKU rationalization, we are making strides in aligning our product offerings with actual customer demand, which also helps us serve them more efficiently. We have removed thousands of offerings this quarter and plan to eliminate around 10,000 to 15,000 SKUs during this fiscal year, continuously assessing this initiative to enhance efficiency in the following year as well. Regarding labor productivity, we are improving in this area. Our efforts to hire new direct employees for manufacturing have decreased, but we are still experiencing some attrition in certain locations, necessitating onboarding, training, and support from experienced machinists and assembly technicians. We may need to adapt to a new normal with slightly higher attrition rates than in the past, so it's essential to stay capable in this area. Nevertheless, I foresee ongoing improvements in labor productivity. Lastly, concerning customer experience, part of the reorganization in Industrial and Aerospace sectors focused on achieving a unified approach for serving these segments. We had multiple teams reaching out to the same OEMs and service providers, and we have made significant efforts to streamline the overall customer experience. From a customer experience perspective, delivering orders accurately and on time, with the right quality and pricing, is a key focus area for us.

Pete Skibitski, Analyst

That's great. Very helpful. I have to ask about the macro environment. I know visibility can be challenging, but with your presence in various industrial niches, are there any indications that any of those niches are reaching a peak or that customer demand is beginning to slow down? Is the cycle changing?

Chip Blankenship, CEO

The global oil rig count is increasing, but U.S. activity, including fracking, is not keeping up and is actually decreasing. We're monitoring this situation, but so far it hasn't led to a slowdown in our order intake. However, we are cautiously observing the situation, as it's the only area that indicates some potential weakness in the macro environment concerning our orders. Everything else is showing positive trends. Revenue passenger miles, build rates at OEMs, airframe production, and shop visit rates for engine overhauls are all trending upward according to our current forecast.

Pete Skibitski, Analyst

Okay. Appreciate the color.

Chip Blankenship, CEO

Yep.

Operator, Operator

Thank you. Your next question comes from the line of Gautam Khanna of TD Cowen. Please state your question.

Gautam Khanna, Analyst

Yes. Thanks. Good afternoon, guys.

Chip Blankenship, CEO

Good afternoon.

Bill Lacey, CFO

Good afternoon.

Gautam Khanna, Analyst

I have a couple of questions. First, on the Industrial side. I remember last quarter, the backlog did not go down, right? There was not a supply chain catch-up that drove a big recovery in shipments. Did that occur in this quarter just reported? The June quarter?

Chip Blankenship, CEO

Just to be clear, when you say backlog, it was our past dues didn't go down.

Gautam Khanna, Analyst

Past dues.

Chip Blankenship, CEO

Yes. But again, that was the same thing this quarter. We are not capacitated at a level right this minute to both satisfy current customer demand and burn down past dues, so Industrial past dues stayed largely the same.

Gautam Khanna, Analyst

Okay. And to an earlier question on the mix impact from the natural gas business in China, it sounded like it was broad-based strength within Industrial. Is there any way for us to isolate what piece of that might be nonrecurring if it is CNG and if it is only here for a quarter or two? Is there any color you can give us on that to where margins would have been, but for CNG?

Bill Lacey, CFO

Yes, not much more than what we already have provided.

Gautam Khanna, Analyst

Okay. Have you guys provided anything on that, or did I miss it? It wasn't clear to me.

Chip Blankenship, CEO

No, we just don't break out our product lines at levels below the segment, Gautam.

Gautam Khanna, Analyst

Okay. But is CNG particularly rich mix?

Chip Blankenship, CEO

It's a healthy business for us. It performs well when volumes are high and doesn't do as well when volumes are low. That's why we use the term volatility, as it reflects good marginal delivery at high volumes, while at low volumes, the performance isn't as favorable.

Gautam Khanna, Analyst

Okay. Can you tell me how far along you are in the SKU rationalization process and how much it influenced the numbers in the June quarter?

Chip Blankenship, CEO

I don't think we have seen the SKU rationalization impact the bottom line in a significant way yet. What we expect to see first are improvements and efficiencies in both our supply chain and plant operations, mainly in Fort Collins. These advancements will contribute to overall productivity, helping us achieve better flow through the factory and greater standardization. The initial phase of addressing this, covering about 10,000 to 15,000 units, has been somewhat easier compared to what lies ahead, where we will need to collaborate more closely with customers.

Gautam Khanna, Analyst

Up slightly. I wasn't aware if that was the case, and is that accurate? I believe that's correct. But is that true? Is there any reason for the pause? We're noticing quite strong sequential aftermarket results from other companies in the industry; can you identify any trends occurring there?

Chip Blankenship, CEO

Yeah. We're not showing up sequential, but we are showing healthy double digits year-over-year.

Operator, Operator

Thank you. Your next question comes from the line of Michael Ciarmoli of Truist Securities. Please state your question.

Michael Ciarmoli, Analyst

Good evening, everyone. Great results, and thank you for taking my questions. Chip, I know we have many people interested here, but if visibility in the China on-highway market is limited, how are you planning to address this? What are your usual lead times and turnaround times? I’m looking to get a clearer picture of how you're managing your facilities with the current lack of visibility.

Chip Blankenship, CEO

Yeah. Right now, I mean, our strategy is to, like I said earlier, have enough inventory to be responsive to the customer. If we have short lead time orders which we have had but also not carry too much inventory so that it's, you know, a big rock around our cash flow. So we're trying to get that optimized. We're doing things like looking at what the rates have been over a longer period of time and try to plan for a low level that we can respond to if it goes up. So it's more of like the protect the ability to get upside if we get orders is kind of how we're thinking about it right now. I mean, Bill and I are both relatively new to this market and we're relatively new to this business line. So we're trying to make sure we don't miss the opportunity right now and get good cash flow and earnings for shareholders and figure out if there's a better way to understand and plan for it.

Michael Ciarmoli, Analyst

Got it. I mean, you're not you're not going to give us 2024 guidance here. But I mean, trying to model this segment now and looking at the volatility just on the margins last quarter, 13 to 4 over 18, I guess the fourth quarter is back down to 13 or so. How should we think about this? I mean, I think the Street has you for 11% in 2024. Is this more of a 13 to 14 business right now? And then the on-highway, depending on volumes would drive those upside pops that we're seeing like in this quarter?

Chip Blankenship, CEO

Yeah. I'm sorry. We're just not ready to talk about 2024. I know why you want to know the answers to all those questions, and we're working through all of our plans right now of trying to make sure we close out 2023 strong, and we have a really solid 2024 plan that will be compelling for investors and that we are sure we can achieve.

Michael Ciarmoli, Analyst

Got it. And just last one, aero OEM looked like it was up 17% sequentially. Any material change or orders or just specific platforms rates that you've broken higher to? Any color on that?

Chip Blankenship, CEO

There hasn't been any significant change to rates, and nothing out of the ordinary has occurred, except for certain customers requesting more parts to support both OEM and their desired inventory positions based on their outlook for the future.

Michael Ciarmoli, Analyst

Okay, great. Thanks guys.

Chip Blankenship, CEO

You bet.

Operator, Operator

Thank you. Your next question comes from the line of Louis Raffetto of Wolfe Research. Please state your question.

Louis Raffetto, Analyst

Hi, thank you. I want to revisit the cash flow, as you've mentioned plans to reduce inventories, but it seems this quarter has shown the best inventory turnover in years. Inventory is significantly lower than it was in 2019. Are we expecting it to decrease further, or will it rise in the fourth quarter? How is this affecting cash flow? Despite raising net income by over 20% in the past couple of quarters, there hasn't been any increase in cash flow.

Chip Blankenship, CEO

Yeah. So we still feel like we're carrying a substantial amount of inventory to support the sales level and that world-class performance would have us at higher turns overall. And so that's what our lean folks, our operational leaders, our planners, everyone striving to figure out how to do better than we are right now. So it is our desire to improve that.

Louis Raffetto, Analyst

Okay. And then maybe trying to tackle this another different way. I think fourth quarter industrial margin guidance is somewhere between 13%, 13.5% to like 16%, which I assume that's bounding some variability around China natural gas. Is that right?

Chip Blankenship, CEO

That's a good way to think about it. We don't provide quarterly guidance, but we are aware of the current situation, and we adjusted our guidance this quarter, so the calculations are clear.

Louis Raffetto, Analyst

Okay. So, at the low end of that range, is the normalized margin rate, excluding natural gas, around 13% to 13.5%, which would be considered a typical run rate?

Chip Blankenship, CEO

I think it's still early for us to provide guidance on what our Industrial margin rate will be going forward. We're pleased with the improvement in our core business, and we will continue to focus on that. When we are ready to issue FY 2024 guidance, we anticipate being able to provide a solid estimate, as well as offer more insights at the Investor Day in December.

Louis Raffetto, Analyst

Yeah. So maybe just one more thing to ask. Last quarter, the back half guidance for Industrial was 9% to 10%, so what changed to give you 300 to 400 basis points more in the fourth quarter than what the implied guidance was before?

Chip Blankenship, CEO

Two things changed. The performance of our factories, our workforce, our material flow, and our suppliers has improved, along with operational enhancements in our core business. We had planned for this improvement, and now we are starting to see progress and meet our milestones. The other change is the significant volume of our China on-highway natural gas business, along with better visibility for orders through the end of the fourth quarter.

Louis Raffetto, Analyst

That’s great. Thank you, Chip.

Chip Blankenship, CEO

You bet.

Operator, Operator

Thank you. Your next question comes from the line of Noah Poponak of Goldman Sachs. Please state your question.

Noah Poponak, Analyst

Hi, everyone.

Chip Blankenship, CEO

Good afternoon, Noah.

Noah Poponak, Analyst

Can you quantify how much China On-Highway revenue you have in the quarter?

Chip Blankenship, CEO

No. Sorry, Noah.

Noah Poponak, Analyst

Okay. Did you have significantly more in this quarter than last quarter?

Bill Lacey, CFO

Quarter-on-quarter, sequentially, we did see an uptick and in our China On-Highway business.

Noah Poponak, Analyst

Okay. And fundamentally, what is it that makes that volatile? What is it that makes it not have visibility? Just in terms of what the customer is doing and thinking fundamentally when they're buying that product from you.

Chip Blankenship, CEO

I think I tried to stay out of trouble on this one. However, I mentioned in one of our conference calls that it doesn't behave like other markets I'm familiar with, and some of our business team has been working through and obtaining forecasts around. It seems like government policy and other factors that we don't fully understand are at play, making it really difficult to forecast from our perspective. However, as soon as we receive orders, we gain a good level of confidence in how much the customer wants for that month, and that's been our approach for a while.

Noah Poponak, Analyst

Okay. When revenue comes from existing inventory into China, is the margin close to a 100% incremental margin drop-through? Does it reflect a multiple of the segment margin, or is it something that's several hundred basis points better than the initial one?

Chip Blankenship, CEO

I believe the best way to respond, Noah, is to highlight that we account for the full cost of our inventory, primarily because our operations are focused on China for the Chinese market. The hardware and systems we deliver to our customers mainly come from China and remain there. We manage this at cost, and when we receive substantial orders, the margin rates can be quite favorable. However, if the volume is low, we face fixed costs that need to be allocated across our operations as usual. I mention this to illustrate that we operate a typical business model where there is significant productivity associated with volume.

Noah Poponak, Analyst

That makes sense. Lastly for me, on the Aerospace side, are you able to tell now where your aftermarket unit stands versus pre-pandemic? And what kind of pricing are you seeing in Aerospace aftermarket relative to that enterprise-wide number that we gave us?

Chip Blankenship, CEO

I got the first part of the question, but I didn't get the last part. But as far as Woodward units cycling through repair, we're closing in on 2019 volumes from both a shop visit and a Woodward LRU standpoint, we're not quite there yet.

Noah Poponak, Analyst

And the second part of that was pricing. How does the Aerospace aftermarket annualized pricing you're seeing now compare to the enterprise-wide level?

Bill Lacey, CFO

Yes. We do not lower pricing at that level below the segment. We mentioned that both segments are contributing to the 7% guidance we provided for overall year price realization.

Noah Poponak, Analyst

Okay. Thanks for taking my question.

Bill Lacey, CFO

Welcome.

Operator, Operator

Your next question comes from the line of David Strauss of Barclays. Please state your question.

David Strauss, Analyst

Great. Thanks for taking my question. Aerospace, it looks like from a revenue standpoint that you should be back to kind of 2019 pre-pandemic levels next year or even higher. And back when you were at those revenue levels, Aerospace did close to 21% margins. I know you don't want to give 2024 guidance, but how should we think about the puts and takes on Aero margin next year relative to where you were at a similar revenue level a couple of years ago?

Chip Blankenship, CEO

Well, like you said, we're not prepared to give 2024 guidance at this time, but it is our intent to continuously improve our performance from an efficiency standpoint and ability to serve customers. So we intend to improve from where we are today, and the fact that we were able to achieve better numbers before with good volume bodes well for us to be able to do it in the future.

David Strauss, Analyst

I think the revenue mix is more favorable than what you experienced in 2019. It seems like there will be more aftermarket revenue, possibly less from Aerospace OE and a bit less from Defense. I believe this revenue mix is positive.

Chip Blankenship, CEO

I'm not sure I'd make that assumption just yet. We're still working through our plans and looking. This is why we're not talking about FY 2024. But right now in the early planning stages, we're looking at what rates the airframers are trying to achieve and what sort of inventory levels they'd want before they do rate breaks, and that propagates to engine manufacturers and then to us. So there may be quite a good amount of OE demand in 2024, which is not necessarily a bad thing at all because that's creating the installed base for the future. So it's good news. Good news, I think, but it's too soon for us to say what we think the mix will be.

David Strauss, Analyst

Okay. And Chip, what is your aerospace headcount today compared to what it was back in 2019?

Chip Blankenship, CEO

That's a question that I don't have the answer to in front of me.

David Strauss, Analyst

Okay. I can follow-up with Dan on that. Thanks.

Chip Blankenship, CEO

Great. Yeah. You bet.

Operator, Operator

Your next question comes from the line of Robert Spingarn of Melius Research. Please state your question.

Robert Spingarn, Analyst

Thanks. Chip, I just want to come back on Aerospace and just ask you briefly. With regard to the LEAP and the GTF and some of the durability and time-on-wing issues, to what extent is that factoring or impacting your aftermarket? Are you shipping more because of these cycles being shorter? And then as a follow-up to that, how might we think about this latest issue at RTX with the GTF and how that might impact with all the inspections? Maybe taking shop time and so forth how might that impact Woodward, as that plays out over the next year or so?

Chip Blankenship, CEO

It's too early to determine how the inspection and potential replacement program for the GTF will impact us. There are several shop visits and quick-turn activities to address the initial issues with the fleet. Most of these have minimal effect on Woodward because our components typically remain on the engine. While we might see some maintenance work as a result, it doesn’t significantly impact us. The main consideration could be the number of spare engines needed to support the entire fleet, but that would be reflected in our regular original equipment versus service numbers, which will balance out over time. Overall, we believe the impact on us is minimal.

Robert Spingarn, Analyst

Okay.

Chip Blankenship, CEO

From a control standpoint, we do have some other hardware that there are some design changes on that we are supporting our customers on those parts.

Robert Spingarn, Analyst

Okay. Thank you.

Chip Blankenship, CEO

Yeah.

Operator, Operator

Mr. Blankenship, there are no further questions at this time. I will now turn the conference back to you.

Chip Blankenship, CEO

All right. Well, thank you very much, operator. And thanks for all the folks online and all your questions today.

Operator, Operator

Ladies and gentlemen, that concludes our conference call today. If you would like to listen to a rebroadcast of this conference call, it would be available today at 7:30 p.m. Eastern Time by dialing 1-800-770-2030 for our U.S. call or 1-647-362-9199 for a non-U.S. call, and by entering the access code 4278216. A rebroadcast will also be available at the company's website, www.woodward.com, for 14 days. We thank you for your participation in today's conference call. And we ask that you please disconnect your line.