Senior plc (SNR) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to Senior plc's 2020 Interim Results Presentation. Of course, we are delivering these in somewhat different circumstances than normal. I wish we could be together at the London Stock Exchange as we usually are, but it's a bit too early to do that safely. Hopefully, the webcast will be an effective alternative, and we do appreciate you making an effort to join. Bindi and I are in our head office in Rickmansworth; and our Chairman, Ian King, is also with us, just out of camera shot at an appropriate social distance. Jennifer Ramsey, our Director of Investor Relations, is also here, and will be curating the Q&A session at the end of the presentation. In terms of our agenda this morning, I will briefly cover the highlights and talk about our response to the extraordinary conditions that we've all been facing. Bindi will run through and comment on the results and I will then focus on markets, strategy and outlook. It probably goes without saying that the group has been significantly affected by the impact of the worst pandemic that any of us have experienced in their lifetimes. Many of the things that we took for granted in our personal and business lives have been turned upside down. And the seismic shock in most of our key end markets has reverberated, in particular, direct to civil aviation and aerospace sectors. The fallout is likely to be felt for years to come. And COVID-19 is not the only black swan event that Senior is dealing with. It is now almost 1.5 years since the Boeing 737 MAX fleet was grounded worldwide, and that was already having a deep impact on the industry before the coronavirus crisis. You may be forgiven for thinking that these events would be a catalyst for self-pity and introspection amongst the leadership team at Senior. I can assure you, this is not the case. Indeed, we are determined to ride out the storm and navigate our way to calmer waters for the benefit of all our stakeholders. Bindi and I look forward to explain today, and in discussions to follow, what we are doing to keep the business healthy and primed to take advantage of the recovery to follow. In a moment, I will explain more about the measures we've taken to mitigate and contain the impact of COVID-19. Suffice to say that today, all 30 of our sites in the 4 continents and 13 countries in which we are located, are operational with best-in-class health and safety practices in place. Through the chaos of the pandemic, there have been some bright spots. We delivered robust free cash flow and increased our headroom. Bindi will explain how we were able to achieve that excellent result. Without doubt, the best news we've heard for a long time on the 737 MAX came a month ago, with the completion of formal flight certification tests by the FAA and Boeing. This is a huge milestone and the clearest sign yet that better times lie ahead for this very important program. ESG remains a very high priority for Senior despite everything else that we are dealing with. We were delighted to announce 2 weeks ago that we are the first company in our sector anywhere in the world to have our greenhouse gas emissions reduction targets approved by the Science Based Targets Initiative. I will talk more about this in a moment. We've been able to effectively contain the direct effects of COVID-19 on our operations. I put that down to 2 reasons. Firstly, health and safety is always the first priority in Senior. It is deeply embedded in our culture. Those of you who have visited any our sites will know this to be the case. So our call to action in the face of the impending threat from COVID-19 was quickly, calmly and effectively answered. Secondly, we have a joint venture in Wuhan, the city in China recognized as the source of the outbreak. So we were on this early. In January, our executive leadership team was discussing the threat in the earnest. And by February, we'd instigated preventative measures across all of our worldwide sites, well in advance of government lockdown restrictions. Some colleagues in Europe and North America were initially surprised that we were taking these measures. But with effective communication, education and training, we were all well prepared as the virus rapidly swept westwards through Asia and beyond. We set up a coronavirus oversight committee, which I chair, meeting daily with an emphasis on rapid decision-making, the focus being on employee health and welfare and business continuity which has allowed unwavering support to customers, suppliers and other stakeholders. Like a number of businesses in our sector, we stepped up to support health care providers. We have supplied parts for ventilators for many years. So of course, those have been in demand, but we also used our know-how and capability to design and make hundreds of thousands of items of PPE kit for hospitals, care homes, medical practices and numerous small businesses who were all facing severe shortages of vital protective equipment. In fact, the photograph on the cover slide of the presentation is from NHS staff, one of the local hospitals in the Macclesfield area that received face visors from us during the worst of the crisis. ESG is at the very heart of our decision-making, and has been since I joined the company almost 5 years ago. In Senior, we put safety and ethics first in our Board meetings, executive meetings and business reviews. Our regular all-employee briefs always start with a dialogue on safety and integrity, values which are at the very core of the company. This has stood us in good stead as we have tackled the COVID-19 crisis head on. In Senior, we've a real focus on behavioral safety as we know that most incidents are caused by unsafe actions as opposed to unsafe conditions. When the pandemic hit, we worked with the Keil Centre to add a coronavirus module to our central behavior safety program. We have a strong commitment to the highest standards of ethics across the company. This is enshrined in our code of conduct that every person in the company, from the Chairman to shop floor, has practical training on a regular basis. We've already launched our 2020 code of conduct training, incorporating a module on cybersecurity, which is especially pertinent given the number of employees we have had working from home. We've also added a module on unconscious bias to support our commitment to diversity and inclusivity. On that front, Senior continues to be an active participant in The Hampton-Alexander Review and the 30% Club, both of which focus on gender diversity on boards and senior leadership teams. In the first half of 2020, women represented 38% of our Board membership and 32% of our Executive Committee. More recently, the 30% Club set new 2023 targets for ethnic diversity in senior teams, which our Board and Executive committee already meet. But we are not being complacent, greater diversity remains a strong focus for us in our succession planning. In terms of our commitment to the environment, hopefully, you will all see that we are demonstrating through our actions, not just words, how important this is to our Board and indeed, to all of our employees. Senior is committed to supporting the Paris Agreement on climate change. In March, we announced that we've been awarded a leadership rating of A- from the globally recognized CDP, the only U.K. company in our sector to achieve a leadership rating. Last month, Senior became the first company worldwide in the aerospace and defense sector to have its scope 1, 2 and 3 greenhouse gas emissions reduction targets independently verified and approved by the Science Based Targets Initiative. The SBTi defines and promotes best practice in science-based target setting and independently assesses company's targets. Our verified targets from our operations are consistent with reductions required to limit climate warming to 1.5 degrees C, the most ambitious goal of the Paris Agreement. Our products directly contribute to a cleaner environment. For years, we have pioneered the development of products for exhaust systems that prevent toxins being released to the atmosphere. And we are rapidly developing thermal management solutions for electric land vehicles as the world accelerates its move from the internal combustion engine to zero-emissions products. I'll talk more about the strategic importance of electrification later in the presentation. Before I hand over to Bindi, I'll quickly set the scene by talking about the disruption that the pandemic has had on our end markets. I'll deal with the easy one first. Defense markets have remained robust. Our exposure is all to U.S. markets, which have seen growth, and you'll see later, that has helped us report increased sales in that sector. Aviation and therefore, civil aerospace are a different matter with massive reductions in air traffic as a consequence of government lockdowns and movement restrictions. I'll talk more about this, but suffice to say, the recovery will take a number of years, and the specific shape is probably dependent on a variety of factors, especially how quickly we find and deploy an effective vaccine. Land vehicle markets, whether that be commercial vehicles or passenger vehicles, have also slumped. The chart here is North American heavy-duty truck. Now admittedly, we were expecting a large cyclical decline this year anyway in that market, but it has been greatly exacerbated. And given the 2 charts at the top, it is no surprise to see the one on the bottom right. Oil and gas products consumption has plummeted as air and land travel greatly reduced. This severe disruption has directly influenced the way in which we have run the business in the first half of the year. And that seems an appropriate point to hand over to Bindi to take us through the financial results, after which I will pick up on markets, strategy and outlook to finish.

Thank you, David. Good morning, everyone. It is fundamental, when you face such external challenges and impacts on your end markets and indeed, on the very way work, that emphasis is focused on liquidity and cash flow. It is reassuring that in these circumstances, Senior has delivered a robust cash position at the end of June. I'll cover the other metrics later, but let's start with cash. Throughout this period, as always, we're focused on generating free cash flow and responded promptly to counteract the effects of the pandemic on the business. As a result of strong controls in our operating and capital expenditure as well as reductions in working capital, primarily in inventory, we delivered robust free cash inflow of GBP 16 million, which was 21% higher than last year. After GBP 12.7 million cash outflows, primarily for restructuring and disposal activities, the group generated net cash inflow of GBP 3.3 million in the first half of the year. And after accounting for adverse currency movements, as most of our debt is U.S. dollar-denominated, net debt, including capitalized leases, was GBP 238.9 million at the end of June, a GBP 29 million improvement from a year ago. As a reminder, our lending covenants are based on frozen GAAP and are therefore calculated on a pre-IFRS 16 basis. At the end of June, the group's net debt-to-EBITDA ratio was 1.6x, and the group's headroom on committed borrowing facilities increased by GBP 3 million since December to GBP 162 million. As you would expect in these circumstances, revenue, profit, earnings per share and return on capital employed all declined in the period. I should cover the impact on revenue and profit at a divisional level in the next slide. We recognize the importance of the dividend for our shareholders. However, in the current operating environment, the Board believes it is not appropriate to pay an interim dividend. I'll now summarize the key elements of the group's trading performance in the first half of 2020. The chart at the top bridges revenue from GBP 580 million in half 1 2019 to GBP 409 million in half 1 2020. The chart at the bottom of the page bridges adjusted operating profit from GBP 46.2 million in half 1 2019 to GBP 9 million in half 1 2020. Coming into the year, we advised that our expectation was for Aerospace revenue to be around 20% lower as a consequence of Boeing's temporary halt in 737 MAX production and our decision not to renew certain contracts which did not meet our returns criteria. However, with the significant impact of COVID-19, Aerospace revenue decreased 31% in the first half of the year compared to prior year. On a quarterly basis, Aerospace revenue declined 22% in Q1 and 40% in Q2. The most significant reduction came from Civil Aerospace, which decreased 42% as civil aircraft and engine OEMs reduced production rates significantly as many airlines cut capacity, retired older aircraft and look to defer deliveries of new aircraft. Further disruption was caused by temporary customer production closures and rebalancing of inventory throughout the supply chain. Military and defense sales increased 5%, primarily due to the ramp-up of the Joint Strike Fighter and higher demand for other defense products, including better work share on the Black Hawk helicopter. A number of our Aerospace businesses also supply product to certain industrial markets, and overall, these decreased by GBP 5.5 million due to lower activity levels as a result of the pandemic. The significant reduction in Aerospace revenue materially impact the adjusted operating margin in this division. This was partly mitigated by savings from the restructuring program, and the net impact was a decrease of 550 basis points to 3.5%. Economic forecast at the start of the year suggested that Flexonics cyclical end markets would decline in 2020 and Flexonics revenue was expected to be lower in 2020 compared to 2019. However, these declines were further exacerbated by the impact of COVID-19 on land vehicle and oil and gas markets, with many of our customers temporarily shutting production facilities and reducing output once reopened. This resulted in Flexonics sales decreasing by 27% in the first half of the year compared to prior year. On a quarterly basis, Flexonics sales declined 23% in quarter 1 and 33% in quarter 2. Revenue from land vehicle markets decreased 41% with sales to the North American truck and off-highway market down 39%; sales to the rest of the world, truck and off-highway markets, down 35%; and sales to passenger vehicle markets down 51% in the period, all reflecting lower end market demand. Revenue from power and energy markets decreased by 15% in the period. The huge decline in air and land travel contributed to an excess of crude oil supply and as a consequence, the mothballing of some upstream capacity. Senior sales to oil and gas markets decreased 9% as a result of this lower upstream capacity. Sales to power generation markets decreased by 19% as large products in the period did not meet repeat in the period. The significant reduction in revenue in the Flexonics division materially impacted the divisional adjusted operating margin, partially mitigated by savings from the restructuring program. The net impact was a decrease of 530 basis points to 4.5%. Central cost decreased by GBP 0.9 million from actions taken to reduce costs and discretionary spend. This slide reconciles adjusted operating profit to the statutory reported profit for the period. It also highlights our interest and tax charges. Net interest payable decreased slightly to GBP 5.4 million. The group's adjusted tax rate for the first half of 2020 was 16.7% compared to 19.9% in half 1 2019. The reduction in rate is attributed to the recognition of prior year adjustments arising from the U.S. Coronavirus Aid, Relief, and Economic Security Act, the CARES Act. In terms of reconciling adjusted profit to statutory reported profit, the following items are excluded from the adjusted profit measures for 2020. Amortization of intangible assets from acquisitions of GBP 4.7 million. Goodwill impairment of GBP 110.5 million relates to the goodwill allocated to the Aerostructures cash generator unit. Our Aerospace structures business is 1 of 3 cash-generating units in the group and has the highest exposure to the Civil Aerospace sector. This noncash impairment reflects the significant impact of COVID-19 in that market. We also recognized a restructuring charge of GBP 20 million, and I will talk more about this in the next slide. Costs associated with disposal activities for the potential divestment of our Aerospace structures business were GBP 4.7 million. And the related tax credit on all of the above-mentioned items was GBP 27.3 million. The restructuring plan actions we initiated in 2019 are delivering the expected benefits. As David mentioned earlier, the coronavirus pandemic has had a profound impact on our markets and customers, and based on our analysis, we expect the impact will be with us for some time to come. Whilst we are doing everything possible to sustain jobs, regrettably, we have had to extend and broaden the scope of the restructuring activities to further reduce costs. We have taken advantage of the period in which customers were closed to accelerate the planned transfer of work packages to Southeast Asia. We're also redeploying some equipment to better utilize it within the group. For example, machines from Civil Aerospace are being used on our growing Military Aerospace and Space work packages. Reflecting these additional actions, the total restructuring charge is expected to be around GBP 35 million, with GBP 12 million recognized in 2019, GBP 20 million recognized in the first half of this year and the remainder expected to be incurred in the second half. Cash outflow in respect of these activities is expected to be approximately GBP 20 million with GBP 3 million recognized in 2019, GBP 6 million in the first half of this year and approximately GBP 11 million outflow expected in the second half of 2020. The main element of the restructuring charge relates to reducing group headcount. Between June 2019 and June 2020, group headcount has reduced by 1,329 employees. And we anticipate a further reduction of around 620 employees in the second half of 2020. Aerospace headcount reduced by 17% in the 12 months to June. And we anticipate a further reduction of 12% in the second half of the year. Flexonics headcount reduced by 16% in the 12 months to June and we anticipate a further reduction of 3% in half 2. We expect these restructuring activities to deliver cumulative savings of around GBP 35 million for the full year 2020 with GBP 11 million delivered in the first half. The annualized run rate of savings is expected to be around GBP 45 million, mainly related to lower headcount. Now on to cash. We have continued our focus on generating robust cash flow, and the group converted 262% of its adjusted operating profit into operating cash flow. This was achieved through careful management of capital expenditure and working capital. We saw a GBP 1.7 million inflow from a changing working capital and provisions compared to a GBP 10 million outflow in the prior year. Our Director of Risk and Assurance is leading our inventory reduction effort, working with inventory champions from our operating businesses to ensure inventory is efficiently aligned to the changing customer demand schedules. Capital expenditure of GBP 14.8 million was 0.7x depreciation, excluding IFRS 16. That compares to spend of GBP 35 million in the first half of 2019. As previously advised, following several years of high capital investment, we are now past the peak investment phase and can expect capital expenditure in the future to be at more normal levels. In the near term, however, we are focusing on conserving cash, including careful management of capital expenditure and for the full year, total capital expenditure is expected to remain around 0.7x depreciation. Pension cash contributions in excess of service costs were GBP 2.8 million. And after allowing for interest and tax payments of GBP 7.6 million, the group generated free cash inflow of GBP 16 million in the first half of 2020. This was 21% higher than in half 1 2019. After GBP 12.7 million cash outflow from restructuring and disposal activities, and the partial settlement of previously recognized legal claims, the group generated net cash inflow of GBP 3.3 million in the first half of 2020. In a period impacted by exogenous events, this was a significant improvement in cash performance compared to the first half of 2019. After taking account of GBP 12 million adverse currency translation movements and lease changes, net debt was GBP 238.9 million at the end of June. I shall now highlight the key movements in the group's balance sheet since December 2019. The reduction in noncurrent assets is primarily related to recognizing impairment of goodwill of GBP 110.5 million, as I described earlier. The reduction in business activity as a result of COVID-19, together with our focus on working capital, has led to the reduction in net current assets. The net retirement benefit surplus decreased from GBP 41 million at the end of 2019 to GBP 38.6 million at the end of June. As you can see from the box in the middle right hand, this decrease was primarily as a result of net actuarial losses, partly offset by the group's cash contributions to the plans. The GBP 38.6 million net pension surplus is comprised of a GBP 51.7 million surplus in respect of the group's U.K. plan, which is an asset on the balance sheet, and a GBP 13.1 million net deficit for the group's U.S. and rest of the world plans, which is a liability on the balance sheet. Although the U.K. plan has an accounting surplus, in actuarial terms, this plan had an actuarial deficit of GBP 10.2 million per its triannual valuation in 2019. And therefore, the company is continuing to make deficit reduction payments of GBP 5.5 million per annum. As a reminder, this is a reduction from the GBP 8.1 million per annum contribution rates from prior years. The reduction in other long-term liabilities is attributed to a reduction in deferred tax liabilities related to the impairment of goodwill. Our lending covenants are currently based on frozen GAAP and therefore, they are calculated on a pre-IFRS 16 basis. Net debt before lease liabilities was GBP 155.2 million at the end of June, giving headroom of GBP 162 million under the group's committed borrowing facilities, and the net debt-to-EBITDA issue was 1.6x. As well as delivering a robust cash flow performance in half 1 2020, we have increased our financial flexibility. At 30th of June 2020, the group held committed borrowing facilities of GBP 317 million, and the group had headroom of GBP 162 million under these facilities. In July 2020, the group refinanced its U.S. revolving credit facility of $50 million and extended the maturity to June 2022. Accordingly, the weighted average maturity of the group's committed facilities is now 4.1 years. At the beginning of June, the group was confirmed as an eligible issuer under the Bank of England's COVID Corporate Financing Facility, the CCFF, under which the group can draw up to GBP 300 million. Access to the CCFF provides financial flexibility should it be needed. And currently, this facility remains undrawn. We have agreed appropriate covenant relaxations with all our lenders in relation to the June and December 2020 and June 2021 testing periods. And we agreed an additional September 2021 testing period to provide financial flexibility for the group through this unprecedented period. For the testing period ended June 2020, the group's net debt-to-EBITDA was 1.6x, and interest cover was 11.8x, both comfortably within pre-relaxation covenant limits. We have undertaken extensive scenario testing for 2020 and 2021 based on a variety of end market assumptions. While taking account of appropriate cost reduction and cash preservation mitigating actions. Against this set of assumptions, our assessment shows that the group has sufficient liquidity under its existing committed facilities. Senior has good liquidity and stable finance arrangements. In summary, the group delivered robust cash performance in the face of significant disruption to our end markets from the pandemic. We converted 178% of adjusted operating profit into free cash flow. Our robust cash performance meant our headroom on our committed borrowing facilities increased to GBP 162 million, and we have agreed appropriate covenant relaxations with our lenders to provide flexibility through 2020 and 2021, and we have sufficient liquidity under existing borrowing facilities. We are continuing to align our cost base to demand through our restructuring program and cost management. And we will continue to focus on generating free cash flow through careful measurement of capital expenditure and working capital. Thank you, and I will now hand back to David to cover the markets, strategy and outlook.

Thank you, Bindi. So let's turn our attention now to markets. And the first half of 2020, Aerospace represented 73% of the group's revenues and Flexonics was 27%. Unsurprisingly, our exposure to civil aircraft has decreased to 47% from 55% of group revenue compared to the first half of 2019. Military aerospace has grown in real terms and as a proportion of group sales, increasing to 19% from 13% of group revenue. Land vehicle revenue has reduced to 10% of sales from 12%, partly because the market's been affected by COVID-19, but also because last year, we sold our Flexonics businesses in Blois, France and São Paulo, Brazil, which were both passenger vehicle-oriented businesses. Power and energy increased to 17% from 14% of group revenue because of the proportionately steeper decline in Civil Aerospace revenue. From a customer perspective, we supply to a very good spread of blue-chip companies across our Aerospace and Flexonics divisions. Despite the issues in Civil Aerospace, Rolls-Royce and Boeing remain our 2 largest customers. With increased defense sales, Lockheed Martin are now our third-largest customer; and Raytheon Technologies are next following the merger between Collins and Raytheon. I always like to highlight the sales to Boeing and Airbus on a derived basis. That is to say, total sales, including direct-to-the-aircraft primes as well as taking account of engine sales and sales to Tier 2 customers. This is where we see the biggest change. Five years ago, we were 70% Boeing and 30% Airbus. Last year, we were close to 50-50. But in the first half of this year, we saw 63% Airbus and 37% Boeing, with the Airbus A320neo program being the single largest for Senior. Clearly, this is partially as a consequence of the ongoing 737 MAX situation. In time, we would expect the ratio to become more balanced again. Cummins, Caterpillar and Schlumberger remain our largest customers on the Flexonics side. We're all familiar with previous so-called black swan events affecting civil aviation. The first Gulf War and 9/11, SARS, the global financial crisis, all had an impact. Nothing, however, prepared us to what we've seen in the past 5 months as COVID-19 has spread around the globe, and governments have responded with lockdowns and movement control orders. The travel industry has been massively affected. In April, air traffic was down 94%. And in its July forecast, IATA predicted that it will be down 63% in 2020 compared to 2019. Most commentators think it will be 2023 before passenger numbers return to 2019 levels. Some say 2024, and you may hear that oddball saying 2022. But no one disputes it will be years. An effective vaccine or vaccines deployed globally will surely help confidence. And let's hope that we see a joined-up, cross-border approach when we get to that stage. Like many, I have a long-held conviction that Aerospace is a long-cycle business. 40 years of empirical evidence confirms this. There is a strong need and desire to fly. While video conferencing of various types has helped us all work reasonably effectively during the lockdown, it is a poor substitute to being on the ground and I predict business travel will pick up strongly when it is safely accessible. Similarly, while holding at home is very enjoyable, people will tire of staycations and will want to travel further afield. This is particularly true for the growing middle classes in Asia which is predicted to be one of the strongest drivers of air traffic growth over the next 15 years. In Senior, we have always planned for long-term air traffic growth of around 4% CAGR. Our view is that this is still what we are likely to see in the long term, but of course, the next few years will not be where we all thought we would be before the crisis. The lower operating costs and better sustainability of new aircraft, on which Senior has significant content, will be more important than ever, and therefore, we are well positioned to benefit from the recovery as it takes shape. The 737 MAX situation remains very important to the sector in general and to Senior specifically. We have 13 operating units that have content on the 737 MAX platform or LEAP-1B engine supplying to multiple customers, including Boeing, Spirit, GE and Safran. As a reminder of when this all started, on 13th of March 2019, the FAA suspended operations of the 737 MAX on the Lion Air and Ethiopian Air tragic air accidents. Since then, all 737 MAX aircraft around the world have been grounded. As mentioned earlier, the good news is that the FAA certification flight tests were completed just over a month ago. Boeing resumed production in May, albeit at a low level. Return to service of the grounded aircraft is now expected in quarter 4 of this year. That would also allow Boeing to complete the necessary steps to start delivering aircraft from inventory to airline customers. The resultant ramp-up in production will be paced by recovering end markets and the burn down in stored aircraft inventory, with Boeing indicating a gradual increase to rate 31 per month by the beginning of 2022, then further increases thereafter to correspond with market demand. With an order backlog in excess of 3,500 aircraft, the 737 MAX remains a very important program. While the recovery is clearly now much lower than previously anticipated, Senior has good content on the aircraft and will benefit as deliveries and production recommence and increase. Overall, our focus for Military airspace is very much on the U.S. market, where defense spending is as high as the next 10 countries combined, and series production volumes reach meaningful levels for sustained periods, which in due course, will also generate good aftermarket sales for our fluid conveyance products. We are actively pursuing further work in the sector therefore. That is in both fluid systems, where we have, for example, been selected for the Boeing-Saab T-7A Red Hawk program, but also in structures where our Connecticut operating business has received the elite supplier award from Sikorsky for the third year running. And we're bidding multiple packages from businesses, such as AMT in the Pacific Northwest, that have traditionally focused on civil aerospace work. Turning now to Flexonics. We will firstly look at land vehicles, which covers truck, off-highway and passenger vehicles. For this market, we sell a range of proprietary products to major OEMs, in particular, our exhaust gas recirculation coolers, or EGR coolers as they are commonly known, which protect the environment by reducing emissions. Coming into the year, we were expecting lower sales in these cyclical end markets, but COVID-19 had an additional impact with production more than halving for the important North American heavy-duty truck sector. Present forecast would see continued weakness in the second half of the year than a return to growth in 2021. Looking further forward, we are positioning ourselves to capture new business by developing solutions for new, higher-efficiency internal combustion engines as well as electric vehicle applications, and we'll talk more about this when I get to strategy. Our other most important Flexonics market is power and energy. I'm sure you are all aware of the slump in demand for oil and gas products brought on by lockdown restrictions implemented by governments around the world, and the subsequent decline in air and land vehicle travel. We saw some mothballing of capacity in quarter 2. And while the supply excess of oil barrels per day over demand has reduced, it is still very high, so we do not anticipate any meaningful recovery in this sector until economic activity levels pick up around the world. We will continue to be vigilant for the effects of the coronavirus situation on our markets and customers and respond accordingly. I'd like to change tack now and talk about progress with strategy. There is no doubt that in recent months, the pandemic has meant that our priorities have been health and safety, liquidity and cash preservation and business continuity. However, we've also continued to focus on strategy implementation, especially in the key areas that will help us to emerge strongly as the recovery takes shape. Many of you watching and listening today would have been on our Capital Markets Day in May 2019. At that, we highlighted 2 key technology themes, 1 with structures, with the other being fluid conveyance and thermal management. Our strategy for our structures business is straightforward. We have a well-equipped global footprint, including excellent manufacturing facilities in Southeast Asia. Our focus is on filling our existing capacity with work that meets our returns criteria. For some years, we have been diversifying into defense, space and highly engineered industrial work, and this is now accelerating given what is happening in the Civil Aero sector. For example, we are providing chassis and thin skin assemblies for satellite applications. Most of our R&D and product development efforts are for our fluid conveyance and thermal management businesses which span our aerospace fluid systems and Flexonics divisions. These products and subsystems come in all shapes and sizes, that share common underpinning technology. Typically, we are responsible for the design as well as manufacture of these products, and they have strong intellectual property content. To bring this to life, I thought I'd provide a short case study of one of our best businesses in this area. Senior Aerospace Metal Bellows. We've recently invested in an expansion of metal bellows, our IP-rich Fluid Systems business based in Massachusetts, U.S.A. This business has shown strong growth in recent years, both top and bottom line and needed more engineering and manufacturing space to meet existing and future demand. Although we think of them as an Aerospace business, in addition, they supply highly engineered products into a range of other diverse and attractive end markets, including medical, semiconductor equipment, military and industrial. Their largest customer this year will actually be Lam Research, a leading semiconductor equipment manufacturer. We have an excellent leadership team in Metal Bellows. They are very focused on continuously investing in engineering research and development. The technical teams work hand-in-hand with the business development team to ensure investment is focused on customer needs. They have a full life cycle approach, so in addition to OE sales, they have decent aftermarket revenues, too. This business creates significant value for the customers as well as Senior's shareholders. This model of providing highly engineered products using core proprietary technology, servicing diverse and attractive end markets is a core element of Senior's go-forward strategy. Our other investments in new technology and product development in the areas of fluid conveyance, thermal management and additive manufacturing are progressing well. In fluid conveyance, as I've just shown, our bellows technology can be applied to a broad range of custom solutions across a diverse range of attractive end markets. In thermal management, our intellectual property can be used to prolong battery life, a key determinant of electric and hybrid vehicle economics. Having already commenced production of our 70-kilowatt battery cooler, our first electric vehicle application, we have numerous development projects underway with a variety of battery manufacturers and land vehicle OEMs. And in addition to vehicle applications, we're also working with customers on future cooling solutions for stationary power storage. Our advanced additive manufacturing center in Burbank, California, U.S.A. works collaboratively across the group, and is focused on designing and manufacturing metallic additive products to reduce cost, weight and overall cycle time. We will be delivering flightworthy hardware from the AAMC to several customers this year. Elsewhere, we're also designing and manufacturing parts using additive technology and our materials for instance, Senior Aerospace BWT, based in Cheshire, U.K., is 3D printing thermoplastic aircraft components using fusion deposition modeling technology with over 700 components in production across 3 major aircraft programs. BWT are also leaders in designing and producing lightweight darts. The team there are exclusively using the patented RT2i technology to design and manufacture composite thermoplastic products. Development continues to progress well with qualification expected to be completed later this year, followed by Senior's production for the launch aircraft program. We will continue to focus on proprietary technology development as it is vital to our medium and long-term success. So let me finish by talking about the outlook for Senior. Civil Aerospace OEMs significantly lowered their production rates in the second quarter, with recent announcements confirming reduced rates across the second half of 2020 and into 2021. As I showed earlier, it's likely to take several years for air traffic and then civil aircraft production levels to return to 2019 levels. However, the demand for air travel is expected to continue to grow in the medium and long-term, as it has for the last 40 years. The lower operating cost and better sustainability of new aircraft, on which Senior has significant content, will continue to be a necessity for the airline industry. In Flexonics, we are not anticipating meaningful improvement in our end markets in the second half of 2020. We anticipate market disruption will continue into 2021, but we expect certain sectors, such as the North American heavy-duty market, to return to growth next year. Whilst we expect the structural long-term drivers of our end markets will remain in place, trading for the rest of 2020 continues to be uncertain because of the impact of COVID-19 on our markets and customers. As a result, guidance for 2020 remains suspended. We remain confident that in the medium term, our differentiated offering in fluid conveyance and thermal management products, our investment in low-carbon and advanced manufacturing technology, our global footprint and our positioning in attractive and diverse end markets will help to ensure that we emerge strongly as the recovery starts to take shape. With that, we'll open the floor for any questions, which Bindi and I will be delighted to answer. Jennifer is going to curate the Q&A. So Jennifer, do we have our first question?

Yes. We have our first question from Andy Douglas at Jefferies. Can you give some color on the covenant relaxations?

Well, I can give some color, yes. I mean, first thing to say is that we have very supportive lenders. In total we have 9, including our private placement lenders. Bindi and I and the treasury team have had really constructive dialogue with those. And all I say is that we have very appropriate covenant relaxations in place for -- well, we had them in place for June. They're also in place for December this year and June next year. And the way that we go about working on what those should be, we stress test a range of assumptions to see what effect it's going to have in the business. Bindi made reference to this in her presentation. And that includes a base case, but it also includes whatever you would call the severe but plausible downside case. And in those instance, we really have taken a very pessimistic view of what might happen to civil aircraft rates in particular. And so our covenant rates are set above the level we would need, and should that either severe but plausible downside case emerge. So we're very comfortable with those levels. I don't know if you want to add anything to that, Bindi?

Yes. Just reiterating what David said. So from a -- in all the stress testing that we've done, we have agreed appropriate covenant levels into 2021. So we are comfortable with the covenant headroom and the liquidity headroom for the group, even in a severe but plausible downside scenario.

Thank you, Bindi.

A further question from Andy. How easy -- can you outline how easy it would be to take out additional costs should that be needed?

Well, in the same way that we've worked on the covenants using a range of assumptions and scenarios. We've done the same thing across the whole business. So we already know what actions we would take if that severe but possible downside scenario happened or something in between. Naturally, we're planning for a base case. But with the whole executive and leadership team, we've gone through the process of a down -- what might happen given certain scenarios. And in that instance, we've already identified the additional measures that we'd take. Clearly, of course, it involves aligning headcount to demand, but also reducing other variable and fixed costs. So we have all range of measures ready to implement, should that be necessary. Of course, we hope it's not.

And looking more positively, can you discuss how well prepared you are for a recovery and how easy it would be to ramp up, should that be needed?

Yes, I think that's a great question. We're very mindful indeed of our twin responsibilities here to our stakeholders. Firstly, we do need to make sure we align our cost base to the demand that we're seeing. Equally, we want to look after employees as well. So wherever possible, we're trying to sustain employment. And of course, we don't want to cut so deep that it then makes it difficult to recover because we are confident the recovery will come as we get through this pandemic crisis. And there's what, 100-odd vaccines are in development. I'm sure some of those will come to the fore at some point over the next year. So we've been very careful not to cut into the bone. We have had to cut pretty deep given the scale of the sales reductions, but not to the extent where we couldn't ramp up when that -- when, not if, that becomes necessary.

Got a question in a number of parts from Sanjay at Panmure. Can you give us an idea of the proportion of civil capacity that has been diverted to military or other end uses and what you or what we should expect going forward?

Yes. Well, Sanjay and I have discussed this before, he even asked me some of the questions about how easy would be to switch our production onto other applications. So it's a small portion today in the businesses that we're previously doing exclusively civil aerospace work. But to take an example, AMT in the Pacific Northwest, which has traditionally supplied large structural components and assemblies, mainly into Boeing, and their suppliers like Spirit. They're now doing work on satellites. They are hosting physical business actually now from defense customers that would lead to some quite sizable orders. But even at that level, we're talking maybe 10% of turnover at the moment. But it could, over time, increase more significantly than that. Now in other businesses, it's a bit different. In Connecticut, for example, which is -- their biggest customer is Sikorsky there. So 90%-plus defense, and their defense work is growing. So at the moment, in the civil aerospace businesses, it's relatively small, but the equipment is generic. So really the only things stopping us from taking on more work there are getting the specific approvals for the parts, and we've been manufacturing on a program by program basis. So we're hopeful that, that will grow. I would say I'm confident that, that will grow, but civil aerospace space will still be the main feature for those businesses that focused on that in the past.

And the second part of -- to Sanjay's question, on lease liabilities. What's the maturity profile for this? And how should we think about this as presumably, some leases may not be renewed or maybe available at reduced rates?

Bindi, do you want to take that one?

So the lease liabilities are all generally long-term and where we may consider not renewing those leases, we would take those as part of our restructuring activities. But on average, when you look at the depreciation rate, the interest charges and the lease cost, on average, they reduced by about GBP 7 million a year, subject to any currency movements.

A question from Sean Stewart at JPMorgan. Can you please explain the GBP 4.9 million of COVID-19 grant income that you received in H1 2020? And is it related to the employee furloughs?

So that, Sean, first of all, that GBP 4.9 million is related to employee furloughs. So that's within Europe and the U.K. where the company continues to pay employees that are on furlough and receives the grant back from the government. So that's what that relates to.

And going on to military aerospace. We've had a question, if you just bear with me a moment, from [ Christian Mayer ], is it reasonable to think that defense will be a significant growth market for the group going forward? And if I can add on to that, Chris Leonard has also asked about what is the ramp-up on any of -- type of ramping up on military aerospace after you've redeployed equipment to that area?

So I think we've grown our -- in the last couple of years, military space, as a percentage of our sales, has grown, I think, from 11% to 19%. Clearly, that's partly because of civil has dropped. But we grew in real terms by about 5.3% this year in the first half. I think that's a reasonable expectation of a 3% to 5% growth to underlying over coming years. If you look at the programs that we're on. But on top of that, we would hope to take additional market share. A good example is on the CH-53K King Stallion helicopter, it seem like I've been talking about that forever. But actually, we're now coming up to the -- the lower initial production then to serious production over the next couple of years. And our customer are Sikorsky and because of that elite supplier award we won, they want us to do more work. So that could help to spur further growth in military aerospace. But as a percentage of overall sales, 19% is not bad. I don't ever see it getting to 50% or anything like that. It's always going to be the smaller, I mean, just because of the sheer volume of Civil Aerospace programs compared to military.

A question again from Andy Douglas about another opportunity. Do you think that your electrification opportunity has actually increased over the last 12 months? And if so, why?

Yes. That's another great question. Thank you, Andy. We've done a lot of research on this and talked to customers, but also various consultants, Glynn, McKinsey, BCG, Roland Berger, on this very point. So I think the answer to that is passenger vehicles, in particular, as sales have slumped in the first half of this year. Actually, electric vehicles stayed pretty flat. So they didn't actually grow, but as a percentage of the overall market, it did grow. It's gone from about 3% to 6% over the past year, in fact. We do now anticipate that as people start buying cars again, that electric vehicles will become increasingly a large percentage of that. Most people say by 2040, it's going to be 50% to 60% of total vehicle sales. So hybrids and ICEs will still be around for a long time, but definitely, it's the fastest-growing area, and that's why we're spending so much time in it. On the commercial vehicle side, it kind of depends on what the class of vehicle it is. For commercial vehicles like buses, we're already on those, and we can expect to see that grow. On heavy-duty truck, it's going to be diesel for a long time, albeit with more efficient diesel engines and perhaps a hybrid electric motor to take it to that last mile once it gets into the city limits. And that's the way we're thinking about it. So we'll see rapid growth from a low level over the medium and long term, and that's really why we're positioning ourselves for that market.

If I can add to that, David, we are powertrain agnostic in Flexonics. And so we produce coolant systems, fuel systems for diesel, petrol. We're developing systems for electrification, natural gas and hydrogen fuel cells. So our customers really like that about Senior. We're not just one powertrain-focused. We are powertrain agnostic, and we're working on multiple development opportunities across that broad range of spectrum.

Yes, good point.

Another question from Chris Leonard at Crédit Suisse. Looking at the portfolio, there were 3 noncore divestments in 2019 under the "prune to grow" strategy. Are there further opportunities that you've identified that can support your restructuring efforts?

Yes. Thanks, Chris. And of course, the 3 -- I think I referred to 2 of them in my presentation, which were the 2 Flexonics businesses in Blois, in France; and São Paulo, in Brazil. The third one is Absolute Aerospace, which is kind of a noncore Aerospace business up in the Pacific Northwest. Our prune to grow activity is ongoing. We always review our portfolio and those assets that are either non-core or dominate the returns criteria, we will continue to consider divesting those. So we can expect to see some -- more prune to grow activity over the next couple of years, yes.

And a few questions you've had in -- on some clarification around some of the numbers. Rory Smith from Investec. It looks like you've written off GBP 7.4 million of inventory and GBP 2.4 million of fixed assets. Do these relate to 1 specific customer program? Can you say which one?

So those numbers are correct. They do not relate to 1 specific customer program. That is looking at what's happened to our end markets in both Aerospace and Flexonics and looking at the demand patterns going out. And in some cases, also where programs have ended. And because of the severe impact of COVID-19, any leftover inventory is now not expected to be utilized by the time those contracts have ended. So we've taken those into account and written them off the first half results.

And from Harry Philips at Peel Hunt. Companies, in general, are referring to temporary cost savings in terms of furlough and salary sacrifice, et cetera, what is the run rate at Senior? Or is this broadly in your cost and sales commentary already?

It is broadly in our cost and savings commentary. So the GBP 11 million of savings that we had in the first half of this year and the GBP 35 million of savings we are expecting for the full year take into account the benefits that we are receiving from these temporary relief measures as well.

And Ben Heelan from Bank of America Merrill Lynch asks, do you -- have you given guidance on the head office costs for the year?

As you know, we have suspended guidance across the group in light of things still rapidly changing with the pandemic. But as you can see that we did take our head office costs down on a year-on-year basis in the first half of the year, and we are absolutely focused on continuing to reduce discretionary spend and take cost down.

Some of the furlough activities do relate to head office staff as well as operational staff.

Ross Law from Berenberg asks about the dividend. What do you need to see to reinstate the dividend? Are there particular metrics, such as profitability or returns, that would indicate you're likely to bring back the dividend?

Yes. Our dividend policy is very clear. We wrote it down. So we all say we take account of a number of factors, which would include earnings, of course, what's happening in markets, our dividend cover and how we see the future. So really, we'd be looking at all of these items. So naturally, we'd want to see our profits ticking up compared to where we've been in the first half of the year. We are confident about the future, but I think we'd really like to see some certainty coming back into markets. So we don't have such a wide range of possible outcomes. And I think that's really related to the pandemic and when we get the vaccine. So that would give us a bit more confidence to predict more accurately what we're likely to see moving forward. But our pulse hasn't changed from a progressive dividend policy. We're looking forward to -- the Board, are looking forward to the time when we can reintroduce that. But it will only be under the right questions. Bindi, did you want to add to that?

So as David said, in addition to looking at earnings, we also look at free cash flow generation as well. So it's looking at both those metrics and the outlook over the medium term.

Right. And we have a classic question from Harry Breach at MainFirst. David and Bindi, a lot of debate around Senior stock level rather than at a macro level. It's about the shape of the margin recovery. And the stock price today is showing some shareholders just capitulating. Can you give us your thoughts on which period you see trough margins for Aerospace and separately for Flexonics, and for each division, what is the rough pace of margin recovery in '21, '22 and '23? And related to this, David, I said at some point, historically, pre-COVID, pre-Max that Senior could get back towards historic margins of 13% to 14%. How many years is that delayed by previously, he said 2021, the cost of the MAX and COVID?

Harry, you don't disappoint me. I had a bet with Jennifer and Bindi that you were going to ask me that question, though I'm quite surprised you did, really. Look, our guidance is suspended. And I'm not a soothsayer. And not be cheeky, what I mean is we really need a bit more certainty around our end markets, in particular, our Civil Aviation, to understand what the shape of the recovery looks like and therefore what we're likely to see in terms of margin improvement going forward. Our overall goals, in terms of return on capital, have not changed from those which Bindi to set out at the Capital Markets Day, and we've reiterated on several occasions. I'm very confident that we will start to generate good returns as activity levels pick up. The trough will be at the lowest ebb of the coronavirus. I hope we've seen that already over the past quarter, but it remains to be seen what happens in the second half of this year and into next year. So that will really determine the shape of that. That's why we're taking all the actions we have on restructuring. That's why we've stressed tested all the different scenarios to make sure that we have very adequate liquidity in those situations. That's why we have a focus on free cash flow. But I can assure you our focus on margin improvement and therefore, returns improvement, is unwavering. We just need a bit of our sales going back to assist us with that. So hard to say. Next year is going to be tough. Most commentators would say, if you think about what Boeing and Airbus have said, there's not really a change in rates next year. We expect some growth in military. We would hope we get a little bit of recovery in some of our Flexonics end markets, notable heavy-duty truck, but not back to the 2019 levels. And most people would think say it's going to be 2023 before air traffic recovers to the levels that were at previously and maybe 1 or 2 years beyond that before we're back at the -- kind of the rate 60-ish on the single-aisle programs that we're all looking forward to seeing. So yes, as soon as we're through the COVID crisis and activity levels pick up, we will see margins pick up as well. We should see decent drop-through from additional sales because the actions we've taken in cost. The shape of that, I can't yet predict with certainty. But when we're able to, we'll certainly share with you.

And can we give some more color about the split on the operating margin between Q1 and Q2 that we've seen in the first half?

So I'm not going to give you margins by quarter, but I think I'd guide you to look at what happened to revenues. So in quarter 1, there was no COVID -- there wasn't a significant COVID impact. It did start in late March. But also on a year-on-year basis, we still had the 737 MAX production in 2019 quarter 1 at rate 52 going to rate 57. Whereas this year, there was 0 production of 737 MAX. And then in quarter 2, we've had the -- particularly the 40% decrease in Aerospace year-on-year. That was taking into account that Q1 last year already had the reduced MAX rates as well. So if you just look at what's happened to the top line on a quarterly basis and also compared to previous years, that will give you some information on what the group's margin profile would have been dealing with the pandemic situation and the significant impact of that in quarter 2 this year.

We've got a follow-up question from Sean Stewart at JPMorgan. It was a follow-up question on the COVID-19 grant income. Should we expect a similar level of income in H2 2020? And then would it be correct to assume it's not going to be repeated in 2021? And does the GBP 45 million run rate savings target includes around GBP 10 million of COVID-19 grant income?

So the grant income goes hand-in-hand with furlough schemes benefits as well. And at the moment, there is no extension of that or we cannot see an extension on that at the moment into 2021. So the GBP 45 million of savings run rate annualized is more just gross savings from the group.

Rory Smith has asked about average shipset values and the 787, 737 MAX, the A320 and the A350 average shipset values look as if they have come down in the first half. And he wondered if he could have some color around that?

Yes. So there's a few changes, as you recall at the full year results, we did say that some of these up and down because we sold Absolute. So also there were some shipset content and actually, pretty much all of those platforms, you mentioned. So part of it is related to that. There's a bit of currency effect going on well. So really, the biggest change has been on the 787 program.

And that will also depend on the engine shift mix as well. So depending on which engine is being delivered more of, that will also impact the average shipset values that we have. So some of that impact is seen across things like A320neo, 787, and 350 as well.

So moving to your -- the great cash results. There's a question, are you pleased with your working capital performance?

Yes.

We are. We are pleased. I mean, look, when you look at it in light of the severe situation we faced with the pandemic and the 737 MAX across the group, to deliver GBP 16 million of positive free cash flow is a good result. However, it doesn't mean we stop there. We are continuing our relentless focus on cash flow into the second half of the year. There is more to do on inventory in particular, to give us more benefits in the second half of the year. And from a CapEx point of view, we would expect a similar level of capital expenditure in half 2 as we had in half 1. So overall, there is more to go for in cash terms, and everybody in the group is driving relentlessly for that.

Yes. I think if you -- I should think about how quickly this crisis hit and rates were cut. That is incredibly difficult to do on an operational basis. Usually, you get very long visibility of any changes in production rates on aircraft programs. So naturally, everybody in the whole supply chain, both from customers down to suppliers, we're trying to protect cash. So it's been necessary to work hand-in-hand with them, and we went out in the front foot, then we contact their customers and contact their suppliers, saying we're all in this together, let's find a way to make sure that we can all reduce the burden in cash. And we've been doing that very proactively. You can't do it all at once, and that's why there remains some opportunity as we go through the second half of this year and into next year as well. So we'll have an unstinting focus on working capital, particularly inventory.

Fantastic. So we have only a few questions left. So if anybody wants to submit any more questions, please do so now. A question on -- in terms of cash, have you benefited from any early payment or prepayment schemes while the U.S. defense contractors or from Boeing, for instance?

I think on the military side, yes, the primes have been fantastic. People at Lockheed Martin -- remember, the Pentagon made available additional funds to the primes to flow through the supply chain, and we absolutely saw that coming through. Worth pointing out that both the U.K. and the U.S., defense contractors are obliged to pay quickly anyway and the Prompt Payment Act, for example. So fully, we do get paid quickly. But we got paid even more quickly on the defense side. We haven't sought to get advanced payments from commercial customers. We've really focused on making sure we're getting paid on time, and we have been.

A question on excess inventory. You mentioned in -- as you were saying, but how long do you think it will take before the exit inventory in the system has worked its way out of the supply chain?

Yes. No, that is a really good question. It naturally depends on production rates based on what Boeing and Airbus have said. And then if you look at the flow into the engines side and to the big Tier 2s like Spirit, it's certainly going to take all of this year, and I would say, into the start of next year before those get aligned. For some programs, longer. But in general, that would be a fair assumption.

Makes sense. Okay. And if I have one more further question. So if anybody wants to submit another question, please do so now. In terms of goodwill impairment, can you give us some more color on detail on that, please?

So that's -- we test for impairment on an annual basis per the accounting standards. But given the unprecedented impact and a significant impact COVID-19 has had, we took an impairment review across all of the group's cash-generating units. So we have 3 cash-generating units internally: Aerospace Structures, Aerospace Fluid Systems and Flexonics. And when you look at all 3 divisions, Aerospace Structures was the one that's most significantly impacted by the slump in Civil Aerospace demand at the moment, and that's why when we looked at that, that's where we had to recognize GBP 110 million of impairment on that goodwill. Both of the other CGUs had sufficient headroom.

Jennifer, we're almost out of time. I think we should take the question you got on the level of bidding activities.

Yes, yes.

So I note something, a couple of you have picked this up, that I did mention in the statement that the bid activities in the presentation -- the bid activity levels were high, and that is true and maybe might surprise you. So we're seeing a range of things here. I already talked about the military side and the space side, which is encouraging. But it might surprise you to know that we're getting a huge amount of inquiries on the commercial aerospace side. And I think that is primarily because -- well, it's for 2 reasons. Firstly, I did contact all the senior guys and our customers, and I said, look, we're financially robust. We're a strong company. We're here to help. We have open capacity. We've shared our open capacity with those customers. And of course, perhaps all companies aren't in such a fortunate position as us in terms of our liquidity and strong free cash flow and a bit of trouble. So customers are making sure they have risk-mitigating options in place. And I think that's one of the reasons why our bid activity levels are so high, a lot of interest in Malaysia and Thailand facilities, but also in the U.S. and the U.K. So I won't predict that they're all going to come to fruition, but it's very encouraging to see that level of bid activities. And hopefully, the next time we talk, we'll be able to mention some of the wins that we've find as a consequence of that.

Okay. There are no further questions at the moment.

Okay. Awesome. Thank you, everybody, very much for tuning in to the webcast. We'll be talking to many of you, I know, over the next week or so. If you have any questions at all, please don't hesitate to contact Jennifer or Bindi or myself, and we look forward to seeing you in person when we're safely able to do so. Thank you very much.

Thank you.

Thank you.