Surface Transforms Plc Further significant progress

Surface Transforms plc

Surface Transforms Plc, (LON:SCE) manufacturers of carbon fibre reinforced ceramic (CFRC) materials, announced today its half-year financial results for the six months ended 30 November 2016.

Financial highlights:

· Turnover decreased to £327k (H1-2015: £782k)
· Total comprehensive loss increased to £976k (H1-2015: £124k)
· £306k of this difference related to late receipt of the tax credit: a tax credit of £356k was received in January 2017 (H1-2015: £306k received in November 2015)
· Loss before tax increased to £976k (H1-2015: £430k)
· Cash at 30 November 2016 was £2,698k (31 May 2016: £4,777k)
· Capital expenditure on property, plant and equipment of £680k mainly related to the new Knowsley facility
· Increased inventory of £193k to £763k (H1-2015: £570k)
· Trading remains in line with management expectations

Sales and Operational Highlights

· Production underway at the new Knowsley factory
· Post period end, first tier 2 supplier nomination to a UK automotive OEM

Financial review

Revenue for the period was £327k (H1-2015: £782k) as previously announced in the Surface Transforms Plc’s ‘Trading and Operations Update’ on 8 December 2016.

The overall sales comparison masks significant changes in underlying mix. Sales to near OEM customers increased by £67k to £163k (H1-2015: £96k), whereas sales to retrofit customers fell by £46k to £164k (H1-2015: £210k) partially reflecting a one off sales catch up last year in H1-2015 following a previous furnace break down. However the biggest change was the absence of any sales into the race car customer in the six months to 30 November 2016 (H1-2015: £337k). There were also no aerospace development revenues in this half-year (H1-2015: £111k), as the Company’s military aircraft development activity has concluded, in anticipation of series production starting in 2018.

The gross profit percentage was 61% (H1-2015: 57%), the improvement being purely a function of sales product mix. The absolute gross profit therefore fell in line with the sales volume to £201k (H1-2015: £447k). Administrative expenses rose £104k to £432k (H1-2015: £328k) reflecting the move to the new site and, towards the end of the half-year, the cost of running two sites. Research costs rose £160k to £750k (H1-2015: £590k), an increase of 27% as a result of significantly increased activity on the target OEM contracts.

The Company did not receive an R&D tax credit in the period (H1-2015: £306k). This was purely a timing issue as £356k was received in the first week of January.

As a result of the above issues, the total comprehensive loss in the period rose to £976k (H1-2015:£124k).

Cash was £2,698k at the half-year end (31 May 2016: £4,777k). This reduction during the period was in line with management expectations and mainly due to the trading loss in the period, increased capital expenditure on property, plant and equipment of £680k mainly related to the new Knowsley facility and increased inventory of £193k primarily the result of minimum order quantities on fibre raw material being delivered towards the end of the period.

Loss per share was 1.08p (H1-2015: 0.23p).

Outlook

Historically, the Company has generated increased revenues in the second half of the year, with the near equal split of sales in 2015-16 being unusual and reflecting the issues described above. In the current financial year, the Company expects to revert to the historic norm. Sales for the current financial year 2016-17 are expected to be comparable with the prior year on a like for like basis, allowing for the sales catch up, which in turn is offset by improved percentage gross margin.

Development spend will, at least, be maintained at the current higher levels, and indeed the current high cost of off site dynamometer testing and contractors to complete the VDA 6.3 work is putting that budget under strain.

Consequently, losses in 2016-17 are expected to be higher than the prior year but within the range of current market expectations.

Progress with potential OEM Customers

The key metric for the Company continues to be the advancement of the game changing contracts where the current status is as follows:

Aerospace: The airframe customer of our landing gear customer has approved and passed all the paperwork to the end use customer, US Navy Air Command (NAVAIR). This is very encouraging, albeit later than anticipated. Given previous programme delays, there is a risk of production being delayed albeit our customer has not informed us of any resultant delay in start of production and understands that formal orders should be placed during this summer. Both parties understand the issues involved and are working to meet the agreed targets. As previously notified, this contract will have a minimal contribution to this financial year but is expected to commence production in the middle of the 2017/18 financial year, reaching mature sales of £1.3m per annum in 2018/19.

Automotive: Including the new OEM customer described in the Company’s announcement on 2 February 2017, (now described as British OEM Six) the Company is in detailed discussions with six mainstream automotive manufacturers. Overall progress is good but the rate of development between OEM’s is varied:

British OEM One: In 2015 this customer informed us of their intention to purchase the Company’s product and shared its Surface Transforms product introduction programme with us, by model type, over the next few years. However it is clear that their model programme timetable has already slipped by six months and the Company’s assumption is that a delay of another six months is quite possible. This one-year delay is now our planning assumption.

In practice the new supplier nomination from British OEM Six has filled the short-term void in the forecast revenues. However British OEM One remains an important target customer for the Company and the Directors still believe that Surface Transforms’ products will be on their new cars when they resume the new programme activity.

British OEM Two: This British luxury car customer is the sister company of German OEM Three and they are following in their wake. As a result, German OEM Three is doing the bench and dynamometer testing for the Group. Trial discs are in production for further car testing for OEM Two during the coming months. The target vehicle is expected to commence production in 2020 and assuming Surface Transforms become the nominated supplier and the production timetable is adhered to, the Company expects to generate sales of up to £1.0m per annum.

German OEM Three: This prestige high performance car customer is the major focus of the Company’s R&D activity. A large team from the customer visited the new Knowsley site in November to review progress. They were complimentary on the site, the work on new capacity and progress towards achieving their quality standard VDA 6.3. There is one key outstanding technical requirement being addressed. Since their visit, the Company has made good progress on both understanding the technical issue and presenting a solution. The resultant new “evolved” design is under test and the Company remains confident of resolving the issue to the customer’s satisfaction. The Company and customer are reviewing progress with weekly conference calls and quarterly site visits. If the work goes to plan, the target model would generate annual run rate sales of approximately £10m per annum starting in Q3 2019.

You might also enjoy reading  Surface Transforms revenue increased by 34% to £1.2m

German OEM Four: This is a sister company of the above customer, they are sharing information with “German OEM Three” and, like British OEM Two effectively following in their wake. Sales with this customer could therefore begin in late 2020 generating sales for Surface Transforms of up to £3.8m per annum for the supply contract for selected new model on which discussions have to date been based.

German OEM Five: This customer is a competitor of the above three companies. Their requirements are similar i.e. capacity, VDA 6.3 and brake performance. They continue to car test and in tandem we are progressing our bench testing – and obviously without damaging any client confidentiality data – sharing what results we can with them from our wider test activity. They remain very keen to ensure that they are not “left behind” and that they secure a share of the future production capacity. The model in question is expected to commence production in mid 2019 and generating sales for Surface Transforms of up to £2.8m per annum on this initial model.

If we were to win both OEM Three and Five we would not have enough capacity and would need to raise funds for this extra capacity. As a reminder each new production cell in Knowsley has capacity for approximately £10m to £15m sales (dependent on disc size and mix) and there is a footprint for five production cells.

British OEM Six: The Company was extremely pleased to announce on 2 February 2017 their first nomination as a tier 2 supplier on a prestigious British OEM sports car. The Company has been working with this customer for about a year but momentum has accelerated more recently. As announced previously, the limited edition car is expected to be produced over the period from the start of 2019 to mid 2020. Including prototype and production revenues the Company expects revenues of approximately £1m.

This is an important strategic win for the Company, endorsing the Company’s proprietary technology and providing a valuable reference point for other major OEM customers.

Knowsley Facility

Gas and Power Supplies: In effect the only substantive problem in the move has been an ongoing issue with an unacceptable gas main. This issue, whilst technically straightforward, has been frustrating. The Company has now taken over the issue from the building contractors and alternative suppliers are now being engaged.

By contrast, the Company has made excellent progress on establishing (in partnership with a specialist supplier) its own leased biomass Combined Heat and Power (CHP) plant on site. The work is expected to finish in the next few weeks. There has been minimal cash requirement for this work and the effect will be that the site’s heating and lighting electricity costs at the 55k ft2 Knowsley site will be less than at the 11k ft2 Ellesmere Port site and, additionally, there will be an approximately 5% reduction in piece part cost of the disc from lower energy costs. These cost reductions were not in the original plan.

Move of Equipment from Ellesmere Port: Production has begun at Knowsley with just a couple of processes still being completed at Ellesmere Port. The relocation of the remaining equipment is scheduled during the next few weeks. All personnel (except those supporting final production at Ellesmere Port) have moved to Knowsley and the Company has changed its registered office. The Company expects to have completed the move by end February as planned.

New quality requirement VDA 6.3: As noted above, our potential German customer was complimentary on the progress we had already made on securing technical standard VDA 6.3 during their visit in November when they conducted a mini audit. They agreed with the Company’s list of outstanding actions and since that date further good progress has been made, albeit at the cost of hiring external contractors to deal with the volume of paperwork involved in the exercise. A further review with the customer is due in early April.

New Capital Equipment: The major items of new capacity are on order and deposits paid. Regular reviews take place with the suppliers and the promised delivery dates are (within a few weeks) on plan; in particular we expect delivery of the CVI 3 furnace at the end of March and the other two major new furnaces before the end of 2017. In respect to the new machining centres, the machines themselves are “off the shelf” standard, but the tooling, whilst proven at the suppliers still requires optimisation; this will take six months, and remains in line with plan. The new ceramic MIST furnaces are still in negotiation.

Grant and Loan Income; At the end of January, against an overall grant and soft loan award of £500k, the Company had claimed £287k of which £103k has been paid, the remainder being not yet due but expected to be paid in the next two months. The Company expects to be able to claim the outstanding £212k before May 2017, payment in the next financial year, as required in our agreements. In the period, the Company concluded the final element of the further support from Knowsley Borough Council.

We expect to be completely clear of Ellesmere Port by the end of February, to have secured the new quality VDA 6.3 quality standard by midyear and be able to physically show the bulk of the new capacity to our customers and potential customers by the end of the calendar year.

Summary

The last six months has seen further significant progress on the journey of Surface Transforms from an industrial technology start up to a mainstream automotive supplier.

This has notably included the achievement of securing one of its long held ambitions of winning a supply nomination with a serious OEM car Company with a prestigious global brand.

In support of this potential growth, the Company has moved most of its operations to a site with a sales footprint in excess of £50m, and additionally (within this footprint) has now ordered equipment that (in combination with existing equipment) will provide capacity, when fully operational, for sales in excess of £15m, notwithstanding orders not yet won.

The strategic focus for Surface Transforms continues to be building on this foundation; in particular resolving the technical requirement with German OEM Three, completing the move and installing the new production cell in the Knowsley factory, whilst achieving the short term financial sales and loss targets.

The Company remains confident of achieving its potential and is optimistic over the outcome.

However I cannot conclude without recording the Board’s appreciation for the outstanding contribution of all members of staff in what has been a tough, albeit exciting and successful six months. Thank you!

David Bundred

Surface Transforms Plc Chairman

10 February 2017

Find more news, interviews, share price & company profile here for:
Surface Transforms plc

Good news travels fast (but only if you make that happen):

Share on twitter
Twitter
Share on linkedin
LinkedIn
Share on facebook
Facebook
Share on email
Email
Share on reddit
Reddit
Find more news, interviews, share price & company profile here for:
Surface Transforms plc

AIM All Share Index