Surface Transforms plc Half-year financial results

Surface Transforms plc

Surface Transforms Plc (LON:SCE) manufacturers of carbon fibre reinforced ceramic materials, announces its half-year financial results for the six months ended 30 November 2017.

Financial highlights:

· Revenue increased to £524k (H1-2016: £327k)

· Loss before and after tax increased to £1,294k (H1-2016: £976k)

· Cash at 30 November 2017 was £3,275k (31 May 2017: £1,532k)

· Successful equity placing raising £3,439k (net of expenses) in the period

· Capital expenditure on property, plant and equipment of £684k (H1-2016: £680k) mainly related to the installation of Production OEM cell 1

· Inventory of £735k (31 May 2017: £507k)

Sales and Operational Highlights:

· Small Volume Production (SVP) cell is in steady state production

· Continuing progress on installation of Production OEM cell 1 including purchase of the ceramic infiltration furnaces (albeit post period end cash transaction)

· Start of production (SOP) on the Aston Martin Valkyrie project scheduled for early 2019. Additional demand from Aston Martin (mainly relating to dealer spares) has added an additional £1m of revenue to the programme

· Testing to satisfy OEM Three road car requirements continues with only one product test yet to be completed; the Company still believes it can meet the customer’s requirements and expects to conclude this testing when required during this year

· As previously notified OEM Three and Five will conduct their VDA 6.3 quality processes audit after the conclusion of the product testing

· Whilst the Company successfully completed OEM Three’s testing requirements for its racetrack car, they have changed the racetrack cars requirements, that necessitates a re-design (and therefore re-test) of the carbon ceramic disc. Management therefore consider it unlikely this product will be launched in the current race season

· Near OEM sales were flat in the period, however the Company now expects further growth in this market in the next two years, particularly in the specialist US conversion segment

· A project plan received from the Company’s target airframe customer indicates a delayed SOP of the upgraded aircraft to January 2020. This reduces revenues by approximately £1.4m over the two financial years FY 2019 and FY 2020; programme and financial offset discussions are continuing

Financial Review:

The increase in revenue from FY 2016 has been delivered primarily from additional sales of aftermarket products, with sales to near OEM customers flat. Development revenues have been low in the first half of the year but are expected to increase in the second half as development income from the Aston Martin project begins in earnest.

Revenue of £524k were £50k less than notified in the trading update issue on 20 November 2017. This reflects a supply chain disruption in the last week of the trading period that was quickly rectified in the second half trading period and has no impact on the expected year end numbers.

Gross profit increased to £286k (H1-2016: £201k) and gross profit margin was 55% (H1-2016: 61%), the movement being a function of product mix, with aftermarket kits having lower margin than development income.

Administrative expenses rose by £115k to £547k (H1-2016: £432k) primarily due to increased costs of the new site combined with upgrades to the IT infrastructure in the business and increased headcount.

Research expenses rose to £1,033k (H1-2016: £750k) due to continuing focus on delivering final product to target OEM customers. The increase was primarily due to additional salaries to increase the available resource for these intensive programs.

An R&D tax credit of £464k (H1-2016: £356k) was received in the last week of January 2018 outside the trading period reported. Total loss for the period was therefore £1,294k (H1-2016: £976k).

Cash at the end of the half-year was £3,275k (31 May 2017: £1,532k). In the period £3,439k of new share capital was raised of which £684k (H1-2016 £680k) was expended in the period on capital equipment relating to OEM cell 1. 23,750,460 of new shares were issued at a price of 15.5p each which increased share premium by £3.2m.

Loss per share was 1.17p (H1-2016: 1.08p).

Outlook

The Company continues to expect year-end sales to be in line with management expectations.

Research expenditure will continue at its current higher level and the increased site costs reflect the on-going higher costs of the new site. These increased costs are already reflected in existing Company budgets and the Company expects to finish the year with a loss in line with budget.

The Company’s projections indicate that there is sufficient cash to reach the point of operational cash generation in FY 2020.

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:

Automotive

Aston Martin Valkyrie: SOP remains early 2019 and the inclusion of contracted dealers’ spares demand has added £200k to FY 2019 projections and £800k in FY 2020. This initial spares demand is firm and continuing on-going demand is expected thereafter, although the quantum of the future demand is difficult to forecast as much depends on the mix between track use and road use by the owners.

The Company also continues to believe that there is potential to win further models beyond the Valkyrie but it is too early to begin detailed discussions.

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German OEM Three: There are two projects underway for this customer – volume road car and the specialist racetrack car.

In respect to the road car, there remains only one outstanding test to be completed, even though completion of this test has been outstanding for some time. As part of the process the Company has been making a number of parallel changes to the product that have now been combined into a series of “near final” discs. The Company continues to believe that tangible engineering progress has been achieved and that the testing will be completed in time for 2018 selection on the Customer’s next product launch.

Testing had been completed for the racetrack car but the customer has, for reasons outside the Company’s control, changed the size of a key adjacent component that requires Surface Transforms to offer up a reduced size disc. This smaller size requires testing and therefore it seems unlikely that the Surface Transforms product will be introduced in the current race season.

British OEM Two and German OEM Four: These are sister companies of OEM 3 and will follow the engineering release of the technology into the Group by OEM Three.

German OEM Five: has repeated its wish to use the Company’s products, the customer having completed some testing but with further testing remaining. None of the testing is considered onerous by the Board and our products have passed equivalent tests in other development programmes.

Aerospace

The Company has now received a project plan from the airframe manufacture building the target aircraft, indicating a start of production of the upgraded aircraft in January 2020. This is a further delay from the previously notified January 2019 date (and two years from the original January 2018 date); it has the effect of reducing total revenue by approximately £500k in FY 2019 and £900k in FY 2020. The Board however remain optimistic that some of these lost revenues will be offset by development income in what is now effectively a re-certification programme – as the Company’s production processes, and raw material suppliers have changed, the product will require a full re-certification. In line with normal aerospace military practice this process will be customer funded with reasonable profit margins.

Knowsley Facility

As a reminder the footprint of the Knowsley facility has the potential for anticipated output of 100,000 discs in five replica cells plus the Small Volume Production (SVP) cell. The current planning and finance availability is focused on SVP and the first of these cells.

Small Volume Production Cell: This cell – effectively transferred from Ellesmere Port – can now be considered steady state albeit with continuing potential for improvement in daily flow rate, establishment of lean manufacturing disciplines, and reduction in the high inventory levels. The Aston Martin contract will be produced in the SVP cell.

OEM Cell 1: All the key technology furnaces are under final test either in Knowsley or at the suppliers’ premises. In the last six months, the Company has purchased and is currently installing and testing the ceramic infiltration furnaces, the final piece of the furnace jigsaw. With all the furnaces and services in place, the only outstanding items are the machine tools, which are “off the shelf” with short lead times. The Company expects to achieve pre production capability and volume capacity in the current calendar year to facilitate “off tool” samples, the key criteria for entering the volume production stage.

VDA 6.3 Quality Requirement: This is the audit process used by the German OEMs to calibrate the Company’s conformance to quality processes. Both German OEM Three and German OEM Five have told the Company that they will undertake the audit when the product testing is complete which is currently expected to be around mid-year.

IATF 16949:2016: In parallel to German OEM activity, the British automotive manufacturers have launched an upgrade of their quality standard (previously TS 16949) which now broadly replicates the German VDA standards. All British automotive companies have to achieve this standard by September 2018. The Surface Transforms audit of this transition is in two phases – March 2018 and May 2018. As the processes and procedures are almost identical to VDA requirements, the Company expects to pass this audit.

Summary

Surface Transforms plc continues its journey from a development company to a mainstream volume automotive supplier with a site capable of production volumes of 100,000 discs, revenues of £50m and firm and repeatable orders.

The past six months has, overall, been one of steady progress rather than major breakthroughs. In this respect the testing on the OEM Three product and the slow but sure installation of the new furnaces in the OEM cell typify the frustrating pace but nonetheless continuing progress, whereas the size of the additional Aston Martin spares order hints at the revenue potential from this marketplace.

The Board expects to continue this progress with news of conclusion of the German OEM Three testing and further detail on SOP with German OEM Five. The Board expect trading for the full year will be in line with current management expectations.

However I cannot conclude without recording the Board’s appreciation of the outstanding contribution by all members of staff. Thank You!

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