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Surface Transforms plc

Surface Transforms plc Pre Close Trading, Customer and Operations Update

Surface Transforms Plc (LON:SCE) provides the following pre-close trading update for the year ended 31 May 2018 together with updates on progress with customers and operations.

Financial highlights

· Revenue increased for the year to £1.4m (2017: £0.7m) broadly in line with market expectations.

· Cash at 31 May was £0.9m (2017: £1.5m) to which should be added an expected November 2018 R&D tax credit of approximately £0.5m (2017: £0.5m) and £0.25m of above average trade receivables resulting from the timing of invoicing large individual items of development income shortly prior to the year end.

· Capital expenditure in the year was £2.0m (2017: £2.1m).

Customer and Operations Highlights

· Work with Aston Martin continues to progress and the Board still expects start of production (“SOP”) in Q1 2019.

· The Company has agreed a Q3 2018 test date with OEM 5 for final track testing, this being the final stage to complete engineering approval.

· Testing on OEM 3 continues with steady progress being made towards expected completion of final rig tests in calendar year 2018.

· Aerospace customer has re-confirmed the revised 2020 SOP date on the potential aerospace contract. The customer has accepted that development costs will be paid before SOP (partially offsetting lost revenues by Surface Transforms arising from the delay of SOP) but the timing and quantum have yet to be agreed.

· All five major furnaces, in Production OEM cell 1, have been tested and accepted by the Company albeit not yet approved for volume production. As part of a risk mitigation and enhanced training exercise for one furnace type, the supplier and the Company’s personnel will start some production at the supplier’s premises. This work is expected to last three months prior to it being dismantled and installed in Knowsley by 31 December 2018.

· The Company has now completed the audit to the new international quality standard IATF 16949 (which mirrors the German VDA standard). A small number of minor items were identified which the Board expects will be demonstrated as having been resolved in the follow up audit in July and be awarded the new quality approval shortly thereafter.

Progress with potential OEM Customers

Aston Martin (OEM 6): The work required to achieve vehicle certification is continuing to plan with all parties expecting SOP in Q1 2019.

The resultant revenues following SOP are particularly important to the Company because they are expected to be sufficient for the Company to then immediately generate ongoing net cash inflows from operations (assuming continuing revenues and R&D tax credits at current levels).

German OEM 3: As previously notified the Company has only one remaining rig test preventing engineering sign off. This is a destructive test and our measure of performance is the number of cycles before destruction, which is then repeated for consistency. Surface Transforms has demonstrated it can exceed the requisite number of cycles, and work is now focussed on achieving consistency of the results. The Board believes this test requirement will be achieved by the end of the calendar year.

Also, the discussions concerning the limited edition racetrack only car have not progressed further. The race season of this car typically runs from March and therefore the Board do not envisage this contract will be finalised until at least 2019.

German OEM 5: As with OEM 3 there is only one test left preventing engineering sign off, the prerequisite to nomination on a future model. It is a different test to that of OEM 3 as it is a high-performance track test, a test that has been satisfactorily completed many times by the Company with other customers. The test date has been agreed for Q3 of 2018 (calendar year) and parts are being manufactured for this test date.

Aerospace: Our customer has reconfirmed SOP as 2020. Discussions are underway on the re-certification work required as the production processes have changed since the original certification. This work will be customer funded which will partially offset the effect of the 18 months delay on an estimated £1.4m per annum contract. The timing and quantum of the development revenue however are yet to be agreed.

Knowsley facility

Capital Expenditure: The delivery and installation of the ceramic furnaces completed the bulk of expenditure on the five furnaces in OEM cell one. The work is now focussed on debugging and securing the necessary permits from the various regulatory authorities to commence volume production.

The final furnace type has been “signed off” at the suppliers but to further mitigate manufacturing risk and improve training for Surface Transforms, the supplier has agreed to extend the testing period to include production parts with some Surface Transforms personnel present, for training purposes. This has a number of advantages to the Company, not least of which is an earlier than planned cost reduction on the limited range of parts which will be manufactured at the supplier. Therefore the furnace will be in production at the supplier throughout Q3 2018 and will be dismantled and reassembled in Knowsley in Q4. Given the capacity available in this new furnace this period of supplier-based manufacture is more than sufficient to meet the total demands for the second half of the current calendar year.

Quality Approvals: The Company is already approved to the British Automotive quality standard TS 16949, however this standard is being replaced by the British automotive industry in favour of a new International Standard IATF 16949, effective October 2018. This standard closely mirrors the German VDA standard; whilst it was (arguably) possible to pass the old TS standard and not meet VDA standards it would be most unusual for this to be the case with IATF. The Company has now been audited to the new higher standards and was asked to address a number of minor issues; the follow up to check that this has happened is in July, at which point the Company expects to be awarded the quality certificate.

As previously notified, OEM 3 and OEM 5 will conduct their VDA 6.3 quality process after the conclusion of their respective product testing.

Kevin Johnson Surface Transforms CEO said “these results are encouraging with good progress being made in virtually all areas. We expect continued revenue growth in all areas during the coming financial year, but principally from Aston Martin as well as improved gross margins. To ensure continued engineering progress, we now intend to maintain a higher level of R&D (approximately £0.2m higher than originally budgeted in FY18/19) and the Board and management team remain confident that the testing required to achieve engineering sign off from OEM 3 and OEM 5 will be completed in the current calendar year.

It is worth repeating the statement made in the pre close statement last year: We are serving a potential £2bn automotive brake disc market where a monopoly supplier currently has sales of over £100m. Our customers want us to succeed in providing a second source of supply to the industry.”