Surface Transforms Plc, (LON:SCE) manufacturers of carbon fibre reinforced ceramic (CFRC) materials has today announced that the Company is carrying out a Placing, Subscription and Open Offer of up to approximately 22,580,806 new Ordinary Shares at a price of 15.5 pence per share to raise gross proceeds for the Company of approximately £3.5 million.
The Placing will be conducted by way of an accelerated bookbuild process which will be launched immediately following this announcement, in accordance with the terms and conditions set out in the Appendix to this announcement. Cantor Fitzgerald is acting as Nominated Adviser and Joint Broker and finnCap is acting as Joint Broker in connection with the Fundraising.
In addition to the proposed Placing and Subscription, the Company intends to provide all Qualifying Shareholders with the opportunity to subscribe for an aggregate of up to 3,225,806 new Ordinary Shares (“Open Offer Shares”) at a price of 15.5 pence per share, to raise approximately £0.5 million (before expenses), on the basis of 1 New Ordinary Share for every 27.99608377 Existing Ordinary Shares held on the Record Date (the “Open Offer”). Shareholders subscribing for their full entitlement under the Open Offer may also request additional Open Offer Shares through the Excess Application Facility.
The proposed Placing, Subscription and Open Offer (together the “Fundraising”) will be subject to shareholder approval. The proposed Placing, Subscription and Open Offer are not being underwritten.
The Issue Price of 15.5 pence per share represents a discount of approximately 0.8 per cent. to the price of 15.625 pence per existing Ordinary Share, being the closing price on 5 July 2017.
The final number of Placing Shares will be agreed by Cantor Fitzgerald Europe, finnCap and Surface Transforms at the close of the bookbuild, and the results of the Placing and Subscription will be announced as soon as practicable thereafter. The timing for the close of the bookbuild and the allocation of Placing Shares shall be at the absolute discretion of Cantor Fitzgerald and finnCap, in consultation with the Company. Surface Transforms reserves the right to issue and sell a greater or lesser number of shares through the Placing.
Reasons for the Fundraising
The Company remains focused on the premium automotive brake disc market, and the brake disc market for military and light commercial aircraft. As previously communicated to Shareholders, the Company is in the process of pursuing a number of significant original equipment manufacturer (“OEM”) production contract opportunities in these markets.
In April 2016, the Company successfully raised £5.5 million by way of an equity fundraising, the net proceeds of which were used to commission the new Knowsley facility, for ongoing research and development (“R&D”) programmes and general working capital purposes.
Since then, the Company has successfully completed its move to the new Knowsley facility and is in full production on all processes. The Knowsley facility is performing more efficiently than the previous site. The Board now consider that the Knowsley facility, when the current investment programme is complete, will be capable of manufacturing approximately 20,000 discs per annum.
Except for the ceramic furnaces, all the new equipment is on order, at prices broadly in line with budget. Extended testing however required by OEM 3, together with additional unbudgeted development costs and delays in contracted aerospace revenues (all of which are discussed further below) resulted in the Board deciding to raise additional money to maintain R&D momentum and progress potential OEM contracts as well as avoiding any significant working capital constraints.
In addition to completing the move to Knowsley, the Board considers that substantial operational progress has been achieved in the last 15 months, and whilst this has not yet translated into commercial agreements for volume road cars, they are increasingly confident on the outlook of the business and further commercial contracts being awarded. These achievements include entering into a pre-production technology development agreement with OEM 3 in June 2016, being nominated as a supplier to Aston Martin (OEM 6) in February 2017, the Company’s expected imminent appointment by OEM 3 for a limited edition track day car for their motorsport series, and VDA 6.3 approval being attained by September 2017.
Accordingly, certain of the Directors have indicated that they intend to subscribe for, in aggregate £300,000 pursuant to subscription agreements with the Company. A further announcement will be made in due course regarding their intentions to subscribe.
As set out further below, the Company is in discussions with several OEMs with certain models anticipated to commence production mid-2018 onwards.
The Company is currently in detailed discussions with six automotive OEMs, details of which are set out below. The Directors consider the key criteria for adoption by automotive OEMs are price, product quality, lead time and security of supply. To address these criteria, the Company is continuing its investment programme to progressively increase annual manufacturing capacity to the next milestone target of 20,000 discs per annum.
Further and as previously advised, in the Board’s experience, automotive OEM’s seek to appoint suppliers for new models approximately 24 months in advance of start of production.
German OEM 3:
The Company is pleased that, if the required technical conditions are met, the customer is now expected to introduce the Company’s products earlier than anticipated – now in 2018 – albeit on a limited edition race track only car. Contractual details are in final discussion, and one relatively straightforward regulatory approval test remains to be completed (note: the Company has already passed this particular test on other cars for OEM3, as well as many other customers). Revenues from this car are expected to be £500k in the 2018 race season – which typically runs from March to October. The customer is able to accelerate this introduction because the product requirement, testing and quality accreditations are different for track cars than road cars. The Board considers this decision further validates the customer’s confidence in the core Surface Transforms product.
In respect to the road car, the Company and the customer are now planning a revised introduction route to the previously announced mainstream, volume, vehicle range. The vehicle range is unchanged but the introduction variant is different to and later than previously announced. This six month delay of road car nomination allows for the completion of technical development and replication. This effectively represents a one year delay on start of production (excluding race car, if awarded). However, as this is solely a different entry point to the same model range it does not impact medium term mainstream sales.
In accordance with the terms of the pre-production technology development agreement with OEM 3, product testing is ongoing and the Company believes it can meet the customer’s requirements by Q3 2017. However the Company and customer have agreed that Surface Transforms needs to replicate these results and this could take until the end of the calendar year – consistent with the new road car nomination date.
British OEM 2 and German OEM 4:
OEM’s 2, 3 and 4 are sister companies in the same group. German OEM 3 has re-iterated that their testing programme covers the requirements of other group companies. Completion of product testing with OEM 3 will therefore complete product testing for OEM’s 2 and 4.
German OEM 5:
This is a different German automotive group. The customer’s testing is going well; they have slightly different test requirements to German OEM 3 although the Company believes it can also meet these. The customer’s target model has a 2019 start of production date with mature run rate volumes of £2.5m per year.
British OEM 6:
In February 2017, the Company won an order from Aston Martin – now described as OEM 6. Engineering work on the Aston Martin order continues to plan and the launch date of January 2019 is unchanged with development revenues for the Company expected before that date.
British OEM 1: Delay with the first model for OEM 1 is understood by the Board to be due to challenges they are having integrating their brake system and unrelated to the discs. The customer’s solution appears to have been to ask the Company’s competitor for a holistic caliper and disc system offering. As a result, this latter project has been deleted from the Company’s internal forecasts and replaced by Aston Martin. The net effect of these changes is minimal. The Company continues to include the second model for OEM 1 in its planning as it will be offering a joint caliper, disc and pad solution to the OEM, replicating the success of Aston Martin.
The Company’s aerospace activities remain focused on one existing customer, for disc braking both in civil and military aviation. As previously reported, testing has been completed and the only outstanding issue is formal sign off by US Naval Air Command and the aeroplane manufacturer. This “sign off” however, continues to be delayed, for reasons the Board believes to be the result of the aeroplane customer wanting to “package” a number of changes at the same time. The Company is in discussions with its immediate landing gear customer with regard to the financial implications of this airframe delay, as the launch date was a fundamental feature of the original commercial agreement. These discussions include off-setting finance if production income is delayed for reasons within the customer’s responsibility.
New Knowsley facility and VDA 6.3
The Company is now in full production, on all processes, at Knowsley. The new site, (approximately five times the size of the old site) has been designed using “lean manufacturing” principles and is performing better than the old site. The Company fully vacated its old Ellesmere Port facility on 30 April 2017.
The current capacity of the new site is sales of £4 million in two cells: Small Volume Automotive Production providing £2.5 million and Aerospace providing £1.5 million. When the current investment programme is complete, total capacity is expected to equate to £16 million in sales per annum by 2021/22, although given the site footprint £50 million of annual sales could be achieved, albeit this would require additional capital expenditure. This £50 million sales target reflects the pipeline of the current customer discussions.
Changes to the production process to meet the further product requirements of OEM 3 will require up to approximately £750k of additional capital equipment for automation of the process and additional ceramic furnaces.
Additionally, further cost reductions have been identified from both the establishment of a Combined Heat and Power Plant on the new site and increased purchasing power on gas supplies.
VDA 6.3: All German customers require this quality standard. At the Company’s request, OEM 3 recently completed a “potential survey analysis” aimed at evaluating our progress and calibrating the Company’s perception on the closeout actions needed before final approval of VDA 6.3. The survey achieved this objective and the customer confirmed Surface Transforms is close to being approved. An action list with a relatively small number of detailed items has been agreed and management expect to address these by September 2017. This timeline is consistent with the new OEM 3 road car nomination date. Racetrack cars however do not require VDA 6.3 approval.
Use of proceeds
To enable the Company to properly exploit the current commercial opportunities, the Directors have decided to raise approximately £3.0 million, before expenses, through a Placing and Subscription of New Ordinary Shares with existing Shareholders and new institutional and other investors, and raising up to £0.5 million, before expenses, by way of an Open Offer to all Qualifying Shareholders. The net proceeds of the Fundraising will be used for:
· capital expenditure, namely £750k for ceramic layer furnaces which is expected to further increase production capacity to 20,000 discs per annum;
· £250k for additional testing and development costs for OEM 3; and
· general working capital purposes of approximately £2.0 million, needed due to (i) expected 12 month delay in aerospace revenues and (ii) OEM 3 commercial road car revenues being delayed by 12 months.
Current Trading and Outlook
The Company recently reported an unaudited trading update for the financial year ended 31 May 2017.
Sales in the year are expected to be approximately £700k. This was below market expectations but was the result of a conscious decision by management to switch capacity from revenue generating product to test parts (see further explanation below) together with problems establishing the gas supply at Knowsley.
These delayed sales however have not been lost. At 31 May 2017, the Company had retrofit and near-OEM customers orders of £770k and customer commitments for sales for delivery in the new financial year for £119k. This £889k total pipeline is the highest visibility of next year sales the Company has ever had (31 May 2016: £427k).
As part of the process of securing the race track and road car business with OEM 3, the Company has spent approximately £350k on extra development costs which will impact FY16/17 results, partially offset by an increase of at least £120k in the R&D tax credit expected to be received and credited to the income statement in FY17/18.
The Company’s cash balance at 31 May 2017 was £1.53 million to which can be added an expected tax credit of more than £450k in the first half of the new financial year and the outstanding grants and loans of £118k (claimed but not yet received).
The Board remain confident in the outlook of the business; the expected new race track business is a welcome short term boost to revenues but the uncertainty over aerospace revenues and the later starting date for the OEM 3 road car are expected to delay total planned revenues by a year, each year, for the period to FY 20/21 returning to the previous notified run rate thereafter.