Surface Transforms plc Q&A: New contracts, settlement of claim and the future of the company (LON:SCE)

Surface Transforms plc

Surface Transforms plc (LON:SCE) Chairman David Bundred caught up with DirectorsTalk for an exclusive interview to discuss the two new contracts, the settlement of a £300,000 claim, announcement of mainstream contracts, further capacity and the future of the company over the next few years.

Q1: It’s a long time since we last spoke?

A1: Yes, it’s been too long but I’ve said it before we only announce when we have something meaningful to say and fortunately, last week was one of those occasions.

Q2: So, what was said in the RNS last week?

A2: Well, we said three things.

Firstly, we announced two contract awards, collectively worth more than over £6 million, over the lifetime of the vehicles involved. These combined with previously announced contracts now give us over £8 million in total of revenue visibility for 4 years from January 2020 with more orders to follow from this customer base with spares and potentially, even more new models.

What really pleased us about these contract awards is that it’s new business from an existing customer group. These people who know us, they know our products, they’ve experienced our supply chain competence, it really is a great endorsement.

The second announcement in the RNS was that we said we had amicably settled our claim, which is worth over £300,000 of cash, arising from the delayed start of production on another previously announced contract. It’s been a long saga but we got there.

Finally, we said that are making progress on the bigger high volume, mainstream customers, particularly the German car manufacturer we describe as OEM5.

Q3: What does all this mean for cash and profits?

A3: We’ve already said we expect to be cash positive in mid calendar 2020 which is, of course, before the start of production on these two new contracts.

So, the contracts part of the announcement relates to the securing future profitability after the cash break-even point. In terms of the immediate issue of cash, we’ve already stated we had sufficient cash headroom to get to cash break but clearly the addition of the £300,000 cash before that date strengthens the position further.

Q4: You mentioned OEM5, the central issue with Surface Transforms is surely the lack of contract with big mainstream OEM’s, you describe them as OEM5 and OEM3. Where are you with testing and when are you going to announce a mainstream contract?

A4: There’s two separate answers on the testing.

The testing/engineering on OEM5, it’s as good as finished, technically, there is nothing significant left to prove.

We’ve still got some work to do on OEM3 testing but I can say test results have been encouraging, most encouraging. If we had anything to announce, we would’ve announced it.

In respect to a contract announcement on OEM5, we said in the RNS that we felt we could announce in the near term and that remains the case.

Q5: You haven’t said anything about the progress on the factory.

A5: No, there’s no significance to this, it’s only because our recent statements have been about customers. If you mix product, production, factory announcements with these customer announcements, the RNS’s become too long and you lose messages.

But, as you asked, in summary, the work on the new factory is going well, we’re on target for signing off the new capacity this year

Equally importantly to the additional capacity is, of course, confirming the product cost reductions, many of which were tied to bringing a number of processes in house. Again, this is progressing well and we expect to hit our production cost targets as the capacity is filled.

Q6: So, just talking about capacity, when do you think you’ll need more capacity as you win new orders?

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A6: Well, the capacity we’re putting in place, in addition to what we already have, gives us enough capacity for sales of roughly £17 million of sales per year in Knowsley that’s enough for now.

The company’s recurring OEM sales growth starts in January 2020, as I’ve said before, with the contracts we announced last year. The new contract awards I referred to before will be starting production mid-2021 to 2022 so we don’t need new capacity for announced contact awards.

The real question I suppose you’re asking, looking beyond the announced contract awards and thinking about the other opportunities that we talk so much about, we’ve got time and we’ve got floor space to deal with capacity needs as we see further contract awards beyond filling the £17 million.

We need about 18 months to build a new line and our factory in Knowsley, with extra production lines, has floor space to generate more than £50 million of sales.

Q7: How do you see Surface Transforms over the next few years?

A7: Perhaps I can answer your question by thinking reiterating the core messages of the company’s investment proposition.

There’s three issues, the market potential, the position of the key customers and where do we now stand.

Let’s talk firstly about the big picture market background and I make no apologies for this being a repetition of things we’ve said before.

There are only two companies in the world who can manufacture carbon ceramic discs, Surface Transforms and a German/Italian JV called Brembo SGL, there really are no other competitors.

The technical superiority of replacing iron discs with carbon ceramic discs has never been in dispute, lower weight, greater heat dissipation, longer life, no dust etc. The issue has always been about cost, put simply are these advantages worth the extra cost of carbon ceramics? Only customers can decide that.

Even at present, where we are now on that costs/selling price curve, the customers are putting carbon ceramic discs on cars over £60,000, initially drive axle only, and on cars over £100,000 on four wheels. On that current position on the price curve, we can achieve strong margins and our sole competitor has already achieved sales of over £150 million.

If every iron disc on those high end cars was replaced with a carbon ceramic disc, that market would be worth £2 billion, obviously it’s going to take many many years to get to these level of sales, we need to keep our feet on the ground. Think of it this way, Brembo SGL penetration into the iron disc competition is currently only 7.5% of the market available.

Secondly, let’s talk about the customer situation. The customers, who are now taking the carbon ceramics, do not like the current sole supplier monopolistic position of Brembo SGL, they are very keen for competition and want more capacity. Let there be no doubt, they are vigorously supporting us, we’re not naive, they’re vigorously supporting us because we’re the only other game in town.

They will only buy a product that’s been tested, literally to destruction and literally with hundreds of thousands of track and road miles testing. In addition, they’ll only buy when they see a supplier with quality competence, robust supply chains, underlying competitiveness and capacity, they’ll only buy from a good supplier.

So, finally, and this is the key point to answer you r question, where are we against all this well-known background? The key point is, we are now just about, arguably already through though that phase, we are confident with the product, we are cost competitive and our customers like what they see with the quality and supply chain.

We are in discussions with customers whose programmes would ultimately fill the £50 million sales floor-space footprint of Knowsley. We have a superior product that works in the field, we are competitive, we have capacity, we have quality approvals and we have a robust supply chain.

Our potential customers support us, we have our tails up so I hope that answers your question.

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Surface Transforms plc

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