Surface Transforms plc (LON:SCE) Chairman David Bundred caught up with DirectorsTalk for an exclusive interview to discuss their recent announcements, the importance of the Aston Martin win, the sign-off of the airframe manufacture, the volume automotive OEM’s, the German OEM’s 2, 3 & 4, the new factory & its capacity needs and what’s next for the company
Q1: Now, you’ve released a number of announcements since we last spoke, what’s been going on at Surface Transforms?
A1: Yes, quite a bit actually. I think there’s been 3 announcements, the preliminary sales numbers in November, the Aston Martin win which we announced on February 2nd and the half year results RNS last week.
Q2: What did it say about Aston Martin?
A2: Well on February 2nd, we announced an important unnamed contract win which we then described anonymously as OEM Six in the half year announcement. We couldn’t say who it was at the time because the customer wouldn’t let us, but Aston Martin themselves announced Surface Transforms as the carbon ceramic disc supplier last week.
Q3: So, why is the Aston Martin win such an important announcement?
A3: Well, it’s a very important announcement. Quite simply, it’s that first serious automotive nomination by a mainstream automotive OEM, other car companies will certainly take note. By the way, what an endorsement, the doyen designer of high performance cars, Adrian Newey, Chief Engineer of Red Bull himself, singing our praises in their press release.
Finally, of course, it’s also a £1m contract over the life of the car, at above average gross margins that will make a pretty useful contribution to our 2019 and 2020 financial years. Why is it so important? Finally, & perhaps above all, we were particularly pleased as to why we won this contract, in simple terms our competitor’s short fibre product couldn’t handle the kinetic energy of this car in the wheel envelope available. It wasn’t a problem for Surface Transforms so all in all a good day in the office.
Q4: Was this the only important customer announcement since we last spoke?
A4: No, not quite. In respect to our aerospace business, the half year RNS announced the fact that the airframe manufacture had signed off our product leaving only the final signatures from US Naval Air Command on this £1.3 million per year on-going contract. As a reminder, I think my first interview with Directors Talk was explaining the crucial significance of this contract because going into production with it, and of course the other known wins, gets our revenue into or passed that £3 million region which is now the day-to-day cash generation figure, financially, this airframe sign off is enormously significant.
Q5: The RNS gave a bit of a hint of a delay on this award is that the case?
A5: Yes, but only because the final airframe sign-off was three months late and it’s not the first time the customers missed a milestone by a few months. But all of us, our landing gear customer, the airframe manufacture and of course Surface Transforms are committed to get this new brake package into production within the next year & this, by the way, is still perfectly doable. Frankly, our customer doesn’t need a year to complete the testing that’s left, it’s now largely a paperwork exercise and we are therefore focussed on getting everybody in the chain above us to understand that whilst a few months might not matter to them it certainly matters to us.
Q6: Now, I understand that’s good news but what about the volume automotive OEM’s, not much solid news there?
A6: That’s a bit unfair, there might not be much we can RNS but there’s actually lots of good progress. Just as a reminder of the big picture here, the battle ground is what we describe as OEM’s 2, 3 & 4, they’re actually sister companies in a very big German group who currently now buy £70 million of carbon ceramic discs, let me repeat that number £70 million and that’s todays number, they tell us that this will increase to over £100 million in 2022. They’ve taken the decision, as a main Board decision, that they are going to dual-source this business and that we, Surface Transforms, are going to be the second supplier. To this end, they then signed a pre-production agreement with us in in mid-2016., that’s enormously significant. I’ll just reemphasise the point, a serious volume German OEM group, currently buying £70 million a year of our product type, has told us their intention to dual source with us. The issue is how and when do we turn their intent into orders for us.
Q7: What are the issues stopping you getting business now with that German group?
A7: What’s happened is the senior management overseeing, the main Board overseeing OEM’s 2, 3 & 4 have picked one of them, they’ve picked OEM 3 to ‘lick us into shape’, if I can use that phrase, for the whole Group. If that sounds like boot camp, I have to tell you that’s how we feel, they’re tough, they’re demanding but we’re getting there, I keep telling management it’s good for us.
So, where are we? There’s a multi-page to-do list but there are only 2 outstanding substantive issues, firstly they require us to be compliant to the German quality standards called VDA 6.3. This objective will be achieved by mid-2017 because it’s fundamentally about resources and we’re throwing subcontract resource at the work involved. The second task is there’s one remaining issue on the product itself.
Q8: So, what is the product question? Why is the issue there?
A8: The background is that we actually thought, all of us I think including our good friends inside the customer, we all thought were technically signed off, however over the past few years our competitors had a small number of field returns which required them to do a product modification. As a result, mid last year, the customer decided to change the wide of acceptance specification for all carbon ceramic discs and extend this new requirement to us. I want to stress, this issue hasn’t arisen from any test failure by Surface Transforms, our customers effectively sent us back into the exam room with a new requirement because of the competitor’s field problem but hey, that’s life. We’ve spent 3 months and a ton of work understanding what was going inside the micro structure of both discs and do now fully understand the failure process. As a result, we’ve got a promising fix which obviously now requires optimisation & optimisation takes time but we will get there.
Q9: What if it takes longer than you expect to complete that optimisation?
A9: Strategically, it doesn’t change the end game, the customer releases models on a regular basis so he will just put us on the next model. Obviously, we don’t need this contract to get to cash breakeven, we discussed that earlier so the issue is tactical, not strategic. Look, that’s not what we want, we want to be on the next model they are going to nominate, not least because any model change would affect the shape of our 2019 and 2020 revenues but let me repeat, VDA 6.3 will be done mid-year, we understand the product problems and have a set of fixes & we’re determined to meet their timetables.
Q10: Finally then, how’s the new factory going?
A10: Well, in simple terms, the move is almost done & that really is a tribute to the fantastic people we have working for us. Frankly, the only real problem was, somewhat unexpected, finding out that our mainstream gas pipe was in breach of current regulations, it’s being fixed but annoying and time consuming than anything else.
Q11: What about the new capacity need for volume OEM’s?
A11: Just for the avoidance of doubt, VDA 6.3 and fixing the product question are pre-requisites for contract nomination, I’ve been asked this question elsewhere. Seeing the new kit physically in place working is not a pre-requisite for nomination but the customers certainly wanted to see the new Knowsley site & have visited actually, they want to be sure that the new capacity is on order. In our case, the plant will arrive over the next twelve months which gives us another year to debug and shake down before the start of production in 2019. So, obviously, the next operational challenge is the build-up of our first production cell in the second half of this calendar year, it’s looking good, deposits have been paid, the bulk of the kit is on order & our suppliers tell us they are broadly on time.
Q12: So where do Surface Transforms plc go from here?
A12: Well, simply, we build on the fantastic successes of the last six months, the Aston Martin win, airframe sign-off, successful factory move, what a great six months but we’re not resting our laurels. That’s great but we now have to kick on from here, get the VDA 6.3 approval, sign a firm contract with our US aerospace customer, nail down the optimisation issues on the product & bring the new kit into Knowsley on time and on budget at the back-end of 2017. We’ve got our tails up and, I’ve said it before, do not underestimate the scale of our ambition and determination.