Surface Transforms Q&A: Still on target to meet profitability in 2022 (LON:SCE)

Ceramic Brakes | Surface Transforms

Surface Transforms plc (LON:SCE) Chairman David Bundred caught up with DirectorsTalk for an exclusive interview to discuss their placing & open offer, COVID-19 effect on customers & the business and the Company still being on target to meet profitability in 2022.

Q1: Now, you announced a Placing and Open Offer last week, what is going on at Surface Transforms?

A1: Clearly, the fundraising is part of our response to COVID-19, a response that most companies in the land are having to do.  It’s a response that’s been a team effort, it’s been energetic in our opinion, we think the response is decisive and we’ve been considered. The response is in three parts:

  • We’ve remained operational, it’s important to state that and that really has been a team effort,
  • We have cut costs but we’ve cut costs in a very considered way of compromise cost cutting I’d describe it as and
  • The question, the fundraising to cover the potential short term cost gap.

I know the purpose of this discussion this morning is to talk about the impact of COVID-19 but before we do so, can we just remind ourselves that the COVID maelstrom has not altered the Company fundamentally. Put simply, thanks to the Placing, we’ve now got enough cash to weather the storm and therefore, the far more important question now, the far more important issue now is to focus on the destination after the storm has passed, and the COVID-19 storm it will pass.

Q2: So, where are you going then with the Company’s underlying business?

A2: We’ve been saying for over a year now that we will be profitable in 2022 and cash generative in 2021, we’re still reiterating that guidance.

Q3: How can you say this when, as a result of COVID-19, your customers are in turmoil?

A3: Yes and no they are, let’s take the four customer situations in turn.

The first one, the inflexion point for us between cash usage and cash break even is the start of production of the Aston Martin Valkyrie. Now, that programme we’re on, it’s a fixed programme, all of the cars have been presold, deposits have been paid and Aston Martin have said that they expect to start production in the second half of 2020. Our scenario planning allows for some further slippage in start of production, potentially impacting 2020, but this car will be a big feature of our Company sales in 2021 and 2022.

The second one of course is German OEM 5, they are still determined to get their new vehicle into production in 2022. I can tell you, telephone and video meetings are still taking place during the lockdown, we are still working to their key gateways, they’re currently telling us that those gateways are still valid. There may be some slippage in start of production but big picture is that this car is going to happen and will contribute to 2022 sales and beyond.

The third, if you leave Aston Martin and German OEM 5 and then move to the next big group of sales in the next 3 years which is the smaller OEM customers, the specialists and tuners, we call them near OEMs. Yes, some of them are going to find it tough during this period but that segment is dominated by big three customers for use and they represent over two thirds of our sales. Those three are well financed, and ok, the rest of them might be in trouble but we’re pretty confident about the big three.

Finally, there are the other major OEMs, beyond and including OEMs 1 to 6. None of them are in any of our forecasts; in fact, we’ve even stopped hinting as to who they might be and we have a portfolio of potential, not certain, wins.

The key message for investors looking about where we’re going is to take the big picture of this portfolio; we don’t need to win everyone to reach our milestone of £50 million sales a year, at least that’s the milestone to fill our Knowsley plant. It’s the portfolio, not individual OEMs that matters.

We reiterate what we’ve said in many recent announcements, the Board expects to make contract award announcements this year and should one or more be awarded they will be material.

Q4: In the meantime, though, have you not been put out of your stride by COVID-19?

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A4: Well sort of, like two thirds of all companies in the world we are impacted.

But, in the meantime, we’re still operational, in fact we’re still open, to date we have had no cancellations or deferments, right now, including sales to date and order book, we can see £1 million combined of those order book for this year, excluding the Aston Martin Valkyrie. Repeating my earlier comments, our development activities with the critical OEMs are continuing, despite the lockdown

In fact, this gives me the opportunity to publicly thank all my colleagues for us being able to be in this situation; we couldn’t be operational without the support of the entire SCE team. Every one of our 50 strong workforce is supportive, whether those who are still working or those on furlough, everyone’s doing their bit.

Q5: It sounds like it’s all going well but why have you needed to raise the money?

A5: Our Chief Executive, Kevin Johnson, will be filming the presentation we gave to the institutions last week, pre-placing, and we’ll be putting it on the website for our retail investors on Monday or Tuesday so I don’t want to steal his thunder.

The central point is that, like everybody else, we don’t actually know what’s going to happen next so what we’ve done is a series of scenario planning.

Our baseline scenario, the one we’ve used for the cash flow, is now that our sales in 2020, this year could, not will, could be half our previous forecasts, stating the obvious our scenario is that we lose half the year’s sales. If that forecasts happens, and I repeat it’s a scenario not a forecast, that’s a £1.3 million hole in our cash flow projections, and to this number we’ve added a further contingency headroom, offset by the cost reductions, if even 50% sales reduction is not enough. That number is so big, we have to mitigate that risk by strengthening our balance sheet.

Our numbers might be wrong, but they are pointed towards being too pessimistic, however in cash flow planning this year for everybody, pessimism trumps optimism.

Q6: I guess some may ask, why don’t you just cut costs deeper and quicker?

A6: Of course, we could furlough everybody and close the plant, but to go too far risks both existing and potential new OEM contracts, don’t forget half our workforce is fundamentally in engineering. Above all, we want the engineers to continue to interface with their opposite numbers in the customer base and we want the factory open, still serving all of our customers, both existing and potential.

The key issue is that we have to maintain the core infrastructure to support the new contracts and because of that, if we cut more, yes, we could ensure short term survival but short term survival is not the objective. So, survival whilst losing the existing and potential new contracts is not our definition of survival.

Our cost cutting plan is therefore a compromise but it’s now at least an adequately funded compromise which maintains our strategic objectives.

Q7: So, if you’ve raised sufficient cash to get through, why are you doing the Open Offer?

A7: Firstly, in these uncertain times if I could steal somebody else’s phrase “every little helps”.

I suspect we won’t be in trouble with shareholders if we have more than expected cash on the balance sheet at Christmas but in all candour, this is also about investor relationships with our retail investors, who are about a fifth to a quarter of our investor base. We aim to respect all our investors including retail and doing this requires us to support an open offer in this situation whenever possible to do so, it’s not also possible but we try.

Of course, it would be unfair in this particular instance to dilute those shareholders who’ve been with us on this long journey without giving them the opportunity to invest at this price.

Q8: So, I guess all in all, interesting times for Surface Transforms?

A8: Yes, in macroeconomics and politics, the most astonishing 6 weeks of my life but we have responded.

Really, the message that I want to get across in this interview is simple, we are still on target for profitability in 2022, we still anticipate further contract awards this year and if they happen, they will be material.

Our response to COVID has been threefold, remain operational, cut costs in a thoughtful manner; surgery not butchery, and raise funds to cover our pessimistic scenario of the potential cash implications.

Finally, the message is we’re delighted to give our retail investors the same opportunity to invest in this round on the same we gave our institutional investors.

It’s been an astonishing 6 weeks but I think we’re now in good shape for the next 6 years.

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