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Surface Transforms Revenue increased 183%

Surface Transforms plc (LON:SCE) manufacturers of carbon fibre reinforced ceramic materials, announces its unaudited interim results for the six months ended 30 November 2019.

As previously reported, the Company has changed its accounting year-end date to 31 December. To assist with the transition this six-month statement also includes certain unaudited results for the seven months to 31 December 2019. The full audited results and report for the seven-month period to 31 December 2019 will be issued on 30 March 2020.

Financial highlights (seven months ended 31 December 2019)

  • Revenue increased 183% to £1,451k (7 months to 31 December 2018: £512k).
  • Gross profit increased to £868k, representing a gross margin of 60%
  • Cash at 31 December 2019 was £770k (31 December 2018: £319k)

Financial highlights (six months ended 30 November 2019)

  • Revenue increased 102% to £1,029k (H1-2018: £509k)
  • Gross profit in the six month period increased 95% to £630k (H1-2018: £322k)
  • Loss before and after tax in the six month period decreased to £1,302k (H1-2018: £1,509k)
  • Capital expenditure on property, plant and equipment of £582k (H1-2018: £144k) mainly related to the installation of Production OEM Cell One
  • Inventory at 30 November 2019 was £1,120k (31 May 2019: £1,162k)

Sales and Operational highlights

  • Secured an €11.8m contract over seven years from major German automotive OEM 5 with start of production (“SOP”) in October 2021. Discussions continue regarding follow on business
  • Further SOP delays of contracts with British automotive customer OEM 6
  • Won and delivered a £400k contract with OEM 1, another British automotive customer. Discussions continue regarding follow on business
  • Continued progress on testing for OEM 3
  • Received full regulatory approval from the Environmental Agency for the Knowsley site

Financial Review

Revenue in the seven months to 31 December 2019 increased to £1,451k (seven months to 31 December 2018: £512k) in part due to the £400k order from OEM 1, whilst the Company is also pleased to report increases in near OEM sales, which we believe to be sustainable. Sales for the six months to November 2019 were £1,029k (H1-2018: £509k). The high sales in December 2019 reflected the production catch up situation on near OEM and aftermarket sales as the prior months of September and November had been devoted to the OEM 1 order.

Gross profit in the seven months to 31 December 2019 increased to £868k whilst for six months period to 30 November 2019, increased to £630k (H1-2018: £322k). Gross profit margin was 61% (H1-2018: 63%) but is expected to improve in 2020 as OEM Production Cell One cost reductions come on stream.

The Company has adopted IFRS 16 in the period, capitalising operating leases. The major lease for the Company is the rent on the Knowsley site; all other leases are minimal. The major impact of IFRS 16 on the Company’s financial statements, is on the Balance Sheet creating right of use assets totalling £1.5m together with corresponding liabilities. The impact on the Income Statement is to exchange a reduction in the rent (hitherto treated as an expense) for an increase in interest and depreciation. In the six months to 30 November 2019 this added a net £29k to the loss for the year before and after tax. These IFRS 16 adjustments have no impact on cash. To facilitate comparison, the 2018 comparatives have been restated to reflect the impact of IFRS 16 had it been applied in that period as well.

Administrative expenses rose by £134k to £864k (H1-2018: £730k) largely driven by above budget plant repair costs of £66k, certification and consultancy costs of £45k to achieve environmental agency approval together with the introduction of IFRS 16. The certification costs will not recur.

Research expenses increased to £1,294k (H1-2018: £1,068k) of which the major elements were significant increases in the number of prototypes being tested along with development of the furnace process in support of cost reduction.

Cash at 31 December 2019 was £770k (December 2018: £319k), to which can be added £425k customer payments received in the first week of January; the corresponding cash balance at the end of the half-year was £81k (31 May 2019: £1,925k). Both periods were impacted by a combination of extended customer credit terms and subsequent late payment. The significant cash inflow in December and January reflected payment of these overdue sums and December receipt of the R&D tax credit. Inventory reduction was less than planned in 2019 but is expected to reduce further during 2020.

Loss per share was 0.96p (H1-2018: 1.24p).

Progress with potential OEM Customers

The Company continues to test products with customers as described in previous announcements and still expects to make further contract announcements during 2020:

OEM 5: In the period the Company was notified of its selection as a tier one supplier of a carbon ceramic disc to the major German automotive Company OEM 5. The selection is to be the sole supplier of the brake disc option on one axle of a new model. Lifetime revenue on this car is estimated to be €11.8m commencing late 2021. Annual revenue is estimated to be €2.0m per year before tapering off during 2026.

In addition, whilst this selection is the first with German OEM 5 the commercial understanding embraces the opportunity to be selected for further multiple platforms in the customer’s portfolio over time – pricing has been agreed providing a link between increasing volumes and decreasing unit prices. These potential awards could generate revenues of many times the value of this first contract.

The customer is now completing the system integration tasks required to bring the car into production. This work is proceeding to plan.

OEM 6: Notwithstanding recent customer announcements on the SOP of future models relevant to Surface Transforms, the Company is maintaining guidance on overall timing of Company revenues. On the first contract we won with them in 2017 the customer now expects to enter production in the summer of 2020; however this delay had been anticipated by the Company and is already reflected in the Company’s previously announced assumptions and revenue guidance.

Similarly the customer has announced SOP delays on the second car on which Surface Transforms is a nominated supplier from the fourth quarter of 2021 to the second half of 2022. Again, the Company had previously included a general overall delay contingency to provide against any such risk.

OEM 1: In the period the Company both received and delivered a £400k order for carbon ceramic discs on a track car to a major high performance British automotive Company.

The Company is in discussions with the customer on further opportunities.

OEM 3: Work continues on the product enhancements to meet the customer’s unique environmental test. Progress has been good with particular focus on ensuring that a capable production process matches the development activities. The Company is now in discussions on whether this enhanced product is sufficiently advanced for approval by OEM 3 for nomination on particular future programmes, in parallel to continuing further process improvement to widen the potential for nominations.

Other OEMs. The Company continues constructive discussions with a number of other OEMs, some of whom are now testing our product for the first time.

Knowsley Facility

OEM Production Cell One: All the new furnaces have now demonstrated functional capability and, indeed, some are being used to contribute to Small Volume Cell production output, thereby taking advantage of superior technology and lower production costs. The key task over the next few months is to demonstrate full systems integration of all the machines in the cell.

Environmental permits: The Company has now received full regulatory approval from the Environmental Agency for all technologies, including furnaces, on the Knowsley site.

2019 production surge: The success in delivering the £400k order for OEM 1 in a very limited period was a significant achievement by the, relatively new, operations team. Apart from the obvious customer relationship and financial benefits arising from this order, the “production surge” was a very valuable learning experience for us in respect to both the Company’s internal processes and supply chain. Where weaknesses were exposed, remedial actions have either been addressed or are in advanced stages of consideration.

Cost reductions: The Company continues to see continuous reduction in manufacturing cost as a crucial key ingredient of future success in the automotive industry. When OEM Production Cell One goes live in 2020, the Company will have achieved its original plan to halve production costs. The Company will not rest on this milestone with further cost reduction initiatives under active consideration.

Outlook

There are no changes to overall revenue guidance. Whilst OEM 6 has announced a number of changes to SOP on important cars for the Company, these changes had been broadly anticipated in internal forecasts.

The Board continues to expect gross margin percentages and overheads to be in line with previous guidance. However, the adoption of IFRS 16 will increase previously stated forecast losses by approximately £48k in 2020, £44k in 2021, and £39k in 2022. These IFRS 16 adjustments have no impact on cash.

Summary

Surface Transforms continues its journey from a development company to a mainstream volume automotive supplier with a site capable of revenues of £50m per year in a market that could ultimately reach £2 billion.

The Board maintains previous guidance that, with the recent awards of multi year, multi million revenue contracts, the Company will reach break-even EBITDA (including the tax credit) in H2 2020, positive EBITDA (including the tax credit) in 2021 and profit before tax in 2022.

In 2020 we expect to build on this foundation by winning further contracts, completing the system integration of OEM Production Cell One and begin delivering both production and development parts on the new contracts.

Finally, may I conclude by recording the Board’s appreciation of the outstanding contribution by all members of staff. Thank You!

David Bundred

Surface Transforms Chairman

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