Surface Transforms (LON:SCE) manufacturers of carbon fibre reinforced ceramic materials, announced its half-year financial results for the six months ended 30 November 2018.
Financial highlights
· Revenue decreased 3% to £509k (H1-2017: £524k)
· Gross profit increased 13% to £322k (H1-2017: £286k)
· Loss before and after tax increased 15% to £1,482k (H1-2017: £1,294k)
· Cash at 30 November 2018 was £745k (31 May 2018: £923k)
· Successful equity placing raising £1,466k (net of expenses) in the period
· Capital expenditure on property, plant and equipment of £156k (H1-2017: £684k) mainly related to the installation of OEM Production Cell One
· Inventory of £1,062k (31 May 2018: £855k)
Sales and Operational Highlights
· Successful testing for OEM5 with all the key engineering tests completed satisfactorily and also received approved supplier status to OEM5 including confirmation that the Company meets VDA 6.3 (and IATF 16949) standards
· Continuing progress on testing for OEM3
· Delay of six months to SOP confirmed by OEM6 but no impact on lifetime revenues and discussions started for follow on OEM6 vehicle
· Capital expenditure on OEM Production Cell One virtually completed with phase one capacity expected to be operational in summer 2019
· Company secured accreditation to new quality standard IATF 16949 and Environmental standard ISO 14001
· Post balance sheet date, Company migrated its computer systems to a new enterprise system compatible with the needs of the German automotive OEMs.
Financial Review
Revenue in the period decreased slightly to £509k (H1-2017: £524k) and the split between retrofit and near OEM was comparable to last year. Sales to OEM6 were due to commence in March 2019 but as previously announced, SOP has been delayed by six months. However, this has no impact on sales in this reporting period.
Gross profit increased to £322k (H1-2017: £286k) and gross profit margin was 63% (H1-2017: 55%), the movement resulting from cost reduction activities beginning to have an effect at the new plant.
Administrative expenses increased to £730k (H1-2017: £547k) primarily due to higher insurance costs, upgrades to the IT infrastructure in the business and increased headcount.
Research expenses increased slightly to £1,073k (H1-2017: £1,033k) due to continuing focus on delivering final product to target OEM customers. The continued high spend was primarily due to increased cost of engineers and extensive external testing together with material costs to deliver these programmes.
Cash at the end of the half-year was £745k (31 May 2018: £923k). In the period the Company successfully placed 9 million shares at 17 pence each in an oversubscribed placing raising net proceeds of £1,461k.
Loss per share was 1.22p (H1-2017: 1.17p).
Progress with potential OEM Customers
The Company continues to test products with customers as described in recent announcements
OEM5: Further progress has been made with German OEM5 during the period. The customer has advised that they intend to select the disc supplier for the target car in the spring.
As previously notified, the customer is approving the Company’s disc with both a slightly modified “traditional” pad as well as a more environmentally friendly pad. This has slightly delayed testing; nonetheless the tests have gone well, with the products comfortably passing all the key criteria on the critical tests. However because the pad-disc configuration is now different from the original testing some regulatory tests need to be repeated in February and March 2019; the Board is not concerned about the time implications on the overall project of these relatively minor repeat tests.
Additionally OEM5 has reviewed the Company’s quality processes, logistics capability, financial strength and capacity plan and has approved Surface Transforms as a potential supplier to them. The Company has been informed, “… it is now officially possible for (OEM5) to place orders under the condition that the development department is happy with the required performance of ST discs”. As part of this process their quality team completed an onsite brief review of the Company’s compliance with VDA 6.3 (and IATF 16949) and confirmed compliance.
The Company has broadly agreed initial pricing and is in the process of agreeing commercial terms.
OEM3: Work on passing the OEM3 rig test continues with good progress having been made in the period on understanding the reason for process variability and reducing the variability in subsequent tests. Whilst results have improved, the Company is not yet consistently meeting the performance criteria of OEM3. However, this work is expected to complete in the next few months, consistent with the next round of nomination dates.
OEM6: As signalled in the trading update on 4 December 2018 there is a delay (now confirmed) of six months to the SOP of the car originally scheduled for SOP in June 2019 – which implied SOP in March 2019 for Surface Transforms. The delay has nothing to do with any brake system parts. Discussions are continuing on both the precise new SOP date and amelioration of the cost of this delay to the Company. In the meantime, the Board is not changing the previous advice provided regarding the risk to current year sales of £500k but with no impact on lifetime revenues from the project itself.
The Company has also begun discussions with this customer on the next car model that is expected to have significantly higher volumes than the current model. Unsurprisingly (as it involves the same customer personnel) the delays on the current model are slowing discussions on the new model; nonetheless the customer has told us of their wish to keep the “blood line” between the two cars, a statement the Board believes to be promising for ultimate selection.
Aerospace: The Company is still awaiting the outcome of discussions between the landing gear manufacturer, airframe builder and the US DOD on its request for pre funding before undertaking any further work on this project.
Knowsley facility
OEM Production Cell One: Capital expenditure on OEM Production Cell One is virtually complete. The final furnace for this cell has successfully completed a number of production runs at the supplier’s premises but as a further risk mitigation exercise the decision has been made to complete the manufacture of the OEM6 production parts in Germany and then ship the furnace in Q2 of the calendar year. This would then give the Company time to successfully commission the new furnace before the production is required from this furnace for the next series of new programmes.
The other furnaces are either in production or finalising software installation. The Company continues to expect OEM Production Cell One to be operational in summer 2019.
Environmental awards and permits: The Company was awarded the environmental standard ISO 14001 in November 2018. The Company is concluding its discussions with the Environmental Agency on securing all the necessary permits for full capacity volume production of OEM Production Cell One.
VDA 6.3 and IATF 16943: As previously notified, conformance with the stand-alone German VDA certification has always been a pre requisite to supply to the German automotive industry. Historically, Surface Transforms conformed with TS 16949, which many German OEMs considered to be less demanding than the German developed VDA 6.3. TS 16949 has been superseded by the new International Automotive Task Force (IATF) quality standard 16949, which German OEMs now see as equivalent to VDA 6.3. Surface Transforms secured accreditation to this standard in July 2018. This does not remove the need for on-going customer quality audits but they are much more “light touch” looking for evidence of continuing conformance with the standards. The first of these audits was conducted by OEM5 in the period and was completed to their satisfaction.
Computer Systems: German OEMs require their suppliers to have computer compatibility with their computer systems; in practice this has meant the Company migrating to the SAP computer system. After extensive work this transition took place, post balance sheet date, in December 2018. There were some inevitable disruptions in December and January but the factory and internal processes are now running smoothly again.
Outlook
The Company signalled a change in the outlook for the current financial year in a trading update on 4 December, reflecting a concern on the SOP date for OEM6. This slippage has now been confirmed as being six months, in line with the concerns expressed at that time. There are no further changes to expectations for the current year.
The outlook for the next financial year ending 31 May 2020 is unchanged in respect of automotive sales but the on-going lack of clarity on the potential aerospace contract, hazards £600k of forecast sales in that year, albeit there is still time to resolve the financial discussions between the key parties.
The Company reaches cash break even when OEM 6 enters production in the financial year 2019-20. Thereafter the outlook is clearly dependent upon winning the expected OEM contracts described above which are scheduled for start of volume production in the 2021 to 2022 calendar years. The Board remains optimistic about being awarded these potential contracts.
