Surface Transforms plc (LON:SCE) manufacturers of carbon fibre reinforced ceramic materials, has announced its half-year financial results for the six months ended 30 June 2020.
|–||Revenue increased by 55% to £902k (H1-2019: £583k)|
|–||Gross profit increased by 72% to £590k (H1-2019: £343k)|
|–||Loss before tax decreased to £1,451k (H1-2019: £1,525k)|
|–||Loss after tax increased to £1,175k (H1-2019: £837k) partially reflecting inclusion of two R&D tax credits in the comparable prior period ended June 2019|
|–||Cash at 30 June 2020 was £2,019k (31 December 2019: £770k), to which can be added £334k of R&D tax credit received in September 2020.|
|–||Capital expenditure on property, plant and equipment of £277k (H1-2019: £32k) mainly relating to the installation of OEM Production Cell One|
|–||Successful equity placing and oversubscribed open offer raising £2,206k (net of expenses)|
Sales and Operational Highlights:
|–||Post balance sheet date, awarded a contract with a global automotive vehicle manufacturer (described as OEM 8) with estimated lifetime value of approximately £27.5 million|
|–||£5m lifetime value contract awarded from Koenigsegg on the recently launched Gemera car|
|–||Continuing delays on start of production (SOP) on the Aston Martin Valkyrie car|
|–||Continuing progress on testing with OEM 3, OEM 1 and a number of other potential customers, some of whom have not tested Surface Transforms products before|
|–||Increasing dialogue with OEM’s for prospective electric vehicle (EV) projects|
|–||Maintained production and sales throughout the Covid 19 lockdown period|
|–||All furnaces and machine tools in the new OEM Production Cell One have successfully operated. Task in H2 is to balance the overall system and demonstrate repeatable volume production|
Despite the Covid 19 lockdown, trading has been better than expected. As a result, the Company reiterates that it now anticipates current FY 20 revenues will be approximately £2.0m.
The OEM 8 contract win increases sales expectations by over £3m in 2021 and £8m in 2022 (and the following two years). As recently announced, given this contract as well as the expectation of further, as yet unspecified, contract awards, the Company is investing in manufacturing support headcount and other costs over the next three years, which will progressively add approximately £2m to annual overheads in 2022 and thereafter.
Consequently, the Company reiterates that it is now forecasting positive profits after tax (including receipt of the R&D tax credit), a year earlier than previously announced, in 2021 and positive operating profit, before interest and tax, in 2022.
The Company continues to expect to announce further contract awards over the next six months.
During the period the Company accelerated its progress to becoming a profitable mainstream automotive supplier of carbon ceramic brake discs. This continued progress was achieved against the most difficult economic and operational conditions in recent memory.
Finally, I would like to conclude by recording the Board’s appreciation of the outstanding contribution by all members of the team, particularly in the context of the Covid 19 pandemic. Thank You!
Revenue in the period increased to £902k despite the Covid 19 pandemic occurring within the period. The growth was fuelled primarily by increased retrofit sales, which held up strongly during the pandemic. OEM sales were also higher in the period and near OEM sales broadly flat compared with the six months to June 2019.
Gross profit increased to £590k (H1-2019: £343k) and gross margin was 65.4% (H1-2019: 58.8%). The increase in margin was due to both better labour productivity and purchasing of raw materials, and is sustainable. Whilst future selling prices will fall, as volumes increase, this will be offset by further production efficiencies being generated as OEM Production Cell One becomes fully operational.
Administrative expenses rose by £173k to £928k (H1-2019: £755k) due in large part to some increased salary costs.
Research expenses increased by £149k to £1,212k (H1-2019: £1,063k) reflecting an increase in the number of customer projects.
The R&D tax credit reduced by £412k to £276k (H1-2019: £688k) following a change in accounting policy in 2019. Previously, the tax credit was recognised when received, but is now accrued in the year to which the tax credit relates. This transition led to the inclusion of two tax credits in the prior period. It had no impact on the quantum or timing of the cash receipt. As Surface Transforms advances into profitability, it is worth noting that the Group has substantial tax losses carried forward.
Within the statement of financial position, property, plant and equipment increased by a net £70k to £5,588k (December 2019: £5,518k) being capital expenditure of £277k in OEM Production Cell One offset by increased depreciation of £207k. Receivables fell by £368k to £950k partially reflecting the reversal of late customer payments noted in our financial results for the seven month period ended 31 December 2019. Within this June 2020 total, trade debtors were £185k and the provision for R&D tax credit was £596k, of which £334k was received in September 2020. Inventories fell by £85k to £921k (December 2019: £1,006k). Notwithstanding this welcome reduction, the Company still suffers from minimum order quantities on key input materials, disproportionate to historic sales levels; thus as sales increase, inventories should not rise at the same rate and the ratio of inventory to sales is therefore expected to improve.
The Company had also taken advantage of HMRC support on PAYE time to pay to improve cash flow during the coronavirus outbreak. At the balance sheet date, Surface Transforms had authorised excess PAYE payments of £246k due. These were settled in full in July.
In the period, the Company raised £2,206k after fees in an over-subscribed equity placing and open offer.
Progress with potential OEM customers
Surface Transforms is undertaking testing on a number of projects for OEMs, including for both existing customers and others who have not tested our products before. The Company believes that it is not commercially appropriate to provide further details of these projects in advance of contract award, but does note that whilst the Covid 19 lockdown has impacted almost all project timings and start of production (SOP), the implications of which have previously been disclosed, the tests are validating the superior performance of Surface Transforms’ discs across a range of key measures.
Consequently, the Company continues to expect that it will be able to announce further contract awards over the next six months.
|–||Electric Vehicles: It is also worth noting that approximately half of the current projects pipeline relate to electric vehicles (EVs). Whilst the generic advantages of carbon ceramic brakes are relevant to all our customers, irrespective of vehicle powertrain, the weight saving of carbon ceramic discs are particularly attractive to EV manufacturers given the weight of batteries and need for extended range. Additionally, EV manufacturers are concerned by the, admittedly small, but nonetheless high impact risk, of pads sticking to grey iron discs on EVs that make little use of the hydraulic brake – known as galvanic corrosion. Galvanic corrosion does not happen on carbon ceramic discs.|
|–||Aston Martin Valkyrie: This project was forecast to launch in the period but for the customer’s own reasons the SOP has been postponed. Despite this, the Company continues to expect this project to be a major element of Surface Transforms activity during 2021.|
|–||OEM 8: Post balance sheet date, the Company announced that it had been selected to be the standard fit, sole supplier of the carbon ceramic brake disc on both axles of a new car to be manufactured by a global automotive manufacturer (hereinafter described as OEM 8). The contract is estimated to be worth £27.5m over the lifetime of the contract from 2021 to 2024. There is also the possibility that the contract will be extended beyond 2024.|
|–||Koenigsegg Gemera: The Company was selected as the tier one sole supplier of carbon ceramic discs on the Koenigsegg Gemera supercar during the period. The contract is valued in excess of £5m with SOP in mid 2022 and completing in mid 2027.|
|–||OEM 3: This customer has a unique environmental test that the Company has been endeavoring to pass for some time now. It is encouraging to report that considerable progress has been made over the last year with discussions on target models continuing. As previously stated, the Company’s generic policy is not to comment further, prior to contract award for any of its existing OEM development programmes. However, an exception has been made for OEM 3 given the uniqueness of their required environmental test.|
|–||Retrofit and Near OEM: Sales into this segment continue to form the bedrock of current trading. In the period, progress in overseas retrofit markets – notably EU and the US – has been most encouraging. Additionally, the Company continues to seek out (and sometimes is sought out by) the small niche automotive vehicle manufacturers that we describe as “Near OEMs”, frequently hardly known and often only building a handful of cars per year. Whilst, not transformational, our growing success in this small segment is important in providing both road mileage experience on our products (important to the mainstream OEMs) and, of course, short term cash generation.|
Progress on Operations
Over the past three years the Company has invested over £6m to increase capacity from circa £4m sales, in what we describe as the small volume production cell (SVP) to an overall site capacity of circa £20m sales by building what we describe as OEM Production Cell One. The site has a footprint that will facilitate duplications of OEM Production Cell One, with the overall potential, in Knowsley and with further investment, of approximately 100,000 discs. The operational task has therefore been, and continues to be, to improve productivity and repeatability in SVP – the initial learning curve – whilst installing and bringing OEM Production Cell One into full operation thus providing the capacity required for the already awarded OEM contracts that commence in early 2021.
|–||Covid 19 Pandemic: The operational team has had to achieve the dual tasks above against the background of the Covid 19 lockdown; for example furnace supplier engineers could not visit the site to assist in installation debugging and trouble-shooting. The priority has, of course, been the health and well being of our staff. With their excellent co-operation, the Knowsley plant remained operational throughout the period, maintaining production whilst also progressing the installation of OEM Cell Production One, even with a high number of staff working from home. Against this background, the results, in both the SVP and OEM Production Cell One, were outstanding and bode well for the next stage of bringing OEM Production Cell One into balanced repeatable production.|
|–||Capacity and Progress with OEM Production Cell One: The recent contract awards noted above, together with existing contracts will utilise approximately 60% of SVP and OEM Production Cell One capacity by early 2022. All furnaces and machine tools in the new OEM Production Cell One have operated successfully; indeed, for cost and superior technology reasons, some of the furnaces are currently contributing to SVP production needs. Clearly there have been some Covid 19 related delays but not to the overall detriment of the project. The task is now to balance overall system performance and demonstrate repeatable volume production. The timetable on completing this task has been tightened since the OEM 8 contract award, which has a shorter period between nomination and SOP than Surface Transforms has historically seen. The resultant accelerated plan includes bringing forward some capital expenditure as well as increasing headcount (assuming the SVP and OEM Production Cell One are operating at capacity). As previously announced, this increased headcount and certain other indirect overheads will progressively increase Group costs up to a steady-state level of approximately £2m p.a. in 2022 and thereafter. Nonetheless the Board and team are confident that the tasks can be accelerated with a repeatable optimised and balanced production capacity available when needed in 2021 and 2022.|
|–||Cost reductions: The Company continues to see continuous cost reduction in manufacturing as a key ingredient for future success in the automotive industry. Not least because carbon ceramic brakes are currently an expensive item and further market size expansion (beyond cars over £50k retail price) require lower costs. Prior to securing the Knowsley plant, the Company set itself the task of halving the then production price. This task is achieved with OEM Production Cell One production. However, the Company will not rest on that laurel with the next stage already in full planning, indeed in some areas already underway.|
|–||Environment: The team at Surface Transforms is proud that its products make a material contribution to a better planet; a longer life product that reduces carbon emissions through weight saving and being considerably less polluting by reducing the amount of brake dust during braking. Our task is to ensure that our production processes complement this product achievement. To this end we are determined to be a good neighbour, protecting the local environment, through constant control and measurement of emissions and have set objectives to continuously reduce our environmental footprint.|