Surface Transforms awarded contract with a lifetime value in excess of £100m

Surface Transforms plc (LON:SCE) manufacturers of carbon fibre reinforced ceramic automotive brake discs, has announced that the Company has been awarded a contract with a lifetime value in excess of £100m as a tier one supplier of a carbon ceramic brake disc to an automotive company – previously described by Surface Transforms as “OEM 10” – which is the single largest contract awarded to date, but crucially sees Surface Transform discs replacing those historically provided by its main competitor. The Company also provides a trading update for the year ending 31 December 2022 and outlook for 2023.

Contract award

OEM 10, based in the United States, is one of the world’s largest automotive companies. This new contract is the second contract with this customer and Surface Transforms will be the standard fit, sole supplier of the carbon ceramic brake disc on two model variants covering front and rear axles.

The lifetime revenue on this contract is estimated to be in excess of £100m over 6 years. The customer is currently estimating a start of production (“SOP”) date in 2024. For prudence, the Company anticipates series production revenues will commence in the first half of 2025. Sales from this contract award are expected to be approximately £20m p.a., tailing off in the later years. The contract is priced in GBP.

The current variant of this contracted model is already fitted with carbon ceramic discs provided by a competitor. The customer’s decision to replace the incumbent with Surface Transform’s discs followed a searching technical evaluation.

The contract award raises the Company’s lifetime contract value to £290m, across 11 contracted models, with an average contract life of 5 yrs.

Trading update

The Company further announces that sales for FY 22 will be lower than previously forecast at approximately £6.5m. This has primarily been caused by technical issues at OEM 8 unrelated to our discs, which delayed the production ramp following the customer’s SOP and was more prolonged than the Company originally anticipated. This is clearly disappointing, but it should be noted that the total OEM 8 contract value remains unchanged at £100 million, and the impact is that the timing of the lifetime programme has started a few months later than originally planned and, unless caught up in the meantime, will eventually finish, a few months later than originally planned.

The Company has also had its own production challenges, now materially rectified, and whilst they were neither the reason for the ramp up delay, nor the bulk of the sales shortfall, have limited the Company’s ability to build a finished stock buffer. Given capacity constraints, it has meant that the Company could not offer OEM 8 more than our previous commitments until the new £50m p.a. plant comes on stream in Q2 2023.

Nevertheless, the Company has been able to partly mitigate OEM 8’s ramp delays through both a change in revenue mix which resulted in a higher than forecast gross margin and tight control of non-essential overheads. As a result the Company expects that profit and cash will be around £3m less than previously guided. As OEM 8 volumes have now resumed, the Board anticipates that the Company will be profitable in November and December 2022.

Furthermore, this delay is fundamentally a few months timing difference, and, additionally, the Company now has forecast additional income from the OEM 10 contract. Therefore, the Company does not anticipate any working capital shortfall to deliver its new factory and short term growth, in line with the statements given in its announcement on 28 September 2022 regarding its “Proposed Placing, Subscription and Open Offer”.

Progress on capacity installation

Deliveries of the Phase 2 equipment that will raise capacity to £50m have continued. There are some project delays associated with supplier supply chain problems (notably electronic components and graphite). However, these are broadly covered by project timing contingencies, and we still expect the planned Phase 2 doubling in capacity to be operational in Q2 2023.

Planning and supplier discussions on the Phase 3.1 capacity increase to £75m p.a. by mid-2024 and £150m p.a. by end 2026 continues apace. The increase in capacity as a result of Phase 2 and Phase 3.1, ahead of order requirements, will be a major contributor to building spare capacity and increasing the Company’s resilience against any future SOP delays.

Outlook for 2023

Whilst the customer and all its suppliers want to swiftly catch up the current delay, each supplier (including Surface Transforms) has their own supply constraints, and it is therefore premature to forecast increases beyond the previously agreed ramp. The new agreed schedules are consistent with previous plans and therefore the Company is not changing its guidance for 2023. The Company will be profitable in that period.

The Company will provide the final FY22 sales number in early January and will report Q1 sales in early April and Q2 sales in early July.

Kevin Johnson, Surface Transforms CEO said “The OEM 10 contract is an extremely significant strategic win, achieved against vigorous technical competition. Moreover, it underpins the key message of our recent fund raise on the need to be installing capacity in advance of contract wins, thereby giving confidence to our customers of our ability to supply. We greatly enjoy working with OEM 10 and look forward to a developing relationship.

However, the separate combination of customer SOP delays and our own challenges is frustrating. The general issue of delays in both SOP and the subsequent production ramp has been previously reported and was the reason for the substantial increase in timing contingencies included in the recent fundraising guidance. Our spare capacity will be an even greater requirement as our order book grows and, therefore, reaching £50m capacity in Q2 2023 and £75m capacity in 2024 will be major contributors to building and ensuring customer and shareholder satisfaction.”

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