Surface Transforms' rising research costs dampen performance

Surface Transforms, a manufacturer of next-generation carbon ceramic brake discs for the automotive and aircraft industries, incurred a full-year loss despite rising revenues due to increased research costs and warned of increased losses for the following year.

The group’s revenue increased by £0.3m to £1.4m for the year ended 31 May 2016.

Sales rose by 28% to £1.4m primarily due to a 55% increase in sales to retrofit customers to reach £384,000 compared to £247,000 in 2015 according to the firm. Near original equipment manufacturers (OEMs) sales also increased by 33.3% to £557,000 and there was a one-off increase in aerospace development revenues by £142,000.

The firm’s gross margin increased to 51.6% compared to 51.1% in the previous period.

Research costs however rose to £1.3m during the reporting period, compared to £933,000 in 2015, to support the achievement of the German Automotive industry standard and increasing activity on its “game changing” contracts. This was offset slightly by an increase in the R&D tax credit to £306,000, however the company still received £100,000 less in research grants than expected.

This led to a loss before tax of £1.2m, versus a loss of £982,000 for the previous period.

One of the “game changing” contracts won during the period was with an internationally renowned German sports car manufacturer.

The firm’s cash generating capacity on the other hand improved, with cash used in operating activities increasing by 62.6% to £909,000 from £559,000 in the previous period and its cash position as at 31 May 2016 rose to £4.8m compared to £829,000 in 2015.

The firm has completed the purchase of a new factory site and new capital equipment to support an annual capacity of 20,000 discs, which the management anticipate will equate to sales of £17m per year.

In the past year, the firm successfully carried out a £5.5m placing and open offer, in part to finance new capital equipment.

The company is focusing on continuing to grow its revenues in both its aerospace and automotive sectors. In aerospace, the company is expecting to start production of its carbon ceramic brake disc package on a US military aeroplane during the start of 2018. The firm expects first financial-year revenues of £0.5m and future mature productions sales of £1.3m.

In the automotive market, the company is pursuing two revenue strategies. In the short term, retrofit and “near OEMs” are important to the firm for demonstrating real road mileage experience and reducing “cash burn”. In the longer-term, the firm is targeting more OEM contracts on cars generally costing over £50,000 - the customers of which are usually international brands.

Surface Transforms expects sales in the first half of next year to be less than in the comparable period of the current fiscal year 2015-16, but unchanged overall for the full-year, as the historical seasonal pattern between both halves reasserts itself. Development costs are also expected to continue at the current higher levels but without increasing.

Based on those projections, the firm expects the recorded loss for the next year-end to be roughly £300,000 higher than its previous projections due to how it accounts for all of the grants and loans supporting investment capital equipment, albeit with no impact on cash as a result.

Despite the above, the board is confident of delivering “substantial” sales growth thereafter.

The share price fell 4.71% to 25.49p at 1138 BST on Monday.