review of operations

From the Annual Report. Things look good. Make sure you have some tucked away.

REVIEW OF OPERATIONS
Chairman's Report
I
t is with pleasure I present to you the 2003 Annual Report for
Orbital Engine Corporation Limited.
The past year has been significant in Orbital's history in that it
has continued the program commenced in 2002, to address the company's
operating costs and reduce them to a level that provides stability
and neutralises excessive cash uses.
The changes have resulted in substantial restructure of costs across
all facets of the company which, for the first time ever, should
enable
Orbital to achieve financial stability that is supported by
continuing profit growth from increased sales and positive cash flow.
The Board is mindful of the substantial erosion of shareholder value
which has occurred, particularly during this restructure period. We
do,
however, have confidence that development of several complementary
revenue streams, including effective use of our installed R&D
facilities
to generate engineering services, will provide the profit and cash
flow from which we can continue to promote the company's proprietary
engine technologies.
Orbital's technology has the potential to be more widely applied and
with persistence we remain positive that it will be taken up by some
of the
major automotive manufacturers, but in reality to achieve these
objectives will take time, particularly to achieve the full
commercialisation of the
OCP direct fuel injection system. That is why getting profit and
positive cash flow from our engineering services is a major step in
enabling us
to allow this technology to realise its potential.
The changes made have started to work through the system in the
second half of 2003. This resulted in Orbital reporting $1 million
profit in
the second half.
We were heartened by the investor support to the capital raisings
which took place either side of the financial year end.
Making definitive forecasts in the current economic environment is
difficult but I can advise shareholders that the outlook for Orbital
is
significantly brighter than it has been for a number of years.
On a personal note, I feel privileged to be invited to join your
Board as a successor to the retiring Chairman, Mr Ross Kelly. Ross
Kelly has
shown strong commitment to your Company throughout the period since
his appointment to the Board in 1995. He has presided over many
changes, including the positive outcomes that you see reflected in
the last six months. We wish Ross well in his retirement.
Your Board will continue to focus on initiatives which are aimed at
building on the stable financial basis that has now been developed
for
Orbital. We will be developing strategies which enable our profit
and cash flow to continue to improve so that we have the run time
available to
enable our technology to penetrate the mass 4-stroke markets.
We fully understand our obligations to shareholders to restore
shareholder value. We thank you for your continued support.
CEO's Report
Overview
The 2003 financial year was a turning point for Orbital Engine
Corporation.
A refined corporate strategy announced in May 2002 delivered lower
costs and further commercialisation of Orbital's engine technology
to the
point where the Company was able to announce a $1 million second
half profit.
For the full year, Orbital continued with its trend toward
profitability and cash flow improvement - a major turnaround from
the previous two
financial years where the Company reported successive losses of
$26.8 million and high cash burn.
The second six months were particularly encouraging with an
operating profit of $1 million and an improvement in cash flow
compared to the
first half.
Emerging from the restructure is a Company with multiple income
streams that are expected to provide Orbital with a stable revenue
base for
the longer term.
Our fee-for-service engineering business has been a major
contributor to the improvement and is starting to emerge as a
leading-edge service
provider in its own right. This has been a crucial change.
Significant also has been the use of the engineering services as an
adjunct to the marketing of our OCP technology. Frequently, major
automobile manufacturers contract Orbital's engineering services to
adapt their development or research engines to OCP, offering an
unrivalled showcase for the technology.
Interest in Orbital technology in automobiles continues to be high.
However, the Company is considerably less reliant on the adoption of
OCP
by the major automotive manufacturers for its short-term cashflow
and financial well-being, than in the past.
The restructure of Synerject announced during the year was also a
major contributor to our improved results. Synerject's top line
growth and
improved profitability year on year has been significant. The
restructure has also provided ongoing financing of Synerject until
September
2006.
Orbital's operating result is now derived from three clear segments -
engineering services, technology income (licence fees and
royalties) and
the Company's share of its 50% ownership of Synerject - each of
which is now a significant contributor to the consolidated financial
result.
Reorganisation
A number of significant changes to the Company's organisation
occurred during the year.
At Board level, the Honourable Andrew Peacock resigned as a Non-
Executive Director and Mr Ross Kelly, after many years of service as
Chairman, retired. Both contributed substantially to the development
and implementation of the Company's revised strategy. At a personal
level I would like to acknowledge and thank Ross Kelly for his
guidance, understanding and counsel as we effected the major changes
necessary over the last eighteen months. Mr. Don Bourke joins the
Board with a great depth of understanding of the needs of Orbital
and I
look forward to his period as Chairman.
At executive level, a number of senior executive's roles have
changed including Mr John Beech, Ms Deana Cesari and Mr Ramon Newmann
whose roles have not continued in the new structure and Mr Mark
Norman who has taken the appointment as President of Synerject. All
had
been long standing employees and I would like to thank them for the
valuable contribution they each made to the Company.
The changes that have been required at Orbital during the past
eighteen months have been significant and have had a major personal
impact
on all staff and their families, whether directly through
retrenchment, international or interstate transfer, reassignment or
indirectly through
ORBITAL ENGINE CORPORATION LIMITED AND ITS CONTROLLED ENTITIES
DIRECTORS' REPORT FOR THE YEAR ENDED 30 JUNE 2003
6
general uncertainty. Throughout, all staff have maintained a
commitment and professionalism to their work, sometimes under very
difficult
circumstances that I would like to acknowledge.
FY03 HIGHLIGHTS
Engineering Services
Orbital has continued throughout FY03 with its strategy of building
competent out-sourcing services in powertrain engineering for
Original
Equipment Manufacturers (OEMs) in all market segments, Tier 1
suppliers and others with an interest in combustion engineering,
including
regulators. This class of business is well developed in the US and
Europe and has enjoyed considerable growth over the last few years.
Historically an area of high cost for Orbital, it has operated at
break even this fiscal year and seen growth in its revenue.
During the year, Orbital won a number of major contracts including
two within OEMs' advanced engineering programs. These involve Orbital
working on a full payment basis with the OEMs on the application of
OCP technology to their product(s). Such contracts are financially
valuable to Orbital in their own right, but also provide the Company
with an unrivalled showcase for the OCP technologies.
Other major programs during the year included the very visible
activities for the Australian Federal Government's Environment
Australia on
20% ethanol/petrol blends and its impact on the Australian car fleet
and emissions.
Our strategy has also focused on improving our sales and marketing
efforts in securing this class of work as well as the broadening of
our
product offering, as demonstrated by the ethanol project.
Further OEM engineering contracts continue to be under discussion,
some with possibly extended revenue streams.
Penetrating the Indian market
In February, Orbital signed a Technical Co-operation Agreement with
Indian-based UCAL Fuel Systems, under which UCAL has the right to
manufacture and supply components of the OCP system to the 2-stroke
motorcycle market in India.
Given the size of the Indian market - twice that of Europe with 4.2
million units manufactured each year - the UCAL agreement is very
significant. While the Indian market remains protected, domestic
manufacturers are facing a looming deadline for reducing emissions.
New
stringent emission standards come into force in 2005, with a further
tightening of the rules in 2007/08.
The UCAL agreement has the potential to open up a significant market
and establish an Asian manufacturing cost base, for all markets.
Synerject
Synerject is Orbital's 50:50 US-based joint venture with Siemens-VDO
Automotive Corporation. Synerject is a manufacturer of air assisted
direct injectors, fuel rail assemblies and related componentry as
well as a systems integrator and components supplier to the non-
automotive
market. Synerject also supplies prototype air assisted direct fuel
injectors for automotive and other 4-stroke applications.
The restructure and refinancing of Synerject during the 2003
financial year was important for the ongoing success of Orbital.
Changes in the
way Synerject is structured and managed have led the company to
record a maiden profit, with sales and earnings growth forecast for
FY04.
The 2003 profit contribution of $1.4 million (on sales up 52% at
US$39 million) compared with a loss of $3.1 million in FY02.
In January, Orbital announced that agreement had been reached to put
new financing arrangements in place for Synerject until 30 September
2006. Synerject was cashflow positive during the financial year and
met all terms and conditions of the new financial arrangements.
As part of the restructure, Synerject acquired the operations of
Orbital's marine and recreation systems business (with substantial
cost savings
to Orbital) and Siemens-VDO's non-automotive systems business with
effect from 1 April 2003. All systems sales previously reported in
Orbital
will now be reported within Synerject, so that in 2004 Orbital's
system sales will be zero. Despite this loss of turnover, we expect
minimal
impact at EBIT level as we have been able to achieve cost reductions
that will compensate, notably through the closure of our operations
at
Newport News in the US. At the same time, Orbital will share in the
gains created by Synerject from the two businesses.
With the restructure now bedded down, the outlook for Synerject
through 2004 and beyond is favourable.
Capital Raisings
In June, Orbital moved to augment its capital reserves with an
underwritten $6 million capital raising. The raising was split
between a $2.8
million placement in June 2003 and a Share Purchase Plan ("SPP")
that concluded in July 2003, which raised a further net $3.2 million.
The issues were successfully completed, with solid demand from both
institutional and retail investors.
Orbital was gratified with the investor support it received for its
strategy of strengthening the balance sheet through the raising of
fresh capital
to allow the Company the financial stability it needed to secure
extended programs of work.
New Products and Awards
There are now more than 30 product models incorporating OCP in the
market from five OEMs. Four new models were introduced or are
planned for introduction during the 2003 calendar year in the marine
and motorcycle markets.
Most significant for Orbital was the move by marine engine
manufacturer Mercury to produce 3 cylinder Optimax ™ engines
alongside their
high capacity, 6 cylinder models. The 115hp, 1.5 litre Optimax ™ 3-
cylinder engine was the first of three new Mercury models planned to
be
introduced this year.
Peugeot also introduced a new model motorscooter using OCP in April
2003. It follows into the market four new scooter models using OCP
direct injection released by Peugeot and Piaggio last financial year.
Your company's contribution to "Environmental Sustainability through
Product Design" was recognised by the receipt of the prestigious
Banksia Award during the year. The Banksia Awards are actively
supported by the Prime Minister and the Minister for the Environment
and
Heritage and cumulatively add weight to possible legislative changes
that could favour the adoption of OCP.
Outlook
The changes introduced during FY03 have streamlined the organisation
and improved accountability. These changes have produced a leaner,
more value oriented organisation.
Most importantly, Orbital has now diversified its risk and
opportunities through the development of the multiple revenue
streams. Each revenue
segment has its own distinct growth path and commercial
opportunities, easily identifiable and better understood by the
market.
Forecasts are difficult to make in the current environment. However,
the restructure and re-focus of Orbital provides improved certainty
of
revenue streams and likelihood of commercial success.
In the 2004 financial year, Orbital is seeking to consolidate its
lower cost operational base and achieve income in line with budget
and ahead
of FY03 in each of its three areas of business activity.
ORBITAL ENGINE CORPORATION LIMITED AND ITS CONTROLLED ENTITIES
DIRECTORS' REPORT FOR THE YEAR ENDED 30 JUNE 2003
7
Commercial Review
Engineering Services
While continuing to develop its OCP technology for motorcycle,
marine and recreation, and automotive applications, Orbital has
sought to
increase its revenue by widening the scope of its engineering
services and testing.
Orbital provides engineering solutions for all types of powertrains
at its development centre in Western Australia.
Customers in all fields of engineering are offered cost effective
solutions utilising a wide range of skills and resources such as:
• engine design and modelling (2D and 3D)
• numerical analysis
• computational fluid dynamics
• combustion and fuel system development
• calibration and control strategy development
• rapid turn around prototyping
• engine management systems development
The Company utilises fully equipped engine emissions and performance
dynamometers, engine durability cells, engine and vehicle
environmental cells, vehicle emissions chassis dynamometers and
mileage accumulation dynamometers.
Orbital's capabilities and expertise in these areas have been
recognised in various programs that the Company has undertaken in
the 2003
financial year, including the following examples.
An extensive program was commissioned in late 2002 by the Australian
Government agency, Environment Australia, to assess the impact of
running a range of vehicles on petrol containing 20% ethanol. The
purpose of the program was to determine the impact on motor vehicles
of
this level of ethanol in petrol through extensive on-bench and
vehicle testing. The results of the work were taken into account by
Government
in establishing policy on the maximum ethanol content of petrol.
On-engine and vehicle production and proofing programs were also
carried out to validate customers' engines and vehicles over
extensive
durability test cycles using robotically controlled mileage
accumulation dynamometers and automatic engine test facilities.
Orbital was also engaged during the year to modify a production
outboard engine to enable it to operate on JP5 fuel. Traditional
problems with
the use of such heavy fuels include poor cold starts and
difficulties in engine calibration.
As a result of offering a wider range of services, Orbital's
customer base has expanded significantly over the past 12 months,
particularly in the
Australasian market.
Marine & Recreation
In the marine and recreation market, the 2-stroke engine is used in
a number of outboard, personal watercraft (PWC), snowmobile and other
applications where high power to weight ratio performance is
desirable.
Emissions legislation for outboards and PWCs enacted in the US in
fiscal year 1997 calls for a progressive and linear reduction in
emissions.
Each succeeding model year requires a greater number of engines
capable of improved emissions or implementation of technology
capable of
larger emissions reductions. The State of California has introduced
an accelerated emissions requirement, which called for 75% emission
reduction in 2001 and further reductions in 2004. Orbital's
customers publicise that they are able to meet these requirements by
incorporating
OCP technology into their engines, while at the same time improving
fuel economy, reducing the tendency to stall, reducing smoke levels,
providing better stability and improving starting, when compared to
conventional (carburetted) two-stroke marine engines. The State of
California has also introduced tighter emissions requirements for
2008. These requirements have been achieved by the Mercury Marine
135hp OptiMax™ outboard.
Two of Orbital's three production customers, Mercury Marine and
Bombardier-Rotax, expanded their product ranges utilising Orbital
technology in the 2003 financial year, despite challenging market
conditions.
Mercury originally set the standard for clean 2-stroke outboards
when it began producing Orbital-equipped models in 1996. In 2001
Mercury
was recognised by the Bluewater Network, an environmental lobby
group that has worked to ban conventional 2-stroke marine engines in
many areas, with the first ever "Excellence in Environmental
Engineering Award". The citation praised Mercury for "taking the
lead in the
development of ultra-low emissions engines" and for its commitment
to protecting the environment. Mercury has stated that it will cease
production of all conventional 2-stroke outboard engines by 2006.
Mercury now produces nine engines in the OptiMax™ line, ranging from
115hp through to 250hp, with the addition in 2003 of the OptimMax™
3-cylinder engine models including the 115hp model and the scheduled
release in the third quarter of calendar 2003 of 75hp and 90hp
models.
Mercury also supplies OptiMax™ engines to Bombardier for their sport
boats and to Polaris for their recently released Jetboat.
Bombardier introduced a fourth OCP-powered PWC in their 2003 model
year with the release of the Sea-Doo XPDI™ watercraft.
Orbital has benefitted from a full year of sales of Tohatsu's four
TLDI™ 3-cylinder outboard models generating record direct injection
production volumes under the Tohatsu and Nissan brand names.
Motorcycle
Orbital's business development efforts in the motorcycle area have
been concentrated on growing OCP technology market share for European
applications and pursuing new business in Asia.
During the 2003 financial year Orbital continued to work proactively
with its European customers and Synerject to assist with the launch
of new
customer models and to win new business. Activities included
marketing OCP technology for use on higher engine capacity platforms
and
increasing the penetration on 50cc applications.
Peugeot's "Jetforce" scooter was released for sale for the European
2003 summer market, bringing to seven the number of motorcycle models
on the market incorporating Orbital's direct injection technology.
Orbital continues to offer engineering services to both regional
motorcycle manufacturers and Tier 1 component suppliers to assist
them in
establishing local component supply infrastructure for Orbital's
technology in major Asian markets.
Business development activities in Asia focused on India and Taiwan
where forthcoming emissions standards will be implemented and where
there is an interest in exploiting the benefits of 2-stroke engines
and extending the life of existing investment in 2-stroke engine
production
lines.
In February 2003, Orbital entered into a Technical Cooperation
Agreement with UCAL Fuel Systems Ltd, a manufacturer of carburettors
and
fuel injection system components for the Indian motorcycle and
automotive markets. Under the agreement, UCAL has been granted the
right
to manufacture and supply components of Orbital's OCP direct
injection fuel system to the 2-stroke motorcycle market in India.
The agreement with UCAL is an important initial step for the
adoption of Orbital technology by domestic Asian motorcycle
manufacturers.
UCAL and Orbital are working with leading Indian manufacturers to
progress the adoption of the technology.
Throughout the year, the range of products offered to motorcycle
customers was expanded to include OCP direct injection 4-stroke
products
developed by Orbital's Automotive group and high value Engine
Management Systems engineering consultancy services.
OCP direct injection for 4-stroke technology has the potential to
deliver fuel economy improvements of approximately 10% to 15% over
existing 4-stroke carburetted engines, depending on the application
and the baseline engine, whilst complying with increasingly stringent
emissions standards. Initial interest in this product has been
strong, particularly for developing countries, with high gasoline
prices and low
average wages.
ORBITAL ENGINE CORPORATION LIMITED AND ITS CONTROLLED ENTITIES
DIRECTORS' REPORT FOR THE YEAR ENDED 30 JUNE 2003
8
Motorcycle (Continued)
Pocket Dash™, Orbital's diagnostic unit designed and manufactured to
support the motorcycle air assist direct injection products, achieved
further sales to dealers in Europe, together with the provision of
upgrade kits which further enhance the functionality of existing
Pocket Dash
units in the field. Potential interest in this low cost diagnostic
system is now being received from India and other countries that may
require the
implementation of Engine Management Systems in the near future in
order to comply with the forthcoming local emission requirements.
Automotive
The worldwide emphasis on reduced vehicle fuel consumption together
with the increasing availability of low sulphur fuels continue to be
major
drivers to the automotive producers' desire to reap the full
potential of direct gasoline fuel injection.
First generation, high pressure systems, have failed to deliver
significant on-road fuel economy benefits. Manufacturers are now
investing in
improved cylinder designs that locate the injector in the centre of
the combustion chamber and which, when combined with low sulphur
fuel,
deliver much improved fuel economy.
This desire to adopt the next generation of direct injection (DI)
technologies has created a renewed interest by original equipment
manufacturers in considering Orbital's low pressure air assisted DI
technology for production applications.
A recently completed extensive development and application program
by Orbital for a European customer has confirmed that the Orbital
direct
injection technology when applied to optimised designs of 4-stroke
engines continues to deliver benefits ahead of competing
technologies.
This customer program involved designing a new 2-valve, 4-cylinder
variant of an existing production engine featuring the close
integration of
Orbital's direct fuel injection technology in the preferred
configuration of a centralised injector. In addition to the design
and analysis of the new
cylinder head and ancillary systems, Orbital was responsible for all
engine test and development activities including engine dynamometer
development of emissions and full load performance, verification of
operation and vehicle chassis dynamometer calibration of emissions,
drivability and catalyst system development. The resulting
demonstrator vehicle delivered a fuel economy improvement over the
standard
production vehicle of approximately 17% using the European drive
cycle together with emissions below Euro 4 levels.
Orbital continues to work with a number of automotive customers on
programs which, if successful, could lead to future serial
production.