ng powered engines

Summary

The key drivers for the demand for natural gas vehicles, in particular:
• the price of oil;
• environmental concerns, especially in big cities; and
• security of energy supplies,
are increasingly becoming more important. Oil prices continue to hit record highs and urban pollution and energy supply
concerns continue to be major issues, particularly in the Asian region. The Asian region also has abundant natural gas
resources.Thus the natural gas vehicle market in China and the Asian region is enormous and expanding as national and
provincial governments focus on cleaning up the pollution caused by buses and trucks by using secure local supplies of
natural gas. AEC has firmly established itself as an international frontrunner in the race to supply this booming market.
Orders from our major customers in China and our continuing supply of spare parts and services to France and
Australia are expected to provide revenue which will see AEC be cash flow positive and post a maiden profit in 2007.


REVIEW OF OPERATIONS

The most significant outcome over the past year is that, despite intense international competition, AEC is now the clear
world leader in the supply of Natural Gas (NG) engine technology to China.
The conclusion of a working agreement with Dongfeng Nanchong Automotive Co Ltd, similar to those already in place
with First Auto Works (FAW) and Weichai, means your Company now has strategic alliances with three of China’s top
five manufacturers of bus and truck engines. Commercial orders have begun to flow from FAW and Weichai, and
development work continues, broadening the range of engines that will be built using AEC’s patented NGVS technology.
Already these low cost, low emission, high performance engines are being promoted aggressively by our partners, both
within China and also to export markets. AEC is also continuing to develop it’s own patented components for sale as
part of the NGVS system or as components to other system developers.


Australia

In Australia your Company continues to provide technical support and spare parts for AEC NGVS powered buses in
Perth, Adelaide and Canberra.
A contract for 25 Transperth DaimlerChrysler (Mercedes – Benz) buses was completed in 2004. AEC has a warranty
service contract on a sliding scale until February 2007 and will supply spare parts for the 20 year anticipated life of the
buses.


Europe

In France, AEC’s involvement with the 600 Irisbus AEC NGVS Renault engined buses continues, with these buses having
travelled 90 million kilometres in route service since the first bus was commissioned in 2002.
AEC completed retrofitting the Closed Loop (Oxygen Sensor) System enhancement to these buses in January 2006
and continues under the contract to supply spare parts for 20 years.
In addition to being a significant revenue producer, in terms of international marketing the track record of the large
Irisbus fleet is a wonderful testimonial to the efficiency and reliability of NGVS powered buses in action.


China

First Auto Works:
The co-operation agreement with FAW is now in it’s third year, and is producing good commercial returns.
A 6.6 cylinder engine, the first engine produced under this agreement, completed the exhaust emission and reliability
testing requirements of the Chinese regulatory authorities and commercial sales started in April 2006, and the levels of
orders is increasing.
The development of a smaller FAW 3.2 litre, 4-cylinder natural gas engine and a third 7.1litre, 6-cylinder engine is
complete. The larger engines have been built into buses and trucks for testing and demonstration to domestic and
export consumers with resultant sales worth $400,000 to AEC being announced in April 2006 and increasing in August
2006. This is consistent with FAW’s earlier requirement that AEC has the capacity to supply approximately $500,000
worth of NGVS kits on a monthly basis i.e. $6 million annually.
The display and demonstration of FAW NG powered engines has resulted in domestic and export sales. FAW has
completed the sale of 100 Chinese NG buses to Myanmar, and further buses will be assembled in that country on an
ongoing basis.

Weichai

Your Company’s original product development agreement with Weifang Weichai Peterson Gas Engine Co (Weichai) was
upgraded during the year, with a 6.2 litre, six cylinder natural gas engine being substituted for a Liquified Petroleum Gas
(LPG) engine that formed part of the early development program. This move reflects Weichai’s strong belief that an
additional natural gas product will have more market potential in China than an LPG engine, which augurs well for future
NGVS sales to that company.
Engine design, development and certification on the 9.7 litre engine is complete and an initial order of NGVS
components to the value of $750,000 has been placed. Delivery will commence through the final quarter of calendar
year 2006.
The collaboration design work between AEC and Weichai on a prototype 6.2 litre Weichai engine is now complete,
and the natural gas prototype engine incorporating AEC NGVS components will be dynamometer tested prior to sign
off in Perth by Weichai engineers in November 2006. Subsequent testing, certification and production will be done in
China with serial production planned by mid 2007.

Dongfeng

Your Company has developed a strategic alliance with a third major Chinese engine manufacturer, Dongfeng Nanchong
Automotive Co Ltd (Donfeng).
Dongfeng is a subsidiary of China’s third largest automotive manufacturer Dongfeng Motor Group Co Ltd
(www.dfmc.com.cn). Dongfeng Motor Group Co Ltd, known as Second Auto Works, is a listed company on the Hong
Kong stock exchange.
Dongfeng’s main products are engines, chassis and bodies for light, medium and heavy-duty trucks and buses. Dongfeng
is one of the largest producers of NG engines in China. In the 2006 calendar year Dongfeng will complete a new
production facility with a capacity of 30,000 vehicles and 20,000 NG engines per annum. Dongfeng expects to produce
4,000 to 5,000 NG engines in the 2006 calendar year with sales particularly strong through central and southern China.
Dongfeng NG engines currently comply with Euro 2 emission standards, but the Company has committed to producing
engines certified to Euro 3 by the end of 2006. To achieve this stated objective Dongfeng selected AEC to jointly
develop a Euro 3, electronically controlled, multipoint sequential injection, NG engine using AEC’s NGVS technology.
Because Dongfeng is already a manufacturer of NG engines, the development time frame will be relatively short.
Dongfeng require the development, certification and testing programme to be complete by the end of 2006, with sales
commencing in 2007. Upon successful completion, the parties will negotiate terms for the ongoing commercial
arrangements with an initial purchase commitment of 300 AEC NGVS kits for the newly developed engines.
The parties have also agreed, upon completion of the initial development programme, to co-operate in the
development of a single point injection system, Euro 3, NG engine.The single point system is more suitable to the lower
end of the NG engine market.

China Summary

AEC has been successful in China and has won its contracts over international competition because of the superiority
of its NG engine technology and the fact that a substantial fleet of 650 vehicles worldwide has proven the technology
with on road validation.
Your Company has capitalised on these contracts by setting up offices and facilities in Beijing and Dalian in China to
service these customers. Mr. David Wang, a Canadian trained engineer, leads our team as General Manager of AEC
China. David has a staff of seven technical and administrative personnel. This enables AEC to procure engine
components in China thus reducing purchase and freight costs and lead times to better service our customers.


OTHER AGREEMENTS

Advanced Fuels Technology

Your Company expanded its alliances in the Asian region with the signing of Memorandum of Understanding (MOU)
with Advanced Fuels Technology Pty Ltd in 2005.
Advanced Fuels Technology (AFT) is an Australian based company with over 29 years experience supplying alternative
fuels technology, training and equipment to projects in Australia.
AEC and AFT manufacture complementary equipment for natural gas engines using proprietary technology.The MOU
provides the opportunity for both AEC and AFT to market and utilise the other party’s products globally including
throughout Indonesia, Thailand, Malaysia, Myanmar and Singapore.
The first initiative in this collaboration is the joint design and development of a NG version of two Volvo 9.6 litre engines
for trucks in Malaysia.The prototype engines are currently being developed in Melbourne prior to dynamometer testing
in Perth and commissioning in trucks in Malaysia by the end of 2006.

Automotive Corporation of Pakistan

Your Company also expanded its alliances in the Asian region with the signing of Memorandum of Understanding
(MOU) with Automotive Corporation of Pakistan (ACP).
ACP imports and distributes international vehicles, including FAW vehicles, into Pakistan, together with the manufacture,
fabrication and complete after sales services for specialised vehicles. The development and marketing MOU provides
for ACP’s design, manufacture, and marketing and after market support of natural gas powered trucks and buses in
Pakistan using AEC FAW natural gas engines, technicians and expertise.
A NG 6.6 litre AEC / FAW engine has been built in China and shipped to Pakistan for demonstration in a Shell tanker
truck. Further NG engines are being prepared for demonstration in city buses.
The AEC /ACP MOU will enable AEC to benefit from Pakistan Government’s promotion of environmentally friendly
technologies and use of alternative fuels. The Pakistan Government’s promotion of natural gas includes setting up
refuelling stations and providing incentives to switch to natural gas powered vehicles. Pakistan ranks third among natural
gas use, and has huge, proven gas reserves.

Motive Energy Pty Ltd

Your Company has entered into an alliance agreement with Motive Energy Pty Ltd (Motive), an industry based
consortium with alliance partners Alinta Asset Management No2, Major Motors Pty Ltd and WA Fork Truck Distributors
Pty Ltd, in addition to AEC.
Motive will integrate the supply of fuel, infrastructure and vehicles for the Australian commercial natural gas vehicle
market. As part of the alliance agreement with Motive, AEC completed three engine development programs on a
7.8 litre Isuzu engine with NGVS components designed and supplied by AEC. Three trucks have been commissioned
and commercial sales are expected this calendar year.
In return for carrying out the engine and truck developments AEC will be entitled to subscribe for shares in Motive to
a value not exceeding the revenue earned for providing these services.
Motive has set up it’s production facilities, is ready for commercial sales and was launched to the industry in May 2006
with natural gas vehicle displays including the 7.8 litre Isuzu truck converted with AEC NGVS.


Vialle Alternative Fuel Systems

Your Company announced in February 2006 that it has signed a MOU with Vialle Alternative Fuel Systems Private
Limited (VAFS) of India.
The MOU combines VAFS’ alternative fuels capabilities and existing associations, with major Original Equipment
Manufacturers (OEMs) based in India, with AEC’s proven natural gas technology systems. The AEC / VAFS consortium
will provide superior technology and high quality systems for the use of natural gas in heavy duty truck and bus engines
and stationary power generation applications throughout India and other Asian countries.
VAFS, on behalf of the ACE / VAFS consortium, has approached several major Indian based bus and truck OEM’s
including an agreement to develop a natural gas engine with Swaraj Mazda Ltd.The consortium offers the OEM proven
natural gas engine development programs, technology and ongoing spare part supply and service.The intent is for OEM
arrangements to be finalised and an AEC/VAFS/OEM natural gas engine development in India to commence by the end
of 2006.

Brehon Energy

AEC has concluded an agreement with Brehon Energy plc (Brehon) to collaborate in the development and promotion
of Hythane powered engines using AEC’s (NG) vehicle system.
Hythane is a low emission fuel being a blend of hydrogen and methane (NG). Brehon is marketing Hythane in many
parts of the world including the USA, China and India. To assist with this marketing Brehon adapts NG engines to
operate on Hythane.
The collaboration agreement with Brehon provides immediate exposure for AEC’s existing NG products. In addition,
the agreement provides the potential for further sales of AEC’s existing products to the Hythane and other alternative

Quality Certification

Your Company continued it’s certification as a Quality Endorsed Company certified to AS/NZS ISO 9001:2000 quality
management systems – Requirements. In addition the Company is now also certified internationally with qualification
to the International Quality Network Certificate (IQNet), which is recognised by, amongst others, CAQ in France and
CQC and CQM in China.These certifications are requirements for most international contracts.







Financial Position

AEC’s operating financial position improved substantially this year. Sales revenue was 46% higher than in 2005 even
though commercial sales to China only commenced in the last quarter of the 2006 financial year.
Sales margins are being maintained at an acceptable level and will improve as the proportion of NGVS components
sourced from China increases.
For the fourth year in a row AEC has reported a reduced loss having improved from a loss of $6.4 million in 2002 to
a loss of $1.4 million in 2006. The reduced loss is after incurring additional costs in the establishment of staff and
infrastructure in China, an increased number of engine development programmes and approximately $120,000
additional costs in AIFRS accounting for amortisation of Convertible Note equity and expensing employee share
options.
Net assets of the Group decreased from $203,000 at 30 June 2005 to $48,000 at 30 June 2006.The major reason for
the decrease was the requirement to amend the accounting treatment of Convertible Notes in accordance with
AASB 132 and AASB 139. The new accounting standard required $1,165,000 of the Convertible Note value to be
transferred from equity to non-current liabilities. Without this change of accounting standards the net assets would have
increased from $203,000 at 30 June 2005 to $1,213,000 at 30 June 2006.
During the 2006 Financial Year the Company issued 17,934,922 ordinary shares to raise $1.5 million cash, to convert
$750,000 debt to equity and to satisfy $150,000 of the $300,000 acquisition cost of Gas Torque Engines Pty Ltd.
The Group’s working capital improved from $377,000 at 30 June 2005 to $982,000 at 30 June 2006.
Orders from our major customers in China and our continuing supply of spare parts and services to France and
Australia are expected to provide revenue which will see AEC be cash flow positive and post a maiden profit in 2007.

Summary

The key drivers for the demand for natural gas vehicles, in particular:
• the price of oil;
• environmental concerns, especially in big cities; and
• security of energy supplies,
are increasingly becoming more important. Oil prices continue to hit record highs and urban pollution and energy supply
concerns continue to be major issues, particularly in the Asian region. The Asian region also has abundant natural gas
resources.Thus the natural gas vehicle market in China and the Asian region is enormous and expanding as national and
provincial governments focus on cleaning up the pollution caused by buses and trucks by using secure local supplies of
natural gas. AEC has firmly established itself as an international frontrunner in the race to supply this booming market.