OEC 4.78% 99.5¢ orbital corporation limited

review of operations

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

    Chairman's Report
    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
    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
    however, have confidence that development of several complementary
    revenue streams, including effective use of our installed R&D
    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
    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
    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
    The 2003 financial year was a turning point for Orbital Engine
    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
    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
    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
    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
    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
    on all staff and their families, whether directly through
    retrenchment, international or interstate transfer, reassignment or
    indirectly through
    general uncertainty. Throughout, all staff have maintained a
    commitment and professionalism to their work, sometimes under very
    circumstances that I would like to acknowledge.
    Engineering Services
    Orbital has continued throughout FY03 with its strategy of building
    competent out-sourcing services in powertrain engineering for
    Equipment Manufacturers (OEMs) in all market segments, Tier 1
    suppliers and others with an interest in combustion engineering,
    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
    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.
    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 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-
    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
    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
    will now be reported within Synerject, so that in 2004 Orbital's
    system sales will be zero. Despite this loss of turnover, we expect
    impact at EBIT level as we have been able to achieve cost reductions
    that will compensate, notably through the closure of our operations
    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
    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
    Heritage and cumulatively add weight to possible legislative changes
    that could favour the adoption of OCP.
    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
    Forecasts are difficult to make in the current environment. However,
    the restructure and re-focus of Orbital provides improved certainty
    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.
    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
    this level of ethanol in petrol through extensive on-bench and
    vehicle testing. The results of the work were taken into account by
    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
    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
    Emissions legislation for outboards and PWCs enacted in the US in
    fiscal year 1997 calls for a progressive and linear reduction in
    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
    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
    Mercury originally set the standard for clean 2-stroke outboards
    when it began producing Orbital-equipped models in 1996. In 2001
    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
    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.
    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
    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
    In February 2003, Orbital entered into a Technical Cooperation
    Agreement with UCAL Fuel Systems Ltd, a manufacturer of carburettors
    fuel injection system components for the Indian motorcycle and
    automotive markets. Under the agreement, UCAL has been granted the
    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
    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
    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.
    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.
    The worldwide emphasis on reduced vehicle fuel consumption together
    with the increasing availability of low sulphur fuels continue to be
    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
    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
    injection technology when applied to optimised designs of 4-stroke
    engines continues to deliver benefits ahead of competing
    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
    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
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