Open Briefing. Orbital Engine Corp. CEO on Continuing Profits

PERTH, Australia, Aug. 24, 2004 -- The following is a transcript of an interview with Orbital Engine's CEO, Peter Cook:

  Record of interview:

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Orbital Engine Corporation Limited yesterday reported net profit of $3.4 million for the year ended June 2004 compared with a loss of $1.9 million in the previous year. The six-month period to June was the third consecutive half-year in which Orbital has booked positive earnings. What level of confidence do you have that you can sustain the profitability of the business?

CEO Peter Cook

We've restructured the business to provide three related but independent income streams: power train engineering services, licences and royalties, and our share of earnings from Synerject, our 50:50 joint venture with Siemens VDO Automotive. Each of these contributed to our very strong results in 2004.

In restructuring and reducing our reliance solely on intellectual property as our model, we've stabilised the business and given it a more sustainable basis. Whilst each sector will be subject from time to time to its own over or under performance against our expectations, we believe we can sustain profitability.

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An outstanding feature of the result was that Orbital generated positive cash flow from operations of $0.7 million for the year, with $1.0 million generated in the second half. Is this sustainable going forward?

CEO Peter Cook

We were particularly pleased with the cash-flow result. It represented a $7.6 million turnaround year on year. We've indicated in the past that turnover of around $10 million in Engineering Services is the point at which we're cash neutral, and we believe 2005 will demonstrate our ability to continue to generate cash from underlying trading.

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What's the outlook for earnings and cash flow in the current year ending June 2005?

CEO Peter Cook

In 2004, the underlying result was very good. We had the full benefit of most of our earlier cost reduction initiatives, except for the head office relocation, which occurred half way through the year. But, we must acknowledge that there were some one-off contributions, particularly in the first half, with foreign exchange gains, Automotive Competitiveness and Investment Scheme (ACIS) credits and certain warranty expiries that won't be easily replicated. Therefore, I see 2005 as a year of consolidation and one in which we'll take advantage of our lower cost base to grow. Hopefully the growth will compensate for the absence of those one-offs.

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Cash on hand totalled $12.4 million at the end of June 2004. What level of cash will you seek to maintain going forward?

CEO Peter Cook

We'd previously indicated that our immediate plans were to use the cash to strengthen the balance sheet and that's exactly what we've done. As the market accepts the sustainability of our turnaround, we may look to deploy some of those funds on co-development programs or an appropriate acquisition, under very strict board guidelines.

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Synerject made a $2.7 million contribution to earnings, up from $1.4 million in the previous year. In the second half of the year, the JV's contribution was $1.8 million, double that of the first half. What were the drivers of Synerject's growth and is this momentum sustainable?

CEO Peter Cook

Synerject's restructuring was put in place very late in the 2003 financial year, and we indicated at that time it would have a very strong year in 2004. It's achieved a turnover in excess of US$40 million and has considerably improved EBIT to US$4.3 million. The variation between Synerject's first-half and second-half EBIT result was in part a product mix issue and in part a currency issue.

The key driver of organic growth in Synerject is the increasing use of engine management systems in the non-automotive market as carburettor products are replaced by electronics. The non-automotive market lags the automotive market in the uptake of electronic management engine systems.

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Can you quantify the impact of the weaker US dollar on Synerject's earnings in 2004? How's it positioned at current US dollar levels?

CEO Peter Cook

Over the full year, the impact of the stronger Australian dollar was to depress Synerject's contribution to our result by about A$586,000 compared with where it would have been at the 2003 exchange rate. In US dollars, our 50 percent share of Synerject's 2004 EBIT result showed a 136 percent increase year on year.

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  What's the earnings outlook for Synerject in 2005?

  CEO Peter Cook

We see 2005 as a year of consolidation for Synerject. Certainly there'll be some areas of good growth and some areas that will under perform, however Synerject does continue to win new programs, which should see improved growth and turnover in the medium term. Additionally, there'll be some investment in new generation Electronic Control Unit (ECU) development to make certain Synerject remains at the forefront as a supplier.

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Orbital's Engineering Services business booked EBIT of $2.1 million in 2004 compared with a loss of $0.7 million in the previous year. Revenue rose 14 percent to $11.5 million. Both revenue and EBIT were lower in the second half of the year than in the first half. What was the reason for the slower revenue in the second half and can Engineering Services remain profitable at lower revenue levels?

CEO Peter Cook

The growth in revenue from engineering power train services has been most encouraging. Even more encouraging was the improved EBIT contribution, which was up $2.8 million year on year. Certainly the second half was a little softer than we would've liked, but not significantly. We expect some volatility over the year in terms of throughput because of project phasing, project timing and resource availability.

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What's the current trend in work flow within the Engineering Services business and what's the outlook for 2005?

CEO Peter Cook

We've demonstrated over the past two years that we can generate Engineering Services work in the range of $10 million to $12 million. It's premature to ask what the outlook for 2005 is since, like many fee for service businesses, three months is the maximum forward order load you could ever expect to have to hand. Any longer would imply our clients are waiting too long for their programs. We have a strong prospects list and the past year's results suggest we should be able to achieve our goals.

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Orbital's revenue from Royalties and Licences was $3.2 million in 2004, down 18 percent. What's the outlook for 2005?

CEO Peter Cook

Licence and royalty revenue has a complex set of drivers, making it difficult to get the sub-parts accurate even though the overall number is reasonably stable. The 18 percent year-on-year decline was a bit disappointing, but attributable to two factors. Nearly half of it was due to currency and the remainder due to the poor volume off-take of 50 cc scooters in the European market.

We'd indicated earlier in the year that the European scooter sector was under performing and that there's considerable pressure on all three European manufacturers we licence. Indeed Aprilia, our first scooter licensee, suspended manufacturing during the year while it reached accommodation with its banks. However, other markets have grown significantly, including the outboard sector at Mercury, hence my comment that it's difficult to predict the sub-components in this area, but relatively easy to get the headline number correct.

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What would you see as a "normal" level of annual revenue from Royalties and Licences going forward?

CEO Peter Cook

In the near term, we'd expect licences and royalties to be in the vicinity of $3 million a year. We do expect that figure to increase when the volume from Bajaj Auto, our Indian licensee, comes online in late calendar 2005, but we'll advise the market a little closer to the proposed launch. Our expectation is that Bajaj will become a major royalty contributor.

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Oil prices are close to record levels at nearly US$50 per barrel. Can you comment on the potential impact on demand for Orbital Combustion Process (OCP) technology in a scenario where these levels are sustained?

CEO Peter Cook

Sustained high oil prices must ultimately be advantageous for us. OCP improves fuel consumption by 12 to 18 percent, depending on the measurement standard and base comparator, a significant saving. However, it'd be wrong to think there'll be any instant conversion to our technology. When similar fuel price escalations have occurred in the past, quickly available short-term adjustments are first to be seen. For example, around the time of the first oil shock, Holden abandoned the Kingswood and moved to the Commodore, a smaller compact sedan, and introduced four cylinders into the Australian sedan range for the first time. It's only after these types of short-term adjustments have occurred that we'd expect to see the design and introduction of more fuel-efficient engines. It's at that stage we'd expect the merits of our technology to be more fully recognised.

I should also add that consumers will need to get used to either paying higher prices for fuel, or paying higher prices for more fuel-efficient engines. To date, the consumer hasn't been prepared to pay for those engines and that's been the major block to our prospects.

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Now that Orbital has established a profitable base, what's your strategy to take the business forward?

CEO Peter Cook

The Chairman announced at last year's AGM that we'd be undertaking a review of our strategy during the year, given we'd met our objectives for profit and cash neutrality well ahead of plan. Importantly the strategy that's worked to date will be enhanced, not radically altered. We'll focus on growth in Engineering Services, principally in the Asia Pacific region. We'll seek additional licensees with niche-market applications for OCP and of course we'll continue to improve the value being built in Synerject. Additionally, we'll increase our work on second-generation OCP systems focussed on cost reduction and in-service improvement for our existing customers, and we'll consider acquisitions within very specific guidelines.

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Can you provide an update on developments in relation to OCP for automotive applications?

CEO Peter Cook

Last year we indicated we had active engineering programs with three OEMs exploring various aspects of OCP on their engines. OEMs continually update their level of understanding of a wide variety of technologies and these programs shouldn't be seen as any commitment to pre-production interest or model introduction. However, we were satisfied with the technical performance and outcomes of each of the programs and although the immediate work's all but concluded, we feel the basis for further interest has been established.

We remain optimistic that OCP has much to offer in automotive applications. Perhaps declining global oil reserves and increasing oil prices, coupled with global warming, will see a more aggressive commitment from OEMs to introduce promising technologies, particularly where government assistance is offered such as the Australian Government's recently announced $150 million extension to the ACIS R&D grant scheme.

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  Thank you Peter.

  ENDS

Orbital is an international developer of engine and related technologies, providing research, design and development services for the worlds producers of powertrains and engine management systems for application in motorcycles, marine and recreational vehicles, automobiles and trucks. Orbital's principal operations in Perth, Western Australia, provide a world class facility with capabilities in design, manufacturing, development and testing of engines and powertrains unparalleled in the Asia Pacific region. Orbital provides its customers with leading edge, world class, engineering expertise. Headquartered in Perth, Western Australia, Orbital stock is traded on the Australian Stock Exchange (OEC) and the OTC Bulletin Board (OBTLY).