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25 October 2005
CHAIRMAN'S & CEO'S SPEECH
ANNUAL GENERAL MEETING
Chairman Don Bourke: Good
morning ladies and gentlemen and welcome to the 17th Annual General
Meeting of Orbital Corporation Limited. My name is Don Bourke and
I will be chairing today's meeting.
We have a quorum of shareholders present, so
I am pleased to declare the meeting open.
With me today are my fellow non-executive Directors,
Grahame Young and John Marshall, and Managing Director and Chief
Executive Officer, Dr Rod Houston. Also present is Keith Halliwell,
our Chief Financial Officer and Joint Company Secretary.
In addition, we have with us today Denise McComish,
representing our auditors, KPMG.
I will start proceedings this morning by giving
you a brief overview of Orbital's year, including detail of the
Company's financial performance. Rod Houston will then follow up
with a more detailed operational review of the Company, after which
we will conduct the formal business of the meeting. We will then
take questions from the floor.
At a strategy meeting in February 2004, the
Board and senior management identified significant opportunities
to enhance profit by capitalising on under-utilised facilities at
our Balcatta premises and our significant skill base in powertrain
engineering services.
Through the 2004 calendar year we gained increasing
market acceptance of our capability to deliver such projects, particularly
from the major automotive manufacturers in Australia. We also continued
our work in the application of our technology in the 2-stroke non-automotive
market.
During the 2005 calendar year, it has become
increasingly evident that the workload from traditional automotive
sources has severely contracted as they engaged in major "right-sizing"
of their operations. To mitigate this workload reduction, we commenced
programs to seek engineering fee for service work from emerging
markets, particularly India and China. We have had some success
in India with both Bajaj and UCAL and additional opportunities are
being developed with both these customers. In China, we have increased
our sales and marketing effort and, while we have a number of significant
potential contracts currently being negotiated, we are yet to finalise
a major sale.
We believe that we have a number of competitive
advantages in dealing with these emerging markets - particularly
our flexibility and skill base, together with our non-alignment
to any specific manufacturer.
The changes within the traditional automotive
industry, and their effect on the workload available to us, have
resulted in a disappointing performance for the 2005 financial year,
with the Company recording a loss of $1.1m, compared to the prior
year's $3.4m profit. Overall, total annual revenue was down 31%
from the 2004 financial year to $11.6m. Notwithstanding, in the
second half of the financial year, the Company recorded a profit
of $0.4m.
Annual revenue from our powertrain engineering
services (PES) business decreased to $8.3m from $11.5m in the 2004
financial year, with the result that the PES business operated at
a loss of $0.11m for the 2005 financial year. While we remain hopeful
of producing a better performance in the 2006 financial year, at
this stage the first half result is unlikely to be better than the
corresponding half in the 2005 financial year.
The significant increase in fuel costs which
has occurred during the 2005 calendar year has re-activated interest
in alternate fuels and it is likely that new opportunities will
emerge to test and validate the impact of ethanol blended fuel on
Australian vehicles, which is an area in which we have accumulated
considerable experience.
During the 2005 financial year, we have taken
the opportunity to either complete or make significant progress
in a number of specific R&D projects with the objective of strengthening
our core technology and verifying its application to a range of
alternate fuels. In turn, this will enable us to seek additional
licensees for our technology as well as stimulating interest with
a number of potential customers for the provision of engineering
fee for service work. Our expenditure on R&D increased by 110%
over the 2004 financial year, to $1.1m.
By continuing our focus on cost reductions
to complement previously implemented measures, we were able to reduce
total engineering and overhead expenses by 8.3% to $14.4m.
Royalties and licence fees for the year ending
30 June 2005 were $2.2m, down by 31% on the prior year's $3.2m,
mainly due to a significant reduction in lump sum licence fees and
continuing difficulties in the motor scooter segment.
The launch by Bajaj of their autorickshaw incorporating
our direct injection technology is planned for early in the 2006
calendar year and we are optimistic that this will lead to a solid
royalty revenue stream flowing to us in the future.
Synerject, our joint venture with Siemens VDO
Automotive, had a successful 2005 financial year, with profit after
tax increasing by 14% over the prior year to US$3.9m. In Australian
dollar terms, our profit share increased by 8.7% to $2.9m.
Both Siemens and Orbital have high expectations
for significant growth in Synerject as the joint venture pursues
opportunities in the non-automotive fuel system market. We expect
that in the 2006 financial year Synerject will incur additional
cash requirements due to the need to adapt the latest automotive
technology into suitable non-automotive applications. This product
strategy is aimed at meeting customer demand for lower fuel consumption
with more cost-effective products that have been custom-designed.
Total project costs are likely to be in the order of US$5m, of which
US$1m was spent in 2005, with over US$2m budgeted for 2006.
Synerject is likely to be adversely impacted
in the 2006 financial year by the decision of one of its major customers
to introduce "just in time" deliveries and therefore run
down its inventories of stock supplied by Synerject. While there
will be a short-term impact on Synerject's revenue, the action reflects
increasing confidence by the customer in Synerject's ability to
supply, in a timely manner, quality product which is widely accepted
in the marketplace.
We have previously advised the market of a
number of structural and organisational changes within Orbital,
which will reduce operating costs by approximately $1m per annum.
Rod Houston, who has 17 year's experience with the Company, most
recently as Chief Engineer, took over as Chief Executive Officer
from Peter Cook on 1 October and your Board believes that he will
lead the Company strongly as it embarks on the next phase of its
development.
Rod will shortly present to you a review of
the Company's operations in the 2005 financial year.
In closing, I thank Peter Cook for his contribution
to the Company since January 2002 and also thank the management
and staff of the Company for their continued support during a difficult
time being experienced by the industry.
Thank you.
Rod Houston will now address you…
CEO Rod Houston: Good morning ladies
and gentlemen, I would like to provide you with a more detailed
overview of the operations at Orbital. Obviously I have only recently
been appointed to my current position and will only fully complete
my assessment of the business and revised and re-defined priorities
within our strategy in the coming months. However, this presentation
will give you an indication of the challenges and opportunities
we have today.
I would like to start off by reviewing the
three major revenue streams for your company and discussing the
details of each part of the business in turn. In particular I would
like to spend a little more time today to explain the background
to our Synerject business and how this investment can deliver significant
value to you, the shareholders.
Synerject
Synerject is a supplier and manufacturer of
electronic engine management systems (EMS) and electronic fuel injection
systems to the non-automotive vehicle market. The company was initially
formed in 1997 with Siemens-VDO as a 50:50 joint venture to manufacture
the Orbital DI fuel system for automotive and non-automotive applications.
In 2003 the company expanded to include all Siemens-VDO engine management
systems for non-automotive. This includes systems for both OCP DI
and electronic port fuel injection, which covers both 2-stroke and
4-stroke engines.
This joint venture company has been profitable
over the past three years (cumulative $14.4M in EBIT and 9.0% ROS)
and cash positive for the past four years (cumulative $20.4M in
cash flow). The value of Synerject as a significant asset for Orbital
is frequently overlooked and I intend to spend some time during
this presentation to give you a more complete view of the company's
outlook and the business sector in which it competes, so that the
future value of this asset can be better understood.
The non-automotive market covers a diverse
range of products including motorcycles, scooters, ATVs and marine
outboards. It is important to note that Synerject's revenues are
derived from sales in two main areas:
- OCP DI engine management systems including
fuel systems and electronic control units which also earn a royalty
for Orbital
and
- Engine management systems incorporating
electronic port fuel injection (PI) systems which are not linked
to royalty payments for Orbital
You may have noticed a few of the motorcycle
products in the room today which I hope will help you appreciate
the diversity of this market. I would encourage you all to take
the opportunity to discuss with me or my colleagues, any of these
applications and understand which Synerject components are included
on the product.
Firstly let me give an indication of the size of the global non-automotive
market. The total annual volumes for the non-automotive market are
in the order of 35 million vehicles today and this is growing at
an annual rate of about 4%, taking the expected market size in terms
of volume to nearly 42 million vehicles by 2010. The market volumes
are dominated by motorcycles in China and India and this is where
most of the volume growth will occur in the next 5 years. As you
can see, this market is of considerable size and has good overall
growth prospects. Today however the vast majority of this market
utilizes a simple carburetor without electronic control.
One of the key drivers for the introduction
of Synerject's products is the staged introduction of emissions
legislation across the globe in all of the non-automotive markets.
As shown here the motorcycle emissions legislation in various countries
will bring on significant change in the technology, in particular
the need for electronic engine management systems and either DI
or electronic port injection. The recreational market (marine outboards
and jet skis) was the first to see these regulations, and this was
a key driver for the introduction of OCP DI for 2-stroke applications
and the introduction of electronic port injection and engine management
systems for 4-stroke engines in this market. It should be noted
that although the recreational market volumes are low in comparison
to motorcycle, the value of the EMS portion of the business is high
due to the much higher margins which can be achieved with these
vehicles.
Having established the size of the overall
market and the key drivers for new technology (i.e. emissions reduction
and improved fuel efficiency) let's look at the current penetration
of EMS today.
The total penetration of electronic EMS and
fuel systems (including DI and PI) is currently quite small, at
less than 10% of the total market, however this is predicted to
grow to between 20% and 25% of the total market by 2010. This translates
to a total non-automotive market value in EMS and componentry in
excess of A$1.0 billion (assuming $100/vehicle of EMS components).
Synerject are very well placed to take advantage of this market
growth, by being able to offer a number of unique advantages which
include:
- Exclusive access
to Siemens-VDO off the shelf high volume components for non-auto
applications
- Exclusive rights
to certain Orbital Proprietary technology for 2-stroke and 4-stroke
applications
- New EMS product offerings designed specifically
for non-automotive which offer reduced cost, higher quality and
increased functionality
- A company specifically sized and managed
for the non-auto OEM and without the overheads of an automotive
Tier 1 supplier.
In the longer term, Synerject sales growth
is expected to come from India and China as their emissions legislation
starts to be become more stringent in 2008-2010. It is also clear
that the India and China markets will require early support as they
prepare for these dramatic changes in emissions legislation and
as they look to the export markets for their products e.g. Europe.
Synerject have already established a good working relationship with
UCAL in India, who have been licensed as a local supplier for OCP
DI, and the expansion of this relationship could deliver a very
low cost and low risk way to participate in this growing market.
In China, Synerject are already beginning to establish a local customer
support group and are investigating setting up a manufacturing capability
for their new ECU products in this region.
The strategic goal for Synerject is to grow
from today's annual sales of US$43m to over US$200m by 2010. It
is clear that in order to meet these goals, Synerject will need
to invest in new products, launch production in Asia (already started
with Kymco OCP DI production launch) and potentially look at strategic
relationships, similar to those already established with UCAL in
India, as well as acquisitions. As discussed today you can see that
these steps are well underway, and we see Synerject as a valuable
investment for the future.
Next I would like to talk about our powertrain
engineering services.
Powertrain Engineering Services (PES)
At our strategy conference in February 2004
the board endorsed the concept of growing our engineering services
business through the exploitation of Orbital's core engineering
strengths and facility capacity. This strategy would also enable
Orbital to retain a core competence that could be utilized to further
enhance our research and development efforts as well as support
the launch of our customers using OCP.
As explained earlier by the Chairman, the PES
business has encountered some recent downturn, more specifically
from the decline in activity from some of our historically core
automotive clients, including those in Australia.
However, we have gained some new clients and
achieved some significant milestones in delivering successful projects
for customers in both Australia and Asia. It is important we continue
to build our reputation, particularly in this region, for the effective
delivery of professional engineering services outside our traditional
proprietary (OCP) technology. This work has enabled us to develop
new contacts and opportunities in the developing market for engineering
services in both China and India. Our approach for these markets
is to develop strategic relationships which enable us to build a
more certain revenue stream based on long term contracts. This approach
is starting to show results in India where we have already developed
good working relationships with both Bajaj and UCAL. We expect these
relationships will result in an increase in the level of engineering
services support as customers grow their products and competence
to meet the new emissions challenges for the motorcycle and automotive
market in India.
The growth in the Chinese automotive industry
and the thirst for know how and technical engineering services are
at an all time high. This need is further reinforced by the introduction
of new emissions and fuel efficiency constraints in China which
require significant upgrades to their current engine technology.
We have increased our sales and marketing effort in this region
and we are currently developing new strategic relationships to assist
in the process of opening up this extensive market. We believe our
competitive advantages of a competent and flexible skill base, IP
portfolio (including OCP) and willingness to provide education and
training have helped us develop a growing list of new opportunities.
We are also learning, however, that there is a real need to be patient
in turning these opportunities into real orders, as the process
for contracting engineering services in China is still quite immature.
The China market remains both the largest challenge
and opportunity for growth in PES. The delays in program orders
have been significantly longer than anticipated and these delays,
along with the downturn in the Australian automotive market, will
impact our first half results significantly, with revenue likely
to be lower than the corresponding half in the 2005 financial year
for engineering services.
Our third revenue stream which I would like
to discuss is Licensing and Royalties.
Licensing and Royalties
Licence and royalty income is derived from
a number of products and markets as well as a mix of customers.
Let's take a look at the respective segments in turn, which will
allow you to form a view of the overall prospects.
Motorcycles & Autorickshaws
The total 50cc scooter market, where OCP DI
has been on the market since 1999, has declined significantly in
overall volumes over the last 3-4 years. This is as a result of
increased helmet and licensing laws in Europe which have moved the
market into the larger displacement motorcycles. The penetration
of OCP DI in this market has also been impacted by delays in the
introduction of stringent Euro 3 emissions for scooters, as well
as a move in the market towards very low cost products imported
from Asia. We believe we will continue to see minimal growth in
this market until around 2008, after which the expected more stringent
emissions legislation will make the Orbital DI product more compelling.
The start of production by Kymco of its 100cc
motor scooter in Taiwan will give a small but positive impact on
royalties for the 2006 financial year. The success of this launch
in Taiwan could lead to export into Europe, which will be the first
DI motor scooter larger than 50cc to be introduced into the market.
If successful this could lead to increased
interest from European manufacturers in a larger than 50cc OCP DI
product range.
Bajaj continue to make good progress on the
development of their new DI autorickshaw which is due for launch
in the 2006 financial year. I have recently returned from India
and I am very encouraged by the positive feedback from the customer
and the potential for other OCP DI 2-stroke related products in
this market. There is also potential for alternative fuel options
such as LPG and CNG which could also generate future royalty streams,
powertrain engineering services and Synerject sales for Orbital.
We expect Bajaj to be a key licensee, given
their competence, their forecast growth in the motorcycle and autorickshaw
market and their satisfaction with the performance of their current
prototypes. This DI autorickshaw product has the potential to contribute
significantly to the future royalty stream for Orbital, and is essential
to our plans given the softness we are experiencing in the near
term European scooter market.
There also continues to be strong interest
shown in assessing the capability of OCP DI 4-stroke systems for
future motorcycle production applications. This interest has been
confirmed in a recent technical presentation by Honda, which discusses
the fuel economy and emissions benefits of an air assisted DI system
for a 195cc motorcycle engine. The investigations by a number of
OEMs for OCP DI 4-stroke (not all in the public domain) are at the
production feasibility level, and along with interest from other
OEMs could lead to significant revenues streams from royalties,
powertrain services and Synerject sales in the future.
Outboards
Our major licensee is Mercury Marine and this
sector has held up well over the last year. We are encouraged by
the wider offering of the OptiMax, the OCP DI 2-stroke variant,
to the market with the extended 3-cylinder range. There continues
to be a struggle in the market place between the 2-stroke and 4-stroke
solutions. However the 2-stroke has clear advantages in:
- power to weight
ratio
- major service costs
- overall price
The good news is that, through Synerject, who
supply fuel systems for both the Mercury 2-stroke and 4-stroke engines,
Orbital benefits from sales in both products !!
Automotive
Always an area of considerable interest to
anyone following our company is the progress in the automotive sector.
All activity to date by the automotive OEMs has been to keep themselves
informed of OCP potential including features and cost. As discussed
previously we believe that OCP DI can offer significant benefits
in fuel economy, and this is well understood by the major OEMs through
previous studies with Orbital.
As with all markets, one of the keys to adoption
of a new technology is the introduction of stringent regulations
or a change in the market demands. Regulations for improved fuel
economy or reduced carbon dioxide emissions are still quite limited
around the world, and up to now the OEMs have been able to meet
market demands without the adoption of sophisticated (lean operation)
direct injection systems. Clearly, however with the reality of diminishing
global reserves of oil and with oil prices, and hence fuel prices,
increasing significantly there should be increasing pressure from
the market for improved fuel economy.
In some markets the response to high fuel prices
has been to buy diesel engine equipped vehicles, which can have
up to 25% better fuel economy than the equivalent gasoline engine.
This market shift has seen a significant reduction in the vehicle
profit margins for the OEM due to the very high cost of the diesel
engine and their high cost fuel systems. This problem will become
even more of an issue as the increased emissions constraints add
significant costs to the diesel engine fuel system and aftertreatment
system.
The above factors of high fuel price and high
diesel engine costs have created a more favourable environment for
the possible adoption of sophisticated DI technology such as OCP
DI, which could deliver significant fuel economy improvements. These
benefits are well understood by the OEMs and offer the opportunity
for further PES, royalty and product related income for Orbital.
However, there remain some key challenges for OCP DI adoption in
this market not the least of which is a number of established competitive
technologies, including high pressure DI.
There are, however, some emerging opportunities
for OCP DI in the new markets such as China where there are significant
fuel economy drivers (new legislation) combined with a hunger for
leapfrog technology to catch up with the established automotive
markets.
It is important that we continue to update
the technology in this area to keep this market opportunity, which
leads me into a brief discussion of some of the continuing research
and development activities at Orbital.
Research & Development
Orbital has continued to invest in further
research and development to extend the capability and value of the
OCP technology. In fact, the R&D expenditure was increased substantially
during last year which resulted in some significant developments.
Initially, let me cover some of the exciting
developments in the area of alternative fuel applications. More
specifically, Orbital has developed a new prototype compressed natural
gas (CNG) DI injector which is an evolution on our current OCP DI
gasoline injector. This development enables the conversion of gasoline
engines to operate on CNG without loss of performance. This injector,
now in prototype form, has opened up significant interest for both
automotive and non-automotive applications. We are already seeing
significant engineering services activity in the application of
this new injector for both of these markets in prototype applications.
The first production application for this technology could likely
be in India, where CNG is already mandated as the fuel in certain
cities. As the oil crisis deepens and combined with legislated CNG
adoption in various countries we expect to see an increased interest
in the global market for this type of technology.
The development of 2-stroke OCP DI gasoline
engines to be able to run on diesel or kerosene with only minor
changes to the combustion system has been discussed previously,
and indeed Mercury Marine are already marketing OptiMax engines
with this solution. An extension of this work has now shown that
the OCP DI technology also works very well for 4-stroke engines.
This new development opens up a much larger market for the conversion
of both 2-stroke and 4-stroke gasoline engines with OCP DI, to enable
multiple fuel operation without the high cost and weight penalties
of the diesel engine.
As part of our forward plans Orbital has embarked
on the development of a new engine combustion program to develop
an advanced combustion system utilizing some of the basic OCP DI
intellectual property and know how. The new combustion concept is
referred to as C3 which stands for Controlled Combustion Cycle.
This solution incorporates all of our knowledge on the future market
demands from our customers for improved powertrain efficiency, and
also recognises that one of the barriers for the introduction of
the OCP DI systems on the current automotive market has been the
lack of a reliable lean operating exhaust after-treatment system.
In order to overcome this, Orbital has initiated
a 2 year program to develop a new combustion system which utilizes
a combination of mechanical features (variable valve-train, engine
downsizing and turbo charging) plus advanced combustion control
techniques (using OCP DI to supply fuel). The intent is to develop
a spectrum of evolutionary solutions which will operate on conventional
aftertreatment systems and deliver fuel economy similar to or better
than today's diesel engines. This concept will further enhance Orbital's
reputation as a leading edge development group for combustion and
is already responsible for a number of new patents which will enhance
the value of Orbital's intellectual property into the future.
Future Objectives
Our aim is to continue develop the three main
revenue streams of Orbital.
The overall prospects for Synerject are positive
with good long term prospects for growth in the non-automotive EMS
supply business. It is important that the joint venture partners
(Orbital and Siemens VDO) ensure that Synerject has all the resources
necessary to take advantage of the significant growth prospects
including organic growth and acquisitions.
We will also need to focus on our powertrain
engineering services. There are certainly some opportunities and
risks with this business, particularly in the emerging target markets.
We need to move toward a steady and predictable income stream. Over
the next few months we will monitor progress in this area closely
and continue to keep our strategy under review, particularly of
the target markets and Orbital's selling strategies into them.
We expect to see an improvement in licensing
and royalties for this financial year compared to last year, due
mainly to growth in the marine outboard market for 2-stroke DI.
It is recognized that more work needs to be done to improve the
European scooter and motorcycle DI market and work has already started
at Orbital and Synerject to develop a new generation of OCP DI system
to reinvigorate this market segment.
The successful launch of the Bajaj autorickshaw and Kymco scooter
will lead to a significant new royalty stream for Orbital; we must
ensure that these program launches and the subsequent customer and
dealer experience are fully supported in the coming year.
In summary
- Our future is not without risk, but :
- We have some good prospects in all three parts of our business.
- We have achieved some important milestones particularly
through our joint venture, Synerject.
Thank you.
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