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Now the CEO's Review

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Lhasa   Tuesday, 05/20/08 11:36:14 AM
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Now the CEO's Review

Chief Executive's Review

Introduction

The value of a technology business, such as Torotrak, is principally determined by the quality of its intellectual property (IP) and engineering capability but also depends upon its ability to convert its know-how and application skills into robust and commercially attractive propositions. In this context, the start of production and sales of our first products at Infinitrak, our JV business in the USA, for use in a highly cost-competitive market, is a major achievement for the Torotrak team and demonstrates that our technology is capable of series production and of delivering strong competitive advantage.

This first production also validates the broad reach of our technology into multiple markets and demonstrates that our diversification strategy is delivering results. The increased strength of our portfolio is reflected in the high quality of our client and licensee base which continues to grow as potential customers, as well as existing clients, draw confidence from this ultimate proof of the commercial viability of our technology.

Our strategy to diversify our markets compensates for inevitable shifts in market outlook, most of which are outside of Torotrak's direct control. The highly significant £7m licence and engineering services deal in our new market of truck and bus is an example of this. With our major new customer in this market, we have secured both short and medium-term contribution, although the ultimate prize is the potential for longer term value from royalty fees from high value transmissions. Contribution from this and from anticipated new business in other markets including fork lift trucks will help offset delays that may occur in other areas.

Market and Sector Review

Outdoor Power Equipment (OPE)

Torotrak's entry to this market is through Infinitrak which has been established to design, develop and manufacture transmissions for the OPE market. MTD, our JV partner and lead customer, enjoys a substantial share of the OPE market and has the capacity to take significant quantities of Infinitrak's transmissions, over a period of time, as the Infinitrak transmissions are adapted for use in more of the MTD product range.

Infinitrak has developed Torotrak's technology and the manufacturing process to produce toroidal transmissions which compete effectively on cost and performance against hydrostatic drives, the incumbent technology in the market. We reported in our Interim Management Statement in February that final testing and validation of Infinitrak's first unit, the Twin Toroidal Transmission (TTT), had highlighted a small number of production conformity issues which we expected to have resolved around the end of our financial year. We are pleased to report that our development and validation process has been successfully concluded and that, as a consequence, series production and sales of transmissions commenced in April 2008, representing an important milestone for Torotrak and Infinitrak. In this first series production run 500 transmissions will be built and will be incorporated into MTD's Cub Cadet range as an end of season introduction and will also satisfy Infinitrak's first order from a previously undisclosed third party customer.

This first external customer for Infinitrak is the UK based Advanced Turf Technology (ATT), which is a developer of highly specified, specialist mowers for use on golf courses. ATT has developed its new 'Infinicut' range of commercial grade mowers using Infinitrak's TTT. We are delighted that Infinitrak is supplying this new client in such a demanding application and, although the initial order is modest (around 300 units), we expect to build on this as ATT's requirements become clearer and as it builds market share in this sector.

It is clearly encouraging that our work at Infinitrak has overcome the previously reported barriers to manufacturing implementation and has also secured the first external customer for the JV business. However, we recognise that the time to start production has taken longer than originally anticipated and that the ramp-up of series production will be more gradual than assumed in Infinitrak's original plan. With the 2008 build season for mowers drawing to a close at MTD, we expect to recommence series production in the fourth calendar quarter of 2008 when transmissions will begin to be built for incorporation in mowers for sale in 2009. At this stage it is difficult to predict MTD's order requirement due to an overall softening of consumer demand for OPE equipment resulting from the well publicised recent credit 'squeeze'. As a consequence, we expect the first year's production volumes to be significantly reduced compared to the initial JV plan representing about a year's delay, but the longer-term market potential remains as strong as we first thought, and the prospects for success have improved markedly as a result of progress during the year.

This positive outlook is illustrated by MTD's appetite to progress with our joint plans for a second, lower cost Infinitrak transmission, which is expected to be competitive in a high volume area of the OPE market. This new unit, now in the design and early prototyping phase, has benefited substantially from the experience gained in the TTT development programme. Subject to MTD's product plans, Infinitrak expects to introduce this transmission during the 2009 calendar year.

Truck and Bus

This year we secured one of most important deals in Torotrak's history, entering into licence and engineering development agreements with a major European truck and bus manufacturer. Whilst the initial financial value of these agreements is significant, we are also delighted to be carrying out a substantial development programme with this client, one of the world's finest commercial vehicle manufacturers who brings significant potential for future volume sales and royalties. Although lead times in this sector are long, the impact of this deal for Torotrak is immediate. The major engineering programme is already underway and will continue to form a substantial part of our forward engineering services order book for several years.

The combined value of the licence and engineering development agreements is in excess of £7m over the next three to four years. This deal has been transformational for Torotrak as it:

Recognises the value of our technology in the form of a significant financial commitment from a respected industry player following two years of joint work and due diligence;

Illustrates the scalability of Torotrak's technology (from application in mowers through to heavy trucks and buses);

Provides a new route to market with Torotrak's technology being incorporated in a high value transmission;

Combines Torotrak's engineering resources with those of a recognised world leading commercial vehicle manufacturer to develop our technology for heavy-duty application.

Off Highway

Tractors

The market for small to medium-sized tractors has continued to be Torotrak's bridgehead into the wider agricultural market. This area is a strategic focus for us because the cost and performance benefits of our technology enable variable ratio transmissions to be offered in a sector of the market where existing technologies cannot currently be afforded.

The market potential for Torotrak's technology in small to medium tractors remains very strong. In back-to-back tests with vehicles drawn from our clients and their competitors, our technology clearly outclasses current powershift transmissions (the sector norm for premium transmissions) and even demonstrates superior driving characteristics when compared to the best of hydrostatic drives - the benchmark technology for larger, more sophisticated tractors.

We have used these advantages to good effect to build our profile in the agriculture sector. We have made good progress, for example, in rapidly growing economies such as India where the potential for new technology, offering the benefits of variable drive but at affordable levels, has been welcomed. We have also been very active with in-market demonstration of our two in-house tractors which are configured to demonstrate the full capability of our technology and the benefits it can provide for these markets.

We currently have three licensees in the off highway tractor market. Iseki and Carraro are actively progressing with the development of our technology in their respective transmissions. Both continue to demonstrate their commitment to series production, with each of them having prototype vehicles undertaking test and development work in preparation for market introduction.

The third licensee, Uzel, was initially a key part of our planned market introduction in small to medium tractor transmissions. However, as has become public knowledge, the Uzel group (based in Istanbul in Turkey and with major trading operations formerly quoted and managed out of the Netherlands) is experiencing financial difficulty. The general consensus amongst other companies trading with Uzel is that the underlying business remains strong and we are hopeful that a restructuring or re-financing of Uzel will be found and that they will be able to recommence their projects with us. Although this is a timing setback for us in the off highway market, it neither diminishes the value of our technology in this sector nor prevents us from proceeding with a revitalised Uzel.

Working in close co-operation with our customers and prospects in this market has enriched our knowledge of the industry needs and, as a result, during the year we have been able to better target the development of specific features and general capability of our technology in this sector. With this additional knowledge and confidence in our competitive advantages, we are seeking to develop this sector further in the year ahead and we continue to prospect for new clients, including potential JV partners, as we seek to have more control over the route to production in this market.

Fork lift trucks

We have made very promising progress within this new sector in the last year though our programme of work with a world-leading fork lift truck (FLT) manufacturer. This is an important strategic sector for our IVT technology which is a near-ideal fit with the requirements of a fork lift truck transmission, being capable of providing exceptional driveability, very smooth shuttling (rapid forward to reverse shifting) and precise low speed control - the key attributes sought by premium FLT manufacturers.

We now have a prototype transmission under internal evaluation in our lead customer's vehicle. We are due to deliver this initial prototype back to the customer shortly to enable them to carry out their own trials of this Infinitely Variable Transmission (IVT) equipped vehicle. This customer is keen to look at technologies which can provide cost-effective alternatives to the mainstream-sector norm of torque convertor powershift transmissions and the premium-sector hydrostatic drive. Early evaluation of our first prototype has confirmed that our IVT provides the competitive advantages as described above, and that it also delivers fuel economy benefits which are of value in the current and future FLT market.

The commercial case for our technology in this sector appears to be strong, with the cost of a transmission expected to be in the range between a powershift and a hydrostatic drive. This is a promising new market for Torotrak where we have clear competitive advantages and where we are working with a customer with a very strong market position.

Automotive

Main drive transmissions

Torotrak's principal activities in the market for main drive automotive transmissions are with the major Japanese tier-1 manufacturer, Aisin AW (Aisin), with whom we continue to work on engineering development programmes. As a market, automotive remains highly valuable, but our path to success requires a strong degree of cost competitiveness. In this respect, our credentials are now supported equally from progress in our other markets, such as low cost OPE, as much as from the original Torotrak foundations in premium car IVT.

Aisin has shown longstanding support for Torotrak's technology. Until recently, this has been focused primarily on premium automotive applications. The last 12 months, however, has seen a number of changes and developments in the automotive market. With growing pressures for fuel economy improvement and greenhouse gas emission reductions, there has been a shift of emphasis in interest in our technology towards higher volume, smaller car applications. As reported in November, Aisin has asked us to conduct a design study to apply our technology to mainstream small and medium-sized cars and this initial study has now commenced. We are delighted that Aisin's appetite for developing our technology is now also directed towards smaller cars, a strategic target area for Torotrak and a prime focus in emerging economies.

This new work on small car applications is in addition to continuing prototype test and development work on the Epicycloidal Roller Control (ERC) configuration that we are completing for Aisin on a consultancy basis. Work on this ERC module, which we regard as a technology suited primarily to large car and sports utility vehicle (SUV) transmissions, is now being handled by Aisin on an independent basis as a result of their target customer deciding not to commit to a prototype development programme for a larger car IVT. ERC's success in large car and SUV applications therefore remains speculative, but we continue to invest in business and technical development for the premium car main drive transmission market with the support of Aisin.

Emerging economies

The Indian government's approval of the Tata Motors licence agreement at the end of March 2008, as envisaged in our February Interim Management Statement, has opened the way for starting technology transfer to Tata's engineers. This process, where Torotrak provides training for the client in our technology and know-how, is taking place both in the UK and in India. We are very excited to be starting our relationship with this ambitious, far-sighted and high-profile company at a time when its reach is growing substantially.

Tata is licensed to use Torotrak's technology across a broad range of their products from small cars to full sized trucks and construction equipment. The nature of the first application to a Tata product is yet to be determined but their selection process is underway. Once Tata decides on its first application, which is likely to be client confidential, we expect to provide engineering and technical support to the company's engineers as they progress through the full prototype and production process.

New technology - mechanical hybrids

This emerging area of the automotive market has generated considerable awareness of, and enthusiasm for, Torotrak's technology. Our traction drive technology is a key element in a mechanical KERS system where our transmission connects the vehicle's drivetrain to a flywheel energy storage device.

Our work with our licensee Xtrac and with flywheel system provider Flybrid Systems has facilitated the development of a mechanical hybrid system for automotive application. The initial market for this technology is the motorsport industry where Xtrac enjoys a prominent reputation as a specialist driveline and component manufacturer. In the working arrangement, Flybrid Systems provides the flywheel technology and overall system integration and Xtrac supplies variable drive CVTs based on Torotrak's technology. A number of these transmission units have already been supplied for test and development purposes to two Formula 1 teams for which Torotrak has received license fees and royalty payments. Whilst all Formula 1 teams work in secrecy, it is clear that several different types of system are being evaluated for the 2009 season when a change in the sport's regulations allows hybrids to be introduced for the first time.

At the time of reporting, the intentions of the two Formula 1 teams working with our technology cannot be confirmed although we know from test results that the system delivers the performance that we anticipated. Whilst future applications in Formula 1 remain speculative, we have already benefited from significant commercial exposure through our affiliation with the sport and from the high level of technical expertise surrounding this industry. The 'profile' that we have secured has already opened doors in other areas of motorsport which we are pursuing jointly with Xtrac and Flybrid Systems.

The strategic, long term value of this sector to Torotrak remains speculative but it is an important area for us to target. The benefits of this mechanical hybrid system, including low-weight, compact size and high efficiency, are already recognised by the mainstream car industry to the extent that we are discussing potential applications with a number of target clients.

Our investment to date has been rewarded with our inclusion in a project being funded by the TSB with Jaguar Cars as the project leader and potential end customer. The consortium will design and develop the mechanical hybrid kinetic energy recovery system for use in a premium segment passenger car; the mechanical system is viewed as a power-dense and cost competitive alternative to other hybrid types. Torotrak's involvement in the project will include granting the other consortium members (Flybrid Systems LLP, Ford Motor Company Ltd, Prodrive, Ricardo UK Ltd and Xtrac Ltd) access to the Company's IP and know-how for the purpose of carrying out the project. In addition, we will support the project with analysis and design expertise relating to our variable drive technology which is central to the function and performance of the proposed system.



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