ADVANCED ENGINE TECHNOLOGIES INC (AENG.OB)
Quarterly Report (SEC form 10QSB)
ITEM 2. Management's Discussion and Analysis or Plan of Operation.
Cautionary Statement

You should read the following discussion and analysis in conjunction with the Financial Statements and related Notes thereto contained elsewhere in this Form 10-QSB ("Report"). The information in this Report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with the SEC, including our Annual Report on Securities and Exchange Commission ("SEC") Form 10-KSB for the year ended June 30, 2001.

The section entitled "Risk Factors" set forth in this Report and similar discussions in our Annual Report on Form 10-KSB for the year ended June 30, 2001 and in our other SEC filings, discuss some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to invest in our Company or to maintain or increase your investment.

This Report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "except," "plan," "anticipate," "believe," "estimate," "predict," "potential" or "continue," the negative of such terms or other comparable terminology. These statements are only predictions. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict.

Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.

Overview

Advanced Engine Technologies, Inc. ("we," "us" or the "Company") was formed to develop and commercialize the OX2 internal combustion engine. Our focus is on the development and commercial introduction of the OX2 engine and the subsequent licensing of the OX2 engine technology to approved manufacturers.

Based on its design, we believe our OX2 engine prototype will be fuel- efficient, lightweight, low-emission, multi-fueled and smaller and less expensive than conventional internal combustion engines. We also believe that it will not have the complex manufacture/production requirements of conventional internal combustion engines.

At the present time only prototypes of the OX2 internal combustion engine, plus additional parts that can be used for engine development or for the building of additional prototypes, have been built. The development and testing of prototypes are ongoing. No

OX2 engines have been manufactured for production use, and no assurance can be given that the OX2 engine will be successfully developed or manufactured for commercial application.

Plan of Operation

We plan to continue the research and development of our OX2 engine prototypes during the 2002 fiscal year. In October 2001, we entered into a new development agreement with Steven Charles Manthey, the inventor of the OX2 engine, and OX2 Engine Development PTY LTD. The new development agreement supercedes and replaces the May 2000 development agreement between the Company and Mr. Manthey and accelerates and enhances the research and development products and services related to the OX2 engine provided by Mr. Manthey and his companies. Research and development activities will include continued maintenance of the first and second performance test engines as well as design and development of three additional OX2 test engines. In addition, the development agreement calls for the design and manufacturing of new and advanced components for the test engines. As consideration for the products and services to be provided pursuant to the new development agreement, we have agreed to repurchase from Mr. Manthey, or his nominee, up to 240,000 shares of common stock of the Company at a purchase price of $2 per share. In addition, we have agreed to pay Mr. Manthey consulting fees in the amount of $80,000 per year.

We have an agreement with the University of California, Riverside ("UCR"), that provides that UCR will continue to provide engine testing and related services to the Company, with particular emphasis on testing related to emissions. These services are being provided under the guidance of Dr. Joseph Norbeck (of the CE-CERT program at UCR) and Dr. Roberta Nichols, one of our consultants. We are also conducting research and development and testing activities in Gardena, California.

Assuming the completion of the necessary research and development required to complete our product and assuming that the tests of our OX2 prototypes are successful, we will attempt to introduce the OX2 engine into the market. Marketing activities will include demonstrations to prospective original equipment manufacturers of products using internal combustion engines and the development of additional joint venture partners to assist in marketing the engine.

In the shorter term, our plans are to develop an engine for stationary generator applications, and in the longer term, we plan to develop an engine for automobile, marine and/or aircraft applications.

We expect that our cash flow requirements to fund general operations in fiscal year 2002 will total between approximately $1,500,000 and $2,000,000, including outside consulting fees and expenditures for equipment. We expect to fund these costs with our cash or cash equivalent reserves, which were $468,951 as of December 31, 2001. The Company also has available a $9,000,000 secured promissory note that can be drawn upon at any time at the discretion of the Board of Directors. Our cost estimates do not include provisions for any contingencies or unexpected expenses that may arise or any unanticipated increases in costs.

Our net loss since inception (September 23, 1996) is $7,398,001.

Currently, there are no signed contracts that will produce revenue, and we can provide no assurance that management will be successful in negotiating any such contracts.

Risk Factors

You should carefully consider the following risks and the other information contained in this Report and in our other filings with the Securities and Exchange Commission before you decide to invest in us or to maintain or increase your investment. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties may also adversely impact and impair our business. If any of the following risks actually occur, our business, results of operations or financial condition would likely suffer. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment.

. There can be no assurance that we will be able to develop successfully the OX2 engine. No OX2 engines have been developed or manufactured

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for production use, and no assurance can be given that the OX2 engine will be successfully developed or manufactured. Testing and development on the engine are still in progress and are being conducted in conjunction with UCR and/or Stanford Research Institute ("SRI"). Until further testing and research and development have been
completed, we will not have a finished product for introduction into the market. We do not have an estimated completion date for the testing and research and development. Furthermore, we cannot provide assurance that we will be successful in the ultimate development of the engine for commercial applications.

. A market for our OX2 engine may take longer to develop than - anticipated or may never develop, which would adversely affect revenues and profitability. Our OX2 engine represents an innovation in the industry for internal combustion engines. The size of the internal combustion engine industry makes the introduction of changes to industry standards a complex promotional and marketing exercise. We cannot ensure that our targeted customers will purchase our engine. If the market for our engines fails to develop, or develops more slowly than anticipated, we may not be able to meet our expenses and may not achieve profitable results. In addition, we cannot provide assurance that we will be successful with our marketing efforts or the development of our joint ventures.

. Our cash or cash equivalent reserves may not be adequate to cover our - costs of operations. To date, we have covered our operating losses by

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privately placing securities. We expect to fund our general operations and marketing activities for 2002 with our current cash and cash equivalents, which were obtained from the sale of securities. However, our cost estimates do not include provisions for any contingence, unexpected expenses or increases in costs that may arise.

. We may not be able to raise the capital we need. It is likely that we

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will need to raise additional capital at some point in the future. If additional funds are raised through the issuance of equity, our shareholders' ownership will be diluted. There can be no assurance that additional financing will be available on terms favorable to us or at all. If funds are not available or are not available on terms acceptable to us, we may not be able to continue the development of our product, respond to our competitors or continue our business.

. Our business depends on the protection of our intellectual property - and may suffer if we are unable to adequately protect our intellectual property. Currently, we have been granted one U.S. Patent and one

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Australian Patent for an Axial Piston Rotary Engine. We have successfully registered these patents in many countries and have patent registrations pending in many other countries throughout the world. We believe that our ability to establish and maintain our position in the market depends on these patents. We cannot provide assurance that our patents will not be invalidated, circumvented or challenged, that the rights granted under the patents will give us competitive advantages or that our patent registrations will be granted.

. If we are found to infringe on the intellectual property rights of others, we may not be able to continue the development and production - of our engine, or we may have to enter into costly license or - settlement agreements. Third parties may allege infringement by us

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with respect to past, current or future intellectual property rights. Any claim of infringement, regardless of merit, could be costly, time- consuming and require us to develop noninfringing technology or enter into royalty, licensing or settlement agreements. These agreements could be on terms unfavorable or unacceptable to us and could significantly harm the development of our product and, ultimately, our business. In the future, we may also have to enforce our patent and other intellectual property rights through litigation. Any such enforcement could also result in substantial costs and could materially affect our financial condition and our business.

. Our business is dependent on our relationships with other parties.

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Research, development and testing of our engine is being carried out internally and in conjunction with Steven Manthey, the inventor of the OXZ engine, and his companies, as well as UCR and SRI. In addition, we have a joint venture agreement with Carroll Shelby to further develop and promote our engine. Completion of the research and development and testing is essential to the success of our business. Until such testing and research and development have been completed, we will not have a finished product to introduce to the market. Thus, if we are unable to maintain our relationships with UCR, SRI, Steven Charles Manthey and Carroll Shelby, our business may be adversely affected.

. We have a history of losses. We have a history of operating losses

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and an accumulated deficit, as of December 31, 2001, of $7,398,001. Our ability to generate revenues and profits is subject to the risks and uncertainties encountered by development stage companies.

. Our future revenues and profitability are unpredictable. We currently

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have no signed contracts that will produce revenue, and we do not have an estimate as to when we will be entering into such contracts. Furthermore, we cannot provide assurance that management will be successful in negotiating such contracts.

. Rapid technological changes could adversely affect our business. The

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market for internal combustion engines is characterized by rapidly
changing technology, evolving industry standards and changing customer demands. Thus, if we are unable to adapt to rapidly changing technologies and to adapt our product to evolving industry standards, our business will be adversely affected.

. Our common stock is not widely traded, which may result in illiquidity and increased volatility. Our common stock is not widely traded, and,

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as a result, the prices quoted for our stock may not reflect its fair
market value. Because of the low volume of trading in our common stock, our stockholders may find it difficult to sell their shares.

. Our principal stockholders can exercise significant control over us and could limit the ability of our other stockholders to influence the outcome of transactions requiring a shareholder vote. As of

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December 31, 2001, approximately 75% of our outstanding common stock is owned by our executive officers, directors and principal stockholders. These stockholders will have the ability to exercise influence over all matters requiring approval by our stockholders, including the election of directors and approval of significant corporate transactions.