May 31, 2005

My goal in this update is to share with you a comprehensive overview of the status of our Infinitely Variable Transmission (IVT™) and the truly exciting developments that are occurring.
 

Our New, All-Hydraulic Transmission

First and foremost, I want to share with you our enthusiasm that, as a result of our research efforts and testing of our transmission over the past eight months, we have created an extremely viable new product for Torvec – an all-hydraulic (“hydrostat”) transmission.

1. Why is an all-hydraulic transmission such a great product?

In a word, cost. Our hydraulic transmission has approximately 170 total parts, of which 25 are separately manufactured parts (excluding nuts, bolts, screws and the like). This contrasts with an average of over 700 parts for an automatic transmission, the majority of which have to be separately manufactured. Significantly, our hydraulic transmission has solved the major problems of weight, size, noise, heat and lack of start-up ability at low revolutions per minute (rpm) all of which have long plagued hydraulic transmissions. While auto companies have recognized the potential benefits of an all-hydraulic transmission for over 50 years, these hurdles have heretofore prevented the development of a hydrostat for automotive use.

2. What are the principal markets for the hydraulic transmission?

The hydrostat is by nature a stand alone, infinitely variable transmission operating purely on the hydraulics of Torvec’s unique pumps and motors. As a standalone transmission, it is ideal for use in subcompact, compact and mid-sized cars where the auto companies’ profit margin is narrowest (see the May 9th issue of Business Week, “Why GM’s Plan Won’t Work”).

The most exciting market for the all-hydraulic transmission may very well be the rapidly emerging, but highly competitive Third World markets like China where:

• cost reduction is king
• roads are difficult to traverse
• city driving is generally congested
• vehicle speeds are reduced

3. What about the SUV, Hummer, truck and bus markets?

While Torvec’s unique pumps and motors can function as a standalone transmission, they also form the core of Torvec’s infinitely variable, hydro-mechanical transmission. Our hydro-mechanical transmission operates both on our unique pumps and motors and on gears. The addition of a gear pack to the hydraulic transmission enables our transmission to operate under the greater torque (power) requirements demanded by SUV’s, Hummers, trucks and buses, and is the ideal transmission for these types of vehicles. This is possible in part because the mechanical portion of the transmission enables our pumps and motors to operate under lower loads than when they are functioning on a standalone (hydraulic) basis.

4. So, the hydraulic and the hydro-mechanical transmissions constitute Torvec’s modular transmission for which several patent applications were filed?

Precisely. In effect, we have created two transmissions for different market applications. Any company that licenses or acquires our transmission technology can decide for itself the application it wishes to pursue and the markets it wishes to penetrate. We describe this concept as a modular unit and recently, we filed a patent application to protect our shareholders’ interest in this valuable technology.

5. All of these developments took place in as little a time as eight months with limited funds?

Yes. As most shareholders are aware, in 2003, we successfully tested our hydro-mechanical transmission in a diesel-fueled Dodge Ram 4x4. See our press release dated November 10, 2003. In April 2004, we tested our hydraulic pump at the EPA national laboratory in Ann Arbor, Michigan to determine its efficiency and to answer the question whether our hydro-mechanical transmission could be adapted to give greater performance in a gasoline engine, in addition to a diesel engine. This determination was necessary because diesel engines operate at low rpm and generate high torque, in contrast to gasoline engines that operate at high rpm and generate little torque and low fuel efficiencies at low rpm.

The question of suitability of our transmission for a gasoline engine lay primarily in the mechanical and volumetric efficiencies of our hydraulic pump and motor. We therefore installed our pump and motor as a standalone transmission in a Tahoe and conducted a series of exhaustive tests, facilitated by our acquisition of a state-of-the art dynamometer. Our tests were designed to demonstrate our transmission’s compatibility with a gasoline engine, its operating efficiencies, its durability and the fuel economy obtainable with the unit.

During this period, we made a number of improvements to the transmission, including a major design improvement to our motor, enabling it to operate over an infinite range of ratios (a design feature previously limited to our pump).

Shareholders should be proud that we now have a modular transmission (see “Q&A 4” above) that operates interchangeably with gasoline and diesel engines. You should be equally proud that all of this was accomplished within eight months on a budget that pales in comparison with the budgets of major auto companies.

6. Why is Torvec’s transmission better than an automatic transmission?

• No vehicle creep — We have all experienced sitting at a red light and our foot comes off the brake. The vehicle creeps forward or rolls backward which, if unanticipated, can be extremely dangerous. Torvec’s transmission eliminates vehicle creep, whether forward or backward.
   
• Incredible vehicle control — On the other hand, our transmission enables a driver to dramatically control vehicle speed, reducing speeds to as little as one-half mph (i.e., two rpm of the wheels), thus providing greater safety in inclement weather, less fuel usage in traffic jams, greater control and flexibility to maneuver through parking lots and narrow streets (such as those in Asia), as well as greater maneuverability on rough terrain and poor road conditions.
   
  We invite you to try to drive your own car for any distance at 2 or 3 mph.
   
• Greater MPG during rapid acceleration — A considerable portion of typical city and suburban driving involves “rapid” acceleration, that is, acceleration from zero to 30 mph at a rate exceeding 6 mph per second. In side-by-side testing of the hydraulic transmission against the Tahoe’s automatic transmission in the zero to 30 mph acceleration range, the automatic transmission used 100% more fuel than our transmission.
   
  While this percentage demonstrates the enormous fuel savings potential of our transmission, it is not the kind of information that can be obtained readily from various EPA-sanctioned tests. This is because EPA tests require the driver to accelerate at prescribed, significantly lower acceleration rates. (See more about the controversy surrounding EPA sanctioned tests in “Q&A 7” below).
   
• Greater MPG for NYC EPA Test — We were asked by auto company representatives to compare our transmission side-by-side under exclusive city driving scenarios, such as those found in New York City, Chicago, Los Angeles, Rio de Janeiro and Beijing. We then ran an entire series of side-by-side comparisons utilizing the EPA-sanctioned New York City cycle test. Over the course of all of these tests, our transmission consistently achieved an average of 4.33% improvement in fuel efficiency over the automatic.

7. How do you reconcile a 100% improvement in the zero to 30 mph acceleration range and “only” a 4.33% improvement in the overall New York City test?

First of all, it is important for you to understand the nature of the EPA New York City test and the opportunities for fuel improvement it allows.

The New York City cycle test runs for 9 minutes, 58 seconds and covers a distance of 1.18 miles. Of the time spent on the test, the vehicle is idling for 211 seconds (approximately 35%), accelerating for 208 seconds (approximately 35%) and decelerating in coast mode for 179 seconds (approximately 30%). The average speed that must be maintained by the driver is 7.1 mph. The top speed permitted is 27.6 mph, and this speed must be attained starting from zero at an average acceleration rate of 1.4 mph per second (which translates into almost 18 seconds to attain a speed of 25 mph!).

Accordingly, the area for fuel efficiency improvement is confined to a band of approximately 3.5 minutes covering only 35% of the entire test, since we cannot improve fuel efficiency in the idle and coast modes. Of that 3.5 minutes of acceleration, none of the time is conducted at an acceleration rate of at least 6 mph per second where our transmission truly shines.

As can be seen, the New York City cycle test (like all of the other EPA-sanctioned tests developed in the mid-1970’s) is extremely unrealistic and directly contributes to the “MPG sticker shock” syndrome consistently experienced by American drivers. Consumer complaints are met with the auto industry’s stock response that American drivers are “lead-footed” when in fact, the sticker fuel mpg is a result of a driving test that allows the vehicle to operate in a narrow zone of high efficiency for an automatic transmission.

Lead-footed or not, Americans simply do not drive the way the EPA says we do and, like it or not, the way we drive has a direct and significant impact on gas mileage. And, reputable organizations, such as the American Automobile Association and even the EPA itself, are beginning to understand that only comparable, side-by-side testing under real-world driving scenarios will provide the public and industry with any truly meaningful information regarding fuel efficiency. In fact, the Senate passed a highway funding bill in May that contains a provision requiring the EPA to make its fuel economy tests more realistic. The AAA says its own tests show the stickers could be off by as much as 30 percent on some models. Further confirming this point, OEM’s with whom we are having discussions have stated that they would be extremely pleased with as much as a 5% improvement on these tests.

(For further information, please refer to the following website: http://www.aaa-calif.com/corpinfo/05-03-03-mileage.asp and the Wall Street Journal article of May 12, 2005 regarding the EPA’s announcement that it is going to overhaul its tests and methodology).

8. What other advantages does our transmission have over the automatic?

• Greater operating efficiencies/durability — Durability and efficiency are directly related (i.e., the more efficient a device is, the more durable it will also be under test conditions). Heat generated is an extremely accurate measure of efficiency. Our all-hydraulic transmission operates in a temperature range of 90 to 160 degrees (the higher temperature reflects higher loads and more difficult driving conditions), with a general operating temperature of approximately 140 degrees. There is no oil cooler (radiator) required, and the entire system utilizes only 6 quarts of oil! In its operating range, our pump is 92% efficient and the motor is 92% efficient, reflecting an overall operating efficiency of 85% (92% x 92%). These efficiencies are validated by our operating temperatures. A further confirmation of our transmission’s efficiency is greater fuel mileage during acceleration as previously described.
   
  Other durability tests have been conducted. First, recall that we developed our all-hydraulic transmission for subcompact, compact and mid-sized cars. These vehicles are less than one-half the weight of our Tahoe as well as one-half of the horsepower. Effectively, we have been driving this transmission at over 100% overload during the entire testing period. In addition to operating in an overloaded condition, we ran the unit in excess of the design limits. We also performed a series of rapid deceleration tests without braking, including a “shock-load” deceleration of the Tahoe from 23 mph to zero in exactly one second!
   
• Greater, less costly compatibility with developing accumulator technology
   
  Developing accumulator technology promises to have a significant impact on fuel efficiency – it enables a vehicle to use no fuel while at rest (since the engine is turned off) and accelerate from rest to approximately 10 mph again using no fuel. This is because kinetic energy produced by hydraulic pressure while the vehicle is coasting and decelerating is not wasted, but stored by the system in the accumulator bags (“tanks”) for later use.
   
  In our discussion above, we indicated that our all-hydraulic transmission did not generate fuel savings while at idle and coasting. If, however, our transmission is integrated with an accumulator system, the combined unit would increase fuel efficiency significantly.
   
  We believe that our all-hydraulic transmission is the most compatible transmission to integrate with advanced accumulator technology. This is because the ability to add a complete accumulator system is built into the design of our hydrostat. Accumulator technology requires the installation of a hydraulic pump and motor in order to function. Obviously, our hydrostat already furnishes the pump and motor unit necessary for the accumulator system. An OEM need only add the plumbing and the bags. This provides another illustration why our hydraulic transmission is the most cost effective technology available to generate fuel savings. Automatic transmission technology requires the addition of a pump and motor, accumulator bags and plumbing.

9. Has Torvec missed its “window of opportunity” with the emergence of electric hybrid and fuel cell technology?

DEFINITELY NOT. Discussions concerning the advantages of electric hybrid and fuel cell technology miss one, all important fact: all electric hybrids and fuel cell driven vehicles require a transmission to function! The issue then is, once again, which transmission is the most efficient.

Obviously, the auto companies will continue to attempt to surmount the economic, efficiency, ecological and logistical problems currently associated with electric hybrid and fuel cell technologies. However, it is vital that our shareholders understand that the auto industry’s enthusiasm for Torvec’s transmission has not waned. To the contrary, the auto industry recognizes that transmissions will always be required, regardless of engine technology in order for a vehicle to move forward and backwards. They have continued to support our efforts to perfect our transmission technology since it may be the perfect technology to integrate with any future engine device.

10. What are the next steps that you anticipate in developing and testing this modular transmission?

Automakers are increasingly calling upon us to create an almost production-ready model transmission that can be installed in a vehicle and driven under real-world driving scenarios. And, as we have indicated above, the American public, Congress, reputable independent organizations and the EPA itself are undeniably concluding that real-world driving scenarios are the only real way to generate meaningful mpg data. Accordingly, our emphasis will be to move forward with our modular transmission technology best suited for real world driving conditions.

At the same time, there continues to be global debate as to whether diesel technology will play an ever increasing role in providing an ecologically sound, fuel efficient, economic solution to the problems besetting the auto industry worldwide. Significantly, our shareholders should recall that our transmission was originally designed to operate, achieve significant fuel economies and emission reduction with a diesel-fuel engine (again, see our press release on this subject dated November 10, 2003). Our efforts in developing our transmission’s affinity for gasoline technology has never meant that we have retreated from our long-held basic premise that diesel technology, not fuel cells or hybrids, may very well be the ultimate solution to the issues of fuel economy and pollution reduction. Our confidence has been reinforced by recent announcement that the Persian Gulf oil states, in cooperation with oil titans, Royal Dutch/Shell Group, ChevronTexaco Corp. and ExxonMobil, are constructing a $20 Billion facility in Qatar to convert natural gas into an odorless diesel fuel that would reduce dependence upon the smelly, sufur soot belched by engines firing on conventional diesel fuel. Interestingly, ExxonMobil’s $7 Billion commitment is the largest investment in the corporate history of America’s largest company, dwarfing the investment in fuel cell technology by government and the private sector alike.

The Middle East focus on gas-to-liquid fuel (GTL), the size of the investment by the world’s oil giants and the strategic location of the GTL facilities in pro-Western Qatar all lead to the conclusion that very soon, there will be plants producing a clear liquid that will have the high efficiency of diesel fuel (one-third more efficient than gas), but none of the smog producing pollutants of conventional, crude oil-based fuel. I am very pleased that the insight of Torvec’s founders has positioned your Company to readily exploit this paradigm shift in fuel.

I will keep you informed of our progress in commercializing all of Torvec technologies on a regular basis.

 
Sincerely,

Philip A. Fain,
Chief Executive Officer