U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002.
SONEX RESEARCH, INC.
Incorporated in the State of Maryland
23 Hudson Street
Annapolis, Maryland 21401
Telephone Number: (410) 266-5556
IRS Employer Identification No. 52-1188993
Commission file number 0-14465
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days.
YES [x] NO [ ]
There were 21,588,669 shares of the Issuer's $.01 par value Common Stock
outstanding at August 14, 2002.
SONEX RESEARCH, INC. FORM 10-QSB
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Sonex Research, Inc.
We have reviewed the condensed financial statements appearing in this Form
10-QSB Quarterly Report of Sonex Research, Inc. (the "Company") as of June 30,
2002. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements for them to be in conformity
with generally accepted accounting principles.
We previously audited, in accordance with generally accepted auditing standards,
the balance sheet as of December 31, 2001, and the related statements of
operations and accumulated deficit and cash flows for the year then ended (the
"audited financial statements", not presented herein), and in our report dated
April 10, 2002, we expressed an unqualified opinion on those financial
statements. We also stated that the audited financial statements were prepared
assuming that the Company will continue as a going concern; however, as
described in Note 3 to the audited financial statements, the Company has
incurred significant net losses since its inception and its ability to commence
generation of significant revenue and ultimately achieve profitable operations
raise substantial doubt about the Company's ability to continue as a going
concern. The audited financial statements and the accompanying condensed
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
C. L. STEWART & COMPANY
Annapolis, Maryland
August 7, 2002
SONEX RESEARCH, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
June 30 , December 31,
ASSETS 2002 2001
------------ ------------
Current assets
Cash and equivalents $ 21,158 $ 3,355
Accounts receivable 7,055 37,828
Prepaid expenses 23,800 25,783
Loans to officers and employees 22,500 22,500
------------ ------------
Total current assets 74,513 89,466
Notes receivable from officers and employees 20,300 18,125
Patents and technology, net of accumulated
amortization of $55,555 in 2002 and
$44,638 in 2001 207,172 204,088
Property and equipment, net of accumulated
depreciation of $448,272 in 2002 and
$434,031 in 2001 49,877 57,249
------------ ------------
Total assets $ 351,862 $ 368,928
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 45,231 $ 46,923
Convertible note to shareholder 6,000
Accrued compensation and benefits 303,753 221,228
------------ ------------
Total current liabilities 354,984 268,151
------------ ------------
Deferred compensation 881,494 857,944
------------ ------------
Stockholders' equity/(deficit)
Preferred stock, $.01 par value - 2,000,000
shares issued; 1,540,001 shares outstanding 15,400 15,400
Common stock, $.01 par value - shares issued
and outstanding: 21,584,669 in 2002 and
21,212,669 in 2001 215,847 212,127
Additional paid-in capital 21,400,982 21,334,577
Accumulated deficit (22,516,845) (22,319,271)
------------ ------------
Total stockholders' equity/(deficit) (884,616) (757,167)
Commitments (Note 9)
------------ ------------
Total liabilities and stockholders' equity $ 351,862 $ 368,928
============ ============
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
(Unaudited) Unaudited)
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Revenue
Defense $ 50,647 $ 33,774 $ 86,517 $ 33,774
Commercial 25,000 50,000
---------- ---------- ---------- ----------
50,647 58,774 86,517 83,774
---------- ---------- ---------- ----------
Costs and expenses
Cost of revenue 15,322 12,103 40,869 21,424
Research & development 57,589 142,893 129,024 274,769
General & administrative 51,821 68,612 116,311 147,262
---------- ---------- ---------- ----------
124,732 223,608 286,274 443,455
---------- ---------- ---------- ----------
Net loss from operations 74,085 164,834 199,757 359,681
Investment and other income (2,175) (204) (2,183) (1,162)
---------- ---------- ---------- ----------
Net loss 71,910 164,630 197,574 358,519
Accumulated deficit
Beginning 22,444,935 21,822,805 22,319,271 21,628,916
---------- ---------- ---------- ----------
End $22,516,845 $21,987,435 $22,516,845 $21,987,435
========== ========== ========== ==========
Weighted average
number of shares
outstanding 21,578,867 20,002,246 21,402,746 19,746,117
========== ========== ========== ==========
Net loss per share $.003 $.008 $.009 $.018
===== ===== ===== =====
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF PAID-IN CAPITAL
(Unaudited)
Price Preferred stock Common stock Additional
per ($.01 par value) ($.01 par value) paid-in
share Shares Amount Shares Amount capital
----- --------- ------ ---------- ------- ----------
Balance, January 1, 2000 1,540,001$15,400 18,008,169$180,082 $20,430,476
February exercise of
warrants .35 285,000 2,850 96,900
March for services .40 24,130 241 10,125
June exercise of warrants .375 196,667 1,967 71,783
June exercise of warrants
for notes .375 48,333 483 17,642
June for services .41 31,538 315 12,695
September for services .24 56,877 569 13,181
December private placement .25 775,000 7,750 186,000
December for services .25 54,154 542 12,996
Stock option compensation 45,875
Amortization of deferred
compensation from grant of
stock options 29,764
--------- ------ ---------- ------- ----------
Balance, December 31, 2000 1,540,001 15,400 19,479,868 194,799 20,927,437
March private placement .25 300,000 3,000 72,000
March for services .25 54,577 546 13,099
April private placement .25 125,000 1,250 30,000
June private placement .20 325,000 3,250 61,750
June for services .29 44,916 449 12,667
August payment of stock
subscription .20 25,000 250 4,750
September for services .25 55,000 550 13,200
October private
placement .15 750,000 7,500 105,000
December for services .25 53,308 533 12,794
December forgiveness
of payables 10,000
Stock option compensation 42,120
Amortization of deferred
compensation from grant of
stock options 29,761
--------- ------ ---------- ------- ----------
Balance, December 31, 2001 1,540,001 15,400 21,212,669 212,127 21,334,577
March private placement .15 360,000 3,600 50,400
May for services .25 12,000 120 2,880
Stock option compensation 13,125
--------- ------ ---------- ------- ----------
Balance, June 30, 2002 1,540,001$15,400 21,584,669$215,847 $21,400,982
========= ====== ========== ======= ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
----------------------
2002 2001
-------- --------
Cash flows from operating activities
Net loss $ (197,574) $ (358,519)
Adjustments to reconcile net loss to
net cash used in operating activities
Depreciation 7,800 9,000
Amortization of patents 8,400 30,568
Amortization of deferred compensation
from grant of stock options 14,880
Current charges paid in stock or options 16,125 44,130
Accrued interest on notes receivable from employees (2,175)
(Increase) decrease in accounts receivable receivable 30,773 (6,434)
(Increase) decrease in prepaid expenses 1,983 1,319
Increase (decrease) in accrued liabilities 80,833 48,758
Increase (decrease) in deferred compensation 23,550 23,551
----------- ----------
Net cash used in operating activities (30,285) (192,747)
----------- ----------
Cash flows from investing activities
Acquisition of property and equipment (428)
Additions to patents (11,484) (20,564)
----------- ----------
Net cash provided by (used in)
investing activities (11,912) (20,564)
----------- ----------
Cash flows from financing activities
Issuance of convertible note 6,000
Issuance of stock - private placement 54,000 171,250
----------- ----------
Net cash provided by financing activities 60,000 171,250
----------- ----------
Increase (decrease) in cash 17,803 (42,061)
Cash
Beginning of period 3,355 89,306
----------- -----------
End of period $ 21,158 $ 47,245
=========== ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - THE COMPANY
Sonex Research, Inc. has developed a proprietary technology, known as the Sonex
Combustion System (SCS), which improves the combustion of fuel in internal
combustion engines through modification of the pistons in large engines or the
cylinder heads in small engines. The SCS achieves in-cylinder control of
ignition and combustion to increase fuel mileage of gasoline engines, reduce
emissions of diesel engines, and permit small gasoline engines to run on safer
diesel-type fuels. The Company's objective is to execute broad agreements with
engine and parts manufacturers for industrial production of SCS components under
license from Sonex.
NOTE 2 - PRESENTATION OF FINANCIAL STATEMENTS
The accompanying unaudited condensed financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-QSB and Item 310(b) of
Regulation S-B. Accordingly, these financial statements do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included.
Operating results for the three- and six-month periods ended June 30, 2002 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2002. For further information, reference is made to the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-KSB for the year ended December 31, 2001.
NOTE 3 - LIQUIDITY
Management recognizes that the Company's history of operating losses, level of
available funds, and revenue from current and future development contracts, in
relation to projected expenditures, raise substantial doubt as to the Company's
ability to commence generation of significant revenues from the
commercialization of the SCS and ultimately achieve profitable operations.
Accordingly, the Company will continue to minimize its operating expenditures
through a number of measures, including the continued deferral by its officers
of portions of their salaries.
As further described in Note 10, in July 2002 the Company was awarded a
subcontract with initial funding of $200,000 from a military prime contractor. A
payment of $25,000 due upon the issuance of the subcontract was received in
early August 2002. Following the award of this subcontract, the Company obtained
a $30,000, six-month loan from one of its shareholders, with repayment of the
loan secured by revenues from the subcontract.
Based upon available resources, current and projected spending levels, and
expected revenue from current and anticipated contracts, management believes the
Company will have sufficient capital to fund operations until sometime during
the fourth quarter of 2002. The Company's prospects beyond that time are
dependent upon its ability to enter into significant funded contracts for the
further development of its SCS technology, establish joint ventures or strategic
partnerships with major industrial concerns, or secure a major capital infusion.
There is no assurance that the Company will be able to achieve these objectives;
however, the Company has high expectations of receiving one or more additional
revenue-generating contracts from the military in the near future.
NOTE 4 - PATENTS
The costs associated with the filing of patent applications are deferred.
Amortization is recorded on a straight-line basis over the remaining legal life
of patents, commencing in the year in which the patent is granted. Costs related
to patent applications which ultimately fail to result in the grant of a patent,
as well as the unamortized costs of patents abandoned by the Company due to lack
of expected commercial potential, are charged to operations at the time such
determination is made.
NOTE 5 - ACCRUED COMPENSATION AND BENEFITS
Accrued compensation consists of the following amounts payable to current
and former employees:
June 30, December 31,
2002 2001
-------------- --------------
Accrued wages $ 176,333 $ 70,536
Accrued consulting fees 18,317 9,692
Accrued bonuses 55,000 83,000
Accrued vacation pay 54,103 58,000
-------------- --------------
$ 303,753 $ 221,228
============== ==============
Since early 2001, the Company's officers have voluntarily and at their own
discretion deferred receipt of payment of significant portions of their current
wages to reduce the Company's monthly cash requirements. Such wages payable to
the Company's officers totaling $151,342 are included in the total of accrued
wages as of June 30, 2002. The continued deferral of portions of current wages
by the Company's officers cannot be expected to continue indefinitely, and the
Company will be required to pay such accrued wages as soon as cash flow permits.
The amount and timing of such payments will be determined at the discretion of
the Company's officers, as these accrued wages are not subject to the terms of
the Company's written agreement with current and former employees to defer
payment of portions of their salaries as described in Note 6. Similar
arrangements exist for consulting fees, the majority of which amounts are
payable to the individual who serves as the Company's director of business
development on a part-time basis.
In December of each of the last three years, the Company awarded bonuses to its
officers and employees with the stipulation that payment of such bonuses is to
be deferred until the Board of Directors determines that the Company's cash
resources are sufficient to enable such payments. In December 2001 the Company
awarded bonuses totaling $57,500, including an aggregate of $50,000 to its two
officers. During 2001 the Company paid $12,500 of the bonuses accrued as of the
previous year-end, portions of which payments represented the conversion of
accrued bonuses to equity. In connection with a private placement at the end of
March 2002, the Company paid $22,500 of accrued bonuses through the conversion
of such amounts to equity.
The Company's only liability to employees for future compensated absences is for
accrued but unused vacation pay. The amount of vacation pay earned by employees
is determined by job classification and length of service. Such amounts are
payable upon termination of employment and are not subject to the terms of the
Company's written agreement with current and former employees to defer payment
of portions of their salaries as described in Note 6. The amount of accrued
vacation included above that was payable to the Company's officers at June 30,
2002 and December 31, 2001 was $40,141 and $41,406, respectively.
NOTE 6 - DEFERRED COMPENSATION
In order to help conserve the Company's limited cash resources, the Company's
officers and certain of employees for several years have voluntarily deferred
receipt of payment of significant portions of their authorized annual salaries
at the request of the Board of Directors. By written agreement with the Company,
these individuals have consented to the deferral of payment of amounts so
accumulated until the Company has received licensing revenue of at least $2
million or at such earlier date as the Board of Directors determines that the
Company's cash flow is sufficient to allow such payment.
Deferred compensation outstanding is payable to the following classifications of
personnel:
June 30, December 31,
2002 2001
-------------- --------------
Current officers $ 548,887 $ 525,337
Current employees and consultants 62,088 62,088
Former officers and other employees 270,519 270,519
-------------- --------------
$ 881,494 $ 857,944
============== ==============
The conditions that would require repayment of deferred amounts have yet to
occur, and it is unlikely that such conditions will occur prior to June 30,
2003. Accordingly, such deferred compensation is reported separately in the
accompanying balance sheet as a non-current liability.
At the conclusion of a legal challenge by two former officers of the Company
initiated in 1993 demanding full payment of deferred salaries upon the
termination of their employment, in 1996 the Maryland Court of Special Appeals
rejected this demand and ruled that the written agreement to defer compensation
was a valid and enforceable contract.
NOTE 7 - INCOME TAXES
The Company has not incurred any federal or state income taxes since its
inception due to operating losses. At December 31, 2001, the Company had net
operating loss and capital loss carryforwards of approximately $14.2 million
available to offset future taxable income. If certain substantial changes in the
Company's ownership should occur, there would be an annual limitation on the
amount of the carryforwards which can be utilized. Since 1995 net operating loss
carryforwards aggregating $4,781,634 have expired unused, as have capital loss
carryforwards of $201,681.
NOTE 8 - STOCKHOLDERS' EQUITY
Authorized capital stock
The Company is presently authorized to issue 48 million shares of $.01 par value
common stock and 2 million shares of $.01 par value convertible preferred stock.
All of the authorized shares of preferred stock, along with common stock
purchase warrants, were issued for $2 million in February 1992 (the "Preferred
Stock Investment") to a small number of individuals who qualified as "accredited
investors" pursuant to Rule 501 of Regulation D of the Securities Act of 1933
(the "Act") and to Proactive Partners, L.P. and certain of its affiliates
("Proactive"), who became the largest beneficial owner of the Company's common
stock by virtue of the acquisition of the convertible preferred stock and common
stock purchase warrants.
The preferred stock has priority in liquidation over the common stock, but it
carries no stated dividend. The holders of the preferred stock, voting as a
separate class, have the right to elect that number of directors of the Company
which represents a majority of the total number of directors. The preferred
stock is convertible at any time at the option of the holder into common stock
at the rate of $.35 per share of common stock. As of March 31, 2002, a total of
459,999 shares of preferred stock had been converted into 1,314,278 shares of
common stock.
Private placements of common equity
In a private placement at the end of March 2002, the Company raised capital of
$60,000, including $27,000 in cash investments, $27,000 from the conversion to
equity of accrued liabilities to officers, employees and consultants, and cash
proceeds of $6,000 through the issuance of a short-term note that is convertible
to equity at the option of the holder. A total of 360,000 shares of the
Company's common stock and five-year warrants to purchase an additional 180,000
shares of common stock at $.25 per share were issued in this financing, and
60,000 shares were reserved for future issuance upon the conversion of the note
payable to common stock and a warrant to purchase common stock.
The offer and sale of these shares of common stock and warrants to purchase
shares of common stock satisfied the conditions of Rule 506 of Regulation D of
the Act and, as such, were exempt from the registration requirements of Section
5 of the Act as transactions not involving any public offering within the
meaning of Section 4(2) of the Act.
Stock options
The Company maintains a non-qualified stock option plan (the "Plan") which has
made available for issuance a total of 7.5 million shares of common stock. All
directors, full-time employees and consultants to the Company are eligible for
participation. Option awards are determined at the discretion of the Board of
Directors. Upon a change in control of the Company, all outstanding options
granted to employees and directors become vested with respect to those options
which have not already vested. Options outstanding expire at various dates
through June 2012.
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board (APB) Opinion No. 25. Under APB
No. 25, compensation cost is measured as the excess, if any, of the quoted
market price of the Company's stock at the date of grant over the exercise price
of the option granted. Compensation cost for stock options, if any, is
recognized ratably over the vesting period. In its complete annual financial
statements presented in its Form 10-KSB, the Company provides additional pro
forma disclosures as required under Statement of Financial Accounting Standards
No. 123 - "Accounting for Stock-Based Compensation" as if the fair value based
method of accounting had been applied to the Company's stock option grants.
From January 1, 2002 through June 30, 2002, the Company had the following
activity in options to purchase shares of common stock under the Plan:
Weighted Weighted
average # of average
# of exercise shares exercise
shares price exercisable price
------ ----- ----------- -----
Unexercised at January 1, 2002 4,534,316 $.46 3,919,316 $.49
Granted 132,812 .25
Becoming exercisable 165,312 .25
Exercised
Lapsed (539,250) .50 (508,000) .50
--------- ---------
Unexercised at June 30, 2002 4,127,878 $.46 3,576,628 $.45
========= ==== ========= ====
Common stock reserved for future issuance
At June 30, 2002, a total of 11,516,832 shares of common stock were reserved by
the Company for issuance for the following purposes:
Purpose # of shares
----------------------------- ------------
Currently exercisable warrants expiring in
December 2005, exercisable at $.50 per share 387,500
March 2006, exercisable at $.50 per share 250,000
April 2006, exercisable at $.50 per share 175,000
March 2007, exercisable at $.25 per share 180,000
----------
992,500
Currently exercisable options 3,576,628
Granted options becoming exercisable in the future 551,250
Options available for future grants 1,936,454
Conversion of note payable 60,000
Conversion of preferred stock 4,400,000
----------
Total shares reserved 11,516,832
==========
NOTE 9 - COMMITMENTS
The Company occupies its office and laboratory facility on a month-to-month
basis under the terms of an operating lease agreement pursuant to which the
property owner is required to provide thirty days notice if he wants the Company
to vacate the premises. The lease currently provides for monthly rent of $4,000
and requires the Company to pay all property related expenses. The Company will
seek to negotiate a new long-term lease for its facility or search for an
alternative location in the event that a long-term agreement cannot be reached
for the existing premises. Management believes that the resolution of the
uncertainty with respect to the facility will not result in a significant
interruption in the operations of the Company.
NOTE 10 - SUBSEQUENT EVENTS
Late in July 2002, the Company was awarded a subcontract with initial funding of
$200,000 from a prime contractor for the Department of Defense (DoD) to begin
the conversion of a commercially available gasoline engine to start and operate
on standard military fuels (also referred to as "heavy fuels") for use in an
unmanned aerial vehicle weapon system. A payment of $25,000 due upon the
issuance of the subcontract was received in early August 2002. The initial
subcontract funding permits a multi-phase program to begin immediately. The
Company expects, although there is no assurance, that the remaining funds needed
to complete the design and testing process to achieve a heavy fuel engine
prototype will be approved by the DoD sponsor later this year.
Following the award of this subcontract, the Company obtained a $30,000 loan
from one of its shareholders, with repayment of the loan secured by revenues
from the subcontract. The loan, bearing interest at 8%, is payable on January
31, 2003.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
Caution regarding forward-looking statements
Sections of this document, as well as all publicly disseminated material about
Sonex Research, Inc. (the "Company" or "Sonex"), contain information in the form
of "forward-looking" statements within the meaning of the Private Securities
Litigation Act of 1995 (the "Act"). Such statements are based on current
expectations, estimates, projections and assumptions by management with respect
to, among other things, trends affecting the Company's financial condition or
results of operations and the impact of competition. Words such as "expects",
"anticipates", "plans", "believes", "estimates", variations of such words, and
similar expressions are intended to identify such statements that include, but
are not limited to, projections of revenues, earnings, cash flows and contract
awards. Such forward-looking statements are not guarantees of future performance
and involve risks and uncertainties, all of which are difficult to predict and
many of which are beyond the control of the Company.
Risk factors
In order to obtain the benefits of the "safe harbor" provisions of the Act for
any such forward-looking statements, the Company cautions shareholders,
investors and prospective investors about significant factors which, among other
things, have in some cases affected the Company's actual results and are in the
future likely to affect the Company's actual results and cause them to differ
materially from those expressed in any such forward-looking statements.
Factors that could cause actual results to differ materially include the
specific risks listed below. These risks and uncertainties are not the only ones
faced by the Company or that may adversely affect its business. If any of the
following risks or uncertainties actually occur, the Company's business,
financial condition or results of operations could be materially adversely
affected.
o ability to generate cash flow from revenue or to secure financing
necessary to fund future operations
o ability to demonstrate commercial viability of its technology
o ability to complete technology development and demonstration programs
and execute licensing agreements that produce significant revenue
o ability to maintain and protect its patents
o ability to attract and retain skilled personnel
o changes in general economic conditions
o competition
Furthermore, since its inception in 1980, the Company has generated cumulative
net losses in excess of $22 million, and is likely to incur quarterly operating
losses for the foreseeable future. The business has not generated sufficient
cash flow to fund operations without resorting to external sources of capital.
In the event that funding from internal and external sources is insufficient,
the Company would have to cut back significantly its level of spending, which
could substantially curtail the Company's operations. These reductions could
have an adverse effect on the Company's relations with its potential customers.
The Company's success also depends in significant part on the continued services
of its key technical and senior management personnel. Losing one or more key
employees, including for reasons of poor health, disability, or death, could
have a material adverse effect on the Company's business, results of operations,
and financial condition. Due to the expense involved, the Company does not
maintain life insurance policies for any of its employees. Additionally, in
order to avoid long-term financial commitments, the Company does not have
employment agreements with any of its personnel.
Further, the market price of the Company's Common Stock could be affected
adversely by the substantial number of shares that are reserved for, and may be
issued in, the future. As of August 14, 2002, there were 21,588,669 shares of
Common Stock issued and outstanding, with an additional 11,516,832 shares
reserved for future issuance as follows: 4,400,000 shares issuable upon the
conversion of preferred stock; 6,064,332 shares issuable under the Company's
Stock Option Plan; 992,500 shares issuable upon the exercise of warrants; and
60,000 issuable upon the conversion of notes payable.
Overview of the Company and its technology
Sonex Research, Inc. ("Sonex" or the "Company"), incorporated in Maryland in
1980, is an engineering research and development firm that is seeking to
commercialize its patented proprietary technology (the "Sonex Combustion
System", "SCS" or "Ultra Clean BurnTM technology") for in-cylinder control of
ignition and combustion. The Company was co-founded in 1980 by Dr. Andrew A.
Pouring, a former Professor of Aerospace Engineering and Chairman of the
Department of Aerospace Engineering at the U.S. Naval Academy. At Sonex, Dr.
Pouring conducted basic research into the principle of in-cylinder control of
ignition and combustion, concentrating on the piston. By the late 1980's and
early 1990's, the development of the SCS had moved in the direction of
chemical/turbulent enhancement of combustion through investigation of the
effects of changing the chemical characteristics and fuel disbursement
characteristics within the combustion chamber.
The SCS technology for in-cylinder control of ignition and combustion is
designed to
o increase fuel mileage of gasoline engines
o reduce emissions of diesel engines
o permit small gasoline engines to run on safer diesel-type heavy fuels
The SCS improves the combustion of fuel in engines through design modification
of the pistons in four-stroke direct injected (DI) engines or the cylinder heads
in two-stroke spark-ignited (SI) gasoline engines to achieve chemical/turbulent
enhancement of combustion. The SCS process changes only a single engine
component while introducing no additional parts and is self-driven by the
combustion process.
Sonex believes it can show the technical feasibility of achieving higher fuel
economy standards while lowering emissions in a new class of DI gasoline engined
vehicles without sacrificing weight and vehicle safety. In 2000 Sonex introduced
its Stratified Charge Radical Ignition (SCRI) combustion technology, a new
branch of the SCS which Sonex believes will enable practical application of an
alternative combustion process known as homogeneous charge compression ignition
(HCCI) that has the potential for lowering both emissions and fuel consumption.
Unresolved issues with ignition have prevented practical implementation of HCCI
to date. Sonex believes it has attained the control of ignition that will make
HCCI viable for commercial application such that the SCRI piston design, with
further development, can enable DI gasoline engined automobiles, currently sold
only in markets outside the U.S. because of emissions problems, to become
emissions compliant in the U.S. while maintaining their current fuel consumption
advantages. In addition, the evolution of hybrid gasoline and electric powered
vehicles would be accelerated since a major improvement in engine fuel mileage
would provide opportunities for tradeoff of vehicle weight versus power.
SCS reductions of soot in diesel truck engines have been confirmed by an
independent engine consulting firm. SCS diesel engine designs require very
little engine modification, and should provide cost advantages over complex
exhaust aftertreatment devices. Evidence to date indicates that the SCS is a
significant new engine design variable, and that the synergy of the SCS in
combination with exhaust gas recirculation can reduce aftertreatment measures
and enable in-cylinder emissions reduction to meet future regulatory standards.
The SCS process for the conversion of reliable, lightweight, SI, two-stroke,
gasoline engines to start and operate on diesel-type heavy fuels has been
applied successfully in a variety of applications such as small, remotely
controlled military unmanned aerial vehicles (UAVs). The military now requires
such engines to operate on less volatile heavy fuels to reduce the hazard
associated with gasoline, making heavy fuel engines (HFEs) more suitable for
applications where gasoline storage and use are undesirable. Sonex HFEs achieve
power and fuel consumption substantially equal to that of the stock gasoline
engines. Potential applications of the SCS heavy fuel conversion process can be
expanded to other military and commercial uses.
Sonex is seeking committed business partners for further technical development
and marketing of the various SCS engine applications. Sonex believes that having
one or more such partners experienced in dealing with the engine and automotive
industries on state-of-the-art technological developments is a key to the
commercial acceptance of the SCS technology in the form of revenue-generating
license agreements for industrial production of SCS components.
As of August 14, 2002, the Company has four full-time and one-part-time
employees, and engages the part-time services of a consultant who serves as its
director of business development and manager of government programs. The Company
also engages the services of several other consultants as needed. The Company
has never experienced a strike or work stoppage, and believes its relations with
its employees are good.
Competition
The Company faces significant competition from the extensive research
departments of the world's major vehicle and engine manufacturers. These
companies exercise a bias toward in-house technologies over those developed by
independent suppliers. Competition also comes from several independent engine
testing and consulting firms around the world which are in the business of
developing engine technologies. The Company's competitors have substantially
greater financial, technical and marketing resources than does the Company.
Accordingly, the Company cannot be sure that it will have the resources or
expertise to compete successfully in the future.
Although the experience and financial resources of its competitors far exceed
those of the Company, management believes that the SCS can provide significant
advantages over the competition in terms of low cost, improved performance, and
simplicity.
Secrecy and non-disclosure
Due to the highly competitive nature of the world's automotive and truck
industries, in connection with its contracts and/or demonstration programs with
such manufacturers, Sonex is required to execute joint secrecy and disclosure
agreements that, in most cases, expressly prohibit the public disclosure of the
names and other significant information about the participants and the current
or proposed programs. Failure by Sonex to maintain this strict level of
confidentiality would jeopardize its relationship with these organizations.
Overview of SCS design modifications
The SCS technology for DI diesel engines improves the process of combustion
through a combination of chemical and fluid dynamic effects that occur by
modifying the engine's combustion chamber and the processes occurring within
that chamber. Patented SCS piston designs for four-stroke engines integrate
cavities called micro-chambers (MCs) which form a ring around the piston bowl,
with each MC positioned with respect to each spray from the fuel injector of a
DI engine. The MCs are designed to function as chemical reactors and are
connected to the piston bowl by vents. The MCs produce highly active radical
(chemical) species from a fraction of the fuel-air charge that are expelled on
the intake stroke of low compression ratio DI engines to fumigate incoming air.
The SCS "Low Soot" design, based on the Sonex U.S. patents issued in January
1999 and January 2001, is a recent invention in the series for the SCS for
"classical" DI diesel engines and involves re-arrangement of SCS features to
exploit new fundamental understandings of fluid dynamics. The SCS "Low Soot"
design has shown significant reductions in soot and oxides of nitrogen (NOx)
while maintaining fuel consumption and power. The key feature of the SCS DI
diesel technology is the presence of improved MCs in the piston which produce
and conserve intermediate and radical chemical species from a small portion of
the incoming fuel. The expulsion of these materials at high velocity enhances
turbulence mixing, achieving better than a 50% soot reduction and a 10% NOx
reduction in the Sonex single cylinder, DI, normally aspirated research engine
with no change in injection timing. Sonex has also demonstrated that the SCS
technology can be transferred to a modern turbocharged, intercooled DI diesel
engine.
SCS generated radical chemical species from a design similar to the "Low Soot"
design are also being used at Sonex in relation to an alternative combustion
process known as homogeneous charge compression ignition (HCCI) that is being
examined by the worldwide automotive industry. HCCI has been studied by many
researchers for years because, in theory, it can lower emissions while also
achieving reduced fuel consumption, because compression ignition does not
require the use of a spark plug; however, the lack of a method for controlling
the ignition point has prevented practical implementation of HCCI. Sonex
believes it has attained the control of ignition that will make HCCI viable for
commercial application by achieving radical assisted, four-stroke combustion to
enable fully controllable compression ignition at low pressures as a function of
fuel injection timing, a mode Sonex refers to as Stratified Charge, Radical
Ignition (SCRI).
With SCRI, radical (chemical) species that enable ignition are created by
interaction of the injected fuel spray with specially designed MCs in the piston
side wall. The net result is an engine that is fully controllable at all loads
and speeds without limitation, has extremely low emissions and the fuel economy
of a diesel engine. On a DI, single cylinder laboratory engine at Sonex, the
SCRI reduced NOx emissions by 80% and smoke by 90% while maintaining fuel
consumption, using diesel-type fuels.
The SCRI combustion chamber modifications make use of certain chemically active
products of combustion known as "free radicals" that, in conventional internal
combustion engines, are not carried from one combustion cycle to the next. The
SCRI process isolates free radicals to be carried from one combustion cycle to
the next to take advantage of the combustion enhancing properties of the free
radicals, thereby enabling ignition of all types of fuels and allowing more
complete combustion of the fuel. The SCRI relies on direct injection of fuel
into the cylinder (rather than in the intake manifold) as well as the production
of radicals for ignition.
The SCS engine design modifications for heavy fuel operation in two-stroke
engines consist of a machined cylinder head and combustion chamber insert
integrated with a glow plug starting system. For engines that have the cylinder
head and cylinder in one casting, the stock cylinder head is removed and the
remaining cylinder casting is decked and machined for cylinder head screws. The
SCS starting system consists of a heavy fuel vaporizer block positioned between
the carburetor and cylinder.
Primary Sonex initiatives
The Company seeks to commercialize its SCS technologies for a variety of engine
applications for commercial and military use. To date, Sonex has engaged in
development and demonstration programs with the engine industry and has sought
funding from the federal government for further development of the SCS
technologies. Some of these proposed projects are expected to achieve certain
milestones that will be key to the commercial development of the SCRI process
for automotive engines.
The next few paragraphs provide an overview of the primary opportunities for
Sonex. Additional detailed information can be found in the Company's December
31, 2001 Annual Report on Form 10-KSB.
Gasoline engined vehicles: With its SCRI process, Sonex intends to show the
technical feasibility of achieving higher fuel economy standards while lowering
emissions in a new class of DI gasoline engined vehicles without sacrificing
weight and vehicle safety. Such an achievement could also accelerate the
evolution of hybrid gasoline and electric powered vehicles since a major
improvement in engine fuel mileage would provide opportunities for tradeoff of
vehicle weight versus power.
Initially, Sonex must transition the results achieved by its SCRI process using
a single-cylinder laboratory engine on diesel-type fuels to gasoline.
Preliminary work on gasoline at Sonex has demonstrated that the SCRI process
does achieve the desired ignition and high rate of heat releases which are
necessary to achieve improved fuel consumption and lower emissions. The first
stage of this effort, expected to take at least six months, will establish
feasibility and design parameters and must also take place on a single cylinder
engine. The emphasis on this first phase will be to establish a knowledge base
upon which a prototype engine can be designed in a second phase.
Immediately following the first stage, Sonex would be in a solid position to
work with the auto industry on demonstration projects to transition SCRI to
multi-cylinder engines so gasoline can be burned effectively in eventual
production engines of all sizes. Fortunately, demonstration projects with
automotive manufacturers could provide results fairly quickly since the
sparkless SCRI process can advantageously employ the centrally located spark
plug hole of most production 4-valve per cylinder engines for the installation
of the injector.
Truck diesel engines: Sonex has engaged in development and demonstration
programs with various international truck diesel engine manufacturers. The SCS
"Low Soot" piston design for the reduction of emissions require very little
engine modification, and should provide cost advantages over complex exhaust
aftertreatment devices.
Recently one the world's leading engine engineering and powertrain consulting
firms, Ricardo Consulting Engineers of the U.K., confirmed the soot reduction
capability of the SCS "Low Soot" design in a DI diesel engine used in
medium-duty trucks. Ricardo published the findings in a technical paper
presented at the Society of Automotive Engineers' May 2002 Fuels and Lubes
Conference. Ricardo is currently introducing the SCS "Low Soot" design results
to engine manufacturers and piston suppliers while Sonex continues its own
efforts in that regard.
Heavy fuel engines: The Company, in its laboratory and under contract with the
U.S. military and defense contractors, also has applied a proprietary patented
SCS starting system and modified combustion chamber to the conversion of
reliable, lightweight, SI, two-stroke, gasoline engines to start and operate on
JP-5/JP-8 standard military fuels (also referred to as "heavy fuels") in a
variety of applications such as small, remotely controlled military UAVs. The
military now requires such engines to operate on less volatile heavy fuels to
reduce the hazard associated with gasoline, making HFEs more suitable for
applications where gasoline storage and use are undesirable. The requirement for
a single military fuel is also a logistics issue, as the military seeks to
minimize the number and complexity of fuels.
Sonex HFEs achieve power and fuel consumption substantially equal to that of the
stock gasoline engines. The Company has performed HFE conversions for various
sizes of small gasoline engines for UAVs, and expects to be awarded additional
contracts from the U.S. Department of Defense (DoD) and or its prime
contractors, although there can be no assurance.
Technology marketing partners: Sonex believes commercial acceptance of the SCS
technology can be accelerated through the establishment of relationships with
entities which possess technical development and marketing capabilities within
the engine industry. In addition to the relationship with Ricardo, Sonex has
been in exploratory discussions with another leading engine engineering and
powertrain consulting firm regarding a formal arrangement for the technical
development and marketing of the various SCS engine applications.
Financial position and liquidity
Because of continuing cash flow difficulties, since the fall of 2001 the
Company's officers have received only a small portion of the cash compensation
due them. In December 2001 Sonex took steps to reduce further its monthly cash
requirements by eliminating one full-time position in its shop and by
restructuring compensation arrangements with its part-time consultants. A second
full-time position became vacant at the end of February 2002.
As of June 30, 2002, the Company had available cash and equivalents of $21,158
and accounts receivable of $7,055. In July 2002 the Company was awarded a
subcontract with initial funding of $200,000 from a military prime contractor. A
payment of $25,000 due upon the issuance of the subcontract was received in
early August 2002. Following the award of this subcontract, the Company obtained
a $30,000, six-month loan from one of its shareholders, with repayment of the
loan secured by revenues from the subcontract.
Since early 2001, the Company's officers have voluntarily and at their own
discretion deferred receipt of payment of significant portions of their current
wages to reduce the Company's monthly cash requirements. Such wages payable to
the Company's officers totaling $151,342 are included in the total of accrued
wages as of June 30, 2002. The continued deferral of portions of current wages
by the Company's officers cannot be expected to continue indefinitely, and the
Company will be required to pay such accrued wages as soon as cash flow permits.
The amount and timing of such payments will be determined at the discretion of
the Company's officers, as these accrued wages are not subject to the terms of
the Company's written agreement with current and former employees to defer
payment of portions of their salaries as described in Note 6 to the accompanying
financial statements.
Based upon available resources, current and projected spending levels, and
expected revenue from current and anticipated contracts, management believes the
Company will have sufficient capital to fund operations until sometime during
the fourth quarter of 2002. The Company's prospects beyond that time are
dependent upon its ability to enter into significant funded contracts for the
further development of its SCS technology, establish joint ventures or strategic
partnerships with major industrial concerns, or secure a major capital infusion.
There is no assurance that the Company will be able to achieve these objectives.
If these objectives are not achieved, the Company will have to reduce the scope
of its operations even further, primarily by laying off its remaining employees
and, possibly, by abandoning its facility. These circumstances could lead to
bankruptcy as well.
The Company has high expectations, however, of receiving one or more additional
revenue-generating contracts from the military in the near future for heavy fuel
engine development. Once such contracts are secured, the Company will supplement
its workforce as needed with part-time personnel before defining and filling
full-time positions. Sonex also intends to seek a commercial marketing partner
experienced in dealing with the industry on state-of-the-art technological
developments. In addition, in May 2002 the Company engaged the services of a
professional investor relations firm to develop, implement and maintain an
ongoing program to increase the investment community's awareness of Sonex
activities.
Results of operations
A net loss of $197,574 was recorded for the first six months of 2002, as
compared to $358,519 for the corresponding period in 2001, a decrease of
$160,945. The decrease in the loss was due primarily to substantially lower
personnel costs in 2002 versus 2001, resulting from a reduction in the
workforce.
Revenue and cost of revenue:
Six months ended
June 30,
------------------------------
2002 2001
------------ -------------
Defense revenue $ 86,517 $ 33,774
Commercial revenue 50,000
------------ -------------
$ 86,517 $ 83,774
============ =============
Cost of revenue $ 40,869 $ 21,424
============ =============
Defense contracts relate to the Company's technology for conversion of
commercial gasoline fueled engines used in UAVs and the like to heavy fuel
operation. Commercial revenue earned in connection with the Company's DI diesel
engine piston technology is subject to the negotiated amount, if any, that an
engine manufacturer is willing to provide in funding to partially offset the
development costs incurred by the Company in applying its technology to one of
the manufacturer's engines. Cost of revenue primarily consists of direct labor
charges and direct purchases attributable to funded programs.
Research and development (R&D) expenses:
R&D expenses for the first six months of the year decreased by $145,675, or 53%,
from $274,769 in 2001 to $129,094 in 2002, almost entirely due to lower
personnel costs. Net R&D personnel costs, after reclassification of amounts
charged to cost of revenue, decreased by $117,095, or 60%, from $194,901 in 2001
to $77,806 in 2002. Amounts charged to cost of revenue were $17,326 in 2001 and
$38,625 in 2002, resulting in total R&D personnel costs before reclassification
of $212,227 in 2001 and $116,431 in 2002, a decrease of $95,796, or 45%.
The decrease in overall R&D personnel costs resulted from a reduction in the
workforce, including consultants, which was placed in effect late in 2001 and
continued into the first quarter of 2002. Salaries and wages decreased by
$54,662, and payroll taxes and benefits decreased by $11,988. The Company
discontinued its consulting agreement at the end of 2001 with the individual
residing in Europe who served as R&D Supervisor and International Liaison
Officer. This individual was compensated in the form of restricted stock and
cash, with related charges totaling $33,433 in the first half of 2001. Charges
for other consultants and temporary personnel increased $4,287 from 2001 to
2002.
Another decrease of $18,961 from the first half of 2001 to 2002 resulted from
lower charges for the write-off of unamortized costs of patents abandoned, from
$21,368 in 2001 to $2,407 in 2002. In addition, project parts and supplies,
which include engine parts and other items used or consumed in engine testing
and in the machine shop, decreased $7,952, from $14,082 in for the first half
2001 to $6,130 in 2002.
General and administrative (G&A) expenses:
Total G&A expenses for the first six months of the year decreased by $30,951, or
21%, from $147,262 in 2001 to $116,311 in 2002. The largest expense category,
personnel costs, accounted for most of the reduction in total G&A expenses.
Personnel costs decreased $29,884, from $108,250 in 2001 to $78,366 in 2002, or
28%, primarily as a result of lower charges for consulting services, which
declined by $13,156 from $40,656 in 2001 to $27,500 in 2002. Charges for
consulting services for the first half of 2001 included $10,000 related to the
former president of the Company, who was engaged on a part-time basis under a
consulting agreement that provided for annual compensation of $20,000. This
arrangement was terminated by mutual agreement effective June 30, 2001, and in
September 2001 this individual resigned as president but remains on the Board of
Directors. An additional $14,880 in 2001 represents amortization of deferred
compensation of charges resulting from the grant of stock options in 1997 to the
president by the Company's principal shareholder. Amortization of the related
charges ended in December 2001.
Professional fees increased $6,642, from $14,373 in 2001 to $20,835 in 2002, or
45%, because during the second quarter of 2002 the Company engaged the services
of an investor relations firm. Such charges totaled $6,745 in 2002 while there
were no related charges in 2001.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4 Instruments defining the rights of security holders (contained
in the Articles of Incorporation and By-laws, as amended,
filed with the 1992 Annual Report on Form 10-KSB)
A Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
On April 4, 2002, the Registrant filed a Current Report on Form 8-K to
disclose that it had raised capital of $60,000 and had been awarded a
$92,000 contract for application of its heavy fuel engine technology.
On May 28, 2002, the Registrant filed a Current Report on Form 8-K to
report that there had been no adverse developments to account for the
recent and sudden decline in the price of the Registrant's common stock,
and that management remains confident in the Registrant's prospects.
On June 24, 2002, the Registrant filed a Current Report on Form 8-K to
disclose the engagement of The Scottsdale Group as its investor relations
consultant.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereto duly
authorized.
SONEX RESEARCH, INC.
(Registrant)
/s/ George E. Ponticas
----------------------------
by: George E. Ponticas
Chief Financial Officer
August 14, 2002
EXHIBIT A
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Sonex Research, Inc. (the
"Company") on Form 10- QSB for the quarter ending June 30, 2002, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), the
undersigned certify, pursuant to and for the purposes of 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
SONEX RESEARCH, INC.
/s/ Andrew A. Pouring /s/ George E. Ponticas
------------------------ ------------------------
Andrew A. Pouring George E. Ponticas
Chief Executive Officer Chief Financial Officer
August 14, 2002