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 September 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 21,592,669 shares of the Issuer's $.01 par value Common Stock
outstanding at November 18, 2002.
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 September
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, 2000, 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
March 30, 2001, 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
November 13, 2002
SONEX RESEARCH, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
September 30, December 31,
ASSETS 2002 2001
------------ ------------
Current assets
Cash and equivalents $ 45,225 $ 3,355
Accounts receivable 28,989 37,828
Prepaid expenses 22,938 25,783
Loans to officers and employees 22,500 22,500
------------ ------------
Total current assets 119,652 89,466
Notes receivable from officers and employees 20,572 18,125
Patents and technology, net of accumulated
amortization of $59,155 in 2002 and
$44,638 in 2001 204,962 204,088
Property and equipment, net of accumulated
depreciation of $451,872 in 2002 and
$434,031 in 2001 54,901 57,249
------------ ------------
Total assets $ 400,087 $ 368,928
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 59,696 $ 46,923
Note payable to shareholder 30,632
Convertible note to shareholder 6,184
Accrued compensation and benefits 356,745 221,228
------------ ------------
Total current liabilities 453,257 268,151
------------ ------------
Deferred compensation 894,175 857,944
------------ ------------
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: 21,592,669 in 2002 and
21,212,669 in 2001 215,927 212,127
Additional paid-in capital 21,410,902 21,334,577
Accumulated deficit (22,589,574) (22,319,271)
------------ ------------
Total stockholders' equity/(deficit) (947,345) (757,167)
Commitments (Note 10) ------------ ------------
Total liabilities and stockholders' equity $ 400,087 $ 368,928
============ ============
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC..
CONDENSED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Revenue
Defense/government $ 120,308 $ 79,936 $ 206,825 $ 113,710
Commercial 50,000 100,000
---------- ---------- ---------- ----------
120,308 129,936 206,825 213,710
---------- ---------- ---------- ----------
Costs and expenses
Cost of revenue 37,952 44,552 78,821 65,976
Research and development 66,671 100,083 195,765 374,852
General and administrative 88,688 84,390 204,999 231,652
---------- ---------- ---------- ----------
193,311 229,025 479,585 672,480
---------- ---------- ---------- ----------
Net loss from operations 73,003 99,089 272,760 458,770
Investment and other income (274) (116) (2,457) (1,278)
---------- ---------- ---------- ----------
Net loss 72,729 98,973 270,303 457,492
Accumulated deficit
Beginning 22,516,845 21,987,435 22,319,271 21,628,916
---------- ---------- ---------- ----------
End $22,589,574 $22,086,408 $22,589,574 $22,086,408
========== ========== ========== ==========
Weighted average number of
shares outstanding 21,621,734 20,342,731 21,476,544 19,947,173
========== ========== ========== ==========
Net loss per share $.003 $.005 $.013 $.023
===== ===== ===== =====
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF PAID-IN CAPITAL
(Unaudited)
Price Preferred stock Common stock Additional
per ($.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 $20,430,476
February exercise of
warrants .35 285,000 2,850 96,900
March for services .40 24,130 241 10,125
June exercise of warrants .375 196,667 1,967 71,783
June exercise of warrants
for notes .375 48,333 483 17,642
June for services .41 31,538 315 12,695
September for services .24 56,877 569 13,181
December private placement .25 775,000 7,750 186,000
December for services .25 54,154 542 12,996
Stock option compensation 45,875
Amortization of deferred
compensation from grant of
stock options 29,764
--------- ------ ---------- ------- ----------
Balance, December 31, 2000 1,540,001 15,400 19,479,868 194,799 20,927,437
March private placement .25 300,000 3,000 72,000
March for services .25 54,577 546 13,099
April private placement .25 125,000 1,250 30,000
June private placement .20 325,000 3,250 61,750
June for services .29 44,916 449 12,667
August payment of stock
subscription .20 25,000 250 4,750
September for services .25 55,000 550 13,200
October private
placement .15 750,000 7,500 105,000
December for services .25 53,308 533 12,794
December forgiveness
of payables 10,000
Stock option compensation 42,120
Amortization of deferred
compensation from grant of
stock options 29,761
--------- ------ ---------- ------- ----------
Balance, December 31, 2001 1,540,001 15,400 21,212,669 212,127 21,334,577
(continued on next page)
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF PAID-IN CAPITAL
(Unaudited)
Price Preferred stock Common stock Additional
per ($.01 par value) ($.01 par value) paid-in
share Shares Amount Shares Amount capital
----- --------- ------ ---------- ------- ----------
(continued from previous page)
Balance, January 1, 2002 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
July for services .25 8,000 80 1,920
Stock option compensation 21,125
--------- ------ ---------- ------- ----------
Balance, Sept. 30, 2002 1,540,001$15,400 21,592,669$215,927 $21,410,902
========= ====== ========== ======= ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
-------------------------
2002 2001
---- ----
Cash flows from operating activities
Net loss loss $ (270,303) $ (457,492)
Adjustments to reconcile net loss to
net cash used in operating activities
Depreciation 11,400 13,500
Amortization of patents 14,407 37,853
Amortization of deferred compensation
from grant of stock options 22,321
Current charges paid in stock or options 26,125 69,380
Accrued interest on notes receivable from employees (2,447)
(Increase) decrease in accounts receivable 8,839 (67,596)
(Increase) decrease in prepaid expenses 2,844 (814)
Increase (decrease) in accrued liabilities 148,291 107,245
Increase (decrease) in deferred compensation 36,231 36,230
---------- ----------
Net cash used in operating activities (24,613) (239,373)
---------- ----------
Cash flows from investing activities
Acquisition of property and equipment (9,052) (1,985)
Additions to patents (15,281) (22,011)
---------- ----------
Net cash used in investing activities (24,333) (23,996)
---------- ----------
Cash flows from financing activities
Issuance of convertible note 6,184
Issuance of note payable to shareholder 30,632
Issuance of stock - private placement 54,000 176,250
---------- ----------
Net cash provided by financing activities 90,816 176,250
---------- ----------
Increase (decrease) in cash 41,870 (87,119)
Cash
Beginning of period 3,355 89,306
---------- ----------
End of period $ 45,225 $ 2,187
=========== ===========
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 nine-month periods ended September 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 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 ongoing deferral by its officers of portions of their salaries.
As described in Note 11, the Company was awarded a $744,246 contract in October
2002 from the Department of Defense (DoD), with the first milestone payment of
approximately $154,000 expected to be received by the end of November 2002.
Revenues from this and a previous contract from a DoD prime contractor are
expected to provide sufficient cash to fund the Company's operating requirements
for the next several months.
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 $188,664 are included in the total of accrued
wages as of September 30, 2002 in the accompanying unaudited balance sheet. The
continued deferral of portions of current wages by the Company's officers is
expected to end in December 2002; however, wages accrued to date are payable
upon demand. 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 7.
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 at least through June
30, 2003. 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. In October
2002 the Company engaged the services of a local venture capital consultant to
assist in the recruiting of qualified personnel and/or firms to supplement the
Company's management capabilities and position itself to consider viable
strategic opportunities.
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 - NOTES PAYABLE TO SHAREHOLDER
In connection with a private placement in March 2002 as detailed in Note 9, the
Company issued a note, initially payable on June 30, 2002, that is convertible
to equity at the option of the holder. The due date of the note was first
extended to September 30, 2002, and has since been extended to January 31, 2003.
The note has an interest rate of 6%, with a total of $184 in interest having
accrued through September 30, 2002.
In late July 2002 upon award of a $200,000 military subcontract, the Company
obtained a $30,000 loan from this same shareholder, with repayment secured by
revenues from the subcontract. The note, which is payable on January 31, 2003,
has an interest rate of 8%, with a total of $632 in interest having accrued
through September 30, 2002.
NOTE 6 - ACCRUED COMPENSATION AND BENEFITS
Accrued compensation consists of the following amounts payable to current and
former employees:
September 30, December 31,
2002 2001
-------------- --------------
Accrued wages $ 217,126 $ 70,536
Accrued consulting fees 27,345 9,692
Accrued bonuses 55,000 83,000
Accrued vacation pay 57,274 58,000
-------------- --------------
$ 356,745 $ 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 $188,664 are included in the total of accrued
wages as of September 30, 2002. The continued deferral of portions of current
wages by the Company's officers is expected to end in December 2002; however,
wages accrued to date are payable upon demand. 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 7. 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. 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 in March 2002 as detailed in Note 9, 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 7. The amount of accrued
vacation included above that was payable to the Company's officers at September
30, 2002 and December 31, 2001 was $42,245 and $41,406, respectively.
NOTE 7 - 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:
September 30, December 31,
2002 2001
-------------- --------------
Current officers $ 561,568 $ 525,337
Current employees and consultants 62,088 62,088
Former officers and other employees 270,519 270,519
-------------- --------------
$ 894,175 $ 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 September 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 8 - 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. Net operating loss carryforwards of approximately
$1,838,000 and capital loss carryforwards of approximately $133,000 are
scheduled to expire at the end of 2002.
NOTE 9 - STOCKHOLDERS' EQUITY
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 September 30, 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 September 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 September 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 211,562 .25
Becoming exercisable 306,562 .30
Exercised
Lapsed (539,750) .50 (508,500) .50
--------- ---------
Unexercised at Sept. 30, 2002 4,206,128 $.45 3,717,378 $.47
========= ==== ========= ====
Common stock reserved for future issuance
At September 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 3,717,378
Granted options becoming exercisable in the future 488,750
Options available for future grants 1,858,204
Conversion of note payable 60,000
Conversion of preferred stock 4,400,000
----------
Total shares reserved 11,516,832
==========
NOTE 10 - 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 11 - SUBSEQUENT EVENTS
In October 2002 the Company was awarded a $744,246 contract from the Defense
Advanced Research Projects Agency (DARPA) to begin the design and development of
a heavy fuel conversion process for a gasoline automotive engine for potential
use in an experimental helicopter-type unmanned aerial vehicle (UAV). The first
milestone payment from DARPA of approximately $154,000 is expected to be
received by the end of November 2002.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
Caution regarding forward-looking statements
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 November 14, 2002, there were 21,592,669 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.
The SCS processes for DI engines are applicable to: (1) classical diesels as a
means to reduce particulate emissions with no fuel consumption increase and, if
used in conjunction with high levels of exhaust gas recirculation (EGR), to
reduce oxides of nitrogen (NOx) and soot with a slight fuel consumption
increase; and (2) gasoline combustion based on compression ignition and high
rates of heat release ("lean burn-fast burn") at normal gasoline engine peak
cylinder pressures to improve fuel economy with the potential to reduce
emissions to EPA Tier II criteria.
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 EGR 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. Currently,
contracts to Sonex from the U.S. Department of Defense (DoD) and its prime
contractors involve development efforts that should provide definitive
conclusions as to the commercial viability of the patented SCS technology for
in-cylinder control of ignition and combustion.
As of November 18, 2002, the Company has seven full-time employees and
one-part-time employee, 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 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.
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 is now working on the conversion of larger gasoline
engines.
In late July 2002 the Company was awarded initial funding of $200,000 under a
subcontract from Science Applications International Corporation (SAIC) of San
Diego, to begin the conversion of a commercially available gasoline engine of
approximately 75 horsepower to start and operate on heavy fuels for use in a UAV
weapon system. SAIC, a leader in the development of advanced gun weapon systems
including launchers and smart projectiles, is the DoD prime contractor for LEWK
(Loitering Electronic Warfare Killer), a joint program endorsed and funded by
the Air Force, Navy, Army, and Marine Corps. The objective of the LEWK program,
an Advanced Concept Technology Demonstration (ACTD), is to develop and
demonstrate the military utility of a low cost flying "truck", or loitering UAV,
system with a 200-pound payload, capable of providing several hours of
continuous EW jamming and loitering "on-demand" warhead delivery.
In October 2002 the Company was awarded a $744,246 contract from the Defense
Advanced Research Projects Agency (DARPA) to begin the design and development of
an HFE conversion process for a gasoline automotive engine for potential use in
the A160 Hummingbird, an experimental helicopter-type UAV under development as
part of the joint DARPA/Army Future Combat Systems (FCS) program. The contract
program with DARPA will focus on the SCRI process to convert an existing SI,
four-stroke, gasoline engine to heavy fuel operation.
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
As of September 30, 2002, the Company had available cash and equivalents of
$45,225 and accounts receivable of $28,989 related to the subcontract awarded in
late July 2002 by SAIC, which amounts were collected during October 2002. The
first milestone payment from the October 2002 DARPA conract of approximately
$154,000 is expected to be received by the end of November 2002. With the
receipt of the SAIC and DARPA contracts, the Company has supplemented its
workforce by hiring additonal full-time and part-time personnel. Revenue from
these two contracts, performance on which will extend well into 2003, is
expected to provide sufficient cash to fund the Company's operating requirements
for the next several months.
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 $188,664 are included in the total of accrued
wages as of September 30, 2002 in the accompanying unaudited financial
statements. The continued deferral of portions of current wages by the Company's
officers is expected to end in December 2002; however, wages accrued to date are
payable upon demand. 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 7
to the accompanying unaudited 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 at least through June
30, 2003. 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. In October
2002 the Company engaged the services of a local venture capital consultant to
assist in the recruiting of qualified personnel and/or firms to supplement the
Company's management capabilities and position itself to consider viable
strategic opportunities.
Results of operations
A net loss of $270,303 was recorded for the first nine months of 2002, as
compared to $457,492 for the corresponding period in 2001, a decrease of
$187,189, or 41%. 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:
Nine months ended
September 30,
2002 2001
---------- ----------
Defense/government revenue $ 206,825 $ 113,710
Commercial revenue 100,000
---------- ----------
$ 206,825 $ 213,710
========== ==========
Cost of revenue $ 78,821 $ 65,976
========== ==========
Defense/government contracts relate to the Company's technology for conversion
of commercial gasoline fueled engines used in UAVs and the like to heavy fuel
operation. Such revenue increased by $93,115 from 2001 to 2002, primarily as a
result of the receipt in late July 2002 of the SAIC contract for the LEWK UAV.
Revenue from this contract recognized during the third quarter of 2002 totaled
$105,133.
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. All of the commercial revenue for 2001 was
recognized in connection with a development and demonstration program with a
foreign diesel engine manufacturer for the Sonex SCRI application. In 2002 the
manufacturer declined to continue with the program.
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 nine months of the year decreased by $179,087, or
48%, from $374,852 in 2001 to $195,765 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 $137,483, or 53%, from $257,249 in 2001
to $119,766 in 2002. Amounts charged to cost of revenue were $61,130 in 2001 and
$63,613 in 2002, resulting in total R&D personnel costs before reclassification
of $318,379 in 2001 and $183,379 in 2002, a decrease of $135,000, or 42%.
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
$80,882, and payroll taxes and benefits decreased by $19,118. 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 $47,974 in the first nine months of 2001.
Charges for other consultants and temporary personnel increased $12,974 from
2001 to 2002.
Another decrease of $20,846 from the first nine months of 2001 to 2002 resulted
from lower charges for the write-off of unamortized costs of patents abandoned,
from $23,253 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 that are not charged to cost of revenue, decreased
$14,379, from $19,120 in the first nine months of 2001 to $4,741 in 2002. Total
depreciation and patent amortization decreased from $28,100 in 2001 to $23,400
in 2002, or $4,700. Other expenses in total decreased by $1,679 from 2001 to
2002.
General and administrative (G&A) expenses:
Total G&A expenses for the first nine months of the year decreased by $26,653,
or 12%, from $231,652 in 2001 to $204,999 in 2002. The largest expense category,
personnel costs, accounted for most of the reduction in total G&A expenses.
Personnel costs decreased $35,690, from $161,812 in 2001 to $126,122 in 2002, or
22%. Specifically, consulting services declined by $15,205, from $59,101 in 2001
to $43,896 in 2002. Charges for consulting services for the first nine months 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
$22,321 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. Total salaries and benefits increased $1,836,or 2%, from $80,390
in 2001 to $82,226 in 2002,
Professional fees increased $16,412, from $17,579 in 2001 to $33,991 in 2002, or
93%, primarily because during the second quarter of 2002 the Company engaged the
services of an investor relations firm. Such charges totaled $13,682 in 2002,
including $5,000 paid in the form of restricted stock, while there were no
related charges in 2001. Other expenses in total decreased from $52,261 in 2001
to $44,886 in 2002, or $7,375.
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 August 5, 2002, the Registrant filed a Current Report on Form 8-K to
disclose that it had been awarded a $200,000 contract for application of
its heavy fuel engine technology.
On September 3, 2002, the Registrant filed a Current Report on Form 8-K
containing a copy of the Letter to Shareholders that would appear in the
Registrant's 2001 Annual Report to be included in proxy materials for the
2002 Annual Meeting of Shareholders scheduled for October 9, 2002.
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
November 18, 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 September 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
November 18, 2002