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, 2001
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 21,159,361 shares of the Issuer's $.01 par value Common Stock
outstanding at November 14, 2001.
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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 on pages 3 through
10 of this Form 10-QSB Quarterly Report of Sonex Research, Inc. (the "Company")
as of September 30, 2001. 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 12, 2001
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SONEX RESEARCH, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
September 30, December 31,
ASSETS 2001 2000
------------ ------------
Current assets
Cash and equivalents $ 2,187 $ 89,306
Accounts receivable 84,936 17,340
Prepaid expenses 27,956 27,142
Loans to officers and employees 22,500 22,500
------------ ------------
Total current assets 137,579 156,288
Notes receivable from officers and employees 18,125 18,125
Patents and technology, net of accumulated
amortization of $48,123 in 2001 and
$39,600 in 2000 199,865 215,707
Property and equipment, net of accumulated
depreciation of $438,531 in 2001 and
$425,031 in 2000 57,511 69,026
------------ ------------
Total assets $ 413,080 $ 459,146
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 78,853 $ 41,775
Accrued wages 84,474 6,807
Accrued bonus and vacation pay 83,500 91,381
------------ ------------
Total current liabilities 246,827 139,582
------------ ------------
Deferred compensation 847,074 810,844
------------ ------------
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, 48,000,000 shares
authorized - shares issued and outstanding:
20,409,361 in 2001 and 19,479,868 in 2000 204,094 194,799
Additional paid-in capital 21,186,093 20,927,437
Accumulated deficit (22,086,408) (21,628,916)
------------ ------------
Total stockholders' equity/(deficit) (680,821) (491,280)
------------ ------------
Total liabilities and stockholders' equity $ 413,080 $ 459,146
============ ============
The accompanying notes are an integral part of the financial statements.
- 3 -
SONEX RESEARCH, INC..
CONDENSED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
(Unaudited) Unaudited)
Three months ended Nine months ended
September 30, September 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Revenue
Defense $ 79,936 $ 29,270 $ 113,710 $ 293,058
Commercial 50,000 0 100,000 70,000
---------- ---------- ---------- ----------
129,936 29,270 213,710 363,058
---------- ---------- ---------- ----------
Costs and expenses
Cost of revenue 44,552 34,919 65,976 186,992
Research & development 100,083 120,978 374,852 340,514
General & administrative 84,390 81,871 231,652 244,353
---------- ---------- ---------- ----------
229,025 237,768 672,480 771,859
---------- ---------- ---------- ----------
Net loss from operations 99,089 208,498 458,770 408,801
Other (income)/expense
Investment and other income (116) (1,241) (1,278) (3,588)
---------- ---------- ---------- ----------
Net loss 98,973 207,257 457,492 405,213
Accumulated deficit
Beginning 21,987,435 21,224,942 21,628,916 21,026,986
---------- ---------- ---------- ----------
End $22,086,408 $21,432,199 $22,086,408 $21,432,199
========== ========== ========== ==========
Weighted average number of
shares outstanding 20,342,731 18,594,455 19,947,173 18,396,873
========== ========== ========== ==========
Net loss per share $.005 $.011 $.023 $.022
===== ===== ===== =====
The accompanying notes are an integral part of the financial statements.
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SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF PAID-IN CAPITAL
(Unaudited)
Price Preferred stock Common stock Additional
per ($.01 par value) ($.01 par value) paid-in
share Shares Amount Shares Amount capital
----- --------- ------ ---------- ------- ----------
Balance, January 1, 1999 1,540,001$15,400 17,642,860$176,429 $20,209,503
March for services $.44 20,975 210 9,098
June for services .46 17,925 179 8,071
September for services .38 36,923 369 13,593
December for services .32 36,803 368 11,478
April and December
option exercises .50 255,000 2,550 124,950
Correction of stock ledger (2,317) (23) 23
Stock option compensation 24,000
Amortization of deferred
compensation from grant of
stock options 29,760
--------- ------ ---------- ------- ----------
Balance, December 31, 1999 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 .25 325,000 3,250 61,750
June for services .25 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
Stock option compensation 28,870
Amortization of deferred
compensation from grant of
stock options 22,321
--------- ------ ---------- ------- ----------
Balance, Sept. 30, 2001 1,540,001$15,400 20,409,361$204,094 $21,186,093
========= ====== ========== ======= ===========
The accompanying notes are an integral part of the financial statements.
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SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
-------------------------
2001 2000
---- ----
Cash flows from operating activities
Net loss $ (457,492) $ (405,213)
Adjustments to reconcile net loss to
net cash used in operating activities
Depreciation 13,500 13,972
Amortization of patents 37,853 48,058
Amortization of deferred compensation 22,321 22,323
Current charges paid in stock or options 69,380 59,126
(Increase) decrease in accounts receivable (67,596) 18,345
(Increase) decrease in prepaid expenses (814) 2,379
Increase (decrease) in current liabilities 107,245 44,048
Increase (decrease) in deferred compensation 36,230 36,230
----------- ----------
Net cash used in operating activities (239,373) (160,732)
----------- ----------
Cash flows from investing activities
Acquisition of property and equipment (1,985) (1,386)
Additions to patents (22,011) (31,092)
----------- ----------
Net cash provided by (used in)
investing activities (23,996) (32,478)
----------- ----------
Cash flows from financing activities
Issuance of stock - exercise of warrants 173,500
Issuance of stock - private placement 176,250
----------- ----------
Net cash provided by financing activities 176,250 173,500
----------- ----------
Increase (decrease) in cash (87,119) (19,710)
Cash
Beginning of period 89,306 57,768
----------- -----------
End of period $ 2,187 $ 38,058
=========== ===========
The accompanying notes are an integral part of the financial statements.
- 6 -
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. Variations of the Company's technology have
been applied to all types of internal combustion engines, including those used
in personal and commercial vehicles as well as engines used in fixed or portable
utility applications. Sonex concentrates its commercial efforts on the
application of the SCS to the reduction of exhaust emissions in direct injected
turbocharged diesel engines. The Company's objective is to execute broad
agreements with engine manufacturers and their piston suppliers for industrial
production of SCS pistons 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 June 30, 2001 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2001. 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, 2000.
Certain reclassifications have been made to the prior period financial
statements to conform to the classifications used in the current period.
NOTE 3 - 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.
- 7 -
NOTE 4 - ACCRUED WAGES
Beginning in the first quarter of 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 $70,077 as of September 30,
2001 are included in the total of accrued wages reported on the accompanying
balance sheet, although that figure had been reduced to $60,199 as of October
31, 2001 as a result of payments made during the month. 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 5.
NOTE 5 - DEFERRED COMPENSATION
In order to help conserve the Company's limited cash resources, certain of the
Company's employees for several years have voluntarily deferred receipt of
payment of significant portions of their authorized annual salaries upon request
by 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. Beginning in January 1997, however,
there has been no further deferral of salary requested of the Company's
non-executive employees.
Deferred compensation outstanding is payable to the following classifications of
personnel:
Sept. 30, December 31,
2001 2000
---- ----
Current executive officers $ 514,467 $ 478,237
Current employees and consultants 62,088 62,088
Former officers and employees 270,519 270,519
--------- ---------
$ 847,074 $ 810,844
========= =========
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,
2002. 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.
- 8 -
NOTE 6 - INCOME TAXES
The Company has not incurred any federal or state income taxes since its
inception due to operating losses. At December 31, 2000, the Company had net
operating loss and capital loss carryforwards of approximately $16.2 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.
NOTE 7 - 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 September 30, 2001, 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 financing during March and April 2001 the Company raised $106,250
from a small number of the Company's shareholders, including its chief executive
officer and chief financial officer, who participated in previous private
financings of the Company. A total of 425,000 shares of the Company's common
stock and five-year warrants to purchase an additional 425,000 shares of common
stock at $.50 per share were issued in this financing.
In a private financing in June 2001 the Company issued 350,000 shares of common
stock for proceeds of $70,000 received from a small group of the Company's local
shareholders. A portion of the proceeds was in the form of a subscription
receivable of $5,000, which amount was received in August 2001.
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.
- 9 -
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 2011.
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 made
subsequent to 1994.
From January 1, 2001 through September 30, 2001, 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, 2001 4,326,216 $.52 3,760,716 $.52
Granted/becoming exercisable 129,375 .25 329,375 .41
Exercised 0 0
Lapsed (160,650) .50 (160,650) .50
--------- ---------
Unexercised at Sept. 30, 2001 4,291,941 $.50 3,929,441 $.51
========= ==== ========= ====
C
ommon stock reserved for future issuance
At June 30, 2001, a total of 11,664,591 shares of common stock were reserved by
the Company for issuance for the following purposes:
- 10 -
Purpose # of shares
----------------------------- -----------
Currently exercisable warrants expiring in
February 2002, exercisable at $.75 per share 167,759
March 2002, exercisable at $.75 per share 220,000
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
----------
1,200,259
Currently exercisable options 3,929,441
Granted options becoming exercisable in the future 362,500
Options available for future grants 1,772,391
Conversion of preferred stock 4,400,000
----------
Total shares reserved 11,664,591
==========
NOTE 8 - 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 9 - SUBSEQUENT EVENT
In a private financing in October 2001, the Company raised $112,500 from a small
number of the Company's shareholders, including its chief executive officer,
chief financial officer, and newest member of the Board of Directors, each of
whom participated in previous private financings of the Company. A total of
750,000 shares of the Company's common stock were issued in this transaction.
- 11 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
Caution regarding forward-looking statements
Sections of this Report, as well as all publicly disseminated material about
Sonex Research, Inc. ("Sonex" or the "Company"), 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. Accordingly, readers are
cautioned not to place undue reliance on such forward-looking statements.
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, but are
not limited to, the following:
o ability to generate cash flow from revenue or to secure financing
necessary to fund future operations
o ability to demonstrate commercial viability of technology
o ability to complete technology development and demonstration programs
and execute licensing agreements that produce significant revenue
o ability to attract and retain skilled personnel
o changes in general economic conditions
o competition
Overview of the Company and its technology
Sonex Research, Inc., 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 that is
- 12 -
designed to reduce emissions and increase fuel mileage of diesel and gasoline
engines. 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.
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.
The SCS improves the combustion of fuel in engines through design
modification of the pistons in four-stroke direct injected (DI) diesel engines
or the cylinder heads in two-stroke spark-ignited (SI) engines. Variations of
the Company's technology have been applied to all types of internal combustion
engines, including those used in personal and commercial vehicles (automobiles,
trucks, buses, boats, motorcycles) as well as engines used in fixed or portable
utility applications (motor generator sets, pumps, chain saws), whether SI or
compression ignited (CI), carburetted or fuel injected, using gasoline, diesel,
alcohol and/or other fuels.
For the past several years, Sonex has concentrated its commercial efforts on the
application of the SCS to the reduction of exhaust emissions in DI turbocharged
diesel engines. SCS designs reduce soot and other emissions while maintaining
fuel consumption and power. Management believes that the Company's piston-based
emissions reduction enabling technology for DI diesel engines, which changes
only a single engine component while introducing no additional parts and is
self-driven by the combustion process, can be an alternative to exhaust
aftertreatment. The Company is participating in demonstration and development
programs with some of the world's largest multi-national diesel engine
manufacturers with the goal of executing license agreements for industrial
production of SCS pistons.
The patented SCS 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. SCS DI diesel designs integrate one or more cavities as
microchambers which form a ring around the piston bowl, with each microchamber
positioned in line with a spray from the fuel injector. The microchambers
perform as reservoirs that produce active chemical species (partially reacted
charges) which are expelled at high velocity to enhance combustion and burn the
soot cloud. The microchambers are connected to the piston bowl by tunnel-like
vents that control the amount of fuel and air that enter the microchamber and
also control the amount of turbulence that is created when gases jet out of the
microchambers through these vents into the piston bowl. The position of the
microchambers is a critical factor in controlling the temperature of the
microchamber and the rate of reaction of gases that may be resident in the
microchamber at any one time.
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 DI
diesel engines and involves re-arrangement of SCS features to exploit new
fundamental understandings of fluid dynamics. The key feature of the SCS DI
diesel technology is the presence of improved microchambers 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
- 13 -
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.
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 is being examined by the worldwide
automotive industry. HCCI has been studied by many researchers for years because
of its potential for lowering both emissions and fuel consumption since
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.
With SCRI, radical (chemical) species that enable ignition are created by
interaction of the injected fuel spray with specially designed microchambers 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.
Management believes 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 while
maintaining their current fuel consumption advantages. The Company is seeking
committed industrial partners and/or funding assistance from agencies of the
U.S. government to provide substantial on-going financial support and technical
expertise to continue development of the SCRI.
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 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. Sonex-modified single-cylinder, 100cc HFEs have been
deployed aboard ship and on land by the U.S. Marine Corps (USMC) in the
Dragondrone UAV, the only UAV qualified for shipboard use.
As of November 12, 2001, the Company has five full-time employees and engages
the part-time services of several consultants on a regular basis. The Company
has never experienced a strike or work stoppage, and believes its relations with
its employees are good.
- 14 -
Competition
The Company faces significant competition from the extensive research
departments of the world's major vehicle and engine manufacturers. These OEMs
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, since no additional moving parts are added to the engine.
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 the Company is required to execute joint secrecy and
disclosure agreements that expressly prohibit the public disclosure of the
customers' names and other significant information. Failure by Sonex to maintain
this strict level of confidentiality would jeopardize the relationship of the
Company with its customers.
Current diesel engine programs
On a continuing basis for the past few years, the Company has performed
extensive design and development work on medium- and heavy-duty truck engines
for large foreign multi-national diesel truck engine original equipment
manufacturers (OEMs) in separate programs. The demonstration process involves
many stages, from proof of concept using screw-assembled prototype pistons
fabricated in-house by Sonex and tested by the engine manufacturer in its
laboratories, to working with piston suppliers for the fabrication of finished
pre-production pistons that will be used in field trials, and durability,
manufacturing optimization, and other tests required before the start of full
series production.
Also, in cooperation with the engine OEMs, the Company has worked with the major
piston suppliers to these manufacturers, providing engineering specifications
and drawings for their use in evaluating alternative production methods in
anticipation of eventual piston orders from the engine manufacturers. The most
extensive collaboration has been with the former T&N Piston Products Group of
the U.K., which was acquired in 1998 by Federal-Mogul Corp., a major
international supplier of engine components based in Southfield, Michigan. T&N
invested significant funds internally in developing innovative and economical
techniques of manufacturing Sonex pistons for series production, as well as
performing finite element, thermal and stress analyses to examine the effects of
stress on the Sonex piston under a variety of extreme conditions.
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Promising test results at Sonex of the SCS "Low Soot" design for "classical"
diesel engines using hand-assembled pistons led a foreign engine OEM to arrange
in 2001 for third party evaluation of the Sonex "Low Soot" diesel technology by
one of the world's leading independent engine R&D and testing firms. The test
engine is a turbocharged and intercooled six-cylinder, DI diesel engine used in
medium-duty trucks. Pre-production SCS pistons were fabricated by Federal-Mogul
for this evaluation. The test program was completed during the third quarter of
2001.
The engine R&D and testing firm recently issued its report confirming the soot
reduction capability of the SCS in this OEM's engine using pre-production
pistons. The observed results approximate those achieved by the Company in-house
with hand-assembled, experimental SCS pistons that showed a 50% reduction in
soot with 10% reduction in NOx while maintaining fuel consumption and power. The
Company and the engine R&D and testing firm are discussing additional
confirmatory testing and evaluating the marketing potential of this report. The
engine OEM is now assessing the program results before deciding on how to
proceed. Federal-Mogul, however, which recently filed for bankruptcy protection,
has informed the Company that it is focusing its limited resources on core
businesses and will no longer participate in SCS research. Sonex plans to focus
its attention to other piston suppliers who have evaluated earlier SCS designs.
In spring 2001 Sonex and a second foreign engine OEM reached agreement on a
joint feasibility study of the potential of the SCRI diesel design. The
objective of the study is to transfer the SCRI results achieved by Sonex on the
single-cylinder laboratory diesel engine to a modern, advanced, multi-cylinder,
naturally aspirated, medium- duty truck diesel engine that employs all of the
latest diesel engine technology such as a high pressure, electronically
controlled injection system, and turbo-charging. The Company has received
progress payments during the feasibility study and will be entitled to incentive
payments at the conclusion of the test program upon the achievement of certain
emissions reduction targets. The agreement also includes provisions pursuant to
which the engine OEM is granted priority rights to negotiate a license for the
SCRI diesel technology.
Testing has proceeded from the design stage to testing with screw-assembled SCS
pistons produced by the manufacturer under Sonex guidance. Recent testing has
moved to a turbo-charged engine and is expected to be completed before the end
of the year.
SCS SCRI Process for Gasoline Engines
Management believes 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 while
maintaining their current fuel consumption advantages.
Vehicle manufacturers are now trying to out do each other on fuel mileage, with
improvement of 15% being a major objective, but NOx emissions remain a problem.
U.S. firms are focusing their attention on hybrid propulsion technologies, such
as gasoline/diesel-electric power plants, rather than improvements in combustion
technology (more efficient ways of burning fuel). Hybrid power plants utilize
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the gasoline or diesel engine during steady speed operation. These engines
operate at high rpm to develop the needed power and suffer from added weight.
There are ongoing efforts in Japan, however, to achieve a new class of engines
known as GDI, Gasoline Direct Injected engines, that operate on high air-fuel
ratios. DI uses unrestricted air flow and a fuel injector in each cylinder of
the engine to provide precisely timed, metered fuel delivery to the combustion
chamber to overcome the air and fuel flow inefficiencies of present gasoline
engines. GDI engines have achieved reductions in gasoline consumption of 20% to
30%. Mitsubishi has produced over 800,000, five-passenger, 2,700 pound vehicles
with GDI engines that achieve 53 mpg, for sale in markets other than the U.S.
Significantly, all the GDI engines reported to date are complex, use a spark
plug to initiate conventional (non-homogeneous) combustion, require premium
fuel, and do not meet U.S. emissions standards for NOx regardless of the
catalytic converter technology.
All automobile manufacturers are familiar with the benefits of the GDI engine in
performance, fuel consumption and cost-to-manufacture, as well as the
challenging exhaust problem with NOx emissions in the presence of excess oxygen
that cannot be solved with a catalytic converter. Engine researchers know the
key to solving the GDI NOx problem is to replace spark ignited, lean combustion
with homogeneous, compression ignition and controlled, high rate heat release
combustion. The vexing challenge has been to achieve a combustion control
mechanism that works effectively over the range of engine operation expected of
an automotive application.
Worldwide automotive industry researchers have been studying HCCI because
compression ignition does not require the use of a spark plug; thus, in theory,
HCCI can lower emissions while also achieving reduced fuel consumption. The lack
of a method for controlling the ignition point, however, has prevented practical
implementation of HCCI.
With the SCRI process, Sonex believes it has the potential not only to make HCCI
viable for commercial application but also to leapfrog the Japanese GDI
accomplishments. The SCRI piston design could enable fuel- efficient GDI engines
to become emissions compliant and thereby improve fuel mileage of U.S. produced
automobile and light trucks by 25% to 30%. Later this fall Sonex will present a
paper on the SCRI at an international symposium of combustion engineers in
France, sponsored by the French Petroleum Institute, that will focus exclusively
on HCCI, or CAI (controlled auto-ignition) as it is also known in Europe.
This fall in its laboratory, Sonex has demonstrated the feasibility of
converting its single cylinder SCRI research engine, originally fueled with JP-5
and diesel, to operate on gasoline using the SCRI combustion process.
Considerable research remains to be done on the single cylinder engine to
establish the design parameters needed to transfer the process to a
multi-cylinder engine.
The Company is seeking committed industrial partners to provide substantial
on-going financial support and technical expertise to continue the work and
achieve these objectives. After establishing design parameters, the Company then
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
- 17 -
effectively in eventual production engines of all sizes. Fortunately,
demonstration projects with automotive manufacturers could provide results
fairly quickly since the sparkless SCRI can advantageously employ the centrally
located spark plug hole of most production 4-valve per cylinder engines for the
installation of the injector.
In March 2001 Dr. Andrew A. Pouring, CEO and founder of Sonex, testified in a
hearing before the House Committee on Armed Services' Subcommittee on Research
and Development on Innovative Research Companies. Dr. Pouring gave an overview
of the potential of the patented SCS, piston-based, engine technology for
in-cylinder control of ignition and combustion to reduce emissions and increase
fuel mileage of diesel and gasoline engines. The Company is following-up with
the Committee and is enlisting the aid of federal legislators to gain exposure
for the SCRI process.
Heavy fuel engines (HFEs)
Also at the hearing before the House Committee on Armed Services, Dr. Pouring
reported on the unresponsiveness of the military to the existing directive
mandating the elimination of gasoline in favor of JP-5/JP- 8 standard military
fuels (also referred to as "heavy fuels"), and how SCS heavy fuel engine (HFE)
technology can assist in the implementation of that directive. Sonex has
successfully applied a patented SCS starting system and modified combustion
chamber design to the conversion of reliable, lightweight small, spark-ignited,
carburetted, two-stroke, gasoline fueled engines of various sizes used in small,
remotely controlled military unmanned aerial vehicles (UAVs) to start and
operate on heavy fuels. Sonex-modified single-cylinder, two-stroke, 100cc HFEs
have been deployed aboard ship by the U.S. Marine Corps in the Dragondrone UAV,
and the Company has successfully completed heavy fuel conversions of other UAV
engines for the military.
UAVs conduct short-range tactical reconnaissance while operating virtually
unseen and unheard, taking pictures of battlefields and enemy installations and
relaying them back to ground forces. Existing UAV engines in the military's
inventory operate on gasoline. Because of safety and logistics concerns,
however, all military small engines, such as those powering UAVs, eventually
will be required to operate on less volatile, widely available heavy fuels used
by jet aircraft and most military vehicles.
The Company is assessing additional potential uses by the military for the SCS
HFE technology, as well as private sector opportunities. Operation of a
light-weight engine on high flash point fuels such as diesel and heavy fuels,
will reduce the hazard associated with gasoline, making such an engine much more
suitable for applications where gasoline storage is undesirable, such as in
diesel fueled utility engines used in pumps, generator sets, etc., in homes,
commercial buildings and boats. Other military applications for two-cycle HFEs
include standby generators, water pumps, chainsaws, earth tampers and outboard
engines.
Sonex also conducted a feasibility study in a single-cylinder laboratory engine
for the Navy using the SCRI combustion system that would allow conversion of an
eight-cylinder gasoline engine to heavy fuel use while retaining its light
- 18 -
weight and flexibility. The feasibility was proven, with the Sonex laboratory
engine achieving the fuel economy of a diesel and low emissions; however, rather
than proceed with a program to transfer the Sonex single-cylinder engine results
to the gasoline engine, which would retain its performance and lightweight
advantages, the Navy instead decided to examine conventional diesel and turbine
technologies.
Dr. Pouring told the Committee that Sonex seeks to capitalize on the success to
date with SCS HFEs by participation in new military programs, and that the
Company is seeking sponsors within the military who are obliged to make an
effort to comply with the directive on the elimination of gasoline.
In June 2001 the Company was awarded two contracts from the military for
prototype development of small HFEs for experimental UAVs. These projects, which
will be completed during the fourth quarter of 2001, could lead to subsequent
contracts for HFE optimization. The Company is also awaiting word on the
potential award of additional military contracts in the near future for
development of various sizes of HFEs.
Additional information on the Company's business, its technology, and its
management can be found in the Company's 2000 Annual Report on Form 10-KSB.
Financial position and liquidity
As of September 30, 2001, the Company had available cash and equivalents of
$2,187 and accounts receivable of $84,936. During October 2001 the Company
raised $112,500 in a private financing from a small group of investors,
including the Company's CEO and co-founder, Dr. Andrew A. Pouring, its CFO, Mr.
George E. Ponticas and Director John H. Drewanz, who joined the Board on October
1. From March 2001 through June 2001 the Company raised capital of $176,250 from
private financings.
Beginning in the first quarter of 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 total $70,077 as of September 30, 2001,
although that figure had been reduced to $60,199 as of October 31, 2001 as a
result of payments made during the month. 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 Company high expectations of receiving additional contracts from the
military in the near future for heavy fuel engine development. 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 through Deceember 31, 2001. In the
event that anticipated revenue is delayed or does not materialize, or if
additional short-term capital is not arranged, the Company will have to reduce
the scope of its operations in the fourth quarter. Furthermore, the Company's
prospects beyond that date are dependent upon its ability to enter into
significant funded contracts for the further development of its SCS technology,
- 19 -
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.
Results of operations
A net loss of $457,492 was recorded for the first nine months of 2001, as
compared to $405,213 for the corresponding period in 2000, an increase of
$52,279. The increase in the loss was due to substantially lower revenue for
defense department contracts, offset in part by the related decrease in costs
incurred for such contracts, in 2001 versus 2000.
Revenue and cost of revenue:
Nine months ended September 30,
2001 2000
---- ----
Defense $ 113,710 $ 293,058
Commercial 100,000 70,000
------------ -------------
$ 213,710 $ 363,058
============ =============
Cost of revenue $ 65,976 $ 186,992
============ =============
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.
All of the defense revenue reported for the first nine months of 2000 relates to
a major sub-contract awarded in the fall of 1999 from a prime contractor to the
U.S. military pursuant to which Sonex demonstrated the technical feasibility of
converting an existing high performance, 650 horsepower, 4-stroke, gasoline
fueled engine for marine use to start and operate on heavy fuels. The Company
devoted a significant portion of its available resources to the performance of
this sub-contract from late in 1999 through June 2000 when work was
substantially completed. Defense department revenue in 2001 has all been
generated from June through September in connection with development contracts
for the heavy fuel conversion of gasoline UAV engines.
Cost of revenue primarily consists of direct labor charges and direct purchases
attributable to funded programs. Such amounts were substantially higher in the
first nine months of 2000 than in 2001 due to the above-mentioned defense
sub-contract.
- 20 -
Research and development (R&D) expenses:
R&D expenses for the first nine months of the year increased by $34,338, or 10%,
from $340,514 in 2000 to $374,852 in 2001. While the number of employees
remained the same and compensation rates increased only slightly, a higher
percentage of the workforce was devoted to funded projects in 2000 as opposed to
2001. Associated charges were therefore classified as "Cost of revenue" rather
than R&D expenses for 2000. "Cost of revenue" in 2000 also included
approximately $52,000 in charges for consulting services incurred for funded
contracts, with no similar charges being incurred in 2001. The increase in R&D
expenses would have been larger than reported were it not for the fact that the
2000 total includes approximately $36,800 for the write-off of unamortized costs
of patents abandoned while the 2001 total includes approximately $21,400 in such
charges.
General and administrative (G&A) expenses:
Total G&A expenses for the first nine months of the year decreased by $12,701,
or 5%, from $244,353 in 2000 to $231,652 in 2001. Personnel costs decreased
$6,060, from $167,872 in 2000 to $161,812 in 2001, or 4%, primarily as a result
of slightly lower use of temporary clerical personnel in 2001 and a reduction in
payroll tax expense resulting from the payment of less cash compensation in 2001
due to the current year deferral of wages by the Company's CFO. Shareholder
meeting expenses were lower by $2,561 in 2001 versus 2000. Net decreases in
other expenses amounted to $4,080.
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)
(b) Reports on Form 8-K:
None.
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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 14, 2001
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