SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001. Commission
file number 0-14465.
SONEX RESEARCH, INC.
Incorporated in State of Maryland
23 Hudson Street, Annapolis, Maryland 21401
Telephone Number:(410)266-5556 I.R.S. Employer Identification No. 52-1188993
Securities registered pursuant to Section 12(b) of the Act:
Title of Name of each exchange on
each class which registered
---------- ----------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B in this form, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ X ]
The number of shares outstanding of the Issuer's $.01 par value Common Stock as
of March 31, 2002 was 21,572,669. The aggregate market value of voting stock
held by non-affiliates of the Registrant was $2,462,418 as of March 31, 2002.
Revenues for the year ended December 31, 2001 were $245,291.
Documents Incorporated by Reference: None
SONEX RESEARCH, INC. 2001 FORM 10-KSB
ITEM 1. DESCRIPTION OF BUSINESS
OVERVIEW
Sonex Research, Inc. ("Sonex" or the "Company"), incorporated in Maryland in
1980, is an engineering research and development firm that is seeking to
commercialize its patented proprietary technology (the "Sonex Combustion
System", "SCS" or "Ultra Clean BurnTM technology") for in- cylinder control of
ignition and combustion. The Company was co-founded in 1980 by Dr. Andrew A.
Pouring, a former Professor of Aerospace Engineering and Chairman of the
Department of Aerospace Engineering at the U.S. Naval Academy. At Sonex, Dr.
Pouring conducted basic research into the principle of in-cylinder control of
ignition and combustion, concentrating on the piston. By the late 1980's and
early 1990's, the development of the SCS had moved in the direction of
chemical/turbulent enhancement of combustion through investigation of the
effects of changing the chemical characteristics and fuel disbursement
characteristics within the combustion chamber.
The SCS technology for in-cylinder control of ignition and combustion is
designed to
o increase fuel mileage of gasoline engines
o reduce emissions of diesel engines
o permit small gasoline engines to run on safer diesel-type heavy fuels
The SCS improves the combustion of fuel in engines through design modification
of the pistons in four-stroke direct injected (DI) engines or the cylinder heads
in two-stroke spark-ignited (SI) gasoline engines to achieve chemical/turbulent
enhancement of combustion. The SCS process changes only a single engine
component while introducing no additional parts and is self-driven by the
combustion process.
Sonex believes it can show the technical feasibility of achieving higher fuel
economy standards while lowering emissions in a new class of DI gasoline engined
vehicles without sacrificing weight and vehicle safety. In 2000 Sonex introduced
its Stratified Charge Radical Ignition (SCRI) combustion technology, a new
branch of the SCS which Sonex believes will enable practical application of an
alternative combustion process known as homogeneous charge compression ignition
(HCCI) that has the potential for lowering both emissions and fuel consumption.
Unresolved issues with ignition have prevented practical implementation of HCCI
to date. Sonex believes it has attained the control of ignition that will make
HCCI viable for commercial application such that the SCRI piston design, with
further development, can enable DI gasoline engined automobiles, currently sold
only in markets outside the U.S. because of emissions problems, to become
emissions compliant in the U.S. while maintaining their current fuel consumption
advantages. In addition, the evolution of hybrid gasoline and electric powered
vehicles would be accelerated since a major improvement in engine fuel mileage
would provide opportunities for tradeoff of vehicle weight versus power.
SCS reductions of soot in diesel truck engines have been confirmed by an
independent engine consulting firm. SCS diesel engine designs require very
little engine modification, and should provide cost advantages over complex
exhaust aftertreatment devices. Evidence to date indicates that the SCS is a
significant new engine design variable, and that the synergy of the SCS in
combination with exhaust gas recirculation can reduce aftertreatment measures
and enable in-cylinder emissions reduction to meet future regulatory standards.
The SCS process for the conversion of reliable, lightweight, SI, two-stroke,
gasoline engines to start and operate on diesel-type heavy fuels has been
applied successfully in a variety of applications such as small, remotely
controlled military unmanned aerial vehicles (UAVs). The military now requires
such engines to operate on less volatile heavy fuels to reduce the hazard
associated with gasoline, making heavy fuel engines (HFEs) more suitable for
applications where gasoline storage and use are undesirable. Sonex HFEs achieve
power and fuel consumption substantially equal to that of the stock gasoline
engines. Potential applications of the SCS heavy fuel conversion process can be
expanded to other military and commercial uses.
Sonex is seeking committed business partners for further technical development
and marketing of the various SCS engine applications. Sonex believes that having
one or more such partners experienced in dealing with the engine and automotive
industries on state-of-the-art technological developments is a key to the
commercial acceptance of the SCS technology in the form of revenue-generating
license agreements for industrial production of SCS components.
As of March 31, 2002, the Company has three full-time employees, and engages the
part-time services of a consultant who serves as its director of business
development. 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.
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
Sections of this document, as well as all publicly disseminated material about
Sonex Research, Inc. (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.
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 SCS 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 March 31, 2002, there were 21,572,669 shares of
Common Stock issued and outstanding, with an additional 10,005,879 shares
reserved for future issuance as follows: 4,400,000 shares issuable upon the
conversion of preferred stock; 4,553,379 shares issuable upon the exercise of
options granted 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.
PATENTS AND PROPRIETARY INFORMATION
The Company has endeavored to protect its technology by filing for patents in
the U.S. and in those foreign countries in which it may be able to commercialize
the SCS. The most recent U.S. patents for the SCS DI diesel engine technology
were issued in January 1999 and January 2001, and the most recent U.S. patent
for the SCS heavy fuel engine technology was issued in January 1999. The name
"SONEX" was registered at the U.S. Patent and Trademark Office in 1987.
The Company has also developed a significant body of trade secrets, proprietary
information and know-how relating to its technology. Although the principles
underlying the SCS concept are capable of being understood by experts in the
field, management believes that it would be difficult to apply the SCS
successfully to any given engine configuration without the benefit of the trade
secrets, know-how and proprietary information owned by the Company.
Management believes that the Company's business depends substantially upon the
protection afforded by its granted and pending patents, as well as its trade
secrets, proprietary information and know-how. All contracts outside the Company
involving any exchange of confidential technical information are made under
secrecy agreements approved by the Company's patent counsel. In addition, all of
the management and technical employees of the Company are required to sign
non-disclosure agreements respecting the Company's technology.
COMPETITION
The Company faces significant competition from the extensive research
departments of the world's major vehicle and engine manufacturers. These
companies exercise a bias toward in-house technologies over those developed by
independent suppliers. Competition also comes from several independent engine
testing and consulting firms around the world which are in the business of
developing engine technologies. The Company's competitors have substantially
greater financial, technical and marketing resources than does the Company.
Accordingly, the Company cannot be sure that it will have the resources or
expertise to compete successfully in the future.
Although the experience and financial resources of its competitors far exceed
those of the Company, management believes that the SCS can provide significant
advantages over the competition in terms of low cost, improved performance, and
simplicity.
SECRECY AND NON-DISCLOSURE
Due to the highly competitive nature of the world's automotive and truck
industries, in connection with its contracts and/or demonstration programs with
such manufacturers, Sonex is required to execute joint secrecy and disclosure
agreements that, in most cases, expressly prohibit the public disclosure of the
names and other significant information about the participants and the current
or proposed programs. Failure by Sonex to maintain this strict level of
confidentiality would jeopardize its relationship with these organizations.
OVERVIEW OF SCS DESIGN MODIFICATIONS
The SCS technology for DI diesel engines improves the process of combustion
through a combination of chemical and fluid dynamic effects that occur by
modifying the engine's combustion chamber and the processes occurring within
that chamber. Patented SCS piston designs for four-stroke engines integrate
cavities called micro-chambers (MCs) which form a ring around the piston bowl,
with each MC positioned with respect to each spray from the fuel injector of a
DI engine. The MCs are designed to function as chemical reactors and are
connected to the piston bowl by vents. The MCs produce highly active radical
(chemical) species from a fraction of the fuel-air charge that are expelled on
the intake stroke of low compression ratio DI engines to fumigate incoming air.
The SCS "Low Soot" design, based on the Sonex U.S. patents issued in January
1999 and January 2001, is a recent invention in the series for the SCS for
"classical" DI diesel engines and involves re-arrangement of SCS features to
exploit new fundamental understandings of fluid dynamics. The SCS "Low Soot"
design has shown significant reductions in soot and oxides of nitrogen (NOx)
while maintaining fuel consumption and power. The key feature of the SCS DI
diesel technology is the presence of improved MCs in the piston which produce
and conserve intermediate and radical chemical species from a small portion of
the incoming fuel. The expulsion of these materials at high velocity enhances
turbulence mixing, achieving better than a 50% soot reduction and a 10% NOx
reduction in the Sonex single cylinder, DI, normally aspirated research engine
with no change in injection timing. Sonex has also demonstrated that the SCS
technology can be transferred to a modern turbocharged, intercooled DI diesel
engine.
SCS generated radical chemical species from a design similar to the "Low Soot"
design are also being used at Sonex in relation to an alternative combustion
process known as homogeneous charge compression ignition (HCCI) that is being
examined by the worldwide automotive industry. HCCI has been studied by many
researchers for years because, in theory, it can lower emissions while also
achieving reduced fuel consumption, because compression ignition does not
require the use of a spark plug; however, the lack of a method for controlling
the ignition point has prevented practical implementation of HCCI. Sonex
believes it has attained the control of ignition that will make HCCI viable for
commercial application by achieving radical assisted, four-stroke combustion to
enable fully controllable compression ignition at low pressures as a function of
fuel injection timing, a mode Sonex refers to as Stratified Charge, Radical
Ignition (SCRI). With SCRI, radical (chemical) species that enable ignition are
created by interaction of the injected fuel spray with specially designed MCs in
the piston side wall. The net result is an engine that is fully controllable at
all loads and speeds without limitation, has extremely low emissions and the
fuel economy of a diesel engine. On a DI, single cylinder laboratory engine at
Sonex, the SCRI reduced NOx emissions by 80% and smoke by 90% while maintaining
fuel consumption, using diesel-type fuels.
The SCRI combustion chamber modifications make use of certain chemically active
products of combustion known as "free radicals" that, in conventional internal
combustion engines, are not carried from one combustion cycle to the next. The
SCRI process isolates free radicals to be carried from one combustion cycle to
the next to take advantage of the combustion enhancing properties of the free
radicals, thereby enabling ignition of all types of fuels and allowing more
complete combustion of the fuel. The SCRI relies on direct injection of fuel
into the cylinder (rather than in the intake manifold) as well as the production
of radicals for ignition.
The SCS engine design modifications for heavy fuel operation in two-stroke
engines consist of a machined cylinder head and combustion chamber insert
integrated with a glow plug starting system. For engines that have the cylinder
head and cylinder in one casting, the stock cylinder head is removed and the
remaining cylinder casting is decked and machined for cylinder head screws. The
SCS starting system consists of a heavy fuel vaporizer block positioned between
the carburetor and cylinder.
PRIMARY SONEX INITIATIVES
The Company seeks to commercialize its SCS technologies for a variety of engine
applications for commercial and military use. To date, Sonex has engaged in
development and demonstration programs with the engine industry and has sought
funding from the federal government for further development of the SCS
technologies. Some of these proposed projects are expected to achieve certain
milestones that will be key to the commercial development of the SCRI process
for automotive engines.
The next few paragraphs provide an overview of the primary opportunities, and
are followed by detailed discussions of the progress achieved to date.
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 will publish the findings in a technical paper to be
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 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 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. The requirement for a single military fuel is also a
logistics issue, as the military seeks to minimize the number and complexity of
fuels.
Sonex HFEs achieve power and fuel consumption substantially equal to that of the
stock gasoline engines. The Company has performed HFE conversions for various
sizes of small gasoline engines for UAVs, and expects to be awarded shortly one
or more contracts from the U.S. Department of Defense (DoD) and or its prime
contractors, although there can be no assurance. In addition, over the past few
weeks the Company has been developing a relationship with a foreign UAV engine
company and is optimistic of executing a contract in the near future for HFE
conversion development.
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.
Improved fuel economy in gasoline engined automobiles
Fuel economy of vehicles sold in the U.S. is a matter of public law under the
CAFE (Corporate Average Fuel Economy) legislation. For nearly the past decade,
the U.S. automobile industry has been successful in postponing any legislative
actions that would have led to an increase in CAFE. Recently, however, the
future of CAFE and other national fuel economy solutions have become front- page
political issues.
The fuel economy issue and potential increases in the CAFE standards are part of
the Senate's current debate on a broad national energy bill. The Senate
Committee on Commerce, Transportation and Science, which held hearings regarding
follow-on legislation to CAFE early in 2002, proposed much higher fuel economy
standards for the near future. Opponents of the proposals, including automakers
and the White House, objected on the basis that higher fuel mileage can only be
achieved by building smaller, lighter - and therefore less safe - vehicles.
Supporters of higher fuel economy standards, however, argued that by using
technology currently available to automakers, the improvements can be
accomplished without making vehicles smaller.
On March 13, 2002, the Senate rejected proposed tough new automobile fuel
economy requirements and instead approved the Levin-Bond Amendment to the Senate
Energy Bill that is more industry- friendly. Under the amendment, before any
increases in the CAFE standards are made, the Department of Transportation (DOT)
would be tasked with developing CAFE proposals that would take into account a
number of factors, including technological and economic feasibility,
competitiveness of U.S. manufacturers, and motor vehicle safety. Proposals to
Congress would be expected within two years. The Levin-Bond Amendment also
includes provisions for additional funding for development of advanced engine
and emissions control systems, including those for gasoline-electric powered
hybrid vehicles.
Sonex believes that, with further development, its SCS Stratified Charge Radical
Ignition (SCRI), low compression ratio, combustion process for unthrottled
operation can lead to gasoline engined vehicles that are 25% - 30% more fuel
efficient than today's vehicles while still meeting U.S. emissions standards.
Many automakers 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 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.
An alternative combustion process known as homogeneous charge compression
ignition (HCCI) is being examined by the worldwide automotive industry because
of its potential for lowering both emissions and fuel consumption; however, the
lack of a method for controlling the ignition point has prevented practical
implementation of HCCI. At the same time, spark ignited (SI), direct injected
gasoline (GDI) engined, five-passenger, 2,700 lb. automobiles (similar in size
to the Volvo S40 and Ford Focus) that deliver 53 mpg are being manufactured by
Mitsubishi and sold in foreign markets. GDI engines operate on high air-fuel
ratios. Direct injection (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. 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 potential benefits of the GDI
engine in performance, fuel consumption and cost-to-manufacture, as well as the
challenging exhaust problem with NOx emissions. Engine researchers know the key
to solving the GDI NOx problem is to replace SI, lean combustion with HCCI 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.
On the basis of extensive SCRI work it has performed with diesel-type fuels (see
"Reduced emissions in diesel engines" below), Sonex believes it has attained the
control of ignition that will make HCCI viable for commercial application in GDI
engines. With the SCRI combustion process, radical (chemical) species that
enable compression 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 NOx emissions, and the fuel economy of a diesel
engine.
SCRI combines the best aspects of HCCI without its inherent limitations.
Combustion pressure is kept low so lightweight gasoline engine construction can
be used. The spark plug is eliminated so diesel-like radical ignition is used;
its timing is fully controllable by the use of diesel-type direct injection into
the cylinder.
Sonex believes that with further development using gasoline, SCRI will enable
practical application of HCCI in GDI engined automobiles and improve on the
current fuel economy advantages and overcome the NOx problem to permit the sale
of such vehicles in the U.S. Sonex has provided input to the Department of
Energy, the White House, and the recent Senate committee hearings on the synergy
between a technologically feasible increase in fuel mileage through the
paradigm-shifting SCRI combustion process and improved vehicle safety. Sonex
expects to provide additional input to the Senate and DOT before the Energy Bill
is finalized.
The anticipated passage of the Levin-Bond Amendment to the Senate Energy Bill
will provide Sonex the time needed to continue SCRI technology maturation work
for gasoline engines and submit to DOT compelling results that are responsive to
the requirements of the Levin-Bond Amendment. Proposals for funding of these
efforts have been made by Sonex to the government and industry, and resolution
is expected in the near future. Preliminary work at Sonex on gasoline 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.
In conclusion, Sonex believes it can show the technical feasibility of achieving
higher fuel economy standards with the SCRI in conventional gasoline engined
vehicles without sacrificing weight and vehicle safety. In addition, the
evolution of U.S. produced hybrid powered vehicles would be accelerated since a
major improvement in engine fuel mileage would provide opportunities for
tradeoff of vehicle weight versus power.
Reduced emissions in diesel engines
Regulatory agencies worldwide continue to mandate increasingly more strict
requirements for the reduction of allowable diesel truck emissions, specifically
with respect to smoke/particulates and NOx. The use of costly electronic
controls and ultra-high pressure injection systems, including the new "common
rail" injection systems that are integral to the engine itself, may permit truck
manufacturers to attain some of these reductions. High pressure injectors may
reduce smoke/particulates, but they also increase NOx emissions while doing so.
Manufacturers, therefore, may be able to eliminate equipment such as particulate
traps, but they likely will need de-NOx catalytic converters, further retard of
injection timing, and replenishment chemicals, leading to an increase in fuel
consumption and additional maintenance, all at a significantly higher cost.
The SCS "Low Soot" design in a DI diesel truck engine has been shown to reduce
soot up to 45% while maintaining fuel consumption.
Sonex has participated in demonstration and development programs with some of
the largest multi-national diesel truck engine manufacturers. The demonstration
process has gone from proof of concept using screw-assembled prototype pistons
fabricated in-house by Sonex and tested by an engine manufacturer in its
laboratories, to working with piston suppliers for the fabrication of finished
pre-production pistons that would be used in field trials, durability testing,
manufacturing optimization, and other tests required before the start of full
series production.
Late in 2001 one the world's leading engine engineering and powertrain
consulting firms, Ricardo Consulting Engineers Ltd, confirmed the soot reduction
capability of the SCS "Low Soot" design. Ricardo reported that a DI diesel
engine used in medium-duty trucks, operating with the SCS "Low Soot" piston at
the best injection timings, emitted up to 45% less soot than the stock engine,
with similar fuel consumption. Ricardo will publish the findings, plus
additional results from their subsequent Computational Fluid Dynamics study of
the combustion process, in a technical paper to be presented at the Society of
Automotive Engineers' May 2002 Fuels and Lubes Conference.
Ricardo is introducing the SCS "Low Soot" design results to engine manufacturers
and piston suppliers. The Ricardo program was conducted with the cooperation of
a major foreign diesel truck engine manufacturer; however, this manufacturer has
not given indication that it intends to proceed with further development with
Sonex.
Pre-production SCS pistons for the tests were fabricated by Federal-Mogul Corp.,
a major international supplier of engine components. In 1998 Federal-Mogul
acquired the former T&N Piston Products Group of the U.K. T&N had invested
significant funds internally in developing innovative and economical techniques
of manufacturing Sonex pistons for series production. Federal-Mogul, however,
filed for bankruptcy protection in the fall of 2001 to protect its ongoing
component supply business from asbestos liabilities left from the acquisition of
T&N. Late in 2001 Federal-Mogul informed the Company that it is focusing its
limited resources on core businesses and will no longer participate in SCS
research.
The pre-production SCS pistons for the Ricardo test program fabricated by
Federal-Mogul, as well as those for an earlier SCS design fabricated by another
piston manufacturer, required special metals processing methods. For that
reason, SCS piston production under these methods might have resulted in a
higher than expected cost premium for SCS pistons. As a result, Sonex, in
conjunction with a consultant who is a former design engineer with a major
piston manufacturer, have developed a much simpler SCS piston production method
which can be be used with existing series production machinery.
Application of the SCS "Low Soot" design for achieving reduced diesel emissions
is highly leveraged when used with exhaust gas recirculation (EGR), allowing
enhanced ignition with low soot production in the presence of large amounts of
EGR. In the Sonex single cylinder research engine, as well as in a
multi-cylinder, normally aspirated diesel engine in the facility of a foreign
diesel engine manufacturer, the synergy of SCS and EGR (at levels up to 45%)
produced far greater NOx reduction than the same engine without EGR over a range
of loads and speeds while maintaining the same soot level. Typically, without
the SCS, a high level of NOx-reducing EGR produces at least a three-fold
increase in soot.
The SCS SCRI, low compression ratio, combustion process operating in a
laboratory engine reduced NOx emissions by 80% and smoke by 90% while
maintaining fuel consumption.
The SCS SCRI combustion process for control of ignition and combustion was
developed initially on diesel-type fuel, and its ability to reduce NOx, the
hardest emissions for diesel engine makers to control, was confirmed. Sonex
demonstrated this ignition control in a laboratory, single cylinder engine in
meeting a U.S. Department of Defense (DoD) objective to convert gasoline engines
to diesel-type heavy fuels, while retaining the performance and lightweight
advantages of a gasoline engine. The laboratory engine was adapted to run on
JP-5 military fuel based on the SCS piston embodiments, DI, sparkless ignition
and low compression ratio controlled combustion over a wide range of speed and
load. The SCRI process reduced NOx emissions by 80% and smoke by 90% while
maintaining fuel consumption when compared to the stock configuration of the
diesel engine.
During 2001 a major international truck engine manufacturer conducted the first
phase of a feasibility study of SCRI combustion technology aimed at transferring
the SCRI results achieved on the Sonex laboratory engine to a modern, advanced,
four cylinder, 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. This program ended recently due to
operational difficulties and reductions in R&D funding without attaining the
performance achieved by Sonex in the single-cylinder engine. The manufacturer
did find that the SCRI process resulted in certain positive effects on
combustion; however, it concluded that the concept was not close enough to
production and would require major funding for further research. The study also
identified some of the problems to be solved in transferring the SCRI results to
a multi-cylinder engine.
Sonex continues to seek funding to complete the transfer of the SCRI results
achieved on the single- cylinder laboratory diesel engine to a modern,
multi-cylinder, diesel engine. One opportunity lies in the follow-up to the work
Sonex has performed for a small U.S. company that is developing a nitrogen
enriched air (NEA) membrane technology, as an alternative to EGR, for the
reduction of NOx emissions in diesel engines. Initial development of the NEA
membrane technology has been funded by the Department of Energy (DOE). In March
2002 this company submitted a proposal to DOE for a follow-on development
program to investigate the use of its NEA membrane technology in combination
with the Sonex SCRI combustion process to achieve even greater NOx emissions
reductions. Word from DOE on the proposal is not expected for several months.
For its part of the DOE program, Sonex has proposed using the state-of-the-art,
multi-cylinder, DI, turbo-charged, automotive diesel engine used by a major
international vehicle manufacturer in the U.S. government funded PNGV
(Partnership for a New Generation Vehicle) which has now ended. Sonex would use
the engine to fully characterize SCRI with and without the NEA membrane. This
program would provide SCRI data on a multi-cylinder diesel engine for
presentation to any engine manufacturer.
Conversion of gasoline engines to run on safer diesel-type heavy fuels
A DoD directive requires the elimination of gasoline such that the primary fuel
for combat support equipment shall be a single kerosene-based "heavy fuel" (such
as D2 diesel, JP-5 and JP-8). Heavy fuels are less volatile than gasoline,
thereby reducing the hazard associated with gasoline. The requirement for a
single military fuel is also a logistics issue, as the military seeks to
minimize the number and complexity of fuels required. Large combat support
equipment acquired by the military is powered by diesel engines that can use
heavy fuels. No solution has been identified, however, for the thousands of
smaller engines, including those powering UAVs, all-terrain vehicles (ATVs),
small boats, and other applications for which gasoline storage, transport and
use are undesirable.
The SCS application for SI, two-stroke gasoline engines permits conversion to
operation on less volatile diesel and other "heavy fuels" for use in UAVs and
other applications using small engines, as well as for use in larger two- and
four-stroke engines.
Sonex, under contract with the U.S. military and defense contractors, has
applied its proprietary patented starting system and modified combustion chamber
to convert commercially available SI two- stroke gasoline engines used in UAVs
to heavy fuel operation. Under a "best efforts" feasibility demonstration
contract from the U.S. Marine Corps (USMC) Systems Command in Quantico,
Virginia, in 1998 the Company delivered five prototype UAV heavy fuel engines
(HFEs). Sonex successfully converted the existing SI, carburetted, 100cc single
cylinder, two-stroke, gasoline fueled engines to start and run on heavy fuel,
leading the USMC to contract Sonex to convert an additional forty UAV engines
used in the Dragondrone UAV. The Dragondrone became the first tactical UAV to be
certified for deployment aboard ship.
Sonex HFEs achieve power and fuel consumption substantially equal to that of the
stock gasoline engines and provide dependable performance over the full engine
operating range without "knocking", which has been a major shortcoming of other
heavy fuel conversion technologies. Significantly, the SCS achieves
gasoline-like performance with heavy fuels while maintaining the compression
ratio and light weight of the gasoline engine.
The Company has found its SCS heavy fuel combustion technology to be scaleable
in two-stroke engines with displacements ranging from 18cc (1hp) to 352cc
(27hp). Sonex hasn't yet had the opportunity to convert a gasoline engine with a
larger cylinder displacement to heavy fuel operation, but is confident that its
SCS HFE technology is scaleable to cylinder displacements of 500cc and larger.
Sonex also intends to develop an SCRI process for the heavy fuel conversion of
SI four-stroke gasoline engines, although significant additional research and
development remain to be done.
In SI two-stroke engines, the SCS enables the combustion of heavy fuels through
design modification of the cylinder heads to achieve a radical-enhanced
combustion process while still relying on the spark to initiate combustion. In
four-stroke engines, the SCS enables the combustion of heavy fuels through
design modification of the pistons to achieve spark-less radical ignition with
direct injection.
Sonex believes its SCS heavy fuel technology can assist military customers in
achieving compliance with the requirement for a single battlefield fuel by
converting existing gasoline engines to operate on heavy fuel. The Sonex HFE
technology can be applied as a retrofit to existing SI two- and four- stroke
gasoline engines or during the engineering of a brand new engine design.
Sonex heavy fuel designs for two-stroke engines are desirable for applications
where safety, light weight, low cost and the use of a single fuel are important.
In addition to UAVs and ATVs, both of which have been used by U.S. forces in
Afghanistan, other military applications include outboard engines, small
watercraft used as targets, and generator sets. Sonex also sees potential for
this technology in the commercial market for other applications such as pleasure
boats for which a lightweight engine burning diesel fuel would eliminate the
hazards of gasoline storage and use.
The primary objective is to capitalize on the success to date with SCS HFEs by
participation in new DoD programs. In addition, Sonex seeks sponsors within the
DoD who are obliged to make an effort to comply with the directive on the
elimination of gasoline when purchasing numerous commerically available items
that are powered by two-stroke gasoline engines.
In recent months the Company has been developing relationships with domestic and
foreign defense contractors. Sonex anticipates receiving one or more contracts
from the DoD and/or defense contractors in the near future for continued
development of its SCS heavy fuel application for UAVs and other military uses.
Some of these proposed projects are also expected to achieve certain milestones
that will be key to the commercial development of the SCRI process for
automotive engines.
Technology marketing partners
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. Sonex believes that having such a
partner 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.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's principal executive offices and testing facility are located at 23
Hudson Street, Annapolis, Maryland, 21401. The facility is equipped with
emissions test equipment and machine shop and storage facilities necessary to
support the laboratory. Management believes that all of the Company's property
is adequately covered by insurance. The building contains approximately 6,000
square feet and is being occupied by the Company 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. Management will seek to negotiate a new long-term lease for its
facility or search for an alternative location in the event that an 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.
ITEM 3. LEGAL PROCEEDINGS
As of the date of this report, management is aware of no legal proceedings
pending against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2001.
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock currently is traded in the over-the-counter market on
the OTC Bulletin Board service under the symbol "SONX". The OTC Bulletin Board
is an electronic and screen-based quotation medium operated by NASDAQ. Quotation
information on OTC Bulletin Board stocks is available on stockbrokers' desktop
terminals.
The Company has never paid cash dividends on its Common Stock and does not
expect to pay any cash dividends in the foreseeable future. The high and low
market prices of the Common Stock for each quarterly period since January 1,
2000 were as follows:
Quarter ended: High Low
---- ----
March 31, 2000 $.50 $.28
June 30, 2000 .47 .28
September 30, 2000 .44 .19
December 31, 2000 .24 .11
March 31, 2001 .25 .14
June 30, 2001 .37 .22
September 30, 2001 .33 .16
December 31, 2001 .40 .15
March 31, 2002 .23 .14
As of March 31, 2002, there were 21,212,669 shares issued and outstanding, with
approximately 950 holders of record. The shares for approximately 2,800
additional beneficial owners of the Common Stock are held of record (in "street
name") by brokers, dealers, banks, and other entities holding such securities of
record in nominee name or otherwise or as a participant in a clearing agency
registered pursuant to Section 17A of the Securities Exchange Act of 1934.
As of March 31, 2002, a total of 10,005,879 shares reserved for future issuance
as follows: 4,400,000 shares issuable upon the conversion of preferred stock;
4,553,379 shares issuable upon the exercise of options granted 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.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
ACCUMULATED LOSSES; SOURCES OF CAPITAL
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. Operating funds
have been raised primarily through the sale of equity securities in both public
and private offerings, with development and demonstration contract revenues also
providing limited operating cash.
Cash available at the beginning of 2001, combined with revenue from development
and demonstration programs, met a significant portion of the Company's operating
expenditure requirements for the year. Additional cash of $288,750 was provided
during 2001 from three private placements of stock.
FINANCIAL POSITION AND LIQUIDITY
Sonex has been operating under cash flow difficulties for several months, having
fallen behind in payments due to some vendors. Since the fall of 2001 the
Company's officers have not received a majority of the cash compensation due
them. In late December 2001 Sonex took steps to reduce further its monthly cash
requirements by eliminating one full-time position in its shop and by
restructuring compensation arrangements with its part-time consultants. A second
full-time position became vacant at the end of February 2002.
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 amounts payable 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. As of March 31, 2002, the Company had
available cash and equivalents of approximately $28,000 and accounts receivable
of approximately $26,000. Also at the end of March 2002, the Company received a
purchase order of approximately $92,000 from a defense contractor for a
four-month effort to develop a small heavy fuel engine for an experimental UAV.
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 June 30, 2002.
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, establish joint ventures or strategic partnerships with major
industrial concerns, or secure a major capital infusion. There is no assurance
that the Company will be able to achieve these objectives. If these objectives
are not achieved, the Company will have to reduce the scope of its operations
even further, primarily by laying off its remaining employees and, possibly, by
abandoning its facility. These circumstances could lead to bankruptcy as well.
Prior to June 30, 2002, the Company will seek to secure additional anticipated
revenue-generating contracts. Once such contracts are secured, the Company will
supplement its workforce as needed with part-time personnel before defining and
filling full-time positions. Sonex also intends to seek a commercial marketing
partner experienced in dealing with the industry on state-of-the-art
technological developments. In addition, the Company plans to engage the
services of a professional investor relations firm to develop, implement and
maintain an ongoing program to increase the investment community's awareness of
Sonex activities.
ONGOING SALARY DEFERRALS BY OFFICERS AND EMPLOYEES
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. Since January 1, 1997, however, there
has been no further deferral of salary requested of the Company's non-officer
employees. The conditions that would require repayment of deferred amounts have
yet to occur.
RESULTS OF OPERATIONS
Condensed comparative results:
2001 2000 1999
---------- ---------- ---------
Total revenue $ 245,291 $ 407,898 $ 324,386
---------- ---------- ---------
Cost of revenue 117,486 228,587 100,857
Research and development (R&D) expenses 482,461 453,494 531,584
General and administrative (G&A) expenses 337,099 332,607 315,649
---------- ---------- ---------
Total expenses 937,046 1,014,688 948,090
---------- ---------- ---------
Net loss from operations (691,755) (606,790) (623,804)
Gain on sale of marketable securities 43,508
Investment income 1,400 4,860 10,181
---------- ---------- ---------
Net loss $ (690,355) $ (601,930) $(570,115)
========== ========== =========
The net loss for 2001 is $88,425, or 15%, higher than the net loss for 2000, as
a significant decrease in revenue was offset in part by lower related cost of
revenue. Total revenue decreased from 2000 to 2001 by $162,607, or 40%, as a
slight increase in revenue from programs for truck diesel engine manufacturers
was more than offset by substantially lower revenue from defense contracts.
Total expenses decreased $77,642, or 8%, from 2000 to 2001, due primarily to the
decrease in costs resulting from a decline in the total of funded contracts.
The net loss for 2000 was $31,815, or 6%, higher than the net loss for 1999. The
net loss for 1999 was reduced in part by gains on the sale of marketable
securities. Revenue increased from 1999 to 2000 by $83,612, or 26%, as higher
revenue from military contracts more than offset a decline in revenue from
programs for truck diesel engine manufacturers. Total expenses increased
$66,598, or 7%, from 1999 to 2000, due to the increase in costs associated with
the higher level of funded contracts and higher personnel costs.
Gains on the sale of marketable securities in 1999 represent the proceeds from
the sale of the Company's holdings in the common stock of Digital Dictation,
Inc. (acquired in 1998 by Medquist, Inc.), the corporation which in 1995 was
merged with and into the Company's inactive former subsidiary, SonoChem, Inc.
The Company liquidated most of this investment during 1998 when its value
increased substantially. The balance of the investment was sold in 1999. Because
the Company's basis for this investment was zero, all sales proceeds are
recognized as gains. Overall, from 1996 through 1999, the Company realized gains
(net proceeds) from the sale of these securities of $359,064.
Revenue and cost of revenue:
2001 2000 1999
--------- --------- ---------
Defense revenue $ 145,291 $ 337,898 $ 224,286
Commercial revenue 100,000 70,000 100,000
--------- --------- ---------
Total revenue 245,291 407,898 324,386
--------- --------- ---------
Cost of revenue 117,486 228,587 100,857
--------- --------- ---------
Changes in annual revenue are subject to the number of funded contracts
received, and the timing of completion of those contracts. 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 offset the development costs incurred by the Company in
applying its technology to one of the manufacturer's engines. Over the past few
years the Company has also obtained several government contracts for its heavy
fuel engine (HFE) technology. All contracts to date in this area have involved
the conversion of commercial gasoline fueled engines used in unmanned aerial
vehicles (UAVs) and the like to heavy fuel operation.
Comparison of 2001 to 2000
Total revenue decreased $162,607, or 40%, from 2000 to 2001, with defense
revenue declining by $192,607, or 57%, from 2000. Defense revenue for 2001 came
from four contracts, three of which were for UAV gasoline engine conversions to
heavy fuel operation. Approximately $260,000 of the defense revenue reported for
2000 relates to a sub-contract awarded in the fall of 1999 from a prime
contractor to the U.S. Navy pursuant to which Sonex demonstrated the technical
feasibility of converting an existing high performance, 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 mid-2000 when work was substantially
completed. The Company did not receive a follow-on contract from the Navy, and
no other contract of similar size was received in 2001. The remaining defense
revenue for 2000 consisted of five smaller contracts, including three contracts
for UAV gasoline engine conversions to heavy fuel operation.
Revenue from commercial contracts, earned in connection with the Company's DI
diesel engine piston technology, increased $30,000 from 2000 to 2001. All of the
revenue for 2001 was earned from a program with a foreign engine manufacturer
for a feasibility study of the Company's SCRI technology in diesel truck
engines. Revenue of $50,000 also was earned in 2000 from this manufacturer in
connection with a test program for the Company's SCS "Low Soot" design. The
Company also recognized revenue of $20,000 in 2000 from a second foreign engine
manufacturer.
Comparison of 2000 to 1999
The increase in total revenue from 1999 to 2000 resulted primarily from an
increase in defense revenue of $113,612, or 51%. Approximately $124,000 of the
defense revenue reported for 1999 related to the Navy sub-contract mentioned
above, while another approximately $100,000 related to a contract from the U.S.
Naval Research Laboratory for heavy fuel engine conversion demonstration for a
UAV engine.
Revenue from commercial contracts declined $30,000 from 1999 to 2000. All of the
revenue for 1999 was earned in connection with the test program for the
Company's SCS "Low Soot" design mentioned above.
Cost of revenue primarily consists of direct labor charges, direct purchases
attributable to funded programs, and consulting fees. Such costs decreased from
2000 to 2001 as a result of the lower revenue generated in 2001, primarily
resulting from the completion in 2000 of the major contract from the Navy. As a
result, a smaller percentage of R&D personnel's time was spent on funded
contracts in 2001 versus 2000, with the associated charges being recorded as R&D
rather than cost of revenue. Such amounts were substantially higher in 2000 than
in 1999 due to the relative sizes of the government contracts being performed at
the time. A small portion of total cost of revenue for each period represented
charges directly attributable to funded commercial projects.
Management is unable to predict future changes to development and demonstration
contract revenue because the amounts earned to date under previous contracts
have been determined through negotiations with individual manufacturers based
upon the level of effort required and the level of funding, if any, that each
manufacturer has been willing to commit. Nor is there any process by which to
estimate the amount and number of defense contracts which the Company may be
awarded. Management anticipates, however, that future revenue may also include
consulting fees earned while working together with manufacturers to optimize the
results achieved on a particular manufacturer's engine, and, ultimately, license
fees and royalty revenue once the Company's technology is placed into production
engines by manufacturers. The future amounts of such other types of revenue,
however, cannot be reasonably estimated.
Research and development (R&D) expenses:
2001 2000 1999
--------- --------- ---------
Personnel:
Employee compensation $ 335,605 $ 333,027 $ 314,442
Taxes & benefits 54,730 48,594 42,761
Consulting fees 64,587 115,672 106,277
--------- --------- ---------
Total personnel 454,922 497,293 463,480
Project parts and supplies 28,116 49,343 44,810
Occupancy 47,591 48,785 47,044
Depreciation, patent amortization
and write-off of abandoned patents 52,326 62,409 51,493
Patent maintenance and renewal fees 7,243 8,831 9,962
Other expenses 9,749 15,420 15,652
--------- --------- ---------
Total R&D expenses 599,947 682,081 632,441
Less amounts classified as cost of revenue:
Personnel (112,873) (192,330) (96,719)
Project parts and supplies (3,598) (32,951) (4,138)
Other expenses (1,015) (3,306)
--------- --------- ---------
Total R&D $ 482,461 $ 453,494 $ 531,584
========= ========= =========
The following analysis is based on a comparison of total R&D expenses as listed
above before deduction of amounts classified as cost of revenue.
Comparison of 2001 to 2000
Total R&D expenses decreased by $82,134, or 12%, from $682,081 in 2000 to
$599,947 in 2001, primarily as a result of the decrease in funded contracts.
Personnel costs decreased by $42,371 from 2000 to 2001, with a $51,085, or 44%,
reduction in consulting fees accounting for the decline while employee
compensation increased only slightly. Total consulting fees for funded contracts
(related only to the Navy contract) decreased from $55,968 in 2000 to zero in
2001 as a result of the contract's ending in 2000. These consulting fees were
for time spent by the consultant who served as program manager (the same
individual who serves as the Company's director of business development - see
G&A discussion) as well as the charges for a fuel injection system consultant. A
slight increase of $2,883 was experienced for other consulting charges for
services of the Company's R&D Supervisor and International Liaison Officer who
resides in Europe. This individual is compensated primarily in the form of
restricted stock for work performed in Europe based on part-time service, while
for time spent in Annapolis he receives cash compensation for full-time service.
His expenses are also reimbursed in cash. The Company recorded charges of
$53,837 in 2001 and $50,664 in 2000 in connection with the issuance of stock as
compensation to this consultant, who spent no time in Annapolis in 2001 or 2000.
(The Company measures compensation for stock issued for services at the market
price on the date of award or at the agreed-upon value of the services.)
The increase in employee compensation of 2,578, or 1%, from 2000 to 2001,
resulted from a number of offsetting differences. A decrease in shop salaries
occurred in part because there was no related amount in 2001 for the salary of a
technician hired early in 2000 who was employed only until October 2000. In
addition, the Company's machinist reduced his work schedule for a few months
during the summer of 2001 and his employment was eventually terminated in
December 2001. On the other hand, total wages increased due to higher wage rates
in 2001 for two shop employees and as a result of a larger amount of bonuses
awarded - $32,500 in 2001 versus $20,000 in 2000, including a higher bonus award
to the Company's CEO and Chief Scientist of $25,000 in 2001 versus $10,000 in
2000. These bonuses are awarded in December of each year with the stipulation
that payment of such amounts is to be deferred until the Board of Directors
determines that the Company's cash resources are sufficient. The 2001 bonus
award to the CEO was higher than in the previous year to reflect the fact in
2001 the CEO made extraordinary sacrifices, both financially in the amount of
wages that have gone unpaid, and personally, to enable the Company to remain in
operation given its poor financial condition. Payroll taxes and employee
benefits in total increased $6,136, or 13%, from 2000 to 2001, due primarily to
an increase in health insurance premium rates.
Total project parts and supplies expense decreased by $21,227, or 43%, from 2000
to 2001, as expenditures for funded contracts declined by $29,353 primarily due
to the completion of the Navy contract in 2000. As a result of fewer hours being
spent on funded contracts, more time was spent on un-funded research in 2001,
thus leading to more purchases of parts and supplies that could not be
reclassified to cost of revenue, which amounted to an increase of $8,126.
Project parts and supplies expense includes motor fuel, engine parts and other
items used or consumed in engine testing and in the machine shop.
Occupancy expenses, primarily rent, have remained relatively consistent for the
past several years except for an increase in the monthly rent in March 2000.
Rent expense is allocated 80% to R&D and 20% to G&A based on the proportionate
share of floor space devoted to each category.
Total depreciation, patent amortization, and patent write-offs decreased by
$10,083, or 16%, from $2000 to 2001. The largest component is patent write-offs,
which were lower by $14,816, decreasing from $38,069 in 2000 to $23,253 in 2001.
Such write-offs represent the unamortized costs of patents abandoned by the
Company due to lack of expected commercial potential, and specifically relate to
older patents filed in small countries. Ongoing patent amortization increased
$5,620 from 2000 to 2001, as amortization began on capitalized costs for several
patents which were granted during 2001. Depreciation expense decreased only $887
from 2000 to 2001 as there were minimal asset additions made in 2001 and 2000.
Comparison of 2000 to 1999
From 1999 to 2000 total R&D expenses increased by $49,640, or 8%, as a result of
increases in personnel costs and non-cash charges for depreciation, patent
amortization and patent write-offs. The increase in personnel costs of $33,813,
or 7%, from 1999 to 2000 resulted from higher total employee compensation and an
increase in consulting fees. Employee compensation increased $18,585, or 6%,
from 1999 to 2000 due to the hiring early in 2000 of a technician who was
employed until October 2000, a 4% increase in the salary of the Company's CEO
and Chief Scientist, an increase in health insurance premium rates, while total
bonus awards declined slightly, from $22,000 in 1999 to $20,000 in 2000. As
described above, payment of bonuses is to be deferred until the Company's cash
resources are sufficient. Payroll taxes and employee benefits in total increased
$5,833, or 14%, from 1999 to 2000, due to an increase in health insurance
premiums.
While consulting fees in total increased only $9,395, or 9%, from 1999 to 2000,
total fees for funded contracts (related only to the Navy contract) increased
from $15,000 in 1999 to $55,968 in 2000 to reflect the increase in time spent by
the consultant who served as program manager, as well as the charges for a fuel
injection system consultant. This was offset significantly by a decrease from
$90,562 in 1999 to $59,704 in 2000 in total charges for the Company's R&D
supervisor and international corporate liaison who resides in Europe. This
individual is compensated primarily in the form of restricted stock for work
performed in Europe based on part-time service, while for time spent in
Annapolis he receives cash compensation for full-time service. His expenses are
also reimbursed in cash. During 1999 he spent a considerable amount of time in
Annapolis and therefore was paid 100% compensation in cash for his time in
Annapolis, while in 2000 he made no trips to Annapolis and thus was paid
part-time compensation in stock for almost the entire year. The Company recorded
charges of $50,664 in 2000 and $43,365 in 1999 in connection with the issuance
of stock as compensation to this consultant.
The amount of personnel costs charged to cost of revenue in 2000 was nearly
double that for 1999, as a much higher percentage of the workforce was devoted
to funded projects in 2000 as opposed to 1999, as well as the fact that nearly
$56,000 in consulting fees were charged to Navy project in 2000 versus only
$15,000 in 1999.
Project parts and supplies expense increased only slightly from 1999 to 2000;
however, a significantly higher percentage of the total expenditures in 2000
were related to funded projects, reflecting the fact that personnel spent more
of their time on funded projects in 2000 versus 1999.
Occupancy expenses, primarily rent, increased slightly as an increase in the
monthly rent as of March 2000 was partially offset by lower charges for
utilities.
Total depreciation, patent amortization, and patent write-offs increased by
$10,916, or 21%, from 1999 to 2000. The largest component is patent write-offs,
which were higher by $12,514, from $25,555 in 1999 versus $38,069 in 2000.
General and administrative (G&A) expenses:
2001 2000 1999
--------- --------- ---------
Personnel (includes stock and options):
Employee compensation $ 125,557 $ 113,564 $ 103,296
Consulting fees 79,186 80,836 71,115
Amortization of deferred compensation
from grant of stock options 29,761 29,764 29,760
Taxes & benefits 10,352 9,560 9,374
--------- --------- ---------
Total personnel 244,856 233,724 213,545
Occupancy 10,882 11,727 11,406
Travel 1,882 6,113 13,550
Proxy solicitation & annual meeting 19,618 19,545 18,021
Legal fees 5,264 8,873 2,069
Audit fees 9,450 9,150 8,580
Stock transfer agent fees 8,496 8,743 9,027
Other expenses 35,131 34,732 39,451
--------- --------- ---------
Total G&A $ 337,099 $ 332,607 $ 315,649
========= ========= =========
Comparison of 2001 to 2000
Total G&A expenses increased by $4,492, or 1%, from 2000 to 2001, as an increase
in personnel costs was only partially offset by a decrease in legal fees and
travel costs. The increase in employee compensation of $11,993, or 11%, from
2000 to 2001 resulted primarily from a higher bonus award to the Company's CFO
($25,000 in 2001 versus $10,000 in 2000). The bonus is awarded in December of
each year with the stipulation that payment of such amount is to be deferred
until the Board of Directors determines that the Company's cash resources are
sufficient. The 2001 bonus award was higher than in the previous year to reflect
the fact in 2001 the CFO made extraordinary sacrifices, both financially in the
amount of wages that have gone unpaid, and personally, to enable the Company to
remain in operation given its poor financial condition. The increase in the
bonus award was offset in part by a decrease in the use of part-time clerical
help in 2001 as opposed to 2000.
Consulting fees decreased by $1,650, or 2%,from 2000 to 2001. Charges for
services, as well as expenses, by the individual who serves as the Company's
director of business development increased from $60,836 in 2000 to $69,186 in
2001. The Company has a contract with this consultant for a minimum amount of
services per month, half of which amount is paid in cash and half is paid in
stock options. During 2001, services in excess of the monthly minimum were
required on occasion, all of which extra charges were paid in stock options.
These extra charges amounted to $18,120 in 2001 and $10,250 in 2000. (The
Company measures compensation for stock issued for services at the market price
on the date of award or at the agreed-upon value of the services.) Consulting
fees also include amounts payable to the former president of the Company, who
was engaged on a part-time basis, under a consulting agreement that provided for
payments of $5,000 per quarter. The arrangement was terminated by mutual
agreement effective June 30, 2001, such that only $10,000 in fees was charged in
2001 as opposed to $20,000 in 2000. At the end of September 2001 this individual
resigned from the position of president but remains on the Board of Directors.
Amortization of deferred compensation from grant of stock options represents
annual non-cash charges in connection with a below-market option to purchase
stock owned by the Company's principal shareholder granted in 1997 to the new
president of the Company in order to induce him to take that position.
Amortization of the related charges has been recorded over the five-year vesting
period of the option.
Occupancy expenses, primarily rent, decreased slightly as an increase in the
monthly rent as of March 2000 was partially offset by higher sublease income in
2000 versus 2001. Rent expense is allocated 80% to R&D and 20% to G&A based on
the proportionate share of floor space devoted to each category. The Company
also subleases a portion of its driveway and parking lot, with such income being
recorded as an offset to G&A rent expense.
Travel costs decreased by $4,231, or 69%, from 2000 to 2001. The Company's
former president, who lives in New England, made fewer trips to Annapolis in
2001 as opposed to 2000 to help conserve cash expenditures.
Comparison of 2000 to 1999
Total G&A expenses increased by $16,958, or 5%, from 1999 to 2000, primarily due
to an increase in personnel costs, while an increase in legal fees was offset by
reductions in travel and other expenses. The increase in personnel costs of
$20,179, or 9%, from 1999 to 2000 resulted from higher salary expense due to a
4% increase in the salary of the Company's CFO in January 2000, the award of a
larger bonus to the CFO in 2000 versus 1999, and an increase in consulting fees
relating almost entirely to increased services by the individual who serves as
the Company's director of business development. The Company has a contract with
this consultant for a minimum amount of services per month, half of which amount
is paid in cash and half is paid in stock options. During 2000 services in
excess of the monthly minimum were required on occasion, all of which extra
charges of $10,250 were paid in stock options. Consulting fees in each of 2000
and 1999 also include $20,000 payable annually to the former president of the
Company, who resigned from that position in Septmber 2001.
Adoption of new accounting pronouncements
The adoption by the Company in fiscal 2002 of new accounting pronouncements
which have a delayed effective date is not expected to have a material impact on
its financial statements.
ITEM 7. FINANCIAL STATEMENTS
Index to financial statements:
Report of independent accountants
Financial statements:
Balance sheets as of December 31, 2001 and 2000
Statements of operations and accumulated deficit for the three years ended
December 31, 2001
Statements of paid-in capital for the three years ended December 31, 2001
Statements of cash flows for the three years ended December 31, 2001
Notes to financial statements
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Sonex Research, Inc.:
We have audited the accompanying balance sheets of Sonex Research, Inc. (the
"Company") as of December 31, 2001 and 2000, and the related statements of
operations and accumulated deficit and cash flows for each of the three years
ended December 31, 2001, 2000 and 1999, respectively. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Sonex Research, Inc. as of
December 31, 2001 and 2000, and the results of its operations and its cash flows
for each of the three years ended December 31, 2001, 2000 and 1999,
respectively, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As described in Note 3 to the
financial statements, the Company's ability to generate sufficient revenue and
ultimately achieve profitable operations remains uncertain. The Company has
incurred significant net losses since its inception. The Company's future
prospects depend upon its ability to demonstrate commercial viability of its
products and ultimately achieve profitable operations, which raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 3. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
C. L. STEWART & COMPANY
Annapolis, Maryland
April 10, 2002
SONEX RESEARCH, INC.
BALANCE SHEETS
December 31,
------------------------
2001 2000
----------- -----------
Assets
Current assets
Cash and equivalents $ 3,355 $ 89,306
Accounts receivable 37,828 17,340
Prepaid expenses 25,783 27,142
Loans to officers and employees (Note 4) 22,500 22,500
----------- -----------
Total current assets 89,466 156,288
Notes receivable from officers and employees (Note 5 ) 18,125 18,125
Patents (Note 6) 204,088 215,707
Property and equipment, (Note 7) 57,249 69,026
----------- -----------
Total assets $ 368,928 $ 459,146
=========== ===========
Liabilities and Stockholders' Equity/(Deficit)
Current liabilities
Accounts payable and other accrued liabilities $ 46,923 $ 41,775
Accrued compensation and benefits (Note 8) 221,228 97,807
----------- -----------
Total current liabilities 268,151 139,582
----------- -----------
Deferred compensation (Note 9) 857,944 810,844
----------- -----------
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 - shares issued
and outstanding: 21,212,669 in 2001 and
19,479,868 in 2000 212,127 194,799
Additional paid-in capital 21,334,577 20,927,437
Accumulated deficit (22,319,271) (21,628,916)
----------- -----------
Total stockholders' equity/(deficit) (757,167) (491,280)
Commitments (Note 14)
----------- -----------
Total liabilities and stockholders' equity/(deficit) $ 368,928 $ 459,146
=========== ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
Year ended December 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
Revenue
Defense $ 145,291 $ 337,898 $ 224,286
Commercial 100,000 70,000 100,000
------------ ------------ ------------
245,291 407,898 324,286
------------ ------------ ------------
Costs and expenses
Cost of revenue 117,486 228,587 100,857
Research and development 482,461 453,494 531,584
General and administrative 337,099 332,607 315,649
------------ ------------ ------------
937,046 1,014,688 948,090
------------ ------------ ------------
Net loss from operations (691,755) (606,790) (623,804)
Other income
Investment income 1,400 4,860 10,181
Gains on sales of marketable
securities 43,508
------------ ------------ ------------
Net loss (690,355) (601,930) (570,115)
Accumulated deficit
Beginning of period (21,628,916) (21,026,986) (20,456,871)
------------ ------------ ------------
End of period $(22,319,271) $(21,628,916) $(21,026,986)
============ ============ ============
Weighted average number of
common shares outstanding 20,224,090 18,472,727 17,765,110
========== ========== ==========
Net loss per share $ (.03) $ (.03) $ (.03)
======= ======= =======
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF PAID-IN CAPITAL
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 stock options 29,760
--------- ------ ---------- ------- ----------
Balance, December 31, 1999 1,540,001 15,400 18,008,169 180,082 20,430,476
Feb. warrants exercised .35 285,000 2,850 96,900
March for services .40 24,130 241 10,125
June warrants exercised .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 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 13,098
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 stock options 29,761
--------- ------ ---------- ------- ----------
Balance, December 31, 2001 1,540,001 $15,400 21,212,669 $212,127 $21,334,577
========= ======= ========== ======== ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF CASH FLOWS
Year ended December 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
Cash flows from operating activities:
Net loss $(690,355) $(601,930) $(570,115)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation 15,441 16,328 13,573
Amortization of patents 36,885 46,091 37,920
Amortization of deferred compensation
from stock options 29,761 29,764 29,760
Current charges paid in stock or options 95,957 96,539 67,366
Gain on sale of marketable securities (43,508)
(Increase) decrease in accounts receivable (20,488) 60,121 25,024
(Increase) decrease in prepaid expenses 1,359 2,694 (999)
Increase (decrease) in accrued liabilities 128,569 10,989 13,680
Increase (decrease) in deferred
compensation 47,100 47,100 49,706
--------- --------- ---------
Net cash used in operating activities (355,771) (292,304) (377,593)
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale of marketable securities 43,508
(Increase) decrease in loans to employees 5,000
Acquisition of property and equipment (3,664) (1,386) (63,009)
Additions to patents and technology (25,266) (42,022) (14,096)
--------- --------- ---------
Net cash provided by (used in)
investing activities (28,930) (43,408) (28,597)
--------- --------- ---------
Cash flows from financing activities:
Issuance of stock - private placements 288,750 193,750
Issuance of stock - exercise of warrants 173,500
Issuance of stock - exercise of options 127,500
Forgiveness of accounts payable 10,000
--------- --------- ---------
Net cash provided by financing activities 298,750 367,250 127,500
--------- --------- ---------
Increase (decrease) in cash (85,951) 31,538 (278,690)
Cash at beginning of period 89,306 57,768 336,458
--------- --------- ---------
Cash at end of period $ 3,355 $ 89,306 $ 57,768
========= ========= =========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
NOTES TO FINANCIAL STATEMENTS
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 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and equivalents The Company's By-Laws restrict the types of permitted
investments to securities issued by the U.S. Treasury, savings accounts insured
by the U.S. Government, or investment companies that invest in obligations of
the U.S. Government or its agencies. The Company considers all short-term,
highly liquid investments which are convertible into cash within three months or
less to be cash equivalents.
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.
Property and equipment Property and equipment is stated at cost or, in the case
of leased equipment under capital leases, at the present value of future lease
payments, less accumulated depreciation. Major renewals and betterments are
capitalized and ordinary repair and maintenance expenditures are charged to
operations in the year incurred. Depreciation is computed using the straight
line method over useful lives of three to seven years.
Revenue recognition Revenue derived from development and demonstration contracts
is recognized upon the Company's completion of the milestones and/or submission
of progress reports specified in each contract. Commercial development contracts
are executed in situations in which an engine manufacturer is willing to provide
funding to partially offset the development costs incurred by the Company in
applying its technology to one of the manufacturer's engines. Generally,
commercial development contracts require the Company to demonstrate that the
manufacturer's engine, when modified with the Company's technology, can meet
certain emissions reduction and performance goals specified in the contract. In
addition, these contracts sometimes provide that payment of part of the contract
amount will be made only if the Company meets the specified goals. The Company
is not required to repay any funds received in connection with its development
contracts.
Development contracts are executed for funding supplied by a United States
Government (the "Government") agency or defense contractor for proof-of-concept
demonstration programs. Revenue and costs for these contracts that require the
Company to provide stipulated services for a fixed price have been recognized
using the percentage-of-completion method of accounting by relating contract
costs incurred to date to total estimated contract costs at completion.
Contracts which are based on costs incurred are subject to post-award audit and
potential price redetermination. In the opinion of management, adjustments, if
any, on completed contracts would not have a material adverse effect on the
Company's financial position or results of operations.
Stock-based compensation The Company accounts for stock-based compensation using
the intrinsic value method prescribed in Accounting Principles Board (APB)
Opinion No. 25 - "Accounting for Stock Issued to Employees". 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. The Company provides additional pro forma
disclosures as required under Statement of Financial Accounting Standards (SFAS)
No. 123 - "Accounting for Stock-based Compensation".
Net loss per share Net loss per share is computed based upon the weighted
average number of common shares outstanding during the year. Potentially
dilutive securities, which include convertible preferred stock, stock options
and warrants, would serve to reduce the loss per share and, accordingly, are
excluded from the computation.
Use of estimates The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
notes. Actual results may differ from those estimates.
NOTE 3 - LIQUIDITY
Management recognizes that the Company's history of operating losses, level of
available funds, and revenue from current and future development contracts, in
relation to projected expenditures, raise substantial doubt as to the Company's
ability to commence generation of significant revenues from the
commercialization of the SCS and ultimately achieve profitable operations.
Accordingly, the Company will continue to minimize its operating expenditures
through a number of measures, including the continued deferral by its officers
of portions of their salaries.
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 amounts payable 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. As of March 31, 2002, the Company had
available cash and equivalents of approximately $28,000 and accounts receivable
of approximately $26,000. Also at the end of March 2002, the Company received a
purchase order of approximately $92,000 from a defense contractor for a
four-month effort to develop a small heavy fuel engine for an experimental UAV.
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 June 30, 2002.
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, 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.
NOTE 4 - LOANS TO OFFICERS AND EMPLOYEES
Loans to officers and employees represent the remaining balance of amounts
advanced in prior years for the payment of income tax liabilities incurred by
these individuals upon their receipt of compensation in the form of shares of
the Company's common stock. The loans, which are non-interest bearing, are
secured by deferred salaries payable to each of the borrowers. The due date of
the loans was recently extended to December 31, 2002.
NOTE 5 - NOTES RECEIVABLE FROM OFFICERS AND EMPLOYEES
In connection with the exercise of warrants to purchase shares of common stock
in June 2000 (see Note 11), the Company accepted notes receivable from its chief
financial officer and two other employees aggregating $18,125. The notes,
payable on or before June 30, 2005, are secured by the shares issuable upon the
exercise of the warrants and deferred salaries payable to each of the
individuals. Interest accruing on the notes at 6% per annum will be waived if
the entire principal amount is paid on or before June 30, 2002.
NOTE 6 - PATENTS
The net unamortized capitalized costs of patents is comprised of the following:
December 31,
---------------------------
2001 2000
---------- ----------
Capitalized costs $ 251,243 $ 255,307
Accumulated amortization (47,155) (39,600)
---------- ----------
$ 204,088 $ 215,707
========== ==========
The Company continues to conduct its own research and development activities
which have resulted in additional patents. Development of commercial
applications of certain elements of the SCS has commenced and management
believes the capitalized cost of patents will be recovered through revenue
derived from the licensing of the underlying technology. Management closely
monitors the patent application process and other factors which may affect the
economic value of the Company's technology, and reduces the capitalized cost of
patents should the recovery of such costs no longer be sustainable. In
connection with patents abandoned by the Company due to lack of expected
commercial potential, unamortized costs of $23,253 in 2001, $38,069 in 2000 and
$25,555 in 1999 were charged to operations and reflected as additional
amortization in the accompanying financial statements.
NOTE 7 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 31,
---------------------------
2001 2000
---------- ----------
Shop equipment $ 460,821 $ 457,545
Office equipment 36,900 36,512
---------- ----------
497,721 494,057
Accumulated depreciation (440,472) (425,031)
---------- ----------
$ 57,249 $ 69,026
========== ==========
NOTE 8 - ACCRUED COMPENSATION AND BENEFITS
Accrued compensation consists of the following amounts payable to current
employees:
December 31,
---------------------------
2001 2000
---------- ----------
Accrued vacation pay $ 58,000 $ 53,000
Accrued bonuses 83,000 38,000
Accrued wages 80,228 6,807
---------- ----------
$ 221,228 $ 97,807
========== ==========
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 9. The amount of accrued
vacation included above that was payable to the Company's officers at December
31, 2001 and 2000 was $41,406 and $39,938, respectively.
In December of each of the last three years, the Company awarded bonuses to its
officers and employees with the stipulation that payment of such bonuses is to
be deferred until the Board of Directors determines that the Company's cash
resources are sufficient to enable such payments. In December 2001, the Company
awarded bonuses totaling $57,500, including an aggregate of $50,000 to its two
officers. During 2001 and 2000, the Company paid $12,500 and $17,000,
respectively, of the bonuses accrued as of the previous year-end.
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 $66,888 are included in the
total of accrued wages as of December 31, 2001. Through March 31,2002, the
officers have deferred an additional $46,822. 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 9.
NOTE 9 - 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:
December 31,
---------------------------
2001 2000
---------- ----------
Current officers $ 525,337 $ 478,237
Current employees and consultants 62,088 62,088
Former officers and other employees 270,519 270,519
---------- ----------
$ 857,944 $ 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 December 31,
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.
NOTE 10 - 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 ("NOL") carryforwards of approximately $14.2 million available to
offset future taxable income. Net operating losses generated in 1998 and
subsequent years may be carried forward twenty years, while such losses
generated in 1997 and prior years may be carried forward fifteen years. 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. Sales of marketable securities have also generated capital loss
carryforwards for income tax purposes. Capital loss carryforwards, which expire
after five years, may only be used to offset future capital gains. The Company's
tax loss carryforwards are summarized as follows:
NOL's Capital
------------ ----------
Year of expiration:
2002 $ 1,837,965 $ 133,400
2003 1,344,816 365,147
2004 1,185,181 14,970
2005 900,267
2006 - 2012 7,095,459
2018 - 2021 1,842,038
------------ ----------
$ 14,205,726 $ 513,517
============ ==========
The difference between the net operating loss carryforwards described above and
the accumulated deficit reported in these financial statements results
principally from (1) temporary differences for income tax and financial
reporting purposes relating to the amounts and timing of deductibility of
deferred salaries and compensation related to the grant of stock options, and
the differences in the accounting for the Company's investment in its former
consolidated subsidiary for income tax and financial reporting purposes, and (2)
permanent differences principally due to the non-deductibility for income tax
purposes of a significant charge to operations for debt conversion expense in a
prior year and the non-deductibility of compensation related to the exercise of
stock options recorded previously in the Company's accounts.
The potential income tax benefit of these loss carryforwards and temporary
differences of approximately $5.5 million has not been recorded in the financial
statements due to the uncertainty of realization based on the Company's
financial performance to date. Since 1995 net operating loss carryforwards
aggregating $4,781,634 have expired unused, as have capital loss carryforwards
of $201,681.
NOTE 11 - CAPITAL STOCK
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 December 31, 2001, a total
of 459,999 shares of preferred stock had been converted into 1,314,278 shares of
common stock.
Exercise of warrants; Private placements of common equity In February 2000 the
Company received cash proceeds of $99,750 from the exercise of warrants to
purchase 285,000 shares of its common stock at an exercise price of $.35 per
share. In June 2000 the Company received cash proceeds of $73,750 from the
exercise of warrants to purchase 196,667 shares, and accepted five-year notes
receivable aggregating $18,125 from its chief financial officer and two other
employees (see Note 5) for the exercise of warrants to purchase 48,333 shares,
of its common stock, all at a price of $.375 per share.
In December 2000 the Company completed a private financing in which it raised
$193,750 from a small number of the Company's shareholders, including its chief
executive officer and chief financial officer, most of whom participated in
previous private financings of the Company. A total of 775,000 shares of the
Company's common stock and five-year warrants to purchase an additional 387,500
shares of common stock at $.50 per share were issued in this financing. No
separate value has been reflected in the financial statements for the warrants
issued in the above transaction based on management's belief that the separate
fair value of such warrants is not significant.
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, most of whom 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, most of whom participated in previous private financings of the
Company. A portion of the proceeds was in the form of a subscription receivable
of $5,000, which amount was received in August 2001.
In a private financing in October 2001 the Company issued 750,000 shares of
common stock for proceeds of $112,500 received from a small group of the
Company's local shareholders, including its chief executive officer and chief
financial officer, most of whom participated in previous private financings of
the Company.
The offer and sale of the shares of common stock and warrants to purchase shares
of common stock in connection with each of the private financings described
above 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.
NOTE 12 - 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 December 2011.
Between January 1, 1999 and December 31, 2001, the Company had the following
activity in options to purchase shares of common stock under the Plan:
Weighted Weighted
average average
exercise # of shares exercise
# of shares price exercisable price
----------- ------- ----------- --------
Unexercised at January 1, 1999 3,856,716 $.52 3,391,966 $.52
========= ====
Granted 556,000 .50
Exercised (255,000) .50
Lapsed or canceled (101,000) .50
-----------
Unexercised at December 31, 1999 4,056,716 $.52 3,426,716 $.52
========= ====
Granted 272,500 .39
Exercised 0
Lapsed or canceled (6,000) .50
-----------
Unexercised at December 31, 2000 4,323,216 $.51 3,760,716 $.52
========= ====
Granted 882,500 .25
Exercised 0
Lapsed or canceled (671,400) .50
-----------
Unexercised at December 31, 2001 4,534,316 $.49 3,919,316 $.46
=========== ==== ========= ====
Options granted under the Plan during 2001 include grants of ten-year options in
December 2001 to each of the Company's four outside directors to purchase
100,000 shares of common stock. These options vest at the rate of 25% per year
beginning with the date of grant. Also in December 2001, the Company's chief
executive officer and chief financial officer each were granted ten-year options
to purchase 100,000 shares of common stock, exercisable 50% on the date of grant
and 50% one year later. These options granted in December 2001 all have an
exercise price of $.25 per share, which price was above the market price of the
common stock at the grant date.
Options granted under the Plan during 1999 include grants of ten-year options in
June 1999 to the Company's chief financial officer, exercisable 50% on the date
of grant and 50% one year later, to purchase 100,000 shares of common stock, and
in September 1999 to the Company's former president, exercisable 25% per year
beginning with the date of grant, to purchase 250,000 shares of common stock.
These options granted in 1999 all have an exercise price of $.50 per share,
which price was above the market price of the common stock at each grant date.
In December 1997 Proactive, the Company's principal shareholder, granted to the
new president of the Company a ten-year option, exercisable 20% per year
beginning with the date of grant, to purchase 714,286 shares of common stock
owned by Proactive at an exercise price of $.35 per share. In December 1999
Proactive granted the Company's president a ten-year option, exercisable 25% per
year beginning with the date of grant, to purchase an additional 500,000 shares
of common stock owned by Proactive at an exercise price of $.50 per share. The
options granted by Proactive are not covered by the Company's Plan. Because
these agreements relate to shares which are already outstanding, the exercise of
these options will not result in an increase in the total number of the
Company's outstanding shares, nor will the Company receive any cash proceeds
upon the exercise of the options.
For options granted with an exercise price below the market price at the date of
grant, the Company credits an amount to additional paid-in capital representing
the excess of the aggregate market value at the date of grant over the aggregate
exercise price of such options, and charges a like amount to compensation
expense in that year. There were no such charges from 1999 through 2001 in
connection with options granted under the Plan. Since late in 1998, the Company
has engaged a consultant to serve as director of business development and
project manager who is compensated partially in cash and partially in stock
options. While the exercise price of such options has been equal to or higher
than the market price of the stock at each date of grant, the Company has
recorded compensation expense equal to the value of the consultant's services
which are payable by such stock options. Such charges aggregated $42,120 in
2001, $45,875 in 2000, and $24,000 in 1999, with like amounts credited to
additional paid-in capital.
In connection with the grant of the option in 1997 by Proactive to the new
president of the Company, $29,761 in 2001, $29,764 in 2000, and $29,760 in 1999,
was credited to additional paid-in capital and like amounts amortized to
compensation expense in each of those years. Amortization of the these charges,
recorded over the five-year vesting period of the option, has been completed as
of December 31,2001. There were no such charges for the option granted by
Proactive in December 1999 to the president of the Company because the exercise
price exceeded the market price of the stock at the date of grant.
While the Company applies APB Opinion No. 25 in accounting for stock option
compensation, SFAS No. 123 requires the Company to make certain disclosures as
if the fair value based method of accounting had been applied to the Company's
stock option grants. Accordingly, the Company has estimated the grant date fair
value of each option using the Black-Sholes option pricing model with the
following weighted average assumptions: volatility factor of 150%, risk-free
interest rate of 2%, zero dividend yield, and expected term of ten years. For
purposes of pro forma disclosures, the estimated fair value of options is
amortized to expense over the vesting period of each option.
Had compensation cost for options granted under the Plan and for the options
granted by Proactive to the Company's president been determined consistent with
the method of SFAS No. 123 using the weighted average fair value of options
granted during the year as indicated below, the Company's net loss and net loss
per share for each year on a pro forma basis would have been as follows:
2001 2000 1999
----------- ---------- --------
Weighted average fair value per share $.19 $.37 $.36
Net loss - as reported $690,355 $601,930 $570,115
Net loss - pro forma $1,019,970 $926,125 $861,650
Net loss per share - as reported $.03 $.03 $.03
Net loss per share - pro forma $.05 $.05 $.05
The increase of $329,615 from the reported net loss to the pro forma net loss
for 2001 associated with the charges for the estmated fair value of options
consists of $84,321 for options granted in 2001 and $245,295 for options granted
in prior years.
The Black-Sholes valuation model were developed for use in estimating the fair
value of traded options which have no vesting restrictions and are fully
transferable, as opposed to the type of compensatory options granted by the
Company. It also requires the input of highly subjective assumptions, such as
the expected stock price volatility, changes in which can materially affect the
fair value estimate. Because the options granted by the Company have
characteristics significantly different from those of traded options, the
amounts calculated using the Black Sholes option valuation model, in the opinion
of management, do not necessarily provide a reliable single measure of the fair
value of options granted by the Company.
NOTE 13 - COMMON STOCK RESERVED FOR FUTURE ISSUANCE
As of December 31, 2001, a total of 11,664,591 shares of common stock were
reserved by the Company for issuance for the following purposes:
Purpose # of shares
----------------------------------------------------- -----------
Currently exercisable warrants:
Exercisable at $.50 per share, expiring in April 2006 175,000
Exercisable at $.50 per share, expiring in March 2006 250,000
Exercisable at $.50 per share, expiring in December 2005 387,500
Exercisable at $.75 per share, expiring in
February 2002 167,759
March 2002 220,000
----------
1,200,259
----------
Currently exercisable options:
Exercisable at $.25 per share 471,550
Exercisable at $.50 per share 3,201,766
Exercisable at $.75 per share 196,000
Exercisable at $1.00 per share 50,000
----------
3,919,316
----------
Granted options becoming exercisable in the future:
Exercisable at $.25 per share 56,250
Exercisable at $.50 per share 88,750
----------
615,000
Options available for future grants 1,530,016
Conversion of preferred stock 4,400,000
----------
Total shares reserved 11,664,591
==========
In February 2000 warrants exercisable at $.35 and $.75 per share to purchase
285,000 and 3,098,209 shares, respectively, of common stock expired unexercised.
In June 2000 warrants exercisable at $.375 and $.50 per share to purchase
350,000 and 590,000 shares, respectively, of common stock expired unexercised.
NOTE 14 - 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. Gross rent
charges aggregated $48,000 in 2001, $47,000 in 2000 and $42,000 in 1999, while
the Company also earned sublease income of $3,000, $2,400, and $2,400 in 2001,
2000 and 1999, respectively. The Company will seek to negotiate a new long-term
lease for its facility or search for an alternative location in the event that
an 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.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company has had no disagreements with its current independent accountants,
C.L. Stewart & Company, on any matter of accounting principles or practices or
financial statement disclosure. C.L. Stewart & Company has been the Company's
independent accountants since October 31, 1997.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS
The Company's Board of Directors is divided into two categories: "Common Stock"
directors elected by the holders of Common Stock; and "Preferred Stock"
directors elected by the holders of Preferred Stock. Pursuant to the Company's
Charter, 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. These two categories of directors are
further divided into three classes as nearly equal in number as possible, with
the term of one of the three classes of directors expiring at each annual
meeting of shareholders. The members of each class of directors are to hold
office for terms of three years until their successors have been elected and
qualified. The terms of Class I, Class II and Class III directors are scheduled
to expire at the annual meeting of shareholders to be held in 2002, 2003, and
2004, respectively.
The Company's By-laws state that the Board of Directors shall consist of not
fewer than three directors, with the total number of directors to be set by the
Board by resolution. Following the resignation of three Preferred Stock
directors and one Common Stock director in July 1997, the total number of
directors was set at five, consisting of two Preferred Stock directors and three
Common Stock directors. At the time of these changes in the membership of the
Board of Directors, the Preferred stockholders waived their right to fill the
vacancies created by the resignations of the three Preferred Stock Directors.
The Preferred Stockholders continued to waive their right to elect a majority of
the total number of directors through December 3, 2001.
At the 2001 Annual Meeting of Shareholders held September 27, 2001, the Company
announced the retirement of Mr. Lawrence H. Hyde as its president, although Mr.
Hyde remains a member of the Board. The Company also announced that Mr. John H.
Drewanz would be joining the Board in October 2001, while Mr. Nuno Brandolini, a
director of the Company since 1982, agreed to resign his position as a Class II
Common Stock director to create a vacancy for Mr. Drewanz. Because he was
elected by the Board to fill a vacancy, Mr. Drewanz's term will expire at the
next annual meeting of shareholders. At that time, Mr. Drewanz, or such other
person as may be validly nominated to fill the vacancy, shall be elected by the
shareholders to serve the remaining scheduled term as a Class II director or
until his successor is elected and qualified.
With respect to the position of president, the Company announced that there were
no immediate plans to name a replacement because the position has been part-time
given the focus of the Company on research. The Company will seek to fill the
position if and when potentially significant business and financial transactions
require more attention such that the position of president will become
prominent.
After giving consideration to the changes in the Board of Directors announced at
the 2001 Annual Meeting, the Preferred stockholders again asserted their right
to elect a majority of the total number of directors. Additionally, the Board
took steps to make the three classes of directors once again as nearly equal in
number as possible as specified in the Company's Charter. As a result, the Board
of Directors took the following actions effective as of December 4, 2001:
Re-affirmed the number of directors currently is set at five, to
consist of three Preferred Stock directors and two Common Stock
directors;
Decreased the number of Class I directors from three to two and
increased the number of Class II directors from one to two; and
Accepted the resignation of Mr. Hyde from his position as a Class I
Common Stock director and then elected him as a Class II Preferred
Stock director
Because he was elected by the Board to fill a vacancy, Mr. Hyde's term will
expire at the next annual meeting of shareholders. At that time, Mr. Hyde, or
such other person as may be validly nominated to fill the vacancy, shall be
elected by the shareholders to serve the remaining scheduled term as a Class II
director or until his successor is elected and qualified.
Directors of the Company do not receive fees for their services, but are
eligible to receive stock option grants and are reimbursed for expenses related
to their activities as directors. Executive officers are appointed and serve at
the discretion of the Board of Directors. The names, ages, dates first elected
as directors, and principal occupations and employment of the directors and
executive officers of the Company are set forth below.
Term as
director
Name Age expires (1) Position
---------------- --- ------- --------------------------------
Preferred Stock Directors:
Lawrence H. Hyde 77 2002 Class II Director
Charles C. McGettigan 57 2002 Class II Director
Myron A. Wick, III 58 2002 Chairman of the Board (Class I
Director)
Common Stock Directors:
John H. Drewanz 62 2002 Class II Director
Andrew A. Pouring 70 2004 Chief Executive Officer, Chief
Scientist and Vice Chairman of the
Board (Class III Director)
Other Executive Officers:
George E. Ponticas 42 Vice President - Finance,
Secretary, Treasurer and Chief
Financial Officer
(1) The terms of the Class II directors normally expire in 2003; however,
because the current Class II directors were elected by the Board to
fill vacancies rather than having been elected by the shareholders,
their terms will expire at the next annual meeting of shareholders.
Background of directors and executive officers
Mr. Lawrence H. Hyde has been a director of the Company since September 1986,
serving as Chairman of the Board from June 1987 to June 1993 and as President
from October 1997 through September 2001. Mr. Hyde is a private investor with
interests in a number of publicly and privately held companies. He spent the
majority of his business career as an executive in the automotive industry,
serving in various engineering, marketing, international, and chief executive
capacities for AM General Company, American Motors Corporation and Ford Motor
Co. Currently, Mr. Hyde also serves as a trustee of the American University in
Cairo, where he is also chairman of the Karnak Equity Fund. Mr. Hyde is a
graduate of Harvard College and Harvard Business School.
Mr. Charles C. McGettigan has been a director of the Company since February
1992. He was a founding partner in 1991 and is a general partner of Proactive
Investment Managers, L.P., which is the general partner of Proactive Partners,
L.P. In 1988 Mr. McGettigan co-founded McGettigan, Wick & Co., Inc., an
investment banking firm, following a career as an executive with major
investment banking firms, including Hambrecht & Quist, Inc. and Dillon, Read &
Co. Inc. He currently serves on the Boards of Directors of Cuisine Solutions,
Inc., Modtech, Inc., PMR Corporation, Tanknology - NDE Corporation, and Onsite
Energy, Inc., of which he is the Chairman. Mr. McGettigan is a graduate of
Georgetown University, and received his MBA in Finance from The Wharton School
of the University of Pennsylvania.
Mr. Myron A. ("Mike") Wick, III, has been a director of the Company since
November 1991 and was elected Chairman of the Board of Directors in June 1993.
He was a founding partner in 1991 and is a general partner of Proactive
Investment Managers, L.P., which is the general partner of Proactive Partners,
L.P. In 1988 Mr. Wick co-founded McGettigan, Wick & Co., Inc., an investment
banking firm. From 1985 to 1988 Mr. Wick was Chief Operating Officer of
California Biotechnology, Inc. in Mountain View, California. He currently serves
on the Boards of Directors of Modtech, Inc., StoryFirst Communications, Inc.,
and Tanknology - NDE Corporation. Mr. Wick received a B.A. degree from Yale
University and an MBA from the Harvard Business School.
Mr. John H. Drewanz was named to the Board of Directors in October 2001. Mr.
Drewanz is a private investor who spent thirty years as a college professor at
the University of Maryland, University of Baltimore, American University and
Anne Arundel (Maryland) Community College. Mr. Drewanz also owned his own real
estate firm and has developed many properties in the Baltimore and Annapolis
vicinity. He received an MBA from the Harvard Business School and a law degree
from the University of Maryland. Mr. Drewanz is also a Certified Public
Accountant.
Dr. Andrew A. Pouring has been a full-time employee, director, and Chief
Scientist of the Company since 1980, serving as President from April 1980
through November 1991, and as Chief Executive Officer since May 1985. In
November 1991 he was elected a Vice Chairman of the Board of Directors. He has
co-authored all of the Company's patented inventions. Prior to forming Sonex,
Dr. Pouring served as a Professor of Aerospace Engineering at the U.S. Naval
Academy, including four years as the Chairman of the Academy's Department of
Aerospace Engineering. Dr. Pouring is a member of various professional and
scientific societies, including the American Society of Mechanical Engineers and
the Society of Automotive Engineers. Dr. Pouring received his Bachelors and
Masters degrees in mechanical engineering from Rensselaer Polytechnic Institute.
He received his Doctor of Engineering degree from Yale University, where he also
was a post doctoral research fellow and lecturer.
Mr. George E. Ponticas has been Vice President of Finance, Chief Financial
Officer, Secretary and Treasurer of the Company since September 1991. From May
1987 through August 1991, he served as the Company's Controller and Assistant
Secretary. Prior to joining Sonex, Mr. Ponticas was a member of the auditing
staff of Price Waterhouse in Baltimore, Maryland, attaining the position of
audit manager. Mr. Ponticas is a Certified Public Accountant, and is a member of
the American Institute of Certified Public Accountants and the Maryland
Association of Certified Public Accountants. He received his B.S. in Accounting
from Loyola College in Maryland.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company to its
executive officers who earned annual compensation during the most recently
completed year in excess of $100,000 (together referred to as the "Named
Executives").
SUMMARY COMPENSATION TABLE
Annual compensation
--------------------------------
Salary Long-term
-------------------- Accrued compensation
Name and Position Year In cash Deferred bonus # of options
----------------- ---- --------- -------- -------- ------------
Dr. Andrew A. Pouring 2001 $ 87,500(1) $ 37,500 $ 25,000 100,000
CEO & Chief Scientist 2000 87,500 37,500 10,000 35,000
1999 84,000 36,000 7,500 35,000
Mr. George E. Ponticas 2001 $ 86,400 1) $ 9,600 $ 25,000 100,000
CFO & Secretary 2000 86,400 9,600 10,000 30,000
1999 82,800 9,200 6,000 125,000
(1) Includes $33,656 for Dr. Pouring and $33,232 for Mr. Ponticas of current
wages for which payment has been deferred voluntarily and at their own
discretion in order to help the Company conserve its limited cash
resources.
The authorized full annual salaries for Dr. Pouring and Mr. Ponticas were
increased in January 2000 from $120,000 to $125,000 and from $92,000 to $96,000,
respectively, representing the first increase since January 1997.
In order to help conserve the Company's limited cash resources, however, the
Named Executives 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 agreement with the Company, these individuals and other
current and former employees 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.
For many years through 1998, Dr. Pouring had been deferring 40% of his annual
salary. In January 1999, the percentage deferral was reduced to 30%. Mr.
Ponticas has been deferring 10% of his annual salary for the last several years.
The conditions that would require repayment of deferred amounts have yet to
occur. As of December 31, 2001, a total of $409,980 and $115,357 in deferred
salary is owed to Dr. Pouring and Mr. Ponticas, respectively, that is payablee
under the conditions described above.
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. The
amount and timing of payment of these unpaid wages will be determined at the
discretion of the Company's officers, as these accrued wages are not subject to
the terms for the repayment of ongoing salary deferrals as described above. Such
unpaid wages due to the Company's two officers totaled $66,888 as of December
31, 2001. Through March 31,2002, the officers have deferred an additional
$46,822.
In December of each of the last three years, the Company awarded bonuses
totaling $57,500 in 2001, $30,000 in 2000, and $25,000 in 1999, to its officers
and employees, including the amounts reported above for the Named Executives.
The bonus awards in both years were made with the stipulation that payment of
such bonuses would be deferred until the Board of Directors determines that the
Company's cash resources are sufficient to enable such payments. As of December
31, 2001, $32,500 and $35,000 in accrued bonuses remained payable to Dr. Pouring
and Mr. Ponticas, respectively.
The December 2001 bonus awards and option grants to the Named Executives were
higher than in the previous year to reflect the fact in 2001 these individuals
made extraordinary sacrifices, both financially in the amount of wages that have
gone unpaid, and personally, to enable the Company to remain in operation given
its poor financial condition, and to provide incentive for the Named Executives
to remain in the employment of the Company under such continuing conditions.
In order to avoid long-term financial commitments, the Company does not have
employment agreements with any of its personnel. The salaries of executive
officers are set by the Board of Directors on an annual basis. With the
exception of the granting of stock options, the Company does not pay its Named
Executives any bonuses or any type of long-term compensation in the form of
restricted stock awards, stock appreciation rights (SARs) or other form of
long-term incentive plan payments.
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
-------------------------------------------------------------------
Number of % of total
securities options
underlying granted to
options employees in Exercise Market Expiration
Name granted fiscal year price price date
---- ------- ----------- ----- ----- -------------
Pouring 100,000 41% $.25 $.17 Dec. 11, 2011
Ponticas 100,000 41% $.25 $.17 Dec. 11, 2011
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION/SAR VALUES
Number of securities Value of unexercised
underlying unexercised in-the-money
options/SARs at options/SARs at
December 31, 2001 December 31, 2001
# of shares
acquired on Value Exercisable/ Exercisable/
Name exercise realized unexercisable unexercisable
-------- ----------- -------- ---------------------- -------------------
Pouring:
Exercisable @ $.25 $0 67,500 / 67,500 $0/$0
Exercisable @ $.50 $0 211,316 / 8,750 $0/$0
Exercisable @ $.75 $0 25,000 / 0 $0/$0
Ponticas:
Exercisable @ $.25 $0 65,000 / 65,000 $0/$0
Exercisable @ $.50 $0 218,750 / 6,250 $0/$0
Exercisable @ $.75 $0 20,000 / 0 $0/$0
The exercise price of all options held by the Named Executives was higher than
the December 31, 2000 market price of $.17 of the Company's publicly traded
common stock.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The following table sets forth as of March 31, 2002 information relating to
beneficial ownership by directors and executive officers of the Company,
individually and as a group, and any other persons known by the Company to be
the beneficial owner of more than five percent of the currently issued and
outstanding common stock of the Company. A reporting person is the "beneficial
owner" of a security if that person has or shares the power to vote or to direct
the voting of such security, or the power to dispose or to direct the
disposition of such security. Under this definition, more than one person may be
a beneficial owner of securities as to which he has no record ownership
interest, and the same shares may be beneficially owned by more than one
reporting person.
Beneficial ownership includes securities which the reporting person currently
owns or has the right to acquire within sixty days through the exercise of
options and warrants or through the conversion of preferred stock. The
percentage of beneficial ownership for a reporting person is based on the number
of outstanding shares of common stock of the Company plus the number of shares
which the reporting person has the right to acquire within sixty days, but does
not include shares which any other reporting person has the right to acquire.
Unless otherwise noted, all shares are beneficially owned and sole voting and
investment power is held by the persons named.
Total Beneficial Ownership
--------------------------
Common Rights to Total shares
shares acquire beneficially Percent
Name and address (1) owned shares owned of class
-------------------- --------- --------- --------- --------
John H. Drewanz 600,000 195,000 795,000 3.7
Lawrence H. Hyde 644,986 1,665,786 2,310,772 10.4
Charles C. McGettigan 1,383,118 1,915,785 3,298,903 (3) 14.0
George E. Ponticas 326,262 383,750 710,012 3.2
Andrew A. Pouring 853,239 396,316 1,249,555 5.7
Myron A. Wick, III 1,383,118 1,915,785 3,298,903 (3) 14.0
All directors & officers
as a group (6 persons) 3,807,605 4,945,637 8,753,242 33.0
Herbert J. Mitschele, Jr.
Far Hills, NJ 1,051,655 92,857 1,144,512 5.3
Proactive, et.al. (2)
San Francisco, CA 2,732,064 3,053,570 5,785,634 23.5
-----------------------------
(1) The business address for each director and named executive officer is 23
Hudson Street, Annapolis, Maryland, 21401.
(2) Includes shares beneficially owned directly and indirectly by Proactive
Partners, L.P. and several affiliated entities and individuals
("Proactive et.al."), as reported in a Form 13D filing with the Securities
and Exchange Commission.
(3) Includes 2,909,903 shares beneficially owned by Proactive et.al.,
which shares could be deemed to be beneficially owned by both Mr.
McGettigan and Mr. Wick by virtue of their executive and ownership
positions in Proactive et.al. Both individuals exercise shared voting
and investment power with respect to such shares.
Rights to Acquire Shares
------------------------
Total
Exercisable Preferred rights to
Exercisable (put)/ Exercisable stock acquire
Name options call (2) warrants converted shares
-------------------- ---------- --------- --------- --------- ---------
John H. Drewanz 100,000 95,000 195,000
Lawrence H. Hyde 576,500 1,089,286 1,665,786
Charles C. McGettigan (1) 389,000 (544,643) 2,071,428 ,915,785
George E. Ponticas 303,750 80,000 383,750
Andrew A. Pouring 303,816 92,500 396,316
Myron A. Wick, III (1) 389,000 (544,643) 2,071,428 1,915,785
All directors & officers
as a group (6 persons) 2,062,066 544,643 267,500 2,071,428 4,945,637
Herbert J. Mitschele, Jr. 50,000 42,857 92,857
Proactive , et.al. (2)
San Francisco, CA (1,089,286) 4,142,856 3,053,570
---------------------------
(1) Includes 1,581,379 shares beneficially owned by Proactive, et.al.,
which shares could be deemed to be beneficially owned by both Mr.
McGettigan and Mr. Wick by virtue of their executive and ownership
positions in Proactive, et.al. Both individuals exercise shared voting
and investment power with respect to such shares.
(2) Represents the currently exercisable portions of ten-year options granted
in December 1997 and December 1999 by Proactive, et.al. to Mr. Hyde to
purchase 714,286 shares and 500,000 shares, respectively, of common stock
presently owned by Proactive, et.al. at an exercise price of $.35 and $.50
per share, respectively. The December 1997 and December 1999 options become
exercisable at the rate of 20% and 25%, respectively, per year beginning
with the date of grant. Because these agreements relate to shares which are
already outstanding, the exercise of such rights will not result in an
increase in the total number of the Company's outstanding shares for
purposes of computing the percentage of beneficial ownership of each
reporting person. Mr. McGettigan and Mr. Wick each has indirect beneficial
ownership in 50% of the shares subject to these agreements.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K
(a) Exhibits.
3 Articles of Incorporation and Bylaws (as amended) - Incorporated
by reference to the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1992.
4 Instruments defining the rights of security holders (contained in
Exhibit 3 hereof).
10.1 1987 Non-Qualified Stock Option Plan, as amended - Incorporated by
reference to the Company's Registration Statement No. 33-34520 on
Form S-8.
21 Subsidiaries of the Registrant: Sonex International, B.V. - The
Netherlands; Sonex Engines, Inc. - Delaware (both are inactive
subsidiaries).
23.a Consent of C.L. Stewart & Company
24 Power of Attorney - Incorporated by reference to the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1998.
27 Financial Data Schedule
(b) Reports on Form 8-K.
None.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act , the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SONEX RESEARCH, INC.
April 15, 2002 By: /s/ Andrew A. Pouring
----------------------------------
Andrew A. Pouring
Principal Executive Officer
April 15, 2002 By: /s/ George E. Ponticas
----------------------------------
George E. Ponticas
Principal Financial and Accounting Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
April 15, 2002 *
----------------------------------
Myron A. Wick, III
Chairman of the Board of Directors
April 15, 2002 *
----------------------------------
John H. Drewanz
Director
April 15, 2002 /s/ Andrew A. Pouring
----------------------------------
Andrew A. Pouring
Vice Chairman of the Board of Directors
April 15, 2002 *
----------------------------------
Lawrence H. Hyde
Director
April 15, 2002 *
----------------------------------
Charles C. McGettigan
Director
--------------------
* Executed on behalf of these persons by George E. Ponticas, a duly appointed
attorney-in-fact of each such person.
/s/ George E. Ponticas
----------------------------------
George E. Ponticas, Attorney-In-Fact
The Registrant will furnish its shareholders with copies of its annual report
and proxy statement after the date of this report.
EXHIBIT 23.a
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-8 (No. 33-34520) of
Sonex Research, Inc. of our report dated April 10, 2002 appearing on page 25 of
this Form 10-KSB.
/s/C.L. STEWART & COMPANY
Annapolis, Maryland
April 10, 2002