UNITED STATES
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003.
SONEX RESEARCH, INC.
Incorporated in the State of Maryland
23 Hudson Street
Annapolis, Maryland 21401
Telephone Number: (410) 266-5556
IRS Employer Identification No. 52-1188993
Commission file number 0-14465
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days.
YES [x] NO [ ]
There were 21,592,669 shares of the Issuer's $.01 par value Common Stock
outstanding at November 19, 2003.
SONEX RESEARCH, INC. FORM 10-QSB
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Balance sheets as of September 30, 2003 and December 31, 2002
Statements of operations and accumulated deficit for the three- and nine-month
periods ended September 30, 2003 and 2002
Statements of paid-in capital for the period January 1, 2001 through September
30, 2003
Statements of cash flows for the nine-month periods ended September 30, 2003 and
2002
Notes to financial statements
SONEX RESEARCH, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
September 30, December 31,
ASSETS 2003 2002
------------ ------------
Current assets
Cash and equivalents $ 9,274 $ 105,998
Accounts receivable 159,434 64,702
Prepaid expenses 21,439 25,814
Loans to officers and employees 22,500 22,500
------------ ------------
Total current assets 212,647 219,014
Patents and technology, net of accumulated amortization
of $74,909 in 2003 and $59,155 in 2002 203,044 203,623
Property and equipment, net of accumulated depreciation
of $460,357 in 2003 and $451,872 in 2002 95,450 58,808
------------ ------------
Total assets $ 511,141 $ 481,445
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 44,078 $ 36,322
Short-term line of credit 17,750
Deferred revenue - billings in excess of costs
and estimated profits on contracts in progress 138,349 66,587
Current portion of capital lease obligations 15,544 5,657
Notes and interest payable to shareholder 56,881 37,327
Accrued compensation and benefits 482,082 427,397
------------ ------------
Total current liabilities 754,684 573,290
------------ ------------
Capital lease obligations 32,593 10,985
------------ ------------
Deferred compensation 956,183 906,856
------------ ------------
Stockholders' equity/(deficit)
Preferred stock, $.01 par value - 2,000,000 shares
authorized and issued; 1,540,001 shares outstanding 15,400 15,400
Common stock, $.01 par value - 48,000,000 shares
authorized; 21,592,669 shares issued and outstanding 215,927 215,927
Additional paid-in capital 21,486,412 21,420,742
Accumulated deficit (22,928,399) (22,640,911)
Notes receivable from officers and
employees (21,659) (20,844)
------------ ------------
Total stockholders' equity/(deficit) (1,232,319) (1,009,686)
Commitments (Note 9)
------------ ------------
Total liabilities and stockholders' equity $ 511,141 $ 481,445
============ ============
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenue $ 214,746 $ 120,308 $ 603,648 $ 206,825
---------- ---------- ---------- ----------
Costs and expenses
Cost of revenue 132,787 46,478 403,931 100,904
Research & development 61,766 58,145 180,901 173,682
General & administrative 118,851 87,604 298,974 202,518
Interest expense 4,478 1,084 8,399 2,481
---------- ---------- ---------- ----------
317,882 193,311 892,205 479,585
---------- ---------- ---------- ----------
Net loss from operations 103,136 73,003 288,557 272,760
Investment and other income (307) (274) (1,069) (2,457)
---------- ---------- ---------- ----------
Net loss 102,829 72,729 287,488 270,303
Accumulated deficit
Beginning 22,825,570 22,516,845 22,640,911 22,319,271
---------- ---------- ---------- ----------
End $22,928,399 $22,589,574 $22,928,399 $22,589,574
========== ========== ========== ==========
Weighted average
number of shares
outstanding 21,592,669 21,590,060 21,592,669 21,472,544
========== ========== ========== ==========
Net loss per share $.005 $.003 $.013 $.012
===== ===== ===== =====
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF PAID-IN CAPITAL
(Unaudited)
Price Preferred stock Common stock Additional
per ($.01 par value) ($.01 par value) paid-in
share Shares Amount Shares Amount capital
----- --------- ------ ---------- ------- ----------
Balance, January 1, 2001 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 grant of
stock options 29,761
--------- ------ ---------- ------- ----------
Balance, December 31, 2001 1,540,001 15,400 21,212,669 212,127 21,334,577
March private placement .15 360,000 3,600 50,400
May for services .25 12,000 120 2,880
July for services .25 8,000 80 1,920
Stock option compensation 30,965
--------- ------ ---------- ------- ----------
Balance, December 31, 2002 1,540,001 15,400 21,592,669 215,927 21,420,742
Stock option compensation 65,670
--------- ------ ---------- ------- ----------
Balance, September 30, 2003 1,540,001$15,400 21,592,669$215,927 $21,486,412
========= ====== ========== ======= ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
----------------------
2003 2002
-------- --------
Cash flows from operating activities
Net loss $ (287,488) $ (270,303)
Adjustments to reconcile net loss to net cash
Provided by (used in) operating activities
Depreciation 22,000 11,400
Amortization of patents 14,881 14,407
Compensation from grant of stock options 65,670 21,125
Current charges paid in stock 5,000
Accrued interest on notes receivable from employees (815) (2,447)
Accrued interest on notes to shareholder 2,363 816
(Increase) decrease in accounts receivable (94,732) 8,839
(Increase) decrease in prepaid expenses 4,375 2,844
Increase (decrease) in accounts payable and
accrued liabilities 62,441 148,291
Increase (decrease) in billings in excess of costs
and estimated profits on contracts in progress 71,762
Increase (decrease) in deferred compensation 49,327 36,231
----------- ----------
Net cash provided by (used in) operating activities (90,216) (23,797)
----------- ----------
Cash flows from investing activities
Acquisition of property and equipment (15,640) (9,052)
Additions to patents (14,302) (15,281)
----------- ----------
Net cash provided by (used in)
investing activities (29,942) (24,333)
----------- ----------
Cash flows from financing activities
Increase in short-term line of credit 17,750
Issuance of notes payable to shareholder 50,000 36,000
Payment of principal on notes to shareholder (30,000)
Payment of accrued interest on notes to shareholder (2,809)
Reduction of capital lease obligations (11,507)
Issuance of stock - private placement 54,000
----------- ----------
Net cash provided by (used in) financing activities 23,434 90,000
----------- ----------
Increase (decrease) in cash (96,724) 41,870
Cash
Beginning of period 105,998 3,355
----------- -----------
End of period $ 9,274 $ 45,225
=========== ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - THE COMPANY
Sonex Research, Inc. has developed a proprietary technology, known as the Sonex
Combustion System (SCS), which improves the combustion of fuel in internal
combustion engines through modification of the pistons in large engines or the
cylinder heads in small engines. The SCS achieves in-cylinder control of
ignition and combustion to increase fuel mileage of gasoline engines, reduce
emissions of diesel engines, and permit small gasoline engines to run on safer
diesel-type fuels. The Company's objective is to execute broad agreements with
engine and parts manufacturers for industrial production of SCS components under
license from Sonex.
NOTE 2 - PRESENTATION OF FINANCIAL STATEMENTS
The accompanying unaudited condensed financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form
10-QSB and Item 310(b) of Regulation S-B. Accordingly, these financial
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three- and nine-month periods ended September 30, 2003
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2003. For further information, reference is made to the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-KSB for the year ended December 31, 2002.
Certain reclassifications have been made to the financial statements of the
prior year to conform to the classifications used in 2003, most notably the
reclassification of amounts in the Statement of Operations from Research and
Development to Cost of Revenue.
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.
All of the Company's revenue for 2002 and 2003 has been derived from development
and demonstration contracts issued by a United States Government or Department
of Defense (the "Government") agency or prime contractor. Revenue is recognized
upon the Company's completion of the milestones and/or submission of progress
reports specified in each contract. 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.
In connection with contracts in progress, any excess of billings over costs
incurred plus estimated profits is recorded as a current liability, while any
excess of costs incurred over billings is recorded as a current asset, at the
financial statement date.
For fiscal year 2003, the Company changed its method of accounting for
stock-based compensation, as described in Note 8.
NOTE 3 - LIQUIDITY
Management recognizes that the Company's history of operating losses, level of
available funds, and revenue from current and future contracts, in relation to
projected expenditures, raise substantial doubt as to the Company's ability to
commence generation of significant revenues from the commercialization of the
SCS and ultimately achieve profitable operations. Accordingly, the Company will
continue to minimize its operating expenditures through a number of measures,
including the ongoing deferral by its officers of portions of their salaries as
described in Notes 5 and 6.
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 March 31, 2004.
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; therefore, there
remains substantial doubt about the Company's ability to continue as a going
concern.
NOTE 4 - DEBT
Short-term lines of credit
In March 2003 the Company obtained a business credit card from Capital One Bank
with a credit limit of $20,000 to facilitate the purchase of equipment and
materials. Repayment of amounts due has been personally guaranteed by the
Company's chief executive officer. Balances accrue interest at a fixed rate of
8.9% per annum. As of September 30, 2003, the outstanding balance on the credit
card account was $17,750.
In October 2003 the Company refinanced $18,050 then outstanding on this credit
card by transferring the balance to a new business credit card from Fleet
National Bank. Repayment of amounts due on this credit card, which has a credit
limit of $19,000, also has been personally guaranteed by the Company's chief
executive officer. The account has a promotional interest rate of 0% through
June 2004, adjusting to prime rate + 6% thereafter.
The account with Capital One Bank remains open and the credit line remains
available for use by the Company if needed.
Capital Lease Obligations
During the first quarter of 2003 the Company incurred capital lease obligations
totaling $43,002 in connection with the acquisition of equipment. The repayment
of a four-year equipment lease obligation in the principal amount of $38,575
included in this total has been personally guaranteed by the Company's chief
executive officer. As of September 30, 2003, the outstanding principal balance
on this lease obligation was $32,212.
Notes Payable to Shareholder
In connection with a private financing in March 2002, the Company issued a
$6,000, 6% note to one of its shareholders, initially payable on June 30, 2002,
that is convertible to equity at the option of the holder. The due date of the
note has been extended several times and is currently due on December 31, 2003.
In July 2002 the Company issued a $30,000, 8% note to this same shareholder
payable initially on January 31, 2003. The due date of the note also was
extended to September 30, 2003. The Company issued a $50,000, 6% note in June
2003 to this same shareholder payable on December 31, 2003. Payment of all three
notes is secured by Company revenues.
In July 2003 the Company paid the July 2002, 8%, $30,000 note in full, as well
as all remaining interest on the note.
NOTE 5 - ACCRUED COMPENSATION AND BENEFITS
Accrued compensation and benefits consists of the following amounts:
Sept. 30, December 31,
2003 2002
----------- -----------
Accrued wages and payroll taxes $ 273,900 $ 235,515
Accrued consulting fees 58,945 31,737
Accrued bonuses 97,576 95,499
Accrued vacation pay 51,661 64,646
----------- -----------
$ 482,082 $ 427,397
=========== ===========
The Company operated under severe cash flow difficulties for extended periods
during 2001 and 2002, prompting its two officers to voluntarily and at their own
discretion defer receipt of payment of significant portions of their current
wages to reduce the Company's monthly cash requirements. With the generation of
cash flow from revenues earned under contracts awarded to the Company during the
second half of 2002, some of the amounts owed to the Company's officers were
repaid in December 2002. Also at that time the Company's officers began
receiving their current wages. During the first quarter of 2003 the Company's
chief executive officer once again began deferring some of his current wages
and, since April 2003, he has deferred all of his current wages. As of September
30, 2003, total such wages payable to the Company's chief executive and chief
financial officers were $166,597 and $86,403, respectively.
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 amounts outstanding as soon as cash flow permits. Similarly, the Company has
accumulated unpaid consulting fees, the majority of which amounts are payable to
the individual who serves as the Company's director of business development and
technical program manager on a part-time basis. As of September 30, 2003, this
individual is owed $41,175. The amount and timing of payments for unpaid
compensation owing to the Company's officers and this consultant will be
determined at the discretion of the Company's officers; however, all such unpaid
compensation is payable upon demand, as these amounts are not subject to the
terms of the Company's written agreement with current and former personnel to
defer payment of portions of their compensation as described in Note 6.
In December of each year, the Company awards 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 connection with a private placement in
March 2002 as detailed in Note 8, the Company paid $22,500 of bonuses accrued as
of December 31, 2001 and $4,500 of consulting fees accrued as of that date
through the conversion of such amounts to equity. The amount of accrued bonuses
included in the table above that was payable to the Company's officers at
September 30, 2003 is $72,500. Payment of accrued bonuses are not subject to the
terms of the Company's written agreement with current and former personnel to
defer payment of portions of their compensation as described in Note 6.
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. The amount of accrued
vacation included in the table above that was payable to the Company's officers
at September 30, 2003 is $47,635. Accrued vacation compensation is payable upon
termination of employment, and such payments are not subject to the terms of the
Company's written agreement with current and former personnel to defer payment
of portions of their compensation as described in Note 6.
NOTE 6 - DEFERRED COMPENSATION
In order to help conserve the Company's limited cash resources, all of the
Company's current and former officers and certain of the Company's other
employees and consultants for several years have voluntarily deferred receipt of
payment of significant portions of their authorized compensation at the request
of the Board of Directors. A written agreement between these individuals and the
Company was first executed in 1992 in connection with an indispensable $2
million private investment made by a venture capital group in exchange for the
issuance of a new class of convertible preferred stock as described in Note 8.
The individuals who are parties to this agreement have consented to the
continued deferral, as necessary, of current compensation and 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:
Sept. 30, December 31,
2003 2002
----------- -----------
Current officers $ 623,576 $ 574,249
Current employees 12,504 12,504
Former officers, employees and consultants 320,103 320,103
----------- -----------
$ 956,183 $ 906,856
=========== ===========
The amount reported above for deferred compensation payable to current officers
consists of $476,327 payable to the Company's chief executive officer and
$147,249 payable to its chief financial officer.
The conditions that would require repayment of deferred amounts have yet to
occur, and it is unlikely that such conditions will occur prior to September 30,
2004. Accordingly, such deferred compensation is reported separately in the
accompanying balance sheet as a non-current liability.
At the conclusion of a legal challenge by two former officers of the Company
initiated in 1993 demanding full payment of deferred salaries upon the
termination of their employment, in 1996 the Maryland Court of Special Appeals
rejected this demand and ruled that the written agreement to defer compensation
was a valid and enforceable contract.
NOTE 7 - INCOME TAXES
The Company has not incurred any federal or state income taxes since its
inception due to operating losses. At December 31, 2002, the Company had net
operating loss and capital loss carryforwards of approximately $12.5 million
available to offset future taxable income. If certain substantial changes in the
Company's ownership should occur, there would be an annual limitation on the
amount of the carryforwards which can be utilized. Since 1995 net operating loss
carryforwards aggregating approximately $6.6 million have expired unused, as
have capital loss carryforwards of approximately $335,000. Net operating loss
carryforwards of approximately $1,345,000 and capital loss carryforwards of
approximately $365,000 are scheduled to expire at the end of 2003.
NOTE 8 - 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 in connection with an indispensable financing of
$2 million received in February 1992 (the "Preferred Stock Investment") from a
small number of individuals who qualified as "accredited investors" pursuant to
Rule 501 of Regulation D of the Securities Act of 1933 (the "Act") and to
Proactive Partners, L.P. and certain of its affiliates ("Proactive"), who became
the largest beneficial owner of the Company's common stock by virtue of the
acquisition of the convertible preferred stock and common stock purchase
warrants.
The preferred stock has priority in liquidation over the common stock, but it
carries no stated dividend. The holders of the preferred stock, voting as a
separate class, have the right to elect that number of directors of the Company
which represents a majority of the total number of directors. The preferred
stock is convertible at any time at the option of the holder into common stock
at the rate of $.35 per share of common stock. As of September 30, 2003, a total
of 459,999 shares of preferred stock had been converted into 1,314,278 shares of
common stock.
Private placement of common equity
In a private financing at the end of March 2002, the Company raised capital of
$60,000, including $27,000 in cash investments, $27,000 from the conversion to
equity of accrued liabilities to officers, employees and consultants, and cash
proceeds of $6,000 through the issuance of a short-term note that is convertible
to equity at the option of the holder. A total of 360,000 shares of the
Company's common stock and five-year warrants to purchase an additional 180,000
shares of common stock at $.25 per share were issued in this financing, and
60,000 shares were reserved for future issuance upon the conversion of the note
payable to common stock and a warrant to purchase common stock.
The offer and sale of these shares of common stock and warrants to purchase
shares of common stock satisfied the conditions of Rule 506 of Regulation D of
the Act and, as such, were exempt from the registration requirements of Section
5 of the Act as transactions not involving any public offering within the
meaning of Section 4(2) of the Act.
Stock options
The Company maintains a non-qualified stock option plan (the "Plan") which has
made available for issuance a total of 7.5 million shares of common stock. All
directors, full-time employees and consultants to the Company are eligible for
participation. Option awards are determined at the discretion of the Board of
Directors. Upon a change in control of the Company, all outstanding options
granted to employees and directors become vested with respect to those options
which have not already vested. Options outstanding expire at various dates
through June 2013. From January 1, 2003 through September 30, 2003, the Company
had the following activity in options to purchase shares of common stock under
the Plan:
Weighted Weighted
average # of average
# of exercise shares exercise
shares price exercisable price
--------- ----- ----------- -----
Unexercised at January 1, 2003 4,523,058 $.43 4,129,058 $.45
Granted 313,415 .25 150,915 .25
Becoming exercisable 5,000 .25
Exercised
Lapsed (372,066) .41 (247,066) .60
--------- -----------
Unexercised at September 30, 2003 4,464,407 $.40 4,037,907 $.40
========= ==== =========== ====
Through December 31, 2002, the Company accounted for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board (APB)
Opinion No. 25. Under APB No. 25, compensation cost is measured as the excess,
if any, of the quoted market price of the Company's stock at the date of grant
over the exercise price of the option granted. Compensation cost for stock
options, if any, is recognized ratably over the vesting period.
As of January 1, 2003, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 123 - "Accounting for Stock-based Compensation", which
provides for the fair value based method of accounting to be applied to the
Company's stock option grants and other stock-based compensation. SFAS No. 148 -
"Accounting for Stock-based Compensation Transition and Disclosure", issued in
December 2002, amends SFAS No. 123 to provide alternative methods of transition
for a voluntary change to the fair value based method of accounting for stock
options and other stock-based employee compensation. The Company has chosen to
apply the "modified prospective method" of SFAS No. 148 pursuant to which fair
value based stock option compensation costs for 2003 will be recognized as if
the fair value based method had been used to account for all employee
stock-based awards made in prior periods as well as the current period.
For purposes of calculating charges to expense for stock option compensation
under SFAS No. 123, the Company has estimated the grant date fair value of each
option using the Black-Scholes option pricing model with the following weighted
average assumptions for 2003: volatility factor of 95%, average risk-free
interest rate of 3.8%, zero dividend yield, and average expected term of eight
years. As a result, for the nine months ended September 30, 2003, the Company
recorded stock option compensation under SFAS No. 123 totaling $65,670 based on
a weighted average fair value per share for options granted during 2003, 2002,
2001, and 2000 of $.17, $.15, $.19, and $.37, respectively. As was the case
under APB Opinion No. 25, the amount of compensation expense is also credited to
additional paid-in capital.
Had compensation cost for options granted been determined in prior periods
consistent with the method of SFAS No. 123, the Company would have recorded
additional compensation expense of $97,899 for the first nine months of 2002,
and the Company's net loss and net loss per share for the nine months ended
September 30, 2002 on a pro forma basis would have been as follows:
Net loss - as reported $270,303
Net loss - pro forma $368,202
Net loss per share - as reported $.012
Net loss per share - pro forma $.017
The Black-Scholes valuation model was 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 Scholes 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.
Common stock reserved for future issuance
At September 30, 2003, a total of 11,516,832 shares of common stock were
reserved by the Company for issuance for the following purposes:
Purpose # of shares
---------------------------------------------- -----------
Currently exercisable warrants expiring in
December 2005, exercisable at $.50 per share 387,500
March 2006, exercisable at $.50 per share 250,000
April 2006, exercisable at $.50 per share 175,000
March 2007, exercisable at $.25 per share 180,000
-----------
992,500
Currently exercisable options 4,037,907
Granted options becoming exercisable in the future 426,500
Options available for future grants 1,599,925
Conversion of note payable 60,000
Conversion of preferred stock 4,400,000
-----------
Total shares reserved 11,516,832
NOTE 9 - COMMITMENTS
The Company occupies its office and laboratory facility on a month-to-month
basis under the terms of an operating lease agreement pursuant to which the
property owner is required to provide thirty days notice if he wants the Company
to vacate the premises. The lease currently provides for monthly rent of $4,000
and requires the Company to pay all property related expenses. The Company will
seek to negotiate a new long-term lease for its facility or search for an
alternative location in the event that a long-term agreement cannot be reached
for the existing premises. Management believes that the resolution of the
uncertainty with respect to the facility will not result in a significant
interruption in the operations of the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
Caution regarding forward-looking statements
Sections of this document, as well as all publicly disseminated material about
Sonex Research, Inc. ("Sonex" or the "Company"), contain expressions of beliefs,
expectations, or intentions, in the form of "forward-looking" statements as that
term is defined under applicable federal securities laws. 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.
Forward-looking statements contained herein speak only as of the date of this
report. The Company disclaims any obligation to update these statements and
cautions readers not to place undue reliance on such statements.
Risk factors
In order to obtain the benefits of the "safe harbor" provisions under applicable
federal securities laws for any "forward-looking" statements of the type
described previously under the heading "Caution Regarding 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 complete technology development and demonstration programs,
demonstrate commercial viability of its technology and execute licensing
agreements that produce significant revenue
o ability to maintain and protect the Company's patents and proprietary
information
o ability to attract and retain skilled personnel
o ability to secure a long-term lease for the Company's existing facility
or to secure an alternative location
o changes in general economic conditions
o competition from companies which have substantially greater financial,
technical and marketing resources than does the Company
Furthermore, since its inception in 1980, the Company has generated cumulative
net losses of approximately $23 million, and may continue to incur quarterly
operating losses for the foreseeable future. Operating results have fluctuated
significantly in the past on an annual and quarterly basis, and are expected to
continue to fluctuate significantly from quarter to quarter for the foreseeable
future. The business historically has not generated sufficient cash flow to fund
operations without resorting to external sources of capital. The Company does
not have any bank financing arrangements. Operating funds have been raised
primarily through the sale of equity securities in both public and private
offerings, although revenues are now providing most of the necessary operating
cash.
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
and government funding sponsors.
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 September 30, 2003, there were 21,592,669 shares of
Common Stock issued and outstanding, with an additional 11,516,832 shares
reserved for future issuance upon the conversion of preferred stock, the
exercise of options and warrants, and the conversion of notes payable.
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.
The same is true with respect to the Company's relationships with the U.S.
Department of Defense (DoD) and its prime contractors. In many instances the
Company is contractually prohibited from disclosing the name of the military
customer and/or specific details about the work being performed unless
permission has been obtained from the customer in advance.
Overview of the Company and its technology
Sonex, 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 in engines of
various types. 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 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 received
funding from the federal government for further development of the SCS
technologies. The Company's primary objective is to execute broad agreements
with engine and parts manufacturers for industrial production of SCS components
under license from Sonex.
The SCS technology for in-cylinder control of ignition and combustion is
designed to
o reduce emissions of diesel engines
o increase fuel mileage of a new generation of gasoline engines
o permit gasoline engines to run on safer, kerosene-based "heavy" fuels
The SCS improves the combustion of fuels 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 for both two- and
four-stroke engines achieves in-cylinder control of ignition and combustion
through the chemical/turbulent enhancement of combustion via combustion chamber
modifications that change the chemical characteristics and fuel disbursement
characteristics within the combustion chamber.
SCS reductions of soot in DI diesel truck engines have been confirmed by an
independent international engine consulting firm. 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 (EGR) can help reduce
exhaust aftertreatment requirements to meet future regulatory standards. The
Company believes that SCS diesel engine designs should provide reductions in the
cost and complexity of future exhaust aftertreatment systems.
Sonex also is seeking to show the technical feasibility of achieving reduced
fuel consumption while lowering emissions in a new class of DI gasoline engines,
yet overcoming the safety concern that vehicles would need to be reduced in size
and weight to improve fuel mileage. A new branch of the SCS focusing on the
control of ignition may, with further development, enable DI gasoline engined
automobiles, currently manufactured and sold only in markets outside the U.S.
due to emissions considerations, to become emissions compliant in the U.S. while
providing fuel consumption benefits. In addition, the evolution of hybrid
gasoline and electric powered vehicles could be accelerated since a major
improvement in engine fuel mileage would provide opportunities for tradeoff of
vehicle weight versus power.
An SCS process for the conversion of reliable, lightweight, SI, two-stroke,
gasoline engines to start and operate on kerosene-based "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. Potential
applications of the SCS heavy fuel conversion process can be expanded to a range
of military and commercial uses. Sonex is also developing a process for the
heavy fuel conversion of SI four-stroke gasoline engines, and has recently begun
investigating the synergy of SCS technology with rotary engines. In addition,
Sonex is examining the potential, through cooperation with one or more companies
which have complementary technologies and production capabilities, of becoming a
supplier of small HFEs to military and commercial markets.
As of November 15, 2003, the Company has seven full-time and three part-time
employees, and engages the part-time services of a consultant who serves as its
director of business development and technical program manager on government
contracts. The Company also engages the services of several other technical and
business consultants as needed. The Company has never experienced a strike or
work stoppage, and believes its relations with its employees are good.
Strategic planning
The Company has come to realize that it lacks the resources to address issues
such as piston manufacturing processes, durability testing, and cost analysis.
Present Sonex technology development is being supported by U.S. Government
funding, and the Company is also 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 may accelerate commercial acceptance of the SCS technology.
Development efforts taking place currently under government contracts to Sonex
could facilitate participation by the engine and automotive industries and
thereby accelerate commercialization potential of the patented SCS technology
for in-cylinder control of ignition and combustion. The Company currently is
developing a marketing strategy targeting the most immediate business
opportunity - the government sector, the success of which is expected to enhance
marketing and commercialization efforts with industry.
In January 2003 the Company engaged the Annapolis, Maryland consulting group
Paradigm Technologies, LLC ("Paradigm") to assess the Company's technologies and
business model and suggest approaches for strategic alliances and additional
market introductions for both commercial and military applications. Presently,
Company management and Paradigm are pursuing a number of initiatives. One of the
first goals is to secure cooperation with one or more companies which have
technologies complementary to the Sonex processes. Additionally, Paradigm will
also seek further funding for Sonex to conduct technology development work
necessary for addressing commercialization issues. The Company has also engaged
the services of The Washington Capitol Group (TWCG), a government relations and
public affairs firm in Washington, D.C., which also specializes in federal
marketing, government procurement assistance, and commercialization services.
The Company's Board of Directors and management will assess other strategic
alternatives, which may include a sale of part or all of the Company or other
corporate transactions, to permit Sonex shareholders to maximize the return on
their investments.
Primary SCS design modifications
The SCS technology for four-stroke DI 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. The SCS processes for DI engines change only a single engine
component (the piston) while introducing no additional parts and are self-driven
by the combustion process. 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 either as chemical
reactors or reservoirs, depending on the specific design needs, and are
connected to the piston bowl by vents. For soot reduction, the reservoirs/vents
are placed to increase turbulence, while for enhanced ignition the MCs produce
highly active 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 and serve as an ignition source.
The SCS process for the conversion of lightweight, SI, two-stroke, gasoline
engines introduces patented features which enable the combustion of heavy fuels
through design modification of the cylinder heads to achieve a chemically
enhanced combustion process while still relying on the spark to initiate
combustion. Sonex uses a machined cylinder head and combustion chamber insert
housing the proprietary SCS technology, and a glow plug-based fuel vaporizer for
cold starting. For engines that have the cylinder head and cylinder in one
single casting, the stock cylinder head is removed and the remaining cylinder
casting is decked and machined for cylinder head screws. The SCS heavy fuel
conversion maintains the gasoline engine's stock carburetion or fuel injection
system, intake and exhaust systems, spark ignition system, compression ratio and
weight. The SCS starting system uses commercial-off-the-shelf 12V glow plugs to
directly vaporize the heavy fuel for cold starting. Once the engine has been
started, the starting system is disabled.
Current funded projects
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 received
funding from the federal government for further development of the SCS
technologies. The next few paragraphs provide an overview of the primary
initiatives taking place at Sonex. Additional detailed information can be found
in the Company's December 31, 2002 Annual Report on Form 10-KSB.
DARPA
In the fourth quarter of 2002 the Company was awarded a $744,246 contract by the
U.S. Defense Advanced Research Projects Agency (DARPA) to begin the design and
development of a heavy fuel conversion process for a gasoline automotive engine
for potential use in a developmental unmanned aerial vehicle (UAV). This project
focuses on the SCS Sonex Controlled Auto Ignition (SCAI) combustion process, an
unthrottled, low compression ratio, sparkless, compression ignition process at
gasoline compression ratios. (Sonex previously referred to this process as
Stratified Charge, Radical Ignition - SCRI.) The primary objective of the DARPA
program is to transfer the SCS SCAI heavy fuel design achieved in the Sonex
single-cylinder laboratory engine to a modern six-cylinder, gasoline automotive
engine, eliminate the spark ignition system, and produce the same power the
engine originally produced on gasoline. As of November 15, 2003, Sonex has
completed the laboratory configuration SCS HFE and has achieved initial
operation on heavy fuel over a limited operating range. The Company will now
conduct iterative testing to reach a final SCS piston design for heavy fuel
operation over the complete engine range. Completion of this project is expected
in early 2004.
The Company believes the availability of the resultant multi-cylinder,
four-stroke heavy fuel engine from a successful outcome of the DARPA project
could lead to use in other military engine programs such as small power boats,
as well as having potential for use in the commercial marine market in pleasure
boats for which a diesel fueled engine would be a safer alternative to the
current gasoline engines which too often result in dangerous onboard fires. In
addition, results from the DARPA project could be applied later to a gasoline
powered version to achieve automotive engines with reduced fuel consumption and
emissions. The time required to achieve technical feasibility could be reduced
since the sparkless SCAI process can advantageously employ the centrally located
spark plug hole of most production 4-valve per cylinder engines for the
installation of the injector.
DOE
In the fourth quarter of 2002 the Company received a subcontract from Compact
Membrane Systems, Inc. (CMS) for $458,862, of which $100,000 is cost-shared
(funded) by Sonex. CMS is a prime contractor for a U.S. Department of Energy
(DOE), Small Business Innovation Research (SBIR) Program, Phase II project.
Sonex and CMS are evaluating the diesel engine emissions reduction potential of
combining the patented piston-based, SCS technology and the CMS polymer membrane
technology for the addition of nitrogen enriched air (NEA) to the combustion
process. In the second quarter of 2003 Sonex took delivery of the advanced
research automotive diesel engine to be used for the testing. The engine is a
state-of-the-art, three-cylinder, direct injected, turbo-charged, automotive
diesel engine developed by a major international vehicle manufacturer in the
joint U.S. government and automotive industry funded PNGV (Partnership for a New
Generation Vehicle) program.
Early stages of the Phase II project are focusing on the emissions reduction
capabilities of the SCS pistons separately, while subsequent testing in
combination with the NEA membrane will demonstrate the viability for
commercialization of the synergy of SCS configurations and the CMS membranes.
This program would provide SCS in-cylinder emissions reduction data on a
multi-cylinder diesel engine as a means for diesel engine manufacturers to
evaluate the potential for SCS designs, alone and in combination with the NEA
membrane, to reduce the cost and complexity of future exhaust aftertreatment
systems. While the entire project is not expected to be completed until 2004,
testing results on the SCS pistons alone may be available later this year.
SAIC
In the third quarter of 2002 the Company received a subcontract, initially
funded for $200,000 and later increased to $281,947, from Science Applications
International Corporation (SAIC), a large DoD prime contractor. Sonex was tasked
to conduct a survey of commercially available two-stroke, spark ignited,
gasoline engines of approximately 72 horsepower and, jointly with SAIC, select a
candidate engine for a "best efforts" SCS conversion to start and operate on
heavy fuels for use in a UAV weapon system. SAIC also awarded a subcontract to a
competing firm to develop a heavy fuel conversion for a rotary engine already in
production. SAIC and its military sponsor subsequently increased the targeted
horsepower requirement to 100. Sonex and SAIC together selected a candidate
gasoline engine, not yet in production, for conversion to heavy fuel.
Due to deficiencies found in operating the candidate engine on gasoline and
concurrent fuel consumption problems experienced by the competing rotary engine
operating on heavy fuel, in the first quarter of 2003 the DoD sponsor expressed
a desire to have Sonex work with the competing rotary engine developer to focus
on improving the fuel consumption of the rotary HFE. This joint effort was not
formalized because work on the engine later was placed on hold while SAIC
concentrated on resolving a number of technical issues with the flight vehicle.
Subsequently, the prime contract to SAIC was terminated by the DoD in October
2003. Sonex now seeks to obtain the necessary funding from DoD to continue
development of this HFE, and others, for use in intermediate size UAVs for
varied missions.
DOD PRIME CONTRACTOR
In September 2003 the Company received a purchase order from another large DoD
prime contractor to develop a combustion system to convert two different small
gasoline engines to start and operate on heavy fuels for potential use in UAVs.
The subcontract amount is $164,944, and work is expected to be completed during
the first quarter of 2004.
Financial position and liquidity
The Company operated under severe cash flow difficulties for extended periods
during 2001 and 2002. Its two officers voluntarily and at their own discretion
deferred receipt of payment of significant portions of their current wages to
reduce the Company's cash requirements. With the generation of cash flow from
revenues earned under contracts awarded to the Company during the second half of
2002, some of the amounts owed to the Company's officers were repaid in December
2002. Also at that time the Company's officers began receiving their current
wages. During the first quarter of 2003 the Company's chief executive officer
once again began deferring some of his current wages and, since April 2003, he
has deferred all of his current wages. As of September 30, 2003, total such
wages payable to the Company's chief executive and chief financial officers were
$166,597 and $86,403, respectively.
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 amounts outstanding as soon as cash flow permits. Similarly, the Company has
accumulated unpaid consulting fees, the majority of which amounts are payable to
the individual who serves as the Company's director of business development and
technical program manager on a part-time basis. As of September 30, 2003, this
individual was owed $41,175. The amount and timing of payments for unpaid
compensation owing to the Company's officers and this consultant will be
determined at the discretion of the Company's officers; however, all such unpaid
compensation is payable upon demand, as these amounts are not subject to the
terms of the Company's written agreement with current and former employees to
defer payment of portions of their salaries as described in Note 6 to the
accompanying unaudited financial statements.
As of September 30, 2003, the Company had available cash of $9,274 and accounts
receivable of $159,434, the entire balance of which has been collected as of
November 15, 2003. The Company historically has derived the majority of its
revenues from engineering and development funding provided by established
companies willing to assist the Company in the development of its SCS technology
and, more recently, from government sources. In 2002, however, revenues
increased substantially, providing cash to fund the majority of the Company's
operating expenditure requirements for the year. All of the Company's revenue
for 2002 and 2003 has been derived from development and demonstration contracts
issued by a United States Government or DoD agency or prime contractor. In 2003
revenues from development and demonstration contracts are again expected,
although there can be no assurance, to provide most of the cash necessary to
fund operations.
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 March 31, 2004.
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.
In the event sufficient funding is not available through the generation of
revenues or from external sources, the Company would have to substantially
reduce the level of its operations. Such a reduction could have an adverse
effect on the Company's relationships with government funding sources, strategic
partners and potential customers.
The accompanying unaudited financial statements have been prepared assuming that
the Company will continue as a going concern, which contemplates continuity of
operations, realization of assets and satisfaction of liabilities in the
ordinary course of business. The propriety of use of the going concern basis is
dependent upon, among other things, the Company's ability to generate sufficient
revenue and ultimately achieve profitable operations. These uncertainties raise
substantial doubt about the Company's ability to continue as a going concern.
The accompanying financial statements do not include any adjustments relating to
the recoverability of the carrying amounts of recorded assets or the amount of
liabilities that might result from the outcome of these uncertainties.
Results of operations
A net loss of $287,488 was recorded for the first nine months of 2003, as
compared to $270,303 for the corresponding period in 2002, a increase of
$17,185, or 6%. With the award of several significant contracts during the
second half of 2002, revenue nearly tripled in the current year versus the prior
year, with related increases in expenses to support the new work resulting in a
slightly higher net loss in 2003.
[Note: In order to conform to the classifications used in 2003, certain amounts
for 2002 presented in the prior year's financial statements as research and
development expenses have been reclassified below to cost of revenue. The net
loss for each period does not change as a result of these reclassifications.]
Revenue and cost of revenue:
Nine months ended
September 30,
-------------------------
2003 2002
---------- ----------
Defense/government revenue $ 603,648 $ 206,825
========== ==========
Cost of revenue $ 403,931 $ 100,904
========== ==========
Revenue increased substantially from the first nine months of 2002 to the first
nine months of 2003, as during the second half of 2002 the Company was awarded
three significant contracts and subcontracts from branches of the U.S.
government and DoD and/or their prime contractors. The following is a listing of
the three major new projects, descriptions of which appear earlier in this
report.
Subcontract awarded by Science Applications International Corporation
(SAIC), a large DoD prime contractor. Awarded third quarter of 2002.
Initial funding of $200,000, later increased by $81,947. Work suspended in
first quarter of 2003; the prime contract to SAIC was terminated by the
DoD in October 2003.
Prime contract awarded by the Defense Advanced Research Projects Agency
(DARPA). Awarded fourth quarter of 2002. Total funding of $744,246.
Completion expected in early 2004.
Subcontract awarded by Compact Membrane Systems, Inc. (CMS) under its
prime contract from the U.S. Department of Energy (DOE). Awarded fourth
quarter of 2002. Total award to Sonex of $458,862, of which $100,000 is
cost-shared (funded) by Sonex. Completion expected sometime in 2004.
Cost of Revenue primarily consists of direct labor charges and other direct
expenditures, including those for consulting services, attributable to funded
programs, as well as allocated fringe benefits, payroll taxes, and labor
overhead charges. Cost of Revenue as a percentage of total revenue increased
from 49% in 2002 to 67% in 2003.
Research and development (R&D) expenses:
Nine months ended
September 30,
-------------------------
2003 2002
---------- ----------
Employee compensation, taxes & benefits $ 327,020 $ 168,218
Consulting fees 93,057 15,161
Other expenses 164,755 91,207
---------- ----------
Total R&D expenses 584,832 274,586
Less amounts classified as cost of revenue (403,931) (100,904)
---------- ----------
Net R&D expenses $ 180,901 $ 173,682
========== ==========
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.
Total R&D expenses for the first nine months of the year increased by $310,246,
or 113%, from 2002 to 2003. The largest component, employee compensation,
increased by $158,802, or 94%, as additional personnel were hired during the
second half of 2002 and the first half of 2003 to work on the new contracts
received by the Company. Another factor was the recording of charges for stock
option compensation in 2003 as the Company changed its method of accounting for
stock-based compensation as described in Note 8 to the accompanying unaudited
financial statements. Such charges, totaling $21,111 during the first nine
months of 2003 versus none in 2002, represent the amortization over the related
vesting period of charges associated with option grants made in prior years as
well as in the current period. Consulting fees also increased significantly due
to the engagement of a program manager and specialized technical consultants on
the new contracts. The increase in other expenses primarily relates to higher
purchases of parts, supplies and fabrication services to support the new
contracts.
General and administrative (G&A) expenses:
Nine months ended
September 30,
-------------------------
2003 2002
---------- ----------
Employee compensation, taxes & benefits $ 118,614 $ 82,226
Consulting fees 99,860 43,896
Professional fees 29,082 33,991
Other expenses 51,418 42,405
---------- ----------
Total G&A expenses $ 298,974 $ 202,518
========== ==========
Total G&A expenses for the first nine months of the year increased by $96,456,
or 48%, from 2002 to 2003. The largest component, employee compensation,
increased by $36,388, or 44%, for a number of reasons. Total salaries were
higher as a result of an increase in the salary (before deferral) of the
Company's chief financial officer effective January 1, 2003, and the hiring of a
part-time administrative assistant beginning in January 2003. Another factor was
the recording of charges for stock option compensation in 2003 as the Company
changed its method of accounting as mentioned previously. Such charges totaled
$15,000 during the first nine months of 2003.
Consulting fees increased by $55,964, or 127%, from 2002 to 2003 as the Company
has expanded its marketing and commercialization capabilities in 2003 by hiring
specialized consultants to provide business advisory services in areas such as
strategic alliances, federal marketing, and government procurement assistance.
Such expenses in 2003 also include higher charges for stock option compensation,
including charges related to options granted to directors in 2001, due to the
change in accounting method mentioned above. Professional fees decreased by
$4,909, or 14%, from 2002 to 2003, reflecting the termination in early 2003 of
the Company's relationship with an investor relations firm engaged in the second
quarter of 2002. This decrease was nearly offset by higher auditing fees, which
more than doubled from 2002 to 2003 as the Company changed independent
accountants for 2003 from a small local firm, which disbanded its public company
audit practice, to a larger regional firm.
Other expenses increased by $9,013, or 21%, from 2002 to 2003 primarily due to
higher office maintenance and equipment depreciation expenses associated with
the increased level of business activity in 2003 over 2002.
ITEM 3. CONTROLS AND PROCEDURES
The Company's chief executive officer and chief financial officer have evaluated
the effectiveness of the Company's disclosure controls and procedures (as such
term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange
Act of 1934) as of an evaluation date within 90 days prior to the filing date of
this Quarterly Report on Form 10-QSB. Based on such evaluation they have
concluded that, as of the evaluation date, the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed in
reports that the Company files or submits under the Exchange Act, is recorded,
processed, summarized and reported in a timely manner.
Since the evaluation date referred to above, there have been no significant
changes in the Company's internal controls or in other factors that could
significantly affect such controls.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of the Company's security holders held on September 16,
2003, the holders of the Company's Preferred Stock re-elected Mr. Lawrence H.
Hyde to serve as a Preferred Stock Director to serve a term ending at the Annual
Meeting in 2006. There were no Common Stock directors up for re-election, nor
were there any other Common Stock proposals offered by the Board of Directors or
presented by any shareholder. No other matters were submitted to a vote of
security holders during the third quarter of 2003.
ITEM 6. EXHIBITS 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.
24 Power of Attorney - Incorporated by reference to the Company's
Annual Report on Form 10-KSB for the year ended December 31,
1998.
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32 Certification of Form 10-QSB for the quarterly period ended
September 30, 2003 pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K.
During the third quarter of 2003, the Company filed the following Current
Reports on Form 8-K:
On September 24, 2003, to report on the Annual Meeting of the
Company's security holders held on September 16, 2003.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereto duly
authorized.
SONEX RESEARCH, INC.
(Registrant)
/s/ George E. Ponticas
----------------------------
by: George E. Ponticas
Chief Financial Officer
November 19, 2003
EXHIBIT 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Andrew A. Pouring, Chief Executive Officer, certify that:
1. I have reviewed this Quarterly Report on Form 10-QSB of Sonex Research,
Inc. (the "Company").
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the Company as of, and for, the periods presented in this report;
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, if any, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) evaluated the effectiveness of the Company 's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this report (the "Evaluation Date"); and
c) presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as
of the Evaluation Date;
5. The Company's other certifying officer and I disclosed, based on our
most recent evaluation, to the Company 's auditors and the audit
committee of Company 's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company 's ability to
record, process, summarize and report financial data and have
identified for the Company 's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company 's
internal controls.
6. The Company's other certifying officer and I have indicated in this
report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: November 19, 2003
/s/ Andrew A. Pouring
----------------------
Andrew A. Pouring
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, George E. Ponticas, Chief Financial Officer, certify that:
1. I have reviewed this Quarterly Report on Form 10-QSB of Sonex Research,
Inc. (the "Company").
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the Company as of, and for, the periods presented in this report;
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, if any, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) evaluated the effectiveness of the Company 's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this report (the "Evaluation Date"); and
c) presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as
of the Evaluation Date;
5. The Company's other certifying officer and I disclosed, based on our
most recent evaluation, to the Company 's auditors and the audit
committee of Company 's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company 's ability to
record, process, summarize and report financial data and have
identified for the Company 's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company 's
internal controls.
6. The Company's other certifying officer and I have indicated in this
report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: November 19, 2003
/s/ George E. Ponticas
----------------------
George E. Ponticas
Chief Financial Officer
EXHIBIT 32
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Sonex Research, Inc. (the
"Company") on Form 10-QSB for the quarter ending September 30, 2003, as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
the undersigned certify, pursuant to and for the purposes of 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
SONEX RESEARCH, INC.
/s/ Andrew A. Pouring /s/ George E. Ponticas
--------------------- ----------------------
Andrew A. Pouring George E. Ponticas
Chief Executive Officer Chief Financial Officer
November 19, 2003