SONEX RESEARCH INC
10QSB, 1997-05-20
COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH
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                     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 March 31, 1997.




                              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  17,134,539  shares  of the  Issuer's  $.01 par value  Common  Stock
outstanding at May 20, 1997.




                                      - 1 -

<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB







                         PART I - FINANCIAL INFORMATION





ITEM 1.  FINANCIAL STATEMENTS (Unaudited)


Index to unaudited financial statements presented on pages 3 to 11:

     Balance sheets as of March 31, 1997 and December 31, 1996

     Statements of operations and  accumulated  deficit for the three-month
     periods ended  March 31,  1997 and  1996,  and for the  period  from
     April 9, 1980 (inception) through March 31, 1997

     Statements of paid-in capital for the period from January 1, 1994 through
     March 31, 1997

     Statements of cash flows for the three-month periods ended March 31, 1997
     and 1996, and for the period from April 9, 1980 (inception) through 
     March 31, 1997

     Notes to financial statements

                                      - 2 -
<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




                              SONEX RESEARCH, INC.
                          (A Development Stage Company)
                            CONDENSED BALANCE SHEETS
                                   (Unaudited)


                                                      March 31,    December 31,
                           ASSETS                        1997         1996
                                                    ------------   -----------

Current assets
  Cash and equivalents                              $    644,355   $    89,739
  Marketable securities, available-for-sale               36,800        36,800
  Accounts receivable                                                   50,000
  Prepaid expenses                                        39,921        38,692
  Loans to officers and employees                         16,805        16,906
                                                    ------------   -----------
      Total current assets                               737,881       232,137

Loans to officers and employees - non-current             15,000        15,000

Patents and technology, net of accumulated amorti-
  zation of $262,750 in 1997 and $246,949 in 1996        272,582       239,308

Property and equipment, net of accumulated depre-
  ciation of $405,408 in 1997 and $402,033 in 1996        24,633        28,008
                                                    ------------   -----------

         Total assets                               $  1,050,096   $   514,453
                                                    ============   ===========


         LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities
  Accrued compensation                              $    633,666   $   620,620
  Accounts payable and other accrued liabilities         180,505       170,371
                                                    ------------   -----------
      Total current liabilities                          814,171       790,991
                                                    ------------   -----------

Stockholders' equity
  Preferred stock, $.01 par value, 2,000,000
      shares issued, 1,550,001 shares outstanding         15,500        15,500
  Common stock, $.01 par value, shares issued
      and outstanding: 17,134,539 in 1997 and
      16,214,020 shares in 1996                          171,345       162,140
  Additional paid-in capital                          19,810,469    19,165,535
  Unrealized increase in value of
      marketable securities                               36,800        36,800
  Deficit accumulated during development stage       (19,798,189)  (19,656,513)
                                                    ------------   ------------
      Total stockholders' equity                         235,925      (276,538)

Commitments (Note 9)
                                                    ------------   ------------

      Total liabilities and stockholders' equity    $  1,050,096   $   514,453
                                                    ============   ============



    The accompanying notes are an integral part of the financial statements.

                                      - 3 -

<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




                              SONEX RESEARCH, INC.
                          (A Development Stage Company)
           CONDENSED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
                                   (Unaudited)



                                                               April 9, 1980
                                                                (inception)
                                 Three months ended March 31,     through
                                                                 March 31,
                                     1997           1996           1997
                                 ------------   ------------   ------------

Revenue
  Development contracts          $     40,000                  $  1,705,566
  Other                                                             124,425
                                 ------------                  ------------

                                       40,000                     1,829,991
                                 ------------                  ------------

Costs and expenses
  Research and development            118,981   $    122,721     11,910,671
  General and administrative           63,748         66,680      7,244,751
  Interest                                286            136        867,235
  Write-off of patents
    and technology                                                  819,036
                                 ------------   ------------   ------------

                                      183,015        189,537     20,841,693
                                 ------------   ------------   ------------

Net loss from operations             (143,015)      (189,537)   (19,011,702)

Other income and expense
  Investment and other income           1,339          4,622        294,473
  Debt conversion expense                                        (1,112,350)
  Gain on sale of marketable
    securities                                                       31,390
                                 ------------   ------------   ------------

Net loss                             (141,676)      (184,915)   (19,798,189)


Deficit accumulated during
  development stage

  Beginning of period             (19,656,513)   (18,984,038)
                                 ------------   ------------   ------------

  End of period                  $(19,798,189)  $(19,168,953)  $(19,798,189)
                                 ============   ============   ============




Net loss per share                       $.01           $.01
                                         ====           ====


Weighted average number of
  common shares outstanding        16,453,886     15,304,019
                                 ============   ============



    The accompanying notes are an integral part of the financial statements.

                                      - 4 -

<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




                              SONEX RESEARCH, INC.
                          (A Development Stage Company)
                     CONDENSED STATEMENTS OF PAID-IN CAPITAL
              FOR THE PERIOD JANUARY 1, 1994 THROUGH MARCH 31, 1997
                                   (Unaudited)


                          Price  Preferred stock    Common stock     Additional
                           per  ($.01 par value)  ($.01 par value)     paid-in
                          share  Shares   Amount   Shares    Amount    capital
                          ----- --------- ------ ---------- -------  ----------

Note: Retroactive effect has been given to all previously declared stock splits.

Balance, January 1, 1994        1,980,000$19,800 12,065,801$120,658 $17,522,838

February through August -
 option exercises           .50                      75,379     754      36,936
April - conversion (.35 to 1)    (150,000)(1,500)   428,567   4,286      (2,786)
April - conversion of
 loan and interest          .75                     281,872   2,819     208,585
June and July for cash      .75                     766,666   7,666     567,334
October for services        .80                      30,000     300      23,700
Stock issuance costs                                                     (7,767)
                                --------- ------ ---------- -------  ----------

Balance, December 31, 1994      1,830,000 18,300 13,648,285 136,483  18,348,840

January - July for services .58                      15,000     150       8,600
June for cash               .25                   1,020,000  10,200     244,800
June - payment of
 accrued compensation       .25                     170,000   1,700      40,800
June - indemnification
 by officer                                                              15,000
September through November -
 option exercises           .50                      88,250     882      43,243
December for cash          1.00                     340,000   3,400     336,600
Compensation - grant of
 stock options                                                           52,500
Stock issuance costs                                                    (12,192)
                                --------- ------ ---------- -------  ----------

Balance, December 31, 1995      1,830,000 18,300 15,281,535 152,815  19,078,191

January for services       1.00                       1,000      10         990
January through August -
 option exercises           .50                     131,488   1,315      64,429
April and July -
 conversion (.35 to 1)           (279,999)(2,800)   799,997   8,000      (5,200)
Compensation - grant of
 stock options                                                           27,125
                                --------- ------ ---------- -------  ----------

Balance, December 31, 1996      1,550,001$15,500 16,214,020$162,140 $19,165,535

January - option exercises  .50                     145,000   1,450      71,050
March for cash              .75                     775,519   7,755     573,884
                                --------- ------ ---------- -------  ----------

Balance, March 31, 1997         1,550,001$15,500 17,134,539$171,345 $19,810,469
                                ========= ====== ========== ======= ===========


    The accompanying notes are an integral part of the financial statements.

                                      - 5 -
<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




                              SONEX RESEARCH, INC.
                          (A Development Stage Company)
                       CONDENSED STATEMENTS OF CASH FLOWS
                                   (Unaudited)

                                                                   April 9, 1980
                                                                    (inception)
                                              Three months ended      through
                                                   March 31,         March 31,
                                                1997       1996        1997
                                             ---------  ---------  ------------

Cash flows from operating activities
 Net loss                                    $(141,676) $(184,915) $(19,798,189)
 Adjustments to reconcile net loss to
  net cash used by operating activities
   Depreciation                                  3,375      5,161       668,890
   Amortization                                 15,801     15,801     1,392,409
   Write-down of patents                                                819,036
   Compensation - stock options                                         877,665
   Imputed interest expense                                             551,247
   Interest credited to paid-in capital                                  44,614
   Debt issuance and conversion expense                               1,112,350
   Accrued liabilities and current
    charges paid in stock                                   1,000     1,124,380
   Gain on sale of marketable securities                                (31,390)
   (Increase)decrease in accounts receivable    50,000     57,500        (6,241)
   (Increase)decrease in prepaid expenses       (1,229)     7,254       (39,921)
   Increase (decrease)in accrued liabilities    23,180     30,543       726,507
                                             ---------  ---------  ------------
Net cash used in operating activities          (50,549)   (67,656)  (12,552,402)
                                             ---------  ---------  ------------

Cash flows from investing activities
 Purchase of marketable securities                                   (2,377,256)
 Proceeds from sales of marketable securities                         2,408,646
 (Increase) decrease in cash posted as
   security for judgment                                   (1,114)
 (Increase) decrease in loans to employees         101      8,772       (31,805)
 Acquisition of property                                               (544,036)
 Additions to patents and technology           (49,075)    (4,045)   (1,359,577)
                                             ---------  ---------  ------------
Net cash provided by (used for)
 investing activities                          (48,974)     3,613   (1,904,028)
                                             ---------  ---------  ------------

Cash flows from financing activities
 Issuance of stock                             654,139     32,500    15,761,794
 Issuance of convertible debt                                         2,287,500
 Indemnification by officer                                              15,000
 Repayment of convertible debt                                          (92,500)
 Stock and debt issuance costs                                       (2,038,916)
 Distribution to stockholders - other                                   (18,772)
 Reduction of technology purchase
  obligations                                                          (797,500)
 Proceeds from borrowings                                             1,592,748
 Reduction of borrowings                                  (7,667)    (1,608,569)
                                             ---------  ---------  ------------
Net cash provided by (used for)
 financing activities                          654,139     24,833    15,100,785
                                             ---------  ---------  ------------

Increase (decrease) in cash                    554,616    (39,210)      644,355

Cash
 Beginning of period                            86,739    256,139
                                             ---------  ---------  ------------
 End of period                               $ 644,355  $ 216,929  $    644,355
                                             =========  =========  ============



    The accompanying notes are an integral part of the financial statements.

                                      - 6 -

<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




                              SONEX RESEARCH, INC.
                          (A Development Stage Company)
                     NOTES TO CONDENSED FINANCIAL STATEMENTS
                                   (Unaudited)


Note 1 - The Company
- --------------------

       Sonex Research, Inc. has developed and acquired technology which controls
the  combustion of fuel in engines.  The Company is in the process of developing
several  commercial  applications  of its  technology,  referred to as the Sonex
Combustion   System  (SCS).   Sonex  expects  to  license   several   commercial
applications  of its  technology  and  commercially  exploit other  applications
itself.  Related  revenue  earned  to date has  been  derived  principally  from
development  contracts,  but such revenue historically has offset only a portion
of the related development  expenditures.  Accordingly,  Sonex Research, Inc. is
classified as a development stage company.


Note 2 - Presentation of Financial Statements
- ---------------------------------------------

       The  accompanying  unaudited  condensed  financial  statements  have been
prepared in accordance with generally accepted accounting principles for interim
financial  information and with the  instructions to Form 10-QSB and Item 310(b)
of Regulation S-B. Accordingly, these financial statements do not include all of
the  information  and  footnotes  required  by  generally  accepted   accounting
principles for complete financial statements. In the opinion of management,  all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair  presentation  have been included.  Operating  results for the  three-month
period ended March 31, 1997 are not  necessarily  indicative of the results that
may be expected for the year ending December 31, 1997. 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, 1996.

       These financial statements include the accounts of the Company and, until
its disposition in October 1995, the accounts of its former 40%-owned, inactive,
consolidated  subsidiary,  SonoChem,  Inc.  In October  1995,  following  a 1:10
reverse  split of all of its  issued  and  outstanding  shares of common  stock,
SonoChem was merged with and into  Digital  Dictation,  Inc.,  a privately  held
Virginia  medical  transcription  services  company.  Pursuant  to  the  merger,
SonoChem  acquired 100% of the issued and outstanding  shares of common stock of
Digital Dictation,  Inc. through the issuance of 5,944,606  post-split shares of
SonoChem's  common stock, and SonoChem's name was changed to Digital  Dictation,
Inc.  Following the merger, the previous holders of the common stock of SonoChem
became  the  holders  of 5%, or 312,874  shares,  of the issued and  outstanding
shares of the surviving corporation Digital Dictation, Inc. ("Digital").


Note 3 - Marketable Securities
- ------------------------------

       In connection with the merger described in Note 2, the Company  exchanged
all of its shares in SonoChem for 125,133 shares of the common stock of Digital,
representing 2% of the issued and outstanding  shares of Digital.  A total of 5%
of the issued and outstanding shares of Digital,  including those shares held by
the Company, began public trading in the over-the-counter  market in April 1996.
Through  March 31,  1997,  the Company has sold a total of 27,000  shares of its
Digital stock and realized aggregate net proceeds of $30,113.

       At the time of this exchange in October  1995,  the fair value of neither
the SonoChem stock nor the Digital stock was reasonably estimable.  As a result,
the Company's  carrying basis in the SonoChem stock of zero was considered to be
its cost basis in the Digital  stock.  Since public  trading began in April 1996
and a readily  determinable  fair value for the Digital  stock has since  become
available,  the investment is now accounted for in accordance  with Statement of
Financial  Accounting  Standards No. 115 and  classified as a current asset as a
security that is "available-for-sale".  Accordingly, the Company's investment in
the 98,133  shares held as of March 31,  1997 is  recorded  in the  accompanying
financial  statements at its aggregate  fair value of $36,800.  A  corresponding
amount,  representing  the aggregate  unrealized  gain in the fair value of this
investment in excess of its cost basis,  is reported as a separate  component of
stockholders'  equity.  Subsequent changes in the aggregate market value of this
investment will be similarly recorded.


                                      - 7 -
<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




Note 4 - Loans to Officers and Employees
- ----------------------------------------

       Loans totaling  $37,180,  bearing interest at six percent per annum, were
made  early  in  1993  to four of the  Company's  officers  and one  non-officer
employee for the payment of income tax liabilities incurred by these individuals
upon  their  receipt in 1992 of shares of common  stock in  payment of  deferred
wages.  Outstanding loan principal and accrued interest  balances are secured by
deferred  salaries  payable to each of the borrowers.  One of these loans in the
principal  amount  of  $14,500  was  made  to the  Company's  vice-president  of
operations,  whose employment was later terminated.  During 1996 this amount and
accrued  interest were satisfied  through offset against deferred salary payable
to the former officer. The maturity date for the remaining unpaid loan principal
and interest due from current  employees has been extended  through December 31,
1997.  As of March 31,  1997,  aggregate  loan  principal  of  $13,280  remained
outstanding, while accrued interest on the loans aggregated $3,525.

       Loans totaling $15,000 were made in December 1995 to one of the Company's
officers and two non-officer employees for the payment of income tax liabilities
incurred  by these  individuals  upon their  receipt in 1995 of shares of common
stock in  payment  of  accrued  bonus  compensation.  The loans are  secured  by
deferred salaries payable to each of the borrowers, and become due within ninety
days of the date that the shares of common  stock  received by the  borrowers in
1995 first become saleable.  The loans originally bore a stated interest rate of
six percent  per annum,  but were  amended  later by the Board of  Directors  to
eliminate the accrual of interest.


Note 5 - Patents and Technology
- -------------------------------

       The costs  associated  with the filing of patent  applications,  computer
models and  simulations  developed  by third  parties,  and the  acquisition  of
patents and technology from third parties 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,  and over a  five-year  period for the
capitalized  costs of computer models and  simulations.  Costs related to patent
applications  which  ultimately fail to result in the grant of a patent,  either
through rejection by patent  authorities or through  abandonment by the Company,
are charged to operations at the time such determination is made.

       Following an extensive  evaluation  in 1994 of the factors  affecting the
economic  value of all of the  Company's  proprietary  technology,  the carrying
values of certain technology  developed  internally,  other technology  acquired
from a third party, and related technology purchase obligations, were reduced to
their estimated  recoverable amounts.  Related charges to operations  aggregated
$739,036 in 1994 and $80,000 in 1995.

       The Company has  conducted  and continues to conduct its own research and
development  activities which have resulted in additional proprietary technology
and patents.  Development of commercial  applications of certain elements of the
SCS has commenced and management  believes the  capitalized  cost of patents and
technology will be recovered  through revenue derived from the licensing of such
technology. Management closely monitors the patent application process and other
factors  which may affect the economic  value of the Company's  technology,  and
will further reduce the  capitalized  cost of patents and technology  should the
recovery of such cost no longer be sustainable.


Note 6 - Accrued Compensation
- -----------------------------

       In order to help conserve the Company's  limited cash  resources,  all of
the  Company's  salaried  employees  for  several  years  have been  voluntarily
deferring  significant  portions  of the  salaries  due them  under the terms of
previous  employment  agreements  or as  otherwise  established  by the Board of
Directors.  As of March 31, 1997,  an aggregate of $608,666 of wages so deferred
remained  unpaid and has been recorded as accrued  compensation on the Company's
balance sheet.

       As a  condition  of the  Company's  receiving  an  indispensable  capital
infusion in February 1992, the investors,  Proactive Partners,  L.P. and certain
of its affiliates ("Proactive"), who became the Company's largest shareholder by
virtue  of their  purchase  of  convertible  preferred  stock and  common  stock
purchase  warrants,   required  that  the  voluntary  deferral  of  salaries  be
documented formally.  Accordingly,  all salaried employees executed an agreement
referred to as the "Consent to Deferral" in which they consented to the past and
future deferral of portions of their

                                      - 8 -

<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




annual salaries, and agreed to defer 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.


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, 1996,  the Company had net
operating loss carryforwards of approximately  $16.5 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.   The  Company's  net  operating  loss
carryforwards expire at various dates from 1997 through 2011, as follows:


              Expiring in 1997                $   289,000
              Expiring in 1998                    658,000
              Expiring in 1999 - 2000           2,005,000
              Expiring in 2001 - 2002           3,907,000
              Expiring in 2003 - 2011           9,667,000
                                              -----------

                                              $16,526,000
                                              ===========

       The difference  between the net operating loss  carryforwards  for income
tax reporting  purposes and the accumulated  deficit reported in these financial
statements results principally from temporary differences relating to the timing
of the recording of deferred  salaries and compensation  related to the grant of
stock options for income tax and financial reporting  purposes,  the differences
in the  accounting  for the  Company's  investment  in its  former  consolidated
subsidiary for income tax and financial reporting  purposes,  and as a result of
the  non-deductibility  for  income tax  purposes  of a prior  year's  charge to
operations  for debt  conversion  expense.  The potential  income tax benefit of
these carryforwards and temporary  differences of approximately $6.4 million has
not  been  recorded  in the  financial  statements  due to  the  uncertainty  of
realization based on the Company's financial performance to date.


Note 8 - Stockholders' Equity
- -----------------------------

Authorized capital stock

       The Company is presently  authorized  to issue 48 million  shares of $.01
par  value  common  stock and 2  million  shares  of $.01 par value  convertible
preferred stock. The preferred stock has priority in liquidation over the common
stock,  but it carries no stated  dividend.  The holders of the preferred stock,
voting as a separate class,  have the right to elect that number of directors of
the Company which  represents a majority of the total number of  directors.  The
preferred  stock is  convertible  at any time at the option of the  holder  into
common  stock at the rate of $.35 per  share of  common  stock.  As of March 31,
1997,  a total of 449,999  shares of  preferred  stock had been  converted  into
1,285,707 shares of common stock.


Private placements of common equity

       On February  28,  1997,  the Company  notified  the holders of all of its
outstanding  warrants to purchase shares its common stock of proposed amendments
to such warrants.  These  amendments were offered because the Company was unable
to complete a planned registration during 1996 of the common stock issuable upon
the exercise of the warrants. The warrants, all of which had original expiration
dates five years from the respective  acquisition  date,  were issued in private
financings  that took place in February 1992,  June 1994, June 1995 and December
1995. The proposed amendments included, in various  combinations,  extensions of
the expiration dates, reductions in the exercise prices, provisions for cashless
exercise, and provisions for "piggy-back" registration rights.

       The  amendments  proposed for the warrants  issued in February  1992 (the
"February 1992 Warrants") were also offered in connection with a $250,000 equity
investment proposal from Proactive accepted by the Company on February 24, 1997.
In exchange  for this cash  investment,  Proactive  received  333,333  shares of
common stock

                                      - 9 -

<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB


and five-year warrants to purchase 166,666 shares of common stock at an exercise
price of $.75 per share,  along with a number of  amendments  to  February  1992
Warrants  issued by the Company to Proactive  and other  investors in connection
with the sale of $2 million of convertible preferred stock in February 1992 (the
"Preferred  Stock  Investment").  One other  participant in the Preferred  Stock
Investment,  a director of the Company, also received the amendments to February
1992 Warrants in exchange for his cash  investment of $1,639,  pursuant to which
he also received 2,186 shares of common stock and five-year warrants to purchase
1,093 shares of common stock at an exercise price of $.75 per share.

       On March 31, 1997, the Company  completed a private financing in which it
raised  $330,000  from  a  small  number  of  the  Company's   shareholders  who
participated in previous private  financings of the Company.  A total of 440,000
shares of the  Company's  common  stock and  five-year  warrants  to purchase an
additional  220,000  shares of common  stock at $.75 per  share  were  issued in
connection with this transaction.

       The offer  and sale of a total of  775,519  shares  of  common  stock and
five-year  warrants  to  purchase a total of 387,759  shares of common  stock in
connection with the two transactions described above satisfied the conditions of
Rule 506 of Regulation D of the  Securities  Act of 1933, as amended (the "Act")
and, as such, were exempt from the reqistration requirements of Section 5 of the
Act as  transactions  not  involving any public  offering  within the meaning of
Section 4(2) of the Act. All of the purchasers of these securities  qualified as
"accredited investors" pursuant to Rule 501 of Regulation D of the Act.

       Presented below is a schedule summarizing the number, exercise prices and
expiration  dates of the  warrants  outstanding  as of March 31,  1997,  both as
originally issued and as amended as described above.


                          Before amendments              After amendments
                   -----------------------------   -----------------------------
 Month issued        $   # of shares  Expiration     $   # of shares  Expiration
 ------------      ----  -----------  ----------   ----  -----------  ----------

February 1992      0.35     571,428   Feb. 1997    0.35     571,428   Feb. 2000
February 1992      1.00   3,121,428   Feb. 1997    0.75   1,858,928   Feb. 2000
                                                   1.00     428,571   Dec. 1997
February 1992      1.50   3,142,857   Feb. 1997    0.75   1,239,286   Feb. 2000
                                                   1.50     428,572   Dec. 1997
June 1994          1.125    524,268   June 1999    0.75     524,268   June 1999
June 1994          1.50     524,268   June 1999    0.75     524,268   June 1999
June 1995          0.375    595,000   June 2000    0.375    595,000   June 2000
June 1995          0.50     595,000   June 2000    0.50     595,000   June 2000
December 1995      1.25     340,000   Dec. 2000    0.75     340,000   Dec. 2000
March 1997         0.75     387,759   Mar. 2002    0.75     387,759   Mar. 2002
                         -----------                     -----------

Totals                    9,802,008                       7,493,080
                          =========                       =========


Stock options

       The Company  maintains a  non-qualified  stock option plan which has made
available  for  issuance a total of five  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
become  vested with  respect to those  options  which have not  already  vested.
Options granted to date expire at various dates through August 2006.

       The Company  accounts for  stock-based  compensation  using the intrinsic
value method  prescribed  in Accounting  Principles  Board (APB) Opinion No. 25.
Under APB No. 25,  compensation  cost is measured as the excess,  if any, of the
quoted  market  price of the  Company's  stock  at the  date of  grant  over the
exercise price of the option granted.  Compensation  cost for stock options,  if
any, is  recognized  ratably over the vesting  period.  In its  complete  annual
financial  statements  presented  in  its  Form  10-KSB,  the  Company  provides
additional  pro forma  disclosures  as required under SFAS No. 123 - "Accounting
for  Stock-Based  Compensation"  as if the fair value based method of accounting
had been applied to the Company's stock option grants made subsequent to 1994.

                                     - 10 -

<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB



Common stock reserved for future issuance

       At March 31,  1997,  a total of  16,117,320  shares of common  stock were
reserved for issuance for the following purposes:


                         Purpose                                  # of shares
              -----------------------------                       -----------

Currently exercisable warrants:
 Exercisable at $.35 per share, expiring in February 2000            571,428
 Exercisable at $.375 per share, expiring in June 2000               595,000
 Exercisable at $.50 per share, expiring in June 2000                595,000
 Exercisable at $.75 per share, expiring on various dates
  from June 1999 through March 2002                                4,874,509
 Exercisable at $1.00 per share, expiring in December 1997           428,571
 Exercisable at $1.50 per share, expiring in December 1997           428,572
                                                                  ----------
                                                                   7,493,080
                                                                  ----------
Currently exercisable options:
 Exercisable at $.50 per share                                     2,837,984
 Exercisable at $.75 per share                                        65,250
 Exercisable at $1.00 per share                                      140,000
                                                                  ----------
                                                                   3,043,234
                                                                  ----------
Granted options becoming exercisable in the future:
 Exercisable at $.50 per share                                       733,500
 Exercisable at $.75 per share                                        33,750
                                                                  ----------
                                                                     767,250

Options available under plan for future grants                       385,182

Conversion of preferred stock                                      4,428,574
                                                                  ----------

 Total shares reserved                                            16,117,320
                                                                  ==========


Note 9 - Commitments
- --------------------

       The Company does not have employment agreements with any of its officers;
however,  as  detailed in Note 6, all  salaried  employees  have been  deferring
significant portions of their authorized salaries under the terms of the Consent
to Deferral in order to help conserve cash.

       The Company occupies its office and laboratory  facilities pursuant to an
extension  through November 1997 under the terms of an operating lease agreement
that has expired.  The lease,  as amended,  provides for monthly rent of $3,500,
and requires the Company to pay all property related expenses.  The Company will
either  attempt to negotiate a new  long-term  lease for its current  office and
laboratory  facility once the current extension  expires,  or continue to occupy
the premises on a  month-to-month  basis under the terms of the previous  lease,
pursuant to which the property  owner is required to provide  thirty days notice
if he wants the Company to vacate the premises.  Management  may also 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.

                                     - 11 -
<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
                         AND RESULTS OF OPERATIONS


Description of the business
- ---------------------------

       Sonex Research, Inc. ("Sonex" or the "Company"), incorporated in Maryland
in 1980,  is engaged in the research,  development  and  commercialization  of a
patented  technology  (the  "Sonex  Combustion  System",  "SCS" or "Ultra  Clean
Burn(TM)  technology")  which  controls  the  combustion  of  fuel  in  engines,
primarily  through  modification  of the piston.  The Company has shown  through
tests in  manufacturers'  engines and in computer models that its technology has
the ability to control  combustion  and allow fuel to be used more  efficiently,
and that engines using the Company's  technology  have  performance  superior to
conventional engines and emit fewer harmful exhaust emissions.

       Management  believes that the Company's  technology can be applied to all
types of internal  combustion  engines,  including  those used in  personal  and
commercial vehicles (automobiles,  trucks, buses, boats and motorcycles) as well
as engines used in fixed or portable utility applications (motor generator sets,
pumps, and chain saws),  whether spark ignited (SI) or compression ignited (CI),
carburetted  or fuel injected,  using either  gasoline,  diesel,  alcohol and/or
other fuels.

       The Company's  competition comes from the extensive research  departments
of the world's major  vehicle and engine  manufacturers  as well as  independent
research  organizations.  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  on  price  and
performance.  Due to the highly competitive nature of the world's automotive and
truck industries, in connection with its contracts and/or demonstration programs
with such  manufacturers  the Company is required to execute  joint  secrecy and
disclosure  agreements  that  expressly  prohibit the public  disclosure  of the
customers' names and other significant information. Failure by Sonex to maintain
this strict level of  confidentiality  would  jeopardize the relationship of the
Company with its customers.

       Sonex is  concentrating  its efforts on the application of its technology
to  direct  injected  (DI)  turbocharged   diesel  engines.   Demonstration  and
development  programs at various  stages of completion are underway with some of
the largest multi-national diesel engine manufacturers in the world. The goal of
such   programs  is  to  execute  broad   agreements   with  the  diesel  engine
manufacturers  and their piston  suppliers  for  industrial  production of Sonex
pistons under license from the Company. The demonstration  process involves many
stages, from proof of concept using screw-assembled prototype pistons fabricated
in-house by Sonex,  to working  with piston  suppliers  for the  fabrication  of
finished   pre-production  pistons  that  will  be  used  in  field  trials  and
durability,  manufacturing  optimization,  and other tests  required  before the
start of full series production.

       To date, the Company has completed separate  demonstration  programs with
two of these manufacturers,  and each has verified and accepted that the SCS can
substantially  reduce particulate  emissions in a DI turbocharged  diesel engine
for  medium  duty  trucks  while   maintaining   fuel   consumption  and  power.
Negotiations  are underway with one of the world's largest piston  suppliers and
with  these  manufacturers  for  licensing,   technology  transfer  and  further
development programs. In the fourth quarter of 1996, a third major international
engine  manufacturer  executed a funded agreement with the Company for a similar
demonstration program.

       In  addition  to  diesel  truck  engine  applications,  the  Company  has
successfully applied its proprietary  combustion technology to the conversion of
a small, lightweight,  SI gasoline fueled engine to start and operate on JP5/JP8
standard military fuel while also improving fuel consumption.  The advantages of
this  converted SI engine,  which also include low cylinder  head  temperatures,
have  been  demonstrated  successfully  in a  public  demonstration  of a small,
remotely  controlled  Unmanned  Aerial  Vehicle  (UAV).  As  a  result  of  this
demonstration,   the  Company   recently   executed   contracts  with  two  U.S.
manufacturers  of small engines to investigate  the  feasibility of applying the
Sonex UAV design to production SI engines:  one contract applies to a two-stroke
gasoline fueled engine, while the other contract applies to a four-stroke engine
using diesel fuel.

       As of March 31, 1997, the Company had six employees:  its three executive
officers and three other individuals who provide technical services.  Additional
information on the Company's business, its technology, and its management can be
found in the Company's 1996 Annual Report on Form 10-KSB.

                                     - 12 -

<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB



Financial position
- ------------------

       Since its  inception  in 1980,  the Company has  generated  net losses of
nearly $20 million.  Operating funds have been raised primarily through the sale
of equity  securities in both public and private  offerings,  while  revenues to
date  have  not  been  significant.  Accordingly,  the  Sonex  continues  to  be
classified as a development stage company.

       At March 31, 1997, the Company held cash and equivalents of $644,355, and
marketable  securities valued at $36,800.  The marketable  securities  represent
holdings in the common stock of the corporation which in October 1995 was merged
with and into the Company's inactive subsidiary, as further described in Notes 2
& 3 to the accompanying financial statements. The fair value of such securities,
however, may be subject to significant  fluctuation due to, among other factors,
limited trading volume and a small public float.

       Based upon current spending levels,  management believes that the cash on
hand and expected revenue from currently  executed  contracts will be sufficient
to fund  operations at least  through the end of the first quarter of 1998.  The
Company is currently  in  negotiations  for  technology  transfer and  licensing
agreements which would provide  substantial  operating funds in the future,  but
execution of such  agreements is not assured.  In the absence of the realization
of significant revenues,  additional capital may be necessary to fund operations
beyond the first quarter of 1998.


Results of operations
- ---------------------

       A net loss from  operations  of $141,676 was recorded for the first three
months of 1997, as compared to $184,915 for the corresponding  period in 1996, a
decrease of $43,239.  The  decrease in the loss  resulted  from the  increase in
development  contract revenue to $40,000 for the first three months of 1996 from
zero for the comparable period in 1996, while total expenses decreased by $6,523
and investment income decreased by $3,284.

       The  revenue of  $40,000 in 1997  represents  the amount  earned  under a
demonstration  program  begun in October 1996 to apply the SCS to a truck diesel
engine for a major  international  OEM.  Work under this  program is expected to
conclude during the second half of the year.

       Research and development (R&D) expenses for the first three months of the
year  decreased by $3,740,  or 3%, from $122,721 in 1996 to $118,981 in 1997, as
an increase in  personnel  costs of $4,455,  from  $66,762 in 1996 to $71,217 in
1997,  was more than offset by a net  decrease in other  expense  categories  of
$8,195.  The  increase  in  personnel  costs  represents  an  average  increase,
effective  January  1,  1997,  of  approximately  10% in the wage  rates for the
Company's  three  non-executive  employees.  The largest  decrease for other R&D
expenses  was $4,261,  from  $15,206 in 1996 to $10,945 in 1997,  for  occupancy
costs,  primarily because the Company negotiated a reduction in its monthly rent
late in 1996.  The Company  also  experienced  declines in testing  supplies and
depreciation expense.

       General and  administrative  (G&A) expenses for the first three months of
the year  decreased  by $2,932 or 4%,  from  $66,680 in 1996 to $63,748 in 1997,
primarily  as a result of a net  decrease  of  $2,975,  from  $19,355 in 1996 to
$16,380  in  1997,  in  professional   fees.  Charges  of  $4,575  in  1996  for
professional  fees were  recorded  for the services of a public  relations  firm
hired to undertake a short-term publicity campaign for the Company.  This amount
was offset in part by an increase of approximately  $2,000 in auditing fees from
1996 to 1997. As to other G&A  expenses,  an increase in travel costs was offset
by decreases in occupancy costs, insurance, and other expenses.

                                     - 13 -
<PAGE>
                        SONEX RESEARCH, INC. FORM 10-QSB




                           PART II - OTHER INFORMATION



ITEM 2.  CHANGES IN SECURITIES


         The  information  required by this item is incorporated by reference to
Note 8 to  the  financial  statements  included  in  Item  1 of  Part I of  this
Quarterly Report on Form 10-QSB.



ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K


  (a)    Exhibits:

           4      Instruments defining the rights of security holders (contained
                  in the  Articles of  Incorporation  and  By-laws,  as amended,
                  filed with the 1992 Annual Report on Form 10-KSB)

  (b)    Reports on Form 8-K:

                  The  Registrant  filed  Current  Reports  on  Form  8-K  dated
         February 28, 1997 and March 31, 1997 to report the equity  transactions
         described in Note 8 to the financial  statements  included in Item 1 of
         Part I of this Quarterly Report on Form 10-QSB.





                                   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


May 20, 1997

                                     - 14 -

<PAGE>

<TABLE> <S> <C>


<ARTICLE>                     5
       
<S>                             <C>
<PERIOD-TYPE>                   3-MOS
<FISCAL-YEAR-END>                          DEC-31-1996
<PERIOD-START>                             JAN-01-1996
<PERIOD-END>                               MAR-31-1997
<CASH>                                         644,355
<SECURITIES>                                    36,800
<RECEIVABLES>                                        0
<ALLOWANCES>                                         0
<INVENTORY>                                          0
<CURRENT-ASSETS>                               737,881
<PP&E>                                         430,041
<DEPRECIATION>                                 405,408
<TOTAL-ASSETS>                               1,050,096
<CURRENT-LIABILITIES>                          814,171
<BONDS>                                              0
                                0
                                     15,500
<COMMON>                                       171,345
<OTHER-SE>                                      49,080
<TOTAL-LIABILITY-AND-EQUITY>                 1,050,096
<SALES>                                         40,000
<TOTAL-REVENUES>                                40,000     
<CGS>                                                0
<TOTAL-COSTS>                                  183,015
<OTHER-EXPENSES>                                     0
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                                   0
<INCOME-PRETAX>                               (141,676)
<INCOME-TAX>                                         0
<INCOME-CONTINUING>                           (141,676)
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                                  (141,676)
<EPS-PRIMARY>                                    ($.01)
<EPS-DILUTED>                                    ($.01)
        



</TABLE>


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