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 June 30, 2000
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 18,593,837 shares of the Issuer's $.01 par value Common Stock
outstanding at August 11, 2000.
- 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 9:
Balance sheets as of June 30, 2000 and December 31, 1999
Statements of operations and accumulated deficit for the three- and six-
month periods ended June 30, 2000 and 1999
Statements of paid-in capital for the period from January 1, 1998 through
June 30, 2000
Statements of cash flows for the six-month periods ended June 30, 2000
and 1999
Notes to financial statements
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Sonex Research, Inc.
We have reviewed the condensed financial statements appearing on pages 3 through
10 of this Form 10Q-SB Quarterly Report of Sonex Research, Inc. (the "Company")
as of June 30, 2000. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements for them to be in conformity
with generally accepted accounting principles.
We previously audited, in accordance with generally accepted auditing standards,
the balance sheet as of December 31, 1999, and the related statements of
operations and accumulated deficit and cash flows for the year then ended (the
"audited financial statements", not presented herein), and in our report dated
March 2, 2000, we expressed an unqualified opinion on those financial
statements. We also stated that the audited financial statements were prepared
assuming that the Company will continue as a going concern; however, as
described in Note 3 to the audited financial statements, the Company has
incurred significant net losses since its inception and its ability to commence
generation of significant revenue and ultimately achieve profitable operations
raise substantial doubt about the Company's ability to continue as a going
concern. The audited financial statements and the accompanying condensed
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
C. L. STEWART & COMPANY
Annapolis, Maryland
August 2, 2000
- 2 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
SONEX RESEARCH, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
June 30, December 31,
ASSETS 2000 1999
------------ ------------
Current assets
Cash and equivalents $ 147,172 $ 57,768
Accounts receivable 88,968 77,461
Prepaid expenses 27,643 29,836
Loans to officers and employees 22,500 22,500
------------ ------------
Total current assets 286,283 187,565
Notes receivable from officers and employees 18,125
Patents and technology, net of accumulated
amortization of $40,090 in 2000 and
$68,746 in 1999 197,392 219,776
Property and equipment, net of accumulated
depreciation of $418,175 in 2000 and
$409,648 in 1999 75,882 83,968
------------ ------------
Total assets $ 577,682 $ 491,309
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 78,489 $ 49,212
Accrued wages, bonuses and vacation pay 69,000 79,381
------------ ------------
Total current liabilities 147,489 128,593
------------ ------------
Deferred compensation 787,294 763,744
------------ ------------
Stockholders' equity/(deficit)
Preferred stock, $.01 par value - 2,000,000
shares issued; 1,540,001 shares outstanding 15,400 15,400
Common stock, $.01 par value - shares issued
and outstanding: 18,593,837 in 2000 and
18,008,169 in 1999 185,938 180,082
Additional paid-in capital 20,666,503 20,430,476
Accumulated deficit (21,224,942) (21,026,986)
------------ ------------
Total stockholders' equity/(deficit) (357,101) (401,028)
------------ ------------
Total liabilities and stockholders' equity $ 577,682 $ 491,309
============ ============
The accompanying notes are an integral part of the financial statements.
- 3 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
SONEX RESEARCH, INC..
CONDENSED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
(Unaudited)
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
---------- ---------- ---------- ----------
Revenue
Government $ 68,783 $ 30,000 $ 263,788 $ 68,800
Commercial 50,000 50,000 70,000 50,000
---------- ---------- ---------- ----------
118,783 80,000 333,788 118,800
---------- ---------- ---------- ----------
Costs and expenses
Cost of revenue 41,784 20,255 152,073 36,387
Research & development 118,041 113,418 219,536 253,883
General & administrative 86,666 87,034 162,482 170,438
---------- ---------- ---------- ----------
246,491 220,707 534,091 460,708
---------- ---------- ---------- ----------
Net loss from operations (127,708) (140,707) (200,303) (341,908)
Other (income)/expense
Investment and other income 1,745 1,609 2,347 4,795
Gain on sale of marketable
securities
---------- ---------- ---------- ----------
Net loss (125,963) (139,098) (197,956) (337,113)
Accumulated deficit
Beginning 21,098,979 20,654,886 21,026,986 20,456,871
---------- ---------- ---------- ----------
End $21,224,942 $20,793,984 $21,224,942 $20,793,984
========== ========== ========== ==========
Weighted average
number of shares
outstanding 18,441,492 17,755,836 18,296,996 17,699,448
========== ========== ========== ==========
Net loss per share $.007 $.008 $.011 $.019
===== ===== ===== =====
The accompanying notes are an integral part of the financial statements.
- 4 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF PAID-IN CAPITAL
(Unaudited)
Price Preferred stock Common stock Additional
per ($.01 par value) ($.01 par value) paid-in
share Shares Amount Shares Amount capital
----- --------- ------ ---------- ------- ----------
Balance, January 1, 1998 1,540,001$15,400 17,393,906$173,939 $20,035,060
January through December -
option exercises $.50 181,500 1,815 88,935
March for services .625 20,000 200 12,300
June for services .75 7,949 80 5,882
September for services .44 26,813 268 11,463
December for services .50 12,692 127 6,219
Stock option compensation 5,000
Amortization of deferred
compensation from grant of
stock options 44,644
--------- ------ ---------- ------- ----------
Balance, December 31, 1998 1,540,001 15,400 17,642,860 176,429 20,209,503
March for services .44 20,975 210 9,098
June for services .46 17,925 179 8,071
September for services .38 36,923 369 13,593
December for services .32 36,803 368 11,478
April and December
option exercises .50 255,000 2,550 124,950
Correction of stock ledger (2,317) (23) 23
Stock option compensation 24,000
Amortization of deferred
compensation from grant of
stock options 29,760
--------- ------ ---------- ------- ----------
Balance, December 31, 1999 1,540,001 15,400 18,008,169 180,082 20,430,476
February exercise of
warrants .35 285,000 2,850 96,900
March for services .40 24,130 241 10,125
June exercise of warrants .375 196,667 1,967 71,783
June exercise of warrants
for notes .375 48,333 483 17,642
June for services .41 31,538 315 12,695
Stock option compensation 12,000
Amortization of deferred
compensation from grant of
stock options 14,882
--------- ------ ---------- ------- ----------
Balance, June 30, 2000 1,540,001$15,400 18,593,837$185,938 $20,666,503
========= ====== ========== ======= ===========
The accompanying notes are an integral part of the financial statements.
- 5 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
-------------------------
2000 1999
---- ----
Cash flows from operating activities
Net loss $ (197,956) $ (337,113)
Adjustments to reconcile net loss to
net cash used in operating activities
Depreciation 9,472 4,500
Amortization of patents 44,308 6,300
Amortization of deferred compensation 14,882 14,880
Current charges paid in stock or options 35,376 29,558
Gain on sale of marketable securities
(Increase) decrease in accounts receivable (11,507) 17,547
(Increase) decrease in prepaid expenses 2,193 3,766
Increase (decrease) in current liabilities 18,897 (10,269)
Increase (decrease) in deferred compensation 23,549 25,265
----------- ----------
Net cash used in operating activities (60,786) (245,566)
----------- ----------
Cash flows from investing activities
Proceeds from sales of marketable securities
(Increase) decrease in loans to employees 1,000
Acquisition of property and equipment (1,386) (59,891)
Additions to patents (21,924) (2,294)
----------- ----------
Net cash provided by (used in)
investing activities (23,310) (61,185)
----------- ----------
Cash flows from financing activities
Issuance of stock - exercise of warrants 173,500
Issuance of stock - exercise of options 56,250
----------- ----------
Net cash provided by financing activities 173,500 56,250
----------- ----------
Increase (decrease) in cash 89,404 (250,501)
Cash
Beginning of period 57,768 336,458
----------- -----------
End of period $ 147,172 $ 85,957
=========== ===========
The accompanying notes are an integral part of the financial statements.
- 6 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
SONEX RESEARCH, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - The Company
--------------------
Sonex Research, Inc. has developed a proprietary technology, known as the
Sonex Combustion System (SCS), which improves the combustion of fuel in internal
combustion engines through modification of the pistons in large engines or the
cylinder heads in small engines. Variations of the Company's technology have
been applied to all types of internal combustion engines, including those used
in personal and commercial vehicles as well as engines used in fixed or portable
utility applications. Sonex concentrates its commercial efforts on the
application of the SCS to the reduction of exhaust emissions in direct injected
turbocharged diesel engines. The Company's objective is to execute broad
agreements with engine manufacturers and their piston suppliers for industrial
production of SCS pistons under license from Sonex.
Note 2 - Presentation of Financial Statements
---------------------------------------------
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and Item 310(b)
of Regulation S-B. Accordingly, these financial statements do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included.
Operating results for the three- and six-month periods ended June 30,
2000 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2000. 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, 1999.
Certain reclassifications have been made to the prior period financial
statements to conform to the classifications used in the current period.
Note 3 - Patents
----------------
The costs associated with the filing of patent applications are deferred.
Amortization is recorded on a straight-line basis over the remaining legal life
of patents, commencing in the year in which the patent is granted. Costs related
to patent applications which ultimately fail to result in the grant of a patent,
either through rejection by patent authorities or through abandonment by the
Company, are charged to operations at the time such determination is made.
Note 4 - Deferred Compensation
------------------------------
In order to help conserve the Company's limited cash resources, certain
of the Company's employees for several years have voluntarily deferred receipt
of payment of significant portions of their authorized annual salaries upon
request by the Board of Directors. By written agreement with the Company, these
individuals have consented to the deferral of payment of amounts so accumulated
until the Company has received licensing revenue of at least $2 million or at
such earlier date as the Board of Directors determines that the Company's cash
flow is sufficient to allow such payment. Since January 1, 1997, however, there
has been no further deferral of salary requested of the Company's non-executive
employees.
Deferred compensation outstanding is payable to the following
classifications of personnel:
- 7 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
June 30,
---------
2000 1999
---- ----
Current executive officers $ 454,688 $ 431,137
Current employees and consultants 62,088 62,088
Former employees 270,519 270,519
--------- ---------
$ 787,294 $ 763,744
========= =========
Note 5 - Income Taxes
---------------------
The Company has not incurred any federal or state income taxes since its
inception due to operating losses. At December 31, 1999, the Company had net
operating loss ("NOL") and capital loss carryforwards of approximately $16.2
million available to offset future taxable income. If certain substantial
changes in the Company's ownership should occur, there would be an annual
limitation on the amount of the carryforwards which can be utilized. The
Company's tax loss carryforwards are summarized as follows:
Expiration NOL Capital
---------- ----- -------
2000 $ 1,105,399
2001 1,748,874 $ 201,681
2002 1,837,965 133,400
2003 1,344,816 365,147
2004 1,185,181 14,970
2005 - 2012 7,995,726
2018 - 2019 941,695
------------ ---------
$ 16,159,656 $ 715,198
============ =========
Note 6 - Stockholders' Equity
-----------------------------
Authorized capital stock
The Company is presently authorized to issue 48 million shares of $.01
par value common stock and 2 million shares of $.01 par value convertible
preferred stock. All of the authorized shares of preferred stock, along with
common stock purchase warrants, were issued for $2 million in February 1992 (the
"Preferred Stock Investment") to a small number of investors, including
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 June 30, 2000,
a total of 459,999 shares of preferred stock had been converted into 1,314,278
shares of common stock.
Exercise and expiration of warrants
In February 2000 the Company received cash proceeds of $99,750 from the
exercise of warrants to purchase 285,000 shares of its common stock at an
exercise price of $.35 per share. At the same time, warrants to purchase an
additional 286,428 shares at $.35 per share expired unexercised, as did warrants
to purchase 3,098,209 shares at $.75 per share.
- 8 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
In June 2000 the Company received cash proceeds of $73,750 from the
exercise of warrants to purchase 196,667 shares of its common stock, and
accepted five-year notes receivable aggregating $18,125 from its chief financial
officer and two other employees for the exercise of warrants to purchase 48,333
shares of its common stock, all at a price of $.375 per share. At the same time,
warrants to purchase an additional 350,000 shares at $.375 per share expired
unexercised, as did warrants to purchase 590,000 shares at $.50 per share.
Stock options
The Company maintains a non-qualified stock option plan (the "Plan")
which has made available for issuance a total of 7.5 million shares of common
stock. All directors, full-time employees and consultants to the Company are
eligible for participation. Option awards are determined at the discretion of
the Board of Directors. Upon a change in control of the Company, all outstanding
options granted to employees and directors become vested with respect to those
options which have not already vested. Options outstanding expire at various
dates through December 2009.
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board (APB) Opinion No. 25.
Under APB No. 25, compensation cost is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of grant over the
exercise price of the option granted. Compensation cost for stock options, if
any, is recognized ratably over the vesting period. In its complete annual
financial statements presented in its Form 10-KSB, the Company provides
additional pro forma disclosures as required under Statement of Financial
Accounting Standards No. 123 - "Accounting for Stock-Based Compensation" as if
the fair value based method of accounting had been applied to the Company's
stock option grants made subsequent to 1994.
From January 1, 2000 through June 30, 2000, 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, 2000 4,056,716 $.52 3,426,716 $.52
Granted/becoming exercisable 65,000 .50 51,250 .50
Exercised 0 0
Lapsed (3,000) .50 (3,000) .50
--------- ---------
Unexercised at June 30, 2000 4,118,716 $.52 3,474,966 $.52
========= ==== ========= ====
Common stock reserved for future issuance
At June 30, 2000, a total of 11,192,091 shares of common stock were
reserved by the Company for issuance for the following purposes:
Purpose # of shares
----------------------------- -----------
Currently exercisable warrants at $.75 per share, expiring in:
December 2000 340,000
February 2002 167,759
March 2002 220,000
----------
727,759
Currently exercisable options 3,474,966
Granted options becoming exercisable in the future 643,750
Options available for future grants 1,945,616
Conversion of preferred stock 4,400,000
----------
Total shares reserved 11,192,091
==========
- 9 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
Note 7 - Commitments
--------------------
The Company occupies its office and laboratory facility under the terms
of an extension of an operating lease agreement through December 31, 2000. In
the absence of a further extension beyond that date, the Company may continue to
occupy the facility on a month-to-month basis, pursuant to which the property
owner is required to provide thirty days notice if he wants the Company to
vacate the premises. The lease 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
Forward-looking statements
--------------------------
Sections of this Report, as well as all publicly disseminated material
about the Company, contain information in the form of "forward-looking"
statements within the meaning of the Private Securities Litigation Act of 1995
(the "Act"). Such statements are based on current expectations, estimates,
projections and assumptions by management with respect to, among other things,
trends affecting the Company's financial condition or results of operations and
the impact of competition. Words such as "expects", "anticipates", "plans",
"believes", "estimates", variations of such words, and similar expressions are
intended to identify such statements that include, but are not limited to,
projections of revenues, earnings, cash flows and contract awards. Such forward-
looking statements are not guarantees of future performance and involve risks
and uncertainties, all of which are difficult to predict and many of which are
beyond the control of the Company. Accordingly, readers are cautioned not to
place undue reliance on such forward-looking statements.
In order to obtain the benefits of the "safe harbor" provisions of the
Act for any such forward-looking statements, the Company cautions shareholders,
investors and prospective investors about significant factors which, among other
things, have in some cases affected the Company's actual results and are in the
future likely to affect the Company's actual results and cause them to differ
materially from those expressed in any such forward-looking statements.
Factors that could cause actual results to differ materially include, but
are not limited to, the following:
o ability to generate cash flow from revenue or to secure financing
necessary to fund future operations
o ability to demonstrate commercial viability of SCS technology
o ability to complete technology development and demonstration programs
and execute licensing agreements that produce significant revenue
o ability to attract and retain skilled personnel
o changes in general economic conditions
o competition
Overview of the Company and its technology
------------------------------------------
Sonex Research, Inc. ("Sonex" or the "Company") has developed a patented
proprietary technology (the "Sonex Combustion System", "SCS" or "Ultra Clean
BurnTM technology") which enables significant combustion process advancements
through design modification of the pistons in four-stroke direct injected (DI)
diesel engines or the cylinder heads in two-stroke engines. The SCS four-stroke
engine technology addresses emissions reduction in "classical" DI diesel engines
and, more recently, the feasibility of a new, enhanced combustion system for low
compression ratio, controlled homogeneous combustion to further reduce emissions
and improve fuel consumption.
- 10 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
The Company has concentrated its commercial efforts on the application of
the SCS to the reduction of exhaust emissions in "classical" DI turbocharged
diesel truck engines through demonstration and development programs with some of
the world's largest foreign multi-national diesel engine original equipment
manufacturers (OEMs). The Company's objective is to execute broad agreements
with engine manufacturers and their piston suppliers for industrial production
of SCS pistons under license from Sonex.
Management believes that the Company's piston-based emissions reduction
enabling technology for DI diesel engines, which changes only a single engine
component while introducing no additional parts, can be an alternative to
exhaust aftertreatment. Evidence to date shows 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 enable in-cylinder emissions reduction to
meet future regulatory standards.
The primary achievements of the SCS DI diesel engine technology are as
follows:
o reduction of exhaust emissions in vehicular diesel engines
o potential elimination of exhaust aftertreatment systems
o equal fuel consumption
o potential for lower cost, less complexity and greater reliability
In separate demonstration programs, diesel engine OEMs have verified and
accepted that the SCS can substantially reduce particulate emissions at future
NOx (oxides of nitrogen) levels in a DI diesel engine for medium duty trucks
while maintaining fuel consumption and power. Tests conducted by one of these
manufacturers showed that an engine using SCS-modified pistons along with EGR
could attain future U.S. and European emissions targets when OEM type production
pistons become available. In-house testing of the Company's most recent patented
design innovation for vehicular DI diesel engines yields more impressive results
than earlier designs. The new SCS design, when coupled with EGR, achieves
significant reductions in soot and NOx emissions with no fuel penalty.
At its June 2000 annual meeting of shareholders, the Company announced a
new enhanced SCS combustion system for low compression ratio, DI engines, called
"stratified charge, radical ignition (SCRI)". Sonex has evolved the SCS-SCRI
design into a simplified, enhanced combustion system that enables fully
controllable homogeneous combustion, which provides all the benefits combustion
engineers worldwide have sought in terms of lower NOx emissions and better fuel
consumption, as well as reduced weight. Sonex has begun marketing to engine OEMs
this improved ignition process for low compression diesel engines and,
potentially, for converted gasoline engines. The Company is seeking a committed
industrial partner to provide substantial on-going financial support and
technical expertise to complete development of the SCRI combustion process.
In addition, the Company, in its laboratory and under contract with the
U.S. military and defense contractors, has applied the SCS to the conversion of
small gasoline engines to start and operate on military heavy fuels in a variety
of applications such as small, remotely controlled military unmanned aerial
vehicles (UAVs). The Sonex heavy fuel engines achieve power and fuel consumption
substantially equal to that of the stock gasoline engines and provide dependable
performance over the full engine operating range without "knocking", which has
been a major shortcoming of other heavy fuel conversion technologies.
Competition
-----------
The Company's competition comes from the extensive research departments
of the world's major vehicle and engine manufacturers as well as independent
engine testing firms. 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.
- 11 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
Current diesel engine programs
------------------------------
Funded development of Sonex pistons for industrial production for one of
the foreign engine OEMs, using an earlier SCS design, proceeded successfully
through verification tests by the engine manufacturer of pre-production,
finished, aluminum pistons. In the first quarter of this year, Sonex delivered
screw-assembled pistons incorporating the latest SCS design innovation for
"classical" DI diesel engines to the engine manufacturer for testing in a
complete six-cylinder engine. The manufacturer's objective is to meet future
stringent emissions limits in the production version of this engine by use of
the SCS technology, in combination with other fuel system improvements, with no
exhaust aftertreatment devices such as catalytic converters or particulate
traps. Results of these tests are expected in the near future. Management is
hopeful that successful evaluation of the Sonex pistons will lead to
negotiations for further design optimization services and a license agreement.
Promising test results at Sonex on a turbocharged six-cylinder DI diesel
engine led a second foreign engine OEM to engage its piston supplier to produce
pre-production SCS pistons. Sonex is providing input into the piston design
process and delivery of the pre-production pistons for engine testing at the OEM
is expected soon.
Sonex has also presented the improved test results demonstrated by the
latest SCS design innovation to U.S. diesel engine OEMs. Last summer one of
these U.S. manufacturers delivered to Sonex an engine used in current production
sport utility vehicles and pick-up trucks for a demonstration of the SCS in that
engine. In June of this year Sonex presented the results of tests it conducted
over the past few months using SCS pistons in this engine. The engine
manufacturer accepted this successful "proof-of-principle" of the SCS, and
proposed a follow-on project for a more extensive evaluation in a different
version of this engine series to begin shortly. In early July the Company
submitted its proposal and engaged in some discussion of terms with the engine
manufacturer; however, at the end of July, the manufacturer indicated that there
would be a delay in executing an agreement. At this time, it is unclear when
this contract will be signed. Sonex continues to have an open line of
communication with the engine OEM and hopes to receive word on the proposed
agreement in the near future.
Heavy fuel engines (HFEs)
-------------------------
The Company has successfully applied a patented SCS starting system and
modified combustion chamber design to the conversion of reliable, lightweight
small, spark-ignited, carburetted, two-stroke, gasoline fueled engines of
various sizes used in small, remotely controlled military unmanned aerial
vehicles (UAVs) to start and operate on JP-5/JP-8 standard military fuels (also
referred to as "heavy fuels"). UAVs conduct short-range tactical reconnaissance
while operating virtually unseen and unheard, taking pictures of battlefields
and enemy installations and relaying them back to ground forces. Existing UAV
engines in the military's inventory operate on gasoline. Because of safety and
logistics concerns, however, all military small engines, such as those powering
UAVs, eventually will be required to operate on less volatile, widely available
heavy fuels used by jet aircraft and most military vehicles.
Under a "best efforts" feasibility demonstration contract from the U.S.
Marine Corps (USMC) Systems Command in Quantico, Virginia, in 1998 the Company
delivered five prototype UAV HFEs. Sonex successfully converted the existing
single cylinder, two-stroke, gasoline fueled engine to start and run on heavy
fuel, leading the USMC to contract Sonex to convert an additional forty UAV
engines used in the Dragondrone UAV. The USMC is now deploying tactical UAVs
aboard ship for the first time, as the Dragondrone UAVs with Sonex HFEs are in
service in several locations around the world. Other demonstration programs for
the Sonex HFE technology for UAVs have taken place under contract with the
military and defense contractors as well.
The Company is assessing additional potential uses by the military for the
SCS HFE technology, as well as private sector opportunities. Operation of a
light-weight engine on high flash point fuels such as diesel and heavy fuels,
will reduce the hazard associated with gasoline, making such an engine much more
suitable for applications where gasoline storage is undesirable, such as in
diesel fueled utility engines used in pumps, generator sets, etc., in homes,
commercial buildings and boats. Other military applications for two-cycle HFEs
include standby generators, water pumps, chainsaws, earth tampers and outboard
engines.
- 12 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
One such program on an alternative HFE application has taken place. Under
a sub-contract from a prime contractor to the U.S. military, Sonex recently
completed its demonstration of the technical feasibility of converting an
existing high performance, 650+ horsepower, 4-stroke, gasoline fueled propulsion
system for marine use to start and operate on heavy fuels. This development of
the SCS 4-stroke HFE technology was conducted in a laboratory feasibility
demonstrator single-cylinder engine at Sonex and is based on SCRI, the new
enhanced SCS combustion process for low compression ratio, DI engines. The
feasibility demonstrator engine starts and operates on JP-5 over a wide range of
engine speeds and loads, with good fuel economy and without knocking. In June
2000 the military requested that Sonex provide a quotation for a follow-up
contract to transfer the design from the single cylinder laboratory engine to a
single cylinder of the gasoline engine. In late July, however, Sonex was
informed by the military sponsor that it would not fund additional development
of the SCRI, instead it would look to alternative propulsion systems. The
Company is presently seeking funding for further development of the SCRI from
other sources within the military.
Employees
---------
As of June 30, 2000, the Company had six full-time employees and one
part-time employee, and engaged the part-time services of two consultants on a
regular basis. Additional information on the Company's business, its technology,
and its management can be found in the Company's 1999 Annual Report on Form
10-KSB.
Financial position and liquidity
--------------------------------
As of June 30, 2000, the Company had available cash and equivalents of
approximately $147,000 and accounts receivable of approximately $89,000, (which
includes receivables of approximately $67,000 from a prime contractor to the
U.S. military). On the basis of available information, management previously had
reasonably expected that by August, the Company would have been awarded the
follow-on military heavy fuel engine contract that would have provided funding
for an additional four to six months; however, award of that contract in the
near future now appears unlikely. Based upon available resources, current and
projected spending levels, and expected revenue from current contracts, the
Company will have sufficient capital to fund operations through September 30,
2000. In the event that the award of anticipated contracts is delayed or does
not materialize, and in the absence of the realization of significant revenues,
additional capital may be necessary to fund operations through and beyond that
date. There is no assurance that such additional capital will be available or,
if available, can be obtained on favorable terms.
Results of operations
---------------------
A net loss from operations of $200,303 was recorded for the first six
months of 2000, as compared to $341,908 for the corresponding period in 1999, a
decrease of $141,605, or 41%. The decrease in the loss was due to substantially
higher revenue in 2000 versus 1999.
Revenue and cost of revenue:
Six months ended June 30
-------------------------
2000 1999
---- ----
Government $ 263,788 $ 68,800
Commercial 70,000 50,000
--------- --------
$ 333,788 $118,800
========= ========
Cost of revenue $ 152,073 $ 36,387
========= ========
- 13 -
<PAGE>
SONEX RESEARCH, INC. FORM 10-QSB
Since 1997 the Company has obtained several government contracts for its
heavy fuel engine technology, an application that has been developed only in the
last few years. All contracts to date in this area have involved the conversion
of commercial gasoline fueled engines used in UAV's and the like to heavy fuel
operation. Commercial revenue earned in connection with the Company's DI diesel
engine piston technology is subject to the negotiated amount, if any, that an
engine manufacturer is willing to provide in funding to partially offset the
development costs incurred by the Company in applying its technology to one of
the manufacturer's engines.
Nearly all of the government revenue reported for the first half of 2000
relates to a sub-contract awarded in the fall of 1999 from a prime contractor to
the U.S. military pursuant to which Sonex is demonstrating the technical
feasibility of converting an existing high performance, 650+ horsepower,
4-stroke, gasoline fueled engine for marine use to start and operate on heavy
fuels. The Company has devoted a significant portion of its available resources
to the performance of this sub-contract since late in 1999. Work under this
sub-contract was substantially completed by June 30, 2000.
Government revenue for the first half of 1999 was entirely related to a
January 1999 contract from the U.S. Naval Research Laboratory for an HFE
conversion demonstration on a gasoline UAV engine. Work on this contract, which
required only a small percentage of the Company's available workforce, continued
through the third quarter of 1999.
Cost of revenue primarily consists of direct labor charges and direct
purchases attributable to funded programs. Such amounts were substantially
higher in the first half of 2000 than in 1999 due to the relative sizes of the
government contracts being performed at the time. A small portion of total cost
of revenue for each period represented charges directly attributable to funded
commercial projects.
Research and development (R&D) expenses:
R&D expenses for the first six months of the year decreased by $34,344,
or 14%, from $253,880 in 1999 to $219,536 in 2000. While the number of employees
remained the same and compensation rates increased only slightly, a much higher
percentage of the workforce was devoted to funded projects in 2000 as opposed to
1999. Associated charges were therefore classified as "Cost of revenue" rather
than R&D expenses for 2000. The decrease in R&D expenses would have been larger
than reported except that the 2000 total includes approximately $36,800 for the
write-off of unamortized costs of patents abandoned while there was no such
charge in 1999.
General and administrative (G&A) expenses:
Total G&A expenses for the first six months decreased by $7,959, or 5%,
from $170,441 in 1999 to $162,482 in 2000. Personnel costs declined from
$105,159 in 1999 to $101,929 in 2000, or $3,230, primarily as a result of a
decrease in wages for an administrative assistant, which position became vacant
early in 1999 and has not since been filled. Net decreases in other expenses
amounted to $4,729.
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 June 26,
2000, the holders of the Company's Common Stock re-elected Mr. Nuno Brandolini
as a Class II director for a term expiring at the annual meeting held in the
year 2003. No other matters were submitted to a vote of security holders during
the second quarter of 2000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4 Instruments defining the rights of security holders (contained
in the Articles of Incorporation and By-laws, as amended,
filed with the 1992 Annual Report on Form 10-KSB)
(b) Reports on Form 8-K:
None.
- 14 -
<PAGE>
SONEX RESEARCH, INC. 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
August 11, 2000
- 15 -
<PAGE>
