SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999. Commission
file number 0-14465.
SONEX RESEARCH, INC.
Incorporated in State of Maryland
23 Hudson Street, Annapolis, Maryland 21401
Telephone Number:(410)266-5556 I.R.S. Employer Identification No. 52-1188993
Securities registered pursuant to Section 12(b) of the Act:
Title of Name of each exchange on
each class which registered
---------- ----------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B in this form, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ X ]
The number of shares outstanding of the Issuer's $.01 par value Common Stock as
of March 15, 2000 was 18,293,169. The aggregate market value of voting stock
held by non-affiliates of the Registrant was $7,646,223 as of March 15, 2000.
Revenues for the year ended December 31, 1999 were $324,286.
Documents Incorporated by Reference: None.
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
ITEM 1. DESCRIPTION OF BUSINESS
The Company
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Sonex Research, Inc. ("Sonex" or the "Company"), incorporated in Maryland in
1980, has developed a patented proprietary technology (the "Sonex Combustion
System", "SCS" or "Ultra Clean BurnTM technology") which improves the combustion
of fuel in engines through design 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 (automobiles, trucks, buses, boats,
motorcycles) as well as engines used in fixed or portable utility applications
(motor generator sets, pumps, chain saws), whether spark ignited (SI) or
compression ignited (CI), carburetted or fuel injected, using gasoline, diesel,
alcohol and/or other fuels.
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. Sonex concentrates its commercial efforts on the application
of the SCS to the reduction of exhaust emissions in direct injected (DI)
turbocharged diesel engines.
Management believes that the Company's piston-based emissions reduction enabling
technology for DI diesel engines, which changes only a single engine component
while introducing no additional parts and is self-driven by the combustion
process, can be an alternative to exhaust aftertreatment. 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 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 operate on military heavy fuels in a variety of
applications.
Employees
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As of March 15, 2000, the Company had five full-time employees and one part-time
employee, and engages the part-time services of two consultants on a regular
basis. The Company has never experienced a strike or work stoppage, and believes
its relations with its employees are good.
Caution regarding forward-looking statements
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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.
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
Factors that could cause actual results to differ materially include, but are
not limited to, the following:
o ability to secure financing necessary to fund future operations
o ability to complete technology development and demonstration programs
and execute licensing agreements that produce significant revenue
o ability to demonstrate commercial viability of SCS technology
o ability to attract and retain skilled personnel
o changes in general economic conditions
o competition
Potential benefits of the SCS in the reduction of emissions
- -----------------------------------------------------------
Government agencies around the world continue to mandate increasingly more
strict requirements for the reduction of allowable diesel truck emissions,
specifically with respect to smoke/particulates and NOx (oxides of nitrogen).
The use of costly electronic controls and ultra-high pressure injection systems,
including the new "common rail" injection systems that are integral to the
engine itself, may permit truck manufacturers to attain some of these
reductions; however, it is unlikely any one emissions reduction technique will
enable manufacturers to meet the emission standards to be implemented in the
next few years.
High pressure injectors may reduce smoke/particulates, but they also increase
NOx emissions while doing so. Manufacturers, therefore, may be able to eliminate
equipment such as particulate traps, but they likely will need de-NOx catalytic
converters, further retard of injection timing, and replenishment chemicals,
leading to an increase in fuel consumption and additional maintenance, all at a
significantly higher cost. Management believes that the Company's diesel
technology, which primarily requires a change of piston design, under various
conditions causes a reduction in smoke/particulates, carbon monoxide (CO),
hydrocarbons (HC), and NOx by significant amounts while maintaining brake
specific fuel consumption (BSFC) and power. In tests conducted in modern
turbocharged engines of several manufacturers, fitted with a variety of Sonex
pistons, including aluminum screw assembled pistons (SAP) and electron beam
welded (EBW) pistons, using an earlier SCS piston design, the Company has
demonstrated that the SCS may reduce smoke/particulate emissions in excess of
40% and HC emissions by 5%, while maintaining equal NOx emissions at future
targets and BSFC approximately equal to that of the stock engine.
The ability of the SCS to reduce soot emissions has an added benefit towards the
reduction of NOx in diesel engines. Many manufacturers are turning to using
exhaust gas recirculation (EGR) to reduce NOx. (EGR is inert exhaust gas
recycled and pumped back into the engine cylinders for the next combustion
cycle.) EGR can significantly reduce NOx, but the soot recirculated with EGR can
increase particulate emissions and increase engine wear. The SCS acts to reduce
both the engine wear and the quantity of particulates in the emissions by
significantly reducing the soot content of the emissions.
Management believes that Sonex Ultra Clean BurnTM technology is perhaps the
least expensive method of emissions reduction, but it is likely to be used in
conjunction with other technologies to enable manufacturers to meet the strict
diesel truck emission standards that will be introduced in the near future. All
testing to date by Sonex and the engine OEM's has shown that SCS diesel
technology is complementary to new developments such as high pressure and common
rail injection and EGR.
Targeted applications
- ---------------------
Ongoing SCS demonstration and development programs at various stages of
completion with some of the largest multi-national diesel engine original
equipment manufacturers (OEMs) in the world target engines used in medium and
heavy duty trucks. The demonstration process involves many stages, from proof of
concept using screw-assembled prototype pistons fabricated in-house by Sonex and
tested by the engine manufacturer in its laboratories, to working with piston
suppliers for the fabrication of finished pre-production pistons that will be
used in field trials, and durability, manufacturing optimization, and other
tests required before the start of full series production.
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
The Company has completed separate demonstration programs with some of the
largest multi-national diesel engine OEMs in the world, and each has verified
and accepted that the SCS can substantially reduce particulate emissions at
future NOx 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, referred to as the "SCS-AD", yields
more impressive results than earlier designs. The SCS-AD, when coupled with EGR,
achieves significant reductions in soot and NOx emissions with no fuel penalty.
Sonex has now reached the next stage with these programs, that is, optimization
of the piston design for the fabrication of pre-production pistons. The engine
manufacturers have stated that the SCS benefits could be in lower cost and less
complexity. These factors are now being addressed by the Company and its
customers. Continued revision of emissions limits, however, has challenged Sonex
to produce piston designs that reduce both NOx and soot, leading to a delay in
successful commercialization of the SCS.
The Company also has successfully applied a patented SCS starting system and
modified combustion chamber design to the conversion of reliable, lightweight,
SI, 2-stroke, gasoline fueled engines of various sizes used in small, remotely
controlled military unmanned aerial vehicles (UAVs) to start and operate on JP-5
standard military fuel (also referred to as "heavy fuel"). The Sonex heavy fuel
engines (HFEs) achieve power and fuel consumption substantially equal to that of
the stock gasoline engines and provide dependable performance over the full
engine operating range without "knocking", which has been a major shortcoming of
other heavy fuel conversion technologies.
As heavy fuels are less volatile than gasoline, in addition to the UAV market,
the Company is examining a wide range of sustained commercial utility engine
applications for its heavy fuel conversion technology to reduce the hazards
associated with the storage of gasoline in buildings and on boats. Over the past
few months, Sonex has also been applying its heavy fuel technology to a 4-stroke
engine in connection with a contract with the U.S. military.
Overview of SCS design modifications; In-house test results
- -----------------------------------------------------------
The SCS engine design modifications for heavy fuel operation in SI two-stroke
engines, based on the Sonex U.S. Patent 5,855,192 issued January 5, 1999,
consist of modified cylinder heads and special combustion chamber inserts
housing the proprietary SCS technology. The SCS conversion aims to maintain the
gasoline engine's stock carburetion, intake and exhaust port timing, intake and
exhaust systems, ignition system, ignition timing, compression ratio and weight.
The SCS starting system employs heaters similar to those used in a diesel
engine.
The patented SCS for DI diesel engines improves the process of combustion
through a combination of chemical and fluid dynamic effects that occur by
modifying the engine's combustion chamber and the processes occurring within
that chamber. SCS DI diesel designs integrate one or more cavities as
microchambers which form a ring around the piston bowl, with each microchamber
positioned in line with a spray from the fuel injector. The microchambers
perform as reservoirs that produce active chemical species (partially reacted
charges) which are expelled at high velocity to enhance combustion and burn the
soot cloud. The microchambers are connected to the piston bowl by tunnel- like
vents that control the amount of fuel and air that enter the microchamber and
also control the amount of turbulence that is created when gases jet out of the
microchambers through these vents into the piston bowl. The position of the
microchambers is a critical factor in controlling the temperature of the
microchamber and the rate of reaction of gases that may be resident in the
microchamber at any one time.
The SCS-AD, based on the Sonex U.S. Patent 5,862,788 issued January 26, 1999, is
the latest invention in the series for the SCS for DI diesel engines and
involves re-arrangement of SCS features to exploit new fundamental
understandings of fluid dynamics. The key feature of the SCS-AD is the presence
of improved micro-chambers in the piston which produce and conserve intermediate
and radical chemical species from a small portion of the incoming fuel. The
expulsion of these materials at high velocity enhances turbulence mixing,
achieving better than a 50% soot reduction and a 15% NOx reduction in the Sonex
single cylinder, DI, normally aspirated research engine with no change in
injection timing. SCS generated radical chemical species from a similar design
are also being used at Sonex to achieve radical assisted, 4-stroke combustion
and therefore represent a major step forward in combustion engineering.
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
Application of the SCS for achieving reduced diesel emissions is highly
leveraged when used with EGR, allowing enhanced ignition with low soot
production in the presence of large amounts of EGR. In the Sonex single cylinder
research engine, the synergy of SCS and EGR (at levels up to 45 percent)
produced far greater NOx reduction than the same engine without EGR over a range
of loads and speeds while maintaining the same soot level. Typically, without
the SCS, a high level of NOx- reducing EGR produces at least a three-fold
increase in soot.
Sonex has also demonstrated that the SCS technology can be transferred to a
modern turbocharged, intercooled DI diesel engine. Our most recent data from
this engine clearly show the potential of the SCS where, with no fuel penalty,
soot is reduced by 50% and NOx is reduced by 11% with no retard of injection
timing or use of EGR. SCS pistons for this engine are now in pre-production
using electron-beam welding for assembly.
Competition
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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 in terms of low cost,
improved performance, and simplicity, since no additional moving parts are added
to the engine.
Secrecy and non-disclosure
- --------------------------
Due to the highly competitive nature of the world's automotive and truck
industries, in connection with its contracts and/or demonstration programs with
such manufacturers the Company is required to execute joint secrecy and
disclosure agreements that expressly prohibit the public disclosure of the
customers' names and other significant information. Failure by Sonex to maintain
this strict level of confidentiality would jeopardize the relationship of the
Company with its customers.
DI diesel engine programs with foreign engine OEMs
- --------------------------------------------------
On a continuing basis for the past few years, the Company has performed
extensive design and development work on medium- and heavy-duty truck engines
for large foreign multi-national diesel truck engine OEMs, in separate programs.
Funded development of Sonex pistons for industrial production for one of the
foreign OEM's proceeded successfully through verification tests by the engine
manufacturer of pre-production, finished, aluminum pistons, using an earlier SCS
design, in an engine in its own facility. During 1998 and 1999 the Company,
under contract with this OEM, participated with suppliers of the OEM's injection
system and turbo-charger, and one of the world's leading independent engine R&D
and testing firms, on a joint engine application program involving Sonex
technology for eventual production in a DI turbo-charged, intercooled, mid-range
diesel engine using high pressure electronically controlled injection, common
rail high pressure, variable geometry turbocharger, cooled EGR, etc.
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 these other fuel system improvements, with no exhaust aftertreatment
devices, such as catalytic converters or particulate traps. Based on all OEM and
Sonex tests to date, with further optimization of traditional diesel parameters
and EGR, the OEM hopes to achieve these particulate and NOx emissions goals.
Testing of the SCS pistons in 1999 was delayed due to difficulties encountered
by the engine testing firm with the very advanced, non-Sonex components being
evaluated. Late in 1999, however, the engine manufacturer moved to accelerate
the schedule by taking over responsibility itself for evaluating the SCS piston
design for its new low emission engine series. In February 2000 Sonex delivered
pistons incorporating the SCS-AD to the engine manufacturer for testing in a
complete six-cylinder engine. Results of these tests are expected in the near
future. Management is hopeful that successful evaluation of the Sonex pistons
will lead later this year to negotiations for further design optimization
services and a license agreement.
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
Promising test results at Sonex of the SCS-AD on a turbocharged six-cylinder DI
diesel engine led a second foreign engine manufacturer last fall 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
further engine testing at the OEM is expected soon.
In cooperation with the engine OEMs, the Company has worked with the major
piston suppliers to these manufacturers, providing engineering specifications
and drawings for their use in evaluating alternative production methods in
anticipation of eventual piston orders from the engine manufacturers. The most
extensive collaboration has been with the former T&N Piston Products Group of
the U.K., which was acquired in 1998 by Federal-Mogul Corp., a major supplier of
engine components based in Southfield, Michgan. T&N invested significant funds
internally in developing innovative and economical techniques of manufacturing
Sonex pistons for series production, as well as performing finite element,
thermal and stress analyses to examine the effects of stress on the Sonex piston
under a variety of extreme conditions. Federal-Mogul, however, has indicated
that it is not prepared to commit further internal funding to complete the work
initiated by T&N, but is willing to cooperate with any engine OEM that would
fund production development. In fact, Federal- Mogul currently is producing
pre-production SCS pistons for one of the foreign engine OEMs discussed above.
U.S. diesel engine manufacturers
- --------------------------------
In November 1998 seven diesel engine manufacturers completed negotiation of a $1
billion settlement with the Environmental Protection Agency (EPA) and the
Department of Justice to settle allegations that the companies used "defeat
devices" for the past several years that allowed their engines to emit more
pollution on the road than in certification tests in order to achieve
performance benefits. The settlement, in the form of Consent Decrees under the
Clean Air Act, levied stiff civil penalties, required industry to accelerate the
introduction of advanced anti-pollution controls on new engines, and included an
industry obligation to fund millions of dollars of research and development in
projects to lower emissions, including consideration of projects proposed by the
public.
In January 1999 Sonex responded to the announcement by submitting a proposal to
the EPA, the Justice Department, and the diesel engine manufacturers for a
cooperative effort between Sonex, the diesel engine manufacturing industry, a
major engine research facility, a major automotive piston manufacturer, and an
advanced metal-forming parts manufacturer, to demonstrate that a new engine
design variable exists in the piston-based SCS allowing in-cylinder reduction of
emissions as an alternative to exhaust aftertreatment.
The Consent Decrees with each manufacturer were formally entered by the Federal
District Court on July 1, 1999. The EPA held public hearings on the progress of
the settlement in September 1999, December 1999 and March 2000, and early in
2000 approved the projects proposed by the diesel engine manufacturers under the
Consent Decrees. After having reviewed limited publicly available information on
the scope of these projects and having attended and addressed the December 1999
public hearing, Sonex believes that the potential benefits of the SCS
in-cylinder piston based emissions reduction technology have not been recognized
in the engine manufacturer responses.
The goal-oriented project descriptions provided by the engine manufacturers
appear to place heavy emphasis on exhaust aftertreatment and alternative fuels,
and do not include an assessment of technical feasibility. As a result, the
potential role for SCS in-cylinder technology is limited to those projects that
indicate that at least some investment will be made to refine or optimize the
combustion system. Sonex will attempt to become a participant in projects of
this scope, particularly by emphasizing the recent discoveries of the synergy of
the SCS and EGR to achieve economical in- cylinder emissions reductions.
Before the Consent Decrees were entered, Sonex maintained correspondence with
and visited several U.S. diesel engine manufacturers during 1999 to present the
improved test results demonstrated by the SCS-AD. 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. Tests conducted over the past few months at Sonex using SCS pistons in
this engine are progressing, and Sonex expects to provide a preliminary report
on results to the manufacturer later this year. Discussions are ongoing with
other U.S. engine manufacturers as well; however, no specific programs have been
defined as yet.
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
Heavy fuel engines (HFEs)
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The Company has successfully converted small, SI, carburetted, two-stroke,
gasoline fueled engines of various sizes used in small, remotely controlled
military unmanned aerial vehicles (UAV's) to start and operate on JP5/JP8
standard military fuels (also referred to as "heavy fuels"). UAV's 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, early in 1998 the Company
delivered five prototype UAV heavy fuel engines (HFEs). Sonex successfully
converted the existing SI, carburetted, 100cc single cylinder, two-stroke,
gasoline fueled 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 UAV's aboard ship for the
first time, as the Dragondrone UAV's with Sonex HFE's are in service in several
locations around the world.
Other demonstration programs have taken place under contract with the military
and defense contractors. Also in 1998 Sonex completed a UAV HFE conversion
feasibility demonstration for the U.S. Naval Air Warfare Center, Aircraft
Division (the "Navy"), in Patuxent River, Maryland. Sonex converted the existing
350cc, two-stroke, carburetted, SI two cylinder gasoline engine used in the
Pioneer UAV to heavy fuel operation, demonstrating starting and running at
various loads and speeds with little visible smoke and without knock or
detonation. Two feasibility demonstration Sonex HFE's were delivered to the
Navy; however, the Company has since been informed that the Navy is planning to
replace the engine used in the Pioneer. The Navy has indicated informally that
Sonex will participate in the development of an HFE for the replacement engine.
In recent months the Army and the Navy have awarded multi-year development
contracts to major defense companies for next generation UAV's that will
ultimately require HFEs. Sonex continues to discuss its HFE technology with
these defense contractors.
By January 1999 the Company completed work on a Phase I Small Business
Innovation Research (SBIR) Program contract awarded by the U.S. Naval Sea
Systems Command (NAVSEA). Sonex demonstrated the feasibility of utilizing SCS
technology to design a low-cost, small, rugged engine to fit in a 5-inch
diameter cylinder, capable of starting and operating on shipboard-safe heavy
fuels, for use in a small aircraft that would be suitable for launch from guns
and missiles and for delivery by airdrop. The aspects of the design ruggedness
and other interface requirements for potential transition opportunities were
performed under subcontract by Science Applications International Corporation
(SAIC), an advanced technology firm with particular expertise in national
defense concepts such as UAV's. The first transition opportunity identified for
such an engine is in the Forward Air Support Munition (FASM), a gun-launched
surveillance, targeting, and precision delivery air vehicle being developed by
the Naval Surface Fire Support program office. SAIC is the designated prime
contractor for the FASM Fleet Advanced Demonstration.
Late in 1999 the Company learned that its proposal for a Phase II award for the
development of an operational prototype engine had been recommended based on
technical merit, but Sonex did not receive a contract award due to a lack of
funding for the program. Nevertheless, the Company expects to collaborate with
SAIC on FASM and other HFE projects for the military.
In September 1999 Sonex completed an HFE conversion demonstration under contract
with the U.S. Naval Research Laboratory (NRL) on a two-stroke, two cylinder,
290cc gasoline UAV engine. The Navy is supportive of UAV technology and the
integration of UAV's into shipboard operations. A supply of heavy fuel is
readily available onboard ships, and the deployment of UAV's would not be
hindered by the amount or type of fuel available. NRL took delivery of two Sonex
HFEs which were to be integrated into a pair of prototype UAVs that NRL is using
as test beds for various UAV technologies and payloads.
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. The range of commercial applications is
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
particularly important to the military as it acquires off-the-shelf products
powered by two-cycle engines and thereby continues to perpetuate the need for
gasoline in the logistics system. Military applications for two-cycle HFEs
include standby generators, water pumps, chainsaws, earth tampers and outboard
engines. Sonex has submitted proposals to several military development sponsors
suggesting a work program for optimization of the SCS heavy fuel conversion
technology to fully examine, engineer and qualify an SCS implementation for
military and commercial applications.
One such program on an alternative HFE application is already underway. Under a
sub-contract from a prime contractor to the U.S. military, Sonex is examining
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 demonstration of the SCS 4-stroke heavy fuel
combustion technology is being conducted in a laboratory feasibility
demonstrator single-cylinder engine at Sonex.
After analysis and design iteration, Sonex has fabricated a preliminary SCS
screw-assembled piston for this engine that will produce and conserve
intermediate and radical chemical species from a small portion of the incoming
fuel to provide radical and spark ignition combustion of the JP-5. At this stage
of the project, the feasibility demonstrator single-cylinder engine is starting
and operating on JP-5 over a wide range of engine speeds and loads, with good
fuel economy and without knocking. Progress reviews to date by the prime
contractor and the military have been favorable; soon, Sonex hopes to receive a
request for quotation for a follow-up contract for prototype conversion, design
enhancements, and installation and operational assessment.
Patents and proprietary information
- -----------------------------------
The Company has endeavored to protect its technology by filing for patents in
the U.S. and in those foreign countries in which it may be able to commercialize
the SCS. The most recent U.S. patents for the SCS DI diesel engine technology
and the SCS heavy fuel engine technology were issued in January 1999.
The Company has also developed a significant body of trade secrets, proprietary
information and know-how relating to its technology. Although the principles
underlying the SCS concept are capable of being understood by experts in the
field, management believes that it would be difficult to apply the SCS
successfully to any given engine configuration without the benefit of the trade
secrets, know-how and proprietary information owned by the Company.
The name "SONEX" was registered at the U.S. Patent and Trademark Office in 1987.
Management believes that the Company's business depends substantially upon the
protection afforded by its granted and pending patents, as well as its trade
secrets, proprietary information and know-how. All contracts outside the Company
involving any exchange of confidential technical information are made under
secrecy agreements approved by the Company's patent counsel. In addition, all of
the management and technical employees of the Company are required to sign
non-disclosure agreements respecting the Company's technology.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's principal executive offices and testing facility are located at 23
Hudson Street, Annapolis, Maryland, 21401. The facility is equipped with
emissions test equipment and machine shop and storage facilities necessary to
support the laboratory. Management believes that all of the Company's property
is adequately covered by insurance. The building contains approximately 6,000
square feet and is being occupied by the Company on a month-to-month basis under
the terms of an operating lease agreement, pursuant to which the property owner
is required to provide thirty days notice if he wants the Company to vacate the
premises. Management will seek to negotiate a new long-term lease for its
facility or search for an alternative location in the event that an agreement
cannot be reached for the existing premises. Management believes that the
resolution of the uncertainty with respect to the facility will not result in a
significant interruption in the operations of the Company.
ITEM 3. LEGAL PROCEEDINGS
As of the date of this report, management is aware of no legal proceedings
pending against the Company.
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock currently is traded in the over-the-counter market on
the OTC Bulletin Board service under the symbol "SONX". The OTC Bulletin Board
is an electronic and screen-based quotation medium operated by Nasdaq. Quotation
information on OTC Bulletin Board stocks is available on stockbrokers' desktop
terminals.
The Company has never paid cash dividends on its Common Stock and does not
expect to pay any cash dividends in the foreseeable future. The high and low
closing prices of the Common Stock for each quarterly period since January 1,
1997 were as follows (These prices, which are drawn from reports provided to the
Company by Nasdaq, reflect inter-dealer prices without mark-ups, mark-downs, or
commissions, and may not necessarily represent actual transactions.):
Quarter ended: High Low
--------- ------
March 31, 1998 $1.09 $.56
June 30, 1998 .84 .47
September 30, 1998 .75 .41
December 31, 1998 .65 .38
March 31, 1999 .63 .38
June 30, 1999 .56 .38
September 30, 1999 .53 .35
December 31, 1999 .47 .22
Through March 15, 2000 .51 .31
As of March 15, 2000, there were 18,293,169 shares issued and outstanding, with
approximately 980 holders of record. The shares for approximately 2,800
additional beneficial owners of the Common Stock are held of record (in "street
name") by brokers, dealers, banks, and other entities holding such securities of
record in nominee name or otherwise or as a participant in a clearing agency
registered pursuant to Section 17A of the Securities Exchange Act of 1934. As of
March 15, 2000, a total of 12,382,091 shares of the Company's Common Stock were
reserved for issuance in connection with the conversion of preferred stock and
the exercise of warrants and options.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
Accumulated losses; sources of capital
- --------------------------------------
Since its inception in 1980, the Company has generated cumulative net losses in
excess of $21 million. Operating funds have been raised primarily through the
sale of equity securities in both public and private offerings. For each of the
last three years, however, revenues have increased substantially from prior
levels.
Cash available at the beginning of 1999, combined with revenue from development
and demonstration programs, met a significant portion of the Company's operating
expenditure requirements for the year. Additional cash was provided by the
exercise of stock options by management, primarily the Company's president, who
exercised options for the purchase of 250,000 shares of common stock for a total
of $125,000 during 1999. In February 2000 the Company received cash proceeds of
$99,750 from the exercise of stock warrants to purchase 285,000 shares of its
common stock.
Financial position and liquidity
- --------------------------------
As of March 15, 2000, the Company had available cash and equivalents of
approximately $80,000 and accounts receivable, all due from a U.S. military
prime contractor, of approximately $133,000. Based upon available resources,
current and projected spending levels, and expected revenue from current and
anticipated contracts, management is optimistic that the Company will have
sufficient capital to fund operations through December 31, 2000. In the event
9
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
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.
Salary deferrals by employees
- -----------------------------
In order to help conserve the Company's limited cash resources, certain of the
Company's employees for several years have voluntarily deferred receipt of
payment of significant portions of their authorized annual salaries upon request
by the Board of Directors. By written agreement with the Company, these
individuals have consented to the deferral of payment of amounts so accumulated
until the Company has received licensing revenue of at least $2 million or at
such earlier date as the Board of Directors determines that the Company's cash
flow is sufficient to allow such payment. Since January 1, 1997, however, there
has been no further deferral of salary requested of the Company's non-officer
employees. The conditions that would require repayment of deferred amounts have
yet to occur, and it is unlikely that such conditions will occur prior to
December 31, 2000.
Results of operations
- ---------------------
Condensed comparative results:
- ------------------------------
1999 1998 1997
--------- --------- ---------
Gross revenue $ 324,286 $ 395,213 $ 417,588
Cost of government/defense sub-contracts (69,326) (111,750)
--------- --------- ---------
Net revenue 324,386 325,887 305,838
--------- --------- ---------
Research and development (R&D) expenses 632,441 583,196 558,526
General and administrative (G&A) expenses 315,649 276,674 334,389
--------- --------- ---------
Total expenses 948,090 859,870 892,915
--------- --------- ---------
Net loss from operations (623,804) (533,983) (587,077)
Gain on sale of marketable securities 43,508 247,144 38,299
Investment and other income 10,181 16,477 18,782
--------- --------- ---------
Net loss $(570,115) $(270,362) $(529,996)
========= ========= =========
While net revenue remained relatively the same in 1999 and 1998, the net loss
from operations increased nearly $90,000, primarily as a result of higher
personnel costs, including the costs of consultants. The net loss for 1999 is
nearly $300,000 higher than the net loss for 1998 because, in addition to the
higher personnel costs, $203,636 more in gains on the sale of marketable
securities were realized in 1998 than in 1999.
Net revenue increased approximately $20,000 from 1997 to 1998, but the net loss
from operations decreased approximately $53,000, as an increase in R&D expenses
of almost $25,000 was more than offset by the combination of higher net revenue
and a decrease in G&A expenses of nearly $58,000.
Gains on the sale of marketable securities represent the proceeds from the sale
of the Company's holdings in the common stock of Digital Dictation, Inc.
(acquired in 1998 by Medquist, Inc.), the corporation which in 1995 was merged
with and into the Company's inactive former subsidiary, SonoChem, Inc. The
Company liquidated most of this investment during 1998 when its value increased
substantially. The balance of this investment was sold in 1999.
10
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
Revenue and cost of subcontracts:
---------------------------------
1999 1998 1997
--------- --------- ---------
Government/defense prime contracts $ 222,866 $ 261,362 $ 90,668
Commercial contracts 101,420 60,550 207,500
--------- --------- ---------
324,286 321,912 298,168
Revenue from government/defense
sub-contracts 73,301 119,420
--------- --------- ---------
Total revenue $ 324,286 $ 395,213 $ 417,588
========= ========= =========
Cost of government/defense sub-contracts $ 69,326 $ 111,750
========= =========
Total revenue decreased 18% from 1998 to 1999, after having decreased 5% from
1997 to 1998. Revenue in 1999 exclusive of subcontracts was nearly the same as
that for 1998. Changes in annual revenues are subject to the number of funded
contracts received, the timing of completion of those contracts, and the extent
of related subcontracts. Revenue from commercial contracts, earned primarily 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. Such revenue for
1999 and 1998 includes $100,000 and $50,000, respectively, for a joint engine
application program for the development and testing of prototype SCS pistons for
an engine OEM. Revenue for 1997 includes $90,000 related to the delivery of
prototype Sonex pistons to another major international OEM, as well as $90,000
under a demonstration program to apply the SCS to a truck diesel engine for a
third international OEM.
For the past three years the Company has obtained several military contracts for
its heavy fuel engine (HFE) technology. All contracts to date in this area have
involved the conversion of commercial gasoline fueled engines used in UAV's and
the like to heavy fuel operation. Two such contracts in 1998 and 1997 also
included subcontracts for services performed by outside firms in connection with
the Company's prime contracts. The related revenue for these subcontracts is
reported separately above, while payments to these subcontractors are reported
as a separate line item of expenses as "Cost of subcontracts." There were no
such subcontracts in 1999.
Management is unable to predict future changes to development and demonstration
contract revenue because the amounts earned to date under previous contracts
have been determined through negotiations with individual manufacturers based
upon the level of effort required and the level of funding, if any, that each
manufacturer has been willing to commit. Management anticipates, however, that
future revenue may also include consulting fees earned while working together
with manufacturers to optimize the results achieved on a particular
manufacturer's engine, and, ultimately, license fees and royalty revenue once
the Company's technology is placed into production engines by manufacturers. The
future amounts of such other types of revenue, however, cannot be reasonably
estimated.
Research and development (R&D) expenses:
----------------------------------------
1999 1998 1997
--------- --------- --------
Personnel (includes stock and options):
Employee compensation $ 314,442 $ 281,886 $ 287,663
Taxes & benefits 42,761 39,676 41,071
Consultants, including expenses 106,277 99,382 63,864
--------- --------- ---------
Total personnel 463,480 420,944 392,598
Project parts and supplies 44,810 59,169 30,869
Occupancy 44,044 46,939 43,263
Depreciation, patent amortization
and renewal fees 61,455 33,614 58,048
Software engineering 5,000 20,000
Other expenses 7,364 17,530 13,748
--------- --------- ---------
Total R&D $ 632,441 $ 583,196 $ 558,526
========= ========= =========
11
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
Total R&D expenses increased by $49,245, or 8%, from 1998 to 1999, as increases
in personnel costs and depreciation and patent amortization were partially
offset by a decrease in project parts and supplies and other expenses. Total R&D
expenses increased by $24,670, or 4%, from 1997 to 1998, as increases in
personnel costs and project parts and supplies were partially offset by
decreases in software engineering fees, depreciation, and patent maintenance
fees and amortization.
The increase in personnel costs from 1998 to 1999 of $42,536, or 10%, includes
an increase in salaries of $32,556, or 12%, resulting primarily from an increase
in the wage rates of non-officer technical personnel effective January 1, 1999
and the award of higher bonus compensation for 1999 versus 1998. While awarded
in 1999, these bonuses remain accrued and will be paid only if the Company's
cash flow is sufficient. Higher consulting charges were also incurred in 1999
related to the Company's R&D supervisor and corporate liaison in Europe. This
individual, a former officer of the Company, is compensated primarily in the
form of restricted stock for work performed in Europe based on part-time
service, while for time spent in Annapolis he receives cash compensation, a
portion of which is deferred, for full-time service. In the fourth quarter of
1998 his annual rate of compensation was increased for the first time in several
years, accounting for most of the increase in consulting charges from 1998 to
1999. (Compensation charges for stock issued for services is measured at the
market price on the date of award or at the agreed-upon value of the services.)
The remaining increase in consulting charges reflects an increase in the
services of a consultant hired in late 1998 to assist in the preparation of the
Company's proposal response to the Justice Department's Consent Decree against
the diesel engine manufacturers. This consultant now serves as the program
manager for the Company's 4-stroke heavy fuel engine contract with the military.
The increase in personnel costs from 1997 to 1998 of $28,346, or 7%, was due to
a $35,518 increase in consulting charges offset by a $7,172 decrease in wages,
taxes and benefits. Most of the increase in consulting expense relates to higher
charges for the compensation and expenses of the Company's R&D supervisor and
corporate liaison in Europe. He was asked to spend considerably more time in
Annapolis for full-time services in 1998 as opposed to 1997. A further increase
resulted from the hiring in late 1998 of the consultant who assisted with the
response to the Consent Decree. The net decrease in wages, taxes and benefits
consisted of an increase resulting from the resignation of an engineer in the
second quarter of 1997 and the hiring of a new engineer in the fourth quarter of
1997, offset by a reduction in charges for compensation paid in the form of
stock or options.
Project parts and supplies expense, which includes motor fuel, engine parts and
other items used or consumed in engine testing and in the machine shop,
decreased by $14,359, or 24%, from 1998 to 1999. Such costs fluctuate from year
to year depending on the number and type of engines being tested. Charges were
higher in 1998 because of greater expenditures for funded contracts and other
research not performed under contract, particularly with respect to the
Company's HFE work, than in either 1999 or 1997.
Occupancy expenses have remained relatively consistent for the past three years,
primarily because the annual rent allocated to R&D, approximately $34,000, has
not changed during that time. Rent expense is allocated 80% to R&D and 20% to
G&A based on the proportionate share of floor space devoted to each category.
Total charges for depreciation, patent maintenance fees and amortization of the
capitalized costs of patents and technology increased from $33,614 in 1998 to
$61,455 in 1999, primarily because in 1999 the Company wrote-off approximately
$25,500 in unamortized costs of patents abandoned while there was no such charge
in 1998. From 1997 to 1998 the Company experienced a reduction in the total of
such charges of $24,434 due to the fact that in 1997 the Company wrote-off
approximately $24,500 in unamortized costs of patents abandoned. Software
engineering charges for 1998 and 1997 represent amounts paid to the Company's
former president for programming assistance with a technology design manual that
is to be used to teach engineers from prospective customers how to incorporate
the elements of the SCS into pistons.
12
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
General and administrative (G&A) expenses:
------------------------------------------
1999 1998 1997
--------- --------- ---------
Personnel (includes stock and options):
Employee compensation $ 103,296 $ 110,079 $ 131,160
Consulting fees 71,115
Other option compensation 29,760 44,644 44,643
Taxes & benefits 9,374 12,066 15,601
--------- --------- ---------
Total personnel 213,545 166,789 191,404
Occupancy 11,406 11,398 12,106
Travel 13,550 10,328 27,761
Proxy solicitation & annual meeting 18,201 22,701 18,554
Legal fees 2,069 8,120 21,641
Audit fees 8,580 8,000 12,454
Stock transfer agent fees 9,027 9,565 8,106
Other expenses 39,451 39,773 42,363
--------- --------- ---------
Total G&A $ 315,649 $ 276,674 $ 334,389
========= ========= =========
Total G&A expenses increased by $38,975, or 14%, from 1998 to 1999 primarily due
to the extensive use of consulting services in 1999, offset in part by slight
decreases in salaries and payroll taxes. Total G&A expenses decreased by
$57,715, or 17%, from 1997 to 1998 due to decreases in personnel costs, legal
and audit fees, and travel charges.
The $46,756, or 28%, increase in personnel costs from 1998 to 1999 resulted from
charges relating to the Company's employing the services of two consultants
beginning in 1999, offset in part by decreases in employee compensation and
other stock option compensation. Total salaries decreased $6,783, or 6%, from
1998 to 1999 as an increase related to a bonus award accrued in 1999 was more
than offset by a decrease in wages for an administrative assistant, which
position became vacant early in 1999. Consulting fees include $20,000 payable
annually to the president of the Company, who is engaged on a part-time basis,
under an agreement effective in January 1999 that recognizes an increase in the
level of services provided. Consulting fees of approximately $50,000 in 1999
represent charges for the services in regard to business opportunities for the
SCS HFE technology by the consultant hired in late 1998 to assist with the
response to the Consent Decree. Of this total, $24,000 represents fees paid in
options to purchase Company stock. (Compensation cost for options granted for
services is measured as the excess, if any, of the market price of the Company's
stock at the date of grant over the exercise price of the option granted, or at
the agreed-upon value of the services.) Other option compensation represents
annual non-cash charges in connection with a below-market option to purchase
stock owned by the Company's principal shareholder granted in 1997 to the new
president of the Company in order to induce him to take that position. The
decrease in such charges from 1998 to 1999 results from a correction to reflect
the actual 5-year vesting period versus the 4-year period improperly used to
calculate the expense in 1998 and 1997.
The $24,615, or 13%, decrease in personnel costs from 1997 to 1998 results from
a decrease in employee compensation caused by the termination of the employment
as of the end of the third quarter of 1997 of the Company's former president,
who had been employed on a part-time basis, and higher charges in 1997 for
options granted to employees, offset in part by the hiring of an administrative
assistant in the fourth quarter of 1998.
The significant decline in travel expenses from 1997 to 1998 is primarily
attributed to the extensive travel required by members of the Board in 1997
while negotiating a piston licensing agreement with an overseas OEM that
ultimately failed to be consummated. Legal fees decreased significantly from
1997 to 1998 as charges from the Company's securities counsel were significantly
higher in 1997 due to work in 1996, some of which was not billed until 1997,
associated with an SEC registration statement that eventually was not filed, as
well as for advice on restructuring certain stock warrants and undertaking two
private financings. A decline in charges from the Company's patent attorney
resulted from the fact that significant services were used in 1997 for the
preparation of the proposed piston licensing agreement that failed to be
consummated. Legal fees declined again from 1998 to 1999 due to fewer services
required of the Company's attorneys.
13
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
Adoption of new accounting pronouncements
- -----------------------------------------
The adoption by the Company in fiscal 2000 of new accounting pronouncements
which have a delayed effective date is not expected to have a material impact on
the financial statements of the Company.
ITEM 7. FINANCIAL STATEMENTS
Index to financial statements:
Reports of independent accountants
Financial statements:
Balance sheets as of December 31, 1999 and 1998
Statements of operations, accumulated deficit and comprehensive
income/loss for the three years ended December 31, 1999
Statements of paid-in capital for the three years ended December 31, 1999
Statements of cash flows for the three years ended December 31, 1999
Notes to financial statements
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Sonex Research, Inc.
We have audited the accompanying balance sheets of Sonex Research, Inc. (the
"Company") as of December 31, 1999 and 1998, and the related statements of
operations, accumulated deficit and comprehensive income/(loss), and cash flows
for each of the three years ended December 31, 1999, 1998 and 1997,
respectively. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Sonex Research, Inc. as of
December 31, 1999 and 1998, and the results of its operations and its cash flows
for each of the three years ended December 31, 1999, 1998 and 1997,
respectively, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As described in Note 3 to the
financial statements, the Company's ability to commence generation of
significant revenue and ultimately achieve profitable operations remains
uncertain. The Company has incurred significant net losses since its inception.
The Company's future prospects depend upon its ability to demonstrate commercial
viability of its products and ultimately achieve profitable operations, which
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 3. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
C. L. STEWART & COMPANY
Annapolis, Maryland
March 2, 2000
14
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
SONEX RESEARCH, INC.
BALANCE SHEETS
December 31,
------------------------
1999 1998
----------- -----------
Assets
Current assets
Cash and equivalents $ 57,768 $ 336,458
Marketable securities, available-for-sale (Note 4) 29,460
Accounts receivable, including unbilled costs
and estimated earnings on uncompleted contracts
of $25,690 in 1998 77,461 102,485
Prepaid expenses 29,836 28,837
Loans to officers and employees (Note 5) 22,500 27,500
----------- -----------
Total current assets 187,565 524,740
Patents and technology (Note 6) 219,776 243,600
Property and equipment (Note 7) 83,968 34,532
----------- -----------
Total assets $ 491,309 $ 802,872
=========== ===========
Liabilities and Stockholders' Equity/(Deficit)
Current liabilities
Accounts payable and other accrued liabilities $ 49,212 $ 46,979
Accrued subcontract costs on uncompleted contracts 16,456
Accrued compensation (Note 8) 79,381 51,477
----------- -----------
Total current liabilities 128,593 114,912
----------- -----------
Deferred compensation (Note 9) 763,744 714,039
----------- -----------
Stockholders' equity/(deficit) (Note 11)
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: 18,008,169 in 1999 and
17,642,860 in 1998 180,082 176,429
Additional paid-in capital 20,430,476 20,209,503
Accumulated other comprehensive income: unrealized
increase in value of marketable securities 29,460
Accumulated deficit (21,026,986) (20,456,871)
----------- -----------
Total stockholders'equity/(deficit) (401,028) (26,079)
----------- -----------
Commitments (Note 14)
Total liabilities and stockholders'equity/(deficit) $ 491,309 $ 802,872
=========== ===========
The accompanying notes are an integral part of the financial statements.
15
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
SONEX RESEARCH, INC.
STATEMENTS OF OPERATIONS, ACCUMULATED DEFICIT
AND COMPREHENSIVE INCOME/(LOSS)
Year ended December 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
Revenue
Development contracts $ 324,286 $ 321,912 $ 298,168
Subcontracts 73,301 119,420
--------- --------- ---------
324,286 395,213 417,588
--------- --------- ---------
Costs and expenses
Research and development 632,441 583,196 558,526
Cost of subcontracts 69,326 111,750
General and administrative 315,649 276,674 333,389
--------- --------- ---------
948,090 929,196 1,004,665
--------- --------- ---------
Net loss from operations (623,804) (533,983) (587,077)
--------- --------- ---------
Other income and expense
Investment and other income 10,181 16,477 18,782
Gain on sales of
marketable securities 43,508 247,144 38,299
--------- --------- ---------
Net loss (570,115) (270,362) (529,996)
Deficit accumulated during
development stage
Beginning of period (20,456,871) (20,186,509) (19,656,513)
------------ ------------ ------------
End of period $(21,026,986) $(20,456,871) $(20,186,509)
============ ============ ============
Net loss per share $ (.03) $ (.02) $ (.03)
====== ====== ======
Weighted average number of
common shares outstanding 17,765,110 17,572,147 17,031,016
========== ========== ==========
Comprehensive income/(loss):
Net loss $ (570,115) $ (270,362) $ (529,996)
Other comprehensive income - unrealized
gains on marketable securities
Arising during the period 19,242 87,900
Reclassification of gains
reported in income (29,460) (106,982) (7,500)
---------- ---------- ----------
Total comprehensive income/(loss) $ (599,575) $ (358,102) $ (449,596)
========== ========== ==========
The accompanying notes are an integral part of the financial statements.
16
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
SONEX RESEARCH, INC.
STATEMENTS OF PAID-IN CAPITAL
Price Preferred stock Common stock Additional
per ($.01 par value) ($.01 par value) paid-in
share Shares Amount Shares Amount capital
----- --------- ------- ---------- -------- -----------
Balance, January 1, 1997 1,550,001 $15,500 16,214,020 $162,140 $19,165,535
January - December
option exercises $.50 352,834 3,528 172,889
January - June
option exercises .75 17,000 170 12,580
March private placements .75 775,519 7,755 573,884
October - conversion
(.35 to 1) (10,000) (100) 28,571 286 (186)
December for services 1.00 5,962 60 5,902
Amortization of deferred
compensation from
stock options 104,456
--------- ------ ---------- ------- ----------
Balance, December 31, 1997 1,540,001 15,400 17,393,906 173,939 20,035,060
January - 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
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
stock options 29,760
--------- ------ ---------- ------- ----------
Balance, December 31, 1999 1,540,001 $15,400 18,008,169 $180,082 $20,430,476
========= ======= ========== ======== ===========
The accompanying notes are an integral part of the financial statements.
17
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
SONEX RESEARCH, INC.
(A Development Stage Company)
STATEMENTS OF CASH FLOWS
Year ended December 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
Cash flows from operating activities:
Net loss $(570,115) $(270,362) $(529,996)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation 13,573 8,955 13,747
Amortization of patents 37,920 12,933 72,394
Amortization of deferred compensation
from stock options 29,760 44,644 104,456
Current charges paid in stock or options 67,366 41,539 5,962
Gain on sale of marketable securities (43,508) (247,144) (38,299)
(Increase) decrease in accounts receivable 25,024 107,603 (160,088)
(Increase) decrease in prepaid expenses (999) 7,447 2,408
Increase (decrease) in current liabilities 13,680 (72,308) (8,150)
Increase (decrease) in deferred
compensation 49,706 65,747 52,671
--------- --------- ---------
Net cash used in operating activities: (377,593) (300,946) (484,895)
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale of marketable securities 43,508 247,144 38,299
(Increase) decrease in loans to employees 5,000 (5,000) 9,406
Acquisition of property and equipment (63,009) (26,281) (2,945)
Additions to patents and technology (14,096) (24,791) (64,828)
--------- --------- ---------
Net cash provided by (used in)
investing activities: (28,597) 191,072 (20,068)
--------- --------- ---------
Cash flows from financing activities:
Issuance of stock - private placement 581,639
Issuance of stock - exercise of options 127,500 90,750 189,167
--------- --------- ---------
Net cash provided by financing activities: 127,500 90,750 770,806
--------- --------- ---------
Increase (decrease) in cash: (278,690) (19,124) 265,843
Cash at beginning of period: 336,458 355,582 89,739
--------- --------- ---------
Cash at end of period: $ 57,768 $ 336,458 $ 355,582
========= ========= =========
The accompanying notes are an integral part of the financial statements.
18
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
SONEX RESEARCH, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - THE COMPANY
Sonex Research, Inc. has developed a proprietary technology, known as the Sonex
Combustion System (SCS), which improves the combustion of fuel in internal
combustion engines through modification of the pistons in large engines or the
cylinder heads in small engines. 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 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Presentation of financial statements
- ------------------------------------
Certain reclassifications have been made to
the financial statements of the prior years to conform to the classifications
used in 1999.
Cash and equivalents
- --------------------
The Company's By-Laws restrict the types of permitted investments to securities
issued by the U.S. Treasury, savings accounts insured by the U.S. Government, or
investment companies that invest in obligations of the U.S. Government or its
agencies. The Company considers all short-term, highly liquid investments which
are convertible into cash within three months or less to be cash equivalents.
Marketable securities
- ---------------------
Securities held by the Company are classified as "available-for-sale" in
accordance with Statement of Financial Accounting Standards (SFAS) No. 115 -
"Accounting for Certain Investments in Debt and Equity Securities"; accordingly,
unrealized gains and losses with respect to such securities are reported as a
separate component of stockholders' equity. Realized gains and losses are
reported in the Company's statement of operations.
Patents and technology
- ----------------------
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.
Property and equipment
- ----------------------
Property and equipment is stated at cost or, in the case of leased equipment
under capital leases, at the present value of future lease payments, less
accumulated depreciation. Major renewals and betterments are capitalized and
ordinary repair and maintenance expenditures are charged to operations in the
year incurred. Depreciation is computed using the straight line method over
useful lives of three to seven years.
Revenue recognition
- -------------------
Revenue derived from development contracts is recognized upon the Company's
completion of the milestones and/or submission of progress reports specified in
each contract. Commercial development contracts are executed in situations in
which an engine manufacturer is willing to provide funding to partially offset
19
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
the development costs incurred by the Company in applying its technology to one
of the manufacturer's engines. Generally, commercial development contracts
require the Company to demonstrate that the manufacturer's engine, when
modifiedwith the Company's technology, can meet certain emissions reduction and
performance goals specified in the contract. In addition, these contracts
sometimes provide that payment of part of the contract amount will be made only
if the Company meets the specified goals. The Company is not required to repay
any funds received in connection with its development contracts.
Development contracts are executed for funding supplied by a United States
Government (the "Government") agency or defense contractor for proof-of-concept
demonstration programs. Certain of these contracts require a performance period
of several months and/or require the Company to serve as prime contractor with a
substantial portion of the related project being assigned to a subcontractor.
Revenue and costs for these contracts that require the Company to provide
stipulated services for a fixed price have been recognized using the
percentage-of-completion method of accounting by relating contract costs
incurred to date to total estimated contract costs at completion. Subcontract
revenue and costs, along with the associated receivables and accrued
liabilities, are reflected in the Company's financial statements because the
Company is contractually responsible for the ultimate acceptability of the
project by the Government.
Stock-based compensation
- -------------------------
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board (APB) Opinion No. 25 -
"Accounting for Stock Issued to Employees". Under APB No. 25, compensation cost
is measured as the excess, if any, of the quoted market price of the Company's
stock at the date of grant over the exercise price of the option granted.
Compensation cost for stock options, if any, is recognized ratably over the
vesting period. The Company provides additional pro forma disclosures as
required under SFAS No. 123 - "Accounting for Stock-based Compensation".
Comprehensive income
- --------------------
SFAS Statement No. 130 - "Reporting Comprehensive Income", effective for fiscal
years beginning after December 15, 1997 and adopted by the Company in 1998 on a
retroactive basis, defines comprehensive income as net income plus other
revenues, expenses, gains and losses that are excluded from net income and
included separately in the stockholders' equity section of the balance sheet.
The only adjustments necessary to arrive at the Company's comprehensive income
relate to unrealized gains, and the subsequent effect of recognized gains, on
marketable securities.
Net loss per share
- -------------------
Net loss per share is computed based upon the weighted average number of common
shares outstanding during the year. Potentially dilutive securities, which
include convertible preferred stock, stock options and warrants, would serve to
reduce the loss per share.
Use of estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results may differ from those estimates.
NOTE 3 - LIQUIDITY
Management recognizes that the Company's history of operating losses, level of
available funds, and revenue from current and future development contracts, in
relation to projected expenditures, raise substantial doubt as to the Company's
ability to commence generation of significant revenues from the
commercialization of the SCS and ultimately achieve profitable operations.
Accordingly, the Company will continue to minimize its operating expenditures
through a number of measures, including the continued deferral by its officers
of portions of their salaries. Based upon available resources, current and
projected spending levels, and expected revenue from current and anticipated
contracts, management is optimistic that the Company will have sufficient
capital to fund operations through December 31, 2000. In the event that the
20
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
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.
NOTE 4 - MARKETABLE SECURITIES
In 1995 the Company's former inactive subsidiary, SonoChem, Inc., effected a
1:10 reverse split of all of its outstanding shares of common stock, and was
merged with and into a privately held medical transcription services company.
The name of the surviving corporation was changed to Digital Dictation, Inc.
("Digital") and the officers and directors of the privately held company, two of
whom are directors of the Company and general partners of its largest
shareholder, Proactive (see Note 11), became the directors and officers of
Digital. At the time of this merger, the Company's carrying basis in the
SonoChem stock of zero was considered to be its cost basis in the Digital stock,
and no gain or loss was recorded in the accounts of the Company with respect to
this transaction. The shares of Digital stock received by the Company pursuant
to this merger became available for public trading in April 1996, and the
Company began to liquidate its holdings. In 1998 Digital was acquired by
Medquist, Inc., its largest competitor, in a share exchange. Shares of Medquist
also trade in the public market.
This investment is accounted for in accordance with SFAS No. 115 and classified
as a current asset as a security that is "available-for-sale". Accordingly, the
Company's investment in the Digital or Medquist shares still held at each
financial statement date is recorded at its aggregate fair value at that date. A
corresponding amount, representing the aggregate unrealized gain in the fair
value of this investment in excess of its cost basis at each financial statement
date, is reported as a separate component of stockholders' equity. The aggregate
net proceeds from the sale of these securities are recognized as gains in the
year of sale.
NOTE 5 - LOANS TO OFFICERS AND EMPLOYEES
Loans to officers and employees represent the remaining balance of amounts
advanced in prior years for the payment of income tax liabilities incurred by
these individuals upon their receipt of compensation in the form of shares of
the Company's common stock, and recent short-term loans made to Company
personnel. The loans, which are non-interest bearing, are secured by deferred
salaries payable to each of the borrowers. The due date of the loans was
recently extended to December 31, 2000.
NOTE 6 - PATENTS AND TECHNOLOGY
The capitalized costs of patents and technology consists of the following:
December 31,
----------------------
1999 1998
-------- --------
Capitalized costs $288,522 $307,318
Accumulated amortization (68,746) (63,718)
-------- --------
$219,776 $243,600
======== ========
The Company 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 reduce
the capitalized cost of patents and technology should the recovery of such cost
no longer be sustainable.
21
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
NOTE 7 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 31,
----------------------
1999 1998
-------- --------
Shop equipment $456,159 $407,687
Office equipment 37,457 22,920
Vehicle 11,053
-------- --------
493,616 441,660
Accumulated depreciation (409,648) (407,128)
-------- --------
$ 83,968 $ 34,532
======== ========
NOTE 8 - ACCRUED COMPENSATION
Accrued compensation consists of the following amounts payable to current
employees:
December 31,
----------------------
1999 1998
-------- --------
Accrued vacation pay $ 48,000 $ 45,000
Accrued bonuses 25,000
Accrued wages at year-end 6,381 6,477
-------- --------
$ 79,381 $ 51,477
======== ========
The Company's only liability to employees for future compensated absences is for
accrued but unused vacation pay. The amount of vacation pay earned by employees
is determined by job classification and length of service. Such amounts are
payable upon termination of employment and are not subject to the terms of the
Company's written agreement with current and former employees to defer payment
of portions of their salaries as described in Note 9. The amount of accrued
vacation included above that was payable to the Company's officers at December
31, 1999 and 1998 was $37,400 and $35,800, respectively.
In December 1999 the Company awarded bonuses totaling $25,000 to its officers
and employees with the stipulation that payment of such bonuses is to be
deferred until the Board of Directors determines that the Company's cash
resources are sufficient to enable such payments.
NOTE 9 - 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:
December 31,
----------------------
1999 1998
-------- --------
Current executive officers $431,137 $385,938
Current employees and consultants 62,088 57,582
Former employees 270,519 270,519
-------- --------
$763,744 $714,039
======== ========
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SONEX RESEARCH, INC. 1999 FORM 10-KSB
The conditions that would require repayment of deferred amounts have yet to
occur, and it is unlikely that such conditions will occur prior to December 31,
2000. Accordingly, such deferred compensation is reported separately in the
accompanying balance sheet as a non-current liability. From time to time in the
past, however, portions of such deferred amounts have been paid through the
issuance to the employees of shares, or discounted options to purchase shares,
of the Company's common stock.
In 1993 two former officers of the Company initiated litigation upon the
termination of their employment, demanding immediate full payment of deferred
salaries and a judgment under the Maryland Wage Payment and Collection Law of up
to three times the amount owed. The litigation was concluded in 1996 when the
Maryland Court of Special Appeals rejected this demand and ruled that the
written agreement to defer compensation was a valid and enforceable contract.
NOTE 10 - INCOME TAXES
The Company has not incurred any federal or state income taxes since its
inception due to operating losses. At December 31, 1999, the Company had net
operating loss ("NOL") carryforwards of approximately $16.2 million available to
offset future taxable income. Net operating losses generated in 1998 and
subsequent years may be carried forward twenty years, while such losses
generated in 1997 and prior years may be carried forward fifteen years. If
certain substantial changes in the Company's ownership should occur, there would
be an annual limitation on the amount of the carryforwards which can be
utilized. Sales of marketable securities have also generated capital loss
carryforwards for income tax purposes. Capital loss carryforwards, which expire
after five years, may only be used to offset future capital gains. The Company's
tax loss carryforwards are summarized as follows:
Expiration NOL's 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
=========== =========
The difference between the net operating loss carryforwards described above and
the accumulated deficit reported in these financial statements results
principally from (1) temporary differences for income tax and financial
reporting purposes relating to the amounts and timing of deductibility of
deferred salaries and compensation related to the grant of stock options, and
the differences in theaccounting for the Company's investment in its former
consolidated subsidiary for income tax and financial reporting purposes, and (2)
permanent differences principally due to the non-deductibility for income tax
purposes of a significant charge to operations for debt conversion expense in
1988 and the non-deductibility of compensation related to the exercise of stock
options recorded previously in the Company's accounts.
The potential income tax benefit of these loss carryforwards and temporary
differences of approximately $6.2 million has not been recorded in the financial
statements due to the uncertainty of realization based on the Company's
financial performance to date. Since 1995 net operating loss carryforwards
aggregating $1,927,361 have expired unused.
NOTE 11 - CAPITAL STOCK
Authorized capital stock
- ------------------------
The Company is presently authorized to issue 48 million shares of $.01 par value
common stock and 2 million shares of $.01 par value convertible preferred stock.
All of the authorized shares of preferred stock, along with common stock
purchase warrants, were issued for $2 million in February 1992 (the "Preferred
Stock Investment") to a small number of individuals who qualified as "accredited
investors" pursuant to Rule 501 of Regulation D of the Securities Act of 1933
(the "Act") and to Proactive Partners, L.P. and certain of its affiliates
("Proactive"), who became the largest beneficial owner of the Company's common
stock by virtue of the acquisition of the convertible preferred stock and common
stock purchase warrants.
23
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
The preferred stock has priority in liquidation over the common stock, but it
carries no stated dividend. The holders of the preferred stock, voting as a
separate class, have the right to elect that number of directors of the Company
which represents a majority of the total number of directors. The preferred
stock is convertible at any time at the option of the holder into common stock
at the rate of $.35 per share of common stock. As of December 31, 1999, a total
of 459,999 shares of preferred stock had been converted into 1,314,278 shares of
common stock.
Private placements of common equity
- -----------------------------------
In February 1997 the Company notified the holders of all of its outstanding
warrants to purchase shares of its common stock, issued in private financings in
February 1992, June 1994, June 1995 and December 1995, of proposed amendments to
such warrants, 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 proposed amendments included, in various combinations, extensions
of the expiration dates, reductions in the exercise prices, reductions in the
number of warrants, 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 Board of Directors in
February 1997. In exchange for this cash investment, Proactive received 333,333
shares of common stock 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 the February 1992 Warrants. One other participant in the Preferred
Stock Investment, who also agreed to make an additional investment in February
1997, also received the amendments to the 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.
In March 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 and who qualified as accredited
investors. 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 this financing.
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 February 1997 and March 1997 financings described above satisfied the
conditions of Rule 506 of Regulation D of the Act and, as such, were exempt from
the registration requirements of Section 5 of the Act as transactions not
involving any public offering within the meaning of Section 4(2) of the Act.
No separate value has been reflected in the financial statements for the
warrants issued in the above transactions based on management's belief that the
separate fair value of such warrants is not significant.
NOTE 12 - STOCK OPTIONS
The Company maintains a non-qualified stock option plan (the "Plan") which has
made available for issuance a total of 7.5 million shares of common stock. All
directors, full-time employees and consultants to the Company are eligible for
participation. Option awards are determined at the discretion of the Board of
Directors. Upon a change in control of the Company, all outstanding options
granted to employees and directors become vested with respect to those options
which have not already vested. Options outstanding expire at various dates
through December 2009.
Between January 1, 1997 and December 31, 1999, the Company had the following
activity in options to purchase shares of common stock under the Plan:
24
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
Weighted Weighted
average average
exercise # of shares exercise
# of shares price exercisable price
----------- ------- ----------- --------
Unexercised at January 1, 1997 3,973,484 $.51 3,195,734 $.53
========= ====
Granted 147,000 .56
Exercised (369,834) .51
Lapsed or canceled (152,934) .50
----------- -------
Unexercised at December 31, 1997 3,597,716 $.52 3,277,966 $.52
========= ====
Granted 548,500 .50
Exercised (181,500) .50
Lapsed or canceled (108,000) .50
----------- -------
Unexercised at December 31, 1998 3,856,716 $.52 3,391,966 $.52
========= ====
Granted 556,000 .50
Exercised (255,000) .50
Lapsed or canceled (101,000) .50
----------- -------
Unexercised at December 31, 1999 4,056,716 $.52 3,426,716 $.52
=========== ==== ========= ====
Options granted under the Plan during 1999, all at an exercise price of $.50 per
share, included grants of ten-year options in June to the Company's chief
financial officer, exercisable 50% on the date of grant and 50% one year later,
to purchase 100,000 shares of common stock, and in September to the Company's
president, exercisable 25% per year beginning with the date of grant, to
purchase 250,000 shares of common stock.
In December 1997 Proactive, the Company's principal shareholder, granted to the
new president of the Company a ten-year option, exercisable 20% per year
beginning with the date of grant, to purchase 714,286 shares of common stock
owned by Proactive at an exercise price of $.35 per share. In December 1999
Proactive granted the Company's president a ten-year option, exercisable 25% per
year beginning with the date of grant, to purchase an additional 500,000 shares
of common stock owned by Proactive at an exercise price of $.50 per share. The
options granted by Proactive are not covered by the Company's Plan.
For certain options under the Plan granted or repriced, the Company credited
$59,813 in 1997 to additional paid-in capital, representing the excess of the
aggregate market value at the date of grant or repricing of shares under option
over the aggregate exercise price of such options, and charged a like amount to
compensation expense in that year. In connection with the grant of the option in
1997 by Proactive to the new president of the Company, $29,760 in 1999, $44,644
in 1998, and $44,643 in 1997 was credited to additional paid-in capital and like
amounts charged to compensation expense in each of those years. Additional
compensation of $59,525 is being amortized to compensation expense over the
remaining vesting period of this option. There are no similar charges for the
option granted by Proactive in December 1999 to the president of the Company
because the exercise price exceeded the market value of the stock at the date of
grant.
The Company applies APB Opinion No. 25 in accounting for stock option
compensation; however, SFAS No. 123 requires the Company to make certain
disclosures as if the fair value based method of accounting had been applied to
the Company's stock option grants. Accordingly, the Company has estimated the
grant date fair value of each option using the Black-Sholes option pricing model
with the following weighted average assumptions: volatility factor of 120% in
1999, 101% in 1998, and 112% in 1997, risk-free interest rate of 6%, zero
dividend yield, and expected term of ten years. For purposes of pro forma
disclosures, the estimated fair value of options is amortized to expense over
the vesting period of each option.
Had compensation cost for options granted under the Plan and for the options
granted by Proactive to the Company's president been determined consistent with
the method of SFAS No. 123 using the weighted average fair value of options
granted during the year as indicated below, the Company's net loss and net loss
per share for each year on a pro forma basis would have been as follows:
25
<PAGE>
SONEX RESEARCH, INC. 1999FORM 10-KSB
1999 1998 1997
-------- -------- --------
Weighted average fair value per share $.36 $.34 $.70
Net loss - as reported $570,115 $270,362 $529,996
Net loss - pro forma $861,650 $531,122 $876,273
Net loss per share - as reported $.03 $.02 $.03
Net loss per share - pro forma $.05 $.03 $.05
The Black-Sholes and other option pricing models were developed for use in
estimating the fair value of traded options as opposed to the type of
compensatory options granted by the Company. It also requires the input of
highly subjective assumptions, such as the expected stock price volatility,
changes in which can materially affect the fair value estimate. As a result, the
amounts calculated using the Black Sholes option pricing model may not
necessarily provide a reliable single measure of fair value of options granted
by the Company. In addition, these pro forma disclosures are not representative
of the effects on reported net loss and net loss per share for future years due
to the effects of vesting.
NOTE 13 - COMMON STOCK RESERVED FOR FUTURE ISSUANCE
As of December 31, 1999, a total of 16,051,728 shares of common stock were
reserved by the Company 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 in
February 2000 3,098,209
December 2000 340,000
February 2002 167,759
March 2002 220,000
----------
5,587,396
----------
Currently exercisable options:
Exercisable at $.50 per share 3,191,966
Exercisable at $.75 per share 184,750
Exercisable at $1.00 per share 50,000
----------
3,426,716
----------
Granted options becoming exercisable in the future:
Exercisable at $.50 per share 618,750
Exercisable at $.75 per share 11,250
----------
630,000
Options available for future grants 2,007,616
Conversion of preferred stock 4,400,000
----------
Total shares reserved 16,051,728
==========
In June 1999 warrants exercisable at $.75 per share to purchase 1,048,536 shares
of common stock expired unexercised. In February 2000 warrants exercisable at
$.35 per share to purchase 285,000 shares of common stock were exercised. At the
same time, warrants to purchase an additional 286,428 shares at $.35 per share
and 3,098,209 shares at $.75 per share expired unexercised.
26
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
NOTE 14- COMMITMENTS
The Company occupies its office and laboratory facility on a month-to-month
basis under the terms of an operating lease agreement pursuant to which the
property owner is required to provide thirty days notice if he wants the Company
to vacate the premises. The lease requires the Company to pay all property
related expenses. Gross rent charges aggregated $42,000 in each of the past
three years, as the Company's rent has been $3,500 per month, while the Company
also earned sublease income of $2,400, $2,000, and $750 in 1999, 1998 and 1997,
respectively. The Company will seek to negotiate a new long-term lease for its
facility or search for an alternative location in the event that an agreement
cannot be reached for the existing premises. Management believes that the
resolution of the uncertainty with respect to the facility will not result in a
significant interruption in the operations of the Company.
NOTE 15 - SUBSEQUENT EVENT
In February 2000 the Company received cash proceeds of $99,750 from the exercise
of stock 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.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company has had no disagreements with its current independent accountants,
C.L. Stewart & Company, on any matter of accounting principles or practices or
financial statement disclosure. C.L. Stewart & Company has been the Company's
independent accountants since October 31, 1997.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS
The Company's Board of Directors is divided into two categories: "Common Stock"
directors elected by the holders of Common Stock; and "Preferred Stock"
directors elected by the holders of Preferred Stock. These two categories of
directors are further divided into three classes as nearly equal in number as
possible, with the term of one of the three classes of directors expiring at
each annual meeting of shareholders. The members of each class of directors are
to hold office for terms of three years until their successors have been elected
and qualified. The 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 Company's By-laws state that the Board of Directors shall consist of not
fewer than three directors, with the total number of directors to be set by the
Board by resolution. Following the resignation of three Preferred Stock
directors and one Common Stock director in 1997, the total number of directors
is now five, two of whom are Preferred Stock directors and three of whom are
Common Stock directors.
Directors of the Company do not receive fees for their services, but are
eligible to receive stock option grants and are reimbursed for expenses related
to their activities as directors. Executive officers are appointed and serve at
the discretion of the Board of Directors. The names, ages, dates first elected
as directors, and principal occupations and employment of the directors and
executive officers of the Company are set forth below.
27
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
Term as
director
Name Age expires Position
---------------- --- ------- -------------------
Preferred Stock Directors:
Charles C. McGettigan 55 2002 Director
Myron A. Wick, III 56 2002 Chairman of the Board
Common Stock Directors:
Nuno Brandolini 46 2000 Vice Chairman of the Board
Lawrence H. Hyde 75 2002 President and Director
Andrew A. Pouring 68 2001 Chief Executive Officer, Chief Scientist
and Vice Chairman of the Board
Other Executive Officers:
George E. Ponticas 40 Vice President - Finance, Secretary,
Treasurer and Chief Financial Officer
Background of directors and executive officers
- ----------------------------------------------
Mr. Charles C. McGettigan has been a director of the Company since February
1992. He was a founding partner in 1991 and is a general partner of Proactive
Investment Managers, L.P., which is the general partner of Proactive Partners,
L.P. In 1988 Mr. McGettigan co-founded McGettigan, Wick & Co., Inc., an
investment banking firm. From 1984 to 1988 he was a Principal, Corporate
Finance, of Hambrecht & Quist, Inc. Prior to that Mr. McGettigan was a Senior
Vice President of Dillon, Read & Co. Inc. He currently serves on the Boards of
Directors of Cuisine Solutions, Inc., Modtech, Inc., PMR Corporation, Tanknology
- - NDE Corporation, WrayTech Instruments, Inc., and Onsite Energy, Inc., of which
he is the Chairman. Mr. McGettigan is a graduate of Georgetown University, and
received his MBA in Finance from The Wharton School of the University of
Pennsylvania.
Mr. Myron A. ("Mike") Wick, III, has been a director of the Company since
November 1991 and was elected Chairman of the Board of Directors in June 1993.
He was a founding partner in 1991 and is a general partner of Proactive
Investment Managers, L.P., which is the general partner of Proactive Partners,
L.P. In 1988 Mr. Wick co-founded McGettigan, Wick & Co., Inc., an investment
banking firm. From 1985 to 1988 Mr. Wick was Chief Operating Officer of
California Biotechnology, Inc. in Mountain View, California. He currently serves
on the Boards of Directors of Modtech, Inc., StoryFirst Communications, Inc.,
Tanknology - NDE Corporation, and WrayTech Instruments, Inc., of which he is the
Chairman. Mr. Wick received a B.A. degree from Yale University and an MBA from
the Harvard Business School.
Mr. Nuno Brandolini has been a director of the Company since January 1982 and
was elected a Vice Chairman of the Board in May 1988. Since November 1995 Mr.
Brandolini has been the Chairman of the Board and Chief Executive Officer of
Scorpion Holdings, Inc., a merchant banking company. From December 1993 through
October 1995 he was a managing director of Rosecliff, Inc., also a merchant
banking company. From June 1991 to November 1993 he was a Vice President with
Salomon Brothers, Inc. From 1988 to 1991 Mr. Brandolini was a part owner of The
Baltheus Group, Inc., a management consulting and financial advisory firm. He
has a law degree from the University of Paris and he received an MBA from The
Wharton School of the University of Pennsylvania.
Mr. Lawrence H. Hyde has been a director of the Company since September 1986,
serving as Chairman of the Board from June 1987 to June 1993, and was appointed
President of the Company in October 1997. Mr. Hyde was a director of Harris
Graphics Corp. from 1983 to 1986, where during 1985 and 1986 he also served as
its Chairman of the Board and Chief Executive Officer. He was President and
Chief Executive Officer of AM General Company from 1979 to 1985. He joined
American Motors in 1974 and remained until 1983. At various times he had
corporate wide responsibility for engineering, international and marketing; his
last position was Executive Vice President responsible for International and
Engineering. Mr. Hyde, now retired from full-time employment, is a private
investor with interests in a number of publicly and privately held companies. In
addition, he serves as a trustee of the American University in Cairo, where he
is also chairman of the Karnak Equity Fund. Mr. Hyde is a graduate of Harvard
College and Harvard Business School.
28
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
Dr. Andrew A. Pouring has been a full-time employee, director, and Chief
Scientist of the Company since 1980, serving as President from April 1980
through November 1991, and as Chief Executive Officer since May 1985. In
November 1991 he was elected a Vice Chairman of the Board of Directors. He has
co-authored all of the Company's patented inventions. He served as a Professor
of Aerospace Engineering at the U.S. Naval Academy from 1964 to 1983, and was
Chairman of the Academy's Department of Aerospace Engineering from 1975 to 1978.
Dr. Pouring is a member of various professional and scientific societies,
including the American Society of Mechanical Engineers and the Society of
Automotive Engineers, as has been organizer and chairman of many symposia for
these societies. Dr. Pouring received his Bachelors and Masters degrees in
mechanical engineering from Rensselaer Polytechnic Institute. He received his
Doctor of Engineering degree from Yale University, where he also was a post
doctoral research fellow and lecturer.
Mr. George E. Ponticas has been Vice President of Finance, Chief Financial
Officer, Secretary and Treasurer of the Company since September 1991. From May
1987 through August 1991, he served as the Company's Controller and Assistant
Secretary. From August 1981 through April 1987, Mr. Ponticas was a member of the
auditing staff of Price Waterhouse in Baltimore, Maryland, attaining the
position of audit manager in 1986. At Price Waterhouse, he worked on the audits
of a number of public and private companies, with an emphasis on small
businesses. Mr. Ponticas is a Certified Public Accountant, and is a member of
the American Institute of Certified Public Accountants and the Maryland
Association of Certified Public Accountants. He received his B.S. in Accounting
from Loyola College in Maryland.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company to its chief
executive officer; no other executive officer earned annual compensation during
the most recently completed year in excess of $100,000 (together referred to as
the "Named Executives").
SUMMARY COMPENSATION TABLE
Annual compensation
--------------------------------
Salary Long-term
-------------------- Accrued compensation
Name and Position Year In cash Deferred bonus # of options
----------------- ---- --------- -------- -------- ------------
Dr. Andrew A. Pouring 1999 $ 84,000 $ 36,000 $ 7,500 35,000
CEO & Chief Scientist 1998 72,000 48,000 35,000
1997 72,000 48,000 35,000
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 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.
For many years through December 31, 1998, Dr. Pouring has been deferring 40% of
his annual salary. On January 1, 1999, the percentage deferral was reduced to
30%. The conditions that would require repayment of deferred amounts have yet to
occur. As of December 31, 1999, a total of $334,980 in deferred salary is owed
to Dr. Pouring.
In December 1999 the Company awarded bonuses totaling $25,000 to its officers
and employees, including $7,500 to Dr. Pouring, with the stipulation that
payment of such bonuses is to be deferred until the Board of Directors
determines that the Company's cash resources are sufficient to enable such
payments.
In order to avoid long-term financial commitments, the Company does not have
employment agreements with any of its personnel. The salaries of executive
officers are set by the Board of Directors on an annual basis. Dr. Pouring's
authorized annual salary was increased in 1997 for the first time since 1989.
With the exception of the granting of stock options, the Company does not pay
its Named Executives any bonuses or any type of long-term compensation in the
form of restricted stock awards, stock appreciation rights (SARs) or other form
of long-term incentive plan payments.
29
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
-------------------------------------------------------------------
Number of % of total
securities options
underlying granted to
options employees in Exercise Market Expiration
Name granted fiscal year price price date
---- ------- ----------- ----- ----- -------------
Pouring 35,000 15% $.50 $.375 Dec. 7, 2009
Options granted under the Company's Stock Option Plan during 1999, all at an
exercise price of $.50 per share, included grants of ten-year options in June to
the Company's chief financial officer, exercisable 50% on the date of grant and
50% one year later, to purchase 100,000 shares of common stock, and in September
to the Company's president, exercisable 25% per year beginning with the date of
grant, to purchase 250,000 shares of common stock.
In December 1997 Proactive, the Company's principal shareholder, granted to the
new president of the Company a ten-year option, exercisable 20% per year
beginning with the date of grant, to purchase 714,286 shares of common stock
owned by Proactive at an exercise price of $.35 per share. In December 1999
Proactive granted the Company's president a ten-year option, exercisable 25% per
year beginning with the date of grant, to purchase an additional 500,000 shares
of common stock owned by Proactive at an exercise price of $.50 per share. The
options granted by Proactive are not covered by the Company's Stock Option Plan.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION/SAR VALUES
Number of securities Value of unexercised
underlying unexercised in-the-money
options/SARs at options/SARs at
December 31, 1999 December 31, 1999
# of shares
acquired on Value Exercisable/ Exercisable/
Name exercise realized unexercised unexercised
- -------- ----------- -------- ---------------------- -------------------
Pouring 0 $0
Exercisable @ $.50 167,566/220,066 $0/$0
Exercisable @ $.75 18,750/25,000 $0/$0
The exercise price of all options held by the Named Executives was higher than
the December 31, 1999 market price of $.375 of the Company's publicly traded
common stock.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The following table sets forth as of March 15, 2000 information relating to
beneficial ownership by directors of the Company, directors and executive
officers of the Company as a group, and any other persons known by the Company
to be the beneficial owner of more than five percent of the currently issued and
outstanding common stock of the Company. A reporting person is deemed to be the
"beneficial owner" of a security if that person has or shares the power to vote
or to direct the voting of such security, or the power to dispose or to direct
the disposition of such security. Under this definition, more than one person
may be deemed to be a beneficial owner of securities as to which he has no
record ownerhip interest, and the same shares may be beneficially owned by more
than one reporting person. Beneficial ownership includes securities which the
reporting person currently owns or has the right to acquire within sixty days
through the exercise of currently exercisable options and warrants or through
the conversion of preferred stock. Shares which the reporting person has the
right to acquire are not deemed to be outstanding for computing the percentage
of beneficial ownership of any other person. Unless otherwise noted, all shares
are beneficially owned and sole voting and investment power is held by the
persons named.
30
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
Total Beneficial Ownership
--------------------------
Common Rights to Total shares
shares acquire beneficially Percent
Name and address (1) owned shares owned of class
-------------------- --------- --------- --------- --------
Nuno Brandolini 111,726 380,150 491,876 2.6
Lawrence H. Hyde 644,986 930,072 1,575,058 8.4
Charles C. McGettigan 1,399,511 2,810,359 4,209,870 (3) 19.9
Andrew A. Pouring 688,239 186,316 874,555 4.7
Myron A. Wick, III 1,399,511 2,810,359 4,209,870 (3) 19.9
All directors & officers
as a group (6 persons) 3,000,724 4,584,397 7,585,121 33.2
Herbert J. Mitschele, Jr.
Far Hills, NJ 946,755 62,857 1,009,612 5.5
Proactive , et.al. (2)
San Francisco, CA 2,748,457 4,770,235 7,518,692 32.6
- -----------------------------
(1) The business address for each director and named executive officer is 23
Hudson Street, Annapolis, Maryland, 21401.
(2) Includes shares beneficially owned directly and indirectly by Proactive
Partners, L.P. and several affiliated entities and individuals
("Proactive et.al."), as reported in a Form 13D filing with the Securities
and Exchange Commission.
(3) Includes 3,895,870 shares beneficially owned by Proactive et.al.,
which shares could be deemed to be beneficially owned by both Mr.
McGettigan and Mr. Wick by virtue of their executive and ownership
positions in Proactive et.al. Both individuals exercise shared voting
and investment power with respect to such shares.
Rights to Acquire Shares
------------------------
Total
Exercisable Preferred rights to
Exercisable (put)/ Exercisable stock acquire
Name options call (2) warrants converted shares
- -------------------- ---------- --------- --------- --------- ---------
Nuno Brandolini 380,150 380,150
Lawrence H. Hyde 376,500 553,572 930,072
Charles C. McGettigan (1) 314,000 (276,786) 487,432 2,285,713 2,810,359
Andrew A. Pouring 186,316 186,316
Myron A. Wick, III (1) 314,000 (276,786) 487,432 2,285,713 2,810,359
All directors & officers
as a group (6 persons) 1,748,466 276,786 587,432 2,285,713 4,584,397
Herbert J. Mitschele, Jr. 20,000 42,857 62,857
Proactive , et.al. (2)
San Francisco, CA (553,572) 966,666 4,357,141 4,770,235
- ---------------------------
(1) Includes 2,496,359 shares beneficially owned by Proactive, et.al.,
which shares could be deemed to be beneficially owned by both Mr.
McGettigan and Mr. Wick by virtue of their executive and ownership
positions in Proactive, et.al. Both individuals exercise shared voting
and investment power with respect to such shares.
(2) Represents the currently exercisable portions of ten-year options granted
in December 1997 and December 1999 by Proactive, et.al. to Mr. Hyde to
purchase 714,286 shares and 500,000 shares, respectively, of common stock
presently owned by Proactive, et.al. at an exercise price of $.35 and $.50
per share, respectively. The December 1997 and December 1999 options become
exercisable at the rate of 20% and 25%, respectively, per year beginning
with the date of grant. Because these agreements relate to shares which are
already outstanding, the exercise of such rights will not result in an
increase in the total number of the Company's outstanding shares for
purposes of computing the percentage of beneficial ownership of each
reporting person. Mr. McGettigan and Mr. Wick each has indirect beneficial
ownership in 50% of the shares subject to these agreements.
31
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K
(a) Exhibits.
3 Articles of Incorporation and Bylaws (as amended) - Incorporated
by reference to the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1992.
4 Instruments defining the rights of security holders (contained in
Exhibit 3 hereof).
10.1 1987 Non-Qualified Stock Option Plan, as amended - Incorporated by
reference to the Company's Registration Statement No. 33-34520 on
Form S-8.
21 Subsidiaries of the Registrant: Sonex International, B.V. - The
Netherlands; Sonex Engines, Inc. - Delaware (both are inactive
subsidiaries).
23.a Consent of C.L. Stewart & Company
24 Power of Attorney - Incorporated by reference to the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1998.
27 Financial Data Schedule
(b) Reports on Form 8-K.
None.
32
<PAGE>
SONEX RESEARCH, INC. 1999 FORM 10-KSB
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act , the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SONEX RESEARCH, INC.
March 30, 2000 By: /s/ Andrew A. Pouring
----------------------------------
Andrew A. Pouring
Principal Executive Officer
March 30, 2000 By: /s/ George E. Ponticas
----------------------------------
George E. Ponticas
Principal Financial and Accounting Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
March 30, 2000 *
----------------------------------
Myron A. Wick, III
Chairman of the Board of Directors
March 30, 2000 *
----------------------------------
Nuno Brandolini
Vice Chairman of the Board of Directors
March 30, 2000 /s/ Andrew A. Pouring
----------------------------------
Andrew A. Pouring
Vice Chairman of the Board of Directors
March 30, 2000 *
----------------------------------
Lawrence H. Hyde
President and Director
March 30, 2000 *
----------------------------------
Charles C. McGettigan
Director
- --------------------
* Executed on behalf of these persons by George E. Ponticas, a duly appointed
attorney-in-fact of each such person.
/s/ George E. Ponticas
- ----------------------------------
George E. Ponticas, Attorney-In-Fact
The Registrant will furnish its shareholders with copies of its annual report
and proxy statement after the date of this report.
EXHIBIT 23.a
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-8 (No. 33-34520) of
Sonex Research, Inc. of our report dated March 10, 1999 appearing on page 13 of
this Form 10-KSB.
/s/C.L. STEWART & COMPANY
Annapolis, Maryland
March 30, 2000
33
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