U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
SONEX RESEARCH, INC.
Incorporated in the State of Maryland
23 Hudson Street
Annapolis, Maryland 21401
Telephone Number: (410) 266-5556
IRS Employer Identification No. 52-1188993
Commission file number 0-14465
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days.
YES [x] NO [ ]
There were 18,650,714 shares of the Issuer's $.01 par value Common Stock
outstanding at November 10, 2000.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Balance sheets as of September 30, 2000 and December 31, 1999
Statements of operations and accumulated deficit for the three- and nine-
month periods ended September 30, 2000 and 1999
Statements of paid-in capital for the period from January 1, 1998 through
September 30, 2000
Statements of cash flows for the nine-month periods ended September 30,
2000 and 1999
Notes to financial statements
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Sonex Research, Inc.
We have reviewed the condensed financial statements appearing on pages 3
through 10 of this Form 10Q-SB Quarterly Report of Sonex Research, Inc. (the
"Company") as of September 30, 2000. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements for them to be in conformity
with generally accepted accounting principles.
We previously audited, in accordance with generally accepted auditing standards,
the balance sheet as of December 31, 1999, and the related statements of
operations and accumulated deficit and cash flows for the year then ended (the
"audited financial statements", not presented herein), and in our report dated
March 2, 2000, we expressed an unqualified opinion on those financial
statements. We also stated that the audited financial statements were prepared
assuming that the Company will continue as a going concern; however, as
described in Note 3 to the audited financial statements, the Company has
incurred significant net losses since its inception and its ability to commence
generation of significant revenue and ultimately achieve profitable operations
raise substantial doubt about the Company's ability to continue as a going
concern. The audited financial statements and the accompanying condensed
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
C. L. STEWART & COMPANY
Annapolis, Maryland
November 6, 2000
- 2 -
SONEX RESEARCH, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
September 30, December 31,
ASSETS 2000 1999
------------ ------------
Current assets
Cash and equivalents $ 38,058 $ 57,768
Accounts receivable 59,116 77,461
Prepaid expenses 27,457 29,836
Loans to officers and employees 22,500 22,500
------------ ------------
Total current assets 147,131 187,565
Notes receivable from officers and employees 18,125
Patents and technology, net of accumulated
amortization of $43,840 in 2000 and
$68,746 in 1999 202,811 219,776
Property and equipment, net of accumulated
depreciation of $422,675 in 2000 and
$409,648 in 1999 71,382 83,968
------------ ------------
Total assets $ 439,449 $ 491,309
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 79,140 $ 49,212
Accrued wages 24,500
Accrued bonus and vacation pay 69,000 79,381
------------ ------------
Total current liabilities 172,640 128,593
------------ ------------
Deferred compensation 799,976 763,744
------------ ------------
Stockholders' equity/(deficit)
Preferred stock, $.01 par value - 2,000,000
shares issued; 1,540,001 shares outstanding 15,400 15,400
Common stock, $.01 par value - shares issued
and outstanding: 18,650,714 in 2000 and
18,008,169 in 1999 186,507 180,082
Additional paid-in capital 20,697,125 20,430,476
Accumulated deficit (21,432,199) (21,026,986)
------------ ------------
Total stockholders' equity/(deficit) (533,167) (401,028)
------------ ------------
Total liabilities and stockholders' equity $ 439,449 $ 491,309
============ ============
The accompanying notes are an integral part of the financial statements.
- 3 -
SONEX RESEARCH, INC..
CONDENSED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
---------- ---------- ---------- ----------
Revenue
Government $ 29,270 $ 45,093 $ 293,058 $ 113,893
Commercial 0 500 70,000 50,500
---------- ---------- ---------- ----------
29,270 45,593 363,058 164,393
---------- ---------- ---------- ----------
Costs and expenses
Cost of revenue 34,919 27,036 186,992 63,423
Research & development 120,978 105,317 340,514 359,200
General & administrative 81,871 70,927 244,353 241,365
---------- ---------- ---------- ----------
237,768 203,280 771,859 663,988
---------- ---------- ---------- ----------
Net loss from operations 208,498 157,687 408,801 499,595
Other (income)/expense
Investment and other income (1,241) (4,767) (3,588) (9,562)
Gain on sale of marketable
securities (43,508) (43,508)
---------- ---------- ---------- ----------
Net loss 207,257 109,412 405,213 446,525
Accumulated deficit
Beginning 21,224,942 20,793,984 21,026,986 20,456,871
---------- ---------- ---------- ----------
End $21,432,199 $20,903,396 $21,432,199 $20,903,396
========== ========== ========== ==========
Weighted average number of
Shares outstanding 18,594,455 17,792,344 18,396,873 17,730,754
========== ========== ========== ==========
Net loss per share $.011 $.006 $.022 $.025
===== ===== ===== =====
The accompanying notes are an integral part of the financial statements.
- 4 -
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF PAID-IN CAPITAL
(Unaudited)
Price Preferred stock Common stock Additional
per ($.01 par value) ($.01 par value) paid-in
share Shares Amount Shares Amount capital
----- --------- ------ ---------- ------- ----------
Balance, January 1, 1998 1,540,001$15,400 17,393,906$173,939 $20,035,060
January through December -
option exercises $.50 181,500 1,815 88,935
March for services .625 20,000 200 12,300
June for services .75 7,949 80 5,882
September for services .44 26,813 268 11,463
December for services .50 12,692 127 6,219
Stock option compensation 5,000
Amortization of deferred
compensation from grant of
stock options 44,644
--------- ------ ---------- ------- ----------
Balance, December 31, 1998 1,540,001 15,400 17,642,860 176,429 20,209,503
March for services .44 20,975 210 9,098
June for services .46 17,925 179 8,071
September for services .38 36,923 369 13,593
December for services .32 36,803 368 11,478
April and November
option exercises .50 255,000 2,550 124,950
Correction of stock ledger (2,317) (23) 23
Stock option compensation 24,000
Amortization of deferred
compensation from grant of
stock options 29,760
--------- ------ ---------- ------- ----------
Balance, December 31, 1999 1,540,001 15,400 18,008,169 180,082 20,430,476
February exercise of
warrants .35 285,000 2,850 96,900
March for services .40 24,130 241 10,125
June exercise of warrants .375 196,667 1,967 71,783
June exercise of warrants
for notes .375 48,333 483 17,642
June for services .41 31,538 315 12,695
September for services .24 56,877 569 13,181
Stock option compensation 22,000
Amortization of deferred
compensation from grant of
stock options 22,323
--------- ------ ---------- ------- ----------
Balance, September 30, 2000 1,540,001$15,400 18,650,714$186,507 $20,697,125
========= ====== ========== ======= ===========
The accompanying notes are an integral part of the financial statements.
- 5 -
SONEX RESEARCH, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
September 30,
-------------------------
2000 1999
---- ----
Cash flows from operating activities
Net loss $ (405,213) $ (446,525)
Adjustments to reconcile net loss to
net cash used in operating activities
Depreciation 13,972 6,750
Amortization of patents 48,058 9,450
Amortization of deferred compensation 22,323 22,320
Current charges paid in stock or options 59,126 49,520
Gain on sale of marketable securities (43,508)
(Increase) decrease in accounts receivable 18,345 60,648
(Increase) decrease in prepaid expenses 2,379 1,480
Increase (decrease) in current liabilities 44,048 (14,573)
Increase (decrease) in deferred compensation 36,230 37,689
----------- ----------
Net cash used in operating activities (160,732) (316,749)
----------- ----------
Cash flows from investing activities
Proceeds from sales of marketable securities 43,508
(Increase) decrease in loans to employees 1,000
Acquisition of property and equipment (1,386) (60,588)
Additions to patents (31,092) (7,529)
----------- ----------
Net cash provided by (used in)
investing activities (32,478) (23,609)
----------- ----------
Cash flows from financing activities
Issuance of stock - exercise of warrants 173,500
Issuance of stock - exercise of options 56,250
----------- ----------
Net cash provided by financing activities 173,500 56,250
----------- ----------
Increase (decrease) in cash (19,710) (284,108)
Cash
Beginning of period 57,768 336,458
----------- -----------
End of period $ 38,058 $ 52,350
=========== ===========
The accompanying notes are an integral part of the financial statements.
- 6 -
SONEX RESEARCH, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - The Company
--------------------
Sonex Research, Inc. has developed a proprietary technology, known as the
Sonex Combustion System (SCS), which improves the combustion of fuel in internal
combustion engines through modification of the pistons in large engines or the
cylinder heads in small engines. Variations of the Company's technology have
been applied to all types of internal combustion engines, including those used
in personal and commercial vehicles as well as engines used in fixed or portable
utility applications. Sonex concentrates its commercial efforts on the
application of the SCS to the reduction of exhaust emissions in direct injected
turbocharged diesel engines. The Company's objective is to execute broad
agreements with engine manufacturers and their piston suppliers for industrial
production of SCS pistons under license from Sonex.
Note 2 - Presentation of Financial Statements
---------------------------------------------
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and Item 310(b)
of Regulation S-B. Accordingly, these financial statements do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included.
Operating results for the three- and nine-month periods ended September 30,
2000 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2000. For further information, reference is made to the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-KSB for the year ended December 31, 1999.
Certain reclassifications have been made to the prior period financial
statements to conform to the classifications used in the current period.
Note 3 - Patents
----------------
The costs associated with the filing of patent applications are deferred.
Amortization is recorded on a straight-line basis over the remaining legal life
of patents, commencing in the year in which the patent is granted. Costs related
to patent applications which ultimately fail to result in the grant of a patent,
either through rejection by patent authorities or through abandonment by the
Company, are charged to operations at the time such determination is made.
- 7 -
Note 4 - Deferred Compensation
------------------------------
In order to help conserve the Company's limited cash resources, certain
of the Company's employees for several years have voluntarily deferred receipt
of payment of significant portions of their authorized annual salaries upon
request by the Board of Directors. By written agreement with the Company, these
individuals have consented to the deferral of payment of amounts so accumulated
until the Company has received licensing revenue of at least $2 million or at
such earlier date as the Board of Directors determines that the Company's cash
flow is sufficient to allow such payment. Since January 1, 1997, however, there
has been no further deferral of salary requested of the Company's non-executive
employees.
Deferred compensation outstanding is payable to the following
classifications of personnel:
September 30,
-------------
2000 1999
---- ----
Current executive officers $ 467,369 $ 431,137
Current employees and consultants 62,088 62,088
Former employees 270,519 270,519
--------- ---------
$ 799,976 $ 763,744
========= =========
Note 5 - Income Taxes
---------------------
The Company has not incurred any federal or state income taxes since its
inception due to operating losses. At December 31, 1999, the Company had net
operating loss ("NOL") and capital loss carryforwards of approximately $16.2
million available to offset future taxable income. If certain substantial
changes in the Company's ownership should occur, there would be an annual
limitation on the amount of the carryforwards which can be utilized. The
Company's tax loss carryforwards are summarized as follows:
Expiration NOL Capital
---------- ----- -------
2000 $ 1,105,399
2001 1,748,874 $ 201,681
2002 1,837,965 133,400
2003 1,344,816 365,147
2004 1,185,181 14,970
2005 - 2012 7,995,726
2018 - 2019 941,695
------------ ---------
$ 16,159,656 $ 715,198
============ =========
- 8 -
Note 6 - Stockholders' Equity
-----------------------------
Authorized capital stock
The Company is presently authorized to issue 48 million shares of $.01
par value common stock and 2 million shares of $.01 par value convertible
preferred stock. All of the authorized shares of preferred stock, along with
common stock purchase warrants, were issued for $2 million in February 1992 (the
"Preferred Stock Investment") to a small number of investors, including
Proactive Partners, L.P. and certain of its affiliates ("Proactive"), who became
the largest beneficial owner of the Company's common stock by virtue of the
acquisition of the convertible preferred stock and common stock purchase
warrants.
The preferred stock has priority in liquidation over the common stock, but
it carries no stated dividend. The holders of the preferred stock, voting as a
separate class, have the right to elect that number of directors of the Company
which represents a majority of the total number of directors. The preferred
stock is convertible at any time at the option of the holder into common stock
at the rate of $.35 per share of common stock. As of September 30, 2000, a total
of 459,999 shares of preferred stock had been converted into 1,314,278 shares of
common stock.
Exercise and expiration of warrants
In February 2000 the Company received cash proceeds of $99,750 from the
exercise of warrants to purchase 285,000 shares of its common stock at an
exercise price of $.35 per share. At the same time, warrants to purchase an
additional 286,428 shares at $.35 per share expired unexercised, as did warrants
to purchase 3,098,209 shares at $.75 per share.
In June 2000 the Company received cash proceeds of $73,750 from the
exercise of warrants to purchase 196,667 shares of its common stock, and
accepted five-year notes receivable aggregating $18,125 from its chief financial
officer and two other employees for the exercise of warrants to purchase 48,333
shares of its common stock, all at a price of $.375 per share. At the same time,
warrants to purchase an additional 350,000 shares at $.375 per share expired
unexercised, as did warrants to purchase 590,000 shares at $.50 per share.
Stock options
The Company maintains a non-qualified stock option plan (the "Plan")
which has made available for issuance a total of 7.5 million shares of common
stock. All directors, full-time employees and consultants to the Company are
eligible for participation. Option awards are determined at the discretion of
the Board of Directors. Upon a change in control of the Company, all outstanding
options granted to employees and directors become vested with respect to those
options which have not already vested. Options outstanding expire at various
dates through December 2009.
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board (APB) Opinion No. 25.
- 9 -
Under APB No. 25, compensation cost is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of grant over the
exercise price of the option granted. Compensation cost for stock options, if
any, is recognized ratably over the vesting period. In its complete annual
financial statements presented in its Form 10-KSB, the Company provides
additional pro forma disclosures as required under Statement of Financial
Accounting Standards No. 123 - "Accounting for Stock-Based Compensation" as if
the fair value based method of accounting had been applied to the Company's
stock option grants made subsequent to 1994.
From January 1, 2000 through September 30, 2000, the Company had the
following activity in options to purchase shares of common stock under the Plan:
Weighted Weighted
average # of average
# of exercise shares exercise
shares price exercisable price
------ ----- ----------- -----
Unexercised at January 1, 2000 4,056,716 $.52 3,426,716 $.52
Granted/becoming exercisable 90,000 .50 188,750 .50
Exercised 0 0
Lapsed (4,500) .50 (4,500) .50
--------- ---------
Unexercised at September 30, 2000 4,142,216 $.52 3,610,966 $.52
========= ==== ========= ====
Common stock reserved for future issuance
At September 30, 2000, a total of 11,215,591 shares of common stock were
reserved by the Company for issuance for the following purposes:
Purpose # of shares
----------------------------- -----------
Currently exercisable warrants at $.75 per share, expiring in:
December 2000 340,000
February 2002 167,759
March 2002 220,000
----------
727,759
Currently exercisable options 3,610,966
Granted options becoming exercisable in the future 531,250
Options available for future grants 1,945,616
Conversion of preferred stock 4,400,000
----------
Total shares reserved 11,215,591
==========
- 10 -
Note 7 - Commitments
--------------------
The Company occupies its office and laboratory facility under the terms
of an extension of an operating lease agreement through December 31, 2000. In
the absence of a further extension beyond that date, the Company may continue to
occupy the facility on a month-to-month basis, pursuant to which the property
owner is required to provide thirty days notice if he wants the Company to
vacate the premises. The lease provides for monthly rent of $4,000, and requires
the Company to pay all property related expenses. The Company will seek to
negotiate a new long-term lease for its facility or search for an alternative
location in the event that a long-term agreement cannot be reached for the
existing premises. Management believes that the resolution of the uncertainty
with respect to the facility will not result in a significant interruption in
the operations of the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
Caution Regarding Forward-looking statements
--------------------------------------------
Sections of this Report, as well as all publicly disseminated material
about the Company, contain information in the form of "forward-looking"
statements within the meaning of the Private Securities Litigation Act of 1995
(the "Act"). Such statements are based on current expectations, estimates,
projections and assumptions by management with respect to, among other things,
trends affecting the Company's financial condition or results of operations and
the impact of competition. Words such as "expects", "anticipates", "plans",
"believes", "estimates", variations of such words, and similar expressions are
intended to identify such statements that include, but are not limited to,
projections of revenues, earnings, cash flows and contract awards. Such forward-
looking statements are not guarantees of future performance and involve risks
and uncertainties, all of which are difficult to predict and many of which are
beyond the control of the Company. Accordingly, readers are cautioned not to
place undue reliance on such forward-looking statements.
In order to obtain the benefits of the "safe harbor" provisions of the
Act for any such forward-looking statements, the Company cautions shareholders,
investors and prospective investors about significant factors which, among other
things, have in some cases affected the Company's actual results and are in the
future likely to affect the Company's actual results and cause them to differ
materially from those expressed in any such forward-looking statements.
Factors that could cause actual results to differ materially include, but
are not limited to, the following:
o ability to generate cash flow from revenue or to secure financing
necessary to fund future operations
o ability to demonstrate commercial viability of SCS technology
- 11 -
o ability to complete technology development and demonstration programs
and execute licensing agreements that produce significant revenue
o ability to attract and retain skilled personnel
o changes in general economic conditions
o competition
Overview of the Company and its technology
------------------------------------------
Sonex Research, Inc. ("Sonex" or the "Company") has developed a patented
proprietary technology (the "Sonex Combustion System", "SCS" or "Ultra Clean
BurnTM technology") which enables significant combustion process advancements
through design modification of the pistons in four-stroke direct injected (DI)
diesel engines or the cylinder heads in two-stroke engines. The SCS four-stroke
engine technology addresses emissions reduction in "classical" DI diesel engines
and, more recently, the feasibility of a new, enhanced combustion system for low
compression ratio, controlled homogeneous combustion to further reduce emissions
and improve fuel consumption.
Although the Company continues to pursue potential business opportunities
as described in the following paragraphs, it will require additional capital
during the fourth quarter to maintain its present level of operations. See the
section below entitled "Financial Position and Liquidity" for further
explanation.
The Company has concentrated its commercial efforts on the application of
the SCS to the reduction of exhaust emissions in "classical" DI turbocharged
diesel truck engines through demonstration and development programs with some of
the world's largest foreign multi-national diesel engine original equipment
manufacturers (OEMs). The Company's objective is to execute broad agreements
with engine manufacturers and their piston suppliers for industrial production
of SCS pistons under license from Sonex.
Management believes that the Company's piston-based emissions reduction
enabling technology for DI diesel engines, which changes only a single engine
component while introducing no additional parts, can be an alternative to
exhaust aftertreatment. Evidence to date shows that the SCS is a significant new
engine design variable, and that the synergy of the SCS in combination with
exhaust gas recirculation (EGR) can enable in-cylinder emissions reduction to
meet future regulatory standards.
The primary achievements of the SCS DI diesel engine technology are as
follows:
o reduction of exhaust emissions in vehicular diesel engines
o potential elimination of exhaust aftertreatment systems
- 12 -
o equal fuel consumption
o potential for lower cost, less complexity and greater reliability
In separate demonstration programs, diesel engine OEMs have verified and
accepted that the SCS "Low Soot"design can substantially reduce particulate
emissions at future NOx (oxides of nitrogen) levels in a DI diesel engine for
medium duty trucks while maintaining fuel consumption and power. Tests conducted
by one of these manufacturers showed that an engine using SCS-modified pistons
along with EGR could attain future U.S. and European emissions targets when OEM
type production pistons become available.
At its June 2000 annual meeting of shareholders, the Company announced a
new enhanced SCS combustion system for low compression ratio, DI engines, called
"stratified charge, radical ignition (SCRI)". Sonex believes that SCRI will
enable practical application of an alternative combustion process known as
homogeneous charge compression ignition (HCCI) that is being examined by the
worldwide automotive industry. HCCI has been studied by many researchers for
years because, in theory, it can lower emissions while also achieving reduced
fuel consumption. The lack of a method for controlling the ignition point,
however, has prevented practical implementation of HCCI. With the SCRI, Sonex
believes it has attained the control of ignition that will make HCCI viable for
commercial application.
On a direct injected, single cylinder laboratory engine at Sonex, the
SCRI reduced oxides of nitrogen (NOx) emissions by 80%, smoke by 90%, and fuel
consumption by 20% to 30%, using diesel-type fuels. Sonex believes that the
SCRI, with further development, can also be applied to gasoline engines.
The Company has two near-term objectives for SCRI that are intended to
set the stage for licensing negotiations with engine and vehicle manufacturers:
(1) Confirm the SCRI single cylinder engine advances in performance on diesel
fuel in a multi-cylinder diesel engine; and (2) transition the SCRI process to a
single cylinder gasoline engine. The Company is seeking committed industrial
partners to provide substantial on-going financial support and technical
expertise to achieve these objectives. Discussions are ongoing with technical
personnel from two major international vehicle manufacturers and a major
supplier of automotive components and systems regarding potential funded
programs for the development of the SCRI. Proposed projects include both diesel
and gasoline engine applications.
In addition, the Company, in its laboratory and under contract with the
U.S. military and defense contractors, has applied the SCS to the conversion of
small gasoline engines to start and operate on military heavy fuels in a variety
of applications such as small, remotely controlled military unmanned aerial
vehicles (UAVs). The Sonex heavy fuel engines achieve power and fuel consumption
substantially equal to that of the stock gasoline engines and provide dependable
performance over the full engine operating range without "knocking", which has
been a major shortcoming of other heavy fuel conversion technologies.
- 13 -
Competition
-----------
The Company's primary competition comes from the extensive research
departments of the world's major vehicle and engine manufacturers. These OEMs
exercise a bias toward in-house technologies over those developed by independent
suppliers. Competition also comes from several independent engine testing and
consulting firms around the world which are in the business of developing engine
technologies. Although the experience and financial resources of its competitors
far exceed those of the Company, management believes that the SCS can provide
significant advantages over the competition on price and performance. Due to the
highly competitive nature of the world's automotive and truck industries, in
connection with its contracts and/or demonstration programs with such
manufacturers the Company is required to execute joint secrecy and disclosure
agreements that expressly prohibit the public disclosure of the customers' names
and other significant information. Failure by Sonex to maintain this strict
level of confidentiality would jeopardize the relationship of the Company with
its customers.
Current diesel engine programs
------------------------------
Funded development of Sonex pistons for industrial production for one of
the foreign engine OEMs, using an earlier SCS design, proceeded successfully
through verification tests by the engine manufacturer of pre-production,
finished, aluminum pistons. In the first quarter of this year, Sonex delivered
screw-assembled pistons incorporating the latest SCS "Low Soot" design
innovation for "classical" DI diesel engines to the engine manufacturer for
testing in a complete six-cylinder engine. The manufacturer's objective is to
meet future stringent emissions limits in the production version of this engine
by use of the SCS technology, in combination with other fuel system
improvements, with no exhaust aftertreatment devices such as catalytic
converters or particulate traps. The results from initial tests concluded
recently, however, did not meet the Company's expectations. The control of
combustion achieved by Sonex previously in a smaller engine for this manufactuer
was not evident in the engine used for the current test series, apparently due
to major differences in the combustion bowl of the two engines. Sonex expects to
meet with the manufacturer before the end of this year to reach agreement on
redesign of the SCS piston for this engine. The Company believes that the
desired control of combustion can be demonstrated such that the emissions
targets can be met. Negotiations for the funding of further design optimization
services and a license agreement, however, have been delayed.
Promising test results at Sonex on a turbocharged six-cylinder DI diesel
engine led a second foreign engine OEM to engage its piston supplier to produce
pre-production SCS pistons. Sonex is providing input into the piston design
process and delivery of the pre-production pistons for engine testing by the OEM
is expected in the near future.
Sonex has also presented the improved test results demonstrated by the
latest SCS design innovation to U.S. diesel engine OEMs. In the summer of 1999
one of these U.S. manufacturers delivered to Sonex an engine used in current
- 14 -
production sport utility vehicles and pick-up trucks for a demonstration of the
SCS in that engine. In June 2000 Sonex presented the results of tests it
conducted over the past few months using SCS pistons in this engine. The engine
manufacturer accepted this successful "proof-of-principle" of the SCS, and
proposed a follow-on project for a more extensive evaluation in an industrial
version of this engine series. The basic terms of an agreement were negotiated
with the manufacturer's technical team in July. After a representative visited
Sonex in August, the manufacturer asked for a short series of additional tests,
which the Company is now concluding. Sonex cannot predict when a decision on the
proposed funded program will be made, however, as the engine manufacturer has
recently indicated that there have been changes involving its senior management
and significant reductions in its workforce in response to a steep decline in
the North American heavy-duty truck market.
Heavy fuel engines (HFEs)
-------------------------
The Company has successfully applied a patented SCS starting system and
modified combustion chamber design to the conversion of reliable, lightweight
small, spark-ignited, carburetted, two-stroke, gasoline fueled engines of
various sizes used in small, remotely controlled military unmanned aerial
vehicles (UAVs) to start and operate on JP-5/JP-8 standard military fuels (also
referred to as "heavy fuels"). UAVs conduct short-range tactical reconnaissance
while operating virtually unseen and unheard, taking pictures of battlefields
and enemy installations and relaying them back to ground forces. Existing UAV
engines in the military's inventory operate on gasoline. Because of safety and
logistics concerns, however, all military small engines, such as those powering
UAVs, eventually will be required to operate on less volatile, widely available
heavy fuels used by jet aircraft and most military vehicles.
Under a "best efforts" feasibility demonstration contract from the U.S.
Marine Corps (USMC) Systems Command in Quantico, Virginia, in 1998 the Company
delivered five prototype UAV HFEs. Sonex successfully converted the existing
single cylinder, two-stroke, gasoline fueled engine to start and run on heavy
fuel, leading the USMC to contract Sonex to convert an additional forty UAV
engines used in the Dragondrone UAV. The USMC is now deploying tactical UAVs
aboard ship for the first time, as the Dragondrone UAVs with Sonex HFEs have
been in service in several locations around the world. Other potential
demonstration programs for the Sonex HFE technology for UAVs have taken place
under contract with the military and defense contractors as well. During the
third quarter of this year, the Company completed delivery on orders from two
defense contractors for a total of five UAV heavy fuel engines.
The Company is assessing additional potential uses by the military for
the SCS HFE technology, as well as private sector opportunities. Operation of a
light-weight engine on high flash point fuels such as diesel and heavy fuels,
will reduce the hazard associated with gasoline, making such an engine much more
suitable for applications where gasoline storage is undesirable, such as in
diesel fueled utility engines used in pumps, generator sets, etc., in homes,
commercial buildings and boats. Other military applications for two-cycle HFEs
include standby generators, water pumps, chainsaws, earth tampers and outboard
engines.
- 15 -
One such program on an alternative HFE application has taken place. Under
a sub-contract from a prime contractor to the U.S. military, Sonex recently
completed its demonstration of the technical feasibility of converting an
existing high performance, 650+ horsepower, 4-stroke, gasoline fueled propulsion
system for marine use to start and operate on heavy fuels. This development of
the SCS 4-stroke HFE technology was conducted in a laboratory feasibility
demonstrator single-cylinder engine at Sonex and is based on SCRI, the new
enhanced SCS combustion process for low compression ratio, DI engines. The
feasibility demonstrator engine starts and operates on JP-5 over a wide range of
engine speeds and loads, with good fuel economy and without knocking. In June
2000 the military requested that Sonex provide a quotation for a follow-up
contract to transfer the design from the single cylinder laboratory engine to a
single cylinder of the gasoline engine. In late July, however, Sonex was
informed by the military sponsor that it would not fund additional development
of the SCRI, instead it would look to alternative propulsion systems. The
Company is presently seeking funding for further development of the SCRI from
other sources within the military.
Employees
---------
As of September 30, 2000, the Company had six full-time employees and one
part-time employee, and engaged the part-time services of two consultants on a
regular basis. Additional information on the Company's business, its technology,
and its management can be found in the Company's 1999 Annual Report on Form 10-
KSB.
Financial position and liquidity
--------------------------------
As of September 30, 2000, the Company had cash and equivalents of
approximately $38,000 and accounts receivable of approximately $59,000, nearly
$57,000 of which receivables were collected in October. Also in October, the
Company executed two additional contracts that are expected to generate revenue
of approximately $45,000 by the end of the fourth quarter. However, cash from
these sources will not be sufficient to fund operations at the present level for
the entire fourth quarter. The Company is hopeful, although there can be no
assurance, of receiving additional modest contract awards in the near future,
but in the event that anticipated revenue is delayed or does not materialize, or
if additional short-term capital is not arranged, the Company will have to
reduce the scope of its operations later in the quarter. Furthermore, the
Company's prospects beyond December 31, 2000 are dependent upon its ability to
enter into significant funded contracts for the further development of its SCS
technology, establish joint ventures or strategic partnerhips with major
industrial concerns, or secure a major capital infusion. There is no assurance
that the Company will be able to achieve these objectives.
- 16 -
Results of operations
---------------------
A net loss from operations of $408,801 was recorded for the first nine
months of 2000, as compared to $499,595 for the corresponding period in 1999, a
decrease of $90,794, or 18%. The decrease in the loss was due to substantially
higher revenue, which more than offset the increase in costs, in 2000 versus
1999.
Revenue and cost of revenue:
Nine months ended Sep. 30,
-------------------------
2000 1999
---- ----
Government $ 293,058 $113,893
Commercial 70,000 50,500
--------- --------
$ 363,058 $164,393
========= ========
Cost of revenue $ 186,992 $ 63,423
========= ========
Since 1997 the Company has obtained several government contracts for its
heavy fuel engine technology, an application that has been developed only in the
last few years. All contracts to date in this area have involved the conversion
of commercial gasoline fueled engines used in UAV's and the like to heavy fuel
operation. Commercial revenue earned in connection with the Company's DI diesel
engine piston technology is subject to the negotiated amount, if any, that an
engine manufacturer is willing to provide in funding to partially offset the
development costs incurred by the Company in applying its technology to one of
the manufacturer's engines.
Approximately $260,000 of the government revenue reported for the first
nine months of 2000 relates to a sub-contract awarded in the fall of 1999 from a
prime contractor to the U.S. military pursuant to which Sonex demonstrated the
technical feasibility of converting an existing high performance, 650+
horsepower, 4-stroke, gasoline fueled engine for marine use to start and operate
on heavy fuels. The Company devoted a significant portion of its available
resources to the performance of this sub-contract from late in 1999 through June
30, 2000 when work was substantially completed. During the third quarter of this
year, the Company completed delivery on orders from two defense contractors for
a total of five UAV heavy fuel engine conversions for revenue of approximately
$23,000.
Approximately $100,000 of the government revenue reported for the first
nine months of 1999 was related to a January 1999 contract from the U.S. Naval
Research Laboratory for an HFE conversion demonstration on a gasoline UAV
engine. Work on this contract, which required only a small percentage of the
Company's available workforce, continued through the third quarter of 1999.
- 17 -
Cost of revenue primarily consists of direct labor charges and direct
purchases attributable to funded programs. Such amounts were substantially
higher in the first nine months of 2000 than in 1999 due to the relative sizes
of the government contracts being performed at the time. A small portion of
total cost of revenue for each period represented charges directly attributable
to funded commercial projects.
Research and development (R&D) expenses:
R&D expenses for the first nine months of the year decreased by $18,686,
or 5%, from $359,200 in 1999 to $340,514 in 2000. While the number of employees
remained the same and compensation rates increased only slightly, a much higher
percentage of the workforce was devoted to funded projects in 2000 as opposed to
1999. Associated charges were therefore classified as "Cost of revenue" rather
than R&D expenses for 2000. The decrease in R&D expenses would have been larger
than reported except that the 2000 total includes approximately $36,800 for the
write-off of unamortized costs of patents abandoned while there was no such
charge in 1999.
General and administrative (G&A) expenses:
Total G&A expenses for the first nine months of the year increased by
$2,988, or 1%, from $241,365 in 1999 to $244,353 in 2000. Personnel costs
increased slightly from $157,877 in 1999 to $167,872 in 2000, or $9,995,
primarily as a result of more extensive use of consulting services and temporary
clerical personnel, and a small salary rate increase, in 2000, offset in part by
a decrease in wages for an administrative assistant, which position became
vacant early in 1999. Net decreases in other expenses amounted to $7,007.
Gain on sale of marketable securities:
The marketable securities previously held represented holdings in the
common stock of the corporation which in October 1995 was merged with and into
the Company's inactive subsidiary. Overall, from 1996 through 1999, the Company
realized gains (net proceeds) from the sale of these securities of $359,064. The
last of these holdings were sold during the third quarter of 1999, yielding net
proceeds of $43,508.
- 18 -
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4 Instruments defining the rights of security holders (contained
in the Articles of Incorporation and By-laws, as amended,
filed with the 1992 Annual Report on Form 10-KSB)
(b) Reports on Form 8-K:
On October 17, 2000, the Registrant filed a Current Report on
Form 8-K to report that it had posted a shareholder update
report on its website on that date.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereto duly
authorized.
SONEX RESEARCH, INC.
(Registrant)
/s/ George E. Ponticas
----------------------------
by: George E. Ponticas
Chief Financial Officer
November 10, 2000
- 19 -
