UNITED STATES
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, 2002.
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 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. [ ]
Revenues for the year ended December 31, 2002 were $471,912.
The number of shares outstanding of the Issuer's $.01 par value Common Stock as
of March 31, 2003 was 21,592,669. The aggregate market value of voting stock
held by non-affiliates of the Registrant was $3,318,824 as of March 31, 2003.
Documents Incorporated by Reference: None.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
Sections of this document, as well as all publicly disseminated material about
Sonex Research, Inc. ("Sonex" or the "Company"), contain expressions of beliefs,
expectations, or intentions, in the form of "forward-looking" statements as that
term is defined under applicable federal securities laws. Such statements are
based on current expectations, estimates, projections and assumptions by
management with respect to, among other things, trends affecting the Company's
financial condition or results of operations and the impact of competition.
Words such as "expects", "anticipates", "plans", "believes", "estimates",
variations of such words, and similar expressions are intended to identify such
statements that include, but are not limited to, projections of revenues,
earnings, cash flows and contract awards. Such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties, all of
which are difficult to predict and many of which are beyond the control of the
Company.
Forward-looking statements contained herein speak only as of the date of this
report. The Company disclaims any obligation to update these statements and
cautions readers not to place undue reliance on such statements.
COMPANY OVERVIEW
Sonex, incorporated in Maryland in 1980, is an engineering research and
development firm that is seeking to commercialize its patented proprietary
technology (the "Sonex Combustion System", "SCS" or "Ultra Clean BurnTM
technology") for in-cylinder control of ignition and combustion in engines of
various types. The Company was co-founded in 1980 by Dr. Andrew A. Pouring, a
former Professor of Aerospace Engineering and Chairman of the Department of
Aerospace Engineering at the U.S. Naval Academy. At Sonex, Dr. Pouring conducted
basic research into the principle of in-cylinder control of ignition and
combustion, concentrating on the piston. By the late 1980's and early 1990's,
the development of the SCS had moved in the direction of chemical/turbulent
enhancement of combustion through investigation of the effects of changing the
chemical characteristics and fuel disbursement characteristics within the
combustion chamber.
The Company seeks to commercialize its SCS technologies for a variety of engine
applications for commercial and military use. To date, Sonex has engaged in
development and demonstration programs with the engine industry and has received
funding from the federal government for further development of the SCS
technologies. The Company's primary objective is to execute broad agreements
with engine and parts manufacturers for industrial production of SCS components
under license from Sonex.
The SCS technology for in-cylinder control of ignition and combustion is
designed to
|X| reduce emissions of diesel engines
|X| increase fuel mileage of a new generation of gasoline engines
|X| permit gasoline engines to run on safer, kerosene-based "heavy" fuels
The SCS improves the combustion of fuels in engines through design modification
of the pistons in four-stroke, direct injected (DI), engines or the cylinder
heads in two-stroke, spark-ignited (SI), gasoline engines to achieve
chemical/turbulent enhancement of combustion. The SCS process for both two- and
four-stroke engines achieves in-cylinder control of ignition and combustion
through the chemical/turbulent enhancement of combustion via combustion chamber
modifications that change the chemical characteristics and fuel disbursement
characteristics within the combustion chamber.
SCS reductions of soot in DI diesel truck engines have been confirmed by an
independent international engine consulting firm. Evidence to date indicates
that the SCS is a significant new engine design variable, and that the synergy
of the SCS in combination with exhaust gas recirculation (EGR) can help reduce
exhaust aftertreatment requirements to meet future regulatory standards. The
Company believes that SCS diesel engine designs should provide reductions in the
cost and complexity of future exhaust aftertreatment systems.
Sonex also is seeking to show the technical feasibility of achieving reduced
fuel consumption while lowering emissions in a new class of DI gasoline engines,
yet overcoming the safety concern that vehicles would need to be reduced in size
and weight to improve fuel mileage. A new branch of the SCS focusing on the
control of ignition may, with further development, enable DI gasoline engined
automobiles, currently manufactured and sold only in markets outside the U.S.
due to emissions considerations, to become emissions compliant in the U.S. while
providing fuel consumption benefits. In addition, the evolution of hybrid
gasoline and electric powered vehicles could be accelerated since a major
improvement in engine fuel mileage would provide opportunities for tradeoff of
vehicle weight versus power.
An SCS process for the conversion of reliable, lightweight, SI, two-stroke,
gasoline engines to start and operate on kerosene-based "heavy" fuels has been
applied successfully in a variety of applications such as small, remotely
controlled military unmanned aerial vehicles (UAVs). The military now requires
such engines to operate on less volatile heavy fuels to reduce the hazard
associated with gasoline, making heavy fuel engines (HFEs) more suitable for
applications where gasoline storage and use are undesirable. Potential
applications of the SCS heavy fuel conversion process can be expanded to a range
of military and commercial uses. Sonex is also developing a process for the
heavy fuel conversion of SI four-stroke gasoline engines, and has recently begun
investigating the synergy of SCS technology with rotary engines. In addition,
Sonex is examining the potential, through cooperation with one or more companies
which have complementary technologies and production capabilities, of becoming a
supplier of small HFEs to military and commercial markets.
Present Sonex technology development is being supported by U.S. Government
funding, and the Company is also seeking committed business partners for further
technical development and marketing of the various SCS engine applications.
Sonex believes that having one or more such partners experienced in dealing with
the engine and automotive industries on state-of-the-art technological
developments may accelerate commercial acceptance of the SCS technology.
Development efforts taking place currently under government contracts to Sonex
could facilitate participation by the engine and automotive industries and
thereby accelerate commercialization potential of the patented SCS technology
for in-cylinder control of ignition and combustion.
In January 2003 the Company engaged the Annapolis, Maryland consulting group
Paradigm Technologies, LLC ("Paradigm") to assess the Company's technologies and
business model and suggest approaches for strategic alliances and additional
market introductions for both commercial and military applications. Presently,
Company management and Paradigm are pursuing a number of initiatives. One of the
first goals is to secure cooperation with one or more companies which have
technologies complementary to the Sonex processes. Additionally, Paradigm will
also seek additional funding for Sonex to conduct technology development work
necessary for addressing commercialization issues.
As of March 31, 2003, the Company has seven full-time employees and
one part-time employee, and engages the part-time services of a consultant who
serves as its director of business development and manager of government
programs. The Company also engages the services of several other technical and
business consultants as needed. The Company has never experienced a strike or
work stoppage, and believes its relations with its employees are good.
RISK FACTORS
In order to obtain the benefits of the "safe harbor" provisions under applicable
federal securities laws for any "forward-looking" statements of the type
described previously under the heading "Caution Regarding Forward-Looking
Statements", the Company cautions shareholders, investors and prospective
investors about significant factors which, among other things, have in some
cases affected the Company's actual results and are in the future likely to
affect the Company's actual results and cause them to differ materially from
those expressed in any such forward-looking statements.
Factors that could cause actual results to differ materially include the
specific risks listed below. These risks and uncertainties are not the only ones
faced by the Company or that may adversely affect its business. If any of the
following risks or uncertainties actually occur, the Company's business,
financial condition or results of operations could be materially adversely
affected.
|X| ability to generate cash flow from revenue or to secure financing
necessary to fund future operations
|X| ability to complete technology development and demonstration programs,
demonstrate commercial viability of SCS technology and execute licensing
agreements that produce significant revenue
|X| ability to maintain and protect the Company's patents and proprietary
information
|X| ability to attract and retain skilled personnel
|X| ability to secure a long-term lease for the Company's existing facility
or to secure an alternative location
|X| changes in general economic conditions
|X| competition from companies which have substantially greater financial,
technical and marketing resources than does the Company
Furthermore, since its inception in 1980, the Company has generated cumulative
net losses in excess of $22 million, and may continue to incur quarterly
operating losses for the foreseeable future. Operating results have fluctuated
significantly in the past on an annual and quarterly basis, and are expected to
continue to fluctuate significantly from quarter to quarter for the foreseeable
future. The business historically has not generated sufficient cash flow to fund
operations without resorting to external sources of capital. The Company does
not have any bank financing arrangements. Operating funds have been raised
primarily through the sale of equity securities in both public and private
offerings, with revenues also providing limited operating cash.
The Company historically has derived the majority of its revenues from
engineering and development funding provided by established companies willing to
assist the Company in the development of its SCS technology and, more recently,
from government sources. In 2002, however, revenues increased substantially,
providing cash to fund the majority of the Company's operating expenditure
requirements for the year. In 2003 revenues from development and demonstration
contracts are again expected, although there can be no assurance, to provide
most of the cash necessary to fund operations.
In the event that funding from internal and external sources is insufficient,
the Company would have to cut back significantly its level of spending, which
could substantially curtail the Company's operations. These reductions could
have an adverse effect on the Company's relations with its potential customers
and government funding sponsors.
The Company's success also depends in significant part on the continued services
of its key technical and senior management personnel. Losing one or more key
employees, including for reasons of poor health, disability, or death, could
have a material adverse effect on the Company's business, results of operations,
and financial condition. Due to the expense involved, the Company does not
maintain life insurance policies for any of its employees. Additionally, in
order to avoid long-term financial commitments, the Company does not have
employment agreements with any of its personnel.
Further, the market price of the Company's Common Stock could be affected
adversely by the substantial number of shares that are reserved for, and may be
issued in, the future. As of March 31, 2003, there were 21,592,669 shares of
Common Stock issued and outstanding, with an additional 11,516,832 shares
reserved for future issuance upon the conversion of preferred stock, the
exercise of options and warrants, and the conversion of notes payable.
PRIMARY SCS DESIGN MODIFICATIONS
The SCS technology for four-stroke DI engines improves the process of combustion
through a combination of chemical and fluid dynamic effects that occur by
modifying the engine's combustion chamber and the processes occurring within
that chamber. The SCS processes for DI engines change only a single engine
component (the piston) while introducing no additional parts and are self-driven
by the combustion process. Patented SCS piston designs for four-stroke engines
integrate cavities called micro-chambers (MCs) which form a ring around the
piston bowl, with each MC positioned with respect to each spray from the fuel
injector of a DI engine. The MCs are designed to function either as chemical
reactors or reservoirs, depending on the specific design needs, and are
connected to the piston bowl by vents. For soot reduction, the reservoirs/vents
are placed to increase turbulence, while for enhanced ignition the MCs produce
highly active chemical species from a fraction of the fuel-air charge that are
expelled on the intake stroke of low compression ratio DI engines to fumigate
incoming air and serve as an ignition source.
The SCS process for the conversion of lightweight, SI, two-stroke, gasoline
engines introduces patented features which enable the combustion of heavy fuels
through design modification of the cylinder heads to achieve a chemically
enhanced combustion process while still relying on the spark to initiate
combustion. Sonex uses a machined cylinder head and combustion chamber insert
housing the proprietary SCS technology, and a glow plug-based fuel vaporizer for
cold starting. For engines that have the cylinder head and cylinder in one
single casting, the stock cylinder head is removed and the remaining cylinder
casting is decked and machined for cylinder head screws. The SCS heavy fuel
conversion maintains the gasoline engine's stock carburetion or fuel injection
system, intake and exhaust systems, spark ignition system, compression ratio and
weight. The SCS starting system uses commercial-off-the-shelf 12V glow plugs to
directly vaporize the heavy fuel for cold starting. Once the engine has been
started, the starting system is disabled.
SCS FOR DI DIESEL ENGINES
The SCS "Low Soot Diesel Design" (LSDD), based on the Sonex U.S. patents issued
in January 1999 and January 2001, is a recent invention in the series for the
SCS for "classical" DI diesel engines and involves re-arrangement of SCS
features to exploit new fundamental understandings of fluid dynamics. The SCS
LSDD has shown significant reductions in soot and oxides of nitrogen (NOx) while
maintaining fuel consumption and power. The key feature of the SCS DI diesel
technology is the presence of improved MCs in the piston which to some extent
produce and conserve intermediate 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 10% NOx
reduction in the Sonex single cylinder, DI, normally aspirated laboratory engine
with no change in injection timing. Sonex has also demonstrated that the SCS
LSDD can be transferred to a modern turbocharged, intercooled DI diesel engine,
as described below.
Application of the LSDD for achieving reduced diesel emissions is highly
leveraged when used with exhaust gas recirculation (EGR), allowing enhanced
ignition with low soot production in the presence of large amounts of EGR. In
the Sonex single cylinder research engine, as well as in a multi-cylinder,
normally aspirated diesel engine in the facility of a foreign diesel engine
manufacturer, the synergy of SCS and EGR (at levels up to 45%) produced 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 participated in demonstration and development programs with some of
the largest multi-national diesel truck engine manufacturers. The demonstration
process has gone from proof of concept using screw-assembled prototype pistons
fabricated in-house by Sonex and tested by an engine manufacturer in its
laboratories, to working with piston suppliers for the fabrication of finished
pre-production pistons that would be used in field trials, durability testing,
manufacturing optimization, and other tests required before the start of full
series production.
Late in 2001 one of the world's leading engine engineering and powertrain
consulting firms, Ricardo Consulting Engineers Ltd of the U.K., completed a
study in which they reported that a six cylinder DI diesel engine used in
medium-duty trucks, operating with the SCS LSDD piston at the best injection
timings, emitted up to 45% less soot than the stock engine, with equivalent fuel
consumption. Ricardo presented these findings, as well as additional results
from their subsequent Computational Fluid Dynamics study of the combustion
process, in a technical paper to the SAE May 2002 Fuels and Lubes Conference.
Sonex is seeking industrial partners to pursue joint marketing and
commercialization programs for the SCS LSDD technology.
Ricardo is introducing the SCS "Low Soot" design results to engine manufacturers
and piston suppliers. The Ricardo program was conducted with the cooperation of
a major foreign diesel truck engine manufacturer; however, this manufacturer has
not proceeded with further development with Sonex.
Pre-production SCS pistons for the tests were fabricated by Federal-Mogul Corp.,
a major international supplier of engine components. In 1998 Federal-Mogul
acquired the former T&N Piston Products Group of the U.K. T&N had invested
significant funds internally in developing innovative and economical techniques
of manufacturing Sonex pistons for series production. Federal-Mogul, however,
filed for bankruptcy protection in the fall of 2001 to protect its ongoing
component supply business from asbestos liabilities left from the acquisition of
T&N. Late in 2001 Federal-Mogul informed the Company that it is focusing its
limited resources on core businesses and will no longer participate in SCS
research.
The pre-production SCS pistons for the Ricardo test program fabricated by
Federal-Mogul, as well as those for an earlier SCS design fabricated by another
piston manufacturer, required special metals processing methods. For that
reason, SCS piston production under these methods might have resulted in a
higher than expected cost premium for SCS pistons. As a result, Sonex, in
conjunction with a consultant who is a former design engineer with a major
piston manufacturer, have developed a much simpler SCS piston production method
which can be used with existing series production machinery.
The Company has come to realize that it lacks the resources to address issues
such as piston manufacturing processes, durability testing, and cost analysis.
The Company is now seeking commercial partners, such as independent engine
testing firms or major component suppliers, to achieve a maturation of the SCS
relative to the expectations of engine manufacturers. In the meantime,
development of the LSDD is being continued in 2003 under a program being funded
from a subcontract awarded to Sonex under a U.S. Department of Energy program as
described in the following section under the heading "SCS and NEA Membrane
Technology".
SCS FOR LOW COMPRESSION RATIO DI ENGINES
SCS Stratified Charge Radical Ignition (SCRI)
Sonex is developing a new, enhanced SCS process with a design similar to the
LSDD, focusing on the control of ignition for low compression ratio four-stroke
DI engines. The combustion chamber modifications for this process make use of
certain chemically active products of combustion known as "free radicals" that,
in conventional internal combustion engines, are not carried from one combustion
cycle to the next. With this SCS process, radical (chemical) species that enable
ignition are created by interaction of the injected fuel spray with specially
designed MCs in the piston side wall. In its early stages of development, Sonex
termed this process Stratified Charge, Radical Ignition (SCRI), as free radicals
are isolated in MCs to be carried from one combustion cycle to the next to take
advantage of the combustion enhancing properties of the free radicals, thereby
enabling ignition of all types of fuels and allowing more complete combustion of
the fuel.
SCRI is an unthrottled, low compression ratio, sparkless, compression ignition
process at gasoline compression ratios. The SCRI relies on direct injection of
fuel into the cylinder (rather than in the intake manifold) as well as the
production of radicals for ignition. SCS microchambers for SCRI place a special
design emphasis on chemical aspects, allowing controlled auto ignition of any
fuel at low compression ratios. The SCS SCRI process for four-stroke engines
achieves compression ignition-combustion of the fuel without raising the
compression ratio to the levels found in diesel engines. The net result is an
engine that is fully controllable at all loads and speeds without limitation,
has extremely low emissions and the fuel economy of a diesel engine. The
inherent light weight of the gasoline engine is preserved and peak combustion
pressures are limited to those of gasoline operation.
The SCRI process for low compression ratio DI engines was developed in a
single-cylinder research engine in the fully equipped Sonex laboratory in
Annapolis. The SCRI combustion process for control of ignition and combustion
was researched initially on diesel-type fuel, and its ability to reduce NOx, the
hardest emissions for diesel engine makers to control, was confirmed. Sonex
demonstrated this ignition control in a laboratory, single cylinder engine in
meeting a U.S. Department of Defense (DoD) objective to convert gasoline engines
to diesel-type heavy fuels, while retaining the performance and lightweight
advantages of a gasoline engine. The laboratory engine was adapted to run on
diesel-type heavy fuel based on the SCS piston embodiments, DI, sparkless
ignition and low compression ratio controlled combustion over a wide range of
speed and load. The SCRI process reduced soot/particulates and NOx emissions
substantially while maintaining fuel consumption when compared to the stock
configuration of the diesel engine.
During 2001 a major international truck engine manufacturer conducted the first
phase of a feasibility study of SCRI combustion technology aimed at transferring
the SCRI results achieved on the Sonex laboratory engine to a modern, advanced,
four cylinder, medium-duty truck diesel engine that employs all of the latest
diesel engine technology such as a high pressure, electronically controlled
injection system, and turbo-charging. This program ended due to operational
difficulties and reductions in R&D funding without attaining the performance
achieved by Sonex in the single-cylinder engine. The manufacturer did find that
the SCRI process resulted in certain positive effects on combustion; however, it
concluded that the concept was not close enough to production and would require
major funding for further research. The study also identified some of the
problems to be solved in transferring the SCRI results to a multi-cylinder
engine.
The Company has come to realize that it lacks the resources to address issues
such as piston manufacturing processes, durability testing, and cost analysis.
The Company is now seeking commercial partners, such as independent engine
testing firms or major component suppliers, to achieve a maturation of the SCS
relative to the expectations of engine manufacturers. In the meantime,
development of the SCRI for DI engines is being continued in 2003 under two
government funded programs as described below under the headings "SCS and NEA
Membrane Technology" and "SCRI for Heavy Fuel Engines".
SCRI and HCCI Gasoline Combustion
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
its SCRI process, Sonex believes it has attained the control of ignition that
will make HCCI viable for military and commercial application. A new Sonex
technical paper supporting the theoretical aspects of SCRI will be presented by
Sonex consultant David A. Blank, Ph.D. in May 2003 at a joint U.S. and Japan
Society of Automotive Engineers Fuels and Lubricants meeting in Yokohama, Japan.
On the basis of the extensive SCRI single cylinder laboratory engine work it has
performed with alcohol fuels, Sonex believes it has attained the control of
ignition that will make HCCI viable for commercial application in a new
generation of gasoline engines. With the SCRI combustion process, radical
(chemical) species that enable compression ignition are created by interaction
of the injected fuel spray with specially designed microchambers in the piston
side wall. The net result is an engine that is fully controllable at all loads
and speeds without limitation, has extremely low NOx emissions, and the fuel
economy of a diesel engine.
SCRI combines the best aspects of HCCI without its inherent limitations.
Combustion pressure is kept low so lightweight gasoline engine construction can
be used. The spark plug is eliminated so diesel-like radical ignition is used;
its timing is fully controllable by the use of diesel-type direct injection into
the cylinder.
Spark ignited (SI), direct injected gasoline (GDI) engines used in
five-passenger automobiles manufactured and sold in Japan and Europe achieve 50
mpg (highway) but cannot be sold in the U.S. due to high NOx emissions, which
require low sulfur gasoline to assure NOx decomposition in an exhaust treatment
system that would be poisoned with high sulfur gasoline sold in the U.S. Low
sulfur gasoline will begin introduction in the U.S. in 2006. GDI engines operate
on high air-fuel ratios. Direct injection uses unrestricted air flow and a fuel
injector in each cylinder of the engine to provide precisely timed, metered fuel
delivery to the combustion chamber to overcome the air and fuel flow
inefficiencies of present gasoline engines. Significantly, all the GDI engines
reported to date are complex, use a spark plug to initiate conventional
(non-homogeneous) combustion, require premium fuel, and do not meet U.S.
emissions standards for NOx regardless of the catalytic converter technology.
All automobile manufacturers are familiar with the potential benefits of the GDI
engine in performance, fuel consumption and cost-to-manufacture, as well as the
challenging exhaust problem with NOx emissions. Engine researchers know the key
to solving the GDI NOx problem is to replace SI, lean combustion with HCCI and
controlled, high rate heat release combustion. The vexing challenge has been to
achieve a combustion control mechanism that works effectively over the range of
engine operation expected of an automotive application.
Sonex believes that with further development using gasoline, SCS SCRI (sparkless
ignition) will enable practical application of HCCI in GDI engined automobiles
and improve on the current fuel economy advantages and overcome the NOx problem
to permit the sale of such vehicles in the U.S. With its SCRI in-cylinder
combustion process, Sonex expects to be able to achieve better performance,
increased fuel mileage, and reduced NOx without sacrificing safety.
Sonex now feels that the very technically descriptive "Stratified Charge,
Radical Ignition" name given originally by Sonex to this enhanced SCS process
does not highlight the special ability of this process, that is, control of low
compression ratio auto ignition in a DI engine. Ignition control is the feature
lacking in HCCI combustion but which gives remarkably low emissions and good
fuel economy. Sonex is considering changing the name of its SCRI process to
highlight the control of ignition, and is investigating names such as Sonex
Controlled Auto Ignition (SCAI) and other combinations which including the term
"controlled" to better communicate this key feature. Until completion of a
review of all factors associated with instituting a formal name change and
perhaps seeking trademark protection, the Company will continue to use the SCRI
designation for this SCS process.
U.S. Fuel Economy Legislation
Fuel economy of vehicles sold in the U.S. is a matter of public law under the
CAFE (Corporate Average Fuel Economy) legislation. For the past decade, the U.S.
automobile industry has been successful in postponing any legislative actions
that would have led to an increase in CAFE. Recently, however, the future of
CAFE and other national fuel economy solutions have become front-page political
issues.
The fuel economy issue and potential increases in the CAFE standards were a
major part of Congressional debate in 2002 on a broad national energy bill
proposal. Senate hearings early in the year regarding follow-on legislation to
CAFE resulted in proposals for much higher fuel economy standards for the near
future. Opponents of the proposals, including automakers and the White House,
objected on the basis that higher fuel mileage can only be achieved by building
smaller, lighter - and therefore less safe - vehicles. Supporters of higher fuel
economy standards, however, argued that by using technology currently available
to automakers, the improvements can be accomplished without making vehicles
smaller.
Many automakers are focusing their attention on hybrid propulsion technologies,
such as gasoline/diesel-electric power plants, rather than improvements in
combustion technology (more efficient ways of burning fuel). Hybrid power plants
utilize the gasoline or diesel engine during steady speed operation. These
engines operate at high rpm to develop the needed power for highway operation,
and suffer from added weight.
In March 2002 the Senate rejected proposed tough new automobile fuel economy
requirements and instead approved the Levin-Bond Amendment to the Senate Energy
Bill that is more industry-friendly. Under the amendment, before any increases
in the CAFE standards are made, the Department of Transportation (DOT) would be
tasked with developing CAFE proposals that would take into account a number of
factors, including technological and economic feasibility, competitiveness of
U.S. manufacturers, and motor vehicle safety. The Senate and the House version
of the proposed Energy Bill did not proceed beyond the conference stage in 2002.
A new Energy Bill is being developed in 2003. Sonex provided input to the
Department of Energy, the White House, and House and Senate conferees on the
synergy between a technologically feasible increase in fuel mileage through the
paradigm-shifting SCRI combustion process and improved safety. The Company
expects to provide additional input to the legislative process in 2003.
Sonex believes that, with further development, its SCRI, low compression ratio,
combustion process for unthrottled operation can lead to conventional gasoline
engined vehicles that are 25% - 30% more fuel efficient than today's vehicles
while still meeting U.S. emissions standards. Sonex believes the SCRI technology
has the potential to achieve these benefits and overcome the safety concern that
vehicles would need to be reduced in size and weight to improve fuel mileage.
Preliminary work at Sonex on gasoline has demonstrated that the SCRI process
does achieve the desired control of ignition and high rate of heat releases
which are necessary to achieve improved fuel consumption and lower emissions.
The Company hopes to progressively mature the SCRI process to conclusively
demonstrate that it enables fully-responsive GDI engines of all sizes as a
viable, near-term alternative to longer-term solutions such as improvements in
hybrid propulsion systems and the development of lighter weight vehicles or
years of further R&D required for fuel cell technology to become practical. Such
an achievement could also accelerate the evolution of hybrid gasoline and
electric powered vehicles since a major improvement in engine fuel mileage would
provide opportunities for tradeoff of vehicle weight versus power.
Development of the SCRI for DI gasoline engines could be continued in 2003
as a result of the government funded program described below under the headings
"SCRI for Heavy Fuel Engines". Outcomes from this program for the transfer of
the SCRI single-cylinder laboratory engine results to a modern, multi-cylinder,
diesel engine should lead to a gasoline powered version of the engine with which
to validate the SCRI technology.
SCS and NEA Membrane Technology
Sonex also is investigating the potential of implementing the SCS piston-based
technology in combination with a diesel engine emissions reduction technology
being developed by Compact Membrane Systems, Inc. (CMS), of Wilmington,
Delaware. The CMS technology is based on a polymer membrane technology for the
addition of nitrogen enriched air (NEA) to the diesel engine combustion process
as an alternative to the use of EGR as a means to reduce the in-cylinder
production of NOx. If successful, the CMS method could provide the benefits of
EGR with reduced risk to engine wear, with reduced heat load for cooling (EGR),
without the burden of additional hardware and without significant impact on the
turbo-charger. In the past, the introduction of high levels of EGR to reduce NOx
emissions has been shown to substantially increase the production of
soot/particulate emissions. SCS piston designs, however, have shown the ability
to reduce diesel engine soot/particulate emissions when the engine operates with
high levels of EGR.
In 2001 the U.S. Department of Energy (DOE) awarded CMS a Small Business
Innovation Research (SBIR) Program, Phase I prime contract to determine the
feasibility of combining SCS piston technology with the CMS polymer membrane
technology, and a subcontract was issued to Sonex. Phase I testing was conducted
on the Sonex laboratory, single-cylinder, normally aspirated, DI diesel engine.
Results showed that the NEA polymer membrane and the SCS piston in the
single-cylinder engine, supercharged by Sonex, have the potential for
significant reduction of NOx without increasing soot/particulate emissions.
In the fourth quarter of 2002 the Company received a $458,862 subcontract, of
which $100,000 is cost-shared (funded) by Sonex, under DOE's SBIR Phase II prime
contract awarded earlier in the year to CMS to transfer the Phase I
single-cylinder results to a multi-cylinder engine. In March 2003 Sonex took
delivery of the test engine, a state-of-the-art, three-cylinder, DI,
turbo-charged, automotive diesel engine used by a major international vehicle
manufacturer in the U.S. government funded PNGV (Partnership for a New
Generation Vehicle). The estimated value of the contribution by the vehicle
manufacturer of the automotive diesel engine and associated technical support
represents the Sonex cost-sharing portion of the subcontract.
Early stages of the Phase II project will focus on the emissions reduction
capabilities of the SCS "Low Soot" and SCRI pistons separately to provide data
for evaluation by DOE and commercial interests. Subsequent testing in
combination with the NEA membrane will demonstrate the viability for
commercialization of the synergy of SCS configurations and the CMS membranes.
This program would provide SCRI data on a multi-cylinder diesel engine for
presentation to any engine manufacturer.
SCRI for Heavy Fuel Engines
The U.S. Department of Defense (DoD) and NATO now require the elimination of
gasoline such that the primary fuel for combat support equipment shall be a
single kerosene-based "heavy fuel" (such as D2 diesel, JP-5 and JP-8). Heavy
fuels are less volatile than gasoline, thereby reducing the hazard associated
with gasoline. The requirement for a single military fuel is also a logistics
issue, as the military seeks to minimize the number and complexity of fuels
required. Large combat support equipment acquired by the military is powered by
diesel engines that can use heavy fuels. No solution has been identified,
however, for the thousands of smaller engines, including those powering remotely
controlled military unmanned aerial vehicles (UAVs), small boats, and other
applications for which gasoline storage, transport and use are undesirable.
In October 2002 the Company received a $744,246 contract from the Defense
Advanced Research Projects Agency (DARPA) to begin the design and development of
an HFE conversion process for a gasoline automotive engine for potential use in
a developmental UAV. The contract program with DARPA focuses on the SCS SCRI
process to convert an existing SI, four-stroke, gasoline engine to heavy fuel
operation. The primary objective of this program is to transfer the SCRI heavy
fuel design achieved in the Sonex single-cylinder laboratory engine to a modern
six-cylinder, gasoline automotive engine, eliminate the spark ignition system,
and produce the same power the engine originally produced on gasoline.
As of March 2003, Sonex has completed a design review with DARPA and is
progressing to engineer the hardware for the SCS conversion. Suppliers have been
engaged and are responsive to this project. Outcomes from this program should
validate the SCRI technology for in-cylinder control of ignition and combustion
that could be applied later to a gasoline powered version. The duration of
demonstration projects with automotive manufacturers could be reduced since the
sparkless SCRI process can advantageously employ the centrally located spark
plug hole of most production 4-valve per cylinder engines for the installation
of the injector.
In addition, the Company believes the availability of the resultant
multi-cylinder, four-stroke heavy fuel engine from a successful outcome of the
DARPA project could lead to use in other military engine programs, as well as
having potential for use in the commercial marine market in pleasure boats for
which a diesel fueled engine would be a safer alternative to current gasoline
engines which too often result in dangerous onboard fires.
SCS FOR SI HEAVY FUEL ENGINES
SCS for Small, Two-Stroke Engines
The Company, in its laboratory and under contract with the U.S. military and
defense contractors, has applied its proprietary patented SCS starting system
and modified combustion chamber to the conversion of reliable, lightweight, SI,
two-stroke, gasoline engines to start and operate on JP-5/JP-8 military heavy
fuels for a variety of applications such as small UAVs. The military now
requires such engines to operate on less volatile heavy fuels to reduce the
hazard associated with gasoline, making heavy fuel engines (HFEs) more suitable
for applications where gasoline storage and use are undesirable. The requirement
for a single military fuel is also a logistics issue, as the military seeks to
minimize the number and complexity of fuels.
The SCS process for the conversion of lightweight, SI, two-stroke, gasoline
engines incorporates a machined cylinder head and combustion chamber insert
housing the proprietary SCS technology. For engines that have the cylinder head
and cylinder in one single casting, the stock cylinder head is removed and the
remaining cylinder casting is decked and machined for cylinder head screws. The
SCS heavy fuel conversion maintains the gasoline engine's stock carburetion or
fuel injection system, intake and exhaust systems, spark ignition system,
compression ratio and weight. The SCS starting system uses
commercial-off-the-shelf 12V glow plugs to directly vaporize the heavy fuel for
cold starting. Once the engine has been started, the starting system is
disabled.
The Sonex HFE technology can be applied as a retrofit to existing engines or
during manufacture of new engines. Sonex HFEs have demonstrated the ability to
provide gasoline-like performance over the full engine range without smoking or
"knocking", which has been a major shortcoming of other heavy fuel conversion
technologies. The SCS heavy fuel conversion maintains the power, fuel
consumption, light weight, low cost, and practicality of the gasoline engine
without the additional weight and expense of other powerplant alternatives being
considered to meet the requirement for heavy fuel operation, such as diesel and
turbine engines.
SCS HFEs for the Military
Sonex has successfully scaled its SCS design from an original cylinder
displacement of 18 cubic centimeters (cc) to an engine with a 176 cc
displacement per cylinder, and is confident that its proprietary SCS technology
is scaleable to cylinder volumes larger than 176cc. An SCS two-stroke HFE
development program has been initiated as described below on a three-cylinder,
fuel injected gasoline engine which displaces 939 cc (313 cc/cylinder).
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 SI,
carburetted, 100cc single cylinder, two-stroke, gasoline fueled engines 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 Dragondrone became
the first tactical UAV to be certified for deployment aboard ship. Other
potential applications include outboard engines, small watercraft used as
targets, and generator sets.
The Company's objective is to capitalize on the success to date with SCS HFEs by
participation in new DoD programs. In addition, Sonex seeks sponsors within the
DoD who are obliged to make an effort to comply with the directive on the
elimination of gasoline when purchasing numerous commercially available items
that are powered by two-stroke gasoline engines. In recent months the Company
also has been developing relationships with domestic and foreign defense
contractors.
In the third quarter of 2002 the Company was awarded a subcontract from Science
Applications International Corporation (SAIC) of San Diego, to conduct a survey
of commercially available gasoline engines of approximately 72 horsepower and,
with the approval of SAIC, select a candidate engine for a "best efforts" SCS
conversion to start and operate on heavy fuels for use in a UAV weapon system.
SAIC, a leader in the development of advanced gun weapon systems including
launchers and smart projectiles, is the DoD prime contractor for this
developmental UAV for which the objective is to develop and demonstrate the
military utility of a low cost loitering UAV system capable of providing several
hours of continuous electronic warfare jamming and loitering "on-demand" warhead
delivery. Initial funding of $200,000 to Sonex was approved to begin the
project. SAIC also awarded a subcontract to a competing company to develop a
heavy fuel conversion for a rotary engine already in production.
During the candidate engine survey and selection process, the DoD program
sponsor increased the targeted horsepower requirement to 100. Sonex and SAIC
together selected a candidate two-stroke gasoline engine advertised to meet the
new target horsepower requirement, although this engine was not yet in
production. Sonex conducted testing of the selected engine on gasoline to
develop baseline performance data. In the meantime, additional funding of
$81,947 for Sonex was approved.
After repeated testing, Sonex found that the candidate engine did not produce
the advertised power and suffered from operational problems as well. At the same
time, SAIC found that the competing rotary HFE suffered from poor fuel
consumption. During the first quarter of 2003, the DoD sponsor expressed a
desire to have Sonex work with the competing rotary HFE to focus on improving
its fuel consumption. DoD engine experts have concluded that Sonex has a unique
fuel handling and combustion technology, which when applied to the rotary
engine, will allow for a reduction in fuel consumption and significantly improve
engine performance in a heavy fuel configuration. The DoD sponsor has now
directed SAIC to develop a new statement of work and arrange for the two
companies to work together. This joint effort is expected to be formalized
during the second quarter of 2003.
SCS Potential for Heavy Fuel Rotary Engines
While rotary technology has been the subject of some work worldwide, it is
becoming an activity of focus and interest for Sonex. The Company has recently
developed a patent application using proprietary techniques to improve the
performance of rotary engines when converted to run on heavy fuels. This is
accomplished by implementation of a unique and innovative Sonex process for fuel
injection and handling, combined with a modification to the rotary engine fuel
system and combustion process, thus resulting in two very important attributes
for engine performance.
The advantages for the rotary engine when compared to piston technologies as in
two-stroke engines are clearly significant. The rotary engine has fewer moving
parts and is a very simple and elegant technical solution for UAV engines.
Rotary engines converted by Sonex to run on heavy fuel are expected to exhibit
efficient and steady performance. Combustion efficiency is expected to improve,
thereby decreasing fuel consumption over all load ranges, which is very
important for increasing endurance and/or increasing available payload capacity
on UAVs.
During 2003 Sonex is exploring a relationship with another small company which
is developing rotary engines for use in generator sets for military and
commercial use.
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
were issued in January 1999 and January 2001, and the most recent U.S. patent
for the SCS heavy fuel engine technology was issued in January 1999. The name
"SONEX" was registered at the U.S. Patent and Trademark Office in 1987.
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.
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.
COMPETITION
The Company faces significant competition from the extensive research
departments of the world's major vehicle and engine manufacturers. These
companies exercise a bias toward in-house technologies over those developed by
independent suppliers. Competition also comes from several independent engine
testing and consulting firms around the world which are in the business of
developing engine technologies. The Company's competitors have substantially
greater financial, technical and marketing resources than does the Company.
Accordingly, the Company cannot be sure that it will have the resources or
expertise to compete successfully in the future.
Although the experience and financial resources of its competitors far exceed
those of the Company, management believes that the SCS can provide significant
advantages over the competition in terms of low cost, improved performance, and
simplicity.
SECRECY AND NON-DISCLOSURE
Due to the highly competitive nature of the world's automotive and truck
industries, in connection with its contracts and/or demonstration programs with
such manufacturers, Sonex is required to execute joint secrecy and disclosure
agreements that, in most cases, expressly prohibit the public disclosure of the
names and other significant information about the participants and the current
or proposed programs. Failure by Sonex to maintain this strict level of
confidentiality would jeopardize its relationship with these organizations.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's principal executive offices and testing facility are housed in a
single story building located at 23 Hudson Street, Annapolis, Maryland, 21401.
The facility is equipped with emissions and engine testing equipment and machine
shop and storage facilities necessary to support the laboratory. Management
believes that this facility is adequate and suitable for the Company's present
needs, and 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the 2002 Annual Meeting of the Company's security holders held on October 9,
2002, the holders of the Company's Common Stock re-elected Mr. John H. Drewanz
as a Class II director for a term expiring at the annual meeting to be held in
2003, and the holders of the Company's Preferred Stock re-elected Mr. Lawrence
H. Hyde as a Class II director for a term expiring at the annual meeting to be
held in 2003, and Mr. Charles C. McGettigan and Mr. Myron A. "Mike" Wick, III,
as Class I directors for terms expiring at the annual meeting to be held in
2005. The only other director whose term continued beyond the 2002 Annual
Meeting was Dr. Andrew A. Pouring, a Class III Common Stock director whose term
expires at the annual meeting to be held in 2004.
No other matters were submitted to a vote of security holders during the fourth
quarter of 2002.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PUBLIC TRADING OF COMMON STOCK
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 high and low closing prices of the Common Stock for each quarterly period
since January 1, 2001 were as follows:
Quarter ended: High Low
March 31, 2001 $.25 $.14
June 30, 2001 .37 .22
September 30, 2001 .33 .16
December 31, 2001 .40 .15
March 31, 2002 .23 .14
June 30, 2002 .16 .06
September 30, 2002 .30 .06
December 31, 2002 .26 .14
March 31, 2003 .24 .15
The closing prices of the Common Stock presented above were obtained from the
historical pricing information available on the NASDAQ website www.nasdaq.com.
SHARES OUTSTANDING AND RESERVED FOR ISSUANCE; HOLDERS; DIVIDENDS
As of March 31, 2003, there were 21,592,669 shares issued and outstanding, with
approximately 900 holders of record. The shares for approximately 1,800
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 31, 2003, a total of 11,516,832 shares are reserved for future
Issuance as follows: 4,400,000 shares issuable upon the conversion of
preferred stock outstanding; 4,523,058 shares issuable upon the exercise of
options granted under the Company's Stock Option Plan (the "Option Plan");
1,541,274 shares for options available to be granted; 992,500 shares issuable
upon the exercise of outstanding warrants; and 60,000 shares issuable upon
the conversion of notes payable outstanding.
Presently the only securities authorized for issuance under equity compensation
plans relate to the Option Plan. Detailed information as of December 31, 2002
with respect to Common Stock issuable under the Plan, including activity during
2002 and weighted average exercise prices, is presented in tabular form in Note
14 to the accompanying financial statements.
The Company has never paid cash dividends on its Common Stock and does not
expect to pay any cash dividends in the foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES
During 2002 the Company issued the following securities without registration
under the Securities Act of 1933 (the "Securities Act"). The Company views these
issuances as transactions by an issuer not involving any public offering and
therefore as exempt from registration under Sections 4(2) and/or 4(6) of the
Securities Act.
In a private financing at the end of March 2002, the Company raised
capital of $60,000, including $27,000 in cash investments, $27,000 from
the conversion to equity of accrued liabilities to officers, employees
and consultants, and cash proceeds of $6,000 through the issuance of a
short-term note that is convertible to equity at the option of the
holder. A total of 360,000 shares of the Company's Common Stock and
five-year warrants to purchase an additional 180,000 shares of Common
stock at $.25 per share were issued in this financing, and 60,000
shares were reserved for future issuance upon the conversion of the
note payable to Common Stock and associated warrant to purchase Common
Stock.
In May 2002 and July 2002 the Company issued a total of 20,000 shares
of Common Stock to a consultant for services valued at $5,000.
The certificates representing such shares are endorsed with a standard
restrictive legend stating that the shares have not been registered under the
Securities Act or in any state or other jurisdiction, and that no disposition of
the shares may be made unless pursuant to an effective registration statement or
upon the issuance of an opinion of the Company's legal counsel that the
disposition may be made pursuant to a valid exemption from any registration
requirements.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Note: Statements made in the following discussion which express beliefs,
expectations, or intentions, as well as those that are not historical fact, are
"forward-looking" statements that are subject to risks, uncertainties and
assumptions. Our actual results, performance or achievements could differ
materially from those expressed in any such forward-looking statements as a
result of a variety of factors, including the risks and uncertainties referred
to under the "Caution Regarding Forward-Looking Statements" and "Risk Factors"
sections in Item 1 of this report.
ACCUMULATED LOSSES; SOURCES OF CAPITAL
Since its inception in 1980, the Company has generated cumulative net losses in
excess of $22 million and may continue to incur quarterly operating losses for
the foreseeable future. Operating results have fluctuated significantly in the
past on an annual and quarterly basis, and are expected to continue to fluctuate
significantly from quarter to quarter for the foreseeable future. The business
historically has not generated sufficient cash flow to fund operations without
resorting to external sources of capital. The Company does not have any bank
financing arrangements. Operating funds have been raised primarily through the
sale of equity securities in both public and private offerings, with development
and demonstration contract revenues also providing limited operating cash. The
Company historically has derived the majority of its revenues from engineering
and development funding provided by established companies willing to assist the
Company in the development of its SCS technology and, more recently, from
government sources.
In 2002, however, revenues increased substantially, providing cash to fund the
majority of the Company's operating expenditure requirements for the year. In
2003 revenues from development and demonstration contracts are again expected,
although there can be no assurance, to provide most of the cash necessary to
fund operations.
The Company is endeavoring to commercialize its SCS technology and, toward that
end, expects significant personnel and financial resources will need to be
applied. The application of personnel and financial resources is greatly
constrained by the Company's liquidity problems and lack of capital.
In January 2003 the Company entered into a consulting agreement with the
Annapolis, Maryland business consulting group Paradigm Technologies, LLC
("Paradigm"), for the services of its president, Mr. Glenn R. Beach, as a Senior
Advisor to Sonex. Paradigm has been engaged to assess the Company's technologies
and business model and suggest approaches for strategic alliances and additional
market introductions for both commercial and military applications. Mr. Beach,
who has spent much of his career in the defense industry, has focused his
attention on the Sonex process for converting gasoline engines of various sizes
to operate on safer, kerosene-based "heavy fuels" for use in military and
commercial applications requiring light weight and safe handling and storage of
fuel, such as in UAVs (unmanned aerial vehicles).
The Company's agreement with Paradigm extends through September 2003. Presently,
Company management and Mr. Beach are pursuing a number of initiatives. One of
the first goals is to secure cooperation with one or more companies which have
technologies complementary to the Sonex processes. Additionally, Paradigm
Technologies, leveraging an extensive network developed over many years with a
unique understanding and capability to access various agencies within the U.S.
Government, will also seek additional funding for Sonex to conduct technology
development work necessary for addressing commercialization issues.
FINANCIAL POSITION AND LIQUIDITY
During much of 2001 and through the third quarter of 2002, the Company operated
under severe cash flow difficulties. At times during 2001 the Company's two
officers voluntarily and at their own discretion deferred receipt of payment of
significant portions of their current wages to reduce the Company's monthly cash
requirements, although some of these amounts were repaid by the end of the year.
In late December 2001 Sonex took steps to reduce further its monthly cash
requirements by eliminating one full-time technical position and by
restructuring compensation arrangements with its part-time consultants. A second
full-time technical position became vacant at the end of February 2002.
Beginning once again in January 2002, the Company's officers voluntarily and at
their own discretion deferred receipt of payment of significant portions of
their current wages for most of the year to reduce the Company's monthly cash
requirements. With the generation of cash flow from revenues during the latter
part of 2002, some of these amounts were repaid by the end of the year, and the
Company hired additional technical personnel. Since December 2002, the Company's
chief financial officer has been receiving his current wages, while the
Company's chief executive officer continues to defer a significant portion of
his current wages. Such wages payable to the Company's officers totaled $199,992
as of December 31, 2002 and are payable upon demand. Through March 31, 2003, the
Company's chief executive officer had deferred an additional $9,255.
The continued deferral of portions of current wages by the Company's officers
cannot be expected to continue indefinitely, and the Company will be required to
pay such outstanding amounts as soon as cash flow permits. The amount and timing
of such payments will be determined at the discretion of the Company's officers,
as these amounts are not subject to the terms of the Company's written agreement
with current and former employees to defer payment of portions of their salaries
as described below. Similar arrangements exist for unpaid consulting fees, the
majority of which amounts are payable to the individual who serves as the
Company's director of business development and technical program manager on a
part-time basis.
As of March 31, 2003, the Company had available cash and equivalents of
approximately $110,000 and accounts receivable, including contract costs
incurred but not yet billed, of approximately $95,000. Based upon available
resources, current and projected spending levels, and expected revenue from
current and anticipated contracts, management believes the Company will have
sufficient capital to fund operations until approximately December 31, 2003. The
Company's prospects beyond that time are dependent upon its ability to enter
into significant funded contracts for the further development of its SCS
technology, establish joint ventures or strategic partnerships with major
industrial concerns, or secure a major capital infusion. There is no assurance
that the Company will be able to achieve these objectives.
In the event sufficient funding is not available through the generation of
revenues or from external sources, the Company would have to substantially
reduce the level of its operations. Such a reduction could have an adverse
effect on the Company's relationships with government funding sources, strategic
partners and potential customers.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern, which contemplates continuity of
operations, realization of assets and satisfaction of liabilities in the
ordinary course of business. The propriety of use of the going concern basis is
dependent upon, among other things, the Company's ability to generate sufficient
revenue and ultimately achieve profitable operations. These uncertainties raise
substantial doubt about the Company's ability to continue as a going concern.
The accompanying financial statements do not include any adjustments relating to
the recoverability of the carrying amounts of recorded assets or the amount of
liabilities that might result from the outcome of these uncertainties.
ONGOING SALARY DEFERRALS BY OFFICERS AND EMPLOYEES
In order to help conserve the Company's limited cash resources, all of the
Company's current and former officers and certain of the Company's other
employees for several years have voluntarily deferred receipt of payment of
significant portions of their authorized annual salaries at the request of the
Board of Directors. A written agreement between these individuals and the
Company was first executed in 1992 in connection with an indispensable $2
million private investment made by a venture capital group in exchange for the
issuance of a new class of convertible preferred stock. The individuals who are
parties to this agreement 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.
At the conclusion of a legal challenge by two former officers of the Company
initiated in 1993 demanding full payment of deferred salaries upon the
termination of their employment, in 1996 the Maryland Court of Special Appeals
rejected this demand and ruled that the written agreement to defer compensation
was a valid and enforceable contract.
RESULTS OF OPERATIONS
Condensed comparative results:
(Note: In order to conform to the classifications used in 2002, certain amounts
for 2001 and 2000 presented in prior years as research and development expenses
(R&D) have been reclassified to cost of revenue.)
2002 2001 2000
---------- ---------- ----------
Total revenue $ 471,912 $ 245,291 $ 407,898
---------- ---------- ----------
Cost of revenue 266,837 164,698 302,994
Research and development(R&D)expenses 224,881 435,249 379,087
General and administrative(G&A)expenses 304,593 337,099 332,607
---------- ---------- ----------
Total expenses 796,311 937,046 1,014,688
---------- ---------- ----------
Net loss from operations (324,399) (691,755) (606,790)
Investment income 2,759 1,400 4,860
---------- ---------- ----------
Net loss $ (321,640) $ (690,355) $ (601,930)
========== ========== ==========
The net loss for 2002 is $368,715, or 53%, lower than the net loss for 2001, as
a significant increase in revenue and an overall reduction in personnel costs
were offset in part by higher associated cost of revenue. The net loss for 2001
is $88,425, or 15%, higher than the net loss for 2000, as a significant decrease
in revenue was offset in part by lower related cost of revenue.
Revenue and cost of revenue:
2002 2001 2000
---------- ---------- ----------
Defense/government revenue $ 471,912 $ 145,291 $ 337,898
Commercial revenue 100,000 70,000
--------- ---------- ----------
Total revenue $ 471,912 $ 245,291 $ 407,898
========== ========== ==========
Cost of revenue $ 266,837 $ 164,698 $ 302,994
========== ========== ==========
The Company's revenues consist of funding received for technology development
and demonstration contracts entered into with commercial or defense/government
entities. 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 such entities based
upon the level of effort required and the level of funding that each entity 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.
Cost of Revenue primarily consists of direct labor charges and other direct
expenditures, including those for consulting services, attributable to funded
programs, and allocated labor overhead charges.
Comparison of 2002 to 2001
Total revenue increased $226,621, or 92%, from 2001 to 2002. During the second
half of 2002 the Company was awarded two significant contracts and a significant
subcontract from branches of the U.S. government and military or their prime
contractors, while there were no revenues in 2002 from commercial contracts.
Department of Defense (DoD) and other government revenue for 2001 came from four
contracts, three of which were for development of the Company's heavy fuel
technology for military applications. The three contracts in 2001 for military
applications all were completed in that year, while work on the fourth contract
from the government extended into early 2002.
The following is a listing of the three major new projects. Detailed discussions
of each program are provided in Item 1 of this report.
Subcontract awarded by Science Applications International Corporation
(SAIC), a large DoD prime contractor. Awarded third quarter of 2002.
Initial funding of $200,000, later increased by $81,947. Completion in
2003.
Prime contract awarded by the Defense Advanced Research Projects Agency
(DARPA). Awarded fourth quarter of 2002. Total funding of $744,246.
Completion expected in late 2003 or early 2004.
Subcontract awarded by Compact Membrane Systems, Inc. (CMS) under its
prime contract from the U.S. Department of Energy (DOE) for a Small
Business Innovation Research (SBIR) Program, Phase II project. Awarded
fourth quarter of 2002. Total award to Sonex of $458,862, of which
$100,000 is cost-shared (funded) by Sonex.
Completion expected in 2004.
Revenues from these three programs, work on each of which continues into 2003,
totaled $391,155 and represented 83% of total revenues recognized in 2002. The
following table summarizes revenue recognized in 2002 and the potential revenue
remaining for future periods in connection with these three programs. Although
management believes that each program will be funded for the entire amount
awarded to date, there is no assurance that this will be the case.
SAIC DARPA CMS/DOE
---------- ---------- ----------
Revenue recognized in 2002 $ 226,247 $ 109,024 $ 55,884
Potential revenue for future periods 55,700 635,622 302,978
---------- ---------- ----------
$ 281,947 $ 744,646 $ 358,862
========== ========== ==========
Progress on commercial applications of the Company's diesel engine emissions
reduction technology slowed considerably in 2002, but outcomes in 2003 from two
of the new defense/government projects are expected to be transferable to
commercial applications. All of the revenue from commercial contracts for 2001
was earned in connection with the Company's diesel engine piston technology
under a program with a foreign engine manufacturer for a feasibility study of
the Company's SCRI technology in diesel truck engines. There was no follow-on
work with this manufacturer once the program was completed.
Cost of revenue increased from 2001 to 2002 as a result of the increased revenue
generated in 2002. As more contracts were secured, a higher percentage of R&D
(direct labor) personnel's time was spent on funded contracts in 2002 versus
2001, with the associated charges being recorded as Cost of Revenue rather than
R&D. On the whole, a higher percentage of total R&D costs were classified as
Cost of Revenue in 2002 (54%) as opposed to 2001 (27%), as new hires in 2002
were brought on to work almost exclusively on funded contracts. The increased
workload also resulted in higher direct costs associated with funded contracts
in 2002 versus 2001.
Comparison of 2001 to 2000
Total revenue decreased $162,607, or 40%, from 2000 to 2001, with
defense/government revenue declining by $192,607, or 57%, from 2000.
Defense/government revenue for 2001 came from four contracts, three of which
were for UAV gasoline engine conversions to heavy fuel operation. Approximately
$260,000 of the defense revenue reported for 2000 relates to a sub-contract
awarded in 1999 from a prime contractor to the U.S. Navy pursuant to which Sonex
demonstrated the technical feasibility of converting an existing high
performance, 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 mid-2000 when
work was substantially completed. The Company did not receive a follow-on
contract from the Navy, and no other contract of similar size was received in
2001. The remaining defense revenue for 2000 consisted of five smaller
contracts, including three contracts for UAV gasoline engine conversions to
heavy fuel operation.
Revenue from commercial contracts, earned in connection with the Company's DI
diesel engine piston technology, increased $30,000 from 2000 to 2001. All of the
revenue for 2001 was earned from a program with a foreign engine manufacturer
for a feasibility study of the Company's SCRI technology in diesel truck
engines. Revenue of $50,000 also was earned in 2000 from this manufacturer in
connection with a test program for the Company's SCS "Low Soot" design. The
Company also recognized revenue of $20,000 in 2000 from a second foreign engine
manufacturer. None of these programs continued beyond 2001.
Cost of revenue decreased from 2000 to 2001 as a result of the lower revenue
generated in 2001, primarily resulting from the completion in 2000 of the major
contract from the Navy. As a result, a smaller percentage of R&D personnel's
time was spent on funded contracts in 2001 versus 2000, with the associated
charges being recorded as R&D rather than cost of revenue. Such amounts were
substantially higher in 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:
2002 2001 2000
---------- ---------- ----------
Personnel (includes stock and options):
Employee compensation $ 255,443 $ 335,605 $ 333,027
Taxes & benefits 30,491 54,730 48,594
Consulting fees 44,008 64,587 115,672
---------- ---------- ----------
Total personnel 329,942 454,922 497,293
Project parts and supplies 66,532 28,116 49,343
Occupancy 46,151 47,591 48,785
Depreciation, patent amortization
and write-off of abandoned patents 35,133 52,326 62,409
Patent maintenance and renewal fees 8,022 7,243 8,831
Other expenses 5,938 9,749 15,420
---------- ---------- ----------
Total R&D expenses 491,718 599,947 682,081
Less amounts classified as cost of revenue:
Personnel (159,250) (106,168) (192,330)
Labor overhead (51,151) (53,917) (74,407)
Project parts and supplies (55,637) (3,598) (32,951)
Other expenses (799) (1,015) (3,306)
---------- ---------- ----------
Net R&D $ 224,881 $ 435,249 $ 379,087
========== ========== ==========
The following analysis is based on a comparison of total R&D expenses as listed
above before deduction of amounts classified as cost of revenue.
Comparison of 2002 to 2001
Total R&D expenses decreased by $108,229, or 18%, from 2001 to 2002, primarily
as a result of a significant decrease in personnel costs, as well as a decrease
in patent write-offs, offset in part by an increase in parts and supplies.
Personnel costs decreased by $124,980, or 27%, from 2001 to 2002 due in part to
large staff reductions, including consultants, at the end of 2001 and the start
of 2002. The increase in the number and size of funded contracts from 2001 to
2002, however, resulted in the hiring of additional personnel during the second
half of 2002, thereby partially offsetting the overall decrease in personnel
costs resulting from the earlier reductions in staff.
The decrease of $80,162, or 24%, in employee compensation was mostly due to the
changes in staffing levels and to the fact that the Company's Chief Scientist
and CEO was awarded a bonus of $25,000 in 2001 but none in 2002. The decrease of
$24,239, or 44%, in payroll taxes and employee benefits from 2001 to 2002 is
related to the lower total payroll as well as significantly lower health
insurance costs because health insurance coverage for the Company's Chief
Scientist and CEO was discontinued in early 2002 when he turned 70 years old.
The overall decrease of $20,579, or 32%, in consulting fees from 2001 to 2002
resulted from two major factors. At the end of 2001 the Company discontinued its
consulting agreement with the individual residing in Europe who served as R&D
Supervisor and International Liaison Officer. This individual was compensated in
the form of restricted stock and cash, with related charges totaling $62,587 in
2001. (The Company measures compensation for stock issued for services at the
market price on the date of award or at the agreed-upon value of the services.)
This decrease was offset in part by an increase in fees for consultants,
primarily for those working on funded contracts, of $41,714, from $2,000 in 2001
to $43,714 in 2002 as a result of the new contracts obtained during the second
half of 2002. These consulting fees were for time spent by the consultant who
served as program manager (the same individual who serves as the Company's
director of business development - see G&A discussion) as well as the charges
for a fuel injection system consultant.
Total project parts and supplies expense increased by $38,416 from 2001 to 2002,
as a result of the increase in the number and size of funded contracts from 2001
to 2002. Project parts and supplies expense includes motor fuel, engine parts
and other items used or consumed in engine testing and in the machine shop.
Occupancy expenses, primarily rent, have remained relatively consistent for the
past several years except for an increase in the monthly rent in March 2000.
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 depreciation, patent amortization, and patent write-offs decreased by
$17,193, or 33%, from 2001 to 2002. The largest component is patent write-offs,
which were lower by $19,830, decreasing from $23,253 in 2001 to $3,423 in 2002.
Such write-offs represent the charging to expense of the unamortized costs of
patents abandoned by the Company due to lack of expected commercial potential,
and specifically relate to older patents filed in small countries. Ongoing
patent amortization was approximately the same in 2002 versus 2001, as there
were no new major patents granted in 2002 for which amortization of costs
capitalized in prior years would begin. Depreciation expense increased slightly
from $15,441 in 2001 to $17,956 in 2002, as there were more asset additions made
in 2002 than in 2001.
Comparison of 2001 to 2000
Total R&D expenses decreased by $82,134, or 12%, from $682,081 in 2000 to
$599,947 in 2001, primarily as a result of a decrease in funded contracts from
2000 to 2001.
Personnel costs decreased by $42,371 from 2000 to 2001, with a $51,085, or 44%,
reduction in consulting fees accounting for the decline while employee
compensation increased only slightly. Total consulting fees for funded contracts
decreased from $55,968 in 2000 to zero in 2001 with the completion of a major
contract in 2000. These consulting fees were for time spent by the consultant
who served as program manager (the same individual who serves as the Company's
director of business development- see G&A discussion) as well as the charges for
a fuel injection system consultant. A slight increase of $2,883 was experienced
for other consulting charges for services of the Company's R&D Supervisor and
International Liaison Officer who resides in Europe. This individual 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 for full-time service. His expenses are also reimbursed in
cash. The Company recorded charges of $53,837 in 2001 and $50,664 in 2000 in
connection with the issuance of stock as compensation to this consultant, who
spent no time in Annapolis in 2001 or 2000
The increase in employee compensation of 2,578, or 1%, from 2000 to 2001,
resulted from a number of offsetting differences. A decrease in shop salaries
occurred in part because there was no related amount in 2001 for the salary of a
technician hired early in 2000 who was employed only until October 2000. In
addition, the Company's machinist reduced his work schedule for a few months
during the summer of 2001 and his employment was eventually terminated in
December 2001. On the other hand, total wages increased due to higher wage rates
in 2001 for two shop employees and as a result of a larger amount of bonuses
awarded - $32,500 in 2001 versus $20,000 in 2000, including a higher bonus award
to the Company's CEO and Chief Scientist of $25,000 in 2001 versus $10,000 in
2000. These bonuses are awarded in December of each year with the stipulation
that payment of such amounts is to be deferred until the Board of Directors
determines that the Company's cash resources are sufficient. The 2001 bonus
award to the CEO was higher than in the previous year to reflect the fact in
2001 the CEO made extraordinary sacrifices, both financially in the amount of
wages that have gone unpaid, and personally, to enable the Company to remain in
operation given its poor financial condition. Payroll taxes and employee
benefits in total increased $6,136, or 13%, from 2000 to 2001, due primarily to
an increase in health insurance premium rates.
Total project parts and supplies expense decreased by $21,227, or 43%, from 2000
to 2001, as expenditures for funded contracts declined by $29,353 primarily due
to the completion of the Navy contract in 2000. As a result of fewer hours being
spent on funded contracts, more time was spent on un-funded research in 2001,
thus leading to more purchases of parts and supplies that could not be
reclassified to cost of revenue, which amounted to an increase of $8,126.
Occupancy expenses, primarily rent, have remained relatively consistent for the
past several years except for an increase in the monthly rent in March 2000.
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 depreciation, patent amortization, and patent write-offs decreased by
$10,083, or 16%, from 2000 to 2001. The largest component is patent write-offs,
which were lower by $14,816, decreasing from $38,069 in 2000 to $23,253 in 2001.
Ongoing patent amortization increased $5,620 from 2000 to 2001, as amortization
began on capitalized costs for several patents which were granted during 2001.
Depreciation expense decreased only $887 from 2000 to 2001 as there were minimal
asset additions made in 2001 and 2000.
General and administrative (G&A) expenses:
2002 2001 2000
---------- ---------- ----------
Personnel (includes stock and options):
Employee compensation $ 130,715 $ 125,557 $ 113,564
Consulting fees 59,778 79,186 80,836
Amortization of deferred compensation
from grant of stock options 29,761 29,764
Taxes & benefits 8,916 10,352 9,560
---------- ---------- ----------
Total personnel 199,409 244,856 233,724
Occupancy 10,651 10,882 11,727
Proxy solicitation & annual meeting 17,862 19,618 19,545
Legal fees 11,435 5,264 8,873
Investor relations 19,942 1,520
Audit fees 9,180 9,450 9,150
Stock transfer agent fees 8,098 8,496 8,743
Other expenses 28,016 37,013 40,485
---------- ---------- ----------
Total G&A $ 304,593 $ 337,099 $ 332,607
========== ========== ==========
Comparison of 2002 to 2001
Total G&A expenses decreased by $32,506, or 10%, from 2001 to 2002, as decreases
in personnel costs and other expenses were partially offset by increases in
professional fees.
Employee compensation increased only $5,158, or 4%, from 2001 to 2002, as an
increase in accrued unused vacation pay was offset in part by a decline in the
use of part-time clerical help in 2002 as opposed to 2001, while the annual
salary and amount of bonus awarded to the Company's CFO remained the same in
both years.
Consulting fees in total decreased $19,408, or 25%, from 2001 to 2002. Charges
for services by the individual who serves as the Company's director of business
development (the same individual who serves as a technical program manager)
decreased $20,733, or 30%, from $69,186 in 2001 to $48,453 in 2002. The Company
pays this consultant part in cash and part in stock options for business
development services. Charges paid through stock options totaled $25,625 in 2002
versus $42,120 in 2001. With the Company's receipt of two significant funded
projects during the second half of 2002, this individual spent nearly all of his
time serving as a program manager, resulting in the decrease in charges to G&A
for business development services from 2001 to 2002.
A further decrease from 2001 to 2002 of $10,000 in consulting fees related to
the former president of the Company, who was engaged on a part-time basis under
a consulting agreement that provided for quarterly compensation of $5,000. This
arrangement was terminated by mutual agreement effective June 30, 2001,
resulting in charges of $10,000 in 2001. At the end of September 2001 this
individual resigned from the position of president but remains on the Board of
Directors. In December 2001 he agreed to waive payment of the fees for 2001; the
Company accounted for this transaction by crediting the same amount to paid-in
capital.
These decreases were offset in part by charges of $11,325 for services by other
consultants engaged for the first time in 2002. Such services primarily were for
accounting and computer assistance, as well as for business strategy services.
Amortization of deferred compensation from grant of stock options 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.
Amortization of the related charges has been recorded over the five-year vesting
period of the option, with the final portion of $29,761 having been charged to
expense in 2001.
Occupancy expenses, as well as proxy solicitation and annual meeting expenses,
remained relatively unchanged from 2001 to 2002. Rent, the primary component of
occupancy expenses, is allocated 80% to R&D and 20% to G&A based on the
proportionate share of floor space devoted to each category.
The Company recorded higher legal fees in 2002 versus 2001 as estimates of legal
fees charged to expense were found to have exceeded actual billings once a
statement was received from the Company's securities legal counsel. The Company
had underestimated charges for 2001 and overestimated charges for 2002,
resulting in disproportionately higher charges recorded in 2002 versus 2001.
Charges for investor relations services increased substantially from $1,520 in
2001 to $19,942 in 2002 because during the second quarter of 2002 the Company
engaged the services of an investor relations firm for the first time in a
decade. This relationship was terminated effective December 31, 2002.
Comparison of 2001 to 2000
Total G&A expenses increased by $4,492, or 1%, from 2000 to 2001, as an increase
in personnel costs was only partially offset by a decrease in legal fees and
other expenses. The increase in employee compensation of $11,993, or 11%, from
2000 to 2001 resulted primarily from a higher bonus award to the Company's CFO
($25,000 in 2001 versus $10,000 in 2000). The bonus is awarded in December of
each year with the stipulation that payment of such amount is to be deferred
until the Board of Directors determines that the Company's cash resources are
sufficient. The 2001 bonus award was higher than in the previous year to reflect
the fact in 2001 the CFO made extraordinary sacrifices, both financially in the
amount of wages that have gone unpaid, and personally, to enable the Company to
remain in operation given its poor financial condition. The increase in the
bonus award was offset in part by a decrease in the use of part-time clerical
help in 2001 as opposed to 2000.
Consulting fees decreased by $1,650, or 2%, from 2000 to 2001. Charges for
services by the individual who serves as the Company's director of business
development (the same individual who serves as a technical program manager)
increased by $8,350, from $60,836 in 2000 to $69,186 in 2001. The Company pays
this consultant part in cash and part in stock options for business development
services. Charges paid through stock options totaled $42,120 in 2001 versus
$33,625 in 2000. With the Company's receipt of two significant funded projects
during the second half of 2002, this individual spent nearly all of his time
serving as a program manager, resulting in the decrease in charges to G&A for
business development services from 2001 to 2002. This increase in fees was
offset by a decrease from 2001 to 2002 of $10,000 in consulting fees related to
the former president of the Company, who was engaged on a part-time basis under
a consulting agreement that provided for quarterly compensation of $5,000. This
arrangement was terminated by mutual agreement effective June 30, 2001,
resulting in charges of $10,000 in 2001 as opposed to $20,000 in 2000. At the
end of September 2001 this individual resigned from the position of president
but remains on the Board of Directors. In December 2001 he agreed to waive
payment of the fees for 2001; the Company accounted for this transaction by
crediting the same amount to paid-in capital.
Amortization of deferred compensation from grant of stock options 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.
Amortization of the related charges has been recorded over the five-year vesting
period of the option, with the final portion of $29,761 having been charged to
expense in 2001.
CRITICAL ACCOUNTING POLICIES
A complete summary of significant accounting policies implemented by the Company
is presented in Note 2 to the accompanying financial statements. The Company
considers the following policies included in that summary to be critical
accounting policies:
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, as well as the unamortized costs of patents abandoned by the
Company due to lack of expected commercial potential, are charged to operations
at the time such determination is made.
Revenue recognition: Revenue derived from development and demonstration
contracts is recognized upon the Company's completion of the milestones and/or
submission of progress reports specified in each contract. Development contracts
are executed for funding supplied by a United States Government or Department of
Defense (the "Government") agency or prime contractor for proof-of-concept
demonstration programs. 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.
Contracts which are based on costs incurred are subject to post-award audit and
potential price redetermination. In connection with contracts in progress, any
excess of billings over costs incurred is recorded as a current liability, while
any excess of costs incurred over billings is recorded as a current asset, at
the financial statement date. In the opinion of management, adjustments, if any,
on completed contracts would not have a material adverse effect on the Company's
financial position or results of operations. Commercial development contracts
are executed in situations in which an engine manufacturer is willing to provide
funding to partially offset 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 modified with 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.
ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS
A summary of recent accounting pronouncements is presented in Note 2 to the
accompanying financial statements.
The Company may in the future adopt Statement of Financial Accounting Standards
(SFAS) No. 123 - "Accounting for Stock-based Compensation", which provides for
the fair value based method of accounting to be applied to the Company's stock
option grants and other stock-based compensation. As detailed in Note 14 to the
accompanying financial statements, the Company has been accounting 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 to present net
loss and net loss per share as determined by applying the fair valued based
method of accounting.
SFAS No. 148 - "Accounting for Stock-based Compensation - Transition and
Disclosure", issued in December 2002, amends SFAS No. 123 to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock options and other stock-based employee compensation. SFAS,
effective for financial statements for fiscal years ending after December 15,
2002, enables companies to recognize expense for the fair value of their past
and present stock option awards as soon as the conversion to the fair value
based method is made. The adoption by the Company in the future of the fair
value based method under SFAS No. 123 pursuant to the provisions of SFAS No. 148
is expected to have a material impact on its financial statements.
The adoption by the Company in fiscal 2003 of other new accounting
pronouncements which have a delayed effective date is not expected to have a
material impact on its financial statements.
ITEM 7. FINANCIAL STATEMENTS
Index to financial statements:
Reports of independent accountants
Financial statements:
Balance sheets as of December 31, 2002 and 2001
Statements of operations and accumulated deficit for the three years
ended December 31, 2002
Statements of paid-in capital for the three years ended December 31, 2002
Statements of cash flows for the three years ended December 31, 2002
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 sheet of Sonex Research, Inc. (the
"Company") as of December 31, 2002, and the related statements of operations and
accumulated deficit, paid-in capital and cash flows for the year then ended.
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 audit in accordance with auditing standards generally accepted
in the United States of America. 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 audit provides 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, 2002, and the results of its operations and its cash flows for the
year then ended, in conformity with accounting principles generally accepted in
the United States of America.
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 generate sufficient 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.
HAUSSER + TAYLOR LLP
Cleveland, Ohio
March 21, 2003
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Sonex Research, Inc.
We have audited the accompanying balance sheet of Sonex Research, Inc. (the
"Company") as of December 31, 2001 and the related statements of operations and
accumulated deficit, paid-in capital and cash flows for the years ended December
31, 2001 and 2000, 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 auditing standards generally
accepted in the United States of America. 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, 2001, and the results of its operations and its cash flows for the
years ended December 31, 2001 and 2000, respectively, in conformity with
accounting principles generally accepted in the United States of America.
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 generate sufficient 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
April 10, 2002
SONEX RESEARCH, INC.
BALANCE SHEETS
December 31,
--------------------------
2002 2001
------------ ------------
ASSETS
Current assets
Cash and equivalents $ 105,998 $ 3,355
Accounts receivable 64,702 37,828
Prepaid expenses 25,814 25,783
Loans to officers and employees (Note 4) 22,500 22,500
------------ ------------
Total current assets 219,014 89,466
Patents (Note 6) 203,623 204,088
Property and equipment (Note 7) 58,808 57,249
------------ ------------
Total assets $ 481,445 $ 350,803
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 36,322 $ 38,923
Deferred revenue - billings in excess of costs
and estimated profits on contracts in progress
(Note 8) 66,587
Current portion of capital lease obligations 5,657
Notes payable to shareholder (Note 9) 37,327
Accrued compensation and benefits (Note 10) 427,397 229,228
------------ ------------
Total current liabilities 573,290 268,151
------------ ------------
Capital lease obligations 10,985
------------
Deferred compensation (Note 11) 906,856 857,944
------------ ------------
Stockholders' equity/(deficit)
Preferred stock, $.01 par value, 2,000,000
shares authorized and issued, 1,540,001
shares outstanding 15,400 15,400
Common stock, $.01 par value, 48,000,000 shares
authorized, shares issued and outstanding:
21,592,669 in 2002 and 21,212,669 in 2001 215,927 212,127
Additional paid-in capital 21,420,742 21,334,577
Accumulated deficit (22,640,911) (22,319,271)
Notes receivable from officers and
employees (Note 5) (20,844) (18,125)
------------ ------------
Total stockholders' equity/(deficit) (1,009,686) (775,292)
Commitments (Note 16)
------------ ------------
Total liabilities and stockholders'equity/(deficit) $ 481,445 $ 350,803
============ ============
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
Year ended December 31,
-----------------------------------------
2002 2001 2000
------------ ------------ ------------
Revenue
Defense/government $ 471,912 $ 145,291 $ 337,898
Commercial 100,000 70,000
------------ ------------ ------------
471,912 245,291 407,898
------------ ------------ ------------
Costs and expenses
Cost of revenue 266,837 164,698 302,994
Research and development 224,881 435,249 379,087
General and administrative 304,593 337,099 332,607
------------ ------------ ------------
796,311 937,046 1,014,688
------------ ------------ ------------
Net loss from operations (324,399) (691,755) (606,790)
Investment income 2,759 1,400 4,860
------------ ------------ ------------
Net loss (321,640) (690,355) (601,930)
Accumulated deficit
Beginning of period (22,319,271) (21,628,916) (21,026,986)
------------ ------------ ------------
End of period $(22,640,911) $(22,319,271) $(21,628,916)
============ ============ ============
Weighted average number of common
shares outstanding 21,495,529 20,224,090 18,472,727
========== ========== ==========
Net loss per share (basic and diluted) $ (.015) $ (.034) $ (.033)
======= ======= =======
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF PAID-IN CAPITAL
Price Preferred stock Common stock Additional
per ($.01 per share) (.01 par value) paid-in
share Shares Amount Shares Amount capital
----- -------- ------- ---------- -------- -----------
Balance, January 1, 2000 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
December private placement .25 775,000 7,750 186,000
December for services .25 54,154 542 12,996
Stock option compensation 45,875
Amortization of deferred
compensation from grant
of stock options 29,764
--------- ------- ---------- -------- -----------
Balance, December 31, 2000 1,540,001 15,400 19,479,868 194,799 20,927,437
March private placement .25 300,000 3,000 72,000
March for services .25 54,577 546 13,098
April private placement .25 125,000 1,250 30,000
June private placement .20 325,000 3,250 61,750
June for services .29 44,916 449 12,667
August payment of stock
subscription .20 25,000 250 4,750
September for services .25 55,000 550 13,200
October private placement .15 750,000 7,500 105,000
December for services .25 53,308 533 12,794
December forgiveness of
payables 10,000
Stock option compensation 42,120
Amortization of deferred
compensation from grant
of stock options 29,761
--------- ------- ---------- -------- -----------
Balance, December 31, 2001 1,540,001 15,400 21,212,669 212,127 21,334,577
March private placement .15 360,000 3,600 50,400
May for services .25 12,000 120 2,880
July for services .25 8,000 80 1,920
Stock option compensation 30,965
--------- ------- ---------- -------- -----------
Balance, December 31, 2002 1,540,001 $15,400 21,592,669 $215,927 $21,420,742
========= ======= ========== ======== ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF CASH FLOWS
Year ended December 31,
-------------------------------
2002 2001 2000
--------- --------- ---------
Cash flows from operating activities
Net loss $(321,640) $(690,355) $(601,930)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Depreciation 17,956 15,441 16,328
Amortization of patents 17,177 36,885 46,091
Amortization of deferred compensation
from grant of stock options 29,761 29,764
Current charges paid in stock or options 35,965 95,957 96,539
Accrued interest on loans to/notes
from employees (2,719)
Accrued interest on notes to shareholder 1,327
(Increase) decrease in accounts receivable (26,874) (20,488) 60,121
(Increase) decrease in prepaid expenses (32) 1,359 2,694
Increase (decrease) in accrued liabilities 195,569 128,569 10,989
Increase (decrease) in billings in excess of
costs on contracts in progress 66,587
Increase (decrease) in deferred compensation 48,912 47,100 47,100
--------- --------- ---------
Net cash provided by (used in)
operating activities 32,228 (355,771) (292,304)
--------- --------- ---------
Cash flows from investing activities
Acquisition of property and equipment (1,869) (3,664) (1,386)
Additions to patents (16,712) (25,266) (42,022)
--------- --------- ---------
Net cash used in investing activities (18,581) (28,930) (43,408)
--------- --------- ---------
Cash flows from financing activities
Issuance of stock - private placements 54,000 288,750 193,750
Issuance of stock - exercise of warrants 173,500
Issuance of notes payable to shareholder 36,000
Reduction of capital lease obligations (1,004)
Forgiveness of payables 10,000
--------- --------- ---------
Net cash provided by financing activities 88,996 298,750 367,250
--------- --------- ---------
Increase (decrease) in cash 102,643 (85,951) 31,538
Cash at beginning of period 3,355 89,306 57,768
--------- --------- ---------
Cash at end of period $ 105,998 $ 3,355 $ 89,306
========= ========= =========
Non-cash transactions - equipment acquired
through capital lease obligation $ 17,646
=========
The accompanying notes are an integral part of the financial statements.
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. The SCS achieves in-cylinder control of
ignition and combustion to increase fuel mileage of gasoline engines, reduce
emissions of diesel engines, and permit small gasoline engines to run on safer
diesel-type fuels. The Company's objective is to execute broad agreements with
engine and parts manufacturers for industrial production of SCS components under
license from Sonex.
NOTE 2 - 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 2002, most notably the reclassification of amounts in the Statement of
Operations from Research and Development to Cost of Revenue.
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 Federal Deposit Insurance Corporation
(FDIC) insures bank balances up to $100,000. At any point in time, the Company's
bank balances may exceed the FDIC insurance limit. The Company considers all
short-term, highly liquid investments which are convertible into cash within
three months or less to be cash equivalents.
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, as well as the unamortized costs of patents abandoned by the
Company due to lack of expected commercial potential, are charged to operations
at the time such determination is made.
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 and demonstration contracts
is recognized upon the Company's completion of the milestones and/or submission
of progress reports specified in each contract. Development contracts are
executed for funding supplied by a United States Government or Department of
Defense (the "Government") agency or prime contractor for proof-of-concept
demonstration programs. 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.
Contracts which are based on costs incurred are subject to post-award audit and
potential price redetermination. In connection with contracts in progress, any
excess of billings over costs incurred is recorded as a current liability, while
any excess of costs incurred over billings is recorded as a current asset, at
the financial statement date. In the opinion of management, adjustments, if any,
on completed contracts would not have a material adverse effect on the Company's
financial position or results of operations.
Commercial development contracts are executed in situations in which an engine
manufacturer is willing to provide funding to partially offset 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 modified with 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.
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 Statement of Financial Accounting Standards (SFAS)
No. 123 - "Accounting for Stock-based Compensation".
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 and, accordingly, are
excluded from the computation.
Use of estimates: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and notes. Actual results may differ from
those estimates.
Major customers:During 2002 the Company's primary customers were branches of the
U.S. government and military or their prime contractors. Revenues generated from
such customers under three contracts-in-progress represented 83% of total
revenues in 2002.
Concentration of credit risk: The Company maintains part of its cash in bank
deposit accounts at financial institutions. At times, the balances in such
accounts may exceed the FDIC insurance limitation of $100,000 per account. The
Company's accounts receivable at December 31, 2002 consist entirely of
uncollateralized customer obligations due under normal business terms from
branches of the U.S. government and military or their prime contractors. Based
on the Company's collection experience and the creditworthiness of such
customers, management concluded that no allowance for doubtful accounts was
necessary.
New accounting standards: In June 2001 the Financial Accounting Standards Board
("FASB") issued SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS
No. 142, goodwill and intangible assets deemed to have indefinite lives are no
longer amortized but are subject to periodic impairment tests. Other intangible
assets continue to be amortized over their useful lives.
In August 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which is effective the first quarter of fiscal year 2003. SFAS 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
cost.
In October 2001 the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-lived Assets," which was adopted by the Company in 2001. SFAS
No. 144 supercedes SFAS No. 121 and modifies and expands the financial
accounting and reporting for the impairment or disposal of long-lived assets
other than goodwill.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
Provisions of SFAS No. 145 become effective in 2002 and 2003. Under SFAS No.
145, gains and losses from the extinguishment of debt should be classified as
extraordinary items only if they meet the criteria of Accounting Principles
Board Opinion No. 30. SFAS No. 145 also addresses financial accounting and
reporting for capital leases that are modified in such a way as to give rise to
a new agreement classified as an operating lease.
In June 2002 the FASB issued SFAS No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities," which is effective for exit or disposal activities
initiated after December 31, 2002. SFAS No. 146 nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." Under SFAS No. 146, a liability is required to be
recognized for costs, including certain lease termination costs and employee
termination benefits, associated with an exit or disposal activity when the
liability is incurred. SFAS No. 146 applies to costs associated with an exit
activity that does not involve an entity newly acquired in a business
combination or with a retirement or disposal activity covered by SFAS Nos. 143
and 144.
In November 2002, the FASB issued FIN 45, which expands previously issued
accounting guidance and disclosure requirements for certain guarantees. FIN 45
requires the recognition of an initial liability for the fair value of an
obligation assumed by issuing a guarantee. The provision for initial recognition
and measurement of the liability will be applied on a prospective basis to
guarantees issued or modified after December 31, 2002.
The adoption of these new standards did not, or is not expected to, materially
affect the Company's financial position and results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based,
Compensation - Transition and Disclosure," that amends SFAS No. 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of transition to
the fair value method of accounting for stock-based employee compensation. SFAS
No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion
No. 28, "Interim Financial Reporting," to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income and
earnings per share in annual and interim financial statements. The Statement
does not amend SFAS No. 123 to require companies to account for employee stock
options using the fair value method. The Statement is effective for fiscal years
beginning after December 15, 2002. The voluntary adoption by the Company in the
future of the fair value based method under SFAS No. 123 pursuant to the
provisions of SFAS No. 148 is expected to have a material impact on its
financial statements.
NOTE 3 - LIQUIDITY
Management recognizes that the Company's history of operating losses, level of
available funds, and revenue from current and future contracts, in relation to
projected expenditures, raise substantial doubt as to the Company's ability to
commence generation of significant revenues from the commercialization of the
SCS and ultimately achieve profitable operations. Accordingly, the Company will
continue to minimize its operating expenditures through a number of measures,
including the ongoing deferral by its officers of portions of their salaries as
described in Notes 10 and 11.
Based upon available resources, current and projected spending levels, and
expected revenue from current and anticipated contracts, management believes the
Company will have sufficient capital to fund operations until approximately
December 31, 2003. The Company's prospects beyond that time are dependent upon
its ability to enter into significant funded contracts for the further
development of its SCS technology, establish joint ventures or strategic
partnerships with major industrial concerns, or secure a major capital infusion.
There is no assurance that the Company will be able to achieve these objectives;
therefore, there remains substantial doubt about the Company's ability to
continue as a going concern.
NOTE 4 - 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. 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, 2003.
NOTE 5 - NOTES RECEIVABLE FROM OFFICERS AND EMPLOYEES
In connection with the exercise of warrants to purchase shares of common stock
in June 2000 (see Note 13), the Company accepted notes receivable from its chief
financial officer and two other employees aggregating $18,125. The notes,
payable on or before June 30, 2005, are secured by the shares issuable upon the
exercise of the warrants and deferred salaries payable to each of the
individuals. Interest on the notes is charged at 6% per annum, with a total of
$2,719 having been accrued as of December 31, 2002.
Because these notes receivable arise from the issuance of common stock, the
amounts are presented in the accompanying balance sheet as deductions from
stockholders' equity/(deficit).
NOTE 6 - PATENTS
The costs capitalized by the Company in connection with the filing of patent
applications consist primarily of charges for services of patent attorneys and
filing fees paid to countries. The net unamortized capitalized costs of patents
is comprised of the following:
December 31,
------------------------
2002 2001
---------- ----------
Capitalized costs $ 264,532 $ 251,243
Accumulated amortization (60,909) (47,155)
---------- ----------
$ 203,623 $ 204,088
========== ==========
Amortization of patent costs was $13,754 in 2002, $13,632 in 2001, and $8,022 in
2000. Annual patent cost amortization is expected to range from $12,000 to
$15,000 over the next five years.
The Company continues to conduct its own research and development activities
which have resulted in additional patents. Development of commercial
applications of certain elements of the SCS has commenced and management
believes the capitalized cost of patents will be recovered through revenue
derived from the licensing of the underlying technology. Management closely
monitors the patent application process and other factors which may affect the
economic value of the Company's technology, and reduces the capitalized cost of
patents should the recovery of such costs no longer be sustainable. In
connection with patents abandoned by the Company due to lack of expected
commercial potential, unamortized costs of $3,423 in 2002, $23,253 in 2001 and
$38,069 in 2000 were charged to operations and reflected as additional
amortization in the accompanying financial statements.
NOTE 7 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 31,
------------------------
2002 2001
---------- ----------
Shop equipment $ 474,940 $ 460,821
Office equipment 22,225 36,900
---------- ----------
497,165 497,721
Accumulated depreciation (438,357) (440,472)
---------- ----------
$ 58,808 $ 57,249
========== ==========
NOTE 8 - DEFERRED REVENUE
In connection with development and demonstration contracts in progress, the
Company records the gross amount of any excess of billings over costs incurred
and estimated profit or loss as deferred revenue, a current liability, while any
excess of costs incurred over billings is recorded as a current asset. The
$66,587 balance of deferred revenue as of December 31, 2002 consists of the
excess of billings ($401,858) over costs incurred and estimated profit or loss
($335,271) on two contracts in progress. Such amounts are expected to be
recognized as revenue during 2003 as the contracts are completed. There were no
contracts for which costs and estimated profits incurred exceeded billings as of
December 31, 2002.
NOTE 9 - NOTES PAYABLE TO SHAREHOLDER
In connection with a private placement in March 2002 as detailed in Note 13, the
Company issued a $6,000 note, initially payable on June 30, 2002, that is
convertible to equity at the option of the holder. The due date of the note has
been extended several times and is currently due on June 30, 2003. The note has
an interest rate of 6%, with a total of $275 in interest having accrued through
December 31, 2002. In July 2002 the Company issued a $30,000 note to this same
shareholder payable initially on January 31, 2003. The due date of the note also
has been extended to June 30, 2003. This note carries an interest rate of 8%,
with a total of $1,052 in interest having accrued through December 31, 2002.
Payment of both notes is secured by Company revenues.
NOTE 10 - ACCRUED COMPENSATION AND BENEFITS
Accrued compensation consists of the following amounts payable to current and
former employees:
December 31,
------------------------
2002 2001
---------- ----------
Accrued wages $ 235,515 $ 80,228
Accrued consulting fees 31,737 8,000
Accrued bonuses 95,499 83,000
Accrued vacation pay 64,646 58,000
---------- ----------
$ 427,397 $ 229,228
========== ==========
From early 2001 through late in 2002, the Company's officers voluntarily and at
their own discretion deferred receipt of payment of significant portions of
their current wages to reduce the Company's monthly cash requirements. Since
December 2002, the Company's chief financial officer has been receiving his
current wages, while the Company's chief executive officer continues to defer a
significant portion of his current wages. Such wages payable to the Company's
officers totaling $199,992 are included in the total of accrued wages as of
December 31, 2002 and are payable upon demand. The continued deferral of
portions of current wages by the Company's officers cannot be expected to
continue indefinitely, and the Company will be required to pay such accrued
wages as soon as cash flow permits. The amount and timing of such payments will
be determined at the discretion of the Company's officers, as these accrued
wages 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 11. Similar arrangements exist for consulting fees, the
majority of which amounts are payable to the individual who serves as the
Company's director of business development on a part-time basis.
In December of each of the last three years, the Company awarded bonuses to its
officers and employees with the stipulation that payment of such bonuses is to
be deferred until the Board of Directors determines that the Company's cash
resources are sufficient to enable such payments. During 2001 the Company paid
$12,500 of the bonuses accrued as of the previous year-end, portions of which
payments represented the conversion of accrued bonuses to equity. In connection
with a private placement in March 2002 as detailed in Note 13, the Company paid
$22,500 of accrued bonuses and $4,500 of accrued consulting fees through the
conversion of such amounts to equity. The amount of accrued bonuses included
above that was payable to the Company's officers at December 31, 2002 and 2001
was $72,500 and $67,500, respectively.
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 11. The amount of accrued
vacation included above that was payable to the Company's officers at December
31, 2002 and 2001 was $48,856 and $41,406, respectively.
NOTE 11 - DEFERRED COMPENSATION
In order to help conserve the Company's limited cash resources, all of the
Company's current and former officers and certain of the Company's other
employees for several years have voluntarily deferred receipt of payment of
significant portions of their authorized annual salaries at the request of the
Board of Directors. A written agreement between these individuals and the
Company was first executed in 1992 in connection with an indispensable $2
million private investment made by a venture capital group in exchange for the
issuance of a new class of convertible preferred stock as described in Note 13.
The individuals who are parties to this agreement 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.
Deferred compensation outstanding is payable to the following classifications of
personnel:
December 31,
------------------------
2002 2001
---------- ----------
Current officers $ 574,249 $ 525,337
Current employees and consultants 31,864 62,088
Former officers and other employees 300,743 270,519
---------- ----------
$ 906,856 $ 857,944
========== ==========
Since January 1, 1997 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, 2003. Accordingly, such deferred compensation
is reported separately in the accompanying balance sheet as a non-current
liability.
At the conclusion of a legal challenge by two former officers of the Company
initiated in 1993 demanding full payment of deferred salaries upon the
termination of their employment, in 1996 the Maryland Court of Special Appeals
rejected this demand and ruled that the written agreement to defer compensation
was a valid and enforceable contract.
NOTE 12 - INCOME TAXES
The Company has not incurred any federal or state income taxes since its
inception due to operating losses. At December 31, 2002, the Company had net
operating loss ("NOL") carryforwards of approximately $12.5 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
---------- ------------ ---------
2003 $ 1,344,816 $ 365,147
2004 1,185,181 14,970
2005 900,267
2006 1,060,169
2007 - 2012 6,035,290
2018 - 2022 1,937,079
------------ ---------
$ 12,462,802 $ 380,117
============ =========
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 the accounting 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 a
prior year 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 $4.8 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 $6,619,599 have expired unused, as have capital loss carryforwards
of $335,081.
NOTE 13 - 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.
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, 2002 a total
of 459,999 shares of preferred stock had been converted into 1,314,278 shares of
common stock.
Exercise of warrants; Private placements of common equity: 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. In June 2000 the Company received cash proceeds of $73,750 from the
exercise of warrants to purchase 196,667 shares, and accepted five-year notes
receivable aggregating $18,125 from its chief financial officer and two other
employees (see Note 5) for the exercise of warrants to purchase 48,333 shares,
of its common stock, all at a price of $.375 per share.
In December 2000 the Company completed a private financing in which it raised
$193,750 from a small number of the Company's shareholders, including its chief
executive officer and chief financial officer, most of whom participated in
previous private financings of the Company. A total of 775,000 shares of the
Company's common stock and five-year warrants to purchase an additional 387,500
shares of common stock at $.50 per share were issued in this financing. No
separate value has been reflected in the financial statements for the warrants
issued in the above transaction based on management's belief that the separate
fair value of such warrants is not significant.
In a private financing during March and April 2001 the Company raised $106,250
from a small number of the Company's shareholders, including its chief executive
officer and chief financial officer, most of whom participated in previous
private financings of the Company. A total of 425,000 shares of the Company's
common stock and five-year warrants to purchase an additional 425,000 shares of
common stock at $.50 per share were issued in this financing.
In a private financing in June 2001 the Company issued 350,000 shares of common
stock for proceeds of $70,000 received from a small group of the Company's local
shareholders, most of whom participated in previous private financings of the
Company. A portion of the proceeds was in the form of a subscription receivable
of $5,000, which amount was received in August 2001.
In a private financing in October 2001 the Company issued 750,000 shares of
common stock for proceeds of $112,500 received from a small group of the
Company's local shareholders, including its chief executive officer and chief
financial officer, most of whom participated in previous private financings of
the Company.
In a private financing at the end of March 2002, the Company raised capital of
$60,000, including $27,000 in cash investments, $27,000 from the conversion to
equity of accrued liabilities to officers, employees and consultants, and cash
proceeds of $6,000 through the issuance of a short-term note that is convertible
to equity at the option of the holder. A total of 360,000 shares of the
Company's common stock and five-year warrants to purchase an additional 180,000
shares of common stock at $.25 per share were issued in this financing, and
60,000 shares were reserved for future issuance upon the conversion of the note
payable to common stock and a warrant to purchase common stock.
The offer and sale of the shares of common stock and warrants to purchase shares
of common stock in connection with each of the private 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.
NOTE 14 - STOCK OPTIONS
The Company maintains a non-qualified stock option plan created in 1987 (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 2012.
Between January 1, 2000 and December 31, 2002, the Company had the following
activity in options to purchase shares of common stock under the Plan:
Weighted Weighted
average average
exercise # of shares exercise
# of shares price exercisable price
----------- -------- ----------- --------
Unexercised at January 1, 2000 4,056,716 $.52 3,426,716 $.52
Granted 272,500 .39 153,750 .45
Becoming exercisable 186,250 .48
Exercised
Lapsed or canceled (6,000) .50 (6,000) .50
--------- ---------
Unexercised at December 31, 2000 4,323,216 .51 3,760,716 .52
Granted 882,500 .25 411,250 .25
Becoming exercisable 405,000 .48
Exercised
Lapsed or canceled (671,400) .50 (657,650) .50
--------- ---------
Unexercised at December 31, 2001 4,534,316 .46 3,919,316 .49
Granted 498,242 .25 340,492 .25
Becoming exercisable 378,750 .29
Exercised
Lapsed (509,500) .50 (509,500) .50
--------- ---------
Unexercised at December 31, 2002 4,523,058 $.43 4,129,058 $.45
========= ==== ========= ====
Options granted under the Plan during 2002 include the grant of a ten-year
option in November 2002 to the Company's chief financial officer to purchase
200,000 shares of common stock. These options are exercisable 50% on the date of
grant 50% one year later. The exercise price of these options of $.25 per share
was above the market price of the common stock at the grant date.
Options granted under the Plan during 2001 include grants of ten-year options in
December 2001 to each of the Company's four outside directors to purchase
100,000 shares of common stock. These options vest at the rate of 25% per year
beginning with the date of grant. Also in December 2001, the Company's chief
executive officer and chief financial officer each were granted ten-year options
to purchase 100,000 shares of common stock, exercisable 50% on the date of grant
and 50% one year later. These options granted in December 2001 all have an
exercise price of $.25 per share, which price was above the market price of the
common stock at the grant date.
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. Because
these agreements relate to shares which are already outstanding, the exercise of
these options will not result in an increase in the total number of the
Company's outstanding shares, nor will the Company receive any cash proceeds
upon the exercise of the options.
For options granted with an exercise price below the market price at the date of
grant, the Company credits an amount to additional paid-in capital representing
the excess of the aggregate market value at the date of grant over the aggregate
exercise price of such options, and charges a like amount to compensation
expense in that year. There were no such charges from 2000 through 2002 in
connection with options granted under the Plan. Certain consultants engaged by
the Company have agreed to be compensated partially in cash and partially in
stock options. While the exercise price of such options has been equal to or
higher than the market price of the stock at each date of grant, the Company has
recorded compensation expense equal to the value of the consultants' services
which are payable by such stock options. Such charges aggregated $30,965 in
2002, $42,120 in 2001, and $45,875 in 2000, with like amounts credited to
additional paid-in capital.
In connection with the grant of the option in 1997 by Proactive to the new
president of the Company, $29,761 in 2001 and $29,764 in 2000 was credited to
additional paid-in capital and like amounts amortized to compensation expense in
each of those years. Amortization of the these charges, recorded over the
five-year vesting period of the option, was been completed as of December 31,
2001. There were no such charges for the option granted by Proactive in December
1999 to the president of the Company because the exercise price exceeded the
market price of the stock at the date of grant.
While the Company applies APB Opinion No. 25 in accounting for stock option
compensation, 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-Scholes option pricing model with the
following weighted average assumptions for 2002: volatility factor of 95%,
average risk-free interest rate of 3.8%, zero dividend yield, and average
expected term of eight 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:
2002 2001 2000
---------- ---------- ----------
Weighted average fair value per share $.15 $.19 $.37
Net loss - as reported $321,640 $690,355 $601,930
Net loss - pro forma $465,693 $948,089 $850,486
Net loss per share - as reported $.015 $.034 $.033
Net loss per share - pro forma $.022 $.047 $.046
The increase of $144,053 from the reported net loss to the pro forma net loss
for 2002 associated with the charges for the estimated fair value of options
consists of $14,440 for options granted in 2002 and $129,613 for options granted
in prior years.
The Black-Scholes valuation model was developed for use in estimating the fair
value of traded options which have no vesting restrictions and are fully
transferable, as opposed to the type of compensatory options granted by the
Company. It also requires the input of highly subjective assumptions, such as
the expected stock price volatility, changes in which can materially affect the
fair value estimate. Because the options granted by the Company have
characteristics significantly different from those of traded options, the
amounts calculated using the Black Scholes option valuation model, in the
opinion of management, do not necessarily provide a reliable single measure of
the fair value of options granted by the Company.
NOTE 15- COMMON STOCK RESERVED FOR FUTURE ISSUANCE
As of December 31, 2002, a total of 11,516,832 shares of common stock were
reserved by the Company for issuance for the following purposes:
Purpose # of shares
----------------------------------------------------- -----------
Currently exercisable warrants:
Exercisable at $.50 per share, expiring in December 2005 387,500
Exercisable at $.50 per share, expiring in March 2006 250,000
Exercisable at $.50 per share, expiring in April 2006 175,000
Exercisable at $.25 per share, expiring in March 2007 180,000
-----------
992,500
Currently exercisable options:
Exercisable at $.25 per share 1,095,792
Exercisable at $.50 per share 2,787,266
Exercisable at $.75 per share 196,000
Exercisable at $1.00 per share 50,000
----------
4,129,058
----------
Granted options becoming exercisable in the future:
Exercisable at $.25 per share 394,000
Options available for future grants 1,541,274
Conversion of note payable 60,000
Conversion of preferred stock 4,400,000
-----------
Total shares reserved 11,516,832
===========
In February 2000 warrants exercisable at $.35 and $.75 per share to purchase
285,000 and 3,098,209 shares, respectively, of common stock expired unexercised.
In June 2000 warrants exercisable at $.375 and $.50 per share to purchase
350,000 and 590,000 shares, respectively, of common stock expired unexercised.
In February and March 2002 warrants exercisable at $.75 per share to purchase
387,759 shares of common stock expired unexercised.
NOTE 16 - COMMITMENTS
The Company occupies its office and laboratory facility on a month-to-month
basis under the terms of an operating lease agreement pursuant to which the
property owner is required to provide thirty days notice if he wants the Company
to vacate the premises. The lease currently provides for monthly rent of $4,000
and requires the Company to pay all property related expenses. Gross rent
charges aggregated $48,000 in 2002 and 2001, and $47,000 in 2000, while the
Company also earned sublease income of $4,050, $3,000, and $2,400 in 2002, 2001
and 2000, 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.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On September 16, 2002, the Company was informed by its independent accountants,
C.L. Stewart & Company, that the firm was discontinuing its audit practice and
would not serve as independent accountants of the Company for the year ended
December 31, 2002. C.L. Stewart & Company agreed to remain as independent
accountants, including to conduct the review of the Company's unaudited
financial statements for the quarter ending September 30, 2002, until the
Company had engaged new independent accountants. The Company's Board of
Directors accepted the decision of C.L. Stewart & Company to withdraw as
independent accountants.
In connection with its audits for the two most recent fiscal years and through
December 17, 2002, there were no disagreements with C.L. Stewart & Company on
any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements, if not resolved
to the satisfaction of C.L. Stewart & Company, would have caused them to make
reference thereto in their report on the financial statements for such years.
The report of C.L. Stewart & Company on the financial statements of the Company
as of December 31, 2001 and for the years ended December 31, 2001 and 2000
presented in this Form 10-KSB, contains no adverse opinion or disclaimer of
opinion and is not qualified or modified as to audit scope or accounting
principle; however, such report is modified by the inclusion of an explanatory
paragraph indicating that there is substantial doubt about the Company's
ability to continue as a going concern.
The Company's Board of Directors engaged Hausser + Taylor LLP as new independent
accountants as of December 17, 2002. During the two most recent fiscal years and
through December 17, 2002, the Company has not consulted with Hausser + Taylor
LLP regarding either (i) the application of accounting principles to a specified
transaction, either completed or proposed; or the type of audit opinion that
might be rendered on the Company's financial statements, and neither a written
report was provided to the Company nor oral advice was provided that Hausser +
Taylor LLP concluded was an important factor considered by the Company in
reaching a decision as to the accounting, auditing or financial reporting issue;
or (ii) any matter that was either the subject of a disagreement, as that term
is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions
to Item 304 of Regulation S-K, or a reportable event, as that term is defined in
Item 304(a)(1)(v) of Regulation S-K.
The Company has had no disagreements with its current independent accountants,
Hausser + Taylor LLP, on any matter of accounting principles or practices or
financial statement disclosure.
PART III
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. Pursuant to the Company's
Charter, 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. 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 terms of Class I, Class II and Class III directors are scheduled
to expire at the annual meeting of shareholders to be held in 2005, 2003, and
2004, respectively.
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. Since July 1997 the total number of directors has been set
at five, and, since December 2001, the Board has consisted of three Preferred
Stock directors and two Common Stock directors. In March 2003 Mr. John H.
Drewanz, a Class II Common Stock director since October 2001 and Chairman of the
Board since October 9, 2002, resigned from the Board. Mr. Drewanz informed other
directors that he had made all the contributions he could as a director and
believes the Company is in capable hands with its current management and other
members of the Board. As of March 31, 2003, the Board had not filled the vacancy
and had not named a new Chairman. The Board expects to fill the Class II Common
Stock director vacancy in the near future and that individual, or such other
person as may be validly nominated to fill the vacancy, shall be elected by the
shareholders at the next annual meeting to serve the remaining scheduled term as
a Class II director or until his successor is elected and qualified.
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.
Term as
director
Name Age expires Position
---------------- --- ------- -------------------------------------
Preferred Stock Directors:
Lawrence H. Hyde 78 2003 Class II Director
Charles C. McGettigan 58 2005 Class I Director
Myron A. "Mike" Wick, III 59 2005 Class I Director
Common Stock Director:
Andrew A. Pouring 71 2004 Chief Executive Officer, Chief
Scientist, and Vice Chairman of
the Board (Class III Director)
Other Executive Officers:
George E. Ponticas 43 Vice President - Finance, Secretary,
Treasurer and Chief Financial Officer
Board Committees
The Board has an Executive Committee, consisting of Mr. Wick, Dr. Pouring and
Mr. Hyde, which meets on short notice when required during intervals between
meetings of the full Board. The Executive Committee has authority to exercise
all of the powers of the Board of Directors, subject to specific directions of
the Board of Directors and subject to the limitations of the Maryland
Corporation Law. The Executive Committee did not hold any meetings during 2002.
Due to the small total number of directors, the Board does not have separate
Nominating, Compensation or Audit Committees; however, the functions of these
committees have been performed by the Board as a whole. The Company does not
have an Audit Committee charter. The Board believes its outside directors
possess the necessary independence and skills to perform all the functions
normally assigned to separate Nominating, Compensation or Audit Committees.
Based on their education and business experience, Board members Mr. Lawrence H.
Hyde and Mr. Charles C. McGettigan, both of whom have experience overseeing or
assessing the performance of companies or public accountants with respect to the
preparation, auditing or evaluation of financial statements, have been
designated as an audit committee "financial expert" with respect to Audit
Committee functions that are performed by the Board as a whole. In general, an
audit committee "financial expert" means an individual who possesses (i) an
understanding of generally accepted accounting principles and financial
statements; (ii) the ability to assess the general application of such
principles in connection with the accounting for estimates, accruals and
reserves; (iii) experience preparing, auditing, analyzing or evaluating
financial statements containing the breadth and level of complexity of
accounting issues that are generally comparable to such issues encountered by
the small business issuer's financial statements; (iv) an understanding of
internal controls and procedures for financial reporting; and (v) an
understanding of audit committee functions.
In performing the duties typically assigned to an audit committee, the entire
Board of Directors has (1) reviewed and discussed the 2002 audited financial
statements of the Corporation with management; (2) discussed with the
independent accountants of the Corporation the independent accountants'
judgments about the quality, not just the acceptability, of the Corporation's
accounting principles, including the clarity and completeness of the financial
statements and related note disclosures; (3) received written assurance from the
independent accountants with respect to independence; and (4) recommended that
the 2002 audited financial statements be included in the December 31, 2002
Annual Report on Form 10-KSB for filing with the Securities and Exchange
Commission (SEC).
The function of recommending potential nominees for Board positions is performed
by the Board as a whole. It is also the policy of the Board to consider nominees
recommended by security holders. Such recommendations should be addressed to the
Chairman of the Board, at the address of the Corporation, and should include the
name and address of the security holder submitting the nomination and a detailed
listing of the business experience and particular qualifications of the nominee.
The Board will review the nomination at its next meeting following receipt of
the nomination and respond accordingly to the security holder who submitted the
nomination.
Background of Directors and Executive Officers
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 as President
from October 1997 through September 2001. Mr. Hyde is a private investor with
interests in a number of publicly and privately held companies. He spent the
majority of his business career as an executive in the automotive industry,
serving in various engineering, marketing, international, and chief executive
capacities for AM General Company, American Motors Corporation and Ford Motor
Co. Currently, Mr. Hyde also 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.
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, following a career as an executive with major
investment banking firms, including Hambrecht & Quist, Inc. and Dillon, Read &
Co. Inc. He currently serves on the Boards of Directors of Cuisine Solutions,
Inc., Modtech, Inc., PMR Corporation, Tanknology - NDE Corporation, 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.,
and Tanknology - NDE Corporation. Mr. Wick received a B.A. degree from Yale
University and an MBA from the Harvard Business School.
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. Prior to forming Sonex,
Dr. Pouring served as a Professor of Aerospace Engineering at the U.S. Naval
Academy, including four years as the Chairman of the Academy's Department of
Aerospace Engineering. Dr. Pouring is a member of various professional and
scientific societies, including the American Society of Mechanical Engineers and
the Society of Automotive Engineers. 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. Prior to joining Sonex, Mr. Ponticas was a member of the auditing
staff of Price Waterhouse in Baltimore, Maryland, attaining the position of
audit manager. 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.
Section 16(A) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who beneficially own more than 10% of a
registered class of the Company's equity securities, to file initial reports of
beneficial ownership and reports of changes in beneficial ownership with the
SEC, and to provide copies of all such reports to the Company. Based solely on
its review of the copies of such reports received by it, or written
representations from certain reporting persons that no reports were required for
those persons, the Company believes that all of its officers, directors, and
greater than 10% shareholders complied with all such filing requirements related
to beneficial ownership of Common Stock during 2002 except as indicated below.
In August 2002 the Company was informed that certain members of the Proactive,
et.al. Form 13D filing group of affiliated entities and individuals, beneficial
owners of more than 10% of the Company's Common Stock, had failed to report to
the Company, and failed to file Form 4s, covering the following sales of the
Company's Common Stock in 2000 and 2001:
Period of Transactions # of shares
-------------------------- -----------
June 2000 - September 2000 78,000
December 2000 6,000
November 2001 11,000
In late July 2002 and August 2002 pursuant to a Form 144 filing with the SEC
dated July 23, 2002, Proactive, et.al. sold an additional 63,000 shares of the
Company's Common Stock for which Form 4s were not timely filed. Two of the
Company's directors, Mr. McGettigan and Mr. Wick, held beneficial ownership of
the shares sold in July 2002 by virtue of their executive and ownership
positions in Proactive, et.al. Form 4s covering these sales were not timely
filed by Mr. McGettigan and Mr. Wick.
Based solely on its review of the copies of such reports received by it, the
Company believes that Form 4s were eventually filed by Proactive, et.al., Mr.
McGettigan and Mr. Wick to report all of the above-described transactions.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company to its chief
executive officer and any other executive officer who 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 Current Deferred bonus # of options
----------------- ---- -------- -------- -------- ------------
Dr. Andrew A. Pouring 2002 $ 87,500 (1) $ 37,500 $ 0 0 (3)
CEO & Chief Scientist 2001 87,500 (1) 37,500 10,000 35,000
2000 87,500 37,500 10,000 35,000
Mr. George E. Ponticas 2002 $ 86,400 (2) $ 9,600 $ 25,000 200,000
CFO & Secretary 2001 86,400 (2) 9,600 25,000 100,000
2000 86,400 9,600 10,000 30,000
(1) Includes $79,933 for 2002 and $33,656 for 2001 which has not been paid as
of December 31, 2002.
(2) Includes $53,171 for 2002 and $33,232 for 2001 which has not been paid as
of December 31, 2002.
(3) In November 2002 Dr. Pouring was granted an option to purchase 100,000
shares of Common Stock effective as of January 1, 2003.
In order to help conserve the Company's limited cash resources, however, the
Named Executives 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 and
other current and former employees 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.
For many years through 1998, Dr. Pouring had been deferring 40% of his annual
salary. In January 1999, the percentage deferral was reduced to 30%. Mr.
Ponticas has been deferring 10% of his annual salary for the last several years.
The conditions that would require repayment of deferred amounts have yet to
occur. As of December 31, 2002, a total of $448,923 and $125,326 in deferred
salary is owed to Dr. Pouring and Mr. Ponticas, respectively, that is payable
under the conditions described above. The authorized full annual salaries for
Dr. Pouring and Mr. Ponticas for each of the past three years were $125,000 and
$96,000, respectively. Effective January 1, 2003, the authorized full annual
salary for Mr. Ponticas was increased to $120,000 while the percentage deferral
was increased to 25%.
During much of 2001 and through the third quarter of 2002, the Company operated
under severe cash flow difficulties. At times during 2001 and 2002 the Company's
officers voluntarily and at their own discretion deferred receipt of payment of
significant portions of their current wages to reduce the Company's monthly cash
requirements, although some of these amounts were repaid by the end of the year.
With the generation of cash flow from revenues during the fourth quarter of
2002, some of these amounts were repaid by the end of the year. Since December
2002, Mr. Ponticas has been receiving his current wages, while Dr. Pouring
continues to defer a significant portion of his current wages. Such wages
payable to the Company's officers totaled $199,992 as of December 31, 2002 and
are payable upon demand. Through March 31, 2003, Dr. Pouring had deferred an
additional $9,255.
In December of each of the last three years, the Company awarded bonuses
totaling $37,500 in 2002, $57,500 in 2001, and $30,000 in 2000, to its officers
and employees, including the amounts reported above for the Named Executives.
The bonus awards in each year were made with the stipulation that payment of
such bonuses would be deferred until the Board of Directors determines that the
Company's cash resources are sufficient to enable such payments. In a private
financing in March 2002, Dr. Pouring and Mr. Ponticas accepted Common Stock in
payment of accrued bonuses of $9,000 each. As of December 31, 2002, $22,500 and
$50,000 in accrued bonuses remained payable to Dr. Pouring and Mr. Ponticas,
respectively.
The bonus awards and option grants in 2001 and 2002 to the Named Executives
continued to increase to reflect the fact since 2001 these individuals have made
extraordinary sacrifices, both financially in the amount of wages that have gone
unpaid, and personally, to enable the Company to remain in operation given its
poor financial condition, and to provide incentive for the Named Executives to
remain in the employment of the Company under such arduous continuing
conditions.
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. 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.
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 0 (1) 0% n/a n/a n/a
Ponticas 200,000 41% $.25 $.20 Nov. 17, 2012
(1) In November 2002 Dr. Pouring was granted a ten-year option to purchase
100,000 shares of Common Stock effective as of January 1, 2003. These
options are exercisable at $.25 per share.
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, 2002 December 31, 2002
# of shares
acquired on Value Exercisable/ Exercisable/
Name exercise realized unexercisable unexercisable
-------- ----------- -------- ---------------------- -------------------
Pouring:
@ $.25 0 $0 126,250 / 8,750 $0/$0
@ $.50 0 $0 210,066 / 0 $0/$0
@ $.75 0 $0 25,000 / 0 $0/$0
Ponticas:
@ $.25 0 $0 222,500 / 65,000 $0/$0
@ $.50 0 $0 205,000 / 0 $0/$0
@ $.75 0 $0 20,000 / 0 $0/$0
The exercise price of all options held by the Named Executives was higher than
the December 31, 2002 market price of $.20 of the Company's publicly traded
Common Stock.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company has two classes of voting securities: its $.01 par value common
stock (the "Common Stock") and its $.01 par value convertible preferred stock
(the "Preferred Stock"). Each share of 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. The Preferred Stock has priority in liquidation over the Common
Stock, but it carries no stated dividend. Additionally, the holders of Preferred
Stock, voting as a separate class, have the right to elect that number of
directors of the Corporation which represents a majority of the total number of
directors. The only other matters with respect to which holders of Preferred
Stock are entitled to vote concern a consolidation, merger, share exchange or
transfer of assets.
The Company is presently authorized to issue up to 48 million shares of Common
Stock and 2 million shares of Preferred Stock. There were 21,592,669 shares of
Common Stock and 1,540,001 shares of Preferred Stock issued and outstanding at
December 31, 2002.
The following tables set forth as of December 31, 2002 information relating to
beneficial ownership of Common Stock by directors and executive officers of the
Company, individually and 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 considered 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 a beneficial owner of securities as to which he has no record ownership
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, such as through the exercise
of options and warrants or through the conversion of preferred stock. The
percentage of beneficial ownership for a reporting person is based on the number
of outstanding shares of common stock of the Company plus the number of shares
which the reporting person has the right to acquire within sixty days, but does
not include shares which any other reporting person has the right to acquire.
Unless otherwise noted, all shares are beneficially owned and sole voting and
investment power is held by the persons named.
TOTAL BENEFICIAL OWNERSHIP
Common Rights to Total shares
shares acquire beneficially Percent
Name and address (1) owned shares (5) owned of class
-------------------- --------- --------- --------- --------
John H. Drewanz (2) 600,000 200,000 800,000 3.7
Lawrence H. Hyde 644,986 1,814,286 2,459,272 11.1
Charles C. McGettigan 1,351,618 1,814,285 3,165,903 (4) 13.5
George E. Ponticas 326,262 528,928 855,910 3.9
Andrew A. Pouring 853,239 455,244 1,308,483 5.7
Myron A. Wick, III 1,351,618 1,814,285 3,165,903 (4) 13.5
All directors & officers
as a group (6 persons) 3,776,105 5,162,743 8,938,848 33.4
Herbert J. Mitschele, Jr.
Far Hills, NJ 1,081,655 65,000 1,146,655 5.3
Proactive, et.al. (3)
San Francisco, CA 2,574,064 2,928,570 5,502,634 22.4
-----------------------------
(1) The business address for each director and named executive officer is 23
Hudson Street, Annapolis, Maryland, 21401.
(2) Mr. Drewanz resigned as a director in March 2003.
(3) 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.
(4) Includes 2,815,903 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.
(5) See detail provided in the following table.
RIGHTS TO ACQUIRE SHARES
Total
Exercisable Preferred rights to
Exercisable (put)/ Exercisable stock acquire
Name options call (2) warrants converted shares
-------------------- ---------- ---------- --------- --------- ----------
John H. Drewanz 125,000 75,000 200,000
Lawrence H. Hyde 600,000 1,214,286 1,814,286
Charles C. McGettigan (1) 350,000 (607,143) 2,071,428 1,814,285
George E. Ponticas 447,500 80,000 1,428 528,928
Andrew A. Pouring 361,316 92,500 1,428 455,244
Myron A. Wick, III (1) 350,000 (607,143) 2,071,428 1,814,285
All directors & officers
as a group (6 persons) 2,233,816 607,143 247,500 2,074,284 5,162,743
Herbert J. Mitschele, Jr. 25,000 40,000 65,000
Proactive , et.al. (2)
San Francisco, CA (1,214,286) 4,142,856 2,928,570
---------------------------
(1) Includes 1,526,785 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.
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).
23.a Consent of Hausser + Taylor LLP.
23.b 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
(b) Reports on Form 8-K.
During the fourth quarter of 2002, the Company filed the following Current
Reports on Form 8-K:
On October 3, 2002, to disclose that it had been awarded a $744,246
contract for application of its heavy fuel engine technology.
On October 11, 2002, to disclose that it had issued an announcement
to shareholders on its website on October 11, 2002 to report on the
change in the Company's chairman of the board which occurred on
October 9, 2002.
On October 11, 2002, to disclose that it had issued an announcement
to shareholders on its website on October 10, 2002 to report on the
2002 Annual Meeting of Shareholders held October 9, 2002.
On December 9, 2002, to disclose that it had been awarded a
$458,862 subcontract for application of its diesel engine emissions
reduction technology.
On December 19, 2002, to disclose a change in independent
accountants for the year ended December 31, 2002.
ITEM 14. CONTROLS AND PROCEDURES
The Company's chief executive officer and chief financial officer have evaluated
the effectiveness of the Company's disclosure controls and procedures (as such
term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange
Act of 1934) as of an evaluation date within 90 days prior to the filing date of
this Annual Report on Form 10-KSB. Based on such evaluation they have concluded
that, as of the evaluation date, the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed in
reports that the Company files or submits under the Exchange Act, is recorded,
processed, summarized and reported in a timely manner.
Since the evaluation date referred to above, there have been no significant
changes in the Company's internal controls or in other factors that could
significantly affect such controls.
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.
April 14, 2003 By: /s/ Andrew A. Pouring
----------------------------------
Andrew A. Pouring
Principal Executive Officer
April 14, 2003 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.
April 14, 2003 /s/ Andrew A. Pouring
----------------------------------
Andrew A. Pouring
Vice Chairman of the Board of Directors
April 14, 2003 *
----------------------------------
Myron A. Wick, III
Chairman of the Board of Directors
April 14, 2003 *
----------------------------------
Lawrence H. Hyde
Director
April 14, 2003 *
----------------------------------
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.
CERTIFICATIONS
I, Andrew A. Pouring, Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-KSB of Sonex Research,
Inc. (the "Company") on Form 10-KSB for the year ending December 31,
2002.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Company as of, and for, the periods presented in this
annual report;
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, if any, is made known to us by others
within those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the Company 's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The Company's other certifying officer and I disclosed, based on our
most recent evaluation, to the Company 's auditors and the audit
committee of Company 's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company 's ability to
record, process, summarize and report financial data and have
identified for the Company 's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's
internal controls
6. The Company's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Dated: April 14, 2003
/s/ Andrew A. Pouring
-----------------------
Andrew A. Pouring
Chief Executive Officer
CERTIFICATIONS
I, George E. Ponticas, Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-KSB of Sonex Research,
Inc. (the "Company") on Form 10-KSB for the year ending December 31,
2002.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Company as of, and for, the periods presented in this
annual report;
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, if any, is made known to us by others
within those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the Company 's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The Company's other certifying officer and I disclosed, based on our
most recent evaluation, to the Company 's auditors and the audit
committee of Company 's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company 's ability to
record, process, summarize and report financial data and have
identified for the Company 's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's
internal controls
6. The Company's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Dated: April 14, 2003
/s/ George E. Ponticas
-----------------------
George E. Ponticas
Chief Financial Officer
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Sonex Research, Inc. (the "Company") on
Form 10-KSB for the year ending December 31, 2002, as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), the undersigned
certify, pursuant to and for the purposes of 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
SONEX RESEARCH, INC.
/s/ Andrew A. Pouring /s/ George E. Ponticas
------------------------ ------------------------
Andrew A. Pouring George E. Ponticas
Chief Executive Officer Chief Financial Officer
April 14, 2003
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 21, 2003 appearing in this Form
10-KSB.
HAUSSER + TAYLOR LLP
Cleveland, Ohio
April 14, 2003
EXHIBIT 23.b
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 April 10, 2002 appearing in this
Form 10-KSB.
C.L. STEWART & COMPANY
Annapolis, Maryland
April 14, 2003