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, 2003.
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, 2003 were $923,813.
The number of shares outstanding of the Issuer's $.01 par value Common Stock as
of March 31, 2004 was 25,032,669. The aggregate market value of voting stock
held by non-affiliates of the Registrant was $2,557,548 as of March 31, 2004.
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 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 by using direct
injection and patented Sonex designs. 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 HFEs to military and commercial markets.
As of March 31, 2004, the Company has seven full-time employees and two
part-time employees, 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.
STRATEGIC PLANNING
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 2003 the Company began
taking steps to focus on business re-positioning, strengthening its internal
capabilities, and planning for growth. The Company engaged consultants to assess
the SCS technologies and business model, suggest approaches for strategic
alliances, and provide federal marketing, government procurement assistance, and
commercialization services.
Management identified a need to secure strong strategic alliances for the
marketing and commercialization of the SCS engine applications by leveraging
technology development currently supported by U.S. Government funding as well as
seeking relationships with companies which have technologies complementary to
the SCS. One of the first objectives on this path was to strengthen the
Company's management team.
At the start of 2004, the composition of the Company's Board of Directors
changed substantially following the resignation in late January and early
February 2004 of three independent directors who had served on the Board for
several years. Each of these former directors cited other business
responsibilities as the reason for his resignation. The only continuing member
of the Board is the Company's Chief Executive Officer. The number of members of
the Board was reduced from four to three. Named to the Board to serve on an
interim basis were the Company's Chief Financial Officer and one independent
director.
In late February 2004 the Company's reconstituted Board of Directors hired a new
president to fill the position that had been vacant and entered into an
employment agreement with this individual. The Company's new president is
developing and implementing an updated business plan, the primary goal of which
is to transition Sonex from a research and development company into a
technology, commercialization, and manufacturing enterprise. There is no
assurance, however, that the Company will be able to complete and implement an
updated business plan.
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 of approximately $23 million, and anticipates incurring 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, although revenues have provided most of the necessary operating cash
for the last two years.
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 with the exception of the new
president hired in February 2004.
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, 2004, there were 25,032,669 shares of
Common Stock issued and outstanding, with an additional 12,636,832 shares
reserved for future issuance, primarily upon the conversion of preferred stock
and the exercise of options and warrants.
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 processes for DI engines are applicable to: (1) classical diesels as a
means to reduce particulate emissions with little or no fuel consumption
increase and, if used in conjunction with high levels of exhaust gas
recirculation (EGR), to reduce oxides of nitrogen (NOx) and soot with a slight
fuel consumption increase; and (2) "throttle-less gasoline combustion based on
compression ignition and high rates of heat release ("lean burn-fast burn") at
normal gasoline engine peak cylinder pressures to improve fuel economy with the
potential to reduce emissions to EPA Tier II criteria.
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 thermally and
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 heated element 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 approximate weight.
SCS FOR LOW COMPRESSION RATIO DI ENGINES
Sonex Controlled Auto Ignition (SCAI)
Sonex is developing a new, enhanced SCS process, focusing on the control of
ignition for low compression ratio four-stroke DI engines. This process is an
in-cylinder method for isolating a small portion of an un-throttled, lean
air-fuel charge in each combustion cycle to produce reactive chemical species
that are carried over to cause spark-less compression ignition in the next cycle
at gasoline compression ratios.
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. Sonex has now labeled this enhanced combustion process Sonex
Controlled Auto Ignition (SCAI) in order to highlight the special ability of the
process to control ignition.
SCAI is an unthrottled, low compression ratio, sparkless, compression ignition
process at gasoline compression ratios. The SCAI 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 micro-chambers for SCAI place a special
design emphasis on the chemical aspect allowing controlled auto ignition of any
fuel at low compression ratios. The SCAI 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. As a
result, the inherent light weight of the gasoline engine is preserved and peak
combustion pressures are limited to those of gasoline operation.
The SCAI process for low compression ratio DI engines was developed in a
single-cylinder research engine in the fully equipped Sonex laboratory. The SCAI
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
kerosene-based, diesel-type "heavy fuels" (JP-5/JP-8), 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 SCAI 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 SCAI combustion technology aimed at transferring
the Sonex single cylinder 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 SCAI
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 SCAI results to a multi-cylinder
engine.
In recognition of the economic realities of the highly competitive,
cost-conscious engine industry and its own limited financial resources, the
Company sought funding from government sources to help achieve a maturation of
the SCAI relative to the expectations of engine manufacturers. Sonex is applying
the experience gained from this discontinued program with the truck engine
manufacturer to work on a $744,246 Phase 1 contract from the Defense Advanced
Research Projects Agency (DARPA) received by the Company in October 2002. The
objective of Phase 1 of the DARPA program is to begin the design and development
of a heavy fuel engine (HFE) conversion process for a gasoline automotive engine
for potential use in a developmental Unmanned Aerial Vehicle (UAV) or other
applications. The 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. Heavy fuels are less volatile than gasoline, thereby reducing the
hazard associated with the storage, transportation and use of gasoline. Gasoline
engines, however, are typically 25% to 30% lighter than diesel engines and,
thus, adaptation of gasoline engine designs to burn low cetane (hard to ignite,
diesel type) fuel addresses DoD logistics and safety issues.
The first phase of the contract program with DARPA focuses on the SCS SCAI
process to convert a modern, spark-ignited (SI), four-stroke, six-cylinder,
automotive gasoline engine to heavy fuel operation. The primary objective is to
transfer the SCAI heavy fuel design achieved in the Sonex single-cylinder
laboratory engine to the multi-cylinder gasoline engine, eliminate the spark
ignition system, and produce the same power the engine originally produced on
gasoline. Conversion of the engine, originally designed for spark ignition, from
gasoline to JP-5 has the advantage of the light weight compared to an ordinary
diesel engine since the engine may be used in a UAV application.
During 2003 Sonex adapted the automotive engine using a computer aided design
and prototyping fabrication process that involved subcontractors and specialty
suppliers, as well as assistance from the engine manufacturer. The SCS
throttle-less HFE features a proprietary SCAI piston design, electronically
controlled common rail fuel injection system and extensive instrumentation. The
first phase recently has demonstrated equal or greater power in a limited range
at reduced fuel consumption. It is anticipated that the SCS HFE Phase 1 design,
which is already 20% more fuel efficient than the original gasoline engine, can
be turbo-charged to higher power output with advantageous rates of fuel
consumption across a wide range of performance criteria. Sonex is seeking Phase
2 funding from DARPA to continue this program.
Outcomes from the DARPA program could validate the SCAI 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 SCAI 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 the current
gasoline engines which too often result in dangerous onboard fires.
SCAI and HCCI Combustion
Sonex believes that SCAI 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 SCAI process, Sonex believes it has attained the control of ignition that
will make HCCI viable for military and commercial application. A Sonex technical
paper supporting the theoretical aspects of SCAI was presented by a consultant
to the Company, Dr. David A. Blank, in May 2003 at a joint U.S. and Japan
Society of Automotive Engineers (SAE) Fuels and Lubricants meeting in Japan. A
second joint paper will be presented at the 2004 SAE Fuels and Lubricants
meeting in France by Sonex Chief Executive Officer and Chief Scientist Dr.
Andrew A. Pouring in June 2004.
On the basis of the extensive SCAI single cylinder laboratory engine work it has
performed with alcohol and heavier fuels, as well as the promising results
achieved on the SCS six-cylinder HFE conversion under the DARPA program, 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 SCAI
combustion process, radical (chemical) species that enable compression ignition
are created by interaction of the injected fuel spray with specially designed
micro-chambers 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.
SCAI 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.
SCAI and Gasoline Combustion
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. Ignition control is the
feature lacking in conventional HCCI combustion but which gives remarkably low
emissions and good fuel economy.
Sonex believes that with further development using gasoline, SCS SCAI sparkless
ignition, unthrottled process for control of 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 SCAI in-cylinder combustion process, Sonex expects
to be able to achieve better performance, increased fuel mileage, and reduced
NOx.
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. The fuel economy issue, potential
increases in the fuel economy standards, and increased dependence on imported
oil are major parts of national legislative and political debate. Opponents of
proposals for higher fuel economy standards, including automakers, object on the
basis that higher fuel mileage can only be achieved by building smaller, lighter
- and therefore, presumably less safe - vehicles. Supporters of higher fuel
economy standards, however, argue that by using technology currently available
to automakers, the improvements can be accomplished without making vehicles
smaller.
Sonex believes that, with further development, its SCAI, 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 also believes the SCAI
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.
Sonex has 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 SCAI combustion process and
improved safety. The Company expects to provide additional input to the
legislative process in 2004.
The Company hopes to progressively mature the SCAI 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 or years of further R&D required for fuel cell technology to
become practical. Outcomes from the current Sonex six-cylinder engine program on
heavy fuel funded by DARPA should validate the SCAI technology for in-cylinder
control of ignition and combustion that could be applied later to a gasoline
powered version. Preliminary experimental work at Sonex on gasoline has
demonstrated that the SCAI 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.
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 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.
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. 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. Ricardo presented its 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.
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.
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.
Sonex and Compact Membrane Systems, Inc. (CMS), a small business in Wilmington,
Delaware, proposed to investigate the diesel engine emissions reduction
potential of combining the patented SCS piston-based technology and the CMS
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 conducted on
the Sonex laboratory, single-cylinder, normally aspirated, DI diesel engine
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 subcontract from CMS for
$458,862, of which $100,000 is cost-shared (funded) by Sonex, under a CMS prime
contract for a DOE, SBIR Program Phase II project. In the second quarter of 2003
Sonex took delivery of the advanced research automotive diesel engine to be used
for the testing. The engine is a state-of-the-art, three-cylinder, DI common
rail injection system, turbo-charged, automotive diesel engine developed by a
major international vehicle manufacturer in the joint U.S. government and
automotive industry funded PNGV (Partnership for a New Generation Vehicle)
program. The estimated value of the contribution by the vehicle manufacturer of
the automotive diesel engine and associated technical support represents the
Sonex cost-shared portion of the subcontract. A successful result of this
program would provide SCS in-cylinder emissions reduction data on a
multi-cylinder diesel engine as a means for diesel engine manufacturers to
evaluate the potential for SCS designs, alone and in combination with the NEA
membrane, to reduce the cost and complexity of future exhaust aftertreatment
systems.
During engine testing, the Company has not been able to achieve the LSDD
performance achieved in other engines with conventional injection systems. Sonex
encountered difficulty in controlling the characteristics of the common rail
injection system and matching its requirements with the design requirements of
the SCS pistons, which must be compatible with the fuel injection system and
computer control. Achieving this synergy has been very challenging since many
critical parameters of the engine baseline and fuel injection design were not
made available to Sonex. In addition, initial testing with the NEA membrane
demonstrated the limited viability for commercialization of the CMS membranes in
this automotive size application.
Sonex has developed a plan to understand the difference between the common rail
system and earlier injection systems when used with SCS pistons; however, during
the first quarter of 2004, CMS suspended further work on the program pending the
outcome of a progress meeting to be held with the DOE program sponsor in April
2004. CMS and Sonex have discussed the potential for applying the SCS piston
technology and the NEA membrane technology to larger diesel engines in which the
NEA membranes are expected to perform better and more consistently.
SCS FOR SMALL HEAVY FUEL ENGINES (HFEs)
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, diesel-type, "heavy fuel" (JP-5/JP-8). Heavy fuels are
less volatile than gasoline, thereby reducing the hazard associated with the
use, storage and transportation of 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.
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,
spark-ignited (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.
Other potential applications include outboard engines, generator sets, and
pleasure boats for which a lightweight engine burning heavy fuel would eliminate
the hazards of gasoline storage and use.
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. 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 approximate
weight.
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. In 1998 under a "best
efforts" feasibility demonstration contract from the U.S. Marine Corps (USMC)
Systems Command, 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
military HFE applications include outboard engines, small watercraft used as
targets, and generator sets.
The Company seeks 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 years 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, the DoD prime
contractor for a developmental UAV, 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. 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, three-cylinder, fuel injected gasoline
engine which displaces 939 cc (313 cc/cylinder) 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.
Due to deficiencies found by Sonex in operating the candidate engine on gasoline
and concurrent fuel consumption problems experienced by the competing rotary
engine operating on heavy fuel, in the first quarter of 2003 the DoD sponsor
expressed a desire to have Sonex work with the competing rotary engine developer
to focus on improving the fuel consumption of the rotary HFE. This joint effort
was not formalized because work on the engine later was placed on hold while
SAIC concentrated on resolving a number of technical issues with the flight
vehicle. Subsequently, the prime contract to SAIC was terminated by the DoD in
October 2003. Sonex now seeks to obtain the necessary funding from DoD to
continue development of this HFE, and others, for use in intermediate size UAVs
for varied missions.
In September 2003 the Company received a purchase order of approximately
$165,000 from another large DoD prime contractor to develop a combustion system
to convert two, twin-cylinder, gasoline engines displacing 50cc and 120cc per
cylinder, respectively, to start and operate on heavy fuels for potential use in
UAVs. To date Sonex has achieved substantial fuel economy benefits on JP-5 fuel
on the SCS HFEs over the stock gasoline engines. Delivery of the HFEs to the
customer is expected to take place during the second quarter of 2004.
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 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.
The Company is exploring a relationship with another small company which is
developing rotary engines for use in generator sets for military and commercial
use, and has applied for funding from the DoD to begin development work on a
small rotary HFE.
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 engine industry, in connection with
its contracts and/or demonstration programs with 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
No matters were submitted to a vote of security holders during the fourth
quarter of 2003.
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, obtained from the
historical pricing information available on the NASDAQ website www.nasdaq.com,
for each quarterly period since January 1, 2002 were as follows:
Quarter ended: High Low
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
June 30, 2003 .22 .14
September 30, 2003 .20 .11
December 31, 2003 .20 .10
March 31, 2004 .16 .09
SHARES OUTSTANDING AND RESERVED FOR ISSUANCE; HOLDERS; DIVIDENDS
As of March 31, 2004, there were 25,032,669 shares of Common Stock 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, 2004, a total of 12,636,832 shares of Common Stock were reserved
for future issuance as follows: 4,400,000 shares issuable upon the conversion of
preferred stock outstanding; 4,733,907 shares issuable upon the exercise of
options granted under the Company's Stock Option Plan (the "Option Plan");
1,330,425 shares for options available to be granted under the Option Plan;
500,000 shares issuable upon the exercise of options granted to the Company's
new president which are not part of the Option Plan; 200,000 shares issuable on
March 15, 2005 to the Company's new president upon continued employment; 992,500
shares issuable upon the exercise of outstanding warrants; 420,000 shares
issuable in connection with a consulting agreement; 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 and the option granted to the Company's new
president which is not part of the Option Plan, which grant was made on February
23, 2004. Detailed information as of December 31, 2003 with respect to Common
Stock issuable under the Option Plan, including activity during 2003 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 2003 the Company issued no securities without registration under the
Securities Act of 1933 (the "Securities Act"). In the first quarter of 2004 the
Company issued without registration under the Securities Act an aggregate of
3,440,000 shares of Common Stock in connection with the execution of various
agreements for services, officer, director and employee compensation, and the
satisfaction of liabilities for accrued compensation, as more fully described in
Note 17 to the accompanying financial statements. 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.
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 of
approximately $23 million and anticipates continuing to incur 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 and 2003, however, revenues increased
substantially, providing cash to fund the majority of the Company's operating
expenditure requirements. During 2002 and 2003 the Company's only customers were
branches of the U.S. government and military or their prime contractors. In 2004
revenues from government sources are expected, although there can be no
assurance, to provide a significant portion of the cash necessary to fund
operations.
FINANCIAL POSITION AND LIQUIDITY
The Company operated under severe cash flow difficulties for extended periods
during 2001 and 2002, prompting its two officers to voluntarily and at their own
discretion defer receipt of payment of significant portions of their current
wages to reduce the Company's monthly cash requirements. With the generation of
cash flow from revenues earned under contracts awarded to the Company during the
second half of 2002, some of the amounts owed to the Company's officers were
repaid in December 2002. Also at that time the Company's officers began
receiving their current wages. During the first quarter of 2003 the Company's
chief executive officer once again began deferring some of his current wages
and, since April 2003, he has deferred all of his current wages. As of December
31, 2003, total such wages payable to the Company's chief executive and chief
financial officers were $190,157 and $86,403, respectively.
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 amounts outstanding as soon as cash flow permits. Similarly, the Company has
accumulated significant unpaid consulting fees, the majority of which amounts as
of December 31, 2003 (a total of $122,732) are payable to two individuals. The
amount and timing of payments for unpaid compensation owing to the Company's
officers and its consultants will be determined at the discretion of the
Company's officers; however, all such unpaid compensation is payable upon
demand.
As of March 31, 2004, the Company had available cash and equivalents of
approximately $22,000 and accounts receivable, including contract costs incurred
but not yet billed, of approximately $91,500. The Company hopes, although there
can be no assurance, that it will receive a follow-on award to its largest
current military contract in the near future.
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, as necessary, the deferral by its officers of portions of their
salaries as described in the notes to the accompanying financial statements.
In 2003 the Company began taking steps to focus on business re-positioning,
strengthening its internal capabilities, and planning for growth, engaging
consultants to assess its technologies and business model and to suggest
approaches for strategic alliances and commercialization services. Management
concluded that significant personnel and financial resources will be required.
The application of personnel and financial resources, however, is greatly
constrained by the Company's liquidity problems and lack of capital.
In late February 2004 the Company hired a new president whose initial focus will
be to develop and implement an updated business plan, the primary goal of which
is to transition Sonex from a research and development company into a
technology, commercialization, and manufacturing enterprise. There is no
assurance, however, that the Company will be able to complete and implement an
updated business plan.
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 June
30, 2004. 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.
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 a material
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.
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 2003, certain amounts
for 2002 and 2001 presented in prior years as research and development expenses
(R&D) have been reclassified to cost of revenue, and interest charges included
in prior years as General and Administrative (G&A) have been presented as a
separate line item. The net loss for each period does not change as a result of
these reclassifications.]
2003 2002 2001
---------- ---------- ----------
Total revenue $ 923,813 $ 471,912 $ 245,291
---------- ---------- ----------
Cost of revenue 689,278 299,360 179,286
R&D expenses 208,201 192,358 420,661
G&A expenses 423,239 301,215 333,260
Interest expense 11,815 3,378 3,839
---------- ---------- ----------
Total expenses 1,332,533 796,311 937,046
---------- ---------- ----------
Net loss from operations (408,720) (324,399) (691,755)
Investment income 3,242 2,759 1,400
---------- ---------- ----------
Net loss $ (405,478) $ (321,640) $ (690,355)
========== ========== ==========
The net loss for 2003 is $83,838, or 26%, higher than the net loss for 2002, as
a significant increase in revenue was offset in part by higher associated cost
of revenue and higher G&A expenses, primarily due to higher personnel costs.
With the award of several significant contracts during the second half of 2002,
revenue nearly doubled in 2003 versus the prior year, with related increases in
expenses to support the increase in business. Total expenses were higher than
would be expected with the increase in revenue because in 2003 the Company
changed its method of accounting for stock-based compensation as described in
the accompanying financial statements, resulting in an increase of $59,729 in
total charges for stock-based compensation, from $30,965 in 2002 to $90,694 in
2003.
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 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 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 2003 to 2002
Total revenue increased $451,901, or 96%, from 2002 to 2003. 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, with the majority of revenues from two of these projects being
recognized in 2003. Revenue for 2002 also included Department of Defense (DoD)
and other government revenue from four smaller contracts.
The following is a listing of the three major projects received in late 2002
which continued into 2003. 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, for development of the Company's
heavy fuel technology for military applications. 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) for heavy fuel technology development. Awarded fourth quarter of
2002. Total funding of $744,246. Completion in 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 for the
Company's diesel emission reduction technology. 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 the DARPA and CMS programs totaled $780,099 and represented 81% of
total revenues recognized in 2003, while revenues from all three of the
government projects totaled $391,155 and represented 83% of total revenues
recognized in 2002.
The following table summarizes defense/government revenue recognized in each of
the past three years:
2003 2002 2001
---------- ---------- ----------
DARPA $ 522,397 $ 109,024
CMS 227,691 55,884 $ 20,000
SAIC 55,700 226,247
Other DoD 118,025 80,757 125,291
---------- ---------- ----------
$ 923,813 $ 471,912 $ 145,291
========== ========== ==========
The potential revenue remaining to be recognized during 2004 in connection with
the DARPA and CMS programs is $69,991 and $100,462, respectively. Although
management anticipates that each program will be funded for the entire amount
awarded to date, there is no assurance that this will be the case.
Cost of revenue increased from $299,360 in 2002 to $689,278 in 2003 as a result
of the increased revenue generated in 2003. As more contracts were secured, a
higher percentage of R&D (direct labor) personnel's time was spent on funded
contracts in 2003 versus 2002, 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 2003 (77%) as opposed to 2002 (61%),
as new hires in 2002 and 2003 were brought on to work almost exclusively on
funded contracts. The increased workload also resulted in higher direct costs,
including consulting fees with the engagement of a program manager and
specialized technical consultants, associated with funded contracts in 2003
versus 2002.
Comparison of 2002 to 2001
Total revenue increased $226,621, or 92%, from 2001 to 2002. As described under
"Comparison of 2003 to 2002" section above, 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. 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.
Progress on commercial applications of the Company's diesel engine emissions
reduction technology slowed considerably in 2002, but outcomes in 2003 and 2004
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 SCAI 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 (61%) 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.
Research and development (R&D) expenses:
2003 2002 2001
---------- ---------- ----------
Personnel:
Employee compensation $ 391,967 $ 255,443 $ 335,605
Taxes & benefits 60,406 30,491 54,730
Stock option compensation 28,442
Consulting fees 208,290 44,008 64,587
---------- ---------- ----------
Total personnel 689,105 329,942 454,922
Project parts and supplies 97,907 66,532 28,116
Occupancy 51,469 46,151 47,591
Depreciation, patent amortization
and write-off of abandoned patents 39,677 35,133 52,326
Patent maintenance and renewal fees 12,204 8,022 7,243
Other expenses 7,117 5,938 9,749
---------- ---------- ----------
Total R&D expenses 897,479 491,718 599,947
Less amounts classified as cost of revenue:
Personnel (489,072) (180,928) (114,975)
Labor overhead (128,053) (61,997) (59,698)
Project parts and supplies (68,049) (55,637) (3,598)
Other expenses (4,104) (798) (1,015)
---------- ---------- ----------
Net R&D $ 208,201 $ 192,358 $ 420,661
========== ========== ==========
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 2003 to 2002
Total R&D expenses increased by $405,761, or 83%, from 2002 to 2003, primarily
as a result of a significant increase in personnel costs, as well as an increase
in parts and supplies.
Personnel costs increased by $359,163, or 109%, from 2002 to 2003 due in large
part to an increase in the number of personnel, including consultants, hired in
response to the increase in business activity in 2003. A portion of the increase
related to the Company's change in method of accounting for stock-based
compensation in 2003, resulting in charges of $28,442 in 2003 and none in 2002.
Additionally, bonus awards were higher, primarily because the Company's Chief
Scientist and CEO was granted a bonus of $25,000 in 2003 versus none in 2002.
The increase in consulting fees reflects increased time spent by the consultant
who serves 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. The increase in project parts and
supplies relates to greater purchases to support the new contracts. Project
parts and supplies expense includes motor fuel, engine parts and other items
used or consumed in engine testing and in the machine shop, as well as
fabrication services.
Occupancy expenses, primarily rent, have remained relatively consistent for the
past several years primarily because the monthly facility rent has not changed
since March 2000. The slight increase from 2002 to 2003 reflects the increase in
business activity in 2003. 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 increased by
$4,544, or 13%, from 2002 to 2003. The largest component is depreciation
expense, which increased from $17,956 in 2002 to $22,565 in 2003 as there were
more equipment additions made in 2003 and 2002 than in recent years.
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.
General and administrative (G&A) expenses:
2003 2002 2001
---------- ---------- ----------
Personnel:
Employee compensation $ 154,630 $ 130,715 $ 125,557
Taxes & benefits 11,558 8,916 10,352
Stock option compensation 62,252 30,965 42,120
Consulting fees 102,460 28,813 37,066
Amortization of deferred compensation
from grant of stock options 29,761
---------- ---------- ----------
Total personnel 330,900 199,409 244,856
Occupancy 15,514 10,651 10,882
Proxy solicitation & annual meeting 18,388 17,862 19,618
Audit fees 20,350 9,180 9,450
Legal fees 4,907 11,435 5,264
Investor relations 19,942 1,520
Stock transfer agent fees 8,297 8,098 8,496
Other expenses 24,883 24,638 37,013
--------- ---------- ---------
Total G&A $ 423,239 $ 301,215 $ 333,260
========= ========== =========
Comparison of 2003 to 2002
Total G&A expenses increased by $122,024, or 41%, from 2002 to 2003, primarily
as a result of a significant increase in personnel costs, offset in part by a
reduction in investor relations charges.
Employee compensation increased $23,915, or 18%, from 2002 to 2003 primarily as
a result of an increase effective January 1, 2003 in the annual salary (before
deferral) of the Company's chief financial officer and the hiring in 2003 of
part-time clerical help. The increase in stock option compensation, which
includes amounts related to options granted to consultants and outside
directors, from 2002 to 2003 of $31,287 reflects the Company's change in method
in 2003 of accounting for stock-based compensation. With the change in method,
such charges in 2003 include the amortization over the related vesting period of
charges associated with option grants made in prior years as well as in the
current period, while there would be no charges related to prior option grants
in the 2002 figure. The option charges for 2002 recorded under the previous
method related entirely to consultants.
Occupancy expenses, primarily rent, increased from 2002 to 2003 because the
figure for 2002 reflects an offset for sublease income, which arrangement ended
in 2003. 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.
Consulting fees in total increased $73,647 from 2002 to 2003 as the Company has
expanded its marketing and commercialization capabilities in 2003 by hiring
specialized consultants to provide business advisory services in areas such as
strategic alliances, federal marketing, and government procurement assistance.
Total professional fees (audit, legal and investor relations) decreased by
$15,200, or 37%, from 2002 to 2003, reflecting the termination at the end of
2002 of the Company's relationship with an investor relations firm engaged in
the second quarter of 2002. In addition, a decline in legal services as well as
an overaccrual for estimated legal fees in 2002 which was reversed in 2003
resulted in disproportionately higher charges recorded in 2002 versus 2003.
These decreases were nearly offset by higher auditing fees, which more than
doubled from 2002 to 2003 as the Company changed independent accountants for
2003 from a small local firm, which disbanded its public company audit practice,
to a larger regional firm.
Comparison of 2002 to 2001
Total G&A expenses decreased by $32,045, or 10%, from 2001 to 2002, as decreases
in personnel costs and other expenses were partially offset by increases in
charges for investor relations services and 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 chief financial officer
remained the same in both years.
Consulting fees in total, including stock option compensation, 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. In 2002 and 2001 the Company paid 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.
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 plus estimated profit is recorded as a
current liability, while any excess of costs incurred plus estimated profit 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.
As of January 1, 2003, the Company adopted 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 equity-based compensation. 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 equity-based employee compensation. The Company has chosen to
apply the "modified prospective method" of SFAS No. 148 pursuant to which fair
value based stock option compensation costs for 2003 have been recognized as if
the fair value based method had been used to account for all employee
equity-based awards made in prior periods as well as the current period.
Prior to 2003 the Company accounted 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 adoption by the Company in fiscal 2004 of 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, 2003 and 2002
Statements of operations and accumulated deficit for the three years
ended December 31, 2003
Statements of paid-in capital for the three years ended December 31, 2003
Statements of cash flows for the three years ended December 31, 2003
Notes to financial statements
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Sonex Research, Inc.
We have audited the accompanying balances sheet of Sonex Research, Inc. (the
"Company") as of December 31, 2003 and 2002, and the related statements of
operations and accumulated deficit, paid-in capital and cash flows for the years
ended December 31, 2003 and 2002, 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, 2003 and 2002, and the results of its operations and its cash flows
for the years ended December 31, 2003 and 2002, 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.
As described in Notes 2 and 14 to the financial statements, in 2003 the Company
changed its method of accounting for stock-based compensation.
HAUSSER + TAYLOR LLC
Cleveland, Ohio
April 2, 2004
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Sonex Research, Inc.
We have audited the accompanying statements of operations and accumulated
deficit, paid-in capital and cash flows for the year ended December 31, 2001 of
Sonex Research, Inc. (the "Company"). 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 results of operations and cash flows of Sonex
Research, Inc. for the year ended December 31, 2001 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,
--------------------------
2003 2002
------------ ------------
ASSETS
Current assets
Cash and equivalents $ 7,616 $ 105,998
Accounts receivable 161,045 64,702
Prepaid expenses 12,276 25,814
Loans to officers and employees (Note 4) 20,000 22,500
----------- ------------
Total current assets 200,937 219,014
Patents (Note 6) 202,518 203,623
Property and equipment (Note 7) 103,005 58,808
----------- ------------
Total assets $ 506,460 $ 481,445
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 23,904 $ 36,322
Short-term lines of credit (Note 9) 22,473
Deferred revenue - billings in excess of costs
and estimated profits on contracts in progress
(Note 8) 42,834 66,587
Current portion of capital lease obligations 18,413 5,657
Notes and interest payable to shareholders (Note 9) 67,751 37,327
Accrued compensation and benefits (Note 10) 657,494 427,397
------------ ------------
Total current liabilities 832,869 573,290
------------ ------------
Capital lease obligations (Note 9) 33,698 10,985
------------ ------------
Deferred compensation (Note 11) 965,450 906,856
----------- ------------
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 2003 and 2002 215,927 215,927
Additional paid-in capital 21,511,436 21,420,742
Accumulated deficit (23,046,389) (22,640,911)
Notes receivable from officers & employees (Note 5) (21,931) (20,844)
------------ ------------
Total stockholders' equity/(deficit) (1,325,557) (1,009,686)
Commitments (Note 16)
------------ ------------
Total liabilities and stockholders' equity/(deficit) $ 506,460 $ 481,445
============ ============
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
Year ended December 31,
-----------------------------------------
2003 2002 2001
------------ ------------ ------------
Revenue
Defense/government $ 923,813 $ 471,912 $ 145,291
Commercial 100,000
------------ ------------ ------------
923,813 471,912 245,291
------------ ------------ ------------
Costs and expenses
Cost of revenue 689,278 299,360 179,286
Research and development 208,201 192,358 420,661
General and administrative 423,239 301,215 333,260
Interest expense 11,815 3,378 3,839
------------ ------------ ------------
1,332,533 796,311 937,046
------------ ------------ ------------
Net loss from operations (408,720) (324,399) (691,755)
Investment income 3,242 2,759 1,400
------------ ------------ ------------
Net loss (405,478) (321,640) (690,355)
Accumulated deficit
Beginning of period (22,640,911) (22,319,271) (21,628,916)
------------ ------------ ------------
End of period $(23,046,389) $(22,640,911) $(22,319,271)
============ ============ ============
Weighted average number of common
shares outstanding 21,592,669 21,495,529 20,224,090
========== ========== ==========
Net loss per share (basic and diluted) $ (.019) $ (.015) $ (.034)
======= ======= =======
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, 2001 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
Stock-based compensation 90,694
--------- ------- ---------- -------- -----------
Balance, December 31, 2003 1,540,001 $15,400 21,592,669 $215,927 $21,511,436
========= ======= ========== ======== ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF CASH FLOWS
Year ended December 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities
Net loss $(405,478) $(321,640) $(690,355)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Depreciation 26,889 17,956 15,441
Amortization of patents 17,112 17,177 36,885
Amortization of deferred compensation
from grant of stock options 29,761
Current charges paid in stock or options 35,965 95,957
Stock-based compensation 90,694
Accrued interest on loans to/notes
from employees (1,087) (2,719)
Accrued interest on notes to shareholder 3,307 1,327
(Increase) decrease in accounts receivable (96,343) (26,874) (20,488)
(Increase) decrease in prepaid expenses 13,538 (32) 1,359
Increase (decrease) in accrued liabilities 217,679 195,569 128,569
Increase (decrease) in billings in excess of
costs on contracts in progress (23,753) 66,587
Increase (decrease) in deferred compensation 58,594 48,912 47,100
--------- --------- ---------
Net cash provided by (used in)
operating activities (98,848) 32,228 (355,771)
--------- --------- ---------
Cash flows from investing activities
(Increase) decrease in loans to/notes
from employees 2,500
Acquisition of property and equipment (20,333) (1,869) (3,664)
Additions to patents (16,007) (16,712) (25,266)
--------- --------- ---------
Net cash provided by (used in) investing
activities (33,840) (18,581) (28,930)
--------- --------- ---------
Cash flows from financing activities
Issuance of stock - private placements 54,000 288,750
Increase (decrease) in short-term lines
of credit 22,473
Issuance of notes payable to shareholders 85,000 36,000
Payment of principal on notes to shareholders (55,000)
Payment of accrued interest on notes to
shareholders (2,883)
Reduction of capital lease obligations (15,284) (1,004)
Forgiveness of payables 10,000
--------- --------- ---------
Net cash provided by (used in) financing
activities 34,306 88,996 298,750
--------- --------- ---------
Increase (decrease) in cash (98,382) 102,643 (85,951)
Cash at beginning of period 105,998 3,355 89,306
--------- --------- ---------
Cash at end of period $ 7,616 $ 105,998 $ 3,355
========= ========= =========
Non-cash transactions:
Equipment acquired through capital
lease obligations $ 50,753 $ 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 2003, most notably the reclassification of amounts in the Statement of
Operations from Research and Development to Cost of Revenue and from General and
Administrative to Interest Expense.
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: As of January 1, 2003, the Company adopted Statement
of Financial Accounting Standards (SFAS) No. 123 - "Accounting for Stock-based
Compensation" issued by the Financial Accounting Standards Board (FASB), which
provides for the fair value based method of accounting to be applied to the
Company's stock option grants and other equity-based compensation. 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 equity-based employee compensation. The Company has
chosen to apply the "modified prospective method" of SFAS No. 148 pursuant to
which fair value based stock option compensation costs for 2003 have been
recognized as if the fair value based method had been used to account for all
employee equity-based awards made in prior periods as well as the current
period.
Prior to 2003 the Company accounted 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.
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 2003 and 2002 the Company's only customers were branches
of the U.S. government and military or their prime contractors. Revenues
generated from two such customers under contracts-in-progress represented 81% of
total revenues in 2003.
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, 2003 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: SFAS No. 148 issued in December 2002 also amends the
disclosure provisions of SFAS No. 123 and APB Opinion No. 28, "Interim Financial
Reporting." The Statement is effective for fiscal years beginning after December
15, 2002.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This statement is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. The Company currently has no derivative instruments and undertakes no
hedging activities.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 was originally to be effective for financial instruments entered into or
modified after May 31, 2003, and otherwise was to be effective at the beginning
of the first interim period beginning after June 15, 2003. In November 2003,
FASB issued FASB Staff Position 150-3 which delays or defers indefinitely the
effective date of certain provisions of SFAS No. 150.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", an interpretation of Accounting
Research Bulletin No. 51. FIN 46 requires certain variable interest entities, or
VIEs, to be consolidated by the primary beneficiary of the entity if the equity
investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective for all VIEs created or acquired after
January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after June 15, 2003. The Company currently has no contractual
relationship or other business relationship with a variable interest entity.
The adoption of the new standards did not, or is not expected to, materially
affect the Company's financial position and results of operations.
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, as necessary, the 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 June
30, 2004. 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 other 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 loans became
payable on December 31, 2003; however, no payments have been made subsequent to
that date, nor has the Company demanded such payment.
NOTE 5 - NOTES RECEIVABLE FROM OFFICERS AND EMPLOYEES
In connection with the exercise of warrants to purchase shares of common stock
in June 2000, 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 $3,806 having been
accrued as of December 31, 2003. 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,
------------------------
2003 2002
---------- ----------
Capitalized costs $ 279,658 $ 264,532
Accumulated amortization (77,140) (60,909)
---------- ----------
$ 202,518 $ 203,623
========== ==========
Amortization of patent costs was $16,231 in 2003, $13,754 in 2002, and $13,632
in 2001. Annual patent cost amortization is expected to range from $15,000 to
$20,000 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 $881 in 2003, $3,423 in 2002, and
$23,253 in 2001 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,
------------------------
2003 2002
---------- ----------
Shop equipment $ 543,428 $ 474,940
Office equipment 24,823 22,225
---------- ----------
568,251 497,165
Accumulated depreciation (465,246) (438,357)
---------- ----------
$ 103,005 $ 58,808
========== ==========
NOTE 8 - DEFERRED REVENUE
In connection with 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. There were no contracts for which costs
and estimated profits incurred exceeded billings as of December 31, 2003 or
2002. Deferred revenue is analyzed as follows:
December 31,
------------------------
2003 2002
---------- ----------
Total billings $ 674,255 $ 401,858
Costs incurred and estimated profit or loss (631,421) (335,271)
---------- ----------
Deferred revenue $ 42,834 $ 66,587
========== ==========
NOTE 9 - DEBT
Notes payable to shareholders: In connection with a private financing in March
2002 as detailed in Note 13, the Company issued a $6,000, 6% note to one of its
shareholders, 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, 2004.
In July 2002 the Company issued a $30,000, 8% note to this same shareholder
payable initially on January 31, 2003. The due date of the note was extended to
September 30, 2003. The Company issued a $50,000, 6% note in June 2003 to this
same shareholder payable initially on December 31, 2003. The due date of this
note has been extended to June 30, 2004. In July 2003 the Company paid the July
2002, 8%, $30,000 note in full, including all remaining unpaid interest.
In October 2003 the Company issued a $25,000, short-term, 6% note to this same
shareholder, which note and related interest were paid in full in November 2003.
As of December 31, 2003, two notes to this shareholder in the principal amount
totaling $56,000, with accrued interest totaling $1,728, remain outstanding.
Payment of both notes is secured by Company revenues. In December 2003 the
Company issued a $10,000, short-term, 6% note to another shareholder, with
interest of $23 having accrued through December 31, 2003. Payment of this note
was secured by a specific invoice for revenue billed in December 2003 under one
of the Company's contracts. In January 2004 the Company paid this note in full,
including all accumulated interest.
Short-term lines of credit: In March 2003 the Company obtained a business credit
card from Capital One Bank with a credit limit of $20,000 to facilitate the
purchase of equipment and materials. Repayment of amounts due has been
personally guaranteed by the Company's chief executive officer. Balances accrue
interest at a fixed rate of 8.9% per annum. In October 2003 the Company
refinanced $18,050 then outstanding on this credit card by transferring the
balance to a new business credit card from Fleet National Bank. Repayment of
amounts due on this credit card, which has a credit limit of $19,000, also has
been personally guaranteed by the Company's chief executive officer. The account
has a promotional interest rate of 0% through June 2004, adjusting to prime rate
+ 6% thereafter. As of December 31, 2003, the outstanding balance on the account
with Fleet National Bank was $17,550, while the balance on the account with
Capital One Bank was $4,923.
Capital lease obligations: The Company has incurred long-term capital lease
obligations in connection with the acquisition of equipment in the following
amounts:
December 31,
------------------------
2003 2002
---------- ----------
Total capital lease obligations $ 52,111 $ 16,642
Less: current portion (18,413) (5,657)
---------- ----------
Long-term portion $ 33,698 $ 10,985
========== ==========
During 2003 the Company incurred new capital lease obligations in the principal
amount of $50,753. The repayment of two four-year equipment lease obligations in
the principal amount of $46,598 included in this total has been personally
guaranteed by the Company's chief executive officer. As of December 31, 2003,
the aggregate outstanding principal balance on these two leases obligations was
$37,949.
NOTE 10 - ACCRUED COMPENSATION AND BENEFITS
Accrued compensation and benefits consists of the following amounts:
December 31,
------------------------
2003 2002
---------- ----------
Accrued wages and payroll taxes $ 299,635 $ 235,515
Accrued consulting fees 150,181 31,737
Accrued bonuses 154,068 95,499
Accrued vacation pay 53,610 64,646
---------- ----------
$ 657,494 $ 427,397
========== ==========
The Company operated under severe cash flow difficulties for extended periods
during 2001 and 2002, prompting its two officers to voluntarily and at their own
discretion defer receipt of payment of significant portions of their current
wages to reduce the Company's monthly cash requirements. With the generation of
cash flow from revenues earned under contracts awarded to the Company during the
second half of 2002, some of the amounts owed to the Company's officers were
repaid in December 2002. Also at that time the Company's officers began
receiving their current wages. During the first quarter of 2003 the Company's
chief executive officer once again began deferring some of his current wages
and, since April 2003, he has deferred all of his current wages. As of December
31, 2003, total such wages payable to the Company's chief executive and chief
financial officers were $190,157 and $86,403, respectively.
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 amounts outstanding as soon as cash flow permits. Similarly, the Company has
accumulated significant unpaid consulting fees, the majority of which amounts as
of December 31, 2003 (a total of $122,732) are payable to two individuals. The
amount and timing of payments for unpaid compensation owing to the Company's
officers and its consultants will be determined at the discretion of the
Company's officers; however, all such unpaid compensation is payable upon
demand, as these amounts are not subject to the terms of the Company's written
agreement with current and former personnel to defer payment of portions of
their compensation as described in Note 11.
In December of each year, the Company awards 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. In connection with a private placement in
March 2002 as detailed in Note 13, the Company paid $22,500 of bonuses accrued
as of December 31, 2001 and $4,500 of consulting fees accrued as of that date
through the conversion of such amounts to equity. The amount of accrued bonuses
included in the table above that was payable to the Company's officers at
December 31, 2003 is $122,500. Payment of accrued bonuses is not subject to the
terms of the Company's written agreement with current and former personnel to
defer payment of portions of their compensation as described in Note 11.
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. The amount of accrued
vacation included in the table above that was payable to the Company's officers
at December 31, 2003 and 2002 was $49,200 and $48,856, respectively. Accrued
vacation compensation is payable upon termination of employment, and such
payments are not subject to the terms of the Company's written agreement with
current and former personnel to defer payment of portions of their compensation
as described in Note 11.
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 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,
------------------------
2003 2002
---------- ----------
Current officers $ 641,749 $ 574,249
Current employees 12,504 12,504
Former officers, employees and consultants 311,197 320,103
---------- ----------
$ 965,450 $ 906,856
========== ==========
The amount reported above for deferred compensation payable to current officers
as of December 31, 2003 consists of $486,423 payable to the Company's chief
executive officer and $155,326 payable to its chief financial officer. As of
January 1, 2004, the Company's chief executive officer is being compensated as a
consultant rather than a salaried employee, with related compensation not
subject to the terms of the written agreement described above for the deferral
of payment of current compensation. Also as of January 1, 2004, the Company's
chief financial officer is no longer deferring any portion of his current
salary.
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,
2004. 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, 2003, the Company had net
operating loss ("NOL") carryforwards of approximately $11.2 million available to
offset future taxable income. Net operating losses generated in 1998 and
subsequent years may be carried forward twenty years, while such losses
generated in 1997 and prior years may be carried forward fifteen years. If
certain substantial changes in the Company's ownership should occur, there would
be an annual limitation on the amount of the carryforwards which can be
utilized. The Company's tax loss carryforwards are summarized as follows:
Expiration Amount
---------- --------------
2004 $ 1,185,181
2005 900,267
2006 1,060,169
2007 1,214,492
2008 1,018,962
2009 - 2012 3,801,836
2018 - 2023 2,071,909
------------
$ 11,252,816
============
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 $4.3 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 $7,964,415 have expired unused.
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, 2003 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 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
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 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 2013.
Between January 1, 2001 and December 31, 2003, 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, 2001 4,323,216 $.51 3,760,716 $.52
Granted 882,500 .25 411,250 .25
Becoming exercisable 405,000 .48
Exercised
Lapsed (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
Granted 568,415 .25 248,415 .25
Becoming exercisable 258,000 .25
Exercised
Lapsed (407,566) .48 (275,066) .59
----------- ---------
Unexercised at December 31, 2003 4,683,907 $.40 4,360,407 $.42
=========== ==== ========= ====
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.
Through December 31, 2002, the Company accounted for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board (APB)
Opinion No. 25. Under APB No. 25, compensation cost is measured as the excess,
if any, of the quoted market price of the Company's stock at the date of grant
over the exercise price of the option granted. Compensation cost for stock
options, if any, is recognized ratably over the vesting period. Although the
Company applied APB Opinion No. 25 in accounting for stock option compensation,
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 stock option grants and other equity-based
compensation, required 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.
Prior to 2003, for options granted with an exercise price below the market price
at the date of grant, the Company credited 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 charged a like
amount to compensation expense in that year. There were no such charges in 2002
or 2001 in connection with options granted under the Plan. Certain consultants
engaged by the Company agreed to be compensated partially in cash and partially
in stock options. While the exercise price of such options was equal to or
higher than the market price of the stock at each date of grant, the Company
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
and $42,120 in 2001, 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 was credited to additional paid-in
capital and a like amount amortized to compensation expense. Amortization of
such charges, recorded over the five-year vesting period of the option, was
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.
As of January 1, 2003, the Company voluntarily adopted SFAS No. 123. SFAS No.
148 - "Accounting for Stock-based Compensation - Transition and Disclosure",
issued in December 2002, amended 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 equity-based employee compensation. The Company
chose to apply the "modified prospective method" of SFAS No. 148 pursuant to
which fair value based stock option compensation costs for 2003 have been
recognized as if the fair value based method had been used to account for all
employee stock-based awards made in prior periods as well as the current period.
For purposes of determining equity-based compensation expense under SFAS No. 123
in 2003 as well as for the pro forma disclosures required in previous years, the
Company has estimated the grant date fair value of stock options using the
Black-Scholes option pricing model. The following weighted average assumptions
were utilized for 2003: volatility factor of 95%, average risk-free interest
rate of 3.3%, zero dividend yield, and average expected term of nine years. As a
result, for 2003 the Company recorded stock option compensation under SFAS No.
123 totaling $90,694 based on a weighted average fair value per share for
options granted during 2003, 2002, 2001, and 2000 of $.13, $.15, $.19, and $.37,
respectively. As was the case under APB Opinion No. 25, the amount of
compensation expense is also credited to additional paid-in capital.
Had compensation cost for options granted been determined in prior periods
consistent with the method of SFAS No. 123, the Company's net loss and net loss
per share for the previous two years on a pro forma basis would have been as
follows:
2002 2001
---------- ----------
Net loss - as reported $321,640 $690,355
Net loss - pro forma $465,693 $948,089
Net loss per share - as reported $.015 $.034
Net loss per share - pro forma $.022 $.047
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, 2003, 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 1,602,207
Exercisable at $.50 per share 2,562,200
Exercisable at $.75 per share 196,000
----------
4,360,407
----------
Granted options becoming exercisable in the future:
Exercisable at $.25 per share 323,500
Options available for future grants 1,380,425
Conversion of note payable 60,000
Conversion of preferred stock 4,400,000
----------
Total shares reserved 11,516,832
==========
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 2003, 2002 and 2001, while the Company also earned
sublease income of $4,050 and $3,000 in 2002 and 2001, 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.
In February 2004 the Company hired a new president to fill the position that had
been vacant and entered into a long-term employment agreement with this
individual as more fully described in Note 17.
NOTE 17- SUBSEQUENT EVENTS
The composition of the Company's Board of Directors changed substantially
following the resignation in late January and early February 2004 of three
independent directors who had served on the Board for several years. Each of
these former directors cited other business responsibilities as the reason for
his resignation. The only continuing member of the Board is the Company's Chief
Executive Officer. Named to the Board to serve on an interim basis were the
Company's Chief Financial Officer and one independent director, and the number
of members of the Board was reduced from four to three.
In 2003 the Company began taking steps to focus on business re-positioning,
strengthening its internal capabilities, and planning for growth. Management
identified a need to secure strong strategic alliances for the marketing and
commercialization of the SCS engine applications by leveraging technology
development currently supported by U.S. Government funding as well as seeking
relationships with companies which have technologies complementary to the SCS.
One of the first objectives on this path was to strengthen the Company's
management team.
In late February 2004 the Company's reconstituted Board of Directors hired a new
president to fill the position that had been vacant and entered into an
employment agreement with this individual. The Company's new president is
developing and implementing an updated business plan. In late March 2004 he
replaced the Company's Chief Financial Officer as a member of the Board of
Directors. The employment agreement, which expires in March 2006, requires the
new president to defer annually $68,000 of his $140,000 salary until the
expiration of the agreement or at such earlier date as the Board of Directors
determines that the Company's cash flow is sufficient to allow payment. Other
key terms of the employment agreement include non-compete provisions, the
payment of shares of common stock and the award of stock options which vest over
the first year as detailed below, and the award of a bonus of $33,000 upon
execution of the agreement, the payment of which bonus will be deferred until
the expiration of the agreement. The agreement also specifies that termination
of employment by the Company following a change in control results in payment of
three times annual salary and bonus and the immediate vesting of shares and
options which have not already vested.
In connection with this change in business strategy, in February and March 2004
the Company entered into other business agreements, obtained a short-term loan
from a shareholder, authorized additional compensation to its officers and
directors, and satisfied liabilities for accrued compensation, through the
issuance of, and the grant of options for, a substantial number of shares of
common stock, as follows:
Shares issued:
Price/
Description share # of shares
------------------------ ----- -----------
Under employment agreement with new president: (1)
Upon execution of agreement $.10 200,000
Held in escrow, vesting in three, six and nine months .10 600,000
Compensation to management and employee .10 250,000
Payment of accrued compensation .12 400,000
Loan origination fee .12 10,000
Upon execution of agreement with new legal counsel .12 1,000,000
Consulting services .10 780,000
Compensation to independent director .12 200,000
----------
Total 3,440,000
(1)The Company's president is purchasing these shares for cash of $.01 per
share. The $.09 per share discount between the purchase price and the
market price of the stock of $.10 per share is accounted for as
compensation expense.
Options granted, all with ten-year terms:
Exercise
Description price # of shares
------------------------ ----- -----------
Under employment agreement with new president: (1)
Vesting at grant date $.25 100,000
Vesting six months after grant date .50 100,000
Vesting 12 months after grant date 1.00 100,000
Vesting 18 months after grant date 1.50 100,000
Vesting 24 months after grant date 2.00 100,000
----------
500,000
To new directors, vesting immediately .25 50,000
----------
Total 550,000
(1) These options were not granted under the Company's existing stock
option plan.
The employment agreement with the Company's president also requires the issuance
of 200,000 shares of common stock on March 15, 2005. The agreement with the new
legal counsel also requires the Company to remit a cash retainer of $50,000 by
June 30, 2004. Shares issued for consulting services represent payment in
connection with a one-year agreement with a firm providing business development,
product planning, corporate structure and financial advisory services. This
consulting firm introduced the new president to the Company and has been
assisting him in the development and implementation of the Company's updated
business plan. The Company has reserved for future issuance an additional
420,000 shares of common stock for services under this consulting agreement.
The transactions described above which involved the issuance of shares of common
stock will result in material effects on the Company's financial statements for
the first quarter of 2004. For shares issued in connection with the two
agreements with an extended term and/or vesting provisions, related charges of
$210,000 will be recorded as deferred assets with amortization of amounts to
expense ratably over the period covered by the agreement. For shares issued and
earned immediately upon execution of the agreement with new legal counsel, the
related charges of $120,000 will be expensed in March 2004.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company has had no disagreements with its current independent accountants,
Hausser + Taylor LLC, on any matter of accounting principles or practices or
financial statement disclosure. Hausser + Taylor LLC has been the Company's
independent accountants since December 17, 2002.
ITEM 8A. CONTROLS AND PROCEDURES
Disclosure 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 the end of the period covered by this report. 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.
Internal Control over Financial Reporting
It is the responsibility of the Company's management to establish and maintain
adequate internal control over financial reporting. Due to its small size and
limited financial resources, however, the Company's chief financial officer, a
member of management, is the only accounting and financial reporting employee.
As a result, there is no segregation of duties within the accounting function,
leaving all aspects of financial reporting and physical control of cash and
equivalents in the hands of the same employee. Usually, this lack of segregation
of duties represents a material weakness in a company's internal control over
financial reporting.
The Company's Board of Directors has recognized this inherent material weakness
in internal control but has been unable to adequately address the situation as
long as the Company has not had the financial resources to hire additional
accounting staff and the numerous responsibilities of the Company's chief
executive officer, the only other member of management until the beginning of
2004, have precluded his participation in the internal control function. Despite
these difficulties, the Board of Directors feels that the Company's chief
financial officer, who has been a member of management since 1991, has
demonstrated his trustworthiness and loyalty to the Company and its
shareholders. Based on its faith in the chief financial officer, as well as the
oversight provided by the Company's independent accountants, the Board of
Directors is confident that there have been no irregularities in the Company's
financial reporting or in the protection of its assets as a result of this
potentially material weakness in the Company's internal control over financial
reporting, and that, under the circumstances, internal control over financial
reporting as of December 31, 2003 is as effective as is possible.
There have been no changes in the Company's internal control over financial
reporting since December 31, 2003 that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting; however, the Company hired an additional member of
management, its new president, in February 2004. As soon as is practical, the
Board of Directors will consider the assignment of specific duties for various
aspects of internal control over financial reporting to its chief executive
officer and its president. In addition, the Company plans to hire a controller
as soon as the financial condition of the Company permits.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS
The Company's Board of Directors is divided into two categories: (1) "Common
Stock" directors elected by the holders of Common Stock; and (2) "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,
2006, 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. In July 1997 the total number of directors was fixed at
five, and, from December 2001 through March 2003 the Board consisted of three
Preferred Stock directors and two Common Stock directors. On March 24, 2003, Mr.
John H. Drewanz, a Class II Common Stock director since October 2001 and
Chairman of the Company's Board of Directors since October 2002, resigned from
the Board. The Board of Directors subsequently decided against filling the
vacancy or naming a new Chairman. In July 2003 the Board of Directors acted to
fix the number of directors at four, consisting of three Preferred Stock
directors and one Common Stock director.
In late January and early February 2004, the three Preferred Stock directors,
Mr. Lawrence H. Hyde, Mr. Charles C. McGettigan, and Mr. Myron A. Wick, III,
resigned from the Board, citing other business responsibilities as the reason
for resignation. The only continuing member of the Board was the Company's Chief
Executive Officer, Dr. Andrew A. Pouring, a Class III Common Stock director. In
connection with the resignations, the total number of directors was fixed at
three, consisting of two Preferred Stock directors and one Common Stock
director. Named to the Board on an interim basis were the Company's Chief
Financial Officer, Mr. George E. Ponticas, to serve as a Class I Preferred Stock
director, and one independent director, Mr. Herbert J. Mitschele, Jr., the
holder of approximately 5% of the Company's issued and outstanding Common Stock,
to serve as a Class II Preferred Stock director.
In late February 2004 the Company's reconstituted Board of Directors hired a new
president, Mr. Roger D. Posey, to fill the position that had been vacant. In
March 2004 Mr. Ponticas resigned from the Board and Mr. Posey was named to
replace him as a Class I Preferred Stock director. Because each was elected by
the Board to fill a vacancy rather than by the shareholders at an annual
meeting, the terms of Mr. Posey and Mr. Mitschele will expire at the next (2004)
Annual Meeting of Shareholders. At that time, these two individuals, or such
other person(s) as may be validly nominated to fill the vacancy, shall be
elected by the shareholders to serve the remaining scheduled term as Class I and
Class II, respectively, Preferred Stock directors or until successors have been
elected and qualified.
The Company will seek to add qualified individuals who have no current
affiliation with the Company in order to constitute a Board with a majority of
independent directors.
Directors of the Company do not receive fees for their services, but are
eligible to receive stock option grants and restricted shares, 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.
Board Committees
Due to the small total number of directors, the Board does not have separate
Executive, 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.
Prior to their recent resignations, Mr. Hyde and Mr. McGettigan, based on their
education and business experience overseeing or assessing the performance of
companies or public accountants with respect to the preparation, auditing or
evaluation of financial statements, were designated as an audit committee
"financial experts" 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. The Board currently has no
member designated as a "financial expert".
In performing the duties typically assigned to an audit committee, the entire
Board of Directors has (1) reviewed and discussed the 2003 audited financial
statements of the Company with management; (2) discussed with the independent
accountants of the Company the independent accountants' judgments about the
quality, not just the acceptability, of the Company '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 2003
audited financial statements be included in the December 31, 2003 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
Secretary, at the address of the Company, 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
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:
Herbert J. Mitschele, Jr. 74 2004 Class II Director
Roger D. Posey 51 2004 President and Class I Director
Common Stock Director:
Andrew A. Pouring 72 2004 Chief Executive Officer, Chief
Scientist, and Vice Chairman of the
Board (Class III Director)
Other Executive Officer:
George E. Ponticas 44 Vice President - Finance, Secretary,
Treasurer and Chief Financial Officer
Mr. Herbert J. Mitschele, Jr. has been a director of the Company since February
2004. Mr. Mitschele is a retired business owner who has been a shareholder of
the Company for approximately twenty years. He received his B.S. in Business and
Administration from Fordham University.
Mr. Roger D. Posey has been a director of the Company since March 2004. Prior to
joining Sonex, Mr. Posey held management and operational leadership positions
with CSX Transportation, Inc., Noise Cancellation Technologies Inc., and Tenneco
Automotive Inc. Recently Mr. Posey personally directed a successful turnaround
of a large privately held metals manufacturing company which realized
exponential growth. In addition, Mr. Posey has considerable experience in
bringing technology to the commercial marketplace. He is a member of a number of
professional organizations, including the Acoustical Society of America,
Institute of Noise Control Engineers, American Industrial Hygiene Association,
among others; further, he has written and published several technical articles,
presented within the U.S. and throughout the World. Mr. Posey holds a B.S.
degree in Science Education from the University of Maryland.
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. He served as a director of the Company during February and March
2004. 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.
Code of Ethics
Recently enacted Item 406 of Regulation S-B of the Exchange Act requires
disclosure of whether the Company has adopted a code of ethics that applies to
its principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions, and
to explain why if it has not adopted such a code of ethics. For purposes of Item
406, the term "code of ethics" refers to written standards that are reasonably
designed to (1) deter wrongdoing and to promote honest and ethical conduct,
including the ethical handling of actual or apparent conflicts of interest
between personal and professional relationships; (2) ensure full, fair,
accurate, timely, and understandable disclosure in public reports, documents and
communications; (3) ensure compliance with applicable governmental laws, rules
and regulations; (4) ensure the prompt internal reporting of violations of the
code to an appropriate person or persons identified in the code; and (5) provide
accountability for adherence to the code.
Adoption of a written code of ethics requires the expenditure of time and funds.
The Company has not adopted such a written code of ethics due to its small size
and limited financial resources. The Board of Directors intends to adopt a code
of ethics for the relevant officers of the Company as soon as funding and
staffing permit.
Compliance with Section 16(A) of the Exchange Act
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 2003 with the following
exceptions: Dr. Andrew A. Pouring and Mr. George E. Ponticas, the Company's
Chief Executive and Chief Financial Officers, respectively, failed to file Form
4s to report the December 31, 2003 grant to each of them of ten-year options
vesting 25% per year to purchase 100,000 and 50,000 shares, respectively, of
Common Stock at an exercise price of $.25 per share, which exercise price was
higher than the December 31, 2003 market price of $.13 of the Company's publicly
traded Common Stock. The Company expects the required Form 4s to be filed in the
near future.
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 2003 $ 87,500 (1) $ 37,500 $ 25,000 100,000
CEO & Chief Scientist 2002 87,500 (1) 37,500 0 100,000 (3)
2001 87,500 (1) 37,500 10,000 35,000
Mr. George E. Ponticas 2003 $ 90,000 $ 30,000 $ 25,000 50,000
CFO & Secretary 2002 86,400 (2) 9,600 25,000 200,000
2001 86,400 (2) 9,600 25,000 100,000
(1) Includes $76,567 for 2003, $79,933 for 2002 and $33,657 for 2001
which has not been paid as of December 31, 2003
(2) Includes $53,171 for 2002 and $33,232 for 2001 which has not been
paid as of December 31, 200
(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. The conditions
that would require repayment of deferred amounts have yet to occur, and it is
unlikely that such conditions will occur during 2004. (Note: 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.)
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%. For many
years through 2002, Mr. Ponticas had been deferring 10% of his annual salary.
The authorized full annual salary for Dr. Pouring has been $125,000 for the past
three years, while the salary for Mr. Ponticas was increased in 2003 from
$96,000 to $120,000, with 25% of the salary being deferred. As of January 1,
2004, Dr. Pouring is being compensated as a consultant rather than a salaried
employee, with related compensation not subject to the terms of the written
agreement described above for the deferral of payment of current compensation.
Also as of January 1, 2004, Mr. Ponticas is no longer deferring any portion of
his authorized salary. As of December 31, 2003, a total of $486,423 and $155,326
in deferred salary is owed to Dr. Pouring and Mr. Ponticas, respectively, that
is payable under the conditions described above.
The Company operated under severe cash flow difficulties for extended periods
during 2001 and 2002, prompting its two officers to voluntarily and at their own
discretion defer receipt of payment of significant portions of their current
wages to reduce the Company's monthly cash requirements. With the generation of
cash flow from revenues earned under contracts awarded to the Company during the
second half of 2002, some of the amounts owed to the Company's officers were
repaid in December 2002. Also at that time the Company's officers began
receiving their current wages. During the first quarter of 2003 Dr. Pouring once
again began deferring some of his current wages and, since April 2003, he has
deferred all of his current wages. As of December 31, 2003, total such wages
payable to Dr. Pouring and Mr. Ponticas were $190,157 and $86,403, respectively.
In December of each of the past several years, the Company has awarded bonuses,
totaling $65,077 in 2003, $37,500 in 2002, and $57,500 in 2001, 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, 2003, $47,500 and
$75,000 in accrued bonuses remained payable to Dr. Pouring and Mr. Ponticas,
respectively.
The bonus awards and option grants to the Named Executives 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 difficult continuing conditions.
In order to avoid long-term financial commitments, through 2003 the Company did
not execute 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 100,000 45% $.25 $.1313 Dec. 30, 2013
Ponticas 50,000 23% $.25 $.13 Dec. 30, 2013
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, 2003 December 31, 2003
# of shares
acquired on Value Exercisable/ Exercisable/
Name exercise realized Unexercisable Unexercisable
-------- ----------- -------- ---------------------- -------------------
Pouring:
@ $.25 0 $0 185,000 / 150,000 $0/$0
@ $.50 0 $0 105,000 / 0 $0/$0
@ $.75 0 $0 25,000 / 0 $0/$0
Ponticas:
@ $.25 0 $0 342,500 / 37,500 $0/$0
@ $.50 0 $0 175,000 / 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, 2003 market price of $.13 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 25,032,669 shares of
Common Stock and 1,540,001 shares of Preferred Stock issued and outstanding at
March 31, 2004.
The following table sets forth as of March 31, 2004 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 (2) owned of class
-------------------- --------- --------- --------- --------
Herbert J. Mitschele, Jr. 1,281,655 90,000 1,371,655 5.5
George E. Ponticas 626,262 643,928 1,270,190 4.9
Roger D. Posey 200,000 100,000 300,000 (3) 1.2
Andrew A. Pouring 1,053,239 408,928 1,462,167 5.7
All directors and officers
as a group (4 persons) 3,161,156 1,242,856 4,404,012 16.8
Proactive, et.al. (4) 2,198,064 2,928,570 5,126,634 18.3
San Francisco, CA
Lawrence H. Hyde (5) 600,000 1,839,286 2,484,272 9.7
-----------------------------
(1) The business address for each director and named executive officer is 23
Hudson Street, Annapolis, Maryland, 21401.
(2) See detail provided in the following table.
(3) Does not include 600,000 shares issued to Mr. Posey under his employment
agreement which are held in escrow until they vest 200,000 shares at a time
on May 31, 2004, August 31, 2004, and November 30, 2004, respectively, with
continued employment.
(4) Includes shares beneficially owned directly and indirectly by Proactive
Partners, L.P. and affiliated entities and individuals ("Proactive, et.al.")
including former directors of the Company Charles C. McGettigan and Myron A.
Wick, III, as reported in a Form 13D filing with the SEC.
(5) Mr. Hyde is a former director, Chairman of the Board, and president of the
Company.
RIGHTS TO ACQUIRE SHARES
Total
Exercisable Preferred rights to
Exercisable (put)/ Exercisable stock acquire
Name options call (1) warrants converted shares
-------------------- ---------- ---------- --------- --------- ----------
Herbert J. Mitschele, Jr. 60,000 25,000 40,000 90,000
George E. Ponticas 562,500 80,000 1,428 643,928
Roger D. Posey 100,000 100,000
Andrew A. Pouring 315,000 92,500 1,428 408,928
All directors and officers
as a group (4 persons) 1,002,500 197,500 42,856 1,242,856
Proactive , et.al.
San Francisco, CA (1,214,286) 4,142,856 2,928,570
Lawrence H. Hyde 600,000 1,214,286 1,839,286
---------------------------
(1) 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.
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.
10.2 Employment Agreement dated February 23, 2004 with Roger D.
Posey, president.
10.3 Stock Option Agreement dated February 23, 2004 with Roger D.
Posey, president.
21 Subsidiaries of the Registrant: Sonex International, B.V. - The
Netherlands; Sonex Engines, Inc. - Delaware (both are inactive).
23.a Consent of Hausser + Taylor LLC.
23.b Consent of C.L. Stewart & Company.
24 Power of Attorney
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32 Certification of Form 10-KSB for the year ended December 31,
2003 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
During the fourth quarter of 2003, the Company filed the following Current
Report on Form 8-K:
On October 2, 2003, to disclose that it had been awarded a $165,000
contract for application of its heavy fuel engine technology.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
During 2003 the Company's current independent accountants, Hausser + Taylor LLC,
billed the Company a total of $20,350 for professional services rendered for the
audit of the Company's 2002 annual financial statements and review of interim
financial statements included in the Company's quarterly Form 10-QSB filings for
2003. Audit fees include fees associated with the annual audit and the reviews
of the Company's quarterly reports and for fees for services that are normally
provided by the accountants in connection with statutory and regulatory filings
or engagements.
Hausser + Taylor LLC (the "Firm") has a continuing relationship with American
Express Tax and Business Services, Inc. ("TBS") from which it leases auditing
staff who are full time, permanent employees of TBS and through which its
shareholders provide non-audit services. As a result of this arrangement, the
Firm has no full time employees and, therefore, none of the audit services
performed were provided by permanent full time employees of the Firm. The Firm
manages and supervises the audit and audit staff, and is exclusively responsible
for the opinion rendered in connection with its audit.
During 2002 the Company's previous independent accountants, C.L. Stewart and
Company, billed the Company a total of $9,180 for professional services rendered
for the audit of the Company's 2001 annual financial statements and review of
interim financial statements included in the Company's quarterly Form 10-QSB
filings for 2002.
Other Fees
There were no fees billed during 2003 or 2002 by the Company's independent
accountants for audit-related fees, tax fees or any other fees.
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, 2004 By: /s/ Andrew A. Pouring
----------------------------------
Andrew A. Pouring
Principal Executive Officer
April 14, 2004 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, 2004 /s/ Andrew A. Pouring
----------------------------------
Andrew A. Pouring
Vice Chairman of the Board of Directors
April 14, 2004 /s/ Roger D. Posey
----------------------------------
Roger D. Posey
Director
April 14, 2004 /s/ Herbert J. Mitschele, Jr.
----------------------------------
Herbert J. Mitschele, Jr.
Director
The Registrant will furnish its shareholders with copies of its annual report
and proxy statement after the date of this report.
Exhibit 10.2
Employment Agreement
THIS EMPLOYMENT AGREEMENT is entered into as of February 23, 2004 by
and between Sonex Research, Inc., a Maryland corporation (the "Company"), and
Roger D. Posey, an individual (the "Executive").
WITNESSETH:
WHEREAS, the Company desires to employ the Executive, and the Executive
desires to be employed by the Company, pursuant to the provisions contained in
this Employment Agreement (the "Agreement");
NOW, THEREFORE, in consideration of the premises, and the respective
covenants and agreements of each of the Company and the Executive contained in
this Agreement, each of the Company and the Executive agrees as follows:
ARTICLE I
Certain Definitions
The following terms shall have the following respective meanings when
utilized in this Agreement:
"Agreement" means this Employment Agreement as it is now or hereafter
in effect.
"Approved Board" means a Board of Directors of the Company that, as of
a given date, is comprised of individuals at least a majority of whom have
continuously served as directors of the Company during the period of two years
ending on such date, unless the election of each director who was not a director
at the beginning of such two year period was approved in advance by the
directors representing at least two-thirds of the directors then in office who
were directors at the beginning of such two year period.
"Approved Change in Control of the Company" means any transaction or
series of transactions which:
(a) results, or is reasonably anticipated to result, in a Change in Control
of the Company;
(b) is approved by the requisite vote of an Approved Board pursuant to,
and in accordance with,
applicable law and the Articles of Incorporation and Bylaws of the
Company; and
(c) if required by applicable law or the Articles of
Incorporation or Bylaws of the Company, is approved by the requisite
vote of the shareholders of the Company pursuant to, and in accordance
with, applicable law and the Articles of Incorporation and Bylaws of
the Company. "Bonus" means, as of a given date, the most recent annual
performance bonus awarded by the Company to the Executive.
"Cause" means any action by the Executive or any inaction by the
Executive which, after due consideration, is reasonably determined by the Board
of Directors of the Company to constitute:
(a) fraud, embezzlement, misappropriation, dishonesty or breach of trust;
(b) a felony or moral turpitude;
(c) material breach or violation of any or all of the covenants,
agreements and obligations of the Executiveset forth in this Agreement,
other than as the result of the Executive's death or Disability;
(d) a willful or knowing failure or refusal by the Executive to perform
any or all of his material duties and responsibilities as an officer
of the Company, other than as the result of the Executive's death or
Disability; or
(e) gross negligence by the Executive in the performance of
any or all of his material duties and responsibilities as an officer of
the Company, other than as a result of the Executive's death or
Disability;
provided, however, that if the basis for any termination of the Executive's
employment by the Company as set forth in the Termination Notice delivered by
the Company to the Executive is any or all of the definitions of Cause set forth
in paragraphs (c), (d) or (e) of this definition, then, in such event, the
Executive shall have thirty (30) days from and after the date of his receipt of
such Termination Notice to present a reasonable plan to cure such action or
inaction specified in the Termination Notice, which plan may require more than
thirty (30) days to cure the specified action or inaction, but such plan shall
be reasonably satisfactory to the Company.
"Change in Control of the Company" means any change in control of the
Company of a nature which would be required to be reported (a) in response to
Item 6(e) of Schedule 14A of Regulation 14A, as in effect on the date of this
Agreement, promulgated under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), (b) in response to Item 1 of the Current Report on Form
8-K, as in effect on the date of this Agreement, promulgated under the Exchange
Act, or (c) in any filing by the Company with the United States Securities and
Exchange Commission; provided, however, that, without limitation, a Change in
Control of the Company shall be deemed to have occurred if:
(a) subsequent to the date of this Agreement, any "person" (as
such term is defined in Sections 13(d)(3) and 14(d)(2) of the Exchange
Act), other than the Company, any subsidiary of the Company or any
compensation, retirement, pension or other employee benefit plan or
trust of the Company or any subsidiary of the Company, becomes the
"beneficial owner" (as such term is defined in Rule 13d-3 promulgated
under the Exchange Act), directly or indirectly, of securities of the
Company or any successor to the Company (whether by merger,
consolidation or otherwise) representing fifteen percent (15%) or more
of the combined voting power of the Company's then outstanding
securities;
(b) during any period of two consecutive years, the
individuals who at the beginning of such period constitute the Board of
Directors of the Company cease for any reason to constitute at least a
majority of such Board of Directors, unless the election of each
director who was not a director at the beginning of such period has
been approved in advance by the directors representing at least
two-thirds of the directors then in office who were directors at the
beginning of such period;
(c) the Company shall merge or consolidate with or into
another corporation or other entity, or enter into a binding agreement
to merge or consolidate with or into another corporation or other
entity, other than a merger or consolidation which would result in the
voting securities of the Company outstanding immediately prior thereto
continuing to represent (either by remaining outstanding or by being
converted into voting securities of the surviving corporation or
entity) not less than eighty-five percent (85%) of the combined voting
power of the voting securities of the Company or such surviving
corporation or entity outstanding immediately after such merger or
consolidation;
(d) the Company shall sell, lease, exchange or otherwise
dispose of all or substantially all of its assets, or enter into a
binding agreement for the sale, lease, exchange or other disposition of
all or substantially all of its assets, in one transaction or in a
series of related transactions; or
(e) the Company shall liquidate or dissolve, or any plan or
proposal shall be adopted for the liquidation or dissolution of the
Company.
"Company" means Sonex Research, Inc., a Maryland corporation.
"Compensation" means the sum of the Executive's Salary and Bonus.
"Deferred Amount" means the aggregate amount of all payments by the
Company to the Executive deferred pursuant to the provisions Sections 4.3 and
5.1 of this Agreement.
"Disability" means any mental or physical illness, condition,
disability or incapacity which prevents the Executive from reasonably
discharging his duties and responsibilities as an officer of the Company. If any
disagreement or dispute shall arise between the Company and the Executive as to
whether the Executive suffers from any Disability, then, in such event, the
Executive shall submit to the physical or mental examination of a licensed
physician, who is mutually agreeable to the Company and the Executive, and such
physician shall determine whether the Executive suffers from any Disability. In
the absence of fraud or bad faith, the determination of such physician shall be
final and binding upon the Company and the Executive. The entire cost of such
examination shall be paid for solely by the Company.
"Executive" means Roger D. Posey, an individual.
"Good Reason" means:
(a) the assignment by the Board of Directors of the Company to
the Executive, without his express written consent, of duties and
responsibilities which results in the Executive having less significant
duties and responsibilities or exercising less significant power and
authority than he had, or duties and responsibilities or power and
authority not comparable to that of the level and nature which he had,
immediately prior to such assignment;
(b) the removal of the Executive from, or a failure to
reappoint the Executive to, his then current position with the Company
or its subsidiaries or affiliates, except (i) with the Executive's
express written consent or (ii) in connection with any termination of
the Executive's employment by the Company as the result of the
Executive's Protracted Disability or for Cause;
(c) the Company's failure to perform on a timely basis its
obligations under this Agreement; (d) the Company's requiring
the Executive, without his express written consent, to travel
on Company business to an extent substantially greater than
the Executive's business travel obligations immediately prior
to such time;
(e) the Company's requiring the Executive, without his express
written consent, to change his place of permanent residency; or
(f) the failure of the Company to obtain the express written
assumption of, and agreement to perform on a timely basis, the
Company's obligations under this Agreement by any successor to the
Company as required by Article X of this Agreement. "Person" means any
individual, person, firm, corporation, partnership, association or
other entity. "Protracted Disability" means any Disability which
prevents the Executive from reasonably discharging his duties and
responsibilities as an officer of the Company for a period of six (6)
consecutive months.
"Salary" means, as of a given date, the Executive's then current
annual salary.
"Successor Agreement" shall have the meaning set forth in Article X of
this Agreement.
"Termination Date" means a specific date not less than forty-five (45)
nor more than ninety (90) days from and after the date of any Termination Notice
upon which the Executive's employment by the Company shall be terminated in
accordance with the provisions of this Agreement.
"Termination Notice" shall mean a written notice which sets forth (a)
the specific provision of this Agreement relied upon to terminate the
Executive's employment, (b) in reasonable detail the facts and circumstances
claimed to provide the basis for the termination of the Executive's employment,
and (c) a Termination Date.
"Territory" shall have the meaning set forth in Section 9.1(a) of this
Agreement.
ARTICLE II
Employment
The Company employs the Executive and the Executive accepts such
employment. Subject to the direction of the Board of Directors, the Executive
shall serve as the President of the Company and each of the existing subsidiary
corporations and other entities currently affiliated with the Company. The
Executive shall have such responsibilities, perform such duties and exercise
such power and authority as are inherent in, or incident to, the office of
President and shall report directly to the Board of Directors of the Company.
The Executive shall devote substantially all of his business time and attention
and his best efforts to the diligent performance of his duties as an employee of
the Company.
ARTICLE III
Term
Subject to the provisions of Article VII below, the term of this
Agreement shall be for the period commencing on the date of this Agreement and
expiring on March 15, 2006.
ARTICLE IV
Salary
4.1 Salary. Beginning on March 15, 2004, the Company shall pay to the
Executive a salary (subject to applicable payroll and/or other taxes required by
law to be withheld) of One Hundred Forty Thousand Dollars ($140,000.00) per
annum. Compensation (salary) to the Executive for the period beginning as of the
date of this Agreement through March 14, 2004 is addressed by the terms of the
February 16, 2004 Letter Agreement between the Company and the Executive.
4.2 Payment of Salary. Payments of salary shall be made to the
Executive in installments from time to time on the same dates payments of salary
are generally made to all senior management employees of the Company.
4.3 Deferral of Salary. Notwithstanding anything contained in this
Article IV, payment of Sixty-Eight Thousand Dollars ($68,000.00) of the
Executive's annual salary for each year of the term of this Agreement shall be
deferred until March 15, 2006, unless payment shall become due on an earlier
date as provided for herein or at such earlier date as the Board of Directors
determines that the Company's cash flow is sufficient to allow such payment in
whole or in part..
ARTICLE V
Additional Compensation
5.1 Inducement Amount. The Company shall pay to the Executive the
amount of Thirty-Three Thousand Dollars ($33,000) upon his execution and
delivery of this Agreement (the "Inducement Amount"). Eight Thousand Dollars
($8,000) of the Inducement Amount shall be retained by the Company in accordance
with the provisions of Section 6.4(a) below. Payment of Twenty-Five Thousand
Dollars ($25,000) of the Inducement Amount shall be shall be deferred until
February 22, 2006, unless payment shall become due on an earlier date as
provided for herein or at such earlier date as the Board of Directors determines
that the Company's cash flow is sufficient to allow such payment in whole or in
part.
5.2 Incentive Compensation. For each fiscal year of the Company, the
Company shall pay to the Executive incentive compensation equal to one and
one-half percent (1.5%) of the amount by which the revenues of the Company for
such fiscal year exceed the revenues of the Company for the fiscal year ended
December 31, 2003. For purposes of this Section 5.1, the term "revenues" shall
mean revenues as determined in accordance with generally accepted accounting
principles applied on a consistent basis with prior years. Such incentive
compensation shall be paid to the Executive in cash not later than ninety days
after the conclusion of the fiscal year of the Company.
5.3 Performance Bonus. The Executive may from time to time receive a
performance bonus as shall be determined by the Board of Directors of the
Company. For the fiscal year ending December 31, 2004, the Executive shall
receive a performance bonus of not less than Ten Thousand Dollars ($10,000).
ARTICLE VI
Certain Fringe Benefits
6.1 Generally. The Executive shall be entitled to receive such benefits
and to participate in such benefit plans as are generally provided from time to
time by the Company to its senior management employees; provided, however, that
nothing contained in this Section 6.1 shall be construed to obligate the Company
to provide any specific benefits to its employees generally. As soon as the
Company's financial situation allows, the Company shall obtain Directors and
Officers Liability Insurance from a reputable carrier and life insurance with
respect to the Executive with the beneficiary thereof to be named by the
Executive.
6.2 Vacations. The Executive shall be entitled to vacation time on an
annual basis in accordance with such policies as are from time to time adopted
by the Company's Board of Directors with respect to its senior management
employees.
6.3 Automobile. The Company shall provide the Executive a monthly cash
allowance for use of his personal automobile by the Executive in connection with
the performance of his duties under this Agreement. Such amount shall be
mutually agreed by the Company and the Executive within thirty days of the
execution of this Agreement. The Executive shall be entitled to receive
reimbursement for such automobile expenses as are incurred by the Executive in
connection with the performance of his duties under this Agreement in accordance
with such policies as are from time to time adopted by the Board of Directors
with respect to senior management employees.
6.4 Stock.
(a) Simultaneously with the execution and delivery of this
Agreement, for and in consideration of Eight Thousand Dollars ($8,000.00), the
Company is issuing to the Executive Eight Hundred Thousand (800,000) shares of
its common stock, par value $.01 per share (the "Common Stock"). The Company
shall retain the first Eight Thousand Dollars ($8,000.00) of the Inducement
Amount in payment for such shares of Common Stock.
(b) Certificates representing Two Hundred Thousand (200,000)
shares of the Common Stock described in Section 6.4(a) above shall be
immediately delivered to the Executive. Certificates representing Six Hundred
Thousand (600,000) shares of the Common Stock described in Section 6.4(a) above
shall be held by Gary D. Lipson, Esquire. On the respective dates set forth
below, regardless of whether the Executive is employed or not employed by the
Company, Gary D. Lipson, Esquire shall deliver certificates representing the
following numbers of shares of Common Stock to the Executive:
Date Number of Shares
May 31, 2004 200,000
August 31, 2004 200,000
November 30, 2004 200,000
provided, however, that if Gary D. Lipson, Esquire shall receive written notice
from the Company that the Executive has terminated his employment without Good
Reason, then Gary D. Lipson, Esquire shall not deliver any of the certificates
then in his possession to the Executive and shall return such certificates to
the Company, and the Company shall pay to the Executive in cash the amount equal
to $.01 per share for each share that is returned to the Company. If there shall
occur a Change in Control of the Company, other than an Approved Change in
Control of the Company, while the Executive is employed by the Company, then
Gary D. Lipson, Esquire shall immediately deliver all of the certificates in his
possession to the Executive. Gary D. Lipson, Esquire may file an action in
interpleader at any time and place the certificates into the registry of a
court.
(c) On or after February 22, 2005, the Company shall issue to
the Executive Two Hundred Thousand (200,000) shares of its Common Stock upon
payment by the Executive to the Company of Two Thousand Dollars ($2,000.00).
(d) The Executive represents and warrants to the Company, and
covenants and agrees with the Company, as follows:
(i) The shares of Common Stock to be issued to the
Executive pursuant to this Section 6.4 are being acquired by the
Executive for his own account, and not for the account or beneficial
interest of any other person or entity. The shares of Common Stock to
be issued to the Executive pursuant to this Section 6.4(a) are not
being acquired by the Executive with a view to, or for resale in
connection with, any "distribution" within the meaning of the
Securities Act of 1933 and the rules and regulations promulgated
thereunder (collectively, the "Federal Securities Laws") or any
applicable state securities or blue sky laws (collectively, the "State
Securities Laws").
(ii) Except as otherwise provided in this Agreement,
the shares of Common Stock to be issued to the Executive pursuant to
this Section 6.4 have not been, and will not be, registered under the
Federal Securities Laws or any State Securities Laws and, as such, must
be held by the Executive unless and until they are subsequently so
registered under the Federal Securities Laws and any applicable State
Securities Laws or an exemption from registration thereunder is
available. The shares of Common Stock to be issued to the Executive
pursuant to this Section 6.4 constitute "restricted securities," as
that term is defined in Rule 144 promulgated by the Securities and
Exchange Commission under the Securities Act of 1933.
(iii) The Executive shall not sell, assign, transfer,
convey, pledge, hypothecate, encumber or otherwise dispose of
(collectively, a "Transfer") any or all of the shares of Common Stock
to be issued to him pursuant to this Section 6.4, unless such Transfer
is registered under the Federal Securities Laws and any applicable
State Securities Laws or a specific exemption from registration
thereunder is available. Any Transfer of any or all of the shares of
Common Stock to be issued to the Executive pursuant to this Section 6.4
which is made pursuant to an exemption claimed under the Federal
Securities Laws and any applicable State Securities Laws will require a
favorable opinion of the Executive's legal counsel, in form and in
substance satisfactory to the Company and its legal counsel, to the
effect that such Transfer does not and will not violate the provisions
of the Federal Securities Laws or any applicable State Securities Laws.
(iv) Except as otherwise provided in this Agreement,
the Company is under no obligation whatsoever to file any registration
statement under the Federal Securities Laws or any State Securities
Laws to register any Transfer of any shares of Common Stock held by the
Executive, or to take any other action necessary for the purpose of
making an exemption from registration available to the Executive in
connection with any such Transfer. Stop transfer instructions will be
issued by the Company with respect to the shares of Common Stock to be
issued to the Executive pursuant to this Section 6.4.
(v) There will be placed upon all of the certificates
representing shares of Common Stock delivered by the Company to the
Executive, and any and all certificates delivered in partial or total
substitution therefore, a restrictive legend which will read
substantially as follows:
THE SHARES REPRESENTED BY THIS CERTIFICATE MAY NOT BE SOLD, ASSIGNED,
TRANSFERRED, CONVEYED, PLEDGED, HYPOTHECATED, ENCUMBERED OR OTHERWISE
DISPOSED OF UNLESS (A) THEY ARE COVERED BY A REGISTRATION STATEMENT OR
POST-EFFECTIVE AMENDMENT THERETO, EFFECTIVE UNDER THE SECURITIES ACT OF
1933, AS AMENDED, OR (B) SUCH SALE, ASSIGNMENT, TRANSFER, CONVEYANCE,
PLEDGE, HYPOTHECATION, ENCUMBRANCE OR OTHER DISPOSITION IS EXEMPT FROM THE
PROVISIONS OF SECTION 5 OF THAT ACT.
(e) At any time and from time to time, promptly upon request
by the Executive, the Company shall cause a registration statement to be filed
with the SEC regarding some or all of the shares of Common Stock issued or to be
issued to the Executive pursuant to this Section 6.4.
6.5 Stock Options.
(a) The Executive shall be entitled to participate in the
Company's stock option plans as may from time to time be in effect, including
without limitation the Company's 1987 Non-Qualified Stock Option Plan, as
amended, and to receive such incentive or other stock options as may from time
to time be granted to him thereunder; provided, however, that nothing contained
in this Section 6.5(a) shall be construed to obligate the Company, its Board of
Directors or any committee of its Board of Directors to grant any incentive or
other stock option whatsoever to the Executive.
(b) Simultaneously with the execution and delivery of this
Agreement, the Company and the Executive are entering into a Stock Option
Agreement pursuant to which, among other things, the Company is granting to the
Executive options to purchase Five Hundred Thousand (500,000) shares of common
stock of the Company on the terms and subject to the conditions set forth
therein.
6.6 Business, Travel and Entertainment Expenses. Within a reasonable
time after the submission of appropriate receipts and other evidence by the
Executive, the Company shall pay, or reimburse the Executive for, all reasonable
business, travel and entertainment expenses incurred by the Executive in
connection with the performance of his duties and responsibilities on behalf of
the Company.
ARTICLE VII
Termination of Employment
7.1 Termination of Employment.
(a) Notwithstanding the provisions of Article III hereof, this
Agreement (i) shall automatically terminate upon the death of the Executive
pursuant to the provisions of Section 7.2 hereof, (ii) may be terminated at any
time by the Company pursuant to the provisions of Sections 7.3 or 7.4 hereof,
and (iii) may be terminated at any time by the Executive pursuant to the
provisions of Section 7.5 hereof.
(b) If either the Company or the Executive shall desire to
terminate the Executive's employment by the Company pursuant to any of the
provisions of Sections 7.3, 7.4, or 7.5 of this Agreement, then, in such event,
the party causing such termination shall provide a Termination Notice to the
other party.
(c) If this Agreement shall be terminated pursuant to any of
the provisions of this Article VII, the Company shall be discharged from all of
its obligations to the Executive under this Agreement upon the payment to the
Executive of the amount set forth in the Section of this Article VII pursuant to
which such termination shall occur. The Executive's sole and exclusive remedy
for the termination of this Agreement prior to March 15, 2006, regardless of
whether such termination shall be initiated by the Company or the Executive, and
regardless of whether such termination shall be with or without Cause, shall be
the payment by the Company to the Executive of the amount set forth in the
Section of this Article VII pursuant to which such termination shall occur.
7.2 Death of Executive. If during the term of this Agreement the
Executive shall die, then the employment of the Executive by the Company shall
automatically terminate on the date of the Executive's death. In such event, not
more than thirty (30) days after the date of the Executive's death, the Company
shall pay to the Executive's estate or as otherwise directed by the Executive's
personal representative or executor, an amount in cash equal to the sum of (a)
the Deferred Amount accrued through the end of the calendar month of the date of
the Executive's death and (b) the Executive's Compensation (subject to
applicable payroll and/or other taxes required by law to be withheld) determined
as of the date of the Executive's death.
7.3 Disability of Executive.
(a) In the event that at any time during the term of this
Agreement the Executive shall suffer any Disability, then the Company shall be
obligated to continue to pay in the ordinary and normal course of its business
to the Executive or his legal representative, as the case may be, the
Executive's Compensation (subject to applicable payroll and/or other taxes
required by law to be withheld) from the date that the Executive shall first
suffer any such Disability to the date that the Executive's employment by the
Company shall be terminated pursuant to any of the provisions of this Agreement.
(b) In the event that the Executive shall suffer any
Protracted Disability during the term of this Agreement, then the Company may
terminate the Executive's employment under this Agreement. In such event, in
addition to any other benefits which may have been provided by the Company to
the Executive or his legal representative, as the case may be, pursuant to the
provisions of Section 7.3(a) above, not later than the Termination Date
specified in the Termination Notice delivered by the Company to the Executive or
his legal representative, as the case may be, the Company shall pay to the
Executive or as otherwise directed by the Executive's legal representative an
amount in cash equal to the sum of (i) the Deferred Amount accrued through the
end of the calendar month of the date of the termination of the Executive's
employment and (ii) the Executive's Compensation (subject to applicable payroll
and/or taxes required by law to be withheld) determined as of the date of such
Termination Notice. Subsequent to such Termination Date, the Executive or his
legal representative, as the case may be, shall also be entitled to receive any
benefits which may be payable under any disability insurance policy or
disability plan provided to the Executive by the Company.
7.4 Termination of Employment by Company.
(a) The Company may terminate this Agreement at any time with
Cause. In such event, the Company shall be obligated to continue to pay in the
ordinary and normal course of its business to the Executive only his Salary
(subject to applicable payroll and/or other taxes required by law to be
withheld) through the Termination Date set forth in the Termination Notice and,
on such date of termination, the Company shall pay to the Executive the Deferred
Amount accrued through the date of termination of the Executive's employment.
(b) The Company may terminate this Agreement at any time
without Cause. In such event, (i) not later than the Termination Date specified
in the Termination Notice, the Company shall pay to the Executive an amount in
cash equal to the sum of (A) the Deferred Amount and (B) the Executive's
Compensation (subject to applicable payroll and/or other taxes required by law
to be withheld) determined as of the date of such Termination Notice through the
remaining term of the Agreement and (ii) the restrictions set forth in Section
9.1(b) hereof shall not be applicable to the Executive.
7.5 Termination of Employment by Executive.
(a) The Executive may terminate this Agreement at any time
with Good Reason. In such event, (i) not later than the Termination Date
specified in the Termination Notice, the Company shall pay to the Executive an
amount in cash equal to the sum of (A) the Deferred Amount and (B) the
Executive's Compensation (subject to applicable payroll and/or other taxes
required by law to be withheld) determined as of the date of such Termination
Notice through the remaining term of the Agreement and (ii) the restrictions set
forth in Section 9.1(b) hereof shall not be applicable to the Executive.
(b) The Executive may terminate this Agreement at any time
without Good Reason. In such event, the Company shall be obligated to continue
to pay in the ordinary and normal course of its business to the Executive only
his Salary (subject to applicable payroll and/or other taxes required by law to
be withheld) through the Termination Date set forth in the Termination Notice
and, on such date of termination, the Company shall pay to the Executive the
Deferred Amount accrued through the date of termination of the Executive's
employment.
ARTICLE VIII
Termination of Employment
Subsequent to a Change in Control
of the Company
8.1 Termination of Employment. Notwithstanding the provisions of
Articles III and VII of this Agreement, in the event that (a) there shall occur
any Change in Control of the Company, other than an Approved Change in Control
of the Company, and (b) at any time subsequent to the date of any such Change in
Control of the Company, either (i) the Company shall terminate the employment of
the Executive for any reason, other than as the result of the death or the
Protracted Disability of the Executive or for Cause, or (ii) the Executive shall
terminate his employment for Good Reason, then, in any such event, (A) not later
than the Termination Date specified in the Termination Notice delivered by the
Company to the Executive, or by the Executive to the Company, as the case may
be, the Company shall pay to the Executive an amount in cash equal to the
Executive's Compensation, determined as of the date of such Termination Notice,
multiplied by three (subject to applicable payroll and/or other taxes required
by law to be withheld), (B) the restrictions set forth in Section 9.1(b) hereof
shall not be applicable to the Executive, and (C) any and all stock options
granted to the Executive under any stock option plan of the Company or otherwise
as may from time to time be in effect, which shall not by their terms have
vested on or before such Termination Date, shall vest on such Termination Date.
8.2 Limitation on Payment. Notwithstanding anything to the contrary set
forth in Section 8.1 above, the amount paid by the Company to the Executive
shall be limited to the maximum amount which will not constitute a "parachute
payment," as such term is defined in Section 280G(b)(2) of the Internal Revenue
Code of 1986, as amended. This limitation shall first be applied to amounts
provided pursuant to clause (C) of Section 8.1 hereof (otherwise included in the
calculation of a parachute payment) to the extent thereof and then to amounts
provided pursuant to clause (A) of Section 8.1 hereof.
ARTICLE IX
Certain Restrictions on the Executive
9.1 Certain Restrictions. The Executive covenants and agrees with
the Company as follows: (a) He shall not at any time, directly
or indirectly, for himself or any other Person which
competes in any manner with the Company or any of its subsidiaries or affiliates
in the United States of America or its territories and possessions or any other
countries in which the Company as of the date of termination of this Agreement
conducts its business directly or indirectly through any of its subsidiaries or
affiliates (collectively, the "Territory"), employ, attempt to employ or enter
into any contractual arrangement for employment with, any employee or former
employee of the Company or any of its subsidiaries or affiliates, unless such
former employee shall not have been employed by the Company or any of its
subsidiaries or affiliates for a period of at least one year.
(b) He shall not, during the term of this Agreement and for a
period of two years from and after the date of termination of this Agreement,
directly or indirectly, (i) acquire or own in any manner any interest in, or
loan any amount to, any Person which competes with the Company or any of its
subsidiaries or affiliates in the combustion process of reciprocating engines of
all kinds and rotary engines (the "Business") in the Territory, (ii) be employed
by or serve as an employee, agent, officer, or director of, or as a consultant
to, any Person, other than the Company and its subsidiaries and affiliates,
which competes with the Company or its subsidiaries or affiliates in the
Business in the Territory, or (iii) compete with the Company or its subsidiaries
or affiliates in the Business in the Territory. The foregoing provisions of this
Section 9.1(b) shall not prevent the Executive from acquiring and owning not
more than five percent (5%) of the equity securities of any Person whose
securities are listed for trading on a national securities exchange or are
regularly traded in the over-the-counter securities market.
(c) In the course of the Executive's employment by the
Company, the Executive will have access to confidential or proprietary
information of the Company and its subsidiaries and affiliates. The Executive
shall not at any time divulge or communicate to any Person, or use to the
detriment of the Company or its subsidiaries or affiliates, any such
confidential or proprietary information. The term "confidential or proprietary
information" shall mean information not generally available to the public,
including without limitation personnel information, financial information,
customer lists, supplier lists, marketing plans and analyses, trade secrets,
computer software and source and object codes and procedures and techniques of
operating and managing the business of the Company and its subsidiaries and
affiliates.
9.2 Remedies. It is recognized and acknowledged by each of the Company
and the Executive that a breach or violation by the Executive of any or all of
his covenants and agreements contained in Section 9.1 of this Agreement will
cause irreparable harm and damage to the Company and its subsidiaries and
affiliates in a monetary amount which would be virtually impossible to ascertain
and, therefore, will deprive the Company of an adequate remedy at law.
Accordingly, if the Executive shall breach or violate any or all of his
covenants and agreements set forth in Section 9.1 hereof, then the Company and
its subsidiaries and affiliates shall have resort to all equitable remedies,
including without limitation the remedies of specific performance and
injunction, both permanent and temporary, as well as all other remedies which
may be available at law.
9.3 Intent. It is the intent of the parties that the restrictions set
forth in Section 9.1 hereof shall be enforced to the fullest extent permissible
under the laws and public policies of each jurisdiction in which enforcement of
such restrictions may be sought. If any provision contained in Section 9.1
hereof shall be adjudicated by a court of competent jurisdiction to be invalid
or unenforceable because of its duration or geographic scope, then such
provision shall be reduced by such court in duration or geographic scope or both
to such extent as to make it valid and enforceable in the jurisdiction where
such court is located, and in all other respects shall remain in full force and
effect.
ARTICLE X
Successor to the Company
The Company shall require any successor, whether direct or
indirect, and whether by purchase, merger, consolidation or otherwise, to all or
substantially all of the business or properties and assets of the Company, to
execute and deliver to the Executive, not later than the date of the
consummation of any such purchase, merger, consolidation or other transaction, a
written instrument in form and in substance reasonably satisfactory to the
Executive and his legal counsel pursuant to which any such successor shall agree
to assume and to perform on a timely basis or to cause to be performed on a
timely basis all of the Company's covenants, agreements and obligations set
forth in this Agreement (a "Successor Agreement"). The failure of the Company to
cause any such successor to execute and deliver a Successor Agreement to the
Executive shall (a) constitute a breach of the provisions of this Agreement by
the Company and (b) be deemed to constitute a termination by the Executive of
his employment hereunder (as of the date upon which any such successor shall
succeed to all or substantially all of the business or properties and assets of
the Company) for Good Reason.
ARTICLE XI
Attorneys' Fees
In the event that any litigation shall arise between the
Company and the Executive based, in whole or in part, upon this Agreement or any
or all of the provisions contained herein, then, in any such event, the
prevailing party in any such litigation shall be entitled to recover from the
non-prevailing party, and shall be awarded by a court of competent jurisdiction,
any and all reasonable fees and disbursements of trial and appellate counsel
paid, incurred or suffered by such prevailing party as the result of, arising
from, or in connection with, any such litigation.
ARTICLE XII
Miscellaneous Provisions
12.1 Governing Law. This Agreement shall be governed by, and shall be
construed and interpreted in accordance, with the laws of the State of Maryland.
12.2 Notices. Any and all notices and other communications required or
permitted to be given pursuant to this Agreement shall be in writing and shall
be deemed to have been duly given when delivered by hand, or when delivered by
mail, by registered or certified mail, postage prepaid, return receipt
requested, to the respective parties at the following respective addresses: If
to the Company: Sonex Research, Inc. 23 Hudson Street Annapolis, Maryland 21401
Attention: Chief Executive Officer If to the Executive: Roger D. Posey 6204 Long
Meadow Drive Sykesville, Maryland 21784 or to such other address as either party
may from time to time give written notice of to the other in accordance with the
provisions of this Section 12.2.
12.3 Entire Agreement. This Agreement constitutes the entire agreement
between the Company and the Executive with respect to the subject matter hereof
and supersedes all prior agreements, understandings, negotiations and
arrangements, both oral and written, between the Company and the Executive with
respect to such subject matter.
12.4 Amendments. This Agreement may not be amended or modified in any
manner, except by a written instrument executed by each of the Company and the
Executive.
12.5 Benefits; Binding Effect. This Agreement shall be for the benefit of,
and shall be binding upon, each of the Company and the Executive and their
respective heirs, personal representatives, executors, legal representatives,
successors and assigns.
12.6 Severability. The invalidity of any one or more of the words, phrases,
sentences, clauses or sections contained in this Agreement shall not affect the
enforceability of the remaining portions of this Agreement or any part hereof,
all of which are inserted conditionally on their being valid in law. Except as
otherwise provided in Section 9.3 above, if any one or more of the words,
phrases, sentences, clauses or sections contained in this Agreement shall be
declared invalid by any court of competent jurisdiction, then, in any such
event, this Agreement shall be construed as if such invalid word or words,
phrase or phrases, sentence or sentences, clause or clauses, or section or
sections had not been inserted.
12.7 No Waivers. The waiver by either party of a breach or violation of any
provision of this Agreement by any other party shall not operate nor be
construed as a waiver of any subsequent breach or violation. The waiver by
either party to exercise any right or remedy it or he may possess shall not
operate nor be construed as a bar to the exercise of such right or remedy by
such party upon the occurrence of any subsequent breach or violation.
12.8 Headings. The headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
any or all of the provisions hereof. 12.9 Counterparts. This Agreement may be
executed in any number of counterparts and by the separate parties in separate
counterparts, each of which shall be deemed to constitute an original and all of
which shall be deemed to constitute the one and the same instrument.
IN WITNESS WHEREOF, each of the parties has executed and delivered this
Agreement as of the date first written above.
Sonex Research, Inc.
By__________________________________ ___________________________________
Andrew A. Pouring, Roger D. Posey
Chief Executive Officer
Exhibit 10.2
Stock Option Agreement
THIS STOCK OPTION AGREEMENT is entered into as of February 23, 2004 by
and between Sonex Research, Inc., a Maryland corporation (the "Company"), and
Roger D. Posey, an individual (the "Executive").
RECITALS:
A. The Company desires to employ the Executive.
B. In order to induce the Executive to be employed by the Company, the
Company desires to grant to the Executive certain options to purchase shares of
the Company's common stock, par value $.01 per share (the "Common Stock").
C. Each of the Company and the Executive desires to enter into this
Stock Option Agreement (the "Agreement") for the purpose of evidencing the grant
of such options and setting forth certain of the terms and conditions governing
the exercise thereof.
NOW, THEREFORE, in consideration of the premises, and the respective
covenants and agreements of the parties set forth herein, each of the Company
and the Executive agrees as follows:
ARTICLE I
Stock Options
1.1 Grant of Options. Subject to the terms and conditions set forth in this
Agreement, for and in consideration of Ten Dollars ($10) and other good and
valuable consideration, the receipt and sufficiency of which are acknowledged by
the Company, the Company grants to the Executive options to purchase an
aggregate of Five Hundred Thousand (500,000) shares of Common Stock
(collectively, the "Options").
1.2 Date of Grant. The date of grant of the Options is February 23, 2004
(the "Grant Date").
1.3 Maximum Term of Options. In no event may the Options be exercised, in
whole or in part, after February 22, 2014.
1.4 Vesting , Exercisabiltiy and Exercise Price of Options. The Options
shall vest and be exercisable on and after the dates set forth below as to the
number of shares of Common Stock set forth below at the respective exercise
price per share of Common Stock set forth below:
Number Exercise Price
Date Becoming Exercisable of shares Per Share
Grant Date 100,000 $0.25
Six months after Grant Date 100,000 $0.50
Twelve months after Grant Date 100,000 $1.00
Eighteen months after Grant Date 100,000 $1.50
Twenty-four months after Grant Date 100,000 $2.00
The vesting of the Options and the Executive's right to exercise the Options
shall be cumulative.
1.5 Exercise and Payment.
(a) Subject to the provisions of Section 1.4 above, the
Options may be exercised, in whole or in part, by delivery of written
notice to the Company indicating the number of Options which are being
exercised by the Executive, accompanied by payment of the full amount
of the "Aggregate Exercise Price" (as such term is hereinafter
defined).
(b) For purposes of this Section 1.5, the term "Aggregate
Exercise Price" shall mean the appropriate exercise price per share set
forth in the Vesting and Exercise Schedule above multiplied by the
number of Options being exercised by the Executive.
(c) The Aggregate Exercise Price shall be paid by the
Executive to the Company by the delivery of (i) cash, (ii) certified or
cashiers' check, (iii) shares of Common Stock already owned by the
Executive, (iv) the withholding of shares of Common Stock issuable upon
such exercise of the Options, (v) irrevocable instructions to a broker
to deliver promptly to the Company the amount of sale or loan proceeds
required to pay the purchase price, or (vi) any combination of the
foregoing methods of payment. Shares of Common Stock delivered in
payment of all or any part of the amounts payable in connection with
the exercise of Options, and shares of Common Stock withheld for such
payment, shall be valued for such purpose at their "Fair Market Value"
(as such term is hereinafter defined) as of the date of exercise of the
Options.
(d) "Fair Market Value" of a share of Common Stock on any day
means the last sale price (or, if no last sale price is reported, the
average of the high bid and low asked prices) for a share of Common
Stock on such day (or, if such day is not a trading day, on the next
preceding trading day) as reported on NASDAQ or, if not reported on
NASDAQ, as quoted by the National Quotation Bureau Incorporated, or if
the Common Stock is listed on an exchange, on the principal exchange on
which the Common Stock is listed. If for any day the Fair Market Value
of a share of Common Stock is not determinable by any of the foregoing
means, then the Fair Market Value for such day shall be determined in
good faith by the Company on the basis of such quotations and other
considerations as the Company deems appropriate.
1.6 Limitations on Exercise and Assignment. During the Executive's
lifetime, the Options granted pursuant to this Agreement shall be exercisable
only by the Executive, and the Options shall not be transferable except, in case
of the death of the Executive, by will or by the laws of descent and
distribution. The Options granted pursuant to this Agreement shall not be
subject to attachment, execution or other similar legal process. In the event of
(a) any attempt by the Executive to alienate, assign, pledge, hypothecate or
otherwise dispose of the Options, except as provided herein, or (b) the levy of
any attachment, execution or similar legal process upon the rights or interest
granted to the Executive pursuant to this Agreement, the Company, at its option,
may terminate the Options by the delivery of written notice to the Executive and
the Options shall thereupon become null and void.
1.7 No Rights of Shareholder. Neither the Executive nor any other person
shall be, or shall have any of the rights and privileges of, a shareholder of
the Company with respect to any shares of Common Stock purchasable or issuable
upon the exercise of the Options, in whole or in part, prior to the date of
exercise of the Options and payment in full of the Aggregate Exercise Price
therefor.
1.8 Stock Adjustment. If there is any change in the number of issued and
outstanding shares of Common Stock by reason of any stock split, stock dividend,
recapitalization or other similar transaction, then the number of shares of
Common Stock subject to the Options and the Exercise Price shall be
proportionately adjusted.
1.9 Stock Reserved. The Company shall at all times during the term of this
Agreement reserve and keep available such number of shares of its authorized but
unissued Common Stock, or its Common Stock held as treasury stock, as shall be
sufficient to satisfy the terms of this Agreement.
1.10 Corporate Reorganization. If there shall be any capital
reorganization or consolidation or merger of the Company with another
corporation or corporations or entity or entities, or any sale of all or
substantially all of the Company's properties and assets to any other
corporation or corporations or entity or entities, then, in any such event, the
Company shall take such action as may be necessary to enable the Executive to
receive upon any subsequent exercise of the Options, in whole or in part,
including any shares under the Options for which the right to exercise has not
accrued pursuant to the provisions of Section 1.4 above, in lieu of shares of
Common Stock, securities or other assets as were issuable or payable upon such
reorganization, consolidation, merger or sale in respect of, or in exchange for,
such shares of Common Stock.
1.11 Intent.
(a) The Options granted to the Executive hereunder shall not
constitute "incentive stock options" under the Internal Revenue Code of 1986, as
amended, and the rules and regulations promulgated thereunder.
(b) The Options granted to the Executive hereunder are not
being granted pursuant to the Company's 1987 Non-Qualified Stock Option Plan.
ARTICLE II
Termination of Employment
2.1 Death; Protracted Disability. If the Executive's employment by the
Company shall be terminated by reason of the Executive's death or Protracted
Disability, then all of the Options granted to the Executive pursuant to this
Agreement which have not previously vested pursuant to the provisions of section
1.4 shall vest on the date of death or the date of the Executive's termination
of employment by reason of Protracted Disability, as the case may be, and may be
exercised by the Executive or his estate, personal representative, executor,
administrator, legal representative or any person who acquired such Options by
will or by the laws of descent and distribution or by law, as the case may be,
at any time prior to the earlier of (a) the expiration date of such Options set
forth in this Agreement or (b) two years after the date of termination of
employment.
2.2 Cause. If the Executive's employment by the Company shall be
terminated by the Company for Cause or by the Executive without Good Reason,
then:
(a) all of the Options granted to the Executive pursuant to
this Agreement which shall not have vested shall terminate on the date
of termination of employment; and
(b) all of the Options granted to the Executive pursuant to this Agreement
which shall have vested but which shall not have been previously exercised by
the Executive shall terminate on the date of termination of employment.
2.3 Other Termination. If the Executive's employment by the Company shall
be terminated for any reason other than one set forth in Section 2.1 or Section
2.2 above, then:
(a) all of the Options granted to the Executive pursuant to
this Agreement which shall not have previously vested shall vest on the
date of termination of employment; and
(b) all of the Options granted to the Executive pursuant to
this Agreement which shall have previously vested pursuant to Section
1.4 but which shall not have been previously exercised by the Executive
may be exercised by the Executive at any time prior to the earlier of
(i) the expiration date of such Options set forth in this Agreement or
(ii) one year from and after the date of termination of employment.
2.4 Certain Defined Terms. The terms "Protracted Disability," "Cause" and
"Good Reason" shall have the respective meanings assigned to them in that
certain Employment Agreement of even date herewith by and between the Company
and the Executive.
ARTICLE III
Delivery of Certificates
As soon as practicable following any exercise by the Executive of the
Options, the Company shall deliver or cause to be delivered to the Executive a
certificate or certificates representing the shares of Common Stock acquired
pursuant to any such exercise; provided, however, that the Company may postpone
the time of delivery of any certificate for such period of time as the Company
shall deem necessary or desirable in order to enable it to comply with (i) the
listing requirements of any securities exchange or the National Association of
Securities Dealers, Inc. Automated Quotation system, (ii) the requirements of
the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934,
as amended, and the rules and regulations promulgated thereunder (collectively,
the "Federal Securities Laws"), or (iii) the requirements of any applicable
state securities or blue sky laws and the rules and regulations promulgated
thereunder (collectively, the "State Securities Laws").
ARTICLE IV
Certain Representations, Warranties, Covenants and Agreements
of the Executive
The Executive represents and warrants to the Company, and covenants and
agrees with the Company, as follows:
(a) The shares of Common Stock to be issued to the Executive upon any
exercise of the Options are being acquired by the Executive for his own account,
and not for the account or beneficial interest of any other person or entity.
The shares of Common Stock to be issued to the Executive upon any exercise of
the Options are not being acquired by the Executive with a view to, or for
resale in connection with, any "distribution" within the meaning of the Federal
Securities Laws or any applicable State Securities Laws.
(b) The shares of Common Stock to be issued to the Executive
upon any exercise of the Options have not been, and will not be, registered
under the Federal Securities Laws or any State Securities Laws and, as such,
must be held by the Executive unless and until they are subsequently so
registered under the Federal Securities Laws and any applicable State Securities
Laws or an exemption from registration thereunder is available. The shares of
Common Stock to be issued to the Executive upon any exercise of the Options
constitute "restricted securities," as that term is defined in Rule 144
promulgated by the Securities and Exchange Commission under the Securities Act.
(c) The Executive shall not sell, assign, transfer, convey,
pledge, hypothecate, encumber or otherwise dispose of (collectively, a
"Transfer") any or all of the shares of Common Stock to be issued to him upon
any exercise of the Options, unless such Transfer is registered under the
Federal Securities Laws and any applicable State Securities Laws or a specific
exemption from registration thereunder is available. Any Transfer of any or all
of the shares of Common Stock to be issued to the Executive upon any exercise of
the Options which is made pursuant to an exemption claimed under the Federal
Securities Laws and any applicable State Securities Laws will require a
favorable opinion of the Executive's legal counsel, in form and in substance
satisfactory to the Company and its legal counsel, to the effect that such
Transfer does not and will not violate the provisions of the Federal Securities
Laws or any applicable State Securities Laws.
(d) The Company is under no obligation whatsoever to file any
registration statement under the Federal Securities Laws or any State Securities
Laws to register any Transfer of any shares of Common Stock held by the
Executive, or to take any other action necessary for the purpose of making an
exemption from registration available to the Executive in connection with any
such Transfer. Stop transfer instructions will be issued by the Company with
respect to the shares of Common Stock to be issued to the Executive upon any
exercise of the Options.
(e) There will be placed upon all of the certificates
representing shares of Common Stock delivered by the Company to the Executive,
and any and all certificates delivered in partial or total substitution
therefor, a restrictive legend which will read substantially as follows:
THE SHARES REPRESENTED BY THIS CERTIFICATE MAY NOT BE SOLD, ASSIGNED,
TRANSFERRED, CONVEYED, PLEDGED, HYPOTHECATED, ENCUMBERED OR OTHERWISE
DISPOSED OF UNLESS (A) THEY ARE COVERED BY A REGISTRATION STATEMENT OR
POST-EFFECTIVE AMENDMENT THERETO, EFFECTIVE UNDER THE SECURITIES ACT OF
1933, AS AMENDED, OR (B) SUCH SALE, ASSIGNMENT, TRANSFER, CONVEYANCE,
PLEDGE, HYPOTHECATION, ENCUMBRANCE OR OTHER DISPOSITION IS EXEMPT FROM THE
PROVISIONS OF SECTION 5 OF THAT ACT.
ARTICLE V
Registration of Shares
At any time and from time to time, promptly upon request by the
Executive, the Company shall cause a registration statement to be filed with the
SEC regarding some or all of the shares of Common Stock issued or to be issued
to the Executive upon exercise of some or all of the Options.
ARTICLE VI
Miscellaneous Provisions
6.1 Governing Law. This Agreement shall be governed by, and shall be
construed and interpreted in accordance, with the laws of the State of Maryland.
6.2 Notices. Any and all notices and other communications required or
permitted to be given pursuant to this Agreement shall be in writing and shall
be deemed to have been duly given when delivered by hand, or when delivered by
mail, by registered or certified mail, postage prepaid, return receipt
requested, to the respective parties at the following respective addresses: If
to the Company: Sonex Research, Inc.
23 Hudson Street
Annapolis, Maryland 21401
Attention: Chief Executive Officer
If to the Executive: Roger D. Posey
6204 Long Meadow Drive
Sykesville, Maryland 21784
or to such other address as either party may from time to time give written
notice of to the other in accordance with the provisions of this Section 6.2.
6.3 Entire Agreement. This Agreement constitutes the entire agreement
between the Company and the Executive with respect to the subject matter hereof
and supersedes all prior agreements, understandings, negotiations and
arrangements, both oral and written, between the Company and the Executive with
respect to such subject matter.
6.4 Amendments. This Agreement may not be amended or modified in any
manner, except by a written instrument executed by each of the Company and the
Executive.
6.5 Benefits; Binding Effect. This Agreement shall be for the benefit
of, and shall be binding upon, each of the Company and the Executive and their
respective heirs, personal representatives, executors, legal representatives,
successors and assigns.
6.6 Severability. The invalidity of any one or more of the words,
phrases, sentences, clauses or sections contained in this Agreement shall not
affect the enforceability of the remaining portions of this Agreement or any
part hereof, all of which are inserted conditionally on their being valid in
law. If any one or more of the words, phrases, sentences, clauses or sections
contained in this Agreement shall be declared invalid by any court of competent
jurisdiction, then, in any such event, this Agreement shall be construed as if
such invalid word or words, phrase or phrases, sentence or sentences, clause or
clauses, or section or sections had not been inserted.
6.7 No Waivers. The waiver by either party of a breach or violation of
any provision of this Agreement by any other party shall not operate nor be
construed as a waiver of any subsequent breach or violation. The waiver by
either party to exercise any right or remedy it or he may possess shall not
operate nor be construed as a bar to the exercise of such right or remedy by
such party upon the occurrence of any subsequent breach or violation.
6.8 Headings. The headings contained in this Agreement are for
reference purposes only and shall not affect in any way the meaning or
interpretation of any or all of the provisions hereof.
6.9 Counterparts. This Agreement may be executed in any number of
counterparts and by the separate parties in separate counterparts, each of which
shall be deemed to constitute an original and all of which shall be deemed to
constitute the one and the same instrument.
IN WITNESS WHEREOF, each of the parties has executed and delivered this
Agreement as of the date first written above.
Sonex Research, Inc.
By____________________________________ ____________________________________
Andrew A. Pouring, Roger D. Posey
Chief Executive Officer
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 April 2, 2004 appearing in this Form
10-KSB.
HAUSSER + TAYLOR LLC
Cleveland, Ohio
April 12, 2004
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, 2004
EXHIBIT 24
APPOINTMENT OF ATTORNEY-IN FACT
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned Directors
and Executive Officers of Sonex Research, Inc., a Maryland corporation that is
subject to certain filing requirements with the Securities and Exchange
Commission (SEC) and other regulatory agencies and governmental bodies,
including but not limited to the Annual Report on Form 10-KSB and Registration
Statements on Forms S-3 and S-8, hereby constitutes and appoints George E.
Ponticas his true and lawful attorney-in-fact and agent with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all reports and registration statements
filed with the SEC and other regulatory agencies and governmental bodies,
including amendments thereto and all other documents in connection therewith,
granting unto said attorney-in-fact and agent full power and authority to do so
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorney-in-fact and agent or his substitute or substitutes may lawfully do or
cause to be done by virtue hereof.
NAME POSITION DATE
/s/ Andrew A. Pouring
------------------------ ----------------
Andrew A. Pouring Vice Chairman of the April 12, 2004
Board of Directors & Chief
Executive Officer
/s/ Roger D. Posey
------------------------ ----------------
Roger D. Posey President and Director April 12, 2004
/s/ Herbert J. Mitshele, Jr.
------------------------ ----------------
Herbert J. Mitschele, Jr. Director April 12, 2004
Exhibit 31.1
Certification of Chief Executive Officer Pursuant to
Securities Exchange Act Rules 13a-14(a) or 15d-14(a) as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act Of 2002
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"), a small business issuer, for the year ending
December 31, 2003.
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-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the Company and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period
in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted financial principles;
c) Evaluated the effectiveness of the Company 's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
d) Disclosed in this report any change in the Company's internal
control over financial reporting that occurred during the Company's
most recent (fourth) fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the Company's
internal control over financial reporting; and
5. The Company's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
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
control over financial reporting which are reasonably likely to
adversely affect the Company 's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's
internal control over financial reporting.
Dated: April 14, 2004
/s/ Andrew A. Pouring
Andrew A. Pouring
Chief Executive Officer
Exhibit 31.2
Certification of Chief Financial Officer Pursuant to
Securities Exchange Act Rules 13a-14(a) or 15d-14(a) as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act Of 2002
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"), a small business issuer, for the year ending
December 31, 2003.
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-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the Company and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period
in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted financial principles;
c) Evaluated the effectiveness of the Company 's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
d) Disclosed in this report any change in the Company's internal
control over financial reporting that occurred during the Company's
most recent (fourth) fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the Company's
internal control over financial reporting; and
5. The Company's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
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
control over financial reporting which are reasonably likely to
adversely affect the Company 's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's
internal control over financial reporting.
Dated: April 14, 2004
/s/ George E. Ponticas
George E. Ponticas
Chief Financial Officer
Exhibit 32.1
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, 2003, 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, 2004