UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
Commission file number 0-14465
SONEX RESEARCH, INC.
Incorporated in the State of Maryland
23 Hudson Street
Annapolis, Maryland 21401
Telephone Number: (410) 266-5556
IRS Employer Identification No. 52-1188993
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days.
YES [x] NO [ ]
There were 26,932,669 shares of the Issuer's $.01 par value Common Stock
outstanding at July 31, 2004.
SONEX RESEARCH, INC. FORM 10-QSB
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Balance sheets as of June 30, 2004 and December 31, 2003
Statements of operations and accumulated deficit for the three- and
six-month periods ended June 30, 2004 and 2003
Statements of paid-in capital for the period January 1, 2002 through June 30,
2004
Statements of cash flows for the six-month periods ended June 30, 2004 and 2003
Notes to financial statements
SONEX RESEARCH, INC.
BALANCE SHEETS
(Unaudited)
June 30, December 31,
ASSETS 2004 2003
------------ ------------
Current assets
Cash and equivalents $ 10,031 $ 7,616
Accounts receivable 161,045
Prepaid expenses 21,493 12,276
Deferred charges 54,000
Deferred financing costs 32,059
Loans to officers and employees 16,000 20,000
------------ ------------
Total current assets 133,583 200,937
Patents, net of accumulated amortization
of $80,002 in 2004 and $77,140 in 2003 185,448 202,518
Property and equipment, net of accumulated depreciation
of $350,254 in 2004 and $465,246 in 2003 96,194 103,005
------------ ----------
Total assets $ 415,225 $ 506,460
============ ==========
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities
Accounts payable and other accrued liabilities $ 42,141 $ 23,904
Short-term lines of credit 34,910 22,473
Deferred revenue - billings in excess of costs
and estimated profits on contracts in progress 42,834
Current portion of capital lease obligations 21,136 18,413
Notes and interest payable to shareholders 108,572 67,751
Accrued compensation and benefits 669,386 657,494
------------ ----------
Total current liabilities 876,145 832,869
------------ ----------
Capital lease obligations 26,601 33,698
------------ ----------
Deferred compensation 984,123 965,450
------------ ----------
Stockholders' equity/(deficit)
Preferred stock, $.01 par value - 2,000,000
shares issued; 1,540,001 shares outstanding 15,400 15,400
Common stock, $.01 par value, 48,000,000 shares
authorized, shares issued and outstanding:
26,932,669 in 2004 and 21,592,669 in 2003 269,327 215,927
Additional paid-in capital 22,270,784 21,511,436
Accumulated deficit (24,004,681) (23,046,389)
Notes receivable from officers and employees (22,474) (21,931)
------------ -----------
Total stockholders' equity/(deficit) (1,471,644) (1,325,557)
Commitments (Note 12)
------------ -----------
Total liabilities and stockholders' equity $ 415,225 $ 506,460
============ ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
(Unaudited)
Three months ended Six months ended
June 30, June 30,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Revenue $ 59,035 $ 214,573 $ 193,775 $ 388,902
---------- ---------- ---------- ----------
Costs and expenses
Cost of revenue 103,186 162,718 286,437 271,144
Research and development 9,831 44,089 23,283 119,135
General and administrative 216,092 89,848 834,433 180,123
Interest expense 1,653 1,202 8,503 3,921
---------- ---------- ---------- ----------
330,762 297,857 1,152,656 574,323
---------- ---------- ---------- ----------
Net loss from operations (271,727) (83,284) (958,881) (185,421)
Interest income 302 363 589 762
---------- ---------- ---------- ----------
Net loss (271,425) (82,921) (958,292) (184,659)
Accumulated deficit
Beginning of period (23,733,256)(22,742,649)(23,046,389)(22,640,911)
---------- ---------- ---------- ----------
End of period (24,004,681)(22,825,570)(24,004,681)(22,825,570)
========== ========== ========== ==========
Weighted average number of
common shares outstanding 26,635,416 21,592,669 24,737,339 21,592,669
========== ========== ========== ==========
Net loss per share (basic
and diluted) $ (.010) $ (.004) $ (.039) $ (.009)
========== ========== ========== ==========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF PAID-IN CAPITAL
(Unaudited)
Price Preferred stock Common stock Additional
per ($.01 par value) ($.01 par value) paid-in
share Shares Amount Shares Amount capital
----- --------- ------ ---------- ------- -----------
Balance, January 1, 2002 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 option compensation 90,694
--------- ------ ---------- ------- ----------
Balance, December 31, 2003 1,540,001 15,400 21,592,669 215,927 21,511,436
February per employment
agreement .01 800,000 8,000
February equity-based
compensation per
employment agreement 90,000
February for compensation
to officers and employee .10 250,000 2,500 22,500
February for consulting
services .10 1,530,000 15,300 137,700
March in payment of
accrued compensation .12 200,000 2,000 22,000
March in payment of
accrued consulting fees .12 200,000 2,000 22,000
March in connection with
issuance of note payable .12 10,000 100 1,100
March for legal fees .12 1,000,000 10,000 110,000
March for directors fees .12 200,000 2,000 22,000
April for consulting
services .10 420,000 4,200 37,800
April for consulting
services .16 210,000 2,100 31,500
April private placement .25 520,000 5,200 124,800
Stock option and warrant
compensation 137,948
--------- ------ ---------- ------- -----------
Balance, June 30, 2004 1,540,001$15,400 26,932,669$269,327 $22,270,784
========= ====== ========== ======= ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30,
------------------------
2004 2003
--------- ---------
Cash flows from operating activities
Net loss $ (958,292) $ (184,659)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities
Depreciation 14,750 13,600
Amortization of patents 18,414 11,200
Compensation from grant of stock options & warrants 137,948 51,673
Charges paid in stock 488,800
Current liabilities paid in stock 48,000
Accrued interest on loans to/notes from employees (543) (544)
Accrued interest on notes to shareholder 2,572 1,418
(Increase) decrease in accounts receivable 161,045 (91,791)
(Increase) decrease in prepaid expenses (9,217) (4,158)
(Increase) decrease in deferred charges (54,000)
Increase (decrease) in accrued liabilities 30,129 17,197
Increase (decrease) in billings in excess of costs (42,834) 45,088
Increase (decrease) in deferred compensation 18,673 33,750
----------- ----------
Net cash provided by (used in) operating activities (144,555) (107,226)
----------- ----------
Cash flows from investing activities
Decrease in loans to/notes from employees 4,000
Acquisition of property and equipment (3,383) (13,815)
Additions to patents (1,344) (3,977)
----------- ----------
Net cash provided by (used in) investing activities (727) (17,792)
----------- ----------
Cash flows from financing activities
Issuance of stock private placement 130,000
Issuance of stock to officer 8,000
(Increase) decrease in deferred financing costs (32,059)
Increase (decrease) in short-term lines of credit 12,437 18,357
Issuance of notes payable to shareholders 50,000 50,000
Payment of principal on notes to shareholders (10,000)
Payment of accrued interest on notes to shareholders (1,751) (1,327)
Reduction of capital lease obligations (8,930) (7,989)
----------- ----------
Net cash provided by (used in) financing activities 147,697 59,041
----------- ----------
Increase (decrease) in cash 2,415 (65,977)
Cash
Beginning of period 7,616 105,998
----------- ----------
End of period $ 10,031 $ 40,021
=========== ===========
Non-cash transactions:
Equipment acquired through capital
lease obligations $ 4,556 $ 43,002
=========== ===========
The accompanying notes are an integral part of the financial statements.
SONEX RESEARCH, INC
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - THE COMPANY
Sonex Research, Inc. has developed a proprietary technology, known as the Sonex
Combustion System (SCS), which improves the combustion of fuel in internal
combustion engines through modification of the pistons in large engines or the
cylinder heads in small engines. 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. In 2004 the Company is developing and implementing an
updated business plan, the primary goal of which is to transition from a
research and development company into a technology and manufacturing enterprise.
A key goal of the updated business plan is to expand the Company's
environmentally friendly technology base into related fields such as noise and
vibration control.
NOTE 2 - PRESENTATION OF FINANCIAL STATEMENTS
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and with the instructions to Form 10-QSB and
Item 310(b) of Regulation S-B. Accordingly, these financial statements do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included.
Operating results for the three- and six-month periods ended June 30, 2004 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2004. For further information, reference is made to the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-KSB for the year ended December 31, 2003.
NOTE 3 - REVENUE RECOGNITION AND MAJOR CUSTOMERS
All of the Company's revenue is derived from development and demonstration
contracts issued by a United States Government or Department of Defense (the
"Government") agency or prime contractor. During the second quarter of 2004, the
Company had an active contract with only one such customer.
Revenue is recognized upon the Company's completion of the milestones specified
in each contract. 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. In connection
with contracts in progress, any excess of billings over costs incurred plus
estimated profits 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.
NOTE 4 - 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.
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
September 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 objectives;
therefore, there remains substantial doubt about the Company's ability to
continue as a going concern.
NOTE 5 - RESTRUCTURING COSTS
During the first quarter of 2004, the Company experienced a number of
significant changes. In February 2004 the Board of Directors was reconstituted
and a new president was hired to fill the position that had been vacant. 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 and manufacturing enterprise. In connection with this
change in business strategy, in February and March 2004 the Company entered into
an employment agreement with its new president and executed other agreements for
consulting services and legal representation, 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 a
substantial number of shares of common stock. Details of these transactions are
presented in Note 11.
NOTE 6 - DEFERRED CHARGES
Deferred charges of $54,000 at June 30, 2004 represent compensation recorded in
connection with the issuance of common stock under the terms of the employment
agreement executed with the Company's new president in February 2004 as
described in detail in Note 11. The amount recorded as a current asset as of
June 30, 2004 is for compensation related to shares issued or to be issued but
not vested as of that date. This amount will be amortized to expense on the
vesting dates of the remaining shares through February 2005.
NOTE 7 - DEBT
Short-term lines of credit
The Company has obtained business credit cards from Capital One Bank with a
credit limit of $22,500 and Fleet National Bank with a credit limit of $19,000.
Repayment of amounts due has been personally guaranteed by the Company's
Chairman. Balances in the Capital One account accrue interest at a fixed rate of
8.9% per annum, while the Fleet account has a promotional interest rate of 1.9%
through September 2004, adjusting to prime rate + 6% thereafter. As of June 30,
2004, the outstanding balance on the account with Fleet was $18,051, while the
balance on the account with Capital One Bank was $16,859.
Capital Lease Obligations
During 2003 the Company incurred new capital lease obligations in the principal
amount of $50,753 in connection with the acquisition of equipment. 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 Chairman.
As of June 30, 2004, the aggregate outstanding principal balance on these two
lease obligations was $32,718.
Notes Payable to Shareholder
In June 2003 the Company issued a $50,000, 6% note to one of its shareholders
payable initially on December 31, 2003. The due date of this note has been
extended to September 30, 2004. In March 2004 the Company issued a $50,000, 6%
note to this same shareholder, initially payable on June 30, 2004. The due date
of this note also has been extended to September 30, 2004. Payment of both notes
is secured by Company revenues.
In connection with a private financing in March 2002, the Company issued a
$6,000, 6% note to this shareholder, 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 September 30, 2004.
Accrued interest on these notes of $2,572 is included in the June 30, 2004
balance shown in the accompanying balance sheet.
NOTE 8 - ACCRUED COMPENSATION AND BENEFITS
Accrued compensation consists of the following amounts:
June 30, December 31,
2004 2003
----------- -----------
Accrued wages and payroll taxes $ 305,490 $ 299,635
Accrued consulting fees 154,216 150,181
Accrued bonuses 151,076 154,068
Accrued vacation pay 58,604 53,610
----------- -----------
$ 669,386 $ 657,494
=========== ===========
The Company has operated under severe cash flow difficulties for extended
periods since 2001, prompting its 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. The total of accrued
wages and payroll taxes shown above consists entirely of amounts payable to the
Company's officers. The deferral of payment of such wages owed to 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 June 30, 2004 (a total of $148,505) are payable to three
individuals, including the Company's Chairman who, as of January 2004, is being
compensated as a consultant rather than as an employee. In March 2004 the
Company paid $24,000 of such previously accrued consulting fees through the
issuance of common stock.
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 9.
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 March 2004 the Company paid $24,000 of
such previously accrued bonuses through the issuance of common stock. The amount
of accrued bonuses included in the table above that was payable to two of the
Company's officers at June 30, 2004 is $98,500. Payment of such 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 9.
In February 2004 in connection with the execution of an employment agreement,
the Company awarded a bonus of $33,000 to its new president, with payment of
$25,000 of this amount being deferred until February 2006 under the terms of the
employment agreement. The deferred portion is included with accrued bonuses in
the table above.
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 June 30, 2004 was $52,017. 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 9.
NOTE 9 - 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 11.
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.
Under the terms of an employment agreement executed in February 2004, the
Company's new president is deferring annually $68,000 of his $140,000 salary
until March 2006 or until such earlier date as the Board of Directors determines
that the Company's cash flow is sufficient to allow payment.
Deferred compensation outstanding is payable to the following classifications of
personnel:
June 30, December 31,
2004 2003
----------- -----------
Current officers $ 662,672 $ 641,749
Current employees 12,504 12,504
Former officers, employees and consultants 308,947 311,197
----------- -----------
$ 984,123 $ 965,450
=========== ===========
The conditions that would require repayment of such deferred amounts have yet to
occur, and it is unlikely that such conditions will occur prior to June 30,
2005. 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.
The amount reported for current officers as of June 30, 2004 also includes
$20,923 owed to the Company's new president in accordance with the terms of his
employment agreement executed in February 2004. The agreement requires the new
president to defer annually $68,000 of his $140,000 salary until the expiration
of the agreement in March 2006 or at such earlier date as the Board of Directors
determines that the Company's cash flow is sufficient to allow payment.
NOTE 10 - INCOME TAXES
The Company has not incurred any federal or state income taxes since its
inception due to operating losses. At December 31, 2003, the Company had net
operating loss carryforwards of approximately $11.2 million available to offset
future taxable income. If certain substantial changes in the Company's ownership
should occur, there would be an annual limitation on the amount of the
carryforwards which can be utilized. Since 1995 net operating loss carryforwards
aggregating approximately $7.9 million have expired unused. Net operating loss
carryforwards of approximately $1.2 million are scheduled to expire at the end
of 2004.
NOTE 11 - CAPITAL STOCK
Authorized capital stock
The Company is presently authorized to issue 48 million shares of $.01 par value
common stock and 2 million shares of $.01 par value convertible preferred stock.
All of the authorized shares of preferred stock 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 June 30, 2004 a total of
459,999 shares of preferred stock had been converted into 1,314,278 shares of
common stock.
Private placement of common equity
In a private financing transaction in late April 2004, the Company raised
$130,000 through the issuance of 520,000 shares of the Company's common stock
and warrants to purchase an additional 520,000 shares of common stock
exercisable at $.25 per share through May 31, 2006. The offer and sale of these
shares of common stock and warrants to purchase shares of common stock 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.
Stock options and other equity-based compensation
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 April 2014.
From January 1, 2004 through June 30, 2004, the Company had the following
activity in options to purchase shares of common stock under the Plan:
Weighted Weighted
average # of average
# of exercise shares exercise
shares price exercisable price
------ ----- ----------- -----
Unexercised at January 1, 2004 4,683,907 $.41 4,360,407 $.42
Granted 150,000 .25 125,000 .25
Becoming exercisable 30,000 .25
Exercised
Lapsed (100,000) .25 (25,000) .25
--------- ---------
Unexercised at June 30, 2004 4,738,907 $.41 4,490,407 $.41
========= ==== ========= ====
The Company accounts for stock options and other stock-based compensation under
the fair value based method in accordance with Statement of Financial Accounting
Standards (SFAS) No. 123 - "Accounting for Stock-based Compensation". For
purposes of calculating charges to expense for stock option compensation under
SFAS No. 123, the Company has estimated the grant date fair value of each option
using the Black-Scholes option pricing model which takes into account weighted
average assumptions for stock price volatility, average risk-free interest rate
of return, expected dividend yield, and average expected term. For the six
months ended June 30, 2004 and 2003, in connection with options granted under
the Plan, the Company recorded stock option compensation under SFAS No. 123
totaling $25,948 and $30,965, respectively. The amount of compensation expense
is also credited to additional paid-in capital.
Under the terms of an employment agreement executed in February 2004, the
Company's new president was granted a ten-year option, not under the Plan, to
purchase 500,000 shares of common stock, which will vest and be exercisable in
accordance with the schedule presented below. For the six months ended June 30,
2004, the Company recorded compensation under SFAS No. 123 totaling $44,500 in
connection with this option grant.
Number Exercise price
Date becoming exercisable of shares per share
------------------------- --------- ---------
February 23, 2004 100,000 $0.25
August 23, 2004 100,000 $0.50
February 23, 2005 100,000 $1.00
August 23, 2005 100,000 $1.50
February 23, 2006 100,000 $2.00
Under the terms of a consulting agreement effective in February 2004, the
Company issued ten-year, immediately exercisable warrants to purchase 750,000
shares of common stock at the following prices: 250,000 shares at $.35, 250,000
shares at $.55, and 250,000 shares at $.75. During the first quarter of 2004,
the Company recorded compensation under SFAS No. 123 totaling $67,500 in
connection with this issuance of warrants.
Compensation expense associated with the grant of options and warrants is
summarized as follows:
Six months ended
June 30,
-----------------------------
2004 2003
----------- -----------
Option grants under Plan $ 25,948 $ 30,965
Other option grants 44,500
Issuance of warrants 67,500
----------- -----------
$ 137,948 $ 30,965
=========== ===========
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.
Also under the terms of the February 2004 employment agreement mentioned above,
the Company will issue to its new president a total of 1,000,000 shares of
common stock for cash of $.01 per share. Of this total, the new president
currently purchased 800,000 shares, with 200,000 of these shares having been
transferred to the new president upon execution of agreement, and the remaining
shares being held in escrow pending vesting of 200,000 shares at a time in
three, six and nine months. The Company is obligated to issue to its new
president an additional 200,000 shares of common stock for cash of $.01 per in
February 2005. With respect to this total of 1 million shares, the $.09 per
share discount between the purchase price and the market price of the stock of
$.10 per share on the effective date of the employment agreement is accounted
for as compensation for a total amount of $90,000. As of June 30, 2004, the
Company has charged to expense compensation of $36,000 for the shares which
vested immediately, and has recorded $54,000 in deferred charges as a current
asset and will amortize such charges to expense on the vesting dates of the
remaining shares.
Also in connection with the consulting agreement mentioned above, in February
2004 the Company issued 1,530,000 shares and in April 2004 issued 420,000 shares
of common stock. With respect to this total of 1,950,000 shares, during the
first quarter of 2004 the Company charged to expense compensation of $195,000
based on the market price of the stock of $.10 per share on the effective date
of the consulting agreement.
Also during the six months ended June 30, 2004, the Company recorded additional
compensation through the issuance of shares of common stock as set forth below.
Price/
Description share # of shares Expense
-------------------------- ----- ----------- ----------
Compensation to officers and employees $.10 250,000 $ 25,000
Consulting fees .16 210,000 33,600
Upon execution of agreement with new
legal counsel .12 1,000,000 120,000
Compensation to independent director .12 200,000 24,000
----------- ----------
Total 1,660,000 $ 182,600
=========== ==========
In March 2004 the Company satisfied liabilities for accrued compensation and
consulting fees through the issuance of shares of common stock as set forth
below.
Price/
Description share # of shares Amount
-------------------------- ----- ----------- ----------
Accrued bonus compensation payable
to officer $.12 200,000 $ 24,000
Accrued consulting fees .12 200,000 24,000
----------- ----------
Total 400,000 $ 48,000
=========== ==========
The issuance of the shares of common stock and warrants to purchase shares of
common stock described above 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. Certain of the shareholders have been
granted registration rights with respect to their shares.
Common stock reserved for future issuance
At June 30, 2004, a total of 13,486,832 shares of common stock were reserved by
the Company for issuance for the following purposes:
Purpose # of shares
---------------------------------------------- -----------
Currently exercisable warrants expiring in
December 2005, exercisable at $.50 per share 387,500
March 2006, exercisable at $.50 per share 250,000
April 2006, exercisable at $.50 per share 175,000
May 2006, exercisable at $.25 per share 520,000
March 2007, exercisable at $.25 per share 180,000
February 2014, exercisable at $.35 per share 250,000
February 2014, exercisable at $.55 per share 250,000
February 2014, exercisable at $.75 per share 250,000
-----------
2,262,500
Currently exercisable options under Plan 4,490,407
Granted options becoming exercisable in the future under Plan 243,500
Options available for future grants under Plan 1,330,425
Currently exercisable options outside of Plan 100,000
Granted options becoming exercisable in the future outside of Plan 400,000
Reserved for issuance to president in February 2005 200,000
Conversion of note payable 60,000
Conversion of preferred stock 4,400,000
-----------
Total shares reserved 13,486,832
===========
NOTE 12 - COMMITMENTS
Employment agreement
In February 2004 the Company entered into an employment agreement with its new
president which expires in March 2006. The agreement provides for an annual
salary of $140,000, of which $68,000 must be deferred annually 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.
Facility lease
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. The Company will
seek to negotiate a new long-term lease for its facility or search for an
alternative location in the event that a long-term agreement cannot be reached
for the existing premises. Management believes that the resolution of the
uncertainty with respect to the facility will not result in a significant
interruption in the operations of the Company.
Legal fee dispute
On March 25, 2004, the Company executed an engagement letter with a law firm in
Orlando, Florida (referred to as the "Florida firm"), for services related to
securities and corporate matters, including acquisitions, mergers and
financings. The engagement letter required the Company to issue to the Florida
firm one million shares of common stock, which shares were deemed earned
immediately upon execution of the engagement letter to insure the immediate
availability of the Florida firm to perform legal services. In addition, the
engagement letter required the Company by June 30, 2004 to pay to the Florida
firm all fees, costs and expenses incurred through that date, and to remit to
the Florida firm a cash retainer of $50,000 to insure the future availability of
the Florida firm to perform legal services and the payment of fees, costs and
expenses.
In May 2004 the Florida firm invoiced the Company $50,000 for fees, costs and
expenses incurred through April 30, 2004. The Company did not remit the $50,000
cash retainer required by the engagement letter. In July 2004 the Florida firm
invoiced the Company an additional $52,000 for the period May 1, 2004 through
June 30, 2004, notified the Company that it was in default of the provisions of
the engagement letter, and reserved the right to take all lawful actions to
preserve, protect, defend, and prosecute its rights and remedies against the
Company.
The Company disputed the Florida firm's entitlement to the fees claimed and is
presently represented by another attorney on a pro bono basis in connection with
this matter. The Company requested an explanation of, and the billing support
for, the amounts invoiced by the Florida firm in order to evaluate the charges
by services requested and performed. The Florida firm then informed the Company
by letter dated August 9, 2004, that it will not provide further legal services.
The Company believes that the amounts invoiced by the Florida firm are far in
excess of what is reasonable based on the limited services requested by the
Company and the limited work product provided by the Florida firm. The Company
has demanded the immediate return of the one million shares of common stock
issued to the Florida firm in connection with the engagement letter, and has
reserved its rights, including the right to pursue affirmative claims for the
damage the Florida firm has caused and continues to cause.
As of the filing of this Form 10-QSB, the Company has received no further
communication from the Florida firm. While the outcome of this dispute is
uncertain and may have an adverse effect on the Company's financial condition,
management believes that the Company has a defensible position. Accordingly, no
liability for any amounts related to this dispute has been recorded in the
accompanying financial statements as of June 30, 2004.
NOTE 13 - SUBSEQUENT EVENTS
In July 2004 the Company received a $192,932 follow-on task from the Defense
Advanced Research Projects Agency (DARPA) to continue development of a
multi-cylinder heavy fuel engine combustion process for potential Department of
Defense applications such as unmanned aerial vehicles (UAVs). The first payment
under this task of $56,132 was received in August 2004.
In connection with a private financing initiated in April 2004, the Company
raised $45,000 in August 2004 through the issuance of 180,000 shares of the
Company's common stock and warrants to purchase an additional 180,000 shares of
common stock exercisable at $.25 per share through May 31, 2006. The offer and
sale of these shares of common stock and warrants to purchase shares of common
stock 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
AND RESULTS OF OPERATIONS
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 June 30, 2004, the Company has five full-time employees and two part-time
employees, and engages the part-time services of several 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.
During the first quarter of 2004, the Company experienced a number of
significant changes. In February 2004 the Board of Directors was reconstituted
and a new president was hired to fill the position that had been vacant. 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 and manufacturing enterprise. A key goal of the
updated business plan is to expand the Company's environmentally friendly
technology base into related fields such as noise and vibration control. There
is no assurance, however, that the Company will be able to raise sufficient
capital to complete and implement this 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.
o ability to generate cash flow from revenue or to secure financing
necessary to fund future operations
o ability to complete technology development and demonstration programs,
demonstrate commercial viability of SCS technology and execute licensing
agreements that produce significant revenue
o ability to maintain and protect the Company's patents and proprietary
information
o ability to attract and retain skilled personnel
o ability to secure a long-term lease for the Company's existing facility
or to secure an alternative location
o changes in general economic conditions
o 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 $24 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 June 30, 2004, there were 26,932,669 shares of
Common Stock issued and outstanding, with an additional 13,486,832 shares
reserved for future issuance, primarily upon the conversion of preferred stock
and the exercise of options and warrants.
Competition
The Company faces significant competition from the extensive research
departments of the world's major vehicle and engine manufacturers. These
companies exercise a bias toward in-house technologies over those developed by
independent suppliers. Competition also comes from several independent engine
testing and consulting firms around the world which are in the business of
developing engine technologies. The Company's competitors have substantially
greater financial, technical and marketing resources than does the Company.
Accordingly, the Company cannot be sure that it will have the resources or
expertise to compete successfully in the future.
Although the experience and financial resources of its competitors far exceed
those of the Company, management believes that the SCS can provide significant
advantages over the competition in terms of low cost, improved performance, and
simplicity.
Secrecy and non-disclosure
Due to the highly competitive nature of the world's automotive and truck
industries, in connection with its contracts and/or demonstration programs with
such manufacturers, Sonex is required to execute joint secrecy and disclosure
agreements that, in most cases, expressly prohibit the public disclosure of the
names and other significant information about the participants and the current
or proposed programs. Failure by Sonex to maintain this strict level of
confidentiality would jeopardize its relationship with these organizations.
The same is true with respect to the Company's relationships with the U.S.
Department of Defense (DoD) and its prime contractors. In many instances the
Company is contractually prohibited from disclosing the name of the military
customer and/or specific details about the work being performed unless
permission has been obtained from the customer in advance.
Financial position and liquidity
The Company has operated under severe cash flow difficulties for extended
periods since 2001, prompting its 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. Similarly, the Company
has accumulated significant unpaid bonus and vacation compensation, as well as
consulting fees. As of June 30, 2004, total such unpaid amounts, as detailed in
Note 8 to the accompanying financial statements, aggregated $669,386.
The deferral of payment of current compensation owed to the Company's officers
and consultants cannot be expected to continue indefinitely, and the Company
will be required to pay amounts outstanding as soon as cash flow permits. 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 9 to the accompanying financial
statements.
As of June 30, 2004, the Company had available cash and equivalents of $10,031.
In July 2004 the Company received a $192,932 follow-on task from the Defense
Advanced Research Projects Agency (DARPA) to continue development of a
multi-cylinder heavy fuel engine combustion process for potential Department of
Defense applications such as unmanned aerial vehicles (UAVs). The first payment
under this task of $56,132 was received in August 2004. In connection with a
private financing initiated in April 2004, the Company raised $45,000 in August
2004 through the issuance of 180,000 shares of the Company's common stock and
warrants to purchase an additional 180,000 shares of common stock at $.25 per
share.
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. 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 September 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 objectives; therefore, there
remains substantial doubt about the Company's ability to continue as a going
concern.
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 unaudited 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.
Results of operations
A net loss of $958,292 was recorded for the first six months of 2004, as
compared to $184,659 for the corresponding period in 2003, an increase of
$771,708. Lower revenue and substantially higher total expenses, a significant
portion of which expenses relate to the restructuring undertaken by the Company,
accounted for the much larger net loss in the current period.
Revenue and cost of revenue:
Six months ended
June 30,
-----------------------------
2004 2003
------------ ------------
Revenue $ 193,775 $ 388,902
============ =============
Cost of revenue $ 286,437 $ 271,144
============ =============
Revenue decreased by $195,127, or 50%, from the first six months of 2003 to the
first six months of 2004, as work wound down in 2004 on two major projects from
branches of the U.S. government and DoD and/or their prime contractors which
were awarded to the Company during the second half of 2002. Combined revenue
from these two projects decreased from $333,202 in the first half of 2003 to
$122,849 in the current period. In July 2004 the Company received a $192,932
follow-on task from the Defense Advanced Research Projects Agency (DARPA) to
continue development of a multi-cylinder heavy fuel engine combustion process
for potential Department of Defense applications such as unmanned aerial
vehicles (UAVs). With respect to the second project, a subcontract for the
Company's diesel emission reduction technology from Compact Membrane Systems,
Inc. (CMS) under its prime contract from the U.S. Department of Energy (DOE),
the Company has received an indication from the DOE that funding to Sonex for
this project will not be continued.
Cost of revenue primarily consists of direct labor charges and other direct
expenditures, including those for technical consulting services, attributable to
funded programs, as well as allocated fringe benefits, payroll taxes, and labor
overhead charges. While cost of revenue during the first half of 2003 was 70% of
revenue, in the first six months of 2004 cost of revenue substantially exceeded
revenue, primarily due to significant, unanticipated project cost overruns.
Research and development (R&D) expenses:
Six months ended
June 30,
------------------------------
2004 2003
------------ -------------
Employee compensation, taxes & benefits $ 139,423 $ 231,310
Consulting fees 60,437 60,415
Other expenses 109,860 98,554
------------ -------------
Total expenses 309,720 390,279
Less amounts classified as cost of revenue (286,437) (271,144)
------------- -------------
Net R&D expenses $ 23,283 $ 119,135
============ =============
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.
Total expenses for the first six months of the year decreased by $80,559, or
21%, from 2003 to 2004, as a reduction in overall employee compensation was only
partially offset by an increase in other expenses. Employee compensation
decreased by $91,887, or 40%, as slight increases resulting from higher salary
rates in 2004 were more than offset by significant decreases relating to the
termination in the second half of 2003 of the employment of one engineer and the
change in status as of January 2004 of the Company's chief scientist and CEO
from salaried employee to consultant. Without this change in status, consulting
fees would have decreased from 2003 to 2004 with the reduced level of funded
work.
The increase in other expenses of $11,306, or 11%, from 2003 to 2004 reflects
charges incurred in the first quarter of 2004 for outside machining and
fabrication services for components for ongoing funded projects and the
write-off of unamortized patent costs on certain older foreign patents abandoned
by the Company.
General and administrative (G&A) expenses:
Six months ended
June 30,
------------------------------
2004 2003
------------ -------------
Employee compensation, taxes & benefits $ 252,394 $ 83,393
Consulting fees 366,537 60,098
Professional fees 151,325 13,463
Other expenses 64,177 23,169
------------ -------------
Total G&A expenses $ 834,433 $ 180,123
============ =============
Total G&A expenses for the first six months of the year more than quadrupled
from the comparable period in the prior year, largely due to substantial charges
incurred with the hiring of a new president in February 2004 who 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 and
manufacturing enterprise.
Employee compensation increased by $169,001 from 2003 to 2004, as charges for
the compensation of the new president totaled $156,577. This figure includes
amounts related to stock and stock option compensation, the award of a cash
bonus for which payment is being deferred until 2006, and salary. The Company's
new president is deferring payment of nearly 50% of his annual salary. Charges
in 2004 also include bonus compensation valued at $10,000 paid in stock to the
Company's chief financial officer.
Consulting fees increased by $306,439 from 2003 to 2004. Charges for 2004
include $262,500 associated with a consulting agreement effective in February
2004 for services to assist in the transition of the Company into a technology
and manufacturing enterprise under the updated business plan being developed.
Such charges consist of $195,000 for the value of common stock issuable and
$67,500 for the estimated fair value of warrants to purchase common stock.
The increase in professional fees of $137,862 from 2003 to 2004 is almost
entirely due to a charge in the first quarter of 2004 for a non-refundable
retainer to the Company's new securities legal counsel payable in stock valued
at $120,000.
The increase in other expenses of $41,008 from 2003 to 2004 is related primarily
to charges for stock-based compensation in the first quarter of 2004 for outside
directors, as well as higher travel expenditures.
ITEM 3. 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, has been the only employee involved in accounting and
financial reporting. The Board of Directors has recognized that 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; however, based on the demonstrated integrity and trustworthiness of
the Company's chief financial officer, the Board of Directors has had confidence
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 has been as
effective as is possible.
As of April 2004, the Board of Directors has implemented additional internal
controls by assigning certain responsibilities for the handling of incoming
receipts to the new president of the Company. There have been no other changes
in the Company's internal control over financial reporting since June 30, 2004
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting. As soon as is
practical, the Board of Directors will consider the assignment of specific
duties for various other aspects of internal control over financial reporting to
its chief executive officer and its president. Once sufficient capital is
secured, it is the Company's intention to increase staffing to mitigate the
current lack of segregation of duties within the accounting function and to
improve internal controls.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
In the second quarter of 2004, the Company issued an aggregate of 1,150,000
shares of common stock and warrants to purchase an aggregate of 520,000 shares
of common stock, without registration under the Securities Act of 1933 (the
"Securities Act"), as follows:
In April 2004 under the terms of a consulting agreement effective in
February 2004, the Company issued 420,000 shares of common stock for
services valued at $.10 per share.
In April 2004 the Company issued an aggregate of 210,000 shares of common
stock for services rendered by five consultants valued at $.16 per share.
In April 2004, the Company raised $130,000 through the issuance of 520,000
shares of common stock and warrants to purchase an additional 520,000
shares of common stock exercisable at $.25 per share through May 31, 2006.
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. EXHIBITS 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 - Incorporated by reference to the Company's Annual
Report on Form 10-KSB for the year ended December 31, 2003.
10.3 Stock Option Agreement dated February 23, 2004 with Roger D.
Posey, president - Incorporated by reference to the Company's
Annual Report on Form 10-KSB for the year ended December 31,
2003.
21 Subsidiaries of the Registrant: Sonex International, B.V. -
The Netherlands; Sonex Engines, Inc. -
Delaware (both are inactive subsidiaries).
24 Power of Attorney - Incorporated by reference to the Company's
Annual Report on Form 10-KSB for the year ended December 31,
2003.
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-QSB for the quarter ended June
30, 2004 pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
(b) Reports on Form 8-K.
During the second quarter of 2004, the Company filed the following Current
Reports on Form 8-K:
On April 16, 2004, to provide an update to shareholders following
the filing of the Company's Annual Report on Form 10-KSB for the
year ended December 31, 2003.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereto duly
authorized.
SONEX RESEARCH, INC.
(Registrant)
August 19, 2004 By: /s/ Andrew A. Pouring
--------------------------------------------
Andrew A. Pouring
Principal Executive Officer
August 19, 2004 By: /s/ George E. Ponticas
---------------------------------------------
George E. Ponticas
Principal Financial and Accounting Officer
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 Quarterly Report on Form 10-QSB of Sonex Research,
Inc. (the "Company"), a small business issuer, for the three months
ending June 30, 2004.
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 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 fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal
control over financial reporting;
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: August 19, 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 Quarterly Report on Form 10-QSB of Sonex Research,
Inc. (the "Company"), a small business issuer, for the three months
ending June 30, 2004.
2. Based on my knowledge, this 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 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 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 fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal
control over financial reporting;
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: August 19, 2004
/s/ George E. Ponticas
-----------------------
George E. Ponticas
Chief Financial Officer
Exhibit 32
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 Quarterly Report of Sonex Research, Inc. (the
"Company") on Form 10-QSB for the quarter ending June 30, 2004, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"),
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
August 19, 2004