It has been some time since we have been in a position to provide a comprehensive report on progress at Sonex, as the many legal and financial challenges we faced made it impossible for the Company to keep current with its Securities and Exchange Commission (“SEC”) reporting, resulting in the recent revocation of the SEC registration of the Company’s stock and suspension of trading.  Your ownership rights as shareholders, however, have not changed.  In addition, since it became necessary for Sonex to take stock transfer agent responsibilities in-house in 2006, we have been unable to communicate by mail with the entire shareholder body as in the past since we do not have the capability in-house to maintain the shareholder address database.  We are actively seeking to engage a new outside stock transfer agent to rectify this situation.

Nevertheless, we are pleased to report that there are positive developments taking place.  In particular, Sonex continues to benefit from the relationship with its licensee, Insitu, Inc., and recently received an extension of time and was awarded additional funding on our DARPA engine project.

Here, then, via our website is an update on what is happening at Sonex.

Financial Summary:

CONDENSED BALANCE SHEETS

(Unaudited)

                                                                              June 30,                       December 31,           

                                                                               2007                    2006                    2005      

Current assets:

Cash and equivalents                                   $        48,062      $      213,674      $        31,545   Accounts receivable                                               140,113                14,132

Prepaid expenses                                                    22,487                 19,929                17,802

  Total current assets                                             210,662              247,735                 49,347

Patents, net of accumulated amortization             112,738              116,205               125,577

Property and equipment, net of

   accumulated depreciation                                     61,584                64,095                 56,607

   Total assets                                                 $      384,984      $      428,035       $      231,531

Current liabilities:

Accounts payable & other accrued liabilities  $          3,577      $        15,295       $        27,772

Business credit card balances                                   5,228                18,073                 42,940

Deferred revenue                                                                                                             26,576

Capital lease obligations                                                                                                  16,727

Notes and interest payable to shareholders             10,000                40,000               197,989

Note payable – office equipment                                2,555                  3,048                   3,983

Deferred compensation                                       1,795,856           1,776,494            1,649,566

Total current liabilities                                          1,817,216           1,852,910            1,965,553

Stockholders' equity/(deficit):

Preferred stock, $.01 par value,

  2,000,000 shares authorized and issued,

  1,540,001 shares outstanding                                15,400                15,400                 15,400

Common stock, $.01 par value,

  48,000,000 shares authorized,

  24,504,336 shares issued and outstanding         245,044              245,044               245,044

Additional paid‑in capital                                    21,986,735         21,986,735          21,986,735

Accumulated deficit                                          (23,679,411)       (23,672,054)       (23,981,201)

Total stockholders' equity/(deficit)                      (1,432,232)         (1,424,875)         (1,734,022)

   Total liabilities and stockholders' equity       $      384,984      $      428,035       $      231,531

                                                  CONDENSED STATEMENTS OF OPERATIONS

                                                                                 (Unaudited)

                                                                        6 months ended

                                                                              June 30,           Year ended December 31,   

                                                                                2007                   2006                   2005      

Revenue:

  Licensing                                                       $           4,782     $       507,579

  Technology development contracts                         69,230              723,688     $       227,552

  Engine testing services                                          221,824                25,816              199,896

  Engine sales and commissions                                 5,180                10,722                81,990

                                                                                  301,016           1,267,805              509,438

Costs and expenses                                               (311,071)            (961,689)           (875,051)

Interest income                                                             2,698                  3,031                  1,227

Net income (loss)                                                        (7,357)             309,147            (364,386)

As reflected in the financial statement summary, the Company was able to pay substantial liabilities and earn a profit in 2006 thanks in large part to the November 2006 signing of the license and collaboration agreements with Insitu, Inc. of Bingen, Washington.  Sonex received cash payments for a non-refundable advance royalty and an exclusivity fee totaling $500,000, and will receive per unit royalties from Insitu for each engine produced over a certain volume.  The collaboration agreement provides for minimum consulting fees to Sonex of $240,000 over two years, $175,000 of which amount has been received through June 2007.

The cash generated from these agreements has permitted Sonex to repay nearly all of the approximately $198,000 in loans from shareholders Mike Keller and Denny Gulick, and nearly $43,000 in business credit card balances, outstanding as of the beginning of 2006, as well as make significant payments on compensation obligations.  Substantial amounts of unpaid compensation, however, remain outstanding.  Company officers Andy Pouring and George Ponticas, and consultant Mike Keller continue to defer all of their current compensation.  Mr. Ponticas has been receiving regular payments, and Dr. Pouring and Mr. Keller have been receiving occasional payments, on past unpaid compensation.  The Company would not have been able to remain in operation without these continued compensation deferrals.

Business relationship with Insitu:

Insitu, an unmanned aerial vehicle (UAV) pioneer, has developed the long endurance, low cost ScanEagle® UAV in partnership with The Boeing Company for military and commercial activities.  The ScanEagle, currently powered by the 3W-28i, 28cc, two-stroke gasoline engine, is used to provide services for the U.S. Marine Corps, U.S. Navy, and Australian Army.  The November 2006 license applies to the Sonex Combustion System (SCS) heavy fuel engine (HFE) technology applicable to UAVs powered by HFEs that are twenty horsepower or less.  Sonex is free to license its HFE technology for use in UAVs powered by engines exceeding 20 hp, or on any size HFE for non-UAV use such as in pumps, outboard engines, small watercraft, and generator sets.

In January 2007 Insitu announced that it set an endurance flight mark for the ScanEagle by running its engine modified with licensed HFE technology from Sonex, along with other enhancements developed by Insitu engineers, on JP-5 heavy fuel for 28 hours and 44 minutes.  The previous longest flight on a ScanEagle was 22 hours and 10 minutes using gasoline.  The endurance flight on JP-5 was conducted in temperatures ranging from -6^o C to -16^o C with no observed problems.  At cruise power levels, the ScanEagle using the SCS HFE^TM consumed up to 28% less fuel than with the stock gasoline engine.

Under the November 2006 collaboration agreement, Insitu has continued to engage Sonex for HFE testing services for performance refinement, endurance and other pre-production issues.

As reported on Insitu’s website (www.insitu.com) recently, “Boeing and Insitu flew a heavy fuel engine on its ScanEagle Block D at the AUVSI/NAVAIR Webster Field UAS Flight Demonstration on Monday August 6.  This is the first public display of a ScanEagle heavy fuel flight.  Insitu plans to be the first to market with a heavy fuel engine in the Small Tactical Unmanned Aerial System class vehicle as part of its Block E release early in the 2008.”  [AUVSI is the Association for Unmanned Vehicle Systems International.  NAVAIR is the Naval Air Systems Command.]

Also at the AUVSI conference, Insitu announced the introduction of its new, larger UAV known as the Integrator^TM.  In an interview published in the August 20, 2007 print edition of Defense News, also available on Insitu’s website, Insitu President and CEO Steven Sliwa stated the following:

 “The Integrator is going to be about a nine-horsepower engine; I’m not going to announce the brand at the moment. It’s going to start out gasoline and it will be converted to heavy fuel in the Block B release.  With the ScanEagle, we’re about to release the heavy-fuel engine.  We’re going to use a similar technology for converting this engine.  There’s a company called Sonex Research in Annapolis, Md., and we’ve taken their technology and made some engineering improvements to it and continue to work with them.”

Licensing revenue:

All reported licensing revenue has been generated from Insitu.  In addition to the advance royalty and exclusivity fee totaling $500,000, licensing revenue in 2006 also included $7,579 for reimbursement by Insitu to Sonex under the two agreements for all fees and costs required to maintain its patents.  The $4,782 in licensing revenue reported for 2007 to date also represents such reimbursements.  As a result of the payment by Insitu of the advance royalty in 2006, Sonex will not earn additional royalties unless and until Insitu’s production volumes exceed certain levels, which may not occur for some time, if at all.  The amount of the royalty is dependent on engine size and is subject to adjustment depending on engine volumes and the emergence of competitive HFEs in the licensed field.

Revenue from technology development contracts:

All technology development and demonstration revenue in the last three years has been generated from Insitu and the Defense Advanced Research Projects Agency (DARPA).  The DARPA project is detailed in a separate section.  Technology development and demonstration revenue from Insitu in 2005 and 2006 related to the initial development of a prototype combustion system to convert the ScanEagle’s 3W-28i gasoline engine to heavy fuel operation and subsequent tasks to develop, fabricate and qualify pre-production, flight ready SCS HFEs.  Work for Insitu in 2007 has been in the form of HFE testing services under the collaboration agreement.

Revenue from engine testing services:

In 2005 the Company generated revenue for engineering and engine testing services performed for the U.S. Department of Defense (DoD) activities or DoD contractors.  The majority of such services in 2005 related primarily to small gasoline engines used to power UAVs being deployed in Iraq, and was performed on an accelerated schedule at the request of the DoD.  There was little such revenue generated in 2006, with $25,000 of the total representing the up-front payment received upon execution of the collaboration agreement with Insitu.

Under the November 2006 collaboration agreement the parties planned to consult and cooperate to identify potential new projects including the continued development and commercial application of the SCS HFE technology.  The agreement provided for minimum consulting fees to Sonex of $240,000 over the next two years.  Subsequent to the $25,000 up-front payment, fees of $150,000 have been received through June 2007, although amounts invoiced for actual services have slightly exceeded the minimum fees.  The majority of the services performed for Insitu in 2007 have been in the form of testing services for HFE performance refinement, endurance and other pre-production issues.  Additional engine testing service revenue has been generated in 2007 from a DoD contractor which has tasked Sonex to evaluate candidate gasoline engines for potential conversion to heavy fuel operation to power a UAV.

Engine Sales:

Also in 2005, the Company generated revenue from the sale of a small quantity of two-stroke gasoline engines manufactured by Limbach Flugmotoren, GmbH & Co. KG of Germany.  Since late 2004, Sonex has been the exclusive U.S. and Canadian distributor of Limbach two- and four-stroke gasoline engines, which are high quality, lightweight, and reliable engines used in UAVs, powered gliders and very light aircraft.  The Company is not in a position to devote significant resources to market Limbach engines.  As a result, related revenue in 2006 and 2007 has been insignificant. 

Agreement with DARPA:

Since late 2002 the Company has been working under an agreement with DARPA for the development of a multi-cylinder, four-stroke, HFE combustion process for potential DoD applications. The SCS improves the combustion of fuels in four-stroke, direct injected (DI) engines through design modification of the pistons to achieve chemical/turbulent enhancement of combustion.  One form of the SCS, called Sonex Controlled Auto Ignition (SCAI), now being applied in the DARPA project allows ignition and combustion of low cetane heavy fuels by controlled auto-ignition at moderate compression ratios, and operates at controlled peak cylinder pressures, which should allow the design of lighter weight HFEs rather than the heavy weight required by normal diesel engines. 

The original objective of the current DARPA task was to apply the SCAI to the reconfiguration of a commercially available, 6-cylinder, automotive diesel engine that approximates the combustion chamber, displacement, bore and stroke of an objective 400 hp HFE.  Demonstration of the performance criteria of this reconfigured engine is intended to provide the impetus needed to establish a sustained DoD effort to develop and qualify lightweight HFEs.

Progress on the DARPA program slowed while the Company devoted most of its resources to the work with Insitu.  In July 2006 Sonex proposed a plan, which DARPA found acceptable, for schedule and cost risk reduction by lowering the power objective to 250 hp.  Characterization of the SCS process at the 250 hp level will provide an indication that the calculations previously reported for a 400 hp HFE may be ultimately achievable in hardware.  In November 2006 the Company reached a project billing milestone when the selected 6-cylinder, automotive diesel engine was assembled for the HFE tryout with the SCAI forged alloy pistons, customized fuel injection tips and extensively revised electronic controls.  Unfortunately, during the follow-on HFE refinement subtask, Sonex experienced technical setbacks leading to the request, subsequently granted by DARPA in June 2007, for modifications to the Agreement, including an extension of time and additional funding for the continuation of the current task.

Replacement pistons with the SCAI embodiments and ceramic coatings will be used for another HFE tryout prior to resumption of the HFE refinement subtask.  The current HFE refinement effort will focus on high loads and higher engine speeds leading to an HFE demonstration for DARPA during fall 2007.  Sonex will propose to DARPA a follow-on task to achieve a one-piece, fully qualified, cast aluminum alloy SCAI piston in order to demonstrate the SCAI HFE operating at the 400 hp level.  The outcomes from this project also relate to the use of SCS SCAI with gasoline and could have significant potential for commercial application in the automotive market.

The SCAI Process for Improving Fuel Mileage on Gasoline:

The SCAI sparkless, fully unthrottled, compression ignition combustion process has been advanced on kerosene-based heavy fuel through the DARPA program.  Sonex submits that its patented piston embodiments have the potential to enable a fuel mileage improvement of 25% to 30% in gasoline engines as well as to address the exhaust emissions challenges inherent to the relatively new class of higher performance engines known as gasoline direct injection (GDI) engines.  (In GDI engines, the fuel injectors are located in the combustion chamber rather than in the intake manifold as in conventional gasoline engines.  SCAI is enabled by a unique patented piston for engines using direct injection.)  The unthrottled SCAI technology responds to the challenging objectives of GDI engine technology to operate at all engine speeds with wide-open throttle to overcome the part-throttle loss of classical gasoline engines at low power and steady speed and to overcome inherent exhaust emissions of high oxides of nitrogen (NOx) and soot.

Additional, significant improvements in fuel economy are obtained from the compression ratio, SCAI rapid rate of heat release, combustion in a piston bowl (all after top-dead-center), and minimal interaction of the fuel with the cylinder wall during combustion.  Preliminary results of the SCAI operating in a laboratory 3-cylinder engine on low octane gasoline confirm the piston enabled, reactive chemical species ignition process and no-flame front combustion can be timed to occur after top-dead-center for maximum efficiency and high power output.  Sonex has obtained a 25% reduction in fuel consumption with non-optimized hardware.

Sonex has designed a three-phase program, expected to cost $1 million, to pursue commercialization of the SCAI combustion process for gasoline engines.  In the first phase, Sonex believes it can accomplish a six-month program to produce compelling SCAI combustion process engine data of a fuel mileage improvement of 25% to 30% in GDI engines.  The compelling data will be the basis of marketing to the automotive industry in Phase 2 as a patent and know-how licensing opportunity that yields significant financial return in Phase 3 based on the U.S. market of 16 million new gasoline powered vehicles per year.

The Sonex laboratory facilities would be available to pursue Phase 1 of the SCAI-GDI program while the proposed one-piece, fully qualified, cast aluminum alloy SCAI piston from the DARPA project is being designed and fabricated in a follow-on task to the DARPA agreement.  In Phase 1 of the proposed GDI venture, the SCAI-GDI piston design from the DARPA program will be refined to determine the ideal control parameters needed for SCAI-GDI engines with outstanding fuel consumption and emissions.

Litigation:

Only one legal action remains active, and that is the original Complaint alleging federal and state securities fraud filed in February 2005 in Federal Court in Pennsylvania by Bruce W. Majer of Plymouth Meeting, PA, his brother-in-law Allen W. Fortna of Whitehall, PA, and the Hermitage Partnership of Philadelphia, PA (together, referred to as the “Investors” or the “Plaintiffs”) seeking the return of $175,000 in equity investments made in Sonex during a private placement in 2004, plus unspecified compensatory and punitive damages.  Sonex management believes that the claims are without merit, and in March 2005 the Company filed a Motion to Dismiss the Complaint.  In July 2006 the Court granted the Company’s Motion to Dismiss, ruling that the Plaintiffs failed to state any of their claims as a matter of law.  In August 2006, the Investors amended and refiled their Complaint.

In September 2006 the Company filed a Motion to Dismiss the Amended Complaint.  In November 2006 the Plaintiffs filed an Opposition to the Company’s Motion to Dismiss, and in early December 2006 the Company filed its Reply in Support of its Motion to Dismiss.  Management believes that the Company will prevail again as it did when the original complaint was dismissed.  No schedule for this case has been released by the Court.  It is anticipated that the Court will decide the Motion to Dismiss prior to issuing any order concerning discovery on the merits of the allegations of the Complaint. 

Outlook:

Management is assessing the future needs of the Company and is working to develop an appropriate strategy for moving forward, including how best to maximize shareholder value.  With the signing in November 2006 of its first technology licensing agreement and approaching production roll-out by Insitu of the SCS HFE powered ScanEagle, Sonex has demonstrated the commercial viability of its small HFE technology in UAVs.  The Company is seeking to capitalize on this success by finding additional licensees for other SCS HFE applications and SCAI piston technology.  In order to fund the Company while that objective is pursued while recognizing that it will be some time before significant additional royalty revenue is generated, if at all, from the Insitu license, management will be looking for continuing revenue opportunities from technology development and demonstration projects and engine testing services.

There is no assurance that the Company will be able to generate significant revenues from the commercialization of its technology and ultimately achieve profitable operations.  Combined with the significant financial liabilities that remain, there is still substantial doubt about the Company’s ability to continue as a going concern.

Caution Regarding Forward-Looking Statements

This document contains information in the form of "forward-looking" statements within the meaning of the Private Securities Litigation Act of 1995 (the "Act").  Such statements are based on current expectations, estimates, projections and assumptions by management with respect to, among other things, trends affecting the Company's financial condition or results of operations and the impact of competition. Words such as "expects", "anticipates", "plans", "believes", "estimates", variations of such words, and similar expressions are intended to identify such statements that include, but are not limited to, projections of revenues, earnings, cash flows and contract awards.  Such 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.  In order to obtain the benefits of the "safe harbor" provisions of the Act for any such forward-looking statements, the Company cautions readers 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. Accordingly, readers are cautioned not to place undue reliance on such forward-looking statements.