SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549

                                    FORM 10-K

[X]  Annual Report Pursuant to Section 13 or 15(d) of the Securities and
     Exchange Act of 1934 For the fiscal year ended June 30, 1996, or

[ ]  Transition Report Pursuant to Section 13 or 15(d) of the Securities and
     Exchange Act of 1934 For the transition period from ________ to ________

                         Commission file number 0-17454

                                NOXSO CORPORATION
             (Exact name of registrant as specified in its charter)

               Virginia                                  54-1118334
     ----------------------------------     ------------------------------------
     (State or other jurisdiction           (I.R.S. Employer Identification No.)
      of incorporation or organization)

           2414 Lytle Road
           Bethel Park,  PA                          15102
     ---------------------------------------      ----------
     (Address of principal executive offices)     (Zip code)

Registrant's telephone number, including area code: (412) 854-1200

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

          Class
----------------------------
Common stock, $.01 par value

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X  No
                                      ---    ---

State the aggregate market value of the voting stock held by nonaffiliates of
the registrant at September 30, 1996: $38,138,300.

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

          Class                     Outstanding at September 30, 1996
----------------------------        ---------------------------------
Common stock, $.01 par value                    9,656,611

Documents Incorporated by Reference: None




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                                     PART I
Item 1.   Business

Background

     NOXSO   Corporation   (the  "Company")  is  a  development   stage  company
incorporated in Virginia on August 28, 1979. The Company is principally  engaged
in developing,  testing,  and marketing a process that is a dry  post-combustion
emission control  technology  which uses a regenerable  sorbent to remove a high
percentage of the pollutants which cause "acid rain" and ground level ozone from
flue gas generated by burning fossil fuel (the "NOXSO Process").  See "The NOXSO
Process" in this Item 1.

     From 1980 until 1984, the Company  devoted all of its efforts and resources
to identifying a test site to conduct basic research on the NOXSO Process and to
designing,  constructing and operating a mobile pre-pilot testing apparatus. The
Company  installed the pre-pilot  apparatus (at a facility having the equivalent
of  approximately  1/60  megawatts  in  electrical  generating  capacity)  on  a
coal-fired  utility  boiler at the Tennessee  Valley  Authority's  Shawnee Steam
Plant in  Paducah,  Kentucky.  From  1982 to 1984,  the  Company  operated  this
apparatus,  developed two separate experimental systems as part of the apparatus
and obtained the  performance  data needed to advance the Company's  development
program.

     From March 1985 to July 1986,  the Company  designed,  built and operated a
pre-pilot  plant  demonstration  of the NOXSO Process at the  Pittsburgh  Energy
Technology  Center  operated by the U.S.  Department  of Energy  ("DOE") under a
Cooperative Agreement with the DOE. The objectives of this Cooperative Agreement
were to establish a workable  system on a larger  pre-pilot scale plant that was
cost  effective and to confirm the operating  performance  and life of the NOXSO
sorbent. Under the Cooperative Agreement, the DOE modified an existing pre-pilot
plant and provided the equipment and operating personnel for the pre-pilot plant
test.

     From 1988 to 1993, the Company, W. R. Grace & Co. ("Grace") and MK-Ferguson
Company ("MK-Ferguson") prepared proposals, designed, constructed,  operated and
compiled and analyzed  results for a pilot-scale  demonstration  plant utilizing
the NOXSO Process (the "Pilot-Scale  Facility") at an Ohio Edison power plant in
Toronto,  Ohio under a grant from the DOE and the Ohio Coal  Development  Office
supplemented  by funds from the Company  and Grace.  The  project  entailed  the
construction,    operation   and   evaluation   of   the   first    larger-scale
fully-integrated  NOXSO Process  treatment  system,  treating flue gas generated
from approximately 5 megawatts of electrical  generating  capacity.  The Company
operated the test program at the  Pilot-Scale  Facility from July 1991 to August
1993. The test program was successfully  performed and the results  submitted to
and approved by the DOE in 1993.

     In 1989, the Company,  MK-Ferguson and Grace submitted a proposal on behalf
of the  Company  to  the  DOE to  secure  government  funding  to  commence  the
development of a full-scale

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commercial  demonstration  of the  NOXSO  Process  (the  "Full-Scale  Commercial
Demonstration") at a facility that had approximately 100 megawatts of electrical
generating  capacity.  In December 1989, the Federal government's Clean Coal III
Technology Program selected the Company's  proposal for a Full-Scale  Commercial
Demonstration.  In March  1991,  the DOE  entered  into a Clean Coal  Technology
Cooperative Agreement with MK-Ferguson (the "Cooperative  Agreement") to provide
funding for one-half of the then-estimated  $66 million cost of the project.  In
September  1994, the  Cooperative  Agreement was amended and novated to NOXSO by
MK-Ferguson.

     The  site  originally  proposed  for  the  construction  of the  Full-Scale
Commercial  Demonstration  was the  Niles  generating  station  of Ohio  Edison.
However,  during the course of the Company's  preliminary  design engineering at
this site, the Company  discovered that the plant's unique boiler design as well
as geological factors would necessitate costly and time consuming  modifications
to the plant and  adaptations  to the NOXSO  Process,  which were also likely to
cause the NOXSO Process to operate less  effectively.  In addition,  Ohio Edison
expressed a reluctance to purchase the process plant following the conclusion of
the Full-Scale Commercial Demonstration. Accordingly, the Company determined not
to proceed with the project at this site.

     In August 1994,  following its search for an alternative  site to operate a
Full-Scale  Commercial  Demonstration,   the  Company  entered  into  a  Project
Agreement  (the "Alcoa Project  Agreement")  with Alcoa  Generating  Corporation
("Alcoa")   for  the  design,   construction,   and   operation  of  a  proposed
demonstration  facility  (the  "NOXSO  Commercial  Demonstration  Facility")  at
Alcoa's Warrick Generating  Station in Newburgh,  Indiana (the "Alcoa Project").
The  project  definition  and  design  phases  of the  Alcoa  Project  have been
completed  by the  Company  in  accordance  with the  terms  of the  Cooperative
Agreement,  and the  construction  phase was commenced in June 1995. The Company
has received  all  necessary  approvals  from the DOE to proceed to complete the
Alcoa Project. As a part of the approval,  the DOE increased the funding for its
share of costs for the project from $33 million to $41.1 million. See "The Alcoa
Project" in this Item 1.

     In April 1995, the Company entered into a License, Construction,  Lease and
Sulfur Supply Agreement (the "Olin  Agreement") with Olin Corporation  ("Olin").
Under the Olin Agreement,  the Company is constructing a complementary  facility
(the  "Olin  Facility")  at Olin's  plant in  Charleston,  Tennessee  that is to
convert elemental sulfur which,  after the Alcoa Project is completed,  is to be
generated as a by-product of the Alcoa Project,  into liquid sulfur dioxide (the
"Olin Project"). See "The Olin Project" in this Item 1.

     The Company is also  engaged in  utilizing  its  engineering  expertise  to
develop other technologies,  processes, sorbents and facilities that can be used
to assist in complying with environmental laws, although all such efforts are at
this time  developmental in nature.  The Company also from time to time performs
research and development for others on a project basis.  See "Other Business" in
this Item 1. In  addition,  the  Company  is  offering  construction  management
services  to  others  through  its  70%-owned   subsidiary,   PROJEX,  Inc.  See
"Construction Management Services" in this Item 1.


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<PAGE>



The NOXSO Process

     The NOXSO  Process is a process  developed  by the Company to remove a high
percentage  of those  pollutants  which cause "acid rain" and ground level ozone
from  flue  gas  generated  by  burning   fossil  fuel.  The  NOXSO  Process  is
distinguishable from current conventional flue gas desulfurization  processes in
that it does not use liquids or slurries in a  "scrubber"  and does not generate
quantities of solid waste requiring disposal. More importantly,  it captures and
removes nitrogen oxides as well as sulfur oxides while conventional  "scrubbers"
capture and remove sulfur oxides only. The NOXSO Process uses sodium  (deposited
by a patented  process which is part of the NOXSO Process  technology) on porous
spheres of alumina  (aluminum oxide), to capture both sulfur oxides and nitrogen
oxides contained in the flue gas.

     The  capture of both  sulfur  oxides and  nitrogen  oxides,  referred to as
sorption,  is  carried  out by  contacting  the flue gas with the NOXSO  Process
sorbent (sodium on alumina) as the flue gas exits the boilers, just before it is
discharged  to the power plant  chimney.  The flue gas leaving the NOXSO Process
sorption  vessel  contains small amounts of residual  sulfur oxides and nitrogen
oxides  as well as fine  particles  of coal ash and  minor  amounts  of  sorbent
"fines." A filtering system is used to remove this  particulate  matter prior to
release to the power  plant  chimney.  The  sorbent  material,  now  holding the
chemically-bound  sulfur oxides and nitrogen oxides is removed from the sorption
vessel and conveyed to the regeneration  portion of the NOXSO Process system. In
the regeneration  section, the sorbent is heated and treated using any number of
reducing  agents to form sulfur oxides and hydrogen  sulfides  which are further
processed to produce  elemental  sulfur.  The nitrogen  oxides released when the
sorbent is heated to regeneration  temperature are returned with air to the coal
combustor.  In the  combustor,  the nitrogen  oxides are reduced to nitrogen and
oxygen which are released to the atmosphere.  The hot combustion air returned to
the  combustor  by the NOXSO  Process  results in a heat credit which is used to
offset process  operating  costs. The sulfur is recovered (and can be sold), and
the nitrogen is released into the atmosphere.  The sorbent,  now regenerated and
able to collect more sulfur oxides and nitrogen  oxides,  is cooled and returned
to the sorption vessel. In demonstrations conducted to date, between 70% and 95%
of the  nitrogen  oxide  emissions  and in  excess  of 95% of the  sulfur  oxide
emissions were simultaneously removed.

Regulatory Background

     The burning of coal, oil and gas as fuel for electric  power  generation in
power plants results in gases being released into the earth's  atmosphere.  This
gaseous emission is commonly referred to as "flue gas." Certain of the chemicals
and particles  contained in flue gas have been found to be harmful to man, other
animals, plants, lakes, forests and streams and to cause damage to paint, cloth,
building materials and other substances.  These harmful chemicals and particles,
commonly  referred to as air pollutants,  are the source of acid rain and ground
level ozone and have been the subject of much  investigation  by the  scientific
community  and,  since the  passage of the Clean Air Act,  the object of federal
government  regulation  through the actions of the United  States  Environmental
Protection Agency (the "EPA"). Of the many potential air pollutants contained in
flue gas from a coal-fired power plant, only sulfur dioxides  ("SO2"),  nitrogen
oxides ("NOx") and particulate matter have been

                                        4

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regulated through imposition of emission limitations,  i.e., a limitation on the
amount of each  pollutant  that the  source (in this  case,  a power  plant) may
release  into  the  atmosphere.  Until  recently,  Federal  regulation  of these
emissions  applied  only to new power  plants that  commenced  operations  after
September 1978.

     The Clean Air Act,  when enacted into law in 1979,  established  new source
performance  standards  that  required  the  removal  of a minimum of 70% of the
sulfur  dioxide when  uncontrolled  emissions are less than 0.6 pounds of sulfur
dioxide  per  million  Btu  and a  minimum  of 90% of the  sulfur  dioxide  when
uncontrolled emissions are greater than or equal to 1.2 pounds of sulfur dioxide
per million  Btu.  When  uncontrolled  emissions  are between 0.6 and 1.2 pounds
(inclusive)  of SO2,  the  minimum  percentage  removed is computed on a sliding
scale and falls  between  70% and 90%.  With  respect to power  plants for which
construction was commenced between August 1971 and September 1978, the Clean Air
Act limited  sulfur  dioxide  emissions  to an  absolute  limit of 1.2 pounds of
sulfur  dioxide per million  Btu  through the use of either  low-sulfur  coal or
scrubbers, as selected by the plant operator.

     In 1990, amendments to the Clean Air Act were enacted into law that require
the utility  industry to reduce  emissions  of sulfur and  nitrogen  oxides from
existing  fossil-fuel-fired power plants. This legislation regulates all utility
power plants having a generating capacity of at least 25 megawatts regardless of
when  placed  into  service.  The  amendments  will  force  drastic  cuts in SO2
emissions and place caps on nationwide  SO2 and NOx emissions  from  fossil-fuel
boilers. The 1990 Clean Air Act amendments and regulations  thereunder establish
a "market-based" system, rather than the "command-and-control" system previously
used to control SO2.

     The  law  provides  for  a  two-phased  program  to  reduce  SO2  emissions
nationwide  by 10 million tons from 1980  levels.  When fully  implemented,  the
amendments will limit  additional  annual  emissions of SO2 to 8.9 million tons.
Once reduced to this level,  electricity generators will be required to maintain
the level indefinitely,  regardless of capacity  additions.  Phase I, which went
into effect in 1995,  affects 261  boilers at 110 power  plants  which have been
identified  by EPA as having  the  highest  emissions.  Phase II,  which  begins
January 1, 2000,  will require the large  generators  to reduce  emissions by an
additional 50% and expand the program to  essentially  all  fossil-fuel  utility
boilers with  generating  capacity of 25  megawatts or more,  of which there are
approximately 2,000. Industrial units such as the ones owned by Alcoa may become
part of the program through certain "opt-in"  provisions of the regulations.  In
July,  1996,  Alcoa opted into the program  with  respect to Unit 2 (the unit at
which the NOXSO Commercial Demonstration Facility is to be built) at its Warrick
Power Plant in Newburgh, Indiana.

     The NOx  emission  provisions  of the  amendments  are not  nearly  as well
defined  as  the  SO2  provisions.  Initial  NOx  reduction  levels  are  to  be
established  by the EPA by January 1,  1997.  Thereafter,  the EPA is to adopt a
program for NOx reduction. The EPA has indicated that it is considering creating
a NOx allowance program similar to the SO2 allowance  Program,  but there can be
no assurance such a program will be implemented.


                                        5

<PAGE>



     Under the SO2 allowance  program,  each  generator  receives SO2 Allowances
("Allowances")  at the  beginning  of each year that,  when  used,  allows it to
generate  one ton of SO2  emissions  during  the  year of use.  To the  extent a
generator  does not expend  Allowances  in a year,  they can be  banked.  Banked
Allowances  can be applied to future use,  thus  enabling  facilities to execute
their  compliance  and  allowance   strategies  according  to  individual  plant
reduction  requirements,  system-wide  planning cycles, and  pollutant-reduction
requirements throughout their entire system. Allowances can also be sold for use
by others to enable them to emit SO2.

     The  standards set by the 1990  amendments,  as they relate to sulfur oxide
emissions,  are  unlikely to be met without the use of flue gas  desulfurization
("FGD") systems or certain advanced coal technologies now under development such
as the NOXSO  Process.  Available  FGD  systems,  commonly  called  "scrubbers,"
present operational problems, consume energy and, except for a few "regenerable"
processes, generate large volumes of solid waste material which must be disposed
of in an environmentally acceptable manner.

The Alcoa Project

     Under  the  Alcoa  Project   Agreement,   the  proposed  NOXSO   Commercial
Demonstration  Facility is to be built to treat a flue gas stream  from  Alcoa's
Warrick  Power  Plant  Unit  Number  2,  a 150  megawatt  electrical  generating
facility.  The projected cost of designing and constructing the Alcoa Project is
estimated  to be $52  million  of  which  approximately  $9.8  million  has been
expended as of September  30, 1996. In addition,  as described  below under "The
Olin Project" in this Item 1, the Company is constructing the complementary Olin
Facility for an estimated cost of $11 million.  The DOE has agreed to provide up
to $41.1  million to pay 50% of the costs  incurred by the Company to design and
construct the NOXSO Commercial  Demonstration Facility and the Olin Facility and
to pay for certain  operating  costs of the Alcoa  Project  during its first two
years of operation  (the  "Demonstration  Period").  The Company must provide or
arrange for the balance of the funding.  Through  September 30, 1996 the DOE had
provided  approximately  $9 million to the Company in connection  with the Alcoa
Project and Olin Project and  approximately  $9 million had been provided by the
Company from its capital  resources  and the loans from Olin and  Praxair,  Inc.
described below.

     The Alcoa Project Agreement provides for the two-year  Demonstration Period
to be followed by an 11-year  operating  period  ending no later than August 31,
2011 during which period the Company is to own and operate the proposed facility
(the "Operating Period").

     All conditions precedent to the Alcoa Project Agreement have been satisfied
with one exception.  On or before October 31, 1996,  NOXSO must present to Alcoa
evidence that it has in hand financial  resources  available for the performance
of its obligations  under the Alcoa Project Agreement of at least $35 million in
addition to funds to be provided by the DOE. As described below, NOXSO will seek
to satisfy the condition  through the sale during October 1996 of $40 million of
revenue  bonds  issued  by the  Indiana  Development  Financing  Authority,  the
proceeds of which are to be used to finance the Alcoa Project.


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     Under the Alcoa Project Agreement,  the Company is to receive approximately
17,000 Allowances per year, the actual amount varying depending upon the removal
efficiency of the NOXSO Commercial  Demonstration  Project. The Company believes
that the NOXSO  Process will work in a manner that will permit it to receive the
maximum  number of  Allowances  available  under the  Alcoa  Project  Agreement,
although  there can be no assurance  that it will receive the maximum  number of
Allowances.

     As discussed above, the 1990 amendments to the Clean Air Act and subsequent
regulations promulgated pursuant to those amendments have created a market-based
system  for  reducing  SO2  emissions.  Under  that  system,  which  began to be
phased-in  in  1995,  electric  utility  generators  receive  Allowances  at the
beginning of each year. Each allowance  permits the generator to emit one ton of
SO2 in a year. Generators can bank Allowances not used in a year or sell them to
other  electricity  generators  to be applied to permit them to emit  additional
SO2.  The Company  believes  that the revenue it will  receive  from the sale of
Allowances, together with revenue it receives under the Olin Agreement described
below will be adequate to pay all costs of operating  those  projects and of the
related Bond financing described below. However,  because the Allowances program
is the result of the 1990  amendments  to the Clean Air Act and the  regulations
thereunder,  some of which were not  promulgated  until  1995,  and  because the
emission  restrictions  began to be  phased-in  in 1995,  it is not  possible to
predict with any certainty the value of the Allowances  NOXSO is to receive from
Alcoa.

     The Alcoa Project  Agreement  also provides that if a system similar to the
SO2 allowance system is developed during the life of the Alcoa Project Agreement
that awards Alcoa  allowances  for  reductions in NOx emissions  effected by the
NOXSO  Commercial  Demonstration  Facility,  the parties are to revise the Alcoa
Project  Agreement to provide that,  under mutually  agreeable  conditions,  the
Company  will receive the  incremental  economic  benefit of the nitrogen  oxide
allowances  received  as a result  of the NOXSO  Process  after  accounting  for
economic  burdens,  if any,  imposed on Alcoa to comply  with the NOx  allowance
program. The amendments to the 1990 Clean Air Act mandate reductions in nitrogen
oxide  emissions,  but do not create an allowance  program for those  emissions.
Although  some  states,  including  California,   have  adopted  nitrogen  oxide
allowance programs,  and the U.S. EPA is considering  adoption of such a program
to implement  the NOx  provisions  of the 1990  amendments to the Clean Air Act,
neither Indiana nor the U.S. government has adopted such a program and there can
be no assurance  that such a program will be created or  implemented  during the
life of the  Alcoa  Project  Agreement  or that  there  will be any  incremental
benefit available to the Company as a result of any such program.

     The Company will not receive any other payments or revenues under the Alcoa
Project Agreement.  The Company is required under the Alcoa Project Agreement to
pay the costs of operating the NOXSO  Commercial  Demonstration  Facility during
the 11-year Operating  Period.  Alcoa is to pay certain of such costs during the
two-year Demonstration Period (with the remainder being paid by NOXSO).


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     If the  NOXSO  Process  does not work as  expected  or,  in  certain  other
instances,  including if there is a cessation in the  Allowance  program or some
other legislative change or event that results in a substantial reduction in the
Allowances  available  to  Alcoa,  Alcoa has the  right to  terminate  the Alcoa
Project Agreement.  Alcoa also has the right, subject to certain conditions,  to
terminate  the  agreement  if it ceases  to  operate  the unit at its  Newburgh,
Indiana  plant  (Unit  Number 2) that is to  provide  the flue gas  stream to be
treated  at  the  NOXSO  Commercial   Demonstration   Facility.   Under  certain
circumstances,  the Company has the right to treat the flue gas from a different
unit at Alcoa's Newburgh plant if Alcoa ceases to operate Unit Number 2.

     During  the  term of the  Alcoa  Project  Agreement,  until  the end of the
Operating  Period,  the  Company  will own the  NOXSO  Commercial  Demonstration
Facility.  At the end of the  operating  period,  at the  option  of  Alcoa,  in
consideration  of the payment of $500,  the Company is required to deliver title
to the NOXSO Commercial Demonstration Facility to Alcoa.

The Olin Project

     Under the Olin Agreement,  the Company is constructing the Olin Facility at
Olin's plant in Charleston,  Tennessee. The Olin Facility will convert elemental
sulfur into liquid sulfur  dioxide.  The estimated  cost of the Olin Facility is
$11 million,  of which  approximately  $8.2  million has been  expended to date.
Provided  that the Olin Facility  produces  sulfur  dioxide in  accordance  with
specifications  set forth in the Olin Agreement,  Olin is required for a 10-year
period  after the Olin  Facility  is  operational,  to pay to the  Company  $3.4
million  annually  which  amount is  subject  to  adjustment  after six years to
account for changes in the Company's cost of producing  elemental  sulfur at the
Alcoa Project,  and the Company is to deliver to Olin 16,000 short tons per year
of elemental  sulfur.  Once the Alcoa Project is operational,  it is anticipated
that all or virtually  all of the 16,000 short tons of elemental  sulfur will be
produced by the Alcoa Project. Until that date, the Company will have to pay the
costs of  purchasing  elemental  sulfur  from  suppliers.  Based  on  historical
pricing,  it is anticipated  that the cost of elemental  sulfur purchased in the
open market will be approximately 12% to 25% of the consideration the Company is
to  receive  from  Olin  under  the Olin  Agreement,  although  there  can be no
assurance the cost will not be greater.  The Company presently  believes that it
will be  able to  complete  the  Alcoa  Project  so that it is  operational  and
producing  elemental sulfur by April 1998. There can, of course, be no assurance
that the Alcoa  Project will be completed by such date,  if at all. See "Forward
Looking Statements" in this Item 1.

     Under the terms of the Olin  Agreement,  the Company's  failure to complete
the Olin Facility by September 1, 1996 entitled Olin to require that the Company
pay to Olin the  amount by which (i) the costs  Olin  incurs to  purchase  up to
2,667  short  tons  of  sulfur  dioxide  per  month  (exclusive  of the  cost of
transportation)  until the Olin Project is operational  exceeds (ii) the cost of
such amount of sulfur dioxide at a price of $130 per short ton. The Company owes
approximately $17,000 to Olin for September 1996 and anticipates that thereafter
it will be required to pay Olin no more than  $70,000 per month with  respect to
sulfur  dioxide   purchases  by  Olin  thereafter  until  the  Olin  Project  is
operational,  although  there can be no  assurance  that the cost to the Company
will not be greater.


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     In  addition,  if the  Company  fails to  substantially  complete  the Olin
Facility  by April 1,  1997,  Olin  will have the  right to  terminate  the Olin
Agreement.  The Company is in the process of completing construction of the Olin
Facility and anticipates  that it will be  substantially  completed by December,
1996 and operational by January, 1997. There can be no assurance that NOXSO will
meet the foregoing schedule.

     In the event that sulfur  dioxide  produced by the Olin  Facility  does not
meet the  specifications  set  forth in the Olin  Agreement,  Olin  will have no
obligation to make any payments to the Company.  There can be no assurance  that
the Olin Facility will produce sulfur dioxide meeting the  specifications  until
it  has  been  tested.   Testing  will  not  commence   until  the  facility  is
substantially completed.

     Under the Olin Agreement,  Olin is responsible for operating and paying the
costs of operation of the Olin Facility other than the cost of replacing capital
items,  which  costs are to be paid by the  Company on a pro rata basis based on
the number of years during the term that remain at the time of the replacement.

     Olin and the  Company  are  presently  in the  process  of  negotiating  an
amendment to the Olin  Agreement.  Under the amendment,  if it is executed,  the
annual  amount  required  to be paid by Olin  under the Olin  Agreement  will be
reduced to $3 million annually (subject to adjustment after six years to account
for changes in the  Company's  cost of producing  elemental  sulfur at the Alcoa
Project).  At the end of the initial  10-year term, Olin would have an option to
purchase  the Olin  Facility  for $2.2  million  which  purchase  price would be
reduced by $250,000 per year over the four years thereafter.  In addition,  Olin
would  agree to  purchase  at the  option of the  Company  the lesser of (i) its
requirements of elemental sulfur or (ii) 16,000 short tons per year of elemental
sulfur at competitive  prices for elemental sulfur established on a yearly basis
during the four-year  period after the expiration of the initial 10-year term of
the sulfur  purchase  portion of the Olin  Agreement,  plus an  additional  $1.2
million per year until Olin purchases the Olin Facility.

     The  Olin  Facility  consists  of an air  separation  plant  that is  being
supplied  to the  Company  by  Praxair,  Inc.  and a sulfur  dioxide  conversion
facility  that was to be  manufactured  and  supplied by  Calabrian  Corporation
("Calabrian") under a Purchase Agreement and License Agreement with the Company.
In May 1996,  Calabrian  abandoned  its portion of the Olin  Facility  and, as a
result,  the  Company was forced to assume  responsibility  for  completing  the
design and  construction  of that  portion of the project  which was  abandoned.
Calabrian  and the Company are  currently  engaged in  litigation  regarding the
abandonment of the project by Calabrian. See Item 3.


Financing

      The funds needed, in addition to those available from the DOE, to complete
the Alcoa project are expected to be provided from the proceeds of $40 million
Indiana Development Finance Authority Taxable Clean Coal Technology Variable
Rate Demand Revenue Bonds (the "Bonds"). In March 1995, the legislature of
Indiana passed a bill establishing a state sponsored program under which the

                                        9

<PAGE>



State of Indiana was  authorized to support the Bonds with the moral  obligation
guarantee  described  below.  On  September  16, 1996,  the Indiana  Development
Finance Authority (the "Authority")  adopted resolutions  approving the issuance
of the Bonds.  However, the Company is still seeking to resolve certain concerns
of representatives of the Authority and the Company has not entered into a final
agreement with the issuer of a direct-pay  letter of credit  required to support
and secure the Bonds.  In addition,  in order to satisfy the  conditions  to the
issuance of the Bonds, among other things (i) the Company must obtain additional
equity capital of  approximately $5 million during October 1996, $2.5 million of
which is to be used to fund  one-half  of a  supplemental  reserve to secure the
Bonds and the remainder of which is to be used to repay  outstanding  loans made
to the  Company  by Olin and  Praxair  described  below,  and (ii) the County of
Warrick,  Indiana must fund or irrevocably commit to fund, in cash or by causing
a letter of credit or its  equivalent  to be  issued,  $2.5  million to fund the
other half of the supplemental reserve.

     The Company  intends to raise the required equity capital through a private
placement of its common stock,  the terms of which placement are presently being
negotiated and are contingent upon the satisfactory  completion of due diligence
and other conditions. Any shares issued in the private placement are expected to
contain  restrictions on resale in accordance with Federal  securities laws and,
thus,  are  expected  to be sold at a  discount  to the  market  price of freely
tradeable shares.  Some, but not all,  required  approvals have been obtained in
order for  Warrick  County to commit  to fund its  portion  of the  supplemental
reserve fund.

     Accordingly,  there  can  be no  assurance  that  either  condition  to the
issuance of the Bonds can be satisfied  prior to October 31,  1996,  the date by
which the Alcoa  Agreement  presently  requires  that the  Company  have in hand
financial  resources  available for the performance of its obligations under the
Alcoa  Project  Agreement  of at least $35  million in  addition  to funds to be
provided by the DOE. If such  financing  is not in hand by that date,  Alcoa has
the right, at its option,  to terminate its obligations  under the Alcoa Project
Agreement.

     As approved by the Authority,  the Bonds are to have a 15-year term and are
to  bear  interest  at a rate  that  will  be  set by  Bear,  Stearns  & Co.  as
remarketing agent (the "Remarketing Agent") on a weekly basis. The rate is to be
the lowest rate (not in excess of 12%) at which the  Remarketing  Agent,  in its
judgment based on prevailing  financial  market  conditions,  believes the Bonds
could be sold at a price equal to 100% of the  principal  amount  thereof,  plus
accrued  interest,  on  the  date  of  each  determination.  In  the  event  the
Remarketing Agent fails at any time to set or announce a rate in accordance with
the  Bond  documents,  the rate is to be  equal  to 101% of the  30-day  Federal
Reserve AA composite index rate.

     Holders of the Bonds are entitled to tender the Bonds at any time by giving
at least  seven  days  prior  notice at a price  equal to 100% of the  principal
amount  thereof,  plus unpaid and accrued  interest  thereon.  In such case, the
Remarketing  Agent is to use its best  efforts to remarket  the Bonds.  If it is
unable to do so, the letter of credit bank must then  purchase the Bonds through
a draw on the letter of credit,  in which case the Company will have obligations
with respect to the draw, as described below.

                                       10

<PAGE>



     The  Bonds  are  to  be  subject  to  mandatory   sinking  fund  redemption
requirements  on  September  1 of each year.  In  addition,  the Bonds are to be
subject to  mandatory  redemption  upon the  expiration  of the letter of credit
without  extension or in certain  other  events,  and the Company is to have the
right to redeem the Bonds at par at any time.

     The Company is in the process of negotiating  the terms of a  reimbursement
agreement  pursuant  to which a letter of credit to support and secure the Bonds
would be issued by Canadian  Imperial Bank of Commerce,  as agent for itself and
other banks. Under the terms being discussed, draws on the letter of credit that
are not repaid within  certain time periods are converted  into  five-year  term
loans.  Term loans that result from a termination  or non-renewal of a letter of
credit are to bear  interest  at a rate  equal to LIBOR plus 1% per annum.  Term
loans that result from draws to purchase bonds tendered and not remarketed  that
are not reimbursed  within 60 days are to bear interest at a rate equal to LIBOR
plus 2.25% per annum. In addition, the default rate is equal to LIBOR plus 2.25%
per annum.

     The letter of credit banks are also to receive  letter of credit fees equal
to 1.10% during  construction of the Alcoa Project and 1% per annum  thereafter,
as well as certain other  administrative  fees. The Company's  obligations under
the reimbursement  agreement proposed and with respect to repayment of the Bonds
is to be secured by a pledge of all revenues  relating to the Alcoa  Project and
the Olin Project (collectively,  the "Projects"),  which revenues are to be held
in trust by a trustee for the letter of credit bank and for the Authority.  As a
result,  until the Bonds are paid in full,  revenues  from the Projects  will be
available  only to secure and repay the Bonds and will not be  available  to the
Company for any other  purposes.  In addition,  the Bonds will be secured by the
collateral assignment of all agreements of the Company relating to the Projects,
including the Alcoa Agreement and the Olin Agreement.

     As a part of the  inducement  to the  letter of  credit  banks to issue the
letter  of  credit,  the  Authority  is also to agree to a  contractual  "moral"
obligation under which, in certain events, it will request an appropriation from
the Indiana  General  Assembly to provide funds to replenish debt reserves or to
repay the Bonds in full. This  contractual  moral obligation is not intended to,
and will not,  create a debtor  liability  of the State of  Indiana  to make any
appropriation  or payment to or for the use of the Authority,  and the Authority
does not have the power to compel the Indiana  General  Assembly to  appropriate
monies upon request.  In certain instances,  as a result of appropriations  with
respect to the contractual moral obligation, if they are made, the Authority may
purchase  the  rights  of the  letter of credit  banks  under the  reimbursement
agreement with the Company. In such cases, the Company would be obligated to the
Authority in the same manner as it is obligated to the letter of credit banks.

     In order to provide  for  construction  of the Olin  Facility,  the Company
obtained a loan from Olin in the amount of $1.874 million that,  since April 12,
1996, has borne interest at a rate of 10% per annum. In August 1996, the Company
also  obtained  the  agreement  of Praxair to defer  payment of the $2.7 million
balance owed for the air separation plant until completion of the bond financing
but no later  than  September  30,1996.  As of  October  14,  1996  Praxair  was
continuing to perform

                                       11

<PAGE>



work on its portion of the Olin Project.  In connection with said agreement with
Praxair, the Company agreed to pay late charges of .3% per week from the date of
each outstanding  invoice and to assign revenues it is entitled to receive under
the Olin  Agreement to Praxair  until the Company's  obligations  to Praxair are
paid in full.

     The  agreements  regarding  the Olin  loan  provide  that the loan is to be
repaid on demand,  but in no event  later than  October  31,  1996.  The loan is
secured by a security interest in all of the Company's  personal  property.  The
loan proceeds have been or are being used to complete  construction  of the Olin
Facility.

     The Olin loan and the Company's  obligations  to Praxair are expected to be
repaid  with funds  available  to the  Company  from the  proceeds of the equity
investment described above.

Business Strategy

     The principal  focus of the Company in the near term will be to finance and
complete the  construction of the Alcoa Project.  The Company's  long-term goals
are to derive  revenues from  licensing the NOXSO Process to  engineering  firms
which specialize in construction of pollution control systems, from sublicensing
fees payable on units those firms sell to others, and from royalties on the sale
by suppliers of sorbent sold to users of the NOXSO Process. The Company may also
directly sell the  technology to end users in return for licensing  fees. If the
NOXSO Process is successfully  commercialized,  the Company expects that it will
also receive  revenue from the  provision  of technical  assistance  and process
engineering  services and that it will  continue to improve and refine the NOXSO
Process.

     The Company  also intends to utilize its  engineering  expertise to develop
other  technologies,  processes,  substances  and facilities to assist others to
comply with  environmental  laws and  regulations  and to perform  research  and
development projects for others. See "Other Business" in this Item 1.

Markets for the NOXSO Process

     The  Company  believes  that the size of the  potential  market  for  NOXSO
Process  treatment  plants  will  depend on a number of  factors.  The acid rain
provisions  of the  amendments  to the Clean Air Act passed by  Congress in 1990
impose  additional  restrictions  on NOx and SO2 emissions at  coal-fired  power
plants.  Facilities  regulated  under the law were  required  to comply with the
Phase I levels  by 1995 and  Phase II  levels  by the  year  2000.  The  Company
believes  this  legislation  will  increase  demand  for the NOXSO  Process  and
competitive processes in and after the year 2000.

     According  to the DOE, in 1994,  52% of all  electricity  generated  in the
United States was generated by coal-burning power plants. Although concerns over
air quality impose  limitations  on the use of coal rather than cleaner  burning
oil and gas, the Company  believes that the increasing  dependency of the United
States on  foreign  oil and  limited  known  domestic  reserves  of oil and gas,
together  with the  increase  in energy  demand,  may result in coal  playing an
increasing role in

                                       12

<PAGE>



electrical power generation.  To the Company's knowledge,  there are several new
coal-burning power plants planned for start-up within the next five to 10 years.
However,  to  the  extent  existing   alternative  energy  sources  become  more
attractive  or new energy  sources are  developed  and prove to be  economically
feasible,  the  use of  coal  as an  energy  source  may  decrease.  This  would
materially reduce the potential market for the NOXSO Process.

     In  addition,   the  Company  believes  that,  although  earlier  sales  of
commercial  NOXSO  Process  units are  possible,  for the most part the  utility
industry will require commercial-scale  demonstration of the NOXSO Process prior
to  committing to the  installation  of such a system to prove the technical and
economic  viability  of  the  process.  The  Company's  efforts  over  the  next
approximately two years will be concentrated on establishing a viable full-scale
commercial  demonstration of the NOXSO Commercial  Demonstration  Facility.  See
"The Alcoa Project" in this Item 1.

     If the NOXSO Process proves successful,  the Company intends to license the
NOXSO   technology  to  engineering   firms  that   specialize  in  the  design,
construction and  installation of pollution  control systems on new and existing
power  plants in exchange for a license fee to the Company and  sublicense  fees
from purchasers of facilities and the Company  anticipates  receiving  royalties
from the sale of sorbent.  The Company also intends to promote the NOXSO Process
directly to the utility and independent power producing industries.  The Company
expects that there will be a  significant  educational  process  required in the
initial marketing of the NOXSO Process.  To begin this process,  during the past
three fiscal years,  the Company  established a marketing  program by hiring two
senior  professional  sales engineers who are highly  experienced in the utility
industry.  The focus of this marketing activity has been to identify a host site
for the Full-Scale  Commercial  Demonstration and to pursue other  opportunities
for future sales of the NOXSO Process.  The Company also hopes to secure license
fees from sales in other  countries  under the FLS License  Agreement  described
below.

     It is anticipated  that, if the NOXSO Process is successful,  the Company's
revenues will be derived  principally from technology license fees and royalties
on the sale of sorbent and, to a lesser extent, by developing other technologies
and  performing  research  and  development  projects  for others and  providing
construction  management  services.  See "Construction  Management Services" and
"Other Business" in this Item 1.

Competition

     The  market  for  pollution  control  equipment  is  directly  impacted  by
environmental laws and regulations.  Federal,  state, and local governments have
enacted laws which set required  reductions  in pollutant  emissions  levels for
certain  industries or a specific source category within an industry by specific
dates.  The market for the NOXSO Process and the  competition for a share of the
market  is,  therefore,  dependent  upon  deadlines  set by  regulators  and the
commercial readiness of the NOXSO system.

     The pollution control business is highly  competitive.  Numerous  companies
are engaged in the construction of flue gas desulfurization  systems,  and there
are a few companies now engaged in

                                       13

<PAGE>



the development of regenerable  systems (systems which,  like the NOXSO Process,
do not  produce  sludge  for  disposal).  At this time,  however,  the market is
dominated by companies  marketing lime and limestone  systems (sludge  producing
systems).

     Many of the companies  engaged in the  development or  construction of flue
gas emission  control systems are  well-established  in this field. The dominant
companies  in the  United  States  include  General  Electric,  Babcock & Wilcox
Company, Asea Brown Boveri, Wheelabrator, Joy Bischoff and Pure Air. The Company
does not intend to construct  pollution control facilities itself, but will seek
to license the technology to major  engineering  firms engaged in the design and
construction of pollution control equipment.

     Clean coal technologies can be generally  grouped into two categories:  (i)
retrofitting, which can be used on existing plants to reduce emissions, and (ii)
repowering, which replaces a significant portion of the original power plant and
often increases capacity while reducing emissions. The retrofitting technologies
include lime/limestone scrubbing,  limestone injection multi-stage burner, spray
drying,  sorbent duct  injection  and  advanced  flue gas  clean-up,  the use of
electron beam radiation to simultaneously remove both sulfur oxides and nitrogen
oxides,  the use of metal oxides such as copper for sulfur  dioxide  control and
selective  catalytic  reduction  of  nitrogen  oxides  by  ammonia.   The  major
repowering technologies include integrated  gasification/combined cycle ("IGCC")
and  fluidized-bed  combustion  ("FBC").  IGCC is a power generating  process in
which coal is  gasified  and the  sulfur  compounds  are  removed.  During  this
process,  the gas  produced is used to fuel a gas turbine  and  subsequently  to
generate  steam to operate a steam  turbine.  FBC is a process  of burning  coal
while it is in a  fluidized  or  suspended  mixture  of air and  limestone.  FBC
extracts  sulfur during  combustion  rather than  cleansing the flue gas.  Other
clean coal  technologies  include  advanced coal cleaning,  modification  of the
combustion  process to reduce nitrogen oxide  production,  coal liquefaction and
coal gasification.

     At  present,  the  Company  is  aware of only  one  commercially  available
approach to control both sulfur and nitrogen  oxides.  Flue gas  desulfurization
coupled with selective  catalytic reduction of nitrogen oxide is currently being
used in Germany and Japan,  where strict  regulations  governing their emissions
are already in force.  This approach uses two separate systems and equipment for
removing sulfur dioxide and nitrogen oxide. The Company estimates,  based on its
pilot test results, that the combined cost of using these two methods is greater
than using a NOXSO Process treatment plant for a major utility. In addition, the
Company  believes  that the  NOXSO  Process  will be more  cost-efficient  on an
operating  basis.  At this time,  the  Company  is aware of a limited  number of
sulfur  oxide/nitrogen  oxide  control  technologies  being  developed.  To  the
Company's  knowledge,  the level at which these  technologies  are being  tested
ranges from the laboratory bench-scale to pilot demonstrations.

     The  Company  believes  that where high  removal  levels of both sulfur and
nitrogen oxides are required  (currently the Northeast  United States) and where
there is a  premium  on  minimizing  solid  waste,  the NOXSO  Process  provides
advantages over other competing  systems,  either currently in commercial use or
under development, for the following reasons:

                                       14

<PAGE>



     o    The NOXSO  Process is a  completely  dry process and does not generate
          any solid waste  material  that must be disposed of,  whereas  certain
          other systems create toxic  substances as a by-product of the reaction
          process, as well as quantities of non-toxic substances,  both of which
          must be  removed  and  disposed  of in an  environmentally  acceptable
          manner.

     o    The NOXSO Process  captures and removes a high percentage  (70-90%) of
          the nitrogen oxides as well as a high percentage (in excess of 90%) of
          the  sulfur  oxides  simultaneously  in  a  single  reaction,  whereas
          conventional  scrubbers  remove  only the  sulfur  oxides  and must be
          combined with a second system to control nitrogen oxides.

     o    The  NOXSO  Process  removes  sulfur  oxides  and  nitrogen  oxides at
          moderate temperatures (250[degree] F), which enables the process to be
          placed in the  power  plant at  practically  any point in the flue gas
          train and does not require reheat or special lined stacks. This should
          be  especially  important in retrofit  applications,  where space is a
          significant concern.

     o    Cost  estimates for the NOXSO Process  developed by the Electric Power
          Research  Institute  indicate  that the cost of building and operating
          the  NOXSO  Process  compares   favorably  to  other  processes  under
          development  that  remove  nitrogen  and  sulfur  oxides  in a  single
          process.

     o    The NOXSO  Process  requires no  modification  to the coal  combustor,
          which enables power  generation to continue  unabated  until the fully
          operational  flue gas treatment system is integrated into the flue gas
          train.

     The Company  believes  that the NOXSO  Process  may  provide a  competitive
advantage over other competing systems where high removal levels of SO2, and NOx
are  required.  In addition,  the NOXSO  Process has been judged by the Electric
Power Research Institute to be economically  competitive with other simultaneous
SO2/NOx  control  technologies.   However,   various  factors  may  favor  other
technologies  or solutions to satisfy the  requirements of the Clean Air Act. It
is not clear how or to what levels NOx emissions  will be required to be reduced
under the Clean Air Act. In addition, in order to comply with the Clean Air Act,
utilities  may opt to burn  low-sulfur  coal,  switch  from coal to oil and gas,
purchase  Allowances  on the open  market  from  other  utilities  whose  actual
emissions are lower than their allowable  levels,  retire capacity,  or purchase
other types of flue gas treatment systems.

     Furthermore, the NOXSO Process involves the circulation of a large quantity
of sorbent in the system  which  creates  substantial  material-handling  issues
which must be  addressed in the  construction  and  operation of a facility.  In
addition,  the sorbent  containing the adsorbed  sulfur tends to be corrosive at
high temperatures.  Thus, corrosion-resistant materials are required in parts of
the system.  The NOXSO  Process  also  requires a  significant  initial  capital
expenditure  which,  in  some  instances,  may  exceed  installation  costs  for
alternative processes.

                                       15

<PAGE>



     In  addition  to  direct   competition  from  other  companies  engaged  in
development of flue gas desulfurization  systems, the Company's process, because
it relates to coal and high sulfur oil is in  competition  with other  available
energy  sources  such as gas,  nuclear  energy and solar,  geo  thermal and wind
power.  To the extent that any of these energy  sources become more desirable or
that  coal  becomes  less  desirable  as  an  energy   source,   for  political,
environmental,  economic or other  reasons,  the ability of the NOXSO Process to
compete effectively may be adversely affected.

     Accordingly,  the NOXSO  Process  will  compete  with a number of different
technologies  on the basis of technical and economic  viability.  In addition to
being able to meet any required  emission  standards on an operating  basis, the
NOXSO Process treatment  facility must be operationally  cost efficient compared
to alternative technologies.

Certain License Agreements

Agreements with Grace

     Since March 1982, Grace, which as of September 30, 1996 owned approximately
21%  of the  Company's  Common  Stock,  has  provided  technical  personnel  and
financial  support to the  Company in its effort to develop  the sorbent for the
NOXSO  Process.  Grace has  provided  different  versions  of the sorbent to the
Company for testing  during this period.  In 1987, the Company and Grace entered
into a series of  agreements  intended to advance the  development  of the NOXSO
Process,  including a research agreement (the "Research  Agreement"),  which has
expired,  under  which  Grace  provided  funding of  $400,000  for  testing  and
development of the NOXSO Process, and a license and supply agreement (the "Grace
License Agreement"),  which continues in effect, relating to sorbent technology.
Grace has no continuing  obligation with respect to the development of the NOXSO
Process or to provide funding to the Company.

     The Grace License  Agreement  provides,  inter alia, that Grace will pay to
the Company a commission  based on any sales by Grace or  suppliers  licensed by
Grace of  sorbent  to the users of the NOXSO  Process  at a  negotiated  rate of
between 6% and 10% of the net sales price of the sorbent. In addition, the Grace
License  Agreement  provides  that  Grace  will  receive a royalty  based on its
licensees'  sales of sorbent to the users of the NOXSO Process.  The License and
Supply Agreement  expires on September 11, 2007 unless Grace exercises its right
to earlier terminate the agreement upon four months advance notice. In the event
of  such  early  termination,  Grace  has  agreed  to  grant  to the  Company  a
royalty-free  exclusive license for certain sorbent  technology  relating to the
removal  and/or  recovery of sulfur oxides and nitrogen  oxides from  stationary
flue gas sources developed by the parties under the Research Agreement.

Agreements with FLS

     In March  1992,  the Company  entered  into a license  agreement  (the "FLS
License  Agreement") with FLS miljo a/s ("FLS"), a Danish corporation engaged in
the construction and design of utility power plants.  The FLS License  Agreement
authorizes FLS to market, sell, design,

                                       16

<PAGE>



and construct NOXSO Process facilities in 33 countries  throughout Europe, parts
of Asia and the  Confederation of Independent  States (formerly the USSR).  Upon
entering into the FLS License Agreement,  FLS purchased 266,666 shares of common
stock and a warrant to purchase  133,334  additional  shares (which  warrant has
expired without being exercised) in consideration of $2 million.

     Under the FLS License  Agreement,  FLS must install the NOXSO Process on at
least  500  megawatts  of  coal-fired   electric  generating  capacity  annually
commencing  in 1997 in order to maintain its license.  FLS is required to pay to
the Company  royalties of (i) 3% of the installed  cost of the NOXSO Process and
5% of associated  engineering  fees if the system installed is completely of the
Company's  design,  or (ii) 2% of the installed cost of the NOXSO Process and 5%
of  associated  engineering  fees if the system  installed is modified  with FLS
technology.

     In March  1993,  FLS  entered  into an  agreement  with  ELKRAFT,  a Danish
utility,  for FLS to  design  and  construct  a  demonstration  plant of a seven
megawatt  facility in Denmark.  The construction of the project was completed in
1994 and the  demonstration is expected to be completed by the Summer of 1997 To
the Company's knowledge,  the demonstration is on schedule and, to date, has met
expectations as to SO2 and NOx removal rates. The Company is not a party to this
agreement and has no role in the funding or operation of the project.  Since the
installation  of the  demonstration  facility,  FLS has submitted three bids for
NOXSO Process systems to be installed in Europe.  The Company does not presently
expect to receive any royalty income on the foreign license before 1997.

Construction Management Services

     The Company's 70%-owned PROJEX,  Inc.  ("PROJEX")  subsidiary was formed in
November  1995 to  conduct a  business  utilizing  the  construction  management
expertise  available to the Company in its development and  demonstration of the
NOXSO Process.  PROJEX provides construction  management support services to the
steel,  public housing,  utility and chemical  industries,  as well as providing
construction management services to engineering firms working for a wide variety
of businesses.

     Robert L. Raymond serves as PROJEX's  President and owns 15% of its capital
stock.  Mr.  Raymond  has 24 years of  experience  in  construction  and project
management,  contract  administration,   planning,  cost  control,  construction
supervision and field  experience for public and industrial  projects ranging in
size from $10  million to $500  million.  Patricia  M.  Conrad  serves as a Vice
President of PROJEX and owns 15% of its capital  stock.  Ms. Conrad has 17 years
of  experience  in planning,  scheduling,  cost control and document  control on
construction  projects.  As of September  30,  1996,  PROJEX had a total of five
full-time and two part-time employees.

     In November 1995, the Company engaged PROJEX to supervise the  construction
of the NOXSO Process systems at the NOXSO Commercial  Demonstration Facility and
to supervise construction of the Olin Project. Under its agreement,  the Company
pays PROJEX for services

                                       17

<PAGE>



on an hourly basis which the Company believes are consistent with rates it would
pay for such services in arm's length transactions with unaffiliated parties. It
is estimated that PROJEX will receive $2.5 million under the agreement.  Through
September  30,  1996,  the Company had paid PROJEX  $659,500  for its  services.
PROJEX  has since its  incorporation  has  entered  into seven  agreements  with
parties other than the Company having an aggregate  estimated  contract price of
$165,000.

Other Business

     The  Company is  presently  engaged in  several  early-stage  developmental
projects that are intended to utilize its engineering expertise to develop other
technologies,  processes, sorbent and facilities to assist others to comply with
environmental   laws.  These  include  the  development  of  a  low  cost,  high
performance  sorbent for controlling  emissions of volatile  organic  compounds,
which are widely used as solvents in many  industries  and the  development of a
new  plasma/thermal  process for controlling NOx emissions from small combusters
that burn fossil fuel. There can be no assurance it will be able to successfully
develop  or  commercialize  any  such  technologies,   processes,  sorbents,  or
facilities.  The  Company  also from time to time on a contract  basis  performs
research and development projects for others.

Patents

     The Company has eight United States patents,  one covering a method for the
removal  of  nitrogen  oxides  from a gas such as a flue  gas,  two  covering  a
regenerable  attrition resistant sorbent and related adsorption processes useful
for the removal of nitrogen  oxides,  sulfur oxides,  and hydrogen  sulfide from
waste gas streams such as a flue gas, and one covering a process for the removal
of nitrogen  oxides and/or sulfur oxides from a gas containing  nitrogen  oxides
and/or  sulfur  oxides such as a flue gas. The Company also was granted a United
States Patent covering its process for regenerating sorbent by removing nitrogen
oxides and sulfur oxides  contained by the sorbent,  two United  States  patents
covering removal of nitrogen and sulfur oxides from a flue gas using a transport
line absorber and a United States patent covering a down comer and flapper valve
used to transport sorbent through a multistage fluid bed adsorber.

     The Company holds one British patent covering both a regenerable  attrition
resistant  sorbent useful for the removal of nitrogen oxides,  sulfur oxides and
hydrogen sulfide from waste gas streams such as a flue gas and a process for the
removal of nitrogen oxides, sulfur oxides,  hydrogen sulfide or a mixture of one
or more thereof  from a gas such as a flue gas.  The Company  holds one Canadian
patent covering both a regenerable  attrition  resistant  sorbent useful for the
removal of nitrogen  oxides,  sulfur oxides and hydrogen  sulfide from waste gas
streams  such as a flue gas,  and a process for the removal of nitrogen  oxides,
sulfur oxides,  hydrogen  sulfide or a mixture of one or more thereof from a gas
such as a flue gas. The Company holds one Mexican  patent  covering  sorbent and
processes for removing nitrogen oxides,  sulfur oxides and hydrogen sulfide from
gas streams,  and one German patent covering the same invention disclosed in the
Mexican Patent.

                                       18

<PAGE>



     The Company also has two United  States patent  applications  pending which
cover   improvements  to  the  NOXSO  Process  that  were  demonstrated  at  the
Pilot-Scale  Facility.  In August 1996, the European  Patent Office approved the
Company's  application  for a patent covering the removal of nitrogen oxides and
sulfur  oxides from flue gas using a  transport  line  adsorber.  The Company is
proceeding  to register or validate  this patent in Belgium,  Germany,  Denmark,
Spain, and the United Kingdom.

Employees

     The Company currently has 20 full-time employees,  exclusive of the persons
employed by PROJEX. These employees are responsible for managing the Company and
the continued  development  of the NOXSO Process and the management and analysis
of the results of the various tests being  performed.  The Company believes that
the further  development  of the NOXSO  Process  will not require the Company to
employ and retain a significant number of employees.

     Although there is competition  for qualified  personnel in the area of flue
gas  desulfurization  systems,  the Company does not anticipate any  significant
problems recruiting and retaining qualified personnel.  Nevertheless,  if any of
the Company's  key  personnel  leave its employ,  the  development,  testing and
commercialization of the NOXSO Process may be adversely affected. The Company is
not a party to any  collective  bargaining  agreement and believes that it has a
favorable relationship with its employees.

Forward Looking and Other Statements

     The  statements  above and  elsewhere  in this Report that suggest that the
Company is likely to, or will meet its various  objectives  (including  that the
Company  expects to sell the Bonds and  successfully  complete the Alcoa Project
and the Olin  Project) are forward  looking  statements.  Various  factors could
prevent the Company from realizing these objectives, including the following:

     The Company expects to service the Bonds from (i) payments from Olin to the
Company  pursuant  to the Olin  Agreement  to purchase  elemental  sulfur in the
aggregate amount of $3.2 million annually and (ii) the sale of Allowances earned
under the Alcoa Project Agreement.

     The Alcoa Project represents the first Full-Scale Commercial  Demonstration
of the NOXSO  Process.  As such,  it is  possible  that it will not  perform  as
expected,  which could  substantially  reduce the number of Allowances  that the
Company  receives  under  the  Alcoa  Agreement  or  which  could  result  in  a
termination  by Alcoa of the Alcoa  Agreement.  A  substantial  reduction in the
number of Allowances  that the Company  receives under the Alcoa Agreement could
have a  material  impact on the cash flows  that the  Company  intends to use to
service the Bonds.  Termination of the Alcoa  Agreement  would in all likelihood
result in acceleration of the Company's  obligations  with respect to the Bonds,
which the Company would likely be unable to pay, and would in addition in

                                       19

<PAGE>



all  likelihood  make it impossible  for the Company to market or sell the NOXSO
Process to other parties.

     Because  the  Alcoa  Project  represents  the first  Full-Scale  Commercial
Demonstration of the NOXSO Process, expenses to operate and maintain the project
may exceed the Company's  expectations even if the project otherwise performs in
accordance with those expectations. In such event, the Company would have to use
cash generated from other operations to fund those expenses.  The Company,  as a
development-stage  company,  does  not  at  this  time  have  other  significant
operations  that would  provide  such cash flow,  and  unless it  develops  such
operations and/or is able to effectively market the NOXSO Process (which may not
be possible if as a result of the  additional  expense of  operation,  the NOXSO
Process fails to operate  effectively and  economically as compared to competing
technologies),  the  Company  may be unable to  generate  revenues  to fund such
costs.

     In  addition,  the  market for  Allowances  is not  well-developed,  having
developed since the  implementation  of the amendments to the 1990 Clean Air Act
in 1995, and there can be no certainty that the market price for Allowances will
be in accordance with Company  expectations.  In such event,  the funds that the
Company currently expects to receive from the sale of earned Allowances will not
be available to service the Bonds.

     If the Olin Facility  fails to perform and provide Olin with sulfur dioxide
in accordance with the specifications set forth in the Olin Agreement, Olin will
not be required to pay to the Company  $3.2  million  annually  for 16,000 short
tons of  elemental  sulfur,  which will most likely make it  impossible  for the
Company to service the Bonds.

     The  Company  must  resolve  certain  concerns  of  representatives  of the
Authority prior to the issuance of the Bonds. The Company has not entered into a
final  agreement  with the issuer of a direct-pay  letter of credit  required to
support and secure the Bonds. In addition, in order to satisfy conditions to the
issuance  of the  Bonds,  among  other  things,  (i)  the  Company  must  obtain
additional  equity capital of approximately $5 million during October 1996, $2.5
million of which is to be used to fund  one-half  of a  supplemental  reserve to
secure the Bonds and the  remainder of which is to be used to repay  outstanding
loans of the Company to Olin and Praxair and (ii) the County of Warrick, Indiana
must  fund or  irrevocably  commit  to fund,  in cash or by  causing a letter of
credit or its  equivalent  to be issued,  $2.5 million to fund the other half of
the supplemental reserve.

     The Company  intends to seek to raise the required equity capital through a
private  placement  of its  common  stock,  the  terms  of which  placement  are
presently being negotiated and are contingent upon the  satisfactory  completion
of due  diligence  and  other  conditions.  Any  shares  issued  in the  private
placement  are expected to contain  restrictions  on resale in  accordance  with
Federal  securities laws and, thus, are expected to be sold at a discount to the
market price of freely tradeable shares.  Some, but not all, required  approvals
have been obtained in order for Warrick  County to commit to fund its portion of
the supplemental debt reserve fund.

                                       20

<PAGE>



     Accordingly,  there  can  be no  assurance  that  either  condition  to the
issuance of the Bonds can be satisfied  prior to October 31,  1996,  the date by
which the Alcoa  Agreement  presently  requires  that the  Company  have in hand
financial  resources  available for the performance of its obligations under the
Alcoa  Project  Agreement  of at least $35  million in  addition to funds to the
provided by the DOE. If such  financing  is not in hand by that date,  Alcoa has
the right, at its option,  to terminate its obligations  under the Alcoa Project
Agreement.

     Although  the Company  expects to pay for  elemental  sulfur to satisfy its
obligations  under the Olin Agreement until April 1998, the month that the Alcoa
Project is scheduled to be operational,  it does not expect to pay for elemental
sulfur after said month. If the NOXSO Commercial Demonstration Facility fails to
produce  elemental  sulfur  commencing  in May 1998 in such  quantities  as will
enable it to be used to  satisfy  the  Company's  obligation  to deliver to Olin
16,000 short tons of elemental  sulfur per year pursuant to the Olin  Agreement,
the  Company  will be  required  to  purchase  additional  elemental  sulfur for
delivery  to Olin.  Based on  historical  prices  for  elemental  sulfur,  it is
anticipated  that the cost of elemental sulfur purchased in the open market will
be approximately  12% to 25% of the consideration the Company is to receive from
Olin  under  the  Olin  Agreement.  Such an  expenditure,  if  required  for any
significant  period of time after  April  1998,  could  have a material  adverse
impact on the cash flows that the Company intends to use to service the Bonds.

     Revenues  from the NOXSO  Commercial  Demonstration  Facility  and the Olin
Facility are required to be held in trust to secure repayment of the Bonds until
they are paid in full in the year 2011. Accordingly,  those revenues will not be
available to the Company to pay its ordinary  operating  expenses and to provide
for cash flow needs, other than those specifically  related to the Alcoa Project
or the Olin Project. As a result, the Company will have to find other sources of
funds to provide for its ordinary  operating and cash flow needs.  Consequently,
even if the NOXSO Commercial  Demonstration  Facility operates sufficiently well
to enable the Company to service the Bonds, if it fails to meet the expectations
of  the  Company's   prospective   customers  or  to  operate   effectively  and
economically as compared to competing technologies, the Company may be unable to
generate revenues to meet its other needs or, ultimately, to establish the NOXSO
Process  as  a  viable   competitor  in  the  marketplace.   See  in  particular
"Competition" in this Item 1.

Item 2.   Properties

     The   Company   leases   approximately   4,170   square   feet  of  office,
administrative and research space in Bethel Park,  Pennsylvania.  The lease term
extends from June 1992 through May 1999.  The Company also leases  approximately
6,400 square feet of laboratory space in Clairton, Pennsylvania. The lease terms
extends from August 1994 through July 1998.

Item 3.   Legal Proceedings

     In late  August  1996 a  Complaint  was filed  against  the  Company in the
District   Court  of  Jefferson   County,   Texas,   by  Calabrian   Corporation
("Calabrian") relating to a Purchase

                                       21

<PAGE>



Agreement  dated  October 16,  1995  between  the  Company  and  Calabrian  (the
"Purchase  Agreement")  and a related License  Agreement,  dated effective as of
September  1, 1995,  between the Company and  Calabrian.  Under the  agreements,
Calabrian  agreed to supply to the  Company  for a fixed  price a portion of the
Olin Facility to be  constructed by the Company for Olin  Corporation  (see "The
Olin Project" in Item 1). The Olin Facility will convert  elemental  sulfur into
liquid  sulfur  dioxide for use by Olin under the Olin  Agreement  (as described
under "The Olin Project" in Item 1). The complaint alleges that the Company took
over  direction  and  supervision  of  Calabrian's  subcontract  relating to the
construction of components of the Olin Facility,  disrupting  Calabrian's  plans
with respect to the  facility and  constituting  an unlawful  interference  with
Calabrian's  contractual  relationships  with its  subcontractors,  and that the
Company defaulted in certain payment obligations to Calabrian under the Purchase
Agreement.   The  complaint   requests   damages  in  the  amount  of  $665,000,
representing  the  balance  of the fee  allegedly  owed to  Calabrian  under the
Purchase  Agreement,  unspecified  damages  caused  Calabrian as a result of the
alleged  interference with contract,  any additional damages caused Calabrian by
the Company's conduct, and, until any amounts due and payable to Calabrian under
its agreements  with the Company are paid, a temporary and permanent  injunction
enjoining the Company from using  Calabrian's  technology and from disclosing it
to third parties.

     The Company's  Counsel has advised that it believes the causes of action in
Calabrian's  complaint  are without merit and that the Company has the basis for
filing a  counterclaim  against  Calabrian for breach of contract as a result of
Calabrian's  abandonment  of its  contract  with the  Company  without  cause or
justification.  The Company intends to deny the  substantive  allegations of the
complaint,  to vigorously defend the action, and to file a counterclaim  seeking
payment of (i) all costs  incurred by the Company to complete the portion of the
Olin Facility abandoned by Calabrian in excess of the fixed price established in
the Company's Purchase  Agreement,  (ii) the Company's legal fees and costs, and
(iii) any and all other damages caused the Company by  Calabrian's  filing of an
action against the Company that is without merit.

     The Company has removed the action to the United States  District Court for
the Eastern  District of Texas,  Beaumont  Division.  On September 30, 1996, the
Company  served a motion to dismiss  all  equitable  claims for failure to state
claims upon which relief can be granted and  requested  an expedited  hearing on
its motion because of concerns that the presence of injunctive  claims threatens
the bond  financing  described  above.  Calabrian was required to respond to the
Company's  motion on or before  October 10, 1996, and the Company hopes that the
Court  will rule on its  motion  shortly  thereafter,  although  there can be no
assurance  that it will do so. The Company has also served counsel for Calabrian
with a copy of a Motion for Rule 11 Sanctions it intends to file and  vigorously
pursue  against  such  counsel  if the  Court  rules in favor of its  motion  to
dismiss.

Item 4.   Submission of Matters to a Vote of Security Holders

     None.

                                       22

<PAGE>



                                     PART II

Item 5.   Market for the Registrant's Common Stock and Related Security Holder
------------------------------------------------------------------------------
Matters
-------

Market Information

     The Company's common stock is traded on the over-the-counter  market and is
currently traded in the Nasdaq Small Cap Market System under the symbol "NOXSO".
The following  table sets forth the range of high and low closing bid quotations
of the common stock as reported by Nasdaq for each fiscal quarter within the two
most recent  fiscal years.  The  quotations  represent  prices  between  dealers
without  adjustment for retail  mark-ups,  mark-downs or commissions and may not
necessarily represent actual transactions.

<TABLE>
<CAPTION>

              Fiscal Quarter Ended                      Bid Prices $

                  1995                              High            Low
                  ----                              -----          ------ 
<S>   <C>                                           <C>            <C>  
      September 30, 1994 (First Quarter)            5.375          2.875
      December 31, 1994 (Second Quarter)            4.750          2.125
      March 31, 1995 (Third Quarter)                5.250          2.750
      June 30, 1995 (Fourth Quarter)                5.500          2.750

                  1996
                  ----
      September 30, 1995 (First Quarter)            8.375          3.063
      December 31, 1995 (Second Quarter)            6.750          4.625
      March 31, 1996 (Third Quarter)                5.625          3.875
      June 30, 1996 (Fourth Quarter)                5.875          3.875

                  1997
                  ----
      September 30, 1996 (First Quarter)            5.875          5.375
</TABLE>

     ---------------------------------

     The closing price of the Company's common stock as reported by
     Nasdaq was $5.125 on October 10, 1996.

Holders of the Company's Common Stock

          As of each of  June  30,  1996  and  September  30,  1996  there  were
approximately 830 record holders of the Company's common stock.


                                       23

<PAGE>



Dividends

     The Company has never paid cash  dividends on its common stock.  Payment of
dividends will be at the discretion of the Company's Board of Directors and will
depend,  among  other  factors,  upon  earnings,  capital  requirements  and the
operating  and  financial  condition  of  the  Company.  The  Company  does  not
anticipate paying cash dividends for the foreseeable future.

Item 6.   Selected Financial Data

     The  following  selected  financial  data is  qualified  in its entirety by
reference to the Company's  Consolidated  Financial Statements and Notes thereto
appearing elsewhere herein. The selected financial data for the five years ended
June 30, 1996, has been derived from the Company's audited financial statements.


<TABLE>
<CAPTION>

                                          Year Ended June 30,
                       ---------------------------------------------------------
<S>                <C>            <C>        <C>         <C>         <C>       
 Operating Results      1996        1995        1994         1993        1992
                        ----        ----        ----         ----        ----
Costs and Expenses  $488,132    $2,648,842   $3,125,312  $4,222,034  $3,190,022
Net Loss            (326,269)   (1,760,658)  (1,931,657) (2,292,197) (2,223,382)
Per Share Data:
Net Loss Per Share    (0.04)        (0.20)       (0.22)      (0.30)      (0.33)
Weighted Average
Number of Shares     
Outstanding (in 000's) 9,308         8,777        8,645       7,723       6,657

Financial Position                             June 30,
                       ---------------------------------------------------------
                        1996        1995        1994         1993        1992
                        ----        ----        ----         ----        ----
Working Capital    $(4,333,882)   $583,359   $1,808,399  $3,578,616  $2,193,442
Total Assets        11,199,396   3,423,873    3,690,130   4,964,195   3,264,951
Long-Term Debt          --           --           --          --          --
Total Stockholders'  
Equity               3,172,454   1,510,629    1,914,415   3,708,560   2,670,026
</TABLE>




                                       24

<PAGE>



Item 7.   Management's Discussion and Analysis of Financial Condition and
          ---------------------------------------------------------------
          Results of Operations
          ---------------------

Overview

     The  Company  is  a  development  stage  company   principally  engaged  in
developing,  testing,  and  marketing  of the  NOXSO  Process  to  remove a high
percentage of the pollutants  which cause "acid rain" from flue gas generated by
burning fossil fuel. In August 1994, the Company  entered into the Alcoa Project
Agreement for the design,  construction,  and operation of the NOXSO  Commercial
Demonstration  Facility  at Alcoa's  Warrick  Generating  Station  in  Newburgh,
Indiana. The project definition and design phases of the Alcoa Project have been
completed by the Company and the construction  phase was commenced in June 1995.
The Company has  received  all  necessary  approvals  from the DOE to proceed to
complete the Alcoa  Project.  As a part of the  approval,  the DOE increased the
funding  for its  share of costs  for the  project  from  $33  million  to $41.4
million. See "The Alcoa Project" in Item 1.

     In April 1995, the Company entered into the Olin Agreement to construct the
complementary Olin Facility in Charleston, Tennessee to convert elemental sulfur
which, after the Alcoa Project is completed,  is to be generated as a by-product
of the Alcoa Project,  into sulfur dioxide.  Under the Olin Agreement,  provided
that the Olin Facility produces sulfur dioxide in accordance with specifications
set forth in the Olin Agreement, Olin is required for a 10-year period after the
Olin Facility is operational,  to pay the Company $3.2 million annually, and the
Company is to deliver to Olin 16,000  short tons per year of  elemental  sulfur.
Once the Alcoa Project is operational,  it is anticipated  that all or virtually
all of the 16,000 short tons of  elemental  sulfur will be produced by the Alcoa
Project.  Until that date,  the Company will have to pay the costs of purchasing
elemental sulfur from suppliers. See "The Olin Project" in Item 1.

     The Company is also  engaged in  utilizing  its  engineering  expertise  to
develop other  technologies,  processes,  substances and facilities  that can be
used to assist in complying with environmental  laws,  although all such efforts
are at this time  developmental  in nature.  The Company  also from time to time
performs  research and  development  for others on a project  basis.  See "Other
Business"  in Item 1. The  Company  has also  licensed  the  NOXSO  Process  for
distribution  internationally,  testing  of  which  is  being  conducted  by its
licensee in Europe. See "Certain License Agreements" in Item 1. In addition, the
Company is  offering  construction  management  services  to others  through its
70%-owned PROJEX subsidiary. See "Construction Management Services" in Item 1.

Liquidity and Capital Resources

     The  Company is a  development  stage  company  engaged in  developing  and
testing  the  NOXSO  Process.   Since  inception,   the  Company  has  dedicated
substantially  all its resources to the acquisition,  development and testing of
the NOXSO Process.  Since its inception,  the Company's  capital  resources have
been derived from various sources including the sale of the Company's

                                       25

<PAGE>



common stock in both public and private offerings,  government grants,  research
contracts and cooperative research activities.  The total of capital raised from
inception through June 30, 1996 was approximately $18.2 million.

     The Company's resources have been used to conduct a series of test programs
which  provided  the data  necessary  to bring the NOXSO  Process to its present
state of  development.  The first of these  programs  began in 1980 in  Paducah,
Kentucky,  at the TVA Shawnee Steam Plan. The next phase of development began in
1985, after a move to DOE's Pittsburgh Energy Technology  Center, and these test
continued  through  June of 1989.  This  development  program was  followed by a
Pilot-Scale  Facility at the Ohio Edison  power plan  located at Toronto,  Ohio.
This Pilot-Scale  Project was completed in August of 1993 with over 10,000 hours
of testing. The Company is constructing a Full-Scale Commercial Demonstration of
the NOXSO  Process  for  Alcoa.  See "The Alcoa  Project"  in Item 1. It is also
constructing a complementary  plant at Olin  Corporation's  plant in Charleston,
Tennessee.  The plant will convert  elemental sulfur into liquid sulfur dioxide.
See "The Olin Project" in Item 1.

     During fiscal 1996, the increase in cash and equivalents  and  certificates
of deposit was the net result of several  transactions.  The major cash  inflows
were proceeds of $1.9 million from private placement offerings, net borrowing on
the line of credit of $755,000 and net borrowings on the Alcoa and Olin loans of
$1.2  million.  These  funds have been used  during the year to pay  expenses of
operating the Company as well as cover the costs associated with the building of
the NOXSO Commercial Demonstration Facility and the Olin Facility. The Company's
current ratio  decreased  from 1.3:1 at June 30,1995 to 0.45:1 at June 30, 1996.
This  decrease  is the  result  of costs of the NOXSO  Commercial  Demonstration
Facility and the Olin Facility  exceeding the funds received by the Company.  As
of June 30, 1996, the Company had working  capital of ($4.4 million) as compared
to  $583,000 at June 30,  1995.  This  decrease  is the result of the  increased
activity in the construction of the NOXSO Commercial  Demonstration Facility and
the Olin  Facility.  The notes payable is increased as a result of the increased
borrowing on the line of credit and the Olin loan.

     The funds needed,  in addition to those available from the DOE, to complete
the Alcoa  project are to be provided from the proceeds of $40 million in Bonds.
On September 16, 1996, the Authority adopted resolutions  approving the issuance
of the Bonds.  However, the Company is still seeking to resolve certain concerns
of  representatives  of the Authority.  The Company has not entered into a final
agreement with the issuer of a direct-pay  letter of credit  required to support
and  secure the  Bonds.  In  addition,  in order to  satisfy  conditions  to the
issuance  of the  Bonds,  among  other  things,  (i)  the  Company  must  obtain
additional  equity capital of approximately $5 million during October 1996, $2.5
million of which is to be used to fund  one-half  of a  supplemental  reserve to
secure the Bonds and the  remainder of which is to be used to repay  outstanding
loans of the Company to Olin and Praxair and (ii) the County of Warrick, Indiana
must  fund or  irrevocably  commit  to fund,  in cash or by  causing a letter of
credit or its  equivalent  to be issued,  $2.5 million to fund the other half of
the supplemental reserve.


                                       26

<PAGE>



     The Company  intends to seek to raise the required equity capital through a
private  placement  of its  common  stock,  the  terms  of which  placement  are
presently being negotiated and are contingent upon the  satisfactory  completion
of due  diligence  and  other  conditions.  Any  shares  issued  in the  private
placement  are expected to contain  restrictions  on resale in  accordance  with
Federal  securities laws and, thus, are expected to be sold at a discount to the
market price of freely tradeable  shares.  Some, but not all required  approvals
have been obtained in order for Warrick  County to commit to fund its portion of
the supplemental reserve fund.

     Accordingly,  there  can  be no  assurance  that  either  condition  to the
issuance of the Bonds can be satisfied  prior to October 31,  1996,  the date by
which the Alcoa  Agreement  presently  requires  that the  Company  have in hand
financial  resources  available for the performance of its obligations under the
Alcoa  Project  Agreement  of at least $35  million in  addition to funds to the
provided by the DOE. If such  financing  is not in hand by that date,  Alcoa has
the right, at its option,  to terminate its obligations  under the Alcoa Project
Agreement.

     The Company expects to service the Bonds from (i) payments from Olin to the
Company  pursuant  to the Olin  Agreement  to purchase  elemental  sulfur in the
aggregate amount of $3.2 million annually and (ii) the sale of Allowances earned
under the Alcoa Project Agreement.

     The Alcoa Project represents the first Full-Scale Commercial  Demonstration
of the NOXSO  Process.  As such,  it is  possible  that it will not  perform  as
expected,  which could  substantially  reduce the number of Allowances  that the
Company  receives  under  the  Alcoa  Agreement  or  which  could  result  in  a
termination  by Alcoa of the Alcoa  Agreement.  A  substantial  reduction in the
number of Allowances  that the Company  receives under the Alcoa Agreement could
have a  material  impact on the cash flows  that the  Company  intends to use to
service the Bonds.  Termination of the Alcoa  Agreement  would in all likelihood
result in acceleration of the Company's  obligations  with respect to the Bonds,
which the Company  would  likely be unable to pay,  and would in addition in all
likelihood  make it  impossible  for the  Company  to  market  or sell the NOXSO
Process to other parties.

     Because  the  Alcoa  Project  represents  the first  Full-Scale  Commercial
Demonstration of the NOXSO Process, expenses to operate and maintain the project
may exceed the Company's  expectations even if the project otherwise performs in
accordance  with the Company's  expectations.  In such event,  the Company would
have to use cash generated  from other  operations to fund those  expenses.  The
Company,  as a  development-stage  company,  does not at this  time  have  other
significant operations that would provide such cash flow, and unless it develops
such  operations  and/or is able to effectively  market the NOXSO Process (which
may not be possible if as a result of the additional  expense of operation,  the
NOXSO  Process  fails to operate  effectively  and  economically  as compared to
competing technologies),  the Company may be unable to generate revenues to fund
such costs.

     In  addition,  in the event that the Company is unable to fund its share of
project costs or timely complete the Alcoa Project,  the Company expects to lose
the DOE's funding. If the

                                       27

<PAGE>



     Company loses its DOE funding,  it does not expect to be able to complete a
Full-Scale  Commercial  Demonstration  of the NOXSO  Process.  This loss of this
funding would  require that greater  emphasis be placed upon the test results of
the Company's  pilot plant conducted at Toronto,  Ohio and on the  demonstration
currently  being  conducted  by FLS in  Denmark.  Because of the  reluctance  of
regulated  utilities to purchase process technology which has not been tested on
a commercial scale, due to the uncertainty of cost  considerations,  the Company
believes  that it would be much  more  difficult  to  secure  sales of the NOXSO
Process to public  utilities  in the United  States if the Alcoa  Project is not
funded and completed.

     If the Olin Facility  fails to perform and provide Olin with sulfur dioxide
in accordance with the specifications set forth in the Olin Agreement, Olin will
not be required to pay to the Company  $3.2  million  annually  for 16,000 short
tons of  elemental  sulfur,  which will most likely make it  impossible  for the
Company service the Bonds.

     Although  the Company  expects to pay for  elemental  sulfur to satisfy its
obligations  under the Olin Agreement until April 1998, the month that the Alcoa
Project is scheduled to be operational,  it does not expect to pay for elemental
sulfur after said month. If the NOXSO Commercial Demonstration Facility fails to
produce  elemental  sulfur  commencing  in May 1998 in such  quantities  as will
enable it to be used to  satisfy  the  Company's  obligation  to deliver to Olin
16,000 short tons of elemental  sulfur per year pursuant to the Olin  Agreement,
the  Company  will be  required  to  purchase  additional  elemental  sulfur for
delivery  to Olin.  Based on  historical  prices  for  elemental  sulfur,  it is
anticipated  that the cost of elemental sulfur purchased in the open market will
be  approximately  12%-25% of the  consideration  the Company is to receive from
Olin  under  the  Olin  Agreement.  Such an  expenditure,  if  required  for any
significant  period of time after  April  1998,  could  have a material  adverse
impact on the cash flows that the Company intends to use to service the Bonds.

     Furthermore,  the  market  for  Allowances  is not  well-developed,  having
developed since the  implementation  of the amendments to the 1990 Clean Air Act
in 1995, and there can be no certainty that the market price for Allowances will
remain at current levels.  In such event,  the funds that the Company  currently
expects to receive from the sale of earned  Allowances  will not be available to
service the Bonds.

     Revenues  from the NOXSO  Commercial  Demonstration  Facility  and the Olin
Facility are required to be held in trust to secure repayment of the Bonds until
they are paid in full in the year 2011. Accordingly,  those revenues will not be
available to the Company to pay its ordinary  operating  expenses and to provide
for cash flow needs, other than those specifically  related to the Alcoa Project
or the Olin Project. As a result, the Company will have to find other sources of
funds to provide for its ordinary  operating and cash flow needs.  Consequently,
even if the NOXSO Commercial  Demonstration  Facility operates sufficiently well
to enable the Company to service the Bonds, if it fails to meet the expectations
of  the  Company's   prospective   customers  or  to  operate   effectively  and
economically as compared to competing technologies, the Company may be unable

                                       28

<PAGE>



to generate  revenues to meet its other needs or,  ultimately,  to establish the
NOXSO Process as a viable  competitor in the marketplace.  See  "Competition" in
Item 1.

     Further, the inability of the Company to fund and timely complete the Alcoa
Project could result in the loss of revenues from  utilities  which  retrofit in
order to  comply  on a timely  basis  with  Phase  II  requirements  of the 1990
amendments to the Clean Air Act. In such event,  the Company customer base could
be limited  principally to those power  stations  having the ability to postpone
compliance beyond the year 2000 by accumulating or purchasing Allowances.

Results of Operations

     To date,  the Company has not derived any  revenues  from  operations.  All
revenues  to  date  have  consisted  of  research  funding,  government  grants,
reimbursement  of project costs and interest  income,  aggregating  $8.3 million
through June 30, 1996.  As a result of the  significant  expenses  incurred from
inception through June 1995 in connection with the acquisition,  development and
testing of the NOXSO  Process,  as well as general and  administrative  expenses
that have been incurred, the Company had an accumulated deficit of $11.9 million
at June 30, 1996.  Since  inception  through June 30, 1996, the Company's  total
costs and  expenses  were $20.2  million  including  $7.6  million  relating  to
salaries and benefits.

     Total funding,  interest income and  reimbursement of project costs for the
fiscal years ended June 30, 1996, 1995 and 1994 were $0.2 million,  $0.9 million
and $1.2  million  respectively,  while  total costs and  expenses  for the same
periods were $0.6  million,  $2.6 million and $3.1  million,  respectively.  The
decrease in revenues from fiscal 1994 to fiscal 1995 and again to fiscal 1996 is
due to the fact that the Company has begun  capitalizing  their costs related to
the NOXSO Commercial  Demonstration Facility and the Olin Facility and the DOE's
portion   of  the   costs   and   revenues   are  being   offset   against   the
construction-in-progress.  Decreased  costs and  expenses  from  fiscal  1994 to
fiscal  1995 and again to fiscal 1996 were also due to the fact that the Company
has begun capitalizing their costs related to the NOXSO Commercial Demonstration
Facility and the Olin  Facility and the DOE's  portion of the costs and revenues
are being offset against the construction-in-progress.

     During the fourth  quarter of 1995,  the Company  began to  capitalize  its
share of costs associated with the NOXSO Commercial  Demonstration  Facility and
the Olin Facility.  As indicated above, the Alcoa Project  Agreement between the
Company and Alcoa was executed for the design,  construction  and operation of a
demonstration facility.  This agreement included a number of conditions,  all of
which have been met by the Company, with the exception of obtaining financing of
its share of the facility.  As discussed above, the Indiana legislature passed a
bill which established a state sponsored program whereby the state could provide
a  guarantee  for the  repayment  of  revenue  bonds  for clean  coal  projects.
Approvals  for  issuance  of such  guarantee  have  been  obtained  although  as
described  above a number of matters  must be resolved  and  conditions  must be
satisfied prior to issuance of the Bonds. In addition,  the DOE has approved the
Company's  Continuation  Application  through the construction  phase. Given the
current status of

                                       29

<PAGE>



the project and the nature of the costs being incurred,  management  believes it
is  appropriate  to  begin  to  capitalize  the  cost  of the  NOXSO  Commercial
Demonstration Facility and the Olin Facility as construction-in-progress. Future
funds  received by the DOE will be used to offset  total  costs  incurred on the
project  with the result that net costs  capitalized  on the balance  sheet will
reflect the Company's portion of the projects costs.

New Accounting Pronouncements

     In March 1995, the Financial  Accounting  Standards  Board ("FASB")  issued
SFAS No.  121,  "Accounting  for the  Impairment  of  Long-Lived  Assets and for
Long-Lived  Assets to Be Disposed Of." SFAS No. 121 requires that carrying value
of long-lived  operating assets, when determined to be impaired,  be adjusted so
as not to exceed the estimated  undiscounted  cash flows provided by such asset.
SFAS No. 121 also  addresses  the  accounting  for  long-lived  assets  that are
expected to be disposed of in future periods.

     In October 1995, the FASB issued SFAS No. 123,  "Accounting for Stock-Based
Compensation."  SFAS No. 123  recommends,  but does not require,  that companies
change their method of accounting for stock-based compensation plans to one that
attributes  compensation  costs equal to the fair market value of a  stock-based
compensation  arrangement  over  the  periods  in  which  service  is  rendered.
Companies not electing to change their method of accounting are required,  among
other  things,  to  provide  additional  disclosures  which in effect  restate a
company's results for comparative periods as if the new method of accounting had
been adopted.

     The Company will be subject to the  provisions  of SFAS No. 121 and No. 123
in fiscal  1997.  At the  present  time, the Company  does not  believe that the
adoption  of  either of these  accounting  pronouncements  will have a  material
effect on its financial position or results of operations.



                                       30

<PAGE>

Item 8.   Financial Statements and Supplementary Data
          -------------------------------------------


                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                          INDEX TO FINANCIAL STATEMENTS
                          -----------------------------


                                                                            Page
                                                                            ----

Report of Independent Public Accountants

Financial Statements:

Consolidated Balance Sheets June 30, 1996 and 1995

Consolidated Statements of Operations for the Cumulative Period from
Inception to June 30, 1996, and for the Years Ended June 30, 1996, 1995 and
1994

Consolidated Statements of Changes in Stockholders' Equity for the Cumulative
 Period from Inception to June 30, 1996, and for the Years Ended June 30,
 1996, 1995 and 1994

Consolidated Statements of Cash Flows for the Cumulative Period from
 Inception to June 30, 1996, and for the Years Ended
 June 30, 1996, 1995 and 1994

Notes to Consolidated Financial Statements


All other schedules have been omitted because the required information is not
applicable or the information is included in the financial statements or notes
thereto.


<PAGE>






                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
                    -----------------------------------------

To the Board of Directors of
     NOXSO Corporation

We  have  audited  the  accompanying   consolidated   balance  sheets  of  NOXSO
Corporation (a Virginia  corporation in the development stage) and subsidiary as
of  June  30,  1996  and  1995,  and  the  related  consolidated  statements  of
operations, changes in stockholders' equity and cash flows for each of the three
years in the period  ended June 30, 1996.  These  financial  statements  are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatements. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects,  the consolidated financial position of NOXSO Corporation
and  subsidiary as of June 30, 1996 and 1995,  and the  consolidated  results of
their  operations and their cash flows for each of the three years in the period
ended  June  30,  1996,  in  conformity  with  generally   accepted   accounting
principles.

The accompanying  consolidated  financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 8 to the
consolidated financial statements, the Company is seeking funding of $40 million
to complete the Full-Scale  Demonstration  Facility and seeking funding to repay
the amounts due Olin Corporation and Praxair, Inc. of $1,874,000 and $2,700,000,
respectively.   At  October  11,  1996  negotiations   regarding  funding  which
management  believes will be successful,  are in process. If such funding is not
secured,  the Company may not be able to complete the  Full-Scale  Demonstration
Facility  and repay the amounts due Olin  Corporation  and  Praxair,  Inc.  This
matter raises  substantial  doubt about the  Company's  ability to continue as a
going concern. Management's plans in regard to this matter are also described in
Note 8. The  consolidated  financial  statements do not include any  adjustments
that might result from the outcome of this uncertainty.

                                             ARTHUR ANDERSEN LLP
Pittsburgh, Pennsylvania
September 6, 1996, (except with respect to the matters 
discussed in Note 8, as to which the date is October 11, 1996)

                                       32


<PAGE>


                                NOXSO Corporation
                        (A Development Stage Enterprise)
                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                   June 30,
                                                       ----------------------------------
                         ASSETS                             1996              1995
                                                       ---------------   ----------------
CURRENT ASSETS:
<S>                                                          <C>                 <C>     
   Cash and equivalents                                $    464,723    $    461,360
   Bank certificate of deposit                            1,000,000       1,000,000
   Accounts receivable                                    2,163,420       1,014,631
   Prepaid expenses and other current assets                 38,136          20,612
                                                       ------------    ------------
       Total Current Assets                               3,666,279       2,496,603
                                                       ------------    ------------

PROPERTY AND EQUIPMENT:
   Equipment                                                341,936         341,936
   Furniture and Fixtures                                   111,661          95,314
   Leasehold improvements                                    16,646          16,646
   Construction in progress                               7,469,545         847,955
                                                       ------------    ------------
                                                          7,939,788       1,301,851
   Less:  Accumulated depreciation                          412,151         378,889
                                                       ------------    ------------
         Net Property and Equipment                       7,527,637         922,962
                                                       ------------    ------------

   Other Assets                                               1,172            --
   Deposits                                                   4,308           4,308
                                                       ------------    ------------
       Total Assets                                    $ 11,199,396    $  3,423,873
                                                       ============    ============

    LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
   Notes payable                                       $  2,874,000    $    915,000
   Accounts payable                                       3,424,692         693,426
   Accrued compensation                                      98,975          28,259
   Advanced Billings                                      1,379,549         194,575
   Other current liabilities                                290,945          81,984
                                                       ------------    ------------
       Total Current Liabilities                          8,068,161       1,913,244
                                                       ------------    ------------

OTHER LIABILITIES:
   Minority interest in consolidated subsidiary              26,781            --


STOCKHOLDERS' EQUITY:
   Common stock, $.01 par value:  Authorized,
     20,000,000 shares.  Issued 9,652,096 shares and
     9,098,810 shares, respectively                          96,523          90,988
   Paid-in capital                                       14,914,953      12,932,394
   Deficit accumulated during the development stage     (11,882,022)    (11,487,753)
                                                       ------------    ------------
                                                          3,129,454       1,535,629
   Less:  Cost of 2,985 shares of common stock
           held in treasury                                 (25,000)        (25,000)
                                                       ------------    ------------
       Total Stockholders' Equity                         3,104,454       1,510,629
                                                       ------------    ------------
       Total Liabilities and Stockholders Equity       $ 11,199,396    $  3,423,873
                                                       ============    ============
</TABLE>

   See accompanying notes to consolidated financial statements.

                                      33
<PAGE>

<TABLE>
<CAPTION>

                                NOXSO Corporation
                        (A Development Stage Enterprise)
                     CONSOLIDATED STATEMENTS OF OPERATIONS



                                                 Date of Inception,                  Fiscal Year
                                                 August 28, 1979,                   Ended June 30,
                                                                  -----------------------------------------
                                                to June 30, 1996       1996            1995          1994
                                                    ------------  ------------   --------------   ---------
                                              (Not covered by
COSTS AND EXPENSES:                          auditor's report)
<S>                                              <C>              <C>            <C>            <C>         
   Purchase of NOXSO Process                      $    260,625    $      --      $      --      $      --   
   Contract development - concept testing            1,169,759           --             --             --   
   Contract development - demonstration testing      1,727,715           --          767,387        368,508 
   Designing, drafting and consulting                1,107,291          4,750         38,679        103,112 
   Supplies, instruments and equipment               1,954,044         19,520         83,102        143,537 
   Depreciation and amortization                       532,933         33,101         32,440         65,417 
   Other research and development                      386,309           --           43,969         48,022 
   Salaries and benefits                             7,614,918        175,633      1,108,250      1,500,811 
   Professional fees                                 1,581,794         33,323        194,023        230,556 
   Rent                                                519,583         33,501        125,628        105,157 
   Income tax expense                                   33,181         33,181           --             --
   Other general and administrative                  3,295,805        223,123        255,364        560,192 
                                                    ----------    -----------    -----------    -----------
TOTAL COSTS AND EXPENSES                            20,183,957        556,132      2,648,842      3,125,312 
                                                    ----------    -----------    -----------    ----------- 

LESS FUNDING AND OTHER:
   Funding of research agreement                     1,200,000           --             --             --   
   Reimbursement of project costs                    4,899,972         45,782        793,086      1,134,396 
   Government grants                                 1,128,020           --           39,863         10,064 
   Interest income                                   1,038,322         81,560         55,235         49,195 
   Other                                                63,267         61,002           --             --   
                                                   -----------     -----------    -----------    -----------
TOTAL FUNDING AND OTHER                              8,329,581        188,344        888,184      1,193,655
                                                   -----------     -----------    -----------    -----------
MINORITY INTEREST IN NET INCOME
  OF CONSOLIDATED SUBSIDIARY                            26,481         26,481           --             --   
                                                   -----------     -----------    -----------    -----------
 
NET LOSS                                          $ 11,880,857    ($  394,269)   ($1,760,658)   ($1,931,657)
                                                  ============    ===========    ===========    =========== 
LOSS PER COMMON SHARE                                                            ($     0.04)   ($     0.20)
AVERAGE NUMBER OF SHARES
   OUTSTANDING                                                       9,308,394      8,776,817      8,645,000
                                                                  ============    ===========    ===========
</TABLE>

   See accompanying notes to consolidated financial statements.


                                       34
<PAGE>



<TABLE>
<CAPTION>


                                                  NOXSO CORPORATION (A Development Stage Enterprise)

                                              CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                                   FOR THE PERIOD AUGUST 28, 1979, DATE OF INCEPTION, TO JUNE 30, 1996 (continued)

                                                                                      Stockholders' Equity
                                                     -------------------------------------------------------------------------------
                                                                                    Deficit Accumu-              Notes
                                Consideration            Common Stock               lated During             Receivable
                               Per                    Shares      Par      Paid-in   Development  Treasury  for Purchase of
                              Share      Total        Issued      Value    Capital     Stage       Stock     Common Stock   Total
                            --------   ---------     --------   --------  --------- ------------  --------  ---------------- -----

AUGUST 28, 1979 (INCEPTION)
TO JUNE 30, 1991 (not covered by auditor's report):
<S>                                 <C>    <C>          <C>        <C>       <C>          <C>      <C>     <C>        <C>
1979 - Issuance of Common Stock$   .005    $   600(1)     120,000  $  1,200  $     (600)  $  -     $   -   $    -     $       600
1980 - Issuance of Common Stock    .563    956,250(2)   1,700,000    17,000     791,382      -         -        -         808,382
1980 - Issuance of Warrants          -         850(3)        -         -            850      -         -        -             850
1983 - Issuance of Common Stock   .2813     28,125(4)     100,000     1,000      27,125      -         -        -          28,125
1986 - Issuance of Common Stock    .125    155,000(1)   1,240,000    12,400     142,600      -         -        -         155,000
1986 - Issuance of Common Stock    .125     32,500(5)     260,000     2,600      29,900      -         -        -          32,500
1987 - Issuance of Common Stock     .50    134,000(1)     268,000     2,680     131,320      -         -        -         134,000
1987 - Issuance of Common Stock     .50     42,900(5)      85,800       858      42,042      -         -        -          42,900
1988 - Issuance of Stock Option            250,000(6)        -         -        250,000      -         -        -         250,000
1989 - Issuance of Common Stock    .675     27,000(7)      40,000       400      26,600      -         -    (27,000)         -
1989 - Issuance of Common Stock     .50    147,500(8)     295,000     2,950     144,550      -         -    (30,000)      117,500
1989 - Issuance of Common Stock    2.50  4,000,000(2)   1,600,000    16,000   3,174,721      -         -        -       3,190,721
1989 - Issuance of Warrants                     80(3)        -         -             80      -         -        -              80
1991 - Issuance of Common Stock   1.129    569,464(9)     504,620     5,046     564,418      -         -        -         569,464
1991 - Issuance of Common Stock    .675     27,000(7)      40,000       400      26,600      -         -    (27,000)         -
1991 - Issuance of Common Stock    .675     27,000(9)      40,000       400      26,600      -         -        -          27,000
Net loss                                                     -         -           -       (3,278,694)          -       3,278,694)
                                                        -------------------  -----------  ------------ -  ----------  --------------
BALANCE, JUNE 30, 1991                                  6,293,420  $ 62,934  $ 5,378,188  $(3,278,694) -  $ (84,000)  $  2,078,428
</TABLE>

(1)  Sale of common stock for cash.
(2)  Proceeds of public offering.
(3)  Sale of warrants for cash.
(4)  Value assigned to common stock issued in connection with purchase of NOXSO
     Process. 
(5)  Value assigned to common stock issued for compensation and services.
(6)  Sale of common stock option.
(7)  Stock issued in connection with exercise of common stock warrants and
     options for notes receivable.
(8)  Stock issued in connection with exercise of common stock purchase warrants 
     for $117,500 cash and a $30,000 note receivable.
(9)  Stock issued in connection with exercise of common stock option agreements.


See accompanying notes to consolidated financial statements.


                                       35
<PAGE>

<TABLE>
<CAPTION>


                                                  NOXSO CORPORATION (A Development Stage Enterprise)

                                              CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                                   FOR THE PERIOD AUGUST 28, 1979, DATE OF INCEPTION, TO JUNE 30, 1996 (continued)

                                                                                      Stockholders' Equity
                                                     -------------------------------------------------------------------------------
                                Consideration            Common Stock               lated During             Receivable
                               Per                    Shares      Par      Paid-in   Development  Treasury  for Purchase of
                              Share      Total        Issued      Value    Capital     Stage       Stock     Common Stock   Total
                            --------   ---------     --------   --------  --------- ------------  --------  ---------------- -----

YEAR ENDED JUNE 30, 1992: (not covered in auditor's report)

<S>                         <C>       <C>             <C>       <C>       <C>          <C>      <C>         <C>        <C>
 Issuance of Common Stock   $ 1.129   $  683,356(9)   605,544   $ 6,056   $  677,300   $   -    $     -     $     -     $   683,356
 Issuance of Common Stock      7.50    2,000,000(1)   266,666     2,666    1,997,334       -          -           -       2,000,000
 Issuance of Common Stock      2.75        5,500(9)     2,000        20        5,480       -          -           -           5,500
 Issuance of Common Stock      2.00      69,124(10)    34,562       346       68,778       -          -           -          69,124
 Issuance of Common Stock                      (11)   116,500     1,165        -          (1,165)     -           -             -
 Satisfaction of notes                                    -         -          -         -            -      57,000(12)      57,000
 receivable \Net loss                                     -         -          -      (2,223,382)     -           -      (2,223,382)
                                                  -----------   -------- ---------- -----------    ------    --------    -----------
BALANCE, JUNE 30, 1992                              7,318,692    73,187    8,127,080  (5,503,241)     -        (27,000)   2,670,026

YEAR ENDED JUNE 30, 1993: (not covered in auditor's report)
 Issuance of Common Stock      1.129      683,35(9)   605,544     6,056      677,300       -          -           -         683,356
 Issuance of Common Stock      2.04       26,260(9)    12,866       129       26,131       -          -           -          26,260
 Issuance of Common Stock       .50                    50,000       500       24,500       -          -        (25,000)         -
 Acquisition of Common Stock                -             -          -         -           -      25,000(15) 25,000(15)         -
 Satisfaction of notes                      -             -          -         -           -                 27,000(14)      27,000
 receivable Issuance of        5.00  2,594,115(16)    571,250     5,712    2,588,403       -          -           -       2,594,115
 Common Stock 
Net loss                                                  -          -         -      (2,292,197)     -           -     (2,292,197)
                                                  -----------   -------- ----------   -----------    ------   --------    ---------
BALANCE, JUNE 30, 1993                              8,558,352    85,584   11,443,414  (7,795,438)   (25,000)      -       3,708,560

YEAR ENDED JUNE 30, 1994:
 Issuance of Common Stock     1.129     113,888(9)    100,920     1,009      112,879       -          -           -         113,888
 Issuance of Common Stock      2.00    23,624 (13)     11,812       118       23,506       -          -           -          23,624
 Net loss                                                  -         -      -         (1,931,657)     -           -      (1,931,657)
                                                  -----------   -------- ----------   -----------   ------     --------  -----------
BALANCE, JUNE 30, 1994                              8,671,084   $86,711  $11,579,799 $(9,727,095) $(25,000)$      -     $ 1,914,415
</TABLE>


(1)  Sale of common stock for cash.
(9) Stock issued in connection with exercise of common stock option agreements.
(10) Stock issued in connection with exercise of common stock warrant
agreements.
(11) Stock issued in exchange for warrant.
(12) Compensation in satisfaction of notes receivable.
(13) Stock issued in connection with exercise of common stock warrants. (14)
Payment in satisfaction of note receivable. (15) Acquisition of 2,985 shares of
treasury stock in satisfaction of notes receivable. (16) Stock issued in
connection with private placement.

See accompanying notes to consolidated financial statements.


                                       36
<PAGE>

<TABLE>
<CAPTION>


                                                  NOXSO CORPORATION (A Development Stage Enterprise)

                                              CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                                   FOR THE PERIOD AUGUST 28, 1979, DATE OF INCEPTION, TO JUNE 30, 1996 (continued)
                                                                                      Stockholders' Equity
                                                     -------------------------------------------------------------------------------
                                                                                    Deficit Accumu-              Notes
                                Consideration            Common Stock               lated During             Receivable
                               Per                    Shares      Par      Paid-in   Development  Treasury  for Purchase of
                              Share      Total        Issued      Value    Capital     Stage       Stock     Common Stock   Total
                            --------   ---------     --------   --------  --------- ------------  --------  ---------------- -----

YEAR ENDED JUNE 30, 1992: (not covered in auditor's report)

<S>                         <C>   <C>          <C>       <C>        <C>        <C>           <C>         <C>         <C>
YEAR ENDED JUNE 30, 1995:
 Issuance of Common Stock   2.00   47,252(10)     23,626      236      47,016           -              -        -            47,252
 Issuance of Common Stock   2.75   11,000 (9)      4,000       40      10,960           -              -        -            11,000
 Issuance of Common Stock   3.85  497,500(16)    150,000    1,500     496,000           -              -        -           497,500
 Issuance of Common Stock   3.56  800,795(16)    250,000    2,500     798,295           -              -        -           800,795
 Issuance of Common Stock   3.25      325(17)        100        1         324           -              -        -               325
 Net loss                                            -       -           -         (1,931,657)         -        -        (1,760,658)
                                               ---------  -------- -----------  --------------  ------------  -----     ------------
BALANCE, JUNE 30, 1995                         9,098,810 $  90,988 $12,932,394   $(11,487,753)  $   (25,000)  $ -      $  1,510,629
                                               ========= ========= ===========   =============  ============  =====    ============
                                                                                                       
YEAR ENDED JUNE 30, 1996:                                                                              
 Issuance of Common Stock   3.25   81,250 (9)     25,000      250      81,000             -             -       -            81,250
 Issuance of Common Stock   1.91   19,063 (9)     10,000      100      18,963             -             -       -            19,063
 Issuance of Common Stock  3.625    5,438 (9)      1,500       15       5,423             -             -       -             5,438
 Issuance of Common Stock  3.625    1,813 (9)        500        5       1,808             -             -       -             1,813
 Issuance of Common Stock   4.55  409,725(16)    100,000    1,000     408,725             -             -       -           409,725
 Issuance of Common Stock   4.54  408,375(16)    100,000    1,000     407,375             -             -       -           408,375
 Issuance of Common Stock   4.56    45,626(9)     10,000      100      45,526             -             -       -            45,626
 Issuance of Common Stock  3.625     9,063(9)      2,500       25       9,038             -             -       -             9,063
 Issuance of Common Stock  3.625     2,719(9)        750        8       2,711             -             -       -             2,719
 Issuance of Common Stock  3.625     1,812(9)        500        5       1,807             -             -       -             1,812
 Issuance of Common Stock   3.21  503,209(16)    156,763    1,569     501,640             -             -       -           503,209
 Issuance of Common Stock  3.425  500,003(16)    145,773    1,458     498,543             -             -       -           500,001
 Net loss                                                    -            -           (394,269)         -       -          (394,269)
                                               ---------  -------- -----------  --------------  ------------  -----     ------------
BALANCE, JUNE 30, 1996                         9,652,096 $  96,523  $14,914,953   $(11,882,022) $(25,000)     $ -      $  3,104,454
                                               ========= =========  ===========   ==========================  =====    ============
</TABLE>



(9)  Stock issued in connection with exercise of common stock option agreements.
(10) Stock issued in connection with exercise of common stock warrant
     agreements.
(16) Stock issued in connection with private placement.
(17) Stock issued as contribution.

See accompanying notes to consolidated financial statements.




                                                                 37
<PAGE>






<TABLE>
<CAPTION>


                                                         NOXSO Corporation
                                                  (A Development Stage Enterprise)
                                                CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                         Date of Inception,
                                                          August 28, 1979,            Fiscal Year Ended June 30,
                                                                              -----------------------------------------
                                                          to June 30, 1996      1996          1995           1994
-----------------------------------------------------------------------------------------------------------------------
CASH FLOWS (USED IN) FROM OPERATING ACTIVITIES:           (Unaudited)
<S>                                                        <C>             <C>            <C>            <C>           
 Net loss                                                  ($11,880,857)   ($  394,269)   ($1,760,658)   ($1,931,657)
 Adjustments to reconcile net loss to
  net cash flows from operating activities:
  Depreciation and amortization                                 527,514         33,101         32,440         65,417
  Minority Interest                                              26,781         26,781           --             --   
  Loss on disposal of property and equipment                      5,752           --             --            5,752
  Issuance of common stock for compensation and other            75,725           --              325           --   
  Issuance of common stock for purchase of NOXSO Process         28,125           --             --             --   
  Compensation in satisfaction of notes receivable               57,000           --             --             --   
  Changes in operating assets and liabilities:
   Accounts receivable                                       (2,163,420)    (1,148,789)       472,193       (471,585)
   Prepaid expenses and other current assets                    (34,533)       (18,851)         1,319         16,517
   Deposits                                                      (4,308)          --             --             --   
   Accounts payable                                           3,424,692      2,731,266        601,309         43,459
   Accrued compensation                                          98,975         70,716        (50,589)         1,314
   Advanced Billings                                          1,379,549      1,184,974        194,575           --   
   Accrued Expenses                                                --             --         (159,736)       159,736
   Other current liabilities                                    290,945        208,961         67,357       (154,429)
                                                            ---------------------------------------------------------
 Net cash flows (used in) from operating activities        ($ 8,168,060)   $ 2,693,890    $  (601,465)   $(2,265,476)
                                                            -----------    -----------    -----------    ------------

CASH FLOWS (USED IN) INVESTING ACTIVITIES:
 Acquisition of and deposits for property and equipment      (8,065,295)    (6,637,621)      (853,694)       (47,241)
 Bank certificate of deposit                                 (1,000,000)          --           29,157           --   
 Proceeds from the sale of property and equipment                 4,546           --             --             --   

 Net cash flows (used in) investing activities             ($ 9,060,749)   ($6,637,621)   ($  824,537)   ($   47,241)
                                                            ---------------------------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES:
 Net proceeds from private placement offering                 5,713,720      1,821,310      1,298,295           --   
 Proceeds from line of credit                                 3,025,000      1,525,000        970,000        470,000
 Payments of line of credit                                  (2,025,000)      (770,000)    (1,195,000)          --   
 Proceeds from issuance of common stock                       7,760,647           --             --             --   
 Proceeds from sales of common stock
  options and warrants                                        1,323,095        166,784         58,252        137,512
 Proceeds from satisfaction of notes receivable                  27,000           --             --             --   
 Proceeds from ACOA and Olin loans                            2,874,000      2,204,000        670,000           --   
 Payment of ACOA loan                                        (1,000,000)    (1,000,000)          --             --   
 Net loans to stockholders and officers                          (4,930)          --             --             --   

             Net cash flows from financing activities      $ 17,693,532    $ 3,947,094    $ 1,801,547    $   607,512
                                                            ---------------------------------------------------------

NET INCREASE (DECREASE), CASH AND EQUIVALENTS                   464,723          3,363        375,545     (1,705,205)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD                          --          461,360         85,815      1,791,020
                                                            ---------------------------------------------------------
CASH AND EQUIVALENTS, END OF PERIOD                        $    464,723    $   464,723    $   461,360    $    85,815
                                                            ===========    ===========    ===========    ============

SUPPLEMENTAL CASH FLOW INFORMATION:
 Interest paid                                             $    207,289    $   130,126    $    70,890    $     4,720
                                                            ===========    ===========    ===========    ============

NONCASH FINANCING ACTIVITIES:
 Issuance of common stock for notes receivable             $     84,000    $      --      $      --      $      --   
                                                            ===========    ===========    ===========    ============
 Acquisition of common stock into treasury to satisfy
  notes receivable                                         ($    25,000)   $      --      $      --      $      --   
                                                            ===========    ===========    ===========    ============
 Issuance of common stock in exchange for warrant          $      1,165    $      --      $      --      $      --   
                                                            ===========    ===========    ===========    ============
 Compensation in satisfaction of notes receivable          $     57,000    $      --      $      --      $      --   
                                                            ===========    ===========    ===========    ============
</TABLE>
See Accompanying notes to consolidated financial statements.



                                       38
<PAGE>


                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 - Nature of Business and Principles of Consolidation:

     NOXSO  Corporation  was  incorporated  in the  Commonwealth  of Virginia on
     August 28, 1979, to engage in  developing,  testing and marketing a process
     capable of removing  certain  emissions  from the flue gas generated by the
     burning of coal.  The Company is in the  development  stage and has not yet
     commenced commercial operation.

     The financial  statements  include  accounts of NOXSO  Corporation  and its
     majority-owned   subsidiary.   All  intercompany   transactions  have  been
     eliminated in  consolidation.  NOXSO  Corporation  and/or NOXSO Corporation
     together with its subsidiary are hereafter referred to as (the "Company").

     The  preparation  of financial  statements  in  conformity  with  generally
     accepted  accounting  principles  requires management to make estimates and
     assumptions  that affect the reported amounts of assets and liabilities and
     disclosure  of the  contingent  assets and  liabilities  at the date of the
     financial  statements  and the  reported  amounts of revenues  and expenses
     during  the  reporting  period.  Actual  results  could  differ  from those
     estimates.

Note 2 - Summary of Significant Accounting Policies:

     Cash  Equivalents - The Company  considers  certificates of deposit,  money
     market funds and all other highly liquid debt instruments,  with a maturity
     of three months or less when purchased, to be cash equivalents.

     Property and  Equipment - Property and  equipment  are stated at cost.  The
     Company provides for depreciation  using various methods over the estimated
     useful lives of 3 to 5 years for machinery and equipment,  5 to 7 years for
     office furniture and fixtures, and the lease term or useful life, whichever
     is shorter, for leasehold improvements.

     Construction-in-Process  - During the fourth  quarter of 1995,  the Company
     began to  capitalize  its  share of costs  associated  with the  Full-Scale
     Demonstration  Facility.  Funds received from the U.S. Department of Energy
     ("DOE") will be used to offset total costs incurred on the project with the
     result that net costs  capitalized  on the balance  sheet will  reflect the
     Company's   portion  of  the  project  costs.   Management   believes  that
     undiscounted  future cash flows from the project  will exceed the  carrying
     amount of the asset.

     Patents - Patent costs are expensed as incurred.

     Income Taxes - Under the  Financial  Accounting  Standards  Board  ("FASB")
     Statement No. 109,  "Accounting for Income Taxes" (SFAS No. 109),  deferred
     tax assets or liabilities are computed based on the difference  between the
     financial  statement and income tax basis of assets and



                                       39
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     liabilities  using the enacted marginal tax rate.  Deferred income taxes or
     credits are based on the changes in the asset or  liability  from period to
     period.  There were no material temporary  differences at June 30, 1996. At
     June 30,  1996,  the Company had tax loss  carryforwards  of  approximately
     $11,400,000 which expire beginning in 1997. The deferred tax assets related
     to these net operating losses were entirely offset by a valuation allowance
     at June 30, 1996.

     The income tax  expense  recorded  relates  entirely  to Projex,  Inc., the
     Company's 70% owned subsidiary which files separate tax returns.

     Other  Postretirement and  Postemployment  Benefits - In December 1990, the
     FASB issued SFAS No. 106 "Employers' Accounting for Postretirement Benefits
     Other Than  Pensions".  SFAS No. 106  requires  the  accrual of the cost of
     postretirement  benefits during the years that the employees render service
     rather than recognizing such benefits when paid. The Company  presently has
     no benefit plans which would be subject to this standard. In November 1992,
     the FASB  issued SFAS No. 112  "Employers'  Accounting  for  Postemployment
     Benefits".  SFAS No. 112 establishes accounting standards for employers who
     provide  benefits  to former or inactive  employees  after  employment  but
     before  retirement,  such  as  severance  benefits,  workers'  compensation
     benefits,  continuance of health care benefits and life insurance coverage.
     Compliance with SFAS No. 112 did not have a material impact on the Company.

     Advanced Billings - The advanced billing account is part of the DOE funding
     mechanism. Under the terms of the contract with the DOE, the Company bills
     estimated costs one month in advance of actual costs incurred.

     Loss per Common  Share - Loss per common  share is based upon the  weighted
     average  number of shares and  equivalents  outstanding  during  each year.
     Common share equivalents consist of outstanding  warrants and options using
     the treasury stock method. Common share equivalents are not included in the
     computation  of average  shares  outstanding  for the years  ended June 30,
     1996, 1995, and 1994 because their inclusion would be antidilutive.

Note 3 - Agreements and Commitments:

     A)   Agreements  with W.R. Grace & Co.  ("Grace") - In September  1987, the
          Company  entered  into  three  agreements  with  Grace.  The  Research
          Agreement  and Option  Agreement  have  expired.  A License and Supply
          Agreement  expiring in September  2007  provides that the Company will
          notify any prospective  user of the NOXSO Process that the Company has
          approved  Grace as a supplier  of sorbent  beads.  Other  terms of the
          license  agreement  include  provisions  for  licensing  other sorbent
          suppliers,  a commission  that may become payable to the Company based
          on sales of sorbent to users of the NOXSO Process and  royalties  that
          Grace will receive based on its  licensees'  sales of


                                       40
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          sorbent  to  users  of the  NOXSO  Process.  Grace  has the  right  to
          terminate this agreement at any time with four months notice.

     B)   Agreements with MK-Ferguson  Company and Morrison Knudsen  Corporation
          ("MK") - The Company entered into agreements with MK-Ferguson  Company
          and MK.

          (1)  Cooperative  Agreement  -  Novation  - On August  31,  1994,  the
               Company  entered  into a series  of  agreements  with MK and,  in
               certain  circumstances,  other  parties  which  resulted  in  the
               Company  assuming  MK's role as the  primary  contractor  for the
               commercial   demonstration   of  the  NOXSO   Process  under  the
               Cooperative  Agreement dated March 11, 1991 by and between MK and
               the DOE. The DOE's  acknowledgment of the Novation  Agreement and
               the ancillary  agreements is evidenced by  Modification  No. 5 to
               the Cooperative  Agreement,  which the Company  received from the
               DOE on  September  26,  1994.  Certain  of these  agreements  are
               retroactively  effective to March 1, 1992, the date renegotiation
               began on  restructuring  the  Cooperative  Agreement.  Certain of
               these agreements are described below.

          (2)  Novation  Agreement - Pursuant to the  Novation  Agreement by and
               among the Company,  MK and the DOE dated as of March 1, 1992,  MK
               has  transferred  to the  Company  all of MK's  rights and duties
               under the Cooperative Agreement.  The Novation Agreement provides
               that  MK will no  longer  be a  "participant"  (as  that  term is
               defined in the  Cooperative  Agreement) in the development of the
               NOXSO  Process  nor will MK have any  ownership  interest  in the
               NOXSO Process.  Pursuant to the Novation  Agreement,  the Company
               has assumed the duties of MK under the Cooperative Agreement.  In
               addition,  MK and  the  Company  have  agreed  to  terminate  the
               subcontract  agreement  between  them dated  March 11,  1991 (the
               "1991   Subcontract"),   and  in  its  place   substitute  a  new
               Subcontract  Agreement  (described  below) which  designates  the
               Company as the prime  contractor for the design and  construction
               of the commercial demonstration facility of the NOXSO Process.

          (3)  Subcontract   Agreement  -  With  the  termination  of  the  1991
               Subcontract,  the  Company  will be paid for all work  under  the
               terms  of  such  subcontract  up to the  date of  termination  in
               accordance  with its terms,  and the Company  agreed that it will
               not be entitled to any  payments for costs  incurred  thereafter,
               including any administrative costs of termination.

               Under the new  subcontract  agreement  between the Company and MK
               dated as of March  1,  1992  (the  "1992  Subcontract"),  MK will
               remain  responsible  for  the


                                       41
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

               design and construction of the commercial  demonstration facility
               under  the  Cooperative  Agreement.  MK  has  agreed  to  certain
               standards with respect to the schedule of performance,  the scope
               of its  work  and the fee  structure  as  subcontractor.  MK will
               perform the design of the commercial  demonstration facility on a
               cost plus fixed fee basis  according to the fee  structure in the
               1992  Subcontract.  At the  conclusion of the final design of the
               facility,  MK and the Company will establish a mutually agreeable
               fixed  price  for  construction  of  the  facility.  MK  has  the
               responsibility  for obtaining,  maintaining and paying  workmen's
               compensation   insurance  as  well  as  other  general  liability
               insurance in connection with the Cooperative Agreement.  The term
               of the 1992  Subcontract  shall be  coincident  with  that of the
               Cooperative Agreement.

               In the event that the DOE terminates the Cooperative Agreement in
               its entirety,  then the 1992 Subcontract may be terminated by the
               Company.  Additional  terms for termination  allow the Company to
               terminate the 1992 Subcontract for convenience.

          (4)  Assignment Agreement - Pursuant to the Assignment  Agreement,  MK
               assigned  to  the  Company  all of  MK's  rights,  interests  and
               obligations in the NOXSO Process and the  Cooperative  Agreement.
               In the Assignment Agreement,  the Company has agreed to indemnify
               MK from claims and costs  arising out of the  Novation  Agreement
               and Cooperative  Agreement,  and the Company has agreed to defend
               MK against any claims or suits arising therefrom.

          (5)  NOXSO   Process   License   Termination   -  Under  this  License
               Termination,  MK and the  Company  have  terminated  the  License
               Agreement  dated  January 21,  1992 in which MK had been  granted
               rights to the patents and technical  information  relating to the
               NOXSO  Process.  The License  Termination  is effective  upon the
               effectiveness   of  the  Novation   Agreement.   In  the  License
               Termination,  each of the Company and MK have  mutually  released
               the other with  respect to any claims  arising  under the License
               Agreement.  MK has agreed to  disclaim  and assign to the Company
               all  rights  to any  inventions  or  technology  developed  by MK
               relating  to the NOXSO  Process  during  the term of the  License
               Agreement.

          (6)  First Amendment to Project Support Agreement - With the execution
               of the Novation Agreement, MK, the Company and Grace have amended
               the NOXSO  Demonstration Plant Project Support Agreement and side
               letter  executed  among  them  ("Project   Support   Agreement").
               Pursuant to this  amendment,  the Company and Grace have released
               MK from its obligations under the Project Support Agreement,  and
               MK has  assigned  to the  Company  and Grace,  respectively,  any

                                       42
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

               ownership interest MK may have acquired under the Project Support
               Agreement form the Company and Grace, respectively.

          (7)  Cancellation of Repayment  Agreement - Under the  Cancellation of
               Repayment Agreement, the DOE has released MK's obligations to the
               DOE under the Repayment Agreement and MK's repayment  obligations
               to the DOE under  the  Cooperative  Agreement.  The  Company  has
               negotiated a Repayment  Agreement with the DOE which provides for
               the Company's payment to the DOE of certain royalties  commencing
               after the third commercial installation of the NOXSO Process.

          The above  agreements have resulted in the  Cooperative  Agreement now
          being  between  the  Company  and the DOE.  Additionally,  the Company
          utilizes   MK  in  a   subcontractor   capacity   on  the   Full-Scale
          Demonstration Facility.

     C)   Agreements with Alcoa Generating Corporation ("Alcoa") - Following the
          decision not to use the Niles generating station of Ohio Edison as the
          commercial  demonstration  site,  the  Company  sought a  satisfactory
          alternate   demonstration  site.  This  effort  has  resulted  in  the
          execution  on August 30,  1994,  of a Project  Agreement  between  the
          Company and Alcoa for the design,  construction,  and  operation  of a
          proposed facility at Alcoa's Warrick  Generating  Station in Newburgh,
          Indiana.

          The project definition and design phases of the proposed demonstration
          facility  have been  completed by the Company in  accordance  with the
          terms of the Cooperative  Agreement,  and the  construction  phase was
          commenced  in June  1995.  The  Company  has  received  all  necessary
          approvals  from the DOE to proceed to complete the project.  As a part
          of the approval,  the DOE increased the funding for its share of costs
          for the project from $33 million to $41.1  million.  The funds needed,
          in excess of those  available  for the DOE to  complete  the  proposed
          demonstration  facility  are to be provided  from the  proceeds of $40
          million  Indiana  Development  Finance  Authority  Taxable  Clean Coal
          Technology  Variable  Rate  Demand  Revenue  Bonds,  Series  1999 (the
          "Bonds"). See further discussion in Note 8.

          Alcoa assisted in the  procurement by the Company of a $1,000,000 loan
          from  Aluminum  Company  of America  ("ACOA"), Alcoa's  parent,  at an
          interest rate of 8.75%,  payable  quarterly in arrears.  As additional
          consideration  for the loan,  the  Company  granted  ACOA a warrant to
          purchase 60,000 shares of the Company's  common stock between December
          1, 1994 to  December  1, 1996 at a price per share equal to the August
          29, 1994 closing price ($3.75 per share).  This price  represented the
          market value of the Company's stock on the date of issuance. On August
          29, 1994, the date of issuance, the Company had not yet


                                       43
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          obtained a commitment from the State of Indiana to guarantee the bonds
          required  to  finance  the  Company's  portion of the  project  costs.
          Accordingly,  given the  uncertainties  regarding project financing at
          that  time,  the  Company  did not  attribute  any  fair  value to the
          warrants at their  issuance  date. The loan proceeds were used towards
          meeting the initial needs in establishing the proposed facility.

          The Project Agreement provides for a two year Demonstration  Period to
          be followed by an 11 year operating period ending no later than August
          31, 2011 during which the Company would operate the proposed  facility
          and  would  obtain  emission  allowances  from  Alcoa  for sale in the
          marketplace  to  provide  part of the  funds  necessary  to cover  the
          operating   costs  and  repay  the  debt  to  be  issued  to   finance
          construction  of the  proposed  facility.  Alcoa may take title to the
          facility by notice to the Company by the end of the 11-year  operating
          period, or upon earlier termination of the Project Agreement.

     D)   Agreement with Olin  Corporation  ("Olin") - Under the Olin Agreement,
          the  Company is  constructing  the Olin  Facility  at Olin's  plant in
          Charleston, Tennessee. The Olin Facility will convert elemental sulfur
          into liquid sulfur dioxide. The estimated cost of the Olin Facility is
          $11 million,  of which approximately $8.2 million has been expended to
          date.  Provided  that the Olin  Facility  produces  sulfur  dioxide in
          accordance with  specifications set forth in the Olin Agreement,  Olin
          is  required,  for  a  10-year  period  after  the  Olin  Facility  is
          operational,  to pay to the Company $3,200,000 annually,  which amount
          is subject to adjustment after six years to account for changes in the
          Company's cost of producing elemental sulfur at the Alcoa Project, and
          the  Company is to  deliver  16,000  short tons per year of  elemental
          sulfur. Once the Alcoa Project is operational,  it is anticipated that
          all or virtually all of the 16,000 short tons of elemental sulfur will
          be produced by the Alcoa  Project.  Until that date,  the Company will
          have to pay the costs of purchasing  elemental  sulfur from suppliers.
          Based  on  historical  pricing,  it is  anticipated  that  the cost of
          elemental  sulfur  purchased in the open market will be  approximately
          12% to 25% of the  consideration  the Company is to receive  from Olin
          under the Olin Agreement, although there can be no assuarance the cost
          will not be greater.  The Company  presently  believes that it will be
          able to  complete  the Alcoa  Project  so that it is  operational  and
          producing  elemental sulfur by April 1998. There can, of course, be no
          assurance that the Alcoa Project will be completed by such date, if at
          all.

          Under  the  terms of the Olin  Agreement,  the  Company's  failure  to
          complete  the Olin  Facility by  September  1, 1996  entitled  Olin to
          require that the Company pay to Olin the amount by which (i) the costs
          Olin incurs to  purchase up to 2,667 short tons of sulfur  dioxide per
          month until the Olin Project is  operational  exceeds (ii) the cost of
          such  amount of sulfur  dioxide at a price of $130 per short ton.  The
          Company  owes  approximately  $17,000 to Olin for  September  1996 and
          anticipates  that it will be required to pay Olin no more than $70,000
          per month with respect to sulfur dioxide  purchases by Olin thereafter
          until  the Olin  Project  is  operational,  although  there  can be no
          assurance that the cost to the Company will not be greater.

          In addition,  if the Company fails to substantially  complete the Olin
          Facility by April 1, 1997,  Olin will have the right to terminate  the
          Olin   Agreement.   The  Company  is  in  the  process  of  completing
          construction  of the Olin  Facility  and  anticipates  that it will be
          substantially  completed by December, 1996 and operational by January,
          1997.  There  can be no  assurance  that  the  Company  will  meet the
          foregoing schedule.

          The Company has accrued  $68,000 in other  general and  administrative
          expenses in the  accompanying  Consolidated  Statement of  Operations,
          which  represents  $17,000  per  month  from  September  1996  through
          December 1996 for the purchase of sulfur dioxide.

                                       44
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     E)   Other  Agreements - During fiscal 1992,  the Company  entered into two
          agreements  with  the  DOE  and the  Pennsylvania  Energy  Development
          Authority  ("PEDA") for research  projects  intended to accelerate the
          development and commercialization of the NOXSO Process.

          At June 30, 1996 the Company had incurred costs totaling $1,112,835 of
          which $891,409 was reimbursed in connection with these projects.

     F)   Patent License  Agreement - On September 5, 1991, the Company  entered
          into an exclusive  license agreement with the DOE expiring November 7,
          2006. The license  agreement relates to a U.S. Patent that pertains to
          methods for removing nitrogen oxides from waste streams.

          The  Company  paid an initial  royalty fee of $10,000 and will pay the
          DOE  royalties  equal  to $75 per  megawatt  rating  at each  licensed
          facility designed or built by MK-Ferguson  Company or a sublicensee of
          MK-Ferguson  Company.  Such  royalties  at no time are to exceed  five
          percent of the revenues received by the Company.

     G)   License  Agreement - On March 24,  1992,  the Company  entered into an
          agreement  with FLS  miljo  a/s  ("FLS"),  a Danish  corporation.  The
          Company sold FLS 266,666 shares of its common stock for $2,000,000 and
          granted FLS a warrant to purchase  133,334  shares of its common stock
          at an exercise price of $7.50 per share, which expired  unexercised on
          March  24,  1994.  On March 24,  1992 the  Company  granted  to FLS an
          exclusive license to enable FLS to design, construct,  market and sell
          the NOXSO Process in Europe and Asia.

     H)   Employment  Agreements - Two  employment  agreements  expired in April
          1994. Minimum  compensation under those contracts  aggregated $240,000
          per annum.  The terms of these  contracts  will remain in effect until
          new agreements have been executed.

Note 4 - Capitalization of Full-Scale Demonstration Facility

     The Company  believes that the costs being  capitalized  for the Full Scale
     Demonstration  Facility  at  Alcoa  and  the  SO2  plant  at  Olin  will be
     recoverable  in the future as revenues  related to sulfur dioxide sales and
     air pollution  control credits,  which it is entitled to under the terms of
     its contracts with Alcoa and Olin, are realized. Any significant future set
     back in the  Company's  attempt to market the bonds  will be  evaluated  in
     order to measure  the  impairment  of its  investment  in  construction  in
     progress.

                                       45
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     The following table provides  supplemental  information  about the type and
     amount of costs  which  have been  capitalized for the years ended June 30,
     1996 and 1995:

                                                  Year Ended        Year Ended
                                                 June 30, 1996     June 30, 1995
                                                 -------------     -------------
                   Subcontractor Costs            $5,255,419        $  455,883
                   Salaries and Benefits             824,379           135,770
                   Other Direct Costs              1,031,986           199,322
                   Other General and                              
                        Administrative               357,761            56,980
                                                  ----------        ----------
                                                  $7,469,545        $  847,955
                                                  ==========        ==========
                                                             
     To date,  the  Company  has  completed  all  engineering  drawings  for the
     Warrick,  Indiana  project and also for the project under  construction  in
     Charleston,  Tennessee. Grading and pouring of a foundation for a warehouse
     storage facility has been performed at the Indiana  Project.  Additionally,
     the Company has completed  construction of an air separation plant,  sulfur
     storage tanks, railcar handling facilities and a heat exchanger at the Olin
     Corporation location in Tennessee. Further, the Company estimates it is 95%
     complete  with  construction  of a sulfur  dioxide  plant at the  Tennessee
     location.  The  majority  of costs  capitalized  to date relate to the Olin
     facility.

     All of the costs  indicated  above  represent  direct  costs  and  overhead
     allocations.  The size of the  Company  and its  current  focus on the full
     scale demonstration project have resulted in additional cost capitalization
     relative to prior years.

Note 5 - Formation of Construction Management Company

     During 1995 the Company formed a new subsidiary,  Projex, Inc.  ("Projex").
     The  Company  holds 70% of the stock in  Projex,  while the  management  of
     Projex holds the remaining  30% of such stock.  The Company will obtain the
     majority of its future revenues through license fees and royalties,  but it
     hopes to participate in future construction management activities at plants
     which use its technology as well as other facilities,  through Projex.  The
     first contract obtained by Projex was a $2,500,000  contract to perform the
     construction  management on the NOXSO  Full-Scale  Demonstration  Facility.
     Because the  Company's  majority  ownership of Projex,  it is  consolidated
     herein since the date of inception.  There is no related party relationship
     between  the  minority  shareholders  and the  Company,  its  employees  or
     directors.

Note 6 - Notes Payable

                                       46
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     The  Company  has a line of credit  with a bank which  expires  October 15,
     1996,  pursuant  to  which  borrowings  can be made up to an  aggregate  of
     $1,000,000.  Borrowings bear interest at prime and are  collateralized by a
     $1,000,000  certificate of deposit.  Borrowings under the line of credit at
     June 30, 1996 and 1995 were $1,000,000 and $245,000, respectively.

     In conjunction  with the Project  Agreement,  Alcoa assisted the Company in
     the  procurement of a $1,000,000  loan from the ACOA at an interest rate of
     8.75% payable quarterly in arrears. The outstanding  borrowings at June 30,
     1996 and 1995 were $0 and  $670,000,  respectively.  The loan was repaid in
     April 1996.

     In April 1996,  Olin granted the Company a loan in the amount of $1,874,000
     to be repaid on or before  October 31, 1996.  The loan bears  interest at a
     rate of 10%. The outstanding  borrowings at June 30, 1996 were  $1,874,000.
     These funds are being used to pay the Company's share of construction costs
     on the proposed demonstration facility.

     The weighted  average  interest rate for total notes payable as of June 30,
     1996 and 1995 was 9.4% and 8.3%, respectively.

Note 7 - Future Minimum Lease Payments:

     The  following is a schedule of future  minimum  rental  payments  required
     under the Company's  noncancellable  operating  leases which have remaining
     lease terms in excess of one year at June 30, 1996.

                      Year Ending June 30,
                      --------------------
                             1997                  157,000
                             1998                  161,000
                             1999                  118,000
                             2000                   10,000
                             2001                    1,000
                                                     -----
                                                  $447,000
                                                  ========

Note 8 - Financing

     The funds needed,  in excess of those  available  from the DOE, to complete
     the proposed demonstration facility are to be provided from the proceeds of
     the $40 million  Bonds.  On  September  16, 1996,  the Indiana  Development
     Finance  Authority  (the  "Authority")  adopted  resolutions  approving the
     issuance of the Bonds.  However,  the  Company is still  seeking to resolve
     certain  concerns of  representatives  of the Authority and the Company has
     not entered into a final  agreement with the issuer of a direct-pay  letter
     of credit


                                       47
<PAGE>

                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     required to support and secure the Bonds. In addition,  in order to satisfy
     the  conditions  to the  issuance of the Bonds,  among other things (i) the
     Company must obtain  additional  equity capital of approximately $5 million
     during  October 1996,  $2.5 million of which is to be used to fund one-half
     of a supplemental reserve to secure the Bonds and the remainder of which is
     to be used to  repay  outstanding  loans  made to the  Company  by Olin and
     Praxair, Inc. described below, and (ii) the County of Warrick, Indiana must
     fund or  irrevocably  commit  to fund,  in cash or by  causing  a letter of
     credit or its equivalent to be issued,  $2.5 million to fund the other half
     of the supplemental reserve.

     The Company  intends to raise the required equity capital through a private
     placement of its common stock,  the terms of which  placement are presently
     being negotiated and are contingent upon the satisfactory completion of due
     diligence and other conditions.  Any shares issued in the private placement
     are expected to contain  restrictions  on resale in accordance with Federal
     securities  laws and,  thus,  are  expected to be sold at a discount to the
     market  price  of  freely  tradeable  shares.  Some,  but not all  required
     approvals  have been obtained in order for Warrick County to commit to fund
     its portion of the supplemental reserve fund.

     There can be no  assurance  that either  condition  to the  issuance of the
     Bonds can be  satisfied  prior to October 31,  1996,  the date by which the
     Alcoa Agreement  presently requires that the Company have in hand financial
     resources  available for the performance of its obligations under the Alcoa
     Project  Agreement  of at least  $35  million  in  addition  to funds to be
     provided by the DOE. If such  financing is not in hand by that date,  Alcoa
     has the right, at its option,  to terminate its obligations under the Alcoa
     Project Agreement.

     The Company is in the process of negotiating  the terms of a  reimbursement
     agreement  pursuant  to which a letter of credit to support  and secure the
     Bonds would be issued by Canadian  Imperial Bank of Commerce,  as agent for
     itself  and other  banks.  Under the terms  being  discussed,  draws on the
     letter of credit  that are not  repaid  within  certain  time  periods  are
     converted  into  five-year  term  loans.  Term  loans  that  result  from a
     termination  or non-renewal of a letter of credit are to bear interest at a
     rate equal to LIBOR plus 1% per annum. Term loans that result from draws to
     purchase bonds tendered and not remarketed  that are not reimbursed  within
     60 days are to bear interest at a rate equal to LIBOR plus 2.25% per annum.
     In addition, the default rate is equal to LIBOR plus 2.25% per annum.

     The letter of credit banks are also to receive  letter of credit fees equal
     to  1.10%  during  construction  of the  Alcoa  Project  and  1% per  annum
     thereafter,  as well as certain other  administrative  fees.  The Company's
     obligations under the reimbursement  agreement  proposed to be entered into
     with the letter of credit  banks and with respect to repayment of the Bonds
     is to be secured by a pledge of all revenues  relating to the Alcoa Project
     and the Olin Project (collectively,  the "Projects"), which revenues are to
     be held in trust by a trustee  for the  letter  of


                                       48
<PAGE>

                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     credit bank and for the Authority. As a result, until the Bonds are paid in
     full, revenues from the Projects will be available only to secure and repay
     the Bonds and will not be available to the Company for any other  purposes.
     In addition,  the Bonds will be secured by the collateral assignment of all
     agreements  of the Company  relating to the  Projects,  including the Alcoa
     Agreement and the Olin Agreement.

     In  order  to  provide  for  construction  of the  Olin  facility  prior to
     receiving the proceeds of the Bonds,  the Company obtained a loan from Olin
     in the amount of  $1,874,000  as discussed  in Note 6. In August 1996,  the
     Company also  obtained the  agreement of Praxair Inc.  ("Praxair"),  an air
     products company,  to defer payment of the $2,700,000  balance owed for the
     air  separation  plant until  completion of the bond financing but no later
     than September 30, 1996. As of October 11, 1996,  Praxair was continuing to
     perform work on its portion of the Olin Project.  In  connection  with said
     agreement  with Praxair,  the Company agreed to pay late charges of .3% per
     week from the date of each outstanding invoice and to assign revenues it is
     entitled to receive under the Olin Agreement to Praxair until the Company's
     obligations to Praxair are paid in full.

     The  agreements  regarding  the Olin  loan  provide  that the loan is to be
     repaid on demand,  but in no event later than October 31, 1996. The loan is
     secured by a security interest in all of the Company's personal property. A
     portion of the  proceeds  of the Olin  loans  were used to repay,  in April
     1995, a $1 million loan from ACOA.  The balance of the loan  proceeds  have
     been or are being used to complete construction of the Olin Facility.

     The Olin loan and the Company's  obligations  to Praxair are expected to be
     repaid with the funds  available  to the Company  from the  proceeds of the
     equity investment described above.

     The Company  anticipates  that  revenues  from its  contractual  right to a
     portion of sulfur dioxide sales and the anticipated  value of air pollution
     control  credits will be  sufficient  to pay  principal and interest on the
     Bonds it intends to issue and to record a profit.  They will  evaluate this
     cash flow analysis quarterly as the project proceeds.

     At October  11,  1996  negotiations  regarding  funding,  which  management
     believes  will  be  successful,  are in  process.  If such  funding  is not
     secured,   the  Company  may  not  be  able  to  complete  the   Full-Scale
     Demonstration  Facility  and repay the amounts due Olin and  Praxair.  This
     matter raises  substantial doubt about the Company's ability to continue as
     a going  concern.  If the Company is unable to continue as a going concern,
     the  Company's  ability to recover  its  construction  in  progress  in the
     accompanying consolidated balance sheet is uncertain.

     In management's  opinion, the Company will complete the Bond sale and raise
     the equity required to complete the proposed  demonstration facility and to
     retire the Olin and Praxair debts.  Management  anticipates that funds will
     be available shortly after the date of this report. The Company will file a
     revised  Form 10-K  immediately  upon  obtaining  the  funding  required to
     complete the proposed demonstration facility.

Note 9 - Private Placement Offerings:

     On April 28, 1995, the Company conducted two private placement offerings to
     foreign  investors.  The first  offering  was for 150,000  shares of common
     stock at a price of $3.85 per share.  The 


                                       49
<PAGE>

                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     second  offering was for 250,000 shares of common stock at a price of $3.56
     per share.  The  $1,298,295 in net proceeds after  transactions  costs have
     been used to fund the ongoing  operations  of the  Company.  On October 17,
     1995, the Company conducted two private  placement  offerings to accredited
     investors.  The first  offering was for 100,000  share of common stock at a
     price of $4.55 per share.  The second  offering  was for 100,000  shares of
     common  stock at a price of $4.54 per share.  The  $818,000 in net proceeds
     after  transaction  costs have been used to fund the ongoing  operations of
     the Company.

     On April 15,  1996,  the Company  sold in a private  placement  offering to
     accredited  investors  156,763  shares at a price of $3.21 per  share.  The
     $503,209 in net proceeds  after  transactions  costs have been used to fund
     the ongoing operations of the Company.

     On June 26,  1996,  the  Company  sold in a private  placement  offering to
     accredited  investors  145,773  shares at a price of $3.43 per  share.  The
     $500,001 in net proceeds after transaction costs have been used to fund the
     ongoing operations of the Company.

     The shareholder's  who purchased the above shares under private  placements
     have been granted  registration rights or piggyback  registration rights by
     the Company.

Note 10 - Common Stock, Options and Warrants:

     The 1990 Stock  Option Plan - On April 18, 1990 the Board of  Directors  of
     the Company adopted, and in March 1991 the Company's stockholders approved,
     the 1990  Stock  Option  Plan (the "1990  Plan").  The 1990 Plan as amended
     authorizes the granting of either "incentive stock options,"  as defined in
     Section 422 of the Internal Revenue Code or "non-qualified  stock options,"
     to acquire 1,000,000 shares of the Company's common stock.  Incentive stock
     options may be granted only to employees. Nonqualified stock options may be
     granted to employees,  non-employee directors and consultants. The exercise
     price shall be such price as is determined by the Stock Option Committee or
     the Board of  Directors.  In  addition,  incentive  stock  options  granted
     pursuant to the 1990 Plan as amended  must have an exercise  price equal to
     fair market value of the  Company's  common stock at the time the option is
     granted,  except  that the price  shall be at least 110% of the fair market
     value  when the option is  granted  to an  employee  who owns more than ten
     percent of the combined voting power of all classes of the Company's voting
     stock at the date of grant.  The  aggregate  fair market value of the stock
     with respect to which incentive stock options are exercisable for the first
     time by any individual  during any calendar year shall not exceed $100,000.
     The Stock Option  Committee  will  determine the term of the options but no
     option  may be  exercised  after  ten  years  from  the date of  grant.  No
     incentive  stock  option  granted  to an  employee  who owns  more than ten
     percent of the  combined  voting  power


                                       50
<PAGE>

                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     of all the  outstanding  classes of stock in the Company  may be  exercised
     after five years from the date of the grant.

     Transactions  in stock  options  under the 1990 Plan as amended  for fiscal
     1996, 1995, and 1994 are as follows:

                                                  1996         1995       1994
                                                  ----         ----       ----
     Options outstanding July 1                 621,500      543,500    422,000
                                                                      
     Granted                                     90,000      328,500    129,000
                                                                      
     Exercised                                  (50,750)      (4,000)       -
     Canceled                                    (6,000)    (246,500)    (7,500)
     Options outstanding at June 30,            654,750      621,500    543,500
     Option price range at June 30,            $1.91 to     $1.91 to   $1.91 to
                                               $12.25       $12.25     $12.25
                                                                      
     Options exercisable at June 30,            609,750      576,500    543,000
     Options available for grant at June 30,    345,250      378,500        500
                                                                     
     On August  15,  1994,  the  Company  canceled  incentive  stock  options to
     purchase  63,500 shares of common stock issued to certain  employees and on
     such date new stock options were issued to purchase 63,500 shares of common
     stock at $3.625 per share, the market price on the date of grant.

     On August 30, 1994, the Company  canceled stock options to purchase  50,000
     shares of common stock issued (in connection with employment agreements) to
     L.G. Neal and John Haslbeck, executive officers of the Company, and on such
     date new stock  options  were  issued to purchase  50,000  shares of common
     stock at $3.25 per share,  the  closing  sale price of the common  stock on
     August 29, 1994. As with the canceled  options,  options to purchase 25,000
     shares were  granted to Dr. Neal and options  covering  25,000  shares were
     granted to Mr. Haslbeck.

     On August  30,  1994,  the  Company  canceled  with  respect to each of the
     Company's outside directors, Messrs. Long, Michael, Stoeckert, Toedtman and
     Voss,  respectively,  options to  purchase  25,000  shares of common  stock
     previously  granted to such persons under the 1990 Plan. On such date, each
     of such persons were granted  options to purchase  25,000  shares of common
     stock at an exercise  price of $3.25 per share,  the closing  sale price of
     the common stock on August 29, 1994.



                                       51
<PAGE>

                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     On March 17, 1995, the President,  Vice President and outside  Directors of
     the Board were granted options to purchase 25,000, 15,000 and 10,000 shares
     of the Company's  common  stock,  respectively  on an annual  basis.  These
     grants would vest 50% immediately  and 50% on the  anniversary  date of the
     issuance.  The grants would be effective on the third Friday of March,  and
     the  option  price will be equal to the  quoted  market  price as listed on
     NASDAQ, for each grant.

     Warrants - The  following  warrants were  outstanding  and  exercisable  to
     purchase the Company's stock at June 30, 1996 and 1995:

                         Aggregate Number
                        of Shares Subject       Price
        Year End           to Warrant         Per Share         Expiration Date
        --------           ----------         ---------         ---------------
     June 30, 1995           60,000              $3.75         February 24, 1997

     June 30, 1996           60,000              $3.75         February 24, 1997

                            156,763              $4.28            April 12, 1999

                             10,000              $6.00          October 27, 2000

                            

Note 11 - Contingencies:

     In late  August  1996 a  Complaint  was filed  against  the  Company in the
     District  Court  of  Jefferson  County,  Texas,  by  Calabrian  Corporation
     ("Calabrian")  relating  to a Purchase  Agreement  dated  October  16, 1995
     between the Company and Calabrian and a related  License  Agreement,  dated
     effective as of September 1, 1995,  between the Company and Calabrian.  The
     complaint  alleges that the Company took over direction and  supervision of
     Calabrian's  subcontract  relating to the construction of components of the
     Olin Facility,  disrupting  Calabrian's  plans with respect to the facility
     and  constituting an unlawful  interference  with  Calabrian's  contractual
     relationships  with its  subcontractors,  and that the Company defaulted in
     certain payment obligations to Calabrian under the Purchase Agreement.  The
     complaint  requests  damages in the amount of  $665,000,  representing  the
     balance  of  the  fee  allegedly  owed  to  Calabrian  under  the  Purchase
     Agreement,  unspecified damages caused Calabrian as a result of the alleged
     interference with contract,  any additional damages caused Calabrian by the
     Company's  conduct,  and,  until any amounts  due and payable to  Calabrian
     under its  agreements  with the Company are paid, a temporary and permanent
     injunction enjoining the Company from using Calabrian's technology and from
     disclosing it to third parties.

                                       52
<PAGE>
                                NOXSO CORPORATION
                        (A Development Stage Enterprise)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     The Company's  Counsel has advised that it believes the causes of action in
     Calabrian's  complaint  are without  merit and that the Company has a basis
     for filing a  counterclaim  against  Calabrian  for breach of contract as a
     result of Calabrian's  abandonment of its contract with the Company without
     cause  or  justification.  The  Company  intends  to deny  the  substantive
     allegations of the complaint,  to vigorously defend the action, and to file
     a counterclaim  seeking payment of (i) all costs incurred by the Company to
     complete the portion of the Olin Facility  abandoned by Calabrian in excess
     of the fixed price established in the Company's  Purchase  Agreement,  (ii)
     the  Company's  legal fees and costs,  and (iii) any and all other  damages
     caused the Company by  Calabrian's  filing of an action against the Company
     that is without merit.

Note 12 - Credit Concentration:

     The Company maintains its cash balances in a financial institution which is
     insured by the Federal Deposit Insurance Corporation.

Note 13 - New Accounting Pronouncements

     In March 1995, the Financial  Accounting  Standards  Board ("FASB")  issued
     SFAS No. 121.  "Accounting for the Impairment of Long-Lived  Assets and for
     Long-Lived  Assets to Be Disposed  Of." SFAS No. 121 requires that carrying
     value of long-lived  operating assets,  when determined to be impaired,  be
     adjusted so as not to exceed the estimated undiscounted cash flows provided
     by such asset.  SFAS No. 121 also  addresses the  accounting for long-lived
     assets that are expected to be disposed of in future periods.

     In October 1995, the FASB issued SFAS No. 123,  "Accounting for Stock-Based
     Compensation",  SFAS  No.  l23  recommends,  but  does  not  require,  that
     companies  change their method of accounting for  stock-based  compensation
     plans to one that  attributes  compensation  costs equal to the fair market
     value of a stock-based  compensation  arrangement over the periods in which
     service is  rendered.  Companies  not  electing to change  their  method of
     accounting  are  required,   among  other  things,  to  provide  additional
     disclosures  which in effect  restate a company's  results for  comparative
     periods as if the new method of accounting had been adopted.

     The Company will be subject to the  provisions  of SFAS NO. 121 and No. 123
     in fiscal 1997. At the present time,  the Company does not believe that the
     adoption of either of these  accounting  annuncements  will have a material
     effect on its financial position or results of operations.



                                       53
<PAGE>



Item 9.   Changes in and Disagreements with Accountants on Accounting and
          Financial Disclosure

        None.




                                       54
<PAGE>

                                    PART III

Item 10.  Directors and Executive Officers of the Registrant

     The directors and executive officers of the Company are listed in the table
below and brief summaries of their business experience are also set forth.

                                           Position with Company
     Name                        Age        or Principal Occupation
     ----                        ---       ------------------------
     Lewis G. Neal               63        President, Director

     John L. Haslbeck            47        Vice President, Treasurer, Director

     Robert M. Long              37        Secretary, Director

     John H. Michael             53        Director

     George I. Stoeckert         48        Director

     John R Toedtman             51        Director

     Stephen C. Voss             48        Director


     Dr.  Lewis G. Neal is a founder of the Company and has been a member of the
Board of Directors  since  November  1979 and was the President and Treasurer of
the Company from November  1982 until May 1985.  From May 1985 until April 1987.
Dr. Neal served as a consultant to the Company.  In addition,  from October 1985
until April 1986, Dr.  Neal was the General manager of the San Francisco  office
of G&E  Engineering,  Inc. G&E is an engineering  company  involved in hazardous
waste  clean-up.  In April 1987,  Dr. Neal rejoined the Company as its President
and Treasurer  and was  appointed  Secretary in November 1989 and served in such
position  until  March,  1991.  Dr. Neal serves on the  Company's  stock  option
committee.  Dr. Neal held several management positions with Teknekron,  Inc., an
environmental engineering and consulting firm from January 1977 through November
1980.  From November 1980 until  November  1982, he was a private  consultant to
various entities,  including the Company.  Prior to 1977, Dr. Neal was assistant
general  manager of the  environmental  engineering  division  of TRW,  Inc.,  a
multi-division   corporation  involved  in  electronics,   defense  contracting,
communications   energy  and  environmental   engineering,   manufacturing  auto
replacement  parts and  credit  reporting.  Dr.  Neal has over  thirty  years of
experience  teaching chemical  engineering and conducting  research.  Dr. Neal's
research and consulting have been directed toward  environmental  problems since
1970. Dr. Neal acquired his Ph.D. from Northwestern University in 1962.

     John L. Haslbeck is the Vice President and Treasurer of the Company.  He is
also a member of the  Company's  Board of  Directors.  Mr.  Haslbeck  joined the
Company in 198l.  He is a co-inventor  of the NOXSO  Process and holds  numerous
patents related to the NOXSO  technology.  Mr Haslbeck has more than 22 years of
experience in evaluating,  designing, building and testing air pollution control
equipment. He has a B.S. in Chemical Engineering from the University of Delaware
(1972).  He has


                                       55
<PAGE>

been  involved in every aspect of the NOXSO  Process  research  and  development
program.  He served as a senior project  engineer on the first test of the NOXSO
Process on flue gas at the TVA's  Shawnee  Steam Plant.  He managed tests of the
NOXSO  Process  at a scale of 0.06 and 0.75  megawatts  at the DOE's  Pittsburgh
Energy Technology Center and managed the pilot test of the NOXSO Process at Ohio
Edison's  Toronto  Power Plant.  Prior to 1981,  Mr.  Haslbeck  held  management
positions with Teknekron,  Inc., TRW, Inc., and Stauffer Chemical Co. working on
all aspects of air pollution measurement and control.

     Robert M. Long has been a member of the Board of Directors  since  November
1988.  Mr.  Long was  appointed  Secretary  in March of 1993.  Mr. Long has been
self-employed as a financial consultant throughout his business career. Mr. Long
is a member of the Board of Directors of Denning Mobile  Robotics Corp. Mr. Long
graduated  from the  University of the South (B.A. - Economics) in 1981 and from
the College of William and Mary (MBA) in 1983.  Mr. Long serves on the Company's
compensation, stock option and shareholder relations committees.

     John H.  Michael has been a member of the Board of Directors of the Company
since  November  1984.  He served as Chairman  of the Board and Chief  Executive
Officer from  September 1985 to March 1991. Mr. Michael has been Chairman of the
Board since June 1986, and President and Chief Executive  Officer since November
1986,  of Personal  Diagnostics,  Incorporated,  engaged in the  development  of
medical  devices and the  engineering  and  assembly of  precision  products and
systems for high-technology industries,  including the medical device field. Mr.
Michael  graduated from Georgetown  University School of Foreign Service in 1964
(BSFS) and Harvard  Business  School (MBA) in 1969.  Mr.  Michael  serves on the
Company's  compensation,   executive,  shareholder  relations,  and  legislative
efforts committees.

     George I.  Stoeckert  is a founder of the  Company  and was a member of the
Board of Directors from November 1979 to July 1985. Mr.  Stoeckert  rejoined the
Board of  Directors in July 1991.  Mr.  Stoeckert  is a Division  President  and
Corporate Vice  President of Automatic  Data  Processing,  Inc.,  Roseland,  New
Jersey.  ADP is a New  York  Stock  Exchange  listed  company  and is one of the
world's  largest  companies  dedicated  to  providing  computerized  transaction
processing,  data  communications and information  services.  Mr. Stoeckert held
various general management,  financial and planning positions with Ryder System,
Inc., one of the world's largest  transportation  service companies from 1974 to
1991 including President of the Insurance  Management Services Division,  Senior
Vice President of Development,  President of Financial & Communication  Services
Division.  Mr.  Stoeckert  graduated from the University of Miami (B.A.) in 1970
and from the University of Miami Graduate  School of Business  (M.B.A.) in 1972.
Mr. Stoeckert serves on the Company's executive committee.

     John R.  Toedtman  has been a member of the Board of  Directors  since July
1986.  Since January 1990, Mr.  Toedtman has been Chairman of GEN/Rx,  Inc. From
November 1987 through January 1990, Mr. Toedtman was  self-employed.  From April
1986 until  November  1987, he was Director of Corporate  Finance at F.N. Wolf &
Co. Inc., the  underwriter of the Company's  most recent public  offering.  From
1981  to  1986,  he  was  Chairman  and  Chief  Executive  Officer  of  Personal
Diagnostics,  Incorporated.  Mr. Toedtman is a director of Vital Signs, Inc. Mr.
Toedtman   serves  on  the  Company's  stock  option,   shareholder   relations,
legislative efforts and executive committees.



                                       56
<PAGE>

     Stephen C. Voss is a founder of the Company  and has been a Director  since
1979. Mr. Voss serves on the Company's executive, compensation, stock option and
legislative efforts committees.  Mr. Voss held the position of Vice President of
the Company from August 1979 to March 1992. Mr. Voss is also President of Voss &
Co. Inc., a stock brokerage firm which he founded more than twenty years ago.

     Board members are elected annually by the shareholders and the officers are
appointed annually by the Board of Directors.

Compliance with Section 16(a) of the Securities Exchange Act of 1934

     Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors,  and persons who own more than 10% of a registered class
of the Company's equity securities,  to file reports of ownership and changes in
ownership  with the Securities  and Exchange  Commission  and Nasdaq.  Officers,
directors  and  greater  than  10%  percent  shareholders  are  required  by SEC
regulation  to furnish the Company  with copies of all Section  16(a) forms they
file. Based solely on review of the copies of such forms furnished,  the Company
believes  that Lewis G. Neal,  a director  and officer of the  Company,  John L.
Haslbeck,  a director and officer of the Company,  Robert M. Long, a director of
the Company, John H. Michael, a director of the Company,  George I. Stoeckert, a
director  of the  Company,  John R.  Toedtman,  a director of the  Company,  and
Stephen C. Voss, a director of the Company,  each inadvertently  failed one time
to timely file Form 4s reporting their receipt of options in March 1996 due to a
misunderstanding  regarding the filing  requirements  under Section 16(a).  This
failure to timely file has been or is in the process of being corrected.



                                       57
<PAGE>


Item 11.       Executive Compensation

     The  following  table sets forth a summary for the fiscal  years ended June
30, 1996,  1995 and 1994,  respectively,  of the cash and non-cash  compensation
awarded,  paid or  accrued,  by the Company to the  President  and to each other
person  who was an  executive  officer  of the  Company  whose  salary and bonus
exceeded $100,000 during fiscal 1996 (the "named executive officers").

<TABLE>
                               SUMMARY COMPENSATION TABLE

<CAPTION>
                                                                   Long Term
                                    Annual Compensation       Compensation Awards
                                    -------------------       -------------------
     Name and          Fiscal                                               All Other
Principal Position      Year         Salary      Bonus    Options/SARs  (#) Compensation
------------------      ----         ------      -----    ------------  ----------------
<S>                     <C>         <C>                      <C>              <C> 
   Lewis G. Neal        1996        $150,000    $37,500      25,000(1)        $ --
     President                                                            
                        1995         156,932     30,000      50,000(2)          --
                                                                          
                        1994         148,846        --       15,000(3)          --
                                                                          
 John L. Haslbeck       1996          90,385        --       15,000(4)          --
Vice President and                                                        
     Treasurer          1995          94,385        --       40,000(5)          --
                                                                          
                        1994          89,077        --       12,000(6)          --
</TABLE>

(1)  The options shown are incentive  stock options  granted under the Company's
     1990 Stock Option Plan, as amended,  to purchase the Company's Common Stock
     at an exercise price of $4.75 per share.  These options  terminate on March
     15,  2006,  subject to early  termination  upon  cessation  of an officer's
     employment with the Company. They were exercisable with respect to one-half
     of the  shares on March 15,  1996,  the date of grant.  They will be vested
     with respect to the balance on the first anniversary of their granting.

(2)  The options shown are incentive  stock options  granted under the Company's
     1990 Stock  Option  Plan,  as  amended,  to purchase  25,000  shares of the
     Company's  Common Stock at an exercise  price of $5.25 per share and 25,000
     shares of the  Company's  Common  Stock at an  exercise  price of $3.25 per
     share. The options having an exercise price of $5.25 per share terminate on
     March 16, 2005, and the options having an exercise price of $3.25 terminate
     on August 29,  2004,  subject to early  termination  upon  cessation  of an
     officer's employment with the Company. The options having an exercise price
     of $3.25 per share  were  issued in  connection  with the  cancellation  of
     options to purchase 25,000 shares of the Company's Common Stock at a higher
     price which were issued in prior fiscal years.

(3)  The options shown are incentive  stock options  granted under the Company's
     1990 Stock Option Plan, as amended,  to purchase the Company's Common Stock
     at an exercise price of $5.00 per share. These options terminate on June 1,
     2004,   subject  to  early  termination  upon  cessation  of  an  officer's
     employment with the Company.


                                       58
<PAGE>

(4)  The options shown are incentive  stock options  granted under the Company's
     1990 Stock Option Plan, as amended,  to purchase the Company's Common Stock
     at an exercise price of $4.75 per share.  These options  terminate on March
     15,  2006,  subject to early  termination  upon  cessation  of an officer's
     employment with the Company. They were exercisable with respect to one-half
     of the  shares on March 15,  1996,  the date of grant.  They will be vested
     with respect to the balance on the first anniversary of their granting.


(5)  The options shown are incentive  stock options  granted under the Company's
     1990 Stock  Option  Plan,  as  amended,  to purchase  15,000  shares of the
     Company's  Common Stock at an exercise  price of $5.25 per share and 25,000
     shares of the  Company's  Common  Stock at an  exercise  price of $3.25 per
     share. The options having an exercise price of $5.25 per share terminate on
     March 16, 2005, and the options having an exercise price of $3.25 terminate
     on August 29,  2004,  subject to early  termination  upon  cessation  of an
     officer's employment with the Company. The options having an exercise price
     of $3.25 per share  were  issued in  connection  with the  cancellation  of
     options to purchase 25,000 shares of the Company's Common Stock at a higher
     price which were issued in prior fiscal years.

(6)  The options shown are incentive  stock options  granted under the Company's
     1990 Stock Option Plan, as amended,  to purchase the Company's Common Stock
     at an exercise price of $5.00 per share. These options terminate on June 1,
     2004,   subject  to  early  termination  upon  cessation  of  an  officer's
     employment with the Company.

     The Company has not had and does not have any annuity, retirement, pension,
deferred or incentive compensation plan or arrangement under which any executive
officers  are  entitled to  benefits,  nor does the Company  have any  long-term
incentive  plan  pursuant  to  which   performance   units  or  other  forms  of
compensation  are paid.  Executive  officers who qualify to  participate  in the
Company's 1990 Stock Option Plan. See "Stock Options" in this Item 11. Executive
officers  participate in group life, health and hospitalization  plans which are
available generally to all employees.


     In January 1992,  the Company  instituted a simplified  employee  pension -
Individual  Retirement Account ("IRA") for the employees under Section 408(k) of
the Internal Revenue Code. The plan allows each employee to contribute up to 15%
or $8,994, whichever is less, of his or her salary to an IRA. This plan is being
sponsored  by the  Company,  but the  Company  has not in the  past and does not
presently intend to make contributions to the plan.

Stock Options

     The  Company's  1990  Stock  Option  Plan,  as amended  (the "1990  Plan"),
authorizes  the  granting  of either  "incentive  stock  options"  as defined in
Section 422 of the Internal Revenue Code of 1986, as amended,  or "non-qualified
stock options" to acquire the Company's  common stock. The Plan does not provide
for the  issuance of stock  appreciation  rights.  The purpose of the Plan is to
advance  the  interests  of  the  Company  and  its  shareholders  by  providing
additional  incentives



                                       59
<PAGE>

to the  Company's  management,  including  members  of the  Company's  Board  of
Directors,  to  accelerate  development  of the  NOXSO  Process  and  to  reward
achievement of corporate  goals.  The Plan authorizes the issuance of options to
purchase up to 1,000,000  shares of common  stock.  The  Company's  stock option
committee consists of John R. Toedtman, Stephen C. Voss and Robert M. Long.

     On March 17, 1995 the Board of  Directors  resolved  that options be issued
each year to officers and directors of the Company in the following manner:

               President            25,000 shares
               Vice President(s)    15,000 shares
               Directors            10,000 shares

     These grants vest 50% immediately and 50% on the first (lst) anniversary of
the issuance.  The grants are effective on the third (3rd) Friday of March,  and
are at an option price equal to the market price of the  Company's  common stock
at close of market on that day as quoted on Nasdaq.

Option Awards

     The following table sets forth information  concerning  options to purchase
the Company's Common Stock or stock appreciation rights ("SARs") with respect to
the Company's Common Stock granted to named executive officer in 1996.

<TABLE>
                          Option/SAR Grants in Fiscal Year 1996

<CAPTION>
                                                                               Potential Realizable
                                                                                 Value at Assumed
                                                                                  Annual Rates of
                                                                                    Stock Price
                                                                                 Appreciation for
                                                 Individual Grants                 Option Term2
----------------------------------------------------------------------------   ----------------------
                    Number of     % of Total
                   Securities    Options/SARs
                   Underlying     Granted to     Exercise
Name               Option/SARs     Employees   or Base Price   Expiration
                  Granted (#)1  in Fiscal Year    ($/Sh)          Date          5% ($)    10% ($)
----------------------------------------------------------------------------   ----------------------
<S>                  <C>             <C>           <C>       <C>               <C>        <C>     
L.G. Neal            25,000          62.5%         $4.75     March 15, 2006    $74,681    $189,253

John Haslbeck        15,000          37.5%         $4.75     March 15, 2006     44,809    113,554
</TABLE>

1/ The options  shown are  incentive  stock  options to purchase  the  Company's
Common Stock at a price of $4.75 per share.  The options were granted  under the
Company's  1990 Stock  Option Plan,  as amended.  The options were 50% vested in
March 15,  1996,  the date of  grant.  The  options  vest  with  respect  to the
remaining shares on the first anniversary of their granting and terminate


                                       60
<PAGE>

on March 15, 2006, subject to earlier termination upon cessation of an officer's
employment with the Company.

2/ The potential realizable value shown is calculated based upon appreciation of
the Common Stock issuable under  options,  calculated  over the full term of the
options  assuming 5% and 10% annual  appreciation  in the value of the Company's
Common Stock from the date of grant, net of the exercise price of the options.


Option Exercises and Holdings

     The  following  table  sets  forth  information  with  respect to the named
executive officers,  concerning the exercises of options during fiscal year 1996
and the number  and value of  unexercised  options  held as of the end of fiscal
year 1996.

<TABLE>
                  AGGREGATED OPTION/SAR EXERCISES IN LAST YEAR AND
                         FISCAL YEAR-END OPTION/SAR VALUES
<CAPTION>
                                              No. of Securities                                 
                                                  Underlying              Value of Unexercised   
                      No. of      Value       Unexercised Options/      In-the-Money Options/SARs
                      Shares     Realized    SARs at Fiscal Year-End      at Fiscal Year-End (2)
                   Acquired on   --------    -----------------------    -------------------------
      Name           Exercise      (1)     Exercisable   Unexercisable  Exercisable  Unexercisable
      ----           --------      ---     -----------   -------------  -----------  -------------
<S>                  <C>          <C>        <C>            <C>           <C>           <C>   
Lewis G. Neal           --          --       112,500        12,500        $85,625       $4,687
John L Haslbeck         --          --        74,500         7,500        $83,375       $2,811
</TABLE>

     (1)  Value  realized is  calculated to equal the market price of the common
          stock at the exercise date less the exercise price.

     (2)  Based on $5.125  market  price of the  common  stock on June 30,  1996
          (fiscal year end) and the exercise price of the option,  multiplied by
          the number of options for each respective person named.


Employment  Agreements  Which Have  Expired  but the Terms of Which are Still in
Effect

     Dr. Neal and Mr. Haslbeck are presently  employed  pursuant to the terms of
employment  agreements  effective as of April 22 and April 29,  1992,  which had
initial terms of two years and which  continue to govern their  employment.  The
agreement with Dr. Neal provides that Dr. Neal will serve as the  President,  at
an annual base salary of $150,000 with additional  increases to be determined by
the Board of  Directors  and certain  bonuses  payable upon the  achievement  of
certain  corporate goals.  The agreement  requires that Dr. Neal devote his full
business  time to the  operations  of the  Company  and  also  contains  certain
covenants  not to compete with the Company in exchange for payment of one year's
salary to Dr.  Neal  following  termination  of the  agreement


                                       61
<PAGE>

if Dr. Neal has complied with such covenants. The agreement is terminable by Dr.
Neal under various conditions  including a change in control of the Company,  in
which case Dr. Neal is  entitled  to a lump sum payment  equal to the greater of
his then annual compensation, or the remaining total compensation payable to him
for the unexpired term of the agreement.  Additionally,  the agreement  requires
that all ideas, inventions, discoveries,  developments or improvements conceived
by Dr. Neal which are within the scope of the Company's business (whether or not
patentable), are and shall remain the exclusive property of the Company. Until a
new employment agreement is reached, the terms of this employment agreement will
remain in effect.

     The agreement  executed with Mr.  Haslbeck  provides that Mr. Haslbeck will
serve as the Vice President, at an annual base salary of $90,000 with additional
increases to be  determined by the Board of  Directors.  The agreement  requires
that Mr. Haslbeck devote his full business time to the operations of the Company
and also contains certain  covenants not to compete with the Company in exchange
for payment of one year's salary to Mr.  Haslbeck  following  termination of the
agreement if Mr.  Haslbeck has complied  with such  covenants.  The agreement is
terminable  by Mr.  Haslbeck  under  various  conditions  including  a change in
control of the  Company,  in which case Mr.  Haslbeck  is entitled to a lump sum
payment equal to the greater of his then annual  compensation,  or the remaining
total  compensation  payable  to him for the  unexpired  term of the  agreement.
Additionally,  the agreement requires that all ideas,  inventions,  discoveries,
developments  or  improvements  conceived by Mr.  Haslbeck  which are within the
scope of the  Company's  business  (whether  or not  patentable),  are and shall
remain the exclusive property of the Company.  Until a new employment  agreement
is reached, the terms of this employment agreement will remain in effect.

Compensation Committee Interlock and Insider Participation

     During  fiscal  1996,  Robert M. Long,  John H. Michael and Stephen H. Voss
served on the Company's Compensation Committee. Mr. Long is the Secretary of the
Company. Mr. Michael was its Chairman and Chief Executive Officer from September
1985 to March 1991.  Mr. Voss was Vice President of the Company from August 1979
to March 1992.  There are no interlocking  relationships,  within the meaning of
such term under the  regulations  of the  Securities  and  Exchange  Commission,
involving any of these individuals or other executive officers of the Company.

Directors Compensation

     The Company's outside directors (Messrs. Michael,  Stoeckert,  Toedtman and
Voss)  receive an annual fee of $30,000  for  serving as members of the Board of
Directors and members of the  Executive  Committee,  and, in addition,  they are
reimbursed  for their  expenses  in  connection  with  attendance  at each Board
Meeting.  The Board agreed to defer  indefinitely  payment of the annual fee for
fiscal 1996 and accordingly did not receive such fee during fiscal 1996.



                                       62
<PAGE>

Item 12.   Security Ownership of Certain Beneficial Owners and Management

     As of September  30, 1996,  there were  9,656,611  shares of the  Company's
Common  Stock  outstanding.  Set forth  below is  information  concerning  stock
ownership of all persons known by the Company to own  beneficially 5% or more of
the Company's common stock, of each executive  officer,  of each director and of
all  directors  and  executive  officers of the Company as a group (7  persons),
based upon the number of shares of common stock  outstanding  on  September  30,
1996.  Unless otherwise  stated,  each person so named exercises sole voting and
investment powers to the shares of Common Stock so indicated.


Name and Address of                Amount and Nature
Beneficial Owner               of Beneficial Ownership(1)          Percentage
----------------               --------------------------          ----------

W.R. Grace & Co.-Conn.                 2,005,494                     20.76%
1114 Avenue of the Americas
New York, NY

Stephen C. Voss                          828,415(2)                   8.52%
8415 Willow Forge Road
Springfield, VA

Lewis G. Neal                            278,500(3)                   2.85%
2414 Lytle Road
Bethel Park, PA

John L. Haslbeck                         189,575(4)                   1.95%
2414 Lytle Road
Bethel Park, PA

George I. Stoeckert                      180,000(5)                   1.85%
One ADP Blvd.
Roseland, NJ

Robert M. Long                           110,000(6)                   1.13%
44 Lake Road
Short Hills, NJ

John R. Toedtman                          70,000(7)                     *
I 1 Birch Drive
Basking Ridge, NJ



                                       63
<PAGE>

John H. Michael                           25,000(8)                     *
1810 24th Street
Washington, DC

All officers and
directors as a
group (7 persons)                      1,681,490(9)                  16.96%


* less than 1%

(1)  For  purposes of this table,  shares are  beneficially  owned if the person
     directly or  indirectly  has the sole or shared power to vote or direct the
     voting of the  securities  or the sole or  shared  power to  dispose  of or
     direct the  disposition of the  securities.  A person also is considered to
     beneficially  own shares if such person has a right to acquire  them within
     60 days, and options  exercisable within such period are referred to herein
     as "currently exercisable."

(2)  The shares  beneficially  owned by Mr. Voss include  171,800 shares held by
     Voss & Co., Inc., a stock brokerage firm of which Mr. Voss is President and
     sole  stockholder  and  include  70,000  shares  issuable  to him  upon the
     exercise of currently  exercisable  options  awarded under the 1990 Plan as
     follows:  for 5,000  shares at an  exercise  price of $4.75 per share  that
     expires on March 15, 2006;  for 10,000 shares at an exercise price of $5.25
     per share that expires on March 16, 2005;  for 25,000 shares at an exercise
     price of $3.25 per share that expires on August 29, 2004; for 20,000 shares
     at an exercise price of $4.5625 per share that expires on December 8, 2001;
     and for  10,000  shares at an  exercise  price of  $1.9063  per share  that
     expires on April 17, 2000.

(3)  The shares  beneficially  owned by Mr. Neal include 112,500 shares issuable
     to him upon the exercise of currently  exercisable  options  awarded to him
     under the 1990 Plan as follows:  for 12,500 shares at an exercise  price of
     $4.75 per share that  expires on March 15,  2006;  for 25,000  shares at an
     exercise  price of $5.25 per share  that  expires  on March 16,  2005;  for
     25,000  shares at an  exercise  price of $3.25 per share  that  expires  on
     August 29, 2004;  for 15,000 shares at an exercise price of $5.00 per share
     that  expires on June 1, 2004;  for 25,000  shares at an exercise  price of
     $11.25 per share that expires  April 1, 2002;  and for 10,000  shares at an
     exercise price of $1.9063 per share that expires on April 17, 2000.

(4)  The  shares  beneficially  owned  by Mr.  Haslbeck  include  74,500  shares
     issuable to him upon the exercise of currently  exercisable options awarded
     to him under  the 1990 Plan as  follows:  for 7,500  shares at an  exercise
     price of $4.75 per share that expires on March 15, 2006;  for 15,000 shares
     at an exercise price of $5.25 per share that expires on March 16, 2005; for
     25,000  shares at an  exercise  price of $3.25 per share  that  expires  on
     August 29, 2004; for 12,000 shares at an exercise price of $5.00 per shares
     that  expires on June 1, 2004;  for 5,000  shares at an  exercise  price of
     $12.25 per share that expires on April 28, 2002;  and for 10,000  shares at
     an exercise price of $1.9063 per share that expires on April 17, 2000.

                                       64
<PAGE>

(5)  The  shares  beneficially  owned by Mr.  Stoeckert  include  60,000  shares
     issuable to him upon the exercise of currently  exercisable options awarded
     under the 1990 Plan as follows:  for 5,000  shares at an exercise  price of
     $4.75 per share that  expires on March 15,  2006;  for 10,000  shares at an
     exercise  price of $5.25 per share  that  expires  on March 16,  2005;  for
     25,000  shares at an  exercise  price of $3.25 per share  that  expires  on
     August 29, 2004;  and for 20,000 shares at an exercise price of $4.5625 per
     share that expires on December 8, 2001.

(6)  The  shares  beneficially  owned by Mr.  Long  consist  of  110,000  shares
     issuable to him upon the exercise of currently  exercisable options awarded
     under the 1990 Plan as follows:  for 5,000  shares at an exercise  price of
     $4.75 per share that  expires on March 15,  2006;  for 10,000  shares at an
     exercise  price of $5.25 per share  that  expires  on March 16,  2005;  for
     25,000  shares at an  exercise  price of $3.25 per share  that  expires  on
     August 29,  2004;  for 20,000  shares at an  exercise  price of $4.5625 per
     share  that  expires on  December  8,  2001;  and for  50,000  shares at an
     exercise price of $1.9063 per share that expires on April 17, 2000.

(7)  The shares  beneficially  owned by Mr.  Toedtman  consist of 70,000  shares
     issuable to him upon the exercise of currently  exercisable options awarded
     under the 1990 Plan as follows:  for 5,000  shares at an exercise  price of
     $4.75 per share that  expires on March 15,  2006;  for 10,000  shares at an
     exercise  price of $5.25 per share  that  expires  on March 16,  2005;  for
     25,000  shares at an  exercise  price of $3.25 per share  that  expires  on
     August 29,  2004;  for 20,000  shares at an  exercise  price of $4.5625 per
     share  that  expires on  December  8,  2001;  and for  10,000  shares at an
     exercise price of $1.9063 per share that expires on April 17, 2000.

(8)  The shares  beneficially  owned by Mr.  Michael  consist  of 25,000  shares
     issuable to him upon the exercise of currently  exercisable options awarded
     under the 1990 Plan as follows:  for 5,000  shares at an exercise  price of
     $4.75 per share that  expires on March 15,  2006;  for 10,000  shares at an
     exercise  price of $5.25 per share that expires on March 16, 2005;  and for
     10,000  shares at an exercise  price of $4.5625  per share that  expires on
     December 8, 2001.

(9)  The shares  beneficially owned by all directors and executive officers as a
     group  includes  shares  owned of record as well as shares  issuable to the
     beneficial  owners upon the exercise of options awarded under the Company's
     1990 Stock Option Plan,  which options are exercisable  currently or within
     sixty (60) days.


                                       65
<PAGE>

Item 13. Certain Relationships and Related Transactions

     Grace and the Company are parties to the Grace License Agreement  described
in "Certain License Agreements" in Item 1.



                                       66
<PAGE>


                                     PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

     (a)(1)  Consolidated  Financial  Statements
             A  list of  financial  statements  filed as a part of the Company's
             Annual Report on Form 10-K is set forth at page ___ hereof.

     (a)(2)  Inapplicable

     (a)(3)  List of Exhibits
             The following exhibits are included as a part of this Annual Report
             on Form 10-K or incorported herein by reference.

  Exhibit No.          Document Description
  -----------          --------------------
     3.1/1     Articles of Incorporation, as amended.

     3.2/1     Amended and Restated By-Laws.

    10.1/2     License and Supply  Agreement  between  W.R.  Grace & Co. and the
               Company, dated September 11, 1987.

    10.2/3     Cooperative   Research   Agreement   between  the  United  States
               Department of Energy's  Pittsburgh  Energy  Technology Center and
               the Company,  dated  February 15, 1985, as amended  September 27,
               1988.

    10.3/4     Amended  and  Restated  Lease,  executed  May  1990  between  WPC
               Associates and the Company

    10.4/4     1990 Stock Option Plan

    10.5/5     License  Agreement,  executed  March 24, 1992 between FLS and the
               Company.

    10.6/6     Novation  Agreement,  dated as of March 1,  1992 by and among the
               Company,  the United  States  Department  of Energy and  Morrison
               Knudsen Corporation, effective March 1, 1992.

    10.7/6     Assignment  Agreement  by and between  the  Company and  Morrison
               Knudsen Corporation, effective March 1, 1992.

                                       67
<PAGE>

    10.8/6     Modification No. 5 to Cooperative Agreement No. DE-FC22-91PC90549
               (Amendment No. M005) and accompanying letter from the DOE.

    10.9/6     Project  Agreement,  dated  August 30,  1994 by and  between  the
               Company and Alcoa Generating Corporation.

    10.10/6    License,  Construction,  Lease and Sulfur Supply Agreement, dated
               April 26, 1995 between the Company and Olin Corporation.

    23         Consent of Arthur Andersen LLP.

Notes
-----

1.   Incorporated by reference to the Company's  Registration  Statement on Form
     S-1 filed with the Commission on January 13, 1989, file No. 33-2654l.

2.   Incorporated by reference to the Company's Annual Report on Form 10-K filed
     with the Commission on December 28, 1987.

3.   Incorporated by reference to the Company's Annual Report on Form 10-K filed
     with the Commission on September 28, 1988.

4.   Incorporated by reference to the Company's Annual Report on Form 10-K filed
     with the Commission on September 28, 1990.

5.   Incorporated by reference to the Company's  Annual Report on Form 8-K filed
     with the Commission on March 24, 1992.

6.   Incorporated by reference to the Company's Annual Report on Form 10-K filed
     with the Commission in September 1995.


                    (b)  Reports  on Form 8-K
                         No  reports on Form 8-K were filed
                         during the last quarter of fiscal 1996




                                       68
<PAGE>



                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange  Act of 1934,  the  Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                                   NOXSO CORPORATION


Date: October 14, 1996                      By: /s/ Lewis G. Neal
                                               ------------------------------
                                                   Lewis G. Neal, President


     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
Report is signed below by the following  persons on behalf of the Company and in
the capacities and on the dates indicated.


 /s/ Lewis G. Neal       President, Director                    October 14, 1996
------------------------ (Principal Executive and
Lewis G. Neal             Accounting Officer)


/s/ John L. Haslbeck     Vice President, Treasurer, Director    October 14, 1996
------------------------ 
John L. Haslbeck


/s/ Robert M. Long      Secretary, Director                     October 14,1996
------------------------ 
Robert M. Long


/s/ John H. Michael      Director                               October 14, 1996
------------------------ 
John H. Michael


/s/ George I. Stoeckert  Director                               October 14, 1996
------------------------ 
George I. Stoeckert


/s/ John R. Toedtman     Director                               October 14, 1996
------------------------ 
John R. Toedtman


/s/ Stephen C. Voss      Director                               October 14, 1996
------------------------ 
Stephen C. Voss



                                       69