SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549

                                   FORM 10-KSB

                   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

             For the fiscal year ended December 31, 1997. Commission
                              file number 0-14465.



                              SONEX RESEARCH, INC.


                        Incorporated in State of Maryland
                   23 Hudson Street, Annapolis, Maryland 21401

Telephone Number:(410)266-5556     I.R.S. Employer Identification No. 52-1188993


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

               Title of                 Name of each exchange on
              each class                    which registered
              ----------                    ----------------
                 None                             None

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

                          Common Stock, $.01 par value


Check  whether the Issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days.   YES [X] NO [ ]


Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B in this form, and no disclosure will be contained, to the best of
registrant's   knowledge,   in  definitive   proxy  or  information   statements
incorporated  by reference  in Part III of this Form 10-KSB or any  amendment to
this Form 10-KSB. [ X ]


The number of shares  outstanding of the Issuer's $.01 par value Common Stock as
of March 31, 1998 was  17,556,406.  The  aggregate  market value of voting stock
held by non-affiliates of the Registrant was $9,156,239 as of March 31, 1998.


Revenues for the year ended December 31, 1997 were $417,588.


                   Documents Incorporated by Reference: None.




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                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


                         ITEM 1. DESCRIPTION OF BUSINESS

The Company
-----------

Sonex Research,  Inc.  ("Sonex" or the  "Company"),  incorporated in Maryland in
1980,  is  engaged  in the  research,  development  and  commercialization  of a
proprietary  technology (the "Sonex  Combustion  System",  "SCS" or "Ultra Clean
Burn(TM)  technology")  which controls the combustion of fuel in engines through
modification  of the  pistons in large  engines or the  cylinder  heads in small
engines.  The Company has shown through tests in  manufacturers'  engines and in
computer  models that its technology  has the ability to control  combustion and
allow fuel to be used more  efficiently,  and that engines  using the  Company's
technology  have  performance  superior to  conventional  engines and emit fewer
harmful exhaust emissions.  The SCS process, which has no moving parts, produces
lower  overall  emissions  at all  engine  speeds,  particularly  soot in diesel
engines, and is self-driven by the combustion process.

Management believes that the Company's technology can be applied to all types of
internal  combustion  engines,  including  those used in personal and commercial
vehicles (automobiles,  trucks, buses, boats and motorcycles) as well as engines
used in fixed or portable utility applications (motor generator sets, pumps, and
chain saws), whether spark ignited (SI) or compression ignited (CI), carburetted
or fuel injected, using either gasoline, diesel, alcohol and/or other fuels.


Focus of commercialization efforts
----------------------------------

Over the past few years,  Sonex has  concentrated its efforts on the application
of its technology to the reduction of exhaust  emissions in direct injected (DI)
turbocharged diesel truck and automobile engines.  Demonstration and development
programs at various  stages of completion  are underway with some of the largest
multi-national  diesel engine original  equipment  manufacturers  (OEM's) in the
world.  The goal of such programs is to execute broad agreements with the diesel
engine  manufacturers  and their piston  suppliers for industrial  production of
Sonex pistons under license from the Company. The demonstration process involves
many  stages,  from proof of concept  using  screw-assembled  prototype  pistons
fabricated  in-house  by  Sonex,  to  working  with  piston  suppliers  for  the
fabrication  of  finished  pre-production  pistons  that  will be used in  field
trials,  and durability,  manufacturing  optimization,  and other tests required
before the start of full series production.

To date, the Company has completed separate demonstration programs with three of
these  manufacturers,  and  each  has  verified  and  accepted  that the SCS can
substantially  reduce particulate  emissions at future NO (nitrous oxide) levels
in a DI turbocharged diesel engine for medium duty trucks while maintaining fuel
consumption  and  power.  The  most  recent  tests  conducted  by one  of  these
manufacturers showed that an engine using Sonex-modified  pistons along with EGR
(exhaust  gas  recirculation)  would attain  future U.S. and European  emissions
targets when OEM type  production  pistons become  available.  Negotiations  are
underway  with one of the  world's  largest  piston  suppliers  and  with  these
manufacturers  for  licensing,   technology  transfer  and  further  development
programs.

In addition to diesel truck engine  applications,  the Company has  successfully
applied  a  proprietary  starting  system  and  modified  engine  design  to the
conversion  of a small,  lightweight,  SI  gasoline  fueled  engine to start and
operate on JP5/JP8 standard  military fuels (also referred to as "heavy fuels").
The advantages of this converted SI engine have been  demonstrated  successfully
in a small,  remotely  controlled  military  Unmanned  Aerial Vehicle (UAV).  In
January 1998 the Company  delivered to the United  States  Marine Corps  Systems
Command  in  Quantico,   Virginia,   five   protoytpe  UAV  engines  that  Sonex
successfully converted from gasoline to heavy fuel operation.


Employees
---------

As of March 31, 1998, the Company had five employees: its two executive officers
and three  individuals  who provide  engineering  and  technical  services.  The
Company  has never  experienced  a strike or work  stoppage,  and  believes  its
relations with its employees are good.



                                        2

<PAGE>

                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


Description of the Company's technology
---------------------------------------

The SCS improves the process of combustion  through a  combination  of chemical,
acoustic  and  fluid  dynamic  effects  that  occur by  modifying  the  engine's
combustion  chamber  and the  processes  occurring  within that  chamber.  Sonex
designs rely on a cavity of some kind located in the piston,  the cylinder head,
or existing temporarily between both the piston and cylinder head.

Current  Sonex  DI  diesel  technology  involves  the  integration  of a  unique
geometric  design of  microchambers  in the  piston,  placing  one  microchamber
adjacent to each fuel injector spray. The microchambers surround the piston bowl
in the form of a  segmented  annulus,  or  tubular  ring.  The  position  of the
microchamber  is a critical factor in controlling the temperature of the chamber
and the rate of reaction of gases that may be resident in the chamber at any one
time. The resultant flux of highly reactive gases issue from the microchamber at
velocities  that can attain sonic speeds under certain  conditions.  These gases
create high turbulence in the piston bowl, allowing  exceptional  oxidization of
the soot.  The  additional  chemical  activity is very effective with the use of
EGR,  allowing  enhanced  ignition  with low soot  production in the presence of
large amounts of EGR.  Similar SCS piston  designs allow the use of  alternative
fuels in diesel engines with a minimum of change.

Sonex  places  several  small  tubular  vents  between  the piston  bowl and the
microchamber.  These  vents  control  the  amount of fuel and air that enter the
microchamber  and also  control the amount of  turbulence  that is created  when
gases jet out of the microchambers through these vents into the piston bowl. The
size,  length,  angle and  position  of the vents are  critical  to the level of
emissions  reduction.  At different times during the combustion  cycle,  air and
fuel are  admitted  to the  microchamber,  compressed  under high  pressure  and
temperature,  reformed chemically, and then exhaled from the microchamber.  This
process,  which has no moving parts,  produces  lower  overall  emissions at all
engine speeds and loads and is self-driven by the combustion process.

Current Sonex SI diesel  technology for carburetted  engines involves the use of
unique  microchambers  in the  cylinder  head of the  engine.  Patents for these
designs are  currently  pending.  This  technology  allows the  conversion of SI
gasoline  engines to use heavy fuels with another Sonex  innovation which allows
starting the engines on heavy fuels ranging from kerosine to diesel fuel.


Potential benefits of the SCS in the reduction of emissions
-----------------------------------------------------------

Government  agencies  in North  America,  Europe and Japan  continue  to mandate
increasingly  more strict  requirements  for the  reduction of allowable  diesel
truck emissions, specifically with respect to smoke/particulates and NO. The use
of costly high pressure  injection  systems and  electronic  controls may permit
truck manufacturers to attain some of these reductions;  however, it is unlikely
any one emissions  reduction  technique  will enable  manufacturers  to meet the
emission standards to be implemented in the next few years.

High  pressure  injectors  may  reduce  smoke/particulates,  but they  also
increase NO emissions while doing so. Manufacturers,  therefore,  may be able to
eliminate present equipment such as particulate traps, but they likely will need
larger  catalytic  converters,  leading to an increase in fuel consumption and a
decrease in power, all at a significantly higher cost.  Management believes that
the Company's diesel technology, which consists of a relatively simple change of
piston   design,    under   various    conditions    causes   a   reduction   in
smoke/particulates,   carbon  monoxide  (CO),   hydrocarbons  (HC),  and  NO  by
significant  amounts while  maintaining  or improving  upon brake  specific fuel
consumption  (BSFC)  and power.  In tests  conducted  in the  latest  production
engines  of  several  manufacturers  fitted  with a  variety  of Sonex  pistons,
including  aluminum screw assembled pistons,  electron beam welded pistons,  and
ferrous  crown  pistons,  the Company has  demonstrated  that the SCS may reduce
smoke/particulate  emissions  in excess  of 40% and HC  emissions  by 5%,  while
maintaining  equal NO  emissions  at future  targets and BSFC within 2% above or
below that of the stock engine.

The Company's  ability to reduce soot emissions has an added benefit towards the
reduction of NO in diesel engines.  Many  manufacturers are turning to using EGR
to reduce NO. (EGR is inert exhaust gas recycled and pumped back into the engine
cylinders for the next combustion  cycle.) EGR can significantly  reduce NO, but
the soot recirculated with EGR can increase  particulate  emissions and increase
engine  wear.  The SCS acts to reduce both the engine  wear and the  quantity of
particulates in the emissions by significantly  reducing the soot content of the
emissions.

                                       3
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


Management  believes  that Sonex Ultra Clean  BurnTM  technology  is perhaps the
least expensive  method of emissions  reduction,  but it is likely to be used in
conjunction with other  technologies to enable  manufacturers to meet the strict
diesel truck emission  standards that will be introduced in the near future. All
testing  to date by Sonex  and the  engine  OEM's  has  shown  that  SCS  diesel
technology is complementary to new developments such as high pressure  injection
and EGR. Testing is scheduled to begin later this year with a diesel common rail
injection system which should also prove complementary.


Competition
-----------

The Company's  competition comes from the extensive research  departments of the
world's major vehicle and engine  manufacturers as well as independent  research
organizations.   Although  the  experience   and  financial   resources  of  its
competitors  far exceed those of the Company,  management  believes that the SCS
can  provide  significant  advantages  over  the  competition  in terms of cost,
performance and simplicity.


Secrecy and non-disclosure
--------------------------

Due to the  highly  competitive  nature  of the  world's  automotive  and  truck
industries,  in connection with its contracts and/or demonstration programs with
such  manufacturers  the  Company is  required  to  execute  joint  secrecy  and
disclosure  agreements  that  expressly  prohibit the public  disclosure  of the
customers' names and other significant information. Failure by Sonex to maintain
this strict level of  confidentiality  would  jeopardize the relationship of the
Company with its customers.


Stages of technology demonstration and piston design
----------------------------------------------------

The major stages in the Company's  demonstration and development  process for DI
turbocharged diesel truck engines include the following:

  o   execution of secrecy and disclosure agreements;
  o   exchange of technical information;
  o   proof of concept with screw-assembled, Sonex-modified pistons fabricated
      and tested by Sonex by the engine manufacturer in its laboratories;
  o   testing at mandated  emissions and part-load cycles at Sonex on one of the
      manufacturer's latest engines, aimed at piston design improvement;
  o   delivery of best  design,  screw-assembled,  Sonex-modified  pistons  that
      allow the test  engine to meet  specified  emission  and fuel  consumption
      targets to the engine manufacturer for verification  testing and to one or
      more piston  suppliers  for the  fabrication  of  finished  pre-production
      pistons;
  o   delivery by piston supplier of pre-production pistons for review, approval
      and testing through the same cycles as before, first by Sonex, then by the
      engine  manufacturer,  to insure  that the  performance  of these  pistons
      equals or exceeds that of the screw-assembled pistons.

The Company has now  reached the next stage with three such  programs,  that is,
optimization of the piston design for the fabrication of piston  prototypes that
will be used in field trials and  durability,  manufacturing  optimization,  and
other tests required before the start of full series  production.  (See "Current
diesel  engine  programs".)  The engine  manufacturers  have stated that the SCS
benefits could be in lower cost, less complexity and greater reliability.  These
three factors are now being addressed by the Company and its customers.


Collaboration with piston suppliers
-----------------------------------

In  cooperation  with the engine  OEM's,  the  Company has worked with the major
piston suppliers to these manufacturers,  providing  engineering  specifications
and  drawings  for their use in  evaluating  alternative  production  methods in
anticipation  of eventual  piston orders from the engine  manufacturers.  One of
these companies,  T&N Piston Products Group of the U.K., is widely recognized as
one of the world's  leading  suppliers  of pistons and other  components  to the
engine industry.  T&N Piston Products Group companies trade under the name of AE
Goetze  Automotive.  T&N was acquired  recently by Federal-Mogul  Corp., a major
supplier of engine components based in Southfield, Michgan.

                                        4
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


T&N has developed  innovative and economical  techniques of manufacturing  Sonex
pistons for series  production.  Additional  work by T&N involves finite element
analysis,  stress  analysis and thermal cycling to examine the effects of stress
on the Sonex piston under a variety of extreme conditions. Sonex and T&N believe
the  results  of the joint  development  work,  which has been  moved from T&N's
research facility to its advanced  technology center, will demonstrate to engine
manufacturers  that  Sonex  pistons  meet  their  technical  requirements  while
remaining cost effective.

In December 1997 Sonex and T&N completed  negotiations  for a license  agreement
for  the  marketing,  manufacture  and  sale  of  diesel  truck  engine  pistons
incorporating  the SCS.  Early in 1998,  however,  T&N informed the Company that
signing of the agreement would be delayed pending further  refinement of the new
manufacturing  techniques developed by T&N for Sonex pistons. T&N indicated that
it  wants  to  be in a  position  to  follow  through  to  diesel  truck  engine
manufacturers with demonstrable  product and well thought through  manufacturing
plans before  concluding  the licensing  agreement  with Sonex.  As of March 31,
1998, the proposed license agreement with T&N has yet to be executed.


Current diesel engine programs
------------------------------

On a  continuing  basis  for the past  few  years,  the  Company  has  performed
extensive  design and development  work on medium- and heavy-duty  truck engines
for three large multi-national  diesel truck engine OEM's, in separate programs.
A funded agreement to develop Sonex pistons for industrial production for one of
these  companies  was executed in 1994.  This  program  advanced to the stage of
verification tests by this engine  manufacturer on an engine in its own facility
using  pre-production  finished Sonex pistons.  Successful results to that point
led to  initial  discussions  in 1995  for  technology  transfer  and  licensing
agreements with this engine  manufacturer;  however,  late in 1996, the focus of
discussions  changed,  and it was agreed by all three  parties  that the Company
first should execute a commercial  license with T&N.  Under this  approach,  the
cost of any and all  royalties  payable to the Company  would be included in the
selling  price for Sonex  pistons to be  produced  and sold by T&N to the engine
manufacturer.  (See "Collaboration with piston suppliers")  Negotiations are now
underway with this engine  manufacturer for a joint program for the optimization
of the Sonex piston designs for a larger engine size to take place  primarily at
an advanced engine laboratory in Europe.

The second large  multi-national OEM has verified Sonex test results on a set of
pre-production  Sonex pistons fabricated by T&N.  Subsequent  adjustments to the
manufacturing  process of these pistons have been agreed to by all parties,  and
further testing is planned in the summer of 1998.

In late 1996 a third major international  engine manufacturer  executed a funded
agreement  with the Company for a similar  demonstration  program that is now at
the stage of testing pre-production prototype SCS pistons. This manufacturer has
demonstrated  that by the use of EGR with  SCS,  it will be  possible  to attain
future U.S. and European  emissions  targets  when OEM type  production  pistons
become available.

In March 1996 Texaco Group,  Inc.  ("Texaco")  agreed to undertake a feasibility
demonstration  and  evaluation  of the SCS to confirm the  capability of a Sonex
piston to reduce  emissions  in a single  cylinder  DI diesel  research  engine.
Texaco's  interest in the SCS was in response to increasingly  rigorous  federal
fuel  specifications now under  consideration that are intended to assist engine
makers in meeting future emissions and performance targets. Texaco believed that
the  development  of an engine  design  meeting the  forthcoming  low  emissions
standards using the diesel fuel being produced today might make  unnecessary the
manufacture  of higher cost diesel  fuel and avoid the  significant  impact that
higher cost would have on fleet owners and operators.

In March  1997 at Sonex,  a  representative  of  Texaco  observed  a  successful
demonstration of the operating performance of this engine outfitted with a Sonex
piston,  after which the engine was delivered to Texaco's  research  facility in
Beacon,  New York, for  confirmation  testing.  In September  1997,  after being
informed  by Texaco  that the  diesel  laboratory  at the  Beacon  facility  was
closing,  Sonex retrieved this engine to continue the investigation.  Texaco has
yet to inform the Company of any future plans with respect to this program.

In March 1996 Texaco Group,  Inc.  ("Texaco")  agreed to undertake a feasibility
demonstration  and  evaluation  of the SCS to confirm the  capability of a Sonex
piston to reduce  emissions  in a single  cylinder  DI diesel  research  engine.
Texaco is funding the SCS  investigation  in response to  increasingly  rigorous
federal fuel  specifications now under consideration that are intended to assist


                                        5
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


engine  makers in  meeting  future  emissions  and  performance  targets.  Tests
conducted  by Texaco  and  others in the  petroleum  industry  have  shown  that
advanced  technology diesel engines exhibit less sensitivity to fuel composition
than current  technology  engines.  Texaco  believes that the  development of an
engine design meeting the forthcoming  low emissions  standards using the diesel
fuel being produced today will make  unnecessary  the manufacture of higher cost
diesel  fuel and avoid the  significant  impact  that  higher cost would have on
fleet owners and operators.

The engine  selected for this testing is a single  cylinder  OEM  generator  set
engine.  The Company first developed a full set of data for the baseline engine,
then fabricated and installed Sonex pistons in the engine. A  representative  of
Texaco observed the operating  performance of both configurations of this engine
in  Annapolis  in March 1997,  after which the engine was  delivered to Texaco's
research  facility  in Beacon,  New York,  for  confirmation  testing.  Assuming
satisfactory  results  are  achieved  in this  first  phase  of the  feasibility
demonstration, Texaco and Sonex will consider more extensive testing to document
optically the  in-cylinder  SCS behavior.  Upon  completion of the testing,  the
companies will publish  jointly the evaluation  findings in scientific and trade
publications.


Lightweight, spark-ignited (SI) engines
---------------------------------------

In 1994 under  contract to the U.S.  Army's Fort  Belvoir,  Virginia,  Research,
Development & Engineering Center, Sonex successfully  demonstrated two prototype
lightweight,  SI, carburetted two-stroke engines, which it modified to start and
run on JP-5/JP8  standard  military  fuels.  The Army was  interested in such an
engine for use in  light-weight,  man-portable  generator  sets in the field but
later informed the Company that the funding for the continuation of this program
had been canceled.

This  demonstration  for the Army led to an inquiry in 1995 from the U.S.  Naval
Research Laboratory (NRL) in Washington,  D.C., for the possible  application of
this engine  technology in Unmanned  Aerial Vehicles  (UAV's),  which are small,
remotely piloted aircraft.  UAV's conduct  short-range  tactical  reconnaissance
while operating  virtually  unseen and unheard,  taking pictures of battlefields
and enemy  installations  and relaying them back to ground forces.  Existing UAV
engines in the military's  inventory operate on gasoline.  Because of safety and
logistics  concerns,  the use of  gasoline  aboard ship and in the motor pool is
being  phased out by the  military.  All small  engines,  such as those found in
UAV's,  will be required to operate on less  volatile,  widely  available  heavy
fuels (such as JP-5 and diesel) used by jet aircraft and most military vehicles.
Conversion of such engines to operate on heavy fuels rather than gasoline  would
permit the  military  to  continue  to deploy  such  weapons  well into the next
century.

Sonex  subsequently  demonstrated and delivered a lightweight,  two-stroke,  SI,
carburetted,  35cc single cylinder engine to NRL,  similar to those delivered to
the Army, that was used in July 1996 in successful flight  demonstrations by NRL
of a UAV. The engine,  originally  gasoline  fueled,  was  converted by Sonex to
operate with less volatile heavy fuels.  NRL has continued flight testing during
the  past  year  and  is  now  considering  this  technology  for  its  possible
application in a larger engine.

In August 1997 the Company  was awarded a  demonstration  contract by the United
States Marine Corps (USMC) Systems Command in Quantico, Virginia, to upgrade the
capabilities  of an  operational  UAV known as the  Exdrone  by  converting  the
existing SI,  carburetted,  100cc single cylinder,  two-stroke,  gasoline fueled
engine to start and run on less volatile JP-5 fuel,  and by installing  improved
electronics.  The contract in the amount of $204,170  included a subcontract  of
$124,170 to AeroComm,  Inc., a privately held Germantown,  Maryland company, for
the  upgrade  of the  electronics  in the UAV to a  configuration  known  as the
Dragondrone, while Sonex, as the prime contractor, would receive $80,000 for the
heavy fuel engine (HFE) conversion and overall program management.

In test flights  conducted by the USMC Systems  Command early in January 1998, a
UAV powered by the prototype Sonex HFE on JP-5 fuel demonstrated  power and fuel
consumption  comparable to that of the stock engine operating on gasoline.  Upon
completion of this contract later in January 1998, the Company  delivered to the
USMC five prototype UAV engines that Sonex successfully  converted from gasoline
to heavy fuel operation.

In  February  1998  Sonex  received  an order from the USMC  Systems  Command to
convert an  additional  forty  Dragondrone  UAV  gasoline  engines to heavy fuel
operation. The total amount of the new order, in the form of an amendment to the
original  contract,  is  approximately  $125,000,  and delivery of the converted
engines is expected to be completed in June 1998.


                                       6
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


Sonex  is  also  performing  a  UAV  heavy  fuel  engine   conversion   under  a
demonstration  contract  awarded in October  1997 by the U.S.  Naval Air Warfare
Center,  Aircraft Division (the "Navy"), in Patuxent River, Maryland.  This UAV,
known as the  Pioneer,  has been in service  for  several  years,  and  provided
reconnaissance support for Persian Gulf operations.  The existing Pioneer engine
is a two-stroke,  carburetted,  SI two cylinder gasoline engine displacing 175cc
per  cylinder.  The contract in the amount of $87,795 calls for Sonex to deliver
two  HFE's to the Navy in April  1998.  The  Navy has the  right to  exercise  a
contract  option by September  30, 1998 pursuant to which Sonex would conduct an
experimental  evaluation of existing  techniques now used in space technology to
be able to eliminate the need for the supplementary  two-stroke  lubricating oil
(required in all gasoline two-stroke  engines) in the converted engine,  without
loss of performance benefits.

The Company is exploring additional potential uses by the military for its heavy
fuel  engine  technology,   such  as  in  other  UAV  models  and  light-weight,
man-portable  generator  sets  used in the  field,  as well  as  private  sector
opportunities.  Operation  of a  light-weight  engine on a high flash point fuel
such as diesel,  rather than gasoline,  will reduce the hazard  associated  with
gasoline,  making  such an engine  much more  suitable  for  applications  where
gasoline  storage is undesirable,  such as in diesel fueled utility engines used
in pumps,  generator sets, etc., in homes,  commercial buildings and boats. As a
result of the NRL demonstration and subsequent published report, during 1997 the
Company  executed  contracts  with two U.S.  manufacturers  of small  engines to
investigate  the  feasibility  of applying the Sonex HFE design to production SI
engines.  Sonex expects to reach agreement on the next prograqm steps with these
manufacturers  later this year,  following  completion  and  publication  of the
results of the Navy contract.


Alternative-fuel engines
------------------------

In the summer of 1994 the National  Renewable Energy Laboratory  Division (NREL)
of the  Midwest  Research  Institute,  which is the  field  manager  for the DOE
Alternative  Fuels  Utilization  Program,  awarded  the  Company a  contract  to
demonstrate  the SCS on a one liter per  cylinder  diesel  engine  running  on a
number of different fuels, including methanol,  ethanol,  biofuel and diesel. In
1995 the  Company  successfully  started  and ran such an  engine  on neat  M100
methanol fuel (100% methanol) at standard diesel  compression  ratio (17:5) with
no fuel additive,  ignition enhancer or in-cylinder  ignition device. The engine
was stable at all speeds and loads,  and achieved  power levels similar to those
of the same  engine  running on diesel  fuel.  These  results  were  achieved by
replacing the engine's stock piston with a Sonex-modified piston, in addition to
the standard modifications normally required to fuel a diesel engine on methanol

On the basis of these results, the Company was informed by NREL that funding was
to be set aside to continue the program in a vehicular demonstration. Sonex then
submitted its final report to NREL,  which was required to distribute the report
for outside review. One such reviewer stated that industry "... sees very little
if no interest in using  alcohol  fuels in diesel  engines."  DOE now appears to
have adopted this position as well.  The Company will re-visit this  application
when there is renewed commercial interest.


Patents and proprietary information
-----------------------------------

The Company has  endeavored  to protect its  technology by filing for patents in
the United  States  and in those  foreign  countries  in which it may be able to
commercialize the technology.  The Company has also developed a significant body
of  trade  secrets,   proprietary  information  and  know-how  relating  to  its
technology.  Although the  principles  underlying the SCS concept are capable of
being understood by experts in the field,  management  believes that it would be
difficult  to apply  the  Sonex  technology  successfully  to any  given  engine
configuration without the benefit of the trade secrets, know-how and proprietary
information owned by the Company.

Management  believes that the Company's business depends  substantially upon the
protection  afforded by its granted  and pending  patents,  as well as its trade
secrets, proprietary information and know-how. All contracts outside the Company
involving  any exchange of  confidential  technical  information  are made under
secrecy agreements approved by the Company's patent counsel. In addition, all of
the  management  and  technical  employees  of the Company are  required to sign
non-disclosure agreements respecting the Company's technology.

The Company  registered the name "SONEX" at the U.S. Patent and Trademark Office
in 1987,  and is in the  process of  registering  the name  "Ultra  Clean  Burn"
technology at the U.S. Patent and Trademark Office.


                                       7
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


                         ITEM 2. DESCRIPTION OF PROPERTY

The Company's principal executive offices and testing facility are located at 23
Hudson  Street,  Annapolis,  Maryland,  21401.  The  facility is  equipped  with
emissions  test equipment and machine shop and storage  facilities  necessary to
support the laboratory.  Management  believes that all of the Company's property
is adequately covered by insurance.  The building contains  approximately  6,000
square feet and is being occupied by the Company on a month-to-month basis under
the terms of an operating  lease agreement that expired in April 1994. The lease
was extended  initially  through June 1995, after which the Company occupied the
premises on a month-to-month basis until November 1996 when an extension through
November 1997 was executed.  No new long-term  lease has been  negotiated  since
this last extension expired.

The Company once again is occupying the premises on a month-to-month basis under
the  terms of the  previous  lease,  pursuant  to which  the  property  owner is
required  to provide  thirty  days  notice if he wants the Company to vacate the
premises.  Management  will  seek to  negotiate  a new  long-term  lease for its
facility or search for an  alternative  location in the event that an  agreement
cannot be  reached  for the  existing  premises.  Management  believes  that the
resolution of the uncertainty  with respect to the facility will not result in a
significant interruption in the operations of the Company.


                            ITEM 3. LEGAL PROCEEDINGS

As of the date of this  report,  management  is  aware  of no legal  proceedings
pending against the Company.



           ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the annual  meeting of the  Company's  security  holders  held on October 22,
1997, the holders of the Company's  Common Stock  re-elected Mr. Nuno Brandolini
as a director for a term  expiring at the annual  meeting held in the year 2000.
No other matters were submitted to a vote of security  holders during the fourth
quarter of 1997.


         ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock currently is traded in the over-the-counter market on
the OTC Bulletin Board service under the symbol  "SONX".  The OTC Bulletin Board
is an electronic and screen-based quotation medium operated by Nasdaq. Quotation
information on OTC Bulletin Board stocks is available on  stockbrokers'  desktop
terminals.

The  Company  has never paid cash  dividends  on its  Common  Stock and does not
expect to pay any cash  dividends in the  foreseeable  future.  The high and low
closing  prices of the Common Stock for each  quarterly  period since January 1,
1996 were as follows (These prices, which are drawn from reports provided to the
Company by Nasdaq, reflect inter-dealer prices without mark-ups,  mark-downs, or
commissions, and may not necessarily represent actual transactions.):

     Quarter ended:                             High              Low
                                             ---------         ------
        March 31, 1996                         $2.06             $1.00
        June 30, 1996                           2.06              1.00
        September 30, 1996                      1.34               .88
        December 31, 1996                       1.28               .69
        March 31, 1997                          1.56               .63
        June 30, 1997                           1.38               .81
        September 30, 1997                      1.28               .69
        December 31, 1997                       1.25               .72
        March 31, 1998                          1.06               .50

As of March 31, 1998, there were 17,556,406 shares issued and outstanding,  with
approximately  1,000  holders of record.  The  shares  for  approximately  2,800
additional  beneficial owners of the Common Stock are held of record (in "street
name") by brokers, dealers, banks, and other entities holding such securities of
record in nominee  name or otherwise or as a  participant  in a clearing  agency
registered  pursuant to Section 17A of the  Securities  Exchange  Act of 1934. A
total of 14,874,273  shares of the  Company's  Common Stock as of March 31, 1998
were reserved for issuance in connection  with the conversion of preferred stock
and the exercise of warrants and options.


                                       8
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


       ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION
                            AND RESULTS OF OPERATIONS

Losses accumulated during development stage
-------------------------------------------

Since its inception in 1980, the Company has generated  cumulative net losses in
excess of $20 million.  Operating funds have been raised  primarily  through the
sale of equity securities in both public and private  offerings,  while revenues
to date have not been significant. Accordingly, Sonex continues to be classified
as a development stage company.


Financial position and liquidity
--------------------------------

As of March  31,  1998,  the  Company  had  available  cash and  equivalents  of
approximately   $400,000  and  marketable  securities  valued  at  approximately
$125,000.  The marketable  securities  represent holdings in the common stock of
the  corporation  which in October  1995 was merged with and into the  Company's
inactive  subsidiary,  as  further  described  in  Note  4 to  the  accompanying
financial statements. The fair value of such securities, however, may be subject
to significant  fluctuation due to, among other factors,  limited trading volume
and a small public float.

Based upon current  spending levels,  management  believes that the cash on hand
and expected revenue from current and potential  contracts will be sufficient to
fund  operations at least  through the end of 1998.  The Company is currently in
negotiations  for  technology  transfer  and  licensing  agreements  which would
provide  substantial  operating  funds,  but execution of such agreements is not
assured. In the absence of the realization of significant  revenues,  additional
capital may be necessary to fund operations for 1999 and beyond.


Salary deferrals by employees
-----------------------------

In order to help  conserve  the  Company's  limited cash  resources,  all of the
Company's employees, at the request of the Board of Directors, for several years
have been voluntarily  deferring  receipt of payment of significant  portions of
their authorized annual salaries.  From time to time,  portions of such deferred
amounts  have been paid  through the  issuance to the  employees  of shares,  or
discounted  options to purchase  shares,  of the Company's  Common Stock.  As of
January 1, 1997, the ongoing deferral of salary for the Company's  non-executive
employees was eliminated.

In February 1992 the Company sold $2 million in convertible  preferred stock and
common stock  purchase  warrants in a private  placement  pursuant to a proposal
from Proactive Partners, L.P. and certain of its affiliates  ("Proactive").  The
proposal called for immediate  payment to employees of a portion of the salaries
deferred  through that time.  As a condition  to the  Company's  receiving  this
indispensable financing, Proactive required that all salaried employees document
and agree in writing to the ongoing deferral of salaries described above.

Accordingly,  in February 1992 all of the Company's  salaried  employees jointly
executed an  agreement  referred to as the  "Consent to  Deferral"  in which the
employees  consented to the past and future deferral of portions of their annual
salaries,  and  agreed to defer  payment of  amounts  so  accumulated  until the
Company has received licensing revenue of at least $2 million or at such earlier
date as the  Board of  Directors  determines  that the  Company's  cash  flow is
sufficient to allow such payment.  Immediately  upon execution of the Consent to
Deferral  and in  accordance  with the terms of the  Proactive  investment,  the
Company  received the proceeds from the financing,  with which it paid a portion
of previously deferred salaries in cash and in Company stock.
Following  the  completion  of this  investment,  Proactive  became the  largest
beneficial  owner of the  Company's  Common  Stock by virtue of its  purchase of
convertible  preferred stock and common stock purchase warrants,  and two of the
general partners of Proactive,  Mr. Myron A. "Mike" Wick, III and Mr. Charles C.
McGettigan, became directors of the Company.

The conditions of the Consent to Deferral that would allow repayment of deferred
salaries have yet to occur. As of December 31, 1997, an aggregate of $648,292 of
wages so deferred is recorded  as accrued  compensation  in the  accounts of the
Company.


                                       9
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


Results of operations
---------------------

Revenue:
-------
                                  Development          Sub-
                                   contracts         contracts

         1997                     $  298,168        $ 119,420
         1996                     $   70,000            -
         1995                     $  223,141            -

Development  contract revenue  consisted of the following  amounts from projects
more fully described in Item 1:

    o   $90,000 in 1997 and $70,000 in 1996 under a demonstration  program begun
        in  1996  to  apply  the  SCS  to a  truck  diesel  engine  for a  major
        international OEM;
    o   $90,000 in 1997 related to the delivery of prototype Sonex pistons to
        another major international OEM;
    o   $64,330 in 1997  pursuant to the contract with the USMC (90% complete as
        of year-end) to convert a gasoline  fueled small UAV engine to use heavy
        fuels and,  through a subcontract  for which related revenue of $119,420
        has been recorded in 1997, to upgrade the electronics in the UAV;
    o   $26,338 in 1997  pursuant to the contract with the Navy (30% complete as
        of year-end) to convert a gasoline fueled UAV engine to use heavy fuels;
    o   $27,500 under contracts with two U.S. manufacturers of small engines to 
        investigate the feasibility of applying the Sonex UAV design to 
        production SI engines;
    o   $150,000 in 1995 earned in connection with the development program begun
        in 1994 on a diesel-fueled  truck engine for another major international
        OEM;
    o  $53,141  in  1995  from  NREL  for  a   methanol-fueled   diesel   engine
        demonstration; o $20,000 in 1995 from the U.S. Naval Research Laboratory
        for a generator set engine.

Management is unable to predict future changes to development  contract  revenue
because the amounts  earned to date under  previous  development  contracts have
been determined through  negotiations with individual  manufacturers  based upon
the level of effort required and the level of funding that each manufacturer has
been willing to commit. Management anticipates, however, that future revenue may
also include consulting fees earned while working together with manufacturers to
optimize  the  results  achieved on a  particular  manufacturer's  engine,  and,
ultimately,  license fees and royalty  revenue once the Company's  technology is
placed into  production  engines by  manufacturers.  The future  amounts of such
other types of revenue, however, cannot be reasonably estimated.


Research and Development (R&D) Expenses:
---------------------------------------

                                 1997           1996           1995
                                 ----           ----           ----
  Personnel:
      Salaries                 $267,663       $255,919       $280,548
      Taxes/benefits             41,071         37,025         35,542
      Consulting                 15,769
      Stock & options            59,525         27,125         61,250
                               --------       --------       --------
      Total personnel           384,028        320,069        377,340

  Patent amortization
    and maintenance fees         44,298         71,180         88,378
  Occupancy                      43,263         55,459         57,314
  Testing supplies               30,869         39,475         31,156
  Software engineering           20,000
  Depreciation                   13,750         21,783         20,646
  Other expenses                 22,318         15,558         10,399
                               --------       --------       --------

      Total R&D                $558,526       $523,524       $585,233
                               ========       ========       ========

Total  R&D  expenses  increased  $35,002,  or 7%,  from  1996 to 1997,  as major
increases in personnel costs  ($63,959,  or 20%) and software  engineering  fees
($20,000 in 1997,  none in 1996) were  partially  offset by  decreases in patent
maintenance fees and amortization  ($26,882,  or 38%), occupancy costs ($12,196,
or 22%), and a net decrease in other expenses ($9,879). From 1995 to 1996, total
R&D  expenses  decreased  $61,709,  or 11%,  primarily  due to a decrease in R&D
personnel  costs of $57,271,  or 15%, while other expenses showed a net decrease
of $4,438.

                                       10
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


From 1996 to 1997, total salaries increased  $11,744,  or 5%, as a result of the
following  factors:  an increase effective January 1, 1997 in the wage rates for
all of the Company's  employees,  an increase in the accrual for unused vacation
pay in 1997, and an increase  resulting from the hiring of a new engineer in the
fourth  quarter  of  1997,  offset  in  part by  decreases  resulting  from  the
resignation in the second  quarter of 1997 of the Company's  manager of research
and the award of bonuses in 1996 while none were  awarded in 1997.  R&D salaries
decreased  by  $24,629,  or 9%, from 1995 to 1996  primarily  due to the $21,627
decrease in the amount of the total  bonuses  awarded in 1995  ($31,625)  versus
1996 ($10,000).

The  Company's  R&D  supervisor  and  corporate  liaison  in Europe  serves as a
consultant,  having been  compensated  in prior years  primarily  in the form of
restricted  stock or stock  options for services  performed in Europe.  In 1997,
however,  he spent  time in  Annapolis,  for  which  service  he  receives  cash
compensation,  a  portion  of which is  deferred  pursuant  to the  terms of the
Consent to Deferral.  The $15,769 shown above as "Consulting - European liaison"
represents  total cash  compensation he earned in 1997, of which $6,308 has been
deferred.

Compensation  cost for stock  options is measured as the excess,  if any, of the
market price of the Company's stock at the date of grant over the exercise price
of the option  granted,  while stock issued as  compensation  is measured at the
market  price on the date of award or at the  agreed-upon  value of the services
rendered.  Charges for compensation paid in the form of stock or options in 1997
included  $35,212 for stock and options  awarded to the Company's R&D supervisor
and  corporate  liaison in Europe,  while such  charges were $14,000 in 1996 and
$38,750 in 1995.  Charges for options granted to employees were $24,313 in 1997,
$13,125 in 1996 and $22,500 in 1995.

The  $26,882  decrease  from  1996  to  1997  in  patent  maintenance  fees  and
amortization of the capitalized costs of patents and technology  resulted from a
reduction in amortization expense of $54,104, offset in part by the write-off in
1997 of $24,527 in  unamortized  costs of patents  abandoned  and an increase in
patent  maintenance fees of $2,695.  The large decrease in amortization  expense
was almost entirely due to higher amortization in 1996 for the capitalized costs
of computer simulations, which became fully amortized early in 1997. The $17,198
decrease  from  1995 to 1996 in patent  maintenance  fees and  amortization  was
primarily  caused by the  write-off in 1995 of $18,862 in  unamortized  costs of
patents abandoned that year, while there was no such charge in 1996.

Occupancy  expenses  declined  significantly  from 1996 to 1997 as a result of a
reduction  in the  monthly  rent from $4,500 to $3,500 in  November  1996.  Rent
expense is allocated 80% to R&D and 20% to G&A based on the proportionate  share
of floor space devoted to each category.  In 1996 the Company for the first time
earned a small amount of sublease income,  but that figure was slightly lower in
1997 than in 1996.

Testing  supplies  include  motor  fuel,  engine  parts and other  items used or
consumed in engine testing and in the machine shop. Related costs fluctuate from
year to year  depending on the number and type of engines being tested,  and the
timing of purchases of certain items. Software engineering charges of $20,000 in
1997 represent  amounts paid to the Company's  former  president for programming
assistance  with the  Company's  technology  design manual that is to be used to
teach  engineers from  prospective  customers how to incorporate the elements of
the SCS into pistons. Depreciation expense has been declining for the last three
years, as most of the Company's  equipment that was purchased  several years ago
has become fully  depreciated,  while  purchases of new equipment  have not been
significant.


Cost of sub-contracts:
---------------------

The Company's  August 1997  contract with the USMC to convert a gasoline  fueled
UAV engine to use heavy fuels also included a subcontract  to AeroComm,  Inc., a
privately held Germantown,  Maryland company, for the upgrade of the electronics
in the UAV. The $111,750  recorded in 1997 as "Cost of subcontracts"  represents
the  accrual,  based on the  percentage  of  completion  of the  contract  as of
year-end,  of a portion of the amount to be paid to  AeroComm,  Inc.  upon final
delivery under the contract.


                                       11
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


General and Administrative (G&A) Expenses:
-----------------------------------------

                                 1997           1996           1995
                                 ----           ----           ----
  Personnel:
      Salaries                 $124,910       $114,753       $217,924
      Taxes/benefits             15,601          9,523         13,084
      Stock options              50,893
                               --------       --------       --------
  Total personnel               191,404        124,276        231,008

  Legal fees                     21,641         18,524         40,143
  Stock transfer agent,
    proxy fees, etc.             15,607         17,221         23,907
  Occupancy                      12,106         13,159         16,983
  Travel                         29,127         22,583         17,810
  Telephone & postage            10,833         10,982         14,215
  Insurance                      11,507         11,789         10,939
  Audit fee                      12,454          9,815          9,720
  Printing                        8,661          8,603          9,238
  Other expenses                 19,914         23,491         20,120
                               --------       --------       --------

      Total G&A                $333,244       $260,443       $394,083
                               ========       ========       ========

Total G&A expenses  increased  $72,801,  or 28%,  from 1996 to 1997,  due almost
entirely to an increase in G&A personnel costs of $67,128, or 54%, that resulted
primarily from stock option charges in 1997 of $50,893. From 1995 to 1996, total
G&A  expenses  decreased  $133,640,  or 34%,  largely  due to a decrease  in G&A
personnel costs of $106,732, or 46%.

The  increase  in G&A  salaries  of  $10,157  from  1996 to 1997  was due to the
following  factors:  (1) an increase effective January 1, 1997 in the wage rates
for all of the  Company's  employees;  (2) an increase in the accrual for unused
vacation  pay in  1997;  (3)  charges  incurred  in 1997  for  temporary  office
employees  (no such  charges  were  incurred  in 1996);  offset in part by (4) a
reduction caused by the termination of the employment as of the end of the third
quarter of 1997 of the Company's former president;  and (5) the award of bonuses
in 1996  while none were  awarded  in 1997.  The large  percentage  increase  in
payroll  taxes and  employee  benefits  was due  primarily  from  payroll  taxes
incurred on the  exercise of stock  options in 1997.  There is no  corresponding
amount  recorded  as wages when  below-market  options  are  exercised,  but the
optionee is taxed on the excess of the aggregate market price over the aggregate
exercise price, and the Company incurs the related payroll taxes.  There were no
such  charges  in 1996 or 1995.  Compensation  cost for  stock  options  in 1997
includes  a charge of  $44,643  related to the  below-market  option  grant from
Proactive,  the  Company's  principal  shareholder,  to the new president of the
Company, and a $6,250 charge for options granted to other employees.

The decrease of $103,171 in G&A salaries  from 1995 to 1996  primarily  resulted
from a  decrease  of $25,000 in bonus  awards and to a  reduction  of $76,000 in
salary expense for the Company's former  president.  Effective  January 1, 1996,
his  employment  commitment  was changed  from  full-time to  part-time,  with a
corresponding  reduction in salary from  $100,000 per year,  40% of which amount
was deferred, to $2,000 per month with no portion deferred.

Total  legal fees  increased  by  $3,117,  or 17%,  from 1996 to 1997,  as lower
charges from the Company's  general legal and securities  counsel were more than
offset by higher  charges from its patent  attorney for  additional  services in
connection  with the filing of new patent  applications  and assistance with the
proposed  piston  license  agreement  with T&N.  Total legal fees  decreased  by
$21,619,  or 54%, from 1995 to 1996, as the amount in 1995 included  significant
charges  related  to the  lawsuit  filed in 1993 by two former  officers  of the
Company seeking payment of deferred salaries. The litigation was concluded early
in 1996 in the Company's favor,  resulting in lower fees in 1996. Also,  charges
for services by the Company's patent attorney were substantially  higher in 1995
versus 1996, as the 1995 figure  included fees related to services in connection
with the review of the  Company's  decision in early 1995 to write-off the costs
of  certain  acquired  technology,  and  related  assistance  in  preparing  and
negotiating  the  proposed  settlement  and in making the filings  necessary  to
legally  abandon the related  patents.  The decrease from 1995 to 1996 resulting
from these factors was offset in part by higher charges for corporate securities
work related to the  preparation  and  ultimate  abandonment  of a  registration
statement during 1996.

Travel  expenses have been  increasing  since 1995 as a result of an increase in
overseas travel by the Company's  chairman and president during 1996 and 1997 in
connection with negotiations for licensing and technology transfer agreements.


                                       12
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


Write-off of acquired technology:
--------------------------------

As  described  in  Note  6 to the  Company's  financial  statements,  management
determined  in 1994 that the value of  certain  of its  older  technologies  had
suffered a permanent impairment.  Accordingly, the net book value of the related
capitalized costs,  representing the unamortized portion of costs capitalized by
the Company in connection  with the  acquisition  and maintenance of these older
technologies,  was  reduced  to its  estimated  recoverable  amount of  $80,000,
resulting  in a  charge  to  operations  in  1994  of  $739,036.  In 1995 it was
determined that the remaining  balance of $80,000 was not recoverable,  and this
amount was also charged to operations.


Gains on sales of marketable securities:
---------------------------------------

Gains  recorded  in 1996  and 1997  represent  the  proceeds  from the sale of a
portion of the Company's investment in Digital Dictation,  Inc., the corporation
which  in  October  1995  was  merged  with  and  into  the  Company's  inactive
subsidiary,  SonoChem,  Inc., as further described in Note 4 to the accompanying
financial  statements.  Because the recorded basis for this  investment is zero,
all sales proceeds are recognized as gains.


Effects of Year 2000 (Y2K) millenium date-change issues:
-------------------------------------------------------

During the past year, the Company has upgraded some of the hardware and software
currently being used in its operations,  and expects to continue to make further
upgrades  to other  hardware  and  software in the  ordinary  course of business
during the  remainder  of 1998 and in 1999 to ensure that all of its systems are
Y2K  compliant.  Expenditures  in this  regard  outside the  ordinary  course of
business are not expected to be significant.


Adoption of new accounting pronouncements
-----------------------------------------

The  adoption  by the Company in fiscal  1998 of new  accounting  pronouncements
which have a delayed effective date is not expected to have a material impact on
the financial statements of the Company.



                          ITEM 7. FINANCIAL STATEMENTS


Index to financial statements:

     Reports of independent accountants

     Financial statements:
         Balance sheets as of December 31, 1997 and 1996

         Statements of operations and accumulated deficit for the three years in
         the period ended  December  31, 1997,  and for the period from April 9,
         1980 (inception) through December 31, 1997

         Statements  of  paid-in  capital  for the  period  from  April 9,  1980
         (inception) through December 31, 1997

         Statements  of cash  flows  for the  three  years in the  period  ended
         December  31, 1997,  and for the period from April 9, 1980  (inception)
         through December 31, 1997

     Notes to financial statements


                                       13
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB





                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and
Stockholders of Sonex Research, Inc.

In our  opinion,  the  financial  statements  listed in the  accompanying  index
present  fairly,  in all  material  respects,  the  financial  position of Sonex
Research,  Inc. (a  development  stage  company) at December 31,  1997,  and the
results of its  operations  and its cash flows for the year then ended,  and for
the  period  from  April 9, 1980  (inception)  through  December  31,  1997,  in
conformity  with  generally  accepted  accounting  principles.  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 of these  statements  in  accordance  with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable  assurance about whether the financial statements are
free of material  misstatement.  An audit includes  examining,  on a test basis,
evidence  supporting the amounts and  disclosures  in the financial  statements,
assessing the  accounting  principles  used and  significant  estimates  made by
management,  and evaluating the overall  financial  statement  presentation.  We
believe  that our audits  provide a reasonable  basis for the opinion  expressed
above.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company  will  continue  as a  going  concern.  As  described  in  Note 3 to the
financial  statements,  the  Company's  ability to emerge  from the  development
stage,  commence  generation  of  significant  revenue  and  ultimately  achieve
profitable  operations remains uncertain.  The Company has incurred  significant
net losses since its inception.  The Company's  future prospects depend upon its
ability to  demonstrate  commercial  viability of its products  and/or to obtain
capital sufficient to assure the completion of its development stage activities,
all of which raise  substantial doubt about the Company's ability to continue as
a going  concern.  Management's  plans  in  regard  to  these  matters  are also
described in Note 3. The  financial  statements  do not include any  adjustments
that might result from the outcome of this uncertainty.


C. L. STEWART & COMPANY

Annapolis, Maryland
March 25, 1998


                                       14
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB





                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and
Stockholders of Sonex Research, Inc.

In our  opinion,  the  financial  statements  listed in the  accompanying  index
present  fairly,  in all  material  respects,  the  financial  position of Sonex
Research,  Inc. (a  development  stage  company) at December 31,  1996,  and the
results  of its  operations  and its cash flows for each of the two years in the
period then ended, in conformity with generally accepted accounting  principles.
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 of these  statements in accordance  with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable  assurance about whether the financial statements are
free of material  misstatement.  An audit includes  examining,  on a test basis,
evidence  supporting the amounts and  disclosures  in the financial  statements,
assessing the  accounting  principles  used and  significant  estimates  made by
management,  and evaluating the overall  financial  statement  presentation.  We
believe  that our audits  provide a reasonable  basis for the opinion  expressed
above.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company  will  continue  as a  going  concern.  As  described  in  Note 3 to the
financial  statements,  the  Company's  ability to emerge  from the  development
stage,  commence  generation  of  significant  revenue  and  ultimately  achieve
profitable  operations remains uncertain.  The Company has incurred  significant
net losses since its inception.  The Company's  future prospects depend upon its
ability to  demonstrate  commercial  viability of its products  and/or to obtain
capital sufficient to assure the completion of its development stage activities,
all of which raise  substantial doubt about the Company's ability to continue as
a going  concern.  Management's  plans  in  regard  to  these  matters  are also
described in Note 3. The  financial  statements  do not include any  adjustments
that might result from the outcome of this uncertainty.


PRICE WATERHOUSE LLP

Linthicum, Maryland
April 8, 1997


                                       15
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



                              SONEX RESEARCH, INC.
                          (A Development Stage Company)

                                 BALANCE SHEETS

                                                         December 31,
                                                         ------------
                                                    1997              1996
                                                    ----              ----
          Assets

Current assets
 Cash and equivalents                            $  355,582        $   89,739
 Marketable securities, available-
   for-sale (Note 4)                                117,200            36,800
 Accounts receivable, including unbilled
   costs and estimated earnings on uncompleted
   contracts of $183,750 in 1997                    210,088            50,000
 Prepaid expenses                                    36,284            38,692
 Loans to officers and employees (Note 5)            22,500            16,906
                                                 ----------        ----------
   Total current assets                             741,654           232,137 

Loans to officers and employees -
   non-current (Note 5)                                                15,000 

Patents and technology (Note 6)                     231,742           239,308 

Property and equipment (Note 7)                      17,206            28,008 
                                                 ----------        ----------

           Total assets                          $  990,602        $  514,453
                                                 ==========        ==========


     Liabilities and Stockholders' Equity

Current liabilities
 Accrued compensation (Note 8)                   $  688,292        $  620,620
 Accounts payable and other accrued liabilities,
   including accrued subcontract costs on
   uncompleted contracts of $111,750 in 1997        147,220           170,371
                                                 ----------        ----------
   Total current liabilities                        835,512           790,991
                                                 ----------        ----------

Stockholders' equity (Note 10)
 Preferred stock, $.01 par value - 2,000,000
   shares issued; shares outstanding: 1,540,001
   in 1997 and 1,550,001 in 1996                     15,400            15,500 
 Common stock, $.01 par value - shares issued
   and outstanding: 17,393,906 in 1997 and
   16,214,020 in 1996                               173,939           162,140 
 Additional paid-in capital                      20,035,060        19,165,535 
 Unrealized increase in value of
   marketable securities                             117,200           36,800
 Deficit accumulated during development stage   (20,186,509)      (19,656,513)
                                                 ----------        ----------
   Total stockholders' equity                       155,090          (276,538)
 
Commitments (Note 11)
                                                 ----------        ----------

   Total liabilities and stockholders' equity    $  990,602        $  514,453
                                                 ==========        ==========






    The accompanying notes are an integral part of the financial statements.


                                       16

<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



                              SONEX RESEARCH, INC.
                          (A Development Stage Company)

                STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT

                                                                   April 9, 1980
                                                                    (inception)
                                      Year ended December 31,         through
                                      -----------------------       December 31,
                                  1997         1996         1995         1997
                                  ----         ----         ----         ----
Revenue
 Development contracts       $   298,168  $    70,000  $   223,141  $ 1,963,734
 Subcontracts                    119,420                                119,420

 Other                                                                  124,425
                               ---------     --------     --------    ---------
                                 417,588       70,000      223,141    2,207,579
                               ---------     --------     --------    --------- 
Costs and expenses
 Research and development        558,526      523,524      585,233   12,350,216
 Cost of subcontracts            111,750                                111,750
 General and administrative      333,244      260,443      394,083    7,514,247
 Interest                          1,145          670        1,198      868,094
 Write-off of acquired
   technology                                               80,000      819,036
                               ---------    ---------    ---------   ----------
                               1,004,665      784,637    1,060,514   21,663,343
                               ---------    ---------    ---------   ----------

Net loss from operations        (587,077)    (714,637)    (837,373) (19,455,764)
                               ---------     --------   ----------  ----------- 

Other income and expense
 Investment and other income      18,872       12,049       12,182      311,916
 Debt conversion expense                                             (1,112,350)
 Gain on sales of
   marketable securities          38,299       30,113                    69,689
                              
                                --------     --------   ----------  -----------

Net loss                        (529,996)    (672,475)    (825,191) (20,186,509)

Deficit accumulated during
 development stage
  Beginning of period        (19,656,513) (18,984,038) (18,158,847)
                             -----------  -----------  -----------  -----------

  End of period             $(20,186,509)$(19,656,513)$(18,984,038)$(20,186,509)
                            ============ ============ ============ ============ 


Net loss per share                $ (.03)      $ (.04)      $ (.06)
                                  ======       ======       ====== 

Weighted average number of
 common shares outstanding    17,031,016   15,968,491   14,368,760
                              ==========   ==========   ==========







    The accompanying notes are an integral part of the financial statements.

                                       17

<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



                              SONEX RESEARCH, INC.
                          (A Development Stage Company)

                          STATEMENTS OF PAID-IN CAPITAL
               APRIL 9, 1980 (INCEPTION) THROUGH DECEMBER 31, 1997


                            Price  Preferred stock   Common stock     Additional
                             per  ($.01 par value) ($.01 par value)    paid-in
                            share  Shares  Amount   Shares  Amount     capital
                            -----  ------  ------  --------  ------  -----------

Note: Retroactive effect has been given to all previously declared stock splits.

April 1980 - property                             1,076,252 $10,764 $   (10,764)
December 1980 - cash        $1.08                   115,312   1,152     123,848
November 1981 - repurchase                         (115,312) (1,152)      1,077
November 1981 for services                           76,874     768        (718)
January, August 1982 - cash  2.25  200,000 $2,000                       448,000
January, August 1982 - cash   .26                    76,874     768      19,232
1982 stock issuance costs                                               (36,975)
February 1983 option exercise .30                   738,000   7,380     213,420
August, November 1983 - cash
  and services                .04                    53,812     538       1,712
January-December 1984 - cash  .78                   830,054   8,300     639,573
1984 stock issuance costs                                              (142,092)
1983 and 1984 anti-dilution        200,000  2,000   492,000   4,920      (6,920)
July, August 1984 - for past
  and future services         .78                   293,620   2,936     226,164
July 1984 conversion (.65 to 1)   (400,000)(4,000)  615,000   6,150      (2,150)
July 1984 note conversion     .78                   160,154   1,602     123,398
April 1985 IPO               2.50                 1,000,000  10,000   2,490,000
1985 stock issuance costs                                              (764,938)
1985 option exercise          .74                    61,494     615      44,585
July through November 1985 -
  exercise of warrants       3.00                       750       8       2,242
Dec. 1985 and Feb. 1986 -
  exercise of warrants       2.62                   521,788   5,218   1,361,079
July 1985 note conversion     .94                    32,030     320      29,680
1986 option exercise          .74                    99,834     998      72,988
1986 exercise of warrants    2.85                   155,943   1,560     442,815
December 1986 - cash         3.57                   280,000   2,800     997,200
1986 stock issuance costs                                              (213,402)
1986 distribution to stockholders                                       (18,772)
1986 deferred compensation -
  grant of stock options                                                276,500
April 1987 - cash            4.55                   220,000   2,200     997,800
May 1987 - cash              7.14                   140,000   1,400     998,600
1987 option exercise         3.50                    20,000     200      69,800
1987 stock issuance costs                                              (265,186)
1987 deferred compensation -
  grant of stock options                                                410,625
March, December 1988 option  3.00                    25,666     257      76,741
1988 exercise of warrants    2.50                     7,500      75      18,675
1988 for services            2.63                    11,428     114      29,886
1988 note conversion         2.00                   816,500   8,165   1,624,835
1988 debt conversion expense                                            737,500
1988 reclassification of
  issuance costs                                                       (176,981)
1988 forgiveness of interest
  on note conversion                                                     44,614
1988 deferred compensation -
  grant of stock options                                                 33,750
1989 for services            2.63                    11,429     114      29,886
1989 option exercise          .48                    36,903     369      17,432
March - June 1989 - cash     2.05                   281,000   2,810     572,200
1989 exercise of warrants    2.00                    28,840     288      57,392
1989 exchange offer          2.38                   604,200   6,042   1,428,933
1989 note conversion         2.38                    55,000     550     130,075
1989 technology rights       2.38                   250,000   2,500     591,250
1989 exercise of warrants    1.75                    73,650     737     128,151
1989 stock issuance costs                                              (252,950)
1989 deferred compensation -
  grant of stock options                                                 25,603
1990 for services             .59                     9,684      97       5,653
                                   -------  ----  --------- ------- -----------

Balance, December 31, 1990           -      -     9,156,279 $91,563 $13,651,066

                            (Continued on next page)

                                       18
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



                              SONEX RESEARCH, INC.
                          (A Development Stage Company)

                          STATEMENTS OF PAID-IN CAPITAL
               APRIL 9, 1980 (INCEPTION) THROUGH DECEMBER 31, 1997

                          Price  Preferred stock     Common stock    Additional
                           per   ($.01 par value)  ($.01 par value)    paid-in
                          share   Shares   Amount   Shares   Amount    capital
                          ----- --------- ------- --------- -------  ----------
                         (Continued from previous page)
Balance, December 31, 1990         -        -     9,156,279 $91,563 $13,651,066
March through December -
 debt issuance costs      $ .50                     765,000   7,650     374,850
May, September for services .50                      86,400     864      42,336
September - conversion of
 notes and interest         .33                     645,442   6,454     208,693
Adjustment to stock ledger                           (1,500)    (15)     (3,547)
                                --------- ------ ---------- -------  ----------
Balance, December 31, 1991         -        -    10,651,621 106,516  14,273,398
February for cash          1.00 1,750,000 17,500                      1,732,500
Feb. - loan conversion     1.00   250,000  2,500                        247,500
February - conversion of
 notes and interest         .33                     349,892   3,499     113,131
February - payment
 of accrued compensation    .50                     384,220   3,842     188,268
April - conversion (.35 to 1)     (20,000)  (200)    57,143     571        (371)
August, December option
 exercise                   .50                      14,050     141       6,884
December - exercise of
 Class A warrants          1.50                     431,775   4,318     643,344
December - exercise of
 Class B warrants          2.00                       1,800      18       3,582
December - exercise of
 warrants                  1.00                      21,429     214      21,215
Compensation - grant of
 stock options                                                           51,562
Stock issuance costs                                                   (164,836)
                                --------- ------ ---------- -------  ----------
Balance, December 31, 1992      1,980,000 19,800 11,911,930 119,119  17,116,177
May through December -
 option exercise            .50                     153,038   1,531      74,988
May - exercise of warrants 2.00                         833       8       1,658
Issuance of discounted
 options in payment of:
  Accrued compensation                                                  303,611
  Note payable to officer                                                28,000
Stock issuance costs                                                     (1,596)
                                --------- ------ ---------- -------  ----------
Balance, December 31, 1993      1,980,000 19,800 12,065,801 120,658  17,522,838
February through August -
 option exercise            .50                      75,379     754      36,936
April - conversion (.35 to 1)    (150,000)(1,500)   428,567   4,286      (2,786)
April - conversion of
 loan and interest          .75                     281,872   2,819     208,585
June and July for cash      .75                     766,666   7,666     567,334
October for services        .80                      30,000     300      23,700
Stock issuance costs                                                     (7,767)
                                --------- ------ ---------- -------  ----------
Balance, December 31, 1994      1,830,000 18,300 13,648,285 136,483  18,348,840
January - July for services .58                      15,000     150       8,600
June for cash               .25                   1,020,000  10,200     244,800
June - payment of
 accrued compensation       .25                     170,000   1,700      40,800
June - indemnification
 by officer                                                              15,000
September through November
 option exercise            .50                      88,250     882      43,243
December for cash          1.00                     340,000   3,400     336,600
Compensation - grant of
 stock options                                                           52,500
Stock issuance costs                                                    (12,192)
                                --------- ------ ---------- -------  ----------
Balance, December 31, 1995      1,830,000$18,300 15,281,535$152,815 $19,078,191

                            (Continued on next page)

                                       19
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



                              SONEX RESEARCH, INC.
                          (A Development Stage Company)

                          STATEMENTS OF PAID-IN CAPITAL
               APRIL 9, 1980 (INCEPTION) THROUGH DECEMBER 31, 1997

                          Price  Preferred stock     Common stock    Additional
                           per   ($.01 par value)  ($.01 par value)    paid-in
                          share   Shares   Amount   Shares   Amount    capital
                          ----- --------- ------- --------- -------  ----------
                         (Continued from previous page)

Balance, December 31, 1995      1,830,000$18,300 15,281,535$152,815 $19,078,191
January for services       1.00                       1,000      10         990
January through August
 option exercise            .50                     131,488   1,315      64,429
April and July -
 conversion (.35 to 1)           (279,999)(2,800)   799,997   8,000      (5,200)
Compensation - grant of
 stock options                                                           27,125
                                --------- ------ ---------- -------  ----------
Balance, December 31, 1996      1,550,001 15,500 16,214,020 162,140  19,165,535
January through December
 option exercise            .50                     352,834   3,528     172,889
January through June
 option exercise            .75                      17,000     170      12,580
March for cash              .75                     775,519   7,755     573,884
October -
 conversion (.35 to 1)            (10,000)  (100)    28,571     286        (186)
December for services      1.00                       5,962      60       5,902
Compensation - grant of
 stock options                                                          104,456
                                --------- ------ ---------- -------  ----------
Balance, December 31, 1997      1,540,001$15,400 17,393,906$173,939 $20,035,060
                                ========= ====== ========== ======= ===========









    The accompanying notes are an integral part of the financial statements.

                                       20
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


                              SONEX RESEARCH, INC.
                          (A Development Stage Company)

                            STATEMENTS OF CASH FLOWS
                                                                  April 9, 1980
                                                                   (inception)
                                     Year ended December 31,         through
                                     -----------------------       December 31,
                                   1997       1996        1995         1997
                                   ----       ----        ----         ----
Cash flows from operating
activities:
 Net loss                       $(529,996)  $(672,475)  $(825,191) $(20,186,509)
 Adjustments to reconcile net
  loss to net cash used in
  operating activities
   Depreciation                    13,747      21,783      20,646       679,262
   Amortization of patents         72,394     101,970      79,653     1,449,002
   Write-off of technology                                 80,000       819,036
   Compensation - stock options    104,456     27,125      52,500       982,121
   Imputed interest expense                                             551,247
   Interest credited to paid-
     in capital                                                          44,614
   Debt conversion expense                                            1,112,350
   Current liabilities and
     charges paid in stock          5,962       1,000      51,250     1,130,342
   Gain on sale of
     marketable securities        (38,299)    (30,113)                  (69,689)
   (Increase) decrease in
     accounts receivable         (160,088)     13,741      17,959      (218,088)
   (Increase) decrease in
     prepaid expenses               2,408      (8,831)      1,935       (36,284)
   Increase in accrued
     liabilities                   44,521      91,729     120,779       747,848
                                ---------   ---------    --------   -----------
Net cash used in operating
activities:                      (484,895)   (454,071)   (400,469)  (12,986,748)
                                ---------   ---------    --------   -----------
Cash flows from investing
activities:
  Purchases of marketable
    securities                                                       (2,377,256)
  Proceeds from sales of
    marketable securities          38,299      30,113      17,292     2,446,945
  (Increase) decrease in
    loans to employees              9,406      26,470     (17,231)      (22,500)
  (Increase) decrease in cash
    posted as security
    for judgment                              182,687      (5,599)
  Acquisition of property
    and equipment                  (2,945)     (4,887)                 (546,981)
  Additions to patents
    and technology                (64,828)    (12,456)    (15,941)   (1,375,330)
                                ---------   ---------    --------   -----------
Net cash provided by (used in)
investing activities:             (20,068)    221,927     (21,479)   (1,875,122)
                                ---------   ---------    ---------  -----------
Cash flows from financing
activities:
  Issuance of stock               770,806      65,744     639,125    15,878,461
  Issuance of convertible debt                                        2,287,500
  Indemnification by officer                               15,000        15,000
  Repayment of convertible debt                                         (92,500)
  Stock and debt issuance costs                           (12,192)   (2,038,916)
  Distribution to stockholders                                          (18,772)
  Reduction of technology
    purchase obligations                                               (797,500)
  Proceeds from borrowings                                            1,592,748
  Reduction of borrowings                                  (9,898)   (1,608,569)
                                ---------   --------     --------   -----------
Net cash provided by
financing activities:             770,806     65,744      632,035    15,217,452
                                ---------   --------     --------   -----------
Increase (decrease) in cash:      265,843   (166,400)     210,087       355,582

Cash at beginning of period:       89,739    256,139       46,052
                                ---------   --------     --------   -----------
Cash at end of period:          $355,582    $ 89,739    $ 256,139   $   355,582
                                =========   ========    =========   ===========

    The accompanying notes are an integral part of the financial statements.

                                       21
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



                              SONEX RESEARCH, INC.
                          (A Development Stage Company)

                          NOTES TO FINANCIAL STATEMENTS

NOTE 1 - THE COMPANY

Sonex Research, Inc. has developed a proprietary technology,  known as the Sonex
Combustion System (SCS),  which controls the combustion of fuel in engines.  The
Company  expects  to  license   several   applications  of  its  technology  and
commercially exploit other applications  itself.  Related revenue earned to date
has been  derived  principally  from  development  contracts,  but such  revenue
historically  has  offset  only  a  small  portion  of the  related  development
expenditures.  Accordingly,  Sonex Research, Inc. is classified as a development
stage company.


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Presentation of financial statements
------------------------------------

Certain  reclassifications  have been made to the financial  statements of prior
years to conform to the classifications  used in 1997. The financial  statements
include the accounts of the Company and,  until its  disposition in October 1995
as  described in Note 4,  SonoChem,  Inc. All  intercompany  balances  have been
eliminated in consolidation.


Cash and equivalents
--------------------

The Company's By-Laws restrict the types of permitted  investments to securities
issued by the U.S. Treasury, savings accounts insured by the U.S. Government, or
investment  companies that invest in  obligations of the U.S.  Government or its
agencies. The Company considers all short-term,  highly liquid investments which
are convertible into cash within three months or less to be cash equivalents.


Marketable  securities
----------------------

Securities  held  by the  Company  are  classified  as  "available-for-sale"  in
accordance  with  Statement of Financial  Accounting  Standards  (SFAS) No. 115;
accordingly,  unrealized  gains and losses with respect to such  securities  are
reported as a separate  component of  stockholders'  equity.  Realized gains and
losses are reported in the Company's statement of operations.


Patents  and  technology
------------------------

The  costs  associated  with the  filing of patent  applications  are  deferred.
Amortization is recorded on a straight-line  basis over the remaining legal life
of patents, commencing in the year in which the patent is granted. Costs related
to patent applications which ultimately fail to result in the grant of a patent,
either through  rejection by patent  authorities  or through  abandonment by the
Company, are charged to operations at the time such determination is made.


Property and equipment
----------------------

Property and equipment is stated at cost or, in the case
of leased  equipment under capital leases,  at the present value of future lease
payments,  less  accumulated  depreciation.  Major renewals and  betterments are
capitalized  and ordinary  repair and  maintenance  expenditures  are charged to
operations in the year  incurred.  Depreciation  is computed  using the straight
line method.  Equipment and vehicles are depreciated  over three to seven years,
while leasehold improvements are depreciated over the shorter of the useful life
or the remaining term of the related lease.


Revenue  recognition
--------------------

Revenue  derived from  development  contracts is  recognized  upon the Company's
completion of the milestones  and/or submission of progress reports specified in
each contract.  Commercial  development  contracts are executed in situations in
which a manufacturer is willing to provide funding to partially offset the

                                       22
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


development  costs  incurred by the Company in applying its technology to one of
the manufacturer's engines.  Development contracts are also executed for funding
supplied  by  a  United  States   Government  (the   "Government")   agency  for
proof-of-concept  demonstration programs, although in such instances the Company
seeks  contract  awards in which revenue is expected to equal or exceed  related
costs.

Generally,  commercial  development contracts require the Company to demonstrate
that the manufacturer's engine, when modified with the Company's technology, can
meet  certain  emissions  reduction  and  performance  goals  specified  in  the
contract. In addition, these contracts sometimes provide that payment of part of
the contract amount will be made only if the Company meets the specified  goals.
The Company is not required to repay any funds  received in connection  with its
development  contracts.  To date, commercial development contract revenue earned
by the  Company  has  offset  only a small  percentage  of  total  research  and
development expenditures.

In 1997 the  Company,  for the  first  time,  entered  into  contracts  with the
Government  which  require a  performance  period of several  months and, in one
instance,  required the Company to serve as prime  contractor with a substantial
portion of the related  project being assigned to a  subcontractor.  Revenue and
costs for these fixed-price  Government  contracts,  which contracts require the
Company to provide  stipulated  services for a fixed price, have been recognized
using the  percentage-of-completion  method of accounting  by relating  contract
costs  incurred  to  date to  total  estimated  contract  costs  at  completion.
Subcontract revenue and costs, along with the associated receivables and accrued
liabilities,  are reflected in the Company's  financial  statements  because the
Company is  contractually  responsible  for the  ultimate  acceptability  of the
project by the Government.


Stock-based  compensation
-------------------------

The Company  accounts for  stock-based  compensation  using the intrinsic  value
method prescribed in Accounting Principles Board (APB) Opinion No. 25. Under APB
No. 25,  compensation  cost is  measured  as the  excess,  if any, of the quoted
market price of the Company's stock at the date of grant over the exercise price
of the  option  granted.  Compensation  cost  for  stock  options,  if  any,  is
recognized ratably over the vesting period. The Company provides  additional pro
forma disclosures as required under SFAS No. 123.


Net loss per  share
-------------------

Net loss per share is computed based upon the weighted  average number of common
shares  outstanding  during the year.  Potentially  dilutive  securities,  which
include convertible preferred stock, stock options and warrants,  would serve to
reduce the loss per share.


Use of estimates
----------------

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial  statements and accompanying notes.
Actual results may differ from those estimates.


NOTE 3 - LIQUIDITY AND ABILITY TO EMERGE FROM THE DEVELOPMENT STAGE

Substantial  progress  toward  commercialization  of the SCS has been made under
joint development  programs with manufacturers,  and negotiations for production
piston development  programs and licensing agreements are currently in progress.
Until such time, however, as licensing  agreements are executed with one or more
major piston suppliers or engine manufacturers,  substantial doubt remains about
the Company's ability to emerge from the development stage,  commence generation
of significant revenues and ultimately achieve profitable operations.

Management  recognizes  that the Company's  current level of available funds and
revenue from current and future development contracts may not provide sufficient
operating  capital  to fund  operations  until  such time as a stream of royalty
revenue is realized from the licensing of the SCS. Accordingly, the Company will
continue to minimize its  operating  expenditures  through a number of measures,
including  the  continued  deferral by its officers of  significant  portions of
their salaries.  In the event that the  realization of significant  revenue from
the  licensing  of the SCS is further  delayed,  the  Company  may need to raise
additional capital to fund its development stage activities.

                                       23
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


NOTE 4 - MARKETABLE SECURITIES

In  October  1995  the  Company's  former  inactive,   consolidated  subsidiary,
SonoChem,  Inc.,  effected a 1:10 reverse split of all of its outstanding shares
of common stock,  and was merged with and into a privately held Virginia medical
transcription  services  company.  The  name of the  surviving  corporation  was
changed to Digital Dictation, Inc. ("Digital") and the officers and directors of
the privately held company, two of whom are directors of the Company and general
partners  of its  largest  shareholder,  Proactive  (see  Note  8),  became  the
directors and officers of Digital.  A total of 5% of the issued and  outstanding
shares of Digital, including the 125,133 shares received by the Company pursuant
to this merger,  began public  trading in the  over-the-counter  market in April
1996.

At the time of this exchange in October 1995,  the Company's  carrying  basis in
the SonoChem  stock of zero was  considered  to be its cost basis in the Digital
stock,  and no gain or loss was recorded in the 1995 financial  statements  with
respect to this  transaction.  Since  public  trading  began in April 1996 and a
readily  determinable  fair value for the Digital  stock became  available,  the
investment is now accounted for in accordance  with SFAS No. 115 and  classified
as a current asset as a security that is "available-for-sale".  Accordingly, the
Company's  investment  in the 78,133  shares  held as of  December  31,  1997 is
recorded in the accompanying financial statements at its aggregate fair value of
$117,200. A corresponding amount,  representing the aggregate unrealized gain in
the fair value of this  investment in excess of its cost basis, is reported as a
separate component of stockholders' equity.  Subsequent changes in the aggregate
market value of this investment will be similarly recorded. During 1997 and 1996
the Company sold 20,000 and 27,000  shares,  respectively,  of its Digital stock
and realized aggregate net proceeds of $38,299 and $30,113, respectively.


NOTE 5 - LOANS TO OFFICERS AND EMPLOYEES

Loans to officers  and  employees  represent  the  remaining  balance of amounts
advanced in prior years for the  payment of income tax  liabilities  incurred by
these  individuals  upon their receipt of  compensation in the form of shares of
the Company's  common stock.  The loans,  which are  non-interest  bearing,  are
secured by deferred salaries payable to each of the borrowers, and become due on
December 31, 1998.


NOTE 6 - PATENTS AND TECHNOLOGY

The capitalized costs of patents and technology consists of the following:

                                                      December 31,
                                                   ------------------
                                                   1997          1996
                                                   ----          ----
    Patent application fees and
      related legal costs                        $282,527      $249,093
    Computer models and simulations                             237,164
                                                 --------      --------
                                                  282,527       486,257 

    Accumulated amortization                      (50,785)     (246,949)
                                                 --------      --------

                                                 $231,742      $239,308
                                                 ========      ========

Following an extensive  evaluation in 1994 of the factors affecting the economic
value of all of the Company's  proprietary  technology,  the carrying  values of
certain technology developed internally,  othertechnology  acquired from a third
party,  and  related  technology  purchase  obligations,  were  reduced to their
estimated recoverable amounts. Related charges to operations in the accompanying
financial statements aggregated $739,036 in 1994 and $80,000 in 1995.

The Company  continues to conduct its own research  and  development  activities
which  have  resulted  in  additional   proprietary   technology   and  patents.
Development  of  commercial  applications  of  certain  elements  of the SCS has
commenced and management believes the capitalized cost of patents and technology
will be recovered through revenue derived from the licensing of such technology.
Management  closely  monitors the patent  application  process and other factors
which may  affect  the  economic  value of the  Company's  technology,  and will
further  reduce  the  capitalized  cost of  patents  and  technology  should the
recovery of such cost no longer be sustainable.

                                       24
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


NOTE 7 - PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

                                                      December 31,
                                                   ------------------
                                                   1997          1996
                                                   ----          ----

    Shop equipment                               $383,380      $394,182
    Vehicles                                       11,053        11,053
    Office equipment                               20,946        24,806
                                                 --------      --------
                                                  415,379       430,041 

    Accumulated depreciation                     (398,173)     (402,033)
                                                 --------      --------

                                                 $17,206       $ 28,008      
                                                 ========      ========


NOTE 8 - ACCRUED COMPENSATION

In order to help  conserve  the  Company's  limited cash  resources,  all of the
Company's employees, at the request of the Board of Directors, for several years
have been voluntarily  deferring  receipt of payment of significant  portions of
their authorized annual salaries.  From time to time,  portions of such deferred
amounts  have been paid  through the  issuance to the  employees  of shares,  or
discounted options to purchase shares, of the Company's Common Stock.

As a condition of the Company's  receiving an indispensable  capital infusion in
February  1992,  the  investors,  Proactive  Partners,  L.P.  and certain of its
affiliates  ("Proactive")  who  became  the  largest  beneficial  owner  of  the
Company's common stock by virtue of the purchase of convertible  preferred stock
and common stock  purchase  warrants,  required that the  voluntary  deferral of
salaries  be  documented  formally.   Accordingly,  all  employees  executed  an
agreement  referred to as the "Consent to  Deferral" in which they  consented to
the past and future deferral of portions of their annual salaries, and agreed to
defer payment of amounts so accumulated until the Company has received licensing
revenue of at least $2 million or at such earlier date as the Board of Directors
determines that the Company's cash flow is sufficient to allow such payment. The
conditions  of the Consent to Deferral  that would allow  repayment  of deferred
salaries have yet to occur. As of December 31, 1997, an aggregate of $648,292 of
wages so deferred remained unpaid and has been recorded as accrued  compensation
on the Company's balance sheet.


NOTE 9 - INCOME TAXES

The  Company  has not  incurred  any  federal or state  income  taxes  since its
inception  due to operating  losses.  At December 31, 1997,  the Company had net
operating loss carryforwards of approximately  $16.8 million available to offset
future taxable income. If certain substantial changes in the Company's ownership
should  occur,  there  would  be an  annual  limitation  on  the  amount  of the
carryforwards   which  can  be  utilized.   The  Company's  net  operating  loss
carryforwards expire at various dates from 1998 through 2012, as follows:


    Expiring in 1998                         $   658,000
    Expiring in 1999                             900,000
    Expiring in 2000                           1,105,000
    Expiring in 2001                           1,749,000
    Expiring in 2002                           1,838,000
    Expiring in 2003 - 2012                   10,526,000
                                             -----------

                                             $16,776,000
                                             ===========

The difference between the net operating loss carryforwards  described above and
the  accumulated   deficit  reported  in  these  financial   statements  results
principally  from  (1)  temporary  differences  for  income  tax  and  financial
reporting  purposes  relating  to the  amounts  and timing of  deductibility  of
deferred  salaries and compensation  related to the grant of stock options,  and
the  differences in the  accounting  for the Company's  investment in its former
consolidated subsidiary for income tax and financial reporting purposes, and (2)
permanent  differences  principally due to the  non-deductibility for income tax
purposes of a significant  charge to operations for debt  conversion  expense in

                                       25
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



1988 and the  non-deductibility of compensation related to the exercise of stock
options recorded  previously in the Company's  accounts.  The Company's sales of
some of its Digital  shares in 1996 and 1997 have also  generated  capital  loss
carryforwards  for income tax purposes of approximately  $335,000.  Capital loss
carryforwards,  which expire after five years, may only be used to offset future
capital gains.

The  potential  income tax  benefit of these loss  carryforwards  and  temporary
differences of approximately $6.5 million has not been recorded in the financial
statements  due  to the  uncertainty  of  realization  based  on  the  Company's
financial performance to date.


NOTE 10 - CAPITAL STOCK

Authorized capital stock
------------------------

Authorized capital stock The Company is presently authorized to issue 48 million
shares of $.01 par  value  common  stock and 2 million  shares of $.01 par value
convertible  preferred  stock.  The preferred  stock has priority in liquidation
over the common  stock,  but it carries no stated  dividend.  The holders of the
preferred stock, voting as a separate class, have the right to elect that number
of directors of the Company  which  represents a majority of the total number of
directors.  The preferred  stock is convertible at any time at the option of the
holder into common  stock at the rate of $.35 per share of common  stock.  As of
December  31,  1997,  a total of  459,999  shares  of  preferred  stock had been
converted into 1,314,278 shares of common stock.


Private placements of common equity
-----------------------------------

In June 1995 the Company received an investment of $200,000 from Proactive,  the
largest  beneficial owner of the Company's  common stock, in  consideration  for
which Proactive  received 800,000 shares of common stock,  five-year warrants to
purchase  400,000  shares of  common  stock at $.375 per  share,  and  five-year
warrants  to  purchase  400,000  shares of common  stock at $.50 per share.  The
Company also accepted additional investments, on the same terms as the Proactive
investment,  aggregating $55,000 from a limited number of other shareholders who
qualified as "accredited  investors" pursuant to Rule 501 of Regulation D of the
Securities  Act of 1933  (the  "Act").  The  Company  also  paid  accrued  bonus
compensation  aggregating  $42,500 due to its officers and employees through the
issuance  of  common  stock  and  warrants  on the same  terms as the  Proactive
investment.  In total,  these employees received 170,000 shares of common stock,
$.375 warrants to purchase  85,000 shares,  and $.50 warrants to purchase 85,000
shares.

In connection  with a private  financing in December 1995, the Company  received
investments aggregating $340,000, in units of $10,000, from several shareholders
who qualified as  accredited  investors.  Each $10,000 Unit  consisted of 10,000
shares of the  Company's  common  stock and  five-year  warrants  to purchase an
additional  10,000  shares  of  common  stock at $1.25  per  share  (the  "$1.25
Warrants").

In February  1997 the  Company  notified  the holders of all of its  outstanding
warrants to purchase  shares of its common stock of proposed  amendments to such
warrants,  offered  because  the  Company  was  unable  to  complete  a  planned
registration  during 1996 of the common stock  issuable upon the exercise of the
warrants.  The warrants,  all of which had original  expiration dates five years
from the respective  acquisition  date,  were issued in private  financings that
took place in  February  1992 and June 1994,  and in the June 1995 and  December
1995 private financings  described above. The proposed amendments  included,  in
various  combinations,  extensions of the  expiration  dates,  reductions in the
exercise prices,  reductions in the number of warrants,  provisions for cashless
exercise, and provisions for "piggy-back" registration rights.

The amendments  proposed for the warrants issued in February 1992 (the "February
1992  Warrants")  were  also  offered  in  connection  with  a  $250,000  equity
investment  proposal  from  Proactive  accepted  by the  Board of  Directors  in
February 1997. In exchange for this cash investment,  Proactive received 333,333
shares of common  stock and  five-year  warrants to purchase  166,666  shares of
common  stock at an  exercise  price of $.75 per  share,  along with a number of
amendments to the February 1992 Warrants  issued by the Company to Proactive and
other  investors  in  connection  with the  sale of $2  million  of  convertible
preferred stock in February 1992 (the "Preferred Stock  Investment").  One other
participant in the Preferred  Stock  Investment  also received the amendments to

                                       26
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


the  February  1992  Warrants in  exchange  for his cash  investment  of $1,639,
pursuant to which he also  received  2,186 shares of common stock and  five-year
warrants to purchase  1,093 shares of common stock at an exercise  price of $.75
per share.

In March  1997 the  Company  completed  a private  financing  in which it raised
$330,000 from a small number of the Company's  shareholders  who participated in
previous  private  financings  of the Company and who  qualified  as  accredited
investors. A total of 440,000 shares of the Company's common stock and five-year
warrants to purchase an  additional  220,000  shares of common stock at $.75 per
share were issued in this financing.

The offer and sale of a total of 775,519  shares of common  stock and  five-year
warrants to  purchase a total of 387,759  shares of common  stock in  connection
with the February 1997 and March 1997  financings  described above satisfied the
conditions of Rule 506 of Regulation D of the Act and, as such, were exempt from
the  registration  requirements  of  Section  5 of the Act as  transactions  not
involving any public offering within the meaning of Section 4(2) of the Act.

No  separate  value  has been  reflected  in the  financial  statements  for the
warrants issued in the above transactions based on management's  belief that the
separate fair value of such warrants is not significant.


Stock options
-------------

The Company  maintains a non-qualified  stock option plan (the "Plan") which has
made available for issuance a total of five million shares of common stock.  All
directors,  full-time  employees and consultants to the Company are eligible for
participation.  Option awards are  determined at the  discretion of the Board of
Directors.  Upon a change in control of the  Company,  all  outstanding  options
granted to employees and  directors  become vested with respect to those options
which have not  already  vested.  Options  outstanding  expire at various  dates
through December 2007.

Between  January 1, 1995 and December 31,  1997,  the Company had the  following
activity in options to purchase shares of common stock:


                                                Weighted               Weighted
                                                 average                average
                                                exercise  # of shares  exercise
                                   # of shares    price   exercisable    price
                                   -----------  -------   -----------  --------

Unexercised at January 1, 1995      2,504,222     $.64     2,270,067     $.64
                                                           =========     ====
    Granted                         1,611,000      .52
    Exercised                         (88,250)     .50
    Lapsed or canceled
                                   -----------  -------

Unexercised at December 31, 1995    4,026,972      .51     2,807,372     $.52
                                                           =========     ====
    Granted                           123,000      .80
    Exercised                        (131,488)     .50
    Lapsed or canceled                (45,000)     .50
                                   -----------  -------

Unexercised at December 31, 1996    3,973,484     $.51     3,195,734     $.53
                                                           =========     ====
    Granted                           147,000      .56
    Exercised                        (369,834)     .51
    Lapsed or canceled               (152,934)     .50
                                   -----------  -------

Unexercised at December 31, 1997    3,597,716     $.52     3,277,966     $.52
                                    =========     ====     =========     ====


During  1997 the number of  members  of the  Company's  Board of  Directors  was
reduced from nine to five,  and one of the  remaining  directors  was also named
president of the Company.  As a result of the resignation of several  directors,
unvested  options for the  purchase of 150,000  shares of common  stock  lapsed.
Also, in order to induce the new president to take that position, Proactive, the
Company's  principal  shareholder,  granted  him a ten-year  option to  purchase
714,286  shares of common stock owned by Proactive at an exercise  price of $.35
per share. This option becomes exercisable at the rate of 20% per year beginning
with the date of grant.

                                       27
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


The  Company  applies  APB  Opinion  No.  25  in  accounting  for  stock  option
compensation;  however,  SFAS No.  123  requires  the  Company  to make  certain
disclosures  as if the fair value based method of accounting had been applied to
the Company's  stock option grants made  subsequent  to 1994.  Accordingly,  the
Company  has  estimated  the grant  date  fair  value of each  option  using the
Black-Sholes   option  pricing  model  with  the  following   weighted   average
assumptions:  volatility  factor  of 112% in 1997  and  124% in 1996  and  1995,
risk-free  interest rate of 6%, zero dividend  yield,  and expected terms of ten
years for options  granted to employees,  officers and directors and three years
for options granted to consultants.  For purposes of pro forma disclosures,  the
estimated  fair value of options is amortized to expense over the vesting period
of each option.

Had  compensation  cost for the  Company's  stock  option  plan been  determined
consistent with the method of SFAS No. 123 using the weighted average fair value
of options  granted during the year as indicated  below,  the Company's net loss
and net loss per share for each year on a pro  forma  basis  would  have been as
follows:

                                            1997       1996        1995
                                          --------   --------   ----------

  Weighted average fair value per share       $.70       $.96         $.47

  Net loss - as reported                  $529,996   $672,475     $825,191
  Net loss - pro forma                    $876,273   $910,840   $1,095,611

  Net loss per share - as reported            $.03       $.04         $.06
  Net loss per share - pro forma              $.05       $.06         $.08


The  Black-Sholes  and other option  pricing  models were  developed  for use in
estimating  the  fair  value  of  traded  options  as  opposed  to the  type  of
compensatory  options  granted by the  Company.  It also  requires  the input of
highly  subjective  assumptions,  such as the expected  stock price  volatility,
changes in which can materially affect the fair value estimate. As a result, the
amounts  calculated  using  the  Black  Sholes  option  pricing  model  may  not
necessarily  provide a reliable  single measure of fair value of options granted
by the Company. In addition,  these pro forma disclosures are not representative
of the effects on reported  net loss and net loss per share for future years due
to the effects of vesting.


Common stock reserved for future issuance:
-----------------------------------------

As of December  31,  1997,  a total of  15,036,772  shares of common  stock were
reserved by the Company for issuance for the following purposes:

                         Purpose                                   # of shares
              -----------------------------                        -----------
Currently exercisable warrants:
 Exercisable at $.35 per share, expiring in February 2000              571,428
 Exercisable at $.375 per share, expiring in June 2000                 595,000
 Exercisable at $.50 per share, expiring in June 2000                  595,000
 Exercisable at $.75 per share, expiring on various dates from                
   June 1999 through March 2002                                      4,874,509
                                                                   -----------
                                                                     6,635,937
Currently exercisable options:                                                  
 Exercisable at $.50 per share                                       3,054,466
 Exercisable at $.75 per share                                         173,500
 Exercisable at $1.00 per share                                         50,000
                                                                   -----------
                                                                     3,277,966
Granted options becoming exercisable in the future:                             
 Exercisable at $.50 per share                                         297,250
 Exercisable at $.75 per share                                          22,500
                                                                   -----------
                                                                       319,750
                                                                              
Options available under plan for future grants                         403,116
                                                                              
Conversion of preferred stock                                        4,400,003
                                                                   -----------
                                                                              
   Total shares reserved                                            15,036,772

                                       28
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



NOTE 11 - COMMITMENTS

The Company  occupies  its office and  laboratory  facility on a  month-to-month
basis under the terms of an operating lease agreement that expired in April 1994
and was subsequently extended twice, most recently through November 1997. No new
long-term lease has been negotiated since this last extension  expired,  and the
Company once again is occupying the premises on a month-to-month basis under the
terms of the previous lease, pursuant to which the property owner is required to
provide  thirty days notice if he wants the Company to vacate the premises.  The
lease  provides for monthly rent of $3,500,  and requires the Company to pay all
property related expenses.  Gross rent charges aggregated  $42,000,  $52,000 and
$54,000 in 1997,  1996 and 1995,  respectively,  while the  Company  also earned
sublease  income of $750 in 1997 and $2,400 in 1996.  The  Company  will seek to
negotiate a new  long-term  lease for its facility or search for an  alternative
location  in the event  that an  agreement  cannot be reached  for the  existing
premises.  Management  believes  that the  resolution  of the  uncertainty  with
respect to the facility  will not result in a  significant  interruption  in the
operations of the Company.



              ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
                     ON ACCOUNTING AND FINANCIAL DISCLOSURE

On October 31, 1997, the Company  informed  Price  Waterhouse  LLP,  independent
accountants  for Sonex since 1985,  that it had been  dismissed  as  independent
accountants  for the year  ended  December  31,  1997.  The  Company's  Board of
Directors made the decision to change independent accountants.

In  connection  with its audits  for each of the two years in the  period  ended
December 31, 1996,  and through  October 31, 1997,  there were no  disagreements
with Price  Waterhouse LLP on any matter of accounting  principles or practices,
financial  statement   disclosure,   or  auditing  scope  or  procedure,   which
disagreements,  if not resolved to the  satisfaction  of Price  Waterhouse  LLP,
would  have  caused  them to make  reference  thereto  in  their  report  on the
financial statements for such years.

The reports of Price  Waterhouse LLP on the financial  statements of the Company
for the past two fiscal years, presented on page 16 of this Form 10-KSB, contain
no adverse opinion or disclaimer of opinion and are not qualified or modified as
to audit scope or accounting  principle;  however,  such reports are modified by
the inclusion of an explanatory  paragraph  indicating that there is substantial
doubt about the Company's ability to continue as a going concern.

The  Company's  Board of  Directors  made the decision to engage C. L. Stewart &
Company as new  independent  accountants as of October 31, 1997.  During the two
most recent  fiscal  years and through  October  31,  1997,  the Company had not
consulted with C. L. Stewart & Company  regarding  either (i) the application of
accounting principles to a specified transaction,  either completed or proposed;
or the type of audit opinion that might be rendered on the  Company's  financial
statements,  and either a written  report was  provided  to the  Company or oral
advice was provided that C.L.  Stewart & Co.  concluded was an important  factor
considered by the Company in reaching a decision as to the accounting,  auditing
or financial  reporting issue; or (ii) any matter that was either the subject of
a disagreement,  as that term is defined in Item 304(a)(1)(iv) of Regulation S-K
and the related  instructions  to Item 304 of  Regulation  S-K, or a  reportable
event, as that term is defined in Item 304(a)(1)(v) of Regulation S-K.

The Company has had no disagreements with its current  independent  accountants,
C. L. Stewart & Company, on any matter of accounting  principles or practices or
financial statement  disclosure.  C. L. Stewart & Company has been the Company's
independent accountants since October 31, 1997.



            ITEM 9. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS

The Company's Board of Directors is divided into two categories:  "Common Stock"
directors  elected  by the  holders  of  Common  Stock;  and  "Preferred  Stock"
directors  elected by the holders of Preferred  Stock.  These two  categories of
directors  are further  divided into three  classes as nearly equal in number as
possible,  with the term of one of the three  classes of  directors  expiring at
each annual meeting of shareholders.  The members of each class of directors are
to hold office for terms of three years until their successors have been elected
and qualified.  The holders of the Preferred Stock,  voting as a separate class,
have the right to elect that number of directors of the Company which represents
a majority of the total number of directors.

                                       29
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


The  Company's  By-laws  state that the Board of Directors  shall consist of not
fewer than three directors,  with the total number of directors to be set by the
Board  by  resolution.  Following  the  resignation  of  three  Preferred  Stock
directors and one Common Stock  director in 1997,  the total number of directors
is now five,  two of whom are  Preferred  Stock  directors and three of whom are
Common Stock directors.

Directors  of the  Company  do not  receive  fees for  their  services,  but are
eligible to receive stock option grants and are reimbursed for expenses  related
to their activities as directors.  Executive officers are appointed and serve at
the discretion of the Board of Directors.

The names, ages, dates first elected as directors, and principal occupations and
employment of the directors and executive  officers of the Company are set forth
below.

                                Term as
                                director
           Name             Age expires           Position
     ----------------       --- -------      -------------------

Preferred Stock Directors:

 Mr. Charles C. McGettigan   53   1999  Director
 Mr. Myron A. Wick, III      54   1999  Chairman of the Board

Common Stock Directors:

 Mr. Nuno Brandolini         44   2000  Vice Chairman of the Board
 Mr. Lawrence H. Hyde        73   1999  President and Director
 Dr. Andrew A. Pouring       66   1998  Chief Executive Officer, Chief Scientist
                                          and Vice Chairman of the Board
Other Executive Officers:

 Mr. George E. Ponticas      38         Vice President - Finance, Secretary,
                                          Treasurer and Chief Financial Officer


Background of Directors and Executive Officers
----------------------------------------------

Mr.  Charles C.  McGettigan  has been a director of the Company  since  February
1992.  He was a founding  partner in 1991 and is a general  partner of Proactive
Investment  Managers,  L.P., which is the general partner of Proactive Partners,
L.P.  In  1988  Mr.  McGettigan  co-founded  McGettigan,  Wick & Co.,  Inc.,  an
investment  banking  firm.  From  1984  to 1988  he was a  Principal,  Corporate
Finance,  of Hambrecht & Quist,  Inc. Prior to that Mr.  McGettigan was a Senior
Vice President of Dillon,  Read & Co. Inc. He currently  serves on the Boards of
Directors  of  Cuisine  Solutions,   Inc.,   Digital  Dictation,   Inc.,  I-Flow
Corporation,  Modtech,  Inc.,  PMR  Corporation,  Tanknology - NDE  Corporation,
WrayTech  Instruments,  Inc.,  and  Onsite  Energy,  Inc.,  of  which  he is the
Chairman.  Mr. McGettigan is a graduate of Georgetown  University,  and received
his MBA in Finance from The Wharton School of the University of Pennsylvania.


Mr.  Myron A.  ("Mike")  Wick,  III,  has been a director of the  Company  since
November  1991 and was elected  Chairman of the Board of Directors in June 1993.
He was a  founding  partner  in  1991  and is a  general  partner  of  Proactive
Investment  Managers,  L.P., which is the general partner of Proactive Partners,
L.P. In 1988 Mr. Wick  co-founded  McGettigan,  Wick & Co.,  Inc., an investment
banking  firm.  From  1985 to 1988  Mr.  Wick was  Chief  Operating  Officer  of
California Biotechnology, Inc. in Mountain View, California. He currently serves
on the Boards of Directors of  Children's  Discovery  Centers of America,  Inc.,
Digital  Dictation,  Inc.,  Modtech,  Inc.,  Tanknology - NDE  Corporation,  and
WrayTech  Instruments,  Inc., of which he is the  Chairman.  Mr. Wick received a
B.A. degree from Yale University and an MBA from the Harvard Business School.

Mr. Nuno  Brandolini  has been a director of the Company  since January 1982 and
was elected a Vice  Chairman of the Board in May 1988.  Since  November 1995 Mr.
Brandolini  has been the  Chairman of the Board and Chief  Executive  Officer of
Scorpion Holdings,  Inc., a merchant banking company. From December 1993 through
October  1995 he was a managing  director of  Rosecliff,  Inc.,  also a merchant
banking  company.  From June 1991 to November 1993 he was a Vice  President with
Salomon Brothers,  Inc. From 1988 to 1991 Mr. Brandolini was a part owner of The
Baltheus Group,  Inc., a management  consulting and financial  advisory firm. He
has a law degree  from the  University  of Paris and he received an MBA from The
Wharton School of the University of Pennsylvania.

                                       30
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


Mr.  Lawrence H. Hyde has been a director of the Company since  September  1986,
serving as Chairman of the Board from June 1987 to June 1993,  and was appointed
President  of the  Company in October  1997.  Mr.  Hyde was a director of Harris
Graphics Corp.  from 1983 to 1986,  where during 1985 and 1986 he also served as
its Chairman of the Board and Chief  Executive  Officer.  He was  President  and
Chief  Executive  Officer of AM  General  Company  from 1979 to 1985.  He joined
American  Motors  in 1974 and  remained  until  1983.  At  various  times he had
corporate wide responsibility for engineering,  international and marketing; his
last position was Executive Vice President  responsible  for  International  and
Engineering.  He is a  director  of Whatman  plc and a trustee  of the  American
University  in Cairo,  where he is also chairman of the  University  Educational
Investment  Fund. Mr. Hyde is a graduate of Harvard College and Harvard Business
School.

Dr.  Andrew  A.  Pouring  has been a  full-time  employee,  director,  and Chief
Scientist  of the  Company  since  1980,  serving as  President  from April 1980
through  November  1991,  and as Chief  Executive  Officer  since May  1985.  In
November 1991 he was elected a Vice  Chairman of the Board of  Directors.  He is
the  principal  author of the  Company's  numerous  patents  and has  personally
contributed  most of the recently  patented  improvements  and extensions to the
original  discoveries.  He served as a Professor of Aerospace Engineering at the
U.S.  Naval  Academy  from  1964 to  1983,  and was  Chairman  of the  Academy's
Department of Aerospace  Engineering  from 1975 to 1978. Dr. Pouring is a member
of various professional and scientific societies, including the American Society
of Mechanical  Engineers and the Society of  Automotive  Engineers,  as has been
organizer  and  chairman  of many  symposia  for these  societies.  Dr.  Pouring
received  his  Bachelors  and Masters  degrees in  mechanical  engineering  from
Rensselaer Polytechnic  Institute.  He received his Doctor of Engineering degree
from Yale  University,  where he also was a post  doctoral  research  fellow and
lecturer.

Mr.  George E.  Ponticas  has been Vice  President of Finance,  Chief  Financial
Officer,  Secretary and Treasurer of the Company since  September 1991. From May
1987 through  August 1991, he served as the Company's  Controller  and Assistant
Secretary. From August 1981 through April 1987, Mr. Ponticas was a member of the
auditing  staff  of Price  Waterhouse  in  Baltimore,  Maryland,  attaining  the
position of audit manager in 1986. At Price Waterhouse,  he worked on the audits
of a  number  of  public  and  private  companies,  with an  emphasis  on  small
businesses.  Mr. Ponticas is a Certified Public  Accountant,  and is a member of
the  American  Institute  of  Certified  Public  Accountants  and  the  Maryland
Association of Certified Public Accountants.  He received his B.S. in Accounting
from Loyola College in Maryland.


                         ITEM 10. EXECUTIVE COMPENSATION

The following table sets forth the compensation paid by the Company to its chief
executive officer;  no other executive officer earned annual compensation during
the most recently  completed year in excess of $100,000 (together referred to as
the "Named Executives").

                           SUMMARY COMPENSATION TABLE

                                        Annual compensation
                                 --------------------------------
                                          Salary                      Long-term
                                 --------------------               compensation
     Name and Position    Year   Cash paid   Deferred      Bonus    # of options
     -----------------    ----   ---------   --------    --------   ------------

Dr. Andrew A. Pouring     1997   $ 72,000    $ 48,000                  35,000
 CEO & Chief Scientist    1996     60,798      40,531    $ 10,000      25,000
                          1995     60,798      40,531

In order to help  conserve  the  Company's  limited cash  resources,  all of the
Company employees,  at the request of the Board of Directors,  for several years
have been voluntarily  deferring  receipt of payment of significant  portions of
their  authorized  salaries.  In February  1992 as a condition of the  Company's
receiving an indispensable capital infusion, this voluntary deferral of salaries
was documented  formally through an agreement known as the "Consent to Deferral"
executed by all salaried  employees.  Under this agreement,  each of the signers
consented to the past and future deferral of portions of their annual  salaries,
and agreed to defer  payment of amounts so  accumulated  until the  Company  has
received licensing revenue of at least $2 million or at such earlier date as the
Board of Directors  determines  that the  Company's  cash flow is  sufficient to
allow such payment.  The  conditions of the Consent to Deferral that would allow
repayment of deferred  salaries  have yet to occur.  As of December 31, 1997, an
aggregate  of  $648,292  in  deferred  salaries  is owed to  current  and former
employees.

                                       31
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


In an effort to avoid long-term financial commitments, the Company does not have
employment  agreements  with any of its  personnel.  The  salaries of  executive
officers  are set by the Board of  directors  on an annual  basis.  For the past
several years Dr.  Pouring has been  deferring 40% of his annual  salary.  As of
December  31,  1997,  the amount of  deferred  salary  owed to Dr.  Pouring  was
$250,981.  His authorized annual salary was increased in 1997 for the first time
since 1989.

With the  exception of the granting of stock  options,  the Company does not pay
its Named  Executives any bonuses or any type of long-term  compensation  in the
form of restricted stock awards,  stock appreciation rights (SARs) or other form
of long-term incentive plan payments.


                       OPTION GRANTS IN LAST FISCAL YEAR

                                    Individual Grants
             -------------------------------------------------------------------
             Number of    % of total
            securities      options
            underlying    granted to
              options    employees in    Exercise     Market        Expiration
 Name         granted     fiscal year      price       price           date
 ----         -------     -----------      -----       -----       -------------

Pouring        35,000          33%          $.50       $.75        Dec. 14, 2007



               AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
                      AND FISCAL YEAR-END OPTION/SAR VALUES

                                    Number of securities    Value of unexercised
                                   underlying unexercised       in-the-money
                                      options/SARs at         options/SARs at
                                     December 31, 1997       December 31, 1997
          # of shares
          acquired on     Value         Exercisable/             Exercisable/
  Name     exercise     realized        unexercised             unexercised
--------  -----------   --------   ----------------------   -------------------

Pouring        -            -         146,316/185,066         $79,178/$97,850

With the exception of options to purchase 25,000 shares held by Dr. Pouring that
are exercisable at $.75 per share,  all options held by the Named Executives are
exercisable  at $.50 per share,  which  price was below the  December  31,  1997
market price of the Company's publicly traded common stock of $1.0625 per share.


            ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
                                 AND MANAGEMENT

The  following  tables set forth as of March 31, 1998  information  relating to
beneficial  ownership  by  directors of the  Company,  directors  and  executive
officers of the Company as a group,  and any other  persons known by the Company
to be the beneficial owner of more than five percent of the currently issued and
outstanding common stock of the Company.  The term "shares  beneficially  owned"
encompasses  those shares which the reporting  person  currently owns or has the
right to acquire within sixty days through the exercise of currently exercisable
options and warrants or through the conversion of preferred stock.  Shares which
the reporting  person has the right to acquire are not deemed to be  outstanding
for computing the percentage of beneficial ownership of any other person. Unless
otherwise  noted,  all  shares  are  beneficially  owned  and  sole  voting  and
investment power is held by the persons named.



                                       32
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB


                           Total Beneficial Ownership
                           --------------------------

                              Common     Rights to    Total shares
                              shares      acquire     beneficially     Percent
 Name and address (1)         owned       shares         owned        of class
 --------------------       ---------    ---------     ---------      --------

Nuno Brandolini               111,726      330,150        441,876         2.5
Lawrence H. Hyde              394,986      606,857      1,001,843         5.6
Charles C. McGettigan       1,570,211    5,842,794      7,413,005  (3)   31.6
Andrew A. Pouring             688,239      146,316        834,555         4.7
Myron A. Wick, III          1,570,211    5,842,794      7,413,005  (3)   31.6
                                                                             
All directors & officers                                                   
 as a group (6 persons)     2,906,424    7,134,868     10,041,292        40.7
                                                                             
Herbert J. Mitschele, Jr.                                                    
  Far Hills, NJ               946,755      105,715      1,052,470         6.0
                                                                             
Proactive , et.al. (2)                                                       
  San Francisco, CA         2,919,157    9,736,003     12,655,160        46.1
                                                                         
-----------------------------
(1)   The business address for each director and named executive officer is 23
      Hudson Street, Annapolis, Maryland, 21401.
(2)   Includes  shares  beneficially  owned directly and indirectly by Proactive
      Partners,  L.P. and several affiliated  entities and  individuals
      ("Proactive et.al."), as reported in a Form 13D filing with the Securities
      and Exchange Commission.
(3)   Includes  7,199,005  shares  beneficially  owned  by  Proactive et.al.,
      which shares could be deemed to be beneficially owned by both Mr.
      McGettigan  and Mr.  Wick by  virtue  of  their  executive  and  ownership
      positions in Proactive et.al. Both individuals  exercise shared voting
      and investment power with respect to such shares.



                           Rights to Acquire Shares
                           ------------------------
                                                                         Total 
                                      Exercisable            Preferred rights to
                         Exercisable    (put)/   Exercisable   stock    acquire
        Name               options     call (2)    warrants  converted  shares 
--------------------      ----------  ---------   ---------  --------- ---------
                                                                                
Nuno Brandolini              330,150                                     330,150
Lawrence H. Hyde             464,000   142,857                           606,857
Charles C. McGettigan (1)    214,000   (71,429)  3,414,510  2,285,713  5,842,794
Andrew A. Pouring            146,316                                     146,316
Myron A. Wick, III (1)       214,000   (71,429)  3,414,510  2,285,713  5,842,794
                                                                                
All directors & officers                                                      
 as a group (6 persons)    1,477,216    71,429   3,514,510  2,285,713  7,134,868
                                                                                
Herbert J. Mitschele, Jr.                           62,858     42,857    105,715
                           
Proactive , et.al. (2)   
  San Francisco, CA                   (142,857)  5,521,719  4,357,141  9,736,003

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

(1)   Includes  5,628,794  shares  beneficially  owned by Proactive,  et.al.,
      which  shares  could be  deemed  to be  beneficially  owned by both Mr.
      McGettigan  and Mr.  Wick by virtue of their  executive  and  ownership
      positions in Proactive,  et.al. Both individuals exercise shared voting
      and investment power with respect to such shares.
(2)   Represents  the  currently  exercisable  portion of a  ten-year  option
      granted by Proactive,  et.al. to Mr. Hyde to purchase 714,286 shares of
      common stock presently owned by Proactive,  et.al. at an exercise price
      of $.35 per share.  This option becomes  exercisable at the rate of 20%
      per year  beginning  with the December 15, 1997 date of grant.  Because
      this  agreement  relates to shares which are already  outstanding,  the
      exercise  of such  rights  will not result in an  increase in the total
      number of the  Company's  outstanding  shares for purposes of computing
      the percentage of beneficial  ownership of each reporting  person.  Mr.
      McGettigan and Mr. Wick each has indirect  beneficial  ownership in 50%
      of the shares subject to this agreement.



                                       33
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



             ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

                                     None.



                 ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K

(a)   Exhibits.

  3       Articles of Incorporation  and Bylaws (as amended) - Incorporated
          by reference to the  Company's  Annual  Report on Form 10-KSB for
          the year ended December 31, 1992.

  4       Instruments defining the rights of security holders (contained in
          Exhibit 3 hereof).

  10.1    1987 Non-Qualified Stock Option Plan, as amended - Incorporated by
          reference to the Company's Registration Statement No. 33-34520 on
          Form S-8.

  21      Subsidiaries of the Registrant:  Sonex International, B.V. - The
          Netherlands; Sonex Engines, Inc. - Delaware (both are inactive
          subsidiaries).

  23.a    Consent of C.L. Stewart & Company

  23.b    Consent of Price Waterhouse LLP

  24      Power of Attorney -  Incorporated  by reference to the  Company's
          Annual Report on Form 10-K for the year ended December 31, 1991.

  27      Financial Data Schedule


(b)   Reports on Form 8-K.

          On November 4, 1997,  the  Registrant  filed a Current  Report on
          Form 8-K to report a change in its  independent  accountants  for
          the fiscal year ended December 31, 1997.



                                       34
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB



                                   SIGNATURES

In  accordance  with Section 13 or 15(d) of the  Exchange  Act , the  Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.


                       SONEX RESEARCH, INC.


April 9, 1998         By:           /s/ Andrew A. Pouring
                              ----------------------------------
                              Andrew A. Pouring
                              Principal Executive Officer

April 9, 1998         By:            /s/ George E. Ponticas
                              ----------------------------------
                              George E. Ponticas
                              Principal Financial and Accounting Officer


In  accordance  with the Exchange  Act, this report has been signed below by the
following  persons on behalf of the  Registrant and in the capacities and on the
dates indicated.


April 9, 1998                                  *
                              ----------------------------------
                              Myron A. Wick, III
                              Chairman of the Board of Directors

April 9, 1998                                  *
                              ----------------------------------
                              Nuno Brandolini
                              Vice Chairman of the Board of Directors

April 9, 1998                       /s/ Andrew A. Pouring
                              ----------------------------------
                              Andrew A. Pouring
                              Vice Chairman of the Board of Directors

April 9, 1998                                  *
                              ----------------------------------
                              Lawrence H. Hyde
                              President and Director

April 9, 1998                                  *
                              ----------------------------------
                              Charles C. McGettigan
                              Director

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

*  Executed on behalf of these persons by George E.  Ponticas,  a duly appointed
   attorney-in-fact of each such person.


      /s/ George E. Ponticas
----------------------------------
George E. Ponticas, Attorney-In-Fact


The Registrant  will furnish its  shareholders  with copies of its annual report
and proxy statement after the date of this report.



                                       35
<PAGE>
                      SONEX RESEARCH, INC. 1997 FORM 10-KSB




                       CONSENT OF INDEPENDENT ACCOUNTANTS


We  hereby  consent  to  the   incorporation  by  reference  in  the  Prospectus
constituting  part of the Registration  Statement on Form S-8 (No.  33-34520) of
Sonex Research,  Inc. of our report dated March 25, 1998 appearing on page 14 of
this Form 10-KSB.


/s/C.L. STEWART & COMPANY

Annapolis, Maryland
April 9, 1998






                       CONSENT OF INDEPENDENT ACCOUNTANTS


We  hereby  consent  to  the   incorporation  by  reference  in  the  Prospectus
constituting  part of the Registration  Statement on Form S-8 (No.  33-34520) of
Sonex  Research,  Inc. of our report dated April 8, 1997 appearing on page 15 of
this Form 10-KSB.



/s/PRICE WATERHOUSE LLP

Linthicum, Maryland
April 8, 1998



                                       36