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, 1998. 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, 1999 was  17,662,518.  The  aggregate  market value of voting stock
held by non-affiliates of the Registrant was $7,368,218 as of March 31, 1999.


Revenues for the year ended December 31, 1998 were $395,213.


                   Documents Incorporated by Reference: None.




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                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


                         ITEM 1. DESCRIPTION OF BUSINESS

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

Sonex Research,  Inc.  ("Sonex" or the  "Company"),  incorporated in Maryland in
1980, has developed a patented  proprietary  technology  (the "Sonex  Combustion
System",  "SCS"  or  "Ultra  Clean  Burn(TM)  technology")  which  improves  the
combustion  of fuel in engines  through  design  modification  of the pistons in
large  engines  or the  cylinder  heads  in  small  engines.  Variations  of the
Company's  technology  have been  applied  to all types of  internal  combustion
engines,  including those used in personal and commercial vehicles (automobiles,
trucks, buses, boats,  motorcycles) as well as engines used in fixed or portable
utility  applications  (motor generator sets, pumps, chain saws),  whether spark
ignited (SI) or compression  ignited (CI),  carburetted or fuel injected,  using
gasoline, diesel, alcohol and/or other fuels.

Management believes that the Company's piston-based emissions reduction enabling
technology for direct injected (DI) diesel engines,  which changes only a single
engine component while introducing no additional parts and is self-driven by the
combustion  process,  can be an alternative to exhaust  aftertreatment.  Ongoing
demonstration and development programs at various stages of completion with some
of the largest  multi-national  diesel engine original  equipment  manufacturers
(OEM's) in the world target  engines  used in medium and heavy duty trucks.  The
Company's goal in such programs is to execute broad  agreements  with the diesel
engine manufacturers and their piston suppliers for industrial production of SCS
pistons under license from Sonex.

The  demonstration  process  involves  many stages,  from proof of concept using
screw-assembled prototype pistons fabricated in-house by Sonex and tested by the
engine  manufacturer in its  laboratories,  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. Tests in OEM engines and in computer
models have shown that the SCS technology for DI turbocharged diesel engines has
the  ability  to  improve  combustion  and  that  engines  using  the  Company's
technology  emit fewer  harmful  exhaust  emissions,  particularly  soot, at all
engine speeds.

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 NOx (oxides of nitrogen)
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 would attain future U.S. and European  emissions  targets when OEM type
production pistons become available.  The Company has now reached the next stage
with  these  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.  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.
Continued revision of emissions limits, however, has challenged Sonex to produce
piston  designs  that reduce both NOx and soot,  leading to a delay in licensing
negotiations.

The  Company  also has  successfully  applied a  patented  starting  system  and
modified  combustion chamber design to the conversion of reliable,  lightweight,
SI, two-stroke, gasoline fueled engines of various sizes used in small, remotely
controlled  unmanned  aerial  vehicles  (UAV's)  by the  military,  to start and
operate on JP5/JP8 standard  military fuels (also referred to as "heavy fuels").
As heavy fuels are less volatile than  gasoline,  in addition to the UAV market,
the Company is exploring a wide range of  sustained  commercial  utility  engine
applications  for its heavy fuel  conversion  technology  to reduce the  hazards
associated with the storage of gasoline in buildings and on boats.


Employees
---------

As of March 31, 1999, the Company had five  full-time  employees and engaged the
part-time  services of three  consultants  on a regular  basis.  The Company has
never experienced a strike or work stoppage, and believes its relations with its
employees are good.


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                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


Cautionary Statement Regarding Forward-Looking Statements
---------------------------------------------------------

Sections of this Annual Report on Form 10-KSB, including but not limited to Item
1 - "Description of Business" and Item 6 - "Management's Discussion and Analysis
of Financial  Position and Results of  Operations",  contain  information in the
form  of  "forward-looking"   statements  within  the  meaning  of  the  Private
Securities  Litigation  Act of 1995 (the "Act").  Such  statements  are based on
management's expectations,  estimates,  projections and assumptions. In order to
obtain the  benefits  of the "safe  harbor"  provisions  of the Act for any such
forward-looking  statements,  the Company cautions  shareholders,  investors and
prospective  investors about significant factors which, among other things, have
in some cases affected the Company's actual results and are in the future likely
to affect the Company's actual results and cause them to differ  materially from
those expressed in any such forward-looking statements.


Overview of SCS Engine Design Modifications
-------------------------------------------

The SCS for DI diesel  engines  improves  the  process of  combustion  through a
combination  of chemical and fluid  dynamic  effects that occur by modifying the
engine's combustion chamber and the processes occurring within that chamber. SCS
DI diesel designs  integrate one or more cavities as microchambers  which form a
ring around the piston bowl,  with each  microchamber  positioned in line with a
spray from the fuel injector. The microchambers are connected to the piston bowl
by tunnel-like vents arranged in a unique geometric design.  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 position of the microchambers is a
critical factor in controlling the temperature of the  microchamber and the rate
of reaction of gases that may be resident in the microchamber at any one time.

The  microchambers  perform as reservoirs that produce active  chemical  species
(partially  reacted  charges)  which are  expelled  at high  velocity to enhance
combustion  and burn the soot cloud.  This  activity is the central point in the
Company's most advanced design  innovation,  the latest  invention in the series
for the SCS for DI diesel engines;  the U.S. patent for this invention issued in
January 1999.  This advanced  design,  which follows the basic  principles  that
Sonex has used for its DI diesel systems for some time, involves  re-arrangement
of SCS features to exploit new fundamental understandings of fluid dynamics.

The additional  chemical activity is very effective with the use of EGR (exhaust
gas  recirculation),  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 to the engine.

The SCS engine design  modifications  for heavy fuel  operation in SI two-stroke
engines  consist of  modified  cylinder  heads and  special  combustion  chamber
inserts  housing the  proprietary  SCS  technology.  The SCS conversion  aims to
maintain  the  gasoline  engine's  stock  carburetion,  intake and exhaust  port
timing,   intake  and  exhaust  systems,   ignition  system,   ignition  timing,
compression ratio and weight. The SCS starting system employs heaters similar to
those used in a diesel engine.


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

Government  agencies  around the world  continue  to mandate  increasingly  more
strict  requirements  for the  reduction  of allowable  diesel truck  emissions,
specifically  with  respect  to  smoke/particulates  and NOx.  The use of costly
electronic controls and ultra-high pressure injection systems, including the new
"common  rail"  injection  systems that are integral to the engine  itself,  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
NOx 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


                                       3
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


piston   design,    under   various    conditions    causes   a   reduction   in
smoke/particulates,   carbon  monoxide  (CO),  hydrocarbons  (HC),  and  NOx  by
significant  amounts while  maintaining  or improving  upon brake  specific fuel
consumption (BSFC) and power. In tests conducted in modern turbocharged  engines
of several  manufacturers,  fitted  with a variety of Sonex  pistons,  including
aluminum screw assembled  pistons and electron beam welded (EBW) pistons,  using
an earlier SCS piston  design,  the Company  has  demonstrated  that the SCS may
reduce  smoke/particulate  emissions  in excess of 40% and HC  emissions  by 5%,
while maintaining equal NOx emissions at future targets and BSFC within 2% above
or below that of the stock engine.

The ability of the SCS to reduce soot emissions has an added benefit towards the
reduction of NOx in diesel engines.  Many manufacturers are turning to using EGR
to reduce  NOx.  (EGR is inert  exhaust  gas  recycled  and pumped back into the
engine cylinders for the next combustion  cycle.) EGR can  significantly  reduce
NOx, 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.

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 and common
rail injection and EGR.


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 low cost,
improved performance, and simplicity, since no additional moving parts are added
to the engine.


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.


Current DI 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 foreign  multi-national  diesel truck engine OEM's,  in separate
programs.  Funded development of Sonex pistons for industrial production for one
of these OEM's proceeded  successfully  through verification tests by the engine
manufacturer of pre-production, finished, aluminum pistons, using an earlier SCS
design, in an engine in its own facility. Since 1998 the Company, under contract
with this OEM, has been  participating  with  suppliers  of the OEM's  injection
system and turbo-charger,  and one of the world's leading independent engine R&D
and  testing  firms,  on a joint  engine  application  program  involving  Sonex
technology for DI diesel engines. In this program, the latest, most advanced SCS
piston  design  innovation  is being  introduced.  SCS  pistons  and all  engine
parameters are being  optimized for eventual  production in a DI  turbo-charged,
intercooled,   mid-range  diesel  engine  using  high  pressure   electronically
controlled injection, common rail high pressure, variable geometry turbocharger,
cooled EGR, etc.


                                        4
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


The manufacturer's objective is to meet future stringent emissions limits in the
production  version of this engine by use of the SCS technology,  in combination
with  these  other fuel  system  improvements,  with no  exhaust  aftertreatment
devices, such as catalytic converters or particulate traps. Based on all OEM and
Sonex tests to date, with further  optimization of traditional diesel parameters
and EGR, the OEM expects to achieve these  particulate and NOx emissions  goals.
This joint engine application  program is expected to continue  throughout 1999,
following which the SCS will be applied to additional engines,  according to the
engine manufacturer.

A second large  multi-national OEM also has verified Sonex test results on a set
of pre-production  aluminum Sonex pistons using the earlier SCS design. In March
1999 the  Company  modified  pistons  received  from  this  manufacturer  to the
advanced  SCS  design,  and is  currently  conducting  tests  at  Sonex  on this
manufacturer's  six-cylinder  engine.  Later  this  year,  the  engine  and  the
Sonex-modified  pistons,  along with recorded test results,  will be returned to
the manufacturer for evaluation.  If emissions test results are confirmed by the
manufacturer,  the  design  can be  turned  over to their  piston  supplier  for
fabrication of pre-production pistons for application to a new engine.

In a similar,  single-cylinder test engine demonstration  program that is now at
the stage of testing  pre-production  prototype EBW pistons based on the earlier
SCS design,  a third major  international  engine  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.
Recently,   Sonex  learned  that  this  OEM  had  experienced   some  mechanical
difficulties while testing the EBW pistons.  The Company is now awaiting further
details from the engine  manufacturer.  It is expected  that this OEM would test
the latest,  most  advanced  SCS design in the  single-cylinder  engine prior to
proceeding to testing on the full, 8-cylinder engine.

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,  formerly  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.  In 1998 T&N was acquired by  Federal-Mogul
Corp., a major supplier of engine components based in Southfield, Michgan.

T&N  invested   significant  funds  internally  in  developing   innovative  and
economical  techniques of manufacturing Sonex pistons for series production,  as
well as performing  finite  element,  thermal and stress analyses to examine the
effects of stress on the Sonex  piston  under a variety  of extreme  conditions.
Late in 1997 Sonex and T&N completed  negotiations  for a license  agreement for
the marketing, manufacture and sale of SCS diesel truck engine pistons. Early in
1998,  however,  T&N informed the Company that signing of the agreement would be
delayed and, in subsequent  discussions  with Sonex following its acquisition of
T&N, Federal-Mogul  indicated that it was not prepared to commit further funding
to complete  the work  initiated  by T&N and  declined  to execute the  license.
Federal-Mogul  has since  confirmed that it would  cooperate with any engine OEM
willing to fund production development.

Because  many of the  on-road  diesel  engines  produced  in the U.S.  use steel
articulated   pistons  for   increased   power,   Sonex  has  recently   started
investigating the feasibility of applying the SCS to steel articulated  pistons.
It is known that such pistons are highly  loaded  thermally and engine OEM's are
projecting even higher thermal loadings. Sonex has conducted an investigation of
thermal effects of Sonex  microchambers  on aluminum  pistons,  which should aid
piston  manufacturers in formulating new  temperature-stress  models in order to
examine the feasibility of using the SCS in steel pistons.


Response to government settlement with diesel engine manufacturers
------------------------------------------------------------------

In November 1998 seven diesel engine manufacturers completed negotiation of a $1
billion  settlement  with the  Environmental  Protection  Agency  (EPA)  and the
Department  of Justice to settle  allegations  that the  companies  used "defeat
devices" for the past  several  years that  allowed  their  engines to emit more
pollution  on  the  road  than  in  certification  tests  in  order  to  achieve
performance benefits.  The settlement,  in the form of Consent Decrees under the
Clean Air Act, levied stiff civil penalties, required industry to accelerate the
introduction of advanced anti-pollution controls on new engines, and included an
industry  obligation to fund millions of dollars of research and  development in
projects to lower emissions, including projects proposed by the public.


                                        5
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


Sonex  responded to the  announcement  by submitting a Proposed  Public  Comment
Project  (the  "Project")  to the EPA,  the Justice  Department,  and the diesel
engine  manufacturers  in January  1999.  The proposed  Project  contemplates  a
cooperative effort between the diesel engine manufacturing  industry and a world
class team, to be assembled and led by Sonex,  consisting of a major  university
or  government-funded  engine  research  facility,  a  major  automotive  piston
manufacturer  and  an  advanced  metal-forming  parts  manufacturer.  It is  the
objective of Sonex to demonstrate  that a new engine design  variable  exists in
its  piston-based  SCS  allowing  in-cylinder   reduction  of  emissions  as  an
alternative to exhaust aftertreatment.

In the proposed Project, Sonex describes a cooperative  applications engineering
program  segregated  into work  elements  structured  to develop,  optimize  and
integrate  pre-production SCS pistons into direct-injected diesel engines, first
using aluminum  pistons and,  after  completion of  feasibility  studies,  steel
pistons.  Sonex proposes to bring the domestic  diesel engine  industry on a par
with foreign diesel engine  manufacturers  with respect to progress made towards
the commercialization of the American-grown SCS technology.

The Company is currently  engaged in discussions with  prospective  Project team
members that include  descriptions  of assigned  tasks,  resources,  facilities,
timelines  and estimated  costs.  Although  there can be no assurances  that the
Company's submission will be favorably received, should the response result in a
contract award, Sonex has received a commitment from an exprienced  military and
commercial  program manager to run the Project.  Official reaction by the engine
companies and the Government to comments and proposed projects  submitted by the
public is expected within the next few months.

Before the settlement becomes final, however, it must pass a judicial review. If
adverse public  comments  warrant,  the agreement could be changed EPA officials
said, but only with the engine makers' consent.  According to published reports,
even when it does become official,  the agreement may face legal challenges from
environmental groups who believe that the settlement did not go far enough.


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

The Company has successfully  applied a proprietary patented starting system and
modified  combustion chamber design to the conversion of reliable,  lightweight,
SI,  carburetted,  two-stroke,  gasoline fueled engines of various sizes used in
small,  remotely  controlled  military unmanned aerial vehicles (UAV's) to start
and  operate on JP5/JP8  standard  military  fuels  (also  referred to as "heavy
fuels").  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 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.

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 heavy fuel and by  installing  improved  electronics.
The electronics  upgrade in the UAV to a configuration  known as the Dragondrone
was performed under subcontract by AeroComm,  Inc., a privately held Germantown,
Maryland  company.  Early in 1998 Sonex completed this program and  demonstrated
the successful  prototype  conversion of five UAV engines from gasoline to heavy
fuel operation.

In March 1998 the USMC Systems Command contracted Sonex to convert an additional
forty of these  gasoline  engines,  used in the  Dragondrone  UAV, to heavy fuel
operation.  The USMC is now deploying  tactical  UAV's aboard ship for the first
time,  as the  Dragondrone  UAV's with Sonex  heavy fuel  engine  (HFE's) are in
service in several locations around the world.


                                       6
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


In August 1998 Sonex  completed a UAV HFE conversion  feasibility  demonstration
under a contract  awarded in October 1997 by the U.S. Naval Air Warfare  Center,
Aircraft Division (the "Navy"), in Patuxent River, Maryland. The existing engine
in this UAV, known as the Pioneer, is a 350cc, two-stroke,  carburetted,  SI two
cylinder  gasoline  engine.  Sonex was able to  demonstrate  this HFE  starting,
idling,  running  steady-state at part load and  wide-open-throttle  (WOT),  and
accelerating  from idle to WOT with little  visible  smoke and without  knock or
detonation.  Two  feasibility  demonstration  Sonex HFE's were  delivered to the
Navy; however,  the Company has since been informed that the Navy is planning to
replace the engine used in the Pioneer.  The Navy has indicated  that Sonex will
participate in the development of an HFE for the replacement engine.

Under a July 1998 contract from Northrop Grumman  Corporation (NGC), in December
1998 Sonex  successfully  demonstrated  the  feasibility  of converting a 342cc,
two-stroke,  SI,  carbureted,  two  cylinder,  gasoline UAV engine to heavy fuel
operation  using a preliminary  SCS design.  Bench tests of the Sonex HFE showed
WOT power to be comparable to that of the gasoline engine;  however,  due to the
limited scope of this feasibility effort, the HFE design was not optimized. Late
in March 1999,  however,  NGC notifed the Company  that it would not pursue this
UAV opportunity and declined to fund further  development work on this engine to
optimize the SCS engine design  modifications for heavy fuel performance.  Sonex
has received  inquiries in regard to the SCS HFE technology  demonstrated in the
various UAV engines from several other defense  contractors  who plan to respond
to the U.S. Army's current Tactical Unmanned Aerial Vehicle solicitation.

At the end of January  1999,  the Company  was  awarded a prototype  development
contract by NRL to modify a two-stroke,  two cylinder,  290cc gasoline engine to
start  and run on JP-5  fuel in a  manner  that  will  allow  the  engine  to be
integrated  into an NRL UAV.  The  objective  is to  demonstrate  the  projected
propeller  load curve or equivalent  of the Sonex HFE over a reasonable  part of
the engine operatingrange, with power, weight and fuel consumption substantially
equal to that for the  gasoline  version of the  engine.  Work is expected to be
completed this summer.

By  January  1999  the  Company  completed  work on a  Phase  I  Small  Business
Innovation  Research  (SBIR) Program  contract  awarded in July 1998 by the U.S.
Naval Sea Systems  Command  (NAVSEA).  Sonex  demonstrated  the  feasibility  of
utilizing SCS technology to design a low-cost,  small, rugged engine to fit in a
5-inch diameter  cylinder,  capable of starting and operating on  shipboard-safe
heavy fuels,  for use in a small aircraft that would be suitable for launch from
guns and  missiles  and for  delivery  by  airdrop.  The  aspects  of the design
ruggedness   and  other   interface   requirements   for  potential   transition
opportunities   were  performed  under   subcontract  by  Science   Applications
International  Corporation  (SAIC), an advanced  technology firm with particular
expertise in national defense concepts such as UAV's.

Phase I results  indicated that the proposed  prototype SCS HFE can be developed
in Phase II and  subsequently  transitioned  in a Phase  III  effort.  The first
transition  opportunity  is in  the  Forward  Air  Support  Munition  (FASM),  a
gun-launched  surveillance,  targeting, and precision delivery air vehicle being
developed  by the  Naval  Surface  Fire  Support  program  office.  SAIC  is the
designated prime contractor for the FASM Fleet Advanced Demonstration.  In April
1999 Sonex  submitted a Phase II SBIR proposal to NAVSEA for the development and
delivery  of  a  well-defined   operational   prototype  engine.   The  proposal
anticipates that SAIC will again serve as a subcontractor to the Company.

Sonex is  exploring  additional  potential  uses by the military for the SCS HFE
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. The Company recently initiated a research
testing program for its HFE technology to determine methods for streamlining the
design process.  Currently,  development work is very specific to each different
type of gasoline  engine  presented to Sonex for heavy fuel  conversion.  A more
general design process would allow the Company to accept  projects for a greater
variety of heavy fuel engine applications while simultaneously reducing time and
cost of development.

Sonex HFE technology is protected by a U.S. patent issued in January 1999, while
foreign  counterparts  to this patent have been  applied for  worldwide.  As new
inventions  are made to enhance  this  technology,  the  Company  will apply for
improvement patents.


                                       7
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


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

The Company has  endeavored  to protect its  technology by filing for patents in
the U.S. and in those foreign countries in which it may be able to commercialize
the SCS. The Company has also  developed a  significant  body of trade  secrets,
proprietary  information and know-how  relating to its technology.  Although the
principles underlying the SCS concept are capable of being understood by experts
in the field,  management  believes  that it would be difficult to apply the SCS
successfully to any given engine configuration  without the benefit of the trade
secrets,  know-how and proprietary  information  owned by the Company.  The name
"SONEX" was registered at the U.S. Patent and Trademark Office in 1987.

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.



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



                            ITEM 3. LEGAL PROCEEDINGS

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



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

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of 1998.



         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,
1997 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, 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                          1.09               .56
        June 30, 1998                            .84               .47
        September 30, 1998                       .75               .41
        December 31, 1998                        .65               .38
        March 31, 1999                           .59               .38


                                       8
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


As of March 31, 1999, there were 17,662,518 shares issued and outstanding,  with
approximately  980  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 17,368,772  shares of the  Company's  Common Stock as of March 31, 1999
were reserved for issuance in connection  with the conversion of preferred stock
and the exercise of warrants and options.



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

Accumulated losses
------------------

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.  During 1997 and
1998, however, revenues increased substantially while net losses from operations
were reduced.  The Company is  considered  to have emerged from the  development
stage in 1998.


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

As of March  31,  1999,  the  Company  had  available  cash and  equivalents  of
approximately  $180,000,  marketable securities valued at approximately $30,000,
and accounts receivable of approximately $87,000, including receivables from the
U.S.  Government  of  approximately  $37,000.  Based upon current and  projected
spending  levels,  management  believes  that  available  resources and expected
revenue from current and potential  contracts  and other  expected cash receipts
will be sufficient to fund operations at least through December 31, 1999. In the
absence of the realization of significant  revenues,  additional  capital may be
necessary to fund operations beyond 1999.


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

In order to help conserve the Company's  limited cash resources,  certain of the
Company's  employees  for several  years have  voluntarily  deferred  receipt of
payment of significant portions of their authorized annual salaries upon request
by the Board of Directors. By agreement with the Company, these individuals have
consented to the deferral of payment of amounts so accumulated until the Company
has received licensing revenue of at least $2 million or at such earlier date as
the Board of Directors  determines that the Company's cash flow is sufficient to
allow such payment.  Since January 1, 1997,  however,  there has been no further
deferral of salary requested of the Company's non-executive employees.


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

     Revenue and cost of subcontracts:
     ---------------------------------

                                              1998        1997        1996
                                           ---------   ---------   ---------

     Government/defense prime contracts    $ 261,362   $  90,668
     Commercial contracts                     60,550     207,500   $  70,000
                                           ---------   ---------   ---------
                                             321,912     298,168      70,000
     Revenue from government/defense
          sub-contracts                       73,301     119,420
                                           ---------   ---------   ---------

     Total revenue                         $ 395,213   $ 417,588   $  70,000
                                           =========   =========   =========


     Cost of government/defense
          sub-contracts                    $  69,326   $ 111,750
                                           =========   =========


                                       9
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


Total  revenue  decreased  5% from 1997 to 1998,  after  having  increased  from
$70,000 in 1996 to $417,588 in 1997. Revenue from commercial  contracts,  earned
primarily in connection  with the Company's DI diesel engine piston  technology,
is subject to the  negotiated  amount,  if any, that an engine  manufacturer  is
willing to provide in funding to partially offset the development costs incurred
by the Company in applying its technology to one of the manufacturer's  engines.
Revenue  for  1998  includes  $50,000  for the  first  phase  of a joint  engine
application program for the development and testing of prototype SCS pistons for
an engine OEM.  Revenue for 1997  includes  $90,000  related to the  delivery of
prototype  Sonex pistons to another  major  international  OEM.  Revenue under a
demonstration  program  begun in 1996 to apply the SCS to a truck diesel  engine
for a third international OEM was $90,000 in 1997 and $70,000 in 1996.

Since August 1997 the Company has obtained  several  military  contracts for its
small engine, heavy fuel technology, an application that has been developed only
in the last few years.  All  contracts  to date in this area have  involved  the
conversion of commercial gasoline fueled engines used in UAV's and the like. The
August  1997  contract  with the U.S.  Marine  Corps (the  USMC) to convert  the
Exdrone UAV to use heavy fuel also  included a substantial  subcontract  for the
installation of improved electronics.

The amount  recorded in 1997 as "Cost of  subcontracts"  represents the accrual,
based on the  percentage of  completion  of the contract as of year-end,  of the
sub-contracted  portion of the in-process  USMC contract.  There were no similar
sub-contract costs related to contracts in-process at December 31, 1998.

Management is unable to predict future changes to development and  demonstration
contract  revenue  because the amounts earned to date under  previous  contracts
have been determined through  negotiations with individual  manufacturers  based
upon the level of effort  required and the level of funding,  if any,  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:
     ---------------------------------------

                                                 1998        1997        1996
                                                 ----        ----        ----
 Personnel (includes stock and options):
     Employee compensation                    $ 281,886   $ 287,663   $ 255,919
     Taxes & benefits                            39,676      41,071      37,025
     Consultants, including expenses             99,382      63,864      27,125
                                              ---------   ---------   ---------
     Total personnel                            420,944     392,598     320,069

 Project parts and supplies                      59,169      30,869      39,475
 Occupancy                                       46,939      43,263      55,459
 Patent maintenance fees
      and amortization                           24,659      44,298      71,180
 Depreciation                                     8,955      13,750      21,783
 Software engineering                             5,000      20,000
 Other expenses                                  17,530      13,748      15,558
                                              ---------   ---------   ---------

     Total R&D                                $ 583,196   $ 558,526   $ 523,524
                                              =========   =========   =========

Total R&D expenses increased by $24,670,  or 4%, from 1997 to 1998, as increases
in personnel  costs and project  parts and  supplies  were  partially  offset by
decreases  in  software   engineering  fees  and  patent  maintenance  fees  and
amortization. From 1996 to 1997, total R&D expenses increased $35,002, or 7%, as
increases in personnel costs and software engineering fees were partially offset
by a large  decrease  in patent  maintenance  fees and  amortization  along with
decreases all other expense categories.

The  increase  in  personnel  costs from 1997 to 1998 was  largely  due to a 55%
increase in consulting  charges.  Most of the increase relates to higher charges
for the  compensation and expenses of the individual who serves as the Company's
R&D  supervisor  and  corporate  liaison in Europe.  This  individual,  a former
officer of the Company, is compensated primarily in the form of restricted stock
or stock  options for services  performed in Europe based on part-time  service,


                                       10
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


while for time spent in Annapolis he receives  cash  compensation,  a portion of
which is deferred,  for full-time  service.  He was asked to spend  considerably
more  time in  Annapolis  in 1998 as  opposed  to  1997,  with no time  spent in
Annapolis in 1996. A further  increase related to the hiring in November 1998 of
a consultant to assist in the preparation of the Company's  proposal response to
the Justice Department's Consent Decree against the diesel engine manufacturers.
This  consultant   continues  to  assist  the  Company  in  regard  to  business
opportunities for the SCS HFE technology.

Employee  compensation  declined  slightly  from 1997 to 1998, as a net increase
resulting from the  resignation of an engineer in the second quarter of 1997 and
the  hiring of a new  engineer  in the  fourth  quarter  of 1997 was offset by a
reduction in charges for compensation  paid in the form of stock or options from
1997 to 1998. Employee  compensation  increased from 1996 to 1997 as a result of
increases  in the wage rates for all  employees in 1997,  an increase  resulting
from the hiring of an  engineer  late in 1997,  and an  increase  in charges for
stock  option  compensation,  offset  in part by  decreases  resulting  from the
resignation  of an engineer early in 1997 and the award of bonuses in 1996 while
none were awarded in 1997. The total number of options granted to employees each
year has  remained  approximately  the same.  Compensation  cost for  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.  Compensation
charges for stock  issued for  services  is measured at the market  price on the
date of award or at the agreed-upon value of the services.

The increase in project parts and supplies resulted from greater expenditures in
1998 versus 1997 for funded  contracts and other  research not  performed  under
contract, particularly with respect to the Company's HFE work. Project parts and
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,  resulting in a decrease in such costs from 1996 to
1997.

Occupancy  expenses  declined  significantly  from 1996 to 1997 as a result of a
reduction in the monthly rent late in 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.

The  Company  experienced  a  reduction  from 1997 to 1998 in total  charges for
patent maintenance fees and amortization of the capitalized costs of patents and
technology  due to the fact  that in 1997 the  Company  wrote-off  approximately
$24,500 in  unamortized  costs of  patents  abandoned,  while  there was no such
charge in 1998.  The decrease in such charges from 1996 to 1997  resulted from a
significant  reduction in  amortization  expense that was almost entirely due to
higher  amortization in 1996 for the capitalized  costs of computer  simulations
that became fully  amortized  early in 1997,  offset in part by the write-off in
1997 of unamortized costs of patents abandoned.

Depreciation  expense has been declining for the last few years,  as most of the
Company's  equipment  that  was  purchased  in  prior  years  has  become  fully
depreciated, while purchases of equipment in 1996 and 1997 were not significant.
Software  engineering  charges  represent  amounts paid to the Company's  former
president for programming  assistance with a technology design manual that is to
be used to teach  engineers from  prospective  customers how to incorporate  the
elements of the SCS into pistons.


     General and administrative (G&A) expenses:
     -----------------------------------------

                                                 1998        1997        1996
                                                 ----        ----        ----
Personnel (includes stock and options):
     Employee compensation                    $ 110,079   $ 131,160   $ 114,753
     Other option compensation                   44,644      44,643
     Taxes & benefits                            12,066      15,601       9,523
                                              ---------   ---------   ---------
     Total personnel                            166,789     191,404     124,276

Proxy solicitation & annual meeting              22,701      18,554      17,144
Legal fees                                        8,120      21,641      18,524
Audit fees                                        8,000      12,454       9,815
Stock transfer agent fees                         9,565       8,106      10,245
Occupancy                                        11,398      12,106      13,159
Travel                                           10,328      27,761      21,153
Other expenses                                   39,773      42,363      46,797
                                              ---------   ---------   ---------
    Total G&A                                 $ 276,674   $ 334,389   $ 261,113
                                              =========   =========   =========


                                       11
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


Total  G&A  expenses  decreased  by  $57,715,  or 17%,  from 1997 to 1998 due to
decreases in personnel costs,  professional fees, and travel charges.  From 1996
to 1997, total G&A expenses increased by $73,276,  or 28%, primarily as a result
of higher personnel charges.

The  decrease in  personnel  costs from 1997 to 1998  results from a decrease in
employee  compensation caused by the termination of the employment as of the end
of the third quarter of 1997 of the  Company's  former  president,  who had been
employed on a part-time basis, and higher charges in 1997 for options granted to
employees,  offset in part by the hiring of an  administrative  assistant in the
fourth quarter of 1998.

The increase in personnel  costs from 1996 to 1997 was due to an increase in the
wage rates for all of the Company's  employees for 1997 and charges  incurred in
1997 for temporary office employees, offset in part by a reduction caused by the
termination of the employment of the Company's former president.

The large percentage  increase in payroll taxes and employee  benefits from 1996
to 1997 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.

Expenses for proxy solicitation and the annual  shareholders'  meeting primarily
represent  the costs for printing and  distributing  proxy  materials,  and also
include  charges for travel and lodging for  directors  attending  the  meeting.
Travel charges accounted for most of the increase from 1997 to 1998.

Legal  fees  decreased  62% from  1997 to 1998 as  charges  from  the  Company's
securities counsel were  significantly  higher in 1997 due to work in 1996, some
of  which  was not  billed  until  1997,  associated  with  an SEC  registration
statement that eventually was not filed, as well as for advice on  restructuring
certain stock  warrants and  undertaking  two private  financings.  A decline in
charges  from  the  Company's  patent  attorney  resulted  from  the  fact  that
significant  services  were  used in 1997 for the  preparation  of the  proposed
piston  licensing  agreement with T&N that failed to be consummated.  Audit fees
declined  as a result  of a change in  independent  accountants  for  1997.  The
significant decline in travel expenses from 1997 to 1998 is primarily attributed
to the  extensive  travel  required  by  members  of the  Board  in  1997  while
negotiating the proposed piston licensing agreement with T&N.


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

Gains on the sale of marketable securities of $247,144 in 1998, $38,299 in 1997,
and  $30,113 in 1996,  represent  the  proceeds  from the sale of the  Company's
holdings in the common  stock of Digital  Dictation,  Inc.  (acquired in 1998 by
Medquist,  Inc.),  the  corporation  which in 1995 was merged  with and into the
Company's inactive former subsidiary, SonoChem, Inc. The Company liquidated most
of this investment during 1998 when its value increased  substantially.  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 in the  ordinary  course of business  during the  remainder  of 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.


                                       12
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB



                          ITEM 7. FINANCIAL STATEMENTS

Index to financial statements:

     Reports of independent accountants

     Financial statements:

       Balance sheets as of December 31, 1998 and 1997

       Statements  of  operations,   accumulated   deficit  and  comprehensive
       income/loss for the three years ended December 31, 1998

       Statements of paid-in capital for the three years ended December 31, 1998

       Statements of cash flows for the three years ended December 31, 1998

     Notes to financial statements



                        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. at December 31, 1998 and 1997, and the results of its operations
and its cash  flows for the years  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  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 ultimately  achieve profitable  operations,  which
raise  substantial  doubt  about the  Company's  ability to  continue as a going
concern.  Management's  plans in regard to these  matters are also  described in
Note 3. The  financial  statements  do not  include any  adjustments  that might
result from the outcome of this uncertainty.


C. L. STEWART & COMPANY

Annapolis, Maryland
March 10, 1999


                   REPORT OF PREVIOUS 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 results of operations and the cash
flows of Sonex Research,  Inc. (a development  stage company) for the year ended
December 31, 1996, 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 audit.  We conducted our audit 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 audit  provides a reasonable  basis for the opinion  expressed
above.


                                       13
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


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.


PRICEWATERHOUSECOOPERS LLP

Baltimore, Maryland
April 8, 1997


                              SONEX RESEARCH, INC.

                                 BALANCE SHEETS

                                                          December 31,
                                                          ------------
          Assets                                     1998              1997
                                                     ----              ----

Current assets
 Cash and equivalents                            $  336,458        $  355,582
 Marketable securities, available-
   for-sale (Note 4)                                 29,460           117,200
 Accounts receivable, including unbilled
   costs and estimated earnings on uncompleted
   contracts of $183,750 in 1997                    102,485           210,088
 Prepaid expenses                                    28,837            36,284
 Loans to officers and employees (Note 5)            27,500            22,500
                                                 ----------        ----------
   Total current assets                             524,740           741,654  

Patents and technology (Note 6)                     243,600           231,742 

Property and equipment (Note 7)                      34,532            17,206 
                                                 ----------        ----------
           Total assets                          $  802,872        $  990,602
                                                 ==========        ==========


     Liabilities and Stockholders' Equity

Current liabilities
 Accounts payable and other accrued liabilities  $   46,979        $   35,470
 Accrued subcontract costs on
   uncompleted contracts                             16,456           111,750
Deferred compensation (Note 8)                      765,516           688,292
                                                 ----------        ----------
   Total current liabilities                        828,951           835,512
                                                 ----------        ----------

Stockholders' equity (Note 10)
 Preferred stock, $.01 par value - 2,000,000
   shares issued; 1,540,001 shares outstanding       15,400            15,400 
 Common stock, $.01 par value - shares issued
   and outstanding: 17,642,860 in 1998 and
   17,393,906 in 1997                               176,429           173,939 
 Additional paid-in capital                      20,209,503        20,035,060
 Accumulated other comprehensive income,
   representing unrealized increase in value
   of marketable securities                          29,460           117,200
 Accumulated deficit                            (20,456,871)      (20,186,509)
                                                 ----------        ----------
   Total stockholders' equity                       (26,079)          155,090
 
Commitments (Note 11)
                                                 ----------        ----------
   Total liabilities and stockholders' equity    $  802,872        $  990,602
                                                 ==========        ==========


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

                                       14
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB



                              SONEX RESEARCH, INC.

                  STATEMENTS OF OPERATIONS, ACCUMULATED DEFICIT

                         AND COMPREHENSIVE INCOME/(LOSS)

                                                                   
                                                                   
                                                 Year ended December 31,      
                                                 -----------------------      
                                            1998          1997          1996   
                                            ----          ----          ----   
Revenue
 Development contracts                 $   321,912   $   298,168   $    70,000 
 Subcontracts                               73,301       119,420               
                                         ---------      --------      -------- 
                                           395,213       417,588        70,000 
                                         ---------      --------      -------- 
Costs and expenses
 Research and development                  583,196       558,526       523,524 
 Cost of subcontracts                       69,326       111,750               
 General and administrative                276,674       333,389       261,113
                                         ---------     ---------     --------- 
                                           929,196     1,004,665       784,637 
                                         ---------     ---------     --------- 

Net loss from operations                  (533,983)     (587,077     (714,637)
                                         ---------      --------    ---------- 

Other income and expense
 Investment and other income                16,477        18,782        12,049
 Gain on sales of
   marketable securities                   247,144        38,299        30,113 
                              
                                          --------      --------    ---------- 

Net loss                                  (270,362)     (529,996)     (672,475)

Deficit accumulated during
 development stage
  Beginning of period                  (20,186,509)  (19,656,513)  (18,984,038)
                                      ------------  ------------  ------------ 

  End of period                       $(20,456,871) $(20,186,509) $(19,656,513)
                                      ============  ============  ============ 


Net loss per share                          $ (.02)       $ (.03)       $ (.04)
                                            ======        ======        ====== 

Weighted average number of
 common shares outstanding              17,572,147    17,031,016    15,968,491
                                        ==========    ==========    ==========



Comprehensive income/(loss):

Net loss                                $ (270,362)   $ (529,996)   $ (672,475)

Other comprehensive income - unrealized
  gains on marketable securities
     Arising during the period              19,242        87,900        36,800
     Reclassification of gains
       reported in income                 (106,982)       (7,500)
                                        ----------    ----------    ----------

Total comprehensive income/(loss)       $ (358,102)   $ (449,596)   $ (635,675)
                                        ==========    ==========    ==========




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







                                       15
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB



                              SONEX RESEARCH, INC.

                          STATEMENTS OF PAID-IN CAPITAL


                            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.

Balance, January 1, 1996        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 exercises           .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 exercises           .50                     352,834   3,528     172,889
January through June
 option exercises           .75                      17,000     170      12,580
March - private placements  .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

January through December -
 option exercises           .50                     181,500   1,815      88,935
March - for services        .625                     20,000     200      12,300
June - for services         .75                       7,949      80       5,882
September - for services    .44                      26,813     268      11,463
December - for services    1.00                      12,692     127       6,219
Compensation - stock options                                              5,000
Compensation - grant of
 stock options                                                           44,644
                                --------- ------ ---------- -------  ----------

Balance, December 31, 1998      1,540,001$15,400 17,642,860$176,429 $20,209,503
                                ========= ====== ========== ======= ===========









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

                                       16
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


                              SONEX RESEARCH, INC.
                          (A Development Stage Company)

                            STATEMENTS OF CASH FLOWS
                                                                  
                                                                  
                                                  Year ended December 31,      
                                                  -----------------------      
                                                1998       1997        1996    
                                                ----       ----        ----    
Cash flows from operating activities:
 Net loss                                    $(270,362)  $(529,996)  $(672,475)
 Adjustments to reconcile net loss to net
  cash used in operating activities
   Depreciation                                  8,955      13,747      21,783 
   Amortization of patents                      12,933      72,394     101,970
   Compensation - stock options                 44,644     104,456      27,125
   Current charges paid in stock                41,539       5,962       1,000 
   Gain on sale of marketable securities      (247,144)    (38,299)    (30,113)
   (Increase) decrease in
     accounts receivable                       107,603    (160,088)     13,741 
   (Increase) decrease in
     prepaid expenses                            7,447       2,408      (8,831)
   Increase (decrease) in
     accrued liabilities                        (6,561)     44,521      91,729 
                                             ---------   ---------   --------- 
Net cash used in operating activities:        (300,946)   (484,895)   (454,071)
                                             ---------   ---------   --------- 
Cash flows from investing activities:
  Proceeds from sales of
    marketable securities                      247,144      38,299      30,113 
  (Increase) decrease in
    loans to employees                          (5,000)      9,406      26,470 
  Decrease in cash posted as
    security for judgment                                              182,687
  Acquisition of property
    and equipment                              (26,281)     (2,945)     (4,887)
  Additions to patents
    and technology                             (24,791)    (64,828)    (12,456)
                                             ---------   ---------   --------- 
Net cash provided by (used in)
investing activities:                          191,072     (20,068)    221,927
                                             ---------   ---------   ---------

Cash flows from financing activities:
  Issuance of stock - private placement                    581,639       
  Issuance of stock - exeercise of options      90,750     189,167      65,744 
                                             ---------   ---------   --------- 
Net cash provided by financing activities:      90,750     770,806      65,744 
                                             ---------   ---------   --------- 

Increase (decrease) in cash:                   (19,124)    265,843    (166,400)

Cash at beginning of period:                   355,582      89,739     256,139
                                             ---------   ---------   --------- 
Cash at end of period:                       $ 336,458   $ 355,582   $  89,739  
                                             =========   =========   ========= 








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

                                       17
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB



                              SONEX RESEARCH, INC.

                          NOTES TO FINANCIAL STATEMENTS


NOTE 1 - THE COMPANY

Sonex Research, Inc. has developed a proprietary technology,  known as the Sonex
Combustion  System  (SCS),  which  improves the  combustion  of fuel in internal
combustion  engines through  modification of the pistons in large engines or the
cylinder  heads in  small  engines.  The  Company  expects  to  license  several
applications of its technology and is commercially exploiting other applications
itself.


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Certain  reclassifications  have been made to the  financial  statements  of the
prior  years to conform to the  classifications  used in 1998.  In prior  years,
Sonex Research, Inc. was classified as a development stage company.


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 -
"Accounting for Certain Investments in Debt and Equity Securities"; 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, will be charged to operations at the time
such determination is made.


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

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


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

Revenue  derived from  development  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 an engine  manufacturer is willing to provide funding to partially  offset
the development  costs incurred by the Company in applying its technology to one
of the  manufacturer's  engines.  Generally,  commercial  development  contracts
require the Company to demonstrate that the manufacturer's engine, when modified


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


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.

Development  contracts  are  executed  for funding  supplied by a United  States
Government (the "Government")  agency or defense contractor for proof-of-concept
demonstration programs.  Certain of these contracts require a performance period
of several months and/or require 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  contracts  that  require  the  Company  to provide
stipulated   services  for  a  fixed  price  have  been  recognized   using  the
percentage-of-completion   method  of  accounting  by  relating  contract  costs
incurred to date to total  estimated  contract costs at completion.  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 -
"Accounting for Stock Issued to Employees".  Under APB No. 25, compensation cost
is measured as the excess,  if any, of the quoted  market price of the Company's
stock at the  date of  grant  over the  exercise  price of the  option  granted.
Compensation  cost for stock  options,  if any, is  recognized  ratably over the
vesting  period.  The  Company  provides  additional  pro forma  disclosures  as
required under SFAS No. 123 - "Accounting for Stock-based Compensation".


Comprehensive income
--------------------

SFAS Statement No. 130 - "Reporting Comprehensive Income",  effective for fiscal
years  beginning after December 15, 1997 and adopted by the Company in 1998 on a
retroactive  basis,  defines  comprehensive  income  as net  income  plus  other
revenues,  expenses,  gains and  losses  that are  excluded  from net income and
included  separately in the  stockholders'  equity section of the balance sheet.
The only adjustments  necessary to arrive at the Company's  comprehensive income
relate to unrealized  gains, and the subsequent  effect of recognized  gains, on
marketable securities.

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

Although the Company is considered to have emerged from the development stage in
1998,  management  recognizes  that the Company's  history of operating  losses,
level of  available  funds,  and revenue  from  current  and future  development
contracts, in relation to projected expenditures,  raise substantial doubt as to
the Company's  ability to commence  generation of significant  revenues from the
commercialization  of the  SCS and  ultimately  achieve  profitable  operations.
Accordingly,  the Company will continue to minimize its  operating  expenditures
through a number of measures,  including the continued  deferral by its officers
of significant portions of their salaries.  In the event that the realization of
significant  revenue from the  commercialization  of the SCS is further delayed,
the Company may need to raise additional  capital to fund its operations  beyond
1999.




                                       19
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


NOTE 4 - MARKETABLE SECURITIES

In 1995 the Company's former inactive  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 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 10),  became the  directors  and  officers of
Digital.  At the  time of this  merger,  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 accounts of the Company with respect to
this  transaction.  The shares of Digital stock received by the Company pursuant
to this  merger  became  available  for public  trading in April  1996,  and the
Company  began to  liquidate  its  holdings.  In 1998  Digital  was  acquired by
Medquist, Inc., its largest competitor,  in a share exchange. Shares of Medquist
also trade in the public market.

This  investment is 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  Digital  or  Medquist  shares  still held at each
financial statement date is recorded at its aggregate fair value at that date. A
corresponding  amount,  representing  the aggregate  unrealized gain in the fair
value of this investment in excess of its cost basis at each financial statement
date, is reported as a separate component of stockholders' equity. The aggregate
net proceeds from the sale of these  securities  are  recognized as gains in the
year of sale.


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,  and  recent  short-term  loans  made to  Company
personnel.  The loans, which are non-interest  bearing,  are secured by deferred
salaries payable to each of the borrowers, and become due on December 31, 1999.


NOTE 6 - PATENTS AND TECHNOLOGY

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

                                                      December 31,
                                                   ------------------
                                                   1998          1997
                                                   ----          ----
    Capitalized costs                            $307,318      $282,527
    Accumulated amortization                      (63,718)      (50,785)
                                                 --------      --------
                                                 $243,600      $231,742
                                                 ========      ========

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 reduce
the capitalized cost of patents and technology  should the recovery of such cost
no longer be sustainable.


NOTE 7 - PROPERTY AND EQUIPMENT

Property and equipment consists of the following:
                                                      December 31,
                                                   ------------------
                                                   1998          1997
                                                   ----          ----

    Shop equipment                               $407,687      $383,380
    Office equipment                               22,920        20,946
    Vehicle                                        11,053        11,053
                                                 --------      --------
                                                  441,660       415,379 
    Accumulated depreciation                     (407,128)     (398,173)
                                                 --------      --------
                                                 $ 34,532      $ 17,206      
                                                 ========      ========

                                       20
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


NOTE 8 - DEFERRED COMPENSATION

In order to help conserve the Company's  limited cash resources,  certain of the
Company's  employees  for several  years have  voluntarily  deferred  receipt of
payment of significant portions of their authorized annual salaries upon request
by the Board of Directors. By agreement with the Company, these individuals have
consented to the deferral of payment of amounts so accumulated until the Company
has received licensing revenue of at least $2 million or at such earlier date as
the Board of Directors  determines that the Company's cash flow is sufficient to
allow such payment.  Since January 1, 1997,  however,  there has been no further
deferral of salary requested of the Company's non-executive employees.

The  conditions  that would  require  repayment of deferred  amounts have yet to
occur. From time to time,  however,  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.  An aggregate of $714,039 and
$648,292 as of December 31, 1998 and 1997, respectively, of wages so deferred by
current and former  employees  remained unpaid and has been recorded as deferred
compensation on the Company's balance sheet.

The  $182,687  described  as "Cash  posted  as  security  for  judgment"  in the
Company's 1996  Statement of Cash Flows  represents the return of funds upon the
reversal  on appeal of a judgment  stemming  from a lawsuit  against the Company
filed in 1993 by two former officers who sought  repayment of deferred  salaries
upon the termination of their employment.


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, 1998,  the Company had net
operating loss ("NOL") carryforwards of approximately $16.6 million available to
offset  future  taxable  income.  Net  operating  losses  generated  in 1998 and
subsequent  years  may be  carried  forward  twenty  years,  while  such  losses
generated  in 1997 and prior  years may be carried  forward  fifteen  years.  If
certain substantial changes in the Company's ownership should occur, there would
be an  annual  limitation  on the  amount  of  the  carryforwards  which  can be
utilized.  Sales of  marketable  securities  have also  generated  capital  loss
carryforwards for income tax purposes. Capital loss carryforwards,  which expire
after five years, may only be used to offset future capital gains. The Company's
tax loss carryforwards are summarized as follows:


         Expiration                 NOL's             Capital
        ------------              ------------       ---------

            1999                  $    900,078
            2000                     1,105,399
            2001                     1,748,874       $ 201,681
            2002                     1,837,965         133,400
            2003                     1,344,816         365,147
         2004 - 2012                 9,180,907
            2018                       433,915
                                  ------------       ---------

                                  $ 16,551,954       $ 700,228
                                  ============       =========

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
1988 and the  non-deductibility of compensation related to the exercise of stock
options recorded previously in the Company's accounts.

The  potential  income tax  benefit of these loss  carryforwards  and  temporary
differences of approximately $6.4 million has not been recorded in the financial
statements  due  to the  uncertainty  of  realization  based  on  the  Company's
financial  performance  to date.  Since 1995 net  operating  loss  carryforwards
aggregating $1,027,283 have expired unused.







                                       21
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


NOTE 10 - CAPITAL STOCK

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

The Company is presently authorized to issue 48 million shares of $.01 par value
common stock and 2 million shares of $.01 par value convertible preferred stock.
All of the  authorized  shares of  preferred  stock,  along  with  common  stock
purchase  warrants,  were issued for $2 million in February 1992 (the "Preferred
Stock Investment") to a small number of individuals who qualified as "accredited
investors"  pursuant to Rule 501 of Regulation D of the  Securities  Act of 1933
(the  "Act") and to  Proactive  Partners,  L.P.  and  certain of its  affiliates
("Proactive"),  who became the largest  beneficial owner of the Company's common
stock by virtue of the acquisition of the convertible preferred stock and common
stock purchase warrants.

The preferred  stock has priority in liquidation  over the common stock,  but it
carries no stated  dividend.  The holders of the  preferred  stock,  voting as a
separate class,  have the right to elect that number of directors of the Company
which  represents a majority of the total  number of  directors.  The  preferred
stock is  convertible  at any time at the option of the holder into common stock
at the rate of $.35 per share of common stock.  As of December 31, 1998, 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 February  1997 the  Company  notified  the holders of all of its  outstanding
warrants to purchase shares of its common stock, issued in private financings in
February 1992, June 1994, June 1995 and December 1995, 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 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. One other participant in the Preferred
Stock Investment,  who also agreed to make an additional  investment in February
1997, also received the amendments to 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 7.5  million  shares of common  stock
following an increase of 2.5 million shares authorized by the Board of Directors
in December  1998.  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


                                       22
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


respect to those  options  which have not already  vested.  Options  outstanding
expire at various dates through December 2008.

In  December  1998 the  Board of  Directors  approved  the  grant to each of the
Company's four outside  directors of ten-year options to purchase 100,000 shares
of common stock.  These options vest at the rate of 25% per year  beginning with
the date of grant and have an exercise price of $.50 per share,  which price was
above the then current market price of the common stock.

Between  January 1, 1996 and December 31,  1998,  the Company had the  following
activity in options to purchase shares of common stock under the Plan:


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

Unexercised at January 1, 1996      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
                                                           =========     ====
    Granted                           548,500      .50
    Exercised                        (181,500)     .50
    Lapsed or canceled               (108,000)     .50
                                   -----------  -------

Unexercised at December 31, 1998    3,856,716     $.52     3,391,966     $.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  reduction  in the  number  of
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, which is not covered by the Plan, is exercisable
at the rate of 20% per year beginning with the date of grant.

For certain  options  under the Plan granted or repriced,  the Company  credited
$59,813  and  $27,125  in 1997 and 1996,  respectively,  to  additional  paid-in
capital,  representing  the excess of the aggregate  market value at the date of
grant or repricing of shares under option over the aggregate  exercise  price of
such options, and charged a like amount to compensation expense in each of those
years.  In  connection  with the grant of the option in 1997 by Proactive to the
new  president of the Company,  $44,644 in 1998 and $44,643 in 1997 was credited
to additional paid-in capital and like amounts charged to compensation  expense.
Additional  compensation of $89,285 is being  amortized to compensation  expense
over the remaining vesting period of this option.

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.  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 101% in
1998,  112% in 1997  and  124% in  1996,  risk-free  interest  rate of 6%,  zero
dividend  yield,  and  expected  term of ten years.  For  purposes  of pro forma
disclosures,  the  estimated  fair value of options is amortized to expense over
the vesting period of each option.





                                       23
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


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:

                                            1998       1997        1996
                                          --------   --------   ----------

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

  Net loss - as reported                  $270,362   $529,996     $672,475
  Net loss - pro forma                    $531,122   $876,273     $910,840

  Net loss per share - as reported            $.02       $.03         $.04
  Net loss per share - pro forma              $.03       $.05         $.06


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,  1998,  a total of  17,355,273  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 in
     June 1999                                                     1,048,536
     February 2000                                                 3,098,214
     December 2000                                                   340,000
     February 2002                                                   167,159
     March 2002                                                      220,000
                                                                  ----------
                                                                   6,635,937
                                                                  ----------
Currently exercisable options:
 Exercisable at $.50 per share                                     3,168,466
 Exercisable at $.75 per share                                       173,500
 Exercisable at $1.00 per share                                       50,000
                                                                  ----------
                                                                   3,391,966
                                                                  ----------
Granted options becoming exercisable in the future:
 Exercisable at $.50 per share                                       442,250
 Exercisable at $.75 per share                                        22,500
                                                                  ----------
                                                                     464,750

Options available for future grants                                  383,617

Conversion of preferred stock                                      4,400,003
                                                                  ----------

 Total shares reserved                                            17,355,273
                                                                  ==========


                                       24
<PAGE>
                      SONEX RESEARCH, INC. 1998 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  pursuant to which the
property owner is required to provide thirty days notice if he wants the Company
to vacate the  premises.  The lease  requires  the  Company to pay all  property
related expenses.  Gross rent charges aggregated $42,000, $42,000 and $52,000 in
1998, 1997 and 1996, respectively, while the Company also earned sublease income
of $2,000,  $750 and $2,400 in 1998,  1997 and 1996,  respectively.  The Company
will seek to negotiate a new  long-term  lease for its facility or search for an
alternative  location in the event that an  agreement  cannot be reached for the
existing  premises.  Management  believes that the resolution of the uncertainty
with respect to the facility  will not result in a significant  interruption  in
the operations of the Company.



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

On  October  31,  1997,  the  Company   informed   PricewaterhouseCoopers   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 audit for the year ended  December 31, 1996, and through
October 31, 1997, there were no disagreements with PricewaterhouseCoopers 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  PricewaterhouseCoopers  LLP, would have caused them to
make reference thereto in their report on the financial statements for 1996.

The report of  PricewaterhouseCoopers  LLP on the  financial  statements  of the
Company for the year ended December 31, 1996,  presented on page 17 of this Form
10-KSB,  contains  no  adverse  opinion  or  disclaimer  of  opinion  and is not
qualified or modified as to audit scope or accounting  principle;  however, such
report is modified by the inclusion of an explanatory  paragraph indicating that
there is  substantial  doubt  about the  Company's  ability  to emerge  from the
development stage and/or 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
previous  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.

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.


                                       25
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


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   54   1999  Director
 Mr. Myron A. Wick, III      55   1999  Chairman of the Board

Common Stock Directors:

 Mr. Nuno Brandolini         45   2000  Vice Chairman of the Board
 Mr. Lawrence H. Hyde        74   1999  President and Director
 Dr. Andrew A. Pouring       67   2001  Chief Executive Officer, Chief Scientist
                                          and Vice Chairman of the Board
Other Executive Officers:

 Mr. George E. Ponticas      39         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., 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 Modtech,  Inc. and  Tanknology - NDE  Corporation,
and is the Chairman of the Board of StoryFirst Communications, Inc.,and WrayTech
Instruments,  Inc. 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.

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


                                       26
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


University in Cairo,  where he is also  chairman of the Karnac Equity 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 has
co-authored all of the Company's patented  inventions.  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   In cash     Deferred      Bonus    # of options
     -----------------    ----   ---------   --------    --------   ------------

Dr. Andrew A. Pouring     1998   $ 72,000    $ 48,000                  35,000
 CEO & Chief Scientist    1997     72,000      48,000                  35,000
                          1996     60,798      40,531    $ 10,000      25,000

In order to help conserve the Company's  limited cash resources,  certain of the
Company's  employees  for several  years have  voluntarily  deferred  receipt of
payment of significant portions of their authorized annual salaries upon request
by the Board of Directors. By agreement with the Company, these individuals have
consented to the deferral of payment of amounts so accumulated until the Company
has received licensing revenue of at least $2 million or at such earlier date as
the Board of Directors  determines that the Company's cash flow is sufficient to
allow such payment.  Since January 1, 1997,  however,  there has been no further
deferral of salary requested of the Company's non-executive employees.

The  conditions  that would  require  repayment of deferred  amounts have yet to
occur. As of December 31, 1998, an aggregate of $714,039 in deferred salaries is
owed to current and former employees, including $298,981 owed to Dr. Pouring.

For many years through  December 31, 1998, Dr. Pouring has been deferring 40% of
his annual salary.  On January 1, 1999,  the percentage  deferral was reduced to
30%.

In order 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.  Dr.  Pouring's
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.


                                       27
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


                       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          30%          $.50       $.375        Dec. 7, 2008



               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, 1998       December 31, 1998
          # of shares
          acquired on     Value         Exercisable/             Exercisable/
  Name     exercise     realized        unexercised             unexercised
--------  -----------   --------   ----------------------   -------------------

Pouring        -            -         163,816/220,066             $0/$0


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 equal to the  December 31, 1998
market price of the Company's publicly traded common stock.



            ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
                                 AND MANAGEMENT

The  following  table sets forth as of March 31,  1999  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. A reporting person is deemed to be the
"beneficial  owner" of a security if that person has or shares the power to vote
or to direct the voting of such  security,  or the power to dispose or to direct
the disposition of such security.  Under this  definition,  more than one person
may be  deemed  to be a  beneficial  owner of  securities  as to which he has no
record ownerhip interest.  Beneficial  ownership  includes  securities 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.



                                       28
<PAGE>
                      SONEX RESEARCH, INC. 1998 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      405,150        516,876         2.9
Lawrence H. Hyde              394,986      824,714      1,219,700         6.7
Charles C. McGettigan       1,570,211    5,846,366      7,416,577  (3)   31.4
Andrew A. Pouring             688,239      163,816        852,055         4.8
Myron A. Wick, III          1,570,211    5,846,366      7,416,577  (3)   31.4
                                                                             
All directors & officers                                                   
 as a group (6 persons)     2,906,424    7,461,296     10,367,720        41.3
                                                                             
Herbert J. Mitschele, Jr.                                                    
  Far Hills, NJ               946,755      105,715      1,052,470         5.9
                                                                             
Proactive , et.al. (2)                                                       
  San Francisco, CA         2,748,457    9,593,146     12,341,603        44.8
                                                                         
-----------------------------
(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  7,127,577  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              405,150                                     405,150
Lawrence H. Hyde             539,000   285,714                           824,714
Charles C. McGettigan (1)    289,000  (142,857)  3,414,510  2,285,713  5,846,366
Andrew A. Pouring            163,816                                     146,316
Myron A. Wick, III (1)       289,000  (142,857)  3,414,510  2,285,713  5,846,366
                                                                                
All directors & officers                                                      
 as a group (6 persons)    1,807,216   142,857   3,514,510  2,285,713  7,461,296
                                                                                
Herbert J. Mitschele, Jr.                           62,858     42,857    105,715
                           
Proactive , et.al. (2)   
  San Francisco, CA                   (285,714)  5,521,719  4,357,141  9,593,146

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

(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.



                                       29
<PAGE>
                      SONEX RESEARCH, INC. 1998 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 PricewaterhouseCoopers LLP

  24      Power of Attorney

  27      Financial Data Schedule


(b)   Reports on Form 8-K.

          None.



                                       30
<PAGE>
                      SONEX RESEARCH, INC. 1998 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 12, 1999         By:           /s/ Andrew A. Pouring
                              ----------------------------------
                              Andrew A. Pouring
                              Principal Executive Officer

April 12, 1999         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 12, 1999                                  *
                              ----------------------------------
                              Myron A. Wick, III
                              Chairman of the Board of Directors

April 12, 1999                                  *
                              ----------------------------------
                              Nuno Brandolini
                              Vice Chairman of the Board of Directors

April 12, 1999                       /s/ Andrew A. Pouring
                              ----------------------------------
                              Andrew A. Pouring
                              Vice Chairman of the Board of Directors

April 12, 1999                                  *
                              ----------------------------------
                              Lawrence H. Hyde
                              President and Director

April 12, 1999                                  *
                              ----------------------------------
                              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.



                                       31
<PAGE>
                      SONEX RESEARCH, INC. 1998 FORM 10-KSB


                                                                   EXHIBIT 23.a

                       CONSENT OF INDEPENDENT ACCOUNTANTS

We  hereby  consent  to  the   incorporation  by  reference  in  the  Prospectus
constituting  part of the Registration  Statement on Form S-8 (No.  33-34520) of
Sonex Research,  Inc. of our report dated March 10, 1999 appearing on page 13 of
this Form 10-KSB.

/s/C.L. STEWART & COMPANY

Annapolis, Maryland
April 12, 1999


                                                                   EXHIBIT 23.b

                       CONSENT OF INDEPENDENT ACCOUNTANTS

We  hereby  consent  to  the   incorporation  by  reference  in  the  Prospectus
constituting  part of the Registration  Statement on Form S-8 (No.  33-34520) of
Sonex  Research,  Inc. of our report dated April 8, 1997 appearing on page 13 of
this Form 10-KSB.

/s/PRICEWATERHOUSECOOPERS LLP

Baltimore, Maryland
April 12, 1999


                                                                    EXHIBIT 24

                         APPOINTMENT OF ATTORNEY-IN FACT

     KNOW ALL MEN BY THESE PRESENTS,  that each of the undersigned Directors and
Executive  Officers of Sonex  Research,  Inc.,  a Maryland  corporation  that is
subject  to  certain  filing  requirements  with  the  Securities  and  Exchange
Commission  (SEC)  and  other  regulatory  agencies  and  governmental   bodies,
including but not limited to the Annual  Report on Form 10-KSB and  Registration
Statements  on Forms S-3 and S-8,  hereby  constitutes  and  appoints  George E.
Ponticas  his true and  lawful  attorney-in-fact  and agent  with full  power of
substitution  and  resubstitution,  for him and in his name, place and stead, in
any and all capacities,  to sign any and all reports and registration statements
filed  with the SEC and  other  regulatory  agencies  and  governmental  bodies,
including  amendments  thereto and all other documents in connection  therewith,
granting unto said  attorney-in-fact and agent full power and authority to do so
and perform each and every act and thing  requisite  and necessary to be done in
and about the  premises,  as fully to all  intents  and  purposes as he might or
could  do  in  person,   hereby   ratifying   and   confirming   all  that  said
attorney-in-fact  and agent or his substitute or substitutes  may lawfully do or
cause to be done by virtue hereof.

        NAME                         POSITION                     DATE

 /s/Myron A. Wick, III    
--------------------------     Chairman of the Board
Myron A. Wick, III                of Directors               September 16, 1998


 /s/Andrew A. Pouring     
--------------------------     Vice Chairman of the
Andrew A. Pouring                 Board of Directors &
                                  Chief Executive Officer    September 16, 1998


 /s/Nuno Brandolini       
--------------------------     Vice Chairman of the
Nuno Brandolini                   Board of Directors         September 16, 1998


 /s/Lawrence H. Hyde           President and Director        September 16, 1998
-------------------------
Lawrence H. Hyde


 /s/Charles C. McGettigan      Director                      September 16, 1998
--------------------------
Charles C. McGettigan