<PAGE>

                     U.S. SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                                   FORM 10-KSB

(MARK ONE)

[X]      ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
         OF 1934 (FEE REQUIRED)

For the fiscal year ended     December 31, 1998
                         -------------------------------------------------------

[ ]      TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
         ACT OF 1934 (NO FEE REQUIRED)

For the transition period from______________________ to ________________________

1934 Act Commission File Number    1-12756
                               -------------------------------------------------

                        ROTARY POWER INTERNATIONAL, INC.
--------------------------------------------------------------------------------
                  Name of small business issuer in its charter)

              Delaware                                 13-3632860
--------------------------------------------------------------------------------
(State or other jurisdiction of          (I.R.S. Employer Identification Number)
incorporation or organization)

PO Box 128, Wood-Ridge, New Jersey                      07075-0128
--------------------------------------------------------------------------------
   (Address of principal executive offices)             (Zip Code)

Issuer's telephone number, including area code    (973) 777-7373
                                              ----------------------------------

Securities registered under Section 12(b) of the Exchange Act:

                                        Name of each exchange on which
Title of Each Class                              Registered
-------------------                     ------------------------------
  Common Stock                                       None

Securities registered under Section 12(g) of the Exchange Act:

Title of Each Class
-------------------
        None

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

Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained 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]

State issuer's revenues for its most recent fiscal year $ 72,848
                                                        --------

The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $1,338,715, which is based on the closing price of
$0.219 on December 31, 1998.

The number of shares of Common Stock outstanding on December 31, 1998 was
6,112,855.

Transitional Small Business Disclosure Format:  Yes     No  X
                                                    ---    ---

                       Documents Incorporated By Reference

No information is incorporated by reference.


<PAGE>

                            FORM 10-KSB ANNUAL REPORT

                                      INDEX

<TABLE>
<CAPTION>

                                                                                             PAGE
<S>          <C>                                                                              <C>
PART I
Item 1.      Description of Business  .....................................................    1
Item 2.      Description of Property  .....................................................   14
Item 3.      Legal Proceedings        .....................................................   14
Item 4.      Submission of Matters to a Vote of Security Holders...........................   15


PART II
Item 5.      Market for Common Equity and Related Stockholder Matters......................   15
Item 6.      Management's Discussion and Analysis or Plan of Operation.....................   17
Item 7.      Financial Statements     .....................................................   22
Item 8.      Changes in and Disagreements with Accountants
             on Accounting and Financial Disclosure........................................   23
Item 9.      Directors, Executive Officers, Promoters and Control Persons;
             Compliance with Section 16(a) of the Exchange Act.............................   23
Item 10.     Executive Compensation   .....................................................   23
Item 11.     Security Ownership of Certain Beneficial Owners and Management................   25
Item 12.     Certain Relationships and Related Transactions................................   26


PART III
Item 13.     Exhibits and Reports on Form 8-K..............................................   26


Signatures   ..............................................................................   32

</TABLE>

                                      -i-
<PAGE>

                                     PART I

ITEM 1.       DESCRIPTION OF BUSINESS

GENERAL

         Rotary Power International, Inc. (the "Company") is in the business of
developing and manufacturing rotary engines for commercial use. The Company
intends to redirect its product development and manufacturing to three
commercial areas where the Company's products are believed to have intrinsic
advantages over reciprocating engines: (i) marine propulsion and shipboard use;
(ii) energy generation; and (iii) refrigeration/compressors. In each of these
markets, the characteristics of the Company's products, including their light
weight, small size and ability to burn unusual fuels, is important.

         The Company believes that the rotary design of its engines provides
advantages over other internal combustion engine designs. Rotary engines do
not have reciprocating parts. The compact nature of the power train of a
rotary engine results in a high power-to-weight ratio. Since a rotary engine
does not require the use of conventional connecting rods between the rotors
and the crankshaft, engine volume reduction is realized making the power
density of the rotary engine superior to a conventional four-stroke
reciprocating engine. The Company believes that its patented SCORE(TM) engine
technology offers several advantages over reciprocating engines, such as
multi-fuel capability, superior size and weight characteristics for a given
power output, low vibration, greater reliability and design simplicity with a
high commonality of parts and, in a natural gas-fueled version, lower
emissions of oxides of nitrogen. The Company also believes that its SCORE(TM)
engine can be manufactured and produced at a significantly lower cost than
turbines and will operate with better fuel economy than turbines. The
SCORE(TM) engine is also ideally configured to operate at high efficiency on
heavy fuels, which include diesel and jet fuel and their derivatives.

         The Company believes that its rotary engines can be successfully
marketed to a wide variety of commercial industrial and marine markets following
appropriate pre-production programs which include cost reduction, value
improvement, pilot production run, accelerated reliability testing, and field
trials. Based upon tests conducted by the Company and independent testing
companies, the Company believes that its rotary engines have demonstrated
important benefits which will allow them to compete favorably with reciprocating
diesel, gasoline and natural gas engines and turbines in chosen major market
segments.

         In response to the loss of the military contract business in 1996, the
Company began redirecting its efforts mainly to produce engines for commercial
markets.

HISTORY AND RECENT DEVELOPMENTS

         The Company, a Delaware corporation, was formed on October 23, 1991 for
the purpose of purchasing substantially all of the assets and the business of
the Rotary Engine Division (the "Division") from John Deere Technologies
International, Inc. ("JDTI"), which it completed on December 31, 1991. JDTI, a
wholly-owned subsidiary of Deere and Company, was, at the time, the leading
company in the United States in the development and production of prototype
rotary engines and the Company believes that JDTI was, at that time, the only
company in the world producing large


<PAGE>

rotary engines. JDTI purchased its rotary engine division from the
Curtiss-Wright Corporation ("Curtiss-Wright") in 1984. Curtiss-Wright had
operated its rotary engine division since 1958.

         As a result of its acquisition of the assets of the Division, the
Company is the sole owner of all of the rotary engine assets of JDTI and
Curtiss-Wright, including the proprietary technology and currently enforceable
patent rights developed by JDTI from 1984 to 1991 and Curtiss-Wright from 1958
to 1984.

         In October 1992, the Company entered into a license agreement with
Wankel GmbH (the "Wankel Licensing Agreement"), to license Wankel GmbH's
technology, know-how and approximately 70 patents and patent applications in six
countries relating to all of its small rotary engines. The Company advised
Wankel GmbH on January 10, 1996 that, due to Wankel's failure to deliver the
know-how or drawings required to be supplied under the provisions of the Wankel
License Agreement, the Company was terminating the Agreement, which termination
was effective September 20, 1996.

         The Company, realizing the need to increase the commercial content of
its business and reduce its reliance on military/government programs, formed an
Industrial Products Group within the Company in March of 1994 to develop and
sell natural gas rotary engines into commercial industrial markets. The Company
executed a Development Agreement with Mazda North America ("MANA") of Flat Rock,
Michigan and Mazda Motor Corporation ("MC") of Hiroshima, Japan on December 7,
1993 for import of rotary short block engines converted to a natural gas
configuration agreed upon by MC Engineering and the Company's Engineering
Department. A natural gas version of the Mazda rotary was developed during the
1994 and 1995 calendar years designated the 65 Series Natural Gas Rotary Engine
("NGRE").

         The Company signed an exclusive four year agreement with the Hussmann
Corporation on October 16, 1995 for the NGRE for supermarket refrigeration
equipment and food store heating. At the time of the agreement, Hussmann
supplied such equipment to 48% of the 31,000 supermarkets in the United States.

         The Company signed a teaming agreement with Teledyne Vehicle Systems
("TVS") of Muskegon, Michigan on July 25, 1995 to work together on the
development, marketing, manufacture and sale of the Company's 580 Series rotary
engine for the United States Marine Corps ("USMC"). General Dynamics Land
Systems Inc. ("GDLS"), a wholly-owned subsidiary of General Dynamics
Corporation, bought the assets of TVS in 1996. The Company transferred its
teaming agreement with TVS to GDLS. This agreement terminated when the USMC and
GDLS did not select the Company's rotary engine for their Advanced Amphibious
Assault Vehicle in June of 1996.

         To further augment its commercial product thrust, the Company created a
wholly-owned subsidiary called Rotary Power Marine, Inc. ("RPM") on July 26,
1995 to address the commercial pleasure craft marine market. RPM purchased
essentially all of the assets of Rotary Marine Industries ("RMI") of Sandpoint,
Idaho on August 30, 1995. RMI was developing a marine rotary engine utilizing
the Mazda RX-7 automobile short block under an agreement with MANA and MC. This
agreement was terminated and the Company signed a new agreement with MANA and MC
on November 10, 1995 for RPM to produce 65 Series rotary marine gasoline
engines. All RPM



                                      -2-
<PAGE>

manufacturing operations were moved from Spokane, Washington to the Company's
Wood-Ridge, New Jersey plant.

         The Company signed a Distributor Agreement on the 580 Series diesel
marine engine family with Abejon on October 5, 1995. The area of responsibility
of Abejon is the states and provinces bordering the Pacific coast of Mexico,
Canada and the United States, including Hawaii. In February, 1996, Abejon
invested a total of $4 million to purchase one million shares of the Company's
Common Stock at a price of $4.00 per share. Simultaneously with the sale of the
Common Stock, the Company loaned $3,750,000 to Hydro Lance, an affiliate of
Abejon. Hydro Lance repaid $850,000 of the loan plus interest. Abejon's area of
responsibility was then increased to all of the United States. A $1 million
repayment which was due on September 30, 1996 was not paid and no further
scheduled payments were received in 1996 or during 1997. As a result of this
default, certificates for 822,916 shares of the Company's common stock, issued
to Abejon, were cancelled.

         In December 1996, the Company concluded an agreement with PowerCold
Corporation ("PowerCold") whereby PowerCold invested $1,000,000 in the Company
in exchange for 2,000,000 shares of the Company's Common Stock. Simultaneously,
the Company and PowerCold agreed in principle to merge the two companies in a
stock-for-stock acquisition, whereby the Company would become a wholly-owned
subsidiary of PowerCold. The Company and PowerCold signed a Plan and Agreement
of Merger on March 21, 1997. This Plan and Agreement was never completed and was
terminated in August, 1997.

         In January, 1998, new management formulated a plan to restructure the
Company's product line, financial position and direction, with the intent to
redirect the remaining assets to attract major new funding as a volume
manufacturer of commercial engines. Management then directed the Company's
efforts toward the settlement of overdue debts, the reduction of running costs,
attracting key customers willing to purchase rotary engines in advance of
production, and finding capital to finance ongoing operations and new plant
capacity. Generic equipment was sold and lines associated with the Mazda 13B
engines were liquidated. Working capital from these activities and other sources
were expended to keep a viable core until funding and customers were secured. As
a part of this restructuring, the Company's wholly-owned subsidiary, RPM was
renamed E-Drive Systems Corporation and repositioned as a supplier of electronic
controls and electric propulsion components in support of the Company's other
activities.

         As part of the restructuring and pursuant to an agreement dated June 4,
1998, RPM sold a portion of its assets, consisting of Series 65 marine engines,
parts, and the supplier agreement for those engines with MANA, as well as
certain related production machinery, tooling and documentation. In accordance
with this agreement, the Company's wholly owned subsidiary was renamed E-Drive
Systems Corp, in keeping with its revised mission as a supplier of electric
drive components. The purchaser assumed the name and logo of Rotary Power Marine
Corporation, as provided by the agreement.

         On July 2, 1998, the Company signed a contract with Rotary Power
Enterprises, Inc. ("RPE"), a value-added reseller of natural gas refrigeration
and power generation equipment, for the sale of the Company's Series 65 natural
gas engine inventory, parts, and intellectual property. Along with the transfer
of engines and parts, the Company assigned its existing supplier contract from
MANA for the gas version of the 13B engines, and also assigned to RPE a contract
with Hussman to sell refrigeration



                                      -3-
<PAGE>

components containing those engines. The Company also signed an Engine
Distributor Agreement with RPE, giving them an exclusive industrial market
territory for the Company's Series 580 NGRE (natural gas fueled) engines.
PowerCold, who had purchased RPE and became a party to the agreement, forgave of
a note due PowerCold for $217,000 as part of the sale.

         After several attempts to raise funds for working capital, the Company
made a private offering to qualified investors and sold an aggregate of 175,000
shares of Series 3 Preferred Convertible Stock at $1.00 per share on November 2,
1998. Each share is convertible to four common shares upon the request of the
shareholder. All of the shares sold in this offering are restricted shares
ineligible for resale unless they are registered or exempt from registration
under applicable federal and state securities regulations.

TECHNOLOGY

        HISTORY

         The Wankel GmbH rotary engine, upon which the Company's rotary engines
are based, was first demonstrated in 1954 and is named after its developer, the
late Dr. Felix Wankel, a specialist in the design of sealing devices. In 1958,
Curtiss-Wright obtained the first license for rotary engine technology from
Wankel GmbH, which gave Curtiss-Wright an exclusive license for North America
and certain non-exclusive rights outside of North America. Curtiss-Wright's
research and development efforts initially involved gasoline rotary engines with
a wide range of power for use in military vehicles and aircraft, and for various
commercial uses including automobiles, aircraft, marine pleasure craft and lawn
mowers. In the 1960's, the early rotary engines experienced serious problems
with gas sealing and poor reliability. These problems were primarily caused by
the unavailability of materials that would permit the principles of the rotary
engine to be successfully transformed into competitive performance engines. In
the past 18 years, enormous progress in materials technology, such as the
development of advanced ceramic material, has significantly contributed to the
solution of past sealing and reliability problems.

         Curtiss-Wright also initiated work on the stratified charge rotary
engine in the mid-1960s in order to provide the advantage of multi-fuel
capability for use in military vehicles and aircraft. JDTI purchased the rotary
engine division of Curtiss-Wright in 1984, including the license agreement with
Audi NSU/Wankel GmbH, and continued to develop stratified charge rotary engines,
leading to a series of patents covering stratified charge technology, seal
design, cooling systems and new longer life materials. In 1984, JDTI canceled
the license agreement with Audi NSU/Wankel GmbH.

         Since its acquisition of the JDTI assets, the Company has continued to
develop and improve the rotary engine, including the reduction in fuel
consumption and emissions, the use of ceramics for increased durability, the use
of high speed electronic fuel injection systems and controls, and increased
power density. The Company's rotary engine technology has now advanced to the
point that its 580 Series engine, producing 1000 horsepower, and its 40 Series
engine, producing 15 horsepower, have both successfully completed a 400 hour
test operating on the standard North Atlantic Treaty Organization ("NATO") test
cycle.


                                      -4-
<PAGE>

        DESCRIPTION OF THE SCORE(TM) ENGINE

         The patented stratified charge combustion concept is used by the
Company in its SCORE(TM) engines in order to improve the burning of the fuel in
the elongated combustion chamber. In this process, exemplified by the 580 Series
implementation, there are two high-pressure injection nozzles. The pilot
injector injects a small amount of fuel that is ignited by an electrically
energized source. This creates a pilot flame which ignites a larger amount of
fuel which is injected by the main injector into a stationary flame front as the
rotor sweeps past it, creating a layered (stratified) charge. This dual
injection system results in more complete combustion of the fuel, reducing
emissions, improving fuel economy and allows the engine to run on a wide range
of fuels which burn at different rates (omnivorous).

         The injection and ignition system of the SCORE(TM) engine allows the
engine to operate using heavy fuels over a wide horsepower and speed range
without the additional weight required by a reciprocating diesel engine. The
SCORE(TM) engine is configured to operate at high efficiency on heavy fuels,
which include diesel and jet fuel and their derivatives as well as light
bunker fuels. Diesel fuel is the fuel of choice for the commercial marine
marketplace because of safety of operation and desirability for insurance
coverage.

ENGINE PRODUCTS

         The Company currently has four different types of displacement rotary
engines as exhibited in the following table, which table also includes the
series designation for each family, the displacement per rotor, the current and
potential horsepower per rotor and the maximum potential horsepower of each
family of the Company's rotary engines. The Company has sold its 65 Series
natural gas and 65 Series gasoline marine engine product lines.

<TABLE>
<CAPTION>

                        DISPLACEMENT            CURRENT           POTENTIAL FAMILY
       FAMILY            PER ROTOR         HORSEPOWER/ROTOR       HORSEPOWER RANGE
       ------           ------------       ----------------       ----------------
<S>                      <C>                      <C>                <C>
                                                                     (1-6 Rotors)

40 Series HF*            0.407 liters             15-50               15- 200(4)
70 Series HF*            0.67 liters              80-125              80- 500(4)
70 Series BF***          0.67 liters              80-125              80- 500(4)
170 Series HF*           1.72 liters              200-325            200-1200(4)
580 Series HF*           5.8 liters               450-520            450-3000(6)
580 Series NGRE**        5.8 liters               250                250-1500(6)
580 Series BF***         5.8 liters               250                250-1500(6)
580 Series RPGE+         5.8 liters               250                250-1500(6)

</TABLE>

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

    * HF    =  Heavy Fuel (Diesel, Jet and Gasoline Fuels)
   ** NGRE  =  Natural Gas
  *** BF    =  Bunker Fuel
    + RPGE  =  Producer Gas
      (  )  =  Number of rotors per engine at top of horsepower range


                                      -5-
<PAGE>

         The heavy fuel (Diesel) 580 Series is the primary product to be focused
upon by the Company. The proceeds from any future financing by the Company will
be used to establish a volume manufacturing facility and put this family of
engines into the commercial marine and generator marketplaces. Future financing
will also be used to manufacture the natural gas variant and the bunker fuel
variant of the 580 Series.

         The 70 Series was developed in the late 1980s by the Deere & Company
Rotary Engine Division for military power generation and for commercial and
pleasure craft marine applications. It was put on the shelf in 1990 and is being
upgraded to take advantage of the technology and material advancements over the
past eight years.

         The 170 Series has been shelved until commercial funding for the final
development of this engine is obtained.

         Modularity is one of the attributes of the rotary engine that does not
exist with reciprocating engines. A given rotor and rotor housing configuration
constitute a unit power module. In each module the rotor and rotor housing are
identical. Engines from one rotor up to six rotors can be constructed either by
stacking the modules or by coupling 2-rotor engines into 4- and 6-rotor
versions. The latter is the preferred choice by the Company for all rotary
engines exceeding two rotors.

         The power output is then equal to the power of the power module unit
times the number of rotors or number of power module units. The addition of each
module entails adding an intermediate housing (to separate the rotor housings,
provide a bearing support and accommodate cooling provisions) and lengthening
the crankshaft, or by coupling 2-rotor engines together. Accessory items, such
as the starter and pumps, must be re-sized to accommodate the increased engine
size, but, because of this modularity, the commonality of parts between
different models of engines in the same family is greater than 90%, reducing
manufacturing cost and spare parts inventory.

RESEARCH AND DEVELOPMENT CONTRACTS

         The Company does not currently have any research and development
contracts for rotary engines with the U.S. Government or any commercial company.
At December 31, 1998, all contracts with the U.S. Government are pending
close-out and government property disposal in accordance with applicable
government property regulations.

INDUSTRY AND COMMERCIAL MARKETS

         The Company believes that the rotary engines which it was developing
for the military can be modified and adapted for use in a wide variety of
commercial and industrial markets, including the commercial and pleasure craft
marine market, the power generation, air compressor, chiller and refrigeration
markets. Set forth below is a description of the various marine, commercial and
industrial markets to which the Company has sold or believes, working on its own
or through manufacturers, distributors, and dealers it can successfully sell its
engines. There can be no assurance that the Company will be able to sell its
engines successfully into any of these markets.


                                      -6-
<PAGE>

        MARINE PROPULSION

         Recent successful hull designs, such as high-speed fishing fleets,
FastShip and high speed catamaran ferries, strongly favor lightweight, powerful
engines. Furthermore, a combination of environmental pressures are forcing
redesign of many traditional engines, such as two-stroke diesels, outboards,
ship engines and stationery generators, all developments favorable to the
Company's products. These redesigned engines are more expensive, heavier and
even less competitive with rotary engines, whose environmental virtues are
innate.

         Stringent requirements for reduction of ship emissions passed by the
International Maritime Organization and adopted by the Untied States as a
signatory, now scheduled for implementation in 2003, are to be measured on a
fleet basis. By replacing non-propulsion engines in shipping fleets with the
Company's low-emissions engines, some fleets will be able to meet emissions
requirements without refit to the propulsion engines. Refitting a ship's main
engines to meet the proposed emission standards is much more costly than the
replacement of non-propulsion engines with less polluting SCORE(TM) engines.

         The Company believes that there are important niche markets for its
rotary engines in the 1000 to 3000 horsepower category, and multiples thereof,
for use in fast ferry boats and other commercial marine craft and yachts. The
Company believes that the size, weight, smoothness of operation, acceleration
and diesel fuel capability of the SCORE(TM) 580 Series engines give this engine
advantages in the marine environment over reciprocating engines. Design studies
by major marine architects have shown that the weight advantage of SCORE(TM)
engines results in increased speed, improved fuel economy and higher payloads in
boats using SCORE(TM) engines than in boats using reciprocating engines. The
compact size advantage of the rotary engine also allows for smaller engine
compartments, which significantly increases the useable space on board.

         At 250 HP for a 2 rotor engine, the Series 70 has several niches in the
marine pleasure craft, fishing and power generation markets. In the marine
markets, a variety of safety and economy issues are moving buyers toward engines
that burn diesel fuel, and the size and weight advantages of the engines are
material in the overall cost and performance of a boat.

         The Company believes the small, light and omnivorous Series 70 engines
will find wide acceptance for peak, mobile and emergency power generation. A
large portion of this market is in the 75 to 180 kilowatt range, which matches
the power outputs of these engines.

        ENERGY GENERATION AND REFRIGERATION

         With successful and profitable production of the 580 Series
diesel-fueled engines for commercial marine applications, the Company believes
there is a substantial industrial market in power generation including
stationary, mobile and standby operations. The natural gas variant of the 580
Series engines, for which the Company will solicit funding, has excellent
potential in the industrial markets of power generation, refrigeration, cooling,
water cooling, process and compression.

         Two major factors in the business environment strongly favor the
Company's products in the energy market: the deregulation of power, now the law
in several states and expected to spread to



                                      -7-
<PAGE>

other states and countries, and the returning of major refineries toward the
production of diesel fuels over gasoline. This latter trend comes in response to
the world-wide environmental pressures that favor the economy of diesel, and
will result in an increase in the cost and declining availability of high-grade
gasoline and a price reduction and increase in the availability of diesel fuels.
The Company's SCORE(TM) technology allows a single engine, unmodified, to run on
either fuel, but produces the expected economies when run on diesel.

         Reserves of natural gas far exceed reserves of oil. The Company has
developed SCORE(TM) engines running on gaseous fuels, including natural gas.
Together with light weight screw compressors, these engines satisfy a large
market for electricity peak-shaving in buildings, shopping malls and
supermarkets, as well as cold-storage facilities and gas field storage
facilities.

         Electricity supplied by large utilities remains scarce in developing
nations and is expensive in other countries with limited natural energy
resources, such as Japan. Light weight, powerful engine driven generators based
on the Company's SCORE(TM) engines can be airlifted to locations inaccessible by
truck, such as fishing villages in Alaska and rural clothing factories in South
America. These units can be installed on rooftops where conventional units would
require major structural reinforcement. Because they are SCORE(TM) engines, they
can run on any locally available fuel.

         In other markets, especially where generators can be mortgaged as part
of a long life asset, the cost of power generation with the Company's products
may be significantly less than the peak price per kilowatt, and owning a
generator allows flexibility when dealing with power contracts that stipulate
minimum and maximum usage, which are common on the Pacific Rim. The deregulation
of power provides an opportunity to sell excess power back to the utility grid,
which encourages users to install larger private generators than would be
required for peak shaving alone.

         The ability of the Company's gaseous fueled RPG series to run on
producer gas or biogas, generated by fermentation or heat decomposition of waste
products ranging from rice hulls to cow manure, has secured letters of intent
from manufacturers of biogas equipment.

         Internationally, the Company finds itself in a favorable position, with
possible alliances with a major Japanese kairetsu (a group of affiliated
Japanese companies) and major Canadian energy suppliers, as well as contacts in
South America and Central America. The Company could supply its products to
these countries, primarily in the energy market and enable the creation of
products thought before to be impossible, such as quiet, 750KW 50/60 HZ
truck-mounted generators capable of negotiating Japan's narrow streets, or a
hatchable engine to replace an aging engine/generator on a submarine.

         Electricity generation is a significant portion of wellhead costs for
petroleum production. The natural gas version of the Series 580 engine is a
competitive product in this market, as well as markets for the transportation
and compression of natural gas in pipelines.

         In 1992, the Company initiated a natural gas development program which
continued development originally started through funding from the Gas Research
Institute. The Company's natural gas development program on its 580 Series
engines is intended to lead to the production of low emission rotary engines
suitable for use in areas with stringent air quality regulations. Due to its
unique geometry, the rotary engine is able to operate at a very lean fuel to air
ratio compared to



                                      -8-
<PAGE>

reciprocating engines. This ratio results in relatively low emissions of oxides
of nitrogen, without some of the negative side effects, such as the adverse
effect on fuel economy and hydrocarbon emissions, experienced with reciprocating
engines. As a result of an internal development program at the Company, a 580
Series prototype engine operating on natural gas has demonstrated emissions of
oxides of nitrogen of less than 1.0 gram per horsepower hour, compared to the
4.0 gram limit specified for 1998 by the California Air Resources Board
("CARB"), for heavy-duty vehicles of greater than 14,000 pounds. Further, based
upon the Company's interpretation of the CARB specification, levels of
non-methane hydrocarbons and carbon monoxide were also well under CARB emissions
requirements without after treatment.

         RENEWABLE ENERGY MARKETS

         Nearly every waste product that is not recycled can be reduced to a
flammable gas that will fuel a Series 580 RPE engine. The Company has identified
potential customers with converters for wooden pallets, vegetation, cow manure,
rice hulls and old tires. These converters, as well as producer gas from
landfills, have a heating value too low for other engines without enrichment.
However, the Series 580 RPE will typically burn these gasses without enrichment
and still yield power outputs near their horsepower ratings. The Company has
contracted with BG Technologies to set up and run a demonstration plant that
will turn expended wooden pallets into electricity with an anticipated output of
375 kilowatts.

        MILITARY MARKETS

         In looking at the potential of the Company's commercial SCORE(TM)
products in defense, there are some uses for engine/propulsion systems
requiring the power density and multi-fuel capability advantages of the
Company's SCORE(TM). These opportunities will be addressed by the Company
following successful commercial market introduction and production of the 580
and/or 70 Series engines. There are no assurances that any military prototype
and production orders will be received.

        UNMANNED AERIAL VEHICLES

The Company believes that a potential market exists for use of its 40 Series
engines in Unmanned Aerial Vehicles ("UAVs") for military and commercial use,
including crop-spraying, package delivery, atmosphere sampling, communications
relay, border patrols, aerial photography and scouting for forest fires.
Unmanned Aerial Vehicle systems used by the military greatly improve the quality
and timeliness of battlefield information while reducing the risk of capture or
loss of personnel, thus allowing faster and more informed decision-making by
battlefield commanders.

         The Company believes that its 40 Series heavy-fueled rotary engine is
the only heavy-fueled engine currently in advanced development that can deliver
between 50 and 60HP per rotor within the weight, size and specific fuel
consumption requirements of the military UAV market. The Company is in pursuit
of the Heavy Fuel Engine development for this Tactical UAV to be used by the
U.S. Army and U.S. Navy. There is no assurance that the Company will be awarded
a Heavy Fuel Engine contract for its 40 Series multi-fuel rotary engine.


                                      -9-
<PAGE>

        AUXILIARY POWER UNITS

         With developmental success for unmanned vehicles resulting in
production of the 40 Series engines the Company will pursue auxiliary power unit
military opportunities. There is no assurance that any new auxiliary power unit
business will be obtained from the U.S. Government.

REGULATION

        PRODUCT REGULATION - GOVERNMENT

         The Company's products are regulated by various federal, state and
local energy and environmental laws and regulations. All of these laws and
regulations are subject to revocation or amendment, and the Company cannot
predict what effect revocation or amendment may have on the Company's sales,
business or operations.

         The 580 Series natural gas engine development which the Company will
reactivate upon receipt of any future equity financing will be subject to
various provisions of recent amendments to the Clean Air Act, as well as energy
and environmental legislation enacted at state and local levels which may be
more stringent than federal laws.

         Federal regulatory standards have been imposed only in connection with
on-highway (I.E., truck and bus) vehicles. Additionally, the United States
Environmental Protection Agency, in accordance with the 1990 Clean Air Act
amendments, has proposed regulations for engines in non-road equipment and
vehicles of 50 horsepower or higher, including agricultural and construction
vehicles with full implementation expected in 2000. Initial regulations for
marine engines are expected in 2001, however, will apply to outboards and
personal watercraft only. Emission regulations on inboard, inboard/outboard and
stern drives are not expected before 2005. Proposed regulations, however,
require reduced NOx emissions, which favor the Company's SCORE(TM) technology
engines.

         The generators, chillers and co-generation products for which the
Company supplies engines to power demonstration and sales products must comply
with federal, state and local environmental laws and regulations. Regulation of
products such as those to be sold by the Company is conducted primarily at the
state and local levels, where standards can vary. For example, environmental
standards in California are stricter than comparable federal guidelines. The
Company believes that its natural gas engines complies with all applicable
federal and state environmental standards, though the Company cannot predict
whether its products will continue to comply with any new environmental
standards in the future. The Company does not believe that the costs and effects
of complying with new or modified environmental laws relating to the Company's
business will have a material adverse effect on the Company's business or
operations.

         Natural gas is one of the many alternative fuels addressed by new laws
and regulations. Others include methanol, ethanol, liquefied petroleum gas,
hydrogen and reformulated gasoline. Although the Company believes that natural
gas will become a preferred alternative fuel, there can be no assurance of this
or that existing and future laws or regulations or their enforcement will create
material long-term demand for natural gas fueled vehicles.


                                      -10-
<PAGE>

        PRODUCT REGULATION - MARINE INDUSTRY REGULATIONS

         Marine engines are required to comply with certain regulations
promulgated by the U.S. Coast Guard. The Company's 580 Series marine engines are
being designed and produced to comply with U.S. Coast Guard regulations. Marine
engine emissions regulation is expected in the year 2003. The U.S. is signatory
to the proposed International Maritime Organization ("IMO") regulations which,
for the first time, specify exhaust stack emission units for shipping on the
high seas. The fleet emissions standards will favor RPI's engines in shipboard
applications as auxiliary power and propulsion. Finally, in order to qualify for
passenger vessels, the Company's larger engines should be submitted for
classification by one or a few marine classification agencies, such as American
Bureau of Shipping, or Lloyd's Registry.

        ENVIRONMENTAL REGULATION

         The Company operates its facility in compliance with all applicable
federal, New Jersey, and local environmental laws and regulations. Provisions in
the Company's lease with Curtiss-Wright Corporation hold the Company harmless
from fines, suits, procedures, claims and/or actions associated with
environmental hazards or clean-ups arising from or resulting from prior or
subsequent use of the premises by Curtiss-Wright or others for whom the Company
is not responsible.

         The discharge of pollutants to the waters of the State of New Jersey is
controlled and restricted by the New Jersey Department of Environmental
Protection ("NJDEP") in accordance with applicable laws and regulations. The
Company uses clean, non-contact water in a closed loop system for cooling
engines and test equipment. The cooling water is analyzed and treated monthly.
Discharge is for emergency only. Since the Company has never discharged water
during its operation, the NJDEP determined that as of March 21, 1995, the
Company is no longer required to submit monthly discharge monitor reports.

         Outdoor noise levels resulting from operations are in accordance with
the town of Wood-Ridge Ordinance.

         The Company had NJDEP stack permits for control apparatus and equipment
at December 31, 1998.

         The Company had no underground storage tanks at December 31, 1998.
Short term fuel and fuel oil storage is contained in above ground tanks
surrounded by containment walls. The Company has a Spill Prevention Control &
Countermeasures Plan, as required by federal regulations.

         The Company has on file with the NJDEP a Notification of Hazardous
Waste Activity in compliance with the Resource Conservation and Recovery Act. On
an occurrence basis, transportation and disposal of hazardous waste is handled
by Safety Kleen Corporation in accordance with applicable federal and State of
New Jersey regulations. The Company maintains a transport manifest of all
hazardous waste removal from the facility. The Company did not generate any
hazardous waste from its operations during the fiscal year ended December 31,
1998.


                                      -11-
<PAGE>

MANUFACTURING AND ASSEMBLY

         The Company had sufficient capital equipment and manufacturing space
available to support its minimal current operations at December 31, 1998. The
Company has adequate capacity in the future to manufacture and test
prototypes and limited production quantities of the Series 70 SCORE(TM),
Series 580 SCORE(TM) and Series 580 NGRE engines, and to assemble and test
engine-alternator units based on these engines. The Company has retained
sufficient machining capability to manufacture the critical features of the
major housing components.

         The Company purchases many of the components used in its rotary engines
and completely assembles each engine at its facilities. The Company believes
that virtually all of the parts necessary to manufacture its engine, such as
rotors, crankshafts, castings, and forgings, are available from a variety of
vendors in the United States and Canada.

SALES & SERVICE

         The primary task of an engine manufacturer is to produce high quality
engines in quantity at a marketable price, with good availability and strong
service. The Company's sales and service policies are directed toward these
ends.

         Major accounts, such as SeaBank and Marubeni, continued to be serviced
directly by Company executives and Company personnel in international sales
management at December 31, 1998. For major accounts, the solicitation of orders,
contract management, delivery and service logistics and production orders will
remain with the Company, even though the contracts originate elsewhere, and
commissions may be payable on these orders.

         Providing engines to special markets is the business of the Company's
Master Engine Distributors, each one having a contractual segment of a vertical
market and a territory and engine line. Master Engine Distributors are required
to stock engines and meet minimum sales targets, make a substantial investment
and to provide service where practical. Master Engine Distributors are also
responsible for service for all external components and to stock replacement
Power Cores. Aside from purchased components such as starters, pumps and
injectors, a typical two-rotor engine has only three moving parts. This core of
the engine, consisting of the housing and internal parts, is called a Power
Core. Any problem internal to an engine is remedied by a replacement of the
Power Core. Therefore, rotary engines do not require as extensive parts and
service network as required for reciprocating diesels. The Company has
sufficient spare parts and Power Cores to service existing engines in the
domestic market. In 1998, the Company had one Master Engine Distributor; the
Company anticipates that several more will be added in 2000.

         PowerCold and its subsidiaries and acquisitions continue to market the
Company's natural gas Series 580 NGRE products in refrigeration markets, oil
field development and stationary industrial engines.

INTELLECTUAL PROPERTY

         The Company believes that it owns or has license and patent protection
for certain elements of the technology necessary to develop and produce its
rotary engine. The Company owns



                                      -12-
<PAGE>

approximately twenty-four (24) patents and four(4) new patent applications
covering the design, materials, and manufacture of its rotary engine. These
patents cover the concepts used in the SCORE(TM) engine combustion system and
certain areas of the design and materials used in the sealing elements and in
other critical technology areas. These patents cover not only the design
currently used in the engines, but also those concepts that have been identified
for future research and development. A portion of the patents and intellectual
property of the Company is subject to the rights of the U.S. Government for
military uses.

         The Company does not consider any one of its patents to be of such
importance that its expiration, termination or invalidity would materially
affect the Company business. There can be no assurance that the issued patents
or the licensed rights of the Company will fully, or even partially, protect the
Company's technology from competitors approaches, or that new patent
applications will be allowed.

COMPETITION

         The Company's success depends upon its ability to maintain a
competitive position in the development and commercialization of its rotary
engine technology in relation to other existing and emerging technologies and
upon its ability to displace current four-stroke and two-stroke reciprocating
engines and turbines, all of which have an established position in the field.
The Company is in competition with automobile engine manufacturers and other
engine manufacturing firms specializing in the development of both diesel and
gasoline reciprocating engines that have greater financial resources and capital
than the Company.

         The Company also may face competition from engineering firms developing
small gas turbines and small fuel cells for industrial sale. These companies may
have substantially greater resources for research, development and manufacturing
than the Company. Even though the Company has developed and patented its rotary
engine technology, the Company's competitors may succeed in developing
technologies and products that are more effective or commercially acceptable
than those developed by the Company. In the given markets in which the Company
intends to sell, however, there are currently no competitive products with the
weight, size, vibration or fuel range of the rotary engine.

EMPLOYEES

         On December 31, 1998, the Company had one full-time employee paid by
the Company, which employee was its President, Chief Executive Officer and Sole
Director, and had three contract employees leased through Employee Solutions,
Inc. See discussion under "Management's Discussion and Analysis or Plan of
Operations" below.

         Until the first quarter of 1997, the Company had been able to attract
and retain the engineers, professionals and other personnel required by its
business. However, due to the financial difficulties encountered by the Company
since October 1996, the Company had to lay off all of its employees. The Company
has maintained close relationships with former employees involved in design and
engineering of rotary engines and believes it will be able to rehire its core
staff; however, in the future it may be more difficult for the Company to
recruit and retain new employees in the future. None of



                                      -13-
<PAGE>

the Company's employees at December 31, 1998 is represented by a labor union and
the Company considers relations with its employees to be good.

ITEM 2.       DESCRIPTION OF PROPERTY

PROPERTY

         Until December 31, 1997, the Company leased 127,640 square feet of
space from Curtiss-Wright at an average annual lease expense of $575,000. The
facility is located at 1 Passaic Street, Wood-Ridge, New Jersey 07075.
Approximately 54,000 square feet of space at the facility was used for
manufacturing and assembly. Four fully instrumented engine test cells, with
the capability of testing engines from 10 to 3,350 horsepower, occupy a
further 20,000 square feet. The balance of the facility includes offices for
design, development engineering, marketing, and administration.

         On October 30, 1997, following a Notice to Quit and Surrender
Possession of the space leased by the Company, the landlord, Curtiss-Wright,
locked the premises. Unpaid rent at that point was $591, 850. In order to regain
limited access, the Company paid $10,000 to Curtiss-Wright in December, and also
reached agreement to settle the arrearage and prepay rent to February 28, 1998.
The value of the settlement rent was approximately $706,000. In accordance with
the settlement, the Company issued a 4% promissory note to Curtiss-Wright for
$400,000 due January 1, 2003, and paid Curtiss-Wright $115,000 in February,
1998.

         In January, 1998, in order to reduce its overhead, the Company
negotiated a new rental contract with Curtiss-Wright which reduced rent from
$57,000 per month to $7,300 per month, retaining the core office space, test
cells, inventory area and a modest manufacturing space. The old space was
vacated and the equipment relocated by the end of August, 1998. There was no
change in the Company's address.

         On December 22, 1997, the Company negotiated a settlement of the rents
due Curtiss-Wright until February 28, 1998. As part of the settlement, the
Company gave up the 54,000 square foot manufacturing area and consolidated its
manufacturing in the test cell areas. In addition to the test cells, the Company
occupies approximately 10,000 square feet of office space.

         On May 1, 1998, the Company signed an annual lease for the test cell
areas with Curtiss-Wright for $72,000, renewable on May 1, 1999, and May 1,
2000. In addition, the Company continues to occupy the office space on a
month-to-month rental basis at a monthly rent of $1,300.

ITEM 3.  LEGAL PROCEEDINGS

         At December 31, 1998, the Company was not a party to, and the Company's
property was not the subject of, any material pending legal proceedings, nor, to
the Company's knowledge, was any material legal proceeding threatened.


                                      -14-
<PAGE>

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

         Due to the lack of available capital and the cessation of operations,
the Company did not hold an annual meeting of the stockholders in 1997 or 1998.
No vote was made by the shareholders of the Company during the fiscal year ended
December 31, 1998.

         During 1997, all of the members of the Board of Directors resigned. On
November 24, 1997, Mr. Richard M.H. Thompson appointed Mr. Ken Brody, a former
Director of the Company and principal in Abejon Rotary Power, President, Sole
Director, and Chief Executive Officer of the Company, and then Mr. Thompson
resigned.

                                     PART II

ITEM 5.       MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The Company's Common Stock ("Common Stock"), par value $.01, has been
publicly traded since February 9, 1994. The Common Stock traded in the
over-the-counter market on the National Association of Securities Automated
Quotation System (NASDAQ) Small Capitalization Issues under the symbol RPII and
on the Pacific Stock Exchange ("PSE") under the symbol RPX until December 14,
1996, in the case of NASDAQ, and December 4, 1996, in the case of the PSE. The
common stock of the Company was delisted from NASDAQ on December 19, 1996 and
was suspended from the PSE on December 4, 1996. Since December 19, 1996, it has
traded on the NASDAQ OTC Bulletin Board ("OTCBB"). On July 23, 1998, the trading
symbol for the common stock changed to "RPIN".

         The following table sets forth the range of high and low bid and ask
prices for the Common Stock on the OTCBB for the fiscal quarters indicated. All
over-the-counter market quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission, and may not represent actual transactions.

<TABLE>
<CAPTION>

                                                        COMMON STOCK

                                                                  BID                               ASK
                                                                  ---                               ---
                                                        HIGH              LOW              HIGH             LOW
                                                        ----              ---              ----             ---
<S>                                                     <C>              <C>                <C>             <C>
       FISCAL YEAR ENDED 12/31/98
          First Quarter                                 2.297            .063               2.375           .10
          Second Quarter                                1.297            .438               1.325           .50
          Third Quarter                                  .906            .375                 .95           .40
          Fourth Quarter                                 .563            .125                .625           .15

</TABLE>


                                      -15-
<PAGE>

<TABLE>
<CAPTION>

                                                        COMMON STOCK

                                                                  BID                               ASK
                                                                  ---                               ---
                                                        HIGH              LOW              HIGH             LOW
                                                        ----              ---              ----             ---
<S>                                                      <C>             <C>              <C>                <C>
       FISCAL YEAR ENDED 12/31/97
          First Quarter                                  .625            .15625           1.03125            .22
          Second Quarter                                .3125               .13              .375            .18
          Third Quarter                                   .14               .04               .18          .0499
          Fourth Quarter                                   .1            .03125              .135            .04

</TABLE>

         The Company has never paid any dividends on its Common Stock and does
not anticipate paying any cash dividends in the foreseeable future. The Board of
Directors of the Company currently anticipates retaining any available earnings
for the growth and expansion of the Company's business. The declaration and
payment of future cash dividends, if any, generally would depend upon the
Company's earnings, financial condition, results of operations, current and
anticipated capital requirements, plans for expansion, if any, future prospects,
restrictions under then existing credit and other debt instruments and
arrangements and other factors deemed relevant by the Board of Directors.

         On December 31, 1998, there were approximately 750 common stockholders
of record.

         The following table sets forth all equity securities issued by the
Company during the fiscal year ending December 31, 1998 that were not registered
under the Securities Act.

<TABLE>
<CAPTION>

     SALE DATE        SHARES       TYPE       CONSIDERATION         PERSONS TO WHOM ISSUED
     ---------        ------       ----       -------------         ----------------------
                                              (PRICE/SHARE)
                                              -------------
<S>                   <C>         <C>               <C>            <C>
   July 8, 1998       74,339      Common            1.00           47 Vendors(1)
   July 8, 1998       70,000      Common            0.38           Trien, Rosenberg, et al.(2)

</TABLE>

--------
(1) Issued in settlement of accounts payable under agreement as part of the
    composition of creditors.
(2) Issued in partial payment for professional accounting and data processing
    services.


         All of the Common Stock and Preferred Stock listed above was issued in
reliance on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933 and no public offering was involved. All of the
purchasers acquired the Common Stock for investment, and there was no general
advertising or general solicitation in connection with the offer and sale of the
Common Stock. The Company believes that each purchaser was given or had access
to detailed financial and other information with respect to the Company and in
connection with these sales.


                                      -16-
<PAGE>

ITEM 6.       MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
              OPERATIONS

GENERAL OVERVIEW

         The Company and its wholly-owned subsidiary, E-Drive Systems
Corporation ("E-Drive"), are engaged in the research, development, demonstration
and production of rotary engines and electric power generation units capable of
operating on a variety of liquid fuels and natural gas. The Company's strategic
thrust is to penetrate commercial engine markets. The Company's
commercialization efforts are focusing on natural gas rotary engines for
industrial markets and liquid fuel engines for the commercial and recreational
marine markets.

         On December 31, 1991, the Company acquired substantially all of the
fixed assets, patents, know-how and technology and other tangible and intangible
assets of the Rotary Engine Division (the "Division") of John Deere Technologies
International, Inc. ("JDTI"). The purchase price was $9.3 million consisting of
$4.2 million of cash and notes, which have been paid, and a non-interest bearing
deferred acquisition obligation of $5.1 million payable over thirteen years.
JDTI and Deere & Company retained all liabilities, including potential liability
for claims resulting from JDTI's contract performance for the U.S. Government.

         Pursuant to the purchase agreement with JDTI, the Company has an
obligation to pay JDTI earned deferred payments for applicable rotary engines
sold. The deferred payments are 3.0% of the first $100 million of engine sales,
2.5% of the next $100 million, 1.5% of the next $100 million up to $300 million
and 0.5% of all applicable rotary engine sales thereafter. These earned deferred
payments are reduced by the amount of the deferred obligations of $5.1 million
discussed above. The Company did not make a payment of $150,000 on January 30,
1998 or January 30, 1997. Also, in 1996 the Company was unable to make the full
payment of $150,000 which was due to the seller on January 30, 1996, deferring
the remaining $75,000 balance to January 30, 1997, which was not paid.

         Prior to 1996, the Company has earned substantially all of its revenues
from contracts or subcontracts with the U.S. Government. All these contracts
have been completed or otherwise terminated, and the Company does not anticipate
substantial revenues from the U.S. Government in the future.

         In 1995, the Company established RPM, a wholly-owned subsidiary, which
acquired certain assets of Rotary Marine Industries, Inc. (RMI) for
approximately $165,000 and a royalty on future 65 Series rotary marine engine
sales. RPM produces rotary engines for commercial and recreational marine
markets. RPM's business has been unprofitable due to sales volume well below
initial projections, while RPM also competed for capital from projects related
to the Company's main businesses. Therefore, management has decided to divest
the Series 65 engine inventory and related assets, as well as the Company's
non-exclusive right to purchase engines under its contract with Mazda, and
redirect the recovered capital into the Company's operations. The subsidiary,
E-Drive, will be redirected to the manufacture of the alternator assemblies for
propulsion and power generation, engine management systems and other electrical
and electronic components of the Company's power generation units.


                                      -17-
<PAGE>

         In accordance with its plans to redirect the RPM subsidiary, the
Company signed a contract for the sale of a portion of RPM's 65 Series gasoline
marine pleasure craft engine inventory and some associated production equipment
with Rotary Power Marine Corporation, a New York corporation, on June 4, 1998,
which closed on July 28, 1998. Under this agreement the purchaser assumed the
Rotary Power Marine name and trademark and the subsidiary was renamed E-Drive
Systems.

         Pursuant to the Company's licensing agreement with Wankel GmbH (the
"Wankel Licensing Agreement"), the Company had an obligation to pay Wankel GmbH
royalty fees for all small rotary engines up to and including 650 cubic
centimeters per rotor (the "Licensed Engines") sold by the Company in varying
amounts through the year 2008. However, the Company advised Wankel GmbH on
January 10, 1996, that know-how required to be supplied under the provisions of
the Wankel License Agreement was not delivered. The Wankel License Agreement was
terminated by mutual consent on September 19, 1996, with no further payments
due.

         To obtain additional working capital for its planned operations in
1998, the Company signed a contract with Rotary Power Enterprise, Inc. ("RPE")
on July 2, 1998 for the sale of its 65 Series Natural Gas Rotary Engine product
line and an Engine Distributor Agreement for the Natural Gas fueled 580 Series
engines. Upon completion of the transaction, which is subject to the fulfillment
of various closing conditions, the Mazda NGRE agreements and the Hussmann
agreement will be included in the sale of the 65 Series Natural Gas engine
product line asset to RPE. The anticipated proceeds from this sale includes the
release of a lien for $217,000, issued to secure a loan by PowerCold to the
Company.

         During the first four months of 1997, the Company experienced negative
cash flow from operations, including net interest paid, of $375,000 per month.
By July, 1997, PowerCold had loaned the Company $217,000. This money was used to
meet the payroll which was owed to employees (other than the payroll for the
week ended May 23, 1997) and to pay certain outstanding payables. Apart from
this loan, neither PowerCold nor the Company was able to secure equity or debt
financing in this time period. As of May 23, 1997, therefore, the Company
terminated all of its remaining employees in an effort to reduce its costs until
it could raise the additional funding required for continued operations. After
May 23, 1997, a few employees resumed work on a full or part-time basis for the
Company and its subsidiary, Rotary Power Marine, Inc. and those employees have
been paid for their time (exclusive of earned vacation pay, which has been
largely settled since then).

         The Company was not successful in raising additional equity throughout
the remainder of 1997. On November 24, 1997 Mr. Richard M.H. Thompson, sole
Director, President and CEO of the Company, appointed Mr. Ken Brody sole
Director, President and CEO of the Company. Thereafter Mr. Thompson resigned
from these positions.

         Commencing in June, 1997, and in each month thereafter, the Company
failed to make its monthly payments to the Trustee for the Company's 1992 bond
financing with the New Jersey Economic Development Authority (NJEDA), and as a
result, the bondholder's Trustee declared an event of default on July 2 under
the terms of the Trust Indenture.

         On December 24, 1997, the Company issued $10,000,000 maturing principal
amount of 10.412% zero-coupon bonds, due December 15, 2007, to yield
approximately $3.6 million. This money, together with approximately $2.9 million
of the net proceeds from the sale of FICO strips held



                                      -18-
<PAGE>

as collateral for the NJEDA bonds, was used to redeem and pay off the NJEDA bond
issue for approximately $6.5 million.

         The first step in this plan was to identify all generic production
assets, excess furniture and fixtures, which were auctioned to yield $575,000 on
January 27, 1998. All custom made equipment and necessary furnishings were
retained to keep a modest manufacturing capability in-house. These funds were
used to settle the rent arrearage noted above, as working capital, and as funds
for subsequent settlements.

         Next, the Company conducted a composition of creditors, in which
$552,218 of the Company's debt was formally settled for $56,643 and 74,336
shares of the Company's common stock. These settlements were concluded, and the
stock issued, by June 30, 1998. No filing under any bankruptcy or reorganization
statute was required.

RESULTS OF OPERATIONS

        TWELVE MONTHS ENDED DECEMBER 31, 1998 VS. TWELVE MONTHS ENDED
        DECEMBER 31, 1997

         Financial results of the Company for the year ended December 31, 1998,
represent the results of the first phase of restructuring during which there
were no manufacturing operations. Revenue for 1998 was $72,847, resulting
entirely from the sales of inventory of discontinued engine lines.

         Cost of revenue for 1998 of $627,695 reflects the cost of prototype and
Mazda engine blocks sold from inventory. Cost of revenue also includes fixed
period charges, such as rent on production facilities and depreciation on
production machinery and equipment that are not related to sales volume.

         Payroll, benefits and rent for the year ended December 31, 1998 were
significantly reduced, but the bulk of General and Administrative costs consists
of fixed expense related to depreciation, legal and auditing expenses, period
charges and corporate expenses, therefore, General and Administrative costs
decreased $573,792, or 43%, from 1997.

         Engineering staff was diverted to accommodate the planning and
relocation of inventory and equipment. No engine development was accomplished in
this period and, consequently, there was no Research and Development expense.

         As a result of the above, the loss from operations decreased from a
$4,350,338 loss in 1997 to a loss of $330,528 for 1998.

         Net interest expense for 1998 decreased 40%, or $330,445 over 1997,
reflecting reduced interest on the Company's 10.412% zero-coupon bonds versus
the retired NJEDA bonds, as well as the reduction in other debts.

         Other income of $466,989 reflects the auction of depreciated machinery
and equipment and the sales of equipment and inventory related to the Mazda
engine businesses. In 1997, Other Income reflects the gain on the disposition of
FICO strips held as collateral for NJEDA bonds.


                                      -19-
<PAGE>

         As a result of the above, net loss decreased dramatically by $3,522,567
to $1,510,252 in 1998 from $5,032,819 in 1997, increasing the Company's net
operating loss carryforward to approximately $15.4 million.

        TWELVE MONTHS ENDED DECEMBER 31, 1997 VS. TWELVE MONTHS ENDED
        DECEMBER 31, 1996

         Financial results of the Company for the year ended December 31, 1997,
represent the results of five months of operations severely limited by funding
followed by seven months of plant closure. Revenue for 1997 decreased by 92% due
to the completion of all U.S. Government contracts and the seven months of
non-operation. The net loss of $5,032,819 increased the Company's net operating
loss carryforward to approximately $15 million. This loss includes write-offs of
$1,541,183 in anticipation of the disposition of assets and the changes in
markets.

         Cost of revenues decreased 51% to $3.0 million, which includes an
inventory reduction of $1.3 million and $475,000 of gross margin reduction taken
on the Series 580 Mark I engine build.

         General and Administrative expenses decreased 43% to $1.3 million
primarily due to the May layoff of virtually all employees, with rent and other
fixed expenses making up the bulk of the continuing expenses after that date.

         Research and development expenses decreased 74% to $0.4 million again
due to the May layoff. Engineering staff worked on the development of the
gaseous fueled engines and the Series 580 value improvement program until the
layoff.

         Although expenses for 1997 were sharply curtailed, the reduction in
revenues was abrupt, resulting in a loss of $4.3 million from operations,
exceeding the 1996 loss by less than 2%.

         Interest expense, reflecting the interest on the NJEDA bonds, remained
roughly the same in 1997 as in 1996. Interest income decreased by 59% due to the
liquidation of a portion of the FICO Strips and the exchange of the remaining
FICO Strips for a different issue of FICO Strips with a lower yield.

         In 1997, the Company had other income of $148,188 consisting of the net
of the realized gain on the sale of FICO strips of $649,076 and the write-off of
deferred financing costs relating to the retirement of the NJEDA bonds of
$481,630, and a loss on the disposal of assets of $19,257. In 1996, the Company
incurred other net expenses of $59,000.

         As part of this restructuring, the Company redeemed and paid off all
$6.5 million of its NJEDA bonds outstanding by liquidating the balance of its
FICO strips, applying $2.9 million of the net proceeds from the FICO strips
towards the NJEDA bonds, and floating a new $10,000,000 maturing principal
amount of ten-year, 10.412% bonds due December 15, 2007, which raised the
remaining balance, $3.6 million. The liquidation of the FICO strips resulted in
a gain of $479,014. Redemption of the NJEDA bonds cured various default
conditions under the loan agreement with the NJEDA. The new bonds are callable
any time at their accreted value and are zero-coupon bonds, preserving the
Company's cash flow during the restructuring and for some time thereafter. The
Indenture of Trust for these bonds requires the Company to establish and
maintain a Bond Reserve Fund equal to 50% of the principal amount of the then
outstanding bonds on December 31, 2000.



                                      -20-
<PAGE>

With no bonds called, the requirement for this Bond Reserve Fund would be
$2,457,000 on January 1, 2001.

         In conjunction with the restructuring of long-term debt, the Company
negotiated a settlement of the $705,890 rents due its landlord, Curtiss-Wright,
until February 28, 1998, by paying $125,000 in cash ($115,000 of which is a
current liability at year-end), and a $400,000 note, due January 1, 2003,
bearing interest at 4% and secured by any excess unsecured collateral after the
satisfaction of provisions in the bond Security Agreement. The Company also
relinquished its 54,000 square foot manufacturing facility to Curtiss-Wright,
and renegotiated a lease for the Company's executive office space and the
existing Engine Test Facility. At this time the Company has complied in all
respects with its agreements with Curtiss-Wright and has consolidated its
manufacturing facilities within the Engine Test facilities.

         As a result of the above, net loss for the Company increased from
$4970,054 in 1996 to $5,031,819 in 1997.

MANAGEMENT

         On November 24, 1997, Richard M. H. Thompson was succeeded by Ken Brody
as President, Chief Executive Officer and Sole Director. Mr. Brody, at one time
a Director of the Company, came in for the express purpose of restructuring the
Company's finances, markets and directions. Mr. Brody then re-hired John Mack as
Chief Engineer, along with several of the Company's experienced and loyal
administrative, engineering and production people to create a core staff. As
further decision support for the restructuring, the Company retains the
consulting services of William T. Figart, former Director and officer, and Gary
LaBouff, former Vice President of Engineering. Subsequent events have shown this
team to be effective, flexible and capable of carrying forward the Company's
mission.

         In order to retain topnotch employees without investing heavily in
management infrastructure and benefits, the Company has leased its employees,
except the Company's President, Chief Executive Officer and sole Director, from
Employee Solutions Inc. ("ESI") since February 15, 1998. Under the ESI leasing
arrangement, the Company's employees get medical insurance, workers compensation
and an employee-contribution 401K plan.

LIQUIDITY AND CAPITAL RESOURCES

         It was anticipated that cash resources and the expected revenues from
further asset sales were sufficient to enable the Company to continue its
operations through January 31, 1999. Thereafter, an issue of preferred stock was
required to reach the point where major financing could be arranged.

         Operating activities absorbed $779,967 in cash during 1998, including
an adjustment of $413,920 which is the amount of accounts payable forgiven in
the composition of creditors, and also including a gain of $106,280 on the sale
of fixed assets at auction.

         Investing activities of $528,720 in 1998 were the proceeds of two asset
sales related to the liquidated Mazda engine lines.


                                      -21-
<PAGE>

         Revenues from the sale of capital assets in 1998 in 1998 were
directed towards the repayment of debt. Collections on the sale of the
Company's Series 3 Preferred Stock amounted to $175,000. Net cash absorbed by
these investing activities was $99,275.

         During 1997, cash was used to (i) maintain the Company in a viable
condition, (ii) redeem the NJEDA bonds, (iii) fund the continued development of
the Company's industrial engines, and (iv) fund the Value Improvement Program on
the Series 580 engines. The Company ended 1997 with cash equivalents of
$371,007, of which $328,113 was held by the Trustee for the NJEDA bonds and was
eventually applied to the repurchase of those bonds.

YEAR 2000 COMPLIANCE

         The Company's accounting, manufacturing, order entry, bill of
materials, and inventory systems at December 31, 1998 were being converted to a
new system that is compliant with processing requirements for the year 2000. The
Company had not experienced any Y2K problems at December 31, 1998. There are no
other systems considered material to the Company's operations that would be
vulnerable to this problem.

"SAFE HARBOR" STATEMENT

         Forward-looking statements made herein are based on current
expectations of the Company that involve a number of risks and uncertainties and
should not be considered as guarantees of future performance. These statements
are made under the Safe Harbor Provisions of the Private Securities Litigation
Reform Act of 1995. The factors that could cause actual results to differ
materially include interruptions or cancellation of existing contracts, the
impact of competitive products and pricing, product demand and market acceptance
risks, the presence of competitors with greater financial resources than the
Company, product development and commercialization risks and an inability to
arrange additional debt or equity financing.

ITEM 7.       FINANCIAL STATEMENTS

<TABLE>

<S>                                                                             <C>
Report of Independent Accountants...............................................   F-1

Consolidated Balance Sheets - December 31, 1998 and 1997........................   F-2

Consolidated Statements of Operations for the Years Ended

December 31, 1998 and 1997 .....................................................   F-3

Consolidated Statements of Changes in Stockholders' Equity (Deficiency)

for the Years Ended December 31, 1998 and 1997..................................   F-4

Consolidated Statements of Cash Flows for the Years

Ended December 31, 1998 and 1997................................................   F-5

Notes to Financial Statements...................................................F-6 - F-18

</TABLE>


                                      -22-
<PAGE>

                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors of
  Rotary Power International, Inc.

We have audited the accompanying consolidated balance sheets of Rotary Power
International, Inc. and subsidiary (the "Company") as of December 31, 1998 and
1997, and the consolidated statements of operations, changes in stockholders'
equity (deficiency), and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Rotary Power
International, Inc. and subsidiary as of December 31, 1998 and 1997 and the
consolidated results of their operations and their cash flows for the years then
ended, in conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 18 to the
financial statements, the Company's significant operating losses and deficiency
in working capital raise substantial doubt about its ability to continue as a
going concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.

/s/ Demetrius & Company, L.L.C.

DEMETRIUS & COMPANY, L.L.C.

Wayne, New Jersey
March 6, 2000


                                      F-1
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS

                           DECEMBER 31, 1998 AND 1997

                                     ASSETS

<TABLE>
<CAPTION>

                                                                                             1998                1997
                                                                                       -----------------   -----------------
<S>                                                                                     <C>                 <C>
Current assets:
      Cash and cash equivalents                                                         $           485     $        42,894
      Cash held by trustee                                                                          --              328,113
      Accounts receivable                                                                        43,566              42,723
      Other receivables                                                                          30,000              15,000
      Inventories                                                                               681,898           1,341,665
      Other current assets                                                                          436                 500
                                                                                       -----------------   -----------------

          Total Current Assets                                                                  756,385           1,770,895

Fixed assets                                                                                    422,695           1,280,794
Patents                                                                                         554,233             615,817
Other assets, net                                                                               284,849             266,214
                                                                                       -----------------   -----------------

                                                                                        $     2,018,162     $     3,933,720
                                                                                       =================   =================

                    LIABILITIES AND STOCKHOLDERS' DEFICIENCY

Current liabilities:
      Current portion of long-term debt                                                 $           --      $       274,275
      Accounts payable                                                                          138,003             939,274
      Loan Payable                                                                                  --              216,768
      Accrued liabilities                                                                       866,715             904,865
      Other current liabilities                                                                 500,000             507,000
      Deferred acquistion obligation - current                                                1,225,000             725,000
                                                                                       -----------------   -----------------

          Total Current Liabilities                                                           2,729,718           3,567,182

Long-term liabilities:
      Deferred acquisition obligation                                                         2,412,563           2,644,049
      Long-term debt                                                                          4,015,925           3,631,265
      Note Payable                                                                              400,000             400,000
                                                                                       -----------------   -----------------

          Total Liabilities                                                                   9,558,206          10,242,496
                                                                                       -----------------   -----------------

Commitments and contingencies

Stockholders' deficiency:
      Preferred stock, 300,000 par value $.01 shares authorized;
        175,000 shares issued and outstanding                                                     1,750                 --
      Common stock, par value $.01; 10,000,000 shares authorized ;
       6,112,855 for 1998 and 5,968,516 for 1997 shares issued and outstanding                   61,129              59,685
      Paid-in capital                                                                        11,612,157          11,336,367
      Accumulated deficit                                                                   (19,215,080)        (17,704,828)
                                                                                       -----------------   -----------------

             Total Stockholders' Deficiency                                                  (7,540,044)         (6,308,776)
                                                                                       -----------------   -----------------

                                                                                        $     2,018,162     $     3,933,720
                                                                                       =================   =================

</TABLE>

The accompanying notes are an integral part of the statements.


                                      F-2
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF OPERATIONS

                 FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997

<TABLE>
<CAPTION>

                                                              1998               1997
                                                        -----------------  ------------------

<S>                                                      <C>                <C>
Revenues                                                 $        72,848    $        413,310
                                                        -----------------  ------------------
Costs and expenses:
      Cost of revenues                                           627,695           2,979,763
      General and administrative                                 775,681           1,349,473
      Research and development                                       --              434,412
                                                        -----------------  ------------------

          Total Cost and Expenses                              1,403,376           4,763,648
                                                        -----------------  ------------------

          Loss From Operations                                (1,330,528)         (4,350,338)

Other income (expense):
      Interest expense                                          (653,173)           (983,618)
      Interest income                                              6,460             152,949
      Other, net                                                 466,989             148,188
                                                        -----------------  ------------------

          Total Other Expense                                   (179,724)           (682,481)
                                                        -----------------  ------------------

          Net Loss                                       $    (1,510,252)   $     (5,032,819)
                                                        =================  ==================


Net loss per common share - primary:                     $         (0.25)   $          (0.82)
Weighted average common shares outstanding:                    6,040,686           6,118,880

</TABLE>



The accompanying notes are an integral part of the statements.


                                      F-3
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

     CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)

                 FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997

<TABLE>
<CAPTION>

                                                 Series 3 Convertible
                                                    Preferred Stock         Common Stock          Subscriptions
                                                 ----------------------------------------------
                                                   Shares     Value       Shares     Par Value           --
                                                 --------------------- ------------------------ ------------------
<S>                                                  <C>       <C>         <C>         <C>       <C>
Balance at December 31, 1996                           --         --       6,641,432   $66,414       $ (3,150,000)

     Cancellation of common stock                      --         --        (822,916)   (8,229)         3,150,000
     Issuance of common stock                          --         --         150,000     1,500              --
     Net loss                                          --         --          --          --                --
                                                 --------------------- ------------------------

Balance at December 31, 1997                           --         --       5,968,516    59,685              --

     Issuance of common stock                          --         --         144,339     1,444              --
     Issuance of preferred stock                     175,000   $1,750         --          --                --
     Net loss                                          --         --          --          --                --
                                                 --------------------- ------------------------ ------------------

Balance at December 31, 1998                         175,000   $1,750      6,112,855   $61,129   $          --
                                                 ===================== ======================== ==================

<CAPTION>


                                                    Paid-In     Accumulated       Stockholders'
                                                    Capital       Deficit       Equity (Deficiency)
                                                 -----------------------------  ------------------
<S>                                               <C>            <C>                 <C>
Balance at December 31, 1996                      $ 14,404,638   $(12,672,009)       $ (1,350,957)

     Cancellation of common stock                   (3,141,771)        --                   --
     Issuance of common stock                           73,500         --                  75,000
     Net loss                                             --       (5,032,819)         (5,032,819)
                                                 -----------------------------  ------------------

Balance at December 31, 1997                        11,336,367    (17,704,828)         (6,308,776)

     Issuance of common stock                          102,540         --                 103,984
     Issuance of preferred stock                       173,250         --                 175,000
     Net loss                                             --       (1,510,252)         (1,510,252)
                                                 -----------------------------  ------------------

Balance at December 31, 1998                      $ 11,612,157   $(19,215,080)       $ (7,540,044)
                                                 =============================  ==================

</TABLE>

The accompanying notes are an integral part of the statements.


                                      F-4
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                 FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997

<TABLE>
<CAPTION>

                                                                           1998              1997
                                                                      ----------------  ----------------
<S>                                                                    <C>               <C>
Cash flows from operating activities:
Net loss                                                               $   (1,510,252)   $   (5,032,819)
Adjustments to reconcile to net cash used in operating activities:
     Depreciation                                                             435,660           955,988
     Amortization                                                              61,584            80,017
     Interest, net                                                            653,174           145,501
     Other                                                                       --             117,681
     Deposit surrender for rent payment                                          --              50,000
     Rent payment with long term note payable                                    --             400,000
     Gain on sale of long term investment                                        --            (651,639)
     Write off deferred issuance cost                                            --             471,145
     (Gain) loss on disposals of fixed assets                                (106,280)           19,257
     Settlement of accounts payable                                          (413,920)             --
     Common stock issued for professional services                             26,600              --
     Loss on contract close                                                      --             152,641
     Inventory write down                                                        --           1,369,285
     Changes in assets and liabilities:
         Accounts receivable                                                     (843)          256,651
         Other receivables                                                    (15,000)           (5,917)
         Inventories                                                          442,999           (53,920)
         Other current assets                                                      64             9,314
         Other assets                                                         (18,635)          (25,663)
         Accounts payable                                                    (309,968)         (163,893)
         Accrued liabilities                                                  (38,150)         (191,773)
         Other current liabilities                                             (7,000)          (57,904)
                                                                      ----------------  ----------------

             Net Cash Used in Operating Activities                           (799,967)       (2,156,048)
                                                                      ----------------  ----------------

Cash flows from investing activities:
     Purchase of long term investment                                            --          (1,583,112)
     Sale of long term investment                                                --           6,381,108
     Proceeds from the sale of fixed assets                                   528,720            20,000
                                                                      ----------------  ----------------

             Net Cash Provided by Investing Activities                        528,720         4,817,996
                                                                      ----------------  ----------------

Cash flows from financing activities:
     Loan Payable                                                                --             216,768
     Repayment of long-term debt                                             (274,275)       (6,538,642)
     Issuance of long-term debt                                                  --           3,631,265
     Deferred issuance cost                                                      --            (233,929)
     Issuance of preferred stock                                              175,000              --
                                                                      ----------------  ----------------

             Net Cash  Used in Financing Activities                           (99,275)       (2,924,538)
                                                                      ----------------  ----------------

             Net Decrease in Cash                                            (370,522)         (262,590)

Cash and cash equivalents at beginning of year                                371,007           633,597
                                                                      ----------------  ----------------

             Cash and Cash Held in Escrow at End of Year               $          485    $      371,007
                                                                      ================  ================

Supplemental disclosures of cash flow information:
     Interest paid during the year                                               --           $ 692,578
     Income taxes paid during the year                                           --                --

See Note 17 for supplemental cash flow information

</TABLE>

The accompanying notes are an integral part of the statements.


                                      F-5
<PAGE>


                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

1.       GENERAL

         Rotary Power International, Inc. ("RPI" or the "Company") and its
         wholly-owned subsidiary, Rotary Power Marine, Inc. are engaged in the
         development, demonstration and production of rotary engines capable of
         operating on a variety of liquid fuels and natural gases. The Company's
         strategic thrust is to penetrate commercial engine markets. The
         Company's commercialization efforts are focusing on natural gas rotary
         engines for commercial refrigeration, compressors, generators, and on
         diesel engines for the commercial and recreational marine market and
         for commercial generator sets.

         In 1995, the Company established a wholly-owned subsidiary, Rotary
         Power Marine, Inc. ("RPM") renamed E-Drive Systems Corp ("E-Drive"),
         which acquired certain assets of Rotary Marine Industries, Inc. for
         approximately $165,000 and a royalty on future 65 Series rotary marine
         engine sales. E-Drive produces rotary engines for commercial and
         recreational marine markets. E-Drive's primary customers consist of
         builders of commercial and recreational marine boats as well as
         distributors of engines, who sell to a diverse customer base.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         a.       Principles of Consolidation

                  The consolidated financial statements include the accounts of
                  the Company and its wholly-owned subsidiary, E-Drive. All
                  significant intercompany accounts and transactions have been
                  eliminated.

         b.       Cash and Cash equivalents

                  Cash and cash equivalents consist of cash and highly liquid
                  investments with an original maturity of three months or less.

         c.       Inventories

                  Inventories are stated at the lower of cost or market. Cost is
                  determined on a first-in, first-out basis.


                                      F-6
<PAGE>


                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

         d.       Fixed Assets

                  Fixed assets are stated at cost, less accumulated depreciation
                  provided on the straight-line method over the estimated useful
                  lives of the respective assets. Assets under construction are
                  depreciated over their respective useful lives when they are
                  placed in service.

                  When fixed assets are sold or otherwise disposed of, the cost
                  and related accumulated depreciation are removed from the
                  accounts and any resulting gain or loss is reflected in the
                  statement of operations for the period.

         e.       Revenue Recognition

                  Revenues from the commercial sales of engines are recognized
                  when shipped to the customer.

                  Revenues on long-term contracts, including government cost
                  reimbursement contracts, are recognized on the percentage of
                  completion method. Percentage of completion is measured by
                  costs (including applicable general and administrative)
                  incurred and accrued to date compared to total estimated
                  costs.

                  Contracts typically extend over a period of one or more years.
                  In accordance with industry practice, receivables include
                  amounts relating to contracts and programs having production
                  cycles longer than one year. Provisions for estimated losses,
                  if any, are made in the period in which such losses are
                  determined.

                  Revenues billed to the U.S. Government and its agencies
                  directly and through prime contractors were approximately $0
                  for each of the years ended December 31, 1998 and 1997,
                  respectively.



                                      F-7
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

         f.       Estimates

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

         g.       Patents

                  Purchased patents are amortized on a straight-line basis over
                  there useful lives, generally seventeen years. Amortization
                  expense was $61,582 for each of the years ended December 31,
                  1998 and 1997. Accumulated amortization was $431,074 and
                  $369,490 for the years ended December 31, 1998 and 1997,
                  respectively.

         h.       Income Taxes

                  Deferred income taxes are recorded to reflect the tax
                  consequences on future years of temporary differences between
                  the tax bases of assets and liabilities, principally
                  inventory, fixed assets, accrued liabilities and deferred
                  acquisition obligation, and their financial reporting amounts
                  at each year-end and net operating loss carryforwards.

         i.       Net Loss Per Common Share

                  Basic and fully diluted net loss per common share is based on
                  the net loss divided by the weighted average number of common
                  shares outstanding during the period. The exercise of stock
                  options and warrants was not assumed as their effect would be
                  anti-dilutive.


                                      F-8
<PAGE>


                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

         j.       Stock Based Compensation

                  The Company has elected to follow APB Opinion No. 25,
                  "Accounting for Stock Issued to Employees" to account for its
                  employee stock option plans. Under APB No. 25, when the
                  exercise price of the Company's employee stock options equals
                  or exceeds the fair value price of the underlying stock on the
                  date of grant, no compensation expense is recognized in the
                  Company's financial statements.

                  The Company applies the provisions of SFAS No. 123, for non
                  employee stock compensation. The shares are valued based upon
                  the value of the services performed.

3.       ACCOUNTS RECEIVABLE

         Accounts receivable at December 31, 1998 and 1997 consisted of the
         following:

<TABLE>
<CAPTION>

                                      1998                1997
                                    -------             -------
<S>                                 <C>                 <C>
         Commercial                 $43,566             $42,723
                                    -------             -------
                    Total           $43,566             $42,723
                                    =======             =======

         Other unbilled costs are subject to future negotiation and are expected
         to be billed and collected within one year.

4.       INVENTORIES

         Inventories at December 31, 1998 and 1997 consisted of the following:

<CAPTION>

                                      1998               1997
                                    --------          ----------
<S>                                 <C>               <C>
              Fuel and oil          $  1,344          $    1,344
              Parts                  680,554           1,340,321
                                    --------          ----------
                                    $681,898          $1,341,665
                                    ========          ==========

</TABLE>

         The preparation of financial statements in conformity with the
         generally accepted accounting principles requires the use of estimates
         relating to the amounts of certain assets and liabilities at the date
         of the financial statements.



                                      F-9
<PAGE>


                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

4.       INVENTORIES (Continued)

         At December 31, 1998, the Company has inventory at cost totaling
         $1,248,815. The Company has estimated the net realizable value of the
         parts and engines to be $681,898. While the ultimate outcome of the net
         realizable value may differ, management believes that any additional
         loss will not have a material impact on the Company's financial
         position.

5.       FIXED ASSETS

         Fixed assets at December 31, 1998 and 19976 consisted of the following:

<TABLE>
<CAPTION>

                                                        Useful Lives              1998                   1997
                                                                             -----------             ----------

<S>                                                           <C>             <C>                    <C>
         Machinery and equipment                              7               $2,693,345             $5,439,417
         Furniture and fixtures                               7                   27,080                 68,388
         Office equipment                                     7                   47,205                 59,444
         Computer equipment                                   5                  342,112                333,796
         Autos and trucks                                     5                       --                  8,500
         Boats                                                5                       --                 27,195
         Tooling                                              3                  181,689                564,598
         Demonstration equipment                              3                  261,663                261,663
         Construction in process                              -                   25,941                 25,941
                                                                             -----------             ----------
                                                                               3,579,035              6,788,942

               Less accumulated depreciation                                   3,156,340              5,508,148
                                                                             -----------             ----------
                                                                             $   422,695             $1,280,794
                                                                             ===========             ==========


6.       OTHER ASSETS

         Other assets as of December 31, 1998 and 1997 consisted of the
         following:

<CAPTION>

                                                                            1998                         1997
                                                                          --------                    --------
<S>                                                                       <C>                         <C>
         Deferred issuance cost                                           $233,929                    $233,929
         Capitalized production cost                                            --                      25,663
         Deposits                                                           31,500                       6,622
         Officers loans                                                     19,420                          --
                                                                          ------------------------------------
                                                                          $284,849                    $266,214
                                                                          ========                    ========

</TABLE>


                                      F-10
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

7.       ACCRUED LIABILITIES

         Accrued liabilities at December 31, 1998 and 1997 consisted of the
         following:

<TABLE>
<CAPTION>

                                                                            1998                        1997
                                                                          --------                    --------
<S>                                                                       <C>                         <C>
         Provision for loss on contracts                                  $697,821                    $697,821
         Contract adjustments                                               62,000                      62,000
         Professional fees                                                  15,338                      15,338
         Other                                                              91,556                     129,706
                                                                          --------                    --------

                                                                          $866,715                    $904,865
                                                                          ========                    ========

8.       DEFERRED ACQUISITION OBLIGATION

         Pursuant to the acquisition of certain assets at the Company's
         inception in 1991, a deferred acquisition obligation was incurred,
         which as of December 31, 1998 and 1997 is payable to the seller as
         follows:

<CAPTION>

                                                                                1998               1997
                                                                              ----------        ----------
<S>                                                                          <C>                <C>
              $150,000 per annum, payable
                 January 31, 1996 through 1997                               $   225,000        $  225,000
              $500,000 per annum, payable
                 January 31, 1998 through 2006                                 4,500,000         4,500,000
                                                                              ----------        ----------
                    Total remaining payments                                   4,725,000         4,725,000

              Less:
                 Unamortized discount at 10%                                  (1,087,437)       (1,355,951)
                 Current portion                                              (1,225,000)         (725,000)
                                                                              ----------        ----------
                    Long term portion                                         $2,412,563        $2,644,049
                                                                              ==========        ==========

</TABLE>

         The Company had not made its required payments through January 31,1999.

         The fair value of this obligation approximates carrying value. In
         addition to the deferred acquisition obligation, the Company may be
         required to make additional payments to the seller based upon a certain
         percentage of engine sales. No additional payments were made in 1998
         and 1997.



                                      F-11
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

8.       DEFERRED ACQUISITION OBLIGATION (Continued)

         The Company is in negotiations with Deere & Company with regard to the
         fixed minimum payments due to John Deere Technologies International
         ("JDTI") under the deferred acquisition obligation.

9.       LOAN PAYABLE AND NOTE PAYABLE

         a.       Loan Payable

                  In May and June 1997, PowerCold Corporation a shareholder,
                  loaned the Company a total of $216,768. The loan was
                  non-interest bearing. The loan was settled in 1998.

         b.       Note Payable

                  In December 1997, the Company issued a $400,000 promissory
                  note to its landlord in satisfaction of rent due through
                  December 31, 1997. The note is due January 1, 2003 and bears
                  interest at 4% per annum. The note is collateralized by a
                  second position in inventory and property and equipment.

10.      LONG-TERM DEBT

         Long-term debt as of December 31, 1998 and 1997 consisted of the
         following:

<TABLE>
<CAPTION>

                                                                                1998             1997
                                                                            -------------     ------------
<S>                                                                           <C>               <C>
         $10,000,000 aggregate principal amount
         of 10.412% bonds due December 15, 2007                               $4,015,925        $3,631,265
         New Jersey Economic Development
           Authority Bonds                                                           --            274,275
                Less current portion                                                 --           (274,275)
                                                                            -------------     ------------
                                                                              $4,015,925        $3,631,265
                                                                            =============     ============

</TABLE>

         On December 22, 1997, the Company issued $10,000,000 aggregate maturing
         principal amount of 10.412% bonds due December 15, 2007. Total proceeds
         from the issuance was $3,631,265, and bond discount is being amortized
         over the bonds' life. The bonds are collateralized by certain property
         and equipment. On or prior to December 31, 2000, the Company shall
         deposit into a Bond Reserve Fund an amount equal to at least 50% of the
         principal amount of bonds outstanding on such date. Interest expense
         for 1998 amounted to $384,660.


                                      F-12
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

10.      LONG-TERM DEBT (Continued)

         As a result of these events, the Company used the proceeds to pay off
         $6,465,725 of NJEDA bonds. As of December 31, 1997, $274,275 of the
         NJEDA bonds was outstanding. The bond trustee was holding in escrow the
         balance due, and on January 22, 1998, the balance due was paid in full
         by the trustee.

11.      COMMITMENTS AND CONTINGENCIES

         The U.S. Government's Defense Contract Audit Agency has performed final
         indirect rate audits of the Company's contract costs for the years
         ended December 31, 1992, 1993, 1994, 1995 and 1996; there are no other
         years outstanding. The results of the audits did not have a material
         effect on the Company's financial position or results of its
         operations. The Company provides for potential adjustments from such
         audits and believes that any adjustments from such audits will not have
         a material effect on the Company's financial position or results of
         operations.

         The Company leases office and laboratory space under an annual
         operating lease. Rent expense for the years ended December 31, 1998 and
         1997 was $103,165 and $551,000, respectively, net of sublease income.

12.      RELATED PARTY TRANSACTIONS

         Ken Brody, President of the Company, is a minority shareholder of
         Abejon Rotary Power Corporation (Abejon). At December 31, 1998 and
         1997, the Company has an advance payable to Abejon of $500,000 for
         future sales of engines. The advance is recorded in other current
         liabilities.


                                      F-13
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

13.      SHAREHOLDERS' EQUITY

         PREFERRED STOCK:

         The Company is authorized to issue 500,000 shares of preferred stock,
         $.01 par value per share. The Company's Board of Directors, may issue
         from time to time the authorized and unissued shares of Preferred Stock
         in one or more series, and may determine as to each series the dividend
         rights and terms, conversion rights, voting rights, redemption rights
         and terms, liquidation preferences, sinking funds and any other rights,
         preferences, privileges and restrictions applicable to each such series
         of Preferred Stock.

         The Company has designated Series 1 convertible preferred stock and
         Series 2 (nonvoting) preferred stock. None of the Series 1 or Series 2
         preferred stock was outstanding at December 31, 1998 and 1997.
         Furthermore, with the completion of the Company's initial public
         offering, neither the Series 1 or Series 2 preferred stock is available
         for issuance.

         In connection with the successful completion of the Company's initial
         public offering of its common stock in 1994, the Series 1 convertible
         preferred stock and accumulated dividends were converted into 734,598
         shares of common stock.

         On November 2, 1998, the Company authorized 300,000 shares of Series 3
         Non-Voting Convertible Stock, par value $0.01 per share. The shares are
         not entitled to dividends and each share is convertible into 4 fully
         paid and non-assessable shares of common stock. At December 31, 1998
         175,000 Series 3 preferred shares have been issued.

         COMMON STOCK:

         During 1998, the Company issued 74,339 shares to creditors for
         settlement of debt and 70,000 shares to an accounting service provider
         for bookkeeping purposes.

         On March 13, 1997, the Company issued 150,000 shares as commission for
         the sale of FICO strips.



                                      F-14
<PAGE>


                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

13.      SHAREHOLDERS' EQUITY (Continued)

         COMMON STOCK: (CONTINUED)

         On March 21, 1997, the Company sent notice to Hydro Lance Maritime
         Transport, Inc. ("Hydro") and Abejon Rotary Power Corporation
         ("Abejon"), declaring the occurrence of an event of default under the
         Company's loan agreement with Hydro and Abejon. The event of the
         default was declared as a result of Hydro's failure to make a principal
         payment of $175,000 and an interest payment of $28,435, both of which
         were due to the Company on December 20, 1996. In its notice to Hydro
         and Abejon, the Company elected to declare the principal of and
         interest on the loan and other amounts payable under the loan agreement
         to be immediately due and payable and to take possession of and execute
         upon 822,916 shares of the Company's common stock which are owned by
         Abejon and were pledged as collateral and security for the obligations
         of Hydro under the loan agreement. In its notice, the Company also
         reserved any and all of its rights and remedies with respect to other
         shares of the Company's common stock owned by Abejon.

         During 1996, the Company issued a total of 3,250,000 shares of its
         common stock. Warrants to purchase 250,000 shares of common stock at a
         price of $2.50 per share were exercised.

         On February 16, 1994, the Company completed an initial public offering
         of 800,000 shares of its common stock at $8.00 per share. The Company
         received proceeds of $5,824,000, net of underwriting discounts and
         commissions. The net proceeds, less related costs and expenses, were
         credited to capital stock and paid-in capital. The Company's common
         shares are traded on the OTC Bulletin Board.

         In connection with the initial public offering, the Company sold to the
         underwriters, for $800, warrants to purchase from the Company 80,000
         shares of common stock at $9.60 per share, which are exercisable for a
         period of four years commencing February 9, 1995.

         There were 45,000 warrants to purchase common stock outstanding at
         December 31, 1998, which are exercisable through 1999 at $4.625.

         At December 31, 1998 52,200 shares of common stock were reserved for
         exercise of warrants and stock options.


                                      F-15
<PAGE>

                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

14.      STOCK OPTION PLAN

         In 1992, the Board of Directors adopted the 1992 Stock Option Plan (the
         "Plan"). Under the terms of the Plan, incentive stock options to
         purchase up to 400,000 shares of common stock may be granted to key
         employees and directors of the Company at the fair market value at the
         date of grant (or 110% of the fair market value for grants issued to
         holders of more than 10% of the voting stock of the Company). Options
         granted under the Plan become exercisable in whole or in part from time
         to time as determined by the Board of Directors, provided, however, in
         no event shall any option become exercisable earlier than the date six
         months following the date on which the option is granted. Options
         granted under the Plan shall have a maximum term of ten years from the
         date of grant. The option price must be paid in full on the date of
         exercise in cash or in common shares of the Company having a fair
         market value on the date of exercise equal to the option price. Stock
         options outstanding are exercisable commencing one year after grant at
         a rate of either 20% or 25% of such shares in each succeeding year.

         Option status and activity were as follows for the years ended
         December 31:

<TABLE>
<CAPTION>

                                                                                  1998              1997
                                                                             -----------         ---------
<S>                                                                               <C>              <C>
         Outstanding, beginning of year                                           52,000           291,000
         Canceled ($.19125 to $5.00 1998 and 1997)                               (44,800)         (239,000)
                                                                                  ------         ---------
         Outstanding ($3.00 per share)
           end of year                                                             7,200            52,000
                                                                                  ======         =========

         Available for grant                                                      95,000            95,000
                                                                                  ======         =========

         Exercisable                                                               7,200            31,200
                                                                                  ======         =========

</TABLE>


                                      F-16
<PAGE>


                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

15.      EMPLOYEE BENEFITS

         The Company is the sponsor of a defined contribution retirement savings
         plan. All employees of the Company are eligible for participation after
         one year of service. The Company matches 100% of pre-tax contributions
         up to 3.0% of the participant's total salary. The Company recorded $-0-
         and $14,576 of matching contributions and $466 and $1,206 of
         administrative expenses related to this plan in 1998 and 1997,
         respectively.

         The Company has established an incentive compensation plan to provide
         incentive compensation to the Company's officers and key employees. Any
         awards must be approved by the Board of Directors and are paid in
         quarterly installments and shall not exceed 100% of the participant's
         salary. There were no such awards granted or accrued during 1998 and
         1997.

16.      INCOME TAXES

         Deferred tax accounts as of December 31, 1998 and 1997 comprise the
         following:

<TABLE>
<CAPTION>

                                                                                 1998              1997
                                                                             -----------       -----------
<S>                                                                            <C>              <C>
               Net operating loss carryforwards                                6,074,700        $6,371,549

               Depreciation                                                      (18,000)          (24,595)
                                                                             -----------       -----------

               Deferred tax assets, net                                        6,056,700         6,346,954

               Valuation allowance                                            (6,056,700)       (6,346,954)
                                                                              ----------       -----------

                  Net deferred tax assets                                     $      --        $       --
                                                                              ==========       ===========

</TABLE>

         As of December 31, 1998, the Company has federal and state net
         operating loss carryforwards available for tax purposes of
         approximately $15,437,200 and $13,907,000 expiring through 2013 and
         2007, respectively.



                                      F-17
<PAGE>


                 ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

17.      SUPPLEMENTAL CASH FLOW INFORMATION

         During 1998, the Company settled debt of $216,768 in exchange for
         inventory.

         During 1998, the Company settled accounts payable in exchange for cash
         and common stock resulting in forgiveness of debt of $491,303.

         During 1998, the Company issued stock for accounting services valued at
         $26,600.

         The Company recorded $145,536 of accreted interest income on the FICO
         Strips during 1997.

         During 1997, the Company issued 150,000 shares of common stock at $0.50
         per share as commission for the sale of FICO strips.

         Additionally, the Company recorded imputed interest expense of $268,513
         and $286,906 on its deferred acquisition obligation during December 31,
         1998 and 1997, respectively.

18.      GOING CONCERN

         As shown in the accompanying financial statements, the Company incurred
         net losses of $1,510,252, $5,032,819 and $4,970,054 during the years
         ended December 31, 1998, 1997 and 1996, respectively. At December 31,
         1998, the Company had working capital deficiency of $1,973,333 and its
         total liabilities exceeded total assets by $7,540,044. These factors,
         as well as the uncertain conditions that the Company faces regarding
         obtaining financing or additional capital investment create uncertainty
         about the Company's ability to continue as a going concern. In January
         1998, the Company auctioned fixed assets resulting in net proceeds of
         $575,000 and in May 1998, a settlement was reached with unsecured
         creditors, reducing accounts payable by approximately $491,000. (See
         Note 19). The ability of the Company to continue as a going concern is
         dependent upon the company obtaining future financing and marketing its
         commercial products. The financial statements do not include any
         adjustments that might be necessary if the Company is unable to
         continue as a going concern.

19.      SUBSEQUENT EVENT

         As of November, 1999, the Company had entered into a series of
         agreements with Londonderry Capital Structuring Ltd. of Toronto,
         Canada, an investment banking firm. Under these agreements, Londonderry
         has signed a stock subscription agreement for the purchase of up to
         3,000,000 shares of common stock subject to the Company meeting certain
         conditions.


                                      F-18






<PAGE>

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

         None.

ITEM 9.       DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
              PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

MANAGEMENT

         The sole director and executive officer of the Company is as follows:

<TABLE>
<CAPTION>

                       NAME                  AGE                 POSITION WITH THE COMPANY
                       ----                  ---                 -------------------------
<S>                                          <C>        <C>
             Kenneth Leighton Brody          57         President and Chief Executive Officer and Director

</TABLE>

         Ken Brody was only a director of the Company from February 1996 until
March, 1997. He was President of Abejon Rotary Power Corporation, a marine
engine and electronics distributor since May 1995. Mr. Brody has also been
Chairman of Hydro Lance Maritime Transport Corporation, a builder of high-speed
ferries. From April 1991 he has been General Manager and a partner of Cadenza
Marine, a marine electronics service and sales firm. From February 1985 through
December 1991, Mr. Brody was a Principal in Pragma Associates, a computer
science consulting firm. Mr. Brody is a Certified Public Accountant and holds a
United States Coast Guard Captain's license. He attended Rensselaer Polytechnic
Institute as a physics major and completed a VLSI Design Course at the
Massachusetts Institute of Technology in 1980.

COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934

         The Securities Exchange Act of 1934 requires the Company's executive
officers and directors, and any persons owning more than 10% of a class of the
Company's stock to file certain reports of ownership and changes in ownership
with the Securities and Exchange Commission (the "SEC"). Copies of these reports
must also be furnished to the Company.

         There were no filings made by the Company's officers, directors or 10%
beneficial owners required under Section 16(a) during the fiscal year ended
December 31, 1998.


ITEM 10.       EXECUTIVE COMPENSATION

         The following table sets forth the compensation during the last three
fiscal years of the Chief Executive Officer and each of the other four most
highly-compensated executive officers of the Company (the "Named Executive
Officers") whose annual salary and bonus, if any, exceeded $100,000 for services
in all capacities to the Company during the last fiscal year through December
31, 1998.


                                      -23-
<PAGE>

<TABLE>
<CAPTION>

                                         SUMMARY COMPENSATION TABLE

                                     ANNUAL COMPENSATION       LONG TERM COMPENSATION AWARDS
                                     -------------------    -----------------------------------

  NAME OF INDIVIDUAL                                            SECURITIES          ALL OTHER
AND PRINCIPAL POSITION      YEAR   SALARY ($)   BONUS ($)   UNDERLYING OPTIONS     COMPENSATION
----------------------      ----   ----------   ---------   ------------------     ------------

<S>                       <C>        <C>          <C>             <C>                   <C>
Kenneth L. Brody,         1998       $104,000     ---             ---                   ---
  President and Chief     1997          7,500     ---             ---                   ---
  Executive Officer       1996          ---       ---             ---                   ---

</TABLE>


COMPENSATION PURSUANT TO PLANS

        STOCK OPTION PLAN

         Effective 1992, the Board of Directors of the Company (the "Board")
adopted the Stock Option Plan. Under the terms of the Stock Option Plan, options
to purchase up to 400,000 shares of Common Stock may be granted to officers, key
employees and non-employee directors of the Company. The Board or a committee
designated by the Board in accordance with the requirements of Rule 16b-3
promulgated under Section 16(b) of the Securities Exchange Act of 1934, as
amended, is authorized to grant options intended to qualify as "incentive stock
options" under Section 422 of the Internal Revenue Code and options not intended
to qualify as incentive stock options ("non-qualifying stock options"), and to
select employees and non-employee directors of the Company and to determine the
participants, the number of options to be granted and other terms and provisions
of each option.

         The exercise price of any incentive stock options granted under the
Stock Option Plan may not be less than 100 percent of the fair market value of
the Common Stock of the Company at the time of the grant. In the case of
incentive stock options granted to holders of more than 10 percent of the voting
power of the Company, the exercise price may not be less than 110 percent of the
fair market value nor shall the option by its terms be exercisable more than 5
years after the date the option is granted.

         Under the terms of the Stock Option Plan, the aggregate fair market
value (determined at the time of grant) of shares issuable upon exercise of
incentive stock options exercisable for the first time during any one calendar
year may not exceed $100,000. Options granted under the Stock Option Plan become
exercisable in whole or in part from time to time as determined by the
committee, provided, however, in no event shall any option become exercisable
earlier than the date six months following the date on which the option is
granted. Options granted under the Stock Option Plan shall have a maximum term
of 10 years from the date of grant. The option price must be paid in full on the
date of exercise and is payable in cash or in Common Stock of the Company having
a fair market value on the date the option is exercised equal to the option
price.

         At December 31, 1998, there was one stock option for 7,200 shares
outstanding under the stock option plan held by an employee of the Company.


                                      -24-
<PAGE>

EMPLOYMENT AGREEMENTS

         The Company had no employment agreements with any of its employees at
December 31, 1998. All employment agreements with the Company's employees
terminated as of December 31, 1996.

COMPENSATION OF DIRECTORS

         It is the policy of the Company to pay $750 per quarter to outside
directors. There were no outside directors during 1998, therefore, no payments
were made.


ITEM 11.       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
               MANAGEMENT

         The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock by each person or group that
is known by the Company to be the beneficial owner of more than 5% of its
outstanding Common Stock, each director of the Company and each person named in
the Summary Compensation Table, and all directors and executive officers of the
Company as a group as of December 31, 1998. Unless otherwise indicated, the
Company believes that the persons named in the table below, based on information
furnished by such owners, have sole voting and investment power with respect to
the Common Stock beneficially owned by them, subject to community property laws,
where applicable.

<TABLE>
<CAPTION>

   NAME AND ADDRESS OF                 NUMBER OF SHARES OF COMMON         PERCENTAGE OWNERSHIP OF
    BENEFICIAL OWNER                    STOCK BENEFICIALLY OWNED          COMMON STOCK OUTSTANDING
   -------------------                 --------------------------         ------------------------
<S>                                                <C>                               <C>
PowerCold Corporation
103 Guadalupe Drive                                1,935,000                         31.1%
Cibolo, Texas   78108

Loeb Investors Co. 104(2)                            933,074                         15.6%
61 Broadway
New York, New York   10006

Ken Brody(1)                                         177,084                          3.0%
c/o Abejon Rotary Power
   Corporation
4960 North Harbor Drive
San Diego, California   92106

All Directors and Executive                          177,084(1)                       3.0%
  Officers as a Group (1 Person)

</TABLE>

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

     (1)Includes 177,084 shares of Common Stock owned by Abejon Rotary Power
        Corporation. Mr. Brody is a 24% shareholder in Abejon Rotary Power
        Corporation and Mr. Brody exercises sole voting and investment power
        over such shares through resolution of the Board of Directors of Abejon.
        Mr. Brody is also the President, Chief Executive



                                      -25-
<PAGE>

        Officer and sole Director of the Company.

     (2)Includes 435,325 shares of Common Stock owned by Loeb Investors Co. 104,
        214,731 Common Shares owned by Loeb Partners Corporation and 198,918
        Common Shares owned by Warren D. Bagatelle, Managing Director of Loeb
        Partners Corporation. Also includes: (i) 28,221 Common Shares owned by
        Loeb Holdings Corp.; (ii) 13,566 Common Shares owned by HSB Capital;
        (iii) 14,104 Common Shares owned by Loeb Investors Co. 105; (iv) 24,686
        Common Shares owned by Pinpoint Partners 1; and (v) 3,523 Common Shares
        owned by the Kempner/Perlmuth Trust (collectively, "Loeb Affiliates").

ITEM 12.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         In the future, the Company will not enter into any transactions with
officers, directors or other affiliates unless the transactions are approved by
a majority of disinterested directors. No such transactions were in effect or
entered into during 1998.

                                    PART III

ITEM 13.       EXHIBITS AND REPORTS ON FORM 8-K

         (a)   EXHIBITS TO 10-KSB

               3.1      Certificate of Incorporation of the Company, as
                        amended(1)

               3.2      By-laws of the Company(1)

               3.3      Certificate of Designations, Preferences and Rights of
                        Preferred Stock of the Company, as amended(1)

               3.4      Certificate of Designations, Preferences and Rights of
                        Preferred Stock of the Company's Series 3 Preferred
                        Shares

               4.0      Warrant Agreement dated June 29, 1992 between the
                        Company and Rickel & Associates, Inc.(1)

               4.1      Non-Transferable Warrant to Purchase 25,000 Shares of
                        Common Stock of Rotary Power International, Inc.(3)

               4.2      Non-Transferable Warrant to Purchase 175,000 Shares of
                        Common Stock of Rotary Power International, Inc.(3)

               4.3      Non-Transferable Warrant to Purchase 200,000 Shares of
                        Common Stock of Rotary Power International, Inc.(5)

               4.4      Non-Transferable Warrant to purchase 250,000 Shares of
                        Common Stock of Rotary Power International, Inc.(8)


                                      -26-
<PAGE>

               10.1     Contract dated August 15, 1989 between the United States
                        Marine Corps and John Deere Technologies International,
                        Inc. and novated to the Company, as amended(1)

               10.2     Contract dated April 23, 1991 between FMC Corporation
                        and John Deere Technologies International, Inc. and
                        novated to the Company, as amended(1)

               10.3     Contract dated January 21, 1993 between the National
                        Aeronautics and Space Administration and the Company, as
                        amended(1)

               10.4     Licensing Agreement dated October 20, 1992 between
                        Wankel GmbH and the Company(1)

               10.5     Teaming Agreement dated May 10, 1993 between Dornier
                        GmbH and the Company(1)

               10.6     Teaming Agreement dated June 30, 1993 between Martin
                        Marietta Corporation and the Company(1)

               10.7     Purchase Agreement dated November 15, 1991 between John
                        Deere Technologies International, Inc. and the
                        Company(1)

               10.8     Loan Agreement dated June 1, 1992 between New Jersey
                        Economic Development Authority and the Company(1)

               10.9     Asset Purchase Agreement dated August 6, 1992 between
                        ROTEC Manufacturing and Engineering Corp., Michael
                        Soimar and the Company(1)

               10.10    Asset Purchase Agreement dated August 12, 1992 between
                        Defense Group Industries, Inc. and the Company(1)

               10.11    Assignment and Transfer of Receivables Agreement dated
                        April 10, 1992 between Commerce Funding Corporation and
                        the Company(1)

               10.12    Employment Agreement dated November 1, 1991 between
                        Richard M.H. Thompson and the Company, as amended(1)

               10.13    Employment Agreement dated December 16, 1991 between
                        Robert L. Osborn and the Company(1)

               10.14    Employment Agreement dated December 16, 1991 between
                        Gary A. LaBouff and the Company(1)

               10.15    Consulting Agreement dated June 1, 1992 between Loeb
                        Partners Corporation and the Company, as amended by
                        Agreement dated May 3, 1993(1)

               10.16    Lease dated January 1, 1992 between Curtiss-Wright
                        Flight, Inc. and the Company, as amended(1)


                                      -27-
<PAGE>

               10.17    Rotary Power International, Inc. 1992 Stock Option
                        Plan(1)

               10.18    Stockholders Agreement dated December 31, 1991 between
                        the Company and its Stockholders(1)

               10.19    Modification P00035, P00036, P00037 and P00038 to the
                        contract between the Company and the USMC (incorporated
                        by reference to Exhibit 10.1 contained in the Company's
                        10-QSB for the period ending September 30, 1994, dated
                        November 7, 1994)

               10.20    Letter Contract dated November 8, 1994 between Martin
                        Marietta Ordnance Systems and the Company(2)

               10.21    Letter Contract dated December 21, 1994 between the USMC
                        and the Company(2)

               10.22    Not used

               10.23    Teaming Agreement dated July 25, 1995 between Teledyne
                        Vehicle Systems and the Company(4)

               10.24    Assets Purchase Agreement dated August 4, 1995 between
                        Rotary Marine Industries, Inc. and the Company(4)

               10.25    Engine Distributor Agreement dated October 5, 1995
                        between Abejon Rotary Power Corporation and the
                        Company(4)

               10.26    Sales Agreement dated October 16, 1995 between Hussmann
                        Corporation and the Company(4)

               10.27    Modifications P00039 through P00044 to the contract
                        between the Company and the USMC referred to in Exhibit
                        10.1(6)

               10.28    Amendment, dated September 30, 1995, to Employment
                        between Richard M. H. Thompson and the Company referred
                        to in exhibit 10.12*(6)

               10.29    Amendment, dated September 30, 1995, to Employment
                        Agreement between Robert L. Osborn the Company referred
                        to in exhibit 10.13*(6)

               10.30    Amendment, dated September 30, 1995, to Employment
                        Agreement between Gary A. LaBouff and the Company
                        referred to in exhibit 10.14*(6)

               10.31    Agreement by and among Mazda Motor Corporation, Mazda
                        (North America), Inc., and the Company dated November
                        10, 1995 with Addendum(6)

               10.32    Contract dated December 22, 1995 between the United
                        States Marine Corps and the Company with modification
                        P00001 thereto(6)


                                      -28-
<PAGE>

               10.33    Advice to Wankel GmbH, dated January 10, 1996
                        terminating the Wankel Licensing Agreement referred to
                        in exhibit 10.4(6)

               10.34    65 Series Distribution Agreement dated January 22, 1996
                        between Abejon Rotary Power Corporation and the
                        Company(6)

               10.35    Amendment 1, dated February 6, 1996, to Engine
                        Distributor Agreement between Abejon Rotary Power
                        Corporation and the Company referred to in exhibit
                        10.25(6)

               10.36    Purchase Order, dated February 6, 1996, from Abejon
                        Rotary Power Corporation(6)

               10.37    Consulting Agreement, dated February 6, 1996, pursuant
                        to the sale of 1,000,000 shares of the Company's Common
                        Stock to Abejon (Abejon) Rotary Power Corporation(6)

               10.38    Loan Agreement, dated February 6, 1996, between Abejon,
                        Hydro Lance Maritime Transport, Inc. and the Company
                        pursuant to the sale of 1,000,000 shares of the
                        Company's Common Stock to Abejon (Abejon) Rotary Power
                        Corporation(6)

               10.39    Promissory Note, dated February 6, 1996, by Hydro Lance
                        Maritime Transport, Inc. pursuant to the sale of
                        1,000,000 shares of the Company's Common Stock to Abejon
                        (Abejon) Rotary Power Corporation(6)

               10.40    Pledge Agreement, dated February 6, 1996, between Abejon
                        and the Company pursuant to the sale of 1,000,000 shares
                        of the Company's Common Stock to Abejon (Abejon) Rotary
                        Power Corporation(6)

               10.41    Pooling Agreement, dated February 6, 1996, between
                        Abejon, Hydro Lance Maritime Transport, Inc. and
                        Affiliates of the Company pursuant to the sale of
                        1,000,000 shares of the Company's Common Stock to Abejon
                        (Abejon) Rotary Power Corporation(6)

               10.42    Settlement Agreement, dated March 1, 1996, between
                        Lockheed Martin Ordnance Systems, Inc. and the Company
                        referred to in Exhibit 10.20(6)

               10.43    Deviation From Purchase Agreement between John Deere
                        Technologies International, Inc. and the Company, dated
                        February 19, 1996, as referred to in exhibit 10.7(7)

               10.44    Investment Banking Consulting Agreement for One Year
                        with R.D. White & Company dated June 25, 1996(9)


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<PAGE>

               10.45    Letter from Shearman & Sterling, attorneys representing
                        Wankel GmbH, dated 19 September 1996, to the Company
                        accepting the termination of the Wankel License
                        Agreement referred to in exhibit 10.4 by mutual
                        consent(9)

               10.46    Vessel Purchase and Sales Agreement (Partial Interest)
                        between Abejon and RPI dated as of October 31, 1996(9)

               10.47    Mar-Trans Affiliates LLC: Operating Agreement between
                        Abejon and RPI dated as of October 31, 1996(9)

               10.48    Agreement of Merger between International Cryogenic
                        Systems Corporation and Rotary Power International dated
                        as of March 21, 1997(9)

               10.49    Security Agreement, dated December 1, 1997, between
                        Sentinel Trust Company, trustees for the holders of the
                        $10,000,000 bonds due December 15, 2007

               10.50    Indenture of Trust between Sentinel Trust Company and
                        Rotary Power International, Inc, dated December 1, 1997

               10.51    Curtiss-Wright Security Agreement, dated December 22,
                        1997

               10.52    Curtiss-Wright Settlement of Claims with RPI, dated
                        December 22, 1997

               10.53    Asset Purchase Agreement, dated June 4, 1998, with
                        Rotary Power Marine Corporation , for the sale of Series
                        65 gasoline engines(10)

               10.54    Asset Sale Agreement, dated July 2, 1998, for the sale
                        of certain assets of the Company (Series 65 NGRE
                        engines) to Rotary Power Enterprise, Inc.(10)

               11       Calculation of Income (Loss) per Common Share filed
                        herewith

               21       Subsidiaries of the Company

               23       Consent of Accountant

               27       Financial Data Schedule**


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

      *  Management contract or compensatory plan or arrangement required to be
         filed as an exhibit to this Form 10-KSB

    **   Filed in Edgar format only

    (1) Incorporated by reference to exhibit of the same number contained in the
        Company's Registration Statement on Form SB-2, (File No. 33-71334) dated
        November 5, 1994

    (2) Incorporated by reference to exhibit of the same number contained in the
        Company's Form 10-KSB for year ending December 31, 1994


                                      -30-
<PAGE>

    (3) Incorporated by reference to exhibit of the same number contained in the
        Company's Form S-8 (File No. 33-93836) dated June 22, 1995

    (4) Incorporated by reference to exhibit of the same number contained in the
        Company's Form 10-QSB for nine months ended September 30, 1995

    (5) Incorporated by reference to exhibit of the same number contained in the
        Company's Form S-8 (File No. 33-98584) dated October 26, 1995

    (6) Incorporated by reference to exhibit of the same number contained in the
        Company's Form 10-KSB for the year ending December 31, 1995

    (7) Incorporated by reference to exhibit of the same number contained in the
        Company's Form 10-QSB for the three months ended March 31, 1996

    (8) Incorporated by reference to exhibit of the same number contained in the
        Company's Form S-8 (File No. 333-06557) dated June 21, 1996

    (9) Incorporated by reference to exhibit of the same number contained in the
        Company's Form 10-KSB for the year ended December 31, 1996.

    (10) Incorporated by reference to exhibit of the same number contained in
        the Company's Form 10-KSB for the year ending December 31, 1997.


         (b)   REPORTS ON FORM 8-K

               The Company did not file any current reports on Form 8-K during
the last quarter of the fiscal year ended December 31, 1998.



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<PAGE>


                                   SIGNATURES

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

                             ROTARY POWER INTERNATIONAL, INC.

                             By:  /s/ Kenneth Leighton Brody
                                  ----------------------------------------------
                                  Name: Kenneth Leighton Brody
                                  Title:Director, President and Chief Executive
                                        Officer (Principal Executive Officer and
                                        Principal Financial Officer)


Dated:  March 15, 2000




         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.

/s/ Kenneth Leighton Brody                  Director          March 15, 2000
---------------------------
Kenneth Leighton Brody



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