<PAGE>

                                                                    Exhibit 13.1

      [Portions of the 1997 Annual Report to Stockholders Incorporated by
       Reference into Form 10-K for the Fiscal Year Ended July 31, 1997]


ABC Rail Products Corporation

SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA


<TABLE>
<CAPTION> 
(in thousands, except per share data)  
     For the Year Ended July 31,              1997          1996          1995(e)       1994(f)         1993             1992
-----------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>           <C>           <C>           <C>             <C>              <C>
Income Statement Data:
Net Sales                                 $259,190      $240,664      $243,229      $187,176        $148,676         $143,412
Cost of sales                              232,069       209,290       207,645       160,615         129,389          127,999
-----------------------------------------------------------------------------------------------------------------------------
     Gross profit                           27,121        31,374        35,584        26,561          19,287           15,413
Selling, general and
 administrative expenses                    14,232        12,290        13,011        11,579           8,521           10,803
Special charges(a)                              --         3,155            --            --              --            1,000
-----------------------------------------------------------------------------------------------------------------------------
     Operating income                       12,889        15,929        22,573        14,982          10,766            3,610
Equity income (loss) of
 unconsolidated joint ventures               1,041          (144)          393            31              --               --
Interest expense                             7,016         5,239         3,387         3,147           4,156            4,672
Amortization of deferred
 financing costs                               362           172           275           380             584              555
-----------------------------------------------------------------------------------------------------------------------------
     Income (loss) before income taxes,
      cumulative effect of accounting
      changes and extraordinary items        6,552        10,374        19,304        11,486           6,026           (1,617)
Provision (benefit) for income taxes         2,951         3,648         7,619         4,599           2,471             (459)
-----------------------------------------------------------------------------------------------------------------------------
     Income (loss) before cumulative
      effect of accounting changes
      and extraordinary items                3,601         6,726        11,685         6,887           3,555           (1,158)
Cumulative effect of
 accounting changes(b)                          --            --        (1,214)           --              --            1,079
Extraordinary items(c)                        (310)           --          (814)       (1,690)             --               --
-----------------------------------------------------------------------------------------------------------------------------
Net income (loss)                         $  3,291      $  6,726      $  9,657      $  5,197        $  3,555         $    (79)
=============================================================================================================================
Per Share Data:
Income (loss) before cumulative effect 
 of accounting changes and extraordinary 
 items per common share                   $   0.41      $   0.81      $   1.46      $   1.05        $   0.81         $  (0.29)
-----------------------------------------------------------------------------------------------------------------------------
Net income (loss) per common share        $   0.38      $   0.81      $   1.21      $   0.79        $   0.81         $  (0.02)
-----------------------------------------------------------------------------------------------------------------------------
Weighted average common
 shares outstanding (000's)                  8,756         8,306         8,012         6,545           4,380            4,058
-----------------------------------------------------------------------------------------------------------------------------
Operating Data:
Total order backlog(d)                    $ 57,332      $ 33,041      $ 45,429      $ 74,747        $ 41,705         $ 31,985
-----------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization             $ 12,412      $ 11,022      $  7,909      $  5,703        $  5,502         $  5,090
=============================================================================================================================
Balance Sheet Data:
Total assets                              $231,685      $170,104      $157,264      $ 95,774        $ 68,778         $ 65,053
Total debt (including cash
 overdrafts)                               101,989        60,292        63,544        28,455          42,901           44,940
Redeemable preferred stock                      --            --            --            --           7,500            7,500
Stockholders' equity (deficit)              78,774        62,674        50,454        34,918          (7,867)         (11,422)
=============================================================================================================================
</TABLE>

a.  Represents non-recurring charges for the closure of a manufacturing facility
    and the cost of certain reengineering efforts (1996), and for payments made
    from fiscal 1992 through fiscal 1994 to the former majority stockholder
    (1992).

b.  Represents the after-tax cumulative effect of accounting changes whereby, in
    fiscal 1992, certain long-lived casting molds and supplies inventory that
    had previously been expensed were capitalized and are being charged to
    operations based on usage and in fiscal 1995, the Company adopted new
    provisions for accounting for certain postemployment benefits which were
    previously accounted for on a cash basis.

c.  Represents the after-tax effect of extraordinary non-cash charges in
    connection with the write-off of unamortized deferred financing costs
    related to the early extinguishment of debt in connection with (i) the
    refinancing and the initial public offering described in note f below in
    fiscal 1994 and (ii) the refinancing of certain indebtedness in fiscal 1995
    and fiscal 1997.

d.  Includes only firm orders, as of the end of the fiscal year, for which
    customers have issued releases for production and delivery and excludes the
    non-current portion of any long-term supply arrangement.

e.  In May 1995, the Company acquired the Wheel Mounting Business for
    approximately $26.1 million. See Note 2 of the Notes to Consolidated
    Financial Statements for additional information.

f.  In September 1993, the Company refinanced a significant portion of its
    outstanding debt and redeemed all outstanding shares of its preferred stock
    at a discount. In December 1993, the Company used net proceeds of $35.1
    million from its initial public offering to retire a substantial portion of
    the debt issued in the September 1993 refinancing.


                                       6

<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS


[PHOTO OF DON MACDONALD APPEARS HERE]

Don MacDonald

Executive Vice President--Administration and Business Development
and Chief Financial Officer


BACKGROUND

ABC Rail Products Corporation was formed in 1987 to acquire the assets of the
Rail Products Group of the Abex Corporation unit of the IC Industries
conglomerate. In a July 1987 leveraged buyout, these assets were refocused into
a stand-alone business aimed at serving the railroad industry. The Company made
progress at First, but its ability to realize its potential was severely limited
by a 1989 leveraged recapitalization and a $20.0 million equity distribution.
The Company's condition was further hurt by reduced trackwork pricing and soft
market demand in Fiscal 1990 and 1991.

Current management, supported by Kohlberg & Co. as Financial partner, acquired
operating control at the beginning of Fiscal 1992 in a transaction that injected
$5.0 million of equity into the Company. Since then, the Company has returned to
its original vision and plan of serving the railroad industry. In Fiscal 1992,
the inherited problems of the 1987-91 period were successfully addressed by
reducing selling, general and administrative expenses, restructuring specialty
track-work operations to ensure an adequate margin over fully-allocated
production costs, and realigning of the Company's sales mix toward higher margin
customers. In December 1993, the Company completed an Initial Public Offering
that improved its capital structure to prepare for the growth phase of its
strategic plan. During Fiscal 1995, Kohlberg & Co. liquidated their investment
in the Company through two secondary offerings.


                                       7

<PAGE>
 
American Systems Technologies, Inc. Joins ABC Rail Products Family

One of ABC's proudest achievements in fiscal year 1997 was acquiring American
Systems Technologies, Inc. (AST) of Verona, Wisconsin. This ten-year-old, 114-
employee company, headed by its dynamic young founder/president, Steven M.
Yoder, brings ABC a whole new technical and service capability: design, build,
install, maintain and manage railroad and transit signal and safety systems.

Steve Yoder, 40, is a former Chicago & Northwestern Railway signalman. Until he
founded AST in 1987, virtually all rail carriers and public-transit agencies
relied on their own full-time signal department employees to install and
maintain these vital safety devices. Steve could see, however, that the new
short line and regional railroads being started at that time would be able to
reduce their expenses dramatically if installation and maintenance of signals
could be contracted out to a high-performance company specializing solely in
that business. Steve designed and built AST to be that kind of contractor, and
under his leadership the new business has grown in spectacular fashion.

Thanks to the increased strength derived from its membership in the ABC Rail
Products family, AST is now poised to expand its customer base from short lines
and regionals to the Class I rail carriers, one of which recently signed a major
contract with AST. In addition, AST has developed a unique and close
relationship with the signalmen union that allows AST to work Class I railroads.

With its outstanding level of customer service, its youthful and innovative
management, and the growing demand for its services, AST is exactly the type of
company ABC Rail Products seeks to add to its expanding line of industry
products and services.

At the same time, the Company began rebuilding its existing core businesses with
construction of a wheel machining plant and a rail mill, and commenced a process
reengineering effort in its trackwork operations. However, the quicker-than-
expected consolidation of the railroad industry, driven by the large Class I
railroad mergers, has complicated the Company's programs.

To keep pace with this change, the Company has had to accelerate its acquisition
and new venture investment program while at the same time speeding up capital
spending for rebuilding and improving the original core businesses.

LIQUIDITY AND CAPITAL RESOURCES

Cash generated from operations, structured borrowings and equity offerings are
the major sources of funds for working capital, capital expenditures and
acquisitions. Because replacement products represent about 80% of sales, the
Company benefits from substantial and reliable cash flows that are somewhat
insulated from the more cyclical conditions which exist in the large capital
equipment sector of the rail supply industry.

To capitalize on growth opportunities, the Company has adopted a flexible stance
on capital structure. Our acquisition approach is based on debt followed by
partial equitization to assure flexibility in pursuit of our acquisition
strategy. Debt was 54% of total capitalization at July 31, 1997, and 45% of
total capitalization at July 31, 1996. Stock alone could be used for future
acquisitions depending on the size involved, as in the Fiscal 1997 acquisition
of AST.

Acquisition spending totaled $27.1 million for the wheel mounting business in
Fiscal 1995; $6.2 million, including $3.4 million in common stock, for various
product lines in Fiscal 1996 and $10.3 million, primarily common stock, in


                                       8

<PAGE>
 
Fiscal 1997. Capital spending was $34.6 million, $13.9 million and $25.5 million
in Fiscal 1997, 1996 and 1995, respectively. During fiscal 1997 and 1996, the
Company also made aggregate cash infusions of $9.2 million into its joint
venture with China's Ministry of Railroads. See Note 11 of the Notes to
Consolidated Financial Statements for additional information.

Cash generated from operating activities was $3.7 million, $22.3 million and
$11.6 million in fiscal 1997, 1996 and 1995, respectively. The decrease in
fiscal 1997 is due primarily to a decrease in earnings, and the use of cash to
support increased working capital requirements.

During Fiscal 1997, the Company's Credit Agreement was amended and restated in
conjunction with the issuance of $50 million of Senior Subordinated Notes. Under
the Amended Credit Agreement, certain loans and acquisition facilities were paid
in full, the revolving credit line was increased to $90 million and terms of
certain Financial covenants were modified. In Fiscal 1996, the Company paid down
debt with surplus cash flow remaining after its acquisitions, capital
expenditures and investments in the Chinese joint venture. See Notes 5 and 11 of
the Notes to Consolidated Financial Statements for additional information.

In Fiscal 1995, in addition to earnings from operations, the Company
restructured its long-term debt to provide more working capital availability and
add a special $25.0 million acquisition Financing facility. This facility
provided $17.0 million of the Financing for the wheel mounting business
acquisition. Proceeds of $6.5 million from the primary equity offering in June
1995 were used to repay a portion of the acquisition loan. The Calera wheel
machining plant and rail mill capital projects were and will be partially
Financed by specific long-term debt secured by these facilities. At July 31,
1997 and 1996, remaining availability under the Credit Agreement was $20.5
million and $31.3 million, respectively. Interest on all amounts borrowed under
the Credit Agreement is payable monthly, at defined rates. The Company has
pledged as collateral under the Credit Agreement substantially all of its
property, plant and equipment, eligible accounts receivable and inventories,
intellectual property and capital stock of its subsidiaries.



                                       9

<PAGE>
 

The Company was in compliance with all its covenants (as amended) under the
Credit Agreement as of July 31, 1997. See Note 5 of the Notes to Consolidated
Financial Statements for additional information.

At the close of business on July 31, 1995, the Company redeployed $3.5 million
of assets used in the composition brake shoe operation into the joint venture
with Anchor Brake Shoe Co. aimed at strengthening competitive cost structures
and broadening the product line. The Company believed that the joint venture
deployment would increase the returns on this capital; and after one year of
operation, we are satisfied that higher returns will be achieved.

The Company expects to continue to Finance its investment activities using the
methods described above. No assurance can be given with respect to whether
financing would be available when required or whether such financing can be
obtained on terms acceptable to the Company, particularly in connection with
specific opportunities for acquisition.

RESULTS OF OPERATIONS

NET SALES

Fiscal 1997 sales increased $18.5 million (7.7%), while Fiscal 1996 sales
experienced a small decrease of $2.6 million from Fiscal 1995 (1.1%). The Fiscal
1997 sales increase was primarily in the Track Products Division ($16.0
million); and was predominantly related to the additional sales ($12.4 million)
associated with the May 1996 acquisition of Deco and the December 1996
acquisition of AST. Sales of specialty trackwork products were marginally above
the prior year's sales. These specialty trackwork product sales were adversely
affected by the merger-induced slowdown of trackwork order releases from the
Western Class I railroads. The slowdown in Class I railroad orders has enabled
the production process changes, described below, to be pursued in the trackwork
operations without a significant negative impact on deliveries. Sales were flat
between years at the Company's Calera wheel manufacturing plant. Offsetting the
recovery from the midfiscal 1996 fire at the Calera plant was an overall lower-
than-normal level of capacity during fiscal 1997 reflecting difficulties in
implementing process improvements and the new sand systems at the wheel foundry.
These foundry process improvements have resulted in temporary cost problems and
production slow-downs at this plant. However, when completed, the foundry
rebuild is expected to provide the quality input needed to capitalize on the
significant improvements recently instituted in the plant's machine shop.


                                      10

<PAGE>
 
Fiscal 1996 sales were reduced because of: (i) lower specialty trackwork sales
($18.8 million) primarily due to the merger-induced slowdown of order releases
from the Western Class I railroads; (ii) lost sales due to curtailed production
resulting from the mid-year fire at the Company's Calera wheel manufacturing and
machining plant ($12.7 million); and (iii) the absence of composition brake shoe
sales due to the formation at the end of fiscal 1995 of an unconsolidated
venture with Anchor Brake Shoe Company for the manufacture of composition brake
shoes ($4.8 million). Offsetting these reductions was the favorable impact of a
full year's sales from the wheel mounting business acquired in late fiscal 1995
($34.4 million).

GROSS PROFIT and COST of SALES

Gross profit decreased in fiscal 1997 and 1996 by $4.3 million (13.6%) and $4.2
million (11.8%), respectively. Absolute gross margins for fiscal 1997, 1996 and
1995 were 10.5%, 13.0% and 14.6%, respectively. During fiscal 1997, gross
margins remained below recent levels as the difficulties in completing major
improvements to manufacturing operations continue to be overcome. The decrease
in fiscal 1996 gross profit is due to the losses from the fire at Calera, the
net reduction in sales discussed above, and the somewhat lower average margins
on the full year of wheel mounting sales. In addition to the impact from the
lost sales related to the fire at the Calera facility, the plant also
experienced higher scrap levels and increased production costs during the
restart period. The Company is insured against physical damage and business
interruption. A business interruption claim was settled in fiscal 1997. Net
recovery did not have a material impact on fiscal 1997 results. Insurance
deductibles are low and coverage continues on the facility.

SELLING, GENERAL and ADMINISTRATIVE EXPENSES

Selling, general and administrative (SG&A) expenses increased $1.9 million in
fiscal 1997 and decreased $0.7 million in fiscal 1996. As a percent of sales,
SG&A expenses for fiscal 1997, 1996 and 1995 were 5.5%, 5.1% and 5.3%,
respectively. The increase in SG&A expense in fiscal 1997 is primarily in the
customer support area (field sales and customer service) to anticipate the
expanding needs of our customers. The change in expense between fiscal periods
1996 and 1995 is due primarily to the fiscal 1995 legal fees incurred in the
Abex environmental lawsuit. See Note 10 of the Notes to Consolidated Financial
Statements for additional information.

OTHER

Equity earnings from unconsolidated joint ventures were $1.0 million in fiscal
1997 primarily due to the Anchor Brake Shoe joint venture established on July
31, 1995. Prior years' equity earnings (loss) were not significant.

Interest expense for fiscal 1997 and fiscal 1996 increased $1.8 million (33.9%)
and $1.9 million (54.7%), respectively. The interest expense increase for fiscal
1997 is due primarily to an

Investing in Information Technology

A very promising recent undertaking was our selection of the world-renowned SAP
R/3 proprietary software to become the basic corporate information technology
for all of ABC Rail Products' activities. Termed "wildly popular" by The Wall
Street Journal, SAP R/3 reportedly has become the system of choice at global
companies such as IBM, Chevron, Owens-Corning, Coca-Cola and General Motors.

Conversion of ABC's current information systems to the SAP R/3 format is not
expected to be completed until the spring of 1999 and will involve considerable
investment. Based on experience with other users, however, the payback should
come early and big, because SAP R/3 is a completely integrated system that
embraces sales and distribution, materials and inventory management,
manufacturing and preventive maintenance, purchasing, finance and cost
accounting.

Different departments that now find themselves isolated on "technological
islands" will be able to communicate in a common language without written
documents. SAP R/3, which was specifically designed for businesses with complex
processes and long time lines, also protects ABC from the notorious "Y2K," or
Year 2000 problem, caused by obsolete programs that cannot recognize dates
beyond 1999.


                                      11

<PAGE>
 
Venturing Abroad

Because revitalization of the railroad industry now has become global, ABC is
pressing forward with several ventures outside the United States.

In addition to the joint venture we announced with our partner Damy in Mexico,
we are moving forward vigorously to complete our new wheel-manufacturing plant
at Datong, in northern China. Datong is the center of China's burgeoning
locomotive and railcar manufacturing industry, which will absorb much of the
plant's expected output of 160,000 wheels annually when production begins in
1998. ABC holds a 40 percent interest in this facility in partnership with the
Ministry of Railways of the People's Republic of China.

We consider the Chinese market particularly important, not only because of that
nation's rapidly expanding economy, but because the vast distances separating
its agricultural, mining, producing and consuming areas make the country a
"natural" for railroad transportation. The Chinese government has acknowledged
this reality by embarking on a program to enlarge the railroad network by 13
percent before the turn of the century.

China's government has budgeted more than $50 billion for these important
projects, and railroads in nations bordering China are recapitalizing their
systems in similar fashion as government officials and private-sector managers
increasingly realize the importance of rail transportation to economic growth.

In addition to taking American technology offshore into growing new markets, we
continue to seek out the best in overseas rail technologies for introduction
into appropriate markets in North America. Light rail transit, the contemporary
version of yester-year's streetcar systems, is making a comeback in the U.S. and
Canada, and we expect our switches, crossings, turnouts and other track products
to continue their role in this ongoing revival.

overall higher level of outstanding debt to support acquisitions, capital
projects and expanding operations, along with the marginally higher interest
rate on the new Senior Subordinated Notes. The $0.3 million extraordinary charge
in fiscal 1997 reflects the after-tax effect of the write-off of unamortized
financing costs related to previous indebtedness which was retired with proceeds
from the Senior Subordinated Notes. The fiscal 1996 increase is due primarily to
additional indebtedness related to the funding for the new wheel machining
center at Calera and the acquisition of the G.E. Railcar wheel mounting
facilities.

The $1.2 million cumulative effect of accounting change in fiscal 1995
represents the after-tax effect of the Company's adoption of SFAS No. 112,
"Employers' Accounting for Postemployment Benefits." The accounting standard
required the accrual of the cost of postemployment benefits over the employees'
years of service rather than accounting for such costs on a cash basis. The one-
time cumulative adjustment was recognized as of the beginning of fiscal 1995 and
has not had a significant ongoing effect.

The $0.8 million extraordinary charge in fiscal 1995 represents the after-tax
effect of the write-off of unamortized deferred financing costs related to the
early extinguishment of debt in connection with the Company's refinancing of its
line of credit in March 1995.

NET INCOME

Net income for fiscal 1997 was $3.3 million, or 38 cents per share on 8.8
million shares outstanding. This compares with net income of $6.7 million, or 81
cents per share, reported a year earlier on fewer shares outstanding.

QUARTERLY RESULTS OF OPERATION AND SEASONALITY

The peak season for installation of specialty trackwork extends from March
through October, when weather conditions are generally favorable for
installation. As a result, net sales of specialty trackwork have historically
been more concentrated in the period from January through June, a period roughly
corresponding to the second half of the Company's fiscal year. In addition, a
number of the Company's facilities close for regularly scheduled maintenance in
late summer and late December. This tends to reduce operating results during the
first half of the Company's fiscal year. Transit industry practice with respect


                                      12

<PAGE>
 
to specialty trackwork generally involves the periodic shipment of large
quantities, which may be unevenly distributed throughout the year. The Company
did not experience any significant departure from the historical demand patterns
during fiscal 1997.

Regarding "Forward-Looking" Statements

The foregoing outlook contains forward-looking statements that are based on
current expectations and are subject to a number of risks and uncertainties.
Actual results could differ materially from current expectations due to a number
of factors, including general economic conditions; competitive factors and
pricing pressures; shifts in market demand; the performance and needs of
industries served by the Company's businesses; actual future costs of operating
expenses such as rail and scrap steel, self-insurance claims and employee wages
and benefits; actual costs of continuing investments in technology; the
availability of capital to finance possible acquisitions and to refinance debt;
the ability of management to implement the Company's strategy of acquisitions,
rebuilding and process improvements; and the risks described from time to time
in the Company's SEC reports.


                                       13

<PAGE>
 
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


TO ABC RAIL PRODUCTS CORPORATION:

We have audited the accompanying consolidated balance sheets of ABC RAIL
PRODUCTS CORPORATION (a Delaware corporation) AND SUBSIDIARIES as of July 31,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for the years ended July 31, 1997, 1996 and
1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
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 financial position of ABC Rail Products Corporation
and Subsidiaries as of July 31, 1997 and 1996, and the results of their
operations and their cash flows for the years ended July 31, 1997, 1996 and 1995
in conformity with generally accepted accounting principles.

As explained in Note 7 to the consolidated financial statements, the Company
changed its method of accounting for postemployment benefits effective August 1,
1994.


                              /s/ Arthur Andersen LLP

                              Arthur Andersen LLP
                              Chicago, Illinois
                              September 10, 1997


                                       14

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
(In thousands, except per share data)                               For the Year Ended July 31,    1997      1996      1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                           <C>       <C>       <C>
Net Sales                                                                                      $259,190  $240,664  $243,229
Cost of Sales                                                                                   232,069   209,290   207,645
---------------------------------------------------------------------------------------------------------------------------
     Gross profit                                                                                27,121    31,374    35,584
Selling, General and Administrative Expenses                                                     14,232    12,290    13,011
Special Charge (Note 12)                                                                             --     3,155        --
---------------------------------------------------------------------------------------------------------------------------
     Operating income                                                                            12,889    15,929    22,573
Equity Income (loss) of Unconsolidated Joint Ventures                                             1,041      (144)      393
Interest Expense                                                                                  7,016     5,239     3,387
Amortization of Deferred Financing Costs                                                            362       172       275
---------------------------------------------------------------------------------------------------------------------------
     Income before income taxes, cumulative effect of accounting change
       and extraordinary items                                                                    6,552    10,374    19,304
Provision for Income Taxes (Note 6)                                                               2,951     3,648     7,619
---------------------------------------------------------------------------------------------------------------------------
     Income before cumulative effect of accounting change
       and extraordinary item                                                                     3,601     6,726    11,685
Cumulative Effect of Accounting Change (Note 7)                                                      --        --    (1,214)
Extraordinary Items (Note 5)                                                                       (310)       --      (814)
---------------------------------------------------------------------------------------------------------------------------
     Net income                                                                                $  3,291  $  6,726   $ 9,657
---------------------------------------------------------------------------------------------------------------------------
Income Per Common Share (Note 1)
     Income before cumulative effect of accounting change
       and extraordinary items                                                                 $   0.41  $   0.81   $  1.46
     Cumulative effect of accounting change                                                          --        --     (0.15)
     Extraordinary items                                                                          (0.03)       --     (0.10)
---------------------------------------------------------------------------------------------------------------------------
     Net income                                                                                $   0.38  $   0.81   $  1.21
---------------------------------------------------------------------------------------------------------------------------
Weighted Average Common Shares Outstanding                                                        8,756     8,306     8,012
===========================================================================================================================

</TABLE> 
 
The accompanying notes to consolidated financial statements are an integral part
of these statements.


                                       15

<PAGE>

 
ABC Rail Products
Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
(In thousands, except share and per share data)                                            As of July 31,      1997         1996
================================================================================================================================
<S>                                                                                                        <C>          <C>
Assets
Current Assets:
  Accounts receivable, less allowances of $1,006 and $865, respectively (Notes 1 and 3)                    $ 38,208     $ 31,515
  Inventories                                                                                                46,580       39,318
  Prepaid expenses and other current assets                                                                   1,964        1,810
  Prepaid income taxes (Note 6)                                                                               2,041        3,625
--------------------------------------------------------------------------------------------------------------------------------
              Total current assets                                                                           88,793       76,268
================================================================================================================================
Property, Plant and Equipment:
  Land                                                                                                        1,927        1,605
  Buildings and improvements                                                                                 12,491       12,127
  Machinery and equipment                                                                                    84,653       73,664
  Construction in progress                                                                                   36,421       15,459
--------------------------------------------------------------------------------------------------------------------------------
                                                                                                            135,492      102,855
  Less--Accumulated depreciation                                                                            (37,480)     (30,106)
--------------------------------------------------------------------------------------------------------------------------------
    Net property, plant and equipment                                                                        98,012       72,749
--------------------------------------------------------------------------------------------------------------------------------
Investment in Unconsolidated Joint Ventures (Note 11)                                                        14,684        5,604
--------------------------------------------------------------------------------------------------------------------------------
Other Assets--net (Note 1)                                                                                   30,196       15,483
--------------------------------------------------------------------------------------------------------------------------------
              Total assets                                                                                 $231,685     $170,104
================================================================================================================================
Liabilities and Stockholders' Equity
Current Liabilities:
  Cash overdrafts (Note 1)                                                                                 $  2,991     $  3,907
  Current maturities of long-term debt (Note 5)                                                               3,987        6,942
  Accounts payable                                                                                           26,617       22,759
  Accrued liabilities (Note 4)                                                                               14,073       14,798
--------------------------------------------------------------------------------------------------------------------------------
              Total current liabilities                                                                      47,668       48,406
--------------------------------------------------------------------------------------------------------------------------------
Long-Term Debt, less current maturities (Note 5)                                                             95,011       49,443
--------------------------------------------------------------------------------------------------------------------------------
Deferred Income Taxes (Note 6)                                                                                5,881        5,316
--------------------------------------------------------------------------------------------------------------------------------
Other Long-Term Liabilities                                                                                   4,351        4,265
--------------------------------------------------------------------------------------------------------------------------------
Commitments and Contingencies (Note 10)
Stockholders' Equity:
  Preferred stock, $1.00 par value; 1,000,000 shares authorized; no shares issued or outstanding                 --           --
  Common stock, $.01 par value; 25,000,000 shares authorized; 8,954,082 shares and 8,271,026
    shares issued and outstanding, respectively                                                                  90           83
  Additional paid-in capital                                                                                 67,362       55,251
  Retained earnings                                                                                          11,322        7,340
--------------------------------------------------------------------------------------------------------------------------------
              Total stockholders' equity                                                                     78,774       62,674
--------------------------------------------------------------------------------------------------------------------------------
              Total liabilities and stockholders' equity                                                   $231,685     $170,104
================================================================================================================================
</TABLE>

The accompanying notes to consolidated financial statements are an integral part
of these statements.


                                      16

<PAGE>
 

ABC Rail Products
Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                        Additional      Retained
                                                             Common        Paid-in      Earnings
(In thousands)                                                Stock        Capital     (Deficit)
================================================================================================
<S>                                                        <C>          <C>            <C>
Balance, July 31, 1994                                          $77        $43,193      $(8,352)
  Net income                                                     --             --        9,657
  Issuance of common stock, net                                   3          6,478           --
  Adjustment of minimum pension liability (Note 7)               --             --         (602)
-----------------------------------------------------------------------------------------------
Balance, July 31, 1995                                           80         49,671          703
  Net income                                                     --             --        6,726
  Shares issued in business acquisition                           2          3,348           --
  Issuance of common stock                                        1          1,600           --
  Adjustment of minimum pension liability (Note 7)               --             --          (89)
  Income tax benefit from exercised stock options                --            632           --
-----------------------------------------------------------------------------------------------
Balance, July 31, 1996                                           83         55,251        7,340
   Net income                                                    --             --        3,291
   Shares issued in business acquisition                          6         10,220           --
   Issuance of common stock                                       1          1,484           --
   Adjustment of minimum pension liabilities (Note 7)            --             --          691
   Income tax benefit from exercised stock options               --            407           --
-----------------------------------------------------------------------------------------------
Balance, July 31, 1997                                          $90        $67,362      $11,322
===============================================================================================
</TABLE>

The accompanying notes to consolidated financial statements are an integral part
of these statements.


                                      17

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
 


<TABLE>
<CAPTION>
(In thousands)                                                    For the Year Ended July 31,        1997       1996        1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                                <C>        <C>        <C>
Cash Flows from Operating Activities:
    Net income                                                                                    $  3,291     $6,726    $  9,657
    Adjustments to reconcile net income to net cash provided by operating activities:
        Cumulative effect of accounting change                                                          --         --       1,214
        Special charge                                                                                  --      3,155          --
        Extraordinary items                                                                            310         --         814
        Equity (income) loss of unconsolidated joint ventures                                       (1,041)       144        (393)
        Depreciation and amortization                                                               12,412     11,022       7,909
        Deferred income taxes                                                                          591       (673)      2,406
        Changes in certain assets and liabilities, net of acquired business
           Accounts receivable--net                                                                   (451)     7,372     (11,140)
           Inventories                                                                              (7,071)      (978)     (4,286)
           Prepaid expenses and other current assets                                                   (54)      (112)       (336)
           Other assets net                                                                         (3,209)    (1,275)     (1,945)
           Accounts payable and accrued liabilities                                                 (1,142)    (2,496)      7,482
           Other long-term liabilities                                                                  86       (604)        257
------------------------------------------------------------------------------------------------------------------------------------
              Total adjustments                                                                        431     15,555       1,982
------------------------------------------------------------------------------------------------------------------------------------
                  Net cash provided by operating activities                                          3,722     22,281      11,639
------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
    Capital expenditures                                                                           (34,607)   (13,943)    (25,497)
    Proceeds from sale of property                                                                   1,272         --          --
    Business acquisitions, less cash acquired                                                          (72)    (2,888)    (27,132)
    Investment in joint ventures                                                                    (8,064)    (1,976)         --
    Change in restricted cash                                                                           --         --         468
------------------------------------------------------------------------------------------------------------------------------------
                  Net cash used in investing activities                                            (41,471)   (18,807)    (52,161)
------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
    Payments under previous revolving lines of credit                                                   --         --     (22,914)
    Activity under the Credit Agreement:
        Issuance (repayment) of non-amortizing term loan                                           (15,000)        --      15,000
        Net receipts (payments) under revolving line of credit                                       8,212     (4,769)     26,096
        Draw on acquisition facility                                                                 1,750         --      17,000
        Repayment of acquisition facility                                                           (5,193)    (5,664)     (7,891)
    Change in cash overdrafts                                                                       (1,064)     3,907          --
    Issuance of Senior Subordinated Notes                                                           50,000         --          --
    Issuance of other long-term debt                                                                 8,128      2,632       9,221
    Repayment of other long-term debt                                                               (7,864)    (2,751)     (1,437)
    Payment of deferred financing costs                                                             (2,705)      (396)       (536)
    Issuance of common stock, net of offering costs                                                  1,485      1,601       6,481
------------------------------------------------------------------------------------------------------------------------------------
                  Net cash provided by (used in) financing activities                               37,749     (5,440)     41,020
------------------------------------------------------------------------------------------------------------------------------------
                  Net increase (decrease) in cash                                                       --     (1,966)        498

Cash, beginning of year                                                                                 --      1,966       1,468
------------------------------------------------------------------------------------------------------------------------------------
Cash, end of year                                                                                 $     --    $    --    $  1,966
====================================================================================================================================
</TABLE> 
 
The accompanying notes to consolidated financial statements are an integral
part of these statements.


                                       18

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)


<TABLE>
<CAPTION>
(In thousands)                                            For the Year Ended July 31,        1997         1996        1995
--------------------------------------------------------------------------------------------------------------------------
<S>                                                                                      <C>          <C>           <C>
Non-Cash Transactions:
     Recognition/adjustment of minimum pension liability --
        Minimum pension liability                                                        $  2,160     $     55    $ (1,257)
        Intangible asset                                                                   (1,035)        (200)        278
        Deferred income taxes                                                                (434)          56         377
        Equity                                                                               (691)          89         602
--------------------------------------------------------------------------------------------------------------------------
     Contribution to brake shoe joint venture --
        Investment in unconsolidated joint venture                                       $     --     $     --    $  3,500
        Accounts receivable and other current assets                                           --           --        (371)
        Inventories                                                                            --           --        (667)
        Property, plant and equipment, net                                                     --           --      (2,462)
--------------------------------------------------------------------------------------------------------------------------
     Business acquisitions --
        Common stock issued                                                              $10,226      $  3,350    $     --
        Cash paid                                                                             72         2,827      27,132
--------------------------------------------------------------------------------------------------------------------------
           Total consideration                                                            10,298         6,177      27,132
        Assets acquired                                                                   19,130        13,234      27,132
--------------------------------------------------------------------------------------------------------------------------
        Liabilities assumed                                                              $ 8,832       $ 7,057    $     --
==========================================================================================================================
</TABLE>

The accompanying notes to consolidated financial statements are an integral part
of these statements.


                                      19

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  Summary of Significant Accounting Policies

ABC Rail Products Corporation (the "Company") is a leader in the engineering,
manufacturing and marketing of replacement products and original equipment for
the freight railroad and rail transit industries. The Company's products include
specialty trackwork, such as rail crossings and switches; mechanical products,
such as railcar, locomotive and idler wheels, mounted wheel sets and metal brake
shoes; classification yard products and automation systems; and railway signal
systems installation and maintenance services. The Company operates 20 plants in
13 states and has unconsolidated joint ventures with plants in one state and in
China.

     Principles of Consolidation

The consolidated financial statements include the accounts of ABC Rail Products
Corporation and its wholly-owned subsidiaries. All significant transactions and
balances between the Company and these subsidiaries have been eliminated in
consolidation.

Investments in unconsolidated joint ventures are accounted for under the equity
method.

     Cash Overdrafts

Cash overdrafts represent the aggregate amount of checks which have been issued
and have not yet cleared the zero-balance disbursement accounts, net of any cash
in specific depository accounts which will be automatically drawn against as
such checks clear the disbursement accounts.

     Allowance for Doubtful Accounts

The allowance for doubtful accounts for the years ended July 31, 1997, 1996 and
1995, consisted of the following:

<TABLE>
<CAPTION>
(in thousands)                              1997     1996    1995
-----------------------------------------------------------------
<S>                                       <C>       <C>     <C>
Balance at beginning of year              $  865    $ 716   $ 262
Provision charged to income                  102      160     403
Accounts recovered (written off) - net       (12)     (23)     51
Allowance from business acquisition           51       12      --
-----------------------------------------------------------------
Balance at end of year                    $1,006    $ 865   $ 716
=================================================================
</TABLE>

     Inventories

Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method for substantially all inventories. Inventory
costs include material, labor and manufacturing overhead. Supplies and spare
parts primarily consist of manufacturing supplies and equipment replacement
parts.

Inventories at July 31, 1997 and 1996, consisted of the following:

<TABLE>
<CAPTION>
(in thousands)                           1997     1996
------------------------------------------------------
<S>                                   <C>      <C>
Raw materials                         $27,734  $22,886
Work in process                         8,575    7,779
Finished goods                          5,983    4,497
Supplies and spare parts                4,288    4,156
------------------------------------------------------
                                      $46,580  $39,318
======================================================
</TABLE>
     Property, Plant and Equipment

Property, plant and equipment are stated at cost. Depreciation is computed on a
straight-line basis over the estimated useful lives of the assets. The useful
lives used for recognizing depreciation expense for financial reporting purposes
are as follows:

     Buildings and improvements  10 - 30 years
     Machinery and equipment      5 - 12 years

Major renewals and betterments which extend the useful life of an asset are
capitalized; routine maintenance and repairs are expensed as incurred. Total
maintenance and repairs expense charged to operations was approximately $12.7
million, $13.8 million and $15.3 million for the years ended July 31, 1997, 1996
and 1995, respectively. Upon sale or retirement of assets, the asset cost and
related accumulated depreciation are removed from the accounts and any related
gain or loss is reflected in operations. The most significant component of
construction in progress as of July 31, 1997 is a rail mill facility being
erected in Illinois. The rail mill is expected to begin commercial production by
the third quarter of fiscal 1998.


                                      20
                            
<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


     Other Assets
Other assets at July 31, 1997 and 1996, consisted of the following:

<TABLE>
<CAPTION>
(in thousands)                     1997     1996
                                  -------  -------
<S>                               <C>      <C>
Molds and patterns                $ 3,169  $ 2,555
Deferred financing costs - net      2,817      992
Intangible asset - pension             --    1,036
Prepaid pension costs               1,972       --
Excess cost over net assets of
     acquired businesses - net     19,686    8,311
Other - net                         2,552    2,589
                                  -------  -------
                                  $30,196  $15,483
                                  =======  =======
</TABLE>

Molds and patterns are used in the Company's foundry operations to cast
specialty trackwork, and railcar, locomotive and idler wheels. The cost of the
molds and patterns is charged to operations based on usage.

Deferred financing costs, net of accumulated amortization of $0.4 million and
$0.2 million as of July 31, 1997 and 1996, respectively, represent legal and
other associated costs related to the Company's issuance of debt for general
corporate purposes. Deferred financing costs are amortized over the term of the
related debt using the effective interest rate method.

The provisions of Statement of Financial Accounting Standards ("SFAS") No. 87,
"Employers' Accounting for Pensions," require recognition in the balance sheet
of an additional minimum liability and related intangible asset for pension
plans with accumulated benefits in excess of plan assets. At July 31, 1996, the
excess of the additional liability over the reported intangible asset is
reflected, net of income tax effects, as a component of stockholders' equity.

The excess cost over net assets of acquired businesses described in Note 2 is
being amortized on the straight-line basis over 15 to 25 years. Related
amortization expense for the fiscal years ended July 31, 1997, 1996 and 1995 was
$0.8 million, $0.2 million and $0.1 million, respectively. Accumulated
amortization expense as of July 31, 1997 and July 31, 1996 was $1.1 million and
$0.3 million, respectively. Should events or circumstances occur subsequent to
the acquisition of a business which bring into question the realizable value or
impairment of the related goodwill, the Company will evaluate the remaining
useful life and balance of goodwill and make appropriate adjustments. The
Company's principal considerations in determining impairment include the
strategic benefit to the Company of the particular business as measured by
undiscounted current and expected future operating income levels of that
particular business and expected undiscounted future cash flows. Should an
impairment be identified, a loss would be reported to the extent that the
carrying value of the related goodwill exceeds the fair value of that goodwill
as determined by valuation techniques available in the circumstances.

     Workers' Compensation Insurance

The Company is primarily self-insured for workers' compensation claims and pays
all eligible claims through an arrangement with an outside administrator for a
service fee. Individual claims in excess of $0.2 million to $0.4 million,
depending upon the year to which the claim relates, are covered by outside
insurance. The Company funds the claims paid through the administrator based on
the administrator's periodic estimate of the ultimate payout related to known
claims or, for more recent years, based on claims paid by the administrator. The
Company provides for workers' compensation insurance each period based on its
estimate of the total ultimate payout for all claims.

     Revenue Recognition

Revenue for a majority of the Company is recognized on the date goods are
shipped to the customer. The principal source of revenue for the Company's
recently acquired railway signal construction and maintenance business is from
cost-plus-fee and from fixed-price contracts. Revenue on such contracts is
recognized on the percentage of completion method based on costs incurred in
relation to total estimated costs. Provisions for estimated losses on
uncompleted contracts are made in the period in which such losses are
determined. Changes in job performance, job conditions and estimated
profitability may result in revisions to costs and income and are recognized in
the period in which the revisions are determined. Sales returns and allowances
are recognized as a charge against revenue in the period in which the related
revenues are recognized.

     Per Share Data

Primary net income per common share amounts are computed by dividing net income
by the weighted average common and common equivalent shares outstanding during
the year. Common equivalent shares represent the dilutive effect of the assumed
exercise of certain outstanding stock options.


                                      21
<PAGE>
 
           ABC Rail Products
Corporation and Subsidiaries
                    NOTES TO
                CONSOLIDATED 
                   FINANCIAL
                  STATEMENTS 
                 (continued)


     Use of Estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the 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 those estimates.

     New Accounting Pronouncements

SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to Be Disposed Of," was issued in March 1995, and adopted by the
Company in fiscal 1997. This new pronouncement establishes standards on when to
review long-lived assets and certain identifiable intangible assets for
impairment and how to measure that impairment. The impact of adopting this
standard did not have a material impact on the Company's financial position or
results of operations.

SFAS No. 123, "Accounting for Stock-Based Compensation," was issued in October
1995, and adopted by the Company in fiscal 1997. This new pronouncement
establishes financial accounting and reporting standards for stock-based
employee compensation plans and requires a fair value based method to determine
the compensation cost of such plans. The Company, as allowed by the standard,
continues to account for stock-based compensation under the prior method, but
has provided supplemental pro forma disclosure of the effect of adopting the new
accounting method prescribed by the new standard in Note 8.

SFAS No. 128, "Earnings per Share," was issued in February 1997 and will be
adopted by the Company in fiscal 1998. The new pronouncement establishes revised
methods for calculating and reporting earnings per share. Under the revised
methods, basic earnings per share, computed by dividing reported net income by
weighted average common shares outstanding, without regard to dilutive common
stock equivalents, would have been $0.38, $0.83 and $1.26 for the fiscal years
ended July 31, 1997, 1996 and 1995, respectively. Previously reported quarterly
earnings (loss) per share would have been similarly adjusted.

In July 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," and SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information." SFAS No. 130 establishes standards
for reporting and display of comprehensive income and its components (primarily
minimum pension liability adjustments for the Company) in a full set of general
purpose financial statements. SFAS No. 131 introduces a new model for segment
reporting, called the "management approach." The management approach is based on
the way that the chief operating decision maker organizes segments within a
company for making operating decisions and assessing performance. Management is
currently evaluating the provisions of this statement to determine its impact
upon current reporting. Both SFAS No. 130 and SFAS No. 131 must be adopted by
the Company by the fiscal year beginning August 1, 1998.

2.   Business Acquisitions

Effective May 15, 1995, the Company purchased from General Electric Railcar
Wheel and Parts Services Corporation ("GESC") substantially all of the assets of
the railcar wheel mounting facilities of GESC (the "Wheel Mounting Business")
located in Lewistown, Pennsylvania; Calera, Alabama; Chicago Heights, Illinois;
Corsicana, Texas; Riverside, California and Kansas City, Kansas. The assets
acquired included (i) the real property of the facilities located in
Pennsylvania, Alabama, Illinois and Texas, (ii) the leases related to the
facilities located in California and Kansas, (iii) plant, machinery and
equipment located at the facilities, (iv) all inventories relating to the
facilities and (v) all personal property and various other property rights
relating to the facilities.

In consideration for the acquisition of the assets of the Wheel Mounting
Business, the Company paid GESC approximately $26.1 million in cash and assumed
certain of GESC's contractual liabilities, including liabilities under real
property leases related to the facilities located in California and Kansas. The
Company obtained the funds to pay the purchase price and related transaction
costs of approximately $1.0 million from borrowings under the Credit Agreement.

Effective May 31, 1996, the Company acquired Deco Industries Inc. of Milwaukee,
Wisconsin and selected assets of Deco Automation located in Norristown,
Pennsylvania for a comb nation of common stock and cash. The acquired companies
manufacture railroad classification yard retarder control and automation
systems. Pursuant to the purchase agreement, the prior owners will be issued
additional shares of common stock


                                      22

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


if certain earnings goals are met over the next five years. For the years ended
July 31, 1997 and 1996, the assumed issuance of such contingent shares (along
with the assumed earnings level) would be antidilutive to earnings per share.

Effective May 31, 1996, the Company purchased its partner's interest in the ABC
Rail Cogifer Industrial joint venture partnership. The then purpose of ABC Rail-
Cogifer Industrial was to manufacture and sell trackwork from the Cincinnati,
Ohio facility purchased by the partnership from Cogifer in January 1994. The
plant's new role within the Company has been redirected towards both new and
remanufactured track products.

Effective June 21, 1996, the Company began operating a wheel mounting, wheel
assembly and trackwork service business in Tacoma, Washington. The Company is
currently leasing the operating facility from the previous operators with whom
the Company also entered into certain employment, consulting and non-compete
agreements.

Effective December 17, 1996, the Company acquired American Systems Technologies,
Inc. ("AST") of Verona, Wisconsin for common stock. AST provides railway signal
system installation and maintenance to the short line, regional, commuter and
transit railroads. As part of the purchase agreement, the prior owners will be
issued additional shares of common stock if certain earnings goals are met over
the next three years. For the year ended July 31, 1997, the assumed issuance of
such contingent shares (along with assumed earnings level) would be antidilutive
to earnings per share.

The aggregate purchase price paid in the fiscal 1996 business acquisitions was
$6.2 million, including 148,889 shares of the Company's common stock valued at
$3.4 million. The aggregate purchase price paid in the fiscal 1997 business
acquisition was $10.3 million which represented 555,556 shares of the Company's
stock valued at $10.2 million. The individual and aggregate effect of these
acquisitions was not significant to the Company's operations.

The acquisitions were accounted for under the purchase method of accounting.
Accordingly, certain recorded assets and liabilities of the acquired businesses
were revalued to estimated fair values as of the acquisition date. Management
has used its best judgment and available information in estimating the fair
value of those assets and liabilities. Any changes to these estimates are not
expected to be material. The operating results of the acquired businesses are
included in the consolidated statement of operations from the date of
acquisition.

3.  Contract Receivables

Billed contract receivables included in accounts receivable as of July 31, 1997
were as follows:
<TABLE>
<CAPTION>
(in thousands)                                                       1997
-------------------------------------------------------------------------
Contract receivables:
<S>                                                              <C>
     Completed contracts                                          $   861
     Contracts in progress                                          3,089
     Retainage                                                        666
-------------------------------------------------------------------------
                                                                   $4,616
=========================================================================
</TABLE>

Information with respect to contracts in progress as of July 31,
1997 was as follows:

<TABLE>
<CAPTION>
(in thousands)                                                       1997
-------------------------------------------------------------------------
<S>                                                              <C>
Costs incurred on uncompleted contracts                           $16,980
Estimated earnings                                                  2,831
-------------------------------------------------------------------------
                                                                   19,811
Less - Billings to date                                            18,495
-------------------------------------------------------------------------
Included in accounts receivable                                   $ 1,316
=========================================================================
</TABLE>

4.   Accrued Liabilities

Current accrued liabilities at July 31, 1997 and 1996, consisted of the
following:

<TABLE>
<CAPTION>
(in thousands)                                                      1997      1996
<S>                                                              <C>       <C>
Insurance                                                        $ 3,150   $ 2,255
Payroll and benefits                                               2,569     5,025
Interest                                                             733       308
Other                                                              7,621     7,210
----------------------------------------------------------------------------------
                                                                 $14,073   $14,798
==================================================================================
</TABLE>

                                      23

<PAGE>
 
           ABC Rail Products
Corporation and Subsidiaries

                    NOTES TO
                CONSOLIDATED
                   FINANCIAL
                  STATEMENTS
                 (continued)

5.   Long-Term Debt

Long-term debt at July 31, 1997 and 1996,
consisted of the following:

<TABLE>
<CAPTION>
(in thousands)                                             1997         1996
--------------------------------------------------------------------------------
<S>                                                     <C>            <C>
Credit Agreement:
  Non-amortizing term loan                              $      --      $15,000
  Revolving line of credit                                 32,580       23,406
  Acquisition facility                                         --        3,443
Other revolving lines of credit                             1,599        1,210
Capital lease obligations                                     140           --
Other notes payable                                           876           --
Term loans                                                 10,063        9,151
Industrial revenue bonds                                    3,740        4,175
9-1/8% Senior Subordinated Notes                           50,000           --
Less current maturities                                    (3,987)      (6,942)
--------------------------------------------------------------------------------
  Total long-term debt                                     $95,011     $49,443
================================================================================
</TABLE>
On March 31, 1995, the Company negotiated a new five-year credit agreement (the
"Credit Agreement") with a group of lenders allowing for maximum direct
borrowings and outstanding letters of credit of up to $80 million. This new
facility included a $15 million non-amortizing term loan, a $40 million
revolving credit line and a $25 million acquisition facility. On November 30,
1995, the Company and its lenders amended the new facility by increasing the
revolving credit line to $50 million from $40 million, and by recharging the
availability under the acquisition line from the $8.0 million remaining after
the wheel mounting business acquisition to $17.8 million. The Credit Agreement
replaced the 1993 credit agreement and resulted in a fiscal 1995 third quarter
extraordinary after-tax charge of $0.8 million representing the write-off of
unamortized deferred financing costs related to the retired debt. The Credit
Agreement was amended and restated on November 15, 1996, in conjunction with the
issuance of the 9-1/8% Senior Subordinated Notes described below. Under the
amended Credit Agreement, (i) the non-amortizing term loan and the acquisition
facility were paid in full and canceled, (ii) the revolving credit line was
increased to $90 million and (iii) the terms of certain financial covenants were
modified.

Interest on all amounts borrowed under the amended Credit Agreement is payable
at the option of the Company at either the base rate (as defined) plus 0.5%, or
LIBOR (as defined) plus 2.0% and is payable monthly while the base rate is in
effect or every one to six months while LIBOR is in effect. As of July 31, 1997,
the weighted average interest rate of outstanding borrowings under the amended
Credit Agreement was 8.0%. The Company has pledged as collateral for the amended
Credit Agreement substantially all of its property, plant and equipment,
eligible accounts receivable and inventories, intellectual property and capital
stock of its subsidiaries. As of July 31, 1997, availability under the amended
Credit Agreement, which is limited to certain advance rates on eligible accounts
receivables and inventories, was $20.5 million.

The amended Credit Agreement contains various financial covenants which, among
other provisions, include prohibiting or limiting the incurrence of additional
indebtedness. The amended Credit Agreement also contains certain financial
covenants (all as defined) (i) requiring the maintenance of a minimum Interest
Coverage Ratio; (ii) requiring the maintenance of a minimum Consolidated Net
Worth; (iii) requiring the maintenance of a maximum funded debt  to
capitalization ratio; and (iv) which limit the incurrence of Capital
Expenditures. The Company was in compliance with all of the covenants under the
amended Credit Agreement as of July 31, 1997 except for the limitation on
Capital Expenditures for which a waiver was obtained.

In conjunction with the purchase of American Systems Technologies, Inc. ("AST"),
the Company assumed AST's existing $1.6 million demand line of credit with a
third party financial institution. Borrowings under this line are secured by
substantially all assets of AST. Interest is payable monthly at the rate of
8.75% as of July 31, 1997. This note was fully paid by the Company in August
1997.

In conjunction with the purchase of its partner's interest in the ABC Rail-
Cogifer Industrial joint venture partnership (see Note 2), the Company assumed
the joint venture's existing $3.0 million revolving credit facility with a third
party financial institution. Borrowings under this facility were secured by
accounts receivable and inventories of ABC Rail-Cogifer Industrial and bore
interest at 8.75% as of July 31, 1996. Outstanding borrowings under this
facility, which were $1.2 million as of July 31, 1996, were repaid in
conjunction with the issuance of the 9-1/8% Senior Subordinated Notes described
below and this facility was canceled.

                                      24
<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
NOTES TO
CONSOLIDATED
FINANCIAL
STATEMENTS
(continued)


Other notes payable represent three separate notes that were assumed by the
Company in conjunction with the purchase of AST. These notes were fully paid by
the Company in August 1997.

On September 26, 1994, the Company entered into a five-year term loan agreement
to finance up to $9.9 million in capital expenditures for the new wheel
machining center for its Calera, Alabama facility. A total of $9.2 million was
drawn under this term loan. This term loan was repaid in full in conjunction
with the issuance of the 9-1/8% Senior Subordinated Notes described below. The
Company entered into an additional seven-year term loan agreement with the same
lender on July 20, 1995 to finance up to $12.5 million of capital expenditures
for the new rail mill center located in Chicago Heights, Illinois. Through July
31, 1997, $10.8 million has been drawn under this second term loan. The term
loan is secured by the related fixed assets, bears weighted interest at 7.4% as
of July 31, 1997 and contains financial covenants which require the Company to
maintain minimum levels of net worth and a minimum interest coverage ratio.
Except for the interest coverage ratio, the Company was in compliance with all
of its covenants under the term loan as of July 31, 1997. A waiver was obtained
from the lender for the non-compliance on the interest coverage ratio.

The $5.0 million IRBs were issued in March 1994, and are secured by the
Company's facility in Newton, Kansas. The IRBs bear interest at rates varying
between 4-1/4% and 6-1/2% and mature approximately 10% per year through 2004.

On November 15, 1996, the Company filed a Registration Statement with the
Securities and Exchange Commission for the issuance of up to $100 million of
Subordinated Debt Securities and/or shares of its Common Stock. On February 1,
1997, the Company completed an offering (the "Offering") of $50 million of 9-
1/8% Senior Subordinated Notes (the "Notes"). The Company used the $47.9 million
of net proceeds of the Offering to repay certain outstanding indebtedness under
its primary and other credit facilities. Financing cost of $2.2 million was
deferred in connection with the issuance of the Notes. A $0.3 million
extraordinary after-tax loss was recognized in the third quarter of fiscal year
1997 upon the early retirement of this indebtedness. The Notes are general
unsecured obligations of the Company and are subordinated in right of payment to
all existing and future senior indebtedness of the Company and other liabilities
of the Company's subsidiaries. The Notes will mature in 2004, unless repurchased
earlier at the option of the Company after January 15, 1999 at 102% of face
value prior to January 14, 2000, or at 100% of face value thereafter. The Notes
are subject to mandatory repurchase or redemption prior to maturity upon a
Change of Control (as defined). The Indenture under which the Notes were issued
subjects the Company to various financial covenants which, among other things,
require the Company to maintain (all as defined) (i) a minimum Consolidated Net
Worth, (ii) a minimum Operating Coverage Ratio and (iii) a maximum Funded Debt
to Consolidated Capitalization Ratio and limits the Company's ability to (i)
incur additional indebtedness, (ii) complete certain mergers, consolidations and
sales of assets, and (iii) pay dividends or other distributions. The Company was
in compliance with all of its covenants under this obligation as of July 31,
1997.

Cash paid for interest was $6.3 million, $4.9 million and $3.3 million for the
years ended July 31, 1997, 1996 and 1995, respectively.

Maturities of debt as of July 31, 1997, are as follows:
<TABLE>
<CAPTION>
(in thousands)
----------------------------------------------------------------------------
Year ending July 31,
============================================================================
<S>                                                                  <C>
1998                                                                 $ 3,987
1999                                                                   2,602
2000                                                                  35,182
2001                                                                   2,622
2002                                                                   2,652
Thereafter                                                            51,953
----------------------------------------------------------------------------
                                                                     $98,998
============================================================================
</TABLE> 

                                      25

<PAGE>
 
           ABC Rail Products
Corporation and Subsidiaries
                    NOTES TO 
                CONSOLIDATED 
                   FINANCIAL 
                  STATEMENTS 
                 (continued)


6.   Income Taxes
The provision for income taxes for the years ended July 31, 1997, 1996 and 1995,
consisted of the following:

<TABLE> 
<CAPTION> 
(in thousands)                                 1997           1996            1995
-----------------------------------------------------------------------------------
<S>                                           <C>            <C>            <C>
Current tax expense -
  Federal                                     $1,848         $3,604          $3,714
  State                                          297            717             935
-----------------------------------------------------------------------------------
                                               2,145          4,321           4,649
Deferred tax expense (benefit)                   591           (673)          1,562
-----------------------------------------------------------------------------------
  Total provision for income taxes             2,736          3,648           6,211
Income tax benefit related
  to cumulative effect of
  accounting change                               --             --             844
Income tax benefit related to
  extraordinary items                            215             --             564
-----------------------------------------------------------------------------------
                                              $2,951         $3,648          $7,619
===================================================================================
</TABLE>

The principal items comprising the difference between taxes on income before
income taxes, cumulative effect of accounting change and extraordinary items
computed at the federal statutory rate and the actual provision for income taxes
for the years presented were as follows:

<TABLE>
<CAPTION>
(in thousands)                                 1997           1996            1995
-----------------------------------------------------------------------------------
<S>                                           <C>            <C>           <C>
Tax provision computed at
  the statutory rate                          $2,228         $3,527          $6,563
State taxes, net of federal benefit              296            380             730
Nondeductible amortization
  of goodwill                                    176             --              --
Other, net                                       251           (259)            326
-----------------------------------------------------------------------------------
                                              $2,951         $3,648          $7,619
===================================================================================
</TABLE>

Deferred tax assets and liabilities are recorded for all temporary differences
between financial and tax reporting and are the result of differences in the
timing of recognition of certain income and expense items for financial and tax
reporting. The major temporary differences that give rise to deferred tax assets
and liabilities are as follows:

<TABLE>
<CAPTION>
(in thousands)                                July 31, 1997                         July 31, 1996
-------------------------------------------------------------------------------------------------
                                     Assets     Liabilities             Assets        Liabilities
-------------------------------------------------------------------------------------------------
<S>                                   <C>     <C>                       <C>           <C>
Property basis differences           $   --      $(7,454)              $    --           $(5,978)
Insurance reserves                    1,803           --                 1,083                --
Inventory basis differences             617           --                   564                --
Allowance for doubtful
  accounts                              464           --                   427                --
Postretirement and
  postemployment
  reserves                              728         (764)                1,218                --
Other employee benefit
  reserves                              649           --                   406                --
Margin recognition under
  contracts                              --         (959)                   --                --
Net operating loss
  credit carryforwards                  145           --                    80                --
AMT credit carryforwards                259           --                    --                --
Other - net                             793         (121)                  517                (8)
-------------------------------------------------------------------------------------------------
                                     $5,458      $(9,298)               $4,295           $(5,986)
=================================================================================================
</TABLE>


The Company did not record any valuation allowances against deferred tax assets
at July 31, 1997 or 1996 because management believes that the Company will
realize the tax benefits associated with those assets as future tax deductions.
The net operating loss carryforwards that resulted from the acquisition of Deco
expire, if unused, in 2010 and are subject to certain limitations under current
income tax regulations. The alternative minimum tax credit can be carried
forward indefinitely.

Net cash paid for income taxes was $1.7 million, $2.8 million and $5.2 million
for the years ended July 31, 1997, 1996 and 1995, respectively.

7.   Employee Benefit Plans

The Company maintains a defined benefit retirement and disability plan, which
includes certain insurance coverage and death benefits, covering hourly
employees. The plan provides benefits for certain employees that are based on
the employee's 


                                      26

<PAGE>
 
           ABC Rail Products
Corporation and Subsidiaries
                    NOTES TO 
                CONSOLIDATED 
                   FINANCIAL 
                  STATEMENTS 
                 (continued)


years of service and also provides benefits for other employees
that are based on the employee's years of service and compensation upon their
retirement from the Company. The Company makes contributions to the plan at
least equal to the minimum funding requirements under the Employee Retirement
Income Security Act of 1974. The plan invests primarily in investment grade
corporate bonds, government bonds, corporate stocks and cash.

Net periodic pension cost for the years ended July 31, 1997, 1996 and 1995,
included the following components:

<TABLE>
<CAPTION>
(in thousands)                                 1997            1996         1995
=================================================================================
<S>                                            <C>            <C>            <C>
Service cost on benefits earned
  during the period                           $   704         $   707      $  588
Interest cost on projected
  benefit obligation                              845             723         606
Actual return on assets                        (1,841)           (737)       (651)
Net amortization and deferral                   1,355             450         516
Curtailment loss                                   --             511          --
----------------------------------------------------------------------------------
  Net periodic pension cost                   $ 1,063         $ 1,654      $1,059
=================================================================================
</TABLE>
 
The following table sets forth the funded status of the plan at July 31, 1997
and 1996:

<TABLE> 
<CAPTION> 
(in thousands)                                                     1997      1996
=================================================================================
<S>                                                             <C>         <C>
Actuarial present value of benefit obligation -
  Vested benefits                                              $  8,026   $ 6,974
  Non-vested benefits                                             3,251     2,963
Accumulated benefit obligation                                   11,277     9,937
Effect of projected future compensation levels                      114       163
---------------------------------------------------------------------------------
Projected benefit obligation                                     11,391    10,100
Plan assets at fair value                                       (11,341)   (7,969)
---------------------------------------------------------------------------------
Projected benefit obligation in excess
  of plan assets                                                     50     2,131
Net unrecognized gain and prior service cost                     (1,763)   (2,589)
Adjustment required to recognize
  minimum liability                                                  --     2,426
---------------------------------------------------------------------------------
  Accrued (prepaid) pension                                    $ (1,713)  $ 1,968
=================================================================================
</TABLE>

The curtailment loss resulted from the January 1996 decision to permanently
displace certain employees of the Company's former brake shoe facility. See Note
12 for further information.

Key assumptions used in the calculations summarized above are as follows:

<TABLE>
<CAPTION>
                                   1997       1996       1995
=============================================================
<S>                                <C>        <C>        <C>
Discount rate                      7.75%      7.75%      8.0%
Average increase in
  compensation level               5.0        5.0        5.0
Expected long-term rate of
  return on assets                 8.5        8.0        8.0
=============================================================
</TABLE>

The Company also maintains a defined contribution plan for the benefit of
salaried and certain hourly employees. The Company makes matching contributions
in an amount equal to 50.0% of the participant contributions. A maximum of 6.0%
of a participant's yearly compensation is eligible for the matching
contribution. The Company made contributions to the plan of $0.5 million, $0.5
million and $0.3 million for the years ended July 31, 1997, 1996 and 1995,
respectively. In addition, the Company makes additional contributions to the
plan equal to 1.0% of salaried and certain hourly employees' compensation. This
additional contribution was $0.2 million for each of the years ended July 31,
1997, 1996 and 1995.

The Company provides postretirement medical benefits for certain hourly
employees covered by collective bargaining agreements. The Company adopted SFAS
No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions," in the first quarter of fiscal 1994. As of July 31, 1993, the present
value of the accumulated obligation for postretirement medical benefits for
employees covered by collective bargaining agreements was approximately $5.0
million. The Company is recognizing this obligation ratably over the 20-year
period ending in 2014. The Company has established a Voluntary Employee Benefit
Association trust to fund this obligation. Contributions of $1.4 million, $0.4
million and $1.1 million were made to the trust in fiscal 1997, 1996 and 1995,
respectively.


                                      27

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(continued)

Net postretirement expense for the years ended July 31, 1997, 1996 and 1995,
respectively, included the following components:

<TABLE>
<CAPTION>
(in thousands)                                                      1997      1996      1995
--------------------------------------------------------------------------------------------
<S>                                                              <C>       <C>         <C>
Service cost on benefits earned
  during the period                                              $   180   $   192     $ 173
Interest cost on accumulated
  benefit obligation                                                 431       368       351
Actual return on plan assets                                        (242)      (52)      (19)
Net amortization and deferral                                        357       202       214
Curtailment loss                                                      --        79        --
--------------------------------------------------------------------------------------------
  Net periodic postretirement cost                               $   726   $   789     $ 719
============================================================================================
</TABLE>

The following table sets forth the status of the plan as of July 31,
1997 and 1996:

<TABLE>
<CAPTION>
(in thousands)                                                     1997      1996
---------------------------------------------------------------------------------
<S>                                                              <C>       <C>
Actuarial present value of benefit obligation -
  Retirees                                                       $ 2,444   $ 1,597
  Fully eligible active plan participants                            337       362
  Other active participants                                        3,010     3,291
----------------------------------------------------------------------------------
Projected benefit obligation                                       5,791     5,250
Plan assets at fair value                                         (2,465)   (1,023)
----------------------------------------------------------------------------------
Projected benefit obligation
  in excess of plan assets                                         3,326     4,227
Net unrecognized gain                                                 68        83
Unrecognized transition obligation                                (3,408)   (3,621)
----------------------------------------------------------------------------------
  Accrued (prepaid) postretirement liabilities                   $   (14)  $   689
==================================================================================
</TABLE>

The curtailment loss resulted from the January 1996 decision to permanently
displace certain employees of the Company's former brake shoe facility. See Note
12 for further information.

The weighted average discount rate used in the calculations summarized above was
7.75% in both 1997 and 1996.

The assumed health care cost trend rate used in measuring the projected
postretirement benefit obligation as of July 31, 1997, was 7.0% in 1997, and
6.0% thereafter. A one-percentage-point increase in the assumed health care cost
trend rate for each year would increase the accumulated postretirement benefit
obligation as of July 31, 1997, by approximately $0.3 million and the total of
the service and interest cost components of net postretirement benefit cost for
fiscal 1997 by approximately $0.1 million.

The Company provides former hourly and salaried disabled employees continued
medical benefits until age 65 or recovered from disability. The Company adopted
SFAS No. 112, "Employers' Accounting for Postemployment Benefits," as of the
beginning of fiscal 1995. The accounting standard requires the accrual of the
cost of postemployment benefits over the employees' years of service rather than
accounting for such costs on a cash basis. A one-time cumulative adjustment of
$2.1 million ($1.2 million, net of income tax) was recognized as of the
beginning of fiscal 1995.

Net periodic postemployment cost for the years ended July 31, 1997 and 1996,
included the following components:

<TABLE>
<CAPTION>
(in thousands)                                                     1997      1996
---------------------------------------------------------------------------------
<S>                                                              <C>       <C>
Estimated costs for newly disabled employees                     $   80    $   80
Interest cost on projected benefit obligation                       170       162
Net amortization and deferral                                       287        --
---------------------------------------------------------------------------------
   Net periodic postemployment cost                              $  537    $  242
=================================================================================
</TABLE>

The following table sets forth the funded status of the plan at July 31, 1997
and 1996:

<TABLE>
<CAPTION>
(in thousands)                                                     1997      1996
---------------------------------------------------------------------------------
<S>                                                              <C>       <C>
Actuarial present value of benefits obligation -
  Terminated employees fully eligible for benefits               $2,009    $2,084
---------------------------------------------------------------------------------
Accumulated benefit obligation                                    2,009     2,084
Plan assets at fair value                                            --        --
---------------------------------------------------------------------------------
Accumulated benefit obligation in excess
  of plan assets                                                  2,009     2,084
Net unrecognized loss                                              (616)     (179)
---------------------------------------------------------------------------------
  Accrued postemployment liabilities                             $1,393    $1,905
=================================================================================
</TABLE>

The discount rate used in the calculations summarized above was 7.75% in both
1997 and 1996.

8.  Stock Option Plans

The Company has stock option plans which provide for the granting of options to
certain directors, officers and employees to purchase shares of its common stock
within prescribed periods at prices equal to the fair market value on the date
of grant.

                                      
                                      28

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
NOTES TO
CONSOLIDATED
FINANCIAL
STATEMENTS
(continued)


Activity during 1997, 1996 and 1995 under the Company's stock option plans and
with respect to separate options is summarized below:
<TABLE>
<CAPTION>
(in thousands, except
weighted average prices)        Outstanding               Exercisable
=====================================================================
                                  Wtd. Avg.                 Wtd. Avg.
                       Shares   Exer. Price     Shares    Exer. Price
<S>                    <C>      <C>             <C>       <C>
=====================================================================
July 31, 1994             535        $10.64        118         $10.34
   Issued                 237         20.73
   Exercised              (14)        10.00
---------------------------------------------------------------------
July 31, 1995             758         13.80        246          11.18
   Issued                 145         21.19
   Exercised             (139)        11.54
   Canceled               (43)        18.90
---------------------------------------------------------------------
July 31, 1996             721         15.42        310          13.05
   Issued                 165         17.66
   Exercised             (128)        11.65
   Canceled              (126)        19.04
---------------------------------------------------------------------
July 31, 1997             632        $16.04        387         $13.98
=====================================================================
</TABLE> 
<TABLE> 
<CAPTION> 
(in thousands, except lives         Outstanding--      Exercisable--
and weighted average prices)        July 31, 1997       July 31, 1997
---------------------------------------------------------------------
                           Wtd. Avg.    Wtd. Avg.           Wtd. Avg.
Range of                   Remaining        Exer.               Exer.
Exercise Prices    Shares       Yrs.        Price    Shares     Price
=====================================================================
<S>                <C>     <C>          <C>          <C>    <C> 
$10.00 -  $18.50      341        6.6       $11.74       261    $10.55
$18.51 - $21.625      291        7.2       $21.07       126    $21.08
=====================================================================
</TABLE>
As allowed under SFAS No. 123, the Company continues to account for its stock-
based compensation plans in accordance with the prior standard under which it
recognized no compensation expense in 1997 or 1996. Had compensation cost been
determined on the fair market value-based accounting method for options granted
in 1997 and 1996, pro forma net earnings and earnings per share for 1997 would
have been $3.0 million and $0.35, respectively, and pro forma net income and
earnings per share for 1996 would have been $6.4 million and $0.77,
respectively. The weighted average fair value of options granted in 1997 and
1996 was $8.51 and $10.52, respectively. The fair value of each option is
estimated on the date of grant using the Black-Scholes options pricing model
with the following assumptions: weighted average risk-free interest rate of
6.3%; weighted average volatility of 30.4% and 27.3%; expected lives of 7.2
years and 6.9 years and zero dividend yield for 1997 and 1996, respectively.

9.   Operating Leases

The Company leases its corporate office space, seven operating facilities,
automobiles and office equipment for periods ranging from one to five years.
Rent expense under operating leases, including leases with terms less than one
year, was approximately $2.5 million, $1.9 million and $1.6 million for the
years ended July 31, 1997, 1996 and 1995, respectively.

At July 31, 1997, future minimum annual rental commitments required under
operating leases that have initial or remaining noncancelable lease terms in
excess of one year were as follows:
<TABLE>
<CAPTION>
(in thousands)
-----------------------------------------------------------------------------
Year ending July 31,
=============================================================================
<S>                                                                   <C>
1998                                                                   $1,747
1999                                                                    1,357
2000                                                                      989
2001                                                                      520
2002                                                                      473
Thereafter                                                              2,192
-----------------------------------------------------------------------------
                                                                       $7,278
=============================================================================
</TABLE>

10.  Commitments and Contingencies

In connection with its formation and the purchase of certain assets and
liabilities from the Railroad Products Group of Abex in 1987, the Company
obtained a comprehensive environmental indemnity from Abex. The indemnity covers
environmental conditions, whether or not then known, in existence at the time of
the purchase, without dollar or time limit. Shortly after the purchase, the
Company performed surveys to assess the environmental conditions at the time of
the purchase. As a result of these studies, the Company has undertaken
environmental projects, including underground storage tank removal, corrective
action and other remedial action as necessary. Some of these actions are ongoing
and similar actions may be undertaken in the future. The costs of all such
actions had been charged to income in the period incurred. When Abex refused to
compensate the Company for costs incurred, the Company filed suit against Abex
on November 18, 1991. In a separate lawsuit filed in October 1994, the Company
also asserts that Abex is required to indemnify the Company for the reduction in
value of one of the sold properties (a Pennsylvania manufacturing facility
formerly owned by the Company) caused by the environmental contamination at that
site.


                                      29

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(continued)


In October 1995, a judgment in the 1991 lawsuit was finalized with the Company
receiving a payment of $2.8 million from Abex. The Company recorded the receipt
of this payment as a reserve to address other potential matters related to
ongoing Abex issues. The judgment is exclusive of indemnification for any future
environmental claims.

The Company is also a party to various other legal proceedings arising in the
ordinary course of business, none of which is expected to have a material
adverse effect on the Company's business, financial condition or results of
operations.

The Company currently has purchase commitments of $1.9 million related to its
planned special capital project expenditures. The majority of the funds are
expected to be spent during fiscal year 1998.

As of July 31, 1997, the Company has letters of credit outstanding totaling $0.3
million which guarantee certain debt which is recorded in the accompanying
consolidated balance sheet.

11.  Unconsolidated Joint Ventures

ABC Rail-Cogifer Technologies is a 50-50 joint venture partnership of the
Company and Cogifer S.A. ("Cogifer") created by a partnership agreement that
expires in February 2022 unless terminated earlier by the executive committee of
the partnership, by the sale of all or substantially all of the partnership's
assets or by the termination of the related technology exchange agreement. The
partnership's purpose is to market, design, engineer and supply European-style
high-speed and light rail technology to the North American market. The marketing
activities of the Company and the partnership are coordinated by the Company.
Production is subcontracted to the most suitable joint venture partner.

The technology exchange agreement provides the Company access to Cogifer's
design concepts, expertise and information which can be applied by the Company
to: the potentially large intercity "Amtrak-type" rail passenger market; the
small but developing market for high-speed freight railroad switches; and the
North American manufacturing of certain elements of European-style high-speed
and light rail specialty trackwork. Cogifer has similar access to the Company's
technology for use outside North America and other defined markets. Certain of
these exchanges may have a 2% royalty in those situations in which the executive
committee of the partnership determines that a partner has contributed
significant value. To date, no such royalty has been paid to either party.

The Company and Cogifer have also entered into a joint marketing agreement
appointing Cogifer as the Company's exclusive worldwide representative for the
sale of the Company's products, excluding sales in the United States, Canada,
Mexico and certain other countries.

In December 1993, the Company formed a second 50-50 joint venture partnership,
ABC Rail-Cogifer Technologies (Industrial Division) ("ABC Rail-Cogifer
Industrial") with Cogifer. The Company coordinated, among other things, ABC 
Rail-Cogifer Industrial's sales and distribution activities. Sales and marketing
fees of $0.1 million and $0.3 million were charged by the Company to ABC Rail-
Cogifer Industrial in fiscal years 1996 and 1995, respectively. The Company, on
an ongoing basis, purchased rail products from the Cincinnati facility. In May
1996, the Company acquired Cogifer's 50% interest in the partnership. Total
purchases from the partnership for the years ended July 31, 1996 (through May)
and 1995, were $5.3 million and $13.8 million, respectively.

On July 31, 1995, the Company entered into 50-50 joint venture with Anchor Brake
Shoe Company ("Anchor"). The purpose of the joint venture is to design,
manufacture, market and sell railcar composite brake shoes. The Company's
initial contribution to the venture included the inventory and property, plant
and equipment of its composite brake shoe facilities in Chicago and certain
related accounts receivable and other current assets aggregating $3.5 million.
Anchor contributed its composite brake shoe facility which, net of a promissory
note from the joint venture, resulted in an initial contribution of $3.5
million. Certain of the assets contributed to the joint venture by the Company
will be sold by the joint venture. Any difference between the aggregate sales
proceeds and the aggregate contributed value of such assets will be credited to
the appropriate partner if such sale occurs prior to an agreed upon date.
Pursuant to a related Commission Agreement between the Company and the joint
venture, the joint venture must pay the Company a 3% commission on sales of the
joint venture that are generated through the Company. No such commissions were
earned in fiscal 1997 or 1996.


                                      30

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
NOTES TO 
CONSOLIDATED 
FINANCIAL 
STATEMENTS 
(continued)


In May 1996, the Company entered into a joint venture agreement with China's
Ministry of Railroads to establish the Datong ABC Castings Company Ltd. The
joint venture will manufacture wheels in China primarily for the Chinese railway
markets. The Company's contribution of its 40% share in the joint venture will
consist of technical know-how, expertise and cash. The Company's cash infusion
of $9.2 million has been contributed to the joint venture and additional amounts
have been deferred in organizing the venture. The cash funding is being used to
construct a manufacturing facility which is expected to be operational by mid
1998.

During fiscal years 1997, 1996 and 1995, the Company earned equity income (loss)
from its joint ventures of $1.0 million, $(0.1 million) and $0.4 million,
respectively. Additionally, the Company occasionally pays certain items on
behalf of the joint ventures and is subsequently reimbursed for such payments.
The Company also charges computer and engineering fees to some of the joint
ventures. As of July 31, 1997, amounts owed to or from these affiliates were not
material.

12.  Special Charge

During the third quarter of fiscal 1996, the Company recorded a special charge
of $3.2 million. The special charge consisted of the following:

<TABLE> 
<CAPTION> 
(in thousands)
-------------------------------------------------------------------------------
<S>                                                                     <C> 
Plant closure expenses                                                   $1,177
Reengineering costs                                                       1,651
Settlement fees                                                             327
-------------------------------------------------------------------------------
                                                                         $3,155
===============================================================================
</TABLE>

As described in Note 11, on July 31, 1995, the Company entered into a joint
venture with Anchor Brake Shoe Company for the purpose of selling railcar
composite brake shoes. The success of the joint venture in meeting total
production needs from one plant has resulted in the closure of the Company's
former brake shoe facility. The plant closure expenses represent the severance,
pension and other related exit expenses for those employees associated with the
permanent displacement of the plant's vested hourly employees. Pursuant to the
joint venture agreement, any such displacement costs were to be borne by the
Company.

In conjunction with the Company's overall strategic goals and growth objectives,
costs are being incurred to reengineer a number of key business processes.
Business processes are being enhanced in the Track Products Division in the
areas of order fulfillment and in Calera to improve the overall foundry
operation. Supporting these and other ongoing Company processes is the
installation of new computer software and hardware which will allow the Company
to address the "Year 2000" computer issues.

During fiscal 1995, the Company sold metal brake shoes to the National Railroad
of Mexico. Subsequent to this transaction, the Mexican government assessed
additional excise and value added taxes. A final settlement was reached on this
issue during the third quarter of fiscal 1996.

13.  Significant Customers
The Company's largest customers are North American Class I railroads, although
the Company also sells its products to a variety of regional and short line
railroads as well as rail transit systems and new freight car builders.
Customers which accounted for over 10% of the Company's sales in fiscal years
1997, 1996 and 1995 were as follows:

<TABLE>
<CAPTION>
                                                         1997   1996   1995
===========================================================================
<S>                                                      <C>    <C>    <C>
Burlington Northern Santa Fe Corporation                  23%    27%    28%
Union Pacific Corporation                                 21     16     14
===========================================================================
</TABLE> 

No other customer accounted for more than 10% of revenues in any of the three
most recent fiscal years. The Company's five largest customers represented
approximately 58%, 55% and 57% of the Company's sales for the fiscal years ended
July 31, 1997, 1996 and 1995, respectively. A significant decrease in business
from any of these customers, or the loss of any major customer, could have a
material adverse effect on the Company. The Company has no indications that such
decreases or losses are imminent.

14.  Quarterly Financial Data (Unaudited)

The Company's business is somewhat seasonal as evidenced by net sales in the
Company's fiscal 1997 and 1996 third and fourth quarters exceeding sales in the
first two quarters of those years.


                                      31

<PAGE>
 
ABC Rail Products
Corporation and Subsidiaries
                    NOTES TO
                CONSOLIDATED
                   FINANCIAL
                  STATEMENTS
                 (continued)


Quarterly financial data for the years ended July 31, 1997 and 1996 are as
follows (in thousands, except per share data):
<TABLE>
<CAPTION>
For the Year Ended July 31, 1997
==========================================================================
                                     First   Second      Third     Fourth
                                    Quarter  Quarter    Quarter    Quarter
--------------------------------------------------------------------------
<S>                                 <C>      <C>        <C>        <C>
Net sales                           $55,911  $55,710    $73,817    $73,752
Gross profit                          5,373    8,608      6,225      6,915
Operating income                      2,131    5,856      1,814      3,088
Net income before
 extraordinary item                     479    2,608        263        251
Net income                              479    2,608        (47)(a)    251
Net income before
 extraordinary item
 per common share                   $  0.06  $  0.30    $  0.03    $  0.03
==========================================================================

For the Year Ended July 31, 1996
==========================================================================
                                      First   Second      Third     Fourth
                                    Quarter  Quarter    Quarter    Quarter
--------------------------------------------------------------------------
<S>                                 <C>      <C>        <C>        <C>
Net sales                           $58,574  $58,545    $60,139    $63,406
Gross profit                          8,082    8,464      3,853     10,975
Operating income (loss)               5,103    6,008     (2,842)(b)  7,660
Net income (loss)                     2,208    2,690     (2,527)     4,355
Net income (loss)
 per common share                   $  0.27  $  0.33    $ (0.30)   $  0.52
==========================================================================
</TABLE>

(a)  Includes an extraordinary loss of $0.3 million ($0.03 per share) from the
     early extinguishment of debt.
(b)  Includes a special charge of $3.2 million as described in Note 12.

Quarterly per share results are not necessarily additive, as per share amounts
are computed independently for each quarter and are based on respective weighted
average common and common equivalent shares outstanding.

Common Stock Market

The common stock of ABC Rail Products Corporation is traded on the Nasdaq
National Market System under the symbol ABCR. Set forth below are the high and
low closing bid prices for the Company's common stock during the periods
indicated, as reported by Nasdaq.
<TABLE>
<CAPTION>
Quarters Ending                       10/31      1/31      4/30      7/31
=========================================================================
<S>                                  <C>       <C>       <C>       <C>
Fiscal Year Ended July 31, 1997
     High                            22.125    21.625    22.250    19.625
     Low                             14.750    14.500    13.750    15.250
-------------------------------------------------------------------------
Fiscal Year Ended July 31, 1996
     High                            25.250    23.875    25.250    24.125
     Low                             19.500    18.375    19.500    19.250
=========================================================================
</TABLE>
As of July 31, 1997, there were 63 shareholders of record of the common stock,
including banks, brokers and other nominees. The Company did not pay dividends
on its common stock in Fiscal years 1996 and 1997.


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