To Our Valued Shareholders, Customers and Friends:

We are pleased to report our  accomplishments  and  continued  progress  towards
furthering Pioneer Railcorp's  long-term  objective of being a premiere provider
of rail  services  through its portfolio of short line  railroads.  To that end,
Pioneer Railcorp will remain focused on generating profitable growth through the
continued development of our existing subsidiaries, augmented by the acquisition
of additional operating railroads and railroad related businesses.

Indicative of our recent growth is the  continuing  improvement of our operating
results.  For  1997,  net  income  increased  to  $366,245  or 8 cents per share
compared  to net  income of  $102,145  or 2 cents  per  share in 1996.  Revenues
increased  to $12.8  million in 1997 from $11 million in 1996.  Many of the 1997
increases  are  attributable  to  operations  of  recently   acquired   railroad
subsidiaries  and leases  which  include the Keokuk  Junction  Railway,  Shawnee
Terminal  Railway,   Michigan  Southern  Railroad,  and  Rochelle  Railroad.  In
addition,  positive contributions to our operating results were obtained through
continued marketing efforts involving our core customer base.

As we reflect over the past 12 years, we are reminded of the many challenges and
successes at Pioneer  Railcorp.  While most of those  challenges are now history
and  new  challenges  are  always  ahead  of us,  Pioneer  Railcorp's  dedicated
management team and sound business  practices will meet those new challenges and
opportunities  with the same  optimism  and hard work that has  always  been our
hallmark in the industry.

In  closing,  I  would  like  to  take  this  opportunity  to  welcome  our  new
shareholders,  thank our loyal long-term  existing  shareholders,  and extend my
sincere  appreciation to our employees and management team for their dedication,
and to our loyal customers for allowing us to serve them.

Sincerely,



/s/ Guy L. Brenkman
-----------------------
Guy L. Brenkman
Chairman, President and
Chief Executive Officer
<PAGE>


Company Background

Pioneer Railcorp, an Iowa corporation, is a railroad holding company. As used in
this annual report, unless the context requires otherwise, the term "Company" or
"PRC" refers to the parent, Pioneer Railcorp and its subsidiaries: West Michigan
Railroad  Co.  (WMI),  Wabash & Western  Railway  Co.  d/b/a  Michigan  Southern
Railroad  (MSO),  Fort Smith  Railroad Co. (FSR),  Alabama  Railroad Co. (ALAB),
Mississippi  Central  Railroad Co. (MSCI),  Alabama & Florida  Railway Co., Inc.
(AF),  Decatur  Junction  Railway Co. (DT),  Vandalia  Railroad  Company (VRRC),
Minnesota  Central  Railroad Co.  (MCTA),  Keokuk  Junction  Railway Co. (KJRY),
Rochelle  Railroad Co. (RRCO),  Shawnee Terminal Railway Company (STR),  Pioneer
Railroad Equipment Co., Ltd. (PREL), Pioneer Air, Inc. (PAR), Pioneer Resources,
Inc. (PRI), and Pioneer Railroad Services, Inc. (PRS).

The Company operates in two business  activities - railroad  transportation  and
railroad  equipment  leasing.  PRC's rail  system  provides  shipping  links for
customers along its routes and interchanges with six major railroads, Burlington
Northern Santa Fe Railroad (BNSF), Conrail, Inc. (CR), CSX Transportation (CSX),
Illinois Central Railroad (IC),  Norfolk Southern Railway (NS) and Union Pacific
Railroad  (UP).  Additionally,  the Company has  interchanges  with five smaller
railroads,  the Kansas City  Southern  Railway  (KCS),  the  Arkansas & Missouri
Railroad (AM),  the Twin Cities & Western  Railway  (TCWR),  the Toledo Peoria &
Western Railway  Corporation  (TPW), and Indiana  Northeastern  Railroad Company
(IN).  PRC's  rail  system is  devoted to  carrying  freight.  PRC also seeks to
encourage  development on or near, and  utilization of, its real estate right of
way by potential  shippers as a source of additional  revenue.  The Company also
generates revenue by granting to various entities,  such as utilities,  pipeline
and communications companies and non-industrial tenants, the right to occupy its
railroad  right of way and other real estate  property.  The Company also leases
rail equipment to, and repairs rail equipment owned by, others.

Pioneer Railcorp Subsidiaries

Fort Smith Railroad Co.
On July 7, 1991, the Fort Smith Railroad Co. (FSR), a wholly-owned subsidiary of
Pioneer  Railcorp,  entered  into a  twenty-year  lease (with three  twenty-year
renewals)  with  the  Missouri  Pacific  Railroad  Company  (now  Union  Pacific
Railroad)) and operates 18 miles of track from Fort Smith to Barling,  Arkansas.
The FSR's primary  interchange is with the Union Pacific  Railroad Company (UP).
FSR also  interchanges  with the  Arkansas & Missouri  Railroad Co. (AM) and the
Kansas City Southern  Railway (KCS).  The railroad's  principal  commodities are
iron, steel, scrap, baby food,  fiberglass,  particle board,  charcoal,  grains,
frozen poultry, meal, chemicals,  alcoholic beverages,  industrial sand, lumber,
paper, pulpboard, fiberboard, peanuts, fertilizer and military movements.

Alabama Railroad Co.

On October 25, 1991,  the Alabama  Railroad  Co., a  wholly-owned  subsidiary of
Pioneer Railcorp, purchased 60 miles of railroad facilities and real estate from
CSX Transportation (CSX). The line runs from Flomaton to Corduroy,  Alabama, and
interchanges  with CSX in Flomaton.  The railroad's  principal  commodities  are
pulpwood, particle board, and finished lumber.

Mississippi Central Railroad Co.

On April 1, 1992,  Pioneer  Railcorp  purchased  the common stock of the Natchez
Trace  Railroad  from  Kyle  Railways,  Inc.  The  railroad  runs  from  Oxford,
Mississippi to Grand Junction, Tennessee, a total of 56.5 miles, 51 of which are
located in  Mississippi.  The railroad  interchanges  with the Norfolk  Southern
Railway (NS) at Grand Junction,  Tennessee and the Burlington  Northern Santa Fe
(BNSF) at Holly  Springs,  Mississippi.  The  Company  changed  the name of this
wholly-owned  subsidiary to Mississippi  Central  Railroad Co. (MSCI) in January
1993.  The  railroad's  principal  commodities  include  outbound  finished wood
products as well as the resins,  chemicals  and pulpwood for  production  of the
finished wood products, scrap steel and cottonseed.

Alabama & Florida Railway Co.

On November 23,  1992,  the Alabama & Florida  Railway Co. (AF), a  wholly-owned
subsidiary of Pioneer  Railcorp,  purchased the tangible assets of the A&F Inc.,
d/b/a the Alabama & Florida Railroad  Company.  This line runs from Georgiana to
Geneva,  Alabama, a distance of 76 miles and interchanges with CSX at Georgiana.
The railroad's principal commodities are resins, plastics, fertilizer,  peanuts,
and pulpwood.
<PAGE>


Decatur Junction Railway Co.

On September 23, 1993,  the Decatur  Junction  Railway Co. (DT), a  wholly-owned
subsidiary of Pioneer Railcorp,  signed a lease agreement with Cisco Co-op Grain
Company  (Cisco) and on  September  24,  1993 with  Central  Illinois  Shippers,
Incorporated  (CISI),  for the lease of two  segments  of track in east  central
Illinois.  Approximately  38 miles of railroad is operated  including 8 miles of
trackage rights on the Illinois Central Railroad (IC) through Decatur, Illinois.
The leases run through December 31, 2006. The railroad's  principal  commodities
are primarily agriculture products.

Vandalia Railroad Company

On October 7, 1994,  Pioneer Railcorp acquired all the outstanding  common stock
of the  Vandalia  Railroad  Company.  The line  located in  Vandalia,  Illinois,
interchanges  with  Conrail  (CR) and is  approximately  3.45  miles  long.  The
railroad's  principal  commodities are steel pipe, plastic pellets,  fertilizer,
and feed ingredients.

Minnesota Central Railroad Co.

On December 12,  1994,  Pioneer  Railcorp's  wholly-owned  subsidiary  Minnesota
Central Railroad Co., acquired certain assets of MNVA Railroad,  Inc. The assets
purchased  included  approximately  94 miles of operating  railroad in southwest
Minnesota,  7 locomotives,  33 railcars,  an engine house in Morton,  Minnesota,
several vehicles,  pieces of maintenance  equipment,  and  miscellaneous  parts,
materials and supplies.  The railroad  interchanges with the Burlington Northern
Santa Fe (BNSF) at Hanley Falls and the Twin Cities and Western  Railroad (TCWR)
at Norwood.  The railroad's principal  commodities are grain, clay,  fertilizer,
canned goods, dairy products, and particle board.

West Michigan Railroad Co.

On July 11, 1995,  Pioneer  Railcorp signed an agreement with the Trustee of the
Southwestern  Michigan  Railroad  Company,  Inc., d/b/a  Kalamazoo,  Lakeshore &
Chicago Railroad  (KLSC),  to purchase all of the tangible assets of KLSC. Those
assets include approximately 15 miles of track and right-of-way,  extending from
Hartford to Paw Paw,  Michigan.  Pioneer  Railcorp  then  assigned  its right to
purchase to the West Jersey Railroad Co., a wholly owned  subsidiary of Pioneer,
which had been  operating  the former KLSC tracks  under a  Interstate  Commerce
Commission  Directed Service Order since June 24, 1995. West Jersey Railroad Co.
amended  its  articles  of  incorporation  to change its name to "West  Michigan
Railroad Co." effective October 2, 1995. The sale was approved by the Interstate
Commerce  Commission  by order served  October 18, 1995,  and the West  Michigan
Railroad  Co. took title to the  property on October 24,  1995.  The  railroad's
principal commodities are frozen and canned foods.

Keokuk Junction Railway Co.

On March 12, 1996, Pioneer Railcorp purchased 93% of the common stock of KNRECO,
Inc., an Iowa  corporation  d/b/a Keokuk Junction Railway  (hereinafter  "KJRY")
from the shareholders,  and purchased all of the remaining common shares of KJRY
in April of 1996.  KJRY operates a common carrier  railroad line within the City
of Keokuk,  Iowa,  from  Keokuk to  LaHarpe,  Illinois,  and a branch  line from
Hamilton to Warsaw,  Illinois,  a total of  approximately 38 miles. In addition,
KJRY  owns all of the  common  stock of  Keokuk  Union  Depot  Company,  an Iowa
corporation,  that owns the  former  Keokuk  Union  Depot  building,  along with
surrounding  track and real estate.  KNRECO,  Inc. changed its corporate name to
Keokuk Junction Railway Co. effective April 10, 1996. The KJRY interchanges with
the Burlington  Northern Santa Fe (BNSF) at Keokuk, Iowa and the Toledo Peoria &
Western Railway Corporation (TPW) at LaHarpe, Illinois. The railroad's principal
commodities are corn, corn germ, corn syrup,  meal, gluten feed,  calcined coal,
ferro silicon, scrap iron, and railroad wheels.

Rochelle Railroad Co.

On March 25, 1996, Pioneer Railcorp through its wholly-owned subsidiary Rochelle
Railroad Co. (RRCO),  signed a one year lease with a five-year  renewal  option,
signed  in  March  1997,  with  the  City  of  Rochelle,  Illinois,  to  operate
approximately  2 miles of track serving the Rochelle  Industrial  Park. The line
interchanges with the Burlington  Northern Santa Fe (BNSF) and the Union Pacific
Railroad  Company (UP) Train  operations  began April 15, 1996.  The  railroad's
principal commodity is frozen foods. The City of Rochelle, Illinois,  terminated
the Rochelle Railroad Co.'s lease agreement effective January 19, 1998, however,
Rochelle  Railroad Co.  continues to operate on the trackage pending the outcome
of certain  legal  proceedings.  The City is seeking  to  replace  the  Rochelle
Railroad  as  operator  of the  line,  with one of the  on-line  customers.  The
Rochelle   Railroad  is  seeking  damages,   seeking  relief  from  the  Surface
Transportation  Board, and is also seeking to condemn the property.  The outcome
of these actions is uncertain.
<PAGE>


Shawnee Terminal Railway Company

On November 13, 1996, Pioneer Railcorp purchased 100% of the common stock of the
Shawnee  Terminal  Railway  Company.  The  line  located  in  Cairo,   Illinois,
interchanges  with the Illinois Central  Railroad (IC) and is approximately  2.5
miles long. The railroad's principal commodities are glycol and railroad freight
cars for cleaning.

Michigan Southern Railroad

On December 19,  1996,  Pioneer  Railcorp  through its  wholly-owned  subsidiary
Wabash & Western Railway Co. d/b/a Michigan Southern Railroad, signed a two year
lease with the Michigan Southern Railroad Company, Inc., Morris Leasing Co. Ltd.
and Gordon D. Morris to operate 53 miles of track and certain  railroad  related
assets.  The lease  contains an  exclusive  option to purchase  the stock of the
Michigan  Southern  Railroad  Company,  Inc. and the  railroad  assets of Morris
Leasing Co.,  Ltd. and Gordon D. Morris  within the lease term.  The railroad is
comprised  of three  separate  non-contiguous  lines,  one  located in  southern
Michigan  and  two  located  in  northern  Indiana.   All  lines  have  separate
interchanges  with Conrail (CR).  The Michigan line also  interchanges  with the
Indiana Northeastern Railroad Company (IN). The railroad's principal commodities
are scrap  paper,  scrap iron,  fertilizer,  plastics,  plywood,  sugar and corn
syrup.

Other Operations

Other  operations  engaged in by the Company are  performed  by its wholly owned
subsidiaries,  Pioneer  Railroad  Equipment Co., Ltd. (PREL) which was formed on
April 1, 1990 and Pioneer Railroad  Services,  Inc. (PRS) which began operations
on October 1, 1993. PREL leases equipment to the Company's  subsidiary railroads
and also purchases,  sells and leases  equipment to and from unrelated  parties.
PREL also earns income from non-company  railroads on its fleet of approximately
900 railcars (as of December 31,  1997) while  carrying  freight on  non-company
railroads.  PREL also engages in retail sales of promotional items. PRS provides
accounting,  management,  marketing,  operational  and  agency  services  to the
Company's subsidiary railroads.  Pioneer Resources,  Inc. was formed on December
30, 1993 to manage real estate and auxiliary resources for Company subsidiaries.
Pioneer Air, Inc. was formed on August 5, 1994 and currently  owns a Cessna 421B
aircraft which is used by Pioneer Railcorp subsidiaries  exclusively for Company
business travel.

Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations

The  following  discussion  should  be read in  connection  with  the  Company's
consolidated financial statements. related notes and other financial information
included elsewhere in this annual report.

Results of Operations

The Company's 1997 operating  results  include full year  operations of the 1996
acquisitions of the Keokuk Junction Railway and the Shawnee Terminal Railway and
also  leases  commencing  in  1996 of the  Michigan  Southern  Railroad  and the
Rochelle  Railroad.  These  subsidiaries  are referred to  collectively  as "new
operating subsidiaries".

The Company's net income in 1997  increased by 259% to $366,245 up from $102,145
in 1996.  Operating revenue  increased by $1.8 million,  or 16% to $12.8 million
from $11 million in 1996.  Operating  expense increased in 1997 by $1.2 million,
or 13%, to $10.8 million from $9.6 million in the prior year.  Operating  income
increased in 1997 by $570,000,  or 41% to $1.97 million from $1.4 million in the
prior year.

Several operating subsidiaries performances were responsible for the increase in
operating  income in 1997. The new operating  subsidiaries  increased  operating
income in 1997 by approximately $1 million. The Mississippi Central Railroad had
a decrease in operating income of $121,000 in 1997 as a result of a reduction in
revenues  from lost local  pulpwood  loadings  which is  attributed to increased
competition for the local pulpwood  supply to  destinations  not served by rail.
Mississippi  Central Railroad  operating income was also affected by a reduction
in cotton seed  loadings  in 1997 due to a decrease  in local  acreage of cotton
seed planting  resulting  from the "Freedom to Farm Act" passed by Congress.  In
addition,  Fort Smith  Railroad  operating  income  decreased  $109,000  in 1997
primarily  resulting from a decrease in demurrage  revenue due to a reduction in
paper car loadings.
<PAGE>


Pioneer Railroad  Equipment Co., Ltd. had a decrease in operating income in 1997
of  approximately  $233,000 as a direct  result of a decrease in  non-affiliated
lease income in 1997 compared to 1996. The decrease is primarily attributable to
the  expiration  in May 1996 of a short term lease of 150 covered  hopper  cars.
PREL continues to seek  opportunities for income generation from  non-affiliates
and it is likely  that  additional  lease  revenues  will be  realized in future
periods depending on demand for railcars and locomotives.

The remaining  operating  subsidiaries had overall operating income in 1997 that
was comparable to 1996.

Operating Revenue

Operating  revenue  increased in 1997 by $1.8 million,  or 16%, to $12.8 million
from $11 million in the prior year.  The new  operating  subsidiaries  increased
operating  revenue by  approximately  $2.1  million in 1997.  The  Company had a
$216,000  decrease in revenue in 1997 from the lease of its  railcars and excess
locomotives to non-affiliated  entities.  The decrease is primarily attributable
to the  expiration in May 1996 of a short term lease of 150 covered hopper cars.
The Company  continues to seek  opportunities  for the  generation  of equipment
lease income from  non-affiliates and it is likely that additional lease revenue
will be  realized  in future  periods  depending  on  demand  for  railcars  and
locomotives.  The  Mississippi  Central  Railroad  had a decrease  in revenue of
$183,000  in 1997 as a  direct  result  of a  reduction  in local  pulpwood  and
cottonseed loadings previously  described.  The Minnesota Central Railroad had a
decrease in revenue of $109,000 in 1997 primarily resulting from decreased first
quarter 1997 loadings due to severe winter weather in the region.

The  remaining  operating  subsidiaries  had  overall  revenue in 1997 which was
comparable to 1996.

Operating Expense

Operating  expense  increased in 1997 by $1.2 million,  or 13%, to $10.8 million
from  $9.6  million  in the  prior  year.  Substantially  all  of the  increased
operating  expense  is  attributable  to the new  operating  subsidiaries  which
increased operating expense approximately $1.1 million in 1997.

Maintenance of way and structures  expense (MOW) increased  $409,000,  or 44% to
$1,341,000 from $932,000 in the prior year. The new operating  subsidiaries were
responsible  for 67% or  approximately  $274,000 of the increased MOW expense in
1997. The Minnesota  Central was  responsible for $81,000 or 20% of the increase
in MOW  expense in 1997  primarily  because  the MCTA MOW expense was reduced in
1996 from the  capitalization  of  $150,000  of labor  related to the MCTA track
rehabilitation  project in 1996. Other operating  subsidiaries had insignificant
changes in MOW expense in 1997 compared to 1996.

Maintenance of equipment expense (MOE) increased $193,000,  or 14% to $1,535,000
from  $1,342,000  in  the  prior  year.  The  new  operating  subsidiaries  were
responsible  for 64% or  approximately  $122,000 of the increased MOE expense in
1997. Most of the remaining  increase in MOE expense is attributable to increase
costs  associated  with managing and  maintaining  the Company's  railcar fleet.
Other operating  subsidiaries had  insignificant  changes in MOE expense in 1997
compared to 1996.

Transportation  expense (TRAN) increased  $300,000,  or 11% to $3.1 million from
$2.8 million in the prior year.  The new operating  subsidiaries  increased TRAN
expense by approximately  $493,000. The Minnesota Central had a decrease in TRAN
expense of $140,000 in 1997 primarily attributable to decreased fuel and payroll
expense,  resulting  from both the  reduction in operations in the first quarter
1997  because of severe  winter  weather,  and also  reductions  resulting  from
improved  operating  procedures that sought to maximize efficient train handling
while considering track conditions and shipping demands. In addition,  reduction
in corporate  management  reduced TRAN  expense  approximately  $95,000 in 1997.
Other operating  subsidiaries had insignificant  changes in TRAN expense in 1997
compared to 1996.

Administration  expense (ADMIN) increased $216,000 in 1997 to $3,283,000,  or 7%
from $3,067,000 in 1996. The new operating subsidiaries were responsible for 72%
or  approximately  $155,000 of the  increased  ADMIN  expense in 1997.  Expenses
related to professional services,  public relations, and other corporate support
expenditures  increased ADMIN expense by  approximately  $100,000 in 1997. Other
operating  subsidiaries had signficant changes in ADMIN expense in 1997 compared
to 1996.

Depreciation and amortization  expense increased $104,000,  or 7%, to $1,497,000
compared to  $1,393,000 in the prior year.  Approximately  $58,000 or 56% of the
increase is related to the new operating subsidiaries,  approximately $27,000 or
26% of the increase is related to the growth of the Company's railcar fleet.
<PAGE>


Other Income and Expense Income Statement Line Item Discussion

Other income and expense, excluding interest expense and gain on sale of assets,
decreased  $41,000 to $205,000  compared to $246,000 in the prior year. In 1997,
approximately  $225,000  of lease  income was  generated  from the  granting  of
easements and leases for the use of railroad right of way property,  compared to
$125,000 of lease income in 1996, an increase of $100,000. This increase was the
direct  result of  increased  efforts  and strong  emphasis on  identifying  and
collecting  revenues from third parties occupying Company property.  In addition
to lease income, other income and expense includes revenues generated from scrap
sales, and other miscellaneous non-operating revenues and expenses. In 1996, the
Fort Smith Railroad  received  $93,000 of revenue  representing  its interest in
track  removed and scrapped from its Paris Branch line. No other item in 1997 or
1996 included in this category is individually material.

Interest expense increased $49,000 in 1997 to $1,384,000  compared to $1,335,000
in 1996. Most of this increased  interest expense is related to the financing of
the Keokuk Junction Railway acquisition and the debt assumed in the transaction.

Net gain on fixed  asset  dispositions  increased  $47,000  in 1997 to  $105,000
compared to $58,000 in 1996. In 1997,  approximately  $11,000 of the net gain on
fixed asset  dispositions was attributable to the sale of 5 acres of land at the
Alabama Railroad.  Also in 1997, a gain of $62,000 was realized from the sale of
three locomotives,  a gain of $19,000 was realized from the sale of a crane, and
a gain of $13,000 was realized from the disposition of three railcars.  In 1996,
approximately   $30,000  of  the  net  gain  on  fixed  asset  dispositions  was
attributable  to the sale of 5.3  miles of  Alabama  Railroad  right of way.  In
addition,  a gain of $20,000  was  realized  from the sale of a  locomotive  and
$10,000 was realized from the sale of two trolley cars. The remainder of the net
gain in 1996  resulted from the  disposition  of other  miscellaneous  pieces of
equipment, none of which was disposed of at a significant gain or loss.

Impact of New Accounting Pronouncements:

In July 1997,  Statement of Financial  Accounting  Standard No. 130,  "Reporting
Comprehensive  Income"  (FAS  130),  was  issued  by  the  Financial  Accounting
Standards Board. The standard establishes  reporting of comprehensive income for
general purpose  financial  statements.  Comprehensive  income is defined as the
change in equity of a business  enterprise  during a period and all other events
and  circumstances  from  non-owner  sources.  The  standard  is  effective  for
financial  statement periods beginning after December 15, 1997. The Company does
not believe  the  adoption of the  standard  will have a material  impact on its
consolidated financial statements.

In July 1997,  Statement of Financial  Accounting Standard No. 131,  "Disclosure
about Segments of an Enterprise and Related  Information"  (FAS 131), was issued
by the Financial  Accounting  Standards Board. The standard requires the Company
to disclose the factors used to identify reportable segments including the basis
of  organization,  differences in products and services,  geographic  areas, and
regulatory  environments.  FAS 131 additionally requires financial results to be
reported in the financial  statements for each reportable segment.  The standard
is effective for financial  statement periods beginning after December 15, 1997.
The Company does not believe the  adoption of the standard  will have a material
impact on its consolidated financial statements.

Year 2000 Compliance:

The Year  2000  compliance  issue  exists  because  many  computer  systems  and
applications  currently use two-digit fields to designate a year. As the century
date  change  occurs,  date-  sensitive  systems  may either fail or not operate
properly unless the underlying programs are modified or replaced.

The Company has  initiated  a program to assure that all  computer  applications
will be Year 2000 compliant by the year-end 1998. The program includes  engaging
an outside  consultant  to review all of the  Company's  computer  hardware  and
software,  as well as to confirm  with outside  vendors that their  products are
Year 2000 compliant.  Although final cost estimates have not been determined, it
is not expected that these expenses will have a material impact on the Company's
financial condition, liquidity, or results of operations.

Liquidity and Capital Resources

The Company  primarily  uses cash  generated  from  operations  to fund  working
capital  needs and relies on long-term  financing  for  railcars,  new operating
subsidiaries, and other significant capital expenditures.
<PAGE>


The  Company  has  working  capital  facilities  totaling  $1,175,000  of  which
$1,027,000  was available  for use at the end of 1997. In addition,  the Company
has seen the market value of its railcar fleet increase  significantly  over the
last several years. This increase in value has resulted from the short supply of
railcars compared to the increased demand for their use. The Company believes it
could  refinance or sell part of its railcar fleet and generate up to $1 million
in cash.

On November 26, 1997, the Company entered into a financing  agreement with First
of America Bank - Illinois,  N.A.  borrowing $3 million at a fixed interest rate
of 9.5%,  subject to adjustment after five years to equal the Five-Year Treasury
+ 250  basis  points.  The  loan  proceeds  were  used to pay off the  Company's
acquisition  line of credit and other  long-term debt assumed through the Keokuk
Junction Railway Co.  acquisition.  The loan is primarily  collateralized by all
assets of the Keokuk Junction Railway.

In March 1996, the Company negotiated a credit facility with its primary bank to
provide  a $2.5  million  annual  revolving  acquisition  line of  credit.  This
facility is  collateralized  by the common stock of the Alabama Railroad Co. and
the  Mississippi  Central  Railroad Co., as well as the Company's  investment in
stock of any  subsidiaries  acquired  under the line.  The interest rate for the
line is currently  11%. The interest rate is  adjustable  quarterly to 2.5% over
New York Prime,  limited to a one percent  annual  increase or decrease,  not to
exceed  13.5% or be reduced  below 10%.  Any  amounts  drawn on the line must be
repaid  monthly  over a seven  year  period.  The line was fully  drawn  upon in
connection  with the  Company's  March 12,  1996  acquisition  of a  controlling
interest of KNRECO,  Inc.  d/b/a Keokuk  Junction  Railway,  common  stock,  and
subsequently  repaid in full on November 26, 1997 through the new debt financing
agreement  with First of America  Bank - Illinois,  N.A.,  as  described  in the
previous paragraph, and is available for use through March 8, 1999.

Long-term  equipment  financing has historically  been readily  available to the
Company for its railcar  acquisition  program.  The Company  believes it will be
able to continue obtaining  long-term equipment financing should the need arise.
The Company's  plans for new debt in the  foreseeable  future is contingent upon
new railroad acquisitions and increased needs and/or opportunities for railcars.
The Company does not expect to make  significant  additions to its railcar fleet
in 1998.

The Company plans to take advantage of the favorable  interest rate  environment
by refinancing some of its present equipment debt in the first half of 1998.

On July 1, 1995, the Company's  stock split and warrant  issuance became payable
to  shareholders.  The 2 for 1 stock split increased the number of shares issued
and  outstanding  from  2,099,042 to  4,198,084.  At the same time  shareholders
became  entitled  to purchase  an  additional  4,198,084  shares  through  stock
warrants  issued by the  Company as  dividends.  One warrant was issued for each
share of common stock held after the split,  entitling  the holder to purchase 1
share of common  stock for $2.00 per share.  The shares  purchased  through  the
exercise of the warrants must be held for 1 year from date of purchase. In 1997,
a total of 9,670 warrants were exercised and the Company  realized  $19,340 as a
result of their  exercise.  As of December 31, 1997, a total of 66,844  warrants
originally  issued had been exercised,  and the Company realized $133,688 on the
issuance of the warrants. The Company expects additional capital to be generated
by the continued exercise of warrants but is uncertain as to the amount.

The  Company  granted  836,000  options  to  certain  employees  under  its 1994
incentive  stock option plan. The options are exercisable at prices equal to the
market value of the  Company's  stock at the date of grant.  The exercise  price
ranges from $1.50 to $4.40 per share.  In 1997,  a total of 26,500  options were
exercised under this plan and the Company  realized $39,750 from their exercise.
As of December 31, 1997, a total of 69,700  options had been  exercised  and the
Company has  realized  $104,550  on the  exercise  of the  options.  The Company
expects  additional  capital to be  generated by the exercise of options in 1997
but is uncertain  as to the amount.  As of December 31, 1997, a total of 691,271
options are outstanding under this plan.

On June 26,  1996,  the  Company's  shareholders  approved a stock  option  plan
permitting the issuance of 407,000 shares of common stock. Options granted under
the plan are  incentive  based  except for the options  granted to the CEO whose
options  are  non-qualified.  The  options  will be  fully  vested  and  will be
exercisable  as of July 1, 2001. The exercise date can be accelerated if Pioneer
Railcorp common shares reach a closing price of $7.25 per share, or higher,  for
any  consecutive  10-day  period,  as reported in the Wall Street  Journal.  The
options will be exercisable  at $2.75,  the market price of the common shares at
the date the options were granted,  in whole or in part within 10 years from the
date of  grant.  As of  December  31,  1997,  a total  of  282,000  options  are
outstanding under this plan.
<PAGE>


The Company plans to continue  efforts to  rehabilitate  the  Minnesota  Central
Railroad and has is currently negotiating with the State of Minnesota Department
of  Transportation  (MNDOT)  for  approximately  $6  million  of  interest  free
financing to rehabilitate  the entire line. The Company  believes the outcome of
these  negotiations  will be know by the end of the  second  quarter  1998.  The
Company  believes  that  there is strong  support  for the  project  from  local
economic development agencies and a majority of the railroad's customers.

The Michigan  Southern  Railroad lease expires in December 1998, and the Company
has an option to purchase the stock and leased personal property of the railroad
for $2.6  million.  The Company has not yet  determined  if it will exercise its
purchase  option.  If the purchase option is exercised the transaction  would be
funded with long-term debt. In 1997, the Michigan Southern Railroad generated $1
million in revenue and $326,000 of operating income.

The City of Rochelle,  Illinois,  terminated  the Rochelle  Railroad Co.'s lease
agreement  effective  January  19,  1998.  The City is seeking  to  replace  the
Rochelle  Railroad as operator of the line,  with one of the on-line  customers.
The  Rochelle  Railroad  is seeking  damages,  seeking  relief  from the Surface
Transportation  Board, and is also seeking to condemn the property.  The outcome
of these actions is uncertain.  If the Rochelle  Railroad  ceases  operating the
railroad,  it would have a material  adverse effect on the Company's  results of
operation.  In 1997, the Rochelle Railroad Co. generated $408,000 in revenue and
$250,000 of operating income.

Except for the  uncertainties  of the  Rochelle  Railroad  Co.  litigation,  the
Company anticipates favorable outcomes involving current legal proceedings.  The
Company does not  anticipate  any material  judgements  against it or any of its
subsidiaries will arise out of the current proceedings.

The Company  believes its cash flow from  operations  and its available  working
capital  credit  lines,  will be more than  sufficient to meet  liquidity  needs
through at least 1998.

Balance Sheet and Cash Flow Items

The Company generated net cash from operating activities of $1.8 million in 1997
and $1.8  million  in 1996.  Net cash  from  operating  activities  for 1997 was
generated  from  $366,000  of  net  income,   $1,497,000  of  depreciation   and
amortization,  $243,000 of deferred  income  taxes,  and  $275,000 of income tax
refunds  received,  reduced by a decrease in accounts payable of $455,000 and by
$126,000  net cash  used by  changes  in  various  other  operating  assets  and
liabilities.

In 1997, the Company  purchased  approximately  $1.4 million of fixed assets and
capital improvements which included the purchase of approximately 89 railcars at
a total cost of  $740,000.  The Company  capitalized  approximately  $149,000 in
leasehold  improvements  relating  to side  tracks  constructed  on the  Decatur
Junction  Railway and the  Rochelle  Railroad.  Capital  expenditures  for track
totaled $111,000 in 1997 of which $37,000 was for the Minnesota Central Railroad
and $65,000 for a yard extension at the Keokuk  Junction  Railway.  In addition,
$149,000 of  transportation  equipment was  capitalized  in 1997 which  included
$30,000 for the  purchase of a  locomotive,  $68,000 of capital  expenditure  to
rebuild  locomotives  and  $51,000 of  capital  expenditures  for the  Company's
corporate aircraft.  A parcel of land in Fort Smith,  Arkansas was purchased for
$42,000  for use as a reload  facility.  In  addition,  a parcel  of land in the
township of Babbie,  Alabama was  purchased for $18,000 and is leased to a large
wood  yard  that has  long-term  contracts  in place  for rail  delivery  of its
product.  Other capital  expenditures  in 1997 include  $92,000 for vehicles and
equipment  and  $179,000  of  other  miscellaneous  capital  expenditures.   The
purchases of railcars for $740,000, vehicles for $54,000, and the locomotive for
$30,000,  were  financed  with  long-term  fixed rate  financing.  The remaining
$576,000 of capital  expenditures  were initially funded through working capital
of which $406,000 was  replenished  through the refinancing of 75 covered hopper
railcars in December 1997.

During  1997,  the  Company  was  awarded a $396,000  grant  from the  Minnesota
Department of  Transportation  which is funded with federal  disaster funds from
the Federal  Railroad  Administration  pursuant to the Federal  Fiscal Year 1997
Supplemental  Appropriations  Act. The grant is designed to aid the Company with
the labor and material costs of  rehabilitating  and repairing  track and bridge
structures  of the Minnesota  Central  Railroad Co. which were damaged by severe
weather  conditions  during the 1996-1997  winter.  As of December 31, 1997, the
Company had expended  approximately $234,000 and had receivables of $112,000 and
payables of $112,000 pursuant to the grant.
<PAGE>


Pioneer  Railcorp sold all of the  outstanding  stock of the Columbia & Northern
Railway  to a  non-  affiliated  entity  on  July  26,  1997  for  $15,000.  The
transaction did not have a material effect on the Company's  financial  position
or results of operation.

On February 20,  1998,  Pioneer  Railcorp  through its  wholly-owned  subsidiary
Pioneer Industrial Railway Co., was assigned a lease by the Peoria Pekin & Union
Railway Company (PPU) to operate  approximately  9 miles of railroad  located in
Peoria County,  Illinois. The PRY interchanges with the PPU at Peoria, Illinois.
The railroad's principal commodities are steel, lumber, and salt.

As of December 31, 1997, the Company had a commitment to purchase 37 railcars at
a total cost of $301,000.  The Company  closed the  transaction  on February 17,
1998 and funded the entire amount with fixed rate long-term financing.
<PAGE>


PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
<TABLE>

ASSETS
                                                                                       1997        1996
----------------------------------------------------------------------------------------------------------
<S>                                                                                <C>          <C>   
Current Assets
   Cash ........................................................................   $  407,428   $  501,212
   Accounts receivable, less allowance for doubtful
      accounts 1997 $82,375; 1996 $45,291 ......................................    2,367,509    2,071,289
   Inventories .................................................................      351,331      420,952
   Prepaid expenses ............................................................      192,952      261,427
   Income tax refund claims ....................................................       74,602      349,881
   Deferred taxes ..............................................................       66,400       25,901
                                                                                  ------------------------
        Total current assets ...................................................    3,460,222    3,630,662

Investments, cash value of life insurance ......................................       95,547       74,962

Property and Equipment, net ....................................................   19,974,702   20,131,566

Intangible Assets, less accumulated amortization
   1997 $197,724; 1996 $140,109 ................................................    1,117,205    1,171,114
                                                                                  ------------------------
                                                                                  $24,647,676  $25,008,304
                                                                                  ========================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
   Notes payable ...............................................................  $   250,034  $   769,535
   Current maturities of long-term debt ........................................    1,836,132    1,813,246
   Accounts payable ............................................................    2,518,190    2,973,258
   Accrued expenses ............................................................      432,145      491,610
   Income taxes payable ........................................................       61,749       18,978
                                                                                  ------------------------
        Total current liabilities ..............................................    5,098,250    6,066,627
                                                                                  ------------------------
Long-Term Debt, net of current maturities ......................................   12,465,498   12,564,133
                                                                                  ------------------------

Deferred Taxes .................................................................    2,250,700    1,967,651
                                                                                  ------------------------

Minority Interest in Subsidiaries ..............................................    1,186,000    1,188,000
                                                                                  ------------------------

Commitments and Contingencies (Note 12)

Stockholders' Equity
   Common  stock,  Class A  (voting),  par  value  $.001 per  share,  authorized
      20,000,000 shares, issued and outstanding
      1997 4,609,513 shares; 1996 4,573,343 shares .............................        4,607        4,571
   Additional paid-in capital ..................................................    2,040,203    1,981,149
   Retained earnings ...........................................................    1,602,418    1,236,173
                                                                                  ------------------------
                                                                                    3,647,228    3,221,893
                                                                                  ------------------------
                                                                                  $24,647,676  $25,008,304
                                                                                  ========================
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>


PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1997 and 1996




                                                         1997          1996
--------------------------------------------------------------------------------

Railway operating revenue ..........................   $12,779,249  $10,979,218
                                                       -------------------------

Operating expenses
   Maintenance of way and structures ...............     1,340,940      931,574
   Maintenance of equipment ........................     1,534,999    1,342,059
   Transportation ..................................     3,155,099    2,851,485
   General and administrative ......................     3,282,602    3,067,191
   Depreciation ....................................     1,439,010    1,343,377
   Amortization ....................................        57,878       49,966
                                                       -------------------------
                                                        10,810,528    9,585,652
                                                       -------------------------

      Operating income .............................     1,968,721    1,393,566
                                                       -------------------------

Other income (expenses)
   Interest income .................................         5,522        7,709
   Interest expense ................................    (1,384,325)  (1,335,304)
   Lease income ....................................       224,569      125,295
   Gain on sale of property and equipment ..........       105,113       57,820
   Provision for unamortized interest discounts
      due to debt refinancing ......................      (101,245)          --
   Other, net ......................................        76,297      112,584
                                                       -------------------------
                                                        (1,074,069)  (1,031,896)
                                                       -------------------------

      Income before provision for income taxes
        and minority interest in preferred stock
        dividends of consolidated subsidiaries .....       894,652      361,670

Provision for income taxes .........................       405,687      135,960
                                                       -------------------------

      Income before minority interest in preferred
        stock dividends of consolidated subsidiaries       488,965      225,710

Minority interest in preferred stock dividends of
   consolidated subsidiaries .......................       122,720      123,565
                                                       -------------------------

      Net income ...................................   $   366,245  $   102,145
                                                       =========================

Basic earnings per common share ....................   $       .08  $       .02
                                                       =========================

Diluted earnings per common share ..................   $       .08  $       .02
                                                       =========================

Weighted average number of common shares used in
   computing earnings per common share .............     4,593,750    4,530,379
                                                       =========================

See Notes to Consolidated Financial Statements.
<PAGE>



PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1997 and 1996
<TABLE>
                                          Common Stock
                                     ---------------------
                                        Class A (voting)     Additional
                                     ---------------------    Paid-In      Retained
                                       Shares      Amount     Capital      Earnings
------------------------------------------------------------------------------------
<S>                                  <C>         <C>         <C>          <C>  
Balance at December 31, 1995 ....    4,487,881   $   4,487   $1,832,353   $1,134,028
   Common stock issued to acquire
      property, equipment, and
      inventory .................        2,342           2        8,238           --
   Common stock issued upon
      exercise of stock warrants
      and options ...............       83,120          82      140,558           --
   Net income ...................           --          --           --      102,145
                                     -----------------------------------------------

Balance at December 31, 1996 ....    4,573,343        4,571   1,981,149    1,236,173
   Common stock issued upon
      exercise of stock warrants
      and options ...............       36,170           36      59,054           --
   Net income ...................           --           --          --      366,245
                                     -----------------------------------------------
Balance at December 31, 1997 ....    4,609,513    $   4,607  $2,040,203   $1,602,418
                                      ==============================================
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>

PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997  AND 1996
<TABLE>
                                                                                     1997           1996
-----------------------------------------------------------------------------------------------------------
<S>                                                                               <C>            <C>    
Cash Flows From Operating Activities
   Net income ................................................................    $  366,245     $  102,145
   Adjustments to reconcile net income to net cash provided
      by operating activities:
      Minority interest in preferred stock dividends of consolidated 
        subsidiaries .........................................................       122,720        123,565
      Depreciation ...........................................................     1,439,010      1,343,377
      Amortization ...........................................................        57,878         49,966
      (Increase) in cash value life insurance ................................       (20,585)        (5,085)
      (Gain) on sale of property and equipment ...............................      (105,113)       (57,820)
      Deferred taxes .........................................................       242,550        185,625
      Provision for unamortized interest discounts due to debt refinancing ...       101,245           --
      Changes in assets and liabilities:
        (Increase) decrease in assets:
           Accounts receivable ...............................................      (296,220)      (103,068)
           Income tax refund claims ..........................................       275,279       (202,292)
           Inventories .......................................................        69,621          1,991
           Prepaid expenses ..................................................        68,475       (104,113)
        Increase (decrease) in liabilities:
           Accounts payable ..................................................      (455,068)       538,375
           Accrued expenses ..................................................       (59,465)       (39,900)
           Income taxes payable ..............................................        42,771          1,611
                                                                                  -------------------------
           Net cash provided by operating activities .........................     1,849,343      1,834,377
                                                                                  -------------------------
Cash Flows From Investing Activities
   Proceeds from sale of property and equipment ..............................       194,959        108,650
   Purchase of property and equipment ........................................    (1,371,992)    (2,179,547)
   Intangible assets .........................................................        (3,969)       (26,659)
   Acquisition of subsidiaries, net of cash acquired .........................          --       (2,795,644)
                                                                                  -------------------------
           Net cash (used in) investing activities ...........................    (1,181,002)    (4,893,200)
                                                                                  -------------------------
Cash Flows From Financing Activities
   Proceeds from short-term borrowings .......................................     3,915,971      1,443,750
   Proceeds from long-term borrowings ........................................     4,608,427      5,715,100
   Principal payments on short-term borrowings ...............................    (4,435,472)      (754,547)
   Principal payments on long-term borrowings ................................    (4,785,421)    (3,130,573)
   Proceeds from common stock issued upon exercise of
      stock warrants and options .............................................        59,090        140,640
   Preferred stock dividend payments to minority interest ....................      (122,720)      (123,565)
   Repurchase of minority interest ...........................................        (2,000)        (7,000)
                                                                                  -------------------------
           Net cash provided by (used in) financing activities ...............      (762,125)     3,283,805
                                                                                  -------------------------

           Net increase (decrease) in cash ...................................    $  (93,784)    $  224,982
Cash, beginning of year ......................................................       501,212        276,230
                                                                                  -------------------------
Cash, end of year ............................................................    $  407,428     $  501,212
                                                                                  =========================
Supplemental Disclosures of Cash Flow Information
   Cash payments for:
      Interest ...............................................................    $1,415,858     $1,324,640
                                                                                  =========================

      Income taxes (net of refunds 1997 $232,251; 1996 $112,471) .............    $ (154,913)    $  151,448
                                                                                  =========================
</TABLE>
<PAGE>


PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997  AND 1996
<TABLE>
                                                                                     1997           1996
-----------------------------------------------------------------------------------------------------------
<S>                                                                               <C>            <C>    
Supplemental Schedule of Noncash Investing
   and Financing Activities
   Railroad acquisitions:
      Fair value of assets acquired, net of cash of $338,714 .................    $       --     $5,686,890
      Cash paid for stock and assets .........................................            --     (2,795,644)
                                                                                  -------------------------
      Liabilities and debt assumed and stock issued ..........................    $       --      2,891,246
                                                                                  =========================

   Reconciliation:
      Liabilities assumed ....................................................    $       --     $2,444,442
      Debt assumed ...........................................................            --        445,564
      Issuance of 342 shares of common stock .................................            --          1,240
                                                                                  -------------------------
                                                                                  $       --     $2,891,246
                                                                                  =========================
   Additional property, equipment and inventory acquired
      upon issuance of 2,000 shares of common stock ..........................    $       --     $    7,000
                                                                                  =========================

   Accounts receivable applied to acquire equipment ..........................    $       --     $    4,741
                                                                                  =========================
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>


PIONEER RAILCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------


Note 1.  Nature of Business and Significant Accounting Policies

Nature of business:  Pioneer Railcorp is the parent company of twelve short-line
common carrier railroad  operations,  an equipment leasing company, a subsidiary
which owns an  airplane,  and two service  companies.  Pioneer  Railcorp and its
subsidiaries (the "Company") operate in the following states: Alabama, Arkansas,
Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi, and Tennessee.

The Company's subsidiaries include the following:

 West Michigan Railroad Co.             Pioneer Air, Inc.
 Minnesota Central Railroad Co.         Pioneer Railroad Services, Inc.
 Vandalia Railroad Company              Keokuk Junction Railway Co. and its
 Decatur Junction Railway Co.             subsidiary, Keokuk Union Depot Company
 Alabama & Florida Railway Co., Inc.    Wabash & Western Railway Co., d/b/a
 Mississippi Central Railroad Co.         Michigan Southern Railroad
 Alabama Railroad Co.                   Rochelle Railroad Co.
 Fort Smith Railroad Co.                Shawnee Terminal Railway Company
 Pioneer Railroad Equipment Co., Ltd.   Pioneer Resources, Inc.

Pioneer Railroad  Equipment Co., Ltd. holds title to a majority of the Company's
operating  equipment,  and Pioneer Air,  Inc.  owns an airplane  utilized by the
Company  for  business  purposes.   Pioneer  Railroad  Services,  Inc.  provides
management,  administrative  and agency  services  to the  Company's  subsidiary
railroads.  Pioneer Resources,  Inc. holds title to certain real estate adjacent
to one of the Company's railroads.  All other subsidiaries are active short-line
common carrier railroad operations.

Significant accounting policies:

Principles of consolidation:  The consolidated  financial statements include the
accounts of Pioneer Railcorp and its wholly-owned subsidiaries.  All significant
intercompany transactions and balances have been eliminated in consolidation.

Presentation  of cash flows:  For the  purposes  of  reporting  cash flows,  the
Company considers all highly liquid debt instruments  purchased with maturity of
three months or less to be cash equivalents. There are no cash equivalents as of
December 31, 1997 and 1996.

Use of estimates in the preparation of financial statements:  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.

Revenue recognition:  Freight revenue, generally derived on a per car basis from
on-line customers and connecting carriers with whom the Company interchanges, is
considered earned at the time a shipment is either delivered to or received from
the connecting carrier at the point of interchange.

Inventories:   Inventories   consisting  of  various   mechanical  parts,  track
materials,  locomotive supplies and diesel fuel, are stated at the lower of cost
(determined  by the average  cost method) or market.  Inventories  are used on a
daily basis for normal operations and maintenance.

Property and equipment:  Property and equipment is stated at cost.  Depreciation
is computed  principally on a straight-line  basis over the following  estimated
useful lives:

                                                                          Years
                                                                        --------
Roadbed ....................................................                20
Transportation equipment ...................................             10-15
Railcars ...................................................             10-15
Buildings ..................................................             20-40
Machinery and equipment ....................................              5-10
Office equipment ...........................................              5-10

Leasehold improvements are depreciated over the lesser of the lease term or life
of the improvements.
<PAGE>


Maintenance and repair expenditures, which keep the rail facilities in operating
condition, are charged to operations as incurred.  Expenditures considered to be
renewals and betterments are capitalized if such expenditures  improve the track
conditions  and benefit  future  operations  with more efficient use of the rail
facilities.

The  Company  reviews  applicable  assets  on a  quarterly  basis  to  determine
potential  impairment by comparing  carrying value of underlying assets with the
anticipated  future cash flows and does not believe that impairment exists as of
December 31, 1997 and 1996.

Intangible  assets:  Intangible assets consist  principally of goodwill which is
being  amortized  by the  straight-line  method over a  forty-year  period.  The
Company reviews intangible assets quarterly by subsidiary to determine potential
impairment  by  comparing  the  carrying  value  of  the  intangible   with  the
undiscounted anticipated future cash flows of the related property before income
taxes and management fees generated by Pioneer Railroad Services, Inc. If future
cash flows are less than the carrying value, the Company will determine the fair
market value of the property and adjust the carrying value of the intangibles if
the fair market  value is less than the  carrying  value.  The Company  does not
believe that impairment exists as of December 31, 1997 and 1996.

Earnings per common share: The Financial  Accounting  Standards Board (FASB) has
issued  Statement No. 128,  "Earnings per Share,"  which  supersedes  Accounting
Principles  Board  (APB)  Opinion  No.  15.  State-  ment No. 128  requires  the
presentation  of earnings  per share by all  entities  that have common stock or
potential common stock, such as options,  warrants, and convertible  securities,
outstanding that trade in a public market.  Those entities that have only common
stock  outstanding  are required to present basic  earnings  per-share  amounts.
Basic  per-share  amounts are computed by dividing net income (the numerator) by
the weighted-average number of common shares outstanding (the denominator).  All
other  entities are  required to present  basic and diluted  per-share  amounts.
Diluted  per-share  amounts assume the  conversion,  exercise or issuance of all
potential  common stock  instruments  unless the effect is to reduce the loss or
increase the net income per common share.

The Company  initially applied Statement No. 128 for the year ended December 31,
1997, and, as required by the Statement,  has restated all per share information
for the prior year to conform to the Statement.

Income taxes: Deferred taxes are provided on a liability method whereby deferred
tax assets are  recognized for deductible  temporary  differences  and operating
loss and tax credit  carryforwards  and deferred tax  liabilities are recognized
for taxable  temporary  differences.  Temporary  differences are the differences
between  the  reported  amounts of assets and  liabilities  and their tax bases.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of
management,  it is more likely than not that some portion or all of the deferred
tax  assets  will not be  realized.  Deferred  tax assets  and  liabilities  are
adjusted  for the  effects  of  changes  in tax  laws  and  rates on the date of
enactment.

Government grant: During 1997, the Company was awarded a $395,688 grant from the
Minnesota  Department of  Transportation  which is funded with federal  disaster
funds from the Federal  Railroad  Administration  pursuant to the Federal Fiscal
Year 1997  Supplemental  Appropriations  Act.  The grant is  designed to aid the
Company with the labor and material costs of rehabilitating  and repairing track
and bridge structures belonging to the Minnesota Central Railroad Co. which were
damaged by severe weather conditions in late 1996 and early 1997. As of December
31,  1997,  the Company had  expended  approximately  $234,000  and had recorded
receivables of $112,000 and accounts payable to vendors of $112,000  pursuant to
the grant.

The grant funds are applied as a reduction of the related capital  additions for
rehabilitating  and  repair of the  applicable  track and bridge  structures  in
determining the carrying value of the assets.  The grant is recognized as income
by way of reduced  depreciation  charges over the estimated  useful lives of the
underlying property and equipment.

Self-insurance:  The Company self-insures a portion of the risks associated with
medical expenses incurred by its employees and their dependents. Under the terms
of the  self-insurance  agreement,  the  Company  is  responsible  for the first
$20,000 of qualifying medical expenses per person on an annual basis and limited
to an aggregate excess amount computed under the terms of the insurance contract
using specified  participant  rates. An insurance contract with a life insurance
company  covers  individual  claims in excess of $20,000 on an annual  basis and
total claims  exceeding  the  aggregate  excess,  subject to a maximum  lifetime
reimbursement of $2,000,000 per person.
<PAGE>


Note 2.  Property and Equipment

Property and equipment consist of the following:

                                                            December 31,
                                                   -----------------------------
                                                       1997              1996
                                                   -----------------------------
Land .......................................       $ 1,412,388       $ 1,352,965
Roadbed ....................................         7,567,135         7,455,782
Transportation equipment ...................         2,202,965         2,235,551
Railcars ...................................         9,963,828         9,659,443
Buildings ..................................         1,090,207         1,078,122
Machinery and equipment ....................           933,034           873,279
Office equipment ...........................           395,122           379,171
Leasehold improvements .....................           211,371            67,511
Capital projects ...........................           800,667           324,352
                                                   -----------------------------
                                                    24,576,717        23,426,176
Less accumulated depreciation ..............         4,602,015         3,294,610
                                                   -----------------------------
                                                   $19,974,702       $20,131,566
                                                   =============================

Note 3.  Pledged Assets, Notes Payable, and Long-Term Debt

The Company has a $75,000 line of credit with Citizens  Bank and Trust  Company,
Chillicothe,  Missouri, that expires April 1998, bears interest at 10.5%, and is
collateralized by transportation equipment. The Company had outstanding balances
under this line of credit of none and $75,000 as of December  31, 1997 and 1996,
respectively.

The Company has a $500,000 line of credit with First of America Bank - Illinois,
N.A.,  Peoria,  Illinois,  that expires June 1998,  bears interest at prime,  as
published in The Wall Street Journal, plus 1%, and is collateralized by accounts
receivable and general intangibles of certain  subsidiaries.  The Company has no
outstanding balance under this line of credit as of December 31, 1997.

The Company has a $600,000 line of credit with First of America Bank - Illinois,
N.A.,  Peoria,  Illinois,  that expires July 1998,  bears interest at prime,  as
published in The Wall Street Journal, plus 1%, and is collateralized by accounts
receivable  and general  intangibles  of certain  subsidiaries.  The Company had
outstanding  balances  under this line of credit of $148,050  and $347,276 as of
December 31, 1997 and 1996, respectively.

The Company has various  unsecured notes payable totaling  $101,984 and $142,861
as of December 31, 1997 and 1996,  respectively,  for the financing of insurance
premiums.  These notes are due in monthly  installments  from $2,198 to $26,141,
including  interest  ranging from 8.5% to 11.11%,  with final install- ments due
from April to May 1998.

The Company had a $400,000  line of credit  with Keokuk  Savings  Bank and Trust
Company,  Keokuk,  Iowa,  which was  renegotiated  with First of American Bank -
Illinois,  N.A., in July 1997,  bore interest at prime, as published in The Wall
Street  Journal,  plus 1.5%,  and was  collateralized  by  accounts  receivable,
inventory, and general intangibles. The Company had an outstanding balance under
this line of credit of $204,398 as of December 31, 1996.
<PAGE>


Long-term debt at December 31, 1997 and 1996, consists of the following:
<TABLE>
                                                                                        1997        1996
                                                                                   ------------------------
<S>                                                                                <C>           <C>    
Mortgage  payable,  First of  America  Bank -  Illinois,  N.A.,  due in  monthly
   installments of $3,775,  including interest at 8.5%, through October 1, 1999 
   At that  date and every  five  years  thereafter,  the  interest  rate may be
   adjusted  based on the Bank's  base rate,  final  installment  due June 2008,
   collateralized by Pioneer
   Railcorp's corporate headquarters building ...................................  $   406,299  $   416,112
Mortgage payable, First of America Bank - Illinois, N.A., due in
   monthly  installments  of $19,314, including interest at 9.25%, through
   December  2001. At that date,  the interest  rate adjusts to a U.S.  Treasury
   index (5-year constant  maturity) plus 3.5%,  final  installment due December
   2006,  collateralized  by real estate,  rail facilities,  and other assets of
   Alabama & Florida Railway Co., Inc. ..........................................    1,398,669    1,500,000
Mortgage payable, Camden National Bank, due in monthly install-
   ments of $4,304, including interest at 12%, final installment due
   July 2001, collateralized by Alabama Railroad Co. real estate and
   rail facilities ..............................................................      161,785      192,019
Notes payable, Norwest Equipment Finance, Inc., due in monthly
   installments of $2,184 to $8,743,  including  interest  ranging from 8.85% to
   10.75%, final installments due from May 2002 to November 2004, 
   collateralized by railcars and equipment .....................................    1,638,397    1,597,880
Note payable, Keycorp, due in monthly installments of $22,744,
   including interest at 8.86%, final installment due December 2003,
   collateralized by railcars ...................................................    1,266,399    1,419,675
Notes payable, Nations Bank, due in monthly installments from
   $8,524 to $23,305,  including  interest  ranging  from 8.75% to 9.35%,  final
   installments due from December 2002 to December
   2003, collateralized by railcars .............................................    1,929,281    1,315,557
Notes payable, FBS Leasing, due in monthly installments from
   $510 to $12,998, including interest ranging from 8.37% to 9.6%, final
   installments due from August 2001 to October 2004, collateralized by railcars.    1,087,819    1,218,244
Notes payable, US Bancorp, due in monthly installments from $637
   to $11,995,  including  interest ranging from 9% to 10.9%, final installments
   due from September 2001 to December 2002, collateralized by railcars .........    1,023,926    1,687,445
Notes payable, Concord Commercial Group, due in monthly install-
   ments from $1,105 to $4,516, final installments due from June 1998
   to March 1999, including interest at 9%, collateralized by railcars ..........      108,950      234,132
Notes payable, Minnesota Valley Bank, due in monthly installments
   of $4,700,  including  interest at prime plus 2-2.75%,  final installment due
   December 2001, collateralized by equipment acquired from MNVA Railroad, Inc. .      168,603      204,667
Note payable, U.S. Small Business Administration, due in monthly
   installments  of $7,577,  including  interest at 4%,  final  installment  due
   October 2000, collateralized by track acquired from MNVA
   Railroad, Inc. ...............................................................      235,197      314,956
Note payable, Rail Authority, interest only payments required through
   October 1998, then due in monthly installments of $3,975,  including interest
   at 7.5%, final installment due January 2011, collateralized
   by rail line acquired from MNVA Railroad, Inc. ...............................      380,000      380,000
Note payable, LDI Corporation, due in monthly installments of
   $16,731, including interest at 10.25%, final installment due
   December 2003, collateralized by locomotives .................................      896,982    1,000,000
Various notes payable, due in monthly installments from $404
   to $2,630, including interest ranging from  6.75% to 10.25%, final
   installments due from April 1998 to December 2001,
   collateralized by vehicles and railcars ......................................      109,591      147,078
Note payable, First of America Bank - Illinois, N.A., due in
   monthly installments of $39,041, including interest at 9.5%,
   through September 2002. At that date, the interest rate will
   be adjusted to 250 basis points over the weekly average yield
   on U.S. Treasury Securities, final installment due September
   2007, collateralized by Keokuk Junction Railway Co. stock
   and assets ...................................................................    3,000,000         --
Notes payable, Center Capital Corporation, due in monthly
   installments from $1,453 to $2,489,  including  interest from 9.05% to 9.75%,
   final installments due from January 2002 to
   September 2004, collateralized by 70 ton box cars ............................      188,732         --
Note payable, Pulman Bank & Trust Company, due in monthly
   installments of $4,933, including interest at 9.45%, final
   installment due December 2004, collateralized by covered hoppers .............      301,000         --
<PAGE>

                                                                                        1997        1996
                                                                                   ------------------------

Mortgage payable, State of Illinois Department of Transportation,
   due in annual installments of $40,581, including interest at 2%,
   final installment due December 2004, collateralized by railroad
   and railroad ties (net of unamortized discount of $79,521) ...................         --        217,751
Note payable, Citizens Bank and Trust Company, due in monthly
   installments of $4,410, including interest at 9.5%, final install-
   ment due June 1997, collateralized by locomotives ............................         --         29,984
Note payable, U.S. Small Business Administration, due in monthly
   installments  of $3,062,  including  interest at 4%,  final  installment  due
   January 2004,  collateralized by second mortgage on all subsidiary-owned real
   estate and a personal  guarantee of the  subsidiary's  former president which
   the Company has indemnified (net of unamortized discount of $35,529) .........         --        187,655
Note payable, Citizens Bank and Trust Company, due in monthly
   installments of $42,483,  including interest adjustable quarterly to New York
   prime plus 2.5%, final  installment due March 2003,  collateralized by common
   stock in Alabama  Railroad  Co.,  Mississippi  Central  Railroad Co., and any
   property later acquired with these loan proceeds .............................         --      2,314,224
                                                                                   ------------------------
                                                                                    14,301,630   14,377,379
Less current portion ............................................................    1,836,132    1,813,246
                                                                                   ------------------------
                                                                                   $12,465,498  $12,564,133
                                                                                   ========================
</TABLE>

Aggregate maturities required on long-term debt as of December 31, 1997, are due
in future years as follows:

Years ending December 31:                               Amount
-----------------------------------------------------------------
   1998 ..............................                $ 1,836,132
   1999 ..............................                  1,919,483
   2000 ..............................                  2,054,848
   2001 ..............................                  2,444,922
   2002 ..............................                  1,787,504
   Thereafter ........................                  4,258,741
                                                      -----------
                                                      $14,301,630
                                                      ===========


Note 4.  Income Tax Matters

The Company and all but three of its  subsidiaries  file a consolidated  federal
income tax return.  Those three  subsidiaries  file separate  federal income tax
returns.

The  provision  (credit) for income taxes  charged to  operations  for the years
ended December 31, 1997 and 1996, was as follows:

                                                          1997          1996
                                                        ----------------------
Current:
   Federal ......................................       $115,432     $ (57,678)
   State ........................................         47,705         8,013

Deferred ........................................        242,550       185,625
                                                        ----------------------
                                                        $405,687      $135,960
                                                        ======================

The income tax  provision  differs from the amount of income tax  determined  by
applying the federal  income tax rate to pretax income from  operations  for the
years ended December 31, 1997 and 1996, due to the following:

                                                                 1997    1996
                                                                 -------------

Computed "expected" tax expense ..............................   35.0%   35.0%
Increase (decrease) in income taxes
   resulting from:
   State income taxes, net of federal tax benefit ............    6.0     8.8
   Other .....................................................    4.3    (6.2)
                                                                 ------------
                                                                 45.3%   37.6%
                                                                 ============
<PAGE>


Deferred tax assets and  liabilities  consist of the following  components as of
December 31, 1997 and 1996:

                                                     1997               1996
                                                 ------------------------------
Deferred tax assets:
   AMT credit carryforwards ..............       $   434,500        $   401,000
   NOL carryforwards .....................         1,037,100            832,000
   Deferred compensation .................            29,800             25,000
   Other .................................            66,400             25,901
                                                 ------------------------------
                                                   1,567,800          1,283,901
Deferred tax liabilities:
   Property and equipment ................        (3,752,100)        (3,181,000)
   Other .................................              --              (44,651)
                                                 ------------------------------
                                                 $(2,184,300)       $(1,941,750)
                                                 ==============================

The components giving rise to the deferred tax assets and liabilities  described
above have been included in the  consolidated  balance sheets as of December 31,
1997 and 1996 as follows:

                                                      1997              1996
                                                   ----------------------------

Current deferred tax assets ..................     $    66,400      $    25,901
Net noncurrent deferred tax liabilities ......      (2,250,700)      (1,967,651)
                                                   ----------------------------
Net deferred tax liability ...................     $(2,184,300)     $(1,941,750)
                                                   ============================

The Company  and its  subsidiaries  have  Alternative  Minimum Tax (AMT)  credit
carryforwards  of approxi- mately $435,000 and $401,000 at December 31, 1997 and
1996,  respectively.  This excess of AMT over regular tax can be carried forward
indefinitely   to  reduce  future  federal  income  tax   liabilities.   Certain
subsidiaries of the Company also have net operating loss carryforwards  totaling
approximately  $2,811,000  at  December  31,  1997,  which can be used to offset
future taxable income of those  subsidiaries.  Net operating loss  carryforwards
expire as follows:

Years ending December 31:                              Amount
---------------------------------------------------------------
    2008                                             $    8,000
    2009                                                 16,000
    2010                                                352,000
    2011                                              1,656,000
    2012                                                779,000
                                                     ----------
                                                     $2,811,000
                                                     ==========


Note 5.  Retirement Plan

The  Company  has  a  defined  contribution  plan  covering   substantially  all
employees,  except  employees  who are  members of a union  which has  bargained
separately for retirement benefits. Employees are eligible to participate in the
plan upon employment and may elect to contribute, on a tax deferred basis, up to
15% of their salary, or $9,500,  whichever is least.  Company  contributions are
discretionary, and during 1997 and 1996, the Company elected to match 50% of the
first 8% of each employee's contributions.  Expenses under the plan were $43,769
and $34,778 for the years ended December 31, 1997 and 1996, respectively.


Note 6.  Deferred Compensation Agreements

The  Company  has  deferred  compensation  agreements  with two Keokuk  Junction
Railway Co.  employees.  The agreements  provide  monthly  benefits for 15 years
beginning with the month immediately  following the employees' normal retirement
date, as defined in the agreements.  If an employee  terminates  employment with
the  Company  for any reason  other than death  prior to the  employees'  normal
retirement date, benefits are rendered on a pro rata basis. The present value of
the estimated  liability  under the agreements is being accrued ratably over the
remaining  years to the date when the employees are first  eligible for benefits
using a discount rate of 7%. Deferred  compensation  expense totaled $12,638 and
$10,541 for the years ended December 31, 1997 and 1996, respectively.
<PAGE>


Note 7.  Stock Options and Warrants

In October 1995, the Financial  Accounting  Standards Board issued  Statement of
Financial   Accounting   Standards   No.  123,   "Accounting   for   Stock-Based
Compensation"  (SFAS 123). SFAS 123 prescribes a fair-value based measurement of
accounting for  stock-based  compensation  plans with  employees,  including the
Company's  stock option plans which are described  below.  The fair-value  based
measurement  prescribed by SFAS 123 results in the  recognition of  compensation
for all awards of stock to  employees.  The Company's  present  accounting is in
accordance with APB Opinion No. 25 and related  interpretations  which generally
requires that the amount of compensation  cost that must be recognized,  if any,
is the quoted market price of the stock at the measurement date, less the amount
the grantee is required to pay to acquire the stock.  SFAS 123 provides that its
recognition and measurement  provisions may be adopted on or after the beginning
of the fiscal  year in which it was  issued,  but does not  require an entity to
adopt those provisions. The Company has elected not to adopt the recognition and
measurement provisions of SFAS 123.

On April 12,  1994,  the Board of  Directors  approved a stock option plan under
which the  Company  granted  options to key  management,  other  employees,  and
outside  directors for the purchase of 760,000  shares of its common stock.  The
plan was approved by the Company's  stockholders  on June 11, 1994.  The options
became exercisable when the Company's stock reached a $4 trading price for a ten
day period in July 1995,  as specified  in the stock  option plan.  The exercise
price is equal to the  trading  price on the date of the grants and ranges  from
$1.50 to $3.92 per share.  Since the target  price was reached by  December  31,
1995, in accordance  with the  provisions  of the plan,  additional  options for
76,000 shares were granted.  The exercise price for these options is equal to or
greater  than the trading  price on the date of the grants and ranges from $4.00
to $4.40 per share.  The options  expire at various dates from April 12, 1999 to
July 5, 2000.

On May 28, 1996, the Board of Directors approved a stock option plan under which
the Company  granted  options to key management,  other  employees,  and outside
directors for the purchase of 407,000  shares of its common stock.  The plan was
approved by the  Company's  stockholders  on June 26, 1996.  The options  become
fully  vested and  exercisable  as of July 1, 2001,  except that the vesting and
exercise date are  accelerated  to the tenth  consecutive  business day that the
Company's  stock  trades at a price of at least  $7.25.  Vested  options  may be
exercised  in  whole or in part  within  10 years  from the date of  grant.  The
exercise price for these options is $2.75,  the trading price on the date of the
grants.

Other pertinent information related to the plans is as follows:

                                                  Weighted-            Weighted-
                                                   Average              Average
                                                  Exercise             Exercise
                                        Shares      Price     Shares     Price
                                      ------------------------------------------
Outstanding at beginning of year ..   1,099,800     $2.35    836,000    $2.15
Granted ...........................          --        --    407,000     2.75
Forfeited .........................    (100,029)     2.56   (100,000)    2.75
Exercised .........................     (26,500)     1.50    (43,200)    1.50
                                      ------------------------------------------
Outstanding at end of year ........     973,271     $2.36   1,099,800   $2.35
                                      ==========================================

Exercisable at end of year ........     691,271               792,800
                                      =========             =========

Weighted-average fair value per 
  option of options granted during 
  the year ........................   $     --              $    1.97
                                      ========              =========
<PAGE>


A further summary about stock options outstanding as of December 31, 1997, is as
follows:

                        Options Outstanding              Options Exercisable
                 ----------------------------------  ---------------------------
                               Weighted-
                                Average    Weighted                 Weighted
  Range of                     Remaining    Average                  Average
  Exercise         Number     Contractual  Exercise     Number      Exercise
   Prices        Outstanding     Life       Price     Exercisable     Price
--------------------------------------------------------------------------------
$1.50 - $1.65      461,512     2.2 years   $  1.55      461,512     $   1.55

$2.38 - $3.56      435,850     6.4 years      2.94      153,850         3.30

$3.92 - $4.40       75,909     2.5 years      4.01       75,909         4.01
                ----------                            ---------
                   973,271                              691,271
                ==========                            =========

Grants under the above plans are  accounted for following APB Opinion No. 25 and
related   interpretations  as  permitted  under  generally  accepted  accounting
principles.   Accordingly,   no  compensation  cost  has  been  recognized.  Had
compensation cost for the stock-based  compensation  plans been determined based
on the grant date fair values of awards (the method  described in FASB Statement
No. 123)  reported  net income,  and  earnings  per common share would have been
reduced to the proforma amounts shown below:

                                                1997       1996
                                              -------------------
Net income:
   As reported ........................       $366,245   $102,145
   Proforma ...........................       $294,245   $ 27,145

Earnings per common share:
   As reported ........................       $    .08   $    .02
   Proforma ...........................       $    .06   $    .01

In determining  the proforma  amounts  above,  the fair value of each option was
estimated at the grant date using the  Black-Scholes  option-pricing  model with
the following assumptions:

                                                 1997         1996
                                                -------------------

Dividend rate .........................         $    --     $    --
Expected life (years) .................             7.5         7.5
Risk-free interest rate ...............            6.55%       6.55%
Price volatility ......................              66%         66%

On June 24, 1995, the stockholders  authorized the issuance of stock warrants as
a dividend to  stockholders  of record,  resulting  in the issuance of 4,198,084
warrants.  Each warrant  permits  stockholders a right to purchase an additional
share of stock at a  predetermined  price of $2 per  share.  Stock  acquired  by
exercise  of each  warrant  must be held for a one  year  period  of  time.  The
warrants  expire  July 1,  2015.  There are  4,131,240  and  4,140,910  warrants
outstanding as of December 31, 1997 and 1996, respectively.


Note 8.  Lease Commitments and Total Rental Expense

The  Company  has  entered  into six lease  agreements  covering  certain of its
railroad properties. For rail- road properties it leases, the Company ordinarily
assumes,   upon   the   commencement   date,   all   operating   and   financial
responsibilities,   including  maintenance,   payment  of  property  taxes,  and
regulatory compliance. Lease payments on five railroad properties are based on a
per car basis,  ranging from $10 to $25 on all cars over a range of 300 to 4,000
cars per year on each segment.  The leases expire between December 1998 and July
2011 and four of these railroads have five to twenty year renewal  options.  One
lease has an option to purchase  the stock and leased  personal  property of the
railroad upon expiration of its lease in December 1998.

The  Company  has a land lease for the  corporate  office  building.  This lease
expires in 2008 and is renewable for five successive  periods of five years with
annual rents equal to ten percent of the appraised value of the land, payable in
monthly  installments,  and  with  appraisal  value  reviews  every  five  years
following  the  origination  date.  The  Company  is  responsible  for  costs of
maintenance, utilities, taxes, and insurance.
<PAGE>


The total  approximate  minimum  rental  commitment  as of  December  31,  1997,
required under  noncancelable  leases, and excluding executory costs and per car
rentals, is due in future years as follows:

   Years Ending December 31:                 Amount
----------------------------------------------------

       1998                                 $187,400
       1999                                   46,300
       2000                                   46,300
       2001                                   46,300
       2002                                   42,000
       Thereafter                            315,900
                                            --------
                                            $684,200
                                            ========

The total  rental  expense  under the leases was  $440,986  and $273,433 for the
years ended December 31, 1997 and 1996, respectively.


Note 9.  Major Customer

Revenue earned from a major customer  amounted to  approximately  $1,760,000 and
$1,465,000  during the years ended  December  31,  1997 and 1996,  respectively.
Accounts  receivable  as of December  31, 1997 and 1996,  include  approximately
$427,000 and $344,000, respectively, from this customer.


Note 10.  Purchase of Railroad Facilities

During March and April 1996,  the Company  acquired all the  outstanding  common
stock of KNRECO, Inc., d/b/a Keokuk Junction Railway, in exchange for $3,124,358
cash, the assumption of liabilities and debt of $2,890,006,  and the issuance of
342 shares of common stock, at $3 5/8 per share, for a total acquisition cost of
$6,015,604.  The excess of the  acquisition  cost over the fair value of the net
assets  acquired was allocated to goodwill and is being  amortized over 40 years
by the straight-line method.

The above  acquisition  was accounted  for by the purchase  method of accounting
and,  accordingly,  operating results of Keokuk Junction Railway Co. is included
in the consolidated statements of income from the date of acquisition.

Unaudited  pro forma  consolidated  results  of  operations  for the year  ended
December 31, 1996, as though Keokuk Junction Railway Co. had been acquired as of
January 1, 1996, follows:

                                                                        1996
                                                                     -----------

Railway operating revenue ..............................             $11,873,809
Net income .............................................                  57,811
Earnings per common share ..............................                    0.01

The above amounts reflect  adjustments for amortization of goodwill,  additional
depreciation on revalued purchased assets, and interest on borrowed funds.

In December 1996, the Company  acquired all of the  outstanding  common stock of
Shawnee Terminal Railway Company in exchange for $10,000. To include the results
of operations of Shawnee  Terminal  Railway Company from January 1, 1996 through
the  acquisition  date would not have a significant  effect on the  consolidated
results of operations for the year ended December 31, 1996.


Note 11.  Minority Interest in Subsidiaries

Three of the Company's subsidiaries have preferred stock outstanding. This stock
is accounted for as minority interest in subsidiaries and dividends on the stock
are accounted for as a current expense.
<PAGE>


Following is a summary of the minority  interest in  subsidiaries as of December
31, 1997 and 1996:
<TABLE>

                                                                                      1997         1996
                                                                                   -----------------------
<S>                                                                                <C>          <C> 
Preferred stock at Alabama Railroad Co.
   Par value - $1,000 per share
   Authorized - 700 shares
   Issued and  outstanding - 424 and 425 shares (cumulative 12%   dividend;
      callable at Company's option at 150% of face value)
      at December 31, 1997 and 1996, respectively ..............................   $  424,000   $  425,000
Preferred stock of Alabama & Florida Railway Co., Inc.
   Par value - $1,000 per share
   Authorized - 500 shares
   Issued and outstanding - 421 and 422 shares (cumulative 9% dividend; callable
      at  Company's  option  after  June 22, 1995, at 150% of face value) at
      December 31, 1997 and 1996, respectively .................................      421,000      422,000
Preferred stock of Mississippi Central Railroad Co. 
   Par value - $1,000 per share
   Authorized - 1,000 shares
   Issued and outstanding - 341 shares (cumulative 10% dividend;  convertible at
      a rate of $10 per common share, callable at Company's option after 
      March 1, 1996, at 110% of face value) ....................................      341,000      341,000
                                                                                   -----------------------
                                                                                   $1,186,000   $1,188,000
                                                                                   =======================
</TABLE>
Note 12.  Commitments and Contingencies

Commitments:  In December 1993, the Company  entered into a five-year  executive
employment  contract  with the  Company's  president.  The  five-year  agreement
provides  for a base  salary with annual  inflation  adjustments  based upon the
Consumer Price Index.  Should the Company acquire or form additional  railroads,
the base salary will increase  $25,000 for the  acquisition  of railroads of 125
miles or less, and $50,000 for railroads over 125 miles.  Should the president's
employment  be  terminated,  the contract  requires a lump sum payment  equal to
three years of his then  current  salary.  Should the  president  retire,  he is
entitled to a lump sum payment of one year's salary.

As of December 31, 1997,  the Company was committed to purchase 37 railcars at a
cost of $301,000.  Management  expects to fund this  transaction  with available
long-term financing.

Contingencies:  In  the  course  of its  business,  the  Company's  subsidiaries
experience  crossing  accidents,   employee  injuries,  delinquent  or  disputed
accounts  and other  incidents,  which  give rise to claims  that may  result in
litigation.  Management vigorously pursues settlement of such claims, but at any
one time, some such incidents, which could result in lawsuits by and against the
Company and its subsidiary railroads, remain unresolved.  Management believes it
has valid claims for, or good defenses to, these actions.  Management  considers
such claims to be a routine part of the  Company's  business and, as of the date
of this  statement,  management  believes  that no incident has the potential to
result in a liability that would  materially  effect the Company's  consolidated
financial position or results of operations.

As  discussed  in Note 1, the  Company  was  awarded a grant from the  Minnesota
Department  of Trans-  portation  in 1997 for the repair and  rehabilitation  of
weather  damaged  railroad  track and related  structures  the  Company  owns in
Minnesota. The Company's obligations under this grant expire two years after the
completion of the repairs.  In the unlikely event the Company should discontinue
using the underlying Minnesota Railroad Co. track prior to the expiration of the
aforementioned two-year commitment period, the Company is contingently liable to
repay to the Federal Railroad  Administration  the value of materials  installed
pursuant to the grant. Management estimates that materials installed pursuant to
the grant will approximate $123,000.
<PAGE>


Note 13.  Earnings Per Share

Following is information  about the  computation of the earnings per share (EPS)
data for the years ended December 31, 1997 and 1996:

                                                     For the  Year Ended
                                             -----------------------------------
                                               Income      Shares      Per-Share
                                            (Numerator) (Denominator)    Amount
                                             -----------------------------------
                                                      December 31, 1997
                                             -----------------------------------

Basic EPS
Income available to common stockholders ...  $ 366,245    4,593,750    $   .08
                                                                       =======
Effect of Dilutive Securities
Employee stock options ....................         --       57,576
                                             ----------------------
Diluted EPS
Income available to common stockholders
   plus assumed conversions ...............  $ 366,245    4,651,326    $   .08
                                             =================================

                                                    December 31, 1996
                                             -----------------------------------
Basic EPS
  Income available to common stockholders .  $ 102,145    4,530,379    $   .02
                                                                       =======
   Effect of Dilutive Securities
   Warrants ...............................         --    1,346,659
   Employee stock options .................         --      281,938
                                             ----------------------
   Dilutive EPS
   Income available to common stockholders
      plus assumed conversions ............  $ 102,145    6,158,976    $   .02
                                             ===================================

Stock warrants totaling  4,131,240 as of December 31, 1997, were not included in
the  computation  of 1997 diluted EPS because the warrants'  exercise  price was
greater than the average market price of the common shares.  However,  4,140,910
warrants as of December 31, 1996,  were utilized in the  computation of the 1996
diluted EPS as the  exercise  price of such  warrants  was less than the average
market price for shares of common stock during 1996.

Options  to  purchase  282,000  shares of common  stock at $2.75 per share  were
outstanding as of December 31, 1997, but were not included in the computation of
diluted EPS because the  options'  exercise  price was greater  than the average
1997 market  price of the common  shares.  The 1996  calculation  of diluted EPS
includes   159,000  options  to  purchase  common  stock  which  represents  the
weighted-average effect of 307,000 options to purchase common stock at $2.75 per
share which were issued during 1996 and outstanding as of December 31, 1996. The
exercise  price on such  options was less than the 1996  average  market  price;
thus, these options are included in the 1996 calculation of diluted EPS.

Options  to  purchase  340,300  shares  of  common  stock at $1.50 per share and
121,212  shares  of  common  stock at $1.65 per  share  were  outstanding  as of
December 31, 1997, and are included in the  computation of diluted EPS since the
exercise price was less than the 1997 average  market price.  As of December 31,
1996, the following  additional  options to purchase shares of common stock were
utilized in the  calculation of diluted EPS, as the exercise price was less than
the 1996 average market price.

        Number                                       Option
      of Options                                     Price
------------------------------------------------------------

       150,000                                   $      1.65
       386,800                                          1.50
        40,000                                          2.58
<PAGE>



Note 14.  Fair Value of Financial Instruments

The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:

The carrying value of cash,  cash value of life  insurance,  notes payable,  and
variable rate long-term debt approximates fair value.

The  remaining   carrying  value  of  fixed  rate  long-term  debt  collectively
approximates  fair value based upon the similarity of interest rates  negotiated
on debt instruments in 1997 and 1996 as compared to existing interest rates.

In addition, other assets and liabilities of the Company that are not defined as
financial  instruments  are  not  included  in the  above  disclosures,  such as
property and equipment.  Also, nonfinancial instruments typically not recognized
in financial statements  nevertheless may have value but are not included in the
above dis- closures.  These include,  among other items, the trained work force,
customer goodwill, and similar items.
<PAGE>



Market for Pioneer Railcorp Common Stock.

The  Company's  common  stock trades on the Nasdaq  SmallCap  Market tier of the
Nasdaq Stock Market under the symbol "PRRR" and the Chicago Stock Exchange under
the  trading  symbol  "PRR".  The  quarterly  high  and low  sales  price of the
Company's common stock for the periods below are as follows:

        96-1Q    96-2Q    96-3Q    96-4Q    97-1Q   97-2Q    97-3Q    97-4Q
        -------------------------------------------------------------------
  
High    $4.13    $4.00    $3.13    $3.13    $2.63   $2.13    $1.88    $1.88
Low     $3.38    $2.75    $2.00    $1.88    $1.75   $1.13    $1.38    $1.32

As of December 31, 1997,  the Company had 1,798 common  stockholders  of record,
including brokers who hold stock for others. No common stock cash dividends have
been declared or paid.

Board of Directors

Guy L. Brenkman, CEO and President, Pioneer Railcorp
J. Michael Carr, Chief Financial Officer, Pioneer Railcorp
Orvel L. Cox, Superintendent Car Department, Pioneer Railroad Services, Inc.
John S. Fulton, Purple Reality
Timothy F. Shea, President, RE/MAX Property Management

Officers

Guy L. Brenkman, Chief Executive Officer and President
J. Michael Carr, Treasurer
Daniel A. LaKemper, Secretary
Kevin L. Williams, Assistant Secretary

Corporate Information

The Corporate  offices of Pioneer  Railcorp and its  subsidiaries are located at
1318 S. Johanson Road, Peoria, Illinois, 61607; Telephone number 309-697-1400.

Reports and Publications

A copy of Pioneer  Railcorp's  1997 Form 10-KSB to the  Securities  and Exchange
Commission  (without  exhibits) can be obtained without charge by contacting the
Company's Investor Relations Department

Quarterly financial reports and other publications and news releases can also be
obtained  through the  Investor  Relations  Department  or accessed  through the
Company's web page located at www.Pioneer-Railcorp.com.