TO THE SHAREHOLDERS


The fiscal year 1996 ended with mixed  results for Pioneer  Railcorp,  with both
disappointing  and  encouraging   developments.   The   disappointment  was  the
unanticipated  negative operating performance of the Minnesota Central Railroad.
In the fourth  quarter of 1996,  the  Minnesota  Central  Railroad was initially
crippled,  then  completely  shut  down as a result of the most  severe  weather
conditions  in that region in years.  The loss of expected  grain traffic on the
Minnesota Central Railroad due to the weather conditions,  as well as a decrease
in  grain  shipments  in the last  six  months  of 1996  resulting  from  market
conditions,  adversely  affected the revenues from the Company's  covered hopper
fleet. None the less, Pioneer Railcorp ended the year profitable.

On the positive side, Pioneer Railcorp acquired five new railroad  operations in
1996,  including  the Keokuk  Junction  Railway,  which was the  Company's  most
significant acquisition to date in terms of revenues and car loads. System wide,
Pioneer Railcorp  railroads handled  approximately  32,000 car loads in 1996, up
from 23,000 in 1995.  In  addition,  the  diversity  of the  Company's  railroad
portfolio  enabled the Company to survive the adverse  effects of the  Minnesota
Central  Railroad  and  post  a  profit  in  1996,   though  far  short  of  our
expectations.  Without the diversity of the Company's  railroad  portfolio,  the
effects of the Minnesota Central Railroad could have been far worse indeed.

In 1996, the Company  continued to build and strengthen its management  team and
asset base. The Company railcar and locomotive fleets were added to and improved
upon and several  departments  were enhanced through the purchase and upgrade of
mechanical and track equipment.  The Company continues to make major investments
in its track,  facilities and structures for the long-term. In 1996, the Alabama
& Florida  Railway spent over $200,000  rebuilding  one major bridge trestle and
strengthening  another. The Fort Smith Railroad replaced its mobile home office,
which was destroyed by a tornado,  with a modern office and mechanical facility.
The Keokuk Junction Railway built a railcar storage yard and installed a railcar
scale to better handle long-term customer needs.

Pioneer  Railcorp  continues to position itself for solid  long-term  growth and
operating results the shareholders  seek. I believe Pioneer Railcorp begins 1997
positioned  and  equipped  to do a terrific  job of  serving  the rail users who
support  our  railroads,  and doing it in the safest and most  efficient  manner
possible.  At the same time, I believe the Company's  shareholders will reap the
rewards associated with our well managed and equipped railroads.

Sincerely yours,



/s/ Guy L. Brenkman
--------------------------
Guy L. Brenkman
Chairman - President - CEO
<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. (WJ) (formerly West Jersey Railroad Co.),  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),  Columbia & Northern Railway
Co. (CNOW),  Shawnee Terminal Railway Com-pany (STR), Pioneer Railroad Equipment
Co., Ltd. (PREL),  Pioneer Air, Inc. (PAR), 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  (TCW),  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 (MP) and operates 18 miles
of track from Fort Smith to Paris,  Arkansas.  The FSR's primary  interchange is
with the  Union  Pacific  Railroad  Company  (UP),  parent  of the MP.  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 steel, 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., Inc.

On October 25, 1991, the Alabama Railroad Co., Inc. 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 Cor-duroy, 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 are outbound finished wood products
and inbound products, such as resins, chemicals,  pulpwood for the production of
finished wood product, scrap steel and cottonseed.
<PAGE>


Alabama & Florida Railway Co., Inc.

On  November  23,  1992,  the  Alabama &  Florida  Railway  Co.,  Inc.  (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. 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
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 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 &  Western  Railroad  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
South- western 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,  a depot building and parking lot in Paw Paw and
various attendant licenses and rights involving the real estate.  This agreement
was approved by the United States  Bankruptcy  Court for the Western District of
Michigan in an order that became final on or about  September 21, 1995.  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 an 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.

Columbia & Northern Railway Co.

On February 21,  1996,  Pioneer  Railcorp  through its  wholly-owned  subsidiary
Columbia & Northern  Railway Co.  (CNOW)  signed a lease with the Marion  County
(Mississippi) Railroad Authority ("Authority") to operate approximately 29 miles
of trackage between Columbia and Silver Creek,  Mississippi.  In addition,  CNOW
leases  approximately  5 miles of  track  between  Silver  Creek  and  Furguson,
Mississippi,  from the  Illinois  Central  Railroad  for  interchange  purposes.
Shipping contracts have delayed the train operations of CNOW and it is uncertain
as to when rail transportation will commence.

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").
All of the  remaining  common  shares  were  purchased  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 BNSF at Keokuk,  Iowa
and the 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.
<PAGE>


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 BNSF and the UP. Train  operations  began April 15, 1996.
The railroad's principal commodity is frozen foods.

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 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.  The Michigan line also interchanges with the Indiana
Northeastern  Railroad Company. 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
850 railcars (as of December 31,  1996) 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.  In addition,  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.

<PAGE>

Managements  Discussion  and  Analysis  of  Financial  Condition  and Results of
Operations

Results of Operations

The Company's net income in 1996 decreased by 78% to $102,000 down from $462,000
in 1995. Operating revenue increased by $2.4 million, or 28% to $11 million from
8.6 million in 1995.  Operating expense increased in 1996 by $2.7 million or 40%
to $9.6 million from $6.9 million in the prior year.  Operating income decreased
in 1996 by $300,000 or 18% to $1.4 million from $1.7 million in the prior year.

Several operating  subsidiaries  performances were responsible for the change in
operating income in 1996. The Keokuk Junction  Railway,  acquired in March 1996,
contributed $792,000 of operating income in 1996. In addition,  increased volume
and  pricing  resulted  in 1996  operating  income  increases  of $67,000 on the
Alabama & Florida Railway and $87,000 on the Vandalia Railroad.

The Alabama Railroad had a decrease in operating income of $188,000 in 1996 as a
result of a three month shut down of the line's  largest  customer  due to plant
modernization. The Minnesota Central Railroad had a decrease in operating income
of $202,000 in 1996  primarily due to severe  weather in the 4th quarter and the
effects of decreased  grain shipping  resulting from both market  conditions and
weather.

Pioneer  Railroad  Equipment Co., Ltd.  revenue was affected by the situation on
the ALAB and MCTA due to the  non-utilization  of box cars and grain hopper cars
assigned to these railroads.  PREL operating  income increased  $51,000 in 1996.
The  small   increase  in  operating   income   combined  with  an  increase  in
non-operating  expense  (primarily  interest expense) of $318,000 resulted in an
overall decrease in pre-tax net income of $267,000 in 1996.

The Decatur  Junction  Railway had a $155,000  decrease in  operating  income in
1996,  primarily  resulting from the January 1996  expiration of a non-recurring
switching contract in effect for most of 1995.  Pioneer Railroad Services,  Inc.
had increased expenses related to hiring and retaining several support personnel
in 1996, and other  administrative  costs,  which decreased  operating income by
$599,000.

Operating Revenue:

Operating  revenue  increased in 1996 by $2.4 million or 28% to $11 million from
$8.6  million  in  the  prior  year.  The  increase  in  operating   revenue  is
attributable to the Keokuk Junction  Railway  acquisition on March 12, 1996, the
Rochelle  Railroad  operating  lease which began in April of 1996, and increased
revenue  from the  Company's  railcar  fleet.  The Keokuk  Junction  Railway had
operating  revenue  of $2.3  million  in  1996  and the  Rochelle  Railroad  had
operating  revenue of  $172,000  in 1996.  Carhire  revenue  from the  Company's
railcar fleet  (approximately 850 cars at 12/31/96)  increased by $150,000 or 8%
to $1.91 million from $1.76 million in the prior year. In addition,  the Company
had  increased  revenue  in 1996  from the  lease  of its  railcars  and  excess
locomotives to  non-affiliated  entities.  This activity  generated  $337,000 of
revenue  in 1996  compared  to  $125,000  of revenue in 1995.  The  increase  is
primarily  attributable  to a short term lease of 150 grain covered  hopper cars
which expired in May of 1996.

Other factors affected the Company's 1996 operating  revenue.  In early February
1995 the  Company's  Decatur  Junction  Railway Co.  began  performing  contract
switching  for the Illinois  Central  Railroad.  This contract was executed as a
direct result of labor disputes at certain Decatur, Illinois industries, and the
refusal of  Illinois  Central  train  crews to cross the  picket  lines at local
industries.  This contract,  which ceased January 2, 1996, generated $139,000 of
revenue in 1995. As a result of this  contract  expiring and a decrease in local
grain  shipments,  DT revenue was down $150,000 or 32% to $313,000 from $463,000
in the prior year.

The Mississippi Central Railroad had a decrease in revenue of $124,000 or 13% to
$803,000 from $927,000 in the prior year. This decrease was a direct result of a
reduction in particle board shipments in 1996 compared to 1995.

The  Alabama  Railroad  had a decrease in revenue of $176,000 or 24% to $572,000
from  $748,000 in the prior year.  This  decrease was a direct result of a three
month shut down of the largest  shipper on the  railroad in order to  facilitate
the modernization of its plant facilities.

The Vandalia Railroad had an increase in operating revenue of $135,000 or 52% to
$397,000 from $262,000 in the prior year. This increase in revenue resulted from
both increased freight volume and pricing.

The Rochelle Railroad contributed $172,000 in revenue from 1996 operations.  The
Shawnee Terminal Railway and the Michigan  Southern  Railroad,  both which began
operations in the fourth quarter of 1996, did not contribute significant revenue
in 1996.
<PAGE>


The  remaining  operating  subsidiaries  had  constant  overall  revenue in 1996
compared to 1995.

Operating Expense

Operating  expense increased in 1996 by $2.7 million or 40% to $9.6 million from
$6.9  million  in  the  prior  year.  The  increase  in  operating   expense  is
attributable to the Keokuk Junction  Railway Co.  acquisition on March 12, 1996,
an  increase  in  depreciation  expense  related to the growth of the  Company's
railcar  fleet,  and  increases in  administrative  expense  resulting  from the
current,  and  anticipated  future  growth of the Company.  The Keokuk  Junction
Railway had  operating  expense of $1.46 million in 1996.  Depreciation  expense
related to the Company's  railcar fleet and  equipment  increased  approximately
$300,000 or 74% to  $705,000  from  $405,000  in the prior year.  Administration
expense increased $800,000 to $3.1 million or 35% from $2.3 million in the prior
year.  The Rochelle  Railroad  had  operating  expense of $139,000 in 1996.  The
Shawnee Terminal Railway and the Michigan  Southern  Railroad,  both which began
operations in the fourth quarter, did not have significant  operating expense in
1996.

Operating Expense Income Statement Line Item Discussion:

Maintenance  of ways  expense  (MOW)  increased  $54,000 or 7% to $932,000  from
$878,000  in the prior  year.  The Keokuk  Junction  Railway  had $70,000 of MOW
expense in 1996. The Minnesota  Central had a decrease in MOW expense of $80,000
or  34%  to  $154,000  from  $234,000  in  1996  primarily  resulting  from  the
capitalization  of  $150,000 of labor  related to the MCTA track  rehabilitation
project in 1996.  Other operating  subsidiaries had constant MOW expense in 1996
compared to 1995.

Maintenance of equipment  expense (MOE) increased  $311,000 or 31% to $1,342,000
from  $1,031,000 in the prior year. Most of this increase is attributable to the
Keokuk Junction Railway which had $300,000 of MOE expense in 1996. Approximately
$156,000 of Keokuk's MOE expense relates to a monthly railcar lease contract, in
effect  at  acquisition,   with  an  unrelated  third  party.   Other  operating
subsidiaries had constant MOE expense in 1996 compared to 1995.

Transportation  expense  (TRAN)  increased  $1,028,00 or 56% to $2,851,000  from
$1,823,000 in the prior year. The Keokuk  Junction  Railway had $707,000 of TRAN
expense in 1996.  The  Minnesota  Central  had an  increase  in TRAN  expense of
$240,000 or 43% to $793,000 from  $553,000 in the prior year.  The MCTA increase
resulted from  increased fuel expense,  derailment  expense and car hire expense
resulting from inefficient  train operations caused by the poor track condition.
The  Rochelle  Railroad  had $78,000 of TRAN  expense in 1996.  The  Mississippi
Central Railroad had a decrease in TRAN expense of approximately $112,000 or 33%
to $232,000 from $344,000 in the prior year.  The MSCI  reduction is a result of
decreased  locomotive  maintenance  expense and fuel expense  resulting from the
reduction  in  shipping,  and a reduction in car hire expense as a result of the
increased  utilization of Company owned railcars.  Other operating  subsidiaries
had constant TRAN expense in 1996 compared to 1995.

Administration  expense  (ADMIN)  increased  $827,000 to  $3,067,000 or 37% from
$2,240,000 in the prior year. The Keokuk Junction  Railway had $247,000 of ADMIN
expense in 1996 and the Rochelle  Railroad had $57,000 of ADMIN expense in 1996.
Expenses  related to hiring and  retaining  several  support  personnel  in 1996
increased ADMIN by  approximately  $241,000.  ADMIN expense related to executive
compensation  contracts  increased  approximately  $36,000 in 1996.  The Company
increased  its  liability  insurance  limits up to $10 million  which  increased
insurance  expense  approximately  $86,000 in 1996.  In  addition,  the  medical
expense  relating to the Company's  self-funded  employee health  insurance plan
increased  $94,000 in 1996.  This  increase is a result of extremely low medical
expenses in 1995 of $43,000  compared to  $137,000 in 1996.  The Company  health
plan includes reinsurance that provides for a maximum expense cap which protects
the Company from incurring medical expenses over a specified amount. This amount
is similar to what the cost would be to the Company  under a  traditional  third
party plan.

Depreciation and amortization  expense  increased  $479,000 or 52% to $1,393,000
compared to $914,000  in the prior  year.  Approximately  27% or $129,000 of the
increase  in  this  expense  is  related  to the  Keokuk  Junction  Railway  and
approximately  63% or $300,000 of this  increase is related to the growth of the
Company's  railcar  fleet.  The remainder is  attributed to other  miscellaneous
capital additions.

Other Income and Expense Income Statement Line Item Discussion:

Other income and expense, excluding interest expense and gain on sale of assets,
increased  $113,000  to $246,000  compared  to  $133,000 in the prior year.  The
majority of this income is generated  from the granting of easements  and leases
for the use of railroad right of way property.  Also included in this income are
revenues  generated  from scrap  sales,  and other  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 included in this category is material when considered alone.
<PAGE>


Equipment interest expense increased  $550,000 or 70% to $1,335,000  compared to
$785,000 in the prior year. Approximately $319,000 of increased interest expense
is related to equipment  financing  and $230,000 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  $14,000  in 1996 to  $58,000
compared  to  $44,000  in 1995.  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  resulted  from  the   disposition  of  the  other
miscellaneous  pieces  of  equipment,  none  of  which  was  disposed  of  at  a
significant gain or loss.

In March 1997, the accounting  requirements  for calculating  earnings per share
were  revised.  Basic  earnings per share for 1997 and later will be  calculated
solely on average  common shares  outstanding.  Diluted  earnings per share will
reflect  the  potential  dilution  of  stock  options  and  other  common  stock
equivalents. All prior calculations will be restated to be comparable to the new
methods.  The Company does not believe this new accounting  standard will have a
material impact on its financial statements.

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.

The  Company has  working  capital  facilities  totaling  $1.1  million of which
$448,000 was available at the end of 1996. 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.

In March of 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 10.75%. 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 has been fully drawn upon in
connection with the Company's March 12, 1996  acquisition of KNRECO,  Inc. d/b/a
Keokuk Junction Railway, common stock.

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 1997. The Company is considering and analyzing the refinancing of some of its
present debt, particularly its $2.5 million annual revolving acquisition line of
credit.

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.  As of
December  31,  1996,  a total of 57,174  warrants  had been  exercised,  and the
Company realized  $114,348 on the issuance of the warrants.  The Company expects
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. As of December 31, 1996, a total of 43,200
options had been exercised,  and the Company realized $64,800 on the issuance of
the  options.  The Company  expects  capital to be  generated by the exercise of
options in 1997 but is uncertain as to the amount.
<PAGE>


On June  26,  1996,  the  Company  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 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.

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 1997.

Balance Sheet and Cash Flow Items:

The Company generated net cash from operating activities of $1.8 million in 1996
and $1.4 million in 1995. Net cash from operating  activities from 1996 resulted
from  $102,000 of net  income,  $1,393,000  of  depreciation  and  amortization,
$185,000  of deferred  income  taxes,  and an  increase  in accounts  payable of
$538,000,  partially  offset by $418,000  net cash used by changes in  operating
assets and  liabilities,  primarily  due to increases in accounts  receivable of
$103,000,  income  tax refund  claims of  $202,000,  and  pre-paid  expenses  of
$104,000.

In 1996 the Company  purchased  approximately  $6.3  million of fixed assets and
capital  improvements  of which  approximately  $4.2 million  relate to railroad
acquisitions.  Other fixed asset and capital  additions  totaling  approximately
$2.1 million in 1996  included the  purchase of  approximately  70 railcars at a
total cost of $805,000.  The majority of railcars  purchased  were financed with
long-term fixed rate financing.  The Company capitalized  approximately $425,000
related to its ongoing efforts to rehabilitate and improve the Minnesota Central
Railroad track. The rehabilitation  expenditures were financed initially through
working capital which was  subsequently  replenished in December of 1996 through
the  refinancing  of 14  locomotives  at a fixed rate of 10.25% for a seven year
term. The total amount borrowed in the locomotive  refinancing was $1 million of
which  $331,000 was used to pay off existing  debt on the  locomotives  with the
remaining  loan proceeds of $669,000  used to replenish  the  Company's  working
capital utilized for the MCTA track rehabilitation.

In addition to the Minnesota Central Railroad track rehabilitation,  the Company
capitalized approximately $626,000 of track and structure betterments in 1996 on
several  other  operating  subsidiaries.  Approximately  $426,000 of these track
betterments was funded with operating cash flows and approximately  $200,000 was
financed with the long-term  debt related to the Alabama & Florida  Railway Co.,
Inc.  refinance.  In 1996 the Company also purchased  approximately  $219,000 of
machinery, equipment and other assets, and $25,000 of furniture and fixtures for
the corporate office.  All these expenditures were financed with working capital
cash flow.  In December  of 1996 the Company  refinanced  the  outstanding  debt
related to its 1992  acquisition of the Alabama & Florida  Railway Co., Inc. The
Company  borrowed $1.5 million at an interest rate of 9.25% and a ten-year term.
The interest  rate is subject to repricing in five years to the then  prevailing
market  rate  of  interest.  The  principal  balance  of the  debt  retired  was
approximately  $1.13  million  dollars  and  had a fixed  interest  rate of 12%.
Approximately   $200,000  of  the  loan  proceeds  were  used  to  pay  for  the
rehabilitation of two bridges, one being the Pea River bridge which had been out
of service for several  years.  Several  customers  on the other side of the Pea
River bridge have begun  shipping by rail and it is possible that within several
years the AF could be handling annually an additional 1,000 car loads generating
almost $500,000 in revenues as a result of the bridge restoration. The remaining
loan proceeds were used for working capital.

Regarding Pioneer  Railcorp's  acquisition of the Keokuk Junction Railway Co. in
1996, the total consideration for the purchase was $6,015,604.  This was paid by
$3,124,358 in cash,  342 shares of Pioneer  Railcorp Class A common stock valued
at $1,240 and the assumption of liabilities  and debt totaling  $2,890,006.  The
total  liabilities  assumed  consisted  of current  liabilities  of  $1,496,006,
long-term debt of $446,000 and a deferred tax liability of $948,000.

The 1996 balance sheet presented has  significant  changes when compared to 1995
as a  result  of the  Keokuk  Junction  Railway  acquisition  and  includes  the
following Keokuk Junction Railway December 31, 1996 approximate  balances:  cash
$186,000,  accounts receivable  $697,000,  income tax receivable  $61,000,  cash
value of life insurance  $75,000,  prepaid  expenses  $30,000,  accounts payable
$1,412,000, and accrued expenses of $138,000.
<PAGE>


Administration  expense  (ADMIN)  increased  $827,000 to  $3,067,000 or 37% from
$2,240,000 in the prior year. The Keokuk Junction  Railway had $247,000 of ADMIN
expense in 1996 and the Rochelle  Railroad had $57,000 of ADMIN expense in 1996.
Expenses  related to hiring and  retaining  several  support  personnel  in 1996
increased ADMIN by  approximately  $241,000.  ADMIN expense related to executive
compensation  contracts  increased  approximately  $36,000 in 1996.  The Company
increased  its  liability  insurance  limits up to $10 million  which  increased
insurance  expense  approximately  $86,000 in 1996.  In  addition,  the  medical
expense  relating to the Company's  self-funded  employee health  insurance plan
increased  $94,000 in 1996.  This  increase is a result of extremely low medical
expenses in 1995 of $43,000  compared to  $137,000 in 1996.  The Company  health
plan includes reinsurance that provides for a maximum expense cap which protects
the Company from incurring medical expenses over a specified amount. This amount
is similar to what the cost would be to the Company  under a  traditional  third
party plan.

Depreciation and amortization  expense  increased  $479,000 or 52% to $1,393,000
compared to $914,000  in the prior  year.  Approximately  27% or $129,000 of the
increase  in  this  expense  is  related  to the  Keokuk  Junction  Railway  and
approximately  63% or $300,000 of this  increase is related to the growth of the
Company's  railcar  fleet.  The remainder is  attributed to other  miscellaneous
capital additions.

Other Income and Expense Income Statement Line Item Discussion:

Other income and expense, excluding interest expense and gain on sale of assets,
increased  $113,000  to $246,000  compared  to  $133,000 in the prior year.  The
majority of this income is generated  from the granting of easements  and leases
for the use of railroad right of way property.  Also included in this income are
revenues  generated  from scrap  sales,  and other  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 included in this category is material when considered alone.

Equipment interest expense increased  $550,000 or 70% to $1,335,000  compared to
$785,000 in the prior year. Approximately $319,000 of increased interest expense
is related to equipment  financing  and $230,000 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  $14,000  in 1996 to  $58,000
compared  to  $44,000  in 1995.  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  resulted  from  the   disposition  of  the  other
miscellaneous  pieces  of  equipment,  none  of  which  was  disposed  of  at  a
significant gain or loss.

In March 1997, the accounting  requirements  for calculating  earnings per share
were  revised.  Basic  earnings per share for 1997 and later will be  calculated
solely on average  common shares  outstanding.  Diluted  earnings per share will
reflect  the  potential  dilution  of  stock  options  and  other  common  stock
equivalents. All prior calculations will be restated to be comparable to the new
methods.  The Company does not believe this new accounting  standard will have a
material impact on its financial statements.

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.

The  Company has  working  capital  facilities  totaling  $1.1  million of which
$448,000 was available at the end of 1996. 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.

In March of 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 10.75%. 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 has been fully drawn upon in
connection with the Company's March 12, 1996  acquisition of KNRECO,  Inc. d/b/a
Keokuk Junction Railway, common stock.
<PAGE>


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 1997. The Company is considering and analyzing the refinancing of some of its
present debt, particularly its $2.5 million annual revolving acquisition line of
credit.

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.  As of
December  31,  1996,  a total of 57,174  warrants  had been  exercised,  and the
Company realized  $114,348 on the issuance of the warrants.  The Company expects
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. As of December 31, 1996, a total of 43,200
options had been exercised,  and the Company realized $64,800 on the issuance of
the  options.  The Company  expects  capital to be  generated by the exercise of
options in 1997 but is uncertain as to the amount.

On June  26,  1996,  the  Company  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 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.

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 1997.

Balance Sheet and Cash Flow Items:

The Company generated net cash from operating activities of $1.8 million in 1996
and $1.4 million in 1995. Net cash from operating  activities from 1996 resulted
from  $102,000 of net  income,  $1,393,000  of  depreciation  and  amortization,
$185,000  of deferred  income  taxes,  and an  increase  in accounts  payable of
$538,000,  partially  offset by $418,000  net cash used by changes in  operating
assets and  liabilities,  primarily  due to increases in accounts  receivable of
$103,000,  income  tax refund  claims of  $202,000,  and  pre-paid  expenses  of
$104,000.

In 1996 the Company  purchased  approximately  $6.3  million of fixed assets and
capital  improvements  of which  approximately  $4.2 million  relate to railroad
acquisitions.  Other fixed asset and capital  additions  totaling  approximately
$2.1 million in 1996  included the  purchase of  approximately  70 railcars at a
total cost of $805,000.  The majority of railcars  purchased  were financed with
long-term fixed rate financing.  The Company capitalized  approximately $425,000
related to its ongoing efforts to rehabilitate and improve the Minnesota Central
Railroad track. The rehabilitation  expenditures were financed initially through
working capital which was  subsequently  replenished in December of 1996 through
the  refinancing  of 14  locomotives  at a fixed rate of 10.25% for a seven year
term. The total amount borrowed in the locomotive  refinancing was $1 million of
which  $331,000 was used to pay off existing  debt on the  locomotives  with the
remaining  loan proceeds of $669,000  used to replenish  the  Company's  working
capital utilized for the MCTA track rehabilitation.
<PAGE>


In addition to the Minnesota Central Railroad track rehabilitation,  the Company
capitalized approximately $626,000 of track and structure betterments in 1996 on
several  other  operating  subsidiaries.  Approximately  $426,000 of these track
betterments was funded with operating cash flows and approximately  $200,000 was
financed with the long-term  debt related to the Alabama & Florida  Railway Co.,
Inc.  refinance.  In 1996 the Company also purchased  approximately  $219,000 of
machinery, equipment and other assets, and $25,000 of furniture and fixtures for
the corporate office.  All these expenditures were financed with working capital
cash flow.  In December  of 1996 the Company  refinanced  the  outstanding  debt
related to its 1992  acquisition of the Alabama & Florida  Railway Co., Inc. The
Company  borrowed $1.5 million at an interest rate of 9.25% and a ten-year term.
The interest  rate is subject to repricing in five years to the then  prevailing
market  rate  of  interest.  The  principal  balance  of the  debt  retired  was
approximately  $1.13  million  dollars  and  had a fixed  interest  rate of 12%.
Approximately   $200,000  of  the  loan  proceeds  were  used  to  pay  for  the
rehabilitation of two bridges, one being the Pea River bridge which had been out
of service for several  years.  Several  customers  on the other side of the Pea
River bridge have begun  shipping by rail and it is possible that within several
years the AF could be handling annually an additional 1,000 car loads generating
almost $500,000 in revenues as a result of the bridge restoration. The remaining
loan proceeds were used for working capital.

Regarding Pioneer  Railcorp's  acquisition of the Keokuk Junction Railway Co. in
1996, the total consideration for the purchase was $6,015,604.  This was paid by
$3,124,358 in cash,  342 shares of Pioneer  Railcorp Class A common stock valued
at $1,240 and the assumption of liabilities  and debt totaling  $2,890,006.  The
total  liabilities  assumed  consisted  of current  liabilities  of  $1,496,006,
long-term debt of $446,000 and a deferred tax liability of $948,000.

The 1996 balance sheet presented has  significant  changes when compared to 1995
as a  result  of the  Keokuk  Junction  Railway  acquisition  and  includes  the
following Keokuk Junction Railway December 31, 1996 approximate  balances:  cash
$186,000,  accounts receivable  $697,000,  income tax receivable  $61,000,  cash
value of life insurance  $75,000,  prepaid  expenses  $30,000,  accounts payable
$1,412,000, and accrued expenses of $138,000.
<PAGE>
 INDEPENDENT AUDITOR'S REPORT



To the Board of Directors
Pioneer Railcorp
Peoria, Illinois

We have audited the accompanying consolidated balance sheets of Pioneer Railcorp
and subsidiaries as of December 31, 1996 and 1995, and the related  consolidated
statements of income,  stockholders'  equity,  and cash flows for the years then
ended.  These  financial  statements  are the  responsibility  of the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects, the financial position of Pioneer Railcorp and
subsidiaries  as of  December  31,  1996  and  1995,  and the  results  of their
operations  and their cash flows for the years  then  ended in  conformity  with
generally accepted accounting principles.



/s/ McGladrey & Pullen, LLP



Peoria, Illinois
February 21, 1997

<PAGE>





PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
<TABLE>

ASSETS
                                                                                        1996        1995
-------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>            <C> 

Current Assets
   Cash ........................................................................ $    501,212 $    276,230
   Accounts receivable, less allowance for doubtful
      accounts 1996 $45,291; 1995 $15,958 ......................................    2,071,289    1,283,124
   Inventories .................................................................      420,952      287,772
   Prepaid expenses ............................................................      261,427      123,609
   Income tax refund claims ....................................................      349,881       50,998
   Deferred taxes ..............................................................       25,901       35,000
                                                                                ---------------------------
Total current assets ...................................................            3,630,662    2,056,733
                                                                                ---------------------------

Investments, cash value of life insurance ......................................       74,962           --
                                                                                ---------------------------

Property and Equipment, less accumulated depreciation
   1996 $3,294,610; 1995 $1,979,998 ............................................   20,131,566   15,220,168
                                                                                ---------------------------

Intangible Assets, less accumulated amortization
   1996 $140,109; 1995 $100,493 ................................................    1,171,114      647,031
                                                                                ---------------------------

                                                                                $  25,008,304 $ 17,923,932
                                                                                ===========================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
   Notes payable ...............................................................$     769,535 $     80,333
   Current maturities of long-term debt ........................................    1,813,246    1,412,552
   Accounts payable ............................................................    2,973,258    1,115,241
   Accrued expenses ............................................................      491,610      354,834
   Income taxes payable ........................................................       18,978       17,367
                                                                                --------------------------
        Total current liabilities ..............................................    6,066,627    2,980,327
                                                                                --------------------------

Long-Term Debt, net of current maturities ......................................   12,564,133    9,934,737
                                                                                --------------------------

Deferred Taxes .................................................................    1,967,651      843,000
                                                                                --------------------------

Minority Interest in Subsidiaries ..............................................    1,188,000    1,195,000
                                                                                --------------------------

Commitments and Contingencies (Note 13)

Stockholders' Equity
   Common  stock,  Class A  (voting),  par  value  $.001 per  share,  authorized
      20,000,000 shares, issued and outstanding 1996 4,573,343 shares; 1995 
      4,487,881 shares .........................................................        4,571        4,487
   Additional paid-in capital ..................................................    1,981,149    1,832,353
   Retained earnings ...........................................................    1,236,173    1,134,028
                                                                                --------------------------
                                                                                    3,221,893    2,970,868
                                                                                --------------------------

                                                                                $  25,008,304 $ 17,923,932
                                                                                ==========================
</TABLE>
See Notes to Consolidated Financial Statements.


<PAGE>


PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1996 and 1995
<TABLE>

                                                                                                     
                                                                                 1996             1995
-----------------------------------------------------------------------------------------------------------
<S>                                                                      <C>               <C>

Railway operating revenue                                                $      10,979,218 $      8,577,421
                                                                         -----------------------------------

Operating expenses
   Maintenance of way and structures                                               931,574          877,654
   Maintenance of equipment                                                      1,342,059        1,030,975
   Transportation                                                                2,851,485        1,822,982
   General and administrative                                                    3,067,191        2,240,581
   Depreciation                                                                  1,343,377          871,910
   Amortization                                                                     49,966           42,548
                                                                         -----------------------------------
                                                                                 9,585,652        6,886,650
                                                                         -----------------------------------

      Operating income                                                           1,393,566        1,690,771
                                                                         -----------------------------------

Other income (expenses)
   Interest income                                                                   7,709            3,005
   Interest expense                                                             (1,335,304)        (785,371)
   Lease income                                                                    125,295           74,551
   Gain on sale of assets                                                           57,820           43,862
   Other, net                                                                      112,584           54,738
                                                                         -----------------------------------
                                                                                (1,031,896)        (609,215)
                                                                         -----------------------------------

      Income before provision for income taxes
        and minority interest in preferred stock
        dividends of consolidated subsidiaries                                     361,670        1,081,556

Provision for income taxes                                                         135,960          495,443
                                                                         -----------------------------------

      Income before minority interest in preferred
        stock dividends of consolidated subsidiaries                               225,710          586,113

Minority interest in preferred stock dividends of
   consolidated subsidiaries                                                       123,565          124,405
                                                                         -----------------------------------

      Net income                                                         $         102,145 $        461,708
                                                                         ===================================

Earnings per common share                                                $             .02 $            .11
                                                                         ===================================
Weighted average number of common shares used in
   computing earnings per common share                                           4,530,379        4,244,162
                                                                         ===================================
</TABLE>

See Notes to Consolidated Financial Statements.

<PAGE>






PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1996 and 1995

<TABLE>

                                                   
                                                       Common Stock
                                                 ----------------------    Additional
                                                      Class A (Voting)      Paid-In       Retained
                                                   Shares        Amount     Capital       Earnings
-----------------------------------------------------------------------------------------------------
<S>                                                <C>        <C>       <C>           <C> 

Balance at December 31, 1994                       2,098,042  $   2,098 $   1,129,725 $       674,418

   Stock split July 1, 1995                        2,098,042      2,098             -          (2,098)
   Common stock issued to acquire
      property, equipment, and
      inventory                                      272,543        272       664,139               -
   Common stock issued upon
      exercise of stock warrants                      19,254         19        38,489               -
   Net income                                              -          -             -         461,708
                                                 -----------------------------------------------------

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
                                                 =====================================================

</TABLE>

See Notes to Consolidated Financial Statements.


<PAGE>
PIONEER RAILCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1995
<TABLE>
                                                                                    1996            1995
------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>            <C>
Cash Flows From Operating Activities
   Net income                                                                $      102,145 $       461,708
   Adjustments to reconcile net income to net cash provided
      by operating activities:
      Minority interest in preferred stock dividends of consolidated 
        subsidiaries                                                                123,565         124,405
      Depreciation                                                                1,343,377         871,910
      Amortization                                                                   49,966          42,548
      Increase in cash value life insurance                                          (5,085)              -
      (Gain) on sale of property and equipment                                      (57,820)        (43,862)
      Deferred taxes                                                                185,625         334,000
      Changes in assets and  liabilities,  net of effects  from  
        acquisition  of subsidiaries:
        (Increase) in accounts receivable                                          (103,068)       (348,550)
        (Increase) in income tax refund claims                                     (202,292)        (50,998)
        (Increase) decrease in inventories                                            1,991         (58,635)
        (Increase) in prepaid expenses                                             (104,113)         (2,145)
        (Increase) in intangible assets                                             (26,659)        (85,298)
        Increase in accounts payable                                                538,375         189,861
        Increase (decrease) in accrued expenses                                     (39,900)         72,943
        Increase (decrease) in income taxes payable                                   1,611         (65,762)
                                                                             -------------------------------
           Net cash provided by operating activities                              1,807,718       1,442,125
                                                                             -------------------------------
Cash Flows From Investing Activities
   Proceeds from sale of property and equipment                                     108,650         244,012
   Purchase of property and equipment, net of property and
      equipment from acquisition of subsidiaries                                 (2,179,547)     (5,096,695)
   Acquisition of subsidiaries, net of cash acquired                             (2,795,644)       (300,000)
                                                                             -------------------------------
           Net cash (used in) investing activities                               (4,866,541)     (5,152,683)
                                                                             -------------------------------
Cash Flows From Financing Activities
   Proceeds from short-term borrowings, net of debt
      assumed in acquisition of subsidiaries                                      1,443,750       1,409,911
   Proceeds from long-term borrowings, net of debt assumed in
      acquisition of subsidiaries                                                 5,715,100       5,479,157
   Payments on short-term borrowings                                               (754,547)     (1,483,738)
   Payments on long-term borrowings                                              (3,130,573)     (1,498,060)
   Proceeds from common stock issued upon exercise of
      stock warrants and options                                                    140,640          38,508
   Preferred stock dividend payments to minority interest                          (123,565)       (124,405)
   Repurchase of minority interest                                                   (7,000)        (14,000)
                                                                             -------------------------------
           Net cash provided by financing activities                              3,283,805       3,807,373
                                                                             -------------------------------
           Net increase in cash                                                     224,982          96,815

Cash, beginning of year                                                             276,230         179,415
                                                                            -------------------------------
Cash, end of year                                                            $      501,212 $       276,230
                                                                             ==============================
Supplemental Disclosures of Cash Flow Information
   Cash payments for:
      Interest                                                               $    1,324,640 $      779,914
                                                                             ==============================
      Income taxes, net                                                      $      151,448 $      278,203
                                                                             ==============================
Supplemental Schedule of Noncash Investing and Financing Activities
      Railroad acquisitions
        Fair value of assets acquired, net of cash 1996 $338,714; 1995 none  $     5,686,890 $    500,000
        Cash paid for stock and assets                                            (2,795,644)    (300,000)
                                                                             -----------------------------
        Liabilities and debt assumed; and stock issued                       $     2,891,246 $    200,000
                                                                             =============================
      Reconciliation:
        Liabilities assumed                                                  $     2,444,442 $         -
        Debt assumed                                                                 445,564           -
        Issuance of common stock 1996 342 shares; 1995 76,190 shares                   1,240      200,000
                                                                             ----------------------------
                                                                             $     2,891,246 $    200,000
                                                                             ============================
      Additional property, equipment and inventory acquired
        upon issuance of common stock 1996 2,000 shares;
        1995 196,353 shares                                                  $         7,000 $    464,411
                                                                             ============================
      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  thirteen
short-line common carrier rail- road operations, an equipment leasing company, a
subsidiary which owns an airplane,  and a service company.  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 active subsidiaries include the following:

<TABLE>
    <S>                                     <C>

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

</TABLE>

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.  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 at
December 31, 1996 and 1995.

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

Improvements to leased property are depreciated  over the lesser of the lease or
life of the improvements.

<PAGE>

Maintenance  and repair  expenditures,  which keep the rail facilities in proper
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 whether
any  circumstances or events would indicate an impairment.  The Company does not
believe that impairment exists at December 31, 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 to determine potential impairment by
comparing the carrying value of the intangible with the undiscounted anticipated
future cash flows of the related  property  before interest  charges.  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 at December 31, 1996.

Earnings  per common  share:  The  earnings  per common  share were  computed by
dividing the net income by the weighted average number of shares of common stock
outstanding  during each of the years  after  giving  retroactive  effect to the
stock split  discussed in Note 11. Common stock  equivalents  were excluded from
the computation  since they were antidilutive in 1996 and the dilutive effect in
1995 was not material.

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.

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.  The  insurance  contract with Safeco Life
Insurance  Company  limits the  insurance  company's  coverage  to a  $2,000,000
maximum lifetime  reimbursement  per person and specifies that individual claims
in excess of $20,000 on an annual basis and total claims exceeding the aggregate
excess will be fully covered by Safeco Life  Insurance  Company,  subject to the
maximum lifetime reimbursement provision.


Note 2.  Property and Equipment

Property and equipment consist of the following:

<TABLE>


                                                                                       December 31,
                                                                           ---------------------------------

                                                                                 1996               1995
                                                                           ---------------------------------
   <S>                                                                     <C>              <C>

   Land                                                                    $     1,352,965  $        280,606
   Roadbed                                                                       7,455,782         4,840,367
   Transportation equipment                                                      2,235,551         1,594,150
   Railcars                                                                      9,659,443         8,328,207
   Buildings                                                                     1,078,122           687,958
   Machinery and equipment                                                         873,279           704,117
   Office equipment                                                                379,171           297,665
   Leasehold improvements                                                           67,511                 -
   Capital projects                                                                324,352           467,096
                                                                           ----------------------------------
                                                                                23,426,176        17,200,166
   Less accumulated depreciation                                                 3,294,610         1,979,998
                                                                           ----------------------------------
                                                                           $    20,131,566  $     15,220,168
                                                                           ==================================
</TABLE>
<PAGE>


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  has an  outstanding
balance under this line of credit as of December 31, 1996, of $75,000.

The Company has a $400,000  line of credit  with Keokuk  Savings  Bank and Trust
Company,  Keokuk,  Iowa,  that expires March 1998,  bears interest at prime,  as
published  in The Wall  Street  Journal,  plus 1.5%,  and is  collateralized  by
accounts  receivable,  inventory  and  general  intangibles.  The Company has an
outstanding balance under this line of credit at December 31, 1996, of $204,398.

The Company has a $600,000 line of credit with First of America Bank - Illinois,
N.A.,  Peoria,  Illinois,  that expires July 1997,  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 an
outstanding  balance  under  this line of credit as of  December  31,  1996,  of
$347,276.

The Company has a $5,121 and $11,682 unsecured note payable to MINNRAIL, Inc. as
of December  31, 1996 and 1995,  respectively.  This note was assumed as part of
the asset  acquisition  from MNVA Railroad,  Inc. The note bears no interest and
requires quarterly payments on the basis of revenue carloads received or shipped
on the Minnesota  Central  Railroad Co., a Pioneer Railcorp  subsidiary,  at the
rate of $10 per car.

The Company has various unsecured notes payable totaling $137,740 and $68,651 as
of December  31, 1996 and 1995,  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 installments due from
April to August 1997.

Long-term debt at December 31, 1996 and 1995, consists of the following:

<TABLE>


                                                                                      1996           1995
                                                                               ------------------------------
<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 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                                  $      416,112 $       425,021
Mortgage payable, First of America Bank - Illinois, N.A., due in
   monthly  installments  of  $19,314,  including  interest  at  
   9.25%,  through December 2, 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.                                                                1,500,000               -
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                                                                    192,019         218,850
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               -
Notes payable, Ford Motor Credit Company, due in monthly install-
   ments  from $418 to $525,  including  interest  ranging  from 9.5% 
   to 10.25%, final installments due from July 2000 to October 2000,
   collateralized by vehicles                                                          54,224          65,703
Notes payable, Commerce Bank, due in monthly installments from
   $593 to $646, including interest at 8.5%, final installments due
   January 1998, collateralized by vehicles                                            15,189          28,155
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 August 2003, collateralized by railcars and equipment                         1,597,880       1,059,044
                                                                               -------------------------------
Balance carried forward                                                        $    3,993,175 $     1,796,773
                                                                               -------------------------------
</TABLE>

<PAGE>
<TABLE>

                                                                                     1996          1995
                                                                               ------------------------------
<S>                                                                            <C>            <C>  

Balance brought forward                                                        $    3,993,175 $     1,796,773
Note payable, Keycorp, due in monthly installments of $22,744,
   including interest at 8.86%, final installment due December 2003,
   collateralized by railcars                                                       1,419,675       1,560,000
Note payable, Nations Bank, due in monthly installments of
   $23,305, including interest at 8.75%, final installment due
   December 2002, collateralized by railcars                                        1,315,557       1,460,000
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                                                       1,218,244       1,337,721
Note payable, A&F, Inc., paid December 1996                                                 -       1,285,600
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                                                                      1,687,445       1,935,017
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                234,132         348,578
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.                                                           204,667         236,834
Note payable, Burling Bank, paid December 1996                                              -         407,143
Note payable, U.S. Small Business Administration, due in monthly 
   installments of $7,577,  including  interest at 4%, final  
   installment  due  September  2000, collateralized by track acquired 
   from MNVA Railroad, Inc.                                                           314,956         391,527
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, 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          77,480
Note payable, Kyle Railways, Inc., due in monthly  installments
   of $2,630, including interest at 8%, final installment due
   April 1998, unsecured                                                               39,787          66,972
Note payable, Citizens Bank and Trust Company, due in
   monthly installments of $1,683, including interest at 9%,
   final installment due May 1998, collateralized by railcars                          26,765          43,657
                                                                               -------------------------------
Balance carried forward                                                        $   10,864,387 $    11,327,302
                                                                               -------------------------------
</TABLE>
<PAGE>

<TABLE>


                                                                                       1996           1995
                                                                               ------------------------------
<S>                                                                            <C>            <C>   

Balance brought forward                                                        $   10,864,387 $    11,327,302
Notes payable, First of America Bank, due in monthly
   installments aggregating $404, including interest at 6.75%,
   final installment due June 1999, collateralized by automobiles                      11,113          15,060
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, LDI Corporation, due in monthly installments of
   $16,731, including interest of 10.25%, final installment due
   December 2003, collateralized by locomotives                                     1,000,000               -
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               -
Various notes payable, due in monthly installments from $332
   to  $1,559,  final  installments  due  from  April  1995 to  
   September  1996, including interest ranging from 7.75% to 16.5%,
   collateralized by vehicles and maintenance equipment                                     -           4,927
                                                                               -------------------------------
                                                                                   14,377,379      11,347,289
Less current portion                                                                1,813,246       1,412,552
                                                                               -------------------------------
                                                                               $   12,564,133 $     9,934,737
                                                                               ===============================
</TABLE>

Aggregate maturities required on long-term debt as of December 31, 1996, are due
in future years as follows:

Years ending December 31,           Amount
------------------------------------------
  1997                         $ 1,813,246
  1998                           1,968,197
  1999                           1,998,351
  2000                           2,155,042
  2001                           1,936,010
  Thereafter                     4,506,533
                               -----------
                               $14,377,379
                               ===========

Note 4.  Income Tax Matters

The Company and thirteen of its subsidiaries file a consolidated  federal income
tax return. Three of the subsidiaries file separate federal income tax returns.

The  provision  (credit) for income taxes  charged to  operations  for the years
ended December 31, 1996 and 1995, was as follows:


                                                  1996            1995
                                           ---------------------------------
   Current:
      Federal                              $       (57,678)  $       149,781
      State                                          8,013            11,662

   Deferred                                        185,625           334,000
                                           ----------------------------------
                                           $       135,960   $       495,443
                                           ==================================

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, 1996 and 1995, due to the following:

                                                             1996        1995
                                                            -------------------
   Computed "expected" tax expense                           35.0 %      35.0 %
   Increase (decrease) in income taxes resulting from:
      State income taxes, net of federal tax benefit          8.8         4.6
      Other                                                  (6.2)        6.2
                                                           --------------------
                                                             37.6 %      45.8 %
                                                           ====================
<PAGE>

The Company  and its  subsidiaries  have  Alternative  Minimum Tax (AMT)  credit
carryforwards  of  approximately  $401,000 and $424,000 at December 31, 1996 and
1995,  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  $2,224,000  at  December  31,  1996,  which can be used to offset
future taxable income of those  subsidiaries.  Net operating loss  carryforwards
expire in the years 2006 and 2007.

Deferred tax assets and  liabilities  consist of the following  components as of
December 31, 1996 and 1995:


                                                   1996              1995
                                             ---------------------------------
   Deferred tax assets:
      AMT credit carryforwards               $       401,000   $       424,000
      NOL carryforwards                              832,000           278,000
      Deferred compensation                           25,000                -
      Other                                           25,901            35,000
                                             ----------------------------------
                                                   1,283,901           737,000
   Deferred tax liabilities:
      Property and equipment                      (3,181,000)       (1,545,000)
      Other                                          (44,651)               -
                                             ----------------------------------
                                             $    (1,941,750)   $     (808,000)
                                             ==================================


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,
1996 and 1995 as follows:


                                                     1996              1995
                                             ----------------------------------
   Current deferred tax assets               $        25,901   $         35,000
   Net noncurrent deferred tax liabilities        (1,967,651)          (843,000)
                                             ----------------------------------

   Net deferred tax liability                $    (1,941,750)  $       (808,000)
                                             ==================================


Note 5.  Retirement Plans

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.  To be eligible for the plan, an employee
must be 21 years of age and have  completed  one year of service.  Employees may
elect to  contribute,  on a tax deferred  basis,  up to 15% of their salary,  or
$9,500,  whichever  is least.  The  Company  matches 50% of the first 8% of each
employee's  contribution.  Keokuk  Junction  Railway  Co.  also  has a  separate
retirement plan with  substantially  similar terms. The Company intends to merge
the plans during 1997.  The  Company's  expense  under the plans was $34,778 and
$21,413 for the years ended December 31, 1996 and 1995, respectively.


Note 6.  Deferred Compensation Agreements

The Company has  deferred  compensation  agreements  with one  employee  and one
former employee.  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  using a discount rate of 7%
ratably  over the  remaining  years to the date  when the  employees  are  first
eligible for  benefits.  The deferred  compensation  charged to expense  totaled
$10,541 for the year ended December 31, 1996.

<PAGE>

Note 7.  Stock Option Plans

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 which  generally  requires that the amount of
compensation  cost that must be  recognized  is the quoted  market  price of the
stock at the  measurement  date, less the amount the employer 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,  as
adjusted for the stock split  described in Note 11. 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.  None of the outstanding  options have been exercised as of December 31,
1996.

Other pertinent information related to the plans is as follows:

<TABLE>


                                                               1996                       1995
                                                    ----------------------------------------------------
                                                                   Weighted-                   Weighted-
                                                                   Average                     Average
                                                                   Exercise                    Exercise
                                                      Shares        Price        Shares         Price
                                                    ----------------------------------------------------
   <S>                                              <C>          <C>             <C>        <C>

   Shares under option, beginning of year              836,000   $        2.15    840,000   $       1.53
   Granted                                             407,000            2.75    256,000           3.56
   Expired                                            (100,000)           2.75   (260,000)          1.50
   Exercised                                           (43,200)           1.50          -              -
                                                    -----------------------------------------------------
   Under option, end of year                         1,099,800   $        2.35    836,000   $       2.15
                                                    =====================================================

   Exercisable at end of year                          792,800                    836,000
                                                    ===========                ===========

   Weighted-average fair value per option
      of options granted during the year            $    1.97                  $     1.37
                                                    ===========                ===========

</TABLE>

<PAGE>

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 SFAS 123)
reported  net income,  and  earnings per common share would have been reduced to
the proforma amounts shown below:


                                                       1996          1995
                                                 -----------------------------
   Net income:
      As reported                                $     102,145 $       461,708
      Proforma                                   $      27,145 $       230,708

   Earnings per common share:
      As reported                                $         .02 $           .11
      Proforma                                   $         .01 $           .05

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:


                                                        1996          1995
                                                  -----------------------------
   Dividend rate                                  $          -    $         -
   Expected life (years)                                    7.5             4
   Risk-free interest rate                                6.55%    5.86-7.27%
   Price volatility                                         66%           44%


Note 8.  Lease Commitments and Total Rental Expense

In July 1991,  the  Company,  through its  wholly-owned  subsidiary,  Fort Smith
Railroad Co., entered into a twenty-year  lease, with three twenty-year  renewal
options,  with the Missouri  Pacific  Railroad  Company and operates 18 miles of
rail  facilities in Arkansas.  The  agreement  contains  numerous  requirements,
including  maintaining existing traffic patterns,  repair and replacement of the
right of way in the  condition  it was  leased  (substantially  FRA Class I) and
payment of any applicable real estate taxes.  The Company is entitled to a fixed
rate per car load switched from the Missouri Pacific Railroad  Company,  as well
as 90% of new leases and easements  and 50% of existing  leases and easements on
the  property.  As long as these  lease  requirements  are met,  the Company may
continue to operate on the rail facilities without additional lease costs.

The Company, through its wholly-owned subsidiary, Alabama & Florida Railway Co.,
Inc., leases a 2 mile segment of track connecting to the subsidiary's facilities
in Andalusia,  Alabama,  from the Andalusia & Conecuh Railroad Company, Inc. for
$375 per month, plus $15 per car on all cars over 300 per year. The Company also
bears the cost of all  maintenance on the track.  The subsidiary also leases the
real estate comprising the right of way from Georgiana to Geneva,  Alabama, from
CSX Transportation, Inc. for $2,305 per month.

In September 1993, the Company,  through its  wholly-owned  subsidiary,  Decatur
Junction  Railway Co.  (DT),  entered  into lease  agreements,  which  expire in
December 2006, with Cisco Co-Op Grain Company (CISCO) and with Central  Illinois
Shippers,  Inc. (CISI).  The Company has an option to renew the CISCO line lease
for a ten-year period.  The CISCO segment is  approximately 13 miles,  while the
CISI segment is approximately 17 miles in distance; both are located in Illinois
and connect via trackage rights on the Illinois  Central  Railroad.  Both leases
require DT to perform normalized  maintenance on the line and pay $10 per car on
all cars over 1,000 per year on each segment.

Vandalia Railroad Company has a lease with the City of Vandalia,  Illinois,  for
3.45 miles of railway. This lease is renewable for ten-year periods beginning in
September  2003, and the annual lease of $1 is prepaid  through  September 2003.
Lease  payments will be equal to $10 per loaded  railcar  handled in interchange
beginning with the first renewal period in September 2003.

In November  1994,  in  conjunction  with the purchase of its  corporate  office
building,  the  Company  assumed  a land  lease  for the  property  on which the
building  is  located.  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,  fire  protection,  taxes and
insurance.

In February 1996, the Company, through its wholly-owned  subsidiary,  Columbia &
Northern  Railway  Co.,  entered  into a lease with the Marion  County  Railroad
Authority for 28.78 miles of railway. This ten year lease is renewable with five
ten-year renewal options, and the annual lease of $1 is prepaid through February
2056. The Company is responsible for costs of normalized maintenance.

<PAGE>

Also in  February  1996,  the  Company,  through  its  wholly-owned  subsidiary,
Rochelle  Railroad Co.,  entered into a one-year lease with a five-year  renewal
option,  signed in March 1997,  with the City of Rochelle,  Illinois,  County of
Ogle,  for the exclusive  right to operate the City's rail line.  The Company is
required  to pay the City of  Rochelle  $20 per car  handled  on the  line.  The
Company also is required to install,  at its own expense, a passing track on the
line for an estimated cost of $86,000 on or before August 1, 1997. The agreement
contains numerous requirements, including repair and replacement of the track in
the condition it was leased (substantially FRA Class I).

In December 1996, the Company,  through its  wholly-owned  subsidiary,  Wabash &
Western Railway Co., d/b/a Michigan Southern Railroad, entered into a lease with
Michigan  Southern  Railroad Co., Inc.,  Morris Leasing Co., Ltd., and Gordon D.
Morris for 49.6 miles of railway and  equipment.  The lease  expires in December
1997, with a one-year renewal option,  and the Company has an option to purchase
the stock and leased  personal  property of the railroad upon  expiration of the
lease.  Monthly equipment lease payments are $5,000,  payable in advance of each
calendar  month.  Monthly railway lease payments are equal to $25 per car on all
loaded cars up to 4,000 cars per year and $15 per car thereafter. The Company is
responsible for payment of all expenses,  including wages,  payroll taxes, fuel,
trackage rights and lease fees, insurance, utilities, and property taxes.

The Company,  through its  wholly-owned  subsidiary,  Keokuk  Junction  Railway,
leases  approximately 50 railcars under certain  agreements which expire between
June 1997 and May 1998 and require minimum monthly rentals.

The total  minimum  rental  commitment as of December 31, 1996,  required  under
noncancelable  leases, and excluding executory costs and per car rentals, is due
in future years as follows:

   Years Ending December 31,                Amount
-----------------------------------------------------
       1997                             $     307,856
       1998                                   187,356
       1999                                    46,256
       2000                                    46,256
       2001                                    46,256
       Thereafter                             361,212
                                       --------------
                                        $     995,192
                                       ==============

The total rental expense  incurred under the leases was $273,433 and $55,109 for
the years ended December 31, 1996 and 1995, respectively.


Note 9.  Major Customer

Revenue earned from a major customer amounted to approximately $1,465,000 during
the year ended December 31, 1996.  Accounts  receivable as of December 31, 1996,
includes approximately $344,000 due from this customer.


Note 10.  Purchases of Railroad Facilities

In July 1995, the Company,  through its wholly-owned  subsidiary,  West Michigan
Railroad Co., 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.  This  acquisition was made by the
Company for $300,000 cash and the issuance of 76,190 shares of common stock,  at
$2 5/8 per share, for a total acquisition cost of $500,000.

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.

In December 1996, the Company  acquired all of the  outstanding  common stock of
Shawnee Terminal Railway Company in exchange for $10,000.

The  above  acquisitions  have  been  accounted  for by the  purchase  method of
accounting and,  accordingly,  operating results of these companies are included
in the consolidated statements of income from the date of acquisition.
<PAGE>

Unaudited  pro forma  consolidated  results of  operations  for the years  ended
December  31,  1996 and 1995,  as though  Keokuk  Junction  Railway Co. had been
acquired as of January 1, 1995, follows:


                                                  1996             1995
                                            --------------------------------
   Railway operating revenue                $    11,873,809  $    11,769,636
   Net income                                        57,811          725,597
   Earnings per common share                           0.01             0.17

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

To include the results of operations  of West Michigan  Railroad Co. and Shawnee
Terminal Railway Company from January 1, 1995, to the date of acquisitions would
not have a significant effect on the consolidated  results of operations for the
years ended December 31, 1996 and 1995.


Note 11.  Stock Split and Stock Warrants Issued as Dividends

On May 16, 1995, the Board of Directors authorized a 2 for 1 stock split payable
to stockholders  of record on June 30, 1995. In addition,  on June 24, 1995, the
stockholders ratified an amendment to the Articles of Incorporation  authorizing
the issuance of stock warrants as a dividend to stockholders  immediately  after
the stock split.  Each stockholder  received one warrant for each share of stock
owned,  resulting in the issuance of 4,198,084  warrants.  Each warrant  permits
stockholders 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 were 4,140,910
and 4,178,830 warrants outstanding at December 31, 1996 and 1995, respectively.


Note 12.  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.

Following is a summary of the minority  interest in  subsidiaries as of December
31, 1996 and 1995:

<TABLE>


                                                                                   
                                                                                      1996          1995
                                                                                -----------------------------
<S>                                                                              <C>            <C> 

Preferred stock of Alabama Railroad Co.
   Par value - $1,000 per share
   Authorized - 700 shares
   Issued and  outstanding  - 425  and  427  shares  (cumulative  
     12%  dividend; callable at Company's option at 150% of face value)
      at December 31, 1996 and 1995, respectively                                $    425,000   $    427,000
Preferred stock of Alabama & Florida Railway Co., Inc.
   Par value - $1,000 per share
   Authorized - 500 shares
   Issued and outstanding - 422 and 423 shares (cumulative 9% dividend; 
      callable at  Company's  option  after  June 22,  1995,  at 150% 
      of face  value)  at December 31, 1996 and 1995, respectively                    422,000        423,000
 Preferred stock of Mississippi Central Railroad Co.
   Par value - $1,000 per share
   Authorized - 1,000 shares
   Issued and outstanding  - 341 and 345 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) at December 31, 
      1996 and 1995, respectively                                                     341,000        345,000
                                                                                 ----------------------------
                                                                                 $  1,188,000   $  1,195,000
                                                                                 ============================
</TABLE>
<PAGE>

Note 13.  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.

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.


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 1996 and 1995 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  disclosures.  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 trading  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  (adjusted to
reflect a 2 for 1 stock split on 6/30/95):

         95-1Q   95-2Q   95-3Q     95-4Q     96-1Q     96-2Q     96-3Q     96-4Q
         -----------------------------------------------------------------------

High     $2.63   $4.50   $4.50     $3.38     $4.13     $4.00     $3.13     $3.13
Low      $2.00   $2.19   $2.63     $2.00     $3.38     $2.75     $2.00     $1.88

As of December 31, 1996,  the Company had 1,768 common  stockholders  of record,
including brokers who held 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 Railcorp Services, Inc.
John S. Fulton, Purple Realty
John P. Wolf, Director of Distribution, Kimball International

Officers

Guy L. Brenkman, Chief Executive Officer and President
John P. Wolf, Treasurer
J. Michael Carr, Assistant Treasurer
Daniel A. LeKemper, 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.