<PAGE>

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-K


     [X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
          EXCHANGE ACT OF 1934.

                 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                                      OR

     [ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
          EXCHANGE ACT OF 1934.

            For the transition period from     -     to     -
                                           --------      --------

                        COMMISSION FILE NUMBER 1-10478


                       WAHLCO ENVIRONMENTAL SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

          DELAWARE                                          33-0391175
(State or other jurisdiction of incorporation     (I.R.S. Identification No.)
       or organization)

     3600 WEST SEGERSTROM AVENUE
     SANTA ANA, CALIFORNIA                                  92704
(Address of principal executive offices)                 (Zip Code)

         REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:  (714) 979-7300
             SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

     TITLE OF EACH CLASS                          NAME OF EACH EXCHANGE ON WHICH
                                                       REGISTERED
Common Stock, Par Value $0.01                     New York Stock Exchange

             SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

     TITLE OF EACH CLASS
          None

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes  X  No
                                                  -----   -----

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K [X]

At February 27, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant was  $1,482,688.

At February 27, 1998, there were 17,649,000 shares of the registrant's common
stock outstanding.

Part III incorporates information by reference from a definitive Proxy
Statement to be filed with the Securities and Exchange Commission within 120
days after the close of the registrant's fiscal year ended December 31, 1997.

                                                                 Page 1 of __
                                                     Exhibit Index at Page __

<PAGE>


                                      PART I

ITEM 1.  BUSINESS.

Wahlco Environmental Systems, Inc. ("WES") is a Delaware corporation with its
principal executive offices located at 3600 West Segerstrom Avenue, Santa
Ana, California  92704 (telephone number (714) 979-7300).  Unless otherwise
indicated, the term "Company" or "WES" refers to WES and its consolidated
subsidiaries.

The Company designs, manufactures, and sells combined cycle gas turbine
products, metallic bellows, air pollution control equipment, and related
products and services to electric utilities, independent power producers,
cogeneration plants, and industrial manufacturers worldwide.  The Company
also provides mechanical plant installation services and rents associated
equipment to users in the U.K.  The Company operates through several
subsidiaries which focus on specific geographical regions or products.  These
entities, located primarily in the United States and the U.K., are
coordinated through common corporate management.

GENERAL DEVELOPMENT OF BUSINESS

The Company was formed in 1990 by Pacific Diversified Capital Company
("PDC"), a wholly-owned subsidiary of San Diego Gas & Electric Company
("SDG&E"), for the purpose of acquiring and operating Wahlco, Inc.
("Wahlco"), at that time a wholly-owned subsidiary of PDC.  In May 1990, the
Company issued 3,389,000 shares of common stock in its initial public
offering.  Upon the completion of the public offering, PDC's ownership
interest in the Company was approximately 81%.

On June 6, 1995, PDC sold to WES Acquisition Corp. ("WESAC"), an affiliate of
Wexford Capital Corporation, its 81% stock interest in the Company.

On March 30, 1990, the Company acquired all of the capital stock of Wahlco
Engineered Products, Inc. ("WEP Inc.") which designs, manufactures and sells
gas flow diverters, dampers, and expansion joints used by electric utilities
and other industrial companies.

On August 8, 1991, WES acquired all the outstanding shares of stock of
Teddington Bellows Ltd. ("Teddington"), which manufactures specialized high
performance metallic expansion joints.  Teddington's customers include power
generation, petrochemical, automobile, construction, and steel companies.

On August 17, 1991, the Company acquired substantially all of the Metro-Flex
Group (now called Wahlco Engineered Products Ltd.), headquartered in Baar,
Switzerland, and Pentney Engineering Ltd. ("Pentney"), and Treste Plant Hire
Limited ("Treste") headquartered in Chesterfield, England. Wahlco Engineered
Products, Ltd. ("WEP Ltd."), now located at the Pentney facilities in
Chesterfield, England, designs and markets gas flow diverters and dampers for
electric utility and industrial power plant exhaust systems.  Pentney
manufactures products for WEP Ltd. and also
                                       2
<PAGE>

provides hydraulic equipment, pipework, and general metal fabrication.

DESCRIPTION OF THE BUSINESS

The Company's business is operated through its subsidiaries:

Wahlco Engineered Products, Inc. (U. S.) designs, manufactures and sells gas
flow diverters, dampers and fabric and metallic expansion joints used by
electric utilities and other industrial companies.

Wahlco Engineered Products, Ltd. (U.K.) ("WEP Ltd.")designs and sells gas
flow diverters which control and direct the flow of gases from a gas turbine
exhaust to a waste heat recovery boiler in a gas-turbine combined-cycle
power-generation plant.

Wahlco, Inc. (U.S.) designs, manufactures, sells, leases and services
equipment used by electric utilities and others to reduce and control air
pollution. Wahlco's products and services include flue gas conditioning
systems, Nitrogen Oxide ("NOx") reduction systems, and industrial electric
heaters and thermocouples.  In addition, through its license agreement with
LTG, Wahlco manufactures and sells catalytic and thermal oxidizers to control
and reduce VOCs.

Pentney Engineering Ltd. (U.K.) provides mechanical pipework and plant
installation, hydraulic equipment manufacture, and general fabrication to WEP
Ltd., utilities and industrial companies.

Teddington Bellows Ltd. (U.K.) designs, manufactures and sells specialized
high performance metallic expansion joints for industrial and utility
applications.

Treste Plant Hire, Ltd. (U. K.) rents mechanical equipment to the United
Kingdom construction industry.

PRODUCTS AND SERVICES

The Company's products are sold in the coal-fired utility after-boiler
market, the gas-turbine power-generation market and other industrial markets.

                                       3
<PAGE>

DAMPERS, DIVERTERS, EXPANSION JOINTS, PIPING SYSTEMS, HYDRAULIC EQUIPMENT AND
OTHER SERVICES (78% OF 1997 REVENUES; 80% OF 1996 REVENUES)

Gas flow diverters direct the flow of exhaust gases from gas turbines either
to the atmosphere via the stack or to a boiler for steam production.  The steam
produced is principally used for power generation by steam turbines (combined
cycle).  In some cases, the steam is used as process steam in district
heating systems, water desalination, or operations such as liquefying oil to
assist in its extraction from the ground (co-generation).  Gas flow diverters
are supplied to the power generation industry, industrial power plant
systems, and similar process industries of gas type isolation equipment.
Diverters are sold to customers in Europe, Southeast Asia, the Far East and
the United States.

Dampers control the flow of air and gas by directing, throttling and/or
channeling air and gas through a single path.  They are used by power
generating utilities, petrochemical plants, refineries, chemical plants,
cement plants, paper and steel mills, and other industrial companies.

Expansion joints are produced from various fabrics and metals, in a variety
of configurations, and are used with diverters and other ducting systems.
These products are provided to a wide range of industries.

Metallic expansion joints are installed in liquid and gas piping, pressure
systems and exhaust systems in the chemical, petrochemical, utility power
generation, aviation, nuclear, ship building, heating and other general
industries.  Expansion joints are used primarily to counteract the negative
effect of the expansion and contraction of pipes and ducts caused by extreme
temperature changes from a production process such as electric power
production and petroleum refining.

In 1996 and 1997, only a small portion of these businesses was driven by
environmental regulation.

WARRANTIES.  Warranties for the Company's products generally average from 12
to 48 months from the date of sale and provide for the repair or replacement,
without charge, of any parts found to be defective in material or workmanship
under normal and proper use (except wear and tear from abrasion or
corrosion). The Company believes that the useful life for this group of
products ranges from 3 to 20 years under normal and proper use.

FGC, NOX, VOC SYSTEMS, HEATERS AND THERMOCOUPLES, AND RELATED PRODUCTS AND
SERVICES (22% OF 1997 REVENUES; 20% OF 1996 REVENUES)

FLUE GAS CONDITIONING ("FGC") SYSTEMS.  The Company is the leading provider
of FGC systems worldwide.  The FGC business is principally driven by
environmental regulations that require electric utilities to meet certain
emissions standards for particulate matter and sulfur oxides.

To comply with these regulations, many utilities previously burning high
sulfur coal have switched to low sulfur coal.  While the conversion from high
sulfur to low sulfur coal enables utilities to meet

                                       4
<PAGE>

existing sulfur oxide emissions standards, the conversion generally results
in an increase in particulate emissions.  FGC systems increase the collection
efficiency of electrostatic precipitators ("ESPs"), which abate particulate
(fly ash) emissions.  The Company's FGC technologies include sulfur trioxide,
ammonia and dual conditioning (both sulfur trioxide and ammonia
conditioning).  FGC systems may be installed on existing or new ESPs.

RENTAL UNITS.  The Company rents FGC test systems to its customers to
demonstrate that the technology will reduce particulate emissions
sufficiently to comply with regulations.

SERVICE AGREEMENTS.  The Company has, from time to time, entered into
maintenance agreements of varying terms and conditions under which it
maintains systems purchased by its customers.

NITROGEN OXIDE ("NOx") REDUCTION SYSTEMS.  The Company's Staged NOx Reduction
System ("SNRS") relies on two NOx reduction technologies: selective
non-catalytic reduction ("SNCR") and selective catalytic reduction (SCR).
The system uses the customer's existing air heater to further reduce NOx
emissions.

HEATERS AND THERMOCOUPLES. Thermocouples are heat-sensing devices used in
conjunction with a temperature controller or indicator to convert an
electrical signal to a temperature readout.  The Company's electrical heaters
include tubular heaters, immersion heaters, duct heaters, tubular elements,
and silicone rubber heaters.

VOLATILE ORGANIC COMPOUND ("VOC") CONTROL SYSTEMS.  Under a license agreement
with LTG Lufttechnische GmbH covering the U.S., Canada and Mexico, the
Company manufactures a full line of thermal and catalytic oxidizers to
control and destroy VOCs.

WARRANTIES.  Warranties for FGC, NOx and VOC systems generally provide for the
repair or replacement, without charge, of any parts found to be defective in
material or workmanship under normal and proper use (excepting wear and tear
from abrasion or corrosion) within 18 months from the date of

                                       5
<PAGE>

shipment or 12 months from the date of initial operation, whichever occurs
first.  In addition, under certain circumstances, the Company guarantees that
proper operation of its FGC, NOx and VOC systems will not exceed certain
effluent opacity or emission levels over an initial acceptance period.

Warranties for heaters and thermocouples generally provide that the Company
will repair or replace, without charge, any parts found to be defective in
material or workmanship under normal and proper use (excepting wear and tear
from abrasion or corrosion) within 12 months from the date of sale.  The
Company believes the useful life of each of these products exceeds five years
under normal and proper use.

PATENTS AND TRADEMARKS

The Company holds twenty-four U.S. patents and corresponding foreign patents
and/or applications.  Existing patents expire between 1999 and 2015.
Although initially enhanced by its patent rights, the Company believes its
ability to compete effectively in the FGC market depends primarily upon its
engineering, scientific and technological expertise and its reputation for
successful installations.  This includes a database of information relating
to coal and ash analysis and precipitator size and operating conditions.  In
addition, the Company has competed successfully in the sale of its sulfur
dioxide-based and ammonia conditioning systems, which are not protected by
patents, and in the sale of its sulfur-burning FGC systems in foreign
countries in which it does not have significant patent protection.

During 1996, the Company was awarded four new U.S. patents covering different
approaches to environmentally beneficial "In-duct gas conditioning" which the
Company believes could become an important FGC technology.  Foreign patent
applications for this technology are in progress.

In May 1992, the Company acquired from L&C Steinmuller GmbH three U.S. and a
number of corresponding foreign patents which broadly cover the core
component of Wahlco's  entry into the market for the control of NOx emissions.

The Company holds several U.S. and foreign patents, relating to dampers,
diverters and expansion joints, which expire between 1998 and 2015.  In
addition, a number of applications are pending, for some of which patent
grants are imminent.  As these patents and applications relate to a diverse
range of products, and because the Company's business is more dependent upon
the engineering quality of the Company's products, the Company does not view
its success as dependent upon any single patent.

Dampers, diverters, expansion joints and related services are marketed under
the trademarks or tradenames "WAHLCO," "METRO-FLEX," and "TEDDINGTON."

RESEARCH AND PRODUCT DEVELOPMENT

Expenditures for research and product development were approximately $294
thousand in 1997 and $277 thousand in 1996.  The Company's research and
development activities are substantially augmented by the knowledge gained
through custom engineering provided for individual customers.

                                       6
<PAGE>

The Company has an ongoing program to improve its products.  As examples, its
research efforts have resulted in the development of FGC process
improvements, development of high efficiency catalysts, improvements to heat
exchange surfaces, NOx reduction systems, a heat transfer testing facility,
and a sophisticated database containing information relating to coal and ash
analysis for sizing and improving the performance of electrostatic
precipitators, and precipitator size and operating conditions. In its
diverter product range, Wahlco is carrying out research into the effects of
high temperature cycling and flow characteristics of GT exhaust systems.

MARKETING

The Company markets its products, technologies and services to electric
utilities and industrial customers worldwide.  The principal export markets
for the Company's products are Asia, Europe and Canada.  (See Note 13 to
Consolidated Financial Statements.)

The Company has a dedicated sales force for each subsidiary, managed under
common corporate control.  Coordination among these groups has aided the
development of relationships and future business prospects for all products.

Since January 1997, Wahlco, Inc.'s sales organization has been headquartered in
Santa Ana, California.  A sales manager oversees approximately 40 independent
sales representative organizations in North America that sell to utility
customers and industrial customers, primarily in the steel, cement, pulp and
paper and related process industries.  The international sales function
operates through a network of 42 representatives in 57 countries in Africa,
Asia, the Pacific Rim, the Caribbean, Europe, the Middle East, and Central
and South America.

Wahlco's FGC marketing efforts are targeted primarily at coal-fired power
plants operated by electric utilities.  Repeat business for FGC systems is
limited because individual customers typically have a small number of
electrostatic precipitators and because FGC systems operate for many years
without the need for replacement.

Wahlco has developed a proprietary staged NOx reduction system ("SNRS") that
provides gas and coal-fired utilities with a modular, economic solution to
NOx removal.  To increase market penetration, the Company is working with
Nalco FuelTech, a significant participant in NOx reduction, to jointly market
the staged reduction technique using the Company's patented heater basket
technology.

                                       7
<PAGE>

Wahlco's marketing activities for the VOC control product line are similar to
those for the FGC product line.  During 1997, the primary VOC control markets
in the U.S. were wood products, semiconductor manufacturing,
printing/coating, surface finishing, metal decorating and chemical processing.

Marketing and sales for Wahlco Engineered Products, Inc. ("WEP, Inc.") is
based in Lewiston, Maine and focuses on customers in the power, pulp & paper,
cement, metals, and petro-chemical industries in North, Central and South
America through a network of approximately 28 independent sales
representative organizations.

WEP, Inc. also markets dampers and expansion joints to customers in Europe
and Asia through a network of 18 independent sales representative
organizations in Europe and Asia.  In addition, WEP, Inc. sell diverters to
U.S. based customers for projects in Europe and Asia.

WEP Ltd.'s products are marketed internationally  by 28 direct and
independent sales representatives in 34 countries.  Sales, engineering and
technical support are performed from the Chesterfield, U.K. facility.

Pentney Engineering Ltd. is based in Chesterfield, England with a branch
office in Doncaster, England. These operations are involved in turnkey
mechanical plant installation and high-integrity steel and pipe-work
fabrication.

Teddington primarily markets its products through 11 of its own sales agents.

Treste Plant Hire is based in Chesterfield, England, and operates a
mechanical equipment rental business.

CUSTOMERS

No customer accounted for more than 10% of the Company's revenues in 1997.
(See Note 13 to Consolidated Financial Statements).

RAW MATERIALS

The materials used in the production of the Company's product lines are
generally available through a number of sources, and the Company does not
anticipate difficulty in obtaining the materials and components used in its
operations.  Most of the materials used by the Company are ordered to a
number of standards, including ASME, ASTM and DIN.

Certain materials and components must withstand extreme operating conditions
and because only relatively few component suppliers consistently meet
necessary specifications, the Company purchases from a limited number of
suppliers. Generally, the Company has not experienced difficulty in obtaining
the necessary materials and components and has several alternative sources of
supply.

Pentney, Teddington and WEP Ltd. have achieved ISO 9000 standards.  The
remaining subsidiaries continue to work toward achieving ISO 9000
accreditation or equivalent standards.

                                       8
<PAGE>

COMPETITION

Wahlco, Inc. competes primarily on its engineering, scientific and
technological expertise.  Wahlco believes that its past performance record of
approximately 450 installed systems is a benefit in dealing with its
customers.  Wahlco bases its belief with respect to the performance record of
its FGC systems on its ongoing communications with customers for which it has
installed such systems.

Since 1990, Wahlco's domestic FGC business has experienced increased price
competition as domestic utilities attempted to reduce the overall costs of
compliance with state and federal regulations.  Several domestic
manufacturers including Chemithon, Inc. and Wilhelm Environmental
Technologies, Inc., have been successful in securing FGC contracts.

As a result of price competition, Wahlco has experienced a decline in market
share and  in overall FGC margins.  During the period 1993-1997, Wahlco
confronted competitive pricing pressures by reducing certain engineering and
manufacturing costs and by reconfiguring various products to better meet
customer demand.

Since there are several alternatives to FGC systems, Wahlco faces substantial
competition from companies providing devices which reduce particulate
emissions.  Examples of such devices are scrubbers, certain ESPs, and
baghouses.  Numerous factors may be considered by an electric utility in
determining whether to install FGC systems or an alternative technology to
achieve compliance.  These include the amount of initial capital
expenditures, issues and policies related to fuel sources, related on-going
operating and maintenance costs, availability and associated costs of low
and/or high sulfur coal, the particular emission standards applicable to the
public utility, and the value of any credits or allowances which may be
available.

One of the largest factors affecting the market and its competitive nature
has been the utilities' strategy to postpone adding FGC and other compliance
equipment by trading compliance credits and blending coals.  By applying
credits earned on plants operating well within compliance levels to plants
operating below acceptable limits, some utilities have been able to postpone
expenditures for clean air technologies. In addition, utilities have mixed
high and low sulfur coal or burned low sulfur coal containing enough sulfur
content to reduce sulfur emissions without impairing the effectiveness of the
particulate control devices.

Wahlco faces substantial competition with respect to its thermocouple and
electrical heater products and serves a relatively small portion of the total
market.  In addition to a few large companies which market such products
nationally, there are also several regional suppliers which compete with
Wahlco. In establishing a market niche, Wahlco targets customers requiring
specially engineered and customized products.

The Company's line of products to control VOC's competes with products from
numerous competitors.  Products are customized for particular applications,
and companies compete based on design and engineering capabilities as well as
installation and on-site reliability.

                                       9
<PAGE>

WEP, Inc. faces significant competition in the sale of its dampers,
diverters, and expansion joints.   Although these products are differentiated
by design, sophistication, reliability, and customer service, many purchasing
decisions are made on the basis of price and delivery.

WEP Ltd. continues to win a significant share of the international market for
gas flow diverters.  Pentney, Treste and Teddington complete in the U.K.
construction market which has been somewhat depressed during the last two
years. Recent strength of the U.K. pound has adversely affected the U.K.
market. Recent problems in Southeast Asian markets will have some negative
effects on sales of the Company's products to that region.

WEP, Inc. and WEP, Ltd. believe that, as a group, they command a significant
share of the global market for gas flow diverters and dampers.  Significant
competitors in this market include Rappold, Braden, Effox, and Stober &
Morlock. Domestically, WEP, Inc. faces competition in the damper market from
Effox, American Warming & Ventilating, ACDC, DDI, and others.  In the
expansion joint market, WEP, Inc. competes with Pathways, EJS, Senior
Flexonics, Badger, and others.

GOVERNMENTAL REGULATION

Although the Company's manufacturing operations are subject to environmental
regulations governing the discharge of pollutants, compliance by the Company
with these environmental regulations has not had, and is not anticipated to
have, a material effect on the capital expenditures, earnings or competitive
position of the Company.

Certain of the Company's business is dependent upon government regulation of
air pollution at the federal, state, local and foreign levels.  In the United
States, the Federal Clean Air Act ("CAA") (which was amended in 1990 to
impose stricter requirements for emissions), and the associated federal and
state regulations largely determine the size and timing of the investments
the Company's customers make in pollution control equipment.  Clean air
legislation in the United States requires compliance with ambient air quality
standards and empowers the Environmental Protection Agency ("EPA") to
establish and enforce limits on the emission of various pollutants.  The
states have primary responsibility for implementing these standards and, in
some cases, have adopted more stringent standards than those adopted by the
EPA.

Several factors have negatively impacted the air pollution control equipment
marketplace since the passage of the CAA Amendments in 1990.  There has been
a general increase in competition and an associated decrease in unit prices.
Changes specific to utility industry customers, such as the industry wide
deregulation and the availability of emission credit trading, caused many air
pollution control equipment customers to reevaluate or postpone capital
equipment decisions.

                                       10
<PAGE>

EMPLOYEES

At December 31, 1997, the Company employed 425 persons, of whom 316 were
engaged in production and operations, 35 were engaged in engineering and
scientific research, 42 were engaged in accounting and administration, 25
were engaged in sales, and 7 were in general management.

At December 31, 1996 the Company employed 354 persons. The increase to 425
personnel at the end of 1997, primarily reflects the hiring of approximately
50 direct laborers at Pentney Limited in December to complete a contract in
Europe.

FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS; EXPORT SALES

Information about revenues, results of operations and identifiable assets by
geographic areas and the amount of export sales for the periods indicated is
set forth in Note 13 to Consolidated Financial Statements.  The Company's
operations outside the United States are subject to the usual risks and
limitations attendant upon investments in foreign countries, such as
fluctuations in currency values, exchange control regulations, wage and price
controls, employment regulations, effects of foreign investment laws,
governmental instability (including expropriation or confiscation of assets)
and other potentially detrimental domestic and foreign governmental policies
affecting U.S. companies doing business abroad. The collapse in Asian
financial markets in late 1997 and early 1998 is having a negative effect on
certain of the Company's products.

ITEM 2.  PROPERTIES.

The building which houses the Company's and Wahlco's headquarters located in
Santa Ana, California, is occupied under a lease expiring July 31, 2001 at a
rental of $42 thousand per month.  The building consists of approximately
28,000 square feet of office space and approximately 22,000 square feet of
production space.  Wahlco also owns a 5,000 square foot service/installation
office located in Thornton, Illinois.

Wahlco Engineered Products, Inc. is headquartered in Lewiston, Maine, in a
49,300 square foot facility owned by the Company, consisting of 12,000 square
feet of office space, and 37,300 square feet of manufacturing area.

WEP Ltd., Pentney and Treste operate from leased facilities in Chesterfield,
England aggregating to approximately 115,000 square feet.  The facilities
consist of 95,000 square feet of manufacturing space and 20,000 square feet
of office space.  Approximately 32,000 square feet of manufacturing space are
subleased, which generates approximately $100 thousand per year.  Lease
payments required on these facilities total $277 thousand per year.  These
lease payments, which are part of the purchase agreement when the Company
purchased Pentney Engineering Ltd., are made to a company which is 50% owned
by an officer of the Company and a previous  co-owner of Pentney Engineering
Ltd. Teddington owns and operates a 75,000 square foot facility near Swansea,
in South Wales.  In March 1993, the Company purchased the facility for
approximately $227 thousand.

The Company believes that its facilities are adequate for its current
operations.

                                       11
<PAGE>

ITEM 3.  LEGAL PROCEEDINGS.

None.

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

None.

                                EXECUTIVE OFFICERS

The names and ages of the executive officers of the Company and the positions
held by each during the last five years were as follows:

C. Stephen Beal, 50, is the President and Chief Executive Officer of Wahlco
Environmental Systems, Inc.  Prior to joining Wahlco, as a result of the
acquisition by the Company of Pentney Engineering, Ltd. in 1991, Mr. Beal
served as Managing Director and joint owner of the Pentney Group since 1974.
From 1991 to 1996, Mr. Beal served as President and CEO of the Company's
Engineered Products Group.

A. Noel DeWinter, 58, has been Vice President and Chief Financial Officer
since October 1996 after serving as Vice President, Controller since March
1995.  Mr. DeWinter  served as Vice President, Finance from October 1991 to
January 1992, and Chief Financial Officer from January 1990 to October 1991.
From January 1992 to January 1994, he served at the Company's Lewiston, Maine
subsidiary as Vice President, Finance.

Barry J. Southam, 61,  has served as Senior Vice President, Sales and
Marketing, Wahlco, Inc., since February 1998.  Prior thereto, he was Senior
Vice President, FGC Technologies, since March 1997.  He served as Senior Vice
President, International Sales and Marketing for the Company since September
1991.

The officers are elected annually by the Board of Directors at the first
meeting following the Annual Meeting of Stockholders.  There is no family
relationship between any of the officers or directors.   There were no
arrangements or understandings between any officer and any other person
pursuant to which he was elected as an officer.

                                       12
<PAGE>

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

COMMON STOCK PRICE FROM JANUARY 1, 1997 TO DECEMBER 31, 1997

<TABLE>
<CAPTION>

                    1st Quarter    2nd Quarter    3rd Quarter    4th Quarter
                    -----------    -----------    -----------    -----------
<S>                <C>            <C>            <C>            <C>
High Price          15/32          15/32          1 26/32        7/8
Low Price            1/8            9/64            11/32        3/8
</TABLE>

COMMON STOCK PRICE FROM JANUARY 1, 1996 TO DECEMBER 31, 1996

<TABLE>
<CAPTION>

               1st Quarter    2nd Quarter    3rd Quarter    4th Quarter
               -----------    -----------    -----------    -----------
<S>           <C>            <C>            <C>            <C>
High Price     1 7/8          1 3/8          5/8            1/2
Low Price      1 1/4            5/8          3/8            9/32
</TABLE>

The Company's Common Stock is listed on the New York Stock Exchange and
trades under the symbol WAL.  At March 3, 1998, there were approximately 271
stockholders of record of the Company's Common Stock.  This number does not
include shareholders whose shares are held in the name of a nominee.

                                       13
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

(Dollar and share amounts in thousands, except per share data)

<TABLE>
<CAPTION>

SUMMARY OF OPERATIONS                   1997           1996           1995           1994           1993
-------------------------------------------------------------------------------------------------------------
<S>                                   <C>           <C>            <C>            <C>            <C>
Revenues                               $49,729       $43,051        $60,100        $69,897       $ 82,121
Operating loss                          (3,683)      (12,945)       (12,536)       (73,523)       (16,353)
Net loss                                (5,419)      (10,809)       (11,352)       (66,149)       (10,896)
Basic loss per common share              (0.31)        (0.61)        $(0.64)       $ (3.75)      $  (0.62)
Average shares outstanding              17,649        17,649         17,649         17,649         17,649

Backlog at year end                    $12,435       $23,899        $20,613        $32,250       $ 33,500
Number of employees at year end            425           354            423            508            814
FINANCIAL POSITION AT YEAR END
-------------------------------------------------------------------------------------------------------------
Working capital (deficit)              $ 1,474       $ 5,163        $12,713        $(6,860)      $  5,695
Property, plant and equipment,  net      4,601         5,190          5,921         10,232         15,468
Goodwill, net                                -              -              -         2,606         53,491
Total assets                            25,191        29,820         46,519         58,930        129,780
Long-term debt                          13,304(1)     12,145          7,948          1,037          1,265
Other liabilities                        2,118         2,435          3,689          4,128          3,300
Stockholders' equity (deficit)          (8,348)(1)    (2,820)         7,367          6,678         72,653
FINANCIAL PERFORMANCE
-------------------------------------------------------------------------------------------------------------
Current ratio                              1.1           1.3            1.5            0.9            1.1
Gross Profit Margin                       18.5%          9.2%          14.3%           7.5%          21.3%
-------------------------------------------------------------------------------------------------------------
</TABLE>
(1)  The Company initiated a Capital Restructuring Plan which is described in
Management's Discussion and Analysis of Financial Condition and Results of
Operations.  Long-Term Debt and Stockholders' Equity at December 31, 1997,
adjusted to give effect to the Capital Restructuring Plan, would be
approximately $0.4 million and a positive $5.1 million, respectively.

                                       14
<PAGE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996.

Revenues in 1997 of $49.7 million increased $6.7 million, or 16%, from
revenues of $43.0 million in 1996. Revenues in 1996 included $4.0 million of
revenues from discontinued businesses, primarily from operations in Italy,
the sale of products from the Company's license agreement with Viking Water
Systems, Inc. and from the operations in Australia. Revenues in 1997 from
continuing businesses increased $10.7 million from revenues reported in 1996.

Revenues from the sales of gas flow diverters, dampers and expansion joints
at WEP, Inc. and WEP Limited increased $7.2 million. Revenues at Wahlco, Inc.
increased $3.1 million, from $8.0 million in 1996 to $11.1 million in 1997,
the result of five significant contracts in late 1996 and early 1997. Sales
of metallic expansion joints at Teddington Bellows decreased $0.8 million in
1997. International revenues accounted for 64% of total revenues in 1997
compared to 67% of total revenues in 1996.

Cost of revenues in 1997 totaled $40.5 million and represented 82% of
revenues. In 1996, the Company's cost of revenues totaled $39.1 million and
represented 91% of revenues. Since cost of revenues in 1996 included $5.0
million of costs related to the three discontinued businesses mentioned
above, 1996 cost of revenues, excluding the three operations, totaled $34.1
million which represented 87% of revenues related to the ongoing businesses.
The decrease in cost of revenues, as a percent of revenues, for the
continuing businesses in 1997 compared to 1996 was due to a lower level of
contract provisions in 1997 versus 1996 and improved contract performance at
Wahlco, Inc. and WEP Ltd. In 1996, contract provisions totaling approximately
$1.5 million were taken in cost of revenues for several contracts at WEP Ltd.
and Pentney. In 1997, these provisions totaled $0.7 million. Activity at
Pentney temporarily increased in the month of December as this operation
hired significant short-term direct laborers to complete one contract. Cost
of revenues at Wahlco, Inc. decreased to 77% of revenues in 1997 from 82% of
revenues in 1996, due to tighter contract and manufacturing cost controls on
large domestic contracts, reduced levels of warranty expenses and lower
unabsorbed manufacturing and engineering overhead as a result of increased
1997 revenues.

Selling, general and administrative (SG&A) expense, before restructuring
charges and intangible write-downs, totaled $12.9 million in 1997, down $4.0
million and $6.3 million from SG&A expense of $16.9 million and $19.2 million
in 1996 and 1995, respectively. SG&A expense, as a percent of revenues,
before restructuring charges and intangible write-downs, was 26% in 1997, 39%
in 1996 and 32% in 1995. SG&A expenses in 1997 benefitted from the absence of
approximately $2.4 million of expenses related to the discontinued operations
in Italy, Australia and at Viking Water Systems, Inc. Additionally, SG&A
expenses in 1997 were down from 1996 levels in all but two continuing
operations, as a result of personnel reductions and tighter cost controls.
SG&A expenses in 1996 included one-time charges of approximately $2.8
million, including $2.4 million of reserves for bad debts and $0.7 million
for executive severance and option costs, partially offset by the reversal of
$0.3 million in reserves deemed unnecessary. Approximately $0.8 million of
the bad debt reserve in 1996 related to reserves required in the Company's
Italian operation. SG&A expenses in 1997 included approximately $0.9 million
of increased bad debt and contract related accruals.

Net interest and other expenses increased $0.9 million in 1997 over 1996.
Interest expense increased $0.2 million, as a result of increased borrowings
from WESAC, and other income declined in 1997 with an absence of gains on the
sales of fixed assets and higher miscellaneous other income reported in 1996.

The Company was unable to provide a tax benefit against domestic losses in
1997 due to the absence of deferred tax liabilities. Deferred tax liabilities
of $5.0 million, recorded at the time of the acquisition by WESAC of PDC's
shares in the Company, were consumed by domestic losses prior to 1997.

                                       15
<PAGE>

YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995.

Revenues in 1996 decreased $17.0 million, or 28%, to $43.1 million from $60.1
million in 1995.  Revenues from businesses discontinued in late 1995,
primarily the operations in Australia, represented $2.9 million of the
revenue decrease. The decrease was primarily associated with reduced revenues
for gas flow diverters ($7.2 million), pipe work systems and hydraulics
equipment ($5.6 million), and flue gas conditioning (FGC) systems ($5.6
million).  These lower revenues were partially offset by an increase in
shipments of damper products from the Company's facility in Maine, ($3.2
million). International revenues accounted for 67% of total revenues in 1996
compared to 78% of total revenues in 1995.

FGC revenues have decreased in each of the last three years due to the
absence of large contracts from domestic utilities.  Commencing in 1994, the
U.S. Electric Utility Industry has undergone major restructuring, as a result
of ongoing federal and state deregulation.  Orders for all significant
capital expenditures, including air pollution control equipment, have been
minimal during this period.

The Company's 1996 cost of revenues totaled $39.1 million and represented 91%
of revenues.  In 1995, the Company's cost of revenues totaled $51.5 million
and represented 86% of revenues.  The increase in cost of revenues as a
percent of revenues in 1996, as compared to 1995, was due to contract
provisions of approximately $2.9 million taken in the second, third and
fourth quarters of 1996, primarily related to jobs subcontracted from Italy
and the U. K. in foreign locations.  Cost of revenues for FGC and De-NOx
systems increased to 91% of revenues in 1996 from 74% of revenues in 1995,
due to a large significant profitable FGC contract in 1995 which did not
recur in 1996.  In addition, fixed manufacturing and engineering cost became
more significant against the lower 1996 revenues.

                                       16
<PAGE>

Selling, general and administrative (SG&A) expense, before restructuring
charges and intangible write-downs, totaled $16.9 million in 1996, down from
$19.2 million in 1995 and $21.4 million in 1994.  SG&A expense, as a percent
of revenues, before restructuring charges and intangible write-downs, was 39%
in 1996, and 32% in 1995 and 31% in 1994.  SG&A expense in 1996 included
one-time charges of approximately $2.8 million, including $2.4 million of
reserves for bad debts and $0.7 million for executive severance and option
costs, partially offset by the reversal of $0.3 million in reserves deemed
unnecessary. Approximately $0.8 million of the bad debt reserve related to
reserves required in the Company's Italian operation.  SG&A expense in 1995
contained one-time charges totaling $2.3 million for legal and closing costs
related to the purchase by WESAC of an 81% interest in the Company and a
decision to close the Puerto Rico production facility.  In 1996, SG&A expense
included approximately $0.9 million of expenses related to the marketing and
sale of VOC products and the Company's license agreement with Viking Water
Systems, Inc.  SG&A expense related to these businesses was $0.3 million in
1995.  The number of employees in the Company totaled 354 at December 31,
1996, down from 423 and 508 at the end of 1995 and 1994, respectively.

Prior to the acquisition by WESAC of 81% of the Company's common stock,  the
Company's U.S. operations were consolidated into the tax return of San Diego
Gas & Electric Company, its former 81% majority stockholder, through a tax
sharing agreement dated April 1990.  This agreement terminated on the closing
of the equity sale to WESAC.

With respect to WESAC's acquisition of PDC's shares on June 6, 1995, the
buyer and seller agreed to jointly elect tax treatment for the transaction as
similar to an asset acquisition under section 338(h)(10) of the Internal
Revenue Code. Under this election, the allocation of the purchase price to
the assets deemed purchased resulted in the recording of deferred tax
liabilities totaling $5.0 million, of which approximately $700 thousand was
recorded in current liabilities.

Subsequent to the closing of the WESAC transaction on June 6, 1995, and after
the deferred tax liabilities were recorded, the Company provided tax benefits
of $3.0 million in 1995 and $2.0 million in 1996 against losses from domestic
operations.  The tax benefit in 1996 also included $0.9 million from the
release of tax reserves deemed unnecessary.

LIQUIDITY AND CAPITAL RESOURCES

The Company had a negative cash flow from operating activities in 1997 of
$3.3 million, compared to a negative cash flow of $4.1 million in 1996.  The
negative cash flow in 1997 resulted from the net loss of $5.4 million,
partially offset by reductions in working capital, principally accounts
receivable and inventories.  The negative cash flow in 1996 resulted
primarily from the net loss of $10.8 million reported in that year, partially
offset by a reduction in inventories and accounts receivable.

                                       17
<PAGE>

In February 1997, Wexford Capital Partners II, L.P., a Delaware limited
partnership, and Wexford Overseas Partners I, L.P., a Delaware limited
partnership, both of which are affiliates of Wexford Management LLC
("Wexford"), and which are hereinafter referred to as the "Wexford 1995
Funds" established and guaranteed a credit facility (the "Chase Facility") at
the Chase Manhattan Bank ("Chase") to provide short-term financing for
companies owned by the Wexford 1995 Funds, including the Company. In 1997 and
1996, the Company funded its operating cash flow deficits through borrowings
from its 81% stockholder, WESAC and the Chase Facility, as further described
below.

The Company had a working capital position of $1.5 million at December 31,
1997 compared to working capital of $5.2 million at December 31, 1996. The
decrease in working capital reflects a $3.6 million reduction in current
assets, primarily accounts receivable and inventories, coupled with a $2.6
million increase in notes payable, reflecting borrowings from the Chase
Facility.

To secure the Company's performance on long-term contracts and customer
advances, the Company is contingently liable in the amount of $4.1 million at
December 31, 1997 under standby letters of credit and performance bonds.
These are secured by $1.2 million of restricted cash at December 31, 1997.

Capital expenditures in 1997 totaled $645 thousand compared to $402 thousand
in 1996.  Approximately $305 thousand was spent on additions to the rental
equipment inventory at Treste Plant Hire Ltd., approximately $91 thousand was
spent for information networks and computers, $78 thousand on
fixtures/equipment at a new Pentney operation and the balance for new
machinery and equipment.

In October 1995, the Company entered into a loan and security agreement with
Silicon Valley Bank. Working capital draws by the Company under this facility
were guaranteed by WESAC, up to the limit of the line.  Borrowings under the
loan totaled $1.8 million at December 31, 1997, which included $1.7 million
of cash borrowings and $109 thousand of cash collateral provided by WBSAC for
letters of credit issued under this loan arrangement.

In August 1996, WESAC agreed to lend the Company up to $1.6 million at an
annual rate of 13%.  The Company had drawn $1.5 million against this loan as
of December 31, 1997, and issued warrants covering 3,404,255 shares of common
stock to four WESAC partnerships which provided the funding.

On September 18, 1997, the Company announced plans to make a rights offering
to its public stockholders.  Holders of the 3,389,000 common shares publicly
traded were issued eight rights for each share of stock owned.  Each right
entitles the holder to purchase one share of the Company's common stock at
$0.10 per share. The rights are freely transferable. The Company filed a
registration statement relating to the rights offering on February 3, 1998
and the rights offering received stockholder approval on March 2, 1998.

A total of 27,112,000 rights have been offered to the existing shareholders
to purchase pre-split shares of the Company's common stock at the exercise
price of $0.10 per share.  The Wexford 1995 Funds have agreed to purchase at
the Subscription Price, all shares not subscribed for in the Rights Offering,
if any.  As a result, the Company will receive cash proceeds of approximately
$2.7 million from the rights offering before deduction of cash expenses,
which are estimated at $0.5 million, for estimated net proceeds of $2.2
million.  The Company plans to utilize $1.7 million of these net proceeds to
pay off the Silicon Valley Bank facility mentioned above.

                                       18
<PAGE>

The Company's rights offering is part of a plan of financial restructuring
which expires on May 6, 1998. As of April 30, 1998, the Company will owe
WESAC a total of approximately $11.7 million for loans made by WESAC at
various times to the Company in 1995 and 1996. Subsequent to the rights
offering, the Company intends to effect a one-for-ten reverse stock split on
or about May 13, 1998. After the completion of the rights offering and the
reverse stock split, the WESAC debt will be converted into common stock of
the Company at a rate of $1.00 of converted debt for each share of post-split
common stock. After giving effect to the rights offering, the reverse stock
split and the WESAC debt conversion, there will be approximately 16,261,000
shares of common stock of the Company issued and outstanding.

In connection with the restructuring plan, the Wexford 1995 Funds and the
Wexford 1996 Funds (as hereinafter defined, and together with the Wexford
1996 Funds, the "Wexford Funds") have agreed, pursuant to an Amended and
Restated Credit Agreement dated as of January 30, 1998 (the "1998 Credit
Agreement") to make available to the Company a line of credit of up to $3.0
million  (the "Tranche A Line") until the closing of the rights offering.
As used herein, the term "Wexford 1996 Funds" means: Wexford Special
Situations 1996, L. P., a Delaware limited partnership, Wexford Special
Situations 1996 Institutional, L. P., a Delaware limited partnership, Wexford
Special Situations 1996 Limited, a Cayman Islands exempted company, and
Wexford-Euris Special Situations 1996, L. P., a Delaware limited partnership.

At the closing of the rights offering, the Wexford Funds under the 1998
credit agreement will make available to the Company an additional line of
credit of up to $2.5 million (the "Tranche B Line"), to be due and payable on
December 31, 2000.  All loans pursuant to the 1998 Credit Agreement will bear
interest at the rate of 13% per annum and will be secured by a first priority
perfected lien on the assets of the Company.  If and to the extent that the
Company borrows under the Chase Facility, described below, on or after
January 30, 1998, the Company's availability under the Tranche A Line,
through the closing date of the rights offering, or the Tranche B Line, from
and after the closing of the rights offering, will be reduced dollar for
dollar by the amount of such borrowings.

The Company has drawn $1.5 million under the Tranche A facility and
anticipates that it will need to draw a total of $2.5 million as Tranche A
loans prior to the closing of the rights offering.  Any amounts drawn under
the Tranche A facility and not repaid by the proceeds of the rights offering
will be extended to December 31, 2000. The Company does not expect to repay
Tranche A advances from the net proceeds of the rights issue, rather the
remaining funds will be used to fund current working capital requirements.

The Chase Facility had a funding capacity of approximately $5.5 million at
December 31, 1997 and

                                       19
<PAGE>

the Company's total cash borrowings under the Chase Facility totaled $2.65
million at December 31, 1997. Under the Chase Facility, the Company may also
request that Chase issue letters of credit for the benefit of the Company,
which Chase may issue in its sole discretion.  At December 31, 1997, Chase
had issued approximately $2.8 million Letters of credit under the Chase
Facility.  Letters of credit issued under the Chase facility do not reduce
availability under the Tranche A Line or the Tranche B Line.  Before making
each loan or issuing each letter of credit, the Chase Manhattan Bank
("Chase") advises the Company of the terms applicable to such loan or letter
of credit.  The current borrowings bear interest at the average annual rate
of 9.5%

The Company plans to use the Chase Facility for letters of credit and
off-shore bank guarantees, as well as loans to the extent the terms offered
are advantageous to the Company.  The Chase Facility supplements the 1998
Credit Agreement.

Because the proceeds of the rights offering will be utilized to pay down the
$1.7 million secured loan with Silicon Valley Bank, and WESAC will convert
approximately $11.7 million of secured debt, the only funded debt remaining
on the balance sheet after the completion of the restructuring plan will be
the approximately $2.65 million of short-term funding provided through the
Chase Facility through the end of December 1997, funds outstanding under the
Tranche A line and certain equipment leases.  The Company anticipates that
the rights offering will provide it with working capital of approximately
$500 thousand, after retiring the Silicon Valley Bank loan and paying
expenses related to the offering.  Additionally, the Company will have access
to the $2.5 million Tranche B line upon the completion of the rights offering
and the debt conversion.

The Company believes that the new 1998 Credit Agreement and the net cash
available from the rights offering, will be adequate to fund the Company's
operations during 1998.  Although loans will be done pursuant to the 1998
Credit Agreement or the Chase Facility, which are either collateralized or
funded by the Wexford Funds (the 81% parent), there can be no assurance that
(i) loans will be available under the 1998 Credit Agreement or the Chase
Facility, or if made, will not be called for repayment, or (ii) such sources
of liquidity will be sufficient to meet the Company's needs.  Significant
changes in the Company's anticipated level of business and other events could
substantially  increase the Company's cash requirements above those now
anticipated.  This could have the effect of requiring that additional cash
resources be obtained.  Therefore, the Company is continuing to seek
additional sources of financing, as well as exploring unrelated sources of
new equity capital, although there can be no assurance that the Company will
be successful in doing so or that any such financing or equity capital would
be available on acceptable terms.

The Company has been out of compliance with certain of the NYSE listing
standards for some time.  In connection with the proposed restructuring, the
Company will issue additional shares of common stock and has met with the
NYSE on both of these matters.  While the Company intends

                                       20
<PAGE>

to address the compliance issues, there is no assurance that the
restructuring plan will allow the Company to achieve compliance with the NYSE
listing criteria.

YEAR 2000 CONVERSION

The Company uses fully integrated operational and accounting software
packages which are commercially available in all of its major facilities.
Additionally, the Company has developed various  proprietary software
packages which are integrated into several of its final products to monitor
and control the processes at customer locations.  All of the commercially
available products and the proprietary software could potentially be affected
by the date change in the year 2000.

The Company continues to assess the impact of the year 2000 issue on its
operations, and has received assurances from the vendors of the licensed
software that all date-sensitive issues related to the year 2000 conversion
have been resolved.  The Company is aware of programming changes which are
required to configure its proprietary software and, is in the process of
detailing a plan to further identify the issues and implement a corrective
program.  Findings to date do not suggest that these costs will be material.

NEW ACCOUNTING PRONOUNCEMENTS

SFAS No. 130 REPORTING COMPREHENSIVE INCOME and SFAS No. 131 DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION were issued in June
1997. The Company will adopt SFAS No. 130 and SFAS No. 131 in 1998 and
anticipates that such adoption will not materially impact the Company's
financial statements.

BACKLOG AND BOOKINGS

Backlog at December 31, 1997 was $12.4 million compared to $23.9 million at
December 31, 1996.  The backlog at WEP, Inc. returned to more normal levels
from a record high on December 31, 1996 and the backlog at Wahlco, Inc. is
down due to the depressed market for domestic air pollution control products.
Backlog is unaudited and is defined as work for which the Company has entered
into a signed agreement or has received a requisition or purchase order.
Approximately $2.2 million of the December 31, 1997 backlog is scheduled for
delivery after December 31, 1998.  Historically, substantially all of the
Company's backlog has resulted in completed contracts.

EFFECTS OF INFLATION; OTHER COST INCREASES

Management does not believe that inflation has had a material effect on
operations during the past several years.  However, the Company experienced
significant stainless steel price increases on one large contract in
Southeast Asia in 1995 and 1996.  Increases in labor, materials and other
operating costs could adversely affect the Company's operations, if the
Company is unable to raise its prices to cover the increases.

FOREIGN CURRENCY TRANSLATION

A substantial portion of the Company's assets are outside of the United
States and are subject to fluctuation in exchange rates.  The foreign
currency translation adjustment to the Balance Sheet at December 31, 1997 was
$2.3 million (net of tax) compared to $2.0 million as of December 31, 1996.

STATEMENT REGARDING FORWARD LOOKING DISCLOSURES

Statements contained in this report, including Management's Discussion and
Analysis, are forward

                                       21
<PAGE>

looking statements that involve a number of risks and uncertainties which may
cause the Company's actual operating results to differ materially from the
projected amounts.  Among the factors that could cause actual results to
differ materially are risk factors listed from time to time in the Company's
SEC reports including:

     -    the Company's highly competitive marketplace,

     -    changes in, as well as, enforcement levels of federal, state and local
          environmental legislation and regulations that change demand for a
          significant portion of the Company's products and services,

     -    the ability to obtain new contracts (some of which are significant)
          from existing and new clients,

     -    the execution of the expected new projects and those projects in
          backlog within the most recent cost estimates and

     -    the favorable resolution of existing claims, including warranty
          issues, arising in the ordinary course of businesses.

                                       22
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Public Accountants

TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF WAHLCO ENVIRONMENTAL SYSTEMS,
INC.:

We have audited the accompanying consolidated balance sheets of Wahlco
Environmental Systems, Inc. as of December 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity (deficit), and
cash flows for the years then ended.  These consolidated financial statements
and the schedule referred to below are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Wahlco Environmental
Systems, Inc. as of  December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.

The accompanying consolidated financial statements have been prepared
assuming that Wahlco Environmental Systems, Inc. will continue as a going
concern.  As more fully described in Note 1, the Company has incurred
recurring operating losses, and has been dependent on advances from its
majority shareholder.  These conditions raise substantial doubt about
the Company's ability to continue as a going concern. The Company has
announced a capital restructuring plan, in conjunction with its majority
shareholder, which is described in Note 2.  The majority shareholder has
indicated its willingness to fund 1998 working capital requirements subject
to the covenants of the 1998 credit agreement.  The consolidated financial
statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets, or the amount and
classification of liabilities that may result from the possible inability of
Wahlco Environmental Systems, Inc. to continue as a going concern.

Our audit was made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole.  The schedule listed in
the index of the consolidated financial statements is presented for purposes
of complying with the Securities and Exchange Commission's rules and is not
part of the basic financial statements.  This schedule has been subjected to
the auditing procedures applied in the audit of the basic consolidated
financial statements and, in our opinion, fairly states in all material
respects the financial data required to be set forth therein in relation to
the basic consolidated financial statements taken as a whole.

Orange County, California
March 13, 1998                                              Arthur Andersen LLP

                                       23
<PAGE>


CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>

                                                                                December 31,
------------------------------------------------------------------------------------------------------
ASSETS                                                                    1997              1996
------------------------------------------------------------------------------------------------------
<S>                                                                  <C>                 <C>
CURRENT ASSETS:
     Cash and cash equivalents                                        $    1,645          $    1,853
     Restricted cash and cash equivalents                                  1,219               1,050
     Accounts receivable                                                   10,322              12,069
     Cost and estimated earnings in excess of
       billings on uncompleted contracts                                   2,357               2,148
     Inventories                                                           2,899               4,738
     Other current assets                                                  1,149               1,365
------------------------------------------------------------------------------------------------------
     TOTAL CURRENT ASSETS                                                  19,591              23,223

Property, plant and equipment, net                                         4,601               5,190
Other assets                                                               999                 1,407
------------------------------------------------------------------------------------------------------
                                                                      $    25,191         $    29,820
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES:
     Notes payable                                                    $     2,978         $       373
     Accounts payable                                                       6,801               9,622
     Accrued payroll and payroll related liabilities                        1,591               1,589
     Billings in excess of costs and estimated earnings
       on uncompleted contracts                                             1,068               1,356
     Current portion of long-term debt                                        273                 228
     Taxes payable                                                            204                 317
     Other accrued liabilities                                              5,202               4,575
------------------------------------------------------------------------------------------------------
     TOTAL CURRENT LIABILITIES                                             18,117              18,060

Long-term debt                                                             13,304              12,145
Other liabilities                                                           2,118               2,435
Deferred income taxes                                                           -                   -

Commitments and contingencies

STOCKHOLDERS' EQUITY (DEFICIT):
     Preferred stock, $.01 par value; 10,000,000 shares authorized,
       None issued or outstanding                                               -                   -
     Common stock, $.01 par value; 50,000,000 shares authorized,
       17,649,000 shares issued and outstanding                               176                 176
     Capital in excess of par value                                        90,855              90,735
     Retained deficit                                                     (97,103)            (91,684)
     Foreign currency translation adjustment                               (2,276)             (2,047)
------------------------------------------------------------------------------------------------------
     TOTAL STOCKHOLDERS' EQUITY (DEFICIT)                                  (8,348)             (2,820)
------------------------------------------------------------------------------------------------------
                                                                      $    25,191         $    29,820
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.

                                       24
<PAGE>

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>

Years ended December 31,                                              1997                1996                1995
----------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>                 <C>                 <C>
REVENUES:
     Product sales                                               $    42,342         $    36,346         $    49,558
     Rental, service and other                                         7,387               6,705              10,542
----------------------------------------------------------------------------------------------------------------------
                                                                      49,729              43,051              60,100
----------------------------------------------------------------------------------------------------------------------
COSTS AND EXPENSES:
     Cost of revenues:
          Product sales                                               34,970              32,685              43,421
          Rental, service and other                                    5,570               6,412               8,099
     Selling, general and administrative                              12,872              16,899              19,171
     Restructuring and other intangibles write-downs                       -                   -                (590)
     Goodwill amortization and write-downs                                 -                   -               2,535
----------------------------------------------------------------------------------------------------------------------
                                                                      53,412              55,996              72,636
----------------------------------------------------------------------------------------------------------------------
Operating loss                                                        (3,683)            (12,945)            (12,536)
----------------------------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE):
     Interest and other income                                           151                 875                 359
     Interest and other expense                                       (1,887)             (1,663)             (2,125)
----------------------------------------------------------------------------------------------------------------------
                                                                      (1,736)               (788)             (1,766)
----------------------------------------------------------------------------------------------------------------------
Loss before income taxes                                              (5,419)            (13,733)            (14,302)
Benefit from income taxes                                                  -              (2,924)             (2,950)
----------------------------------------------------------------------------------------------------------------------
Net loss                                                         $    (5,419)        $   (10,809)       $    (11,352)
----------------------------------------------------------------------------------------------------------------------
Basic loss per common share                                      $     (0.31)        $     (0.61)       $      (0.64)
Diluted loss per common share                                          (0.31)              (0.61)              (0.64)
----------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding                            17,649              17,649              17,649
----------------------------------------------------------------------------------------------------------------------
</TABLE>

See notes to consolidated financial statements.

                                       25
<PAGE>


CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>

                                                                 CAPITAL        RETAINED       FOREIGN
                                                                 IN EXCESS      EARNINGS       CURRENCY       TOTAL
                                             COMMON STOCK        OF PAR       (ACCUMULATED     TRANSLATION    STOCKHOLDERS'
                                        SHARES      AMOUNT       VALUE          DEFICIT)       ADJUSTMENT     EQUITY (DEFICIT)
--------------------------------------------------------------------------------------------------------------------------------
<S>                               <C>               <C>           <C>           <C>            <C>            <C>
Balance, December 31, 1994         17,649,000           176        78,188        (69,523)       (2,163)           6,678
Net loss                                  -              -            -          (11,352)           -           (11,352)
Contribution to capital, net
of deferred taxes                         -              -         11,750             -             -            11,750
Stock option programs                     -              -            596             -             -               596
Change in foreign currency
translation adjustment
(net of deferred taxes
of $164)                                  -              -             -              -           (305)            (305)
--------------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1995         17,649,000           176        90,534        (80,875)       (2,468)           7,367
Net loss                                  -              -             -         (10,809)           -           (10,809)
Stock option programs                     -              -            201             -             -               201
Change in foreign currency
translation adjustment
(net of deferred taxes
of $227)                                  -              -             -              -            421              421
--------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996         17,649,000           176        90,735        (91,684)       (2,047)          (2,820)
Net loss                                  -              -             -          (5,419)           -            (5,419)
Stock option programs                     -              -            120             -             -               120
Change in foreign currency
translation adjustment
(net of deferred taxes
of $123)                                  -              -             -              -           (229)            (229)
--------------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1997         17,649,000       $   176        $90,855     $ (97,103)      $(2,276)         $(8,348)
                                   ----------       -------        -------     ----------      --------         --------
                                   ----------       -------        -------     ----------      --------         --------
</TABLE>

See notes to consolidated financial statements.

                                       26
<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>

Years ended December 31,                                                         1997                 1996                 1995
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                            <C>                 <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                                                     (5,419)            $ (10,809)            $(11,352)
   Adjustments to reconcile net loss to net cash provided by
      (used in) operating activities:                                            1,249                 1,406                1,692
      Depreciation and amortization                                                -                     -                  2,405
      Non-current asset write-downs                                                 (8)               (2,924)              (3,422)
      Deferred income taxes
      Loss (gain) on sale of fixed assets                                           19                   (83)                 625
      Deferred compensation                                                        120                   311                  596
      Changes in current assets and liabilities net of effects
         from acquisitions:
         Accounts receivable                                                     1,453                 4,982                1,124
         Refundable income taxes                                                   -                     -                    883
         Costs and estimated earnings in excess of
            billings on uncompleted contracts                                     (240)                5,254                2,016
         Inventories                                                             1,772                 4,596               (4,168)
         Other current assets                                                      179                   317                   17
         Accounts payable                                                       (2,594)                   24               (1,799)
         Accrued payroll and payroll related liabilities                            25                  (425)                 615
         Billings in excess of costs and estimated earnings on
            uncompleted contracts                                                 (257)               (1,134)                 314
         Income taxes payable                                                     (107)                  (87)                (252)
         Other accrued liabilities                                                 459                (5,520)                 368
-----------------------------------------------------------------------------------------------------------------------------------
         NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                    (3,349)               (4,092)             (10,338)

CASH FLOWS FROM INVESTING ACTIVITIES:
   Proceeds from sales of marketable securities                                    -                     -                    -
   Purchase of property, plant and equipment                                      (645)                 (402)                (648)
   Proceeds from dispositions of property, plant and equipment                      53                    46                2,799
   Change in other assets                                                          263                   774                1,375
-----------------------------------------------------------------------------------------------------------------------------------
         NET CASH PROVIDED BY INVESTING ACTIVITIES                                (329)                  418                3,526

CASH FLOWS FROM FINANCING ACTIVITIES:
   Advances from WESAC                                                           1,358                 2,738                3,248
   Payments to WESAC                                                               -                     -                 (1,000)
   Borrowing on notes payable                                                    2,937                    11                3,206
   Payments on notes payable                                                      (320)                 (714)                (922)
   Borrowings on long-term debt                                                     69                    53                   65
   Payments on long-term debt                                                     (220)                 (280)                (336)
   Payments to Pacific Diversified Capital Company                                 -                     -                   (372)
   Advances from Pacific Diversified Capital Company                               -                     -                  1,267
-----------------------------------------------------------------------------------------------------------------------------------
        NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                      3,824                 1,808                5,156

Effect of exchange rate changes on cash                                           (185)                 (378)                (318)
-----------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents                                   (39)               (2,244)              (1,974)

Cash and cash equivalents, beginning of year                                     2,903                 5,147                7,121
-----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year                                         $ 2,864             $   2,903             $  5,147
-----------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Cash (paid for) received from income taxes                                   $  (119)            $    (107)            $  1,221
-----------------------------------------------------------------------------------------------------------------------------------
  Cash (paid for) interest                                                     $  (495)            $    (541)            $ (1,088)
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

See notes to consolidated financial statements.

                                       27
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
(Dollars in thousands, except share and per share data)

1.  ORGANIZATION, OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION

Wahlco Environmental Systems, Inc. ("the Company") was incorporated on
February 6, 1990 as a Delaware corporation and issued ten shares of common
stock to Pacific Diversified Capital Company ("PDC"), a wholly-owned
subsidiary of San Diego Gas & Electric Company ("SDG&E").  On April 25, 1990,
the Company issued an additional 14,259,990 shares of common stock to PDC in
exchange for all of the outstanding stock of Wahlco, Inc. ("Wahlco"), at that
time a wholly-owned subsidiary of PDC.

In May 1990, the Company issued 3,389,000 shares of common stock in its
initial public offering. Total proceeds to the Company, net of underwriters'
discount and expenses related to the offering, were approximately $37,881.
As a result of the offering, PDC's ownership interest in the Company was
reduced to approximately 81%.

On May 15, 1995, PDC entered into a purchase agreement with WES Acquisition
Corporation ("WESAC"), an affiliate of Wexford Capital Corporation, under
which WESAC purchased $4,900 of the Company's outstanding debt to PDC, and
PDC contributed to the capital of the Company the remaining approximately
$20,000 the Company owed to PDC.  Pursuant to the same agreement, WESAC
agreed to purchase PDC's 81 percent stock interest in the Company.  The share
transfer was approved under the Hart-Scott-Rodino Antitrust Act on June 2,
1995, and the purchase of the stock interest was completed on June 6, 1995.

OPERATIONS

The Company designs, manufactures, and sells combined cycle gas turbine
products, metallic bellows, air pollution control equipment, and related
products and services to electric utilities, independent power producers,
cogeneration plants, and industrial manufacturers worldwide.  The Company
also provides mechanical plant installation services and rents associated
equipment to users in the U.K.  The Company operates through several
subsidiaries which focus on specific geographical regions or products.  These
entities, located primarily in the United States and the U.K., are
coordinated through common corporate management.

The Company's business is affected by world, national and local economic
conditions and events, legislation, government negotiations, competition,
exchange and interest rates and changing technology.

The Company sells its products primarily to large utility and other
industrial customers worldwide. Credit is extended based on an evaluation of
the customer's financial condition, and collateral generally is not required.

                                       28
<PAGE>

The Company incurred net losses of $5,419 in 1997, $10,809 in 1996, and
$11,352 in 1995, and a net cash outflow from operations of $3,349 in 1997,
$4,092 in 1996, and $10,338 in 1995.  The cash flow deficits in 1997 and 1996
were funded through borrowings from WESAC and the Chase Facility as
described more fully in Note 2.

As a result, without the ongoing support of WESAC, its 81% shareholder, and
the Wexford Funds, these conditions raise substantial doubt about the
Company's ability to continue as a going concern.  The Company believes that
the financing available from a restructuring plan announced in late 1997,
which is more fully described in Note 2 to the Consolidated Financial
Statements, will be adequate to fund the Company's operations during 1998.
In summary, the restructuring plan provides funds from the net proceeds
available from a rights offering and a new 1998 credit agreement with the
Wexford funds.  Additionally, the Company's capital structure will be
enhanced by the conversion of approximately $11,730 (April 30, 1998) of WESAC
debt to equity and future earnings will be benefitted by the elimination of
approximately $1,500 of annual interest expense related to this debt.

The consolidated financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification
of assets or the amount and classification of liabilities that may result
from the possible inability of the Company to continue as a going concern.

Significant changes in the Company's anticipated level of business and other
events could substantially  increase the Company's cash requirements above
those now anticipated, and thereby materially and adversely affect the
Company's results of operations and financial condition. Therefore, the
Company is continuing to seek additional sources of financing and to evaluate
various strategies, including seeking new capital to meet its working capital
requirements.  There can be no assurance, however, that the Company will be
successful in these efforts.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and
its subsidiaries.  All material intercompany accounts and transactions have
been eliminated.

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

Revenues from most of the Company's large contracts are recognized using the
percentage-of-

                                       29
<PAGE>

completion method.  Under this method, revenues are recognized in the same
proportion as the percentage of costs incurred during the period to estimated
total costs for each contract.  Changes in job performance, job conditions,
estimated profitability and final contract settlements may result in
revisions to revenue recognition and are recognized in the period in which
the revisions are determined.  It is reasonably possible that the revenues
and estimated costs on certain contracts may change in the near term.

Revenues from other products are recognized on a completed contract basis,
where revenues and their associated costs are recognized when the contract is
complete or when the product is shipped.

Revenues from rental and service contracts are recognized over the respective
lease or service period.

Cost of revenues includes all direct materials, labor costs and indirect
costs related to contract performance such as indirect labor, warranty,
supplies, tools, repairs and depreciation.

Selling, general and administrative costs are charged to expense as incurred.

CASH EQUIVALENTS

The Company considers all highly liquid investments with maturities, at the
date of purchase, of three months or less to be cash equivalents.

RESTRICTED CASH

At December 31, 1997, $1,219 of cash was pledged to the Company's various
banks as collateral for the letters of credit and other off-shore bank
guarantees.

INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out method) or
market.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment is stated at cost and depreciated over the
following estimated useful lives, predominantly using the straight-line
method:

<TABLE>
<S>                          <C>
Buildings and improvements    5 to 35 years
Machinery and equipment       3 to 15 years
</TABLE>


GOODWILL AND OTHER INTANGIBLE ASSETS

Management routinely evaluates  events or conditions that might indicate
impairment of value or

                                       30
<PAGE>

require a reduction in the amortization period of the Company's goodwill and
other intangible assets.  As a result, management took substantial
write-downs against goodwill and other intangibles during the quarter ended
June 30, 1994, reduced the amortization period from 40 to 20 years effective
June 1, 1994 and wrote-off the remaining goodwill during the fourth quarter
of 1995. (See note 5).

In March, 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121 ("FAS 121") which changed the method
of accounting for long-lived assets.  Subsequent to the write-off of goodwill
in the fourth quarter of 1995, the Company adopted the provisions of FAS 121,
effective December 31, 1995.  No additional write downs of assets were
required under FAS 121 in 1997 or 1996.

INCOME TAXES

The Company prepares a consolidated Federal income tax return.  The effective
tax rate is different than the Federal statutory rate principally due to
losses from the Company's operations which cannot be utilized and from
certain state taxes.  The Company files separate state, Puerto Rican and
foreign income tax returns.

The Company accounts for income taxes under the method prescribed by FAS No.
109.  Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.

Prior to the acquisition by WESAC, the Company's U.S. operations were
consolidated into the tax return of its 81% parent, PDC. A tax sharing
agreement with PDC dated April 2, 1990, enabled the Company to receive tax
benefits from its taxable losses.  This tax sharing agreement between the
Company and PDC terminated on the closing of the equity sale to WESAC,
retroactive to January 1, 1995.  The Company has not and is not expected to
enter into a similar tax sharing arrangement with WESAC.

As a result of domestic taxable losses, the Company had tax loss
carry-forwards at December 31, 1996 sufficient to shelter $12,200 of future
taxable income.

NET LOSS PER SHARE

In February 1997, the Financial Accounting Standards Board issued Statement
128, relating to the presentation of earnings per share and disclosure of
information about capital structure.  FASB 128 superseded APB Opinion No. 15,
which had governed the calculation and presentation of earnings per share for
many years.

Under FASB 128, primary earnings per share is replaced with basic earnings
per share.  The computation of fully diluted earnings per share, where
appropriate, is still required, but fully diluted earnings per share is
called "diluted earnings per share" under FASB 128.

Since there has been no change in the Company's average number of common
shares outstanding, the calculation of basic earnings per share under FASB
128 is identical to the calculation of earnings per share under APB Opinion
No. 15. Additionally, since the calculation of diluted earnings per share
under FASB 128, for entities with losses from continuing operations, will
always result in anti-dilutive per share amounts, the provisions of FASB 128
relative to the calculation of diluted earnings per share have no impact at
the present time.

                                       31
<PAGE>

FOREIGN CURRENCY TRANSLATION

Assets and liabilities of the Company's foreign subsidiaries, which are
principally located in the United Kingdom and Italy, are translated at
year-end rates of exchange, and revenues and expenses are translated at
average monthly rates of exchange.  Gains and losses resulting from foreign
currency transactions (transactions denominated in  other than the
subsidiary's functional currency) are included in operations and are not
significant.  The change in the Foreign Currency Translation Adjustment,
which is included in stockholders' deficit, was primarily due to a
strengthening of the foreign currencies against the U.S. dollar.

PRODUCT WARRANTY COSTS

Provision for estimated warranty expense is recorded at the time of sale and
periodically adjusted to reflect actual experience.  The Company reported
warranty expense provisions of  $1,137,  $981 and $2,209 in 1995, 1996, and
1997, respectively.

RECLASSIFICATIONS

Certain amounts in the 1996 and 1995 consolidated financial statements have
been reclassified to conform with the 1997 presentation.

2.  CAPITAL RESTRUCTURING PLAN

On September 18, 1997, the Company announced plans to make a rights offering
to its public stockholders.  Holders of the 3,389,000 common shares publicly
traded will be issued eight rights for each share of stock owned.  Each right
will entitle the holder to purchase one share of the Company's common stock
at $0.10 per share.  The rights expect to trade in the NASDAQ over the
counter market under the symbol WALZR.  The Company filed a Registration
Statement relating to the rights offering on February 5, 1998 and the rights
offering received stockholder approval on March 2, 1998.

A total of 27,112,000 rights have been offered to the existing shareholders
to purchase pre-split shares of the Company's common stock at the exercise
price of $0.10 per share.  Wexford Capital Partners II, L. P., a Delaware
limited partnership, and Wexford Overseas Partners I, L.P., a Delaware
limited partnership, both of which are affiliates of Wexford Management LLC
("Wexford"), and which are hereinafter referred to as the "Wexford 1995
Funds" have agreed to purchase at the Subscription Price, all shares not
subscribed for in the Rights Offering, if any.  As a result, the Company will
receive cash proceeds of approximately $2,700 from the rights offering before
deduction of cash expenses, which are estimated at $500, for estimated net
proceeds of $2,200.  The Company plans to utilize $1,700 of these net
proceeds to pay off the Silicon Valley Bank facility (see Note 6).

                                       32
<PAGE>

The Company's rights offering is part of a plan of financial restructuring
which expires on May 6, 1998.  As of April 30, 1998, the Company will owe
WESAC a total of approximately $11,730 for loans made by WESAC at various
times to the Company in 1995 and 1996. Subsequent to the rights offering, the
Company intends to effect a one-for-ten reverse stock split on or about May
13, 1998. After the completion of the rights offering and the reverse stock
split, the WESAC debt will be converted into common stock of the Company at
the rate of $1.00 of converted debt for each share of post split common
stock. After giving effect to the rights offering, the reverse stock split
and the WESAC debt conversion, there will be approximately 16,261,000 shares
of common stock of the Company issued and outstanding. The Company's
financial statements at December 31, 1997 do not give effect to the capital
restructuring plan.

In connection with the restructuring plan, the Wexford 1995 Funds and the
Wexford 1996 Funds (as hereinafter defined, and together with the Wexford
1996 Funds, the "Wexford Funds") have agreed, pursuant to an Amended and
Restated Credit Agreement dated as of January 30, 1998 (the "1998 Credit
Agreement") to make available to the Company a line of credit of up to $3,000
(the "Tranche A Line") until the closing of the rights offering. As used
herein, the term "Wexford 1996 Funds" means: Wexford Special Situations 1996,
L. P., a Delaware limited partnership, Wexford Special Situations 1996
Institutional, L. P., a Delaware limited partnership, Wexford Special
Situations 1996 Limited, a Cayman Islands exempted company, and Wexford-Euris
Special Situations 1996, L. P., a Delaware limited partnership.

At the closing of the rights offering, the Wexford Funds under the 1998
credit agreement will make available to the Company an additional line of
credit of up to $2,500 (the "Tranche B Line"), to be due and payable on
December 31, 2000. All loans pursuant to the 1998 Credit Agreement will bear
interest at the rate of 13% per annum and will be secured by a first priority
perfected lien on the assets of the Company.  If and to the extent that the
Company borrows under the Chase Facility, described in Note 5, on or after
January 30, 1998, the Company's availability under the Tranche A Line,
through the closing date of the rights offering, or the Tranche B Line, from
and after the closing of the rights offering, will be reduced dollar for
dollar by the amount of such borrowings.

The Company has drawn $1,500 under the Tranche A facility and anticipates
that it will need to draw a total of $2,500 as Tranche A loans prior to the
closing of the rights offering.  Any amounts drawn under the Tranche A
facility and not repaid by the proceeds of the rights offering will be
extended to December 31, 2000. The Company does not expect to repay Tranche A
advances from the net proceeds of the rights issue, rather they will be used
to fund current working capital requirements.

The Chase Facility had a funding capacity of approximately $5,500 on December
31, 1997 and the Company's cash borrowings under the Chase Facility totaled
$2,650. Under the Chase Facility, the Company may also request that Chase
issue letters of credit for the benefit of the Company, which Chase may issue
in its sole discretion.  At December 31, 1997, Chase had issued approximately
$2,800 Letters of credit under the Chase Facility.  Letters of credit issued
under the Chase facility do not reduce availability under the Tranche A Line
or the Tranche B Line.  Before making each loan or issuing each letter of
credit, the Chase Manhattan Bank ("Chase") advises the Company of the terms
applicable to such loan or letter of credit.  The current borrowings bear
interest at the average rate of 9.5%

                                       33
<PAGE>

The Company plans to use the Chase Facility for letters of credit and
off-shore bank guarantees, as well as loans to the extent the terms offered
are advantageous to the Company.  The Chase facility supplements the 1998
credit agreement.

Because the proceeds of the rights offering will be utilized to pay down the
$1,700 secured loan with Silicon Valley Bank, and WESAC will convert
approximately $11,730 of secured debt (April 30, 1998), the only funded debt
remaining on the balance sheet will be the approximately $2,650 of short-term
funding provided through the Chase Facility through the end of December 1997,
any funds borrowed under the Tranche A line and certain equipment leases.
The Company anticipates that the rights offering will provide it with working
capital of approximately $500, after retiring the Silicon Valley Bank loan
and paying expenses related to the offering.  Additionally, the Company will
have access to the $2,500 Tranche B line upon the completion of the rights
offering and the debt conversion.

The Company believes that the new 1998 Credit Agreement and the net cash
available from the rights offering, will be adequate to fund the Company's
operations during 1998.  Although these loans will be effected pursuant to the
1998 Credit Agreement or the Chase Facility, which are either collateralized
or funded by the Wexford Funds, there can be no assurance that (i) loans will
be available under the 1998 Credit Agreement or the Chase Facility, or if
made, will not be called for repayment, or (ii) such sources of liquidity
will be sufficient to meet the Company's needs.  Significant changes in the
Company's anticipated level of business and other events could substantially
increase the Company's cash requirements above those now anticipated.  This
could have the effect of requiring that additional cash resources be
obtained. Therefore, the Company is continuing to seek additional sources of
financing, as well as exploring unrelated sources of new equity capital,
although there can be no assurance that the Company will be successful in
doing so or that any such financing or equity capital would be available on
acceptable terms.

The Company has been out of compliance with certain of the NYSE listing
standards for some time.  In connection with the proposed recapitalization,
the Company anticipates issuing additional shares of common stock and has met
with the NYSE on both of these matters.  While the Company intends to
address the compliance issues, there can be no assurance that the
restructuring plan will allow the Company to achieve compliance with the NYSE
listing criteria.

                                       34
<PAGE>

3.  BALANCE SHEET COMPONENTS

<TABLE>
<CAPTION>

                                       1997          1996
---------------------------------------------------------------
<S>                                 <C>       <C>
 Inventories:
    Raw materials                   $  1,189   $    1,375
    Work in process                    1,441        3,152
    Finished goods                       269          211
---------------------------------------------------------------
                                    $  2,899   $    4,738
---------------------------------------------------------------
 Other accrued liabilities:
    Commissions                     $    946   $      944
    Warranty                           2,012        1,279
    Restructuring                         37          249
    Accrued contract costs               865          880
    Other                              1,342        1,223
---------------------------------------------------------------
                                    $  5,202   $    4,575
---------------------------------------------------------------
 Property, plant and equipment, at
 cost:
    Land                            $    270   $      270
    Buildings and improvements         4,272        4,290
    Machinery and equipment           11,681       11,301
---------------------------------------------------------------
                                      16,223       15,861
    Less accumulated depreciation
    and amortization                 (11,622)     (10,671)
---------------------------------------------------------------
                                    $  4,601   $    5,190
---------------------------------------------------------------
</TABLE>

4.  GOODWILL AND OTHER INTANGIBLE WRITE-DOWNS

During 1995, the Company evaluated the value of goodwill and intangibles,
given intensifying competition and declining margins.  As a result of this
analysis, the Company wrote-off goodwill totaling $2,406 during the fourth
quarter of 1995, which represented the remaining goodwill at Wahlco, Inc. and
Pentney of $1,772 and $634, respectively.  Since December 31, 1995, the
Company has had no goodwill on the balance sheet.

5.  LINES OF CREDIT

In February 1997, Wexford Capital Partners II, L.P., a Delaware limited
partnership and Wexford Overseas Partners I, L.P., a Delaware limited
partnership, both of which are affiliates of Wexford Management LLC
("Wexford"), and which are hereinafter referred to as the "Wexford 1995
Funds" established and guaranteed a credit facility (the "Chase Facility") at
the Chase Manhattan Bank ("Chase") to provide short-term financing for
companies owned by the Wexford 1995 Funds, including the Company. In December
1997, the Chase Facility had a funding capacity of $5,500 and the Company's
total cash borrowings under the Chase Facility totaled $2,650.

                                       35
<PAGE>

Under the Chase Facility, the Company may also request that Chase issue
letters of credit for the benefit of the Company, which Chase may issue in
its sole discretion. At December 31, 1997, Chase had issued approximately
$2,800 letters of credit under the Chase Facility. Before making each loan or
issuing each letter of credit, the Chase Manhattan Bank ("Chase") advises the
Company of the terms applicable to such loan or letter of credit. The current
borrowings bear interest at the average rate of 9.5%.

Selected data, with respect to the Chase Facility is shown below:

<TABLE>
<CAPTION>

                                    1997      1996      1995
----------------------------------------------------------------
<S>                               <C>       <C>       <C>
Balance at December 31             $2,650    $0        $0
Interest rate at December 31          9.5%    0%        0%
Maximum amount outstanding         $2,650    $0        $0
Average amount outstanding         $  638    $0        $0
Weighted average interest rate        9.5%    0%        0%
----------------------------------------------------------------
</TABLE>

The average amounts outstanding and weighted average interest rates during
each year are based on daily balances outstanding.


                                       36
<PAGE>

6.  LONG-TERM DEBT

In October 1995, the Company entered into a loan and security agreement with
Silicon Valley Bank ("SVB") under which SVB provided the Company with a $4,000
working capital loan through September 1996.  Working capital draws by the
Company under this facility were guaranteed by WESAC, up to the limit of the
line.

In May 1996, the Company revised the terms of the credit line with SVB.
Under the renegotiated terms, SVB agreed to provide a $3,000 line of credit,
without covenants, to the Company through October 25, 1996.  WESAC agreed to
collateralize its guarantee of the Company's outstanding loan balance of
$1,900 with cash, and to similarly collateralize any additional principal and
interest borrowings up to the maximum of $3,000.  As consideration for
posting the collateral, the Company agreed to pay WESAC a fee in the form of
a note for $150 payable in two years at 15% interest.

In October 1996, the Silicon Valley Bank agreement was further modified, so that
(i) the maturity date was extended to May 1998, and (ii) the interest rate on
funds borrowed by the Company was reduced from about 11% to about 5.5%, since
WESAC deposited cash collateral equivalent to the funds borrowed with Silicon
Valley Bank.  As part of the loan and security agreement in October 1995 and the
renegotiation in October 1996, the Company issued warrants to SVB to purchase
175,000 shares of the Company's Common Stock at $2.29 per share, which warrants
expire on October 26, 2000.

In December 1997, SVB agreed to extend the stated maturity of the SVB Loan to
December 31, 2000.  Outstanding borrowings under the SVB Loan at December 31,
1997, totaled $1,809 including $1,700 of cash borrowings and $109 of cash
collateral backing letters of credit.

In August 1996, WESAC agreed to lend the Company up to $1,600.  The loan bears
interest at an annual rate of 13%, and is secured by substantially all of the
assets of the Company.  Interest and a commitment fee of $32 payable to WESAC
are compounded.  The Company had drawn $1,500 against this loan as of December
31, 1997.  As of December 31, 1997, the Company owed to WESAC approximately
$11,244 including interest loans made by WESAC at various times in 1995 and
1996. On March 13, 1998, the maturity of all of the loans with WESAC was
extended to December 31, 1999.

Long-term debt consists of the following at December 31:

<TABLE>
<CAPTION>

                                                                 1997      1996
-----------------------------------------------------------------------------------
<S>                                                           <C>       <C>
7.9525% note payable, due in monthly
installments of $19 to Sanwa Business Credit Corp.
(principal and interest) through June 2000, secured by
related lease payments                                         $   516   $   702

Secured term loan from WESAC, bearing interest at
13.0% and due December, 1999.                                    6,559     5,763

Secured term loan from WESAC, bearing interest at
13.0% and due December, 1999.                                    2,696     2,372

Secured loan from Silicon Valley Bank, bearing interest at
5.5% and due December 1999.                                       1,700     1,700

Secured term loan from WESAC, bearing interest at
13.0% and due December, 1999.                                     1,801     1,585

Other credit agreements                                            305       251
-----------------------------------------------------------------------------------
                                                                13,577    12,373
Less current portion                                              (273)     (228)
-----------------------------------------------------------------------------------
                                                               $13,304   $12,145
-----------------------------------------------------------------------------------
</TABLE>

The fair value of each of the long-term debt instruments discussed above, as
well as the notes payable discussed in Note 5, approximate the carrying
amounts within an insignificant difference based on current market interest
rates for similar instruments.

Under agreements reached between the Company and WESAC on April 12, 1996 and
March 12, 1997, interest due and payable from WESAC is compounded.  This
agreement commenced with interest due and payable for the fourth quarter of
1995 and extends through the maturity date.  The above secured loan balances
with WESAC include compounded interest of $2,656 and $1,304, as of December
31, 1997 and 1996, respectively, under this agreement.

Principal payments due on long-term debt for the years subsequent to December
31, 1997 are as follows:

<TABLE>
<S>                             <C>
1998                             $    273
1999                               11,493
2000                                1,811
2001                                    0
------------------------------------------
Total                            $ 13,577
                                 --------
                                 --------
</TABLE>

                                       37
<PAGE>


7.  INCOME TAXES

The benefit from income taxes consists of the following:

<TABLE>
<CAPTION>

 Years ended December 31,                          1997       1996        1995
---------------------------------------------------------------------------------
<S>                                           <C>         <C>        <C>
 Federal
   Current                                     $      -   $      -    $      -
   Deferred                                           -     (2,266)     (2,286)

 State
   Current                                            -          -           -
   Deferred                                           -       (658)       (664)

 Puerto Rico
   Current                                            -          -           -
   Deferred                                           -          -           -

 Foreign
   Current                                            -          -           -
   Deferred                                           -          -           -
---------------------------------------------------------------------------------
 Benefit from income taxes                     $      -   $ (2,924)   $ (2,950)
---------------------------------------------------------------------------------
</TABLE>

The benefit from income taxes differs from the amount obtained by applying the
statutory tax rate as follows:

<TABLE>
<CAPTION>

 Years ended December 31,                                              1997        1996        1995
-----------------------------------------------------------------------------------------------------
<S>                                                               <C>          <C>        <C>
 Federal benefit at statutory rate                                 $  (1,842)   $ (4,669)  $  (4,863)
 Federal benefit not allowable (pre-acquisition)                           -           -       1,326
 Goodwill amortization                                                     -           -         735
 State taxes, net of Federal impact                                     (224)       (498)       (703)
 Limitation on benefit from current year net operating losses          1,506       1,327           -
 Puerto Rican earnings (benefitted) taxed at lower rates                   -           -          44
 Foreign losses without current benefit                                  560       1,816       1,032
 Reduction in Federal and state tax liabilities no longer required         -        (900)       (106)
 Investment loss in foreign affiliates and  other                          -           -        (415)
-----------------------------------------------------------------------------------------------------
 Benefit from income taxes                                          $       -    $ (2,924)  $  (2,950)
-----------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------
</TABLE>


The Company had a tax sharing agreement with PDC which terminated on the
closing of the equity sale to WESAC. The Company will not enter into a
similar tax sharing agreement with WESAC. The tax effect of the WESAC
purchase transaction resulted in a net deferred tax liability for the
Company, which was offset against paid in capital.

                                       38
<PAGE>

Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>

 Deferred tax assets                                       1997          1996
---------------------------------------------------------------------------------
<S>                                                   <C>             <C>
    Accruals                                           $ 1,360         $ 1,681
    Net operating loss carry forwards                    6,138           4,904
---------------------------------------------------------------------------------
    Total deferred tax assets                            7,498           6,585
    Valuation allowance                                 (3,629)         (2,423)
---------------------------------------------------------------------------------
    Net deferred tax assets                              3,869           4,162
---------------------------------------------------------------------------------
    Deferred tax liabilities
---------------------------------------------------------------------------------
    Depreciation                                           795           1,088
    Basis adjustments on purchased assets                3,074           3,074
---------------------------------------------------------------------------------
    Total deferred tax liabilities                       3,869           4,162
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
    Net deferred tax assets (liabilities)              $     0         $     0
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
</TABLE>

The Company has provided residual Puerto Rico tollgate tax on approximately
$11,000 of undistributed earnings as of December 31, 1997 and will be
obligated to pay tollgate taxes estimated at approximately $1,000 over the
next several years, which has been included in other liabilities in the
accompanying balance sheet.

As a result of domestic taxable losses, the Company had tax loss
carry-forwards at December 31, 1996 sufficient to shelter $12,200 of future
taxable income.

8.  RELATED PARTY TRANSACTIONS

Included in other assets at December 31, 1997 and 1996 are $270 and $282,
respectively, of non-interest bearing relocation loans to officers, employees
and certain former employees, which become due in 1998 and are secured by
second trust deeds on each individual's primary residence.  The amount of
discount and imputed interest income related to these notes is not material.

9.  LEASING ACTIVITIES

The Company leases buildings, certain office space, vehicles, equipment and
manufacturing facilities under non-cancelable operating leases which require
annual aggregate rental payments as follows:


<TABLE>
<S>           <C>
1998           $1,127
1999            1,056
2000            1,010
2001              588
2002                4
-------------------------
Total          $3,785
               ------
               ------
</TABLE>

Total rental expense for the years ended December 31, 1997, 1996 and 1995 was
$1,193, $1,296 and $1,251, respectively.

                                       39
<PAGE>

10.  EMPLOYEE BENEFIT PLANS

The Company has a defined contribution plan established under Internal
Revenue Code Section 401(k) covering substantially all eligible domestic
employees.  In addition, as a result of certain acquisitions, the Company has
adopted several foreign defined contribution plans covering substantially all
eligible foreign employees.  Employer contributions to the plans are made to
an individual account for each participant based on a prescribed percentage
of the employee's voluntary contribution, in accordance with the plans.
Retirement benefits to the employees are based solely on the amount available
in each participant's account at the time of retirement or termination of
employment.  The Company's contributions to the plans for the years ended
December 31, 1997, 1996, and 1995 were $0, $324, and $419, respectively.

11.  STOCK-BASED COMPENSATION PLAN

The Company has a stock option plan, the Second Amended and Restated 1990
Stock Incentive Plan (the "Amended Plan").  The Company accounts for the
Amended Plan under APB No. 25, under which the Company recognized
compensation cost of $109 and $201 in 1997 and 1996, respectively.

During 1994, the stockholders approved an amendment to the Amended Plan,
which increased the number of Stock Appreciation Rights ("SARs") available to
1,764,900 from 882,450 and extended the expiration date of the plan to April
23, 1997.

During 1995, the stockholders approved a further  amendment to the Amended
Plan which increased the number of shares available for grant to 2,647,350
from 1,764,900, eliminated the minimum purchase price for non-qualified stock
options which had been established at 100% of the fair market value of the
Company's Common Stock on the grant date and increased the maximum number of
shares that may be subject to options granted to any one person in any
one-year period from 50,000 to 1,000,000.

On March 2, 1998 the stockholders of the Company approved the adaption by the
Board of Directors in November 1996 of the 1996 Employee Stock Option Plan,
which provides for the issuance of up to 2.250 million shares of common stock
to directors, officers, employees, consultants and advisors of the Company.
No options had been granted under the 1996 plan at December 31, 1997.

                                       40
<PAGE>

Information with respect to the Amended Plan follows:

<TABLE>
<CAPTION>

                                               Rights and                                            Number of
                                               Options           Number of              Rights       Stock Options       Option
                                               Available for     Rights                 Prices                            Price
                                               Issuance
---------------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>                  <C>              <C>             <C>            <C>
 Outstanding at December 31, 1994                   1,157,390         567,510         $ 4.50-13.00        40,000      $      7.25
 Granted                                                                    -                    -     2,069,920        0.49-2.50
 Canceled                                                            (124,600)                   -             -                -
---------------------------------------------------------------------------------------------------------------------------------
 Outstanding at December 31, 1995                      94,520         442,910           4.50-13.00     2,109,920        0.49-7.25
 Granted                                                                    -                            345,048                -
 Canceled                                                            (145,510)                          (220,612)               -
---------------------------------------------------------------------------------------------------------------------------------
 Outstanding at December 31, 1996                     115,594         297,400           4.50-13.00     2,234,356        0.49-7.25
 Granted                                                    -               -                    -             -                -
 Exercised                                                  -               -                    -        (5,000)           (0.49)
 Canceled                                                   -         (17,850)                   -       (15,000)           (0.49)
---------------------------------------------------------------------------------------------------------------------------------
 Outstanding at December 31, 1997                     153,444         279,550           4.50-13.00     2,214,356        0.49-7.25
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------
 Exercisable                                                          279,550         $ 4.50-13.00     1,790,606      $ 0.49-7.25
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Had compensation cost for these plans been determined consistent with FASB
Statement No. 123, the Company's net loss and earnings per share would have
been the following pro forma amounts:

<TABLE>
<CAPTION>

                                1997            1996          1995
                                ----            ----          ----
<S>           <C>             <C>            <C>          <C>
Net Loss:      As Reported    $(5,419)       $(10,809)     $(11,352)
               Pro Forma       (5,623)        (11,554)      (12,084)

Basic EPS:     As Reported    $(0.31)        $  (0.61)     $  (0.64)
               Pro Forma       (0.32)           (0.65)        (0.68)
</TABLE>


Because the Statement 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.

                                       41
<PAGE>

A summary of the status of the Company's option plan at December 31, 1995,
1996 and 1997, and changes during the years then ended, is presented in the
table and narrative below:

<TABLE>
<CAPTION>

                                                1997                              1996                            1995
                                     --------------------------        --------------------------       ------------------------
                                       Shares          Wtd Avg           Shares          Wtd Avg         Shares        Wtd Avg
                                        (000)         Ex Price            (000)         Ex Price          (000)        Ex Price
                                      -------        ---------           ------         --------         ------        --------
<S>                                   <C>            <C>                 <C>            <C>              <C>            <C>
 Outstanding at beg. of year            2,234,356       $ .760         2,109,920          $.756           40,000        $7.25

 Granted                                        0                        345,048             -         2,069,920           -

 Exercised                                  (5000)       0.490                 0              0                0            0

 Forfeited                                (15,000)       0.490          (220,612)         0.490                0            0

 Expired                                        0                              0              0                0            0
                                       -----------                    -----------                     -----------
 Outstanding at end of year             2,214,356       $7.762         2,234,356          $.760        2,109,920        $.756
                                       -----------                    -----------                     -----------
 Exercisable at end of year             1,790,606                      1,419,016                         753,960

 Weighted average fair value of
 options granted                                                                          $0.53                         $0.94
</TABLE>

The options granted vest through 2000 and expire from 2000 to 2006.

At December 31, 1997, a total of 1,564,356 options outstanding have an
exercise price of $0.49 per share, 580,000 shares have an exercise price of
$.992 per share,  30,000 shares have an exercise price of $1.875 per share,
and 40,000 have an exercise price of $7.25 per share.  A total of 2,079,920
options were granted in 1995 which have a weighted average remaining
contractual life of 8.2 years; 335,048 options were granted in 1996 which
have a weighted average remaining contractual life of 9.6 years.

The fair value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions. Risk-free interest rates ranged from 5.7 to 6.3 percent for
options granted in 1995, and ranged from 5.9 to 6.6 percent for options
granted in 1996.  Expected dividend yields of 0 percent were assumed for all
options.  Expected option lives of 8.2 and 9.6 years were assumed for the
1995 and 1996 options, respectively, and expected volatility was 62% and 76%
for options granted in 1995 and 1996, respectively.

13.  BUSINESS SEGMENT, GEOGRAPHIC AREA AND MAJOR CUSTOMER INFORMATION

The Company operates in several industries: the thermal power generation
after-boiler market, the gas-turbine power-generation market, and the steel
and chemical industries.  The Company markets and sells most of its products
through a coordinated worldwide sales force which interacts with both
electric utilities and industrial customers in connection with the reduction
and control of air pollution,

                                       42

<PAGE>

gas flow control, energy efficiency, and the control of volatile organic
compounds.

The following table shows financial information by geographic area. "Other"
consists principally of Canada and Australia:

<TABLE>
<CAPTION>

1997                            United States               Europe       Other           Totals
<S>                              <C>                       <C>          <C>              <C>
Revenues                           $27,458                  $22,271        $0             $49,729
Operating loss                      (2,340)                  (1,343)        0              (3,683)
Loss before income taxes            (3,772)                  (1,647)        0              (5,419)
Identifiable assets                 15,458                    9,733         0              25,191
-----------------------------------------------------------------------------------------------------
1996

Revenues                           $20,404                  $22,042        $605           $43,051
Operating loss                      (7,160)                  (5,555)       (230)          (12,945)
Loss before income taxes            (8,392)                  (5,495)        154           (13,733)
Identifiable assets                 16,049                   13,675          96            29,820
-----------------------------------------------------------------------------------------------------
1995

Revenues                           $21,550                  $35,122      $3,428           $60,100
Operating loss                      (9,826)                  (2,341)       (369)          (12,536)
Loss before income taxes           (11,267)                  (2,864)       (171)          (14,302)
Identifiable assets                 22,638                   22,999         882            46,519
-----------------------------------------------------------------------------------------------------

</TABLE>

Export sales were as follows:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
Years ended December 31,              1997                1996               1995
                                      ----                ----               ----
<S>                                 <C>               <C>                    <C>
Canada                               $  315            $  413              $   685
Europe                                  408               997                3,228
Asia                                  8,869             2,869                3,451
Africa and Other                        297             1,932                1,331
                                     ------            ------              ------
                                     $9,889            $6,211              $ 8,695
                                     ------            ------              ------
                                     ------            ------              ------
</TABLE>

There were no sales to individual customers constituting 10% or more of total
revenues in 1997, 1996 or 1995.

                                       43
<PAGE>

14.  COMMITMENTS AND CONTINGENCIES

As security for performance and advances on long-term contracts, the Company
at December 31, 1997 is contingently liable in the amount of approximately
$4,085 under standby letters of credit and off-shore bank guarantees.

The Company is contingently liable under a repurchase agreement related to
the sale of a customer equipment lease contract to a lease lender in 1993.
As of December 31, 1997, the contingent liability totaled $1,467. The Company
believes any liability under the repurchase agreement is unlikely.

The Company and certain of its subsidiaries are parties to claims and
litigation proceedings arising in the normal course of business.  Although
the legal responsibility and financial impact with respect to such claims and
litigation cannot presently be ascertained, the Company does not believe that
these matters will result in the payment by the Company of monetary damages
that in the aggregate, would be material in relation to the consolidated
financial position of the Company.  It is reasonably possible that the
reserves provided for by the Company with respect to such claims and
litigation could change in the near term.

15.  QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>


                                                                      Net Income
                     Revenue          Gross           Net Income        (Loss)
                                      Margin            (Loss)         Per Share
----------------------------------------------------------------------------------
<S>              <C>          <C>             <C>                <C>
 1997
 Quarters:
 First           $    12,734   $       2,751   $           (604)  $      (0.03)
 Second               14,062           3,067               (390)         (0.03)
 Third                10,752           2,058             (1,451)         (0.08)
 Fourth               12,181           1,313             (2,974)         (0.17)
----------------------------------------------------------------------------------
      Total      $    49,729   $       9,189   $         (5,419)  $      (0.31)
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
 1996
 Quarters:
 First           $    13,388   $       2,812   $           (810)  $      (0.05)
 Second               10,119              11             (4,058)         (0.23)
 Third                 9,123           1,243             (1,417)         (0.08)
 Fourth               10,421            (112)            (4,524)         (0.27)
----------------------------------------------------------------------------------
      Total      $    43,051   $       3,954   $        (10,809)  $      (0.63)
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
</TABLE>
During the second and fourth quarters of 1996, the Company's gross margin,
net loss and net loss per share were affected by write-downs and
restructuring charges. In the fourth quarter of 1997, the Company's gross
margin, net loss and net loss per share were negatively impacted by contract
provisions and reserves for bad debts. See Management's Discussion and
Analysis of Financial Condition and Results of Operations.

                                       44
<PAGE>

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

                 Wahlco Environmental Systems, Inc. and Subsidiaries
<TABLE>
<CAPTION>

                                                                  Additions
                                                                  ---------
                                          Balance at     Charged to Costs   Charged to Other                             Balance at
                                     Beginning of Period   and Expenses   Accounts - Describe  Deductions - Describe(1) End of Year
                                     -------------------   ------------   -------------------  ------------------------------------
<S>                                  <C>
Year ended December 31, 1997:
Allowance for doubtful accounts         $3,206                  $1,017                                  $1,858               $2,365
Inventory valuation reserve                169                       0                                       1                  168
Restructuring reserve                      249                       0                                     212                   37
Warranty reserve                         1,279                   2,209                                   1,476                2,012
                                        ------                  ------                                  ------               ------
Total                                   $4,903                  $3,226                                  $3,547               $4,582
                                        ------                  ------                                  ------               ------
                                        ------                  ------                                  ------               ------
Year ended December 31, 1996:
Allowance for doubtful accounts         $1,277                  $2,350                                  $  421               $3,206
Inventory valuation reserve                286                     120                                     237                  169
Restructuring reserve                      375                       0                                     126                  249
Warranty reserve                           826                     981                                     528                1,279
                                        ------                  ------                                  ------               ------
Total                                   $2,764                  $3,451                                  $1,312               $4,903
                                        ------                  ------                                  ------               ------
                                        ------                  ------                                  ------               ------
Year ended December 31, 1995:
Allowance for doubtful accounts         $  923                  $  870                                  $  516               $1,277
Inventory valuation reserve              1,110                     141                                     965                  286
Restructuring reserve                    1,819                    (590)                                    854                  375
Warranty reserve                         1,662                   1,137                                   1,973                  826
                                        ------                  ------                                  ------               ------
Total                                   $5,514                  $1,558                                  $4,308               $2,764
                                        ------                  ------                                  ------               ------
                                        ------                  ------                                  ------               ------
</TABLE>

(1) Amounts charged off during the year.

                                       45
<PAGE>

ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.


None.

                                       46
<PAGE>

PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information required by this item regarding the Company's directors is
included in the Company's Proxy Statement to be filed pursuant to Schedule
14A in connection with the Company's 1998 Annual Meeting of Stockholders
under the section captioned "Election of Directors" and is incorporated
herein by reference thereto. Information regarding the Company's executive
officers is set forth in Part I hereof, above, under the caption "Executive
Officers" and is incorporated herein by reference thereto.

ITEM 11.  EXECUTIVE COMPENSATION.

The information required by this item is included in the Company's Proxy
Statement to be filed pursuant to Schedule 14A in connection with the
Company's 1998 Annual Meeting of Stockholders under the sections captioned
"Directors' Compensation" and "Executive Compensation" and is incorporated
herein by reference thereto.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information required by this item is included in the Company's Proxy
Statement to be filed pursuant to Schedule 14A in connection with the
Company's 1998 Annual Meeting of Stockholders under the section captioned
"Security Ownership of Certain Beneficial Owners and Management" and is
incorporated herein by reference thereto.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information required by this item is included in the Company's Proxy
Statement to be filed pursuant to Schedule 14A in connection with the
Company's 1998 Annual Meeting of Stockholders under the section captioned
"Compensation Committee Interlocks and Insider Participation" and is
incorporated herein by reference thereto.

                                       47
<PAGE>

                                       PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>
                                                                              Page No.
                                                                              --------
<S>  <C>                                                                      <C>
(a)  1.   Financial Statements, included in Part II of this report:

          Reports of Independent Public Accountants                              23

          Consolidated Balance Sheets at December 31, 1997 and 1996              24

          Consolidated Statements of Operations for the Years ended              25
          December 31, 1997, 1996 and 1995

          Consolidated Statements of Stockholders' Equity (Deficit) for the      26
          Years ended December 31, 1997, 1996 and 1995

          Consolidated Statements of Cash Flows for the Years ended              27
          December 31, 1997, 1996, and 1995

          Notes to Consolidated Financial Statements                             28

     2.   Financial Statement Schedules, included in Part II of this report:

          Schedule II Valuation and Qualifying Accounts                          45

          All other schedules for which provision is made in the applicable
          accounting regulations of the Securities and Exchange Commission
          are not required under the related instructions or are
          inapplicable, and therefore have been omitted.

     3.   Exhibits

</TABLE>


<TABLE>
<CAPTION>
     EXHIBIT #                              DESCRIPTION
<S>      <C>
   3.1    Certificate of Incorporation of the Company.  (FILED AS AN EXHIBIT TO
          THE COMPANY'S REGISTRATION STATEMENT NO. 33-33698, AS AMENDED.)

   3.2    Bylaws  of  the  Company.    (FILED  AS  AN  EXHIBIT TO THE COMPANY'S
          REGISTRATION STATEMENT NO. 33-33698, AS AMENDED.)
</TABLE>

                                       48
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT #                              DESCRIPTION

<S>      <C>
   10.1   Grant  of Industrial Tax Exemption by the Commonwealth of Puerto Rico
          to  Wahlco  International,  Inc., a Delaware corporation, dated as of
          March  10,  1982.  (FILED AS AN EXHIBIT TO THE COMPANY'S REGISTRATION
          STATEMENT NO. 33-33698, AS AMENDED.)

   10.2   Order  of Conversion of Grant of Puerto Rico Industrial Tax Exemption
          to  Wahlco  International,  Inc. dated as of October 29, 1987, and as
          amended  on  March  8,  1989.   (FILED AS AN EXHIBIT TO THE COMPANY'S
          REGISTRATION STATEMENT NO. 33-33698, AS AMENDED.)

   10.3   Redemption  and  Indemnification  Agreement,  dated as of October 28,
          1987, by and among Pacific Diversified Capital Company, Wahlco, Inc.,
          Robert  R.  Wahler,  as Trustee of the Wahler Family Trust, Triple R,
          John  H.  McDonald,  Westfore,  a  California limited partnership and
          Corona  Properties,  a  California limited partnership.  (FILED AS AN
          EXHIBIT  TO  THE  COMPANY'S  REGISTRATION  STATEMENT NO. 33-33698, AS
          AMENDED.)

  X10.4   Form  of  Indemnity  Agreement  between  the  Company and each of its
          directors  and  officers.    (FILED  AS  AN  EXHIBIT TO THE COMPANY'S
          REGISTRATION STATEMENT NO. 33-33698, AS AMENDED.)

   10.5   Standard  Industrial  Lease,  dated  as  of September 3, 1991, by and
          between Triple R, a California general partnership and Wahlco Inc., a
          California  corporation.    (FILED AS AN EXHIBIT TO THE COMPANY'S THE
          ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1991.)

   10.6   First Addendum to Standard Industrial Lease, dated as of September 3,
          1991  between  Triple R and Wahlco, Inc.  (FILED AS AN EXHIBIT TO THE
          COMPANY'S  THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER
          31, 1991.)

   10.7   Second  Amendment  to Office Lease, dated as of December 16, 1991, by
          and between BCG and the Company (FILED AS AN EXHIBIT TO THE COMPANY'S
          THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1991.)

   10.8   Installment  Note,  dated as of July 20, 1992, by and between Wahlco,
          Inc.  and  Sanwa  Business Credit Corporation, a Delaware corporation
          (FILED  AS  AN EXHIBIT TO THE COMPANY'S QUARTERLY REPORT ON FORM 10-Q
          FOR THE QUARTER ENDED SEPTEMBER 30, 1992.)

   10.9   Guaranty  Agreement,  dated  as  of July 20, 1992, by and between the
          Company  and  Sanwa.  (FILED AS AN EXHIBIT TO THE COMPANY'S QUARTERLY
          REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1992.)

  10.10   Security Agreement, dated as of July 20, 1992, by and between Wahlco,
          Inc.  and  Sanwa, with accompanying Consent and Acknowledgment of the
          Company,  as  Guarantor.    (FILED  AS  AN  EXHIBIT  TO THE COMPANY'S
          QUARTERLY  REPORT  ON  FORM  10-Q FOR THE QUARTER ENDED SEPTEMBER 30,
          1992.)
</TABLE>

                                       49
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT #                              DESCRIPTION

<S>      <C>
  X10.11  First  Amended  and Restated 1990 Incentive Award Plan.  (FILED AS AN
          EXHIBIT  TO  THE  COMPANY'S  QUARTERLY  REPORT  ON  FORM 10-Q FOR THE
          QUARTER ENDED SEPTEMBER 30, 1992.)

  10.12   Letter  Agreement  dated August 31, 1993, by and between the Company,
          Wahlco,  Inc.,  Wahlco  Power Products, Inc., a Delaware corporation,
          Bachmann  Companies,  Inc.,  and  Sanwa.  (FILED AS AN EXHIBIT TO THE
          COMPANY'S  QUARTERLY  REPORT  ON  FORM  10-Q  FOR  THE  QUARTER ENDED
          SEPTEMBER 30, 1993.)

  10.13   Settlement  Agreement,  dated  as  of October 7, 1994, by and between
          Wahlco  Power Products, Inc. and ABB Air Preheater, Inc. (FILED AS AN
          EXHIBIT  TO  THE  COMPANY'S  QUARTERLY  REPORT  ON  FORM 10-Q FOR THE
          QUARTER ENDED SEPTEMBER 30, 1994.)

  10.14   Mutual  General  Release, dated as of October 6, 1994, between Wahlco
          Power  Products,  Inc.  and  ABB  Air  Preheater, Inc..  (FILED AS AN
          EXHIBIT  TO  THE  COMPANY'S  QUARTERLY  REPORT  ON  FORM 10-Q FOR THE
          QUARTER ENDED SEPTEMBER 30, 1994.)

  10.15   Assignment  of Note, Loan Agreement and Collateral Documents.  (FILED
          AS  AN  EXHIBIT  TO  THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE
          YEAR ENDED DECEMBER 31, 1994.)

  10.16   Promissory  Note,  dated  as of May 15, 1995, between the Company and
          WES  Acquisition  Corp.  (FILED AS AN EXHIBIT TO THE COMPANY'S ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1994.)

  10.17   Commitment  letter,  dated  as  of May 15, 1995, from WES Acquisition
          Corp.  to the Company for a secured term loan in the principal amount
          of  $2  million.    (FILED  AS AN EXHIBIT TO THE COMPANY'S THE ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1994.

 X10.18  Employment Agreement between the Company and C. Stephen Beal dated as
          of  May  5,  1995.   (FILED AS AN EXHIBIT TO THE COMPANY'S THE ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995.)

 X10.19  Employment  Agreement  between the Company and A. Noel DeWinter dated
          as of May 16, 1995.  (FILED AS AN EXHIBIT TO THE COMPANY'S THE ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995.)

 X10.20  Employment  Agreement  between the Company and Barry J. Southam dated
          June  1,  1995.    (FILED  AS  AN EXHIBIT TO THE COMPANY'S THE ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995.)

  10.21   Loan  and  Security Agreement between Wahlco, Inc. and Silicon Valley
          Bank.    (FILED  AS  AN EXHIBIT TO THE COMPANY'S THE ANNUAL REPORT ON
          FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995.)
</TABLE>

                                       50
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT #                              DESCRIPTION

<S>      <C>
  10.22   Amendment  and Forbearance Agreement, dated as of May 9, 1996, by and
          between Silicon Valley Bank and Wahlco, Inc.  (FILED AS AN EXHIBIT TO
          THE  COMPANY'S  QUARTERLY  REPORT  ON FORM 10-Q FOR THE QUARTER ENDED
          JUNE 30, 1996.)

  10.23   Term Loan Agreement and Warrant Agreement and Form of Warrant between
          the  Company and WES Acquisition Corp. dated August 28, 1996.  (FILED
          AS  AN  EXHIBIT  TO  THE  COMPANY'S QUARTERLY REPORT ON FORM 10-Q FOR
          QUARTER ENDED SEPTEMBER 30, 1996.)

  10.24   Letter  Agreement  dated  March  12, 1997 between the Company and WES
          Acquisition  Corp.    (FILED  AS  AN  EXHIBIT TO THE COMPANY'S ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996.)

  10.25   Letter  Agreement  dated  April  12, 1996 between the Company and WES
          Acquisition  Corp.    (FILED  AS  AN  EXHIBIT TO THE COMPANY'S ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996.)

  10.26   Promissory  Note  dated  as of May 9, 1996 made by the Company to WES
          Acquisition  Corp.    (FILED  AS  AN  EXHIBIT TO THE COMPANY'S ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996.)

  10.27   Promissory  Note dated as of November 15, 1996 made by the Company to
          WES  Acquisition  Corp.  (FILED AS AN EXHIBIT TO THE COMPANY'S ANNUAL
          REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996.)

  10.28   Warrant  dated  as  of  November  15,  1996  issued by the Company to
          Wexford  Special  Situations 1996, L. P.  (FILED AS AN EXHIBIT TO THE
          COMPANY'S  ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31,
          1996.)

  10.29   Warrant  dated  as  of  November  15,  1996  issued by the Company to
          Wexford  Special  Situations  1996 Institutional, L. P.  (FILED AS AN
          EXHIBIT  TO  THE  COMPANY'S  ANNUAL  REPORT ON FORM 10-K FOR THE YEAR
          ENDED DECEMBER 31, 1996.)

  10.30   Warrant  dated  as  of  November  15,  1996  issued by the Company to
          Wexford Special Situations 1996 Limited.  (FILED AS AN EXHIBIT TO THE
          COMPANY'S  ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31,
          1996.)

  10.31   Warrant  dated  as  of  November  15,  1996  issued by the Company to
          Wexford  - Euris Special Situations 1996, L. P.  (FILED AS AN EXHIBIT
          TO  THE  COMPANY'S  ANNUAL  REPORT  ON  FORM  10-K FOR THE YEAR ENDED
          DECEMBER 31, 1996.)

  10.32   Term  Loan  Agreement,  dated  as  of  July  28,  1995,  between  WES
          Acquisition  Corp.  and  the  Company  for a secured term loan in the
          principal  amount  of  $2.0  million.    (FILED  AS AN EXHIBIT TO THE
          COMPANY'S  ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31,
          1996.)
</TABLE>
                                       51

<PAGE>

<TABLE>
<CAPTION>
EXHIBIT #                              DESCRIPTION

<S>      <C>
  10.33   Restructuring  Agreement  dated  as  of  January  30,  1998 among the
          Company,  WES  Acquisition Corp., the other parties named therein and
          Wexford  Management  LLC,  as  Agent.    (FILED  AS AN EXHIBIT TO THE
          COMPANY'S REGISTRATION STATEMENT NO. 333-42805.)

  10.34   Amended  and  Restated  Credit Agreement dated as of January 30, 1998
          among  the  Company,  as  Borrower,  the  Lenders  and the Individual
          Parties  thereto  and Wexford Management LLC, as Agent.  (FILED AS AN
          EXHIBIT TO THE COMPANY'S REGISTRATION STATEMENT NO. 333-42805.)

  10.35   Agreement  between  the Company and ChaseMellon Shareholder Services,
          Inc.  re  Subscription Agency.  (FILED AS AN EXHIBIT TO THE COMPANY'S
          REGISTRATION STATEMENT NO. 333-42805.)

  10.36   $750,000 promissory note dated as of July 2, 1997 between the Company
          and  The Chase Manhattan Bank.  (FILED AS AN EXHIBIT TO THE COMPANY'S
          REGISTRATION STATEMENT NO. 333-42805.)

  10.37   $1,000,000  promissory  note dated as of October 13, 1997 between the
          Company  and  The  Chase Manhattan Bank.  (FILED AS AN EXHIBIT TO THE
          COMPANY'S REGISTRATION STATEMENT NO. 333-42805.)

  10.38   $400,000  promissory  note  dated as of November 17, 1997 between the
          Company  and  The  Chase Manhattan Bank.  (FILED AS AN EXHIBIT TO THE
          COMPANY'S REGISTRATION STATEMENT NO. 333-42805.)

  10.39   Waiver  letter  of  Silicon Valley Bank dated as of December 19, 1997
          re:  extension  of  maturity  and  waiver of covenants.  (FILED AS AN
          EXHIBIT TO THE COMPANY'S REGISTRATION STATEMENT NO. 333-42805.)

  X10.40  Wahlco  Environmental  Systems, Inc. 1996 Employee Stock Option Plan.
          (FILED AS AN EXHIBIT TO THE COMPANY'S REGISTRATION STATEMENT NO. 333-
          42805.)

    21    Subsidiaries  of  the Company.  (FILED AS AN EXHIBIT TO THE COMPANY'S
          ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995.)

   *27    Financial Data Schedule (EDGAR filing only)
</TABLE>
--------------------

          *    Filed herewith
          X    Management contract or compensatory plan.

     (b)  No reports on Form 8-K were filed during the last quarter of the
          period covered by this report. [or if any, list them and the item
          numbers of the 8-K filed]

                                       52

<PAGE>

                                      SIGNATURES

       Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

DATE: May 30, 1998                   WAHLCO ENVIRONMENTAL SYSTEMS, INC.

                                     By: /s/ C. Stephen Beal
                                     ------------------------------------
                                     C. Stephen Beal
                                     President and Chief Executive Officer


                                     POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears
below constitutes and appoints each of C. Stephen Beal, A. Noel DeWinter and
Roger M. Barzun jointly and severally his true and lawful attorneys-in-fact
and agent with full power of substitution for him and in his name, place and
stead in any and all capacities to sign on his behalf, individually and in
each capacity stated below, to file any and all amendments to this Annual
Report on Form 10-K with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents and each of them full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises as fully as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents, or any of them, or their substitute or substitutes may lawfully
do or cause to be done by virtue thereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant
and in the capacities and on the date indicated.


<TABLE>
<CAPTION>

NAME                        TITLE/CAPACITY                          DATE
<S>                     <C>                                         <C>
/s/ C. Stephen Beal      President & Chief Executive Officer         May 30, 1998
-----------------------  (principal executive officer)
C. Stephen Beal          and Director

/s/ A. Noel DeWinter     Vice President & Chief Financial Officer    May 30, 1998
-----------------------  (principal financial and accounting
A. Noel DeWinter         officer)

/s/ Maarten D. Hemsley   Director                                    May 30, 1998
-----------------------
Maarten D. Hemsley
</TABLE>
                                       53

<PAGE>

<TABLE>
<S>                     <C>                                         <C>
/s/ Paul H. Hunn         Director                                    May 30, 1998
-----------------------
Paul H. Hunn

/s/ Mark L. Plaumann     Director                                    May 30, 1998
-----------------------
/s/David R. A. Steadman  Director                                    May 30, 1998
</TABLE>

                                       54
<PAGE>

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT #                         DESCRIPTION                           AT PAGE
<S>     <C>                                                             <C>
  3.1    Certificate  of Incorporation of the Company.  (FILED AS AN
         EXHIBIT  TO  THE  COMPANY'S  REGISTRATION STATEMENT NO. 33-
         33698, AS AMENDED.)

  3.2    Bylaws  of  the  Company.    (FILED  AS  AN  EXHIBIT TO THE
         COMPANY'S REGISTRATION STATEMENT NO. 33-33698, AS AMENDED.)

  10.1   Grant  of  Industrial  Tax Exemption by the Commonwealth of
         Puerto  Rico  to  Wahlco  International,  Inc.,  a Delaware
         corporation,  dated  as  of  March  10, 1982.  (FILED AS AN
         EXHIBIT  TO  THE  COMPANY'S  REGISTRATION STATEMENT NO. 33-
         33698, AS AMENDED.)

  10.2   Order  of Conversion of Grant of Puerto Rico Industrial Tax
         Exemption to Wahlco International, Inc. dated as of October
         29,  1987,  and  as amended on March 8, 1989.  (FILED AS AN
         EXHIBIT  TO  THE  COMPANY'S  REGISTRATION STATEMENT NO. 33-
         33698, AS AMENDED.)

  10.3   Redemption  and  Indemnification  Agreement,  dated  as  of
         October  28, 1987, by and among Pacific Diversified Capital
         Company,  Wahlco, Inc., Robert R. Wahler, as Trustee of the
         Wahler  Family Trust, Triple R, John H. McDonald, Westfore,
         a  California  limited partnership and Corona Properties, a
         California  limited  partnership.   (FILED AS AN EXHIBIT TO
         THE  COMPANY'S  REGISTRATION  STATEMENT  NO.  33-33698,  AS
         AMENDED.)

 X10.4   Form of Indemnity Agreement between the Company and each of
         its  directors  and  officers.  (FILED AS AN EXHIBIT TO THE
         COMPANY'S REGISTRATION STATEMENT NO. 33-33698, AS AMENDED.)

  10.5   Standard  Industrial  Lease, dated as of September 3, 1991,
         by  and  between Triple R, a California general partnership
         and  Wahlco  Inc.,  a California corporation.  (FILED AS AN
         EXHIBIT TO THE COMPANY'S THE ANNUAL REPORT ON FORM 10-K FOR
         THE YEAR ENDED DECEMBER 31, 1991.)

  10.6   First  Addendum  to  Standard Industrial Lease, dated as of
         September 3, 1991 between Triple R and Wahlco, Inc.  (FILED
         AS  AN  EXHIBIT  TO THE COMPANY'S THE ANNUAL REPORT ON FORM
         10-K FOR THE YEAR ENDED DECEMBER 31, 1991.)

  10.7   Second  Amendment to Office Lease, dated as of December 16,
         1991,  by  and  between  BCG  and  the Company (FILED AS AN
         EXHIBIT TO THE COMPANY'S THE ANNUAL REPORT ON FORM 10-K FOR
         THE YEAR ENDED DECEMBER 31, 1991.)

  10.8   Installment Note, dated as of July 20, 1992, by and between
         Wahlco,  Inc.  and  Sanwa  Business  Credit  Corporation, a
         Delaware  corporation (FILED AS AN EXHIBIT TO THE COMPANY'S
         QUARTERLY  REPORT  ON  FORM  10-Q  FOR  THE  QUARTER  ENDED
         SEPTEMBER 30, 1992.)
</TABLE>

                                       55
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT #                         DESCRIPTION                           AT PAGE
<S>     <C>                                                             <C>
  10.9   Guaranty  Agreement,  dated  as  of  July  20, 1992, by and
         between the Company and Sanwa.  (FILED AS AN EXHIBIT TO THE
         COMPANY'S  QUARTERLY  REPORT  ON  FORM 10-Q FOR THE QUARTER
         ENDED SEPTEMBER 30, 1992.)

 10.10   Security  Agreement,  dated  as  of  July  20, 1992, by and
         between  Wahlco,  Inc. and Sanwa, with accompanying Consent
         and  Acknowledgment  of the Company , as Guarantor.  (FILED
         AS AN EXHIBIT TO THE COMPANY'S QUARTERLY REPORT ON FORM 10-
         Q FOR THE QUARTER ENDED SEPTEMBER 30, 1992.)

X10.11   First  Amended  and  Restated  1990  Incentive  Award Plan.
         (FILED  AS  AN EXHIBIT TO THE COMPANY'S QUARTERLY REPORT ON
         FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1992.)

 10.12   Letter  Agreement dated August 31, 1993, by and between the
         Company,  Wahlco,  Inc.,  Wahlco  Power  Products,  Inc., a
         Delaware  corporation, Bachmann Companies, Inc., and Sanwa.
         (FILED  AS  AN EXHIBIT TO THE COMPANY'S QUARTERLY REPORT ON
         FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1993.)

 10.13   Settlement  Agreement,  dated as of October 7, 1994, by and
         between  Wahlco Power Products, Inc. and ABB Air Preheater,
         Inc. (FILED AS AN EXHIBIT TO THE COMPANY'S QUARTERLY REPORT
         ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1994.)

 10.14   Mutual  General  Release,  dated  as  of  October  6, 1994,
         between  Wahlco Power Products, Inc. and ABB Air Preheater,
         Inc..    (FILED  AS  AN  EXHIBIT TO THE COMPANY'S QUARTERLY
         REPORT  ON  FORM  10-Q  FOR THE QUARTER ENDED SEPTEMBER 30,
         1994.)

 10.15   Assignment of Note, Loan Agreement and Collateral Documents.
         (FILED  AS AN  EXHIBIT  TO THE  COMPANY'S ANNUAL  REPORT  ON
         FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1994.)

 10.16   Promissory  Note,  dated  as  of  May 15, 1995, between the
         Company  and WES Acquisition Corp.  (FILED AS AN EXHIBIT TO
         THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
         DECEMBER 31, 1994.)

 10.17   Commitment  letter,  dated  as  of  May  15, 1995, from WES
         Acquisition Corp. to the Company for a secured term loan in
         the  principal  amount of $2 million.  (FILED AS AN EXHIBIT
         TO  THE  COMPANY'S  THE  ANNUAL REPORT ON FORM 10-K FOR THE
         YEAR ENDED DECEMBER 31, 1994.

X10.18  Employment  Agreement  between  the  Company and C. Stephen
         Beal  dated as of May 5, 1995.  (FILED AS AN EXHIBIT TO THE
         COMPANY'S THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
         DECEMBER 31, 1995.)

X10.19  Employment  Agreement  between  the  Company  and  A.  Noel
         DeWinter dated as of May 16, 1995.  (FILED AS AN EXHIBIT TO
         THE  COMPANY'S  THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR
         ENDED DECEMBER 31, 1995.)
</TABLE>

                                       56
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT #                         DESCRIPTION                           AT PAGE
<S>     <C>                                                             <C>
X10.20   Employment  Agreement  between  the  Company  and  Barry J.
         Southam  dated  June  1, 1995.  (FILED AS AN EXHIBIT TO THE
         COMPANY'S THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
         DECEMBER 31, 1995.)

 10.21   Loan  and  Security  Agreement  between  Wahlco,  Inc.  and
         Silicon Valley Bank.  (FILED AS AN EXHIBIT TO THE COMPANY'S
         THE  ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER
         31, 1995.)

 10.22   Amendment  and  Forbearance  Agreement,  dated as of May 9,
         1996,  by  and between Silicon Valley Bank and Wahlco, Inc.
         (FILED  AS  AN EXHIBIT TO THE COMPANY'S QUARTERLY REPORT ON
         FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1996.)

 10.23   Term  Loan  Agreement  and  Warrant  Agreement  and Form of
         Warrant between the Company and WES Acquisition Corp. dated
         August  28,  1996.    (FILED AS AN EXHIBIT TO THE COMPANY'S
         QUARTERLY  REPORT  ON FORM 10-Q FOR QUARTER ENDED SEPTEMBER
         30, 1996.)

 10.24   Letter  Agreement  dated March 12, 1997 between the Company
         and  WES  Acquisition  Corp.    (FILED AS AN EXHIBIT TO THE
         COMPANY'S  ANNUAL  REPORT  ON  FORM 10-K FOR THE YEAR ENDED
         DECEMBER 31, 1996.)

 10.25   Letter  Agreement  dated April 12, 1996 between the Company
         and  WES  Acquisition  Corp.    (FILED AS AN EXHIBIT TO THE
         COMPANY'S  ANNUAL  REPORT  ON  FORM 10-K FOR THE YEAR ENDED
         DECEMBER 31, 1996.)

 10.26   Promissory Note dated as of May 9, 1996 made by the Company
         to  WES  Acquisition  Corp.    (FILED  AS AN EXHIBIT TO THE
         COMPANY'S  ANNUAL  REPORT  ON  FORM 10-K FOR THE YEAR ENDED
         DECEMBER 31, 1996.)

 10.27   Promissory  Note  dated as of November 15, 1996 made by the
         Company  to  WES Acquisition Corp.  (FILED AS AN EXHIBIT TO
         THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
         DECEMBER 31, 1996.)

 10.28   Warrant dated as of November 15, 1996 issued by the Company
         to  Wexford  Special  Situations  1996, L. P.  (FILED AS AN
         EXHIBIT TO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE
         YEAR ENDED DECEMBER 31, 1996.)

 10.29   Warrant dated as of November 15, 1996 issued by the Company
         to  Wexford  Special  Situations  1996 Institutional, L. P.
         (FILED AS AN EXHIBIT TO THE COMPANY'S ANNUAL REPORT ON FORM
         10-K FOR THE YEAR ENDED DECEMBER 31, 1996.)

 10.30   Warrant dated as of November 15, 1996 issued by the Company
         to  Wexford  Special Situations 1996 Limited.  (FILED AS AN
         EXHIBIT TO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE
         YEAR ENDED DECEMBER 31, 1996.)

 10.31   Warrant dated as of November 15, 1996 issued by the Company
         to  Wexford  - Euris Special Situations 1996, L. P.  (FILED
         AS  AN  EXHIBIT TO THE COMPANY'S ANNUAL REPORT ON FORM 10-K
         FOR THE YEAR ENDED DECEMBER 31, 1996.)
</TABLE>

                                       57
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT #                         DESCRIPTION                           AT PAGE
<S>     <C>                                                             <C>
 10.32   Term Loan Agreement, dated as of July 28, 1995, between WES
         Acquisition  Corp.  and the Company for a secured term loan
         in  the  principal  amount  of  $2.0 million.  (FILED AS AN
         EXHIBIT TO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE
         YEAR ENDED DECEMBER 31, 1996.)

 10.33   Restructuring  Agreement dated as of January 30, 1998 among
         the Company, WES Acquisition Corp., the other parties named
         therein and Wexford Management LLC, as Agent.  (FILED AS AN
         EXHIBIT  TO  THE  COMPANY'S REGISTRATION STATEMENT NO. 333-
         42805.)

 10.34   Amended  and  Restated Credit Agreement dated as of January
         30,  1998  among  the Company, as Borrower, the Lenders and
         the  Individual Parties thereto and Wexford Management LLC,
         a s   Agent.    (FILED  AS  AN  EXHIBIT  TO  THE  COMPANY'S
         REGISTRATION STATEMENT NO. 333-42805.)

 10.35   Agreement  between  the Company and ChaseMellon Shareholder
         Services, Inc. re Subscription Agency. (FILED AS AN EXHIBIT
         TO  THE  COMPANY'S REGISTRATION STATEMENT NO. 333-42805.)

 10.36   $750,000  promissory  note dated as of July 2, 1997 between
         the  Company  and  The  Chase Manhattan Bank.  (FILED AS AN
         EXHIBIT  TO  THE  COMPANY'S REGISTRATION STATEMENT NO. 333-
         42805.)

 10.37   $1,000,000  promissory  note  dated  as of October 13, 1997
         between  the  Company and The Chase Manhattan Bank.  (FILED
         AS  AN  EXHIBIT TO THE COMPANY'S REGISTRATION STATEMENT NO.
         333-42805.)

 10.38   $400,000  promissory  note  dated  as  of November 17, 1997
         between  the  Company and The Chase Manhattan Bank.  (FILED
         AS  AN  EXHIBIT TO THE COMPANY'S REGISTRATION STATEMENT NO.
         333-42805.)

 10.39   Waiver  letter  of Silicon Valley Bank dated as of December
         19, 1997 re: extension of maturity and waiver of covenants.
         (FILED  AS  AN  EXHIBIT  TO  THE  COMPANY'S  REGISTRATION
         STATEMENT NO. 333-42805.)

X10.40  Wahlco  Environmental  Systems,  Inc.  1996  Employee Stock
         Option  Plan.    (FILED  AS  AN  EXHIBIT  TO  THE COMPANY'S
         REGISTRATION STATEMENT NO. 333-42805.)

 21      Subsidiaries  of  the Company.  (FILED AS AN EXHIBIT TO THE
         COMPANY'S  ANNUAL  REPORT  ON  FORM 10-K FOR THE YEAR ENDED
         DECEMBER 31, 1995.)

  *27    Financial Data Schedule (EDGAR filing only)
</TABLE>
--------------------

*    Filed herewith
X    Management contract or compensatory plan.

                                       58