<PAGE>   1


                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

[X]  Annual Report Pursuant to Section 13 or 15(d) of the Securities and
     Exchange Act of 1934 For the fiscal year ended December 31, 1998, or

[ ]  Transition Report Pursuant to Section 13 or 15(d) of the Securities and
     Exchange Act of 1934 For the transition period from ______ to ______

                         Commission file number 0-23802

                          MOTIVEPOWER INDUSTRIES, INC.
             (Exact name of registrant as specified in its charter)


           Delaware                         82-0461010
---------------------------------           ------------------------------------
(State or other jurisdiction                (I.R.S. Employer Identification No.)
of incorporation or organization)


Two Gateway Center, 14th Floor, Pittsburgh, PA                15222
----------------------------------------------                ----------
(Address of principal executive offices)                      (Zip code)


Registrant's telephone number, including area code:  (412) 201-1101
                                                     --------------

Securities registered pursuant to Section 12(b) of the Act: None


Securities registered pursuant to Section 12(g) of the Act:


          Class
----------------------------
Common stock, $.01 par value


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 this Form 10-K or any amendment to this
Form 10-K. [ ]

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
    -----     -----

State the aggregate market value of the voting stock held by nonaffiliates of
the registrant at February 25, 1999: $486,655,011

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.


          Class                                 Outstanding at February 25, 1999
----------------------------                    --------------------------------
Common stock, $.01 par value                               17,777,352


Documents Incorporated by Reference: Certain sections or portions of the
registrant's proxy statement for the annual meeting of stockholders to be held
on April 27, 1999, described in Part III hereof, are incorporated by reference
in this report.


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FORM 10-K
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PART I

Unless otherwise indicated or the context otherwise requires, the terms
"Company" and "MotivePower" refer to MotivePower Industries, Inc., and its
subsidiaries.

ITEM 1. BUSINESS

THE COMPANY
The Company is a leader in the manufacturing and distribution of products for
rail and other power-related industries, and also provides a variety of related
contract services. The Company provides products and services to freight and
passenger railroads, including every Class I railroad in North America,
metropolitan transit and commuter rail authorities, original equipment
manufacturers, industrial power-related markets and other customers
internationally. The Company has headquarters in Pittsburgh, Pennsylvania and
2,999 employees at strategically located facilities in the United States, Canada
and Mexico.

FORWARD-LOOKING STATEMENTS
This Form 10-K contains forward-looking statements. The Company's actual results
could differ materially from the results suggested in any forward-looking
statement. Factors that could cause or contribute to these material differences
include, but are not limited to, the following: a slowdown in the U.S. or
Mexican economies; a decrease in North American Free Trade Agreement ("NAFTA")
rail traffic; continued rail consolidation by U.S. and Canadian railroads, which
could cause them to reduce purchases of goods and services; a strengthening or a
weakening of the U.S. dollar and/or a change in the availability of letters of
credit in targeted foreign markets; the Company's ability to timely and
efficiently implement productivity improvement plans; the Company's ability to
maintain current favorable relations with its labor unions; and the Company's
ability to successfully implement its information technology upgrade and
business improvement project, including "Year 2000" compliance. The Company
assumes no obligation to update these forward-looking statements or advise of
changes in the assumptions on which they were based.

BUSINESS STRATEGY
MotivePower's business strategy is to grow and continue to strengthen its core
businesses, including manufacturing and distributing engineered locomotive
components and parts; providing locomotive fleet maintenance; overhauling and
remanufacturing locomotives and diesel engines; and manufacturing
environmentally friendly switcher, commuter and mid-range, DC and AC traction,
diesel-electric and liquefied natural gas locomotives up to 4,000 horsepower.
The Company is looking to expand further into other niche power, marine and
industrial markets by growing the existing business in these markets and by
modifying certain existing products to fit new applications.

     The Company believes that it has six primary opportunities for growth, or
"growth engines": (1) capitalize on the NAFTA railroads' desire to outsource
non-transportation functions such as running locomotive maintenance and repair
projects by continuing to improve quality and by reducing product cycle times;
(2) continue to grow its Mexican market share and operations by expanding
current capabilities; (3) expand sales of components and parts in targeted
non-NAFTA markets, such as South America, the Middle East and the Pacific Rim;
(4) develop new products for the rail industry and expand sales of similar
components into non-rail markets; (5) acquire companies that provide products or
services that complement the Company's current capabilities either
geographically or technically, or that expand the Company's current product
line; and (6) develop alliances and joint ventures with other global rail
industry suppliers.

INDUSTRY CONDITIONS AND TRENDS
The Company's operating results are strongly influenced by general economic
conditions, and the financial conditions and level of activity of the global
railroad industry. In 1998, favorable conditions generally prevailed in the
NAFTA economy. As a result, U.S. railroads carried a record 1.38 trillion
revenue ton-miles, the main indicator of activity in the industry, up 1.8
percent from the prior year. There can be no assurance that these favorable
conditions will continue.

     The Company's business is primarily providing parts, components and
services engineered for locomotives, mainly for the aftermarket. Currently, the
active locomotive fleet in the NAFTA market numbers about



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FORM 10-K
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33,000 units, which include heavy-haul freight locomotives, commuter locomotives
and lower-horsepower, short-haul and terminal locomotives. Purchases of new
heavy-haul locomotives have been at historical highs in recent years as
railroads have been seeking to modernize their fleets, but the Company believes
production capacity for new units is limited to current levels of about 1,200
per year. As a result, demand for overhauling older locomotives and for
aftermarket parts has been high as railroads work equipment harder and look to
maximize the efficiency, availability and productivity of their existing fleets
to meet the increased need for locomotive power, and to improve reliability to
shippers. Historically, the components, parts and maintenance, and overhaul
segments of the railroad industry, while still subject to the impact of rail
traffic fluctuations, have been more stable and less cyclical than the new
locomotive segment. The Company operates in a highly competitive environment,
and there can be no assurance that increased rail traffic, higher fleet
utilization, or other economically favorable industry conditions will benefit
the Company.

     Since the deregulation of the U.S. railroad industry in 1980, freight
railroads have reduced their equipment base, consolidated operations, and
reduced suppliers to reduce operating costs and improve their competitive
position compared to trucking companies, which compete with the railroad
industry. Railroads have been consolidating and merging, hoping to achieve
additional operating and financial efficiencies that will allow them to compete
more effectively with other modes of transportation. Management believes these
consolidations offer the Company opportunities to increase business with the
surviving railroads as these railroads seek operating efficiencies through such
means as outsourcing locomotive fleet maintenance and components repair. In
addition, the supplier base has been consolidating, and the Company is a primary
consolidator. These are forward-looking statements, and there can be no
assurances that continued consolidation will not adversely impact the Company
through concentration of bargaining power over prices or rationalization of
locomotive fleet sizes.

DESCRIPTION OF BUSINESS OPERATIONS
The Company operates principally through two groups of business units, the
Components Group and the Locomotive Group.

COMPONENTS GROUP
The Components Group manufactures and distributes primarily aftermarket, or
replacement, new and remanufactured components and parts for freight and
passenger railroads, including every Class I railroad in North America,
metropolitan transit and commuter rail authorities, original equipment
manufacturers, industrial power-related markets, and other customers
internationally. MotivePower provides aftermarket components for locomotives
manufactured by the Electro-Motive Division of General Motors Corporation
("EMD"), certain components for locomotives made by the GE Transportation
Systems unit of General Electric Company ("GE") and certain components for Alco
locomotives. MotivePower believes it is the leading independent supplier in
North America of aftermarket locomotive components such as traction motors,
generators, alternators, turbochargers, cooling systems, gearing and overhauled
diesel engines. Through the acquisition of G&G Locotronics and Q-Tron in January
1999, the Company is also a leading supplier of electronic and electrical
components and software for locomotives and freight cars. Demand for components
is influenced by rail traffic activity. As traffic increases, the railroads seek
to maximize locomotive availability and capacity, which can increase the
frequency of necessary repairs and maintenance. This business is highly
competitive, as the Company faces competition from EMD, GE and numerous smaller,
independent manufacturers and distributors. EMD and GE accounted for virtually
100% of the new high-horsepower locomotives delivered in the United States in
the past five years and, as original equipment manufacturers, are the principal
suppliers of original parts for their locomotives.



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FORM 10-K
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LOCOMOTIVE GROUP
The Locomotive Group provides fleet maintenance, overhauling and remanufacturing
of locomotives and diesel engines, and manufacturing of environmentally friendly
switcher, commuter and mid-range, DC and AC traction, diesel-electric and
liquefied natural gas locomotives up to 4,000 horsepower. The Company's fleet
maintenance business unit provides locomotive maintenance under long-term
contracts. These contracts generally cover normal, expected maintenance costs
but also allow the Company to bill additional amounts to cover extraordinary
maintenance.

     Demand for fleet maintenance services is driven by the railroads' focus on
cost reduction and productivity improvements as the industry has consolidated
over recent decades, and as railroads consider outsourcing non-transportation
functions. While most railroads have their own mechanical and maintenance
facilities, some achieve cost savings and productivity improvements by
outsourcing the work to an independent servicer. In this business segment, the
Company competes against GE, EMD and the captive in-house repair shops of
various railroads. When possible, the Company supplies its own component parts,
at market prices, for use in overhaul and maintenance under these contracts. In
this manner, the locomotive fleet maintenance contracts provide additional
opportunities for sales of component parts.

     There are approximately 6,000 low-horsepower locomotives operating in
switcher/short-haul service in the United States and Canada, with an average age
of 30 years. Demand for new state-of-the-art low-horsepower locomotives has been
minimal since the early 1980s because the railroads have focused instead on
modernizing, rationalizing and downsizing their higher-horsepower freight
locomotive fleets. In addition, older freight locomotives are often used as
switchers. As a result of this low level of demand, the Company believes it is
the only manufacturer of new lower-horsepower locomotives. In March 1998, the
Company formed a strategic alliance with EMD to market 1,500- and 2,000-
horsepower locomotives with the EMD brand name. The Company has a number of
proposals outstanding through this alliance, but there can be no assurance that
it will be successful.

     The Company has been providing overhauling and remanufacturing services to
the railroad industry since 1972, and management believes the Company is the
largest, independent overhauler and remanufacturer of locomotives in North
America. In this business unit, the Company faces competition from VMV, Alstom,
numerous smaller regional remanufacturers, the captive in-house shops of Class I
railroads, and from GE and EMD. Most large railroads have in-house capacity to
overhaul locomotives but not to remanufacture and substantially upgrade them.

     Typically, a locomotive overhaul includes replacement of various engine and
electrical rotating equipment. The cost can vary greatly depending on the number
and type of options included. Remanufacturing is a more extensive process
involving the disassembly, redesign from the frame up and reassembly of a
locomotive with upgraded equipment to substantially as-new condition.

     The Company's overhauling and remanufacturing businesses have been driven
by the aging of the rail industry's locomotive fleet and the historical cost
advantages compared to purchasing new locomotives. Between 1970 and 1980, the
industry purchased approximately 12,000 new locomotives, compared to
approximately 10,500 since then. As a result, the average age of the fleet has
increased, with nearly 75% of the fleet at least 10 years old. The typical
maintenance cycle calls for a locomotive to be overhauled after approximately
seven years, remanufactured after 15 years and replaced after 20 to 25 years if
it has not been remanufactured.

PRODUCT DEVELOPMENT
In response to new emission control regulations released by the U.S.
Environmental Protection Agency (the "EPA"), the Company has established a new,
focused business unit to explore opportunities that will be created by these new
EPA guidelines. Under the regulations, locomotives will be required to meet more
stringent standards for the emission of oxides of nitrogen, beginning in the
year 2001. The standards will be phased in over several years and may encourage
the railroads to overhaul locomotives before the year 2001 so that those
locomotives will qualify under the current, less-stringent regulations. No
assurance can be provided, however, that these new regulations will have a
favorable impact on the Company's results of operations.


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FORM 10-K
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BACKLOG
The Company defines backlog as future sales commitments, which constitute a
binding agreement between the Company and the customer. Examples include signed
contracts and purchase orders. The Company is the preferred supplier of certain
components to customers, having received notice of the customer's estimate of
anticipated purchases. Because these notices are not binding commitments, the
Company has not included these amounts in backlog calculations. At December 31,
1998, these anticipated purchases totaled $48 million. At December 31, 1998 and
1997, the Company's recorded backlog was approximately $706 million and $538
million, respectively.

     The Company's multi-year locomotive fleet maintenance contracts account for
the majority of the Locomotive Group backlog. The largest contract is subject to
termination by the customer, however the contract provides for the Company to
receive a substantial fee for early termination of the contract. Multi-year
fleet maintenance contracts virtually assure additional components and parts
sales will occur. 

     The backlog as of December 31, 1998, and December 31, 1997, and the
expected year of recognition is as follows:


<TABLE>
<CAPTION>
----------------------------------------------------------
                            As of December 31, 1998
                      ------------------------------------
                                      Other          Total
(In thousands)            1999        Years        Backlog
----------------------------------------------------------
<S>                   <C>           <C>            <C>     
Locomotive            $ 99,574     $553,347       $652,921
Components              51,664        1,220         52,884
----------------------------------------------------------
Total                 $151,238     $554,567       $705,805
==========================================================
</TABLE>


<TABLE>
<CAPTION>
----------------------------------------------------------
                            As of December 31, 1997
                      ------------------------------------
                                      Other          Total
(In thousands)            1998        Years        Backlog
----------------------------------------------------------
<S>                   <C>          <C>            <C>     
Locomotive            $136,772     $364,948       $501,720
Components              36,135           --         36,135
----------------------------------------------------------
Total                 $172,907     $364,948       $537,855
==========================================================
</TABLE>

EMPLOYEES
At December 31, 1998, MotivePower had 2,999 employees versus 2,351 in 1997. This
included 426 salaried employees and 1,748 hourly employees in the United States,
and 163 salaried employees and 662 hourly employees in Mexico. Of the hourly
employees in the United States, 326 at Boise Locomotive Company ("Boise
Locomotive") are represented by the International Union of Operating Engineers
("Operating Engineers"), and 612 at Motor Coils Manufacturing Co. ("Motor
Coils") are represented by the International Union of Electronic, Electrical,
Salaried, Machine and Furniture Workers ("Electrical Workers"). The collective
bargaining agreements with the Operating Engineers at Boise and the Electrical
Workers at Motor Coils' St. Louis, Missouri, plant expire in June 2000. The
collective bargaining agreement with the Electrical Workers at the Motor Coils
Braddock, Pennsylvania plant expires in 2001, and the agreement at the Motor
Coils Emporium, Pennsylvania plant expires in 2002. Of the hourly employees in
Mexico, 615 are represented by the Mexico Workers Railroad Union, and 47 are
represented by the Metal-Mechanical Workers of the State of San Luis Potosi,
Mexico. These contracts are reviewed annually for wages and bi-annually for
benefits. The Company considers its relations with its employees and union
representation to be good but cannot, however, assure that future contract
negotiations will be favorable to the Company.

ENVIRONMENTAL MATTERS
Information with respect to environmental matters is included in Note 12 to the
consolidated financial statements included in Part II, Item 8 of this report.

MAJOR CUSTOMERS
In 1998, sales to three customers each represented at least 10% of net sales:
Burlington Northern Santa Fe (18%), Transportacion Ferroviaria Mexicana ("TFM")
(10%), and Union Pacific (10%). No other single customer accounted for 10% or
more of net sales. Total customers number approximately 2,000 located in 42
countries globally.

     Based on current operations, management expects that sales to Burlington
Northern Santa Fe, TFM and Union Pacific will each exceed 10% of 1999 total net
sales. The Company sells to virtually all Class I and II railroad customers in
NAFTA and has good relations with all major customers.

FOREIGN AND DOMESTIC OPERATIONS
Information with respect to foreign and domestic operations is included in Note
13 to the consolidated financial statements included in Part II, Item 8 of this
report.


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FORM 10-K
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ITEM 2. PROPERTIES

The Company's headquarters are located in Pittsburgh, Pennsylvania and its
manufacturing facilities are located throughout North America. The Company
considers that its properties are generally in good condition, well-maintained,
suitable, and adequate to carry on its business except as noted below. The
principal facilities of the Company and its subsidiaries or operating units are
as follows:


<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
Property Location                Square Footage         Owned/Leased         Usage
-------------------------------------------------------------------------------------------------------------
<S>                              <C>                    <C>                  <C>
MOTIVEPOWER INDUSTRIES, INC.     
   Pittsburgh, Pennsylvania         18,500              Leased               Corporate Headquarters
                                 
BOISE LOCOMOTIVE CO.             
   Mountaintop, Pennsylvania (1)   204,000              Owned                Warehousing
   Boise, Idaho                    294,650              Owned                Manufacturing/Office
   Helper, Utah (2)                   N.A.              Leased               Maintenance Shop
   Barstow, California (2)            N.A.              Leased               Maintenance Shop
   Houston, Texas (2)                 N.A.              Leased               Maintenance Shop
                                 
ENGINE SYSTEMS CO., INC.         
   Latham, New York                 66,000              Owned                Manufacturing/Office
   Alsip, Illinois                  42,600              Owned                Manufacturing/Office
   Gilman, Illinois                 31,800              Leased               Manufacturing
                                 
G&G LOCOTRONICS (5)              
   Itasca, Illinois                 83,500              Leased               Manufacturing/Office
                                 
MICROPHOR CO.                    
   Willits, California              70,000              Owned                Manufacturing/Warehousing/Office
                                 
MPI NORESTE, S.A. DE C.V.        
   San Luis Potosi, Mexico       1,235,700              Leased               Manufacturing/Office
   Acambaro, Mexico                132,300              Leased               Maintenance Shop
   Mexico City, Mexico               3,700              Leased               Office
                                 
MOTOR COILS MFG. CO.             
   Pittsburgh, Pennsylvania (3)    123,400              Leased               Warehousing
   Braddock, Pennsylvania          127,000              Owned                Manufacturing/Office
   Emporium Pennsylvania            53,000              Owned                Manufacturing
   St. Louis, Missouri              62,000              Owned                Manufacturing
   St. Louis, Missouri (4)          10,000              Leased               Warehousing
   San Luis Potosi, Mexico          20,200              Leased               Manufacturing/Warehouse
   San Luis Potosi, Mexico          48,600              Owned                Manufacturing/Office
                                 
POWER PARTS CO.                  
   Elk Grove Village, Illinois     150,700              Leased               Distribution/Office
                                 
Q-TRON LTD. (5)                  
   Calgary, Canada                  38,000              Owned                Manufacturing/Office
   Westminster, Colorado             1,600              Leased               Repair/Office
                                 
TOUCHSTONE CO.                   
   Jackson, Tennessee              150,000              Owned                Manufacturing/Office
   Jackson, Tennessee               16,000              Leased               Manufacturing
                                 
YOUNG RADIATOR CO.               
   Racine, Wisconsin                50,000              Owned                Engineering/Office
   Racine, Wisconsin               181,000              Owned                Warehousing
   Lexington, Tennessee            170,000              Owned                Manufacturing
   Centerville, Iowa               100,000              Owned                Manufacturing
=============================================================================================================
</TABLE>

(1)  The Company closed this facility in the second quarter of 1996 and is
     marketing the facility for sale.

(2)  Represents unspecified portions of maintenance facilities owned by the
     railroads for which the Company provides locomotive fleet maintenance
     services. These facilities have been made available to the Company to
     perform these services for nominal consideration.

(3)  The Company's Motor Coils subsidiary has commenced a civil action seeking
     rescission of this 15-year lease agreement. The administrative office
     portion of the building was vacated by Motor Coils during 1998.

(4)  Motor Coils has an option to lease an additional 15,000 square feet.

(5)  Acquired in January 1999.


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FORM 10-K
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ITEM 3. LEGAL PROCEEDINGS
Information with respect to legal proceedings is included in Note 12 to the
consolidated financial statements included in Part II, Item 8 of this report.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MotivePower's Common Stock traded on the Nasdaq Stock Market under the symbol
"MOPO" from April 1994 through August 15, 1997. On August 18, 1997 the Company's
Common Stock began trading on the New York Stock Exchange (NYSE) under the
symbol "MPO." As of February 25, 1999, the approximate number of holders of
record of its Common Stock was 1,500.

     The high and low sales prices for the Company's Common Stock, as reported
in the NYSE/Nasdaq Stock Market Summary of Activity reports in 1998 and 1997
were as follows:


<TABLE>
<CAPTION>
----------------------------------------------------------
                               1998               1997
                         ---------------------------------
                           High      Low     High      Low
----------------------------------------------------------
<S>                      <C>      <C>      <C>      <C>
First Quarter            $28.00   $19.75   $11.38   $ 7.75
Second Quarter            29.00    28.06    16.13    10.75
Third Quarter             29.88    19.75    27.25    15.25
Fourth Quarter            32.25    16.56    28.88    19.75
==========================================================
</TABLE>

     The Board of Directors did not declare dividends for 1998 or 1997. The
Board of Directors reviews its dividend policy regularly.

     At the close of business on February 25, 1999, the Company's Common Stock
traded at $27.38 per share.


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FORM 10-K
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND INDUSTRY DATA
The following Selected Consolidated Financial Data is qualified in its entirety
by, and should be read in conjunction with, the consolidated financial
statements of the Company and the related notes thereto, and with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" set
forth under Item 7. The Statement of Income data and the Balance Sheet data for
each of the five years in the five-year period ended December 31, 1998, have
been derived from the audited consolidated financial statements of the Company.


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------------
                                                                                          December 31,
                                                         ------------------------------------------------------------------------
                                                                1998           1997           1996           1995           1994
---------------------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>            <C>            <C>            <C>            <C>
Statement of Income (000s)
   Net sales(1) ........................................ $   365,218    $   305,930    $   277,321    $   236,822    $   302,434
   Gross profit (loss) .................................      81,322         72,342         56,847         (5,167)        (5,478)
   Operating income (loss) .............................      40,363         34,618         24,232        (51,113)       (49,977)
   Net income (loss) ...................................      32,197         20,276         11,509        (40,414)       (42,793)
   EBITDA(2) ...........................................      51,770         44,585         34,589          1,057            871

Balance Sheet (000s)
   Total assets ........................................ $   371,198    $   283,102    $   234,044    $   280,948    $   311,297
   Debt ................................................     105,798         50,507         49,592        120,118        108,176
   Stockholders' equity ................................     177,929        144,548        120,980         94,527        114,124

Per Diluted Share
   Net income (loss)(3) ................................ $      1.73    $      1.11    $      0.66    $     (2.34)   $     (2.47)
   EBITDA ..............................................        2.78           2.45           1.97           0.06           0.05
   Cash dividends ......................................        0.00           0.00           0.00           0.04           3.31(4)
   Year-end book value(5) ..............................       10.05           8.13           6.89           5.38           6.65
   Year-end shares outstanding (000s) ..................      17,700         17,774         17,563         17,563         17,149
   Adjusted weighted average common shares
      outstanding (000s) ...............................      18,619         18,209         17,566         17,269         16,853

Cash Flows (000s)
   Net cash provided by (used in) operating activities.. $    31,344    $    35,452    $    43,368    $   (21,743)   $   (85,141)
   Net cash provided by (used in) investing activities..    (102,324)       (22,472)        12,407        (15,408)       (36,941)
   Net cash provided by (used in) financing activities..      59,743         (1,319)       (56,235)        30,388        120,463

Company
   Market capitalization (000s)(6) ..................... $   569,719    $   421,368    $   137,218    $    66,959    $   182,208
   Employees at year-end ...............................       2,999          2,351          2,108          2,205          2,976
   Sales per employee(7) ............................... $   140,009    $   138,680    $   131,556    $   107,402    $   101,624

Industry(8)
   Revenue ton-miles (000,000s) ........................   1,376,400      1,348,926      1,355,975      1,305,688      1,200,701
   Locomotives in service(9) ...........................      20,000         19,684         19,269         18,812         18,505
   New locomotives delivered ...........................         750            743            761            928            821
=================================================================================================================================
</TABLE>

(1)  From continuing operations

(2)  Operating income plus depreciation and amortization

(3)  Figures for 1994 is a supplemental pro forma amount

(4)  Includes a special dividend of $3.19 per share to Morrison Knudsen

(5)  Stockholders' equity divided by year-end shares outstanding

(6)  Year-end shares outstanding multiplied by year-end closing stock price

(7)  Adjusted for acquisitions

(8)  Source: American Association of Railroads. Figures for 1998 are estimates

(9)  Figures are for U.S. Class I railroads only. Figures do not include an
     estimated 5,000 units in service in Canada and Mexico, and on short-line
     and regional railroads



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FORM 10-K
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW
In 1998, the Company set records with net income of $32.2 million, earnings per
diluted share of $1.73 and net sales of $365.2 million. Net sales increased
19.4% in 1998 including the effects of acquisitions. Gross margin of 22.3% was
negatively impacted by costs associated with the relocation and start-up of
certain production facilities, estimated production inefficiencies associated
with labor contract negotiations, the effects of a sale/leaseback transaction
entered into by the Company, an inventory adjustment, and a loss provision on a
fleet maintenance contract. Excluding these items, the Company's gross margin
was 26.1% versus a reported gross margin of 23.6% in 1997 and a normalized gross
margin of 24.4% excluding a 1997 charge incurred for the estimated warranty
replacement of piston liners.

     The Company's Locomotive and Components Groups showed net sales increases
of 22.6% and 16.4%, respectively, and operating income increases of 28.2% and
10.4%, respectively, from 1997 after excluding non-recurring items in both
years. The Locomotive Group had increases in net sales due to increased overhaul
and freight car work in the United States and in Mexico as well as increased
sales of switcher locomotives in 1998. The Locomotive Group's operating income
increase was the result of the increased volume, sales mix and production
efficiencies primarily at the Company's MPI de Mexico subsidiary, offset by the
loss provision for the fleet maintenance contract. The Components Group's net
sales increase was primarily attributed to acquisitions and an increase in sales
to international markets, while the operating income increase was primarily
attributable to acquisitions.

RESULTS OF OPERATIONS
The following table sets forth the percentage of net sales represented by
certain items in the Company's Consolidated Statements of Income for the years
indicated.


<TABLE>
<CAPTION>
-----------------------------------------------------------------
                                        Year Ended December 31,
                                      ---------------------------
                                       1998      1997       1996
-----------------------------------------------------------------
<S>                                   <C>       <C>        <C>   
Net sales                             100.0%    100.0%     100.0%
Cost of sales                         (77.7)    (76.4)     (80.5)
-----------------------------------------------------------------
Gross profit                           22.3      23.6       19.5
Selling, general and
   administrative expenses            (11.2)    (12.3)     (11.2)
-----------------------------------------------------------------
Operating income                       11.1      11.3        8.3

Investment income                       0.5       0.2        0.7
Interest expense                       (1.6)     (1.7)      (3.1)
Other income - Argentina                2.8       0.7        0.5
Gain on sale of assets                   --        --        0.5
Foreign exchange gain (loss)            0.6      (0.1)       0.1
-----------------------------------------------------------------
Income before income taxes             13.4      10.4        7.0
Income tax expense                     (4.0)     (3.8)      (2.6)
-----------------------------------------------------------------
Income before extraordinary item        9.4       6.6        4.4
Extraordinary loss on
   extinguishment of debt              (0.6)       --       (0.4)
-----------------------------------------------------------------
Net income                              8.8%      6.6%       4.0%
=================================================================
</TABLE>

CONSOLIDATED OPERATIONS 
1998 COMPARED TO 1997
Net sales increased 19.4% to $365.2 million in 1998 from $305.9 million in 1997.
Acquisitions contributed $21.1 million or 6.8% of the increase while increased
overhaul and freight car work and the sale of switcher locomotives (including
four under a $3.9 million sale/leaseback transaction) in the Locomotive Group
and an increase in international sales in the Components Group contributed to
the increase.

     Cost of sales was $283.9 million in 1998 compared to $233.6 million in
1997. Gross margin decreased to 22.3% in 1998 from 23.6% in 1997. The decrease
was the result of several non-recurring charges to cost of sales in 1998. After
excluding non-recurring items for both years, the Company's gross margin was
26.1% compared to 24.4% in 1997. Non-recurring charges for 1998 included $4.6
million of facility relocation and start-up expenses incurred with the Company's
construction of manufacturing plants for its Touchstone and Motor Coils
subsidiaries and estimated production inefficiencies associated with labor
contract negotiations; a $3 million contract loss provision recorded on a
long-term fleet maintenance contract; and a $2.8 million inventory


                                       8
<PAGE>   10


FORM 10-K
--------------------------------------------------------------------------------

adjustment. These charges were partially offset by a $1.2 million gain related
to the reversal of a 1994 contract contingency which expired in 1998. Also 
excluded from the 1998 gross margin calculation was a $3.9 million 
sale/leaseback transaction.

     Selling, general and administrative expenses increased 8.6% to $41 million
from $37.7 million in 1997. Cost reductions and productivity improvements were
offset by additional costs of acquired companies ($3.9 million).

     Investment income increased to $1.8 million from $761,000 in 1997 for an
increase of 134%. The increase is primarily attributed to increased earnings on
funds invested in the United States and Mexico.

     Interest expense increased 14.2% to $5.9 million in 1998 from $5.2 million
in 1997. The increase is a result of the Company's net debt increasing to $100
million at December 31, 1998, versus $33.6 million at December 31, 1997,
partially offset by lower interest rates in 1998 on borrowings under the
Company's credit facility. The net debt increase was primarily a result of the
acquisition of Young Radiator Company in November 1998 ($67.7 million, net of
cash and marketable securities acquired), which was funded with borrowings under
the Company's credit facility.

     Other income - Argentina represents income recognized related to the
Company's investment in Argentina and was $10.4 million for 1998 versus $2
million in 1997. The increase of $8.4 million is due to the Company selling its
19% Argentine investment in Trenes de Buenos Aires S.A. ("TBA") in 1998, for
cash and a secured note receivable from TBA.

     The Company realized a foreign exchange gain of $2.2 million in 1998 versus
a loss of $230,000 in 1997. Both the gain and the loss are the results primarily
of fluctuations in the value of the Mexican peso, and the Company's net peso
position during the two years.

     A $2 million extraordinary loss on the extinguishment of debt, net of an
income tax benefit of $1.1 million was the result of the Company restructuring
its domestic credit facility in the first quarter of 1998 and the Company paying
off its higher-rate Mexican facility in the fourth quarter of 1998. No such
charges were incurred in 1997.

     The Company recorded income tax expense of $14.6 million in 1998 versus
$11.7 million in 1997. Excluding the foreign exchange remeasurement gain/loss,
which is not taxable, as a percentage of pre-tax income, income tax expense was
31.2% in 1998 compared to 36.4% in 1997. The decrease in income tax expense is
attributed to the Company changing the legal structure of its Mexican
operations. At December 31, 1998, the Company had a consolidated United States 
federal net operating loss carryforward of approximately $25.2 million expiring
in 2010, and MPI de Mexico had a net operating loss carryforward of 
approximately $14.3 million expiring in various amounts through 2005.

1997 COMPARED TO 1996
Net sales increased 5% to $305.9 million in 1997 from $291.4 million in 1996.
Excluding net sales from divested operations of $14 million in 1996, net sales
increased 10.3%. The increase between periods, excluding net sales from divested
operations, was attributed to increased domestic and international net sales in
the Components Group, including $1.2 million of net sales from acquisitions in
the fourth quarter of 1997.

     Cost of sales was $233.6 million in 1997 compared to $234.6 million in
1996. Gross profit margins increased to 23.6% in 1997 from 19.5% in 1996. The
improvement in gross profit was the result of the increased sales volume,
particularly the international portion, a favorable product mix, and continuing
cost reductions and productivity improvements. Included in cost of sales in 1997
was a $2.2 million charge for a warranty provision.

     Selling, general and administrative expenses increased 15.7% to $37.7
million in 1997 from $32.6 million in 1996. The increase is attributed to
variable costs incurred for incentive related programs ($4.1 million) and stock
option and stock appreciation programs ($2.9 million). These cost increases were
partially offset by cost reductions at the operating entities and reductions in
corporate overhead.

     Investment income decreased 61.6% to $761,000 in 1997 from $2 million in
1996. The decrease was primarily attributed to lower investment income on
secured notes receivable from the sale of a portion of the Company's former
Argentina investments and decreased funds in Mexico available for investment.

     Interest expense decreased 43.5% to $5.2 million in 1997 from $9.1 million
in 1996. The decrease was the result of the elimination of interest expense on
debt owed to Morrison Knudsen, a former majority shareholder of the Company,
which was paid off in September 1996; and a reduction in domestic interest
expense as a result of lower borrowing costs, strong operating results and
working capital management. These decreases were partially offset by increased
interest expense at MPI de Mexico as a result of increased borrowings to support
contractual capital improvements and locomotive overhauls.


                                       10
<PAGE>   11

FORM 10-K
--------------------------------------------------------------------------------

     Other income - Argentina increased 28% to $2 million in 1997 from $1.6
million in 1996. For both years, this income represents funds received on the
unsecured portion of the Company's restructured Argentina investments.

     There were no gains on the sale of assets in 1997 compared to $1.5 million
in 1996. In 1996, the Company sold Alert Manufacturing and Supply Co. and Power
Parts Sign Co., recording gains on the sales of $700,000 and $783,000,
respectively.

     In 1997, the Company realized a foreign exchange loss of $230,000 compared
to a foreign exchange gain of $169,000 in 1996. Both the loss and the gain were
the result primarily of fluctuations in the value of the Mexican peso, and the
Company's net peso position during the two years.

     A $1.1 million extraordinary loss on extinguishment of debt in 1996, net of
income tax benefit of $687,000, was the result of the Company's restructuring of
its domestic credit facility.

     The Company recorded income tax expense of $11.7 million in 1997 versus
$7.7 million in 1996. Excluding the foreign exchange remeasurement loss/gain
which is not taxable, as a percentage of pre-tax income, income tax expense was
36.4% in 1997 compared to 38.3% in 1996. The decrease in income tax expense as a
percentage of pre-tax income in 1997 was primarily the result of the formation
and utilization of a Foreign Sales Corporation and a favorable change to a tax
valuation reserve.

COMPONENTS GROUP

<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                    1998         1997        1996
----------------------------------------------------------------
<S>                           <C>          <C>         <C>     
Net sales                      $187,424    $160,960    $144,649
Less divested operations             --          --      (7,054)
----------------------------------------------------------------
Adjusted net sales             $187,424    $160,960    $137,595
================================================================
Change                             16.4%
================================================================
</TABLE>


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                    1998         1997        1996
----------------------------------------------------------------
<S>                           <C>          <C>         <C>     
Operating income               $22,912     $ 25,258    $ 17,812
Less divested operations            --           --        (142)
----------------------------------------------------------------
Adjusted operating income      $22,912     $ 25,258    $ 17,670
================================================================
Change                            (9.3)%
================================================================
</TABLE>

1998 COMPARED TO 1997
In 1998, net sales for the Components Group increased 16.4% from 1997 due
primarily to net sales from acquisitions of $21.1 million. Excluding
acquisitions, net sales increased 4.2% over 1997 due to increased international
sales at the Company's Power Parts subsidiary and increased sales of cooling
systems and turbochargers at the Company's Touchstone and Engine Systems
subsidiaries, respectively.

     Operating income decreased 9.3% in 1998 from 1997. The decrease was caused
by charges incurred in 1998 which the Company believes are non-recurring. These
charges in 1998 included $4.6 million for facility relocation and start-up
expenses incurred with the Company's construction of manufacturing plants for
its Touchstone and Motor Coils subsidiaries and estimated production
inefficiencies due to extended labor contract negotiations at Motor Coils. The
Company incurred a $2.8 million charge for an inventory adjustment at its Motor
Coils subsidiary which the Company attributes to the closing of a plant in the
United States and the opening of two plants in Mexico. The adjustment was
recorded as a result of the Motor Coils annual physical inventory in the fourth
quarter of 1998. Included in the 1997 adjusted operating income was a $2.2
million charge for the estimated warranty replacement of piston liners produced
at the Company's Clark Industries subsidiary. Excluding these items, operating
income would have increased 10.4% in 1998 from 1997, due to acquisitions and
improved operating performance at all component companies with the exception of
Motor Coils.

1997 COMPARED TO 1996
In 1997, adjusted net sales for the Components Group increased 17% due to
increased international and domestic sales at Motor Coils, and increased
domestic sales at Engine Systems and Power Parts. In addition, the acquisition
of Jomar and Microphor in December 1997 added $1.2 million in net sales.
Adjusted operating income increased 42.9% due to higher margin international
sales at Motor Coils, the general increased sales volume, and continued cost
reductions and productivity improvements. Operating income included a $2.2
million charge recorded in the fourth quarter for the estimated warranty
replacement of piston liners produced by the Company's Clark Industries
subsidiary. The charge included the cost of inventory on hand, in addition to
the cost to replace product currently in the hands of customers. The provision
was the result of defective castings provided by an outside supplier.


                                       11
<PAGE>   12


FORM 10-K
--------------------------------------------------------------------------------

LOCOMOTIVE GROUP

<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                    1998          1997       1996
----------------------------------------------------------------
<S>                           <C>           <C>        <C>     
Net sales                     $177,794      $144,970   $146,758
Less divested operations            --            --     (6,931)
----------------------------------------------------------------
Adjusted net sales            $177,794      $144,970   $139,827
================================================================
Change                            22.6%
================================================================
</TABLE>


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                    1998          1997       1996
----------------------------------------------------------------
<S>                           <C>           <C>        <C>     
Operating income               $28,362       $23,530    $16,728
Less divested operations            --            --     (1,487)
----------------------------------------------------------------
Adjusted operating income      $28,362       $23,530    $15,241
----------------------------------------------------------------
Change                            20.5%
================================================================
</TABLE>

1998 COMPARED TO 1997
In 1998, net sales for the Locomotive Group increased 22.6% from 1997 due to
increased overhaul and freight car work in the United States and in Mexico,
additional third party work and the sale of switcher locomotives (including four
under a $3.9 million sale/leaseback transaction).

     Operating income increased 20.5% in 1998 from 1997. The Locomotive Group's
operating margin increase was the result of the higher sales volume, sales mix
and production efficiencies primarily at the Company's MPI de Mexico subsidiary,
partially offset by a charge taken against a fleet maintenance contract. The
Company recognized a $3 million contract loss provision for a 1994 fleet
maintenance contract entered into by the Company's predecessor. In late 1998,
the Company began to realize additional costs to meet certain performance
targets which brought the contract to a loss position. The Company's efforts to
renegotiate this contract in the fourth quarter of 1998 were unsuccessful and as
a result the Company recorded the contract loss provision. The provision
represents the estimated costs to complete the contract through 2001 as compared
to the expected revenue and component company product pull through on the
contract. The Company benefited in 1998 from a $1.2 million gain related to the
reversal of a 1994 contract contingency which expired in 1998. Excluding these
items, adjusted operating income would have increased 28.2% in 1998 from 1997.

1997 COMPARED TO 1996
In 1997, adjusted net sales for the Locomotive Group increased 3.7%. Lower net
sales at Boise Locomotive due to a decrease in sales of new switcher locomotives
were offset by a net sales increase at MPI de Mexico as a result of additional
third party work, and maintenance and overhaul work on additional locomotives
received during the year. Adjusted operating income increased 54.4% principally
as a result of higher margins at MPI de Mexico, and as a result of cost
reductions and a favorable product mix at Boise Locomotive.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The table below highlights the debt and cash position of the Company at December
31.


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                                 1998         1997
----------------------------------------------------------------
<S>                                        <C>           <C>
Domestic revolver                          $ 98,500      $ 5,000
Industrial revenue bonds                      7,298           --
Domestic term loans                              --       17,999
MPI de Mexico credit facility                    --       27,508
----------------------------------------------------------------
Total debt                                 $105,798      $50,507
================================================================
Less cash and cash equivalents                5,660       16,897
================================================================
Net debt                                   $100,138      $33,610
================================================================
</TABLE>

     The Company's net debt increased in 1998 due principally to the acquisition
of Young Radiator Company in November 1998 for $67.7 million, net of cash and
marketable securities acquired.

     During 1998 the Company had capital expenditures of $28.9 million, as
highlighted in the table below.


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                               Actual Expenditures
----------------------------------------------------------------
<S>                                          <C>    
Expansion and modernization of 
  production facilities                                  $16,921
Maintenance                                                6,651
Equipment upgrades                                         3,907
Information systems                                        1,402
----------------------------------------------------------------
  Total                                                  $28,881
================================================================
</TABLE>

     The Company completed construction of new manufacturing plant facilities at
its Touchstone, Motor Coils and Boise Locomotive subsidiaries in 1998, as well
as various expansion projects. The facilities are anticipated to increase
productivity and efficiency. The facilities were completed in the second and
third quarter of 1998 and were producing at expected levels at year end. In
addition to the facility projects, the Company's Components Group accounted for
the majority of the equipment upgrade projects in 1998.

     The Company anticipates that 1999 capital spending will approximate $11
million, consisting primarily of equipment upgrades and maintenance-type items.
The Company plans to limit its capital spending in the first half of 1999 and
closely monitor economic indicators before proceeding forward with projects
which the Company believes can be delayed until the second half


                                       12
<PAGE>   13



FORM 10-K
--------------------------------------------------------------------------------

of 1999 or the year 2000. Funding for 1999 capital spending will be provided
from operations and the Company's domestic revolver.

     In January 1998, the Company closed on two new revolving credit facilities
with ABN AMRO Bank N.V. and Mellon Bank N.A. totaling $200 million. The new
credit lines consist of a $100 million five-year revolving loan, and a 364-day
$100 million revolving loan which the Company may renew annually with the
approval of the lenders. Under the new facilities, the Company may issue up to
$35 million in letters of credit. Proceeds of the new facilities were used to
repay the Company's outstanding balance under its previous domestic loans, fund
acquisitions and capital expenditures, and for general corporate purposes. In
December 1998, the Company repaid amounts owed under its Mexican credit facility
to take advantage of lower domestic interest rates and to make available
restricted cash.

     The Company has completed five strategic acquisitions in the past 14
months. As part of its continuing growth strategy, the Company expects to pursue
additional acquisition candidates in 1999, which could have a material effect on
the utilization and availability of the Company's credit facilities.

     The following table summarizes the net changes in cash flows for the years
ended December 31, 1998, 1997 and 1996:


<TABLE>
<CAPTION>
----------------------------------------------------------------
                                      Year Ended December 31,
----------------------------------------------------------------
(In thousands)                       1998       1997       1996
----------------------------------------------------------------
<S>                             <C>         <C>        <C>     
Net cash provided by (used in)
   Operating activities         $  31,344   $ 35,452   $ 43,368
   Investing activities          (102,324)   (22,472)    12,407
   Financing activities            59,743     (1,319)   (56,235)
----------------------------------------------------------------
Net (decrease) increase
   in cash and cash
   equivalents                  $ (11,237)  $ 11,661   $   (460)
================================================================
Cash and cash equivalents
   at year end                  $   5,660   $ 16,897   $  5,236
================================================================
</TABLE>

     Net cash provided by operations in 1998 was $31.3 million, primarily the
result of the Company's net income of $32.2 million. Offsetting $11.4 million of
non-cash charges for depreciation and amortization, deferred taxes of $10.2
million, a $5.5 million decrease in underbillings - MPI de Mexico, a $3.7
million increase in commitments and contingencies, and a $2 million
extraordinary loss on the extinguishment of debt was a $33.7 million increase in
working capital. The increase in working capital was primarily the result of a
$16.3 million increase in receivables from customers and a $11.5 million
decrease in accrued expenses and other current liabilities. The increase in
receivables is the result of the timing of sales in the Locomotive Group while
the decrease in accrued expenses and other current liabilities is primarily due
to the payment of such items during 1998. The change in underbillings is the
result of the percentage of completion revenue recognition method at MPI de
Mexico. The increase in commitments and contingencies is primarily due to the
loss provision set up for a 1994 fleet maintenance contract entered into by the
Company's predecessor.

     Net cash used in investing activities in 1998 was $102.3 million,
consisting primarily of $67.7 million for the acquisition of Young and $28.9
million in capital expenditures.

     Net cash provided by financing activities in 1998 was $59.7 million,
consisting primarily of an increase in domestic borrowings of $82.8 million,
offset by the early extinguishment of the $27.5 million Mexican credit facility
and the release of $5.2 million of restricted cash related to the Mexican credit
facility. The increase in domestic borrowings was used to fund the Young
acquisition and capital expenditure projects in 1998.

CURRENCY RISK
The Company has significant manufacturing and distribution operations in the
United States, Mexico and Canada. It purchases a portion of its raw materials,
castings and parts from third party foreign suppliers primarily in Poland,
Mexico and Canada. The Company also sells products and services in countries
throughout the world. Many of these foreign commercial activities give rise to
foreign currency exposures. If these exposures are left unhedged, and if there
are fluctuations in the rates of exchange between the U.S. Dollar and the
foreign currencies in which the Company has unhedged exposures, the Company will
experience gains or losses that could have a material impact on earnings.

     The Company manages its foreign exchange exposure by identifying each
subsidiary's foreign currency commitments arising from cash balances,
receivables, payables, and expected purchases and sales. Where offsetting
currency positions cannot be identified through consideration of the Company's
consolidated exposure in each currency, the Company selectively hedges part or
all of its remaining exposure through the use of foreign currency forward
contracts purchased at market rates. The Company does not use foreign currency
forward contracts, or any other


                                       13
<PAGE>   14


FORM 10-K
--------------------------------------------------------------------------------

derivative product, to speculate in the foreign currency market. The Company
will continue to monitor its exposure to foreign currency risks and may adjust
its strategy in the future.

INFORMATION TECHNOLOGY AND YEAR 2000 COMPLIANCE
The Company is currently engaged in a $7.2 million multi-year information
technology upgrade and business improvement project. This project, which
encompasses all of the Company's subsidiaries, includes a thorough review of
manufacturing, material flow and administrative business processes. Where
appropriate, hardware and software upgrades are being applied. To manage the
improved processes and systems moving forward, additional training,
implementation support and hiring of staff are being provided. The Company
expects that the project will improve working capital through improved material
management and production planning and control, in addition to cost reductions
for communications and other related expenses.

     As part of its project, the Company is addressing the Year 2000 compliance
issue. The Company has developed a four-step approach regarding the Year 2000
compliance issue. The steps are to (1) assess; (2) remediate; (3) test and
audit; and (4) develop a contingency plan. The Company is using both internal
and external resources to execute its plan. The assessment phase is completed
with respect to the Company's business systems, and the Company is in the
process of remediation. All mission critical business systems have been upgraded
to software release levels which, per the vendor, are Year 2000 compliant.
Testing of these mission critical systems is currently underway. The focus is
now on remediating non-mission critical systems. The Company expects that the
remediation and testing of all mission critical and non-mission critical systems
will be completed in the second quarter of 1999. The Company is also assessing
its own products, machinery and equipment which are date sensitive to provide
assurances to its customers that its products are Year 2000 compliant. In
addition to the Company's internal activities, the Company is in the process of
contacting key material suppliers, vendors and customers to determine their
readiness with respect to the Year 2000. The Company has developed a compliance
questionnaire, which was circulated to its key material suppliers, vendors and
customers in the third quarter of 1998. The Company has received responses to
31% of the questionnaires sent and is currently following up on non-responding
and unsatisfactory responses. As of December 31, 1998, the Company had not
uncovered any significant problems with respect to the questionnaires returned.

     The Company has estimated that as part of its $7.2 million information
technology upgrade project approximately $900,000 is specifically Year 2000
related. The Company has expended approximately $500,000 in completing the items
noted above as of December 31, 1998. These costs have been and are expected to
continue to be funded out of the Company's operating cash flow. The Company is
expensing as incurred all costs related specifically to Year 2000 activities;
however, costs associated with new systems and the Company's information
technology upgrade are being capitalized in accordance with the Company's
accounting policies. The Company continually reviews its cost estimates for the
Year 2000 project and makes changes as deemed necessary.

     The Company has recently completed three acquisitions: Young Radiator
Company (November 1998); G&G Locotronics, Inc. (January 1999); and Q-Tron
(January 1999). The Company assessed the Year 2000 compliance issue as part of
its due diligence efforts and is currently in the remediation stage. The Company
expects all three subsidiaries to be Year 2000 compliant by August 31, 1999.

     The Company's Year 2000 plan only contemplates its current group of
subsidiaries and does not consider future acquisition candidates. These
acquisitions, if completed, will be evaluated separately from the Company's
current Year 2000 plan. Though the Company expects to be Year 2000 compliant, a
contingency plan is to be finalized by August 31, 1999. The Company is currently
developing this contingency plan. Despite the Company's efforts and contingency
plans, the most reasonably likely worst case scenario of a Year 2000 failure by
the Company or its key suppliers, vendors or customers would likely be a
slowdown of the Company's manufacturing operations at one or more of the
Company's subsidiaries and/or an inability of the Company to process orders and
meet customer delivery schedules.

     The foregoing discussion regarding the Year 2000 involves management's
current assessment and estimates with respect to the Company's Year 2000 efforts
which include inherent risks and uncertainties whereby the actual results could
differ materially from the discussion above. Various factors could cause actual
plans and results to differ materially from those contemplated by such
assessments and estimates and, as such, noncompliant computer systems and/or
noncompliant suppliers, vendors or customers could have a material adverse
effect on the Company's results of operations and financial condition.


                                       14
<PAGE>   15

FORM 10-K
--------------------------------------------------------------------------------

INFLATION AND PRICING
General price inflation in the United States has been moderate during the
three-year period ended December 31, 1998, and its effects have been more than
offset by productivity and efficiency gains. Some of the Company's labor
contracts contain negotiated wage and benefit increases, and others contain
cost-of-living adjustment clauses which would cause the Company's costs to
automatically increase if inflation were to become significant. Because of the
competitive nature of the Company's business and its long-term contract terms
and conditions, it is possible that the Company may be unable to pass on
significant inflationary effects to the Company's customers in the form of
higher prices, and it is unlikely that the Company can increase margins through
price increases. The Company's strategy for reducing the possible adverse
effects of higher inflation is to continue to increase productivity and reduce
manufacturing costs, and to bundle a variety of its goods and services to
customers.

STOCK OWNERSHIP
Stock ownership guidelines for the Company's officers, directors and key
managers were established in March 1997. The guidelines set minimum levels of
stock ownership as a multiple of annual salaries to encourage management
ownership of 10% or more of the Company's stock within five years to demonstrate
an owner/management commitment to increase long-term stockholder value.

ITEM 7A. MARKET RISK
The fair value of a financial instrument represents the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. The fair value of the financial
instruments disclosed herein is not necessarily representative of the amount
that could be realized or settled, nor does the fair value amount consider the
tax consequences of realization or settlement.

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

     The carrying amounts of cash and cash equivalents, trade receivables,
certain other current assets, current portion of long-term debt, and certain
other current liabilities approximate fair value because of the short maturity
of these instruments.

     The carrying amount of the Company's bank borrowings under its revolving
credit agreement approximate fair value because the interest rates are based on
floating rates identified by reference to market rates.

     At December 31, 1998 and 1997 the Company had 30 million MXP and 20 million
MXP of notional value foreign currency forward contracts. Notional amounts do
not quantify risk or represent assets or liabilities of the Company, but are
used in the calculation of cash settlements under the contracts. The estimated
fair value of the foreign currency forward contracts in excess of the contract
value was $240,000 in 1998 and $8,000 in 1997.

INDEPENDENT AUDITORS' REPORT

To the Stockholders and Board of Directors of MotivePower Industries, Inc.:

     We have audited the accompanying consolidated balance sheets of MotivePower
Industries, Inc. and subsidiaries as of December 31, 1998 and 1997 and the
related consolidated statements of income, cash flows and stockholders' equity
for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

     In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of MotivePower Industries, Inc.
and subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.


/s/ Deloitte & Touche LLP
-------------------------
Deloitte & Touche LLP


Pittsburgh, Pennsylvania
February 11, 1999 (March 2, 1999 as to Note 18)


                                       15
<PAGE>   16


FORM 10-K
--------------------------------------------------------------------------------

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 

CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
                                                                       Year Ended December 31,
                                                          ---------------------------------------------
(In thousands except per share data)                           1998              1997             1996
-------------------------------------------------------------------------------------------------------
<S>                                                       <C>               <C>              <C>      
Net sales...............................................  $ 365,218         $ 305,930        $ 291,407

Cost of sales...........................................   (283,896)         (233,588)        (234,560)
                                                          ---------------------------------------------
Gross profit............................................     81,322            72,342           56,847

Selling, general and administrative expenses............    (40,959)          (37,724)         (32,615)
                                                          ---------------------------------------------
Operating income........................................     40,363            34,618           24,232

Investment income.......................................      1,781               761            1,981

Interest expense........................................     (5,894)           (5,163)          (9,143)

Other income - Argentina................................     10,362             2,003            1,565

Gain on sale of assets..................................         --                --            1,483

Foreign exchange gain (loss)............................      2,169              (230)             169
                                                          ---------------------------------------------
Income before income taxes and extraordinary item.......     48,781            31,989           20,287

Income tax expense......................................    (14,554)          (11,713)          (7,714)
                                                          ---------------------------------------------
Income before extraordinary item........................     34,227            20,276           12,573

Extraordinary loss on extinguishment of debt,
   net of income tax benefit of $1,104 and
   $687 in 1998 and 1996, respectively..................     (2,030)               --           (1,064)
                                                          ---------------------------------------------
Net income and comprehensive income.....................  $  32,197         $  20,276        $  11,509
                                                          =============================================
EARNINGS PER COMMON SHARE - BASIC:

   Income before extraordinary item.....................  $    1.92         $    1.15        $     .72

   Extraordinary item...................................       (.11)               --             (.06)
                                                          ---------------------------------------------
   Net income...........................................  $    1.81         $    1.15        $     .66
                                                          =============================================
   Adjusted weighted average common shares outstanding..     17,847            17,694           17,563

EARNINGS PER COMMON SHARE - ASSUMING DILUTION:

   Income before extraordinary item.....................  $    1.84         $    1.11        $     .72

   Extraordinary item...................................       (.11)               --             (.06)
                                                          ---------------------------------------------
   Net income...........................................  $    1.73         $    1.11        $     .66
                                                          =============================================
   Adjusted weighted average common shares outstanding..     18,619            18,209           17,566
</TABLE>

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


                                       16
<PAGE>   17


FORM 10-K
--------------------------------------------------------------------------------

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
                                                                                                        December 31,
                                                                                              ------------------------------
(In thousands except share and per share data)                                                     1998                1997
----------------------------------------------------------------------------------------------------------------------------
<S>                                                                                           <C>                 <C>      
ASSETS
Current Assets:
Cash and cash equivalents ..................................................................  $   5,660           $  16,897
Receivables from customers:
   Billed, net of allowance for doubtful accounts of
     $673 and $394, respectively ...........................................................     54,428              34,588
   Unbilled ................................................................................      2,831                 450
Inventories ................................................................................     92,993              81,448
Deferred income taxes ......................................................................      6,765               7,596
Income tax receivable ......................................................................      5,216                 953
Other ......................................................................................      4,230               3,358
                                                                                              ------------------------------
         Total current assets ..............................................................    172,123             145,290
Locomotive lease fleet, net ................................................................      1,189               1,468
Property, plant and equipment:
   Land ....................................................................................      2,420               1,408
   Buildings and improvements ..............................................................     50,997              36,095
   Machinery and equipment .................................................................     94,143              64,862
                                                                                              ------------------------------
   Property, plant and equipment, cost .....................................................    147,560             102,365
   Less accumulated depreciation ...........................................................    (54,492)            (49,942)
                                                                                              ------------------------------
Property, plant and equipment, net .........................................................     93,068              52,423
Underbillings - MPI de Mexico ..............................................................     26,775              32,298
Deferred income taxes ......................................................................         --               7,724
Goodwill and other intangibles, net ........................................................     63,593              27,362
Other ......................................................................................     14,450              16,537
                                                                                              ------------------------------
         Total assets ......................................................................  $ 371,198           $ 283,102
                                                                                              ==============================

LIABILITIES AND STOCKHOLDERS' EQUITY 
Current Liabilities:
Current portion of long-term debt ..........................................................  $     549           $  10,725
Accounts payable - trade ...................................................................     34,293              30,340
Accrued expenses and other current liabilities .............................................     30,919              36,065
Revolving credit agreement borrowings ......................................................     10,000               5,000
Advances from customers ....................................................................      1,174                 426
                                                                                              ------------------------------
         Total current liabilities .........................................................     76,935              82,556
Long-term debt .............................................................................     95,249              34,782
Commitments and contingencies ..............................................................     19,205              15,552
Deferred income taxes ......................................................................        559                  --
Other ......................................................................................      1,321               5,664
                                                                                              ------------------------------
         Total liabilities .................................................................    193,269             138,554
                                                                                              ------------------------------

Stockholders' Equity:
   Common Stock, par value $.01 per share, authorized 55,000,000 shares;
      17,941,118 shares issued and 17,700,277 shares outstanding at
      December 31, 1998, and 17,774,093 shares issued and outstanding 
      at December 31, 1997 .................................................................        179                 178
   Additional paid-in capital ..............................................................    206,434             205,609
   Deficit .................................................................................    (23,156)            (55,353)
   Accumulated other comprehensive income ..................................................     (5,105)             (5,105)
   Deferred compensation ...................................................................      4,113                (781)
                                                                                              ------------------------------
                                                                                                182,465             144,548
Less -- Treasury stock, at cost (240,841 shares at December 31, 1998) ......................      4,536                  --
                                                                                              ------------------------------
Total stockholders' equity .................................................................    177,929             144,548
                                                                                              ------------------------------
Total liabilities and stockholders' equity .................................................  $ 371,198           $ 283,102
                                                                                              ==============================
</TABLE>

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



                                       17
<PAGE>   18


FORM 10-K
--------------------------------------------------------------------------------

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                       Year Ended December 31,
                                                                                             ---------------------------------------
(In thousands)                                                                                  1998            1997           1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                          <C>            <C>            <C>     
Operating Activities
Net income ............................................................................      $ 32,197       $ 20,276       $ 11,509

Adjustments to reconcile net income to net cash provided by operating
   activities:
   Depreciation .......................................................................         7,981          6,634          6,950
   Amortization .......................................................................         3,426          3,333          3,407
   Extraordinary loss on extinguishment of debt (net of tax) ..........................         2,030             --          1,064
   Gain on sale of assets .............................................................            --             --         (1,483)
   Deferred income taxes ..............................................................        10,218          6,486          5,402
   Other, net .........................................................................            --            261             83
   Changes in operating assets and liabilities net of effects from 1998 purchase
      of Young, 1997 purchases of Jomar and Microphor, and 1996 sale of Alert
      and Sign:
        Receivables from customers ....................................................       (16,258)        (6,048)         5,787
        Inventories ...................................................................        (3,469)           (85)        19,088
        Other current assets ..........................................................          (872)          (578)        (2,919)
        Underbillings - MPI de Mexico .................................................         5,523        (12,737)        (9,233)
        Accounts payable - trade ......................................................         1,931         16,219         (4,162)
        Accrued expenses and other current liabilities ................................       (11,501)         7,081         (2,928)
        Income taxes receivable .......................................................        (4,263)        (2,974)         1,708
        Advances from customers .......................................................           748            426             --
        Commitments and contingencies .................................................         3,653         (2,842)         9,095
                                                                                             ---------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES .............................................        31,344         35,452         43,368
                                                                                             ---------------------------------------

Investing Activities
Payment for purchase of Young, net of cash acquired ...................................       (67,685)            --             --
Additions to property, plant and equipment ............................................       (28,881)       (15,001)        (4,063)
Proceeds from locomotive lease fleet ..................................................            --             --         10,071
Proceeds from sale of assets ..........................................................            --          1,815          4,838
Payment for purchase of Jomar .........................................................            --         (8,158)            --
Payment for purchase of Microphor, net of cash acquired ...............................            --         (3,120)            --
Other, net ............................................................................        (5,758)         1,992          1,561
                                                                                             ---------------------------------------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES ...................................       (102,324)      (22,472)        12,407
                                                                                             ---------------------------------------

Financing Activities
Net borrowings (repayments) under credit agreements ...................................        55,291          9,568        (16,970)
Decrease (increase) in restricted cash ................................................         5,194         (2,550)        (2,043)
Proceeds from exercise of stock options including tax-related benefit .................           826          2,409             --
Increase in intangibles ...............................................................        (1,568)        (2,093)        (1,228)
Repayment of long-term debt ...........................................................            --         (8,653)        (2,461)
Redemption of preferred stock .........................................................            --             --         (1,056)
Change in payable to Morrison Knudsen .................................................            --             --        (32,477)
                                                                                             ---------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ...................................        59,743         (1,319)       (56,235)
                                                                                             ---------------------------------------

Net (decrease) increase in cash and cash equivalents ..................................       (11,237)        11,661           (460)
Cash and cash equivalents at beginning of year ........................................        16,897          5,236          5,696
                                                                                             ---------------------------------------
Cash and cash equivalents at end of year ..............................................      $  5,660       $ 16,897       $  5,236
                                                                                             =======================================
</TABLE>

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


                                       18
<PAGE>   19


FORM 10-K
--------------------------------------------------------------------------------

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Year Ended December 31,
                                                                                  --------------------------------------------------
(In thousands)                                                                         1998                1997                1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>                 <C>                 <C>      
Supplemental Disclosures of Cash Flow Information:

   Interest paid .......................................................          $   4,752           $   3,311           $   1,126

   Income taxes paid (refunded) ........................................              7,963               7,811                (169)

   Young acquisition:

      Fair value of assets acquired ....................................             89,594                  --                  --

      Liabilities assumed ..............................................            (10,188)                 --                  --
                                                                                  --------------------------------------------------

         Cash paid .....................................................             79,406                  --                  --

      Less cash acquired ...............................................             11,721                  --                  --
                                                                                  --------------------------------------------------

         Net cash paid .................................................             67,685                  --                  --

   Jomar acquisition:

      Fair value of assets acquired ....................................                 --               9,351                  --

      Liabilities assumed ..............................................                 --              (1,193)                 --
                                                                                  --------------------------------------------------

         Cash paid .....................................................                 --               8,158                  --
                                                                                  ==================================================

   Microphor acquisition:

      Fair value of assets acquired ....................................                 --               4,935                  --

      Liabilities assumed ..............................................                 --              (1,115)                 --
                                                                                  --------------------------------------------------

         Cash paid .....................................................                 --               3,820                  --

      Less cash acquired ...............................................                 --                 700                  --
                                                                                  --------------------------------------------------

      Net cash paid ....................................................          $      --           $   3,120           $      --
                                                                                  ==================================================

Noncash Investing and Financing Activities:

   Deferred compensation ...............................................          $   4,536           $   1,541           $      78

   Treasury stock ......................................................             (4,536)                 --                  --

   Reduction of payable to Morrison Knudsen:

      Payable to Morrison Knudsen ......................................                 --                  --              18,816

      Additional paid-in capital .......................................                 --                  --             (14,902)

      Deferred income taxes ............................................                 --                  --              (3,914)
====================================================================================================================================
</TABLE>

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



                                       19
<PAGE>   20



FORM 10-K
--------------------------------------------------------------------------------

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                          Accumulated    
                                                            Additional      Retained            Other    
                                                  Common       Paid-In      Earnings    Comprehensive         Deferred     Treasury
(In thousands)                                     Stock       Capital     (Deficit)           Income     Compensation        Stock
------------------------------------------------------------------------------------------------------------------------------------
<S>                                               <C>       <C>            <C>          <C>               <C>              <C>
Balance December 31, 1995 ..................       $ 176      $186,681      $(87,107)        $ (5,105)        $   (118)    $     --
                                                   ---------------------------------------------------------------------------------
Net income .................................          --            --        11,509               --               --           --
Capital contribution, reduction                                                                          
   of payable to Morrison                                                                                
   Knudsen, net of deferred                                                                              
   taxes of $3,914 .........................          --        14,902            --               --               --           --
Accretion of preferred stock ...............          --            --           (31)              --               --           --
Compensatory stock options granted .........          --            78            --               --              (78)          --
Compensation expense .......................          --            --            --               --               73           --
                                                   ---------------------------------------------------------------------------------
Balance December 31, 1996 ..................       $ 176      $201,661      $(75,629)        $ (5,105)        $   (123)    $     --
                                                   ---------------------------------------------------------------------------------
Net income .................................          --            --        20,276               --               --           --
Compensatory stock options granted .........          --         1,541            --               --           (1,541)          --
Compensation expense .......................          --            --            --               --              883           --
Stock options exercised, including 
   tax-related benefit of $215 .............           2         2,407            --               --               --           --
                                                   ---------------------------------------------------------------------------------
Balance December 31, 1997 ..................       $ 178      $205,609      $(55,353)        $ (5,105)        $   (781)    $     --
                                                   ---------------------------------------------------------------------------------
Net income .................................          --            --        32,197               --               --           --
Compensation expense .......................          --            --            --               --              358           --
Treasury stock, at cost ....................          --            --            --               --            4,536       (4,536)
Stock options exercised, including 
   tax-related benefit of $149 .............           1           825            --               --               --           -- 
                                                   ---------------------------------------------------------------------------------
Balance December 31, 1998 ..................       $ 179      $206,434      $(23,156)        $ (5,105)        $  4,113     $ (4,536)
                                                   =================================================================================
</TABLE>

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



                                       20
<PAGE>   21


FORM 10-K
--------------------------------------------------------------------------------

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION, OPERATIONS AND BASIS OF ACCOUNTING
The consolidated financial statements include the accounts of MotivePower
Industries, Inc. and its subsidiaries (collectively, the "Company").

     The Company is a leader in the manufacturing of products for rail and other
power-related industries. Through its subsidiaries, the Company manufactures and
distributes engineered locomotive components and parts; provides locomotive
fleet maintenance; overhauls and remanufactures locomotives and diesel engines;
manufactures environmentally friendly switcher, commuter and mid-range DC and AC
traction, diesel-electric and liquefied natural gas locomotives up to 4,000
horsepower; and manufactures components for power, marine and industrial
markets. The Company's primary customers are freight and passenger railroads,
including every Class I railroad in North America.

SUBSIDIARIES (WHOLLY OWNED):

LOCOMOTIVE GROUP:
Boise Locomotive Company ("Boise Locomotive"), formed in 1972, performs
locomotive remanufacturing, overhauling and manufacturing, and locomotive fleet
maintenance as its principal business.

MPI Noreste S.A. de C.V. ("MPI de Mexico"), a Mexican variable stock corporation
formed in 1994, performs locomotive fleet maintenance and overhauls.

MotivePower Foreign Sales Corporation ("MPFSC"), formed in 1997, is a Barbados
corporation whose purpose is to take advantage of allowable U.S. tax benefits
regarding export sales and expenses.

COMPONENTS GROUP:
Motor Coils Manufacturing Company ("Motor Coils"), acquired in 1991, is a
remanufacturer of locomotive traction motors, and a manufacturer of rotating
electrical components and gearing.

Power Parts Company ("Power Parts"), acquired in 1992, is a supplier of new and
replacement engine and nonengine parts for locomotives, and inventory management
services.

Engine Systems Company, Inc. ("Engine Systems"), acquired in 1992,
remanufactures turbochargers for locomotive, industrial and marine engines.

Touchstone Company ("Touchstone"), acquired in 1994, manufactures,
remanufactures and distributes locomotive radiators, oil coolers, brake
adjusters and other industrial heat exchangers.

Microphor Inc. ("Microphor"), acquired in 1997, is a manufacturer of
self-contained sanitation and waste retention systems, primarily for the rail
and marine industries.

MotivePower Investments Limited ("MPIL"), formed in 1997, is a Delaware holding
company which holds the investment in Touchstone, Motor Coils, Microphor and
Young.

Young Radiator Company ("Young"), acquired in 1998, manufactures radiators, air
coolers, and heat exchange systems for rail and industrial power-related
markets.

JANUARY 1999 ACQUISITIONS:
G&G Locotronics ("G&G") designs and assembles high-voltage electrical cabinets
and control stands for locomotives.

Q-Tron Limited ("Q-Tron") designs and manufactures a complete line of locomotive
electronic equipment, including event recorders, speed controls, excitation
control computers, speedometers and related software products.

AFFILIATES:
On December 18, 1998, MotivePower completed the sale of its 19% investment in
Trenes de Buenos Aires S.A. ("TBA"), a company based in Buenos Aires, Argentina,
which, under a concession contract, operates the Mitre and Sarmiento passenger
railway lines in Buenos Aires.

     On July 6, 1995, the Company sold its interest in Morrison Knudsen of
Australia, Ltd. ("MKA") to Morrison Knudsen, a former majority shareholder of
the Company. In consideration, the Company received a nominal cash payment and
MKA's redeemable preferred stock bearing a 9% cumulative dividend. The Company
sold the preferred stock to Morrison Knudsen in December 1997 for a nominal cash
payment.


                                       21
<PAGE>   22



FORM 10-K
--------------------------------------------------------------------------------

     On October 25, 1996, the Company sold substantially all of the assets of
the Company's Power Parts Sign Co. ("Sign") for $1.3 million plus the assumption
of certain trade payables. In addition, on July 26, 1996, the Company sold
substantially all of the assets of the Company's Alert Manufacturing and Supply
Co. ("Alert") for $3.9 million plus the assumption of trade payables of
$750,000. The Company recorded gains of $783,000 and $700,000 on the sale of the
assets of Sign and Alert, respectively.

2. SIGNIFICANT ACCOUNTING POLICIES 
PRINCIPLES OF CONSOLIDATION: 
The consolidated financial statements include the accounts of the Company and
its subsidiaries. Sales between the Company and its subsidiaries are billed at
prices consistent with sales to third parties and are eliminated in
consolidation. Investments in affiliates in which the Company's ownership is
less than 20% are accounted for using the cost method.

REVENUE RECOGNITION: The Company recognizes revenues on locomotive
remanufacturing and manufacturing contracts on the percentage of
completion-units delivered method, and on component part sales when product is
shipped to the customer. Contract revenues and cost estimates are reviewed and
revised quarterly and adjustments are reflected in the accounting period when
known. Provisions are made currently for estimated losses on uncompleted
contracts. Unbilled accounts receivable represent shipments for which invoices
have not been processed.

     Revenue recognized on the MPI de Mexico long-term maintenance contract is
based upon a percentage of the expected gross margin. Under the terms of the
maintenance contract, significant costs are incurred in the early years
(locomotive overhauls and fleet normalization), while payments from the
customers remain relatively constant throughout the life of the contract. By
using a percentage of the expected gross margin to recognize revenue under the
maintenance contract appropriate consideration is given to the risks associated
with the contract. Costs and estimated earnings in excess of billings
("Underbillings") and billings in excess of costs and estimated earnings
("Overbillings") on the contract in progress are recorded on the balance sheet
and are classified as current or non-current based upon the expected timing of
their realization or liquidation.

     Remanufactured and overhauled locomotives are warranted for a period from
one to three years, and component parts are warranted for a period from one to
four years. Additionally, the Company provides an overhaul reserve on owned
locomotives. Estimated costs for product warranty are recognized at the time the
products are sold. Overhaul reserves are recorded on a straight-line basis over
the period of time from acquisition of the locomotive to the estimated date of
the related overhaul. Warranty and overhaul reserves are included in accrued
expenses and other current liabilities in the consolidated balance sheet.

USE OF ESTIMATES: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities 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. On an ongoing basis, management reviews its estimates based on
currently available information. Changes in facts and circumstances may result
in revised estimates.

CASH EQUIVALENTS: Cash equivalents consist of investments in highly liquid debt
securities having an original maturity of three months or less. Such securities
are considered to be held to maturity.

INVENTORIES: Inventories are stated at the lower of cost or market. Locomotive
inventories under long-term contracts consist of actual direct material, labor
and manufacturing overhead and are allocated to individual units based on the
estimated average production costs of units to be produced under a contract.
Locomotive inventories under contract were $3.6 million and $8.7 million at
December 31, 1998 and 1997, respectively. Component part inventories are valued
at production cost using either the last-in first-out ("LIFO") method or the
first-in, first-out ("FIFO") method.

MARKET, CONCENTRATIONS AND CREDIT RISKS: Financial instruments which potentially
subject the Company to concentrations of credit risk consist of cash equivalents
and accounts receivable. The Company, by its policy, limits the amount of credit
exposure to any one financial institution and places its investments with
financial institutions that the Company believes are financially sound.


                                       22
<PAGE>   23



FORM 10-K
--------------------------------------------------------------------------------

     The Company provides its products and services to the Class I railroads in
North America, metropolitan transit and commuter rail authorities, Amtrak,
original equipment manufacturers, short lines and other customers
internationally. Collectively, the Company's top five customers accounted for
51%, 66% and 63% of net sales in the years ended December 1998, 1997 and 1996,
respectively. Net sales to three customers exceeded 10% of total net sales
(Burlington Northern Santa Fe - 18%; Union Pacific - 10%; Transportacion
Ferroviaria Mexicana ("TFM") - 10%). The Company performs ongoing credit
evaluations of its customers' accounts and historically has not incurred any
significant credit-related losses.

     The Company's Boise Locomotive, Motor Coils and MPI de Mexico subsidiaries
have union labor contracts expiring at various times through June 2002. The
Company considers the renegotiation of these contracts under terms and
conditions consistent with market conditions for similar U.S. based labor forces
to be an important factor in the maintenance of operations.

FOREIGN EXCHANGE FORWARD CONTRACTS: Foreign exchange forward contracts are legal
agreements between two parties to purchase and sell a foreign currency for a
price specified at the contract date, with delivery and settlement in the
future. The Company uses such contracts to hedge the risk of changes in foreign
currency exchange rates associated with certain assets and obligations
denominated primarily in the Mexican peso ("MXP"). Changes in the market value
of the forward contracts are recognized in income when the effects of related
changes in the price of the hedged item are recognized.

LOCOMOTIVE LEASE FLEET: Equipment on operating leases includes the Company's
locomotive lease fleet. The locomotives are depreciated on a straight-line basis
over their estimated useful lives of five to 15 years. Cost and accumulated
depreciation at December 31, 1998 were $2.4 million and $1.3 million,
respectively. Cost and accumulated depreciation at December 31, 1997 were $2.9
million and $1.4 million, respectively.

PROPERTY, PLANT AND EQUIPMENT: Buildings and improvements and machinery and
equipment are recorded at cost and depreciated on the straight-line method over
periods from three to 30 years. The cost and accumulated depreciation associated
with property and equipment that is disposed of are removed from the accounts,
and gains or losses from such disposals are included in income. Leasehold
improvements are capitalized and amortized on the straight-line method over the
terms of the related leases. Included in buildings and improvements is the
Company's Mountaintop facility, which is an asset held for sale. The book value
of this Locomotive Group asset was $1.9 million at December 31, 1998 and 1997.
Expenditures for repairs and maintenance are charged to expense as incurred.

GOODWILL AND OTHER INTANGIBLES: Significant components of goodwill and other
intangibles are the following:

     Goodwill -- Cost in excess of tangible assets of businesses acquired in
     purchase transactions is amortized on the straight-line method over 15 to
     40 years from the date of acquisition. The unamortized cost of goodwill was
     $59.7 million at December 31, 1998 and $20.2 million at December 31, 1997.

     Covenants Not To Compete -- These agreements are recorded at cost and
     amortized on the straight-line method over the terms of the agreements.
     Terms of the agreements range from three to 10 years. The unamortized cost
     was $3.3 million at December 31, 1998 and $4.2 million at December 31,
     1997.

     Loan Origination Fees -- These fees are associated with the origination of
     the Company's debt. The fees are recorded at cost and amortized on the
     straight-line method over the terms of the respective loan agreements. The
     unamortized cost was $575,000 at December 31, 1998 and $2.9 million at
     December 31, 1997.

     Accumulated amortization at December 31, 1998 and 1997 was $14.5 million
and $12 million, respectively. The Company evaluates the realization of
intangible assets on a quarterly basis and adjusts, if necessary, the carrying
value or useful life accordingly.



                                       23
<PAGE>   24


FORM 10-K
--------------------------------------------------------------------------------

FOREIGN CURRENCY TRANSLATION: Assets and liabilities of foreign subsidiaries are
translated at the rate of exchange in effect on the balance sheet date while
income and expenses are translated at the average rates of exchange prevailing
during the year. Foreign currency gains and losses resulting from transactions,
and the translation of financial statements are recorded in the Company's
consolidated financial statements based upon the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation."
The accumulated other comprehensive income included in the consolidated balance
sheets consists of cumulative translation adjustments net of tax.

     MPI de Mexico has contracts that provide for escalation adjustments based
upon, among other things, changes in the exchange rate. Such escalation
adjustments are included in revenues when realized.

INCOME TAXES: The provision for income taxes includes Federal, state and local,
and foreign income taxes currently payable and those deferred or prepaid because
of temporary differences between the financial statement and tax bases of assets
and liabilities. The carrying amounts of deferred tax assets and liabilities are
determined based on differences between the financial statement amounts and the
tax bases of assets and liabilities using the enacted tax rates in effect in the
years in which the differences are expected to reverse.

DEFERRED COMPENSATION ARRANGEMENTS: In May 1998, a consensus on Emerging Issues
Task Force Issue No. 97-14, "Accounting for Deferred Compensation Arrangements
Where Amounts Earned Are Held in a Rabbi Trust and Invested" ("EITF 97-14"), was
issued. The Company has reflected the adoption of EITF 97-14 in the December 31,
1998 financial statements. The adoption of EITF 97-14 required the Company to
record as treasury stock the historical value of the Company's stock maintained
in its deferred compensation plans.

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: In June 1998, SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activity", was issued. SFAS
133 is effective for financial statements for all fiscal quarters of fiscal
years beginning after June 15, 1999. The Company has not yet determined the
effect of this standard on its financial statements.

RECLASSIFICATIONS: Certain reclassifications have been made to the 1997 and 1996
consolidated financial statements to conform to the current year presentation.

3. INVENTORIES

Inventories consist of the following:

<TABLE>
<CAPTION>
----------------------------------------------------------------
                                               December 31,
                                        ------------------------
(In thousands)                             1998            1997
----------------------------------------------------------------
<S>                                     <C>             <C>    
Cores                                   $11,854         $ 7,477
Raw materials                            46,646          35,421
Work in process                          14,411          21,396
Finished goods                           20,082          17,154
----------------------------------------------------------------
Total inventories                       $92,993         $81,448
================================================================
</TABLE>

     Approximately $38.3 million and $30.7 million of total inventories at
December 31, 1998 and 1997, respectively, were valued on the LIFO cost method,
and the excess of current replacement cost of these inventories over the stated
LIFO value was $1.9 million and $1.2 million at December 31, 1998 and December
31, 1997, respectively. Costs for other inventories have been determined
principally by the FIFO method. The Company defines cores as inventory units
designated for unit exchange programs.

4. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of the following:


<TABLE>
<CAPTION>
----------------------------------------------------------------
                                               December 31,
                                        ------------------------
(In thousands)                             1998            1997
----------------------------------------------------------------
<S>                                     <C>             <C>    
Accrued payroll and benefits            $10,906         $13,125
Warranty and overhaul accruals           10,328           8,622
Reserve for future losses                   954           1,760
Other accrued liabilities                 8,731          12,558
----------------------------------------------------------------
   Total accrued expenses                           
      and other current liabilities     $30,919         $36,065
================================================================
</TABLE>

5. UNDERBILLINGS - MPI DE MEXICO

MPI de Mexico has a long-term contract to provide maintenance and other
locomotive services. Details relative to cumulative costs incurred and revenues
recognized are as follows:


<TABLE>
<CAPTION>
----------------------------------------------------------------
                                               December 31,
                                        ------------------------
(In thousands)                             1998            1997
----------------------------------------------------------------
<S>                                     <C>            <C>    
Costs incurred                          $ 198,921      $ 148,433
Estimated earnings                         39,686         17,633
----------------------------------------------------------------
                                          238,607        166,066
Less billings to date                    (211,832)      (133,768)
----------------------------------------------------------------
Total underbillings                     $  26,775      $  32,298
================================================================
</TABLE>


                                       24

<PAGE>   25


FORM 10-K
--------------------------------------------------------------------------------

6. INDEBTEDNESS 
REVOLVING CREDIT BORROWINGS

<TABLE>
<CAPTION>
----------------------------------------------------------------
                                               December 31,
                                        ------------------------
(In thousands)                             1998            1997
----------------------------------------------------------------
<S>                                     <C>            <C>    

Variable rate $100,000 revolving 
   364-day credit facility, 
   effective interest rate 6.95% as 
   of December 31, 1998                 $10,000        $      --

Domestic revolver under Second
   Amended and Restated Credit
   Agreement, effective
   interest rate 6.47% as of
   December 31, 1997                         --            5,000
                                        ------------------------
Total revolving credit borrowings       $10,000        $   5,000
                                        ========================
</TABLE>


LONG-TERM DEBT

<TABLE>
<CAPTION>
----------------------------------------------------------------
                                               December 31,
                                        ------------------------
(In thousands)                             1998            1997
----------------------------------------------------------------
<S>                                     <C>             <C>    

Variable rate $100,000
   revolving credit facility,
   expires 2002, effective
   interest rate 6.19% as of
   December 31, 1998                    $88,500         $     --

5.5% Industrial revenue bonds due 2008    7,298               --

MPI de Mexico credit facility,
   due 2000, effective
   interest rate 8.8% as of
   December 31, 1997                         --           27,508


Domestic term loan under
   Second Amended and Restated
   Credit Agreement, effective
   interest rate 6.47% as of
   December 31, 1997                         --           17,999
                                        ------------------------
                                         95,798           45,507
Less current portion of long-term debt     (549)         (10,725)
                                        ------------------------
Total long-term debt                    $95,249         $ 34,782
                                        ========================
</TABLE>


SCHEDULED MATURITIES OF LONG-TERM DEBT

<TABLE>
<CAPTION>
----------------------------------------------------------------
                                   Year of Maturity
----------------------------------------------------------------
(In thousands)           1999    2000    2001       2002    2003
----------------------------------------------------------------
<S>                      <C>     <C>     <C>     <C>        <C>
Long-term debt           $549    $580    $613    $89,147    $683
                         =======================================
</TABLE>

     In August 1995, the Company and its subsidiaries entered into a $75 million
loan agreement with BankAmerica Business Credit ("BABC"). In 1996, the Company
repaid amounts owed certain participating lenders who were no longer lenders
under the loan agreement, as modified, and paid early termination fees to those
lenders. The early termination fees and the unamortized portion of previously
incurred deferred debt issuance costs were expensed as an extraordinary item of
$1.1 million, net of tax.

     In February 1997, the Company and a syndicate of lenders led by Bank of
America NT and SA entered into a Second Amended and Restated Credit Agreement to
replace the Company's loan agreement with BABC. In May 1997, the Company entered
into Amendment No. 1 to the Second Amended and Restated Credit Agreement. The
amendment increased the limit on the issuance of performance bonds from $10
million to $30 million, increased the limit on the issuance of letters of credit
in support of performance bonds from $2.5 million to $10 million and increased
the limit on the aggregate amount of letters of credit from $15 million to $20
million.

     In January 1998, the Company closed two new revolving credit facilities
("the facilities") with ABN AMRO Bank, N.V. and Mellon Bank N.A. totaling $200
million. ABN AMRO and Mellon Bank subsequently sold participations in these
facilities to a syndicate of 10 additional banks. The facilities consist of a
$100 million five-year revolving loan and a 364-day $100 million revolving loan
which the Company may renew annually with the approval of the lenders. Under the
new facilities, the Company may issue up to $35 million in letters of credit.
The Company has issued $5.7 million in letters of credit as of December 31,
1998. In connection with the establishment of the two new revolving credit
facilities, the Company incurred a one-time, non-cash charge of approximately
$472,000, net of tax in the first quarter of 1998 to write off the unamortized
portion of previously incurred deferred debt issuance costs under the Company's
Second Amended and Restated Credit Agreement.


                                       25
<PAGE>   26


FORM 10-K
--------------------------------------------------------------------------------

     The facilities provide for revolving borrowings at a variable margin over
the London Interbank Offered Rate ("LIBOR"), or at Prime Rate, at the Company's
option. The margin over LIBOR at which the Company may borrow is adjusted each
fiscal quarter based on the ratio obtained when the Company's debt at the end of
the quarter is divided by the Company's cash flow over the past four quarters,
as measured by earnings before interest and tax, plus depreciation and
amortization ("EBITDA"). The Company's maximum borrowings under the facilities
are limited to the lesser of $200 million or 3.5 times trailing 12-month EBITDA.
At December 31, 1998, the Company's gross availability under its revolving
credit facilities was $200 million. After deducting outstanding debt and other
reserves, the Company calculates its net available borrowing capacity on
December 31, 1998 to be $88.5 million.

     The Company had a U.S. dollar-denominated credit facility with a Mexican
bank, Bancomer S.A., to support its operations in Mexico. The facility was a $30
million, five-year term loan with support from the Export-Import Bank of the
United States. The facility required certain cash balances to be held in trust.
Amounts held in trust at the balance sheet date are classified as restricted
cash and have been included in other non-current assets in the accompanying
consolidated balance sheets at December 31, 1998 and 1997. In December 1998, the
Company repaid amounts owed on the term loan. The early termination fees and the
unamortized portion of previously incurred deferred debt issuance costs were
expensed as an extraordinary item of $1,558,000, net of tax in the 1998 fourth
quarter.

7. REDEEMABLE PREFERRED STOCK
In September 1995, the Company deposited 10,000 shares of Preferred Stock into a
joint settlement account in connection with the settlement of certain class
action suits. On December 6, 1996, the Company exercised its option to redeem
all of the outstanding shares of Preferred Stock at a price of $1.1 million
including accrued dividends.

8. STOCK OPTION PLANS
The Company has established two stock option plans, which are described below.
The Company applies Accounting Principles Board Opinion Number 25 and related
Interpretations in accounting for its plans.

     The compensation cost that has been charged against income was $495,000,
$2.7 million and $775,000 for 1998, 1997 and 1996, respectively. Had
compensation cost for the Company's plans been determined based on the fair
value at the grant dates for awards under those plans consistent with the method
of SFAS No. 123 "Accounting for Stock-Based Compensation," the Company's net
income and earnings per share would have been reduced to the pro forma amounts
indicated below:


<TABLE>
<CAPTION>
----------------------------------------------------------------
                                              December 31,
(In thousands except                 ---------------------------
earnings per share data)                1998      1997      1996
----------------------------------------------------------------
<S>                                  <C>       <C>       <C>
                                   
Net income           As reported     $32,197   $20,276   $11,509
                     Pro forma       $30,926   $19,444   $11,104
----------------------------------------------------------------
Earnings per diluted share         
                     As reported     $  1.73   $  1.11   $   .66
                     Pro forma       $  1.66   $  1.07   $   .63
================================================================
</TABLE>

     The following weighted-average assumptions were used to estimate the fair
value of each option grant on the grant date using the Black-Scholes
option-pricing model in 1998, 1997 and 1996, respectively: dividend yield of
zero percent for all years; expected volatility of 63%, 65% and 72%; risk free
interest rates of 5.3%, 6.26% and 6.5%; and expected lives of six years, 10
years and 10 years.

     In the MotivePower Industries, Inc. Stock Incentive Plan (the "Incentive
Plan"), a maximum of 2.5 million shares may be issued upon the exercise of stock
options granted or through limited stock appreciation rights. Officers and other
key employees of the Company or its subsidiaries are eligible to receive awards.
The exercise price, term and other conditions applicable to each award are
determined by the Compensation Committee of the Board of Directors at the time
of the grant of each award and may vary with each award granted. Awards are
generally made at not less than current market prices at date of grant, and have
been granted to executives and directors under the Incentive Plan in the form of
stock options. Options granted generally vest either over a five-year period,
20% on each anniversary date following the grant, or a four-year period, 25% on
each anniversary date following the grant. All unexercised options expire 10
years from the date of grant, subject to acceleration in certain cases.


                                       26
<PAGE>   27



FORM 10-K
--------------------------------------------------------------------------------

     Restricted stock awards for a total of 125,000 shares of the Company's
Common Stock have been granted to certain key management employees. The weighted
average grant date fair value of restricted stock was $5.36 per share. Sale
restrictions on the restricted stock lapse between January 1, 1997 and January
1, 2007. The Company recorded expense of $156,000, $193,000 and $155,000 for
1998, 1997 and 1996, respectively, related to the restricted stock.

     In the MotivePower Industries, Inc. Stock Option Plan for Non-Employee
Directors (the "Non-Employee Directors Plan"), a maximum of 150,000 shares may
be granted. Under the Non-Employee Directors Plan, each non-employee director
was entitled to receive options to purchase shares of the Company's common stock
upon their election to the Board at an exercise price equal to 50% of the market
price of the common stock based on the date awarded. In 1998, the Board resolved
that it would cease the practice of discounting the initial options by 50%. In
addition to the initial grant date, each director is awarded an annual stock
option award on January 2, at an exercise price equal to the fair market value
of such common stock as of the date of the grant. All options granted vest over
a three-year period, one-third on each anniversary date.

     A summary of the status of the Company's two stock option plans as of
December 31, 1998, 1997 and 1996, and the changes during the years ending on
those dates, is presented below:


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
                                               1998                        1997                              1996
                                      -------------------------   -------------------------        -------------------------
                                                       Weighted                    Weighted                         Weighted
                                                        Average                     Average                          Average
                                         Shares  Exercise Price      Shares  Exercise Price           Shares  Exercise Price
----------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>        <C>              <C>        <C>                   <C>        <C>   
Outstanding at beginning of year      1,985,950          $ 7.94   1,740,500          $ 7.08        1,271,000          $ 5.26
Granted                                 281,200           24.62     548,000           12.87        1,261,500            4.96
Exercised                              (109,225)           8.24    (211,300)           9.93               --              --
Surrendered/Canceled                    (85,000)          14.95     (91,250)           8.56         (792,000)          10.59
----------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year            2,072,925            9.97   1,985,950            7.94        1,740,500            7.08
============================================================================================================================
Options exercisable at year end         978,471                     773,825                          457,396
Weighted average fair value of
   options granted during the year                       $18.96                      $10.18                            $3.98
</TABLE>

   The following table summarizes information about stock options outstanding at
December 31, 1998:


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
                                           Options Outstanding                                     Options Exercisable
                               --------------------------------------------------       ------------------------------------
                                            Weighted Average
Range of                            Number         Remaining     Weighted Average               Number     Weighted Average
Exercise Price                 Outstanding  Contractual Life       Exercise Price          Exercisable       Exercise Price
----------------------------------------------------------------------------------------------------------------------------
<S>                            <C>         <C>                   <C>                       <C>             <C>
$ 4.75  to $16.00                  238,000               5.5               $14.35              238,000               $14.35
$ 3.81  to $10.72                  373,750               6.7                 9.68              360,000                 9.74
$ 2.84  to $ 7.75                  772,975               7.3                 5.47              288,725                 5.41
$ 7.94  to $25.16                  427,500               8.1                12.99               91,746                13.09
$22.47  to $29.32                  260,700               9.2                24.79                   --                   --
----------------------------------------------------------------------------------------------------------------------------
                                 2,072,925                                                     978,471
============================================================================================================================
</TABLE>



                                       27
<PAGE>   28


FORM 10-K
--------------------------------------------------------------------------------

9. TAXES ON INCOME
The Company and its domestic subsidiaries file a consolidated Federal income tax
return and certain combined or separate state income tax returns. MPI de Mexico
and certain other subsidiaries file an income tax return in Mexico.

   The components of income tax (expense) benefit are as follows:


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)               1998           1997           1996
----------------------------------------------------------------
<S>                      <C>            <C>             <C>     
U.S. Federal:
   Current               $ (3,242)      $ (3,862)       $(1,687)
   Deferred                (7,275)        (1,166)        (4,235)
----------------------------------------------------------------
                          (10,517)        (5,028)        (5,922)
----------------------------------------------------------------
State and local:
   Current                   (532)        (1,365)          (625)
   Deferred                   105           (384)           345
----------------------------------------------------------------
                             (427)        (1,749)          (280)
----------------------------------------------------------------
Foreign:
   Current                   (562)            --             --
   Deferred                (3,048)        (4,936)        (1,512)
----------------------------------------------------------------
Income tax expense       $(14,554)      $(11,713)       $(7,714)
================================================================
</TABLE>

     Income before income taxes and extraordinary item for the Company's foreign
and domestic operations were as follows:


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)               1998           1997           1996
----------------------------------------------------------------
<S>                      <C>            <C>             <C>     
Domestic                 $ 31,284       $ 21,084        $14,116
Foreign                    17,497         10,905          6,171
----------------------------------------------------------------
   Total                 $ 48,781       $ 31,989        $20,287
================================================================
</TABLE>

   The provision for income taxes differs from tax calculated by applying the
U.S. Federal statutory income tax rate to income before income taxes due to the
following:


<TABLE>
<CAPTION>
----------------------------------------------------------------
                             1998           1997           1996
----------------------------------------------------------------
<S>                              <C>          <C>         <C>     
U.S. Federal statutory tax rate  35.0%        35.0%       35.0%
State income tax effect,
   net of Federal benefit         0.6          3.6         4.2
Differences between U.S.
   Federal statutory and
   foreign tax rates             (5.9)         5.7          --
Valuation allowance                --         (6.4)       (8.7)
Other, net                        0.1         (1.3)        7.5
----------------------------------------------------------------
   Total                         29.8%        36.6%       38.0%
================================================================
</TABLE>

     Deferred income taxes result from temporary differences in the financial
bases and tax bases of assets and liabilities. The types of differences that
give rise to significant portions of deferred income tax assets and liabilities
at December 31, 1998 and 1997 are as follows:


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                                1998         1997
----------------------------------------------------------------
<S>                                       <C>          <C>     
Deferred tax assets:
   Accrued expenses and reserves          $  9,690     $ 11,078
   Inventory reserves, capitalized costs        53        1,046
   Plant and equipment, intangibles          3,318        3,912
   Employee benefit/
      compensation accruals                  2,427        2,952
   Allowance for doubtful accounts             157          164
   Net operating loss carryforwards         15,258       22,395
   Other                                       137           --
----------------------------------------------------------------
Deferred tax assets                         31,040       41,547
   Valuation allowance                     (17,204)     (17,204)
----------------------------------------------------------------
   Net deferred tax asset                   13,836       24,343

Deferred tax liabilities:
   Underbillings                            (6,802)      (7,978)
   Prepaid insurance                          (828)      (1,045)
----------------------------------------------------------------
      Total deferred tax liabilities        (7,630)      (9,023)
----------------------------------------------------------------
Deferred income taxes, net                $  6,206     $ 15,320
================================================================
</TABLE>

     The Company's effective tax rate for the year was reduced to 29.8%,
primarily due to the Company changing the legal structure of its Mexican
operations.

     A valuation allowance is provided when it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The Company has
established a valuation allowance for certain net operating loss carryforwards
and for losses anticipated to produce no tax benefit. Although realization of
the net deferred tax asset is not assured, management believes that it is more
likely than not that the net deferred tax asset will be realized.

     The Company's net operating loss carryforward for the year ended December
31, 1998 is $39.5 million. The net operating losses expire in various amounts,
as follows:


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)              U.S.          Mexico          Total
----------------------------------------------------------------
<S>                     <C>              <C>            <C>     
                                     
2004                     $    --         $ 9,807        $ 9,807
2005                          --           4,515          4,515
2010                      25,222              --         25,222
----------------------------------------------------------------
   Total                 $25,222         $14,322        $39,544
================================================================
</TABLE>


                                       28
<PAGE>   29



FORM 10-K
--------------------------------------------------------------------------------

10. BENEFIT PLANS
Retirement: In May 1994, the Company established a defined contribution, 401(k)
savings plan. In January 1996, the Company suspended Company contributions to
the 401(k) savings plan. On July 1, 1997 the Company reinstated those
contributions equal to 2% of an eligible employee's gross wages in the form of
Company stock. In addition, beginning January 1, 1998 the Company matches 50% of
an eligible employee's contributions into the 401(k) savings plan to a maximum
total of 3% per an eligible employee's gross wages. The Company match is in the
form of Company stock. The Company's contributions were $1.3 million, $357,000
and $71,000 for 1998, 1997 and 1996, respectively.

     The Company participates in multiemployer pension, and health and welfare
plans. The plans are defined contribution plans and provide benefits for craft
employees covered under collective bargaining agreements at Boise Locomotive and
Motor Coils. Costs under the plans amounted to $3.8 million, $3.1 million and
$2.1 million for 1998, 1997 and 1996, respectively. The Company adopted two
long-term incentive plans for selected employees in 1994. The plans provide
deferred compensation based upon total shareholder return or return on total
capital. No compensation expense was recognized in connection with these plans
in 1998, 1997 or 1996.

YOUNG RETIREMENT BENEFITS:
In connection with the acquisition of Young, the Company assumed liability for
Young's defined benefit pension plan (the "Young Plan"), covering substantially
all of the employees of Young. The benefits under the Young Plan are based on
years of service. The Company intends to suspend future benefits accruing under
the Young plan as of April 1, 1999, and to terminate the Young plan in
accordance with the provisions of the Internal Revenue Code as of June 1, 1999.
This treatment of the Young plan was contemplated when accounting for the
acquisition of Young under Accounting Principles Board Opinion No. 16, "Business
Combinations."

     The Company recognized net periodic pension (income) cost for 1998 as
follows:


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                                             1998
----------------------------------------------------------------
<S>                                                       <C>  
Service cost for 1998                                     $  47
Interest cost on projected benefit obligation               128
Expected return on Young Plan assets                       (251)
----------------------------------------------------------------
   Net periodic pension income                            $ (76)
================================================================
</TABLE>

     The following table sets forth the Young Plan's funded status and amounts
recognized at November 18, 1998 (date of acquisition), which approximates the
funded status at December 31, 1998, based upon actuarial data and the market
value of Young Plan assets (primarily fixed income mutual funds):


<TABLE>
<CAPTION>
----------------------------------------------------------------
(In thousands)                                             1998
----------------------------------------------------------------
<S>                                                    <C>      
Projected benefit obligation for service
   rendered to date                                    $(22,769)
Plan assets at fair value                                25,393
----------------------------------------------------------------
Young Plan assets in excess of projected
   benefit obligation                                  $  2,624
================================================================
</TABLE>

     The actuarial assumptions used to determine net periodic pension income and
the projected benefit obligation at December 31, 1998 were:


<TABLE>
<CAPTION>
----------------------------------------------------------------
                                                           1998
----------------------------------------------------------------
<S>                                                        <C>  
Discount rate                                              4.75%
Expected long-term rate of return                          8.50%
</TABLE>

     The discount rate reflects the rate expected to be received in connection
with annuities to be purchased at the termination of the Young Plan.

POSTRETIREMENT HEALTHCARE BENEFITS FOR FORMER EMPLOYEES:
Effective December 31, 1998, the Company transferred its current and future
liabilities associated with its employee postretirement health care plan to
Morrison Knudsen for cash consideration of $1.5 million. The resulting
settlement gain was immaterial to the 1998 statement of income. At December 31,
1997 the Company had a postretirement healthcare obligation of $1.4 million.


                                       29
<PAGE>   30



FORM 10-K
--------------------------------------------------------------------------------

11. RELATED PARTY TRANSACTIONS
The Company leases certain facilities from entities controlled by former
directors and officers of the Company. Lease payments, including utilities, to
these entities totaled $836,000, $999,000 and $1.1 million for the years ended
December 31, 1998, 1997 and 1996, respectively.

     The Company incurred $505,000, $829,000 and $1.9 million of legal fees and
expenses from a firm in which a former officer of the Company is a shareholder,
for the years ended December 31, 1998, 1997 and 1996, respectively.

     In September 1996, the Company repurchased for $34.6 million all of the
debt of the Company owed to Morrison Knudsen. The amount of the debt outstanding
as of the date of repurchase, including accrued interest, was $56.6 million. The
effect of this transaction was an increase to additional paid-in capital of
$14.9 million, a decrease in the net deferred tax asset of $3.9 million and a
reduction in amounts due to Morrison Knudsen of $56.6 million.

12. COMMITMENTS AND CONTINGENCIES 
The Company has commitments and performance guarantees arising from locomotive
remanufacturing contracts and maintenance agreements, and warranties from the
sale of new locomotives, remanufactured locomotives and locomotive components.

ENVIRONMENTAL: The Company is subject to Federal, state, local and foreign
environmental laws and regulations concerning the discharge, storage, handling
and disposal of hazardous or toxic substances and petroleum products. Examples
of regulated activities are the disposal of lubricating oil, the discharge of
water used to clean parts and to cool machines, the maintenance of underground
storage tanks and the release of particulate emissions produced by Company
operations. The Company has a Chief Compliance Officer who audits the Company
policies and reports directly to the Audit Committee of the Board of Directors.

BOISE, IDAHO
The Company is subject to a RCRA Part B Closure Permit ("the Permit") issued by
the Environmental Protection Agency and the Idaho Department of Health and
Welfare, Division of Environmental Quality relating to the monitoring and
treatment of groundwater contamination on, and adjacent to, the Company's Boise
Locomotive facility. In compliance with the Permit, the Company has drilled
wells onsite to retrieve and treat contaminated groundwater, and onsite and
offsite to monitor the amount of hazardous constituents. The Company has
estimated the expected aggregate undiscounted costs to be incurred over the next
23 years, adjusted for inflation at 3% per annum, to be $4 million, based on the
Permit's Corrective Action Plan, and $3.7 million for contingent additional
Permit compliance requirements related to offsite groundwater contamination. The
discounted liability at December 31, 1998, using a discount rate of 5.25%, was
$2.2 million based on the Permit's Corrective Action Plan, and $2 million for
contingent additional Permit compliance requirements related to offsite
groundwater contamination. The estimated outlays for each of the five succeeding
years from 1999 to 2003 are: $245,000, $290,000, $260,000, $268,000 and
$276,000. The Company was in compliance with the Permit at December 31, 1998.

MEXICO
Through its MPI de Mexico subsidiary, the Company has operational responsibility
for facilities in Acambaro and San Luis Potosi, Mexico, pursuant to a contract
with TFM. Under the contract, MPI de Mexico is responsible for performing
certain work related to environmental protection at the facilities, such as
waste water treatment, storm water control, tank repair, and spill prevention
and control. The costs of this work are either to be directly reimbursed to MPI
de Mexico by TFM or recoverable through fees payable under the contract, which
has been structured to account for such cost. No assurance can be given,
however, that TFM will not dispute any submissions for reimbursement or that the
fee structure under the contract will, in fact, cover MPI de Mexico's costs.

MOUNTAINTOP, PENNSYLVANIA
The Comprehensive Environmental Response, Compensation and Liability Act (also
known as "CERCLA" or "Superfund") is a federal law regarding abandoned hazardous
waste sites which imposes joint and several liability, without regard to fault
or the legality of the original act, on certain classes of persons, including
those who contribute to the release of a "hazardous substance" into the
environment. Foster Wheeler Energy Corporation ("FWEC") is named as a
potentially responsible party with respect to the Company's Mountaintop,
Pennsylvania plant, which has been listed by the EPA in its database of
potential hazardous waste sites. FWEC, the seller of the Mountaintop property to
the Company's predecessor in 1989, agreed to indemnify the Company's predecessor
against any liabilities associated with this Superfund site. Management believes
that this indemnification arrangement is enforceable for the benefit of the
Company and, although such obligation is unsecured


                                       30
<PAGE>   31


FORM 10-K
--------------------------------------------------------------------------------

and therefore structurally subordinate to secured indebtedness of FWEC, that
FWEC has the financial resources to honor its obligations under this
indemnification arrangement. This indemnification does not alter the Company's
potential liability to third parties (other than FWEC) or governmental agencies
under CERCLA but creates contractual obligations on the part of FWEC for such
liabilities.

MATTOON, ILLINOIS
Young had received a notice from the current owners of a plant previously owned
and operated by Young indicating that Young is the responsible party for
contamination at the plant site. The current owner seeks to recover the
estimated costs of cleaning up the alleged contamination. To resolve this
matter, the Company has entered into a formal agreement with the current owners
to assume full responsibility for environmental restoration of this property.
Although management has not fully completed its investigation of this matter, it
believes this matter could ultimately have an unfavorable impact on the
Company's financial position. The Company has accrued $1 million for this matter
as management's best estimate of the ultimate financial restoration costs. This
accrual was based on management's expectation that the property will be included
in the state of Illinois Site Remediation Program as a commercial/industrial
property. While the estimated accrued costs are considered adequate by
management, actual results could differ materially from this estimate.

LEASES: The Company leases office and manufacturing facilities under operating
leases with terms ranging from one to 14 years, excluding renewal options.

     The Company has also financed its locomotive lease fleet with operating
leases arising from sale and leaseback transactions. The Company has sold
remanufactured locomotives to various financial institutions and leased them
back under operating leases with terms from five to 20 years.

     Total net rental expense (income) charged (or credited) to operations in
1998, 1997 and 1996 was $2.4 million, $2.8 million and $(799,000), respectively.
Certain of the Company's equipment rental obligations under operating leases
pertain to locomotives, which are subleased to customers under both short-term
and long-term agreements. The above amounts are shown net of sublease rentals of
$7.6 million, $7.2 million and $8.7 million for the years 1998, 1997 and 1996,
respectively. Future minimum rental payments under operating leases with
remaining noncancelable terms in excess of one year are as follows:


<TABLE>
<CAPTION>
----------------------------------------------------------------
(in thousands)        Real                 Sublease
Year                Estate    Equipment     Rentals       Total
----------------------------------------------------------------
<S>                 <C>       <C>           <C>         <C>    
1999                $1,703      $ 6,862     $(2,901)    $ 5,664
2000                 1,636        5,756      (2,901)      4,491
2001                 1,561        4,849      (2,599)      3,811
2002                 1,570        4,807      (2,190)      4,187
2003                 1,452        4,791      (2,190)      4,053
2004 and after       3,704       26,522      (9,399)     20,827
</TABLE>                    

LEGAL PROCEEDINGS:
The Company is engaged in a commercial dispute with a former supplier, Samyoung
Machinery Industrial Co. and Samyoung (America), Inc. (collectively,
"Samyoung"). The Company filed suit on April 16, 1996 alleging delivery of
defective product and seeking damages in excess of $1 million. Samyoung denies
that the product was defective and countersued to recover $300,000 under the
contract, and $10 million for trade libel and interference with prospective
economic relationships as a result of the Company allegedly making false
disparaging statements concerning the diesel engine cylinder liners to potential
Samyoung customers. The Company believes that Samyoung's claims are without
merit, and, to date, no evidence supporting Samyoung's counterclaims has come to
light through the discovery being conducted by the parties. The Company intends
to vigorously prosecute its own claims and defend against Samyoung's
counterclaims. The Company has tendered the counterclaims to its liability
insurers, which have been provided a partial defense subject to a reservation of
rights.

     The Company is involved in legal proceedings incident to the normal conduct
of its business, including contract claims and employee matters. Although the
outcome of any pending legal proceeding cannot be predicted with certainty,
management believes that such legal proceedings are adequately provided for in
the consolidated financial statements and that the proceedings, individually and
in the aggregate, will not have a material adverse effect on the consolidated
operations or financial condition of the Company.


                                       31
<PAGE>   32


FORM 10-K
--------------------------------------------------------------------------------

13. SEGMENT INFORMATION
The Company has two reportable segments: Locomotive and Components. The
reportable segments are comprised of strategic business units which offer
different products and services. The Locomotive Group provides fleet
maintenance, overhauling and remanufacturing, and manufacturing of
environmentally friendly switcher, commuter and mid-range, DC and AC traction,
diesel-electric and liquefied natural gas locomotives up to 4,000 horsepower.
The Components Group manufactures and distributes primarily aftermarket, or
replacement, new and remanufactured components and parts for freight and
passenger railroads, including every Class I railroad in North America,
metropolitan transit and commuter rail authorities, original equipment
manufacturers, industrial power-related markets and other customers
internationally.

     The Company evaluates segment performance based primarily on operating
income, excluding unusual items. The Company accounts for intersegment sales and
transfers as if the sales or transfers were to third parties at current market
prices. The accounting policies of the segments are the same as those described
in the summary of significant policies.

     Following is condensed segment financial information for the years ending
December 31.


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
                                                                                        1998
                                                                 -------------------------------------------------
(In thousands)                                                   Locomotive         Components             Total
------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>                <C>                  <C>
Gross sales                                                        $186,859           $213,763           $400,622
Intercompany sales                                                    9,065             26,339             35,404
Interest expense                                                      2,643                188              2,831
Depreciation and amortization                                         3,885              7,056             10,941
Operating income                                                     28,362             22,912             51,274

Segment assets                                                      134,369            229,726            364,095

Capital expenditures                                                  9,045             19,498             28,543
==================================================================================================================
</TABLE>


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
                                                                                        1997
                                                                 -------------------------------------------------
(In thousands)                                                   Locomotive         Components              Total
------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>                 <C>                <C>
Gross sales                                                        $153,572           $179,338           $332,910
Intercompany sales                                                    8,602             18,378             26,980
Interest expense                                                      3,298                 37              3,335
Depreciation and amortization                                         3,117              6,259              9,376
Operating income                                                     23,530             25,258             48,788

Segment assets                                                      131,925            131,892            263,817

Capital expenditures                                                  7,107              7,828             14,935
==================================================================================================================
</TABLE>


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
                                                                                        1996
                                                                 -------------------------------------------------
(In thousands)                                                   Locomotive         Components              Total
------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>                <C>                <C>
Gross sales                                                        $156,320           $162,544           $318,864
Intercompany sales                                                    9,562             17,895             27,457
Interest expense                                                      1,779                141              1,920
Depreciation and amortization                                         3,141              6,449              9,590
Operating income                                                     16,728             17,812             34,540

Segment assets                                                       95,882            116,145            212,027

Capital expenditures                                                  2,748              1,425              4,173
==================================================================================================================
</TABLE>



                                       32
<PAGE>   33


FORM 10-K
--------------------------------------------------------------------------------

   The following reconciles segment information presented above to the
consolidated financial statements for the years ending December 31.


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
(In thousands)                                              1998               1997               1996
----------------------------------------------------------------------------------------------------------
<S>                                                     <C>                <C>                <C>     
Net sales:
   Gross sales from segments                            $400,622           $332,910           $318,864
   Intercompany sales elimination                        (35,404)           (26,980)           (27,457)
----------------------------------------------------------------------------------------------------------
      Net sales                                         $365,218           $305,930           $291,407
==========================================================================================================

Income before income taxes and extraordinary item:
   Operating income from segments                       $ 51,274           $ 48,788           $ 34,540
   Unallocated corporate expenses and elimination
      of intercompany profit                              (8,911)           (14,170)           (10,308)
   Allocated corporate expenses                           (2,000)                --                 --
   Investment income                                       1,781                761              1,981
   Interest expense                                       (5,894)            (5,163)            (9,143)
   Other income - Argentina                               10,362              2,003              1,565
   Gain on sale of assets                                     --                 --              1,483
   Foreign exchange gain (loss)                            2,169               (230)               169
----------------------------------------------------------------------------------------------------------
   Income before income taxes and extraordinary item    $ 48,781           $ 31,989           $ 20,287
==========================================================================================================

Assets:
   Assets from segments                                 $364,095           $263,817           $212,027
   Corporate assets                                        7,103             19,285             22,017
----------------------------------------------------------------------------------------------------------
      Total assets                                      $371,198           $283,102           $234,044
==========================================================================================================
</TABLE>


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
                                                                            1998
                                                  --------------------------------------------------------
(In thousands)                                    Total Segments          Corporate    Consolidated Totals
----------------------------------------------------------------------------------------------------------
<S>                                                   <C>                <C>                <C>       
Other significant items:
   Interest expense                                     $  2,831           $  3,063               $  5,894
   Depreciation and amortization                          10,941                466                 11,407
   Capital expenditures                                   28,543                338                 28,881
==========================================================================================================
</TABLE>


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
                                                                            1997
                                                  --------------------------------------------------------
(In thousands)                                    Total Segments          Corporate    Consolidated Totals
----------------------------------------------------------------------------------------------------------
<S>                                                   <C>                <C>                <C>       
Other significant items:
   Interest expense                                     $  3,335           $  1,828               $  5,163
   Depreciation and amortization                           9,376                591                  9,967
   Capital expenditures                                   14,935                 66                 15,001
==========================================================================================================
</TABLE>


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
                                                                            1996
                                                  --------------------------------------------------------
(In thousands)                                    Total Segments          Corporate    Consolidated Totals
----------------------------------------------------------------------------------------------------------
<S>                                                   <C>                <C>                <C>       
Other significant items:
   Interest expense                                     $  1,920           $  7,223               $  9,143
   Depreciation and amortization                           9,590                767                 10,357
   Capital expenditures                                    4,173               (110)                 4,063
==========================================================================================================
</TABLE>


                                       33
<PAGE>   34


FORM 10-K
--------------------------------------------------------------------------------

GEOGRAPHIC INFORMATION:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
                                            1998                       1997                     1996       
                                   --------------------      ---------------------    ---------------------
                                             Long-Lived                 Long-Lived               Long-Lived
(In thousands)                     Net Sales     Assets      Net Sales      Assets    Net Sales      Assets
-----------------------------------------------------------------------------------------------------------
<S>                                 <C>        <C>            <C>        <C>           <C>        <C>      
United States                       $245,787   $145,296       $195,173   $  81,258     $225,908   $  80,264
Mexico                                85,579     53,779         80,773      56,554       50,877      36,611
Other                                 33,852         --         29,984          --       14,622          --
-----------------------------------------------------------------------------------------------------------
   Total                            $365,218   $199,075       $305,930    $137,812     $291,407    $116,875
===========================================================================================================
</TABLE>

14. FINANCIAL INSTRUMENTS
The fair value of a financial instrument represents the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. The fair value of the financial
instruments disclosed herein is not necessarily representative of the amount
that could be realized or settled, nor does the fair value amount consider the
tax consequences of realization or settlement.

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

Cash and cash equivalents, trade receivables, certain other current assets,
current portion of long-term debt, and certain other current liabilities
The carrying amounts approximate fair value because of the short maturity of
these instruments.

Long-term debt
The carrying amount of the Company's bank borrowings under its revolving credit
agreement approximate fair value because the interest rates are based on
floating rates identified by reference to market rates.

Foreign currency contracts
At December 31, 1998 and 1997 the Company had 30 million MXP and 20 million MXP
of notional value foreign currency forward contracts. Notional amounts do not
quantify risk or represent assets or liabilities of the Company, but are used in
the calculation of cash settlements under the contracts. The estimated fair
value of the foreign currency forward contracts in excess of the contract value
was $240,000 in 1998 and $8,000 in 1997.

15. ACQUISITIONS
On November 18, 1998, the Company acquired 100% of the common stock of Young, a
manufacturer of radiators, air coolers and heat exchange systems for rail and
industrial power-related markets, through MPIL, a subsidiary of the Company, for
$67.7 million, net of cash and marketable securities acquired. The acquisition
has been accounted for by the purchase method of accounting, and accordingly,
the results of operations of Young have been included in the Company's
consolidated financial statements from the date of acquisition. The $41 million
excess of the purchase price over the fair value of the net identifiable assets
acquired has been recorded as goodwill and is being amortized on a straight-line
basis over 40 years.

   Pro-forma results assuming Young was included in the Company's Statements 
of Income for the 12 months ended December 31, 1998 and 1997, respectively 
are included below by significant line items:


<TABLE>
<CAPTION>
------------------------------------------------------------
                                              December 31,
(Unaudited)                            ---------------------
(In thousands except per share data)       1998         1997
------------------------------------------------------------
<S>                                    <C>          <C>
Net sales                              $409,006     $354,099
Income before income taxes
   and extraordinary items               37,919       32,368
Net income                               32,884       20,518
Earnings per share - assuming dilution $   1.77     $   1.13
============================================================
</TABLE>


                                       34
<PAGE>   35


FORM 10-K
--------------------------------------------------------------------------------

16. EARNINGS PER SHARE
The following table reflects the earnings per share calculations for the years
ended December 31, 1998, 1997 and 1996. Antidilutive securities for the years
ended December 31, 1998, 1997 and 1996 were 82,000, 50,000 and 1,632,000 shares,
respectively.


<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------
                                                                               Year Ended December 31,
                                                                       ---------------------------------------
(In thousands, except per share data)                                     1998           1997          1996
--------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>            <C>           <C>
Earnings per common share - basic:
  Net income                                                           $32,197        $20,276       $11,509
  Weighted average common shares outstanding                            17,822         17,669        17,563
  Contingently issuable shares                                              25             25            --
==============================================================================================================
Adjusted weighted average common shares outstanding                     17,847         17,694        17,563
Earnings per common share - basic                                        $1.81          $1.15          $.66
Earnings per common share - assuming dilution:
   Net income                                                          $32,197        $20,276       $11,509
   Adjusted weighted average common shares outstanding                  17,847         17,694        17,563
   Effect of dilutive securities
   Stock options and restricted stock                                      772            515             3
==============================================================================================================
   Adjusted weighted average common shares outstanding                  18,619         18,209        17,566
Earnings per common share-- assuming dilution                          $  1.73        $  1.11       $   .66
==============================================================================================================
</TABLE>

17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following information summarizes the Company's quarterly financial results.


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
                                                                           Quarter
                                              --------------------------------------------------------------------
(In thousands, except per share data)          First        Second          Third         Fourth         Total
------------------------------------------------------------------------------------------------------------------
1998
<S>                                             <C>          <C>          <C>           <C>           <C>
Net sales                                       $82,853      $88,461      $87,406       $106,498      $365,218
Gross profit                                     21,356       21,336       19,082         19,548        81,322
Income before extraordinary item                  7,120        7,870        7,712         11,525        34,227
Net income                                        6,648        7,870        7,712          9,967        32,197
Earnings per common share before
   extraordinary item-- basic                       .40          .44          .43            .65          1.92
Earnings per common share before
   extraordinary item-- assuming dilution           .38          .42          .41            .62          1.84
Earnings per common share-- basic                   .37          .44          .43            .55          1.81
Earnings per common
   share-- assuming dilution                        .36          .42          .41            .53          1.73

------------------------------------------------------------------------------------------------------------------
                                                  First       Second        Third         Fourth         Total
------------------------------------------------------------------------------------------------------------------
1997
Net sales                                       $69,658      $73,813      $73,849      $  88,610      $305,930
Gross profit                                     15,825       19,315       17,499         19,703        72,342
Net income                                        3,477        5,409        5,377          6,013        20,276
Earnings per common share-- basic                   .20          .31          .30            .34          1.15
Earnings per common
   share-- assuming dilution                        .20          .30          .29            .32          1.11
==================================================================================================================
</TABLE>



                                       35
<PAGE>   36


FORM 10-K
--------------------------------------------------------------------------------

18. SUBSEQUENT EVENTS
On January 11, 1999, the Company acquired certain assets of G&G Locotronics,
Inc. (Itasca, Illinois), a privately held designer and manufacturer of
high-voltage electrical cabinets and control stands for locomotives, for total
consideration of $17.8 million. G&G Locotronics, Inc. had sales of approximately
$22 million for its fiscal year ended December 31, 1998.

   On January 14, 1999, the Company acquired 100% of the common shares of Q-Tron
Ltd., (Calgary, Canada), a privately held designer and manufacturer of
locomotive electronics equipment, for total consideration of $14.9 million.
Q-Tron Ltd., had sales of approximately $10 million for its fiscal year ended
December 31, 1998.

   Pro forma results of operations have not been presented for 1998 as the
effects of these acquisitions are not significant to the Company's consolidated
financial statements.

   On February 16, 1999, the Company's Board of Directors approved a
three-for-two common stock split in the form of a 50 percent stock dividend
effective April 2, 1999. Shareholders of record as of March 17, 1999 will
receive one additional share of stock for each two shares they own. The
pro-forma effects to the shares issued and outstanding as of December 31, 1998
would be to increase the shares to 26,550,000. The pro-forma effect to the
weighted average basic shares would be to increase the number of basic shares to
26,771,000 which would have resulted in basic earnings per share of $1.20 as of
December 31, 1998. The pro-forma effect to the weighted average diluted shares
outstanding would be to increase the number of diluted shares to 27,929,000
which would have resulted in diluted earnings per share of $1.15 as of December
31, 1998.

   On March 2, 1999, MotivePower amended and restated the terms of its revolving
credit facilities with a syndicate of 12 lenders led by ABN AMRO Bank as agent.
The amendment increases the amount of the credit line from $200 million to $350
million, available as a five-year $175 million revolving credit facility, and a
364-day $175 million revolving credit facility, which the Company may renew
annually with the approval of the lenders. Under the amended facilities,
interest rates paid on borrowed money and the total amount of credit available
to the Company are determined as they were under the facilities prior to
amendment. The Company continues to have the option to borrow at a spread over
LIBOR rates, or to borrow at prime rate.

PART III

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE 
None.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers of the Company is set
forth under the captions "Election of Directors" and "Information Concerning
Executive Officers" in the Company's proxy statement related to the 1999 annual
meeting of stockholders (the "Proxy Statement") and is incorporated herein by
reference.

ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is set forth under the caption "Compensation"
in the Proxy Statement and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is set forth under the caption "Security
Ownership" in the Proxy Statement and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.



                                       36
<PAGE>   37

FORM 10-K
--------------------------------------------------------------------------------

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, REPORTS ON FORM 8-K (a)
Documents filed as a part of this Report:

     (1) and (2) Reference is made to the separate index to the Company's 
         Consolidated Financial Statements and Financial Statement Schedules as
         set forth on page 39 hereof.

     (2) The following Exhibits are included as a part of this Annual Report on
         Form 10-K or are incorporated herein by reference:

EXHIBIT NO.  DOCUMENT DESCRIPTION
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S>       <C>
3.01       Form of Amended and Restated Certificate Of Incorporation of the Company

3.02(9)    Form of Amended and Restated By-Laws of the Company as of December 26, 1996 

3.03(4)    Designation of Rights and Preferences of Class A Preferred Stock

3.04(4)    Designation of Rights and Preferences of Class B Preferred Stock 

3.05(5)    Certificate of Designations of Series C Junior Participating Preferred Stock

3.06(7)    Certificate of Designations of Class B Preferred Stock

3.07(9)    Certificate of Ownership and Merger of MotivePower Industries, Inc. Into 
           MK Rail Corporation dated December 26, 1996 

4.01(5)    Rights Agreement, dated as of January 19, 1996, between the Company and 
           Chemical Mellon Shareholder Services, L.L.C. 

4.02(5)    Form of Rights Certificate 

4.04(8)    Second Amendment to Rights Agreement dated as of June 20, 1996 between 
           the Company and Chase Mellon Shareholder Services, L.L.C.

10.16(1)   MotivePower Industries, Inc. Stock Incentive Plan

10.31(2)   MotivePower Industries, Inc. Deferred Compensation Plan

10.44(6)   Employment Agreement between Company and John C. Pope dated as of December 29, 1995

10.60(9)   Form of Employment Agreement and Exhibits thereto, dated July 1, 1996 between 
           MotivePower Industries, Inc. and Michael A. Wolf

10.63(10)  Amended Employment Agreement between the Company and John C. Pope dated as of December 9, 1997

10.64(10)  Amended Employment Agreement between the Company and Michael A. Wolf dated as of February 9, 1998

21.01(11)  Subsidiaries of the Company

23.01(11)  Consent of Independent Auditor

27.01(11)  Article 5 Financial Data Schedule for the year ended December 31, 1998

99.01(1)   MotivePower Industries, Inc. Executive Incentive Plan

99.02(1)   MotivePower Industries, Inc. Stock Option Plan for Non-Employee Directors

99.03(1)   MotivePower Industries, Inc. Long-Term Performance Compensation Benefit Plan

99.04(3)   MotivePower Industries, Inc. Long Term Incentive Plan
--------------------------------------------------------------------------------
</TABLE>

(1)  Incorporated by reference from Amendment No. 1 to the Company's
     Registration Statement on Form S-1 filed with the Commission on March 29,
     1994.

(2)  Incorporated by reference from the Company's Quarterly Report on Form 10-Q
     for the quarter ended September 30, 1994.

(3)  Incorporated by reference from the Company's Annual Report on Form 10-K for
     the year ended December 31, 1994.

(4)  Incorporated by reference from the Company's Report on Form 8-K filed with
     the Commission on September 18, 1995.

(5)  Incorporated by reference from the Company's Report on Form 8-K filed with
     the Commission on January 31, 1996.

(6)  Incorporated by reference from the Company's Annual Report on Form 10-K for
     the year ended December 31, 1995.

(7)  Incorporated by reference from the Company's Current Report on Form 8-K
     filed with the Commission on April 18, 1995.

(8)  Incorporated by reference from the Company's Amendment No. 2 on 
     Form 8K/A filed with the Commission on July 3, 1996.

(9)  Incorporated by reference from the Company's Annual Report on Form 10-K 
     for the year ended December 31, 1996.

(10) Incorporated by reference from the Company's Annual Report on Form 10-K 
     for the year ended December 31, 1997.

(11) Filed herewith.


                                       37
<PAGE>   38


FORM 10-K
--------------------------------------------------------------------------------

(b) REPORTS ON FORM 8-K
On December 3, 1998, the Company filed a Current Report on Form 8-K announcing
that MotivePower Industries, Inc. had purchased 100% of the common stock of
Young Radiator Company.

On February 1, 1999, the Company filed an Amended Current Report on Form 8-K/A,
amending the Current Report filed on December 3, 1998. The Amended Report
provides financial statements of Young Radiator Company and pro forma financial
information.


                                       38
<PAGE>   39
                          MOTIVEPOWER INDUSTRIES, INC.

  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE


The following documents are filed as part of this report:


<TABLE>
<CAPTION>
                                                                                  Page(s) in 
                                                                                 Annual Report*
                                                                                 --------------


<S>                                                                                    <C>
(1)  Consolidated Financial Statements:

     Consolidated Statements of Income for each of the years in the three 
     year period ended December 31, 1998                                                36

     Consolidated Balance Sheets at December 31, 1998 and 1997                          37

     Consolidated Statements of Cash Flows for each of the years in the three 
     year period ended December 31, 1998                                               38-39 

     Consolidated Statements of Changes in Stockholders Equity for each of the 
     years in the three year period ended December 31, 1998                             40

     Notes to Consolidated Financial Statements                                        41-56

     Independent Auditors' Report                                                       35


     * Incorporated by reference from the indicated pages of the MotivePower 
       Industries, Inc 1998 Annual Report to Shareholders                               


(2)  Financial Statement Schedule:

     Independent Auditor's Report on Financial Statement Schedule for each of    
     the years in the three year period ended December 31, 1998                         40

     Schedule II -- Valuation & Qualifying Accounts.                                    41  
</TABLE>


All other schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.


                                       39
<PAGE>   40



INDEPENDENT AUDITORS' REPORT

To the Stockholders and Board of Directors of MotivePower Industries, Inc.:

We have audited the consolidated financial statements of MotivePower Industries,
Inc. and subsidiaries as of December 31, 1998 and 1997, and for each of the
three years in the period ended December 31, 1998, and have issued our report
thereon dated February 11, 1999 (March 2, 1999 as to Note 18); such report is
included elsewhere in this Form 10-K. Our audits also included the consolidated
financial statement schedule of MotivePower Industries, Inc., listed in Item 14.
This consolidated financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express a opinion based on our
audits. In our opinion, such consolidated financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.


/s/ DELOITTE & TOUCHE LLP

DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
February 11, 1999 (March 2, 1999 as to Note 18)


                                       40
<PAGE>   41



                                                                     Schedule II



                          MOTIVEPOWER INDUSTRIES, INC.
                       VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                   Additions-
                                      Balance at     Additions-    Charged to
                                       beginning     Charged to      other                       Balance at   
                                          of          costs and     accounts                       end of
                                        period         expenses    - describe     Deductions       period
                                        ------         --------    ----------     ----------       ------

YEAR ENDED DECEMBER 31, 1998
----------------------------

<S>                                     <C>            <C>            <C>         <C>              <C>
Loss reserves                           $11,853        $  554         $ --        $ (2,296)        $10,111

Warranty and overhaul reserves            8,622         7,718           --          (6,012)         10,328

Inventory reserves                        2,162         1,472           --            (859)          2,775

Allowance for doubtful accounts             394           378           --             (99)            673

Valuation allowance-taxes                17,204            --           --              --          17,204

Environmental reserves                    4,256         1,545           --             (76)          5,725


YEAR ENDED DECEMBER 31, 1997
----------------------------

Loss reserves                           $12,121        $1,027         $ --        $ (1,295)        $11,853

Warranty and overhaul reserves            7,053         4,188           --          (2,619)          8,622

Inventory reserves                        3,546         1,771           --          (3,155)          2,162

Allowance for doubtful accounts             284           374           --            (264)            394

Valuation allowance-taxes                19,278            --           --          (2,074)         17,204

Environmental reserves                    4,078           178           --              --           4,256


YEAR ENDED DECEMBER 31, 1996
----------------------------

Loss reserves                           $15,176        $2,841         $ --        $ (5,896)        $12,121

Warranty and overhaul reserves            4,402         5,450           --          (2,799)          7,053

Inventory reserves                       13,028         4,072           --         (13,554)          3,546

Allowance for doubtful accounts             531            97           --            (344)            284

Valuation allowance-taxes                22,375            --           --          (3,097)         19,278

Environmental reserves                    4,060            18           --              --           4,078
</TABLE>


                                       41
<PAGE>   42
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.

<TABLE>
<CAPTION>
Signature                                  Title                                        Date
----------------------------------------------------------------------------------------------------------
<S>                                       <C>                                          <C>
/s/ John C. Pope                           Non-Executive Chairman and                   March 8, 1999
-----------------------------              Director
John C. Pope

/s/ Michael A. Wolf                        President and Chief Executive                March 8, 1999
-----------------------------              Officer and Director
Michael A. Wolf                            (Principal Executive Officer)

/s/ William F. Fabrizio                    Senior Vice President                        March 8, 1999
-----------------------------              and Chief Financial Officer
William F. Fabrizio                        (Principal Financial Officer)
                                                                          

/s/ David L. Bonvenuto                     Vice President, Controller and               March 8, 1999
-----------------------------              Principal Accounting Officer
David L. Bonvenuto                         

/s/ Gilbert E. Carmichael                  Vice Chairman and Director                   March 8, 1999
-----------------------------
Gilbert E. Carmichael

/s/ Ernesto Fernandez Hurtado              Director                                     March 8, 1999
-----------------------------
Ernesto Fernandez Hurtado

/s/ Lee B. Foster II                       Director                                     March 8, 1999
-----------------------------
Lee B. Foster II

/s/ James P. Miscoll                       Director                                     March 8, 1999
-----------------------------
James P. Miscoll

/s/ Nicholas J. Stanley                    Director                                     March 8, 1999
-----------------------------
Nicholas J. Stanley
</TABLE>


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