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, 1996, 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.
                          ----------------------------
                     (formerly known as MK Rail Corporation)
             (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)

1200 Reedsdale Street, Pittsburgh, PA                                 15233
-------------------------------------                                 -----
(Address of principal executive offices)                              (Zip code)

Registrant's telephone number, including area code:  (412) 237-2250

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 March 10 1997: $193,190,700

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 March 10, 1997
              -----                         -----------------------------
Common stock, $.01 par value                          17,562,793

Documents  Incorporated  by  Reference:  Certain  sections  or  portions  of the
registrant's  proxy  statement for the annual meeting of stockholders to be held
on June 24, 1997,  described in Part III hereof are incorporated by reference in
this report.



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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
predecessors.

Item 1.           BUSINESS

The Company
         MotivePower,  formerly MK Rail  Corporation,  is a leading  supplier of
products and services to the railroad industry.  The Company was formed in April
1993 by Morrison Knudsen Corporation  ("Morrison Knudsen"),  which later sold 35
percent of the  Company's  common stock in an initial  public stock  offering in
April 1994. In October 1996,  Morrison Knudsen  distributed all of its remaining
ownership  stake in the  Company  to  Morrison  Knudsen's  creditors  as part of
Morrison  Knudsen's  bankruptcy  settlement.  The Company  and its  subsidiaries
design,  manufacture and distribute  engineered locomotive components and parts;
provide  locomotive  fleet  maintenance,   remanufacturing  and  overhauls;  and
manufacture  environmentally  friendly  switcher,  commuter  and  mid-range,  DC
traction,  diesel-electric  and liquefied  natural gas  locomotives  up to 4,000
horsepower.  The Company provides products and services to freight and passenger
railroads,  including every Class I Railroad in North America, commuter rail and
transit  authorities,  original  equipment  manufacturers  and  other  customers
internationally.

Forward-looking Statements
         Statements  in this Form 10-K as to efforts  to  increase  or  maximize
stockholder  value  or  otherwise  improve   operations,   are   forward-looking
statements.  Factors  such  as a  decrease  in  rail  traffic,  a  reduction  in
railroads'  capital  and  maintenance   spending  plans  with  regard  to  their
locomotive fleets, industry consolidations, a decrease in railroads' outsourcing
trends,  increased  competition  in  the  locomotive  or  locomotive  components
segments,  adverse general economic  conditions,  changes in laws or regulations
affecting the industry, technological developments that render existing industry
technology  obsolete or the Company's inability to retain existing contracts and
or obtain  new  contract  awards are among the  factors  which  could  cause the
Company to be unable to meet its objectives.

Business Strategy
         MotivePower's  business  strategy is to grow and continue to strengthen
its core businesses.  The Company considers the following to be core businesses:
manufacturing  and  distributing  engineered  locomotive  components  and parts;
providing  locomotive  fleet  maintenance and  overhauling  and  remanufacturing
locomotives;  and manufacturing  environmentally friendly switcher, commuter and
mid-range, DC traction, diesel-electric and liquefied natural gas locomotives up
to 4,000 horsepower. To the extent market conditions, technological developments
or other  factors  change,  management  will  reconsider  its  strategy  to best
position the Company under the conditions and circumstances then prevailing.

Industry Conditions and Trends
         The  Company's  operating  results are strongly  influenced  by general
economic  conditions,  railroad freight traffic,  the financial condition of the
railroad industry and their outsourcing of

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work to improve  their  competitive  position.  Favorable  conditions  generally
prevailed in the economy and the railroad  industry during 1996,  although there
is no assurance that these  favorable  conditions in the railroad  industry will
continue.  Historically,  however,  the  components and parts,  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
and  remanufactured  locomotive  segments.  The  Company  operates  in a  highly
competitive  environment,  and there can be no  assurance  that  increased  rail
traffic and outsourcing by the railroads will benefit the Company.
         Since the deregulation of the U.S. railroad  industry in 1980,  freight
railroads  have reduced  their  equipment  base and  consolidated  operations to
reduce  operating  costs and  improve  their  competitive  position  compared to
trucking companies,  which compete with the railroad industry.  In recent years,
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. This is
a forward-looking statement. There can be no assurances, however, 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  business  units,  the
Components Group and the Locomotive Group.

         Components Group
         The   Components   Group   manufactures   and   distributes   primarily
aftermarket,  or  replacement  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  and
other  customers   internationally.   MotivePower   provides  most   aftermarket
components  for  locomotives  manufactured  by the  Electro-Motive  Division  of
General Motors  Corporation  ("EMD") and certain components for locomotives made
by the GE  Transportation  Systems  unit of  General  Electric  Company  ("GE").
MotivePower  believes it is the leading independent supplier in North America of
aftermarket   locomotive  components  such  as  traction  motors,   alternators,
turbochargers, cooling systems and overhauled diesel engines.
         Demand  for  components  tends to depend  largely on rail  traffic.  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.

         Locomotive Group
         The  Locomotive  Group  provides  fleet  maintenance,  overhauling  and
remanufacturing,   and  manufacturing  of  environmentally   friendly  switcher,
commuter and mid-range, DC traction,

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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 can 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  shops of certain
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    4,000    locomotives    operating    in
switcher/short-haul service in the United States and Canada, with an average age
of 30 years.  Demand for new mid- range  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 sometimes used as switchers.  As a
result of this low level of demand, few switcher  manufacturers  exist today. In
this business,  the Company competes against Peoria  Locomotive  Works. In 1996,
the  Company  delivered  32  switchers  to two  terminal  railroads  in Houston.
Although the Company does not currently have additional switcher  contracts,  it
has  several  proposals  outstanding  as of March 1997 for  delivery in 1997 and
1998.
         The Company has been providing overhauling and remanufacturing services
to the railroad industry since 1972, and management  believes the Company is the
largest,  independent  remanufacturer  of locomotives in North America.  In this
business  segment,  the Company  faces  competition  from VMV,  AMF Canada,  GEC
Alsthom Mexico, 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 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  8,000 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 1994 and 1995,  MotivePower  signed  agreements
with CSX Intermodal ("CSXI"), a unit of CSX Corporation, for the development and
manufacturing of the Iron Highway,  a proposed new system for intermodal freight
transportation. The Company developed four Iron

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Highway trainsets,  two of which are currently in revenue-testing  service by CP
Rail. CSXI has postponed testing of its two units. In 1996, the Company and CSXI
cancelled  an  Iron  Highway  manufacturing  agreement.  The  Company  currently
receives no revenues and incurs no costs for the Iron Highway project, and there
is no  certainty  that CP Rail will  proceed  with the Iron  Highway  beyond the
testing phase, or that CSXI will resume testing.

Backlog
         At December 31, 1996,  the  Company's  backlog was  approximately  $526
million,  related  to the  Company's  multi-year  locomotive  fleet  maintenance
agreements.  The largest  agreement is subject to  termination,  but the Company
would receive a substantial termination settlement.
         The Components Group,  which  represented  approximately 50% of Company
sales in 1996,  has no  backlog  because  the vast  majority  of its  sales  are
considered  to be  maintenance  items on short lead time  cycles.  However,  the
Components  Group does have several  long-term  supply  agreements  with certain
Class I  railroads  that  designate  that  Group as the  preferred  supplier  of
required maintenance products.

Employees
         At March 10,  1997,  MotivePower  had 2,102  employees  versus 2,141 in
1995.  This  included 589  salaried  employees  and 898 hourly  employees in the
United States, and 135 salaried employees and 480 hourly employees in Mexico. Of
the hourly  employees  in the United  States,  348 at Boise  Locomotive  Company
("Boise  Locomotive")  are represented by the  International  Union of Operating
Engineers  ("Operating  Engineers"),  and 550 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  agreement with the Operating  Engineers  expires in June
2000 and the three collective bargaining agreements with the Electrical Workers,
covering Motor Coils employees in Braddock and Emporium,  Pennsylvania,  and St.
Louis, Missouri,  expire in July 1998, October 1998 and June 2000, respectively.
The Company considers its relations with its employees and union  representation
to be good.

Environmental Matters
         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
(collectively referred to as "waste").  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.  For some activities the
Company must obtain  permits.  Violation of  environmental  laws or  regulations
could subject the Company and its management to civil and criminal penalties and
other  liabilities.  In  addition,  third  parties may make claims for  personal
injuries and property  damage  associated  with releases of waste.  A current or
prior owner or operator of property may be required to investigate  and clean up
waste  releases and may be liable to  governmental  entities or some other third
party for their  investigation  and  remediation  costs in  connection  with the
contamination.  The Company  arranges  for the disposal or treatment of waste at
disposal or treatment  facilities  owned by third parties.  The Company could be
liable  for the costs of  removing  or  remediating  a release  of waste at such
facilities.

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         Because  it  owns  and   operates   property,   the  Company  may  have
responsibility  and liability  even if it does not know of or cause the presence
of  contaminants.  Liability  is often joint and several  and is  generally  not
limited. The cost to investigate,  remediate and remove waste may be substantial
and may even  exceed the value of the  property or the  aggregate  assets of the
owner  or  operator.   The  Company  may  have  difficulty  selling  or  renting
contaminated  property  or  borrowing  against  such  property.  The  government
sometimes  creates  liens  against  property  for damages and costs it incurs in
connection with contamination.  The Company has potential liabilities associated
with  its  and its  predecessor's  past  waste  disposal  activities,  including
disposal activities at plants currently being operated by the Company.
         The  Company  has a Chief  Compliance  Officer  who audits the  Company
policy and reports  directly to the Audit  Committee of the Board of  Directors.
All Audit Committee members are independent directors.

Boise, Idaho
       Heavy equipment repair and locomotive  remanufacturing commenced at Boise
Locomotive in 1972.  At the time,  solvents were used in the process of cleaning
parts  and  equipment  as  part  of the  repair/remanufacturing  process  at the
facility.  Wastewater  generated from the equipment  cleaning process containing
solvents was discharged  during the process to in-ground  wastewater  separation
basins that were  connected to buried drain fields.  This  wastewater  treatment
system was in place until 1984.  In 1985,  the  Company's  predecessor  received
notices  from  the  Idaho   Department  of  Health  and  Welfare,   Division  of
Environmental  Quality and the United States  Environmental  Protection  Agency,
indicating that it was in violation of state and federal environmental laws with
respect  to this  treatment  system  at  Boise  Locomotive.  Related  regulatory
requirements  led to the closure of the buried drain fields and a buried  trench
that was used for disposal of waste material.  Further  requirements  led to the
issuance in 1991 of a Resource Conservation and Recovery Act Part B Post Closure
Permit (the  "Permit"),  which is the formal permit pursuant to which a detailed
corrective  action plan is specified for groundwater  cleanup and for protection
of the public and  environment  following  the "closure" or  termination  of the
releases  which  created the problem.  In compliance  with the Permit,  about 57
wells  have  been  drilled  on the Boise  Locomotive  property  and on  adjacent
property to monitor,  collect, and treat contaminated  shallow  groundwater,  to
monitor  any  movement  of the  contaminated  plume,  and to monitor  the deeper
groundwater  systems at the  facility.  The Company was in  compliance  with the
Permit at December 31, 1996. In addition,  Boise  Locomotive would be liable for
any damages resulting from hazardous  substances  migrating from the facility to
deeper groundwater  systems,  including the regional aquifer system which serves
most of the  domestic and  industrial  users of  groundwater  in the area (which
includes and extends  beyond Boise).  Three private  off-site wells are known to
have been impacted by shallow groundwater contamination.  Two of these wells are
used for residential domestic purposes, and the third well is used for supply to
a pond and landscape  watering for a residential  subdivision.  Boise Locomotive
has entered into agreements  whereby the  residential  domestic use of the wells
will be abandoned and domestic  water will be provided via a public water supply
hook-up. In the event of contamination of the regional aquifer, Boise Locomotive
would be required,  among other  things,  to provide  potable  water to affected
users and to install a  treatment  system to clean up the  polluted  water,  and
could incur other  liabilities,  the combined cost of which cannot be estimated,
but would be expected to be material in amount.  The  regional  aquifer  system,
however, occurs at a depth which is

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approximately  200 feet  below  the  shallow  contaminated  groundwater  that is
currently being remediated.  While management believes there is no evidence that
the regional aquifer system is currently  threatened by releases of contaminants
from Boise Locomotive, no assurance can be given in this regard.

Mexico
         Through its MK Gain, S.A. de C.V. ("MK Gain")  subsidiary,  the Company
has operational responsibility for facilities in Acambaro and San Luis Potosi in
Mexico,  pursuant to a contract  with the Mexican  National  Railway.  Under the
contract,  MK Gain  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 MK Gain by the  Mexican  National
Railway or recoverable  through fees payable under the contract,  which has been
structured to account for such cost. No assurance  can be given,  however,  that
the Mexican National Railway will not dispute any submissions for  reimbursement
or that the fee  structure  under the contract  will, in fact,  cover costs.  MK
Gain's operations are subject to Mexican environmental laws and regulations.  It
has obtained, or is in the process of obtaining, environmental permits, licenses
and approvals required for its continuing operations.

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  data  base of
potential  hazardous  waste sites,  the  Comprehensive  Environmental  Response,
Compensation and Liability  Information System ("CERCLIS").  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 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.

Richland Township, Pennsylvania
         Motor Coils owns a vacant lot in Richland Township,  Pennsylvania which
has been subject to unauthorized dumping by unknown parties. The Company has not
yet tested the soil at the site or materials  disposed there.  Based on a visual
inspection,  Motor Coils  cannot yet  estimate  the cost to remove and  properly
dispose of the  material,  and does not  believe  that the  removal  will have a
material  adverse  impact on the  Company's  financial  position  or  results of
operations.


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St. Louis, Missouri
         Motor Coils completed voluntary remediation of surficial  contamination
resulting from a release of xylene in connection with a storage tank leak at its
St. Louis, Missouri facility. Motor Coils notified the relevant state regulatory
agency of its  remediation  plan and, with the  concurrence of the state agency,
initiated site  remediation in 1994.  Based on monitoring  results,  the Company
discontinued site remediation in 1996.
         The Company believes that its planned expenditures are adequate to meet
its known environmental  obligations and liabilities,  including those under the
Permit, and under CERCLA and similar legislation. The Company's knowledge of its
environmental   obligations   and  liabilities  is,  for  the  majority  of  its
facilities,   based  on   assessments   and  due  diligence   conducted  by  its
predecessor's  personnel and Phase I and/or Phase II  environmental  assessments
conducted by third-party  consultants.  No assurance can be given, however, that
stricter  interpretation  and  enforcement  of  existing  environmental  laws or
regulations, the adoption of new laws or regulations, the discovery of currently
unknown  waste or  contamination  for  which  the  Company  may be  liable,  the
inability  of the Company to enforce  the  indemnification  with  respect to the
Mountaintop  plant or the continued  spread of the hazardous waste plume through
off-site  groundwater  near Boise  Locomotive  will not result in  significantly
higher environmental costs to the Company.
          Environmental  laws and regulations are subject to change at any time.
Compliance  with  current  or  future  laws and  regulations  could  potentially
necessitate  significant capital outlays by the Company, affect the economics of
a given project or cause material changes or delays in intended activities.

         In October 1996, the American Institute of Certified Public Accountants
issued Statement of Position 96-1, "Environmental Remediation Liabilities" ("SOP
96-1").  SOP 96-1 is effective  for fiscal years  beginning  after  December 15,
1996. The Company believes that its liabilities have been recorded in compliance
with SOP 96-1 and, therefore,  implementation of SOP 96-1 will have no impact on
the Company's financial position or results of operations.

Major Customers
         In  1996,  sales  to  three  customers  exceeded  10% of  total  sales:
Burlington  Northern/Santa  Fe  (19%),  Union  Pacific  (16%),  and the  Mexican
National  Railway (14%). No other single  customer  accounted for 10% or more of
sales. Based on current operations,  management expects that sales to Burlington
Northern/Santa  Fe, Union Pacific and the Mexican  National  Railway will exceed
10% of 1997 total sales.


Item 2.           PROPERTIES

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




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                                 Square       Owned/
Location                         Footage      Leased    Use
--------                         -------      -------   ---

MotivePower Industries, Inc.
Pittsburgh, Pennsylvania           8,430      Leased    Corporate Headquarters

Boise Locomotive Company
Pittsburgh, Pennsylvania           5,000      Leased    Office
Mountaintop, Pennsylvania*       204,000      Owned     Manufacturing
Boise, Idaho                     210,000      Owned     Manufacturing
Boise, Idaho                      66,900      Owned     Manufacturing
Helper, Utah**                        --      Leased    Maintenance Shop
Barstow, California**                 --      Leased    Maintenance Shop

Clark Industries Co.
Gilman, Illinois                  31,800      Leased    Manufacturing

Engine Systems Co., Inc.
Latham, New York                  63,000      Owned     Manufacturing

MK Gain, S.A. de C.V.
San Luis Potosi, Mexico          968,400      Leased    Manufacturing
Acambaro, Mexico                 138,000      Leased    Manufacturing
Mexico City, Mexico                3,700      Leased    Office

Motor Coils Mfg. Co.
Pittsburgh, Pennsylvania          61,777      Leased    Office
Pittsburgh, Pennsylvania          57,000      Leased    Warehouse
Pittsburgh, Pennsylvania          71,950      Leased    Warehouse/Manufacturing
Braddock, Pennsylvania           111,000      Owned     Manufacturing
Emporium, Pennsylvania            37,000      Owned     Manufacturing
St. Louis, Missouri               65,000      Owned     Manufacturing

Power Parts Co.
Elk Grove Village, Illinois       18,000      Leased    Office
Elk Grove Village, Illinois***   132,700      Leased    Warehouse

Touchstone Co.
Jackson, Tennessee                88,000      Owned     Manufacturing
Jackson, Tennessee                77,200      Leased    Warehouse
Jackson, Tennessee                 2,590      Leased    Storage
Jackson, Tennessee                 1,540      Leased    Office
Racine, Wisconsin                  1,200      Leased    Office
-----------------------

* The Company  closed this  facility in the second  quarter of 1996. On March 6,
1997 the Company signed a letter of intent to sell this facility.

                                        9

<PAGE>



**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.
*** The Company subleases 59,500 sq. ft. of space through July 1997,  subject to
two consecutive six-month renewals at the option of the subtenant.


Item 3.           LEGAL PROCEEDINGS

                  In December 1995, Morrison Knudsen, the Company and certain of
Morrison  Knudsen's  directors  and  officers  were  named  as  defendants  in a
complaint (the  "Pilarczyk  Lawsuit")  filed in the United States District Court
for the  Northern  District of New York by  plaintiffs  who were  principals  in
and/or held  substantial  stock in TMS,  Inc.  ("TMS"),  a New York  corporation
acquired by Morrison Knudsen on December 30, 1992. The complaint alleges,  among
other things,  violations of Section 10(b),  Rule 10b-5 and Section 20(a) of the
Securities  Exchange  Act  of  1934,  breach  of  contract,  unjust  enrichment,
negligent  misrepresentation  and common  law fraud  during  Morrison  Knudsen's
acquisition of TMS in 1992.  Plaintiffs  assert that the Company,  which was not
formed by Morrison  Knudsen  until 1993,  is fully  responsible  for the acts of
Morrison Knudsen. However, the actions complained of occurred before the Company
was formed and the Company did not assume such liabilities of Morrison  Knudsen.
A motion to  dismiss,  filed in April  1996 on behalf of all  defendants  to the
Pilarczyk Lawsuit, is still pending.  Counsel to the Company believes the causes
of action in the Pilarczyk Lawsuit relating to the Company are without merit and
the Company expects that it will be successful on this motion,  even if the suit
is not dismissed as to all defendants. If the Company is successful, the Company
intends  to make  appropriate  requests  to the  court  to seek to  require  the
plaintiff to pay the Company's legal fees and costs.
         In June 1995,  the Company was named as defendant in a complaint  filed
with the Idaho Human Rights  Commission (the "Idaho  Commission")  and the Equal
Employment  Opportunity Commission by a female employee on behalf of herself and
other women employed by the Company alleging  discrimination based on sex, which
complaint was amended in December  1995 to include  allegations  of  retaliatory
discharge.  In 1996,  the idaho  Commission  announced that it found no probable
cause to believe either  discrimination or retaliatory discharge had occurred as
alleged in the complaint and, accordingly, the proceeding was dismissed.
          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  assembly  liners  to
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.





                                       10

<PAGE>



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

            On October 30, 1996, the annual meeting of the  shareholders  of the
Company was held, at which the shareholders  voted on and approved the following
matters:

          1.   The election of John C. Pope and Nicholas J. Stanley to the Board
               of Directors  for a term of three years.  A summary of the voting
               results is as follows:

                                        John C. Pope       Nicholas J. Stanley

               For                    14,474,146                14,459,321
               Withheld                   32,198                    47,023

          2.   The amendment of the Company's  Certificate of  Incorporation  to
               permit  vacancies on the Board or newly created  directorships to
               be filled at meetings of the stockholders  called by the Board. A
               summary of the voting results is as follows:

               For                                              13,056,523
               Against                                              34,700
               Abstain                                              10,013

          3.   The amendment of the Company's  Stock  Incentive Plan to increase
               the maximum  number of shares which may be issued under such Plan
               by one  million  shares.  A summary of the  voting  results is as
               follows:

               For                                              12,707,091
               Against                                             273,480
               Abstain                                              20,309

          4.   The amendment of the Company's Stock Option Plan for Non-Employee
               Directors to (i) provide for annual  stock  option  awards to the
               Company's  non-employee  directors  and (ii) increase the maximum
               number of shares  which may be issued  under  such plan by 50,000
               shares. A summary of the voting results is as follows:

               For                                              12,630,604
               Against                                             382,521
               Abstain                                              19,709

          5.   The  appointment  of  Deloitte  &  Touche  LLP as  the  Company's
               independent  auditors.  A summary  of the  voting  results  is as
               follows:

               For                                              14,459,462
               Against                                              38,681
               Abstain                                               8,201

                                       11

<PAGE>



                                     PART II

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

         MotivePower's Common Stock trades on the Nasdaq National Market Tier of
the Nasdaq  Stock  Market  under the symbol  "MOPO." As of March 10,  1997,  the
approximate number of holders of record of its Common Stock was 983.
         The high and low  sales  prices  for the  Company's  Common  Stock,  as
reported in the Nasdaq Stock Market Summary of Activity reports in 1996, were as
follows:


                            1996                                  1995
               ---------------------------        ------------------------------

                 High                 Low              High                 Low
First Quarter    $4.50               $2.88            $10.63               $5.75
Second Quarter    6.75                3.38              9.25                4.50
Third Quarter     6.63                5.00              8.75                6.38
Fourth Quarter    8.00                5.88              8.75                3.88

         The Board did not declare  dividends  for 1995 or 1996. On February 27,
1997,  the Company  entered  into a new credit  facility  which  allows up to $3
million in annual  dividends  to be paid if declared by the Board of  Directors.
The Board reviews its dividend policy regularly.
         At the close of business on March 10, 1997, the Company's  Common Stock
was trading at $11.00 per share.



















                                       12

<PAGE>



Item 6.           SELECTED CONSOLIDATED FINANCIAL DATA

         The following  Selected  Consolidated  Financial  Data are qualified in
their  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 Balance Sheet Data at December 31, 1992,
1993,  1994, 1995 and 1996, and the Statement of Operations Data for each of the
five years in the period ended  December  31,  1996,  have been derived from the
audited Consolidated Financial Statements of the Company.
<TABLE>
<CAPTION>


                                                                              December 31,
                                                     --------------------------------------------------------------------------
                                                     1996            1995            1994            1993            1992
                                                     ----            ----            ----            ----            ----
                                                                    (In thousands except share information)
Statements of Operations Data:
<S>                                                   <C>              <C>             <C>            <C>              <C>     
     Net sales                                        $ 291,407        $263,718        $368,537       $218,160         $129,507
     Net income (loss)                                   11,509         (40,414)        (42,793)         3,632            1,790
     Earnings (loss) per common share                      0.66           (2.34)              --            --               --
     Pro forma supplemental income
       (loss) per common share (1)                           --             --            (2.47)          0.21               --
     Special dividend to                                                                                             
       Morrison Knudsen                                      --             --             3.19             --               --
     Other dividends                                         --            0.04            0.12             --               --


Balance Sheet Data:
     Total assets                                     $ 234,044        $280,948        $311,297       $181,930         $138,263
     Long-term debt and
         Redeemable Preferred Stock                      27,161          61,296          40,867             --               --
     Stockholders' equity                               120,980          94,527         114,124        100,061           68,863
----------
<FN>


(1) The net loss for 1994 has been adjusted to reflect the following: additional
interest expense on a $19 million debt from January 1, 1994 through February 25,
1994,  transferred from Morrison Knudsen and assumed by the Company; a reduction
of interest  expense  resulting from the assumed payment of $39.6 million on the
intercompany debt due Morrison Knudsen,  and a dividend payment of $35.6 million
to Morrison  Knudsen.  Net income for 1993 has been adjusted for the net effects
of the acquisitions of Touchstone,  Inc., Clark Industries, Inc., and Arrowsmith
Power Systems, Inc., as if such acquisitions occurred on January 1, 1993.

</FN>
</TABLE>


                                       13

<PAGE>



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

Overview
         In 1996,  MotivePower had net income of $11.5 million,  or 66 cents per
share, on sales of $291.4 million.  During the year, the Company reduced debt by
$71  million,  cut general and  administrative  costs by $13  million,  sold $21
million of non-core assets and reduced inventories by $21 million. For the year,
both the Locomotive  Group and the Components  Group had operating  income above
prior  year  results,  exclusive  of any  Unusual  Items.  The  Company's  Boise
Locomotive  subsidiary  completed a contract for 32 switcher  locomotives during
the year, contributing significantly to the improved performance of the Company.

Business Strategy
         MotivePower's  business  strategy is to grow and continue to strengthen
its core businesses.  The Company considers the following to be core businesses:
manufacturing  and  distributing  engineered  locomotive  components  and parts;
providing  locomotive  fleet  maintenance and  overhauling  and  remanufacturing
locomotives;  and manufacturing  environmentally friendly switcher, commuter and
mid-range DC traction,  diesel electric and liquefied natural gas locomotives up
to 4,000 horsepower. To the extent market conditions, technological developments
or other  factors  change,  management  will  reconsider  its  strategy  to best
position the Company under the conditions and circumstances then prevailing.

Industry Conditions and Trends
         The  Company's  operating  results are strongly  influenced  by general
economic  conditions,  railroad freight traffic,  the financial condition of the
railroad  industry and their  outsourcing  of work to improve their  competitive
position.  Favorable  conditions  generally  prevailed  in the  economy  and the
railroad  industry  during  1996,  although  there is no  assurance  that  these
favorable  conditions  in the railroad  industry  will  continue.  Historically,
however,  the components  and parts,  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 and
remanufactured locomotive segments. The Company operates in a highly competitive
environment,  and there can be no  assurance  that  increased  rail  traffic and
outsourcing will benefit the Company.
         Since the deregulation of the U.S. railroad  industry in 1980,  freight
railroads  have reduced  their  equipment  base and  consolidated  operations to
reduce  operating  costs and  improve  their  competitive  position  compared to
trucking companies,  which compete with the railroad industry.  In recent years,
railroads  have  been  consolidating  and  merging.  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 parts repair.  This is a
forward-looking statement.  There can be no assurances,  however, that continued
consolidation  will not adversely  impact the Company through  concentration  of
bargaining power over prices or rationalization of locomotive fleet sizes.





                                       14

<PAGE>



Results of Operations
         The following  table sets forth the percentage of sales  represented by
certain items in the  Company's  Consolidated  Statements of Operations  for the
years indicated.


                                                   Year Ended December 31,
                                                   --------------------------
                                                   1996      1995    1994
                                                   ----      ----    ----

Net sales .....................................    100.0%    100.0%    100.0%
                                                   ------    ------    ------


Cost of sales .................................    (79.8)    (86.5)    (90.8)
Unusual items .................................     (0.7)    (15.5)    (10.6)
                                                   ------    ------    ------


Gross profit (loss) ...........................     19.5      (2.0)     (1.4)
                                                   ------    ------    ------ 

General and administrative expenses ...........    (11.2)    (17.4)    (11.2)
Research and development expense ..............      --        --       (0.9)
                                                   ------    ------    ------ 

Operating income (loss) .......................      8.3     (19.4)    (13.5)

Interest income ...............................      0.7       0.4       0.5
Interest expense ..............................     (3.1)     (3.6)     (1.8)
Other income ..................................      0.5       --        --
Gain on sale of assets ........................      0.5       --        --
Foreign exchange gain (loss) ..................      0.1      (0.2)     (0.3)
                                                   ------    ------    ------ 

Income (loss) before income taxes and
   minority interest ..........................      7.0     (22.8)    (15.1)

Income tax (expense) benefit ..................     (2.6)      7.5       3.3
Minority interest in loss of subsidiary .......      --        --        0.3
                                                  ------    ------    ------  

Income (loss) before extraordinary item .......      4.4     (15.3)    (11.5)

Extraordinary loss on extinguishment of debt ..     (0.4)      --        --
                                                   ------    ------    ------ 
Net income (loss) .............................      4.0%    (15.3%)   (11.5%)
                                                   ======    =======   =======



Consolidated Operations
         1996 Compared to 1995
         Sales  increased 10% to $291.4  million in 1996 from $263.7  million in
1995. The increase was primarily due to increased sales in the Locomotive  Group
which  completed  a $34  million  contract to deliver  switcher  locomotives  in
December  1996.  The  Components  Group  had  lower  sales in 1996  versus  1995
principally as a result of the sale of non-core businesses during the year.
         Cost of sales  (exclusive  of Unusual  Items) as a percentage  of sales
decreased  to 80% in 1996  compared to 87% in 1995,  resulting  in gross  profit
margins of 20% and 13%, respectively. The

                                       15

<PAGE>



improvement  in gross  profit is the  result  of cost  reductions  and  improved
productivity in the operating  groups and increased  profitability at the higher
sales volume due to the benefits of operating leverage.
         Charges for Unusual  Items were $2.1 million in 1996  compared to $40.8
million in 1995.  The charges in 1996 were  incurred  due to the  impairment  of
certain  assets,  facility   rationalization  and  the  restructuring  of  lease
commitments.  The  charges  in 1995  related  to the  Company's  exit  from  the
high-horsepower  locomotive business, the impairment of the Mountaintop facility
and the locomotive  lease fleet,  the  disposition  of the Company's  Australian
operations and other miscellaneous charges.
         General and  administrative  expenses decreased 29% to $32.6 million in
1996 from $45.9 million in 1995. The decrease  resulted from the  elimination of
$4.5  million in costs  incurred in 1995 during the attempt to sell the Company,
cost reductions at the operating entities and reductions in corporate  overhead,
including legal expenses and staff reductions.
         Interest  income  increased 108% to $2 million in 1996 from $951,000 in
1995.  The 1996  amount  includes  $947,000  of  interest  income  on the  notes
receivable  related to the restructuring of the Company's  Argentina  investment
and $1 million in interest on funds invested by MK Gain.  Based on the remaining
term of the notes receivable,  the Company expects interest income to be minimal
in 1997.
         Interest expense decreased 5% to $9.1 million in 1996 from $9.6 million
in 1995.  The  decrease is the result of a decrease of $1.6  million in interest
expense on the amount owed to Morrison  Knudsen  which was paid off in September
1996,  a decrease  of $1 million in  interest  expense on the amount owed on the
Company's  domestic  credit  facility  which was paid down $30  million in 1996,
partially  offset by an  increase  in  interest  expense of $1.4  million on the
Company's  Mexican  credit  facility,  and an increase  in  interest  expense of
$737,000 on customer  advances to Boise Locomotive  Company related to contracts
for the production of switcher locomotives.
         Other income of $1.6 million in 1996  represents  funds received on the
unsecured portion of the Company's restructured Argentina investments.  There is
no assurance that the Company will receive such payments in the future.
         Gain on sale of assets of $1.5  million in 1996 is the result of a gain
on the sale of Alert  Manufacturing  and Supply Co.  ("Alert") of $700,000 and a
gain on the sale of Power Parts Sign Co.  ("Sign") of $783,000.  Both  companies
were sold in the second half of 1996 after having been previously  identified as
non-core assets.
         The foreign  exchange  gain in 1996 of  $169,000  compares to a foreign
exchange loss of $544,000 in 1995. The respective gain and loss is the result of
fluctuations in the Mexican peso and its effects on the net peso exposure at the
Company's Mexican subsidiary.
         The  extraordinary  loss on  extinguishment  of debt  in  1996,  net of
deferred tax benefit of $687,000,  is the result of the Company's  restructuring
of its domestic  credit  facility.  The gross charge includes $1 million paid to
bank  syndication  partners for the  break-up of the  existing  facility and the
write-off of $751,000 of unamortized fees related to that facility.
         The Company  recorded income tax expense of $7.7 million in 1996 versus
a  benefit  of $19.9  million  in 1995.  The 1995  benefit  was a result  of the
Company's  net loss during the year.  At December  31,  1996,  MK Gain had a net
operating loss  carryforward of approximately  $23 million,  expiring in various
amounts  during  2004-2005,  and the Company had a  consolidated  United  States
federal net operating loss carryforward of approximately  $48 million,  expiring
in various  amounts  during  2009-2010.  The Company  has  reflected a valuation
allowance with respect to these net operating loss carryforwards of $6.3 million
at December 31, 1996.


                                       16

<PAGE>




1995 Compared to 1994
         Sales  decreased  28%, to $263.7 million in 1995 from $368.5 million in
1994.  The decrease was  primarily due to lower sales in the  Locomotive  Group,
which  completed a major  remanufacturing  contract in February 1995 and did not
secure  comparable new contracts.  The Components Group also had lower sales due
to a general  slowdown in rail traffic growth for much of the year. The decrease
in sales in 1995 was  partially  offset by sales  increases  from a full  year's
results of operations for the Company's maintenance contracts.
         Cost of sales  (exclusive  of Unusual  Items) as a percentage  of sales
decreased to 87% in 1995 from 91% in 1994  resulting in a gross margin of 13% of
sales in 1995 versus 9% in 1994.  The  improvement  in the gross margin for 1995
was primarily a result of cost reductions in the Locomotive Group resulting from
the decline in sales volume,  and the  inclusion of the operating  results of MK
Gain for the entire year of 1995.
         General and administrative  expenses increased 12%, to $45.9 million in
1995 from $41.1 million in 1994. The increase  resulted  primarily from expenses
related  to  efforts  to sell the  Company,  costs  associated  with  hiring and
relocating corporate employees,  and costs related to fulfilling  regulatory and
other requirements.
         Research and development  expense  decreased to zero in 1995, from $3.4
million  in 1994.  The  decrease  was due to the  curtailment  of the  Company's
high-horsepower  (over 4,000  horsepower)  locomotive  manufacturing  program in
early 1995.
         Interest  income  decreased  52% to $951,000 in 1995 from $2 million in
1994.  The decrease  was due  primarily to the  elimination  of an  intercompany
receivable from Morrison Knudsen. Interest expense increased 43% to $9.6 million
in 1995  from  $6.7  million  in 1994.  The  increase  resulted  from  increased
borrowings  under existing credit  facilities  needed to fund operating  capital
requirements and significantly higher general and administrative expenses.
         The Company's  foreign  exchange loss decreased 55% to $544,000 in 1995
from $1.2 million in 1994. The decrease is the result of the use of U.S. dollars
as the functional  currency for the Company's Mexican  operations in 1995 versus
the Mexican peso as the  functional  currency in 1994.  The change in functional
currency  resulted  from changes in the  sourcing of  component  parts from U.S.
suppliers during the year and the U.S.  dollar-denominated  financing secured by
MK Gain in 1995.
         Income taxes  reflect a benefit of $19.9 million that resulted from the
Company's net loss in 1995.

Components Group
         1996 Compared to 1995
         In 1996,  net  sales  for the  Components  Group  decreased  1% to $145
million from $146 million in 1995.  The decrease is primarily  attributed to the
sale of Alert  which  generated  net sales of $5.6  million in 1996 prior to the
sale,  compared to $10.7  million in the full year 1995.  Excluding the sales of
Alert  for both  periods,  net  sales  increased  3% in 1996  compared  to 1995.
Operating income  (exclusive of Unusual Items) increased 27% to $19.9 million in
1996 from $15.7 million in 1995. The increase is attributed to cost-cutting  and
productivity improvements.
         1995 Compared to 1994
         In 1995,  net  sales  for the  Components  Group  decreased  6% to $146
million from $156 million in 1994. The decrease was due to a general slowdown in
rail  traffic  growth  for much of 1995,  which  caused the  railroads  to defer
certain maintenance costs. Operating income also

                                       17

<PAGE>



decreased by 37% to $14.2 million in 1995 from $22.6 million in 1994.  Excluding
charges  related  to  the  discontinued  high-horsepower  program,  the  group's
operating  profit  would  have been  $15.7  million  in 1995.  The  decrease  in
operating income was due primarily to the group's high level of fixed costs.

Locomotive Group
         1996 Compared to 1995
         In 1996,  net sales  increased  by 25% to $146.8  million  from  $117.4
million in 1995.  The increase is  attributed  to a 38% increase in net sales at
Boise  Locomotive,  primarily  the result of the  completion of contracts for 32
switcher  locomotives  which  were  manufactured  during  the  year.  Six of the
switcher  locomotives  were  accelerated for delivery in 1996, at the customer's
request,  to allow the units to be operating in the customer's  fleet by the end
of the year.  In  addition,  MK Gain had an 11%  increase in net sales under its
contract to provide  locomotive  operations and  maintenance.  Operating  income
increased to $16.7 million in 1996 from an operating loss  (exclusive of Unusual
Items) of $6.2 million in 1995.  The increase is  attributed  to the increase in
sales, costs reductions and improved productivity,  and the accelerated delivery
of switcher locomotives in 1996.
         1995 Compared to 1994
         In 1995,  net sales for the Locomotive  Group  decreased 45%, to $117.4
million  from $212.8  million in 1994.  The  decrease  was due  primarily to the
completion  of  a  large  remanufacturing  contract,  which  produced  sales  of
approximately  $80  million in 1994 and $10.7  million in 1995,  which more than
offset an increase in sales at MK Gain. The group had an operating loss of $45.4
million in 1995, compared to an operating loss of $40.8 million in 1994. MK Gain
had sales of $46 million and $18 million,  and operating  income of $1.7 million
and $1.7 million in 1995 and 1994, respectively.  The 1995 loss included Unusual
Items  of  $39.3  million  to  discontinue   manufacturing  of   high-horsepower
locomotives,  and to establish reserves against the locomotive lease fleet and a
manufacturing  plant in Mountaintop,  Pa.  Excluding these charges and losses in
the discontinued  Australian  operations,  the group would have had an operating
loss of $1.7 million in 1995. The  comparable  loss in 1994,  excluding  Unusual
Items, was $8.9 million.

Financial Condition, Liquidity and Capital Resources
         During 1996 the Company significantly  improved its financial liquidity
through improved operating results,  an overall reduction of debt of $71 million
including  the  repurchase  of debt the  Company  owed to  Morrison  Knudsen,  a
reduction of receivables of $6 million, a reduction of inventory of $19 million,
and the restructuring of its domestic credit facility. In addition,  the Company
sold non-core assets during the year,  including Alert, Sign and the majority of
its locomotive  lease fleet as part of the  restructuring  plan.  Also,  capital
expenditures  were  reduced in 1996,  and certain  overhead  costs were  reduced
through work force  reductions  at both the  operating  level and the  corporate
level.








                                       18

<PAGE>



         The following  table  summarizes  the net changes in cash flows for the
years ended December 31, 1996, 1995 and 1994:


                                                  Year Ended December 31,
                                           -----------------------------------
                                              1996         1995         1994
                                           ---------    ---------    ---------
                                                     (In thousands)
Net cash provided by (used in)
  Operating activities .................  $  43,368    $ (21,743)   $ (85,141)
  Investing activities .................     12,407      (15,408)     (36,941)
  Financing activities .................    (56,235)      30,388      120,463
  Effect of exchange rates on cash .....       --           --          2,207
                                           ---------    ---------    ---------  
Net (decrease) increase in cash and cash
 equivalents ...........................  $    (460)   $  (6,763)   $     588
                                           =========    =========    =========  

Cash and cash equivalents at end
  of year ..............................  $   5,236    $   5,696    $  12,459
                                            =========    =========    ========= 



         Net cash provided by operations  in 1996 was $43.4  million,  primarily
the result of net income of $11.5 million and working capital management. During
1996,  steps  were  taken to return  the  Company  to  profitability,  including
improving operations through production efficiencies and cutting overhead costs.
As a result of these  actions,  and  significantly  improved sales volume in the
Locomotive Group, the Company improved its financial condition and is positioned
for future growth. In addition,  inventories were reduced by $19 million in 1996
as the  Company  continued  to manage  assets and  improve  liquidity.  Non-cash
charges during the year for depreciation and amortization totaled $10.4 million.
         Net cash provided by investing activities in 1996 was $12.4 million. As
part of the Company's  restructuring  plan, non-core assets were sold during the
year,  generating net proceeds of $14.9 million.  Offsetting these proceeds were
capital additions of $4.1 million. Domestic capital spending during the year was
limited to normal  maintenance  items, with MK Gain  expenditures  being made in
accordance with contractual  obligations.  Other investing  activities  provided
cash of $1.6 million,  principally from the reduction of other long-term assets.
The Company anticipates a $10 million increase in capital  expenditures in 1997,
principally due to contractual  obligations at MK Gain and the construction of a
new facility at its Touchstone subsidiary.  This is a forward-looking statement.
Actual  capital  expenditures  could  vary  based on  availability  of  capital,
interest rate increases, site availability and changes in market conditions.
         Cash  used in  financing  activities  in 1996  totaled  $56.2  million,
primarily the result of the buy back of the note payable to Morrison Knudsen for
$34.6 million and the reduction of debt under credit  agreements of $17 million.
In  addition,  the  Company  also  used  funds to buy back the  preferred  stock
outstanding  for $1.1 million.  The repurchase of the Morrison  Knudsen note was
completed at a discount of approximately $22 million,  as the note plus interest
at the date of closing was $56.6 million.  This debt  repurchase was part of the
Company's overall strategy of reducing debt and improving liquidity. As a result
of the improved operating results, the proceeds from the sale of non-core assets
and funds  received from unsecured  notes related to the Company's  restructured
Argentina  investments,  the  Company  was able to pay down  amounts  owed under
existing credit agreements. Also, in December 1996, the Company restructured its
domestic credit

                                       19

<PAGE>



facility to reduce the cost of borrowing and increase net borrowing availability
through increases in the term loan portion of the facility,  and MK Gain entered
into a new credit  agreement which will provide up to $3.5 million in additional
financing to support investments in property, plant and equipment.

Currency Risks
         MK Gain is the source of foreign currency risks.  Under a contract with
the Mexican National Railway,  MK Gain provides locomotive fleet maintenance and
overhauls for 276 locomotives.  For its services, MK Gain receives a monthly fee
paid in Mexican pesos. As currency  exchange or inflation rates  fluctuate,  the
fee is adjusted periodically  (currently monthly) based on an escalation formula
in the contract.  In 1996, despite continued  fluctuation of the peso and a high
rate of Mexican  inflation,  the formula  effectively  preserved the U.S. dollar
value of the monthly fee.
         MotivePower  did,  however,  record a foreign currency gain of $169,000
for the year,  related to MK Gain's net peso  exposure.  Most goods and services
used in maintenance and overhaul activities are invoiced in U.S. dollars.
         The  Company  does  not  speculate  or  use  derivatives  in any of its
investment  decisions.  The Company  will  continue  to monitor its  exposure to
foreign currency risks and may adjust its strategy in the future.

Inflation
         General price  inflation in the United States has been moderate  during
the three-year  period ended December 31, 1996 and has not had a material impact
on the Company's  results of operations.  Some of the Company's  labor contracts
contain   negotiated   salary  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 any
significant  inflationary  effects  to the  Company's  customers  in the form of
higher prices.  The Company's strategy for reducing the possible adverse effects
of higher inflation is to continue to adopt methods to increase productivity and
reduce manufacturing costs.

Stock Ownership
         Stock ownership  guidelines for the Company's  officers,  directors and
key managers, which sets minimum levels of Company stock ownership as a multiple
of annual salaries,  have been established as of March 1997. Their purpose is to
encourage  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.

                                       20

<PAGE>



Item 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


                          INDEX TO FINANCIAL STATEMENTS




MotivePower Industries, Inc.                                              Page
                                                                          ----
Consolidated Financial Statements as of December 31, 1996 and 1995, 
and for each of the three years in the period ended December 31, 1996
      Independent Auditors' Report....................................     22
      Consolidated Statements of Operations...........................     23
      Consolidated Balance Sheets.....................................     24
      Consolidated Statements of Cash Flows...........................     25
      Consolidated Statements of Changes in Stockholders' Equity......     27
      Notes to Consolidated Financial Statements......................     28


                                       21

<PAGE>



                          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  listed in the  accompanying  index.  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,  1996 and 1995,  and the results of their
operations  and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.



DELOITTE & TOUCHE LLP

Pittsburgh, Pennsylvania
February 10, 1997
(except for Note 7, as to which the date
is February 27, 1997 and Note 18, as to
which the date is March 6, 1997)





















                                       22

<PAGE>

<TABLE>
<CAPTION>


                          MOTIVEPOWER INDUSTRIES, INC.
                     (Formerly known as MK Rail Corporation)
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (Thousands of dollars except share data)


Year Ended December 31,
                                                                   1996            1995            1994
                                                              ------------    ------------    ------------
<S>                                                           <C>             <C>             <C>         
Net sales .................................................   $    291,407    $    263,718    $    368,537
Cost of sales .............................................       (232,434)       (228,047)       (334,799)
Unusual items .............................................         (2,126)        (40,838)        (39,216)
                                                              ------------    ------------    ------------   

Gross profit (loss) .......................................         56,847          (5,167)         (5,478)

General and administrative expenses .......................        (32,615)        (45,946)        (41,125)
Research and development expense ..........................           --              --            (3,374)
                                                              ------------    ------------    ------------   

Operating income (loss) ...................................         24,232         (51,113)        (49,977)

Interest income ...........................................          1,981             951           1,979
Interest expense ..........................................         (9,143)         (9,602)         (6,724)
Other income ..............................................          1,565            --              --
Gain on sale of assets ....................................          1,483            --              --
Foreign exchange gain (loss) ..............................            169            (544)         (1,204)
                                                              ------------    ------------    ------------

Income (loss) before income taxes and minority interest ...         20,287         (60,308)        (55,926)
Income tax (expense) benefit ..............................         (7,714)         19,894          12,065
Minority interest in loss of subsidiary ...................           --              --             1,068
                                                              ------------    ------------    ------------   

Income (loss) before extraordinary item ...................         12,573         (40,414)        (42,793)
Extraordinary loss on extinguishment of debt,
net of income tax benefit of $687 .........................         (1,064)           --              --
                                                              ------------    ------------    ------------ 

Net income (loss) .........................................   $     11,509    $    (40,414)   $    (42,793)
                                                              ============    ============    ============  

Weighted average shares outstanding .......................     17,562,793      17,255,953      16,852,668
                                                              
Earnings (loss) per share:
Earnings (loss) before extraordinary item .................   $        .72    $      (2.34)   $       --
Extraordinary item ........................................           (.06)           --              --
                                                              ------------    ------------    ------------ 
Earnings (loss) ...........................................   $        .66    $      (2.34)   $       --
                                                              ============    ============    ============ 

Supplemental pro forma loss per share .....................   $       --      $       --      $      (2.47)

Dividends per share:
Other dividends ...........................................   $       --      $        .04    $        .12

Special dividend to Morrison Knudsen (on 11,149,000 shares)   $       --      $       --      $       3.19
</TABLE>


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

                                       23

<PAGE>
<TABLE>
<CAPTION>



                          MOTIVEPOWER INDUSTRIES, INC.
                     (Formerly known as MK Rail Corporation)
                           CONSOLIDATED BALANCE SHEETS
                    (Thousands of dollars except share data)


                                                                      December 31,
                                                         --------------------------------------
                                                             1996                      1995
ASSETS                                                   ------------              ------------
Current Assets:
<S>                                                      <C>                       <C>         
Cash and cash equivalents ..........................     $      5,236              $      5,696
Receivables from customers:
Billed, net of allowance for doubtful
accounts of $284 and $531, respectively ............           25,754                    29,684
Unbilled ...........................................              468                     3,922
Inventories ........................................           78,438                    99,459
Deferred income taxes ..............................            4,635                     1,082
Other current assets ...............................            2,638                     2,903
                                                         ------------              ------------
Total current assets ...............................          117,169                   142,746
Locomotive lease fleet, net ........................            2,083                    14,840
Property, plant and equipment:
Land ...............................................            1,193                     1,193
Buildings and improvements .........................           47,298                    40,952
Machinery and equipment ............................           39,136                    42,612
                                                         ------------              ------------   
Property, plant and equipment - cost ...............           87,627                    84,757
Less accumulated depreciation ......................          (43,644)                  (38,010)
                                                         ------------              ------------  
Property, plant and equipment - net ................           43,983                    46,747
Underbillings ......................................           19,561                    10,328
Deferred income taxes ..............................           15,348                    27,530
Goodwill and other intangibles .....................           24,637                    27,789
Other ..............................................           11,263                    10,968
                                                         ------------              ------------   
Total assets .......................................     $    234,044              $    280,948
                                                         ============              ============ 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt ..................     $     11,626              $        978
Current portion of note payable to Morrison Knudsen              --                      10,440
Accounts payable:
Trade ..............................................           13,470                    18,509
Morrison Knudsen ...................................             --                       2,348
Accrued expenses and other current liabilities .....           28,236                    33,271
Income taxes payable ...............................            1,957                       249
Revolving credit agreement borrowings ..............           22,431                    59,847
                                                         ------------              ------------    
Total current liabilities ..........................           77,720                   125,642
Long-term debt .....................................           15,535                     7,198
Note payable to Morrison Knudsen ...................             --                      41,655
Commitments and contingencies ......................           18,394                     9,299
Other ..............................................            1,415                     1,602
                                                         ------------              ------------  
Total liabilities ..................................          113,064                   185,396
                                                         ------------              ------------  
Redeemable Preferred Stock, par value
$.10 per share, authorized 10,000,000
shares, redemption price $100 per share;
shares issued 0 at December 31, 1996,
10,000 Class A, at December 31, l995 ...............             --                       1,025
                                                         ------------              ------------ 
Stockholders' Equity:
Common Stock, par value $.01 per share,
authorized 55,000,000 shares;
issued 17,562,793 shares ...........................              176                       176
Additional paid-in capital .........................          201,661                   186,681
Deficit ............................................          (75,629)                  (87,107)
Cumulative translation adjustments, net of tax .....           (5,105)                   (5,105)
Deferred compensation ..............................             (123)                     (118)
                                                         ------------              ------------   
Total stockholders' equity .........................          120,980                    94,527
                                                         ------------              ------------  
Total liabilities and stockholders' equity .........     $    234,044              $    280,948
                                                         ============              ============  
</TABLE>











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

                                       24

<PAGE>

<TABLE>
<CAPTION>


                          MOTIVEPOWER INDUSTRIES, INC.
                     (formerly known as MK Rail Corporation)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Thousands of dollars)

                                                                     Year Ended December 31,
                                                               ------------------------------------
                                                                  1996         1995         1994
                                                               ----------   ----------   ---------- 
Operating Activities
--------------------
<S>                                                            <C>          <C>          <C>       
Net income (loss) ..........................................   $  11,509    $ (40,414)   $ (42,793)
                                                               ----------   ----------   ----------  
Adjustments to reconcile net income
(loss) to net cash provided by (used in)
operating activities:
  Depreciation .............................................       6,950        8,209        8,315
  Amortization .............................................       3,407        3,123        3,317
  Extraordinary loss on extinguishment of debt (net of tax)        1,064         --           --
  Gain on sale of assets ...................................      (1,483)        --           --
  Deferred income taxes ....................................       5,403      (20,341)     (16,166)
  Provision for loss on disposition of Argentine operations         --           --         11,060
  Unusual Items ............................................       2,126       40,838         --
  Gain on sale of Talleres .................................        --           --         (1,255)
  Other, net ...............................................          82          194          105
  Changes in operating assets and liabilities
  net of 1994 purchase of Touchstone and the
  1996 sale of Alert and Sign:
    Receivables from customers .............................       5,787       13,090      (31,440)
    Inventories ............................................      19,088       (4,823)     (26,339)
    Other current assets ...................................      (2,919)          93       (2,763)
    Long-term lease ........................................        --           --        (12,297)
    Accounts payable .......................................      (4,162)      (9,866)      14,440
    Accrued expenses and other current liabilities .........      (5,054)      (2,241)      20,194
    Advances from customers ................................        --           --         (9,204)
    Income taxes payable ...................................       1,708          (74)      (2,218)
    Underbillings/overbillings .............................      (9,233)     (12,252)       2,778
    Commitments and contingencies ..........................       9,095        2,721        7,893
    Argentine operations - noncash charges
    and working capital changes ............................        --           --         (8,768)
                                                               ----------   ----------   ----------  
Net cash provided by (used in) operating activities ........      43,368      (21,743)     (85,141)
                                                               ----------   ----------   ----------  
Investing Activities
--------------------
Additions to property, plant and equipment .................      (4,063)      (8,565)     (21,041)
Proceeds from (additions to) locomotive lease fleet ........      10,071       (6,389)     (15,333)
Proceeds from sale of assets ...............................       4,838         --           --
Proceeds from sale of Talleres .............................        --           --          4,303
Purchase of Touchstone .....................................        --           --         (3,900)
Other, net .................................................       1,561         (454)        (970)
                                                               ----------   ----------   ----------   
Net cash provided by (used in) investing activities ........      12,407      (15,408)     (36,941)
                                                               ----------   ----------   ----------   
Financing Activities
--------------------
Repayment of preferred stock ...............................      (1,056)        --           --
Increase in intangibles ....................................      (1,228)      (2,688)        --
Increase in restricted cash ................................      (2,043)        (601)        --
Payments of long-term debt .................................      (2,461)        (475)     (36,922)
Net borrowings under credit agreements .....................     (16,970)      27,667       52,870
Change in payable to Morrison Knudsen ......................     (32,477)      11,628       41,581
Funding of MKA operations prior to disposition .............        --         (3,771)        --
Dividends paid .............................................        --         (1,372)     (36,972)
Proceeds from public sale of common stock ..................        --           --         88,237
Capital contributions ......................................        --           --         11,669
                                                               ----------   ----------   ----------  
Net cash (used in) provided by financing activities ........     (56,235)      30,388      120,463
Effect of exchange rates on cash ...........................        --           --          2,207
                                                               ----------   ----------   ---------- 
Net (decrease) increase in cash and cash equivalents .......        (460)      (6,763)         588
Cash and cash equivalents at beginning of year .............       5,696       12,459       11,871
                                                               ----------   ----------   ----------  
Cash and cash equivalents at end of year ...................   $   5,236    $   5,696    $  12,459
                                                               ==========   ==========   ==========  
</TABLE>

The accompanying notes are an integral part of the financial statements 

                                       25

<PAGE>

<TABLE>
<CAPTION>


                          MOTIVEPOWER INDUSTRIES, INC.
                     (formerly known as MK Rail Corporation)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Thousands of dollars)

                                                                   Year Ended December 31,
                                                                 ----------------------------
                                                                 1996        1995        1994
                                                                 ----        ----        ----
Supplemental Disclosures of Cash Flow Information:
<S>                                                          <C>         <C>         <C>     
   Interest paid ..........................................  $  1,126    $  3,244    $  5,795
   Income taxes paid (refunded) ...........................      (169)        610       6,263

Noncash Investing and Financing Activities:
   Reduction of payable to Morrison Knudsen:
     Payable to Morrison Knudsen ..........................    18,816      29,500        --
     Additional paid-in capital ...........................   (14,902)    (18,600)       --
     Deferred income taxes ................................    (3,914)    (10,900)       --

   Deferred compensation ..................................        78          54         152

   Issuance of equity securities to settle obligation:
     Preferred stock ......................................      --        (1,000)       --
     Common stock .........................................      --            (5)       --
     Additional paid-in capital ...........................      --        (2,995)       --
     Commitments and contingencies ........................      --        (4,000)       --

   Acquisition of assets for stock:
      Property, plant and equipment and other assets ......      --          --        12,619
      Goodwill and other intangibles ......................      --          --        19,840
      Liabilities assumed .................................      --          --        (9,952)

   Additional paid-in capital .............................      --          --           241
   Exchange of locomotive lease for raw materials .........      --          --           910
   Assumption of debt .....................................      --          --       (22,900)

</TABLE>


















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

                                       26

<PAGE>

<TABLE>
<CAPTION>



                          MOTIVEPOWER INDUSTRIES, INC.
                     (Formerly known as MK Rail Corporation)
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                             (Thousands of dollars)

                                            Additional  Retained    Cumulative
                                   Common   Paid-In     Earnings    Translation    Deferred
                                   Stock    Capital     (Deficit)   Adjustments    Compensation
                                ---------   ---------   ---------   -----------    ------------

<S>                             <C>         <C>          <C>          <C>          <C>    
Balance December 31, 1993 ...   $     111   $  85,952    $  13,944    $      54    $    --

Net loss ....................        --          --        (42,793)        --           --
Proceeds from initial public
   offering, net of related
   expenses of $7,763 .......          60      88,177         --           --           --
Dividends, including special
   dividend .................        --       (20,525)     (17,133)        --           --
Capital contribution, net of
   debt assumed .............        --        11,276         --           --           --
Cumulative translation
   adjustment, net of
   deferred taxes of
   $1,145 ...................        --          --           --         (5,023)        --
Compensatory stock options
   granted ..................        --           152         --           --           (152)
Compensation expense ........        --          --           --           --             24
                                ---------   ---------    ---------    ---------    --------- 

Balance December 31, 1994 ...   $     171   $ 165,032    $ (45,982)   $  (4,969)   $    (128)
Net loss ....................        --          --        (40,414)        --           --
Dividends ...................        --          --           (686)        --           --
Sale of MKA, impact on
   cumulative translation
   adjustment ...............        --          --           --           (136)        --
Issuance of equity securities
   to settle litigation .....           5       2,995         --           --           --
Capital contribution,
   reduction of payable to
   Morrison Knudsen,
   net of deferred taxes
   of $10,900 ...............        --        18,600         --           --           --
Accretion of preferred
   stock ....................        --          --            (25)        --           --
Compensatory stock options
   granted ..................        --            54         --           --            (54)
Compensation expense ........        --          --           --           --             64
                                ---------   ---------    ---------    ---------    ---------  

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)
                                =========   =========    =========    =========    =========  


</TABLE>

                                       27

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

<PAGE>

                          MOTIVEPOWER INDUSTRIES, INC.
                     (Formerly known as MK Rail Corporation)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       Organization, Operations and Basis of Accounting
         The  consolidated   financial   statements   include  the  accounts  of
MotivePower  Industries,  Inc.  (the  "Company"),  formerly  known  as  MK  Rail
Corporation,  formed in April  1993,  which  was a  wholly-owned  subsidiary  of
Morrison Knudsen Corporation ("Morrison Knudsen").  The Company acquired certain
assets of the Rail Systems Group of Morrison  Knudsen,  including the Locomotive
Division,  which have been included in the financial  statements for all periods
presented on a pooling-of-interests basis for entities under common control.
         On April 26,  1994,  the Company,  then a  wholly-owned  subsidiary  of
Morrison  Knudsen,  commenced an initial public  offering of 6 million shares of
its Common Stock at an offering  price of $16 a share which  decreased  Morrison
Knudsen's interest in the Company to 65%. Effective as of September 11, 1996, as
part of its bankruptcy plan,  Morrison Knudsen  distributed all of its ownership
in the Company to its  creditors  and certain of its then current  stockholders.
Morrison Knudsen is no longer a stockholder in the Company.
         The Company and its  subsidiaries  design,  manufacture  and distribute
engineered   locomotive   components  and  parts;   provide   locomotive   fleet
maintenance,   overhauling  and  remanufacturing  locomotives;  and  manufacture
environmentally  friendly switcher,  commuter and mid-range DC traction,  diesel
electric and  liquefied  natural gas  locomotives  up to 4,000  horsepower.  The
consolidated financial statements include the following:

Subsidiaries (Wholly Owned):
Boise  Locomotive  Company  ("Boise  Locomotive"),   formed  in  1972,  performs
locomotive  remanufacturing,  overhauling  and  manufacturing  as its  principal
business.

Clark  Industries  Company  ("Clark"),  acquired in 1993, is a  manufacturer  of
cylinder heads, pistons and liner assemblies.

Engine Systems Company, Inc. (formerly known as MK Engine Systems Company, Inc.)
("Engine Systems"), formed in 1994, remanufactures turbochargers for locomotive,
industrial and marine engines.

MK Gain S.A. de C.V. ("MK Gain"), a Mexican variable stock corporation formed in
1994, performs  locomotive fleet maintenance as its principal  business,  almost
exclusively  for one  customer,  Ferrocarriles  Nacionales  de Mexico  ("Mexican
National Railway").

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

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

                                       28

<PAGE>



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

Affiliates:
MK Rail Systems of Argentina,  S.A.,  the  Company's 19%  investment in Morrison
Knudsen Rail Systems of Argentina, S.A. ("MKRSA"), is accounted for by the cost
method and has been valued at zero.

Trenes de Buenos Aires S.A.  ("TBA"),  a 19%-owned  affiliate  which  operates a
concession contract to operate the Mitre and Sarmiento railway passenger lines
in Buenos Aires is accounted for by the cost method and has been valued at zero.

         On July 6, 1995,  the Company sold its interest in Morrison  Knudsen of
Australia,  Ltd.  (MKA) to  Morrison  Knudsen.  In  consideration,  the  Company
received a nominal cash payment and MKA's  redeemable  preferred stock bearing a
9% cumulative dividend. The Company has valued this stock at zero.

         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  all of its  majority-owned  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 periodically 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 MK Gain  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 customer
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.

                                       29

<PAGE>



         Remanufactured 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 of $7.1 million and $4.4 million at
December 31, 1996 and 1995,  respectively,  are included in accrued  expenses in
the consolidated balance sheets.
         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.

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 $3.5  million and $2.5 million at
December 31, 1996 and 1995, respectively.  Component part inventories are valued
at purchase cost using the last-in first-out (LIFO) method or average production
cost.

Credit Risks:  Financial  instruments which  potentially  subject the Company to
concentrations   of  credit  risk  consist  of  cash  equivalents  and  accounts
receivable.  The Company, by 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.  The Company  provides  its
products and services to the Class I Railroads in North America, to metropolitan
transit  and  commuter  rail  authorities,  to  Amtrak,  to  original  equipment
manufacturers and to other customers internationally.  A relatively small number
of customers has represented a significant  percentage of the Company's revenues
in most years. Collectively, the Company's top five customers accounted for 63%,
62%,  and 57% of  sales  in the  years  ended  December  1996,  1995  and  1994,
respectively.  The Company performs ongoing credit  evaluations of its customers
and their accounts with the Company.  The Company  historically has not incurred
any significant credit-related losses.

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,  1996  were  $3.6  million  and  $1.5  million,
respectively.  Cost and accumulated depreciation at December 31, 1995 were $17.9
million and $3.1 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

                                       30

<PAGE>



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.  Expenditures  for repairs and maintenance
are charged to expense as incurred.

Goodwill and Other  Intangibles:  Goodwill and other intangibles  consist of the
following:

         Goodwill - Cost in excess of tangible assets of businesses  acquired in
         purchase  transactions is amortized on the straight-line method over 15
         years from the date of acquisition.  The  unamortized  cost of goodwill
         was $17.8  million at December  31, 1996 and $19.5  million at December
         31, 1995.

         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 $4.5 million at December 31, 1996 and $5.3 million at December
         31, 1995.

         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 $2.1 million at December 31, 1996
         and $2.5 million at December 31, 1995.

         Patent Costs - Patent costs related to proprietary technology have been
         deferred  and are  amortized  on the  straight-line  method  over three
         years.  The  unamortized  cost was  $217,000 at  December  31, 1996 and
         $417,000 at December 31, 1995.

         Accumulated amortization at December 31, 1996 and 1995 was $8.0 million
and $4.1  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.

Research  and  Development:  Research  and  development  costs are  expensed  as
incurred  and  include  research  and  development   expenses  for  new  product
development and costs to improve existing products.  The Company does not engage
in research and  development  activities in the normal  course of business,  but
rather in point of use engineering.

Foreign  Currency  Translation:  During 1995,  due to changes in the sourcing of
component  parts to U.S.  suppliers  at MK Gain and the U.S.  dollar-denominated
financing  secured  by MK  Gain  in  1995,  it was  determined  that  MK  Gain's
functional  currency was the U.S.  dollar and not the Mexican peso. As a result,
MK Gain  remeasures  monetary  assets and liabilities at year end exchange rates
and inventory,  property and  nonmonetary  assets and  liabilities at historical
rates. Income and expense accounts are remeasured at the average rates in effect
during the year,  except that  depreciation,  amortization and cost of sales are
remeasured at historical rates. Adjustments resulting from the remeasurement are
included in the result of operations as they occur.  Gains and losses  resulting
from foreign currency transactions are

                                       31

<PAGE>



included  in  income  based  upon  the  provisions  of  Statement  of  Financial
Accounting Standards No. 52 Foreign Currency Translation. MK Gain has a contract
that provides for escalation  adjustments to the base contract 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 foreign
income  taxes  currently  payable  and those  deferred  or  prepaid  because  of
temporary  differences  between the financial  statement and tax basis 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 basis of assets and liabilities using the enacted tax rates in effect in the
years in which the differences are expected to reverse. The Company has recorded
a net deferred tax asset of $20 million reflecting the benefit of $71 million in
loss  carryforwards,  which  expire in varying  amounts  between  2004 and 2010.
Realization  is  dependent  on  generating  sufficient  taxable  income prior to
expiration  of the loss  carryforwards.  Although  realization  is not  assured,
management  believes it is more likely than not that the net  deferred tax asset
will be realized.

Asset Impairment: In March 1995, Statement of Financial Accounting Standards No.
121  "Accounting  for the  Impairment  of Long-Lived  Assets and for  Long-Lived
Assets to be Disposed of" ("SFAS 121") was issued.  The Company adopted SFAS 121
on January 1, 1996. Adoption of SFAS 121 did not have an effect on the Company's
financial position or results of operations.

Stock-based  Compensation:  In October 1995,  Statement of Financial  Accounting
Standards No. 123  "Accounting for  Stock-Based  Compensation"  ("SFAS 123") was
issued. SFAS 123 is effective for transactions entered into in fiscal years that
begin after December 15, 1995. The Company  adopted SFAS 123 on January 1, 1996,
and  as  permitted  by  that  standard  the  Company  retained  the  recognition
provisions of Accounting  Principles  Board Opinion Number 25.  Adoption of SFAS
123 did not have an impact on the  Company's  financial  position  or results of
operations.

Environmental  Remediation Liabilities:  In October 1996, the American Institute
of  Certified   Public   Accountants   issued   Statement   of  Position   96-1,
"Environmental  Remediation Liabilities" ("SOP 96-1"). SOP 96-1 is effective for
fiscal years  beginning  after December 15, 1996. The Company  believes that its
liabilities  have been  recorded  in  compliance  with SOP 96-1 and,  therefore,
implementation  of SOP 96-1  will  have no  impact  on the  Company's  financial
position or results of operations.

Reclassifications: Certain reclassifications have been made to the 1995 and 1994
financial statements to conform to the current year presentation.

                                       32

<PAGE>


3.       Unusual Items
         The Company  incurred  charges for Unusual Items in 1996, 1995 and 1994
which consisted of the following:
<TABLE>
<CAPTION>


                                                                           December 31,
                                                                  ---------------------------
                                                                     1996      1995      1994
                                                                  -------   -------   -------
                                                                          (In thousands)

<S>                                                               <C>       <C>       <C>  
Provisions for impaired assets and lease losses ...............   $ 2,126   $  --     $  --
High horsepower locomotive manufacturing and technology .......      --      20,273     8,398
Mountaintop facility writedown ................................      --       9,570      --
Locomotive lease fleet impairment .............................      --       7,064      --
Provision for loss on disposition of Australian operations ....      --       2,849      --
Contract losses ...............................................      --         500    12,418
Provision for loss on disposition of Argentine operations .....      --        --      11,060
Legal and finance (primarily attributable to stockholder
   litigation), Other .........................................      --         582     7,340
                                                                  -------   -------   ------- 
                                                                  $ 2,126   $40,838   $39,216
                                                                  =======   =======   =======
</TABLE>


         Year Ended December 31, 1996
         As a continuation of the restructuring plan of the Company, which began
in early 1996,  charges were incurred due to the  impairment of certain  assets,
facility rationalization and the restructuring of lease commitments.

         Year Ended December 31, 1995
         Charges for Unusual Items in 1995 were incurred  principally due to the
Company's exit from the high-horsepower  locomotive  manufacturing business, the
writedown  of  the  Mountaintop  production  facility,  the  impairment  of  the
locomotive  lease  fleet  and  the  disposition  of  the  Company's   Australian
operations.  These charges were incurred as part of the Company's  restructuring
plan,  which  would  allow  the  Company  to  concentrate  efforts  on its  core
businesses.

         Year Ended December 31, 1994
         Charges  for  Unusual  Items in 1994  were  incurred  due to  losses on
high-horsepower   locomotive  manufacturing,   contract  losses  for  locomotive
remanufacturing,  maintenance  contracts,  and  losses on certain  contracts  in
Australia,  the restructuring and disposition of Argentine  operations and legal
costs incurred in connection with stockholder  litigation.  In 1994, the Company
experienced  significant  operational  and  financial  management  turnover  and
incurred charges to provide for the losses on previously  underbid contracts and
the decision to terminate manufacturing operations in Argentina.





                                       33

<PAGE>




4.       Inventories
         Inventories consist of the following:


                                                                  December 31,
                                                             -------------------
                                                                1996        1995
                                                             -------     -------
                                                                (In thousands)
Raw materials ..........................................     $50,699     $74,251
Work in process ........................................      13,912      14,279
Finished goods .........................................      13,827      10,929
                                                             -------     -------

Total inventories ......................................     $78,438     $99,459
                                                             =======     =======


         Approximately  $34  million  and $37  million of total  inventories  at
December 31, 1996 and 1995,  respectively,  were valued on the LIFO cost method,
and the excess of current  replacement cost of these inventories over the stated
LIFO value was $902,000 and $3.6 million,  at December 31, 1996 and December 31,
1995,  respectively.  Two of the Company's domestic subsidiaries value inventory
on the LIFO basis.

5.       Accrued Expenses and Other Current Liabilities
         Accrued  expenses  and  other  current   liabilities   consist  of  the
following:


                                                                  December 31,
                                                               -----------------
                                                                  1996      1995
                                                               -------   -------
                                                                 (In thousands)
Accrued payroll and benefits ..........................        $ 8,075   $ 8,260
Warranty and overhaul accruals ........................          7,053     4,402
Reserve for future losses .............................          2,085    12,308
Other accrued liabilities .............................         11,023     8,301
                                                               -------   -------

     Total ............................................        $28,236   $33,271
                                                               =======   =======


6.       Underbillings
         During  1994,  MK Gain  entered  into a  long-term  contract to provide
maintenance and other locomotive services.  Details relative to cumulative costs
incurred and revenue recognized are as follows:

                                                              December 31,
                                                         ----------------------
                                                            1996         1995
                                                         ---------    ---------
                                                             (In thousands)
Costs incurred .......................................   $ 101,326    $  56,602
Estimated earnings ...................................      12,682        6,655
                                                         ---------    --------- 
                                                           114,008       63,257
Less billings to date ................................     (94,447)     (52,929)
                                                         ---------    --------- 
Underbillings ........................................   $  19,561    $  10,328
                                                         =========    =========
                                                                         
7.       Indebtedness

         In August  1995,  the Company and its  subsidiaries  entered into a $75
million loan agreement (the "Loan  Agreement") with BankAmerica  Business Credit
("BABC")  which  provided  for  revolving  borrowings  based on the  amounts  of
eligible  accounts  receivable,  inventory,  and  certain  other  assets  which,
together  with  property,  plant  and  equipment,   collateralized  the  amounts
borrowed.
         The Loan  Agreement was modified  several times during 1995 and 1996 to
revise covenants, provide for term borrowings, and various other provisions and,
on September 10, 1996, was amended and renamed the Amended and Restated Loan and
Security  Agreement  (the  "Restated  Agreement").  On December  31,  1996,  the
Restated  Agreement was modified to effect  reductions  in rates on  borrowings,
reinstate the Company's ability to convert borrowings to LIBOR-based rather than
base-rate  loans,  and to provide for a September 30, 1997  termination date for
the Restated  Agreement  at which time all  outstanding  principal  and interest
would  become  due.  In  connection  with  the  modifications  to  the  Restated
Agreement, the Company repaid amounts owed certain participating lenders who are
no longer  lenders  under the Restated  Agreement,  as modified,  and paid early
termination   fees  to  those  lenders.   The  early   termination  fees  and  a
proportionate  unamortized portion of previously incurred deferred debt issuance
costs were expensed as an extraordinary item of $1,751,000 in the 1996 statement
of operations.
         Under the terms of the Restated  Agreement,  as modified,  the interest
rate on amounts drawn under the revolving portion of the facility was reduced to
the base rate  plus .5% (as  compared  to the  prior  rate of the base rate plus
1.5%),  and the rate on the term loan portion of the facility was reduced to the
base rate plus .75%  (compared  to the prior rate of the base rate plus  1.75%).
Additionally,  the  modifications  enabled  the  Company  to  convert  revolving
base-rate borrowings to LIBOR-based  borrowings at LIBOR plus 2%. Under both the
Loan  Agreement  and the Restated  Agreement,  the Company was required to pay a
monthly fee based on the unused portion of its borrowing  capacity.  At December
31, 1996 and 1995,  balances  outstanding under the Restated  Agreement and Loan
Agreement  were  $29.8  million  and $59.8  million,  respectively,  and  unused
borrowing   capacity  at  those  dates  was  $22.8  million  and  $3.1  million,
respectively.  The interest  rates in effect on amounts  borrowed at Decmber 31,
1996 ranged from 8.75% to 9.00%, and at December 31,1995 was 10%.
         The Restated Agreement provides for a maximum of $10 million of letters
of credit, of which  approximately  $4.3 million was outstanding at December 31,
1996.  The Company pays a monthly fee of 1.5% per annum on the undrawn amount of
outstanding letters of credit.
         The  Restated   Agreement  provides  certain   restrictive   covenants,
including  attaining a minimum  consolidated  tangible  net worth,  fixed charge
coverage,  limitations on capital  expenditures,  restrictions on the payment of
dividends and other financial covenants.
         In November 1995,  the Financial  Accounting  Standards  Board Emerging
Issues Task Force  reached a consensus on issue  number  95-22,  "Balance  Sheet
Classification of Borrowings  Outstanding under Revolving Credit Agreements that
Include both a Subjective Acceleration Clause and a Lock-Box  Arrangement"("EITF
95-22").  In accordance with EITF 95-22,  the Company has classified the balance
of the revolving loans due under the Loan Agreement as current.
         On February  27,  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  Restated  Agreement  with BABC. The facility
consists  of a $20  million  amortizing  term loan and a $55  million  revolving
credit line including a $15 million letter of credit subfacility. The entire $75
million  facility  is  for a  term  of  four  years  and  is  collateralized  by
substantially  all of the domestic assets of the Company.  Interest rate spreads
charged  under the new facility  will reset at the end of each quarter  based on
the ratio of the Company's  quarter-ending  debt to trailing 12-month cash flow.
Both base rate and LIBOR

                                       34

<PAGE>



borrowings are available, at the Company's discretion. Interest rates range from
LIBOR plus  0.50% to LIBOR plus 2.0%,  and base rate plus 0.0% to base rate plus
1.0%. For the first six months of the facility,  interest rates may not go below
LIBOR  plus 1.0% for  LIBOR-based  borrowings,  and base rate plus 0.0% for base
rate borrowings.
         On July 6, 1995, MK Gain entered into a $30 million loan agreement (the
"Agreement")  with  Bancomer,  S.A.  ("Bancomer"),  a  Mexican  bank.  Under the
Agreement,  Bancomer  will  advance  up to $30  million  to  finance  85% of the
purchase price of U.S.-manufactured  locomotive parts and components exported to
Mexico for use in the overhaul of  locomotives  in  connection  with the Mexican
National  Railway  contract.  Each  advance  under the  Agreement  is subject to
interest at the Funding  Rate  (5.9180% to 6.0625% at  December  31,  1996),  as
defined in the  Agreement  plus 2.5%.  The  Canadian  Imperial  Bank of Commerce
("CIBC") has agreed to fund Bancomer in connection  with this  transaction.  The
Export-Import  Bank of the  United  States  ("Eximbank")  has  issued  a  credit
guarantee which covers  repayment risk between  Bancomer and CIBC. Upon funding,
Eximbank receives,  from MK Gain, an Exposure Fee equal to 4.14% of each advance
under the Agreement.
         Advances  under the  Agreement  will be drawn over a period of up to 36
months  from July 6, 1995 as  documents  evidencing  MK Gain's  receipt  of U.S.
exports are  presented  to the  satisfaction  of  Bancomer,  CIBC and  Eximbank.
Principal and interest payments on each advance are to be made in 10 semi-annual
installments  due on May 15 and November 15 of each year with interest  payments
beginning May 15, 1996 and principal  payments  beginning November 15, 1996. The
Agreement  provides for a prepayment  penalty under certain  circumstances.  The
balance  outstanding  at  December  31,  1996 and 1995  was $18  million  and $6
million,  respectively.  Maturities under the Agreement are as follows:  1997 to
2000 - $3,888,000 annually; and 2001 - $2,479,000.
         The Agreement contains certain covenants,  including a requirement that
MK Gain maintain specified  cash-flow-to-debt-service and debt-to-equity ratios.
Additionally,  the return of $13.7 million of the initial  equity  investment to
the Company from MK Gain is restricted by a subordination  agreement. If MK Gain
maintains specified operating and financial ratios, the subordination  agreement
permits payments of interest and principal on the intercompany debt concurrently
with payments to Bancomer under the Agreement.
         In  connection  with  the  Agreement,  MK  Gain  entered  into a  trust
agreement  ("Trust  Agreement")  with a  Mexican  multiple  banking  institution
("Trustee").  The Trust  Agreement  provides  that all monies  received from the
Mexican  National Railway contract are to be deposited into a trust. The Trustee
is required to maintain  specified  balances in a reserve fund  established  for
debt service.  Once required debt service and other payments have been made, any
remaining  amounts in excess of the reserve fund requirements are to be returned
to MK Gain.  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, 1996 and 1995.
         On December 16, 1996, MK Gain and Bancomer  amended the Agreement.  The
amendment is intended to provide MK Gain with greater  financial  flexibility by
way of, among other modifications,  an increase in the maximum permitted monthly
disbursement  from $1.1  million to $1.5  million,  an  increase  in the maximum
amount of principal  that MK Gain is permitted  to have  outstanding  under this
facility from $23.5 million to $27.1 million, a change in the calculation of the
success fee payable to Bancomer  from 5.56% of net  after-tax  cash flow without
limitation to a series of 11 fixed semi-annual  payments of $75,000 each, and an
initial  payment of $90,000 which was made in December  1996.  The amendment did
not modify the interest rate or term of the facility.

                                       35

<PAGE>



         On  December  16,  1996,  MK Gain  entered  into an  additional  credit
agreement  with  Bancomer  which will provide up to $3.5 million in U.S.  dollar
financing,  non-recourse  to  MotivePower,  to support MK Gain's  investments in
property,  plant and  equipment.  At  December  31,  1996 and 1995,  a  domestic
subsidiary of the Company had other outstanding debt obligations of $1.8 million
and  $2.2  million,   respectively.   These  obligations  consist  primarily  of
Industrial  Revenue Bonds ("IRB") in the amount of $1.4 million in 1996 and $1.6
million in 1995, and bear interest at rates ranging from 4.5% to 10%. Maturities
under these  obligations at December 31, 1996 were as follows:  1997 - $411,000;
1998 - $444,000;  1999 - $477,000;  and 2000 - $471,000.  Total maturities under
long-term  obligations  are as follows:  1997 - $11,626,000;  1998 - $4,332,000;
1999 - $4,365,000; 2000 - $4,359,000; 2001 - $2,479,000.

8.       Redeemable Preferred Stock
         In  September  1995,  the Company  deposited  10,000  shares of Class A
Preferred  Stock  into  a  joint  settlement  account  in  connection  with  the
settlement  of certain  class action  suits.  Effective as of May 15, 1996,  the
Company  exercised  its right to  replace  the Class A  Preferred  Stock with $1
million  in cash and  issued  10,000  shares of Class B  Preferred  Stock to The
Fidelity & Casualty Company of New York in  consideration  of $1 million,  which
was in turn paid to the  plaintiffs  to satisfy  the  Company's  obligations  to
settle the class action suits, and all of the previously  issued shares of Class
A Preferred Stock were simultaneously canceled. On December 6, 1996, the Company
exercised  its  option  to  redeem  all of the  outstanding  shares  of  Class B
Preferred Stock at a price of $1.1 million including accrued dividends.

9.       Stock Option Plans
         The Company has  established two stock option plans which are described
below.  The  Company  applies  APB  Opinion 25 and  related  Interpretations  in
accounting for its plans.
         The compensation cost that has been charged against income was $775,000
and  $63,000  for 1996 and 1995,  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 123, the Company's
net  income and  earnings  per share  would  have been  reduced to the pro forma
amounts indicated below:

                                                       1996              1995
                                                       ----              ----

Net income (loss)             As reported....       $   11,509      $   (40,414)
                              Pro forma......       $   11,104      $   (40,414)

Earnings (loss) per share     As reported....       $        .66    $     (2.34)
                              Pro forma......       $        .63    $     (2.34)

         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 1996 and  1995,  respectively;  dividend  yield of zero
percent for all years;  expected  volatility  of 72% and 69%; risk free interest
rates of 6.5% and 6.0%; and expected lives of 10 years for all plans.
         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

                                       36

<PAGE>



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,  which are made at not
less  than  current  market  prices  at date of  grant,  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.
         Restricted  stock awards for a total of 150,000 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 granted was $5.27 per share.
Sale restrictions on the restricted stock lapse between January 1, 1997 and June
30,  2001.  The Company  recorded an expense of $155,000 in 1996  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. The price per share of the options shall be equal to 50% of the fair
market value of the stock on the grant date. All options granted shall vest over
a three-year period,  one-third on each anniversary date. Unearned compensation,
representing the difference  between the fair market value at the grant date and
the exercise price is charged to income over the vesting period.
         A summary of the status of the  Company's  two stock option plans as of
December  31,  1996 and 1995 and the  changes  during the years  ending on those
dates is presented below:
<TABLE>
<CAPTION>



                                                                    1996                      1995
                                                          ------------------------   --------------------------                 

                                                                        Weighted                    Weighted
                                                                        Average                     Average            
                                                                        Exercise                    Exercise 
                                                           Shares       Price           Shares      Price
                                                          ----------    -----------   ----------    -----------

<S>                                                       <C>           <C>            <C>          <C>      
Outstanding at beginning of year ......................   1, 271,000    $  5.26        1,476,250    $   14.91
Granted ...............................................    1,261,500    $  4.96          532,000    $    7.72
Forfeited .............................................     (792,000)   $ 10.59         (737,250)   $   15.82
                                                          ----------                  -----------

Outstanding at end of year ............................    1,740,500    $  7.08        1,271,000    $    5.26
                                                          ==========                   ========== 


Options exercisable at year end .......................      457,396                     313,292
Weighted average fair value of options
granted during the year ...............................    $    3.98                   $    6.20

</TABLE>










                                       37

<PAGE>



         The  following  table  summarizes   information   about  stock  options
outstanding at December 31, 1996:
<TABLE>
<CAPTION>


                                       Options Outstanding                         Options Exercisable
                        ------------------------------------------------------    -----------------------------

                                         Weighted Average       Weighted                         Weighted
Range of                Number           Remaining              Average           Number         Average
Exercise Prices         Outstanding      Contractual Life       Exercise price    Exercisable    Exercise Price
---------------         -----------      ----------------       --------------    -----------    --------------
   
<C>      <C>                <C>              <C>                      <C>           <C>            <C>        
$4.75 to $16.00             374,000          7.5                     $  14.26       282,500        $     13.74
$5.375 to $8.00             105,000          8.6                     $   7.00        41,396        $      6.64
$2.84 to $8.00            1,261,500          9.3                     $   4.96       150,000        $      3.81
                          ---------                                                 -------        
                   
                          1,740,500                                                 457,396
                          =========                                                 =======
                   
</TABLE>


10.      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.  MK
Gain files an income tax return in Mexico. For tax periods ended prior to May 3,
1994,  the Company  filed  consolidated  federal  income tax returns and certain
combined  state income tax returns with Morrison  Knudsen and its  subsidiaries.
The  Company is  responsible  for all taxes  attributable  to the  Company  with
respect to periods ending after May 3, 1994.
         The components of income tax (expense) benefit are as follows:


                                           Year ended December 31,
                                      --------------------------------
                                        1996        1995        1994
                                               (In thousands)
                                      --------    --------    --------          

Currently payable:
         U.S. federal ............   $ (1,687)   $   --      $ (2,370)
         State and local .........       (625)       (447)       (505)
         Foreign .................       --          --          (133)
                                     --------    --------    --------
                                       (2,312)       (447)     (3,008)
                                     --------    --------    --------  
Deferred:
         U.S. federal ............     (4,235)     16,957      15,067
         State and local .........        345       3,172         332
         Foreign .................     (1,512)        212        (326)
                                     --------    --------    --------    
                                       (5,402)     20,341      15,073
                                     --------    --------    --------
                                                             
Total income tax (expense) benefit   $ (7,714)   $ 19,894    $ 12,065
                                     ========    ========    ========
                                                            

         For the year ended  December  31,  1996,  income tax  expense  was $7.7
million,  and the extraordinary loss on debt  extinguishment  produced an income
tax benefit of $687,000.

                                       38

<PAGE>



         As discussed in Note 12, on September 10, 1996, the Company repurchased
for $34.6  million all of the debt plus accrued  interest of the Company owed to
Morrison Knudsen, which totaled $56.6 million. This settlement decreased the net
deferred  tax asset by $3.9  million.  On June 15, 1995 the Company and Morrison
Knudsen  entered into an agreement  under which the Company's  net  intercompany
account was reduced by $29.5 million. This settlement decreased the net deferred
tax asset by $10.9 million.
         At December 31, 1996, MK Gain had a net operating loss  carryforward of
approximately  $23.4 million expiring in various amounts during  2004-2005,  and
the Company had a consolidated  U.S. federal net operating loss  carryforward of
approximately  $48 million expiring in various amounts during 2009- 2010. Due to
an ownership  change on September 11, 1996, the Company will be restricted as to
annual use of certain tax attributes.
         For the years ended  December  31, 1996,  1995 and 1994 foreign  income
(loss) before income tax (benefit) was $4.6 million,  ($3.2) million and ($12.3)
million, respectively.
         Deferred  tax assets and  liabilities  as of December 31, 1996 and 1995
consist of the following:

<TABLE>
<CAPTION>

                                                  December 31, 1996                 December 31, 1995
                                            ----------------------------      ------------------------------
                                            Assets   Liabilities   Total      Assets    Liabilities    Total
                                            ------   -----------   -----      ------    -----------    -----                        
                                                    (In thousands)                    (In thousands)
Provision for estimated
<S>                                       <C>         <C>        <C>         <C>         <C>         <C>     
   losses .............................   $ 18,624    $  --      $ 18,624    $ 22,818    $   --      $ 22,818
Depreciation ..........................       --       (3,022)     (3,022)       --        (5,753)     (5,753)
Revenue recognition ...................       --       (3,293)     (3,293)       --        (5,230)     (5,230)
Employee benefit plans ................      2,249       --         2,249       1,246        --         1,246
Deferred costs ........................       --         (538)       (538)       --        (1,834)     (1,834)
Affiliate earnings ....................      3,222       --         3,222       3,519        --         3,519
Other .................................        260       --           260         854        --           854
Net operating loss
   carryforwards ......................      8,792       --         8,792      22,400        --        22,400
                                          --------    -------    --------    --------    --------    --------

Subtotal ..............................     33,147     (6,853)     26,294      50,837     (12,817)     38,020
Valuation allowance ...................     (6,311)      --        (6,311)     (9,408)       --        (9,408)
                                          --------    -------    --------    --------    --------    --------

Net deferred tax assets
   (liabilities) ......................   $ 26,836    $(6,853)   $ 19,983    $ 41,429    $(12,817)   $ 28,612
                                          ========    =======    ========    ========    ========    ========
</TABLE>


         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 not expected to be utilized and for losses  anticipated to produce
no tax benefit.









                                       39

<PAGE>



         The  provision  for income  taxes  differ from the amounts  computed by
applying the statutory U.S. Corporate income tax rate of 35% for all years shown
for the following reasons:
<TABLE>
<CAPTION>


                                                                    Year ended December 31,
                                                                -------------------------------
                                                                  1996        1995      1994
                                                                -------    --------    --------                       
                                                                       (In thousands)

<S>                                                             <C>        <C>         <C>     
U.S. corporate income tax (expense) benefit at statutory rate   $(7,100)   $ 21,108    $ 19,547
Research and development tax credits ........................      --          --           149
State income taxes, net of federal benefit ..................      (855)      1,187       2,205
Foreign income taxes ........................................      --           680         328
Losses involving jurisdictions without tax benefit ..........      --        (1,590)     (4,242)
Valuation allowance .........................................     1,762      (2,156)     (6,063)
Other .......................................................    (1,521)        665         141
                                                                -------    --------    --------

Income tax (expense) benefit ................................   $(7,714)   $ 19,894    $ 12,065
                                                                =======    ========    ========
</TABLE>


11.      Benefit Plans
         Retirement:  Beginning in May 1994,  the Company  established a defined
contribution,  401(k) savings plan to replace the former Morrison  Knudsen plan.
In January  1996,  the Company  suspended  Company  contributions  to the 401(K)
savings  plan.  On  January  1,  1997 the  Company  partially  reinstated  those
contributions  equal to 1% of an eligible  employees gross salary in the form of
Company stock.  The program may be fully reinstated (2%) later in 1997 dependent
upon the achievement of certain  performance  goals. The Company's costs of this
plan were $71,000, $752,000 and $446,000 for 1996, 1995 and 1994, respectively.
           In addition,  Company salaried employees  participated  through April
1994 in a Morrison Knudsen Employee Stock Ownership Plan ("ESOP").  Compensation
expense  was  $281,000  in 1994.  The  Company's  employees  had the  option  of
transferring  their  contributions into the Company's new 401(k) plan or leaving
their contributions in the Morrison Knudsen ESOP.


















                                       40

<PAGE>



           One  of  the  Company's  subsidiaries  sponsored  a  non-contributory
defined benefit pension plan covering  certain  nonunion  salaried  employees of
that subsidiary.  During 1994, the subsidiary  curtailed its plan resulting in a
loss of  $233,000.  In 1996 the plan was  settled  which  resulted  in a gain of
$309,000. Pension cost included the following components:


                                                 Year ended December 31,
                                                 -----------------------
                                                  1996     1995    1994
                                                 -----    -----   -----        
                                                     (In thousands)
Service cost of benefits earned during year .   $  --    $ --     $  39
Interest cost on projected benefit obligation      --      61        16
Prior service cost ..........................     311      --        --
Return on plan assets .......................      --     (96)      (10)
Net amortization and deferral ...............      --     (22)       10
                                                -----    ----    ------

Net periodic pension (income) cost ..........     311     (57)       55
Curtailment loss ............................      --      --       233
Settlement gain .............................    (309)     --        --
                                                -----    ----    ------
Pension (income) cost .......................   $   2    $(57)   $  288
                                                =====    ====    ======

           The funded status of the plan is as follows:


                                                             December 31,
                                                            --------------
                                                            1996      1995
                                                            ----      ----
                                                           (In thousands)
Accumulated benefit obligation (all vested) ...........   $ --     $  (868)
                                                          ======   =======


Projected benefit obligation ..........................     --     $  (868)
Plan assets at fair value .............................     --       1,183
                                                          ------   -------

Excess of plan assets over projected benefit obligation     --         315
Unrecognized net gains ................................     --        (309)
                                                          ------   -------

Prepaid pension liability .............................   $   --   $     6
                                                          ======   =======
                                                                                

           The discount rates used in determining the actuarial present value of
the  accumulated  benefit  obligation  were  7.5% and  8.5%  for 1995 and  1994,
respectively. The expected long-term rate of return was 8.5% for 1995 and 1994.
           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 plan amounted to $2.1 million,  $2.3
million and $3.8 million for 1996, 1995 and 1994, 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 1996, 1995 or 1994.


                                       41

<PAGE>



 Health Care:  Certain  health care  benefits are  provided  for  employees  who
retired  prior to July 1, 1993.  Employees  who have  retired,  or will  retire,
thereafter  must pay the  full  cost of  postretirement  health  care  benefits.
Retirees who retired before July 1, 1990 pay no contributions for coverage while
those who  retired  after  July 1,  1990 and  before  July 1, 1993 make  monthly
contributions equal to 1% of their final annual pay.

           Net   post-retirement   health  care  cost   includes  the  following
components:


                                            Year Ended December 31,
                                            -----------------------
                                              1996   1995  1994
                                              ----   ----  ----
                                               (In thousands)
Interest cost on accumulated postretirement
   benefit obligation .....................   $122   $138   $79
Net amortization and deferral .............     25     20    17
                                              ----   ----   ---

Net postretirement health care cost .......   $147   $158   $96
                                              ====   ====   ===


           The plans' funded status was as follows:


                                                           December 31,
                                                  ---------------------------
                                                  1996        1995       1994
                                                  ----        ----       ----
                                                         (In thousands)
Actuarial present value of benefit obligation:
     Retirees ................................   $(1,578)   $(1,800)   $(1,678)
                                                 =======    =======    =======

Accumulated postretirement benefit
     obligations in excess of plan assets ....    (1,578)    (1,800)    (1,678)
Unrecognized net loss ........................       266        505        455
                                                 -------    -------    -------

Accrued postretirement health care
obligation ...................................   $(1,312)   $(1,295)   $(1,223)
                                                 =======    =======    =======


           Assumptions  used for the Company's  retiree  health care plans as of
December 31 include:


                                                    1996    1995    1994
                                                    ----    ----    ----
 Discount rate for determining benefit obligations  7.5%    7.0%    8.5%
 Discount rate for interest cost                    7.0%    8.5%    7.0%

           The  annual  rate  increase  in the per  capita  cost of health  care
benefits is assumed to be 9% in 1996,  decreasing to 8% in 1999 and then grading
down .5% per  year to 4.5% in 2006 and  thereafter,  over the  projected  payout
period of the  benefits.  A 1% increase in the health care cost trend rate would
increase accumulated  postretirement  benefit obligation as of December 31, 1996
by $133,347 and the  aggregate of the service and interest cost  components  for
the year then ended by $13,052.



                                       42

<PAGE>



12.        Related Party Transactions
           As of December  31,  1995,  the  Company's  note  payable to Morrison
Knudsen  was $52.1  million.  This note  related  to  various  items,  including
advances made to the Company by Morrison  Knudsen net of repayments  made by the
Company to Morrison Knudsen.
           On June 15,  1995,  in order  to  settle  their  good  faith  dispute
regarding the intercompany account and the various transactions related thereto,
the Company and  Morrison  Knudsen  entered  into an  agreement  under which the
Company's  net  intercompany  account  was reduced by $29.5  million  from $81.7
million as of May 31, 1995 to $52.2 million.
           The $52.2 million original  balance of the net  intercompany  account
was  evidenced  by an  unsecured  promissory  note,  due May 31,  2000,  bearing
interest at the prime rate. On September 10, 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  Deferred Tax
Asset of $3.9  million  and a reduction  in amounts  due to Morrison  Knudsen of
$56.6 million.
           The Company  leases  certain  facilities  from certain  directors and
former  directors  and  officers  of  the  Company.  Lease  payments,  including
utilities, to these individuals totaled $1.1 million,  $986,000 and $900,000 for
the years ended December 31, 1996, 1995 and 1994, respectively.

           The Company  incurred $1.9 million and $3.6 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, 1996 and 1995, respectively.

13.        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
(collectively referred to as "waste").  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.  For some activities the
Company must obtain permits.
           Violation of  environmental  laws or  regulations  could  subject the
Company  and  its   management  to  civil  and  criminal   penalties  and  other
liabilities.  In addition,  third parties may make claims for personal  injuries
and property damage  associated with releases of waste. A current or prior owner
or  operator  of property  may be  required  to  investigate  and clean up waste
releases  and may be liable to  governmental  entities or some other third party
for  their   investigation   and  remediation   costs  in  connection  with  the
contamination.  The Company  arranges  for the disposal or treatment of waste at
disposal or treatment  facilities  owned by third parties.  The Company could be
liable  for the costs of  removing  or  remediating  a release  of waste at such
facilities.
           Because  it  owns  and  operates  property,   the  Company  may  have
responsibility  and liability  even if it does not know of or cause the presence
of  contaminants.  Liability  is often joint and several  and is  generally  not
limited. The cost to investigate, remediate and remove waste may be substantial

                                       43

<PAGE>



and may even  exceed the value of the  property or the  aggregate  assets of the
owner  or  operator.   The  Company  may  have  difficulty  selling  or  renting
contaminated  property  or  borrowing  against  such  property.  The  government
sometimes  creates  liens  against  property  for damages and costs it incurs in
connection with contamination.  The Company has potential liabilities associated
with  its  and its  predecessor's  past  waste  disposal  activities,  including
disposal activities at plants currently being operated by the Company.

Boise, Idaho
       Heavy equipment repair and locomotive  remanufacturing commenced at Boise
Locomotive in 1972.  At the time,  solvents were used in the process of cleaning
parts  and  equipment  as  part  of the  repair/remanufacturing  process  at the
facility.  Wastewater  generated from the equipment  cleaning process containing
solvents was discharged  during the process to in-ground  wastewater  separation
basins that were  connected to buried drain fields.  This  wastewater  treatment
system was in place until 1984.  In 1985,  the  Company's  predecessor  received
notices  from  the  Idaho   Department  of  Health  and  Welfare,   Division  of
Environmental  Quality and the United States  Environmental  Protection  Agency,
indicating that it was in violation of state and federal environmental laws with
respect  to this  treatment  system  at  Boise  Locomotive.  Related  regulatory
requirements  led to the closure of the buried drain fields and a buried  trench
that was used for disposal of waste material.  Further  requirements  led to the
issuance in 1991 of a Resource Conservation and Recovery Act Part B Post Closure
Permit (the  "Permit"),  which is the formal permit pursuant to which a detailed
corrective  action plan is specified for groundwater  cleanup and for protection
of the public and  environment  following  the "closure" or  termination  of the
releases  which  created the problem.  In compliance  with the Permit,  about 57
wells  have  been  drilled  on the Boise  Locomotive  property  and on  adjacent
property to monitor,  collect, and treat contaminated  shallow  groundwater,  to
monitor  any  movement  of the  contaminated  plume,  and to monitor  the deeper
groundwater  systems at the  facility.  The Company has  estimated  the expected
aggregate undiscounted costs to be incurred over the next 24 years, adjusted for
inflation at 3% per annum, to be $4.8 million,  based on the Permit's corrective
action  plan,  and $4.4  million for  contingent  additional  Permit  compliance
requirements  related to  off-site  groundwater  contamination.  The  discounted
liability at December 31, 1996,  using a discount rate of 6.5%, was $2.1 million
based on the  Permit's  corrective  action plan,  and $2 million for  contingent
additional  Permit  compliance  requirements  related  to  off-site  groundwater
contamination.  The estimated outlays for each of the five succeeding years from
1997 to 2001 are:  $253,000,  $260,000,  $268,000,  $317,000 and  $284,000.  The
Company was in  compliance  with the Permit at December 31,  1996.  In addition,
Boise  Locomotive  would be liable  for any  damages  resulting  from  hazardous
substances migrating from the facility to deeper groundwater systems,  including
the regional  aquifer  system  which serves most of the domestic and  industrial
users of  groundwater  in the area (which  includes and extends  beyond  Boise).
Three  private  off-site  wells  are  known to have  been  impacted  by  shallow
groundwater contamination.  Two of these wells are used for residential domestic
purposes, and the third well is used for supply to a pond and landscape watering
for a residential  subdivision.  Boise  Locomotive  has entered into  agreements
whereby the residential domestic use of the wells will be abandoned and domestic
water  will be  provided  via a public  water  supply  hook-up.  In the event of
contamination of the regional aquifer, Boise Locomotive would be required, among
other  things,  to  provide  potable  water to  affected  users and to install a
treatment  system  to  clean  up the  polluted  water,  and  could  incur  other
liabilities,  the  combined  cost of which  cannot  be  estimated,  but would be
expected to be material in amount. The regional aquifer system,  however, occurs
at a depth which is approximately 200 feet below the shallow

                                       44

<PAGE>



contaminated  groundwater that is currently being  remediated.  While management
believes  there is no evidence  that the  regional  aquifer  system is currently
threatened by releases of contaminants from Boise  Locomotive,  no assurance can
be given in this regard.

Mexico
         Through its MK Gain, S.A. de C.V. ("MK Gain")  subsidiary,  the Company
has operational responsibility for facilities in Acambaro and San Luis Potosi in
Mexico,  pursuant to a contract  with the Mexican  National  Railway.  Under the
contract,  MK Gain  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 MK Gain by the  Mexican  National
Railway or recoverable  through fees payable under the contract,  which has been
structured to account for such cost. No assurance  can be given,  however,  that
the Mexican National Railway will not dispute any submissions for  reimbursement
or that the fee  structure  under the contract  will, in fact,  cover costs.  MK
Gain's operations are subject to Mexican environmental laws and regulations.  It
has obtained, or is in the process of obtaining, environmental permits, licenses
and approvals required for its operations.

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  data  base of
potential  hazardous  waste sites,  the  Comprehensive  Environmental  Response,
Compensation and Liability  Information System ("CERCLIS").  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 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.

Richland Township, Pennsylvania
         Motor Coils owns a vacant lot in Richland Township,  Pennsylvania which
has been subject to unauthorized dumping by unknown parties. The Company has not
yet tested the soil at the site or materials  disposed there.  Based on a visual
inspection,  Motor Coils  cannot yet  estimate  the cost to remove and  properly
dispose of the  material,  and does not  believe  that the  removal  will have a
material  adverse  impact on the  Company's  financial  position  or  results of
operations.

         St. Louis,  Missouri  Motor Coils  completed  voluntary  remediation of
surficial  contamination resulting from a release of xylene in connection with a
storage tank leak at its St. Louis, Missouri facility. Motor Coils

                                       45

<PAGE>



notified the relevant state regulatory  agency of its remediation plan and, with
the concurrence of the state agency,  initiated site  remediation in 1994. Based
on monitoring results, the Company discontinued site remediation in 1996.
         The Company believes that its planned expenditures are adequate to meet
its known environmental  obligations and liabilities,  including those under the
Permit, and under CERCLA and similar legislation. The Company's knowledge of its
environmental   obligations   and  liabilities  is,  for  the  majority  of  its
facilities,   based  on   assessments   and  due  diligence   conducted  by  its
predecessor's  personnel and Phase I and/or Phase II  environmental  assessments
conducted by third-party  consultants.  No assurance can be given, however, that
stricter  interpretation  and  enforcement  of  existing  environmental  laws or
regulations, the adoption of new laws or regulations, the discovery of currently
unknown  waste or  contamination  for  which  the  Company  may be  liable,  the
inability  of the Company to enforce  the  indemnification  with  respect to the
Mountaintop  plant or the continued  spread of the hazardous waste plume through
off-site  groundwater  near Boise  Locomotive  will not result in  significantly
higher environmental costs to the Company.
          Environmental  laws and regulations are subject to change at any time.
Compliance  with  current  or  future  laws and  regulations  could  potentially
necessitate  significant capital outlays by the Company, affect the economics of
a given project or cause material changes or delays in intended activities.

 Leases: The Company leases office and manufacturing  facilities under operating
leases with terms ranging from one to 12 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 1996, 1995 and 1994 was $(799,000), $(504,000), and $3 million, 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
$8.7 million,  $7.8 million, and $5.7 million for the years 1996, 1995 and 1994,
respectively.  Future  minimum  rental  payments  under  operating  leases  with
remaining  noncancelable  terms  in  excess  of  one  year  are as  follows  (in
thousands):


                                                         Sublease
                   Year     Real Estate   Equipment      Rentals          Total
                  -----      --------      --------      --------       --------
                   1997      $  1,005      $  6,139      $ (4,751)      $  2,393
                   1998           999         5,933        (4,395)         2,537
                   1999         1,041         4,852        (2,750)         3,143
                   2000         1,039         4,748        (2,750)         3,037
                   2001         1,044         4,616        (2,376)         3,284
             2002 and after     4,188        33,039       (12,805)        24,422


 Legal Proceedings:  In December 1995, Morrison Knudsen, the Company and certain
of Morrison  Knudsen's  directors  and officers  were named as  defendants  in a
complaint (the  "Pilarczyk  Lawsuit")  filed in the United States District Court
for the Northern District of New York by plaintiffs who were

                                       46

<PAGE>



principals in and/or held  substantial  stock in TMS, Inc.  ("TMS"),  a New York
corporation  acquired by Morrison  Knudsen on December 30, 1992.  The  complaint
alleges, among other things, violations of Section 10(b), Rule 10b-5 and Section
20(a)  of the  Securities  Exchange  Act of 1934,  breach  of  contract,  unjust
enrichment,  negligent  misrepresentation  and common law fraud during  Morrison
Knudsen's acquisition of TMS in 1992. Plaintiffs assert that the Company,  which
was not formed by Morrison Knudsen until 1993, is fully responsible for the acts
of Morrison  Knudsen.  However,  the actions  complained of occurred  before the
Company was formed and the Company did not assume such  liabilities  of Morrison
Knudsen. A motion to dismiss, filed in April 1996 on behalf of all defendants to
the Pilarczyk  Lawsuit,  is still pending.  Counsel to the Company  believes the
causes of action in the  Pilarczyk  Lawsuit  relating to the Company are without
merit and the Company expects that it will be successful on this motion, even if
the suit is not dismissed as to all  defendants.  If the Company is  successful,
the Company intends to make appropriate requests to the court to seek to require
the plaintiff to pay the Company's legal fees and costs.
         In June 1995,  the Company was named as defendant in a complaint  filed
with the Idaho Human Rights  Commission (the "Idaho  Commission")  and the Equal
Employment  Opportunity Commission by a female employee on behalf of herself and
other women employed by the Company alleging  discrimination based on sex, which
complaint was amended in December  1995 to include  allegations  of  retaliatory
discharge.  In 1996,  the idaho  Commission  announced that it found no probable
cause to believe either  discrimination or retaliatory discharge had occurred as
alleged in the complaint and, accordingly, the proceeding was dismissed.
          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  assembly  liners  to
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.
          In the  ordinary  course of its  business,  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, at December 31, 1996, the Company
had accrued  approximately  $405,000 for these matters.  In part because of this
accrual,  and based upon the information  obtained to date,  management believes
that such legal proceedings,  individually and in the aggregate, will not have a
material adverse effect on the consolidated operations or financial condition of
the Company.









                                       47

<PAGE>



14.      Geographic Information and Major Customers
         A summary of the Company's  operations for the years ended December 31,
1996,  1995 and 1994 and the operating  assets employed at the end of such years
by geographic area as follows:

<TABLE>
<CAPTION>


                                                        Year Ended December 31,
                                                    ------------------------------
                                                    1996         1995         1994
                                                    ----         ----         ----
                                                            (In thousands)
Sales
<S>                                             <C>          <C>          <C>      
United States ...............................   $ 253,026    $ 234,300    $ 315,323
Mexico ......................................      51,196       46,032       17,919
Australia ...................................        --          1,830       36,041
Argentina ...................................        --           --          4,923
United States sales to other geographic areas     (12,815)     (18,444)      (5,669)
                                                ---------    ---------    ---------

     Net sales to customers .................   $ 291,407    $ 263,718    $ 368,537
                                                =========    =========    =========
</TABLE>
                                                                        



                                          Year Ended December 31,
                                    -------------------------------
                                        1996       1995        1994
                                    --------   --------    --------
                                            (In thousands)
Operating income (loss)
     United States ..............   $ 19,051   $(48,319)   $(38,447)
     Mexico .....................      5,181      1,691       1,705
     Australia ..................       --       (4,485)       (674)
     Argentina ..................       --         --       (12,561)
                                    --------   --------    --------

          Operating income (loss)   $ 24,232   $(51,113)   $(49,977)
                                    ========   ========    ========





                                      Year Ended December 31,
                                      -----------------------
                                        1996        1995
                                        ----        ----
                                         (In thousands)
Identifiable assets
     United States ................   $181,131   $238,258
     Mexico .......................     52,913     42,690
                                      --------   --------

          Total identifiable assets   $234,044   $280,948
                                      ========   ========



         The following table shows the annual  percentage of the Company's sales
to customers who accounted for 10% or more of the Company's  sales for the three
years ended December 31, 1996:


                                                 Year Ended December 31,
                                            -------------------------------
                                            1996          1995         1994
                                            ----          ----         ----
Burlington Northern/Santa Fe.......          19%           18%           12%
Union Pacific/Southern Pacific.....          16%           21%           32%
Mexican National Railway...........          14%           14%            5%


                                       48

<PAGE>



         The Mexican National Railway has the right, exercisable at any time, to
rescind its contract with the Company.  While it is not  presently  determinable
what effect, if any, this would have, if the contract is rescinded,  the Company
has the right to collect a  termination  payment  intended  to  provide  for the
recovery of the Company's investment. In addition, the contract with the Mexican
National Railway is subject to certain governmental privatization actions.

15.      Supplemental Pro Forma Earnings Per Share
         Supplemental  pro forma  earnings per share for the year ended December
31, 1994 is determined by dividing the adjusted net income for the period by the
number of shares determined as follows due to the initial public offering:


Common stock outstanding
   prior ..................................          11,149,000
Incremental shares of
   common stock ...........................           5,111,005
Weighted average shares
   since May 3, 1994 ......................             592,663
                                                     ----------

Weighted average shares ...................          16,852,668
                                                     ==========
                                                                         

         The net loss for the year ended  December  31,  1994,  was  adjusted to
reflect the  additional  interest  expense on a $19 million debt from January 1,
1994,  through February 25, 1994,  transferred from Morrison Knudsen and assumed
by the Company and the reduction of interest expense  resulting from the assumed
payment of $35.6 million  dividend  notes and $39.6  million gross  intercompany
debt due  Morrison  Knudsen  as if such debt had been paid at the  beginning  of
1994.

16.      Financial Instruments
         The estimated fair values of financial instruments have been determined
by the Company,  using available  market  information and appropriate  valuation
methodologies.   Although  considerable  judgment  is  necessarily  required  in
interpreting  market data to develop  estimates of fair value,  due to the small
notional  amount of  outstanding  letters of credit,  in the  estimation  of the
Company's management, the fair values of the Company's financial instruments are
not materially  different from their carrying values on the Company's  financial
statements.  In management's  estimation,  based on the variable  interest rates
applicable to outstanding  long-term  debt, the fair value of the long-term debt
is not materially different from its carrying value.











                                       49

<PAGE>








17.      Quarterly Financial Information (unaudited)
         The following information  summarizes the Company's quarterly financial
results. Information for the first and second quarters of 1995 has been restated
for the effects of certain accounting adjustments.

<TABLE>
<CAPTION>

                                                       Quarter
                                 ---------------------------------------------------------
                                 First       Second       Third        Fourth        Total
                                 -----       ------       -----        ------        -----
                                              (In thousands, except per share data)
1996                                        
----                                        
<S>                           <C>          <C>          <C>          <C>          <C>      
Net sales .................   $  69,655    $  66,581    $  69,046    $  86,125    $ 291,407
Unusual items .............        --           --           --         (2,126)      (2,126)
Gross profit ..............      13,786       12,885       12,716       17,460       56,847
Income before extraordinary
items .....................       2,584        2,437        2,588        4,964       12,573
Extraordinary item ........        --           --           --         (1,064)      (1,064)
Net income ................       2,584        2,437        2,588        3,900       11,509
Earnings per share before
extraordinary items .......        0.15         0.14         0.15         0.28         0.72
Earnings per share ........        0.15         0.14         0.15         0.22         0.66

1995
----
Net sales .................   $  78,404    $  60,669    $  57,189    $  67,456    $ 263,718
Unusual items .............        --         (2,849)        (125)     (37,864)     (40,838)
Gross profit (loss) .......      10,181        6,642       10,822      (32,812)      (5,167)
Net loss ..................      (4,155)      (3,735)      (3,212)     (29,312)     (40,414)
Loss per share ............       (0.24)       (0.22)       (0.19)       (1.67)       (2.34)

</TABLE>


18.      Subsequent Event
         On March 6,  1997 the  Company  signed a letter  of  intent to sell its
Mountaintop,  Pa. plant for $2.9 million.  The transaction,  which is subject to
certain conditions, is expected to close later this year.

                                       50

<PAGE>



<PAGE>



                                    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 1997  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, except for
                  the information  under the caption  "Executive  Compensation -
                  Report  of  the   Compensation   Committee"   and   "Executive
                  Compensation  -  Performance  Information",   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

                  Information  required  by this  item is set  forth  under  the
                  caption "Certain  Relationships  and Related  transactions" in
                  the Proxy Statement and is incorporated by reference herein.















                                       51

<PAGE>




                                     PART IV

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

(a)  Documents filed as a part of this Report:

         (1) A list of the financial  statements  filed as a part of this Annual
Report on Form 10-K is set forth on page 22 hereof.

         (2) See Item 14(d) below, for a description of the financial  statement
schedule filed as a part of this Annual Report on Form 10-K.

         (3) 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
-----------                                  --------------------

3.01[1]        Form of Amended and Restated  Certificate of Incorporation of the
               Company
3.02[18]       Form  of  Amended  and  Restated  By-Laws  of the  Company  as of
               December 26, 1996
3.03[7]        Designation of Rights and Preferences of Class A Preferred Stock
3.04[7]        Designation of Rights and Preferences of Class B Preferred Stock
3.05[9]        Certificate  of  Designations  of  Series C Junior  Participating
               Preferred Stock
3.06[12]       Certificate of Designations of Class B Preferred Stock
3.07[18]       Certificate  of Ownership and Merger of  MotivePower  Industries,
               Inc. Into MK Rail Corporation dated December 26, 1996.
4.01[9]        Rights  Agreement,  dated as of January  19,  1996,  between  the
               Company and Chemical Mellon Shareholder Services, L.L.C.
4.02[9]        Form of Right Certificate
4.03[11]       Amendment to Rights  Agreement  dated as of April 5, 1996 between
               the  Company  and  Chase  Mellon  Shareholder  Services,   L.L.C.
               (Formerly Chemical Mellon Shareholder Services, L.L.C.)
4.04[13]       Second  Amendment to Rights  Agreement  dated as of June 20, 1996
               between the Company and Chase Mellon Shareholder Services, L.L.C.
10.01[2]       Environmental  Liability  Transfer  Agreement between the Company
               and Morrison Knudsen Corporation
10.02[2]       Corporate Support and Professional Services Agreement between the
               Company and Morrison Knudsen Corporation
10.03[2]       Form of Tax Matters  Agreement  between the Company and  Morrison
               Knudsen Corporation
10.04[1]       Agreement  between Morrison Knudsen  Corporation and Local 370 of
               the International Union of Operating Engineers, effective July 1,
               1992
10.05[1]       Agreement between Motor Coils Manufacturing Company and Local 606
               of the International Union of Electronic,  Electrical,  Salaried,
               Machine and Furniture Workers, AFL-CIO, effective August 1, 1990

                                       52

<PAGE>




10.06[1]       Agreement between Motor Coils Manufacturing Company and Local 607
               of the International Union of Electronic,  Electrical,  Salaried,
               Machine and Furniture  Workers,  AFL-CIO,  effective  November 1,
               1990
10.07[1]       Agreement between Motor Coils Manufacturing Company and Local 823
               of the International Union of Electronic,  Electrical,  Salaried,
               Machine and Furniture Workers, AFL-CIO, effective July 1, 1992
10.08[3]+      Railroad Equipment Lease Agreement between Caterpillar  Financial
               Services  Corporation  and Morrison  Knudsen  Corporation,  dated
               December 27, 1991
10.09[3]+      Railroad Equipment Lease Agreement between Caterpillar  Financial
               Services  Corporation  and Morrison  Knudsen  Corporation,  dated
               December 21, 1993
10.10[3]+      Master  Equipment  Lease  Agreement  between  Pitney Bowes Credit
               Corporation and Morrison Knudsen Corporation,  dated December 21,
               1991
10.11[3]+      Master  Equipment  Lease  Agreement  between  Pitney Bowes Credit
               Corporation and Morrison Knudsen Corporation,  dated December 10,
               1993
10.12[1]       Passenger  Railway Service Joint Venture Agreement between Benito
               Roggio  e  Hijos,  S.A.,  Cometrans,  S.A.,  Burlington  Northern
               Railroad Company and Morrison Knudsen Corporation,  dated June 1,
               1992
10.13[1]       Joint Venture Agreement between Morrison Knudsen  Corporation and
               Cometrans S.A. and IDESA S.A., dated May 7, 1993
10.14[3]       Concession Agreement between the Argentine Government Ministry of
               Economy and Public Works and Services and Metrovias S.A.
10.15[6]       Waiver and  Amendment  Letter  Agreement  dated  February 7, 1995
               between the Company and PNC Bank, National Association
10.16[2]       Form of MotivePower Industries , Inc. Stock Incentive Plan
10.17[1]       Credit Agreement  between Morrison Knudsen  Corporation and CIBC,
               Inc., dated as of February 18, 1994
10.18[6]       Lease between M & T Partners and Motor Coils  Manufacturing  Co.,
               dated July 16, 1991, and Amendment dated January 30, 1995
10.19[1]       Lease  between  Pittsburgh   Flatroll  Company  and  Motor  Coils
               Manufacturing Company, dated March 1, 1991
10.20[6]       Lease between MotivePower Industries, Inc. and SCI North Carolina
               Limited Partnership dated May 17, 1995
10.21[6]       Lease  between  MotivePower  Industries,  Inc. and M & T Partners
               effective  April 1,  1994  
10.22[10]      Employment Agreement between the Company and Joseph Fearon
10.23[2]       Form of Employment  Agreement  between the Company and Michael J.
               Farrell
10.24[3]       Master Lease Purchase Agreement, dated December 29, 1993, between
               MetLife Capital Corporation and Morrison Knudsen Corporation.
10.25[5]       Revolving  Credit and Letter of Credit  Insurance  Agreement  and
               Receivables  Purchase  Agreement  dated  September 30, 1994 among
               MotivePower Industries,  Inc., Touchstone, Inc. MK Engine Systems
               Company, Inc., Motor Coils Manufacturing Co., Power Parts Company
               and PNC Bank, National Association
10.26[4]       Form of  Company's  Indemnification  Agreement  and a schedule of
               individuals   with  whom  the  Company  has  entered   into  such
               agreements
10.27[5]       A schedule listing  additional  individuals with whom the Company
               has entered into Indemnification Agreements


                                       53

<PAGE>




10.28[5]       Employment Agreement between Company and Joseph S. Crawford dated
               as of March 29, 1994
10.29[5]       Receivables  Purchase  Agreement  dated as of September 30, 1994,
               among the Company,  Touchstone,  Inc., MK Engine Systems Company,
               Inc.,  Motor Coils  Manufacturing  Co., Power Parts Company,  and
               Clark Industries, Inc., and PNC Bank, National Association
10.30[5]       Indemnification   Agreement  between  the  Company  and  Morrison
               Knudsen Corporation, dated as of October 20, 1994
10.31[5]       MotivePower Industries, Inc. Deferred Compensation Plan
10.32[6]       Amended  and  Restated  Revolving  Credit  and  Letter  of Credit
               Issuance   Agreement  dated  March  31,  1995  among  MotivePower
               Industries,  Inc.,  Touchstone,  Inc., MK Engine Systems Company,
               Inc., Motor Coils  Manufacturing Co., Power Parts Company,  Power
               Parts Sign Company,  Alert Manufacturing & Supply Company,  Clark
               Industries, Inc. and PNC Bank, National Association
10.33[6]       Agreement  on Transfer of Rights and  Corporate  Governance  with
               Cometrans dated February 21, 1995
10.34[6]       Agreement  with  Benito  Roggio e Hijos  S.A.  regarding  sale of
               interest in Metrovias dated February 21, 1995
10.35[6]       Development  Agreement and Manufacturing and License Agreement by
               and between  MotivePower  Industries,  Inc.  and CSX  Intermodal,
               Inc., dated March 30, 1995 (The Iron Highway)
10.36[7]       Global  Settlement  Agreement  dated June 15,  1995  between  the
               Company and Morrison Knudsen Corporation
10.37[6]       Share Purchase  Agreement dated June 15, 1995 between the Company
               and Morrison Knudsen Corporation
10.38[8]       Credit Line Agreement  dated July 6, 1995 among  Bancomer,  S.A.,
               Institution De Banca Multiple,  Grupo Financiero  Bancomer and MK
               Gain S.A. De C.V. (Translated version from Spanish to English)
10.39[7]       Loan and Security  Agreement  dated  August 31,  1995,  among the
               financial  institutions named as lenders and BankAmerica Business
               Credit,   Inc.,   as  agent,   and  the   Company,   Motor  Coils
               Manufacturing Co., MK Engine Systems Co., Inc., Clark Industries,
               Inc., Power Parts, Inc.,  Touchstone,  Inc., Power Parts Sign Co.
               and Alert Mfg. & Supply Co.
10.40[8]       Waiver and First  Amendment  to the Loan and  Security  Agreement
               dated November 7, 1995, among the financial institutions named as
               lenders and BankAmerica  Business Credit, Inc., as agent, and the
               Company,  Motor Coils  Manufacturing  Co., MK Engine Systems Co.,
               Inc.,  Clark  Industries,  Inc., Power Parts,  Inc.,  Touchstone,
               Inc., Power Parts Sign Co. and Alert Mfg. & Supply Co.
10.41[7]       Memorandum of Understanding between Plaintiffs and the Individual
               Defendants  re: Newman v. Agee, et al. and Susser v. Agee, et al.
               and side letters thereto
10.42[7]       Memorandum of Understanding  between Plaintiffs,  the Underwriter
               Defendants,  MotivePower Industries and MK re: Newman v. Agee, et
               al. and Susser v. Agee, et al. and side letter thereto

10.43[7]       MotivePower   Industries   Derivative  Litigation  Memorandum  of
               Understanding re: Wohlgelernter v. Agee, et al.
10.44[10]      Employment Agreement between Company and John C. Pope dated as of
               December 29, 1995
10.45[10]      Stipulation of Settlement  between  Plaintiffs,  the  Underwriter
               Defendants, the Individual Defendants,  Deloitte & Touche LLP and
               the Insurers re:  Newman v. Agee,  et al. and Susser v. Agee,  et
               al.
10.46[10]      Stipulation of Settlement between Plaintiffs acting derivatively,
               Defendants and the Insurers re: Wohlgelernter v. Agee, et al.
10.47[10]      Second Amendment to the Loan and Security Agreement dated January
               22, 1996, among the financial  institutions  named as lenders and
               BankAmerica  Business  Credit,  Inc., as agent,  and the Company,
               Motor Coils Manufacturing Co., MK Engine Systems Co., Inc., Clark
               Industries,  Inc.,  Power Parts,  Inc.,  Touchstone,  Inc., Power
               Parts Sign Co. and Alert Mfg. & Supply Co.
10.48[10]      Waiver and  Amendment  No. 3 to the Loan and  Security  Agreement
               dated February 15, 1996, among the financial  institutions  named
               as lenders and BankAmerica  Business Credit,  Inc., as agent, and
               the Company,  Motor Coils  Manufacturing  Co., MK Engine  Systems
               Co., Inc., Clark Industries, Inc., Power Parts, Inc., Touchstone,
               Inc., Power Parts Sign Co. and Alert Mfg. & Supply Co.
10.49[14]      Locomotive  Purchase  Agreement dated as of April 8, 1996 between
               the Company and Helm Financial Corporation.
10.50[14]      Representative  Agreement  dated as of March 20, 1996 between the
               Company and Helm Financial Corporation.
10.51[14]      Agreement  dated  April 16,  1996  between  the  Company and Helm
               Financial Corporation.
10.52[14]      Locomotive  Lease  Agreement dated as of April 1, 1996 between MK
               Gain S.A. de C.V. and Helm Financial Corporation.
10.53[17]      Note  Cancellation and  Restructuring  Agreement dated as of June
               20, 1996,  by and among MK Rail  Corporation,  Morrisson  Knudsen
               Corporation,   a  Delaware  corporation,   and  Morrison  Knudsen
               Corporation, an Ohio Corporation
10.54[17]      Stockholders  Agreement dated as of June 20, 1996 between MK Rail
               Corporation and Morrison Knudsen Corporation
10.55[17]      Agreement for the Purchase and sale of Assets dated June 27, 1996
               by and among MK Rail  Corporation,  Alert  Manufacturing & Supply
               Co. and All-State Industrial
               Rubber Co., Inc.
10.56[15]      Closing  Agreement  dated July 29, 1996 among the Company,  Alert
               Manufacturing & Supply Co. and All-State  Industrial  Rubber Co.,
               Inc.
10.57[16]      Asset Purchase Agreement dated October 15, 1996 among Power Parts
               Sign Company and RI-DEL MFG. INC.
10.58[18]      Amendment  No. 1 and  Waiver to  Amended  and  Restated  Loan and
               Security Agreement dated December 30, 1996


                                       54

<PAGE>




10.59[18]      Second Amended and Restated  Credit  Agreement dated February 27,
               1997 among MotivePower Industries, Inc., as borrower, and Bank of
               America  National  Trust and  Savings  Association,  as Agent and
               Lender,  and The Other Financial  Institutions  Party Hereto,  as
               lenders
10.60[18]      Form of Employment Agreement and Exhibits thereto,  dated July 1,
               1996  between  MotivePower  Industries,  Inc. and Michael A. Wolf
10.61[18]      Form of Amendment to the Credit  Agreement dated December 13,1996
               between Bancomer,  A.A., Multiple Banking  Institution,  Bancomer
               Financial Group and MK Gain, S.A. de C.V.(Translated version from
               Spanish to English)
10.62[18]      Form of Loan Agreement dated December  13,1996 between  Bancomer,
               A.A., Multiple Banking Institution,  Bancomer Financial Group and
               MK Gain, S.A. de C.V.(Translated version from Spanish to English)
11.01[10]      Computation of Per Share Earnings
21.01[10]      Subsidiaries of the Company
23.01[18]      Consent of Independent  Auditor
27.01[18]      Article 5 Financial Data Schedule for the Year Ended December 31,
               1996
99.01[2]       Form of MotivePower Industries, Inc. Executive Incentive Plan
99.02[2]       Form of  MotivePower  Industries,  Inc.  Stock  Option  Plan  for
               Non-Employee Directors
99.03[2]       Form  of  MotivePower  Industries,   Inc.  Long-Term  Performance
               Compensation Benefit Plan
99.04[6]       Form of MotivePower Industries, Inc. Long Term Incentive Plan
99.05[6]       Class Action  Complaint  filed in the case of Newman v. Agee,  et
               al., United States  District  Court,  District of Idaho (Case No.
               CIV 94-0478-S-EJL).
99.06[6]       Class Action  Complaint  filed in the case of Susser v. Agee,  et
               al., United States  District  Court,  District of Idaho (Case No.
               CIV 94-0477-S-LMB).
99.07[6]       Derivative  Complaint  filed in the District  Court of the Fourth
               Judicial   District  of  the  State  of  Idaho  in  the  case  of
               Wohlgelernter v. Agee, et al. (Case No. CV OC 9500656 D).
99.08[9]       First Amended  Complaint,  Pilarczyk et al. v. Morrison Knudsen ,
               Inc., MotivePower  Industries,  Inc. et al., U.S. District Court,
               Northern District of New York, Civil Action No. 95-CV-1835
99.09[14]      Complaint of Vicki Kovash dated June 19,1995, as amended December
               21, 1995,  filed with the Idaho Human Rights  Commission  and the
               United States Equal Employment Opportunity Commission.
------------------------
1.             Incorporated by reference to the Company's Registration Statement
               on Form S-1 filed with the Commission on February 24, 1994.
2.             Incorporated  by reference to  Amendment  No. 1 to the  Company's
               Registration  Statement on Form S-1 filed with the  Commission on
               March 29, 1994.
3.             Incorporated  by reference to  Amendment  No. 3 to the  Company's
               Registration  Statement on Form S-1 filed with the  Commission on
               April 18, 1994.
4.             Incorporated  by reference to the Company's  Quarterly  Report on
               Form 10-Q for the Quarter ended June 30, 1994.
5.             Incorporated  by reference to the Company's  Quarterly  Report on
               Form 10-Q for the Quarter ended September 30, 1994.
6.             Incorporated by reference to the Company's  Annual Report on Form
               10-K for the Year ended December 31, 1994.
7.             Incorporated  by  reference to the  Company's  Report on Form 8-K
               filed with the Commission on September 18, 1995.
8.             Incorporated  by reference to the Company's  Quarterly  Report on
               Form 10-Q for the Quarter ended September 30, 1995.

                                       55

<PAGE>



9.             Incorporated  by  reference to the  Company's  Report on Form 8-K
               filed with the Commission on January 31, 1996.
10.            Incorporated by reference to the Company's  Annual Report on Form
               10-K for the Year ended December 31, 1995.
11.            Incorporated  by reference to the  Company's  Amendment  No. 1 on
               Form 8-A/A filed with the Commission on April 25, 1996.
12.            Incorporated by reference to the Company's Current Report on Form
               8-K filed with the Commission on April 18, 1995.
13.            Incorporated  by reference to the  Company's  Amendment  No. 2 on
               Form 8-A/A filed with the Commission on July 3, 1996.
14.            Incorporated  by reference to the Company's  Quarterly  Report on
               Form 10-Q for the Quarter ended March 31, 1996.
15.            Incorporated  by reference to the Company's  Quarterly  Report on
               Form 10-Q for the Quarter ended June 30, 1996.
16.            Incorporated  by reference to the Company's  Quarterly  Report on
               Form 10-Q for the Quarter ended September 30, 1996.
17.            Incorporated by reference to the Company's Current Report on Form
               8-K filed with the Commission on July 3, 1996.
18.            Filed herewith.

+ Subject to Freedom of Information Act request for confidential treatment.


(b)  Reports on Form 8-K

No reports  on Form 8-K were  filed by the  Company  during  the  quarter  ended
December 31, 1996.

(c)  Exhibits

The exhibits  listed under Item 14(a)(3) are filed herewith or are  incorporated
by reference herein.

(d)  Financial Statement Schedules

Independent Auditors' Report

Schedule II - Valuation and Qualifying Accounts is filed herewith.

                                       56
<PAGE>




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, 1996 and 1995,  and for each of the
three years in the period ended  December  31, 1996,  and have issued our report
thereon  dated  February  10,  1997  (except for Note 7, as to which the date is
February  27,  1997 and Note 18,  as to which the date is March 6,  1997);  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 an
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.

DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
February 10, 1997























                                       57

<PAGE>
<TABLE>

<CAPTION>

                                                                     Schedule II

                          MotivePower Industries, Inc.
                        Valuation and Qualifying Accounts
                                 (In thousands)


                                                          Additions -
                                Balance at  Additions -   Charged to
                                 beginning  Charged to      other                  Balance at
                                    of       costs and     accounts                  end of
Description                       period     expenses     - describe  Deductions     period
-----------                       ------     --------     ----------  ----------     ------

Year Ended December 31,
1996
-----------------------
<S>                               <C>        <C>        <C>           <C>         <C>     
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 ...      9,408       --         --          (3,097)      6,311
Environmental reserves ........      4,060         18       --            --         4,078

Year Ended December 31,
1995
-----------------------                                                                                  
Loss reserves .................   $ 14,903   $ 10,458   $   --        $(10,185)   $ 15,176
Warranty and overhaul reserves       5,434      6,370       --          (7,402)      4,402
Inventory reserves ............        865     12,263       --            (100)     13,028
Allowance for doubtful accounts        205        450       --            (124)        531
Valuation allowance - taxes ...      7,252      2,156       --            --         9,408
Environmental reserves ........      2,653      1,451       --             (44)      4,060

Year Ended December 31,
1994
-----------------------
Loss reserves .................   $    797   $ 15,790   $   --        $ (1,684)   $ 14,903
Warranty and overhaul reserves       4,032      4,315       --          (2,913)      5,434
Inventory reserves ............        351        790       --            (276)        865
Allowance for doubtful accounts        111        651       --            (557)        205
Valuation allowance - taxes ...       --        6,063      1,189(a)       --         7,252
Environmental reserves ........      2,669        160       --            (176)      2,653

<FN>



Notes:
(a) Effect of valuation  allowance  related to deferred  income taxes  resulting
from  translation  gains  and  losses  deferred  as  a  separate   component  of
stockholders' equity.
</FN>
</TABLE>

                                       58

<PAGE>



                                   SIGNATURES

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


MotivePower Industries, Inc.

By:/s/ Michael A. Wolf
Michael A. Wolf
President and Chief Executive Officer

Date: March 13, 1997




                                       59

<PAGE>



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


  Signature                       Title                              Date
  ---------                       -----                              ----


/s/ John C. Pope                Non-Executive Chairman and        March 13, 1997
-----------------------------   Director
John C. Pope                    


/s/ Michael A. Wolf             President and Chief Executive     March 13, 1997
-----------------------------    Officer and Director         
Michael A. Wolf                  (Principal Executive Officer) 
                                


/s/ William F. Fabrizio         Senior Vice President             March 13, 1997
-----------------------------    and Chief Financial Officer 
William F. Fabrizio             (Principal Financial Officer)
                                


/s/ William D. Grab             Vice President, Controller and    March 13, 1997
-----------------------------   Principal Accounting Officer
William D. Grab                 


/s/ Gilbert E. Carmichael       Vice Chairman and Director        March 13, 1997
-----------------------------
Gilbert E. Carmichael


                                 Director                         March 13, 1997
-----------------------------
Ernesto Fernandez Hurtado


/s/ Lee B. Foster II             Director                         March 13, 1997
-----------------------------
Lee B. Foster II


/s/ James P. Miscoll             Director                         March 13, 1997
-----------------------------
James P. Miscoll


/s/ Nicholas J. Stanley          Director                         March 13, 1997
-----------------------------
Nicholas J. Stanley                                            

                                   60

<PAGE>