UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

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

For the Fiscal Year Ended December 31, 2004

Commission file number:   000-50543

PORTEC RAIL PRODUCTS, INC.

(412) 782-6000

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

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

Common Stock, par value $1.00 per share

     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 þ  NO o

     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. þ

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES o  NO þ

     As of June 30, 2004, the aggregate market value of the registrant’s common stock held by non-affiliates based upon the closing price of $7.94 was $33.2 million.

     As of March 15, 2005, there were 9,601,779 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

1.	Portions of the Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference into Parts III and IV.

PORTEC RAIL PRODUCTS, INC.

INDEX TO FORM 10-K

Cautionary Statement Relevant to Forward-looking Statements

     This Form 10-K contains or incorporates by reference forward-looking statements relating to the Company. These statements may be found throughout this Form 10-K, particularly under the headings “Management’s Discussion and Analysis of Financial Condition and Results of Operation” and “Business,” among others. Forward-looking statements typically are identified by the use of terms, such as “may,” “will,” “plan,” “should,” “expect,” “anticipate,” “believe,” “if,” “estimate,” “intend,” and similar words, although some forward-looking statements are expressed differently. You should consider statements that contain these and similar words carefully because they describe our expectations, plans, strategies, goals and beliefs concerning future business conditions, our results of operations, our financial position, and our business outlook, or state other “forward-looking” information based on currently available information. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors. We undertake no obligation to update publicly or revise any forward-looking statements. You should not place undue reliance on the forward-looking statements.

     The Company identifies below important factors that could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. In particular, the Company’s future results could be affected by a variety of factors, such as:

	•	customer demand;
	•	competitive dynamics in the North American and worldwide railroad and railway supply industries;
	•	capital expenditures by the railway industry in North America and worldwide;
	•	economic conditions, including changes in inflation rates or interest rates;
	•	product development and the success of new products;
	•	our ability to successfully pursue, consummate and integrate attractive acquisition opportunities;
	•	changes in laws and regulations;
	•	limited international protection of our intellectual property;
	•	the loss of key personnel;
	•	fluctuations in the cost and availability of raw materials and supplies, and any significant disruption of supplies;
	•	foreign economic conditions, including currency rate fluctuations;
	•	political unrest in foreign markets and economic uncertainty due to terrorism or war;
	•	exposure to pension liabilities;
	•	seasonal fluctuations in our sales;
	•	technological innovations by our competitors; and
	•	the importation of lower cost competitive products into our markets.

     The Company specifically declines to undertake any obligation to publicly revise any forward-looking statements that have been made to reflect events or circumstances after the date of those statements or to reflect the occurrence of anticipated or unanticipated events.

PART I

ITEM 1.     BUSINESS

Overview

     Portec Rail Products, Inc. (sometimes herein referred to as “we,” the “Company,” or “Portec Rail Products”) was incorporated in West Virginia in 1997. We manufacture, supply and distribute a broad range of railroad products, including rail joints, rail anchors, rail spikes, railway friction management products, railway wayside data collection and data management systems and freight car securement devices. We also manufacture

material handling equipment through our United Kingdom operation. We serve both the domestic and international markets. We and our predecessors have served the railroad industry since 1906. In 1997, a group of private investors including several senior executives of Portec, Inc., our predecessor company, purchased the rail-related assets and selected material handling assets of, and assumed certain liabilities of, Portec, Inc.

We operate through four global business segments consisting of Railway Maintenance Products Division (“RMP”), Shipping Systems Division (“SSD”), 3094497 Nova Scotia Company (“Canada”) and Portec Rail Products (UK) Ltd. (“United Kingdom”). The presentation of segment information reflects the manner in which we organize and manage our segments by geographic areas for making operating decisions, assessing performance and allocating resources. Sales and operating income by segment are presented in Management’s Discussion and Analysis set forth in Item 7 in this annual report on Form 10-K and Note 14 “Segments, Geographic and Major Customer Financial Information” of our consolidated financial statements set forth in Item 8 in this annual report on Form 10-K.

Our corporate headquarters is located at 900 Old Freeport Road, Pittsburgh, Pennsylvania. Our telephone number is (412) 782-6000.

Railway Maintenance Products Division – “RMP”

     In our RMP business segment, our largest overall business segment, we provide track components and friction management products and services to railroads, transit systems, and railroad contractors from our manufacturing and assembly plant located in Huntington, West Virginia. In addition, RMP’s newly acquired wholly-owned subsidiary, Salient Systems, Inc (Salient Systems), also provides our railroad customers with railway wayside detection and operating asset data management systems from its engineering and assembly operation in Dublin, Ohio. We will continue to operate and sell this product line under the Salient Systems name. Approximately 90% to 95% of our sales from this entire business segment are to our United States and Canadian customers while 5% to 10% of our sales from this segment are to other customers. RMP’s administrative functions such as customer service, engineering, purchasing and accounting are conducted in Pittsburgh, Pennsylvania in the same office location as the corporate headquarters.

     Track and Related Products. We sell a variety of products to support track work repair and installation. The primary customers for these products are the major Class I railroads, regional railroads, local railroads and transit systems. These products include standard and insulated rail joints, gauge plates, track mats, curve blocks and jacking systems.

     RMP is a major supplier of rail joints in the North American market. Rail joints are high strength bars, designed to join rails together while maintaining rail strength and continuity. Many joints are designed to be insulated from the rail to facilitate the railway signal system. Low voltage current is transmitted through the rail and segments of the track are electrically isolated through the use of insulated rail joints. We furnish our customers epoxy-bonded insulated joints, polyurethane-coated insulated joints and epoxy fiberglass insulated joints.

     As railroads have increased axle loads, train speeds and utilization of main lines, the demands placed upon the rail joint also have increased. To meet these demands, we have expanded and improved our product line of standard joints, bonded insulated joints, polyurethane-coated insulated joints and fiberglass epoxy insulated joints. Continued technological advancements in metallurgy and adhesives in addition to engineering tools such as computer aided design analysis and advanced product testing processes are enabling us to provide a higher level of product performance.

     Friction Management Products and Services. As the North American market leader, our friction management products and services improve train-operating efficiency and reduce track stresses and related maintenance costs for our customers. Friction management or rail lubrication involves placing a film of grease or other lubricant between the flanges of locomotive or railcar wheels and the inside of the rail head (the gauge face). Our friction modifiers are applied to the top-of-rail (the running surface) between the rail head and the tread of the wheel. A friction modifier is designed to reduce friction, but not below the level needed for braking and traction. These products can be applied by a fixed station at the side of the track (wayside application), by a specifically equipped truck as it moves along the rails (hi-rail application), or by units mounted on a locomotive or transit system car (on-board application). The dominant technology is a wayside tank and pump with special distribution bars

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fastened to the rail. As railroads increase axle loads and utilization of main lines, friction management becomes increasingly important. If done effectively, friction management reduces noise, and may provide large savings to the customer through reduced rail wear, wheel wear, road bed maintenance and reduced fuel consumption. We design, manufacture and sell the equipment for the application of our friction modifiers and various other purchased lubricants.

     Our most advanced electronic wayside friction management system is the Protector^® IV which we began producing and selling in August 2000. The Protector^® IV is a transit system and freight railroad solution that reduces rail wear, lateral forces and noise, and is now in service in the United States, Canada, Europe and Japan. The Protector^® IV is our first wayside system developed to function in the wide array of operating conditions found in all of these diverse markets.

     On November 30, 2004, we purchased Kelsan Technologies Corp. (Kelsan) located in Vancouver, British Columbia, Canada that now provides us the capability to manufacture and sell the friction modifiers that are pumped through both our wayside and top of rail equipment. See “Recent Acquisitions”.

     We believe we now offer our customers the widest choice of railway friction management products and services for most applications and have a significant share of the United States market for railway friction management products.

     Railway Wayside Detection and Operating Asset Data Management Systems. On September 30, 2004, we acquired Salient Systems, Inc., which has been in the railway wayside and operating data management business since 1984. We believe that the acquisition will strengthen our global footprint in the growing market for wayside detection and operating asset data management systems, as well as strengthen our friction management product lines. We believe that the Salient Systems technology will enhance the capabilities of our friction management equipment so that we can continue to provide our customers with improved and cutting edge technology to achieve even greater railroad operating efficiencies.

     Salient Systems designs, manufactures and provides wayside measurement and detection products, services and support for both the domestic and the international railway transportation industry. Salient Systems’ equipment and software are engineered to enhance our rail customers equipment utilization by improving reliability and reducing maintenance expense . We will continue to sell this product line to our customers under the Salient Systems name.

     Salient Systems’ three major product lines fall under its comprehensive set of software and hardware solutions for the global railroad market as its IntelliTrack® technologies.

  Wayside Data Collection Systems. The wayside data collection systems focus on the health of rolling stock:

	•	Wheel Impact Load Detector — Continually monitors locomotive and rail car wheel health by measuring and reporting the impact loads from moving trains allowing for the targeted removal of defective wheels from service.
	•	Hunting Truck Detector — Provides alarms for excessive lateral forces caused by hunting trucks before they significantly contribute to the rapid wear of rail and rail cars.
	•	Truck Performance Detector — Provides alarms for rail cars whose suspension systems are not tracking properly along curved track due to worn or defective undercarriages.
	•	Automatic Vehicle Overload & Imbalance Detector — Provides alarms for overloaded or imbalanced rail cars at track speeds with an additional high speed weigh-in-motion capability.
	•	Low Hose Detector — Provides alarms for low or dragging coupling hoses on rail cars by means of an optical sensing approach to minimize false alarms common to mechanically-based systems.

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StressNet® — A strategic network of proprietary Rail Stress Monitors installed along the rail that routinely measure and record a region’s longitudinal stress and temperature history. The data can then be uploaded for analysis and reporting by the StressNet® Data Management System.

  Database Management Systems. Salient Systems also markets two database management systems that provide extensive trend analysis to proactively identify potential safety problems and optimize maintenance planning:

	•	Wheel Data Management System — Presents fleet performance and actionable maintenance information in a customer readable form.
	•	StressNet® Data Management System — Provides long-term trend analysis of shifts in neutral rail temperature to reveal track regions increasingly at risk of rail buckling or pull-aparts.

  Rail Friction Management Systems. The rail industry recognizes the benefits of proper system-wide lubrication and the effects of poor or improper lubrication on fuel consumption, rail wear and noise. Salient Systems’ product line includes two tribometer products to assist in rail friction management that we will now utilize as part of our approach of providing a total solution to a customer’s friction management problem:

	•	High Speed TriboRailer® — A lightweight, automated high speed tribometer that provides complete system-wide lubrication analysis of both rails simultaneously with minimal service disruption.
	•	Portable Tribometer — An effective, user-friendly method to spot-check the coefficient of friction of rail/wheel interfaces and validate the quality of rail lubrication methods.

Shipping Systems Division – “SSD”

     In our SSD segment, we engineer and sell load securement systems to the railroad industry. These systems secure a wide variety of products and lading onto freight cars. Although SSD has some assembly work performed at our RMP division’s Huntington, West Virginia plant, most manufacturing is subcontracted to independent third parties. SSD is headquartered near Chicago, in Oak Brook, Illinois.

     We believe that we possess a significant share of the combined United States and Canadian railroad load securement systems market. Our customers include railroads, railcar builders, railcar repair shops and railcar lessors. Our largest customer is TTX Company, which also is headquartered in Chicago and is owned by certain Class I railroads. TTX Company leases to the railroads its large fleet of railroad flat cars, intermodal railcar platforms, boxcars and gondolas. Many of these cars are outfitted with fastening systems designed and manufactured by us to haul specific products such as lumber, pipe, farm equipment, construction equipment and military vehicles.

     During 2004, SSD commercialized the Cushioned Banding Anchor (CBA) for load securement systems used in transporting large diameter gas-line pipe. The CBA was developed in response to the railroads’ need to transport pipe more effectively and safely over long distances. We feel that the product was a success as our customers purchased over 63,000 units, which generated net sales of approximately $1.8 million in 2004.

     SSD continues to work closely with TTX Company and a major rail car builder, Trinity Rail, to promote its patented WinChock^TM Securement System for transporting heavy-duty highway truck tractors, fire trucks, school buses, and farm tractors as well as other similar vehicles in fully enclosed railcars.

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3094497 Nova Scotia Company, our wholly-owned Canadian subsidiary – “Canada”

     In conjunction with the Kelsan acquisition, we established a new Canadian subsidiary, 3094497 Nova Scotia Company (Nova Scotia) and transferred ownership of Portec, Rail Products Ltd to Nova Scotia. Portec, Rail Products Ltd. is now a wholly-owned indirect Canadian subsidiary and Nova Scotia is our wholly-owned Canadian subsidiary. Nova Scotia was established to provide a legal structure for our Canadian subsidiaries that would provide the most advantageous tax benefits under both Canadian and United States income tax laws.

     From an operations standpoint, in Canada, we produce rail anchors and spikes primarily for the Canadian railroads with some products exported to the United States and other international customers at our manufacturing plant in St. Jean located about 30 miles southeast of Montreal. Rail anchors and rail spikes are devices used to secure rails to ties to restrain the movement of the rail tracks. In addition, our Canadian operation manufactures and sells friction management products out of its headquarter facilities located in Lachine, Quebec, a suburb of Montreal.

     We believe our Montreal operation has been successful over the years in maintaining a dominant market share with the Canadian railroads for our friction management, rail anchor and rail spike product lines. There are two major Canadian transcontinental railroads that we serve, the Canadian Pacific Railway and the Canadian National Railway, and a number of regional railroads.

     In November 2004, we acquired Kelsan Technologies Corp. (Kelsan), a manufacturer of proprietary friction control solutions for the railway industry. The Kelsan acquisition will provide us with the ability to broaden the scope of our railway friction management services and products. Kelsan has two primary product lines, a stick friction modifier and related application system which is utilized for gauge face lubrication and a top of rail liquid friction modifier, Keltrack^®. Kelsan’s unique solutions control friction at the wheel/rail interface in order to reduce a railroad’s operating costs while improving performance by extending rail and wheel life, improving fuel efficiency and also reducing noise and lateral forces. Kelsan has a commercially driven research and development team that has generated an ongoing stream of intellectual property while trying to generate a patent wall around its technology. Kelsan also has an established network of agents and distributors throughout the world, in particular Europe and Asia, to supplement its sales team. This network will also be used as a platform to more aggressively promote our friction management equipment product lines into these two key markets, while realizing continuing ongoing sales of the friction modifier solutions being pumped onto the rails through our equipment. See “Recent Acquisitions”.

Portec Rail Products (UK) Ltd., our wholly-owned United Kingdom subsidiary – “United Kingdom”

     In the United Kingdom, we operate and serve customers in two markets. In the rail market, we produce railway lubrication products at our Wrexham, Wales location. Over the past several years, there has been heightened interest at Network Rail, the United Kingdom national railway infrastructure system, in the rail/wheel interface due to several accidents involving broken rail. Proper rail grinding to profile the rail and friction management are seen as preventative measures and this has stimulated additional business for us. We have also recently introduced our Protector^® IV system to the United Kingdom operation from North America. We believe that our United Kingdom operation possesses a significant share of the wayside lubrication market in the United Kingdom.

     In the material handling market, we operate and serve our customers primarily from a dedicated material handling operation in Leicester, England although some functions are also performed in Wrexham. At our Leicester operation, we design, manufacture and sell various material handling products, such as overhead and floor conveyors, racking systems and mezzanine flooring systems. Our material handling systems are designed to provide our customers with a total solution to moving their products throughout their factory, offloading their products from trucks and moving their goods in other types of applications.

     In December 2002, we acquired the Quodeck product line from Quodeck Ltd. Quodeck is a line of conveyors, racking systems, mezzanine floor systems and turnkey equipment mainly used in the garment distribution industry. The Quodeck acquisition helped to expand our client base and provided us with new opportunities to serve the warehouse and distribution markets in the United Kingdom.

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Alliances

     In recent years, we have created alliances with independent strategic partners within our industry to broaden the scope of our existing friction management products and services we provide our customers. In 2000, we formed an informal alliance of technology companies to enhance friction management solutions for the wheel/rail interface. There are no written agreements among all the members of the alliance, although we have entered into sales representation or distribution agreements with three individual alliance members. Under the Friction Force^sm service marked brand of products and services, the alliance strengthens our market position in lubrication and friction management and enables us to deliver improved solutions with enhanced value to our customers, especially in the area of providing our customers with different types of lubricants. We are the exclusive North American distributor for the SoyTrak™ Rail Curve Lubricant, a biodegradable, environmentally-friendly soy-based lubricant developed and manufactured by Environmental Lubricants Manufacturing, Inc.

Industry Overview

     We provide products and services primarily for the railway industry, which includes freight railroads and transit systems. Rail traffic is a key factor underlying the demand for our products and services. Deregulation and consolidation in the railroad industry, market competition between railroads and trucking and the impact of the global economy continue to impact the railway industry, including the railway supply market. We believe the railway industry is in a long-term growth trend. In North America and Europe, the industry is being driven by economic growth as well as highway traffic congestion. In developing countries, the growth is being driven by economic growth and development and modernization.

     United States freight railroads fall into several classifications. “Class I” railroads are defined as those with operating revenue of at least $273 million in 2003. “Regional” railroads are defined as line-haul railroads that operate at least 350 miles of road and/or earned revenue between $40 million and the Class I threshold. Lastly, “Local” railroads include freight railroads, which are not Class I or regional. Local railroads operate less than 350 miles of road and earn less than $40 million annually. Since 1979, consolidation in the railroad industry has resulted in 36 Class I railroads being reduced to seven. In addition, two Canadian railroads and two Mexican railroads have enough revenue that they would be Class I railroads if they were U.S. companies. In particular, several mergers of large U.S. railroads have occurred in the last 15 years. We believe that the improved efficiency and service capabilities of the new larger railroads ultimately tend to boost rail traffic, which is the underlying source of demand for our products.

     The railway industry in North America and worldwide is a capital intensive industry, and our sales activity depends in significant part upon the industry’s capital expenditures for railroad maintenance and for programs designed to increase the efficiency and productivity of rail operations.

Public Offering

     On January 28, 2004, we sold 2,000,000 shares of our common stock at a price of $10 per share in an underwritten initial public offering. Net proceeds were approximately $17.1 million. A portion of the proceeds from this offering was used to repay approximately $7.3 million of outstanding indebtedness. In addition, on February 26, 2004, upon exercise by the underwriter of its option to purchase additional shares to cover over-allotments in the initial public offering, we completed the sale of an additional 95,000 shares of our common stock at a price of $10 per share. Net proceeds from the sale of additional shares were approximately $867,000.

Recent Acquisitions

     On July 20, 2004, we entered into an agreement to acquire 100% of the outstanding common shares of Salient Systems, Inc., a global leader in railway electronic wayside data collection and data management systems, located in Dublin, Ohio. This acquisition was completed on September 30, 2004. Including a working capital adjustment of $758,000 paid in November 2004, Salient Systems was acquired for $13.5 million in a combination of cash and common stock plus direct acquisition costs of $504,000. Goodwill and other intangible assets of approximately $15.1 million were created as part of the acquisition purchase price allocation. Salient Systems currently operates as part of our RMP business segment.

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     On November 1, 2004, we entered into an agreement to acquire Kelsan Technologies Corp., a manufacturer of rail lubrication and friction management products, located in Vancouver, Canada. This acquisition was completed on November 30, 2004. Kelsan was acquired for approximately $14.9 million in cash, not including acquisition costs, and was financed entirely by bank financing. Direct acquisition costs amounted to approximately $496,000. Goodwill and other intangible assets of approximately $15.0 million were created as part of the acquisition purchase price allocation. Kelsan is a subsidiary of Portec, Rail Products Ltd. and operates as part of our Canadian business segment.

Business Strategy

     Our business strategy is to (i) increase the market share of our track component products that serve as the foundation for our railway business, (ii) advance the technology and expand the friction management products and services along with our wayside detection and data operating management systems that we offer to railroads and transit system companies in North America while expanding our geographic footprint globally, with a primary focus on Europe and Asia, (iii) increase our offering of products and services to assist businesses in loading, securing and transporting materials on railcars, and (iv) increase sales and profitability of our material handling products.

     We intend to continue to evaluate acquisition opportunities as they arise. To this end, we completed the Salient Systems and Kelsan acquisitions in 2004. These transactions resulted in the acquisition of companies with complementary product lines or that can provide technological enhancements to our current products and which can benefit from utilizing our existing distribution and manufacturing platforms.

Sales and Marketing

     Each of our business units initiate their individual sales programs, which vary due to the different product lines and geographic locations. Our marketing efforts include promoting our business through trade show presentations, through trade magazine advertising and through our website. In addition, our managers and engineers participate in various industry conferences and industry professional organizations to interface with customer engineers and end users of our products. The business units also use an inside sales department to sell small orders and replacement parts and a combination of employee sales managers, third party sales representatives and distributors to call on customer purchasing managers, engineers and operations managers. Internationally, we also utilize a network of agents across Europe and Asia as well as our own in-house sales people to reach our current customers as well as cultivating potential new customers in these areas.

Sources and Availability of Raw Materials and Supplies

     The products we manufacture and sell require a supply of raw materials, including steel and steel fabrications and numerous specialty components, such as pumps, distribution bars and electronic controls. There are at least two suppliers for most components. Inventory levels are continually monitored to ensure adequate supplies are available to meet our production requirements. Periodically, advance purchases are made to avoid possible shortages of material due to capacity limitations of component suppliers and possible price increases. We rely on established relationships with major suppliers to ensure the availability of raw materials and specialty items rather than long term supply contracts.

     Although there are a large number of domestic and foreign suppliers of steel and steel fabricators, our RMP division for many years has relied upon a supply relationship with Steel of West Virginia, Inc. for a substantial amount of its joint bar steel. Joint bar steel is rolled to various profiles and sizes requiring proprietary steel mill rolls that are not easily transferable from mill to mill. Steel of West Virginia, Inc. maintains the rolls for us after we purchase them. Similarly, for the most part, our Montreal operation obtains the bulk of its steel supply for rail spikes and rail anchors from Norambar Inc., but also has a second source for steel from another Canadian supplier. Raw materials for Salient Systems, SSD, Kelsan and United Kingdom are readily available from various suppliers.

     In recent years, substantially all of our domestic requirements for steel were purchased from Steel of West Virginia, Inc. and our Canadian requirements were purchased from Norambar Inc. In 2005, we have arranged to import a small quantity of steel from China. This will provide an additional steel source as we continue to monitor

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the prices and availability from our domestic steel suppliers. Our goal is to maintain good relationships with our suppliers and we have not experienced any significant interruptions in recent years in the supply of raw materials or specialty components.

Principal Customers

     Our business depends largely upon sales to United States and Canadian railroads and transit systems. For the year ended December 31, 2004, sales to our two largest customers, Canadian Pacific Railway and Canadian National Railway, accounted for approximately 13% and 8% of our total sales, respectively. For the year ended December 31, 2003, sales to Canadian Pacific Railway and Norfolk Southern Railway accounted for approximately 15% and 9% of our total sales, respectively. For additional information on our principal customers, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Business Segment Review.”

Backlog

     Our backlog is based on customer purchase orders that we believe are firm. Customer orders, however, may be subject to cancellation and other customary industry terms and conditions. Historically, little variation has been experienced between the number of products ordered and the number of products actually sold. A significant portion of our sales have very short lead terms of 30 to 60 days, that may not be recorded on any quarter or year end backlog summary. The backlog is not necessarily indicative of future results of operations. The railroad industry, in general, has historically been subject to fluctuations due to overall economic conditions.

     The following table sets forth the dollar amount of backlog for each of our business segments at the dates indicated.

Seasonality of Business

     The demand for certain of our products is subject to seasonal fluctuations. Our railroad product lines normally experience strong sales during the second quarter as a result of seasonal pick-up in construction and trackwork due to favorable weather conditions. In contrast, our railroad product lines experience normal downturns in sales during the fourth quarter due in large part to reductions in construction and trackwork during the cold weather months, particularly in the northern United States and Canada. This reduction in sales generally has a negative impact on our fourth quarter results. Notwithstanding seasonal trends, quarterly fluctuations in railroad capital spending programs can alter the expected seasonal impact on our business.

Patents and Trademarks

     We own a number of United States and Canadian patents and trademarks including those acquired with the purchase of Salient Systems and Kelsan in 2004. We have several patents on our friction management products, such as the Protector® IV application system, along with a significant number of patents related to our newly acquired friction modifier product lines at Kelsan, which we believe are of material importance to the business as a

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whole. We believe that, in the aggregate, our patents and trademarks give us a competitive advantage. We also rely on a combination of trade secrets and other intellectual property laws, non-disclosure agreements and other protective measures to establish and protect our proprietary rights in intellectual property.

Research and Development

     Our research and development programs focus on improving the effectiveness of our existing products and innovating new products and technologies for our customers. During the years ended December 31, 2004, 2003 and 2002, we estimate we spent approximately $1.0 million, $579,000 and $584,000, respectively on these research and development programs.

     The largest portion of our research and development efforts have been devoted to developing friction management products, particularly the Protector® IV electronic lubricator, as well as the associated distribution bars for both gauge face lubrication and top-of-rail friction modifiers. In addition to the wayside Protector® IV system, we have devoted resources to the high-rail spray system for applying friction management products and to a lesser extent investigations into the on-board locomotive mounted spray system. We also have research and development programs for our securement systems products, particularly the WinChock™ securement system. With the acquisition of Salient Systems in 2004, we intend to continue to dedicate resources to bring the Railstress Monitor product line to commercialization during 2005. In addition, we will continue to fund the necessary improvements and technological advancements of Kelsan’s stick lubrication and liquid friction modifier product lines.

Competitors

     We operate in a competitive marketplace. Price competition is strong, customers are cost-conscious and the number of significant customers is limited, particularly with respect to our track component product lines. Therefore, our ability to increase prices has been limited. In addition to price, competition is based on product performance and technological leadership, quality, reliability of delivery and customer service and support. Our principal competitors vary to some extent across our principal product lines. A number of our competitors are larger and have greater financial resources.

     We believe we have a dominant share of the wayside rail lubrication market in North America because of our technically advanced lubrication products. At present, we are aware of two companies, Lincoln Industrial Corporation and Queyhead Industries Limited (Queyhead), that are trying to penetrate this market. In addition, we believe that Queyhead is our only competitor for wayside lubrication products in the United Kingdom; however, we believe this competitor has a significantly smaller market share than our United Kingdom business segment.

     We feel that we also possess a dominant share of the rail anchor market in Canada. We believe that Unit Rail Anchor Company, Inc., owned by Amsted Industries Incorporated, is our only major competitor for rail anchors in North America and the dominant supplier of rail anchors in the United States. Because of its high volume and low cost structure, Unit Rail Anchor remains a competitive threat as the North American market leader.

     Through our acquisition of Salient Systems, we also believe that we possess a dominant market share of the Wheel Impact Load Detector and associated wayside detection and operating asset data management systems in North America. Competitive products have been developed in certain markets, notably Australia and South Africa, but, to date, these systems have not yet been effectively marketed outside of their home countries.

     Through our acquisition of Kelsan, we also believe that we possess a dominant market share of the top of rail friction management systems in North America. Kelsan also markets a solid stick lubrication system for gauge face lubrication. Competitive stick lubrication products have been developed in certain market segments, but, to date, these systems have not yet been effectively marketed outside of their home market segments and have not been a competitive threat to Kelsan’s existing business.

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Environmental Matters

     We are subject to foreign, national, state, provincial, and local environmental laws and regulations concerning, among other matters, air emissions, wastewater discharge, solid and hazardous waste disposal, and employee health and safety. We maintain an active program of environmental compliance and believe that our current operations are in material compliance with all applicable environmental laws and regulations. See “Legal Proceedings” for information relating to a proceeding in which we are involved, regarding environmental matters.

Regulation

     In the course of our operations we furnish products and services which are required to meet industry specifications. The American Railway Engineering and Maintenance of Way Association (AREMA) publishes standards and recommends practices applicable to our track component product line. Our customers use the AREMA standards and from time to time include their own specifications for the products and services that they purchase. The Association of American Railroads (AAR) promulgates a wide variety of rules and regulations governing the safety and design of equipment. Our securement system designs require AAR approval as well as our customer’s approval and often the approval of the shipper. In the United Kingdom, our products must gain approval and meet the specifications of Network Rail, the national United Kingdom rail infrastructure system.

     We maintain quality assurance programs at all of our locations. The RMP business segment follows the standards of the National Association of Purchasing Managers and the AAR’s M1003 Quality Assurance requirements. Our plant in St. Jean, Quebec, Canada has attained ISO 9001:2000 certification; our plant in Vancouver, British Columbia, Canada has attained ISO 9001:2000 certification; and our United Kingdom locations are certified under ISO 9001:2000.

Employees

     We employed 279 people at December 31, 2004, of which 118 were located in the United States, 97 were located in Canada, 63 were located in the United Kingdom and one person was located in Australia. The acquisition of Salient Systems and Kelsan added 19 and 45 new employees to our company in 2004, respectively. We consider our relationship with our employees to be good. Our employees in the United States, the United Kingdom and our Canadian employees in Vancouver, British Columbia (Kelsan) are not subject to any collective bargaining agreement. Approximately 12% of our employees, all of whom are employed at our Canadian operation near Montreal, are subject to a collective bargaining agreement. This agreement is effective through August 31, 2006.

Available Information

     Availability of Reports. Portec Rail Products is a reporting company under the Securities Exchange Act of 1934, as amended (the “1934 Act”), and files reports, proxy statements and other information with the Securities and Exchange Commission (the “Commission”). The public may read and copy any Company filings at the Commission’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330. Because the Company makes filings to the Commission electronically, you may access this information at the Commission’s internet site: www.sec.gov. This site contains reports, proxies and information statements and other information regarding issuers that file electronically with the Commission.

     Web Site Access. Our internet Web site address is www.portecrail.com. We make available, free of charge at this Web site, access to annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8 – K , and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the 1934 Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Commission. Access to reports of beneficial ownership filed pursuant to Section 16(a) of the 1934 Act are also available on our Web site.

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ITEM 2.     PROPERTIES

     We conduct our business through our corporate office, which is also one of our business unit offices, five other offices and through our manufacturing facilities. Our offices and manufacturing facilities are suitable and adequate to meet our current and future production requirements. The following table sets forth information about our offices and manufacturing facilities as of December 31, 2004.

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ITEM 3.     LEGAL PROCEEDINGS

     We are involved periodically in various claims and lawsuits that arise in connection with our business. Other than as set forth below, these are routine legal proceedings that, in the aggregate, are not material to our financial condition and results of operations.

     Portec, Inc., the predecessor of Portec Rail Products, was named as a defendant in Niagara Mohawk Power Corporation v. Consolidated Rail Corporation, et al. In July 1999, the action was filed in the United States District Court, Northern District of New York. Niagara Mohawk Power Corporation (“Niagara Mohawk”) is seeking contribution from nine named defendants for costs it has incurred, and is expected to incur, in connection with the environmental remediation of property located in Troy, New York. Niagara Mohawk’s claim against the named defendants under the Comprehensive Environmental Response, Compensation and Liability Act, also known as “CERCLA” or “Superfund,” alleges several, but not joint liability. The basis of the action stems from Niagara Mohawk’s agreement with the New York State Department of Environmental Conservation, pursuant to an Order on Consent, to environmentally remediate property identified as the Troy Water Street Site. The defendants consist of companies that at the time were industrial in nature, or owners of companies industrial in nature, and who owned or operated their businesses on portions of the Troy Water Street site or on properties contiguous, or otherwise in close proximity, to the Troy Water Street Site. Niagara Mohawk alleges that the defendants either released hazardous materials directly to the Troy Water Street site or released hazardous materials that migrated onto the Troy Water Street Site, and therefore the defendants should be responsible for a portion of the costs of remediation.

     In September 1999, we filed our answer to Niagara Mohawk’s action, denying responsibility for Niagara Mohawk’s allegations. In November 2001, we filed a motion for summary judgment, seeking to have Portec, Inc. removed as a defendant or, in the alternative, to have the court limit the claims that may be asserted against Portec, Inc. On November 6, 2003, the United States District Court, Northern District of New York granted the summary judgment motion filed on behalf of Portec, Inc., and dismissed all claims and cross-claims against Portec, Inc. Although a number of other defendants were also dismissed on summary judgment, a few were not, and therefore the action is continuing. The summary judgment decision was entered as an amended judgment on March 11, 2004. On March 25, 2004, Niagara Mohawk filed a notice of appeal to the United States Court of Appeals for the Second Circuit. All briefs on appeal were filed in late 2004, but the Second Circuit has not yet scheduled oral argument.

     We believe that Niagara Mohawk’s case against Portec, Inc. is without merit and, therefore, if Niagara Mohawk prevails on appeal we intend to vigorously defend against Niagara Mohawk’s claims. Because Niagara Mohawk is seeking unspecified monetary contribution from the defendants, we are unable to determine, if Niagara Mohawk were to prevail on appeal, the extent to which we would have to make contribution, or whether such contribution would have a material adverse effect on our financial condition or results of operations. However, total clean up costs at the Troy Water Street site are expected to be substantial and may approach $50 million. If liability for a portion of these costs is attributed to us, such liability could be material. Furthermore, if Niagara Mohawk wins on appeal, ongoing litigation may be protracted, and legal expenses may be material to our results of operations.

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

     No matters were submitted during the fourth quarter of the year ended December 31, 2004 to a vote of security holders.

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PART II

     Portec Rail Products, Inc. common stock is currently listed on the Nasdaq National Market under the symbol “PRPX.” Trading in the Company’s common stock on the Nasdaq National Market commenced on January 23, 2004.

     As of March 15, 2005, there were 9,601,779 shares of Portec Rail Products, Inc. common stock issued and outstanding, and approximately 350 shareholders of record.

     Set forth below is information regarding the payment of dividends and our high and low bid and asked price for each quarter since our initial public offering was completed.

     Under West Virginia law, we may pay dividends and make other capital distributions to our shareholders provided that no distribution may be made if, after giving it effect: (i) we would not be able to pay our debts as they become due in the usual course of business; or (ii) our total assets would be less than the sum of our total liabilities plus the amount that would be needed, if we were to be dissolved at the time of the distribution, or to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those of our common stockholders.

     As of December 31, 2004, there were no compensation plans under which equity securities of the Company were authorized for issuance.

     No securities were repurchased by the Company during the year ended December 31, 2004.

     On January 15, 2004, the Company’s registration statement on Form S-1 (Registration No. 333-110288) was declared effective. Pursuant to the registration statement, as amended, the Company registered 2,300,000 shares of common stock, par value $1.00 per share, with a proposed maximum aggregate offering price of $29,900,000. The stock was first offered to the public pursuant to a preliminary prospectus dated January 6, 2004. On January 28, 2004, the Company completed the sale of 2,000,000 shares of common stock at a price to the public of $10.00 per share. Ferris, Baker Watts, Incorporated, of Baltimore, Maryland, acted as sole underwriter for the offering. On February 26, 2004, the Company completed the sale of an additional 95,000 shares of its common stock at a price to the public of $10.00 per share upon the exercise by Ferris, Baker Watts, Incorporated of its over-allotment option to purchase additional shares. The stock offering, including the exercise of the over-allotment option, resulted in gross proceeds of $20,950,000. Expenses related to the offering were as follows: $1,467,000 for underwriting discounts and commissions, $367,000 for expenses paid to or for the underwriter (including a $105,000 financial advisory fee), and $1,144,000 for other expenses. Total expenses were $2,978,000. No finders fees were paid in connection with the offering. None of the expenses were direct of indirect payment to directors, officers, general partners of the Company or their associates, to persons owning 10% or more of the Company’s common stock or to affiliates of the Company. Net proceeds of the offering were approximately $17,972,000.

     As of February 28, 2005, the net proceeds of the offering were used as follows: $7,313,000 was used to repay indebtedness; $5,291,000 was used for the acquisition of Salient Systems; $496,000 was used for the acquisition of Kelsan; $1,855,000 was used for working capital; and $3,017,000 was used for temporary investments, consisting of short-term government money market funds and cash. The repayment of debt included a payment of $73,000 to pay off our outstanding loan balance to Boone County Bank, Inc. Marshall T. Reynolds, our chairman of the board, may be deemed an associate of Boone County Bank, Inc.

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     The following tables set forth selected consolidated historical financial data of Portec Rail Products for the periods and at the dates indicated. The information is derived in part from, and should be read together with, the audited consolidated financial statements and notes thereto of Portec Rail Products.

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     The following discussion should be read in conjunction with the consolidated financial statements of Portec Rail Products, Inc. and the related notes beginning on page 29. Unless otherwise specified, any reference to a “year” is to a year ended December 31. Additionally, when used in this Form 10-K, unless the context requires otherwise, the terms “we,” “our” and “us” refer to Portec Rail Products, Inc. and its business segments.

Overview

     In the United States, Canada and the United Kingdom, we are a manufacturer, supplier and distributor of a broad range of rail products, including rail joints, rail anchors, rail spikes, railway friction management systems and related products such as friction modifiers, railway wayside data collection and data management systems and securement devices. End users of our rail products include Class I railroads, short-line and regional railroads and transit systems. Our three North American business segments along with the rail division of our United Kingdom business segment serve these end users.

     In addition, our United Kingdom business segment also manufactures and supplies material handling products primarily to end users within the United Kingdom. These products include overhead and floor conveyor systems, racking systems and mezzanine flooring systems. The end users of our material handling products are primarily in the manufacturing, distribution, garment and food industries.

Results of Operations

Year Ended December 31, 2004 compared to the Year Ended December 31, 2003

     Net Sales. Net sales increased to $69.4 million for the year ended December 31, 2004, an increase of $11.8 million or 20.5%, from $57.6 million for the comparable period in the prior year. The increase in net sales is attributable to increased sales of $6.8 million at our RMP business segment, $3.3 million within our Canadian operations, $1.5 million at our United Kingdom operation and $352,000 at SSD. The increase in net sales at RMP is primarily due to increases in sales of our rail joints and related track component products along with our friction management products and services, as our larger customers continue to increase spending for these products reflecting their increased rail traffic. In addition, net sales at RMP also reflected the recent acquisition of Salient Systems that added $1.6 million during the fourth quarter of 2004. The increased sales at our Canadian operations are primarily due to sales volume increases of $1.6 million resulting from increased customer demand for our rail anchors and spikes, along with a favorable foreign currency translation of approximately $1.0 million. In addition, net sales at our Canadian business segment were positively impacted by the recent acquisition of Kelsan, that added $662,000 in sales during December 2004. The increase in sales at our United Kingdom operation is primarily attributable to a favorable foreign currency translation of approximately $1.6 million. The increase in sales at SSD is primarily due to increased customer demand for our strap securement systems, partially offset by decreased customer demand for our heavy-duty load securement systems.

     Gross Profit. Gross profit increased to $19.7 million for the year ended December 31, 2004, an increase of $3.1 million or 18.7%, from $16.6 million for the comparable period in the prior year. The increase in gross profit is due to increased gross profit at our RMP business segment of $1.0 million, due primarily to the increased sales volume from our rail joints and related track component products along with our higher margin friction management products and services. Also, gross profit at RMP reflected the recent acquisition of Salient Systems, which added $1.1 million of gross profit during the fourth quarter of 2004. In addition, a favorable foreign currency translation of British pounds sterling and Canadian dollars into U.S. dollars of approximately $438,000 and $218,000, respectively, has also increased gross profit during the current period. Furthermore, the recent Kelsan acquisition increased gross profit by $440,000 within our Canadian business segment while SSD’s gross profit increased by $278,000 due to the increased sales volume of our strap securement systems. These increases in gross profit were partially offset by a decrease in gross profit at our United Kingdom operation, due to a lower sales volume of our higher margin friction management products and services. In addition our gross profit was negatively impacted at our Montreal operation due primarily to raw material increases on our rail anchor and rail spike product lines.

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     Selling, General and Administrative Expenses. Selling, general and administrative expenses for the twelve months ended December 31, 2004 increased by $2.4 million or 22.0% to $13.3 million from $10.9 million during the comparable period in the prior year. This increase is partially due to an increase in Corporate shared service expenses of $502,000, resulting primarily from higher legal and professional fees, employee additions, and director and officer insurance costs as a result of becoming a public company. In addition, increased expenses at RMP’s Pittsburgh location of $501,000, our Montreal operation of $173,000 and SSD of $118,000, are primarily attributable to increased salaries, fringe benefit costs and employee additions, along with increased sales commissions at RMP. In addition, the acquisitions of Salient Systems and Kelsan have increased selling and administrative expenses by $458,000 and $388,000, respectively, within their business segments. Also, unfavorable currency translation of British pounds sterling and Canadian dollars into U.S. dollars have increased expenses by approximately $469,000 in 2004. These increases in selling, general and administrative expenses were partially offset by decreases in these same expenses at our United Kingdom operation of $142,000, due primarily to decreased salary and fringe benefit costs as a result of our workforce reduction that occurred during the first quarter of 2004.

     Interest Expense. Interest expense decreased to $203,000 for the twelve months ended December 31, 2004, a decrease of $150,000 or 42.5%, from $353,000 for the comparable period in the prior year, primarily due to reduced debt levels during the first three quarters of 2004. Net proceeds from our initial public offering of common stock in January 2004 were used to repay outstanding domestic indebtedness of approximately $7.3 million in January 2004. Debt levels increased at the end of the fourth quarter of 2004 due to additional borrowings incurred for the financing of the Kelsan acquisition.

     Provision for Income Taxes. Provision for income taxes increased to $2.0 million for the twelve months ended December 31, 2004, from $1.8 million for the comparable period in the prior year. The effective tax rates on reported taxable income were 33.0% and 34.4% for the twelve months ended December 31, 2004 and 2003, respectively. Our consolidated tax rate for the twelve months ended December 31, 2004 was reduced due to lower taxes on foreign source income.

     Net Income. Net income increased to $4.1 million for the twelve months ended December 31, 2004, an increase of $675,000 or 19.9%, from $3.4 million for the comparable period in the prior year for the reasons set forth above. Our basic and diluted net income per share decreased to $.46 for the twelve months ended December 31, 2004 on average basic and diluted shares of 8,929,599, from $.52 for the comparable period in the prior year on average basic and diluted shares of 6,524,002.

Year Ended December 31, 2003 compared to the Year Ended December 31, 2002

     Net Sales. Our net sales increased to $57.6 million for the year ended December 31, 2003, an increase of $7.6 million or 15.2%, from $50.0 million in 2002. The increase in net sales is primarily attributable to a $3.2 million increase in net sales at RMP as a result of increased demand for friction management products and services. Additionally, a favorable exchange rate translation on our Canadian and United Kingdom sales to U.S. dollars resulted in an increase of approximately $2.5 million in net sales in 2003. Lastly, total material handling sales at our United Kingdom operation increased by $1.4 million, reflecting a broader product line offering to our customers following the acquisition of the Quodeck product line in December 2002, partially offset by a decrease in sales from other material handling product lines.

     Gross Profit. Our gross profit increased to $16.6 million for the year ended December 31, 2003, an increase of $2.9 million or 21.2%, from $13.7 million in 2002. The increase in gross profit during 2003 is a result of a shift in demand from our lower margin to our higher margin products and services, which increased gross profit by approximately $1.0 million. Additionally, favorable exchange rate translations contributed approximately $700,000 to the overall increase in gross profit. As a result of the Quodeck acquisition, an increase in total material handling gross profit of $646,000 was realized on the additional sales volume. Lastly, our Shipping Systems Division experienced greater sales activity as the market for new freight cars continued to improve during 2003, which resulted in an additional $463,000 of gross profit for 2003, compared to the prior year.

     Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $10.9 million for the year ended December 31, 2003, an increase of $1.6 million or 17.2%, from $9.3 million in

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2002. The increase in selling, general, and administrative expenses during 2003 is attributable to the addition of four key management positions along with certain other integration costs related to the Quodeck acquisition that resulted in $419,000 of additional expense over 2002. Also, we incurred $410,000 of additional expense at our North American business segments and our corporate office due to other general salary and benefit increases, employee additions and increases in accrued incentive compensation. Exchange rate translations contributed approximately $407,000 to the overall increase in selling, general, and administrative costs. Lastly, a preferential treatment claim at our RMP Division related to a former customer’s bankruptcy filing in 2001 resulted in additional accrued expenses of approximately $153,000 in 2003.

     Amortization Expense. Our amortization expense decreased 65.9% to $78,000 for the year ended December 31, 2003 from $229,000 in 2002 due primarily to certain deferred financing costs becoming fully amortized in 2002.

     Interest Expense. Our interest expense decreased 33.4% to $353,000 for the year ended December 31, 2003 from $530,000 in 2002 primarily due to our average monthly outstanding long-term debt being lower throughout 2003 compared to the prior year.

     Other Expense. Other expense decreased 30.3% to $85,000 for the year ended December 31, 2003 from $122,000 in 2002, due primarily to maintenance expenses on our Troy, New York rental property that were incurred in 2002.

     Provision for Income Taxes. Our provision for income taxes increased to $1.8 million for the year ended December 31, 2003 from $1.3 million in 2002, reflecting an increase in income before taxes to $5.2 million for the year ended December 31, 2003 from $3.5 million in 2002. The effective tax rates on reported taxable income were 34.4% and 37.5% for the years ended December 31, 2003 and 2002, respectively. During 2003, our Canadian operation received research and development tax credits, which lowered our 2003 effective tax rate by approximately 1.5%.

     Net Income. Our net income increased to $3.4 million for the year ended December 31, 2003, an increase of $1.2 million or 54.5%, from $2.2 million in 2002. Our basic and diluted net income per share increased to $.52 for the year ended December 31, 2003, from $.35 (basic) and $.34 (diluted) for 2002.

Business Segment Review

     Our operations are organized into four business segments consisting of the Railway Maintenance Products Division (“RMP”), the Shipping Systems Division (“SSD”), 3094497 Nova Scotia Company (“Canada”) and Portec Rail Products (UK) Ltd. (“United Kingdom”), along with a corporate functional shared service. The presentation of segment information reflects the manner in which we organize and manage segments by geographic areas for making operating decisions, assessing performance and allocating resources. Intersegment sales do not have an impact on our consolidated financial condition or results of operations. Salient Systems is operated under the RMP segment and all its assets and liabilities are included in the RMP segment. Salient Systems’ results of operations have been included in the RMP segment and the consolidated financial statements since the date of the acquisition. In conjunction with the Kelsan acquisition, we established a new Canadian subsidiary, 3094497 Nova Scotia Company (Nova Scotia) and transferred ownership of Portec, Rail Products Ltd to Nova Scotia. Portec, Rail Products Ltd. is now a wholly-owned indirect Canadian subsidiary and Nova Scotia is our wholly-owned Canadian subsidiary. Nova Scotia was established to provide a legal structure for our Canadian subsidiaries that would provide the most advantageous tax benefits under both Canadian and United States income tax laws. Kelsan is operated under the Canadian business segment and all its assets and liabilities are included in the Canadian business segment. Kelsan’s results of operations for December 2004 have been included in the Canada segment and the consolidated financial statements since the date of acquisition.

     Railway Maintenance Products Division – “RMP”. Within our RMP business segment, we manufacture and assemble track components and related products, friction management products, wayside data collection and data management systems and also provide services to railroads, transit systems and railroad contractors. We are also a distributor and reseller of purchased track components and lubricants manufactured by third parties. Our manufactured and assembled track component and friction management products consist primarily of standard and

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insulated rail joints, friction management systems and wayside data collection and data management systems. Our purchased and distributed products consist primarily of various lubricants. RMP’s largest customers are Class I railroads in North America. For the years ended December 31, 2004, 2003 and 2002, RMP’s consolidated total external sales to its two largest customers represented 29%, 33% and 30%, respectively. Salient Systems’ fourth quarter 2004 operating results and related assets and liabilities are included in this business segment.

     For the year ended December 31, 2004, RMP’s consolidated external sales of $34.6 million increased by $6.8 million or 24.5%, from $27.8 million during the same period in 2003. The increase in external sales is primarily due to increases in sales of our rail joints and related track component products and our friction management products and services, as our larger customers continue to increase spending for these products. In addition, the acquisition of Salient Systems added approximately $1.6 million of sales during the fourth quarter of 2004. Operating income for year ended December 31, 2004 increased to $4.9 million from $3.8 million for the same period in 2003, an increase of $1.1 million or 28.9%, primarily due to increased gross profit on the additional sales volume. In addition, operating income was positively impacted by the acquisition of Salient Systems, which added $632,000 of operating income during the last quarter of 2004. These increases were partially offset by increased selling, general and administrative expenses of $501,000 at RMP’s Pittsburgh operation, which were primarily attributable to increased salaries, fringe benefit costs, employee additions and sales commissions.

     For the year ended December 31, 2003, RMP’s external sales increased by $3.2 million or 13.0%, to $27.8 million from $24.6 million during 2002. The increase in external customer sales is primarily related to increases in sales of friction management products and services to our larger Class I railroad customers, as capital spending for these products and services increased during 2003. Operating income for the year ended December 31, 2003 increased to $3.8 million from $3.4 million in 2002, an increase of $411,000 or 12.2%, this increase is primarily due to the gross profit realized from the increased sales volume on higher margin friction management products and services.

     Shipping Systems Division – “SSD”. SSD engineers and sells load securement systems to the railroad freight car market. These systems are used to secure a wide variety of products and lading onto freight cars. Independent subcontractors had previously produced all of our manufactured products. However, beginning in 2002, RMP began to perform some of the assembly work for SSD at its Huntington, West Virginia plant. For the years ended December 31, 2004, 2003 and 2002, SSD’s two largest customers represented 78%, 74% and 61% of total external sales, respectively.

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     For the year ended December 31, 2004, SSD’s external sales increased by $352,000 or 8.1%, to $4.7 million from $4.3 million during the same period in 2003. This increase is primarily due to increased customer demand for our strap securement systems, in particular, our new Cushioned Banding Anchor product line. However, this increase was somewhat offset by decreased customer demand for our heavy-duty load securement systems. Operating income for the year ended December 31, 2004 increased by $160,000 or 31.1% to $674,000 from $514,000 during the same period in 2003. The increase in operating income is primarily due to an increase in gross profit resulting from increased sales volume of our higher margin strap securement systems, partially offset by increased salaries, fringe benefit costs, and employee additions.

     For the year ended December 31, 2003, SSD’s external sales of $4.3 million increased by $882,000 or 25.6%, from $3.4 million in 2002. The increase in external sales is primarily related to improved spending in the freight car market, in particular for refurbishment of military flat cars as a result of the war in Iraq and our largest customer upgrading its fleet of flatcars. Operating income for the year ended December 31, 2003 increased to $514,000 from $144,000 in 2002, an increase of $370,000 or 257%, primarily related to the increased sales volume in 2003.

     3094497 Nova Scotia Company – “Canada”. At our Canadian operation, near Montreal, we manufacture rail anchors and rail spikes and assemble friction management products primarily for the two largest Canadian railroads. Rail anchors and spikes are devices to secure rails to the ties to restrain the movement of the rail tracks. On November 30, 2004, we acquired Kelsan. Kelsan operates a technology and manufacturing facility in Vancouver, British Columbia. Kelsan’s two primary product lines are stick lubrication and application systems and a liquid friction modifier, Keltrack^®. Kelsan manufactures its stick and applicator systems in Vancouver and subcontracts its manufacturing of the Keltrack^® product line. For the years ended December 31, 2004, 2003 and 2002, Canada’s total consolidated external sales to its two largest customers represented 65%, 66% and 56%, respectively. Kelsan’s one month operating results and related assets and liabilities are included in this business segment.

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     For the year ended December 31, 2004, Canada’s consolidated external sales of $15.4 million increased by $3.3 million or 27.3%, from $12.1 million during the same period in 2003. The increase in external sales is primarily due to sales volume increases of $1.6 million resulting from increased customer demand for our rail anchors and spikes, along with a favorable foreign currency translation of approximately $1.0 million. In addition, net sales at our Canadian business segment were positively impacted by the recent acquisition of Kelsan, which added $662,000 of sales in December of 2004. Operating income for the year ended December 31, 2004 decreased by $117,000 or 6.6% to $1.7 million from $1.8 million during the same period in 2003. This decrease in operating income is primarily due to higher raw material costs on our rail anchor and rail spike product lines as a result of steel surcharges, partially offset by increased operating income due to the higher sales volume. Raw material and steel surcharges negatively impacted our gross profit margins on our rail anchors and rail spikes by approximately 1.6% for the year ended December 31, 2004, compared to the prior year. Although we have been successful at passing most of the steel surcharges on to our customers, we have been able to do so at no added gross margin. In addition, increased overall selling, general and administrative expenses at our Montreal operation have also negatively impacted operating income. These decreases in operating income are being partially offset by a favorable foreign currency translation of Canadian dollars to U.S. dollars of approximately $119,000.

     For the year ended December 31, 2003, Canada’s external sales of $12.1 million increased by $1.5 million or 14.5%, from $10.6 million during 2002. The increase in external sales is primarily related to foreign currency translation of Canadian dollar sales to U.S. dollars of approximately $1.4 million. Operating income for the year ended December 31, 2003 increased to $1.8 million from $1.2 million in 2002, an increase of $563,000 or 46.8%, primarily related to the increased gross profit on additional sales volume and increases related to foreign currency translation.

     Portec Rail Products (UK) Ltd.- “United Kingdom”. In the United Kingdom, we operate and serve our customers in two markets. The United Kingdom’s rail business, which comprised approximately 40% of total sales for the years ended 2004, 2003 and 2002, is primarily driven by sales of friction management products and services to the United Kingdom passenger rail network. For the years ended December 31, 2004, 2003 and 2002, this segment’s two largest rail customers represented 19%, 11% and 20% of total external sales, respectively.

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     Over the same time period described above, our material handling business represented approximately 60% of the total sales generated by the United Kingdom segment. Our major product lines in this market include overhead and floor conveyor systems, racking systems and mezzanine flooring systems. The end users of our products are primarily United Kingdom based companies in the manufacturing, distribution, garment and food industries. As our material handling products are primarily dependent upon the capital spending plans of manufacturers, our largest customers vary each year depending upon the contracts that are secured. For the years ended December 31, 2004, 2003 and 2002, our two largest material handling customers represented 30%, 11% and 18% of total external sales, respectively. In December 2002, we acquired the Quodeck product line from Quodeck Ltd. in order to broaden our material handling product offerings. The primary customers utilizing this product line are in the garment industry.

     For the year ended December 31, 2004, United Kingdom’s external sales of $14.8 million increased by $1.5 million or 11.3%, from $13.3 million during the same period in 2003. This increase in external sales is attributable to a favorable foreign currency translation of approximately $1.6 million, partially offset by a slight sales volume decrease. This sales volume decrease is primarily due to decreased demand for our friction management products and services, as a result of our largest customer, Network Rail, undergoing a significant reorganization that began during the latter part of 2003 and has carried into 2004. The decrease in sales of our friction management products and services was almost entirely offset by an increase in sales of our material handling products resulting from increased customer demand of our overhead and floor conveyor systems. Operating income of $740,000 for the year ended December 31, 2004 was consistent with the same period in 2003 as the increased sales volume of our material handling product line has somewhat offset the decrease in our higher margin rail sales.

     For the year ended December 31, 2003, United Kingdom’s external sales of $13.3 million increased by $1.9 million or 16.5%, from $11.4 million in 2002. The increase in external sales is primarily due to an incremental increase in total material handling sales of $1.4 million as a result of the Quodeck acquisition and favorable foreign exchange translations of approximately $600,000 for material handling sales in British pounds sterling to U.S. dollars. The incremental increase in material handling sales of $1.4 million was the result of an increase in Quodeck product sales of $3.2 million, partially offset by a $1.8 million decrease in sales of other material handling products. Operating income for the year ended December 31, 2003 increased to $742,000 from $618,000 in 2002, an increase of $124,000 or 20.1%, due primarily to the Quodeck acquisition, which increased incremental material handling operating income by approximately $227,000 for the year ended December 31, 2003. This increase in operating income was partially offset by increases in rail related administrative expenses in 2003.

Liquidity and Capital Resources

     Our cash flow from operations is the primary source of financing for internal growth, capital expenditures, and repayments of long-term contractual obligations, dividends to our shareholders, and other commercial commitments. The most significant risk associated with our ability to generate sufficient cash flow from operations is the overall level of demand for our products. In addition, we have cash invested in short-term government money

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market funds of $4.4 million, and cash invested in U.S. Treasury Bills of $1.5 million at December 31, 2004 primarily as a result of our initial public offering and subsequent underwritten over-allotment exercise. We believe we can manage our working capital and control costs to meet our cash flow needs for the next twelve months to meet our growth objectives. In addition to cash generated from operations, we have four primary revolving and overdraft credit facilities in place to support the working capital needs of each of our business segments. We believe that cash flow from operations and the availability under our credit lines and proceeds from the initial public offering will be sufficient to meet our cash flow requirements over the next twelve months.

     Cash Flow Analysis. For the year ended December 31, 2004, cash flow provided by operations was $2.9 million, an increase of $2.2 million, compared to $734,000 during the same 2003 period. The primary reasons for this increase is related to timing differences in operating assets and liabilities, along with an increase in net income of approximately $675,000. In addition, cash provided by operations in 2004 also includes decreases in prepaid expenses and other assets, which were primarily related to legal and accounting costs incurred for the initial public offering of our common stock in January 2004, which resulted in an increase of $1.7 million in cash provided by operations during 2004, compared to 2003.

     For the year ended December 31, 2003, cash flow provided by operations was $734,000 compared to $5.6 million in cash flow provided by operations in 2002. The primary reasons for this decrease in 2003 are due to increases in inventory levels, accounts receivable balances and prepaid expenses related to our pending initial public offering. Inventory levels at our Canadian operation near Montreal increased by $2.5 million during 2003, as inventory levels were artificially low due to a work stoppage at our primary steel supplier at the end of 2002. Also, inventory levels at RMP increased by $589,000 during 2003 to meet customer demands during the fourth quarter of 2003. Accounts receivable increased by $862,000 during 2003 due primarily to the increased sales volume at RMP. Also, increased prepaid expenses and other assets of $1.1 million negatively impacted cash provided from operations as these costs were primarily related to costs incurred for our pending initial public offering.

     Net cash used in investing activities was $19.1 million in 2004, compared to $663,000 of cash used in investing activities during 2003. We used approximately $18.1 million for business acquisitions in 2004. In addition, our capital expenditures for 2004, 2003 and 2002 approximated $1.0 million, $678,000 and $762,000, respectively, and were primarily to support new strategic initiatives, develop new products, and upgrade machinery and equipment, almost all of which was discretionary. We believe the overall level of capital spending for our business segments is sufficient to remain competitive.

     Net cash provided by financing activities was $23.4 million in 2004, compared to cash used in financing activities of $1.3 million in 2003. During 2004, cash provided by financing activities was primarily related to the net proceeds from the issuance of common stock of approximately $18.0 million and net proceeds from bank term debt of $14.9 million for the purchase of 100% of the outstanding common and preferred stock of Kelsan. These sources of cash were partially offset by net repayments on revolving and overdraft credit facilities of $5.2 million, repayments of long-term debt and capital lease obligations in the amount of $2.3 million and cash dividends paid of $1.8 million.

     Net cash used in financing activities was $1.3 million for 2003 compared to $3.7 million in 2002. Cash used in financing activities during 2003 is related to the net repayments and borrowings of long-term obligations in the amount of $2.6 million and cash dividends paid of $815,000. These uses of cash were offset by increased borrowings of $2.1 million on our revolving credit facilities, which were used to support working capital needs due to the increased demand for our products, as well as costs incurred in conjunction with our pending initial public offering of common stock.

     Credit Facilities.

     Our term loan, working capital revolving credit and overdraft facilities are summarized as follows:

     In the United States and Canada, we have a $25.0 million term loan and revolving credit facility with National City Bank and its Canadian affiliate that provides for acquisition financing along with supporting the working capital requirements of our United States business units and our Canadian operation near Montreal. Under this agreement, there are three separate borrowing components, a $7.0 million United States revolving credit facility,

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a $3.1 million ($3.75 million CDN) revolving credit facility for our Canadian operation located near Montreal, and an outstanding term loan of $14.9 million. As of December 31, 2004, we had the ability to borrow an additional $9.3 million under this facility, as the combined borrowings under the total facility cannot exceed $25.0 million. This agreement contains certain financial covenants that require us to maintain cash flow coverage and leverage ratios as well as maintaining minimum amounts of tangible net worth. This credit facility further limits capital expenditures, sales of assets, and additional indebtedness. We were in compliance with all of these financial covenants as of December 31, 2004. For additional details, see Note 8 of the consolidated financial statements included under Item 8 of this Form 10-K.

     As of February 28, 2005, the balance outstanding on the Canadian revolving credit facility was $2.2 million ($2.7 million CDN $). There were no outstanding borrowings on the U.S. revolving credit facility at February 28, 2005. The balance outstanding on the Kelsan acquisition loan was $14.0 million ($17.2 million CDN $) at February 28, 2005.

     In the United Kingdom, we have a £400,000 (approximately $767,000 U.S.) overdraft facility with a local financial institution to support the working capital needs of our United Kingdom operation. As of December 31, 2004, there were no outstanding borrowings under this facility and we had the ability to borrow up to the maximum value of the facility. The overdraft facility is reviewed on an annual basis and had an original maturity date of March 19, 2005. In March 2005, this facility was increased to £750,000 (approximately $1.4 million U.S.) and the maturity date was extended to March 19, 2006.

     At our Vancouver location (Kelsan), we have a $750,000 Canadian dollar ($625,000 U.S.) overdraft facility with a local financial institution to support the working capital requirements of this operation. This facility is secured by a general security agreement granting a first security interest in all the assets of Kelsan. As of December 31, 2004, outstanding borrowings were $325,000 ($390,000 Canadian dollars) and we had the ability to borrow up to the maximum value of the facility. The overdraft facility is reviewed on an annual basis and has a current maturity date of December 31, 2005. As of February 28, 2005 there were $558,335 in borrowings on this facility.

     In addition to these credit facilities, we have a $1.6 million line of credit with a United States financial institution to fund capital expenditures for our United States business segments. See “Item 13. Certain Relationships and Related Transactions” herein. Any advances on this line are made in term notes and the line availability is reduced by that amount. As of December 31, 2004, we had no outstanding borrowings under this facility. This facility has a current maturity date of June 30, 2005. As a result of our initial public offering, this facility was paid in full during January 2004. We also maintain various local financing arrangements in Canada and the United Kingdom.

Summary of Contractual Obligations

     The following is a summary of our contractual obligations as of December 31, 2004:

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Financial Condition

     At December 31, 2004, total assets were $88.6 million, an increase of $48.2 million or 119.3% from December 31, 2003. This increase in total assets at December 31, 2004 is primarily due to the tangible and intangible assets, including goodwill, of approximately $30.1 million added as a result of the Salient Systems and Kelsan acquisitions during 2004. At December 31, 2004, net working capital (defined as current assets minus current liabilities) was $25.3 million, an increase of $19.1 million or 308%, from $6.2 million at December 31, 2003. Cash and cash equivalents have increased approximately $7.3 million at December 31, 2004 from December 31, 2003, primarily as a result of our initial public offering of common stock in January 2004. Inventory levels have increased $5.8 million at December 31, 2004 from December 31, 2003, primarily to meet customer demand. In addition, at December 31, 2004, inventory levels at Salient Systems and Kelsan were $527,000 and $1.2 million, respectively. Accounts receivable balances have increased by approximately $4.4 million from December 31, 2003, primarily resulting from the acquisitions of Salient Systems and Kelsan during 2004, as well as increased sales volumes at our other operating business units during the fourth quarter.

     Total outstanding debt obligations at December 31, 2004 increased by approximately $8.4 million or 90.3%, to $17.7 million as of December 31, 2004, from $9.3 million at December 31, 2003. The primary reasons for the increase in debt obligations at December 31, 2004 are due to the Kelsan and Salient Systems acquisitions during 2004. Outstanding borrowings related to the financing of these acquisitions amounted to $15.8 million as of December 31, 2004. Offsetting this increase in debt obligations were net term loan, revolving credit and overdraft credit facility repayments totaling approximately $7.4 million during 2004, most of which was repaid with proceeds from our initial public stock offering in January 2004.

     As discussed in “Item 3. Legal Proceedings”, Portec, Inc., our predecessor, was named with other defendants in an environmental lawsuit. Niagara Mohawk, as plaintiff, seeks to recover costs that it has incurred to investigate and remediate its own property as required by the New York State Department of Environmental Conservation (NYSDEC). We have not been named as a liable party by the NYSDEC and believe we have no liability to the plaintiff in the case.

     We believe that Niagara Mohawk’s case against Portec, Inc. is without merit and, therefore, if Niagara Mohawk prevails on appeal we intend to vigorously defend against Niagara Mohawk’s claims. Because Niagara Mohawk is seeking unspecified monetary contribution from the defendants, we are unable to determine, if Niagara Mohawk were to prevail on appeal, the extent to which we would have to make contribution, or whether such contribution would have a material adverse effect on our financial condition or results of operations. However, total clean up costs at the Troy Water Street site are expected to be substantial and may approach $50 million. If liability for a portion of these costs is attributed to us, such liability could be material. Furthermore, if Niagara Mohawk wins on appeal, ongoing litigation may be protracted, and legal expenses may be material to our results of operations.

     We maintain a noncontributory defined benefit pension plan that covers substantially all United States employees and our retirees. Benefits under the plan were based on years of service for hourly employees. For salaried employees, benefits under the plan were based on years of service and the employee’s average compensation during defined periods of service. In August 2003, we amended our United States defined benefit plan by freezing the benefits accrued for all participants effective December 31, 2003 and preventing new enrollments after December 31, 2003. Our future net periodic pension cost and plan funding will be dependent upon the performance of plan assets.

     In addition, we also maintain a contributory defined benefit plan in the United Kingdom. The plan covers some of our active employees, former employees and our retirees and has been frozen to new entrants since April 1, 1997. Benefits under the plan were based on years of service and eligible compensation during defined periods of service. The estimated cash flow funding for the next five years is expected to range from $20,000 to $50,000 per year. In accordance with United Kingdom pension regulations, employee cash contributions to the plan were terminated on December 31, 2003.

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     The products we manufacture and sell, such as our joint bars, rail anchors and rail spikes, require steel as a major element in the production process. Throughout 2004, worldwide steel prices have spiked upwards resulting in surcharges being added to our overall raw material costs. As a result, these steel surcharges increased our raw material costs. While these higher material costs have had some negative impact on our financial results over the last half of 2004 and during the first two months of 2005, particularly on our rail anchor and rail spike product lines and our track component product lines, we believe the impact of the higher material costs have not had a material impact on our overall financial results. Although we have been successful in passing through most of the steel surcharges on to our customers, we have been able to do so at no added gross margin. If a prolonged increase in steel prices should continue and we are unable to pass on these added costs to our customers, our future earnings could be negatively impacted.

Discussion of Critical Accounting Policies

     Our discussion and analysis of our financial condition and results of operations is based upon our audited and unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. We review the accounting policies we use in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. We evaluate the appropriateness of these estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

     Revenue Recognition. Revenue from product sales is recognized at the time products are delivered and title has passed or when service is performed. Delivery is determined by our shipping terms, which are primarily FOB shipping point. Shipments are made only under a valid contract or purchase order where the sales price is fixed or determinable and collectability of the resulting receivable is reasonably assured. Revenue is recognized net of returns, discounts and other allowances.

     Revenue from installation of material handling equipment, and railway wayside data collection and data management systems is generally recognized by applying percentages of completion for each contract to the total estimated profits for the respective contracts. The length of each contract varies, but is typically about two to five months. The percentages of completion are determined by relating the actual costs of work performed to date, to the current estimated total costs of the respective contracts. Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, repairs and depreciation costs.

     When the estimate on a contract indicates a loss, the entire loss is immediately recorded in the accounting period that the loss is determined. The cumulative effect of revisions in estimates of total costs or revenue during the course of the work is reflected in the accounting period in which the facts that caused the revision first become known.

     Allowances for Doubtful Accounts. We maintain a reserve to absorb probable losses relating to bad debts arising from uncollectible accounts receivable. The allowance for doubtful accounts is maintained at a level that we consider adequate to absorb probable bad debts inherent in the accounts receivable balance and is based on ongoing assessments and evaluations of the collectability, historical loss experience of accounts receivable and the financial status of customers with accounts receivable balances. Bad debts are charged and recoveries are credited to the reserve when incurred.

     We believe the accounting estimate related to the allowance for doubtful accounts is a “critical accounting estimate” because we have a significant concentration of accounts receivable in the rail industry. The economic conditions could affect our customers’ ability to pay and changes in the estimate could have a material effect on net income.

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     Inventories. We establish obsolescence reserves for slow-moving and obsolete inventories. Obsolescence reserves reduce the carrying value of slow moving and obsolete inventories to their estimated net realizable value, which generally approximates the recoverable scrap value. We utilize historical usage, our experience, current backlog and forecasted usage to evaluate our reserve amounts. We also periodically evaluate our inventory carrying value to ensure that the amounts are stated at the lower of cost or market. If actual market conditions are less favorable than those projected by us, additional inventory reserves may be required.

     Goodwill and Other Intangible Assets. We assess the impairment of goodwill at least annually and whenever events or significant changes in circumstances indicate that the carrying value may not be recoverable. We evaluate the goodwill of each of our reporting units for impairment as required under SFAS No. 142 “Goodwill and Other Intangible Assets.” SFAS No. 142 requires that goodwill be tested for impairment using a two-step process. The first step is to identify a potential impairment and the second step measures the amount of an impairment loss, if any. Goodwill is deemed to be impaired if the carrying amount of a reporting unit’s goodwill exceeds its estimated fair value. The fair values of our reporting units are determined using a combination of a discounted cash flow analysis and market multiples based upon historical and projected financial information. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require our judgment. Factors that could change the result of our goodwill impairment test include, but are not limited to, different assumptions used to forecast future revenue, expenses, capital expenditures and working capital requirements used in our cash flow models. In addition, selection of a risk adjusted discount rate on the estimated undiscounted cash flow is susceptible to future changes in market conditions and when unfavorable, can adversely affect our original estimates of fair values. Since adoption of SFAS 142, we have not recognized any impairment of goodwill.

     As part of the acquisitions of Salient Systems and Kelsan, we recorded the fair value of the tangible and intangible assets of the companies in accordance with SFAS No. 142. As part of our procedures to assign fair values to all acquired assets, we hired an independent appraiser to evaluate the technology and intellectual property along with any other intangible assets that we could assign a fair value to under both of these acquisitions. We supplied the independent appraiser with the historical and estimated cash flows of the companies along with an estimate of future costs to maintain these technologies. The independent appraiser used these estimates and other assumptions to determine the present value of the discounted cash flows of these various technologies. In addition, we evaluated the future lives of the identified intangible assets to determine if they have definite or indefinite lives.

     As a result of the Salient Systems acquisition, we assigned a fair value to their Wheel Impact Load Detector and Rail Stress Monitor in the amounts of $9.8 million and $3.6 million, respectively. We also determined that there was $1.7 million of goodwill to be recorded as part of this transaction. In addition, we determined that the intangible assets under the Salient Systems acquisition had indefinite lives due to our plans to make continual enhancements to the technology and related products, such that some generation of this technology could be in use for as long as railroads operate. In the future, we will monitor these intangible assets to determine if certain events occur that would cause the lives to become definite and thereby assign a future estimated life based on the years that we feel that the product would have value in the marketplace and then record an impairment charge in the proper accounting period.

     As a result of the Kelsan acquisition, we assigned a fair value to their Stick friction modifier product line and the Keltrack^® liquid friction modifier product line in the amounts of $5.5 million and $5.2 million, respectively. We also determined that there was $4.1 million of goodwill to be recorded as part of this transaction. In addition, we have estimated that the Stick friction modifier product technology and Keltrack^® liquid friction modifier product technology have definite lives of 15 years and 28 years due to our estimates that the projected economic earnings associated with these technology based product lines will begin to lapse after these time frames. In the future, we will monitor these assets to determine if certain events occur that would cause the lives assigned to these intangible assets to become shorter than originally assigned, and thereby, we would assign a shorter future estimated life based on the years that we feel that the product would have value in the marketplace and record an impairment charge in the proper accounting period.

     Defined Benefit Pension Plans. We sponsor defined benefit pension plans for certain of our employees and retirees. We account for these plans as required under SFAS No. 87, “Employers’ Accounting for Pensions.” The liabilities and expenses for pensions require significant judgments and estimates. These amounts are determined

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using actuarial methodologies and incorporate significant assumptions, including the rate used to discount the future estimated liability, inflation, the long-term rate of return on plan assets and mortality tables. Management has mitigated the future liability for active employees by freezing all defined benefit pension plans effective December 31, 2003. The rate used to discount future estimated liabilities is determined considering the rates available at year-end on AA rated corporate long term bonds that could be used to settle obligations of the plan. Our inflation assumption is based on an evaluation of external market indicators. The long-term rate of return is estimated by considering historical returns and expected returns on current and projected asset allocations. The effects of actual results that differ from these assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligations in future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect our obligations and future expense.

     As interest rates decline, the actuarially calculated pension plan liability increases. Conversely, as interest rates increase, the actuarially calculated pension liability decreases. Past declines in interest rates and equity markets have had a negative impact on the pension plan liability and fair value of our plan assets. As a result, the accumulated benefit obligation exceeded the fair value of plan assets at December 31, 2004, 2003 and 2002, which resulted in a $882,000, $577,000 and $1.4 million, net of tax, respectively, charge to other comprehensive loss.

     Income Taxes. Significant judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any necessary valuation allowance recorded against net deferred tax assets. As a company with international operations, we record an estimated liability or benefit for our current income tax provision and other taxes based on what we determine will likely be paid in various jurisdictions in which we operate. We use our best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid are dependent on various matters including the resolution of the tax audits in the various affected tax jurisdictions and may differ from the amounts recorded. An adjustment to the estimated liability would be recorded through income in the period in which it becomes probable that the amount of the actual liability differs from the recorded amount. We do not believe that such a charge would be material.

     The process of recording deferred tax assets and liabilities involves summarizing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the consolidated balance sheet. We must then assess the likelihood that deferred tax assets will be recovered from future taxable income and to the extent that we believe that recovery is not likely, a valuation allowance is established. If a valuation allowance is established in a period, an expense is recorded. The valuation allowance is based on our experience, current economic situation and budgets. We believe that operations will provide taxable income levels to recover the deferred tax assets.

     We are exposed to interest rate risk on our contractual long-term debt obligations and our working capital facilities are under floating interest rate arrangements. However, we have determined that these risks are not significant enough to warrant hedging programs. If interest rates increase, we will be exposed to higher interest rates and we will be required to use more cash to settle our long-term debt obligations. As interest rates increase on our variable long-term debt, it will have a negative impact on future earnings because the increased rates will increase our interest expense. Conversely, if interest rates decrease on our variable long-term debt, it will have a positive impact on future earnings because the lower rates will decrease our interest expense. Based upon the long-term debt amount as of December 31, 2004, for every 1% increase or decrease in the interest rate on our long-term debt, our annual interest expense will fluctuate by approximately $177,000.

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     In addition, we are exposed to foreign currency translation fluctuations with our two international operations. We do not have any foreign exchange derivative contracts to hedge against foreign currency exposures. Therefore, we are exposed to the related effects when the foreign currency exchange rates fluctuate. If the U.S. dollar strengthens against the Canadian dollar and/or the British pound sterling, the translation rate for these foreign currencies will decrease, which will have a negative impact on our operating income. For example, for year ended December 31, 2004, for every 1/100 change in the exchange rate of the Canadian dollar to the U.S. dollar, our Canadian operation’s operating income would have changed by approximately $21,300. Further, for every 1/100 change in the exchange rate of the British pound sterling to the U.S. dollar, the impact on operating income for our United Kingdom operations for the year ended December 31, 2004 would have been approximately $4,000. Foreign currency translation fluctuations have no impact on cash flows as long as we continue to reinvest any profits back into the respective foreign operations.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following are included in this item:

The supplementary data required by this Item (selected quarterly financial data) is provided in Note 15 of the Notes to Consolidated Financial Statements.

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Consolidated Balance Sheets

See Notes to Consolidated Financial Statements

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Consolidated Statements of Income

See Notes to Consolidated Financial Statements

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Consolidated Statements of Shareholders’ Equity

See Notes to Consolidated Financial Statements

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Consolidated Statements of Cash Flows

See Notes to Consolidated Financial Statements

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Note 1: Nature of Operations and Significant Accounting Policies

Nature of Operations

We are a manufacturer, supplier and distributor of a broad range of rail products, including rail joints, rail anchors, rail spikes, railway friction management systems and related products, railway wayside data collection and data management systems and freight car securement devices. We also manufacture material handling equipment through our United Kingdom operation. We serve both the domestic and international markets. We have five manufacturing facilities located in Huntington, West Virginia; St. Jean, Quebec, Canada; Vancouver, British Columbia, Canada; Wrexham, Wales, United Kingdom; and Leicester, England, United Kingdom, and an engineering and assembly facility in Dublin, Ohio. We also have offices near Chicago, Illinois; Montreal, Quebec, Canada; Birmingham, England, United Kingdom and our corporate office is near Pittsburgh, Pennsylvania.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Portec Rail Products, Inc., our wholly-owned United States subsidiary, Salient Systems, Inc. (Salient Systems), our wholly-owned Canadian subsidiary, 3094497 Nova Scotia Company (Canada) and our wholly-owned United Kingdom subsidiary, Portec Rail Products (UK) Ltd. (United Kingdom). All significant intercompany accounts and transactions have been eliminated in consolidation.

Cash and Cash Equivalents

We consider all highly liquid investments with an original maturity of 90 days or less to be cash equivalents.

Accounts Receivable

Accounts receivable are stated at the amount billed to our customers. We provide an allowance for doubtful accounts, which is based upon a review of outstanding receivables, historical collection information and existing economic conditions. Accounts receivable are ordinarily due between 30 and 60 days after the issuance of the invoice. Accounts past due more than 90 days are considered delinquent. Delinquent receivables are written-off based on individual credit evaluation and specific customer circumstances.

Inventories

Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method for all inventories. Inventory costs include material, labor and manufacturing overhead.

Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is recorded by the straight-line method based on estimated useful lives, as follows:

Leasehold improvements are amortized over the shorter of the useful life of the asset or the term of the lease. Expenses for repairs, maintenance and renewals are charged to operations as incurred. Expenditures that improve an asset or extend its useful life are capitalized.

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Goodwill and Identifiable Intangible Assets

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 ceases the amortization of goodwill and other intangible assets with indefinite useful lives. SFAS No. 142 also requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives and will be reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable.

We adopted SFAS No. 142 effective January 1, 2002. We are required to test our goodwill for impairment using a two-step process described in SFAS No. 142 on an annual basis or whenever events or circumstances indicate that the fair value of our reporting units may have been affected. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. We completed the transitional goodwill impairment test effective January 1, 2002 and determined no transition adjustment was required. We have established October 1^st as our annual measurement date for impairment of goodwill. We completed the annual impairment test for 2004 and 2003, and determined no impairment adjustment was required.

We evaluate the recoverability of identifiable intangible assets whenever events or changes in circumstances indicate that an intangible asset’s carrying amount may not be recoverable. Such circumstances could include, but are not limited to: (1) a significant decrease in the market value of an asset, (2) a significant adverse change in the extent or manner in which an asset is used, or (3) an accumulation of costs significantly in excess of the amount originally expected for the acquisition of an asset. We measure the carrying amount of the asset against the estimated undiscounted future cash flows associated with it. Should the sum of the expected future net cash flows be less than the carrying value of the asset being evaluated, an impairment loss would be recognized. The impairment loss would be calculated as the amount by which the carrying value of the asset exceeds its fair value. The fair value is measured based on quoted market prices, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including the discounted value of estimated future cash flows. The evaluation of asset impairment requires that we make assumptions about future cash flows over the life of the asset being evaluated. These assumptions require significant judgment and actual results may differ from assumed and estimated amounts.

Patents

Patents consist of legal and filing costs incurred in obtaining patent protection for product technology. Patent costs are amortized on a straight-line basis over a period of two to five years.

Deferred Financing Costs

Deferred financing costs relating to obtaining term debt are capitalized and amortized over the term of the loan using the level-yield method. When a loan is paid in full, any unamortized financing costs are removed from the related accounts and charged to operations.

Foreign Currency Translation

The assets and liabilities of our foreign subsidiaries are measured using the local currency as the functional currency and are translated into U.S. dollars at exchange rates as of the balance sheet date. Income statement amounts are translated at the weighted-average rates of exchange during the year. The translation adjustment is accumulated as a separate component of accumulated other comprehensive income (loss). Foreign currency transaction gains and losses are included in determining net income. Such amounts have not been material.

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Revenue Recognition

Revenue from product sales is recognized at the time products are delivered and title has passed or when service is performed. Delivery is determined by our shipping terms, which are primarily FOB shipping point. Revenue is recognized net of returns, discounts and other allowances.

Revenue from installation of material handling equipment and railway wayside data collection and data management systems is generally recognized by applying percentages of completion for each contract to the total estimated profits for the respective contracts. The length of each contract varies, but is typically about two to five months. The percentages of completion are determined by relating the actual costs of work performed to date to the current estimated total costs of the respective contracts. Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, repairs and depreciation.

When the estimate on a contract indicates a loss, our policy is to record the entire loss immediately in the accounting period that the loss is determined. The cumulative effect of revisions in estimates of total costs or revenue during the course of the work is reflected in the accounting period in which the facts that caused the revision first become known.

Related Party Transactions

Related party transactions are conducted with companies under common control of our shareholders or directors. Transactions with related parties are conducted at arms length and are not material.

Warranty Obligations

We record a liability for product warranty obligations based upon historical warranty claims experience. Product warranty accruals as of December 31, 2004 and 2003 were not significant.

Income Taxes

Deferred income taxes are provided for the tax consequences of temporary differences between financial statement carrying amounts and the tax basis of assets and liabilities. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.

Research and development tax credits are accounted for under the flow-through method as a reduction of income tax expense in the year the credits are earned.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Shipping and Handling

Shipping and handling costs that we incur are included in the cost of sales.

Financial Instruments

The carrying value of all of our financial instruments approximate their fair values.

Recent Accounting Pronouncements

In January of 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51. In December 2003, the FASB revised FIN 46 by issuing FIN 46R. In addition to conforming to previously issued Staff Positions, FIN 46R deferred the implementation date for certain variable interest entities. For all variable interest entities other than special

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purpose entities, the revised Interpretation is effective for periods ending after March 15, 2004. For variable interest entities meeting the definition of special purpose entities under earlier accounting rules, the Interpretation remains effective for periods ending after December 31, 2003. The Interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling interest through ownership of a majority voting interest in the entity. We have determined that we have no such instruments.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures in its balance sheet certain financial instruments with characteristics of both liabilities and equity. The objective of this Statement is to require issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of a nonpublic company. For these instruments, this Statement is effective for existing or new contracts for fiscal periods beginning after December 15, 2003. We adopted SFAS No. 150 effective January 1, 2004 as required. The Adoption of this Standard had no effect on the financial statements.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs – An amendment of ARB No. 43, Chapter 4. SFAS No. 151 requires that abnormal amounts of idle facility expense, freight and/or handling, and wasted materials (spoilage) be recognized as current-period charges. It also requires that allocation of fixed production overheads to inventory be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Adoption of this Standard is not expected to have a material effect on us.

In December 2004, the FASB issued an amendment to SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123R) which eliminates the ability to account for share-based compensation transactions using the Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires that such transactions be accounted for using a fair value-based method. SFAS 123R will be effective for the Company beginning in July 2005. SFAS 123R applies to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date as well as for the unvested portion of awards existing as of the effective date. The cumulative effect of initially applying this Statement, if any, is recognized as of the required effective date. As of the required effective date, the Company will apply SFAS 123R. Adoption of this Standard is not expected to have a material effect on us.

Stock Options

Until 2002, we had a stock-based employee compensation plan, which is described more fully in Note 11. We accounted for this plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the grant date.

All options vested in 1998. All unexercised options expired on December 10, 2002. Due to these facts there is no pro forma impact on net income per share had we applied the fair value provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation.

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Earnings Per Share

Basic earnings per share (EPS) are computed as net income available to common shareholders divided by the weighted average common shares outstanding. Diluted earnings per share considers the potential dilutive effects of the exercise of the outstanding stock options under our stock option plan. All stock options were exercised prior to December 31, 2002.

Reclassifications

Certain reclassifications have been made to the 2003 financial statements to conform to the 2004 financial statement presentation. These reclassifications had no effect on net earnings.

Note 2: Acquisition of Salient Systems, Inc.

On September 30, 2004, we completed the acquisition of Salient Systems, Inc. (Salient Systems) whereby we acquired 100% of the outstanding shares of Salient Systems for a total purchase price of $14,052,000, including the initial purchase price at September 30, 2004 of $12,790,000, a subsequent working capital adjustment of $758,000, paid in November 2004, and direct cash acquisition costs of approximately $504,000. The initial purchase price at September 30, 2004 of $12,790,000 consisted of $1,958,000 in cash, net of cash received of $2,526,000, the issuance of 933,274 shares of common stock valued at $7,186,000 and the issuance of promissory notes in the amounts of $1,120,000. The value of the 933,274 shares of common stock was determined based on our closing stock value on September 30, 2004 of $7.70 per share. Based on the merger agreement, in November 2004 we paid a working capital adjustment to the former Salient Systems’ shareholders in the amount of $758,000 which consisted of $303,000 in cash and the issuance of 50,503 shares of our common stock valued at $455,000. The value of the 50,503 shares of common stock was determined based on $9.00 per share, in accordance with the merger agreement. We feel that this acquisition will strengthen our global footprint in the growing market for Wayside Detection and Operating Asset Data Management systems as well as strengthen our friction management product line so that we can better serve our railway customers. Salient Systems is operated under the RMP segment and all its assets and liabilities are included in the RMP segment. The results of operations for Salient Systems have been included in the RMP segment and the consolidated financial statements since the date of acquisition.

In accordance with Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, we accounted for the acquisition using the purchase method of accounting. Accordingly, the assets and liabilities from the acquisition of Salient Systems were adjusted to fair value at the date of the acquisition. In addition, all identified intangible assets were recorded at fair value and included as part of the net assets acquired. The fair values of intangible assets relating to the acquired technology were determined by an independent appraiser. The assets acquired included $13,376,000 of intangible assets other than goodwill. Of the $13,376,000 of acquired intangible assets, a value of $9,797,000 was assigned to their Wheel Impact Load Detector product technology and a value of $3,579,000 was assigned to their Railstress Monitor product technology. Due to the expectation that these acquired product technologies will continue to be enhanced, such that it is expected that some generation of this technology could be in use for as long as railroads operate, both of these identified intangible assets were recorded without determinable lives. Until some unidentified and unpredicted factor arises, the life of these intangible assets will continue to be indeterminable. As part of the transaction, we recorded

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$1,692,000 of goodwill, which represents the excess purchase price over the fair value of net assets acquired. We will not be able to deduct any costs associated with the total identifiable intangible assets and goodwill for tax purposes. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and identified intangible assets without determinable lives will not be amortized, but will be evaluated for impairment annually. All intangible assets resulting from the acquisition are included in the RMP segment. The purchase price allocations are subject to adjustment and may be modified within one year from the acquisition. Subsequent changes are not expected to have a material effect on our consolidated financial position. In accordance with the terms of the merger agreement, we may be required to pay additional consideration, in the form of Portec Rail Products, Inc. common stock, based upon the future profitability of Salient Systems for Lthe years ended December 31, 2004, 2005 and 2006. Based on Salient Systems’ net income being below the threshold for an earn-out payment as defined in the merger agreement, no additional payments are due to former Salient Systems shareholders for 2004. In accordance with SFAS No. 141, Business Combinations, the Company does not accrue contingent consideration obligations prior to the attainment of the business objectives being achieved as set forth in the business combination. At December 31, 2004, the maximum potential future consideration, to be resolved over the following two years, is not determinable. Any such payments, if they are realized, would result in increases in goodwill.

The following summarizes the estimated fair values at the acquisition date:

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Pro Forma Financial Information – Salient Systems Acquisition

The following table presents the unaudited pro forma financial information of the Company including Salient Systems for the years ended December 31, 2004 and 2003, as if the acquisition had occurred on the first day of each period presented, after giving effect to certain purchase accounting adjustments. The pro forma adjustments include the elimination of certain officers’ salaries, elimination of acquisition related expenses, the recording of a bonus and consulting agreement and related income tax effects. The pro forma information is presented for information purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

Note 3: Acquisition of Kelsan Technologies Corp.

On November 30, 2004, we completed the acquisition of Kelsan Technologies Corp. (Kelsan) whereby we acquired 100% of the outstanding common and preferred shares of Kelsan for a total purchase price of $15,373,000, including estimated direct acquisition costs of $496,000. The aggregate cash purchase price was $15,373,000, of which $14,877,000 was financed with a seven-year term loan with a Canadian financial institution through a newly established wholly-owned subsidiary, 3094497 Nova Scotia Company (“Nova Scotia”). Although Nova Scotia is the actual borrower of the funds, Portec Rail Products, Inc. is the sole guarantor of the term loan with substantially all of its United States assets pledged as collateral, as well as approximately $1.5 million of cash pledged as collateral in the form of a United States Treasury Bill that matures in May 2005. We feel that this acquisition significantly strengthens and expands our total friction management product offerings by providing essential products and services to the railway industry. Kelsan is operated under our Canada segment and all assets and liabilities are included in the Canada segment. The results of operations for Kelsan have been included in the Canada segment and the consolidated financial statements since the date of acquisition.

In accordance with Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, we accounted for the acquisition using the purchase method of accounting. Accordingly, the assets and liabilities from the acquisition of Kelsan were adjusted to fair value at the date of the acquisition. In addition, all identified intangible assets were recorded at fair value and included as part of the net assets acquired. The fair value of intangible assets related to the acquired technologies was determined by an independent appraiser. The assets acquired included $10,895,000 of intangible assets, other than goodwill. Of the $10,895,000 of acquired intangible assets, a value of $5,505,000 was assigned to their Stick friction modifier product technology which will be amortized on a straight-line basis over an estimated useful life 15 years; a value of $5,178,000 was assigned to their Keltrack ^® liquid friction modifier product technology, which will be amortized on a straight-line basis over an estimated useful life of 28 years; and $212,000 was assigned to patent costs and will be amortized on a straight-line basis over an estimated useful life of 2 to 5 years. As part of the transaction, we recorded $4,100,000 of goodwill, which represents the excess purchase price over the fair value of net assets acquired. Of the total identifiable intangible assets and goodwill, $212,000 is expected to be deductible for tax purposes. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and identified intangibles without determinable lives will not be amortized, but will be evaluated for impairment annually. All intangible assets resulting from the acquisition are included in the Canada segment. The purchase price allocations are subject to adjustment and may be modified within one year from the acquisition. Subsequent changes are not expected to have a material effect on our consolidated financial position.

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     The following summarizes the estimated fair values at the acquisition date:

Pro Forma Financial Information – Kelsan Acquisition

The following table presents the unaudited pro forma financial information of the Company including Kelsan for the years ended December 31, 2004 and 2003, as if the acquisition had occurred on the first day of each period presented, after giving effect to certain purchase accounting adjustments. The pro forma adjustments include the elimination of certain administrative and officer salaries, the elimination of certain warehouse facility expense and certain operational employees, the elimination of certain duplicate administration costs, the elimination of acquisition related expenses, the elimination of inter-company transactions, the elimination of interest expense for certain long-term debt and preferred shares, the recording of a consulting agreement, the recording of interest expense for the debt incurred to finance the acquisition, the recording of amortization expense for deferred financing fees, the recording of amortization expense for acquired intangible assets, the recording of the related income tax effects for the above adjustments, the recording of a reduction in research and development tax credits, and the recording of income taxes. The pro forma information is presented for information purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

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Note 4: Accounts Receivable

Accounts receivable are presented net of an allowance for doubtful accounts. We generally do not require collateral for our trade accounts receivable. We continually evaluate our accounts receivable and adjust our allowance for doubtful accounts for changes in potential credit risk.

Accounts receivable consists of the following:

Note 5: Inventories

The major components of inventories are as follows:

Note 6: Property, Plant and Equipment

Property, plant and equipment consists of the following:

Total depreciation expense was approximately $1,488,000, $1,321,000 and $1,338,000 for the years ended December 31, 2004, 2003 and 2002, respectively.

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Note 7: Goodwill and Intangible Assets

On September 30, 2004, we completed the acquisition of Salient Systems whereby we acquired 100% of their outstanding common shares (see Note 2). The assets acquired included $13,376,000 of intangible assets, other than goodwill. Of the $13,376,000 of acquired intangible assets, a value of $9,797,000 was assigned to their Wheel Impact Load Detector product technology and a value of $3,579,000 was assigned to their Railstress Monitor product technology. Both of these identified intangibles were recorded with indefinite lives. As part of the transaction, we recorded $1,692,000 of goodwill, which represents the excess purchase price over the fair value of net assets acquired.

On November 30, 2004, we completed the acquisition of Kelsan whereby we acquired 100% of their outstanding common and preferred shares (see Note 3). The assets acquired included $10,895,000 of intangible assets, other than goodwill. Of the $10,895,000 of acquired intangible assets, a value of $5,505,000 was assigned to their Stick friction modifier product technology which will be amortized on a straight-line basis over an estimated useful life of 15 years, a value of $5,178,000 was assigned to the Keltrack ^® liquid friction modifier product technology which will be amortized on a straight-line basis over an estimated useful life of 28 years and $212,000 was assigned to patent costs which will be amortized on a straight-line basis over an estimated useful life of 2 to 5 years. The $4,100,000 of acquired goodwill represents the excess purchase price over the fair value of net assets acquired.

The changes in the carrying amounts of goodwill attributable to each segment at December 31, 2004 and 2003 are as follows: