-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KbxPczF2K8Jpi9PHrcav/uXOUU+MI0CJMILTrgyzuRYUm5O9gjTeTwvsn1zr74n+ aJ1DrVFxGqa4MGM4BKth9A== 0000912057-97-011404.txt : 19970401 0000912057-97-011404.hdr.sgml : 19970401 ACCESSION NUMBER: 0000912057-97-011404 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HARMON INDUSTRIES INC CENTRAL INDEX KEY: 0000045635 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 440657800 STATE OF INCORPORATION: MO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-07916 FILM NUMBER: 97571152 BUSINESS ADDRESS: STREET 1: 1300 JEFFERSON CT CITY: BLUE SPRINGS STATE: MO ZIP: 64015 BUSINESS PHONE: 8162293345 MAIL ADDRESS: STREET 1: 1300 JEFFERSON INC CITY: BLUE SPRINGS STATE: MO ZIP: 64015 FORMER COMPANY: FORMER CONFORMED NAME: HARMON ELECTRONICS INC DATE OF NAME CHANGE: 19780823 10-K 1 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 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, 1996 Commission file number 0-7916 HARMON INDUSTRIES, INC. ----------------------- IRS Employer Identification Number 44-0657800 State or other jurisdiction of incorporation or organization Missouri (Address of principal executive offices) 1300 Jefferson Court, Blue Springs, Missouri 64015 Registrant's telephone number, including area code: (816) 229-3345 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered ------------------------- ---------------------------- None ------------------------- ---------------------------- ------------------------- ---------------------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock - -------------------------------------------------------------------------------- Title of each class - -------------------------------------------------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- As of March 17, 1997, 6,836,208 common shares were outstanding, and the aggregate market value of the common stock (based upon the closing bid price of these shares per NASDAQ for Over-the Counter trading) of Harmon Industries, Inc. held by non-affiliates was approximately $112,841,000. The information required by Item 405 of Regulation S-K regarding late filings or failure to file in connection with Form 3, Form 4 or Form 5 is included herein under Part III, Item 12. 1 DOCUMENTS INCORPORATED BY REFERENCE PART II Item 6: Selected Consolidated Pages 16 and 17 of the Financial Data. Annual Report to Shareholders for the year ended December 31,1996. Item 7: Management's Discussion Pages 18 through 23 of and Analysis of Financial the Annual Report to Condition and Results of Shareholders for the year Operations. ended December 31, 1996. Item 8: Financial Statements Page 24 through 39 of and Supplementary Data. the Annual Report to Shareholders for the year ended December 31, 1996. PART III Item 10: Directors and Executive Pages 3 through 5 of the Officers of the Registrant. Company's Proxy Statement, dated April 1, 1997 Item 11: Executive Compensation Pages 6 through 14 of the and Other Information. Company's Proxy Statement dated April 1, 1997. Item 12: Security Ownership of Pages 2 and 3 of the Certain Beneficial Owners Company's Proxy Statement and Management. dated April 1, 1997. Item 13: Certain Relationships and Page 5 (last paragraph Related Transactions of Election of Directors) and page 5 ("Certain Transactions") of the Company's Proxy Statement dated April 1, 1997. 2 HARMON INDUSTRIES, INC. ANNUAL REPORT FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 PART I ITEM 1. BUSINESS The Company is a leading supplier of signal and train control systems, products and services to rail systems throughout North America and the world. The Company sells its products to Class I and short line freight railroads and to rail transit customers. Harmon designs, manufactures, markets and services a broad line of products beneficial to the operating efficiency and safety of its customers. The products include an extensive line of railroad signal and train control systems and related components and services. The Company emphasizes innovation and technology to develop timely and sophisticated solutions to problems that confront its customers. It also provides customized asset management services through a warehousing and distribution business. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." A rapidly growing share of the Company's sales now involve combining and customizing individual products to meet specific customer applications, representing an evolution for the Company from a supplier of separate component products to an integrator of systems able to provide customers with solutions to complex problems. INDUSTRY FREIGHT RAILROADS The domestic freight railroad industry includes Class I, regional and short line railroads. However, the industry is dominated by the 11 large freight carriers that the Interstate Commerce Commission defines as Class I railroads because of their significant annual operating revenues. From the 1930's to the 1980's, the Class I freight railroads endured a nearly constant decrease in their share of the total inter-city freight transportation market.(1) The reversal of this trend is a result of their ability to offer customers a lower cost and higher quality method of transporting freight than was provided in the past. Freight railroads achieved this result through strict cost controls, reductions in train crew sizes and other employment expenses, divestiture of unprofitable track segments and other assets unrelated to the railroad industry and a more marketing oriented operating strategy. The Company has traditionally sold its products to the freight railroad industry. Many Harmon products are designed to assist the railroads in cutting costs. For example, the 23% decrease in Class I employment levels from 1986 to 1995 required the Class I railroads to look to products like those manufactured by Harmon to monitor the condition of moving trains, help ensure ___________________ (1) This fact and the other statistical information about the Class I railroads in this Annual Report come from RAILROAD FACTS, 1996 EDITION, a recognized industry source for information on Class I railroads. 3 the safe switching and passage of trains and facilitate better communication among crew members on a train and between moving trains and railroad traffic controllers. Class I railroads have also used Harmon products to increase asset utilization and productivity. The 27% reduction from 1986 to 1995 in the number of Class I railroad freight cars in service required the Class I railroads to look to products like those manufactured by Harmon which permit the railroads to track more closely the location and performance of a particular train. This improved utilization of cars and the reduction in employment levels have caused the freight revenue ton miles per employee hour for Class I railroads to increase by 111% from 1986 to 1995. The Class I railroads have become more profitable despite a 38% reduction (in constant 1986 dollars) from 1986 to 1995 in revenue per ton mile. Many Class I railroads have entered into alliances with large trucking organizations that have resulted in an increase in the shipment of "intermodal" freight (i.e., containerized freight that moves from truck to train and back to truck) for which the railroads have retained the long haul segment. The amount of intermodal traffic has increased 61% from 1986 to 1995. The Company believes that the willingness of the Class I railroads to enter into such alliances with their former competitors is a positive development. The Company believes that the cost reductions and improved efficiencies described above permit the Class I railroads to better compete in the long haul segment of the freight transportation market. While final figures are not yet available for the year ended December 31, 1996, the total volume of intermodal shipments is estimated to have increased approximately 2% to 3% from 1995. The growth momentum of the Class I railroads is important to the success of Harmon. Class I railroads also have improved profitability by divesting themselves of assets viewed as unprofitable, including large portions of under-utilized track. From 1986 to 1995, the Class I railroads have reduced their track miles by 23%, to approximately 180,000 miles. These divestitures permit the Class I railroads to spend more money on products like those manufactured by Harmon for their high-traffic corridors. From 1986 to 1995, total capital expenditures by Class I railroads per mile of track owned has increased from approximately $15,400 to $33,200 per mile of track. Many of these expenditures are for products, such as the Company's Electro Code product, that reduce the significant maintenance expenses otherwise incurred by Class I railroads. Federal legislation in the early 1980's permitted the Class I railroads to sell some of their lines to short line railroads rather than abandon such track. Such sales have increased the number of short line railroads to 530, with 30 of these short line railroads being above the threshold of either $40.0 million annual revenues or 350 miles of railroad track. Short line railroads are able to profitably operate sections of track deemed unprofitable by Class I railroads because the short line railroads generally have smaller administrative, maintenance and engineering staffs, have locally focussed management, generally operate at lower speeds and are typically not burdened with the more restrictive collective bargaining agreements as the Class I railroads. 4 The manner in which the short line railroads operate creates significant opportunities for Harmon. These railroads typically do not have substantial engineering or maintenance staffs and, therefore, frequently look to Harmon to provide complete pre-engineered systems. Sales to these customers have become a meaningful portion of the Company's sales. Harmon expects to continue to develop products and services that will meet the evolving maintenance and operating needs of these railroads. The market in the freight railroad industry for Harmon products is influenced by the availability of government funding, the relative health of the freight railroad industry and the changing needs that such industry has for various Harmon products. The Intermodel Surface Transportation Efficiency Act of 1991 (ISTEA) provides federal funds through 1997 for railroad crossing warning systems in the same amount each year as existed under previous federal legislation. For many years this funding has been dedicated solely to railroad crossing warning systems. There has been discussion in Washington in recent years to convert future funding, like most other funding, to block grants to the states to be used for highway safety. If this occurs, it is unknown whether the states would continue to spend all of these funds on railroad crossing warning systems or spend all or a portion of them on other highway safety projects. Harmon expects the Class I railroads to continue their recent favorable financial performance. Accordingly, Harmon expects the equipment maintenance and capital improvement expenditures of Class I railroads to grow, or at least remain stable, in coming years. RAIL TRANSIT RAILROADS The rail transit industry includes AMTRAK and numerous existing and proposed commuter and urban transit rail systems. The development of such systems is generally enhanced by the federal funding provided by ISTEA, which nearly doubled the federal funding available annually for mass transit projects. The aggregate amount of federal funds appropriated by ISTEA that is expected to be made available for such projects between January 1992 and September 1997 is $31.5 billion. Current expectations are that the 1997 rail transit project funding will equal or exceed the 1996 level. In addition, ISTEA permits local governments to shift funds otherwise allocated for highway construction into mass transit projects. Harmon's participation in the expansion of existing or construction of new rail transit systems will generally require a long selling cycle and generally result in multi-year contracts. In addition, the selling process requires Harmon to consult regularly with engineers responsible for designing such systems. Such consultation permits Harmon to better understand the requirements of proposed projects and help insure that such projects are designed in a way that will permit use of many Harmon products. See "Business- Marketing and Sales." In addition to the rail transit projects expected to be expanded or originated in the next several years, Harmon has targeted existing rail transit systems as potential customers. These systems are under pressure to increase their capacity and maintain or improve passenger safety. These dual objectives are met through the increasing use of Harmon products containing advanced technology to control passenger trains and to install in such trains 5 equipment that guards against human error. An example of the Harmon ability to swiftly address safety concerns is the development by Harmon of its Ultra Cab product after a highly publicized 1987 passenger train accident in the Northeast Corridor. As a result of that accident, federal regulators required that all trains operating in the Northeast Corridor be equipped with automatic devices to guard against human error in responding to signals. Conrail, the major freight railroad most affected by this requirement, solicited bids from Harmon and its competitors for development of a product like Ultra Cab. Harmon won this bid and completed development of Ultra Cab, which now enjoys a substantial share of the cab signalling market. Another example of Harmon addressing safety concerns arose in 1991, when an over-speeding subway train derailed in New York City and caused several fatalities. As a result, the New York City Transit Authority embarked on a program of installing speed measurement and enforcement systems at critical locations along the subway track. Under sub-contract, Harmon developed a computer-based system for this application and has since been awarded additional sub-contracts. Harmon's first major contract for new construction in the rail transit market was the St. Louis Metro Link project, which totalled $4.7 million, the first phase of which entered service in July 1993. This project has served as a visible and successful entry by Harmon into the transit market as a major contractor. The Company's transit business has grown to include active transit projects in many major cities in North America. Harmon's first prime contract, with construction under its direction, was with the Chicago Transit Authority (CTA) for reconstruction of the signal and train control system for the Green Line elevated line. This contract, totalling over $13 million, was also Harmon's first as a prime contractor, with construction under its direction. The project was completed successfully and on time under an extremely aggressive schedule, and establishes Harmon as a major contender in this market. In November, 1996, the Company was awarded a $17.6 million contract for the design and manufacture of the train control system for a new light-rail system for the New Jersey Transit Authority. This contract award, the largest in the Company's history, further establishes Harmon as a significant supplier in the rail transit market. It is difficult to estimate the potential size of this market, particularly since railroad track used extensively by a rail transit operator in some metropolitan areas may be owned and maintained by a Class I railroad. Accordingly, sales to Class I railroads of Harmon products expected to upgrade certain areas of railroad track may well be sales that are related to or result from growth in the rail transit industry. INTERNATIONAL OPPORTUNITIES The Company has identified certain international markets as opportunities for growth. Standards for the railroad industry in Latin America, Canada, Australia, and certain parts of eastern Asia are generally consistent with the standards of the United States railroad industry. In addition, some nationalized railroads in Latin America are now being privatized and United States freight railroads, many of which are Harmon customers, are potential purchasers or operators of large portions of such 6 track. Harmon expects that its current relationships with such railroads will provide it the opportunity to sell its products through its existing customers for international use. Harmon is also pursuing strategic alliances with other railroad industry suppliers to assist Harmon's efforts to penetrate the international markets. The North American Free Trade Agreement is also expected to provide opportunities for Harmon in Mexico and Canada because the expected growth in trade will increase the railroad traffic in both directions across the borders. In July, 1996, Harmon acquired Vaughan Systems Ltd., subsequently renamed Vaughan Harmon Systems Ltd., located in the United Kingdom. The Vaughan Harmon Systems Ltd. acquisition established the first international manufacturing operations for the Company. Vaughan Harmon Systems Ltd. manufactures train control products which are complementary to the Company's domestic product lines and should provide a base for introducing the Company's products into the European market. Also, in December 1994, Harmon acquired the railroad division of SERVO Corporation of America (SERVO), including SERVO's distributors in Europe, Africa and the Middle East, which should enable the Harmon products to become more widely represented in these markets. BUSINESS STRATEGY Harmon's business strategy is to utilize its technological expertise, ability to install turnkey systems, broad product lines, extensive sales network and customer service orientation to provide high quality products and services to its customers. Harmon plans to continue to expand and improve its product lines and services to meet its customers' needs. Harmon expects that the continued development of its product lines may be accomplished, in part, by strategic acquisitions of product lines or companies that complement the Company's current product lines. The Company actively pursues potential acquisitions as part of this strategy. Internal development of new products will continue, consistent with Harmon's desire to expand its product base. The Company intends to improve its leadership position as a vendor to the freight railroad industry by continuing to expand its long-standing relationships with Class I railroads, continuing to explore opportunities with short line railroads, developing new technologies to meet customer needs, and by adding value through its engineering, installation and asset management services capabilities. The Company has seen and expects to continue to see a shift in its revenue mix from revenues generated strictly from the sale of its individual products to revenues resulting from the sale of complete systems that are designed, installed and, potentially, maintained by the Company. Systems sales now represent over half of total sales. The Company plans to utilize its extensive experience and expertise in the freight railroad industry to expand its presence in the rail transit market. The Company has successfully adapted several of its products to the needs of the rail transit industry and plans to add to the products and services that it can offer to the rail transit market. In international markets, the Company intends to continue forming strategic alliances with entities resident in such markets that are familiar with the local customers, the railroad standards and the individuals making the decisions to purchase equipment. Growth in this market may also be aided by active pursuit of additional acquisitions, continued development of distributor relationships and increased direct presence in international 7 markets. In addition, the ownership or operation by domestic Class I and short line railroads of railroad track in other countries provides Harmon the opportunity to sell its products through its existing customers for international use. The Company will continue its cost control system that subjects all research and development, acquisition and capital expenditure programs to a return on investment analysis. If the anticipated return from any such expenditure meets objectives set by the Company, such expenditure will generally be considered for implementation. The Company is continuing the process of upgrading its fully integrated financial, manufacturing and inventory control computer system that will assist its efforts to further contain costs. The Company continued its training and education efforts to finalize implementation of its Total Quality System program and to complete its ISO 9000 certification efforts in 1996. The Company's Grain Valley manufacturing and engineering, the Riverside Hot Box Detector manufacturing, the Warrensburg systems and the Long Island engineering facilities became ISO 9000 certified in 1996. In January 1997, the circuit board manufacturing plant attained its ISO certification. Substantially all of the Company's facilities are now ISO 9000 certified, with the final two facilities planned for certification in 1997. The Company underwent a realignment at the end of 1996 to provide a management structure organized along functional lines instead of separate operating subsidiaries. Effective December 31, 1996, the Company's domestic operating subsidiaries Harmon Electronics, Inc.; Electro Pneumatic Corporation; and Consolidated Asset Management Company, Inc., were merged into the parent company Harmon Industries, Inc. This realignment should allow the Company to better serve its customers and streamline its operations. Finally, the Company will continue to enhance its Total Quality System, promoting continuous improvement in all aspects of the Company's operations. The Company was one of the first in its industry to institute such a program. PRODUCT CLASSIFICATIONS The products of the Company can generally be separated into six categories. TRAIN CONTROL SYSTEMS include all Company products related to the control of train movement. These include the Company's signal control track circuits (Electro Code); interlocking control equipment (Electro Logic, HLC and VHLC); car-borne equipment (Ultra Cab); computer-based traffic control systems (TTM); and train describers and other train control systems manuafactured by Vaughan Harmon Systems Ltd. SIGNAL SYSTEMS include all Company products related to rail/highway crossing warning systems including: motion detectors (the Company's PMD and HXP products, among others); flashing lights and cantilevers; and the design, wiring and installation of these products. ASSET MANAGEMENT SERVICES involve a single-source, rapid delivery service for railroad components by warehousing commonly-used parts and equipment that are manufactured by the Company and other vendors. TRAIN INSPECTION SYSTEMS include all Company products related to monitoring information regarding a moving train as it passes by a train inspection site. PRINTED WIRING BOARDS include production of customer designed printed wiring 8 boards for use by other electronics manufacturers. OTHER sales include products that do not readily fit into the other five categories. PROFILE OF CURRENT OPERATIONS The Company's current products are summarized by product category in the following table. The table shows yearly sales and percentages of total sales for each of the past three years. Sales by Product or Service Function(1) Years Ended December 31, 1994 1995 1996 ---- ---- ---- (dollars in thousands) Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- Train Control Systems $45,711 38.4% $55,437 40.7% $87,080 47.4% Signal Systems 35,448 29.8% 42,375 32.1% 48,927 26.6% Asset Management Services 20,894 17.5% 14,194 10.4% 22,217 12.1% Train Inspection Systems 5,054 4.2% 11,360 8.4% 12,906 7.1% Printed Wiring Boards 6,307 5.3% 6,752 5.0% 5,249 2.9% Other 5,712 4.8% 5,999 4.4% 7,489 4.1% -------- ------ -------- ------ -------- ------ Total $119,126 100.0% $136,117 100.0% $183,868 100.0% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ (1)Sales volumes shown above are gross totals and do not include cash discounts or deferred contract revenue. As a result, there are small differences between the figures in this table and those presented in the "Consolidated Statements of Operations". See "Financial Statements." The differences do not affect the validity of the discussion and analysis. PRODUCTS While the Company's principal products and services have been grouped for purposes of discussion by primary product or service function, each product and service interrelates or is complementary to other Company products and services. Substantially all products and services (except printed wiring boards) are marketed to the railroad industry. TRAIN CONTROL SYSTEMS include all Company products and services related to the control of train movement. These include the Company's signal control 9 track circuits (Electro Code); interlocking control equipment such as Electro Logic, the Harmon Logic Controller (HLC) and the Vital Harmon Logic Controller (VHLC); car-borne equipment (Ultra Cab); computer-based dispatch and traffic control systems; train describers; and the design, wiring and installation of packages and systems comprised of these products. Signal control track circuits control signals regulating train traffic by sending and receiving coded electrical impulses using the rails for transmission. The primary advantage of this method is the elimination of overhead transmission lines between signal locations. The product also eliminates the need for some of the expensive electro-mechanical signal relays. Computer-based dispatch systems monitor and control train movement over designated tracks from a central location. These systems provide important information enabling the railroads to direct the movement of trains over large sections of track, thereby reducing the number of control towers and related personnel otherwise required. Although the technology is similar, each system requires individualized design and specialized software. Interlocking control equipment controls the track switches and train signals at intersections or junction points (interlockings) where main tracks cross or merge, or where trains may cross over between adjacent main tracks at running speeds. Interlockings generally employ data telemetry to and from a remote location (site of the computer-based dispatch system) and also frequently interface to signal control track circuits. Interlockings use standard products but often require extensive application engineering to define a site-specific configuration. Ultra Cab communicates speed commands directly to moving locomotives through electrical currents in the rails, displays the resulting speed requirements to the engine crew using colored light signals in the cab, and enforces compliance with the speed commands by initiating an automatic brake application if the engineer fails to stay within prescribed limits. A more advanced system called Incremental Train Control System (ITCS) is being developed by the Company. It uses radio data communications rather than currents in the rails to exchange data between trains and the wayside equipment, and provides many added features. An initial installation of ITCS is being done on an Amtrak line in southern Michigan under an FRA grant to demonstrate enhanced train control technology for High Speed Rail corridors. SIGNAL SYSTEMS include all Company products and services related to rail/highway crossing warning systems including: motion detectors (the Company's PMD and HXP products, among others); flashing lights and cantilevers; and the design, wiring and installation of packages and systems comprised of these products. Rail/highway crossing warning systems activate flashing lights and audible bells, and initiate the lowering of crossing gates to provide traffic barriers in installations so equipped. While the Company offers complete systems, the more sophisticated electronic equipment that activates the warning lights or crossing gates is often sold separately. The Harmon Railroad Crossing Processor (HXP) and the Phase Motion Detector (PMD) are the trade names for the electronic controllers used in most of these systems. The HXP is the Company's most sophisticated device for control of railroad crossing warning devices, and is protected by U.S. patent #4,581,700. It uses microprocessors to calculate the train's speed and distance to the crossing and provides a consistent warning time. The less-costly PMD activates the warning device when the approaching train is within a 10 predefined distance from the crossing and may be used over a wider range of trackside conditions. The latest versions of these two products, HXP-3 and PMD- 3, represent superior technology and offer the convenience of modular interchangeability between the two products. ASSET MANAGEMENT SERVICES involve a single-source, rapid delivery service for railroad components by warehousing commonly-used parts and equipment that are manufactured by the Company and other vendors. Asset management services include a portion of the revenues of our former subsidiary, Consolidated Asset Management Company, Inc. (CAMCO). In late 1988, CAMCO received its first orders and began providing services for the railroad industry including assembly and storage of materials for track projects. CAMCO provides other services including purchasing and distribution of communication and signal inventory. One of the predominant services is the assembly of containerized construction kits including all material needed for a signal installation project, some of which is not made by Harmon. These kits greatly improve the productivity of the railroad's construction crews and are finding growing acceptance in the industry. CAMCO's success has helped Harmon diversify from a predominantly manufacturing operation into the service portion of the railroad supply industry. TRAIN INSPECTION SYSTEMS include all Company products and services related to monitoring information regarding a moving train as it passes by a train inspection site, and the design, wiring and installation of packages and systems comprised of these products. The Company's acquisition of the transportation division of SERVO Corporation of America in December 1994 has increased its market share of this product line. The principal product used in these systems is a hot-bearing detector, which is installed beside the track and is designed to detect overheated bearings of passing rail cars. Overheated bearings, if not detected in time, may cause derailments, resulting in substantial expense and potential liability to the railroads. Some hot bearing detectors include an auxiliary function to provide hot wheel detection. Hot wheels can result from sticking brakes on a car and can cause severe wheel damage and even derailments if left unchecked. Other train inspection products include a device to detect when a rail car is dragging an unwanted object and a sensor to monitor high or wide loads. PRINTED WIRING BOARDS include production of customer designed printed wiring boards (PWB) for shipment to other electronics manufacturers. A substantial portion of the plant capacity for PWB is used in the Company's own products. The category OTHER includes a variety of items. One of these is radio communication equipment which includes mobile and stationary two-way radios specifically designed for railroad applications involving transmission of voice and/or data messages. PRODUCT DEVELOPMENT AND PATENTS The Company considers product development essential to both maintaining its market position and to future growth. Product innovation has been a major contributor to the Company's profitability during the past few years, as the railroads have sought more cost effective methods of controlling and monitoring train operations. Frequently, a customer's technical staff works closely with the Company's staff on the design of a system or component parts. 11 The Company will continue to focus on rapid response to customer needs in its introduction of new products. The Company anticipates increasing its efforts and expenditures for product development. The Company continues to develop new products and new variations of previously successful products, where market demands and competition dictate the need. Major development efforts have recently concentrated on several key areas: (i) the new Incremental Train Control System (ITCS) for initial application to the FRA funded demonstration project in Michigan, (ii) a communication-based train control system called UltraBlock which is intended for Rail Transit applications, and (iii) ongoing enhancements to most of the existing products including crossing warning systems, interlocking controls, signal control track circuits, train inspection systems, and Ultra Cab. Development of these products is expected to maintain the Company's position in the freight railroad market and improve the Company's ability to compete in the rail transit market. Consistent with its objective of protecting its position as a leading developer of technologically advanced products, the Company spent approximately $4,561,000, $5,218,000 and $6,331,000 in the years ended December 31, 1994, 1995 and 1996, respectively, on research and development activities related either to the improvement of existing products or to the development of new products. While the dollar amount classified as research and development has fluctuated over the years, the number of engineers in the Company's employ has increased. A significant portion of the engineering resources are involved in applying developed products to specific customer needs. In addition to expanding its product line by means of internal research and development, the Company will consider acquisitions of complementary product lines like those that have previously allowed the Company rapid entry into new areas of the railroad equipment market. In conjunction with the purchase of Vaughan Systems Ltd., the Company obtained their existing complementary product lines, technology and R&D projects along with a significant research and development workforce that was already in place. Although the Company believes that its patents and patent applications have value, the Company relies primarily on trade secrets to protect its technology. Rapidly changing technology makes the Company's future success dependent on the technical competence and creative skill of its personnel. MARKETING AND SALES The Company's products are sold to the freight railroads and rail transit industries through experienced direct sales employees who work closely with the Company's customers to identify existing or potential products to improve the efficiency and enhance the safety of their operations. The Company's sales force is organized along industry lines. A separate group is primarily responsible for sales to each of the market segments: Class I, short line, rail transit and international. The international marketing organization is assisted by a distributor in which the Company has a minority interest. Henkes-Harmon Industries, Pty. Ltd. is based in Melbourne, Victoria, Australia and sells the Company's products in Australia and New Zealand. The Company also utilizes foreign nationals to assist the Company's sales staff with sales in other foreign 12 markets. The addition of Vaughan Harmon Systems, Ltd. in England and the distributor network associated with the SERVO hot box detector product line acquisition should enable Harmon to increase its penetration in the international market, particularly in Europe. The Company considers Mexico and Canada to be a portion of its domestic market and these countries are serviced by its domestic marketing group. This effort is enhanced in Canada by using Vale-Harmon Enterprise Ltd., which is based in Quebec, Canada and sells Harmon products to the Canadian railroads. Harmon has a minority equity interest in Vale-Harmon. Harmon is considering strategic alliances with entities that design and manage the construction and expansion of track systems to assist Harmon with sales in the United States and elsewhere. The Company's products are sold individually or are packaged together as a system to provide a broad array of combined products and services. Although sales of some of the Company's products are seasonal, the Company does not consider its business generally to be seasonal. The Company is actively pursuing opportunities on freight and passenger railroads in both the United States and international markets. Sales in the rail transit market are usually large multi-year contracts for major new installations compared with shorter term projects or individual product sales that typically occur in the freight market. If the Company is successful in obtaining such contracts, which are generally awarded on a fixed price bid basis, significant variations in overall sales and backlog may result. BACKLOG The Company's backlog of orders was approximately $59.4 Million at December 31, 1996. Approximately, $12.8 million of these orders have delivery dates in 1998 and 1999. Management believes the remaining $46.6 million in orders are firm and will be filled in 1997. The backlog of orders was approximately $49.1 million at December 31, 1995, the majority of which were filled during 1996. Although the Company has historically experienced few order cancellations or delays in filling orders, cancellations could occur and delivery dates could be extended due to customer requests or production scheduling. COMPETITION The Company's business is highly competitive. The Company competes effectively on the basis of the reliability and design of its products, customer service and price. Competition will require the Company to continue to introduce new products and services to its customers. The Company's three major competitors, all of which are subsidiary units of foreign companies, appear to have greater financial resources than the Company. Nonetheless, the Company has demonstrated its ability to develop and introduce new products and expects that a continuation of such ability will permit it to maintain its competitive position. WARRANTY AND FIELD SERVICE The Company provides a high level of customer support through warranty and customer service departments. The Company's engineers and technicians 13 provide field service support, repairs and customer training in the use and maintenance of the Company's products. These efforts are important to maintain customer satisfaction and learn of customer needs, but do not now directly generate significant revenue for the Company. MANUFACTURING Manufacturing consists of the assembly of component parts either purchased from others or produced internally and the production of printed wiring boards. The Company generally manufactures products in response to specific customer orders and specifications and, as a result, does not maintain a significant finished goods inventory. Furthermore, an increasing number of the products sold by the Company are incorporated into a complete system that is assembled by the Company and delivered as a package. The Company's employees participate in the Total Quality System, working in teams to improve processes and products. Harmon was one of the first vendors to the railroad industry to institute a total quality program and considers its program to be an important part of its continuing efforts to improve its manufacturing process and products. The Company is dependent upon a continuing supply, both domestic and foreign, of some component parts and materials. The Company occasionally experiences some delays in the availability of certain component parts and materials, and in many cases suppliers require long lead times. In recent years, there has been no significant interruption of the Company's business due to a shortage of components or manufacturing materials. EMPLOYEES As of December 31, 1996, the Company had 1,202 full-time employees. There were 1,059 employees in manufacturing, 32 in marketing and sales and 111 in general and administrative services. Some of the 1,059 manufacturing employees are engaged in research and development. The Company estimates that the time expended on research and development equals approximately 77 full-time employees. In addition, the Company estimates that approximately 103 full-time employees are involved in applications engineering. In general, the Company believes its relations with its employees are excellent. The Company's employees are not covered by a collective bargaining agreement. ITEM 2. PROPERTIES The Company owns or leases an aggregate of approximately 500,000 square feet of space for manufacturing, warehousing, research and general office use. In addition, the Company owns 32 acres of land zoned for industrial use, on which the Grain Valley manufacturing and research facilities, and the Warrensburg component plant are located. All real property owned or leased by the Company is subject to liens arising from the Company's long term debt, as described in Note 3 of Notes to the Consolidated Financial Statements. The following table summarizes the Company's principal facilities. 14 Floor Space Annual Lease Expiration Location Principal Use (square feet) Payment (1) Date of Lease - -------- ------------- ------------ ------------ ------------- Grain Valley, Design and 77,750 Owned Owned Missouri manufacture of (2 facilities) electronic products and railroad signal systems Warrensburg, Manufacture of 48,000 Owned Owned Missouri railroad crossing warning systems and hardware Warrensburg, Manufacture of 30,400 Owned Owned Missouri printed wiring boards Jacksonville, Design and 94,300 $351,004 12-31-2001 Florida manufacture of railroad crossing warning systems and hardware Omaha, Design of 2,000 $ 20,100 3-02-98 Nebraska railroad crossing warning systems Louisville, Design of 9,765 $ 57,500 8-31-99 Kentucky railroad crossing warning systems Atlanta, Design and 35,364 Owned Owned Georgia assembly of railroad crossing warning systems Riverside, Administration 88,027 $ 344,949 9-30-2001(2) California and product (3 facilities) design, management information service operations and manufacture of electronic products 15 Floor Space Annual Lease Expiration Location Principal Use (square feet) Payment (1) Date of Lease - -------- ------------- ------------ ------------ ------------- Hauppauge, Design of 10,000 $103,612 5-1-2000(3) New York electronic products for the railroad industry Riverside, Assembly, 47,000 $107,128 2-01-98 California storage and distribution of products for the railroad industry Blue Springs, Assembly, 38,500 $ 32,083 6-30-97 Missouri storage and distribution of products for the railroad industry Lee's Summit, Assembly, storage 20,000 $ 68,000 7-01-99(4) Missouri and distribution of products for the railroad industry Lee's Summit, Assembly, 10,000 $ 34,050 7-01-98(5) Missouri storage and distribution of products for the railroad industry Blue Springs, Corporate 14,166 $135,930 11-01-99(6) Missouri Headquarters Ware, Design and 18,145 Owned Owned England manufacture of (2 facilities) electronic products and control systems (1) For additional discussion and information concerning the Company's lease commitments, see "Financial Statements - Note 6 of Notes to the Consolidated Financial Statements." (2) Consumer price indexed increases (maximum 4% per year) are effective October 1, 1998 and October 1, 1999. Upon notice by January 1, 1998, the Company has the right to terminate this lease on October 1, 1998 subject to an early termination penalty. 16 (3) Lease payments are as follows: May 1, 1997 through April 30, 1998 - $107,368/year May 1, 1998 through April 30, 1999 - $111,275/year May 1, 1999 through April 30, 2000 - $115,338/year (4) The annual lease payment increases to $73,000 and $77,000 effective July 1, 1997 and 1998, respectively. The Company may terminate this lease in June 1997 upon payment of a predetermined early termination fee. (5) The Company has the option to extend and renew this lease for three successive one year terms after June 30, 1997. (6) The Company has the option to renew the lease for up to two successive five year terms. In addition to these facilities, the Company also leases office space in Grain Valley and Blue Springs, Missouri. The Company owns all significant machinery and equipment used in its manufacturing operations. The Company is at near-capacity in several areas of its business and anticipates spending significant amounts of money over the next several years to expand its manufacturing and engineering facilities. ITEM 3. LEGAL PROCEEDINGS GRAIN VALLEY MATTER During the last quarter of 1987, officials of the Company discovered ground contamination from used solvents classified as hazardous waste at the Grain Valley, Missouri production facility that it owns. A voluntary report was made to the State of Missouri Department of Natural Resources ("MDNR"), and negotiations are ongoing regarding the extent of remedial or clean up actions and monitoring requirements. MDNR has approved the Company's Closure/Post-Closure Plan which sets forth the soil remediation and groundwater monitoring obligations at this site. The Company and MDNR also have entered into a Consent Decree which authorizes the Company to implement the approved Closure/Post-Closure Plan pending the issuance of a post-closure permit. The Company submitted a post-closure permit application to MDNR in October 1994. Any remediation requirements are set forth in the post-closure permit. The Company has designed and installed a system to begin soil remediation and expects that system will be required to continue in operation for some time. The Company completed closure work and submitted its closure report to MDNR for approval on February 1, 1996. A post closure permit was issued to the Company by the MDNR in June, 1996. The Company has established a trust fund to provide financial assurance for the anticipated post-closure costs of approximately $500,000 to be incurred over approximately 30 years. To date, the Company has contributed approximately $490,000 million to a trust to cover these costs. On September 30, 1991, the EPA issued a Complaint against the Company alleging violations of the Resource Conservation and Recovery Act ("RCRA") and RCRA regulations in its disposal of the solvents that created the contamination described above. The Complaint initially sought penalties in the amount of $2,777,000 and proposed certain compliance actions. On December 6, 1994, EPA amended its Complaint to decrease the amount of proposed 17 penalties to $2,343,706. The Company is vigorously defending the EPA Complaint and related proposed penalties under RCRA. Management believes that all of the allegations are for technical violations. The case proceeded to hearing before an Administrative Law Judge on January 12-14, 1995, on the issue of penalties. The Company presented evidence on a variety of penalty reduction theories, including good faith, minor potential harm to human health and the environment, and economic benefit. On December 12, 1995, the Administrative Law Judge issued an Initial Decision, in which he assessed penalties of $586,716 against the Company. Additionally, the Judge issued a Compliance Order requiring the Company to obtain liability coverage for sudden and non-sudden accidental occurrences, despite a Consent Decree with the Missouri Department of Natural Resources which excused the Company from this requirement as long as the Company continued to make semi-annual showings that the type of insurance required by the regulations was unattainable. On January 9, 1996, the Company filed a Notice of Appeal of the Initial Decision with the Environmental Appeals Board. On appeal, the Company will argue that the complaint is barred by the federal statute of limitations, that EPA lacks jurisdiction to bring the Complaint and that the penalties assessed against the Company are excessive in light of the Company's discovery during an internal audit and subsequent voluntary disclosure and clean-up. The Company will also argue that the Judge's Order for the Company to obtain liability coverage is inconsistent with the State Consent Decree and violates the spirit of the RCRA state authorization provisions. EPA did not appeal the Initial Decision, but has filed briefs in support of the $586,716 penalty. Special legal counsel has advised that the penalties sought by EPA in this case are consistent with its applicable penalty guidelines that were adopted by the EPA in October, 1990. Based on the Company's cooperation with MDNR (which has original jurisdiction and, therefore, primary responsibility in the matters complained by the EPA), in voluntarily disclosing the alleged violations, and in promptly undertaking all remedial actions specified to date by the MDNR, the penalties appear to the Company's special legal counsel to be excessive. However, because so few analogous cases have been disposed of by settlement or by administrative or judicial proceedings since the new penalty guidelines were adopted, special legal counsel cannot express an opinion as to the ultimate amount, if any, of the Company's liability. Since the amount of the penalties cannot be reasonably determined at this time, no estimate is included here or in the financial statements. OTHER MATTERS The Company has been named as a defendant in several other lawsuits in the normal course of its business. In the opinion of management of the Company, after consulting with legal counsel, the liabilities, if any, resulting from these matters are not expected to have a material effect on the consolidated financial statements of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There were no matters submitted to a vote of security holders during the quarter ended December 31, 1996. 18 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. The Company's common stock trades on The NASDAQ Market under the symbol HRMN. Stock price quotations can be found in major daily newspapers and in The Wall Street Journal. At February 1, 1997 the following securities firms were making a dual auction market in the Company's common stock: George K. Baum & Company Piper Jaffray Companies Inc. Paine Webber Inc. The approximate number of holders of record for the Company's common stock as of March 18, 1997 was 637. ITEM 6. SELECTED FINANCIAL DATA Incorporated by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Incorporated by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no disagreements on accounting and financial disclosure as described in Item 304 of Regulation S-K. There has been no change in the Company's accountants within the preceding twenty-four months. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following is a list of the officers and key employees of the Company. This information should be read in connection with the Company's Proxy Statement (Pages 3 through 4). Principal Occupation For Individual Office Age For The Last Five Years - -------------------------------------------------------------------------------- Breshears, Ronald G. VP-Human Resources 50 VP-Human Resources of the Company since 7/1/81. Bush, William L. Director-Research 51 Director-Research & & Development Development of the Company since 8/8/93. Prior to that, Manager, Defense Business Unit with Xetron Corporation, a subsidiary of Northrop Grumman. 19 Principal Occupation For Individual Office Age For The Last Five Years - -------------------------------------------------------------------------------- Bush, William L. Director-Research & 51 Director-Research & Development Development of the Company since 8/8/93. Prior to that, Manager, Defense Business Unit with Xetron Corporation since 1990. Daniels, Richard A. VP-Transit Sales 56 Appointed VP Transit Sales 2/1/93. Prior to that, Director Transit / Commuter Systems of the Company since April 1991. Foudree, Charles M. Exec. VP-Finance, 52 Exec. VP of the Company Secretary and since 9/9/86. Secretary Treasurer of the Company since 2/2/82. Treasurer of the Company since 2/5/74. Harmon, Robert E. Chairman of the 57 Chairman of the Board Board the Company since 2/4/75. Chief Executive Officer of the Company from 8/1/90 through 12/31/94. Heggestad, Robert E. VP-Technology 58 VP-Technology of the Company since 10/2/86. John, James R. VP-Services 48 Appointed VP-Services of the Company on May 1, 1996. President of Consolidated Asset Management Services Company, Inc. from March 1992 to April 1996. Prior to that VP Manufacturing of Harmon Electronics, Inc. since February 1987. Johnson, John W. VP-Domestic Sales 50 Appointed VP-Domestic Sales 2/1/93. Prior to that Director-Product Support for the Company since March 1992; prior to that held several positions with the Company, including Sales Manager-Signal Products, Director of Engineering for Harmon Electronics, Director of Customer Service and Sales since 1972. 20 Principal Occupation For Individual Office Age For The Last Five Years - -------------------------------------------------------------------------------- Kaiser, Lloyd T. Exec. VP-Systems 45 Appointed Exec. VP- Systems May 1, 1996. President of Harmon Electronics, Inc. from March 1992 to April 1996. Prior to that VP- Research & Development of Harmon Electronics, Inc. (HEI) since 4/1/91. Olsson, Bjorn E. President & Chief 51 President & Chief Executive Officer Executive Officer Officer of the Company since 1/1/95. President of the Company since 8/1/90. Chief Operating Officer of the Company from 8/1/90 through 12/31/94. Rosewall, Raymond A. VP-Manufacturing 45 VP-Manufacturing since 12/27/95. President of Electro Pneumatic Corporation from 12/27/95 to 4/30/96. Prior to that Executive VP Worldwide Sales and Marketing for QMS, Inc. since 1992; prior to that Executive VP Operations for QMS, Inc. since 1989. Ryker, Gary E. Exec. VP-Marketing, 47 Appointed Exec. VP- Sales and Service Marketing Sales and Service Marketing Sales and Service 2/1/93. Prior to that VP-Marketing and Sales of the Company since 9/1/92; prior to that Marketing and Operations Director and Marketing and Support Manager for Railroad Electronics for Rockwell International since 1979. 21 Principal Occupation For Individual Office Age For The Last Five Years - -------------------------------------------------------------------------------- Scheerer, William J. VP-Applications 49 Appointed VP- Engineering Applications Engineering 1/4/94. Prior to that held various positions with the CSX Railroad, the latest one being Chief Engineer Train Control for CSX Transportation. Schmitz, Stephen L. VP-Controller 43 VP-Controller of the Company since 11/1/83. Utterback, Jeffery J. Director-Quality Director-Quality Assurance Assurance of the Company since 1993. Prior to that, Manager of Product Assurance of the Company since 1990. Although some of the above have employment agreements which provide for twelve months of continued employment on a rolling basis, all of the above serve as officers at the pleasure of the respective Board of Directors and are appointed for one year terms. The following is a list of the Board of Directors of the Company: Individual Affiliation ---------- ----------- Robert E. Harmon Chairman of the Board Thomas F. Eagleton Attorney-at-Law, Thompson & Coburn St. Louis, Missouri Bruce M. Flohr Chairman and CEO RailTex, Inc., San Antonio, Texas Charles M. Foudree Executive Vice President-Finance, Treasurer and Secretary Rodney L. Gray Chairman & CEO Enron International, Inc., Houston, Texas Herbert M. Kohn Attorney-at-Law, Bryan Cave Kansas City, Missouri Douglass Wm. List Management Consultant Baltimore, Maryland Gerald E. Myers Management Consultant Tempe, Arizona Bjorn E. Olsson Chief Executive Officer and President Donald V. Rentz Grant Leighton Associates of Texas, Inc. Plano, Texas Judith C. Whittaker Vice President,General Counsel / Secretary Hallmark Cards, Incorporated Kansas City, Missouri 22 ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Financial Statements The following consolidated financial statements of Harmon Industries, Inc. and subsidiaries are incorporated by reference from the Company's 1996 Annual Report to Shareholders at the following pages: Page ----- Independent Auditors' Report 37 Consolidated Balance Sheets - December 31, 1996 and 1995 24-25 Consolidated Statements of Earnings - Years ended December 31, 1996, 1995 and 1994 26 Consolidated Statements of Stockholders' Equity - Years ended December 31, 1996, 1995 and 1994 27 Consolidated Statements of Cash Flows - Years ended December 31, 1996, 1995, and 1994 28 Notes to Consolidated Financial Statements 29-35 (a)(2) Financial Statement Schedules Selected Financial Data - for the years ended December 31, 1996, 1995 and 1994, are attached hereto at the following pages: Independent Auditors' Report on Financial Statement Schedule 27 Schedule VIII - Valuation and Qualifying Accounts 28 All other schedules are omitted as they are either not applicable or the required information is presented in the footnotes to the financial statements in the annual report. 23 (a)(3) Exhibits: Exhibit No. Page ---------------------------------------------------------------------- 11 Computation of Weighted Average Shares Outstanding 29 thru 30 13 Sections of the 1996 Annual Report to Shareholders 31 thru 72 20 Notice of Annual Meeting and Proxy Statement dated April 1, 1997. Incorporated by reference N/A 21 Listing of Subsidiaries 73 99-1 Articles of Merger 75 thru 81 99-2 Forward Looking Information Incorporated by reference from Page 36 of Exhibit 13 (b) Reports on Form 8-K: There were no reports on Form 8-K for the three months ended December 31, 1996. 24 SIGNATURES Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HARMON INDUSTRIES, INC. Date: March 25, 1997 By: /s/ Bjorn E. Olsson ----------------------- Bjorn E. Olsson President Date: March 25, 1997 By: /s/ Charles M. Foudree ------------------------ Charles M. Foudree Executive Vice President- Finance Date: March 25, 1997 By: /s/ Stephen L. Schmitz ------------------------ Stephen L. Schmitz Vice President-Controller 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in their capacities as directors and on the dates indicated: By: Date: March 25, 1997 --------------------------- Thomas F. Eagleton, Director By: /s/ Bruce M. Flohr Date March 25, 1997 --------------------------- Bruce M. Flohr, Director By: /s/ Charles M. Foudree Date: March 25, 1997 --------------------------- Charles M. Foudree, Director By: Date: March 25, 1997 --------------------------- Rodney L. Gray, Director By: /s/ Robert E. Harmon Date: March 25, 1997 --------------------------- Robert E. Harmon, Director By: /s/ Herbert M. Kohn Date: March 25, 1997 --------------------------- Herbert M. Kohn, Director By: /s/ Douglass Wm. List Date: March 25, 1997 --------------------------- Douglass Wm. List, Director By: /s/ Gerald E. Myers Date: March 25, 1997 --------------------------- Gerald E. Myers, Director By: /s/ Bjorn E. Olsson Date: March 25, 1997 --------------------------- Bjorn E. Olsson, Director By: Date: March 25, 1997 --------------------------- Donald V. Rentz, Director By: /s/ Judith C. Whittaker Date: March 25, 1997 --------------------------- Judith C. Whittaker, Director 26 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Harmon Industries, Inc.: Under date of February 4, 1997, we reported on the consolidated balance sheets of Harmon Industries, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996, as contained in the 1996 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1996. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed under Item 14 of Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, this financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Kansas City, Missouri February 4, 1997 27 Schedule VIII HARMON INDUSTRIES, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS) Charged to Beginning costs and Recoveries Ending Description balance expenses (deductions) balance ----------- --------- --------- ------------ ------- Year ended December 31, 1994: Allowance for doubtful trade accounts receivable $ 241 $ 1 $ 118 $ 360 ------ ------ ------ ------ ------ ------ ------ ------ Year ended December 31, 1995: Allowance for doubtful trade accounts receivable $ 360 $ - $ 2 $ 362 ------ ------ ------ ------ ------ ------ ------ ------ Year ended December 31, 1996: Allowance for doubtful trade accounts receivable $ 362 $ 32 $ (87) $ 307 ------ ------ ------ ------ ------ ------ ------ ------ Warranty reserve $ - $2,938 $ - $2,938 ------ ------ ------ ------ ------ ------ ------ ------ 28 EX-11.A 2 EXHIBIT 11A HARMON INDUSTRIES, INC. EXHIBIT 11A FORM 10-K ----------- DECEMBER 31, 1996 Computation of earnings per share (Instruction H(g)) - ---------------------------------------------------- Computation of the average number of shares of Common Stock outstanding for the three months ended December 31, 1996 and 1995.
(1) (2) (3) (4) Average number of shares outstanding as shown on consolidated statements Shares of Number of operations (3) common of days Share days divided by number stock outstanding (2 x 1) of days in period --------- ----------- ------------ ----------------------- 1996 October 1 - December 31 6,823,273 92 627,741,116 Options exercised 1,000 8 8,000 5,000 7 35,000 Equivalent shares under the Company's option plans 39,897 92 3,670,524 ------------ 631,454,640 6,863,637 ------------ --------- ------------ --------- 1995 October 1 - December 31 6,805,626 92 626,117,592 Equivalent shares under the Company's bonus plan 2,698 92 248,189 Equivalent shares under the Company's option plans 25,461 92 2,342,412 ------------ 628,708,193 6,833,785 ------------ --------- ------------ ---------
29 Computation of the average number of shares of Common Stock outstanding for the twelve months ended December 31, 1996 and 1995. 1996 Quarter 1 weighted average 6,828,883 Quarter 2 weighted average 6,834,674 Quarter 3 weighted average 6,837,743 Quarter 4 weighted average 6,844,216 Divided by 27,345,516 4 quarters = 6,836,379 --------- --------- 1995 Quarter 1 weighted average 6,814,783 Quarter 2 weighted average 6,823,650 Quarter 3 weighted average 6,837,112 Quarter 4 weighted average 6,833,785 Divided by 27,309,330 4 quarters = 6,827,333 --------- --------- 30 EX-13 3 ANNUAL REPORT Harmon Industries, Inc. 1996 Annual Report Signal and Train Control Systems for Railroads Worldwide [COVER PHOTO] Photograph of a passenger rail station, rail transit cars and track.\ 31 Corporate Profile Harmon is a leading supplier of sophisticated signal and train control products and systems. It serves three railroad markets: domestic freight, domestic rail transit, and international, which includes both freight and rail transit. Harmon's design focus is microprocessor based and aimed toward systems and products that improve the operating efficiency and safety performance of its customers. Products include railroad signal and train control equipment, train inspection systems, rail/highway grade crossing hardware and related components. Harmon emphasizes engineering innovation and rapid response to customer needs. Many of its products provide sophisticated and timely solutions to signal and control problems that impact the railroad industry. Harmon is headquartered in Blue Springs, Missouri, a suburb of Kansas City. It operates from numerous facilities in the U.S., Canada, England, Switzerland, and Australia. Harmon common stock trades on The Nasdaq Stock Market under the symbol: hrmn. Its current annual dividend is 15 cents per share. Table of Contents Financial Highlights 1 Report to Shareholders 2 Harmon Markets 4 Corporate Progress 14 Selected Financial Data 16 Financial Review 18 Consolidated Financial Statements 24 Notes to Consolidated Financial Statements 29 Investor Information 38 Management, Directors and Corporate Data 39 Locations 39 32 FINANCIAL HIGHLIGHTS (in thousands except per share data, where applicable) OPERATING DATA Year ended December 31, 1996 1995 Percent Change - ------------------------------------------------------------------------------- Net sales $175,440 $136,780 + 28.3% Pre-tax income 15,105 11,180 + 35.1 Income taxes 5,775 4,294 + 34.5 Net earnings 9,330 6,886 + 35.5 Earnings per share 1.36 1.01 + 34.7 Dividends per share .15 .15 -0- PERFORMANCE DATA Year ended December 31, 1996 1995 Percent Change - ------------------------------------------------------------------------------- Return on sales (pre-tax) 8.6% 8.2% + 4.9% Return on year-end equity 16.1% 14.0% + 15.0 Return on capital employed 1 25.9% 21.7% + 19.4 YEAR-END DATA December 31, 1996 1995 Percent Change - ------------------------------------------------------------------------------- Working capital $33,629 $35,014 - 4.6% Interest-bearing long-term debt 3,412 12,090 -71.8 Approximate number of shareholders 2 637 675 - 5.6 Number of employees 1,200 1,075 +11.6 Outstanding shares (000s) 6,829 6,806 + 0.3 1 Return on capital employed is a measurement that encourages management to operate as efficiently as possible. It promotes reduced asset values relative to sales, and measures how effective it is (for example) to borrow money to purchase capital goods to reduce manufacturing costs. The formula is: the sum of pre-tax earnings plus interest expense divided by the sum of average total assets minus non-interest bearing liabilities. 2 Includes only registered shareholders. Since many shareholders hold their shares in "street name," the number of individual shareholders is larger than the number shown. 1 33 REPORT TO SHAREHOLDERS In 1996, we celebrated our 50th anniversary by delivering the best year ever for Harmon. Incoming orders increased 35% to $187.5 million. Shipments rose 28% to $175.4 million. Earnings before taxes were $15.1 million, and net earnings increased 35% to a record $9.3 million, or $1.36 per share. Our order backlog grew to $59 million from $49 million at 1995 year-end. This performance was especially noteworthy because it was achieved in a year when the rail supply industry as a whole was experiencing weak sales and earnings. Our record breaking performance in 1996 was due largely to a combination of leading-edge technology, a partnership-service concept that we introduced four years ago, a marketing strategy that commits us to grow simultaneously in three markets: domestic freight, rail transit, and international, and superb performances by our dedicated and talented employees who enabled us to reach our 1996 objectives. GROWTH STRATEGY As Harmon continuously develops smarter, smaller and less expensive products, it needs to grow its markets correspondingly. Consequently, we are working on a growth strategy that dictates that we maintain our strong position with our domestic freight railroad customers in our traditional product areas while adding new products and services. It also requires us to enhance our established position in the North American rail transit market, and seek meaningful expansion within international markets with basically similar products and technology that we provide to our domestic markets. This latter focus is particularly important as the international markets are roughly eight times as large as our domestic markets . - - DOMESTIC FREIGHT. We received record orders of $151 million in 1996. These were 34% above 1995's intake and 94% ahead of our 1992 level. Part of that five-year growth is the result of our having increased the number of our service offerings over the past several years to include asset management and on-time deliveries. Among our order gains for 1996 was our first turnkey signal system installation. It entailed the design, manufacture and installation of microprocessor interlockings, track circuits, hot box detectors and rail/highway crossing systems for 150 miles of track at Stampede Pass in Washington. We completed the job in just six months. The speed of our performance was appreciated by the customer and confirmed Harmon as a major force in time-sensitive turnkey installations. In 1996 we saw a continuing change from product business to systems business, which, because of the size of systems, intensifies the need for close, partnership relations. We intend to expand our services gradually by expanding the partnership concept to include repair shops, installation services, spare parts pools, proactive maintenance and other services. - - RAIL TRANSIT. We booked orders aggregating $22.5 million in 1996, a 19% increase from 1995 and a ninefold gain over the past five years. This year's orders included a $17.6 million contract to design and build a train control system for New Jersey Transit's new light rail line. This was the largest single contract ever awarded to Harmon. Other highlights included our completion of the CTA Green Line rehabilitation project in Chicago in which we acted as its main transit signal and systems supplier, an invitation from the New York City Transit Authority to participate with other signal suppliers in its planning process for future train control systems, and the Florida Department of Transportation's agreement to award a consortium, of which Harmon is a member, a franchise to build a 200 mph passenger train system to link Miami to Orlando and Tampa. - - INTERNATIONAL. We booked orders amounting to $14.3 million in 1996, more than twice what we received in 1995 and 14 times what we got in 1992. The gain last year was sparked by our acquisition of Vaughan Harmon Systems Ltd., which produced orders in excess of $10 million. Vaughan Harmon is an industry leader in Europe for software and systems, which gives us a strong entry into the European market. Moreover, we expect our technology and products will be a major factor in growing Vaughan Harmon's business. The market in the UK is presently very strong as, after 2 1/2 years of little capital spending, Railtrack is now planning 2 34 a major upgrade of its track systems, which presents a strong opportunity for us. STRATEGY VALIDATION Our growth over the past five years is strong evidence that our strategy is working, and we were very pleased with our performance in 1996. STRATEGIC GOALS Within our strategic plan, we have identified six areas where we need to be better than our competition: customer service, quality/reliability, fast cycle times, cost effectiveness, technology and systems integration. In order to further improve our CUSTOMER SERVICE, we merged our three domestic operating subsidiaries into the parent company. We took this step to improve operations internally by assigning total responsibility along functional lines rather than through corporate subsidiaries. We also acquired two contract engineering companies in Florida, and they will enhance our industry position as a signal and engineering design company. To improve our QUALITY/RELIABILITY we focussed close attention on various manufacturing and other processes. We now have two of our facilities TickIT certified, and all but two ISO-9000 certified. To improve on our CYCLE TIMES, we reinforced our project management resources. This was instrumental in our getting the CTA rehab contract in Chicago and the 150 mile signal system turnkey installation contract at Stampede Pass last year, as both were extremely time sensitive. This focus has enabled us also to reduce our system delivery time from 90 to 60 days. We are approaching COST EFFECTIVENESS as it relates to the total cost incurred by customers. This includes the cost of the product, its installation cost, its subsequent maintenance cost, and the time involved to complete a project. As a result of this focus, we find that our on-time complete delivery service for signal installations has reduced installation costs by 30-40%, resulting in material savings for the customer. To maintain our TECHNOLOGY leadership, we spend an average of four percent of each sales dollar on research and development, which is yielding exciting technology. Last October, we demonstrated our ITCS high speed train control system in Michigan. Amtrak ran a passenger train at speeds up to 101 mph over a distance of 20 miles. Amtrak's goal is to reduce the trip time between Detroit and Chicago from 5 3/4 hours to 3 1/2 hours or less, a major advance in enroute speed, which has already triggered some international interest. Our system provides a cost effective means of improving safety and reducing travel times because it can be integrated into other control systems currently in place. In addition, our advanced technology and patented method of applying cab signalling on board AC traction locomotives generated substantial business for us in 1996. The trend towards INCREASED SYSTEMS INTEGRATION is continuing. In this respect, Harmon is building up capabilities not only to integrate its products into a system, but also to provide an interface for other existing systems. This will enable us to supply our products to the replacement market, regardless whether Harmon or another company made the original system. GROWTH OUTLOOK We strongly believe that we will be able to maintain our growth through the remainder of the 20th Century. Most of the growth should come through additional services for the freight railroads in North America and from increased business both in the transit and international markets. The near-term perspective is more difficult to predict because of the ongoing merger activities among the North American railroads. We are presently experiencing a slowdown in our business as some railroads are deferring certain capital expenditures, pending the outcome of ongoing negotiations. But as we saw in 1996, once the mergers are completed, there is much work to be done to consolidate track systems, which should give us many sales opportunities. On balance, 1997 is expected to be another strong year for Harmon. /s/ Bjorn E. Olsson Bjorn E. Olsson PRESIDENT AND CHIEF EXECUTIVE OFFICER Blue Springs, Missouri, March 21, 1997 [GRAPHS:] ORDERS BOOKED ($ - Millions) 92 93.4 93 121.5 94 127.9 95 138.6 96 187.5 NET EARNINGS ($ - Millions) 92 5.0 93 6.9 94 7.6 95 6.9 96 9.3 RETURN ON CAPITAL EMPLOYED 92 35% 93 39% 94 34% 95 22% 96 26% [INSET PHOTO] Photograph of Bjorn E. Olsson, President and Chief Executive Officer of Harmon Industries, Inc. GROSS SALES ($ - Millions) 92 82.5 93 98.8 94 119.1 95 136.1 96 183.9 3 35 HARMON MARKETS Harmon's Potential and Performance Harmon supplies signal and train control systems, products and services to three rail markets: domestic freight, domestic rail transit, and international, which is comprised of both freight and rail transit customers. Our strategy is to develop lasting relationships with customers by providing safe, efficient and technologically advanced products and services that enable them to enhance their productivity. An analysis of each market and the validity of our business strategies for each of our three major markets follow. DOMESTIC FREIGHT AND SERVICE Domestic freight carriers purchase several hundred million dollars in signal and train control systems and products annually. We derive the majority of our revenues from this market. Our market share is roughly 30 percent. Our sales volume increased in each of the last five years, concrete evidence of how well our business strategy is working. - - GROWTH POTENTIAL We have both a technological lead in products and systems, and a complete service operation. Our near-term growth potential lies principally in increasing the amount of services we provide. Over the longer term, we see an increase in the size of this market. One of the railroads' ongoing requirements is to reduce costs and increase the utility of their rolling stock and infrastructure. These needs play to our strengths. Our product focus, in addition to providing safety, has always been to develop products that provided direct cost savings or enhanced our customers' efficiency, or both. Our advanced signal and control systems, for example, enable railroads to achieve substantial cost savings quickly because Harmon systems provide a rapid payback. Thus the opportunity to reduce operating costs has become a strong incentive for the railroads to make cost-saving equipment and system purchases, regardless of market conditions. - - EFFECT OF RAILROAD MERGERS Railroad mergers are a fact of life. While merger negotiations are in progress, an uncertainty sometimes surrounds the involved railroads' intentions regarding their near-term capital goods purchases. In general, the more ambitious and expansive projects are put on hold until the merger negotiations run their course. Once the merger is completed, our sales often increase for a period while the new railroad seeks to modernize and consolidate its operations with more cost effective equipment. Mergers also tend to foster the sale of marginal operations to short line railroads. This often means that these "feeder" railroads will also require some revamping of their signals and controls. Further, short line railroads often lack the staff to assemble the components and install them, a situation that is tailor-made for our service organization. Thus it can be fairly said that anticipated sales often shrink while merger talks are in progress and then for a time grow to above average levels once the merger is either completed or abandoned. [CHART] GROSS SALES - 1996 ($- Millions) Domestic $142.1 Domestic Service $22.2 Domestic Rail Transit $14.4 International $5.2 DURING THE PAST FIVE YEARS HARMON INCREASED ITS BUSINESS SUBSTANTIALLY BY ENTERING THE SERVICE BUSINESS AS WELL AS THE NEW PROJECT MARKET FOR DOMESTIC RAIL TRANSIT AND THE INTERNATIONAL MARKET. DOMESTIC FREIGHT RAIL IS INDISPENSABLE. IT IS THE ONLY TRANSPORTATION SYSTEM CAPABLE OF CARRYING MASSIVE LOADS. THIS MARKET IS HARMON'S LARGEST SOURCE OF REVENUE, PROVIDING 77% OF ITS SHIPMENTS IN 1996. 4 36 [PHOTO] Photograph of rail cars on tracks at an industrial site. 37 [PHOTO] Photograph of Chicago Transit Authority rail transit cars on tracks with a Chicago background. 38 - - COMPETITIVE POSITION We occupy a dominant position in the signal and train control sector of the domestic freight market. - - TECHNOLOGY Our product development continues to capitalize on advances in technology. Communications-based signalling, a subject of intense interest in both the freight and rail transit markets, is a major focus of our R&D efforts. This concept uses radio data communications to convey operating instructions between computers on the ground and computers on trains, rather than relying on human operators to correctly interpret trackside signal lights. Combined with a means such as Global Positioning Satellites (GPS) to let the on-board computer know its exact location on the track, these innovations can greatly improve the efficiency of train operations while simultaneously enhancing their safety. Our Incremental Train Control System (ITCS), which is being installed on a portion of Amtrak's high-speed rail line between Detroit and Chicago, is a form of communications-based signalling. It enables trains to operate safely at higher speeds than previously, making them more competitive with air travel in many instances. A short segment of the system was demonstrated successfully last October. It is now being expanded to complete a 71 mile corridor, which will be operational in late 1997. We also have a strong lead in on-board cab signal systems. Our Ultra Cab II, combined with a unique patented antenna, is the only such product that can operate successfully in the face of intense electrical interference generated by new, high-power AC traction locomotives. For many years, our Electro Code products have been in wide use by domestic railroads. These products carry information through the rails between trackside block signals and eliminate the need for wayside pole line. Thousands of miles of pole line have been replaced with Electro Code, with a resulting major increase in operating reliability and safety. Our Vital Harmon Logic Controller (VHLC) is the product of choice of most freight railroads for control of signals and switches at interlockings. Its outstanding performance record and cost effectiveness have led to installations of nearly 900 units, more than any other competitor's product worldwide. - - SERVICE ADVANTAGE Service has evolved into a major line of business for us, adding $22 million to our revenues in 1996, up 57 percent from that of the previous year. Our service arm warehouses commonly-used signal components (regardless of which supplier manufactured them); manages customers' off-premise signal and control inventories; and performs assembly of component parts. These functions give us the ability to manage even complex projects from beginning to end, which provides us with a powerful competitive advantage. Adding project management to our expanding list of services proved timely. Last year we completed a $13 million contract to modernize a freight railroad's signal system at Stampede Pass in the Cascade Mountains. Time to completion was a crucial element. Upon completion, it would enable our customer to materially increase its freight traffic, thereby enhancing its revenues. AMTRAK'S HIGH SPEED TEST RUN [INSET PHOTO] Photograph of an AMTRAK train on tracks in the countryside. HARMON'S INCREMENTAL TRAIN CONTROL SYSTEM (ITCS) SUCCESSFULLY PASSED ITS INITIAL TEST PHASE LAST OCTOBER ON A 20-MILE TRACK SECTION OF AMTRAK'S LINE IN SOUTHWESTERN MICHIGAN. THIS IS THE FIRST STEP TOWARD AMTRAK'S REALIZATION OF RAIL SERVICE BETWEEN DETROIT AND CHICAGO AT SPEEDS IN EXCESS OF 100 MPH. IN KEEPING WITH ITS PHILOSOPHY OF DESIGNING COST EFFECTIVE PRODUCTS, THE HARMON ITCS WAS MADE TO OPERATE WITH EXISTING SIGNALS AND CONTROLS, THUS MAKING IT HIGHLY AFFORDABLE. We furnished and installed all the signal equipment on 150 miles of main line, plus six passing sidings and numerous rail/highway crossings. The project used a broad spectrum of our products: HXP-3 for crossings, Electro Code for track circuits, VHLC controllers for interlockings, plus the signals themselves and HARMON'S TECHNOLOGICAL LEAD OVER ITS DOMESTIC COMPETITORS IS DUE LARGELY TO ITS R&D FOCUS, WHICH AVERAGES FOUR PERCENT OF EVERY SALES DOLLAR. 7 39 [PHOTO] Photograph of a Harmon Industries, Inc. engineer testing train control equipment. 40 other accessories. To maximize our installation productivity, our service warehouse assembled complete installation kits and shipped them directly to the site. Despite unfavorable weather and other obstacles, we finished the project on schedule--a feat considered impossible by many. - - 1996 RESULTS During 1996, our incoming orders from the domestic freight market were $151 million, an increase of 34 percent over the previous year. Our 1996 shipments to freight railroad customers were $164 million, up 51 percent from those of 1995. Our year-end backlog for domestic freight was $25 million. - - SUMMARY--DOMESTIC FREIGHT AND SERVICE We have steadily increased our sales to the domestic freight railroad market year after year. We are also helping to enlarge this market by providing contract services in addition to our manufacture of products and systems. Contract services have enormous potential. They come at a time when the domestic freight railroads are heavily focussed on their primary mission--moving freight economically. Consequently, many are downsizing their ancillary roles to reduce operating costs, outsourcing many service and purchasing functions they formerly did for themselves. We believe contract services may well grow in size to rival our product and systems sales. It has certainly given Harmon an additional sales opportunity that most of its principal competitors do not possess. Consequently, we find our business is growing at a time when some of our competitors' volumes are shrinking. DOMESTIC RAIL TRANSIT The size of the domestic transit market for our products is roughly the same as that of the domestic freight market -- in excess of $300 million annually. We have long served the repair and renovation side of this market, but the new project side is relatively recent for us. We entered it in 1991. That year the St. Louis Metro Link rail transit system accepted our electronic signal solutions, and awarded us a contract to supply its signal and control systems. Their acceptance of our electronic innovations became a defining moment in Harmon history. Shortly thereafter, microprocessor-based systems became widely accepted for domestic rail transit signal products and systems. - - FUNDAMENTAL DIFFERENCES There are major differences between freight and rapid transit customers and how business is done in the rail transit market. - The transit market involves moving people, not freight. Thus, in addition to safety and efficiency, other considerations such as train frequency and comfort are extremely important issues. - Unlike the freight railroads, which are generally focused on improving or extending existing facilities, the transit market is involved in major new starts as well as upgrades to its current signals and controls. - In some instances, new "turnkey" construction projects are so large that only huge corporations or consortiums can function as the general contractor. In these situations, Harmon takes on a subcontractor role for its portion of the project. For other projects, Harmon's increasing size and proven track record are enabling it to act as a prime contractor. - In many cases, the buyer is a municipal authority, not a private company. Since municipal authorities often lack the technical expertise to design a system, they [CHART] SERVICE REVENUES - 1995-96 $ - Millions 96 $22 million 95 $14 million THE ADDITION OF A PROJECT MANAGEMENT FUNCTION TO HARMON'S SERVICE ORGANIZATION AND A SIZABLE INCREASE IN SHIPMENTS TO EXISTING CUSTOMERS HELPED SERVICE REVENUES INCREASE 57% IN THE PAST YEAR. HARMON'S ENGINEERING DEPARTMENT WAS EXPANDED LAST YEAR TO ENABLE THE COMPANY TO MAINTAIN ITS HIGH LEVEL OF PRODUCT INNOVATIONS. 9 41 [PHOTO] Photograph of a rail transit passenger station with rail transit cars. 42 frequently rely on consultants to draw up the detailed specifications. As a result, consulting firms are the gate keepers to projects. Initially, rail transit consultants often ignored our microprocessor technology, preferring to support older mechanical relay systems. Our initial success in St. Louis, followed by subsequent installations in Chicago, Denver, New York, Philadelphia, and San Diego, established the superiority of our systems. Many rail transit consultants are now among our most enthusiastic supporters. Winning them over was a critically important milestone in our sales strategy. - - In general, sizable fluctuations in orders received in any given year are to be expected simply because the market consists of a relatively small number of immense projects rather than a great volume of smaller orders, which are typical in the freight markets. In addition, many projects are spread out over several construction phases, which may extend from two to five years, or more. Thus, winning the signal and control portion of a rail transit project often translates into large order backlogs that may take several years to complete. We expect to build such a backlog over the next several years, which will tend to balance out year-to-year fluctuations in shipments. - - For the most part, rail transit projects are funded by federal, state and local governments. The funding is being driven, at least in part, by public pressure to relieve congestion on already crowded highways and to reduce the air pollution that accompanies automobile use. Rail transit has strong support in Washington, which suggests that a reasonable level of federal funding will be in place for at least several years. - - MARKET POTENTIAL Domestic rail transit continues to expand. We expect to bid on signal and control system contracts approximating several hundred million dollars for rail transit projects in 1997 - both new and upgrade projects. Sources within the industry indicate that projects of similar magnitude are likely to be put out for bid each year through the year 2000. - - 1996 RESULTS At year-end 1996, our rail transit backlog was $24 million, 74 percent in new construction and the balance in repair and upgrade work. The new installation backlog consisted principally of a $17.6 million contract awarded in November, 1996, for us to design and build a microprocessor-based train control system for a 9.5-mile light-rail system that will connect the New Jersey cities of Bayonne and Hoboken. This project includes equipping 43 transit cabs with Ultra Cab units. Total contracts received in 1996 were $22 million, up 19 percent over 1995 awards. Shipments for 1996 were off 32 percent at $14 million, which reflected a drought in rail transit contracts awarded in 1995 and early 1996. - - SUMMARY - RAIL TRANSIT The outlook is quite positive. Our products and systems are gaining greater acceptance each year, largely because of their exemplary performance on jobs undertaken during the past five years. We have learned how to do business in this environment. We have been able to join forces with some of the largest railroad builders in the world to assure our participation in the multimillion dollar projects that are now in various stages of planning. In addition, we have increased our service and project management staffs so that we can be the prime contractor on installations such as the $13 million Green Line project in Chicago. Finally, the amount of planned new projects and repair and upgrades to existing systems is larger than at any time in recent memory. [INSET PHOTO] Photograph of a rail passenger station with rail transit cars. RAIL TRANSIT IS OFTEN SEEN AS THE BEST SOLUTION FOR RELIEVING TRAFFIC AND ATTENDANT AIR POLLUTION IN MAJOR CITIES IN THE U.S. HARMON MICROPROCESSOR TECHNOLOGY IS BEING EMBRACED BY RAIL TRANSIT AUTHORITIES. LAST YEAR, ORDERS FOR HARMON RAIL TRANSIT EQUIPMENT REACHED $22 MILLION. 11 43 [PHOTO] Photograph of Vaughan Harmon Systems Ltd. train describer equipment [INSET PHOTO] Photograph of a rail transit station in London, England. 44 INTERNATIONAL The international market dwarfs the domestic market. It is estimated at $4-$5 billion annually, roughly eight times that of the North American freight and rail transit markets, combined. The international market holds enormous potential for Harmon. In many parts of the world, notably China, India, Southeast Asia, Africa, Latin America, and the former Soviet-bloc countries, significant investment in the railway infrastructure is under way or being planned, with the addition of new lines, modernization of existing lines and expansion of passenger services. Railroads in the UK, South America and the European Continent are presently undergoing a wave of privatization. Declining government subsidies to the former state-run railways are creating greater demand for products that deliver improved efficiency while assuring safe and reliable operations. This new attention to economics opens the door for our products, as cost effectiveness with safety has been a major product development focus of Harmon for 50 years. Our products and technologies continue to attract growing attention on the international front. We anticipate an opportunity to demonstrate our interlocking controls and crossing warning systems in the UK in 1997. Greater acceptance of our products in Australia is providing Harmon with expanding business opportunities there. In China, our established hot box detector business is expanding, and several railroads have shown interest in testing other Harmon products. In 1996, we were awarded a contract to resignal the first 39 km of a 900 km mining railroad in Brazil, with potential for the remainder to follow over the next several years. Other areas in South America, along with major markets in Europe and Southeast Asia, are fertile markets for Harmon's products. - - 1996 RESULTS In 1996 we booked orders aggregating $14.3 million, up 107 percent from $6.9 million in 1995. Shipments rose 30 percent to $5.2 million from $4.0 million in 1995. The considerable growth in 1996 included enhanced sales of our hot box detectors, completion of a major cab signalling system in Australia, and the introduction of software and several hardware products, which we obtained when we acquired UK-based Vaughan Harmon Systems Ltd. last July. Vaughan Harmon is a premier railroad software developer with a market leading position in the UK specializing in train describer systems, passenger information systems and modular railway control systems. In the first six months after the acquisition, Vaughan Harmon produced $10 million in new orders. A key benefit that Vaughan Harmon brings is being a recognized and respected rail systems supplier within the European Community. Thus, in addition to having a strong local presence in the UK, Vaughan Harmon will serve as the platform for Harmon's growth into the broader European signalling market. - - SUMMARY - INTERNATIONAL Long-term, the international market affords us great promise because of its enormous size. Numerous rail projects are either already underway or in planning stages. In addition, the benefits of more cost-effective signal and control systems are now gaining increased attention overseas. Although our market penetration is growing each year, it remains small relative to the overall market potential. Our growth strategy is threefold: to foster additional partnership relations with multinational railroad supply companies; to gain additional market inroads and rapid acceptance through acquisitions of established, local rail suppliers, and to increase our direct physical presence in overseas market areas. [INSET PHOTO] Photograph of a train crossing a bridge in the countryside. COMPARED TO THE DOMESTIC RAILROAD MARKET, THE INTERNATIONAL MARKET IS ROUGHLY EIGHT TIMES LARGER. AN EMPHASIS ON PRODUCTS THAT DELIVER COST SAVINGS AS WELL AS SAFETY HAS INCREASED HARMON'S POTENTIAL FOR INTERNATIONAL SALES. VAUGHAN HARMON SYSTEMS LTD., WHICH WE ACQUIRED LAST JULY, IS A PREMIER RAILROAD SOFTWARE DEVELOPER IN THE UK AND A MARKET LEADER IN THE MANUFACTURE OF TRAIN DESCRIBERS (SHOWN AT LEFT), PASSENGER INFORMATION AND MODULAR RAILWAY CONTROL SYSTEMS, WHICH CONTROL MANY PASSENGER AND COMMUTER TRAINS IN THE UK. IT PRODUCED $10 MILLION IN NEW ORDERS IN THE FIRST SIX MONTHS WE OWNED THEM. 13 45 CORPORATE PROGRESS During the past several years, we have been reshaping Harmon so that it could achieve our expanded growth objectives here and abroad. That effort was intensified last year. Some of the major issues were: adding staff to service our rail transit and international markets; expanding our research and development efforts; accelerating product development; introducing modular construction so that our products could be readily modified to function equally well for freight rail or rail transit --both at home and overseas; reshaping the corporate structure along functional lines for better customer service; and finally, managing our cash flow so we could accomplish what we set out to do. In the space of five years, we: - Entered the new project segment of rail transit, which generated over $53 million in shipments, and produced a $24 million backlog at year-end 1996; - Effectively expanded into the international market, which has since provided shipments of more than $12 million, including $5 million last year and a year-end backlog of $11 million; - Increased the size of our design and engineering staff by 164 percent. We expanded our engineering facilities at two locations and purchased two engineering companies last year; - Created a separate service organization that developed aggregate shipments of more than $70 million since 1991, and $22 million in 1996. It has been instrumental in our ability to take a complex project from beginning to end. - This capability enabled us to complete the Stampede Pass project last year in record time; - Established partnership relations with several major builders of rail transit systems, domestic as well as international; - Increased our bonding power to a point where we can bid on any project that fits our capabilities; - Obtained ISO 9000 certifications for nearly all our operations, including three last year; and finally, - Materially streamlined our organizational structure in 1996. The new structure enables us to be more productive and simultaneously more responsive to our customers' needs. These accomplishments, which often involved substantial expenditures, were made during a five-year period which saw Harmon revenues increase 147 percent from $71 million to $175 million and net profits grow from less than $1 million to more than $9 million. We believe our past record is evidence that our overall strategy is working and that it is possible to build for the future internally and expand revenue and earnings at the same time. These accomplishments are the bases for our confidence in the future. PRODUCT DEVELOPMENT [PHOTO] Photograph of a railroad highway grade crossing warning system. UNRELENTING DEVELOPMENT OF SIGNAL AND TRAIN CONTROL SYSTEMS HAS ENABLED HARMON TO WIDEN ITS POSITION AS A TOP SUPPLIER OF SUCH SYSTEMS TO FREIGHT RAILROADS IN NORTH AMERICA. STAMPEDE PASS, WASHINGTON. HERE HARMON MODERNIZED A FREIGHT RAILROAD'S SIGNAL SYSTEM IN RECORD TIME. WITHOUT HAVING BUILT UP OUR SERVICE STAFF LAST YEAR, WE COULD NOT HAVE UNDERTAKEN THE PROJECT. 14 46 [PHOTO] Photograph of track installation at Stampede Pass in the State of Washington. [INSET PHOTO] Photograph of a work crew installing equipment along a railroad track. 47 SELECTED CONSOLIDATED FINANCIAL DATA (UNAUDITED) (Dollars in thousands, except per share data)
Years ended December 31 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------ OPERATIONS Net sales $175,440 $136,780 $119,703 $ 99,295 $ 81,899 Cost of sales 126,997 96,094 81,023 65,716 54,271 Research and development expenditures 6,331 5,218 4,561 3,442 3,541 ---------------------------------------------------------- Gross profit 42,112 35,468 34,119 30,137 24,087 Selling, general and administrative expenses 25,990 23,200 21,176 18,558 15,646 Other operating expenses (income) 544 481 44 114 137 ---------------------------------------------------------- Operating income 15,578 11,787 12,899 11,465 8,304 Other expenses 473 607 214 388 1,228 ---------------------------------------------------------- Pre-tax earnings (continuing operations) 15,105 11,180 12,685 11,077 7,076 Income taxes 5,775 4,294 5,046 4,193 2,498 ---------------------------------------------------------- Earnings from continuing operations 9,330 6,886 7,639 6,884 4,578 Gain (loss) from discontinued operations - - - - 165 Use of net operating loss carryforward - - - - 273 ---------------------------------------------------------- Net earnings (loss) $ 9,330 $ 6,886 $ 7,639 $ 6,884 $ 5,016 ---------------------------------------------------------- ---------------------------------------------------------- Effective tax rate - continuing operations 38.2% 38.4% 39.8% 37.9% 35.3 Return on sales - continuing operations 5.3% 5.0% 6.4% 6.9% 5.6 Return on equity - continuing operations 16.1% 14.0% 17.7% 20.8% 30.1% Return on equity - total 16.1% 14.0 17.7% 20.8% 33.0% Weighted average shares 6,844 6,827 6,567 6,212 5,275 PER SHARE DATA Earnings from continuing operations $ 1.36 $ 1.01 $ 1.16 $ 1.11 $ .87 Net earnings (loss) 1.36 1.01 1.16 1.11 .95 Cash dividends .15 .15 .15 - - Book value 8.48 7.23 6.40 5.23 2.82 Price/earnings ratio range 8.8-14.3 13.2-20.3 14.2-20.9 10.5-20.9 3.6-13.4 OTHER DATA AT YEAR-END Working capital $ 33,629 $ 35,014 $ 21,670 $ 20,790 $ 10,740 Total assets 104,677 86,845 68,395 53,000 38,488 Long-term debt 3,412 12,090 733 439 4,898 Stockholders' equity 57,939 49,232 43,063 33,086 15,197 Current ratio 1.85:1 2.60:1 2.03:1 2.28:1 1.72:1 Quick assets ratio 1.01:1 1.16:1 1.03:1 1.32:1 .87:1 Liabilities to equity ratio .81:1 .76:1 .59:1 .60:1 1.53:1 Capital additions (continuing operations) 6,371 5,532 3,242 3,189 2,154 Capital additions (total) 6,371 5,532 3,242 3,189 2,154 Depreciation & amortization (continuing operations) 5,004 3,906 2,621 2,121 1,936 Depreciation & amortization (total) 5,004 3,906 2,621 2,121 1,936 Outstanding shares (000s) 6,829 6,806 6,728 6,328 5,383
16 48
Five-Year Ten-Year Compound Compound 1991 1990 1989 1988 1987 1986 Growth Growth - ------------------------------------------------------------------------------------------------------- $ 70,934 $ 72,707 $ 70,154 $ 64,558 $ 57,068 $ 47,223 + 19.85% + 14.02% 45,536 47,478 46,377 42,044 37,995 30,333 4,000 3,414 3,200 3,669 3,318 2,360 - ------------------------------------------------------------------------------ 21,398 21,815 20,577 18,845 15,755 14,530 + 14.50% + 11.23% 13,550 14,427 13,186 11,965 10,671 9,362 1,122 762 (263) (27) 43 145 - ------------------------------------------------------------------------------ 6,726 6,626 7,654 6,907 5,041 5,023 + 18.29% + 11.98% 2,118 1,504 1,244 1,301 1,519 885 - ------------------------------------------------------------------------------ 4,608 5,122 6,410 5,606 3,522 4,138 + 26.80% + 13.82% 1,688 2,022 2,506 2,100 1,613 2,039 - ------------------------------------------------------------------------------ 2,920 3,100 3,904 3,506 1,909 2,099 + 26.15% + 16.09% (2,492) (12,306) (2,744) (1,020) (217) - 395 - - - - - - ------------------------------------------------------------------------------ $ 823 $ (9,206) $ 1,160 $ 2,486 $ 1,692 $ 2,099 + 62.52% + 16.09% - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ 36.6% 39.5% 39.1% 37.5% 45.8% 49.3% 4.1% 4.3% 5.6% 5.4% 3.3% 4.4 39.6% 53.9% 26.5% 25.9% 16.5% 20.0% 11.2% (160.2%) 7.9% 18.3% 14.6% 20.0% 5,066 4,723 4,633 4,479 4,472 4,854 $ .58 $ .66 $ .84 $ .78 $ .43 $ .43 + 18.58% + 12.20% .16 (1.95) .25 .56 .38 .43 + 53.42% + 12.20% - .0625 .125 .125 .125 .125 1.48 1.20 3.19 3.03 2.59 2.34 + 41.88% + 13.74% 21.9-45.3 N/A 23.0-35.0 9.5-14.8 13.2-22.4 15.4-27.3 $ 9,660 $ 7,955 $ 14,444 $ 7,037 $ 11,870 $ 11,599 + 28.34% + 11.23% 36,575 41,408 48,082 42,948 37,984 34,045 + 23.41% + 11.89% 11,915 17,220 17,688 12,139 14,621 13,793 7,377 5,747 14,756 13,557 11,604 10,470 + 51.01% + 18.66% 1.71:1 1.49:1 2.08:1 1.45:1 2.17:1 2.36:1 .76:1 .66:1 .84:1 .60:1 1.09:1 .96:1 3.96:1 6.21:1 2.26:1 2.17:1 2.27:1 2.25:1 1,098 2,187 2,236 1,830 1,504 2,212 1,098 4,521 4,589 9,886 3,552 2,212 2,022 2,410 2,373 2,541 2,481 2,074 2,022 3,511 3,185 2,834 2,531 2,074 4,998 4,790 4,628 4,478 4,472 4,472
17 49 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Harmon's overall business has been on an upward trend for the past several years. It continues to increase its sales with its principal customers, the Class I and Short-Line Railroads, and it now occupies a strong, competitive position within the new construction portion of the rail transit market, principally because of its advanced technology and service. Its international business is also beginning to assume a meaningful role in Harmon's overall sales, increasing 29% to over $5 million in 1996. Additionally, demand for its purchasing, materials management and pre-assembly services supplied by its asset management services business is growing rapidly as these services fill an increasing need in the railroad industry, which continues to downsize and outsource functions the industry previously did internally. Harmon's growth has been aided also by acquisitions of businesses and/or product lines that fit its core business. In July, 1996 Harmon acquired UK-based Vaughan Systems Ltd. (since renamed Vaughan Harmon Systems Ltd.). It was a strategic acquisition to increase Harmon's sales in Europe. Vaughan Harmon is a designer of signal and control software and a leading manufacturer of train describers, passenger information and modular railway control systems, which complement Harmon's existing product line. It is a promising acquisition, producing $3 million in sales in its first six months of ownership, and $10 million in new orders, which will be shipped in 1997. Harmon also acquired two railroad contract-engineering firms last year, which provided a significant gain in engineering resources. In 1995 Harmon acquired the assets of Atlanta-based Serrmi Services, Inc. It provides signal design engineering and wiring and highway grade crossing services to freight railroads. In 1994 Harmon acquired the Transportation Division of Servo Corporation of America. It makes hot box detector systems and other railroad monitoring devices. It has an established position overseas, especially in Europe. PROFILE OF CURRENT OPERATIONS The Company's sales are summarized by product category in the table on page 19. The table also breaks out gross sales and percentages of total sales for each of the past three years. Sales of Harmon crossing and control products by its asset management services operation are included in those separate descriptive categories. The value-added services supplied with those products are included in the asset management services category. Train Control Systems include products related to the control of train movement. These include signal control track circuits (Electro Code); interlocking control equipment such as Electro Logic, the Harmon Logic Controller (hlc) and the Vital Harmon Logic Controller (vhlc); carborne equipment (Ultra Cab); computer-based control systems; train describers; and the design, wiring and installation of packages and systems comprised of these products. Crossing Systems include all products related to rail/highway crossing warning systems. The products include train detection devices (the Company's pmd and hxp, among others); flashing lights and cantilevers; and the design, wiring and installation of packages and systems comprised of these products. Asset Management Services is a single-source, rapid delivery service of railroad components for railroad customers. It involves warehousing commonly-used parts and equipment that are manufactured by the Company and by other vendors. This service has been expanded in recent years to include asset and materials management as well as kitting of various components, which are delivered as a complete unit, ready for installation. Train Inspection Systems include products that monitor the condition of trains when they pass a train inspection site, and the design, wiring and installation of packages and systems comprised of these products. The hot box detector is the principal product, which is installed beside the track to detect overheating bearings in passing rail cars, a serious condition that could lead to derailments. Other products include a sensor to identify high or wide loads and a device that detects foreign objects being dragged under a rail car. Printed Wiring Boards include production of customer designed printed wiring boards for shipment to other electronics manufacturers. Other sales include communication equipment and products that do not fit readily into the other five categories. 18 50 SALES BY PRODUCT OR SERVICE FUNCTION * Years ended December 31, 1996 1995 1994 ------------------------------------------------- (Dollars in thousands) Amount % Amount % Amount % - ------------------------------------------------------------------------------- Train Control Systems $ 87,080 47.3% $ 55,437 40.7% $ 45,711 38.4% Crossing Systems 48,927 26.6% 42,375 31.1% 35,448 29.8% Asset Management Services 22,217 12.1% 14,194 10.4% 20,894 17.5% Train Inspection Systems 12,906 7.0% 11,360 8.4% 5,054 4.2% Printed Wiring Boards 5,249 2.9% 6,752 5.0% 6,307 5.3% Other 7,489 4.1% 5,999 4.4% 5,712 4.8% ---------------------------------------------------- Total $183,868 100.0% $136,117 100.0% $119,126 100.0% - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- * Sales volumes shown above are gross totals and do not include cash discounts or deferred contract revenue. As a result, there are differences between the figures in this table and those presented in the Consolidated Statements of Earnings. The differences do not affect the validity of the discussion and analysis. RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994. Net sales increased 28% to a record $175.4 million for 1996 compared with $136.8 million for 1995 and $119.7 million for 1994. Net earnings increased 35.5% to a record $9.3 million in 1996 ($1.36 per share) compared with $6.9 million in 1995 ($1.01 per share). The increase in earnings from 1995 to 1996 was due chiefly to substantially higher sales in 1996. Return on equity was 16.1% for 1996 compared with 14.0% for 1995. Return on capital employed was 25.9%, up from 21.7% in 1995. Net earnings for 1995 were 9.9% below the previous record net earnings of $7.6 million ($1.16 a share) reported for 1994. The decrease in earnings between 1995 from 1994 was due to a higher cost of sales principally occasioned by production issues related to an acquired hot box detector line, operating inefficiencies resulting from customer-induced delays in shipments, a $657,000 increase in research and development expenditures, and higher interest costs. SALES ANALYSIS The railroad industry has been moving toward the purchase of entire systems and away from the purchase of individual components. This trend reflects the railroads' desires to fix operational responsibility on one supplier and to place orders with large suppliers, which have broad-based product lines, meaningful research and engineering support, and strong service capabilities. This trend has played to Harmon's strengths, which are evident in a $31.6 million increase to $87.1 million in sales of train control systems, a $6.6 million increase to $48.9 million in sales of crossing systems, and an $8.0 million increase to $22.2 million in sales of services in 1996 compared with 1995. The increase in train control system sales is a result of increased orders from recently-merged railroad companies, greater sales of Harmon's Ultra Cab and the initial sale of Harmon's Incremental Train Control system to Amtrak. The increase in crossing system sales primarily reflects higher levels of business with recently-merged railroad companies. Train inspection sales increased 13.6% in 1996, and generally reflected increased domestic sales. The sales gain in asset management services reflects orders that were put on hold in 1995 and subsequently released in 1996. Sales of printed wiring boards were down 22.3%, which is the result of a general downturn in that industry. Harmon's strengths in crossing and control systems and asset management services were the principal reasons its 1996 sales reached a record $175.4 million, which was $38.7 million greater, or 28.3%, than those of 1995. Net sales of $136.8 million in 1995 were 14.3% ahead of those of 1994. The sales improvement over 1994 was due to gains in train control, crossing control and train inspection system sales. Approximately half of the gain was the result of a combination of the Serrmi acquisition and a resurgence in rail-highway crossing system sales. The remainder reflected gains in shipments on rail transit contracts, carborne equipment, and hot box detectors. Sales of asset management services were down $6.7 million in 1995 when shipments were delayed because of railroad merger activity. 19 51 OPERATING SUMMARY
Percentage of Net Sales Percentage of Change ------------------------------------------------------------------- Years ended December 31, 1996 1995 1994 over over over 1996 1995 1994 1995 1994 1993 - --------------------------------------------------------------------------------------------------------- Net sales 100.0% 100.0% 100.0% 28.3% 14.3% 20.6% Cost of sales 72.4% 70.3% 67.7% 32.2% 18.6% 23.3% Research and development 3.6% 3.8% 3.8% 21.3% 14.4% 32.5% ------------------------------------------------------------------- Gross profit 24.0% 25.9% 28.5% 18.7% 4.0% 13.2% Selling, general and administrative expenses 14.8% 17.0% 17.7% 12.0% 9.6% 14.1% Other operating expenses, net 0.3% 0.4% 0.0% 13.1% 993.2% (61.4)% ------------------------------------------------------------------- Operating income 8.9% 8.5% 10.8% 32.2% (8.6)% 12.5% Other expenses 0.3% 0.4% 0.2% (22.1)% 183.6% (44.8)% ------------------------------------------------------------------- Earnings before income taxes 8.6% 8.1% 10.6% 35.1% (11.9)% 14.5% Income taxes 3.3% 3.1% 4.2% 34.5% (14.9)% 20.3% ------------------------------------------------------------------- Net earnings 5.3% 5.0% 6.4% 35.5% (9.9)% 11.0% ------------------------------------------------------------------- -------------------------------------------------------------------
The table above illustrates the percentage relationship to net sales for certain items reflected in the Company's Consolidated Statements of Earnings and the percentage increase or decrease in the dollar amounts of such items year-to-year. Sales of the Company's signal and control systems are influenced by various factors. They include the financial condition of the railroad industry, the railroads' budgets for planned equipment expenditures and the level of activity in authorizing grade crossing warning system improvements. These improvements receive up to 80% federal support, up to an authorized limit of $160 million. Authorization expires in 1997, and the Congress is presently working on an extension of this funding. Rail transit funding for train control and signal systems is expected to approximate 1996 levels. The market for the remainder of the Company's products is largely dependent on the financial condition of the railroad industry, the trend of the general economy, and individual railroads' budgets for capital expenditures and repairs and maintenance. At year-end 1996, the railroad industry as a whole was healthy, and it continued to look for ways to improve profits, which includes the purchase of more efficient operating systems, the use of outsourced services, and better utilization of current capital equipment. The industry was also merger minded, which historically has reduced capital spending while mergers were pending and increased spending after they were completed. GROSS PROFIT Gross profit as a percent of sales declined to 24.0% for 1996 compared with 25.9% in 1995 and 28.5% in 1994. The decline in 1996 reflects the effect of the material increase in system sales, including the Stampede Pass project, which included wafer-thin profit margins on roughly $6 million of pass-through sales, and an increase in asset management revenues, which traditionally provide only modest profit margins. Additionally, the Company absorbed product upgrade costs of approximately $2.3 million in 1996. These narrow margins and product upgrade costs were modestly offset, relative to 1995, by the absence of start-up costs for the hot box detector line. The decline in gross profit margins in 1995 from those of 1994 was caused primarily by inefficiencies in manufacturing the acquired hot box detector product line, difficulties encountered by the Company when its shipment stream was interrupted by railroad merger activity, increased r&d expenditures and from low margins obtained on pass-through sales that were part of rail transit contracts. Traditionally, declining profit margins have negative connotations. Harmon's experience is otherwise. Management's focus is on net earnings, and less so on margins. It takes on additional lower margin business when overall increased profits are likely to occur. Its asset management service business illustrates this business concept. Standing 20 52 alone, it is a low margin, but profitable business. But when linked to Harmon's total business strategy, it makes a healthy profit contribution because its function adds to the overall sale of Harmon products and systems, and it performs a service few others in the railroad industry can match. Moreover, the Company believes this service business will increase as the railroads continue to outsource their asset management and maintenance projects. RESEARCH AND DEVELOPMENT Research and development expenses increased $1.1 million in 1996, which illustrates Harmon's commitment to incorporating new technology into its products. The principal reason for the increase in 1996 was related to Harmon's intense efforts directed toward the continued development of its Incremental Train Control System. Although R&D expenditures were up in absolute terms for 1996, as a percent of sales they declined fractionally because of the sharp increase in 1996 sales. Expenditures in 1995 were $670,000 above those in 1994. In both prior years, R&D as a percentage of sales was 3.8%. SELLING, GENERAL & ADMINISTRATIVE EXPENSES Selling, general and administrative expenses (sg&a) for 1996 were $26.0 million, roughly $2.8 million higher than those of 1995. The 1996 increase principally relates to the 28% sales increase, which generated more sales expense and increased profit-based incentive compensation. While sg&a expenses increased in absolute dollar terms last year, their cost relative to net sales declined for the third consecutive year--to 14.8% of sales from 17.0% in 1995 and 17.7% in 1994. The $7 million increase in service revenues in 1996 helped reduce sg&a expenses as a percent of sales because the asset management services operation incurs proportionally less sg&a expenses per dollar of revenue than Harmon's other revenue producing units. This illustrates the beneficial effect on profits when otherwise low-margin business is added to an already profitable enterprise. Moreover, the 1996 dollar increase in sg&a expenses was only 12% above that of 1995, or roughly 40% of the increase in sales from 1995 to 1996. In short, for every dollar of increased sg&a expenses in 1996, the Company increased its sales two-and-a-half fold. Thus relative sg&a cost savings at the corporate level were a major factor in Harmon's $2.4 million increase in net earnings in 1996. These same expenses increased approximately $2.0 million to $23.2 million for 1995 from $21.2 million for 1994. The downward trend as a percentage of net sales reflects gains in cost controls and the fixed nature of certain costs. The absolute increase in dollars each year basically reflects the result of inflation, commissions incident to higher sales volume, and additions to sg&a expenses incident to acquisitions made in 1996, 1995 and 1994. These expenses were offset somewhat in 1995 by lower profit-based bonuses. AMORTIZATION EXPENSES Amortization expenses increased 7.3% in 1996 and 601% in 1995. The increase in 1996 is attributable to three acquisitions made that year, and in 1995 to the acquisitions of the assets of Serrmi Services, Inc. in the first quarter of 1995, and the hot box detector line of Servo Corporation of America at the end of 1994. Acquisitions in 1994 were of little consequence relative to increases in amortization expenses. OTHER OPERATING EXPENSES Changes in other operating expenses were insignificant in 1996, 1995 and 1994. INTEREST EXPENSE Interest expense was $724,000 in 1996, $741,000 in 1995 and $264,000 in 1994. The decrease in 1996 reflected lower average borrowings in 1996. The increase for 1995 reflected increased borrowings to finance acquisitions and to provide working capital that year. INCOME TAXES The Company's effective income tax rate for 1996 was 38.3% compared with 38.4% in 1995 and 39.8% for 1994. The tax rate was lower in 1995 than 1994 because more business was done in states with lower tax rates in 1995 than 1994. INFLATION Inflation has been moderate during the past three years, averaging 3% to 4% for materials and wages. Competitive pressure has required the Company to maintain or reduce sales prices to sustain market share. Management believes that competitive pricing pressures will remain for the 21 53 foreseeable future. Its program to combat this is to continue to increase productivity, adopt emerging lower-cost technological advances into its products, expand its available products through internal development and acquire products or companies in the railroad supply industry that will expand Harmon's product or service offerings. LIQUIDITY, CASH FLOW AND CAPITAL RESOURCES The Company has a very strong balance sheet at 1996 year-end. Total assets were $104.7 million, up $17.8 million. Stockholders' equity rose to $57.9 million ($8.48 per share) from $49.2 million ($7.23 per share). Working capital was $33.6 million, which produced a current ratio of 1.85:1 compared to 2.6:1 a year earlier. Cash was negligible at both year-ends, and interest-bearing debt was down $8.7 million at 1996 year-end, which reflects Harmon's aggressive cash management policies. Cash was used to fund the acquisitions of two engineering firms and Vaughan Harmon Systems Ltd. ($2.1 million), capital expenditures of $6.4 million, increased receivables of $14.3 million (largely because of the $19.5 million increase in sales in the 1996 fourth quarter), and to support increased year-end inventories. The majority of the receivables were collected in January, 1997. The Company renegotiated its primary bank lines of credit in 1996, which increased its line of credit to $35 million at reduced interest rates compared with $18 million a year earlier. At December 31, 1996, approximately $3 million was borrowed against this line versus $11.5 million at 1995 year-end. In January, 1997 all outstanding borrowings on the line of credit were paid off. Additionally, the Company completed a private placement of unsecured senior notes, priced to yield 6.87%, which provided an additional $15 million of cash and long-term debt with a ten year maturity. Thus, by January, 1997 the Company had $50 million available for use. Capital expenditures for 1997 are budgeted at $11 million, roughly $4.6 million higher than the capital expenditures for 1996. Traditionally, the Company spends less on capital expenditures than it actually budgets. 1997 OUTLOOK There is much to be optimistic about for 1997. The Company's core business is solid. It began the new year with a record backlog of $59.4 million, up $10.3 million from the year earlier backlog of $49.1 million. Customer acceptance of our newer products has been excellent. In addition, the pending Union Pacific/Southern Pacific merger may generate additional business. Despite the favorable climate for increased business for Harmon, there are some uncertainties to consider as well. Among them are whether the economy and our railroad customers will perform as well in 1997 as they did in 1996, and whether government funding for rail transit and grade crossing warning systems will continue as before, and whether our r&d departments will continue their output of innovative and very successful products. Further, 1996 sales included a $13 million contract of a onetime nature which will not recur in 1997. Merger activity in the railroad industry remains strong. Mergers typically create short-term problems, particularly with shipment continuity and immediate new business. The proposed eastern railroad merger battle may sharply reduce 1997 capital expenditures of these major customers until that issue is resolved. Long-term, however, mergers often prove beneficial as the surviving entity often consolidates traffic patterns to strengthen its operations, which for Harmon translates into additional orders for crossing and control systems. Finally, we are operating at near-capacity in several areas of our business. Accordingly, we will spend substantial sums of money over the next several years to expand capacity in order to bid on larger contracts and to produce larger and more complex systems. We are addressing these issues by expanding our manufacturing space at several locations and increasing the size of our research and development center to accommodate many additional engineers. In this latter regard, the Company opened an expanded r&d facility at its plant site in Grain Valley, Missouri, in 1996, and it plans further expansions in 1997 and beyond. The Company's goal is to achieve an annual order rate of approximately $300 million by the year 2000. This goal is predicated upon maintaining our current product and systems sales levels and increasing our service business to the domestic freight railroad market. It also assumes we will book a representative share of the mass transit 22 54 projects that are presently contemplated for release during the next three years, and that our aggressive pursuit of business in the international market will result in material sales gains. It does not depend on acquisitions. It should be recognized that these are goals, not forecasts. Much depends on the future trends of domestic and international economies, which are unknown. OTHER The Company streamlined its organizational structure during 1996, merging its domestic operating subsidiaries into the parent company effective January 1, 1997. Harmon is now organized along functional lines instead of separate operating subsidiaries. This realignment is designed to improve customer service and streamline overall operations. There are no pending accounting pronouncements that would have a significant effect on the Company's financial statements. FOURTH QUARTER RESULTS Sales for Harmon's 1996 fourth quarter were $56 million, 53.4% greater than its 1995 fourth quarter sales of $36.5 million. Cost of sales as a percentage of sales was 78.4% in 1996 compared with 70.8% in 1995. The difference between the two years reflects greater shipments of lower margin products in 1996, chiefly asset management services, which carry smaller markups than Harmon-manufactured goods and often include pass-through business--products not germane to Harmon's core business but which are purchased by Harmon to complete a turnkey project. A sizable portion of the 1996 fourth quarter sales included asset management service business from two of its largest customers, and the completion of a $13 million turnkey project in the Cascade Mountains, of which approximately 50% was pass-through business. Net earnings for the 1996 fourth quarter were $2.1 million, or $0.31 per share, compared with $1.8 million, or $0.27 per share, for the 1995 fourth quarter. QUARTERLY CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (Dollars in thousands, except per share data)
1996 1995 Quarters ended March 31 June 30 Sept. 30 Dec. 31 March 31 June 30 Sept. 30 Dec. 31 - --------------------------------------------------------------------------------------------------------------------------------- Net sales $ 38,397 $ 39,111 $ 41,957 $ 55,975 $ 29,415 $ 32,854 $ 38,026 $ 36,485 Cost of sales 27,224 26,141 29,721 43,911 21,330 21,971 26,954 25,839 R&D expenditures 1,458 1,726 1,492 1,656 1,022 1,236 1,503 1,457 ----------------------------------------------------------------------------------------------------- Gross profit 9,715 11,244 10,744 10,408 7,063 9,647 9,569 9,189 Selling, general and administrative expenses 6,164 6,560 6,491 6,774 5,612 5,990 5,464 6,134 Amortization 137 137 154 159 133 133 144 137 Miscellaneous (income) expense-net (16) (14) (14) 2 (25) (7) (13) (21) ----------------------------------------------------------------------------------------------------- Operating income 3,430 4,561 4,113 3,473 1,343 3,531 3,974 2,939 Investment income 169 29 28 25 17 60 4 53 Interest expense 255 234 123 112 147 190 197 207 ----------------------------------------------------------------------------------------------------- Pre-tax earnings 3,344 4,356 4,018 3,386 1,213 3,401 3,781 2,785 Income taxes 1,269 1,699 1,530 1,278 507 1,343 1,501 943 ----------------------------------------------------------------------------------------------------- Net earnings $ 2,075 $ 2,657 $ 2,488 $ 2,108 $ 706 $ 2,058 $ 2,280 $ 1,842 - -------------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------------- Earnings per common share $ 0.30 $ 0.39 $ 0.36 $ 0.31 $ 0.10 $ 0.30 $ 0.33 $ 0.27 - -------------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------------- Weighted average shares (000s) 6,829 6,840 6,844 6,864 6,815 6,824 6,837 6,834 - -------------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------------- Quarterly per share amounts may not add to annual amounts due to the timing of net earnings and changes in common stock equivalents during each year.
55 CONSOLIDATED BALANCE SHEETS (Dollars in thousands) At December 31, 1996 1995 - -------------------------------------------------------------------------------- ASSETS Current assets: Trade receivables, less allowance for doubtful accounts of $307 in 1996 and $362 in 1995 $ 39,656 $25,317 Costs and estimated earnings in excess of billings on uncompleted contracts (note 2) 1,665 4,053 Inventories: Work in process 4,145 4,583 Raw materials and supplies 23,076 21,262 ----------------- 27,221 25,845 Income tax receivable - 434 Deferred tax asset (note 4) 1,637 584 Prepaid expenses and other current assets 2,851 608 ----------------- Total current assets 73,030 56,841 ----------------- Property, plant and equipment, at cost (note 3): Land 356 356 Buildings 9,010 5,802 Machinery and equipment 14,292 12,820 Office furniture and equipment 16,032 14,589 Transportation equipment 1,236 1,036 Leasehold improvements 2,395 2,288 ----------------- 43,321 36,891 Less accumulated depreciation and amortization 25,389 22,714 ----------------- Net property, plant and equipment 17,932 14,177 Deferred tax asset (note 4) 738 621 Cost in excess of fair value of net assets acquired, net of accumulated amortization of $2,483 in 1996 and $1,896 in 1995 (note 11) 7,606 7,674 Deferred compensation asset (note 6) 4,998 5,575 Other assets 373 1,957 ----------------- $104,677 $86,845 ----------------- ----------------- SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 24 56 At December 31, 1996 1995 - -------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current debt installments (note 3) $ 737 $ 337 Accounts payable 15,119 11,698 Accrued payroll, bonus and employee benefit plan contributions (note 6) 10,892 6,688 Billings in excess of costs and estimated earnings on uncompleted contracts (note 2) 5,926 1,279 Other accrued liabilities 6,235 1,825 Current tax liability 492 - ----------------- Total current liabilities 39,401 21,827 ----------------- Deferred compensation liability (note 6) 3,925 3,696 Long-term debt (note 3) 3,412 12,090 ----------------- Total liabilities 46,738 37,613 Stockholders' equity (notes 3 and 7): Common stock of $.25 par value; authorized 20,000,000 shares, issued 6,829,273 shares in 1996 and 6,805,626 shares in 1995 1,707 1,702 Additional paid-in capital 23,194 23,003 Foreign currency translation 203 - Retained earnings 32,835 24,527 ----------------- Total stockholders' equity 57,939 49,232 Commitments and contingencies (notes 6 and 10) ----------------- $104,677 $86,845 ----------------- ----------------- 25 57 CONSOLIDATED STATEMENTS OF EARNINGS (Dollars in thousands, except per share data) Years ended December 31, 1996 1995 1994 - -------------------------------------------------------------------------------- Net sales $175,440 $136,780 $119,703 Cost of sales 126,997 96,094 81,023 Research and development expenditures 6,331 5,218 4,561 ------------------------------ Gross profit 42,112 35,468 34,119 ------------------------------ Selling, general and administrative expenses 25,990 23,200 21,176 Amortization of cost in excess of fair value of net assets acquired 587 547 78 Miscellaneous income - net 43 66 34 ------------------------------ Operating income 15,578 11,787 12,899 Interest expense 724 741 264 Investment income 251 134 50 ------------------------------ Earnings before income taxes 15,105 11,180 12,685 Income tax expense (benefit) (note 4): Current 6,945 4,413 5,098 Deferred (1,170) (119) (52) ------------------------------ 5,775 4,294 5,046 ------------------------------ Net earnings $ 9,330 $ 6,886 $ 7,639 ------------------------------ ------------------------------ Earnings per common share $ 1.36 $ 1.01 $ 1.16 ------------------------------ ------------------------------ Weighted average shares outstanding (000s) 6,844 6,827 6,567 ------------------------------ ------------------------------ SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 26 58 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in thousands)
Additional Foreign Total Common Paid-in Currency Retained Stockholders' Stock Capital Translation Earnings Equity - ------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1993 $1,582 $19,513 $ - $11,991 $33,086 Net earnings - - - 7,639 7,639 Cash dividends paid ($0.15 per share) - - - (968) (968) Common stock issued (notes 7 and 11): Servo acquisition 65 2,860 - - 2,925 Stock options and other 35 346 - - 381 ------------------------------------------------------ BALANCE AT DECEMBER 31, 1994 1,682 22,719 - 18,662 43,063 Net earnings - - - 6,886 6,886 Cash dividends paid ($0.15 per share) - - - (1,021) (1,021) Common stock issued (note 7): Stock options and other 20 284 - - 304 ------------------------------------------------------ BALANCE AT DECEMBER 31, 1995 1,702 23,003 - 24,527 49,232 Net earnings - - - 9,330 9,330 Cash dividends paid ($0.15 per share) - - - (1,022) (1,022) Common stock issued (notes 7 and 11): Acquisition of businesses 4 146 - - 150 Stock options and other 1 45 - - 46 Foreign currency translation - - 203 - 203 ------------------------------------------------------ BALANCE AT DECEMBER 31, 1996 $1,707 $23,194 $203 $32,835 $57,939 ------------------------------------------------------ ------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 27 59 CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) Years ended December 31, 1996 1995 1994 - -------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 9,330 $ 6,886 $ 7,639 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: Depreciation and amortization 5,004 3,906 2,621 Gain on sale of property, plant and equipment (5) (34) (6) Deferred tax expense (benefit) (1,170) (119) 211 Changes in assets and liabilities, net of acquisition of businesses: Trade receivables (13,740) (3,860) (3,046) Inventories (1,060) (7,830) (1,558) Estimated costs, earnings and billings on contracts 7,381 (2,873) (920) Prepaid expenses and other current assets (360) 131 (109) Accounts payable 3,345 3,052 2,588 Accrued payroll and benefits 4,000 (651) 1,506 Other liabilities 5,007 (478) (1,423) Other deferred liabilities 371 157 304 ------------------------------ Total adjustments 8,773 (8,599) 168 ------------------------------ Net cash provided by (used in) operating activities 18,103 (1,713) 7,807 ------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (6,371) (5,532) (3,242) Acquisition of businesses (2,146) (1,182) (6,661) Proceeds from sale of property, plant and equipment 46 84 30 Deferred compensation, net (1,339) (429) (524) Other investing activities 1,584 (974) (37) ------------------------------ Net cash used in investing activities (8,226) (8,033) (10,434) ------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 46 292 300 Cash dividends (1,022) (1,021) (968) Borrowings under line of credit agreements 46,530 31,152 5,075 Repayments under line of credit agreements (55,165) (20,491) (4,275) Principal payments of long-term debt (469) (436) (320) ------------------------------ Net cash provided by (used in) financing activities (10,080) 9,496 (188) Foreign currency translation 203 - - Net decrease in cash and cash equivalents - (250) (2,815) ------------------------------ Cash and cash equivalents at beginning of year - 250 3,065 ------------------------------ Cash and cash equivalents at end of year $ - $ - $ 250 ------------------------------ ------------------------------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 690 $ 661 $ 265 Income taxes $ 6,019 $ 4,167 $ 5,939 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 28 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION. The consolidated financial statements of the Company include the accounts of Harmon Industries, Inc., and its wholly-owned subsidiaries, Harmon Electronics, Inc. (HEI), Electro Pneumatic Corporation (EPC), Consolidated Asset Management Company, Inc. (CAMCO), Harmon Railway Systems International (HRSI) and Vaughan Harmon Systems Limited (Vaughan Harmon). Effective January 1, 1997 HEI, EPC and CAMCO were merged with and into Harmon Industries, Inc. such that Harmon Industries was the surviving corporation. Significant intercompany accounts and transactions have been eliminated in consolidation. Management of the Company has made estimates and assumptions relating to the reporting of assets and liabilities and disclosure of contingent liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. NATURE OF BUSINESS. The Company is a major supplier of signal and train control products to railroads throughout North America and the world. It manufactures an extensive line of railroad signal and communication equipment, traffic control systems, rail/highway grade crossing hardware and related components. The Company also provides a single-source, rapid delivery service for urgently needed railroad components by warehousing commonly-used parts and equipment, which are manufactured both by Harmon and other vendors. INVENTORY VALUATION. Inventories are valued primarily at the lower of cost (first-in, first-out) or market (net realizable value). The components of cost are labor, materials and an allocation of manufacturing overhead. PROPERTY, PLANT AND EQUIPMENT. Buildings, machinery and equipment, office furniture and equipment, transportation equipment and leasehold improvements are being depreciated or amortized using the straight-line method over the estimated useful lives of the assets, which range from two to thirty-three years. Maintenance and repairs are charged to operations as incurred. Renewals and betterments are capitalized as additions to the appropriate asset accounts. Upon sale or retirement of assets, the cost and related accumulated depreciation applicable to such assets are removed from the accounts, and any resulting gain or loss is reflected in operations. INCOME TAXES. Income taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. LONG-TERM CONTRACTS. Profits on long-term contracts are recorded on the basis of the Company's estimates of the percentage of completion of individual contracts. That portion of the total contract price is accrued which is allocable, on the basis of the Company's engineering estimates of the percentage of completion, to contract expenditures incurred. Profits are not recorded during the start-up phase of the contract, which has been determined by the Company to approximate the initial 15% of design and construction. All losses are recognized in the period during which they become evident. COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED. Cost in excess of the fair value of net assets acquired is amortized on a straight-line basis generally over five to fifteen years. The Company assesses the recoverability of such cost by determining whether the amortization of the cost in excess of the fair value of net assets acquired over its remaining life can be recovered through undiscounted future operating cash flows. 29 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS. For purposes of the statement of cash flows, the Company considers all investments purchased with a maturity of three months or less to be cash equivalents. RESEARCH AND DEVELOPMENT. Costs incurred in the creation and start-up of new products or in changing existing products are charged to expense as incurred. EARNINGS PER COMMON SHARE. Earnings per common share are based on the weighted average number of common shares outstanding, including common shares held by the Company's Employee Stock Ownership Plan and Trust. Effect is given to common stock equivalents (stock options), if dilutive. FAIR VALUE OF FINANCIAL INSTRUMENTS. Estimates of fair values are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could affect the estimates. The fair market value of the Company's financial instruments approximates the carrying value. STOCK OPTION PLANS. Prior to January 1, 1996 the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. 2. CONTRACTS IN PROGRESS Contract costs on uncompleted contracts are as follows: Costs and Billings in estimated excess of earnings costs and in excess estimated (Dollars in thousands) of billings earnings Total - -------------------------------------------------------------------- December 31, 1996: Costs and estimated earnings $ 7,796 $73,397 $81,193 Billings 6,131 79,323 85,454 ----------------------------------- $ 1,665 $(5,926) $(4,261) ----------------------------------- ----------------------------------- - -------------------------------------------------------------------- December 31, 1995: Costs and estimated earnings $25,234 $28,541 $53,775 Billings 21,181 29,820 51,001 ----------------------------------- $ 4,053 $(1,279) $ 2,774 ----------------------------------- ----------------------------------- Balances billed, but not paid by customers under retainage provisions in contracts amounted to $1,165,000 and $1,146,000 at December 31, 1996 and 1995, respectively. All receivables on contracts in progress are considered to be collectible within twelve months. 3. INDEBTEDNESS (Dollars in thousands) 1996 1995 - -------------------------------------------------------------------- Revolving credit agreements $2,826 $11,461 Bank loan 273 - Note payable 198 - Capitalized lease obligations 852 966 -------------------- Total indebtedness 4,149 12,427 Less current installments 737 337 -------------------- Long-term debt $3,412 $12,090 -------------------- -------------------- REVOLVING CREDIT AGREEMENTS. The Company has an unsecured $20,000,000 revolving credit agreement which expires August 1999. At December 31, 1996, there were no outstanding borrowings. Outstanding borrowings bear interest at a base rate established by the bank plus a variable component depending on the Company's funded debt to capitalization percentage and fixed charges coverage ratio. 30 62 The Company has a reducing revolving credit agreement with original total credit availability of $15,000,000 reducing by $536,000 as of the last day of each quarter beginning September 30, 1996. The Company has remaining total credit availability of $13,928,000 at December 31, 1996 against which there are outstanding borrowings of $2,826,000. Outstanding borrowings are due on August 15, 2001 and bear interest at a base rate established by the bank plus a variable component depending on the Company's funded debt to capitalization percentage and fixed charges coverage ratio (8.25% at December 31, 1996). Borrowings under this agreement are collateralized by liens against substantially all of the Company's equipment and machinery. The Company pays commitment fees of 1/10 of 1% annually on the unused portion of the revolving credit agreements. BANK LOAN. The bank loan is a term note payable in monthly installments including interest through April 2002. The note bears interest at a base rate established by the bank plus 2.1% (7.85% at December 31, 1996). The note is collateralized by liens against real and personal property with a net book value of $1,537,000 at December 31, 1996. OVERDRAFT FACILITY. The Company has a $343,000 overdraft facility which expires August 21, 1997. At December 31, 1996 there were no outstanding borrowings. Outstanding borrowings bear interest at a base rate established by the bank plus 1.9%. Borrowings under this agreement are collateralized by liens against real and personal property which amounts to $1,537,000 at December 31, 1996. NOTE PAYABLE. The Company has a term note payable in full within five business days after January 1, 1997. The note bears interest at 7.25% and is unsecured. The note was paid in full on January 8, 1997. CAPITALIZED LEASE OBLIGATIONS. The Company entered into various computer hardware and software capital lease agreements totaling $330,000 and $295,000 in 1996 and 1995, respectively. Monthly installments are due through October 1998. The average implied interest rate in the lease agreements is 7.0%. COVENANTS. The various indebtedness agreements contain, among other things, covenants relating to: maintenance of certain levels of consolidated net worth and limitations of total liabilities; maintenance of certain ratios of debt to equity and current assets to current liabilities; and certain limitations on the payment of cash dividends. At December 31, 1996, the Company is in compliance with all covenants under its indebtedness agreements and has retained earnings available for dividends of $3,643,000. MATURITIES. At December 31, 1996, long-term debt maturities for 1997 and thereafter are: Years ended December 31 (Dollars in thousands) - -------------------------------------------------------------------- 1997 $ 737 1998 417 1999 51 2000 51 2000 and thereafter 2,893 -------- $4,149 -------- -------- On January 24, 1997 the Company issued $15,000,000 of senior unsecured notes. The notes are payable in seven equal annual installments beginning January 24, 2000. The notes bear interest at 6.87% payable semi-annually. 31 63 4. INCOME TAXES Income tax expense consisted of the following: (Dollars in thousands) 1996 1995 1994 - -------------------------------------------------------------------- Current: Federal $ 5,741 $3,664 $4,193 State 1,204 749 905 --------------------------- Total current 6,945 4,413 5,098 Deferred: Federal (976) (99) (14) State (194) (20) (38) --------------------------- Total deferred (1,170) (119) (52) --------------------------- Total income tax expense $ 5,775 $4,294 $5,046 --------------------------- --------------------------- Income tax expense for the years ended December 31, 1996, 1995, and 1994, respectively, differed from the amounts computed by applying the U.S. federal income tax rate of 35 percent to pretax income as a result of the following: (Dollars in thousands) 1996 1995 1994 - -------------------------------------------------------------------- Computed "expected" tax expense $5,287 $3,913 $4,440 Increase (reduction) in income taxes resulting from: State and local income taxes, net of federal income tax benefit 657 473 564 Other, net (169) (92) 42 --------------------------- $5,775 $4,294 $5,046 --------------------------- --------------------------- The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1996 and 1995 are presented below: (Dollars in thousands) 1996 1995 - -------------------------------------------------------------------- Deferred tax assets: Deferred compensation $1,531 $1,442 Compensated absences 353 356 Inventories 490 329 Allowance for doubtful accounts 120 141 Various other reserves 1,043 127 ----------------- Total gross deferred tax assets 3,537 2,395 Less valuation allowance 369 369 ----------------- 3,168 2,026 Deferred tax liabilities: Plant and equipment (793) (821) ----------------- Net deferred tax assets $2,375 $1,205 ----------------- ----------------- The valuation allowance for deferred tax assets as of January 1, 1995 was approximately $369,000. There were no net changes in the total valuation allowance for the years ended December 31, 1996 and 1995. Management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets as reduced by the valuation allowance. During 1995, the Internal Revenue Service completed examinations of the Company's federal income tax returns for the years ended December 31, 1992, 1993 and 1994. The results of the examinations did not have a material effect on the Company's financial statements. 5. BUSINESS SEGMENT INFORMATION The Company and its subsidiaries operate in one reportable segment of railroad electronics and related products. Two customers accounted for net sales of approximately $77,302,000 and $16,126,000 for the year ended December 31, 1996, net sales of approximately $19,091,000 and $15,532,000 for the year ended December 31, 1995 and net sales of approximately $25,735,000 and $11,015,000 for the year ended December 31, 1994. At December 31, 1996, the Company had significant receivable balances from five customers totaling approximately $23,734,000. The Company has no other unusual credit risks or concentrations. 6. COMMITMENTS The Company has entered into various lease arrangements covering the use of manufacturing facilities, administrative offices and equipment, all of which are operating leases. Rental expense related to these leases amounted to $1,661,000, $1,581,000 and $1,398,000 for the years ended December 31, 1996, 1995 and 1994, respectively. 32 64 A summary of non-cancelable long-term operating lease commitments follows (Dollars in thousands): Real Total Years ended December 31, Equipment property commitments - -------------------------------------------------------------------- 1997 $75 $1,216 $1,291 1998 20 1,132 1,152 1999 7 883 890 2000 - 734 734 2001 - 259 259 It is expected that in the normal course of business, leases that expire will be renewed or replaced by leases on other properties; thus, it is anticipated that future minimum lease commitments will not be less than the amounts shown for 1997. EMPLOYEE BENEFITS. In 1985, the Company formed an Employee Stock Ownership Plan and Trust (ESOP), which includes all employees. The ESOP held 503,497 shares and 506,904 shares of Company common stock which had been allocated to plan participants at December 31, 1996 and 1995, respectively. Company contributions to the ESOP are normally based on a percentage of pretax earnings. Dividends on common shares held by the ESOP are reflected as a reduction in retained earnings. ESOP contributions charged to operating expense were $3,815,000, $2,785,000 and $3,045,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The Company and its subsidiaries have various bonus plans based primarily on Company performance. Accrued and unpaid bonuses at December 31, 1996 and 1995 were $2,505,000 and $757,000, respectively. The Company has a nonqualified, unfunded deferred compensation plan for certain key executives providing for payments upon retirement, death or disability. Under the plan, certain employees receive retirement payments equal to a portion of the three highest continuous years' average compensation. These payments are to be made for the remainder of the employees' life with a minimum payment of ten years' benefits to either the employee or his or her beneficiary. The plan also provides for reduced benefits upon early retirement, disability or termination of employment. The deferred compensation (gain) expense was $(365,000), $491,000 and $522,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The Company has recorded the assets and liabilities for the deferred compensation at gross amounts in the Consolidated Balance Sheets because such assets and liabilities belong to the Company. The Company does not provide other post-retirement benefits. 7. STOCKHOLDERS' EQUITY A summary of stock options granted, exercised and expired follows: Shares Price Per Share - -------------------------------------------------------------------- Balance at January 1, 1994 307,250 $ 5.70 Average Price Granted 42,000 20.50-22.75 Exercised (157,600) 3.88-13.38 Expired (2,000) 5.50-7.25 Balance at December 31, 1994 189,650 10.44 Average Price Granted 28,000 14.00-17.75 Exercised (83,150) 3.88-13.38 Expired (10,000) 13.38 Balance at December 31, 1995 124,500 15.20 Average Price Granted 101,000 13.50-17.00 Exercised (6,000) 5.50-8.25 Expired (25,500) 16.50-20.63 Balance at December 31, 1996 194,000 $14.69 Average Price The Company has outstanding stock options for 38,500 shares of common stock at prices ranging from $5.50 to $8.25 and outstanding stock options for 155,500 shares of common stock at prices ranging from $14.00 to $20.63. The Company has exercisable outstanding stock options for 33 65 151,885 shares of common stock at prices ranging from $5.50 to $22.75 a share ($14.21 average per share) as of December 31, 1996. In May 1996 the Company granted stock options for up to 1,000 common shares to each of the Company's nine non-employee directors which expire on May 31, 2003. In May 1995, the Company granted stock options for up to 2,000 common shares to each of the Company's eleven directors which expire on May 31, 1997. In May 1994, the Company granted stock options for up to 2,000 common shares to each of the Company's eleven directors as of that date which expired on May 31, 1996. The Company issued 17,647 shares of unregistered common stock in connection with the 1996 acquisition of businesses. (See Note 11). The Company issued 260,000 shares of unregistered common stock to Servo Corporation of America in December 1994 (See Note 11). 8. AFFILIATES The Company has investments of 38% and 20% in unconsolidated affiliates which are accounted for under the equity method. Equity in earnings (losses) of these affiliates was not significant for the years ended December 31, 1996, 1995 and 1994. The Company had sales to these related entities totaling $841,000, $1,477,000 and $272,000 for 1996, 1995 and 1994, respectively. The Company had receivables due from these entities of $223,000 and $434,000 as of December 31, 1996 and 1995, respectively. 9. OTHER FINANCIAL INFORMATION The Company has classified certain environmental compliance expenses as cost of sales in the accompanying statements of operations. These expenses amounted to $283,000, $215,000 and $164,000 for the years ended December 31, 1996, 1995 and 1994, respectively. 10. LITIGATION ENVIRONMENTAL MATTER. On September 30, 1991, the United States Environmental Protection Agency (EPA) issued a complaint against the Company alleging violations of the Resource Conservation and Recovery Act (RCRA) and RCRA regulations in the disposal of solvents at the Company's Grain Valley, Missouri, plant. The complaint sought penalties in the amount of $2,344,000 and proposed certain compliance actions. In January 1994 the administrative hearing on the penalty assessment was heard. The decision from that hearing reduced the penalties to $586,000. Based on the Company's cooperation with the Missouri Department of Natural Resources (MDNR), which had the original jurisdiction of the matters complained by the EPA, in voluntarily disclosing the alleged violations and in promptly undertaking all remedial actions specified by the MDNR, the penalties appear to the Company's legal counsel to be excessive. However, because so few cases have been disposed of by settlement, or by administrative or judicial proceedings since the new penalty guidelines were adopted, legal counsel cannot express an opinion as to the ultimate amount, if any, of the Company's liability. The Company has recorded a total of $2,232,000 of environmental compliance expenses to date relating to this matter. The Company has recorded a liability for its best estimates of the costs to be incurred relative to the compliance actions in other accrued liabilities. Since the amount of the penalty cannot be reasonably determined at this time, no liability has been accrued in the financial statements. OTHER LITIGATION. The Company has been named as a defendant in several other lawsuits in the normal course of its business. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these matters will not have a material effect on the consolidated financial statements of the Company. 11. ACQUISITION OF BUSINESSES On July 1, 1996 the Company acquired the stock of Vaughan Systems Limited for an initial purchase price of $2,003,000 in cash. In addition to the initial purchase price, the purchase agreement provides for contingent payments. These payments are based on the average after-tax earnings of Vaughan Harmon over the three year period ending June 30, 1999 as well as the utilization of certain tax net operating loss carryforwards. Any additional consideration paid will 34 66 be recorded as goodwill. The acquisition has been accounted for by the purchase method of accounting and accordingly, the operating results have been included in the Company's consolidated results of operations from the date of acquisition. The excess of the cash paid over the fair value of net assets acquired has been recorded as goodwill of $156,000. In 1996 the Company acquired the assets of two contract engineering firms. These acquisitions were made with the issuance of 17,467 shares of unregistered common stock valued at $8.50 per share, a $198,000 note payable and $145,000 in cash. These acquisitions have been accounted for by the purchase method of accounting and accordingly, the operating results have been included in the Company's consolidated results of operations from the dates of acquisition. The excess of the consideration given over the fair value of net assets acquired has been recorded as goodwill of $363,000. The pro forma effects of the 1996 acquisitions on the consolidated financial statements are not significant. On February 24, 1995, the Company acquired certain assets of Serrmi Services, Inc. (Serrmi) for approximately $1,182,000 in cash. The acquisition has been accounted for by the purchase method of accounting and accordingly, the operating results have been included in the Company's consolidated results of operations from the date of acquisition. The excess of the cash paid over the fair value of net assets acquired has been recorded as goodwill of $139,000. The pro forma effects of the Serrmi acquisition on the consolidated financial statements are not significant. On December 20, 1994, the Company acquired the transportation division of Servo Corporation of America. Servo's transportation division manufactures hot box detector systems and various components to help railroads monitor the condition of bearings and wheels on freight and passenger vehicles. The purchase method of accounting for business combinations was used and accordingly, the operating results of this division have been included in the Company's consolidated results of operations from the date of acquisition and were insignificant in 1994. The Servo acquisition was made with the issuance of 260,000 shares of unregistered common stock valued at $11.25 per share, as determined by a fair market value analysis conducted by an independent investment and securities firm, and $6,661,000 in cash. The fair value of assets acquired, including goodwill, was $10,283,000 and liabilities assumed totaled $697,000. Goodwill of $7,967,000 is being amortized over fifteen years on a straight line basis. Assets acquired included inventory, fixed assets and other miscellaneous items. The pro forma results below (unaudited) for 1994 assume the acquisition occurred at the beginning of that year. (Dollars in thousands, except per share data) - -------------------------------------------------------------------- Net sales $131,024 Operating income 13,730 Net earnings 8,152 Earnings per common share 1.19 12. ACCOUNTING FOR STOCK-BASED COMPENSATION The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based compensation plans other than for restricted stock and performance-based awards. Had compensation cost for the Company's other stock option plans been determined based upon the fair value at the grant date for 1996 awards under these plans consistent with the methodology presented in Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, the Company's net income and earnings per share in 1996 would have been reduced by approximately $325,000 ($88,000 - 1995), or $.05 per share ($.01 per share -1995). The fair value of the options granted during 1996 is estimated at values ranging from $5.88 to $8.86 on the dates of grant using the Black-Scholes option-pricing model with the following assumptions: dividend rate of .15 per share, volatility ranging between 41% and 70%, risk-free interest rate ranging between 5.25% and 7.01%, assumed forfeiture rate of 0%, and an expected life ranging between 1.9 and 3.75 years. 35 67 FORWARD LOOKING INFORMATION This annual report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which may include statements concerning projection of revenues, income or loss, capital expenditures, capital structure, or other financial items, statements regarding the plans and objectives of management for future operations, statements of future economic performance, statements of the assumptions underlying or relating to any of the foregoing statements, and other statements which are other than statements of historical fact. These statements appear in a number of places in this annual report and include statements regarding the intent, belief, or current expectations of the Company's management with respect to (i) the demand and price for the Company's products and services, (ii) the Company's competitive position, (iii) the supply and price of materials used by the Company, (iv) the cost and timing of the completion of new or expanded facilities, or (v) other trends affecting the Company's financial condition or results of operations. Statements made throughout this report are based on current estimates of future events, and the Company has no obligation to update or correct these estimates. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially as a result of these various factors. REPORT OF MANAGEMENT TO THE STOCKHOLDERS OF HARMON INDUSTRIES, INC.: The management of Harmon Industries, Inc., is responsible for the preparation, presentation, and integrity of the consolidated financial statements and other information included in this annual report. The financial statements have been prepared by the Company in accordance with generally accepted accounting principles and, as such, include amounts based on management's best estimates and judgments. The financial statements have been audited by KPMG Peat Marwick LLP, independent public accountants. Their audits were made in accordance with generally accepted auditing standards and included such reviews and tests of the Company's internal accounting controls as they considered necessary. The Company maintains a system of internal accounting controls designed to provide reasonable assurance at reasonable cost that Company assets are protected against loss or unauthorized use and that transactions and events are properly recorded. The Board of Directors, through its Audit Committee, comprised solely of directors who are not employees of the Company, meets with management and the independent public accountants to assure that each is properly discharging its respective responsibilities. The independent accountants have free access to the Audit Committee, without management present, to discuss the results of their work and their assessment of the adequacy of internal accounting controls and the quality of financial reporting. /s/ BJORN E. OLSSON Bjorn E. Olsson President and Chief Executive Officer /s/ CHARLES M. FOUDREE Charles M. Foudree Executive Vice President - Finance, Treasurer and Secretary February 4, 1997 36 68 REPORT OF INDEPENDENT AUDITORS THE BOARD OF DIRECTORS AND STOCKHOLDERS OF HARMON INDUSTRIES, INC. AND SUBSIDIARIES: We have audited the accompanying consolidated balance sheets of Harmon Industries, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the years in the three year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Harmon Industries, Inc. and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1996, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Kansas City, Missouri February 4, 1997 37 69 INVESTOR INFORMATION FORM 10-K Shareholders may receive a copy of the Corporation's 1996 Annual Report to the Securities and Exchange Commission on Form 10-K free of charge by writing: Mr. Charles M. Foudree Executive Vice President-Finance at the Corporation's headquarters. ANNUAL MEETING Shareholders are cordially invited to attend the Annual Meeting of Shareholders, which will be held at 2:00 p.m. on Tuesday, May 13, 1997, at the Country Club of Blue Springs, Blue Springs, Missouri. Management urges all shareholders to vote their proxies and thus participate in the decisions that will be made at this meeting. REGISTRAR & TRANSFER AGENT UMB Bank, n.a. P.O. Box 419226 Kansas City, Missouri 64141-6226 816/860-7000 For change of name, address, or to replace lost stock certificates, write or call the Securities Transfer Division. SECURITIES ANALYST CONTACT Securities analyst inquiries are welcome. Please direct them to: Mr. Charles M. Foudree Executive Vice President-Finance 816/229-3345 INDEPENDENT AUDITORS KPMG Peat Marwick LLP 1600 Commerce Bank Building Kansas City, Missouri 64106 OUTSIDE COUNSEL Morrison & Hecker LLP 2600 Grand Avenue Kansas City, Missouri 64108-4606 816/691-2600 CORPORATE HEADQUARTERS 1300 Jefferson Court Blue Springs, Missouri 64015 816/229-3345 Telefax: 816/229-0556 COMMON STOCK PRICE RANGE AND DIVIDEND INFORMATION At December 31, 1996, there were 6,829,273 shares outstanding and approximately 637 shareholders of record. Cash dividends were resumed in 1994 at the rate of 15 cents per share per year, paid semi-annually at 7H cents per share. The range of high and low prices for the past eight quarters ended December 31, 1996 is shown below. Per share prices have been adjusted for all stock splits and stock dividends, if any. Price Range Calendar Quarter Ended 1996 1995 - -------------------------------------------------------------------- March 31 $15 3/4 - $12 $19 1/2 - $13 1/2 June 30 18 3/4 - 13 3/4 18 - 13 1/2 September 30 18 - 15 1/2 20 1/2 - 13 3/8 December 31 19 1/2 - 15 18 1/4 - 14 STOCK TRADING The Company's common stock trades on The Nasdaq Stock Market under the symbol: hrmn. Stock price quotations can be found in major daily newspapers and in THE WALL STREET JOURNAL. At March 6 , 1997, the following securities firms were making a dual auction market in the Company's common stock: George K. Baum & Company Piper Jaffray Companies Inc. PaineWebber Inc. HARMON ON THE WORLD WIDE WEB Information on Harmon Industries, Inc. is available on the Company's World Wide Web site at: http://www.harmonind.com 38 70 MANAGEMENT, DIRECTORS AND CORPORATE DATA BOARD OF DIRECTORS Robert E. Harmon (57) CHAIRMAN OF THE BOARD Thomas F. Eagleton (67) ATTORNEY-AT-LAW THOMPSON & COBURN ST. LOUIS, MISSOURI Bruce M. Flohr (58) CHAIRMAN & CEO RAILTEX, INC. SAN ANTONIO, TEXAS Charles M. Foudree (52) EXECUTIVE VICE PRESIDENT- FINANCE, TREASURER AND SECRETARY Rodney L. Gray (44) CHAIRMAN & CEO ENRON INTERNATIONAL, INC. HOUSTON, TEXAS Herbert M. Kohn (58) ATTORNEY-AT-LAW BRYAN CAVE LLP KANSAS CITY, MISSOURI Gary E. Ryker* (47) EXECUTIVE VICE PRESIDENT MARKETING, SALES AND SERVICE Douglass Wm. List (41) MANAGEMENT CONSULTANT BALTIMORE, MARYLAND Gerald E. Myers (55) MANAGEMENT CONSULTANT TEMPE, ARIZONA Bjorn E. Olsson (51) PRESIDENT AND CHIEF EXECUTIVE OFFICER Donald V. Rentz (58) GRANT LEIGHTON ASSOCIATES OF TEXAS, INC. PLANO, TEXAS Judith C. Whittaker (58) VICE PRESIDENT-LEGAL HALLMARK CARDS, INC. KANSAS CITY, MISSOURI - ---------------------------- * Denotes Advisory Director () Indicates age of director MANAGEMENT Bjorn E. Olsson PRESIDENT AND CHIEF EXECUTIVE OFFICER Charles M. Foudree EXECUTIVE VICE PRESIDENT- FINANCE, TREASURER AND SECRETARY Lloyd T. Kaiser EXECUTIVE VICE PRESIDENT-SYSTEMS Gary E. Ryker EXECUTIVE VICE PRESIDENT MARKETING, SALES AND SERVICE Ronald G. Breshears VICE PRESIDENT- HUMAN RESOURCES Richard A. Daniels VICE PRESIDENT-TRANSIT SALES Robert E. Heggestad VICE PRESIDENT-TECHNOLOGY J. Randall John VICE PRESIDENT-SERVICES John W. Johnson VICE PRESIDENT-DOMESTIC SALES Raymond A. Rosewall VICE PRESIDENT-MANUFACTURING William J. Scheerer VICE PRESIDENT-APPLICATIONS ENGINEERING Stephen L. Schmitz VICE PRESIDENT-CONTROLLER William L. Bush DIRECTOR-RESEARCH & DEVELOPMENT Jeffery J. Utterback DIRECTOR-QUALITY ASSURANCE DOMESTIC LOCATIONS Riverside, California (2) + Jacksonville, Florida Atlanta, Georgia Louisville, Kentucky Blue Springs, Missouri Grain Valley, Missouri (3) + Lee's Summit, Missouri Warrensburg, Missouri (2) + Omaha, Nebraska Hauppauge, New York - ---------------------------------------- + Denotes number of plants and locations INTERNATIONAL LOCATIONS Harmon Industries Lausanne, Switzerland Henkes-Harmon Industries, Pty. Ltd. Mooroolbark, Victoria, Australia Vale-Harmon Enterprises, Ltd. Saint-Laurent, Quebec, Canada Vaughan Harmon Systems Ltd. Ware, England 39 71 [HARMON LOGO] CORPORATE OFFICE 1300 JEFFERSON COURT BLUE SPRINGS, MO 64015 816-229-3345 FAX: 816-229-0556 72 EX-21 4 EXHIBIT 21 Exhibit 21 HARMON INDUSTRIES INC. FILE #0-7916 DECEMBER 31, 1996 LISTING OF SUBSIDIARIES Names Under Which Subsidiary Name Business is Conducted Jurisdiction - --------------- ---------------------------------- Harmon Electronics, Inc.** Same Missouri Electro Pneumatic Corporation** Same California Consolidated Asset Management Company, Inc.** CAMCO Missouri Cedrite Technologies, Inc. Same Kansas Harmon Railway Systems Same Virgin Islands International Corporation Vaughan Harmon Systems Ltd. Same Ware, England **Effective 1/1/97 these companies were merged into Harmon Industries, Inc. 73 EX-27 5 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS OF HARMON INDUSTRIES, INC. AT DECEMBER 31, 1996 AND FOR THE YEAR THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 0 0 39,963 (307) 27,221 73,030 43,321 (25,389) 104,677 39,401 4,149 0 0 1,707 56,232 104,677 175,440 175,440 133,328 133,328 0 0 724 15,105 5,775 9,330 0 0 0 9,330 1.36 1.36
EX-99 6 EXHIBIT 99 ARTICLES OF MERGER BY AND AMONG HARMON INDUSTRIES, INC., HARMON ELECTRONICS, INC., CONSOLIDATED ASSET MANAGEMENT COMPANY, INC. AND ELECTRO PNEUMATIC CORPORATION ----------------------------- (Section 351.447 RSMo) Pursuant to the provisions of The General and Business Corporation Law of Missouri, the undersigned corporations certify the following: 1. Electro Pneumatic Corporation, a California corporation ("EPC"), Consolidated Asset Management Company, Inc., a Missouri corporation ("CAMCO"), Harmon Electronics, Inc., a Missouri corporation ("HEI"), are hereby merged (the "Merger") with and into Harmon Industries, Inc., a Missouri corporation ("HII"). 2. HII is the surviving corporation in the Merger. 3. CAMCO, EPC and HEI are hereinafter referred to collectively as the "Constituent Corporations". 4. The Boards of Directors of the Constituent Corporations have approved these Articles of Merger and the Plan of Merger ("Plan of Merger") set forth herein by resolutions adopted on August 23, 1996 by unanimous written consent of all of the members of the Boards of Directors of the Constituent Corporations. The resolutions adopted by the Board of Directors of HII are as follows: WHEREAS, HII is the sole shareholder of HEI, a Missouri corporation; and WHEREAS, HII is the sole shareholder of EPC, a California corporation; and WHEREAS, HII is the sole shareholder of CAMCO, a Missouri corporation; and WHEREAS, HEI, CAMCO and EPC are solvent active corporations; and WHEREAS, the directors of HII deem it advisable and in the best interest of HII that HEI, CAMCO and EPC shall merge with and into HII; NOW, THEREFORE, BE IT RESOLVED, that the Board of Directors of HII hereby approve the merger (the "Merger") of its wholly owned subsidiaries HEI, CAMCO and EPC with and into HII, pursuant to which HII shall be the surviving corporation and all the rights and obligations 75 of HEI, CAMCO and EPC shall become the rights and obligations of HII; FURTHER RESOLVED, that all rights to or associated with the names of the Constituent Corporations, including, but not limited to, trademarks, service marks and other intellectual or common law rights, shall be the property of HII after the merger; FURTHER RESOLVED, that the Merger shall be a statutory merger and is intended to be a tax-free reorganization under the Internal Revenue Code. FURTHER RESOLVED, that the Plan of Merger by and among HII, CAMCO, HEI and EPC, attached hereto as Exhibit A and incorporated herein by reference, is hereby adopted and approved; FURTHER RESOLVED, that the officers of HII be, and they hereby are, authorized and directed to prepare, execute and file with the appropriate office of any jurisdiction any documents, including but not limited to, Articles of Merger setting forth the Plan of Merger, and to take any actions on behalf of HII as they deem necessary and appropriate for the purpose of effecting the Merger. 5. The Plan of Merger has been adopted pursuant to Section 351.447 RSMo. 6. The Plan of Merger is set forth in Exhibit A attached hereto and incorporated herein by reference. 7. HII, the parent corporation, is in compliance with the 90 percent ownership requirement of Section 351.447 RSMo, and will maintain at least 90 percent ownership of each of HEI, CAMCO and EPC, parties to the Merger, until the issuance of the Certificate of Merger by the Secretary of State of Missouri. IN WITNESS WHEREOF, these Articles of Merger have been executed in duplicate by the aforementioned corporations as of the day and year hereafter acknowledged. HARMON INDUSTRIES, INC. (CORPORATE SEAL) By: -------------------------------------- Bjorn E. Olsson, President ATTEST: - ---------------------------------------- Charles M. Foudree, Secretary -2- 76 HARMON ELECTRONICS, INC. (CORPORATE SEAL) By ------------------------------------- Lloyd T. Kaiser, President ATTEST: - ------------------------------------- James O. Selzer, Secretary CONSOLIDATED ASSET MANAGEMENT COMPANY, INC. (CORPORATE SEAL) By ------------------------------------- J. Randall John, President ATTEST: - -------------------------------------- James O. Selzer, Secretary ELECTRO PNEUMATIC CORPORATION, INC. (CORPORATE SEAL) By ------------------------------------ Raymond A. Rosewall, President ATTEST: - --------------------------------------- James O. Selzer, Secretary -3- 77 STATE OF______________________________) ) ss. COUNTY OF_____________________________) On this _______day of ________________________, 1996, before me, _______________________________________, Notary Public in and for said state and county, personally appeared Bjorn E. Olsson, President of Harmon Industries, Inc., known to me to be the person who executed the within Articles of Merger in behalf of said corporation and acknowledged to me that he executed the same for the purposes therein stated. ---------------------------------------- Notary Public (NOTARY SEAL) My Commission Expires: - -------------------------- STATE OF ____________________________) ) ss. COUNTY OF____________________________) On this _________ day of ________________________, 1996, before me, _______________, Notary Public in and for said state and county, personally appeared Lloyd T. Kaiser, President of Harmon Electronics, Inc., known to me to be the person who executed the within Articles of Merger in behalf of said corporation and acknowledged to me that he executed the same for the purposes therein stated. --------------------------------------- Notary Public (NOTARY SEAL) My Commission Expires: - ---------------------------------- -4- 78 STATE OF______________________________) ) ss. COUNTY OF_____________________________) On this _______day of ________________________, 1996, before me, _______________________________________, Notary Public in and for said state and county, personally appeared J. Randall John, President of Consolidated Asset Management Company, Inc., known to me to be the person who executed the within Articles of Merger in behalf of said corporation and acknowledged to me that he executed the same for the purposes therein stated. ---------------------------------------- Notary Public (NOTARY SEAL) My Commission Expires: - -------------------------- STATE OF ____________________________) ) ss. COUNTY OF____________________________) On this _________ day of ________________________, 1996, before me, _________________, Notary Public in and for said state and county, personally appeared Raymond A. Rosewall, President of Electro Pneumatic Corporation, known to me to be the person who executed the within Articles of Merger in behalf of said corporation and acknowledged to me that he executed the same for the purposes therein stated. --------------------------------------- Notary Public (NOTARY SEAL) My Commission Expires: - -------------------------------- -5- 79 EXHIBIT A --------- PLAN OF MERGER BY AND AMONG HARMON INDUSTRIES, INC., HARMON ELECTRONICS, INC., CONSOLIDATED ASSET MANAGEMENT COMPANY, INC. AND ELECTRO PNEUMATIC CORPORATION ----------------------------- 1. Harmon Electronics, Inc., a Missouri corporation ("HEI"), Consolidated Asset Management Company, Inc., Missouri corporation ("CAMCO") and Electro Pneumatic Corporation, a California corporation ("EPC"), hereby merge (the "Merger") with and into Harmon Industries, Inc., a Missouri corporation ("HII"). HII is the surviving corporation (the "Surviving Corporation") in the Merger. 2. The effective date of the Merger (the "Effective Date") shall be December 31, 1996, at midnight. 3. On the Effective Date of the Merger, the separate existence of HEI, CAMCO and EPC shall cease. On the Effective Date, HEI, CAMCO and EPC shall be merged with and into HII, and HII, as the Surviving Corporation, shall, without further action, succeed to and possess all the rights, privileges, immunities and franchises, as well of a public as of a private nature, of HII, HEI, CAMCO and EPC; and all property, real, personal, and mixed, and all debts due on whatever account, including subscriptions to shares, and all other causes in action and all and every other interest of or belonging to or due to each of said corporations, shall be taken and deemed to be transferred to and vested in HII as the Surviving Corporation without further act or deed; and the title to any real estate, or any interest therein, under the laws of the State of Missouri vested in any of such corporations shall not revert or be in any way impaired by reason of the Merger. All rights to or associated with the names of HEI, CAMCO and EPC, including, but not limited to, trademarks, service marks and corporate usage rights, shall be the property of HII after the merger. 4. The officers and directors of the above named corporations are authorized to execute all deeds, assignments and documents of every nature which may be needed to effectuate a full and complete transfer of ownership. 5. The Articles of Incorporation and Bylaws of HII shall continue in full force and effect as the Articles of Incorporation and Bylaws of the Surviving Corporation. 6. The directors and officers of HII on the Effective Date shall continue in office as the directors and officers of the Surviving Corporation and shall hold such offices until their respective successors have been duly elected and qualified. -6- 80 7. Upon and after the Effective Date of the Merger: a. The Surviving Corporation may be served with process in the State of Missouri in any proceeding for the enforcement of any obligation of any corporation organized under the laws of the State of Missouri which is a party to the Merger and in any proceeding for the enforcement of the rights of a dissenting shareholder of any such corporation organized under the laws of the State of Missouri against the Surviving Corporation; b. The Surviving Corporation will promptly pay to the dissenting shareholders of any corporation organized under the laws of the State of Missouri which is a party to the merger the amount, if any, to which they shall be entitled under the provisions of The General and Business Corporation Law of Missouri with respect to the rights of dissenting shareholders. -7- 81 -----END PRIVACY-ENHANCED MESSAGE-----