-----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, U50NCPxzS2NlFmO9zS1Vt4dwMHjo4NNevYn584HprOXaSJKeYiGiqR/6VmDhCe7Y v9I84EOEpxRMiJNWKNxPsQ== 0001047469-99-011798.txt : 19990330 0001047469-99-011798.hdr.sgml : 19990330 ACCESSION NUMBER: 0001047469-99-011798 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990329 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: SEC FILE NUMBER: 000-07916 FILM NUMBER: 99575262 BUSINESS ADDRESS: STREET 1: 1600 NE CORONADO DR CITY: BLUE SPRINGS STATE: MO ZIP: 64015-6236 BUSINESS PHONE: 8162293345 MAIL ADDRESS: STREET 1: 1600 NE CORONADO DR CITY: BLUE SPRINGS STATE: MO ZIP: 64015-6236 FORMER COMPANY: FORMER CONFORMED NAME: HARMON ELECTRONICS INC DATE OF NAME CHANGE: 19780823 10-K 1 FORM 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, 1998 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 1600 NE CORONADO DRIVE, BLUE SPRINGS, MISSOURI 64014 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: TITLE OF EACH CLASS Common Stock ------------------------ 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 15, 1999, 10,741,964 common shares were outstanding. The aggregate market value of the common stock (based upon the closing price of these shares per NASDAQ for Over-the-Counter trading) of Harmon Industries, Inc. held by non-affiliates was approximately $209,039,000. 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. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- DOCUMENTS INCORPORATED BY REFERENCE PART II Item 6: Selected Consolidated Financial Data. Pages 18 and 19 of the Annual Report to Shareholders for the year ended December 31, 1998. Item 7: Management's Discussion and Analysis of Pages 20 through 27 of the Annual Report Financial Condition and Results of to Shareholders for the year ended Operations. December 31, 1998. Item 8: Financial Statements and Supplementary Pages 28 through 47 of the Annual Report Data. to Shareholders for the year ended December 31, 1998. PART III Item 10: Directors and Executive Officers of the Pages 3 through 6 of the Company's Proxy Registrant. Statement dated April 1, 1999. Item 11: Executive Compensation and Other Pages 7 through 16 of the Company's Information. Proxy Statement dated April 1, 1999. Item 12: Security Ownership of Certain Beneficial Pages 2 and 3 of the Company's Proxy Owners and Management. Statement dated April 1, 1999. Item 13: Certain Relationships and Related Page 6 (last paragraph of Director Transactions. Nominees) and page 6 ("Certain Transactions") of the Company's Proxy Statement dated April 1, 1999.
2 HARMON INDUSTRIES, INC. ANNUAL REPORT FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 PART I ITEM 1. BUSINESS Harmon Industries, Inc. ("Harmon" or "the Company") is a leading supplier of signal, inspection, train control and communications products, systems and services to freight and transit railroads throughout the world. The Company sells its products to Class I and short line freight railroads and to rail transit systems. 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, train control and communications 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 NORTH AMERICAN FREIGHT RAILROADS The North American freight railroad industry includes U.S. and Canadian Class I railroads, Mexican railroads and regional and short line railroads. The industry is dominated by the nine railroads the Surface Transportation Board 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 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 25% decrease in Class I employment levels from 1988 to 1997 required the Class I railroads to look to products like those manufactured by Harmon to monitor the condition of moving trains, help ensure 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 22% reduction from 1988 to 1997 in the number of Class I railroad freight cars in service required the 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 77% from 1988 to 1997. The Class I railroads have become more profitable despite a 32% reduction (in constant 1988 dollars) from 1988 to 1997 in revenue per ton mile. - ------------------------ (1) This fact and the other statistical information about the Class I railroads in this Annual Report come from RAILROAD FACTS, 1998 EDITION, a recognized industry source for information on Class I railroads. 3 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 portion. The amount of intermodal traffic has increased 50% from 1988 to 1997. 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 will permit the Class I railroads to better compete in the long haul portion of the freight transportation market. 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 1988 to 1997, the Class I railroads reduced their track miles by 19%, to approximately 173,000 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 1988 to 1997, capital expenditures by Class I railroads per mile of track owned has increased from approximately $17,200 to $36,300 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. In recent years, one of the cost containment strategies increasingly adopted by the freight railroads has been outsourcing of support functions formerly done internally. In the areas of interest to Harmon, this has included a reduction in the internal engineering staffs, construction forces and materials management. This has led to a dramatic increase in opportunities and business for Harmon in providing direct engineering support, materials management and construction services for the 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 541, with 34 of these short line railroads being above the threshold of either $40.0 million in 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 focused management, generally operate at lower speeds and are typically not burdened with the more restrictive collective bargaining agreements as are many of the Class I railroads. 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 the industry has for various Harmon products. The Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA) provided federal funds through 1997 for railroad crossing warning systems in the same amount each year as existed under previous federal legislation. In 1997, ISTEA was extended for six months through March 1998 pending agreement on a new, long-term transportation bill. This new bill, the Transportation Equity Act for the 21(st) Century (TEA-21), was signed into law in June 1998. TEA-21 is the largest infrastructure funding bill ever enacted in the United States. It provides for up to $217 billion in expenditures over its six year life. TEA-21 provides for an increase of approximately 55%, or $50 million, in the amount of funds dedicated annually to installing grade crossing warning devices. 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. 4 The Company has identified Canada and Mexico as areas for new or increased business. In June 1997, Harmon acquired the remaining interest in Vale-Harmon Enterprises, Ltd. ("Vale Harmon"), located near Montreal, Quebec, Canada, which it previously did not own. Vale Harmon serves the freight and transit markets in Canada. In 1998, Harmon established a wholly owned subsidiary in Mexico, Industrias Harmon de Mexico, S.A. de C.V., to expand the relationship it has with two customers arising from the recent concessions granted to operate portions of a state owned rail in Mexico. RAIL TRANSIT RAILROADS The rail transit industry includes Amtrak and numerous existing and proposed commuter and urban transit rail systems. Federal funding generally enhances the development of such systems. TEA-21 includes $42 billion for transit projects of which $36 billion is guaranteed. At the guaranteed level, this represents a 50% increase over appropriated transit funding during the six years of ISTEA. If fully funded, the increase is nearly 75%. Harmon's participation in the expansion of existing or construction of new rail transit systems generally requires a long selling cycle and frequently results 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 the installation of equipment that guards against human error. An example of the Company's 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 signaling 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 Bi-State Metro Link project in St. Louis, which totaled $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. In 1998, the Company was awarded the signal and train control contract on the first extension of this system. 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 for reconstruction of the signal and train control system for the Green Line elevated train. This contract exceeded $13 million. The project was completed successfully and on time under an extremely aggressive schedule, and established 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 further established Harmon as a significant supplier in the rail transit market. 5 In December 1997, Harmon obtained a license agreement from Hughes Aircraft Company (now Raytheon Company) to develop, build and market a new Advanced Automatic Train Control (AATC) system which is based in part on a converted military communications system. Hughes, in combination with the San Francisco Bay Area Rapid Transit District (BART), developed a prototype of this system and demonstrated it on BART in 1996. In February 1998, Harmon was awarded, assuming all options are exercised, the contract to complete the development of the full AATC system and deploy it over a substantial portion of the BART system by the end of 2001. Harmon intends to market this system aggressively in the transit marketplace, both domestically and internationally. The first step in this international effort has been an agreement with Nippon Signal of Japan to license the AATC technology in Japan and jointly market AATC systems in the Pacific Rim. INTERNATIONAL OPPORTUNITIES The Company has identified certain international markets as opportunities for growth. Standards for the railroad industry in Mexico, Canada, South America, 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 Mexico, Europe, and South America have been recently privatized and United States freight railroads, which are Harmon customers, are investors in some of these privatizations. The Company's relationships with such railroads provide it the opportunity to sell its products to these new entities for international use. Harmon is also pursuing strategic alliances with other railroad industry suppliers to assist its 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 anticipated 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. ("Vaughan Harmon"), located in the United Kingdom. This acquisition established the first international manufacturing operations for the Company. Vaughan Harmon manufactures train control products which are complementary to the Company's domestic product lines and provide a base for introducing the Company's products into the European market. It has several contracts with Railtrack, including one for the resignaling of the Cromer line in Norfolk, England. This will be the first project in which Vaughan Harmon products and Harmon products from the United States will be combined to provide an integrated system to the customer. In 1998, Harmon continued its international expansion by purchasing the operating assets of its long-time Australian affiliate, Henkes-Harmon Industries, Pty. Ltd., to establish a new wholly owned subsidiary, Harmon Industries Australia, Pty. Ltd. 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 6 individual products to revenues resulting from the sale of complete systems that are designed, installed and, potentially, maintained by the Company. 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 it can offer that 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 markets. In addition, the ownership or operation by North American 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 continues to enhance its Total Quality Systems (TQS) in all aspects of its operation. The Company was one of the first in its industry to institute such a program. ISO 9000 certification is one of the foundations of the Company's TQS which is evident by the fact the Company has five ISO certificates which cover most of its domestic facilities. Continuous improvement, employee involvement, education and training continue to receive strong emphasis as a strategic initiative. The Company actively employs TQS teams to improve processes, reduce scrap and rework and enhance customer service with up to 50 active teams, at any one time, working on improving internal systems. PRODUCT CLASSIFICATIONS The products of the Company can generally be separated into seven categories. TRAIN CONTROL PRODUCTS & 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; train describers and other train control systems. CROSSING PRODUCTS & 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 PRODUCTS & SYSTEMS include all Company products related to monitoring a moving train as it passes by a train inspection site. COMMUNICATION PRODUCTS & SYSTEMS include voice and data communications, security and dispatching systems used in the transportation industry. PRINTED WIRING BOARDS include production of custom designed printed wiring boards for use by Harmon and other electronics manufacturers. OTHER sales include products that do not readily fit into the other six categories. 7 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) (DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31, ------------------------------------------------------------------- 1996 1997 1998 --------------------- --------------------- --------------------- AMOUNT % AMOUNT % AMOUNT % ---------- --------- ---------- --------- ---------- --------- Train Control Products & Systems............ $ 87,080 47.3% $ 101,624 47.4% $ 132,348 50.5% Crossing Products & Systems................. 48,927 26.6% 55,598 25.9% 53,035 20.3% Asset Management Services................... 22,217 12.1% 29,913 14.0% 34,928 13.3% Train Inspection Products & Systems......... 12,906 7.0% 13,407 6.2% 16,312 6.2% Communication Products & Systems............ 1,891 1.0% 655 0.3% 6,606 2.5% Printed Wiring Boards....................... 5,249 2.9% 5,772 2.7% 5,220 2.0% Other....................................... 5,598 3.1% 7,458 3.5% 13,547 5.2% ---------- --------- ---------- --------- ---------- --------- Total................................... $ 183,868 100.0% $ 214,427 100.0% $ 261,996 100.0% ---------- --------- ---------- --------- ---------- --------- ---------- --------- ---------- --------- ---------- ---------
- ------------------------ (1) Sales volumes shown above do not include cash discounts or deferred contract revenue. As a result, there are small differences between the amounts 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 freight railroad and rail transit industries. TRAIN CONTROL PRODUCTS & SYSTEMS include all Company products and services related to the control of train movement. These include the Company's 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); 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 some level of 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 8 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 taking place on an Amtrak line in southern Michigan under a FRA grant to demonstrate enhanced train control technology for High-Speed Rail corridors. Advanced Automatic Train Control (AATC) is a very sophisticated train control system that uses a radio data network linking trains with wayside computers to continuously monitor the location of trains and update the instructions to each train based on the reported locations of other trains. This will allow much more capacity in high density transit operations such as San Francisco's Bay Area Rapid Transit District (BART) where the AATC system will allow reductions in headway between trains from 2.5 minutes to 90 seconds and permit more trains per hour to handle peak load conditions. It also achieves this result with a dramatic reduction in the amount of physical equipment required along the track compared to more conventional train control techniques. CROSSING PRODUCTS & 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 complete systems utilizing 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 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. The Highway Crossing Analyzer (HCA) is a recording and monitoring device intended mostly for use at grade crossings that can monitor and record many aspects of the warning system operation, detect anomalies and report trouble to a central reporting location. It is being adopted in many areas as a means for improving the efficiency of maintenance procedures by providing better and faster information on the location and nature of potential problems and the ability to develop pro-active preventative maintenance procedures. The acquisition of Devtronics, Inc. in 1997 added other related products similar to the HCA and additional capability and expertise in this area. 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. The Company 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. Success in this area has helped Harmon diversify from a predominantly manufacturing operation into the service portion of the railroad supply industry. The Company expanded its service 9 offering in January 1998 with the acquisition of CSS, Inc., a provider of installation and maintenance services to domestic freight railroads. TRAIN INSPECTION PRODUCTS & SYSTEMS include all Company products and services related to monitoring 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 Devtronics, Inc. in November 1997 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 axle 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. COMMUNICATION PRODUCTS & SYSTEMS include fiber optic communication networks, tunnel and above ground radio systems, vehicle radio systems, passenger emergency telephone systems, audio/visual passenger information systems, fire and intrusion systems, closed circuit television, premise distribution, local area networks and Supervisory Control and Data Acquisition (SCADA) systems. The Company's October 1998 acquisitions of SESCO, Inc. and Seaboard Systems Co., Inc. significantly enhanced its ability to offer complete communications solutions to its customers, particularly in the transit market. 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. OTHER includes services such as contract engineering, repair, installation and maintenance as well as the sale of miscellaneous products outside the categories discussed above. 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 as 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. 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 dictates 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) the communication-based train control system called Advanced Automatic Train Control (AATC) 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 $6,331,000, $7,664,000 and $8,454,000 in the years ended December 31, 1996, 1997 and 1998, respectively, on research and development (R&D) activities related either to the improvement of existing products or to the development of new products. The AATC system, however, is being developed under a commercial contract therefore most of its development costs are not considered R&D expense. 10 The number of engineers involved in research and development activity has increased significantly, commensurate with the rise in investment in this field. However, a much larger increase has occurred in the number of engineers dedicated to Applications Engineering which apply developed products to specific customer needs and, in part, replace the customer's internal engineering staffs. In addition to expanding its product line by means of internal R&D, 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 Devtronics, Inc., the Company obtained its technology and R&D projects along with a research workforce that is 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 railroad 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 market: Class I, short line, rail transit and international. The United States-based marketing organization is assisted by wholly owned subsidiaries in the United Kingdom, Canada, Mexico and Australia. The Company also utilizes foreign nationals to assist the Company's sales staff with sales in other foreign markets. 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 $131.8 million at December 31, 1998. Approximately $95 million of these orders are expected to be filled in 1999 with the balance filled in 2000. The backlog of orders was approximately $74.5 million at December 31, 1997, the majority of which were filled during 1998. 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. 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 provide field service support, repairs and customer 11 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, 1998, the Company had 1,662 full-time employees. There were 1,161 employees in manufacturing, 212 in engineering, 190 in general and administrative services and 99 in marketing and sales. In general, the Company believes its relations with its employees are excellent. Approximately 14 of the Company's employees are covered by a collective bargaining agreement. 12 ITEM 2. PROPERTIES The Company owns or leases an aggregate of approximately 800,000 square feet of space for manufacturing, warehousing, research and general office use. In addition, the Company owns land zoned for industrial use, on which the Grain Valley and Warrensburg facilities are located. The following table summarizes the Company's principal locations.
LOCATION PRINCIPAL USE - ------------------------------------- -------------------------------------------------------------------------- Grain Valley, Missouri............... Administration, design and manufacture of electronic products and railroad signal systems Warrensburg, Missouri................ Manufacture of railroad crossing warning systems and hardware and printed wiring boards Jacksonville, Florida................ Design and manufacture of railroad crossing warning systems and hardware Atlanta, Georgia..................... Design and assembly of railroad crossing warning systems Riverside, California................ Administration, product design, and manufacture of electronic products Lee's Summit, Missouri............... Assembly, storage and distribution of products for the railroad industry Blue Springs, Missouri............... Corporate headquarters Ware, England........................ Design and manufacture of electronic products and control systems St. Laurent, Quebec, Canada.......... Design, manufacture and distribution of products for the railroad industry Monterrey, Mexico.................... Assembly, storage and distribution of products for the railroad industry Bayswater, Victoria, Australia....... Design and distribution of products for the railroad industry Hingham, Massachusetts............... Administration, design, project management and installation of communications systems for the transit industry
In addition to these principal locations, the Company also owns or leases various other office, engineering and warehouse facilities. Management believes that its facilities are adequate for current and foreseeable needs. For additional discussion and information concerning the Company's lease commitments, see "Financial Statements--Note 6 of Notes to the Consolidated Financial Statements." The Company owns all significant machinery and equipment used in its manufacturing operations. 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. MDNR issued a permit on July 31, 1996. Groundwater and other remediation requirements are set forth in the post-closure permit. The Company has designed and installed a system to begin soil remediation and that system will continue in operation for some time. The Company has 13 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. The market value of assets in this trust exceeded $585,000 at December 31, 1998. 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 penalties to $2,343,706. After several unsuccessful settlement attempts, the case proceeded to hearing before an EPA administrative law judge on January 12-14, 1994, on the issue of penalties. Prior to the hearing, the judge found the Company liable for all alleged violations. The Company presented evidence on several penalty reduction theories, including good faith, minor potential for harm to human health and the environment, and minimum economic benefit. On December 12, 1994, the administrative law judge issued an Initial Decision in which he assessed penalties against the Company of $586,716. 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 unobtainable. On January 9, 1995, the Company filed a Notice of Appeal of the Initial Decision with the Environmental Appeals Board ("EAB") and on May 1, 1996, the EAB heard oral arguments. The EAB affirmed the penalty of the administrative law judge. On June 6, 1997, Harmon filed a complaint in the Federal District Court for the Western District of Missouri seeking judicial review of the EAB's decision. On August 25, 1998, the District Court entered its Order Reversing the Final Decision of the Environmental Appeals Board. The District Court held that RCRA, as well as Missouri law principles of res judicata, barred EPA from filing a duplicative enforcement action after the violator has entered a final settlement with an authorized State agency. The District Court rejected Harmon's argument that EPA's penalty claim was barred by the applicable statute of limitations and that the penalty should be reduced based on EPA's failure to properly consider all relevant circumstances. Nevertheless, the effect of the District Court's holding is to bar the EPA from collecting penalties from Harmon based on the alleged violations. On October 21, 1998, the EPA filed a Notice of Appeal in the United States Court of Appeals for the Eight Circuit requesting the Appeals Court to reverse the District Court's order setting aside the penalty against Harmon. On December 28, 1998, the EPA filed its brief in support of its appeal and on January 27, 1999, Harmon filed its responsive brief. The EPA filed its reply brief on February 24, 1999. Harmon and the EPA have consented to have organizations interested in the Appeals Court's ruling file amicus briefs stating their various positions on the issues raised in this litigation. After the Court has received briefs on the issues, it will set a time to hear oral argument. Harmon intends to vigorously present its position in the Court of Appeals, and is supported in its position by a number of amicus briefs. However, because so few analogous cases have been disposed of by judicial decision, special legal counsel cannot express an opinion as to the likelihood of Harmon ultimately prevailing on appeal. 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. 14 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, 1998. 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 March 4, 1999 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. C.L. King & Associates Knight Securities L.P. Mayer & Schweitzer, Inc. Sherwood Securities Corporation The approximate number of holders of record for the Company's common stock as of March 4, 1999 was 608. 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's exposure to market risk is limited to interest rate risk associated with its variable rate credit facilities and foreign currency exchange rate risk. The Company does not currently use, nor has it historically used, derivative financial instruments to manage or reduce market risk. At December 31, 1998, 78% of the Company's total indebtedness contained fixed rates of interest. A 10% change in interest rates on the Company's variable rate indebtedness would not have a significant impact on future earnings. The Company has operations in Great Britain, Canada, Australia and Mexico. The functional currency for each of these operations is the respective local currency. Based upon the amount of business in these countries during 1998, a 10% change in exchange rates would not have a material impact on future earnings. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Incorporated by reference. 15 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.
PRINCIPAL OCCUPATION FOR THE LAST FIVE INDIVIDUAL OFFICE AGE YEARS - ------------------------- --------------------- --- ---------------------------------------- Breshears, Ronald G...... VP-Human Resources 52 VP-Human Resources of the Company since 7/1/81. Daniels, Richard A....... VP-Transit and 58 VP-Transit and International Systems International Systems Sales of the Company since 1/1/98. Sales Prior to that, VP-Transit since 2/1/93. Foudree, Charles M....... Executive VP-Finance, 54 Executive VP-Finance of the Company and Secretary since 9/9/86. Secretary of the Company since 2/2/82. Harmon, Robert E......... Chairman of the Board 59 Chairman of the Board of 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 60 VP-Technology of the Company since 10/2/86. John, James R............ VP-Services 50 VP-Services of the Company since 5/1/96. Prior to that, President of Consolidated Asset Management Company, Inc. since 1992. Johnson, John W.......... VP-Domestic Sales 51 VP-Domestic Sales of the Company since 2/1/93. Kaiser, Lloyd T.......... Executive VP-Domestic 47 Executive VP-Domestic Sales and Service Sales and Service of the Company since 1/1/98. Prior to that, Executive VP-Systems since 5/1/96. Prior to that, President of Harmon Electronics, Inc. since 1992. Marberg, William P....... Executive VP-Systems 47 Executive VP-Systems Sales and Support Sales and Support of the Company since 4/13/98. Prior to that, President and Chief Executive Office of Airsys ATM, Inc. since December 1995. Prior to that, Vice President-Air Traffic Control of Unisys, Inc.
16
PRINCIPAL OCCUPATION FOR THE LAST FIVE INDIVIDUAL OFFICE AGE YEARS - ------------------------- --------------------- --- ---------------------------------------- Olsson, Bjorn E.......... President and Chief 53 President and Chief Executive Officer of Executive Officer the Company since 1/1/95. President of the Company since 8/1/90. Rosewall, Raymond A...... Executive 47 Executive VP-Manufacturing since June VP-Manufacturing 1998. Prior to that, VP-Manufacturing of the Company 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. Scheerer, William J...... VP-Applications 51 VP-Applications Engineering of the Engineering Company since 1/4/94. Prior to that, various positions with CSX Transportation, most recently Chief Engineer-Train Control. Schmitz, Stephen L....... VP-Controller 45 VP-Controller of the Company since 11/1/83. Utterback, Jeffery J..... Vice President and 37 Vice President and General General Manager-Riverside Operations of the Manager-Riverside Company since June 1998. Prior to Operations that, Assistant VP-Quality Systems of the Company since 1/1/98. Prior to that, Director-Quality Assurance since 1993.
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 Board of Directors and are appointed for one year terms. 17 The following is a list of the Board of Directors of the Company:
INDIVIDUAL AFFILIATION - --------------------------------------------------------------- ------------------------------------------------- Robert E. Harmon............................................... Chairman of the Board Bruce M. Flohr................................................. Founder and Chairman Emeritus RailTex, Inc., San Antonio, Texas Charles M. Foudree............................................. Executive Vice President-Finance and Secretary Rodney L. Gray................................................. Vice Chairman Azurix, Houston, Texas Herbert M. Kohn................................................ Attorney-at-Law Bryan Cave LLP, Kansas City, Missouri Douglass Wm. List.............................................. Management Consultant Baltimore, Maryland Gerald E. Myers................................................ Management Consultant Tempe, Arizona Bjorn E. Olsson................................................ President and Chief Executive Officer John A. Sprague................................................ Managing Partner Jupiter Partners, LP, New York, New York Judith C. Whittaker............................................ Vice President, General Counsel/Secretary Hallmark Cards, Inc., Kansas City, Missouri
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. 18 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT 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 1998 Annual Report to Shareholders at the following pages:
PAGE(S) ----------- Independent Auditors' Report......................................................... 45 Consolidated Balance Sheets--December 31, 1998 and 1997.............................. 28-29 Consolidated Statements of Earnings--Years ended December 31, 1998, 1997 and 1996.... 30 Consolidated Statements of Stockholders' Equity--Years ended December 31, 1998, 1997 and 1996........................................................................... 31 Consolidated Statements of Cash Flows--Years ended December 31, 1998, 1997 and 1996............................................................................... 32 Notes to Consolidated Financial Statements........................................... 33-44
(a)(2) Financial Statement Schedules Selected Financial Data--for the years ended December 31, 1998, 1997 and 1996, are attached hereto at the following pages: Independent Auditors' Report on Financial Statement Schedule........... 23 Schedule VIII--Valuation and Qualifying Accounts....................... 24
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. 19 (a)(3) Exhibits:
EXHIBIT NUMBER PAGE(S) - ----------- ---------------- 3 (ii) Amended Bylaws........................................................................ 25 through 38 11 Computation of Per Share Earnings..................................................... 39 13 1998 Annual Report to Shareholders.................................................... 40 through 89 21 Listing of Subsidiaries............................................................... 90 23 Auditors' Consent..................................................................... 91 27 Financial Data Schedule............................................................... 92 99-1 Forward Looking Information........................................................... Incorporated by reference to page 44 of Exhibit 13 N/A Notice of Annual Meeting and Proxy Statement dated April 1, 1999...................... 93 through 112
(b) Reports on Form 8-K: There were no reports on Form 8-K for the three months ended December 31, 1998. 20 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 19, 1999 By: /s/ BJORN E. OLSSON ------------------------------------------ Bjorn E. Olsson PRESIDENT Date: March 19, 1999 By: /s/ CHARLES M. FOUDREE ------------------------------------------ Charles M. Foudree EXECUTIVE VICE PRESIDENT-FINANCE Date: March 19, 1999 By: /s/ STEPHEN L. SCHMITZ ------------------------------------------ Stephen L. Schmitz VICE PRESIDENT-CONTROLLER
21 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: /s/ BRUCE M. FLOHR Date March 19, 1999 ------------------------------------------ Bruce M. Flohr, DIRECTOR By: /s/ CHARLES M. FOUDREE Date: March 19, 1999 ------------------------------------------ Charles M. Foudree, DIRECTOR By: /s/ RODNEY L. GRAY Date: March 19, 1999 ------------------------------------------ Rodney L. Gray, DIRECTOR By: /s/ ROBERT E. HARMON Date: March 19, 1999 ------------------------------------------ Robert E. Harmon, DIRECTOR By: /s/ HERBERT M. KOHN Date: March 19, 1999 ------------------------------------------ Herbert M. Kohn, DIRECTOR By: /s/ DOUGLASS WM. LIST Date: March 19, 1999 ------------------------------------------ Douglass Wm. List, DIRECTOR By: /s/ GERALD E. MYERS Date: March 19, 1999 ------------------------------------------ Gerald E. Myers, DIRECTOR By: /s/ BJORN E. OLSSON Date: March 19, 1999 ------------------------------------------ Bjorn E. Olsson, DIRECTOR By: /s/ JOHN A. SPRAGUE Date: March 19, 1999 ------------------------------------------ John A. Sprague, DIRECTOR By: /s/ JUDITH C. WHITTAKER Date: March 19, 1999 ------------------------------------------ Judith C. Whittaker, DIRECTOR
22 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Harmon Industries, Inc.: Under date of February 10, 1999, we reported on the consolidated balance sheets of Harmon Industries, Inc. and subsidiaries as of December 31, 1998 and 1997 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, 1998, as contained in the 1998 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 1998. 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. KPMG LLP Kansas City, Missouri February 10, 1999 23 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, 1996: Allowance for doubtful trade accounts receivable.......... $ 362 $ 32 $ (87) $ 307 Warranty reserve.......................................... $ -- $ 2,988 $ -- $ 2,988 Year ended December 31, 1997: Allowance for doubtful trade accounts receivable.......... $ 307 $ 18 $ (7) $ 318 Warranty reserve.......................................... $ 2,988 $ 70 $ (335) $ 2,723 Year ended December 31, 1998: Allowance for doubtful trade accounts receivable.......... $ 318 $ 59 $ (26) $ 351 Warranty reserve.......................................... $ 2,723 $ 217 $ (885) $ 2,055
24 EX-3.(II) 2 EXHIBIT 3(II) As Amended December 10, 1998 BYLAWS OF HARMON INDUSTRIES, INC. * * * * * ARTICLE I Offices The principal office of the Corporation in the State of Missouri shall be located in Jackson County, Missouri. The Corporation may have such other offices, either within or without the State of Missouri, as the businesses of the Corporation may require from time to time. The registered office of the Corporation required by The General and Business Corporation Act of Missouri to be maintained in the State of Missouri may be, but need not be, identical with the principal office in the State of Missouri, and the address of the registered office may be changed from time to time by the Board of Directors. ARTICLE II Shareholders SECTION 1. ANNUAL MEETING: The Annual Meeting of the Shareholders shall be held at any hour during normal business hours as determined by the President on the second Tuesday in May of each year, beginning with the year 1990, for the purpose of electing Directors and for the transaction of such other business as may come before the meeting. If the day fixed for the Annual Meeting shall be a legal holiday, such meeting shall be held on the next succeeding business day. If the election of Directors shall not be held of the date designated herein for any annual meeting, or at any adjournment thereof, the Board of Directors shall cause the election to be held at a special meeting of the Shareholders as soon thereafter as conveniently may be. SECTION 2. SPECIAL MEETINGS: Special meetings of the Shareholders may be called by the President, by the Board of Directors or by the holders of not less than two-fifths of all the outstanding shares of the Corporation. SECTION 3. PLACES OF MEETING: The Board of Directors may designate any place, either within or without the State of Missouri, as the place of meeting for any annual meeting of the Shareholders or for any special meeting of the Shareholders called by the Board of Directors. The Shareholders may designate any place, either within or without the State of Missouri, as the place for the holding of such meeting, and may include the same in a waiver of notice of any meeting. If no designation is made, or if a special meeting be otherwise called, the place of meeting shall be the registered office of the Corporation in the State of Missouri, except as otherwise provided in Section 5 of this Article. Page 26 SECTION 4. NOTICE OF MEETINGS: Written or printed notice stating the place, day and hour of the meeting and, in case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten nor more than fifty days before the date of the meeting, either personally or by mail, by or at the direction of the President, or the Secretary, or the office or persons calling the meeting, to each Shareholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail in a sealed envelope addressed to the Shareholder at his address as it appears on the records of the Corporation, with postage thereon prepaid. SECTION 5. MEETING OF ALL SHAREHOLDERS: If all of the Shareholders shall meet at any time and place, either within or without the State of Missouri, and consent to the holding of a meeting, such meeting shall be valid, without call or notice, and at such meeting any corporate action may be taken. SECTION 6. BUSINESS WHICH MAY BE TRANSACTED AT ANNUAL AND SPECIAL MEETINGS: At each annual meeting of the Shareholders the Shareholders shall elect, by ballot, a Board of Director nominated for election as provided in Article II, Section 13 and in accordance with Article III, Section 2 of these Bylaws, and they may transact such other business as may be approved by the Board of Directors or submitted by a shareholder for consideration pursuant to Article II, Section 16 of these Bylaws; whether or not the same are specified in the notice of the meeting, unless the consideration of such other business without its having been specified in the notice of the meeting as one of the purposes thereof, is prohibited by law. Business transacted at all special meetings shall be confined to the purposes stated in the notice of such meetings, unless the transaction of other business is consented to by the holders of all of the outstanding shares of stock of the Corporation entitled to vote thereat. SECTION 7. CLOSING OF TRANSFER BOOKS OR FIXING OF RECORD DATE: The Board of Directors of the Corporation may close its stock transfer books for a period not exceeding fifty days preceding the date of any meeting of Shareholders, or the date for the payment of any dividend or for the allotment of rights, or the date when any exchange or reclassification of shares shall be effective; or, in lieu thereof, may fix in advance a date, not exceeding seventy days preceding the date of any meeting of Shareholder, or to the date for the payment of any dividends or for the allotment of rights, or to the date when any exchange or reclassification of shares shall be effective, as the record date for determination of Shareholders entitled to notice of, or to vote at, such meeting, or Shareholders entitled to receive payment of any such dividend or to receive any such allotment of rights, or to exercise rights in respect to any exchange or reclassification of shares; and the Shareholders of record on such date of closing the transfer books, or on the record date so fixed, shall be the Shareholders entitled to notice of and to vote at, such meeting, or to receive payment of such dividend, or to receive such allotment of rights, or to exercise such rights in the event of an exchange or reclassification of shares, as the case may be. If the Board of Directors shall not have closed the transfer books or set a record date for the determination of its stockholders entitled to vote as hereinabove provided, no person shall be admitted to vote directly or by proxy except those in whose names the shares of the Corporation shall have stood on the transfer books on a date fifty days previous to the date of the meeting. Page 27 SECTION 8. VOTING LISTS: At least ten days before each meeting of Shareholders, the officer or agent having charge of the transfer book for shares of the Corporation shall make a complete list of the Shareholders entitled to vote at such meeting, arranged in alphabetical order with the address of, and the number of shares held by, each Shareholder which list, for a period of ten days prior to such meeting, shall be kept on file at the registered office of the Corporation and shall be subject to inspection by any Shareholder at any time during usual business hours. Such list shall also be produced and kept open at the time and place of the meeting and shall be subject to inspection of any Shareholder during the whole time of the meeting. The original share ledger or transfer book, or a duplicate thereof kept in this state, shall be prima facie evidence as to who are the Shareholders entitled to examine such list or share ledger or transfer book or to vote at any meeting of Shareholders. SECTION 9. QUORUM: A majority of the outstanding shares of the Corporation, represented in person or by proxy, shall constitute a quorum at any meeting of the Shareholders; provided, that if less than a majority of the outstanding shares are represented at said meeting, a majority of the shares so represented may adjourn the meeting, from time to time, without further notice, to a date not longer than ninety days from the date originally set for such meeting. SECTION 10. PROXIES: At all meetings of Shareholders, a Shareholder may vote by proxy executed in writing by the Shareholder or by his duly authorized attorney-in-fact. Such proxy shall be filed with the Secretary of the Corporation before or at the time of the meeting. No proxy shall be valid after eleven months from the date of its execution, unless otherwise provided in the proxy. SECTION 11. VOTING OF SHARES: Subject to the provisions of Section 13, each outstanding share of capital stock having voting rights shall be entitled to one vote upon each matter submitted to a vote at a meeting of Shareholders. SECTION 12. VOTING OF SHARES BY CERTAIN HOLDERS: Shares standing in the name of another corporation, domestic or foreign, may be voted by such officer, agent, or proxy as the bylaws of such corporation may prescribe, or, in the absence of such provision, as the Board of Directors of such corporation may determine. Shares standing in the name of a deceased person may be voted by his administrator or executor, either in person or by proxy. Shares standing in the name of a guardian, conservator, or trustee may be voted by such fiduciary, either in person or by proxy, but no guardian, conservator, or trustee shall be entitled, as such fiduciary, to vote shares held by him without a transfer of such shares into his name. Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority so to do be contained in an appropriate order of the court by which such receiver was appointed. A Shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred. Page 28 SECTION 13. VACANCIES AND NEWLY CREATED DIRECTORSHIPS; NOMINATIONS OF DIRECTORS; ELECTION. (a) Newly created directorships resulting from any increase in the number of Directors and any vacancies on the Board resulting from death, resignation, disqualification, removal, or other cause will be filled solely by the affirmative vote of not less than 75% of the remaining Directors then in office, or by a sole remaining Director. Any Director elected in accordance with the preceding sentence will hold office for the remainder of the full term of the class of Directors in which the new directorship was created or the vacancy occurred and until such Director's successor is elected and qualified. No decrease in the number of Directors constituting the Board will shorten the term of an incumbent Director. (b) Other than persons nominated and elected pursuant to Paragraph (a), only persons who are nominated in accordance with the following procedures will be eligible for election as Directors of the Corporation. (c) Nominations of persons for election as Directors of the Corporation may be made at a meeting of stockholders (i) by or at the direction of the Board (including the Director Nomination and Compensation Committee thereof) or (ii) by any stockholder who is a stockholder of record at the time of giving of notice provided for in this Bylaw 13 who is entitled to vote for the election of such Director at the meeting and who complies with the procedures set forth in this Bylaw 13. All nominations by stockholders must be made pursuant to timely notice in proper written form to the Secretary. (d) To be timely, a stockholder's notice must be delivered to or mailed and received at the principal executive offices of the Corporation not less than 180 calendar days prior to the meeting. To be in proper written form, such stockholder's notice must set forth or include (i) the name and address, as they appear on the Corporation's books, of the stockholder giving the notice and of the beneficial owner, if any, on whose behalf the nomination is made; (ii) a representation that the stockholder giving the notice is a stockholder of record of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting for such Director to nominate the person or persons specified in the notice; (iii) the number of shares of stock of the Corporation owned beneficially and of record by the stockholder giving the notice and by the beneficial owner, if any, on whose behalf the nomination is made; (iv) a description of all arrangements or understandings between or among any of (A) the stockholder giving the notice, (B) the beneficial owner, if any, on whose behalf the notice is given, (C) each nominee, and (D) any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the stockholder giving the notice; (v) such other information regarding each nominee proposed by the stockholder giving the notice as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission had the nominee been nominated, or intended to be nominated, by the Board; and (vi) the signed consent of each nominee to serve as a Director of the Corporation if so elected. At the request of the Board, any person nominated by the Board for election as a Director must furnish to the Secretary that information required to be set forth in a stockholder's notice of nomination which pertains to the nominee. The presiding officer of the meeting for election of Directors will, if the facts warrant, determine that a nomination was not made in accordance with the procedures prescribed by this Bylaw 13, and if so determined, so declare to the meeting and the defective nomination will be disregarded. Page 29 (e) Stockholders shall not have a right to cumulate their votes for Directors. Directors shall be elected by a plurality of the votes cast by the shares entitled to vote in the election at a meeting at which a quorum is present. SECTION 14. INFORMAL ACTION BY SHAREHOLDERS: Any action required to be taken at a meeting of the Shareholders may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the Shareholders entitled to vote with respect to the subject matter thereof. SECTION 15. REMOVAL OF DIRECTORS: The Shareholders shall have the power by a two-thirds vote of the holders of shares at any regular meeting or special meeting expressly called for that purpose, to remove any director from office with cause. The Shareholders shall not have the power at any regular meeting or special meeting expressly called for that purpose to remove any director with cause. "Cause" shall mean for purposes of this section, fraud involving the Corporation, gross abuse of office amounting to a breach of trust or fiduciary responsibility or failure of any Director to attend in person or telephonically three consecutive regular meetings of the Board of Directors. SECTION 16. ITEM SUBMITTED BY SHAREHOLDER FOR VOTING CONSIDERATION AT SHAREHOLDERS MEETINGS. (a) Submission of matters to a vote of the Shareholders at any regular or special meeting of the Shareholders may be made by any shareholder who (i) is a shareholder of record at the time of giving of notice provided for in this Bylaw 16, (ii) is entitled to vote on such matter at the meeting and (iii) complies with the procedures set forth in this Bylaw 16. All such matters submitted by shareholders for a vote at a special or annual meeting of shareholders must be made pursuant to timely notice and proper written form to the Secretary as required by this Bylaw 16. (b) To be timely, a shareholder's notice must be delivered to or mailed and received at the principal executive offices of the Corporation not less than 180 calendar days prior to the meeting. To be in proper written form, such shareholder's notice must set forth or include (i) the name and address as they appear on the Corporation's books, of the shareholder or shareholders giving the notice and of the beneficial owner, if any, on whose behalf the proposal is made; (ii) a representation that the shareholder giving the notice is a shareholder of record of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting for approval of the items submitted for vote; (iii) number of shares of stock of the Corporation owned beneficially and of record by the shareholder or shareholders giving the notice and by the beneficial owner, if any, on whose behalf the matter is submitted; (iv) a description of all arrangements or understandings between or among any of (A) the shareholder giving the notice, (B) the beneficial owner, if any, on whose behalf the notice is given, and (C) any other person or persons (naming such person or persons pursuant to which the matter is being submitted); (v) a description or statement of the matter to be presented for a vote, together with a brief description of the reasons for a vote for the proposed matter; and (vi) such other information regarding such matter as may be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission. The presiding officer of the meeting at which the matter is to be considered will, if the facts warrant, determine that a proposal has not been made in accordance with the procedures described by this Bylaw 16, and if so, Page 30 determine to so declare to the meeting and the proposed matter will be disregarded. SECTION 17. CONDUCT OF SHAREHOLDER'S MEETINGS, ADJOURNMENTS. The Chairman of the Board of Directors or, in the absence of the Chairman of the Board of Directors, the President of the Corporation, shall chair and conduct any annual or special meeting of the shareholders. Such person acting as chair shall have the authority to conduct the meeting for the purpose of transacting business on behalf of the Corporation as provided in the notice of meeting and in these Bylaws and shall also have the authority to determine whether matters submitted for consideration at any such meeting have been submitted in accordance with the provisions of these Bylaws. Such person chairing any meeting of the Shareholders may adjourn the meeting to a specified place and future time not to exceed more than 90 days from the date of such meeting without the necessity of a motion or vote. ARTICLE III Directors SECTION 1. POWERS OF THE BOARD OF DIRECTORS: The property and business of the Corporation shall be managed by the directors, acting as a Board. The Board of Directors shall have and is vested with all and unlimited powers and authorities, except as may be expressly limited by law, the Articles of Incorporation or by these Bylaws, to do or cause to be done any and all lawful things for and in behalf of the Corporation, to exercise or cause to be exercised any or all of its powers, privileges and franchises, and to seek the effectuation of its objects and purposes. SECTION 2. NUMBER, TENURE AND QUALIFICATIONS: The provisions of Article VI of the Corporation's Articles of Incorporation provide for an indefinite number of directors, not less than seven (7) nor more than twelve (12), and require the exact number of directors to be determined by the Board of Directors as set forth in these Bylaws. It is specified that the Corporation shall have ten (10) directors. Such number may be increased or decreased from time to time within the above-mentioned limits by amendment of these Bylaws. Each director shall hold office for the term for which he is elected or until his successor shall have been duly elected and qualified. The total number of directors shall be divided into three groups, with each group containing one-third of the total, as near may be. At the first annual shareholder's meeting at which the election of directors is to be conducted following the adoption of this Bylaw, the Director Nomination and Compensation Committee shall nominate three classes of directors, each class containing one-third of the total as near as may be done and the classes shall have terms of one year, two years and three years, respectively. At each annual shareholder's meeting held thereafter, directors shall be chosen for a term of three years, as the case may be, to succeed those whose terms expire. SECTION 3. REGULAR MEETINGS: A regular meeting of the Board of Directors shall be held without other notice than this Bylaw, immediately after, and at the same place as the annual meeting of Shareholders. The Board of Directors may provide, by resolution, the time and place, either within or without the State of Missouri, for the holding of additional regular meetings with notice of such resolution to all directors. Page 31 SECTION 4. SPECIAL MEETINGS: Special meetings of the Board of Directors may be called by or at the request of the President or any two directors. The person or persons authorized to call special meetings of the Board of Directors may fix any place in the United States, either within or without the State of Missouri, as the place for holding any special meeting of the Board of Directors called by them. SECTION 5. NOTICE: Notice of any special meeting shall be given at least five days previous thereto by written notice delivered personally or mailed to each director at his business address, or by telegram provided, however, that if the designated meeting place is without the State of Missouri, an additional five days notice be given. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail in a sealed envelope so addressed, with postage thereon prepaid. If notice be given by telegram, such notice shall be deemed to be delivered when the telegram is delivered to the telegraph company. Any director may waive notice of any meeting. The attendance of a director at any meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting that the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the Board of Directors need be specified in the notice or waiver of notice of such meeting. SECTION 6. QUORUM: A majority of the Board of Directors shall constitute a quorum for the transaction of business at any meeting of the Board of Directors, provided that if less than a majority of the directors are present at said meeting, a majority of the directors present may adjourn the meeting from time to time without further notice. SECTION 7. MANNER OF ACTING: The act of the majority of the directors present at a meeting of the directors at which a quorum is present shall be the act of the Board of Directors. SECTION 8. VACANCIES: In case of the death or resignation or disqualification of one or more of the directors, a majority of the survivors or remaining directors may fill such vacancy or vacancies until the successor or successors are elected at the next annual meeting of the Shareholders. A director elected to fill a vacancy shall serve as such until the next annual meeting of the Shareholders. SECTION 9. COMPENSATION: Directors shall be entitled to receive the annual fee as shall be determined from time to time by resolution of the Board of Directors; provided that any such fee shall be applicable only to subsequent terms of the Board of Directors. In addition, the Board of Directors by resolution may establish a fixed sum to be paid for attendance at each regular or special meeting of the Board of Directors; provided that any such fee shall be applicable only to subsequent terms of the reasonable out of pocket expenses incurred by the directors in attendance at any special or regular meeting of the Board of Directors. Notwithstanding the foregoing, nothing herein contained shall be construed to preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. SECTION 10. APPOINTMENT OF COMMITTEES: The Board of Directors may, by resolution or resolutions passed by a majority of the whole Board, designate one Page 32 or more committees, each committee to consist of two or more of the directors of the Corporation, which to the extent provided in said resolution or resolutions, in the management of the business and affairs of the Corporation, and may have power to authorize the seal of the Corporation to be affixed to all papers which may require it. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors. SECTION 11. ADVISORY DIRECTOR: The Board of Directors of the Corporation may, in its sole discretion, select one Advisory Director per year from the group consisting of (i) the Presidents of the Corporation's subsidiaries or (ii) the executive officers of the Corporation; provided, that the outstanding common stock of such subsidiaries must be at least eighty percent (80%) owned by the Corporation. Said Advisory Director shall be selected at the Annual Board of Directors' Meeting of the Corporation and shall serve for a one year period only, terminating upon the earlier of the selection of a successor Advisory Director or the expiration of one year from the date of acceptance of the Advisory Director position. The Advisory Director shall not be entitled to vote on any matters on which the Board of Directors may vote. The Advisory Director shall not be counted for purposes of determining a majority of the Board or a quorum present at any meeting. The Advisory Director shall be permitted to participate in discussion of matters coming before the Board but shall not be authorized or empowered to present or second motions coming for consideration to the Board of Director or otherwise present resolutions for adoption by the Board of Directors. Compensation for the Advisory Director shall be as determined by the Board of Directors. SECTION 12. QUALIFICATION FOR DIRECTORS: In order to be nominated to serve as a director of the Corporation, a nominee must not yet have attained his/her seventieth birthday. Directors who shall have attained his/her seventieth birthday may not be renominated to serve another term. However, any director who reaches his/her seventieth birthday during his/her term as a director shall not be prohibited from completing such term by application of this Section; provided, however, that this Section 12 shall not be applicable to any Board member serving as of March 15, 1988. ARTICLE IV Officers SECTION 1. NUMBER: The officers of the Corporation shall be a Chairman of the Board, a President, one or more Vice-Presidents (the number thereof to be determined by the Board of Directors), a Treasurer, a Secretary and such other officers as the Board may elect. The Chairman of the Board, President and the Vice-President or if there is more than one Vice-President, then at least one Vice-President shall be chosen from the Members of the Board of Directors. The remaining officers of the Corporation need not be chosen from the Members of the Board, but they may be so chosen. The Board of Directors, by resolution, may create the offices of one or more Assistant Treasurers and Assistant Secretaries, all of whom shall be elected by the Board of Directors. The Board of Directors from time to time may also appoint such other officers and agents for the Corporation as it shall deem necessary or advisable. All appointed officers and agents shall hold their respective positions at the pleasure of the Board of Directors or for such terms as the Board of Directors may specify, and they shall exercise such powers and perform such duties as shall be Page 33 determined from time to time by the Board of Directors or by an elected officer empowered by the Board of Directors to make such determination. All officers and agents of the Corporation, as between themselves and the Corporation, shall have such authority and perform such duties in the management of the property and affairs of the Corporation as may be provided in the Bylaws, or, in the absence of such provisions, as may be determined by resolution of the Board of Directors. SECTION 2. DELEGATION OF AUTHORITY TO HIRE, DISCHARGE, ETC. The Board of Directors from time to time may delegate to the Chairman of the Board, the President or other officer or executive employee of the Corporation, authority to hire, discharge and fix and modify the duties, salary or other compensation of employees of the Corporation under their jurisdiction, and the Board of Directors may delegate to such officer or executive employee similar authority with respect to obtaining and retaining for the Corporation the services of attorneys, accountants and other experts. SECTION 3. ELECTION AND TERM OF OFFICE: The officers of the Corporation shall be elected annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of Shareholders. If the election of officers shall not be held at such meeting, such election shall be held as soon thereafter as conveniently may be. Vacancies may be filled or new offices created and filled at any meeting of the Board of Directors. Each officer shall hold office until his successor shall have been duly elected and shall have qualified or until his death or until he shall resign or shall have been removed in the manner hereinafter provided. SECTION 4. REMOVAL: Any officer or agent elected or appointed by the Board of Directors may be removed by the Board of Directors whenever in its judgment the best interests of the Corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. SECTION 5. VACANCIES: A vacancy in any office because of death, resignation, removal, disqualification or otherwise, may be filled by the Board of Directors for the unexpired portion of the term. SECTION 6. CHAIRMAN OF THE BOARD: The Chairman of the Board shall preside at all meetings of the Shareholders and Board of Directors at which he is present. He shall, subject to the direction of the Board of Directors, have general oversight over the affairs of the Corporation and shall, from time to time, consult and advise with the President in the direction and management of the Corporation's business and affairs. He shall also do and perform such other duties as may, from time to time, be assigned to him by the Board of Directors. SECTION 7. PRESIDENT: The President shall be the principal executive officer of the Corporation and shall in general supervise and control all of the business and affairs of the Corporation. In the absence of the Chairman of the Board, he shall preside at all meetings of the Shareholders and Board of Directors. He shall be an ex officio member of all standing committees. He may sign with Secretary or Treasurer or any other proper officer thereunto authorized by the Board of Directors, certificates for shares of the Corporation, any deeds, mortgages, bonds, contracts, or other instruments which the Board of Directors or any authorized committee have authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the Board of Page 34 Directors or by these Bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed; and in general shall perform such other duties as may be prescribed by the Board of Directors from time to time. SECTION 8. THE VICE-PRESIDENTS: In the absence of the President or in the event of his inability or refusal to act, the Vice-President (or in the event there be more than one Vice-President, the Vice-Presidents in the order of their election) shall perform the duties of the President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the President. Any Vice-President may sign, with the Secretary or an Assistant Secretary, or with the Treasurer or an Assistant Treasurer, certificates for shares of the Corporation and shall perform such other duties as from time to time may be assigned to him by the President or by the Board of Directors. SECTION 9. THE TREASURER: If required by the Board of Directors, the Treasurer shall give a bond for the faithful discharge of his duties in such sum and with surety or sureties as the Board of Directors shall determine. He shall: (a) have charge and custody of and be responsible for all funds and securities of the Corporation; receive and give receipts for moneys due and payable to the Corporation from any source whatsoever, and deposit all such moneys in the name of the Corporation in such banks, trust companies or other depositaries as shall be selected in accordance with the provisions of Article V of these Bylaws; (b) in general perform all the duties as from time to time may be assigned to him by the President or by the Board of Directors. SECTION 10. THE SECRETARY: The Secretary shall: (a) keep the minutes of the Shareholders' and of the Board of Directors' meetings in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these Bylaws or as required by law; (c) be custodian of the corporate records and of the seal of the Corporation and see that the seal of the Corporation is affixed to all certificates for shares prior to the issue thereof and to all documents, the execution of which on behalf of the Corporation under its seal is duly authorized in accordance with the provisions of these Bylaws; (d) keep a register of the post office address of each Shareholder which shall be furnished to the Secretary by such Shareholder; (e) sign with the President, or a Vice-President, certificates for shares of the corporation, the issue of which shall have been authorized by resolution of the Board of Directors; (f) have general charge of the stock transfer books of the Corporation; (g) in general perform all duties incident to the office of Secretary and such other duties as from time to time may be assigned to him by the President or by the Board of Directors. SECTION 11. ASSISTANT TREASURERS AND ASSISTANT SECRETARIES: The Assistant Treasurers shall respectively, if required by the Board of Directors, give bonds for the faithful discharge of their duties in such sums and with such sureties as the Board of Directors shall determine. Assistant Secretaries and Treasurers, as thereunto authorized by the Board of Directors, may sign with the President or a Vice-President certificates for shares of the Corporation, the issue of which shall have been authorized by a resolution of the Board of Directors. The Assistant Treasurers and Assistant Secretaries, in general, shall perform such duties as shall be assigned to them by the Treasurer or the Secretary, respectively, or by the President or the Board of Directors. SECTION 12. SALARIES: The salaries of the officers shall be fixed from Page 35 time to time by the Board of Directors and no officer shall be prevented from receiving such salary by reason of the fact that he is also a director of the Corporation. ARTICLE V Contracts, Loans, Checks and Deposits SECTION 1. CONTRACTS: The Board of Directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation, and such authority may be general or confined to specific instances. SECTION 2. LOANS: No loans shall be contracted on behalf of the Corporation and no evidences or indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors. Such authority may be general or confined to specific instances. SECTION 3. CHECKS, DRAFTS, ETC.: All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation, shall be signed by such officer or officers, agent or agents of the Corporation and in such manner as shall from time to time be determined by resolution of the Board of Directors. SECTION 4. DEPOSITS: All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositaries as the Board of Directors may select. ARTICLE VI Certificates for Shares and Their Transfer SECTION 1. CERTIFICATES FOR SHARES OF STOCK: The certificates for shares of stock of the Corporation shall be numbered, shall be in such form as may be prescribed by the Board of Directors in conformity with law, and shall be entered in the stock books of the Corporation as they are issued, and such entries shall show the name and address of the person, firm, partnership, corporation or association to whom each certificate is issued. Each certificate shall have printed, typed or written thereon the name of the person, firm, partnership, corporation or association to whom it is issued, and number of shares represented thereby and shall be signed by the President or a Vice-President, and the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the Corporation and sealed with the seal of the Corporation, which seal may be facsimile, engraved or printed. If the Corporation has a registrar, a transfer agent, or a transfer clerk who actually signs such certificates, the signature of any of the other officers above mentioned may be facsimile, engraved or printed. In case any such officer who has signed or whose facsimile signature has been placed upon any such certificate shall have ceased to be such officer before such certificate is issued, such certificate may nevertheless be issued by the Corporation with the same effect as if such officer were an officer at the date of its issue. SECTION 2. TRANSFER OF SHARES - TRANSFER AGENT - REGISTRAR: Transfers of shares of stock shall be made on the stock record or transfer books of the Corporation only by the person named in the stock certificate, or by his attorney Page 36 lawfully constituted in writing, and upon surrender of the certificate therefor. The stock record book and other transfer records shall be in the possession of the Secretary or of a transfer agent or clerk for the Corporation. The Corporation, by resolution of the Board of Directors may from time to time appoint a transfer agent, and, if desired, a registrar, under such arrangements and upon such terms and conditions as the Board of Directors deems advisable; but until and unless the Board of Directors appoints some other person, firm or corporation as its transfer agent (and upon the revocation of any such appointment, thereafter until a new appointment is similarly made) the Secretary of the Corporation shall be the transfer agent or clerk of the Corporation, without the necessity of any formal action of the Board of Directors, and the Secretary shall perform all of the duties thereof. SECTION 3. LOST OR DESTROYED CERTIFICATES: In case of the loss or destruction of any certificate for shares of stock of the Corporation, upon due proof of the registered owner thereof or his representatives, by affidavit of such loss or otherwise, the President and Secretary may issue a duplicate certificate (plainly marked "duplicate") in its place, upon the Corporation being fully indemnified therefor. ARTICLE VII Fiscal Year The fiscal year of the Corporation shall begin on the first day of January in each year and end of the last day of December in each year. ARTICLE VIII Dividends The Board of Directors may from time to time, declare, and the Corporation may pay, dividends on its outstanding shares in the manner and upon the terms and conditions provided by law and its Articles of Incorporation. ARTICLE IX Seal The Board of Directors shall provide a corporate seal which shall be in the form of a circle and shall have inscribed thereon the name of the Corporation and the words, "Corporate Seal, Missouri." ARTICLE X Waiver of Notice Whenever any notice whatever is required to be given under the provisions of these Bylaws or under the provisions of the Articles of Incorporation or under the provisions of The General and Business Corporation Act of Missouri, waiver thereof in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice. Page 37 ARTICLE XI Indemnification of Officers and Directors Against Liabilities and Expenses in Actions SECTION 1. INDEMNIFICATION IN NON-DERIVATIVE ACTIONS: The Corporation will indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceedings, whether civil, criminal, administrative or investigative, other than an action by or in the right of the Corporation, by reason of the fact that he is or was a director (or nominee for a director position) or officer of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any expenses, including attorneys' fees, judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The determination of any action, suit, or proceeding by judgment, order, settlement, conviction or upon a plead of nolo contendere or its equivalent shall not of itself create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to be in the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful. SECTION 2. INDEMNIFICATION IN DERIVATIVE ACTIONS: The Corporation will indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a director (or nominee for a director position) or officer of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses, including attorneys' fees, actually and reasonably incurred by him in connection with the defense or settlement of the action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation; provided, however, that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for gross negligence or misconduct in the performance of his duty to the Corporation unless and only to the extent that the court in which the action or suit was brought determines upon application that, despite the adjudication of liability and in view of all the circumstances of the case, the person is fairly and reasonably entitled to indemnity of such expenses which the court shall deem proper. SECTION 3. MANDATORY INDEMNIFICATION WHENEVER DEFENSE IS SUCCESSFUL: To the extent that a director or officer of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to above, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses, including attorneys' fees, actually and reasonably incurred by him in connection with the action, suit or proceeding. SECTION 4. EXPENSES MUST BE AUTHORIZED IN EACH CASE: Any indemnification under Section 1 and 2, unless ordered by a court, shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because Page 38 he has met the applicable standard of conduct set forth in these sections. The determination shall be made by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to the action, suit, proceeding, or if such a quorum is not attainable, or even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or by the Shareholders. SECTION 5. EXPENSES TO BE ADVANCED: Expenses incurred in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of the action, suit, or proceeding as authorized by the Board of Directors of the Corporation in the specific case upon receipt of an undertaking by or on behalf of said director or officer to repay such amount to be indemnified by the Corporation. SECTION 6. NON-EXCLUSIVE INDEMNIFICATION: The indemnification provided by this section shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any Bylaw, agreement, vote of Shareholder or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director or officer of the Corporation and shall inure to the benefit of the heirs, executors and administrators of such person. SECTION 7. INSURANCE: The Corporation may purchase and maintain insurance on behalf of any person who is or was a director (or nominee for a director position) or officer of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this amendment. ARTICLE XII Amendments These Bylaws may be altered, amended or repealed and new Bylaws may be adopted at any annual meeting of the Shareholders or at any special meeting of the Shareholders called for that purpose or at any meeting of the Board of Directors provided, however, that the Board of Directors shall take no such action contrary to the provisions of any resolution of the Shareholders directing the Board not to do so. Page 39 EX-11 3 EXHIBIT 11 Exhibit 11 Harmon Industries, Inc. Form 10-K Computation of Per Share Earnings (in thousands, except earnings per share)
Three Months ended December 31, --------------------------------------------- --------------------------------------------- 1998 1997 ---- ---- Basic: Net earnings $ 3,520 $ 3,889 ------------------- ------------------- ------------------- ------------------- Weighted average shares outstanding 10,638 10,391 Shares representing unearned compensation (12) (12) ------------------- ------------------- Total 10,626 10,379 ------------------- ------------------- ------------------- ------------------- Basic earnings per share $ 0.33 $ 0.37 ------------------- ------------------- ------------------- ------------------- Diluted: Net earnings $ 3,520 $ 3,889 ------------------- ------------------- ------------------- ------------------- Weighted average shares outstanding 10,638 10,391 Shares representing unearned compensation (12) (12) Equivalent shares under option plans 148 88 ------------------- ------------------- Total 10,774 10,467 ------------------- ------------------- ------------------- ------------------- Diluted earnings per share $ 0.33 $ 0.37 ------------------- ------------------- ------------------- ------------------- Twelve Months ended December 31, --------------------------------------------- --------------------------------------------- 1998 1997 ---- ---- Basic: Net earnings $ 13,402 $ 10,961 ------------------- ------------------- ------------------- ------------------- Weighted average shares outstanding 10,553 10,319 Shares representing unearned compensation (12) (6) ------------------- ------------------- Total 10,541 10,313 ------------------- ------------------- ------------------- ------------------- Basic earnings per share $ 1.27 $ 1.06 ------------------- ------------------- ------------------- ------------------- Diluted: Net earnings $ 13,402 $ 10,961 ------------------- ------------------- ------------------- ------------------- Weighted average shares outstanding 10,553 10,319 Shares representing unearned compensation (12) (6) Equivalent shares under option plans 143 61 ------------------- ------------------- Total 10,684 10,374 ------------------- ------------------- ------------------- ------------------- Diluted earnings per share $ 1.25 $ 1.06 ------------------- ------------------- ------------------- -------------------
Page 40 EX-13 4 EXHIBIT 13 HARMON INDUSTRIES, INC. [GRAPHIC] ANNUAL REPORT 1998 CORPORATE PROFILE HARMON is a leading supplier of signal, inspection, train control and communication products and systems to freight and transit railroads throughout the world. Harmon's design focus is 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 systems, voice and data communications systems, asset management, installation and maintenance services. Harmon emphasizes engineering innovation and rapid response to customer needs. Its products and services provide sophisticated and timely solutions to signaling, communications and train control problems that impact the railroad industry. Harmon's technology base was greatly enhanced in 1997 when it obtained exclusive rail transportation rights to a revolutionary spread spectrum radio technology that was developed by the former Hughes Aircraft Company (now Raytheon). This technology will provide the basis for a communication-based train control system that will be marketed to rail systems in North America and world wide. Harmon is headquartered in Blue Springs, Missouri, a suburb of Kansas City. It operates from numerous facilities in the U.S., as well as Canada, England, Mexico, and Australia. Harmon common stock trades on The Nasdaq Stock Market under the symbol: hrmn. Its current annual dividend is 11 cents per share. - -------------------------------------------- TABLE OF CONTENTS Financial Highlights 1 Report to Shareholders 2 Year in Review 7 Selected Financial Data 18 Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Consolidated Financial Statements 28 Notes to Consolidated Financial Statements 33 Investor Information 46 Corporate Officers and Directors 47 1 [GRAPHIC] ABOUT THE COVER This year's cover illustration depicts Harmon's expanding business internationally. Last year, two of its key systems were certified for use on railroads in Great Britain. This was a watershed achievement. It validates Harmon's advanced technology, and its U.K. certification is expected to lead to greater acceptance of Harmon products throughout Europe. - ------------------------------------------------------------------------------- HARMON POSTED RECORD SALES FOR THE SEVENTH CONSECUTIVE YEAR AND RECORD EARNINGS FOR THE THIRD CONSECUTIVE YEAR. THIS IS THE RESULT OF DEVELOPING NEW TECHNOLOGY THAT HELPS TO MAKE RAILROADS MORE EFFICIENT, CAPITALIZING ON MARKET CHANGES, MAKING COMPLEMENTARY ACQUISITIONS, AND RESPONDING QUICKLY AND DECISIVELY TO CUSTOMER NEEDS. FINANCIAL HIGHLIGHTS (IN THOUSANDS, EXCEPT PER SHARE ITEMS AND NUMBER OF EMPLOYEES)
OPERATING DATA YEAR ENDED DECEMBER 31, 1998 1997 Change Net sales $ 265,219 $ 213,530 + 24.2% Pretax income 21,049 17,583 + 19.7 Income taxes 7,647 6,622 + 15.5 Net earnings 13,402 10,961 + 22.3 Earnings per share (basic) 1.27 1.06 + 19.8 Earnings per share (diluted) 1.25 1.06 + 17.9 Dividends per share .11 .10 + 10.0 PERFORMANCE DATA YEAR ENDED DECEMBER 31, 1998 1997 Change Return on sales (pretax) 7.9% 8.2% - 3.7% Return on year-end equity 15.8% 15.7% + 0.6 Return on capital employed(1) 23.2% 23.8% - 2.5 YEAR-END DATA AT DECEMBER 31, 1998 1997 Change Working capital $ 55,864 $ 50,323 + 11.0% Interest-bearing long-term debt $ 19,540 $ 15,456 + 26.4 Approximate number of shareholders(2) 613 596 + 2.9 Number of employees 1,662 1,510 + 10.1 Outstanding shares (000s) 10,662 10,437 + 2.2
(1) Return on capital employed is a measurement that promotes reduced asset values relative to sales. It measures (for example) the efficacy of borrowing money to purchase capital goods to reduce manufacturing costs. The formula is: the sum of pretax 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 amount shown. 2 [PHOTO] Bjorn E. Olsson, President & Chief Executive Officer REPORT TO SHAREHOLDERS 1998 was an outstanding year. It marked the seventh consecutive year of sales and booking gains and the third consecutive year of increased net earnings. Sales rose 24% last year to $265 million, an increase of nearly $52 million over the 1997 level. These higher shipments drove net earnings up 22% to a record $13.4 million, or $1.27 per share (basic), up from $1.06 per share for 1997. Incoming orders rose even faster than sales. They increased 26% to $289 million, $61 million greater than 1997 bookings. Each market's new orders were the largest ever received in a single year. RECEIPT of incoming orders accelerated greatly during the fourth quarter of 1998. They rose to $105 million, a new record for any quarter, and nearly twice the amount we booked in the fourth quarter of 1997. As a result, we finished 1998 with a record backlog of $132 million, 77% above the 1997 year-end level. FREIGHT RAILROAD MARKET Business remained exceptionally solid with our principal customers - the North American freight railroads. Our sales to them were $221 million last year, an increase of 22%. Incoming orders increased 10% over those of 1997 to $219 million and comprised 76% of the $289 million we booked in new orders last year. The freight railroads continued their drive to improve their capacity and efficiency, which our advanced signal and control systems provide. Railroad mergers also helped our sales last year. The participants seek products and systems that will help them coordinate their expanded rail systems and improve their utilization of capacity. In addition, the railroads continued to increase the amount of work they outsource. They are finding that our asset management services component materially reduces their total cost of ownership. Last year asset management services billings comprised $35 million of our freight sales. This sales figure, however, understates the full contribution of this service organization as service project contracts typically include additional orders for some Harmon products and systems as well. Cost savings are the catalyst for our increased service revenues. This same principle now extends to single-source, multi-year supply contracts, which the freight railroads are beginning to adopt. Harmon received three last year, which will aggregate more than $70 million annually. Multi-year contracts will enable us to work in close partnership with these customers to uncover 3 other areas of important cost savings. We plan to introduce this partnering concept to other major railroads. Finally, the Transportation Equity Act for the 21st Century (TEA-21), which was signed into law last year, is expected to be of major assistance in the sale of rail/highway grade crossing systems and products. The new Act provides for a 55% increase in government funding of these projects over the next six years. A DECISIVE NEW TREND The most significant trend affecting Harmon's future became evident last year. Our non-freight orders soared. Rail transit bookings were $43 million, up 229%; international orders were $27 million, up 60%. Growth of this magnitude in a single year highlights the growth potential in these markets. The $70 million in orders derived from these two markets is very significant. That amount comprised 24% of all orders received by Harmon last year, up from 13% in 1997, almost doubling its contribution to total bookings in one year. Moreover, $70 million is nearly equal to our entire sales for 1991. In effect, during the past seven years we have entered two markets largely from the ground up and built them to a size that closely matches our total 1991 output. And we did this without compromising our service to our traditional core market, the North American freight railroad community, which tripled their business with us since 1991. VALIDATED STRATEGY The impressive sales gains on all three fronts confirm that the long-term growth strategy we began in 1993 is living up to expectations. That strategy was to develop two other markets - rail transit and international - while simultaneously continuing to expand our traditional business - the North American freight railroads. That strategy has proved highly effective. We needed to do two things simultaneously. We had to build internal capacity to have more products and services to offer our present customers, and we had to develop new customers. We did this piece by piece over a five-year period beginning in early 1994. We nearly doubled our research and development efforts and expanded our marketing and sales forces. We hired additional engineers, built new engineering offices, added new test equipment, and built new manufacturing facilities. Each aspect involved a considerable investment. Yet by tight control of expenses and insistence on meeting schedules, the cost of those investments was absorbed and more than offset by the consistent gains in revenues and earnings that followed. [CHART]
Gross Sales ($ in millions) 94 119 95 136 96 184 97 214 98 262
[CHART]
Net Earnings ($ in millions) 94 7.6 95 6.9 96 9.3 97 11.0 98 13.4
ACQUISITIONS Acquisitions of companies and products also occupy a pivotal role in our strategy. We look for companies with complementary technologies and products that add market potential so that in future years we could obtain a larger share of freight railroad and transit markets. To that end, we acquired 11 companies in the past five years as 4 well as several exciting technologies. For example, in 1997 we secured a license for the rail transportation application of a very sophisticated wireless data communication network from Raytheon, which it had built for the military. This radio is key to our revolutionary Advanced Automatic Train Control (AATC) system, which we believe is the most advanced in the world. We redesigned the military version radio last year to one using commercially available components. It is now far less costly to build, which enhances its potential for commercial use. In 1996, we acquired Vaughan Harmon Systems, Ltd. It is a premier railroad software developer in the U.K., and it is also a market leader in the manufacture of train describers, passenger information and modular control systems that control many passenger and commuter trains in the U.K. To date, this acquisition has produced substantial new business, chiefly with Railtrack, which is aggressively seeking new technology for its planned upgrades. Vaughan Harmon provides us entry into Britain and the European continent. Through them, we were able to gain major exposure of our products and systems to the British rail market last year. In December, 1998, Railtrack awarded us a $12 million contract for our micro-processor based interlocking and level control systems. This contract has great significance. Ours was the first new technology to receive initial approval from Railtrack. Permanent approval is pending. Not only did our products pass rigorous safety and operating tests, it was also confirmed that our technology is highly cost effective, which is a growing requirement in most of Europe. The demonstration and test phase is over. With Railtrack's initial adoption of our technology, other railroads will undoubtedly now take a much closer look at our technology. We made three acquisitions in 1998. The largest was SES CO. It provides complete communications, security and dispatching systems for the transportation industry. Its forte is an ability to integrate communication systems used in transportation and other commercial operations into efficient, reliable functioning systems. In essence, SES CO enables us to bring added value to our customers, which should help us become even more competitive. Acquisitions continue. On March 2, 1999, we signed a letter of intent to acquire the majority control of Angiolo Siliani S.p.A. and Siliani Elettronica ed Impianti S.p.A. of Florence, Italy (Siliani). Siliani makes equipment and systems for signaling, train control and rolling stock. It is a leader in switch point machines for both standard and high-speed lines, equipment, interlockings, and electromechanical devices for locomotives serving the Italian rail market. Taken as a whole, each acquisition added a service, product or technology that we previously had to purchase elsewhere, or opens a new market area. Collectively, we are now able to offer a more complete line of products and services to our customers. [CHART]
Backlog (in millions) 94 44.6 95 49.1 96 59.4 97 74.5 98 131.8
[CHART]
Return on Capital Employed 94 34% 95 22% 96 26% 97 24% 98 23%
[CHART]
Price Range of Stock 94 $11.00-$16.17 95 $8.92-$13.67 96 $8.00-$13.00 97 $11.00-$19.67 98 $16.83-$26.50
5 RAIL TRANSIT EXPANSION In 1993, rail transit sales were $5 million. Five years later they totaled $25 million. Even more important, new orders in 1998 amounted to $43 million. They comprised major contracts with five rail transit authorities - one new customer and four for which we did prior work. At 1998 year-end our rail transit backlog was $71 million versus $16 million at the end of 1993. This backlog is expected to increase further as we submitted the best bid on several other projects, amounting to $23 million. RAIL TRANSIT is experiencing a major renewal in the U.S. There are more projects now in planning than at any other time in this decade. Many are expected to be let for bids in 1999. Most important, government funding has increased substantially. Last year, the same tea-21 bill that provided increased funding for rail/highway grade crossings allocated even more funds for the rail transit industry. It provided for a minimum 50% (and potentially 75%) increase in funding for transit projects over the next six years. We anticipate this will be the catalyst that moves many pending projects from the drawing boards and planning stages to bids that lead to construction contracts. INTERNATIONAL GROWTH INTERNATIONALLY, we began to gain momentum in 1995 when we booked orders for $6.5 million that year. By 1998, orders had swelled to $27 million, and we were doing sizable business in Britain, Brazil, China and Australia. Being a player on the international rail scene is critical to the long-term prosperity of Harmon. This is where our greatest opportunities will be found. First, the international market is estimated to be eight times larger than the North American freight and rail transit markets combined - roughly $4 to $5 billion annually. Second, our technology is very cost effective. It delivers greater usage per rail mile and a lower cost of operation than older, traditional systems. With railroad privatization waves presently sweeping Europe, the incentive to operate rail systems more efficiently has increased markedly. Third, there are more, massive upgrade projects underway or in the planning stages in Europe, Asia and South America than anything we have ever seen before. And we now have the technology, systems and products that make our participation a distinct possibility. U.K.-based Railtrack, for example, has a $4 billion, 10-year program to invest in signal and train control products and systems. In addition, the London underground will be privatized in about a year. Estimated capital expenditures for upgrades to its signal and train control system are in excess of $11 billion. The London project is particularly interesting because communication-based train control may well be the best solution, and our AATC is the most advanced in the world. The Italian railroads recently proposed a ten-year capital expenditure plan of $44 billion - half for a high speed train system, and half to upgrade their existing systems, which makes our pending acquisition of the majority control of Siliani especially timely. Again, privatizations are the catalyst for railroad refurbishments throughout Mexico. As a result, we opened a subsidiary there last year to handle the sizable increases in business we are now experiencing in that country. Also, we signed an agreement with Japan's Nippon Signal Co. Ltd. to collaborate on the worldwide implementation of our revolutionary AATC System. We will sublicense our AATC technology to Nippon Signal for installations in Asia. Nippon Signal and Harmon will join together to build a common AATC platform that will be marketed world wide. CONCLUSION I am delighted with our 1998 performance and excited about the prospects for 1999. The economy is very strong. Our year-end record backlog of $132 million has been subsequently strengthened by the receipt of several significant contracts. Domestic mergers, which drive the sales of many products, continue at a rapid pace. Rail transit and international business offer promise of substantially increased business in 1999. /s/ Bjorn E. Olsson Bjorn E. Olsson President & Chief Executive Officer Blue Springs, MO March 9, 1999 6 [PHOTO] Burlington Northern Santa Fe Railway Co. awarded Harmon a three-year contract to provide materials integration services. These services will be interfaced with BNSF's engineering offices and construction forces in the field. Harmon will purchase materials, coordinate material movement logistics and ship to job sites on a just-in-time basis from its three warehouses in the U.S. Harmon will be the exclusive provider of its VHLC interlockings for the next three years and its Electro Code track circuit equipment through 1999. 7 - ------------------------------------------------------------------------------- SALES TO NORTH AMERICAN FREIGHT RAILROADS ROSE 22% IN 1998 - THE COMBINATION OF A STRONG ECONOMY AND THE STRENGTH OF HARMON'S PRODUCTS. [CHART]
Gross Sales - 1998 $ in millions North American Freight $220.6 (84.2%) North American Transit $25.5 (9.7%) International $15.9 (6.1%) ------------ $262.0
YEAR IN REVIEW NORTH AMERICAN FREIGHT ------- HARMON CONTINUED ITS MARKET PENETRATION OF THE SIGNAL AND CONTROL SECTOR OF THE FREIGHT RAILROAD INDUSTRY DURING 1998. THE PAST YEAR'S RECORD SALES AND NEW ORDERS REFLECT A VIBRANT ECONOMY THAT FOSTERED INCREASED CAPITAL GOODS PURCHASES BY FREIGHT CARRIERS AND HARMON'S CONTINUED DEVELOPMENT OF TECHNOLOGICALLY-ADVANCED SYSTEMS, PRODUCTS, AND SERVICES. BUSINESS from our North American freight railroad customers was excellent in 1998. Sales gained 22% to $221 million from $180 million in 1997. New orders booked in 1998 rose some $20 million to $219 million from $199 million in 1997. The overall strength of the economy last year aided our sales to freight carriers. Many enjoyed record car loadings. This general prosperity enabled them to press forward with their sizable capital investment programs, many of which are dedicated to increasing operating efficiency, particularly among merged railroads as they seek to optimize capacity on their combined rail systems. We continued to benefit from their programs as so many of our systems, products and services help provide major increases in efficiency and capacity. Included among product sales was a two-year agreement for Ultra Cab II equipment for installation on the latest models of ac traction locomotives. Several other railroads have sections of line equipped for cab signal operation, which requires compatible equipment on their locomotives. Sales of rail/highway grade crossing equipment and systems declined 4.6% last year to $53.0 million. Sales of these products, which include our hxp-3 detection and control equipment, should increase in 1999 largely because of the 1998 enactment of the Transportation Equity Act for the 21st Century (TEA-21). The new bill increased the level of federal funding over the next five years by 55% for warning systems at rail/highway grade crossings. Thus, the opportunity for increased sales from these markets is substantial. Our business in Mexico continues to grow. As a consequence, we created a Mexican subsidiary, Industrias Harmon de Mexico, S.A. de C.V. to increase our share of the expanding Mexican rail market. Based in Monterrey, this Harmon subsidiary will handle sales and support of our growing Mexican customer base. 8 [PHOTO] 1. Upon completion of a $58 million two-year project for CSX Corporation last year, Harmon received a five-year contract to supply its VHLC racks as part of CSX's program to eliminate its pole lines, replacing them with Harmon coded track equipment and a radio-based supervisory control system. [PHOTO] 2. Conrail is scheduled to be merged into two other railroads this June, which should spur additional sales of Harmon's efficiency- and capacity-enhancing signal and control systems. [PHOTO] 3. Harmon's asset management services group increased its revenues from $10.2 million in 1993 to $34.9 million in 1998 principally by expanding its services from chiefly an alternate customer warehousing operation in 1993 to total project management by 1998. 9 - ------------------------------------------------------------------------------- OVERALL BOOKINGS IN 1998 RAN 26.5% AHEAD OF 1997 AT $289 MILLION VERSUS $229 MILLION, RAISING THE CORPORATE YEAR-END BACKLOG 77% TO $132 MILLION. [CHART]
ORDER BOOKINGS - 1998 $ IN MILLIONS North American Freight $219.3 (75.8%) North American Transit $42.5 (14.7%) International $27.4 (9.5%) ------ $289.2
Our timing was excellent. Last July we booked an $8 million order from Mexico's TFM railroad to install a centralized traffic control system for freight rail traffic between Monterrey and Nuevo Laredo, Mexico. The project will use many Harmon products, including its VHLC and Electro Code track circuits. Of the $221 million in sales to North American freight carriers last year, service revenues comprised $34.9 million, up 17% from the previous year. A major factor driving our growth within the freight sector is the growing acceptance of our service concept, which has expanded greatly since inception in 1991 as an alternate warehouse facility. In addition to warehousing, we now provide inventory control, materials management, subassemblies, equipment maintenance, delivery of containerized, pre-assembled components, on-site construction and project management. Customers are discovering that these services materially lower their total costs of ownership, thereby reducing their overall costs - a major goal of every railroad. SHORTLY after the close of 1998, we signed a three-year contract with the Burlington Northern Santa Fe Railway Co. to provide materials integration services. These services will include interfacing with that railroad's engineering offices and construction forces in the field. Harmon will purchase materials, coordinate material movement logistics and ship to job sites on a just-in-time basis from its three warehouses in the U.S. Harmon will be the exclusive provider of its VHLC interlockings for the next three years and its Electro Code track circuit equipment throughout 1999. Further, superior on-time and on-budget performance brought us even more business. Upon completion of a $58 million turnkey project last year to expand CSX Transportation, Inc.'s capacity in the Midwest, the largest and most extensive project ever undertaken by Harmon, we were awarded a five-year contract from that same railroad to supply our VHLC racks as part of that railroad's program to eliminate its pole lines, substituting our coded track equipment and a radio-based supervisory control system in their place. RAILROADS are now seeking single-source, multi-year contracts as a way to reduce costs. Three of these contracts we signed last year should yield more than $70 million in annual sales over the next several years. We expect to build on our multi-year service contracts by providing similar services to other railroads -in effect, providing a cost-effective labor and materials management source we believe will become commonplace in the years ahead. 10 [PHOTO] 1. We are presently in the development phase of a contract to provide our Advanced Automatic Train Control system for BART, the transit authority serving the San Francisco Bay Area. If successful, the value of the implementation phase will be around $45 million. [PHOTO] 2. Rail transit is a major source of passenger transportation in New Jersey. Last year we completed a $17.6 million contract for the New Jersey Transit Authority and were the low bidder on an $11.6 million contract for the Newark City Subway. [PHOTO] 3. The Denver Light Rail System awarded us a $3.5 million contract last year to furnish and install a signal system on its line extension to Littleton, co. [PHOTO] 4. Our subsidiary, SES CO, presently is working on a $6.5 million subcontract with the Dallas dart light rail system. 11 - ------------------------------------------------------------------------------- HARMON'S NORTH AMERICAN RAIL TRANSIT BUSINESS LAST YEAR WAS ITS BEST TO DATE - $25.5 MILLION IN BILLINGS AND $42.5 MILLION IN NEW CONTRACTS. YEAR IN REVIEW NORTH AMERICAN RAIL TRANSIT ------------ NORTH American rail transit revenues increased 70% to $25.5 million in 1998. Incoming orders rose 229% to $42.5 million from $12.9 million booked in 1997. In 1999, the industry is contemplating more new projects and upgrades to existing properties than at any other time in the previous ten years. These new projects encompass signaling, communications and train control requirements with an estimated value of over $200 million. These new projects are particularly timely as the TEA-21 federal appropriations bill authorized a funding increase for transit projects that is 50% to 75% greater than the previous funding bill, which expired last year. During 1998, our billings were primarily from contracts awarded in 1996-1998. They included signal and train control installations for the New Jersey Transit Authority, grade crossings, interlockings and block signals for the Utah Transit Authority, which is expanding its line for the upcoming Winter Olympic Games, and the first phase of a major project with the Bay Area Rapid Transit District (BART) in San Francisco. The BART project involves implementation of a revolutionary, highly cost-effective, advanced automatic train control system (AATC). AATC is based on an extremely reliable and completely wireless data radio network, which was originally developed for the U.S. military by the former Hughes Aircraft Corporation (now Raytheon). The radio can accurately determine the position of trains without using conventional track circuitry. When completed in 2001, AATC will enable BART to substantially increase system capacity by reducing headways between trains to less than 90 seconds. It will also help eliminate the potential need for another tunnel under San Francisco Bay. Sales of communication products and systems soared to $6.6 million in 1998 from $655,000 in 1997. The gain was due primarily to our acquisition of SES CO last year. Its ability to link a variety of communication devices into reliable functioning systems obtained several contracts for us in 1998. The SES CO acquisition greatly expands our range of communication products for transit applications. WE received a $13.6 million contract for a signal and control system for a 17.5-mile extension of the St. Louis Metrolink. We also received a separate contract to supply our carborne equipment for new vehicles needed for this project. SES CO, which we acquired last year, received a $4.7 million award from SEPTA for audio/visual PA systems and passenger information improvements. We were awarded a $4.2 million contract to furnish and install grade crossing warnings systems on a new commuter rail line that will restore passenger service between Charlotte and Burlington, VT. Denver's Light Rail system awarded us a $3.5 million contract to furnish and install a signal system on its line extension to Littleton, CO. IN addition, Harmon and SES CO were the apparent low bidders on two projects with the Newark City Subway (NCS). We bid $11.6 million to install our Automatic Train Control (ATC) system over a 4.2-mile, 11-station NCS network. The ATC system is comprised of our VHLC vital processor interlockings, electronic audio frequency track circuits and highway crossing warnings systems. Our subsidiary, SES CO, will provide a fiber optic communications network for this project. Also, SES CO submitted the lowest bid of $6.9 million to install multi-disciplined communications and controls for the St. Louis Metrolink extension. Harmon's share of the rail transit business continues to expand - in part because of its advanced technology but also because its reputation for superior performance continues to grow. 12 [PHOTO] 1. Brazilian mining railroad CVRD last year awarded us a $2.5 million order in U.S. funds to replace the on-board portion of its automatic train control system with our Ultra Cab II. [PHOTO] 2. Last July we booked an $8 million order from Mexico's TFM railroad to install a centralized traffic control system for freight rail traffic between Monterrey and Nuevo Laredo, Mexico. [MAP] 3. Major upgrades to rail systems in Mexico are occurring following privatization of railroads in that country. 13 - ------------------------------------------------------------------------------- Harmon's international business gained momentum last year as important contracts were secured in England and Brazil. YEAR IN REVIEW INTERNATIONAL ------------- OUR INTERNATIONAL business showed a marked improvement last year. Although revenues were down 9% on the year at $15.9 million, incoming orders more than made up for that shortfall, which was more a matter of contract delays than an actual downturn in business. New orders rose 60% last year to a record $27.4 million, a gain of more than $10 million. We completed the first phase of a multi-million dollar signal and train control project in England with Railtrack last December. Our subsidiary, Vaughan Harmon, was then awarded a $12.5 million contract to replace the signal system on the Cromer Branch Line in Norfolk, England. This is the breakthrough we have long awaited. It introduces our microprocessor-based interlocking and level crossing control systems into Europe for the first time. Vaughan Harmon also received a second award from Railtrack last year to replace its train describer at Clapham Junction, which controls all train movements from London's Victoria Station for trains bound for Brighton and the southeast coast, including part of the route used by Eurostar trains to Belgium and France. This is the largest train describer yet installed for Railtrack by Vaughan Harmon. Coupled with earlier installations at London Bridge and Dartford by this subsidiary, our systems now form the heart of London's railway control. Vaughan Harmon was also awarded a contract to supply a modular signaling control system for Irish Rail. The new system is part of a mini-centralized traffic control project to resignal a number of important branch lines throughout Ireland. It will run alongside the current system, which presently controls Dublin suburban traffic. Upon completion, all suburban lines will be able to be controlled by a single signalman. In Brazil we received a contract last October for $2.5 million (in U.S. funds) to replace the on-board portion of Cia Vale Do Rio Doce's (CVRD) automatic train control system with our Ultra Cab II. Our system will enable CVRD to add a communications-based operation system at a later date, thereby expanding its usefulness when its needs dictate. We also see greater opportunities developing in Australia and Asia. It was for this reason that we purchased the assets of our former sales affiliate and created our own sales and service subsidiary, Harmon Industries Australia, Pty. Ltd. in Bayswater, Australia. Having a Harmon-owned and operated company in Australia enables us to provide a higher level of sales support and service than previously. It also gives a broader base from which to deepen and expand our business in that part of the world. 14 [PHOTO] 1. Final inspection of Harmon's Hot Box Detector system at Riverside. [PHOTO] 2. Harmon's new Electro Code V provides many new features including easier setup procedures. [PHOTO] 3. Hot Box Detector systems are subjected to complete system set up and calibration before shipment to customer sites. 15 - ------------------------------------------------------------------------------- HARMON INVESTED $32 MILLION IN THE PAST FIVE YEARS TO DEVELOP NEW PRODUCTS AND SYSTEMS. THEY ACCOUNTED FOR A SUBSTANTIAL PORTION OF THE NEW ORDERS BOOKED LAST YEAR, WHICH ILLUSTRATES THE IMPORTANCE OF DEVELOPING NEW PRODUCTS AND THE RETURNS R&D DOLLARS PROVIDE. YEAR IN REVIEW RESEARCH & DEVELOPMENT [CHART]
R&D EXPENDITURES $ IN MILLIONS 96 $6.33 97 $7.66 98 $8.45
In 1998, the development of new products and systems continued to be a primary focus of Harmon's R&D efforts. Several new products completed development and there was considerable effort expended to increase Harmon's systems development capability. Work was substantially completed on our new Electro Code V track circuit product, which offers many performance advantages over our predecessor Electro Code IV model. Surface mount technology was used in this upgrade which provides reduced installation and maintenance costs for the user. Earlier Electro Code versions required two technicians for field installation while the Electro Code V requires only a single technician. Sales of Electro Code V will begin in early 1999. We also made substantial progress in our next generation hot box detector system. This next generation system was also designed using surface mount technology which enabled Harmon to significantly increase the reliability of the system while at the same time reducing the cost of ownership for the user. Sales of these next generation hot box detector systems will also begin in 1999. As part of our efforts to expand into the international market, Harmon began a series of upgrades of its standard products to make them suitable for use in that market. Among these was an upgrade to the Vital Harmon Logic Controller (VHLC) to enable it to control railroad signal lamps with higher voltage AC power as well as traditional low volt DC. This upgrade will be implemented in the Cromer project in the United Kingdom in 1999 and should have application in many other countries as well. We also obtained CE Mark certification for our VHLC and HXP-3. This is a European Community product certification roughly comparable to a UL designation in the U.S. and is expected to materially increase the acceptance of our products throughout Europe. As Harmon has engaged in larger systems projects like the BART project, we have seen the need to improve the processes we use to develop our products and systems. In 1998 we began a multi-year effort to improve our hardware, software and systems development processes. Our software process is being modified to meet the stringent demands of the industry recognized Software Capability Maturity Model developed by the Software Engineering Institute. We believe these changes will substantially decrease the cost and time needed to develop the software used in Harmon products and systems. Similar efforts are underway in the hardware and systems areas and will continue in 1999. Investments for research and development are budgeted at $12.0 million for 1999 versus $8.5 million expended in 1998 and $7.7 million in 1997. With these investments, Harmon will be in an even better position to meet the needs of its existing customers and to gain new ones. 16 [PHOTO] The traffic control center at the Dallas Area Rapid Transit (DART) system. The lighted display, which shows the operation of all dart trains, was designed by SES CO, which Harmon acquired in 1998. 17 - ------------------------------------------------------------------------------- HARMON MADE THREE ACQUISITIONS LAST YEAR. ALL WERE COMPLEMENTARY TO ITS PRINCIPAL BUSINESS, EXPANDING ITS CAPABILITIES AND INCREASING ITS COMPETITIVE POSITION. YEAR IN REVIEW ACQUISITIONS ------------ HARMON acquired three companies last year. In January, 1998, we purchased CSS, Inc. of Delphi, Indiana. CSS operates in a seven-state area throughout the Midwest and Florida. CSS installs and maintains products and equipment used by railroads, primarily at grade crossings on short-line and regional railroads. This acquisition adds equipment maintenance as well as additional installation capabilities to Harmon's railroad service operation. Last October we finalized the purchase of SES CO., inc. and a related company, which are headquartered in Hingham, Massachusetts. SES CO is a leader in railroad communications, particularly in rail transit applications. It integrates communication, detection and monitoring equipment of many manufacturers into functional systems. Its capabilities extend to fiber optic networks, tunnel and above-ground radio systems, vehicle radio systems, passenger emergency telephone systems, audio/visual passenger information systems, fire alarm systems, closed circuit tv, local area networks and Supervisory Control and Data Acquisition (SCADA) systems. SES CO provides Harmon with a broader range of systems design, manufacturing and construction capabilities, which will increase Harmon's competitive position whenever contracts are put up for bid. When SES CO was acquired it brought with it several important rail transit contracts. Subsequent to its acquisition, SES CO has been the successful bidder on contracts totalling nearly $18 million in Dallas, St. Louis and Philadelphia. We also established a wholly-owned sales and service subsidiary last year in Bayswater, Australia, by purchasing the assets of a former affiliate. Harmon Industries Australia, Pty. Ltd. strengthens our position in Australia and increases our ability to expand our business in that part of the world. Our March 2, 1999, letter of intent to acquire the majority control of Angiolo Siliani S.p.A. and Siliani Elettronica ed Impianti S.p.A. of Florence, Italy (Siliani) is expected to be of substantial assistance in acquiring European business. Siliani makes equipment and systems for signaling, train control and rolling stock. It is a leader in switch point machines for both standard and high-speed lines, equipment, interlockings, and electromechanical devices for locomotives serving the Italian rail market. The pending Siliani acquisition may also prove very timely as the Italian railroads recently proposed a ten-year capital expenditure plan of $44 billion -half for a high speed train system, and half to upgrade their existing systems. Harmon is presently evaluating several additional acquisition opportunities. Each would expand and complement our core business. 18 19 SELECTED CONSOLIDATED FINANCIAL DATA (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31 1998 1997 1996 1995 1994 1993 1992 - -------------------------------------------------------------------------------------------------------------------------------- OPERATIONS NET SALES $265,219 $213,530 $175,440 $136,780 $119,703 $99,295 $81,899 COST OF SALES 200,478 156,224 126,997 96,094 81,023 65,716 54,271 RESEARCH AND DEVELOPMENT EXPENDITURES 8,454 7,664 6,331 5,218 4,561 3,442 3,541 ------------------------------------------------------------------------ GROSS PROFIT 56,287 49,642 42,112 35,468 34,119 30,137 24,087 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 33,415 30,298 25,990 23,200 21,176 18,558 15,646 OTHER OPERATING EXPENSES (INCOME) 664 964 544 481 44 114 137 ------------------------------------------------------------------------ OPERATING INCOME 22,208 18,380 15,578 11,787 12,899 11,465 8,304 OTHER EXPENSES 1,159 797 473 607 214 388 1,228 ------------------------------------------------------------------------ PRE-TAX EARNINGS (CONTINUING OPERATIONS) 21,049 17,583 15,105 11,180 12,685 11,077 7,076 INCOME TAXES 7,647 6,622 5,775 4,294 5,046 4,193 2,498 ------------------------------------------------------------------------ EARNINGS FROM CONTINUING OPERATIONS 13,402 10,961 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) $ 13,402 $ 10,961 $ 9,330 $ 6,886 $ 7,639 $ 6,884 $ 5,016 ------------------------------------------------------------------------ ------------------------------------------------------------------------ EFFECTIVE TAX RATE - CONTINUING OPERATIONS 36.3% 37.7% 38.2% 38.4% 39.8% 37.9% 35.3% RETURN ON SALES - CONTINUING OPERATIONS 5.1% 5.1% 5.3% 5.0% 6.4% 6.9% 5.6% RETURN ON EQUITY - CONTINUING OPERATIONS 15.8% 15.7% 16.1% 14.0% 17.7% 20.8% 30.1% RETURN ON EQUITY - TOTAL 15.8% 15.7% 16.1% 14.0% 17.7% 20.8% 33.0% WEIGHTED AVERAGE SHARES (000S) - BASIC* 10,541 10,313 10,217 10,187 9,649 8,948 7,672 PER SHARE DATA* EARNINGS FROM CONTINUING OPERATIONS - BASIC $ 1.27 $ 1.06 $ .91 $ .68 $ .79 $ .77 $ .60 NET EARNINGS (LOSS) - BASIC 1.27 1.06 .91 .68 .79 .77 .65 CASH DIVIDENDS .11 .10 .10 .10 .10 -- -- BOOK VALUE 7.97 6.68 5.66 4.82 4.27 3.49 1.88 PRICE/EARNINGS RATIO RANGE - BASIC 13.2-20.8 10.3-18.5 8.8-14.2 13.2-20.2 13.9-20.4 10.1-20.1 3.4-13.0 2 OTHER DATA AT YEAR-END WORKING CAPITAL $ 55,864 $ 50,323 $ 33,629 $ 35,014 $ 21,670 $20,790 $10,740 TOTAL ASSETS 162,853 135,769 104,677 86,845 68,395 53,000 38,488 LONG-TERM DEBT 19,540 15,456 3,412 12,090 733 439 4,898 STOCKHOLDERS' EQUITY 84,958 69,762 57,939 49,232 43,063 33,086 15,197 CURRENT RATIO 2.05:1 2.09:1 1.85:1 2.60:1 2.03:1 2.28:1 1.72:1 QUICK ASSETS RATIO 1.01:1 1.12:1 1.01:1 1.16:1 1.03:1 1.32:1 .87:1 LIABILITIES TO EQUITY RATIO .92:1 .95:1 .81:1 .76:1 .59:1 .60:1 1.53:1 CAPITAL ADDITIONS (CONTINUING OPERATIONS) 8,271 10,475 6,371 5,532 3,242 3,189 2,154 CAPITAL ADDITIONS (TOTAL) 8,271 10,475 6,371 5,532 3,242 3,189 2,154 DEPRECIATION & AMORTIZATION (CONTINUING OPERATIONS) 7,186 5,639 5,004 3,906 2,621 2,121 1,936 DEPRECIATION & AMORTIZATION (TOTAL) 7,186 5,639 5,004 3,906 2,621 2,121 1,936 OUTSTANDING SHARES (000S)* 10,662 10,437 10,244 10,208 10,092 9,493 8,075 FIVE-YEAR TEN-YEAR COMPOUND COMPOUND YEARS ENDED DECEMBER 31 1991 1990 1989 1988 GROWTH GROWTH - -------------------------------------------------------------------------------------------------------------------- OPERATIONS NET SALES $ 70,934 $ 72,707 $ 70,154 $ 64,558 +22% +15% COST OF SALES 45,536 47,478 46,377 42,044 RESEARCH AND DEVELOPMENT EXPENDITURES 4,000 3,414 3,200 3,669 -------------------------------------------- GROSS PROFIT 21,398 21,815 20,577 18,845 +13% +12% SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 13,550 14,427 13,186 11,965 OTHER OPERATING EXPENSES (INCOME) 1,122 762 (263) (27) -------------------------------------------- OPERATING INCOME 6,726 6,626 7,654 6,907 +14% +12% OTHER EXPENSES 2,118 1,504 1,244 1,301 -------------------------------------------- PRE-TAX EARNINGS (CONTINUING OPERATIONS) 4,608 5,122 6,410 5,606 +14% +14% INCOME TAXES 1,688 2,022 2,506 2,100 -------------------------------------------- EARNINGS FROM CONTINUING OPERATIONS 2,920 3,100 3,904 3,506 +14% +14% GAIN (LOSS) FROM DISCONTINUED OPERATIONS (2,492) (12,306) (2,744) (1,020) USE OF NET OPERATING LOSS CARRYFORWARD 395 -- -- -- -------------------------------------------- NET EARNINGS (LOSS) $ 823 $ (9,206) $ 1,160 $ 2,486 +14% +18% -------------------------------------------- -------------------------------------------- EFFECTIVE TAX RATE - CONTINUING OPERATIONS 36.6% 39.5% 39.1% 37.5% RETURN ON SALES - CONTINUING OPERATIONS 4.1% 4.3% 5.6% 5.4% RETURN ON EQUITY - CONTINUING OPERATIONS 39.6% 53.9% 26.5% 25.9% RETURN ON EQUITY - TOTAL 11.2% (160.2%) 7.9% 18.3% WEIGHTED AVERAGE SHARES (000S) - BASIC* 7,490 7,084 6,948 6,720 PER SHARE DATA* EARNINGS FROM CONTINUING OPERATIONS - BASIC $ .39 $ .44 $ .56 $ .52 +11% + 9% NET EARNINGS (LOSS) - BASIC .11 (1.30) .17 .37 +11% +13% CASH DIVIDENDS -- .042 .083 .083 BOOK VALUE .98 .80 2.13 2.02 +18% +15% PRICE/EARNINGS RATIO RANGE - BASIC 1.2-44.0 N/A 23.0-34.9 9.5-14.6 OTHER DATA AT YEAR-END WORKING CAPITAL $ 9,660 $ 7,955 $ 14,444 $ 7,037 +22% +23% TOTAL ASSETS 36,575 41,408 48,082 42,948 +25% +14% LONG-TERM DEBT 11,915 17,220 17,688 12,139 STOCKHOLDERS' EQUITY 7,377 5,747 14,756 13,557 +21% +20% CURRENT RATIO 1.71:1 1.49:1 2.08:1 1.45:1 QUICK ASSETS RATIO .76:1 .66:1 .84:1 .60:1 LIABILITIES TO EQUITY RATIO 3.96:1 6.21:1 2.26:1 2.17:1 CAPITAL ADDITIONS (CONTINUING OPERATIONS) 1,098 2,187 2,236 1,830 CAPITAL ADDITIONS (TOTAL) 1,098 4,521 4,589 9,886 DEPRECIATION & AMORTIZATION (CONTINUING OPERATIONS) 2,022 2,410 2,373 2,541 DEPRECIATION & AMORTIZATION (TOTAL) 2,022 3,511 3,185 2,834 OUTSTANDING SHARES (000S)* 7,497 7,185 6,942 6,717
* Adjusted for three-for-two stock split in February 1998. 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- OVERVIEW During the past five years, Harmon's sales have increased at an average compound rate of 22% per year. The North American freight railroads are its largest market, accounting for 84% of Harmon's sales in 1998. Business with North American freight railroads has been excellent in recent years. This is due principally to their increased demand for advanced signal and control systems that maximize the capacity and efficiency of their rail systems, a major consideration due to various rail mergers and railroad privatizations in recent years. In addition, demand for Harmon's purchasing, materials management, and project management services continues to grow rapidly. These services fill an increasing need in the railroad industry as it continues to outsource functions it previously performed internally. International business (chiefly, Britain, the European continent, South America, Asia and Australia) has grown materially in recent years. Finally, the new construction portion of the North American rail transit market, which Harmon entered in 1991, is entering a major growth cycle. Contract awards for Harmon and its subsidiaries amounted to $43 million in 1998 compared to $5 million in 1991. Growth has been aided also by acquisitions of businesses and/or product lines that fit Harmon's core business. In 1998, Harmon acquired the following companies: CSS, Inc. of Delphi, IN, and SES CO, Inc. and its sister company, Seaboard Systems, Inc., of Hingham, MA. CSS installs and maintains products and equipment used by railroads, primarily at grade crossings. This acquisition adds equipment maintenance as well as additional installation capabilities to Harmon's railroad service operation. SES CO is a world-wide leader in railroad communications, particularly in rail transit applications. It integrates communication, detection and monitoring equipment of many manufacturers into functional systems. At year-end 1998, SES CO had a $43.5 million backlog. Also in 1998, Harmon acquired the assets of its long-time Australian affiliate, turning it into a wholly-owned subsidiary in that country. Harmon also created a new subsidiary operation in Mexico to capture expanding business opportunities in that country. In 1997, Harmon acquired Devtronics, Inc., which makes recorders and remote maintenance monitoring equipment that offer substantial savings to railroads. In 1996 Harmon acquired United Kingdom-based Vaughan Systems Ltd. (since renamed Vaughan Harmon Enterprises Ltd.). It was a strategic acquisition to increase Harmon's sales in Europe. It designs signal and control software and is a leading manufacturer of train describers, passenger information and modular railway control systems, which complement Harmon's existing product line. In 1997, Harmon acquired a remaining majority interest in Vale Harmon Enterprises, Ltd. In 1996, Harmon acquired two railroad contract-engineering firms, which provided a significant gain in engineering resources. - ------------------------------------------------------------------------------- PROFILE OF CURRENT OPERATIONS The Company's sales are summarized by product category in the table on page 21. The table 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 Products and 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 Products and 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. A system to remotely monitor rail/highway crossing systems is under development. Asset Management Services is a single-source, rapid delivery/and or installation of railroad components. It involves warehousing commonly-used parts and equipment that are manufactured by the Company and by other vendors. Service functions continue to expand. They now include asset and materials management and kitting of various components, which are delivered as a complete unit, ready for installation. Total project management was added in 1996 and has since grown rapidly. 21 Train Inspection Products and 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. Communications Products and Systems include products and systems used to provide voice and data communications for rail systems. These include conventional and fiber optic networks, tunnel and above ground radio systems, passenger emergency telephone systems, audio/visual passenger information systems, fire alarm systems, closed circuit tv, local area networks and Supervisory Control and Data Acquisition (SCADA) systems. Printed Wiring Boards include production of customer-designed printed wiring boards for shipment to other electronics manufacturers. Other sales include products that do not fit readily into the other six categories. SALES BY PRODUCT OR SERVICE FUNCTION*
YEARS ENDED DECEMBER 31, 1998 1997 1996 --------------------------------------------------------- (DOLLARS IN THOUSANDS) AMOUNT % AMOUNT % AMOUNT % ------------------------------------------------------------------------------------------------- TRAIN CONTROL PRODUCTS & SYSTEMS $ 132,348 50.5% $101,624 47.4% $ 87,080 47.4% CROSSING PRODUCTS & SYSTEMS 53,035 20.2% 55,598 25.9% 48,927 26.6% ASSET MANAGEMENT SERVICES 34,928 13.3% 29,913 14.0% 22,217 12.1% TRAIN INSPECTION PRODUCTS & SYSTEMS 16,312 6.2% 13,407 6.3% 12,906 7.0% COMMUNICATIONS PRODUCTS & SYSTEMS 6,606 2.5% 655 0.3% 1,891 1.0% PRINTED WIRING BOARDS 5,220 2.0% 5,772 2.7% 5,249 2.9% OTHER 13,547 5.2% 7,458 3.5% 5,598 3.0% ------------------------------------------------------------------------------------------------- TOTAL $ 261,996 100.0% $214,427 100.0% $ 183,868 100.0% ------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------
* 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, 1998, 1997 AND 1996. Harmon achieved record sales and earnings in 1998. Net sales increased 24% to $265.2 million compared with $213.5 million in 1997 and $175.4 million for 1996. Net earnings for 1998 set records for the third consecutive year, increasing 22.3% to $13.4 million ($1.25 per share-diluted) compared with $11.0 million ($1.06 per share-diluted) for 1997, and $9.3 million for 1996 ($0.91 per share-diluted). The increase in earnings from 1996 to 1998 was due chiefly to substantially higher sales levels each year. Return on equity was 15.8% for 1998 compared with 15.7% for 1997 and 16.1% for 1996. Return on capital employed was 23.2% in 1998 compared with 23.8% in 1997 and 25.9% in 1996. SALES ANALYSIS. Harmon's continuing strengths in signal and train control products and systems, train inspection products and systems, asset management services and new acquisitions offering communication products and systems were the principal reasons its 1998 sales reached a record $265.2 million. Thus, 1998 sales were $51.7 million above those of 1997 and $89.8 million higher those of 1996. Throughout 1998, the railroad industry continued its move 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 larger suppliers that have broad-based product lines, meaningful research and engineering support, and strong service capabilities. In addition, in 1998, several railroads began to enter into long-term supplier contracts to obtain price concessions for their larger and longer-term orders. These trends benefited Harmon in 1998. 22 Sales of train control systems and products increased $30.7 million to $132.3 million; sales of asset management services were up $5.0 million to $34.9 million; sales of train inspection systems and products rose $2.9 million, communication products and system sales gained $6 million, and sales of other miscellaneous products rose $6.1 million to $13.5 million. Lower sales were posted by crossing products and systems, which were off 4.6% at $53 million, and printed wiring boards, which slipped 9.6% to $5.2 million. The increase in train control systems and products sales is chiefly the result of increased orders from recently-merged railroads and continued strong sales of Harmon's Ultra Cab units. The sales gain in asset management services reflects an increased continuation toward outsourcing among domestic freight railroads and an expansion in Harmon's material management contracts. The gain in communication products and system sales is due primarily to the 1998 acquisition of SES CO. The increase in train inspection sales is due chiefly to the 1997 Devtronics acquisition and increased business in Mexico. The decrease in crossing system sales primarily reflects timing differences in shipments between 1998 and 1997, and the decrease in printed wiring board sales reflects reduced demand industry-wide. Orders booked in 1998 were a record $289.2 million, a 26.5% gain over the $228.6 million booked 1997 and 54.2% better than the $187.5 million booked in 1996. Freight orders were $219 million; rail transit, $43 million; and international, $27 million. At 1998 year-end, Harmon's backlog was a record $132 million, of which approximately $95 million is expected to ship in 1999. Approximately 30% ($39 million) of the backlog was North American freight related; 16% ($22 million) related to international business (chiefly Great Britain and Brazil), and 54% ($71 million) related to North American rail transit. The backlog soared late in the year as Harmon added $30.5 million in rail transit orders and $20.1 million in international business during the fourth quarter of 1998. The table below 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.
OPERATING SUMMARY PERCENTAGE OF NET SALES PERCENTAGE OF CHANGE ----------------------------------------------------------- YEARS ENDED DECEMBER 31, 1998 1997 1996 OVER OVER OVER 1998 1997 1996 1997 1996 1995 ------------------------------------------------------------------------------------------------ NET SALES 100.0% 100.0% 100.0% 24.2% 21.7% 28.3% COST OF SALES 75.6% 73.2% 72.4% 28.3% 23.0% 32.2% RESEARCH AND DEVELOPMENT 3.2% 3.6% 3.6% 10.3% 21.1% 21.3% GROSS PROFIT 21.2% 23.2% 24.0% 13.4% 17.9% 18.7% SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 12.6% 14.2% 14.8% 10.3% 16.6% 12.0% OTHER, NET 0.3% 0.4% 0.3% (31.1)% 77.2% 13.1% OPERATING INCOME 8.3% 8.6% 8.9% 20.8% 18.0% 32.2% OTHER EXPENSES 0.4% 0.4% 0.3% 45.4% 68.5% (22.1)% EARNINGS BEFORE INCOME TAXES 7.9% 8.2% 8.6% 19.7% 16.4% 35.1% INCOME TAXES 2.9% 3.1% 3.3% 15.5% 14.7% 34.5% NET EARNINGS 5.0% 5.1% 5.3% 22.3% 17.5% 35.5%
The market for the majority of the Company's products is largely dependent on the financial condition of the railroad industry, the trend of the general economy, individual railroads' budgets for capital expenditures and repairs and maintenance, and the Company's reputation for reliable and cost-effective products. At year-end 1998, the freight railroad industry was enjoying good market conditions. It is estimated that 1999 capital expenditure budgets will be at or above 1998 levels. The industry continues 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 also remained merger minded, which historically has reduced capital spending while mergers were pending and increased spending after they were completed. 23 The market for the Company's signal and control systems is influenced by all of the factors listed above plus one other element-the level of activity by the railroads in authorizing grade crossing warning system improvements. These latter improvements receive up to 80% federal support. The Transportation Equity Act for the 21st Century (tea-21) was passed in 1998. It increased funding to $217 billion over the next six years, which resulted in a 55% increase for rail/highway grade crossing installations and at least a 50% increase for transit projects. These increases are an extremely positive development for the sale of our products and systems. GROSS PROFIT. Gross profit as a percent of sales declined to 21.2% for 1998 as compared with 23.2% for 1997 and 24.0% for 1996 . The declines in 1998 and 1997 reflect a continuing shift away from individual product sales to those of entire systems and outsourced services, both of which deliver substantially higher sales but with reduced profit margins. For example, the $58 million upgrade project for a Class I railroad, which commenced in 1997 and was completed in 1998, added substantially to the sale of Harmon products and systems in 1997 and 1998, but the upgrade project also contained sizable amounts of "pass-through" business that provide only modest profit margins. In addition, profit margins were under additional pressure during the past two years because of Harmon capacity expansions in 1997. Traditionally, declining profit margins have negative con-notations. Harmon's experience is otherwise. Management's primary 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 philosophy. Standing alone, it is a low margin, narrowly profitable business. But when linked to Harmon's total business strategy, it makes a healthy profit contribution because its function begets additional sales of Harmon products and systems, and it performs a service few others in the railroad industry can match. Moreover, the Company is confident its service business will increase as the railroads continue to out-source their asset management, maintenance and line upgrade projects. RESEARCH AND DEVELOPMENT. Research and development expenditures increased $790,000 in 1998 and $1.3 million in 1997, which illustrates Harmon's ongoing commitment to incorporating new technology into its products. The increase in 1998 relates to product development on Harmon's Electro Code 5, advanced train control systems, new technology for communication systems, and carborne products. During the 1998 fourth quarter, R&D expenses decreased as some engineering costs were charged directly to customer orders. In 1997, the increase was related to continued development of our Incremental Train Control System (ITCS), development of next-generation products, and costs related to demonstrating our Advanced Automatic Train Control (AATC) system to several prospective buyers. Although R&D expenditures were up in absolute dollar terms in 1998 and 1997, as a percent of sales they declined because of the sales increase in 1998. SELLING, GENERAL & ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses (SG&A) for 1998 were $33.4 million as compared with $30.3 million in 1997, an increase of 10.3% on a sales gain of 24% from 1997 to 1998, which naturally generated more sales expense and increased profit-based incentive compensation. While SG&A expenses increased in absolute dollar terms last year, their costs relative to net sales declined for the fifth consecutive year-to 12.6% of sales from 14.2% in 1997 and 14.8% in 1996. This down-ward trend as a percentage of net sales reflects improvements in cost controls and the fixed nature of certain costs. The absolute increase in dollars each year is the result of inflation, higher overall personnel-related expenses, commissions on higher sales volume, converting and upgrading Harmon's operating systems, and added SG&A expenses for acquisitions made in the past several years. In 1997, the company also incurred an additional $1.5 million in certain other SG&A expenses, chiefly, costs related to employee recruiting as well as legal and outside computer consulting services. AMORTIZATION EXPENSES. Amortization expenses increased 48.1 % from 1997 to 1998 and 18.7% from 1996 to 1997. The increases are the result of acquisitions made during 1998 and 1997. MISCELLANEOUS INCOME - Net. Miscellaneous income advanced $303,000 over that of 1997. The difference resulted from increases in purchase discounts, gains on disposal of certain assets, and a variety of other transactions, which collectively accounted for the positive gains in 1998 compared with 1997. Changes between 1997 and 1996 were insignificant. 24 INTEREST INCOME AND EXPENSE. Interest expense was $1,555,000 in 1998, $1,219,000 in 1997 and $724,000 in 1996. The increase in 1998 over 1997 reflected higher average borrowings to finance increased working capital and acquisitions and a full year of interest on senior notes in 1998 versus a partial year in 1997. The increase in 1997 over 1996 was the result of interest on a January, 1997 private placement of $15 million in senior unsecured notes. Investment income was greater in 1997 than in 1998 or 1996 because the proceeds from the $15 million private placement were invested during the first half of 1997. Subsequently, those same funds were redeployed to support greater working capital needs and for capital expansion programs to increase the Company's manufacturing capacity. INCOME TAXES. The Company's effective income tax rate was 36.3% in 1998 compared with 37.7% in 1997 and 38.2% in 1996. The tax rate in 1998 was lower than in 1997 because of increased benefit for our Foreign Sales Corporation and a reduced effective tax rate in the Company's state of incorporation from tax refunds arising under recent legislation. The tax rate in 1997 was lower than in 1996 because of United Kingdom net operating loss usage applied in 1997. - ------------------------------------------------------------------------------- INFLATION Inflation has been modest in the past three years. Wage increases have been about 4% in each of the past three years. Raw material cost increases were about 3% in 1996, and negligible in 1997 and 1998. 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 foreseeable future. Its program to combat this is to continue to increase productivity, adopt emerging lower-cost technological advances into its products, expand its avail-able 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 concluded 1998 with a very strong balance sheet. Total assets were $162.9 million, up $27.1 million. Stock-holders' equity rose to $85.0 million ($7.97 per share) from $69.8 million ($6.68 per share). Working capital was $55.9 million, which produced a current ratio of 2.05:1 compared to 2.09:1 a year earlier. Interest-bearing long-term debt was up $4.1 million at $19.5 million as a result of making acquisitions in 1998. Accounts receivable were up $7.2 million principally because of added sales volume derived from our acquired companies. The Company completed a new, $75 million line of credit in September, 1998. The new line, which carries lower interest rates than our previous line, provides $40 million for working capital and $35 million for acquisitions. The expanded line gives Harmon added financial strength to meet its strategic objectives over the next several years. At December 31, 1998, availability under the Company's new credit line was $68.5 million, with borrowings of $4.2 million against it. Capital expenditures for 1999 are budgeted at $17.5 million, roughly $3.0 million higher than the capital expenditure budget for 1998. Traditionally, the Company spends less on capital expenditures than it actually budgets. The Company believes cash flow from operations and borrowings under the new line of credit will provide sufficient funds for both its capital expenditure and acquisition programs. - ------------------------------------------------------------------------------- 1999 OUTLOOK On balance, the outlook for 1999 is excellent. Positive aspects are: increased bookings in January, 1999, which added to our record 1998 year-end backlog of $13i.8 million, up $57.3 million from the year earlier backlog of $74.5 million; recent and upcoming railroad mergers, which typically result in railroad purchases of efficiency-enhancing systems and products of a type that Harmon makes; a trend toward sole-source, multi-year supplier arrangements under which Harmon secured several major contracts in 1998; and substantially increased funding for rail transit projects and rail/highway crossing protection installations under the 1998-enacted tea 21 legislation. Other positives include the possibility of substantial 25 additional rail transit business as Harmon was the low bidder on several contracts; the possibility of obtaining even more rail transit contracts in 1999 as signal and control portions with communications-based train control technology are expected to be put up for bid in 1999. Finally, upgrading and privatization of railroads in Mexico is continuing; more railroads are becoming interested in outsourcing; international sales opportunities are increasing, particularly because of the expanding business relationship between Harmon's British-based subsidiary (Vaughan Harmon Systems Ltd.) and British Railtrack; and an opportunity to gain a greater portion of future rail transit contracts, owing to SES CO's added technical capabilities and its excellent reputation within the rail transit industry. Despite the many positives for Harmon, there are several potential negatives as well. First, we are getting increased price pressure from major customers, particularly from those granting long-term supplier contracts. Second, we are seeing heightened price competition in the markets of our higher margin products. Third, competition is increasing in two areas: on the domestic front as well as from huge European conglomerates. Fourth, potential problems may be encountered with y2k compliance issues, which are outlined below. Finally, although we expect a record year for sales in 1999, our first quarter sales and earnings will be weak-not because of a lack of business but rather because we obtained several contracts in the fourth quarter of 1998 that are not expected to reach the applicable milestones before any proportionate profit can be booked. Thus, we expect our greater gains will occur as the year unfolds. - ------------------------------------------------------------------------------- OTHER There are no recently issued accounting pronouncements which have not been implemented that would have a significant effect on the Company's financial statements. - ------------------------------------------------------------------------------- THE EURO There was no impact on Harmon as a result of the January 1999 implementation of the new common European currency, the euro. Our current European presence is largely confined to the United Kingdom, which is not a participant in the first implementation of the euro. Virtually all sales by our UK subsidiary are to UK customers and are denominated in pounds sterling. Sales by our U.S. operations to European customers to date have typically been denominated in U.S. dollars. - ------------------------------------------------------------------------------- YEAR 2000 ISSUE "Year 2000 Issue" or "y2k" refers to the practice in many existing computer programs that uses only the last two digits when designating a year. Therefore, these programs cannot distinguish a year that begins with 19 from a year that begins with 20. If not corrected, many computer applications could fail or create erroneous results beginning January 1, 2000. BACKGROUND-- In 1997, the Company's Management Information Systems Steering Team developed a long-range plan to consolidate substantially all of its domestic operations onto a single computer operating system. The software vendor chosen was the one that currently supplies the largest of the Company's three primary operating systems. The benefits of this consolidation are increased efficiency and uniformity throughout the Company, particularly in the areas of manufacturing, inventory management and engineering, as well as achieving y2k compliance. READINESS-- PROJECT MANAGEMENT. To properly manage and coordinate the Company's y2k efforts, the Management Information Systems Steering Team, using a formal team structure, appointed a project leader who supervises various sub-teams responsible for y2k compliance in the following areas: OPERATING SYSTEMS. To complete the consolidation discussed above, the Company completed one systems upgrade and will perform two systems conversions. The upgrade, which affected the largest portion of the Company's business, was successfully completed at the end of the third quarter 1998. The conversions of the 26 remaining two systems are scheduled for 1999. An inventory of workstation hardware identified over 300 personal computers that require installation of y2k compliant systems boards. These boards are being installed in 1999. CUSTOMERS. A review by the Company of the products it sells has thus far identified a minimal number of areas of y2k non-compliance. One area involves a vendor-supplied operating system. The Company is currently awaiting a proposed solution from the manufacturer. An installed base of fewer than ten is affected by this issue. All customers have been informed of this problem and are being kept up-to-date with the progress. Another potential issue involves a clock chip that the Company has been informed is not y2k compliant. The Company is conducting a review to determine if and when this component may have been used in any of its products. The Company believes that none of the y2k issues described above, if not corrected, would jeopardize the systems of any of its customers or the safety of the public at large. While final action plans are not yet complete, the Company does not believe the costs necessary to achieve y2k compliance for its products will be material to the Company's financial statements on a consolidated basis. VENDORS. The Company is nearing completion of a survey of all significant vendors to determine if the Company's operations could be materially impacted by the failure of key vendors to achieve y2k compliance. The next step is to determine which vendor responses require follow-up or audit. MISCELLANEOUS. The Company is presently testing manufacturing and production equipment, telephone systems, security systems, and other peripheral devices associated with the Company's facilities for y2k compliance. COSTS- As discussed above, y2k compliance is one of two benefits achieved by the Company's upgrade and conversion efforts. While the Company is monitoring the costs of these projects against established budgets, it is not possible to allocate these costs between the two objectives; the benefits of a common operating system and the requirement for y2k compliance. The Company incurred operating expenses of approximately $1.1 million in 1998 and has budgeted operating expenses of $1.1 million in 1999. These costs will be funded by cash flow from operations. RISKS- The Company's primary y2k risks are in the timing of the conversions planned for 1999 and the potential for failure of key vendors to achieve y2k compliance. Operations of the Company's Lee's Summit, MO and Riverside, CA locations could be impacted if those conversions are not completed by the time it is necessary to enter dates beyond December 31, 1999. The Company believes the impact of y2k non-compliance at these locations would be limited to decreased productivity and the substitution of manual processes for certain automated ordering and planning processes. The evaluation of the Company's exposure resulting from non-compliance by key vendors is in process and the impact, if any, is therefore not yet known. CONTINGENCY PLANS- The Company is upgrading the operating system at its Riverside, CA location to be y2k compliant to minimize the chance of any disruptions in production if the conversion of that location to the chosen common operating system is delayed. The Company is also identifying alternative suppliers for certain critical components. 27 - ------------------------------------------------------------------------------- FOURTH QUARTER RESULTS Sales for Harmon's 1998 fourth quarter were $73.2 million compared with $73.8 million for fourth quarter sales of 1997. Cost of sales as a percentage of sales was 75.7% compared with 74.4% in 1997. The difference between the two years reflects greater shipments of lower margin products in 1998. In 1997, a sizable portion of Harmon's fourth quarter revenues were comprised of Harmon-manufactured goods, which traditionally carry higher margins. Although shipments were fractionally lower in the 1998 fourth quarter, overall business was extremely strong. New orders written during the fourth quarter of 1998 were $105 million, a record level for any quarter. Net earnings for the 1998 fourth quarter were $3.5 million, or $0.33 per share - diluted, compared with $3.9 million, or $0.37 per share, for the 1997 fourth quarter. - ------------------------------------------------------------------------------- QUARTERLY CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1998 1997 QUARTERS ENDED MARCH 31 JUNE 30 SEPT. 30 DEC. 31 MARCH 31 JUNE 30 SEPT. 30 DEC. 31 ------------------------------------------------------------------------------------------------------- NET SALES $ 60,558 $73,705 $ 57,754 $73,202 $35,988 $ 47,621 $56,125 $73,796 COST OF SALES 46,014 55,324 43,749 55,392 26,196 33,607 41,512 54,909 R&D EXPENDITURES 2,107 2,376 2,103 1,867 1,602 1,809 1,758 2,496 ------------------------------------------------------------------------------ GROSS PROFIT 12,437 16,005 11,902 15,943 8,190 12,205 12,855 16,391 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 7,540 8,426 7,783 9,665 5,847 6,687 8,228 9,534 AMORTIZATION 217 217 234 365 160 166 178 192 MISCELLANEOUS (INCOME) EXPENSE-NET 10 (27) (188) (163) (23) 281 (4) 13 ------------------------------------------------------------------------------ OPERATING INCOME 4,670 7,389 4,073 6,076 2,206 5,071 4,453 6,652 INVESTMENT INCOME 36 75 98 187 138 176 67 41 INTEREST EXPENSE 304 352 304 594 124 428 333 334 ------------------------------------------------------------------------------ EARNINGS BEFORE INCOME TAXES 4,402 7,112 3,867 5,669 2,220 4,819 4,187 6,359 INCOME TAXES 1,590 2,510 1,399 2,149 772 1,832 1,548 2,470 ------------------------------------------------------------------------------ NET EARNINGS $ 2,812 $ 4,602 $ 2,468 $ 3,520 $ 1,448 $ 2,987 $ 2,639 $ 3,889 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ EARNINGS PER COMMON SHARE - DILUTED $ 0.27 $ 0.43 $ 0.23 $ 0.33 $ 0.14 $ 0.29 $ 0.25 $ 0.37 WEIGHTED AVERAGE SHARES - DILUTED 10,608 10,685 10,666 10,774 10,304 10,335 10,392 10,467
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. 28 CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
At December 31, 1998 1997 - ------------------------------------------------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents $ 1,669 $ 6,748 Trade receivables, less allowance for doubtful accounts of $351 in 1998 and $318 in 1997 52,229 45,001 Costs and estimated earnings in excess of billings on uncompleted contracts (note 2) 9,649 2,850 Inventories: Work in process 6,372 6,171 Raw materials and supplies 36,640 32,894 --------------------------- 43,012 39,065 Income tax receivable 597 - Deferred tax asset (note 4) 587 2,215 Prepaid expenses and other current assets 1,301 473 --------------------------- Total current assets 109,044 96,352 --------------------------- Property, plant and equipment, at cost (note 3): Land 465 465 Buildings 11,671 11,363 Machinery and equipment 18,830 16,319 Office furniture and equipment 25,246 20,671 Transportation equipment 1,709 1,393 Leasehold improvements 3,938 3,120 --------------------------- 61,859 53,331 Less accumulated depreciation and amortization 35,284 29,302 --------------------------- Net property, plant and equipment 26,575 24,029 Deferred tax asset (note 4) 654 414 Cost in excess of fair value of net assets acquired, net of accumulated amortization of $4,212 in 1998 and $3,180 in 1997 (note 11) 17,327 8,766 Deferred compensation asset (note 6) 6,839 5,807 Other assets 2,414 401 ---------------------------- $ 162,853 $ 135,769 ---------------------------- ----------------------------
See accompanying notes to consolidated financial statements. 29
At December 31, 1998 1997 - -------------------------------------------------------------------------------------------------------------------- 29 Liabilities and Stockholders' Equity Current liabilities: Current debt installments (note 3) $ 280 $ 1,162 Accounts payable 16,415 21,554 Accrued payroll, bonus and employee benefit plan contributions (note 6) 13,342 11,893 Billings in excess of costs and estimated earnings on uncompleted contracts (note 2) 17,493 5,677 Other accrued liabilities 5,650 5,177 Current tax liability - 566 ---------------------------- Total current liabilities 53,180 46,029 ---------------------------- Deferred compensation liability (note 6) 5,175 4,522 Long-term debt (note 3) 19,540 15,456 ---------------------------- Total liabilities 77,895 66,007 Stockholders' equity (notes 3, 6, 7 and 11): Common stock of $.25 par value; authorized 50,000,000 shares, issued 10,662,400 shares in 1998 and 10,437,369 shares in 1997 2,666 2,609 Additional paid-in capital 27,457 24,514 Foreign currency translation 127 104 Unearned compensation (287) (224) Retained earnings 54,995 42,759 ---------------------------- Total stockholders' equity 84,958 69,762 Commitments and contingencies (notes 6 and 10) ---------------------------- $ 162,853 $ 135,769 ---------------------------- ----------------------------
30 CONSOLIDATED STATEMENTS OF EARNINGS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Years ended December 31, 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Net sales $ 265,219 $ 213,530 $ 175,440 Cost of sales 200,478 156,224 126,997 Research and development expenditures 8,454 7,664 6,331 ---------------------------------------------- Gross profit 56,287 49,642 42,112 ---------------------------------------------- Selling, general and administrative expenses 33,415 30,298 25,990 Amortization of cost in excess of fair value of net assets acquired (note 11) 1,032 697 587 Equity in net loss of affiliate (note 8) - 330 - Miscellaneous income - net 368 63 43 ---------------------------------------------- Operating income 22,208 18,380 15,578 Interest expense 1,555 1,219 724 Investment income 396 422 251 ---------------------------------------------- Earnings before income taxes 21,049 17,583 15,105 Income tax expense (benefit) (note 4): Current 6,259 6,876 6,945 Deferred 1,388 (254) (1,170) ---------------------------------------------- 7,647 6,622 5,775 ---------------------------------------------- Net earnings $ 13,402 $ 10,961 $ 9,330 ---------------------------------------------- ---------------------------------------------- Basic earnings per common share $ 1.27 $ 1.06 $ 0.91 Diluted earnings per common share $ 1.25 $ 1.06 $ 0.91 ---------------------------------------------- ---------------------------------------------- Weighted average shares used in computation (000s) Basic earnings per common share 10,541 10,313 10,217 Diluted earnings per common share 10,684 10,374 10,268 ---------------------------------------------- ----------------------------------------------
See accompanying notes to consolidated financial statements. 31 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
ADDITIONAL FOREIGN TOTAL COMPRE- COMMON PAID-IN CURRENCY UNEARNED RETAINED STOCKHOLDERS' HENSIVE STOCK CAPITAL TRANSLATION COMPENSATION EARNINGS EQUITY INCOME - ------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1995 $2,553 $ 22,152 $ - $ - $ 24,527 $ 49,232 Net earnings - - - - 9,330 9,330 $ 9,330 Foreign currency translation - - 203 - - 203 203 ------- Comprehensive income - - - - - - 9,533 ------- ------- Cash dividends paid ($0.10 per share) - - - - (1,022) (1,022) Common stock issued (notes 7 and 11): Acquisitions of businesses 6 144 - - - 150 Stock options and other 2 44 - - - 46 ------------------------------------------------------------------- Balance at December 31, 1996 2,561 22,340 203 - 32,835 57,939 ------------------------------------------------------------------- ------------------------------------------------------------------- Net earnings - - - - 10,961 10,961 10,961 Foreign currency translation - - (99) - - (99) (99) ------- Comprehensive income - - - - - - 10,862 ------- ------- Cash dividends paid ($0.10 per share) - - - - (1,037) (1,037) Common stock issued (notes 6, 7 and 11): Acquisition of business 23 1,337 - - - 1,360 Deferred compensation 6 355 - (224) - 137 Stock options and other 19 482 - - - 501 ------------------------------------------------------------------- Balance at December 31, 1997 2,609 24,514 104 (224) 42,759 69,762 ------------------------------------------------------------------- ------------------------------------------------------------------- Net earnings - - - - 13,402 13,402 13,402 Foreign currency translation - - 23 - - 23 23 ------- Comprehensive income - - - - - - $13,425 ------- ------- Cash dividends paid ($0.11 per share) - - - - (1,166) (1,166) Common stock issued (notes 6, 7 and 11): Acquisitions of businesses 44 2,114 - - - 2,158 Deferred compensation 2 184 - (63) - 123 Stock options and other 11 645 - - - 656 ------------------------------------------------------------------- Balance at December 31, 1998 $2,666 $ 27,457 $ 127 $ (287) $ 54,995 $ 84,958 ------------------------------------------------------------------- -------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 32 CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Cash Flows From Operating Activities: Net earnings $13,402 $10,961 $ 9,330 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: Depreciation and amortization 7,186 5,639 5,004 Loss (gain) on sale of property, plant and equipment 20 45 (5) Deferred tax expense (benefit) - (254) (1,170) Earned stock compensation 122 137 - Equity in net loss of affiliate - 330 - Changes in assets and liabilities, net of acquisitions of businesses: Trade receivables 4,666 (3,900) (13,740) Inventories (3,414) (11,677) (1,060) Estimated costs, earnings and billings on contracts (3,387) (1,371) 7,381 Prepaid expenses and other current assets (319) 2,454 (360) Current income taxes receivable 340 - - Accounts payable (6,745) 5,209 3,345 Accrued payroll and benefits (130) 911 4,000 Other liabilities 473 (995) 5,007 Other deferred liabilities 653 597 371 -------------------------------------- Total adjustments (535) (2,875) 8,773 -------------------------------------- Net cash provided by operating activities 12,867 8,086 18,103 -------------------------------------- Cash Flows From Investing Activities: Capital expenditures (8,271) (10,475) (6,371) Acquisitions of businesses (8,487) (196) (2,146) Proceeds from sale of property, plant and equipment 49 29 46 Deferred compensation, net (1,032) (809) (1,339) Other investing activities (2,013) (358) 1,584 -------------------------------------- Net cash used in investing activities (19,754) (11,809) (8,226) -------------------------------------- Cash Flows From Financing Activities: Proceeds from issuance of common stock 542 501 46 Cash dividends (1,166) (1,037) (1,022) Proceeds from issuance of long-term debt - 15,000 - Borrowings under line of credit agreements 60,126 52,370 46,530 Repayments under line of credit agreements (56,514) (55,293) (55,165) Principal payments of long-term debt (1,203) (971) (469) -------------------------------------- Net cash provided by (used in) financing activities 1,785 10,570 (10,080) -------------------------------------- Foreign currency translation 23 (99) 203 -------------------------------------- Net increase (decrease) in cash and cash equivalents (5,079) 6,748 - Cash and cash equivalents at beginning of year 6,748 - - -------------------------------------- Cash and cash equivalents at end of year $ 1,669 $ 6,748 $ - -------------------------------------- -------------------------------------- Supplemental Disclosures of Cash Flow Information: Cash paid during the year for: Interest $ 1,442 $ 884 $ 690 Income taxes $ 8,570 $ 6,635 $ 6,019
See accompanying notes to consolidated financial statements. 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 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, Vaughan Harmon Systems Limited (Vaughan Harmon), Vale-Harmon Enterprises, Ltd. (Vale Harmon), Devtronics, Inc. (Devtronics), CSS Inc. (CSS), Harmon Industries Australia PTY LTD (Harmon Australia), Seaboard Systems Co., Inc. (Seaboard), SES CO., Inc. (SESCO), Industrias Harmon De Mexico, S.A. De C.V. (Harmon de Mexico) and Harmon Railway Systems International (HRSI). Effective January 1, 1997 the Company's former subsidiaries Harmon Electronics, Inc. (HEI), Electro Pneumatic Corporation (EPC) and Consolidated Asset Management Company, Inc. (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 communications 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. 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 twenty years. The Company assesses the recoverability and measures impairment, if any, 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. 34 COMPREHENSIVE INCOME. In June 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income" which establishes rules for the reporting of comprehensive income and its components. Comprehensive income consists of net income and foreign currency translation adjustments and is presented in the Statement of Stockholders' Equity. The adoption of Statement No. 130 had no impact on total stockholders' equity. FOREIGN CURRENCY TRANSLATION. Assets and liabilities in foreign currencies are translated into dollars at the rates prevailing at the balance sheet date. Revenues and expenses are translated at average rates for the year. The net exchange differences resulting from these translations are reported in stockholders' equity, net of tax effects. 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 of new products or in changing existing products are charged to expense as incurred. STOCK SPLIT. On February 3, 1998, the Company declared a three-for-two stock split, payable on February 27, 1998 in the form of a stock dividend to stockholders of record on February 13, 1998. Share and per share data for all periods presented have been adjusted to give retroactive effect to this stock split. EARNINGS PER COMMON SHARE. Basic earnings per common share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. For the years ended December 31, 1998, 1997 and 1996 there are no differences between the numerator used in computing basic and diluted earnings per share which represents the net earnings of the Company. For the years ended December 31, 1998, 1997 and 1996 the denominator used in computing basic earnings per share represents the weighted average number of common shares outstanding (10,553,000 shares-1998, 10,319,000 shares-1997, 10,217,000 shares-1996), reduced by the weighted average number of shares of nonvested stock (12,000 shares - 1998, 6,000 shares - 1997) issued pursuant to employee benefit plans. The denominator used in computing diluted earnings per share represents the weighted average number of common shares outstanding used for purposes of the basic earnings per share computation (10,541,000 shares-1998, 10,313,000 shares-1997, 10,217,000 shares-1996) increased to reflect the potential dilution under the treasury stock method of the outstanding stock options and nonvested stock under the Company's employee benefit plans and stock option programs (143,000 shares-1998, 61,000 shares-1997, 51,000 shares-1996). 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 subsequent 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. 35 ENVIRONMENTAL REMEDIATION LIABILITIES. October 1996 the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 96-1, Environmental Remediation Liabilities. SOP 96-1 was adopted by the Company on January 1, 1997 and requires, among other things, environmental remediation liabilities to be accrued when the criteria of SFAS No. 5, Accounting for Contingencies, have been met. The guidance provided by the SOP is consistent with the Company's current method of accounting for environmental remediation costs and, therefore, adoption of this new Statement did not have a material impact on the Company's financial position or results of operations. NOTE 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, 1998: Costs and estimated earnings $ 30,374 $ 121,701 $ 152,075 Billings 20,725 139,194 159,919 ------------------------------------------- $ 9,649 $ (17,493) $ (7,844) ------------------------------------------- ------------------------------------------- December 31, 1997: Costs and estimated earnings $ 13,850 $ 110,836 $ 124,686 Billings 11,000 116,513 127,513 ------------------------------------------- $ 2,850 $ (5,677) $ (2,827) ------------------------------------------- -------------------------------------------
Balances billed, but not paid by customers under retainage provisions in contracts amounted to $2,643,000 and $798,000 at December 31, 1998 and 1997, respectively. Receivables on contracts in progress are considered to be collectible within twelve months. NOTE 3. INDEBTEDNESS - -------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 1998 1997 ------------------------------------------------------------------------------------------------- Revolving credit agreements $ 4,200 $ - Senior unsecured notes payable 15,000 15,000 Lines of credit 39 583 Bank loans 387 336 Capitalized lease obligations 194 699 -------------------------- Total indebtedness 19,820 16,618 Less current installments 280 1,162 -------------------------- Long-term debt $ 19,540 $ 15,456 -------------------------- --------------------------
REVOLVING CREDIT AGREEMENTS. On September 29, 1998 the Company entered into a new credit agreement with a major commercial bank. The new credit agreement provides for a five (5) year unsecured Revolving Line of Credit (RC) of $40,000,000 to be used to provide working capital and refinance existing indebtedness, replacing the old revolving credit agreement of $20,000,000. At December 31, 1998, there are no outstanding borrowings. Outstanding borrowings bear interest at the base rate less one half percent (1/2%) or LIBOR plus a variable component depending on the Company's funded debt/EBITDA ratio. 36 Also, included in this new agreement is an unsecured reducing revolving credit agreement with original total credit availability of $35,000,000 reducing $1,750,000 as of the last day of each quarter beginning December 31, 2000. The Company has remaining total credit availability of $35,000,000 at December 31, 1998 against which there are outstanding borrowings of $4,200,000 at December 31, 1998. Outstanding borrowings are due on September 28, 2003 and bear interest at the base rate less one half percent (1/2%) or LIBOR plus a variable component depending on the Company's funded debt/EBITDA ratio. SENIOR UNSECURED NOTES PAYABLE. On January 24, 1997 the Company issued $15,000,000 of senior unsecured notes. The notes bear interest at 6.87% and are payable in equal annual installments of $2,142,857 commencing in 2001 with the final payment due in 2007. LINES OF CREDIT. A subsidiary company has a line of credit with total availability of $423,000 against which there are outstanding borrowings of $39,000 at December 31, 1998. The line of credit does not have a stated expiration date as all amounts are payable upon demand of the lender and accordingly the entire balance outstanding has been classified as current in the Consolidated Balance Sheets. The line of credit bears interest at the lender's prime lending rate plus 1/2% (7.25% at December 31, 1998), payable monthly. The line of credit is collateralized by liens against certain real and personal property. A subsidiary company has a line of credit with total availability of $2,000,000 against which there are no outstanding borrowings at December 31, 1998. The line of credit does not have a stated expiration date as all amounts are payable upon demand of the lender. The line of credit bears interest at the lender's prime lending rate plus 1% (8.75% at December 31, 1998), payable monthly. The line of credit is collateralized by liens against certain real and personal property. BANK LOANS. A subsidiary company has a $166,000 bank loan which 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% (8.1% at December 31, 1998). The note is collateralized by liens against certain real and personal property. A subsidiary company has a $68,000 bank loan which is a term note payable in monthly installments including interest through December, 2000. The note bears interest at a base rate established by the bank plus 3.0% (11.75% at December 31, 1998). The note is collateralized by liens against certain real and personal property. A subsidiary company has, in aggregate, a $102,000 bank loan which represents term notes payable in monthly installments including interest through July 2002. These notes bear interest at fixed rates ranging from 4.9% to 9.75%. The notes are collateralized by motor vehicles. A subsidiary company has, in aggregate, a $51,000 bank loan which represents term notes payable in monthly installments including interest through November 2002. These notes bear interest at fixed rates ranging from 5.9% to 12%. The notes are collateralized by motor vehicles. CAPITALIZED LEASE OBLIGATIONS. The Company entered into various computer hardware and software capital lease agreements totaling $312,000 in 1997. Monthly installments are due through November 2000. The implied interest rates in the lease agreements range from 7.0% to 9.0%. The Company did not enter into any new capital lease agreements during 1998. COVENANTS. The various indebtedness agreements contain, among other things, covenants relating to: maintenance of certain levels of consolidated net worth, limitations of maximum capital expenditures and maintenance of minimum EBITDA; maintenance of certain ratios of debt to EBITDA, debt service coverage ratio and funded debt to total capitalization ratio. At December 31, 1998, the Company is in compliance with all covenants under its indebtedness agreements. 37 MATURITIES. At December 31, 1998, long-term debt maturities for 1999 and thereafter are:
YEARS ENDED DECEMBER 31 (DOLLARS IN THOUSANDS) --------------------------------------------------------------------- 1999 $ 280 2000 244 2001 2,205 2002 2,177 2003 and thereafter 14,914 -------- $19,820 -------- --------
NOTE 4. INCOME TAXES - ------------------------------------------------------------------------------- Income tax expense consisted of the following:
(DOLLARS IN THOUSANDS) 1998 1997 1996 ---------------------------------------------------------------------------------- Current: Federal $ 4,857 $ 4,992 $ 5,741 Foreign 600 1,002 - State 802 882 1,204 ---------------------------------------- Total current 6,259 6,876 6,945 Deferred: Federal 1,251 (223) (976) State 137 (31) (194) ---------------------------------------- Total deferred 1,388 (254) (1,170) ---------------------------------------- Total income tax expense $ 7,647 $ 6,622 $ 5,775 ---------------------------------------- ----------------------------------------
Income tax expense for the years ended December 31, 1998, 1997, and 1996, 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) 1998 1997 1996 ------------------------------------------------------------------------------------------------- Computed "expected" tax expense $ 7,367 $ 6,154 $ 5,287 Increase (reduction) in income taxes resulting from: State and local income taxes, net of federal income tax benefit 610 553 657 Other, net (330) (85) (169) ---------------------------------------- $ 7,647 $ 6,622 $ 5,775 ---------------------------------------- ----------------------------------------
38 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below:
(DOLLARS IN THOUSANDS) 1998 1997 ------------------------------------------------------------------------------------------------- Deferred tax assets: Deferred compensation $ 2,080 $ 1,805 Compensated absences 495 425 Inventories 516 481 Allowance for doubtful accounts 124 117 Various other reserves 999 1,561 ----------------------- Total gross deferred tax assets 4,214 4,389 Less valuation allowance 369 369 ----------------------- 3,845 4,020 Deferred tax liabilities: Depreciation and Amortization (1,426) (1,391) Long-term contract deferred costs (1,178) - ----------------------- Total deferred tax liabilities (2,604) (1,391) ----------------------- Net deferred tax assets $ 1,241 $ 2,629 ----------------------- -----------------------
There were no net changes in the total valuation allowance for the years ended December 31, 1998 and 1997. 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. NOTE 5. BUSINESS SEGMENT INFORMATION - ------------------------------------------------------------------------------- Harmon Industries manages its operations through two business segments: domestic and international. Each unit sells train control and train signal products as well as services to railroads and transit authorities. The international business segment sells the Company's products and services outside the U.S. The Company is reporting business segment information in accordance with the provisions of Financial Accounting Standards No. 131, "Disclosures about segments of an Enterprise and Related Information" which was issued in June 1997. Prior to a series of acquisitions and establishment of new foreign subsidiaries, which occurred between 1995 and 1998, the Company had only one business segment. Because of the desire to market its products and services on a global scale, the Company began to manage its operations using the domestic and international approach in fiscal year 1997. Harmon Industries evaluates performance based upon net operating profit. Administrative functions such as finance, treasury and information systems are centralized. However, where applicable portions of the administrative function expenses are allocated between the operating segments. The operating segments do not share manufacturing or distribution facilities. In the event any materials and/or services are provided to one operating segment by the other, the transaction is valued according to the company's transfer policy, which approximates market price. The costs of operating the manufacturing plants are captured discretely within each segment. The Company's property, plant and equipment, inventory and accounts receivable are captured and reported discretely within each operating segment. 39 Summary financial information for the two reportable segments is as follows (dollars in thousands):
1998 1997 ------------------------------------------------------------------------------------------------- USA Operations Net Sales 251,537 200,181 Operating Income/(Loss) 21,516 15,273 Assets 156,245 129,352 Accounts Receivable 50,513 42,396 Inventory 42,448 38,645 International Operations Net Sales 13,682 13,349 Operating Income/(Loss) 692 3,107 Assets 6,608 6,417 Accounts Receivable 1,716 2,605 Inventory 564 420 Consolidated Net Sales 265,219 213,530 Operating Income/(Loss) 22,208 18,380 Assets 162,853 135,769 Accounts Receivable 52,229 45,001 Inventory 43,012 39,065
NOTE 6. COMMITMENTS - ------------------------------------------------------------------------------- The Company has also entered into various operating lease arrangements covering the use of manufacturing facilities, administrative offices and equipment. Rental expense related to these leases amounted to $2,667,000, $2,122,000 and $1,661,000 for the years ended December 31, 1998, 1997 and 1996, respectively. A summary of non-cancelable long-term operating lease commitments follows (dollars in thousands):
REAL TOTAL YEARS ENDED DECEMBER 31, EQUIPMENT PROPERTY COMMITMENTS --------------------------------------------------------------------------------------------------- 1999 $ 322 $ 2,093 $ 2,415 2000 193 1,800 1,993 2001 91 1,431 1,522 2002 and Thereafter 1 9,630 9,631
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 1999. 40 EMPLOYEE BENEFITS. In 1985, the Company formed an Employee Stock Ownership Plan and Trust (ESOP), which includes all employees. The ESOP held 743,437 shares and 746,358 shares of Company common stock which had been allocated to plan participants at December 31, 1998 and 1997, 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 $4,809,000, $3,874,000 and $3,815,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company and its subsidiaries have various bonus plans based primarily on Company performance. Accrued and unpaid bonuses at December 31, 1998 and 1997 were $3,133,000 and $2,776,000, 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 cost (gain) related to this plan was $286,000, $573,000 and $(365,000) for the years ended December 31, 1998, 1997 and 1996, respectively. In 1997 the Company established a nonqualified, unfunded deferred compensation plan for certain key executives providing for payments upon termination, retirement, death or disability. This plan is available to new officers of the Company in lieu of participation in the plan described above. Under the plan, contributions are based on a formula which is expected to result in a target benefit for the participant and vest on a graded basis. The amount of a participant's benefit is based solely on the participant's vested account balance except in the case of death prior to termination in which case the participant's benefit is the greater of the participant's vested account balance or the lesser of eight times the participant's base annual compensation which would have been paid for the calendar year of death or $1,400,000. Plan contributions are made in the form of stock and cash to a grantor trust. The cost related to this plan was $15,000 in 1998. In 1997 the Company also established a supplemental executive retirement plan which is a nonqualified, unfunded deferred compensation plan for certain key employees providing for payments upon termination, retirement, death or disability. This plan is available to key employees of the Company exclusive of members of the Executive staff. Under the plan Company contributions equal to three percent of each participant's annual compensation are made if the Company's earnings per share are at least 50% of the Company's earnings per share for the prior calendar year with such contributions vesting on a graded basis. The plan also allows for participant deferrals of compensation and bonus awards to be contributed to the plan. The amount of a participant's benefit is based solely on the participant's vested account balance. Plan contributions are made in the form of cash to a grantor trust. The cost related to the plan was $120,000 in 1998 and $27,000 in 1997. The Company also has employment agreements with certain key executives. Under the terms of these agreements the Company contributed 9,268 shares and 24,150 shares of common stock of the Company to a grantor trust in 1998 and 1997 respectively. The stock price as of the date of grant was $19.25 in 1998 and ranged from $13.92 to $16.50 in 1997. These contributions vest on a graded basis with the unvested portion shown in the Consolidated Balance Sheets and Statements of Stockholders' Equity as "Unearned Compensation". The Company has recorded the assets and liabilities for the deferred compensation plans and employment agreements 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. 41 NOTE 7. STOCKHOLDERS' EQUITY - ------------------------------------------------------------------------------- Share and per share information reflected herein has been adjusted for the three-for-two stock split in February 1998. A summary of stock options granted, exercised and expired follows:
SHARES PRICE PER SHARE ------------------------------------------------------------------------------------------------- Balance at January 1, 1996 186,750 $ 10.13 Average Price Granted 151,500 9.00-11.33 Exercised (9,000) 3.67-5.50 Expired (38,250) 11.00-13.75 Balance at December 31, 1996 291,000 9.79 Average Price Granted 132,000 12.17-13.00 Exercised (76,253) 3.67-13.75 Expired (35,647) 11.00-13.75 Balance at December 31, 1997 311,100 11.51 Average Price Granted 168,000 20.375-23.875 Exercised (39,600) 11.00-20.875 Expired (3,900) 11.00-20.875 Balance at December 31, 1998 435,600 $ 14.93 Average Price
The Company has outstanding stock options for 435,600 shares of common stock at prices ranging from $9.33 to $23.88 with a weighted-average remaining contractual life of 4.85 years of which 230,175 shares (average price $12.86) are exercisable as of December 31, 1998. In May 1998 the Company granted stock options for up to 1,500 common shares to each of the Company's eight non-employee directors which expire on May 31, 2005. In May 1997 the Company granted stock options for up to 1,500 common shares to each of the Company's nine non-employee directors which expire on May 31, 2004. In May 1996, the Company granted stock options for up to 1,500 common shares to each of the Company's nine non-employee directors which expire on May 31, 2003. The Company issued 43,962, 92,307 and 26,471 shares of unregistered common stock in connection with the 1998, 1997 and 1996 acquisitions of businesses respectively (See Note 11). NOTE 8. AFFILIATES - ------------------------------------------------------------------------------ As of December 31, 1997 the Company had an investment of 20% in Henkes & Harmon Industries PTY LTD, an unconsolidated affiliate which was accounted for under the equity method. During 1998 the Company sold its 20% interest in the affiliate and acquired the Assets of Henkes & Harmon through an asset purchase (See note 11). Equity in earnings from this affiliate was not significant prior to the asset purchase or for the years ended December 31, 1997 and 1996. Prior to the acquisition, the Company had sales to this related entity totaling $373,000, $253,000 and $559,000 for 1998, 1997 and 1996, respectively. The Company had receivables due from this entity of $69,000 at December 31, 1997. As of December 31, 1996 the Company also had an investment of 38% in a formerly unconsolidated affiliate, Vale Harmon Enterprises, Ltd., which was accounted for under the equity method. During 1997 the Company acquired the remaining interest in this subsidiary company (See note 11). Equity in losses of this affiliate prior to acquisition amounted to $330,000 in 1997. Equity in earnings (losses) of this affiliate was not significant for the year ended December 31, 1996. The Company had sales to this related entity totaling $27,000 in 1997 prior to acquisition and $282,000 and $543,000 in 1996 and 1995, respectively. The Company had receivables due from this entity of $79,000 as of December 31, 1996. NOTE 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 $90,000, $150,000 and $283,000 for the years ended December 31, 1998, 1997 and 1996, respectively. 42 NOTE 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. On January 9, 1995 the Company filed a Notice of Appeal of the initial decision with the Environmental Appeals Board (EAB) and on May 1, 1996, the EAB heard oral arguments. The EAB affirmed the penalty of the administrative law judge. On June 6, 1997 the Company filed a complaint in the Federal District Court for the Western District of Missouri seeking judicial review of the EAB's decision. On August 25, 1998 the United States District court for the Western District of Missouri granted the Company's motion of summary judgment, overturning the EAB's ruling. The Missouri Department of Natural Resources (MDNR) agreed to forego monetary damages and a subsequent circuit court decree released Harmon from further claims in exchange for performing further monitoring and cleanup. The decision dismisses the EPA's complaint and releases Harmon from the EPA penalty action. A federal judge ruled the complaint is barred by the RCRA which requires the EPA to delegate enforcement to authorized states. Under the statute, the actions of states "have the same force and effect" as those taken by the EPA directly. Missouri has been an authorized state since 1985. On December 28, 1998 the EPA filed an appeal with the United States Court of Appeals contesting the United States District courts decision. Harmon is expected to file its opening brief in the first quarter of 1999, with oral arguments expected 3 to 6 months thereafter. Based on the Company's cooperation with the 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 EPA 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 $2,472,000 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 any 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. NOTE 11. ACQUISITIONS OF BUSINESSES - ------------------------------------------------------------------------------- On January 29, 1998 the Company acquired the stock of CSS Inc. This acquisition was made with the issuance of 80,820 shares of unregistered common stock valued at $17.92 per share. This 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 consideration given over the fair value of net assets acquired has been recorded as goodwill of $1,158,348. On April 20, 1998 the Company established a new wholly owned subsidiary, Industrias Harmon de Mexico, S.A. de C.V. (Harmon de Mexico). The operating results have been included in the Company's consolidated results of operations from the date of incorporation. On October 1, 1998 the Company established a new wholly owned subsidiary, Harmon Industries Australia PTY LTD (Harmon Australia), which was capitalized through a cash investment. On that same date, Harmon Australia (the newly formed subsidiary) acquired substantially all of the assets of Henkes & Harmon Industries PTY LTD (Henkes Harmon) which consisted primarily of inventory and accounts receivable. Harmon Australia also assumed certain liabilities related to the purchased assets on the acquisition date. This 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 consideration given over the fair value of net assets acquired has been recorded as goodwill of $373,000. 43 On October 1, 1998 the Company acquired the stock of Seaboard Systems CO., Inc. for an initial purchase price of $1,800,000 in cash. In addition to the initial purchase price, the purchase agreement provides for contingent payments. These payments are based on the average earnings before taxes for the calendar years 1998 through 2000. Any additional consideration paid will 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 $277,166. On October 1, 1998 the Company acquired the stock of SES CO, Inc. This acquisition was made with the issuance of 95,026 shares of unregistered common stock valued at $21.05 per share and $10,200,000 in cash. In addition to the initial purchase price, the purchase agreement provides for contingent payments. These payments are based on the average earnings before taxes for the calendar years 1998 through 2000. Any additional consideration paid will 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 $7,601,076. The following unaudited pro forma consolidated results of operations are presented as if the acquisition of SES CO, Inc. had been made at the beginning of the periods presented. The effects of the other 1998 acquisitions on the consolidated financial statements are not significant and have been excluded from the pro forma presentation.
(IN THOUSANDS OF DOLLARS) YEARS ENDED DECEMBER 31, 1998 1997 ------------------------------------------------------------------------------------- Net sales $ 276,812 $ 227,653 Net earnings 13,440 12,020 Basic earnings per common share 1.28 1.17 Diluted earnings per common share 1.26 1.16
The pro forma consolidated results of operations include adjustments to give effect to amortization of goodwill, interest expense on acquisition debt and certain other adjustments, together with related income tax effects. The unaudited pro forma information is not necessarily indicative of the results of operations that would have occurred had the purchase been made at the beginning of the periods presented or the future results of the combined operations. On November 10, 1997 the Company acquired the stock of a railroad industry equipment and services supplier. This acquisition was made with the issuance of 92,307 shares of unregistered common stock valued at $14.73 per share. This 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 consideration given over the fair value of net assets acquired has been recorded as goodwill of $591,000. On June 12, 1997 the Company acquired the remaining 62% of the outstanding stock of Vale Harmon for $167,000 in cash. Prior to this transaction the Company held a 38% ownership interest in Vale Harmon and accounted for the investment under the equity method. This 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 consideration given over the fair value of net assets acquired has been recorded as goodwill of $1,083,000. The pro forma effects of the 1997 acquisitions on the consolidated financial statements are not significant. 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 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 1997 the Company recorded an additional $131,000 in goodwill relating to the use of certain tax net operating loss carryforwards. In 1996 the Company acquired the assets of two contract engineering firms. These acquisitions were made with the issuance of 26,201 shares of unregistered common stock valued at $5.67 per share, a $198,000 note payable and $145,000 in 44 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. NOTE 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 1998, 1997 and 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 basic earnings per share would have been reduced by approximately $637,000 in 1998, $280,000 in 1997 and $325,000 in 1996, or $.06 per share in 1998, $.03 per share in 1997 and $.03 per share in 1996. The fair value of the options granted is estimated at values ranging from $7.56 to $11.86 in 1998, $3.91 to $5.93 in 1997 and $3.92 to $5.91 in 1996, on the dates of grant using the Black-Scholes option-pricing model with the following assumptions: dividend rate of .11 per share in 1998 and .10 per share in 1997 and 1996, volatility of 49% in 1998 and ranging between 46% and 48% in 1997 and between 41% and 70% in 1996, risk-free interest rate ranging between 5.57% and 5.65% in 1998, 5.90% and 6.40% in 1997 and 5.25% and 7.01% in 1996, assumed forfeiture rate of 0% in 1998, 1997 and 1996, and an expected life of 2.85 years in 1998 and ranging between 1.9 and 3.75 years in 1997 and 1996. Pro forma net income reflects only options granted since December 31, 1994. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options vesting period and compensation cost for options granted prior to January 1, 1995 is not considered. NOTE 13. SUBSEQUENT EVENT - ------------------------------------------------------------------------------- On March 2, 1999, the Company signed a letter of intent to acquire the majority control of Angiolo Siliani S.p.A. and of Siliani Elettronica ed Impianti S.p.A. of Florence, Italy (Siliani). The acquisitions will involve a combination of cash and the issuance of common stock. The companies will operate under the name Siliani Harmon. Closing is expected on April 30, 1999. Angiolo Siliani S.p.A. is a market leader in switch point machines for both standard and high-speed lines, equipment and devices for interlockings, as well as electromechanical devices for locomotives. Siliani Elettronica ed Impianti S.p.A. operates in the field of electronic equipment and systems for signaling and train control, including axle-counter equipment, hot wheel and hot box detectors, Automatic Train Control (ATC), speed control and diagnostics. It also has a division in Genoa, Italy that designs and installs railway interlockings. 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. 39 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 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 /s/ Charles M. Foudrec Bjorn E. Olsson Charles M. Foudree President and Executive Vice President - Finance, Chief Executive Officer Treasurer and Secretary February 10, 1999 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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1998, in conformity with generally accepted accounting principles. KPMG LLP Kansas City, Missouri February 10, 1999 46 INVESTOR INFORMATION FORM 10-K - ------------------------------------------------------------------------------- Shareholders may receive a copy of the Corporation's 1998 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. e-mail: cfoudree@harmonind.com 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 11, 1999, 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 e-mail: cfoudree@harmonind.com INDEPENDENT AUDITORS - ------------------------------------------------------------------------------- KPMG 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 - ------------------------------------------------------------------------------- 1600 NE Coronado Drive Blue Springs, Missouri 64014-6236 816/229-3345 Telefax: 816/229-0556 COMMON STOCK PRICE -RANGE AND DIVIDEND INFORMATION - ------------------------------------------------------------------------------- At December 31, 1998, there were 10,662,400 shares outstanding and approximately 613 shareholders of record. Cash dividends are 11 cents per share per year, paid semi-annually at 51_2 cents per share. The range of high and low prices for the past eight -quarters ended December 31, 1998 is shown below. Per share prices and cash dividends have been adjusted for all stock splits and stock dividends.
CALENDAR PRICE RANGE QUARTER ENDED 1998 1997 - ------------------------------------------------------------ March 31 $ 22 - $16 5/6 $12 2/3 - $ 11 June 30 26 - 19 3/4 16 - 11 1/6 September 30 24 - 17 3/8 18 1/3 - 12 5/6 December 31 26 1/2 - 18 5/8 19 2/3 - 15 1/3
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 4, 1999, the following securities firms were making a dual auction market in the common stock of the Company: George K. Baum & Company Piper Jaffray Companies Inc. PaineWebber Inc. C.L. King & Associates Knight Securities L.P. Mayer & Schweitzer, Inc. Sherwood Securities Corp. 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 47 MANAGEMENT, DIRECTORS AND CORPORATE DATA BOARD OF DIRECTORS - -------------------------------------------------- Robert E. Harmon (59) Chairman of the Board Bruce M. Flohr (60) Founder & Chairman Emeritus RailTex, Inc. San Antonio, Texas Charles M. Foudree (54) Executive Vice President- Finance, Treasurer and Secretary Rodney L. Gray (46) Vice Chairman Azurix Houston, Texas Herbert M. Kohn (60) Attorney-at-Law Bryan Cave LLP Kansas City, Missouri Douglass Wm. List (43) Management Consultant Baltimore, Maryland Gerald E. Myers (57) Management Consultant Tempe, Arizona Bjorn E. Olsson (53) President & CEO John A. Sprague (45) Managing General Partner Jupiter Partners, LP New York, New York Judith C. Whittaker (60) Vice President, General Counsel/Secretary Hallmark Cards, Inc. Kansas City, Missouri ( ) Indicates Age of Director MANAGEMENT - -------------------------------------------------- Bjorn E. Olsson President & CEO Charles M. Foudree Executive Vice President- Finance and Secretary Lloyd T. Kaiser Executive Vice President- Domestic Sales and Service William P. Marberg Executive Vice President- System Sales & Support Raymond A. Rosewall Executive Vice President- Manufacturing Ronald G. Breshears Vice President-Human Resources Richard A. Daniels Vice President-Transit and International Systems Sales Robert E. Heggestad Vice President-Technology J. Randall John Vice President-Services John W. Johnson Vice President-Domestic Sales William J. Scheerer Vice President-- Applications Engineering Stephen L. Schmitz Vice President-Controller Jeffery J. Utterback Vice President and General Manager- Riverside Operations DOMESTIC LOCATIONS - -------------------------------------------------- Riverside, California Torrance, California Jacksonville, Florida Atlanta, Georgia Delphi, Indiana Louisville, Kentucky Hingham, Massachusetts Blue Springs, Missouri Grain Valley, Missouri [3] + Lee's Summit, Missouri Warrensburg, Missouri [3] + Omaha, Nebraska Hauppauge, New York Spokane, Washington - -------------------------------------------------- + Denotes number of plants and locations INTERNATIONAL LOCATIONS - -------------------------------------------------- Harmon Industries Australia, Pty. Ltd. Bayswater, Victoria, Australia Vale-Harmon Enterprises, Ltd. Saint-Laurent, Quebec, Canada Vaughan Harmon Systems Ltd. Ware, England Industrias Harmon de Mexico, SA de CV Monterrey, Mexico HARMON INDUSTRIES, INC. 1600 NE Coronado Drive Blue Springs, Missouri 64014 Telephone 816-229-3345 Facsimile: 816-229-0556 www.hamonind.com [LOGO] EX-21 5 EXHIBIT 21 Exhibit 21 Harmon Industries, Inc. Listing of Subsidiaries at December 31, 1998
NAME UNDER WHICH SUBSIDIARY NAME BUSINESS IS CONDUCTED JURISDICTION - --------------- --------------------- ------------- Consolidated Asset Management Consolidated Asset Management Missouri Company, Inc. Company, Inc. Harmon Railway Systems Harmon Railway Systems Virgin Islands International Corporation International Corporation Vaughan Harmon Systems, Ltd. Vaughan Harmon Systems, Ltd. England Vale Harmon Enterprises, Ltd. Vale Harmon Enterprises, Ltd. Quebec, Canada Devtronics, Inc. Devtronics, Inc. Florida Harmon Industries Australia Pty. Ltd. Harmon Industries Australia Pty. Ltd. Australia Industrias Harmon de Mexico, SA de CV Industrias Harmon de Mexico, SA de CV Mexico CSS, Inc. CSS, Inc. Indiana SES CO, Inc. SES CO, Inc. Massachusetts Seaboard Systems, Inc. Seaboard Systems, Inc. Massachusetts
Page 91 EX-23 6 EXHIBIT 23 The Board of Directors Harmon Industries, Inc.: We consent to incorporation by reference in the registration statements (No. 333-25493 and No. 333-53809) on Form S-8 of Harmon Industries, Inc. of our report dated February 10, 1999 relating to the consolidated balance sheets of Harmon Industries, Inc. and subsidiaries as of December 31, 1998, and 1997, 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, 1998, and all related schedules, which report appears in the December 31, 1998, annual report on Form 10-K of Harmon Industries, Inc. /s/ KPMG LLP Kansas City, Missouri March 26, 1999 EX-27 7 EXHIBIT 27 - FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1,669 0 52,580 (351) 43,012 109,044 61,859 (35,284) 162,853 53,180 19,540 0 0 2,666 82,292 162,853 265,219 265,219 208,932 208,932 34,414 33 1,555 21,049 7,647 13,402 0 0 0 13,402 1.27 1.25
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