<PAGE>

Harmon Industries, Inc.
1996 Annual Report

Signal and Train Control Systems for Railroads Worldwide

[COVER PHOTO]

Photograph of a passenger rail station, rail transit cars and track.\

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Corporate Profile

Harmon is a leading supplier of sophisticated signal and train control
products and systems. It serves three railroad markets: domestic freight,
domestic rail transit, and international, which includes both freight and
rail transit.

Harmon's design focus is microprocessor based and aimed toward systems and
products that improve the operating efficiency and safety performance of its
customers. Products include railroad signal and train control equipment,
train inspection systems, rail/highway grade crossing hardware and related
components.

Harmon emphasizes engineering innovation and rapid response to customer
needs. Many of its products provide sophisticated and timely solutions to
signal and control problems that impact the railroad industry.

Harmon is headquartered in Blue Springs, Missouri, a suburb of Kansas City.
It operates from numerous facilities in the U.S., Canada, England,
Switzerland, and Australia.

Harmon common stock trades on The Nasdaq Stock Market under the symbol: hrmn.
Its current annual dividend is 15 cents per share.

Table of Contents

Financial Highlights         1
Report to Shareholders       2
Harmon Markets               4
Corporate Progress          14
Selected Financial Data     16
Financial Review            18
Consolidated Financial
Statements                  24
Notes to Consolidated
Financial Statements        29
Investor Information        38
Management, Directors
and Corporate Data          39
Locations                   39


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FINANCIAL HIGHLIGHTS
(in thousands except per share data, where applicable)

OPERATING DATA
Year ended December 31,                  1996         1995      Percent Change
-------------------------------------------------------------------------------
Net sales                              $175,440     $136,780        + 28.3%
Pre-tax income                           15,105       11,180        + 35.1
Income taxes                              5,775        4,294        + 34.5
Net earnings                              9,330        6,886        + 35.5
Earnings per share                         1.36         1.01        + 34.7
Dividends per share                         .15          .15           -0-


PERFORMANCE DATA
Year ended December 31,                  1996          1995     Percent Change
-------------------------------------------------------------------------------
Return on sales (pre-tax)                   8.6%         8.2%       +  4.9%
Return on year-end equity                  16.1%        14.0%       + 15.0
Return on capital employed 1               25.9%        21.7%       + 19.4


YEAR-END DATA
December 31,                             1996          1995     Percent Change
-------------------------------------------------------------------------------
Working capital                        $33,629       $35,014         - 4.6%
Interest-bearing long-term debt          3,412        12,090         -71.8
Approximate number of shareholders 2       637           675         - 5.6
Number of employees                      1,200         1,075         +11.6
Outstanding shares (000s)                6,829         6,806         + 0.3


1  Return on capital employed is a measurement that encourages management to
   operate as efficiently as possible. It promotes reduced asset values relative
   to sales, and measures how effective it is (for example) to borrow money to
   purchase capital goods to reduce manufacturing costs. The formula is: the sum
   of pre-tax earnings plus interest expense divided by the sum of average total
   assets minus non-interest bearing liabilities.

2  Includes only registered shareholders. Since many shareholders hold their
   shares in "street name," the number of individual shareholders is larger than
   the number shown.

                                                                             1

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REPORT TO SHAREHOLDERS

In 1996, we celebrated our 50th anniversary by delivering the best year ever
for Harmon. Incoming orders increased 35% to $187.5 million. Shipments rose
28% to $175.4 million. Earnings before taxes were $15.1 million, and net
earnings increased 35% to a record $9.3 million, or $1.36 per share. Our
order backlog grew to $59 million from $49 million at 1995 year-end. This
performance was especially noteworthy because it was achieved in a year when
the rail supply industry as a whole was experiencing weak sales and earnings.

   Our record breaking performance in 1996 was due largely to a combination
of leading-edge technology, a partnership-service concept that we introduced
four years ago, a marketing strategy that commits us to grow simultaneously
in three markets: domestic freight, rail transit, and international, and
superb performances by our dedicated and talented employees who enabled us to
reach our 1996 objectives.

GROWTH STRATEGY

As Harmon continuously develops smarter, smaller and less expensive products,
it needs to grow its markets correspondingly. Consequently, we are working on
a growth strategy that dictates that we maintain our strong position with our
domestic freight railroad customers in our traditional product areas while
adding new products and services. It also requires us to enhance our
established position in the North American rail transit market, and seek
meaningful expansion within international markets with basically similar
products and technology that we provide to our domestic markets. This latter
focus is particularly important as the international markets are roughly
eight times as large as our domestic markets .

- DOMESTIC FREIGHT. We received record orders of $151 million in 1996. These
were 34% above 1995's intake and 94% ahead of our 1992 level. Part of that
five-year growth is the result of our having increased the number of our
service offerings over the past several years to include asset management and
on-time deliveries. Among our order gains for 1996 was our first turnkey
signal system installation. It entailed the design, manufacture and
installation of microprocessor interlockings, track circuits, hot box
detectors and rail/highway crossing systems for 150 miles of track at
Stampede Pass in Washington. We completed the job in just six months. The
speed of our performance was appreciated by the customer and confirmed Harmon
as a major force in time-sensitive turnkey installations.

   In 1996 we saw a continuing change from product business to systems
business, which, because of the size of systems, intensifies the need for
close, partnership relations. We intend to expand our services gradually by
expanding the partnership concept to include repair shops, installation
services, spare parts pools, proactive maintenance and other services.

- RAIL TRANSIT. We booked orders aggregating $22.5 million in 1996, a 19%
increase from 1995 and a ninefold gain over the past five years. This year's
orders included a $17.6 million contract to design and build a train control
system for New Jersey Transit's new light rail line. This was the largest
single contract ever awarded to Harmon. Other highlights included our
completion of the CTA Green Line rehabilitation project in Chicago in which
we acted as its main transit signal and systems supplier, an invitation from
the New York City Transit Authority to participate with other signal
suppliers in its planning process for future train control systems, and the
Florida Department of Transportation's agreement to award a consortium, of
which Harmon is a member, a franchise to build a 200 mph passenger train
system to link Miami to Orlando and Tampa.

- INTERNATIONAL. We booked orders amounting to $14.3 million in 1996, more
than twice what we received in 1995 and 14 times what we got in 1992. The
gain last year was sparked by our acquisition of Vaughan Harmon Systems Ltd.,
which produced orders in excess of $10 million. Vaughan Harmon is an industry
leader in Europe for software and systems, which gives us a strong entry into
the European market. Moreover, we expect our technology and products will be
a major factor in growing Vaughan Harmon's business. The market in the UK is
presently very strong as, after 2 1/2 years of little capital spending,
Railtrack is now planning

2
                                     34

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a major upgrade of its track systems, which presents a strong opportunity for
us.

STRATEGY VALIDATION

Our growth over the past five years is strong evidence that our strategy is
working, and we were very pleased with our performance in 1996.

STRATEGIC GOALS

Within our strategic plan, we have identified six areas where we need to be
better than our competition: customer service, quality/reliability, fast
cycle times, cost effectiveness, technology and systems integration.

   In order to further improve our CUSTOMER SERVICE, we merged our three
domestic operating subsidiaries into the parent company. We took this step to
improve operations internally by assigning total responsibility along
functional lines rather than through corporate subsidiaries. We also acquired
two contract engineering companies in Florida, and they will enhance our
industry position as a signal and engineering design company.

   To improve our QUALITY/RELIABILITY we focussed close attention on various
manufacturing and other processes. We now have two of our facilities TickIT
certified, and all but two ISO-9000 certified.

   To improve on our CYCLE TIMES, we reinforced our project management
resources. This was instrumental in our getting the CTA rehab contract in
Chicago and the 150 mile signal system turnkey installation contract at
Stampede Pass last year, as both were extremely time sensitive. This focus
has enabled us also to reduce our system delivery time from 90 to 60 days.

   We are approaching COST EFFECTIVENESS as it relates to the total cost
incurred by customers. This includes the cost of the product, its
installation cost, its subsequent maintenance cost, and the time involved to
complete a project. As a result of this focus, we find that our on-time
complete delivery service for signal installations has reduced installation
costs by 30-40%, resulting in material savings for the customer.

   To maintain our TECHNOLOGY leadership, we spend an average of four percent
of each sales dollar on research and development, which is yielding exciting
technology. Last October, we demonstrated our ITCS high speed train control
system in Michigan. Amtrak ran a passenger train at speeds up to 101 mph over
a distance of 20 miles. Amtrak's goal is to reduce the trip time between
Detroit and Chicago from 5 3/4 hours to 3 1/2 hours or less, a major advance
in enroute speed, which has already triggered some international interest.
Our system provides a cost effective means of improving safety and reducing
travel times because it can be integrated into other control systems
currently in place. In addition, our advanced technology and patented method
of applying cab signalling on board AC traction locomotives generated
substantial business for us in 1996.

   The trend towards INCREASED SYSTEMS INTEGRATION is continuing. In this
respect, Harmon is building up capabilities not only to integrate its
products into a system, but also to provide an interface for other existing
systems. This will enable us to supply our products to the replacement
market, regardless whether Harmon or another company made the original system.

GROWTH OUTLOOK

We strongly believe that we will be able to maintain our growth through the
remainder of the 20th Century. Most of the growth should come through
additional services for the freight railroads in North America and from
increased business both in the transit and international markets.

   The near-term perspective is more difficult to predict because of the
ongoing merger activities among the North American railroads. We are
presently experiencing a slowdown in our business as some railroads are
deferring certain capital expenditures, pending the outcome of ongoing
negotiations.

   But as we saw in 1996, once the mergers are completed, there is much work
to be done to consolidate track systems, which should give us many sales
opportunities. On balance, 1997 is expected to be another strong year for
Harmon.

/s/ Bjorn E. Olsson

Bjorn E. Olsson
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Blue Springs, Missouri, March 21, 1997

[GRAPHS:]

ORDERS BOOKED ($ - Millions)
92  93.4
93  121.5
94  127.9
95  138.6
96  187.5

NET EARNINGS ($ - Millions)
92  5.0
93  6.9
94  7.6
95  6.9
96  9.3

RETURN ON CAPITAL EMPLOYED
92  35%
93  39%
94  34%
95  22%
96  26%

                          [INSET PHOTO]

Photograph of Bjorn E. Olsson, President and Chief Executive Officer of
Harmon Industries, Inc.

GROSS SALES ($ - Millions)
92  82.5
93  98.8
94  119.1
95  136.1
96  183.9

                                                                              3

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HARMON MARKETS
Harmon's Potential and Performance

Harmon supplies signal and train control systems, products and services to three
rail markets: domestic freight, domestic rail transit, and international, which
is comprised of both freight and rail transit customers. Our strategy is to
develop lasting relationships with customers by providing safe, efficient and
technologically advanced products and services that enable them to enhance their
productivity.

An analysis of each market and the validity of our business strategies for each
of our three major markets follow.

DOMESTIC FREIGHT AND SERVICE

Domestic freight carriers purchase several hundred million dollars in signal
and train control systems and products annually. We derive the majority of
our revenues from this market. Our market share is roughly 30 percent. Our
sales volume increased in each of the last five years, concrete evidence of
how well our business strategy is working.

- GROWTH POTENTIAL

We have both a technological lead in products and systems, and a complete
service operation. Our near-term growth potential lies principally in
increasing the amount of services we provide. Over the longer term, we see an
increase in the size of this market.

One of the railroads' ongoing requirements is to reduce costs and increase
the utility of their rolling stock and infrastructure. These needs play to
our strengths.

Our product focus, in addition to providing safety, has always been to
develop products that provided direct cost savings or enhanced our customers'
efficiency, or both. Our advanced signal and control systems, for example,
enable railroads to achieve substantial cost savings quickly because Harmon
systems provide a rapid payback. Thus the opportunity to reduce operating
costs has become a strong incentive for the railroads to make cost-saving
equipment and system purchases, regardless of market conditions.

- EFFECT OF RAILROAD MERGERS

Railroad mergers are a fact of life. While merger negotiations are in
progress, an uncertainty sometimes surrounds the involved railroads'
intentions regarding their near-term capital goods purchases. In general, the
more ambitious and expansive projects are put on hold until the merger
negotiations run their course.

Once the merger is completed, our sales often increase for a period while the
new railroad seeks to modernize and consolidate its operations with more cost
effective equipment.

Mergers also tend to foster the sale of marginal operations to short line
railroads. This often means that these "feeder" railroads will also require
some revamping of their signals and controls. Further, short line railroads
often lack the staff to assemble the components and install them, a situation
that is tailor-made for our service organization.

Thus it can be fairly said that anticipated sales often shrink while merger
talks are in progress and then for a time grow to above average levels once
the merger is either completed or abandoned.

[CHART]

GROSS SALES - 1996
($- Millions)

Domestic              $142.1
Domestic Service       $22.2
Domestic Rail Transit  $14.4
International           $5.2

DURING THE PAST FIVE YEARS HARMON INCREASED ITS BUSINESS SUBSTANTIALLY BY
ENTERING THE SERVICE BUSINESS AS WELL AS THE NEW PROJECT MARKET FOR DOMESTIC
RAIL TRANSIT AND THE INTERNATIONAL MARKET.

DOMESTIC FREIGHT RAIL IS INDISPENSABLE. IT IS THE ONLY TRANSPORTATION
SYSTEM CAPABLE OF CARRYING MASSIVE LOADS. THIS MARKET IS HARMON'S LARGEST
SOURCE OF REVENUE, PROVIDING 77% OF ITS SHIPMENTS IN 1996.

4

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                       [PHOTO]

Photograph of rail cars on tracks at an industrial site.

                                     37
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                       [PHOTO]

Photograph of Chicago Transit Authority rail transit cars on tracks with a
Chicago background.

                                     38

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- COMPETITIVE POSITION

We occupy a dominant position in the signal and train control sector of the
domestic freight market.

- TECHNOLOGY

Our product development continues to capitalize on advances in technology.
Communications-based signalling, a subject of intense interest in both the
freight and rail transit markets, is a major focus of our R&D efforts. This
concept uses radio data communications to convey operating instructions
between computers on the ground and computers on trains, rather than relying
on human operators to correctly interpret trackside signal lights. Combined
with a means such as Global Positioning Satellites (GPS) to let the on-board
computer know its exact location on the track, these innovations can greatly
improve the efficiency of train operations while simultaneously enhancing
their safety.

Our Incremental Train Control System (ITCS), which is being installed on a
portion of Amtrak's high-speed rail line between Detroit and Chicago, is a
form of communications-based signalling. It enables trains to operate safely
at higher speeds than previously, making them more competitive with air
travel in many instances. A short segment of the system was demonstrated
successfully last October. It is now being expanded to complete a 71 mile
corridor, which will be operational in late 1997.

We also have a strong lead in on-board cab signal systems. Our Ultra Cab II,
combined with a unique patented antenna, is the only such product that can
operate successfully in the face of intense electrical interference generated
by new, high-power AC traction locomotives.

For many years, our Electro Code products have been in wide use by domestic
railroads. These products carry information through the rails between
trackside block signals and eliminate the need for wayside pole line.
Thousands of miles of pole line have been replaced with Electro Code, with a
resulting major increase in operating reliability and safety.

Our Vital Harmon Logic Controller (VHLC) is the product of choice of most
freight railroads for control of signals and switches at interlockings. Its
outstanding performance record and cost effectiveness have led to
installations of nearly 900 units, more than any other competitor's product
worldwide.

- SERVICE ADVANTAGE

Service has evolved into a major line of business for us, adding $22 million
to our revenues in 1996, up 57 percent from that of the previous year. Our
service arm warehouses commonly-used signal components (regardless of which
supplier manufactured them); manages customers' off-premise signal and
control inventories; and performs assembly of component parts. These
functions give us the ability to manage even complex projects from beginning
to end, which provides us with a powerful competitive advantage.

Adding project management to our expanding list of services proved timely.
Last year we completed a $13 million contract to modernize a freight
railroad's signal system at Stampede Pass in the Cascade Mountains. Time to
completion was a crucial element. Upon completion, it would enable our
customer to materially increase its freight traffic, thereby enhancing its
revenues.

AMTRAK'S HIGH SPEED
TEST RUN

                            [INSET PHOTO]

Photograph of an AMTRAK train on tracks in the countryside.

HARMON'S INCREMENTAL TRAIN CONTROL SYSTEM (ITCS) SUCCESSFULLY PASSED ITS INITIAL
TEST PHASE LAST OCTOBER ON A 20-MILE TRACK SECTION OF AMTRAK'S LINE IN
SOUTHWESTERN MICHIGAN. THIS IS THE FIRST STEP TOWARD AMTRAK'S REALIZATION OF
RAIL SERVICE BETWEEN DETROIT AND CHICAGO AT SPEEDS IN EXCESS OF 100 MPH.

IN KEEPING WITH ITS PHILOSOPHY OF DESIGNING COST EFFECTIVE PRODUCTS, THE HARMON
ITCS WAS MADE TO OPERATE WITH EXISTING SIGNALS AND CONTROLS, THUS MAKING IT
HIGHLY AFFORDABLE.

We furnished and installed all the signal equipment on 150 miles of main line,
plus six passing sidings and numerous rail/highway crossings. The project used a
broad spectrum of our products: HXP-3 for crossings, Electro Code for track
circuits, VHLC controllers for interlockings, plus the signals themselves and

HARMON'S TECHNOLOGICAL LEAD OVER ITS DOMESTIC COMPETITORS IS DUE LARGELY TO ITS
R&D FOCUS, WHICH AVERAGES FOUR PERCENT OF EVERY SALES DOLLAR.

                                                                              7

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                                  [PHOTO]

Photograph of a Harmon Industries, Inc. engineer testing train control
equipment.

                                     40
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other accessories. To maximize our installation productivity, our service
warehouse assembled complete installation kits and shipped them directly to
the site. Despite unfavorable weather and other obstacles, we finished the
project on schedule--a feat considered impossible by many.

- 1996 RESULTS

During 1996, our incoming orders from the domestic freight market were $151
million, an increase of 34 percent over the previous year. Our 1996 shipments to
freight railroad customers were $164 million, up 51 percent from those of 1995.
Our year-end backlog for domestic freight was $25 million.

- SUMMARY--DOMESTIC FREIGHT AND SERVICE

We have steadily increased our sales to the domestic freight railroad market
year after year. We are also helping to enlarge this market by providing
contract services in addition to our manufacture of products and systems.
Contract services have enormous potential. They come at a time when the
domestic freight railroads are heavily focussed on their primary
mission--moving freight economically. Consequently, many are downsizing their
ancillary roles to reduce operating costs, outsourcing many service and
purchasing functions they formerly did for themselves. We believe contract
services may well grow in size to rival our product and systems sales. It has
certainly given Harmon an additional sales opportunity that most of its
principal competitors do not possess. Consequently, we find our business is
growing at a time when some of our competitors' volumes are shrinking.

DOMESTIC RAIL TRANSIT

The size of the domestic transit market for our products is roughly the same
as that of the domestic freight market -- in excess of $300 million annually.
We have long served the repair and renovation side of this market, but the
new project side is relatively recent for us. We entered it in 1991. That
year the St. Louis Metro Link rail transit system accepted our electronic
signal solutions, and awarded us a contract to supply its signal and control
systems. Their acceptance of our electronic innovations became a defining
moment in Harmon history. Shortly thereafter, microprocessor-based systems
became widely accepted for domestic rail transit signal products and systems.

- FUNDAMENTAL DIFFERENCES

There are major differences between freight and rapid transit customers and
how business is done in the rail transit market.

   - The transit market involves moving people, not freight. Thus, in addition
     to safety and efficiency, other considerations such as train frequency and
     comfort are extremely important issues.

   - Unlike the freight railroads, which are generally focused on improving or
     extending existing facilities, the transit market is involved in major new
     starts as well as upgrades to its current signals and controls.

   - In some instances, new "turnkey" construction projects are so large that
     only huge corporations or consortiums can function as the general
     contractor. In these situations, Harmon takes on a subcontractor role for
     its portion of the project. For other projects, Harmon's increasing size
     and proven track record are enabling it to act as a prime contractor.

   - In many cases, the buyer is a municipal authority, not a private company.
     Since municipal authorities often lack the technical expertise to design
     a system, they

[CHART]

SERVICE REVENUES - 1995-96

$ - Millions

96  $22 million
95  $14 million

THE ADDITION OF A PROJECT MANAGEMENT FUNCTION TO HARMON'S SERVICE ORGANIZATION
AND A SIZABLE INCREASE IN SHIPMENTS TO EXISTING CUSTOMERS HELPED SERVICE
REVENUES INCREASE 57% IN THE PAST YEAR.

HARMON'S ENGINEERING DEPARTMENT WAS EXPANDED LAST YEAR TO ENABLE THE COMPANY TO
MAINTAIN ITS HIGH LEVEL OF PRODUCT INNOVATIONS.

                                                                             9

                                     41
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                                 [PHOTO]

Photograph of a rail transit passenger station with rail transit cars.

                                     42
<PAGE>

frequently rely on consultants to draw up the detailed specifications. As a
result, consulting firms are the gate keepers to projects. Initially, rail
transit consultants often ignored our microprocessor technology, preferring
to support older mechanical relay systems. Our initial success in St. Louis,
followed by subsequent installations in Chicago, Denver, New York,
Philadelphia, and San Diego, established the superiority of our systems. Many
rail transit consultants are now among our most enthusiastic supporters.
Winning them over was a critically important milestone in our sales strategy.

- In general, sizable fluctuations in orders received in any given year are
to be expected simply because the market consists of a relatively small
number of immense projects rather than a great volume of smaller orders,
which are typical in the freight markets. In addition, many projects are
spread out over several construction phases, which may extend from two to
five years, or more. Thus, winning the signal and control portion of a rail
transit project often translates into large order backlogs that may take
several years to complete. We expect to build such a backlog over the next
several years, which will tend to balance out year-to-year fluctuations in
shipments.

- For the most part, rail transit projects are funded by federal, state and
local governments. The funding is being driven, at least in part, by public
pressure to relieve congestion on already crowded highways and to reduce the
air pollution that accompanies automobile use. Rail transit has strong
support in Washington, which suggests that a reasonable level of federal
funding will be in place for at least several years.

- MARKET POTENTIAL

Domestic rail transit continues to expand. We expect to bid on signal and
control system contracts approximating several hundred million dollars for
rail transit projects in 1997 - both new and upgrade projects. Sources within
the industry indicate that projects of similar magnitude are likely to be put
out for bid each year through the year 2000.

- 1996 RESULTS

At year-end 1996, our rail transit backlog was $24 million, 74 percent in new
construction and the balance in repair and upgrade work. The new installation
backlog consisted principally of a $17.6 million contract awarded in
November, 1996, for us to design and build a microprocessor-based train
control system for a 9.5-mile light-rail system that will connect the New
Jersey cities of Bayonne and Hoboken. This project includes equipping 43
transit cabs with Ultra Cab units.

Total contracts received in 1996 were $22 million, up 19 percent over 1995
awards. Shipments for 1996 were off  32 percent at $14 million, which
reflected a drought in rail transit contracts awarded in 1995 and early 1996.

- SUMMARY - RAIL TRANSIT

The outlook is quite positive. Our products and systems are gaining greater
acceptance each year, largely because of their exemplary performance on jobs
undertaken during the past five years.

We have learned how to do business in this environment. We have been able to
join forces with some of the largest railroad builders in the world to assure
our participation in the multimillion dollar projects that are now in various
stages of planning. In addition, we have increased our service and project
management staffs so that we can be the prime contractor on installations
such as the $13 million Green Line project in Chicago. Finally, the amount of
planned new projects and repair and upgrades to existing systems is larger
than at any time in recent memory.

                                 [INSET PHOTO]

        Photograph of a rail passenger station with rail transit cars.

RAIL TRANSIT IS OFTEN SEEN AS THE BEST SOLUTION FOR RELIEVING TRAFFIC AND
ATTENDANT AIR POLLUTION IN MAJOR CITIES IN THE U.S.

HARMON MICROPROCESSOR TECHNOLOGY IS BEING EMBRACED BY RAIL TRANSIT AUTHORITIES.
LAST YEAR, ORDERS FOR HARMON RAIL TRANSIT EQUIPMENT REACHED $22 MILLION.

                                                                            11

                                     43
<PAGE>

                                 [PHOTO]

  Photograph of Vaughan Harmon Systems Ltd. train describer equipment


                              [INSET PHOTO]

       Photograph of a rail transit station in London, England.

                                     44
<PAGE>

INTERNATIONAL

The international market dwarfs the domestic market. It is estimated at $4-$5
billion annually, roughly eight times that of the North American freight and
rail transit markets, combined.

The international market holds enormous potential for Harmon. In many parts
of the world, notably China, India, Southeast Asia, Africa, Latin America,
and the former Soviet-bloc countries, significant investment in the railway
infrastructure is under way or being planned, with the addition of new lines,
modernization of existing lines and expansion of passenger services.

Railroads in the UK, South America and the European Continent are presently
undergoing a wave of privatization. Declining government subsidies to the
former state-run railways are creating greater demand for products that
deliver improved efficiency while assuring safe and reliable operations. This
new attention to economics opens the door for our products, as cost
effectiveness with safety has been a major product development focus of
Harmon for 50 years.

Our products and technologies continue to attract growing attention on the
international front. We anticipate an opportunity to demonstrate our
interlocking controls and crossing warning systems in the UK in 1997. Greater
acceptance of our products in Australia is providing Harmon with expanding
business opportunities there. In China, our established hot box detector
business is expanding, and several railroads have shown interest in testing
other Harmon products. In 1996, we were awarded a contract to resignal the
first 39 km of a 900 km mining railroad in Brazil, with potential for the
remainder to follow over the next several years. Other areas in South
America, along with major markets in Europe and Southeast Asia, are fertile
markets for Harmon's products.

- 1996 RESULTS

In 1996 we booked orders aggregating $14.3 million, up 107 percent from $6.9
million in 1995. Shipments rose 30 percent to $5.2 million from $4.0 million
in 1995. The considerable growth in 1996 included enhanced sales of our hot
box detectors, completion of a major cab signalling system in Australia, and
the introduction of software and several hardware products, which we obtained
when we acquired UK-based Vaughan Harmon Systems Ltd. last July.

Vaughan Harmon is a premier railroad software developer with a market leading
position in the UK specializing in train describer systems, passenger
information systems and modular railway control systems. In the first six
months after the acquisition, Vaughan Harmon produced $10 million in new
orders.

A key benefit that Vaughan Harmon brings is being a recognized and respected
rail systems supplier within the European Community. Thus, in addition to
having a strong local presence in the UK, Vaughan Harmon will serve as the
platform for Harmon's growth into the broader European signalling market.

- SUMMARY - INTERNATIONAL

Long-term, the international market affords us great promise because of its
enormous size. Numerous rail projects are either already underway or in
planning stages. In addition, the benefits of more cost-effective signal and
control systems are now gaining increased attention overseas.

Although our market penetration is growing each year, it remains small
relative to the overall market potential. Our growth strategy is threefold:
to foster additional partnership relations with multinational railroad supply
companies; to gain additional market inroads and rapid acceptance through
acquisitions of established, local rail suppliers, and to increase our direct
physical presence in overseas market areas.

                             [INSET PHOTO]

     Photograph of a train crossing a bridge in the countryside.

COMPARED TO THE DOMESTIC RAILROAD MARKET, THE INTERNATIONAL MARKET IS ROUGHLY
EIGHT TIMES LARGER. AN EMPHASIS ON PRODUCTS THAT DELIVER COST SAVINGS AS WELL AS
SAFETY HAS INCREASED HARMON'S POTENTIAL FOR INTERNATIONAL SALES.

VAUGHAN HARMON SYSTEMS LTD., WHICH WE ACQUIRED LAST JULY, IS A PREMIER RAILROAD
SOFTWARE DEVELOPER IN THE UK AND A MARKET LEADER IN THE MANUFACTURE OF TRAIN
DESCRIBERS (SHOWN AT LEFT), PASSENGER INFORMATION AND MODULAR RAILWAY CONTROL
SYSTEMS, WHICH CONTROL MANY PASSENGER AND COMMUTER TRAINS IN THE UK. IT PRODUCED
$10 MILLION IN NEW ORDERS IN THE FIRST SIX MONTHS WE OWNED THEM.

                                                                            13
                                     45
<PAGE>

CORPORATE PROGRESS

During the past several years, we have been reshaping Harmon so that it could
achieve our expanded growth objectives here and abroad. That effort was
intensified last year.

Some of the major issues were: adding staff to service our rail transit and
international markets; expanding our research and development efforts;
accelerating product development; introducing modular construction so that
our products could be readily modified to function equally well for freight
rail or rail transit --both at home and overseas; reshaping the corporate
structure along functional lines for better customer service; and finally,
managing our cash flow so we could accomplish what we set out to do.

In the space of five years, we:

   - Entered the new project segment of rail transit, which generated over $53
     million in shipments, and produced a $24 million backlog at year-end 1996;

   - Effectively expanded into the international market, which has since
     provided shipments of more than $12 million, including $5 million last year
     and a year-end backlog of $11 million;

   - Increased the size of our design and engineering staff by 164 percent. We
     expanded our engineering facilities at two locations and purchased two
     engineering companies last year;

   - Created a separate service organization that developed aggregate shipments
     of more than $70 million since 1991, and $22 million in 1996. It has been
     instrumental in our ability to take a complex project from beginning to
     end.

   - This capability enabled us to complete the Stampede Pass project last year
     in record time;

   - Established partnership relations with several major builders of rail
     transit systems, domestic as well as international;

   - Increased our bonding power to a point where we can bid on any project that
     fits our capabilities;

   - Obtained ISO 9000 certifications for nearly all our operations, including
     three last year; and finally,

   - Materially streamlined our organizational structure in 1996. The new
     structure enables us to be more productive and simultaneously more
     responsive to our customers' needs.

These accomplishments, which often involved substantial expenditures, were
made during a five-year period which saw Harmon revenues increase 147 percent
from $71 million to $175 million and net profits grow from less than $1
million to more than $9 million.

We believe our past record is evidence that our overall strategy is working
and that it is possible to build for the future internally and expand revenue
and earnings at the same time. These accomplishments are the bases for our
confidence in the future.

PRODUCT DEVELOPMENT

                                 [PHOTO]

   Photograph of a railroad highway grade crossing warning system.

UNRELENTING DEVELOPMENT OF SIGNAL AND TRAIN CONTROL SYSTEMS HAS ENABLED HARMON
TO WIDEN ITS POSITION AS A TOP SUPPLIER OF SUCH SYSTEMS TO FREIGHT RAILROADS IN
NORTH AMERICA.

STAMPEDE PASS, WASHINGTON. HERE HARMON MODERNIZED A FREIGHT RAILROAD'S SIGNAL
SYSTEM IN RECORD TIME. WITHOUT HAVING BUILT UP OUR SERVICE STAFF LAST YEAR, WE
COULD NOT HAVE UNDERTAKEN THE PROJECT.

14

                                   46
<PAGE>

                                     [PHOTO]

Photograph of track installation at Stampede Pass in the State of Washington.

                                  [INSET PHOTO]

    Photograph of a work crew installing equipment along a railroad track.

                                     47
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA (UNAUDITED)
(Dollars in thousands, except per share data)

<TABLE>
<CAPTION>

Years ended December 31                                     1996        1995       1994        1993        1992
------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>         <C>         <C>         <C>         <C>
OPERATIONS
Net sales                                                 $175,440    $136,780    $119,703    $ 99,295    $ 81,899
Cost of sales                                              126,997      96,094      81,023      65,716      54,271
Research and development expenditures                        6,331       5,218       4,561       3,442       3,541
                                                        ----------------------------------------------------------
Gross profit                                                42,112      35,468      34,119      30,137      24,087
Selling, general and administrative expenses                25,990      23,200      21,176      18,558      15,646
Other operating expenses (income)                              544         481          44         114         137
                                                        ----------------------------------------------------------
Operating income                                            15,578      11,787       12,899     11,465       8,304
Other expenses                                                 473         607          214        388       1,228
                                                        ----------------------------------------------------------
Pre-tax earnings (continuing operations)                    15,105      11,180       12,685     11,077       7,076
Income taxes                                                 5,775       4,294        5,046      4,193       2,498
                                                        ----------------------------------------------------------
Earnings from continuing operations                          9,330       6,886        7,639      6,884       4,578
Gain (loss) from discontinued operations                       -           -            -          -           165
Use of net operating loss carryforward                         -           -            -          -           273
                                                        ----------------------------------------------------------
Net earnings (loss)                                       $  9,330    $  6,886    $   7,639   $  6,884    $  5,016
                                                        ----------------------------------------------------------
                                                        ----------------------------------------------------------

Effective tax rate - continuing operations                    38.2%       38.4%        39.8%      37.9%       35.3
Return on sales - continuing operations                        5.3%        5.0%         6.4%       6.9%        5.6
Return on equity - continuing operations                      16.1%       14.0%        17.7%      20.8%      30.1%
Return on equity - total                                      16.1%       14.0         17.7%      20.8%      33.0%
Weighted average shares                                      6,844       6,827        6,567      6,212       5,275

PER SHARE DATA
Earnings from continuing operations                       $   1.36    $   1.01    $    1.16   $   1.11    $    .87
Net earnings (loss)                                           1.36        1.01         1.16       1.11         .95
Cash dividends                                                 .15         .15          .15        -          -
Book value                                                    8.48        7.23         6.40       5.23        2.82
Price/earnings ratio range                                8.8-14.3   13.2-20.3    14.2-20.9  10.5-20.9    3.6-13.4

OTHER DATA AT YEAR-END
Working capital                                           $ 33,629    $ 35,014    $  21,670  $  20,790   $ 10,740
Total assets                                               104,677      86,845       68,395     53,000     38,488
Long-term debt                                               3,412      12,090          733        439      4,898
Stockholders' equity                                        57,939      49,232       43,063     33,086     15,197
Current ratio                                               1.85:1      2.60:1       2.03:1     2.28:1     1.72:1
Quick assets ratio                                          1.01:1      1.16:1       1.03:1     1.32:1      .87:1
Liabilities to equity ratio                                  .81:1       .76:1        .59:1      .60:1     1.53:1
Capital additions (continuing operations)                    6,371       5,532        3,242      3,189      2,154
Capital additions (total)                                    6,371       5,532        3,242      3,189      2,154
Depreciation & amortization (continuing operations)          5,004       3,906        2,621      2,121      1,936
Depreciation & amortization (total)                          5,004       3,906        2,621      2,121      1,936
Outstanding shares (000s)                                    6,829       6,806        6,728      6,328      5,383

</TABLE>

16

                                     48
<PAGE>

<TABLE>
<CAPTION>
                                                                                 Five-Year    Ten-Year
                                                                                  Compound    Compound
   1991           1990          1989          1988          1987         1986      Growth      Growth
-------------------------------------------------------------------------------------------------------
<S>           <C>          <C>           <C>           <C>          <C>            <C>         <C>
$  70,934    $    72,707     $ 70,154      $  64,558     $  57,068    $ 47,223     + 19.85%    + 14.02%
   45,536         47,478       46,377         42,044        37,995      30,333
    4,000          3,414        3,200          3,669         3,318       2,360
------------------------------------------------------------------------------
   21,398         21,815       20,577         18,845        15,755      14,530     + 14.50%    + 11.23%
   13,550         14,427       13,186         11,965        10,671       9,362
    1,122             762        (263)           (27)           43         145
------------------------------------------------------------------------------
    6,726          6,626        7,654          6,907         5,041       5,023     + 18.29%    + 11.98%
    2,118          1,504        1,244          1,301         1,519         885
------------------------------------------------------------------------------
    4,608          5,122        6,410          5,606         3,522       4,138     + 26.80%    + 13.82%
    1,688          2,022        2,506          2,100         1,613       2,039
------------------------------------------------------------------------------
    2,920          3,100        3,904          3,506         1,909       2,099     + 26.15%     + 16.09%
   (2,492)       (12,306)      (2,744)        (1,020)         (217)        -
      395            -            -              -              -          -
------------------------------------------------------------------------------
$     823     $   (9,206)    $  1,160      $   2,486      $  1,692    $  2,099     + 62.52%     + 16.09%
------------------------------------------------------------------------------
------------------------------------------------------------------------------

     36.6%          39.5%        39.1%          37.5%         45.8%       49.3%
      4.1%           4.3%         5.6%           5.4%          3.3%        4.4
     39.6%          53.9%        26.5%          25.9%         16.5%       20.0%
     11.2%        (160.2%)        7.9%          18.3%         14.6%       20.0%
    5,066          4,723        4,633          4,479         4,472       4,854

$     .58       $    .66     $    .84      $     .78      $    .43     $   .43     + 18.58%     + 12.20%
      .16          (1.95)         .25            .56           .38         .43     + 53.42%     + 12.20%
      -            .0625         .125           .125          .125        .125
     1.48           1.20         3.19           3.03          2.59        2.34     + 41.88%     + 13.74%
21.9-45.3           N/A     23.0-35.0       9.5-14.8     13.2-22.4    15.4-27.3

$   9,660       $  7,955     $ 14,444      $   7,037      $  11,870    $ 11,599    + 28.34%     + 11.23%
   36,575         41,408       48,082         42,948         37,984      34,045    + 23.41%     + 11.89%
   11,915         17,220       17,688         12,139         14,621      13,793
    7,377          5,747       14,756         13,557         11,604      10,470    + 51.01%     + 18.66%
   1.71:1         1.49:1       2.08:1         1.45:1         2.17:1      2.36:1
    .76:1          .66:1        .84:1          .60:1         1.09:1       .96:1
   3.96:1         6.21:1       2.26:1         2.17:1         2.27:1      2.25:1
    1,098          2,187        2,236          1,830          1,504       2,212
    1,098          4,521        4,589          9,886          3,552       2,212
    2,022          2,410        2,373          2,541          2,481       2,074
    2,022          3,511        3,185          2,834          2,531       2,074
    4,998          4,790        4,628          4,478          4,472       4,472

</TABLE>
                                                                            17
                                     49
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

OVERVIEW

Harmon's overall business has been on an upward trend for the past several
years. It continues to increase its sales with its principal customers, the
Class I and Short-Line Railroads, and it now occupies a strong, competitive
position within the new construction portion of the rail transit market,
principally because of its advanced technology and service. Its international
business is also beginning to assume a meaningful role in Harmon's overall
sales, increasing 29% to over $5 million in 1996. Additionally, demand for
its purchasing, materials management and pre-assembly services supplied by
its asset management services business is growing rapidly as these services
fill an increasing need in the railroad industry, which continues to downsize
and outsource functions the industry previously did internally.

Harmon's growth has been aided also by acquisitions of businesses and/or
product lines that fit its core business. In July, 1996 Harmon acquired
UK-based Vaughan Systems Ltd. (since renamed Vaughan Harmon Systems Ltd.). It
was a strategic acquisition to increase Harmon's sales in Europe. Vaughan
Harmon is a designer of signal and control software and a leading
manufacturer of train describers, passenger information and modular railway
control systems, which complement Harmon's existing product line. It is a
promising acquisition, producing $3 million in sales in its first six months
of ownership, and $10 million in new orders, which will be shipped in 1997.
Harmon also acquired two railroad contract-engineering firms last year, which
provided a significant gain in engineering resources. In 1995 Harmon acquired
the assets of Atlanta-based Serrmi Services, Inc. It provides signal design
engineering and wiring and highway grade crossing services to freight
railroads. In 1994 Harmon acquired the Transportation Division of Servo
Corporation of America. It makes hot box detector systems and other railroad
monitoring devices. It has an established position overseas, especially in
Europe.

PROFILE OF CURRENT OPERATIONS

The Company's sales are summarized by product category in the table on page
19. The table also breaks out gross sales and percentages of total sales for
each of the past three years. Sales of Harmon crossing and control products
by its asset management services operation are included in those separate
descriptive categories. The value-added services supplied with those products
are included in the asset management services category.

Train Control Systems include products related to the control of train
movement. These include signal control track circuits (Electro Code);
interlocking control equipment such as Electro Logic, the Harmon Logic
Controller (hlc) and the Vital Harmon Logic Controller (vhlc); carborne
equipment (Ultra Cab); computer-based control systems; train describers; and
the design, wiring and installation of packages and systems comprised of
these products.

Crossing Systems include all products related to rail/highway crossing
warning systems. The products include train detection devices (the Company's
pmd and hxp, among others); flashing lights and cantilevers; and the design,
wiring and installation of packages and systems comprised of these products.

Asset Management Services is a single-source, rapid delivery service of
railroad components for railroad customers. It involves warehousing
commonly-used parts and equipment that are manufactured by the Company and by
other vendors. This service has been expanded in recent years to include
asset and materials management as well as kitting of various components,
which are delivered as a complete unit, ready for installation.

Train Inspection Systems include products that monitor the condition of
trains when they pass a train inspection site, and the design, wiring and
installation of packages and systems comprised of these products. The hot box
detector is the principal product, which is installed beside the track to
detect overheating bearings in passing rail cars, a serious condition that
could lead to derailments. Other products include a sensor to identify high
or wide loads and a device that detects foreign objects being dragged under a
rail car.

Printed Wiring Boards include production of customer designed printed wiring
boards for shipment to other electronics manufacturers.

Other sales include communication equipment and products that do not fit
readily into the other five categories.

18

                                     50
<PAGE>

SALES BY PRODUCT OR SERVICE FUNCTION *

                                           Years ended December 31,
                                       1996            1995             1994
                            -------------------------------------------------
(Dollars in thousands)        Amount     %      Amount     %      Amount     %
-------------------------------------------------------------------------------
Train Control Systems       $ 87,080   47.3%   $ 55,437  40.7%   $ 45,711  38.4%
Crossing Systems              48,927   26.6%     42,375  31.1%     35,448  29.8%
Asset Management Services     22,217   12.1%     14,194  10.4%     20,894  17.5%
Train Inspection Systems      12,906    7.0%     11,360   8.4%      5,054   4.2%
Printed Wiring Boards          5,249    2.9%      6,752   5.0%      6,307   5.3%
Other                          7,489    4.1%      5,999   4.4%      5,712   4.8%
                            ----------------------------------------------------
    Total                   $183,868  100.0%   $136,117 100.0%   $119,126 100.0%
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
*   Sales volumes shown above are gross totals and do not include cash
    discounts or deferred contract revenue. As a result, there are differences
    between the figures in this table and those presented in the Consolidated
    Statements of Earnings. The differences do not affect the validity of the
    discussion and analysis.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994.

Net sales increased 28% to a record $175.4 million for 1996 compared with
$136.8 million for 1995 and $119.7 million for 1994. Net earnings increased
35.5% to a record $9.3 million in 1996 ($1.36 per share) compared with $6.9
million in 1995 ($1.01 per share). The increase in earnings from 1995 to 1996
was due chiefly to substantially higher sales in 1996. Return on equity was
16.1% for 1996 compared with 14.0% for 1995. Return on capital employed was
25.9%, up from 21.7% in 1995. Net earnings for 1995 were 9.9% below the
previous record net earnings of $7.6 million ($1.16 a share) reported for
1994. The decrease in earnings between 1995 from 1994 was due to a higher
cost of sales principally occasioned by production issues related to an
acquired hot box detector line, operating inefficiencies resulting from
customer-induced delays in shipments, a $657,000 increase in research and
development expenditures, and higher interest costs.

SALES ANALYSIS

The railroad industry has been moving toward the purchase of entire systems
and away from the purchase of individual components. This trend reflects the
railroads' desires to fix operational responsibility on one supplier and to
place orders with large suppliers, which have broad-based product lines,
meaningful research and engineering support, and strong service capabilities.
This trend has played to Harmon's strengths, which are evident in a $31.6
million increase to $87.1 million in sales of train control systems, a $6.6
million increase to $48.9 million in sales of crossing systems, and an $8.0
million increase to $22.2 million in sales of services in 1996 compared with
1995. The increase in train control system sales is a result of increased
orders from recently-merged railroad companies, greater sales of Harmon's
Ultra Cab and the initial sale of Harmon's Incremental Train Control system
to Amtrak. The increase in crossing system sales primarily reflects higher
levels of business with recently-merged railroad companies. Train inspection
sales increased 13.6% in 1996, and generally reflected increased domestic
sales. The sales gain in asset management services reflects orders that were
put on hold in 1995 and subsequently released in 1996. Sales of printed
wiring boards were down 22.3%, which is the result of a general downturn in
that industry.

Harmon's strengths in crossing and control systems and asset management
services were the principal reasons its 1996 sales reached a record $175.4
million, which was $38.7 million greater, or 28.3%, than those of 1995. Net
sales of $136.8 million in 1995 were 14.3% ahead of those of 1994. The sales
improvement over 1994 was due to gains in train control, crossing control and
train inspection system sales. Approximately half of the gain was the result
of a combination of the Serrmi acquisition and a resurgence in rail-highway
crossing system sales. The remainder reflected gains in shipments on rail
transit contracts, carborne equipment, and hot box detectors. Sales of asset
management services were down $6.7 million in 1995 when shipments were
delayed because of railroad merger activity.

                                                                            19

                                     51
<PAGE>

OPERATING SUMMARY

<TABLE>
<CAPTION>
                                         Percentage of Net Sales              Percentage of Change
                                      -------------------------------------------------------------------
                                         Years ended December 31,          1996       1995       1994
                                                                           over       over       over
                                       1996       1995       1994          1995       1994       1993
---------------------------------------------------------------------------------------------------------
<S>                                   <C>       <C>        <C>           <C>       <C>          <C>

Net sales                             100.0%     100.0%     100.0%        28.3%      14.3%       20.6%
Cost of sales                          72.4%      70.3%      67.7%        32.2%      18.6%       23.3%
Research and development                3.6%       3.8%       3.8%        21.3%      14.4%       32.5%
                                      -------------------------------------------------------------------
Gross profit                           24.0%      25.9%      28.5%        18.7%       4.0%       13.2%
Selling, general and administrative
 expenses                              14.8%      17.0%      17.7%        12.0%       9.6%       14.1%
Other operating expenses, net           0.3%       0.4%       0.0%        13.1%     993.2%      (61.4)%
                                      -------------------------------------------------------------------
Operating income                        8.9%       8.5%      10.8%        32.2%      (8.6)%      12.5%
Other expenses                          0.3%       0.4%       0.2%       (22.1)%    183.6%      (44.8)%
                                      -------------------------------------------------------------------
Earnings before income taxes            8.6%       8.1%      10.6%        35.1%     (11.9)%      14.5%
Income taxes                            3.3%       3.1%       4.2%        34.5%     (14.9)%      20.3%
                                      -------------------------------------------------------------------
Net earnings                            5.3%       5.0%       6.4%        35.5%      (9.9)%      11.0%
                                      -------------------------------------------------------------------
                                      -------------------------------------------------------------------

</TABLE>

The table above illustrates the percentage relationship to net sales for
certain items reflected in the Company's Consolidated Statements of Earnings
and the percentage increase or decrease in the dollar amounts of such items
year-to-year.

Sales of the Company's signal and control systems are influenced by various
factors. They include the financial condition of the railroad industry, the
railroads' budgets for planned equipment expenditures and the level of
activity in authorizing grade crossing warning system improvements. These
improvements receive up to 80% federal support, up to an authorized limit of
$160 million. Authorization expires in 1997, and the Congress is presently
working on an extension of this funding. Rail transit funding for train
control and signal systems is expected to approximate 1996 levels.

The market for the remainder of the Company's products is largely dependent
on the financial condition of the railroad industry, the trend of the general
economy, and individual railroads' budgets for capital expenditures and
repairs and maintenance. At year-end 1996, the railroad industry as a whole
was healthy, and it continued to look for ways to improve profits, which
includes the purchase of more efficient operating systems, the use of
outsourced services, and better utilization of current capital equipment. The
industry was also merger minded, which historically has reduced capital
spending while mergers were pending and increased spending after they were
completed.


GROSS PROFIT Gross profit as a percent of sales declined to 24.0% for 1996
compared with 25.9% in 1995 and 28.5% in 1994. The decline in 1996 reflects
the effect of the material increase in system sales, including the Stampede
Pass project, which included wafer-thin profit margins on roughly $6 million
of pass-through sales, and an increase in asset management revenues, which
traditionally provide only modest profit margins. Additionally, the Company
absorbed product upgrade costs of approximately $2.3 million in 1996. These
narrow margins and product upgrade costs were modestly offset, relative to
1995, by the absence of start-up costs for the hot box detector line.

The decline in gross profit margins in 1995 from those of 1994 was caused
primarily by inefficiencies in manufacturing the acquired hot box detector
product line, difficulties encountered by the Company when its shipment
stream was interrupted by railroad merger activity, increased r&d
expenditures and from low margins obtained on pass-through sales that were
part of rail transit contracts.

Traditionally, declining profit margins have negative connotations. Harmon's
experience is otherwise. Management's focus is on net earnings, and less so
on margins. It takes on additional lower margin business when overall
increased profits are likely to occur. Its asset management service business
illustrates this business concept. Standing

20

                                     52
<PAGE>

alone, it is a low margin, but profitable business. But when linked to
Harmon's total business strategy, it makes a healthy profit contribution
because its function adds to the overall sale of Harmon products and systems,
and it performs a service few others in the railroad industry can match.
Moreover, the Company believes this service business will increase as the
railroads continue to outsource their asset management and maintenance
projects.

RESEARCH AND DEVELOPMENT

Research and development expenses increased $1.1 million in 1996, which
illustrates Harmon's commitment to incorporating new technology into its
products. The principal reason for the increase in 1996 was related to
Harmon's intense efforts directed toward the continued development of its
Incremental Train Control System.

Although R&D expenditures were up in absolute terms for 1996, as a percent of
sales they declined fractionally because of the sharp increase in 1996 sales.
Expenditures in 1995 were $670,000 above those in 1994. In both prior years,
R&D as a percentage of sales was 3.8%.

SELLING, GENERAL & ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses (sg&a) for 1996 were $26.0
million, roughly $2.8 million higher than those of 1995. The 1996 increase
principally relates to the 28% sales increase, which generated more sales
expense and increased profit-based incentive compensation. While sg&a
expenses increased in absolute dollar terms last year, their cost relative to
net sales declined for the third consecutive year--to 14.8% of sales from
17.0% in 1995 and 17.7% in 1994. The $7 million increase in service revenues
in 1996 helped reduce sg&a expenses as a percent of sales because the asset
management services operation incurs proportionally less sg&a expenses per
dollar of revenue than Harmon's other revenue producing units. This
illustrates the beneficial effect on profits when otherwise low-margin
business is added to an already profitable enterprise. Moreover, the 1996
dollar increase in sg&a expenses was only 12% above that of 1995, or roughly
40% of the increase in sales from 1995 to 1996. In short, for every dollar of
increased sg&a expenses in 1996, the Company increased its sales
two-and-a-half fold. Thus relative sg&a cost savings at the corporate level
were a major factor in Harmon's $2.4 million increase in net earnings in
1996. These same expenses increased approximately $2.0 million to $23.2
million for 1995 from $21.2 million for 1994. The downward trend as a
percentage of net sales reflects gains in cost controls and the fixed nature
of certain costs. The absolute increase in dollars each year basically
reflects the result of inflation, commissions incident to higher sales
volume, and additions to sg&a expenses incident to acquisitions made in 1996,
1995 and 1994. These expenses were offset somewhat in 1995 by lower
profit-based bonuses.

AMORTIZATION EXPENSES

Amortization expenses increased 7.3% in 1996 and 601% in 1995. The increase
in 1996 is attributable to three acquisitions made that year, and in 1995 to
the acquisitions of the assets of Serrmi Services, Inc. in the first quarter
of 1995, and the hot box detector line of Servo Corporation of America at the
end of 1994. Acquisitions in 1994 were of little consequence relative to
increases in amortization expenses.

OTHER OPERATING EXPENSES

Changes in other operating expenses were insignificant in 1996, 1995 and 1994.

INTEREST EXPENSE

Interest expense was $724,000 in 1996, $741,000 in 1995 and
$264,000 in 1994. The decrease in 1996 reflected lower average borrowings in
1996. The increase for 1995 reflected increased borrowings to finance
acquisitions and to provide working capital that year.

INCOME TAXES

The Company's effective income tax rate for 1996 was 38.3% compared with
38.4% in 1995 and 39.8% for 1994. The tax rate was lower in 1995 than 1994
because more business was done in states with lower tax rates in 1995 than
1994.

INFLATION

Inflation has been moderate during the past three years, averaging 3% to 4%
for materials and wages. Competitive pressure has required the Company to
maintain or reduce sales prices to sustain market share. Management believes
that competitive pricing pressures will remain for the

                                                                            21

                                     53
<PAGE>

foreseeable future. Its program to combat this is to continue to increase
productivity, adopt emerging lower-cost technological advances into its
products, expand its available products through internal development and
acquire products or companies in the railroad supply industry that will
expand Harmon's product or service offerings.

LIQUIDITY, CASH FLOW AND CAPITAL RESOURCES

The Company has a very strong balance sheet at 1996 year-end. Total assets
were $104.7 million, up $17.8 million. Stockholders' equity rose to $57.9
million ($8.48 per share) from $49.2 million ($7.23 per share). Working
capital was $33.6 million, which produced a current ratio of 1.85:1 compared
to 2.6:1 a year earlier. Cash was negligible at both year-ends, and
interest-bearing debt was down $8.7 million at 1996 year-end, which reflects
Harmon's aggressive cash management policies. Cash was used to fund the
acquisitions of two engineering firms and Vaughan Harmon Systems Ltd. ($2.1
million), capital expenditures of $6.4 million, increased receivables of
$14.3 million (largely because of the $19.5 million increase in sales in the
1996 fourth quarter), and to support increased year-end inventories. The
majority of the receivables were collected in January, 1997.

The Company renegotiated its primary bank lines of credit in 1996, which
increased its line of credit to $35 million at reduced interest rates
compared with $18 million a year earlier. At December 31, 1996, approximately
$3 million was borrowed against this line versus $11.5 million at 1995
year-end. In January, 1997 all outstanding borrowings on the line of credit
were paid off. Additionally, the Company completed a private placement of
unsecured senior notes, priced to yield 6.87%, which provided an additional
$15 million of cash and long-term debt with a ten year maturity. Thus, by
January, 1997 the Company had $50 million available for use. Capital
expenditures for 1997 are budgeted at $11 million, roughly $4.6 million
higher than the capital expenditures for 1996. Traditionally, the Company
spends less on capital expenditures than it actually budgets.

1997 OUTLOOK

There is much to be optimistic about for 1997. The Company's core business is
solid. It began the new year with a record backlog of $59.4 million, up $10.3
million from the year earlier backlog of $49.1 million. Customer acceptance
of our newer products has been excellent. In addition, the pending Union
Pacific/Southern Pacific merger may generate additional business.

Despite the favorable climate for increased business for Harmon, there are
some uncertainties to consider as well. Among them are whether the economy
and our railroad customers will perform as well in 1997 as they did in 1996,
and whether government funding for rail transit and grade crossing warning
systems will continue as before, and whether our r&d departments will
continue their output of innovative and very successful products. Further,
1996 sales included a $13 million contract of a onetime nature which will not
recur in 1997.

Merger activity in the railroad industry remains strong. Mergers typically
create short-term problems, particularly with shipment continuity and
immediate new business. The proposed eastern railroad merger battle may
sharply reduce 1997 capital expenditures of these major customers until that
issue is resolved. Long-term, however, mergers often prove beneficial as the
surviving entity often consolidates traffic patterns to strengthen its
operations, which for Harmon translates into additional orders for crossing
and control systems.

Finally, we are operating at near-capacity in several areas of our business.
Accordingly, we will spend substantial sums of money over the next several
years to expand capacity in order to bid on larger contracts and to produce
larger and more complex systems. We are addressing these issues by expanding
our manufacturing space at several locations and increasing the size of our
research and development center to accommodate many additional engineers. In
this latter regard, the Company opened an expanded r&d facility at its plant
site in Grain Valley, Missouri, in 1996, and it plans further expansions in
1997 and beyond.


The Company's goal is to achieve an annual order rate of approximately $300
million by the year 2000. This goal is predicated upon maintaining our
current product and systems sales levels and increasing our service business
to the domestic freight railroad market. It also assumes we will book a
representative share of the mass transit

22

                                     54
<PAGE>

projects that are presently contemplated for release during the next three
years, and that our aggressive pursuit of business in the international
market will result in material sales gains. It does not depend on
acquisitions. It should be recognized that these are goals, not forecasts.
Much depends on the future trends of domestic and international economies,
which are unknown.

OTHER

The Company streamlined its organizational structure during 1996, merging its
domestic operating subsidiaries into the parent company effective January 1,
1997. Harmon is now organized along functional lines instead of separate
operating subsidiaries. This realignment is designed to improve customer
service and streamline overall operations.

There are no pending accounting pronouncements that would have a significant
effect on the Company's financial statements.

FOURTH QUARTER RESULTS

Sales for Harmon's 1996 fourth quarter were $56 million, 53.4% greater than
its 1995 fourth quarter sales of $36.5 million. Cost of sales as a percentage
of sales was 78.4% in 1996 compared with 70.8% in 1995. The difference
between the two years reflects greater shipments of lower margin products in
1996, chiefly asset management services, which carry smaller markups than
Harmon-manufactured goods and often include pass-through business--products
not germane to Harmon's core business but which are purchased by Harmon to
complete a turnkey project. A sizable portion of the 1996 fourth quarter
sales included asset management service business from two of its largest
customers, and the completion of a $13 million turnkey project in the Cascade
Mountains, of which approximately 50% was pass-through business.

Net earnings for the 1996 fourth quarter were $2.1 million, or $0.31 per
share, compared with $1.8 million, or $0.27 per share, for the 1995 fourth
quarter.

QUARTERLY CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
(Dollars in thousands, except per share data)

<TABLE>
<CAPTION>

                                              1996                                                1995
Quarters ended             March 31    June 30    Sept. 30    Dec. 31         March 31     June 30    Sept. 30     Dec. 31
---------------------------------------------------------------------------------------------------------------------------------
<S>                        <C>        <C>         <C>       <C>               <C>        <C>          <C>         <C>

Net sales                  $ 38,397   $ 39,111    $ 41,957   $ 55,975         $ 29,415    $ 32,854    $ 38,026    $  36,485
Cost of sales                27,224     26,141      29,721     43,911           21,330      21,971      26,954       25,839
R&D expenditures              1,458      1,726       1,492      1,656            1,022       1,236       1,503        1,457
                           -----------------------------------------------------------------------------------------------------
Gross profit                  9,715     11,244      10,744     10,408            7,063       9,647       9,569        9,189
Selling, general and
  administrative expenses    6,164       6,560       6,491      6,774            5,612       5,990       5,464        6,134
Amortization                   137         137         154        159              133         133         144          137
Miscellaneous (income)
  expense-net                  (16)        (14)        (14)         2              (25)         (7)        (13)         (21)
                           -----------------------------------------------------------------------------------------------------
Operating income             3,430       4,561       4,113      3,473            1,343       3,531       3,974        2,939
Investment income              169          29          28         25               17          60           4           53
Interest expense               255         234         123        112              147         190         197          207
                           -----------------------------------------------------------------------------------------------------
Pre-tax earnings             3,344       4,356       4,018      3,386            1,213       3,401       3,781        2,785
Income taxes                 1,269       1,699       1,530      1,278              507       1,343       1,501          943
                           -----------------------------------------------------------------------------------------------------
Net earnings               $ 2,075    $  2,657    $  2,488   $  2,108         $    706    $  2,058    $  2,280    $   1,842
--------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------
Earnings per
  common share             $  0.30    $   0.39    $   0.36   $   0.31         $   0.10    $   0.30    $   0.33    $    0.27
--------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------
Weighted average
  shares (000s)              6,829       6,840       6,844      6,864        6,815         6,824       6,837         6,834
--------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------
    Quarterly per share amounts may not add to annual amounts due to the
    timing of net earnings and changes in common stock equivalents during
    each year.

</TABLE>

                                     55
<PAGE>

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)





At December 31,                                                  1996     1995
--------------------------------------------------------------------------------


ASSETS

Current assets:
    Trade receivables, less allowance for doubtful accounts
     of $307 in 1996 and $362 in 1995                          $ 39,656  $25,317
    Costs and estimated earnings in excess of billings on
     uncompleted contracts (note 2)                               1,665    4,053
    Inventories:
         Work in process                                          4,145    4,583
         Raw materials and supplies                              23,076   21,262
                                                               -----------------
                                                                 27,221   25,845
    Income tax receivable                                           -        434
    Deferred tax asset (note 4)                                   1,637      584
    Prepaid expenses and other current assets                     2,851      608
                                                               -----------------

              Total current assets                               73,030   56,841
                                                               -----------------
Property, plant and equipment, at cost (note 3):
    Land                                                            356      356
    Buildings                                                     9,010    5,802
    Machinery and equipment                                      14,292   12,820
    Office furniture and equipment                               16,032   14,589
    Transportation equipment                                      1,236    1,036
    Leasehold improvements                                        2,395    2,288
                                                               -----------------
                                                                 43,321   36,891
    Less accumulated depreciation and amortization               25,389   22,714
                                                               -----------------
              Net property, plant and equipment                  17,932   14,177

Deferred tax asset (note 4)                                         738      621
Cost in excess of fair value of net assets acquired, net of
 accumulated amortization of $2,483 in 1996 and $1,896
 in 1995 (note 11)                                                7,606    7,674
Deferred compensation asset (note 6)                              4,998    5,575
Other assets                                                        373    1,957
                                                               -----------------
                                                               $104,677  $86,845
                                                               -----------------
                                                               -----------------


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.



24

                                     56
<PAGE>

At December 31,                                                  1996     1995
--------------------------------------------------------------------------------

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Current debt installments (note 3)                         $    737  $   337
    Accounts payable                                             15,119   11,698
    Accrued payroll, bonus and employee benefit plan
     contributions (note 6)                                      10,892    6,688
    Billings in excess of costs and estimated earnings on
     uncompleted contracts (note 2)                               5,926    1,279
    Other accrued liabilities                                     6,235    1,825
    Current tax liability                                           492      -
                                                               -----------------
              Total current liabilities                          39,401   21,827
                                                               -----------------


Deferred compensation liability (note 6)                          3,925    3,696
Long-term debt (note 3)                                           3,412   12,090
                                                               -----------------
              Total liabilities                                  46,738   37,613

Stockholders' equity (notes 3 and 7):
    Common stock of $.25 par value; authorized 20,000,000
     shares, issued 6,829,273 shares in 1996 and 6,805,626
     shares in 1995                                               1,707    1,702
    Additional paid-in capital                                   23,194   23,003
    Foreign currency translation                                    203      -
    Retained earnings                                            32,835   24,527
                                                               -----------------
              Total stockholders' equity                         57,939   49,232

Commitments and contingencies (notes 6 and 10)





                                                               -----------------
                                                               $104,677  $86,845
                                                               -----------------
                                                               -----------------



                                                                              25
                                     57
<PAGE>

CONSOLIDATED STATEMENTS OF EARNINGS

(Dollars in thousands, except per share data)





Years ended December 31,                           1996       1995       1994
--------------------------------------------------------------------------------
Net sales                                        $175,440   $136,780   $119,703
Cost of sales                                     126,997     96,094     81,023
Research and development expenditures               6,331      5,218      4,561
                                                 ------------------------------
              Gross profit                         42,112     35,468     34,119
                                                 ------------------------------

Selling, general and administrative expenses       25,990     23,200     21,176
Amortization of cost in excess of fair value
 of net assets acquired                               587        547         78
Miscellaneous income - net                             43         66         34
                                                 ------------------------------
              Operating income                     15,578     11,787     12,899

Interest expense                                      724        741        264
Investment income                                     251        134         50
                                                 ------------------------------
              Earnings before income taxes         15,105     11,180     12,685

Income tax expense (benefit) (note 4):
    Current                                         6,945      4,413      5,098
    Deferred                                       (1,170)      (119)       (52)
                                                 ------------------------------
                                                    5,775      4,294      5,046
                                                 ------------------------------
              Net earnings                       $  9,330   $  6,886   $  7,639
                                                 ------------------------------
                                                 ------------------------------

Earnings per common share                        $   1.36   $   1.01   $   1.16
                                                 ------------------------------
                                                 ------------------------------

Weighted average shares outstanding (000s)          6,844      6,827      6,567
                                                 ------------------------------
                                                 ------------------------------


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.



26

                                     58
<PAGE>

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Dollars in thousands)



<TABLE>
<CAPTION>

                                        Additional  Foreign                 Total
                               Common    Paid-in    Currency   Retained  Stockholders'
                               Stock     Capital   Translation  Earnings  Equity
------------------------------------------------------------------------------------
<S>                            <C>       <C>       <C>          <C>       <C>
BALANCE AT DECEMBER 31, 1993  $1,582     $19,513    $    -      $11,991   $33,086
Net earnings                     -         -             -        7,639     7,639
Cash dividends paid
 ($0.15 per share)               -         -             -         (968)     (968)
Common stock issued (notes 7
 and 11):
    Servo acquisition             65       2,860         -         -        2,925
    Stock options and other       35         346         -         -          381
                              ------------------------------------------------------

BALANCE AT DECEMBER 31, 1994   1,682      22,719         -       18,662    43,063
Net earnings                     -           -           -        6,886     6,886
Cash dividends paid
 ($0.15 per share)               -           -           -       (1,021)   (1,021)
Common stock issued (note 7):
    Stock options and other       20         284         -         -          304
                              ------------------------------------------------------

BALANCE AT DECEMBER 31, 1995   1,702      23,003         -       24,527    49,232
Net earnings                     -           -           -        9,330     9,330
Cash dividends paid
 ($0.15 per share)               -           -           -       (1,022)   (1,022)
Common stock issued (notes 7
 and 11):
    Acquisition of businesses      4         146         -         -          150
    Stock options and other        1          45         -         -           46
Foreign currency translation     -           -          203        -          203
                              ------------------------------------------------------
BALANCE AT DECEMBER 31, 1996  $1,707     $23,194         $203     $32,835   $57,939
                              ------------------------------------------------------
                              ------------------------------------------------------
</TABLE>

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.



                                                                              27

                                     59
<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)





Years ended December 31,                            1996      1995       1994
--------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings                                      $  9,330  $  6,886   $  7,639
Adjustments to reconcile net earnings to net cash
 provided by (used in) operating activities:
    Depreciation and amortization                    5,004     3,906      2,621
    Gain on sale of property, plant and equipment       (5)      (34)        (6)
    Deferred tax expense (benefit)                  (1,170)     (119)       211
Changes in assets and liabilities, net of
 acquisition of businesses:
    Trade receivables                              (13,740)   (3,860)    (3,046)
    Inventories                                     (1,060)   (7,830)    (1,558)
    Estimated costs, earnings and billings on
     contracts                                       7,381    (2,873)      (920)
    Prepaid expenses and other current assets         (360)      131       (109)
    Accounts payable                                 3,345     3,052      2,588
    Accrued payroll and benefits                     4,000      (651)     1,506
    Other liabilities                                5,007      (478)    (1,423)
    Other deferred liabilities                         371       157        304
                                                  ------------------------------
         Total adjustments                           8,773    (8,599)       168
                                                  ------------------------------
              Net cash provided by (used in)
               operating activities                 18,103    (1,713)     7,807
                                                  ------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures                                (6,371)   (5,532)    (3,242)
Acquisition of businesses                           (2,146)   (1,182)    (6,661)
Proceeds from sale of property, plant and
 equipment                                              46        84         30
Deferred compensation, net                          (1,339)     (429)      (524)
Other investing activities                           1,584      (974)       (37)
                                                  ------------------------------
              Net cash used in investing
               activities                           (8,226)   (8,033)   (10,434)
                                                  ------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock                  46       292        300
Cash dividends                                      (1,022)   (1,021)      (968)
Borrowings under line of credit agreements          46,530    31,152      5,075
Repayments under line of credit agreements         (55,165)  (20,491)    (4,275)
Principal payments of long-term debt                  (469)     (436)      (320)
                                                  ------------------------------
              Net cash provided by (used in)
               financing activities                (10,080)    9,496       (188)
Foreign currency translation                           203       -          -
Net decrease in cash and cash equivalents              -        (250)    (2,815)
                                                  ------------------------------
Cash and cash equivalents at beginning of year         -         250      3,065
                                                  ------------------------------
Cash and cash equivalents at end of year          $    -    $    -     $    250
                                                  ------------------------------
                                                  ------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
    Interest                                      $    690  $    661   $    265
    Income taxes                                  $  6,019  $  4,167   $  5,939

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.


28

                                     60
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





1. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION. The consolidated
financial statements of the Company include the accounts of Harmon
Industries, Inc., and its wholly-owned subsidiaries, Harmon Electronics,
Inc. (HEI), Electro Pneumatic Corporation (EPC), Consolidated Asset
Management Company, Inc. (CAMCO), Harmon Railway Systems International
(HRSI) and Vaughan Harmon Systems Limited (Vaughan Harmon). Effective
January 1, 1997 HEI, EPC and CAMCO were merged with and into Harmon
Industries, Inc. such that Harmon Industries was the surviving corporation.

Significant intercompany accounts and transactions have been eliminated in
consolidation. Management of the Company has made estimates and assumptions
relating to the reporting of assets and liabilities and disclosure of
contingent liabilities to prepare these financial statements in conformity
with generally accepted accounting principles. Actual results could differ
from those estimates.

NATURE OF BUSINESS. The Company is a major supplier of signal and train
control products to railroads throughout North America and the world. It
manufactures an extensive line of railroad signal and communication
equipment, traffic control systems, rail/highway grade crossing hardware and
related components. The Company also provides a single-source, rapid delivery
service for urgently needed railroad components by warehousing commonly-used
parts and equipment, which are manufactured both by Harmon and other vendors.

INVENTORY VALUATION. Inventories are valued primarily at the lower of cost
(first-in, first-out) or market (net realizable value). The components of
cost are labor, materials and an allocation of manufacturing overhead.

PROPERTY, PLANT AND EQUIPMENT. Buildings, machinery and equipment, office
furniture and equipment, transportation equipment and leasehold improvements
are being depreciated or amortized using the straight-line method over the
estimated useful lives of the assets, which range from two to thirty-three
years. Maintenance and repairs are charged to operations as incurred.
Renewals and betterments are capitalized as additions to the appropriate
asset accounts. Upon sale or retirement of assets, the cost and related
accumulated depreciation applicable to such assets are removed from the
accounts, and any resulting gain or loss is reflected in operations.

INCOME TAXES. Income taxes are accounted for in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes. Under
the asset and liability method of Statement 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period that includes
the enactment date.

LONG-TERM CONTRACTS. Profits on long-term contracts are recorded on the basis
of the Company's estimates of the percentage of completion of individual
contracts. That portion of the total contract price is accrued which is
allocable, on the basis of the Company's engineering estimates of the
percentage of completion, to contract expenditures incurred. Profits are not
recorded during the start-up phase of the contract, which has been determined
by the Company to approximate the initial 15% of design and construction. All
losses are recognized in the period during which they become evident.

COST IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED. Cost in excess of the
fair value of net assets acquired is amortized on a straight-line basis
generally over five to fifteen years. The Company assesses the recoverability
of such cost by determining whether the amortization of the cost in excess of
the fair value of net assets acquired over its remaining life can be
recovered through undiscounted future operating cash flows.


                                                                              29

                                     61
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





STATEMENT OF CASH FLOWS. For purposes of the statement of cash flows, the
Company considers all investments purchased with a maturity of three months
or less to be cash equivalents.

RESEARCH AND DEVELOPMENT. Costs incurred in the creation and start-up of new
products or in changing existing products are charged to expense as incurred.

EARNINGS PER COMMON SHARE. Earnings per common share are based on the
weighted average number of common shares outstanding, including common shares
held by the Company's Employee Stock Ownership Plan and Trust. Effect is
given to common stock equivalents (stock options), if dilutive.

FAIR VALUE OF FINANCIAL INSTRUMENTS. Estimates of fair values are subjective
in nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could
affect the estimates. The fair market value of the Company's financial
instruments approximates the carrying value.

STOCK OPTION PLANS. Prior to January 1, 1996 the Company accounted for its
stock option plan in accordance with the provisions of Accounting Principles
Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations. As such, compensation expense would be recorded on
the date of grant only if the current market price of underlying stock
exceeded the exercise price. On January 1, 1996, the Company adopted SFAS No.
123, Accounting for Stock-Based Compensation, which permits entities to
recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123 also
allows entities to continue to apply the provisions of APB Opinion No. 25 and
provide pro forma net income and pro forma earnings per share disclosures for
employee stock option grants made in 1995 and future years as if the
fair-value-based method defined in SFAS No. 123 had been applied. The Company
has elected to continue to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosure provisions of SFAS No. 123.

2. CONTRACTS IN PROGRESS
Contract costs on uncompleted contracts are as follows:

                                Costs and    Billings in
                                estimated     excess of
                                earnings      costs and
                                in excess     estimated
(Dollars in thousands)         of billings     earnings    Total
--------------------------------------------------------------------
December 31, 1996:
Costs and estimated earnings     $ 7,796       $73,397    $81,193
Billings                           6,131        79,323     85,454
                                 -----------------------------------
                                 $ 1,665       $(5,926)   $(4,261)
                                 -----------------------------------
                                 -----------------------------------

--------------------------------------------------------------------
December 31, 1995:
Costs and estimated earnings     $25,234       $28,541    $53,775
Billings                          21,181        29,820     51,001
                                 -----------------------------------
                                 $ 4,053       $(1,279)   $ 2,774
                                 -----------------------------------
                                 -----------------------------------

Balances billed, but not paid by customers under retainage provisions in
contracts amounted to $1,165,000 and $1,146,000 at December 31, 1996 and
1995, respectively. All receivables on contracts in progress are considered
to be collectible within twelve months.

3. INDEBTEDNESS
(Dollars in thousands)                           1996       1995
--------------------------------------------------------------------
Revolving credit agreements                     $2,826    $11,461
Bank loan                                          273        -
Note payable                                       198        -
Capitalized lease obligations                      852        966
                                                --------------------
  Total indebtedness                             4,149     12,427
Less current installments                          737        337
                                                --------------------
  Long-term debt                                $3,412    $12,090
                                                --------------------
                                                --------------------

REVOLVING CREDIT AGREEMENTS. The Company has an unsecured $20,000,000
revolving credit agreement which expires August 1999. At December 31, 1996,
there were no outstanding borrowings. Outstanding borrowings bear interest at
a base rate established by the bank plus a variable component depending on
the Company's funded debt to capitalization percentage and fixed charges
coverage ratio.


30

                                     62
<PAGE>

The Company has a reducing revolving credit agreement with original total
credit availability of $15,000,000 reducing by $536,000 as of the last day of
each quarter beginning September 30, 1996. The Company has remaining total
credit availability of $13,928,000 at December 31, 1996 against which there
are outstanding borrowings of $2,826,000. Outstanding borrowings are due on
August 15, 2001 and bear interest at a base rate established by the bank plus
a variable component depending on the Company's funded debt to capitalization
percentage and fixed charges coverage ratio (8.25% at December 31, 1996).
Borrowings under this agreement are collateralized by liens against
substantially all of the Company's equipment and machinery.

The Company pays commitment fees of 1/10 of 1% annually on the unused portion
of the revolving credit agreements.

BANK LOAN. The bank loan is a term note payable in monthly installments
including interest through April 2002. The note bears interest at a base rate
established by the bank plus 2.1% (7.85% at December 31, 1996). The note is
collateralized by liens against real and personal property with a net book
value of $1,537,000 at December 31, 1996.

OVERDRAFT FACILITY. The Company has a $343,000 overdraft facility which
expires August 21, 1997. At December 31, 1996 there were no outstanding
borrowings. Outstanding borrowings bear interest at a base rate established
by the bank plus 1.9%. Borrowings under this agreement are collateralized by
liens against real and personal property which amounts to $1,537,000 at
December 31, 1996.

NOTE PAYABLE. The Company has a term note payable in full within five
business days after January 1, 1997. The note bears interest at 7.25% and is
unsecured. The note was paid in full on January 8, 1997.

CAPITALIZED LEASE OBLIGATIONS. The Company entered into various computer
hardware and software capital lease agreements totaling $330,000 and $295,000
in 1996 and 1995, respectively. Monthly installments are due through October
1998. The average implied interest rate in the lease agreements is 7.0%.

COVENANTS. The various indebtedness agreements contain, among other things,
covenants relating to: maintenance of certain levels of consolidated net
worth and limitations of total liabilities; maintenance of certain ratios of
debt to equity and current assets to current liabilities; and certain
limitations on the payment of cash dividends. At December 31, 1996, the
Company is in compliance with all covenants under its indebtedness agreements
and has retained earnings available for dividends of $3,643,000.

MATURITIES. At December 31, 1996, long-term debt maturities for 1997 and
thereafter are:

Years ended December 31                      (Dollars in thousands)
--------------------------------------------------------------------
1997                                                        $  737
1998                                                           417
1999                                                            51
2000                                                            51
2000 and thereafter                                          2,893
                                                            --------
                                                            $4,149
                                                            --------
                                                            --------

On January 24, 1997 the Company issued $15,000,000 of senior unsecured notes.
The notes are payable in seven equal annual installments beginning January 24,
2000. The notes bear interest at 6.87% payable semi-annually.



                                                                              31

                                     63
<PAGE>

4. INCOME TAXES

Income tax expense consisted of the following:

(Dollars in thousands)                     1996     1995     1994
--------------------------------------------------------------------
Current:
  Federal                                $ 5,741   $3,664   $4,193
  State                                    1,204      749      905
                                         ---------------------------
    Total current                          6,945    4,413    5,098

Deferred:
  Federal                                   (976)     (99)     (14)
  State                                     (194)     (20)     (38)
                                         ---------------------------
    Total deferred                        (1,170)    (119)     (52)
                                         ---------------------------
    Total income tax expense             $ 5,775   $4,294   $5,046
                                         ---------------------------
                                         ---------------------------

Income tax expense for the years ended December 31, 1996, 1995, and 1994,
respectively, differed from the amounts computed by applying the U.S. federal
income tax rate of 35 percent to pretax income as a result of the following:

(Dollars in thousands)                     1996     1995     1994
--------------------------------------------------------------------
Computed "expected" tax   expense         $5,287   $3,913   $4,440
Increase (reduction) in income
 taxes resulting from:
   State and local income
    taxes, net of federal
    income tax benefit                       657      473      564
   Other, net                               (169)     (92)      42
                                         ---------------------------
                                          $5,775   $4,294   $5,046
                                         ---------------------------
                                         ---------------------------

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1996 and 1995 are presented below:


(Dollars in thousands)                              1996     1995
--------------------------------------------------------------------
Deferred tax assets:
  Deferred compensation                            $1,531   $1,442
  Compensated absences                                353      356
  Inventories                                         490      329
  Allowance for doubtful accounts                     120      141
  Various other reserves                            1,043      127
                                                   -----------------
    Total gross deferred tax assets                 3,537    2,395
    Less valuation allowance                          369      369
                                                   -----------------
                                                    3,168    2,026
Deferred tax liabilities:
  Plant and equipment                                (793)    (821)
                                                   -----------------
    Net deferred tax assets                        $2,375   $1,205
                                                   -----------------
                                                   -----------------

The valuation allowance for deferred tax assets as of January 1, 1995 was
approximately $369,000. There were no net changes in the total valuation
allowance for the years ended December 31, 1996 and 1995. Management believes
it is more likely than not that the results of future operations will
generate sufficient taxable income to realize the deferred tax assets as
reduced by the valuation allowance.

During 1995, the Internal Revenue Service completed examinations of the
Company's federal income tax returns for the years ended December 31, 1992,
1993 and 1994. The results of the examinations did not have a material effect
on the Company's financial statements.

5. BUSINESS SEGMENT INFORMATION
The Company and its subsidiaries operate in one reportable segment of
railroad electronics and related products.

Two customers accounted for net sales of approximately $77,302,000 and
$16,126,000 for the year ended December 31, 1996, net sales of approximately
$19,091,000 and $15,532,000 for the year ended December 31, 1995 and net
sales of approximately $25,735,000 and $11,015,000 for the year ended
December 31, 1994. At December 31, 1996, the Company had significant
receivable balances from five customers totaling approximately $23,734,000.
The Company has no other unusual credit risks or concentrations.

6. COMMITMENTS
The Company has entered into various lease arrangements covering the use of
manufacturing facilities, administrative offices and equipment, all of which
are operating leases. Rental expense related to these leases amounted to
$1,661,000, $1,581,000 and $1,398,000 for the years ended December 31, 1996,
1995 and 1994, respectively.

32

                                     64
<PAGE>

A summary of non-cancelable long-term operating lease commitments follows
(Dollars in thousands):

                                               Real         Total
Years ended December 31,         Equipment   property    commitments
--------------------------------------------------------------------
1997                                $75       $1,216        $1,291
1998                                 20        1,132         1,152
1999                                  7          883           890
2000                                 -           734           734
2001                                 -           259           259

It is expected that in the normal course of business, leases that expire will
be renewed or replaced by leases on other properties; thus, it is anticipated
that future minimum lease commitments will not be less than the amounts shown
for 1997.

EMPLOYEE BENEFITS. In 1985, the Company formed an Employee Stock Ownership
Plan and Trust (ESOP), which includes all employees. The ESOP held 503,497
shares and 506,904 shares of Company common stock which had been allocated to
plan participants at December 31, 1996 and 1995, respectively. Company
contributions to the ESOP are normally based on a percentage of pretax
earnings. Dividends on common shares held by the ESOP are reflected as a
reduction in retained earnings.

ESOP contributions charged to operating expense were $3,815,000, $2,785,000
and $3,045,000 for the years ended December 31, 1996, 1995 and 1994,
respectively.

The Company and its subsidiaries have various bonus plans based primarily on
Company performance. Accrued and unpaid bonuses at December 31, 1996 and 1995
were $2,505,000 and $757,000, respectively.

The Company has a nonqualified, unfunded deferred compensation plan for
certain key executives providing for payments upon retirement, death or
disability. Under the plan, certain employees receive retirement payments
equal to a portion of the three highest continuous years' average
compensation. These payments are to be made for the remainder of the
employees' life with a minimum payment of ten years' benefits to either the
employee or his or her beneficiary. The plan also provides for reduced
benefits upon early retirement, disability or termination of employment. The
deferred compensation (gain) expense was $(365,000), $491,000 and $522,000
for the years ended December 31, 1996, 1995 and 1994, respectively.

The Company has recorded the assets and liabilities for the deferred
compensation at gross amounts in the Consolidated Balance Sheets because such
assets and liabilities belong to the Company.

The Company does not provide other post-retirement benefits.

7. STOCKHOLDERS' EQUITY

A summary of stock options granted, exercised and expired follows:

                            Shares   Price Per Share
--------------------------------------------------------------------
Balance at
 January 1, 1994            307,250  $ 5.70            Average Price
Granted                      42,000   20.50-22.75
Exercised                  (157,600)   3.88-13.38
Expired                      (2,000)   5.50-7.25
Balance at
 December 31, 1994          189,650   10.44            Average Price

Granted                      28,000   14.00-17.75
Exercised                   (83,150)   3.88-13.38
Expired                     (10,000)  13.38
Balance at
 December 31, 1995          124,500   15.20            Average Price

Granted                     101,000   13.50-17.00
Exercised                    (6,000)   5.50-8.25
Expired                     (25,500)  16.50-20.63
Balance at
 December 31, 1996          194,000  $14.69            Average Price

The Company has outstanding stock options for 38,500 shares of common stock
at prices ranging from $5.50 to $8.25 and outstanding stock options for
155,500 shares of common stock at prices ranging from $14.00 to $20.63. The
Company has exercisable outstanding stock options for

                                                                              33

                                     65
<PAGE>

151,885 shares of common stock at prices ranging from $5.50 to $22.75 a share
($14.21 average per share) as of December 31, 1996. In May 1996 the Company
granted stock options for up to 1,000 common shares to each of the Company's
nine non-employee directors which expire on May 31, 2003. In May 1995, the
Company granted stock options for up to 2,000 common shares to each of the
Company's eleven directors which expire on May 31, 1997. In May 1994, the
Company granted stock options for up to 2,000 common shares to each of the
Company's eleven directors as of that date which expired on May 31, 1996.

The Company issued 17,647 shares of unregistered common stock in connection
with the 1996 acquisition of businesses. (See Note 11). The Company issued
260,000 shares of unregistered common stock to Servo Corporation of America
in December 1994 (See Note 11).

8. AFFILIATES

The Company has investments of 38% and 20% in unconsolidated affiliates which
are accounted for under the equity method. Equity in earnings (losses) of
these affiliates was not significant for the years ended December 31, 1996,
1995 and 1994. The Company had sales to these related entities totaling
$841,000, $1,477,000 and $272,000 for 1996, 1995 and 1994, respectively. The
Company had receivables due from these entities of $223,000 and $434,000 as
of December 31, 1996 and 1995, respectively.

9. OTHER FINANCIAL INFORMATION

The Company has classified certain environmental compliance expenses as cost
of sales in the accompanying statements of operations. These expenses
amounted to $283,000, $215,000 and $164,000 for the years ended December 31,
1996, 1995 and 1994, respectively.

10. LITIGATION

ENVIRONMENTAL MATTER. On September 30, 1991, the United States Environmental
Protection Agency (EPA) issued a complaint against the Company alleging
violations of the Resource Conservation and Recovery Act (RCRA) and RCRA
regulations in the disposal of solvents at the Company's Grain Valley,
Missouri, plant. The complaint sought penalties in the amount of $2,344,000
and proposed certain compliance actions. In January 1994 the administrative
hearing on the penalty assessment was heard. The decision from that hearing
reduced the penalties to $586,000.

Based on the Company's cooperation with the Missouri Department of Natural
Resources (MDNR), which had the original jurisdiction of the matters
complained by the EPA, in voluntarily disclosing the alleged violations and
in promptly undertaking all remedial actions specified by the MDNR, the
penalties appear to the Company's legal counsel to be excessive. However,
because so few cases have been disposed of by settlement, or by
administrative or judicial proceedings since the new penalty guidelines were
adopted, legal counsel cannot express an opinion as to the ultimate amount,
if any, of the Company's liability.

The Company has recorded a total of $2,232,000 of environmental compliance
expenses to date relating to this matter. The Company has recorded a
liability for its best estimates of the costs to be incurred relative to the
compliance actions in other accrued liabilities. Since the amount of the
penalty cannot be reasonably determined at this time, no liability has been
accrued in the financial statements.

OTHER LITIGATION. The Company has been named as a defendant in several other
lawsuits in the normal course of its business. In the opinion of management,
after consulting with legal counsel, the liabilities, if any, resulting from
these matters will not have a material effect on the consolidated financial
statements of the Company.

11. ACQUISITION OF BUSINESSES

On July 1, 1996 the Company acquired the stock of Vaughan Systems Limited for
an initial purchase price of $2,003,000 in cash. In addition to the initial
purchase price, the purchase agreement provides for contingent payments.
These payments are based on the average after-tax earnings of Vaughan Harmon
over the three year period ending June 30, 1999 as well as the utilization of
certain tax net operating loss carryforwards. Any additional consideration
paid will

34

                                     66
<PAGE>

be recorded as goodwill. The acquisition has been accounted for by the
purchase method of accounting and accordingly, the operating results have
been included in the Company's consolidated results of operations from the
date of acquisition. The excess of the cash paid over the fair value of net
assets acquired has been recorded as goodwill of $156,000.

In 1996 the Company acquired the assets of two contract engineering firms.
These acquisitions were made with the issuance of 17,467 shares of
unregistered common stock valued at $8.50 per share, a $198,000 note payable
and $145,000 in cash. These acquisitions have been accounted for by the
purchase method of accounting and accordingly, the operating results have
been included in the Company's consolidated results of operations from the
dates of acquisition. The excess of the consideration given over the fair
value of net assets acquired has been recorded as goodwill of $363,000.

The pro forma effects of the 1996 acquisitions on the consolidated financial
statements are not significant.

On February 24, 1995, the Company acquired certain assets of Serrmi Services,
Inc. (Serrmi) for approximately $1,182,000 in cash. The acquisition has been
accounted for by the purchase method of accounting and accordingly, the
operating results have been included in the Company's consolidated results of
operations from the date of acquisition. The excess of the cash paid over the
fair value of net assets acquired has been recorded as goodwill of $139,000.
The pro forma effects of the Serrmi acquisition on the consolidated financial
statements are not significant.

On December 20, 1994, the Company acquired the transportation division of
Servo Corporation of America. Servo's transportation division manufactures
hot box detector systems and various components to help railroads monitor the
condition of bearings and wheels on freight and passenger vehicles. The
purchase method of accounting for business combinations was used and
accordingly, the operating results of this division have been included in the
Company's consolidated results of operations from the date of acquisition and
were insignificant in 1994. The Servo acquisition was made with the issuance
of 260,000 shares of unregistered common stock valued at $11.25 per share, as
determined by a fair market value analysis conducted by an independent
investment and securities firm, and $6,661,000 in cash. The fair value of
assets acquired, including goodwill, was $10,283,000 and liabilities assumed
totaled $697,000. Goodwill of $7,967,000 is being amortized over fifteen
years on a straight line basis. Assets acquired included inventory, fixed
assets and other miscellaneous items.

The pro forma results below (unaudited) for 1994 assume the acquisition
occurred at the beginning of that year.

(Dollars in thousands, except per share data)
--------------------------------------------------------------------
Net sales                                                  $131,024
Operating income                                             13,730
Net earnings                                                  8,152
Earnings per common share                                      1.19

12. ACCOUNTING FOR STOCK-BASED COMPENSATION

The Company applies Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations in accounting for
its plans. Accordingly, no compensation expense has been recognized for its
stock-based compensation plans other than for restricted stock and
performance-based awards. Had compensation cost for the Company's other stock
option plans been determined based upon the fair value at the grant date for
1996 awards under these plans consistent with the methodology presented in
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, the Company's net income and earnings per share in
1996 would have been reduced by approximately $325,000 ($88,000 - 1995), or
$.05 per share ($.01 per share -1995). The fair value of the options granted
during 1996 is estimated at values ranging from $5.88 to $8.86 on the dates
of grant using the Black-Scholes option-pricing model with the following
assumptions: dividend rate of .15 per share, volatility ranging between 41%
and 70%, risk-free interest rate ranging between 5.25% and 7.01%, assumed
forfeiture rate of 0%, and an expected life ranging between 1.9 and 3.75
years.


                                                                              35

                                     67
<PAGE>

FORWARD LOOKING INFORMATION


This annual report contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, which may include
statements concerning projection of revenues, income or loss, capital
expenditures, capital structure, or other financial items, statements
regarding the plans and objectives of management for future operations,
statements of future economic performance, statements of the assumptions
underlying or relating to any of the foregoing statements, and other
statements which are other than statements of historical fact.

These statements appear in a number of places in this annual report and
include statements regarding the intent, belief, or current expectations of
the Company's management with respect to (i) the demand and price for the
Company's products and services, (ii) the Company's competitive position,
(iii) the supply and price of materials used by the Company, (iv) the cost
and timing of the completion of new or expanded facilities, or (v) other
trends affecting the Company's financial condition or results of operations.

Statements made throughout this report are based on current estimates of
future events, and the Company has no obligation to update or correct these
estimates.

Readers are cautioned that any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, and
that actual results may differ materially as a result of these various
factors.

REPORT OF MANAGEMENT

TO THE STOCKHOLDERS OF HARMON INDUSTRIES, INC.:

The management of Harmon Industries, Inc., is responsible for the
preparation, presentation, and integrity of the consolidated financial
statements and other information included in this annual report. The
financial statements have been prepared by the Company in accordance with
generally accepted accounting principles and, as such, include amounts based
on management's best estimates and judgments.

The financial statements have been audited by KPMG Peat Marwick LLP,
independent public accountants. Their audits were made in accordance with
generally accepted auditing standards and included such reviews and tests of
the Company's internal accounting controls as they considered necessary.

The Company maintains a system of internal accounting controls designed to
provide reasonable assurance at reasonable cost that Company assets are
protected against loss or unauthorized use and that transactions and events
are properly recorded.

The Board of Directors, through its Audit Committee, comprised solely of
directors who are not employees of the Company, meets with management and the
independent public accountants to assure that each is properly discharging
its respective responsibilities. The independent accountants have free access
to the Audit Committee, without management present, to discuss the results of
their work and their assessment of the adequacy of internal accounting
controls and the quality of financial reporting.

/s/ BJORN E. OLSSON


Bjorn E. Olsson
President and Chief Executive Officer

/s/ CHARLES M. FOUDREE

Charles M. Foudree
Executive Vice President - Finance, Treasurer and Secretary

February 4, 1997

36

                                     68
<PAGE>

REPORT OF INDEPENDENT AUDITORS





THE BOARD OF DIRECTORS AND STOCKHOLDERS OF
HARMON INDUSTRIES, INC. AND SUBSIDIARIES:

We have audited the accompanying consolidated balance sheets of Harmon
Industries, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of earnings, stockholders' equity, and cash
flows for each of the years in the three year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Harmon
Industries, Inc. and subsidiaries at December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the years in the
three year period ended December 31, 1996, in conformity with generally
accepted accounting principles.



KPMG Peat Marwick LLP

Kansas City, Missouri
February 4, 1997



                                                                              37

                                     69
<PAGE>

INVESTOR INFORMATION





FORM 10-K
Shareholders may receive a copy of the Corporation's 1996 Annual Report to
the Securities and Exchange Commission on Form 10-K free of charge by
writing: Mr. Charles M. Foudree Executive Vice President-Finance at the
Corporation's headquarters.

ANNUAL MEETING
Shareholders are cordially invited to attend the Annual Meeting of
Shareholders, which will be held at 2:00 p.m. on Tuesday, May 13, 1997, at
the Country Club of Blue Springs, Blue Springs, Missouri.

     Management urges all shareholders to vote their proxies and thus
participate in the decisions that will be made at this meeting.

REGISTRAR & TRANSFER AGENT
UMB Bank, n.a.
P.O. Box 419226
Kansas City, Missouri 64141-6226
816/860-7000

For change of name, address, or to replace lost stock certificates, write or
call the Securities Transfer Division.

SECURITIES ANALYST CONTACT
Securities analyst inquiries are welcome.
Please direct them to:
Mr. Charles M. Foudree
Executive Vice President-Finance
816/229-3345

INDEPENDENT AUDITORS
KPMG Peat Marwick LLP
1600 Commerce Bank Building
Kansas City, Missouri 64106

OUTSIDE COUNSEL
Morrison & Hecker LLP
2600 Grand Avenue
Kansas City, Missouri 64108-4606
816/691-2600

CORPORATE HEADQUARTERS
1300 Jefferson Court
Blue Springs, Missouri 64015
816/229-3345
Telefax: 816/229-0556

COMMON STOCK PRICE RANGE AND
DIVIDEND INFORMATION

At December 31, 1996, there were 6,829,273 shares outstanding and
approximately 637 shareholders of record. Cash dividends were resumed in 1994
at the rate of 15 cents per share per year, paid semi-annually at 7H cents
per share.
    The range of high and low prices for the past eight quarters ended
December 31, 1996 is shown below. Per share prices have been adjusted for all
stock splits and stock dividends, if any.

                                         Price Range
Calendar Quarter Ended            1996                  1995
--------------------------------------------------------------------
March 31                      $15 3/4 - $12       $19 1/2 - $13 1/2
June 30                        18 3/4 -  13 3/4    18     -  13 1/2
September 30                   18     -  15 1/2    20 1/2 -  13 3/8
December 31                    19 1/2 -  15        18 1/4 -  14

STOCK TRADING
The Company's common stock trades on The Nasdaq Stock Market under the
symbol: hrmn. Stock price quotations can be found in major daily newspapers
and in THE WALL STREET JOURNAL.
    At March 6 , 1997, the following securities firms were making a dual
auction market in the Company's common stock:

George K. Baum & Company
Piper Jaffray Companies Inc.
PaineWebber Inc.

HARMON ON THE WORLD WIDE WEB
Information on Harmon Industries, Inc. is available on the Company's World Wide
Web site at:
http://www.harmonind.com


38

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<PAGE>

MANAGEMENT, DIRECTORS AND CORPORATE DATA

BOARD OF DIRECTORS
Robert E. Harmon (57)
CHAIRMAN OF THE BOARD

Thomas F. Eagleton (67)
ATTORNEY-AT-LAW
THOMPSON & COBURN
ST. LOUIS, MISSOURI

Bruce M. Flohr (58)
CHAIRMAN & CEO
RAILTEX, INC.
SAN ANTONIO, TEXAS

Charles M. Foudree (52)
EXECUTIVE VICE PRESIDENT-
FINANCE, TREASURER AND SECRETARY

Rodney L. Gray (44)
CHAIRMAN & CEO
ENRON INTERNATIONAL, INC.
HOUSTON, TEXAS

Herbert M. Kohn (58)
ATTORNEY-AT-LAW
BRYAN CAVE LLP
KANSAS CITY, MISSOURI

Gary E. Ryker* (47)
EXECUTIVE VICE PRESIDENT
MARKETING, SALES AND SERVICE

Douglass Wm. List (41)
MANAGEMENT CONSULTANT
BALTIMORE, MARYLAND

Gerald E. Myers (55)
MANAGEMENT CONSULTANT
TEMPE, ARIZONA

Bjorn E. Olsson (51)
PRESIDENT AND
CHIEF EXECUTIVE OFFICER

Donald V. Rentz (58)
GRANT LEIGHTON ASSOCIATES OF TEXAS, INC.
PLANO, TEXAS

Judith C. Whittaker (58)
VICE PRESIDENT-LEGAL
HALLMARK CARDS, INC.
KANSAS CITY, MISSOURI

----------------------------
*  Denotes Advisory Director
() Indicates age of director



MANAGEMENT
Bjorn E. Olsson
PRESIDENT AND
CHIEF EXECUTIVE OFFICER

Charles M. Foudree
EXECUTIVE VICE PRESIDENT-
FINANCE, TREASURER AND SECRETARY

Lloyd T. Kaiser
EXECUTIVE VICE PRESIDENT-SYSTEMS

Gary E. Ryker
EXECUTIVE VICE PRESIDENT
MARKETING, SALES AND SERVICE

Ronald G. Breshears
VICE PRESIDENT-
HUMAN RESOURCES

Richard A. Daniels
VICE PRESIDENT-TRANSIT SALES

Robert E. Heggestad
VICE PRESIDENT-TECHNOLOGY

J. Randall John
VICE PRESIDENT-SERVICES

John W. Johnson
VICE PRESIDENT-DOMESTIC SALES

Raymond A. Rosewall
VICE PRESIDENT-MANUFACTURING

William J. Scheerer
VICE PRESIDENT-APPLICATIONS ENGINEERING

Stephen L. Schmitz
VICE PRESIDENT-CONTROLLER

William L. Bush
DIRECTOR-RESEARCH & DEVELOPMENT

Jeffery J. Utterback
DIRECTOR-QUALITY ASSURANCE



DOMESTIC LOCATIONS
Riverside, California (2) +
Jacksonville, Florida
Atlanta, Georgia
Louisville, Kentucky
Blue Springs, Missouri
Grain Valley, Missouri (3) +
Lee's Summit, Missouri
Warrensburg, Missouri (2) +
Omaha, Nebraska
Hauppauge, New York
----------------------------------------
+ Denotes number of plants and locations



INTERNATIONAL LOCATIONS
Harmon Industries
Lausanne, Switzerland

Henkes-Harmon Industries, Pty. Ltd.
Mooroolbark, Victoria, Australia

Vale-Harmon Enterprises, Ltd.
Saint-Laurent, Quebec, Canada

Vaughan Harmon Systems Ltd.
Ware, England


                                                                              39

                                     71
<PAGE>

[HARMON LOGO]

CORPORATE OFFICE
1300 JEFFERSON COURT
BLUE SPRINGS, MO 64015
816-229-3345
FAX: 816-229-0556

                                     72