1 0 8 , 1 6 4 0 , 2 2 9 7 , 1 2 9 6 , 1 6 5 7 , 1 7 8 6 0 1 4 7 1 9 8 9 ’ 9 9 ’ 0 0 ’ 0 1 ’ 0 2 ’ 0 3 ’ 9 9 ’ 0 0 ’ 0 1 ’ 0 2 ’ 0 3 N E T S A L E S (in millions) N E T I N C O M E (in millions) 1 . 8 1 8 . 9 1 8 . 2 1 7 . 4 1 5 . 4 1 4 4 . 1 7 7 . 1 6 2 . 1 5 5 . 1 8 6 . 1 ’ 9 9 ’ 0 0 ’ 0 1 ’ 0 2 ’ 0 3 ’ 9 9 ’ 0 0 ’ 0 1 ’ 0 2 ’ 0 3 R E T U R N O N A V E R A G E S H A R E H O L D E R S ’ E Q U I T Y (percent) D I L U T E D E A R N I N G S P E R S H A R E (dollars) Great brands are like great people. The best ones blend a distinctive personality with a strong character. They combine a “can-do” attitude with a “can’t-wait-to-try-something- new” enthusiasm. They know themselves as well as they know the people who associate with them. They know that while good looks are important, beauty is only skin deep; it’s what’s inside that counts. Because all of our brands have some- thing unique and valuable to offer, we’re letting them speak for themselves. As for the people who know and love our brands, we’ve invited a few to share an “up close and personal” look into why and how HON INDUSTRIES is … T H E P E R F E C T M A T C H A N A N T I D O T E T O T H E O R D I N A R Y Functional and timeless yet durable to the core. Problem-solver who values long-lasting and well-designed solutions seeks modern professional with a passion for helping people be both productive and inspired. Great cus- tomer relationships and confident, forward- thinking approach a must. A L L S T E E L Y O U W O O D L O V E M E Of course, you wood love the new me even more, since I thrive on change and self- improvement. Seek a seeker of all things bold and beautiful — someone who desires elegant solutions and tailored style, and who appreci- ates handcrafted expressions of commitment. I’m easy to be around, and I’m certain I could fit into both your life and your office. Let’s create a new way of being — together. G U N L O C K E P R A C T I C A L A N D P R O F E S S I O N A L Something of a paradox, too; highly competi- tive but approachable; stylish but never a slave to fashion. I have a true talent for leadership. I’m stable, steady, reliable, and efficient. At the same time, I’m good-looking, good-natured, and good-humored. Seek successful business person driven by values, with a “whatever it takes” attitude — just like me, practical and professional. T H E H O N C O M P A N Y H O T ! H O T ! H O T ! Competitive, inventive, expansive by day … cozy, intimate, and warm by night. On one hand, a technology buff; while on the other hand, an incurable romantic. I’ll bathe you in heat — and show you how to fill a room with a very special glow. Seek hearthwarming per- sonality with a powerful appreciation for style and performance. Must have aspirational dreams and family values. My dream: some- one to ignite my potential … someone to keep the home fires burning. H E A R T H & H O M E T E C H N O L O G I E S H O N I N D U S T R I E S 2 0 0 3 T O O U R S H A R E H O L D E R S : L E F T : St an A . A skren, P R E S I D E N T R I G H T : Jack D. Michaels, C H A I R M A N A N D C H I E F E X E C U T I V E O F F I C E R As we celebrate our 60th year, HON INDUSTRIES has seen leaner, more focused, and have more clearly defined brands much change. The industry has changed. The world has than ever before. Our challenge is to grow, aggressively and changed. Our business has changed. What has not changed profitably, through market-driven solutions while maintain- are the culture and values on which we were founded: integ- ing focus on what we do best — operational excellence. Our rity, fairness, and respect — in the treatment of others, transformation continues: continuous improvement, and responsiveness to those who buy our products and services. In our unique and powerful B U I L D I N G B R A N D M A R K E T P O W E R member-owner culture, throughout our history, every member We are investing significantly in our brands and increasing our has had an opportunity to participate in making the business understanding of our diverse range of end-users and the solu- better. We did so again in 2003. tions they want. We are building market power through several We outperformed our peers. We grew our sales and initiatives: focused selling models; clear brand identity; tar- profits. We gained market share by providing strong brands, geted advertising; expanded channel presence; and aggressive innovative products and services, and greater value to our end- products and solutions development. We are strengthening our users. We continued to increase our gross margins, a direct ability to be the “perfect match” with end-users in every seg- result of our ongoing commitment to lean initiatives. We used ment we serve. our strong, positive cash flow to invest in our business for the long term and returned profits to shareholders. We accom- A C H I E V I N G B E S T T O T A L C O S T A N D plished all of this in a very challenging economy and market. L E A N E N T E R P R I S E Although we are proud of what we achieved, our phi- “Best total cost” means more than being a low-cost manufac- losophy of constructive discontent drives us to continue to turer. It requires us to think about the entire value stream — challenge ourselves to do better. We believe to succeed in a where and how to manufacture, ship, install, outsource, business environment of ongoing change and continuous trans- assemble, service, procure, and sell — all to provide the best formation we also must continue to change. Today, we are total value to our end-users. We implemented lean initiatives, 13 H O N I N D U S T R I E S 2 0 0 3 our rapid continuous improvement (RCI) programs, in 1992. It announced in February 2003, was an important part of is not only a process to drive out cost, it is a powerful tool to this process. engage every member every day in making choices to improve Our office furniture and hearth businesses are healthy the value we provide to our customers. and well-positioned for growth; still we continue to face a com- petitive business environment. We are confident of our financial E N H A N C I N G C U L T U R E A N D C A P A B I L I T I E S security, and certain that our transition to becoming a market- Our values are simple yet powerful. They are as relevant today driven, operationally excellent company will continue to en- as they were when the company was founded 60 years ago. hance shareholder value. The transformation continues. We will Our member-owner culture of shared responsibility and shared be seeking shareholder approval, in early May 2004, to change reward engages all members in the ongoing business improve- the name of HON INDUSTRIES to HNI Corporation, drawing ment process and allows us to embrace change. As we continue on our heritage while remaining true to our culture and values. to add and develop talent to support our growth strategies, we The new name will serve to better align the corporate identity become more diverse in our perspectives, strengthening our with the direction of the company, as a strategic manager of ability to understand and meet the needs of our customers and multiple, distinct, and independent brands. end-users. We thank our member-owners for their continued dedication, and look forward to the challenges and opportuni- On January 5, 2004, we completed the acquisition of ties of 2004. Paoli Inc., a leading provider of wood case goods and seating. The acquisition reflects our commitment to achieving profit- able growth. With annual sales in excess of $80 million, Paoli has well-known brands, a broad product offering, and strong independent representative sales and dealer networks. This Jack D. Michaels acquisition supports our operating philosophy to work through C H A I R M A N A N D C H I E F E X E C U T I V E O F F I C E R autonomous, decentralized businesses with strong brands focused on distinct markets. Important to our company’s success, is a strong Board of Directors who bring their individual skills, knowledge, and experience to our company. Their involvement, independence, Stan A. Askren and integrity provide the ongoing foundation for effective gov- P R E S I D E N T ernance and corporate oversight for you, our shareholders. This year we recognize retiring directors Lorne R. Waxlax, Robert W. Cox, and M. Farooq Kathwari. We thank them for their dedication. We are also pleased to welcome Joseph Scalzo, President, Personal Care Products, The Gillette Company, to our board. Our CEO succession process is progressing smoothly. The appointment of Stan Askren as President of HON INDUSTRIES and as a member of the Board of Directors, 14 15 H O N I N D U S T R I E S 2 0 0 3 F I N A N C I A L H I G H L I G H T S 2003 2002 Change $ 1,755,728 $ 1,692,622 639,215 599,879 36.4% 35.4% 480,744 454,189 8,510 3,000 149,961 142,690 98,105 91,360 5.6% 14.5% $ 1.69 $ 1.68 12.19 0.52 5.4% 14.7% 1.55 1.55 11.08 0.50 $ 462,122 $ 405,054 1,021,826 245,816 1.88 1,020,552 298,680 1.36 0.6% 1.5% $ 709,889 $ 646,893 678,391 619,787 $ 34,842 $ 25,885 141,274 202,391 3.7% 6.6% — 5.8% 183.7% 5.1% 7.4% — — 9.0% 8.4% 10.0% 4.0% 14.1% 0.1% (17.7%) — (58.1%) — 9.7% 9.5% 34.6% (30.2%) (1.0%) — (5.3%) 1.1% (In thousands, except for per share data) I N C O M E S T A T E M E N T D A T A Net sales Gross profit Gross profit as a % of: Net sales Selling and administrative expenses Restructuring related charges Operating income Net income Net income as a % of: Net sales Average shareholders’ equity Per common share: Net income – basic Net income – diluted Book value – basic Cash dividends B A L A N C E S H E E T D A T A Current assets Total assets Current liabilities Current ratio Debt/capitalization ratio Shareholders’ equity Average shareholders’ equity Working capital O T H E R D A T A Capital expenditures Cash flow from operations Long-term debt and capital lease obligations $ 4,126 $ 9,837 216,306 106,374 103.3% Weighted-average shares outstanding during year – basic 58,178,739 58,789,851 Price/earnings ratio at year-end Number of shareholders at year-end Members (employees) at year-end 26 6,416 8,926 18 6,777 8,828 14 15 P E R F E C T M A T C H # 1 T H E F O R T U N E 5 0 0 A N D A L L S T E E L When we saw Get SetTM it was love at first sight. Then we got to know everything else you have to offer, and realized you’re more than just a pretty face — you’re a brand with a head for business and uplifting products that set the standard for functionality, durability, and style. Of course we know we Fortune 500 types are not the only ones in your life — corporate, government, and institutional customers are excited about you, too, since you match everyone’s workplace furniture and service needs with energy, confidence, and great customer relationships. That’s ok, Allsteel; you’re worth sharing. P E R F E C T M A T C H # 2 T H E DESIGN COMMUNITY A N D G U N L O C K E In addition to your handsome good looks, what impresses us most about you, Gunlocke, is how open you are to self-improvement. It’s usually a slow and difficult process to make fundamental shifts in attitude, but you jump at the idea of collaboration, and quickly turn the wheel in a different direction. We also love how you balance your sense of detail and approach with a truly refined aesthetic. Bold and strong, yet sophisticated and classy — able to adjust to the nuances of your customer’s personality. Bottom line? You’re simply irresistible. H O N I N D U S T R I E S 2 0 0 3 A L L S T E E L : A N A N T I D O T E T O T H E O R D I N A R Y A C A S E S T U D Y I N Q U A L I T Y Great, high-quality design creates better work environments communication products. All of our products respond com- and happier end-users. Whether we’re building lateral files (the pletely to the needs of end-users because that’s where the first product for which we became known) or designing award- design process starts. winning seating, like our #19® chair, the Allsteel core message In all that we do, our main focus is to identify end-user remains constant: the highest quality in functionality, dura- problems and solve them better than anyone else. The majority bility, and service. of our customers are large corporations with multiple locations Today’s Allsteel is about a broad array of workplace worldwide. According to the senior vice president responsible furniture solutions: new, exciting panel and desking systems, for the global design, construction, and project management storage, seating, and tables that offer a unique counterpoint to of an internationally renowned financial services company, the sea of sameness provided by most office furniture. Working “Allsteel offers extremely attractive, cost-effective furniture closely with architects and designers, we target the contract solutions. Your manufacturing and service are best in class — market, providing project-driven and design-oriented office you turn everything around with impressive swiftness. There’s solutions. Our rapid modeling and prototyping allows for really not much in the market to beat you.” equally rapid product development, a reflection of our agile, Well-designed, forward-thinking, and glad to be of lean culture. As innovative as many of our products are, design service. Allsteel is proud to uphold our long heritage of quality. innovation — for us — is simply what happens along the way to solving customer problems. Some of our products, like the #19® chair, are icono- graphically associated with the Allsteel name, and are quite influential in our brand building efforts. Our two newest enter- prises are Terrace® 2.6 — a fast-growing systems line providing enormous flexibility and durability — and Get SetTM — an incred- ibly versatile line of multi-purpose room tables, chairs, and 20 21 H O N I N D U S T R I E S 2 0 0 3 G U N L O C K E : Y O U W O O D L O V E M E A C A S E S T U D Y I N T R A N S F O R M A T I O N For more than a century, Gunlocke has been known almost mixed material solutions that retain status appeal while hold- exclusively for quality wood seating and case goods. Today’s ing costs in check. Gunlocke is about transformation. Our goal is to leverage our From new products to new showrooms, everything history and experience in fine wood furnishings to achieve new we’re doing today reflects our allegiance to our customers’ levels of leadership in a competitive market segment. We are desire for continuous improvement, fresh styling, superior building our brand into a leading provider in the contract furni- quality, beautiful craftsmanship, and highly customized solu- ture market through a stronger focus on our most promising tions. Our design-savvy attitude is geared to the eye of the customer segments — and through fine-tuning our design and architects and designers who make brand recommendations to manufacturing to best meet their unique requirements. our end-users. The majority of our current efforts are on wood office A leading interior designer praises our “consistent solutions for the private office segment: customers in the busi- quality, sensitivity to critical time frames and quick delivery, ness of delivering professional services. Typically, they’re and capability to change detailing and finishing to achieve a medium to large law, accounting, and investment firms, as well custom look.” He also speaks about the “high touch” of as certain segments of federal and state government. Of course, Gunlocke products, the kind of warmth, comfort, and natural- they’re all wood lovers seeking beautiful, tailored wood solu- ness that is associated with fine wood. Citing his work with tions, which they believe project an image of stability, security, one accounting firm that has been a client for 20 years: “We success, and prestige. We agree. could have chosen any brand for their office renovation, but we We’re designing new product solutions to meet these chose Gunlocke for your blend of value and quality. Clients customers’ changing needs. We’re applying all that we’ve want both — and you give them what they need.” learned over the years — on our production lines and through conversations with our customers — to improve our manufac- turing processes and achieve our best product quality ever. Our goal is to develop highly functional, task-specific, wood and 20 21 P E R F E C T M A T C H # 3 T H E S M A L L T O M I D - S I Z E D B U S I N E S S A N D T H E H O N C O M P A N Y The truth is, The HON Company, “practical and professional” is only one part of who you are. When it comes to partnering with small to mid-sized businesses as we are, you are the champion of the hardworking office: sensible, honest, and unpretentious, yet strong, well built, and totally committed to quality. You help us to be more productive by keeping us comfortable and relieving our stress. Your files, desks, panel systems, and other products are as contemporary, intelligent, and adapt- able as we are! So call us both practical and professional; call us a perfect match. P E R F E C T M A T C H # 4 T H E H O M E O W N E R A N D H E A R T H & H O M E T E C H N O L O G I E S Hearth & Home Technologies, you warm our hearts by making a powerful impact on our lives; you are the ones who transform our houses into homes. First, you warmed up our living rooms and family rooms with style, elegance, and comfort. Now, you’re heating up our porches and our kitchens … and find- ing creative and innovative ways to make our bedrooms, bathrooms, dens, guest rooms, and kids’ rooms all toasty with your beautiful glow. The home fires are burning brighter and hotter than ever, now that you’ve come into our lives. H O N I N D U S T R I E S 2 0 0 3 T H E H O N C O M P A N Y : PRACTICAL AND PROFESSION AL A C A S E S T U D Y I N K N O W I N G O U R C U S T O M E R S The HON Company today is the country’s largest provider of brand’s aesthetic drive is way up, while our price and function- office furniture to small and medium-sized businesses. We’re ality remain absolutely consistent and true to expectation. widely recognized for having the broadest line of durable, One customer, an office manager of a Chicago-based functional, practical, and professional office furniture — from manufacturer, is exactly the kind of end-user we’re looking for. storage files to seating, desks, panel systems, and tables — and In addition to her other responsibilities, she’s in charge of we’re admired for bringing it all in at a competitive price. ordering furniture for her 65-person firm — and she knows As tough as it is to become a leader, it’s even tougher exactly what she wants. “I don’t care how many times you tell to hold on to the lead. To do it, we’re working to know our cus- me your product is comfortable,” she says, “I’m the hands-on tomers better than ever, and to continually respond to their type, so I have to touch it, sit on it, and see it myself. I looked for evolving needs. We’ve come to understand that our customers chairs that had great back support, good casters to roll around want the same reliable and affordable furniture they’ve always on, adjustable arms, backs, and seats, and generous width — wanted from us, but with a twist: greater choice. but didn’t cost a fortune. I also wanted them to look good and Over the past three years we’ve raised the bar in terms wear well. I don’t want to have to buy replacements any time of design and aesthetics. We create design that is beautiful soon. All in all, HON was the brand that fit the bill.” without being intimidating or pretentious; design that provides Making our customers happy, productive, and satisfied complete workplace solutions with a value-added contempo- is the focus The HON Company is all about. We’re committed rary twist of color, or fabric, or function. to staying on track, focusing on customer needs, and building a For example, our award-winning Perpetual® Series of brand — and products — that will last for generations. seating and desking products is made of wood, steel, and lami- nate, and offers a range of finishes. Other innovations include combined seating and file storage, combined organizer tray top and file storage, and mobile marker boards. In short, our 26 27 H O N I N D U S T R I E S 2 0 0 3 H E A R T H & H O M E T E C H N O L O G I E S : H O T ! H O T ! H O T ! A C A S E S T U D Y I N E X P A N D I N G M A R K E T S With four brand names under the Hearth & Home Technologies Our newest store in Eagan, Minnesota, for example, is umbrella, we are collectively the world’s largest fireplace manu- living proof that we’re succeeding in growing core product facturer, the country’s premier fireplace brands, the most rec- share by getting closer to consumers. One customer, a St. Paul, ognized name in the industry, and the preferred brands among Minnesota veterinarian, recently had a typically dynamic retail home builders. As the leading provider of hearth and home prod- experience at the Eagan store. He’s among a large group of ucts and services, we make houses feel more like homes. people who own at least one of our hearth products — and In addition to our commanding leadership position in who comes back for more. He explains: “When we moved into manufacturing the two strongest hearth and home product our house, there were three fireplaces built into the family brand names — Heatilator® and Heat-N-Glo® — we also offer room, living room, and kitchen. Since we used them every day innovative wood fuel technology, fireplaces, and stoves through and liked them so much, we decided to convert our three- Quadra-FireTM, while Fireside Hearth & Home distributes, ser- season porch into a year-round porch.” vices, and sells fireplace systems. “We all went to the Eagan store to purchase our fourth What are we up to with all our great brands? We are Heat-N-Glo® fireplace. Once we were walking around the store, meeting a broad range of customer needs, particularly by sell- taking in the lifestyle environments that are set up and dreaming ing both to consumers and builders through a network of about what our house could look and feel like, we realized we independent and company-owned, stand-alone, or gallery- wanted more! We saw an amazing stone surround setting in one of style design and installation centers. These Fireside Hearth & the store displays — and before you knew it, we had bought the Home design centers — visually impressive and aspirational whole wall. Not only does our new fireplace now have a beautiful in setting — manifest our proprietary concept of elevating the aesthetic and terrific functionality, but so does our porch. Because hearth retail, installation, and distribution experience to a new the surround wall installation was so surprisingly easy and clean, level of sophistication and service. Since there is no other we’re even considering our next purchase.” nationally branded hearth retailer in the industry, we are once again changing the game by being first-to-market innovators. 26 27 H O N I N D U S T R I E S 2 0 0 3 O F F I C E F U R N I T U R E A T - A - G L A N C E Allsteel Inc. provides high quality office furni- The Gunlocke Company L.L.C. is one of The HON Company is North America’s lead- ture solutions with advanced functionality America’s oldest and most respected produc- ing manufacturer and marketer of office solu- and lifetime durability for the contract mar- ers of quality wood office furniture. The tions for small and medium-sized workplaces. ket. Products are distributed through a na- company handcrafts executive case goods, as Its strong distribution channel of independent tional network of aligned, independent well as a wide range of executive seating, dealers, wholesalers, and retailers supports contract dealers as well as our sales force, lounge furniture, and conference tables. the broadest mid-market product offering in targeting corporate, government, and insti- Known for more than a century for crafting the industry. tutional markets. elegantly tailored solutions for distinctive H I G H L I G H T S / A W A R D S : • Major product introductions — Get SetTM and Terrace® 2.6 have been well received by business and government clients, Gunlocke focuses primarily on the contract market and furniture specifying communities. H I G H L I G H T S / A W A R D S : • Launched contemporary Perpetual® collec- tion targeting the 18- to 35-year-old segment. • 2003 Shingo Award for Excellence in the market, winning industry awards. H I G H L I G H T S / A W A R D S : Manufacturing. • Get SetTM – 2003 Editor’s Choice, Top Pick • Aggressive 2003 product launch of nine new • Office Furniture Dealers Alliance (OFDA), Annual Award by Buildings Magazine and the seating lines: AmalfiTM, ValorTM, PorterTM, 2003 Dealers’ Choice Manufacturer of the Chicago Atheneum Good Design Award. TiaraTM, RaffaellaTM, NapoliTM, SirmioneTM, Year, Best Support, Service, and Training, and • Terrace® 2.6 – recognized among top products FitzgeraldTM, and DebonairTM. Best Management. of 2003 by Architectural Record magazine. • Launched MantraTM, a new modular and • General Services Administration’s (GSA) • The #19® chair, introduced in 2002, contin- contemporary case good line. Using mixed 2003 “Evergreen Furniture and Furnishings ues to receive numerous awards including the materials — from wood to brushed aluminum Award” for environmental stewardship. California IIDA Acclaim Award and the Best of and glass — the line focuses on the integration • The Chicago Athenaeum: Museum of Arch- Category Award by I.D. magazine. of technology into today’s executive office itecture and Design Award for the Olson Flex • Office Furniture Dealers Alliance (OFDA), environments. StackerTM Chair and Perpetual® desking. 2003 Dealers Choice award for Management. • The AmalfiTM line won the Silver Award at • Buildings Magazine’s Innovations Award • General Services Administration’s (GSA) NeoCon. and Editor’s Top 100 — Perpetual® desking. 2003 “Evergreen Furniture and Furnishings • Experienced record operational performance. • Today’s Facilities Manager Readers’ Choice Award” for environmental stewardship. Award — Non-task seating, storage, and con- W W W . A L L S T E E L O F F I C E . C O M W W W . G U N L O C K E . C O M ference room furnishings. W W W . H O N . C O M 28 29 H O N I N D U S T R I E S 2 0 0 3 O F F I C E F U R N I T U R E A T - A - G L A N C E Paoli Inc. is a leading provider of wood case Maxon Furniture Inc. targets small to mid- HON International Inc. is responsible for HON goods, modular desking, conference pro- sized businesses seeking “planned” offices fea- INDUSTRIES’ sales and business develop- ducts, and seating through its well-known turing workstations and compatible storage ment outside the United States and Canada. brands Paoli® and Whitehall®. Founded in and seating. Maxon’s customers appreciate Our members in local countries market the 1926, it is the newest member of the HON office furniture that efficiently organizes space HON INDUSTRIES’ brands through a global INDUSTRIES family, acquired in January and creates a positive working environment. distribution network. With an extensive prod- 2004. Outstanding product design at a great value makes Paoli a highly sought after solu- tion in the market for wood private offices. Paoli’s production capability and resources allow the company to respond quickly to changing market needs. Paoli’s strong, inde- pendent representative sales and dealer net- works support its broad product offering in the mid-market and contract furniture segments. H I G H L I G H T S / A W A R D S : • Introduced the ReflectTM product line of modular, traditional case goods in 2003. • Created CAPTM — a comprehensive family of library products designed to effectively fur- nish today’s diverse learning environments and sports stadium suites. W W W . P A O L I . C O M H I G H L I G H T S / A W A R D S : • Gave the Empower® product line a com- plete makeover; including a new trim design, segmented panels, and redesigned storage cabinets. W W W . M A X O N F U R N I T U R E . C O M uct selection, HON International is able to provide dealers and customers with the widest collection of “compelling value” office furni- ture in the world. The international team is dedicated to providing customers with world- class service, from initial inquiry to com- plete-and-on-time installation. Extensive international experience helps to ensure cus- tomers are provided with solutions for even their most challenging international needs Holga Inc. provides filing and storage solu- and opportunities. tions to contract, commercial, and institutional markets. Signature products include high-den- sity shelving and mobile storage systems designed for efficient space utilization. Holga also offer a broad range of traditional metal filing and storage products. H I G H L I G H T S / A W A R D S : • A lead exhibitor in the first-ever Office Furniture Expo in Mexico City. • Successfully completed projects for key multinational accounts in Ireland, Barbados, Jamaica, Egypt, and Hong Kong, among others. H I G H L I G H T S / A W A R D S : • Opened the first HON INDUSTRIES’ show- • Introduced 8000 Series Stackable Storage room outside the United States in Monterrey, units, which provide a wide array of customiz- Mexico. able storage options within a standard plat- form. The Series complements our new 8000 Series Pedestals, which offer a unique inter- locking system and end tab filing capabilities. W W W . H O L G A . C O M W W W . H O N I N T E R N A T I O N A L . C O M 29 H O N I N D U S T R I E S 2 0 0 3 H E A R T H & H O M E T E C H N O L O G I E S A T - A - G L A N C E Since the first air-circulating fireplace was The hearth industry’s design and innovation The Fireside Furnishings business is the patented in 1927, Heatilator® has become the leader, Heat-N-Glo® has been awarded more preferred manufacturer for mantels and most recognized and preferred fireplace than 50 patents and is known for its inno- surrounds to complement Heatilator ®, brand among homebuilders. Heatilator Home vative hearth technology. The Heat-N-Glo® Heat-N-Glo®, or Quadra-FireTM fireplaces. It ProductsTM extends our business beyond the brand now includes a complete line of gas, builds the widest range of mantels, shelves, hearth to include products that enhance a wood, and electric fireplaces, stoves and cabinets, and wall systems, from simple and healthy home environment. inserts, unique surrounds, and distinctive inexpensive offerings to elegant and elaborate H I G H L I G H T S / A W A R D S : nating homeowners’ desires for comfort, imported stone. accessories — all designed to meet discrimi- designs featuring custom millwork and • Redesigned and launched NovusTM, the larg- est Heatilator® product family, continuing a beauty, and elegance. H I G H L I G H T S / A W A R D S : best-in-class tradition in the gas fireplace H I G H L I G H T S / A W A R D S : • Heritage CollectionTM was named a 2003 segment. New product introductions: Vesta Award Finalist for Mantels, Facings, and • Won the hearth industry’s Vesta Award that • Cutting EdgeTM — the world’s only customiz- Surrounds. recognized the SilhouetteTM electric fireplace able insert surround that allows for a natural as the best new electric fireplace on the market stone finish at installation. W W W . F I R E S I D E F U R N I S H I N G S . C O M in 2003. • EscapeTM fireplace — the world’s first and W W W . H E A T I L A T O R . C O M only direct-vent gas fireplace that has a com- plete masonry appearance inside and out — was a finalist for the Vesta award for “Best The leader in high-efficiency, durable, and stylish hearth products, the Quadra-FireTM brand offers specialty channel partners the widest selection of high-performance fire- places, stoves, and fireplace inserts in the wood, gas, pellet, and electric fuel categories. New Gas Fireplace.” The leading provider of hearth and home • Vesta awarded the DakotaTM outdoor fire- products and services, Fireside Hearth & Home place “Best New Outdoor Fireplace Product” design centers help consumers achieve the in 2003, and also named RekindlerTM a finalist feeling they want in their home by supporting for “Best New Gas Insert.” the entire buying process — from purchase to • The InfinityTM fireplace won “Best New installation and after-sale service. Fireside Product” from Building Products magazine, Hearth & Home works through a network of for its innovative combination of traditional independent and company-owned, stand- H I G H L I G H T S / A W A R D S : masonry appearance and advanced venting alone or gallery design centers, as well as • 2003 product introductions included new and installation applications. installation centers, catering both to con- W W W . H E A T N G L O . C O M sumers and builders. W W W . F I R E S I D E U S A . C O M wood- and pellet-burning stoves and fire- places; wood and gas inserts and fireplace fronts; and electric stoves and fireplaces. • The Quadra-FireTM 7100 EPA Wood Fireplace won the Vesta Awards’ “Best New Hearth Product for 2003” and “Best in Show in 2003.” W W W . Q U A D R A F I R E . C O M 30 afkljdf aojvoaipdddd S E E K I N G I N V E S T O R S F O R A P E R F E C T M A T C H Join us in the dynamic, aggressive, profitable growth of HON INDUSTRIES. T H E B E S T I S Y E T T O C O M E ! Management’s Discussion and Analysis … 32 Consolidated Financial Statements and Notes … 39 Eleven-Year Summary … 56 Reports of Independent Auditors … 58 A Message from the Board of Directors … 61 Board of Directors and Officers … 62 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S The following discussion of the Company’s historical results of opera- Critical Accounting Policies and Estimates tions and of its liquidity and capital resources should be read in G E N E R A L conjunction with the Consolidated Financial Statements of the Management’s Discussion and Analysis of Financial Condition and Company and related notes. Results of Operations is based upon the Consolidated Financial Overview The Company has two reportable core operating segments: office furni- ture and hearth products. The Company is the second largest office furniture manufacturer in the United States and the nation’s leading manufacturer and marketer of gas- and wood-burning fireplaces. From 2000 to 2003, the office furniture industry experi- enced an unprecedented three-year decline due to the challenging economic environment. In 2003, this decline negatively impacted the Company’s office furniture segment. In contrast, the housing market was at record high levels during 2003, which positively impacted the Company’s hearth segment. The Company outperformed its peers in Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of con- tingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Actual results may differ from these estimates under different assump- both segments in which it competes. The Company gained market share by providing strong brands, innovative products and services, tions or conditions. and greater value to its end-users. Fiscal 2003 also included an extra week of activity due to the Company’s 52/53-week fiscal year. Net sales were $1.8 billion in 2003, as compared to $1.7 bil- lion in 2002. The increase in net sales reflects the 9% increase in the hearth segment and the additional week of business activity. In 2003 and 2002, the Company recorded restructuring charges and accelerated depreciation related to the closure and consolidation of office furniture facilities totaling $15.2 million and $3.0 million, respectively. Gross margins increased to 36.4% in 2003 from 35.4% in 2002 due to benefits An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements. from restructuring initiatives and its rapid continuous improvement Fiscal year end – The Company’s fiscal year ends on the Saturday program, new products, and increased price realization. The Company nearest December 31. Fiscal year 2003, the year ended January 3, also invested aggressively in brand building and selling initiatives in 2004, contained 53 weeks, while fiscal year 2002, the year ended 2003. Net income was $98.1 million or $1.68 per diluted share in 2003, December 28, 2002, and fiscal year 2001, the year ended December 29, as compared to $91.4 million or $1.55 per diluted share in 2002. 2001, contained 52 weeks. A 53-week year occurs approximately every The Company generated $141.3 million in cash flow from sixth year. operating activities and increased its cash position, including short- term investments, by $48.6 million to $204.2 million. The Company paid dividends of $30.3 million and repurchased $21.5 million of its common stock, while investing $35.7 million in net capital expendi- tures and repaying $20.2 million of debt. Revenue recognition – Revenue is normally recognized upon shipment of goods to customers. In certain circumstances revenue is not recognized until the goods are received by the customer or upon installation and customer acceptance based on the terms of the sale agreement. Revenue includes freight charged to customers; related 32 33 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S costs are included in selling and administrative expense. Rebates, of the asset reflected in the Company’s balance sheet may not be recov- discounts, and other marketing program expenses directly related to erable. An estimate of undiscounted cash flows produced by the asset, the sale are recorded as a reduction to net sales. Marketing program or the appropriate group of assets, is compared to the carrying value to accruals require the use of management estimates and the consider- determine whether impairment exists. The estimates of future cash ation of contractual arrangements subject to interpretation. Customer flows involve considerable management judgment and are based upon sales that reach certain award levels can affect the amount of such assumptions about future operating performance. The actual cash flows estimates, and actual results could differ from these estimates. Future could differ from management’s estimates due to changes in business market conditions may require increased incentive offerings, possibly conditions, operating performance, and economic conditions. Asset resulting in an incremental reduction in net sales at the time the impairment charges associated with the Company’s restructuring incentive is offered. activities are discussed in the Restructuring Related Charges note. Allowance for doubtful accounts receivable – The allowance for receivables is based on several factors including overall customer credit quality, historical write-off experience, and specific account analysis that project the ultimate collectibility of the account. As such, these factors may change over time, causing the reserve level to adjust accordingly. When it is determined that a customer is unlikely to pay, a The Company’s continuous focus on improving the manufac- turing process tends to increase the likelihood of assets being replaced; therefore, the Company is constantly evaluating the expected useful lives of its equipment, which can result in accelerated depreciation. Additionally, the Company recorded losses on the disposal of assets in the amount of $1 million and $5 million in 2003 and 2002, respec- tively, as a result of its rapid continuous improvement initiatives. charge is recorded to bad debt expense in the income statement and the Goodwill and other intangibles – In accordance with the allowance for doubtful accounts is increased. When it becomes certain Statement of Financial Accounting Standards (“SFAS”) No. 142, the the customer cannot pay, the receivable is written off by removing the Company evaluates its goodwill for impairment on an annual basis accounts receivable amount and reducing the allowance for doubtful based on values at the end of third quarter or whenever indicators of accounts accordingly. impairment exist. The Company has evaluated its goodwill for impair- At January 3, 2004, there was approximately $192 million in ment and has determined that the fair value of the reporting units outstanding accounts receivable and $11 million recorded in the allow- exceeded their carrying value, so no impairment of goodwill was recog- ance for doubtful accounts to cover all potential future customer nized. Goodwill of approximately $192 million is shown on the non-payments. However, if economic conditions deteriorate signifi- consolidated balance sheet as of the end of fiscal 2003. cantly or one of our large customers were to declare bankruptcy, a Management’s assumptions about future cash flows for the larger allowance for doubtful accounts might be necessary. The reporting units require significant judgment and actual cash flows in allowance for doubtful accounts was approximately $10 million and the future may differ significantly from those forecasted today. We $17 million at year end 2002 and 2001, respectively. believe our assumptions used in discounting future cash flows would Inventory valuation – The Company values 96% of its inventory by the last-in, first-out (LIFO) method. Additionally, the Company evalu- ates inventory reserves in terms of excess and obsolete exposure. This evaluation includes such factors as anticipated usage, inventory turn- over, inventory levels, and ultimate product sales value. As such, these factors may change over time, causing the reserve level to adjust accordingly. have no impact on the reported carrying amount of goodwill. The esti- mated future cash flow for any reporting unit could be reduced by 50% without decreasing the fair value to less than the carrying value. The Company also determines the fair value of an indefinite lived trademark on an annual basis or whenever indication of impair- ment exists. The Company has evaluated its trademark for impairment and has determined that the fair market value of the trademark exceeds its carrying value, so no impairment was recognized. The car- Long-lived assets – Long-lived assets are reviewed for impairment rying value of the trademark was approximately $8 million at the end as events or changes in circumstances occur indicating that the amount of fiscal 2003. 32 33 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S Self-insurance reserves – The Company is partially self-insured Results of Operations for general liability, product liability, workers’ compensation, and The following table sets forth the percentage of consolidated net sales certain employee health benefits. The general, product, and workers’ represented by certain items reflected in the Company’s statements of compensation liabilities are managed using a wholly owned insurance income for the periods indicated. captive; the related liabilities are included in the accompanying finan- cial statements. The Company’s policy is to accrue amounts in accordance with the actuarially determined liabilities. The actuarial valuations are based on historical information along with certain assumptions about future events. Changes in assumptions for such matters as claims, medical costs, and changes in actual experience could cause these estimates to change in the near term. Stock-based compensation – The Company accounts for its stock-option plan using Accounting Principles Board Opinion No. 25, Fiscal Net sales Cost of products sold Gross profit Selling and administrative expenses Restructuring related charges Operating income Interest income (net) Income before income taxes Income taxes 2003 100.0% 63.6 36.4 27.4 0.5 8.5 0.1 8.6 3.0 2002 100.0% 64.6 35.4 26.8 0.2 8.4 (0.1) 8.3 2.9 Net income 5.6% 5.4% 2001 100.0% 65.9 34.1 25.9 1.3 6.9 (0.4) 6.5 2.3 4.2% “Accounting for Stock Issued to Employees,” which results in no charge to earnings when options are issued at fair market value. SFAS No. 123, N E T S A L E S “Accounting for Stock-Based Compensation” issued subsequent to APB No. 25 and amended by SFAS No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure” defines a fair value-based method of accounting for employee stock options but allows companies to continue to measure compensation cost for employee stock options using the intrinsic value based method described in APB No. 25. Net sales increased 3.7% in 2003 and decreased 5.6% in 2002. The increase in 2003 was due to the extra week in 2003 as a result of the Company’s 52/53-week fiscal year and strong performance in the hearth products segment. The decrease in 2002 was due to the decline in the office furniture market due to unstable economic conditions and the deletion of less profitable product lines in the hearth products segment. The Company has no immediate plans at this time to volun- G R O S S P R O F I T tarily change its accounting policy to the fair value based method; Gross profit as a percent of net sales improved 1.0 percentage point in however, the Company continues to evaluate this alternative. In accor- 2003 as compared to fiscal 2002 and 1.3 percentage points in 2002 as dance with SFAS No. 148, the Company has been disclosing in the Notes compared to 2001. The improvement in both periods was a result of the to the Consolidated Financial Statements the impact on net income and continued net benefits of rapid continuous improvement, restructuring earnings per share had the fair value based method been adopted. If the initiatives, business simplification, new products, and improved price fair value method had been adopted, net income for 2003, 2002, and realization. Included in 2003 gross profit was $6.7 million of acceler- 2001 would have been $3 million, $2.2 million, and $1.4 million lower ated depreciation, which reduced gross profits 0.4 percentage points. than reported and earnings per share would have been reduced approx- The Company expects to mitigate any future increases in material costs imately $0.06, $0.04 and $0.02 per diluted share, respectively. through various initiatives, including alternative materials and sup- Recent Accounting Pronouncements pliers and its rapid continuous improvement program. See the Notes to the Consolidated Financial Statements for a full S E L L I N G A N D A D M I N I S T R A T I V E E X P E N S E S description of recent accounting pronouncements including the respec- Selling and administrative expenses, excluding restructuring charges, tive expected dates of adoption and effects on results of operations and increased 5.8% in 2003 and decreased 2.2% in 2002. The increase in financial conditions. 2003 was due to additional investment of approximately $14 million in brand building and selling initiatives, and increased freight costs of $7 million due to rate increases, fuel surcharges, and volume. The decrease in 2002 was due to no longer amortizing goodwill and certain other intangible assets of approximately $9 million and lower overall 34 35 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S sales volume, offset by increased investment in brand equity build- This was due to the fact that the Company was able to exit a lease with ing and new product development of approximately $7 million, and the lessor at more favorable terms than previously estimated. increased incentive compensation of which approximately $4 million During the second quarter of 2001, the Company recorded a was for a debenture earn out related to a prior acquisition. pretax charge of $24 million or $0.26 per diluted share for a restructur- Selling and administrative expenses include freight expense ing plan that involved consolidating physical facilities, discontinuing for shipments to customers, product development costs, and amortiza- low-volume product lines, and reductions of workforce. Included in the tion expense of intangible assets. The Selling and Administrative charge was the closedown of three of its office furniture facilities located Expenses note included in the Notes to Consolidated Financial in Williamsport, Pennsylvania; Tupelo, Mississippi; and Santa Ana, Statements provides further information regarding the comparative California. Approximately 500 members were terminated and received expense levels for these major expense items. severance due to the closedown of these facilities. During the second R E S T R U C T U R I N G C H A R G E S During 2003, the Company closed two office furniture facilities and consolidated production into other U.S. manufacturing locations to increase efficiencies, streamline processes, and reduce overhead costs. quarter of 2002, a restructuring credit of approximately $2.4 million was taken back into income relating to this charge. This was mainly due to the fact that the Company was able to exit a lease with a lessor at more favorable terms than originally estimated and the Company’s ability to minimize the number of members terminated as compared to The two facilities were located in Hazleton, Pennsylvania, and Milan, Tennessee. In connection with the closures, the Company recorded the original plan. $15.7 million of pre-tax charges or $0.17 per diluted share. These O P E R A T I N G I N C O M E charges included $6.7 million of accelerated depreciation of machinery Operating income increased 5% in 2003 and 16% in 2002, respectively. and equipment which was recorded in cost of sales, $3.4 million of sev- The increase in 2003 is due to the additional week, strong sales volume erance, and $5.6 million of facility exit, production relocation, and other in the hearth segment, and improved gross margins in both segments, costs which were recorded as restructuring costs. A total of 316 members offset by increased restructuring charges due to additional plant clo- were terminated and received severance due to these shutdowns. The sures and consolidations, increased investment in brand building and closures are substantially complete. The Company anticipates additional selling initiatives, and increased freight costs. The increase in 2002 costs of $0.3 to $0.5 million during the first quarter of 2004 related to was due to a $24 million restructuring charge in 2001 compared to a these closures. $3 million restructuring charge in 2002 and goodwill and indefinite- The Hazleton, Pennsylvania, facility is an owned facility and lived intangibles amortization of $9 million incurred in 2001 that is has been reclassified to current assets as it is currently being held as not included in 2002 due to a change in accounting standards. available for sale. It is included in the “Prepaid expenses and other cur- rent assets” in the January 3, 2004, condensed consolidated balance sheet at its carrying value of $2.1 million. The Milan, Tennessee, facility is a leased facility that is no longer being used in the production of goods. The restructuring expense for 2003 included $1.4 million of costs that will continue to be incurred under the lease contract reduced by estimated sublease rentals that could be reasonably obtained. During 2002, the Company recorded a pretax charge of approximately $5.4 million due to the shutdown of an office furniture facility in Jackson, Tennessee. A total of 125 members were terminated and received severance due to this shutdown. During the second quarter of 2003, a restructuring credit of approximately $0.6 million or $0.01 per diluted share was taken back into income relating to this charge. N E T I N C O M E Net income increased 7% in 2003 and 23% in 2002, respectively. Net income in 2003 was favorably impacted by increased interest income due to increased investments and decreased interest expense due to reduc- tion in debt. Net income in 2002 was favorably impacted by a decrease in interest expense and a decrease in the effective tax rate to 35% in 2002 from 36% in 2001 mainly due to tax benefits associated with various federal and state tax credits. The Company anticipates that its tax rate will increase to 36% in 2004 due to increased state taxes and a reduced benefit from federal and state tax credits. Net income per diluted share increased by 8% to $1.68 in 2003 and by 23% to $1.55 in 2002, respec- tively. Due to the appreciation in the Company’s stock price, outstanding options had a dilutive impact of $0.01 per share in 2003. 34 35 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S O F F I C E F U R N I T U R E Liquidity and Capital Resources Office furniture comprised 74% of consolidated net sales for 2003 and During 2003, cash flow from operations was $141.3 million, which 76% of consolidated net sales for 2002 and 2001. Net sales for office along with funds from stock option exercises under employee stock furniture increased 2% in 2003 and decreased 6% in 2002. The plans, provided the funds necessary to meet working capital needs, increase in 2003 is due to the increased week from the Company’s invest in capital improvements, repay long-term debt, repurchase com- 52/53-week fiscal year. The office furniture industry has experienced an mon stock, and pay increased dividends. unprecedented three-year decline in shipments. The Business and Cash, cash equivalents, and short-term investments totaled Institutional Furniture Manufacturer’s Association (BIFMA) reported $204.2 million at the end of 2003 compared to $155.5 million at the 2003 shipments down over 5% and 2002 shipments down 19%. The end of 2002 and $78.8 million at the end of 2001. The Company used Company’s estimated share of the market based on reported office approximately $80 million of cash to acquire Paoli Inc. on January 5, furniture shipments increased to 15.3% in 2003 compared to 14.4% 2004. These remaining funds, coupled with cash from future opera- in 2002 and 12.4% in 2001. This increase was achieved by provid- tions and additional long-term debt, if needed, are expected to be ing strong brands, innovative products and services, and greater value adequate to finance operations, planned improvements, and internal to end-users. growth. The Company is not aware of any known trends or demands, Operating profit as a percent of sales was 10.0% in 2003, commitments, events, or uncertainties that are reasonably likely to 10.2% in 2002, and 8.2% in 2001. Included in 2003 were $15.2 million result in its liquidity increasing or decreasing in any material way. of net pretax charges related to the closure of two office furniture The Company places special emphasis on the management facilities, which impacted operating margins by 1.1 percentage points. and reduction of its working capital with a particular focus on trade Included in 2002 were $3.0 million of restructuring charges, which receivables and inventory levels. The success achieved in managing impacted operating margins by 0.2 percentage points, and 2001 receivables is in large part a result of doing business with quality cus- included $22.5 million of restructuring charges, which impacted oper- tomers and maintaining close communication with them. Trade ating margins by 1.7 percentage points. The increase in operating receivables at year-end 2003 were virtually unchanged from the prior margins is due to increased gross profit from the benefits of restructur- year. Trade receivable days outstanding have averaged approximately ing initiatives, rapid continuous improvement programs, and increased 37 to 38 days over the past three years. The Company’s inventory turns price realization, offset by additional investments in brand building and were 23, 23, and 18 for 2003, 2002, and 2001, respectively. Increased selling initiatives and increased freight expense. imports of raw materials and finished goods may negatively affect H E A R T H P R O D U C T S Hearth products sales increased 9% in 2003 and decreased 3% in 2002, respectively. The growth in 2003 was attributable to strong housing starts, growth in market share in both the new construction and retail channels, strengthening alliances with key distributors and dealers, as well as focused new product introductions. The decrease in 2002 was mainly due to pruning out less profitable product lines. inventory turns in the future but the Company is constantly looking for ways to add efficiency to its supply chain. The decrease in accounts pay- able and accrued expenses is due to timing of vendor and marketing program payments and the payment of additional purchase consider- ation and debenture earn out related to a prior acquisition. The Company also funded the retiree medical portion of its postretirement benefit obligation in 2003. Operating profit as a percent of sales in 2003 was 12.1% com- I N V E S T M E N T S pared to 10.8% and 9.2% in 2002 and 2001, respectively. The improved The Company has investments in investment grade equity and debt profitability in 2003 was the result of leveraging fixed costs over a securities. Management classifies investments in marketable securities higher sales volume and increased sales through company-owned dis- at the time of purchase and reevaluates such classification at each bal- tribution offset by increased freight costs and higher labor costs from ance sheet date. Equity securities are classified as available-for-sale and increased use of overtime and temporary labor to meet record levels of are stated at current market value with unrealized gains and losses demand. The increase in 2002 was mainly due to discontinuance of included as a separate component of equity, net of any related tax goodwill and indefinite-lived intangible amortization of approximately effect. Debt securities are classified as held-to-maturity and are stated $7 million due to the adoption of SFAS 142. at amortized cost. A table of holdings as of year-end 2003 and 2002 is 36 37 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S included in the Cash, Cash Equivalents, and Investments note included P A Y M E N T S D U E B Y P E R I O D in the Notes to Consolidated Financial Statements. C A P I T A L E X P E N D I T U R E I N V E S T M E N T S Capital expenditures were $34.8 million in 2003, $25.9 million in 2002, and $36.9 million in 2001. Expenditures during 2003, 2002, and 2001 have been consistently focused on machinery and equipment needed to support new products, process improvements, and cost (In thousands) Less than 1 year Total Long-term debt Capital lease obligations Operating leases Transportation service $ 28,933 2,338 50,750 26,243 523 13,012 1 – 3 years 212 799 19,166 4 – 5 years 95 426 9,510 After 5 years 2,383 590 9,062 contract 9,650 4,794 4,856 – – Other long-term obligations 11,893 4,289 1,430 914 5,260 savings initiatives. Expenditures in 2003 also included the purchase Total $ 103,564 48,861 26,463 10,945 17,295 from a related party of a previously leased hearth products plant for $3.6 million. A C Q U I S I T I O N S Other long-term obligations includes $2,959,000 earn-out on convert- ible debentures included in current liabilities, $69,000 of financial guarantees with customers, and $8,865,000 of payments included in During 2001, the Company completed the acquisition of three small long-term liabilities, due to members who are participants in the hearth products distributors for a total purchase price of approximately Company’s salary deferral program. $7.6 million. The acquisitions were accounted for using the purchase method, and the results of the three distributors have been included in the Company’s financial statements since the date of acquisition. On January 5, 2004, the Company completed the acquisition of Paoli Inc., a provider of wood case goods and seating, for approximately $80 mil- lion. The acquisition will be accounted for using the purchase method. C A S H D I V I D E N D S Cash dividends were $0.52 per common share for 2003, $0.50 for 2002, and $0.48 for 2001. Further, the Board of Directors announced a 7.7% increase in the quarterly dividend from $0.13 to $0.14 per com- mon share effective with the March 1, 2004, dividend payment for shareholders of record at the close of business February 20, 2004. The L O N G - T E R M D E B T previous quarterly dividend increase was from $0.125 to $0.13, effec- Long-term debt, including capital lease obligations, was 1% of total tive with the February 28, 2003, dividend payment for shareholders of capitalization at January 3, 2004, 2% at December 28, 2002, and 12% record at the close of business on February 21, 2003. A cash dividend at December 29, 2001. The reductions in long-term debt during 2003 has been paid every quarter since April 15, 1955, and quarterly divi- and 2002 were due to the retirement of Industrial Revenue Bonds. dends are expected to continue. The average dividend payout The Company does not expect future capital resources to be a constraint percentage for the most recent three-year period has been 32% of on planned growth. Additional borrowing capacity of $136 million, prior year earnings. less amounts used for designated letters of credit, is available through a revolving bank credit agreement in the event cash generated from operations should be inadequate to meet future needs. Certain of the Company’s credit agreements include covenants that limit the assump- tion of additional debt and lease obligations. The Company has been, and currently is, in compliance with the covenants related to the debt agreements. C O M M O N S H A R E R E P U R C H A S E S During 2003, the Company repurchased 762,300 shares of its com- mon stock at a cost of approximately $21.5 million, or an average price of $28.22 per share. During 2002, the Company repurchased 614,580 shares of its common stock at a cost of approximately $15.7 million, or an average price of $25.60 per share. During 2001, the Company repurchased 1,472,937 shares at a cost of approximately C O N T R A C T U A L O B L I G A T I O N S $35.1 million, or an average price of $23.80 per share. The following table discloses the Company’s obligations and commit- ments to make future payments under contracts: L I T I G A T I O N A N D U N C E R T A I N T I E S The Company has contingent liabilities that have arisen in the course of its business, including pending litigation, preferential payments claims in customer bankruptcies, environmental remediation, taxes, and other 36 37 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S claims. The Company currently has a claim for approximately $7.6 mil- consolidations and its rapid continuous improvement program to con- lion pending against it arising out of the bankruptcy of a customer filed tinue to build brands, product solutions, and selling models. in 2001. The Company was named a critical vendor by the bankruptcy Because of the following factors, as well as other variables court and, accordingly, was paid in full for all outstanding receivables. affecting the Company’s operating results, past financial performance The claim alleges that the Company received preferential payments may not be a reliable indicator of future performance, and historical from the customer during the ninety days before the customer filed for trends should not be used to anticipate results or trends in future bankruptcy protection. The claim was brought in February 2003. The periods: Company has recorded an accrual with respect to this contingency, in • competition within the office furniture and fireplace industries, an amount substantially less than the full amount of the claim, which including competition from imported products and competitive represents the best estimate within the range of likely exposure and pricing; intends to vigorously defend against the claim. Given the nature of this • increases in the cost of raw materials, including steel, which is the claim, it is possible that the ultimate outcome could differ from the Company’s largest raw material category; recorded amount. It is our opinion, after consultation with legal coun- • increases in the cost of health care benefits provided by the sel, that additional liabilities, if any, resulting from these matters, are Company; not expected to have a material adverse effect on our financial condi- • reduced demand for the Company’s storage products caused by tion, although such matters could have a material effect on our changes in office technology, including the change from paper record quarterly or annual operating results and cash flows when resolved in storage to electronic record storage; a future period. Looking Ahead The Company is encouraged by indications that the economy is recov- ering and is cautiously optimistic that the office furniture industry will • the effects of economic conditions on demand for office furniture, customer insolvencies and related bad debts, and claims against the Company that it received preferential payments; • changes in demand and order patterns from the Company’s customers, particularly its top ten customers, which represented approximately begin to rebound in the second half of 2004. Global Insight, BIFMA’s forecasting consultant, increased its estimate for the industry shipment 36% of net sales in 2003; growth from 2.4% to 5.6% in 2004, with first quarter flat and improving as the year progresses. • issues associated with acquisitions and integration of acquisitions; • the ability of the Company to realize cost savings and productivity improvements from its cost containment and business simplification The hearth segment is impacted by the housing market, initiatives; • the ability of the Company to realize financial benefits from invest- ments in new products; • the ability of the Company’s distributors and dealers to successfully market and sell the Company’s products; and • the availability and cost of capital to finance planned growth. which may experience a slight decline from record high levels, but is expected to remain at healthy levels. Management believes its strong brand recognition and new innovative product introductions in addition to strengthening distribution will allow it to grow its hearth segment. On January 5, 2004, the Company completed the acquisition of Paoli Inc., a leading provider of wood case goods and seating. The Company intends to continue to build on Paoli’s strong position in the market and excellent selling capabilities while leveraging its lean enter- prise practices to achieve greater cost efficiencies and improved customer performance. The Company’s strategy is to grow its business through aggressive investment in building its brands, enhancing its strong member-owner culture, and remaining focused on its rapid continu- ous improvement program to continue to build best total cost. The Company plans to reinvest a large portion of its cost savings from plant 38 39 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F I N C O M E (Amounts in thousands, except for per share data) For the Years 2003 2002 2001 Net sales Cost of products sold Gross Profit Selling and administrative expenses Restructuring related charges Operating Income Interest income Interest expense Income Before Income Taxes Income taxes Net Income Net Income Per Common Share – Basic $ 1,755,728 $ 1,692,622 $ 1,792,438 1,116,513 1,092,743 1,181,140 639,215 480,744 8,510 149,961 3,940 2,970 150,931 52,826 98,105 1.69 $ $ 599,879 454,189 3,000 142,690 2,578 4,714 140,554 49,194 91,360 1.55 $ $ 611,298 464,206 24,000 123,092 1,717 8,548 116,261 41,854 74,407 1.26 $ $ Weighted Average Shares Outstanding – Basic 58,178,739 58,789,851 59,087,963 Net Income Per Common Share – Diluted $ 1.68 $ 1.55 $ 1.26 Weighted Average Shares Outstanding – Diluted 58,545,353 59,021,071 59,210,049 The accompanying notes are an integral part of the consolidated financial statements. 38 39 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S C O N S O L I D A T E D B A L A N C E S H E E T S (Amounts in thousands of dollars and shares except par value) As of Year-End 2003 2002 2001 A S S E T S C U R R E N T A S S E T S Cash and cash equivalents Short-term investments Receivables Inventories Deferred income taxes Prepaid expenses and other current assets Property, Plant, and Equipment Goodwill Other Assets Total Assets L I A B I L I T I E S A N D S H A R E H O L D E R S ’ E Q U I T Y C U R R E N T L I A B I L I T I E S $ 138,982 $ 139,165 $ 78,838 65,208 181,459 49,830 14,329 12,314 16,378 181,096 46,823 10,101 11,491 312,368 192,086 55,250 353,270 192,395 69,833 – 161,390 50,140 14,940 14,349 319,657 404,971 214,337 22,926 $ 1,021,826 $ 1,020,552 $ 961,891 Total Current Assets 462,122 405,054 Accounts payable and accrued expenses $ 211,236 $ 252,145 $ 216,184 Income taxes Note payable and current maturities of long-term debt Current maturities of other long-term obligations 5,958 26,658 1,964 3,740 41,298 1,497 6,112 6,715 1,432 Total Current Liabilities 245,816 298,680 230,443 Long-Term Debt Capital Lease Obligations Other Long-Term Liabilities Deferred Income Taxes Commitments and Contingencies S H A R E H O L D E R S ’ E Q U I T Y Preferred stock – $1 par value Authorized: 2,000 Issued: None Common stock – $1 par value Authorized: 200,000 2,690 1,436 24,262 37,733 8,553 1,284 28,028 37,114 79,570 1,260 18,306 39,632 58,239 58,374 58,673 Issued and outstanding 2003 – 58,239; 2002 – 58,374; 2001 – 58,673 Additional paid-in capital Retained earnings Accumulated other comprehensive income Total Shareholders’ Equity 10,324 549 641,732 587,731 (406) 239 709,889 646,893 Total Liabilities and Shareholders’ Equity $ 1,021,826 $ 1,020,552 891 532,555 561 592,680 $ 961,891 The accompanying notes are an integral part of the consolidated financial statements. 40 41 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F S H A R E H O L D E R S ’ E Q U I T Y (Amounts in thousands) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income Total Shareholders’ Equity Retained Earnings Balance, December 30, 2000 $ 59,797 $ 17,339 $ 495,796 $ 410 $ 573,342 Comprehensive Income: Net income Other comprehensive income Comprehensive income Cash dividends Common shares — treasury: Shares purchased Shares issued under Members’ Stock 74,407 (28,373) 151 74,407 151 74,558 (28,373) (1,473) (24,311) (9,275) (35,059) Purchase Plan and stock awards 349 7,863 8,212 Balance, December 29, 2001 58,673 891 532,555 561 592,680 Comprehensive income: Net income Other comprehensive income (loss) Comprehensive income Cash dividends Common shares — treasury: Shares purchased Shares issued under Members’ Stock 91,360 (29,386) (322) 91,360 (322) 91,038 (29,386) (614) (8,324) (6,798) (15,736) Purchase Plan and stock awards 315 7,982 8,297 Balance, December 28, 2002 58,374 549 587,731 239 646,893 Comprehensive income: Net income Other comprehensive income (loss) Comprehensive income Cash dividends Common shares — treasury: Shares purchased Shares issued under Members’ Stock 98,105 98,105 (645) (645) 97,460 (30,299) (30,299) (762) (6,945) (13,805) (21,512) Purchase Plan and stock awards 627 16,720 17,347 Balance, January 3, 2004 $ 58, 239 $ 10,324 $ 641,732 $ (406) $ 709,889 The accompanying notes are an integral part of the consolidated financial statements. 40 41 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S (Amounts in thousands) For the Years 2003 2002 2001 N E T C A S H F L O W S F R O M ( T O ) O P E R A T I N G A C T I V I T I E S : Net income Noncash items included in net income: Depreciation and amortization Other postretirement and postemployment benefits Deferred income taxes Loss on sales, retirements and impairments of property, plant and equipment Stock issued to retirement plan Other — net Changes in working capital, excluding acquisition and disposition: Receivables Inventories Prepaid expenses and other current assets Accounts payable and accrued expenses Income taxes Increase (decrease) in other liabilities Net cash flows from (to) operating activities N E T C A S H F L O W S F R O M ( T O ) I N V E S T I N G A C T I V I T I E S : Capital expenditures Proceeds from sale of property, plant and equipment Capitalized software Additional purchase consideration Short-term investments — net Purchase of long-term investments Sales or maturities of long-term investments Other — net $ 98,105 $ 91,360 $ 74,407 72,772 2,166 (3,314) 5,415 4,678 391 1,006 (3,004) 1,508 (35,288) 2,218 (5,379) 141,274 (34,842) 1,808 (2,666) (5,710) (49,326) (5,742) 15,000 – 68,755 2,246 2,321 8,976 5,750 2,613 (19,414) 2,348 2,431 37,857 (2,370) (482) 202,391 (25,885) — (65) — (16,377) (22,493) — 924 81,385 1,757 6,962 16,200 — 109 47,897 35,048 (1,661) (26,149) (5,957) (2,198) 227,800 (36,851) — (1,757) (8,748) — — — 343 Net cash flows from (to) investing activities (81,478) (63,896) (47,013) N E T C A S H F L O W S F R O M ( T O ) F I N A N C I N G A C T I V I T I E S : Purchase of HON INDUSTRIES common stock Proceeds from long-term debt Payments of note and long-term debt Proceeds from sale of HON INDUSTRIES common stock Dividends paid (21,512) 761 (20,992) 12,063 (30,299) (15,736) 825 (35,967) 2,096 (29,386) (35,059) 36,218 (87,365) 9,449 (28,373) Net cash flows from (to) financing activities (59,979) (78,168) (105,130) Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year (183) 139,165 138,982 60,327 78,838 139,165 75,657 3,181 78,838 S U P P L E M E N T A L D I S C L O S U R E S O F C A S H F L O W I N F O R M A T I O N : Cash paid during the year for: Interest Income taxes The accompanying notes are an integral part of the consolidated financial statements. $ 3,408 $ 53,855 $ 5,062 $ 48,598 $ 8,646 $ 40,916 42 42 43 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Nature of Operations date. Equity securities are classified as available-for-sale and are stated HON INDUSTRIES Inc., with its subsidiaries (the “Company”), is a at current market value with unrealized gains and losses included as a provider of office furniture and hearth products. Both industries are separate component of equity, net of any related tax effect. Debt securi- reportable segments; however, the Company’s office furniture business ties are classified as held-to-maturity and are stated at amortized cost. is its principal line of business. Refer to the Operating Segment The specific identification method is used to determine realized gains Information note for further information. Office furniture products are and losses on the trade date. Short-term investments include municipal sold through a national system of dealers, wholesalers, mass merchan- bonds, money market preferred stock, and U.S. treasury notes. Long- disers, warehouse clubs, retail superstores, end-user customers, and to term investments include U.S. government securities, municipal bonds, federal and state governments. Dealer, wholesaler, and retail super- certificates of deposit, and asset- and mortgage-backed securities. stores are the major channels based on sales. Hearth products include At January 3, 2004, and December 28, 2002, cash, cash electric, wood-, pellet-, and gas-burning factory-built fireplaces, fire- equivalents and investments consisted of the following (cost approxi- place inserts, stoves, and gas logs. These products are sold through a mates market value): national system of dealers, wholesalers, large regional contractors, and Company-owned retail outlets. The Company’s products are marketed predominantly in the United States and Canada. The Company exports select products to a limited number of markets outside North America, principally Latin America and the Caribbean, through its export subsid- iary; however, based on sales, these activities are not significant. (In thousands) Y E A R - E N D 2 0 0 3 Held-to-maturity securities Municipal bonds U.S. government securities Certificates of deposit Cash and cash equivalents Short- term investments Long- term investments $ $ 31,000 – – – – – $ 2,396 – 400 Summary of Significant Accounting Policies PRINCIPLES OF CONSOLIDATION AND FISCAL YEAR-END The consolidated financial statements include the accounts and trans- actions of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. The Company follows a 52/53-week fiscal year which ends on the Saturday nearest December 31. Fiscal year 2003 ended on January 3, 2004; 2002 ended on December 28, 2002; and 2001 ended on December 29, 2001. The financial statements for fiscal year 2003 are based on a 53-week period; fiscal years 2002 and 2001 are on a 52-week basis. Available-for-sale securities U.S. treasury notes Money market preferred stock Asset- and mortgage-backed securities – – – 4,259 – 60,949 Cash and money market accounts 107,982 – – – 12,835 – Total $ 138,982 $ 65,208 $ 15,631 Y E A R - E N D 2 0 0 2 Held-to-maturity securities Municipal bonds U.S. government securities Certificates of deposit $ 82,300 – – $ 1,900 – – $ 5,396 11,995 400 Available-for-sale securities U.S. treasury notes Money market preferred stock Asset- and mortgage-backed securities – – – 3,478 11,000 – Cash and money market accounts 56,865 – – – 7,098 – Total $ 139,165 $ 16,378 $ 24,889 C A S H , C A S H E Q U I V A L E N T S , A N D I N V E S T M E N T S Cash and cash equivalents generally consist of cash, money market accounts, and debt securities. These securities have original maturity The 2001 cash and cash equivalents generally consisted of cash and commercial paper. dates not exceeding three months from date of purchase. The Company R E C E I V A B L E S has short-term investments with maturities of less than one year Accounts receivable are presented net of an allowance for doubtful and also has investments with maturities greater than one year that accounts of $10,859,000, $9,570,000, and $16,576,000 for 2003, are included in Other Assets on the consolidated balance sheet. 2002, and 2001, respectively. The allowance for receivables is devel- Management classifies investments in marketable securities at the time oped based on several factors including overall customer credit quality, of purchase and reevaluates such classification at each balance sheet historical write-off experience and specific account analyses that 42 43 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S project the ultimate collectibility of the account. As such, these factors evaluated its goodwill for impairment and has determined that the fair may change over time, causing the reserve level to adjust accordingly. value of reporting units exceeds their carrying value, so no impairment I N V E N T O R I E S The Company values 96% of its inventory by the last-in, first-out (LIFO) method. Additionally, the Company evaluates its inventory reserves in terms of excess and obsolete exposures. This evaluation includes such factors as anticipated usage, inventory turnover, inven- tory levels, and ultimate product sales value. As such, these factors may change over time, causing the reserve level to adjust accordingly. of goodwill was recognized. Management’s assumptions about future cash flows for the reporting units requires significant judgment, and actual cash flows in the future may differ significantly from those fore- casted today. The Company also determines the fair value of an indefinite lived trademark on an annual basis, or whenever indications of impair- ment exist. The Company has evaluated its trademark for impairment and has determined that the fair market value of the trademark exceeds P R O P E R T Y , P L A N T , A N D E Q U I P M E N T its carrying value, so no impairment was recognized. Property, plant, and equipment are carried at cost. Depreciation has been computed using the straight-line method over estimated useful lives: land improvements, 10–20 years; buildings, 10–40 years; and machinery and equipment, 3–12 years. P R O D U C T W A R R A N T I E S The Company issues certain warranty policies on its furniture and hearth products that provide for repair or replacement of any covered product or component that fails during normal use because of a defect L O N G - L I V E D A S S E T S in design, materials, or workmanship. A warranty reserve is determined Long-lived assets are reviewed for impairment as events or changes in by recording a specific reserve for known warranty issues and an addi- circumstances occur indicating that the amount of the asset reflected in tional reserve for unknown claims that are expected to be incurred the Company’s balance sheet may not be recoverable. An estimate of based on historical claims experience. Actual claims incurred could dif- undiscounted cash flows produced by the asset, or the appropriate fer from the original estimates, requiring adjustments to the reserve. group of assets, is compared to the carrying value to determine whether Activity associated with warranty obligations was as follows: impairment exists. The estimates of future cash flows involve consider- able management judgment and are based upon assumptions about expected future operating performance. The actual cash flows could dif- fer from management’s estimates due to changes in business conditions, operating performance, and economic conditions. Asset impairment charges connected with the Company’s restructuring activities are dis- cussed in the Restructuring Related Charges note. These assets included real estate, manufacturing equipment, and certain other fixed assets. The Company’s continuous focus on improving the manufacturing pro- cess tends to increase the likelihood of assets being replaced; therefore, the Company is constantly evaluating the expected lives of its equipment and accelerating depreciation where appropriate. The Company recorded losses on the disposal of assets in the amount of approximately $1 million and $5 million during 2003 and 2002, respectively, as a result of its rapid continuous improvement initiatives. (In thousands) 2003 2002 Balance at the beginning of the period Accruals for warranties issued during the period Accrual related to pre-existing warranties Settlements made during the period $ 8,405 7,907 629 (8,015) $ 5,632 6,542 2,686 (6,455) Balance at the end of the period $ 8,926 $ 8,405 R E V E N U E R E C O G N I T I O N Revenue is normally recognized upon shipment of goods to customers. In certain circumstances revenue is not recognized until the goods are received by the customer or upon installation and customer acceptance based on the terms of the sales agreement. Revenue includes freight charged to customers; related costs are in selling and administrative expense. Rebates, discounts, and other marketing program expenses that are directly related to the sale are recorded as a deduction to net sales. Marketing program accruals require the use of management esti- mates and the consideration of contractual arrangements that are G O O D W I L L A N D O T H E R I N T A N G I B L E A S S E T S subject to interpretation. Customer sales that reach certain award levels In accordance with SFAS No. 142, the Company evaluates its goodwill can affect the amount of such estimates and actual results could differ for impairment on an annual basis based on values at the end of third from these estimates. quarter, or whenever indicators of impairment exist. The Company has 44 45 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S P R O D U C T D E V E L O P M E N T C O S T S bility approach that requires the recognition of deferred tax assets and Product development costs relating to the development of new prod- liabilities for the expected future tax consequences of events that have ucts and processes, including significant improvements and refinements been recognized in the Company’s financial statements or tax returns. to existing products, are expensed as incurred. These costs include sala- Deferred income taxes are provided to reflect the differences between ries, contractor fees, building costs, utilities, and administrative fees. the tax bases of assets and liabilities and their reported amounts in the The amounts charged against income were $25,791,000 in 2003, financial statements. $25,849,000 in 2002, and $21,415,000 in 2001. E A R N I N G S P E R S H A R E S T O C K - B A S E D C O M P E N S A T I O N Basic earnings per share are based on the weighted-average number of The Company accounts for its stock option plan using Accounting common shares outstanding during the year. Shares potentially issu- Principles Board Opinion No. 25, “Accounting for Stock Issued to able under options and deferred restricted stock have been considered Employees,” whereby stock-based employee compensation is reflected outstanding for purposes of the diluted earnings per share calculation. in net income as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. SFAS No. 123, “Accounting for Stock-Based Compensation” issued subsequent to APB No. 25 and amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Trans- ition and Disclosure” defines a fair value-based method of accounting for employees’ stock options but allows companies to continue to measure compensation cost for employee stock options using the intrinsic value-based method described in APB No. 25. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based U S E O F E S T I M A T E S The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires manage- ment to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The more significant areas requiring the use of management estimates relate to allowance for doubtful accounts, inventory reserves, market- ing program accruals, warranty accruals, accruals for self-insured medical claims, workers’ compensation, legal contingencies, general liability and auto insurance claims, and useful lives for depreciation and amortization. Actual results could differ from those estimates. Compensation,” as amended by SFAS No. 148 “Accounting for Stock- S E L F - I N S U R A N C E Based Compensation — Transition and Disclosure,” to stock-based The Company is partially self-insured for general and product liability, employee compensation. workers’ compensation, and certain employee health benefits. The gen- 2003 $ 98.1 2002 $ 91.4 2001 $ 74.4 eral, product, and workers’ compensation liabilities are managed using a wholly owned insurance captive; the related liabilities are included in (In thousands) Net income, as reported Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects (3.0) (2.2) Pro forma net income $ 95.1 $ 89.2 Earnings per share: Basic – as reported Basic – pro forma Diluted – as reported Diluted – pro forma $ 1.69 $ 1.64 $ 1.68 $ 1.62 $ 1.55 $ 1.52 $ 1.55 $ 1.51 (1.4) $ 73.0 $ 1.26 $ 1.24 $ 1.26 $ 1.24 the accompanying consolidated financial statements. The Company’s policy is to accrue amounts in accordance with the actuarially deter- mined liabilities. The actuarial valuations are based on historical information along with certain assumptions about future events. Changes in assumptions for such matters as legal actions, medical costs, and changes in actual experience could cause these estimates to change in the near term. Increase in expense in 2003 is due to accelerated vesting upon the R E C E N T A C C O U N T I N G P R O N O U N C E M E N T S retirement of plan participants. I N C O M E T A X E S The Company accounts for income taxes under SFAS No. 109, “Accounting for Income Taxes.” This Statement uses an asset and lia- In December 2003, the Financial Accounting Standards Board issued Interpretation 46R (FIN 46R), a revision to Interpretation 46 (FIN 46), “Consolidation of Variable Interest Entities.” Fin 46R clarifies some of the provisions of FIN 46 and exempts certain entities from its requirements. 44 45 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S FIN 46R is effective at the end of the first interim period ending after duction into other U.S. manufacturing locations. Charges for the March 15, 2004. Entities that have adopted FIN 46 prior to this effective closures totaled $15.7 million, which consists of $6.7 million of acceler- date can continue to apply the provision of FIN 46 until the effective date ated depreciation of machinery and equipment which was recorded in of FIN 46R. The Company adopted FIN 46 on January 3, 2004, and it did cost of sales, $3.4 million of severance, and $5.6 million of facility exit, not have an impact on the Company’s financial statements. production relocation, and other costs which were recorded as restruc- The Financial Accounting Standards Board finalized SFAS turing costs. A total of 316 members were terminated and received No. 150, “Accounting for Certain Financial Instruments with Charac- severance due to these shutdowns. The closures and consolidation are teristics of both Liabilities and Equity,” effective for financial instru- substantially complete. ments entered into or modified after May 31, 2003, and otherwise is The Hazleton, Pennsylvania, facility is an owned facility and effective at the beginning of the first interim period beginning after has been reclassified to current assets as it is currently being held as June 15, 2003. The adoption of SFAS No. 150 did not have an impact available for sale. It is included in the “Prepaid expenses and other cur- on the Company’s financial statements. rent assets” in the January 3, 2004, condensed consolidated balance During 2002, the Financial Accounting Standards Board sheet at its carrying value of $2.1 million. The Milan, Tennessee, facility finalized SFAS No. 146, “Accounting for Costs Associated with Exit or is a leased facility that is no longer being used in the production of Disposal Activities” for exit and disposal activities that are initiated goods. The restructuring expense for 2003 included $1.4 million of after December 31, 2002. This Statement requires that a liability for a costs that will continue to be incurred under the lease contract reduced cost associated with an exit or disposal activity be recognized when the by estimated sublease rentals that could be reasonably obtained. liability is incurred. The Company applied this statement to its 2003 During 2002, the Company recorded a pretax charge of restructuring activities which resulted in a charge of $8.5 million approximately $5.4 million due to the shutdown of an office furniture during 2003. facility in Jackson, Tennessee. A total of 125 members were terminated The Financial Accounting Standards Board also issued and received severance due to this shutdown. During the second quar- Interpretation No. 45, “Guarantor’s Accounting and Disclosure ter of 2003, a restructuring credit of approximately $0.6 million was Requirements for Guarantees, Including Indirect Guarantees of taken back into income relating to this charge. This was due to the fact Indebtedness to Other.” FIN 45 clarifies the requirements of SFAS that the Company was able to exit a lease with the lessor at more favor- No. 5, “Accounting for Contingencies” relating to the guarantor’s able terms than previously estimated. accounting for and disclosure of the issuance of certain types of guar- During the second quarter of 2001, the Company recorded a antees. The provisions for initial recognition and measurement are pretax charge of $24.0 million or $0.26 per diluted share for a restruc- effective on a prospective basis for guarantees that are issued or modi- turing plan that involved consolidating physical facilities, discontinuing fied after December 31, 2002. The adoption did not have a material low-volume product lines, and reductions of workforce. Included in the impact on the Company’s financial statements. charge was the closedown of three of its office furniture facilities located In December 2003, the Financial Accounting Standards in Williamsport, Pennsylvania; Tupelo, Mississippi; and Santa Ana, Board issued a revised SFAS No. 132, “Employers’ Disclosures about California. Approximately 500 members were terminated and received Pensions and Other Postretirement Benefits.” In 2003, the Company severance due to the closedown of these facilities. During the second adopted the revised disclosure requirements of this pronouncement. quarter of 2002, a restructuring credit of approximately $2.4 million R E C L A S S I F I C A T I O N S Certain prior year amounts have been reclassified to conform to the 2003 presentation. was taken back into income relating to this charge. This was mainly due to the fact that the Company was able to exit a lease with a lessor at more favorable terms than originally estimated and the Company’s ability to minimize the number of members terminated as compared to Restructuring Related Charges the original plan. As a result of the Company’s business simplification and cost reduction The following table details the change in restructuring strategies, the Company closed two office furniture facilities located in reserve for the last three years: Milan, Tennessee, and Hazleton, Pennsylvania, and consolidated pro- 46 47 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S Facility Severance Termination & Asset Impairment Other Costs Write-downs this standard, the Company evaluates its goodwill for impairment on an Total annual basis based on values at the end of third quarter, or whenever indicators of impairment exist. The Company has evaluated its goodwill (In thousands) Costs Restructuring reserve at December 31, 2000 $ Restructuring charge Cash payments Charge against assets – 3,090 (2,322) – Restructuring reserve at December 29, 2001 $ Restructuring charge Restructuring credit Cash payments Charge against assets 768 737 (852) (653) – Restructuring reserve at December 28, 2002 $ Restructuring charges Restructuring credit Cash payments – 3,438 – (3,104) $ – 4,710 (2,761) – $ – 16,200 – (16,200) $ – 24,000 (5,083) (16,200) $ 1,949 3,328 (1,513) (1,577) – $ – 1,300 – – (1,300) $ 2,717 5,365 (2,365) (2,230) (1,300) $ $ 2,187 5,622 (550) (6,159) – – – – $ 2,187 9,060 (550) (9,263) Restructuring reserve at January 3, 2004 $ 334 $ 1,100 $ – $ 1,434 Business Combinations for impairment and has determined that the fair value of its reporting units exceeds the carrying values and therefore, no impairment of goodwill was recorded. Also pursuant to the standard, the Company has ceased recording of goodwill and indefinite-lived intangibles amortiza- tion in 2002. The Company also owns a trademark having a net value of $8.1 million as of January 3, 2004, December 28, 2002, and December 29, 2001. The fair value of the trademark exceeds the car- rying value of the trademark and thus, no impairment was recorded. The trademark is deemed to have an indefinite useful life because it is expected to generate cash flows indefinitely. The Company ceased amortizing the trademark in 2002. The table below summarizes amortizable definite-lived During 2001, the Company completed the acquisition of three small intangible assets, which are reflected in Other Assets in the Company’s hearth product distributors for a total purchase price of approximately consolidated balance sheets: $7.6 million. The acquisitions were accounted for using the purchase (In thousands) method, and the results of the three distributors have been included in the Company’s financial statements since the date of acquisition. Patents Customer lists and other Less: accumulated amortization Net intangible assets Inventories 2003 2002 $ 16,450 26,076 16,671 $ 16,450 26,076 13,980 $ 25,855 $ 28,546 (In thousands) 2003 2002 2001 Finished products Materials and work in process LIFO reserve $ 31,407 28,287 (9,864) $ 30,747 26,266 (10,190) $ 33,280 26,469 (9,609) Amortization expense for definite-lived intangibles for 2003, 2002, and 2001 was $2,690,100, $2,690,100, and $2,200,200, respectively. Amortization expense is estimated to be approximately $2.7 million per $ 49,830 $ 46,823 $ 50,140 year through 2005, $2.4 million in 2006, $1.2 million in 2007, and Property, Plant, and Equipment The goodwill at December 29, 2001, included other intangi- (In thousands) 2003 2002 2001 ble assets that are required to be accounted for as assets apart from $1.0 million in 2008. goodwill under SFAS No. 142. The following table summarizes the reclassification: Land and land improvements Buildings Machinery and equipment Construction and equipment installation in progress $ 23,065 211,005 495,901 $ 21,566 208,124 494,354 $ 21,678 212,352 494,458 9,865 10,227 14,247 739,836 734,271 742,735 Less: allowances for depreciation 427,468 381,001 337,764 (In thousands) $ 312,368 $ 353,270 $ 404,971 Goodwill Customer lists and other Goodwill and Other Intangible Assets The Company adopted Statement of Financial Accounting Stan- dards (SFAS) No. 142, “Goodwill and Other Intangible Assets” on Trademarks (included in Other Assets) Patents (included in Other Assets) (included in Other Assets) 3,049 19,564 22,613 Net Book Value December 29, Net Book Value as modified for SFAS 142 SFAS 142 December 29, 2001 2001 Reclassification $ 214,337 $ (27,643) $ 186,694 – 8,079 8,079 8,574 $ 225,960 $ – – 8,574 $ 225,960 46 47 December 30, 2001, the beginning of its 2002 fiscal year. Pursuant to Total H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S The changes in the carrying amount of goodwill since December 29, Long-Term Debt 2001, are as follows by reporting segment: (In thousands) 2003 2002 2001 (In thousands) Balance as of December 29, 2001 (after SFAS 142 reclassification) Goodwill increase during period Net goodwill disposed of during period Office Furniture Hearth Products Total $ 43,611 $ 143,083 $ 186,694 – – 5,710 5,710 (9) (9) Balance as of December 28, 2002 $ 43,611 $ 148,784 $ 192,395 Adjustment for a prior acquisition – (309) (309) Balance as of January 3, 2004 $ 43,611 $ 148,475 $ 192,086 The goodwill increase in 2002 relates to additional purchase consider- ation associated with debentures issued in connection with a prior acquisition. The decrease in goodwill in 2003 is due to an adjustment relating to a prior acquisition. The following schedule reports the adjusted net income for the goodwill and indefinite-lived trademark amortization effect: (In thousands except for per share data) 2003 2002 2001 Industrial development revenue bonds, various issues, payable through 2018 with interest at 1.49-5.40% per annum Convertible debentures payable to individuals, with interest at 5.5% per annum Other notes and amounts Total debt Less: current portion $ 2,300 $ 7,938 $ 23,995 26,130 503 28,933 26,243 40,443 736 49,117 40,564 58,074 3,285 85,354 5,784 Long-term debt $ 2,690 $ 8,553 $ 79,570 Aggregate maturities of long-term debt are as follows: (In thousands) 2004 2005 2006 2007 2008 Thereafter $ 26,243 117 95 52 43 2,383 Reported net income Add back: Goodwill amortization, net of tax Add back: Trademark amortization, net of tax $ 98,105 $ 91,360 $ 74,407 The convertible debentures are payable to the former owners of busi- – – – – 5,611 nesses that were acquired by the Company. Following the acquisition some of these individuals continued as members of the Company. The 149 Adjusted net income $ 98,105 $ 91,360 $ 80,167 convertible debentures are convertible into cash. The debentures con- Diluted earnings per share: Reported net income Goodwill & trademark amortization, net of tax $ 1.68 $ 1.55 $ 1.26 2003 the Company recorded approximately $3 million of appreciation tain certain conversion features that are recorded as earned. During – – .10 on these debentures. Adjusted net income $ 1.68 $ 1.55 $ 1.36 Certain of the above borrowing arrangements include Accounts Payable and Accrued Expenses (In thousands) 2003 2002 Trade accounts payable Compensation Profit sharing and retirement expense Vacation pay Marketing expenses Casualty self-insurance expense Other accrued expenses $ 44,295 22,803 $ 66,204 $ 20,686 30,365 13,745 44,795 9,385 45,848 26,788 14,095 59,224 10,973 54,175 2001 53,660 13,663 26,020 13,881 54,861 17,189 36,910 $ 211,236 $ 252,145 $ 216,184 covenants which limit the assumption of additional debt and lease obligations. The Company has been and currently is in compliance with the covenants related to these debt agreements. The fair value of the Company’s outstanding long-term debt obligations at year- end 2003 approximates the recorded aggregate amount. Selling and Administrative Expenses (In thousands) 2003 2002 2001 Freight expense for shipments to customers Amortization of intangible and other assets Product development costs Other selling and administrative expenses $ 105,933 $ 98,876 $ 103,489 4,625 25,791 4,317 25,849 12,646 21,415 344,395 325,147 326,656 $ 480,744 $ 454,189 $ 464,206 48 49 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S Income Taxes Shareholders’ Equity and Earnings Per Share Significant components of the provision for income taxes are as follows: 2003 2002 2001 (In thousands) Current: Federal State Deferred 2003 2002 2001 $ 49,721 4,159 53,880 (1,054) $ 38,966 3,473 42,439 6,755 $ 32,393 2,442 34,835 7,019 $ 52,826 $ 49,194 $ 41,854 A reconciliation of the statutory federal income tax rate to the Com- pany’s effective income tax rate is as follows: Federal statutory tax rate State taxes, net of federal tax effect Credit for increasing research activities Extraterritorial income exclusion Other – net 2003 35.0% 2002 35.0% 2001 35.0% 1.8 1.6 1.6 (2.0) (1.6) – share (EPS): (0.5) 0.7 (1.0) 1.0 – (0.6) Effective tax rate 35.0% 35.0% 36.0% Deferred income taxes reflect the net tax effects of temporary dif- ferences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax lia- bilities and assets are as follows: (In thousands) 2003 2002 2001 Common Stock, $1 Par Value Authorized Issued and outstanding Preferred Stock, $1 Par Value Authorized Issued and outstanding 200,000,000 200,000,000 200,000,000 58,672,933 58,238,519 58,373,607 2,000,000 – 2,000,000 – 2,000,000 – The Company purchased 762,300; 614,580; and 1,472,937 shares of its common stock during 2003, 2002, and 2001, respectively. The par value method of accounting is used for common stock repurchases. The excess of the cost of shares acquired over their par value is allocated to Additional Paid-In Capital, with the excess charged to Retained Earnings. The following table reconciles the numerators and denom- inators used in the calculation of basic and diluted earnings per Numerators: Numerators for both basic and diluted EPS net income Denominators: Denominator for basic EPS weighted- average common shares outstanding Potentially dilutive shares from stock option plans Denominator for diluted EPS Earnings per share – basic Earnings per share – diluted 2003 2002 $ 98,105,000 $ 91,360,000 58,178,739 58,789,851 366,614 58,545,353 231,220 59,021,071 $ $ 1.69 $ 1.68 $ 1.55 1.55 Certain exercisable and nonexercisable stock options were not included in the computation of diluted EPS for fiscal year 2003 and 2002, because the option prices were greater that the average market prices for the applicable periods. The number of stock options outstanding which met this criterion for 2003 was 20,000, with a range of per share exer- cise prices of $42.49–$42.98; and for 2002 was 30,000, with a range of $ (28,103) 182 4,912 (18,044) 3,320 $ (34,398) 3,581 3,821 (14,173) 4,055 $ (38,759) 3,197 2,519 (5,550) (1,039) (37,733) (37,114) (39,632) per share exercise prices of $28.25–$32.22. 298 4,754 – 4,343 528 (5,462) 2,886 6,982 1,517 4,617 – 5,101 821 (3,820) 2,369 (504) 1,119 4,002 (3,766) 1,969 3,302 – 1,606 6,708 14,329 10,101 14,940 Components of other comprehensive income (loss) consist of the following: (In thousands) 2003 2002 2001 Foreign currency translation adjustments – net of tax Change in unrealized gains (losses) on marketable securities – net of tax Other comprehensive income (loss) $ 45 $ – $ 109 (690) (322) 42 $ (645) $ (322) $ 151 Net long-term deferred tax liabilities: Tax over book depreciation OPEB obligations Compensation Goodwill Other – net Total net long-term deferred tax liabilities Net current deferred tax assets: Workers’ compensation, general, and product liability accruals Vacation accrual Integration accruals Inventory differences Plant closing accruals Deferred income Warranty accruals Other – net Total net current deferred tax assets Net deferred tax 48 49 (liabilities) assets $ (23,404) $ (27,013) $ (24,692) H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S In May 1997, the Company registered 400,000 shares of its common instead of the common stock of the Company. The Company has reserved stock under its 1997 Equity Plan for Non-Employee Directors. This preferred shares necessary for issuance should the rights be exercised. plan permits the Company to issue to its non-employee directors The Company has entered into change in control employ- options to purchase shares of Company common stock, restricted ment agreements with corporate officers and certain other key stock of the Company, and awards of Company stock. The plan also employees. According to the agreements, a change in control occurs permits non-employee directors to elect to receive all or a portion of when a third person or entity becomes the beneficial owner of 20% or their annual retainers and other compensation in the form of shares of more of the Company’s common stock or when more than one-third of Company common stock. During 2003, 2002, and 2001, 10,922; the Company’s Board of Directors is composed of persons not recom- 11,958; and 8,662 shares of Company common stock were issued mended by at least three-fourths of the incumbent Board of Directors. under the plan, respectively. Upon a change in control, a key employee is deemed to have a two-year Cash dividends declared and paid per share for each year are: employment with the Company, and all his or her benefits are vested (In dollars) Common shares 2003 $ .52 2002 $ .50 2001 $ .48 During 2002, shareholders approved the 2002 Members’ Stock Purchase Plan. Under the new plan, 800,000 shares of common stock were registered for issuance to participating members. Beginning on under Company plans. If, at any time within two years of the change in control, his or her position, salary, bonus, place of work, or Company- provided benefits are modified, or employment is terminated by the Company for any reason other than cause or by the key employee for good reason, as such terms are defined in the agreement, then the key employee is entitled to receive a severance payment equal to two times annual salary June 30, 2002, rights to purchase stock are granted on a quarterly and the average of the prior two years’ bonuses. basis to all members who have one year of employment eligibility and work a minimum of 20 hours a week. The price of the stock purchased Stock-Based Compensation under the plan is 85% of the closing price on the applicable purchase date. No member may purchase stock under the plan in an amount which exceeds the lesser of 20% of his/her gross earnings or a maxi- mum fair value of $25,000 in any calendar year. During 2003, 79,237 shares of common stock were issued under the plan at an average price of $29.25. During 2002, 47,419 shares of common stock were issued under the plan at an average price of $22.58. An additional 673,344 shares were available for issuance under the plan at January 3, 2004. This plan replaced the 1994 Members’ Stock Purchase Plan. Under this plan, during 2002 and 2001, 43,388 shares at an aver- age price of $23.63 and 85,385 shares at an average price of $20.51 were issued, respectively. Under the Company’s 1995 Stock-Based Compensation Plan, as amended and restated effective November 10, 2000, the Company may award options to purchase shares of the Company’s common stock and grant other stock awards to executives, managers, and key personnel. The Plan is administered by the Human Resources and Compensation Committee of the Board of Directors. Restricted stock awarded under the plan is expensed ratably over the vesting period of the awards. Stock options awarded to employees under the Plan must be at exercise prices equal to or exceeding the fair market value of the Company’s common stock on the date of grant. Stock options are generally subject to four-year cliff vesting and must be exercised within 10 years from the date of grant. The weighted-average fair value of options granted during The Company has a shareholders’ rights plan which will 2003, 2002, and 2001, estimated on the date of grant using the expire August 20, 2008. The plan becomes operative if certain events occur involving the acquisition of 20% or more of the Company’s common stock by any person or group in a transaction not approved by the Company’s Board of Directors. Upon the occurrence of such an event, each right entitles its holder to purchase an amount of common stock of Black-Scholes option-pricing model, was $10.74, $11.74, and $9.70, respectively. The fair value of 2003, 2002, and 2001 options granted is estimated on the date of grant using the following assumptions: dividend yield of 1.2% to 2.1%, expected volatility of 34.9% to 38.4%, risk-free interest rate of 4.2% to 5.4%, and an expected life of 10 to 12 the Company with a market value of $400 for $200, unless the Board years, depending on grant date. authorizes the rights be redeemed. The rights may be redeemed for $0.01 The status of the Company’s stock option plans is summa- per right at any time before the rights become exercisable. In certain rized in the following table: instances, the right to purchase applies to the capital stock of the acquirer 50 51 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S Number of Weighted-Average Exercise Price Shares Outstanding at December 30, 2000 Granted Exercised Forfeited Outstanding at December 29, 2001 Granted Exercised Forfeited Outstanding at December 28, 2002 Granted Exercised Forfeited Outstanding at January 3, 2004 Options exercisable at: January 3, 2004 December 28, 2002 December 29, 2001 918,250 266,500 (17,500) (37,000) 1,130,250 290,000 – (17,000) 1,403,250 446,500 (362,000) (18,500) 1,469,250 202,250 156,250 105,000 $ 21.89 23.39 18.31 21.57 $ 22.32 25.77 – 21.69 $ 23.03 26.78 23.10 23.57 $ 24.15 $ 25.47 25.02 24.86 The following table summarizes information about fixed stock options outstanding at January 3, 2004: Options Outstanding Weighted- Average Range of Remaining Exercise Prices Outstanding Contractual Life Number Options Exercisable Weighted- Number Average Exercisable Exercise at January 3, 2004 Price $24.50–$28.25 $32.22 $23.47 $18.31–$26.69 $23.32–$25.27 $25.75–$25.77 $25.50–$42.98 31,000 20,000 101,250 411,000 223,500 261,000 421,500 2.9 years 4.1 years 5.1 years 6.6 years 7.1 years 8.1 years 9.2 years $ 25.71 $ 32.22 $ 23.47 $ 20.42 $ 23.41 $ 25.77 $ 26.83 31,000 20,000 101,250 50,000 – – – Retirement Benefits The Company has defined contribution profit-sharing plans cover- ing substantially all employees who are not participants in certain defined benefit plans. The Company’s annual contribution to the de- fined contribution plans is based on employee eligible earnings and results of operations and amounted to $26,489,000, $23,524,000, and $24,826,000 in 2003, 2002, and 2001, respectively. The Company sponsors defined benefit plans which include a limited number of salaried and hourly employees at certain subsidiar- ies. The Company’s funding policy is generally to contribute annually the minimum actuarially computed amount. Net pension costs relating employees. Pension expense for this plan amounted to $309,000, $309,000, and $310,000 in 2003, 2002, and 2001, respectively. Postretirement Health Care In accordance with the guidelines of revised SFAS No. 132, “Employers’ Disclosures about Pensions and other Postretirement Benefits,” the fol- lowing table sets forth the funded status of the plan, reconciled to the accrued postretirement benefits cost recognized in the Company’s bal- ance sheet at: (In thousands) 2003 2002 2001 Change in benefit obligation Benefit obligation at beginning of year Service cost Interest cost Benefits paid Actuarial (gain) or loss Current year prior service cost $ 17,617 249 1,105 (1,206) 566 – $ 17,351 398 1,091 (1,356) 133 – $ 12,229 278 941 (952) 3,042 1,813 Benefit obligation at end of year $ 18,331 $ 17,617 $ 17,351 Change in plan assets Fair value at beginning of year $ Employer contributions Benefits paid – 11,456 (1,206) $ – 1,356 (1,356) $ – 952 (952) Fair value at end of year $ 10,250 $ – $ – Reconciliation of funded status Funded status Unrecognized actuarial (gain) $ (8,081) $ (17,617) $ (17,351) or loss 1,105 539 364 Unrecognized transition obligation or (asset) Unrecognized prior service cost Net amount recognized at 5,361 1,122 5,942 1,352 6,523 1,582 year-end $ (493) $ (9,784) $ (8,882) Amounts recognized in the statement of financial position consist of: Accrued benefit liability $ (493) $ (9,784) $ (8,882) Net amount recognized at year-end, included in Other Liabilities $ (493) $ (9,784) $ (8,882) Estimated Future Benefit Payments (In thousands) Fiscal 2004 Fiscal 2005 Fiscal 2006 Fiscal 2007 Fiscal 2008 Fiscal 2009 – 2013 Expected Contributions During Fiscal 2004 Total $ 1,133 1,189 1,195 1,217 1,265 6,874 $ 12,873 2003 0% 0% 100% 100% 50 to these plans were $176,000; $0; and $0 for 2003, 2002, and 2001, Plan Assets – Percentage of Fair Value by Category respectively. The actuarial present value of obligations, less related plan assets at fair value, is not significant. The Company also participates in a multiemployer plan, which provides defined benefits to certain of the Company’s union Equity Debit Other Total 51 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S The Company invests these funds in high grade money market instru- Property, plant, and equipment at year-end include the following ments. Prior to 2003 the plan was not funded. The discount rates at amounts for capitalized leases: fiscal year-end 2003, 2002, and 2001 were 6.0%, 6.5%, and 6.5%, respectively. The Company payment for these benefits has reached the maximum amounts per the plan; therefore, healthcare trend rates have (In thousands) Buildings Machinery and equipment Office equipment no impact on company cost. In December 2003, the United States enacted into law the Less: allowances for depreciation 2003 $ 3,299 196 761 4,256 2,879 2002 $ 3,299 196 – 3,495 2,514 2001 $ 3,299 15,805 – 19,104 17,052 $ 1,377 $ 981 $ 2,052 Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). The Act established a prescription drug benefit under Medicare, known as “Medicare Part D,” and a federal subsidy to spon- sors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In January 2004, the FASB issued FASB Staff Position Rent expense for the years 2003, 2002, and 2001 amounted to approx- imately $13,592,000, $13,683,000, and $13,387,000, respectively. Contingent rent expense under both capitalized and operating leases (generally based on mileage of transportation equipment) amounted to $313,000, $787,000, and $869,000 for the years 2003, 2002, and No. 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2001, respectively. 2003” (“FSP 106-1”). The Company has elected to defer accounting for Guarantees, Commitments, and Contingencies the economic effects of the Act, as permitted by FSP 106-1. Therefore, During the second quarter ended June 28, 2003, the Company entered in accordance with FSP 106-1, the accumulated postretirement benefit into a one-year financial agreement for the benefit of one of its distribu- obligation or net period postretirement benefit cost included in the tion chain partners. The maximum financial exposure assumed by the consolidated financial statements and disclosed above do not reflect the Company as a result of this arrangement totals $3 million of which over effects of the Act. Specific authoritative guidance on accounting for the 75% is secured by collateral. In accordance with the provisions of FIN federal subsidy is pending. The final issued guidance could require a 45, the Company has recorded the fair value of this guarantee, which is change to previously reported information. estimated to be less than $0.1 million. Leases The Company leases certain warehouses. Commitments for minimum rentals under noncancelable leases at the end of 2003 are as follows: The Company utilizes letters of credit in the amount of $24 million to back certain financing instruments, insurance policies, and payment obligations. The letters of credit reflect fair value as a condition of their underlying purpose and are subject to fees competi- (In thousands) 2004 2005 2006 2007 2008 Thereafter Capitalized Leases Operating Leases tively determined. $ 523 515 284 215 211 590 $ 13,012 10,742 8,424 5,430 4,080 9,062 The Company is contingently liable for future minimum pay- ments totaling $9.7 million under a transportation service contract. The transportation agreement is for a three-year period and is auto- matically renewable for periods of one year unless either party gives Total minimum lease payments $ 2,338 $ 50,750 sixty days’ written notice of its intent to terminate at the end of the Less: amount representing interest 487 Present value of net minimum lease payments, including current maturities of $415 $ 1,851 original three-year term or any subsequent term. The minimum pay- ments are $4.8 million in 2004, and $4.9 million in 2005. The Company has guaranteed a contractual lease obligation of an independent contract furniture dealership. The related term expires in the fourth quarter of 2004. As of January 3, 2004, the remaining unpaid lease payments subject to this guarantee totaled approximately $69,000. In accordance with the provisions of FIN 45 no liability has been recorded, as the Company entered into this agree- ment prior to December 31, 2002. 52 53 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S The Company has contingent liabilities, which have arisen in expense. Management views interest income and expense as corporate the course of its business, including pending litigation, preferential financing costs and not as an operating segment cost. In addition, man- payment claims in customer bankruptcies, environmental remediation, agement applies an effective income tax rate to its consolidated income taxes, and other claims. The Company currently has a claim for approx- before income taxes so income taxes are not reported or viewed inter- imately $7.6 million pending against it, arising out of the bankruptcy of nally on a segment basis. Identifiable assets by segment are those assets a customer filed in 2001. The Company was named a critical vendor by applicable to the respective industry segments. Corporate assets consist the bankruptcy court and, accordingly, was paid in full for all out- principally of cash and cash equivalents, short-term investments, and standing receivables. The claim alleges that the Company received corporate office real estate and related equipment. preferential payments from the customer during the ninety days before No geographic information for revenues from external cus- the customer filed for bankruptcy protection. The claim was brought in tomers or for long-lived assets is disclosed, since the Company’s primary February 2003. The Company has recorded an accrual with respect to market and capital investments are concentrated in the United States. this contingency, in an amount substantially less than the full amount Reportable segment data reconciled to the consolidated finan- of the claim, which represents the best estimate within the range of cial statements for the years ended 2003, 2002, and 2001 is as follows: likely exposure, and intends to vigorously defend against the claim. Given the nature of this claim, it is possible that the ultimate outcome could differ from the recorded amount. Significant Customer One office furniture customer accounted for approximately 13% of con- solidated net sales in 2003 and 14% in 2002 and 2001. Operating Segment Information In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” management views the Company as being in two operating segments: office furniture and hearth prod- ucts, with the former being the principal segment. The office furniture segment manufactures and markets a broad line of metal and wood commercial and home office furniture, which includes storage prod- ucts, desks, credenzas, chairs, tables, bookcases, freestanding office partitions and panel systems, and other related products. The hearth products segment manufactures and markets a broad line of manufac- tured gas-, pellet-, and wood-burning fireplaces and stoves, fireplace inserts, gas logs, and chimney systems, principally for the home. The Company’s hearth products segment is somewhat sea- sonal, with the third (July-September) and fourth (October-December) fiscal quarters historically having higher sales than the prior quarters. (In thousands) Net sales: Office furniture Hearth products Operating profit: Office furniture(a) Hearth products(a) Total operating profit Unallocated corporate 2003 2002 2001 $ 1,304,054 $ 1,279,059 $ 1,366,312 426,126 451,674 413,563 $ 1,755,728 $ 1,692,622 $ 1,792,438 $ 130,080 $ 54,433 130,014 $ 44,852 184,513 174,866 112,405 39,282 151,687 expenses (33,582) (34,312) (35,426) Income before income taxes $ 150,931 $ 140,554 $ 116,261 Depreciation and amortization expense: Office furniture Hearth products General corporate(b) Capital expenditures: Office furniture Hearth products General corporate Identifiable assets: Office furniture Hearth products General corporate(b) $ 54,121 $ 13,599 5,052 48,546 $ 13,993 6,216 58,658 20,389 2,338 $ 72,772 $ 68,755 $ 81,385 $ 17,619 $ 12,577 7,312 17,183 $ 6,132 2,570 29,785 7,149 (83) $ 37,508 $ 25,885 $ 36,851 $ 452,350 $ 494,559 $ 526,712 320,199 114,980 303,811 265,665 305,326 220,667 $ 1,021,826 $ 1,020,552 $ 961,891 (a)Included in operating profit for the office furniture segment are pretax charges of $8.5 million, $3.0 million, and $22.5 million for closing of facilities and impairment In fiscal 2003, 56% of consolidated net sales of hearth products were charges in 2003, 2002, and 2001, respectively. Included in operating profit for the generated in the third and fourth quarters. For purposes of segment reporting, intercompany sales transfers between segments are not material, and operating profit is income before income taxes exclusive of certain unallocated corporate expenses. These unallocated corporate expenses include the net costs of the Company’s corporate operations, interest income, and interest hearth products segment is a pretax charge of $1.5 million for closing of facilities and impairment charges in 2001. (b)In 2002 the Company’s information technologies departments became a shared service at the corporate level. The costs continue to be charged out to the segments; however, the assets and related depreciation are now classified as general corporate. 52 53 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S Subsequent Acquisition On January 5, 2004, the Company finalized the acquisition of Paoli Inc., a subsidiary of Klaussner Furniture Industries, Inc. Paoli is a leading provider of wood case goods and seating, with well-known brands, broad product offering, and strong independent representative sales and dealer networks. Further details of the transaction will be included in the Company’s SEC Quarterly Report on Form 10-Q for the first quarter ended April 3, 2004. Summary of Quarterly Results of Operations (Unaudited) The following table presents certain unaudited quarterly financial information for each of the past 12 quarters. In the opinion of the Company’s management, this information has been prepared on the same basis as the consolidated financial statements appearing elsewhere in this report and includes all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial results set forth herein. Results of operations for any previous quarter are not necessarily indicative of results for any future period. (In thousands, except per share data) YEAR-END 2003: Net sales Cost of products sold Gross profit Selling and administrative expenses Restructuring-related charges (income) Operating income Interest income (expense) – net Income before income taxes Income taxes Net income Net income per common share – basic Weighted-average common shares outstanding – basic Net income per common share – diluted Weighted-average common shares outstanding – diluted As a Percentage of Net Sales Net sales Gross profit Selling and administrative expenses Restructuring-related charges Operating income Income taxes Net income YEAR-END 2002: Net sales Cost of products sold Gross profit Selling and administrative expenses Restructuring-related charges (income) Operating income Interest income (expense) – net Income before income taxes Income taxes Net income Net income per common share – basic and diluted Weighted-average common shares outstanding – basic As a Percentage of Net Sales Net sales Gross profit Selling and administrative expenses Restructuring-related charges Operating income Income taxes Net income First Quarter Second Quarter Third Quarter Fourth Quarter $ 391,971 252,841 $ 406,793 260,367 139,130 114,426 – 24,704 (265) 24,439 8,554 146,426 112,979 2,265 31,182 (149) 31,033 10,861 $ 500,091 316,412 183,679 127,472 3,881 52,326 617 52,943 18,530 $ 456,873 286,893 169,980 125,867 2,364 41,749 767 42,516 14,881 $ 15,885 $ 20,172 $ 34,413 $ 27,635 $ $ .27 58,317 .27 58,582 $ $ .35 58,143 .35 58,468 $ $ .59 58,043 .59 58,448 $ $ .47 58,222 .47 58,731 100.0% 36.0 27.8 0.6 7.7 2.7 5.0 $ 399,299 256,696 142,603 111,320 (900) 32,183 (710) 31,473 11,330 20,143 .34 58,918 $ $ 100% 35.7 27.9 (.2) 8.1 2.8 5.0 100.0% 36.7 25.5 0.8 10.5 3.7 6.9 $ 446,274 285,996 160,278 117,274 – 43,004 (577) $ $ 42,427 15,274 27,153 .46 59,140 100% 35.9 26.3 – 9.6 3.4 6.1 100.0% 37.2 27.5 0.5 9.1 3.3 6.0 $ 447,910 290,653 $ $ 157,257 115,170 – 42,087 (269) 41,818 13,649 28,169 .48 58,546 100% 35.1 25.7 – 9.4 3.0 6.3 100.0% 35.5 29.2 – 6.3 2.2 4.1 $ 399,139 259,398 139,741 110,425 3,900 25,416 (580) 24,836 8,941 $ $ 15,895 .27 58,777 100% 35.0 27.7 1.0 6.4 2.2 4.0 54 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S Summary of Unaudited Quarterly Results of Operations (continued) (In thousands, except per share data) YEAR-END 2001: Net sales Cost of products sold Gross profit Selling and administrative expenses Restructuring-related charges Operating income Interest income (expense) – net Income before income taxes Income taxes Net income Net income per common share – basic and diluted Weighted-average common shares outstanding – basic As a Percentage of Net Sales Net sales Gross profit Selling and administrative expenses Restructuring-related charges Operating income Income taxes Net income Investor Information First Quarter Second Quarter Third Quarter Fourth Quarter $ 461,997 311,711 150,286 119,050 – 31,236 (2,700) 28,536 10,273 $ $ 18,263 .31 59,448 100.0% 32.5 25.8 – 6.8 2.2 4.0 $ 444,196 292,789 151,407 118,983 24,000 8,424 (1,832) 6,592 2,373 4,219 .07 $ $ 59,205 100.0% 34.1 26.8 5.4 1.9 0.5 0.9 $ 459,352 298,427 160,925 114,759 – 46,166 (1,375) 44,791 16,125 $ 28,666 $ .48 59,048 100.0% 35.0 25.0 – 10.1 3.5 6.2 $ 426,893 278,213 148,680 111,414 – 37,266 (924) 36,342 13,083 23,259 .40 58,651 $ $ 100.0% 34.8 26.1 – 8.7 3.1 5.4 C O M M O N S T O C K M A R K E T P R I C E S A N D D I V I D E N D S COMMON STOCK MARKET PRICE AND PRICE/EARNINGS ( U N A U D I T E D ) Q U A R T E R L Y 2 0 0 3 – 2 0 0 2 RATIO (UNAUDITED) FISCAL YEARS 2003 – 1993 2003 by Quarter High Low 1st 2nd 3rd 4th Total Dividends Paid $ 29.38 31.67 38.60 44.12 $ 24.65 27.27 30.15 36.65 2002 by Quarter High Low 1st 2nd 3rd 4th Total Dividends Paid $ 29.12 30.85 28.67 29.20 $ 24.55 25.45 23.80 22.88 Dividends per Share $ .13 .13 .13 .13 $ .52 Dividends per Share $ .125 .125 .125 .125 $ .500 Market Price* Diluted Earnings Price/Earnings Ratio Year 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 High 44.12 30.85 28.85 27.88 29.88 37.19 32.13 21.38 15.63 17.00 14.63 Eleven-Year Average *Adjusted for the effect of stock splits Low per Share* High Low 24.65 22.88 19.96 15.56 18.75 20.00 15.88 9.25 11.50 12.00 10.75 1.68 1.55 1.26 1.77 1.44 1.72 1.45 1.13 .67 .87 .70 26 20 23 16 21 22 22 19 23 20 21 21 15 15 16 9 13 12 11 8 17 14 15 13 54 55 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S S E L E C T E D F I N A N C I A L D A T A E L E V E N - Y E A R S U M M A R Y 2003 2002(a) 2001 2000 P E R C O M M O N S H A R E D A T A ( B A S I C A N D D I L U T I V E ) Income before Cumulative Effect of Accounting Changes - basic $ 1.69 $ Cumulative Effect of Accounting Changes - basic Net Income – basic Net Income – diluted Cash Dividends Book Value – basic Net Working Capital – basic O P E R A T I N G R E S U L T S ( T H O U S A N D S O F D O L L A R S ) Net Sales Cost of Products Sold Gross Profit Interest Expense Income Before Income Taxes Income Before Income Taxes as a % of Net Sales Federal and State Income Taxes Effective Tax Rate – 1.69 1.68 .52 12.19 3.71 1.55 – 1.55 1.55 .50 11.08 1.82 $ 1.26 $ – 1.26 1.26 .48 10.10 1.52 1.77 – 1.77 1.77 .44 9.59 1.09 $ 1,755,728 $ 1,692,622 $ 1,792,438 $ 2,046,286 1,116,513 639,215 2,970 150,931 8.60% 1,092,743 599,879 4,714 140,554 8.30% 1,181,140 611,298 8,548 116,261 6.49% 1,380,404 665,882 14,015 165,964 8.11% $ 52,826 $ 49,194 $ 41,854 $ 59,747 35.0% 35.0% 36.0% 36.0% Income before Cumulative Effect of Accounting Changes $ 98,105 $ 91,360 $ 74,407 $ 106,217 Net Income Net Income as a % of Net Sales 98,105 5.59% 91,360 5.40% 74,407 4.15% 106,217 5.19% Cash Dividends and Share Purchase Rights Redeemed $ 30,299 $ 29,386 $ 28,373 $ 26,455 Addition to (Reduction of) Retained Earnings Net Income Applicable to Common Stock % Return on Average Shareholders’ Equity 54,001 98,105 14.46% 55,176 91,360 14.74% 36,759 74,407 12.76% 79,762 106,217 19.77% Depreciation and Amortization $ 72,772 $ 68,755 $ 81,385 $ 79,046 D I S T R I B U T I O N O F N E T I N C O M E % Paid to Shareholders % Reinvested in Business F I N A N C I A L P O S I T I O N ( T H O U S A N D S O F D O L L A R S ) Current Assets Current Liabilities Working Capital Net Property, Plant, and Equipment Total Assets % Return on Beginning Assets Employed 30.88% 69.12% 32.16% 67.84% 38.13% 61.87% 24.91% 75.09% $ 462,122 $ 405,054 $ 319,657 $ 330,441 245,816 216,306 312,368 1,021,826 14.69% 298,680 106,374 353,270 1,020,552 14.83% 230,443 264,868 89,214 404,971 961,891 12.04% 65,273 454,312 1,022,470 19.63% Long-Term Debt and Capital Lease Obligations $ 4,126 $ 9,837 $ 80,830 $ 128,285 Shareholders’ Equity Retained Earnings Current Ratio C U R R E N T S H A R E D A T A 709,889 641,732 1.88 646,893 587,731 1.36 592,680 532,555 1.39 573,342 495,796 1.25 Number of Shares Outstanding at Year-End 58,238,519 58,373,607 58,672,933 59,796,891 Weighted-Average Shares Outstanding During Year – basic 58,178,739 58,789,851 59,087,963 60,140,302 Number of Shareholders of Record at Year-End 6,416 6,777 6,694 6,563 O T H E R O P E R A T I O N A L D A T A Capital Expenditures (Thousands of Dollars) $ 34,842 $ 25,885 $ 36,851 $ 59,840 Members (Employees) at Year-End 8,926 8,828 9,029(b) 11,543(b) (a)Per SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company has ceased recording of goodwill and indefinite-lived Intangible amortization. (b)Includes acquisitions completed during year. 56 57 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S 1999 1998 1997 1996 1995 1994 1993 $ 1.44 – 1.44 1.44 .38 8.33 1.52 $ $ 1.72 – 1.72 1.72 .32 7.54 1.19 $ $ 1.45 – 1.45 1.45 .28 6.19 1.53 1.13 – 1.13 1.13 .25 4.25 .89 $ .67 – .67 .67 .24 3.56 1.07 .87 – .87 .87 .22 3.17 1.27 $ .69 .01 .70 .70 .20 2.83 1.23 $ 1,800,931 $ 1,706,628 $ 1,362,713 $ 998,135 $ 893,119 $ 845,998 $ 780,326 1,236,612 1,172,997 564,319 9,712 137,575 7.64% 50,215 36.5% 87,360 87,360 4.85% 23,112 64,248 87,360 18.14% $ $ $ 533,632 10,658 170,109 9.97% $ 63,796 37.50% $ 106,313 106,313 6.23% $ $ $ 19,730 $ 86,583 106,313 25.20% 933,157 429,556 8,179 139,128 10.21% 52,173 37.50% 86,955 86,955 6.38% 16,736 37,838 86,955 27.43% 679,496 318,639 4,173 105,267 10.55% 37,173 35.31% 68,094 68,094 6.82% 14,970 33,860 68,094 29.06% $ $ $ 624,700 268,419 3,569 65,517 7.34% 24,419 37.27% 41,098 41,098 4.60% 14,536 18,863 41,098 20.00% $ $ $ 573,392 272,606 3,248 86,338 10.21% 31,945 37.00% 54,393 54,156 6.43% 13,601 13,563 54,156 28.95% $ $ $ 537,828 242,498 3,120 70,854 9.08% 26,216 37.00% 44,638 45,127 5.78% 12,587 17,338 45,127 26.35% $ $ $ $ 65,453 $ 52,999 $ 35,610 $ 25,252 $ 21,416 $ 19,042 $ 16,631 26.46% 73.54% 18.56% 81.44% 19.25% 80.75% 21.98% 78.02% 35.37% 64.63% 25.11% 74.89% 27.89% 72.11% $ 316,556 $ 290,329 $ 295,150 $ 205,527 $ 194,183 $ 188,810 $ 188,419 225,123 91,433 455,591 906,723 16.94% 217,438 72,891 444,177 864,469 23.74% 200,759 94,391 341,030 754,673 28.27% 152,553 52,974 234,616 513,514 25.93% $ 124,173 $ 135,563 $ 134,511 $ 77,605 $ 501,271 416,034 1.41 462,022 351,786 1.34 381,662 265,203 1.47 252,397 227,365 1.35 128,915 65,268 210,033 409,518 17.91% 42,581 216,235 193,505 1.51 111,093 77,717 177,844 372,568 24.72% $ 45,877 $ 194,640 174,642 1.70 110,759 77,660 157,770 352,405 22.14% 45,916 179,553 161,079 1.70 60,171,753 60,854,579 6,737 61,289,618 61,649,531 5,877 61,659,316 59,779,508 5,399 59,426,530 60,228,590 5,319 60,788,674 60,991,284 5,479 61,349,206 62,435,450 5,556 63,351,692 64,181,088 4,653 $ 71,474 10,095 $ 149,717 $ 85,491 $ 44,684 $ 53,879 $ 35,005 $ 9,824(b) 9,390(b) 6,502(b) 5,933 6,131 27,541 6,257 (a)Per SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company has ceased recoding of goodwill and indefinite-lived Intangible amortization. (b)Includes acquisitions completed during year. 56 57 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S R E P O R T O F I N D E P E N D E N T A U D I T O R S To the Board of Directors and Shareholders, HON INDUSTRIES Inc.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders’ equity, and cash flows present fairly, in all material respects, the financial position of HON INDUSTRIES Inc. and its subsidiaries at January 3, 2004, and December 28, 2002, and the results of their operations and their cash flows for the fiscal years ended January 3, 2004, and December 28, 2002, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The financial statements of the Company as of December 29, 2001, and for the fiscal year then ended, prior to the adjustments discussed in the Goodwill and Other Intangible Assets note, were audited by other independent accountants who have ceased opera- tions. Those independent accountants expressed an unqualified opinion on those financial statements in their report dated February 1, 2002. As disclosed in the Goodwill and Other Intangible Assets note, the Company changed the manner in which it accounts for goodwill and other intangible assets upon adoption of the accounting guidance of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, on December 30, 2001. As discussed above, the financial statements of HON INDUSTRIES Inc., as of December 29, 2001, and for the period then ended, were audited by other independent accountants who have ceased operations. As described in the Goodwill and Other Intangible Assets note, these financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards (Statement) No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company as of December 30, 2001. We audited the transitional disclo- sures described in the Goodwill and Other Intangible Assets note. In our opinion, the transitional disclosures for 2001 in the Goodwill and Other Intangible Assets note are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of the Company other than with respect to such disclosures, and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole. PricewaterhouseCoopers LLP Chicago, Illinois February 6, 2004 58 59 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S R E P O R T O F I N D E P E N D E N T A U D I T O R S Predecessor Auditor (Arthur Andersen LLP) Opinion The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. In 2002, the corporation adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). As discussed in the Goodwill and Intangible Assets note, the Company has presented the transitional disclosures for 2001 required by SFAS No. 142. The Arthur Andersen LLP report does not extend to these changes to the 2001 consolidated financial statements. The adjustments to the 2001 consolidated financial statements were reported on by PricewaterhouseCoopers LLP as stated in their report appearing herein. To the Board of Directors and Shareholders of HON INDUSTRIES Inc. We have audited the accompanying consolidated balance sheets of HON INDUSTRIES Inc. and Subsidiaries as of December 29, 2001, December 30, 2000*, and January 1, 2000*, and the related consolidated statements of income, shareholders equity, and cash flows for each of the fiscal years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 HON INDUSTRIES Inc. and Subsidiaries as of December 29, 2001, December 30, 2000*, and January 1, 2000*, and the results of its operations and its cash flows for each of the three fiscal years then ended in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Chicago, Illinois February 1, 2002 *The December 30, 2000, and January 1, 2000, consolidated financial statements are not required to be presented in the 2003 annual report. 58 59 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S M A N A G E M E N T ’ S R E S P O N S I B I L I T Y F O R F I N A N C I A L S T A T E M E N T S Management is responsible for the preparation and integrity of the consolidated financial statements and other financial information presented in this report. That responsibility is accomplished using internal controls designed to provide reasonable assurance as to the integrity and accuracy of the Company’s financial records and to adequately safeguard, verify, and maintain accountability of assets. Such controls are based on estab- lished written policies and procedures, are implemented by trained personnel with an appropriate segregation of duties, and are monitored through a comprehensive internal audit program. These policies and procedures prescribe that the Company and all its members are to maintain the highest ethical and business standards. PricewaterhouseCoopers, LLP, independent accountants, is retained to audit HON INDUSTRIES’ financial statements. Their accompa- nying report is based on audits conducted in accordance with auditing standards, generally accepted in the United States. The Board of Directors exercises its responsibility for these financial statements through its Audit Committee, which consists entirely of independent board members. The Audit Committee meets periodically with the independent accountants and with the Company’s internal audi- tors, both privately and with management present, to review accounting, auditing, internal controls, and financial reporting matters. Jack D. Michaels Jerald K. Dittmer C H A I R M A N A N D V I C E P R E S I D E N T A N D C H I E F E X E C U T I V E O F F I C E R C H I E F F I N A N C I A L O F F I C E R 60 61 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S A M E S S A G E F R O M T H E B O A R D O F D I R E C T O R S Dear Shareholders: We, the members of the HON INDUSTRIES Board of Directors, believe that integrity is central to good corporate governance. This belief is reflected in the HON INDUSTRIES vision statement (shown on the back of this annual report), adopted many years ago. Our Vision statement represents much more than a traditional “mission,” and it goes much deeper than company policy. The beliefs and values represented in that document are the very foundation of our corporate culture, and guide the attitude and actions of every member, every day. From its beginnings, HON INDUSTRIES has sought to implement its vision through sound policies and practices, and by maintaining a strong Board composed predominantly of outside directors. We are fully committed to executing our responsibilities, and we will continue to maintain the company’s long-standing tradition of an independent, well-informed, active, and engaged Board of Directors. Our board meetings and procedures have been developed and refined to encourage open and informed communication. The company’s accounting policies have always been conservative and straightforward. The Board’s three committees — Audit; Human Resources and Compensation; Public Policy and Corporate Governance — have consisted entirely of non-management directors for many years. During 2003, we have given significant attention to the newly released rules emanating from the Sarbanes-Oxley Act of 2002 and the New York Stock Exchange listing requirements — rules intended to improve corporate governance across the country. It is gratifying to report that HON INDUSTRIES governance practices were already in accord with the spirit of the rules. It is an honor to serve as directors of HON INDUSTRIES. We are very proud to represent you, the shareholder, as we oversee the man- agement of this great company. Please be assured that we intend to remain vigilant and focused on good corporate governance. Sincerely, The HON INDUSTRIES Board of Directors Stan A. Askren Abbie J. Smith Dennis J. Martin Gary M. Christensen Richard H. Stanley Jack D. Michaels Cheryl A. Francis Brian E. Stern Joseph Scalzo Robert L. Katz Ronald V. Waters, III 61 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S B O A R D O F D I R E C T O R S A N D O F F I C E R S B O A R D O F D I R E C T O R S Brian E. Stern President, Melinda C. Ellsworth Vice President, Treasurer and Former Executive Vice President and A U D I T Stan A. Askren President, HON INDUSTRIES Inc. Gary M. Christensen Retired President and Chief Executive Officer, Pella Corporation Cheryl A. Francis Advisor/Consultant Chief Financial Officer, RR Donnelley & Sons Robert L. Katz President, Robert L. Katz and Associates Dennis J. Martin Chairman, President and Chief Executive Officer, General Binding Corporation Jack D. Michaels Chairman and Chief Executive Officer, HON INDUSTRIES Inc. Joseph Scalzo Vice President and President, Personal Care Products, The Gillette Company Abbie J. Smith Chaired Professor, Xerox Supplies Technology Enterprises Investor Relations Xerox Corporation Jeffrey D. Fick Ronald V. Waters, III Vice President, Member and Chief Operating Officer, Community Relations Wm. Wrigley Jr. Company C O M M I T T E E S O F T H E B O A R D Cheryl A. Francis, Chairperson Dennis J. Martin Ronald V. Waters, III H U M A N R E S O U R C E S A N D C O M P E N S A T I O N Gary M. Christensen, Chairperson Robert L. Katz Abbie J. Smith Malcolm C. Fields Vice President and Chief Information Officer James I. Johnson Vice President, General Counsel and Secretary Timothy R. Summers Vice President, Lean Enterprise S U B S I D I A R I E S David C. Burdakin Executive Vice President, HON INDUSTRIES, Inc. President, The HON Company P U B L I C P O L I C Y A N D C O R P O R A T E G O V E R N A N C E Brad D. Determan Richard H. Stanley, Chairperson President, Joseph Scalzo Brian E. Stern H O N I N D U S T R I E S I N C . O F F I C E R S Jack D. Michaels Chairman and Chief Executive Officer Hearth and Home Technologies Inc. Thomas D. Head Vice President, General Manager, Holga Inc. Eric K. Jungbluth President, Allsteel Inc. Donald T. Mead Stan A. Askren President, The Gunlocke Company L.L.C. The University of Chicago President Marco V. Molinari Graduate School of Business Peter R. Atherton President, International and Business Richard H. Stanley Vice President and Chief Technology Officer Development Vice Chairman, HON INDUSTRIES Inc. Chairman, SC Companies, Inc. Chairman, Stanley Consultants, Inc. Jerald K. Dittmer Jean M. Reynolds Vice President and Chief Financial Officer President, Maxon Furniture Inc. Robert J. Driessnack Thomas A. Tolone Vice President, Controller President, Paoli Inc. 62 H O N I N D U S T R I E S I n c . a n d S U B S I D I A R I E S I N V E S T O R I N F O R M A T I O N S C H E D U L E O F Q U A R T E R L Y R E S U L T S The Company operates on a fiscal year ending on the Saturday nearest December 31. Quar- terly results are typically announced within 25 days after the end of each quarter, and audited results are typically announced within 40 days after year-end. F I S C A L 2 0 0 4 Q U A R T E R - E N D D A T E S 1st Quarter: Saturday, April 3 2nd Quarter: Saturday, July 3 3rd Quarter: Saturday, October 2 4th Quarter: Saturday, January 1 I N V E S T O R R E L A T I O N S C O M M O N S T O C K Send inquiries to: Investor Relations HON INDUSTRIES common stock trades on the New York Stock Exchange under the HON INDUSTRIES Inc. symbol: HNI. Stock price quotations can be 414 East Third Street Muscatine, IA 52761 Telephone: 563.264.7400 Fax: 563.264.7655 found in major daily newspapers and The Wall Street Journal. T R A N S F E R A G E N T E-mail: investorrelations@honi.com C O R P O R A T E H E A D Q U A R T E R S Shareholders may report a change of address or make inquiries by writing or calling: Computershare Investor Services, LLC HON INDUSTRIES Inc. 414 East Third Street P.O. Box 1109 Muscatine, IA 52761-0071 2 North LaSalle Street Chicago, IL 60602 Telephone: 312.588.4991 A N N U A L M E E T I N G Telephone: 563.264.7400 The Company’s annual shareholders’ meeting Fax: 563.264.7217 will be held at 10:30 a.m. on May 4, 2004, at Website: www.honi.com the Holiday Inn, Highways 61 & 38 North, Muscatine, Iowa. Shareholders and other interested investors are encouraged to attend the meeting. I N D E P E N D E N T P U B L I C A C C O U N T A N T S PricewaterhouseCoopers LLP One North Wacker Drive Chicago, IL 60606 F O R W A R D - L O O K I N G S T A T E M E N T S Statements in this report that are not strictly historical, including statements as to • changes in demand and order patterns from the Company’s customers, par- plans, objectives, and future financial performance, are “forward-looking” state- ticularly its top ten customers, which represented approximately 36% of net sales ments that are made pursuant to the safe harbor provisions of the Private Securities in 2003; Litigation Reform Act of 1995. Forward-looking statements involve known and • issues associated with acquisitions and integration of acquisitions; unknown risks, which may cause the Company’s actual results in the future to dif- • the ability of the Company to realize cost savings and productivity improve- fer materially from expected results. These risks include, among others: ments from its cost containment and business simplification initiatives; • competition within the office furniture and fireplace industries, including • the ability of the Company to realize financial benefits from investments in new competition from imported products and competitive pricing; products; • increases in the cost of raw materials, including steel, which is the Company’s • the ability of the Company’s distributors and dealers to successfully market largest raw material category; and sell the Company’s products; • increases in the cost of health care benefits provided by the Company; • the availability and cost of capital to finance planned growth; and • reduced demand for the Company’s storage products caused by changes in • other risks, uncertainties, and factors described from time to time in the office technology; including the change from paper record storage to electronic Company’s filings with the Securities and Exchange Commission. record storage; We caution the reader that the above list of factors may not be exhaustive. The • the effects of economic conditions, on demand for office furniture, customer Company does not assume any obligation to update any forward-looking state- insolvencies and related bad debts and claims against the Company that it ment, whether as a result of new information, future events or otherwise. received preferential payments; K R O Y W E N , O I D U T S L E U Q E S : N G I S E D 63 O U R V I S I O N We, the members of HON INDUSTRIES, are dedicated to creating long-term value for all of our stakeholders, to exceeding our customers’ expectations, and to making our company a great place to work. We will always treat each other, as well as customers, suppliers, shareholders, and our communities, with fairness and respect. Our success depends upon business simplification, rapid continuous improvement, and innovation in every- thing we do, individual and collective integrity, and the relentless pursuit of the following long-standing beliefs: W E W I L L B E P R O F I T A B L E . We pursue mutually profitable relationships with customers and suppliers. Only when our company achieves an ade- quate profit can the other elements of this Vision be realized. W E W I L L C R E A T E L O N G - T E R M V A L U E F O R S H A R E H O L D E R S . We create long-term value for shareholders by earning financial returns significantly greater than our cost of capital and pursuing profitable growth opportunities. We will safeguard our shareholders’ equity by maintaining a strong balance sheet to allow flexibility in responding to a continuously changing market and business environment. We pursue profitable growth on a global basis in order to provide continued job opportunities for members and finan- W E W I L L P U R S U E P R O F I T A B L E G R O W T H . cial success for all stakeholders. W E W I L L B E A S U P P L I E R O F Q U A L I T Y P R O D U C T S A N D S E R V I C E S . We provide reliable products and services of high quality and brand value to our end-users. Our products and services exceed our customers’ expectations and enable our distributors and our company to make a fair profit. W E W I L L B E A G R E A T P L A C E T O W O R K . We pursue a participative environment and support a culture that encourages and recognizes excellence, active involvement, ongoing learning, and contributions of each member; that seeks out and values diversity; and that attracts and retains the most capable people who work safely, are motivated, and are devoted to making our company and our members successful. W E W I L L B E A R E S P O N S I B L E C O R P O R A T E C I T I Z E N . We conduct our business in a way that sustains the well-being of society, our environment, and the economy in which we live and work. We follow ethical and legal business practices. Our company supports our volunteer efforts and provides charitable contributions so that we can actively participate in the civic, cultural, educational, environmental, and governmental affairs of our society. T O O U R S T A K E H O L D E R S : When our company is appreciated by its members, favored by its customers, supported by its suppliers, respected by the public, and admired by its shareholders, this Vision is fulfilled. H O N I N D U S T R I E S I n c . ( H N I ) 414 East Third Street, P.O. Box 1109, Muscatine, IA 52761-0071 www.honi.com