HNI Annual Report 2005 | Quarterlytics

Plain-text annual report

414 East Third Street Muscatine, Iowa 52761 www.hnicorp.com H N I C o r p o r a t i o n 2 0 0 5 A n n u a l R e p o r t Our story hasn’t changed. HNI Corporation 2005 Annual Report I N V E S T O R I N F O R M AT I O N Fiscal 2006 Quarter-End Dates 1st Quarter: Saturday, April 1 2nd Quarter: Saturday, July 1 3rd Quarter: Saturday, September 30 4th Quarter: Saturday, December 30 Annual Meeting The Corporation’s annual shareholders’ meeting will be held at 10:30 a.m. on Tuesday, May 2, 2006, at the Holiday Inn, Highways 61 & 38 North, Muscatine, Iowa. Shareholders and other interested investors are encouraged to attend the meeting. Investor Relations Send inquiries to: Investor Relations HNI Corporation 414 East Third Street Muscatine, IA 52761 Telephone: 563.272.7400 Fax: 563.272.7655 E-mail: investorrelations@hnicorp.com Corporate Headquarters HNI Corporation 414 East Third Street P.O. Box 1109 Muscatine, IA 52761-0071 Telephone: 563.272.7400 Fax: 563.272.7217 Website: www.hnicorp.com Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP One North Wacker Drive Chicago, IL 60606 Common Stock HNI Corporation common stock trades on the New York Stock Exchange (NYSE) under the symbol: HNI. Stock price quotations can be found in major daily newspapers and The Wall Street Journal. Transfer Agent Shareholders may report a change of address or make inquiries by writing or calling: Computershare Investor Services, LLC 2 North LaSalle Street Chicago, IL 60602 Telephone: 312.588.4991 Management Certifications On June 1, 2005, the Corporation submitted to the NYSE, the Annual CEO Certification required by Section 303A.12(a) of the NYSE Listed Company Manual. The Corporation also filed with the Securities and Exchange Commission the CEO/CFO Certification required under Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 to the Corporation’s annual report on Form 10-K for the fiscal year ended December 31, 2005. It’s the . r e p a p e l b a l c y c e r d n a d e l c y c e r n o d e t n i r P h p a r g o h t i L n o s r e d n A o e v n e C : g n i t n i r P f p e n h c S s e m a J : y h p a r g o t o h P e v i t u c e x E m o c . m m o c n c b . w w w / s n o i t a c i n u m m o C N C B : n g i s e D same culture. Our culture hasn’t changed. Culture is a major part of what differentiates us from the competition. But besides making us different, why is our culture relevant? Because it drives our behaviors, which in turn drive our results. Virtually everyone who works here owns stock and has a stake in the proﬁts. That creates an ownership mentality across the entire company—a sense of shared risk and shared reward, and a belief among members that they can make a difference in HNI’s performance. This culture of ours is a constant. It will continue to be a guiding and unifying force as we expand our capabilities and pursue growth. HNI CORPORATION 2005 ANNUAL REPORT 1 The same mindset. 2 HNI CORPORATION 2005 ANNUAL REPORT Constructive discontent. That’s our mindset, and it hasn’t changed. Constructive discontent drives a constant focus on the customer and end user, on how we can provide them more, better, faster and for less—in short, on how we can deliver performance that’s always improving. Our mindset is supported and formalized across nearly every aspect of our operations, from manufacturing to marketing, in Rapid Continuous Improvement (RCI) processes. That will continue. HNI CORPORATION 2005 ANNUAL REPORT 3 The same business model. 4 HNI CORPORATION 2005 ANNUAL REPORT Our split-and-focus business model hasn’t changed. HNI’s decentralized structure enables operating businesses to stay closely connected to the customer, maintain maximum marketplace awareness and quickly respond to emerging opportunities. At the same time, communication and collaboration between the business units create leverage in core functions like purchasing, IT and logistics. HNI businesses also routinely share best practices, from lean manufacturing to product development and marketing techniques. HNI CORPORATION 2005 ANNUAL REPORT 5 Moving continuously forward. 6 HNI CORPORATION 2005 ANNUAL REPORT It’s the same strategy. It hasn’t changed. We’re pushing constantly ahead, leveraging our unique culture, mindset and business model toward the overriding goal of aggressive, proﬁtable growth. Key to achieving this goal is building our market power, continuing to hone our best-cost, lean enterprise, and enhancing our culture and capabilities. Our strategy has a dual focus: working continuously to extract new growth from our core markets while we identify and develop new, adjacent potential areas of growth. We call this strategy Core Plus. HNI CORPORATION 2005 ANNUAL REPORT 7 Core. 8 HNI CORPORATION 2005 ANNUAL REPORT At the core of our approach is HNI’s decentralized split-and-focus business model: a group of separate business units, operating in the ofﬁce furniture In the “Core” portion of our and hearth products markets, centered Core Plus growth strategy, we are on speciﬁc segments of end users. extracting new growth from each The HON Company’s core emphasis existing business by deepening our is on the ofﬁce furniture needs of small understanding of end users, using new businesses and individuals. Allsteel Inc. insights gained to refine branding, focuses primarily on larger organizations selling and marketing and developing and designers/architects who serve new products to serve them better. them. The Gunlocke Company L.L.C. We’re continually improving operations and Paoli Inc. concentrate on those while increasingly applying lean who want the elegance of wood in principles to the customer-facing end their private ofﬁces. Hearth & Home of our businesses. And we are always Technologies Inc. helps builders, alert to potential acquisitions that designers and homeowners enhance expand the core customer base. the warmth and beauty of the home. All our other businesses share this sharp focus on speciﬁc end-user groups, each of which has unique wants, needs and buying processes. HNI CORPORATION 2005 ANNUAL REPORT 9 The “Plus” side of our growth strategy is the application of our split-and-focus model to new buyer segments. That is, we identify an opportunity, then we distribution model, which both Allsteel leverage our strengths and tailor the and our Hearth & Home business are business to pursue it. The highly agile, developing. A “Plus” opportunity also ﬂexible nature of our business structure can be a new business entirely, such as enables us to adjust the moving parts— Omni Workspace Company’s furniture the selling model, the product/business services, or new geographic markets, model or a combination of both—to which HNI International is exploring. create winning buying experiences and We often support “Plus” strategies new sources of growth. with highly specialized “Segment A “Plus” opportunity is deﬁned Selling Experts.” These are professionals by any potential growth driver outside who intimately know the end users of but related to our core business. That a given segment—how they talk, how could be a vertical market like schools, they work, what they need and how government ofﬁces, healthcare providers they buy—and help us tune the selling or entrepreneurs, which are segments process to ﬁt. being pursued by a number of our business units. Or, it could be a new 10 HNI CORPORATION 2005 ANNUAL REPORT Plus. HNI CORPORATION 2005 ANNUAL REPORT 11 FINANCIAL HIGHLIGHTS Amounts in thousands, except for per share data 2005 2004 Change Income Statement Data 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 Balance Sheet Data Current assets Total assets Current liabilities Current ratio Long-term debt and capital lease obligations Debt/capitalization ratio Shareholders’ equity Average shareholders’ equity Working capital Other Data Capital expenditures Cash ﬂow from operations Weighted-average shares outstanding during year – basic Price/earnings ratio at year-end Number of shareholders at year-end Members (employees) at year-end $2,450,572 887,918 $2,093,447 751,304 36.2% 668,910 3,462 215,546 137,420 5.6% 21.8% $÷÷÷÷«2.51 2.50 11.46 0.62 $÷«486,598 1,140,271 358,174 1.36 ÷$÷«103,869 19.5% $÷«593,944 631,554 128,424 $÷÷«38,912 201,009 54,649,199 22 6,702 12,504 35.9% 572,006 886 178,412 113,582 5.4% 16.5% $÷÷÷÷«1.99 1.97 12.10 0.56 $÷«374,579 1,021,657 266,250 1.41 $÷÷÷«3,645 0.6% $÷«669,163 689,526 108,329 $÷÷«32,417 194,256 57,127,110 22 6,465 10,589 Net Sales (in millions) Net Income (in millions) 1 5 4 2 , 3 9 0 2 , 2 9 7 1 , 6 5 7 1 , 2 9 6 1 , 7 3 1 3 9 0 4 1 2 1 , 8 9 1 9 4 7 Return on Average Shareholders’ Equity (percent) . 8 1 2 3 9 0 2 , . 5 6 1 . 7 4 1 . 5 4 1 . 8 2 1 17.1 % 18.2 % – 16.9 % 290.7 % 20.8 % 21.0 % – – 26.1 % 26.9 % (5.3) % 10.7 % 29.9 % 11.7 % 34.5 % – 2,749.6 % – (11.2) % (8.4) % 18.5 % 20.0 % 3.5 % (4.3) % – 3.7 % 18.1 % Diluted Earnings per Share (dollars) 0 5 2 . 3 9 0 2 7 9 1 , . 8 6 1 . 5 5 1 . 6 2 1 . 1 0 0 2 2 0 0 2 3 0 0 2 4 0 0 2 5 0 0 2 1 0 0 2 2 0 0 2 3 0 0 2 4 0 0 2 5 0 0 2 1 0 0 2 2 0 0 2 3 0 0 2 4 0 0 2 5 0 0 2 1 0 0 2 2 0 0 2 3 0 0 2 4 0 0 2 5 0 0 2 12 HNI CORPORATION 2005 ANNUAL REPORT 3 9 0 2 , LE T TER TO SHAREHOLDERS Dear shareholders: Our story has not changed. We’re still leveraging our unique culture, mindset and business model to grow. We’re still committed to the same set of values and beliefs. We’re still focused on continuously enhancing our processes and products to improve performance. The story hasn’t changed because we’re in the midst of executing our strategy to deliver aggressive, proﬁtable growth. If our 2005 results are any indication, the strategy is working well. But this is no time to rest. Because, even though we posted excellent results in the year just past, investors rightfully want to know how we plan to sustain our performance going forward. Our answer is Core Plus. HNI CORPORATION 2005 ANNUAL REPORT 13 S TA N A . ASK REN CH A IRM A N, PRE SIDEN T A ND CHIE F E X ECU T I V E OF F ICER A POWERFUL PLATFORM: OUR SPLIT-AND-FOCUS BUSINESS MODEL Along with our culture and our lean operations, our decentralized business model is absolutely key to our growth plans. As we said in last year’s annual report: “We believe strongly that smaller, focused groups of skilled, dedicated people, empowered and energized in the right business models, are very effective competitors to larger, more centralized organizations. We believe this split-and- focus approach, where leaders in each operating company have responsibility for a distinct P&L, a specialist’s knowledge of the target market and the ability to operate with minimal corporate interference, is a much more effective way to deliver value to customers and, ultimately, shareholders.” Believers in centralization speak of economies of scale. Scale certainly has its benefits in terms of managing costs—we achieve these without structural centralization though our business units working together on such functions as procurement, IT, logistics and legal—but we believe operating as a large, centralized business can be a disadvantage in a dynamic and highly com- petitive marketplace. It can be more difficult to tailor processes for market segments, tougher to respond quickly to opportunities and more of a challenge to maintain focus. We call this the “dis-economies of scale.” Split and focus is a very effective model from which to identify and develop new avenues of growth. It’s designed to separate a target segment, then tune and tailor a business model to go after it, efﬁciently and effectively. Allsteel is an excellent example of the power of this approach. 14 HNI CORPORATION 2005 ANNUAL REPORT “Along with our culture and our lean operations, the HNI split-and-focus business model is what makes our Core Plus growth strategy so viable.” Several years ago, we split and focused the Allsteel business, creating a separate management team and business model. Today, Allsteel is a vital and growing part of our core business. CORE PLUS: CONVERTING OUR MODEL INTO PROFITABLE LONG-TERM GROWTH Core Plus is about ﬁnding ways of growing the existing businesses (the “Core”) while seeking out and developing new frontiers for growth (the “Plus”), which we call domain extensions. If a domain extension thrives, it becomes a part of the core; if it does not meet our expectations, we end it and move on. At any given time, we have numerous domain extensions in progress. A good example is The HON Company’s development of the K–12 classroom segment. This is a natural extension for HON, already a strong brand among those who buy furniture for school administrative ofﬁces. HON for LearningTM represents a whole new product line and selling model designed for the classroom furniture segment, which is different in its needs and processes from purchasers of school ofﬁce furnishings. The basyx brand represents a new brand and product line for The HON Company focused on entrepreneurs and start-ups, a segment reachable largely through its existing selling model. Allsteel Inc., The HON Company and Paoli Inc. are pursuing domain extensions with the government segment, a strong market for existing product lines that requires a highly tailored selling and fulﬁllment model. Allsteel Inc. and Hearth & Home Technologies Inc. are developing a unique, more competitive distribution model that includes the strategic acquisition of key dealers. In this promising “Plus” strategy, we invest together with the dealer to more aggressively, efﬁciently and effectively develop markets. These are just a few of the domain extensions currently in development that we believe will drive proﬁtable growth in both the short and long term for HNI. HNI CORPORATION 2005 ANNUAL REPORT 15 CULTURE: THE POWER BEHIND THE STRATEGY You’ve heard us say this many times before: Culture matters because it drives behaviors. And, at all levels of any organization, behaviors drive results. That’s why enhancing culture and capabilities is an important element of aggressive, proﬁtable growth. Our model, our culture and our values also are beneﬁting us by increasingly attracting people to HNI who seek, rather than avoid, accountability; who are motivated rather than intimidated by risk and reward; who are excited to have an opportunity to have an impact on the success of the business. Our culture is the power that really makes split and focus and Core Plus work. It is something we will continue to nurture as we grow. THANKS It has been a very gratifying year. We met or exceeded our objectives. We made signiﬁcant progress in our strategies. We owe a debt of gratitude to all who have contributed to our performance thus far. First and foremost, this group includes our members, whose dedication and performance are a source of collective pride for us all. Thanks also are due our customers and suppliers for the critical part they play in our success. It’s an exciting time to be associated with HNI—with our business model, our strategy and our people, I see powerful potential and possibilities. We intend to stay humble, stay focused and work hard to achieve great things for our company, our customers and our investors. STAN A. ASKREN Chairman, President and Chief Executive Ofﬁcer 16 HNI CORPORATION 2005 ANNUAL REPORT HNI at a glance HNI CORPORATION 2005 ANNUAL REPORT 17 HNI AT A GL ANCE HNI Corporation is a strong group of performers in the ofﬁ ce furniture and hearth products businesses. Our unique business model enables a high degree of focus and agility in distinct markets. ® ® ® ™™ ™ ® ® ™™ ™ ® 18 HNI CORPORATION 2005 ANNUAL REPORT HNI CORPORATION 2005 ANNUAL REPORT 19 HNI AT A GL ANCE CON T INUED Allsteel Inc. delivers the highest level of functionality, durability, service, design and style to large corporate and institutional clients. By focusing on these five elements of quality, Allsteel helps clients achieve more productive facilities, more satisifed workers and unique, inspiring workspaces. Allsteel prides itself on being easy to work with, responsive and responsible. This is Allsteel: Designed to work. Built to last. 20 HNI CORPORATION 2005 ANNUAL REPORT The HON Company is North America’s brand of choice for small and medium-sized businesses. From file cabinets to executive chairs, desks to panel systems, The HON Company offers a full line of affordable and stylish products that look great for years to come. The HON Company’s nationwide distribution network provides industry-leading access to top-selling products. As businesses expand, HON designs allow new products to easily integrate with existing solutions. The HON Company: Smart now. . .smarter later. HNI CORPORATION 2005 ANNUAL REPORT 21 HNI AT A GL ANCE CON T INUED The Gunlocke Company L.L.C. is recognized as an industry leader in the design, manufacture and marketing of premium wood ofﬁ ce furniture: casegoods, seating and tables. As it focuses on developing fresh, responsive new solutions for the private ofﬁ ce, the company carries forward a tradition of quality craftsmanship, technical expertise and conscientious customer service. The choice of leading decision makers in a range of industries as well as of eight U.S. Presidents, the Gunlocke name is synonymous with design integrity, manufacturing excellence and enduring value. 22 HNI CORPORATION 2005 ANNUAL REPORT Paoli Inc. is one of the leading providers of high-aesthetic wood desks and seating at moderate prices for small to medium-sized companies and furniture specifiers who serve them. Paoli Inc. is known for its broad line of products and quick-ship program, close relationships and positive reputation with dealers, flexibility and responsiveness to customer needs, and experienced, dedicated management team. Paoli Inc. goes to market through the Paoli® and Whitehall® brands. HNI CORPORATION 2005 ANNUAL REPORT 23 ® Maxon Furniture Inc. provides panel system solutions for small to mid-sized businesses seeking to remodel or expand their ofﬁ ces. Reaching potential end users with Internet- based marketing and interactive online tools, Maxon Furniture Inc. creates uncontested leads for its distribution partners. Its simpliﬁ ed buying process for target customers provides innovative tools that satisfy their unique needs. Maxon Furniture Inc. provides proven products and services at outstanding value and industry-leading speed. In short, MAXON gets customers working fast. HNI AT A GL ANCE CON T INUED ™ basyx™ answers the small business owner’s need to furnish an office by providing professional office furniture at an exceptional price without sacrificing design and quality. The basyx brand has a simple yet complete line of desking, seating, storage and table options that offers clear solutions for open office, private office, reception area, conference room and training room layouts. For easy availability, basyx product is offered through a nationwide network of dealers. Although running a business comes with risks, basyx ensures that purchasing office furniture will not be one of them. basyx: Simple, clear, easy. 24 HNI CORPORATION 2005 ANNUAL REPORT ™™ Omni Workspace Company comprises two divisions, Omni Service Group and IntraSpec Solutions, that serve small, medium-sized and large businesses. Omni Service Group executes facility services for Fortune 1000 customers and contract furniture dealerships, simplifying the work order, management and reporting process. IntraSpec Solutions provides high-quality, remanufactured brand-name office furniture systems. IntraSpec Solutions asset management and trade-in programs help customers with standardized systems get the most value from their existing furniture assets. HNI CORPORATION 2005 ANNUAL REPORT 25 ® ® and Paoli ® and Paoli ® ®, Gunlocke ®, Gunlocke HNI International Inc. markets and distributes HON®, Allsteel ® ® brands ® brands ® ®, Allsteel worldwide, outside of the United States and Canada. It offers one of the largest selections of office furniture and related services in the world, providing a “house of brands” that allows it to tailor solutions to every need, budget and location. HNI International Inc. supports global corporate accounts as well as domestic and international dealers with sales, installation and service for industries all over the globe. With dealers, members and servicing partners in many countries, HNI International Inc. can provide complete project management virtually anywhere in the world. Fireside Hearth & Home™, the leading brand in providing hearth products and services, helps consumers achieve the feeling they want in their home by supporting the entire buying process – from purchase to installation and after-sale service. The Fireside Hearth & Home business operates through a network of independent and company-owned, stand-alone or gallery design centers, as well as installation centers, catering to both consumers and builders. HNI AT A GL ANCE CON T INUED Heatilator® has become the most recognized and preferred fireplace brand among home- builders since its first air-circulating fireplace was patented in 1927. As testament to its long-standing reputation for quality, leading builders choose Heatilator because they know that the brand assures their customers continuous comfort and reliability. 26 HNI CORPORATION 2005 ANNUAL REPORT Heat & Glo™, winner of the most industry awards for technology and innovation, owns the premium position in the marketplace by consistently developing hearth products that push techno- logical and design boundaries. The Heat & Glo brand is focused sharply on consumer desires to create products that promote balance, style, comfort and sophistication in the home. As a result, the Heat & Glo brand represents some of the most distinctive and realistic gas, wood and electric fireplaces, stoves and fireplace inserts, surrounds and accessories in the market. HNI CORPORATION 2005 ANNUAL REPORT 27 Quadra-Fire®, the leader in highly efficient, durable and powerful hearth products, offers the widest selection of high-performance fireplaces, stoves and fireplace inserts in the wood, gas and pellet fuel categories. Quadra-Fire products boast high efficiency and a rugged exterior. The products use heavy-gauge steel and cast iron along with details to improve performance and enhance appearance. MANAGEMENT ’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPER ATIONS The following discussion of the Corporation’s historical results of operations and of its liquidity and capital resources should be read in conjunction with the Consolidated Financial Statements of the Corporation and related notes. Overview The Corporation has two reportable core operating segments: ofﬁce furniture and hearth products. The Corporation is the second largest ofﬁce furniture manufacturer in the world and the nation’s leading manufacturer and marketer of gas- and wood-burning ﬁreplaces. The Corporation utilizes its split and focus, decentralized business model to deliver value to its customers with its various brands and selling models. The Corporation is focused on growing its existing businesses while seeking out and developing new opportunities for growth. During 2005 and 2004, the ofﬁce furniture industry experienced a rebound from the unprecedented three-year decline it faced from 2000 to 2003 that positively impacted the Corporation’s ofﬁce furniture segment. The housing market remained strong during 2005, which positively impacted the Corporation’s hearth segment. During this rebound in the ofﬁce furniture industry and strong housing market, the Corporation continued its focus on business simpliﬁcation and cost reduction as well as investing in growth initiatives to provide long-term shareholder value. In 2005, the Corporation experienced strong growth across its multiple brands and product lines. Sales beneﬁted from price increases that were implemented in 2004 and early 2005 as well as acquisitions completed over the past two years. While steel prices moderated slightly during 2005, they remained at high levels. The Corporation also experienced increases in other material costs as well as increased freight costs as a result of fuel surcharges. The Corporation completed a number of small acquisitions during 2005 to support speciﬁc company strategies in both segments of its business. The Corporation began the shutdown of two ofﬁce furniture facilities in 2005 and recorded charges of $4.1 million for restructuring costs and accelerated depreciation. Critical Accounting Policies and Estimates GE N E R AL Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon the Consolidated Financial Statements, which have been prepared in accordance with Generally Accepted Accounting Principles (“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 contingent 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 assumptions or conditions. 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. Fiscal year end – The Corporation follows a 52/53-week ﬁscal year which ends on the Saturday nearest December 31. Fiscal year 2005 ended on December 31, 2005; 2004 ended on January 1, 2005; and 2003 ended on January 3, 2004. The ﬁnancial statements for ﬁscal year 2003 are based on a 53-week period, and ﬁscal years 2005 and 2004 are on a 52-week basis. A 53-week year occurs approximately every sixth year. Revenue recognition – The Corporation normally recognizes revenue 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 costs are included in selling and administrative expense. Rebates, discounts, and other marketing program expenses directly related to the sale are recorded as a reduction to net sales. Marketing program accruals require the use of management estimates and the consideration of contractual arrangements subject to interpretation. Customer sales that reach certain award levels can affect the amount of such estimates, and actual results could differ from these estimates. Future market conditions may require increased incentive offerings, possibly resulting in an incremental reduction in net sales at the time the incentive is offered. Allowance for doubtful accounts receivable – The allowance for doubtful accounts receivable is based on several factors including overall customer credit quality, historical write-off experience, and speciﬁc account analysis that projects the ultimate collectibility of the account. As such, these factors may change over time causing the Corporation to adjust the reserve level accordingly. When the Corporation determines that a customer is unlikely to pay, a charge is recorded to bad debt expense in the income statement and the allowance for doubtful accounts is increased. When the Corporation is certain the customer cannot pay, the receivable is written off by removing the accounts receivable amount and reducing the allowance for doubtful accounts accordingly. 28 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT MANAGEMENT ’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPER ATIONS As of December 31, 2005, there was approximately $290 million in outstanding accounts receivable and $12 million recorded in the allowance for doubtful accounts to cover potential future customer non-payments. However, if economic conditions deteriorate signiﬁcantly or one of the Corporation’s large customers declares bankruptcy, a larger allowance for doubtful accounts might be necessary. The allowance for doubtful accounts was approximately $11 million at year end 2004 and 2003. Inventory valuation – The Corporation valued 90% of its inventory by the last-in, ﬁrst-out (LIFO) method at December 31, 2005. Additionally, the Corporation evaluates inventory reserves in terms of excess and obsolete exposure. This evaluation includes such factors as anticipated usage, inventory turnover, inventory levels, and ultimate product sales value. As such, these factors may change over time causing the Corporation to adjust the reserve level accordingly. The Corporation’s reserves for excess and obsolete inventory were $8 million, $8 million, and $6 million at year-end 2005, 2004, and 2003, respectively. Long-lived assets – The Corporation reviews long-lived assets for impairment as events or changes in circumstances occur indicating that the amount of the asset reﬂected in the Corporation’s balance sheet may not be recoverable. The Corporation compares an estimate of undiscounted cash ﬂows produced by the asset, or the appropriate group of assets, to the carrying value to determine whether impairment exists. The estimates of future cash ﬂows involve considerable management judgment and are based upon the Corporation’s assumptions about future operating performance. The actual cash ﬂows could differ from management’s estimates due to changes in business conditions, operating performance, and economic conditions. Asset impairment charges associated with the Corporation’s restructuring activities are discussed in the Restructuring Related Charges note to the Consolidated Financial Statements of the Corporation. The Corporation’s continuous focus on improving the manufacturing process tends to increase the likelihood of assets being replaced; therefore, the Corporation is constantly evaluating the expected useful lives of its equipment, which can result in accelerated depreciation. Goodwill and other intangibles – In accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 142, the Corporation evaluates its goodwill for impairment on an annual basis based on values at the end of third quarter or whenever indicators of impairment exist. The Corporation has evaluated its goodwill for impairment and has determined that the fair value of the reporting units exceeded their carrying value, so no impairment of goodwill was recognized for the period ending December 31, 2005. Goodwill of approximately $242 million is shown on the consolidated balance sheet as of the end of ﬁscal 2005. Management’s assumptions about future cash ﬂows for the reporting units require signiﬁcant judgment, and actual cash ﬂows in the future may differ signiﬁcantly from those forecasted today. The Corporation believes that its assumptions used in discounting future cash ﬂows have no impact on the reported carrying amount of goodwill. The estimated future cash ﬂow for any reporting unit could be reduced by 40% without decreasing the fair value to less than the carrying value. The Corporation also determines the fair value of indeﬁnite lived trademarks on an annual basis or whenever indication of impairment exist. The Corporation has evaluated its trademarks for impairment and recorded an impairment charge of $0.5 million in 2005 related to two trademarks where the carrying value exceeded the current fair market value. The carrying value of the trademarks was approximately $30 million at the end of ﬁscal 2005. Self-insured reserves – The Corporation is partially self-insured for general, auto, and product liability, workers’ compensation, and certain employee health beneﬁts. The general, auto, product, and workers’ compensation liabilities are managed via a wholly- owned insurance captive; the related liabilities are included in the accompanying ﬁnancial statements. The Corporation’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 number of claims, medical cost inﬂation, and magnitude of change in actual experience development could cause these estimates to change in the near term. Stock-based compensation – The Corporation accounts for its stock option plan using Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” which results in no charge to earnings when options are issued at fair market value. 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 – 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. In December 2004, the Financial Accounting Standards Board issued SFAS No. FAS123(R), “Share-Based Payment,” effective as of the beginning of the ﬁrst annual reporting period that begins after June 15, 2005. The Corporation plans to adopt FAS123(R) on January 1, 2006, the beginning of its ﬁscal year. FAS123(R) eliminates the alternative to use the intrinsic value method of accounting that was provided in FAS123 as originally issued. In accordance with SFAS No. 148, the Corporation has been disclosing in the notes in the Consolidated Financial Statements the impact on net income and earnings per share had the fair value-based method been adopted. If the fair value method had been adopted, the Corporation’s net income for 2005, 2004, and 2003 would have been reduced by approximately $2 million, $5 million, and $3 million, respectively, and earnings per share would have been reduced approximately $0.03, $0.08, and $0.06 per diluted share, respectively. HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 29 MANAGEMENT ’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPER ATIONS Recent Accounting Pronouncements See the notes to the Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and ﬁnancial conditions. Results of Operations The following table sets forth the percentage of consolidated net sales represented by certain items reﬂected in the Corporation’s statements of income for the periods indicated. Fiscal 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 and minority interest Income taxes Minority interest in earnings of subsidiary Net income 2005 100.0% 63.8 36.2 27.3 0.1 8.8 0.0 8.8 3.2 0.0 5.6% 2004 100.0% 64.1 35.9 27.3 0.1 8.5 0.0 8.5 3.1 0.0 5.4% 2003 100.0% 63.6 36.4 27.4 0.5 8.5 0.1 8.6 3.0 0.0 5.6% N E T SALES Net sales during 2005 were $2.5 billion, an increase of 17.1 percent, compared to net sales of $2.0 billion in 2004. The increase in 2005 was due to $92 million of incremental sales from acquisitions, $112 million from price increases implemented in 2004 and early 2005, and strong volume across all brands in both the ofﬁce furniture and hearth products segments. Net sales during 2004 were $2.0 billion, an increase of 19.2 percent, compared to net sales of $1.8 billion in 2003. The increase in 2004 was due to $136 million of sales from the Corporation’s 2004 acquisitions, $36 million from price increases, and increased volume in both segments. G ROS S PRO F I T Gross proﬁt as a percent of net sales increased 0.3 percentage points in 2005 as compared to ﬁscal 2004 but is still 0.2 percentage points below 2003 levels due to ongoing cost reduction initiatives in addition to the beneﬁt of price realization partially offsetting the signiﬁcant steel and other material price increases experienced over the past two years. The Corporation’s gross margins decreased 0.5 percentage points in 2004 compared to ﬁscal 2003 due to increased steel and other material costs. SE LL I N G AN D AD M I N I ST R AT I V E E X PE N SES Selling and administrative expenses, excluding restructuring charges, increased 16.9 percent and 19.0 percent in 2005 and 2004, respectively. The increase in 2005 was due to $26 million of additional costs from acquisitions; increased freight and distribution costs of $34 million due to volume, rate increases and fuel surcharges; investments in selling and marketing initiatives and product launches; and increased proﬁt-sharing and incentive compensation expense due to strong results. The increase in 2004 was due to $39 million of additional costs from acquisitions; $26 million of increased freight and distribution costs due to volume, rate increases, and fuel surcharges; and investments in brand building and selling initiatives. Selling and administrative expenses include freight expense for shipments to customers, product development costs, and amortization expense of intangible assets. The Selling and Administrative Expenses note included in the Consolidated Financial Statements provides further information regarding the comparative expense levels for these major expense items. R EST RUC TU R I N G C H A RGES During 2005, the Corporation began the shutdown of two ofﬁce furniture facilities and is consolidating production into other U.S. manufacturing locations to increase efﬁciencies, streamline processes, and reduce overhead costs. The two facilities are located in Kent, Washington, and Van Nuys, California. In connection with these closures, the Corporation recorded $4.1 million of pre-tax charges or $0.04 per diluted share. These charges included $0.6 million of accelerated depreciation of machinery and equipment recorded in cost of sales, $1.2 million of severance, $0.4 million of pension related expenses, and $1.9 million of facility exit, production relocation, and other costs which were recorded as restructuring costs. The closures and consolidation will be completed during the ﬁrst quarter of 2006. During 2003, the Corporation closed two ofﬁce furniture facilities and consolidated production into other U.S. manufacturing locations. The two facilities were located in Hazleton, Pennsylvania, and Milan, Tennessee. In connection with these closures, the Corporation recorded $15.7 million of pre-tax charges or $0.17 per diluted share. These charges included $6.7 million of accelerated depreciation of machinery and equipment that was recorded in cost of sales, $3.4 million of severance, and $5.6 million of facility exit, production relocation, and other costs that were recorded as restructuring costs. A total of 316 members were terminated and received severance due to these shutdowns. In connection with the shutdowns, the Corporation incurred $1.2 million of current period charges during 2004. The Corporation also reduced the restructuring charge recorded in 2003 by approximately $0.3 million related to its Milan, Tennessee, facility during 2004. The reduction was due to the fact that the Corporation was able to exit a lease with the lessor on more favorable terms than previously estimated. These closures were completed in 2004. 30 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT MANAGEMENT ’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPER ATIONS O PE R AT I N G I N C O M E Operating income was $216 million in 2005, an increase of 20.8 percent compared to $178 million in 2004. The increase in 2005 was due to increased sales volume in both segments, and price increases, offset by increased material costs, investments in selling and marketing initiatives and product launches, increased freight costs, and restructuring costs due to plant closures and consolidations. Operating income increased 19.0 percent to $178 million in 2004 compared to $150 million in 2003. The increase in 2004 was due to increased sales volume in both segments, price increases, contributions from new acquisitions, and a $15 million restructuring charge in 2003, offset by increased steel and other material costs, increased investment in brand building and selling initiatives, and increased freight costs. N E T I N C O M E Net income increased 21.0 percent to $137 million in 2005 compared to $114 million in 2004. Net income in 2005 was favorably impacted by a decrease in the effective tax rate to 36.0 percent in 2005 from 36.5 percent in 2004 due to beneﬁts resulting from the implementation of the American Jobs Creation Act of 2004. Net income in 2005 was negatively impacted by increased interest expense due to a planned increase in debt. Net income increased 15.8 percent to $114 million in 2004 compared to $98 million in 2003. Net income in 2004 was unfavorably impacted by an increase in the effective tax rate to 36.5 percent from 35 percent in 2003 due to increased state taxes and a reduced beneﬁt from federal and state tax credits. Net income per diluted share increased by 26.9 percent to $2.50 in 2005 and by 17.3 percent to $1.97 in 2004. Net income per share was positively impacted $0.11 per share in 2005 and $0.03 per share in 2004 by the Corporation’s share repurchase program. O FF I C E FU R N I TU R E Ofﬁce furniture comprised 76 percent, 75 percent, and 74 percent of consolidated net sales for 2005, 2004, and 2003, respectively. Net sales for ofﬁce furniture increased 18 percent in 2005 to $1.9 billion compared to $1.6 billion in 2004. The increase in 2005 was due to approximately $66 million of incremental sales from the Corporation’s acquisitions and organic growth of $219 million or 13.9 percent, including increased price realization of $91 million. Net sales increased 20 percent in 2004 to $1.6 billion compared to $1.3 billion in 2003. The increase in 2004 was due to approximately $117 million of sales from the Corporation’s 2004 acquisitions, $22 million of price increases, and increased market share gain. The Business and Institutional Furniture Manufacturer’s Association (“BIFMA”) reported 2005 shipments up 13 percent and 2004 shipments up more than 5 percent. The Corporation believes it was once again able to outperform the market by providing strong brands, innovative products and services, and greater value to end-users. Operating proﬁt as a percent of sales was 9.5 percent in 2005, 9.9 percent in 2004, and 10.0 percent in 2003. Included in 2005 were $4.1 million of net pre-tax charges related to the closure of two ofﬁce furniture facilities, which impacted operating margins by 0.2 percentage points. In addition the Corporation continued to make investments in the areas of selling, product launches, and strategic distribution acquisitions that had an expected negative impact on proﬁtability. The decrease in operating margins in 2004 was due to approximately $56 million of higher steel and other material costs, additional investments in brand building and selling initiatives, and increased freight expense partially offset by the beneﬁts of restructuring initiatives, rapid continuous improvement programs, and increased price realization. Included in 2003 were $15.2 million of restructuring charges, which impacted operating margins by 1.1 percentage points. H E A R T H PRO DUC TS Hearth products sales increased 14 percent in 2005 to $594 million compared to $523 million in 2004, and 16 percent in 2004 compared to $452 million in 2003. The growth in 2005 and 2004 was attributable to strong housing starts, focused new product introductions, contributions from new acquisitions as well as price increases. Acquisitions accounted for $26 million, or 5 percentage points, of the increase in 2005, and $18 million, or 4 percentage points, of the increase in 2004. Operating proﬁt as a percent of sales in 2005 was 12.6 percent compared to 11.9 percent and 12.1 percent in 2004 and 2003, respectively. The increase in operating margins in 2005 was due to volume and increased price realization as well as continued focus on cost improvements. The decrease in operating margins in 2004 was mainly due to increased steel and freight costs. Liquidity and Capital Resources During 2005, cash ﬂow from operations was $201.0 million, which along with available cash and short-term investments, funds from stock option exercises under employee stock plans, and proceeds from the Corporation’s revolving credit agreement, provided the funds necessary to meet working capital needs, pay for strategic acquisitions, invest in capital improvements, repurchase common stock, and pay increased dividends. Cash, cash equivalents, and short-term investments totaled $84.7 million at the end of 2005 compared to $36.5 million at the end of 2004 and $204.2 million at the end of 2003. These remaining funds, coupled with cash from future operations and additional long-term debt, if needed, are expected to be adequate to ﬁnance operations, planned improvements, and internal growth. The Corporation is not aware of any known trends or demands, commitments, events, or uncertainties that are reasonably likely to result in its liquidity increasing or decreasing in any material way. The Corporation places special emphasis on the management and control of its working capital with a particular focus on trade receivables and inventory levels. The success achieved in managing receivables is in large part a result of doing business with quality customers and maintaining close communication with them. Trade receivables at year-end 2005 increased from the prior year due to the Corporation’s new acquisitions and increased sales volume. HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 31 MANAGEMENT ’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPER ATIONS Trade receivables days outstanding have averaged approximately 36 to 38 days over the past three years. The Corporation’s inventory turns were 19, 21, and 23, for 2005, 2004, and 2003, respectively. The Corporation is increasing its foreign sourced raw materials and ﬁnished goods, which while reducing inventory turns does have a favorable impact on the overall total cost. I N V EST M E N TS Management classiﬁes investments in marketable securities at the time of purchase and re-evaluates such classiﬁcation at each balance sheet date. Equity securities are classiﬁed as available-for- sale and are stated at current market value with unrealized gains and losses included as a separate component of equity, net of any related tax effect. Debt securities are classiﬁed as held-to-maturity and are stated at amortized cost. In 2004 the Corporation made an investment, which was excluded from the scope of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” due to the fact that the investment’s per unit value in a Master Fund is not readily available. Therefore, this investment was recorded at cost. The weighted average cost method was used to determine realized gains and losses on the trade date. In 2005 the Corporation liquidated this investment and subsequently invested in an investment fund that is also excluded from the scope of SFAS No. 115; however, the Corporation’s ownership in this investment fund is such that the underlying investments are recorded at fair market value. A table of holdings as of year-end 2005, 2004, and 2003 is included in the Cash, Cash Equivalents, and Investments note included in the Consolidated Financial Statements. CAPI TAL E XPE N D I TU R E I N VEST M E N T S Capital expenditures were $38.9 million in 2005, $32.4 million in 2004, and $34.8 million in 2003, respectively. These expenditures have consistently focused on machinery and equipment and tooling required to support new products, continuous improvements in our manufacturing processes, and cost savings initiatives. Expenditures in 2003 also included the purchase from a related party of a previously leased hearth products plant for $3.6 million. The Corporation anticipates capital expenditures for 2006 to be approximately 30 to 40 percent higher than previous years due to increased focus on new products and process improvement, and increased investment in distribution. AC QU I S I T I O N S During 2005, the Corporation completed the acquisition of four small ofﬁce furniture services companies, three ofﬁce furniture dealers, and three small hearth distributors for a total combined purchase price of approximately $35 million. During 2004, the Corporation completed three ofﬁce furniture business acquisitions and the acquisitions of two hearth products distributors, as well as the acquisitions of a strategic sourcing entity for a combined purchase price of approximately $135 million. Each of the transactions was paid in cash, and the results of the acquired entities have been included in the Consolidated Financial Statements since the date of acquisition. LO N G -TE R M DE BT Long-term debt, including capital lease obligations, was 15% of total capitalization as of December 31, 2005, 1% as of January 1, 2005, and 1% as of January 3, 2004. The increase in long-term debt was due to the Corporation utilizing its revolving credit facility to fund acquisitions and share repurchases in accordance with its strategy of operating with a more efﬁcient capital structure. The reduction in long-term debt during 2004 was due to the payment of convertible debentures related to a previous hearth acquisition. The reduction in 2003 was due to the retirement of Industrial Revenue Bonds. On January 28, 2005, the Corporation replaced a $136 million revolving credit facility entered into on May 10, 2002 with a new revolving credit facility that provided for a maximum borrowing of $150 million subject to increase (to a maximum amount of $300 million) or reduction from time to time according to the terms of the agreement. On December 22, 2005, the Corporation increased the facility to the maximum amount of $300 million. Additional borrowing capacity of $160 million, less amounts used for designated letters of credit, is available through this revolving bank credit agreement in the event cash generated from operations should be inadequate to meet future needs. The Corporation does not expect future capital resources to be a constraint on planned growth. Certain of the Corporation’s credit agreements include covenants that limit the assumption of additional debt and lease obligations. The Corporation has been, and currently is, in compliance with the covenants related to the debt agreements. C O N T R AC TUAL O B L I G AT I O N S The following table discloses the Corporation’s obligations and commitments to make future payments under contracts: (In thousands) Long-term debt, Payments Due by Period Total Less than 1 year 1–3 years 4–5 years After 5 years including estimated interest (1) $177,914 $÷6,893 $14,197 $13,411 $143,413 Capital lease obligations Operating leases Transportation service contract Purchase obligations (2) Other long-term obligations (3) 1,300 284 426 422 168 71,479 18,231 25,329 16,480 11,439 4,276 4,276 51,846 51,846 – – – – – – 38,972 7,246 6,576 414 24,736 Total $345,787 $88,776 $46,528 $30,727 $179,756 (1) The $140 million in borrowings outstanding under the revolving credit facility at December 31, 2005 are due in 2011; however, $40 million is included in current liabilities in the consolidated ﬁnancial statements based on management’s intent to repay the $40 million during ﬁscal 2006. Assuming the amount is repaid in 2006, interest obligation amounts included in this table would be reduced by approximately $3.8 million in the 1-3 year and 4-5 year categories and $0.1 million in the after 5 year category. Interest has been included for all debt at either the ﬁxed rate or variable rate in effect as of December 31, 2005, as applicable. (2) Purchase obligations include agreements to purchase goods or services that are enforceable, legally binding, and specify all signiﬁcant terms, including the quantity to be purchased, the price to be paid, and the timing of the purchase. (3) Other long-term liabilities represent payments due to members who are participants in the Corporation’s salary deferral and long-term incentive plan programs, mandatory purchases of the remaining interest in Omni Workspace Company and two of the 2005 ofﬁce furniture dealer acquisitions, and contribution and beneﬁt payments expected to be made for our post- retirement beneﬁt plans. It should be noted that our obligations related to post-retirement beneﬁt plans are not contractual and the plans could be amended at the discretion of the Corporation. We limited our disclosure of contributions and beneﬁt payments to 10 years, as information beyond this time period was not available. 32 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT MANAGEMENT ’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPER ATIONS Looking Ahead Global Insight, BIFMA’s forecasting consultant, is estimating U.S. ofﬁce furniture shipments to increase 7 percent in 2006 compared to 13 percent in 2005. The housing market, a key indicator for the hearth industry, is expected to soften from its record levels but remain at healthy levels. Management anticipates 2006 will be another good year. The Corporation will continue to execute its strategy for aggressive proﬁtable growth, continuously investing in core markets and strategic acquisitions, which will generate returns to enhance shareholder value. Management expects to continue to outperform the industry. The Corporation anticipates that its tax rate will increase to 36.5 percent in 2006; however, if the credit for increasing research activities is renewed, the Corporation anticipates that the effective tax rate would remain at 36 percent. On January 12, 2006, the Corporation signed an agreement to purchase Lamex, a privately held Chinese manufacturer and marketer of ofﬁce furniture. Lamex operates primarily in China and Hong Kong, where as a market leader, it generates sales in excess of $70 million annually. The acquisition is expected to close in early 2006, subject to satisfactory completion of closing conditions. The Corporation intends to make the purchase with cash and debt. The acquisition is expected to initially have minimal impact on earnings. Lamex’ strong brand, signiﬁcant customer base, and manufacturing capability offers the Corporation the opportunity to drive aggressive growth in China, one of the largest and fastest growing ofﬁce furniture markets in the world. The Corporation remains focused on creating long-term shareholder value by growing its business through investment in building brands, product solutions, and selling models, enhancing its strong member- owner culture, and remaining focused on its long-standing rapid continuous improvement programs to build best total cost and a lean enterprise. CAS H D I V I DE N DS Cash dividends were $0.62 per common share for 2005, $0.56 for 2004, and $0.52 for 2003. Further, the Board of Directors announced a 16.1 percent increase in the quarterly dividend from $0.155 to $0.18 per common share effective with the March 1, 2006 dividend payment for shareholders of record at the close of business February 24, 2006. The previous quarterly dividend increase was from $0.14 to $0.155, effective with the March 1, 2005 dividend payment for shareholders of record at the close of business on February 25, 2005. A cash dividend has been paid every quarter since April 15, 1955, and quarterly dividends are expected to continue. The average dividend payout percentage for the most recent three-year period has been 32 percent of prior year earnings. C O M M O N S H A R E R E PU R C H ASES During 2005, the Corporation repurchased 4,059,068 shares of its common stock at a cost of approximately $202.2 million, or an average price of $49.82. The Board of Directors authorized $100 million on May 4, 2004, an additional $150 million on November 12, 2004, and an additional $200 million on November 11, 2005 for repurchases of the Corporation’s common stock. As of December 31, 2005, approximately $143.5 million of this authorized amount remained unspent. During 2004, the Corporation repurchased 3,641,400 shares of its common stock at a cost of approximately $145.6 million, or an average price of $39.99. During 2003, the Corporation repurchased 762,300 shares of its common stock at a cost of approximately $21.5 million, or an average price of $28.22 per share. L I T I G AT I O N AN D UN C E R TA I N T I ES The Corporation is involved in various kinds of disputes and legal proceedings that have arisen in the course of its business, including pending litigation, preferential payment claims in customer bankruptcies, environmental remediation, taxes, and other claims. It is the Corporation’s opinion, after consultation with legal counsel, that additional liabilities, if any, resulting from these matters are not expected to have a material adverse effect on the Corporation’s ﬁnancial condition, although such matters could have a material effect on the Corporation’s quarterly or annual operating results and cash ﬂows when resolved in a future period. On December 9, 2005, the Corporation settled a lawsuit which sought approximately $7.6 million and arose out of the 2001 bankruptcy of a customer, US Ofﬁce Products Company. The lawsuit alleged that the Corporation received preferential payments from the customer during the ninety days before the customer ﬁled for bankruptcy protection. The Corporation was named a critical vendor by the bankruptcy court and, accordingly, was paid in full for all outstanding receivables. The lawsuit was brought in February 2003 by USOP Liquidating LLC in the United States Bankruptcy Court for the District of Delaware. The Corporation settled all claims arising out of this lawsuit for a cash payment in the amount of $585,000. As a consequence of the settlement, the lawsuit was dismissed with prejudice on December 14, 2005. HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 33 CONSOLIDATED STATEMENTS OF INCOME (Amounts in thousands, except for per share data) For the Years 2005 2004 2003 Net sales Cost of products sold Gross proﬁt Selling and administrative expenses Restructuring related charges Operating income Interest income Interest expense Earnings before income taxes and minority interest Income taxes Earnings before minority interest Minority interest in earnings of subsidiary Net income Net income per common share – basic Weighted average shares outstanding – basic Net income per common share – diluted Weighted average shares outstanding – diluted The accompanying notes are an integral part of the consolidated ﬁnancial statements. $2,450,572 1,562,654 $2,093,447 1,342,143 $1,755,728 1,116,513 887,918 668,910 3,462 215,546 1,518 2,355 214,709 77,295 137,414 (6) $÷«137,420 $÷÷÷÷«2.51 54,649,199 $÷÷÷÷«2.50 55,033,741 751,304 572,006 886 178,412 1,343 886 178,869 65,287 113,582 – 639,215 480,744 8,510 149,961 3,940 2,970 150,931 52,826 98,105 – $÷«113,582 $÷÷«98,105 $÷÷÷÷«1.99 $÷÷÷÷«1.69 57,127,110 58,178,739 $÷÷÷÷«1.97 $÷÷÷÷«1.68 57,577,630 58,545,353 34 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT CONSOLIDATED BAL ANCE SHEE TS (Amounts in thousands of dollars and shares except par value) As of Year-End 2005 2004 2003 Assets Current Assets Cash and cash equivalents Short-term investments Receivables Inventories Deferred income taxes Prepaid expenses and other current assets Total current assets Property, plant, and equipment Goodwill Other assets Total assets Liabilities and Shareholders’ Equity Current Liabilities Accounts payable and accrued expenses Income taxes Note payable and current maturities of long-term debt Current maturities of other long-term obligations Total current liabilities Long-term debt Capital lease obligations Other long-term liabilities Deferred income taxes Minority interest in subsidiary Commitments and contingencies Shareholders’ Equity Preferred stock – $1 par value Authorized: 2,000 Issued: None Common stock – $1 par value Authorized: 200,000 Issued and outstanding 2005 – 51,849; 2004 – 55,303; 2003 – 58,239 Additional paid-in capital Retained earnings Accumulated other comprehensive income Total shareholders’ equity Total liabilities and shareholders’ equity The accompanying notes are an integral part of the consolidated ﬁnancial statements $÷÷«75,707 $÷÷«29,676 $÷«138,982 9,035 278,515 91,110 15,831 16,400 486,598 294,660 242,244 116,769 6,836 234,731 77,590 14,639 11,107 374,579 311,344 224,554 111,180 65,208 181,459 49,830 14,329 12,314 462,122 312,368 192,086 55,250 $1,140,271 $1,021,657 $1,021,826 $÷«307,952 $÷«253,958 $÷«211,236 1,270 40,350 8,602 358,174 103,050 819 48,671 35,473 140 6,804 646 4,842 266,250 2,627 1,018 40,045 42,554 – 5,958 26,658 1,964 245,816 2,690 1,436 24,262 37,733 – 51,849 55,303 58,239 941 540,822 332 593,944 6,879 606,632 349 669,163 10,324 641,732 (406) 709,889 $1,140,271 $1,021,657 $1,021,826 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 35 CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUIT Y (Amounts in thousands) Balance, December 28, 2002 Comprehensive income: Net income Other comprehensive income (loss) Comprehensive income Cash dividends Common shares – treasury: Shares purchased Shares issued under Members’ Stock Purchase Plan and stock awards Balance, January 3, 2004 Comprehensive income: Net income Other comprehensive income (loss) Comprehensive income Cash dividends Common shares – treasury: Shares purchased Shares issued under Members’ Stock Purchase Plan and stock awards Balance, January 1, 2005 Comprehensive income: Net income Other comprehensive income (loss) Comprehensive income Cash dividends Common shares – treasury: Shares purchased Shares issued under Members’ Stock Purchase Plan and stock awards Balance, December 31, 2005 Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income Total Shareholders’ Equity $«58,374 $÷÷÷549 $«587,731 $«239 $«646,893 98,105 (30,299) (645) (6,945) (13,805) 98,105 (645) 97,460 (30,299) (21,512) 17,347 (762) 627 58,239 16,720 10,324 641,732 (406) 709,889 113,582 (32,023) 755 (3,642) (25,303) (116,659) 706 21,858 113,582 755 114,337 (32,023) (145,604) 22,564 55,303 6,879 606,632 349 669,163 137,420 (33,841) (17) (4,059) (28,769) (169,389) 605 22,831 137,420 (17) 137,403 (33,841) (202,217) 23,436 $«51,849 $÷÷÷941 $«540,822 $«332 $«593,944 The accompanying notes are an integral part of the consolidated ﬁnancial statements. 36 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) For the Years 2005 2004 2003 $«137,420 $«113,582 $÷98,105 Net Cash Flows From (To) Operating Activities Net income Noncash items included in net income: Depreciation and amortization Other postretirement and post-employment 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 Net Cash Flows From (To) Investing Activities Capital expenditures Proceeds from sale of property, plant, and equipment Capitalized software Acquisition spending, net of cash acquired Additional purchase consideration Short-term investments – net Purchase of long-term investments Sales or maturities of long-term investments Other – net Net cash ﬂows from (to) investing activities Net Cash Flows From (To) Financing Activities Purchase of HNI Corporation common stock Proceeds from long-term debt Payments of note and long-term debt and other ﬁnancing Proceeds from sale of HNI Corporation common stock Dividends paid Net cash ﬂows from (to) ﬁnancing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental Disclosures of Cash Flow Information Cash paid during the year for: Interest Income taxes The accompanying notes are an integral part of the consolidated ﬁnancial statements. 65,514 2,002 (8,933) 1,029 6,199 1,664 (25,654) (10,488) (4,207) 36,809 (5,534) 5,188 201,009 (38,912) 317 (2,890) (33,804) – 2,400 (34,495) 32,505 (68) (74,947) (202,217) 199,000 (57,970) 14,997 (33,841) (80,031) 46,031 29,676 66,703 1,874 708 1,394 5,990 1,947 (26,960) (9,409) (145) 25,990 846 11,736 72,772 2,166 (3,314) 5,415 4,678 391 1,006 (3,004) 1,508 (35,288) 2,218 (5,379) 194,256 141,274 (32,417) 2,968 (3,383) (134,848) – 60,949 (24,496) 16,858 (350) (114,719) (145,604) – (26,795) 15,579 (32,023) (188,843) (109,306) 138,982 (34,842) 1,808 (2,666) – (5,710) (49,326) (5,742) 15,000 – (81,478) (21,512) 761 (20,992) 12,063 (30,299) (59,979) (183) 139,165 $138,982 $÷«75,707 $÷«29,676 $÷÷«1,961 $÷«88,133 $÷÷÷÷883 $÷«59,938 $÷÷3,408 $÷53,855 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Nature of Operations HNI Corporation (formerly HON INDUSTRIES Inc.) with its subsidiaries (the “Corporation”), is a provider of ofﬁce furniture and hearth products. Both industries are reportable segments; however, the Corporation’s ofﬁce furniture business is its principal line of business. Refer to the Operating Segment Information note for further information. Ofﬁce furniture products are sold through a national system of dealers, wholesalers, retail superstores, and to end-user customers, and federal and state governments. Dealer, wholesaler, and retail superstores are the major channels based on sales. Hearth products include wood- and gas-burning factory-built ﬁreplaces, pellet and electric hearth appliances, ﬁreplace inserts, stoves, gas logs, and accessories. These products are sold through a national system of dealers, wholesalers, large regional contractors, as well as Corporation-owned distribution and retail outlets. The Corporation’s products are marketed predominantly in the United States and Canada. The Corporation exports select products to a limited number of markets outside North America, principally Latin America and the Caribbean, through its export subsidiary; however, based on sales, these activities are not signiﬁcant. Summary of Signiﬁcant Accounting Policies PR I N C I PLES O F C O N SO L I DAT I O N AN D F I SCAL Y E A R - E N D The consolidated ﬁnancial statements include the accounts and transactions of the Corporation and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. The Corporation follows a 52/53 week ﬁscal year which ends on the Saturday nearest December 31. Fiscal year 2005 ended on December 31, 2005; 2004 ended on January 1, 2005; and 2003 ended on January 3, 2004. The ﬁnancial statements for ﬁscal year 2003 are based on a 53-week period, and ﬁscal years 2005 and 2004 are on a 52-week basis. CAS H, CAS H EQU I VALE N TS, AN D I N VEST M E N T S Cash and cash equivalents generally consist of cash, money market accounts, and debt securities. These securities have original maturity dates not exceeding three months from date of purchase. The Corporation has short-term investments with maturities of less than one year and also has investments with maturities greater than one year that are included in Other Assets on the Consolidated Balance Sheet. Management classiﬁes investments in marketable securities at the time of purchase and reevaluates such classiﬁcation at each balance sheet date. Equity securities are classiﬁed as available-for- sale and are stated at current market value with unrealized gains and losses included as a separate component of equity, net of any related tax effect. Debt securities are classiﬁed as held-to-maturity and are stated at amortized cost. The speciﬁc identiﬁcation method is used to determine realized gains and losses on the trade date. Short-term investments include municipal bonds, money market preferred stock, and U.S. treasury notes. Long-term investments include U.S. government securities, municipal bonds, certiﬁcates of deposit, and asset-and mortgage-backed securities. During 2004, the Corporation sold all of its available-for-sale securities to fund acquisitions and to move its investments to a Master Fund. The Corporation realized 38 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT losses of approximately $0.8 million. This investment was excluded from the scope of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” due to the fact that the investment’s per unit value in a Master Fund was not readily available. Therefore, this investment was recorded at cost. The weighted average cost method was used to determine realized gains and losses on the trade date. During 2005, the Corporation liquidated this Master Fund investment and subsequently invested in an investment fund that is also excluded from the scope of SFAS No. 115; however, the Corporation’s ownership in this investment fund is such that the underlying investments are recorded at fair market value. At December 31, 2005, January 1, 2005, and January 3, 2004, cash, cash equivalents, and investments consisted of the following (cost approximates market value): Year-End 2005 (In thousands) Held-to-maturity securities Certiﬁcates of deposit Cash and Cash Equivalents Short-term Investments Long-term Investments $÷÷÷÷«– $÷÷÷«– $÷÷«400 Investment in Master Fund – 9,035 19,085 Cash and money market accounts 75,707 – – Total $75,707 $9,035 $19,485 Year-End 2004 (In thousands) Held-to-maturity securities Municipal bonds Certiﬁcates of deposit Investment in Master Fund Cash and Cash Equivalents Short-term Investments Long-term Investments $÷÷÷÷«– $2,400 $÷÷÷÷«– – – – 400 4,436 20,187 Cash and money market accounts 29,676 – – Total $29,676 $6,836 $20,587 Year-End 2003 (In thousands) Held-to-maturity securities Municipal bonds U.S. government securities Certiﬁcates of deposit Available-for-sale securities U.S. treasury notes Asset and mortgage-backed securities Cash and Cash Equivalents Short-term Investments Long-term Investments $÷31,000 $÷÷÷÷«– $÷2,396 – – – – – – 4,259 – 400 – 60,949 12,835 Cash and money market accounts 107,982 – – Total $138,982 $65,208 $15,631 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS R EC E I VAB LES Accounts receivable are presented net of an allowance for doubtful accounts of $12.0 million, $11.4 million, and $10.9 million, for 2005, 2004, and 2003, respectively. The allowance is developed based on several factors including overall customer credit quality, historical write-off experience and speciﬁc account analyses that project the ultimate collectibility of the account. As such, these factors may change over time causing the reserve level to adjust accordingly. I N VE N TO R I ES The Corporation valued 90%, 80%, and 96% of its inventory by the last-in, ﬁrst-out (LIFO) method at December 31, 2005, January 1, 2005, and January 3, 2004, respectively. Additionally, the Corporation evaluates its inventory reserves in terms of excess and obsolete exposures. This evaluation includes such factors as anticipated usage, inventory turnover, inventory levels, and ultimate product sales value. As such, these factors may change over time causing the reserve level to adjust accordingly. The reserves for excess and obsolete inventory were $8.2 million, $7.7 million, and $5.7 million, at year- end 2005, 2004, and 2003, respectively. PRO PE R T Y, PL AN T, AN D EQU I PM E N T 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. LO N G - L I VE D AS SE T S Long-lived assets are reviewed for impairment as events or changes in circumstances occur indicating that the amount of the asset reﬂected in the Corporation’s balance sheet may not be recoverable. An estimate of undiscounted cash ﬂows produced by the asset, or the appropriate group of assets, is compared to the carrying value to determine whether impairment exists. The estimates of future cash ﬂows involve considerable management judgment and are based upon assumptions about expected future operating performance. The actual cash ﬂows could differ from management’s estimates due to changes in business conditions, operating performance, and economic conditions. Asset impairment charges recorded in connection with the Corporation’s restructuring activities are discussed in the Restructuring Related Charges note. These assets included real estate, manufacturing equipment, and certain other ﬁxed assets. The Corporation’s continuous focus on improving the manufacturing process tends to increase the likelihood of assets being replaced; therefore, the Corporation is constantly evaluating the expected lives of its equipment and accelerating depreciation where appropriate. GOO DW I LL AN D OT H E R I N TAN G I B LE AS SE TS In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), the Corporation evaluates its goodwill for impairment on an annual basis based on values at the end of third quarter or whenever indicators of impairment exist. The Corporation has evaluated its goodwill for impairment and has determined that the fair value of reporting units exceeds their carrying value, so no impairment 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 forecasted today. The Corporation also determines the fair value of indeﬁnite lived trade names on an annual basis or whenever indications of impairment exist. The Corporation has evaluated its trade names for impairment and recognized an impairment charge of $0.5 million in 2005 related to two trademarks where the carrying value exceeded the fair market value. PRO DUC T WA R R AN T I ES The Corporation 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 in design, materials, or workmanship. A warranty reserve is determined by recording a speciﬁc reserve for known warranty issues and an additional reserve for unknown claims that are expected to be incurred based on historical claims experience. Actual claims incurred could differ from the original estimates, requiring adjustments to the reserve. Activity associated with warranty obligations was as follows: (In thousands) 2005 2004 2003 Balance at the beginning of the period $10,794 $÷«8,926 $«8,405 Accrual assumed from acquisition – 688 – Accruals for warranties issued during the period 9,809 10,486 7,907 Accrual related to pre-existing warranties Settlements made during the period 1,449 (11,895) 1,054 (10,360) 629 (8,015) Balance at the end of the period $10,157 $«10,794 $«8,926 R E V E N UE R EC 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 reduction to net sales. Marketing program accruals require the use of management estimates and the consideration of contractual arrangements that are subject to interpretation. Customer sales that reach certain award levels can affect the amount of such estimates, and actual results could differ from these estimates. PRO DUC T DE VE LO PM E N T C OST S Product development costs relating to the development of new products and processes, including signiﬁcant improvements and reﬁnements to existing products, are expensed as incurred. These costs include salaries, contractor fees, building costs, utilities, and administrative fees. The amounts charged against income were $27.3 million in 2005, $27.4 million in 2004, and $24.0 million in 2003. STO C K- BASE D C O M PE N SAT I O N The Corporation accounts for its stock option plan using Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” whereby stock-based employee compensation is reﬂected 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 the grant. SFAS No. 123, “Accounting for Stock-Based Compensation,” issued subsequent to APB No. 25 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition 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 Corporation had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock- Based Compensation,” as amended by SFAS No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure,” to stock-based employee compensation. (In thousands, except for per share data) 2005 2004 Net income, as reported $137.4 $113.6 Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects (1.8) (5.0) Pro forma net income $135.6 $108.6 Earnings per share: Basic – as reported Basic – pro forma Diluted – as reported Diluted – pro forma $÷2.51 $÷2.48 $÷2.50 $÷2.47 $÷1.99 $÷1.90 $÷1.97 $÷1.89 2003 $98.1 (3.0) $95.1 $1.69 $1.64 $1.68 $1.62 Increase in expense in 2004 and 2003 is due to accelerated vesting upon the retirement of plan participants. I N C O M E TA XES The Corporation accounts for income taxes under SFAS No. 109, “Accounting for Income Taxes.” This Statement uses an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Corporation’s ﬁnancial statements or tax returns. Deferred income taxes are provided to reﬂect the differences between the tax bases of assets and liabilities and their reported amounts in the ﬁnancial statements. E A R N I N GS PE R S H A R E Basic earnings per share are based on the weighted-average number of common shares outstanding during the year. Shares potentially issuable under options and deferred restricted stock have been considered outstanding for purposes of the diluted earnings per share calculation. USE O F EST I M ATES The preparation of ﬁnancial statements in conformity with accounting principles generally accepted in the United States requires management 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, marketing 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. SE LF - I N SU R AN C E The Corporation is partially self-insured for general, auto, and product liability, workers’ compensation, and certain employee health beneﬁts. The general, auto, product, and workers’ compensation liabilities are managed using a wholly owned insurance captive; the related liabilities are included in the accompanying consolidated ﬁnancial statements. The Corporation’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 legal actions, medical cost inﬂation, and magnitude of change in actual experience development could cause these estimates to change in the near term. F O R E I G N C U R R E N CY T R AN S L AT I O N S Foreign currency ﬁnancial statements of foreign operations where the local currency is the functional currency are translated using exchange rates in effect at period end for assets and liabilities and average exchange rates during the period for results of operations. Related translation adjustments are reported as a component of Shareholders’ Equity. Gains and losses on foreign currency transactions are included in the “Selling and administrative expenses” caption of the Consolidated Statements of Income. R EC L AS S I F I CAT I O N S Certain reclassiﬁcations have been made within the footnotes to conform to current year presentation. There have been no reclassiﬁcations on the primary ﬁnancial statements. R EC E N T AC C OUN T I N G PRO N OUN C E M E N T S In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an Interpretation of FASB Statement No. 142” (“FIN 47”). Under FIN 47, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Any uncertainty about the amount and/or timing of future settlement should be factored into the measurement of the liability when sufﬁcient information exists. FIN 47 also clariﬁes when an entity would have sufﬁcient information to reasonably estimate the fair value. The Corporation adopted FIN 47 during the fourth quarter of 2005, and it did not have an impact on the Corporation’s ﬁnancial statements. In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”). SFAS No. 123(R) replaces SFAS No. 123, “Accounting for Stock- Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the ﬁnancial statements over the period that an employee provides service in exchange for the award. Public companies are required to adopt the new standard using a modiﬁed prospective method and may elect to restate prior periods using the modiﬁed retrospective method. Under the modiﬁed prospective method, companies are required to record compensation cost for new and modiﬁed awards over the related vesting period of such awards prospectively and record compensation cost prospectively for the unvested portion, at the date of adoption, 4 0 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of previously issued and outstanding awards over the remaining vesting period of such awards. No change to prior periods presented is permitted under the modiﬁed prospective method. Under the modiﬁed retrospective method, companies record compensation costs for prior periods retroactively through restatement of such periods using the exact pro forma amounts disclosed in the companies’ footnotes. Also, in the period of adoption and after, companies record compensation based on the modiﬁed prospective method. SFAS No. 123(R) is effective beginning with the ﬁrst annual ﬁscal period after June 15, 2005. The Corporation plans to adopt SFAS No. 123(R) on January 1, 2006, the beginning of its ﬁscal year and to use the modiﬁed prospective method. Based on adopting SFAS No. 123(R) on January 1, 2006, and using the modiﬁed prospective method, the Corporation estimates that total stock- based compensation expense will be approximately $3.5 million for the year-ending December 30, 2006. In November 2004, the Financial Accounting Standards Board issued SFAS No. 151, “Inventory Costs.” SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of ﬁxed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for ﬁscal years beginning after June 15, 2005. The Corporation intends to adopt SFAS No. 151 on January 1, 2006, the beginning of its 2006 ﬁscal year. The adoption of SFAS No. 151 is not expected to have a material impact on the Corporation’s ﬁnancial statements. Restructuring Related Charges As a result of the Corporation’s ongoing business simpliﬁcation and cost reduction strategies the Corporation began the shutdown of two ofﬁce furniture facilities in third quarter 2005. The Corporation will close plants in Kent, Washington, and Van Nuys, California, and consolidate production into other U.S. manufacturing locations. In connection with the shutdowns, the Corporation recorded $4.1 million of pre-tax charges during 2005. These charges included $0.6 million of accelerated depreciation of machinery and equipment recorded in cost of sales, $1.2 million of severance, $0.4 million of pension related expenses, and $1.9 million of factory exit, production relocation, and other costs which were recorded as restructuring costs. The closures and consolidation will be completed during the ﬁrst quarter of 2006. During 2003, the Corporation closed two ofﬁce furniture facilities located in Milan, Tennessee, and Hazleton, Pennsylvania, and consolidated production into other U.S. manufacturing locations. Charges for the closures during 2003 totaled $15.7 million, which consisted of $6.7 million of accelerated depreciation of machinery and equipment which was recorded in cost of sales, $3.4 million of severance, and $5.6 million of facility exit, production relocation, and other costs which were recorded as restructuring costs. A total of 316 members were terminated and received severance due to these shutdowns. In connection with those shutdowns, the Corporation incurred $1.2 million of current period charges during 2004. The Corporation also reduced the restructuring charge recorded in 2003 by approximately $0.3 million related to its Milan, Tennessee, facility during 2004. The reduction was due to the fact that the Corporation was able to exit a lease with the lessor at more favorable terms than previously estimated. The closures and consolidation are complete. During 2002, the Corporation 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 was taken back into income relating to this charge. This was due to the fact that the Corporation was able to exit a lease with the lessor at more favorable terms than previously estimated. The following table summarizes the restructuring accrual activity since the beginning of ﬁscal 2003. This summary does not include the effect of the Corporation’s employee retirement plans in 2005, as this item was not accounted for through the restructuring accrual on the Consolidated Balance Sheets but is included as a component of “Restructuring Related Charges” in the Consolidated Statements of Operations. (In thousands) Restructuring reserve at December 28, 2002 Restructuring charges Restructuring credit Cash payments Restructuring reserve at January 3, 2004 Restructuring charges Restructuring credit Cash payments Restructuring reserve at January 1, 2005 Restructuring charges Cash payments Restructuring reserve at December 31, 2005 Facility Termination and Other Costs Total $«2,187 $«2,187 5,622 (550) (6,159) 9,060 (550) (9,263) Severance Costs $÷÷÷÷– 3,438 – (3,104) $÷÷334 $«1,100 $«1,434 42 (31) (345) 1,147 (272) (1,975) 1,189 (303) (2,320) $÷÷÷÷– $÷÷÷÷– $÷÷÷÷– 1,142 (325) 1,876 (632) 3,018 (957) $÷÷817 $«1,244 $«2,061 Business Combinations The Corporation completed the acquisition of four small ofﬁce furniture services companies, three ofﬁce furniture dealers, and three small hearth distributors during 2005. The combined purchase price of these acquisitions totaled $35.4 million, of which $33.4 million was paid in cash and the remaining is due to the sellers over the next several years. The Corporation acquired controlling interests in the three ofﬁce furniture dealers and the ability to call the remaining interests on or after ﬁscal year-end 2008 and 2010. The Corporation HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS must exercise its calls on or before the end of ﬁscal 2014 and 2015. SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 150”), requires a mandatorily redeemable ﬁnancial instrument to be classiﬁed as a liability unless the redemption is required to occur only upon the liquidation or termination of the reporting entity. It also requires that mandatorily redeemable ﬁnancial instruments be measured at fair value. Therefore, the Corporation has recorded a liability for the remaining interest at fair value at the acquisition date. The Corporation has ﬁnalized the allocation of the purchase price for all acquisitions other than those completed in the ﬁnal quarter of the year. Any modiﬁcation is not expected to be signiﬁcant. There are approximately $14.1 million of intangibles associated with these acquisitions. Of these acquired intangible assets, $1.5 million was assigned to indeﬁnite-lived trade names that are not subject to amortization. The remaining $12.6 million have estimated useful lives ranging from two to ﬁfteen years with amortization recorded based on the projected cash ﬂow associated with the respective intangible assets’ existing relationships. There is approximately $17.0 million of goodwill associated with these acquisitions, of which $11.8 million was assigned to the furniture segment and $5.2 million was assigned to the hearth products segment. Approximately $1.8 million of the goodwill assigned to the furniture segment is not deductible for tax purposes. On January 5, 2004, the Corporation acquired certain assets of Paoli Inc., a subsidiary of Klaussner Furniture Industries, Inc. for $81.1 million. Paoli Inc. is a leading provider of wood case goods and seating with well-known brands, broad product offering, and strong independent representatives sales and dealer networks located in Orleans, Indiana. The Corporation acquired $26.3 million of intangible assets from the Paoli acquisition, of which $18.3 million was assigned to registered trademarks that are not subject to amortization. The remaining $8.0 million of acquired intangible assets have a weighted-average useful life of approximately 15 years with amortization recorded based on the projected cash ﬂow associated with the respective intangible assets existing relationships. The $9.2 million of goodwill was assigned to the ofﬁce furniture segment and is deductible for income tax purposes. Assuming the acquisition of Paoli Inc. had occurred on December 29, 2002, the beginning of the Corporation’s 2003 ﬁscal year, instead of the actual date reported above, the Corporation’s unaudited pro forma consolidated net sales would have been approximately $1.9 billion. Unaudited pro forma consolidated net income would have been $103.8 million or $1.77 per diluted share. Pro forma results are not shown for the remaining acquisitions as they were deemed immaterial by management. On July 6, 2004, the Corporation acquired a controlling interest in Omni Workspace Company (formerly Omni Remanufacturing, Inc.). Omni Workspace Company is comprised of two divisions – IntraSpec Solutions, a panel systems re-manufacturer, and Omni Service Group (formerly A&M Business Interior Services), an ofﬁce furniture services company. The Corporation acquired 80 percent of the common stock of Omni Workspace Company and the ability to call the remaining 20 percent of the shares on or after the ﬁscal year end 2009. The Corporation must exercise its call on or before the end of ﬁscal year end 2014. SFAS No. 150 requires a mandatorily redeemable ﬁnancial instrument to be classiﬁed as a liability unless the redemption is required to occur only upon the liquidation or termination of the reporting entity. It also requires that mandatorily redeemable ﬁnancial instruments be measured at fair value. Therefore, the Corporation has recorded a liability at the acquisition date for the remaining 20 percent of the shares at fair value. The Corporation continues to monitor and adjust the recorded amount to accrete the obligation to the estimated redemption amount in 2014 through a charge to earnings as required. The Corporation acquired $12.7 million of intangible assets from the Omni acquisition, of which $2.8 million was assigned to registered trademarks that are not subject to amortization. The Corporation did recognize an impairment charge of $0.5 million in 2005 on two of the trademarks due to the carrying value exceeding the current fair market value. The remaining $9.9 million of acquired intangible assets have a weighted-average useful life of approximately 9 years with amortization recorded based on the projected cash ﬂow associated with the respective intangible assets existing relationships. The $12.0 million of goodwill was assigned to the ofﬁce furniture segment and is not deductible for income tax purposes. On July 19, 2004, the Corporation acquired Edward George Company, a distributor of ﬁreplaces, stone products, barbecues, and other building materials throughout Illinois, Indiana, and Kentucky, and its afﬁliate, Wisconsin Fireplace Systems, with locations in Wisconsin for $27.7 million. The acquired intangible assets from the Edward George acquisition of $9.3 million have a weighted-average useful life of approximately 13 years with amortization recorded based on the projected cash ﬂow associated with the respective intangible assets existing relationships. The $9.6 million of goodwill was assigned to the hearth products segment and is deductible for income tax purposes. The consideration for each of these transactions was paid in cash. The results of the acquired entities have been included in the Consolidated Financial Statements since the date of acquisition. The Corporation also completed the acquisition of a small ofﬁce furniture services company, a small hearth distributor, and a strategic sourcing entity during 2004. The combined purchase price for these acquisitions totaled approximately $8.5 million. There is approximately $5.4 million of intangibles associated with these acquisitions with estimated useful lives ranging from one to ten years. There is approximately $2.2 million of goodwill associated with these acquisitions of which $0.9 million was assigned to the ofﬁce furniture segment and $1.3 million was assigned to the hearth products segment. All goodwill is deductible for income tax purposes. 42 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Inventories (In thousands) Finished products Materials and work in process LIFO reserve 2005 2004 2003 $«61,027 $«52,796 $«31,407 46,398 (16,315) 40,712 (15,918) 28,287 (9,864) $«91,110 $«77,590 $«49,830 Property, Plant, and Equipment (In thousands) 2005 2004 2003 Land and land improvements $÷26,361 $÷26,042 $÷23,065 Buildings Machinery and equipment Construction and equipment installation in progress Less: allowances for depreciation 240,174 523,240 234,421 512,544 211,005 495,901 23,976 13,686 9,865 813,751 519,091 786,693 475,349 739,836 427,468 The changes in the carrying amount of goodwill since December 28, 2002 are as follows by reporting segment: (In thousands) Ofﬁce Furniture Hearth Products Total 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 Goodwill increase during period 21,920 10,548 32,468 Balance as of January 1, 2005 $65,531 $159,023 $224,554 Goodwill increase during period 12,128 5,562 17,690 Balance as of December 31, 2005 $77,659 $164,585 $242,244 The decrease in goodwill in 2003 is due to an adjustment relating to a prior acquisition. The goodwill increases in 2004 and 2005 relate to acquisitions completed. See Business Combinations note. $294,660 $311,344 $312,368 Accounts Payable and Accrued Expenses Goodwill and Other Intangible Assets Pursuant to Statement of Financial Accounting Standards (SFAS) No. 142, the Corporation evaluates its goodwill for impairment on an annual basis based on values at the end of third quarter or whenever indicators of impairment exist. The Corporation has evaluated its goodwill 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. The Corporation also owns trademarks having a net value of $30.2 million as of December 31, 2005, $29.2 million as of January 1, 2005, and $8.1 million as of January 3, 2004. The trademarks are deemed to have an indeﬁnite useful life because they are expected to generate cash ﬂow indeﬁnitely. The Corporation recorded an impairment charge of $0.5 million in 2005 related to two ofﬁce furniture trademarks where the carrying amount exceeded the current fair market value. The charge was included in selling and administrative expenses on the Consolidated Statements of Income. The table below summarizes amortizable deﬁnite-lived intangible assets, which are reﬂected in Other Assets in the Corporation’s consolidated balance sheets: (In thousands) 2005 2004 2003 Trade accounts payable $÷86,945 $÷64,319 $÷42,048 Compensation Proﬁt sharing and retirement expense Vacation pay Marketing expenses Other accrued expenses 34,272 32,461 14,230 54,797 85,247 25,722 30,516 13,095 50,939 69,367 22,803 30,365 13,745 44,795 57,480 $307,952 $253,958 $211,236 Long-Term Debt (In thousands) 2005 2004 2003 Note payable to bank, revolving credit agreement with interest at a variable rate Industrial development revenue bonds, various issues, payable through 2018 with interest at 1.40–3.62% per annum Convertible debentures payable to individuals, with interest at 5.5% per annum Other notes and amounts Total debt $140,000 $÷÷÷«– $÷÷÷«– 2,300 2,300 2,300 – 900 143,200 40,150 – 560 2,860 233 26,130 503 28,933 26,243 (In thousands) Patents Customer lists and other Less: accumulated amortization 2005 2004 2003 Less: current portion $18,480 67,211 28,758 $18,820 $16,450 54,702 21,785 26,076 16,671 Long-term debt $103,050 $2,627 $÷2,690 Aggregate maturities of long-term debt are as follows: Net intangible assets $56,933 $51,737 $25,855 Amortization expense for deﬁnite-lived intangibles for 2005, 2004, and 2003, was $7.3 million, $5.1 million, and $2.7 million, respectively. Amortization expense is estimated to range between $4.5 and $7.5 million per year over the next ﬁve years. (In thousands) 2006 2007 2008 2009 2010 Thereafter $÷40,150 500 250 – – $102,300 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 4 3 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On January 28, 2005, the Corporation replaced a $136 million revolving credit facility entered into on May 10, 2002 with a new revolving credit facility that provided for a maximum borrowing of $150 million subject to increase (to a maximum amount of $300 million) or reduction from time to time according to the terms of the agreement. On December 22, 2005, the Corporation increased the facility to the maximum amount of $300 million. Amounts borrowed under the Credit Agreement may be borrowed, repaid, and reborrowed from time to time until January 28, 2011. The convertible debentures were payable to the former owners of businesses that were acquired by the Corporation. Following the acquisition some of these individuals continued as members of the Corporation. The convertible debentures were convertible into cash. The debentures contained certain conversion features that are recorded as earned. During 2003, the Corporation recorded approximately $3 million of appreciation on these debentures. Certain of the above borrowing arrangements include covenants which limit the assumption of additional debt and lease obligations. The Corporation has been and currently is in compliance with the covenants related to these debt agreements. The fair value of the Corporation’s outstanding long-term debt obligations at year-end 2005 approximates the recorded aggregate amount. Selling and Administrative Expenses (In thousands) 2005 2004 2003 Freight expense for shipments to customers Amortization of intangible and other assets Product development costs Other selling and administrative expenses $159,189 $132,866 $105,933 10,642 27,338 8,521 27,401 4,625 24,021 471,741 403,218 346,165 $668,910 $572,006 $480,744 A reconciliation of the statutory federal income tax rate to the Corporation’s effective income tax rate is as follows: Federal statutory tax rate State taxes, net of federal tax effect Deduction related to domestic production activities Credit for increasing research activities Extraterritorial income exclusion Other – net Effective tax rate 2005 35.0«% 2.4« (0.9)« (0.4)« (0.3)« 0.2« 36.0«% 2004 35.0«% 2.2« –« (0.6)« (0.3)« 0.2« 2003 35.0«% 1.8« –« (2.0)« (0.5)« 0.7« 36.5«% 35.0«% Deferred income taxes reﬂect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for ﬁnancial reporting purposes and the amounts used for income tax purposes. Signiﬁcant components of the Corporation’s deferred tax liabilities and assets are as follows: (In thousands) 2005 2004 2003 Net long-term deferred tax liabilities: Tax over book depreciation $(16,458) $(25,549) $(28,103) Compensation Goodwill Other – net Total net long-term deferred tax liabilities Net current deferred tax assets: Allowance for doubtful accounts Vacation accrual Inventory differences Deferred income Warranty accruals Other – net 5,907 (30,499) 5,577 5,697 (24,362) (1,660) 4,912 (18,044) 3,502 (35,473) (42,554) (37,733) 3,858 4,924 5,720 (6,596) 3,847 4,078 3,512 4,588 4,304 (6,238) 3,504 4,969 1,913 4,754 4,343 (5,462) 2,886 5,895 Total net current deferred tax assets 15,831 14,639 14,329 Net deferred tax (liabilities) assets $(19,642) $(27,915) $(23,404) Income Taxes Signiﬁcant components of the provision for income taxes excluding tax allocated to minority interest are as follows: (In thousands) Current: Federal State 2005 2004 2003 $77,474 8,954 $60,425 $49,721 5,976 4,159 Shareholders’ Equity and Earnings Per Share Common Stock, $1 Par Value Authorized Issued and outstanding Preferred Stock, $1 Par Value 2005 2004 2003 200,000,000 200,000,000 200,000,000 58,238,519 55,303,323 51,848,591 Authorized 2,000,000 2,000,000 2,000,000 Current provision 86,428 66,401 53,880 Issued and outstanding – – – Deferred: Federal State Deferred provision (8,048) (1,081) (9,129) (1,008) (106) (1,114) (973) (81) (1,054) $77,299 $65,287 $52,826 The Corporation purchased 4,059,068; 3,641,400; and 762,300 shares of its common stock during 2005, 2004, and 2003, 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. 4 4 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table reconciles the numerators and denominators used in the calculation of basic and diluted earnings per share (EPS): 2005 2004 2003 Cash dividends declared and paid per share for each year are: (In dollars) Common shares 2005 $.62 2004 $.56 2003 $.52 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 $137,420,000 $113,582,000 $98,105,000 54,649,199 57,127,110 58,178,739 384,542 450,520 366,614 Denominator for diluted EPS 55,033,741 57,577,630 58,545,353 Earnings per share – basic Earnings per share – diluted $«÷÷÷÷÷÷2.51 $«÷÷÷÷÷÷1.99 $«÷÷÷÷÷÷2.50 $«÷÷÷÷÷÷1.97 $«÷÷÷÷÷1.69 $«÷÷÷÷÷1.68 Certain exercisable and non-exercisable stock options were not included in the computation of diluted EPS for ﬁscal year 2005, 2004, and 2003, 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 2005 was 2,500 with a per share exercise price of $52.91; for 2004 was 25,000 with a range of per share exercise prices of $42.15 to $42.98; and for 2003 was 20,000 with a range of per share exercise prices of $42.49 to $42.98. Components of other comprehensive income (loss) consist of the following: (In thousands) 2005 2004 2003 Foreign currency translation adjustments – net of tax Change in unrealized gains (losses) on marketable securities – net of tax Change in minimum pension liability – net of tax Other comprehensive income (loss) $«293 $348 $÷«45 – (310) $÷(17) 407 – (463) (227) $755 $(645) In May 1997, the Corporation registered 400,000 shares of its common stock under its 1997 Equity Plan for Non-Employee Directors. This plan permits the Corporation to issue to its non-employee directors options to purchase shares of Corporation common stock, restricted stock of the Corporation, and awards of Corporation common stock. The plan also permits non-employee directors to elect to receive all or a portion of their annual retainers and other compensation in the form of shares of Corporation common stock. During 2005, 2004, and 2003, 13,621; 10,738; and 10,922 shares of Corporation common stock were issued under the plan, respectively. During 2002, shareholders approved the 2002 Members’ Stock Purchase Plan. Under the plan, 800,000 shares of common stock were registered for issuance to participating members. Beginning on June 30, 2002, rights to purchase stock are granted on a quarterly 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 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 maximum fair value of $25,000 in any calendar year. During 2005, 77,410 shares of common stock were issued under the plan at an average price of $45.48. During 2004, 73,921 shares of common stock were issued under the plan at an average price of $34.96. During 2003, 79,237 shares of common stock were issued under the plan at an average price of $29.25. An additional 522,013 shares were available for issuance under the plan at December 31, 2005. The Corporation has a shareholders’ rights plan which will expire August 20, 2008. The plan becomes operative if certain events occur involving the acquisition of 20% or more of the Corporation’s common stock by any person or group in a transaction not approved by the Corporation’s Board of Directors. Upon the occurrence of such an event, each right entitles its holder to purchase an amount of common stock of the Corporation with a market value of $400 for $200, unless the Board authorizes the rights be redeemed. The rights may be redeemed for $0.01 per right at any time before the rights become exercisable. In certain instances, the right to purchase applies to the capital stock of the acquirer instead of the common stock of the Corporation. The Corporation has reserved preferred shares necessary for issuance should the rights be exercised. The Corporation has entered into change in control employment agreements with corporate ofﬁcers and certain other key employees. According to the agreements, a change in control occurs when a third person or entity becomes the beneﬁcial owner of 20% or more of the Corporation’s common stock or when more than one-third of the Corporation’s Board of Directors is composed of persons not recommended by at least three-fourths of the incumbent Board of Directors. Upon a change in control, a key employee is deemed to have a two-year employment with the Corporation, and all his or her beneﬁts are vested under the Corporation plans. If, at any time within two years of the change in control, his or her position, salary, bonus, place of work, or Corporation-provided beneﬁts are modiﬁed, or employment is terminated by the Corporation 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 and the average of the prior two years’ bonuses. HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Stock-Based Compensation Under the Corporation’s 1995 Stock-Based Compensation Plan, as amended and restated effective November 10, 2000, the Corporation may award options to purchase shares of the Corporation’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 Corporation’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 2005, 2004, and 2003, estimated on the date of grant using the Black- Scholes option-pricing model, was $15.74, $17.70, and $10.74, respectively. The fair value of 2005, 2004, and 2003, options granted is estimated on the date of grant using the following assumptions: dividend yield of 1.2% to 2.0%, expected volatility of 31.8% to 35.1%, risk-free interest rate of 4.2% to 4.8%, and an expected life of 7 to 10 years. The status of the Corporation’s stock option plans is summarized below: Number of Shares Weighted-Average Exercise Price Outstanding at December 28, 2002 Granted Exercised Forfeited Outstanding at January 3, 2004 Granted Exercised Forfeited Outstanding at January 1, 2005 Granted Exercised Forfeited Outstanding at December 31, 2005 Options exercisable at: December 31, 2005 January 1, 2005 January 3, 2004 1,403,250 446,500 (362,000) (18,500) 1,469,250 340,900 (448,500) (53,200) 1,308,450 175,800 (331,500) (24,100) 1,128,650 433,250 604,750 202,250 $23.03 26.78 23.10 23.57 $24.15 39.59 22.33 27.61 $28.65 42.81 25.14 30.95 $31.84 $23.00 27.56 25.47 The following table summarizes information about ﬁxed stock options outstanding at December 31, 2005: Options Outstanding Options Exercisable Range of Exercise Prices Number Outstanding Weighted- Average Remaining Contractual Life Weighted- Average Exercise Price Number Exercisable at December 31, 2005 $24.50 $32.22 $23.47 $18.31–$26.69 $23.32 $25.75–$25.77 $25.50–$42.98 $37.57–$42.15 $42.66–$52.91 7,000 3,000 49,750 132,500 69,500 139,000 227,500 328,500 171,900 1.4 years 2.1 years 3.1 years 4.6 years 5.1 years 6.1 years 7.2 years 8.2 years 9.2 years $24.50 $32.22 $23.47 $19.89 $23.32 $25.77 $27.70 $39.58 $42.81 7,000 3,000 49,750 132,500 69,500 11,000 7,000 153,500 – Retirement Beneﬁts The Corporation has deﬁned contribution proﬁt-sharing plans covering substantially all employees who are not participants in certain deﬁned beneﬁt plans. The Corporation’s annual contribution to the deﬁned contribution plans is based on employee eligible earnings and results of operations and amounted to $27.4 million, $27.3 million, and $26.5 million, in 2005, 2004, and 2003, respectively. The Corporation sponsors deﬁned beneﬁt plans which include a limited number of salaried and hourly employees at certain subsidiaries. The Corporation’s funding policy is generally to contribute annually the minimum actuarially computed amount. Net pension costs relating to these plans were $653,000, $0, and $176,000 in 2005, 2004, and 2003, respectively. The increase in 2005 is due to a plan curtailment resulting from the shutdown of an ofﬁce furniture facility in Van Nuys, California. The actuarial present value of obligations, less related plan assets at fair value, is not signiﬁcant. The Corporation also participates in a multi-employer plan, which provides deﬁned beneﬁts to certain of the Corporation’s union employees. Pension expense for this plan amounted to $353,000, $322,000, and $309,000, in 2005, 2004, and 2003, respectively. 4 6 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Postretirement Health Care In accordance with the guidelines of revised SFAS No.132, “Disclosures about Pensions and other Postretirement Beneﬁts,” the following table sets forth the funded status of the plan, reconciled to the accrued postretirement beneﬁts cost recognized in the Corporation’s balance sheet at: (In thousands) 2005 2004 2003 Change in beneﬁt obligation Beneﬁt obligation at beginning of year Service cost Interest cost Beneﬁts paid Actuarial (gain) or loss $«18,958 $«18,331 $17,617 303 1,057 (1,503) 923 284 1,066 (1,780) 1,057 249 1,105 (1,206) 566 Beneﬁt obligation at end of year $«19,738 $18,958 $18,331 Change in plan assets Fair value at beginning of year $÷«8,777 $«10,250 $÷÷÷÷«– Actual return on assets Employer contributions Beneﬁts paid 300 8 112 195 (1,503) (1,780) – 11,456 (1,206) Fair value at end of year $÷«7,582 $÷«8,777 $10,250 Reconciliation of funded status Funded status $(12,156) $(10,181) $«(8,081) Unrecognized actuarial (gain) or loss 3,132 2,340 1,105 The Corporation invests these funds in high-grade money market instruments. Prior to 2003 the plan was not funded. The discount rates at ﬁscal year-end 2005, 2004, and 2003 were 5.5%, 5.75%, and 6.0%, respectively. The Corporation payment for these beneﬁts has reached the maximum amounts per the plan; therefore, healthcare trend rates have no impact on the Corporation’s cost. In December 2003, the United States enacted into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Modernization Act”). The Modernization Act established a prescription drug beneﬁt under Medicare, known as “Medicare Part D,” and a federal subsidy to sponsors of retiree health care beneﬁt plans that provide a beneﬁt that is at least actuarially equivalent to Medicare Part D. In May 2004, the FASB issued FASB Staff Position No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP 106-2”). The Corporation adopted FSP 106-2 on July 4, 2004. The Corporation has determined that the beneﬁts provided by the plan are not actuarially equivalent to the Medicare Part D beneﬁt under the Modernization Act based on the percentage of the cost of the plan that the Corporation provides. Therefore, the adoption of FSP 106-2 did not have an impact on the Corporation’s ﬁnancial statements during 2004. The Corporation will continue to monitor the effect as regulations evolve regarding actuarial equivalency. Unrecognized transition obligation or (asset) Unrecognized prior service cost 4,199 661 4,780 892 5,361 1,122 Leases Net amount recognized at year-end $÷(4,164) $÷(2,169) $÷÷(493) Amounts recognized in the statement of ﬁnancial position consist of: Accrued beneﬁt liability $÷(4,164) $÷(2,169) $÷÷(493) Net amount recognized at year-end, included in other liabilities $÷(4,164) $÷(2,169) $÷÷(493) Estimated future beneﬁt payments (in thousands) Fiscal 2006 Fiscal 2007 Fiscal 2008 Fiscal 2009 Fiscal 2010 Fiscal 2011–2015 $÷1,199 1,236 1,278 1,301 1,310 7,077 The Corporation leases certain warehouse, plant facilities, and equipment. Commitments for minimum rentals under non-cancelable leases at the end of 2005 are as follows: (In thousands) 2006 2007 2008 2009 2010 Thereafter Capitalized Leases Operating Leases $÷«284 $18,231 215 211 211 211 168 13,957 11,372 9,235 7,245 11,439 Total minimum lease payments $1,300 $71,479 Less: amount representing interest Expected contributions during ﬁscal 2006 Total Present value of net minimum lease payments, $÷÷÷÷÷0 including current maturities of $200 281 $1,019 Plan Assets – Percentage of Fair Value by Category 2005 2004 Property, plant, and equipment at year-end include the following amounts for capitalized leases: Equity Debt Other Total 0% 0% 100% 100% 0% 0% 100% 100% (In thousands) Buildings Machinery and equipment Ofﬁce equipment Less: allowances for depreciation 2005 2004 2003 $3,299 $3,299 $3,299 38 761 4,098 3,564 196 761 4,256 3,307 196 761 4,256 2,879 $÷«534 $÷«949 $1,377 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Rent expense for the years 2005, 2004, and 2003 amounted to approximately $19.5 million, $16.1 million, and $13.6 million, respectively. The Corporation has an operating lease for a production facility with annual rentals totaling approximately $362,000 with a corporation in which the minority owner of one of the Corporation’s consolidated subsidiaries is an investor. Contingent rent expense under both capitalized and operating leases (generally based on mileage of transportation equipment) amounted to $169,000, $241,000, and $313,000, for the years 2005, 2004, and 2003, respectively. Guarantees, Commitments and Contingencies During the second quarter ended June 28, 2003, the Corporation entered into a one-year ﬁnancial agreement for the beneﬁt of one of its distribution chain partners which was extended through August 31, 2005. During the third quarter of 2005 the Corporation paid $1.2 million associated with this guarantee. The Corporation expects to recover this amount through liquidations of secured collateral and settlements. As of December 31, 2005, the Corporation has recovered $0.9 million. The Corporation utilizes letters of credit in the amount of $23 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 competitively determined. The Corporation is contingently liable for future minimum payments totaling $4.3 million under a transportation service contract. The transportation agreement was for a three-year period ending May 1, 2005, with an automatic renewal provision for periods of one year. This contract was renewed. Either party may terminate the agreement upon 90 days’ written notice. The Corporation has contingent liabilities, which have arisen in the course of its business, including pending litigation, preferential payment claims in customer bankruptcies, environmental remediation, taxes, and other claims. On December 9, 2005, the Corporation settled a lawsuit, which sought approximately $7.6 million and arose out of the 2001 bankruptcy of a customer. The lawsuit alleged that the Corporation received preferential payments from the customer during the ninety days before the customer ﬁled for bankruptcy protection. The Corporation was named a critical vendor by the bankruptcy court and, accordingly, was paid in full for all outstanding receivables. The lawsuit was brought in February 2003 in the United States Bankruptcy Court for the District of Delaware. The Corporation settled all claims arising out of this lawsuit for a cash payment in the amount of $585,000. As a consequence of the settlement, the lawsuit was dismissed with prejudice on December 14, 2005. Signiﬁcant Customer One ofﬁce furniture customer accounted for approximately 12%, 13%, and 13% of consolidated net sales in 2005, 2004, and 2003, respectively. Operating Segment Information In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” management views the Corporation as being in two operating segments: ofﬁce furniture and hearth products, 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 products, 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 manufactured electric, gas-, pellet-, and wood-burning ﬁreplaces and stoves, ﬁreplace inserts, gas logs, and chimney systems principally for the home. The Corporation’s hearth products segment is somewhat seasonal with the third (July–September) and fourth (October–December) ﬁscal quarters historically having higher sales than the prior quarters. In ﬁscal 2005, 54% of consolidated net sales of hearth products were 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 Corporation’s corporate operations, interest income, and interest expense. Management views interest income and expense as corporate ﬁnancing costs and not as an operating segment cost. In addition, management applies an effective income tax rate to its consolidated income before income taxes so income taxes are not reported or viewed internally on a segment basis. Identiﬁable assets by segment are those assets applicable to the respective industry segments. Corporate assets consist principally of cash and cash equivalents, short-term investments, and corporate ofﬁce real estate and related equipment. No geographic information for revenues from external customers or for long-lived assets is disclosed since the Corporation’s primary market and capital investments are concentrated in the United States. 4 8 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Reportable segment data reconciled to the consolidated ﬁnancial statements for the years ended 2005, 2004, and 2003, is as follows: (In thousands) Net sales: Ofﬁce furniture Hearth products Operating proﬁt: Ofﬁce furniture(a) Hearth products Total operating proﬁt Unallocated corporate expenses 2005 2004 2003 $1,855,642 $1,570,777 $1,304,054 594,930 522,670 451,674 $2,450,572 $2,093,447 $1,755,728 $÷«176,321 $÷«154,896 $÷«130,080 74,822 62,158 54,433 251,143 (36,424) 217,054 (38,185) 184,513 (33,582) Income before income taxes $÷«214,719 $÷«178,869 $÷«150,931 Depreciation and amortization expense: Ofﬁce furniture Hearth products General corporate Capital expenditures: Ofﬁce furniture Hearth products General corporate Identiﬁable assets: Ofﬁce furniture Hearth products General corporate $÷÷«43,967 $÷÷«45,737 $÷÷«54,121 15,275 6,272 15,061 5,905 13,599 5,052 $÷÷«65,514 $÷÷«66,703 $÷÷«72,772 $÷÷«27,760 $÷÷«18,635 $÷÷«17,619 8,498 5,544 13,878 3,287 12,577 7,312 $÷÷«41,802 $÷÷«35,800 $÷÷«37,508 $÷«617,591 $÷«570,294 $÷«452,350 361,568 161,112 338,602 112,761 303,811 265,665 $1,140,271 $1,021,657 $1,021,826 (a) Included in operating proﬁt for the ofﬁce furniture segment are pretax charges of $3.5 million, $0.9 million, and $8.5 million, for closing of facilities and impairment charges in 2005, 2004, and 2003, respectively. Subsequent Event On January 13, 2006, the Corporation signed an agreement to purchase Lamex, a privately held Chinese manufacturer and marketer of ofﬁce furniture. Lamex operates primarily in China and Hong Kong, where as a market leader, it generates sales in excess of $70 million annually. The acquisition is expected to close in early 2006. The Corporation intends to make the purchase with cash and debt. Further details of the transaction will be included in the Corporation’s SEC Quarterly Report on Form 10-Q for the ﬁrst quarter ended April 1, 2006. HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Corporation’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 2005 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 Minority interest in earnings of subsidiary 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 2004 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 50 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT First Quarter Second Quarter Third Quarter Fourth Quarter $562,261 366,416 195,845 155,400 – 40,445 55 40,500 14,378 – $594,168 379,880 214,288 160,146 – 54,142 98 54,240 19,255 – $632,280 396,042 236,238 171,802 1,071 63,365 (498) 62,867 22,317 (11) $661,863 420,316 241,547 181,562 2,391 57,594 (492) 57,102 21,345 5 $÷26,122 $÷34,985 $÷40,561 $÷35,752 $÷÷÷÷.47 55,176 $÷÷÷÷.47 55,551 $÷÷÷÷.63 55,131 $÷÷÷÷.63 55,513 $÷÷÷÷.74 55,012 $÷÷÷÷.73 55,447 $÷÷÷÷.67 53,278 $÷÷÷÷.67 53,693 100.0% 34.8 27.6 – 7.2 2.6 4.6 $464,037 294,275 169,762 134,580 520 34,662 355 35,017 12,606 100.0% 36.1 27.0 – 9.1 3.2 5.9 $508,605 324,984 183,621 142,579 215 40,827 120 40,947 15,121 100.0% 37.4 27.2 0.2 10.0 3.5 6.4 $573,457 367,835 205,622 147,594 135 57,893 (29) 57,864 21,120 100.0% 36.5 27.4 0.4 8.7 3.2 5.4 $547,348 355,049 192,299 147,253 16 45,030 11 45,041 16,440 $÷22,411 $÷25,826 $÷36,744 $÷28,601 $÷÷÷÷.38 58,240 $÷÷÷÷.38 58,690 $÷÷÷÷.45 57,943 $÷÷÷÷.44 58,378 $÷÷÷÷.65 56,192 $÷÷÷÷.65 56,635 $÷÷÷÷.52 55,511 $÷÷÷÷.51 55,897 100.0% 36.6 29.0 0.1 7.5 2.7 4.8 100.0% 36.1 28.0 – 8.0 3.0 5.1 100.0% 35.9 25.7 – 10.1 3.7 6.4 100.0% 35.1 26.9 – 8.2 3.0 5.2 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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 Investor Information C O M M O N STO C K M A R K E T PR I C ES AN D D I V I DE N DS ( UN AU D I TE D ) QUA R TE R LY 20 0 5 –20 0 4 2005 by Quarter 1st 2nd 3rd 4th Total Dividends Paid 2004 by Quarter 1st 2nd 3rd 4th Total Dividends Paid High Low $45.70 $38.80 54.23 60.23 62.41 44.65 50.92 46.94 High Low $45.71 $35.25 42.42 42.13 43.65 36.56 36.97 38.52 Dividends per Share $.155 .155 .155 .155 $÷.62 Dividends per Share $.14 .14 .14 .14 $.56 First Quarter Second Quarter Third Quarter Fourth Quarter $391,971 252,841 139,130 114,426 – 24,704 (265) 24,439 8,554 $406,793 260,367 146,426 112,979 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% 35.5 29.2 – 6.3 2.2 4.1 100.0% 36.0 27.8 0.6 7.7 2.7 5.0 100.0% 36.7 25.5 0.8 10.5 3.7 6.9 100.0% 37.2 27.5 0.5 9.1 3.3 6.0 Common Stock Market Price and Price/Earnings Ratio (Unaudited) F I SCAL YE A R S 2 0 0 5 –19 9 5 Market Price * High Low Diluted Earnings per Share * Price/Earnings Ratio High Low Year 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 Eleven-year average * Adjusted for the effect of stock splits $62.41 $38.80 $2.50 45.71 44.12 30.85 28.85 27.88 29.88 37.19 32.13 21.38 15.63 35.25 24.65 22.88 19.96 15.56 18.75 20.00 15.88 9.25 11.50 1.97 1.68 1.55 1.26 1.77 1.44 1.72 1.45 1.13 .67 25 23 26 20 23 16 21 22 22 19 23 22 16 18 15 15 16 9 13 12 11 8 17 13 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 51 SELEC TED FINANCIAL DATA – FIVE-YE AR SUMMARY Per Common Share Data (Basic and Dilutive) Net income – basic Net income – diluted Cash dividends Book value – basic Net working capital – basic Operating Results (Thousands of Dollars) Net sales Cost of products sold Gross proﬁt Interest expense Income before income taxes Income before income taxes as a % of net sales Effective tax rate Net income Net income as a % of net sales 2005 2004 2003 2002(a) 2001 $÷÷÷÷«2.51 $÷÷÷÷«1.99 $÷÷÷÷«1.69 $÷÷÷÷«1.55 $÷÷÷÷«1.26 2.50 .62 11.46 2.48 1.97 .56 12.10 1.96 1.68 .52 12.19 3.71 1.55 .50 11.08 1.82 1.26 .48 10.10 1.52 $2,450,572 1,562,654 887,918 2,355 214,709 8.76% 36.0% $2,093,447 $1,755,728 $1,692,622 $1,792,438 1,342,143 1,116,513 1,092,743 1,181,140 751,304 886 178,869 8.54% 36.5% 639,215 2,970 150,931 8.60% 35.0% 599,879 4,714 140,554 8.30% 35.0% 611,298 8,548 116,261 6.49% 36.0% $÷«137,420 $÷«113,582 $÷÷«98,105 $÷÷«91,360 $÷÷«74,407 5.61% 5.43% 5.59% 5.40% 4.15% Cash dividends and share purchase rights redeemed $÷÷«33,841 $÷÷«32,023 $÷÷«30,299 $÷÷«29,386 $÷÷«28,373 Addition to (reduction of) retained earnings Net income applicable to common stock % return on average shareholders’ equity Depreciation and amortization Distribution of Net Income % paid to shareholders % reinvested in business Financial Position (Thousands of Dollars) Current assets Current liabilities Working capital Net property, plant, and equipment Total assets % return on beginning assets employed Long-term debt and capital lease obligations Shareholders’ equity Retained earnings Current ratio Current Share Data (65,810) 137,420 21.76% (35,100) 113,582 16.47% 54,001 98,105 14.46% 55,176 91,360 14.74% 36,759 74,407 12.76% $÷÷«65,514 $÷÷«66,703 $÷÷«72,772 $÷÷«68,755 $÷÷«82,385 24.63% 75.37% 28.19% 71.81% 30.88% 69.12% 32.17% 67.84% 38.13% 61.87% $÷«486,598 $÷«374,579 $÷«462,122 $÷«405,054 $÷«319,657 358,174 128,424 294,660 266,250 108,329 311,344 245,816 216,306 312,368 298,680 106,374 353,270 1,140,271 1,021,657 1,021,826 1,020,552 21.10% 17.46% 14.69% 14.83% 230,443 89,214 204,971 961,891 12.04% $÷«103,869 $÷÷÷«3,645 $÷÷÷«4,126 $÷÷÷«9,837 $÷÷«80,830 593,944 540,822 1.36 669,163 606,632 1.41 709,889 641,732 1.88 646,893 587,731 1.36 592,680 532,555 1.39 Number of shares outstanding at year-end Weighted-average shares outstanding during year – basic Weighted-average shares outstanding during year – diluted Number of shareholders of record at year-end 51,848,591 54,649,199 55,033,741 6,702 55,303,323 58,238,519 58,373,607 58,672,933 57,127,110 58,178,739 58,789,851 59,087,963 57,577,630 58,545,353 59,021,071 59,210,049 6,465 6,416 6,777 6,694 Other Operational Data Capital expenditures (thousands of dollars) Members (employees) at year-end $÷÷«38,912 $÷÷«32,417 $÷÷«34,842 $÷÷«25,885 $÷÷«36,851 12,504(b) 10,589(b) 8,926 8,828 9,029(b) (a) Per SFAS No. 142, “Goodwill and Other Intangible Assets,” the Corporation has ceased recording of goodwill and indeﬁnite-lived intangible amortization. (b) Includes acquisitions completed during the ﬁscal year. 52 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT FORWARD-LOOKING STATEMENTS Statements in this report that are not strictly historical, including statements as to plans, objectives, and future ﬁnancial performance, are “forward-looking” statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as “anticipate,” “believe,” “could,” “conﬁdent,” “estimate,” “expect,” “forecast,” “intend,” “likely,” “may,” “plan,” “possible,” “potential,” “predict,” “project,” “should,” and variations of such words and similar expressions identify forward-looking statements. Forward-looking statements involve known and unknown risks, which may cause the Corporation’s actual results in the future to differ materially from expected results. Because of the following risks, as well as other variables affecting the Corporation’s operating results, past ﬁnancial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods: • competition within the ofﬁce furniture and ﬁreplace industries, including competition from imported products and competitive pricing; • increases in the cost of raw materials, including steel, which is the Corporation’s largest raw material category; • higher than expected costs for energy and fuel; • uncertainty related to disruptions of business by terrorism, military action, epidemic, acts of God, or other force majeure events; • the ability of the Corporation to realize ﬁnancial beneﬁts through price realization from its price increases; • increases in the cost of health care beneﬁts provided by the Corporation; • reduced demand for the Corporation’s storage products caused by changes in ofﬁce technology, including the change from paper record storage to electronic record storage; • the effects of economic conditions on demand for ofﬁce furniture, customer insolvencies, and related bad debts and claims against the Corporation that it received preferential payments; • changes in demand and order patterns from the Corporation’s customers, particularly its top 10 customers, which represented approximately 36% of net sales in 2005; • issues associated with acquisitions and integration of acquisitions; • the ability of the Corporation to realize cost savings and productivity improvements from its cost containment and business simpliﬁcation initiatives; • the ability of the Corporation to realize ﬁnancial beneﬁts from investments in new products; • the ability of the Corporation’s distributors and dealers to successfully market and sell the Corporation’s products; • currency ﬂuctuations; • the availability and cost of capital to ﬁnance planned growth; and • other risks, uncertainties, and factors described from time to time in the Corporation’s ﬁlings with the Securities and Exchange Commission. The factors identiﬁed above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward- looking statement. Unpredictable or unknown factors could also have material adverse effects on the Corporation. All forward-looking statements included in this report are expressly qualiﬁed in their entirety by the foregoing cautionary statements. The Corporation does not assume any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by applicable law. HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 5 3 REPOR T OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of HNI Corporation: We have completed integrated audits of HNI Corporation’s ﬁscal year 2005 and ﬁscal year 2004 consolidated ﬁnancial statements and of its internal control over ﬁnancial reporting as of December 31, 2005, and an audit of its January 3, 2004 consolidated ﬁnancial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. C O N SO L I DATE D F I N AN C I AL STAT E M E N T S In our opinion, the accompanying consolidated balance sheets and related statements of income, shareholders’ equity and cash ﬂows, present fairly, in all material respects, the ﬁnancial position of HNI Corporation and its subsidiaries (the “Corporation”) at December 31, 2005, January 1, 2005, and January 3, 2004, and the results of their operations and their cash ﬂows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. These ﬁnancial statements are the responsibility of the Corporation’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 the standards of the Public Company Accounting Oversight Board (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 of ﬁnancial statements 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. I N TE R N AL C O N T RO L OVE R F I N AN C I AL R E P O R T I N G Also, in our opinion, management’s assessment, included in the Management Report on Internal Control Over Financial Reporting that the Corporation maintained effective internal control over ﬁnancial reporting as of December 31, 2005 based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Corporation maintained, in all material respects, effective internal control over ﬁnancial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the COSO. The Corporation’s management is responsible for maintaining effective internal control over ﬁnancial reporting and for its assessment of the effectiveness of internal control over ﬁnancial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Corporation’s internal control over ﬁnancial reporting based on our audit. We conducted our audit of internal control over ﬁnancial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over ﬁnancial reporting was maintained in all material respects. An audit of internal control over ﬁnancial reporting includes obtaining an understanding of internal control over ﬁnancial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company’s internal control over ﬁnancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over ﬁnancial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the ﬁnancial statements. Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP Chicago, Illinois February 27, 2006 5 4 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT MANAGEMENT REPOR T ON INTERNAL CONTROL OVER FINANCIAL REPOR TING Management of HNI Corporation is responsible for establishing and maintaining adequate internal control over ﬁnancial reporting as deﬁned in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. HNI Corporation’s internal control over ﬁnancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Corporation’s internal control over ﬁnancial reporting includes those written policies and procedures that: • Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂect the transactions and dispositions of the assets of HNI Corporation; • Provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of HNI Corporation are being made only in accordance with authorizations of management and directors of HNI Corporation; and • Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the consolidated ﬁnancial statements. Internal control over ﬁnancial reporting includes the controls themselves, monitoring (including internal auditing practices), and actions taken to correct deﬁciencies as identiﬁed. Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of HNI Corporation’s internal control over ﬁnancial reporting as of December 31, 2005. Management based this assessment on criteria for effective internal control over ﬁnancial reporting described in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of the Corporation’s internal control over ﬁnancial reporting and testing of the operational effectiveness of the Corporation’s internal control over ﬁnancial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors. Based on this assessment, management determined that, as of December 31, 2005, HNI Corporation maintained effective internal control over ﬁnancial reporting. Management’s assessment of the effectiveness of the Corporation’s internal control over ﬁnancial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting ﬁrm, as stated in their report which appears herein. Stan A. Askren Chairman, President and Chief Executive Ofﬁcer Jerald K. Dittmer Vice President and Chief Financial Ofﬁcer February 22, 2006 HNI CORPORATION AND SUBSIDIARIES 2005 ANNUAL REPORT 55 A MESSAGE FROM THE BOARD OF DIREC TORS Dear shareholders: We, the members of the HNI Corporation Board of Directors, believe that integrity is central to good corporate governance. That belief is reflected in the HNI Corporation Vision Statement, which appears on page 58 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, HNI Corporation 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 responsibility on the Board is to fulfill our role in the implementation of the vision through sound policies and practices, through clear and open communication, and through a conservative and straightforward financial management philosophy. It is an honor to serve as Directors of HNI Corporation. Rest assured that we will continue to work to honor the values and priorities expressed in HNI’s Vision Statement. Sincerely, The HNI Corporation Board of Directors Stan A. Askren Miguel M. Calado Gary M. Christensen Cheryl A. Francis John A. Halbrook James R. Jenkins Dennis J. Martin Larry B. Porcellato Joseph Scalzo Abbie J. Smith Brian E. Stern Ronald V. Waters, III 56 HNI CORPORATION 2005 ANNUAL REPORT BOARD OF DIREC TORS AND OFFICERS Board of Directors Stan A. Askren Chairman, President and Chief Executive Officer, HNI Corporation Miguel M. Calado Former Executive Vice President and President, International, Dean Foods Company Gary M. Christensen Lead Director, HNI Corporation Advisor, Wind Point Partners Retired President and Chief Executive Officer, Pella Corporation Cheryl A. Francis Advisor/Consultant, Vice Chairman, Corporate Leadership Center John A. Halbrook Chairman, Woodward Governor Company James R. Jenkins Senior Vice President and General Counsel, Deere & Company Dennis J. Martin Independent Consultant, Retired Chairman, President and Chief Executive Officer, General Binding Corporation Larry B. Porcellato Chief Executive Officer, ICI Paints North America Joseph Scalzo President and Chief Executive Officer, WhiteWave Foods Company Abbie J. Smith Chaired Professor, The University of Chicago Graduate School of Business Brian E. Stern Senior Vice President, Xerox, Fuji Xerox Operations, Xerox Corporation Ronald V. Waters, III Chief Operating Officer, Wm. Wrigley Jr. Company Director Emeritus Richard H. Stanley Chairman, SC Companies, Inc. Chairman, Stanley Consultants, Inc. Committees of the Board Audit Ronald V. Waters, III, Chairperson Miguel M. Calado James R. Jenkins Joseph Scalzo Human Resources and Compensation Abbie J. Smith, Chairperson Gary M. Christensen John A. Halbrook Larry B. Porcellato Public Policy and Corporate Governance Brian E. Stern, Chairperson Cheryl A. Francis Dennis J. Martin HNI Corporation Officers Operating Companies Stan A. Askren Chairman, President and Chief Executive Officer Jerald K. Dittmer Vice President and Chief Financial Officer Robert J. Driessnack Vice President, Controller Melinda C. Ellsworth Vice President, Treasurer and Investor Relations Tamara S. Feldman Vice President, Financial Reporting Robert D. Hayes Vice President, Business Analysis and General Auditor Douglas L. Jones Vice President and Chief Information Officer Jeffrey D. Lorenger Vice President, General Counsel and Secretary Donald T. Mead Vice President, Member and Community Relations Timothy R. Summers Vice President, Lean Enterprise Timothy J. Anderson President, Omni Workspace Company David C. Burdakin Executive Vice President, HNI Corporation President, The HON Company Bradley D. Determan Executive Vice President, HNI Corporation President, Hearth & Home Technologies Inc. Eric K. Jungbluth Executive Vice President, HNI Corporation President, Allsteel Inc. Russell S. Minick President, The Gunlocke Company L.L.C. Marco V. Molinari Executive Vice President, HNI Corporation President, HNI International Inc. Jean M. Reynolds President, Maxon Furniture Inc. Thomas A. Tolone President, Paoli Inc. HNI CORPORATION 2005 ANNUAL REPORT 57 OUR VISION We, the members of HNI Corporation, 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 everything we do, individual and collective integrity, and the relentless pursuit of the following long-standing beliefs: We will be proﬁtable. We will be a great place to work. We pursue mutually proﬁtable relationships with customers We pursue a participative environment and support a culture and suppliers. Only when our company achieves an adequate that encourages and recognizes excellence, active involvement, proﬁt can the other elements of this Vision be realized. ongoing learning and contributions of each member; that seeks out and values diversity; and that attracts and retains We will create long-term value for shareholders. the most capable people who work safely, are motivated and We create long-term value for shareholders by earning are devoted to making our company and our members successful. ﬁnancial returns signiﬁcantly greater than our cost of capital and pursuing proﬁtable growth opportunities. We will be a responsible corporate citizen. We will safeguard our shareholders’ equity by maintaining We conduct our business in a way that sustains the well-being a strong balance sheet to allow ﬂexibility in responding to of society, our environment and the economy in which we live a continuously changing market and business environment. and work. We follow ethical and legal business practices. Our company supports our volunteer efforts and provides charitable We will pursue proﬁtable growth. contributions so that we can actively participate in the civic, We pursue proﬁtable growth on a global basis in order to cultural, educational, environmental and governmental affairs provide continued job opportunities for members and of our society. ﬁnancial success for all stakeholders. To our stakeholders: We will be a supplier of quality products and services. When our company is appreciated by its members, favored We provide reliable products and services of high quality by its customers, supported by its suppliers, respected by the and brand value to our end-users. Our products and services public and admired by its shareholders, this Vision is fulﬁlled. exceed our customers’ expectations and enable our distributors and our company to make a fair proﬁt. 58 HNI CORPORATION 2005 ANNUAL REPORT I N V E S T O R I N F O R M AT I O N Fiscal 2006 Quarter-End Dates 1st Quarter: Saturday, April 1 2nd Quarter: Saturday, July 1 3rd Quarter: Saturday, September 30 4th Quarter: Saturday, December 30 Annual Meeting The Corporation’s annual shareholders’ meeting will be held at 10:30 a.m. on Tuesday, May 2, 2006, at the Holiday Inn, Highways 61 & 38 North, Muscatine, Iowa. Shareholders and other interested investors are encouraged to attend the meeting. Investor Relations Send inquiries to: Investor Relations HNI Corporation 414 East Third Street Muscatine, IA 52761 Telephone: 563.272.7400 Fax: 563.272.7655 E-mail: investorrelations@hnicorp.com Corporate Headquarters HNI Corporation 414 East Third Street P.O. Box 1109 Muscatine, IA 52761-0071 Telephone: 563.272.7400 Fax: 563.272.7217 Website: www.hnicorp.com Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP One North Wacker Drive Chicago, IL 60606 Common Stock HNI Corporation common stock trades on the New York Stock Exchange (NYSE) under the symbol: HNI. Stock price quotations can be found in major daily newspapers and The Wall Street Journal. Transfer Agent Shareholders may report a change of address or make inquiries by writing or calling: Computershare Investor Services, LLC 2 North LaSalle Street Chicago, IL 60602 Telephone: 312.588.4991 Management Certifications On June 1, 2005, the Corporation submitted to the NYSE, the Annual CEO Certification required by Section 303A.12(a) of the NYSE Listed Company Manual. The Corporation also filed with the Securities and Exchange Commission the CEO/CFO Certification required under Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 to the Corporation’s annual report on Form 10-K for the fiscal year ended December 31, 2005. It’s the . r e p a p e l b a l c y c e r d n a d e l c y c e r n o d e t n i r P h p a r g o h t i L n o s r e d n A o e v n e C : g n i t n i r P f p e n h c S s e m a J : y h p a r g o t o h P e v i t u c e x E m o c . m m o c n c b . w w w / s n o i t a c i n u m m o C N C B : n g i s e D 414 East Third Street Muscatine, Iowa 52761 www.hnicorp.com H N I C o r p o r a t i o n 2 0 0 5 A n n u a l R e p o r t Our story hasn’t changed. HNI Corporation 2005 Annual Report

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