HUTTIG BUILDING PRODUCTS INC - Annual Report: 2003 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

x    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

¨     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 1-14982

HUTTIG BUILDING PRODUCTS, INC.

(Exact name of registrant as specified in its charter)

555 Maryville University Drive

Suite 240

St. Louis, Missouri 63141

(Address of principal executive offices, including zip code)

(314) 216-2600

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes x    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ¨    No x

The aggregate market value of the Common Stock held by non-affiliates of the registrant as of the last business day of the quarter ended June 30, 2003 was approximately $34,671,325. For purposes of this calculation only, the registrant has excluded stock beneficially owned by the registrants’ directors and officers. By doing so, the registrant does not admit that such persons are affiliates within the meaning of Rule 405 under the Securities Act of 1933 or for any other purposes.

The number of shares of Common Stock outstanding on February 26, 2004 was 19,435,701 shares.

Documents incorporated by reference and the part of this Form 10-K into which the documents are incorporated:

Portions of the Definitive Proxy Statement for the 2004 Annual Meeting of Stockholders—Part III

PART I

ITEM 1—BUSINESS

General

Huttig Building Products, Inc., a Delaware corporation originally incorporated in 1913, is one of the largest domestic distributors of millwork, building materials and wood products used principally in new residential construction and in home improvement, remodeling and repair work. We distribute our products through 54 distribution centers serving 47 states. Our wholesale distribution centers sell principally to building materials dealers, national buying groups and home centers, who, in turn, supply the end-user. Our Builder Resource locations sell directly to professional builders and contractors. We also produce softwood mouldings at our American Pine Products manufacturing facility in Prineville, Oregon.

In this Annual Report on Form 10-K, when we refer to “Huttig,” the “Company,” “we” or “us,” we mean Huttig Building Products, Inc. and its subsidiaries and predecessors unless the context indicates otherwise.

Industry Characteristics and Trends

The home building materials distribution industry is characterized by its substantial size and dependence on the cyclical and seasonal home building industry, its highly fragmented ownership structure and an increasingly competitive environment.

Residential construction activity is closely linked to a variety of factors directly affected by general economic conditions, including job and household formation, interest rates, housing prices, availability of mortgage financing, immigration patterns, regional demographics and consumer confidence. We monitor new housing starts on a national and regional basis as an important indicator of our potential future sales volume.

New housing starts in the United States totaled approximately 1.85 million in 2003 versus 1.70 million in 2002, including 1.66 million single family residences in 2003 versus 1.47 million in 2002, based on data from the U.S. Census Bureau. Approximately 73% of single family new construction in 2003 occurred in markets that we serve. According to the U.S. Census Bureau, total spending on new residential construction in 2003 was $333 billion. The Census Bureau also estimates that aggregate expenditures for residential repair and remodeling were an additional $173 billion, and we believe that sales of doors, windows and other millwork accounted for approximately $17 billion in 2003.

Prior to the 1970s, building materials were sold in both rural and metropolitan markets largely by local dealers, such as lumberyards and hardware stores. These dealers, who generally purchased their products from wholesale distributors, sold building products directly to homeowners, contractors and homebuilders. In the late 1970s and 1980s, The Home Depot and Lowe’s began to alter this distribution channel, particularly in metropolitan markets. They began displacing local dealers by marketing a broad range of competitively priced building materials to the homeowner and small home improvement contractor. At the same time, some building materials manufacturers, such as Georgia Pacific and Weyerhaeuser, began selling their products directly to home center chains and to local dealers as well. In response, most wholesale distributors have been diversifying their businesses by seeking to sell directly to large contractors and homebuilders in selected markets and by providing home centers with fill-in and specialty products. Also, as large homebuilding companies seek to streamline the new residential construction process, we believe building materials distributors have increasing opportunities to provide higher margin turnkey products and services.

The increasingly competitive environment faced by dealers also has prompted a trend toward industry consolidation and formation of buying groups to leverage their purchasing power. We believe this trend offers significant opportunities to a company like Huttig. Many distributors in the building materials industry are small,

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privately-held companies that generally lack the purchasing power of a larger entity and may also lack the broad lines of products and sophisticated inventory management and control systems typically needed to operate a multi-branch distribution network. These characteristics are also driving the consolidation trend in favor of companies like us that operate nationally and have significant infrastructure in place to accommodate the needs of customers across geographic regions. We increased sales to major and national accounts in 2003 by over 9%, with sales to our top 10 customers increasing by 12%. Additionally, sales by the top 10 wholesale distributors grew by approximately 9% during the period 2001 to 2002.

Products

Each of our distribution centers carries a variety of products that vary by location. Our principal products are:

The following table sets forth information regarding the percentage of our net sales represented by our principal product categories sold during each of the last three fiscal years. While the table below generally indicates the mix of our sales by product category, changes in the prices of commodity wood products and in unit volumes sold typically affect our product mix on a year-to-year basis.

Millwork—Net sales of millwork were $484.5 million in 2003 versus $486.1 million and $502.5 million in 2002 and 2001, respectively. The majority of sales in this product category are from the sale of exterior and interior doors which totaled $332.2 million, $317.5 million, and $334.8 million in 2003, 2002 and 2001, respectively. Although growth of millwork declined as a percentage of sales in 2003, door sales increased by more than $14.7 million over 2002. Sales of windows declined to 5% of our total sales in 2003, compared with 6% in both 2002 and 2001. Mouldings, which declined to 5% of our sales in 2003, compared with 7% in both 2002 and 2001, are a complementary product line to doors and windows as part of a house’s millwork package. Profitability of these highly competitive, commodity-priced products depends upon efficient plant operations, rapid inventory turnover and quick reaction to changing market conditions. Key brands in this product category include Therma Tru, Masonite, Woodgrain, Weathershield and L. J. Smith.

General Building Products—Net sales of general building products totaled $243.5 million in 2003 versus $222.4 million and $261.3 million in 2002 and 2001, respectively. General building products increased as a percentage of sales by 2% in 2003 over 2002, largely as a result of the increase in sales of connectors, which totaled $29.0 million in 2003 versus $25.8 million in 2002. Key brands in this product category include Typar, Simpson Strong-Tie, Owens Corning, Grace and Timbertech.

Wood Products—Net sales of wood products were $181.3 million in 2003 versus $164.8 million and $184.1 million in 2002 and 2001, respectively. Growth of wood products as a percentage of sales from 2002 to 2003 resulted primarily from additional value-added services and an increase in commodity wood prices. Our Builder Resource branches provide builders with the capability to purchase a house’s framing and package of wood products from one source and have each component delivered when needed. Key brands in this product category include Louisiana-Pacific and I Joist.

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Customers

During 2003, we served over 10,000 customers, and no single customer accounted for more than 8% of our sales. Building materials dealers represent our single largest customer group. Despite the advent of the home center chains, the trend toward consolidation of dealers and increased direct participation in wholesale distribution by some building materials manufacturers, we believe that the wholesale distribution business continues to provide sales growth opportunities. We believe that opportunities exist for large distributors, like Huttig, that can provide value-added services, such as pre-hanging doors, which we believe is a key service we provide at many of our branches. We also target home centers for sales of fill-in and specialty products.

The percentages of our revenues attributable to various categories of customers in each of the past three years are as follows:

Sales

During 2003, we returned sales and operations responsibility to our general managers at our distribution centers. Each general manager reports to a regional director in one of five geographic regions. Our sales organization consists of outside field sales personnel who serve customers on-site and who in turn report directly to sales managers, who report to the general managers. Our outside sales force is supported by inside customer service representatives at each branch and is compensated by a base salary plus commissions based primarily on sales margin.

Our branch and regional sales efforts are supported by a national accounts team, which coordinates sales programs with national and major regional customers and buying groups. In 2003, we increased sales to national accounts by over 9%, increased sales to our top 10 customers by 13% and began doing business with over 1,000 new customers.

Each of our distribution centers is focused on meeting local market needs and offering competitive prices. Inventory levels, merchandising, and pricing are tailored to local markets. Our single-platform information system provides each general manager with real-time pricing, inventory availability, and margin analysis to facilitate this strategy. We support our distribution centers with centralized financial controls, training programs, and human resource expertise.

Product Management and Marketing

In 2003, Huttig transitioned from a centralized product management and procurement organization to a field-driven organization. The change allows us to continue to manage national programs centrally but execute those programs regionally and locally, thus bringing the program closer to the customer. In addition, the new organization allows us to manage inventory levels locally, providing more flexibility in the field to respond proactively to changing local market conditions and demands.

We purchased products from more than 2,400 different suppliers during 2003. Approximately 75% of our inventory purchases were made from 84 major suppliers and our top five suppliers represented 34% of our inventory purchases in 2003. We negotiate with our major suppliers on a national basis to leverage our total volume purchasing power and obtain favorable terms and pricing, which we believe provides us with an advantage over our locally limited competitors. The majority of our purchases are made from suppliers that offer payment discount and volume related incentive programs.

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We expanded our marketing function in 2003 to include corporate, regional and local campaigns. Our corporate marketing staff is responsible for developing and implementing marketing programs that enhance Huttig as a preferred brand through nationwide print and merchandising campaigns. Once developed, the campaigns are implemented throughout the organization by regional and local product managers. The national and regional marketing personnel are responsible for developing programs for specific product categories to increase sales and gross profit. This structure helps us to develop national programs that tie directly to the efforts of the regional and local product management group and provide a cohesive brand approach throughout the organization.

Competition

Our competition varies by product line, customer classification and geographic market. We compete with many local and regional building product distributors and dealers and, in certain markets and product categories, with national building product distributors and dealers. In certain markets we compete with national building materials suppliers with national distribution capability, such as Georgia-Pacific, Weyerhaeuser and other product manufacturers that engage in direct sales, while at the same time distributing products for some of these manufacturers. We also sell products to large home center chains such as Lowe’s and The Home Depot and, to a limited extent in certain markets, we compete with them for business from smaller contractors. Competition from such large home center chains for the business of larger contractors may increase in the future.

The principal factors on which we compete are:

Our size, geographic coverage and financial position are advantageous in obtaining and retaining distributorships for brand name products. Our size also permits us to attract experienced sales and service personnel and gives us the resources to provide company-wide sales, product and service training programs. By working closely with our customers and utilizing our information technology, our branches are able to maintain appropriate inventory levels and are well positioned to deliver completed orders on time.

Seasonality and Working Capital

Various factors historically have caused our results of operations to fluctuate from period to period. These factors include levels of construction, home improvement and remodeling activity, weather, prices of commodity wood products, interest rates, competitive pressures, availability of credit and other local, regional and economic conditions. Many of these factors are cyclical or seasonal in nature. We anticipate that fluctuations from period to period will continue in the future. Our first quarter and, occasionally, our fourth quarter are adversely affected by winter weather patterns in the Midwest, Mid-Atlantic and Northeast, which typically result in seasonal decreases in levels of construction activity in these areas. Because much of our overhead and expenses remain relatively fixed throughout the year, our operating profits also tend to be lower during the first and fourth quarters.

We depend on cash flow from operating activities and funds available under our secured credit facility to finance seasonal working capital needs, capital expenditures and any acquisitions that we may undertake. Our working capital requirements are generally greatest in the second and third quarters, which reflects the seasonal nature of our business. The second and third quarters are typically our strongest operating quarters, largely due to

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more favorable weather throughout many of our markets compared to the first and fourth quarters. We typically generate cash from working capital reductions in the fourth quarter of the year and build working capital during the first quarter in preparation for our second and third quarters. We also maintain significant inventories to meet rapid delivery requirements of our customers and to enable us to obtain favorable pricing, delivery and service terms with our suppliers. At December 31, 2003, inventories constituted approximately 35% of our total assets. We also closely monitor operating expenses and inventory levels during seasonally affected periods and, to the extent possible, manage variable operating costs to minimize seasonal effects on our profitability.

Credit

Huttig’s corporate management establishes an overall credit policy for sales to customers, and regional credit managers are responsible for all credit decisions. Our credit policies, together with monitoring of customer balances, have resulted in average bad debt expense of approximately 0.2% of net sales during the last three years. Approximately 98% of our sales in 2003 were made to customers to whom we had provided credit for those sales. Approximately 2% of sales in 2003 included cash purchases and purchases made with third-party credit cards, such as MasterCard, Visa and American Express.

Backlog

Our customers generally order products on an as-needed basis. As a result, virtually all product shipments in a given fiscal quarter result from orders received in that quarter. Consequently, order backlog represents only a very small percentage of the product sales that we anticipate in a given quarter and is not indicative of actual sales for any future period.

Tradenames

Historically, Huttig has operated under various tradenames in the markets we serve, retaining the names of acquired businesses for a period of time to preserve local identification. To capitalize on our national presence, we converted our branch operations to the primary tradename “Huttig Building Products.” Some branches continue to use historical tradenames as secondary tradenames to maintain local identity. Huttig has no material patents, trademarks, licenses, franchises, or concessions other than the Huttig Building Products^® name and logo and the Builder Resource^® name and logo, which are registered trademarks.

Environmental Matters

We are subject to federal, state and local environmental protection laws and regulations. We believe that we are in material compliance, or are taking action aimed at assuring material compliance, with applicable environmental protection laws and regulations. However, there can be no assurance that future environmental liabilities will not have a material adverse effect on our financial condition or results of operations.

We have been identified as a potentially responsible party in connection with the cleanup of contamination at a formerly owned property in Montana. See Part I, Item 3—“Legal Proceedings.”

In addition, some of our current and former distribution centers are located in areas of current or former industrial activity where environmental contamination may have occurred, and for which we, among others, could be held responsible. We currently believe that there are no material environmental liabilities at any of our distribution center locations.

Employees

As of December 31, 2003, we employed 2,427 persons, of which approximately 12% were represented by unions. We have not experienced any strikes or other work interruptions in recent years and have maintained generally favorable relations with our employees.

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The following table shows the approximate breakdown by job function of our employees:

Available Information

Huttig files with the U.S. Securities and Exchange Commission quarterly and annual reports on Forms 10-Q and 10-K, respectively, current reports on Form 8-K, and proxy statements pursuant to the Securities Exchange Act of 1934, in addition to other information as required. The public may read and copy our SEC filings at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549 and may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We file this information with the SEC electronically, and the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.

Our website address is http://www.huttig.com. We make available, free of charge at the “Investor Information” section of our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the 1934 Act. This information is available on our website as soon as reasonably practicable after we electronically file it with, or furnish it to, the SEC. Reports of beneficial ownership filed pursuant to Section 16(a) of the 1934 Act are also available on our website.

ITEM 2—PROPERTIES

Our corporate headquarters are located at 555 Maryville University Drive, Suite 240, St. Louis, Missouri 63141, in leased facilities. We lease approximately half of our distribution centers and own the rest. Warehouse space at distribution centers aggregates approximately 3.9 million square feet. Distribution centers range in size from 11,500 square feet to 160,000 square feet. The types of facilities at these centers vary by location, from traditional wholesale distribution warehouses, which may have particular value-added service capabilities such as pre-hung door operations, to traditional lumberyards and builder support facilities with broad product offerings and capabilities for a wide range of value-added services. We also own a 280,000-square foot manufacturing facility for softwood mouldings located in Prineville, Oregon. We believe that our locations are well maintained and adequate for their purposes.

The following table sets forth the geographic location of our operating facilities as of December 31, 2003:

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ITEM 3—LEGAL PROCEEDINGS

We are involved in various lawsuits, claims and proceedings arising in the ordinary course of business. While the outcome of any lawsuits, claims or proceedings cannot be predicted, we do not believe that the disposition of any pending matters will have a material adverse effect on our financial condition, results of operations or liquidity.

In April 2002, we filed a lawsuit in the Supreme Court of the State of New York against The Rugby Group Ltd., our principal stockholder, and Rugby IPD Corp., a subsidiary of The Rugby Group Ltd., alleging that they breached their contractual obligations to indemnify and defend Huttig against asbestos-related liabilities and claims arising out of the business that was acquired in 1994 by Rugby Building Products, Inc. We acquired Rugby Building Products, Inc., a distributor of building materials, in December 1999, when we acquired the stock of its parent, Rugby USA, Inc., from The Rugby Group Ltd. In our lawsuit, we seek to recover sums we have spent to defend and, with respect to one lawsuit, settle our asbestos lawsuits, as well as a declaratory judgment that Rugby Group and Rugby IPD indemnify and defend us for these lawsuits and any similarly situated claims that may be asserted against us in the future. Rugby Group has denied any obligation to defend, or indemnify us for, any of these cases. While we believe that our factual allegations and legal claims are meritorious, there can be no assurance at this time that Huttig will recover any of its costs related to past or future asbestos-related claims from insurance carriers or from The Rugby Group or Rugby IPD Corp. or that such costs will not have a material adverse effect on Huttig’s business or financial condition.

In January 2004, Huttig, individually and as a successor-in-interest to Rugby Building Products, Inc., was named in an action filed in Superior Court of California, County of Alameda, by an individual alleging that he suffered personal injury as a result of exposure to asbestos-containing products distributed by Huttig and/or Rugby Building Products. The plaintiff seeks unspecified damages from Huttig and many other defendants named in this pending action. We believe that this lawsuit also relates to products distributed by a business acquired by Rugby Building Products and expect to seek indemnification for this lawsuit as part of our action against The Rugby Group and Rugby IPD Corp. While we believe that the factual allegations and legal claims asserted against us in this action are without merit, there can be no assurance at this time that we will recover any costs relating to these claims from insurance carriers or from The Rugby Group or Rugby IPD Corp., or that such costs will not have a material adverse effect on our business or financial condition.

In 1995, Huttig was identified as a potentially responsible party in connection with the clean up of contamination at a formerly owned property in Montana that was used for the manufacture of wood windows. We are voluntarily remediating this property under the oversight of and in cooperation with the Montana Department of Environmental Quality (“DEQ”), and is complying with a 1995 unilateral administrative order of the DEQ to complete a remedial investigation and feasibility study. The remedial investigation has been completed and approved by the DEQ, which has issued its final risk assessment of this property. The DEQ has also approved Huttig’s work plan for conducting a feasibility study to evaluate alternatives for cleanup. We expect to submit the feasibility study, which will evaluate several potential remedies, including continuation or enhancement of remedial measures already in place and operating, in 2004. The DEQ then will select a final remedy, publish a record of decision and negotiate with Huttig for an administrative order of consent on the implementation of the final remedy. Management currently believes that the DEQ will select the final remedy in late 2004 or early 2005 and that the remediation will take several more years to complete. During remediation, we intend to continue monitoring the site, evaluating and improving upon the selected remedy, and reporting regularly to the DEQ. Based on our experience to date in remediating this site, we do not believe that the scope of remediation that the DEQ ultimately determines will have a material adverse effect on our results of operations or financial condition. We spent $0.3 million on remediation costs at this site in 2003. The annual level of future remediation expenditures is difficult to estimate because of the uncertainty relating to the final remedy to be selected. We have accrued $0.8 million for costs of remediating this site and believe this accrual represents management’s best estimate, based on current facts and circumstances, of the currently expected costs of continued remediation. Until the DEQ selects a final remedy, however, management can give no assurance as to the scope or cost to Huttig of the final remediation order.

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ITEM 4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to our shareholders during the fourth quarter of 2003.

PART II

Our common stock is listed on the New York Stock Exchange and trades under the symbol “HBP.”

At February 26, 2004, there were approximately 2,817 holders of record of our common stock. The following table sets forth the range of high and low sale prices of the common stock on the New York Stock Exchange Composite Tape during each quarter of the years ended December 31, 2003 and 2002:

We have never declared, nor do we anticipate declaring or paying, any cash dividends on our common stock in the foreseeable future in order to make cash generated available for use in operations, debt reduction, stock repurchases and, if any, acquisitions. Provisions of our senior secured revolving credit facility contain various covenants which, among other things, limit our ability to incur indebtedness, incur liens, make certain types of acquisitions, declare or pay dividends or make restricted payments, consolidate, merge or sell assets. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

See Part III, Item 12, for information on securities authorized for issuance under equity compensation plans.

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ITEM 6—SELECTED CONSOLIDATED FINANCIAL DATA

The following table summarizes certain selected financial data of Huttig for each of the five years in the period ended December 31, 2003. The information contained in the following table may not necessarily be indicative of our past or future performance. Such historical data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this report.

Overview

Huttig is one of the largest domestic distributors of building materials used principally in new residential construction and in home improvement, remodeling and repair work. We distribute our products through 54 distribution centers serving 47 states. Our wholesale distribution centers sell principally to building materials dealers, national buying groups and home centers, who, in turn, supply the end-user. Our Builder Resource locations sell directly to professional builders and contractors. Our American Pine Products manufacturing facility in Prineville, Oregon, produces softwood mouldings. Approximately 36% of American Pine’s sales were to Huttig’s distribution centers during 2003.

Various factors historically have caused our results of operations to fluctuate from period to period. These factors include levels of construction, home improvement and remodeling activity, weather, prices of commodity

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wood products, interest rates, competitive pressures, availability of credit and other local, regional and economic conditions. Many of these factors are cyclical or seasonal in nature. We anticipate that fluctuations from period to period will continue in the future. Our first quarter and, occasionally, our fourth quarter are adversely affected by winter weather patterns in the Midwest, Mid-Atlantic and Northeast, which typically result in seasonal decreases in levels of construction activity in these areas. Because much of our overhead and expenses remain relatively fixed throughout the year, our operating profits also tend to be lower during the first and fourth quarters.

We believe we have the product offerings, warehouse and builder support facilities, personnel, systems infrastructure and financial and competitive resources necessary for continued business success. Our future revenues, costs and profitability, however, are all likely to be influenced by a number of risks and uncertainties, including those discussed under “Cautionary Statement”.

Branch Consolidations

During the third quarter of 2003, we decided to consolidate and reorganize branch operations in our Southeast and Northeast regions to eliminate overlapping sales territories, reduce costs and more effectively address our existing and potential customer base. Based on the production capabilities, product mix and proximity of our Albany, Georgia and Dothan, Alabama locations, we closed our Albany branch and consolidated its production facilities and operations with those of our Dothan branch. We also reorganized our sales territories, allowing our Dothan, Alabama, Macon, Georgia, and Jacksonville, Florida branches to better service our customer base. As of December 31, 2003, we completed this consolidation, including the transfer of assets and inventory from Albany to Dothan, as well as the sales territory reorganization.

As of December 31, 2003, we also completed the consolidation of our Sharon, Vermont branch into our Manchester, New Hampshire branch. We also reorganized our sales territories among our Manchester, Taunton, Massachusetts and Selkirk, New York branches. We believe that this consolidation will allow us to provide better customer service, improve our production capabilities, expand our product mix and grow sales in our Northeast region.

In connection with these branch consolidations, we recorded a $0.1 million severance expense at September 30, 2003, all of which we expect to have paid during the first quarter of 2004.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions (see Note 1 to the consolidated financial statements). Management bases these estimates and assumptions on historical results and known trends, as well as our forecasts as to how these might change in the future. Actual results could differ from these estimates, assumptions and forecasts. We believe that, of our significant accounting policies, the following may involve a higher degree of judgment and complexity.

Accounts Receivable—Trade accounts receivable consist of amounts owed for orders shipped to customers and are stated net of an allowance for doubtful accounts. Huttig’s corporate management establishes an overall credit policy for sales to customers and is responsible for all credit decisions. The reserve for bad debt is determined based on a number of factors including when customer accounts exceed 90 days past due or sooner depending on the credit strength of the customer. Our credit policies, together with monitoring of customer balances, have resulted in average bad debt expense of approximately 0.2% of net sales during the last three years.

LIFO Inventories—Inventories are stated at the lower of cost or market. Substantially all of the Company’s inventory consists of finished goods. Approximately 78% and 77% of inventories were determined by using the LIFO (last in, first out) method of inventory valuation as of December 31, 2003 and 2002, respectively; the

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remainder were determined by the FIFO (first in, first out) method. Had the Company used the FIFO method of inventory valuation for all inventories, net income would have decreased by $0.1 million and $1.7 million in 2003 and 2001, respectively, and would have increased by $0.2 million in 2002. During 2003 and 2001, the LIFO inventory quantities were reduced, resulting in a partial liquidation of the LIFO bases, the effect of which increased net income by $0.1 million and $1.7 million, respectively. During 2002, the LIFO inventory quantities increased, resulting in an increase to the existing LIFO bases, the effect of which decreased net income by $0.2 million. The replacement cost would be higher than the LIFO valuation by $7.7 million in 2003 and $7.9 million in 2002.

Excess and Obsolete Inventory Reserve—We provide a reserve for excess and obsolete inventory for stock inventory items that have had no sales in the past 12 months and for those inventory items that the quantity on hand is greater than a 24-month supply. We also reserve for special order items that have not been sold within 60 days from their date of receipt at our branch.

Valuation of Goodwill and Other Long-Lived Assets—We test the carrying value of our goodwill for impairment on an annual basis and between annual tests in certain circumstances. The carrying value of goodwill is considered impaired when the discounted cash flow model results in a fair value that is less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of goodwill. We test the carrying value of other long-lived assets, including intangible and other tangible assets, for impairment when events and circumstances warrant such review. The carrying value of long-lived assets are considered impaired when the anticipated undiscounted cash flows from such assets are less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved.

Contingencies—We accrue expenses when it is probable that an asset has been impaired or a liability has been incurred and we can reasonably estimate the expense. Contingencies for which we have made accruals include environmental, product liability and other legal matters. Based on management’s assessment of the most recent information available, management currently does not expect any of these contingencies to have a material adverse effect on our financial position or cash flow. It is possible, however, that future results of operations for any particular quarter or annual period and our financial condition could be materially affected by changes in assumptions or other circumstances related to these matters. We accrue our best estimate of the cost of resolution of these matters and make adjustments to the amounts accrued as circumstances change.

Insurance—We carry insurance policies on insurable risks with coverages and other terms that we believe are appropriate. We generally have self-insured retention limits and have obtained fully insured layers of coverage above such self-insured retention limits. Accruals for self-insurance losses are made based on our claims experience. We accrue for these liabilities for existing and unreported claims when it is probable that future costs will be incurred and when we can estimate those costs.

Results of Operations

Fiscal 2003 Compared to Fiscal 2002

Net sales were $909.3 million in 2003, a 4% increase from 2002 when sales were $873.3 million. Same branch sales increased 5% in 2003 over 2002. Sales through wholesale distribution branches were $790.5 million, an increase of 5% over 2002 as sales increased in all regions of the country. The increase is primarily related to the strong recovery in the second quarter in the Northeast region and the strong second half of the year across all regions of the country. Sales increased 12% during the second half of 2003 compared to the second half of 2002, which more than offset the decline in sales during the first quarter of 2003 due primarily to the severe winter weather in our Northeast, Mid-Atlantic and Midwest regions. Net sales in Builder Resource branches were $84.6 million, an increase of $0.4 million over the prior year. Excluding the first quarter of 2003, which was negatively

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impacted by a new competitor in the Kansas City area that commenced operations in the second quarter of 2002, we have seen a sales recovery in the Kansas City market during the last three quarters of the year for 2003 as sales increased by 16% versus the same period in 2002. Net sales for our mouldings manufacturer, American Pine Products, were $34.2 million in 2003, a decrease of $3.9 million compared to $38.1 million in 2002. The sales decrease is primarily related to the severe winter weather in the first quarter of the year in the Northeast and Mid-Atlantic states and a decline in finished moulding sales prices in the second half of 2003.

Gross profit increased $7.8 million to $176.3 million in 2003 from $168.5 million in 2002. Gross profit as a percentage of net sales was 19.4% and 19.3% in 2003 and 2002, respectively. We improved inventory controls and lowered material costs in 2003 compared to 2002. These improvements were partially offset by losses on builder contracts and the loss of purchase discounts primarily during the first quarter, which negatively impacted gross margins by 0.2%. Operating expenses increased $7.4 million to $159.6 million in 2003 compared to $152.2 million in 2002. Personnel expenses increased $3.7 million, due largely to increased bonus expense and a higher average headcount than a year ago which reflects 69 additions to the sales force. Non-personnel expenses increased $2.7 million, as rent for new buildings increased $1.0 million, costs of fuel and forklift supplies increased $1.0 million and costs of outside services increased $0.7 million. During 2003, we also recorded a total of $2.1 million of severance costs, which contributed to the increase in operating expenses compared to 2002. In 2003, we reduced bad debt expense by $1.1 million versus 2002.

Depreciation and amortization was $6.6 million in 2003, which is $0.5 million higher than 2002. The increase primarily reflects the timing of our spending of $4.2 million in the second half of 2002 for operating equipment replacements and for a warehouse logistics system implementation.

We recognized $1.1 million in gains on disposal of capital assets during 2003 from the sale of vacant facilities. During 2002, gains on disposal of assets were $0.4 million for the sale of vacant facilities.

Net interest expense was $6.5 million in 2003, which is $2.9 million less than in 2002. The decrease reflects the reduction in our effective borrowing rate resulting from the expiration of our interest rate swaps in May 2003. Average debt outstanding during 2003 was $84.2 million versus $80.2 million in 2002.

During 2002, we recorded a charge of $0.9 million to write off the remaining unamortized loan fees related to our previous credit facility, which we replaced in August 2002.

During 2003, we recorded a $0.7 million gain in the fair value of two interest rate swaps that did not qualify as hedges for accounting purposes. These interest rate swaps expired in May 2003. During 2002, we recorded a $1.1 million gain on derivatives. See Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.”

As a result of the foregoing factors, pretax income increased 218%, or $3.7 million, to $5.4 million in 2003 as compared to pretax income of $1.7 million in 2002.

Income taxes were calculated at an effective rate of 38.0% and 37.7% in 2003 and 2002, respectively.

We also incurred an after-tax non-cash charge of $12.8 million in 2002 due to the cumulative effect of a change in accounting principle related to the write-off of goodwill under Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. See “New Accounting Pronouncements,” below, for further discussion.

Fiscal 2002 Compared to Fiscal 2001

Net sales were $873.3 million in 2002, an 8% decrease from 2001 when sales were $947.9 million. Excluding $24.1 million of sales attributable to branches that we closed, same branch net sales in 2002 decreased 5% or $49.8 million from the prior year. Approximately $23.9 million of the same branch sales decrease was

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attributable to the impact of a new competitor in the Kansas City, Missouri area. Approximately $11.8 million of the same branch sales decrease was due to softer sales in our other Midwest region branches. Another $10.7 million of our same branch sales decrease was attributable to lower housewrap sales resulting from the termination of our distribution of Tyvek^® and our transition to Typar^®, a competing housewrap product, which affected sales in the Northwest. Also, international sales decreased $3.7 million compared to 2001 due to the weak economy in the Far East.

Gross profit decreased $26.7 million to $168.5 million in 2002 from $195.2 million in 2001. The change in gross profit attributable to branches that we closed was $5.3 million. The decrease attributable to lower volume was $9.4 million. Of the remaining $12.0 million decrease, same branch gross profit as a percentage of net sales decreased to 19.3% in 2002 versus 20.6% in 2001. The decrease in gross profit percentage resulted from a shift in product mix and pricing pressures in certain regions.

Operating expenses were $152.2 million in 2002 compared to $165.3 million in 2001. The decrease included $6.9 million of cost reductions from closed branches. The remaining decrease was primarily attributable to a $3.2 million decrease in supplies and maintenance costs at ongoing facilities as a result of our expense reduction initiatives during the year, a $1.8 million decrease in labor related costs resulting from lower headcount than the prior year, a $0.8 million decrease in bad debt expense, and a $0.8 million decrease in professional services fees associated with lower legal and consulting fees. Additionally, we incurred lower system implementation costs by $1.1 million and lower environmental costs by $0.8 million in 2002 as compared to 2001. These decreases were partially offset by an increase of $0.9 million from an increase in our insurance reserves, due to higher claims incidence, expenses of $0.9 million for costs relating to the settlement and legal expenses of an asbestos-related product liability lawsuit and a $0.6 million increase in rent expense from the facilities which are leased.

Depreciation and amortization was $6.1 million in 2002, which is $1.6 million lower than the prior year. The decrease was due primarily to goodwill no longer being amortized, in accordance with SFAS No. 142, which we adopted effective January 1, 2002. In 2001, we amortized $2.4 million of goodwill. The decrease was partially offset by a $0.8 million increase in depreciation expense in 2002. The increase in depreciation was due to our capital expenditures during the year to maintain and refurbish our buildings and equipment.

In the third quarter of 2002, we reversed $0.3 million of restructuring charges for branches that we originally planned to close but decided to keep open. During the fourth quarter of 2001, we recorded $3.2 million of restructuring charges related to the closure of several historically under-performing branches, of which $1.1 million was recorded in cost of sales. The charge was primarily for severance, inventory write-downs, vacant facilities and other shutdown-related costs. See “Restructuring Activities,” below, for further discussion.

Gains on disposal of assets were $0.4 million in 2002 for the sale of previously closed facilities. During 2001, gains on disposal of assets were $0.9 million for the sale of previously closed facilities.

Our full year operating profits in 2002 were $10.9 million, which were $10.1 million less than 2001. Nearly all the decline occurred in the second quarter of 2002. Our third and fourth quarter operating results in 2002 were a combined $2.2 million better than the same quarters a year ago.

Net interest expense decreased to $9.4 million in 2002 from $10.0 million in 2001. Our average outstanding total debt decreased $7.1 million in 2002 compared to the prior year. The interest rate swap agreements effectively provided for a fixed rate of interest.

During 2002, we recorded a charge of $0.9 million in the third quarter to write off the remaining unamortized loan fees related to our previous credit facility, which we replaced with our existing senior secured revolving credit facility.

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Unrealized gain on derivatives of $1.1 million was recorded in 2002 versus a $1.8 million loss in 2001. The gain related to a $1.6 million change in the fair value on two interest rate swaps that do not qualify as hedges for accounting purposes, which was partially offset by $0.5 million of expense amortized from accumulated other comprehensive loss established upon the adoption of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, in 2001. See Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”

We also incurred an after-tax non-cash charge of $12.8 million in 2002 due to the cumulative effect of a change in accounting principle related to the write-off of goodwill under SFAS No. 142. See “New Accounting Pronouncements,” below, for further discussion.

Liquidity and Capital Resources

We depend on cash flow from operating activities and funds available under our secured credit facility to finance seasonal working capital needs, capital expenditures and any acquisitions that we may undertake. Our working capital requirements are generally greatest in the second and third quarters, which reflects the seasonal nature of our business. The second and third quarters are also typically our strongest operating quarters, largely due to more favorable weather throughout many of our markets compared to the first and fourth quarters. We typically generate cash from working capital reductions in the fourth quarter of the year and build working capital during the first quarter in preparation for our second and third quarters. We also maintain significant inventories to meet rapid delivery requirements of our customers and to enable us to obtain favorable pricing, delivery and service terms with our suppliers. At December 31, 2003 and 2002, inventories constituted approximately 35% and 36% of our total assets, respectively. We also closely monitor operating expenses and inventory levels during seasonally affected periods and, to the extent possible, manage variable operating costs to minimize seasonal effects on our profitability.

Cash provided from operating activities decreased $6.4 million from $10.8 million in 2002 to $4.4 million in 2003. The decrease was primarily due to an increase in trade accounts receivable and a decrease in trade accounts payable, offset in part by a decrease in inventories. The increase in trade accounts receivable reflects higher sales in 2003 than in 2002. However, days sales outstanding improved from 34.8 days at December 31, 2002 to 31.3 days at December 31, 2003. Our days sales outstanding is determined by dividing month end trade accounts receivable, net, by current month net sales, then multiplying by 30. The decrease in trade accounts payable of $13.1 million in 2003 compared to 2002 was primarily attributable to inventory reductions in 2003 versus 2002 and our ability in 2003 to take greater advantage of vendor discount terms. As a result of lower inventory and higher sales volume at the end of 2003 versus 2002, our inventory turns improved from 5.3 turns at December 31, 2002 to 6.5 turns at December 31, 2003. Our inventory turns are determined by averaging the two most recent monthly warehouse and production cost of sales, dividing by month end FIFO inventory, net, then multiplying by 12.

Cash used in investing activities in 2003 reflects $2.7 million of capital expenditures for normal operating activities. These expenditures were partially offset by $1.7 million of proceeds from the disposals of assets from vacant facilities. Cash used in investing activities in 2002 reflects $5.2 million of capital expenditures for normal operating activities and $1.4 million for a warehouse logistics system implementation at selected branches. These expenditures were partially offset by $1.5 million of proceeds on disposals of assets from vacant facilities.

Cash used in financing activities is driven by payments of debt and capital lease obligations and repurchases of our own stock. In 2003 versus 2002, we decreased bank debt by $1.5 million and repaid $1.3 million of capital lease obligations. These uses of cash were partially offset by $1.0 million of proceeds from the sale-leaseback of technology and production equipment in 2003. In 2002 versus 2001, we decreased bank debt by $4.8 million, repaid $0.9 million of capital lease obligations and repurchased $0.8 million of stock under our former stock repurchase program and $0.3 million of stock from our repurchase of shares from a former employee, which uses of cash were partially offset by $0.5 million of proceeds from the exercise of stock options. Also in 2002, we incurred $1.6 million of debt issuance costs related to our senior secured revolving credit facility.

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In the second quarter of 2003, we entered into a $2.7 million four-year capital lease obligation to re-finance equipment under a previously existing operating lease, which also increased our fixed assets by $2.7 million. The equipment consisted of existing rolling stock, forklifts and production equipment. The transaction had no impact on cash or our borrowing availability.

We have a $150.0 million senior secured revolving credit facility, which expires in August 2005. Our credit facility consists of a revolving line of credit that provides financing of up to $150.0 million, including up to $10.0 million of letters of credit, at a floating rate of either:

in each case depending on our trailing average collateral availability. The revolving credit borrowing base cannot exceed the sum of (a) up to 85% of eligible domestic trade receivables and (b) up to the lesser of 65% of the cost of eligible inventory or 85% of the appraised net liquidation value of eligible inventory. We pay a commitment fee in the range of 0.25% to 0.50% per annum on the average daily unused amount of the revolving credit commitment. Huttig and its domestic subsidiary are co-borrowers under this facility, and all of the borrowers’ assets, except real property, collateralize borrowings under the credit facility.

Provisions of the credit facility, which we amended as of May 30, 2003 and also as of February 13, 2004, contain various covenants which, among other things, limit our ability to incur indebtedness, incur liens, make certain types of acquisitions, declare or pay dividends or make restricted payments, consolidate, merge or sell assets. It also contains financial covenants tied to our borrowing base. If, at the end of any month, our daily average borrowing base during that month exceeds our daily average outstanding borrowing and pre-established reserve levels during that month by less than an average monthly amount that will adjust over the term of the facility as set forth in the table below, we must maintain or meet a minimum fixed charge coverage ratio set forth in the table below. As defined in the agreement, the ratio is determined for a rolling 12-month period by dividing EBITDA plus cash rent expense, less non-facility-financed capital expenditures and cash taxes, by cash interest expense plus scheduled debt repayments plus cash rent expense for such period. As defined in the credit agreement, EBITDA means the sum of:

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less all cash and non-cash extraordinary income and gains during the period of measurement. The monthly minimum average collateral availability and minimum fixed charge coverage ratio will adjust over the term of the facility, as set forth below:

Also, we may not allow our daily revolving availability under the credit facility to fall below $10.0 million. During the period of May 30, 2003 (the date we amended the collateral availability and fixed charge coverage ratio requirements described above) through December 31, 2003, our monthly average collateral availability exceeded the required monthly minimum average, and our daily revolving availability was in excess of $10.0 million each day.

Prior to February 13, 2004, the credit agreement that evidenced our revolving credit facility required that we maintain a mandatory lock-box arrangement whereby remittances from our customers reduced the borrowings outstanding under the facility. The credit agreement also contains a “material adverse effect” clause that grants the agent and lenders having more than 66 ²/3% of the commitment or borrowings the right to accelerate the maturity of the facility and to block our requests for future advances if the agent reasonably determines that an event or condition has occurred which has had, or reasonably could be expected to have, a material adverse effect on

Our credit agreement does not expire or have a maturity date within one year, but rather has a final expiration date of August 12, 2005. However, Emerging Issues Task Force Issue No. 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include both a Subjective Acceleration Clause and a LockBox Arrangement,” requires borrowings under credit agreements with those two provisions to be classified as current liabilities. As a result, we restated the December 31, 2002 balance sheet to reclassify $65.0 million of borrowings under the credit agreement, which was previously reported as non-current liability, as a current liability.

On February 13, 2004, we and the agent and lenders amended the credit agreement to provide for a “springing” lock-box arrangement. Under this arrangement, we now maintain a lock-box from which we may apply cash receipts to any corporate purpose so long as our monthly average availability does not fall below $20.0 million and we are not in default under the credit agreement. The agent and the lenders maintain a security interest in our lock-box and, upon the occurrence of either of the foregoing triggering events, may redirect funds from the lock-box to a loan account in the name of the lenders on a daily basis and applied against the revolving loan balance. Effective with the amendment, we have classified the outstanding borrowings under the credit facility as long-term liabilities as of December 31, 2003. In addition, we have restated our December 31, 2002 balance sheet to reflect the borrowings under the credit agreement as current liabilities as of December 31, 2002. This restatement will have no impact on our debt covenants under the credit agreement, our ability to draw on existing facilities or our previously reported net income.

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At December 31, 2003, we had revolving credit borrowings of $63.5 millions with $42.7 million of total excess credit available under the credit facility. The $42.7 million of total excess credit available is net of letters of credit totaling $6.6 million, primarily for health and workers compensation insurance.

On May 5, 2003, our three interest rate swap agreements expired. These swap agreements, in combination with our revolving credit facility, effectively provided for a fixed weighted average annual rate of 7.15% plus the applicable spread over LIBOR on up to $80.0 million of our outstanding revolving credit borrowings. Prior to the expiration of the swaps, when actual borrowings under the facility were less than the notional amount of the interest rate swaps, we incurred an expense equal to the difference between $80.0 million and the actual amount borrowed, times the difference between the fixed rate on the interest rate swap agreement and the 90-day LIBOR rate. Effective May 6, 2003, all of our bank debt began accruing interest at a floating rate of between 200 and 300 basis points above LIBOR.

We believe that cash generated from our operations and funds available under our credit facility will provide sufficient funds to meet our currently anticipated short-term and long-term liquidity and capital expenditure requirements.

Commitments and Contingencies

The table below summarizes our contractual obligations as of December 31, 2003:

Stock Repurchases

In October 2002, the Company’s Board of Directors authorized a $5.0 million stock repurchase program that expired in October 2003. Upon expiration, the Company had used $0.8 million of the $5.0 million authorized under the stock repurchase program.

Restructuring Activities

During the fourth quarter of 2001, we recorded $3.2 million of restructuring charges related to the closure of several historically under-performing branches, of which $1.1 million was recorded in cost of sales for the write-down of inventory to realizable value. Other components of the charge were $0.8 million for severance related costs and $1.3 million for facility and other shutdown-related costs. Severance costs related to approximately 175 employees primarily at distribution center locations. Also, included in amounts charged against this restructuring reserve in 2001 was $0.5 million for inventory losses and $0.3 million for facility shutdown costs.

During the first six months of 2002, we completed the closure of three facilities. During the third quarter of 2002, management determined not to close two branches which had originally been planned for closure.

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Consequently, in 2002 we reversed $0.3 million of the restructuring reserve related to these two branches, the components of which are $0.1 million for severance and $0.2 million for facility and other shut-down related costs. The remaining balance was utilized during 2002.

Management Change and Terms of Separation

Severance expense of $1.8 million was recorded in the first quarter of 2003 as part of operating expenses for payments, including future payments, to the Company’s former President and Chief Executive Officer and 11 other employees whose employment terminated during the quarter ended March 31, 2003. An additional severance expense of $0.3 million was recorded in the third and fourth quarters for the termination of employees related to the consolidation of branches and the reorganization of corporate headquarters staff. During the twelve months ended December 31, 2003, total severance payments of $1.3 million were paid. The present values of the remaining severance payments totaled $0.8 million at December 31, 2003, and are expected to be fully paid by March 31, 2005.

New Accounting Pronouncements

In July 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement requires recording costs associated with exit or disposal activities at their fair values when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management’s commitment to an exit plan, which is generally before an actual liability has been incurred. Adoption of this Statement is required for exit or disposal activities initiated after December 31, 2002. Previously issued financial statements shall not be restated under SFAS No. 146. We adopted this statement effective January 1, 2003, and the adoption will impact the timing of exit or disposal activities reported by us on an on-going basis. The adoption did not have any material effect on our consolidated financial condition or results of operations for the year ended December 31, 2003.

Effective November 22, 2002, the Emerging Issues Task Force (“EITF”) reached a consensus regarding EITF Issue No. 02-16, Accounting by a Customer, Including a Reseller, for Cash Consideration Received from a Vendor. This consensus requires that payments from a vendor be classified as a reduction to the price of the vendor’s goods and taken as a reduction to cost of sales unless the payments are (1) reimbursements for costs incurred to sell the product or (2) payments for assets or services provided. The consensus also requires that payments from a vendor be recognized as a reduction to cost of sales on a rational and systematic basis. This consensus became effective for us on January 1, 2003. We already recognized vendor payments as a reduction to cost of sales, based on related purchase volume, and no change was required by us in adopting this consensus, thereby having no material impact on our consolidated financial position or results of operations.

Cautionary Statement Relevant to Forward-looking Information for the Purpose of “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995

This Annual Report on Form 10-K and our annual report to shareholders contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including but not limited to statements regarding:

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The words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project” or similar expressions identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements present management’s expectations, beliefs, plans and objectives regarding our future business and financial performance. These forward-looking statements are based on current projections, estimates, assumptions and judgments, and involve known and unknown risks and uncertainties. We disclaim any obligation to publicly update or revise any of these forward-looking statements. There are a number of factors that could cause our actual results to differ materially from those expressed or implied in the forward-looking statements. These factors include, but are not limited to, the following:

Our sales and profitability depend significantly on new residential construction and home improvement activity in markets in which we compete, which is highly cyclical and seasonal.

Our sales depend heavily on the strength of national and local new residential construction and home improvement and remodeling markets. The strength of these markets depends on new housing starts and residential renovation projects, which are a function of many factors beyond our control. Some of these factors include employment levels, interest rates, availability of credit, housing prices, prices of commodity wood products, immigration patterns, regional demographics and consumer confidence. Future downturns in the markets that we serve or in the economy generally could have a material adverse effect on our operating results and financial condition. Reduced levels of construction activity may result in intense price competition among building materials suppliers, which may adversely affect our gross margins.

Our first quarter revenues and, to a lesser extent, our fourth quarter revenues are typically adversely affected by winter construction cycles and weather patterns in colder climates as the level of activity in the new construction and home improvement markets decreases. Because much of our overhead and expense remains relatively fixed throughout the year, our operating profits also tend to be lower during the first and fourth quarters.

The building materials distribution industry is extremely competitive, and we may not be able to compete successfully with some of our existing competitors or new entrants in the markets we serve.

The building materials distribution industry is extremely competitive. Our competition varies by product line, customer classification and geographic market. The principal competitive factors in our industry are:

Also, financial stability and geographic coverage are important to manufacturers in choosing distributors for their products.

We compete with many local, regional and, in some markets and product categories, national building materials distributors and dealers. We also compete with major integrated product manufacturers with national

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distribution capability, such as Georgia-Pacific, Weyerhaeuser and Boise-Cascade. To a limited extent in some of our markets, we compete with the large home center chains, such as The Home Depot and Lowe’s, for the business of smaller contractors. Some of our competitors have greater financial and other resources and may be able to withstand sales or price decreases better than we can. We also expect to continue to face competition from new market entrants, such as our new competitor in Kansas City. We can give no assurance that we will continue to compete effectively with these existing or new competitors.

The termination of key supplier relationships may have an immediate adverse effect on our financial condition and results of operations.

We distribute building materials that we purchase from a number of major suppliers. As is customary in our industry, most of our relationships with these suppliers are terminable without cause on short notice. During 2002, we began selling housewrap product, Typar^®, in markets where we used to sell Tyvek^®, a competing housewrap, after our distributorship of Tyvek^® was terminated. As a result of our having to transition to a new supplier in markets in which we formerly sold Tyvek^®, housewrap sales declined approximately $10.7 million in 2002 compared to 2001. During 2003 compared to 2002, housewrap sales increased $0.7 million or 6%. Although we believe that relationships with our existing suppliers are strong and that we would have access to similar products from competing suppliers, any disruption in our sources of supply, particularly of our most commonly sold items, could have a material adverse effect on our financial condition and results of operations. We also can give no assurance that any supply shortages resulting from unanticipated demand or production difficulties will not occur from time to time or have a material adverse effect on our financial condition and results of operations.

If we are unable to generate sufficient earnings in order to comply with availability requirements and financial covenants under our revolving credit facility, our ability to conduct business would be limited and we could be forced to seek alternative sources of financing.

Our credit facility agreement contains various covenants which, among other things, limit our ability to incur indebtedness, incur liens, make certain types of acquisitions, declare or pay dividends or make restricted payments, consolidate, merge or sell assets. It also contains financial covenants tied to our borrowing base. Our financial results in the near term may vary from those required by our credit facility as a result of the risks we face in our business, including those that may prevent us from achieving the levels of EBITDA required under our credit facility. We can give no assurance that we will be able to achieve sufficient EBITDA or other financial results necessary to satisfy our revolving credit facility covenants. If we were unable to comply with these covenants, our lender would have the right, but not the obligation, to accelerate the repayment of the entire amount outstanding under the credit facility.

Fluctuation in prices of commodity wood products that we buy and then resell may have a significant impact on our results of operations.

Parts of our business, such as the softwood moulding manufacturing operation and our distribution centers that sell directly to home builders and large contractors, directly face the risk of periodic fluctuations in the prices of wood commodities. Changes in wood commodity prices between the time we buy these products and the time we resell them have occurred in the past and we expect fluctuations to occur again in the future. There can be no assurance that we will be able to manage these fluctuations effectively or minimize any impact of these changes on our financial condition and results of operations.

We face risks of incurring significant costs to comply with environmental regulations.

We are subject to federal, state and local environmental protection laws and regulations and may have to incur significant costs to comply with these laws and regulations in the future. We have been identified as a potentially responsible party in connection with the clean up of contamination at a formerly owned property in

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Montana, where we are voluntarily remediating this property under the oversight of the Montana Department of Environmental Quality. Until the DEQ selects and orders us to implement a final remedy, we can give no assurance as to the scope or cost to us of any final remediation order. See Part I, Item 3, “Legal Proceedings,” for additional discussion. In addition, some of our current and former distribution centers are located in areas of current or former industrial activity where environmental contamination may have occurred, and for which we, among others, could be held responsible. We can give no assurance that we will have no material environmental liabilities with respect to any of our current or former distribution center locations in the future.

We face the risks that product liability claims and other legal proceedings relating to the products we distribute may adversely affect our business and results of operations.

As is the case with other companies in our industry, we face the risk of product liability and other claims of the type that are typical to our industry, such as asbestos and mold related claims, in the event that the use of products that we have distributed causes personal injury or other damages. Product liability claims in the future, regardless of their ultimate outcome and whether or not they are covered under our insurance policies or may be indemnified by our suppliers, could result in costly litigation and have a material adverse effect on our business and results of operations.

Our failure to attract and retain key personnel could have a material adverse effect on our future success.

Our future success depends, to a significant extent, upon the continued service of our executive officers and other key management, sales and technical personnel and on our ability to continue to attract, retain and motivate qualified personnel. The loss of the services of one or more key employees or our failure to attract, retain and motivate qualified personnel could have a material adverse effect on our business.

ITEM 7A—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have exposure to market risk as it relates to effects of changes in interest rates. We had debt outstanding at December 31, 2003 under our secured revolving credit facility of $63.5 million.

Included in other income for the year ended December 31, 2003, is $0.7 million of an unrealized gain related to the portion of our former interest rate swap agreements, which did not qualify for hedge accounting treatment according to the SFAS No. 133 criteria. This unrealized gain resulted in an increase to diluted earnings per share of $0.02 in the year ended December 31, 2003. During 2002 we had an unrealized gain of $1.1 which resulted in an increase to diluted earnings per share of $0.03. There was no impact on cash flow as a result of the accounting treatment required by SFAS No. 133. These interest rate swap agreements expired in May 2003.

As of May 6, 2003, all of our bank debt began accruing interest at a floating rate basis of between 200 and 300 basis points above LIBOR. If market interest rates for LIBOR had been different by an average of 1% between May 6, 2003 and December 31, 2003, our interest expense and income before taxes would have changed by $0.6 million. These amounts are determined by considering the impact of the hypothetical interest rates on our borrowing cost. These analyses do not consider the effects of any change in the overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in our financial structure.

We are subject to periodic fluctuations in the price of wood commodities. Profitability is influenced by these changes as prices change between the time we buy and sell the wood. In addition, to the extent changes in interest rates affect the housing and remodeling market, we would be affected by such changes.

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ITEM 8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEPENDENT AUDITORS’ REPORT

To the Shareholders of Huttig Building Products, Inc.:

We have audited the accompanying consolidated balance sheets of Huttig Building Products, Inc. and its subsidiaries (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill to conform to Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets.

As discussed in Note 5 to the consolidated financial statements, the accompanying December 31, 2002 consolidated balance sheet has been restated.

/s/    Deloitte & Touche LLP

St. Louis, Missouri

February 13, 2004

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In Millions)

see notes to consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In Millions, Except Share and Per Share Data)

see notes to consolidated financial statements

25

HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Millions, Except Per Share Data)

see notes to consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001

(In Millions)

see notes to consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Millions)