HUTTIG BUILDING PRODUCTS INC - Quarter Report: 2005 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

Commission file number 1-14982

HUTTIG BUILDING PRODUCTS, INC.

(Exact name of registrant as specified in its charter)

(314) 216-2600

(Registrant’s telephone number, including area code)

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

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

The number of shares of Common Stock outstanding on July 31, 2005 was 20,160,951 shares.

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see notes to unaudited 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 unaudited consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In Millions, Except Per Share Data)

see notes to unaudited consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

(UNAUDITED)

(In Millions)

see notes to unaudited consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In Millions)

see notes to consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. BASIS OF PRESENTATION

The unaudited interim consolidated financial statements of Huttig Building Products, Inc. (the “Company” or “Huttig”) were prepared in accordance with U.S. generally accepted accounting principles and reflect all adjustments (including normal recurring accruals) which, in the opinion of management, are considered necessary for the fair presentation of the results for the periods presented. These statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

The consolidated results of operations and resulting cash flows for the interim periods presented are not necessarily indicative of the results that might be expected for the full year. Due to the seasonal nature of Huttig’s business, operating profitability is usually lower in the Company’s first and fourth quarters than in the second and third quarters.

2. STOCK-BASED EMPLOYEE COMPENSATION

Effective April 21, 2005, the Securities and Exchange Commission adopted a final ruling amending the compliance date for the Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised), Share-Based Payment. Each registrant that is not a small business issuer will be required to prepare financial statements in accordance with Statement No. 123 (Revised) starting with the first interim or annual reporting period of the registrant’s first fiscal year beginning on or after June 15, 2005. The Company currently accounts for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. At the time of grant, all options issued under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. During the second quarter of 2005, the Company recorded $0.3 million of non-cash compensation expense due to the early vesting and extension of the exercise period of previously granted options in connection with a severance agreement. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

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Had the compensation cost for these plans been determined according to SFAS No. 123, the Company’s net income and earnings per share would have been the following pro forma amounts for the three and six months ended June 30, 2005 and 2004:

3. DEBT

Debt consisted of the following at June 30, 2005 and December 31, 2004 (in millions):

Credit Agreement — The Company has a Credit Agreement, which provides for a term loan facility of $30 million and a revolving credit facility of $130 million, which expires in September 2009. The revolving credit facility may be increased, subject to certain conditions, including bank approval, to a maximum availability of $180 million. As of June 30, 2005, the Company had revolving credit borrowings of $40.0 million, at a weighted average interest rate of 5.2%, and $26.8 million outstanding on the term loan, at an interest rate of 5.2%, under the Credit Agreement. Compliance with the loan covenant in the Credit Agreement that is based on the amount of senior debt outstanding limits the amount available to the Company under its revolving credit facility. At June 30, 2005, the Company would have had approximately $28.5 million of credit available under its revolving credit facility in addition to the amount outstanding, based on the revised financial covenants (see below).

The term loan facility provides for quarterly principal payments of approximately $1.1 million. Subject to certain exceptions, the Company is required to repay amounts outstanding under the Credit Agreement from the cash proceeds of asset dispositions, debt or equity securities issuances and insurance claims related to its owned real estate. The Company must also pay a commitment fee in the range of 0.25% to 0.40% per annum on the average daily-unused amount of the revolving credit commitment. The entire unpaid balance under the Credit Agreement is due and payable on September 23, 2009, the maturity date of the Credit Agreement.

The Credit Agreement contains financial covenants, including a minimum fixed charge coverage ratio, a maximum senior debt to earnings before interest, taxes, depreciation and amortization, as defined (EBITDA), ratio, a minimum asset coverage ratio, and minimum tangible net worth. The Credit Agreement also contains restrictive covenants

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pertaining to the management and operations of Huttig and its subsidiaries. The covenants include, among others, limitations on indebtedness, guarantees, letters of credit, liens, investments, dividends, acquisitions and asset sales. Effective July 30, 2005, the Company amended its Credit Agreement including certain of the financial covenants. The Company is in compliance with the debt covenants as amended.

The Company has an interest rate swap agreement, which will expire in September 2009, which mirrors the term loan facility and provides a fixed rate of interest of 3.76% plus an applicable borrowing spread of between 100 and 200 basis points above LIBOR depending on the ratio of senior debt to EBITDA at the end of each quarter. This interest rate swap is used to hedge interest rate risks related to the Company’s variable rate term loan and is accounted for as a cash flow hedge.

At June 30, 2005, the Company had letters of credit outstanding under the Credit Agreement totaling $7.2 million, primarily for health and workers’ compensation insurance.

4. COMMITMENTS AND CONTINGENCIES

The Company is subject to federal, state and local environmental protection laws and regulations. The Company’s management believes the Company is in compliance, or is taking action aimed at assuring 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 the consolidated financial condition or results of operations.

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. Huttig is voluntarily remediating this property under the oversight of and in cooperation with the Montana Department of Environmental Quality (“MDEQ”), and is complying with a 1995 unilateral administrative order of the MDEQ to complete a remedial investigation and feasibility study. The remedial investigation was completed and approved in 1998 by the MDEQ, which has issued its final risk assessment of this property. In March 2003, the MDEQ approved Huttig’s work plan for conducting a feasibility study to evaluate alternatives for cleanup. In July 2004, Huttig submitted the feasibility study report, which evaluated several potential remedies, including continuation and enhancement of remedial measures already in place and operating. The MDEQ will comment on the feasibility study report and its recommended remedy, and 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. Based on experience to date in remediating this site, the Company believes that the scope of remediation that the MDEQ ultimately determines will not have a material adverse effect on its results of operations or financial condition. The Company spent approximately $0.1 million on remediation costs at this site in both of the six-month periods ended June 30, 2005 and June 30, 2004. The annual level of future remediation expenditures is difficult to estimate, because of the uncertainty relating to the final remedy to be selected. As of June 30, 2005, the Company has accrued $0.5 million for future costs of remediating this site which management believes represents a reasonable estimate, based on current facts and circumstances, of the currently expected costs of continued remediation. Until the MDEQ selects a final remedy, however, management can give no assurance as to the scope or cost to Huttig of the final remediation order.

In June 2004, as part of the due diligence conducted by a party interested in acquiring the American Pine Products facility, a previously unknown release of petroleum hydrocarbons and pentachlorophenol, or PCP, was discovered in soil and groundwater at the facility. Based on the initial investigation, the Company believes that the source of the contamination was a former wood-dipping operation on the property that was discontinued approximately 20 years ago, prior to Huttig acquiring the facility. The Company has voluntarily reported this discovery to the Oregon Department of Environmental Quality (“ODEQ”) and has agreed to participate in the ODEQ’s voluntary cleanup program. Pursuant to this program the Company is investigating and has begun to remediate the property under the oversight of the ODEQ. The Company is currently conducting a preliminary assessment of the scope of contamination and potential required remediation, and reviewing whether it can recover its costs from other possible responsible parties, including previous owners of this facility. The Company spent less than $0.1 million on remediation costs at this site in the six-month period ended June 30, 2005. As of June 30, 2005, the Company has accrued $0.1 million for future costs of remediating this site which management believes represents a reasonable estimate, based on current facts and circumstances, of the currently expected costs of continued remediation. Until the ODEQ selects a final remedy, however, management can give no assurance as to the scope or cost to Huttig of the final remediation order.

The Company and a former-employee driver have both been named as defendants in a wrongful-death lawsuit that alleges liability for damages arising out of an accident that occurred on January 8, 2004 in Tampa, FL. The lawsuit commenced on or about January 28, 2005. The case is pending in the Federal District Court, District of Florida, Middle District, Tampa Division. Defendants have denied liability for the claim and are defending themselves in the litigation. The case is in an early, pre-discovery stage. At this time, management of the Company cannot reasonably predict the ultimate or likely outcome of this matter.

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The Company accrues expenses for contingencies when it is probable that an asset has been impaired or a liability has been incurred and management can reasonably estimate the expense. Contingencies for which the Company has 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 the Company’s 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.

5. BASIC AND DILUTED NET INCOME PER SHARE

The following table sets forth the computation of net income per basic and diluted share (net income amounts in millions, share amounts in thousands, per share amounts in dollars):

At June 30, 2005 and 2004, all stock options were dilutive.

6. DIVESTITURES

During the first half of 2005, the Company sold its remaining Builder Resource one-step branches, and certain assets, including certain accounts receivable, inventory, equipment and real property for $10.8 million in cash and reported an after-tax gain of $1.3 million. The after-tax gain is included in net income from discontinued operations for the 2005 first half. The Company used the proceeds of the sale to pay down debt and retained trade payables. The Company reported these branches as discontinued operations and related assets were classified as held for sale effective December 31, 2004.

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The following are major classes of assets for the discontinued operations described above that were held for sale at June 30, 2005 and December 31, 2004:

DISCONTINUED OPERATIONS

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions)

Operating results of our discontinued operations are shown below:

DISCONTINUED OPERATIONS

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

7. ACQUISITION

Effective January 1, 2005, the Company, through its wholly owned subsidiary, Huttig Texas Limited Partnership, completed the purchase of substantially all of the assets of Texas Wholesale Building Materials, Inc. (“Texas Wholesale”) for $15.0 million in cash, $2.2 million in guaranteed payments to the former majority owner and the assumption of certain liabilities. Texas Wholesale’s results of operations have been included in the consolidated financial statements since the date of acquisition. The Texas Wholesale acquisition represents the Company’s first full line distribution operation in the state of Texas, in accordance with its acquisition strategy.

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The following table presents the preliminary allocation of the acquisition costs to the assets acquired and liabilities assumed, based on fair values:

The allocation of the purchase price is based on preliminary data and could change when valuations of assets and property, plant, and equipment are finalized. The assets that make up the $3.3 million of acquired intangible assets include: customer relationships valued at $0.9 million (20-year weighted average useful life) and a covenant not to compete valued at $2.4 million (6-year weighted average useful life). The residual purchase price of $6.0 million was assigned to goodwill.

The following tables reflect the acquisition of intangible assets and the changes in the carrying amount of goodwill for the six months ended June 30, 2005:

Acquired Amortizable Intangibles

Estimated amortization expense:

Goodwill

The pro forma effects of the Texas Wholesale acquisition on the Company’s consolidated income statements were not material.

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Huttig is a distributor of building materials used principally in new residential construction and in home improvement, remodeling, and repair work. We distribute our products through 46 distribution centers serving 47 states and sell primarily to building materials dealers, national buying groups, home centers and industrial users, including makers of manufactured homes.

The following table sets forth our sales from continuing operations, by product classification as a percentage of total sales, for the three and six months ended June 30, 2005 and June 30, 2004:

Industry Conditions

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, generally, 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,” below.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles, which require management to make estimates and assumptions. Management bases these estimates and assumptions on historical results and known trends as well as management forecasts. Actual results could differ from these estimates and assumptions. See our Annual Report on Form 10-K in Part II, Item 7 - “Critical Accounting Policies.”

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Results of Operations

Three Months Ended June 30, 2005 Compared to the Three Months Ended June 30, 2004

Continuing Operations

Net sales from continuing operations were $281.4 million, which was $38.7 million, or approximately 16%, higher than 2004. Dallas and, to a lesser extent, the new branches in Atlanta, Minneapolis, and Long Island accounted for over one-half of the increase in the 2005 period. Same branch sales increased by approximately 6% in the 2005 second quarter over the prior year quarter, primarily as a result of increased millwork and building products sales.

By product, sales increased in the millwork and building product categories, compared to the year-ago quarter and remained relatively flat in the wood products category. Millwork sales increased 20% to $147.3 million led by exterior and interior doors, windows and columns, which increases were partially offset by a decrease in mouldings. Building products increased 19% to $84.5 million led by connectors, decking and housewrap. Wood products remained relatively stable at $49.6 million.

By region, sales in the Southeast region increased 20%, excluding Dallas. Sales in the West increased 5%. Due in part to the heavy rain early in the quarter, sales in the Northeast increased only 1% and sales were stable in the Midwest.

Gross margin increased about 10% to $52.9 million or 18.8% of sales as compared to $48.2 million or 19.9% of sales in the prior year period. Approximately one-half of the decline in gross margin percentage was due to Dallas and the remainder of the change was primarily due to lower gross margins on mouldings, steel, lumber and panel products, partially offset by improved gross margins on doors and a slightly improved product mix. Excluding Dallas, gross margin as a percentage of sales would have been approximately 19.3% for the quarter.

Operating expenses totaled approximately $44.7 million or 15.9% of sales, compared to approximately $39.6 million or 16.3% of sales in the prior-year quarter. Dallas and the other new branches accounted for approximately $3.6 million of this increase. Operating expenses in the 2005 second quarter also reflected increased fuel costs and building rent partially offset by lower incentive compensation expense and lower insurance reserve expenses. Operating expenses in the 2005 second quarter also reflected executive severance costs of $0.6 million, including non-cash expense of $0.3 million.

The year-ago quarter included a gain on the sale of a facility of $0.5 million, which benefited after tax results by approximately $0.02 a share.

Net interest expense increased to $1.2 million in the current quarter from $1.1 million in the prior year quarter. This increase was largely due to higher interest rates.

Income taxes as a percentage of pre-tax income for the three months ended June 30, 2005 and 2004 were 37% and 25%, respectively. The effective tax rate in the year-ago quarter was lower due to the closure of multi-year tax audits allowing Huttig to eliminate certain tax accruals. The difference in the effective tax rate benefited the prior year by approximately $0.04 per diluted share, compared to the current-year period.

As a result of the foregoing factors, income from continuing operations decreased to $3.6 million in the 2005 second quarter from $5.0 million in the year-ago quarter.

Six Months Ended June 30, 2005 Compared to the Six Months Ended June 30, 2004

Continuing Operations

Net sales from continuing operations were $530.8 million, which was $74.2 million, or approximately 16%, higher than in the first half of 2004. Dallas and, to a lesser extent, the new branches in Atlanta, Minneapolis, and Long Island accounted for over one-half of the increase in the 2005 period. Same branch sales increased by approximately 6% in the 2005 first half over the prior year first half, primarily as a result of increased millwork and building products sales.

By product, sales increased in all major product categories compared to the same period last year. Millwork sales increased 18% to $276.8 million led by exterior and interior doors, windows and columns, which increases were partially offset by a decrease in mouldings. Building products increased 20% to $157.4 million led by connectors, decking and housewrap. Wood products increased slightly to $96.6 million.

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By region, sales in the Southeast region increased 22%, excluding Dallas. Sales in the West increased 8%. Due in part to the heavy snowstorms and rain in the first half of 2005, sales in the Northeast decreased 1% and sales were stable in the Midwest.

Gross margin increased about 12% to $100.4 million or 18.9% of sales as compared to $90.0 million or 19.7% of sales in the first half of last year. Approximately one-half of the decline in gross margin percentage was due to Dallas and the remainder of the change was primarily due to lower gross margins on mouldings, steel, lumber and panel products, partially offset by improved gross margins on doors and a slightly improved product mix. Excluding Dallas, gross margin as a percent of sales would have been approximately 19.5% for the first half of 2005.

Operating expenses totaled approximately $85.6 million or 16.1% of sales, compared to approximately $75.6 million or 16.6% of sales in the first half of 2004. Dallas and the other new branches accounted for approximately $6.5 million of this increase. Operating expenses in the first half of 2005 also reflected increased fuel cost and building rent as well as executive severance costs of $0.8 million, including non-cash expenses of $0.3 million, and were partially offset by a receipt of $0.6 million from Rugby in connection with the settlement of a lawsuit.

The first half of 2005 included a gain on the sale of a facility of $2.5 million compared to a $0.5 million gain in the same period in the prior year.

Net interest expense increased to $2.3 million in the first-half of 2005 from $2.2 million in the prior year first half. This increase was largely due to higher interest rates.

Income taxes as a percentage of pre-tax income for the six months ended June 30, 2005 and 2004 were 39% and 30%, respectively. The effective tax rate in the year-ago quarter was lower due to the closure of multi-year tax audits allowing Huttig to eliminate certain tax accruals. The difference in the effective tax rate benefited the prior year by approximately $0.04 per diluted share, compared to the current year period.

As a result of the foregoing factors, income from continuing operations increased to $7.5 million in the 2005 first half from $7.1 million in the first-half of 2004.

Discontinued Operations

Results from discontinued operations in the 2005 first half reflect sales of $2.5 million and an after-tax gain of $1.3 million on the February 1, 2005 divestiture of the remaining Builder Resource one-step branches. Sales in the first half of 2004 were $64.3 million, operating profit was $3.7 million, and net income was $2.3 million. Operating results included American Pine Products, and all of the Builder Resource branches, some of which were sold later in 2004.

Liquidity and Capital Resources

We depend on cash flow from operations and funds available under our revolving 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 reflect 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 June 30, 2005 and 2004, inventories constituted approximately 37% and 33% 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.

Operations. Cash used in operating activities increased $2.9 million to $22.3 million for the six months ended June 30, 2005 from $19.4 million in 2004. The increase in cash used by operating activities primarily reflects an increase in working capital compared to the six months ended June 2004. Days sales outstanding decreased to 35 days at June 30, 2005 compared to 36 days at June 30, 2004 based on annualized sales for the respective immediately preceding quarter. Annualized inventory turns, calculated as the ratio of annualized respective cost of goods sold for each three-month period ended June 30 divided by the average of the beginning and ending inventory balances for each such three-month period, decreased to 8.4 turns at June 30, 2005 compared to 8.7 turns at June 30, 2004.

Investing. Cash used in investing activities for the six months ended June 30, 2005 reflects $15.0 million used for the acquisition of Texas Wholesale, and $3.3 million of capital expenditures for normal, continuing operating activities. The

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uses of cash in investing activities were partially offset by $10.8 million of proceeds from the disposition of our remaining Builder Resource locations in Alabama, Tennessee, and Kansas, $2.4 million of proceeds from the sale of our Manchester, New Hampshire facility and $0.2 million of proceeds from the sale of various other equipment. Cash used in investing activities in the six months ended June 30, 2004 reflects $1.2 million of capital expenditures for normal operating activities, which were partially offset by $0.5 million of proceeds from the sale of a facility.

Financing. Cash provided from financing activities for the first six months of 2005 and 2004 primarily reflect the $32.0 million and $21.0 million in net borrowings, respectively, under our revolving credit facilities. Cash provided from financing activities in the 2005 first half also reflects $4.2 million from the exercise of employee stock options. In 2005 and 2004, cash was used to pay back $0.6 million and $0.7 million, respectively, of capital lease obligations.

We have a Credit Agreement, which provides for a term loan facility of $30 million and a revolving credit facility of $130 million, which expires in September 2009. The revolving credit facility may be increased, subject to certain conditions, including bank approval, to a maximum availability of $180 million. As of June 30, 2005, we had revolving credit borrowings of $40.0 million, at a weighted average interest rate of 5.2% and $26.8 million outstanding on the term loan, at an interest rate of 5.2% under the Credit Agreement. Compliance with the loan covenant in the Credit Agreement that is based on the amount of senior debt outstanding limits the amount available under our revolving credit facility. At June 30, 2005, we would have had approximately $28.5 million of credit available under the revolving credit facility, in addition to the amount outstanding, based on the revised financial covenants (see below).

The term loan facility provides for quarterly principal payments of approximately $1.1 million. Subject to certain exceptions, we are required to repay amounts outstanding under the Credit Agreement from the cash proceeds of asset dispositions, debt or equity securities issuances and insurance claims related to its real estate. We must also pay a commitment fee in the range of 0.25% to 0.40% per annum on the average daily-unused amount of the revolving credit commitment. The entire unpaid balance under the Credit Agreement is due and payable on September 23, 2009, the maturity date of the Credit Agreement.

The Credit Agreement contains financial covenants, including a minimum fixed charge coverage ratio, a maximum senior debt to earnings before interest, taxes, depreciation and amortization, as defined (EBITDA), ratio, a minimum asset coverage ratio, and minimum tangible net worth. The Credit Agreement also contains restrictive covenants pertaining to the management and operations of Huttig and its subsidiaries. The covenants include, among others, limitations on indebtedness, guarantees, letters of credit, liens, investments, dividends, acquisitions and asset sales. Effective July 30, 2005, the Company amended its Credit Agreement, including certain of the financial covenants. We are in compliance with the debt covenants as amended.

We have an interest rate swap agreement, which will expire in September 2009, which mirrors the term loan facility and provides a fixed rate of interest of 3.76% plus an applicable borrowing spread of between 100 and 200 basis points above LIBOR, depending on the ratio of senior debt to EBITDA at the end of each quarter. This interest rate swap is used to hedge interest rate risks related to our variable rate term loan and is accounted for as a cash flow hedge.

At June 30, 2005, we had letters of credit outstanding under the Credit Agreement totaling $7.2 million, primarily for health and workers’ compensation insurance.

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.

Off-Balance Sheet Arrangements

In addition to funds available from operating cash flows, and bank credit agreements as described above, we use a principal off-balance sheet technique: operating leases. Operating leases are employed as an alternative to purchasing certain property, plant and equipment. See our Annual Report on Form 10-K in Part II, Item 7 - “Commitment and Contingencies.”

Divestitures

During the first half of 2005, we sold our remaining Builder Resource one-step branches, and certain assets, including accounts receivable, inventory, equipment and real property for $10.8 million in cash and reported an after-tax gain of $1.3 million. The after-tax gain is included in net income from discontinued operations for the six months ended June 30, 2005. We used the proceeds of the sale to pay down debt and trade payables. We reported these branches as discontinued operations and related assets were classified as held for sale effective December 31, 2004.

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Acquisition

During the first quarter of 2005, we, through our wholly owned subsidiary, Huttig Texas Limited Partnership, completed the purchase of substantially all of the assets of Texas Wholesale for $15.0 million in cash, $2.2 million in guaranteed payments to the former majority owner and the assumption of certain liabilities. The source of funds for the acquisition was our existing credit facility.

Environmental Regulation

We are subject to federal, state and local environmental protection laws and regulations. We believe that we are in compliance, or are taking action aimed at assuring 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 or operations.

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 and are complying with a 1995 unilateral administrative order of the Montana DEQ to complete a remedial investigation and feasibility study. The remedial investigation was completed and approved in 1998 by the Montana DEQ, which has issued its final risk assessment of this property. In March 2003, the Montana DEQ approved Huttig’s work plan for conducting a feasibility study to evaluate alternatives for cleanup. In July 2004, we submitted the feasibility study report, which evaluated several potential remedies, including continuation and enhancement of remedial measures already in place and operating. The Montana DEQ will comment on the feasibility study report and its recommended remedy, and 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. Based on our experience to date in remediating this site, we believe that the scope of remediation that the Montana DEQ ultimately determines will not have a material adverse effect on our results of operations or financial condition. We spent approximately $0.1 million on remediation costs at this site in both of the six-month periods ended June 30, 2005 and June 30, 2004. The annual level of future remediation expenditures is difficult to estimate because of the uncertainty relating to the final remedy to be selected. As of June 30, 2005, we have accrued $0.5 million for future costs of remediating this site which management believes represents a reasonable estimate, based on current facts and circumstances, of the currently expected costs of continued remediation. Until the Montana DEQ selects a final remedy, however, management can give no assurance as to the scope or cost to Huttig of the final remediation order.

In June 2004, as part of the due diligence conducted by a party interested in acquiring the American Pine Products facility, a previously unknown release of petroleum hydrocarbons and pentachlorophenol, or PCP, was discovered in soil and groundwater at the facility. Based on the initial investigation, we believe that the source of the contamination was a former wood-dipping operation on the property that was discontinued approximately 20 years ago, prior to our acquiring the facility. We voluntarily reported this discovery to the Oregon Department of Environmental Quality and agreed to participate in the Oregon DEQ’s voluntary cleanup program. Pursuant to this program we are investigating and, have begun to remediate the property under the oversight of the Oregon DEQ. We are currently conducting a preliminary assessment of the scope of contamination and potential required remediation, and reviewing whether we can recover our costs from other possible responsible parties, including previous owners of this facility. We spent less than $0.1 million on remediation costs at this site in the six-month period ended June 30, 2005. As of June 30, 2005, we have accrued $0.1 million for future costs of remediating this site which management believes represents a reasonable estimate, based on current facts and circumstances, of the currently expected costs of continued remediation. Until the Oregon DEQ selects a final remedy, however, management can give no assurance as to the scope or cost to Huttig of the final remediation order.

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.

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Cautionary Statement

Certain statements in this Form 10-Q contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including but not limited to statements regarding:

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. 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:

Additional information concerning these and other factors that could materially affect our results of operations and financial condition are included in our most recent Annual Report on Form 10-K. We disclaim any obligation to publicly update or revise any of these forward-looking statements.

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ITEM 3 — 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 June 30, 2005 under our secured revolving credit facility of $40.0 million and a term loan of $26.8 million.

In September 2004, we entered into an interest rate swap agreement, which will expire in September 2009, which mirrors the amortization of the $30.0 million term loan and provides a fixed rate of interest of 3.76% plus the applicable borrowing spread of between 100 and 200 basis points above LIBOR, depending on the ratio of senior debt to EBITDA at the end of each quarter. This interest rate swap is used to hedge interest rate risks related to our variable rate term loan and is accounted for as a cash flow hedge.

All of our bank debt under our secured revolving credit facility accrues interest at a floating rate basis of between 100 and 200 basis points above LIBOR. If market interest rates for LIBOR had been different by an average of 1% for the six months ended June 30, 2005, our interest expense and income before taxes would have changed by $0.2 million. These amounts are determined by considering the impact of the hypothetical interest rates on our borrowing cost. This analysis does 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 and steel commodities. Profitability is influenced by these changes as prices change between the time we buy and sell the wood or steel products. In addition, to the extent changes in interest rates affect the housing and remodeling markets, we could be affected by such changes.

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ITEM 4 – CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures – The Company, under the supervision and with the participation of our Disclosure Committee and management, including our Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities and Exchange Act of 1934). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective as of June 30, 2005 in (a) causing information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 to be recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (b) causing such information to be accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in internal control of financial reporting – We routinely review our system of internal control over financial reporting to identify potential changes to our processes and systems that may improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating the activities of acquired business units, formalizing policies and procedures, improving segregation of duties, and adding additional monitoring controls. In addition, when we acquire new businesses, we incorporate our controls and procedures into the acquired business as part of our integration activities. There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Control systems must reflect resource constraints and be cost-effective, can be undercut by simple errors and misjudgments, and can be circumvented by individuals within an organization. Because of these and other inherent limitations in all control systems, no matter how well they are designed, our disclosure controls and procedures and internal controls can provide reasonable, but not absolute, protection from error and fraud.

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