HUTTIG BUILDING PRODUCTS INC - Quarter Report: 2022 March (Form 10-Q)

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 March 31, 2022

or

☐ 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)

(314) 216-2600

(Registrant’s telephone number, including area code)

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

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  ☑    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☑    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☑

The number of shares of Common Stock outstanding on May 2, 2022 was 27,326,213 shares.

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PART I FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS

HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in millions, except per share data)

See notes to condensed consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

(in millions)

See notes to condensed consolidated financial statements

4

HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

(in millions, except share data)

See notes to condensed consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(unaudited)

(in millions)

See notes to condensed consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in millions)

See notes to condensed consolidated financial statements

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HUTTIG BUILDING PRODUCTS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. BASIS OF PRESENTATION

The unaudited interim condensed consolidated financial statements of Huttig Building Products, Inc. and its subsidiary (the “Company” or “Huttig”) were prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) 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. Financial statement preparation further requires 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 and these differences may be material. 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, 2021.

The condensed 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, or any other interim period, which may differ materially due to, among other things, the factors described in Part I, Item 2 of this Quarterly Report on Form 10-Q and those set forth under Part I, Item 1A – “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, as updated by Part II, Item IA – “Risk Factors” of this Quarterly Report on Form 10-Q. 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. NEW ACCOUNTING STANDARDS

Adoption of New Accounting Standards

Recent accounting pronouncements pending adoption are either not applicable or will not have, or are not expected to have, a material impact on our consolidated financial condition, results of operations, or cash flows.

3. REVENUE

Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods.  The Company reports sales revenue, including direct sales, on a net basis, which includes gross revenue adjustments for estimated returns, cash payment discounts based on the satisfaction of outstanding receivables, and volume purchase rebates.  The Company’s customer payment terms vary by customer, location, and the products purchased, but are typical for the Company’s industry.

Regarding direct sales, the Company is the principal of these arrangements and is responsible for fulfilling the promise to provide specific goods to its customers, including product specifications, pricing and modifications prior to delivery.  Direct sales as a percentage of net sales were 27.7% and 25.8% in the three month periods ended March 31, 2022 and 2021, respectively.

The following table disaggregates revenue by product classification (in millions):

4. LEASES

The Company has operating and financing leases for corporate offices, distribution centers, vehicles, and certain equipment. These leases have remaining lease terms of less than one year to 10 years, and many of the leases have renewal options.  Because the Company is not reasonably certain to exercise the renewal options, the options are not considered in determining the lease term, and associated potential option payments are excluded from lease payments and right-of-use calculations.  Leases with an initial term of 12 months or less are likewise excluded from right-of-use calculations.

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In addition to fixed payments, many of the Company’s lease contracts contain variable payments. Vehicle lease variable payments typically include mileage, and real estate leases include variable charges for taxes and common area maintenance. Variable lease payments and payments for leases with an initial term of 12 months or less are recognized in the period incurred.

The following lease assets and liabilities are included on the condensed consolidated balance sheet (in millions):

As of March 31, 2022, the weighted average remaining lease term for the Company’s operating leases was 4.7 years and for its financing leases was 3.5 years. These leases have weighted average discount rates of 5.5% and 4.6% for operating leases and financing leases, respectively. The rate implicit in the lease is used to discount leases when known. While the implicit rate is often known for finance leases, the Company is generally unable to calculate the implicit rate in operating leases because it does not have access to the lessor’s residual value estimates nor the amount of the lessor’s deferred initial direct costs.  When the implicit rate is not known, the Company uses the incremental borrowing rate for secured loans of similar term. The Company uses available data for unsecured loans to borrowers of similar credit to the Company and adjusts the rate to reflect the effect of providing collateral equivalent to the outstanding obligation balance.

The following cash flow items are included on the condensed consolidated statement of cash flows (in millions):

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Maturities of lease liabilities are as follows (in millions):

5. ALLOWANCE FOR DOUBTFUL ACCOUNTS

The allowance for doubtful accounts consisted of the following (in millions):

6. DEBT

Debt consisted of the following (in millions): 

Credit Facility — In the third quarter of 2021, the Company entered into a five-year, $250.0 million asset-based senior secured revolving credit facility (the “credit facility”) with a maturity date of September 29, 2026, replacing its prior credit facility. Borrowing availability under the credit facility is based on eligible accounts receivable, inventory and real estate. The real estate component of the borrowing base amortizes monthly over 15.0 years on a straight-line basis. Borrowings under the credit facility are collateralized by substantially all of the Company’s assets, and the Company is subject to certain operating limitations applicable to a loan of this type, which, among other things, place limitations on indebtedness, liens, investments, mergers and acquisitions, dispositions of assets, cash dividends and transactions with affiliates.  

At March 31, 2022, the Company had revolving credit borrowings of $80.7 million outstanding at a weighted average interest rate of 1.84% per annum, letters of credit outstanding totaling $3.5 million, primarily used as collateral for health and workers’ compensation insurance, and $163.9 million of excess committed borrowing availability.  The Company pays an unused commitment fee of 0.25% per annum. In addition, the Company had $0.6 million of other obligations maturing in 2023 at a borrowing rate of 6.11%. The Company also had $4.0 million of financing lease obligations at March 31, 2022. See Note 4 – “Leases” for more information.  

The sole financial covenant in the credit facility is the minimum fixed charge coverage ratio (“FCCR”) of 1.00:1.00, which must be tested by the Company if the excess committed borrowing availability falls below an amount in the range of $15.0 million to $25.0 million, depending on the borrowing base. Since the inception of the agreement in 2021, the Company was not required to test the minimum FCCR as excess borrowing availability was greater than the minimum threshold. If the Company’s availability would have fallen below that threshold, the Company would have met the minimum FCCR. The FCCR must also be tested on a pro forma basis prior to consummation of certain significant business transactions outside the ordinary course of business, as defined in the agreement.

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7. OTHER ACCRUED LIABILITIES

The Company had other accrued liabilities consisting of the following (in millions):

8. CONTINGENCIES

The Company carries insurance policies on insurable risks with coverage and other terms that it believes to be appropriate. The Company has self-insured retention limits and has obtained fully insured layers of coverage above such self-insured retention limits. Accruals for self-insurance losses are made based on claims experience. Liabilities for existing and unreported claims are accrued when it is probable that future costs will be incurred and can be reasonably estimated.

Environmental and Legal Matters

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 and other legal matters. It is possible, however, that actual expenses could exceed the accruals by a material amount, which could have a material adverse effect on the Company’s future liquidity, financial condition, and operating results in the period in which any such additional expenses are incurred or recognized.

Environmental Matters

The Company was previously identified as a potentially responsible party in connection with contamination cleanup at a formerly owned property in Montana. On February 18, 2015, the Montana Department of Environmental Quality (the “DEQ”) issued an amendment to the unilateral administrative order of the DEQ outlining the final remediation of the property in its Record of Decision.  In September 2015, the remedial action work plan (“RAWP”) was approved.

The Company paid approximately $0.3 million in the first three months of 2022 implementing the RAWP.  The Company estimates the total remaining cost of implementing the RAWP to be $2.0 million at March 31, 2022, with $0.9 million in short-term other accrued liabilities and $1.1 million in other non-current liabilities. As of March 31, 2022, the Company believes the accrual represents a reasonable best estimate of the total remaining remediation costs, based on facts, circumstances, and information currently available.  However, there are currently unknown variables relating to the actual levels of contaminants and amounts of soil that will ultimately require treatment or removal. As part of the remediation process, additional soil and groundwater sampling, and bench and pilot testing are required to ensure the remediation will achieve the outcome required by the DEQ.  The ultimate final amount of remediation costs and expenditures is difficult to estimate with certainty and as a result, the amount of actual costs and expenses ultimately incurred by the Company with respect to this property could be lower than, or exceed the amount accrued as of March 31, 2022 by a material amount.  If actual costs are materially higher, the incremental expenses over the amount currently accrued could have a material adverse effect on the Company’s liquidity, financial condition and operating results.

With consent of the DEQ, remediation efforts and expenditures were temporarily suspended during 2020 as a result of pandemic-related health, safety, financial and other considerations.  During the first quarter of 2021, the Company re-engaged in remediation efforts in cooperation with the DEQ and expects to continue remedial activities throughout the remainder of 2022.  

In addition, some of the Company’s current and former distribution centers are located in areas where environmental contamination may have occurred, and for which the Company, among others, could be held responsible. The Company currently believes that there are no material environmental liabilities at any of its distribution center locations.

9. EARNINGS PER SHARE

The Company calculates its basic income per share by dividing net income allocated to common shares outstanding by the weighted average number of common shares outstanding. Unvested shares of restricted stock participate in dividends on the same basis as common shares. As a result, these share-based awards meet the definition of participating securities, and the Company applies the two-class method to compute earnings per share. The two-class method is an earnings allocation formula that treats participating securities as having rights to earnings that would otherwise have been available to common stockholders. In periods in which the Company has net losses, the losses are not allocated to participating securities because the participating security holders are not obligated to share in such losses.

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The following table presents the number of participating securities (in millions):

The diluted earnings per share calculations include the effect of assumed exercise using the treasury stock method for unvested restricted stock units, except when the effect would be anti-dilutive.  The following table presents the number of common shares used in the calculation of net income per share from continuing operations (in millions):

10. INCOME TAXES

In each reporting period, the Company assesses available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of existing deferred tax assets. A significant component of this analysis is to determine whether the Company is in a cumulative loss position for the most recent three-year period. As a result of the Company’s financial performance in 2021, and the three-year period ended March 31, 2022, the Company is in a cumulative income position related to federal and certain state deferred tax assets. At March 31, 2022, the Company maintained an $6.6 million valuation allowance on other state deferred tax assets, including state net operating losses that are more likely than not to expire before utilization.

The Company’s effective tax rate from continuing operations was an expense of 24.2% and 0% for the three-month periods ended March 31, 2022 and 2021, respectively.

11. STOCK-BASED COMPENSATION

The Company recognized $0.2 million and $0.4 million in non-cash, stock-based compensation expense for the first quarter of 2022 and 2021, respectively.  During the first three months of 2022, the Company granted zero shares of restricted stock under its 2005 Executive Incentive Compensation Plan, as amended and restated. Most restricted shares vest in three equal installments on the first, second, and third anniversaries of the grant date. During the first three months of 2022, the Company granted zero shares of restricted stock under its Non-Employee Directors’ Restricted Stock Plan, as amended. The directors’ restricted shares vest on the first anniversary of the grant date. Unearned compensation expense is amortized into expense on a straight-line basis over the requisite service period for the entire award. As of March 31, 2022 and 2021, the total compensation expense not yet recognized related to all outstanding restricted stock awards was $1.1 million and $2.2 million, respectively.

12. WOODGRAIN PLAN OF MERGER

On March 20, 2022, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Woodgrain Inc., an Oregon corporation (“Woodgrain”), and HBP Merger Sub, Inc. a Delaware corporation and a wholly-owned subsidiary of Woodgrain (“Merger Sub”) under which Merger Sub will purchase all of the outstanding shares of the Company’s common stock for $10.70 per share. On May 3, 2022, Merger Sub and Woodgrain completed the acquisition of all outstanding shares of the Company, repaid the outstanding borrowings under the Credit Facility dated as of September 29, 2021, and terminated the Credit Facility. Additionally, on May 3, 2022, the Company notified The Nasdaq Market LLC (“Nasdaq”) that the Merger Agreement had been completed and requested that trading of the Company’s shares on Nasdaq be halted prior to the opening of trading on May 3, 2022 and suspended at the close of the trading on May 3, 2022.

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 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 Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  The words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “believe,” “estimate,” “project” or similar expressions may identify forward-looking statements, although not all forward-looking statements contain such words.  Statements made in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K looking forward in time, including, but not limited to, statements regarding our current views with respect to financial performance, future growth in the housing market, distribution channels, sales, favorable supplier relationships, inventory levels, the ability to meet customer needs, enhanced competitive posture, strategic initiatives, absence of material financial impact from litigation or contingencies, including environmental proceedings, are included pursuant to the “safe harbor” provision 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. We cannot guarantee that any forward-looking statements will be realized or achieved.  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, whether as a result of new information, future events or otherwise.

There are a number of factors, some of which are beyond our control 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: our ability to successfully identify and execute upon a potential strategic alternative to maximize shareholder value; the success of our growth initiatives; risks associated with our private brands; the strength of new construction, home improvement and remodeling markets, including the overall strength of the homebuilding industry where the historical annual average of total housing starts from 1959 to 2021 is approximately 1.4 million starts based on statistics tracked by the U.S. Census Bureau (“Historical Average”); the cyclical nature of our industry; risks of international suppliers; the impact of global health concerns, including the current COVID-19 pandemic, and governmental responses to such concerns, on our business, results of operations, liquidity and capital resources; product liability claims and other legal proceedings; market price changes, including inflation; commodity prices and demand in light of the COVID-19 pandemic; competition with existing or new industry participants; our failure to attract and retain key personnel and our general employee population; deterioration in our relationship with our unionized employees, including work stoppages or other disputes; funding requirements for multi-employer pension plans for our unionized employees; our ability to comply with, and the restrictive effect of, the financial covenant applicable under our credit facility; deterioration of our customers’ creditworthiness or our inability to forecast such deteriorations, particularly in light of the COVID-19 pandemic; the loss of a significant customer; termination of key supplier relationships; the ability to source alternative suppliers in light of the COVID-19 pandemic; supply chain disruption; current or future litigation; the cost of environmental compliance, including actual expenses we may incur to resolve proceedings we are involved in arising out of a formerly owned facility in Montana; federal and state transportation regulations; uncertainties resulting from changes to United States and foreign laws, regulations and policies; the potential impact of changes in tariff costs, including tariffs on imported steel and aluminum, and potential anti-dumping or countervailing duties; fuel cost increases; stock market volatility; failure to meet exchange listing requirements; stockholder activist disruption; information technology failures, network disruptions, cybersecurity attacks or breaches in data security; significant uninsured claims; the integration of any business we acquire and the liabilities of such businesses; the seasonality of our operations; any limitations on our ability to utilize our deferred tax assets to reduce future taxable income and tax liabilities; intangible asset impairment; and those factors set forth under Part I, Item 1A – “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021, as updated by Part II, Item 1A – “Risk Factors” of this Quarterly Report on Form 10-Q. These factors may not constitute all factors that could cause actual results to differ from those discussed in any forward-looking statement. Accordingly, forward-looking statements should not be relied upon as a predictor of actual results.

Overview

We are a distributor of a broad array of building material products used principally in new residential construction, home improvement, and remodeling and repair projects.  We distribute our products through 25 distribution centers serving 41 states and sell primarily to building materials dealers, national buying groups, home centers and industrial users, including makers of manufactured homes.

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The following table sets forth our sales by product classification as a percentage of total sales:

Industry Conditions

New housing activity has shown improvement each year since 2009. In 2021, total housing starts increased approximately 16% to 1.6 million, crossing the Historical Average of 1.4 million total housing starts from 1959 to 2021 based on statistics tracked by the United States Census Bureau. Total housing starts were approximately 0.4 million in the first three months of 2022. Through March 31, 2022, based on the most recent data provided by the United States Census Bureau, total new housing starts were 10.3% higher than 2021 levels for the corresponding three-month period.

In March 2020, the World Health Organization recognized the novel strain of coronavirus, COVID-19, as a pandemic. The United States, various other countries and state and local jurisdictions imposed, among other things, travel and business operation restrictions intended to limit the spread of the COVID-19 virus and advised or required individuals to adhere to social distancing or limit or forego their time outside of their home beginning the first quarter of 2020.  Some countries and jurisdictions began to lift these restrictions in 2021 as a result of the distribution of COVID-19 vaccines but, given the recent rise of COVID-19 variants, this trend may reverse and has reversed in some countries and jurisdictions experiencing a recent rise in COVID-19 cases. This pandemic and the governmental response have resulted in significant and widespread economic disruptions to, and uncertainty in, the global and U.S. economy, including in the regions in which we operate. In many jurisdictions, we and our customers were deemed “essential businesses” and continued to operate, reducing the impact of these restrictions on our operations and results for the three-month period ended March 31, 2022. We expect the Company will continue to be deemed an “essential business” throughout 2022 and will continue to operate. However, we cannot reliably predict the future impact of the pandemic and the governmental response to the pandemic on our operations and future results.

All of our branches remain open and capable of meeting customer needs. We have taken protective measures to guard the health and well-being of our employees and customers, including the implementation of social distancing requirements and remote work options where possible. The pandemic has also had a global adverse impact to the supply chain, including significant ocean cargo delays and material shortages. Some of our vendors have put us on allocation as a result of reduced inventory and labor shortages, resulting in longer lead-times for the fulfillment of certain products. Early in the pandemic, in 2020, we adjusted our sales forecast and took proactive measures to protect our operating liquidity, including communicating with vendors and customers, seeking modification of payment and other terms of rental and procurement agreements and monitoring accounts receivable. We initially reduced inventory levels to meet an anticipated decrease in demand and have continued to manage inventories according to regularly updated sales forecasts.. We have utilized our diverse overseas network to source alternative suppliers of our proprietary products, while simultaneously adjusting our purchase volume to better align with our current sales projections and to manage the supply chain. We have experienced COVID-19 related delays in obtaining distribution and warehouse equipment through 2021 and continuing into the first quarter of 2022.

While we believe these actions have mitigated the impact of the pandemic on our operations, we cannot provide any assurance that these actions will be successful if the pandemic continues to have a longer-term impact on the economy.

Various factors cause our results of operations to fluctuate from period to period. These factors include levels of residential construction, the mix of single family and multi-family starts as a percentage of total residential construction, home improvement and remodeling activity, weather, prices of commodity wood and steel products, dumping duties, tariffs, interest rates, competitive pressures, availability of credit, availability of labor and other local, regional and national economic conditions. Many of these factors are cyclical or seasonal in nature. We anticipate that further fluctuations in operating results from period to period will continue in the future. Our results in the first and fourth quarters of each year are generally adversely affected by winter weather patterns in the Midwest, Northeast and Northwest, which typically result in seasonal decreases in levels of construction activity in these areas. As much of our overhead and expenses remain relatively fixed throughout the year, our operating profits tend to be lower during the first and fourth quarters.

We believe we have the product offerings, distribution channels, personnel, systems infrastructure and financial and competitive resources necessary for continued operations. Our future revenues, costs and profitability, however, are all likely to be influenced by a number of risks and uncertainties, all of which may be amplified by the COVID-19 pandemic. If the pandemic were to worsen or negatively impact our industry due to its duration, we are prepared to selectively re-activate or extend actions previously taken as part

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of our readiness and response plan. These actions may include deferral or cancelation of planned capital spending, negotiation of terms with vendors and customers, lay-offs and wage reductions, suspension of matching contributions to our qualified defined contribution plan, further rationalization of inventories and reduction of other fixed and variable costs.

Early and aggressive actions taken to mitigate the impact of the pandemic coupled with a subsequent level of market stability have resulted in our improved financial performance. Management believes that certain actions taken with regard to working capital management and efficiency, as well as cost reduction activities, can be sustainable and provide leverage if the economy continues to improve. However, there remains a significant amount of uncertainty related to the continued impact the pandemic may have on the economy and our operating results.

Strategic Initiatives

Our strategy is to increase shareholder value through focused, profitable growth and diversification of our business.  To accomplish this, we have developed strategic initiatives that require investments in our infrastructure, our people and technology platform.  Our goals are to accelerate profitable growth and diversify our business, which we believe will improve operating leverage over the intermediate term.  We have continued to make progress on our strategic initiatives, although our ability to continue advancing these initiatives has been, and may continue to be, impaired by present and future impacts of the COVID-19 pandemic on our operations.

To accelerate profitable growth and diversification, we have made strategic capital and operating investments to execute our product line expansion and market segment penetration organic growth initiatives.  The national expansion of our Huttig-Grip fastener product line, which is primarily sourced internationally, expands the breadth and geographic coverage of our private label specialty building product lines.  Through our investments in automated, high-capacity, pre-finish door lines and segment-focused sales resources, further penetration of the home improvement, repair and remodel market diversifies our business to be less dependent on new home construction, reinforces our position as the largest, value-add door fabricator to the professional residential construction market in the country, and accelerates our growth in higher-value, and higher-gross margin products.  In addition to accelerating our profitable growth and diversification through our internal initiatives, our Board of Directors has also commenced a public strategic review process to consider alternatives for maximizing shareholder value. We evaluate our strategic initiatives on a regular basis as part of our overall strategic planning process.

On March 20, 2022, we entered into a Merger Agreement with Woodgrain, and Merger Sub under which Merger Sub will purchase all of the outstanding shares of our common stock for $10.70 per share. On May 3, 2022, Merger Sub and Woodgrain completed the acquisition of all of our outstanding shares, repaid the outstanding borrowings under the Credit Facility dated as of September 29, 2021, and terminated the Credit Facility. Additionally, on May 3, 2022, we notified Nasdaq that the Merger Agreement had been completed and requested that trading of our shares on Nasdaq be halted prior to the opening of trading on May 3, 2022 and suspended at the close of the trading on May 3, 2022.

In addition to the above initiatives, we continue to invest in our organization to attract the best talent to achieve our goal of creating a top-performing, disciplined organization with talented, engaged, and empowered people.  We also continue to invest in our technology platform to achieve improved operating efficiencies in the functional areas of the business while delivering advanced customer interface technology to make Huttig the clear supplier of choice for the products we sell.

Critical Accounting Policies

We prepare our condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles, which requires 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, and these differences may be material. For a discussion of our significant accounting policies and estimates, see our Annual Report on Form 10-K for the year ended December 31, 2021 in Part II, Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies.” During the three months ended March 31, 2022, there were no material changes to the critical accounting policies and estimates discussed in our Annual Report on Form 10-K for the year ended December 31, 2021.

Results of Operations

Three Months Ended March 31, 2022 Compared to Three Months Ended March 31, 2021

Net sales were $272.7 million in the first quarter of 2022, which were $58.0 million, or 27.0%, higher than the first quarter of 2021. Net sales benefitted from greater housing demand in the first quarter of 2022 compared to first quarter 2021, and were favorably impacted by an improved pricing environment where demand-driven pricing was pronounced due to higher input costs, including labor and materials, caused primarily by supply chain disruption. Sales increased in all three of our product classifications.

Millwork sales of $125.4 million in the first quarter of 2022 were $29.1 million, or 30.2%, higher than the first quarter of 2021. Millwork has been significantly impacted by supply chain disruption. This product classification has been subject to multiple price increases and supply chain challenges. Building products sales increased 23.5% in the first quarter of 2022 to $125.8 million, compared to $101.9 million in the first quarter of 2021. First quarter 2022 building products sales benefitted from consistent high levels of demand and by price increases for certain product lines within the category. Wood product sales increased 30.3% in the first quarter of 2022 to $21.5

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million, compared to $16.6 million in the first quarter of 2021. Higher market prices on a year-over-year basis contributed to the increase in this category.

Gross margin was $63.0 million in the first quarter of 2022, compared to $45.7 million in the first quarter of 2021. As a percentage of net sales, gross margin was 23.1% in the first quarter of 2022, compared to 21.3% in the first quarter of 2021. Gross margins were favorably impacted by our continued focus on non-commoditized, strategic product lines which carry higher margins, as well as effective pricing management.

Operating expenses were $42.0 million in the first quarter of 2022, which were $5.1 million, or 13.8% higher than the $36.9 million reported in the first quarter of 2021. Personnel costs increased $3.6 million, or 16.7%, primarily due to increased variable incentive compensation from improved operating results. Non-personnel costs increased $1.5 million, or 9.7%. The increase was primarily driven by higher contract hauling, fuel and bad debt expense, as well as costs associated with our strategic alternatives efforts. These costs were partially offset by lower insurance costs. Overall, our cost structure was levered against higher sales volume. As a percentage of net sales, operating expenses were 15.4% in the first quarter of 2022 compared to 17.2% in the first quarter of 2021.

Net interest expense was $0.5 million in the first quarter of 2022 compared to $0.7 million in the first quarter of 2021. Lower overall net interest expense in the first quarter of 2022 reflects both lower average debt balances and lower interest rates.

Income taxes were an expense of $5.0 million and zero for the quarters ended March 31, 2022 and 2021, respectively. We utilized carryforward federal tax net operating losses to offset taxable income during the first quarter of 2021, reducing our federal deferred tax asset and releasing an equivalent amount of our valuation allowance. We fully utilized our federal net operating losses in the prior year resulting in an effective tax rate of 24.2% in the first quarter of 2022.

As a result of the foregoing factors, we reported net income of $15.5 million for the quarter ended March 31, 2022, compared to net income of $8.1 million for the quarter ended March 31, 2021.

Liquidity and Capital Resources

We depend on our cash flows from operations and funds available under our revolving credit facility to finance seasonal working capital needs, capital expenditures, additional investments in our product lines, and any acquisitions that we may undertake. In the third quarter of 2021, we executed a new credit facility with a maturity date of September 29, 2026. To the extent that our sales decline or our customers are unable to meet their obligations, including as a result of the current COVID-19 pandemic and global economic instability, our cash flows would be negatively affected.

Typically, our working capital requirements are greatest in the second and third quarters, which reflects the seasonal nature of our business. The second and third quarters also tend to be 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 second quarter in preparation for our second and third quarters. We also maintain significant inventories to meet the rapid delivery requirements of our customers and to enable us to obtain favorable pricing, delivery and service terms with our suppliers.

At March 31, 2022, we had $163.9 million of excess committed borrowing availability and $3.9 million in cash. We reduced our senior indebtedness at March 31, 2022 by $30.5 million as compared to a year ago. However, based on the potential impact from the COVID-19 pandemic, or variants thereof, our excess committed borrowing availability could be negatively impacted if sales and working capital levels decline and outstanding debt increases. Our liquidity assumptions and our ability to meet our credit facility covenants are dependent on many additional factors, including those included in the “Risk Factors” set forth in Part I, Item 1A of the Form 10-K for the year ended December 31, 2021, as updated by Part II, Item IA – “Risk Factors” of this Quarterly Report on Form 10-Q.

Operations.  Cash used in operating activities was $11.5 million and $16.5 million during the first three months of 2022 and 2021, respectively. We used cash from operations in both periods based on higher net sales resulting in an increase in accounts receivable of $48.0 million and $38.1 million for the first three months of 2022 and 2021, respectively. The increase in accounts receivable over the first three months of 2022 was primarily a result of cyclical increases in sales activity and an improved pricing environment as year over year sales growth was more pronounced as compared to 2021. During the first three months of 2022, we invested $14.5 million in a normal seasonal build of inventories, compared to $16.9 million in 2021. These impacts were partially offset by improved operating results combined with a $33.8 million and $26.9 million increase in accounts payables during the first three months of 2022 and 2021, respectively, primarily due to seasonal inventory purchases to support cyclical sales activity.

Investing.  Cash used in investing activities was $1.4 million during the first three months of 2022 and resulted from capital expenditures primarily for replacement equipment at various distribution centers. Cash used in investing activites was $0.2 million during the first three months of 2021, primarily for capital expenditures to replacement equipment at various distribution centers.

Financing.  Cash provided by financing activities of $13.5 million during the first three months of 2022 resulted from a $14.0 million increase in net borrowings under our credit facility partially offset by $0.5 million for the repurchase of shares to satisfy employee tax withholdings on stock-based awards. Cash provided by financing activities of $20.8 million in the first three months of 2021 resulted from a $21.0 million increase in net borrowings under our credit facility partially offset by $0.2 million for the repurchase of shares to satisfy employee tax withholdings on stock-based awards.

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While we believe that our cash on hand, borrowing capacity available under our new credit facility, and cash flows from operations for the next 12 months will be sufficient to service our liquidity needs, we cannot predict whether future developments associated with the COVID-19 pandemic will materially adversely affect our liquidity position. Our liquidity assumptions and our ability to meet our credit facility covenants are dependent on many additional factors, including the “Risk Factors” in Part I, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2021, as updated by Part II, Item IA – “Risk Factors” of this Quarterly Report on Form 10-Q.

At March 31, 2022, the minimum fixed charge coverage ratio (“FCCR”) was not required to be tested, as excess borrowing availability was greater than the minimum threshold. If our availability had fallen below that threshold, we would have met the minimum FCCR. If we are unable to maintain excess borrowing availability of more than the applicable amount in the range of $15.0 million to $25.0 million, and we did not meet the minimum FCCR, our lenders would have the right to terminate the loan commitments and accelerate the repayment of the entire amount outstanding under our credit facility. Our lenders could also foreclose on our assets securing the credit facility. If the credit facility was terminated, we would be forced to seek alternative sources of financing, which may not be available on terms acceptable to us, or at all.

Contingencies

We carry insurance policies on insurable risks with coverage and other terms that we believe to be 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 claims experience. Liabilities for existing and unreported claims are accrued for when it is probable that future costs will be incurred and can be reasonably estimated.

See Note 8 – “Contingencies” of the Notes to the Condensed Consolidated Financial Statements (unaudited) in Part I, Item 1 for information on legal proceedings in which we are involved.  See also Note 10- “Commitments and Contingencies” in the notes to our consolidated financial statements under Part II, Item 8 – “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in market risk from the information provided in Part II, Item 7A – “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2021.

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 Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e)) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2022 in all material respects to (a) cause information required to be disclosed by us in reports that we file or submit under the U.S. Securities and Exchange Commission’s rules and forms and (b) cause such information to be accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

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.

Management’s Report on Internal Control Over Financial Reporting – The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors. Based on our evaluation under the framework in Internal Control-Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of March 31, 2022.

Changes in Internal Control of Financial Reporting – The Company did not modify any existing internal controls as a result of its response to the COVID-19 pandemic that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1 — LEGAL PROCEEDINGS 

See Note 8 – “Contingencies” of the Notes to the Condensed Consolidated Financial Statements (unaudited) in Part I, Item 1 for information on legal proceedings in which the Company is involved. See also Note 10 – “Commitments and Contingencies” in the notes to our consolidated financial statements under Part II, Item 8 “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

ITEM 1A — RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A – “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021. Such risk factors could materially affect our business, financial condition, and future results. These described risks are not the only risks that we face. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, also may materially adversely affect our business, financial condition, and operating results. Other than the risk factor set forth below, there have been no material changes to the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2021.

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ITEM 6 — EXHIBITS

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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