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 31 distribution centers serving 44 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:

                                         Three Months Ended          Nine Months Ended
                                            September 30,              September 30,
                                         2008           2007         2008          2007
       Millwork(1)                          43 %           48 %         45 %         49 %
       General Building Products(2)         45 %           39 %         43 %         37 %
       Wood Products(3)                     12 %           13 %         12 %         14 %

       Total Net Product Sales             100 %          100 %        100 %        100 %

(1) Millwork includes exterior and interior doors, pre-hung door units, windows, patio doors, mouldings, frames, stair parts and columns.

(2) General building products include composite decking, connectors, fasteners, housewrap, roofing products, insulation and other miscellaneous building products.

(3) Wood products include engineered wood products and other wood products, such as lumber and panels.

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, steel and petroleum-based products, fuel costs, interest rates, competitive pressures, availability of credit and other local, regional and national economic conditions. Many of these factors are cyclical or seasonal in nature. During the past two years, our results of operations have been adversely affected by the severe downturn in new housing activity in the United States. We expect the severe downturn in new housing activity to continue to adversely affect our operating results for at least the next twelve months. We anticipate that further fluctuations in operating results from period to period will continue in the future. Our first quarter and fourth quarter are generally adversely affected by winter weather patterns in the Midwest 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 tend to be lower during the first and fourth quarters.
We believe we have the product offerings, warehouse and 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 for the year ended December 31, 2007 in Part II, Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies." Results of Operations
Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007
Net sales from continuing operations for the third quarter of 2008 were $182.8 million, which were $50.2 million, or approximately 22%, lower than the third quarter of 2007. Third quarter 2008 results were impacted by a 32% drop in housing starts to an average annualized rate of approximately .88 million, compared to approximately 1.30 million in the third quarter

of 2007. We continue to anticipate decreased housing starts for the balance of 2008 versus 2007 based on the current level of housing activity and industry forecasts. As a result, we are continuing to examine our cost structure, looking for opportunities to reduce expenses and increase efficiencies. Sales decreased in all product categories. General building products sales decreased 8% to $83.0 million. Millwork sales decreased 30% to $78.8 million. Other wood products, mostly commodity products, decreased 27% to $15.7 million and engineered wood sales were down 41% to $5.3 million.
Gross margin decreased 24% to $33.0 million, or 18.1% of sales, as compared to $43.3 million, or 18.6% of sales, in the prior year period. Third quarter 2008 results reflect the liquidation and net write down of inventory at closed branches of $0.8 million. These items negatively impacted 2008 gross margin percentage by approximately 0.4%. In addition, third quarter 2008 was negatively impacted by a less favorable mix of millwork sales partially offset by higher margins on building products, a more favorable mix of higher margin non-direct sales and lower customer rebates earned.
Operating expenses decreased 7% to $39.2 million, or 21.4% of sales, in the 2008 third quarter, compared to $42.3 million, or 18.2% of sales, in the 2007 third quarter. Third quarter 2008 results included $1.1 million in charges related to the cost reduction actions. Excluding these 2008 third quarter charges, operating expenses decreased by $4.2 million primarily due to lower employee headcount and lower infrastructure levels as a result of the prior restructuring actions, partially offset by higher fuel and contract hauling costs. Net interest expense decreased to $0.6 million in the 2008 third quarter from $1.1 million in the prior year third quarter due to lower interest rates and decreased borrowing levels.
We recognized income tax expense of $0.9 in the third quarter of 2008 as we decreased our projections of the full year 2008 income tax benefit to 18% of income before taxes at September 30, 2008, from 31% at June 30, 2008. The decrease primarily related to our third quarter branch closures and additional deterioration of the housing market in the third quarter 2008, resulting in the Company recording a valuation allowance against a portion of it federal tax loss carryforward benefit. We had long-term deferred tax assets, net of valuation allowances, of $6.8 million at September 30, 2008. We believe it is more likely than not that, considering our projections of future taxable income, including available tax planning strategies, we will generate sufficient future taxable income to realize the benefits of the net deferred tax assets existing at September 30, 2008. However, we believe it is likely that a valuation allowance will need to be established for any additional deferred tax assets generated in conjunction with losses incurred in future periods.
As a result of the foregoing factors, operating loss from continuing operations was $6.2 million in the 2008 third quarter, as compared to $1.0 million of operating income from continuing operations in the 2007 third quarter. Net loss from continuing operations was $7.7 million, or $0.37 per diluted share, in the 2008 third quarter, as compared to a net loss from continuing operations of $0.1 million, or breakeven per diluted share, in the 2007 third quarter. Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007
Net sales from continuing operations for the nine months ended September 30, 2008 were $545.0 million, which were $149.9 million, or approximately 22%, lower than in the first nine months of 2007. The results for the nine months ended September 30, 2008 were impacted by a 30% drop in housing starts to an average annualized rate of approximately .99 million, compared to approximately 1.40 million in the first nine months of 2007. We continue to anticipate decreased housing starts for the balance of 2008 versus 2007 based on the current level of housing activity and industry forecasts.
Sales decreased in all product categories. Millwork sales decreased 29% to $244.8 million. General building products sales decreased 7% to $237.3 million. Other wood products, mostly commodity products, decreased 30% to $46.2 million and engineered wood sales were down 41% to $16.7 million.
Gross margin decreased 22% to $101.8 million, or 18.7% of sales, as compared to $130.9 million, or 18.8% of sales, in the prior year period. The results for first nine months of 2008 and 2007 reflect the liquidation and net write down of inventory at closed branches of $1.1 and $1.0 million, respectively. These items negatively impacted 2008 and 2007 gross margin percentages by approximately 0.2% and 0.1%, respectively. In addition, the gross margin percentage in the first nine months of 2008 was negatively impacted by a less favorable mix of millwork sales, which was substantially offset by higher margins on building products and more favorable inventory variances.

Operating expenses decreased 11% to $117.2 million, or 21.5% of sales, in the first nine months of 2008, compared to $132.3 million, or 19.0% of sales, in the first nine months of 2007. Results for the first nine months of 2008 and 2007 included $2.1 and $2.7 million in charges related to the cost reduction actions, respectively. Excluding these charges, operating expenses in the first nine months of 2008 decreased by $14.5 million primarily due to lower employee headcount and lower infrastructure levels as a result of the prior restructuring actions, partially offset by higher fuel and contract hauling costs and increased bad debt expense.
During the first nine months of 2008, we determined that, based on a further decline in actual and forecasted operating results at certain of our reporting units, an interim test for goodwill impairment was necessary for the impacted units. In determining if there was impairment, we first compared the fair value of the reporting unit (calculated by discounting projected cash flows and earnings multiples) to the carrying value. Because the carrying value of certain reporting units exceeded the fair value, we allocated the fair value to the assets and liabilities of the units and determined that the fair value of the implied goodwill was lower than what was recorded. Accordingly, we recorded goodwill impairment charges of $7.1 million for these reporting units in the Consolidated Statements of Operations. At September 30, 2008, we had $11.2 million remaining in goodwill. A prolonged continuation of the current downturn and any future unanticipated downturns in the markets we serve could result in further goodwill impairment charges in future periods.
In the nine months ended September 30, 2007, we recognized gains of $0.5 million on the sale of our Grand Rapids, MI facility and $1.0 million on the sale of our Spokane, WA facility.
Net interest expense decreased to $2.0 million in the nine months ended September 30, 2008 from $3.4 million in the prior year first nine months due to lower interest rates and decreased borrowing levels.
Income taxes as a percentage of pre-tax loss for the nine months ended September 30, 2008 and 2007 were approximately 18% and 33%, respectively. We believe that the 18% rate will approximate the full year rate for 2008, and includes the impact of a valuation allowance established to offset a portion of our federal tax loss carryforward benefit. We had long-term net deferred tax assets of $6.8 million at September 30, 2008. We believe it is more likely than not that, considering our projections of future taxable income, including available tax planning strategies, we will generate sufficient future taxable income to realize the benefits of the net deferred tax assets existing at September 30, 2008. However, we believe it is likely that a valuation allowance will need to be established for any additional deferred tax assets generated in conjunction with losses incurred in future periods.
As a result of the foregoing factors, operating loss from continuing operations was $22.3 million in the first nine months of 2008, as compared to an operating profit of $0.1 million from continuing operations in the first nine months of 2007. Net loss from continuing operations was $19.9 million, or $0.95 per diluted share, in the first nine months of 2008, as compared to a net loss from continuing operations of $2.2 million, or $0.11 per diluted share, in the first nine months of 2007.
Discontinued Operations
We recorded a $0.1 million and $0.2 million after-tax loss from discontinued operations for environmental and litigation expenses associated with previously reported discontinued operations in the nine months ended September 30, 2008 and 2007, respectively.
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 increased construction activities from more favorable weather throughout many of our markets compared to the first and fourth quarters. Absent unusual market conditions, 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 September 30, 2008, December 31, 2007 and September 30, 2007, inventories constituted approximately 36%, 42% and 38% 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 totaled $0.6 million for the nine months ended September 30, 2008 as compared to cash provided by operating activities of $3.6 million for the first nine months of 2007. Accounts receivable increased by $8.7 million in the first nine months of 2008, compared to an increase of $9.9 million in the first nine months of 2007. Days sales outstanding decreased to 32.3 days at September 30, 2008, compared to 32.9 days at September 30, 2007, based on annualized sales for the respective immediately preceding quarter. Inventory decreased by $17.9 million in the 2008 first nine months, compared to an increase of $0.8 million in the 2007 first nine months. Annualized inventory turns, calculated as the ratio of annualized cost of goods sold for each three-month period ended September 30 divided by the average of the beginning and ending inventory balances for each such three-month period, were 8.1 turns at September 30, 2008 compared to 7.6 at September 30, 2007. Accounts payable decreased by $0.9 million in the nine months ended September 30, 2008 as compared to an increase of $8.5 million in the nine months ended September 30, 2007.
Investing. In the nine-month period ended September 30, 2008, net cash used in investing activities was $1.1 million, as compared to $0.4 million of net cash provided by investing activities in the nine-month period ended September 30, 2007. We made capital expenditures of $1.7 million in the first nine months of 2008 primarily to purchase machinery and equipment at multiple branches. In the first nine months of 2007, we made capital expenditures of $2.6 million related primarily to the purchase of computer software necessary to upgrade our enterprise resource planning system and to purchase machinery and equipment at multiple branch locations. In the 2007 first nine months, we received proceeds of $2.9 million and recorded gains on disposal of capital assets of $1.5 million as a result of our sales of the Grand Rapids, MI and Spokane, WA facilities. Financing. Cash provided by financing activities for the first nine months of 2008 primarily reflects a $6.1 million increase in net borrowings and $0.9 million from stock options. Cash provided from financing activities for the first nine months of 2007 primarily reflects $1.0 million from stock options and a $0.9 million increase in net borrowings.
Credit Agreement. We have a five-year $160.0 million asset based senior secured revolving credit facility ("credit facility"). Borrowing availability under the credit facility is based on eligible accounts receivable, inventory and real estate. We added the real estate component to the borrowing base in July 2008. The inclusion of the real estate component initially provided approximately $25 million of additional borrowing capacity under the credit facility. The real estate component of the borrowing base amortizes monthly over ten years on a straight-line basis. Additionally, the credit facility includes an option to request an increase in the size of the facility by up to an additional $40.0 million, subject to certain conditions and approvals. We must also pay a fee in the range of 0.25% to 0.32% per annum on the average daily-unused amount of the revolving credit commitment. The entire unpaid balance under the credit facility is due and payable on October 20, 2011, the maturity date of the credit facility.
At September 30, 2008, under the credit facility we had revolving credit borrowings of $32.0 million outstanding at a weighted average interest rate of 3.76%, letters of credit outstanding totaling $5.2 million, primarily for health and workers' compensation insurance, and $76.4 million of additional borrowing capacity. In addition, we had $0.7 million of other obligations outstanding at September 30, 2008. Given the Company's current LIBOR based borrowing rates, we expect the weighted average interest rate under the credit facility will increase as the outstanding advances at September 30, 2008 roll-over in the fourth quarter of 2008.
The borrowings under the credit facility are collateralized by substantially all of our assets and are subject to certain operating limitations commonly 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, stock repurchases and transactions with affiliates. The financial covenant in the credit facility is limited to a fixed charge coverage ratio to be tested only when excess borrowing availability, as defined, is less than $25.0 million, on a pro forma basis prior to consummation of certain significant business transactions outside the ordinary course of business, and prior to increasing the size of the facility.
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 our credit facility as described above, we use operating leases as a principal off-balance sheet financing technique. Operating leases are employed as an alternative to purchasing certain

property, plant and equipment. See our Annual Report on Form 10-K for the year ended December 31, 2007 in Part II, Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations-Commitments and Contingencies."
Contingencies
We are involved in a number of legal proceedings incidental to the conduct of our business, relating to such matters as product liability, environmental liability and vehicular accidents. 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 when it is probable that future costs will be incurred and such future costs can be reasonably estimated. We are subject to federal, state and local environmental protection laws and regulations. Our management believes 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 consolidated financial condition or results of operations.
We have been 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 and at a currently-owned facility in Prineville, Oregon, in connection with the clean up of petroleum hydrocarbons and PCP discovered in soil and groundwater at the facility. As of September 30, 2008, we have accrued approximately $0.8 million for future costs of remediating these sites. However, until a final remedy is selected by the respective state departments of environmental quality, management cannot estimate the top of the range of loss or cost to us 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.
We accrue 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 we have made accruals include environmental, product liability and other legal matters. Based on management's assessment of the most recent information available, management currently does not expect any of these contingencies to have a material adverse effect on our financial position or cash flow. It is possible, however, that future results of operations for any particular quarter or annual period and our financial condition could be materially affected by changes in assumptions or other circumstances related to these matters.
Cautionary Statement
Certain statements in this Quarterly Report on 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:
• our expectation that known contingencies, including risks relating to environmental, product liability and other legal matters, will not have a material adverse effect on our financial position or cash flow;

• our belief that there are no material environmental liabilities at any of our distribution center locations;

• our anticipation of decreased housing starts for the balance of 2008 as compared to 2007;

• our belief that the weighted average interest rate under our credit facilities will increase as the outstanding advances roll over in the fourth quarter of 2008;

• our belief that cash from operations and funds under our credit facility will be sufficient to meet our future liquidity and capital expenditure requirements;

• our belief that it is more likely than not we will generate sufficient taxable income to realize the benefits of the net deferred tax assets existing at September 30, 2008;

• our belief that it is likely that a valuation allowance will need to be established for any additional deferred tax assets generated in conjunction with losses incurred in future periods;

• our expectation that the severe downturn in new housing activity will continue to adversely affect our operating results for at least the next twelve months;

• our estimate of the annualized effective tax rate for 2008;

• our belief that we have the product offerings, warehouse and support facilities, personnel, systems infrastructure and financial and competitive resources necessary for continued business success;

• our liquidity and exposure to market risk; and

• cyclical and seasonal trends.

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:
• the strength of the national and local new residential construction and home improvement and remodeling markets, which in turn depend on factors such as:

• interest rates;

• immigration patterns;

• job and household formation;

• household prices;

• tax policy;

• regional demographics;

• employment levels;

• availability of credit;

• inventory levels of new and existing homes for sale;

• prices of wood and steel-based products;

• fuel costs; and

• consumer confidence;

• the level of competition in our industry;

• our relationships with suppliers of the products we distribute;

• our ability to comply with availability requirements and the financial covenant under our revolving credit facility;

• the financial condition and credit worthiness of our customers;

• fluctuation in prices of wood and steel-based products;

• cyclical and seasonal trends;

• costs of complying with environmental laws and regulations,;

• our exposure to product liability claims;

• our ability to attract and retain key personnel;

• risk of losses associated with accidents;

• costs of complying with federal and state transportation regulations, as well as fluctuations in the cost of fuel;

• accuracy of our assumptions underlying our projections of future taxable income, including available tax planning strategies.

We disclaim any obligation to publicly update or revise any of these forward-looking statements.