FRIEDMAN INDUSTRIES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview Friedman Industries, Incorporated is a manufacturer and processor of steel products and operates in two reportable segments; coil products and tubular products. The coil product segment includes the operation of two hot-roll coil processing facilities; one in Hickman, Arkansas and the other in Decatur, Alabama. The Hickman facility operates a temper mill and a cut-to-length line. The temper mill improves the flatness and surface qualities of the coils and the cut-to-length line levels the steel and cuts the coils into sheet and plate of prescribed lengths. The Hickman facility is capable of cutting sheet and plate with thicknesses ranging from 14 gauge to ½” thick in widths ranging from 36” wide to 72” wide. The Decatur facility previously operated a temper mill and a cut-to-length line but during the quarter ended June 30, 2020, the equipment was removed to allow the foundation to be prepared for a new stretcher leveler line that will be installed. Installation is expected to begin in December 2020 and commercial use is expected to start in February 2021. The estimated total cost of this project is $7,200,000 with approximately $5,427,000 having been spent as of September 30, 2020 . This estimated cost is greater than our previously disclosed cost of $5,800,000 due to additional components that have been added to the project to improve the efficiency and output of the equipment. The new equipment will expand the coil segment’s processing capabilities to include material up to 96” wide and material of higher grades and will allow the Decatur facility to cut material that is up to ½” thick compared to the previous equipment’s capability of 5/16” thick. In addition, sheet and plate that has been stretcher leveled is preferable to some customers and applications compared to material that has been leveled through the temper mill process. The coil product segment sells its prime grade inventory under the Friedman Industries name but also maintains an inventory of non-standard coil products, consisting primarily of mill secondary and excess prime coils, which are sold through the Company’s XSCP division. The coil product segment also processes customer-owned coils on a fee basis. The tubular product segment consists of the Company’s Texas Tubular Products division (“TTP”) located in Lone Star, Texas. TTP operates two electric resistance welded pipe mills with a combined outside diameter (“OD”) size range of 2 3/8” OD to 8 5/8” OD. Both pipe mills are American Petroleum Institute (“API”) licensed to manufacture line pipe and oil country pipe and also manufacture pipe for structural purposes that meets other recognized industry standards. TTP has an API licensed pipe finishing facility that threads and couples oil country tubular goods and performs other services that are customary in the pipe finishing process. The pipe finishing facility is currently idled due to market conditions. TTP’s inventory consists of raw materials and finished goods. Raw material inventory consists of hot-rolled steel coils that TTP will manufacture into pipe. Finished goods inventory consists of pipe that TTP has manufactured and new mill reject pipe that TTP purchased from U.S. Steel Tubular Products, Inc. 12 COVID-19 Update In March 2020, the World Health Organization declared the novel strain of coronavirus (“COVID-19”) a global pandemic. In addition to the devastating effects on human life, this contagious virus has adversely affected economies globally. It has also disrupted the normal operations of many businesses, including ours and many of our customers. Our facilities have continued to operate during this crisis but we are operating with modifications to our facility practices, employee travel, employee work locations and virtualization or cancellation of company and customer events, among other modifications. We may take further actions that alter our business operations as the situation evolves. There are no comparable events that provide guidance as to the effect the COVID-19 pandemic may have, and, as a result, the ultimate effect of the pandemic is highly uncertain and subject to change. We do not yet know the full extent of the effects on the economy, the markets we serve, our business or our operations. We have experienced a small number of cases within our workforce with each case being isolated with no spread to other employees. Results of Operations Six Months Ended September 30, 2020 Compared to Six Months Ended September 30, 2019 During the six months ended September 30, 2020 (the “ 2020 period”), sales and costs of goods sold decreased $32,584,620 and $33,243,797, respectively, and gross profit increased $659,177 compared to the amounts recorded during the six months ended September 30, 2019 (the “ 2019 period”). The decrease in sales was related to both a decline in tons sold and a decrease in the average per ton selling price. Tons sold decreased from approximately 112,000 tons in the 2019 period to approximately 81,500 tons in the 2020 period. The drop in volume was primarily attributable to economic impacts of COVID-19. Discussion of the change in sales is expanded upon at the segment level in the following paragraphs. Gross profit as a percentage of sales increased from approximately 1.0% in the 2019 period to approximately 2.8% in the 2020 period. Our operating results are significantly impacted by the market price of hot-rolled steel coil. Results for both the 2020 period and the 2019 period were negatively impacted by a declining steel price. The 2020 period experienced additional challenges related to the COVID-19 pandemic. Coil Segment Coil product segment sales for the 2020 period totaled $33,888,870 compared to $56,602,077 for the 2019 period. For a more complete understanding of the average selling prices of goods sold, it is helpful to isolate sales generated from processing of customer owned material and sales generated from coil segment inventory. Sales generated from processing of customer owned material totaled $390,034 for the 2020 period compared to $393,021 for the 2019 period. Sales generated from coil segment inventory totaled $33,498,836 for the 2020 period compared to $56,209,056 for the 2019 period. Inventory tons sold decreased from approximately 81,000 tons in the 2019 period to approximately 60,000 tons in the 2020 period. The average per ton selling price related to these shipments decreased from approximately $695 per ton in the 2019 period to approximately $556 per ton in the 2020 period. Coil segment operations recorded operating profits of approximately $291,000 and $668,000 for the 2020 and 2019 periods, respectively. Operating results for both the 2020 period and the 2019 period were negatively impacted by declining hot-rolled steel prices but the 2020 period was impacted additionally by a decline in volume primarily related to impacts of the COVID-19 pandemic. Compared to the average monthly sales volume for the fiscal year ended March 31, 2020 , April 2020 volume was down approximately 51%, May 2020 volume was down approximately 33%, June 2020 volume was down approximately 3%, July 2020 volume was down approximately 6%, August 2020 volume was down approximately 19% and September 2020 volume was down approximately 12%. The coil segment sales volume has experienced a fairly rapid recovery during the 2020 period from the initial volume drop in April 2020. We expect monthly volume for the third quarter of fiscal 2021 to remain slightly below the average monthly fiscal 2020 volume. Coil segment sales volume for October 2020 was down approximately 10% compared to the fiscal 2020 monthly average. The Company’s coil segment purchases its inventory from a limited number of suppliers. Loss of any of these suppliers could have a material adverse effect on the Company’s business. Tubular Segment Tubular product segment sales for the 2020 period totaled $14,497,410 compared to $24,368,823 for the 2019 period. Sales declined due to both a reduction in the volume sold and a decrease in the average selling price per ton. Tons sold decreased from approximately 31,000 tons in the 2019 period to approximately 21,000 tons in the 2020 period. The average per ton selling price related to these shipments decreased from approximately $787 per ton in the 2019 period to approximately $680 per ton in the 2020 period. The tubular segment operations recorded operating losses of approximately $285,000 and $1,201,000 for the 2020 and 2019 periods, respectively. Operating results for both the 2020 period and the 2019 period were negatively impacted by declining hot-rolled steel prices, but the 2020 period was impacted additionally by a decline in volume primarily related to impacts of the COVID-19 pandemic and challenging conditions for the U.S. energy industry. Compared to the average monthly sales volume for the fiscal year ended March 31, 2020 , April 2020 volume was down approximately 4%, May 2020 volume was down approximately 36%, June 2020 volume was down approximately 27%, July 2020 volume was down approximately 20%, August 2020 volume was down approximately 51% and September 2020 volume was down approximately 25%. The volume for April was supported by the segment fulfilling manufactured pipe orders that were received prior to the COVID-19 pandemic’s broad impact on the U.S. economy. The tubular segment volume has seen a challenging recovery with energy industry conditions being weak and, in recent months, additional challenges from increased imported pipe competition. October 2020 volume was down approximately 18% compared to the fiscal 2020 monthly average. Operating results for both the 2020 and 2019 periods were also negatively impacted by inventory write downs related to the segment's manufactured pipe inventory. In the 2020 period there was a write down of $274,093 at June 30, 2020 and in the 2019 period there was a write down of $955,605 at September 30, 2019. 13 The Company’s tubular segment purchases its inventory from a limited number of suppliers. Loss of any of these suppliers could have a material adverse effect on the Company’s business. In March 2020, U.S. Steel announced the idling of their Lone Star Tubular Operations which is our sole supplier of mill reject pipe. At September 30, 2020 , we had approximately 30,500 tons of mill reject inventory which we believe to be approximately two years of inventory. We expect the idling to have a negative impact on our operations as we eventually sell out of inventory. General, Selling and Administrative Costs During the 2020 period, general, selling and administrative costs increased $331,405 compared to the 2019 period. The increase was related primarily to increased payroll, professional fees and restricted stock plan compensation expense. Income Taxes The income tax benefit for the 2020 period decreased $73,009 from the benefit recorded in the 2019 period. This decrease was related primarily to the smaller loss before taxes for the 2020 period compared to the 2019 period. Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019 During the three months ended September 30, 2020 (the “ 2020 quarter”), sales and costs of goods sold decreased $15,133,900, $17,007,647, respectively and gross profit increased $1,873,747 compared to the amounts recorded during the three months ended September 30, 2019 (the “ 2019 quarter”). The decrease in sales was related to both a decline in tons sold and a decrease in the average per ton selling price. Tons sold decreased from approximately 58,500 tons in the 2019 quarter to approximately 43,000 tons in the 2020 quarter. The drop in volume was primarily attributable to economic impacts of COVID-19. Discussion of the change in sales is expanded upon at the segment level in the following paragraphs. Gross margin as a percentage of sales increased from a loss margin of approximately 2.0% in the 2019 quarter to a profit margin of approximately 4.4% in the 2020 quarter. Our operating results are significantly impacted by the market price of hot-rolled steel coil. Results for both the 2020 quarter and the 2019 quarter were negatively affected by the impact of declining steel prices. However, steel prices started increasing in the middle of the 2020 quarter which sparked margin improvement, especially for the coil segment where margin typically responds quicker to fluctuations in steel prices. Coil Segment Coil product segment sales for the 2020 quarter totaled $18,456,086 compared to $28,420,609 for the 2019 quarter. For a more complete understanding of the average selling prices of goods sold, it is helpful to isolate sales generated from processing of customer owned material and sales generated from coil segment inventory. Sales generated from processing of customer owned material totaled $205,721 for the 2020 quarter compared to $212,521 for the 2019 quarter. Sales generated from coil segment inventory totaled $18,250,365 for the 2020 quarter compared to $28,208,088 for the 2019 quarter. Inventory tons sold decreased from approximately 43,000 tons in the 2019 quarter to approximately 33,000 tons in the 2020 quarter. The average per ton selling price related to these shipments decreased from approximately $653 per ton in the 2019 quarter to approximately $548 per ton in the 2020 quarter. Coil segment operations recorded operating profits of approximately $751,000 and $324,000 for the 2020 and 2019 quarters, respectively. Operating results for both the 2020 quarter and the 2019 quarter were negatively impacted by low margins associated with declines in hot-rolled steel prices. However, margins did start to improve at the end of the 2020 quarter when hot-rolled steel pricing increased. The 2020 quarter was impacted additionally by a decline in volume primarily related to impacts of the COVID-19 pandemic. The Company’s coil segment purchases its inventory from a limited number of suppliers. Loss of any of these suppliers could have a material adverse effect on the Company’s business. Tubular Segment Tubular product segment sales for the 2020 quarter totaled $6,405,594 compared to $11,574,971 for the 2019 quarter. Sales declined due to both a reduction in the volume sold and a decrease in the average selling price per ton. Tons sold decreased from approximately 15,500 tons in the 2019 quarter to approximately 10,000 tons in the 2020 quarter. The average per ton selling price related to these shipments decreased from approximately $755 per ton in the 2019 quarter to approximately $634 per ton in the 2020 quarter. The tubular segment operations recorded operating losses of approximately $344,000 and $1,746,000 for the 2020 and 2019 quarters, respectively. 14 Operating results for both the 2020 quarter and the 2019 quarter were negatively impacted by declines in hot-rolled steel prices, but the 2020 quarter was impacted additionally by a decline in volume primarily related to impacts of the COVID-19 pandemic and challenging conditions for the U.S. energy industry. Energy industry conditions remain challenging and, in recent months, we have seen increased competition from imported pipe. Operating results for the 2019 quarter were also negatively impacted by an inventory write down of $955,605 at September 30, 2019 related to the segment’s manufactured pipe inventory. The Company’s tubular segment purchases its inventory from a limited number of suppliers. Loss of any of these suppliers could have a material adverse effect on the Company’s business. In March 2020, U.S. Steel announced the idling of their Lone Star Tubular Operations which is our sole supplier of mill reject pipe. At September 30, 2020 , we had approximately 30,500 tons of mill reject inventory which we believe to be approximately two years of inventory. We expect the idling to have a negative impact on our operations as we eventually sell out of inventory. General, Selling and Administrative Costs During the 2020 quarter, general, selling and administrative costs increased $148,039 compared to the 2019 quarter. The increase was related primarily to increased payroll, professional fees and restricted stock plan compensation expense. Income Taxes The income tax benefit for the 2020 quarter decreased $425,276 from the benefit recorded in the 2019 quarter. This decrease was related primarily to the smaller loss before taxes for the 2020 quarter compared to the 2019 quarter. Outlook During August 2020 hot-rolled steel pricing started to rise and has continued a significant increase of approximately 60% as of the filing date of this Form 10-Q. Our coil segment margins started improving late in the second quarter and have continued to improve during the third quarter. Our tubular segment margins do not respond as quickly to the fluctuations in steel price but we have started to see improved margins for our manufactured pipe sales during November 2020. In general, we expect solid margins for the third quarter. We expect both coil segment and tubular segment sales volumes for the third quarter to be comparable to those of the second quarter with the potential to be slightly less due to typical seasonality associated with the holidays and fewer shipping days. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES The Company’s current ratio was 9.0 at September 30, 2020 and 6.8 at March 31, 2020 . Working capital was $51,947,484 at September 30, 2020 and $55,566,158 at March 31, 2020 . During the six months ended September 30, 2020 , the Company maintained assets and liabilities at levels it believed were commensurate with operations. Changes in balance sheet amounts occurred in the ordinary course of business. Cash increased primarily from operating activities and from Paycheck Protection Program loan proceeds with these increases being partially offset by the purchase of property, plant and equipment, payment of cash dividends and the repurchase of common stock. The Company expects to continue to monitor, evaluate and manage balance sheet components depending on changes in market conditions and the Company’s operations. In April 2020, the Company received a $1,690,385 loan (the “PPP Loan”) from JPMorgan Chase Bank, N.A. (the “Bank”), under the Paycheck Protection Program, which was established under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), as modified by the Paycheck Protection Flexibility Act of 2020 (the “PPP Flexibility Act”). The term of the PPP Loan is two years from the funding date of the PPP Loan. The interest rate on the PPP Loan is 0.98%. Under the terms of the PPP Loan, interest accrues from the funding date of the PPP Loan but payment of both principal and interest is deferred for six months. Pursuant to the terms of the CARES Act, the Company can apply for and may be granted forgiveness for all or a portion of the PPP Loan, if and to the extent that the Company satisfies certain requirements. Such forgiveness is subject to use of the PPP Loan proceeds for qualifying purposes and is also subject to maintenance or achievement of certain employee and compensation levels. While the Company plans to apply for forgiveness of the PPP Loan in accordance with the requirements and limitations under the CARES Act, the PPP Flexibility Act and the Small Business Administration regulations and requirements, no assurance can be given that all or any portion of the PPP Loan will be forgiven. As of the filing date of this Form 10-Q, the Company was waiting to receive an invitation from the Bank to submit an application for forgiveness. On June 25, 2020, our Board of Directors authorized a share repurchase program under which the Company may repurchase up to 1,062,067 shares of the Company’s outstanding common stock through June 30, 2023, which equates to 15% of the Company’s outstanding shares of common stock as of June 25, 2020. During the September 30, 2020 quarter we repurchased 67,281 shares at a total cost of $410,221. Repurchases under the program may be made from time to time at the Company’s discretion and may be made in open market transactions, through block trades, in privately negotiated transactions and pursuant to any trading plan that may be adopted by the Company’s management in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, or otherwise. The timing and actual number of shares repurchased pursuant to the program will depend on a variety of factors including price, corporate and regulatory requirements, market conditions and other corporate liquidity requirements and priorities. The repurchase program does not obligate the Company to acquire a specific dollar amount or number of shares and may be modified, suspended or discontinued at any time. The Company believes that its current cash position along with cash flows from operations and borrowing capability due to its financial position are adequate to fund its expected cash requirements for the next 12 months. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant estimates that are subject to the Company’s assumptions include the fair value of the pipe-finishing facility, determination of useful lives for fixed assets, determination of the allowance for doubtful accounts and the determination of net realizable value relative to inventory. The fair value determination of the pipe-finishing facility requires assumptions related to future operations of the facility and estimates related to the replacement cost and value in exchange for the assets. The determination of useful lives for depreciation of fixed assets requires the Company to make assumptions regarding the future productivity of the Company’s fixed assets. The allowance for doubtful accounts requires the Company to draw conclusions on the future collectability of the Company’s accounts receivable. The determination of net realizable value when reviewing inventory value requires the Company to make assumptions concerning sales trends, customer demand and steel industry market conditions. Actual results could differ from these estimates. 15 CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS From time to time, the Company may make certain statements that contain forward-looking information (as defined in the Private Securities Litigation Reform Act of 1996, as amended) and that involve risk and uncertainty. Such statements may include those risks disclosed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this report. These forward-looking statements may include, but are not limited to, future changes in the Company’s financial condition or results of operations, future production capacity, product quality and proposed expansion plans. Forward-looking statements may be made by management orally or in writing including, but not limited to, this Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of the Company’s filings with the U.S. Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including the Company’s Annual Report on Form 10-K and its other Quarterly Reports on Form 10-Q. Forward-looking statements include those preceded by, followed by or including the words “will,” “expect,” “intended,” “anticipated,” “believe,” “project,” “forecast,” “propose,” “plan,” “estimate,” “enable,” and similar expressions, including, for example, statements about our business strategy, our industry, our future profitability, growth in the industry sectors we serve, our expectations, beliefs, plans, strategies, objectives, prospects and assumptions, and estimates and projections of future activity and trends in the oil and natural gas industry. These forward-looking statements are not guarantees of future performance. These statements are based on management’s expectations that involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. Although forward-looking statements reflect our current beliefs, reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Actual results and trends in the future may differ materially depending on a variety of factors including, but not limited to, changes in the demand for and prices of the Company’s products, changes in government policy regarding steel, changes in the demand for steel and steel products in general and the Company’s success in executing its internal operating plans, changes in and availability of raw materials, unplanned shutdowns of our production facilities due to equipment failures or other issues, increased competition from alternative materials and risks concerning innovation, new technologies, products and increasing customer requirements. Accordingly, undue reliance should not be placed on our forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changed circumstances or otherwise, except to the extent law requires. Item 3. Quantitative and Qualitative Disclosures About Market Risk Not required