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: flat-roll products and tubular products. The flat-roll product segment consists of the operation of five hot-rolled coil processing facilities located in Hickman, Arkansas; Decatur, Alabama; East Chicago, Indiana; Granite City, Illinois and Sinton, Texas. The Hickman, Granite City and East Chicago facilities operate temper mills and cut-to-length lines. The Decatur and Sinton facilities operate stretcher leveler cut-to-length lines. The equipment at all locations improve the flatness and surface quality of the coils and cut the coils into sheet and plate of prescribed lengths. On a combined basis, the facilities are capable of cutting sheet and plate with thicknesses ranging from 16 gauge to 1” thick in widths ranging from 36” wide to 96” wide. The vast majority of flat-roll product segment revenue is generated from sales of Company owned inventory but the segment also generates revenue from the processing or storage of 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. All of the tubular segment's revenue is generated from sales of Company owned inventory. 16 Table of Contents Results of Operations Three Months Ended June 30, 2024 Compared to Three Months Ended June 30, 2023 During the three months ended June 30, 2024 (the “ 2024 quarter”), sales, costs of materials and gross margin decreased approximately $22.7 million, $11.8 million and $10.9 million , respectively, compared to the amounts recorded during the three months ended June 30, 2023 (the “ 2023 quarter”). The decrease in sales was associated with both a decline in sales volume and a decrease in the average selling price per ton. Sales volume for the 2024 quarter consisted of approximately 119,000 tons from inventory and another 24,000 tons of toll processing customer owned material compared to the 2023 quarter volume consisting of approximately 129,000 tons from inventory and 24,000 tons of toll processing. The decline in sales volume for the 2024 quarter was related to a combination of challenging conditions for some of our customers and extended planned downtime for equipment upgrades and maintenance at the Company's Sinton and Decatur facilities. Gross margin was approximately $18.1 million for the 2024 quarter compared to approximately $29.1 million for the 2023 quarter. Gross margin is calculated as net sales minus cost of materials sold. Gross margin as a percentage of sales was approximately 15.8% for the 2024 quarter compared to approximately 21.2% for the 2023 quarter. Our operating results are significantly impacted by the market price of hot-rolled steel coil ("HRC"). Entering the 2023 quarter, HRC prices had increased approximately 95% from November 2022 to April 2023. As a result, the Company experienced strong physical margins during the 2023 quarter. Entering the 2024 quarter, HRC prices were on a predominately declining trend dropping approximately 40% from January 2024 through the end of the 2024 quarter. As a result, the Company experienced compressed physical margins during the 2024 quarter. The Company utilizes HRC futures to partially manage exposure to commodity price risk. The Company recognized hedging related gains of approximately $5.4 million in the 2024 quarter compared to hedging activities having a neutral impact on the 2023 quarter results. Flat-roll Segment Flat-roll product segment sales for the 2024 quarter totaled approximately $103.4 million compared to approximately $125.2 million for the 2023 quarter. For a more complete understanding of the average selling prices of goods sold, it is helpful to exclude any sales generated from processing or storage of customer owned material. Sales generated from processing or storage of customer owned material totaled approximately $1.6 million for the 2024 quarter compared to approximately $1.2 million for the 2023 quarter. Sales generated from flat-roll segment inventory totaled approximately $101.8 million for the 2024 quarter compared to approximately $124.0 million for the 2023 quarter. The average per ton selling price related to these shipments decreased from approximately $1,038 per ton in the 2023 quarter to approximately $932 per ton in the 2024 quarter. Sales volume for the 2024 quarter consisted of approximately 109,000 tons from inventory and another 24,000 tons of toll processing customer owned material compared to the 2023 quarter volume consisting of approximately 120,000 tons from inventory and 24,000 tons of toll processing. The decline in sales volume for the 2024 quarter was related to a combination of challenging conditions for some of our customers and extended planned downtime for equipment upgrades and maintenance at the Company's Sinton and Decatur facilities. Flat-roll segment operations recorded operating profits of approximately $2.7 million and $11.8 million for the 2024 quarter and 2023 quarter, respectively. The Company’s flat-roll 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 2024 quarter totaled approximately $11.2 million compared to approximately $12.1 million for the 2023 quarter. Sales decreased due primarily to a decrease in the average selling price per ton from approximately $1,358 per ton for the 2023 quarter to approximately $1,140 per ton for the 2024 quarter. Sales volume was comparable between period with approximately 10,000 tons sold in the 2024 quarter compared to approximately 9,000 tons sold in the 2023 quarter. The tubular segment recorded an operating loss of approximately $1.2 million for t he 2024 quarter compared to recording operating profit of approximately $2.3 million for the 2023 quarter. The 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. General, Selling and Administrative Costs During the 2024 quarter, selling, general and administrative costs decreased approximately $1.4 million compared to the 2023 quarter. This decrease is primarily related to lower incentive compensation expense due to the lower earnings in the 2024 quarter. Income Taxes Income taxes decreased from a provision for the 2023 quarter of approximately $2.6 million to a provision for the 2024 quarter of approximately $0.7 million. This decrease was primarily related to lower earnings before taxes for the 2024 quarter. The income tax provision as a percentage of earnings before tax was approximately 22.2% and 25.0% for the three months ended June 30, 2024 and 2023, respectively. For the three months ended June 30, 2024 , the effective tax rate differed from the federal statutory rate due primarily to the inclusion of state tax expenses in the provision with this impact partially reduced by the tax effect of restricted stock vesting during the quarter. For the three months ended June 30, 2023 , the effective tax rate differed from the federal statutory rate due primarily to the inclusion of state tax expenses in the provision. 17 Table of Contents FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES The Company’s current ratio amounted to 4.2 a t June 30, 2024 and 3.1 at March 31, 2024 . Working capital was approximately $123.6 million at June 30, 2024 and $116.0 million at March 31, 2024 . During the three months ended June 30, 2024, 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 and restricted cash decreased due primarily to cash used in operating activities and investing activities exceeding cash provided by financing activities. The Com pany expects to continue to monitor, evaluate and manage balance sheet components depending on changes in market conditions and the Company’s operations. The Company has a $150 million asset-based lending facility ("ABL Facility") which matures on May 19, 2026 and is secured by substantially all of the assets of the Company. The Company can elect borrowings on a floating rate basis or a term basis. Floating rate borrowings accrue interest at a rate equal to the prime rate minus 1% per annum. Term rate borrowings accrue interest at a rate equal to the SOFR rate applicable to the selected term plus 1.8% per annum. Availability of funds under the ABL Facility is subject to a borrowing base calculation determined as the sum of (a) 90% of eligible accounts receivable, plus (b) the product of 85% multiplied by the net orderly liquidating value percentage identified in the most recent inventory appraisal multiplied by eligible inventory. The ABL Facility contains a springing financial covenant whereby the financial covenant is only tested when availability falls below the greater of 15% of the revolving commitment or $22.5 million. The financial covenant restricts the Company from allowing its fixed charge coverage ratio to be, as of the end of any calendar month, less than 1.10 to 1.00 for the trailing twelve month period then ending. The fixed charge coverage ratio is calculated as the ratio of (a) EBITDA, as defined in the ABL Facility, minus unfinanced capital expenditures to (b) cash interest expense plus scheduled principal payments on indebtedness plus taxes paid in cash plus restricted payments paid in cash plus capital lease obligation payments plus cash contributions to any employee pension benefit plans. The ABL Facility contains other representations and warranties and affirmative and negative covenants that are usual and customary. If certain conditions precedent are satisfied, the ABL facility may be increased by up to an aggregate of $25 million, in minimum increments of $5 million. At June 30, 2024, the Company had a balance of approximately $46.1 million under the ABL Facility with an applicable interest rate of 7.5%. At June 30, 2024, the Company's applicable borrowing base calculation supported access to approximately $112.4 million of the ABL Facility. As of the filing date of this Form 10-Q, the Company had borrowings of approximately $50.6 million outstanding under the ABL Facility and the Company's most recent borrowing base calculation provided access to approximately $120.2 million of the ABL Facility. 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. HEDGING ACTIVITIES The Company utilizes hot-rolled coil futures to manage price risk on unsold inventory and longer-term fixed price sales agreements. The Company has elected hedge accounting for some of its hedging activities previously but most recently the Company has classified its hedging activities as economic hedges of risk with mark-to-market ("MTM") accounting treatment. Hedging decisions are intended to protect the value of the Company's inventory and produce more consistent financial results over price cycles. The Company recognized a gain of approximately $5.4 million in the 2024 quarter related to it hedging activities with all of this being classified as economic hedges of risk. With MTM accounting treatment it is possible that hedging related gains or losses might be recognized in a different fiscal quarter or fiscal year than the corresponding improvement or contraction in our physical margins. See Note G for additional information related to the Company's hedging activities. OUTLOOK The Company expects sales volume for its second quarter of fiscal 2025 to be similar to the sales volume for the first quarter. The second quarter started with further decline in HRC price but as of the filing date of this Form 10-Q, HRC index prices have started to increase and HRC futures are pricing in further increases. The Company may experience a generally challenging margin environment in the second quarter but, if sustained, the increasing HRC price should result in improved physical margins toward the end of the second quarter and entering the third quarter. CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in conformity with U.S. generally accepted accounting principles may require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from any estimates. The Company did not identify any significant estimates or judgements related to the consolidated financial statements and accompanying notes presented in this Form 10-Q filing. 18 Table of Contents 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, including the adequacy of cash and expectations as to future sales, prices and margins. 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.