Friedman Industries Inc: Form 10-Q for the period ended Jun 30, 2020

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. As part of the equipment removal, the cut-to-length line was sold for scrap resulting in anticipated proceeds of $30,957 and $2,688,381 of original cost being removed from machinery and equipment and accumulated depreciation of $2,657,424 being removed. The temper mill was disassembled with the components being cleaned, cataloged and stored as the Company intends to sell the equipment. Installation of the new equipment is expected to begin in October 2020 and commercial use is expected to start in February 2021. The estimated total cost of this project is $5,800,000 with approximately $3,874,000 having been spent as of June 30, 2020. 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. 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 purchases from U.S. Steel Tubular Products, Inc.

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. We are pleased to report that all of those cases have successfully recovered and that we are not aware of any active cases as of the filing of this Form 10-Q.

Results of Operations

Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019

During the three months ended June 30, 2020 (the “2020 quarter”), sales, costs of goods sold and gross profit decreased $17,450,720, $16,236,150 and $1,214,570, respectively, compared to the amounts recorded during the three months ended June 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 53,500 tons in the 2019 quarter to approximately 38,000 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 profit as a percentage of sales decreased from approximately 3.6% in the 2019 quarter to approximately 1.1% 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 impacted by a declining steel price. The 2020 quarter experienced additional challenges related to the COVID-19 pandemic.

Coil Segment

Coil product segment sales for the 2020 quarter totaled $15,432,784 compared to $28,181,468 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 $184,313 for the 2020 quarter compared to $180,500 for the 2019 quarter. Sales generated from coil segment inventory totaled $15,248,471 for the 2020 quarter compared to $28,000,968 for the 2019 quarter. Inventory tons sold decreased from approximately 38,000 tons in the 2019 quarter to approximately 27,000 tons in the 2020 quarter. The average per ton selling price related to these shipments decreased from approximately $743 per ton in the 2019 quarter to approximately $566 per ton in the 2020 quarter. Coil segment operations recorded an operating loss of approximately $459,000 for the 2020 quarter and an operating profit of approximately $345,000 for the 2019 quarter.

Operating results for both the 2020 quarter and the 2019 quarter were negatively impacted by declining 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. 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% and June 2020 volume was down approximately 3%. The coil segment experienced a rapid recovery in sales volume during the 2020 quarter, and we expect the recovery of monthly volumes to near fiscal 2020 volume levels to be sustained for the second quarter of fiscal 2021. Coil segment sales volume for July 2020 was down approximately 6% compared to the fiscal 2020 monthly average and we expect similar volume for August 2020.

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 $8,091,816 compared to $12,793,852 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 11,000 tons in the 2020 quarter. The average per ton selling price related to these shipments decreased from approximately $819 per ton in the 2019 quarter to approximately $723 per ton in the 2020 quarter. The tubular segment operations recorded operating profits of approximately $59,000 and $545,000 for the 2020 and 2019 quarters, respectively.

Operating results for both the 2020 quarter and the 2019 quarter were negatively impacted by declining 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. Compared to the average monthly sales volume for the fiscal year ended March 31, 2020, April 2020 volume was down approximately 4%, May 2020 was down approximately 36% and June 2020 was down approximately 27%. 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 has seen a slow but gradual improvement since May with this trend continuing into July, with monthly volume down 20% from the fiscal 2020 monthly average. Energy industry conditions remain challenging and, in recent months, we have seen increased competition from imported pipe. Operating results for the 2020 quarter were also negatively impacted by an inventory write down of $274,093 at June 30, 2020 related to the segment’s manufactured pipe inventory. The write down was necessary due to the continued decline in steel prices and reduced product demand resulting in unadjusted inventory values that were in excess of net realizable values at and subsequent to June 30, 2020. We expect tubular demand to remain soft during the second quarter of fiscal 2021.

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 June 30, 2020, we had approximately 31,000 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 $183,366 compared to the 2019 quarter. Approximately $78,000 of this increase is due to the reclassification of some payroll costs that were previously classified as part of costs of goods sold and now classified under general and administrative costs. The remaining increase was related primarily to increased professional fees and restricted stock plan compensation expense.

Income Taxes

Income taxes in the 2020 quarter decreased $352,267 from the amount recorded in the 2019 quarter. This decrease was related primarily to the decrease in earnings before taxes for the 2020 quarter compared to the 2019 quarter.

FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES

The Company’s current ratio was 16.2 at June 30, 2020 and 6.8 at March 31, 2020. Working capital was $54,394,416 at June 30, 2020 and $55,566,158 at March 31, 2020.

During the three months ended June 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 decreased from operating activities and the purchase of property, plant and equipment partially offset by a cash inflow from financing associated with a Paycheck Protection Program loan discussed in more detail below. 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.

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.

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.

The Company’s management, with the participation of the Company’s principal executive officer (“CEO”) and principal financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act), as of the end of the fiscal quarter ended June 30, 2020. Based on this evaluation, the Company’s CEO and principal financial officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the fiscal quarter ended June 30, 2020 to ensure that information that is required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to the Company’s management, including the CEO and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

There were no changes in the Company’s internal control over financial reporting that occurred during the fiscal quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Three Months Ended June 30, 2020