FRD 10-Q Quarter ended Sept. 30, 2018

FRIEDMAN INDUSTRIES, INCORPORATED

FRIEDMAN INDUSTRIES, INCORPORATED

FRIEDMAN INDUSTRIES, INCORPORATED

FRIEDMAN INDUSTRIES, INCORPORATED

CONDENSED NOTES TO QUARTERLY REPORT — UNAUDITED

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. Each 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. Combined, the facilities are capable of cutting sheet and plate with thicknesses ranging from 14 gauge to ½” thick. 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. Effective April 1, 2018, the Company changed the inventory valuation method for the coil segment’s prime coil inventory from the LIFO method to the average cost method. The impact of this change in accounting principle to both the current fiscal year periods and, as applied retrospectively, to the comparable periods of the prior fiscal year are disclosed in Note B of this quarterly report on Form 10-Q. Prior period information provided in this Management’s Discussion and Analysis has been updated to reflect the retrospective application of the change in accounting principle.

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 a 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 API licensed and focuses on threading semi-premium connections. 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 TTP has manufactured and new mill reject pipe that TTP purchases from U.S. Steel Tubular Products, Inc. (“USS”).

Results of Operations

Six Months Ended September 30, 201 8 Compared to Six Months Ended September 30, 201 7

During the six months ended September 30, 2018, sales, costs of goods sold and gross profit increased $52,464,368, $45,371,070 and $7,093,298, respectively, from the comparable amounts recorded during the six months ended September 30, 2017. The increase in sales was related to both an increase in tons sold and an increase in the average per ton selling price. Tons sold increased approximately 72% from approximately 72,000 tons in the 2017 period to approximately 124,000 tons in the 2018 period. Discussion of the sales improvement is expanded upon at the segment level in the following paragraphs. Gross profit as a percentage of sales increased from approximately 6.2% in the 2017 period to approximately 10.0% in the 2018 period.

Coil Segment

Coil product segment sales for the 2018 period totaled $65,957,644 compared to $38,137,674 for the 2017 period, representing a sales increase of $27,819,970 or approximately 73%. 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 $600,920 for the 2018 period compared to $591,008 for the 2017 period. Sales generated from coil segment inventory totaled $65,356,724 for the 2018 period compared to $37,546,666 for the 2017 period. The increase in coil segment sales was driven by an increase in tons shipped from inventory and an increase in the average selling price per ton for these shipments. Inventory tons sold increased from approximately 57,000 tons in the 2017 period to approximately 74,000 tons in the 2018 period. The average per ton selling price related to these shipments increased from approximately $663 per ton in the 2017 period to approximately $883 per ton in the 2018 period. The improved shipping volume for the 2018 period is attributable to increased demand among many of the segment’s customers. Management believes the demand improvement was primarily related to the effects of the U.S. government’s Section 232 steel trade actions, sustained improvement of the U.S. energy industry and the current steel industry and U.S. economic conditions in general. Coil segment operations recorded operating profits of approximately $5,103,000 and $1,709,000 in the 2018 and 2017 periods, respectively.

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 2018 period totaled $35,667,703 compared to $11,023,305 for the 2017 period, representing a sales increase of $24,644,398 or approximately 224%. For a more complete understanding of the average selling prices of goods sold, it is helpful to isolate sales generated from the finishing of customer owned pipe and sales generated from tubular segment inventory. Sales generated from finishing of customer owned pipe totaled $770,266 for the 2018 period compared to $1,664,256 for the 2017 period. Sales generated from tubular segment inventory totaled $34,897,437 for the 2018 period compared to $9,359,049 for the 2017 period. The increase in tubular segment sales was driven by an increase in tons shipped from inventory and an increase in the average selling price per ton for these shipments. Tons sold increased from approximately 15,500 tons in the 2017 period to approximately 50,000 tons in the 2018 period. The average per ton selling price related to these shipments increased from approximately $599 per ton in the 2017 period to approximately $697 per ton in the 2018 period. Tubular segment operations recorded operating profits of approximately $3,698,000 and $314,000 in the 2018 and 2017 periods, respectively.

Management believes the improved tubular results are primarily related to the sustained recovery of the U.S. energy industry and the segment’s new product offering of API line pipe. Late in the third quarter of fiscal 2018, TTP began actively producing, marketing and selling line pipe directly to distributors. Shipments of line pipe during the 2018 period totaled approximately 14,000 tons, or approximately 41%, of the 34,500 ton increase in tubular sales volume. Management expects line pipe sales to be a significant component of total tubular segment sales moving forward.

Shipments of mill reject pipe during the 2018 period totaled approximately 27,500 tons compared to approximately 8,000 tons during the 2017 period, accounting for approximately 57% of the 34,500 ton increase in tubular sales volume. The increased shipping volume of mill reject pipe is due to improved demand and a concentrated effort to reduce the level of inventory.

Due to fluctuations in our customers’ needs, revenue related to the finishing of customer owned pipe decreased $893,990 in the 2018 period compared to the 2017 period.

USS has been the primary supplier of new mill reject pipe to the Company. In March 2016, USS announced it was temporarily idling pipe production at its Lone Star Tubular Operations facility due to weak market conditions. In December 2016, USS announced plans to permanently idle its #1 pipe mill at the Lone Star facility. In May 2017, USS resumed production at its Lone Star facility’s #2 pipe mill. The Company expects the volume and size range of new mill reject pipe supply from USS to be reduced given the permanent idling of the Lone Star facility’s #1 pipe mill. USS is also a significant customer of the tubular segment’s pipe-finishing facility. Loss of USS as a supplier or customer could have a material adverse effect on the Company’s business. In general, 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 2018 period, general, selling and administrative costs increased $819,259 compared to the 2017 period. This increase was related primarily to increases in bonuses and commissions associated with the increased earnings and sales volume.

Income Taxes

Income taxes in the 2018 period increased $1,477,441 from the amount recorded in the 2017 period. This increase was related primarily to the increase in earnings before taxes for the 2018 period compared to the 2017 period but partially offset due to effects of the Tax Cuts and Jobs Act (the “Tax Act”) that was enacted by the U.S. government on December 22, 2017. The Tax Act reduced the federal corporate tax rate applicable to the Company from 34% to 21% effective January 1, 2018.

Three Months Ended September 30, 201 8 Compared to Three Months Ended September 30, 201 7

During the three months ended September 30, 2018 (the “2018 quarter”), sales, costs of goods sold and gross profit increased $27,354,319, $24,910,189 and $2,444,130, respectively, compared to the amounts recorded during the three months ended September 30, 2017 (the “2017 quarter”). The increase in sales was related to both an increase in tons sold and an increase in the average per ton selling price. Tons sold increased approximately 63% from approximately 39,000 tons in the 2017 quarter to approximately 63,500 tons in the 2018 quarter. Discussion of the sales improvement is expanded upon at the segment level in the following paragraphs. Gross profit as a percentage of sales increased from approximately 5.8% in the 2017 quarter to approximately 7.4% in the 2018 quarter.

Coil Segment

Coil product segment sales for the 2018 quarter totaled $34,828,444 compared to $20,127,839 for the 2017 quarter, representing a sales increase of $14,700,605 or approximately 73%. 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 $358,209 for the 2018 quarter compared to $225,367 for the 2017 quarter. Sales generated from coil segment inventory totaled $34,470,235 for the 2018 quarter compared to $19,902,472 for the 2017 quarter. The increase in coil segment sales was driven by an increase in tons shipped from inventory and an increase in the average selling price per ton for these shipments. Inventory tons sold increased from approximately 30,500 tons in the 2017 quarter to approximately 38,000 tons in the 2018 quarter. The average per ton selling price related to these shipments increased from approximately $656 per ton in the 2017 quarter to approximately $912 per ton in the 2018 quarter. The improved shipping volume for the 2018 quarter is attributable to increased demand among many of the segment’s customers. Management believes the demand improvement was primarily related to the effects of the U.S. government’s Section 232 steel trade actions, sustained improvement of the U.S. energy industry and the current steel industry and U.S. economic conditions in general. Coil segment operations recorded operating profits of approximately $1,925,000 and $675,000 in the 2018 and 2017 quarters, respectively. Due to seasonality and a reduced number of shipping days, management expects coil segment shipments for the third quarter to decline compared to second quarter volume with third quarter volume in the range of 31,000 tons to 34,000 tons. Management also expects slight margin contraction for the third quarter due primarily to a decline in steel prices.

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 2018 quarter totaled $18,603,585 compared to $5,949,871 for the 2017 quarter, representing a sales increase of $12,653,714 or approximately 213%. For a more complete understanding of the average selling prices of goods sold, it is helpful to isolate sales generated from the finishing of customer owned pipe and sales generated from tubular segment inventory. Sales generated from finishing of customer owned pipe totaled $82,396 for the 2018 quarter compared to $1,146,192 for the 2017 quarter. Sales generated from tubular segment inventory totaled $18,521,189 for the 2018 quarter compared to $4,803,679 for the 2017 quarter. The increase in tubular segment sales was driven by an increase in tons shipped from inventory and an increase in the average selling price per ton for these shipments. Tons sold increased from approximately 8,500 tons in the 2017 quarter to approximately 25,500 tons in the 2018 quarter. The average per ton selling price related to these shipments increased from approximately $567 per ton in the 2017 quarter to approximately $722 per ton in the 2018 quarter. Tubular segment operations recorded operating profits of approximately $1,376,000 and $316,000 in the 2018 and 2017 quarters, respectively.

Management believes the improved tubular results are primarily related to the sustained recovery of the U.S. energy industry and the segment’s new product offering of API line pipe. Late in the third quarter of fiscal 2018, TTP began actively producing, marketing and selling line pipe directly to distributors. Shipments of line pipe during the 2018 quarter totaled approximately 8,000 tons, or approximately 47%, of the 17,000 ton increase in tubular sales volume. Management expects line pipe sales to be a significant component of total tubular segment sales moving forward. Management expects third quarter line pipe shipments to be approximately 5,000 tons. Management believes this decrease compared to the second quarter volume is primarily related to customers managing year-end inventory levels and a level of uncertainty surrounding the volume and impact of foreign imports when Section 232 quotas reset at the start of 2019.

Shipments of mill reject pipe during the 2018 quarter totaled approximately 13,500 tons compared to 5,000 tons during the 2017 quarter, accounting for approximately 50% of the 17,000 ton increase in tubular sales volume. The increased shipping volume of mill reject pipe is due to improved demand and a concentrated effort to reduce the level of inventory. Management currently expects a decline in volume during the third quarter as desired inventory levels are achieved.

For the third quarter, management expects slight margin contraction related to manufactured pipe sales and expects moderate margin improvement related to mill reject pipe sales but management is unable to accurately estimate whether the net effect will be an overall increase, decrease or neutral impact to total tubular segment margins.

Due to fluctuations in our customers’ needs, revenue related to the finishing of customer owned pipe decreased from $1,146,192 in the 2017 quarter to $82,396 in the 2018 quarter. For the third quarter, management expects a low level of activity similar to that of the second quarter. These revenues are generated at the Company’s pipe finishing facility that commenced operations in May 2017. The facility is designed to function optimally as a high volume processing facility with a small customer base. Operations at the facility have been sporadic as new customer relationships evolve and due to some fluctuation in the energy industry and the steel industry in general. In addition to cultivating existing customer relationships, management continues to seek additional customers that are a strategic fit for the facility. Management will continue to evaluate the long-term operating potential of the facility on a continual basis.

USS has been the primary supplier of new mill reject pipe to the Company. In March 2016, USS announced it was temporarily idling pipe production at its Lone Star Tubular Operations facility due to weak market conditions. In December 2016, USS announced plans to permanently idle its #1 pipe mill at the Lone Star facility. In May 2017, USS resumed production at its Lone Star facility’s #2 pipe mill. The Company expects the volume and size range of new mill reject pipe supply from USS to be reduced given the permanent idling of the Lone Star facility’s #1 pipe mill. USS is also a significant customer of the tubular segment’s pipe-finishing facility. Loss of USS as a supplier or customer could have a material adverse effect on the Company’s business. In general, 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 2018 quarter, general, selling and administrative costs increased $364,913 compared to the 2017 quarter. This increase was related primarily to increases in bonuses and commissions associated with the increased earnings and sales volume.

Income Taxes

Income taxes in the 2018 quarter increased $459,782 from the amount recorded in the 2017 quarter. This increase was related primarily to the increase in earnings before taxes for the 2018 quarter compared to the 2017 quarter but partially offset due to effects of the Tax Act that was enacted by the U.S. government on December 22, 2017. The Tax Act reduced the federal corporate tax rate applicable to the Company from 34% to 21% effective January 1, 2018.

FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES

We believe the Company remained in a strong, liquid position at September 30, 2018. The current ratios were 5.1 and 6.1 at September 30, 2018 and March 31, 2018, respectively. Working capital was $61,857,215 at September 30, 2018 and $56,238,771 at March 31, 2018.

At September 30, 2018, 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 as a result of the purchase of property, plant and equipment and the payment of cash dividends partially offset by cash provided by operating activities. The balance of accounts payable and inventory rose considerably due to the volume and timing of inventory purchases for both the Company’s coil and tubular segments. 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 December 2017, the Company put into place a $7,500,000 revolving line of credit facility (the “Credit Facility”) that expires December 11, 2018. At September 30, 2018 and as of the filing date of this quarterly report on Form 10-Q, the Company had no borrowings outstanding under the Credit Facility. The Company was not in violation of any terms or covenants related to the Credit Facility as of the filing date of this quarterly report on Form 10-Q. Management expects to renew the Credit Facility prior to its expiration.

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 24 months.

CRITICAL ACCOUNTING POLICIES

The preparation of consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Significant estimates that are subject to the Company’s assumptions include the determination of useful lives for fixed assets and the determination of the allowance for doubtful accounts. 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. 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 the demand for steel and steel products in general and the Company’s success in executing its internal operating plans, including any proposed expansion plans. 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.

Not required.

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 September 30, 2018. 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 September 30, 2018 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 September 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

FRIEDMAN INDUSTRIES, INCORPORATED

Three Months Ended September 30, 201 8

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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