FRD

Business Context and Reporting Period

Company: Friedman Industries, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2010
Business Overview: The Company operates in two primary segments: Coil and Tubular products. It is a smaller reporting company incorporated in Texas. The Company is heavily dependent on Nucor Steel Company (NSC) for coil inventory and United States Steel Tubular Products, Inc. (USS) for tubular supply and as a major customer.

Key Financial Metrics

Material Changes Versus Prior Period

• Revenue Growth: Net sales increased significantly compared to the prior year periods. For the nine months ended Dec 31, 2010, sales rose $47.9 million (114.6%) compared to the same period in 2009. This was driven by a substantial increase in tons sold (from ~72,000 to ~122,000 tons) and higher average selling prices.
• Profitability Turnaround: The Company reported a net loss of $410,234 for the nine months ended Dec 31, 2009, compared to net earnings of $4,953,062 for the same period in 2010. Gross margins improved from approximately 5.0% in 2009 to 12.4% in 2010.
• Segment Performance:
  • Tubular: Sales increased ~$32.0 million (nine months) due to improved market conditions and increased orders from USS. Operating profit margin improved from 9.0% to 18.4%.
  • Coil: Sales increased ~$15.9 million (nine months), but the segment continued to operate at a loss due to soft demand and rising material costs that could not be fully passed to customers.
• Inventory Build: Inventories increased by $7.1 million (from $20.1M to $27.2M) to support higher production levels, resulting in a cash outflow of $7.1 million in operating activities.
• Dividends: The Company paid cash dividends of $4.28 million in the nine months ended Dec 31, 2010, compared to $0.61 million in the prior year period, including a special dividend of $0.50 per share.

Guidance, Outlook, and Risks

• Market Outlook: Management expects market conditions for coil products to remain soft until the U.S. economy improves and demand for durable goods recovers. The Decatur, Alabama coil facility is expected to continue producing losses until demand improves.
• Tubular Segment: Outlook is positive due to increased orders from USS following the reopening of their Lone Star facility in February 2010.
• Liquidity and Capital Resources: The Company maintains a strong liquid position with a current ratio of 5.7. A revolving line of credit expired on April 1, 2010, and was not renewed due to unfavorable lending terms; however, the Company believes cash flows and borrowing capability are adequate for the next 24 months.
• Key Risks:
  • Supplier/Customer Concentration: Significant reliance on NSC for coil supply and USS for tubular supply and sales. Loss of either relationship could have a material adverse effect.
  • Economic Sensitivity: Operations are heavily dependent on the U.S. economy and demand for energy-related products and durable goods.
  • Inventory Valuation: Use of LIFO method for prime coil inventory requires estimates of year-end quantities, which involves judgment.

Investor Verification Checklist

• Verify the sustainability of the 12.4% gross margin given the volatility in steel prices and the Company's inability to pass on all cost increases in the coil segment.
• Confirm the status of the relationship with USS and NSC, specifically regarding future order volumes and supply availability.
• Assess the impact of the $7.1 million inventory build on future working capital requirements and cash flow.
• Review the continued operating losses at the Decatur, Alabama coil facility and management's timeline for profitability.
• Monitor the Company's ability to maintain liquidity without a revolving credit facility, particularly if market conditions deteriorate.