FRD Friedman Industries Inc

NOTE A — BASIS OF PRESENTATION

The accompanying unaudited, condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and footnotes of Friedman Industries, Incorporated (the “Company”) included in its annual report on Form 10-K for the year ended March 31, 2021.

NOTE B — NEW ACCOUNTING PRONOUNCEMENTS

In December 2019, the FASB issued Accounting Standards Update 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which simplifies accounting for income taxes by revising or clarifying existing guidance in ASC 740, as well as removing certain exceptions within ASC 740. We adopted this guidance on April 1, 2021. The adoption of this guidance did not have a material impact on the Company's Condensed Consolidated Financial Statements.

NOTE C — INVENTORIES

Inventories consist of prime coil, non-standard coil and tubular materials. Prime coil inventory consists primarily of raw materials, non-standard coil inventory consists primarily of raw materials and tubular inventory consists of both raw materials and finished goods. Cost for prime coil inventory is determined using the average cost method. Cost for non-standard coil inventory is determined using the specific identification method. Cost for tubular inventory is determined using the average cost method. All inventories are valued at the lower of cost or net realizable value.

A summary of inventory values by product group follows:

Tubular raw material inventory consists of hot-rolled steel coils that the Company will manufacture into pipe. Tubular finished goods inventory consists of pipe the Company has manufactured and new mill reject pipe the Company has purchased from U.S. Steel Tubular Products, Inc.

NOTE D – DEBT

          On June 22, 2021, the Small Business Administration authorized full forgiveness of our Paycheck Protection Program loan. The gain of $1,706,614 from this extinguishment of debt included both principal and interest and is recorded as a component of "Other income (loss), net" on the Company's Condensed Consolidated Statement of Operations for the nine months ended Decemberr 31, 2021.

On March 8, 2021, the Company entered into a Credit Agreement providing for a $10 million revolving line of credit facility (the "Interim Credit Facility) with JPMorgan Chase Bank, N.A. (the "Bank"). The term of the Interim Credit Facility had an expiration date of July 15, 2021 because the Company was evaluating options for longer term credit arrangements. On April 14, 2021, the Company executed a first amendment to the Interim Credit Facility that increased the size of the facility from $10 million to $20 million. On May 19, 2021, the Company entered into an Amended and Restated Credit Agreement with the Bank that amends and restates the Interim Credit Facility and provides for asset-based revolving loans in an aggregate principal amount up to $40 million (the "ABL Facility"). The ABL Facility matures on May 19, 2026 and replaced the Interim Credit Facility in its entirety. The ABL Facility is secured by substantially all of the assets of the Company and borrowings bear interest at a rate equal to LIBOR plus 1.7% per annum. Availability of funds under the ABL Facility is subject to a borrowing base calculation determined as the sum of (a) 85% 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 and plus (c) a machinery and equipment component that is the lesser of 85% of the net orderly liquidating value of eligible equipment or the machinery and equipment component limit which is initially $5 million and reduces over the term of the facility. The ABL Facility contains a financial covenant restricting 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 $10 million, in minimum increments of $5 million. At  December 31, 2021, the Company had a balance of $15,187,824 under the ABL Facility with an applicable interest rate of 1.80%. At  December 31, 2021, the Company's borrowing base calculation provided full access to the ABL Facility and the Company was in compliance with all covenants related to the ABL Facility. 

 NOTE E — LEASES

The Company’s lease of its office space in Longview, Texas is the only operating lease included in the Company's right-of-use ("ROU") asset and lease liability. The lease calls for monthly rent payments of $4,878 and expires on April 30, 2024. The Company’s other operating leases for items such as IT equipment and storage space are either short-term in nature or immaterial.

In October 2019, the Company received a new heavy-duty forklift under a 5-year finance lease arrangement with a financed amount of $518,616 and a monthly payment of $9,074.

The components of expense related to leases for the three and nine months ended December 31, 2021 and 2020 are as follows:

The following table illustrates the balance sheet classification for ROU assets and lease liabilities as of December 31, 2021 and March 31, 2021:

As of December 31, 2021, the weighted-average remaining lease term was 2.3 years for operating leases and 2.8 years for finance leases. The weighted average discount rate was 7% for operating leases and 1.9% for finance leases.

Maturities of lease liabilities as of December 31, 2021 were as follows:

NOTE F — PROPERTY, PLANT AND EQUIPMENT

On May 25, 2021, the Company announced plans for a new facility in Sinton, Texas that will be part of the coil product segment. The new facility will be on the campus of Steel Dynamics, Inc.'s ("SDI") new flat roll steel mill currently under construction in Sinton, Texas. The Company's new location will consist of an approximately 70,000 square foot building located on approximately 26.5 acres leased from SDI under a 99-year agreement with an annual rental payment of $1. The Company has selected Red Bud Industries to build a stretcher leveler cut-to-length line for the facility that is capable of handling material up to 1” thick, widths up to 96” and yields exceeding 100,000 psi. The Company expects the location to commence operations in August 2022 and estimates the total cost of the project to be $21 million. The Company previously expected the facility to commence operations in April 2022 but has received notification from the electricity provider that the electrical infrastructure necessary to operate the facility is not expected to be complete until July 2022. At  December 31, 2021, the Company's construction in process related to the Sinton project was $12,983,850 consisting of $7,383,850 in cash payments and $5,600,000 of accrued capital expenditures.

During the nine months ended December 31, 2021, the Company wrote off fully depreciated fixed assets that were no longer in use with an original cost and accumulated depreciation of approximately $2,060,226. During the nine months ended December 31, 2021, the Company disposed of the temper mill that was taken out of the Decatur facility prior to the new stretcher leveler coil processing line being installed. The Company received $160,542 in proceeds from the disposal of the equipment which had an original cost of $3,604,209 and accumulated depreciation of $3,447,465.

NOTE G — STOCK BASED COMPENSATION

The Company maintains the Friedman Industries, Incorporated 2016 Restricted Stock Plan (the “Plan”). The Plan is administered by the Compensation Committee (the “Committee”) of the Board of Directors (the “Board”) and continues indefinitely until terminated by the Board or until all shares allowed by the Plan have been awarded and earned. The aggregate number of shares of the Company’s Common Stock eligible for award under the Plan is 500,000 shares. Subject to the terms and provisions of the Plan, the Committee may, from time to time, select the employees to whom awards will be granted and shall determine the amount and applicable restrictions of each award. Forfeitures are accounted for upon their occurrence.

The following table summarizes the activity related to restricted stock awards for the nine months ended December 31, 2021:

Compensation expense is recognized over the requisite service period applicable to each award. The Company recorded compensation expense of $375,935 and $376,363 in the nine months ended December 31, 2021 and 2020, respectively, relating to the stock awards issued under the Plan. As of December 31, 2021, unrecognized compensation expense related to stock awards was approximately $618,714, which is expected to be recognized over a weighted average period of approximately 2.4 years. As of December 31, 2021, a total of 130,185 shares were still available to be issued under the Plan.

NOTE H — DERIVATIVE FINANCIAL INSTRUMENTS

In June 2020, the Company implemented its first commodity price risk management activities by transacting hot-rolled coil futures. From time to time, we expect to use derivative financial instruments to minimize our exposure to commodity price risk that is inherent in our business. At the time derivative contracts are entered into, we assess whether the nature of the instrument qualifies for hedge accounting treatment according to the requirements of ASC 815 – Derivatives and Hedging (“ASC 815”). By using derivatives, the Company is exposed to credit and market risk. The Company’s exposure to credit risk includes the counterparty’s failure to fulfill its performance obligations under the terms of the derivative contract. The Company attempts to minimize its credit risk by entering into transactions with high quality counterparties and uses exchange-traded derivatives when available. Market risk is the risk that the value of the financial instrument might be adversely affected by a change in commodity prices. The Company manages market risk by continually monitoring exposure within its risk management strategy and portfolio. For those transactions designated as hedging instruments for accounting purposes, we document all relationships between hedging instruments and hedged items, as well as our risk-management objective and strategy for undertaking the various hedge transactions. We also assess, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in cash flows or fair value of hedged items.

From time to time, derivatives designated for hedge accounting may be closed prior to contract expiration. The accounting treatment of closed positions depends on whether the closure occurred due to the hedged transaction occurring early or if the hedged transaction is still expected to occur as originally forecasted. For hedged transactions that occur early, the closure results in the realized gain or loss from closure being recognized in the same period the accelerated hedged transaction affects earnings. For hedged transactions that are still expected to occur as originally forecasted, the closure results in the realized gain or loss being deferred until the hedged transaction affects earnings.

If it is determined that hedged transactions associated with cash flow hedges are no longer probable of occurring, the gain or loss associated with the instrument is recognized immediately into earnings. 

From time to time, we may have derivative financial instruments for which we do not elect hedge accounting. 

The Company has forward physical purchase supply agreements in place with some of its suppliers for a portion of its monthly physical steel needs. These supply agreements are not subject to mark-to-market accounting due to the Company electing the normal purchase normal sale exclusion provided in ASC 815. 

At December 31, 2021 and  March 31, 2021, the Company held hot-rolled coil futures contracts which were designated as hedging instruments and classified as cash flow hedges, either as hedges of variable purchase prices or as hedges of variable sales prices. Accordingly, realized and unrealized gains and losses associated with the instruments are reported as a component of other comprehensive income and reclassified into earnings during the period in which the hedged transaction affects earnings. During the three and nine months ended December 31, 2021, some of the Company's cash flow hedges were closed prior to expiration but the hedged transactions were still expected to occur as originally forecasted resulting in the realized gain or loss being deferred in other comprehensive income until the hedged transactions occur and affect earnings. At September 30, 2021, the Company removed some derivative instruments from hedge accounting due to the hedged transactions no longer being expected to occur. This was the result of the Company reducing its forecasted sales for the quarter ending December 31, 2021 due to anticipated customer reaction to plateauing and declining steel prices. Since these hedged sales were no longer expected to occur, a loss of $9,930,720 associated with these instruments was immediately recognized into earnings for the September 30, 2021 quarter and reported as a component of “Other income (loss), net”. During the three and nine months ended December 31, 2021, the Company also entered into hot-rolled coil futures contracts that were not designated as hedging instruments for accounting purposes. Accordingly, the change in fair value related to these instruments was immediately recognized in earnings.  

The following table summarizes the fair value of the Company’s derivative financial instruments and the respective line in which they were recorded in the Consolidated Balance Sheet as of December 31, 2021:

All derivatives are presented on a gross basis on the Consolidated Balance Sheet.

The following table summarizes the fair value of the Company’s derivative financial instruments and the respective line in which they were recorded in the Consolidated Balance Sheet as of March 31, 2021:

All derivatives are presented on a gross basis on the Consolidated Balance Sheet.

At December 31, 2021 and  March 31, 2021, the Company reported $280,220 and $501,360, respectively, in "Accounts payable and accrued expenses" on its Consolidated Balance Sheets related to futures contracts which were closed but were pending cash settlement.

The notional amounts (quantities) of our cash flow hedges outstanding at December 31, 2021 consisted of 34,020 tons hedging sales with maturity dates ranging from January 2022 to December 2022.

The following table summarizes the pre-tax gain (loss) recognized in other comprehensive income and the gain (loss) reclassified from accumulated other comprehensive loss into earnings for derivative financial instruments designated as cash flow hedges for the periods presented:

The estimated amount of net losses recognized in AOCI at December 31, 2021 expected to be reclassified into net earnings (loss) within the succeeding twelve months is $9,220,880. This amount consists of $9,952,400 in realized losses associated with closed hedges and net unrealized gains of $731,520 associated with open hedges that was computed using the fair value of the cash flow hedges as of December 31, 2021 and is subject to change before actual reclassification from AOCI to net earnings (loss).

The following table summarizes the gain (loss) recognized in earnings for derivative instruments not designated as hedging instruments during the three and nine months ended December 31, 2021:

The notional amount (quantity) of our derivative instruments not designated as hedging instruments at December 31, 2021 consisted of 16,860 tons of long positions with maturity dates ranging from January 2022 to August 2022 and 21,380 tons of short positions with maturity dates ranging from January 2022 to December 2022.

The Company did not have any derivative instruments not designated as hedging instruments for the three and nine months ended December 31, 2020.

The following table reflects the change in accumulated other comprehensive income (loss), net of tax, for the period presented:

(1) The loss reclassified from AOCI is presented net of tax benefit of $2,976,019 which are included in provision for (benefit from) income taxes on the Company's Consolidated Statement of Operations for the three and nine months ended December 31, 2021.

(1) The gain reclassified from AOCI is presented net of taxes of $83,311 which are included in provision for (benefit from) income taxes on the Company's Consolidated Statement of Operations for the three and nine months ended December 31, 2020.

At  December 31, 2021 and  March 31, 2021, cash of $1,585,350 and $12,001,485, respectively, was held by our clearing agent to collateralize our open derivative positions. These cash requirements are included in "Other current assets" on the Company's Consolidated Balance Sheets at  December 31, 2021 and  March 31, 2021.

NOTE I — FAIR VALUE MEASUREMENTS

Accounting standards provide a comprehensive framework for measuring fair value and sets forth a definition of fair value and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable value inputs. Levels within the hierarchy are defined as follows:

At  March 31, 2021, our financial liabilities, net, measured at fair value on a recurring basis were as follows:

At  December 31, 2021 and  March 31, 2021, the Company did not have any fair value measurements on a non-recurring basis.

Operating profit is total net sales less operating expenses, excluding general corporate expenses, interest expense and other income (loss). General corporate expenses reflect general and administrative expenses not directly associated with segment operations and consist primarily of corporate and accounting salaries, professional fees and services, bad debts, retirement plan contribution expense, corporate insurance expenses, restricted stock plan compensation expense and office supplies. Other income (loss) for the three months ended December 31, 2021 consisted primarily of a $1,721,700 gain related to derivatives not designated for hedge accounting. Other income (loss) for the nine months ended December 31, 2021 consisted primarily of a $6,498,040 loss related to derivatives not designated for hedge accounting partially offset by a $1,706,614 gain from the PPP Loan forgiveness. Corporate assets consist primarily of cash, restricted cash and the cash value of officers’ life insurance. Although inventory is transferred at cost between product groups, there are no sales between product groups.

NOTE K — REVENUE

Revenue is generated primarily from contracts to manufacture or process steel products. Most of the Company’s revenue is generated by sales of material out of the Company’s inventory, but a portion of the Company’s revenue is derived from processing of customer owned material. Generally, the Company’s performance obligations are satisfied, control of our products is transferred, and revenue is recognized at a single point in time, when title transfers to our customer for product shipped or when services are provided. Revenues are recorded net of any sales incentives. Shipping and other transportation costs charged to customers are treated as fulfillment activities and are recorded in both revenue and cost of sales at the time control is transferred to the customer. Costs related to obtaining sales contracts are incidental and expensed when incurred. Because customers are invoiced at the time title transfers and the Company’s rights to consideration are unconditional at that time, the Company does not maintain contract asset balances. Additionally, the Company does not maintain contract liability balances, as performance obligations are satisfied prior to customer payment for product. The Company offers industry standard payment terms.

The Company has two reportable segments: Coil and Tubular. Coil primarily generates revenue from cutting to length hot-rolled steel coils. Coil segment revenue consists of three main product types: Prime Coil, Non-Standard Coil and Customer Owned Coil. Tubular primarily generates revenue from the manufacture, distribution and processing of steel pipe. Tubular segment revenue consists of three main product or service types: Manufactured Pipe, Mill Reject Pipe and Pipe Finishing Services. In March 2020, U.S. Steel announced the idling of their Lone Star Tubular Operations which was the Company's sole supplier of mill reject pipe. U.S. Steel's facility was idled as announced and the Company's receipts of mill reject pipe ceased in August 2020. At December 31, 2021, the Company had approximately 3,000 tons of mill reject inventory and believes the balance will be substantially sold within 6 months. The Company expects the idling to have a negative impact on operations as mill reject pipe inventory is sold out. The Company did not generate any revenue from pipe finishing services during either of the three month or nine month periods ended December 31, 2021 or December 31, 2020. The pipe finishing facility is currently idled due to market conditions. The following table disaggregates our revenue by product for each of our reportable business segments for the three and nine months ended December 31, 2021 and 2020, respectively:

NOTE N — SUPPLEMENTAL CASH FLOW INFORMATION

The Company paid interest of approximately $154,000 during the nine months ended December 31, 2021 and $6,000 during the nine months ended December 31, 2020. The Company paid income taxes of approximately $7,487,000, net of a tax refund of approximately $423,000, during the nine months ended December 31, 2021 and paid income taxes of approximately $10,000 during the nine months ended December 31, 2020. At  December 31, 2021, the “Construction in process” balance of $12,983,850 consisted of $5,600,000 of accrued capital expenditures for which cash outlay had not occurred.

NOTE O — INCOME TAXES

For the nine months ended December 31, 2021, the Company recorded an income tax provision of $6,303,899, or 22.7% of earnings before income taxes, compared to an income tax provision of $298,668, or 22.6% of earnings before income taxes for the nine months ended December 31, 2020. Typically, the Company’s effective tax rate differs from the federal statutory rate due to the inclusion of state tax expenses or benefits in the provision. However, for the nine months ended December 31, 2021, the Company’s effective tax rate differed from the federal statutory rate due to a combination of the inclusion of state tax expenses in the provision and the exclusion of the non-taxable gain associated with forgiveness of the Company’s PPP Loan from the provision. For the nine months ended December 31, 2020, the effective tax rate differed from the federal statutory rate due primarily to the inclusion of state tax benefits in the provision.