FRIEDMAN INDUSTRIES INC - Quarter Report: 2006 September (Form 10-Q)

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

                         Large accelerated filer (  )            Accelerated filer (  )            Non-accelerated filer (X)

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

		September 30,				March 31,
		2006				2006
Prime Coil Inventory		$	8,410,897			$	10,525,848
Non-Standard Coil Inventory			1,000,714				788,266
Tubular Raw Material			8,112,186				3,889,206
Tubular Finished Goods			9,372,005				12,753,601
		$	26,895,802			$	27,956,921

requirements of the Prospective Method but further permits entities to restate all prior periods presented based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures. The Company adopted the Prospective Method on April 1, 2006 and there was no impact on the financial statements as all of the options were vested as of April 1, 2006.

     Under the Company’s 1989 and 1996 Stock Option Plans, options were granted to certain officers and key employees to purchase common stock of the Company. Pursuant to the terms of the plans, no additional options may be granted. All options have ten-year terms and become fully exercisable at the end of six months of continued employment. The following is a summary of activity relative to options outstanding during each of the periods ended September 30:

		2006								2005
						Weighted								Weighted
						Average								Average
						Exercise								Exercise
		Shares				Price				Shares				Price
Outstanding at beginning of period			137,212			$	2.35				224,718			$	2.62
Granted			—				—				—				—
Exercised			—				—				—				—
Canceled or expired			(2,894	)		$	3.13				(10,979	)		$	2.40
Outstanding at end of period			134,318			$	2.33				213,739			$	2.63
Exercisable at the end of the period			134,318			$	2.33				213,739			$	2.63
Weighted average fair value of options granted during the period							N/A								N/A

Outstanding and exercisable stock options at September 30, 2006, were as follows:

Outstanding

Exercisable

Weighted

Weighted

Weighted

Average

Average

Average

Range of

Remaining

Exercise

Exercise

Exercise Price

Years

Shares

Price

Shares

Price

$2.33

6.2

134,318

$

2.33

134,318

$

2.33

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

    Six Months Ended September 30, 2006 Compared to Six Months Ended September 30, 2005

During the six months ended September 30, 2006, sales, costs of goods sold and gross profit increased $15,466,044, $14,035,591 and $1,430,453, respectively, from the comparable amounts recorded during the six months ended September 30, 2005. The increase in sales was related to an increase in tons sold as well as an increase in the average per ton selling price. Tons shipped increased from approximately 143,000 tons in the 2005 period to 157,000 tons in the 2006 period as the average per ton selling price increased from approximately $620 per ton in the 2005 period to approximately $664 per ton in the 2006 period. The increase in costs of goods sold was primarily related to the increase in sales. Average per ton costs of goods sold increased from approximately $572 in the 2005 period to $611 in the 2006 period. Gross profit as a percentage of sales remained approximately the same at approximately 7.7% and 7.9% in the 2005 and 2006 periods, respectively.

Coil product segment sales increased approximately $10,092,000 during the 2006 period. This segment experienced increases in both tons sold and average selling prices. Tons of coil products sold increased from approximately 71,000 tons in the 2005 period to 78,000 tons in the 2006 period while the average per ton selling price increased from approximately $631 per ton to approximately $700 per ton. Coil operating profit decreased approximately $330,000 as increased costs of material could not be passed along in total to customers in the short term. Coil operating profit as a percentage of coil segment sales decreased from approximately 5.4% in the 2005 period to 3.8% in the 2006 period.

In the 2006 period, the Company phased out its Lone Star coil facility located in Lone Star, Texas ("LSCF"). LSCF accounted for approximately 1% of total sales and generated a loss of approximately $8,000 in the 2006 period. Certain LSCF assets will be redeployed to the Company’s new coil operation to be located in Decatur, Alabama.

The Company is dependent on Nucor Steel Company ("NSC") for its supply of coil inventory. In the 2006 period, NSC continued to supply steel coils in amounts that were adequate for the Company’s purposes. The Company does not currently anticipate any significant change in such supply from NSC.

Tubular product segment sales increased approximately $5,374,000 during the 2006 period. This increase was primarily related to an increase in tons shipped in the 2006 period. Tons shipped increased from approximately 73,000 tons in the 2005 period to 79,000 tons in the 2006 period. Tubular product segment operating profits as a percentage of segment sales were approximately 10.1% and 7.6% in the 2006 and 2005 periods, respectively. The Company experienced somewhat improved market conditions for its pipe products in the 2006 period as compared to conditions in the 2005 period.

During the 2006 period, Lone Star Steel Company ("LSS"), the Company’s primary supplier of tubular products and coil material used in pipe manufacturing, continued to supply such products in amounts that were adequate for the Company’s purposes. The Company does not currently anticipate any significant change in such supply from LSS.

During the 2006 period, general, selling and administrative costs increased $285,998 from the amount recorded during the 2005 period. This increase was related primarily to increases in commissions and bonuses associated with the increase in earnings and volume.

In September 2006, the Company sold the real property owned by the Company in Houston, Texas. This sale resulted in a before tax gain of $1,312,839. Proceeds received from the sale were used to purchase and improve real property associated with the Company’s new coil operation to be located in Decatur, Alabama. The Company signed a 12 month rental agreement to rent corporate office space at this location for $1,400 per month.

Interest and other income increased $28,876 from the comparable amount recorded in the 2005 period. This increase was associated primarily with an increase in the average interest rates paid on invested cash positions in the 2006 period.

Federal income taxes increased $773,040 from the comparable amount recorded during the 2005 period. This increase was primarily related to the increase in earnings before taxes. Effective tax rates were 38.0% and 35.5% in the 2005 and 2006 periods, respectively. In the 2006 period, the Company benefited from a reduction in state taxes and from a tax decrease associated with manufacturing companies.

    Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005

During the three months ended September 30, 2006, sales and costs of goods sold increased $8,899,899 and $9,232,709, respectively, and gross profit decreased $332,810, from the comparable amounts recorded during the three months ended September 30, 2005. The increase in sales was related primarily to an increase in the average selling price per ton as the average increased from approximately $579 per ton in the 2005 quarter to $682 per ton in the 2006 quarter. In the 2005 quarter, the Company sold approximately 74,000 tons compared to approximately 76,000 tons in the 2006 quarter. The increase in costs of goods sold was primarily related to increased material costs. The average per ton cost of goods increased from approximately $529 in the 2005 quarter to $637 in the 2006 quarter. The decrease in gross profit resulted primarily from a reduction in margins earned on sales as average selling prices increased at a lower rate than did the average cost of material. The Company could not pass along all of the increased material costs to customers in the short term. Gross profit as a percentage of sales declined from approximately 8.8% in the 2005 quarter to approximately 6.6% in the 2006 quarter.

Coil product segment sales increased approximately $5,258,000 during the 2006 quarter. This increase was related primarily to an increase in average selling prices which increased from approximately $586 per ton in the 2005 quarter to $731 per ton in the 2006 quarter. The Company sold approximately 37,000 tons of coil products in both the 2005 and 2006 quarters. Coil operating profit decreased approximately $1,004,000 from the amount recorded in the 2005 quarter. Coil operations were adversely affected by an increase in the cost of material that could not be passed along to customers in the short term. Coil operating profits as a percentage of sales were approximately 7.0% and 1.9% in the 2005 and 2006 quarters, respectively.

Tubular product segment sales increased approximately $3,642,000 during the 2006 quarter. This increase was related primarily to an increase in the average per ton selling price which increased from approximately $572 per ton in the 2005 quarter to $636 per ton in the 2006 quarter. In addition, tons sold increased from approximately 37,000 tons in the 2005 quarter to 39,000 tons in the 2006 quarter. Tubular product segment operating profits as a percentage of segment sales were approximately 7.8% and 8.9% in the 2005 and 2006 quarters, respectively. The Company experienced somewhat improved market conditions for its pipe products in the 2006 quarter as compared to conditions in the 2005 quarter.

In September 2006, the Company sold the real property owned by the Company in Houston, Texas. This sale resulted in a before tax gain of $1,312,839. Proceeds received from the sale were used to purchase and improve real property associated with the Company’s new coil operation to be located in Decatur, Alabama. The Company signed a 12 month rental agreement to rent corporate office space at this location for $1,400 per month.

Interest and other income increased $16,963 from the comparable amount recorded in the 2005 quarter. This increase was associated primarily with an increase in the average interest rates paid on invested cash positions in the 2006 quarter.

Federal income taxes increased $241,715 from the comparable amount recorded during the 2005 quarter. This increase was primarily related to the increase in earnings before taxes. Effective tax rates were 38.2% and 34.8% in the 2005 and 2006 quarters, respectively. In the 2006 quarter, the Company benefited from a reduction in state taxes and from a tax decrease associated with manufacturing companies.

8

FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES

      The Company remained in a strong, liquid position at September 30, 2006. Current ratios were 2.6 at both September 30, 2006 and March 31, 2006. Working capital was $30,304,424 at September 30, 2006 and $29,167,810 at March 31, 2006.

      During the six months ended September 30, 2006, the Company maintained assets and liabilities at levels it believed were commensurate with operations. Changes in current assets and liabilities during the 2006 period were related primarily to the ordinary course of business of the Company. The Company expects to continue to monitor, evaluate and manage balance sheet components depending on changes in market conditions and the Company’s operations.

      During the six months ended September 30, 2006, the Company purchased approximately $2,936,000 in fixed assets. These assets were related primarily to improvements to the small diameter pipe mill which began operations at Lone Star, Texas in April 2004 and to land, land improvements and equipment associated with the new coil operation to be located in Decatur, Alabama. In connection with this planned new operation, the Company phased out LSCF in the six months ended September 30, 2006. At the Decatur site, the Company intends to construct a coil processing facility using, in part, assets used at its Lone Star facility. The Company expects that the Decatur processing facility will initially operate a hot roll steel temper mill and a hot roll steel cut-to-length and leveling line. The Company expects that the Decatur facility will commence operations in fiscal 2008. In addition to the funds to be used to purchase the real property in Alabama, the Company’s Board of Directors has authorized up to an additional $16 million to be used for capital expenditures and working capital related to the acquisition and improvement of the Decatur facility.

      In September 2006, the Company sold the real property owned by the Company in Houston, Texas. This sale resulted in a before tax gain of $1,312,839. The proceeds of the sale were used to purchase and improve real property associated with the new coil operation to be located in Decatur, Alabama. The Company signed a 12 month rental agreement to rent corporate office space at this location for $1,400 per month.

      The Company has an arrangement with a bank which provides for a revolving line of credit facility (the “revolving facility”). Pursuant to the revolving facility, which expires April 1, 2008, the Company may borrow up to $6 million at the bank’s prime rate or 1.5% over LIBOR. The Company uses the revolving facility to support cash flow and will borrow and repay the note as working capital is required. At September 30, 2006 and March 31, 2006, the Company had no borrowings outstanding under the revolving facility.

      The Company has in the past and may in the future borrow funds on a term basis to build or improve facilities. The Company currently has no plans to borrow funds on a term basis.

      Notwithstanding the current market conditions, the Company believes its cash flows from operations and borrowing capability under its revolving facility 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. One such accounting policy which requires significant estimates and judgments is the valuation of LIFO inventories in the Company’s quarterly reporting. The quarterly valuation of inventory requires estimates of the year end quantities which is inherently difficult. Historically, these estimates have been materially correct. In addition, the Company maintains an allowance for doubtful accounts receivable by providing for specifically identified accounts where collectibility is doubtful. On an ongoing basis, the Company evaluates estimates and judgments. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances.

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) and that involve risk and uncertainty. These forward-looking statements may include, but are not limited to, future 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 Securities and Exchange Commission under the Securities Act of 1933 and the Securities Exchange Act of 1934. 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 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.

      In the normal course of business the Company is exposed to market risks primarily from changes in the cost of steel in inventory and in interest rates. The Company closely monitors exposure to market risks and develops appropriate strategies to manage risk. With respect to steel purchases, there is no recognized market to purchase derivative financial instruments to reduce the inventory exposure risk on changing commodity prices. The exposure to market risk associated with interest rates relates primarily to debt. Recent debt balances are minimal and, as a result, direct exposure to interest rate changes is not significant.

      The Company’s management, with the participation of the Company’s principal executive officer (CEO) and principal financial officer (CFO), 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 Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the fiscal quarter ended September 30, 2006. Based on this evaluation, the CEO and CFO have concluded that the Company’s disclosure controls and procedures were effective as of the end of the fiscal quarter ended September 30, 2006 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 recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

      There were no changes in the Company’s internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

9

Three Months Ended September 30, 2006

Name		Shares Voted For				Shares Withheld
Jack Friedman			5,530,775				708,881
Harold Friedman			5,595,829				643,827
William E. Crow			5,599,357				640,299
Charles W. Hall			5,491,963				747,693
Alan M. Rauch			6,014,077				225,579
Hershel M. Rich			6,097,159				142,497
Kirk K. Weaver			6,097,389				142,267
Joe L. Williams			5,589,672				649,984