================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended September 30, 2004
OR
[_] TRANSITION REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission file number 001-31747
UNIVERSAL SECURITY INSTRUMENTS, INC.
(Exact name of registrant as specified in its charter)
Maryland 52-0898545
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7-A Gwynns Mill Court
Owings Mills, Maryland 21117
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 363-3000
Inapplicable
(Former name, former address and former fiscal year if changed
from last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act. Yes |X| No |_|
At November 15, 2004, the number of shares outstanding of the registrant's
common stock was 1,627,728.
================================================================================
TABLE OF CONTENTS
-----------------
Part I - Financial Information Page
----
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets at September 30, 2004
and March 31, 2004 3
Consolidated Statements of Earnings for the Three
Months Ended September 30, 2004 and 2003 4
Consolidated Statements of Earnings for the Six
Months Ended September 30, 2004 and 2003 5
Consolidated Statements of Cash Flows for the Six
Months Ended September 30, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosure About Market Risk 14
Item 4. Controls and Procedures 14
Part II - Other Information
Item 1. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 6. Exhibits 16
Signatures
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
--------------------
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
ASSETS September 30, 2004 March 31, 2004
------------------ --------------
CURRENT ASSETS
Cash $ 80,602 $ 188,190
Accounts receivable:
Trade (less allowance for doubtful accounts of $15,000) 1,007,158 90,852
Employees 24,286 23,770
------------ ------------
1,031,444 114,622
Amount due from factor 3,563,759 3,111,003
Inventory 2,928,642 2,867,650
Prepaid expenses 313,528 107,052
------------ ------------
TOTAL CURRENT ASSETS 7,917,975 6,388,517
DEFERRED TAX ASSET 56,899 56,899
INVESTMENT IN JOINT VENTURE 5,544,627 4,832,286
PROPERTY AND EQUIPMENT - NET 82,969 93,431
OTHER ASSETS 15,486 15,486
------------ ------------
TOTAL ASSETS $ 13,617,956 $ 11,386,619
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,860,574 $ 1,517,305
Accrued liabilities:
Patent litigation reserve 374,172 159,197
Payroll, commissions and other 348,731 504,621
Current obligations under capital lease 2,750 7,224
------------ ------------
TOTAL CURRENT LIABILITIES 2,586,227 2,188,347
------------ ------------
COMMITMENTS AND CONTINGENCIES -- --
SHAREHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized 20,000,000 shares; issued
and outstanding 1,580,729 and 1,552,896 shares at September 30, 2004 and
March 31, 2004, respectively 15,809 15,529
Additional paid-in capital 11,244,465 11,188,903
Accumulated deficit (228,545) (2,006,160)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 11,031,729 9,198,272
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 13,617,956 $ 11,386,619
============ ============
See accompanying notes to consolidated financial statements.
-3-
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended
September 30,
2004 2003
---- ----
Net sales $ 6,622,221 $ 4,988,483
Cost of goods sold 4,500,443 3,412,776
------------ ------------
GROSS PROFIT 2,121,778 1,575,707
Research and development expense 79,995 65,860
Selling, general and administrative expense 1,641,124 1,285,187
------------ ------------
Operating income 400,659 224,660
Other (expense):
Interest expense (18,683) (30,663)
------------ ------------
INCOME BEFORE EARNINGS FROM JOINT VENTURE
381,976 193,997
Earnings from Joint Venture:
Equity in earnings of Joint Venture 661,860 546,449
------------ ------------
NET INCOME $ 1,043,836 $ 740,446
============ ============
Net income per common share amounts:
Basic $ 0.66 $ 0.49
Diluted $ 0.59 $ 0.43
Weighted average number of common shares outstanding
Basic 1,580,149 1,503,457
Diluted 1,757,998 1,724,693
See accompanying notes to consolidated financial statements.
-4-
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Six Months Ended
----------------
September 30,
-------------
2004 2003
------------ -----------
Net sales $ 11,497,003 $ 9,420,433
Cost of goods sold 7,890,512 6,384,481
------------ -----------
GROSS PROFIT 3,606,491 3,035,952
Research and development expense 146,221 130,477
Selling, general and administrative expense 2,822,482 2,502,427
------------ -----------
Operating income 637,788 403,048
Other (expense):
Interest expense (31,454) (63,372)
------------ -----------
INCOME BEFORE EARNINGS FROM JOINT VENTURE
606,334 339,676
Earnings from Joint Venture:
Equity in earnings of Joint Venture 1,171,281 1,253,269
------------ -----------
NET INCOME $ 1,777,615 $ 1,592,945
============ ===========
Net income per common share amounts:
Basic $ 1.13 $ 1.06
Diluted $ 1.01 $ 0.93
Weighted average number of common shares outstanding
Basic 1,572,558 1,500,412
Diluted 1,761,141 1,706,021
See accompanying notes to consolidated financial statements.
-5-
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended September 30,
2004 2003
---- ----
OPERATING ACTIVITIES
Net income $ 1,777,615 $ 1,592,945
Adjustments to reconcile net income to net cash (used in) provided by operating
activities:
Depreciation and amortization 12,363 17,013
Gain on sale of land -- (175,965)
Earnings of the Joint Venture (1,171,281) (1,253,269)
Change in allowance for doubtful accounts -- 60,000
Changes in operating assets and liabilities:
(Increase) in accounts receivable and amounts due from factor (1,369,578) (595,872)
(Increase) in inventories and prepaid expenses (267,468) (18,312)
Increase in accounts payable and accrued expenses 861,294 656,162
------------ -----------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (157,055) 282,702
INVESTING ACTIVITIES:
Purchase of property and equipment (1,901) (5,489)
Gross proceeds from sale of land -- 350,000
------------ -----------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (1,901) 344,511
FINANCING ACTIVITIES:
Proceeds from issuance of common stock from exercise of employee stock options 55,842 21,560
Principal payments on capital lease (4,474) (7,586)
Retirement of common stock -- (1,426)
------------ -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 51,368 12,548
------------ -----------
(DECREASE) INCREASE IN CASH (107,588) 639,761
Cash at beginning of period 188,190 51,112
------------ -----------
CASH AT END OF PERIOD $ 80,602 $ 690,873
============ ===========
Supplemental information:
Interest paid $ 31,454 $ 63,372
Income tax paid -- --
Non-cash financing activities:
Repayment of trade payables due the Joint Venture in lieu of cash distribution 458,940 592,188
See accompanying notes to consolidated financial statements
-6-
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Statement of Management
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. Significant inter-company accounts and
transactions have been eliminated in consolidation. In the opinion of the
Company's management, the interim consolidated financial statements include all
adjustments, consisting of only normal recurring adjustments, necessary for a
fair presentation of the results for the interim periods. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles in the United States of
America have been condensed or omitted. The interim consolidated financial
statements should be read in conjunction with the Company's March 31, 2004
audited financial statements filed with the Securities and Exchange Commission
on Form 10-K. The interim operating results are not necessarily indicative of
the operating results for the full fiscal year.
Income Taxes
No income tax expense has been provided for the three and six month periods
ended September 30, 2004, principally as a result of the carryforward of prior
years' operating losses.
Joint Venture
The Company maintains a 50% interest in a joint venture with a Hong Kong
corporation ("Joint Venture") that has manufacturing facilities in the People's
Republic of China, for the manufacturing of consumer electronic products. The
following represents summarized balance sheet and income statement information
of the Hong Kong Joint Venture for the six months ended September 30, 2004 and
2003:
2004 2003
---------- -----------
Net sales $13,058,422 $13,078,644
Gross profit 4,223,978 4,188,176
Net income 2,561,766 2,566,465
Total current assets 6,994,456 9,909,010
Total assets 14,507,826 12,694,320
Total current liabilities 4,798,055 3,232,572
During the six months ended September 30, 2004 and 2003, respectively, the
Company purchased $4,699,686 and $4,159,596 of products from the Hong Kong Joint
Venture. At September 30, 2004 and 2003, the Company had amounts payable to the
Hong Kong Joint Venture of $500,000 and $490,071, respectively. For the quarter
ended September 30, 2004, the Company has adjusted its equity in earnings of the
Joint Venture to reflect the elimination of $10,958 of inter-company profit as
required by US GAAP.
Net Income Per Common Share
Basic earnings per common share is computed based on the weighted average number
of common shares outstanding during the periods presented. Diluted earnings per
common share is computed based on the weighted average number of common shares
outstanding plus the effect of stock options and other potentially dilutive
common stock equivalents. The dilutive effect of stock options and other
potentially dilutive common stock equivalents is determined using the treasury
stock method based on the Company's average stock price.
A reconciliation of the weighted average shares of common stock utilized in the
computation of basic and diluted earnings per share for the three and six month
periods ended September 30, 2004 and 2003 is as follows:
-7-
Three Months Ended Six months Ended
------------------ ----------------
September 30, September 30,
------------- -------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Weighted average number of common 1,580,149 1,503,457 1,572,558 1,500,412
shares outstanding for basic EPS
Shares issued upon the assumed 177,849 221,236 188,583 205,609
----------- ----------- ----------- -----------
exercise of outstanding stock options
Weighted average number of common 1,757,998 1,724,693 1,761,141 1,706,021
and common equivalent shares
outstanding for diluted EPS
During the current quarter 3,333 shares were issued in July 2004. The basic
weighted average common shares outstanding for the quarter ended September 30,
2004 equals 1,580,149 shares computed as follows:
7/01/2004 - 7/16/2004 (1,577,396 x 16/92) 274,329
7/16/2004 - 9/30/2004 (1,580,729 x 76/92) 1,305,820
---------
1,580,149
During the six months ended September 30, 2004, 23,333 shares were issued in May
2004 and 1,167 shares were issued in June 2004. The basic weighted average
common shares outstanding for the six-month period ended September 30, 2004
equals 1,572,558 shares computed as follows:
4/01/2004 - 5/15/2004 (1,552,896 x 45/183) 381,860
5/16/2004 - 6/15/2004 (1,576,229 x 31/183) 267,011
6/15/2004 - 7/15/2004 (1,577,396 x 31/183) 267,209
7/16/2004 - 9/30/2004 (1,580,729 x 76/183) 656,478
----------
1,572,558
Basic and diluted weighted average number of common shares outstanding for the
three and six month periods ending September 30, 2004 have been restated to show
the effect of a four for three stock dividend paid on April 5, 2004 to
shareholders of record on March 15, 2004. The basic and diluted shares
outstanding at September 30, 2003 as restated are 1,503,457 and 1,724,693,
respectively computed as follows:
Basic (1,127,593 / 3 x 4) 1,503,457
Diluted (1,293,520 / 3 x 4) 1,724,693
At September 30, 2004, and 2003 there were no securities outstanding whose
issuance would have an anti-dilutive effect on the earnings per share
calculation.
Stock Based Compensation
The Company uses the intrinsic value method as defined by Accounting Principles
Board Opinion No. 25 to account for stock-based employee compensation. The
Company has adopted the disclosure requirements of Financial Accounting
Standards Board (FASB) Statement No. 123, Accounting for Stock-Based
Compensation, as amended by FASB No. 148 during fiscal 2003. The following table
illustrates the effect on net income and earnings per share as if the fair value
based method had been applied to all outstanding and unvested awards in each
period.
-8-
Three Months Ended Six months Ended
September 30, September 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income, as reported $ 1,043,836 $ 740,446 $ 1,777,615 $ 1,592,945
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
(15,520) (18,757) (31,040) (37,514)
----------- ----------- ----------- -----------
Pro forma net income $ 1,028,316 $ 721,689 $ 1,746,575 $ 1,555,431
=========== =========== =========== ===========
Earnings per share:
Basic - as reported $ 0.66 $ 0.49 $ 1.13 $ 1.06
=========== =========== =========== ===========
Basic - pro forma $ 0.65 $ 0.48 $ 1.11 $ 1.04
=========== =========== =========== ===========
Diluted - as reported $ 0.59 $ 0.43 $ 1.01 $ 0.93
=========== =========== =========== ===========
Diluted - pro forma $ 0.58 $ 0.42 $ 0.99 $ 0.91
=========== =========== =========== ===========
All share and per share amounts included in the consolidated financial
statements have been retroactively adjusted to reflect the 4-for-3 stock
dividend paid on April 5, 2004 to shareholders of record on March 15, 2004.
-9-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
As used throughout this Report, "we," "our," "the Company" and similar
words refers to Universal Security Instruments, Inc.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain forward-looking
statements reflecting our current expectations with respect to our operations,
performance, financial condition, and other developments. These forward-looking
statements may generally be identified by the use of the words "may", "will",
"believes", "should", "expects", "anticipates", "estimates", and similar
expressions. These statements are necessarily estimates reflecting management's
best judgment based upon current information and involve a number of risks and
uncertainties. We caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and readers
are advised that various factors could affect our financial performance and
could cause our actual results for future periods to differ materially from
those anticipated or projected. While it is impossible to identify all such
factors, such factors could include: (i) our and our Hong Kong Joint Venture's
respective ability to maintain operating profitability, (ii) competitive
practices in the industries in which we compete, (iii) our dependence on current
management, (iv) the impact of current and future laws and governmental
regulations affecting us and our Hong Kong Joint Venture, (v) general economic
conditions, (vi) other factors which may be identified from time to time in our
Securities and Exchange Commission filings and other public announcements, and
(vii) currency fluctuations. We do not undertake and specifically disclaim any
obligation to update any forward-looking statements to reflect occurrence of
anticipated or unanticipated events or circumstances after the date of such
statements.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2004 and 2003
Sales. Net sales for the three months ended September 30, 2004 were
$6,622,221 compared to $4,988,483 for the comparable three months in the prior
fiscal year, an increase of $1,633,738 (32.75%). Net sales of safety products
increased by $1,694,601 as compared to the quarter ended September 30, 2003. Net
sales of other products decreased by $60,863, as compared to the quarter ended
September 30, 2003. The primary reason for the increase in safety sales was an
increase in volume of sales of smoke alarm, GFCI, and carbon monoxide alarm
units. Other products' sales decreased primarily due to a decrease in volume of
sales of audio tapes.
Gross Profit Margin. The gross profit margin is calculated as net sales
less cost of goods sold expressed as a percentage of net sales. Our gross profit
margin increased 0.5%, to 32% of sales for the quarter ended September 30, 2004
from 31.5% for the corresponding quarter last year. The increase in gross profit
margin resulted from higher sales volume without a corresponding increase in the
fixed costs component of the cost of goods sold.
Expenses. Research and development and selling, general and administrative
expenses increased by $370,072 from the comparable three months in the prior
year. As a percentage of net sales, these expenses were reduced to 26% for the
three month period ended September 30, 2004, from 27.1% for the comparable 2003
period. The decrease in research, selling and general administrative expense as
a percent of sales was due to higher sales volume and variable costs that did
not increase at the same rate as sales. Various expense categories contributed
to the increased dollar amount of the expense, but the following major account
classifications were significant factors in this dollar increase: (i)
Commissions and freight charges as a percentage of sales remained consistent
with commissions and freight charges of the prior year; however, these expenses
vary directly with sales volume and, therefore, of the $370,072 increase in
expenses, $87,735 is attributable to higher sales volume during the 2004 period.
(ii) Research and development expenses increased by $14,135 due to new product
development. (iii) Professional fees associated with litigation and
Sarbanes-Oxley related compliance and auditing costs increased by $55,287 for
the 2004 period as compared to the same quarter in the previous year. The
Company believes professional fees will continue at least at the level
experienced during the current fiscal year until the Sarbanes-Oxley compliance
costs level off and outstanding litigation issues are resolved. (iv) Finally,
selling, general and administrative expenses for the 2003 period were reduced by
the $146,836 gain (net of selling expenses) from the sale of a parcel of land,
which reduction is not repeated in the 2004 period.
+
-10-
Interest Expense and Income. Our interest expense, net of interest income,
decreased from $30,663 for the quarter ended September 30, 2003 to $18,683 for
the quarter ended September 30, 2004. The lower interest expenses resulted
primarily from a reduction in the average balance of borrowings.
Net Income. We reported net income of $1,043,836 for the quarter ended
September 30, 2004 compared to net income of $740,446 for the corresponding
quarter of the prior fiscal year. The primary reasons for the increase in net
income are our increased gross profit and increased earnings of $115,411 from
our Hong Kong Joint Venture.
Six Months Ended September 30, 2004 and 2003
Sales. Net sales for the six months ended September 30, 2004 were
$11,497,003 compared to $9,420,433 for the comparable six months in the prior
fiscal year, an increase of $2,076,570 (22%). Net sales of safety products
increased by $2,205,117 as compared to the six months ended September 30, 2003.
Net sales of other products decreased by $128,547, as compared to the six months
ended September 30, 2003. The primary reason for the increase in safety sales
was an increase in volume of sales of smoke alarm, GFCI, and carbon monoxide
alarm units. Other products' sales decreased primarily due to a decrease in
volume of sales of audio tapes.
Gross Profit Margin. The gross profit margin is calculated as net sales
less cost of goods sold expressed as a percentage of net sales. The Company's
gross profit margin decreased 0.8% from 32.2% for the period ended September 30,
2003 to 31.4% for the current period ended September 30, 2004. The primary
reason for this was higher costs of goods sold for safety products which costs
were not reflected in the pricing of our products.
Expenses. Research and development and selling, general and administrative
expenses increased by $335,799 from the comparable six months in the prior year.
As a percentage of sales, these expenses were reduced to 25.8% for the six month
period ended September 30, 2004 from 27.9% for the comparable 2003 period. The
decrease in research, selling and general administrative expense as a percent of
sales was due to higher sales volume and variable costs that did not increase at
the same rate as sales. Various expense categories contributed to the increased
dollar amount of the expense, but the following major account classifications
were significant factors in this dollar increase: (i) Commissions and freight
charges as a percentage of sales remained consistent with commissions and
freight charges of the prior year; however, these expenses vary directly with
sales volume and, therefore, of the $335,799 increase in expenses, $82,774 is
attributable to higher sales volume during the 2004 period. (ii) Research and
development expenses increased by $15,744 due to new product development. (iii)
Professional fees associated with litigation and Sarbanes-Oxley related
compliance and auditing costs increased by $43,471 for the 2004 period as
compared to the same period in the previous year. The Company believes
professional fees will continue at least at the level experienced during the
current fiscal year until the Sarbanes-Oxley compliance costs level off and
outstanding litigation issues are resolved. (iv) Finally, selling, general and
administrative expenses for the 2003 period were reduced by the $146,836 gain
(net of selling expenses) from the sale of a parcel of land, which reduction is
not repeated in the 2004 period.
Interest Expense and Income. Our interest expense, net of interest income,
decreased from $63,372 for the six months ended September 30, 2003, to $31,454
for the six months ended September 30, 2004. The lower interest expenses
resulted primarily from a reduction in the average balance of borrowings.
Net Income. We reported net income of $1,777,615 for the six months ended
September 30, 2004 compared to net income of $1,592,945 for the corresponding
period of the prior fiscal year. The primary reason for the increase in net
income is increased sales without a corresponding increase in associated
expenses (i.e., while the expenses increased, they did not increase at the same
rate as sales), partially offset by a decrease in earnings of the Hong Kong
Joint Venture of $81,988 from the same period of the prior year.
FINANCIAL CONDITION AND LIQUIDITY
Our cash needs are currently met by funds from our Factoring Agreement
which supplies both short-term borrowings and letters of credit to finance
foreign inventory purchases. The maximum amount available under the Factoring
Agreement is currently $7,500,000. However, based on specified percentages of
our accounts receivable and inventory and letter of credit commitments, we had
$4,628,466 available under the Factoring Agreement of which $675,466 was
borrowed as of September 30, 2004. The interest rate under the Factoring
Agreement on the uncollected factored accounts receivable and any additional
borrowings is equal to 1% in excess of the prime rate of interest charged by our
lender. At September 30, 2004, the prime rate was 4.5%. Beginning October 1,
2004, the interest rate under the Factoring Agreement has been lowered to the
prime rate. Borrowings are collateralized by all of our accounts receivable and
inventory.
-11-
Our accounts receivable as of the end of our last fiscal year (net of
allowances for doubtful accounts) were $90,852, and were $1,007,158 as of
September 30, 2004. The increase in trade accounts receivable during the first
six months of the current fiscal year is due to increased sales to customers for
which we bear the credit risk. Our prepaid expenses as of the end of our last
fiscal year were $107,052, and were $313,528 as of September 30, 2004. The
increase in prepaid expenses during the first six months of the current fiscal
year is due to the timing of premium payments to various insurance carriers.
Operating activities used cash of $157,055 for the quarter ended September
30, 2004. This was primarily due to an increase in accounts receivable and
amount due from factor of $1,369,578, and equity in the earnings from our Hong
Kong Joint Venture of $1,171,281, which were partially offset by an increase in
accounts payable and accrued expenses of $861,294. For the same period last
year, operating activities provided cash of $282,702.
Investing activities used cash of $1,901 in the current quarter, primarily
to acquire equipment. For the same period last year, investing activities
provided cash of $344,511, primarily from the sale of the 1.5 acre parcel of
land.
Financing activities provided cash of $51,368 primarily from the exercise
of employee stock options. For the same period last year, financing activities
provided cash of $12,548.
We believe that funds available under the Factoring Agreement,
distributions from the Hong Kong Joint Venture, and working capital provide us
with sufficient resources to meet our requirements for liquidity and working
capital in the ordinary course of our business over the next twelve months and
over the long term.
On August 4, 2004, Stephen C. Knepper, our Chairman and Chief Executive
Officer, died suddenly and unexpectedly. While Mr. Knepper's contributions to
the Company and our success cannot be overstated, management believes that Mr.
Knepper's passing will not have a material adverse effect on our growth and
results of operations.
HONG KONG JOINT VENTURE
Net Sales. Net sales of the Hong Kong Joint Venture for the three and six
months ended September 30, 2004 were $6,216,118 and $13,058,422, respectively,
compared to $6,317,099 and $13,078,644, respectively, for the comparable periods
in the prior fiscal year. The 1.6% decrease in net sales for the three month
period was due to changes in the sales product mix.
Net Income. Net income for the three and six months ended September 30,
2004 was $1,323,720 and $2,561,766, respectively, compared to $1,290,429 and
$2,566,465, respectively, in the comparable periods last year. The 2.3% increase
in net income for the quarter was due to changes in the sales product mix and an
increase in investment income.
Gross Margins. Gross margins of the Hong Kong Joint Venture for the three
month period ended September 30, 2004 decreased to 32% from 35% for the 2003
period. For the six month period ended September 30, 2004, gross margins were
32%. Since gross margins depend on sales volume of various products, changes in
product sales mix caused these changes in gross margins.
Expenses. Selling, general and administrative expenses were $758,793 and
$1,623,462, respectively, for the three and six month periods ended September
30, 2004, compared to $880,139 and $1,570,281, in the prior year's respective
periods. As a percentage of sales, expenses were 12% and 12%, respectively, for
the three and six month periods ended September 30, 2004, compared to 14% and
12%, respectively, for the three and six month periods ended September 30, 2003.
The decrease in selling, general and administrative expense was due to lower
depreciation expenses.
-12-
Interest Income and Expense. Interest income, net of interest expense, was
$11,714 and $21,494, respectively, for the three and six month periods ended
September 30, 2004, compared to interest expense of $298 and $854, respectively,
for the prior year's periods. The increase in interest income is primarily due
to bond interest income.
Liquidity. Cash needs of the Hong Kong Joint Venture are currently met by
funds generated from operations. During the six months ended September 30, 2004,
working capital increased by $877,744 from $1,318,657 on March 31, 2004 to
$2,196,401 on September 30, 2004.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of our consolidated financial
statements and results of operations are based on our Consolidated Financial
Statement included as part of this document. The preparation of these
consolidated financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosures of contingent assets and liabilities. On an
ongoing basis, we evaluate these estimates, including those related to bad
debts, inventories, income taxes, and contingencies and litigation. We base
these estimates on historical experiences and on various other assumptions that
are believed to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily available from other sources. Actual results
may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect management's
more significant judgments and estimates used in the preparation of its
consolidated financial statements. For a detailed discussion on the application
on these and other accounting policies, see Note A to the consolidated financial
statements included in Item 8 of the Form 10-K for the year ended March 31,
2004. Certain of our accounting policies require the application of significant
judgment by management in selecting the appropriate assumptions for calculating
financial estimates. By their nature, these judgments are subject to an inherent
degree of uncertainty and actual results could differ from these estimates.
These judgments are based on our historical experience, terms of existing
contracts, current economic trends in the industry, information provided by our
customers, and information available from outside sources, as appropriate. Our
critical accounting policies include:
Our revenue recognition policies are in compliance with Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements" issued by the
Securities and Exchange Commission. We recognize sales upon shipment of products
net of applicable provisions for any discounts or allowances. We believe that
the shipping date from our warehouse is the appropriate point of revenue
recognition since upon shipment we have substantially completed our obligations
which entitle us to receive the benefits represented by the revenues, and the
shipping date provides a consistent point within our control to measure revenue.
Customers may not return, exchange or refuse acceptance of goods without our
approval. We have established allowances to cover anticipated doubtful accounts
based upon historical experience.
Inventories are valued at the lower of market or cost. Cost is determined
on the first-in first-out method. We have recorded a reserve for obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and
the estimated market value based upon assumptions about future demand and market
conditions. Management reviews the reserve quarterly.
We currently have significant deferred tax assets resulting from tax
credit carryforwards, net operating loss carryforwards and deductible temporary
differences, which will reduce taxable income in future periods. We have
provided a valuation allowance on future tax benefits such as foreign tax
credits, foreign net operating losses, capital losses and net operating losses.
A valuation allowance is required when it is more likely than not that all
or a portion of a deferred tax assets will not be realized. Forming a conclusion
that a valuation allowance is not needed is difficult when there is a negative
evidence such as cumulative losses and losses in recent years. Cumulative losses
weigh heavily in the overall assessment. As a result of management's assessment,
we established a full valuation allowance for our remaining net deferred tax
assets at September 30, 2004.
-13-
We are subject to lawsuits and other claims, related to patents and other
matters. Management is required to assess the likelihood of any adverse
judgments or outcomes to these matters, as well as potential ranges of probable
losses. A determination of the amount of reserves required, if any, for these
contingencies is based on a careful analysis of each individual issue with the
assistance of outside legal counsel. The required reserves may change in the
future due to new developments in each matter or changes in approach such as a
change in settlement strategy in dealing with these matters.
We generally provide warranties from one to ten years to the
non-commercial end user on all products sold. The manufacturers of our products
provide us with a one-year warranty on all products we purchase for resale.
Claims for warranty replacement of products beyond the one-year warranty period
covered by the manufacturers are immaterial and we do not record estimated
warranty expense or a contingent liability for warranty claims.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
No material changes have occurred in our quantitative and qualitative
market risk disclosures as presented in our Annual Report Form 10-K for the year
ended March 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of disclosure controls and procedures that is
designed to provide reasonable assurance that information, which is required to
be disclosed by us in the reports that we file or submit under the Securities
and Exchange Act of 1934, as amended, is accumulated and communicated to
management in a timely manner. Our Chief Executive Officer and Chief Financial
Officer have evaluated this system of disclosure controls and procedures as of
the end of the period covered by this quarterly report, and believe that the
system is operating effectively to ensure appropriate disclosure. There have
been no changes in our internal control over financial reporting during the most
recent fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
Management is aware that there is a lack of segregation of duties at the
Company due to the small number of employees dealing with general administrative
and financial matters. However, at this time management has decided that
considering the employees involved and the control procedures in place, the
risks associated with such lack of segregation are insignificant and the
potential benefits of adding employees to clearly segregate duties do not
justify the expenses associated with such increases. Management will
periodically reevaluate this situation.
We have also been advised that the independent registered public
accounting firm for the Hong Kong Joint Venture has identified certain internal
control deficiencies at the Hong Kong Joint Venture which the auditors consider
to be "significant deficiencies" that, in the aggregate, constitute "material
weaknesses" under U.S. accounting standards. The Hong Kong Joint Venture's
independent auditors have advised the Hong Kong Joint Venture that these
internal control deficiencies do not affect the results reported in the Hong
Kong Joint Venture's consolidated financial statements as of September 30, 2004.
The Hong Kong Joint Venture is in the process of addressing these deficiencies
and Company management will continue to monitor the Hong Kong Joint Venture's
progress in this area.
-14-
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As we previously reported in our Annual Report on Form 10-K for the fiscal
year ended March 31, 2004, Leviton Manufacturing Co., Inc. filed a civil suit
against the Company and our USI Electric subsidiary on June 13, 2003, in the
United States District Court for the District of Maryland (Case No. 03cv1701),
alleging that our ground fault circuit interrupter (GFCI) units infringe one or
more patents, and also asserted trade dress and unfair competition claims which
largely correspond to the claim in an earlier pending suit filed by Leviton
against the Company. The plaintiff is seeking injunctive relief and damages to
be determined at trial. On July 23, 2003, the GFCI manufacturer, Shanghai Meihao
Electric, Inc, filed an action for declaratory judgment of non-infringement,
invalidity, and unenforceability of the asserted patents, and we moved to stay
the litigation until the ruling on the declaratory judgment suit. In July 2004,
the court denied the motion but agreed to consolidate the actions. We and our
counsel believe that we have meritorious defenses to the claim and are
aggressively defending the suit. In the event of an unfavorable outcome, the
amount of any potential loss to USI is not yet determinable.
As we previously reported in our Annual Report on Form 10-K for the fiscal
year ended March 31, 2004, Maple Chase Company filed a civil suit on February 2,
2004 in the United States District Court for the Northern District of Illinois
(Case No. 03cv07205), against the Company, our USI Electric subsidiary, and one
former and one present Illinois-based sales representative, alleging that
certain of our smoke detectors infringe on a patent owned by Maple Chase. The
defendants have answered and counterclaimed against Maple Chase. In an effort to
bring about a conclusion to the litigation, we sought and successfully obtained
reexamination of the asserted patent in the United States Patent and Trademark
Office (USPTO) based on the references cited and analysis presented by the
Company. The reexamination will now proceed and we expect the court to stay the
litigation pending the outcome of the reexamination. Due to the preliminary
status of the litigation and the outcome of proceedings before the USPTO, the
amount, if any, of potential loss to us is not yet determinable. We believe that
we have meritorious and substantial technical defenses to the action and that we
are entitled to a number of legal and equitable defenses due to the long period
of inaction and acquiescence by Maple Chase and its predecessors. We intend to
vigorously defend the suit and press our pending counterclaims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On October 5, 2004, the Company held its Annual Meeting of Stockholders.
The only matter submitted to the stockholders for a vote was the election of two
directors in the Class of 2007. The nominees were Cary Luskin and Howard
Silverman, Ph.D. At the Meeting, at least 1,104,415 shares were voted in favor
of each nominee, no more than 368,111 shares were voted to withhold approval of
any nominee's election, and 13,449 shares abstained. As a result, the nominees
were elected.
Directors not up for re-election and continuing in office after the
Meeting are: Harvey B. Grossblatt and Ronald A. Seff, M.D.
-15-
ITEM 6. EXHIBITS.
Exhibit No.
- -----------
3.1 Articles of Incorporation (incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the period ended December 31, 1988,
File No. 0-7885)
3.2 Articles Supplementary, filed October 14, 2003 (incorporated by
reference to Exhibit 3.1 to the Company's Current Report on Form 8-K
filed October 31, 2002, file No. 0-7885)
3.3 Bylaws, as amended (incorporated by reference to Exhibit 3.3 to the
Company's Quarterly Report on Form 10-Q for the period ended June 30,
2004, File No. 0-7885)
10.1 Non-Qualified Stock Option Plan, as amended (incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
period ended September 30, 2003, File No. 0-7885)
10.2 Hong Kong Joint Venture Agreement, as amended (incorporated by
reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K
for the year ended March 31, 2003, File No. 0-7885)
10.3 Amended Factoring Agreement with CIT Group (successor to Congress
Talcott, Inc.) dated November 14, 1999 (incorporated by reference to
Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year
ended March 31, 2003, File No. 0-7885)
10.4 Amendment to Factoring Agreement with CIT Group (incorporated by
reference to Exhibit 10.4 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 2002, File No. 0-7885)
10.5 Amendment to Factoring Agreement with CIT Group dated September 28,
2004*
10.6 Lease between Universal Security Instruments, Inc. and National
Instruments Company dated October 21, 1999 for its office and warehouse
located at 7-A Gwynns Mill Court, Owings Mills, Maryland 21117
(incorporated by reference to Exhibit 10.19 to the Company's Annual
Report on Form 10-K for the Fiscal Year Ended March 31, 2000, File No.
0-7885)
10.7 Amended and Restated Employment Agreement dated April 1, 2003 between
the Company and Harvey B. Grossblatt (incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year
ended March 31, 2003, File No. 0-7885)
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer*
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer*
32.1 Section 1350 Certifications*
99.1 Press Release dated November 15, 2004*
*Filed herewith
-16-
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.
UNIVERSAL SECURITY INSTRUMENTS, INC.
(Registrant)
Date: November 15, 2004 By: /s/ Harvey B. Grossblatt
-------------------------------------
Harvey B. Grossblatt
President, Chief Executive Officer
By: /s/ James B. Huff
-------------------------------------
James B. Huff
Chief Financial Officer
-17-