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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 December 31, 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 |_| No |X|
At February 11, 2005, the number of shares outstanding of the registrant's
common stock was 1,637,464.
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-1-
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
ITEM 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets at December 31, 2004
and March 31, 2004 3
Consolidated Statements of Earnings for the Three and
Nine Months Ended December 31, 2004 and 2003 4
Consolidated Statements of Cash Flows for the Nine
Months Ended December 31, 2004 and 2003 5
Notes to Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk 13
ITEM 4. Controls and Procedures 13
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 14
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 14
ITEM 4. Submission of Matters to a Vote of Security Holders 14
ITEM 6. Exhibits 14
Signatures 16
-2-
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS December 31, 2004 March 31, 2004
----------------- --------------
CURRENT ASSETS
Cash $ 61,068 $ 188,190
Accounts receivable:
Trade (less allowance for doubtful accounts of $15,000) 750,772 90,852
Employees 11,922 23,770
------------ ------------
762,694 114,622
Amount due from factor 2,479,111 3,111,003
Inventory 4,895,497 2,867,650
Prepaid expenses 237,628 107,052
------------ ------------
TOTAL CURRENT ASSETS 8,435,998 6,388,517
56,899
DEFERRED TAX ASSET 44,699
INVESTMENT IN JOINT VENTURE 5,972,252 4,832,286
PROPERTY AND EQUIPMENT - NET 82,352 93,431
0
OTHER ASSETS 15,486 15,486
------------ ------------
TOTAL ASSETS $ 14,550,787 $ 11,386,619
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,553,387 $ 1,517,305
Accrued liabilities:
Patent litigation reserve 516,051 237,545
Payroll, commissions and other 496,344 426,273
Current obligations under capital lease -- 7,224
------------ ------------
TOTAL CURRENT LIABILITIES 2,565,782 2,188,347
------------ ------------
COMMITMENTS AND CONTINGENCIES -- --
SHAREHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized 20,000,000 shares;
issued
and outstanding 1,630,345 and 1,552,896 shares at December 31, 2004 and 16,305 15,529
March 31, 2004, respectively
Additional paid-in capital 11,403,676 11,188,903
Returned earnings (deficit) 565,024 (2,006,160)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 11,985,005 9,198,272
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 14,550,787 $ 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 December 31, Nine Months Ended December 31,
------------------------------- ------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net sales $ 5,849,144 $ 3,838,192 $ 17,346,147 $ 13,258,624
Cost of goods sold 4,023,316 2,607,525 11,913,828 8,992,005
------------ ------------ ------------ ------------
GROSS PROFIT 1,825,828 1,230,667 5,432,319 4,266,619
Research and development expense 61,116 68,130 207,337 198,607
Selling, general and administrative expense 1,703,826 1,083,574 4,526,308 3,586,002
------------ ------------ ------------ ------------
Operating income 60,886 78,963 698,674 482,010
Other (expense):
Interest expense (25,789) (26,884) (57,243) (90,256)
------------ ------------ ------------ ------------
INCOME BEFORE EARNINGS FROM JOINT VENTURE
35,097 52,079 641,431 391,754
Earnings from Joint Venture:
Equity in earnings of Joint Venture 758,472 441,713 1,929,753 1,694,983
------------ ------------ ------------ ------------
NET INCOME $ 793,569 $ 493,792 $ 2,571,184 $ 2,086,737
============ ============ ============ ============
Net income per common share amounts:
Basic $ 0.49 $ 0.33 $ 1.62 $ 1.39
Diluted $ 0.45 $ 0.29 $ 1.45 $ 1.22
Weighted average number of common shares outstanding
Basic 1,621,582 1,514,276 1,588,959 1,505,033
Diluted 1,777,876 1,724,693 1,769,927 1,714,545
See accompanying notes to consolidated financial statements.
-4-
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended December 31,
------------------------------
2004 2003
----------- -----------
OPERATING ACTIVITIES
Net income $ 2,571,184 $ 2,086,737
Adjustments to reconcile net income to net cash (used in) provided by operating
activities:
Depreciation and amortization 16,300 25,058
Stock issued in lieu of directors' fee 10,000 10,000
Gain on sale of land -- (175,965)
State income tax refunds 12,200 --
Earnings of the Joint Venture (1,929,753) (1,694,983)
Change in allowance for doubtful accounts -- 60,000
Changes in operating assets and liabilities:
(Increase) in accounts receivable and amounts due from factor (16,180) (1,916,810)
(Increase) decrease in inventories and prepaid expenses (2,158,422) 328,366
Increase in accounts payable and accrued expenses 833,599 991,236
----------- -----------
NET CASH (USED IN) OPERATING ACTIVITIES (661,072) (286,361)
INVESTING ACTIVITIES:
Cash dividends from Joint Venture 330,846 --
Purchase of property and equipment (5,221) (6,336)
Gross proceeds from sale of land -- 350,000
----------- -----------
NET CASH PROVIDED BY INVESTING ACTIVITIES 325,625 343,664
FINANCING ACTIVITIES:
Proceeds from issuance of common stock from exercise of employee stock 215,549 123,095
options
Principal payments on capital lease (7,224) (11,379)
Retirement of common stock -- (1,426)
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 208,325 110,290
----------- -----------
(DECREASE) INCREASE IN CASH (127,122) 167,593
Cash at beginning of period 188,190 51,112
----------- -----------
CASH AT END OF PERIOD $ 61,068 $ 218,705
=========== ===========
Supplemental information:
Interest paid $ 57,243 $ 90,256
Income tax paid -- --
Non-cash financing activities:
Repayment of trade payables due the Joint Venture in lieu of cash distribution 458,940 874,904
Issuance of 950 shares in 2004 and 756 shares in 2003 of common stock as
directors' fees 10,000 10,000
See accompanying notes to consolidated financial statements.
-5-
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 nine month periods
ended December 31, 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 security products. The following
represents summarized balance sheet and income statement information of the Hong
Kong Joint Venture for the nine months ended December 31, 2004 and 2003:
2004 2003
----------- -----------
Net sales $20,513,915 $18,862,545
Gross profit 6,777,440 5,822,631
Net income 4,150,916 3,319,731
Total current assets 7,132,753 7,215,778
Total assets 15,486,646 12,248,733
Total current liabilities 4,819,232 2,580,509
During the nine months ended December 31, 2004 and 2003, respectively, the
Company purchased $8,011,032 and $5,276,159 of products from the Hong Kong Joint
Venture. At December 31, 2004 and 2003, the Company had amounts payable to the
Hong Kong Joint Venture of $500,000 and $554,874, respectively. For the quarter
ended December 31, 2004, the Company has adjusted its equity in earnings of the
Joint Venture to reflect the elimination of $36,240 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.
-6-
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 nine month
periods ended December 31, 2004 and 2003 is as follows:
Three Months Ended Nine months Ended
------------------ -----------------
December 31, December 31,
------------ ------------
2004 2003 2004 2003
--------- --------- --------- ---------
Weighted average number of common
shares outstanding for basic EPS 1,621,582 1,514,276 1,588,959 1,505,033
Shares issued upon the assumed
exercise of outstanding stock options 156,294 210,417 180,968 209,512
--------- --------- --------- ---------
Weighted average number of common
and common equivalent shares
outstanding for diluted EPS 1,777,876 1,724,693 1,769,927 1,714,545
During the current quarter, 47,616 shares were issued in October 2004 and 2,000
shares were issued in November 2004. The basic weighted average common shares
outstanding for the quarter ended December 31, 2004 equals 1,621,582 shares
computed as follows:
10/01/2004 - 10/15/2004 (1,580,729 x 15/92) 257,728
10/16/2004 - 11/15/2004 (1,628,345 x 31/92) 548,682
11/16/2004 - 12/15/2004 (1,630,345 x 46/92) 815,172
---------
1,621,582
During the nine months ended December 31, 2004, 23,333 shares were issued in May
2004, 1,167 shares were issued in June 2004, 47,616 shares were issued in
October 2004, and 2,000 shares were issued in November 2004. The basic weighted
average common shares outstanding for the nine month period ended December 31,
2004 equals 1,588,958 shares computed as follows:
04/01/2004 - 05/15/2004 (1,552,896 x 45/275) 254,110
05/16/2004 - 06/15/2004 (1,576,229 x 31/275) 177,684
06/15/2004 - 07/15/2004 (1,577,396 x 31/275) 177,815
07/16/2004 - 10/15/2004 (1,580,729 x 91/275) 523,078
10/16/2004 - 11/15/2004 (1,628,345 x 31/275) 183,559
11/16/2004 - 12/15/2004 (1,630,345 x 46/275) 272,712
---------
1,588,958
Basic and diluted weighted average number of common shares outstanding for the
three and nine month periods ending December 31, 2003 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 December 31, 2003 as restated are 1,514,276 and 1,724,693,
respectively computed as follows:
Three Months Ended 12/31/03 Nine Months Ended 12/31/03
--------------------------- --------------------------
Basic (1,135,707 / 3 x 4) 1,514,276 (1,128,775 / 3 x 4) = 1,505,033
Diluted (1,293,520 / 3 x 4) 1,724,693 (1,285,909 / 3 x 4) = 1,714,545
At December 31, 2004, and 2003 there were no securities outstanding whose
issuance would have an anti-dilutive effect on the earnings per share
calculation. 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.
-7-
STOCK BASED COMPENSATION
During the nine months ended December 31, 2004 and 2003, the Company granted
options for the purchase of 7,500 and 8,000 shares, respectively, to employees.
These options are exercisable at an average price of $11.50 and $14.04 per
share, respectively, expiring in 2008, and vested over a four year period from
the date of grant.
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.
Three Months Ended Nine months Ended
------------------ -----------------
December 31, December 31,
------------ ------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Net income, as reported $ 793,569 $ 493,792 $ 2,571,184 $ 2,086,737
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
(19,534) (21,009) (47,839) (63,028)
------------- ------------- ------------- -------------
Pro forma net income $ 774,035 $ 472,783 $ 2,523,345 $ 2,023,709
============= ============= ============= =============
Earnings per share:
Basic - as reported $ 0.49 $ 0.33 $ 1.62 $ 1.39
============= ============= ============= =============
Basic - pro forma $ 0.48 $ 0.31 $ 1.59 $ 1.34
============= ============= ============= =============
Diluted - as reported $ 0.45 $ 0.29 $ 1.45 $ 1.22
============= ============= ============= =============
Diluted - pro forma $ 0.44 $ 0.27 $ 1.43 $ 1.18
============= ============= ============= =============
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No.123 (revised 2004), "Share-Based
Payment". This statement will provide investors and other users of financial
statements with more complete and neutral financial information by requiring
that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the fair
value of the equity or liability instruments issued. This statement covers a
wide range of share-based compensation arrangements including share options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans, and replaces FASB SFAS No. 123, "Accounting for
Stock-Based Compensation", and supersedes APB Opinion No. 25. Statement 123, as
originally issued in 1995, established as preferable a fair-value-based method
of accounting for share-based payment transactions with employees. However, that
statement permitted entities the option of continuing to apply the guidance in
APB No. 25, as long as the footnotes to financial statements disclosed the pro
forma net income under the fair-value-based method. Public entities (other than
those filing as small business issuers) will be required to apply SFAS No.
123(R) as of the first interim or annual reporting period that begins after June
15, 2005. The Company has evaluated the impact of the adoption of SFAS No.
123(R), and does not believe the impact will be significant to the Company's
overall results of operations or financial position.
-8-
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 DECEMBER 31, 2004 AND 2003
Sales. Net sales for the three months ended December 31, 2004 were
$5,849,144 compared to $3,838,192 for the comparable three months in the prior
fiscal year, an increase of $2,010,952 (52.4%). Net sales of safety products
increased by $2,071,903 as compared to the quarter ended December 31, 2003. Net
sales of other products decreased by $60,951, as compared to the quarter ended
December 31, 2003. The primary reason for the increase in safety sales was that
sales were up across our core product lines, including ground fault circuit
interrupters (GFCI), smoke and carbon monoxide alarms and chimes. 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 decreased 2.5%, to 31.2% of sales for the quarter ended December 31, 2004
from 32.0% for the corresponding quarter last year. The decrease in gross profit
margin resulted from a change in the mix of products sold.
Expenses. Selling, general and administrative expenses increased by
$620,252 from the comparable three months in the prior year. As a percentage of
net sales, these expenses increased to 29.1% for the three month period ended
December 31, 2004, from 28.2% for the comparable 2003 period. The increase in
selling and general administrative expense as a percent of sales was due to
higher sales volume and variable costs that increase with 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
$620,252 increase in expenses, $234,142 is attributable to commissions and
freight charges from higher sales volume during the 2004 period. (ii)
Professional fees (principally associated with the previously reported suit by a
former director and chief executive officer) increased by $343,104 for the 2004
period as compared to the same quarter in the previous year. The Company
believes that professional fees will continue at an increased level as compared
to the previous fiscal year until outstanding litigation matters are resolved
and Sarbanes-Oxley compliance costs level off.
Interest Expense and Income. Our interest expense, net of interest income,
decreased to $25,789 for the quarter ended December 31, 2004 from $26,884 for
the quarter ended December 31, 2003. The lower interest expenses resulted
primarily from a decrease in the average balance of borrowings during the
current quarter.
-9-
Net Income. We reported net income of $793,569 for the quarter ended
December 30, 2004 compared to net income of $493,792 for the corresponding
quarter of the prior fiscal year. The primary reason for the increase in net
income is the increased earnings of $316,759 from our Hong Kong Joint Venture.
NINE MONTHS ENDED DECEMBER 31, 2004 AND 2003
Sales. Net sales for the nine months ended December 31, 2004 were
$17,346,147 compared to $13,258,624 for the comparable nine months in the prior
fiscal year, an increase of $4,087,523 (30.8%). Net sales of safety products
increased by $4,202,077 as compared to the nine months ended December 31, 2003.
Net sales of other products decreased by $114,554, as compared to the nine
months ended December 31, 2003. The primary reason for the increase in safety
sales was that sales were up across our core product lines, including ground
fault circuit interrupters (GFCI), smoke and carbon monoxide alarms and chimes.
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 2.8% to 31.3% for the period ended December 31,
2004 from 32.2% for the period ended December 31, 2003. The primary reason for
this was a change in the mix of products sold.
Expenses. Selling, general and administrative expenses increased by
$940,306 from the comparable nine months in the prior year. As a percentage of
sales, these expenses were reduced to 26.1% for the nine month period ended
December 31, 2004 from 27.0% for the comparable 2003 period. The decrease in
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 $940,306 increase in expenses, $684,896 is attributable to
commissions and freight charges from higher sales volume during the 2004 period.
(ii) Professional fees (principally associated with the previously reported suit
by a former director and chief executive officer) increased by $386,574 for the
2004 period as compared to the same period in the previous year. The Company
believes that professional fees will continue at an increased level as compared
to the previous fiscal year until outstanding litigation matters are resolved
and Sarbanes-Oxley compliance costs level off. (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 to $57,243 for the nine months ended December 31, 2004, from $90,256
for the nine months ended December 31, 2003. The lower interest expenses
resulted primarily from a reduction in the average balance of borrowings for the
nine month period.
Net Income. We reported net income of $2,571,184 for the nine months ended
December 31, 2004 compared to net income of $2,086,737 for the corresponding
period of the prior fiscal year. The primary reasons for the increase in net
income are 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), and by an increase in earnings of the Hong Kong Joint Venture of
$234,770 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
$4,677,178 available under the Factoring Agreement of which $1,201,178 was
borrowed as of December 31, 2004. The interest rate under the Factoring
Agreement on the uncollected factored accounts receivable and any additional
borrowings is equal to the prime rate of interest charged by our lender. At
December 31, 2004, the prime rate was 5.25%. Borrowings are collateralized by
all of our accounts receivable and inventory.
-10-
On December 17, 2004, the Company obtained an unsecured $250,000 line of
credit from a commercial bank. Amounts borrowed on this line of credit bear
interest at the prime rate of interest as published from time to time by The
Wall Street Journal. The agreement requires, among other provisions, that the
Company maintain a zero balance on the facility for thirty consecutive days each
year. At December 31, 2004 no amounts have been borrowed or are outstanding on
this line of credit.
Our accounts receivable as of the end of our last fiscal year (net of
allowances for doubtful accounts) were $90,852, and were $750,772 as of December
31, 2004. The increase in trade accounts receivable during the first nine months
of the current fiscal year is due to increased sales, primarily direct shipments
from our foreign manufacturers, directly 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 $237,628 as of December 31, 2004. The increase in prepaid
expenses during the first nine months of the current fiscal year is primarily
due to the timing of premium payments to various insurance carriers.
Operating activities used cash of $661,072 for the period ended December
31, 2004. This was primarily due to an increase in inventory and prepaid
expenses of $2,158,422, and equity in the earnings from our Hong Kong Joint
Venture of $1,929,753, which were partially offset by an increase in accounts
payable and accrued expenses of $833,599. For the same period last year,
operating activities used cash of $286,361.
Investing activities provided cash of $325,625 in the current period,
primarily from dividends received from our Hong Kong Joint Venture. For the same
period last year, investing activities provided cash of $343,664, primarily from
the sale of the 1.5 acre parcel of land.
Financing activities provided cash of $208,325 primarily from the exercise
of employee stock options. For the same period last year, financing activities
provided cash of $110,290.
We believe that funds available under the Factoring Agreement,
distributions from the Hong Kong Joint Venture, working capital, and our new
line of credit 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.
HONG KONG JOINT VENTURE
Net Sales. Net sales of the Hong Kong Joint Venture for the three and nine
months ended December 31, 2004 were $7,436,845 and $20,513,915, respectively,
compared to $5,783,901 and $18,862,545, respectively, for the comparable periods
in the prior fiscal year. Sales of the Hong Kong Joint Venture to the Company
amounted to $3,312,469 (44.5%) and $8,011,032 (39.1%) for the three and nine
month periods ended December 31, 2004 and $1,116,825 (19.3%) and $5,277,394
(28.0%) for the same periods of the prior year.
Net Income. Net income for the three and nine months ended December 31,
2004 was $1,589,425 and $4,150,916, respectively, compared to $753,266 and
$3,319,731, respectively, in the comparable periods last year. The 111% increase
in net income for the quarter was due to increased sales and an increase in
investment income
Gross Margins. Gross margins of the Hong Kong Joint Venture for the three
month period ended December 31, 2004 increased to 34.6% from 28% for the 2003
period. For the nine month period ended December 31, 2004, gross margins
increased to 33% from 31% for the 2003 period. 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 $992,921 and
$2,519,160, respectively, for the three and nine month periods ended December
31, 2004, compared to $667,976 and $2,248,257, in the prior year's respective
periods. As a percentage of sales, expenses were 13% and 12%, respectively, for
the three and nine month periods ended December 31, 2004, compared to 12% and
12%, respectively, for the three and nine month periods ended December 31, 2003.
The increase in selling, general and administrative expense was primarily due to
increased professional fees associated with the pursuit of legal action against
a company in Germany which the Hong Kong Joint Venture believes is infringing on
patents and copyrights of the Hong Kong Joint Venture.
Interest Income and Expense. Interest income, net of interest expense, was
$23,407 and $61,057, respectively, for the three and nine month periods ended
December 31, 2004, compared to interest expense of $490 and $562, respectively,
for the prior year's periods. The increase in interest income is primarily due
to bond interest income.
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Liquidity. Cash needs of the Hong Kong Joint Venture are currently met by
funds generated from operations. During the nine months ended December 31, 2004,
working capital increased by $994,864 from $1,318,657 on March 31, 2004 to
$2,313,521 on December 31, 2004.
We previously announced that the Hong Kong Joint Venture was being
positioned for a possible initial public offering (IPO) and is proceeding with
the application process for an IPO and listing on the Hong Kong Stock Exchange
Main Board. The Hong Kong Joint Venture recently determined it would wait until
the completion of the audit with respect to its current fiscal year, ending
March 31, 2005, in order to pursue a listing. No assurances can be given that
these steps will result in an initial public offering for the Hong Kong Joint
Venture. We will report further developments at such time as permitted in
accordance with Hong Kong and U.S. regulations.
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 December 31, 2004.
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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 recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission, and 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 effective. 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 review this situation.
We were advised that as of March 31, 2004 the independent registered
public accounting firm for the Hong Kong Joint Venture had 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. These significant
deficiencies arose from (i) the lack of appropriately skilled and experienced
accounting staff at the Hong Kong Joint Venture, (ii) a lack of segregation of
duties due to the small number of administrative staff employed by the Hong Kong
Joint Venture, and (iii) because the Hong Kong Joint Venture uses primarily a
manual accounting system. As a result of these factors, account reconciliations
have not been completed in a timely manner and there is a lack of evidence of
review of several items, including payment vouchers.
During the nine month period ended December 31, 2004, the Hong Kong Joint
Venture added a senior accounting supervisor and automated certain accounting
systems. Our management believes that this has remediated several of the
significant deficiencies at the Hong Kong Joint Venture, but we will continue to
monitor the Hong Kong Joint Venture's progress pending further review by the
independent registered accounting firm in conjunction with their audit for the
fiscal year ending March 31, 2005. 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 December 31, 2004.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously reported, on September 3, 2003, the Company was advised that
Michael Kovens, a then-director, principal stockholder and the former Chairman
and chief executive officer of the Company ("Kovens"), had filed an action in
Baltimore County Circuit Court (Case No. C-03-9639) against the Company and the
other directors seeking: (i) to enjoin the Company from holding its Annual
Meeting of Stockholders on September 8, 2003 until Kovens was able to nominate
directors for election at the Annual Meeting; (ii) to require the Company to
provide Kovens with certain confidential information to which Kovens claims he
is entitled under Maryland law; (iii) to enjoin the Company from voting as proxy
any shares issued by the Company since Kovens was replaced as Chairman and CEO;
(iv) to void the employment agreement between the Company and its president, and
to enjoin the Company from enforcing a "Change of Control" provision in the
Company's president's employment agreement; (v) to void all issuances by the
Company of restricted stock and options from and after October 1, 2001; (vi) to
void any Bylaw amendments adopted by the Company from and after October 1, 2001;
(vii) to enforce the exercise of an option by Kovens to purchase 20,000 shares
of the Company's common stock at $2.25 per share which the Company maintains has
expired; (viii) to void the election by the Company, pursuant to the Maryland
General Corporation Law, to be governed by certain provisions of Maryland law;
and (ix) other unspecified relief.
The Court refused to issue a temporary restraining order requested by
Kovens to enjoin the Company and the other directors from holding the Annual
Meeting, enforcing the "Change of Control" provision in the Company's
president's employment agreement, and taking other unspecified actions. Kovens
filed an amended complaint on May 28, 2004, and a second amended complaint on
August 13, 2004. On January 11, 2005, the Court dismissed Count I of the Second
Amended Complaint, which sought injunctive and declaratory relief against the
Company. A third amended complaint was filed on January 21, 2005. The third
amended complaint names the Company, Harvey B. Grossblatt and the Estate of
Stephen C. Knepper as the only defendants, and makes two claims. In the first
claim, Kovens alleges that Messrs. Grossblatt and Knepper breached a fiduciary
duty owed to Kovens. Kovens seeks compensatory damages against Grossblatt and
the Estate in the amount of $20 million and injunctive and equitable relief
against the Company for essentially the same matters requested in the original
complaint. In the second claim, Kovens is seeking an additional $500,000 from
the Company with respect to the exercise of the option for the purchase of
20,000 shares at $2.25 per share (mentioned above) which the Company maintains
has expired. The Company, in accordance with its charter and bylaws, is
providing a defense for the directors named in the third amended complaint and,
subject to the provisions of applicable law, is obligated to indemnify them for
any loss they might ultimately incur. The Company believes that the action as
filed is wholly without merit, and the Company intends to aggressively defend
the action. The case is set for trial beginning on May 11, 2005.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On October 5, 2004, the Company issued 950 shares of its Common Stock to
one of its directors in lieu of an annual $10,000 director's fee. These shares
were issued pursuant to an exemption from registration from the Securities Act
of 1933 pursuant to Section 4(2) and Regulation D thereunder.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 5, 2004, we held our Annual Meeting of Stockholders. Reference
is made to the Quarterly Report on Form 10-Q for our quarter ended September 30,
2004 with respect to the voting results of the Annual Meeting.
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)
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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
(incorporated by reference to Exhibit 10.5 to the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 2004, File No.
0-7885)
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 February 14, 2005*
*Filed herewith
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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: February 14, 2005 By: /s/ Harvey B. Grossblatt
----------------------------------------
Harvey B. Grossblatt
President, Chief Executive Officer
By: /s/ James B. Huff
----------------------------------------
James B. Huff
Vice President, Chief Financial Officer
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