Universal Security Instruments, Inc. — Form 10-Q
Reporting period: Quarter and nine months ended December 31, 2019. The filing identifies the registrant as Universal Security Instruments, Inc., not Universal Safety Products, Inc. Financial statements are unaudited except for the March 31, 2019 balance sheet.
Business context and financial results
The company markets and distributes safety and security products, primarily manufactured by its 50%-owned Hong Kong joint venture (HKJV). USI accounts for the venture using the equity method.
| Metric | Three months ended Dec. 31, 2019 | Prior-year quarter | Nine months ended Dec. 31, 2019 | Prior-year period |
|---|---|---|---|---|
| Net sales | $3.224 million | $4.492 million | $11.189 million | $13.064 million |
| Gross profit / margin | $770,000 / 23.9% | $1.061 million / 23.6% | $3.105 million / 27.8% | $3.758 million / 28.8% |
| Operating loss | $484,000 | $146,000 | $838,000 | $20,000 |
| Loss from HKJV investment | $409,000 | $255,000 | $1.152 million | $764,000 |
| Interest expense | $119,000 | $116,000 | $332,000 | $293,000 |
| Net loss | $1.012 million | $517,000 | $2.322 million | $1.077 million |
| Loss per share | $0.44 | $0.22 | $1.00 | $0.47 |
For the quarter, selling, general and administrative expense was $1.084 million and research and development was $170,000. For the nine-month period, those expenses were $3.456 million and $487,000, respectively.
Cash flow, balance sheet and liquidity
- Operating cash flow was positive $310,000 for the nine months, versus positive $100,000 a year earlier. Working-capital movements contributed to cash generation despite the $2.322 million net loss; the loss includes a $1.152 million noncash equity-method loss from HKJV.
- Financing activities used $507,000, principally net repayments on the factoring line. Investing cash flow was zero. Cash declined by $197,000 to $177,000.
- At December 31, 2019, current assets were $9.017 million and current liabilities $7.984 million; working capital was $1.033 million, down from $2.354 million at March 31, 2019. Total assets were $16.462 million and shareholders’ equity $8.266 million.
- Factor borrowings were $1.345 million, with approximately $466,000 of remaining availability. The facility bears interest at prime plus 2% (6.75% at period-end), is secured by receivables and inventory, and advances are at the factor’s discretion.
- Amounts payable to HKJV were $5.616 million, including $3.940 million beyond agreed repayment terms. The filing describes extended terms for eligible purchases up to $4 million; HKJV had discretionary approval for the overdue balance to remain outstanding. These unsecured amounts bear interest at 5.125% after November 13, 2019.
- Operating lease liabilities totaled $367,000, of which $156,000 was current and $212,000 long term. Adoption of lease accounting created a right-of-use asset and lease liability of $476,000; there was no cumulative-effect adjustment.
Changes, outlook and risks
- Quarterly sales fell 28.2% and nine-month sales fell 14.3%. Management attributed the decline to reduced Puerto Rico rebuilding-project sales following delayed emergency-management funding and customer resistance to tariff-related price increases.
- Nine-month gross margin declined one percentage point, to 27.8%, primarily due to tariffs and product/customer mix. SG&A was relatively stable in dollars but rose as a share of sales; R&D increased 35% year over year, largely for engineering work addressing revised smoke-alarm testing standards proposed for 2020.
- Management reported that certain products imported from China, including carbon monoxide and photoelectric alarms and USB devices, were subject to 25% tariffs. The company says all products are imported from China; tariffs not offset by higher prices could hurt results and cash flows.
- HKJV’s nine-month sales declined 40.9% to $6.600 million; its net loss increased to $2.399 million from $1.176 million. USI’s share of HKJV losses was a significant contributor to its own net loss.
- Management cited a history of losses, limited financing sources, higher costs and sales below expectations. It plans to grow sales of sealed-battery ionization smoke alarms, carbon monoxide products and GFCIs, and stated that factor and HKJV credit availability and cash flows are expected to fund operations for one year from the report’s issuance, if plans succeed; no assurance was given.
- Disclosure controls and procedures were deemed ineffective because of material weaknesses in oversight of accounting and HKJV disclosure controls. Management described planned remediation, including added financial-reporting oversight and reinforcing internal policies.
- Management said routine legal matters were not expected to have a material adverse effect. The filing provides no specific earnings or revenue guidance.
Investor verification priorities
- Confirm the basis and continued availability of the factor facility, including its discretionary advances and remaining capacity.
- Track repayment status of the $5.616 million HKJV payable, especially the $3.940 million overdue balance and the venture’s continued willingness to extend terms.
- Assess whether sales recover, particularly Puerto Rico project demand, and whether tariff costs can be passed through without further volume losses.
- Monitor HKJV sales, margins and losses, and their effect on USI’s equity-method investment and earnings.
- Review progress remediating the disclosed material weaknesses in internal controls, including controls over HKJV reporting.
- Compare future operating cash generation with reported losses and near-term liquidity needs.