Universal Security Instruments, Inc. — Q3 FY2018 Form 10-Q
Reporting period: Quarter and nine months ended December 31, 2017. The filing is for Universal Security Instruments, Inc. (not “Universal Safety Products, Inc.”). The company markets and distributes safety and security products, primarily manufactured by its 50%-owned Hong Kong joint venture (HKJV); it accounts for the investment using the equity method.
Financial performance
| Metric | Three months ended Dec. 31, 2017 | Three months ended Dec. 31, 2016 | Nine months ended Dec. 31, 2017 | Nine months ended Dec. 31, 2016 |
|---|---|---|---|---|
| Net sales | $3.56 million | $3.18 million | $10.46 million | $10.57 million |
| Gross profit / margin | $1.07 million / 30.0% | $1.05 million / 33.0% | $3.21 million / 30.7% | $3.36 million / 31.8% |
| Operating loss | $238,006 | $159,723 | $730,830 | $438,711 |
| Net loss | $1.01 million | $549,806 | $1.73 million | $1.00 million |
| Loss per share, basic and diluted | $0.44 | $0.24 | $0.75 | $0.43 |
Quarterly sales rose 11.9%, mainly from higher sales to one customer; nine-month sales declined 1.1%, as reduced sales to a large customer were partly offset by new customers. Management attributed lower gross margins to customer/product mix. Quarterly SG&A increased to $1.14 million, including higher product-liability insurance expense; nine-month SG&A was $3.43 million. Nine-month R&D was $513,000.
The reported nine-month interest expense was $140,728, versus $49,123 a year earlier; it includes approximately $57,000 reclassified from cost of goods sold after being misclassified in the first two fiscal quarters. The nine-month equity-method loss from the HKJV was $854,826, compared with $515,717 a year earlier.
Cash, liquidity and obligations
- Cash was $52,525 at December 31, 2017, down from $262,355 at March 31, 2017. Total assets were $18.46 million; shareholders’ equity was $12.88 million.
- Working capital was $2.69 million, down $864,080 from March 31, 2017. Current liabilities totaled $5.58 million, including $1.38 million outstanding under the factoring line and $3.86 million payable to the HKJV.
- Operating activities provided $689,175 in the nine months, versus $689,358 used in the prior-year period. The 2017 inflow primarily reflected a $2.31 million increase in payables and accrued expenses; investing activities used $16,106 and financing activities used $882,899. Cash declined by $209,830 overall.
- The factor facility had approximately $722,000 of availability at period-end. Borrowing is at the factor’s discretion, secured by receivables and inventory, and bore interest at 6.25%. The agreement was extended January 7, 2018, through January 6, 2020.
- Separate HKJV purchase terms permit up to $4 million of unsecured credit, bearing 4.5% interest and payable within 120 days of purchase; $3.86 million was outstanding at period-end.
HKJV, outlook and risks
HKJV nine-month sales fell 23.4% to $10.17 million and it recorded a $1.56 million net loss, versus a $782,051 loss in the prior-year period. Management linked the decline mainly to reduced sales to the company. HKJV gross margin was 15.5%, compared with 16.4%.
The company reported recurring losses and limited financing sources. Management’s response is to grow sales from its sealed-battery safety-alarm line and other new products, seek additional financing, and reduce non-essential spending. Management said cash flows and credit availability were expected to fund operations for one year from issuance of the financial statements if its plan succeeds, but gave no assurance. Factor advances are discretionary, and the company’s dependence on the factor and HKJV credit presents liquidity risk.
The company reported 10 patents granted, including six for new technologies or features, and applications for 13 patents. The filing provides no quantified sales or earnings guidance. The Tax Cuts and Jobs Act reduced the stated value of deferred tax assets by approximately $1 million; a full valuation allowance had already been recorded. Management had not completed its analysis of its share of HKJV accumulated earnings and profits.
Disclosure controls were deemed ineffective because of a material weakness in oversight of the HKJV’s accounting function and disclosure controls. The company said it was monitoring suggested improvements. Management stated routine legal matters were not expected to have a material adverse effect.
Most important facts to verify
- Whether new-product sales, customer diversification, and cost actions can reverse recurring losses.
- Whether discretionary factoring availability and HKJV extended payment terms remain accessible and sufficient for liquidity needs.
- The source and sustainability of operating cash flow, given that the nine-month inflow depended heavily on higher payables and accrued expenses.
- Progress in remediating the HKJV-related internal-control material weakness and the effect on financial reporting reliability.
- The final tax-law and HKJV accumulated-earnings analysis, and any effect on tax liabilities or financial statements.