UNIVERSAL SAFETY PRODUCTS, INC. annual report, FY2020

Business context and reporting period

Universal Security Instruments, Inc. designs and markets smoke and carbon-monoxide alarms and other safety products, primarily imported from China and sold through retailers and electrical distributors. This Form 10-K covers the fiscal year ended March 31, 2020, with fiscal 2019 as the comparable period; it also reports unaudited quarterly results. The filing was signed August 11, 2020.

On March 31, 2020, the Company sold its 50% interest in Eyston Company Limited, its Hong Kong joint venture and principal manufacturer, for $4.0 million. The proceeds were applied directly against amounts payable to Eyston, rather than received as cash. Eyston remained the Company’s principal supplier after the sale.

Key financial results

• Sales declined 15.8%; management attributed the decline mainly to lower distributor demand over the final three fiscal quarters. COVID-19-related restrictions and supply delays also hurt fourth-quarter sales, though the Company could not quantify their full impact.
• Gross margin fell, which management attributed to product mix. SG&A decreased in dollars to $4.63 million but rose to 31.3% of sales from 27.6%. Research and development expense increased to $691,886 from $502,845, primarily due to additional independent product testing.
• The net loss included $3.84 million of loss from the joint-venture investment: a $2.47 million loss on the sale and $1.37 million of the Company’s share of Eyston’s operating loss. Net interest expense was $409,703, down from $484,953.
• Fourth-quarter FY2020 net sales were $3.61 million and net loss was $3.49 million, compared with sales of $4.52 million and a net loss of $271,000 in fourth-quarter FY2019.
• Operating cash flow was near breakeven despite the large reported loss, which included substantial noncash joint-venture losses; lower receivables and inventory provided cash. Financing activities used $289,926, primarily for net repayment to the factor. Cash fell to $93,794 from $374,472.

Financial position, liquidity and material changes

At March 31, 2020, current assets were $7.78 million, current liabilities $2.72 million, and working capital $5.06 million, versus $2.35 million of working capital a year earlier. Total assets were $8.18 million, down from $18.91 million, reflecting the removal of the joint-venture investment and lower inventory. Shareholders’ equity declined to $4.45 million from $10.87 million.

• Factor borrowings were $1.56 million, secured by receivables and inventory, at an effective rate of 5.25%. Approximately $738,000 of facility availability was reported at year-end. Advances are at the factor’s discretion and are based on its assessment of the Company’s financial position and collateral.
• After the sale, $839,831 of Eyston payables was converted into an unsecured, interest-only note due April 19, 2022; the agreement was formalized in April 2020. The balance owed to Eyston also included $266,409 of current trade payables at year-end. Future purchases are payable upon evidence of shipment.
• The Company sourced 82.7% of its fiscal 2020 inventory purchases from Eyston, down from 87.2%. Substantially all products are imported, and Chinese products were subject to tariffs ranging from 10% to 25%.
• In May 2020, the Company received a $221,400 Paycheck Protection Program loan and expected forgiveness subject to compliance with program requirements.

Outlook, risks and unusual items

No quantified financial guidance was provided. Management said second-quarter FY2021 sales to a major home-improvement retailer had increased, improving availability under the factoring facility, and expected the growth to continue. It stated that cash flows and credit availability should fund operations for 12 months from the report’s issuance if its plan succeeds, but gave no assurance.

• Management cited a history of losses, limited financing sources, and uncertainty about achieving product acceptance; it warned that failure to gain acceptance could significantly affect operations and the ability to continue operating in the current manner.
• COVID-19 caused shipping and receiving delays and weakened demand from construction and do-it-yourself customers. The Company said the full effect remained uncertain.
• Results are sensitive to U.S. housing and construction conditions, tariffs, foreign-supplier dependence, shipping disruption, and competition from larger companies.
• Internal control over financial reporting and disclosure controls were deemed ineffective at March 31, 2020 because of a material weakness involving oversight of accounting and the joint venture’s disclosure controls. Management said the sale of its joint-venture interest would remove the need to implement controls over that entity in future periods; this is not a statement that all control weaknesses were remediated.
• The independent auditor gave an unqualified opinion on the financial statements, but was not engaged to audit internal control effectiveness. Routine legal matters were not expected by management to have a material adverse effect.
• The Company reported no income-tax benefit despite significant losses because deferred tax assets were fully offset by a valuation allowance; it reported approximately $5.71 million of federal and state net operating loss carryforwards.

Investor verification priorities

• Verify whether reported post-year-end retailer sales growth continued, and whether it translated into sustained margins and operating cash flow.
• Assess the Company’s actual liquidity, factor availability and borrowing terms, and its ability to fund operations as supplier payments fall due.
• Review the Eyston sale accounting, the $839,831 note terms, and the Company’s ongoing supplier concentration and payment arrangements.
• Track the effects of COVID-19, tariffs, shipping constraints, and housing-market conditions on sales, inventory and gross margin.
• Confirm the status of internal-control remediation and whether the material weakness has been addressed in subsequent filings.
• Evaluate the assumptions underlying management’s 12-month liquidity outlook and expected PPP loan forgiveness.