UUU

Business Context and Reporting Period

Company: Universal Security Instruments, Inc. (USI)
Filing Type: Form 10-K (Annual Report)
Period Ended: March 31, 2010
Business Overview: USI designs and markets safety products, primarily smoke alarms and carbon monoxide alarms, sold through retail stores and the electrical distribution trade. The company imports 100% of its products, with approximately 99% sourced from a 50%-owned Hong Kong Joint Venture (HKJV) manufacturing in China. The company also operates a wholly-owned subsidiary, USI Electric, Inc., focusing on the electrical distribution trade.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 1.3% to $26.4 million. This was driven by a 14.6% increase in retail/wholesale sales ($20.0M), partially offset by a 25.7% decline in electrical distribution trade sales ($6.4M) due to the downturn in U.S. residential construction.
• Profitability: Income from continuing operations rose 57.2% to $2.27 million. This increase was primarily due to a $1.1 million increase in equity earnings from the Hong Kong Joint Venture. However, Net Income decreased 53.4% compared to 2009, as the prior year included a $3.4 million gain from discontinued operations (Canadian subsidiary settlement) which was absent in 2010.
• Margins: Gross margin declined from 23.4% to 20.2%, attributed to increased sales volume to a national home improvement retailer which carries lower margins.
• Expenses: Selling, General, and Administrative (SG&A) expenses decreased 10.7% to $4.73 million, largely due to reduced commissions and freight costs associated with lower distribution trade volume and the elimination of a $401,000 litigation accrue following a settlement.
• Discontinued Operations: The Canadian subsidiary (Icon) was fully settled in 2009. As of March 31, 2010, all Icon liabilities were settled, and no assets remained.

Guidance, Outlook, and Risks

• Customer Concentration Risk: The Home Depot represented 51.3% of total revenue in 2010. The retailer announced it would sell USI products only online and through professional contractor desks starting April 1, 2010. Management expects sales to The Home Depot to decrease significantly in fiscal 2011.
• Supply Chain Dependency: The company relies on the Hong Kong Joint Venture for 99% of inventory purchases. Risks include political/economic instability in China, currency fluctuations, and potential trade restrictions.
• Product Development: Management is developing next-generation smoke and carbon monoxide alarms with new sensing technology. Certification is expected to be completed in fiscal 2011, with an estimated additional cost of $400,000 to $600,000.
• Legal Proceedings: Long-standing patent infringement litigation with Walter Kidde Portable Equipment, Inc. (UTC) was settled in February 2010. All claims were dismissed, and USI received worldwide non-exclusive licenses under the patented technology.
• Liquidity: The company maintains a factoring agreement with CIT Group with a maximum borrowing capacity of $7.5 million. As of March 31, 2010, $5.1 million was available. No borrowings were outstanding under this agreement at year-end.

Investor Verification Checklist

• Home Depot Impact: Verify the actual decline in revenue from The Home Depot in the first quarter of fiscal 2011 following the change in sales channel.
• Joint Venture Performance: Review the financial statements of the Hong Kong Joint Venture (included in the filing) to confirm the sustainability of the increased equity earnings driving USI's profit growth.
• Inventory Levels: Monitor inventory turnover given the shift in sales mix and the reduction in inventory levels from $9.0M in 2009 to $3.4M in 2010.
• Product Certification: Track the progress of the new smoke alarm technology certification and the associated costs in fiscal 2011.
• Factoring Agreement: Confirm the status of the factoring line and any potential changes in terms given the company's cash position.