UNIVERSAL SECURITY INSTRUMENTS INC - Quarter Report: 2006 December (Form 10-Q)
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, 2006
OR
o
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 o
Indicate
by check mark if the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and
large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated
filer o Accelerated
filer x Non-Accelerated
Filer o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No
x
At
February 14, 2007, the number of shares outstanding of the registrant’s common
stock was 2,433,483.
TABLE
OF CONTENTS
Part
I - Financial Information
|
Page
|
|
Item
1.
|
Consolidated
Financial Statements (unaudited):
|
|
Consolidated
Balance Sheets at December 31, 2006
|
||
and
March 31, 2006
|
3
|
|
Consolidated
Statements of Earnings for the Three
|
4
|
|
Months
Ended December 31, 2006 and 2005
|
||
Consolidated
Statements of Earnings for the Nine
|
5
|
|
Months
Ended December 31, 2006 and 2005
|
||
Consolidated
Statements of Cash Flows for the Nine
|
6
|
|
Months
Ended December 31, 2006 and 2005
|
||
Notes
to Consolidated Financial Statements
|
7
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition
|
|
and
Results of Operations
|
13
|
|
Item
3.
|
Quantitative
and Qualitative Disclosure About Market Risk
|
17
|
Item
4.
|
Controls
and Procedures
|
17
|
Part
II - Other Information
|
||
Item
1.
|
Legal
Proceedings
|
18
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
19
|
|
||
Item
6.
|
Exhibits
|
19
|
Signatures
|
20
|
PART
I - FINANCIAL INFORMATION
ITEM
1. FINANCIAL
STATEMENTS
UNIVERSAL
SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(Unaudited)
|
December
31, 2006
|
March
31, 2006
|
|||||
ASSETS
|
|||||||
CURRENT
ASSETS
|
|||||||
Cash
and cash equivalents
|
$
|
533,882
|
$
|
3,015,491
|
|||
Accounts receivable: | |||||||
Trade
less allowance for doubtful accounts of $15,000
|
2,175,104
|
1,106,435
|
|||||
Employees
|
24,373
|
23,656
|
|||||
2,199,477
|
1,130,091
|
||||||
Amount
due from factor
|
4,201,034
|
4,259,131
|
|||||
Inventories,
net of allowance for obsolete inventory of $40,000
|
9,854,960
|
4,062,086
|
|||||
Prepaid
expenses
|
383,026
|
196,863
|
|||||
TOTAL
CURRENT ASSETS
|
17,172,379
|
12,663,662
|
|||||
DEFERRED
TAX ASSET
|
948,935
|
476,384
|
|||||
INVESTMENT
IN JOINT VENTURE
|
9,031,410
|
7,140,859
|
|||||
PROPERTY
AND EQUIPMENT - NET
|
2,679,077
|
62,212
|
|||||
GOODWILL
|
1,508,718
|
-
|
|||||
OTHER
ASSETS
|
15,486
|
15,486
|
|||||
TOTAL
ASSETS
|
$
|
31,356,005
|
$
|
20,358,603
|
|||
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|||||||
CURRENT
LIABILITIES
|
|||||||
Note
payable - bank
|
1,803,473
|
-
|
|||||
Notes
payable - other
|
266,599
|
-
|
|||||
Lease
obligation
|
59,532
|
-
|
|||||
Accounts
payable
|
3,620,956
|
1,604,845
|
|||||
Accrued
liabilities:
|
|||||||
Patent
litigation and settlement reserve
|
671,192
|
556,787
|
|||||
Payroll,
commissions and other
|
1,477,973
|
590,402
|
|||||
TOTAL
CURRENT LIABILITIES
|
7,899,725
|
2,752,034
|
|||||
LEASE
OBLIGATION
|
55,810
|
-
|
|||||
COMMITMENTS
AND CONTINGENCIES
|
-
|
-
|
|||||
Minority
interest
|
-
|
-
|
|||||
SHAREHOLDERS’
EQUITY
|
|||||||
Common
stock, $.01 par value per share; authorized 20,000,000 shares; issued
and
outstanding 2,420,573 and 2,258,409 shares at December 31, 2006 and
March
31, 2006, respectively
|
18,181
|
16,940
|
|||||
Additional
paid-in capital
|
12,767,187
|
11,577,583
|
|||||
Retained
earnings
|
10,711,308
|
6,012,046
|
|||||
Other
comprehensive income (loss)
|
(96,206
|
)
|
-
|
||||
TOTAL
SHAREHOLDERS’ EQUITY
|
23,400,470
|
17,606,569
|
|||||
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
$
|
31,356,005
|
$
|
20,358,603
|
See
accompanying notes to consolidated financial statements.
-3-
UNIVERSAL
SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF EARNINGS
(Unaudited)
Three
Months Ended
December 31, |
|||||||
2006
|
2005
|
||||||
Net
sales
|
$
|
8,620,893
|
$
|
7,353,597
|
|||
Cost
of goods sold
|
5,825,551
|
4,804,297
|
|||||
GROSS
PROFIT
|
2,795,342
|
2,549,300
|
|||||
Research
and development expense
|
85,599
|
57,492
|
|||||
Selling,
general and administrative expense
|
1,949,952
|
1,675,332
|
|||||
Operating
income
|
759,791
|
816,476
|
|||||
Other
income (expense):
|
|||||||
Interest
income
|
3,141
|
-
|
|||||
Interest
expense
|
(51,663
|
)
|
(23,783
|
)
|
|||
INCOME
BEFORE EARNINGS FROM AFFILIATES
|
711,269
|
792,693
|
|||||
Equity
in earnings of Joint Venture
|
995,097
|
525,021
|
|||||
Loss
on currency translation
|
(17,906
|
)
|
-
|
||||
NET
INCOME BEFORE TAXES and MINORITY INTEREST
|
1,688,460
|
1,317,714
|
|||||
Provision
for income tax (benefit)
|
(731
|
)
|
(139,095
|
)
|
|||
NET
INCOME BEFORE MINORITY INTEREST
|
1,689,191
|
1,456,809
|
|||||
Minority
interest
|
23,692
|
-
|
|||||
NET
INCOME
|
$
|
1,712,883
|
$
|
1,456,809
|
|||
Net
income per common share amounts:
|
|||||||
Basic
|
$
|
0.71
|
$
|
0.65
|
|||
Diluted
|
$
|
0.68
|
$
|
0.60
|
|||
Weighted
average number of common shares outstanding:
|
|||||||
Basic
|
2,417,972
|
2,231,331
|
|||||
Diluted
|
2,514,536
|
2,436,136
|
See
accompanying notes to consolidated financial statements.
-4-
UNIVERSAL
SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF EARNINGS
(Unaudited)
Nine
Months Ended December
31,
|
|||||||
2006
|
2005
|
||||||
Net
sales
|
$
|
24,655,342
|
$
|
21,396,507
|
|||
Cost
of goods sold
|
16,479,066
|
14,519,415
|
|||||
GROSS
PROFIT
|
8,176,276
|
6,877,092
|
|||||
Research
and development expense
|
223,539
|
159,306
|
|||||
Selling,
general and administrative expense
|
5,528,408
|
5.264.201
|
|||||
Operating
income
|
2,424,329
|
1,453,585
|
|||||
|
|||||||
Other
income (expense):
|
|||||||
Interest
income
|
31,217
|
-
|
|||||
Interest
expense
|
(51,663
|
)
|
(47,160
|
)
|
|||
INCOME
BEFORE EARNINGS FROM AFFILIATES
|
2,403,883
|
1,406,425
|
|||||
|
|||||||
Equity
in earnings of Joint Venture
|
3,164,817
|
1,776,326
|
|||||
Loss
on currency translation
|
(17,906
|
)
|
-
|
||||
NET
INCOME BEFORE TAXES and MINORITY INTEREST
|
5,550,794
|
3,182,751
|
|||||
Provision
for income tax expense (benefit)
|
875,224
|
(326,523
|
)
|
||||
NET
INCOME BEFORE MINORITY INTEREST
|
$
|
4,675,570
|
$
|
3,509,274
|
|||
Minority
interest
|
23,692
|
-
|
|||||
NET
INCOME
|
$
|
4,699,262
|
$
|
3,509,274
|
|||
Net
income per common share amounts:
|
|||||||
Basic
|
$
|
1.97
|
$
|
1.58
|
|||
Diluted
|
$
|
1.88
|
$
|
1.45
|
|||
Weighted
average number of common shares outstanding:
|
|||||||
Basic
|
2,380,163
|
2,222,297
|
|||||
Diluted
|
2,499,175
|
2,423,900
|
See
accompanying notes to consolidated financial statements.
-5-
UNIVERSAL
SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Unaudited)
Nine
Months Ended December 31,
|
|||||||
|
2006
|
2005
|
|||||
OPERATING
ACTIVITIES
|
|
|
|||||
Net
income
|
$
|
4,699,262
|
$
|
3,509,274
|
|||
Adjustments
to reconcile net income to net cash (used in) provided by operating
activities:
|
|||||||
Depreciation
and amortization
|
108,538
|
20,891
|
|||||
Earnings
of the Joint Venture
|
(3,164,817
|
)
|
(1,776,322
|
)
|
|||
Changes
in operating assets and liabilities:
|
|||||||
Decrease
(increase) in accounts receivable and amounts due from
factor
|
302,094
|
(715,787
|
)
|
||||
Increase
in inventories and prepaid expenses
|
(3,853,840
|
)
|
(364,533
|
)
|
|||
Increase
(decrease) in accounts payable and accrued expenses
|
695,424
|
(125,851
|
)
|
||||
Increase
in deferred tax asset
|
(458,596
|
)
|
(348,604
|
)
|
|||
|
|||||||
NET
CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES
|
(1,671,935
|
)
|
199,068
|
||||
|
|||||||
INVESTING
ACTIVITIES:
|
|||||||
Dividends
received from Joint Venture
|
1,274,266
|
771,677
|
|||||
Purchase
of property and equipment
|
(468,453
|
)
|
(5,994
|
)
|
|||
Acquisition
of subsidiaries
|
(1,784,120
|
)
|
-
|
||||
|
|||||||
NET
CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES
|
(978,307
|
)
|
765,683
|
||||
|
|||||||
FINANCING
ACTIVITIES:
|
|||||||
Tax
benefit from exercise of stock options
|
739,000
|
-
|
|||||
Borrowings
net of repayments from Foreign Commercial Bank
|
148,475
|
-
|
|||||
Payments
of notes payable acquired in acquisition
|
(1,043,389
|
)
|
-
|
||||
Payments
of lease obligation
|
(31,092
|
)
|
|||||
Proceeds
from issuance of common stock from exercise of employee stock
options
|
451,845
|
46,318
|
|||||
|
|||||||
NET
CASH PROVIDED BY FINANCING ACTIVITIES
|
264,839
|
46,318
|
|||||
|
|||||||
Impact
of foreign currency
|
(96,206
|
)
|
-
|
||||
|
|||||||
(DECREASE)
INCREASE IN CASH
|
(2,481,609
|
)
|
1,011,069
|
||||
|
|||||||
Cash
at beginning of period
|
3,015,491
|
59,287
|
|||||
|
|||||||
CASH
AT END OF PERIOD
|
$
|
533,882
|
$
|
1,070,356
|
|||
|
|||||||
Supplemental
information:
|
|||||||
Interest
paid
|
$
|
51,663
|
$
|
47,160
|
See
accompanying notes to consolidated financial statements.
-6-
UNIVERSAL
SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Statement
of Management
The
consolidated financial statements include the accounts of Universal Security
Instruments, Inc. (USI or the Company) and its majority 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, 2006 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.
All
share
and per share amounts included in the consolidated financial statements have
been retroactively adjusted to reflect a 4-for-3 stock dividend paid on October
16, 2006 to shareholders of record on September 25, 2006.
Acquisition
On
October 2, 2006, 2113824 Ontario, Inc., a newly formed wholly owned subsidiary
the Company, acquired two-thirds of the issued and outstanding capital stock
of
International Conduit, Inc. (Icon) and Intube, Inc. (Intube). Icon and Intube
are based in Toronto, Canada and manufacture and distribute electrical
mechanical tubing (EMT) steel conduit. Icon also sells home safety products
primarily purchased from USI. The purchase price for the capital stock of Icon
and Intube was $1,784,120 in cash. The primary purpose of the Icon and Intube
acquisition was to expand our product offering and service the commercial
construction market.
The
acquisition described above was accounted for under the purchase method of
accounting. Accordingly, the purchase price has been allocated to reflect the
fair value of assets and liabilities acquired at the date of acquisition.
The
results of these acquisitions, had they been consummated at the beginning of
each period shown, are included in the pro forma information below. This
unaudited pro forma information does not necessarily reflect the results of
operations that would have occurred had the acquisitions taken place at the
beginning of each twelve month period and is not necessarily indicative of
results that may be obtained in the future.
Nine
Months Ended
December
31,
|
|||||||
2006
|
2005
|
||||||
Revenue
|
$
|
9,136,000
|
$
|
8,305,000
|
|||
Net
(loss)
|
(100,000
|
)
|
(90,900
|
)
|
|||
Earnings
per share (diluted)
|
($0.04
|
)
|
(0.04
|
)
|
Purchase
Price Allocation
The
allocation of the purchase price for Icon and Intube is as
follows:
Assets
acquired
|
||||
Cash
|
$
|
48,378
|
||
Accounts
receivable
|
1,171,616
|
|||
Inventory
|
1,825,917
|
|||
Property
and equipment
|
1,968,735
|
|||
Other
|
82,335
|
|||
$ | 5.096,981 |
-7-
Liabilities
Assumed
|
||||
Debt
|
$
|
(2,775,573
|
)
|
|
Accounts
payable and accruals
|
(2,088,979
|
)
|
||
Minority
interest
|
(4,800
|
)
|
||
$
|
(4,879,352
|
)
|
||
Goodwill
|
1,556,491
|
|||
Total
consideration
|
$
|
1,784,120
|
The
goodwill from the Icon and Intube acquisitions are fully allocated to the
Company’s Canadian operations. The allocation may be adjusted pending final
purchase accounting.
Goodwill.
Goodwill
represents the excess of the purchase price above the fair value of the net
assets acquired. Goodwill is evaluated for impairment annually or when events
or
circumstances occur indicating that goodwill might be impaired. In accordance
with FAS No. 142, “Goodwill and Other Intangible Assets,” the evaluation is a
two-step process that begins with an estimation of the fair value of the
reporting units. The first step assesses potential impairment and the second
step measures that impairment. The measurement of possible impairment is based
on the comparison of the fair value of each reporting unit with the book value
of its assets.
Income
Taxes
A
provision (benefit) for federal and state income taxes of $(731) and $875,224
has been provided for the three and nine month periods ended December 31, 2006.
For income tax purposes, this provision is reduced by a $739,000 benefit derived
from deductions associated with the exercise of employee stock options. Under
FAS 123, the tax benefit of this deduction has been treated as a credit to
additional paid in capital and will not require a cash payment for income
taxes..
Joint
Venture
The
Company and its co-venturer, a Hong Kong corporation, each owns a 50% interest
in a Hong Kong joint venture, Eyston Company Limited (the “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 Joint Venture for the nine months
ended December 31, 2006 and 2005:
2006
|
|
2005
|
|||||
Net
sales
|
$
|
31,566,816
|
$
|
18,610,343
|
|||
Gross
profit
|
10,859,898
|
6,495,286
|
|||||
Net
income
|
7,096,898
|
3,559,233
|
|||||
Total
current assets
|
13,832,205
|
7,415,265
|
|||||
Total
assets
|
24,958,330
|
18,056,986
|
|||||
Total
current liabilities
|
7,601,540
|
5,192,751
|
During
the nine months ended December 31, 2006 and 2005, respectively, the Company
purchased $12,837,511 and $9,644,986 of products from the Joint Venture. At
December 31, 2006 and March 31, 2006, the Company had amounts payable to the
Joint Venture of $250,000 and $500,000, respectively. For the quarter ended
December 31, 2006, the Company has adjusted its equity in earnings of the Joint
Venture to reflect a reduction of $288,896 for inter-company profit in inventory
as required by US GAAP.
Foreign
Currency Translation
The
financial statements of the Company's foreign subsidiaries acquired in October
2006 have been translated into U.S. dollars in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation"
and SFAS No. 130, "Reporting Comprehensive Income." Translation adjustments
are
included in other comprehensive income. All balance sheet accounts of foreign
subsidiaries are translated into U.S. dollars at the current exchange rate
at
the balance sheet date. Statement of operations items are translated at the
average foreign currency exchange rates. The resulting foreign currency
translation adjustment is recorded in accumulated other comprehensive income
(loss). The Company has no other components of comprehensive income (loss).Gains
and losses from foreign currency transactions are included in the consolidated
statements of income. The Company had no foreign operations until the
acquisition 2006 acquisitions.
-8-
Capital
Lease Obligation
The
Company’s Canadian subsidiary is party to capital lease agreements to lease
equipment for various periods from 2007 through 2009. Minimum amounts payable
for equipment leases for each of the next three years and in aggregate are
as
follows:
2007
|
$
|
28,440
|
||
2008
|
59,532
|
|||
2009
|
44,649
|
|||
Total
minimum lease payments
|
132,621
|
|||
Less:
amount representing interest at 8.043%
|
17,279
|
|||
115,342
|
||||
Less:
current portion
|
59,532
|
|||
$
|
55,810
|
Business
Segments
The
Company conducts its business through two operating segments based on geographic
location.
Historically,
the combined U.S. operations of the Company and its wholly-owned subsidiary,
USI
Electric, Inc., are operated from the Baltimore, Maryland and Chicago, Illinois
offices, respectively, marketing a line of home safety devices such as smoke
alarms, carbon monoxide alarms, and ground fault circuit interrupter (GFCI)
devices to retail customers and to the electrical distribution
trade.
The
Company’s Canadian operations consist of Icon and Intube, the majority owned
subsidiaries acquired by the Company in October 2006 and operated from offices
in Toronto, Ontario, with sales in both Canada and the United States. The
primary product line of the Canadian segment is EMT conduit sold to the
electrical distribution trade. Icon also sells home safety devices purchased
primarily from the Company.
While
USI
did not have any significant sales of EMT conduit since the October 2006
acquisition through December 31, 2006, it anticipates that it will sell EMT
conduit through its distribution network. Icon’s sales of safety products during
the quarter ended December 31, 2006 totaled $402,761.
For
the
period ended December 31, 2006, no inter-company allocation of expenses has
been
made between the Company, Icon and Intube.
The
following chart provides segmental information on the U.S. and Canadian
operations of the Company for the three months ended December 31, 2006 (all
figures are presented in U.S. dollars):
U.S.
Operations
|
|
|
|
Canadian
Operations
|
||||||
Sales
|
$
|
7,078,827
|
$
|
1,542,066
|
||||||
Cost
of sales
|
4,335,645
|
1,489,906
|
||||||||
Gross
profit
|
2,743,182
|
52,160
|
||||||||
Selling,
general and administrative
|
1,712,997
|
322,554
|
||||||||
Operating
income (loss)
|
1,030,185
|
(270,394
|
)
|
|||||||
Equity
in earnings of Joint Venture
|
995,097
|
-
|
||||||||
Interest
income (expense)
|
3,141
|
(51,663
|
)
|
|||||||
Net
income (loss) before taxes
|
2,028,423
|
(322,057
|
)
|
|||||||
Currency
translation adjustment
|
-
|
(17,906
|
)
|
|||||||
Provision
for income taxes (benefit)
|
268,154
|
(268,885
|
)
|
|||||||
Net
income (loss)
|
$
|
1,760,269
|
$
|
(71,078
|
)
|
-9-
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.
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, 2006 and 2005 is as follows:
Three
Months Ended
December
31,
|
Nine
Months Ended
December
31,
|
||||||||||||
2006
|
2005
|
2006
|
2005
|
||||||||||
Weighted
average number of common shares outstanding for basic EPS
|
2,417,972
|
2,231,331
|
2,380,163
|
2,222,297
|
|||||||||
Shares
issued upon the assumed exercise of outstanding stock
options
|
96,564
|
204,805
|
119,012
|
201,603
|
|||||||||
Weighted
average number of common and common equivalent shares outstanding
for
diluted EPS
|
2,514,536
|
2,436,136
|
2,499,175
|
2,423,900
|
At
December 31, 2006 and 2005, there were no securities outstanding whose issuance
would have an anti-dilutive effect on the earnings per share
calculation.
Line
of Credit
Icon
and
Intube, have a line of credit facility with a Canadian commercial bank. This
facility, in the amount of CAD $3,000,000 (US $2,580,000) is payable on demand,
bears interest at the bank’s prime rate of interest plus .25% (effective rate
6.25% at December 31, 2006) and is collateralized by all of the assets of the
Canadian subsidiaries and by the guarantees of the Company and its wholly owned
subsidiary, 2113824 Ontario, Inc. Advances under the line of credit facility
are
based on specified percentages of trade accounts receivable and inventory.
At
December 31, 2006, the Canadian subsidiaries had borrowed CAD $2,101,705 (US
$1,803,473) of the total amount available under the terms of the line of credit
facility.
Notes
Payable - Other
Notes
payable - other consists of three notes payable to former stockholders of Icon
and Intube, the Company’s newly- acquired majority-owned subsidiaries. The notes
are payable in nine remaining monthly installments of principal and interest
totaling $15,343, with a balloon payment in October 2007 of $136,102. The notes
are non-collateralized, bear interest at 4.0%, and are guaranteed by the
Company.
Stock
Based Compensation
As
of
December 31, 2006, under the terms of the Company’s Non-Qualified Stock Option
Plan, as amended, 877,777 shares of our common stock are reserved for the
granting of stock options, of which 875,544 have been issued, leaving 2,233
available for issuance.
Adoption
of SFAS No. 123R. In
December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123 (revised 2004),
Share-Based Payment,
which
requires compensation costs related to share-based payment transactions to
be
recognized in financial statements. SFAS No. 123R eliminates the intrinsic
value method of accounting available under Accounting Principles Board (APB)
Opinion No. 25,
Accounting for Stock Issued to Employees,
which
generally resulted in no compensation expense being recorded in the financial
statements related to the grant of stock options to employees if certain
conditions were met.
Effective
April 1, 2006, we adopted SFAS No. 123R using the modified prospective
method. Under this method, compensation costs for all awards granted after
the
date of adoption and the unvested portion of previously granted awards will
be
measured at an estimated fair value and included in operating expenses or
capitalized as appropriate over the vesting period during which an employee
provides service in exchange for the award. Accordingly, prior period amounts
presented have not been restated to reflect the adoption of SFAS No. 123R.
-10-
As
a
result of adopting SFAS No. 123R, net income for the nine months ended December
31, 2006 was reduced by $25,238. No portion of employees’ compensation,
including stock compensation expense, was capitalized during the period.
During
the nine month period ended December 31, 2006, 162,164 shares of our common
stock have been issued as a result of the exercise of the options granted under
the plan. The tax benefit, for income tax purposes, of $739,000 from the
exercise of these stock options is presented as a cash flow from financing
activities.
Fair
Value Determination.
Under
SFAS No. 123R, we have elected to continue using the Black-Scholes option
pricing model to determine fair value of our awards on date of grant. We will
reconsider the use of the Black-Scholes model if additional information becomes
available in the future that indicates another model would be more appropriate,
or if grants issued in future periods have characteristics that cannot be
reasonably estimated under this model.
Stock
Option Activity.
During
the nine month period ended December
31,
2006,
no stock options were granted.
Stock
Compensation Expense.
We have
elected to continue straight-line amortization of stock-based compensation
expense over the requisite service period. Prior to the adoption of SFAS
No. 123R, we recognized the effect of forfeitures in our pro forma
disclosures as they occurred. In accordance with the new standard, we have
estimated forfeitures and are only recording expense on shares we expect to
vest. For the nine months ended December
31,
2006,
we recorded $25,238 of stock-based compensation cost as general and
administrative expense in our statement of operations. No forfeitures have
been
estimated. No portion of employees’ compensation including stock compensation
expense was capitalized during the period.
As
of
December
31,
2006,
there was $37,072 of unrecognized compensation cost related to share-based
compensation arrangements that we expect to vest. This cost will be fully
amortized within three years. The aggregate intrinsic value of currently
exercisable options was $2,812,608 at December
31,
2006.
In
prior
periods, as permitted under Statement of Financial Accounting Standards (SFAS)
No. 123,
Accounting for Stock-Based Compensation,
we
accounted for our stock-based compensation plan using the intrinsic value method
under the recognition and measurement principles of APB Opinion No. 25. In
accordance with the provisions of SFAS No. 148,
Accounting for Stock-Based Compensation - Transition and
Disclosure,
the
following table illustrates the effect on net income and earnings per share
if
we had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation for the three and nine months ended December
31, 2005.
Three
Months Ended
December
31,
|
Nine
Months Ended
December
31,
|
||||||
2005
|
2005
|
||||||
Net
income, as reported
|
$
|
1,456,809
|
$
|
3,509,274
|
|||
Deduct:
Total stock-based employee compensation expense determined under
fair
value based method for all awards, net of related tax
effects
|
(25,962
|
)
|
(77,885
|
)
|
|||
Pro
forma net income
|
$
|
1,430,847
|
$
|
3,431,389
|
|||
Earnings
per share:
|
|||||||
Basic
- as reported
|
$
|
0.65
|
$
|
1.58
|
|||
Basic
- pro forma
|
$
|
0.64
|
$
|
1.54
|
|||
Diluted
- as reported
|
$
|
0.60
|
$
|
1.45
|
|||
Diluted
- pro forma
|
$
|
0.59
|
$
|
1.42
|
-11-
Recent
Accounting Pronouncements
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” to
define fair value, establish a framework for measuring fair value in accordance
with generally accepted accounting principles, and expand disclosures about
fair
value measurements. SFAS No. 157 will be effective for fiscal years beginning
after November 15, 2007, the beginning of the Company’s 2009 fiscal year. The
Company is assessing the impact the adoption of SFAS No. 157 will have on the
Company’s consolidated financial position and results of
operations.
In
February 2006, the Financial Accounting Standards Board (“FASB”) issued FAS
155, “Accounting for Certain Hybrid Financial Instruments,” which clarifies when
certain financial instruments and features of financial instruments must be
treated as derivatives and reported on the balance sheet at fair value with
changes in fair value reported in net income. We will implement FAS 155
beginning with financial instruments acquired on or after January 1, 2007,
which is the effective date of FAS 155. We do not expect the adoption of FAS
155
to have a material impact on our financial position at our date of adoption.
However, FAS 155 may affect future income recognition for certain financial
instruments that contain certain embedded derivatives as any changes in their
fair values will be recognized in net income each period.
In
September 2006, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin 108, “Considering the Effects on Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements,” (“SAB 108”). SAB 108 requires registrants to quantify errors using
both the income statement method (i.e. iron curtain method) and the rollover
method and requires adjustment if either method indicates a material error.
If a
correction in the current year relating to prior year errors is material to
the
current year, then the prior year financial information needs to be corrected.
A
correction to the prior year results that is not material to those years, would
not require a “restatement process” where prior financials would be amended. SAB
108 is effective for fiscal years ending after November 15, 2006. We do not
anticipate that SAB 108 will have a material effect on our financial position,
results of operations or cash flows.
The
FASB
issued FASB Interpretation 48, Accounting
for Uncertainty in Income Taxes: an interpretation of FASB Statement No.
109,
on July
13, 2006. Interpretation 48 clarifies Statement 109, Accounting
for Income Taxes,
to
indicate a criterion that an individual tax position would have to meet for
some
or all of the benefit of that position to be recognized in an entity’s financial
statements. Interpretation 48 is effective for fiscal years beginning after
December 15, 2006 (fiscal year beginning April 1, 2007 for the Company). The
cumulative effect of applying Interpretation 48, if any, will be reported as
an
adjustment to retained earnings at the beginning of the period in which it
is
adopted. The Company is currently working on the potential impact of adoption
of
the guidance.
Reclassifications
Certain
prior year amounts have been reclassified in order to conform with current
year
presentation.
-12-
ITEM
2. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
As
used
throughout this Report, “we,” “our,” “the Company” “USI” 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 include,
but are not limited to, those risks identified in our periodic reports filed
with the Securities and Exchange Commission, including our most recent Annual
Report on Form 10-K.
OVERVIEW
We
are in
the business of marketing and distributing safety and security products which
are primarily manufactured through our 50%-owned Hong Kong Joint Venture. Our
financial statements detail our sales and other operational results only, and
report the financial results of the Hong Kong Joint Venture using the equity
method. Accordingly, the following discussion and analysis of the three and
nine
months ended December 31, 2006 and 2005 relate to the operational results of
the
Company only. A discussion and analysis of the Hong Kong Joint Venture’s
operational results for these periods is presented below under the heading
“Joint Venture.”
On
October 24, 2006, we acquired a majority interest in Icon and Intube, our two
Canadian subsidiaries which manufacture and distribute EMT steel conduit. As
we
previously announced, we believe that this acquisition will further
leverage our existing U.S. electrical distribution network and diversify our
revenue streams within the commercial market. For
the
quarter ended December 31, 2006, our U.S. operations did not have any
significant sales of or net income from EMT conduit products, while our Canadian
subsidiaries generated $1,139,305 in EMT conduit sales and $402,761 in safety
product sales. For the quarter, our Canadian operations’ gross profit margin was
3.38% and reported an operating loss of $322,057 and a net loss of $71,078.
Management
believes that we must focus on increasing
EMT conduit production capacity for our Canadian operations
thereby
increasing revenues and gross profit margins to achieve profitability in our
Canadian operations. To further these goals, we are in
the
process of tripling the production capacity of the Canadian facility
and have
focused sales efforts to Canadian and U.S. customers.
While
our
reported results of operations for the three and nine months ended December
31,
2006 include our Canadian operations, since we acquired the Canadian operations
in our third fiscal quarter, we reported the results of our Canadian operations
in our third fiscal quarter and discuss these results only in the section below
on the three months ended December 31, 2006.
RESULTS
OF
OPERATIONS
Three
Months Ended December 31, 2006 and 2005
Sales.
Net
sales for the three months ended December 31, 2006 were $8,620,893 compared
to
$7,353,597 for the comparable three months in the prior fiscal year, an increase
of $1,267,296 (17.2%). The primary reason for the increase in net sales volumes
was that our sales included $1,542,066 in sales by our Canadian operations.
Sales of our core product lines, including smoke alarms, carbon monoxide alarms
and GFCI units decreased by $274,770 due to a decrease in new home construction
during the quarter.
Gross
Profit Margin.
Gross
profit margin is calculated as net sales
less cost of goods sold expressed as a percentage of net
sales.
Our
gross
profit margin was 32.4% and 34.7% of sales for the quarters ended December
31,
2006 and 2005, respectively. The decrease in gross profit margin was primarily
due to a lower gross profit margin realized by our Canadian operations, which
typically has margins of approximately 13%, and to differences in the mix of
products sold.
-13-
Our
U.S.
operations’ gross profit margin for the quarter ended December 31, 2006 was
38.8% compared to 34.7% for the quarter ended December 31, 2005, a 4.1%
increase. The primary reason for this increase was a reduction in a provision
for contingent losses previously charged to cost of sales as a result of the
favorable outcome of certain litigation. Our Canadian operations’ gross profit
margin for the quarter ended December 31, 2006 was 3.38%. We believe that
increasing EMT conduit production capacity for our Canadian operations will
have
a significant impact on the Canadian operations’ gross profit margins.
Expenses.
Research
and development, and selling, general and administrative expenses increased
by
$302,727 from the comparable three months in the prior year. As a percentage
of
net sales, these expenses were consistent at 23.6% for the three month period
ended December 31, 2006, and 23.6% for the comparable 2005 period.
Research
and development, and selling, general and administrative expenses for our U.S.
operations decreased by $19,827 from the comparable three months in the prior
year, and, as a percentage of net sales, these expenses were 24.2% for the
three
month period ended December 31, 2006, and 23.6% for the comparable 2005 period.
Selling, general and administrative expenses for our Canadian operations were
$322,554, or 20.9% of net sales.
Interest
Expense and Income.
Our
interest expense, net of interest income, was $48,522 for the quarter ended
December 31, 2006, compared to net interest expense of $23,783 for the quarter
ended December 31, 2005. Net interest expense resulted from borrowings of our
Canadian subsidiaries.
Interest
income, net of interest expense, for our U.S. operations was $3,141 for the
quarter ended December 31, 2006. For the comparable three months in the prior
year, interest expense, net of interest income, was $23,783. Interest expense,
net of interest income, for our Canadian operations was $51,663 for the quarter
ended December 31, 2006.
Income
Taxes.
During
the quarter ended December 31, 2006, the Company had a net income tax benefit
of
$(731). A provision for income taxes of $268,154 is provided for taxable
earnings of U.S. operations, which is offset by an income tax benefit of
$268,885, resulting from net operating losses on Canadian operations. For the
corresponding 2005 period, the Company has a tax benefit of $139,095 as a result
of its net operating loss carryforward deduction which was fully utilized during
the Company’s fiscal year ended March 31, 2006.
Net
Income.
We
reported net income of $1,712,883 for the quarter ended December 31, 2006,
compared to net income of $1,456,809 for the corresponding quarter of the prior
fiscal year. The primary reasons for the increase in net income is an increase
of $470,076 in the Company’s equity in the earnings of the Joint Venture from
the same period of the prior year, partially offset by the pretax loss from
operations of the acquired subsidiaries of $322,057.
Net
income for our U.S. operations was $1,760,269 for the quarter ended December
31,
2006, compared to net income of $1,456,809 for the corresponding quarter of
the
prior fiscal year, primarily due to increased Joint Venture earnings. For the
reasons stated above, our Canadian subsidiary had a net loss of $71,078 for
the
quarter ended December 31, 2006.
Nine
Months Ended December 31, 2006 and 2005
Sales.
Net
sales for the nine months ended December 31, 2006 were $24,655,342 compared
to
$21,396,507 for the comparable nine months in the prior fiscal year, an increase
of $3,258,835 (15.2%). The primary reason for the increase in sales was an
increase in volume of sales of smoke alarm, GFCI and carbon monoxide alarm
units. Included in our net sales are $1,542,066 in sales by our Canadian
operations.
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 increased from 32.1% for the period ended December
31, 2005 to 33.2% for the current period ended December 31, 2006. The primary
reason for this increase was a reduction in a provision for contingent losses
previously charged to cost of sales as a result of the favorable outcome of
certain litigation.
-14-
Expenses.
Research
and development, and selling, general and administrative expenses increased
by
$328,440 from the comparable nine months in the prior year. As a percentage
of
sales, these expenses were 23.3% for the nine month period ended December 31,
2006 and 25.3% for the comparable 2005 period. The primary reason for the
decrease as a percentage of sales is that our legal professional fees decreased
by $587,980 for the 2006 period as compared to the same period in the previous
year due to reduced litigation.
Interest
Expense and Income.
Our
interest expense, net of interest income was $20,446 for the nine months ended
December 31, 2006, compared to net interest expense of $47,160 for the nine
months ended December 31, 2005. The
reduction in net interest expense resulted from a reduction in the average
balance of borrowings together with an increase in interest income on
investments.
Income
Taxes.
During
the nine months ended December 31, 2006, the Company had an income tax expense
of $875,224. A provision for income taxes of $1,144,109 is provided for taxable
earnings of U.S. operations, which is offset by an income tax benefit of
$268,885, resulting from net operating losses on our Canadian operations. For
the corresponding 2005 period, the Company has a tax benefit of $326,523 as
a
result of its net operating loss carryforward deduction which was fully utilized
during the Company’s fiscal year ended March 31, 2006
Net
Income.
We
reported net income of $4,699,262 for the nine months ended December 31, 2006
compared to net income of $3,509,274 for the corresponding period of the prior
fiscal year. The primary reason for the increase in net income is an increase
of
$1,388,491 in the Company’s equity in the earnings of the Joint Venture from the
same period of the prior year.
FINANCIAL
CONDITION
AND
LIQUIDITY
The
Company has a 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. Based on
specified percentages of our accounts receivable and inventory and letter of
credit commitments, we had $7,500,000 available under the Factoring Agreement
(including the amount due from factor of $4,201,034), as of December 31, 2006.
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, 2006, the prime rate was 8.25%.
Borrowings are collateralized by all of our accounts receivable and
inventory.
Icon
and
Intube our majority-owned Canadian subsidiaries, have a line of credit facility
with a Canadian commercial bank. This facility, in the amount of CAD$3,000,000
(US$2,580,000) is payable on demand, bears interest at the bank’s prime rate of
interest plus .25% (effective rate 6.25% at December 31, 2006) and is
collateralized by all of the assets of the Canadian subsidiaries and by the
guarantees of the Company and its wholly owned subsidiary, 2113824 Ontario,
Inc.
Advances under the line of credit facility are based on specified percentages
of
trade accounts receivable and inventory. At December 31, 2006, the Canadian
subsidiaries had borrowed CAD $2,101,705 (US $1,803,473) of the total amount
available under the terms of the line of credit facility.
Our
non-factored accounts receivable as of the end of our last fiscal year (net
of
allowances for doubtful accounts) were $1,106,435, and were $2,175,104 as of
December 31, 2006. The increase in non-factored trade accounts receivable during
the first nine months of the current fiscal year is due to the consolidation
of
accounts receivable of our acquired Canadian subsidiaries. Our prepaid expenses
as of the end of our last fiscal year were $196,863, and were $383,026 as of
December 31, 2006. The increase in prepaid expenses during the first nine months
of the current fiscal year is due to the timing of premium payments to various
insurance carriers, and the prepayment of estimated federal and state income
taxes.
Operating
activities used cash of $1,671,935 for the nine months ended December 31, 2006.
This was primarily due to net income supplemented by a decrease in accounts
receivable and due from factor of $302,094 and an increase in accounts payable
and accrued expenses of $695,424. This was offset by increases in inventories
and prepaid expenses of $3,853,840, earnings of the Joint Venture of $3,164,817,
and in the deferred tax asset of $458,596.
Investing
activities used cash of $978,307 during the nine months ended December 31,
2006
as a result of the acquisition of property, equipment of $468,453, and from
the
acquisition of the Canadian subsidiaries offset by dividends received from
the
Hong Kong Joint Venture. For the same period last year, investing activities
provided cash of $765,683, primarily as a result of dividends from the Joint
Venture.
-15-
During
the nine months ended December 31, 2006, financing activities provided cash
of
$264,839 from the exercise of employee stock options and the tax benefit of
exercised options of 1,190,845, borrowings from a foreign commercial bank of
$148,475, payments on a lease obligation and payments on acquired notes payable
to former stockholders of the Canadian subsidiaries, offset by $1,043,389 of
payments on notes acquired in the acquisition. For the same period last year,
financing activities provided cash of $46,318, from the exercise of employee
stock options.
We
believe that funds available under the Factoring Agreement, distributions from
the Joint Venture, and our line of credit facilities 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.
JOINT
VENTURE
Net
Sales.
Net
sales of the Joint Venture for the three and nine months ended December 31,
2006
were $11,622,579 and $31,530,020, respectively, compared to $6,993,903 and
$18,610,343, respectively, for the comparable periods in the prior fiscal year.
The 66.2% and 69.4% respective increases in net sales for the three and nine
month periods were due to increased sales of smoke alarm products, both to
the
Company and to non-related customers.
Net
Income.
Net
income for the three and nine months ended December 31, 2006 was $2,567,559
and
$7,088,625, respectively, compared to $1,360,402 and $3,559,233, respectively,
in the comparable periods last year. The 88.7% and 99.2% respective increases
in
net income for the three and nine month periods were due primarily to increased
sales volume as noted above.
Gross
Margins.
Gross
margins of the Joint Venture for the three month period ended December 31,
2006
decreased to 33.6% from 35.7% for the 2005 period. For the nine month period
ended December 31, 2006, gross margins were 34.4% which was a decrease from
the
34.9% gross margin of the prior 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 $1,205,107 and $3,395,189,
respectively, for the three and nine month periods ended December 31, 2006,
compared to $1,059,396 and $2,767,628 in the prior year’s respective periods. As
a percentage of sales, expenses were 10.4% and 10.8% for the three and nine
month periods ended December 31, 2006, compared to 15% for the three and nine
month periods ended December 31, 2005. The decrease in selling, general and
administrative expense as a percent of sales was due to variable costs that
did
not increase at the same rate as sales.
Interest
Income and Expense.
Interest
expense, net of interest income, was $14,192 and $41,430, respectively, for
the
three and nine
month
periods ended December 31, 2006, compared to net interest expense of $4,515
and
$15,633, respectively, for the prior year’s periods. Net interest expense
resulted from an increase in the Joint Venture’s borrowings.
Liquidity.
Cash
needs of the Joint Venture are currently met by funds generated from operations.
During the nine months ended December 31, 2006, working capital increased by
$1,764,306 from $4,466,360 on March 31, 2006 to $6,230,666 on December 31,
2006.
CRITICAL
ACCOUNTING
POLICIES
Management’s
discussion and analysis of our consolidated financial statements and results
of
operations are based on our Consolidated Financial Statements 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.
-16-
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, 2006. 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
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, 2006.
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 reevaluate this
situation.
-17-
PART
II - OTHER INFORMATION
ITEM
1. LEGAL
PROCEEDINGS
As
previously reported, on June 10, 2003, Leviton Manufacturing Co., Inc.
(“Leviton”) filed a civil action in the United States District Court for the
District of Maryland (Case No. 03cv1701) alleging that the Company’s and its USI
Electric subsidiary’s GFCI units infringe one or more of Leviton’s six patents
for reset lockout technology related to but not required by UL Standard 943
for
ground GFCI units, effective January 2003 (“Leviton II”). Leviton II also
asserted trade dress and unfair competition claims which largely correspond
to
the claim in the Leviton I suit. In May 2006 Leviton and the Company settled
the
trade dress/deceptive trade practice claims of Leviton II, subject to a
confidential agreement. The settlement did not cover the patent infringement
claims of Leviton II. In January 2006, the Company was granted summary judgment
on the infringement claims asserted in Leviton II. Leviton has appealed that
judgment and dismissal to the United States Court of Appeals for the Federal
Circuit. On January 10, 2007, the appellate court issued a decision affirming
the lower court’s summary judgment and dismissal of Leviton’s patent
infringement claims. As a result of this decision, absent review by the United
States Supreme Court, which the Company and counsel believe to be highly
unlikely, the Company obtained a successful outcome and the entirety of the
Leviton II case is now concluded.
As
previously reported, on June 11, 2003, Walter Kidde Portable Equipment, Inc.
(“Kidde”) filed a civil suit against the Company in the United States District
Court for the Middle District of North Carolina (Case No. 03cv00537), alleging
that certain of the Company’s AC powered/battery backup smoke detectors infringe
on a patent acquired by Kidde. The plaintiff is seeking injunctive relief and
damages to be determined at trial. On March 31, 2006, following numerous
procedural and substantive rulings by the judge, Kidde obtained dismissal,
without prejudice, of its suit. On November 28, 2005, prior to the March 31,
2006 dismissal of the original suit, Kidde filed a second lawsuit based on
virtually identical infringement allegations as the earlier case. Because,
the
court dismissed the first case without conditions and without prejudice, the
Company has appealed the dismissal to the United States Court of Appeals for
the
Federal Circuit, believing that at a minimum, procedurally, conditions should
have been imposed. On January 11, 2007, the appellate court heard oral arguments
on the appeal. The second case is now in the preliminary pre-discovery motion
stage. The Company’s substantive position and its defenses to Kidde’s claims are
substantially the same between the first and second Kidde cases. The Company
and
its counsel believe that the Company has significant defenses relating to the
patent in suit. In the event of an unfavorable outcome, the amount of any
potential loss to the Company is not yet determinable.
As
previously reported, on October 13, 2003, Maple Chase Company filed a civil
suit
in the United States District Court for the Northern District of Illinois (Case
No. 03cv07205), against the Company, its USI Electric subsidiary, and one former
and one present Illinois-based sales representative, alleging that certain
of
the Company's smoke detectors infringe on a patent owned by Maple Chase (US
Reissue Patent No. Re: 33290). On April 11, 2005, this action was dismissed
pending the outcome of a reexamination in the United States Patent and Trademark
Office (USPTO). In April 2006, the USPTO rejected most of the claims in the
patent. Maple Chase filed a substantive response which resulted in issuance
of a
further Official Action from the USPTO. After considering Maple Chase’s
arguments, on September 29, 2006 the USPTO issued a further action confirming
the patentability of many of the claims at issue and rejecting others. On
October 30, 2006, Maple Chase filed a further response canceling the rejected
claims. On December 19, 2006, the USPTO issued a formal notice of intent to
issue a re-examination certificate for the Maple Chase Company patent on which
a
patent infringement suit was filed in 2003. It is unclear if the certificate
can
and will be processed by the USPTO before the patent expires on March 4, 2007.
Notwithstanding this development in the re-examination, the Company remains
confident of its defenses in the event that Maple Chase re-opens the action.
The
amount of potential loss to the Company, if any, is not yet
determinable.
From
time
to time, the Company is involved in various lawsuits and legal matters. It
is
the opinion of management, based on the advice of legal counsel, that these
matters will not have a material adverse effect on the Company’s financial
statements.
-18-
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On
October 9, 2006, the Company held its Annual Meeting of Stockholders. The only
matter submitted to the stockholders for a vote was the election of one director
in the Class of 2009. The nominee was Ronald A. Seff, M.D. At the Meeting,
at
least 1,400,753
shares
were voted in favor of the nominee, no more than 117,323
shares abstained, were voted against, or were voted to withhold approval
of
the
nominee’s election (any
of
which has the same effect as a “no” vote).
As a
result, the nominee was elected.
Directors
not up for re-election and continuing in office after the Meeting are: Harvey
B.
Grossblatt, Cary Luskin, and Howard Silverman, Ph.D.
Exhibit
No.
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|
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3.1
|
|
Articles
of Incorporation (incorporated by reference to the Company’s Quarterly
Report on Form 10-Q for the period ended , 1988, File No.
1-31747)
|
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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. 1-31747)
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|
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3.3
|
|
Bylaws,
as amended (incorporated by reference to Exhibit 3.3 to the Company’s
Quarterly Report on Form10-Q for the period ended June 30, 2004,
File No.
0-7885)
|
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|
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10.1
|
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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
December 31, 2003, File No. 1-31747)
|
|
|
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10.2
|
|
Joint
Venture Agreement, as amended (incorporated by reference to Exhibit
10.2
to Amendment No. 1 on Form 10-K/A to the Company’s Annual Report on Form
10-K for the year ended March 31, 2006, File No.
1-31747)
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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. 1-31747)
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|
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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 December 31, 2002, File No. 1-31747)
|
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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 December 31, 2004, File
No.
1-31747)
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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. 1-31747)
|
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|
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10.7
|
|
Amended
and Restated Employment Agreement dated July 18, 2005 between
the Company
and Harvey B. Grossblatt (incorporated by reference to Exhibit
10.7 to the
Company’s Quarterly Report on Form 10-Q for the period ended December
31,
2005, File No. 1-31747)
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31.1
|
|
Rule
13a-14(a)/15d-14(a) Certification of Chief Executive
Officer*
|
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31.2
|
|
Rule
13a-14(a)/15d-14(a) Certification of Chief Financial
Officer*
|
|
|
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32.1
|
|
Section
1350 Certifications*
|
|
|
|
99.1
|
|
Press
Release dated February 14, 2007*
|
*Filed
herewith
-19-
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)
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Date: February 14, 2007 | 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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-20-