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.

OVERVIEW

We are in the business of marketing and distributing safety and security products. Our financial statements detail our sales and other operational results for the three and nine-month periods ended December 31, 2022 and 2021.

In light of the shutdowns, quarantines and other restrictions and delays in operations and travel caused by or related to COVID-19 in Hong Kong, the PRC and the United States, the Company has experienced delays in shipping and receiving of products.

As the Company's products are sold primarily to the construction industry and do-it-yourself centers, restrictions and limitations imposed by the COVID-19 pandemic have had a negative impact on the Company's sales. The Company is not yet able to quantify the full impact of the COVID-19 pandemic on its sales and financial results.

The Company has developed products based on new smoke and gas detection technologies, with what the Company believes are improved sensing technology and product features. Most of our new technologies and features have been trademarked under the trade name IoPhic.

Changes in international trade duties and other aspects of international trade policy, both in the U.S. and abroad, could materially impact the cost of our products. All of our products are imported from the Peoples Republic of China (PRC). To date, only certain of our products such as Carbon Monoxide and Photoelectric alarms, and wiring devices, have been subjected to tariffs of 25%. We are monitoring these developments and will determine our strategies as additional information becomes available. Any increase in tariffs that is not offset by an increase in our sales prices could have an adverse effect on our business, financial position, results of operations or cash flows.

As previously reported, on February 25, 2022, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") by and among the Company (USI), a wholly owned subsidiary of the Company D-U Merger Sub, Inc. a Delaware corporation ("Merger Sub") and Infinite Reality, Inc., a Delaware corporation ("Infinite Reality"). On May 16, 2022, the Company filed with the United States Securities Exchange Commission (SEC) a proxy statement and Form S-4 registration statement in connection with the Merger. On December 12, 2022, Infinite Reality terminated the Merger Agreement.

RESULTS OF OPERATIONS

Three Months Ended December 31, 2022 and 2021

Sales. Net sales for the three months ended December 31, 2022, were $5,758,661 compared to $5,319,014 for the comparable three months in the prior year, an increase of $439,647 (8.3%). Sales increased principally due to the Company's ability to fill orders as delays in unloading inventory at California ports of entry continued to abate during the period.

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 29.5% and 32.3% of sales for the quarters ended December 31, 2022, and 2021, respectively. Gross margins



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were negatively impacted in the period ended December 31, 2022, principally due to increases in the cost of certain electronic components and due to the mix of products sold.

Expenses. Selling, general and administrative expenses were $1,178,502 for the three months ended December 31, 2022, compared to $1,569,746 for the comparable three months in the prior year. As a percentage of net sales, these expenses decreased to 20.5% for the three-month period ended December 31, 2022, from 29.5% for the 2021 period. These expenses decreased as a percentage of net sales principally due to a reduction in salaries expense, a reduction in legal and consulting expenditures related to the potential merger, and a reduction in freight, and other selling expenditures.

Research and development expenses were comparable at $101,670 for the three-month period ended December 31, 2022, to $97,370 for the comparable quarter of the prior year.

Interest Expense. Our interest expense was $76,755 for the quarter ended September 30, 2022, compared to interest expense of $14,156 for the quarter ended December 31, 2021. Interest expense is dependent upon the total amounts borrowed from the Factor and the increase in interest rates during the period as compared to the corresponding period of the prior year.

Net Income. We reported net income of $341,312 for the quarter ended December 31, 2022, compared to a net income of $35,351 for the corresponding quarter of the prior fiscal year, a $305,961 (865.5%) increase in net income. The primary reasons for the increase in the net income is supply chain disruptions have begun to abate resulting in higher sales and due to reduced selling, general, and administrative expense as described above.

Nine Months Ended December 31, 2022 and 2021

Sales. Net sales for the nine months ended December 31, 2022, were $16,251,106 compared to $15,259,235 for the comparable nine months in the prior period, an increase of $991,871 (6.5%). Sales increased principally due to the Company's ability to fill orders as delays in unloading inventory at California ports of entry began to abate during the period.

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 was 28.8% for the period ended December 31, 2022, and 29.8% for the period ended December 31, 2021. Gross margins were negatively impacted in the nine-month period ended December 31, 2022, principally due to increases in the cost of certain electronic components and due to the mix of products sold.

Expenses. Selling, general and administrative expenses were $3,750,348 for the nine months ended December 31, 2022, compared to $4,059,988 for the comparable nine months in the prior year. As a percentage of sales, these expenses were 23.1% for the nine-month period ended December 31, 2022, and 26.6% for the comparable 2021 period. These expenses decreased as a percentage of net sales principally due to a reduction in salaries expense resulting from recording an employee retention credit of $181,000 under the CARES Act, and a reduction in work force. These expenses also decreased due to a reduction in legal and consulting expenditures related to the potential merger.

Research and development expenses were comparable at $294,177 for the nine months ended December 31, 2022, to $295,496 for the comparable period of the prior year.

Interest Expense. Our interest expense was $200,776 for the nine months ended December 31, 2022, compared to interest expense of $37,954 for the nine months ended December 31, 2021. Interest expense is dependent upon the total amounts borrowed from the Factor and the increase in interest rates during the period as compared to the corresponding period of the prior year.

Net Income. We reported net income of $435,776 for the nine months ended December 31, 2022, compared to a net income of $157,688 for the corresponding period of the prior fiscal year, an increase in the net income of $278,088 (176.4%). The primary reasons for the increase in the net income is supply chain disruptions have begun to abate resulting in higher sales. In addition, the Company recorded a reduction in salaries expense resulting from an Employee Retention Credit under the provisions of the Coronavirus Aid Relief, and Economic Security Act, and due to reduced selling, general, and administrative expense as described above.



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Management Plans and Liquidity

In light of the shutdowns, quarantines and other restrictions and delays in operations and travel caused by or related to COVID-19 in Hong Kong, the PRC and the United States, the Company has experienced delays during the nine months ended December 31, 2022, in shipping and receiving of products.

Our short-term borrowings to finance any operating losses, trade accounts receivable, and foreign inventory purchases are provided pursuant to the terms of its Factoring Agreement with Merchant Factors Corporation (Merchant or Factor). Borrowings under the Factoring Agreement bear interest at prime plus 2% and are secured by trade accounts receivable and inventory. Advances from Merchant are at the sole discretion of Merchant based on Merchant's assessment of the Company's receivables, inventory, and financial condition at the time of each request for an advance. The Company had no availability on this facility on December 31, 2022. The Company's non-factored trade and other accounts receivable net of allowance for uncollectible amounts totaled $817,589 on December 31, 2022.

The Company's factor has withheld financing on approximately $725,000 of the Company's accounts receivable subject to resolution of any disputes. The resolution of disputed items is ongoing and subsequent to December 31, 2022, the Company continues to provide support for resolution of any disputed items. The Company expects that all amounts in dispute will be resolved satisfactorily. In addition, the Company has filed requests for refunds of customs payments with US Customs and Border Protection for approximately $300,000 (including interest expected) for overpayments of tariff. The Company expects this refund to be available during either the fourth quarter of the fiscal year ending March 31, 2023, or the first quarter of the fiscal year ending March 31, 2024. Though no assurances can be given, if management's plan continues to be successful over the next twelve months, the Company anticipates that it should be able to meet its cash needs for the next twelve months following the issuance date of this report. Cash flows and credit availability is expected to be adequate to fund operations for one year from the issuance date of this report.

Operating activities provided cash of $347,270 for the nine months ended December 31, 2022. This was primarily due to net income of $435,776, a decrease in inventories, prepaid expenses and other assets of $1,719,546, and a decrease in accounts receivable and amount due from factor of $98,698. This was partially offset by a decrease in accounts payable and accrued expenses of $1,921,596. Operating activities used cash of $2,111,908 for the nine months ended December 31, 2021. This was primarily due to an increase in accounts receivable and amounts due from factor of $1,657,549, an increase in inventories, prepaid expenses and other of $808,245, and partially offset by an increase in accounts payable and accrued expenses of $189,243, and net income of $157,688.

There were no investing activities for the nine-month periods ended December 31, 2022, or 2021.

Financing activities used cash of $585,850 during the nine months ended December 31, 2022, from net borrowing in excess of repayments from the factor of $314,150, offset by repayments of the note payable to Eyston Company, Ltd. of $900,000. Financing activities provided cash of $2,338,527 during the nine months ended December 31, 2021, from net borrowing in excess of repayments from the factor.

CRITICAL ACCOUNTING POLICIES

In the notes to the consolidated financial statements, and in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Form 10-K, we have disclosed those accounting policies that we consider to be significant in determining our results of Operations and financial condition. There have been no material changes to those policies that we consider to be significant since the filing of our Form 10-K. The accounting principles used in preparing our unaudited condensed consolidated financial statements conform in all material respects to accounting principles generally accepted in the United States of America.


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