ITEM 1. BUSINESS
General
Universal Security Instruments, Inc. ("we" or "the Company") designs and markets a variety of popularly-priced safety products consisting primarily of smoke alarms, carbon monoxide alarms and related products. Most of our products require minimal installation and are designed for easy installation by the consumer without professional assistance, and are sold through retail stores. We also market products to the electrical distribution trade through our wholly-owned subsidiary, USI Electric, Inc. ("USI Electric"). The electrical distribution trade includes electrical and lighting distributors as well as manufactured housing companies. Products sold by USI Electric usually require professional installation.
In 1989 we formed a limited liability company under the laws of Hong Kong, as a joint venture with a Hong Kong-based partner to manufacture various products in the Peoples Republic of China (the "Hong Kong Joint Venture"). We currently own a 50% interest in the Hong Kong Joint Venture and are a significant customer of the Hong Kong Joint Venture (49.81% and 40.66% of its sales during fiscal 2006 and 2005 respectively), with the balance of its sales made to unrelated customers worldwide.
We import all of our products from various foreign suppliers. For the fiscal year ended March 31, 2006, approximately 66.4% of our purchases were imported from the Hong Kong Joint Venture. Our sales for the year ended March 31, 2006 were $28,894,101 compared to $23,465,443 for the year ended March 31, 2005, an increase of approximately 23.1%.
We reported net income of $4,600,352 in fiscal 2006 compared to net income of $3,417,854 in fiscal 2005, an increase of 34.6%. The primary reasons for the increase in earnings were higher operating income from sales due to increased volume.
The Company was incorporated in Maryland in 1969. Our principal executive office is located at 7-A Gwynns Mill Court, Owings Mills, Maryland 21117, and our telephone number is 410-363-3000. Information about us may be obtained from our website www.universalsecurity.com. Copies of our Annual Report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, are available free of charge on our website as soon as they are filed with the Securities and Exchange Commission (SEC) through a link to the SEC's EDGAR reporting system. Simply select the "Investor Relations" menu item, then click on the "SEC Filings" link. The SEC's EDGAR reporting system can also be accessed directly at www.sec.gov.
Safety Products
We market a line of residential smoke alarms under the trade names "USI Electric" and "UNIVERSAL" both of which are manufactured by the Hong Kong Joint Venture.
Our line of smoke alarms consists of battery, electrical and electrical with battery backup alarms. Our products contain different types of batteries with different battery lives, and some with alarm silencers. The smoke alarms marketed to the electrical distribution trade also include hearing impaired and heat alarms with a variety of additional features. We also market outdoor floodlights under the name "Lite Aide(TM)," carbon monoxide alarms, door chimes and ground fault circuit interrupter (GFCI) units.
We are focusing our sales and marketing efforts to maximize safety product sales, especially smoke alarms and carbon monoxide alarms manufactured by our Hong Kong Joint Venture and marketed to the electrical distribution and retail trade.
Import Matters
We import all of our products. As an importer, we are subject to numerous tariffs which vary depending on types of products and country of origin, changes in economic and political conditions in the country of manufacture, potential trade restrictions and currency fluctuations. We have attempted to protect ourself from fluctuations in currency exchange rates to the extent possible by negotiating commitments in U.S. dollars.
Our inventory purchases are also subject to delays in delivery due to problems with shipping and docking facilities, as well as other problems associated with purchasing products abroad. Substantially all of our products, including products we purchase from our Hong Kong Joint Venture, are imported from the People's Republic of China.
Sales and Marketing; Customers
We sell our products to various customers, and our total sales market can be divided generally into two categories; sales by the Company, and sales by our USI Electric subsidiary.
The Company markets our products to retailers, including wholesale distributors, chain, discount, television retailers and home center stores, catalog and mail order companies and to other distributors ("retailers"). Our products have historically been retailed to "do-it-yourself" consumers by these retailers. We do not currently market any significant portion of our products directly to end users.
The Company's retail sales are made directly by our employees and by approximately 17 independent sales organizations who are compensated by commissions. Our agreements with these sales organizations are generally cancelable by either party upon 30 days notice. We do not believe that the loss of any one of these organizations would have a material adverse effect upon our business. Sales which are made directly by us are effected by our officers and full-time employees, seven of whom are also engaged in sales, management and training. Sales outside the United States, are made by our officers and through exporters, and amounted to approximately 5.1% of total sales in the fiscal year ended March 31, 2006.
Our USI Electric subsidiary markets our products to the electrical distribution trade (primarily electrical and lighting distributors and manufactured housing companies). USI Electric has established a national distribution system with 12 regional stocking warehouses throughout the United States which generally enables customers to receive their orders the next day without paying for overnight freight charges. USI Electric engages sales personnel from the electrical distribution trade and has engaged 27 independent sales organizations which represent approximately 230 sales representatives, some of which have warehouses where USI Electric products are maintained by our sales representatives for sale.
We also market our products through our own sales catalogs and brochures, which are mailed directly to trade customers, and our website. Our customers, in turn, may advertise our products in their own catalogs and brochures and in their ads in newspapers and other media. We also exhibit and sell our products at various trade shows, including the annual National Hardware Show in Las Vegas, Nevada.
Our backlog of orders believed to be firm as of March 31, 2006 was approximately $2,996,000. Our backlog as of March 31, 2005 was approximately $841,278. This increase in backlog is a function of the timing of orders received from our customers. In addition, we have a backlog of orders for ground fault circuit interrupters in advance of new regulations affecting these devices which go into effect July 28, 2006. The new regulations are expected to increase the unit price of these devices.
Hong Kong Joint Venture
We have a 50% interest in the Hong Kong Joint Venture which has manufacturing facilities in the People's Republic of China, for the manufacturing of certain of our electronic and electrical products.
We believe that the Hong Kong Joint Venture arrangement will ensure a continuing source of supply for a majority of our safety products at competitive prices. During fiscal year 2006, 66.4% of our total inventory purchases were made from the Hong Kong Joint Venture. The products produced by the Hong Kong Joint Venture include smoke alarms and carbon monoxide alarms. Changes in economic and political conditions in China or any other adversity to the Hong Kong Joint Venture will unfavorably affect the value of our investment in the Hong Kong Joint Venture and would have a material adverse effect on the Company's ability to purchase products for distribution.
We previously announced in a form 8-K filing dated July 7, 2005 that the Hong Kong Joint Venture filed for listing of an IPO on the Main Board of the Hong Kong Exchange on June 30, 2005. The Hong Kong Joint Venture has experienced delays in the listing process and no assurances can be given that the application process will continue or will result in an initial public offering for the Hong Kong Joint Venture. We will report further developments at such time as permitted in accordance with Hong Kong and U.S. regulations. Should the Hong Kong Joint Venture complete its IPO, our ownership of the Hong Kong Joint Venture will be reduced to thirty-seven and one-half percent. During the fourth quarter and for the fiscal year ended March 31, 2006, the Hong Kong Joint Venture established a reserve of approximately $535,000 for costs previously capitalized associated with the Hong Kong Joint Venture's application for listing on the Hong Kong Stock Exchange.
Our purchases from the Hong Kong Joint Venture represented approximately 50% of the Hong Kong Joint Venture's total sales during fiscal 2006 and 41% of total sales during fiscal 2005, with the balance of the Hong Kong Joint Venture's sales being primarily made in Europe and Australia, to unrelated customers. The Hong Kong Joint Venture's sales to unrelated customers are $12,506,135 in fiscal 2006 and $15,347,017 in fiscal 2005. Please see Note C of the Financial Statements for a comparison of annual sales and earnings of the Hong Kong Joint Venture.
Other Suppliers
Certain private label products not manufactured for us by the Hong Kong Joint Venture are manufactured by other foreign suppliers. We believe that our relationships with our suppliers are good. We believe that the loss of our ability to purchase products from the Hong Kong Joint Venture would have a material adverse effect on the Company. The loss of any of our other suppliers would have a short-term adverse effect on our operations, but replacement sources for these other suppliers could be developed.
Competition
In fiscal year 2006, sales of safety products accounted for substantially all of our total sales. In the sale of smoke alarms, we compete in all of our markets with First Alert, Firex and Walter Kidde. In the sale of GFCI units, we compete in all our markets with Leviton Manufacturing Co., Inc., Pass & Seymour, Inc., Cooper Wiring Devices and Hubbell, Inc. All of these companies have greater financial resources and financial strength than we have. We believe that our safety products compete favorably in the market primarily on the basis of styling, features and pricing.
The safety industry in general involves changing technology. The success of our products may depend on our ability to improve and update our products in a timely manner and to adapt to new technological advances.
Employees
As of March 31, 2006, we had 15 employees, 12 of whom are engaged in administration and sales, and the balance of whom are engaged in product development and servicing. Our employees are not unionized, and we believe that our relations with our employees are satisfactory.
ITEM 1A.
ITEM 1A. RISK FACTORS
An investment in our Common Stock is subject to risks inherent to our business. The material risks and uncertainties that management believes affect the Company are described below. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company's business operations.
RISK FACTORS RELATING TO OUR BUSINESS GENERALLY
Our success depends to a very large degree on our relationship with and the success of our Hong Kong Joint Venture.
During fiscal year 2006, 66.4% of our total inventory purchases were made from the Hong Kong Joint Venture. The products produced by the Hong Kong Joint Venture include smoke alarms and carbon monoxide alarms, and we are currently pursuing the development of additional products to be manufactured by the Hong Kong Joint Venture. Our purchases from the Hong Kong Joint Venture represented approximately 50% of the Hong Kong Joint Venture's total sales during fiscal 2006, with the balance of the Hong Kong Joint Venture's sales being primarily made in Europe and Australia to unrelated customers. If the Hong Kong Joint Venture does not maintain profitability, our profitability will be adversely affected.
In addition, adverse changes in our relationship with our Hong Kong Joint Venture partners would unfavorably affect the value of our investment in the Hong Kong Joint Venture and would have a material adverse effect on our ability to purchase products for distribution.
Our reliance on the Hong Kong Joint Venture exposes us to uncertainties and risks from abroad which could negatively affect our operations and sales.
Our relationship with the Hong Kong Joint Venture and our and the Hong Kong Joint Venture's sales in other countries expose us to particular risks. The following are among the risks that could negatively affect our imports and our and the Hong Kong Joint Venture's sales in foreign markets:
o new restrictions on access to markets, o currency devaluation, o new tariffs, o adverse changes in monetary and/or tax policies, o inflation, and o governmental instability.
Should any of these risks occur, the value of our investment in the Hong Kong Joint Venture could be reduced and our results of operations could be negatively impacted.
The lack of availability of inventory could adversely affect our financial results.
We source inventory primarily from our Hong Kong Joint Venture, which has manufacturing facilities in the People's Republic of China. Our purchases of inventory are subject to being affected by a number of factors, namely, production capacity, labor unrest and untimely deliveries. Changes in economic and political conditions in China or any other adversity to the Hong Kong Joint Venture will unfavorably affect the value of our investment in the Hong Kong Joint Venture and could have a material adverse effect on the our ability to purchase products for distribution.
Our Hong Kong Joint Venture is subject to political and economic factors unique to China.
The Chinese government has been reforming the Chinese economic system. In recent years, the government has also begun reforming the government structure. These reforms have resulted in significant economic growth and social progress. Although the majority of the production assets in China are still state-owned, economic reform policies have emphasized autonomous enterprises and the utilization of market mechanisms. Our Hong Kong Joint Venture currently expects that the Chinese government will continue its reform by further reducing governmental intervention in business enterprises and allowing market mechanisms to allocate resources. Any adverse changes in political, economic or social conditions in China could have a material adverse effect on the Hong Kong Joint Venture's operations and our financial results, as well as our ability to purchase products manufactured by the Hong Kong Joint Venture.
We are subject to risks in connection with the importation of our products from foreign countries.
We import all of our products. As an importer, we are subject to numerous tariffs which vary depending on types of products and country of origin, changes in economic and political conditions in the country of manufacture, potential trade restrictions and currency fluctuations. We have attempted to protect ourselves from fluctuations in currency exchange rates to the extent possible by negotiating commitments in U.S. dollars. We are also subject to strikes or other labor unrest at points of origin and destination, as well as delays and restrictions which impact shipping and shipping routes.
We rely on our key personnel and the loss of one or more of those personnel could have a material adverse effect on our business, financial condition and results of operations.
Our operations and prospects depend in large part on the performance of our senior management team. There can be no assurance that we would be able to find qualified replacements for any of these individuals if their services were no longer available. The loss of the services of one or more members of our senior management team could have a material adverse effect on our business, financial condition, and results of operations.
Our competition is both intense and varied and our failure to effectively compete could adversely affect our prospects.
In fiscal year 2006, our sales of safety products accounted for virtually all of our sales. Many of our competitors have greater financial resources and financial strength than we have. Some of our competitors may be willing to reduce prices and accept lower profit margins to compete with us. While we believe that our safety products compete favorably with other such products in the market, primarily on the basis of styling, features, and pricing, the safety industry in general involves changing technology. The success of our products may depend on our ability to improve and update our products in a timely manner and to adapt to new technological advances. As a result of this competition, we could lose market share and suffer losses, which could have a material adverse effect on our future financial performance.
The security products marketplace is dynamic and challenging because of the introduction of new products and services.
We must constantly introduce new products, services, and product features to meet competitive pressures. We may be unable to timely change our existing merchandise sales mix in order to meet these competitive pressures, which may result in increased inventory costs or loss of market share.
Adverse changes in national or regional U.S. economic conditions could adversely affect our financial results.
We market our products nationally to retailers, including wholesale distributors, chain, discount, and home center stores, catalog and mail order companies and to other distributors. Overall consumer confidence, consumer credit availability, recessionary trends, housing starts and prices, mortgage rates, and consumers' disposable income and spending levels directly impact our sales. Negative trends, whether national or regional in nature, in any of these economic conditions could adversely affect our financial results.
Our products must meet specified quality and safety standards to enter and stay on the market.
Our smoke and carbon monoxide alarms must meet U.S. and various international standards before they are sold. For example, in the United States, our products must be certified by Underwriters Laboratories (UL) and similar certifications must be obtained in each country where we compete for market share. If our manufacturers' products or manufacturing facilities (including those of the Hong Kong Joint Venture) fail to pass periodic inspections, the approval certificates for the relevant products may be suspended until corrections are made. Loss of UL or other independent certifications could have a material adverse affect on our sales and financial results.
Our products expose us to the potential of product liability claims.
We do not manufacture any of our own products. All of our products are manufactured by the Hong Kong Joint Venture or others. Nevertheless, we could be named as a defendant in an action arising from damages suffered as a result of one of our products. While we carry products liability insurance, to the extent we are found liable for damages for which we are uninsured, our profitability may be adversely affected. Any suit, even if not meritorious or if covered by an indemnification obligation, could result in the expenditure of a significant amount of our financial and managerial resources and could create significant negative publicity for us and our products.
We may be unable to successfully execute our merchandising and marketing strategic initiatives.
We are focusing our sales and marketing efforts and initiatives to maximize safety product sales, especially smoke alarms and carbon monoxide alarms manufactured by our Hong Kong Joint Venture and marketed to the electrical distribution and retail trade. If we fail to successfully execute these initiatives, our business could be adversely affected.
We are and could become subject to litigation regarding intellectual property rights, which could seriously harm our business.
We design most of our security products and contract with suppliers to manufacture those products and deliver them to us. We have been the subject of lawsuits by third parties which assert against us infringement claims or claims that we have violated a patent or infringed upon a copyright, trademark or other proprietary right belonging to them. If such infringement by our suppliers or us were found to exist, we could be subject to monetary damages and an injunction preventing the use of their intellectual property. If one of our products were found to infringe, we may attempt to acquire a license or right to use such technology or intellectual property, which could result in higher manufacturing costs. Any infringement claim, even if not meritorious and/or covered by an indemnification obligation, could result in the expenditure of a significant amount of our financial and managerial resources.
If governmental regulations change or are applied differently, our business could suffer.
The sales of our smoke and carbon monoxide alarms are impacted by local laws and regulations mandating the installation of these security devices in new and sometimes existing homes and buildings. Changes in these consumer safety regulations, both in the United States and abroad, could impact our business.
RISK FACTORS RELATING TO OUR ARTICLES OF INCORPORATION AND OUR STOCK
The liability of our directors is limited.
Our Articles of Incorporation limit the liability of directors to the maximum extent permitted by Maryland law.
It is unlikely that we will issue dividends on our common stock in the foreseeable future.
We have not declared or paid cash dividends on our common stock in over 20 years and do not intend to pay cash dividends in the foreseeable future. The payment of dividends in the future will be at the discretion of our board of directors.
The exercise of outstanding options will dilute the percentage ownership of our stockholders, and any sales in the public market of shares of our common stock underlying such options may adversely affect prevailing market prices for our common stock.
As of March 31, 2006, there are outstanding options to purchase an aggregate of 242,496 shares of our common stock at per share exercise prices ranging from $0.98 to $21.45. The exercise of such outstanding options would dilute the percentage ownership of our existing stockholders, and any sales in the public market of shares of our common stock underlying such options may adversely affect prevailing market prices for our common stock.
It may be difficult for a third party to acquire us, which could affect our stock price.
Our charter and Bylaws contain certain anti-takeover provisions pursuant to the Maryland General Corporation Law. This means that we may be a less attractive target to a potential acquirer who otherwise may be willing to pay a premium for our common stock above its market price.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
Effective December 1999, we entered into an operating lease for a 9,000 square foot office and warehouse located in Baltimore County, Maryland. This lease is due to expire October 2008. The current rental, with common area maintenance, approximates $5,680 per month during the current fiscal year, with increasing rentals at 3% per year.
Effective March 2003, we entered into an operating lease for an approximately 2,600 square foot office in Naperville, Illinois. This lease expires in February 2009 and is subject to increasing rentals at 3% per year. The monthly rental, with common area maintenance, approximates $3,016 per month during the current fiscal year.
The Hong Kong Joint Venture currently operates an approximately 100,000 square foot manufacturing facility in the Guangdong province of Southern China. In response to our and the Hong Kong Joint Venture's growth and expanding product lines, the Hong Kong Joint Venture completed construction of a new, approximately 250,000 square-foot manufacturing facility in the Fujian province of Southern China. Limited manufacturing operations have commenced at the new facility as the Hong Kong Joint Venture awaits full regulatory and operational approvals.
The Company believes that its current facilities, and those of the Hong Kong Joint Venture, are currently suitable and adequate.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In December 2001, Leviton Manufacturing Co., Inc. ("Leviton") filed a civil action in the United States District Court for the District of Maryland (Case No. 01cv3855) alleging that the Company's and its USI Electric subsidiary's GFCI units infringed one of plaintiff's patents and configuration trade dress ("Leviton I"). On June 10, 2003, Leviton filed a second civil suit against the Company and its USI Electric subsidiary in the United States District Court for the District of Maryland (Case No. 03cv1701), alleging this time that the Company's GFCI units infringe one or more of Leviton's six more recently issued 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 Leviton I and Leviton II, all subject to a confidential agreement. Under the terms of the settlement, Leviton I has been dismissed, and the trade dress/deceptive trade practice claims of Leviton II have been dismissed. The settlement does 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. Should Leviton's appeal be successful and the summary judgment of non-infringement be overturned, then Leviton's infringement claims will be reinstated. If reinstated, the Company's belief in its strong defenses to Leviton's claims in that suit remains unchanged. However, in the event of an unfavorable outcome, including reversal of the lower court's dismissal on appeal and rejection of the Company's defenses at trial, the amount of any potential loss to the Company is not determinable at this time.
On March 31, 2005, Leviton filed a third lawsuit, Civil Action No. 05cv0889, in the United States District Court for the District of Maryland against the Company ("Leviton III"). In this suit, Leviton alleges that the Company's GFCI units infringe US Patent 6,864,766. The Company has filed a counterclaim against Leviton and the case has been consolidated with a declaratory judgment action filed by the GFCI manufacturer, Shanghai Meihao Electric, Inc. Discovery is now ongoing. The Company believes that it has strong 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 determinable at this time.
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 believing that at a minimum, procedurally, conditions should have been imposed. 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.
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 has not yet filed a substantive response to the USPTO action. While the Company is confident that the USPTO reexamination and rejection of the claims indicates that the Company will prevail in this action, no assurances can be given. 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.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
There were no submissions of matters to a vote of security holders during the quarter ended March 31, 2006.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is information about the Company's executive officers.
NAME AGE POSITIONS
Harvey B. Grossblatt 59 President, Chief Operating Officer and Chief Executive Officer James B. Huff 54 Chief Financial Officer, Secretary and Treasurer
HARVEY B. GROSSBLATT has been President a director of the Company since 1996. He served as Chief Financial Officer from October 1983 through August 2004, Secretary and Treasurer of the Company from September 1988 through August 2004, and Chief Operating Officer from April 2003 through August 2004. Mr. Grossblatt was appointed Chief Executive Officer in August 2004.
JAMES B. HUFF was appointed Chief Financial Officer in August 2004 and Secretary and Treasurer in October 2004. From December 2003 until August 2004, Mr. Huff was controller of Essex Corporation, a Columbia, Maryland based public company which provides intelligence engineering services to federal government agencies. From August 2002 until November 2003, Mr. Huff served as chief financial officer of Computer Temporaries, Inc., Lanham, Maryland; from August 2000 until July 2002, he was chief financial officer of HLM Architects and Engineering, Inc., a Charlotte, North Carolina based public company; and from January 1990 until November 1999, Mr. Huff was chief financial officer of RMF Engineering, Inc., Baltimore, Maryland.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock, $.01 par value (the "Common Stock") trades on the American Stock Exchange under the symbol UUU.
As of June 20, 2006, there were 151 record holders of the Common Stock. The closing price for the Common Stock on that date was $21.11. We have not paid any cash dividends on our common stock, and it is our present intention to retain all earnings for use in future operations.
The following table sets forth the high and low prices for the Common Stock for each full quarterly period during the fiscal years indicated.
Fiscal Year Ended March 31, 2006 First Quarter High $19.50 Low $12.00
Second Quarter High $19.69 Low $15.00
Third Quarter High $19.00 Low $16.01
Fourth Quarter High $24.16 Low $16.45
Fiscal Year Ended March 31, 2005 First Quarter High $17.60 Low $10.75
Second Quarter High $13.30 Low $10.00
Third Quarter High $15.24 Low $10.35
Fourth Quarter High $19.08 Low $13.97
Information regarding our equity compensation plans is set forth in the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A and issued in conjunction with the 2006 Annual Meeting of Stockholders (the "Proxy Statement") in the Section entitled "Executive Compensation" and is incorporated herein by reference.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with, and is qualified by reference to, the consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Annual Report on Form 10-K. The Statement of Operations data and the Balance Sheet data for the years ended, and as at, March 31, 2002, 2003, 2004, 2005 and 2006 are derived from our audited consolidated financial statements. All share and per share amounts included in the following financial data have been retroactively adjusted to reflect the 4-for-3 stock dividend paid on April 5, 2004 to shareholders of record on March 15, 2004.
Quarterly Results of Operations (Unaudited)
The unaudited quarterly results of operations for fiscal years 2006 and 2005 are summarized as follows:
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
When used in this discussion and elsewhere in this Annual Report on Form 10-K, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. 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, including the Risk Factors discussed elsewhere in this Annual Report and other risks, could affect our financial performance and could cause our actual results for future periods to differ materially from those anticipated or projected. We do not undertake and specifically disclaim any obligation to update any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
General
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 fiscal years ended March 31, 2006, 2005 and 2004 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 "Hong Kong Joint Venture."
Comparison of Results of Operations for the Years Ended March 31, 2006, 2005 and
Sales. In fiscal year 2006, our net sales increased by $5,428,658 (23.13%), from $23,465,443 in fiscal 2005 to $28,894,101 in fiscal 2006. Our focus on marketing to the electrical distribution trade through our USI Electric subsidiary accounted for approximately $4,780,000 of the increased sales, principally due to increased volume (from approximately $16,480,000 in 2005 to approximately $21,260,000 in 2006). The Company also increased its sales to retail and wholesale customers in the fiscal year ended March 31, 2006. We anticipate continued revenue growth in all of our markets.
In fiscal year 2005, sales increased by $6,264,327 (36%) from $17,201,116 in fiscal 2004 to $23,465,443 in fiscal 2005. The increased sales of GFCI units and our focus on marketing to retailers, including the wholesale distribution trade, generated the majority of the increase.
Gross Profit. Gross profit as a percentage of net sales (or "gross margin") in fiscal 2006 was 32.73% compared to 31.2% and 33.7% in fiscal 2005 and 2004, respectively. The increase in gross margin in the fiscal year ended March 31, 2006 reflects variations in the mix of products sold and is a function of higher sales, since certain fixed costs do not increase at the same rate as sales. The decrease in gross margin for the year ended March 31, 2005 when compared to 2004 resulted from higher costs and pricing concessions applied to meet competitive pressures.
Expenses. Selling, general and administrative expenses for fiscal 2006 increased by $585,663 (9.5%) from $6,191,025 in fiscal 2005 to $6,776,688 in fiscal 2006. As a percentage of net sales, these expenses decreased to 23.5% for the fiscal year ended March 31, 2006 from 26.4% for the fiscal year ended March 31, 2005. The decrease in selling, general and administrative expense as a percent of sales is attributable to costs that do not increase proportionately with the higher sales volume and a reduction in legal expenses from the 2005 period. Our legal expenses decreased by $259,876 in 2006 to $822,477 from $1,082,353 in fiscal 2005. The reduction in legal expense was partially offset by an increase of $718,216 in commissions and freight charges, the account classification which was the most significant factor in this dollar increase, due to our higher 2006 sales volume. Commissions and freight charges, as a percentage of sales, while consistent with commissions and freight charges of the prior year, vary directly with sales volume. Currently, we are a non-accelerated filer and the Company is not required to comply with the registered public accounting firm attestation provisions of Section 404(a) of the Sarbanes-Oxley Act of 2002. It is anticipated the Company will be required to comply with these provisions for the fiscal year commencing April 1, 2007. The Company expects to incur initial and ongoing costs that, at present, cannot be quantified in complying with the provisions of Section 404(a) of Sarbanes-Oxley.
Selling, general and administrative expenses for fiscal 2005 increased by $1,180,242 (23.55%) from $5,010,783 in fiscal 2004 to $6,191,025 in fiscal 2005. As a percentage of net sales, these expenses decreased to 26.4% for the fiscal year ended March 31, 2005 from 29.1% for the fiscal year ended March 31, 2004. The decrease in selling, general and administrative expense as a percent of sales is attributable to costs that do not increase proportionately with the higher sales volume. Various expense categories contributed to the increased dollar amount of the expense, but the following major account classifications were significant factors in this dollar increase: (i) Commissions and freight charges, as a percentage of sales, while consistent with commissions and freight charges of the prior year, vary directly with sales volume. Therefore, of the $1,180,242 increase in expenses, $224,165 is attributable to commissions and freight charges from higher sales volume during the 2005 period. (ii) Professional fees increased by $558,370 to $1,082,353 for the fiscal year ended March 31, 2005. Costs associated with our litigation with a former director and chief executive officer (since settled) were approximately $880,000 for the fiscal year ended March 31, 2005, as compared to $79,768 for the prior fiscal year. Professional fees associated with the patent litigation decreased by approximately $129,000 to approximately $171,000 for the fiscal year ended March 31, 2005. Professional fees associated with patent litigation for the 2005 period were reduced by insurance reimbursements.
Interest Income and Expense. Interest expense for fiscal 2006 decreased to $48,999 from $85,521 in fiscal 2005 primarily due to decreased borrowing. Interest expense for fiscal 2005 increased to $85,521 from $83,589 in fiscal 2004 primarily due to higher interest rates. The majority of the Company's cash balances are maintained on deposit with the factor and earn interest at the factor's prime rate of interest minus 3%. During the fiscal year ended March 31, 2006, the Company earned $9,668 on these deposits.
Income Taxes. During the fiscal year ended 2006, the Company offset $2,151,593 of taxable income by utilizing the remainder of its net operating loss carryforward deduction. In addition, the Company offset federal taxes of approximately $115,000 with foreign tax credits available as a result of foreign taxes paid on the repatriated earnings of the Hong Kong Joint Venture. At March 31, 2006, the Company has no remaining net operating loss carryforwards available to offset future U.S. federal taxable income, and the valuation allowance previously established to offset tax benefits associated with our net operating loss carryforwards and other deferred tax assets was fully utilized.
We did not make a provision for federal income taxes in each of the 2005 and 2004 fiscal years, due to our operating loss carryforward for income tax purposes. However, we made a provision of $5,250 and $24,001 for state income taxes for fiscal year 2005 and 2004, respectively.
Net Income. We reported net income of $4,600,352 for fiscal year 2006 compared to a net income of $3,417,854 for fiscal year 2005, a $1,182,498 (34.6%) increase. This increase in net income resulted from increased sales volume and higher gross profit, partially offset by higher selling, general and administrative expenses as described above, and the income tax benefits provided by the use of net operating loss carryforwards, foreign tax credits, and arising from the reduction of the deferred tax valuation allowance.
We reported net income of $3,417,854 for fiscal year 2005 compared to a net income of $2,571,026 for fiscal year 2004, a $846,828 (33%) increase. This increase in net income resulted from both higher Hong Kong Joint Venture earnings and higher gross profit, partially offset by higher selling, general and administrative expenses as described above.
Financial Condition, Liquidity and Capital Resources
Our cash needs are currently met by funds generated from operations and from our Factoring Agreement, which supplies both short-term borrowings and letters of credit to finance foreign inventory purchases. The maximum we may borrow under this Agreement is $7,500,000. Accordingly, based on specified percentages of our accounts receivable and inventory and letter of credit commitments, at March 31, 2006, our maximum borrowing availability under this Agreement is $7,500,000. Any outstanding principal balance under this Agreement is payable upon demand. The interest rate on the Factoring Agreement, on the uncollected factored accounts receivable and any additional borrowings is equal to the prime rate of interest charged by the factor which, as of March 31, 2006, was 7.75%. Any borrowings are collateralized by all our accounts receivable and inventory. During the year ended March 31, 2006, working capital (computed as the excess of current assets over current liabilities) increased by $3,594,397, from $6,317,231 on March 31, 2005, to $9,911,628 on March 31, 2006.
Our operating activities provided cash of $1,766,297 for the year ended March 31, 2006. For the fiscal year ended March 31, 2005, operating activities used cash of $1,098,082. This increase of $2,864,379 was primarily due to higher net income and a reduction in inventories from the prior period.
Our investing activities provided cash of $1,091,358 during fiscal 2006 and provided cash of $704,860 during fiscal 2005. This increase resulted primarily from higher distributions from the Joint Venture. During 2005, as in prior years, the Company offset a portion of its distributions from the Hong Kong Joint Venture with amounts due by the Company to the Hong Kong Joint Venture for the purchase of safety products. The Company offset $458,940 during fiscal 2005 and $1,164,608 during fiscal 2004 of trade amounts due by it to the Hong Kong Joint Venture in lieu of cash distributions. The Company discloses these payments as a non-cash transaction in its statement of cash flows.
Financing activities in 2006 provided the Company with cash of $98,549, due to the exercise of employee stock options. Financing activities in 2005 provided cash of $264,319 which was also primarily from the exercise of employee stock options.
Hong Kong Joint Venture
The financial statements of the Hong Kong Joint Venture are included in this Form 10-K beginning on page JV-1. The reader should refer to these financial statements for additional information. There are no material Hong Kong - - U.S. GAAP differences in the Hong Kong Joint Venture's accounting policies.
In fiscal year 2006, sales of the Hong Kong Joint Venture were $24,811,790 compared to $25,899,630 and $24,114,967 in fiscal years 2005 and 2004, respectively. The decrease in sales for the 2006 period from the 2005 period primarily was due to lower sales to unrelated third parties, partially offset by higher sales to the Company. The increase in sales for the 2005 period from the 2004 period primarily was due to higher sales to unrelated third parties and to the Company.
Net income was $4,160,935 for fiscal year 2006 compared to net income of $5,005,886 and $4,171,334 in fiscal years 2005 and 2004, respectively. The decrease in the current fiscal year is due to the lower sales, increased legal expense, and the establishment of a reserve of approximately $535,000 for costs previously capitalized associated with the Hong Kong Joint Venture's application for listing on the Hong Kong Stock Exchange during the fourth quarter and for the fiscal year ended March 31, 2006. The increase in income for the year ended March 31, 2005 was due primarily to price increases initiated during the year.
Gross margins of the Hong Kong Joint Venture for fiscal 2006 increased to 34.7% from 33.55% in the prior fiscal year. The primary reason for this increase was price increases instituted during the fiscal year ended March 31, 2006. At March 31, 2005, the Hong Kong Joint Venture's gross margin increased to 33.55% from 30.6% at March 31, 2004. The primary reason for this increase was higher gross margins attributed to price increases initiated during the year.
Selling, general and administrative expenses of the Hong Kong Joint Venture were $4,269,714, $3,495,678 and $2,971,274 for fiscal years 2006, 2005 and 2004, respectively. As a percentage of sales, these expenses were 17%, 13% and 12% for fiscal years 2006, 2005 and 2004, respectively. The increase in dollars of selling, general and administrative expenses each year was due to higher costs, increased legal expense and the establishment of a reserve of approximately $535,000 for costs previously capitalized associated with the Hong Kong Joint Venture's application for listing on the Hong Kong Stock Exchange during the fiscal year ended March 31, 2006.
Interest income net of interest expense was $34,130 for fiscal year 2006, compared to $30,666 and $45,795 in fiscal years 2005 and 2004, respectively. The increase in interest income for 2006 was due to returns on investments in higher yielding bonds. The decrease from 2004 to 2005 is due to a reduction in investments in bonds during that fiscal period.
Cash needs of the Hong Kong Joint Venture are currently met by funds generated from operations. During fiscal year 2006, working capital increased by $232,989 from $1,593,767 on March 31, 2005 to $1,826,756 on March 31, 2006. We are not in a position to quantify any funds which may be available to the Hong Kong Joint Venture from IPO proceeds, if any, if an IPO by the Hong Kong Joint Venture is completed (as previously discussed).
Contractual Obligations and Commitments
The following table presents, as of March 31, 2006, our significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in Note E to the consolidated financial statements.
Critical Accounting Policies
Management's discussion and analysis of our consolidated financial statements and results of operations are based upon our Consolidated Financial Statement 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.
We believe that 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 this Annual Report. 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. 104, "Revenue Recognition in Financial Statements" issued by the Securities and Exchange Commission. Revenue is recognized at the time product is shipped and title passes pursuant to the terms of the agreement with the customer, the amount due from the customer is fixed and collectibility of the related receivable is reasonably assured. We established allowances to cover anticipated doubtful accounts and sales returns 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 currently have a foreign tax credit carryforward and deferred tax assets resulting from deductible temporary differences, which will reduce taxable income in future periods. We had previously provided a valuation allowance on the deferred tax assets associated with the future tax benefits such as foreign tax credits, foreign net operating losses, capital losses and net operating losses. A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses and losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of management's assessment, the allowance previously provided to offset tax benefits associated with net operating loss carryforwards and other deferred tax assets at March 31, 2006 has been reduced to zero.
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.
Recently Issued Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("Statement") 123 (revised 2004), Share Based Payment, which is a revision of Statement 123. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in operating results based on their fair values. Statement 123(R) will be effective for the Company on April 1, 2006, the beginning of the Company's fiscal 2007.
Statement 123(R) permits public companies to adopt its requirements using one of two methods: (1) a "modified prospective" method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date, or (2) a "modified retrospective" method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. The Company plans to use the modified prospective method to adopt the provisions of Statement 123(R).
As permitted by Statement 123, the Company currently accounts for share-based payments to employees using APB Opinion No. 25's intrinsic value method and, as such, recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)'s fair value method will have an impact on the Company's operating results. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted Statement 123(R) in prior periods, the Company believes the impact would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in Note 1. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the Company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions has not been significant.
In May 2005, the FASB issued Statement 154, Accounting for Changes and Error Corrections, which replaces APB Opinion No. 20, Accounting Changes, and Statement 3, Reporting Accounting Changes in Interim Financial Statements, and provides guidance on the accounting for and reporting of accounting changes and error corrections. Statement 154 applies to all voluntary changes in accounting principle and requires retrospective application (a term defined by the statement) to prior periods' financial statements, unless it is impracticable to determine the effect of a change. It also applies to changes required by an accounting pronouncement that does not include specific transition provisions. In addition, Statement 154 redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. The statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company will adopt Statement 154 beginning April 1, 2006.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our principal financial instrument is our Factoring Agreement which provides for interest at the factor's prime rate (7.75% at March 31, 2006). We are affected by market risk exposure primarily through the effect of changes in interest rates on amounts payable by us under our Factoring Agreement. A significant rise in the prime rate could materially adversely affect our business, financial condition and results of operations. However, at March 31, 2006 and during the fiscal year then ended, we had no material principal amount outstanding under the facility. We do not utilize derivative financial instruments to hedge against changes in interest rates or for any other purpose.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by this Item 8 are included in the Company's Consolidated Financial Statements and set forth in the pages indicated in Item 15(a) of this Annual Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. 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 annual 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 year 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 review this situation.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information with respect to the identity and business experience of the directors of the Company and their remuneration set forth in the section captioned "Election of Directors" in the Proxy Statement is incorporated herein by reference. The information with respect to the identity and business experience of executive officers of the Company is set forth in Part I of this Form 10-K. The information with respect to the Company's Audit Committee is incorporated herein by reference to the section captioned "Meetings and Committees of the Board of Directors" in the Proxy Statement. The information with respect to compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the section captioned "Compliance With Section 16(a) of the Exchange Act" in the Proxy Statement. The information with respect to the Company's Code of Ethics is incorporated herein by reference to the section captioned "Code of Ethics" in the Proxy Statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the sections captioned "Director Compensation" and "Executive Compensation" in the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference to the sections captioned "Beneficial Ownership" and "Information Regarding Share Ownership of Management" in the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the section captioned "Transactions with Management" in the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated herein by reference to the section captioned "Independent Registered Public Accountants" in the Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements.
(a) 3. Exhibits required to be filed by Item 601 of Regulation S-K.
Exhibit No.
3.1 Articles of Incorporation (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended December 31, 1988, File No. 1-31747) 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) 3.3 Bylaws, as amended (incorporated by reference to Exhibit 3 to the Company's Form 8-A/A filed July 24, 2003) 10.1 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 September 30, 2003, File No. 1-31747) 10.2 Hong Kong Joint Venture Agreement, as amended (incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, File No. 1-31747) 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) 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 September 30, 2002, File No. 1-31747) 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 September 30, 2004, File No. 1-31747) 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) 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 September 30, 2005, File No. 1-31747) 14 Code of Ethics (incorporated by reference to Exhibit 14 to the Company's Annual Report on Form 10-K for the year ended March 31, 2004, File No. 1-31747) 21 Subsidiaries of the Registrant (incorporated by reference to Exhibit 14 to the Company's Annual Report on Form 10-K for the year ended March 31, 2004, File No. 1-31747) 23.1 Consent of Grant Thornton LLP* 23.2 Consent of Grant Thornton LLP (Hong Kong)* 31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer* 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer* 32.1 Section 1350 Certifications* 99.1 Press Release dated June 29, 2006*
*Filed herewith
(c) Financial Statements Required by Regulation S-X.
Separate financial statements of the Hong Kong Joint Venture
Independent Auditors' Report Report of Independent Registered Public Accounting Firm JV-1 Consolidated Income Statement JV-2 Consolidated Balance Sheet JV-3 Balance Sheet JV-4 Consolidated Statement of Changes in Equity JV-5 Consolidated Cash Flow Statement JV-6 Notes to Financial Statements JV-7
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
June 29, 2006 By: /s/ Harvey B. Grossblatt --------------------------------- Harvey B. Grossblatt President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Harvey B. Grossblatt President, Chief Executive June 29, 2006 - --------------------------- Officer and Director Harvey B. Grossblatt
/s/ James B. Huff Chief Financial Officer June 29, 2006 - --------------------------- James B. Huff
/s/ Cary Luskin Director June 29, 2006 - --------------------------- Cary Luskin
/s/ Ronald A. Seff, M.D. Director June 29, 2006 - --------------------------- Ronald A. Seff
/s/ Howard Silverman, Ph.D. Director June 29, 2006 - --------------------------- Howard Silverman, Ph.D.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Universal Security Instruments, Inc.
We have audited the accompanying consolidated balance sheets of Universal Security Instruments, Inc. and subsidiaries (the Company) as of March 31, 2006 and 2005, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended March 31, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Universal Security Instruments, Inc. and subsidiaries as of March 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
We have also audited Schedule II for each of the three years in the period ended March 31, 2006. In our opinion, this schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required therein.
/s/ GRANT THORNTON LLP Baltimore, Maryland June 23, 2006
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
See notes to consolidated financial statements.
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See notes to consolidated financial statements
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business: The Company's primary business is the sale of smoke alarms and other safety products to retailers, wholesale distributors and to the electrical distribution trade which includes electrical and lighting distributors as well as manufactured housing companies. The Company imports all of its safety and other products from foreign manufacturers. The Company, as an importer, is subject to numerous tariffs which vary depending on types of products and country of origin, changes in economic and political conditions in the country of manufacture, potential trade restrictions and currency fluctuations.
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. We believe that our 50% ownership interest in the Hong Kong Joint Venture allows us to significantly influence the operations of the Hong Kong Joint Venture. As such, we account for our interest in the Hong Kong Joint Venture using the equity method of accounting. We have included our investment balance as a non-current asset and have included our share of the Hong Kong Joint Venture's income in our consolidated statement of operations. The investment and earnings are adjusted to eliminate intercompany profits.
Use of Estimates: In preparing financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition: 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 upon which 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.
Warranties: 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 have not been historically material and we do not record estimated warranty expense or a contingent liability for warranty claims.
Stock-Based Compensation: We account for stock-based employee compensation using the intrinsic value method, which calculates compensation expense based on the difference, if any, on the date of the grant, between the fair value of our stock and the option exercise price. US GAAP requires companies who choose to account for stock option grants using the intrinsic value method to also determine the fair value of option grants using an option pricing models, such as the Black-Scholes models, and to disclose the impact of fair value accounting in a note to the financial statements. In December 2004, the Financial Accounting Standards Board, or FASB, issued FASB Statement No. 123R, "Share-Based Payment," which requires companies to expense the value of employee stock options and similar awards. The effective date of FASB 123R is for annual periods beginning after June 15, 2005. Subsequently, the Securities and Exchange Commission (SEC) approved a rule which delays the effective date of FAS 123R for certain public companies. Under the SEC's rule, FAS 123R is now effective for the Company's annual period beginning April 1, 2006. We have elected to defer adoption of the change to the fair value based method of accounting for stock-based employee compensation and the recordation of such amounts as charges to operating expense until the annual period beginning April 1, 2006.
Stock issued to directors in lieu of directors' fees is valued at market price on the day of issuance.
The following table illustrates the effect on net income and net income per share had compensation costs for the stock-based compensation plan been determined based on the grant date fair values of awards.
Research and Development: Research and development costs are charged to operations as incurred.
Accounts Receivable: In September, 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No. 140), which is effective for transfers of financial assets occurring after March 31, 2001.
In fiscal year 2002, the Company achieved the sales criteria of SFAS No. 140, and, as such, amounts transferred under the Company's Factoring Agreement are treated as sales.
Beginning in fiscal year 2002, with the achievement of SFAS 140 sales criteria, the Company nets the factored accounts receivable with the corresponding advance from the Factor, showing the amount net in its consolidated balance sheet.
The Company sells trade receivables on a pre-approved non-recourse basis to the Factor under the Factoring Agreement on an ongoing basis. Factoring charges recognized on sales of receivables are included in selling, general and administrative expenses in the consolidated statements of income and amounted to $262,670, $208,913 and $167,561 for the years ended March 31, 2006, 2005 and 2004, respectively. The Agreement for the sale of accounts receivable provides for continuation of the program on a revolving basis until terminated by one of the parties to the Agreement.
Shipping and Handling Fees and Costs: The Company includes shipping and handling fees billed to customers in net sales. Shipping and handling costs associated with inbound freight are included in cost of goods sold. Shipping and handling costs associated with outbound freight are included in selling, general and administrative expenses and totaled $966,981, $702,779 and $521,556 in fiscal years 2006, 2005 and 2004, respectively.
Inventories: Inventories (consisting primarily of finished goods) are stated at the lower of cost (first-in, first-out method) or market. Included as a component of finished goods inventory are additional non-material costs. These costs include overhead costs, freight, import duty and inspection fees of $370,419 and $514,373 at March 31, 2006 and 2005, respectively. Inventories are shown net of an allowance for inventory obsolescence of $40,000 for the fiscal year ended March 31, 2006 and $100,000 for the fiscal years ended 2005.
The Company reviews inventory quarterly to identify slow moving products and valuation allowances are adjusted when deemed necessary.
Property and Equipment: Property and equipment are recorded at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided by using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes. The estimated useful lives for financial reporting purposes are as follows:
Leasehold improvements - Shorter of term of lease or life of asset Machinery and equipment - 5 to 10 years Furniture and fixtures - 5 to 15 years Computer equipment - 5 years
Income Taxes: The Company recognizes a liability or asset for the deferred tax consequences of temporary differences between the tax basis of assets or liabilities and their reported amounts in the financial statements. These temporary differences will result in taxable or deductible amounts in future years when the reported amounts of the assets or liabilities are recovered or settled. The deferred tax assets are reviewed periodically for recoverability and valuation allowances are provided, as necessary.
Net Income per Share: The Company reports basic and diluted earnings per share. Basic earnings per share is computed by dividing net income for the period by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income for the period by the weighted number of common shares and common share equivalents outstanding (unless their effect is anti-dilutive) for the period. All common share equivalents are comprised of exercisable stock options.
Reclassifications: Certain prior year amounts have been reclassified in order to conform with current year presentation.
NOTE B - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
March 31, 2006 2005 -------- -------- Leasehold improvements $ 73,535 $ 73,535 Machinery and equipment 158,696 158,696 Furniture and fixtures 197,482 195,873 Computer equipment 88,736 81,855 -------- -------- 518,449 509,959
Less accumulated depreciation and amortization 456,237 428,269 -------- -------- $ 62,212 $ 81,690 ======== ========
NOTE C - INVESTMENT IN THE HONG KONG JOINT VENTURE
The Company holds a 50% interest in a Joint Venture with a Hong Kong Corporation, which has manufacturing facilities in the People's Republic of China, for the manufacturing of consumer electronic products. As of March 31, 2006, the Company has an investment balance of $7,140,859 for its 50% interest in the Hong Kong Joint Venture. There are no material Hong Kong - U.S. GAAP differences in the Hong Kong Joint Venture's accounting policies.
The following represents summarized financial information derived from the audited financial statements of the Hong Kong Joint Venture as of March 31, 2006 and 2005 and for the years ended March 31, 2006, 2005 and 2004.
March 31, 2006 2005 ----------- ----------- Current assets $ 7,402,171 $ 6,131,539 Property and other assets 10,911,009 9,112,863 ----------- -----------
Total $18,313,180 $15,244,402 =========== ===========
Current liabilities $ 5,575,415 $ 4,537,772 Non-current liabilities 32,870 24,750
Equity 12,740,895 10,681,880 ----------- -----------
Total $18,313,180 $15,244,402 =========== ===========
For the Year Ended March 31, 2006 2005 2004 ---- ---- ----
Net sales $24,811,790 $25,899,630 $24,114,967 Gross profit 8,608,220 8,689,538 7,375,113 Net income 4,160,935 5,005,886 4,171,334
During the years ended March 31, 2006, 2005 and 2004, the Company purchased $12,321,401, $10,513,800 and $7,481,716, respectively, of finished product from the Hong Kong Joint Venture, which represents 66%, 68% and 73%, respectively, of the Company's total finished product purchases for the years ended at March 31, 2006, 2005 and 2004. Amounts due the Hong Kong Joint Venture included in Accounts Payable totaled $500,000 and $549,527 at March 31, 2006 and 2005, respectively. Amounts due from the Hong Kong Joint Venture included in Accounts Receivable totaled $48,205 and $84,330 at March 31, 2006 and 2005, respectively.
The Company incurred interest costs charged by the Hong Kong Joint Venture of $37,389, $17,581 and $25,482 during the years ended March 31, 2006, 2005 and 2004, respectively, related to its purchases.
NOTE D - AMOUNTS DUE FROM FACTOR
The Company sells certain of its trade receivables on a pre-approved, non-recourse basis to a Factor. Since these are sold on a non-recourse basis, the factored trade receivables and related repayment obligations are not separately recorded in the Company's consolidated balance sheets. The Agreement provides for financing of up to a maximum of $7,500,000 with the amount available at any one time based on 85% of uncollected non-recourse receivables sold to the factor and 45% of qualifying inventory. Financing of $7,500,000 is available at March 31, 2006. Any outstanding amounts due to the factor are payable upon demand and bear interest at the prime rate of interest charged by the factor, which is 7.75% at March 31, 2006. Any amount due to the factor is also secured by the Company's inventory. There were no borrowings outstanding under this agreement at March 31, 2006.
Under this Factoring Agreement, the Company sold receivables of approximately $26,713,439 and $20,954,000 during the years ended March 31, 2006 and 2005, respectively. Gains and losses recognized on the sale of factored receivables include the fair value of the limited recourse obligation. The uncollected balance of non-recourse receivables held by the factor amounted to $4,414,654 and $3,399,130 at March 31, 2006 and 2005. The amount of the uncollected balance of non-recourse receivables borrowed by the Company as of March 31, 2006 and 2005 is $0 and $0, respectively. Amounts due from the factor to the Company amounted to $7,136,282 at March 31, 2006, of which $2,877,151 represents collected cash due the Company and maintained on deposit with the factor for investment. Collected cash maintained on deposit with the factor earns interest at the factor's prime rate of interest less three percentage points (4.75%) at March 31, 2006. Amounts due from the factor amounted to $3,394,084 at March 31, 2005.
NOTE E - LEASES
During December 1999, the Company entered into an operating lease for its office and warehouse which expires in October 2008. This lease is subject to increasing rentals at 3% per year. In February 2004, the Company entered into an operating lease for an approximately 2,600 square foot office in Naperville, Illinois. This lease expires in February 2009 with increasing rentals at 3% per year.
Rent expense totaled $102,589, $97,011 and $92,063 for the years ended March 31, 2006, 2005 and 2004, respectively. Future obligations, including the lease renewal option exercised subsequent to March 31 2006, for the years ended March 31, under these non-cancelable operating leases are as follows:
Year Ended March 31, 2007 $105,479 2008 108,429 2009 77,097 -------- $291,005 ======== NOTE F - INCOME TAXES
Universal Security Instruments, Inc. ("USI") provides for Income Taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Accordingly, deferred income tax assets and liabilities are computed and recognized for those differences that have future tax consequences and will result in net taxable or deductible amounts in future periods. Deferred tax expense or benefit is the result of changes in the net asset or liability for deferred taxes. The deferred tax liabilities and assets for USI result primarily from reserves, inventories, accrued liabilities and changes in the unremitted earnings of the Hong Kong Joint Venture.
Beginning in 2004, USI will no longer recognize the deferred tax liability related to the unremitted earnings of the Hong Kong Joint Venture. There is no longer a plan to repatriate the unremitted earnings in the future, other than a possible $850,000 payment. The Company has foreign tax credits available as a result of foreign taxes paid on the repatriated earnings of the Hong Kong Joint Venture. Approximately $115,000 of foreign tax credits were used to offset federal taxes at March 31, 2006.
USI had a net operating loss carryforward as of March 31, 2005 of $2,151,593, of which $2,151,593 was utilized during the year ended March 31, 2006. Therefore, the net operating loss carryforward has been fully utilized as of March 31, 2006.
The components of income tax expense (benefit) for USI are as follows:
March 31, 2006 2005 ---------- ----------- Current Federal $ 17,651 $ 21,000 State 10,453 5,250 ---------- ----------- 28,104 26,250 Deferred (benefit) (124,604) (307,387) ---------- ----------- Total income tax (benefit) expense $ (96,500) $ (281,137) ========== ===========
The reconciliation between the statutory federal income tax provision and the actual effective tax provision is as follows:
NOTE G - SHAREHOLDERS' EQUITY
Common Stock - During the year ended March 31, 2006, the Company issued 40,954 shares of its common stock, of which 40,499 were issued on the exercise of employee stock options for total proceeds of $98,549, and 455 shares were issued to a director in lieu of a directors fee.
Stock Options - Under terms of the Company's 1978 Non-Qualified Stock Option Plan, as amended, 658,333 shares of common stock are reserved for the granting of stock options, of which 657,158 shares have been issued as of March 31, 2006, leaving 1,175 available for issuance upon exercise of options granted, or available for future grants to employees and directors. Under provisions of the Plan, a committee of the Board of Directors determines the option price and the dates exercisable. All options expire five years from the date of grant and have an exercise price at least equal to the market price at the date of grant. The options usually vest at 25% a year over four years. Share amounts have been retroactively adjusted to reflect the 4-for-3 stock dividend paid on April 5, 2004 to shareholders of record on March 15, 2004.
The following tables summarize the status of options under the Non-Qualified Stock Option Plan at March 31, 2006 and option transactions for the three years then ended:
Status as of March 31, 2006 Number of Shares --------------------------- ----------------
Presently exercisable 231,788 Exercisable in future years 10,708 ----------------
Total outstanding 242,496 Available for future grants 1,175
Shares of common stock reserved 243,671
Outstanding options: Number of holders 19 Average exercise price per share $ 7.31 Expiration dates June 2006 to March 2011
The following table summarizes information about stock options outstanding at March 31, 2006:
The fair value of each stock option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions in 2006, 2005 and 2004; no annual dividends, expected volatility of 36%, 45% and 53%, respectively, risk-free interest rate ranging from 4.0% to 6.5% and expected lives of five years. The weighted-average fair values of the stock options granted in 2006, 2005 and 2004 were $8.29, $6.47 and $6.95 per share, respectively.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of normal publicly traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options.
NOTE H - COMMITMENTS AND CONTINGENCIES
In December 2001, Leviton Manufacturing Co., Inc. ("Leviton") filed a civil action in the United States District Court for the District of Maryland (Case No. 01cv3855) alleging that the Company's and its USI Electric subsidiary's GFCI units infringed one of plaintiff's patents and configuration trade dress ("Leviton I"). On June 10, 2003, Leviton filed a second civil suit against the Company and its USI Electric subsidiary in the United States District Court for the District of Maryland (Case No. 03cv1701), alleging this time that the Company's GFCI units infringe one or more of Leviton's six more recently issued 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 Leviton I and Leviton II, all subject to a confidential agreement. Under the terms of the settlement, Leviton I has been dismissed, and the trade dress/deceptive trade practice claims of Leviton II have been dismissed. The settlement does 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. Should Leviton's appeal be successful and the summary judgment of non-infringement be overturned, then Leviton's infringement claims will be reinstated. If reinstated, the Company's belief in its strong defenses to Leviton's claims in that suit remains unchanged. However, in the event of an unfavorable outcome, including reversal of the lower court's dismissal on appeal and rejection of the Company's defenses at trial, the amount of any potential loss to the Company is not determinable at this time.
On March 31, 2005, Leviton filed a third lawsuit, Civil Action No. 05cv0889, in the United States District Court for the District of Maryland against the Company ("Leviton III"). In this suit, Leviton alleges that the Company's GFCI units infringe US Patent 6,864,766. The Company has filed a counterclaim against Leviton and the case has been consolidated with a declaratory judgment action filed by the GFCI manufacturer, Shanghai Meihao Electric, Inc. Discovery is now ongoing. The Company believes that it has strong 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 determinable at this time.
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 believing that at a minimum, procedurally, conditions should have been imposed. 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.
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 has not yet filed a substantive response to the USPTO action. While the Company is confident that the USPTO reexamination and rejection of the claims indicates that the Company will prevail in this action, no assurances can be given. 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.
NOTE I - MAJOR CUSTOMERS
The Company is primarily a distributor of safety products for use in home and business under both its tradenames and private labels for other companies. As described in Note C, the Company's purchased a majority of its products from its 50% owned Hong Kong Joint Venture.
There were no customers that represented in excess of 10% of the Company's product sales during the three years in the period ended March 31, 2006.
NOTE J - QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly Results of Operations (Unaudited):
The unaudited quarterly results of operations for fiscal years 2006 and 2005 are summarized as follows:
SCHEDULE II
UNIVERSAL SECURITY INSTRUMENTS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED March 31, 2006, 2005 and 2004
S-1
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission)
Reports and Financial Statements For the year ended 31 March 2006
Contents
Auditors' Report JV-1
Consolidated Income Statement JV-2
Consolidated Balance Sheet JV-3
Balance Sheet JV-4
Consolidated Statement of Changes in Equity JV-5
Consolidated Cash Flow Statement JV-6
Notes to the Financial Statements JV-7
Expressed in Hong Kong dollars ("HK$")
Report of Independent Registered Public Accounting Firm
To the Board of Directors of The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission) :
We have audited the accompanying consolidated balance sheets of The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission) and subsidiaries ("the Company"), as of March 31, 2006 and 2005, and the related consolidated statements of income, changes in equity, and cash flows for each of the two years in the period ended March 31, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of March 31, 2006 and 2005, and the consolidated results of its income and its cash flows for each of the two years in the period ended March 31, 2006, in conformity with accounting principles generally accepted in Hong Kong.
Grant Thornton Certified Public Accountants Hong Kong
June 23, 2006
JV-1
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission Consolidated income statement for the year ended 31 March 2006
Notes 2006 2005 HK$ HK$
Turnover 5 192,697,968 201,851,572
Cost of sales (125,843,197) (134,128,970)
- -------------------------------------------------------------------------------
Gross profit 66,854,771 67,722,602
Other income 6 2,798,681 2,550,272
Administrative expenses (33,160,250) (27,242,707)
- -------------------------------------------------------------------------------
Profit from operations 36,493,202 43,030,167
Finance costs 7 (265,063) (239,239)
- -------------------------------------------------------------------------------
Profit before income tax 8 36,228,139 42,790,928
Income tax expense 9 (3,912,698) (3,776,352)
- -------------------------------------------------------------------------------
Profit for the year 10 32,315,441 39,014,576
- -------------------------------------------------------------------------------
Dividends 11 17,163,365 18,508,258
- -------------------------------------------------------------------------------
JV-2
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission Consolidated balance sheet as at 31 March 2006
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission Balance sheet as at 31 March 2006
JV-4
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission Consolidated statement of changes in equity for the year ended 31 March 2006
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission Consolidated cash flow statement for the year ended 31 March 2006
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission Notes to the financial statements for the year ended 31 March 2006
1. GENERAL INFORMATION
The company is a limited liability company incorporated and domiciled in Hong Kong. The principal activities of the company and the group are manufacturing and trading of consumer electronic products including smoke, fire and carbon monoxide alarms and other home safety products. Details of the company's subsidiaries are set out in note 15 to the financial statements.
The financial statements have been prepared in accordance with Hong Kong Financial Reporting Standards ("HKFRS") as issued by the Hong Kong Institute of Certified Public Accountants and the Hong Kong Companies Ordinance.
The financial statements for the year ended 31 March 2006 were approved by the board of directors on 23 June 2006.
2. ADOPTION OF NEW OR REVISED HKFRS
From 1 April 2005, the group has adopted, for the first time, the new or revised standards and interpretations of HKFRS, which are relevant to its operations. This includes the following new, revised and renamed standards:
HKAS 1 Presentation of Financial Statements HKAS 2 Inventories HKAS 7 Cash Flow Statements HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors HKAS 10 Events after the Balance Sheet Date HKAS 12 Income Taxes HKAS 16 Property, Plant and Equipment HKAS 17 Leases HKAS 18 Revenue HKAS 19 Employee Benefits HKAS 21 The Effects of Changes in Foreign Exchange Rates HKAS 24 Related Party Disclosures HKAS 27 Consolidated and Separate Financial Statements HKAS 32 Financial Instruments : Disclosure and Presentation HKAS 36 Impairment of Assets HKAS 37 Provisions, Contingent Liabilities and Contingent Assets HKAS 39 Financial Instruments : Recognition and Measurement HK(SIC)-Int 15 Operating leases - Incentives
JV-7
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
2. ADOPTION OF NEW OR REVISED HKFRS (Continued)
All the standards have been applied retrospectively except where specific transitional provisions require a different treatment and accordingly the 2005 financial statements and their presentation have been amended in accordance with HKAS 8. Due to the change in accounting policies, the 2005 comparatives contained in these financial statements differ from those published in the financial statements for the year ended 31 March 2005.
Significant effects on current, prior or future periods arising from the first-time application of the standards listed above in respect to presentation, recognition and measurement of accounts are described in the following notes :
2.1 Adoption of HKAS 17
The adoption of HKAS 17 has resulted in a change in the accounting policy relating to the reclassification of leasehold land and land use rights from property, plant and equipment to operating leases. The up-front prepayments made for the leasehold land and land use rights are charged to the income statement on a straight-line basis over the period of the lease. In prior years, leasehold land and buildings were not separated. Leasehold land and buildings and land use rights were classified under property, plant and equipment and carried at cost less accumulated depreciation and accumulated impairment losses. The reclassification does not give rise to any adjustment to prior year's profit.
2.2 Adoption of HKAS 32 and HKAS 39
Prior to the adoption of HKAS 39, investments of the group were classified into unlisted equity securities and listed debt securities, which were stated in the balance sheet at cost less any impairment losses and at fair value, respectively. Any impairment losses on unlisted equity securities and changes in fair value of listed debt securities were recognised in the income statement in the period in which they arose.
On the adoption of HKAS 39, the listed debt securities as at 31 March 2005 were redesignated into available-for-sale financial assets on 1 April 2005. After initial recognition, available-for-sale financial assets are measured at fair value with gains or losses being recognised as a separate component of equity until the investment is sold, collected or otherwise disposed of or until the investment is determined to be impaired at which time the aggregate gain or loss previously reported in equity is included in the income statement.
JV-8
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
2. ADOPTION OF NEW OR REVISED HKFRS (Continued)
2.2 Adoption of HKAS 32 and HKAS 39 (Continued)
In accordance with the transitional provisions of HKAS 39, the recognition, derecognition and measurement of financial assets and liabilities on a retrospective basis is not permitted. Accordingly, an adjustment has been made to restate the aggregate changes in fair value of the group's listed debt securities of HK$251,023 from retained profits to fair value reserve at 1 April 2005.
According to the relevant transitional provisions of HKAS 39, the group's bills discounted with full recourse, which were derecognised and treated as contingent liabilities (note 29) until 31 March 2005, have been accounted for as collateralised bank advances (note 23) and bills receivable (note 17) prospectively on or after 1 April 2005 as the financial assets derecognition conditions as stipulated in HKAS 39 have not been fulfilled.
2.3 Other standards adopted
All other standards did not result in significant changes to the group's accounting policies. The specific transitional provisions contained in some of these standards were considered. The adoption of these standards and interpretations did not result in any significant changes to the amounts or disclosures in these financial statements.
JV-9
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
2. ADOPTION OF NEW OR REVISED HKFRS (Continued)
2.4 New standards or interpretations that have been issued but are not yet effective.
The group has not early adopted the following standards or interpretations that have been issued but are not yet effective. The directors of the company anticipate that the adoption of such standards and interpretations will not result in substantial changes to the group's accounting policies.
JV-10
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
3.1 Basis of preparation
The significant accounting policies that have been used in the preparation of these financial statements are summarised below.
The financial statements have been prepared on the historical cost basis except for the revaluation of certain financial assets and liabilities. The measurement bases are fully described in the accounting policies below.
It should be noted that accounting estimates and assumptions are used in preparation of the financial statements. Although these estimates are based on management's best knowledge of current events and actions, actual results may ultimately differ from those estimates.
3.2 Basis of consolidation
The consolidated financial statements incorporate the financial statements of the company and its subsidiaries made up to 31 March each year.
3.3 Subsidiaries
Subsidiaries are those entities in which the company controls more than half of the voting power, or holds more than half of the issued share capital, or controls the composition of the board of directors. Subsidiaries are fully consolidated from the date on which control is transferred to the group. They are de-consolidated from date that control ceases.
Inter-company transactions, balances and unrealised gains on transactions between group companies are eliminated. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred.
In the company's balance sheet, subsidiaries are carried at cost less any impairment loss. The results of the subsidiaries are accounted for by the company on the basis of dividends received and receivable at the balance sheet date.
JV-11
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
3.4 Property, plant and equipment
Property, plant and equipment are stated at acquisition cost less accumulated depreciation and impairment losses.
Subsequent costs are included in the asset's carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the group and company and the cost of the item can be measured reliably. All other repairs and maintenance are charged to the income statement during the period in which they are incurred.
Depreciation is provided to write off the cost of property, plant and equipment less their residual values over their estimated useful lives, using the straight line method, at the following rates per annum :
Buildings 5% or where shorter over 16 - 19 years Leasehold improvements 20% Plant and machinery 10% Furniture and fixtures 20% Motor vehicles 20% Computer equipment and software 50%
Construction in progress represents costs incurred in the construction of buildings. These costs are not depreciated until such time as the relevant assets are completed and put into use, at which time the relevant costs are transferred to the appropriate category of property, plant and equipment.
The asset's residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
The gain or loss arising on the disposal is determined as the difference between the sales proceeds and the carrying amount of the asset and is recognised in the income statement.
JV-12
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
3.5 Inventories
Inventories are stated at the lower of cost and net realisable value. Cost comprises direct materials computed using first-in, first-out method and, where applicable, direct labour and those overheads that have been incurred in bringing the inventories to their present location and condition. Net realisable value is calculated as the actual or estimated selling price less all further costs of completion and estimated costs necessary to make the sale.
3.6 Financial assets
The financial assets include available-for-sale financial assets, trade and other receivables, bills receivable, and amounts due from group companies.
In previous years, the group classified its investments in debt securities as other investments. Other investments which were held for non-trading purpose were stated at fair value at the balance sheet date. Changes in fair value of other investments were recognised in the income statement as they arose. Gains or losses on disposal of other investments, representing the difference between the net sales proceeds and the carrying amounts, were recognised in the income statement as they arose.
From 1 April 2005 onwards, the group classifies its financial assets into loans and receivables and available-for-sale financial assets. Management determines the classification of its financial assets at initial recognition depending on the purpose for which the financial assets were acquired and where allowed and appropriate, re-evaluates this designation at every reporting date.
Loans and receivables
Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Loans and receivables are initially recognised at fair value and subsequently measured at amortised cost using the effective interest method less any impairment. Any changes in their value are recognised in income statement.
JV-13
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
3.6 Financial assets (Continued)
Loans and receivables (Continued)
Loans and receivables are provided against when objective evidence is received that the group will not be able to collect all amounts due to it in accordance with the original terms of the receivables. The amount of the impairment is the difference between the asset's carrying amount and the present value of expected cash flows, discounted at the effective interest rate.
Available-for-sale financial assets
Available-for-sale financial assets include non-derivative financial assets that are either designated to this category or do not qualify for inclusion in any of the other categories of financial assets. All financial assets within this category are subsequently measured at fair value, with changes in value recognised in equity (i.e. fair value reserve). Upon disposal, the cumulative gain or loss previously recognised in equity is transferred to the income statement. When a decline in the fair value of an available-for-sale financial asset has been recognised directly in equity and there is objective evidence that the asset is impaired, the cumulative loss that had been recognised directly in equity is removed from equity and recognised in the income statement even though the financial asset has not been derecognised. Impairment losses previously recognised in the income statement on equity instruments will not reverse in subsequent periods. Impairment losses previously recognised in income statement are subsequently reversed if an increase in the fair value of the investment can be objectively related to an event occurring after the recognition of the impairment loss.
Derecognition of financial assets occurs when the rights to receive cash flows from the investments expire or are transferred and substantially all of the risks and rewards of ownership have been transferred. An assessment for impairment is undertaken at least at each balance sheet date whether or not there is objective evidence that a financial asset or a group of financial assets is impaired.
3.7 Cash and cash equivalents
Cash and cash equivalents include cash at bank and in hand.
JV-14
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
3.8 Impairment of assets
Property, plant and equipment are subject to impairment testing.
For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash-generating units). As a result, some assets are tested individually for impairment and some are tested at cash-generating unit level.
All individual assets or cash-generating units are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
An impairment loss is recognised for the amount by which the asset's or cash-generating unit's carrying amount exceeds its recoverable amount. The recoverable amount is the higher of fair value, reflecting market conditions less costs to sell and value in use, based on an internal discounted cash flow evaluation. Any impairment loss is charged pro rata to the assets in the cash generating unit.
An impairment loss is reversed if there has been a change in the estimates used to determine the asset's recoverable amount and only to the extent that the asset's carrying amount does not exceed the carrying amount that would have been determined, net of depreciation, if no impairment had been recognised.
3.9 Financial liabilities
The financial liabilities include trade and other payables, amounts due to group and related companies and borrowings.
Financial liabilities are recognised when the group or the company becomes a party to the contractual agreements of the instrument. All interest related charges are recognised as an expense in the income statement.
Trade and other payables and amounts due to group and related companies are recognised initially at their fair value and subsequently measured at amortised cost, using the effective interest method.
Borrowings are recognised initially at fair value, net of transaction costs incurred. Borrowings are subsequently stated at amortised cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest method.
JV-15
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
3.10 Employee benefits
Retirement benefits costs
The company operates a defined contribution Mandatory Provident Fund retirement benefits scheme (the "MPF Scheme") under the Mandatory Provident Fund Schemes Ordinance, for all of its employees in Hong Kong. The MPF Scheme became effective on 1 December 2000. Contributions are made based on a percentage of the employees' basic salaries, limited to a maximum of HK$1,000 per month, and are charged to the income statement as they become payable in accordance with the rules of the MPF Scheme. The assets of the MPF Scheme are held separately from those of the company in an independently administered fund. The company's employer contributions vest fully with the employees when contributed into the MPF Scheme.
3.11 Equity
Ordinary shares are classified as equity. Share capital is determined using the nominal value of shares that have been issued.
The transaction costs of an equity transaction are accounted for as deduction from equity (net of any related income tax benefits) to the extent they are incremental cost directly attributable to the equity transaction that otherwise would have been avoided. The cost of an equity transaction that is abandoned are recognised as an expense.
3.12 Foreign currencies
The financial statements are presented in Hong Kong Dollars (HK$), which is also the functional currency of the company.
In the separate financial statements of the consolidated entities, foreign currency transactions are translated into the functional currency of the individual entity using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities denominated in foreign currencies at year-end exchange rates are recognised in the income statement. Non-monetary items that are measured in terms of historical cost in a foreign currency are not retranslated.
JV-16
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
3.12 Foreign currencies (Continued)
In the consolidated financial statements, all separate financial statements of subsidiaries, originally presented in a currency different from the group's presentation currency, have been converted into Hong Kong dollars. Assets and liabilities have been translated into Hong Kong dollars at the closing rate at the balance sheet date. Income and expenses have been converted into Hong Kong dollars at the average rates over the reporting period. Any differences arising from this procedure have been dealt with in the exchange reserve in equity.
3.13 Accounting for income taxes
Income tax comprises current tax and deferred tax.
Current income tax assets and/or liabilities comprise those obligations to, or claims from, tax authorities relating to the current or prior reporting period, that are unpaid at the balance sheet date. They are calculated according to the tax rates and tax laws applicable to the periods to which they relate, based on the taxable profit for the year. All changes to current tax assets or liabilities are recognised as a component of income tax expense in the income statement.
Deferred tax is calculated using the liability method on temporary differences at the balance sheet date between the carrying amounts of assets and liabilities in the financial statements with their respective tax bases. Deferred tax liabilities are generally recognised for all taxable temporary differences. Deferred tax assets are recognised for all deductible temporary differences, tax losses available to be carried forward as well as other unused tax credits, to the extent that it is probable that taxable profit will be available against which the deductible temporary differences, unused tax losses and unused tax credits can be utilised.
Deferred tax is calculated, without discounting, at tax rates that are expected to apply in the period the liability is settled or the asset realised, provided they are enacted or substantively enacted at the balance sheet date.
Changes in deferred tax assets or liabilities are recognised in the income statement, or in equity if they relate to items that are charged or credited directly to equity.
JV-17
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
3.14 Leases
Leases where substantially all the risks and rewards of ownership of assets remain with the lessor are accounted for as operating leases. Operating lease payments are recognised as an expense on a straight-line basis. Affiliated costs, such as maintenance and insurance, are expensed as incurred. Contingent rentals are charged to the income statement in the accounting period in which they are incurred.
3.15 Recognition of revenue
Revenue from the sale of goods is recognised when the significant risks and rewards of ownership of the goods have been transferred to customers.
Rental income from properties letting under operating leases is recognised on the straight line basis over the lease terms.
Interest income is recognised on a time proportion basis.
3.16 Related parties
Parties are considered to be related to the group if :
(i) directly, or indirectly through one or more intermediaries, the party : -controls, is controlled by, or is under common control with, the group; -has an interest in the group that gives it significant influence over the group; -has joint control over the group;
(ii) the party is a jointly-controlled entity;
(iii) the party is an associate;
(iv) the party is a member of the key management personnel of the group or its parent;
(v) the party is a close member of the family of any individual referred to in (i) or (iv);
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
3.16 Related parties (Continued)
(vi) the party is an entity that is controlled, jointly-controlled or significantly influenced by or for which significant voting power in such entity resides with, directly or indirectly, any individual referred to in (iv) or (v); or
(vii) the party is a post-employment benefit plan for the benefit of employees of the group, or of any entity that is a related party of the group.
3.17 Contingent liabilities
A contingent liability is a possible obligation that arises from past events and whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the group. It can also be a present obligation arising from past events that is not recognised because it is not probable that outflow of economic resources will be required or the amount of obligation cannot be measured reliably.
A contingent liability is not recognised but is disclosed in the notes to the financial statements. When a change in the probability of an outflow occurs so that the outflow is probable, it will then be recognised as a provision.
4. CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS
Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.
The group makes estimates and assumptions concerning the future. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below :
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
Depreciation and amortisation
The group and company depreciated the property, plant and equipment on a straight-line basis over the estimated useful lives, starting from the date on which the assets are placed into productive use. The estimated useful lives reflect the directors' estimate of the periods that the group intends to derive future economic benefits from the use of the group's and company's property, plant and equipment.
JV-20
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
4. CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS (Continued)
Impairment of receivables
The policy for the impairment of receivables of the group is based on the evaluation of collectibility and ageing analysis of accounts and on the management's judgement. A considerable amount of judgement is required in assessing the ultimate realisation of these receivables, including the current creditworthiness and the past collection history of each debtor.
Net realisable value of inventories
Net realisable value of inventories is the actual or estimated selling price in the ordinary course of business, less further costs of completion and the estimated costs necessary to make the sale. These estimates are based on the current market condition and the historical experience of selling products of similar nature. It could change significantly as a result of competitor actions in response to the changes in market condition. Management reassess these estimations at the balance sheet date.
Current taxation and deferred taxation
The group is subject to income taxes in Hong Kong and the People's Republic of China ("PRC"). Significant judgement is required in determining the amount of the provision of taxation and the timing of payment of the related taxations. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.
5. TURNOVER
Revenue, which is also the group's turnover, represents total invoiced value of goods supplied, less discounts and returns.
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
6. OTHER INCOME
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
9. INCOME TAX EXPENSE
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
10. PROFIT FOR THE YEAR
Of the consolidated profit attributable to shareholders of HK$32,315,441 (2005 : HK$39,014,576), HK$39,334,216 (2005 : HK$42,542,423) has been dealt with in the financial statements of the company.
11. DIVIDENDS
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
12. PROPERTY, PLANT AND EQUIPMENT
Group
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
12. PROPERTY, PLANT AND EQUIPMENT
Company
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
13. ADVANCED LEASE PAYMENTS
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
15. INTERESTS IN SUBSIDIARIES
Company
2006 2005 HK$ HK$
Unlisted shares, at cost 39,993,130 32,658,008 Less : Impairment (200,000) (200,000) ----------------------------------------------------------------------- 39,793,130 32,458,008
Amounts due from subsidiaries - 19,079,609 Less : Impairment - (785,384) ----------------------------------------------------------------------- - 18,294,225
Amount due to a subsidiary (8) (8) ----------------------------------------------------------------------- 39,793,122 50,752,225 -----------------------------------------------------------------------
At 31 March 2006, the amount due to a subsidiary is unsecured, interest-free and has no fixed terms of repayment and the amounts due from subsidiaries are repayable on demand and accordingly, are classified as current assets (note 18).
At 31 March 2005, the amounts due from/(to) subsidiaries were unsecured, interest-free and had no fixed terms of repayment. In the opinion of the directors, no part of amounts would be repayable within one year from the balance sheet date and the balances were therefore shown as non-current assets.
JV-28
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
15. INTERESTS IN SUBSIDIARIES (Continued)
Details of the subsidiaries as at 31 March 2006 are as follows :
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
16. INVENTORIES
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
17. TRADE AND OTHER RECEIVABLES
Group 2006 2005 HK$ HK$
Accounts receivable 3,511,654 3,133,328 Bills receivable (note 2.2) 3,435,122 - Deposits, prepayments and other receivables 1,334,007 3,012,763 ------------------------------------------------------------------------ 8,280,783 6,146,091 ------------------------------------------------------------------------
18. AMOUNTS DUE FROM SUBSIDIARIES
2006 2005 HK$ HK$
Trade * 7,371,509 8,414,502 Non-trade ** 20,251,108 - ------------------------------------------------------------------------ 27,622,617 8,414,502 Less : Impairment (975,147) - ------------------------------------------------------------------------ 26,647,470 8,414,502 ------------------------------------------------------------------------
* The amount is unsecured and arises from trading activities of which the settlement period is in accordance with normal commercial terms. Interest is charged on the overdue portion over HK$3,900,000 (equivalent to US$500,000) at 6% per annum.
** The amount is unsecured, interest-free and repayable on demand.
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
19. LOAN TO A SHAREHOLDER
The loan to a shareholder is unsecured, interest bearing at 6% per annum and is repayable on demand.
20. AMOUNT DUE TO A RELATED COMPANY/ A SHAREHOLDER
The amount is unsecured, interest-free and repayable on demand.
21. DIVIDEND PAYABLE
At a board meeting held on 7 February 2004, the directors declared a final dividend of HK$5,850,000 per share, totalling HK$11,700,000, which is expected to be payable to the shareholders upon successful initial listing of the company's shares on the Main Board of The Stock Exchange of Hong Kong Limited ("the HKEX").
22. LOANS FROM SHAREHOLDERS
The loans are unsecured, interest-free and repayable on demand by the respective shareholders with the consent of each other and upon successful initial listing of the company's shares on the Main Board of HKEX, whichever is earlier.
23. COLLATERALISED BANK ADVANCES
As described in note 2.2 to the financial statements, this amount represents the recognition of the bills discounted with recourse at 31 March 2006.
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
24. DEFERRED TAXATION
At 31 March 2006, the major deferred tax liabilities recognised in the balance sheets and the movements during the current and prior years :
Group and Company
Accelerated tax depreciation HK$
Balance at 1 April 2004 75,000 Charge to income statement 118,000
---------------------------------------------------------------------- Balance at 31 March 2005 and 1 April 2005 193,000 Charge to income statement (Note 9) 62,000 255,000 ---------------------------------------------------------------------- Balance at 31 March 2006
----------------------------------------------------------------------
2006 2005 HK$ HK$
Deferred tax liabilities recognised in the balance sheets of the group and company 255,000 193,000 ------------------------------------------------------------------------
At the balance sheet date, the major component of the deferred tax assets has not been recognised is the temporary difference in respect of the pre-operating expenses incurred by The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission), the PRC subsidiary of the company, of approximately HK$1,524,303 (2005 : HK$1,074,000) as it is not certain that future taxable profits will be available against which this deductible temporary difference can be utilised.
25. SHARE CAPITAL
2006 2005 HK$ HK$
Authorised : 100 ordinary shares of HK$100 each 10,000 10,000
-----------------------------------------------------------------------
Issued and fully paid : 2 ordinary shares of HK$100 each 200 200
-----------------------------------------------------------------------
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
26. RESERVES
Group
2006 2005 HK$ HK$
Exchange reserve 649,522 34,233 Fair value reserve (750,629) - Retained profits 98,664,880 83,261,781
------------------------------------------------------------------------ 98,563,773 83,296,014
------------------------------------------------------------------------
Details of the movements in the above reserves during the year are set out in the consolidated statement of changes in equity on page 6.
Company
The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
27. OPERATING LEASE ARRANGEMENTS
At 31 March 2006, the total future minimum rental receivable under non-cancellable operating leases in respect of land and buildings are as follows :
Group and Company 2006 2005 HK$ HK$
Within one year 53,265 76,800 In the second to fifth years - 53,265
------------------------------------------------------------------------- 53,265 130,065
-------------------------------------------------------------------------
At 31 March 2006, the total future minimum lease payments under non-cancellable operating leases in respect of land and buildings are payable as follows :
The group and the company lease land and buildings under operating leases. The leases run for an initial period of one to two years, with an option to renew the leases at the expiry dates. None of the leases includes contingent rentals.
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
28. CAPITAL COMMITMENTS
29. CONTINGENT LIABILITIES
The current and prior years' tax provisions have been prepared on the basis that the management fees and bonuses are deductible in the determination of the assessable profits of the company and the company is entitled to the offshore claims. During the year ended 31 March 2006, the company received enquiries from the Hong Kong Inland Revenue Department regarding these deductions and offshore claims. The directors have assessed the circumstances as at the date of approval of these financial statements, no additional tax provision being suggested since the outcome is uncertain. The total contingent tax exposures to the group and company in respect of the deductions and offshore claims are estimated to be approximately HK$2.8 million and HK$8.3 million, respectively.
At 31 March 2005, the group has a contingent liability of HK$3,906,240 in respect of the bills discounted with recourse.
Save as disclosed above, the group and company have no contingent liabilities at 31 March 2006.
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
30. DIRECTORS' REMUNERATION
Remuneration of the directors of the company disclosed pursuant to section 161 of the Hong Kong Companies Ordinance is as follows :
Group Company 2006 2005 2006 2005 HK$ HK$ HK$ HK$
Fees - - - - Other emoluments - - - -
------------------------------------------------------------------------
31. RELATED PARTY TRANSACTIONS
During the year, the following transactions were carried out with related parties :
Group 2006 2005 HK$ HK$
Transactions with a related company Rental expense 840,000 840,000 Management fee expense 4,434,600 4,434,600 Management bonus expense 2,914,238 3,337,730
Transactions with a shareholder Sales 95,570,482 82,241,295 Purchases 5,713,786 2,410,042 Sales commission expense 605,942 1,111,515 Interest income 234,000 229,550 Interest expenses - 46,957
Transaction with a director Rental expenses 240,000 240,000
------------------------------------------------------------------------
32. MAJOR NON-CASH TRANSACTION
During the year ended 31 March 2006, HK$4,004,689 (2005 : HK$3,582,073) of the dividends for the year was settled through the current account with a shareholder.
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The Joint Venture (name withheld and filed separately with The Securities and Exchange Commission
33. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES
The group's major financial assets and liabilities include bank balances and cash, available-for-sale financial assets, trade receivables and payables. Details of these financial instruments are disclosed in respective notes. The risks associated with these financial instruments and the policies on how to mitigate these risks are set out below. The management manages and monitors these exposures to ensure appropriate measures are implemented on a timely and effective manner.
(a) Interest rate risk
The group does not have any significant exposure to interest rate risk as the group currently has no financial assets and liabilities with floating interest rates.
(b) Foreign currency risk
The group's exposure to risk resulting from changes in foreign currency exchange rates is minimal.
(c) Credit risks
The company's bank balances are all deposited with major banks in Hong Kong and the PRC.
The carrying amount of trade and other receivables represent the group's maximum exposure to credit risk in relation to its financial assets. No other financial assets carry a significant exposure to credit risk. The group has no significant concentration of credit risk.
(d) Fair values
The fair values of the group's current financial assets and liabilities are not materially different from their carrying amounts because of the immediate or short term maturity of these financial instruments.
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