Universal Security Instruments, Inc. (NYSEMKT:UUU) produces a range of security systems such as smoke alarms, carbon monoxide alarms and door chimes. The company offers its products through a range of distributors such as wholesale, television sales, home retail stores and mail order companies. The company was founded in 1969 and has a current market capitalization of only $10.3 million. Average daily volume is 7,600 and the company’s fiscal 2013 revenues came to $15.4 million.

Universal Security Instruments

Universal Security Instruments, Inc. (NYSEMKT:UUU) recently reported fiscal second quarter results, which showed the company reporting a net loss of $2.5 million on net sales of $3.2 million, compared to a net loss of $220,000 for the same period last year. Unfortunately, Universal has extremely high operational gearing and a thin gross margin; until these two factors can be sorted out, the company is likely to remain loss making. Indeed, during the fiscal second quarter, the company reported a gross margin of only 25%, or $809k which was then eclipsed by $1.1 million of research and administration costs. What’s more, this loss was compounded by an additional $2.3 million income tax provision. Thankfully, this provision was a non-cash charge. Universal took this charge after the company realized it would no longer be entitled to previous deferred tax benefits.

Why does Universal look appealing?

So why does Universal look appealing? Well, with a current market capitalization of $10.3 million and shareholder equity of $24.3 million, the company is trading significantly below its book value. I calculate that book value stands at about $10.56 per share. For the most part, it would seem that the company is also financially stable. Current assets cover current liabilities nearly 17 times and debt is almost nonexistent. That said, I’m wary about the large amount of inventory that the company is currently holding. Inventory is booked at $6.05 million, around 25% of the company’s total assets based on the numbers reported within Universal’s last fiscal quarter.

Universal also has an interest in Hong Kong-based, joint venture, Eyston Company Limited, which manufactures security products within the China. Universal has booked its holding in Eyston at $15 million.

Universal’s figures on Eyston show company is making a profit

Universal does supply details on its Chinese joint venture, Eyston. Indeed, according to Universal’s figures, it would appear that while Universal is a 50% owner of Eyston, Universal also accounts for around 50% of Eyston’s sales. In particular, for the first six months of this year, Universal’s sales totaled $6.2 million, 70% of which was based on products acquired from Eyston. Universal’s figures on Eyston reveal that the company is making a profit, unlike Universal. Eyston’s net income was $1.2 million for the first six months of this year on sales of $12.7 million.

Having said all of that, it does not appear as if Universal is registering any financial benefit from its investment.  For the first six months of this year, it would appear that the company booked a loss of $128k on its investment in securities in Eyston, excluding currency translation.

Universal Security is an interesting play

So overall, Universal Security Instruments, Inc. (NYSEMKT:UUU) is an interesting play. While the company trades at a discount to its book value, profit is elusive. That said, the alarm systems that Universal produces are a fairly defensive product, so it likely that the company will see consistent demand for these. Still, Universal needs to get its house in order and lower costs before it can start to book a profit.