As used throughout this Report, "we," "our," "the Company" "USI" and similar words refers to Universal Security Instruments, Inc.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain forward-looking statements reflecting our current expectations with respect to our operations, performance, financial condition, and other developments. These forward-looking statements may generally be identified by the use of the words "may", "will", "believes", "should", "expects", "anticipates", "estimates", and similar expressions. These statements are necessarily estimates reflecting management's best judgment based upon current information and involve a number of risks and uncertainties. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and readers are advised that various factors could affect our financial performance and could cause our actual results for future periods to differ materially from those anticipated or projected. While it is impossible to identify all such factors, such factors include, but are not limited to, those risks identified in our periodic reports filed with the Securities and Exchange Commission, including our most recent Annual Report on Form 10-K.

overview

We are in the business of marketing and distributing safety and security products which are primarily manufactured through our 50%-owned Hong Kong Joint Venture. Our financial statements detail our sales and other operational results only, and report the financial results of the Hong Kong Joint Venture using the equity method. Accordingly, the following discussion and analysis of the three and six months ended September 30, 2008 and 2007 relate to the operational results of the Company only. A discussion and analysis of the Hong Kong Joint Venture's operational results for these periods is presented below under the heading "Joint Venture."

Discontinued Canadian Operations

In October 2006, we formed 2113824 Ontario, Inc., an Ontario corporation, as a wholly-owned subsidiary of the Company for the purpose of acquiring a two-thirds interest in two Canadian corporations, International Conduits, Ltd. (Icon) and Intube, Inc. (Intube). Icon and Intube are based in Toronto, Canada and manufacture and distribute electrical mechanical tubing (EMT) steel conduit. Icon also sold home safety products, primarily purchased from the Company, in the Canadian market. The primary purpose of the Icon and Intube acquisition was to expand our product offerings to include EMT steel conduit, and to provide this product and service to the commercial construction market. On April 2, 2007, Icon and Intube were merged under the laws of Ontario to form one corporation.

In September 2007, Icon entered into a credit agreement with CIT Financial, Ltd. to provide a term loan and a line of credit facility. These loans are secured by all of the assets of Icon and by the corporate guarantees of the Company and our USI Electric subsidiary, as further explained below.

As a result of continuing losses at Icon, management undertook an evaluation of the goodwill from our acquisition of Icon to determine whether the value of the goodwill has been impaired in accordance with FAS No. 142, "Goodwill and Other Intangible Assets". Based on that evaluation, management determined that the value of the goodwill from our acquisition of Icon was impaired, and recognized an impairment charge of US$1,926,696 for the goodwill as of December 31, 2007. The impairment was recorded in discontinued operations in the consolidated statements of operations for the year ended March 31, 2008.

At the time of the investment in Icon, management projected that the established U.S. sales network would allow us to increase sales of EMT to U.S. customers. Despite the Company's efforts, Icon suffered continuing losses, and the Company was not successful in increasing Icon's sales in the face of competition and a weakening U.S. dollar. On January 29, 2008, Icon received notice from CIT Financial, Ltd. (CIT Canada), Icon's principal and secured lender, that Icon was in default under the terms of the Credit Agreement dated September 22, 2007 between Icon and CIT Canada and demanding immediate payment of all of Icon's obligations to CIT Canada under the Credit Agreement. On February 11, 2008, the assets of Icon were placed under the direction of a court appointed receiver, the operations of Icon were suspended and the assets of Icon were classified as assets held for sale in the consolidated balance sheets. Accordingly, the consolidated statements of earnings and the related note disclosures reflect the operations of Icon as discontinued operations for all periods presented.

On July 16, 2008, the receiver in possession of Icon's assets held a public auction to liquidate production machinery and equipment held for sale. These assets were recorded at their appraised net realizable value of US$831,555 as of March 31, 2008. During the quarter ended June 30, 2008, the Company revised its estimate based on further communications with the auctioneer and appraisers and adjusted the carrying value to approximately $1,020,000, resulting in a write-up of approximately US$190,000 during the quarter ended June 30, 2008. Auction proceeds, net of auction fees, amounted to US$1,033,652.

On September 22, 2008, Icon's obligations were settled in the receivership action by Ontario Superior Court order. After complete liquidation of the assets of Icon, the receiver held CAD$2,419,831 (US$2,314,326). Of this amount, CAD$2,150,000 (US$2,056,260) was distributed to CIT Canada in partial settlement of Icon's secured obligations to CIT Canada. The remaining cash of CAD$260,009 (US$258,066) is currently held by the receiver for other obligations. As a result of the settlement of Icon's obligations, a gain of CAD$5,101,674 (US$4,910,718) was realized by Icon in the quarter ended September 30, 2008. Approximately US$3,000,000 of the gain related to extinguishment of liabilities due to unsecured creditors. The company applied guidance in FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and determined that a legal release of the liabilities had been achieved to allow recognition of the gain on extinguishment of liabilities. This gain was partially offset in consolidation by the US$1,481,003 after-tax effect loss recognized by the Company in settlement of its guarantee of Icon's secured debt and other losses attributable to the Icon discontinued operations to arrive at the gain from discontinued operations of $3,381,254 for the six months ended September 30, 2008.

At September 30, 2008, the assets of Icon held by the receiver consisted of cash of US$260,009, and its liabilities include post-receivership accounts payable of US$87,009 and a pre-receivership trade account payable of approximately US$173,000. The pre-receivership trade account payable is subject to settlement in accordance with a "claim process" administrated by the receiver. To the extent any portion of the pre-receivership account payable is ultimately disallowed, that portion will reduce the gain from discontinued operations.

The major classes of assets and liabilities of businesses reported as discontinued operations included in the accompanying consolidated balance sheets shown below.

                                          September 30, 2008     March 31, 2008
Assets
Cash                                     $            260,009   $        823,550
Trade receivables, net                                      0            371,793
Inventories                                                 0            817,022
Property, plant and equipment - net                         0            831,555
Other assets                                                0              6,811
Assets of discontinued operations        $            260,009   $      2,850,731

Liabilities
Accounts payable, trade and other        $            260,009   $      3,344,624
Notes payable - bank                                        0          4,478,826
Liabilities of discontinued operations   $            260,009   $      7,823,450

In the accompanying consolidated financial statements, the results of Icon for the three and six months ended September 30, 2008 have been restated and are presented as the results of discontinued operations, and certain other prior year amounts have been reclassified in order to conform with the current year's presentation.

Results of Operations

Three Months Ended September 30, 2008 and 2007

Sales. Net sales for the three months ended September 30, 2008 were $8,381,379 compared to $9,689,537 for the comparable three months in the prior fiscal year, a decrease of $1,308,158 (13.5%). The primary reasons for the decrease in net sales were (i) lower sales volumes of our core product lines, including smoke alarms and carbon monoxide alarms, to the electrical distribution trade due to a decrease in new home construction during the quarter, and (ii) our inability to import ground fault circuit interrupter (GFCI) units because the manufacturer has not yet received certifications for mandated UL changes to the units.

Gross Profit Margin. Gross profit margin is calculated as net sales less cost of goods sold expressed as a percentage of net sales. Our gross profit margin was 22.6% and 20.0% of sales for the quarters ended September 30, 2008 and 2007, respectively. The increase in gross profit margin was primarily due to changes in the mix of products sold.

Expenses. Research and development, and selling, general and administrative expenses increased by $123,626 from the comparable three months in the prior year. As a percentage of net sales, these expenses increased to 20.7% for the three month period ended September 30, 2008, from 16.6% for the 2007 period. The increase in costs as a percentage of net sales was primarily due to fixed costs that did not decrease at the same rate as sales.

Interest Expense and Income. Our interest expense on cash deposits, net of interest charges, was $3,259 for the quarter ended September 30, 2008, compared to net interest expense of $12,364 for the quarter ended September 30, 2007. Net interest expense in the prior year's quarterly period resulted from higher borrowings by us in support of our Canadian subsidiary.

Income Taxes. During the quarter ended September 30, 2008, the Company had a net income tax benefit of $868,443 due to net operating losses generated principally as a result of the loss recognized on the settlement of the Company's guarantee of the debt of its Canadian subsidiary. For the corresponding 2007 period, the Company has a provision for income taxes of $108,000.

Net Income. We reported net income of $4,091,214 for the quarter ended September 30, 2008, compared to net income of $318,130 for the corresponding quarter of the prior fiscal year. The primary reason for the increase in net income is the gain of $3,434,913 recognized as a result of the settlement of the obligations of our Canadian subsidiary.

Six Months Ended September 30, 2008 and 2007

Sales. Net sales for the six months ended September 30, 2008 were $14,574,180 compared to $19,375,195 for the comparable six months in the prior fiscal year, a decrease of $4,801,015 (24.8%). The primary reason for the decrease in net sales was lower sales volumes of our core product lines, including smoke alarms and carbon monoxide alarms, to the electrical distribution trade due to a decrease in new home construction during the period.

Gross Profit Margin. The gross profit margin is calculated as net sales less cost of goods sold expressed as a percentage of net sales. The Company's gross profit margin decreased from 24.1% for the period ended September 30, 2007 to 23.8% for the current period ended September 30, 2008. The decrease in gross profit margin was primarily due to a change in the mix of products sold.

Expenses. Research and development, and selling, general and administrative expenses decreased by $171,631 from the comparable six months in the prior year. As a percentage of sales, these expenses were 21.0% for the six month period ended September 30, 2008 and 16.7% for the comparable 2007 period. The primary reason for the increase in expenses as a percentage of sales is that these expenses did not decrease at the same rate as sales.

Interest Expense and Income. Our interest income net of interest expense was $15,576 for the six months ended September 30, 2008, compared to net interest expense of $70,861 for the six months ended September 30, 2007. Interest expense in the comparable period of the last year resulted primarily from borrowings to support the Canadian subsidiary.

Income Taxes. During the six months ended September 30, 2008, the Company recorded an income tax expense from continuing operations of $198,795. For the corresponding 2007 period, the Company had a tax expense of $537,876.

Net Income. We reported net income of $4,494,694 for the six months ended September 30, 2008 compared to net income of $1,109,133 for the corresponding period of the prior fiscal year. The primary reasons for the increase is the gain of $3,381,254 recognized as a result of the settlement of the obligations of our Canadian subsidiary.

Financial Condition and Liquidity

The Company has a Factoring Agreement which supplies both short-term borrowings and letters of credit to finance foreign inventory purchases. The maximum amount available under the Factoring Agreement is currently $7,950,000. Based on specified percentages of our accounts receivable and inventory and letter of credit commitments, we had $4,188,000 available under the Factoring Agreement. There is $625,594 borrowed under this agreement as of September 30, 2008. The interest rate under the Factoring Agreement on the uncollected factored accounts receivable and any additional borrowings is equal to the prime rate of interest charged by our lender. At September 30, 2008, the prime rate was 5.0%. Borrowings are collateralized by all of our accounts receivable and inventory.

Our factored accounts receivable as of the end of our last fiscal year (net of allowances for doubtful accounts) were $5,600,408, and were $5,848,088 as of September 30, 2008. Our prepaid expenses as of the end of our last fiscal year were $206,197, and were $342,790 as of September 30, 2008. The increase in prepaid expenses during the first three months of the current fiscal year is due to the timing of premium payments to various insurance carriers.

Operating activities used cash of $3,073,310 for the six months ended September 30, 2008. This was primarily due to the operations of the discontinued subsidiary and to an increase in accounts receivable of $698,818, an increase in accounts payable and accrued expenses of $1,663,855, increases in inventories and prepaid expenses of $3,463,975, and earnings of the Joint Venture of $892,962. For the same period last year, operating activities used cash of $2,217,104, primarily as a result of unremitted earnings of the Hong Kong Joint Venture, increases in inventory and prepaid expenses, and the operations of the discontinued subsidiary.

Investing activities provided cash of $2,807,341 during the six months ended September 30, 2008, principally as a result of the activities of the discontinued operations. Investing activities used $1,520,801 in the prior period.

Financing activities used cash of $3,575,517 during the six months ended September 30, 2008, principally as a result of the activities of discontinued operations. In the comparable six months in the prior year, financing activities provided cash of $4,252,560, primarily from the activities of the discontinued operations.

We believe that funds available under the Factoring Agreement, distributions from the Joint Venture, and our line of credit facilities provide us with sufficient resources to meet our requirements for liquidity and working capital in the ordinary course of our business over the next twelve months and over the long term.

Joint Venture

Net Sales. Net sales of the Joint Venture for the three and six months ended September 30, 2008 were $11,870,728 and $19,667,762, respectively, compared to $6,811,530 and $15,773,412, respectively, for the comparable period in the prior fiscal year. Although the Joint Venture's sales to the Company increased, primarily for products purchased by the Company for sale to the Company's new national home improvement retailer customer, the 74.3% and 24.7% respective increases in net sales by the Joint Venture for the three and six month periods were due to higher volumes of sales of smoke alarm products to non-related customers in the Australian and European market. The Joint Venture's management believes that these increases in net sales to the European market were due to increased market share in those markets.

Gross Margins. Gross margins of the Joint Venture for the three month period ended September 30, 2008 increased to 28.0% from 25.9% for the 2007 corresponding period. For the six month period ended September 3, 2008, gross margins increased to 26.1% from the 26.0% gross margin of the prior year's corresponding period. Since gross margins depend on sales volume of various products, with varying margins, increased sales of higher margin products and decreased sales of lower margin products affect the overall gross margins. The increase in the Joint Venture's gross margins for the three and six month periods were due to the increase in the sales of products to customers in the Australian and European markets.

Expenses. Selling, general and administrative expenses were $1,389,104 and $2,607,670, respectively, for the three and six month periods ended September 30, 2008, compared to $1,051,125 and $2,296,985 in the prior year's respective periods. As a percentage of sales, expenses were 11.7% and 13.3% for the three and six month periods ended September 30, 2008, compared to 15.4% and 14.6% for the three and six month periods ended September 30, 2007. The decrease in selling, general and administrative expense as a percent of sales was primarily due to variable costs that remained constant despite increased net sales.

Interest Income and Expense. Interest expense, net of interest income, was $4,267 and $5,761, respectively, for the three and six month periods ended September 30, 2008, compared to net interest expense of $9,594 and $15,569, respectively, for the prior year's periods. The reduction in net interest expense resulted from a decrease in the Joint Venture's borrowings.

Net Income. Net income for the three and six months ended September 30, 2008 were $1,732,256 and $2,382,837, respectively, compared to $790,453 and $1,871,242, respectively, in the comparable periods last year. The 119.0% and 23.9% respective increases in net income for the three and six month periods were due primarily to increased sales volume and gross margins as noted above

Liquidity. Cash needs of the Joint Venture are currently met by funds generated from operations. During the six months ended September 30, 2008, working capital increased by $2,356,309 from $8,953,871 on March 31, 2008 to $11,310,380 on September 30, 2008.

Critical Accounting Policies

Management's discussion and analysis of our consolidated financial statements and results of operations are based on our Consolidated Financial Statements included as part of this document. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates, including those related to bad debts, inventories, income taxes, and contingencies and litigation. We base these estimates on historical experiences and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect management's more significant judgments and estimates used in the preparation of its consolidated financial statements. For a detailed discussion on the application on these and other accounting policies, see Note A to the consolidated financial statements included in Item 8 of the Form 10-K for the year ended March 31, 2008. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty and actual results could differ from these estimates. These judgments are based on our historical experience, terms of existing contracts, current economic trends in the industry, information provided by our customers, and information available from outside sources, as appropriate. Our critical accounting policies include:

Our revenue recognition policies are in compliance with Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" issued by the Securities and Exchange Commission. We recognize sales upon shipment of products net of applicable provisions for any discounts or allowances. The shipping date from our warehouse is the appropriate point of revenue recognition since upon shipment we have substantially completed our obligations which entitle us to receive the benefits represented by the revenues, and the shipping date provides a consistent point within our control to measure revenue. Customers may not return, exchange or refuse acceptance of goods without our approval. We have established allowances to cover anticipated doubtful accounts based upon historical experience.

Inventories are valued at the lower of market or cost. Cost is determined on the first-in first-out method. We have recorded a reserve for obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. Management reviews the reserve quarterly. Shipping and handling costs incurred by the Company to deliver goods to its customers are not included in costs of goods sold but are presented as an element of selling, general and administrative expense within the condensed consolidated statements of earnings. The Company incurred $175,676 and $189,851 of shipping and handling costs in the quarters ended September 30, 2008 and 2007, respectively.

Impairment of Long-Lived Assets: The Company's policy is to review its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with Statement of Financial Accounting Standards ("SFAS"), SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets", ("SFAS No. 144"). The Company recognizes an impairment loss when the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. The measurement of the impairment losses to be recognized is based upon the difference between the fair value and the carrying amount of the assets.

We are subject to lawsuits and other claims, related to patents and other matters. Management is required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is based on a careful analysis of each individual issue with the assistance of outside legal counsel. The required reserves may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters.

We generally provide warranties from one to ten years to the non-commercial end user on all products sold. The manufacturers of our products provide us with a one-year warranty on all products we purchase for resale. Claims for warranty replacement of products beyond the one-year warranty period covered by the manufacturers are immaterial and we do not record estimated warranty expense or a contingent liability for warranty claims.