XNAS:USHS Quarterly Report 10-Q Filing - 3/31/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2012

OR

For the transition period from             to             

Commission file number 000-18291

U.S. HOME SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (214) 488-6300

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of May 8, 2012 there were 7,466,304 shares of the registrant’s common stock, $0.001 par value, outstanding.

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INDEX

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PART I. FINANCIAL INFORMATION

U.S. Home Systems, Inc.

Consolidated Balance Sheets

See accompanying notes.

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U.S. Home Systems, Inc.

Consolidated Statements of Operations

(Unaudited)

See accompanying notes.

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U.S. Home Systems, Inc.

Consolidated Statements of Stockholders’ Equity

Three Months Ended March 31, 2012

(Unaudited)

See accompanying notes.

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U.S. Home Systems, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

See accompanying notes.

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U.S. Home Systems, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

U.S. Home Systems, Inc. (the “Company” or “U.S. Home”), a Delaware corporation, is engaged in the specialty product home improvement business. The Company manufactures or procures, designs, sells and installs custom quality specialty home improvement products. The Company’s principal product lines include kitchen and bathroom cabinet refacing products, storage organization systems for closets and garages, and related accessories.

The accompanying interim consolidated financial statements of the Company and its wholly-owned subsidiaries as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 are unaudited; however, in the opinion of management, these interim financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and cash flows. All intercompany accounts and transactions are eliminated in consolidation. These financial statements should be read in conjunction with the consolidated annual financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

The Company’s accounting policies require it to apply methodologies, estimates and judgments that have significant impact on the results reported in the Company’s financial statements. The Company’s Annual Report on Form 10-K includes a discussion of those policies that management believes are critical and requires the use of complex judgment in their application. There have been no material changes to the Company’s accounting policies, or the methodologies or assumptions applied under them, since December 31, 2011.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments, including accounts receivable, marketable securities and accounts payable, approximate fair value due to their short term nature.

Accounts Receivable-trade

Trade accounts receivable consist primarily of amounts due from The Home Depot. Trade accounts receivable are reported net of an allowance for doubtful accounts. The Company provides for estimated losses of uncollectible accounts based upon specific identification of problem accounts and expected default rates based on historical default rates. An allowance for doubtful accounts is established through a provision for bad debt charged against income. The Company charges off accounts against the allowance when deemed to be uncollectible. Subsequent recoveries, if any, are credited to the allowance.

Investments

At March 31, 2012, the Company’s short-term investments consist of bond mutual funds which are classified as trading. Trading securities are recorded at fair value based on significant other observable inputs which are considered Level 2 securities in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). For the three months ended March 31, 2012 and 2011, the Company recognized $2,208 and $2,915 in interest earnings and no unrealized holding gains or losses. These amounts are included in “Other income” in the Company’s Consolidated Statements of Operations.

The equity method of accounting is used to account for investments in affiliated companies in which the Company does not exercise control and has a 20% or more voting interest. The Company has a 39.92% membership interest in Blue Viking Storage, LLC (“BV”), a distributor of garage organizer systems. For the three months ended March 31, 2012 and 2011, the Company’s share of loss from affiliated entities was approximately $200 and $1,000, respectively, and is included in the Company’s consolidated operating results. The Company’s initial investment of $195,000, reduced by its share of losses and increased by its share of income, to approximately $188,000 is included in “Other assets” on the Company’s Consolidated Balance Sheets at March 31, 2012. At December 31, 2011, the carrying value of the investment was approximately $188,000.

For the three months ended March 31, 2012 and March 31, 2011 the Company made payments to BV for purchases of garage storage products and consulting services of approximately $32,000 and $69,000, respectively. At March 31, 2012 and December 31, 2011, the amount due BV was approximately $8,000 and $29,000, respectively.

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U.S. Home Systems, Inc.

Notes to Consolidated Financial Statements

Goodwill

The amount of goodwill at March 31, 2012 and December 31, 2011 is $3,589,870. Goodwill is not amortized to expense. However, the Company is required to test goodwill for impairment at least on an annual basis or more often if an event or circumstance indicates that an impairment or decline in value may have occurred. The Company performed an impairment test as of December 31, 2011. During the three months ended March 31, 2012, the Company determined that additional changes in market conditions did not necessitate updating the Company’s December 31, 2011 analysis.

Warranties

In addition to the manufacturers’ warranties for defective materials, the Company provides each customer a limited warranty covering defective materials and workmanship. The estimated costs related to warranties are accrued at the time products are sold, based on various factors, including the Company’s stated warranty policies and practices, the historical frequency of claims, and the cost to replace or repair its products under warranty. Warranty expenses are included in the cost of remodeling contracts. The following table provides a reconciliation of the activity related to the Company’s accrued warranty expense.

Intangible Assets

Intangible assets other than goodwill consist of license agreements which allow the Company to sell certain products in selected markets. The gross carrying value of intangible assets was $252,505 at March 31, 2012 and December 31, 2011, and accumulated amortization was $199,900 and $193,587, respectively. During the three months ended March 31, 2012 and 2011, the Company did not incur any costs to renew or extend its intangible assets. Amortization expense was approximately $6,300 for the three months ended March 31, 2012 and 2011.

Recently Adopted Accounting Standards Updates

In May 2011, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that further addresses fair-value-measurement accounting and related disclosure requirements. The ASU clarifies the FASB’s intent regarding the application of existing fair-value measurement and disclosure requirements, changes the fair-value measurement requirements for certain financial instruments, and sets forth additional disclosure requirements for other fair-value measurements. The Company adopted this new standard effective January 1, 2012. The adoption of this guidance did not have an effect on the Company’s results of operations or financial position.

In September 2011, the FASB issued an ASU that amends the accounting guidance on goodwill impairment testing. The amendments in this accounting standard update are intended to reduce complexity and costs by allowing an entity the option to make a qualitative evaluation to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If after assessing qualitative factors an entity determines that is not more likely than not that the fair value of a reporting unit is less than its carrying value, then the current two-step impairment test is unnecessary. If an entity concludes otherwise, then it is required to test goodwill for impairment under the current two-step process. The amendments also improve previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The Company adopted this new standard effective January 1, 2012. The adoption of this guidance did not have an effect on the Company’s results of operations or financial position.

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U.S. Home Systems, Inc.

Notes to Consolidated Financial Statements

In September 2011, the FASB issued new disclosure guidance related to the presentation of the Statement of Comprehensive Income. This guidance eliminates the current option to report other comprehensive income and its components in the consolidated statement of stockholders’ equity. In December 2011 the requirement to present reclassification adjustments out of accumulated other comprehensive income on the face of the consolidated statement of income has been indefinitely deferred. The Company adopted this new standard effective January 1, 2012. The adoption of this guidance only has an impact on financial presentation and disclosure.

The Company’s current reporting segment consists only of the home improvement business. In the home improvement business, the Company manufactures or procures designs, sells and installs custom kitchen and bathroom cabinet refacing products, laminate and solid surface countertops and organization storage systems for closets and garages. The Company’s products and installed services are marketed in the United States exclusively through The Home Depot under a service provider agreement (SPA), which terminates on February 25, 2014, and a product supply agreement (“PSA”) related to The Home Depot’s Do-It-Yourself program (“DIY”), which terminates on December 31, 2013.

Revenues attributable to each of the Company’s product lines are as follows (in thousands):

The home improvement business is subject to seasonal trends. The generation of new orders for the Company’s products typically declines in the last six weeks of the year during the holiday season, which negatively impacts first quarter revenues and net income. Extreme weather conditions in the markets the Company serves occasionally impact revenues and net income.

Generally accepted accounting principles define fair value as a price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, generally accepted accounting principles establish a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows:

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — Include other inputs that are directly or indirectly observable in the marketplace.

Level 3 — Unobservable inputs which are supported by little or no market activity.

The Company measures cash equivalents at fair value using quoted market prices and marketable securities at fair value using other inputs that are directly observable in the marketplace.

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U.S. Home Systems, Inc.

Notes to Consolidated Financial Statements

Assets measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011 are as follows:

Inventories, net of applicable reserves, consisted of the following:

As of March 31, 2012 and December 31, 2011, the Company had no debt. The Company has a credit agreement with Wells Fargo Bank (the “Credit Agreement”). The Credit Agreement is secured by accounts receivable and other rights to payment, general intangibles, inventory and equipment of the Company’s domestic subsidiaries. The Company’s domestic subsidiaries are guarantors.

The Credit Agreement allows for borrowings up to $2.5 million for working capital. Borrowings and required payments under the Credit Agreement are based on an asset formula using accounts receivable and inventory. At March 31, 2012, the Company had no balance outstanding under the Credit Agreement and a borrowing capacity of $2,500,000. Interest on borrowings is payable monthly on the unpaid balance at LIBOR plus 2.75%. The Credit Agreement matures on August 22, 2014, at which time any outstanding principal and accrued interest is due and payable.

The Company’s prior loan agreement with Frost National Bank provided for a line of credit and a term loan. On March 31, 2011, the Company paid off the term loan in the amount of $889,000. The term loan was payable in monthly principal payments of $27,778, plus accrued interest at the prime rate plus 1.25% maturing on August 10, 2013.

The Company’s Credit Agreement contains covenants which require the Company to maintain a debt to adjusted tangible net worth ratio of less than 2.0 to 1, and no cumulative net loss for the preceding 4 quarters. In addition, the Company’s Credit Agreement contains other covenants, which among other matters, (i) limit the Company’s ability to incur indebtedness, merge, consolidate and sell assets; (ii) limit the company from making investment in fixed assets in any fiscal year in excess of an aggregate of $1,500,000, and (iii) limit any acquisition which requires more than $2,000,000 million in cash in any fiscal year. The Company is in compliance with all restrictive covenants at March 31, 2012.

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U.S. Home Systems, Inc.

Notes to Consolidated Financial Statements

Other Taxes

The Company is subject to audits in various jurisdictions from time to time for taxes, including sales and use tax, payroll tax, gross receipts tax and property tax. The Company is currently engaged in audit proceedings in certain states related to sales and use tax. The Company believes that it has adequately provided for all of the obligations for these taxes; however, the Company may be subject to additional sales and use tax obligations, penalties and interest assessments beyond the amount currently accrued at March 31, 2012. Accordingly, additional provisions may be recorded in the future as revised estimates are made or underlying matters are settled or resolved.

Litigation

The Company is subject to legal proceedings and claims that arise in the ordinary course of business. While the ultimate outcome of pending litigation and threatened lawsuits cannot be predicted with certainty, if decided adversely to or settled by the Company, individually or in the aggregate, the outcome may result in a liability material to the Company’s consolidated financial condition or results of operations. However, at this time, the Company believes that the ultimate resolution of these matters will not materially affect the consolidated financial position or results of operations of the Company.

On March 13, 2008, the Board of Directors authorized the repurchase of the Company’s outstanding stock up to $2 million. Any repurchase under the Company’s stock repurchase program may be made in the open market, at such times and such prices as the Company may determine appropriate. During the three months ended March 31, 2012, the Company did not repurchase any shares under the stock repurchase program. Cumulative repurchases under this program through March 31, 2012 were 376,018 shares, at a cost of approximately $1,111,000, of which all of the shares were cancelled and reclassified as authorized and unissued shares. Shares of common stock repurchased by the Company are recorded at cost as treasury stock and result in a reduction of stockholders’ equity in the Consolidated Balance Sheets until retired.

The following table sets forth the computation of basic and diluted net income per share for the periods indicated:

The calculation of diluted net income per share excludes all anti-dilutive shares. For the three months ended March 31, 2012 and 2011, approximately 0 and 40,000 common stock equivalents were not included in the computation of diluted net income per share, because the effect would have been anti-dilutive.

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The following should be read in conjunction with our unaudited financial statements for the three months ended March 31, 2012 included herein, and our audited financial statements for the years ended December 31, 2011, 2010 and 2009, and the notes to these financial statements included in the Company’s Annual Report on Form 10-K. Except for the historical information contained herein, certain matters set forth in this report are forward-looking statements that are based on management’s current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and as expressed in such forward-looking statements.

Overview

We are engaged in the specialty product home improvement business. In our home improvement business, we manufacture or procure, design, sell and install custom kitchen and bathroom cabinet refacing products and organizational storage systems for closets and garages.

We market, sell and install our products and installed services in the United States exclusively through The Home Depot under a service provider agreement (“SPA”) and a product supply agreement (“PSA”). At March 31, 2012 our home improvement business served The Home Depot in 69 markets covering 37 states. Our installed kitchen refacing products were available in all 69 markets encompassing approximately 1,810 The Home Depot stores and our installed bath products are offered in 23 markets, which include approximately 676 The Home Depot stores. Our kitchen refacing products are also available for purchase by The Home Depot customers or their designated installation contractor in conjunction with The Home Depot’s customer Do-It-Yourself (“DIY”) program in all US The Home Depot stores. In the DIY program, the customer, or their designated installation contractor, completes the installation of the home improvement project. In-store kitchen refacing displays provide information as to the availability of our products.

During the fourth quarter 2011, we developed a new line of Martha Stewart Living ^TM kitchen cabinet refacing products. We believe the Martha Stewart Living ^TM line of replacement kitchen cabinets has been very successful within The Home Depot. Our line of Martha Stewart Living ^TM cabinet refacing products provides a “refacing” solution to The Home Depot customers who prefer the look of the Martha Stewart Living ^TM line of cabinetry in a refacing product. We commenced offering these products to The Home Depot customers in January 2012. We believe the Martha Stewart Living ^TM line of kitchen refacing products will be an exciting extension to our kitchen refacing product portfolio.

Also during the fourth quarter 2011, we and The Home Depot agreed to test a new “installed” product category, “Replacement Kitchen Remodeling”. The pilot program commenced in late February 2012 in two markets in Florida. In connection with the test pilot, we are re-marketing customers who expressed an interest in kitchen refacing, however did not purchase our refacing products. We believe that these customers may be more interested in replacing their complete kitchen cabinetry rather than installing a refacing product. Under this program we purchase kitchen cabinetry and other related accessories from unaffiliated suppliers.

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Results of Operations

Results of operations for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011:

Management’s Summary of Results of Operations.

New orders in the three months ended March 31, 2012 increased 7.4% to $46,373,000, from $43,187,000 in the same period last year reflecting continued strong demand for our kitchen and bath refacing products.

New orders for our kitchen refacing products increased 4.3%. The increase reflected a larger number of customer appointments in the current period which we attribute to The Home Depot’s emphasis of our product category in their marketing initiatives. Additionally, we believe our new line of Martha Stewart Living ^TM kitchen cabinet refacing products was well received by customers contributing to our increase in new orders. Our line of Martha Stewart Living ^TM cabinet refacing products provides a “refacing” solution to The Home Depot customers who prefer the look of the Martha Stewart Living ^TM line of cabinetry in a refacing product.

New orders for our bath products increased 51.6% to $3,606,000 in the first quarter 2012 from $2,379,000 in the same quarter last year. The increase in new orders is principally due to increased marketing activities generating an increase in the number of customer appointments.

In February 2012, we commenced a test pilot program with The Home Depot in which we began offering a new product category, Replacement Kitchen Remodeling, in two markets in Florida. In connection with the test pilot, we are re-marketing customers who expressed an interest in kitchen refacing, however did not purchase our refacing products. We believe that these customers may be more interested in replacing their complete kitchen cabinetry rather than installing a refacing product. In the first quarter 2012, we generated $151,000 in new orders for Kitchen Replacement products. In April 2012, we and The Home Depot agreed to expand this test program to all our markets in Florida, with the exception of the Jacksonville, FL market. We anticipate we will begin offering Replacement Kitchen Remodeling products in the remaining Florida Markets in June 2012.

Despite the increase in new orders, we continued to be challenged by the credit decline rate for our and The Home Depot customers. Since the recession in 2008, we have experienced a significant increase in the credit decline rate for our customers who are seeking to finance their home improvement project. Historically, approximately 85% of our customers elected to utilize financing products, provided principally through The Home Depot, to fund their home improvement project. Customers must qualify under these programs to receive financing. Prior to 2008, the

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credit decline rate averaged 7.0%. In the first quarter last year the credit decline rate was 17.5%. In the first quarter 2012, the number of customers seeking financing declined to 70.7% (as compared to our historical average of 85% of customers) and the credit decline rate increased to 24.6%. During the last 24 months we have continued to seek other alternatives to aid our customers in securing financing for their projects. Although we believe that credit decline rates will ultimately improve, we cannot predict the timing of this improvement. Therefore we will continue to seek financing alternatives for our customers to improve the financing approval rate.

For the three months ended March 31, 2012, revenues increased 8.3% to $42,226,000 from $38,990,000 in the three months ended March 31, 2011. The increase in revenues resulted from sustained increases in new orders for our kitchen and bath refacing products.

Gross profit for the first quarter 2012 was $22,475,000 or 53.2% of revenues, as compared with $20,808,000 or 53.3% of revenues in the same period last year. Gross profit as a percentage of revenue was unchanged as compared to the prior year period. The increase in gross profit in dollar terms reflects higher revenues in the period as compared to the first quarter last year. Gross profit margin as a percentage of revenues increased sequentially from 52.9% in the fourth quarter ended December 31, 2011 on favorable sales mix and manufacturing cost efficiencies in the first quarter 2012.

Net income was $853,000, or $0.11 per diluted share for the three months ended March 31, 2012, as compared with $560,000, or $0.08 per share in the same period last year.

Results of Operations – Detail Review

Revenues and new orders for the three months ended March 31, 2012 and 2011, and backlog of uncompleted orders at March 31, 2012 and 2011 attributable to each of our product lines were as follows (in thousands):

Kitchen refacing and countertops – New orders for kitchen and countertop products were $41,810,000 in the three months ended March 31, 2012 as compared to $40,099,000 in the same period last year. The increase reflects an increase in the number of customer appointments resulting from marketing initiatives principally by The Home Depot and the successful introduction of our new line of Martha Stewart Living ^TM kitchen cabinet refacing products. This increase was partially offset by an increase in customer credit declines. Although the number of kitchen refacing customers seeking financing declined 4.9% in the first quarter 2012 as compared to the same period last year, the credit decline rate increased to 25.0% compared with 17.7%, respectively.

Revenues from kitchen refacing and countertop products increased 6.0% to $38,473,000 in the three months ended March 31, 2012, from $36,294,000 in the same period last year. The increase in revenues principally resulted from an increase in demand.

Bathroom refacing – Revenues from bathroom refacing products were $2,971,000 in the first quarter 2012 as compared with $1,940,000 in the first quarter 2011. The increase in revenues reflected a 51.6% increase in new orders to $3,606,000 in the first quarter 2012 from $2,379,000 in the same quarter last year. The increase in new orders is principally due to increased marketing activities generating an increase in the number of customer appointments.

Organization Systems – Revenues from organization systems products were $782,000 in the three months ended March 31, 2012 as compared to $756,000 in the prior year period. New orders for organization systems products were $806,000 and $709,000, respectively.

Kitchen Replacement – In February 2012 we commenced a test pilot program with The Home Depot in which we are offering a new product category, Replacement Kitchen Remodeling, in two markets in Florida. In

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connection with the test pilot, we are re-marketing customers who expressed an interest in kitchen refacing, however did not purchase our refacing products. We believe that these customers may be more interested in replacing their complete kitchen cabinetry rather than installing a refacing product. In the first quarter 2012, we generated $151,000 in new orders for Kitchen Replacement products. None of the orders were installed in the period as our cycle time from order date to completion date is estimated to be 60 days for Kitchen Replacement products. Consequently, we had no revenues for this product in the quarter ended March 31, 2012.

Gross profit for the first quarter 2012 was $22,475,000 or 53.2% of revenues, as compared with $20,808,000 or 53.3% of revenues in the same period last year. Gross profit as a percentage of revenue was unchanged as compared to the prior year period. The increase in gross profit in dollar terms reflects higher revenues in the period as compared to the first quarter last year.

Branch operating expenses were $1,821,000 or 4.3% of revenues in the first quarter 2012, as compared to $1,921,000, or 4.9% of revenues in the first quarter last year. Branch operating expenses are primarily comprised of fixed costs associated with each of our sales and installation centers, including rent, telecommunications, branch administration salaries and supplies. The decrease in branch operating expense is principally due to reduced rent expenses, reflecting successful efforts to “right size” certain of our sales and installation centers, as well as lower lease rates on certain lease renewals.

Marketing expenses were $10,433,000 or 24.7% of revenues in the first quarter 2012 as compared with $9,308,000 or 23.9% of revenues in the first quarter last year. Marketing expenses consist primarily of marketing fees we pay to The Home Depot on each sale, commissions we pay to a third party in-store service provider on each sale in which the customer lead was originated by them, advertising, and personnel costs related to administration of our in-store marketing program and our marketing center. Also in connection with our third party in-store service provider, if certain performance criteria are met, a bonus is payable to the marketing firm, and if the criteria are not met, a certain refund is due us. Marketing expense in dollar terms in the first quarter 2012 increased principally due to higher advertising expenditures and increased marketing fees paid to The Home Depot as a result of higher revenues.

Sales expenses, which consist primarily of sales commissions and bonuses, sales manager salaries, sales materials, and travel and recruiting expenses, were $5,815,000, or 13.8% of revenues for the first quarter 2012, as compared to $5,535,000, or 14.2% of revenues in the prior year first quarter. Sales expenses in dollar terms increased principally as a result of higher compensations costs, including salary ($123,000), commissions and incentives on higher sales volume ($120,000) and higher payroll taxes ($68,000).

General and administrative expenses were $3,013,000 or 7.1% of revenues in the first quarter 2012, as compared to $3,090,000 or 7.9% of revenues in the first quarter last year. The decrease in general and administrative expense as a percentage of revenue is primarily due to leverage of costs on higher revenues.

Liquidity and Capital Resources

We have historically financed our liquidity needs through cash flows from operations, borrowing under bank credit agreements and proceeds from the sale of common stock. At March 31, 2012, we had approximately $13,229,000 in cash and cash equivalents and $819,000 in marketable securities. Working capital, defined as current assets less current liabilities, was $20,904,000 at March 31, 2012 as compared to $19,725,000 at December 31, 2011.

Net cash utilized in operations was $714,000 in the three months ended March 31, 2012 as compared to $402,000 in the same period last year. Cash utilized in operations reflected an increase in accounts receivable of $2,202,000 in the first quarter 2012 and $2,176,000 in the same period last year. The increase in receivables principally reflects higher revenues at the end of the each respective period.

In the first quarter 2012, we utilized $245,000 for capital expenditures, principally consisting of machinery, equipment, computer hardware and software and furniture and fixtures. Capital expenditures in the first quarter 2011 were $145,000. We generated approximately $285,000 in proceeds in the first quarter 2012 from issuance of common stock upon the exercise of stock options as compared with $163,000 in the same period last year.

During the first quarter 2011, we utilized $889,000 to pay off and retire a term loan we had outstanding with Frost Bank.

We had no debt outstanding at March 31, 2012. We have a credit agreement with Wells Fargo Bank (Credit Agreement). The Credit Agreement replaced our prior loan agreement with Frost National Bank (“Frost Bank”). The Credit Agreement allows for borrowings up to $2.5 million for working capital. Borrowings and required payments under the Credit Agreement are based on an asset formula using accounts receivable and inventory. At March 31, 2012, we had no balance outstanding under the Credit Agreement and a borrowing capacity of $2,500,000. Interest on the Credit Agreement is payable monthly on the unpaid balance at LIBOR plus 2.75%. The Credit Agreement matures on August 22, 2014, at which time any outstanding principal and accrued interest is due and payable.

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The Credit Agreement contains covenants which require us to maintain a debt to adjusted tangible net worth ratio of less than 2.0 to 1, and have no cumulative net loss for the preceding four quarters. In addition, the Credit Agreement contains other covenants, which among other matters, (i) limit the Company’s ability to incur indebtedness, merge, consolidate and sell assets; (ii) limit the company from making investment in fixed assets in any fiscal year in excess of an aggregate of $1,500,000, and (iii) limit any acquisition which requires in any fiscal year $2.0 million cash. We are in compliance with all restrictive covenants at March 31, 2012.

On March 13, 2008, our Board of Directors authorized a repurchase program for up to $2.0 million of our outstanding stock. Any repurchase under our stock repurchase program may be made in the open market at such times and such prices as we may determine appropriate. Cumulative repurchases under this authorization through March 31, 2012 were 376,018 shares at a cost of approximately $1,111,000. During the first quarter 2012 and 2011 we did not repurchase any shares under this program.

We operate principally in leased facilities, and in most cases, management expects that leases currently in effect will be renewed or replaced by other leases of a similar nature and term. Escalation charges imposed by lease agreements are not significant.

In connection with our business strategy, we may open sales and installation centers as we enter new markets or we may utilize our SCN program to expand into additional markets. If we open facilities, it would require expenditures for facility improvements, machinery, furniture and fixtures, inventory, product displays, sales kits and requires cash to fund operating losses during the initial months following the opening of a facility. In addition, our agreement with The Home Depot may provide opportunities to introduce additional products in markets we serve. Introducing additional products requires expenditures customarily associated with rolling out products in new territories.

We believe that the current economic environment is improving. We believe we will be successful in executing our initiatives and that we will have sufficient cash, including cash generated by operations, and borrowing capacity under our credit facilities to meet our anticipated working capital needs for our current operations over the next twelve months, and that such capacity will be adequate to fund the expansion of our operations under our agreement with The Home Depot for the next 12-18 months. However, if we need additional capital to execute our business strategy or fund our operations, we may have to issue equity or debt securities. If we issue additional equity securities, the ownership percentage of our stockholders will be reduced. If we borrow money, we may incur significant interest charges which could reduce our net income. Holders of debt or preferred securities may have rights, preferences or privileges senior to those of existing holders of our common stock. However, additional financing may not be available to us, or if available, such financing may not be on favorable terms.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. For a discussion of our critical accounting policies, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” included in our Annual Report on Form 10-K for the year ended December 31, 2011 and Note 2 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2011, which includes a summary of the significant accounting policies and methods used by us in the preparation of our financial statements. There have been no material changes to the critical accounting policies discussed in our Annual Report on Form 10-K for the year ended December 31, 2011.

Recently Adopted Accounting Standards Updates

In May 2011, the FASB issued an Accounting Standards Update (ASU) that further addresses fair-value-measurement accounting and related disclosure requirements. The ASU clarifies the FASB’s intent regarding the application of existing fair-value measurement and disclosure requirements, changes the fair-value measurement requirements for certain financial instruments, and sets forth additional disclosure requirements for other fair-value measurements. The Company adopted this new standard effective January 1, 2012. The adoption of this guidance did not have an effect on the Company’s results of operations or financial position.

In September 2011, the FASB issued an ASU that amends the accounting guidance on goodwill impairment testing. The amendments in this accounting standard update are intended to reduce complexity and costs

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by allowing an entity the option to make a qualitative evaluation to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If after assessing qualitative factors an entity determines that is not more likely than not that the fair value of a reporting unit is less than its carrying value, then the current two-step impairment test is unnecessary. If an entity concludes otherwise, then it is required to test goodwill for impairment under the current two-step process. The amendments also improve previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The Company adopted this new standard effective January 1, 2012. The adoption of this guidance did not have an effect on the Company’s results of operations or financial position.

In September 2011, the FASB issued new disclosure guidance related to the presentation of the Statement of Comprehensive Income. This guidance eliminates the current option to report other comprehensive income and its components in the consolidated statement of stockholders’ equity. In December 2011 the requirement to present reclassification adjustments out of accumulated other comprehensive income on the face of the consolidated statement of income has been indefinitely deferred. The Company adopted this new standard effective January 1, 2012. The adoption of this guidance only has an impact on financial presentation and disclosures.

Off-Balance Sheet Arrangements

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or variable interest entities, or VIEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of March 31, 2012, we are not involved in VIE or off-balance sheet transactions.

We may be subject to financial market risks from changes in short-term interest rates since our credit facility contains an interest rate that varies with interest rate changes in the Libor rate. However, we currently have no outstanding balance under our credit facility. If we were to borrow funds under our credit facility we believe that these rates would have to increase significantly for the resulting adverse impact on our interest expense to be material to our results of operations.

Evaluation of Disclosure Controls and Procedures.

As required by Rule 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934 (Exchange Act), the Company’s management has carried out an evaluation, with the participation and under the supervision of its chief executive officer and chief financial officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of March 31, 2012. Disclosure controls and procedures means controls and other procedures of the Company that are designed to ensure that information required to be disclosed in the reports the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its chief executive officer and chief financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

Management conducted its evaluation of disclosure controls and procedures under the supervision of its chief executive officer and chief financial officer. Based upon such evaluation, the Company’s chief executive officer and chief financial officer concluded that as of March 31, 2012, the Company’s disclosure controls and procedures were effective.

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Changes in Internal Control over Financial Reporting.

There have not been any changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f)) that occurred during the first fiscal quarter of 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

We are subject to legal proceedings and claims that arise in the ordinary course of business. While the ultimate outcome of pending litigation and threatened lawsuits cannot be predicted with certainty, an unfavorable outcome could have a negative impact on the Company and its financial condition and results of operations. However, at this time, the Company believes that the ultimate resolution of these matters will not have a material effect on our consolidated financial position or results of operations.

In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed under “Risk Factors” in our Form 10-K for fiscal 2011 as filed with the SEC. There have not been any substantive changes to the Risk Factors described in our 2011 Form 10-K. These risks could materially and adversely affect our business, financial condition and results of operations. The risks described in our Form 10-K are not the only risks we face. Our operations could also be affected by additional factors that are not presently known to us or by factors that we currently consider immaterial to our business.

During the first quarter 2012, we did not repurchase any shares of our common stock. Our current common stock repurchase program was announced on March 18, 2008. Our Board of Directors authorized the repurchase of up to $2.0 million of the Company’s common stock. Any repurchase of common stock under our stock repurchase program may be made in the open market at such time and such prices as our CEO may from time to time determine. The program does not have an expiration date. Cumulative repurchases under this program through March 31, 2012 were 376,018 shares at a cost of approximately $1,111,000.

(a) Exhibits. The exhibits required to be furnished pursuant to Item 6 are listed in the Exhibit Index filed herewith, which Exhibit Index is incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on May 15, 2012 on its behalf by the undersigned, thereto duly authorized.

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