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EX-31.2 - SECTION 302 CFO CERTIFICATION - MIDAS INCdex312.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - MIDAS INCdex321.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - MIDAS INCdex311.htm

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 2, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 01-13409

 

 

MIDAS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   36-4180556

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1300 Arlington Heights Road, Itasca, Illinois   60143
(Address of Principal Executive Offices)   (Zip Code)

(630) 438-3000

(Registrant’s telephone number, including area code)

 

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ¨    NO  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer, as defined in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer   ¨    Accelerated Filer   x
Non-Accelerated Filer   ¨    Smaller Reporting Company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act)    YES  ¨    NO  x

The number of shares of the Registrant’s Common Stock, $.001 par value per share, outstanding as of November 1, 2010 was 14,195,434.

 

 

 


 

PART I. FINANCIAL INFORMATION

 

Item 1: Condensed Financial Statements

MIDAS, INC.

CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

(In millions, except for earnings per share)

 

     For the quarter
ended fiscal September
    For the nine months
ended fiscal September
 
     2010     2009     2010     2009  
     (13 weeks)     (13 weeks)     (39 weeks)     (39 weeks)  

Sales and revenues:

        

Franchise royalties and license fees

   $ 13.8      $ 14.0      $ 40.7      $ 41.0   

Real estate revenues from franchised shops

     8.0        8.2        23.8        24.6   

Company-operated shop retail sales

     19.7        17.0        60.0        49.4   

Replacement part sales and product royalties

     5.9        5.9        16.9        18.0   

Software sales and maintenance revenue

     1.4        1.3        4.4        4.1   
                                

Total sales and revenues

     48.8        46.4        145.8        137.1   
                                

Operating costs and expenses:

        

Franchised shops – occupancy expenses

     5.7        5.8        16.6        17.1   

Company-operated shop parts cost of sales

     5.9        4.8        17.1        13.7   

Company-operated shop payroll and employee benefits

     8.5        7.4        25.3        21.1   

Company-operated shop occupancy and other operating expenses

     6.5        5.8        19.5        16.6   

Replacement part cost of sales

     5.1        5.2        14.6        15.8   

Warranty expense

     0.3        0.1        0.9        0.5   

Selling, general, and administrative expenses

     12.7        12.5        40.3        39.6   

Loss on sale of assets, net

     0.2        0.1        0.1        0.2   

Business transformation charges

     —          0.1        —          0.3   
                                

Total operating costs and expenses

     44.9        41.8        134.4        124.9   

Operating income

     3.9        4.6        11.4        12.2   

Interest expense

     (2.4     (2.0     (7.3     (6.1

Other income, net

     0.1        0.1        0.3        0.4   
                                

Income before income taxes

     1.6        2.7        4.4        6.5   

Income tax expense

     0.8        1.3        2.1        3.7   
                                

Net income

   $ 0.8      $ 1.4      $ 2.3      $ 2.8   
                                

Earnings per share:

        

Basic

   $ 0.06      $ 0.10      $ 0.17      $ 0.21   
                                

Diluted

   $ 0.06      $ 0.10      $ 0.17      $ 0.21   
                                

Average number of shares:

        

Common shares outstanding

     13.8        13.7        13.7        13.7   

Common stock warrants

     0.1        0.1        0.1        0.1   
                                

Shares applicable to basic earnings

     13.9        13.8        13.8        13.8   

Equivalent shares on outstanding stock awards

     0.2        —          0.3        —     
                                

Shares applicable to diluted earnings

     14.1        13.8        14.1        13.8   
                                

See notes to condensed financial statements.

 

1


 

MIDAS, INC.

CONDENSED BALANCE SHEETS

(In millions, except per share data)

 

     Fiscal
September
2010
    Fiscal
December
2009
 
     (Unaudited)        

Assets:

    

Current assets:

    

Cash and cash equivalents

   $ 1.1      $ 0.9   

Receivables, net

     25.5        31.2   

Inventories

     5.1        5.6   

Deferred income taxes

     9.2        9.5   

Prepaid assets

     4.0        4.4   

Other current assets

     2.5        3.0   
                

Total current assets

     47.4        54.6   

Property and equipment, net

     82.7        86.4   

Goodwill and other intangible assets, net

     41.5        36.8   

Deferred income taxes

     44.8        46.1   

Other assets

     3.7        4.7   
                

Total assets

   $ 220.1      $ 228.6   
                

Liabilities and equity:

    

Current liabilities:

    

Current portion of long-term obligations

   $ 1.5      $ 1.5   

Current portion of accrued warranty

     2.0        2.0   

Accounts payable

     20.6        22.8   

Accrued expenses

     20.2        24.0   
                

Total current liabilities

     44.3        50.3   

Long-term debt

     65.1        71.9   

Obligations under capital leases

     1.5        1.6   

Finance lease obligation

     29.5        30.5   

Pension liability

     19.0        20.1   

Accrued warranty

     9.5        11.3   

Deferred warranty obligation

     6.5        5.3   

Other liabilities

     7.0        4.6   
                

Total liabilities

     182.4        195.6   
                

Temporary equity:

    

Non-vested restricted stock subject to redemption

     3.5        3.7   

Shareholders’ equity:

    

Common stock ($.001 par value, 100 million shares authorized, 17.7 million shares issued) and paid-in capital

     8.8        6.3   

Treasury stock, at cost (3.5 million shares)

     (71.8     (71.5

Retained income

     113.3        111.0   

Accumulated other comprehensive loss

     (16.1     (16.5
                

Total shareholders’ equity

     34.2        29.3   
                

Total liabilities and shareholders’ equity

   $ 220.1      $ 228.6   
                

See notes to condensed financial statements.

 

2


 

MIDAS, INC.

CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

(In millions)

 

     For the nine  months
ended fiscal September
 
     2010     2009  

Cash flows from operating activities:

    

Net income

   $ 2.3      $ 2.8   

Adjustments reconciling net income to net cash provided by operating activities:

    

Depreciation and amortization

     7.1        7.1   

Stock-based compensation

     2.3        2.9   

Amortization of financing fees

     0.4        0.2   

Business transformation charges

     —          0.3   

Deferred income taxes

     1.6        2.9   

Loss on sale of assets

     0.1        0.2   

Cash outlays for business transformation costs

     (0.2     (0.2

Changes in assets and liabilities, exclusive of effects of business transformation charges, acquisitions and dispositions

     0.7        (3.6
                

Net cash provided by operating activities

     14.3        12.6   
                

Cash flows from investing activities:

    

Capital investments

     (3.3     (3.4

Cash paid for acquired businesses

     (3.5     (0.1

Proceeds from sales of assets

     1.5        0.1   
                

Net cash used in investing activities

     (5.3     (3.4
                

Cash flows from financing activities:

    

Net repayments under revolving lines of credit

     (6.8     (6.2

Decrease in outstanding checks

     (0.5     (0.7 )

Payment of principal obligations under capital leases

     (0.2     (0.3

Payment of principal obligations under finance lease

     (1.0     (0.8

Borrowings under capital lease arrangements

     0.1        —     

Cash paid for treasury shares

     (0.4     (0.7
                

Net cash used in financing activities

     (8.8     (8.7
                

Net change in cash and cash equivalents

     0.2        0.5   

Cash and cash equivalents at beginning of period

     0.9        1.1   
                

Cash and cash equivalents at end of period

   $ 1.1      $ 1.6   
                

See notes to condensed financial statements.

 

3


 

MIDAS, INC.

CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

(In millions)

 

     Common Stock
And Paid In
Capital
    Treasury Stock     Retained
Income
     Comprehensive
Income
    Accumulated Other  
     Shares      Amount     Shares     Amount          Comprehensive Loss  

Fiscal year end 2009

     17.7       $ 6.3        (3.5   $ (71.5   $ 111.0         $ (16.5

Stock option expense

     —           0.8        —          —          —             —     

Restricted stock awards

     —           (0.3     —          0.3        —             —     

Restricted stock vesting

     —           1.5        —          —          —             —     

Forfeiture of restricted stock awards

     —           0.5        —          (0.2     —             —     

Purchase of treasury shares

     —           —          —          (0.4     —             —     

Net income

     —           —          —          —          2.3       $ 2.3        —     

Other comprehensive income

                

— foreign currency translation

     —           —          —          —          —           0.2        0.2   

— unrecognized pension costs, net of tax

     —           —          —          —          —           0.5        0.5   

— loss on derivative financial instruments, net of tax

     —           —          —          —          —           (0.3     (0.3
                      

Comprehensive income

     —           —          —          —          —         $ 2.7        —     
                                                          

Fiscal third quarter end 2010

     17.7       $ 8.8        (3.5   $ (71.8   $ 113.3         $ (16.1
                                                    

See notes to condensed financial statements.

 

4


 

MIDAS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)

1. Financial Statement Presentation

As used herein, and except where the context otherwise requires, the terms “MDS” and the “Company” refer to Midas, Inc. and its consolidated subsidiaries. The term “Midas” refers to the Midas retail system only. The term “SpeeDee” refers to the SpeeDee retail system.

The condensed interim period financial statements presented herein do not include all of the information and disclosures customarily provided in annual financial statements and they have not been audited, as permitted by the rules and regulations of the Securities and Exchange Commission. The condensed interim period financial statements should be read in conjunction with the annual financial statements included in the annual report on Form 10-K for the fiscal year ended January 2, 2010. In the opinion of management, these financial statements have been prepared in conformity with accounting principles generally accepted in the United States and reflect all adjustments necessary for a fair statement of the results of operations and cash flows for the interim periods ended October 2, 2010 (“third quarter fiscal 2010”) and October 3, 2009 (“third quarter fiscal 2009”) and of its financial position as of October 2, 2010. All such adjustments are of a normal recurring nature. The results of operations for the third quarter of fiscal 2010 and 2009 are not necessarily indicative of the results of operations for the full year.

The unaudited condensed interim period financial statements present the consolidated financial information for MDS and its wholly-owned subsidiaries. The unaudited condensed interim period financial statements for the quarters and nine months ended October 2, 2010 and October 3, 2009 both cover a 13-week period and a 39 week period respectively. All significant inter-company balances and transactions have been eliminated in consolidation.

Certain reclassifications have been made to the fiscal December 2009 condensed balance sheet, as well as the consolidated statement of cash flow for the nine months ended September 2009, in order to provide comparability with the fiscal 2010 financial statements.

Potential common share equivalents that could impact basic and diluted earnings per share but were excluded because they would be anti-dilutive were as follows (in millions):

 

     For the quarter
ended  fiscal September
     For the nine  months
ended fiscal September
 
     2010      2009      2010      2009  

Stock options

     1.1         1.8         1.2         1.8   

Franchise royalties are recognized in the periods that correspond to the periods in which retail sales and revenues are recognized by franchisees. Franchise renewal fees are recognized when the new franchise agreement is signed by the franchisee, the renewal period commences and all contractual obligations have been met. Product royalties are recognized as earned based on the volume of franchisee purchases of products from certain vendors. Real estate revenues are recognized as earned on a monthly basis in accordance with underlying property lease terms using the straight-line method. The majority of real estate revenues are derived from Midas shop locations. Nearly all of these locations are subject to an annual percentage rent based upon the location’s retail sales volume for the calendar year. Replacement part sales are recognized at the time products are shipped. Sales and revenues of company-operated shops are recognized when customer vehicles are repaired or serviced. Taxes collected on behalf of taxing authorities are not recognized as revenue but rather are recorded as a liability and remitted to the proper taxing authority.

Cash and cash equivalents consist of deposits with banks and financial institutions and are unrestricted as to withdrawal or use, and credit card receivables, which generally settle within three days or less.

Management has evaluated all activity of MDS and concluded that no material subsequent events have occurred that would require recognition in the condensed interim period financial statements or disclosure in the notes to the condensed interim period financial statements.

 

5


MIDAS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)—(Continued)

 

 

New Accounting Pronouncements

On January 3, 2010, MDS adopted changes issued by the Financial Accounting Standards Board (FASB) to accounting for variable interest entities. These changes require significant modifications to the analysis, evaluation and disclosure of variable interest entities. The adoption of these changes had no material impact on the Company’s Financial Statements.

On January 3, 2010, MDS adopted changes issued by the FASB to disclosure requirements for fair value measurements. Specifically, the changes require a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. The changes also clarify existing disclosure requirements related to how assets and liabilities should be grouped by class and valuation techniques used for recurring and nonrecurring fair value measurements. Other than the required additional disclosures, the adoption of these changes had no impact on the Company’s Financial Statements.

2. Supplemental Cash Flow Activity

Net cash flows from operating activities reflect cash payments for interest and taxes as follows (in millions):

 

     For the nine  months
ended fiscal September
 
     2010      2009  

Interest paid

   $ 7.1       $ 6.0   

Income taxes paid

     0.3         0.5   

The acquisition of certain previously franchised shops resulted in non-cash reductions of accounts receivable of approximately $2.5 million during the first nine months of fiscal 2010. See Footnote 7, “Acquisitions and Divestitures” for additional information.

3. Debt Agreements

On December 4, 2009, MDS entered into a three-year extension of its existing unsecured revolving credit facility. The credit agreement was extended through October 27, 2013 with no material changes in existing covenants. The extended facility is for $125 million and is further expandable to $175 million by the Company with lender approval. The interest rate floats based on the underlying rate of LIBOR and the Company’s leverage and was priced at LIBOR plus 3.00% at October 2, 2010. This facility requires maintenance of certain financial covenants including maximum allowable leverage and minimum net worth. As of October 2, 2010, the Company was in compliance with all debt covenants.

As of October 2, 2010, a total of $65.1 million was outstanding under the revolving credit facility. As of January 2, 2010, a total of $71.9 million was outstanding under the revolving credit facility.

In November 2005, $20 million in revolving bank debt was converted from floating rate to fixed rate by locking-in LIBOR at 4.89% for a five-year period. In addition, in March 2007, MDS entered into an interest rate swap arrangement to convert an additional $25 million in revolving bank debt from floating rate to a fixed rate by locking-in LIBOR at 4.91% through October 2010. As a consequence, at the end of the third quarter of fiscal 2010 $45 million of the Company’s $65.1 million in revolving bank debt was at fixed rates.

In January 2010, the Company entered into a $40 million forward starting swap to coincide with the end dates of its existing swaps. As a result of this forward swap transaction, in the period from November 2010 through October 2013 (end of the recently extended bank agreement) the Company has locked-in LIBOR at 2.71% for $40 million of revolving bank debt.

The November 2005, March 2007 and January 2010 swap arrangements have been designated as cash flow hedges and have been evaluated to be highly effective. As a result, the after-tax change in the fair value of these swaps is recorded in accumulated other comprehensive loss as a gain or loss on derivative financial instruments. See Footnote 8, “Fair Value Measurements and Derivative Instruments” for additional information.

 

6


MIDAS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)—(Continued)

 

 

The fair value of the Company’s revolving credit facility is determined as the present value of expected future cash flows discounted at the current interest rate for loans of similar terms and comparable credit risk.

 

Expected Maturity Date

   2010      2011      2012      Thereafter     Total     Fair
Value
 

Long-term debt (in millions):

               

Revolving credit facility (variable rate)

   $ —         $ —         $ —         $ 65.1      $ 65.1      $ 65.9   

Average interest rate

              3.8     3.8  

4. Pension Plans

Certain MDS employees are covered under various defined benefit pension plans sponsored and funded by MDS. Plans covering salaried and hourly corporate employees provide pension benefits based on years of service, and generally are limited to a maximum of 20% of the employees’ average annual compensation during the five years preceding retirement. Plan assets are invested primarily in common stocks, corporate bonds, and government securities.

The components of net periodic pension cost recognized for the interim periods are presented in the following table (in millions):

 

     For the quarter
ended fiscal September
    For the nine  months
ended fiscal September
 
     2010     2009     2010     2009  

Service cost

   $ 0.2      $ 0.2      $ 0.6      $ 0.5   

Interest cost on projected benefit obligation

     0.9        0.9        2.7        2.7   

Expected return on assets

     (1.1     (1.1     (3.2     (3.2

Net amortization and deferral

     0.3        0.2        0.8        0.6   
                                

Total net periodic pension cost

   $ 0.3      $ 0.2      $ 0.9      $ 0.6   
                                

The Company made cash contributions of approximately $1.5 million to the pension plans during the first nine months of fiscal 2010. The Company expects to make additional cash contributions of approximately $0.2 million to the pension plans during fiscal 2010 in order to maintain minimum statutory funding requirements.

5. Stock-Based Compensation and Other Equity Instruments

Stock Options

The Midas Stock Incentive Plan, the Midas Treasury Stock Plan and the Midas Directors’ Deferred Compensation Plan (the “Plans”) authorize the issuance of up to 4,806,886 shares of Midas common stock pursuant to the exercise of incentive stock options, non-qualified stock options and stock appreciation rights and the grant of restricted stock and performance awards. Options granted pursuant to the Plans generally vest annually over a period of four to five years commencing one year after the date of grant. It is the Company’s policy to issue shares out of treasury when options are exercised. The following table summarizes information regarding the outstanding stock options as of October 2, 2010:

 

     Number of
Shares
    Option Price Ranges    Weighted
Average
Exercise  Price
     Weighted
Average
Remaining
Contractual Term

(in years)
     Aggregate
Intrinsic
Value (in millions)
 

Outstanding at fiscal year end 2009

     1,927,053      $6.77–$23.99    $ 13.12         

Granted

     5,000      7.00–7.00      7.00         

Cancelled or forfeited

     (36,100 )   14.88–21.53      15.72         

Tendered for exchange

     (747,090 )   15.22–23.99      18.91         

Issued in exchange

     297,760      7.52–7.52      7.52         
                   

Outstanding at October 2, 2010

     1,446,623      6.77–22.17      8.88         5.3       $ 0.3   

Exercisable at October 2, 2010

     1,081,735      6.77–22.17      8.69         4.1         0.3   

 

7


MIDAS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)—(Continued)

 

 

At its annual meeting of shareholders on May 11, 2010, the Company received shareholder approval to implement an employee stock option exchange program. Under this program, employees holding stock options granted between 2004 and 2008 with exercise prices ranging from $15.22 to $23.99 were offered the opportunity to exchange their existing stock options for a lesser number of replacement stock options. The exchange program was completed on September 10, 2010. As a result of this exchange, 747,090 options were retired and 297,760 replacement options were issued at a strike price of $7.52. The replacement options will vest in two equal installments of 50% per year on the first and second anniversaries of the grant date and are exercisable for a period of 10 years from the grant date. The number of replacement stock options granted was determined using an exchange ratio such that the fair value of the replacement options received in the exchange equaled the fair value of the options surrendered in the exchange. The stock option exchange program did not result in additional expense.

The Company granted 5,000 stock options in the first nine months of fiscal 2010 and 298,000 options in the first nine months of fiscal 2009. Additional information pertaining to option activity during the first nine months of fiscal 2010 and 2009 was as follows (in millions):

 

     For the quarter
ended fiscal
September
    For the nine
months ended
fiscal September
 
     2010     2009     2010     2009  

Weighted average grant-date fair value of option activity:

        

Stock options granted

   $ —        $ —        $ —        $ 1.3   

Stock options vested

     0.5        —          0.7        1.1   

Stock options tendered for exchange

     (14.1     —          (14.1     —     

Stock options issued in exchange

     2.2        —          2.2        —     

Stock options cancelled or forfeited

     (0.3     (0.7     (0.3     (0.7

The weighted average estimated fair value of the options granted in the nine months ended fiscal 2010 and 2009 was $3.47 and $4.52 respectively, based on the Black-Scholes valuation model using the following assumptions:

 

Fiscal Year

   2010     2009  

Risk-free interest rate

     1.84     2.45

Dividend yield

     0.0     0.0

Expected volatility

     47.50     43.48

Expected life in years

     5.75        6.25   

Volatility is derived based on historical trends. Expected life is calculated utilizing the simplified method as prescribed by Accounting Standards Codification (“ASC”) 718 Compensation – Stock Compensation.

As of October 2, 2010, there was $2.0 million in stock option compensation expense related to unvested awards not yet recognized, which is expected to be recognized over a weighted-average period of 1.4 years.

Restricted Stock

Annually the Company grants shares of restricted stock to certain employees, officers and directors. Certain restricted stock vests at the five or seven year anniversary of the grant date, with provisions for accelerated vesting upon the occurrence of certain pre-determined events (“cliff-vesting shares”), while other restricted stock vests equally over periods of three to five years or only upon the occurrence of certain pre-determined events (the latter being referred to as “performance shares”). The fair value of all but the performance share grants is equal to the stock price on the date of the grant. The fair value of the performance share grants is based on their derived service period calculated using either a Monte Carlo simulation model or management’s expectations of achieving the objectives depending on the nature of the performance criteria. Activity for restricted shares for the first nine months of fiscal 2010, including the non-vested restricted shares outstanding and the weighted average grant-date fair value of those restricted shares, is shown in the table below:

 

     Number of
Restricted
Shares
    Weighted
Average
Grant-Date

Fair Value
 

Non-vested balance as of January 2, 2010

     758,203      $ 10.57   

Granted

     15,000        9.32   

Forfeited

     (33,379     (11.67

Vested

     (108,988     (12.56
          

Non-vested balance as of October 2, 2010

     630,836      $ 10.37   
          

 

8


MIDAS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)—(Continued)

 

 

The 2010 shares granted included independent directors and a special grant to an employee.

As of October 2, 2010, there was $2.6 million of unamortized restricted stock compensation of which $6.1 million was included as a reduction to paid-in capital and $3.5 million was included in non-vested restricted stock subject to redemption. The $2.6 million of unamortized restricted stock compensation is expected to be recognized over a weighted average period of 1.7 years.

Restricted stock grants include a “change in control” provision, which provides for cash redemption of non-vested restricted stock in certain circumstances. ASC 480 Distinguishing Liabilities from Equity requires securities with contingent cash settlement provisions that are not solely in the control of the issuer, without regard to probability of occurrence, to be classified outside of shareholders’ equity. While the Company believes the possibility of occurrence of any such change of control event is remote, the contingent cash settlement of the restricted stock as a result of such event would not be solely in the control of the Company. As such, the Company presents the $3.5 million value of non-vested restricted stock as temporary equity on the consolidated balance sheet as of October 2, 2010. Upon the vesting of the restricted stock the Company reclassifies the value of the restricted stock to permanent equity.

Common Stock Warrants

On March 27, 2003, the Company issued 1.0 million warrants valued at $5.0 million in connection with its 2003 debt restructuring. On January 5, 2004, 500,000 of these warrants were automatically cancelled because the Company met certain financial objectives contained in the warrant agreements. As of October 2, 2010, a total of 41,273 warrants remained outstanding. The exercise price of the warrants is $0.01, and the warrants are exercisable at any time up to March 27, 2013. Any warrants that remain unexercised at March 27, 2013 are automatically exercised as of that date.

The Company did not record an excess tax benefit in the first nine months of fiscal 2010 or fiscal 2009 related to stock-based compensation plans or equity instruments. The Company was in a net operating loss carry-forward position for the first nine months of fiscal 2010 and 2009. As a result, the excess tax benefit is not recognized until the deduction reduces the Company’s income taxes payable, which occurs once the net operating loss has been fully utilized. Therefore, there was no impact on cash flows from operating activities or cash flows from financing activities in the Statement of Cash Flows.

6. Warranty

Customers are provided a written warranty from MDS on certain Midas products purchased from Midas shops in North America, namely brake friction, mufflers, shocks and struts. The warranty will be honored at any Midas shop in North America and is valid for the lifetime of the vehicle, but is voided if the vehicle is sold. For warranties issued prior to July 1, 2009 in Canada and January 1, 2008 in the United States, the Company maintains a warranty accrual to cover the estimated future liability associated with outstanding warranties. The Company determines the estimated amount of outstanding warranty claims based on: 1) an estimate of the percentage of all warranted products sold and registered in prior periods at retail that are likely to be redeemed; and 2) an estimate of the cost of redemption of each future warranty claim on a current cost basis. These estimates are computed using actual historical registration and redemption data as well as actual cost information on current redemptions.

Year-to-date warranty activity through the first nine months of fiscal 2010 is summarized as follows (in millions):

 

Accrued warranty at beginning of period

   $ 13.3   

Changes in foreign exchange rate

     0.1   

Warranty credit issued to franchisees (warranty claims paid)

     (1.9
        

Accrued warranty at end of period

     11.5   

Less current portion

     (2.0
        

Accrued warranty – non-current

   $ 9.5   
        

 

9


MIDAS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)—(Continued)

 

 

As of January 1, 2008, the Company changed how the Midas warranty obligations are funded in the United States. From June 2003 through December 2007, product royalties received from the Company’s preferred supply chain vendors were recorded as revenue and substantially offset the cost of warranty claims. Beginning in fiscal 2008, the Midas warranty program in the United States is funded directly by Midas franchisees. The franchisees are charged a fee for each warranted product sold to customers. The fee is charged when the warranty is registered with the Company. The fee billed to franchisees is deferred and is recognized as revenue when the actual warranty is redeemed and included in warranty expense. This fee is intended to cover the Company’s cost of the new warranty program, thus revenues under this program will match expenses and the new warranty program will have no impact on the results of operations. In connection with this change, beginning in 2008 Midas system franchisees in the United States started receiving rebates on their purchases from the Company’s preferred supply chain vendors and MDS no longer receives product royalties on Midas franchisee purchases in the United States.

As of July 1, 2009, the Company changed how the Midas warranty obligations are funded in Canada to match the U.S. program. As a result, beginning in July 2009 Midas system franchisees in Canada started receiving rebates on their purchases from the Company’s preferred supply chain vendors and MDS no longer receives product royalties on Midas franchisee purchases in Canada.

Year-to-date activity through the first nine months of fiscal 2010 for the deferred warranty obligation related to this program is summarized as follows (in millions):

 

Deferred warranty obligation at beginning of period

   $ 5.3   

Warranty fees charged to franchisees and company-operated shops

     2.2   

Warranty credits issued to company-operated shops

     (0.1

Warranty credits issued to franchisees

     (0.9
        

Deferred warranty obligation at end of period

   $ 6.5   
        

In the first nine months of fiscal 2010, the Company recognized $0.9 million of warranty revenue in replacement part sales and product royalties and an equal amount of warranty expense under this program.

7. Acquisitions and Divestitures

In January 2010, MDS acquired 22 Midas shops from an existing Midas franchisee. MDS acquired these shops to be run as company-operated shops in connection with a settlement between the franchisee and the California Attorney General and the California Bureau of Automotive Repair. The franchisee had been charged with violating state business and professional codes in a suit seeking civil penalties and costs. The Company was not named in the suit and worked closely with the California Attorney General’s Office on acquiring these shops.

Simultaneous with and as part of the transaction, the Company re-franchised two of the locations to a new franchisee and bought out of the lease on a third location, bringing the net acquisition to 19 shops. The Company is actively seeking to re-franchise the remainder of these shops.

MDS gave total consideration of approximately $6.6 million for the shops. The total cash outlay for the purchase was approximately $3.5 million. The acquisition also resulted in an approximately $2.5 million non-cash reduction of accounts receivable. MDS also assumed certain liabilities of $0.5 million and assumed a capital lease liability of $0.1 million.

As a result of this acquisition, the Company recorded $5.5 million in incremental goodwill and other intangibles, which included $1.9 million of intangible franchise agreements, $0.2 million of customer lists and $3.4 million of goodwill. The $1.9 million of intangible franchise agreements will be amortized over a weighted average period of 12.0 years and the $0.2 million of customer lists will be amortized over a period of 2 years. The intangible goodwill is not amortized in accordance with GAAP, but is tested annually for impairment in the fourth quarter. All of the acquired intangible assets are deductible for tax purposes.

The Company re-franchised 10 company-operated Midas and two company-operated SpeeDee shops in the first nine months of fiscal 2010. The re-franchising of these 12 company-operated shops resulted in a write-down of $0.4 million of intangible assets and a net gain on sale of assets of approximately $45,000.

 

10


MIDAS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)—(Continued)

 

 

8. Fair Value Measurements and Derivative Instruments

The Company has market risk exposure to changes in interest rates, principally in the United States. MDS attempts to minimize this risk and fix a portion of its overall borrowing costs through the utilization of interest rate swaps. MDS hedges variable cash flows resulting from floating-rate debt. Variable cash flows from outstanding debt are converted to fixed-rate cash flows by entering into receive-variable, pay-fixed interest-rate swaps. Hedge ineffectiveness is eliminated by matching all terms of the hedged item and the hedging derivative at inception and on an ongoing basis. MDS does not exclude any terms from consideration when applying the matched terms method.

The fair values of the Company’s interest rate swaps are estimated using Level 2 inputs, which are based on model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. The Company also considers counterparty credit-risk and bilateral or “own” credit risk adjustments in estimating fair value, in accordance with the requirements of U.S. GAAP.

The fair value of derivative instruments is summarized as follows (in millions):

 

    

As of October 2, 2010

     As of January 2, 2010  
    

Balance Sheet Location

   Fair
Value
     Balance Sheet Location      Fair
Value
 

Derivatives designed as hedging instruments

           

Interest rate contracts

   Other liabilities    $ 2.1         Other liabilities       $ —     

Interest rate contracts

   Accrued expenses      0.2         Accrued expenses         1.8   
                       

Total derivatives designed as hedging instruments

      $ 2.3          $ 1.8   
                       

Because the interest rate contracts have been designated as cash flow hedges and have been evaluated to be highly effective, there is no impact on the Condensed Interim Statement of Operations. The after-tax change in the fair value of these swaps is recorded in accumulated other comprehensive loss as a loss on derivative financial instruments.

As of October 2, 2010, the carrying values of cash and cash equivalents and accounts payable approximated their fair values because of the short-term nature of these instruments. The fair value of accounts and notes receivable, net of allowances, approximates their carrying value. The Company’s revolving debt obligations, excluding capital leases, were estimated to have a fair value of $65.9 million, compared to their carrying value of $65.1 million.

9. Contingencies

As previously disclosed in the Company’s Form 10-K for the year ended January 2, 2010, the Company is engaged in an arbitration proceeding with MESA S.p.A. (“MESA”) and Norauto Groupe SA (“Norauto”). Midas filed its second substantive written submission to the arbitration panel in June 2010 and formal hearings were held in Geneva, Switzerland on July 13-16. On August 2, Midas and MESA and Norauto filed their closing submissions. A ruling by the arbitral tribunal is expected at any time.

The Company continues to believe that the claims by MESA and Norauto are without merit.

 

11


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

MDS management is focused on building shareholder value through the profitable growth of the Company. The three main drivers of profit growth for MDS are the refranchising of company-operated shops, increasing the shop count through the opening of additional franchised units and increasing comparable shop sales. These drivers are closely integrated, as the opening of franchises is much easier in an environment where franchised shop sales and profits are growing.

Refranchising Company-Operated Shops

While many of the company-operated shops are profitable, the company-operated shop business is unprofitable as a whole. The refranchising of company-operated shops, particularly those that are unprofitable, benefits the Company in a number of ways. First, the operating losses of the shops are replaced by royalty revenue that has no associated costs. Second, the operational risks associated with running a shop on a day-to-day business are no longer borne by the Company. Third, the Company is able to reduce corporate overhead in its company-operated shop business and in back-office support functions.

As of October 2, 2010, MDS operated 116 company-operated Midas, SpeeDee and Midas-SpeeDee Co-Branded shops. The Company refranchised 14 shops in the first nine months of fiscal 2010 and expects to refranchise additional shops during the remainder of 2010.

Growing Shop Count

Sales performance among U.S. Midas shops varies dramatically between the top-third performing shops and the bottom-third performing shops. For the first nine months of fiscal 2010, the top-third performing shops reported comparable shop sales increases of 18%, including a 10% increase in brake sales, while the bottom-third performing shops experienced a 10% decline in sales, including a 13% decline in brakes. The Company believes that this diversity in performance is largely due to the fact that Midas is an older franchise system and that certain long-term franchisees are struggling with the ongoing changes required to adapt to the current automotive aftermarket. As a result, the Company has been working diligently to identify those franchisees that are cannot or will not adapt to the new environment and has been assisting them in transitioning out of the Midas system in favor of new franchise ownership.

The benefits of transitioning Midas shops to new franchisees can be seen in the performance of these shops. Sales at shops within the first year after transition have historically far outperformed the sales performance of the broader Midas system. In some cases, the improvement is dramatic with sales rising by more than 100%. In the next several years the Company hopes to accelerate the number of transitions each year and thereby increase the capacity of the Midas system as a whole to adapt and succeed in this new business environment.

In addition to transitions, the Company believes that the re-opening of previously-operated Midas shops (i.e., “available shop inventory”) and the acquisition/conversion of competing automotive repair centers both provide a significant opportunity to grow the North American franchise system.

As of October 2, 2010, the Company’s available shop inventory consisted of 69 shops, 15 of which were owned by the Company and 54 of which were leased from third parties. During 2009, the Company collected an average annual rent amount of $59,000 from the locations it leased to franchisees and collected an average of $29,000 in royalties from each Midas shop in North America. Therefore, the reopening of these previously operated shops has the potential of adding significant revenues and operating profits in the future. The Company re-opened 10 shops in the first nine months of fiscal 2010 and expects to re-open more shops from its available shop inventory during the remainder of 2010.

The Company also believes that the acquisition of existing automotive repair shops, as well as the conversion of independent repair facilities to the Midas, SpeeDee or Co-Brand formats, is the most efficient way to grow the MDS system. Furthermore, the Company believes that the current economic environment will result in an increase in acquisition and conversion opportunities, as competitors struggle to remain viable during this economic downturn.

Growing Comparable Shop Sales

The Company believes that the key to growing sales in the Midas system in North America is to grow average daily car count by focusing on those services that are most critical to the regular maintenance of vehicles; namely, oil and other fluid exchanges, brake replacement and tire replacement. These services are required of all vehicles at periodic intervals and management believes future success in automotive service requires that a service provider possess expertise, credibility and top-of-mind awareness in all three categories.

 

12


 

As a result, in 2009, the Company changed its promotional advertising strategy in the U.S. from national television advertising to a more locally-focused advertising approach featuring value-priced oil changes. This change has had a significant impact on average daily car count per shop, as car count grew by 12% in fiscal 2009 and by an additional 11% in the first nine months of fiscal 2010. The Company believes that this value-priced, locally-focused oil change advertising strategy will provide an opportunity to form broader, longer-term relationships with these new customers for brake repairs, factory scheduled maintenance and major repairs.

Comparable shop sales of oil changes in North America have increased in each of the past three years and rose 16% in the first nine months of fiscal 2010. However, revenues from this category still represent less than 10% of U.S. Midas system sales, and the typical Midas shop performs fewer than eight oil changes per day. While oil change revenue and car count have been growing over the past several years, management believes the Midas system has the capacity to significantly increase that number.

With respect to growing brake sales, the Company is in the process of a system-wide training effort for franchisees and shop employees called the “Midas Way”. The program is focused on establishing greater operating uniformity throughout the Midas system, including phone handling, customer interaction, product stocking and the brake inspection process, as well as the customer follow-up process.

The Company also continues to believe that the sales of tires and related tire services represent a significant opportunity for sales growth at Midas. Comparable shop sales of tires and related tire services in the U.S. increased significantly in each of the past four years and were up nearly 8% in the first nine months of 2010. The Company continues to test a significantly expanded tire program in certain company-operated and franchised Midas shops. If this program succeeds, it will serve as a model for shops throughout the Midas system.

Finally, the Company believes that by Co-Branding Midas and SpeeDee shops by combining into one location Midas’ expertise in general repairs and strong brand awareness with SpeeDee’s strength in executing quick-lube and fluid exchanges, that it can create a powerful new format focused on satisfying the needs of time-pressed consumers seeking value, excellence in service and a long-term auto service relationship. The SpeeDee franchise locations that were Co-Branded in late 2009 reported a comparable shop sales increase of 6% in the first nine months of fiscal 2010, while the SpeeDee franchise locations that were co-branded in the first six months of 2010 also reported a 6% comparable shop sales increase in the third quarter of fiscal 2010. The company-operated Midas shops that have been Co-Branded generated a comparable shop sales increase of 7.3% in the first nine months of 2010. Finally, the Midas franchised shops that have converted to the Co-Brand concept saw sales increase 13.6% in the first nine months of fiscal 2010.

As of October 2, 2010, there were 39 Co-Brand locations in operation. The Company expects to have 50 Co-Brand locations operating by the end of fiscal 2010.

MDS management believes that while the current economic environment, and the need to develop stronger customer relationships and improve operations execution, pose significant challenges for automotive aftermarket service providers, the potential to succeed is significant for those automotive service providers that are willing and able to adapt.

RESULTS OF OPERATIONS

Third Quarter Fiscal 2010 Compared with Third Quarter Fiscal 2009

The following is a summary of the Company’s sales and revenues for the third quarter of fiscal 2010 and 2009: ($ in millions)

 

     2010      Percent
to Total
    2009      Percent
to Total
 

Franchise royalties and license fees

   $ 13.8         28.3   $ 14.0         30.2

Real estate revenues from franchised shops

     8.0         16.4        8.2         17.7   

Company-operated shop retail sales

     19.7         40.3        17.0         36.6   

Replacement part sales and product royalties

     5.9         12.1        5.9         12.7   

Software sales and maintenance revenue

     1.4         2.9        1.3         2.8   
                                  

Total sales and revenues

   $ 48.8         100.0   $ 46.4         100.0
                                  

 

13


 

Total sales and revenues for the third quarter of fiscal 2010 increased $2.4 million, or 5.2%, from the third quarter of fiscal 2009. Within the retail auto service business, royalty revenues and license fees were $13.8 million in the third quarter of fiscal 2010 compared to $14.0 million in third quarter of fiscal 2009. This decrease primarily reflects fewer shops in operation in North America, growth in the company-operated shop portfolio and weakness in Canadian retail sales, partially offset by a comparable shop sales increase of 4.4% in the U.S. and a weaker U.S. dollar that increased the value of Canadian royalties. U.S. average daily car count per shop rose by 11% and U.S. oil change revenues increased by 14% on a comparable shop basis as the Company continues to acquire new customers with value-priced oil changes and greater focus on local marketing promotions. License fees from the Company’s European licensee of approximately $1.1 million for both the third quarter of fiscal 2010 and the third quarter of fiscal 2009 are included in franchise royalties and franchise fees.

Revenues from real estate leases declined $0.2 million to $8.0 million driven by a 3% net reduction in the number of shops paying rent to Midas due to shop closures and the net growth in the company-operated shop portfolio, partially offset by a more favorable Canadian currency exchange rate.

Sales from company-operated shops were $19.7 million in the third quarter of fiscal 2010 compared to $17.0 million in third quarter of fiscal 2009. The increased revenues primarily reflect an increase in the shop count from 101 to 116 in the past year. Sales at the Midas company-operated shops increased by 3.0% on a comparable shop basis. Sales at Midas company-operated shops were boosted by a 7.3% increase in comparable shop sales for Co-Brand locations.

Replacement part sales and product royalties of $5.9 million in the third quarter or fiscal 2010 were flat compared to the third quarter of fiscal 2009. Lower sales of tires and equipment to Midas franchisees were offset by growth in warranty billings. Software sales and maintenance revenue of $1.4 million in the third quarter of fiscal 2010 increased $0.1 million over the third quarter of fiscal 2009.

Total operating costs and expenses increased $3.1 million, or 7.4%, in the third quarter of fiscal 2010 to $44.9 million. Occupancy expenses for franchised shops declined $0.1 million to $5.7 million in the third quarter of fiscal 2010 due to fewer shops under lease. Company-operated shop costs and expenses rose to $20.9 million in the third quarter of fiscal 2010 from $18.0 million in the third quarter of fiscal 2009. The increase in operating expenses was primarily driven by the higher shop count and the incremental overhead required to support the higher shop count. Payroll and employee benefit costs decreased slightly to 43.2% of company-operated shop sales in fiscal 2010 compared to 43.5% in the same period of the prior year. Company-operated shop occupancy and other expenses as a percentage of company-operated shop sales were 33.0% for the third quarter of fiscal 2010 compared to 34.1% for the same period in the prior year. Company-operated shop cost of sales increased from 28.2% of company-operated shop sales in the third quarter of fiscal 2009 to 30.0% in the third quarter of fiscal 2010, primarily as a result of an increase in the proportion of sales of oil and tires (which have lower margins) and higher discounts that helped to drive customer traffic.

Replacement part cost of sales declined to 86.4% of replacement part sales and product royalties, from 88.0% in the third quarter of fiscal 2009. Warranty expense in the third quarter of fiscal 2010 was $0.3 million compared to $0.1 million in the third quarter of fiscal 2009. Warranty expense increased due to higher warranty redemptions, including the start of warranty redemptions in Canada (one year after the launch of the new warranty program in Canada). In the past several years there have been changes in the warranty programs for both countries whereby Midas franchisees are now responsible for directly funding the warranty programs. The Company’s future warranty expense under the new programs will be exactly offset by warranty revenue.

Selling, general and administrative expenses increased to $12.7 million in the third quarter of fiscal 2010 from $12.5 million in the third quarter of fiscal 2009. The increase in expense was driven by $0.8 million in incremental legal and other costs incurred in connection with the Company’s arbitration process with its licensee in Europe. Should MDS prevail in its arbitration proceedings, it will be entitled to reimbursement of all legal and arbitration fees, although there is no guarantee that the tribunal would order reimbursement as this decision is within the discretion of the tribunal. Without these incremental costs, the Company’s selling, general and administrative expenses would have decreased by 4.8% primarily as a result of cost containment measures initiated in late 2009 and reduced management compensation.

No business transformation charges were recorded in the third quarter of fiscal 2010. During the third quarter of fiscal 2009, MDS recorded business transformation charges of $0.1 million related to the Company’s partial funding of the rollout of a new shop image for Canadian Midas franchisees.

During the third quarter of fiscal 2010 and 2009, the Company recorded net losses on the sale of certain company-operated shop assets of $0.2 million and $0.1 million, respectively.

As a result of the above changes, operating income decreased $0.7 million to $3.9 million in the third quarter of fiscal 2010 from $4.6 million in the third quarter of fiscal 2009. Operating income margin decreased to 8.0% of sales from 9.9% of sales.

 

14


 

Interest expense was $2.4 million in the third quarter of fiscal 2010 compared to $2.0 million in third quarter of fiscal 2009. Interest expense increased in the third quarter of fiscal 2010 due to an increase in the Company’s average borrowing rate as a result of the resetting of interest rate spreads to current market rates when the Company extended its credit agreement in December 2009.

The Company recorded other income of $0.1 million in the third quarter of fiscal 2010 and fiscal 2009. Other income consists primarily of interest income on overdue customer accounts and foreign currency exchange gains or losses.

The Company’s effective tax rate was 49.8% in the third quarter 2010 compared to 47.5% in the third quarter of fiscal 2009 and the 2010 statutory tax rate of 39.2%. The 2010 variance from the statutory rate was primarily due to the revaluation of the U.S. deferred tax asset associated with the vesting of restricted stock in July 2010 at a stock price that was lower than the stock price on the day these awards were initially granted. In addition, the rate was negatively impacted by the forfeiture of certain restricted shares by former executives who left the Company during the quarter. The fiscal 2009 variance from the statutory rate was due to a revaluation of the Canadian deferred tax asset due to a reduction in provincial corporate income tax rates enacted during fiscal 2009.

As a result of the above items, net income decreased $0.6 million from net income of $1.4 million in the third quarter of fiscal 2009 to net income of $0.8 million in the third quarter of fiscal 2010.

First Nine Months of Fiscal 2010 Compared with First Nine Months of Fiscal 2009

The following is a summary of the Company’s sales and revenues for the first nine months of fiscal 2010 and 2009: ($ in millions)

 

     2010      Percent
to Total
    2009      Percent
to Total
 

Franchise royalties and license fees

   $ 40.7         27.9   $ 41.0         29.9

Real estate revenues from franchised shops

     23.8         16.3        24.6         18.0   

Company-operated shop retail sales

     60.0         41.2        49.4         36.0   

Replacement part sales and product royalties

     16.9         11.6        18.0         13.1   

Software sales and maintenance revenue

     4.4         3.0        4.1         3.0   
                                  

Total sales and revenues

   $ 145.8         100.0   $ 137.1         100.0
                                  

Total sales and revenues for the first nine months of fiscal 2010 increased $8.7 million, or 6.4%, from the first nine months of fiscal 2009. Within the retail auto service business, royalty revenues and license fees decreased $0.3 million, or 0.7%, from fiscal 2009. This decrease primarily reflects fewer shops in operation in North America, growth in the company-operated shop portfolio and weakness in Canadian retail sales, partially offset by a comparable shop sales increase of 2.2% in the U.S. and a weaker U.S. dollar that increased the value of Canadian royalties.

Revenues from real estate leases declined $0.8 million to $23.8 million driven by a net reduction in the number of shops paying rent to Midas due to shop closures and the acquisition of company-operated shops from franchisees, partially offset by a more favorable Canadian currency exchange rate.

Sales from company-operated shops were $60.0 million in the first nine months of fiscal 2010 compared to $49.4 million in the first nine months of fiscal 2009. The increased revenues reflect an increase in the average shop count in the past year, as well as an increase in comparable shop sales of 2.9% for Midas company-operated shops.

Replacement part sales and product royalties decreased 6.1% from $18.0 million to $16.9 million in the first nine months of fiscal 2010 primarily due to lower sales of tires to Midas franchisees. Software sales and maintenance revenue increased $0.3 million to $4.4 million reflecting continued growth in the Company’s R.O. Writer point-of-sale software business, especially with customers outside of the Midas system.

Total operating costs and expenses increased $9.5 million, or 7.6%, in the first nine months of fiscal 2010 to $134.4 million. Occupancy expenses for franchised shops declined $0.5 million to $16.6 million in the first nine months of fiscal 2010 due to fewer shops under lease during the period. Company-operated shop costs and expenses rose to $61.9 million in the first nine months of fiscal 2010 from $51.4 million in the first nine months of fiscal 2009. The increase in operating expenses was driven by the higher average shop count and higher comparable shop sales, as well as the incremental overhead required to support the higher shop count. Payroll and employee benefit costs improved to 42.2% of company-operated shop sales in fiscal 2010 compared to 42.7% in the same period of the prior year. Company-operated shop occupancy and other expenses as a percentage of company-operated shop sales improved to 32.5% for the first nine months of fiscal 2010 compared to 33.6% for the same period in the prior year. Company-operated shop parts cost of sales increased from 27.7% of company-operated shop sales in the first nine months of fiscal 2009 to 28.5% in the first nine months of fiscal 2010, primarily as a result of an increase in the proportion of sales of oil and tires and higher discounts.

 

15


 

Replacement part cost of sales decreased to 86.4% of replacement part sales and product royalties from 87.8% in the first nine months of fiscal 2009. Warranty expense in the first nine months of fiscal 2010 was $0.9 million compared to $0.5 million in the first nine months of fiscal 2009. Warranty expense increased due to higher warranty redemptions and the fact that no warranty expense or revenue was recorded in Canada until third quarter of 2010. This reflects changes in the warranty programs in each of the countries whereby Midas franchisees are now directly responsible for funding the warranty program. The Company’s future warranty expense under the new programs will be exactly offset by warranty revenue.

Selling, general and administrative expenses in the first nine months of fiscal 2010 increased $0.7 million, or 1.8%, from the first nine months of fiscal 2009 to $40.3 million. The increase was driven by $2.7 million in incremental legal and other costs incurred in connection with the Company’s arbitration process with its licensee in Europe. Should MDS prevail in its arbitration proceedings, it will be entitled to reimbursement of all legal and arbitration fees, although there is no guarantee that the tribunal would order reimbursement as this decision is within the discretion of the tribunal. Without these incremental costs, the Company’s selling, general and administrative expenses would have decreased by 5.1% primarily as a result of cost containment measures initiated in late 2009.

During the first nine months of fiscal 2010, the Company recorded a net loss of $0.1 million in connection with the sale of certain company-operated shop assets. During the first nine months of fiscal 2009, the Company recorded a net loss on sale of $0.2 million in connection with the sale of certain company-operated shop assets.

As a result of the above changes, operating income decreased $0.8 million to $11.4 million in the first nine months of fiscal 2010 from $12.2 million in the first nine months of fiscal 2009 and operating income margin decreased to 7.8% of sales from 8.9% of sales.

Interest expense was $7.3 million in the first nine months of fiscal 2010 compared to $6.1 million in the first nine months of fiscal 2009. Interest expense increased in the first nine months of fiscal 2010 due to an increase in the Company’s average borrowing rate as a result of the resetting of interest rate spreads to current market rates when the Company extended its credit agreement in December 2009.

Other income was $0.3 million in the first nine months of fiscal 2010 compared to $0.4 million in the first nine months of fiscal 2009. Other income consists primarily of interest income on overdue customer accounts and foreign currency exchange gains or losses.

The Company’s effective tax rate was 46.8% in the first nine months of fiscal 2010 compared to 56.6% in the first nine months of fiscal 2009 and the 2010 statutory tax rate of 39.2%. The higher tax rate than the statutory rate in the first nine months of fiscal 2010 was primarily due to the revaluation of the U.S. deferred tax asset associated with restricted stock that vested in May and July 2010 at a stock price that was lower than the stock price on the day these awards were initially granted. In addition, the rate was negatively impacted by the forfeiture of certain restricted shares by former executives. The fiscal 2009 variance from the statutory rate was due to the revaluation of the U.S. deferred tax asset associated with restricted stock that vested in May 2009 at a stock price that was lower than the stock price on the day these awards were initially granted, as well as a revaluation of the Canadian deferred tax asset due to a reduction in provincial corporate income tax rates enacted during fiscal 2009.

As a result of the above items, net income decreased $0.5 million from net income of $2.8 million in the first nine months of fiscal 2009 to net income of $2.3 million in the first nine months of fiscal 2010.

 

16


 

LIQUIDITY AND CAPITAL RESOURCES

Following is a summary of the Company’s cash flows from operating, investing and financing activities for the first nine months of fiscal 2010 and 2009, respectively (in millions):

 

     2010     2009  

Cash provided by operating activities before net changes in assets and liabilities

   $ 13.6      $ 16.2   

Net changes in assets and liabilities, exclusive of the effects of acquisitions and dispositions

     0.7        (3.6
                

Net cash provided by operating activities

     14.3        12.6   

Net cash used in investing activities

     (5.3     (3.4

Net cash used in financing activities

     (8.8     (8.7
                

Net change in cash and cash equivalents

   $ 0.2      $ 0.5   
                

The Company’s cash management system permits the Company to make daily borrowings and repayments on its revolving line of credit, allowing MDS to minimize interest expense and to maintain a low cash balance. The Company’s cash and cash equivalents increased $0.2 million in the first nine months of fiscal 2010.

The Company’s operating activities provided net cash of $14.3 million during the first nine months of fiscal 2010 compared to $12.6 million of cash provided by operations in the first nine months of fiscal 2009. Excluding changes in assets and liabilities, cash provided by operating activities decreased from $16.2 million in the first nine months of fiscal 2009 to $13.6 million in the first nine months of fiscal 2010, primarily due to the lower net income, decrease in stock based compensation expense as limited stock awards were granted to management in 2010, lower utilization of deferred tax assets and lower business transformation charges.

Changes in assets and liabilities went from a $3.6 million use of cash in the first nine months of fiscal 2009 to a $0.7 source of cash in the first nine months of fiscal 2010. In the first nine months of fiscal 2010 the reduction in receivables was substantially off-set by a decline in accounts payable and accrued expenses due to the timing of payments. The $3.6 million use of cash in the first nine months of fiscal 2009 was driven by a permanent one-time decline in accrued advertising due to the timing of payments as a result of changes in the Company’s marketing strategy.

Investing activities used $5.3 million of cash in the first nine months of fiscal 2010 compared to $3.4 million of cash in the first nine months of fiscal 2009. Investing activities in the first nine months of fiscal 2010 consisted of $3.3 million in capital expenditures, $3.5 million paid in conjunction with the acquisition of 22 shops and other assets from a Midas franchisee in Northern California, and $1.5 million in cash generated as a result of the sale of 10 company-operated Midas shops and two company-operated SpeeDee shops. The $3.3 million in capital expenditures included $1.8 million in real estate and leasehold improvements, $0.7 million for systems development projects and $0.8 million for company-operated shop equipment additions. Fiscal 2009 investing activities consisted of $3.4 million in capital expenditures, $0.1 million paid in conjunction with the acquisition of a shop and other assets from a Midas franchisee and $0.1 million in cash generated as the result of the sale of a company-operated shop. The $3.4 million in capital expenditures in 2009 included $2.0 million in Co-Branding spending on Midas company-operated shops, $0.5 million for systems development projects, $0.6 million for company-operated shop equipment additions and $0.3 million of other capital expenditures.

Net cash used in financing activities was $8.8 million in the first nine months of fiscal 2010, compared to net cash used of $8.7 million in the first nine months of fiscal 2009. During the first nine months of fiscal 2010, MDS decreased total debt by $7.9 million, decreased outstanding checks by $0.5 million and paid $0.4 million to repurchase shares of the Company’s common stock from employees to satisfy tax obligations upon vesting of restricted stock awards. The decrease in total debt included $0.1 million of capital leases assumed as a result of acquisition of 22 shops and other assets from a Midas franchisee in Northern California. During fiscal 2009, MDS decreased total debt by $7.3 million, decreased outstanding checks by $0.7 million and paid $0.7 million to repurchase shares of the Company’s common stock from employees to satisfy tax obligations upon vesting of restricted stock awards.

On December 4, 2009, MDS entered into a three-year extension of its existing unsecured revolving credit facility. The credit agreement was extended through October 27, 2013 with no material changes in existing covenants. The extended facility is for $125 million and is further expandable to $175 million by the Company with lender approval. The interest rate floats based on the underlying rate of LIBOR and the Company’s leverage and was priced at LIBOR plus 3.00% at October 2, 2010. This facility requires maintenance of certain financial covenants including maximum allowable leverage and minimum net worth. The financial covenants require, among other things, that the Company maintain a leverage ratio (“Leverage Ratio”) of Total Debt (defined as outstanding borrowings and letters-of-credit under the revolving credit facility plus the balance of capital leases but excluding finance leases) to consolidated adjusted EBITDA as defined in the credit agreement (“Consolidated Adjusted EBITDA”) of no more than 3.00 to 1. The Company is required to test this ratio quarterly. As calculated in accordance with the credit agreement, the following table presents the Company’s actual Leverage Ratio as of the three most recent measurement periods ($ in millions):

 

Fiscal Period

   Fiscal
September
2010
   Fiscal
June
2010
   Fiscal
March
2010

Total Debt

   $67.6    $72.6    $77.0

Consolidated Adjusted EBITDA

   $28.2    $29.1    $29.6

Leverage Ratio

   2.40 to 1    2.49 to 1    2.60 to 1

 

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The Leverage Ratio is the most restrictive covenant. As of October 2, 2010, there was $17.0 million of available borrowing capacity under the Company’s revolving credit facility and the Company was in compliance with all financial covenants.

As of October 2, 2010, a total of $65.1 million was outstanding under the revolving credit facility. As of January 2, 2010, a total of $71.9 million was outstanding under the revolving credit facility.

In November 2005, $20 million in revolving bank debt was converted from floating rate to fixed rate by locking-in LIBOR at 4.89% for a five-year period. In addition, in March 2007, MDS entered into an interest rate swap arrangement to convert an additional $25 million in revolving bank debt from floating rate to a fixed rate by locking-in LIBOR at 4.91% through October 2010. As a consequence, at October 2, 2010, $45 million of the Company’s $65.1 million in revolving bank debt was at fixed rates.

In January 2010, the Company entered into a $40 million forward starting swap to coincide with the end dates of its existing swaps. As a result of this forward swap transaction, in the period from November 2010 through October 2013 (end of the recently extended bank agreement) the Company has locked-in LIBOR at 2.71% for $40 million of revolving bank debt.

The November 2005, March 2007 and January 2010 swap arrangements have been designated as cash flow hedges and have been evaluated to be highly effective. As a result, the after-tax change in the fair value of these swaps is recorded in accumulated other comprehensive loss as a gain or loss on derivative financial instruments.

On November 9, 2004, the MDS Board of Directors authorized a share repurchase program to begin in fiscal 2005 for up to $25 million of the Company’s outstanding common stock. On May 9, 2006, the MDS Board of Directors authorized a $25 million increase in the share repurchase program and on May 8, 2007 the Board authorized an additional $50 million increase. The Company has paid approximately $65.7 million for shares acquired under this current program since the buyback program was first authorized in 2004. At this time, the Company has suspended its share repurchases and is focused on reducing outstanding bank debt.

In January 2010, the Company acquired 22 Midas shops from an existing franchisee in Northern California for total consideration of approximately $6.6 million. Simultaneous to the shop purchase, two shops were sold to a new Midas franchisee. The total cash outlay for the purchase, net of proceeds received in the shop sale was approximately $3.5 million.

The Company believes that cash generated from operations and availability under the current debt agreement provides sufficient liquidity to finance operations and execute strategic initiatives for at least the next 12 months.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management must make a variety of decisions which impact the reported amounts and related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied, the assumptions on which to base accounting estimates, and the consistent application of those accounting principles. Due to the type of industry in which the Company operates, the nature of its business, and the Company’s existing business transformation process, the following accounting policies are those that management believes are most important to the portrayal of the Company’s financial condition and results and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

 

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Valuation of Warranty Liabilities

Customers are provided a written warranty from MDS on certain Midas products purchased from Midas shops in North America, namely brake friction, mufflers, shocks and struts. The warranty will be honored at any Midas shop in North America and is valid for the lifetime of the vehicle, but is voided if the vehicle is sold.

Prior to July 1, 2009 in Canada and January 1, 2008 in the U.S., product royalties received from the Company’s preferred supply chain vendors were recorded in revenue and substantially offset the cost of warranty claims. Beginning on January 1, 2008 in the U.S. and July 1, 2009 in Canada, the Midas warranty program became funded directly by franchisees. The Company maintains a warranty accrual to cover the estimated future liability associated with outstanding warranties issued prior to July 1, 2009 in Canada and January 1, 2008 in the U.S. The Company determines the estimated amount of outstanding warranty claims based on: 1) an estimate of the percentage of all warranted products sold and registered in prior periods at retail that are likely to be redeemed; and 2) an estimate of the cost of redemption of each future warranty claim on a current cost basis. These estimates are computed using actual historical registration and redemption data as well as actual cost information on current redemptions.

The determination of the number of products sold that are likely to be redeemed requires MDS to make significant estimates and assumptions regarding the relationship of historical warranty claim behavior; warranty claim behavior across product lines and geographical areas; and the impact of changes in consumer behavior on future warranty claims. A decrease of one percentage point in the estimated percentage of warranted products likely to be redeemed in the U.S. would have the effect of changing the Company’s January 2, 2010 outstanding U.S. warranty liability by approximately $1.6 million. A change in the estimated current cost of warranty redemptions of one dollar would have the effect of changing the outstanding U.S. warranty liability by $0.6 million.

Valuation of Receivables

The Company records receivables due from its franchisees and other customers at the time the sale is recorded in accordance with its revenue recognition policies. These receivables consist of amounts due from the sale of products, royalties due from franchisees and suppliers, rents and other amounts. The future collectability of these amounts can be impacted by the Company’s collection efforts, the financial stability of its customers, and the general economic climate in which it operates. Recent market conditions have increased the uncertainty of these estimates. Any adverse change in these factors could have a significant impact on the collectability of these assets and could have a material impact on the Company’s consolidated financial statements.

The Company applies a consistent practice of establishing an allowance for accounts that it feels may become uncollectible through reviewing the historical aging of its receivables and by monitoring the financial strength of its franchisees and other customers. Where MDS becomes aware of a customer’s inability to meet its financial obligations (e.g., where it is in financial distress or has filed for bankruptcy), the Company specifically reserves for the potential bad debt to reduce the net recognized receivable to the amount it reasonably believes will be collected. The valuation of receivables is performed on a quarterly basis.

Pensions

The Company has non-contributory defined benefit pension plans covering certain of its employees. The Company’s funding policy for the U.S. plan is to contribute amounts sufficient to meet the minimum funding requirement of the Employee Retirement Income Act of 1974, plus any additional amounts the Company may deem to be appropriate. The Company accounts for its defined benefit pension plans in accordance with ASC 715 Compensation – Retirement Benefits, which requires that amounts recognized in the financial statements be determined on an actuarial basis. The amount recorded as pension assets or liabilities is determined by comparing the projected benefit obligation (PBO) to the fair value of the plan assets. Amounts recognized in accumulated other comprehensive income consist of unrecognized actuarial gains, losses, and prior service costs, net of tax.

To account for its defined benefit pension plans in accordance with ASC 715, the Company must make three main determinations at the end of each fiscal year. First, it must determine the actuarial assumption for the discount rate used to reflect the time value of money in the calculation of the projected benefit obligation for the end of the current fiscal year and to determine the net periodic pension cost for the subsequent year. To determine this rate, the Company prepares a detailed analysis of projected future cash flows using the Citigroup Pension Discount Curve.

Second, the Company must determine the actuarial assumption for rates of increase in compensation levels used in the calculation of the accumulated and projected benefit obligations for the end of the current fiscal year and to determine the net periodic pension cost for the subsequent year. In determining these rates the Company looks at its historical and expected rates of annual salary increases.

 

19


 

Third, the Company must determine the expected long-term rate of return on assets assumption that is used to determine the expected return on plan assets component of the net periodic pension cost for the subsequent year. The difference between the actual return on plan assets and the expected return is deferred and is recognized in net periodic pension cost over a five-year period. The Company assumed a long-term rate of return on pension assets of 8.25% in fiscal 2009 and 2008, and experienced a gain on plan assets of $6.2 million in fiscal 2009 and a loss on plan assets of $14.6 million in fiscal 2008.

Recent market conditions have resulted in an unusually high degree of volatility and increased risks associated with certain investments held by MDS pension plans, which could impact the value of investments, net periodic pension costs and future funding requirements after the date of this filing. The Company’s pension plan investments are comprised of bond and equity mutual funds and cash reserves. The pension plans have no investments in alternative investment vehicles such as private equity funds or hedge funds, nor have the plans ever held such investments.

Carrying Values of Goodwill and Long-Lived Assets

Goodwill: The Company tests the recorded amount of goodwill for recovery on an annual basis in the fourth quarter of each fiscal year. Goodwill is tested more frequently if indicators of impairment exist. The Company continually assesses whether any indicators of impairment exist, which requires a significant amount of judgment. Such indicators may include: a sustained significant decline in our share price and market capitalization; a decline in our expected future cash flows; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; or slower growth rates, among others. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements.

The goodwill impairment test is a two step analysis. In Step One, the fair value of each reporting unit is compared to its book value. Management must apply judgment in determining the estimated fair value of these reporting units. Fair value is determined using a combination of present value techniques and quoted market prices of comparable businesses. If the fair value of the reporting unit exceeds its carrying value, goodwill is not deemed to be impaired for that reporting unit, and no further testing would be necessary. If the fair value of the reporting unit is less than the carrying value, the Company performs Step Two. Step Two uses the calculated fair value of the reporting unit to perform a hypothetical purchase price allocation to the fair value of the assets and liabilities of the reporting unit. The difference between the fair value of the reporting unit calculated in Step One and the fair value of the underlying assets and liabilities of the reporting unit is the implied fair value of the reporting unit’s goodwill. A charge is recorded in the financial statements if the carrying value of the reporting unit’s goodwill is greater than its implied fair value.

The determination of fair value of the reporting units and assets and liabilities within the reporting units requires management to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to, the discount rate, terminal growth rates, earnings before depreciation and amortization, and capital expenditures forecasts. Due to the inherent uncertainty involved in making these estimates, actual results could differ from those estimates. In both the U.S. and Canada, the reporting unit is defined as retail operations, which consists of both franchised and Company-operated locations. Both the U.S. and Canadian retail operations reporting units generate significant operating income and therefore the risk of goodwill impairment is remote.

Long-lived Assets: Long-lived assets include property and equipment, intangible assets, long-term prepaid assets and other non-current assets. The Company reviews long-lived assets held for use for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Events that may indicate long-lived assets may not be recoverable include, but are not limited to, a significant decrease in the market price of long-lived assets, a significant adverse change in the manner in which the Company utilizes a long-lived asset, a significant adverse change in the business climate, a recent history of operating or cash flow losses, or a current expectation that it is more likely than not likely that a long-lived asset will be sold or disposed of in the future. For impairment testing purposes, the Company groups its long-lived assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities (the asset group).

If the Company determines that a long-lived asset or asset group may not be recoverable, it compares the sum of the expected undiscounted future cash flows that the asset or asset group is expected to generate to the asset or asset group’s carrying value. If the sum of the undiscounted future cash flows exceed the carrying amount of the asset or asset group, the asset or asset group is not considered impaired. However, if the sum of the undiscounted future cash flows is less than the carrying amount of the assets or asset group, a loss is recognized for the difference between the fair value of the asset or asset group and the carrying value of the asset or asset group. The fair value of the asset or asset group is generally determined by discounting the expected future cash flows using a discount rate that is commensurate with the risk associated with the amount and timing of the expected future cash flows. Due to the inherent uncertainty involved in making these estimates, actual results could differ from those estimates.

 

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Deferred Income Taxes

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Any adverse change in these factors could have a significant impact on the realizability of the Company’s deferred tax assets and could have a material impact on the Company’s consolidated financial statements.

Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences at October 2, 2010. In the event that management determines the Company would not be able to realize all or part of the net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made. As of October 2, 2010, the Company had recorded a valuation allowance of $0.4 million against certain state income tax net operating loss carry forwards because the Company has determined that it is more likely than not that this portion of these deferred tax assets will not be realized. However, due to the inherent uncertainty involved in determining the realizability of the company’s deferred tax assets, the future realizability could differ from management estimates at October 2, 2010.

IMPACT OF NEW ACCOUNTING STANDARDS

New Accounting Pronouncements – Adopted

On January 3, 2010, MDS adopted changes issued by the Financial Accounting Standards Board (FASB) to accounting for variable interest entities. These changes require significant modifications to the analysis, evaluation and disclosure of variable interest entities. The adoption of these changes had no material impact on the Company’s Financial Statements.

On January 3, 2010, MDS adopted changes issued by the FASB to disclosure requirements for fair value measurements. Specifically, the changes require a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. The changes also clarify existing disclosure requirements related to how assets and liabilities should be grouped by class and valuation techniques used for recurring and nonrecurring fair value measurements. Other than the required additional disclosures, the adoption of these changes had no impact on the Company’s Financial Statements.

New Accounting Pronouncements – Issued

In October 2009, the FASB issued new accounting guidance related to the recognition of revenue for multiple deliverable arrangements as well as guidance which alters the scope of revenue recognition for software deliverables to exclude items sold that include hardware with software that is essential to its functionality. The Company does not engage in the type of transactions covered by this guidance. As a result, the Company has determined that the adoption of this guidance will not have a material impact on the on the Company’s Financial Statements.

In January 2010, the FASB issued changes to disclosure requirements for fair value measurements. Specifically, the changes require a reporting entity to disclose, in the reconciliation of fair value measurements using significant unobservable inputs (Level 3), separate information about purchases, sales, issuances, and settlements on a gross basis rather than as one net number. These changes become effective for MDS beginning January 2, 2011. The Company has determined that the adoption of this guidance will have no impact on the on the Company’s Financial Statements.

FORWARD LOOKING STATEMENTS

This report contains (and oral communications made by MDS may contain) forward-looking statements that may be identified by their use of words like “plans,” “expects,” “anticipates,” “intends,” “estimates,” “forecasts,” “will,” “outlook” “should” or other words of similar meaning. All statements that address the Company’s expectations or projections about the future, including statements about MDS’s strategy for growth, cost reduction goals, expenditures and financial results, pending legal proceedings or the Company’s ability to recover any costs in such legal proceedings are forward-looking statements. Forward-looking statements are based on the Company’s estimates, assumptions and expectations of future events and are subject to a number of risks and uncertainties. MDS cannot guarantee that these estimates, assumptions and expectations are accurate or will be realized. MDS disclaims any intention or obligation (other than as required by law) to update or revise any forward-looking statements.

 

21


 

The Company’s results of operations and the forward-looking statements could be affected by, among others things: general economic conditions in the markets in which the Company operates; economic developments that have a particularly adverse effect on one or more of the markets served by the Company; the ability to execute management’s internal operating plans; the timing and magnitude of capital expenditures; the Company’s ability to access debt and equity markets; economic and market conditions in the U.S. and worldwide; currency exchange rates; changes in consumer spending levels and demand for new products and services; and overall competitive activities. Certain of these risks are more fully described in Item 1A of Part I of the Company’s annual report on Form 10-K. The Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The Company is subject to certain market risks, including foreign currency and interest rates. MDS uses a variety of practices to manage these market risks, including, when considered appropriate, derivative financial instruments. The Company uses derivative financial instruments only for risk management and does not use them for trading or speculative purposes. MDS is exposed to potential gains or losses from foreign currency fluctuations affecting net investments and earnings denominated in foreign currencies. Specifically, the Company’s primary exposure is to changes in exchange rates for the U.S. dollar versus the Canadian dollar and the Euro for international license fees from Europe.

The Company is exposed to credit risk on certain assets, primarily accounts receivable. The Company provides credit to customers in the ordinary course of business and performs ongoing credit evaluations. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company’s customer base. The Company believes its allowance for doubtful accounts is sufficient to cover customer credit risk.

Interest rate risk is managed through variable rate borrowings in combination with swaps to fixed interest rates on a portion of those borrowings. In November 2005, $20 million in revolving bank debt was converted from floating rate to fixed rate by locking-in LIBOR at 4.89% for a five-year period. In addition, in March 2007, MDS entered into an interest rate swap arrangement to convert an additional $25 million in revolving bank debt from floating rate to a fixed rate by locking-in LIBOR at 4.91% through October 2010. As a consequence, as of October 2, 2010, $45 million of the Company’s $65.1 million in revolving bank debt was at fixed rates.

In January 2010, the Company entered into a $40 million forward starting swap to coincide with the end dates of its existing swaps. As a result of this forward swap transaction, in the period from November 2010 through October 2013 (end of the recently extended bank agreement) the Company has locked-in LIBOR at 2.71% for $40 million of revolving bank debt.

The November 2005, March 2007 and January 2010 swap arrangements have been designated as cash flow hedges and have been evaluated to be highly effective. As a result, the after-tax change in the fair value of these swaps is recorded in accumulated other comprehensive income as a gain or loss on derivative financial instruments. As of October 2, 2010, the fair value of these instruments was a pre-tax loss of approximately $2.3 million.

Market risk also arises within the Company’s defined benefit plans to the extent that the obligations of the plans are not fully matched by assets. Pension plan obligations are subject to change due to fluctuations in long-term interest rates as well as factors such as inflation, salary increases and plan members living longer. The pension plan assets include equity and debt securities, the values of which will change as equity prices and interest rates vary. Changes in equity prices and interest rates could result in plan assets which are insufficient over time to cover the level of projected obligations. This could result in material changes to the Company’s pension expense and impact the level of contributions to the plans in the future.

 

22


 

Item 4. Controls and Procedures.

(a) Evaluation of disclosure controls and procedures.

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that its disclosure controls and procedures and its internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

(b) Changes in internal controls over financial reporting.

There were no changes in internal controls during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

Reference is made to the disclosures set forth in the Company’s Form 10-K for the year ended January 2, 2010 and in the Company’s form 10-Q for the quarter ended April 3, 2010, under the heading “Legal Proceedings” for a description of certain legal proceedings in which the Company is involved.

As previously disclosed in the Company’s Form 10-K for the year ended January 2, 2010, the Company is engaged in an arbitration proceeding with MESA S.p.A. (“MESA”) and Norauto Groupe SA (“Norauto”). Midas filed its second substantive written submission to the arbitration panel in June 2010 and formal hearings were held in Geneva, Switzerland on July 13-16. On August 2, Midas and MESA and Norauto filed their closing submissions. A ruling by the arbitral tribunal is expected at any time.

The Company continues to believe that the claims by MESA and Norauto are without merit. However, there can be no assurance the Company will prevail in such proceedings. An adverse ruling could have a material adverse effect on the Company’s financial condition and results of operations.

 

Item 1A. Risk Factors.

There have been no material changes from the risk factors previously disclosed in the Company’s most recent annual report on form 10-K.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

The following table includes all issuer repurchases, including those made pursuant to publicly announced plans or programs and those not made pursuant to publicly announced plans or programs.

 

Period

   Total Number
of Shares
Purchased (1)
     Average
Price Paid
per Share
     Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
     Approximate Dollar
Value of Shares That
May Yet Be

Purchased Under the
Plans or Programs (2)
 

July 2010:

           

(July 4, 2010 through July 31, 2010)

     1,571       $ 8.80         —         $ 34,347,399   

August 2010:

           

(August 1, 2010 through August 28, 2010)

     —           —           —         $ 34,347,399   

September 2010:

           

(August 29, 2010 through October 2, 2010)

     —           —           —         $ 34,347,399   
                       

Total

     1,571       $ 8.80         —        
                       

 

(1) All the shares repurchased during the third quarter of fiscal 2010 reflect shares surrendered to cover withholding taxes upon the vesting of restricted stock.
(2) On November 9, 2004, the Company announced that the Board of Directors had authorized a share repurchase of up to $25 million in MDS stock. On May 9, 2006, the MDS Board of Directors authorized a $25 million increase in the share repurchase program, and on May 8, 2007, the Board authorized an additional $50 million increase. As of October 2, 2010, a total of approximately 3,248,100 shares had been repurchased under this plan since its inception. The average price of shares repurchased under the plan was approximately $20.21. This program has been suspended.

 

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Item 3. Defaults Upon Senior Securities.

None

 

Item 4. Removed and Reserved

 

Item 5. Other Information.

 

(a) Information required to be disclosed in a report on Form 8-K.

 

(b) Not applicable.

 

Item 6. Exhibits.

 

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.

SIGNATURE

Pursuant to the requirements 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.

 

Date: November 9, 2010    

/S/    ALAN D. FELDMAN        

    Alan D. Feldman
    Chairman, President and Chief Executive Officer
   

/S/    WILLIAM M. GUZIK        

    William M. Guzik
    Executive Vice President and Chief Financial Officer
   

/S/    AUDREY L. GUALANDRI        

    Audrey L. Gualandri
    Vice President and Controller

 

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