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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended July 3, 2004

OR

For the transition period from              to             

Commission File Number: 01-13409

MIDAS, INC.

(Exact Name of Registrant as Specified in its Charter)

(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 is an accelerated filer (as defined in Rule 12b-2).    Yes  x    No  ¨

The number of shares of the Registrant’s Common Stock, $.001 par value per share, outstanding as of July 28, 2004 was 15,681,840.

PART I. FINANCIAL INFORMATION

Item 1: Condensed Financial Statements

MIDAS, INC.

CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

(In millions, except for earnings per share)

See notes to condensed financial statements.

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MIDAS, INC.

CONDENSED BALANCE SHEETS

(In millions)

See notes to condensed financial statements.

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MIDAS, INC.

CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

(In millions)

See notes to condensed financial statements.

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MIDAS, INC.

CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

(In millions)

See notes to condensed financial statements.

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MIDAS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

1. Financial Statement Presentation

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 3, 2004. 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 July 3, 2004 (“second quarter fiscal 2004”) and June 28, 2003 (“second quarter fiscal 2003”) and of its financial position as of July 3, 2004. All such adjustments are of a normal recurring nature. The results of operations for the second quarter fiscal 2004 and 2003 are not necessarily indicative of the results of operations for the full year.

The unaudited condensed financial statements present the consolidated financial information for Midas, Inc. and its wholly-owned subsidiaries (“Midas” or the “Company”). The unaudited condensed financial statements for the quarters ended July 3, 2004 and June 28, 2003 both cover a 13-week period. All significant inter-company balances and transactions have been eliminated in consolidation.

Certain reclassifications have been made to the previously reported fiscal 2003 financial statements in order to provide consistency with the fiscal 2004 results. These reclassifications did not affect previously reported net income or earnings per share.

Basic and diluted earnings per share were calculated based on the following share counts (in millions):

Common share equivalents were excluded from 2003 diluted earnings per share as they would have had an anti-dilutive effect.

2. Supplemental Cash Flow Activity

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

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3. Inventories

Inventories, summarized by major classification, were as follows (in millions):

4. Business Transformation Charges

The Company is in the process of transforming its business. As part of the Company’s business transformation, the Company has developed and implemented strategic initiatives that it believes will enhance its long-term competitive position. The Company believes these initiatives will enable it to reduce costs and enhance sustainable profitability while delivering critical products and services to its customers. These initiatives included the disposition of the assets of Parts Warehouse, Inc. (“PWI”), the closure and re-franchising of certain company-operated shops, the redesign of the Company’s wholesale parts distribution network, and the reduction of administrative expenses related to former operating activities. The implementation of these initiatives is having the effect of substantially lowering overall Company revenues and expenses. Furthermore, the implementation of the Company’s strategic initiatives has resulted in the Company recording substantial business transformation charges in fiscal 2003, 2002 and 2001, to reflect the write-down of assets, the disposition of lease agreements, severance costs, and other related expenses.

The fiscal 2004 activity affecting the accrual for business transformation charges was as follows (shown in millions):

5. Debt Agreements

As of January 4, 2004, the Company had credit facilities consisting of a $25 million revolving loan facility, a $64.7 million Term Loan A, and a $29.4 million Term Loan B. These facilities were secured by substantially all of the assets of the Company and were scheduled to expire on October 3, 2004. Interest on the revolving loan was payable monthly at the prime rate plus 2.75% or LIBOR plus 3.75%. Interest on a portion of the Term Loan A was fixed at 7.67%, while interest on the balance of the Term Loan A was payable monthly at the prime rate plus 5.0% or LIBOR plus 6.0%. The interest rate on the Term Loan B was fixed at 12% cash interest paid monthly plus 6% paid-in-kind (“PIK”), which was added to principal and due at maturity. Availability under the revolving credit facility was based on a borrowing base, which took into consideration the Company’s inventory and accounts receivable levels. The revolving credit facility was senior to both the Term Loan A and Term Loan B.

On March 16, 2004, the Company entered into a new three-year, $115 million credit facility to refinance its existing debt facility. The new debt facility is comprised of a $55 million revolving credit facility and a $60 million term loan. The new facility is secured by substantially all of the assets of the Company and expires on March 16, 2007. Under the

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terms of the debt refinancing, the Company retired its former $25 million revolving credit facility as well as its Term A and Term B loans. The refinancing resulted in a loss on early extinguishment of debt of $4.7 million due to the write-off of unamortized debt discount and financing fees. Due to the refinancing of the Company’s debt in March 2004, the amounts due after January 1, 2005 were classified as long-term in the January 3, 2004 balance sheet.

Interest on the $55 million revolving loan was initially payable monthly at LIBOR plus 3.25%. Interest on the $60 million term loan was initially payable monthly at LIBOR plus 3.5%. The interest rates float based on the underlying rate of LIBOR and the Company’s leverage. Availability under the revolving credit facility is not predicated on a borrowing base. The term loan requires quarterly principal payments of $1.25 million on July 2, 2004 and $2.5 million thereafter. In addition, the term loan must be prepaid by an amount equal to: (i) 100% of equity issued, or (ii) 75% of any material asset proceeds in excess of $1 million (other than the sale of inventory in the normal course of business), or (iii) 50% of any excess cash flow as provided for by the agreement. The new facility requires maintenance of certain financial covenants including maximum allowable leverage and minimum tangible net worth.

In April 2004, the Company entered into an interest rate swap arrangement to convert $40 million of the $60 million term loan from a floating rate to a fixed rate, by locking-in LIBOR at 2.76% for the three-year term of the loan. As of July 3, 2004, the fair value of this instrument is approximately $100,000, net of taxes. This amount was recorded in other comprehensive income as a gain on derivative instruments.

The components of debt as of July 3, 2004 and January 3, 2004 were as follows:

6. Pension Plans

Certain Midas employees are covered under various defined benefit pension plans sponsored and funded by Midas. Plans covering salaried 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. Plans covering hourly employees generally provide benefits of stated amounts for each year of service. Plan assets are invested primarily in common stocks, corporate bonds, and government securities. Contributions of approximately $50,000 were made to the plans for the six months ended July 3, 2004. The Company does not expect to make material contributions to the plans during the remainder of the fiscal year.

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

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7. Stock-Based Compensation

Stock options granted under the Company’s stock incentive plans are granted at market prices on the date of grant and generally vest over three or five years commencing one year after the date of the grant.

Midas accounts for stock-based compensation in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations using the intrinsic value method, which resulted in no compensation cost for options granted.

Midas’s net income (loss) and earnings (loss) per share would equal the pro forma amounts shown below if compensation cost had been determined based on the fair value at the grant dates in accordance with SFAS Nos. 123 and 148, “Accounting for Stock-Based Compensation.”

8. Warranty

Customers are provided a written warranty from Midas on genuine Midas products purchased from Midas shops in North America. 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. The Company maintains a warranty accrual to cover the estimated future liability associated with outstanding warranties. The Company determines the estimated value 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

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cost basis. These estimates are computed using actual historical registration and redemption data as well as actual cost information on current redemptions.

Prior to fiscal 2003, the Company had not maintained an accrual for estimated future warranty claims related to its lifetime guarantee of exhaust and brake products. Instead, the Company recorded expenses related to these product warranties as warranty claims were incurred. This was due to the fact that the average warranty claim generated gross profit to the Company, as the revenues and gross profit to Midas from a warranty claim exceeded the cost of reimbursement to the franchisee. As a result of the fiscal 2003 outsourcing of the Midas distribution function to AutoZone, Inc. in the U.S. and Uni-Select Inc. in Canada, Midas no longer generates sufficient gross profit on a warranty claim to offset the average warranty claim reimbursement. Consequently, the Company recorded charges during fiscal 2003 to reflect its estimated liability associated with outstanding warranties in the U.S. and Canada. Midas now accrues for the expected future cost of warranty redemptions at the time of the original installation of the warranted part based on the method described above. Warranty expense is included in cost of sales and revenues in the condensed statements of operations.

Year-to-date warranty activity through July 3, 2004 is summarized as follows (in millions):

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

RESULTS OF OPERATIONS

The Midas Business Transformation

The Company is in the process of transforming its business. In the past year, management has dramatically restructured the Company’s operations and re-directed the Company’s strategic focus towards the Midas retail system. These actions are intended to transform the Company by improving profitability, enhancing the competitive position of the Midas retail system, strengthening the Company’s balance sheet and reducing future capital requirements. This transformation encompasses sweeping changes in the way Midas dealers are supplied with genuine Midas products and other replacement auto parts, a re-definition of the service relationship between Midas dealers and their customers, and a shift in the way the Company approaches its relationship with Midas franchisees. The implementation of these initiatives is having the effect of substantially lowering overall Company revenues and expenses in fiscal 2004 compared with historical levels.

Certain aspects of the transformation were completed in fiscal 2003. During 2003, the Company outsourced the wholesale distribution of genuine Midas products and other replacement parts, closed all but one of the Company’s regional distribution centers, disposed of all 77 of its Parts Warehouse, Inc. (“PWI”) quick-delivery distribution locations through sale or closure, closed or re-franchised 34 company-operated shops, and significantly reduced corporate administrative overhead. However, other changes to the way Midas does business continue to evolve, and this process will continue during fiscal 2004. The ultimate objective of this business transformation is reflected in Midas’ 2010 vision of “4-3-2-1.” Midas management is working towards:

With these goals in mind, Midas management is committed to the Company’s mission of becoming the most trusted professional and first choice for customers’ auto service needs.

Second Quarter Fiscal 2004 Compared with Second Quarter Fiscal 2003

The following is a summary of the Company’s sales and revenues for the second quarter of fiscal 2004 and 2003: ($ millions)

Sales and revenues for the second quarter of fiscal 2004 decreased $25.9 million or 33.2% from the second quarter of fiscal 2003 to $52.0 million, reflecting the impact of the Company’s business transformation that began during fiscal 2003.

Within the retail auto service business, royalty revenues and license fees increased 1.8% from the second quarter of 2003 due to an increase in royalties from international licensees, a 1.4% comparable shop increase in system-wide Midas retail sales and the positive sales impact of the Company’s re-franchising of 24 company-operated shops during fiscal 2003, whose royalties were previously not included in franchising revenues. These increases were partially offset by a reduction in North American shop count and lower franchise fee revenue compared to the prior year. Sales from

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company-operated shops declined $1.9 million, or a decrease of 17.0% from the same period in fiscal 2003. The sales decrease primarily reflects a reduction in the number of company-operated shops in operation during the quarter compared to the prior year, which offset a comparable shop sales increase of approximately 2%. As of July 3, 2004, there were 73 company-operated shops compared to 90 shops at the end of the second quarter of fiscal 2003. Revenues from real estate rentals increased slightly to $9.0 million. The increase reflects the improvement in system-wide comparable shop retail sales and the re-franchising of 24 previously company-operated shops during fiscal 2003, which offset a decrease in the number of shops in operation.

Replacement part sales and product royalties decreased $24.6 million to $16.2 million from $40.8 million in the second quarter of fiscal 2003. The decrease reflects the Company’s exit from the traditional wholesale and PWI parts distribution businesses during fiscal 2003. In fiscal 2004, such revenues are comprised of the distribution of exhaust products to AutoZone, Inc. in the US, Uni-Select Inc. in Canada and to certain independent exhaust distributors, as well as sales derived from the Company’s coordination and administration of certain merchandise programs on behalf of Midas dealers, including tires, batteries and oil. Product royalties reflect royalties earned on the sale of parts to Midas dealers by AutoZone and Uni-Select. During the second quarter of fiscal 2004, product royalties increased more than five fold when compared to the royalties earned in the same period in 2003.

Gross profit margin was 57.5% in the second quarter of fiscal 2004 compared to a gross margin of negative 1.7% in the second quarter of fiscal 2003. During the second quarter of fiscal 2003, the Company recorded charges to gross profit of $41.9 million to establish a reserve for estimated future warranty claims related to its lifetime guarantee of exhaust and brake products in the US and to write-down the value of inventory associated with the Company’s exit from the traditional wholesale parts distribution business. Excluding these charges to gross profit, the Company’s gross profit margin of 57.5% in the second quarter of fiscal 2004 compares to a gross margin of 52.1% in the second quarter of fiscal 2003. This increase was primarily due to a shift in the mix of the Company’s revenues. In fiscal 2004, more than 50% of the Company’s sales and revenues were derived from the higher margin franchising and company-operated shop operations, compared with only 35% in the second quarter of fiscal 2003. The favorable shift in sales mix helped to offset lower gross margins generated on the sale of exhaust parts in connection with the Company’s outsourcing of exhaust distribution to AutoZone and Uni-Select.

Selling, general and administrative expenses for the second quarter of 2004 decreased $13.1 million, or 35.9% from 2003 to $23.4 million. The large decrease in expenses reflects the closure of PWI and all but one of the Company’s regional distribution centers during fiscal 2003, as well as lower operating expenses associated with a reduced number of company-operated shops compared to the second quarter of fiscal 2003.

During the second quarter of fiscal 2003, the Company recorded a charge of $8.9 million related to the Company’s business transformation activities. The charges primarily reflect costs incurred as a result of the Company’s decision to exit the traditional auto parts distribution business in the US, as well as costs related to PWI closures and the closure and re-franchising of certain company-operated shops.

As a result of the above changes, operating income increased $53.2 million from a loss of $46.7 million in the second quarter of 2003 to income of $6.5 million in the second quarter of 2004. These changes caused an increase in operating income margin to 12.5% in the second quarter of 2004 from a negative 60.0% in the second quarter of 2003.

Interest expense decreased from $7.3 million in the second quarter of 2003 to $2.5 million in the second quarter of 2004 due to much lower interest rates on borrowings as a result of the March 2004 refinancing and a substantial reduction in the Company’s total debt compared to the prior year.

The Company’s effective tax rate was 38.9% in the second quarter of both fiscal 2004 and 2003.

As a result of the above items, net income improved $35.3 million from a loss of $32.7 million in the second quarter of 2003 to income of $2.6 million in the second quarter of 2004.

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Six Months Ended Fiscal 2004 Compared with Six Months Ended Fiscal 2003

The following is a summary of the Company’s sales and revenues for the first six months of fiscal 2004 and 2003: ($ millions)

Sales and revenues for the first six months of fiscal 2004 decreased $53.5 million or 35.1% from the first six months of fiscal 2003 to $98.9 million, reflecting the impact of the Company’s business transformation that began during fiscal 2003.

Within the retail auto service business, royalty revenues and license fees increased 3.3% from the first six months of 2003 due to an increase in royalties from international licensees, a 1.4% comparable shop increase in system-wide Midas retail sales and the positive sales impact of the Company’s re-franchising of 24 company-operated shops during fiscal 2003, whose royalties were previously not included in franchising revenues. These increases were partially offset by a reduction in North American shop count and lower franchise fee revenue compared to the prior year. Sales from company-operated shops declined $5.0 million, or a decrease of 21.8% from the same period in fiscal 2003. The sales decrease primarily reflects a reduction in the average number of company-operated shops in operation during the first six months compared to the prior year. Comparable shop sales for company-operated shops were approximately flat in the first six months of 2004 compared to the same period in 2003. Revenues from real estate rentals increased slightly to $18.1 million. The increase reflects the improvement in system-wide comparable shop retail sales and the re-franchising of 24 previously company-operated shops during fiscal 2003, which offset a decrease in the number of shops in operation.

Replacement part sales and product royalties decreased $50.1 million to $30.3 million from $80.4 million in the first six months of fiscal 2003. The decrease reflects the Company’s exit from the traditional wholesale and PWI parts distribution businesses during fiscal 2003. During the first six months of 2004, product royalties earned on the sale of parts to Midas dealers by AutoZone and Uni-Select increased sharply over the prior year when the transition to the AutoZone outsourced distribution arrangement had only just begun.

Gross profit margin was 57.8% in the first six months of fiscal 2004 compared to a gross profit margin of 22.6% in the first six months of fiscal 2003. During the first six months of fiscal 2003, the Company recorded charges to gross profit of $41.9 million to establish a reserve for estimated future warranty claims related to its lifetime guarantee of exhaust and brake products in the US and to write-down the value of inventory associated with the Company’s exit from the traditional wholesale parts distribution business. Excluding these charges to gross profit, the Company’s gross profit margin of 57.8% in the first six months of fiscal 2004 compares to a gross margin of 50.1% in the first six months of fiscal 2003. This increase was primarily due to a shift in the mix of the Company’s revenues towards a greater share of sales derived from higher margin franchising and company-operated shop operations. The favorable shift in sales mix helped to offset lower gross margins generated on the sale of exhaust parts in connection with the Company’s outsourcing of exhaust distribution to AutoZone and Uni-Select.

Selling, general and administrative expenses for the first six months of 2004 decreased $28.4 million, or 38.5% from 2003 to $45.4 million. The large decrease in expenses reflects the closure of PWI and all but one of the Company’s regional distribution centers during fiscal 2003, as well as lower operating expenses associated with a reduced number of company-operated shops compared to the first six months of fiscal 2003.

During the first six months of fiscal 2003, the Company recorded charges of $12.6 million related to the Company’s business transformation activities. The charges primarily reflected costs incurred as a result of the Company’s decision to exit the traditional auto parts distribution business in the US, as well as costs related to PWI closures and the closure and re-franchising of certain company-operated shops.

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As a result of the above changes, operating income increased $63.7 million from a loss of $51.9 million in the first six months of 2003 to income of $11.8 million in the first six months of 2004. These changes caused an increase in operating income margin to 11.9% in the first six months of 2004 from a negative 34.1% in the first six months of 2003.

Interest expense decreased from $11.6 million in the first six months of 2003 to $7.6 million in the first six months of 2004 as result of lower interest rates on borrowings and a substantial reduction in the Company’s average total debt level compared to the prior year. In addition, the Company recorded a loss on early extinguishment of debt of $4.7 million in the first six months of fiscal 2004 to reflect a write-off of the unamortized debt discount and financing fees related to the Company’s prior debt agreement. In the first six months of fiscal 2003, the Company recorded $1.4 million in charges related to the extinguishment of a prior debt agreement.

The Company incurred no income tax expense in the first six months of fiscal 2004. In the first six months of fiscal 2003, the Company recorded an income tax benefit based on a 38.9% tax rate.

As a result of the above items, net income improved $39.1 million from a loss of $39.1 million in the first six months of 2003 to break even in the first six months of 2004.

LIQUIDITY AND CAPITAL RESOURCES

Midas’ cash and cash equivalents decreased $6.8 million in the first six months of fiscal 2004.

The Company’s operating activities generated net cash of $5.8 million during the first six months of fiscal 2004 compared to $4.4 million of cash generated in the first six months of fiscal 2003. The year-over-year increase of $1.4 million was primarily due to a $39.1 million increase in net income and a $26.5 million increase in deferred income taxes, partially offset by $11.9 million less cash generated by changes in assets and liabilities and a $1.5 million reduction in depreciation and amortization. Additionally, business transformation costs, net of cash payments, and losses on early extinguishment of debt were $50.8 million lower than the prior year. The $11.9 million decrease in cash generated by changes in assets and liabilities was primarily due to a much smaller reduction in inventory in fiscal 2004 compared to 2003, when the Company was selling inventory as part of its exit from the wholesale distribution business. The smaller reduction in inventory was partially offset by lower growth in accounts receivable in the first six months of fiscal 2004 relative to 2003, as the collection of remaining receivables associated with the traditional wholesale and PWI operations offset the typical seasonal growth in royalty accounts receivable.

Investing activities used $0.8 million in cash during the first six months of fiscal 2004 compared to generating $3.4 million in cash during the first six months of fiscal 2003. Fiscal 2004 investing activities consisted primarily of capital expenditures to maintain facilities and investments in information systems. Fiscal 2003 investing activities primarily consisted of $1.4 million in systems development and other maintenance capital expenditures, and $5.2 million in cash generated as the result of asset sales, including a sale and leaseback of the one of the Company’s distribution facilities and the sale of certain PWI locations.

Net cash used in financing activities was $11.8 million in the first six months of fiscal 2004, compared to net cash used of $6.0 million in the first six months of fiscal 2003. In fiscal 2004, the Company reduced total debt by $12.3 million and paid $2.1 million in fees in association with the Company’s debt refinancing in March 2004. In addition, the Company received $3.0 million in cash from the exercise of outstanding stock options. In fiscal 2003, the Company paid $4.8 million in financing fees and reduced total debt by $6.1 million. Additionally, the Company issued 1.0 million warrants valued at $5.0 million in connection with its 2003 debt restructuring.

As of January 4, 2004, the Company had credit facilities consisting of a $25 million revolving loan facility, a $64.7 million Term Loan A, and a $29.4 million Term Loan B. These facilities were secured by substantially all of the assets of the Company and were scheduled to expire on October 3, 2004. Interest on the revolving loan was payable monthly at the prime rate plus 2.75% or LIBOR plus 3.75%. Interest on a portion of the Term Loan A was fixed at 7.67%, while interest on the balance of the Term Loan A was payable monthly at the prime rate plus 5.0% or LIBOR plus 6.0%. The interest rate on the Term Loan B was fixed at 12% cash interest paid monthly plus 6% paid-in-kind (“PIK”), which was added to principal and due at maturity. Availability under the revolving credit facility was based on a borrowing base,

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which took into consideration the Company’s inventory and accounts receivable levels. The revolving credit facility was senior to both the Term Loan A and Term Loan B.

On March 16, 2004, the Company entered into a new three-year, $115 million credit facility to refinance its existing debt facility. The new debt facility is comprised of a $55 million revolving credit facility and a $60 million term loan. The new facility is secured by substantially all of the assets of the Company and expires on March 16, 2007. Under the terms of the debt refinancing, the Company retired its former $25 million revolving credit facility as well as its Term A and Term B loans. The refinancing resulted in a loss on early extinguishment of debt of $4.7 million due to the write-off of unamortized debt discount and financing fees.

Interest on the $55 million revolving loan was initially payable monthly at LIBOR plus 3.25%. Interest on the $60 million term loan was initially payable monthly at LIBOR plus 3.5%. The interest rates float based on the underlying rate of LIBOR and the Company’s leverage. Availability under the revolving credit facility is not predicated on a borrowing base. The term loan requires quarterly principal payments of $1.25 million on July 2, 2004 and $2.5 million thereafter. In addition, the term loan must be prepaid by an amount equal to: (i) 100% of equity issued, or (ii) 75% of any material asset proceeds in excess of $1 million (other than the sale of inventory in the normal course of business), or (iii) 50% of any excess cash flow as provided for by the agreement. The new facility requires maintenance of certain financial covenants including maximum allowable leverage and minimum tangible net worth.

In April 2004, the Company entered into an interest rate swap arrangement to convert $40 million of the $60 million term loan from a floating rate to a fixed rate, by locking-in LIBOR at 2.76% for the three-year term of the loan.

The Company believes that availability under the current debt agreement provides sufficient liquidity to finance operations and execute strategic initiatives.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

In preparing the condensed 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 and 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.

Valuation of Warranty Liabilities

Customers are provided a written warranty from Midas on genuine Midas products purchased from Midas shops in North America. 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. The Company maintains a warranty accrual to cover the estimated future liability associated with outstanding warranties. The Company determines the estimated value 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.

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 collectibility 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. 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 the Company 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.

Inventory Valuation

As a manufacturer and distributor of certain automotive aftermarket parts, inventory has historically represented a substantial portion of the total assets of the Company. Inventories are valued at the lower of cost or net realizable value. Inventory cost is determined using the weighted-average cost method, which approximates the first-in, first-out method. Additionally, the Company periodically evaluates the carrying value of its inventory to assess the proper valuation. This includes having adequate accruals to cover losses in the normal course of operation, provide for excess and obsolete inventory, and ensure that inventory is valued at the lower of cost or market. In performing this evaluation the Company considers historical data such as actual loss experience, past and projected usage, and actual margins generated from sales of its products.

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 Statement of Financial Accounting Standards (SFAS) No. 87, “Employers’ Accounting for Pensions,” which requires that amounts recognized in the financial statements be determined on an actuarial basis. A minimum liability is required to be established on the balance sheet representing the amount of unfunded accrued pension cost. This represents the difference between the accumulated benefit obligation and the fair value of plan assets. When it is necessary to establish an additional

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minimum pension liability, an amount is recorded as an intangible asset limited to unrecognized prior service cost. Any amount in excess of unrecognized prior service cost is recorded as a reduction to shareholders’ equity through cumulative other comprehensive income, net of tax, in the balance sheet.

To account for its defined benefit pension plans in accordance with SFAS No. 87, 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. For guidance in determining this rate, the Company looks at rates of return on high-quality fixed-income investments and periodic published rate ranges.

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 this rate the Company looks at its historical and expected rates of annual salary increases.

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 under SFAS No. 87 and is recognized to net periodic pension cost over a five-year period.

Carrying Values of Long-Lived Assets

Midas evaluates the carrying values of its long-lived assets to be held and used in the business by reviewing undiscounted cash flows by asset group. Such evaluations are performed whenever events and circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the projected undiscounted cash flows over the remaining lives of the related assets does not exceed the carrying values of the assets, the carrying values are adjusted for the differences between the fair values and the carrying values. Additionally, in the case of fixed assets related to locations that will be closed or sold, the Company writes down fixed assets to their estimated recovery value.

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. 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 July 3, 2004. 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.

Self-Insurance Reserves