ITEM
2.
MANAGEMENT’S DISCUSSION AND
ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD
LOOKING
STATEMENTS
This Quarterly Report on Form 10-QSB and any documents incorporated herein
contain “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995 (the “Reform Act”) We claim
the protection of the safe harbor for forward-looking statements contained
in
the Reform Act. Such forward-looking statements involve known and unknown
risks,
uncertainties and other factors which may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied
by
such forward-looking statements. When used in this Quarterly Report, statements
that are not statements of current or historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, the words
“plan”, “intend”, “may,” “will,” “expect,” “believe”, “could,” “anticipate,”
“estimate,” or “continue” or similar expressions or other variations or
comparable terminology are intended to identify such forward-looking statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. Except as
required by law, the Company undertakes no obligation to update any
forward-looking statements, whether as a result of new information, future
events or otherwise.
Any
reference to the “Company, “Midnight,” the “Registrant”, the “Small Business
Issuer”, “we”, “our” or “us” means Midnight Holdings Group, Inc.
The following discussion and analysis should be read in conjunction with
our
unaudited financial statements as of September 30, 2007 and for the three
and
nine month periods ended September 30, 2007 and 2006, and the notes thereto,
all
of which financial statements are included elsewhere in this Form
10-QSB.
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Critical
Accounting
Policies
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Our discussion and analysis of our financial statements and the
results of
our operations are based upon our financial statements and the
data used
to prepare them. The Company’s financial statements have been prepared in
accordance with accounting principles generally accepted in the
United
States. On an ongoing basis we reevaluate our judgments and estimates
including those related to revenues, bad debts, long-lived assets,
and
derivative financial instruments. We base our estimates and judgments
on
our historical experience, knowledge of current conditions and
our beliefs
of what could occur in the future considering available information.
Actual results may differ from these estimates under different
assumptions
or conditions.
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Our significant accounting policies are disclosed in the Notes
to our
consolidated financial statements. The following discussion describes
our
most critical accounting policies, which are those that are both
important
to the presentation of our financial condition and results of operations
and that require significant judgment or use of complex estimates.
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We
recognize revenues in accordance with SEC Staff Accounting Bulletin No. 104,
“Revenue Recognition”, which superseded SAB No. 101, “Revenue Recognition in
Financial Statements”. Accordingly, revenues are recorded when persuasive
evidence of an arrangement exists, delivery has occurred or services have
been
rendered, our prices to buyers are fixed or determinable, and collectibility
is
reasonably assured.
We derive a majority of our revenues from a combination of direct sales of
automotive products and services to retail, commercial and fleet clients
through
Company owned service center/retail outlets as well as through services provides
to our joint-venture partnerships and franchisees.
These
revenues generally consist of facility lease rents, percentages of the sales
volume of our joint-venture partnerships. We are reimbursed for expenditures
made on behalf of the joint-venture partnerships for property operating
expenses, real estate taxes, maintenance and repairs, automotive tools, and
equipment services and products.
Revenues
also include franchise
royalties based upon a percentage of the gross revenue generated by each
franchised location as well as other franchise related fees for services
provided to franchisees under the terms of their franchise agreements
(including, but not limited to, the initial franchisee fees and training
fees).
Derivative
Financial Instruments
We
do
not use derivative instruments to hedge exposures to cash flow, market, or
foreign currency risks. We evaluate all of it financial instruments to determine
if such instruments are derivatives or contain features that qualify as embedded
derivatives. For derivative financial instruments that are accounted for
as
liabilities, the derivative instrument is initially recorded at its fair
value
and is then re-valued at each reporting date, with changes in the fair value
reported as charges or credits to income. For option-based derivative financial
instruments, we use the Black-Scholes option-pricing model to value the
derivative instruments at inception and subsequent valuation dates. The
classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is re-assessed at the end
of
each reporting period. Derivative instrument liabilities are classified in
the
balance sheet as current or non-current based on whether or not net-cash
settlement of the derivative instrument could be required within 12 months
of
the balance sheet date.
Income
taxes
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We
have a history of losses. These losses have generated sizable federal
net
operating loss (NOL) carry forwards, which approximated $11,600,000
at
December 31, 2006.
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Generally
accepted accounting principles require that we record a valuation allowance
against the deferred income tax asset associated with these NOL and other
deferred tax assets if it is “more likely than not” that we will not be able to
utilize them to offset future income taxes. Due to our history of unprofitable
operations, we have recorded a valuation allowance that fully offsets our
deferred tax assets. We currently provide for income taxes only to the extent
that we expect to pay cash taxes on current income.
The
achievement of profitable future operations at levels sufficient to begin
using
the NOL carry forwards could cause management to conclude that it is more
likely
than not that we will realize all of the remaining NOL carry forwards and
other
deferred tax assets. The NOL carry forwards could be limited in accordance
with
the Internal Revenue Code based on certain changes in ownership that occur
or
could occur in the future. Upon achieving profitable operations, we would
immediately record the estimated net realizable value of the deferred tax
assets
at the time and would then provide for income taxes at a rate equal to our
combined federal and state effective rates. Subsequent revisions to the
estimated net realizable value of the deferred tax assets could cause our
provision for income taxes to vary significantly from period to
period.
Results
of Operations: Comparison of Nine Months Ended September 30, 2007 to
Nine Months Ended September 30, 2006
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Significant
Transactions:
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The following significant transactions impacted the consolidated
results
of operations for the nine month period ended September 30, 2007
compared
to the nine month period ended September 30, 2006:
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We
were in the initial stages of opening additional service centers
in 2006,
and as such were increasing the operating expenses to provide the
infrastructure to do so. As these newly opened service centers
were in
their infancy, they had not yet reach the level of attaining profitable
operations. In addition, all of the services that were opened in
2006 were
either sold to one of our joint venture partners in 2007 or were
closed.
The results of the operations that were closed have been reclassified
to
income or loss from discontinued operations in both periods.
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We
have obtained significant additional funding in the form of convertible
callable secured notes, which has resulted in a considerable increase
in
the amount of interest expense incurred compared to the year ago
period.
This was necessary to fund the infrastructure to enable us to execute
our
business plan.
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The following discussion compares and discusses for each item below, the
Company’s performance year to date, with the Company’s year to date performance
as of the same date in 2006 (“Year to Date”), and the Company’s performance for
the calendar quarter covered by this Report, with the performance for the
same
calendar quarter in 2006 (“Quarter to Quarter”).
During the nine months ended September 30, 2007, revenues increased by
$2,154,000, or 133% to $3,773,500 compared to the same nine months performance
in the prior fiscal year. Service center revenue increased $878,200
as the result of the acquisition of the Oklahoma operations purchased from
a
former franchisee as well as from sales growth at the Joint-venture operations
in Aurora, Illinois and Tempe Arizona. The Oklahoma operations contributed
$977,000 of revenue in the third quarter of 2007, Poor overall economic
conditions in Michigan contributed significantly to the Troy, Michigan location
experiencing a decrease and the ineffectiveness of the Bloomington, Illinois
store lead to a revenue decrease of $99,000 and the resulting closure of
the
Bloomington, Illinois location as of September 30, 2007. Sales to our
Joint Venture partners in both Illinois and Arizona for the 2007 period
increased by $1,315,214. The increase is attributed to the increase in the
Company’s purchasing power and in turn, the selling of the products to the joint
venture operations as well as to the sale of two of service operations in
Illinois being sold to one of the Company’s Joint Venture partners at the end of
the first quarter of 2007. Revenue from royalties on franchise operating
sales
decreased by $39,400 as the result of the sale of the operations of the
franchisee to the Company at the end of the first quarter of 2007.
Revenues for the quarter ended September 30, 2007 increased by $768,100 or
124%
to $1,388,800 compared to the quarter ended September 30,
2006. Service center revenue increased $223,300. The Oklahoma
operations contributed $496,700 of the service center increase, while the
Tempe,
AZ, Aurora, IL, Tinley Park, IL and Troy, MI stores contributed revenues
of
$892,100 which is a decrease of $273,400 primarily due to the decreasing
economic conditions affecting the Troy, MI and Tinley Park, IL locations,
respectively. Sales to our Joint Venture partners in the 2007 period increased
by $223,316. This can be attributed to the greater reliance on our corporate
purchasing and in turn, the selling of the products to the joint venture
operations, in addition to two of the service centers being sold to one of
the
Company’s Joint Venture partners at the end of the first quarter of 2007.
Revenue from royalties on franchise operating sales decreased by $24,000
as
there were no franchise operations during the quarter ended September 30,
2007.
Cost
of Sales: