**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-KSB**

**x**                              ANNUALREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe fiscal year ended June 30, 2007**

**o**                                 TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Commissionfile number 0-29478**

**PRECISION AUTO CARE, INC.**

(Name of small businessissuer in its charter)

| **Virginia**                                                     | ** ** | **54-1847851**                           |
|------------------------------------------------------------------|------------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification Number) |

 

**748 Miller Drive, S.E.,Leesburg, Virginia 20175**

(Address of principalexecutive offices)(Zip Code)

**703-777-9095**

(Issuer’s telephonenumber, including area code)

Securities registered pursuant to Section 12(b) ofthe Act:

**None**

Securities registered pursuant to Section 12(g) ofthe Act:

**CommonStock, par value $.01 per share**

Check whether the issuer (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. x Yes  oNo

Check if no disclosure ofdelinquent filers in response to Item 405 of Regulation S-B is contained inthis form, and no disclosure will be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB. x

The issuer’s revenues forits most recent fiscal year were: $12,071,612.

The aggregate market valueof Common Stock held by persons not “affiliated” with the issuer at August 31,2007 was approximately $3,600,000 based on the closing price of $0.35 pershare. As of August 31, 2007, 28,993,752 of Common Stock were issued andoutstanding.

Transitional SmallBusiness Disclosure Format:  oYes  xNo

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). oYes  xNo

**DOCUMENTSINCORPORATED BY REFERENCE:**

Certainportions of Registrant’s definitive proxy statement, to be filed with theSecurities and Exchange Commission pursuant to Regulation 14A not later than120 days after the close of the Corporation’s fiscal year, are incorporated byreference under Part III.

 

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**TABLEOF CONTENTS**
|               | ** ** | ** ** | ** ** | ** **                                                                                                                  | ** ** | ** ** | **Page** | ** ** |
|---------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|------------|----------|------------|
| PART I   |       | Item 1.    |       | Business                                                                                                                    |       | 4          |     |
|          |       | Item 2.    |       | Properties                                                                                                                  |       | 11         |     |
|          |       | Item 3.    |       | Legal Proceedings                                                                                                           |       | 11         |     |
|          |       | Item 4.    |       | Submission of Matters to a  Vote of Security Holders                                                                        |       | 12         |     |
| PART II  |       | Item  5.   |       | Market for Common Equity and  Related Stockholder Matters and Small Business Issuer Purchases of Equity  Securities         |       | 13         |     |
|          |       | Item 6.    |       | Management’s Discussion and  Analysis or Plan of Operation                                                             |       | 14         |     |
|          |       | Item 7.    |       | Financial Statements                                                                                                        |       | 20         |     |
|          |       | Item 8.    |       | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                                       |       | 39         |     |
|          |       | Item 8A.   |       | Controls and Procedures                                                                                                     |       | 40         |     |
|          |       | Item 8B.   |       | Other Information                                                                                                           |       | 40         |     |
| PART III |       | Item  9.   |       | Directors, Executive  Officers, Promoters and Control Persons; Compliance With  Section 16(a) of the Exchange Act |       | 40         |     |
|          |       | Item 10.   |       | Executive Compensation                                                                                                      |       | 40         |     |
|          |       | Item 11.   |       | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                             |       | 40         |     |
|          |       | Item 12.   |       | Certain Relationships and  Related Transactions                                                                             |       | 40         |     |
|          |       | Item 13.   |       | Exhibits                                                                                                                    |       | 41         |     |
|          |       | Item 14.   |       | Principal Accountant Fees  and Services                                                                                     |       | 43         |     |
|               |            |            |            |                                                                                                                             |            |            |          |            |  |

 

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**FORWARD-LOOKINGSTATEMENTS**

This report includes forward-looking statements withinthe meaning of the Securities Act of 1933 (the ‘‘Securities Act’’) and theSecurities Exchange Act of 1934. When used in this report, the words ‘‘anticipate,’’‘‘believe,’’ ‘‘estimate,’’ ‘‘expect,’’ ‘‘intend’’ and ‘‘plan’’ as they relateto Precision Auto Care, Inc. or its management are intended toidentify such forward-looking statements. All statements regarding PrecisionAuto Care, Inc. or Precision Auto Care, Inc.’s expected futurefinancial position, business strategy, cost savings and operating synergies,projected costs and plans, and objectives of management for future operationsare forward-looking statements. Although Precision Auto Care, Inc.believes the expectations reflected in such forward-looking statements arebased on reasonable assumptions, no assurance can be given that suchexpectations will prove to have been correct. Important factors that couldcause actual results to differ materially from the expectations reflected inthe forward-looking statements herein include, among others, the factors setforth under the caption ‘‘Business—Risk Factors,’’ general economic andbusiness and market conditions, changes in federal and state laws, andincreased competitive pressure in the automotive aftermarket services business.

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**PART I**

**Item 1.**                        *Business*

**OVERVIEW**

Precision Auto Care, Inc. (“PACI” or the “Company”)is a franchisor of automotive service centers owned and operated by licensedfranchisees. These franchises are located in the United States and in certainforeign countries. In addition, the Company owns and operates an automotiveservice center. At June 30, 2007, the Company had 28 total employees ofwhich 26 were full time employees. Through its franchised centers, services areprovided to automobile owners and focus on those high-frequency items requiredon a periodic basis to maintain the vehicle properly.

The Company was incorporated as a Virginia corporationin April 1997, but its predecessors have been in the automotivemaintenance services business since 1976. The first Precision Tune wasestablished in 1976 to provide quick, convenient and inexpensive enginetune-ups. Franchising of Precision Tune centers began the next year. Asautomotive technology changed, Precision Tune expanded its menu of offeredautomotive maintenance and repair services to include oil changes, fuelinjection service, air conditioning service, cooling system service, brakeservice and more diagnostic services. In September 1996, the PrecisionTune brand name was changed to Precision Tune Auto Care to reflect the shift inemphasis.

The Company is theresult of the November 1997 combination of WE JAC Corporation (the ownerof Precision Tune Auto Care) and nine other automotive maintenance servicescompanies in connection with its initial public offering. With the goal ofreturning focus on core operations, the Company disposed of ancillarybusinesses. Now the Company focuses on the automotive aftermarket, which iscomprised of Precision Tune Auto Care (“PTAC”), and provides automotiveservices through franchised and company-owned operations located in the UnitedStates and in certain foreign countries.

·       PTAC provides automotivemaintenance and repair services, such as engine performance, oil change andlubrication and brake services, which require relatively short service times.At June 30, 2007, these services were provided at one center owned andoperated by the Company and 400 domestic and international Precision TuneAuto Care centers owned and operated by franchisees.

**OPERATIONS**

*Precision Tune AutoCare*

Precision Tune Auto Care is a franchisor of automotiveservice centers that provide specialized quality maintenance and repairservices that require relatively short service times. The automotive careservices provided by Precision Tune Auto Care centers include the diagnosis,maintenance and repair of ignition systems, fuel systems, computerized enginecontrol systems, cooling systems, starting/charging systems, emissions controlsystems, engine drive train systems, electrical systems, air conditioningsystems, oil and other fluid systems, and brake systems. The Company hasrecently made the decision to sell tires and tire related services at thecenters as well. In addition, the Company owns and operates an automotiveservice center.

*PrototypeCenter.**  *Thecurrent prototype Precision Tune Auto Care center is a free-standing buildingwith six to eight service bays, of which two to four are drive-through andinclude pits to facilitate fast oil change and lubrication services. Franchiseestypically develop Precision Tune Auto Care centers either by entering into abuild-to-suit lease, under which the landlord constructs the center and leasesit to the franchisee, or by purchasing land and building the facility. TheCompany typically seeks sites in commercial areas with a minimum population of50,000 people within a five mile radius. Exclusive of real estate, the 

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estimated capital requiredto open a prototype Precision Tune Auto Care center ranges from $123,000 to$208,075.

*RetailMarketing.**  *PrecisionTune Auto Care’s marketing objectives at the retail level are to increasefranchisee sales, enhance first-time customers’ experiences, and bolster eachfranchisee’s customer retention efforts. To further these objectives, PrecisionTune Auto Care has developed and implemented a marketing plan containingprograms and materials for use by Precision Tune Auto Care centers. The planincludes targeted marketing programs designed to reach key market segments,in-store merchandising materials designed to enhance retail sales and firsttime customer trials, and other local marketing materials (e.g., second cardiscounts, service reminder cards, and ATM receipt coupons) designed togenerate customers and improve customer retention.

*Trainingand Operational Support.**  *Asignificant element of Precision Tune Auto Care’s commitment to service is itstraining program for franchisees. New franchisees are required to successfullycomplete over 40 hours of initial training at its national training center inLeesburg, Virginia. The Company also offers a full line of technical training,including courses on engine performance, fuel systems and emissions, automotiveelectronics, fuel injection, and brake certification. These courses, whichinclude both classroom and hands-on training, are designed to allow franchiseesand service center technicians to maintain and update their technicalcapability to service today’s more complex vehicles.

*FranchiseMarketing.**  *TheCompany (through a predecessor company) has marketed franchises for PrecisionTune Auto Care centers since 1977. Its franchise sales process includesadvertising in appropriate franchise and business publications, establishingrelationships and working with sales brokers, conducting franchise salesseminars, maintaining a home page on the Internet through which interestedparties may submit a franchise inquiry, and advertising on several franchisesales orientated web sites. Prospective franchisees are asked to complete aConfidential Qualifications Report, which serves as the initial screening todetermine whether a prospect is qualified. The Company seeks individuals withmanagement experience who will make a full-time commitment to the operation oftheir franchise and who have a minimum of $70,000 and $250,000 in liquid assetsand net worth, respectively.

Precision Tune Auto Care’s area-development system hasplayed a significant role in its franchise development efforts. Under thissystem, Precision Tune Auto Care has entered into area-development agreementsthat grant area developers the right and obligation to develop franchiseswithin specific geographic regions for stated periods of time. Franchiseagreements within the area are between the Company and the franchisee. The areadeveloper typically receives up to one-half of the initial franchise fee,one-half of the subsequent royalty revenues and one-half of franchise renewaland transfer fees. After the creation of a franchise, the area developer performsmany of Precision Tune Auto Care’s franchise support obligations. As of June 30,2007, 16 area developers and their affiliates had an ownership interest inapproximately 26% of the total number of Precision Tune Auto Care centers.

*Open Area Development.**  *Precision Tune Auto Care’s current strategy is alsoto pursue new area developers to develop open areas in which current areadevelopers have not been granted rights. To attract new area developers, thecompany employs strategies similar to those used in marketing unit franchises. However,the net worth requirements for prospective area developers are greater thanthose required for a unit franchisee. These requirements range from $500,000 to$1,000,000 net worth, depending upon the size of the particular area.

**FRANCHISINGACTIVITIES**

*PrecisionTune Auto Care.*   As of June 30, 2007, theoverwhelming majority of Precision Tune Auto Care domestic and internationalcenters were owned and managed by franchisees. Precision Tune Auto Care’sdomestic franchises have been sold during the preceding years under franchise agreementsthat vary in detail as the Precision Tune Auto Care’s franchise program hasevolved. Royalty rates in existing 

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franchise agreements rangefrom 6.0% to 7.5%. Currently, Precision Tune Auto Care’s standard franchiseagreement requires payment to the Company of an initial franchise fee of$25,000 and a continuing royalty of 6.0% to 7.5% of weekly gross receipts. Inaddition, the franchisee is required to contribute to or expend up to 9% ofweekly gross receipts on advertising, of which 1.5% is currently paid into thenational marketing fund and up to 7.5% of which is spent locally. The currentstandard form franchise agreement has an initial term of ten years and providesfor five-year renewal options.

The Company has implemented a domestic program underwhich qualified franchisees are eligible to have their royalty rate reduced toas low as 6% if they satisfy certain criteria. Under the program, franchiseesare also provided with an incentive to purchase additional Precision Tune AutoCare franchises. Any franchisee that has owned and operated a center for atleast one year in accordance with this program will be charged an initialfranchise fee of $15,000 for a second franchise and $10,000 for each additionalfranchise purchased, provided certain conditions are met.

Under its current form of domestic franchiseagreement, the Company has a continuing obligation to make technical andadministrative support available, centralized marketing support, and trainingand related support available to its franchisees. In areas where there are areadevelopers, the Company has delegated most of these duties to area developersunder its area developer system.

Upon non-renewal and transfer, the Company has thefirst right to purchase the operating assets and obtain an assignment of leasedfacilities in certain cases. In certain situations, the Company will repurchasefranchise rights. The decision to repurchase is made solely at its discretionand is not a contractual obligation. The Company also periodically obtains possessionof some franchisees’ franchise rights by exchanging for such rights notespayable or other consideration, or by exercising rights outlined in thefranchise agreements.

The Company also entersinto master franchise agreements to develop international markets. At thepresent time, the Company has master franchise agreements in Taiwan, Oman,Indonesia, United Arab Emirates, the Dominican Republic, El Salvador, SaudiArabia, China, Spain, Portugal, Qatar, Kuwait and Bahrain. Generally, themaster franchisee pays a license fee and is required to develop Precision TuneAuto Care centers in accordance with an agreed upon schedule within the definedarea. Franchise agreements within the area are between the master franchiseeand the unit franchisee. The master franchisee is required to perform all ofthe obligations of the franchisor including training, administrative andoperational support, and the Company generally receives 20% of the initialfranchise fee and 20% of royalty fees.

**COMPETITION**

The Company’s franchisees encounter competition in allaspects of their business, including the sale by Precision Tune Auto Carecenters of automotive maintenance and repair services and fast oil andlubrication services. The Company believes that automobile dealerships,including recently emerging national and regional new and used autodealerships, represent Precision Tune Auto Care’s principal competitors. OtherPrecision Tune Auto Care competitors include tire companies and regionalunder-the-hood service specialists. National competitors within Precision TuneAuto Care’s market include Sears Auto Center and the automotive maintenancecenters operated by Goodyear, Midas, Meineke, Jiffy Lube, and Firestone, amongothers. The Company believes that the greater technical complexity of today’svehicles provides a substantial barrier to entry for competitors in the “under-the-hood”segment of the automotive care services industry.

The Company believes thatthe Precision Tune Auto Care centers all compete on the basis of customerawareness through advertising, service, convenience and location and, to alesser extent, on price. The Company believes that the potential ability tooffer all of the services provided by each of the 

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operationsat one center or in centers in close proximity to one another will be asignificant competitive advantage.

**GOVERNMENTREGULATION**

*FranchisingRegulation.*   The Company is subject to federal,international and state laws and regulations, including the regulations of theFederal Trade Commission as well as similar authorities in individual states,in connection with the offer, sale and termination of franchises and theregulation of the franchisor/franchisee relationship. From time to time, theCompany experiences periods during which sales are restricted while the Companyregisters updates of its disclosure material with various states. Such delaysmay have an adverse effect on its ability to offer and sell franchises. Inaddition, the Company may become subject to litigation with, or other claimsfiled with state, federal or international authorities by, franchisees or areadevelopers based on alleged unfair trade practices, implied covenants of goodfaith and fair dealing or express violations of agreements. The failure by theCompany to comply with these laws could subject the Company to liability tofranchisees and to fines or other penalties imposed by governmental authoritiesand could have a material adverse effect on its financial condition and resultsof operations.

*Environmental Regulation.*   PrecisionTune Auto Care centers store new oil and handle large quantities of usedautomotive oils and fluids. As a result of these activities, the Company, itsfranchisees and area developers are subject to various federal, state and localenvironmental laws and regulations dealing with the transportation, storage,presence, use, disposal and handling of hazardous materials and hazardouswastes, and underground fuel storage tanks. If any such substances wereimproperly released or improperly stored on the property of any franchisee,including leased properties, or if the Company were found to be in violation ofapplicable environmental laws and regulations, the Company could be responsiblefor clean-up costs, property damage and fines or other penalties, any one ofwhich could have a material adverse effect on its financial condition andresults of operations.

**TRADEMARKS**

The Company has registereda number of trademarks and service marks with the United States Patent andTrademark Office, including “Precision Tune Auto Care.” Its failure to obtainand maintain trademark and service mark registration could have a materialadverse effect on its operations. The Company has also registered or madeapplication to register trademarks in foreign countries where master franchiselicenses have been granted.

**SEASONALITY**

Seasonal changes mayimpact various sectors of the Company’s businesses and, accordingly, itsoperations may be adversely affected by seasonal trends in certain periods. Inparticular, severe weather in winter months may make it difficult for consumersin affected parts of the country to travel to Precision Tune Auto Care andobtain services.

**RISK FACTORS**

The Company’s business and investment in its CommonStock are subject to certain risks, including the following:

*StockListing.**  *TheCompany’s common stock trades on the National Association of Securities Dealers, Inc.’sOTC Bulletin Board. Like other stocks traded over this quotation system, itscommon stock is thinly traded, highly volatile and not followed by analysts.

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*PennyStock Regulations.**  *TheCompany’s common stock is subject to the rules promulgated under theSecurities Exchange Act of 1934, as amended, relating to “penny stocks.” These rules requirebrokers selling securities subject to these rules to persons other thanestablished customers and institutional accredited investors to completecertain documentation, make suitability inquiries of investors, and provideinvestors with certain information concerning the risks of trading in thesecurity. These rules may restrict the ability of brokers to sell theCompany’s common stock and thus may have an adverse effect on the liquidity andmarket price of its common stock.

*ResaleRestrictions on Common Stock.**  *Becauseof large broker-dealer spreads, investors may be unable to sell the stockimmediately back to the broker-dealer at the same price the broker-dealer soldthe stock to the investor. In some cases, the stock may fall quickly in value.The market among broker-dealers may not be active, making it more difficult forinvestors to sell this stock. Investors in a penny stock often are unable tosell stock back to the dealer that sold them the stock. The mark-ups orcommissions charged by the broker-dealers may be greater than any profit aseller may make.

*Penny Stock Market.**  *Shareholders should be aware that, according toSecurities and Exchange Commission Release No. 34-29093, the marketfor penny stocks has suffered in recent years from patterns of fraud and abusewhich could cause investors to lose their entire investment. Such patternsinclude:

·       controlof the market for the security by one or a few broker-dealers that are oftenrelated to the promoter or issuer;

·       manipulationof prices through prearranged matching of purchases and sales and false andmisleading press releases;

·       “boilerroom” practices involving high pressure sales tactics and unrealistic priceprojections by inexperienced sales persons;

·       excessiveand undisclosed bid-ask differentials and mark-ups by selling broker-dealers;and

·       thewholesale dumping of the same securities by promoters and broker-dealers afterprices have been manipulated to a desired level, along with the inevitablecollapse of those prices with consequent investor losses.

The Company’s management is aware of the abuses thathave occurred historically in the penny stock market. Although it does notexpect to be in a position to dictate the behavior of the market or ofbroker-dealers who participate in the market, it will strive within theconfines of practical limitations to prevent the described patterns from beingestablished with respect to its securities.

*Competition.*   Theautomotive services industry is highly competitive. The Company believes thatautomobile dealerships, including recently emerging national and regional newand used auto dealerships, represent the principal competitors for PrecisionTune Auto Care service centers; however, these service centers also competewith national and regional fast oil change and lube companies, major oilmanufacturers, local service stations and local, regional and nationalautomobile maintenance and repair service providers.

The Company believes the principal competitive factorsin the markets serviced by each of its business units are location, namerecognition and reputation, and quality of service and price.

The Company also competes with some of those notedabove and with other parties in the sale of franchises. Competitive factorsinclude startup costs, royalty rates, franchisee support and the financialperformance of existing centers. With respect to the sales of supplies andequipment to franchisees, competition is based on availability, price, abilityto provide prompt delivery and the quality of support services.

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Certain competitors discussed above have greaterfinancial resources than the Company. There can be no assurance that theCompany or individual Precision Tune Auto Care centers will be able to competeeffectively. *See “Business**3⁄4Competition.”*

*Relianceon Franchising.**  *Franchiseroyalties are a significant component of its revenue base. Therefore, theCompany depends upon the ability of its franchisees to promote and capitalizeupon the “Precision Tune Auto Care” brand and the reputation the Companybelieves it enjoys for quality and value. There can be no assurance that theCompany or our area developers will be able to recruit and retain franchiseeswith the business abilities or financial resources necessary to open PrecisionTune Auto Care centers on schedule or that the franchisees will conductoperations profitably. In addition, to the extent that franchisees financetheir operations with secured indebtedness, the Company’s rights to receivefranchise royalties would be effectively subordinated to the rights offranchisees’ lenders. *See “Business**3⁄4Operations.”*

*AutomotiveTechnology Advances.**  *Thedemand for the services offered by its Precision Tune Auto Care centers couldbe adversely affected by continuing developments in automotive technology.Automotive manufacturers are producing cars that last longer and requireservice and maintenance at less frequent intervals. For example, somemanufacturers now recommend that consumers change oil at 10,000 mileintervals and replace spark plugs and other engine components at 100,000 miles,a significant increase from the mileage intervals recommended for earliermodels and those currently recommended by most manufacturers. The demand forits services also could be adversely affected by longer and more comprehensivewarranty programs offered by automobile manufacturers and other third parties.The Company believes that a majority of new automobile owners have their carsserviced by a dealer during the period the car is under warranty. In addition,advances in automotive technology may require the Company to incur additionalcosts to update its technical training program and upgrade the diagnosticcapabilities of its centers.

*LaborAvailability.*   The provision of high qualitymaintenance services by Precision Tune Auto Care centers requires an adequatesupply of skilled labor. In addition, the operating costs and operatingrevenues of such centers may be adversely affected by high turnover in skilledtechnicians. Trained and experienced automotive technicians are in high demand.Accordingly, a center’s ability to increase productivity and revenues could beaffected by its inability to maintain the employment of skilled techniciansnecessary to provide the center’s services. There can be no assurance thatPrecision Tune Auto Care or its franchisees will be able to attract andmaintain an adequate skilled labor force necessary to operate these centersefficiently or that labor expenses will not increase as a result of a shortagein the supply of skilled technicians, thereby adversely impacting its financialperformance.

*Dependenceon Management and Key Personnel.**  *TheCompany’s success depends to a significant extent on the performance andcontinued services of senior management and certain key personnel. The Companybelieves these individuals possess the necessary experience in financing,operating and managing a company intent on improving its financial performance.The loss of the services of one or more of these key employees could have amaterial adverse impact on its financial condition and results of operations.

*SeasonalNature of Portions of the Business.**  *Seasonal changes may impact various sectors of itsbusinesses and, accordingly, its operations may be adversely affected byseasonal trends in certain periods. In particular, severe weather in wintermonths may make it difficult for consumers in affected parts of the country totravel to Precision Tune Auto Care centers and obtain services.

*Controlby Management and Principal Shareholders.**  *As of August 31, 2007, the Company’s directors,executive officers and shareholders beneficially owning more than 5% of itsoutstanding common stock, in the aggregate, beneficially owned approximately83% of its outstanding common stock. Accordingly, these persons havesubstantial influence over its affairs, including the ability to influence theelection of directors and appointment of management, the outcome of votes byits shareholders on major corporate 

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transactions, includingmergers and the sales of substantial assets and other matters requiringshareholder approval.

*FranchisingRegulations.**  *TheCompany is subject to federal, international and state laws and regulations,including the regulations of the Federal Trade Commission as well as similarauthorities in individual states, in connection with the offer, sale andtermination of franchises and the regulation of the franchisor/franchiseerelationship. *See “Business**3⁄4GovernmentRegulation.”* Its failure to comply with these laws could subject theCompany to liability to franchisees and to fines or other penalties imposed bygovernmental authorities. From time to time, the Company experiences periodsduring which sales are restricted while the Company registers updates of itsdisclosure material with various states, such delays may have an adverse effecton its ability to offer and sell franchises. In addition, the Company maybecome subject to litigation with, or other claims filed with state, federal orinternational authorities by, franchisees or area developers based on allegedunfair trade practices, implied covenants of good faith and fair dealing orexpress violations of agreements. Accordingly, its failure to comply withapplicable franchise laws and regulations could have a material adverse effecton its financial condition and results of operations.

*Environmental Regulation.**  *Precision Tune Auto Care centers store new lubricantsand handle large quantities of used automotive lubricants and fluids. As aresult of these activities, the Company, its franchisees and area developersare subject to various federal, state and local environmental laws andregulations dealing with the transportation, storage, presence, use, disposaland handling of hazardous materials and hazardous wastes, discharge of stormwater, and underground fuel storage tanks. If any such substances were improperlyreleased or improperly stored on its property or the property of anyfranchisee, including leased properties, or the Company were found to be inviolation of applicable environmental laws and regulations, the Company couldbe responsible for clean-up costs, property damage and fines or otherpenalties, any one of which could have a material adverse effect on itsfinancial condition and results of operations. *See “Business**3⁄4Government Regulation.”*

**EXECUTIVE OFFICERSOF PRECISION AUTO CARE, INC.**

*LouisM. Brown, Jr.,*age 64 became Chairman of theBoard in October 2003. From October 2003 to May 2006, he wasChairman of the Board and Chief Executive Officer. From August 2000 until October 2003,he was the Company’s President and Chief Executive Officer. He is Vice Chairmanof Micros Systems, Inc. since April 2003 and was Chairman of theBoard from January 1987 to April 2003.

*RobertR. Falconi,*age 53, became Chief Executive Officer in May 2006.He also remains President. From November 2003 to April 2006, he was ChiefOperating Officer and Chief Financial Officer. From March 2002 to October 2003,he was Executive Vice President and Chief Operating Officer/Chief FinancialOfficer. From September 2000 to February 2002, he was the Company’sVice President—Finance, Administration and Chief Financial Officer. From August 1998until September 2000, he was Chief Financial Officer of Apptis, Inc.

*MarkP. Francis,*age 41, became Chief Financial Officer in May 2006.From October 2004 to April 2006, he was Controller. From April 2004until October 2004, Mr. Francis was the Assistant Controller of theCompany. From December 1999 until April 2004, he was an accountingmanager of REHAU, Inc.

*FrederickF. Simmons,*age 45, became Senior Vice President,General Counsel and Secretary in March 2001. From December 1995 to February 2001,he was Assistant General Counsel and Assistant Secretary of AdvanticaRestaurant Group, Inc.

*JohnT. Wiegand,*age 45, became Senior Vice President—OperationalPrograms and Training in March 2002. From August 2000 to March 2002,he was Senior Vice president of Franchise Operations and 

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from June 1998 to August 2000,he was Vice President of North American Operations. Mr. Wiegand joined WEJAC Corporation, the Company’s predecessor, as Director of Field Operations in August 1996.

*KevinBates,*age 45, became Senior Vice President ofMarketing in August 2004. From October 1999 to August 2004, Mr. Bateswas Vice President—Marketing and Advertising. From January 1998 until October 1999,he was our Director of Field Operations.

*JoelBurrows,*age 50, became Vice President—Training/Researchand Development in September 1999. From December 1997 until September 1999,he was the PTAC Director of Training/Research and Development.

*Glyn D. Massingill,*age61, became Vice President—Franchise Services in January 2000. From September 1990through December 1999, Mr. Massingill was Vice President and GeneralManager of Precision Automotive Components Manufacturing and Distribution(PAC), a division of the Company.

**Item 2.**                        *Properties*

The Company’s corporate headquarters are located inapproximately 18,000 square feet of leased office space in Leesburg, Virginiapursuant to a lease that expires in 2009.

In the opinion ofmanagement, the Company’s current space is adequate for its operating needs.

**Item 3.**                        *Legal Proceedings*

From time to time, the Company and its subsidiariesare subject to litigation in the ordinary course of business, includingcontract, franchisee and employment-related litigation. In the course of enforcingits rights under existing and former franchisee agreements, the Company issubject to complaints and letters threatening litigation concerning theinterpretation and applicability of these agreements, particularly in casesinvolving defaults and terminations of franchises.

The Company is involved inlitigation. The details of the litigation are as follows:

***Triton Commercial Building Contractors, Inc. v.Jeffrey Caldwell, RPM Solutions, Inc. and Precision Tune Auto Care, Inc.,***Common Pleas Court of Green County, OH (CivilDivision), 2007CV0250, Filed: March 13, 2007.

This case stems from a dispute between an areadeveloper of Precision Franchising LLC (PFL) and one of its vendors. PFL doesnot believe it is a proper party to this suit.

The plaintiff, Triton Commercial Building Contractors, Inc.(Triton), is in the business of constructing buildings for commercial use. DefendantMr. Jeffrey Caldwell (Caldwell) is the President of RPM Solutions, Inc.(RPM). RPM is a Precision Tune Auto Care (PTAC) area developer and franchiseethat operates several PTAC franchises in Ohio. Pursuant to executory contractsbetween RPM and PFL, RPM has a duty to defend and indemnify PFL and itsaffiliates, including Precision Tune Auto Care, Inc., from claims of thetype made by Triton.

Triton alleges that in October 2005Caldwell approached Triton and requested that Triton construct a building for aPrecision Tune Auto Care franchise which Caldwell intended to rent from Triton.After Triton allegedly incurred significant costs, Caldwell informed Tritonthat he had engaged another contractor to construct a building for thePrecision Tune Auto Care franchise. Triton filed a complaint in the CommonPleas Court of Green County, Ohio on March 13, 2007 requesting judgmentagainst Caldwell and Precision Tune Auto Care, Inc. in the amount of$136,000 plus punitive damages, interest, costs, attorneys’ fees, and any otherlegal or equitable relief the Court deems proper. PFL sent a letter to Caldwelland RPM advising them of their duty to indemnify Precision Tune Auto Care, Inc.Counsel has been retained by Caldwell to provide a defense to these claims. Ananswer to the complaint was filed on 

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April 10,2007. Precision Tune Auto Care filed a motion for summary judgment without oralargument on May 23, 2007. Currently, the judge has yet to make a decisionregarding the motion for summary judgment, and there have been no furtherdevelopments in the case.

***United Bank, NA v. C. Eugene Deal, Miracle Partners, Inc.,Star Auto Center, Inc.,***Common Pleas Court ofCuyahoga County, Ohio, Case No. 01-CV0019, Filed January 11,2001.

Miracle Partners, Inc.,a wholly-owned subsidiary of the Company, was party to a confessed judgment ofapproximately $1.3 million. The subsidiary is currently inactive and has noassets. As such, management believes this judgment will have no material impacton the Company’s consolidated results of operations. Furthermore, the Companybelieves that it has a meritorious claim against Mr. Deal for misrepresentationsmade in connection with the Company’s acquisition of Miracle Partners, Inc.in 1997 for all amounts covered by the judgment.

***Lumnivision, S.A. de C.V. v. Praxis Afinaciones, S.A.de C.V.,***Third Civil Court, First JudicialDistrict, Monterrey, Nuevo Laredo, Mexico.

Lumnivision filed suit against Praxis Afinaciones, anindirect wholly owned subsidiary of the Company, seeking payment of 766,000Mexican Pesos, plus interest at the rate of 5% per month, for services under acontract. Praxis Afinaciones denies the allegations and is defending theallegations in the lawsuit.

The Company does notbelieve that any of the above claims or proceedings will result in a materialjudgment against the Company or any of it’s subsidiaries. There can be noassurance, however, that these suits will ultimately be decided in its favor. Anyone of these claims or proceedings may result in a material judgment againstthe Company, which could cause material adverse consequences to its operations.

**Item 4.**                        *Submission of Matters to a Vote of Security Holders*

None.

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**PART II**

**Item5.**                        *Market for Common Equity and Related Stockholder Matters and SmallBusiness Issuer Purchases of Equity Securities*

The Company’s common stock, par value $.01 per share (“CommonStock”) is publicly traded on the National Association of Security Dealers Inc.’sOTC Bulletin Board and is quoted under the symbol “PACI.’’

The following table sets forth the high and low salesprices on NASD OTC Bulletin Board for the Common Stock during the fiscal yearsended June 30, 2007, and June 30, 2006, respectively. To date, theCompany has not paid any Common Stock dividends and does not anticipate payingany Common Stock dividends in the foreseeable future; however dividends arecurrently being paid on the Company’s Series A redeemable preferred stock(see “Management’s Discussion and Analysis or Plan of Operation—Liquidity andCapital Resources”).

These over the countermarket quotations reflect inter-dealer prices, without retail mark-up,markdown, or commission, and may not necessarily represent actual transactions.

**Fiscal Year Ended June 30, 2007**

| **Quarter** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------|------------|------------|------------|----------|------------|---------|------------|
| First       |       | $          | 0.65       |     | $          | 0.45    |       |
| Second      |       | 0.52       |       | 0.35     |       |
| Third       |       | 0.50       |       | 0.40     |       |
| Fourth      |       | 0.51       |       | 0.35     |       |
|             |            |            |            |          |            |         |            |  |  |

 

**Fiscal Year Ended June 30, 2006**

| **Quarter** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------|------------|------------|------------|----------|------------|---------|------------|
| First       |       | $          | 1.10       |     | $          | 0.85    |       |
| Second      |       | 1.00       |       | 0.67     |       |
| Third       |       | 0.80       |       | 0.55     |       |
| Fourth      |       | 0.70       |       | 0.55     |       |
|             |            |            |            |          |            |         |            |  |  |

 

As of August 31,2007, there were approximately 183 record holders of Common Stock andapproximately 600 beneficial owners of the Company’s Common Stock.

**Equity Compensation Plan Information**

| **Plan category**                                      | ** ** | ** ** | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** | ** ** | **Weighted average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available  for future issuance** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                              | ** ** | **(c)**                                                                                                          | ** ** |
| Equity  compensation plans approved by security holders     |       |       | 1,491,700  |                                                                                                                                                 |       |                                                                                                             | 0.89       |                                                                                        |       |   | 921,997 |   |   |
| Equity  compensation plans not approved by security holders |       |       | —     |                                                                                                                                                 |       |                                                                                                             | —     |                                                                                        |       |   | — |   |   |
| Total                                                       |       |       | 1,491,700  |                                                                                                                                                 |       |                                                                                                             | 0.89       |                                                                                        |       |   | 921,997 |   |   |

 

No shares were repurchased by or on behalf of the Companyduring the fourth quarter of 2007.

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**Item 6.**                        *Management’s Discussion and Analysis or Plan of Operation*

**Introduction**

The following discussionshould be read in conjunction with the consolidated Financial Statements of theCompany and related notes thereto included elsewhere herein.

**Overview**

Precision Auto Care is a global franchisor of autocare centers. Company revenues are derived from four primary areas: franchisedevelopment, royalties, company-operated retail stores and product sales.Franchise development revenues include sales of franchises and master licenses.Royalty revenues are derived from royalty fees paid by individual franchiseesto the Company based on qualified retail sales by the franchisee. Retailrevenues are realized from providing maintenance and repair services, as well asfrom the parts that are provided as part of that service to the general public.Product revenues are derived from the sale of automotive related supplies andequipment to individual franchisees.

Direct costs consist of fees paid to area developersfor the sale of new franchises and for supporting franchisees on an ongoingbasis, other costs associated with directly supporting the franchise system,and the cost of automotive related supplies. General and administrativeexpenses include all legal, accounting, general overhead, informationtechnology and corporate staff expenses. Other income and expense items includeinterest income and expense which are included within the non-operatingincome/expense category on the Statement of Operations.

The Company’s core autocare and franchising business continues to benefit from an improved focus onunit economics, offering certain product services to the franchisees such asequipment and other marketing related materials as well as in the fieldtraining programs. Additionally, the Company is seeking growth throughacquisitions.

**Critical AccountingPolicies**

The following is a summaryof the Company’s critical accounting policies. For a full description of theseand other accounting policies, see Note 2 of the Notes to the ConsolidatedFinancial Statements. These critical accounting policies require estimates andassumptions that affect the amounts of assets, liabilities, revenues andexpenses reported in the consolidated financial statements. Due to theirnature, estimates involve judgments based on available information. Actualresults or amounts could differ from estimates and the difference could have amaterial impact on the consolidated financial statements. Therefore,understanding these policies is important in understanding the reported resultsof operations and the financial position of the Company.

*Revenue Recognition*

The Company enters into domestic Area Developmentagreements and international Master License agreements which grant the areadeveloper and master licensor, respectively, the right to sell, on the Company’sbehalf, Precision Tune Auto Care franchises within a specific geographic region.Revenue from the sale of Area Development agreements and international MasterLicense agreements is recognized as all material services or conditions relatedto the agreements are satisfied.

Revenue from the sale of a franchise is recognizedwhen all material services and conditions have been satisfied, generally at theopening of the franchised center.

The Company’s royalty revenue is recognized as earnedin accordance with the specific terms of each agreement and to the extent noknown issues involving collection exist. In the case when revenues are notlikely to be collected, the Company establishes reserves for such amounts. Suchreserves are based upon 

14

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our historical collectionexperience with the various franchisees taking into consideration the financialstability of such franchisees.

Product services in the form of equipment and othermarketing materials related sales are recognized upon delivery to thefranchisee.

Retail revenues arerealized from providing maintenance and repair services, as well as from theparts that are provided as part of that service to the general public, arerecognized when the service is performed.

*Goodwill andIntangible Assets*

Statement of Financial Accounting Standards (SFAS) No. 142,“Goodwill and Intangible Assets”, requires that goodwill no longer beamortized, but instead be tested for impairment at least annually. Impairmenttesting is performed in the first quarter of each fiscal year. The Companyengaged a valuation specialist in fiscal year 2007 to assist management withits test for impairment. The fair value of franchising operations was estimatedutilizing a discounted cash flow approach that estimates revenue, driven byassumed market growth rates and appropriate discount rates. These estimates areconsistent with the plans and estimates management uses to manage theunderlying business. The fair value of the franchising operations exceeded itscarrying value by a substantial margin. Based upon the above, management hasconcluded that the $8.7 million carrying value of goodwill was not impaired. Therewas additional goodwill of $230,000 associated with the purchase of an operatingautomotive service center during the second quarter of fiscal year 2007. Aspreviously stated, the annual impairment testing was performed in the firstquarter of the current fiscal year, thus this transaction was not included.However, there were no substantial changes in the operations of the automotiveservice center that would indicate impairment (see Note 5 of the ConsolidatedFinancial Statements). 

*Deferred TaxValuation Allowance*

The Company recognizes deferred income tax liabilitiesand assets for the expected future tax consequences of events that have beenincluded in the financial statements or tax returns. Deferred tax liabilitiesand assets reflect the effects of tax losses and the future income tax effectsof temporary differences between the consolidated financial statement carryingamounts of existing assets and liabilities and their respective tax bases andare measured using enacted tax rates that apply to taxable income in the yearsin which those temporary differences are expected to be recovered or settled. TheCompany recognizes deferred tax assets if it is more likely than not that theasset will be realized in future years.

The Company regularly reviews the recoverability ofits deferred tax assets and establishes a valuation allowance as deemedappropriate. In assessing the need for a valuation allowance against thedeferred tax asset, management considers factors such as future reversals ofexisting taxable temporary differences, tax planning strategies and future taxableincome exclusive of reversing temporary differences and carryforwards. As of June 30,2007, the Company decided to release its $2.9 million valuation allowance as ithas determined that it is more likely than not that the assets will be realizedin future years.

While the Companyanticipates recognizing a full provision in future periods, the Company expectsto pay only alternative minimum tax and state taxes until such time that ournet operating loss carryforwards are fully utilized.

**Recently IssuedAccounting Standards**

In June 2006, the Financial Accounting StandardsBoard (FASB) issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”),which clarifies the accounting for uncertainty in income taxes recognized in acompany’s financial statements in accordance with FAS 109, “Accounting forIncome Taxes”. The Interpretation 

15

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provides a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.FIN 48 also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure and transition. FIN 48 iseffective for the Company beginning July 1, 2007. The Company is requiredto disclose the cumulative effect of the change in retained earnings as of thedate of adoption, and such disclosure is required only in the year of adoption.Based on our current assessment, the Company believes that the impact to theconsolidated financial statements taken as a whole will be in the range of$100,000 to $150,000.

In fiscal year 2007, we adopted Staff AccountingBulletin (“SAB”) No. 108, “Considering the Effects of Prior YearMisstatements when Quantifying Current Year Misstatements”. SAB No. 108requires companies to quantify misstatements using both a balance sheet (ironcurtain) and an income statement (rollover) approach to evaluate whether eitherapproach results in an error that is material in light of relevant quantitativeand qualitative factors, and provides for a one-time cumulative effecttransition adjustment. The adoption of SAB No. 108 did not have an impacton our financial statements.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements”, which defines fair value, establishes a frameworkfor measuring fair value in generally accepted accounting principles, andexpands disclosures about fair value measurements. SFAS No. 157 does notrequire any new fair value measurements, but provides guidance on how tomeasure fair value by providing a fair value hierarchy used to classify thesource of the information. This statement is effective for us beginning July 1,2008. We currently are assessing the potential impact that adoption of SFAS No. 157would have on our financial statements.

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities”. SFAS No. 159 gives us the irrevocable option tocarry many financial assets and liabilities at fair values, with changes infair value recognized in earnings. SFAS No. 159 is effective for usbeginning July 1, 2008, although early adoption is permitted. We arecurrently assessing the potential impact that adoption of SFAS No. 159will have on our financial statements.

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**Results ofOperations**

**Comparison of theyear ended June 30, 2007 to the year ended June 30, 2006**

Summary(in thousands)

| ** **                                    | ** ** | **Twelve Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                             | ** ** | **%** | ** ** | **2006** | ** ** | **%** | ** ** |
| Automotive care  franchising revenue          |       | $                                                    | 10,620     |   | 88 |   | $ | 10,949 |   | 93 |   |
| Automotive care  development revenue          |       | 667                                                  |       | 6 |   | 436 |   | 4 |   |
| Company-operated  store retail revenue        |       | 415                                                  |       | 3 |   | — |   | — |   |
| Other                                         |       | 369                                                  |       | 3 |   | 334 |   | 3 |   |
| Total revenues                                |       | $                                                    | 12,071     |   | 100 | % | $ | 11,719 |   | 100 | % |
| Automotive care  franchising direct cost      |       | 6,785                                                |       | 56 |   | 6,864 |   | 59 |   |
| Automotive care  development direct cost      |       | 595                                                  |       | 5 |   | 324 |   | 3 |   |
| Company-operated  store cost                  |       | 417                                                  |       | 3 |   | — |   | — |   |
| Other                                         |       | 344                                                  |       | 3 |   | 286 |   | 2 |   |
| Total direct  costs                           |       | 8,141                                                |       | 67 |   | 7,474 |   | 64 |   |
| General and  administrative expense           |       | 3,172                                                |       | 26 |   | 2,999 |   | 25 |   |
| Depreciation and  amortization expense        |       | 59                                                   |       | 1 |   | 67 |   | 1 |   |
| Operating income                              |       | 699                                                  |       | 6 |   | 1,179 |   | 10 |   |
| Other income                                  |       | 197                                                  |       | 1 |   | 134 |   | 1 |   |
| Earnings before  taxes                        |       | 896                                                  |       | 7 |   | 1,313 |   | 11 |   |
| (Benefit) provision  for income taxes         |       | (2,513                                               | )          | 3 |   | 590 |   | 5 |   |
| Net income                                    |       | 3,409                                                |       | 4 |   | 723 |   | 6 |   |
| Preferred stock  dividends                    |       | 2                                                    |       | — |   | 2 |   | — |   |
| Net income applicable to  common shareholders |       | $                                                    | 3,407      |   | 4 | % | $ | 721 |   | 6 | % |

 

*Revenue.*   Totalrevenue for the year ended June 30, 2007 was $12.1 million, an increase ofapproximately $352,000, or 3%, compared with total revenue of $11.7 million forthe year ended June 30, 2006.

Automotive care franchising revenue for the year endedJune 30, 2007 was $10.6 million, a decrease of approximately $329,000, or3%, compared with automotive care revenue of $10.9 million for the year ended June 30,2006. The decrease was due to a decrease in royalty revenue of approximately$193,000 due to franchisees participating in the partners in profit program andqualifying to pay a lower royalty percentage on their weekly sales (see Part IItem 1. Business—Franchising Activities). Additionally, there was a decrease indistribution sales and international royalties in the amount of $122,000 and$14,000, respectively.

Automotive care development revenue for the year endedJune 30, 2007 was $667,000, an increase of approximately $231,000, or 53%,compared with automotive care revenue of $436,000 for the year ended June 30,2006. The increase was primarily due to a net increase in revenue from arearights in the amount of $240,000, which was primarily due to the $225,000 ofrevenue recognized from the installment payments from Precision-SociedadeGestora de Franchising S.A. de C.V. for the area rights to Spain. Additionally,there was an increase in transfer revenue in the amount of approximately$34,000 offset by a decrease in franchise sales revenue in the amount of$43,000.

Company-operated store retail revenue for the yearended June 30, 2007 was $415,000. The Company purchased an operatingautomotive service center in October 2006, thus there was no comparablerevenue for the year ended June 30, 2006 (see Note 5 of the ConsolidatedFinancial Statements).

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The Company recognized revenue from foreign franchiseeoperations of $559,000 and $311,000 for the fiscal years ended June 30,2007 and 2006, respectively. This increase was primarily due to the $225,000 ofrevenue recognized from the installment payments from Precision-SociedadeGestora de Franchising S.A. de C.V. for the area rights to Spain. Additionally,$110,000 of revenue was recognized from the signing of the master franchiseagreements for Qatar, Kuwait, Bahrain and five provinces in the People’sRepublic of China. There was no comparable revenue in 2006. The Companyterminated the original China master franchise agreement during 2006. There was$53,000 of revenue recognized from the terminated agreement for the fiscal yearended June 30, 2006 (see Note 3 of the Consolidated Financial Statements).

Other revenue for the year ended June 30, 2007was $369,000, an increase of approximately $35,000, or 10%, compared to$334,000 for the year ended June 30, 2006. The increase in other revenuewas primarily due an increase of approximately $72,000 from support feesassociated with the point of sale system offset by a decrease in training andrebate programs revenue of approximately $37,000.

*DirectCost.*   Total direct cost for the year ended June 30,2007 totaled $8.1 million, an increase of approximately $667,000 or 9%,compared with $7.5 million for the year ended June 30, 2006.

Automotive care franchising direct cost for the yearended June 30, 2007 totaled $6.8 million, which was comparable to the yearended June 30, 2006.

Automotive care development direct cost for the yearended June 30, 2007 totaled $595,000, an increase of $271,000 or 84%,compared with $324,000 for the year ended June 30, 2006. In FY ‘07, theCompany bought back the area developer rights to the Dallas, Texas and southernFlorida markets for $285,000. There was no comparable expense for the yearended June 30, 2006 (see Note 9 of the Consolidated Financial Statements).

Company-operated store costs for the year ended June 30,2007 were $417,000. The Company purchased an operating automotive servicecenter in October 2006, thus there was no comparable expense for the yearended June 30, 2006 (see Note 5 of the Consolidated Financial Statements).

Other direct cost for the year ended June 30,2007 totaled $344,000, an increase of $58,000 or 20%, compared with $286,000for the year ended June 30, 2006. The increase in other direct cost wasprimarily due to an increase in support costs associated with the point of salesystem offset by a decrease in training and rebate programs expenses.

*Generaland Administrative Expense.*   General andadministrative expense was $3.2 million for the year ended June 30, 2007,an increase of approximately $173,000 or 6%, compared with $3.0 million for theyear ended June 30, 2006. For the years ended June 30, 2007 and 2006,respectively, the Company recorded a benefit of approximately $46,000 and$207,000 related to variable accounting for certain outstanding stock optionsbecause the Company’s stock price declined during the last twelve months. Inaddition to the $161,000 difference from the variable accounting adjustment,the Company recorded a pre-tax compensation expense of approximately$45,000 due to the adoption of SFAS No. 123(R). This increase was offsetby approximately $33,000 due to the efforts of management’s on-going costreduction initiatives in general and administrative expenses.

*OperatingIncome.**  *TheCompany recorded operating income for the year ended June 30, 2007 ofapproximately $699,000, a decrease of $480,000, or 41%, compared with anoperating income of $1.2 million for the year ended June 30, 2006. Asdiscussed previously, there were multiple variables that attributed to thedecrease in operating income during the year ended June 30, 2007. The mostsignificant variables were the expense incurred for the termination of the areadeveloper agreements, the impact of the difference in the benefit recordedrelated to variable accounting for stock options and the additionalcompensation expense from the implementation of SFAS No. 123 (R).

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*OtherIncome.**  *TheCompany recorded other income of $197,000 for the year ended June 30,2007, an increase of approximately $63,000 or 47% compared to $134,000 in otherincome for the year ended June 30, 2006. This increase is primarily due toan increase in interest income.

*IncomeTaxes.**  *TheCompany’s effective tax rate for the year ended June 30, 2007 and 2006 wasapproximately—280% and 45%, respectively. The significant fluctuation in theeffective tax rate was due to management releasing the remainder of the taxvaluation allowance of $2.9 million as of June 30, 2007. This adjustmentwas based upon management’s assessment of the recoverability of deferred taxeswhich included its recent history of generating pre-tax income and projectionsof future earnings.

*Net Income Applicable toCommon Shareholders and Earnings Per Share.*   TheCompany recorded Net Income Applicable to Common Shareholders of $3,407,000, or$0.12 per share, for the year ended June 30, 2007 compared to $721,000, or$0.02 per share, for the year ended June 30, 2006.

**Liquidity and Capital Resources**

Sources and Uses of Cash

Cash at June 30, 2007 was $4.9 million. Duringthe period, cash provided by operations was $798,000.

Cash used in investing activities for the twelvemonths ended June 30, 2007 was $370,000. Cash used in investing activitiesconsisted of the purchase of property and equipment of $40,000 for use in theCompany’s franchise operations and $330,000 for the purchase of acompany-operated store.

Cash used in financing activities for the twelvemonths ended June 30, 2007 was $10,000. Cash used in financing activitiesconsisted primarily of the payments of dividends and a capital leaseobligation.

Management believes thatthe Company’s current cash balance, cash generated from operations, and theavailable $250,000 credit line will be sufficient to meet the Company’s workingcapital needs, capital expenditures, and contractual obligations for fiscalyear 2008. At June 30, 2007, the entire line of credit was available.

Equity Transactions

In August 2005,10,000 warrants were exercised pursuant to an agreement the Company reached torestructure the Board LLC subordinated debt. Upon the exercise of thesewarrants at the previously agreed to exercise price of $0.44 per share, theholder purchased 10,000 restricted shares of common stock for $4,400.

Line-of-Credit

On February 28, 2007,the Company renewed the $250,000 line of credit with Chevy Chase Bank. Theinterest rate on this line of credit is indexed to the Prime Rate as publishedin *The Wall Street Journal*(8.25% at June 30,2007) and the Company has pledged the assets of its wholly-owned subsidiariesas collateral. The Company has not borrowed against this line of credit. Underthis agreement, the Company must meet financial covenants relating toprofitability, debt service coverage and a maximum leverage ratio. The Companywas in compliance with all such covenants as of June 30, 2007 and 2006,respectively.

Seasonality and Quarterly Fluctuations

Seasonal changes mayimpact various sectors of the Company’s business differently and, accordingly,the Company’s operations may be affected by seasonal trends in certain periods.In particular, severe weather in winter months can adversely affect the Companybecause such weather makes it difficult for consumers in affected parts of thecountry to travel to Precision Auto Care centers.

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**Item 7.**                        *Financial Statements*

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**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors andStockholders of Precision Auto Care, Inc. and Subsidiaries

We have audited the accompanying consolidated balancesheet of Precision Auto Care, Inc. (the Company) and subsidiaries as of June 30,2007, and the related consolidated statements of operations, stockholders’equity and cash flows for the year then ended. These financial statements arethe responsibility of the Company’s management. Our responsibility is to expressan opinion on these financial statements based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In ouropinion, the financial statements referred to above, present fairly, in allmaterial respects, the consolidated financial position of Precision Auto Care, Inc.and subsidiaries as of June 30, 2007, and the consolidated results oftheir operations and their cash flows for the year then ended in conformitywith accounting principles generally accepted in the United States of America.
|                          | /s/ YOUNT, HYDE & BARBOUR, P.C. |
|--------------------------|------------------------------------------|
| Winchester,  Virginia    |                                     |
| September 24,  2007 |                                     |

 

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**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors andStockholders of Precision Auto Care, Inc. and Subsidiaries

We have audited the accompanying consolidated balancesheet of Precision Auto Care, Inc. (the Company) and subsidiaries as of June 30,2006, and the related consolidated statements of operations, stockholders’equity and cash flows for the year then ended. These financial statements arethe responsibility of the Company’s management. Our responsibility is to expressan opinion on these financial statements based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In ouropinion, the financial statements referred to above, present fairly, in allmaterial respects, the consolidated financial position of Precision Auto Care, Inc.and subsidiaries as of June 30, 2006, and the consolidated results of itsoperations and its cash flows for the year then ended in conformity withaccounting principles generally accepted in the United States of America.
|                          | /s/ GRANT THORNTON LLP |
|--------------------------|------------------------|
| McLean, Virginia         |                   |
| September 13,  2006 |                   |

 

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**PRECISION AUTO CARE, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                   | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                                   | ** ** | **2007**          | ** ** | **2006**          | ** ** |
| **ASSETS**                                                                                                                   |       |              | ** ** | ** **        | ** ** |
| Current assets:                                                                                                              |       |              |       |              |       |
| Cash and cash equivalents                                                                                                    |       | $                 | 4,859,025  |              | $          | 4,441,850 |   |
| Accounts receivable, net of allowance of $215,792  and $228,642, Respectively                                                |       | 371,716           |       | 499,364           |       |
| Notes receivable, net of allowance of $155,943 and  $184,856, respectively                                                   |       | 110,700           |       | 115,145           |       |
| Deferred tax asset                                                                                                           |       | 810,821           |       | 447,710           |       |
| Other assets                                                                                                                 |       | 414,102           |       | 395,737           |       |
| Total current assets                                                                                                         |       | 6,566,364         |       | 5,899,806         |       |
| Property and equipment, net                                                                                                  |       | 151,791           |       | 121,681           |       |
| Goodwill                                                                                                                     |       | 8,941,744         |       | 8,711,744         |       |
| Notes receivable,  net of allowance of $346,056 and $269,222, respectively                                                   |       | 159,656           |       | 140,385           |       |
| Deferred tax  asset                                                                                                          |       | 4,873,376         |       | 2,667,970         |       |
| Deposits and  other                                                                                                          |       | 74,394            |       | 23,685            |       |
| Total assets                                                                                                                 |       | $                 | 20,767,325 |              | $          | 17,565,271 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                               | ** ** | ** **        | ** ** | ** **        | ** ** |
| Current  liabilities:                                                                                                        |       |              |       |              |       |
| Line-of-credit                                                                                                               |       | $                 | —     |              | $          | — |   |
| Capital lease obligation—current                                                                                        |       | 8,989             |       | 7,853             |       |
| Accounts payable and accrued liabilities                                                                                     |       | 257,330           |       | 255,138           |       |
| Taxes payable                                                                                                                |       | 551,098           |       | 565,541           |       |
| Accrued commission payable                                                                                                   |       | 216,061           |       | 314,077           |       |
| Accrued salaries and related expenses                                                                                        |       | 390,251           |       | 375,648           |       |
| Due to related party                                                                                                         |       | 190,801           |       | 167,053           |       |
| Deferred revenue                                                                                                             |       | 196,140           |       | 320,029           |       |
| Total current liabilities                                                                                                    |       | 1,810,670         |       | 2,005,339         |       |
| Capital lease obligation, net of current portion                                                                             |       | 26,357            |       | 35,346            |       |
| Total liabilities                                                                                                            |       | 1,837,027         |       | 2,040,685         |       |
| Commitments and contingencies                                                                                                |       | —            |       | —            |       |
| Series A redeemable preferred stock, $.01 par  value; 1,000,000 shares authorized; 11,227 shares issued and outstanding |       | 116,312           |       | 116,312           |       |
| Stockholders’ equity:                                                                                                   |       |              |       |              |       |
| Common stock, $.01 par value; 39,000,000 shares  authorized; 28,993,752 shares issued and outstanding                   |       | 289,938           |       | 289,938           |       |
| Additional paid-in capital                                                                                                   |       | 67,808,942        |       | 67,809,836        |       |
| Accumulated deficit                                                                                                          |       | (49,284,894       | )          | (52,691,500       | )          |
| Total stockholders’ equity                                                                                              |       | 18,813,986        |       | 15,408,274        |       |
| Total liabilities  and stockholders’ equity                                                                             |       | $                 | 20,767,325 |              | $          | 17,565,271 |   |

 

See accompanying notes.

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**PRECISION AUTO CARE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                                                           | ** ** | **For The Years Ended June 30,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Revenue:                                                             | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Franchise royalties                                                  |       | $                                                    | 10,619,819 |   | $ | 10,948,289 |   |
| Franchise development                                                |       | 667,396                                              |       | 436,454 |   |
| Company-operated retail store                                        |       | 415,397                                              |       | — |   |
| Other                                                                |       | 369,000                                              |       | 334,524 |   |
| Total revenues                                                       |       | 12,071,612                                           |       | 11,719,267 |   |
| Direct cost:                                                         |       |                                                 |       |   |   |
| Franchise support and other                                          |       | 7,723,939                                            |       | 7,474,006 |   |
| Company-operated retail store                                        |       | 416,725                                              |       | — |   |
| Total direct costs                                                   |       | 8,140,664                                            |       | 7,474,006 |   |
| General and administrative expense                                   |       | 3,172,076                                            |       | 2,999,518 |   |
| Depreciation  expense                                                |       | 59,608                                               |       | 67,284 |   |
| Operating income                                                     |       | 699,264                                              |       | 1,178,459 |   |
| Interest expense                                                     |       | (7,690                                               | )          | (8,171 | ) |
| Interest income                                                      |       | 203,673                                              |       | 136,677 |   |
| Other income                                                         |       | 585                                                  |       | 6,323 |   |
| Total other income                                                   |       | 196,568                                              |       | 134,829 |   |
| Income before income tax (benefit) expense                           |       | 895,832                                              |       | 1,313,288 |   |
| (Benefit)  provision for income taxes                                |       | (2,513,100                                           | )          | 589,644 |   |
| Net income                                                           |       | 3,408,932                                            |       | 723,644 |   |
| Preferred stock  dividends                                           |       | 2,326                                                |       | 2,326 |   |
| Net income  applicable to common stockholders                        |       | $                                                    | 3,406,606  |   | $ | 721,318 |   |
| Net income applicable to common stock per common  share—Basic   |       | $                                                    | 0.12       |   | $ | 0.02 |   |
| Net income  applicable to common stock per common share—Diluted |       | $                                                    | 0.12       |   | $ | 0.02 |   |
| Weighted average common shares outstanding—Basic                |       | 28,993,752                                           |       | 28,950,823 |   |
| Weighted average common  shares outstanding—Diluted             |       | 29,117,768                                           |       | 29,647,208 |   |

 

See accompanying notes.

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**PRECISION AUTOCARE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

| ** **                                      | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|-------------------|------------|--------------------------------------|------------|--------------------------|------------|-----------|------------|
| Balance at  June 30, 2005                  |       | 28,862,252         |       | $                 | 288,623    |                                 |       | $                        | 67,949,970 |      |       | $ | (53,412,818 | ) | $ | 14,825,775 |   |
| Issuance of  common stock                       |       | 131,500            |       | 1,315             |       |                                 | 40,415     |                     |       | —    |       | 41,730 |   |
| Tax benefit from  exercise of stock options     |       | —             |       | —            |       |                                 | 21,693     |                     |       | —    |       | 21,693 |   |
| Stock based  benefit due to variable accounting |       | —             |       | —            |       |                                 | (202,242   | )                        |       | —    |       | (202,242 | ) |
| Net income                                      |       | —             |       | —            |       |                                 | —     |                     |       | 721,318   |       | 721,318 |   |
| Balance at  June 30, 2006                  |       | 28,993,752         |       | $                 | 289,938    |                                 |       | $                        | 67,809,836 |      |       | $ | (52,691,500 | ) | $ | 15,408,274 |   |
| Stock based  benefit due to variable accounting |       | —             |       | —            |       |                                 | (45,634    | )                        |       | —    |       | (45,634 | ) |
| Stock based  compensation                       |       | —             |       | —            |       |                                 | 44,740     |                     |       | —    |       | 44,740 |   |
| Net income                                      |       | —             |       | —            |       |                                 | —     |                     |       | 3,406,606 |       | 3,406,606 |   |
| Balance at June 30,  2007                  |       | 28,993,752         |       | $                 | 289,938    |                                 |       | $                        | 67,808,942 |      |       | $ | (49,284,894 | ) | $ | 18,813,986 |   |

 

See accompanying notes.

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**PRECISION AUTOCARE, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS**

| ** **                                                                         | ** ** | **For The Years Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                                  | ** ** | **2006** | ** ** |
| Operating activities:                                                              |       |                                                      |       |   |   |
| Net income  applicable to common shareholders                                      |       | $                                                         | 3,406,606  |   | $ | 721,318 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                                      |       |   |   |
| Depreciation and amortization                                                      |       | 59,608                                                    |       | 67,284 |   |
| Bad debt expense                                                                   |       | 42,100                                                    |       | 133,816 |   |
| Loss on disposal of property and equipment                                         |       | —                                                    |       | 9,530 |   |
| Decrease in deferred tax valuation allowance                                       |       | (2,899,000                                                | )          | — |   |
| Deferred taxes                                                                     |       | 330,483                                                   |       | 529,805 |   |
| Stock based benefit due to variable accounting                                     |       | (45,634                                                   | )          | (202,242 | ) |
| Stock based compensation                                                           |       | 44,740                                                    |       | — |   |
| Changes in assets  and liabilities:                                                |       |                                                      |       |   |   |
| Accounts and notes receivable                                                      |       | 70,722                                                    |       | 39,021 |   |
| Prepaid expenses, deposits and other                                               |       | (18,449                                                   | )          | (50,515 | ) |
| Accounts payable and accrued liabilities                                           |       | (93,338                                                   | )          | (168,626 | ) |
| Due to related party                                                               |       | 23,748                                                    |       | 50,980 |   |
| Deferred revenue and other                                                         |       | (123,889                                                  | )          | 66,707 |   |
| Net cash provided by operating activities                                          |       | 797,697                                                   |       | 1,197,078 |   |
| Investing  activities:                                                             |       |                                                      |       |   |   |
| Purchases of property and equipment                                                |       | (40,343                                                   | )          | (42,188 | ) |
| Purchase of company-operated store                                                 |       | (330,000                                                  | )          | — |   |
| Net cash used in investing activities                                              |       | (370,343                                                  | )          | (42,188 | ) |
| Financing  activities:                                                             |       |                                                      |       |   |   |
| Proceeds from issuance of common stock                                             |       | —                                                    |       | 41,730 |   |
| Payment of preferred stock dividends                                               |       | (2,326                                                    | )          | (2,326 | ) |
| Repayment of capital lease                                                         |       | (7,853                                                    | )          | (32,012 | ) |
| Net cash (used in) provided by financing activities                                |       | (10,179                                                   | )          | 7,392 |   |
| Net change in cash and cash equivalents                                            |       | 417,175                                                   |       | 1,162,282 |   |
| Cash and cash  equivalents at beginning of year                                    |       | 4,441,850                                                 |       | 3,279,568 |   |
| Cash and cash equivalents at end of period                                         |       | $                                                         | 4,859,025  |   | $ | 4,441,850 |   |
| Cash paid for the  period for:                                                     |       |                                                      |       |   |   |
| Interest                                                                           |       | $                                                         | 7,690      |   | $ | 8,171 |   |
| Income taxes                                                                       |       | $                                                         | 56,066     |   | $ | 73,748 |   |
| Supplemental  schedule of non cash investing and finance activities:               |       |                                                      |       |   |   |
| Property and equipment  acquired under capital lease                               |       | $                                                         | —     |   | $ | 47,875 |   |

 

See accompanying notes.

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**Precision Auto Care, Inc.and SubsidiariesNotes to Consolidated Financial Statements**

**Note 1—BusinessDescription and Financial Statement Presentation**

Precision Auto Care, Inc.(the ‘‘Company’’) is headquartered in Leesburg, VA and is a franchisor of automotivemaintenance service centers which provide specialized automotive care services,and fast oil change and lube services. The company-owned center and franchiseeowned centers operate primarily under the Precision Tune Auto Care brand name.

**Note 2—Summary ofSignificant Accounting Policies**

*Principles ofConsolidation*

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated in consolidation.

*Revenue Recognition*

The Company enters into domestic Area Developmentagreements and international Master License agreements which grant the areadeveloper and master licensor, respectively, the right to sell, on the Company’sbehalf, Precision Tune Auto Care franchises within a specific geographic region.Revenue from the sale of Area Development agreements and international MasterLicense agreements is recognized as all material services or conditions relatedto the agreements are satisfied.

Revenue from the sale of a franchise is recognizedwhen all material services and conditions have been satisfied, generally at theopening of the franchised center.

The Company’s royalty revenue is recognized as earnedin accordance with the specific terms of each agreement and to the extent noknown issues involving collection exist. In the case when receivables are notlikely to be collected, the Company establishes reserves for such amounts. Suchreserves are based upon our historical collection experience with the variousfranchisees taking into consideration the financial stability of suchfranchisees.

Product services in the form of equipment and othermarketing materials related sales are recognized upon delivery to thefranchisees.

Retail revenues arerealized from providing maintenance and repair services, as well as from theparts that are provided as part of that service to the general public, arerecognized when the service is performed.

*Cash and CashEquivalents*

Cash and cash equivalents,consisting of certificates of deposit of approximately $3.1 million, arecomprised of highly liquid debt instruments with original maturities of threemonths or less. Cash balances may exceed insured amounts.

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*Property andEquipment*

Propertyand equipment are stated at cost and depreciated on a straight-line basis forbook purposes and accelerated methods for tax purposes over the estimateduseful lives of the related assets. The estimated useful lives are as follows:

| ** **              | ** ** | **Years**     | ** ** |
|-------------------------|------------|---------------|------------|
| Furniture and  fixtures |       | 5-7           |       |
| Equipment               |       | 3-10          |       |
| Other items             |       | 3-7           |       |
| Leasehold improvements  |       | Life of lease |       |

 

*Income Taxes*

The Company recognizesdeferred income tax liabilities and assets for the expected future taxconsequences of events that have been included in the financial statements ortax returns. Deferred tax liabilities and assets reflect the effects of taxlosses and the future income tax effects of temporary differences between theconsolidated financial statement carrying amounts of existing assets andliabilities and their respective tax bases and are measured using enacted taxrates that apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled.

*Impairment ofLong-Lived Assets*

The Company evaluates thecarrying amount of long-lived assets to be held and used, including goodwilland other intangible assets, when events and circumstances warrant such areview. The carrying amount of a long lived asset is considered impaired whenthe estimated undiscounted cash flow from each asset is less than its carryingamount. In that event, the Company would record a loss equal to the amount bywhich the carrying amount exceeds the fair value of the long-lived asset.

*Concentration ofCredit Risk*

Financial instruments thatpotentially subject the Company to significant concentrations of credit riskconsist primarily of cash, trade accounts receivable and notes receivable. Thetrade receivable balances are dispersed among a wide customer and franchiseebase. The Company routinely assesses the financial strength of its franchises. TheCompany maintains reserves for credit losses, and such losses have been withinmanagement’s expectations. The Company holds cash and cash equivalentsprimarily in one financial institution, which often exceed FDIC insured limits.Historically, the Company has not experienced any losses due to suchconcentration of credit risk.

*Fair Value ofFinancial Instruments*

The Company’s financialinstruments, as defined under SFAS No. 107, Disclosures about Fair Valueof Financial Instruments, include its cash, accounts receivable and accountspayable and line of credit debt. The fair value of cash, accountsreceivable, accounts payable and borrowings outstanding under our line ofcredit approximate their respective carrying values at June 30, 2007 and2006 based on the short-term maturities of these instruments.

*Advertising Costs*

The Company expenses alladvertising costs as incurred. The Company incurred $60,000 and $10,000 inadvertising costs for the years ended June 30, 2007 and 2006,respectively.

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*Use of Estimates inthe Preparation of Financial Statements*

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.

*Goodwill andIntangible Assets*

Statement of Financial Accounting Standards (SFAS) No. 142,“Goodwill and Intangible Assets”, requires that goodwill no longer beamortized, but instead be tested for impairment at least annually. Impairmenttesting is performed in the first quarter of each fiscal year. The Companyengaged a valuation specialist in fiscal year 2007 to assist management withits test for impairment. The fair value of franchising operations was estimatedutilizing a discounted cash flow approach that estimates revenue, driven byassumed market growth rates and appropriate discount rates. These estimates areconsistent with the plans and estimates management uses to manage theunderlying business. The fair value of the franchising operations exceeded itscarrying value by a substantial margin. Based upon the above, management hasconcluded that the $8.7 million carrying value of goodwill was not impaired. Therewas additional goodwill of $230,000 associated with the purchase of anoperating automotive service center during the second quarter of fiscal year2007. As previously stated, the annual impairment testing was performed in thefirst quarter of the current fiscal year, thus this transaction was notincluded. However, there were no substantial changes in the operations of theautomotive service center that would indicate impairment (see Note 5). 

*Accounting forStock Based Compensation*

On July 1, 2006 the Company adopted Statement ofFinancial Accounting Standards No. 123 (revised 2004) “Share-Based Payment”(“SFAS 123(R)), which requires the measurement and recognition ofcompensation expense for all share-based payment awards made to employees,including grants of employee and director stock options, to be recognized inthe income statement based on their fair values. SFAS 123(R) supersedesthe Company’s previous accounting under Accounting Principles Board OpinionNo.25, “Accounting for Stock Issued to Employees” (“APB 25”) and relatedinterpretations for the periods beginning fiscal 2007.

The Company adopted SFAS 123(R) using themodified prospective transition method, which required the application of theaccounting standard as of July 1, 2006. The Company’s ConsolidatedFinancial Statements for the twelve months ended June 30, 2007 reflect theimpact of SFAS 123(R). In accordance with the modified prospective transitionmethod, the Company’s Consolidated Financial Statements for the prior periodshave not been restated to reflect, and do not include the impact of SFAS 123(R).As a result of the adoption of SFAS 123(R), the Company recognized a pre-taxcharge of approximately $45,000 (included in general and administrativeexpenses), $26,000 after-tax and $0.00 per share on a diluted basis in the periodended June 30, 2007 associated with the expensing of stock options.Employee stock option compensation expense in 2007 includes the estimated fairvalue of options granted, amortized on a straight-line basis over the requisiteservice period for the entire portion of the award. Pro forma stock basedcompensation of approximately $115,000 for the twelve months ended June 30,2006 was related to employee stock options, which the Company had beenrecognizing under previous accounting standards for disclosure purposes only.

SFAS 123(R) requires companies to estimate thefair value of share-based payment awards on the date of grant using anoption-pricing model. The value of the portion of the award that is ultimatelyexpected to vest is recognized as expense over the requisite service periods inthe Company’s Consolidated Statement of Operations. Prior to the adoption ofSFAS 123(R), the Company accounted for the stock-

29

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based awards to employeesand directors using the intrinsic value method. Additionally, certainoutstanding stock options are subject to variable accounting. In the yearsended June 30, 2007 and 2006, the Company recorded a benefit ofapproximately $46,000 and $207,000, respectively, as a result of a decline inthe Company’s stock price over the previous twelve months.

Asummary of option activity under all plans as of June 30, 2007 and 2006,respectively, and changes during the periods then ended are presented below:

| ** **          | ** ** | **Shares  Under Option** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual Term** | ** ** |
|---------------------|------------|-------------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------|------------|
| June 30,  2005 |       |                          | 1,721,700  |                                        |       |                                                     | 0.85       |   |   |   | 5.88 |   |   |
| Options granted     |       |                          | —     |                                        |       |                                                     | —     |   |   |   |   |   |   |
| Options exercised   |       |                          | (120,000   | )                                           |       |                                                     | .31        |   |   |   |   |   |   |
| Options forfeited   |       |                          | —     |                                        |       |                                                     | —     |   |   |   |   |   |   |
| June 30,  2006 |       |                          | 1,601,700  |                                        |       |                                                     | 0.89       |   |   |   | 5.0 |   |   |
| Options granted     |       |                          | —     |                                        |       |                                                     | —     |   |   |   |   |   |   |
| Options exercised   |       |                          | —     |                                        |       |                                                     | —     |   |   |   |   |   |   |
| Options forfeited   |       |                          | —     |                                        |       |                                                     | —     |   |   |   |   |   |   |
| June 30, 2007  |       |                          | 1,601,700  |                                        |       |                                                     | 0.89       |   |   |   | 4.54 |   |   |

 

No options were granted in the twelve months ended June 30,2007 and 2006, respectively. The exercise price of options outstanding at June 30,2007 ranged from $0.25 to $10.00 per share.

Asummary of the status of the Company’s non-vested shares as of June 30,2007 and changes during the period is presented below:

| ** **                               | ** ** | **Shares  Under Option** | ** ** | **Weighted-  Average  Grant Date  Fair Value** | ** ** |
|------------------------------------------|------------|-------------------------------|------------|----------------------------------------------------------|------------|
| Non-vested shares  at June 30, 2006 |       |                          | 271,667    |                                                     |       |   | .61 |   |   |
| Granted                                  |       |                          | —     |                                                     |       |   |   |   |   |
| Vested                                   |       |                          | 146,667    |                                                     |       |   |   |   |   |
| Forfeited                                |       |                          | —     |                                                     |       |   |   |   |   |
| Non-vested shares at  June 30, 2007 |       |                          | 125,000    |                                                     |       |   | .62 |   |   |

 

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Themodified prospective transition method of SFAS 123(R) requires thepresentation of pro forma information for periods presented prior to theadoption of SFAS 123(R) regarding net income and income per share as ifthe Company had accounted for our stock plans under the fair value method ofSFAS 123(R). For pro forma purposes, the fair value of stock options wasestimated using the Black-Scholes option valuation model and amortizing on astraight-line basis. The pro forma amounts are as follows:

| ** **                                                                                               | ** ** | **Year Ended  June 30, 2006**                            | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| Net income  applicable to common shareholders                                                            |       | $    721,318                                        |       |
| Deduct: Total  stock-based compensation benefit reported in net  income under the intrinsic value method |       | 202,242                                                                 |       |
| Deduct: Total  stock-based compensation expense determined under  fair value based method for all awards |       | 114,910                                                                 |       |
| Pro forma net  income                                                                                    |       | $    404,166                                        |       |
| Earnings per  share:                                                                                     |       |                                                                    |       |
| Basic—as reported                                                                                   |       | $           0.02 |       |
| Diluted—as reported                                                                                 |       | $           0.02 |       |
| Basic—pro forma                                                                                     |       | $           0.01 |       |
| Diluted—pro forma                                                                                   |       | $           0.01 |       |
| Weighted average  shares:                                                                                |       |                                                                    |       |
| Weighted average  common shares outstanding—Basic                                                   |       | 28,950,823                                                              |       |
| Weighted average common  shares outstanding—Diluted                                                 |       | 29,647,208                                                              |       |

 

*Earnings Per Share*

The Company reports earnings per share (“EPS”) inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 128,“Earnings per Share” which specifies the methods of computation, presentation,and disclosure. Basic EPS is calculated by dividing net income available tocommon shareholders by the weighted average number of shares outstanding duringthe period. Diluted EPS is calculated by dividing net income available to commonshareholders by the weighted average number of shares outstanding during theperiod plus the dilutive effect of common stock equivalents. The number ofshares outstanding related to stock options and warrants at June 30, 2007and 2006 was 1,945,320 and 1,986,635, respectively. Only stock options andwarrants with exercise prices lower than the average market price of the commonshares were included in the diluted EPS calculation for fiscal year 2007 and2006. For the years ended June 30, 2007 and 2006, respectively 432,950 and182,950 shares attributable to outstanding stock options were not included inthe computation of diluted earnings per share because their inclusion wouldhave been anti-dilutive.

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Thefollowing table sets forth the computation of basic and diluted earnings pershare:

| ** **                                                    | ** ** | **For The Years Ended June 30,**               | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                                                                | ** ** | **2006** | ** ** |
| Numerator:                                                    |       |                                                                    |       |   |   |
| Net income                                                    |       | $ 3,408,932                                                        |       | $    723,644 |   |
| Preferred stock dividends                                     |       | (2,326                                                                  | )          | (2,326 | ) |
| Net income applicable to common Shareholders                  |       | $ 3,406,606                                                        |       | $    721,318 |   |
| Denominator:                                                  |       |                                                                    |       |   |   |
| Denominator for basic EPS weighted-average-shares             |       | 28,993,752                                                              |       | 28,950,823 |   |
| Common stock equivalents-stock options and warrants           |       | 124,016                                                                 |       | 696,385 |   |
| Denominator for diluted EPS weighted-average-shares           |       | 29,117,768                                                              |       | 29,647,208 |   |
| Basic earnings  per share applicable to common shareholders   |       | $           0.12 |       | $           0.02 |   |
| Diluted earnings per  share applicable to common shareholders |       | $           0.12 |       | $           0.02 |   |

 

*Reclassifications*

Certain amounts on theprior period financial statements have been reclassed to be in conformity withthe current period financial statements.

**Note3—Recently Issued Accounting Standards**

In June 2006, the Financial Accounting Standards Board(FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes – an Interpretation of FASB Statement No. 109” (“FIN 48”),which clarifies the accounting for uncertainty in income taxes recognized in acompany’s financial statements in accordance with FAS 109, “Accounting forIncome Taxes”. The Interpretation provides a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. FIN 48 alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure and transition. FIN 48 is effectivefor the Company beginning July 1, 2007. The Company is required to disclose thecumulative effect of the change in retained earnings as of the date ofadoption, and such disclosure is required only in the year of adoption. Basedon our current assessment, the Company believes that the impact to theconsolidated financial statements taken as a whole will be in the range of$100,000 to $150,000.

In fiscal year 2007, we adopted Staff Accounting Bulletin(“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements whenQuantifying Current Year Misstatements”. SAB No. 108 requires companies toquantify misstatements using both a balance sheet (iron curtain) and an incomestatement (rollover) approach to evaluate whether either approach results in anerror that is material in light of relevant quantitative and qualitativefactors, and provides for a one-time cumulative effect transition adjustment.The adoption of SAB No. 108 did not have an impact on our financialstatements. 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements”, which defines fair value, establishes a frameworkfor measuring fair value in generally accepted accounting principles, andexpands disclosures about fair value measurements. SFAS No. 157 does notrequire any new fair value measurements, but provides guidance on how tomeasure fair value by providing a fair value hierarchy used to classify thesource of the information. This statement is effective for us beginningJuly 1, 2008. We currently are assessing the potential impact thatadoption of SFAS No. 157 would have on our financial statements. 

In February 2007, the FASBissued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities”. SFAS No. 159 gives us the irrevocable option tocarry many financial assets and liabilities at fair values, with changes infair value recognized in earnings. SFAS No. 159 is effective for us 

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beginningJuly 1, 2008, although early adoption is permitted. We are currentlyassessing the potential impact that adoption of SFAS No. 159 will have onour financial statements. 

**Note 4—MasterLicense Agreements**

In August 2004, the Company signed a masterfranchise agreement with Hung Yue Holdings (Hong Kong) Co., Ltd. giving thatfirm’s affiliate, Precision Tune Auto Care (China) Company Limited, a licenseto open and operate at least 330 Precision Tune Auto Care (PTAC) car carecenters in China over the next seven years. Under the terms of the originalagreement, Hung Yue Holdings was obligated to pay the Company approximately$2.1 million over seven years. Approximately $246,000 was collected under theagreement and recognized as revenue as all substantial obligations under thatagreement were fulfilled. In March 2006, the Company sent a default letterto Hung Yue Holdings notifying them that their exclusive master franchiserights were terminated due to Hung Yue Holdings failure to develop therequisite number of PTAC car care centers by the first anniversary of theoriginal agreement as well as being in default of several payments.Additionally, franchisees in the People’s Republic of China have threatened tosue Hung Yue Holdings and the Company for non-performance. Management believesthat there is very little likelihood of any formal legal proceedings and doesnot believe that there will be any material judgment against the Company.

In May 2005, the Company signed a masterfranchise agreement with Precision—Sociedade Gestora de Franchising S.A. de C.V.giving that corporation a license to open and operate at least 180 PrecisionTune Auto Care (PTAC) car care centers in Spain over a five year period. Underthe terms of the agreement, Precision—Sociedade Gestora de Franchising S.A. deC.V. is obligated to pay the Company $750,000. The Company received $150,000upon the signing of the master franchising agreement and will receive theremaining $600,000 through 2010 in accordance with an agreed upon paymentschedule. The Company recognized revenue of $225,000 for the year ended June 30,2007 as the Company had substantially fulfilled all required obligations. Nocomparable revenue was recognized for the year ended June 30, 2006.Additionally, future revenue will not be recognized until collection of such amountsis probable. Two centers were open as of June 30, 2007.

In March 2007, the Company signed a masterfranchise agreement with Alice Wu Hiu Mui and Chris Ng Wai-shun givingthese individuals a license to open and operate Precision Tune Auto Care (PTAC)car care centers in the People’s Republic of China. The territory within thePeople’s Republic of China is specifically for the 5 provinces of Guangdong,Guangxi, Fujuan, Jiangxi, and Hainan. Under the terms of the agreement, AliceWu Hiu Mui and Chris Ng Wai-shun are obligated to pay the Company $100,000 overthe next four years. The Company recognized revenue of $10,000 as the Companyhad substantially fulfilled all required obligations and the amount had beenpaid. The Company will receive monthly installment payments totaling $24,000during the fiscal year ending June 30, 2008, monthly installment paymentstotaling $36,000 during the fiscal year ending June 30, 2009, and monthlyinstallment payments totaling $30,000 during the fiscal year ending June 30,2010. The revenue will be recognized once the amounts are collected.

In March 2007, theCompany signed a master franchise agreement with Opal Marketing &Industry LLC (Opal Marketing), giving that company a license to open andoperate Precision Tune Auto Care (PTAC) car care centers in Qatar, Kuwait, andBahrain. Under the terms of the agreement, Opal Marketing was obligated to paythe Company $100,000 for these rights. The Company recognized $100,000 asincome as all substantial obligations under that agreement have been fulfilledand the amount had been paid in full.

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**Note 5—Property andEquipment**

Thecomponents of property and equipment are as follows:

| ** **                   | ** ** | **June 30,**   | ** ** |
|------------------------------|------------|---------------------|------------|
| ** **                   | ** ** | **2007**            | ** ** | **2006** | ** ** |
| Furniture and  fixtures      |       | $  45,844 |       | $ 1,066,753 |   |
| Equipment                    |       | 360,542             |       | 2,676,386 |   |
| Capital leases               |       | 47,875              |       | 101,342 |   |
| Leasehold  improvements      |       | 65,070              |       | 64,461 |   |
| Other items                  |       | 86,986              |       | 338,411 |   |
|                         |       | 606,317             |       | 4,247,353 |   |
| Accumulated  depreciation    |       | (454,526            | )          | (4,125,672 | ) |
| Property and equipment,  net |       | $ 151,791      |       | $   121,681 |   |

 

**Note 6—Acquisition**

On October 19,2006, the Company purchased an existing Precision Tune Auto Care center inNorthern Virginia. This center will be operated as a company-owned store andoperations of such have been included in the Company’s consolidated financial statementsfrom the purchase date through June 30, 2007. The Company purchased theassets of this center for $330,000. Goodwill of $230,000 is deductible for taxpurposes. The following table summarizes the estimated fair values of theassets acquired at the date of acquisition:

| Current assets        |   | $ 10,000  |   |
|-----------------------|--------|----------------|--------|
| Equipment             |   | 40,000         |   |
| Intangible asset      |   | 50,000         |   |
| Goodwill              |   | 230,000        |   |
| Total assets acquired |   | $ 330,000 |   |

 

**Note 7—Income Taxes**

The(benefit) provision for income taxes consisted of the following items:

| ** **                          | ** ** | **Years Ended June 30,**     | ** ** |
|-------------------------------------|------------|---------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                    | ** ** | **2006** | ** ** |
| Current tax  expense:               |       |                                        |       |   |   |
| Federal                             |       | $      35,000 |       | $ 15,000 |   |
| State                               |       | 23,000                                      |       | 45,000 |   |
| Total current tax  expense          |       | 58,000                                      |       | 60,000 |   |
| Deferred tax expense:               |       |                                        |       |   |   |
| Federal                             |       | 271,000                                     |       | 434,000 |   |
| State                               |       | 60,000                                      |       | 96,000 |   |
| Total deferred  tax expense         |       | 331,000                                     |       | 530,000 |   |
| Change in  valuation allowance      |       | (2,899,000                                  | )          | (— | ) |
| Total income tax  (benefit) expense |       | $ (2,510,000                           | )          | $ 590,000 |   |

 

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Theeffective tax rate differed from the statutory rate as follows:

| ** **                         | ** ** | **Years Ended June 30,**                              | ** ** |
|------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                         | ** ** | **     2007     ** | ** ** | **     2006     ** | ** ** |
| Statutory federal  rate            |       |                                                                 | 34         | % |   |   | 34 | % |   |
| State taxes                        |       |                                                                 | 7.3        |   |   |   | 8 |   |   |
| Foreign taxes                      |       |                                                                 | 1.8        |   |   |   | — |   |   |
| Nondeductible  expenses            |       |                                                                 | 0.6        |   |   |   | 1 |   |   |
| Adjustment to  deferred tax assets |       |                                                                 | (0.1       | ) |   |   | 2 |   |   |
| Change in  valuation allowance     |       |                                                                 | (323.7     | ) |   |   | — |   |   |
| Other                              |       |                                                                 | —     |   |   |   | — |   |   |
| Effective tax rate                 |       |                                                                 | (280.10    | )% |   |   | 45 | % |   |

 

Deferred tax assets and liabilities reflect theeffects of tax losses and the future income tax effects of temporarydifferences between the consolidated financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and are measuredusing enacted tax rates that apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. Duringfiscal year 2007 and 2006, the Company made an adjustment of $1,000 and$(29,000), respectively, to the deferred tax assets primarily to adjustcumulative temporary balances and the net operating loss carryforwards.

Significantcomponents of the Company’s deferred tax liabilities and assets are as follows:

| ** **                                   | ** ** | **June 30,** | ** ** |
|----------------------------------------------|------------|-------------------|------------|
| ** **                                   | ** ** | **2007**          | ** ** | **2006** | ** ** |
| Deferred tax assets:                         |       |              |       |   |   |
| Net operating loss                           |       | $ 4,970,000  |       | $ 5,277,000 |   |
| Other                                        |       | 714,000           |       | 738,000 |   |
|                                         |       | 5,684,000         |       | 6,015,000 |   |
| Valuation  allowance for deferred tax assets |       | (—           | )          | (2,899,000 | ) |
| Net deferred taxes                           |       | $ 5,684,000  |       | $ 3,116,000 |   |

 

As of June 30, 2007, the Company had netoperating loss carryforwards for federal tax purposes of approximately $12.9million, which expire from 2019 through 2024.

The Company regularlyreviews the recoverability of its tax deferred assets and establishes avaluation allowance as deemed appropriate. As of June 30, 2006, theCompany had a valuation allowance of $2.9 million against its deferred taxassets. Based on the Company’s evaluation of positive and negative evidence,which includes recent operating performance and projections for futureprofitability, management determined that it is more likely than not that itsdeferred tax assets would be realized. Accordingly, management released theremaining valuation allowance of $2.9 million.

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**Note 8—Debt**

*Line of Credit*

On February 28, 2007,the Company renewed the $250,000 line of credit with Chevy Chase Bank. Theinterest rate on this line of credit is indexed to the Prime Rate as publishedin *The Wall Street Journal*(8.25% atJune 30, 2007) and the Company has pledged the assets of its wholly-ownedsubsidiaries as collateral. The Company has not borrowed against this line ofcredit. Under this agreement, the Company must meet financial covenantsrelating to profitability, debt service coverage and a maximum leverage ratio.The Company was in compliance with all such covenants as of June 30, 2007and 2006, respectively.

*Capital LeaseObligations*

Capitallease obligations consist of the following:

| ** **                | ** ** | **June 30,** | ** ** |
|---------------------------|------------|-------------------|------------|
| ** **                | ** ** | **2007**          | ** ** | **2006** | ** ** |
| Lease obligations         |       | $                 | 35,346     |   | $ | 43,199 |   |
| Less: current  maturities |       | (8,989            | )          | (7,853 | ) |
| Long-term portion         |       | $                 | 26,357     |   | $ | 35,346 |   |

                                                                                             

Thefuture capital lease obligations with maturities in excess of one year as of June 30,2007 are as follows:

| ** ** | ** ** | **Future  Maturities** | ** ** |
|------------|------------|------------------------|------------|
| 2008       |       |                   | 8,989      |   |   |
| 2009       |       |                   | 10,289     |   |   |
| 2010       |       |                   | 11,776     |   |   |
| 2011       |       |                   | 4,292      |   |   |
|       |       |                   | $          | 35,346 |   |   |
|            |            |                        |            |  |  |  |

                                                                        

**Note 9—LeaseCommitments**

At June 30, 2007, theCompany has lease commitments for office space, a training center, and a numberof service center locations as well as office equipment under operating andcapital leases. These leases expire between 2008 and 2012, with renewal optionsin certain of the leases. The monthly rent for the office space increases by 3%on February 1 of each year. Most of the service center location leases aresubleased to franchisees. The Company recognizes rent expense on astraight-line basis for certain leases which contain fixed escalations. Rentexpense for office space and warehouse facilities of approximately $347,000 and$350,000 is included in operating expenses for the years ended June 30,2007 and 2006, respectively. Rent expense for service center locations ofapproximately $130,000 and $47,000 is recorded net of sublease income of$73,000 and $47,000 for the years ended June 30, 2007 and 2006, respectively.

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*Operating Leases*

Thefuture minimum lease payments and related sublease payments for operatingleases with terms in excess of one year as of June 30, 2007 are asfollows:

| ** ** | ** ** | **Future Minimum  Lease Payments** | ** ** | **Sublease  Income** | ** ** | **Net** | ** ** |
|------------|------------|----------------------------------------------|------------|----------------------|------------|---------|------------|
| 2008       |       |                                         | $          | 629,000              |       |    | $          | 210,000 |   | $ | 419,000 |   |
| 2009       |       |                                         | 378,000    |                 |       | 91,000  |       | 287,000 |   |
| 2010       |       |                                         | 92,000     |                 |       | —  |       | 92,000 |   |
| 2011       |       |                                         | 94,000     |                 |       | —  |       | 94,000 |   |
| 2012       |       |                                         | 48,000     |                 |       | —  |       | 48,000 |   |
|       |       |                                         | $          | 1,241,000            |       |    | $          | 301,000 |   | $ | 940,000 |   |

 

*Capital Leases*

At June 30, 2007 and 2006, the Company hadrecorded capital assets of $47,875 and $101,341, respectively. Accumulatedamortization related to the leased assets was $16,756 and $60,649 at June 30,2007 and 2006, respectively.

Thefuture minimum lease payments for capital leases with terms in excess of one yearas of June 30, 2007 are as follows:

| ** **                           | ** ** | **Future Minimum  Lease Payments** | ** ** |
|--------------------------------------|------------|----------------------------------------------|------------|
| 2008                                 |       |                                         | 13,244     |   |   |
| 2009                                 |       |                                         | 13,244     |   |   |
| 2010                                 |       |                                         | 13,244     |   |   |
| 2011                                 |       |                                         | 4,414      |   |   |
| Total lease  payments                |       |                                         | $          | 44,146 |   |   |
| Less amounts  representing interest  |       |                                         | 8,800      |   |   |
| Present value of net  lease payments |       |                                         | $          | 35,346 |   |   |

 

*Lease*

On July 15, 2006, theCompany was party to a lease amendment related to one of its franchise centers.Under the terms of the original lease agreement which was executed in fiscalyear 2001, the Company agreed to guarantee the lessee performance. Under theterms of the amendment, the Company has agreed to continue its guarantorobligations in conjunction with the leasing of the facility to anothernon-related party. The terms of the amendment are in effect through April 30,2009. In the event that the new lessee defaults, the Company could be requiredto perform as the lessee resulting in additional rental expense ofapproximately $136,400 through April 30, 2009. In accordance with theprovisions of FIN 45; Guarantor’s Accounting and Disclosure Requirements forGuarantees, the Company utilized a third party to assist with assessing thefair value of the leased property. Based on the fair market valuation ofcomparable properties**,**if there wasan imbedded premium in the lease due to the fact the Company was the guarantoron the lease, it was immaterial. The Company did not record a liability at theinception of the lease amendment for issuing the guarantee pursuant toparagraph 9 of FIN 45.

**Note 10—AreaDeveloper Agreements**

On January 4, 2007, the Company and the areadeveloper for the Dallas, Texas market mutually agreed to terminate the areadeveloper agreement for the Dallas, Texas market for an amount slightly in 

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excess of $100,000. TheCompany bought back the area rights and the amount was expensed as a directfranchise support cost for the year ended June 30, 2007.

On February 15, 2007, the Company and the areadeveloper for the southern Florida market mutually agreed to terminate the areadevelopment agreement for the Florida market for an amount slightly in excessof $150,000. The Company bought back the area rights and the amount wasexpensed as a direct franchise support cost for the year ended June 30,2007.

With no area developer forthese markets, the Company will support the franchisees and develop new storesin that market and will keep 100 percent of the royalty stream instead ofsplitting those monies with an area developer.

**Note 11—RelatedParty Transactions**

The Company manages the operation of PTAC MarketingFund, Inc. (‘‘PMF’’), the national advertising fund for Precision TuneAuto Care Centers, pursuant to a Management Agreement approved by the Board ofDirectors of PMF, which is comprised of franchisee and Company personnel. TheCompany charged PMF $707,000 and $741,000 for administrative and other expensesincurred on behalf of PMF, for the years ended June 30, 2007 and 2006,respectively. Based on the timing of receipts and disbursements, it is commonfor amounts to be due to and from the Company and PMF. At June 30, 2007and 2006, the amount due from PMF was $58,000 and $61,250, respectively. Thisamount is included in accounts receivable. At June 30, 2007 and 2006, theamount due to PMF was $190,801 and $167,053, respectively. This amount isincluded in due to related party.

Bassam N. Ibrahim, adirector of the Company, is a shareholder in Buchanan Ingersoll PC, anAlexandria, Virginia law firm that performs legal services for the Companyrelated to intellectual property protection. Fees paid in the amount of approximately$49,000 and $44,000 to the firm by the Company in the fiscal years ended June 30,2007 and 2006, respectively, did not exceed five percent of the firm’s grossrevenues.

**Note 12—Stockholders’Equity**

*Voting Rights andOutstanding Shares*

Each share of non-voting preferred stock is entitledto receive, when and as declared by the Board of Directors, cumulativepreferential cash dividends at the rate of 2% of the liquidation preference ofthe Series A redeemable preferred stock, $10.36 per share, per annumpayable quarterly in arrears in cash on the last day, or the next succeedingbusiness day, of January, April, July, and October in each year, beginningJanuary 31, 2003. Accrued dividends were approximately $233 at June 30,2007 and 2006, respectively.

Each share of common stockis entitled to one vote for each matter submitted to the shareholders forapproval.

*Common Stock OptionPlan*

In 1999, the Company’s Board of Directors and theCompany’s stockholders approved the 1999 Employee Stock Option Plan (the ‘‘OptionPlan’’) and, as amended, reserved 2,600,000 shares of common stock for issuanceunder the Plan. Options available for future grants under this plan were307,000 at June 30, 2007.

Options reserved for issuance under predecessor plansconsist of 400,000 related to the 1997 Employee Stock Option Plan, 175,000related to the 1996 Employee Stock Option Plan, and 75,000 related to the 1998Director’s Stock Option Plan. Options available for future grant at June 30,2007, under these 

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plans were 327,500,175,000 and 75,000, respectively. The Compensation Committee of the Company’sBoard of Directors determines the recipients of the award to be granted,exercise price, vesting period, term and number of shares underlying theoptions.

Thefollowing is a summary of the Company’s stock option activity under all plans:

| ** **          | ** ** | **Shares  Under Option** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
|---------------------|------------|-------------------------------|------------|---------------------------------------------|------------|
| June 30,  2005 |       |                          | 1,721,700  |                                        |       |   | 0.85 |   |   |
| Options granted     |       |                          | —     |                                        |       |   | — |   |   |
| Options exercised   |       |                          | (120,000   | )                                           |       |   | 0.31 |   |   |
| Options forfeited   |       |                          | —     |                                        |       |   | — |   |   |
| June 30,  2006 |       |                          | 1,601,700  |                                        |       |   | 0.89 |   |   |
| Options granted     |       |                          | —     |                                        |       |   | — |   |   |
| Options exercised   |       |                          | —     |                                        |       |   | — |   |   |
| Options forfeited   |       |                          | —     |                                        |       |   | — |   |   |
| June 30, 2007  |       |                          | 1,601,700  |                                        |       |   | 0.89 |   |   |

 

At June 30, 2007 and2006, options for 1,477,000 and 1,330,000 shares, respectively, wereexercisable. No options were granted in fiscal year 2007 and 2006,respectively. The weighted average remaining contractual term of the optionswas 4.54 years as of June 30, 2007. The exercise price of optionsoutstanding at June 30, 2007 ranged from $0.25 to $10.00 per share.

*Outside Director’sStock Plan*

In 2000, the Company’sBoard of Directors and the Company’s stockholders approved the 2000 OutsideDirectors’ Stock Plan and reserved 50,000 shares for issuance under the Plan. Sharesavailable for future grants at June 30, 2007, under this plan were 37,000.

*Warrants*

In 1998, a subordinateddebenture was executed with an LLC composed of certain members of the Company’sboard of directors (Board LLC). Terms of the agreement included issuance of warrantsto purchase 400,000 shares of the Company’s common stock with an exercise priceof $0.44 per share. The number of shares outstanding related to warrants at June 30,2007 and 2006 was 343,620.

*Equity Transactions*

In August 2005,10,000 warrants were exercised pursuant to an agreement the Company reached torestructure the Board LLC subordinated debt. Upon the exercise of thesewarrants at the previously agreed to exercise price of $0.44 per share, theholder purchased 10,000 restricted shares of common stock for $4,400.

**Note 13—Employees’Savings Plan**

The Company maintains a401(k) plan under which the Company may contribute up to 25% of anemployee’s first 6% of compensation deferred under the plan. Employees becomeeligible after attaining the age of 21 and completing three months ofemployment with the Company. The employees may elect to contribute all of theirannual compensation subject to limitations set forth in the Internal RevenueCode. Employees’ contributions vest immediately. The employee matchingcontribution is discretionary and vests 20% after one year and in increments of20% each additional year. The employee matching contributions for each of theyears ended June 30, 2007 and 2006 were $27,000 and $31,000, respectively.

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**Note 14—Contingencies**

The Company is subject tolitigation that could have a material adverse impact on its liquidity (see Part IItem 3. Legal Proceedings).

**Note 15—SubsequentEvent**

On July 24,2007, the Company purchased an existing Precision Tune Auto Care center inBeltsville, Maryland. This center will be operated as a company-owned store.The Company purchased the assets of this center for $140,000. The followingtable summarizes the estimated fair values of the assets acquired at the dateof acquisition:

| Current assets         |   | $       | 6,000   |   |
|------------------------|--------|---------|---------|--------|
| Equipment              |   | 19,000  |    |
| Intangible asset       |   | 12,000  |    |
| Goodwill               |   | 103,000 |    |
| Total assets  acquired |   | $       | 140,000 |   |

 

**Item 8.**                        *Changes In And Disagreements With Accountants On Accounting AndFinancial Disclosures*

On September 28, 2006 the Audit Committee of theBoard of Directors of Precision Auto Care, Inc. (the “Company”) elected tochange independent registered public accounting firms. As such, Grant ThorntonLLP (“Grant Thornton”) was dismissed and Yount, Hyde & Barbour P.C. (“Yount,Hyde & Barbour”) were appointed the independent registered publicaccountants beginning first quarter of the fiscal year ending June 30,2007.

Grant Thornton’s reports on the Company’s financialstatements for the fiscal years ended June 30, 2006 and 2005 did not containan adverse opinion or disclaimer of opinion, and were not qualified or modifiedas to uncertainty, audit scope, or accounting principle. During the fiscalyears ended June 30, 2006 and 2005, and through September 28, 2006,there were no disagreements with Grant Thornton on any matter of accountingprinciples or practices, financial statement disclosure, or auditing scope orprocedure, which disagreements if not resolved to the satisfaction of GrantThornton would have caused Grant Thornton to make reference thereto in itsreports on the Company’s financial statements for such years.

During the fiscal years ended June 30, 2006 and2005, and through September 28, 2006, there were no “reportable events”with respect to the Company as such term is defined in Item 304(a)(1)(v) ofRegulation S-K.

As required by Item 4.01 of the current report on Form 8-K,we included the above disclosure in a Form 8-K we filed on October 2,2006. We provided Grant Thornton with a copy of the disclosure in advance offiling the Form 8-K and requested that Grant Thornton furnish uswith a letter addressed to the Securities and Exchange Commission statingwhether it agrees with the statements made by us and, if not, stating therespects in which it did not agree.

During our fiscal yearsended June 30, 2006 and 2005 and through September 28, 2006, neitherwe nor anyone acting on our behalf consulted with Yount, Hyde &Barbourregarding any of the matters specified in Item 304(a)(2)(i) and (ii) ofRegulation S-K.

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**Item 8A.**                *Controls and Procedures*

Under the supervision andwith the participation of our management, including the Chief Executive Officerand Chief Financial Officer, we have evaluated the effectiveness of the designand operation of our disclosure controls and procedures pursuant to ExchangeAct Rule 13a-14(c) as of the end of the period covered by thisreport. Based on that evaluation, the Chief Executive Officer and ChiefFinancial Officer have concluded that these disclosure controls and proceduresare effective. There were no changes in our internal control over financialreporting during the year ended June 30, 2007 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

**Item 8B.**               *Other Information*

None.

**PART III**

**Item 9.**                        *Directors, Executive Officers, Promoters and Control Persons;Compliance with Section 16(a) of the Exchange Act.*

The required information on directors will becontained in the Company’s Proxy Statement, and reference is expressly made tothe Proxy Statement for the specific information incorporated in the Form 10-KSB.The required information on executive officers is set forth in Part I ofthis Form 10-KSB under an unnumbered item captioned “ExecutiveOfficers of Precision Auto Care, Inc.”

The code of ethics thatapplies to the Company’s Chief Executive Officer, Chief Financial Officer, andall other employees is attached as an exhibit in Item 13 of this report. If theCompany makes any substantive amendments to the code of ethics or grant anywaiver, including any implicit waiver, from a provision of the code to ourChief Executive Officer or Chief Financial Officer, the Company will disclosethe nature of such amendment or waiver in a report on Form 8-K.

**Item 10.**                 *Executive Compensation*

The required informationwill be set forth under “Executive Compensation” and  “Report of the Organization and CompensationCommittee on Executive Compensation” in the Company’s Proxy Statement, andreference is expressly made to the Proxy Statement for the specific informationincorporated in the Form 10-KSB.

**Item 11.**                 *Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters*

The required informationwill be set forth under “Security Ownership of Certain Beneficial Owners andManagement” in the Company’s Proxy Statement, and reference is expressly madeto the Proxy Statement for the specific information incorporated in the Form 10-KSB.Except as otherwise stated in the Proxy Statement, the address of each of thepersons owning more than 5% of the Company’s Common Stock is 748 Miller Drive,S. E., Leesburg, VA 20175.

**Item 12.**                 *Certain Relationships and Related Transactions*

The required informationwill be set forth under “Certain Relationships and Related Transactions” in theCompany’s Proxy Statement, and reference is expressly made to the ProxyStatement for the specific information incorporated in the Form 10-KSB.

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**Item 13.**                 *Exhibits*

(a)           Thefollowing documents are filed as part of this report:

1.     FinancialStatements

Thefollowing financial statements appear in Part II, Item 7 of this report:

| Report of Independent  Auditors                       |   | 21     |   |
|-------------------------------------------------------|--------|--------|--------|
| Audited Financial  Statements                         |   |   |   |
| Consolidated  Balance Sheets                          |   | 23     |   |
| Consolidated  Statements of Operations                |   | 24     |   |
| Consolidated  Statements of Stockholders’ Equity |   | 25     |   |
| Consolidated  Statements of Cash Flows                |   | 26     |   |
| Notes to Consolidated  Financial Statements           |   | 27     |   |

 

(b)          Exhibits

| 2.1  |   | Plan of  Reorganization and Agreement for Combination of Business dated as of  August 27, 1997, by and among the Company, WE JAC Corporation, Miracle  Industries, Inc., Lube Ventures, Inc., Rocky Mountain  Ventures, Inc., Rocky Mountain Ventures II, Inc., Miracle  Partners, Inc., Prema Properties, LLC, Ralston Car Wash, LLC and KBG  LLC, included as an Exhibit to the Company’s Registration Statement on  Form S-1 (No. 333-34439) filed August 27, 1997, is  incorporated herein by reference. |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1  |   | Articles of  Incorporation of the Company included as an exhibit to the Company’s  Registration Statement on Form S-1 (No. 333-34439)  filed August 27, 1997, are incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                             |
| 3.2  |   | By-laws of the  Company as amended August 18, 2004 are incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 3.3  |   | Articles of  Amendment to the Articles of Incorporation of Precision Auto Care, Inc.  dated October 28, 2002 to create a new series of preferred stock  designated as Series A Cumulative Redeemable Preferred Stock, included  as an exhibit to the Company’s Quarterly Report on Form 10-QSB,  filed November 14, 2002, is incorporated herein by reference.                                                                                                                                                                        |
| 3.4  |   | Articles of  Amendment to the Articles of Incorporation of Precision Auto Care, Inc.  dated January 15, 2003 to increase the number of authorized shares,  amend the required number of Board of Directors, and amend the terms of the  Board of Directors, included as an exhibit to the Company’s Quarterly Report  on Form 10-QSB, filed February 14, 2003, is incorporated  herein by reference.                                                                                                                                       |
| 4.1  |   | Warrant to  Purchase Shares of Common Stock of Precision Auto Care, Inc. dated  October 30, 2002 (Warrant No. 2002-01) between the Company  and Desarollo Integrado, S. A. de C. V., included as an exhibit to the Company’s  Quarterly Report on Form 10-QSB, filed November 14, 2002, is  incorporated herein by reference.                                                                                                                                                                                                         |
| 4.2  |   | Warrant to  Purchase Shares of Common Stock of Precision Auto Care, Inc. dated  October 30, 2002 (Warrant No. 2002-02) between the Company  and Arthur C. Kellar, included as an exhibit to the Company’s Quarterly  Report on Form 10-QSB, filed November 14, 2002, is  incorporated herein by reference.                                                                                                                                                                                                                            |
| 10.1 |   | Precision Auto  Care, Inc. 1998 Employee Stock Purchase Plan, included as an exhibit to  the Company’s Registration Statement on Form S-8 (No. 333-49097),  filed April 1, 1998, is incorporated herein by reference.                                                                                                                                                                                                                                                                                                                      |

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| 10.2  |   | Precision Auto Care Inc. 2000 Outside Directors’  Stock Plan, included as an exhibit to the Company’s Registration Statement on  Form S-8 (No. 333-39226), filed June 14, 2000, is  incorporated herein by reference.                       |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.3  |   | Precision Auto Care, Inc. 1998 Outside  Directors’ Stock Option Plan, included as an exhibit to the Company’s  Registration Statement on Form S-8 (No. 333-85877),  filed August 25, 1999, is incorporated herein by reference.        |
| 10.4  |   | Precision Auto Care, Inc. 1999 Employee Stock  Option and Restricted Stock Plan, included as an exhibit to the Company’s  Registration Statement on Form S-8 (No. 333-85879),  filed August 25, 1999, is incorporated herein by reference.  |
| 10.5  |   | Precision Tune Stock Option Plan, included as an  exhibit to the Company’s Registration Statement on Form S-8  (No. 333-47165), filed March 2, 1998, is incorporated herein  by reference.                                                       |
| 10.6  |   | Precision Auto Care Employee Stock Option Plan,  included as an exhibit to the Company’s Registration Statement on Form S-8  (No. 333-47169), filed March 2, 1998, is incorporated herein  by reference.                                         |
| 10.7  |   | Precision Auto Care, Inc. Director Stock Option  Plan, included as an exhibit to the Company’s Registration Statement on  Form S-8 (No. 333-47171), filed March 2, 1998, is  incorporated herein by reference.                              |
| 10.8  |   | Subordinated Debenture Agreement with Board LLC,  dated October 15, 1998, included as an exhibit to the Company’s Amended  Quarterly Report on Form 10-Q/A, filed November 20, 1998, is  incorporated herein by reference.                       |
| 10.9  |   | Agreement dated August 3, 2000 between the  Company and Louis M. Brown, Jr., included as an Exhibit to the  Company’s Annual Report on Form 10-K, filed October 13, 2000,  is incorporated herein by reference.                        |
| 10.10 |   | Lease dated December 3, 2001 between Leesburg  Airpark III, LLC and Precision Tune Auto Care, Inc., included as an  Exhibit to the Company’s Annual Report on Form 10-K, filed  October 15, 2002, is incorporated herein by reference. |
| 10.11 |   | Agreement dated July 17, 2003 between the  Company and Board L.L.C. terminating the Subordinated Debenture dated  October 15, 1998 between the Company and Board L.L.C. is incorporated  herein by reference.                                              |
| 10.12 |   | Renewal of Promissory Note dated February 28,  2007 between Precision Auto Care, Inc. and Chevy Chase Bank, F.S.B. is  incorporated herein by reference.                                                                                                   |
| 21*   |   | Significant Subsidiaries of the Company.                                                                                                                                                                                                                             |
| 23.1* |   | Consent of Yount, Hyde and Barbour, P.C. Independent  Auditors.                                                                                                                                                                                                      |
| 23.2* |   | Consent of Grant Thornton LLP, Independent Auditors.                                                                                                                                                                                                                 |
| 31.1* |   | Written statement of Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                        |
| 31.2* |   | Written statement of Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                        |
| 32.1* |   | Written statement of Chief Executive Officer and  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                           |

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*                    Filedherewith

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**Item 14.**                 PrincipalAccountant Fees and Services

The required information will be set forth under “PrincipalAccountant Fees and Services” in the Company’s Proxy Statement, and referenceis expressly made to the Proxy Statement for the specific informationincorporated in the Form 10-KSB.

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**SIGNATURES**

**Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized, on September 19,2007.**
|            |       | PRECISION AUTO  CARE, INC. |
|------------|------------|---------------------------------|
|       |       | By:                             | /s/  ROBERT R. FALCONI |
| ** ** |       |                            | **Robert  R. Falconi** |
|       |       | * *                        | *President  and Chief Executive Officer* |
| ** ** | ** ** | ** **                      | ***(Duly  Authorized Officer)*** |

 

**Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.**

|                              | **Signature** | ** **                             | ** ** | ** **               | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------------|---------------|----------------------------------------|------------|--------------------------|-----------|------------|------------|------------|----------|------------|
| /s/ LOUIS M.  BROWN, JR.     |          | Chairman of the Board                  |       | September 19,  2007 |
| **Louis M. Brown, Jr.** |          |                                   |       |                     |
| /s/ ROBERT R.  FALCONI       |          | President and Chief  Executive Officer |       | September 19,  2007 |
| **Robert R. Falconi**        |          |                                   |       |                     |
| /s/ WOODLEY A.  ALLEN        |          | Director                               |       | September 19,  2007 |
| **Woodley A. Allen**         |          |                                   |       |                     |
| /s/ BASSAM N.  IBRAHIM       |          | Director                               |       | September 19,  2007 |
| **Bassam N. Ibrahim**        |          |                                   |       |                     |
| /s/ JOHN D.  SANDERS         |          | Director                               |       | September 19,  2007 |
| ** John D.  Sanders**   |          |                                   |       |                     |
| /s/ PETER C.  KEEFE          |          | Director                               |       | September 19,  2007 |
| **Peter C. Keefe**           |          |                                   |       |                     |
| /s/ MARK P.  FRANCIS         |          | Chief Financial Officer                |       | September 19,  2007 |
| **Mark P.  Francis**         |          |                                   |       |                     |

 

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