**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

** **

**Washington,D. C. 20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

** **
| **ý**                                         | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|----------------------------------------------------|------------------------------------------------------------------------------------------------|
| ** **                                         |
| **For the  quarterly period ended: April 2, 2006** |
| ** **                                         |
| **OR**                                             |
| ** **                                         |
| **o**                                              | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**For the transition period from                    **

** **

**Commission file number 1-10233**

** **

**MAGNETEK,INC.**

(Exact name ofRegistrant as specified in its charter)

 

| **DELAWARE**                     | ** ** | **95-3917584**          |
|----------------------------------|------------|-------------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer        |
| incorporation or  organization)  |       | Identification  Number) |

 

**8966 Mason Ave.**

**Chatsworth,California 91311**

(Address ofprincipal executive offices)

 

**(818)727-2216**

(Registrant’stelephone number, including area code)

 

 

(Former name,former address and former fiscal year,if changed since last report)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes  ý  No o

 

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):
| Large accelerated filer  o |   | Accelerated filer ý |   | Non-accelerated filer o |
|----------------------------|--------|--------------------------|--------|-------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). 

Yes o  No ý

 

Thenumber of shares outstanding of Registrant’s Common Stock, as of April 28, 2006,was 29,111,133 shares.

 

 

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2006 MAGNETEK,INC. FORM 10-Q

 

TABLE OF CONTENTSFOR THE QUARTERLY REPORT ON FORM 10-Q

FOR THE FISCALQUARTER ENDED APRIL 2, 2006

 

MAGNETEK, INC.

 
| **Part  I.** | **Financial  Information**                                                                  | ** ** |
|--------------|---------------------------------------------------------------------------------------------|------------|
| ** **   | ** **                                                                                  | ** ** |
| Item 1.      | Financial Statements                                                                        |       |
| Item 2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       |
| Item 3.      | Quantitative  and Qualitative Disclosures about Market Risk                                 |       |
| Item 4.      | Controls and  Procedures                                                                    |       |
|         |                                                                                        |       |
| **Part II.** | **Other Information**                                                                       | ** ** |
| ** **   | ** **                                                                                  | ** ** |
| Item 1.      | Legal Proceedings                                                                           |       |
| Item 1A.     | Risk Factors                                                                                |       |
| Item 2.      | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       |
| Item 3.      | Defaults  Upon Senior Securities                                                            |       |
| Item 4.      | Submission  of Matters to a Vote of Security Holders                                        |       |
| Item 5.      | Other Information                                                                           |       |
| Item 6.      | Exhibits                                                                                    |       |
|         |                                                                                        |       |
| Signatures   |                                                                                        |

 

2

----

 

**PART I – FINANCIAL INFORMATION**

 

**Item 1 –Financial Statements**

** **

MAGNETEK, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREEMONTHS ENDED

April 2, 2006 and April3, 2005

(amounts inthousands, except per share data)

(unaudited)

 
| ** **                                                         | ** ** | **Three Months Ended**         | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                         | ** ** | **(13 weeks)  April 2,  2006** | ** ** | **(13 weeks)  April 3,  2005** | ** ** |
| ** **                                                         | ** ** | ** **                     | ** ** | **(restated)** | ** ** |
|                                                               |       |                           |       |   |   |
| Net sales                                                          |       | $                              | 57,212     |   | $ | 57,038 |   |
| Cost of sales                                                      |       | 44,833                         |       | 42,874 |   |
|                                                               |       |                           |       |   |   |
| Gross profit                                                       |       | 12,379                         |       | 14,164 |   |
| Research and  development                                          |       | 4,214                          |       | 3,991 |   |
| Selling, general  and administrative                               |       | 10,717                         |       | 11,053 |   |
|                                                               |       |                           |       |   |   |
| Loss from  operations                                              |       | (2,552                         | )          | (880 | ) |
| Interest  expense, net                                             |       | 863                            |       | 418 |   |
| Other expense                                                      |       | 175                            |       | 68 |   |
|                                                               |       |                           |       |   |   |
| Loss from  continuing operations before provision for income taxes |       | (3,590                         | )          | (1,366 | ) |
| Provision for  income taxes                                        |       | 850                            |       | 550 |   |
| Net loss from  continuing operations                               |       | (4,440                         | )          | (1,916 | ) |
|                                                               |       |                           |       |   |   |
| Income (loss)  from discontinued operations                        |       | 10                             |       | (23,085 | ) |
|                                                               |       |                           |       |   |   |
| Net loss                                                           |       | $                              | (4,430     | ) | $ | (25,001 | ) |
|                                                               |       |                           |       |   |   |
| Earnings (loss)  per common share                                  |       |                           |       |   |   |
|                                                               |       |                           |       |   |   |
| Basic and  diluted:                                                |       |                           |       |   |   |
| Net loss from  continuing operations                               |       | $                              | (0.15      | ) | $ | (0.07 | ) |
| Income (loss)  from discontinued operations                        |       | 0.00                           |       | (0.81 | ) |
| Net loss                                                           |       | $                              | (0.15      | ) | $ | (0.88 | ) |
|                                                               |       |                           |       |   |   |
| Weighted shares  outstanding:                                      |       |                           |       |   |   |
| Basic                                                              |       | 28,911                         |       | 28,544 |   |
| Diluted                                                            |       | 29,460                         |       | 28,544 |   |

 

See accompanyingnotes

 

3

----

 

MAGNETEK, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE NINEMONTHS ENDED

April 2, 2006 andApril 3, 2005

(amounts inthousands, except per share data)

(unaudited)

 
| ** **                                                                  | ** ** | **Nine Months Ended**          | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                  | ** ** | **(39 Weeks)  April 2,  2006** | ** ** | **(40 Weeks)  April 3,  2005** | ** ** |
| ** **                                                                  | ** ** | ** **                     | ** ** | **(restated)** | ** ** |
|                                                                        |       |                           |       |   |   |
| Net sales                                                                   |       | $                              | 173,056    |   | $ | 185,245 |   |
| Cost of sales                                                               |       | 130,882                        |       | 139,358 |   |
|                                                                        |       |                           |       |   |   |
| Gross profit                                                                |       | 42,174                         |       | 45,887 |   |
| Research and  development                                                   |       | 11,690                         |       | 11,180 |   |
| Selling, general  and administrative                                        |       | 30,935                         |       | 32,136 |   |
|                                                                        |       |                           |       |   |   |
| Income (loss)  from operations                                              |       | (451                           | )          | 2,571 |   |
| Interest  expense, net                                                      |       | 2,065                          |       | 999 |   |
| Other (income)  expense                                                     |       | 700                            |       | (1,115 | ) |
|                                                                        |       |                           |       |   |   |
| Income (loss)  from continuing operations before provision for income taxes |       | (3,216                         | )          | 2,687 |   |
| Provision for  income taxes                                                 |       | 2,550                          |       | 1,725 |   |
| Net income  (loss) from continuing operations                               |       | (5,766                         | )          | 962 |   |
|                                                                        |       |                           |       |   |   |
| Loss from  discontinued operations                                          |       | (1,443                         | )          | (25,261 | ) |
|                                                                        |       |                           |       |   |   |
| Net loss                                                                    |       | $                              | (7,209     | ) | $ | (24,299 | ) |
|                                                                        |       |                           |       |   |   |
| Earnings (loss)  per common share                                           |       |                           |       |   |   |
|                                                                        |       |                           |       |   |   |
| Basic and  diluted:                                                         |       |                           |       |   |   |
| Net income  (loss) from continuing operations                               |       | $                              | (0.20      | ) | $ | 0.04 |   |
| Loss from  discontinued operations                                          |       | (0.05                          | )          | (0.89 | ) |
| Net loss                                                                    |       | $                              | (0.25      | ) | $ | (0.85 | ) |
|                                                                        |       |                           |       |   |   |
| Weighted shares  outstanding:                                               |       |                           |       |   |   |
| Basic                                                                       |       | 28,905                         |       | 28,525 |   |
| Diluted                                                                     |       | 28,905                         |       | 29,229 |   |

 

See accompanyingnotes

 

4

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MAGNETEK, INC.

CONDENSEDCONSOLIDATED BALANCE SHEETS

April 2, 2006 andJuly 3, 2005

(amounts inthousands)

 
| ** **                                 | ** ** | **April 2,  2006** | ** ** | **July 3,  2005** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **(unaudited)**    | ** ** | ** **        | ** ** |
| ASSETS                                     | ** ** | ** **         | ** ** | ** **        | ** ** |
| Current assets:                            |       |               |       |              |       |
| Cash                                       |       | $                  | 1,426      |              | $          | 6,854 |   |
| Restricted cash  - escrow account          |       | 22,602             |       | —            |       |
| Accounts  receivable, net                  |       | 54,918             |       | 54,022            |       |
| Inventories, net                           |       | 55,335             |       | 49,950            |       |
| Prepaid expenses  and other                |       | 4,943              |       | 5,713             |       |
| Assets held for  sale                      |       | 6,339              |       | 4,727             |       |
| Total current  assets                      |       | 145,563            |       | 121,266           |       |
|                                       |       |               |       |              |       |
| Property, plant and equipment              |       | 134,735            |       | 129,473           |       |
| Less accumulated depreciation              |       | (104,437           | )          | (97,534           | )          |
| Net property, plant and equipment          |       | 30,298             |       | 31,939            |       |
|                                       |       |               |       |              |       |
| Goodwill                                   |       | 63,820             |       | 63,656            |       |
| Other assets                               |       | 11,621             |       | 12,319            |       |
| Total assets                               |       | $                  | 251,302    |              | $          | 229,180 |   |
|                                       |       |               |       |              |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY  |       |               |       |              |       |
|                                       |       |               |       |              |       |
| Current liabilities:                       |       |               |       |              |       |
| Accounts payable                           |       | $                  | 33,598     |              | $          | 36,974 |   |
| Accrued  liabilities                       |       | 11,017             |       | 8,523             |       |
| Accrued  arbitration award                 |       | 22,602             |       | 22,602            |       |
| Liabilities held  for sale                 |       | 1,570              |       | 1,220             |       |
| Current portion  of long-term debt         |       | 29,359             |       | 5,702             |       |
| Total current  liabilities                 |       | 98,146             |       | 75,021            |       |
|                                       |       |               |       |              |       |
| Long-term debt, net of current portion     |       | 19,168             |       | 19,528            |       |
|                                       |       |               |       |              |       |
| Pension benefit obligations, net           |       | 73,418             |       | 70,568            |       |
|                                       |       |               |       |              |       |
| Other long-term obligations                |       | 8,196              |       | 7,627             |       |
|                                       |       |               |       |              |       |
| Deferred income taxes                      |       | 11,522             |       | 10,376            |       |
|                                       |       |               |       |              |       |
| Commitments and contingencies              |       |               |       |              |       |
|                                       |       |               |       |              |       |
| Stockholders’ equity:                 |       |               |       |              |       |
| Common stock                               |       | 287                |       | 286               |       |
| Additional paid  in capital                |       | 129,260            |       | 128,664           |       |
| Retained  earnings                         |       | 32,809             |       | 40,018            |       |
| Accumulated  other comprehensive loss      |       | (121,504           | )          | (122,908          | )          |
| Total  stockholders' equity                |       | 40,852             |       | 46,060            |       |
|                                       |       |               |       |              |       |
| Total liabilities and stockholders' equity |       | $                  | 251,302    |              | $          | 229,180 |   |

 

See accompanyingnotes

 

5

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MAGNETEK, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOW

FOR THE NINEMONTHS ENDED

April 2, 2006 and April3, 2005

(amounts inthousands)

(unaudited)

 
| ** **                                                                                                                       | ** ** | **Nine Months Ended**          | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                       | ** ** | **(39 Weeks)  April 2,  2006** | ** ** | **(40 Weeks)  April 3,  2005** | ** ** |
| ** **                                                                                                                       | ** ** | ** **                     | ** ** | **(restated)** | ** ** |
| Cash flows from  continuing operating activities:                                                                                |       |                           |       |   |   |
| Net income  (loss) from continuing operations                                                                                    |       | $                              | (5,766     | ) | $ | 962 |   |
| Adjustments to  reconcile net income (loss) from continuing operations to net cash provided  by continuing operating activities: |       |                           |       |   |   |
| Depreciation and  amortization                                                                                                   |       | 6,746                          |       | 7,270 |   |
| Tax refund  proceeds, net                                                                                                        |       | —                         |       | 3,332 |   |
| Stock based  compensation expense                                                                                                |       | 361                            |       | — |   |
| Changes in  operating assets and liabilities                                                                                     |       | 818                            |       | (5,782 | ) |
| Total  adjustments                                                                                                               |       | 7,925                          |       | 4,820 |   |
| Net cash provided  by continuing operating activities                                                                            |       | 2,159                          |       | 5,782 |   |
|                                                                                                                             |       |                           |       |   |   |
| Cash flows from  discontinued operations:                                                                                        |       |                           |       |   |   |
| Loss from  discontinued operations                                                                                               |       | (1,443                         | )          | (25,261 | ) |
| Adjustments to  reconcile loss from discontinued operations to net cash used in discontinued  operations:                        |       |                           |       |   |   |
| Arbitration  award expense                                                                                                       |       | —                         |       | 21,977 |   |
| Depreciation and  amortization                                                                                                   |       | —                         |       | 94 |   |
| Changes in  operating assets and liabilities                                                                                     |       | (1,262                         | )          | (550 | ) |
| Capital  expenditures                                                                                                            |       | —                         |       | (16 | ) |
| Net cash used in  discontinued operations                                                                                        |       | (2,705                         | )          | (3,756 | ) |
|                                                                                                                             |       |                           |       |   |   |
| Net cash  provided by (used in) operating activities                                                                             |       | (546                           | )          | 2,026 |   |
|                                                                                                                             |       |                           |       |   |   |
| Cash flows from  investing activities:                                                                                           |       |                           |       |   |   |
| Capital  expenditures                                                                                                            |       | (4,146                         | )          | (6,076 | ) |
| Net cash used in  investing activities                                                                                           |       | (4,146                         | )          | (6,076 | ) |
|                                                                                                                             |       |                           |       |   |   |
| Cash flows from  financing activities:                                                                                           |       |                           |       |   |   |
| Deposit into  escrow account                                                                                                     |       | (22,602                        | )          | — |   |
| Proceeds from  issuance of common stock                                                                                          |       | 236                            |       | 366 |   |
| Borrowings under  line-of-credit agreements                                                                                      |       | 3,361                          |       | 6,024 |   |
| Principal  repayments under capital lease obligations                                                                            |       | (180                           | )          | (417 | ) |
| Borrowings under  long term notes                                                                                                |       | 20,817                         |       | — |   |
| Repayments of  long term notes                                                                                                   |       | (701                           | )          | (829 | ) |
| Increase in  deferred financing costs                                                                                            |       | (1,667                         | )          | (82 | ) |
| Net cash  provided by (used in) financing activities                                                                             |       | (736                           | )          | 5,062 |   |
|                                                                                                                             |       |                           |       |   |   |
| Net increase  (decrease) in cash                                                                                                 |       | (5,428                         | )          | 1,012 |   |
| Cash at the  beginning of the period                                                                                             |       | 6,854                          |       | 2,318 |   |
|                                                                                                                             |       |                           |       |   |   |
| Cash at the end  of the period                                                                                                   |       | $                              | 1,426      |   | $ | 3,330 |   |

 

See accompanyingnotes

 

6

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MAGNETEK, INC.

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

APRIL 2, 2006

(Amounts inthousands unless otherwise noted, except per share data)

(unaudited)

 

1.             Basisof Presentation

 

The accompanying unaudited condensed consolidated financial statementsinclude the accounts of Magnetek, Inc. and its subsidiaries (the “Company”). Allsignificant intercompany accounts and transactions have been eliminated.

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements. For furtherinformation, refer to the financial statements and footnotes thereto includedin the Company’s Form 10-K for the year ended July 3, 2005 filed with theSecurities and Exchange Commission. In the Company's opinion, these unauditedstatements contain all adjustments, consisting of normal recurring adjustments,necessary to present fairly the financial position of the Company as of April 2,2006, and the results of its operations and its cash flows for the three-month andnine-month periods ended April 2, 2006 and April 3, 2005. Results for the nine-monthsended April 2, 2006 are not necessarily indicative of results that may beexperienced for the full fiscal year.

 

The Company uses a fifty-two, fifty-three week fiscal year ending onthe Sunday nearest to June 30. Fiscal quarters are the thirteen or fourteenweek periods ending on the Sunday nearest September 30, December 31, March 31and June 30. The three-month periods ended April 2, 2006 and April 3, 2005 eachcontained 13 weeks; the nine-month periods ended April 2, 2006 and April 3,2005 contained 39 and 40 weeks, respectively.

 

2.             Summaryof Significant Accounting Policies

 

Restatement - The accompanying condensed consolidatedfinancial statements have been restated for the three- and nine-month periodsended April 3, 2005.

 

Since fiscal 2002 the Company has provided valuation reserves againstits U.S. deferred tax assets that result in a zero net deferred tax position(net deferred assets equal to deferred tax liabilities).  In its 2005fiscal year-end review of its tax accounts, the Company determined that aportion of its deferred tax liability related to tax-deductible amortization ofgoodwill that is no longer amortized for financial reporting purposes. Underapplicable accounting rules, such deferred tax liabilities are considered tohave an indefinite life and are therefore ineligible to be considered as asource of future taxable income in assessing the realization of deferred taxassets.

 

The Company has determined that such deferred tax liabilities existedat July 3, 2005, and therefore increased its valuation allowance fordeferred tax assets and the related provision for income taxes for fiscal year2005 by $1.6 million. The Company further determined that the increasedprovision for income taxes should have been recorded on a pro-rata basisthroughout fiscal year 2005, and as a result, the Company has restated itsquarterly results for fiscal 2005.  The impact of this restatement on thethree- and nine-month periods ended April 3, 2005 was an increase in theCompany’s valuation allowance for deferred tax assets and related provision forincome taxes of $0.4 million and $1.2 million, respectively.

 

The restatement did not have a material impact on the Company’sfinancial position at the end of the reported period and had no impact on theCompany’s cash flows for the restated periods.

 

7

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The table below reflects the impact of the restatement on the Company’sresults of operations for the three- and nine- month periods ended April 3,2005:

 

Condensed ConsolidatedStatements of Operations

 
| ** **                                                                                | ** ** | **Three Months Ended**       | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------|------------|
| **For the periods ended April 3,  2005  (Amounts in thousands except per share amounts)** | ** ** | **As  previously  reported** | ** ** | **As  restated**      | ** ** | **As  previously  reported** | ** ** | **As  restated** | ** ** |
| ** **                                                                                | ** ** | ** **                   | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Provision for  income taxes                                                               |       | $                            | 150        |                  | $          | 550 |   | $ | 525 |   | $ | 1,725 |   |
|                                                                                      |       |                         |       |                  |       |   |   |   |   |
| Net loss                                                                                  |       | $                            | (24,601    | )                     | $          | (25,001 | ) | $ | (23,099 | ) | $ | (24,299 | ) |
|                                                                                      |       |                         |       |                  |       |   |   |   |   |
| Net loss per  common share, basic and diluted                                             |       | $                            | (0.86      | )                     | $          | (0.88 | ) | $ | (0.81 | ) | $ | (0.85 | ) |

 

Useof Estimates - The preparation of financial statements inaccordance with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes. Actual resultscould differ from those estimates. Significant areas requiring managementestimates include the following key financial areas:

 

*AccountsReceivable*

* *

Accounts receivable represent receivables from customers in theordinary course of business. The Company is subject to losses fromuncollectible receivables in excess of its allowances. The Company maintainsallowances for doubtful accounts for estimated losses from customers’ inabilityto make required payments. In order to estimate the appropriate level of thisallowance, the Company analyzes historical bad debts, customer concentrations,current customer creditworthiness, current economic trends and changes incustomer payment patterns. If the financial conditions of the Company’scustomers were to deteriorate and to impair their ability to make payments,additional allowances may be required in future periods. The Company’s managementbelieves that all appropriate allowances have been provided.

 

*Inventories*

* *

The Company’s inventories are stated at the lower of cost or market. Costis determined by the first-in, first-out (“FIFO”) method, including material,labor and factory overhead. Inventory on hand may exceed future demand eitherbecause the product is obsolete, or the amount on hand is more than can be usedto meet future needs. The Company identifies potentially obsolete and excessinventory by evaluating overall inventory levels. In assessing the ultimaterealization of inventories, the Company is required to make judgments as tofuture demand requirements and compare those with the current or committedinventory levels. If future demand requirements are less favorable than thoseprojected by management, additional inventory write-downs may be required.

 

*Reservesfor Contingencies*

* *

The Company periodically records the estimated impacts of variousconditions, situations or circumstances involving uncertain outcomes. The accountingfor such events is prescribed under Statement of Financial Accounting Standard(“SFAS”) No. 5, *Accounting for Contingencies*. SFASNo. 5 defines a contingency as an existing condition, situation, or set ofcircumstances involving uncertainty as to possible gain or loss to anenterprise that will ultimately be resolved when one or more future eventsoccur or fail to occur.

 

SFAS No. 5 does not permit the accrual of gain contingencies under anycircumstances. For loss contingencies, the loss must be accrued if (1)information is available that indicates it is probable that the loss has beenincurred, given the likelihood of uncertain events; and (2) that the amount ofthe loss can be reasonably estimated.

 

The accrual of a contingency involves considerable judgment on the partof management. The Company uses its internal expertise, and outside experts, asnecessary, to help estimate the probability that a loss has been incurred andthe amount (or range) of the loss.

 

*IncomeTaxes*

* *

The Company uses the liability method to account for income taxes. Thepreparation of consolidated financial statements involves estimating theCompany’s current tax exposure together with assessing temporary differencesresulting from differing treatment of items for tax and accounting purposes. Thesedifferences result in deferred tax assets and liabilities, which are includedin the consolidated balance sheets. An assessment of the recoverability of thedeferred tax assets is made, and a valuation allowance is established based uponthis assessment.

 

8

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The Company does not record deferred taxes on domestic pre-tax incomeor losses, due to (1) the availability of net operating loss (NOL)carryforwards that have been fully reserved through valuation allowances for pre-taxincome, and (2) uncertainty surrounding the timing of realizing NOLcarryforwards generated in the current period in future periods.

 

With the exception of approximately $3.0 million of foreign earningsthat the Company repatriated during the nine months ended April 2, 2006 forvarious financing needs, the Company presently intends to reinvest any earningsoverseas indefinitely.

 

*PensionBenefits*

* *

The valuation of the Company’s pension plan requires the use of assumptionsand estimates to develop actuarial valuations of expenses, assets and liabilities.These assumptions include discount rates, investment returns and mortalityrates. Changes in assumptions and future investments returns could potentiallyhave a material impact on the Company’s pension expense and related fundingrequirements.

 

Revenue Recognition – The Company’s policy is torecognize revenue when the earnings process is complete.  The criteriaused in making this determination are persuasive evidence that an arrangementexists, delivery has occurred, the sales price is fixed or determinable, andcollectibility is reasonably assured.  Sales are recorded net of returnsand allowances, which are estimated using historical data at the time of sale.

 

Revenue is recognized upon shipment, except in those few cases whereterms of shipment are FOB destination, or where product is shipped to customerswith consignment stock agreements, wherein revenue is recognized when thecustomer receives the product, or removes the product from consignmentstock.  With the foregoing exceptions, terms of shipment are FOB shippingpoint, and payment is not contingent upon resale or any other matter other thanpassage of time.  Amounts billed to customers for shipping costs are reflectedin net sales; shipping costs are reflected in cost of sales.

 

Sales to distributors are recorded with appropriate reserves for futurereturns in accordance with SFAS No. 48,*Revenue Recognition When Right of Return Exists*, and generally donot include future installation obligations or acceptance requirements.

 

Stock-Based Compensation – On December 16, 2004,the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised2004), *Share-Based Payment*, which is a revisionof SFAS No. 123,*Accounting for Stock-Based Compensation*. SFAS No. 123(R) supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees,* and amends SFAS No. 95, *Statement of Cash Flows*. Generally, the approach in SFAS No.123(R) is similar to the approach described in SFAS No. 123.  However,SFAS No. 123(R) requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the income statementbased on their fair values. Pro forma disclosure is no longer an alternative.

 

Prior to fiscal year 2006, as was permitted under SFAS No. 123,*Accounting for Stock-Based Compensation*,the Company accounted for stock-based awards using the intrinsic-value methodunder APB No. 25.  Under APB No. 25, the Company recognized nocompensation expense with respect to such awards, as the exercise prices ofstock option grants were always equal to or greater than the market price ofthe stock at the grant date.  Accordingly, no stock-based employeecompensation expense for stock options is reflected in determining net loss inthe accompanying condensed consolidated financial statements for the three- andnine-month periods ended April 3, 2005.

 

Effective July 4, 2005, the Company adopted SFAS No. 123 (R),which requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the Company’s financial statementsbased upon their fair values.  The Company selected the modifiedprospective method of adoption in which compensation cost is recognized beginningwith the effective date.  Compensation cost recognized for the three- and nine-monthperiods ended April 2, 2006 is the same as that which would have beenrecognized had the fair value method of SFAS No. 123 been applied from itsoriginal effective date.  In accordance with the modified prospectivemethod of adoption, the Company’s results of operations for prior periods havenot been restated.

 

In the fourth quarter of fiscal 2005, the Company approved theacceleration of the vesting of all out-of-the-money (“underwater”) unvestedstock options held by the Company’s current employees, including executiveofficers, on June 1, 2005. No stock options held by directors were subjectto the acceleration.  The decision to accelerate vesting of these underwateroptions was made primarily to avoid recognizing compensation cost in theconsolidated statement of operations upon adoption of SFAS No. 123 (R), asdescribed above.  As a result of the acceleration, the

 

9

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Company reduced the stock option compensation expense it otherwisewould be required to record by approximately $1.9 million in fiscal 2006, $1.4million in fiscal 2007 and less than $0.1 million in fiscal 2008 on a pre-taxbasis, resulting in an additional $3.4 million of pro-forma expense in fiscal2005.  The accelerated vesting was a modification of outstanding awards asdefined by SFAS No. 123, which resulted in incremental pro-forma compensationexpense of $0.3 million in fiscal 2005.

 

The Company did not issue any stock options during the nine-monthperiod ended April 2, 2006. In August 2005, the Company granted 500,000 sharesof restricted stock with a fair value of $2.77 per share. The restricted sharesfully vest on January 1, 2009. The total estimated compensation expense of $1.4million related to the grant will be recorded ratably from the grant datethrough the vesting date. Compensation expense related to the restricted stockgrant included in the condensed consolidated statement of operations for thethree- and nine-month periods ended April 2, 2006 is $103 and $252 respectively.The remaining portion of stock-based compensation expense recorded in thethree- and nine-month periods ended April 2, 2006, of $36 and $109respectively, relates to non-vested director stock option grants.

 

The following table illustrates the effect on net loss and loss pershare as if the fair value method had been applied to all outstanding andunvested awards in each period:

 
| ** **                                                                                                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Amounts in thousands, except  per share amounts)**                                                                          | ** ** | **April 2,  2006**     | ** ** | **April 3,  2005**    | ** ** | **April 2,  2006** | ** ** | **April 3,  2005** | ** ** |
| ** **                                                                                                                     | ** ** | ** **             | ** ** | **(restated)**        | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Net loss, as  reported                                                                                                         |       | $                      | (4,430     | )                     | $          | (25,001 | ) | $ | (7,209 | ) | $ | (24,299 | ) |
|                                                                                                                           |       |                   |       |                  |       |   |   |   |   |
| Add: Stock-based  compensation expense included in reported net income, net of related tax  effects                            |       | 139                    |       | —                |       | 361 |   | — |   |
|                                                                                                                           |       |                   |       |                  |       |   |   |   |   |
| Deduct: Total  stock-based compensation expense determined under fair value method for all awards,  net of related tax effects |       | (139                   | )          | (1,137                | )          | (361 | ) | (3,521 | ) |
|                                                                                                                           |       |                   |       |                  |       |   |   |   |   |
| Pro forma net  loss                                                                                                            |       | $                      | (4,430     | )                     | $          | (26,138 | ) | $ | (7,209 | ) | $ | (27,820 | ) |
| ** **                                                                                                                     | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss per share  as reported:                                                                                                   |       |                   |       |                  |       |   |   |   |   |
| Basic and  diluted                                                                                                             |       | $                      | (0.15      | )                     | $          | (0.88 | ) | $ | (0.25 | ) | $ | (0.85 | ) |
|                                                                                                                           |       |                   |       |                  |       |   |   |   |   |
| Pro forma loss  per share:                                                                                                     |       |                   |       |                  |       |   |   |   |   |
| Basic and  diluted                                                                                                             |       | $                      | (0.15      | )                     | $          | (0.92 | ) | $ | (0.25 | ) | $ | (0.98 | ) |
|                                                                                                                                |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |

 

Thefair value of the Company's stock-based awards to employees was estimated usingthe Black-Scholes model, assuming no dividends, using the following historicalassumptions: 

 
| ** **                                                     | ** ** | **Options** | ** ** |
|----------------------------------------------------------------|------------|-------------|------------|
| **Weighted average assumptions  used in recent fiscal years:** | ** ** | **2006**    | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                           |       |        |       |   |   |   |   |
| Expected life  (years)                                         |       | 6.1         |       | 6.1 |   | 6.1 |   |
| Expected stock  price volatility                               |       | 72.2        | %          | 72.2 | % | 65.8 | % |
| Risk-free  interest rate                                       |       | 4.9         | %          | 4.4 | % | 3.5 | % |

 

As stated above, no options were issued in the first nine months offiscal 2006.

 

In fiscal year 2005, a total of 750,000 options were granted withexercise prices equal to the market price of the stock on the grant date. Theweighted average exercise price was $7.48 and the average fair value of theoptions was $5.04. In addition, the Company issued 240,000 shares of restrictedstock in fiscal 2005.

 

10

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In fiscal year 2004, a total of 1,836,000 options were granted withexercise prices equal to the market price of the stock on the grant date. Theweighted average exercise price was $4.58 and the average fair value of theoptions was $2.83. The Company did not issue any shares of restricted stock infiscal 2004.

 

Property, Plant and Equipment – Additions andimprovement are capitalized at cost, whereas expenditures for maintenance andrepair are charged to expense as incurred.  Depreciation is provided overthe estimated useful lives of the respective assets principally on the straight-linemethod (machinery and equipment normally five to ten years, buildings andimprovements normally ten to forty years).

 

Goodwill – In accordance with SFAS No. 142, *Goodwill and Other Intangible Assets*, the Company reviewsthe carrying value of goodwill at least annually, and more frequently ifindicators of potential impairment arise, using discounted future cash flowanalyses as prescribed in SFAS No. 142.

 

Deferred Financing Costs – Costs incurred to obtainfinancing are deferred and included in other assets in the condensedconsolidated balance sheets. Deferred financing costs are amortized over theterm of the financing facility.

 

Warranties – The Company offers warranties forcertain products that it manufactures, with warranty terms generally rangingfrom one to two years.  Warranty reserves are established for costsexpected to be incurred after the sale and delivery of products under warranty,based mainly on known product failures and historical experience.  Actualrepair costs incurred for products under warranty are charged against theestablished reserve balance as incurred.

 

Earnings per Share – In accordance with SFAS No. 128,*Earnings per Share*, basic earnings pershare are computed using the weighted average number of common shares outstandingduring the period. Diluted earnings per share incorporate the incrementalshares issuable upon the assumed exercise of stock options as if all exerciseshad occurred at the beginning of the fiscal period.

 

Derivative Financial Instruments – The Companyperiodically uses derivative financial instruments to reduce financial marketrisks. These instruments are used to hedge foreign currency and interest ratemarket exposures. The Company does not use derivative financial instruments forspeculative or trading purposes.  The accounting policies for theseinstruments are based on the Company’s designation of such instruments ashedging transactions. The criteria the Company uses for designating aninstrument as a hedge include the instrument’s effectiveness in risk reductionand the matching of the derivative to the underlying transaction. The resultinggains or losses are accounted for as part of the transactions being hedged,except that losses not expected to be recovered upon the completion of the hedgetransaction are expensed.  The Company had no derivative financialinstruments at April 2, 2006 and July 3, 2005.

 

Foreign Currency Translation - The Company’s foreignentities’ accounts are measured using local currency as the functionalcurrency.  Assets and liabilities are translated at the exchange rate ineffect at the fiscal period-end.  Revenues and expenses are translated atthe rates of exchange prevailing during the reported fiscal period. Unrealized translation gains and losses arising from differences in exchangerates from period to period are included as a component of accumulated othercomprehensive loss in stockholders’ equity.

 

Reclassifications – Certain prior year balances werereclassified to conform to the current year presentation.

 

Recent Accounting Pronouncements – In May 2005,the FASB issued SFAS No. 154,*Accounting Changes and Error Corrections*, which changes theaccounting for and the reporting of voluntary changes in accountingprinciples.  SFAS No. 154 requires changes in accounting principlesto be applied retrospectively to prior period financial statements, wherepracticable, unless specific transition provisions permit alternativetransition methods. SFAS No. 154 will be effective in fiscal yearsbeginning after December 15, 2005. The Company’s adoption of SFASNo. 154 is not expected to have a material impact on the Company’s resultsof operations, financial position or cash flows.

 

In November 2004, the FASB issued SFAS No. 151,*Inventory Costs*, which amends the guidancein ARB No. 43, Chapter 4,*Inventory Pricing*. This amendment clarifies the accounting forabnormal amounts of idle facility expense, freight, handling costs and wastedmaterial (spoilage). This Statement requires that those items be recognized ascurrent-period charges, regardless of whether they meet the criteria specifiedin ARB 43 of “so abnormal”. In addition, this Statement requires thatallocation of fixed production overheads to the costs of conversion be based onnormal capacity of the production facilities. SFAS No. 151 is effectivefor financial statements for fiscal years beginning after June 15, 2005.The Company adopted SFAS No. 151 during the three month period endedOctober 2, 2005, and the adoption did not have a material impact on theresults of operations or the financial position of the Company.

 

11

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3.             DiscontinuedOperations

 

In the third quarter of fiscal 2005, the Company committed to a plan todivest its telecom power business and began marketing the business. Management determined that the assets and liabilities to be sold constituted adisposal group under SFAS No. 144,*Accounting for the Impairment of Disposal of Long-Lived Assets,* andthat all of the “assets held for sale” criteria outlined in SFAS No. 144were met.  Accordingly, the operating results of this business areclassified as discontinued operations in the accompanying condensedconsolidated statements of operations and its assets and liabilities areclassified as held for sale in the accompanying condensed consolidated balancesheets for all periods presented. The estimated fair value of the disposalgroup at April 2, 2006 is $4.8 million.  

 

The Company also recorded other expenses related to divested businessesas discontinued operations, primarily legal fees related to a patentinfringement claim and a related indemnification agreement provided by theCompany upon the sale of its lighting business in prior years.  Theseexpenses are reported as “other discontinued operations expense” in the tablebelow.

 

The results of discontinued operations are as follows: 

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **April 2,  2006**     | ** ** | **April 3,  2005**    | ** ** | **April 2,  2006** | ** ** | **April 3,  2005** | ** ** |
| Net Sales                                        |       | $                      | 6,921      |                  | $          | 1,896 |   | $ | 14,713 |   | $ | 6,893 |   |
|                                             |       |                   |       |                  |       |   |   |   |   |
| Income (loss)  from telecom business, net of tax |       | $                      | 364        |                  | $          | (435 | ) | $ | 230 |   | $ | (1,029 | ) |
| Other  discontinued operations expense           |       | (354                   | )          | (22,650               | )          | (1,673 | ) | (24,232 | ) |
| Income (loss)  from discontinued operations      |       | $                      | 10         |                  | $          | (23,085 | ) | $ | (1,443 | ) | $ | (25,261 | ) |
|                                                  |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

The Company did not allocate any interest expense to discontinuedoperations, and no tax benefit was recorded related to discontinued operationsfor any of the periods presented.

 

4.             Inventories

*** ***

Inventories at April 2, 2006 and July 3, 2005 consist of the following:

 
| ** **                     | ** ** | **April 2,  2006** | ** ** | **July 3,  2005** | ** ** |
|--------------------------------|------------|--------------------|------------|-------------------|------------|
| Raw materials  and stock parts |       | $                  | 31,097     |              | $          | 30,257 |   |
| Work-in-process                |       | 11,907             |       | 9,452             |       |
| Finished goods                 |       | 12,331             |       | 10,241            |       |
|                           |       | $                  | 55,335     |              | $          | 49,950 |   |

 

5.             Commitmentsand Contingencies

 

*Litigation– Product Liability*

* *

The Company has settled or otherwise resolved all of the productliability lawsuits associated with its discontinued business operations andbelieves that any new claims associated with discontinued operations wouldeither qualify as an assumed liability, as defined in the various purchaseagreements related to the sale of those businesses, or would be barred by anapplicable statute of limitations.  The Company was a named party in twoproduct liability lawsuits related to the Telemotive Industrial Controlsbusiness acquired in December 2002 through the purchase of the stock ofMXT Holdings, Inc.  The Company tendered both claims to the insurancecompanies that provided coverage for MXT Holdings, Inc. against suchlosses and the tenders were accepted by the carriers, subject to a reservationof rights.  One of the cases has settled, with the insurer bearing allliability for the claim, and management believes that the insurer will bear allliability, if any, with respect to the remaining case and that theproceedings will not have a material adverse effect on the Company’s results ofoperations, financial position or cash flows.

 

12

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The Company has been named, along with multiple other defendants, inasbestos-related lawsuits associated with business operations previouslyacquired by the Company, but which are no longer owned. During the Company’sownership, none of the businesses produced or sold asbestos-containingproducts. With respect to these claims, the Company is either contractuallyindemnified against liability for asbestos-related claims or believes that ithas no liability for such claims. The Company aggressively seeks dismissal fromthese proceedings, and has also tendered the defense of these cases to theinsurers of the previously acquired businesses and is awaiting theirresponse.  The Company has also filed a late claim in the amount of $2.5million in the Federal-Mogul bankruptcy proceedings to recover attorney’s feepaid for the defense of these claims, which the Company believes is anobligation of Federal Mogul although the claim is subject to challenge. Management does not believe the asbestos proceedings, individually or in theaggregate, will have a material adverse effect on its financial position,results of operations or cash flows.

 

*Litigation– Patent Infringement*

* *

In April 1998, Mr. Ole K. Nilssen (“Nilssen”) filed a lawsuit inthe U.S. District Court for the Northern District of Illinois alleginginfringement by the Company of seven of his patents pertaining to electronicballast technology, and seeking unspecified damages and injunctive relief topreclude the Company from making, using or selling products allegedlyinfringing his patents. In April 2003, Nilssen’s lawsuit against theCompany and the Company’s counterclaims against Nilssen were dismissed withprejudice and both parties agreed to submit limited issues in dispute tobinding arbitration before an arbitrator with a relevant technical background.The arbitration occurred in November, 2004 and a decision awarding Nilssen$23.4 million was issued on May 3, 2005. Nilssen’s motion to enter theaward as a judgment in U.S. District Court for the Northern District ofIllinois and Magnetek’s counter-motion to vacate the award on grounds that itwas fraudulently obtained are pending in the U.S. District Court for theNorthern District of Illinois.  Magnetek’s request for oral argument wasgranted and the hearing was held on October 19, 2005.  The judge isexpected to render his decision by mail after further consideration.  Anunfavorable decision by the Court could result in payment of the award by theCompany to Nilssen in the amount of $22.6 million (the arbitration award of$23.4 million net of previously paid amounts of $0.8 million), which would havea material adverse effect on the Company’s cash flows during the period suchpayment would be made. In November 2005, the Company deposited $22.6 millioninto an escrow account to ensure that it is able to satisfy the Nilssen arbitrationaward in the event that its appeal of the award is not successful.

 

In June 2001, the Company sold its lighting business to UniversalLighting Technologies, Inc. (“ULT”), and agreed to provide a limitedindemnification against certain claims of infringement that Nilssen mightallege against ULT. In February 2003, Nilssen filed a lawsuit in the U.S.District Court for the Northern District of Illinois alleging infringement byULT of 29 of his patents pertaining to electronic ballast technology, andseeking unspecified damages and injunctive relief to preclude ULT from making,using or selling products allegedly infringing his patents. ULT made a claimfor indemnification, which the Company accepted, subject to the limitations setforth in the sale agreement.  A response was filed denying that theproducts infringe any valid patent and asserting affirmative defenses, as wellas a counterclaim for a judicial declaration that the patents are unenforceableand invalid. The case was removed to the District Court for the CentralDistrict of Tennessee and Nilssen voluntarily dismissed claims related to allbut four of the patents. The Patent and Trademark Office (“PTO”) has acceptedULT’s request for reexamination of the four remaining patents.  A motionfor summary judgment that various claims of the patents at issue are invalidand that the accused ULT products do not infringe a claim of one of the patentswas filed on November 1, 2005 but no hearing had been set as of January 5,2006 when the Court granted ULT’s motion to stay proceedings in the lawsuitpending the PTO reexamination. The Company will continue to aggressively defendthe claims against ULT however, a decision in the lawsuit that is ultimatelyunfavorable to ULT could have a material adverse effect on the Company’sfinancial position, cash flows and results of operations as a result of itsindemnification obligations.

 

*Environmental*

* *

From time to time, Magnetek has taken action to bring certainfacilities associated with previously owned businesses into compliance withapplicable environmental laws and regulations. Upon the subsequent sale ofthose businesses, the Company agreed to indemnify the buyers againstenvironmental claims associated with the divested operations, subject tocertain conditions and limitations. Remediation activities, including thoserelated to the Company’s indemnification obligations, did not involve materialexpenditures during the third quarter of fiscal year 2006 and are not expectedto result in material expenditures for the remainder of fiscal 2006.

 

13

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Magnetek has also been identified by the United States EnvironmentalProtection Agency and certain state agencies as a potentially responsible partyfor cleanup costs associated with alleged past waste disposal practices atseveral previously owned facilities and offsite locations. Its remediationactivities as a potentially responsible party were not material during the thirdquarter of fiscal year 2006 and are not expected to be material during theremainder of fiscal 2006.  Although the materiality of future expendituresfor environmental activities may be affected by the level and type ofcontamination, the extent and nature of cleanup activities required by governmentalauthorities, the nature of the Company’s alleged connection to the contaminatedsites, the number and financial resources of other potentially responsibleparties, the availability of indemnification rights against third parties andthe identification of additional contaminated sites, the Company’s estimatedshare of liability, if any, for environmental remediation, including itsindemnification obligations, is not expected to be material.

 

*Environmental- Century Electric (McMinnville, Tennessee)*

* *

Prior to the Company’s purchase of Century Electric, Inc.(“Century Electric”) in 1986, Century Electric acquired a business fromGould Inc. (“Gould”) in May 1983 that included a leasehold interestin a fractional horsepower electric motor manufacturing facility located inMcMinnville, Tennessee. Gould agreed to indemnify Century Electric from andagainst liabilities and expenses arising out of the handling and cleanup ofcertain waste materials, including but not limited to cleaning up anypolychlorinated biphenyls (“PCBs”) at the McMinnville facility (the “1983Indemnity”). The presence of PCBs and other substances, including solvents, inthe soil and in the groundwater underlying the facility and in certain offsitesoil, sediment and biota samples has been identified. The McMinnville plant islisted as a Tennessee Inactive Hazardous Waste Substance Site and plantemployees were notified of the presence of contaminants at the facility. Gouldhas completed an interim remedial excavation and disposal of onsite soilcontaining PCBs and a preliminary investigation and cleanup of certain onsiteand offsite contamination. The Company believes the cost of furtherinvestigation and remediation (including ancillary costs) are covered by the1983 Indemnity. The Company sold its leasehold interest in the McMinnvilleplant in August 1999 and while the Company believes that Gould willcontinue to perform substantially under its indemnity obligations, Gould’ssubstantial failure to perform such obligations could have a material adverseeffect on the Company’s financial position, cash flows and results ofoperations.

 

*Environmental- Effect of Fruit of the Loom Bankruptcy (Bridgeport, Connecticut)*

* *

In 1986, the Company acquired the stock of Universal ManufacturingCompany (“Universal”) from a predecessor of Fruit of the Loom (“FOL”), and thepredecessor agreed to indemnify the Company against certain environmentalliabilities arising from pre-acquisition activities at a facility inBridgeport, Connecticut. Environmental liabilities covered by theindemnification agreement include completion of additional cleanup activities,if any, at the Bridgeport facility (sold in connection with the sale of thetransformer business in June 2001) and defense and indemnification againstliability for potential response costs related to offsite disposal locations.FOL, the successor to Universal’s indemnification obligation, filed a petitionfor Reorganization under Chapter 11 of the Bankruptcy Code in 1999 and theCompany filed a proof of claim in the proceeding for obligations related to theenvironmental indemnification agreement. The Company believes that FOL hadsubstantially completed the clean-up obligations required by theindemnification agreement prior to the bankruptcy filing. In November 2001,the Company and FOL entered into an agreement involving the allocation ofcertain potential tax credits and Magnetek withdrew its claims in thebankruptcy proceeding. FOL’s obligation to the state of Connecticut was notdischarged in the reorganization proceeding. FOL’s inability to satisfy itsremaining obligations related to the Bridgeport facility and any offsitedisposal locations, or the discovery of additional environmental contaminationat the Bridgeport facility could have a material adverse effect on theCompany’s financial position, results of operations or cash flows.

 

14

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6.             ComprehensiveLoss

 

For the three- and nine-month periods ended April 2, 2006 and April 3,2005, comprehensive loss consisted of the following:

 
| ** **                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **April 2,  2006**          | ** ** | **April 3,  2005**         | ** ** | **April 2,  2006** | ** ** | **April 3,  2005** | ** ** |
| ** **                       | ** ** | ** **                       | ** ** | **(restated)**                  | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Net loss                         |       | $                                | (4,430     | )                               | $          | (25,001 | ) | $ | (7,209 | ) | $ | (24,299 | ) |
| Currency  translation adjustment |       | 1,247                            |       | (2,874                          | )          | 1,404 |   | 4,817 |   |
| Comprehensive  loss              |       | $                                | (3,183     | )                               | $          | (27,875 | ) | $ | (5,805 | ) | $ | (19,482 | ) |
|                                  |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |

 

7.             Earnings(Loss) Per Share

 

The following table sets forth the computation of basic and dilutedearnings (loss) per share for the three- and nine- month periods ended April 2,2006 and April 3, 2005.

 
| ** **                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **April 2,  2006**     | ** ** | **April 3,  2005**    | ** ** | **April 2,  2006** | ** ** | **April 3,  2005** | ** ** |
| ** **                                              | ** ** | ** **             | ** ** | **(restated)**        | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Numerator:                                              |       |                   |       |                  |       |   |   |   |   |
| Net income  (loss) from continuing operations           |       | $                      | (4,440     | )                     | $          | (1,916 | ) | $ | (5,766 | ) | $ | 962 |   |
| Income (loss)  from discontinued operations             |       | 10                     |       | (23,085               | )          | (1,443 | ) | (25,261 | ) |
| Net loss                                                |       | $                      | (4,430     | )                     | $          | (25,001 | ) | $ | (7,209 | ) | $ | (24,299 | ) |
|                                                    |       |                   |       |                  |       |   |   |   |   |
| Denominator:                                            |       |                   |       |                  |       |   |   |   |   |
| Weighted average  shares for basic earnings per share   |       | 28,911                 |       | 28,544                |       | 28,905 |   | 28,525 |   |
| Add dilutive  effective of stock options outstanding    |       | 549                    |       | —                |       | — |   | 704 |   |
| Weighted average  shares for diluted earnings per share |       | 29,460                 |       | 28,544                |       | 28,905 |   | 29,229 |   |
|                                                    |       |                   |       |                  |       |   |   |   |   |
| Basic &  Diluted:                                   |       |                   |       |                  |       |   |   |   |   |
| Net income  (loss) per share from continuing operations |       | $                      | (0.15      | )                     | $          | (0.07 | ) | $ | (0.20 | ) | $ | 0.04 |   |
| Income (loss)  per share from discontinued operations   |       | $                      | 0.00       |                  | $          | (0.81 | ) | $ | (0.05 | ) | $ | (0.89 | ) |
| Net loss per  share                                     |       | $                      | (0.15      | )                     | $          | (0.88 | ) | $ | (0.25 | ) | $ | (0.85 | ) |
|                                                         |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Due to the net loss from continuing operations and the net loss for thethree- and nine-month periods ended April 2, 2006, and the loss fromdiscontinued operations for the nine-month period ended April 2, 2006, theeffect of 0.5 million and 0.4 million shares of stock options, respectively, wasexcluded from the calculations of diluted loss per share, as their impact wouldbe anti-dilutive.  Similarly, the dilutive effect of stock optionsoutstanding was not included in the calculation of diluted loss per share fromdiscontinued operations or net loss per share for the three- and nine-monthperiods ended April 3, 2005, nor was it included in the calculation of dilutedloss per share from continuing operations in the three-month period ended April3, 2005.

 

15

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8.             Warranties

 

The Company offers warranties for certain products that itmanufactures, with warranty terms generally ranging from one to two years. Warrantyreserves are established for costs expected to be incurred after the sale anddelivery of products under warranty, based mainly on known product failures andhistorical experience. Actual repair costs incurred for products under warrantyare charged against the established reserve balance as incurred. Changes in thewarranty reserve for the nine months ended April 2, 2006 and April 3, 2005 wereas follows:

 
| ** **                                            | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **April 2,  2006**    | ** ** | **April 3,  2005** | ** ** |
| Balance,  beginning of fiscal year                    |       | $                     | 315        |   | $ | 204 |   |
| Additions  charged to earnings for product warranties |       | 450                   |       | 363 |   |
| Use of reserve  for warranty obligations              |       | (415                  | )          | (288 | ) |
| Balance, end of  period                               |       | $                     | 350        |   | $ | 279 |   |

 

Warrantyreserves are included in accrued liabilities in the condensed consolidatedbalance sheets.

 

9.             RestructuringCosts

 

The Company began restructuring activities during the second quarter offiscal 2004, which included a workforce reduction of approximately 200positions in Europe and the relocation of those positions to lower costfacilities in Eastern Europe and China.  The Company completed theserestructuring activities in fiscal 2005, and as a result, did not incur anycosts related to these activities in the three- and nine-month periods endedApril 2, 2006.  The Company incurred restructuring costs for the three-and nine-month periods ended April 3, 2005 of $0.1 million and $0.3 million,respectively, which are included in selling, general and administrative expensein the accompanying condensed consolidated statements of operations.

 

In the fourth quarter of fiscal 2004, the Company began theconsolidation of its Glendale Heights, IL operation into its Menomonee Falls,WI facility.  The Company completed these restructuring activities by theend of fiscal 2005, and as a result, did not incur any costs related to these activitiesin the three- and nine-month periods ended April 2, 2006.  Costs incurredin the three-month period ended April 3, 2005 were $0.4 million, which areincluded in selling, general and administrative expense in the accompanyingcondensed consolidated statements of operations.  Costs incurred in the nine-monthperiod ended April 3, 2005 were $0.9 million, of which $0.3 million areincluded in cost of goods sold and $0.6 million are included in selling,general and administrative expense in the accompanying condensed consolidatedstatements of operations. 

 

During the three-month period ended April 2, 2006, the Company begannegotiations with the labor union in Italy to further reduce the workforce atits Valdarno, Italy facility by up to 75 additional positions. A finalagreement between the Company and the union has not yet been reached, and as aresult, the total cost of the workforce reduction, as well as the timing of thereduction and related expense and future cash outflows, is not known at this time.While the Company currently estimates the total cost of the reduction at Euro 2million (approximately $2.5 million), the accompanying condensed consolidatedstatements of operations do not include any costs related to this action.

 

10.           Stock-BasedCompensation Plans

 

The Company has two stock option plans (the “Plans”), one of whichprovides for the issuance of both incentive stock options (underSection 422A of the Internal Revenue Code of 1986) and non-qualified stockoptions at exercise prices not less than the fair market value of the Company’scommon stock at the date of grant, and one of which only provides for theissuance of non-qualified stock options at exercise prices not less than thefair market value of the Company’s common stock at the date of grant. One ofthe Plans also provides for the issuance of stock appreciation rights,restricted stock, incentive bonuses and incentive stock units. The total numberof shares of the Company’s common stock authorized to be issued upon exerciseof the stock options and other stock rights under the Plans is 2,100,000. Options granted under these Plans vest in equal annual installments of two,three or four years.

 

The accompanying condensed consolidated statements of operations forthe three- and nine-month periods ended April 2, 2006, include compensationexpense related to all stock-based awards of $0.1 million and $0.4 million,respectively  (see Note 2 of Notes toCondensed Consolidated Financial Statements).  The three- and nine-monthperiods ended April 3, 2005, do not include any compensation expense related tostock-based awards, as the Company was accounting for stock-based compensationusing the intrinsic-value method under APB No. 25, which permitted footnotedisclosure only of the impact of stock-based awards on a pro formabasis.   The pro forma expense related to stock-based awards for thethree- and nine-month periods ended April 3, 2005 was $1.1 million and $3.5million respectively.

 

16

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A summary of certain information with respect to options under thePlans follows:

 
| **Stock Option Activty  Nine Months Ended April 2, 2006** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  Value  ($000s)** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
|                                                      |       |       |       |                                    |       |                                     |       |
| Options  outstanding, July 3, 2005                        |       | 8,178,294  |       | $                                       | 8.77       |                                     |       |   |
| Options granted                                           |       | —     |       |                                    |       |                                     |       |
| Options  exercised                                        |       | (2,500     | )          | $                                       | 3.35       |                                     |       |   |
| Options  cancelled                                        |       | (789,790   | )          | $                                       | 9.98       |                                     |       |   |
| Options  outstanding, April 2, 2006                       |       | 7,386,004  |       | $                                       | 8.65       |                                     | $          | 209 |   |
|                                                      |       |       |       |                                    |       |                                     |       |
| Exercisable  options                                      |       | 7,326,004  |       | $                                       | 8.68       |                                     | $          | 156 |   |

 

As of April 2, 2006, there was $0.1 million of total unrecognizedcompensation cost related to unvested stock option awards granted under thePlans.  This cost is expected to be recognized over a weighted-averageperiod of 0.75 years.

 

The following table provides information regarding exercisable andoutstanding options as of April 2, 2006:

 
| ** **                             | ** ** | **Exercisable**          | ** ** | **Outstanding**                                   | ** ** |
|----------------------------------------|------------|--------------------------|------------|---------------------------------------------------|------------|
| **Range of exercise price per  share** | ** ** | **Options  exercisable** | ** ** | **Weighted  average  exercise  price per  share** | ** ** | **Weighted  average  remaining  contractual  life (years)** | ** ** | **Options  outstanding** | ** ** | **Weighted  average  exercise  price per  share** | ** ** | **Weighted  average  remaining  contractual  life (years)** | ** ** |
|                                   |       |                     |       |                                              |       |   |   |   |   |   |   |   |   |
| Under $5.00                            |       | 1,655,000                |       | $                                                 | 3.91       |   | 7.28 |   | 1,701,168 |   | $ | 3.87 |   | 7.57 |   |
| $5.00 - $10.00                         |       | 3,553,140                |       | 7.80                                              |       | 5.54 |   | 3,664,540 |   | 7.80 |   | 5.79 |   |
| $10.00 - $15.00                        |       | 1,192,875                |       | 11.45                                             |       | 4.79 |   | 1,242,601 |   | 11.44 |   | 5.04 |   |
| Over $15.00                            |       | 924,989                  |       | 17.03                                             |       | 2.28 |   | 928,989 |   | 17.03 |   | 2.52 |   |
| Total                                  |       | 7,326,004                |       | $                                                 | 8.68       |   | 5.40 |   | 7,537,298 |   | $ |  8.65 |   | 5.67 |   |

 

The following tableprovides information regarding unvested restricted stock activity for the ninemonths ended April 2, 2006:

 
| **Unvested Shares**        | ** ** | **Shares** | ** ** | **Weighted-  Average  Grant Date  Fair Value** | ** ** |
|----------------------------|------------|------------|------------|------------------------------------------------|------------|
|                       |       |       |       |                                           |       |
| Unvested at July  3, 2005  |       | —     |       |                                           |       |
| Granted                    |       | 500,000    |       | $                                              | 2.77       |   |
| Vested                     |       | —     |       |                                           |       |
| Forfeited                  |       | —     |       |                                           |       |
| Unvested at  April 2, 2006 |       | 500,000    |       | $                                              | 2.77       |   |

 

As of April 2, 2006, there was $1.1 million of total unrecognizedcompensation cost related to unvested restricted stock arrangements grantedunder the Plans.  This cost is expected to be recognized over aweighted-average period of 2.75 years.

 

17

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11.          PensionExpense

 

For the three- and nine-month periods ended April 2, 2006 and April 3,2005, pension expense related to the Company’s defined benefit pension planconsisted of the following:

 
| ** **                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **April 2,  2006**     | ** ** | **April 3,  2005**    | ** ** | **April 2,  2006** | ** ** | **April 3,  2005** | ** ** |
| Interest cost                    |       | $                      | 2,440      |                  | $          | 2,699 |   | $ | 7,320 |   | $ | 7,602 |   |
| Expected return  on plan assets  |       | (2,552                 | )          | (3,066                | )          | (7,656 | ) | (8,635 | ) |
| Recognized net  actuarial losses |       | 1,062                  |       | 760                   |       | 3,186 |   | 2,140 |   |
|                             |       |                   |       |                  |       |   |   |   |   |
| Total net  pension expense       |       | $                      | 950        |                  | $          | 393 |   | $ | 2,850 |   | $ | 1,107 |   |

 

The net pension expense amounts above are included in selling, generaland administrative expense in the accompanying condensed consolidatedstatements of operations.

 

12.          Income Taxes

 

Since fiscal 2002 the Company has provided valuation reserves againstits U.S. deferred tax assets that result in a zero net deferred tax position(net deferred assets equal to deferred tax liabilities).  In its 2005fiscal year-end review of its tax accounts, the Company determined that aportion of its deferred tax liability related to tax-deductible amortization ofgoodwill that is no longer amortized for financial reporting purposes. Underapplicable accounting rules, such deferred tax liabilities are considered tohave an indefinite life and are therefore ineligible to be considered as asource of future taxable income in assessing the realization of deferred taxassets.

 

The Company has determined that such deferred tax liabilities existedat July 3, 2005, and therefore increased its valuation allowance for deferredtax assets and the related provision for income taxes for fiscal year 2005 by$1.6 million. The Company further determined that the increased provision forincome taxes should have been recorded on a pro-rata basis throughout fiscalyear 2005, and as a result, the Company has restated its quarterly results forfiscal 2005.  The impact of this restatement on the three- and nine-monthperiods ended April 3, 2005 was an increase in the Company’s valuationallowance for deferred tax assets and related provision for income taxes of$0.4 million and $1.2 million, respectively.  

 

Similarly, the Company’s tax provision of $0.9 million for the threemonths ended April, 2006 also included an amount of $0.4 million to increasethe Company’s valuation allowance for deferred tax assets related totax-deductible amortization of goodwill.   The remaining taxprovision of $0.5 million for the three months ended April 2, 2006 wascomprised of income taxes of the Company’s foreign subsidiaries.   The Company’s tax provision of $2.6 millionfor the nine months ended April 2, 2006 included an amount of $1.2 million toincrease the Company’s valuation allowance for deferred tax assets related totax-deductible amortization of goodwill.   The remaining taxprovision of $1.4 million for the nine months ended April 2, 2006 was comprisedof income taxes of the Company’s foreign subsidiaries.    

 

13.          Bank Borrowing Arrangements

 

At July 3, 2005, the Company had an asset based credit agreement forNorth American operations with Chase Bank (formerly Bank One). The Company wasin violation of certain covenants under this agreement at July 3, 2005, and inJuly 2005, in exchange for a waiver of the covenant defaults and the lender's willingnessto continue to extend credit under the agreement, the Company agreed to apermanent reduction in the aggregate lending commitment and a change in thefacility termination date from July 15, 2006 to September 30, 2005. The Companyalso agreed to use its best efforts to obtain financing from other sources thatwould enable the Company to fully repay all indebtedness under the agreement.

 

On September 30, 2005, the Company entered into an agreement withAbleco, Inc. providing for an $18 million term loan and an agreement with WellsFargo Foothill, Inc. providing for a $13 million revolving credit facility.Borrowings under the term loan bear interest at the lender’s reference rateplus 5%, or, at the Company’s option, the London Interbank Offering Rate(LIBOR) plus 7.5%. Such rates may be increased by up to one percentage pointdepending upon the level of U.S. funded debt to EBITDA as defined in theagreement. The term loan requires quarterly principal payments of $1 millionbeginning in October 2006. Borrowings under the revolving credit facility

 

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bear interest at the bank’s prime lending rate plus 2.5% or, at theCompany’s option, LIBOR plus 4%. Borrowings under the revolving credit facilityare determined by a borrowing base formula as defined in the agreement, basedon the level of eligible domestic accounts receivable and inventory. The revolvingcredit facility also supports the issuance of letters of credit. Borrowingsunder the term loan and revolving credit facility are secured by substantiallyall of the Company’s domestic assets. The Company used the proceeds from the revolvingcredit facility to fully repay all outstanding obligations under its previousfinancing agreement with Chase Bank.

 

In November 2005 the Company deposited $22.6 million into an escrowaccount to ensure that it is able to satisfy the Nilssen arbitration award inthe event that its appeal of the award is not successful (see Note 5 of Notesto Condensed Consolidated Financial Statements). The deposit was funded byborrowings under the $18.0 million term loan and by $4.6 million from therevolving credit facility, and is reported as restricted cash in the accompanyingcondensed consolidated balance sheet as of April 2, 2006. As of April 2, 2006,the $18.0 million term loan was outstanding, and approximately $9.3 million wasoutstanding under the revolving credit facility. The total of these twoamounts, $27.3 million, is included in current portion of long-term debt in theaccompanying condensed consolidated balance sheet. This classification reflectscertain provisions in the term loan and revolving credit agreements which allowthe lenders to declare a default and accelerate the loans should certain eventsoccur which could be expected to result in a “Material Adverse Effect” (asdefined in the agreements) on the Company. Such provisions are considered“subjective acceleration” clauses under accounting guidelines which require theclassification of debt balances as current although the related agreements havetermination dates that are beyond one year from the balance sheet date.

 

As of April 2, 2006, the Company was in violation of a covenant whichrequired it to divest its telecom power business prior to the end of the secondquarter of fiscal 2006. On April 20, 2006, the Company entered into anamendment with its lenders which extends the period to divest its telecom powerbusiness to September 30, 2006 and also adjusts the levels of certain financialcovenants for the periods ending March 31, 2006 and June 30, 2006.

 

The Company’s European subsidiary maintains revolving borrowingarrangements with local banks, primarily to support working capital needs.Available borrowings under these arrangements aggregate approximately Euro 20.0million depending in part upon levels of accounts receivable, and bear interestat various rates ranging from 3% to 8%. In addition, the Company’s Europeansubsidiary has an agreement with a European bank to provide borrowings securedby the subsidiary’s land and building. Borrowings under this agreement bearinterest at EURIBOR plus 1.5%. The initial commitment to lend under thisagreement was Euro 7.0 million, and the commitment has been reduced ratably ona quarterly basis beginning March 31, 2004 and ending September 30, 2013. TheCompany’s European subsidiary also has certain long-term notes and capitalleases outstanding related mainly to equipment purchases. As of April 2, 2006,total amounts outstanding under all European borrowing arrangements were $21.2million, of which $2.1 million is included in current portion of long-term debtand $19.1 million is included in long term debt in the accompanying condensedconsolidated balance sheet as of April 2, 2006.

 

**Item 2 - Management’s Discussion and Analysis of Results ofOperations and Financial Condition**

** **

Restatement ofFiscal 2005 Interim Periods and Reclassification

 

As stated in Note 2 of Notes to Condensed Consolidated FinancialStatements, we have restated our financial statements for the interim periodsof fiscal 2005 with respect to accounting for income taxes.

 

Since fiscal 2002 we have provided valuation reserves against our U.S.deferred tax assets that result in a zero net deferred tax position (netdeferred assets equal to deferred tax liabilities).  In our 2005 fiscalyear-end review of our tax accounts, we determined that a portion of ourdeferred tax liability related to tax-deductible amortization of goodwill thatis no longer amortized for financial reporting purposes. Under applicableaccounting rules, such deferred tax liabilities are considered to have anindefinite life and are therefore ineligible to be considered as a source offuture taxable income in assessing the realization of deferred tax assets.

 

We determined that such deferred tax liabilities existed atJuly 3, 2005, and therefore increased our valuation allowance for deferredtax assets and the related provision for income taxes for fiscal year 2005 by$1.6 million. We further determined that the increased provision for incometaxes should have been recorded on a pro-rata basis throughout fiscal year2005, and as a result, we have restated our quarterly results for fiscal2005.  The impact of this restatement on the three and nine months ended April2, 2006 was an increase in our valuation allowance for deferred tax assets andrelated provision for income taxes of $0.4 million and $1.2 million,respectively.  The restatement did not have a material impact on ourfinancial position as of April 2, 2006, and had no impact on our cash flows forthe restated periods.

 

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During fiscal year 2005, we reclassified the assets and liabilities ofour telecom power business as held for sale, and the results of operations ofthis business as discontinued operations (see Note 3 of Notes to CondensedConsolidated Financial Statements).  We also recorded other expensesrelated to divested businesses as discontinued operations, including certainexpenses for patent infringement claims, product liability claims,environmental issues, and asbestos claims.  Prior period amounts relatedto the telecom business or other divested businesses have been reclassified inthe accompanying condensed consolidated financial statements in order to conformto the current year presentation.  All of these issues relate tobusinesses we no longer own and most relate to indemnification agreements weprovided when we divested those businesses.

 

Overview

 

We are a global provider of digital power-electronic products,including electronic converters, inverters, rectifiers and systems.  Theseproducts are used primarily in industrial, telecommunications, data processing,consumer, imaging, alternative energy, power generation and other applicationsrequiring precise, efficient, reliable power.  We believe that with ourtechnical and productive resources we are well positioned to respond toincreasing demand for such power.  We operate in a single businesssegment, Digital Power Products, which includes two broad product categories,systems and components.

 

Our power control systems consist primarily of programmable motioncontrol and power conditioning systems used in the followingapplications:  cranes and hoists; transportation (elevators and railway);fuel cell, wind and photovoltaic markets; street light monitoring and control;and utility grid monitoring.

 

Our embedded power control products, which are sold primarily tooriginal equipment manufacturers for installation in their products, include:AC-to-DC switching power supplies, AC-to-DC rectifiers and battery chargers, DCto-DC power converters, DC-to-AC power inverters and peripheral componentinterconnects.  These products are used primarily in telecommunications(telecom), data processing and storage, digital imaging, semiconductorprocessing and testing equipment, medical instrumentation and home appliances.

 

We continue to see fluctuating demand in our traditionaltelecommunications and information technology markets (embedded powerproducts), stable to growing demand in our traditional systems markets(crane & hoist and elevators), and increased interest in ouralternative energy and utility products. Our operating results in the thirdquarter of fiscal 2006 were negatively impacted by delays in new program introductionsat certain key customers, continued relocation of production, start-up costsassociated with new systems offerings, and volume-related variances at ourmanufacturing operation in Italy. In an effort to improve our competitiveposition and our operating results, during fiscal 2004 and 2005 we completed certainrestructuring actions in both North America and Europe and doubled ourproduction capacity in China. At the same time, we increased our investment inresearch and development (“R&D”) spending on new products, and are focusedon gaining share in systems markets through new product introductions intransportation, utility and alternative energy markets. Our current growthrates for these new products are not as strong as we anticipated, and as aresult, we have experienced unfavorable manufacturing variances in Italy, wherewe have relatively large production capacity. As a result, during the thirdquarter of fiscal 2006, we began the process to further reduce our workforce inItaly by up to 75 additional positions and to shift additional production toChina. Negotiations with the labor union in Italy are in progress and we expectto have an agreement in place within several months.

 

Third-quarter fiscal 2006 bookings (new orders received) were $65.1million and our backlog (undelivered orders) as of April 2, 2006 was $72.7million. Bookings for the third quarter of fiscal 2005 were $55.3 million andour backlog as of April 3, 2005 was $65.0 million.  The increase inbookings versus the prior year is primarily related to an increase in bookingsfor embedded power products. Net sales for the third quarter of fiscal 2006were $57.2 million comparable to net sales of $57.0 million in the thirdquarter of fiscal 2005. Net sales for the nine months ended April 2, 2006 were$173.1 million, a decrease of $12.1 million compared to net sales of $185.2million for the nine months ended April 3, 2005. The decrease is due to lowersales of embedded power products, and in addition, the first nine months of fiscal2005 contained 40 weeks while the first nine months of fiscal 2006 contained 39weeks. We continue to focus on gaining share in systems markets and on newproduct introductions in industrial, transportation, utility, and alternativeenergy markets, and our future sales growth is largely dependent on the successof this strategy. 

 

Gross profit in the third quarter of fiscal 2006 was $12.4 million,down from $14.2 million in the third quarter of fiscal 2005, due to theaforementioned program delays, production relocation, systems start-up costsand volume variances.

 

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Our R&D expense was $4.2 million in the third quarter of fiscal2006, compared to $4.0 million in the third quarter of fiscal 2005. We continueto invest in developing new products for existing and new markets, includingalternative energy products for solar and wind applications and monitoring andcontrol systems for utility markets.  Selling, general and administrative(“SG&A”) expense was $10.7 million in the third quarter of fiscal 2006compared to $11.1 million in the third quarter of fiscal 2005, mainly due tothe absence of restructuring costs in fiscal 2006 and reduced rent expense, partiallyoffset by higher pension expense, which increased by $0.6 million in the thirdquarter of fiscal 2006 compared to the third quarter of fiscal 2005.  Ourfuture annual pension expense will depend on future interest rate levels,values in equity and fixed income markets, and contributions we may elect tomake to the plan.

 

Mainly as a result of reduced gross profit, our loss from operations increasedto $2.6 million in the third quarter of fiscal 2006 from $0.9 in the thirdquarter of fiscal 2005.  Our net loss from continuing operations in the thirdquarter of fiscal 2006 was $4.4 million, or $0.15 per share, and reflects interestexpense of $0.9 million as well as a provision for income taxes of $0.9million.  Our net loss from continuing operations in the third quarter offiscal 2005 was $1.9 million, or $0.07 per share (as restated).

 

In September 2005, we entered into agreements with lendersproviding for an $18 million term loan and a $13 million revolving creditfacility, expanding our credit facilities for greater operating flexibility(see Note 13 of Notes to Condensed Consolidated Financial Statements) . In November 2005, we deposited $22.6 million into an escrow account to be usedto satisfy the Nilssen arbitration award in the event our appeal of the awardis not successful (see Note 5 of Notes to Condensed Consolidated FinancialStatements). The source of funds for the escrow deposit was the $18 millionterm loan and $4.6 million from our revolving credit facility, and is includedin the current portion of long term debt in the accompanying condensedconsolidated balance sheet as of April 2, 2006. The funds in escrow arereported as restricted cash in the accompanying condensed consolidated balancesheet as of April 2, 2006.

 

We consumed $0.5 million in cash from operating activities during the ninemonths ended April 2, 2006, compared to cash generation of $2.0 million for thenine months ended April 3, 2005. Capital expenditures in the first nine months offiscal 2006 were $4.1 million, while depreciation and amortization expense was$6.7 million, compared to capital expenditures of $6.1 million and depreciationand amortization expense of $7.3 million for the same period in fiscal 2005. Our total debt increased during the first nine months of fiscal 2006 by $23.3million to $48.5 million, due mainly to borrowings to fund the escrow accountreferred to above. Similarly, our combined cash and restricted cash balances increasedfrom $6.9 million at July 3, 2005, to $24.0 million at April 2, 2006.

 

We will continue to focus our development, marketing and sellingcapabilities on higher margin systems applications and markets.  Ourefforts to improve margins include manufacturing cost reduction programs, mostnotably a continued shift of our manufacturing to China. We have also furtherconsolidated administrative operations and functions in fiscal 2006. However, webelieve that future sustained profitability is highly dependent uponimprovement in revenues and gross margins, successful implementation of ourstrategy to penetrate higher margin markets, and favorable outcomes in certainlegal matters, primarily the patent infringement claims (see Note 5 of Notes toCondensed Consolidated Financial Statements).   We believe that global borrowing capacityunder our various credit facilities and internally generated cash flows will besufficient to fund anticipated operational needs, capital expenditures andother near-term commitments. However, our future cash flows will be impacted byhigher interest expense, and scheduled debt repayments and pension contributionsin fiscal years 2007 and 2008. As a result, we are currently reviewing variouscash raising alternatives that would enable us to address these pendingobligations as well as provide funds for future growth initiatives. Thesealternatives may include, but would not necessarily be limited to, asset sales,including the divestiture of major product lines or businesses, and capitalmarket transactions that may be available to us.

 

CriticalAccounting Policies

 

The following discussion and analysis of our financial condition andresults of operations is based upon our condensed consolidated financialstatements.  In preparing financial statements in conformity withaccounting principles generally accepted in the United States, we must makeestimates and assumptions that affect the reported amount of assets andliabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities at the date of our financial statements.  Such estimatesare based upon historical experience and other assumptions believed to bereasonable given known circumstances.  Actual results could differ fromthose estimates.  On an ongoing basis, we evaluate and update ourestimates, including those related to accounting for inventories, goodwill,pension benefits and reserves for contingencies, including litigation andenvironmental issues.  We consider the following policies critical tounderstanding our financial position and results of operations.

 

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*AccountsReceivable*

* *

Accounts receivable represent amounts due from customers in theordinary course of business.  We are subject to losses from uncollectiblereceivables in excess of our allowances.  We maintain allowances fordoubtful accounts for estimated losses from customers’ inability to makerequired payments.  In order to estimate the appropriate level of thisallowance, we analyze historical bad debts, customer concentrations, currentcustomer creditworthiness, current economic trends and changes in customerpayment patterns.  Our total allowance includes a specific allowance basedon identification of customers where we feel full payment is in doubt, as wellas a general allowance calculated based on our historical losses on accountsreceivable as a percentage of historical sales.  We believe that ourmethodology has been effective in accurately quantifying our allowance fordoubtful accounts and do not anticipate changing our methodology in thefuture.  However, if the financial conditions of any of our customers wereto deteriorate and impair their ability to make payments, additional allowancesmay be required in future periods.  We believe that all appropriateallowances have been provided.

 

*Inventories*

* *

Our inventories are stated at the lower of cost or market.  Costis determined by the first-in, first-out (FIFO) method, including material,labor and factory overhead.  We identify potentially obsolete and excessinventory by evaluating overall inventory levels in relation to expected futurerequirements and market conditions, and provisions for excess and obsoleteinventory and inventory valuation are recorded accordingly.  Items with nousage for the past 12 months and no expected future usage are consideredobsolete, and are disposed of or fully reserved.  Reserves for excessinventory are determined based upon historical and anticipated usage ascompared to quantities on hand.  Excess inventory is defined as inventoryitems with on-hand quantities in excess of one year’s usage and specifiedpercentages are applied to the excess inventory value in determining thereserve.  Our reserve for excess and obsolete inventory has ranged from 9%to 10% of gross inventory value during the fiscal years 2005 and 2006. Our assumptions have not changed significantly in the past, and we believe theyare not likely to change in the foreseeable future.  We feel that ourassumptions regarding inventory valuation have been accurate in the past, withthe exception of an unexpected significant decline in demand in our telecombusiness in fiscal 2003, which resulted in a charge to discontinued operationsof $4.7 million to increase our inventory reserves.

 

*Long-LivedAssets and Goodwill*

* *

We periodically evaluate the recoverability of our long-lived assets,including property, plant and equipment.  Impairment charges are recordedin operating results when the undiscounted future expected cash flows derivedfrom an asset are less than the carrying value of the asset.

 

We are required to perform annual impairment tests of our goodwill, andmay be required to test more frequently in certain circumstances.  We haveelected to perform our annual impairment test in the fourth quarter of ourfiscal year.  We have identified our power electronics and power systemsgroups as reporting units under SFAS No. 142.  In assessing potentialimpairment, we make significant estimates and assumptions regarding thediscounted future cash flows of our reporting units to determine the fair valueof those reporting units.  Such estimates include, but are not limited to,projected future operating results, working capital ratios, cash flow, terminalvalues, market discount rates and tax rates.  We review the accuracy ofour projections by comparing them to our actual results annually, and have determinedthat, historically, our cash flow estimates used in determining the fair valueof our reporting units have been reasonably accurate.  We use the resultsof this analysis as well as projected operating results to modify our estimatesannually.  However, if circumstances cause these estimates to change inthe future, or if actual circumstances vary significantly from theseassumptions, this could result in additional goodwill impairment charges. We cannot predict the occurrence of future events that may adversely affect ourreported goodwill balance.

 

*PensionBenefits*

* *

We sponsor a defined benefit plan that covers a number of current andformer employees in the U.S.  The valuation of our pension plan requiresthe use of assumptions and estimates that attempt to anticipate future eventsto develop actuarial valuations of expenses, assets and liabilities. These assumptions include discount rates, expected rates of return on planassets and mortality rates.  We consider market conditions, includingchanges in investment returns and interest rates, in making theseassumptions.  Our plan assets are comprised mainly of common stock andbond funds.  The expected rate of return on plan assets is a long-termassumption and is generally not changed on an annual basis.  The discountrate reflects the market for high-quality fixed income debt instruments and issubject to change each year.  Changes in assumptions typically result inactuarial gains or losses that are amortized in accordance with the methodsspecified in SFAS No. 87, *Employers’ Accounting forPensions*.

 

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Significant differences between our assumptions and actual futureinvestment return or discount rates could have a material impact on ourfinancial position or results of operations and related funding requirements.

 

*Reservesfor Contingencies*

* *

We periodically record the estimated impacts of various conditions,situations or circumstances involving uncertain outcomes.  The accountingfor such events is prescribed under SFAS No. 5, *Accountingfor Contingencies*.  SFAS No. 5 defines a contingency as“an existing condition, situation, or set of circumstances involvinguncertainty as to possible gain or loss to an enterprise that will ultimatelybe resolved when one or more future events occur or fail to occur.”

 

SFAS No. 5 does not permit the accrual of gain contingencies underany circumstances.  For loss contingencies, the loss must be accrued if(1) information is available that indicates it is probable that the losshas been incurred, given the likelihood of uncertain events; and (2) thatthe amount of the loss can be reasonably estimated.

 

The accrual of a contingency involves considerable judgment on ourpart.  We use our internal expertise, and outside experts as necessary, tohelp estimate the probability that a loss has been incurred and the amount orrange of the loss.

 

*IncomeTaxes*

* *

We operate in numerous taxing jurisdictions and are subject to avariety of income and related taxes. Judgment is required in determining ourprovision for income taxes and related tax assets and liabilities. We believewe have reasonably estimated our tax positions for all jurisdictions for allopen tax periods. It is possible that, upon closure of our tax periods, our finaltax liabilities could differ from our estimates.

 

We record deferred income tax assets in tax jurisdictions where wegenerate losses for income tax purposes.  We also record valuationallowances against these deferred tax assets in accordance with SFAS No. 109,*Accounting for Income Taxes,* when, inour judgment, the deferred income tax assets will likely not be realized in theforeseeable future.

 

Resultsof Operations - Three Months Ended April 2, 2006 and April 3, 2005

 

NetSales and Gross Profit

 

Net sales for the third quarter of fiscal 2006 were $57.2 million, a slightincrease from the third quarter of fiscal 2005 sales of $57.0 million. The increaseis due to higher sales of systems in material handling, elevator andalternative energy markets, offset by lower sales of embedded power suppliesand consumer products.

 

Our fiscal 2006 third quarter gross profit was $12.4 million, or 21.7%of sales, versus $14.2 million, or 24.9% of sales in the third quarter offiscal 2005. The reduction in gross profit of $1.8 million is due mainly tolower sales volumes of embedded power supplies, new program delays,inefficiencies related to production relocation, reduced production volume inItaly, and price reductions on consumer products, offset by higher sales volumesof systems. The reduction in gross profit as a percentage of sales is due to unfavorablesales mix within our systems business as well as unfavorable volume variancesin Italy. While systems offerings are expected to generate higher grossmargins, many are in the initial stages of introduction and have not yet beenfully cost reduced from both a material and labor efficiency standpoint.

 

Researchand Development, Selling, General and Administrative

 

R&D expense was $4.2 million, or 7.3% of sales, in the thirdquarter of fiscal 2006 compared to $4.0 million, or 7.0% of sales, in the thirdquarter of fiscal 2005. We continue to invest in product development for newmarkets and applications such as alternative energy markets for wind and solarmarkets and monitoring and control systems for the utility market.

 

SG&A expense was $10.7 million (18.7% of sales) in the thirdquarter of fiscal 2006 versus $11.1 million (19.5% of sales) in the thirdquarter of fiscal 2005. Our third quarter fiscal 2006 selling expenses were $4.5million versus $4.3 million in the third quarter of fiscal 2005. Our thirdquarter fiscal 2006 general and administrative (G&A) expense was $6.2million, compared to third quarter fiscal 2005 G&A expense of $6.7 million.The fiscal 2006 third quarter

 

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G&A expense as compared to the fiscal 2005 third quarter G&Aexpense had higher pension expense by $0.6 million (see Note 11 of Notes toCondensed Consolidated Financial Statements) and stock compensation expense of$0.1 million, offset by lower rent expense of $0.2 million and reducedpayroll-related expenses from headcount reductions and the closure of ourGlendale Heights, IL operations. In addition, the third quarter of fiscal 2005G&A expense included $0.5 million in restructuring costs (see Note 9 ofNotes to Condensed Consolidated Financial Statements).

 

Loss fromOperations

 

Our loss from operations for the third quarter of fiscal 2006 was $2.6million compared to a loss from operations of $0.9 million for the thirdquarter of fiscal 2005. The reduction in income from operations is mainly due tothe reduction in gross profit in the third quarter of fiscal 2006 as comparedto the third quarter of fiscal 2005.

 

InterestExpense, Net

 

Net interest expense was $0.9 million for the third quarter of fiscal2006 compared to interest expense of $0.4 million for the third quarter offiscal 2005. The increase in net interest expense in the third quarter offiscal 2006 was due to higher outstanding debt balances, due mainly toborrowings associated with the Nilssen arbitration award (see Note 5 of Notesto Condensed Consolidated Financial Statements). In November 2005, we deposited$22.6 million into escrow to satisfy payment of the award in the event ourappeal is not successful. The escrow deposit was funded by our $18.0 millionterm loan and $4.6 million from our revolving debt facility. The term loanbears interest at a current rate of 12.5% while we receive interest on theescrow deposit at a current rate of 4.7%. As a result, our reported interestexpense for the third quarter of fiscal 2006 is net of $0.3 million of interestincome.

 

OtherExpense

 

Other expense for the third quarter of fiscal 2006 was $0.2 millioncompared to other expense of $0.1 million for the third quarter of fiscal 2005,comprised entirely of deferred financing amortization expense for both periods.The increase in deferred financing amortization expense in the third quarter offiscal 2006 compared to the third quarter of fiscal 2005 was due to our newcredit agreements entered into on September 30, 2005.

 

Income(Loss) from Discontinued Operations

 

Income from discontinued operations for the third quarter of fiscal2006 was effectively break-even compared to a loss from discontinued operationsof $23.1 million in the third quarter of fiscal 2005. Income from discontinuedoperations for the third quarter of fiscal 2006 includes income from ourtelecom power business of $0.4 million, offset by other discontinued operationsexpenses of $0.4 million incurred in the third quarter of fiscal 2006,comprised mainly of legal fees related to the Nilssen arbitration award appealand indemnification of $0.2 million and expenses incurred in environmentalissues of $0.2 million. Our loss from discontinued operations for the thirdquarter of fiscal 2005 was comprised of a charge for a patent arbitration awardof $22.0 million, legal fees related to the patent award of $0.4 million,losses in our telecom power business of $0.4 million, and other discontinuedoperations expense of $0.2 million, mainly related to product liability issues.

 

NetLoss

 

Our net loss for the third quarter of fiscal 2006 was $4.4 millioncompared to a net loss of $25.0 million (as restated) for the third quarter offiscal 2005. Despite our pre-tax loss for the third quarter of fiscal 2006, werecorded a provision for income taxes of $0.9 million, comprised of a provisionof $0.5 million due to net income generated by our foreign subsidiaries and a$0.4 million non-cash tax provision related to tax basis goodwill amortization.Our provision for income taxes for the third quarter of fiscal 2005 was $0.6million (as restated), which includes $0.2 million due to net income generatedby our foreign subsidiaries and a $0.4 million non-cash tax provision relatedto tax basis goodwill amortization.

 

Results ofOperations - Nine Months Ended April 2, 2006 and April 3, 2005

 

Net Sales andGross Profit

 

Netsales for the first nine months of fiscal 2006 were $173.1 million, a decreaseof 6.5% from net sales of $185.2 million for the first nine months of fiscal2005. The decrease is due to lower sales of embedded power supplies, delays innew program introductions, and currency translation impact from a weaker Eurorelative to the U.S. dollar, partially offset by higher sales of systems inmaterial handling and alternative energy markets.. In addition, the first ninemonths of fiscal 2005 contained an additional week (40 weeks) compared to thefirst nine months of fiscal 2006 (39 weeks), resulting in additional sales of$4.7 million in the first nine months of fiscal 2005.

 

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Our gross profit for the first nine months of fiscal 2006 was $42.2million, or 24.4% of sales, versus $45.9 million, or 24.8% of sales in thefirst nine months of fiscal 2005. The decrease in gross profit is due to lowersales volumes of embedded power supplies, inefficiencies from productionrelocation, volume-related variances at our manufacturing operations in Italy, andtranslation impact from the weaker Euro, partially offset by higher salesvolumes of systems and cost reductions due mainly to the absence ofrestructuring costs in fiscal 2006.

 

Research andDevelopment, Selling, General and Administrative

 

R&D expense was $11.7 million, or 6.8% of sales, for the first ninemonths of fiscal 2006 compared to $11.2 million, or 6.0% of sales for the firstnine months of fiscal 2005. During the first nine months of fiscal 2006, wecontinued to increase spending in new product development aimed at alternativeenergy markets, mainly solar and wind applications, as well utility monitoring andcontrol products, in addition to continuing to invest in new power-electronicplatforms and applications.

 

SG&A expense was $30.9 million (17.9% of sales) for the first ninemonths of fiscal 2006 versus $32.1 million (17.3% of sales) for the first ninemonths of fiscal 2005. Selling expenses were $13.1 million for the first ninemonths of fiscal 2006, versus $13.7 million for the first nine months of fiscal2005. The reduction in selling expenses in the first nine months of fiscal 2006compared to the first nine months of fiscal 2005 was due mainly to decreasedcommission expense and other volume-related selling expenses. G&A expenses were$17.8 million for the first nine months of fiscal 2006, compared to $18.4 millionof G&A expense for the first nine months of fiscal 2005. G&A expensefor the first nine months of fiscal 2006 as compared to the first nine monthsof fiscal 2005 reflects increased pension expense of $1.7 million, increasedaudit fees of $0.4 million, and stock compensation expense of $0.4 million,partially offset by a favorable currency translation impact of $0.3 million,lower rent expense of $0.4 million and lower consulting fees of $0.4 million,and lower payroll-related expenses from headcount reductions and the closure ofour Glendale Heights, IL operations. In addition, G&A expense for the firstnine months of fiscal 2005 includes $0.9 million in restructuring expenses,while no restructuring expenses were incurred in the first nine months offiscal 2006.

 

Income (Loss) fromOperations

 

As a result of the above factors, our loss from operations for the ninemonths ended April 2, 2006 was $0.5 million compared to income from operationsof $2.6 million for the nine months ended April 3, 2005. The decrease in incomefrom operations is mainly due to lower sales volumes and the related reductionin gross profit in the first nine months of fiscal 2006 as compared to the firstnine months of fiscal 2005.

 

Interest Expense,Net

 

Net interest expense was $2.1 million for the first nine months offiscal 2006 compared to interest expense of $1.0 million for the first ninemonths of fiscal 2005. The increase in net interest expense in the first ninemonths of fiscal 2006 was due to higher outstanding debt balances, due mainlyto borrowings associated with the Nilssen arbitration award (see Note 5 ofNotes to Condensed Consolidated Financial Statements). In November 2005, wedeposited $22.6 million into escrow to satisfy payment of the award in theevent our appeal is not successful. The escrow deposit was funded by our $18.0million term loan and $4.6 million from our revolving debt facility. The termloan bears interest at a current rate of 12.5% while we receive interest on theescrow deposit at a current rate of 4.7%. As a result, our reported interestexpense for the nine months ended April 2, 2006, is net of $0.4 million ofinterest income.

 

Other(Income) Expense

 

Other expense for the first nine months of fiscal 2006 was $0.7 million,comprised entirely of deferred financing amortization expense, which includes$0.3 million due to the accelerated write-off of deferred financing assets uponexpiration of our financing agreement with Chase Bank (formerly Bank One) atthe end of the first quarter of fiscal 2006. Other income for the first ninemonths of fiscal 2005 of $1.1 million includes $1.3 million from the one-timesale and license of certain patents and technology rights, offset by $0.2million in deferred financing amortization expense. Under the terms of the fiscal2005 sale and license agreement, we have no remaining obligations nor will wereceive future payments.

 

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Loss fromDiscontinued Operations

 

Our loss from discontinued operations for the first nine months offiscal 2006 was $1.4 million compared to a loss from discontinued operations of$25.3 million in the first nine months of fiscal 2005. Loss from discontinued operationsfor the first nine months of fiscal 2006 is comprised of income from ourtelecom power business (held for sale) of $0.2 million, offset by discontinuedoperations expenses of $1.6 million, mainly legal fees related to the Nilssenarbitration award appeal and indemnification of $1.3 million, as well as legalfees related to asbestos claims and environmental expenses.

 

Loss from discontinued operations of $25.3 million for the first ninemonths of fiscal 2005 is comprised a charge for the Nilssen arbitration awardof $22.0 million, related legal fees in the Nilssen arbitration of $1.5million, losses in our telecom power business of $1.0 million, as well as legalfees related to asbestos claims and product liability claims.

 

Net Loss

 

Our net loss for the first nine months of fiscal 2006 was $7.2 millioncompared to a net loss of $24.3 million (as restated) for the first nine monthsof fiscal 2005. Despite our pre-tax loss for the first nine months of fiscal2006, we recorded a provision for income taxes of $2.6 million, comprised of aprovision of $1.4 million due to net income generated by our foreignsubsidiaries and a $1.2 million non-cash tax provision related to tax basis goodwillamortization. Our provision for income taxes for the first nine months offiscal 2005 was $1.7 million (as restated), which includes $0.5 million due tonet income generated by our foreign subsidiaries and a $1.2 million non-cashtax provision related to tax basis goodwill amortization.

 

Liquidity andCapital Resources

 

Our cash balances increased $17.1 million in the first nine months offiscal 2006, from $6.9 million at July 3, 2005 to $24.0 million at April 2,2006, which includes restricted cash of $22.6 million. In November 2005 wedeposited $22.6 million into an escrow account to ensure that we are able tosatisfy the Nilssen arbitration award in the event that our appeal of the awardis not successful (see Note 5 of Notes to Condensed Consolidated FinancialStatements). The deposit was funded by borrowings under our $18.0 million termloan and by $4.6 million from our revolving credit facility. As a result, ouroutstanding debt balance has increased $23.3 million during the first ninemonths of fiscal 2006, from $25.2 million at July 3, 2005 to $48.5 million at April2, 2006. Our primary uses of cash in the first nine months of fiscal 2006 werefor vendor payments, capital expenditures of $4.1 million, and loan originationand legal fees related to our new financing agreements of $1.7 million. We haveno current requirements or plans for additional major capacity expansion and wecurrently anticipate capital expenditures in fiscal 2006 will be less than $8.0million. The expected amount of capital expenditures could change dependingupon changes in revenue levels, our financial condition and the generaleconomy.

 

On September 30, 2005, we entered into an agreement with Ableco, Inc.providing for an $18.0 million term loan and an agreement with Wells FargoFoothill, Inc. providing for a $13.0 million revolving credit facility. Borrowingsunder the term loan bear interest at the lender’s reference rate plus 5%, or,at our option, the London Interbank Offering Rate (LIBOR) plus 7.5%. Such ratesmay be increased by up to one percentage point depending upon the level of U.S.funded debt to EBITDA as defined in the agreement. The term loan requiresquarterly principal payments of $1.0 million beginning in September 2006. Borrowingsunder the revolving loan bear interest at the bank’s prime lending rate plus2.5% or, at our option, LIBOR plus 4%. Borrowings under the revolving creditfacility are determined by a borrowing base formula as defined in theagreement, based on the level of eligible domestic accounts receivable andinventory. The revolving credit facility also supports the issuance of lettersof credit. Borrowings under the term loan and revolving credit facility aresecured by substantially all of our domestic assets. We used the funds from therevolving credit facility to fully repay all outstanding obligations under ourprevious financing agreement with Chase Bank, which expired on September 30,2005. Entering the third quarter of fiscal 2006, we were in violation of acovenant that required us to divest our telecom power business before the endof the second quarter of fiscal 2006. This violation was initially waived byour lenders and on April 20, 2006, we entered into an amendment with ourlenders which extends the divestiture period to September 30, 2006. Theamendment also adjusts the levels of certain financial covenants for theperiods ending March 31, 2006 and June 30, 2006. As of April 2, 2006, the $18.0million term loan was outstanding, and approximately $9.3 million wasoutstanding under our revolving credit facility. The total of these twoamounts, $27.3 million, is included in current portion of long-term debt in theaccompanying condensed consolidated balance sheet as of April 2, 2006 (see Note13 of Notes to Condensed Consolidated Financial Statements).

 

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Our European subsidiary maintains revolving borrowing arrangements withlocal banks, primarily to support working capital needs. Available borrowingsunder these arrangements aggregate approximately Euro 20.0 million depending inpart upon levels of accounts receivable, and bear interest at various ratesranging from 3% to 8%. In addition, our European subsidiary has an agreementwith a European bank to provide borrowings secured by the subsidiary’s land andbuilding. Borrowings under this agreement bear interest at EURIBOR plus 1.5%. Theinitial commitment to lend under this agreement was Euro 7.0 million, and thecommitment has been and will continue to be reduced ratably on a quarterlybasis beginning March 31, 2004 and ending September 30, 2013. Our Europeansubsidiary also has certain capital leases outstanding related mainly toequipment purchases. As of April 2, 2006, total amounts outstanding under allof our European borrowing arrangements were $21.2 million, of which $2.1million is included in current portion of long-term debt and $19.1 million isincluded in long term debt in the accompanying condensed consolidated balancesheet as of April 2, 2006.

 

During the three-month period ended April 2, 2006, we begannegotiations with the labor union in Italy to further reduce the workforce atour Valdarno, Italy facility by up to 75 additional positions. A finalagreement with the union has not yet been reached, and as a result, the totalcost of the workforce reduction, as well as the timing of the reduction andrelated expense and future cash outflows, is not known at this time. While wecurrently estimate the total cost of the reduction at Euro 2 million(approximately $2.5 million), the accompanying condensed consolidatedstatements of operations do not include any costs related to this action.

 

As a result of the decline in interest rates and stock market equityvalues over the past several years, the accumulated benefit obligation of ourdefined benefit pension plan exceeds plan assets as of April 2, 2006. We have notmade any contributions to the plan during fiscal 2006, as none have been mandated.Based upon current contribution credits available under pension fundingregulations, actuarial projections indicate no mandatory contributions to theplan would be required through fiscal year 2007. Depending upon changes inasset values and interest rates, as well as any discretionary contributionsmade by us in the interim period, required contributions in periods subsequentto fiscal 2007 could be significant.

 

We are subject to certain potential environmental and legal liabilitiesassociated primarily with the past divestiture of discontinued operations (seeNote 5 of Notes to Condensed Consolidated Financial Statements). In the fourthquarter of fiscal 2005, a decision was rendered in a patent infringement actionbrought against us by Mr. Ole K. Nilssen. In settlement of pending litigation,we agreed to submit the matter to binding arbitration, and in May 2005, thearbitrator awarded damages to Nilssen of $23.4 million, to be paid within 10days of the award. Nilssen’s counsel filed a motion to enter the award in U.S.District Court for the Northern District of Illinois, and we filed acounter-motion to vacate the award on grounds that it was fraudulently obtained. Our request for oral argument was granted and the hearing was held on October19, 2005. The judge is expected to render his decision by mail after furtherconsideration. An unfavorable decision by the Court could result in payment ofthe award by the Company to Nilssen in the amount of $22.6 million (thearbitration award of $23.4 million net of previously paid amounts of $0.8million), which would have a material adverse effect on the Company’s cashflows during fiscal 2006. Based on funds held in escrow, we have adequateresources to support payment of the award if payment is required. However, borrowingsassociated with the payment of the award would result in higher interestexpense in fiscal 2006 as compared to fiscal 2005.

 

We do not have any off-balance sheet arrangements or variable interestentities as of April 2, 2006. 

 

Based upon current plans and business conditions, we believe thatglobal borrowing capacity under our various credit facilities and internallygenerated cash flows will be sufficient to fund anticipated operational needs,capital expenditures and other near-term commitments for the next 12 months. However,our future cash flows will be impacted by higher interest expense, andscheduled debt repayments and pension contributions in fiscal years 2007 and2008. As a result, we are currently reviewing various cash raising alternativesthat would enable us to address these pending obligations as well as providingfunds for future growth initiatives. These alternatives may include, but wouldnot necessarily be limited to, asset sales, including the divestiture ofproduct lines or businesses, and capital market transactions that may beavailable to us. We have engaged the investment banking firm of Stephens Inc.to assist in the evaluation of these alternatives.

 

Caution RegardingForward-Looking Statements and Risk Factors

 

This document, including documents incorporated herein by reference,contains “forward-looking statements” (including financial projections) that webelieve are subject to the safe harbor provisions of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  The words “believe”, “expect”, “estimate”,“anticipate”, “intend”, “may”, “might”, “will”, “would”, “could”, “project”,and “predict”, or similar words and phrases generally identify forward-lookingstatements.  Forward-looking statements are inherently subject to risksand uncertainties which in many cases are beyond our control and which cannotbe predicted or quantified.  As a result, future events and actual resultscould differ materially from those set forth in, contemplated by, or underlying

 

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forward-looking statements.  Forward-looking statements containedin this document speak only as of the date of this document or, in the case ofany document incorporated by reference from another document, the date of thatdocument.  We do not have any obligation to publicly update or revise anyforward-looking statement contained or incorporated by reference in thesedocuments to reflect changed assumptions, the occurrence of unanticipatedevents or changes to future operating results over time. We do not endorse anyprojections regarding future performance that may be made by third parties.

 

Our future results of operations and the other forward-lookingstatements contained in this filing, including this section titled“Management’s Discussion and Analysis of Financial Condition and Results ofOperations”, involve a number of risks and uncertainties.  In particular,the statements regarding future economic conditions, including those in theelectronic power industry, our goals and strategies, new product introductions,penetration of new markets, projections of sales revenues, manufacturing costsand operating costs, pricing of our products and raw materials required tomanufacture our products, gross margin expectations, relocation and outsourcingof production capacity, capital spending, research and development expenses, theoutcome of pending legal proceedings and environmental matters, tax rates,sufficiency of funds to meet our needs including contributions to our definedbenefit pension plan, and our plans for future operations, as well as ourassumptions relating to the foregoing, are all subject to risks anduncertainties.

 

A number of factors could cause our actual results to differ materiallyfrom our expectations.  We are subject to all of the business risks facingpublic companies, including business cycles and trends in the general economy,financial market conditions, changes in interest rates, demand variations andvolatility, potential loss of key personnel, supply chain disruptions,government legislation and regulation, and natural causes.  Additional risksand uncertainties include but are not limited to industry conditions,competitive factors such as technology and pricing pressures, businessconditions in the telecommunications and electronic equipment markets,international sales and operations, dependence on significant customers,increased material costs, risks and costs associated with acquisitions anddivestitures, environmental matters and the risk that our ultimate costs ofdoing business exceed present estimates.  This list of risk factors is notall-inclusive, as other factors and unanticipated events could adversely affectour financial position or results of operations.  Further information onfactors that could affect our financial results can be found in ourForm 10-K filing with the Securities and Exchange Commission for the yearended July 3, 2005, under the heading “Risk Factors Affecting theCompany’s Financial Outlook”. A copy of our Form 10-K and other reports filedby us with the SEC under the Securities Exchange Act of 1934 are available onour website, www.magnetek.com, or through the SEC’s website, www.sec.gov.

 

**Item 3 –Quantitative and Qualitative Disclosures About Market Risk**

** **

We are exposed to market risks in the areas of foreign exchange andinterest rates.  To mitigate the effect of such risks, from time to timewe selectively use specific financial instruments. Hedging transactions can beentered into under Company policies and procedures and are monitored monthly.Company policy prohibits the use of such financial instruments for trading orspeculative purposes. There have been no material changes in the reportedmarket risks since that reported in our Annual Report on Form 10-K for thefiscal year ended July 3, 2005.  A discussion of our accountingpolicies for derivative financial instruments is included in the Summary ofSignificant Accounting Policies under Note 2 in the Notes to CondensedConsolidated Financial Statements.  We did not have any outstanding hedgeinstruments or contracts at April 2, 2006 or July 3, 2005.

 

***Interest Rates***

*** ***

The fair value of our debt was $48.5 million at April 2, 2006, equal tothe carrying value at that date.  The fair value of our debt is equal tothe borrowings outstanding from domestic and foreign banks and small amountsowed under capital lease arrangements.  For our debt outstanding at April2, 2006, a hypothetical 10% adverse change in interest rates would increase ourannual interest expense by an estimated $0.4 million.  Prospectively weexpect our interest expense to increase compared to fiscal 2005 interestexpense, based on higher interest rates and potentially continued higheroutstanding debt levels under our term loan and revolving credit facility (seeLiquidity and Capital Resources) in the event that our appeal in the Nilssenpatent infringement award is not successful and we are required to pay theaward.

 

***Foreign Currency Exchange Rates***

*** ***

We generally do not enter into foreign exchange contracts to protectagainst reductions in value and volatility of future cash flows caused bychanges in exchange rates, but we may selectively enter into foreign exchangecontracts to hedge certain exposures in Europe.  Gains and losses on thesenon-U.S.-currency investments would generally be offset by corresponding lossesand gains on the related hedging instruments, resulting in negligible netexposure.

 

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A portion of our products are manufactured in Europe and sold in theU.S.  Many of these sales to U.S. customers are denominated in U.S.dollars.  As a result, our financial results could be significantlyimpacted by changes in exchange rates, particularly the exchange rate betweenthe U.S. dollar and the Euro.  Our exposure on sales by our Europeansubsidiaries consists of (1) the exposure related to a weakening U.S.dollar for U.S. dollar denominated sales, as most of our European subsidiaries’costs are in Euro; in the event of a weakening U.S. dollar, locally recordedsales in the functional currency (the Euro) are decreased, (2) theexposure related to a weakening U.S. dollar when payment of U.S. dollarreceivables are received from customers, resulting in less local currency thanwas originally recorded at the date of sale, and (3) the exposure thatupon translation of the subsidiaries’ periodic financial statements, aweakening local currency would result in lower reported sales in U.S. dollarsthan if the local currency had been stable relative to the U.S. dollar. In the latter case, operating expenses would also be translated at the lower amountand accordingly, the effect on net income would be mitigated.

 

We had no foreign currency contracts outstanding at April 2, 2006 orJuly 3, 2005.

** **

**Item 4 –Controls and Procedures**

 

 In connection with this Form 10-Q, under the direction ofour Chief Executive Officer and Chief Financial Officer, we evaluated ourdisclosure controls and procedures as defined in Exchange ActRules 13a-15(e) and 15d-15(e), and internal control over financialreporting and concluded that (i) our disclosure controls and procedureswere effective as of April 2, 2006, and (ii) no change in internalcontrol over financial reporting occurred during the quarter ended April 2,2006, that has materially affected, or is reasonably likely to materiallyaffect, such internal control over financial reporting.

 

**PART II– OTHER INFORMATION**

 

**Item 1 –Legal Proceedings**

 

In April 1998, Mr. Ole K. Nilssen (“Nilssen”) filed a lawsuit inthe U.S. District Court for the Northern District of Illinois alleginginfringement by the Company of seven of his patents pertaining to electronicballast technology, and seeking unspecified damages and injunctive relief topreclude the Company from making, using or selling products allegedlyinfringing his patents. In April 2003, Nilssen’s lawsuit against the Companyand the Company’s counterclaims against Nilssen were dismissed with prejudiceand both parties agreed to submit limited issues in dispute to bindingarbitration before an arbitrator with a relevant technical background. Thearbitration occurred in November, 2004 and a decision awarding Nilssen $23.4million was issued on May 3, 2005. Nilssen’s motion to enter the award asa judgment in U.S. District Court for the Northern District of Illinois andMagnetek’s counter-motion to vacate the award on grounds that it wasfraudulently obtained are pending in the U.S. District Court for the NorthernDistrict of Illinois.  Magnetek’s request for oral argument was grantedand the hearing was held on October 19, 2005.  The judge is expectedto render his decision by mail after further consideration.  Anunfavorable decision by the Court could result in payment of the award by theCompany to Nilssen in the amount of $22.6 million (the arbitration award of$23.4 million net of previously paid amounts of $0.8 million), which would havea material adverse effect on the Company’s cash flows during the period suchpayment would be made. In November 2005, the Company deposited $22.6 millioninto an escrow account to ensure that it is able to satisfy the Nilssenarbitration award in the event that its appeal of the award is not successful.

 

In June 2001, the Company sold its lighting business to UniversalLighting Technologies, Inc. (“ULT”), and agreed to provide a limitedindemnification against certain claims of infringement that Nilssen mightallege against ULT. In February 2003, Nilssen filed a lawsuit in the U.S.District Court for the Northern District of Illinois alleging infringement byULT of 29 of his patents pertaining to electronic ballast technology, and seekingunspecified damages and injunctive relief to preclude ULT from making, using orselling products allegedly infringing his patents. ULT made a claim forindemnification, which the Company accepted, subject to the limitations setforth in the sale agreement.  A response was filed denying that theproducts infringe any valid patent and asserting affirmative defenses, as wellas a counterclaim for a judicial declaration that the patents are unenforceableand invalid. The case was removed to the District Court for the CentralDistrict of Tennessee and Nilssen voluntarily dismissed claims related to allbut four of the patents. The Patent and Trademark Office (“PTO”) has acceptedULT’s request for reexamination of the four remaining patents.  A motionfor summary judgment that various claims of the patents at issue are invalidand that the accused ULT products do not infringe a claim of one of the patentswas filed on November 1, 2005 but no hearing had been set as of January 5,2006 when the Court granted ULT’s motion to stay proceedings in the lawsuitpending the PTO reexamination. The Company will continue to aggressively defendthe claims against ULT however, a decision in the lawsuit that is ultimatelyunfavorable to ULT could have a material adverse effect on the Company’sfinancial position, cash flows and results of operations as a result of itsindemnification obligations.

 

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**Item 1A – Risk Factors**

 

There have been no material changes from risk factorsas previously disclosed in our Form 10-K for the year ended July 3, 2005filed with the Securities and Exchange Commission.

 

**Item 2 – Unregistered Sales of Equity Securities and Use ofProceeds**

 

There were no unregistered sales of equity securitiesand there were no repurchases of equity securities during the Company’s thirdfiscal quarter ended April 2, 2006.

 

**Item 3 –Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**Item 5 – Other Information**

 

None.

 

**Item 6 – Exhibits**

 

(a)           Indexto Exhibits

 
| 31.1   |   | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act of 1934. *                                                                                                                           |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                          |
| 31.2   |   | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act of 1934. *                                                                                                                           |
|   |   |                                                                                                                                                                                                                                          |
| 32.1   |   | Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. ***                                                                                                                 |
|   |   |                                                                                                                                                                                                                                          |
| 10.1   |   | Second  Amendment to Credit Agreement and Waiver dated as of April 20, 2006, among the  Company, certain subsidiaries of the Company party thereto, the lenders party  thereto and Wells Fargo Foothill, Inc., as administrative agent.**     |
|   |   |                                                                                                                                                                                                                                          |
| 10.2   |   | Amendment  No. 2 to Financing Agreement dated as of April 24, 2006, among the Company,  certain subsidiaries of the Company party thereto, the lenders party thereto  and Ableco Finance LLC, as collateral agent and administrative agent.** |

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| *      |   | Filed with this  Report on Form 10-Q.                                                                                                                                 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                  |
| **     |   | Incorporated by  reference to the Registrant’s Report on Form 8-K filed April 26, 2006, file  number 1-10233.                                                    |
|   |   |                                                                                                                                                                  |
| ***    |   | Furnished  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be  deemed filed by the Registrant as part of this Quarterly Report on Form 10-Q. |

 

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                |                            | MAGNETEK, INC. |
|---------------------|---------------------------------|----------------|
|                |                            | (Registrant)   |
|                |                            |
| Date: May 12,  2006 | /s/ David P. Reiland            |
|                | David P. Reiland                |
|                | Executive Vice President        |
|                | and Chief Financial Officer     |
|                | (Duly authorized officer of the |
|                | registrant and principal        |
|                | financial officer)              |

 

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