**UNITED STATES 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:  January 1, 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 of Registrant as specified in itscharter)

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

 

**8966 MasonAve.**

**Chatsworth, California 91311**

(Address of principal executive offices)

 

**(818) 727-2216**

(Registrant’s telephone number, including areacode)

 

 

(Former name, former address and formerfiscal year,

if changed since last report)

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes  ý  No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer  o          Acceleratedfiler  ý          Non-acceleratedfiler  o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

Yes o  No ý

 

Thenumber of shares outstanding of Registrant’s Common Stock, as of January 31,2006, was 29,090,834 shares.

 

 

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2006 MAGNETEK, INC. FORM 10-Q

 

TABLE OF CONTENTS FOR THE QUARTERLY REPORT ONFORM 10-Q

FOR THE FISCAL QUARTER ENDED JANUARY 1,2006

 

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

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**PART I– FINANCIAL INFORMATION**

 

**Item 1 – Financial Statements**

 

MAGNETEK, INC.

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

FOR THE THREE MONTHS ENDED

January 1, 2006 and January 2, 2005

(amounts in thousands, except per share data)

(unaudited)

 
| ** **                                                           | ** ** | **Three Months Ended**                | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                           | ** ** | **(13 weeks)  January 1,  2006** | ** ** | **(13 weeks)  January 2,  2005** | ** ** |
| ** **                                                           | ** ** | ** **                            | ** ** | **(restated)** | ** ** |
|                                                                 |       |                                  |       |   |   |
| Net sales                                                            |       | $                                     | 59,333     |   | $ | 61,999 |   |
| Cost of sales                                                        |       | 44,026                                |       | 46,397 |   |
|                                                                 |       |                                  |       |   |   |
| Gross profit                                                         |       | 15,307                                |       | 15,602 |   |
| Research and development                                             |       | 3,947                                 |       | 3,694 |   |
| Selling, general and administrative                                  |       | 10,281                                |       | 10,557 |   |
|                                                                 |       |                                  |       |   |   |
| Income from operations                                               |       | 1,079                                 |       | 1,351 |   |
| Interest expense                                                     |       | 856                                   |       | 274 |   |
| Other (income) expense                                               |       | 149                                   |       | (1,240 | ) |
|                                                                 |       |                                  |       |   |   |
| Income from continuing operations before  provision for income taxes |       | 74                                    |       | 2,317 |   |
| Provision for income taxes                                           |       | 750                                   |       | 540 |   |
| Net income (loss) from continuing  operations                        |       | (676                                  | )          | 1,777 |   |
|                                                                 |       |                                  |       |   |   |
| Loss from discontinued operations                                    |       | (1,049                                | )          | (1,615 | ) |
|                                                                 |       |                                  |       |   |   |
| Net income (loss)                                                    |       | $                                     | (1,725     | ) | $ | 162 |   |
|                                                                 |       |                                  |       |   |   |
| Earnings (loss) per common share                                     |       |                                  |       |   |   |
|                                                                 |       |                                  |       |   |   |
| Basic and diluted:                                                   |       |                                  |       |   |   |
| Net income (loss) from continuing  operations                        |       | $                                     | (0.02      | ) | $ | 0.06 |   |
| Loss from discontinued operations                                    |       | (0.04                                 | )          | (0.05 | ) |
| Net income (loss)                                                    |       | $                                     | (0.06      | ) | $ | 0.01 |   |
|                                                                 |       |                                  |       |   |   |
| Weighted shares outstanding:                                         |       |                                  |       |   |   |
| Basic                                                                |       | 28,890                                |       | 28,520 |   |
| Diluted                                                              |       | 28,890                                |       | 29,278 |   |

 

See accompanying notes

 

3

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MAGNETEK, INC.

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

FOR THE SIX MONTHS ENDED

January 1, 2006 and January 2, 2005

 (amounts in thousands, except per share data)

(unaudited)

 
| ** **                                                           | ** ** | **Six Months Ended**                  | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                           | ** ** | **(26 Weeks)  January 1,  2006** | ** ** | **(27 Weeks)  January 2,  2005** | ** ** |
| ** **                                                           | ** ** | ** **                            | ** ** | **(restated)** | ** ** |
|                                                                 |       |                                  |       |   |   |
| Net sales                                                            |       | $                                     | 115,844    |   | $ | 128,207 |   |
| Cost of sales                                                        |       | 86,049                                |       | 96,484 |   |
|                                                                 |       |                                  |       |   |   |
| Gross profit                                                         |       | 29,795                                |       | 31,723 |   |
| Research and development                                             |       | 7,476                                 |       | 7,189 |   |
| Selling, general and administrative                                  |       | 20,218                                |       | 21,083 |   |
|                                                                 |       |                                  |       |   |   |
| Income from operations                                               |       | 2,101                                 |       | 3,451 |   |
| Interest expense                                                     |       | 1,202                                 |       | 581 |   |
| Other (income) expense                                               |       | 525                                   |       | (1,183 | ) |
|                                                                 |       |                                  |       |   |   |
| Income from continuing operations before provision  for income taxes |       | 374                                   |       | 4,053 |   |
| Provision for income taxes                                           |       | 1,700                                 |       | 1,175 |   |
| Net income (loss) from continuing  operations                        |       | (1,326                                | )          | 2,878 |   |
|                                                                 |       |                                  |       |   |   |
| Loss from discontinued operations                                    |       | (1,453                                | )          | (2,176 | ) |
|                                                                 |       |                                  |       |   |   |
| Net income (loss)                                                    |       | $                                     | (2,779     | ) | $ | 702 |   |
|                                                                 |       |                                  |       |   |   |
| Earnings (loss) per common share                                     |       |                                  |       |   |   |
|                                                                 |       |                                  |       |   |   |
| Basic and diluted:                                                   |       |                                  |       |   |   |
| Net income (loss) from continuing  operations                        |       | $                                     | (0.05      | ) | $ | 0.10 |   |
| Loss from discontinued operations                                    |       | (0.05                                 | )          | (0.08 | ) |
| Net income (loss)                                                    |       | $                                     | (0.10      | ) | $ | 0.02 |   |
|                                                                 |       |                                  |       |   |   |
| Weighted shares outstanding:                                         |       |                                  |       |   |   |
| Basic                                                                |       | 28,888                                |       | 28,511 |   |
| Diluted                                                              |       | 28,888                                |       | 29,272 |   |

 

See accompanying notes

 

4

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MAGNETEK, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

January 1, 2006 and July 3, 2005

(amounts in thousands)

 
| ** **                                      | ** ** | **January 1,  2006** | ** ** | **July 3,  2005** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **(unaudited)**           | ** ** | ** **             | ** ** |
| ASSETS                                          |       |                      |       |                   |       |
|                                            |       |                      |       |                   |       |
| Current assets:                                 |       |                      |       |                   |       |
| Cash                                            |       | $                         | 3,607      |                   | $          | 6,854 |   |
| Restricted cash – escrow account           |       | 22,602                    |       | —                 |       |
| Accounts receivable, net                        |       | 53,474                    |       | 54,022                 |       |
| Inventories, net                                |       | 51,523                    |       | 49,950                 |       |
| Prepaid expenses and other                      |       | 5,194                     |       | 5,713                  |       |
| Assets held for sale                            |       | 6,265                     |       | 4,727                  |       |
| Total current assets                            |       | 142,665                   |       | 121,266                |       |
|                                            |       |                      |       |                   |       |
| Property, plant and equipment                   |       | 131,715                   |       | 129,473                |       |
| Less accumulated depreciation                   |       | 100,690                   |       | 97,534                 |       |
| Net property, plant and equipment               |       | 31,025                    |       | 31,939                 |       |
|                                            |       |                      |       |                   |       |
| Goodwill                                        |       | 63,592                    |       | 63,656                 |       |
| Other assets                                    |       | 11,229                    |       | 12,319                 |       |
| Total assets                                    |       | $                         | 248,511    |                   | $          | 229,180 |   |
|                                            |       |                      |       |                   |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY       |       |                      |       |                   |       |
|                                            |       |                      |       |                   |       |
| Current liabilities:                            |       |                      |       |                   |       |
| Accounts payable                                |       | $                         | 34,697     |                   | $          | 36,974 |   |
| Accrued liabilities                             |       | 7,657                     |       | 8,523                  |       |
| Accrued arbitration award                       |       | 22,602                    |       | 22,602                 |       |
| Liabilities held for sale                       |       | 1,963                     |       | 1,220                  |       |
| Current portion of long-term debt               |       | 28,198                    |       | 5,702                  |       |
| Total current liabilities                       |       | 95,117                    |       | 75,021                 |       |
|                                            |       |                      |       |                   |       |
| Long-term debt, net of current portion          |       | 18,024                    |       | 19,528                 |       |
|                                            |       |                      |       |                   |       |
| Pension benefit obligations, net                |       | 72,468                    |       | 70,568                 |       |
|                                            |       |                      |       |                   |       |
| Other long-term obligations                     |       | 7,959                     |       | 7,627                  |       |
|                                            |       |                      |       |                   |       |
| Deferred income taxes                           |       | 11,134                    |       | 10,376                 |       |
|                                            |       |                      |       |                   |       |
| Commitments and contingencies                   |       |                      |       |                   |       |
|                                            |       |                      |       |                   |       |
| Stockholders’ equity:                      |       |                      |       |                   |       |
| Common stock                                    |       | 287                       |       | 286                    |       |
| Additional paid in capital                      |       | 129,034                   |       | 128,664                |       |
| Retained earnings                               |       | 37,239                    |       | 40,018                 |       |
| Accumulated other comprehensive loss            |       | (122,751                  | )          | (122,908               | )          |
| Total stockholders’ equity                 |       | 43,809                    |       | 46,060                 |       |
|                                            |       |                      |       |                   |       |
| Total liabilities and stockholders’ equity |       | $                         | 248,511    |                   | $          | 229,180 |   |

 

See accompanying notes

 

5

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MAGNETEK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOW

FOR THE SIX MONTHS ENDED

January 1, 2006 and January 2, 2005

(amounts in thousands)

(unaudited)

 
| ** **                                                                                                                       | ** ** | **Six Months Ended**                  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                       | ** ** | **(26 Weeks)  January 1,  2006** | ** ** | **(27 Weeks)  January 2,  2005** | ** ** |
| ** **                                                                                                                       | ** ** | ** **                            | ** ** | **(restated)** | ** ** |
| Cash flows from continuing operating  activities:                                                                                |       |                                  |       |   |   |
| Net income (loss) from continuing  operations                                                                                    |       | $                                     | (1,326     | ) | $ | 2,878 |   |
| Adjustments to reconcile net income (loss)  from continuing  operations to net cash provided by continuing operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                                                                    |       | 4,445                                 |       | 4,834 |   |
| Tax refund proceeds, net                                                                                                         |       | —                                |       | 3,332 |   |
| Stock based compensation expense                                                                                                 |       | 222                                   |       | — |   |
| Changes in operating assets and liabilities                                                                                      |       | 1,771                                 |       | (8,133 | ) |
| Total adjustments                                                                                                                |       | 6,438                                 |       | 33 |   |
| Net cash provided by continuing operating  activities                                                                            |       | 5,112                                 |       | 2,911 |   |
|                                                                                                                             |       |                                  |       |   |   |
| Cash flows from discontinued operations:                                                                                         |       |                                  |       |   |   |
| Loss from discontinued operations                                                                                                |       | (1,453                                | )          | (2,176 | ) |
| Adjustments to reconcile loss from  discontinued operations to net cash used  in discontinued operations:                        |       |                                  |       |   |   |
| Depreciation and amortization                                                                                                    |       | —                                |       | 63 |   |
| Changes in operating assets and liabilities                                                                                      |       | (795                                  | )          | (398 | ) |
| Capital expenditures                                                                                                             |       | —                                |       | (16 | ) |
| Net cash used in discontinued operations                                                                                         |       | (2,248                                | )          | (2,527 | ) |
|                                                                                                                             |       |                                  |       |   |   |
| Net cash provided by operating activities                                                                                        |       | 2,864                                 |       | 384 |   |
|                                                                                                                             |       |                                  |       |   |   |
| Cash flows from investing activities:                                                                                            |       |                                  |       |   |   |
| Deposit into escrow account                                                                                                      |       | (22,602                               | )          | — |   |
| Capital expenditures                                                                                                             |       | (3,182                                | )          | (3,922 | ) |
| Net cash used in investing activities                                                                                            |       | (25,784                               | )          | (3,922 | ) |
|                                                                                                                             |       |                                  |       |   |   |
| Cash flows from financing activities:                                                                                            |       |                                  |       |   |   |
| Proceeds from issuance of common stock                                                                                           |       | 149                                   |       | 236 |   |
| Borrowings under line-of-credit agreements                                                                                       |       | 687                                   |       | 6,391 |   |
| Principal repayments under capital lease  obligations                                                                            |       | (148                                  | )          | (40 | ) |
| Borrowings under long term notes                                                                                                 |       | 20,819                                |       | — |   |
| Repayments of long term notes                                                                                                    |       | (366                                  | )          | (1,272 | ) |
| Increase in deferred financing costs                                                                                             |       | (1,468                                | )          | (41 | ) |
| Net cash provided by financing activities                                                                                        |       | 19,673                                |       | 5,274 |   |
|                                                                                                                             |       |                                  |       |   |   |
| Net increase (decrease) in cash                                                                                                  |       | (3,247                                | )          | 1,736 |   |
| Cash at the beginning of the period                                                                                              |       | 6,854                                 |       | 2,318 |   |
|                                                                                                                             |       |                                  |       |   |   |
| Cash at the end of the period                                                                                                    |       | $                                     | 3,607      |   | $ | 4,054 |   |

 

See accompanying notes

 

6

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MAGNETEK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS

JANUARY 1, 2006

(Amounts in thousands unless otherwise noted,except per share data)

(unaudited)

 

1.             Basisof Presentation

 

The accompanyingunaudited condensed consolidated financial statements include the accounts ofMagnetek, Inc. and its subsidiaries (the “Company”).  All significant intercompany accounts andtransactions have been eliminated.

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  For further information,refer to the financial statements and footnotes thereto included in the Company’sForm 10-K for the year ended July 3, 2005 filed with the Securitiesand Exchange Commission.  In the Company’sopinion, these unaudited statements contain all adjustments, consisting ofnormal recurring adjustments, necessary to present fairly the financialposition of the Company as of January 1, 2006, and the results of itsoperations and its cash flows for the three-month and six-month periods ended January 1,2006 and January 2, 2005.  Resultsfor the six-months ended January 1, 2006 are not necessarily indicative ofresults that may be experienced 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 fourteen week periods ending on theSunday nearest September 30, December 31, March 31 and June 30.  The three-month periods ended January 1,2006 and January 2, 2005 each contained 13 weeks; the six-month periodsended January 1, 2006 and January 2, 2005 contained 26 and 27 weeks,respectively.

 

2.             Summary ofSignificant Accounting Policies

 

Restatement - Theaccompanying condensed consolidated financial statements have been restated forthe three- and six-month periods ended January 2, 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 six-month periods ended January 2, 2005 was an increase in theCompany’s valuation allowance for deferred tax assets and related provision forincome taxes of $0.4 million and $0.8 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.

 

The table below reflects the impact of the restatement on the Company’sresults of operations for the three- and six- month periods ended January 2,2005:

 

7

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Condensed Consolidated Statements of Operations

 
| ** **                                                                                       | ** ** | **Three Months Ended**       | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------|------------|----------------------|------------|
| **For the periods ended  January 2, 2005  (Amounts in thousands except per share amounts)** | ** ** | **As  previously  reported** | ** ** | **As  restated**     | ** ** | **As  previously  reported** | ** ** | **As  restated** | ** ** |
| ** **                                                                                       | ** ** | ** **                   | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Provision  for income taxes                                                                      |       | $                            | 140        |                 | $          | 540 |   | $ | 375 |   | $ | 1,175 |   |
|                                                                                             |       |                         |       |                 |       |   |   |   |   |
| Net income                                                                                       |       | $                            | 562        |                 | $          | 162 |   | $ | 1,502 |   | $ | 702 |   |
|                                                                                             |       |                         |       |                 |       |   |   |   |   |
| Net income  per common share, basic and diluted                                                  |       | $                            | 0.02       |                 | $          | 0.01 |   | $ | 0.05 |   | $ | 0.02 |   |

 

Use of Estimates -The preparation of financial statements in accordance with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from thoseestimates.   Significant areas requiringmanagement estimates include the following key financial areas:

 

*Accounts Receivable*

 

Accounts receivable represent receivables from customers in theordinary course of business.  The Companyis subject to losses from uncollectible receivables in excess of itsallowances.  The Company maintainsallowances for doubtful accounts for estimated losses from customers’ inabilityto make required payments.  In order toestimate the appropriate level of this allowance, the Company analyzeshistorical bad debts, customer concentrations, current customercreditworthiness, current economic trends and changes in customer paymentpatterns.  If the financial conditions ofthe Company’s customers were to deteriorate and to impair their ability to makepayments, additional allowances may be required in future periods.  The Company’s management believes that allappropriate allowances have been provided.

 

*Inventories*

 

TheCompany’s inventories are stated at the lower of cost or market.  Cost is determined by the first-in, first-out(“FIFO”) method, including material, labor and factory overhead.  Inventory on hand may exceed future demandeither because the product is obsolete, or the amount on hand is more than canbe used to meet future needs.  TheCompany identifies potentially obsolete and excess inventory by evaluatingoverall inventory levels.  In assessing theultimate realization of inventories, the Company is required to make judgmentsas to future demand requirements and compare those with the current orcommitted inventory levels.  If futuredemand requirements are less favorable than those projected 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 accounting for such events is prescribedunder Statement of Financial Accounting Standard (“SFAS”) No. 5, *Accounting for Contingencies*.  SFAS No. 5 defines a contingency as anexisting condition, situation, or set of circumstances involving uncertainty asto possible gain or loss to an enterprise that will ultimately be resolved whenone or more future events occur or fail to occur.

 

SFASNo. 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 itis probable that the loss has been incurred, given the likelihood of uncertainevents; and (2) that the amount of the loss can be reasonably estimated.

 

The accrual of a contingency involves considerable judgment on the partof management.  The Company uses itsinternal expertise, and outside experts, as necessary, to help estimate theprobability that a loss has been incurred and the amount (or range) of theloss.

 

*Income Taxes*

 

The Company uses the liability method to account for income taxes.  The preparation of consolidated financialstatements involves estimating the Company’s current tax exposure together withassessing temporary differences resulting from differing treatment of items fortax and accounting purposes.  Thesedifferences result in deferred tax assets and liabilities, which are includedin the consolidated balance sheets.  Anassessment of the recoverability of the deferred tax assets is made, and avaluation allowance is established based upon this assessment.

 

8

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The Companydoes not record deferred taxes on domestic pre-tax income or losses, due to (1) theavailability of net operating loss (NOL) carryforwards that have been fullyreserved through valuation allowances for pre-tax income, and (2) uncertaintysurrounding the timing of realizing NOL carryforwards generated in the currentperiod in future periods.

 

With the exception of approximately $3.0 million of foreign earningsthat the Company repatriated during the six months ended January 1, 2006for various financing needs, the Company presently intends to reinvest anyearnings overseas indefinitely.

 

*Pension Benefits*

 

Thevaluation of the Company’s pension plan requires the use of assumptions andestimates to develop actuarial valuations of expenses andassets/liabilities.  These assumptionsinclude discount rates, investment returns and mortality rates.  Changes in assumptions and future investmentsreturns could potentially have a material impact on the Company’s expenses andrelated funding requirements.

 

Revenue Recognition– The Company’s policy is to recognize revenue when the earnings process iscomplete.  The criteria used in making this determination are persuasiveevidence that an arrangement exists, delivery has occurred, the sales price isfixed or determinable, and collectibility is reasonably assured.  Salesare recorded net of returns and allowances, which are estimated usinghistorical 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 arereflected in 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 (revised 2004), *Share-Based Payment*,which is a revision of *SFAS No. 123,Accounting for Stock-Based Compensation*.  SFAS No. 123(R)supersedes APB Opinion No. 25, *Accounting for StockIssued 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, including grants of employeestock options, to be recognized in the income statement based on their fairvalues. 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 net income in theaccompanying condensed consolidated financial statements for the three- andsix-month periods ended January 2, 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 recognizedbeginning with the effective date.  Compensation cost recognized for thethree- and six-month periods ended January 1, 2006 is the same as thatwhich would have been recognized had the fair value method of SFAS No. 123been applied from its original effective date.  In accordance with themodified prospective method of adoption, the Company’s results of operationsfor prior periods have not 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 theseunderwater options was made primarily to avoid recognizing compensation cost inthe consolidated statement of operations upon adoption of SFAS No. 123(R), as described above.  As a result of the acceleration, the Companyreduced the stock option compensation expense it otherwise would be required torecord by approximately

 

9

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$1.9 million in fiscal 2006, $1.4 million in fiscal 2007 and less than$0.1 million in fiscal 2008 on a pre-tax basis, resulting in an additional $3.4million of pro-forma expense in fiscal 2005.  The accelerated vesting wasa modification of outstanding awards as defined by SFAS No. 123, whichresulted in incremental pro-forma compensation expense of $0.3 million infiscal 2005.

 

The Company did not issue any stock options during the six-month periodended January 1, 2006.  In August 2005,the Company granted 500,000 shares of restricted stock with a fair value of$2.77 per share.  The restricted sharesfully vest on January 1, 2009.  Thetotal estimated compensation expense of $1.4 million related to the grant willbe recorded ratably from the grant date through the vesting date.  Compensation expense related to therestricted stock grant included in the condensed consolidated statement ofoperations for the three- and six-month periods ended January 1, 2006 is$103 and $149 respectively.  The remainingportion of stock-based compensation expense recorded in the three- andsix-month periods ended January 1, 2006, $37 and $73 respectively, relatesto non-vested director stock option grants.

 

The following table illustrates the effect on net income (loss) andearnings (loss) per share as if the fair value method had been applied to alloutstanding and unvested awards in each period:

 
| ** **                                                                                                                     | ** ** | **Three Months Ended**    | ** ** | **Six Months Ended**      | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| **(Amounts in thousands, except per share amounts)**                                                                           | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** |
| ** **                                                                                                                     | ** ** | ** **                | ** ** | **(restated)**            | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Net income (loss), as reported                                                                                                 |       | $                         | (1,725     | )                         | $          | 162 |   | $ | (2,779 | ) | $ | 702 |   |
|                                                                                                                           |       |                      |       |                      |       |   |   |   |   |
| Add: Stock-based compensation expense  included in reported net income, net of  related tax effects                            |       | 140                       |       | —                    |       | 222 |   | — |   |
|                                                                                                                           |       |                      |       |                      |       |   |   |   |   |
| Deduct: Total stock-based compensation  expense determined under fair value method for all awards, net of related tax  effects |       | (140                      | )          | (1,160                    | )          | (222 | ) | (2,384 | ) |
|                                                                                                                           |       |                      |       |                      |       |   |   |   |   |
| Pro forma net loss                                                                                                             |       | $                         | (1,725     | )                         | $          | (998 | ) | $ | (2,779 | ) | $ | (1,682 | ) |
|                                                                                                                           |       |                      |       |                      |       |   |   |   |   |
| Earnings (loss) per share as reported:                                                                                         |       |                      |       |                      |       |   |   |   |   |
| Basic and diluted                                                                                                              |       | $                         | (0.06      | )                         | $          | 0.01 |   | $ | (0.10 | ) | $ | 0.02 |   |
|                                                                                                                           |       |                      |       |                      |       |   |   |   |   |
| Pro forma loss per share:                                                                                                      |       |                      |       |                      |       |   |   |   |   |
| Basic and diluted                                                                                                              |       | $                         | (0.06      | )                         | $          | (0.03 | ) | $ | (0.10 | ) | $ | (0.06 | ) |

 

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 | % |

 

Asstated above, no options were issued in the first six months of fiscal 2006.

 

In fiscalyear 2005, a total of 750,000 options were granted with exercise prices equalto the market price of the stock on the grant date.  The weighted average exercise price was $7.48and the average fair value of the options was $5.04.  In addition, the Company issued 240,000shares of restricted stock in fiscal 2005.

 

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Infiscal year 2004, a total of 1,836,000 options were granted with exerciseprices equal to the market price of the stock on the grant date.  The weighted average exercise price was $4.58and the average fair value of the options was $2.83.  The Company did not issue any shares ofrestricted stock in fiscal 2004.

 

Property, Plant and Equipment– Additions and improvement are capitalized at cost, whereas expenditures formaintenance and repair are charged to expense as incurred.  Depreciationis provided over the estimated useful lives of the respective assetsprincipally on the straight-line method (machinery and equipment normally fiveto ten years, buildings and improvements normally ten to forty years).

 

Goodwill – Inaccordance with SFAS No. 142, *Goodwill and OtherIntangible Assets*, the Company reviews the carrying value ofgoodwill at least annually, and more frequently if indicators of potentialimpairment arise, using discounted future cash flow analyses as prescribed inSFAS No. 142.

 

DeferredFinancing Costs – Costs incurred toobtain financing are deferred and included in other assets in the condensedconsolidated balance sheets.  Deferredfinancing costs are amortized over the term of the financing facility.

 

Warranties – TheCompany offers warranties for certain products that it manufactures, withwarranty terms generally ranging from one to two years.  Warranty reservesare established for costs expected to be incurred after the sale and deliveryof products under warranty, based mainly on known product failures andhistorical experience.  Actual repair costs incurred for products underwarranty are charged against the established reserve balance as incurred.

 

Earningsper Share – In accordance withSFAS No. 128, *Earnings per Share*,basic earnings per share are computed using the weighted average number ofcommon shares outstanding during the period. Diluted earnings per share incorporate the incremental shares issuableupon the assumed exercise of stock options as if all exercises had occurred atthe beginning of the fiscal period.

 

Derivative Financial Instruments– The Company periodically uses derivative financial instruments to reducefinancial market risks. These instruments are used to hedge foreign currencyand interest rate market exposures. The Company does not use derivativefinancial instruments for speculative or trading purposes.  The accountingpolicies for these instruments are based on the Company’s designation of suchinstruments as hedging transactions. The criteria the Company uses fordesignating an instrument as a hedge include the instrument’s effectiveness inrisk reduction and the matching of the derivative to the underlyingtransaction. The resulting gains or losses are accounted for as part of thetransactions being hedged, except that losses not expected to be recovered uponthe completion of the hedge transaction are expensed.  The Company had noderivative financial instruments at January 1, 2006 and July 3, 2005.

 

Foreign Currency Translation -The Company’s foreign entities’ accounts are measured using local currency asthe functional currency.  Assets and liabilities are translated at theexchange rate in effect at year-end.  Revenues and expenses are translatedat the rates of exchange prevailing during the year.  Unrealizedtranslation gains and losses arising from differences in exchange rates fromperiod to period are included as a component of accumulated other comprehensiveloss in stockholders’ equity.

 

Reclassifications –Certain prior year balances were reclassified to conform to the current yearpresentation.

 

Recent Accounting Pronouncements– In May 2005, the FASB issued SFAS No. 154,*Accounting Changes and Error Corrections*,which changes the accounting for and the reporting of voluntary changes inaccounting principles.  SFAS No. 154 requires changes in accountingprinciples to be applied retrospectively to prior period financial statements,where practicable, 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 SFAS No. 154is not expected to have a material impact on the Company’s results ofoperations, financial position or cash flows.

 

In November 2004, the FASB issued SFAS No. 151,*Inventory Costs*, which amends theguidance in ARB No. 43, Chapter 4,*Inventory Pricing*. This amendment clarifies the accounting for abnormalamounts of idle facility expense, freight, handling costs and wasted material(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 ended October 2,

 

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2005, and the adoption did not have a material impact on the results ofoperations or the financial position of the Company.

 

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.  Theestimated fair value of the disposal group at January 1, 2006 is $4.3million.

 

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**    | ** **  | **Six Months Ended**      | ** ** |
|----------------------------------------|------------|---------------------------|-------------|---------------------------|------------|
| ** **                             | ** ** | **January 1,  2006** | ** **  | **January 2,  2005** | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** |
| Net Sales                              |       | $                         |  4,262 |                      | $          |  2,027 |   | $ |  7,792 |   | $ |  4,997 |   |
|                                   |       |                      |        |                      |       |   |   |   |   |   |   |   |   |
| Loss from telecom business, net of tax |       | $                         | (142        | )                         | $          | (475 | ) | $ | (134 | ) | $ | (594 | ) |
| Other discontinued operations expense  |       | (907                      | )           | (1,140                    | )          | (1,319 | ) | (1,582 | ) |
| Loss from discontinued operations      |       | $                         | (1,049      | )                         | $          | (1,615 | ) | $ | (1,453 | ) | $ | (2,176 | ) |

 

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 January 1, 2006 and July 3, 2005 consist ofthe following:

 
| ** **                    | ** ** | **January 1,  2006** | ** ** | **July 3,  2005** | ** ** |
|-------------------------------|------------|---------------------------|------------|------------------------|------------|
| Raw materials and stock parts |       | $                         | 28,953     |                   | $          | 30,257 |   |
| Work-in-process               |       | 10,818                    |       | 9,452                  |       |
| Finished goods                |       | 11,752                    |       | 10,241                 |       |
|                          |       | $                         | 51,523     |                   | $          | 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

 

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the insurer will bear all liability, if any, with respect to theremaining case and that the proceedings will not have a material adverseeffect on the Company’s results of operations, financial position or cashflows.

 

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 their response. The Company has also filed a late claim in the amount of $2.5 million in theFederal-Mogul bankruptcy proceedings to recover attorney’s fee paid for thedefense of these claims, which the Company believes is an obligation of FederalMogul although the claim is subject to challenge.  Management does notbelieve the asbestos proceedings, individually or in the aggregate, will have amaterial adverse effect on its financial position, results of operations orcash flows.

 

*Litigation – Patent Infringement*

 

In April 1998, Mr. Ole K. Nilssen (“Nilssen”) filed a lawsuitin the 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 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 million into an escrow account to ensure that it isable to satisfy the Nilssen arbitration award in the event that its appeal ofthe 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 andTrademark Office (“PTO”) has accepted ULT’s request for reexamination of thefour remaining patents.  A motion for summary judgment that various claimsof the patents at issue are invalid and that the accused ULT products do notinfringe a claim of one of the patents was filed on November 1, 2005 butno hearing had been set as of January 5, 2006 when the Court granted ULT’smotion to stay proceedings in the lawsuit pending the PTO reexamination.  The Company will continue to aggressivelydefend the claims against ULT  however, adecision in the lawsuit that is ultimately unfavorable to ULT could have amaterial adverse effect on the Company’s financial position, cash flows andresults of operations as a result of its indemnification 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 second quarter of fiscal year 2006 and are not expectedto result in material expenditures for the remainder of fiscal 2006.

 

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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 thesecond quarter of fiscal year 2006 and are not expected to be material duringthe remainder 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 bygovernmental authorities, the nature of the Company’s alleged connection to thecontaminated sites, the number and financial resources of other potentiallyresponsible parties, the availability of indemnification rights against thirdparties and the identification of additional contaminated sites, the Company’sestimated share of liability, if any, for environmental remediation, includingits indemnification obligations, is not expected to be material.

 

*Environmental - Century Electric(McMinnville, Tennessee)*

 

Prior to the Company’s purchase of Century Electric, Inc. (“CenturyElectric”) in 1986, Century Electric acquired a business from Gould Inc. (“Gould”)in May 1983 that included a leasehold interest in a fractional horsepowerelectric motor manufacturing facility located in McMinnville, Tennessee. Gouldagreed to indemnify Century Electric from and against liabilities and expensesarising out of the handling and cleanup of certain waste materials, includingbut not limited to cleaning up any polychlorinated biphenyls (“PCBs”) at theMcMinnville facility (the “1983 Indemnity”). The presence of PCBs and othersubstances, including solvents, in the soil and in the groundwater underlyingthe facility and in certain offsite soil, sediment and biota samples has beenidentified. The McMinnville plant is listed as a Tennessee Inactive HazardousWaste Substance Site and plant employees were notified of the presence ofcontaminants at the facility. Gould has completed an interim remedialexcavation and disposal of onsite soil containing PCBs and a preliminaryinvestigation and cleanup of certain onsite and offsite contamination. TheCompany believes the cost of further investigation and remediation (includingancillary costs) are covered by the 1983 Indemnity. The Company sold itsleasehold interest in the McMinnville plant in August 1999 and while theCompany believes that Gould will continue to perform substantially under itsindemnity obligations, Gould’s substantial failure to perform such obligationscould have a material adverse effect on the Company’s financial position, cashflows and results of operations.

 

*Environmental - Effect of Fruit of the LoomBankruptcy (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 the Company’sfinancial position, results of operations or cash flows.

 

6.             ComprehensiveIncome (Loss)

 

For the three- and six-month periods ended January 1, 2006 and January 2,2005, comprehensive income (loss) consisted of the following:

 

14

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| ** **                      | ** ** | **Three Months Ended**    | ** ** | **Six Months Ended**      | ** ** |
|---------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** |
| ** **                      | ** ** | ** **                | ** ** | **(restated)**            | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Net income (loss)               |       | $                         | (1,725     | )                         | $          | 162 |   | $ | (2,779 | ) | $ | 702 |   |
| Currency translation adjustment |       | (685                      | )          | 5,816                     |       | 157 |   | 7,691 |   |
| Comprehensive income (loss)     |       | $                         | (2,410     | )                         | $          | 5,978 |   | $ | (2,622 | ) | $ | 8,393 |   |

 

7.             Earnings (Loss)Per Share

 

The following table setsforth the computation of basic and diluted earnings (loss) per share for thethree- and six- month periods ended January 1, 2006 and January 2,2005.  

 
| ** **                                              | ** ** | **Three Months Ended**    | ** ** | **Six Months Ended**      | ** ** |
|---------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                              | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** |
| ** **                                              | ** ** | ** **                | ** ** | **(restated)**            | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Numerator:                                              |       |                      |       |                      |       |   |   |   |   |
| Net income (loss) from continuing  operations           |       | $                         | (676       | )                         | $          | 1,777 |   | $ | (1,326 | ) | $ | 2,878 |   |
| Loss from discontinued operations                       |       | (1,049                    | )          | (1,615                    | )          | (1,453 | ) | (2,176 | ) |
| Net income (loss)                                       |       | $                         | (1,725     | )                         | $          | 162 |   | $ | (2,779 | ) | $ | 702 |   |
|                                                    |       |                      |       |                      |       |   |   |   |   |
| Denominator:                                            |       |                      |       |                      |       |   |   |   |   |
| Weighted average shares for basic earnings  per share   |       | 28,890                    |       | 28,520                    |       | 28,888 |   | 28,511 |   |
| Add dilutive effective of stock options  outstanding    |       | —                    |       | 758                       |       | — |   | 761 |   |
| Weighted average shares for diluted  earnings per share |       | 28,890                    |       | 29,278                    |       | 28,888 |   | 29,272 |   |
|                                                    |       |                      |       |                      |       |   |   |   |   |
| Basic & Diluted:                               |       |                      |       |                      |       |   |   |   |   |
| Net income (loss) per share from continuing  operations |       | $                         | (0.02      | )                         | $          | 0.06 |   | $ | (0.05 | ) | $ | 0.10 |   |
| Loss per share from discontinued operations             |       | $                         | (0.04      | )                         | $          | (0.05 | ) | $ | (0.05 | ) | $ | (0.08 | ) |
| Net income (loss) per share                             |       | $                         | (0.06      | )                         | $          | 0.01 |   | $ | (0.10 | ) | $ | 0.02 |   |

 

Due to the net loss fromcontinuing operations, the loss from discontinued operations, and the net lossfor the three- and six-month periods ended January 1, 2006, the effect of0.5 million and 0.4 million shares of stock options, respectively, was excludedfrom the calculations of diluted loss per share, as their impact would beanti-dilutive.  Similarly, the dilutive effect of stock optionsoutstanding was not included in the calculation of diluted loss per share fromdiscontinued operations for the three- and six-month periods ended January 2,2005.

 

8.             Warranties

 

TheCompany offers warranties for certain products that it manufactures, withwarranty terms generally ranging from 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.  Actual repair costs incurred for productsunder warranty are charged against the established reserve balance as incurred.  Changes in the warranty reserve for the sixmonths ended January 1, 2006 and January 2, 2005 were as follows:

 
| ** **                                            | ** ** | **Six Months Ended**      | ** ** |
|-------------------------------------------------------|------------|---------------------------|------------|
| ** **                                            | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** |
| Balance, beginning of fiscal year                     |       | $                         | 315        |   | $ | 204 |   |
| Additions charged to earnings for product  warranties |       | 319                       |       | 363 |   |
| Use of reserve for warranty obligations               |       | (292                      | )          | (288 | ) |
| Balance, end of period                                |       | $                         | 342        |   | $ | 279 |   |

 

15

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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 six-month periods ended January 1,2006.  The Company incurred restructuring costs for the three- and six-monthperiods ended January 2, 2005 of $0.1 million and $0.2 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 six-month periods ended January 1, 2006.  Costsincurred in the three-month period ended January 2, 2005 were $0.2million, of which $0.1 million are included in cost of goods sold and $0.1million are included in selling, general and administrative expense in theaccompanying condensed consolidated statements of operations.  Costsincurred in the six-month period ended January 2, 2005 were $0.6 million,of which $0.3 million are included in cost of goods sold and $0.3 million areincluded in selling, general and administrative expense in the accompanyingcondensed consolidated statements of operations.

 

10.           Stock-BasedCompensation Plans

 

The Company has two stock option plans (the “Plans”), one of whichprovides for the issuance of both incentive stock options (under Section 422Aof the Internal Revenue Code of 1986) and non-qualified stock options atexercise prices not less than the fair market value of the Company’s commonstock at the date of grant, and one of which only provides for the issuance ofnon-qualified stock options at exercise prices not less than the fair marketvalue of the Company’s common stock at the date of grant. One of the Plans alsoprovides for the issuance of stock appreciation rights, restricted stock,incentive bonuses and incentive stock units. The total number of shares of theCompany’s common stock authorized to be issued upon exercise of the stockoptions and other stock rights under the Plans is 2,100,000.  Optionsgranted under these Plans vest in equal annual installments of two, three orfour years.

 

The accompanying condensed consolidated statements of operations forthe three- and six-month periods ended January 1, 2006, includecompensation expense related to all stock-based awards of $0.1 million and $0.2million, respectively  (see Note 2 ofNotes to Condensed Consolidated Financial Statements).  The three- andsix-month periods ended January 2, 2005, do not include any compensationexpense related to stock-based awards, as the Company was accounting forstock-based compensation using the intrinsic-value method under APB No. 25,which permitted footnote disclosure only of the impact of stock-based awards ona pro forma basis.   The pro forma expense related to stock-basedawards for the three- and six-month periods ended January 2, 2005 was $1.2million and $2.4 million respectively.

 

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

 
| **Stock Option Activty**                   | ** ** | ** ** | ** ** | **Weighted-  Average  Exercise** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------------------|------------|---------------------------------|------------|
| **Six Months Ended  January 1, 2006** | ** ** | **Shares** | ** ** | **Price**                        | ** ** | **($000s)**                     | ** ** |
|                                       |       |       |       |                             |       |                            |       |
| Options outstanding, July 3, 2005     |       | 8,178,294  |       | $                                | 8.77       |                            |       |   |
| Options granted                            |       | —     |       |                             |       |                            |       |
| Options exercised                          |       | —     |       |                             |       |                            |       |
| Options cancelled                          |       | (640,996   | )          | $                                | 10.21      |                            |       |   |
| Options outstanding, January 1, 2006  |       | 7,537,298  |       | $                                | 8.65       |                            | $          | 52 |   |
|                                       |       |       |       |                             |       |                            |       |
| Exercisable options                        |       | 7,477,298  |       | $                                | 8.68       |                            | $          | 27 |   |

 

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As of January 1, 2006, there was $0.1 million of totalunrecognized compensation cost related to unvested stock option awards grantedunder the Plans.  This cost is expected to be recognized over aweighted-average period of 1.0 years.

 

The following table provides information regarding exercisable andoutstanding options as of January 1, 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                            |       | 1,663,668                |       | $                                                 | 3.90       |   | 7.52 |   | 1,701,168 |   | $ | 3.87 |   | 7.57 |   |
| $ 5.00 -  $10.00                  |       | 3,642,040                |       | 7.80                                              |       | 5.78 |   | 3,664,540 |   | 7.80 |   | 5.79 |   |
| $ 10.00 -  $15.00                 |       | 1,242,601                |       | 11.44                                             |       | 5.04 |   | 1,242,601 |   | 11.44 |   | 5.04 |   |
| Over $15.00                            |       | 928,989                  |       | 17.03                                             |       | 2.52 |   | 928,989 |   | 17.03 |   | 2.52 |   |
| Total                                  |       | 7,477,298                |       | $                                                 | 8.68       |   | 5.64 |   | 7,537,298 |   | $ | 8.65 |   | 5.67 |   |

 

The following table provides information regarding unvested stockactivity for the six months ended January 1, 2006:

 
| **Unvested Shares**              | ** ** | **Shares** | ** ** | **Weighted-  Average  Grant Date  Fair Value** | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------------------|------------|
|                             |       |       |       |                                           |       |
| Unvested at July 3, 2005    |       | —     |       |                                           |       |
| Granted                          |       | 500,000    |       | $                                              | 2.77       |   |
| Vested                           |       | —     |       |                                           |       |
| Forfeited                        |       | —     |       |                                           |       |
| Unvested at January 1, 2006 |       | 500,000    |       | $                                              | 2.77       |   |

 

As of January 1, 2006, there was $1.2 million of totalunrecognized compensation cost related to unvested restricted stockarrangements granted under the Plans.  This cost is expected to berecognized over a weighted-average period of 3.0 years.

 

11.           Pension Expense

 

For the three- and six-month periods ended January 1, 2006 and January 2,2005, pension expense related to the Company’s defined benefit pension planconsisted of the following:

 
| ** **                      | ** ** | **Three Months Ended**    | ** ** | **Six Months Ended**      | ** ** |
|---------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** |
| Interest cost                   |       | $                         | 2,440      |                      | $          | 2,364 |   | $ | 4,880 |   | $ | 4,903 |   |
| Expected return on plan assets  |       | (2,552                    | )          | (2,630                    | )          | (5,104 | ) | (5,569 | ) |
| Recognized net actuarial losses |       | 1,062                     |       | 659                       |       | 2,124 |   | 1,380 |   |
|                            |       |                      |       |                      |       |   |   |   |   |
| Total net pension expense       |       | $                         | 950        |                      | $          | 393 |   | $ | 1,900 |   | $ | 714 |   |

 

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

 

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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 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 six-month periods ended January 2, 2005 was an increase in theCompany’s valuation allowance for deferred tax assets and related provision forincome taxes of $0.4 million and $0.8 million, respectively.

 

Similarly, the Company’s tax provision of $0.8 million for the threemonths ended January 1, 2006 also included an amount of $0.4 million toincrease the Company’s valuation allowance for deferred tax assets related totax-deductible amortization of goodwill.   The remaining taxprovision of $0.4 million for the three months ended January 1, 2006 wascomprised of income taxes of the Company’s foreign subsidiaries.   The Company’s tax provision of $1.7 millionfor the six months ended January 1, 2006 included an amount of $0.8million to increase the Company’s valuation allowance for deferred tax assetsrelated to tax-deductible amortization of goodwill.   The remainingtax provision of $0.9 million for the six months ended January 1, 2006 wascomprised of income taxes of the Company’s foreign subsidiaries.

 

13.           BankBorrowing Arrangements

 

AtJuly 3, 2005, the Company had an asset based credit agreement (“CreditAgreement”) for North American operations with Chase Bank (formerly Bank One).  Available borrowings under the CreditAgreement were determined by a borrowing base formula as defined in theagreement, based primarily on the levels of domestic accounts receivable andinventory.  The facility also supportedthe issuance of letters of credit. Borrowings under the Credit Agreement were secured by substantially allof the Company’s North American assets and bore interest at the bank’s primelending rate plus 1%, or, at the Company’s option, the London InterbankOffering Rate (LIBOR) plus 3.25%.

 

TheCompany was in violation of certain covenants at July 3, 2005, and in July 2005,in exchange for a waiver of certain covenant defaults and the lender’swillingness to continue to extend credit under the agreement, the Companyagreed to a permanent reduction in the aggregate lending commitment to $7.5million and a change in the facility termination date from July 15, 2006to 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 with Ableco, Inc. providingfor an $18 million term loan and an agreement with Wells Fargo Foothill, Inc.providing for a $13 million revolving credit facility. Borrowings under theterm loan bear interest at the lender’s reference rate plus 5%, or, at theCompany’s option, the London Interbank Offering Rate (LIBOR) plus 7.5%.  Such rates may be increased by up to onepercentage point depending upon the level of U.S. funded debt to EBITDA asdefined in the agreement.  The term loanrequires quarterly principal payments of $1 million beginning in September 2006.  Borrowings under the revolving creditfacility 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 facility are determined by aborrowing base formula as defined in the agreement, based on the level ofeligible domestic accounts receivable and inventory.  The revolving credit facility also supportsthe issuance of letters of credit. Borrowings under the term loan and revolving credit facility are securedby substantially all of the Company’s domestic assets.  The Company used the proceeds from therevolving credit facility to fully repay all outstanding obligations under itsprevious financing agreement with Chase Bank (formerly Bank One), which expiredon September 30, 2005.

 

In November 2005the Company deposited $22.6 million into an escrow account to ensure that it isable to satisfy the Nilssen arbitration award in the event that its appeal ofthe award is not successful (see Note 5 of Notes to Condensed ConsolidatedFinancial Statements).  The deposit wasfunded by borrowings under the $18.0 million term loan and by $4.6 million fromthe revolving credit facility, and is reported as restricted cash in the accompanyingcondensed consolidated

 

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balance sheet as of January 1,2006.  As of January 1, 2006, the$18.0 million term loan was outstanding, and approximately $8.2 million wasoutstanding under the revolving credit facility.  The total of these two amounts, $26.2million, is included in current portion of long-term debt in the accompanyingcondensed consolidated balance sheet as of January 1, 2006.  As of January 1, 2006, the Company wasin violation of a covenant which required it to divest its telecom powerbusiness prior to the end of the second quarter of fiscal 2006.  The Company is in the process of formalizinga waiver of this covenant violation with its lenders.

 

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 European subsidiary has an agreement with aEuropean bank to provide borrowings secured by the subsidiary’s land andbuilding.  Borrowings under thisagreement bear interest at EURIBOR plus 1.5%. The initial commitment to lend under this agreement was Euro 7.0million, and the commitment has been reduced ratably on a quarterly basisbeginning March 31, 2004 and ending September 30, 2013.  The Company’s European subsidiary also has certaincapital leases outstanding related mainly to equipment purchases.  As of January 1, 2006, total amountsoutstanding under all European borrowing arrangements were $20.0 million, ofwhich $2.0 million is included in current portion of long-term debt and $18.0million is included in long term debt in the accompanying condensedconsolidated balance sheet as of January 1, 2006.

 

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

 

Restatement of Fiscal 2005 Interim Periodsand 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 at July 3,2005, and therefore increased our valuation allowance for deferred tax assetsand the related provision for income taxes for fiscal year 2005 by $1.6million. We further determined that the increased provision for income taxesshould have been recorded on a pro-rata basis throughout fiscal year 2005, andas a result, we have restated our quarterly results for fiscal 2005.  Theimpact of this restatement on the three and six months ended January 1,2006 was an increase in our valuation allowance for deferred tax assets andrelated provision for income taxes of $0.4 million and $0.8 million,respectively.  The restatement did not have a material impact on ourfinancial position as of January 1, 2006, and had no impact on our cashflows for the restated periods.

 

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 expenses relatedto divested businesses as discontinued operations, including certain expensesfor patent infringement claims, product liability claims, environmental issues,and asbestos claims.  Prior period amounts related to the telecom businessor other divested businesses have been reclassified in the accompanyingcondensed consolidated financial statements in order to conform to the currentyear presentation.  All of these issues relate to businesses we no longerown and most relate to indemnification agreements we provided when we divestedthose 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.

 

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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 our alternative energy andutility products, although these products are not yet contributingsignificantly to our sales.  Our operating results continue to benegatively impacted by expenses related to businesses we no longer own, mainlylegal fees incurred in our appeal of a $23.4 million patent infringementarbitration award and a related indemnification agreement (see Note 5 of Notesto Condensed Consolidated Financial Statements).  These expenses areincluded in loss from discontinued operations in the accompanying condensedconsolidated statements of operations. In an effort to improve our competitive position and our operatingresults, within the past year we decided to divest our telecom power business,have completed restructuring actions in both North America and Europe, doubledour production capacity in China, increased our investment in research anddevelopment (“R&D”) spending on new products, and obtained new financingagreements to improve our liquidity.  Inaddition, we recently announced plans to further reduce our workforce in Europeand shift additional production to China.

 

Second-quarter fiscal 2006 bookings (new orders received) were $63.6million and our backlog as of January 1, 2006 was $63.4 million.  Bookings for the second quarter of fiscal2005 were $53.6 million and our backlog as of January 2, 2005 was $69.9million.  The increase in bookings versus the prior year is primarilyrelated to an increase in bookings for embedded power products.  Net sales for the second quarter of fiscal2006 were $59.3 million compared to net sales of $62.0 million in the secondquarter of fiscal 2005.  The decrease innet sales was due to lower sales of embedded power products.  Net sales for the six months ended January 1,2006 were $115.8 million, a decrease of $12.4 million compared to net sales of$128.2 million for the six months ended January 2, 2005.  The decrease is due to lower sales ofembedded power products, and in addition, the first six months of fiscal 2005contained 27 weeks while the first six months of fiscal 2006 contained 26weeks.  We continue to focus on gainingshare in systems markets and on new product introductions in industrial,transportation, utility, and alternative energy markets, and our future salesgrowth is largely dependent on the success of this strategy.

 

Gross profit in the second quarter of fiscal 2006 was $15.3 million,down from $15.6 million in the second quarter of fiscal 2005.  However,gross profit as a percentage of sales increased from 25.2% in the secondquarter of fiscal 2005 to 25.8% in the second quarter of fiscal 2006, afour-year high.  The gross profit percentage improvement is attributed toan improved sales mix as well as cost reductions from restructuring actions andour operations in China.

 

Our R&D expense was $3.9 million in the second quarter of fiscal2006, compared to $3.7 million in the second quarter of fiscal 2005.  We continue to invest in developing newproducts for existing and new markets, including alternative energy productsfor solar and wind applications and monitoring and control systems for utilitymarkets.  Selling, general and administrative (“SG&A”) expense was$10.3 million in the second quarter of fiscal 2006 compared to $10.6 million inthe second quarter of fiscal 2005, mainly due to reduced volume-related sellingexpenses and the absence of restructuring costs in fiscal 2006, partiallyoffset by higher pension expense, which increased by $0.6 million in the secondquarter of fiscal 2006 compared to the second 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 decreased sales and the resulting lower grossprofit, our income from operations decreased to $1.1 million in the secondquarter of fiscal 2006 from $1.4 in the second quarter of fiscal 2005. Our net loss from continuing operations in the second quarter of fiscal 2006was $0.7 million, or $0.02 per share, and reflects interest expense of $0.9million as well as a provision for income taxes of $0.8 million.  In thesecond quarter of fiscal 2005 we earned net income from continuing operationsof $1.8 million, or $0.06 per share. Fiscal 2005 second quarter net income includes other income of $1.3million from the sale and license of patents and rights, offset by interestexpense of $0.3 million.

 

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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 operatingflexibility.  In November 2005, we deposited $22.6 million into anescrow account to be used to satisfy the Nilssen arbitration award in the eventour appeal of the award is not successful (see Note 5 of Notes to CondensedConsolidated Financial Statements).  Thesource of funds for the escrow deposit was the $18 million term loan and $4.6million from our revolving credit facility, and is included in the currentportion of long term debt in the accompanying condensed consolidated balancesheet as of January 1, 2006.  Thefunds in escrow are reported as restricted cash in the accompanying condensedconsolidated balance sheet as of January 1, 2006.

 

We generated $2.9 million in cash from operating activities during thesix months ended January 1, 2006, compared to $0.4 million for the sixmonths ended January 2, 2005. Capital expenditures in the first six months of fiscal 2006 were $3.2million, while depreciation and amortization expense was $4.4 million, comparedto capital expenditures of $3.9 million and depreciation and amortizationexpense of $4.8 million for the same period in fiscal 2005.  Our totallong-term debt increased during the first six months of fiscal 2006 by $21.0million to $46.2 million, due mainly to borrowings to fund the escrowaccount.  Similarly, our combined cashand restricted cash balances increased from $6.9 million at July 3, 2005, to$26.2 million at January 1, 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, and selectedoutsourcing.  We have also further consolidated administrative operationsand functions in fiscal 2006.  However,future sustained profitability is highly dependent upon improvement in revenuesand gross margins, successful implementation of our strategy to penetratehigher margin markets, a shift in our sales mix to proportionately higher salesof systems, and favorable outcomes in certain legal matters, primarily thepatent infringement claims (see Note 5 of Notes to Condensed ConsolidatedFinancial Statements).

 

Critical Accounting 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.

 

*Accounts Receivable*

 

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 appropriate allowanceshave 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 

 

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inventory is defined as inventory items with on-hand quantities inexcess of one year’s usage and specified percentages are applied to the excessinventory value in determining the reserve.  Our reserve for excess andobsolete inventory has ranged from 9% to 10% of gross inventory value duringthe fiscal years 2005 and 2006.  Our assumptions have not changedsignificantly in the past, and we believe they are not likely to change in theforeseeable future.  We feel that our assumptions regarding inventoryvaluation have been accurate in the past, with the exception of an unexpectedsignificant decline in demand in our telecom business in fiscal 2003, whichresulted in a charge to discontinued operations of $4.7 million to increase ourinventory reserves.

 

*Long-Lived Assets 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 havedetermined that, historically, our cash flow estimates used in determining thefair value of our reporting units have been reasonably accurate.  We usethe results of this analysis as well as projected operating results to modifyour estimates annually.  However, if circumstances cause these estimatesto change in the future, or if actual circumstances vary significantly fromthese assumptions, this could result in additional goodwill impairmentcharges.  We cannot predict the occurrence of future events that mayadversely affect our reported goodwill balance.

 

*Pension Benefits*

 

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*.

 

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.

 

*Reserves for Contingencies*

 

We periodically record the estimated impacts of various conditions, situationsor circumstances involving uncertain outcomes.  The accounting for suchevents is prescribed under SFAS No. 5, *Accounting forContingencies*.  SFAS No. 5 defines a contingency as “anexisting condition, situation, or set of circumstances involving uncertainty asto possible gain or loss to an enterprise that will ultimately be resolved whenone 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) informationis available that indicates it is probable that the loss has been incurred,given the likelihood of uncertain events; and (2) that the amount of theloss 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.

 

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*Income Taxes*

 

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, ourfinal tax 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 January 1, 2006 and January 2,2005

 

NetSales and Gross Profit

 

Netsales for the second quarter of fiscal 2006 were $59.3 million, a decrease of4.3% from the second quarter of fiscal 2005 sales of $62.0 million.  The decrease is due to lower sales ofembedded power supplies, $3.2 million, and currency translation impact from aweaker Euro relative to the U.S. dollar, $2.2 million, partially offset byhigher sales of systems of $2.7 million in material handling and alternativeenergy markets.

 

Ourfiscal 2006 second quarter gross profit was $15.3 million, or 25.8% of sales,versus $15.6 million, or 25.2% of sales in the second quarter of fiscal2005.  The reduction in gross profit of$0.3 million is due mainly to lower sales volumes of embedded power suppliesand currency translation impact from the weaker Euro, offset by higher salesvolumes of systems.  The improvement ingross profit as a percentage of sales is due to improved sales mix with greatersales of systems in the second quarter of fiscal 2006, cost reductions fromrestructuring actions and the relocation of production to lower costfacilities, including our plant in China.

 

Researchand Development, Selling, General and Administrative

 

R&Dexpense was $3.9 million, or 6.7% of sales, in the second quarter of fiscal2006 compared to $3.7 million, or 6.0% of sales, in fiscal 2005.  We continue to invest in product developmentfor new markets and applications such as alternative energy markets for windand solar markets and monitoring and control systems for the utility market.

 

SG&A expense was $10.3 million (17.3% of sales) in the secondquarter of fiscal 2006 versus $10.6 million (17.0% of sales) in the fiscal2005.  Our second quarter fiscal 2006selling expenses were $4.4 million versus $4.6 million in the second quarter offiscal 2005.  The decrease in sellingexpenses in the second quarter of fiscal 2006 compared to the second quarter offiscal 2005 was due mainly to reduced commission expense.  Our second quarter fiscal 2006 general andadministrative (G&A) expense was $5.9 million, comparable to second quarterfiscal 2005 expense of $6.0 million. The fiscal 2006 second quarter G&Aexpense as compared to the fiscal 2005 second quarter G&A expense hadhigher pension expense by $0.6 million (see Note 11 of Notes to CondensedConsolidated Financial Statements), higher audit fees of $0.1 million, andstock compensation expense of $0.1 million, offset by lower rent expense of$0.2 million, lower consulting expenses of $0.1 million and a favorablecurrency translation impact from the weaker Euro of $0.1 million.  In addition, the second quarter of fiscal2005 G&A expense included $0.2 million in restructuring costs (see Note 9of Notes to Condensed Consolidated Financial Statements).

 

Income from Operations

 

Ourincome from operations for the second quarter of fiscal 2006 was $1.1 millioncompared to income from operations of $1.4 million for the second quarter offiscal 2005.  The reduction in incomefrom operations is due to lower sales volumes and the related reduction ingross profit in the second quarter of fiscal 2006 as compared to the secondquarter of fiscal 2005.

 

InterestExpense

 

Interestexpense was $0.9 million for the second quarter of fiscal 2006 compared tointerest expense of $0.3 million for the second quarter of fiscal 2005.  The increase in interest expense in thesecond quarter of fiscal 2006 was due to higher outstanding debt balances, duemainly to a deposit of $22.6 million into escrow in November 2005, whichis being held to satisfy the Nilssen arbitration award in the event our appealof the award is not successful (see Note 5

 

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ofNotes to Condensed Consolidated Financial Statements).  The escrow deposit was funded by our $18.0million term loan and $4.6 million from our revolving debt facility.

 

Other(Income) Expense

 

Otherexpense for the second quarter of fiscal 2006 was $0.1 million, comprised entirelyof deferred financing amortization expense. Other income for the second quarter of fiscal 2005 of $1.2 millionincludes $1.3 million from the one-time sale and license of certain patents andtechnology rights, offset by $0.1 million in deferred financing amortizationexpense.  Under the terms of the fiscal2005 sale and license agreement, we have no remaining obligations nor will wereceive future payments.

 

Lossfrom Discontinued Operations

 

Ourloss from discontinued operations for the second quarter of fiscal 2006 was$1.0 million compared to a loss from discontinued operations of $1.6 million inthe second quarter of fiscal 2005.  Thedecrease in loss from discontinued operations from the prior year relates mainlyto improved operating results in our telecom power business, which generated aloss of $0.1 million in the second quarter of fiscal 2006 versus a loss of $0.5million in the second quarter of fiscal 2005. Other discontinued operations expenses of $0.9 million incurred in thesecond quarter of fiscal 2006 were comprised of legal fees related to theNilssen arbitration award appeal and indemnification of $0.7 million, as wellas legal fees related to asbestos claims. Other discontinued operations expenses of $1.1 million in the secondquarter of fiscal 2005 were comprised of legal fees related to the Nilssenarbitration of $0.9 million, legal fees related to asbestos issues of $0.1million, and expenses related to our divested telecom service business of $0.1million.

 

NetIncome (Loss)

 

Ournet loss for the second quarter of fiscal 2006 was $1.7 million compared to netincome of $0.2 million (as restated) for the second quarter of fiscal2005.  Despite our pre-tax loss for thesecond quarter of fiscal 2006, we recorded a provision for income taxes of $0.8million, comprised of a provision of $0.4 million due to net income generatedby our foreign subsidiaries and a $0.4 million non-cash tax provision relatedto goodwill amortization.  Our provisionfor income taxes for the second quarter of fiscal 2005 was $0.5 million (asrestated), which includes $0.1 million due to net income generated by ourforeign subsidiaries and a $0.4 million non-cash tax provision related togoodwill amortization.

 

Resultsof Operations - Six Months Ended January 1, 2006 and January 2, 2005

 

NetSales and Gross Profit

 

Netsales for the first six months of fiscal 2006 were $115.8 million, a decreaseof 9.7% from net sales of $128.2 million for the first six months of fiscal2005.  The decrease is due to lower salesof embedded power supplies of $9.8 million and currency translation impact froma weaker Euro relative to the U.S. dollar of $3.0 million, partially offset byhigher sales of systems in material handling of $4.2 million and alternativeenergy of $1.2 million.  In addition, thefirst six months of fiscal 2005 contained an additional week (27 weeks)compared to the first six months of fiscal 2006 (26 weeks), resulting inadditional sales of $4.7 million in the first six months of fiscal 2005.

 

Ourgross profit for the first six months of fiscal 2006 was $29.8 million, or25.7% of sales, versus $31.7 million, or 24.7% of sales in the first six monthsof fiscal 2005.  The decrease in grossprofit is due to lower sales volumes of embedded power supplies, $2.7 million,and translation impact from the weaker Euro of $0.7 million, partially offsetby higher sales volumes of systems of $1.1 million and cost reductions of $0.4million due mainly to the absence of restructuring costs in fiscal 2006.  Gross profit for the first six months offiscal 2005 was impacted by $0.3 million in restructuring costs, and lowerefficiency related to production relocation and plant consolidation (see Note 9of Notes to Condensed Consolidated Financial Statements).

 

Researchand Development, Selling, General and Administrative

 

R&Dexpense was $7.5 million, or 6.5% of sales, for the first six months of fiscal2006 compared to $7.2 million, or 5.6% of sales for the first six months offiscal 2005.  During the first six monthsof fiscal 2006, we continued to increase spending in new product developmentaimed at alternative energy markets, mainly solar and wind applications, aswell utility monitoring and control products, in addition to continuing toinvest in new power-electronic platforms and applications.

 

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SG&A expense was $20.2 million (17.4% of sales) for the first sixmonths of fiscal 2006 versus $21.1 million (16.5% of sales) for the first sixmonths of fiscal 2005.  Selling expenseswere $8.6 million for the first six months of fiscal 2006, versus $9.4 millionfor the first six months of fiscal 2005. The reduction in selling expenses in the first six months of fiscal 2006compared to the first six months of fiscal 2005 was due mainly to decreasedcommission expense and other volume-related selling expenses.  G&A expenses were $11.6 for the first sixmonths of fiscal 2006, comparable to $11.7 million of G&A expense for thefirst six months of fiscal 2005.  G&Aexpense for the first six months of fiscal 2006 as compared to the first sixmonths of fiscal 2005 reflects increased pension expense of $1.2 million,increased audit fees of $0.4 million, and stock compensation expense of $0.2million, partially offset by a favorable currency translation impact of $0.5million, lower rent expense of $0.2 million and lower consulting fees of $0.2million. In addition, G&A expense for the first six months of fiscal 2005includes $0.5 million in restructuring expenses, while no restructuring expenseswere incurred in the first six months of fiscal 2006.

 

Income from Operations

 

Asa result of the above factors, our income from operations for the six monthsended January 1, 2006 was $2.1 million compared to income from operationsof $3.5 million for the six months ended January 2, 2005.  The decrease in income from operations is dueto lower sales volumes and the related reduction in gross profit in the firstsix months of fiscal 2006 as compared to the first six months of fiscal 2005.

 

InterestExpense

 

Interestexpense was $1.2 million for the first six months of fiscal 2006 compared tointerest expense of $0.6 million for the first six months of fiscal 2005.  The increase in interest expense in the firstsix months of fiscal 2006 was due to higher outstanding debt balances, duemainly to a deposit of $22.6 million into escrow in November 2005, whichis being held to satisfy the Nilssen arbitration award in the event our appealof the award is not successful (see Note 5 of Notes to Condensed ConsolidatedFinancial Statements).  The escrowdeposit was funded by our $18.0 million term loan and $4.6 million from ourrevolving debt facility.

 

Other(Income) Expense

 

Otherexpense for the first six months of fiscal 2006 was $0.5 million, comprisedentirely of deferred financing amortization expense, which includes $0.3million 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 six months of fiscal 2005 of $1.2 millionincludes $1.3 million from the one-time sale and license of certain patents andtechnology rights, offset by $0.1 million in deferred financing amortizationexpense.  Under the terms of the fiscal2005 sale and license agreement, we have no remaining obligations nor will wereceive future payments.

 

Lossfrom Discontinued Operations

 

Ourloss from discontinued operations for the first six months of fiscal 2006 was$1.5 million compared to a loss from discontinued operations of $2.2 million inthe first six months of fiscal 2005.  Thedecrease in our loss from discontinued operations from the prior year relatesmainly to improved operating results in our telecom power business, which generateda loss of $0.1 million in the first six months of fiscal 2006 versus a loss of$0.6 million in the first six months of fiscal 2005.  Other discontinued operations expenses of$1.3 million incurred in the first six months of fiscal 2006 were comprised oflegal fees related to the Nilssen arbitration award appeal and indemnificationof $1.1 million, as well as legal fees related to asbestos claims.  Other discontinued operations expenses of$1.6 million in the first six months of fiscal 2005 were comprised of legalfees related to the Nilssen arbitration of $1.1 million, legal fees related toasbestos issues of $0.2 million, product liability costs of $0.1 million andexpenses related to our divested telecom service business of $0.1 million.

 

NetIncome (Loss)

 

Ournet loss for the first six months of fiscal 2006 was $2.8 million compared tonet income of $0.7 million (as restated) for the first six months of fiscal2005.  Despite our pre-tax loss for thefirst six months of fiscal 2006, we recorded a provision for income taxes of$1.7 million, comprised of a provision of $0.9 million due to net incomegenerated by our foreign subsidiaries and a $0.8 million non-cash tax provisionrelated to goodwill amortization.  Ourprovision for income taxes for the first six months of fiscal 2005 was $1.2million (as restated), which includes $0.4

 

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milliondue to net income generated by our foreign subsidiaries and a $0.8 millionnon-cash tax provision related to goodwill amortization.

 

Liquidityand Capital Resources

 

Ourcash balances increased $19.3 million in the first six months of fiscal 2006,from $6.9 million at July 3, 2005 to $26.2 million at January 1,2006, which includes restricted cash of $22.6 million.  In November 2005 we deposited $22.6million into an escrow account to ensure that we are able to satisfy theNilssen arbitration award in the event that our appeal of the award is notsuccessful (see Note 5 of Notes to Condensed Consolidated Financial Statements).  The deposit was funded by borrowings underour $18.0 million term loan and by $4.6 million from our revolving creditfacility.  As a result, our outstandingdebt balance has increased $21.0 million during the first six months of fiscal2006, from $25.2 million at July 3, 2005 to $46.2 million at January 1,2006.  Our primary uses of cash in thefirst six months of fiscal 2006 were for vendor payments, capital expendituresof $3.2 million, and loan origination and legal fees related to our new financingagreements of $1.5 million.  We have nocurrent 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 capitalexpenditures could change depending upon changes in revenue levels, ourfinancial condition and the general economy.

 

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 Fargo Foothill, Inc.providing for a $13.0 million revolving credit facility.  Borrowings under the term loan bear interestat the lender’s reference rate plus 5%, or, at our option, the London InterbankOffering Rate (LIBOR) plus 7.5%.  Suchrates may be increased by up to one percentage point depending upon the levelof U.S. funded debt to EBITDA as defined in the agreement.  The term loan requires quarterly principalpayments of $1.0 million beginning in September 2006.  Borrowings under the revolving loan bear interestat the bank’s prime lending rate plus 2.5% or, at our option, LIBOR plus4%.  Borrowings under the revolvingcredit facility are determined by a borrowing base formula as defined in theagreement, based on the level of eligible domestic accounts receivable andinventory.  The revolving credit facilityalso supports the issuance of letters of credit.  Borrowings under the term loan and revolvingcredit facility are secured by substantially all of our domestic assets.  We used the funds from the revolving creditfacility to fully repay all outstanding obligations under our previousfinancing agreement with Chase Bank (formerly Bank One), which expired on September 30,2005.  As of January 1, 2006, wewere in violation of a covenant which required us to divest our telecom powerbusiness prior to the end of our second quarter of fiscal 2006. We are in theprocess of formalizing a waiver of this covenant violation with ourlenders.  As of January 1, 2006, the$18.0 million term loan was outstanding, and approximately $8.2 million wasoutstanding under our revolving credit facility.  The total of these two amounts, $26.2million, is included in current portion of long-term debt in the accompanyingcondensed consolidated balance sheet as of January 1, 2006.

 

Our European subsidiary maintains revolving borrowing arrangements withlocal banks, primarily to support working capital needs.  Available borrowings under these arrangementsaggregate approximately Euro 20.0 million depending in part upon levels ofaccounts receivable, and bear interest at various rates ranging from 3% to8%.  In addition, our European subsidiaryhas an agreement with a European bank to provide borrowings secured by thesubsidiary’s land and building. Borrowings under this agreement bear interest at EURIBOR plus 1.5%.  The initial commitment to lend under thisagreement was Euro 7.0 million, and the commitment has been and will continueto be reduced ratably on a quarterly basis beginning March 31, 2004 andending September 30, 2013.  Our Europeansubsidiary also has certain capital leases outstanding related mainly toequipment purchases.  As of January 1,2006, total amounts outstanding under all of our European borrowingarrangements were $20.0 million, of which $2.0 million is included in currentportion of long-term debt and $18.0 million is included in long term debt inthe accompanying condensed consolidated balance sheet as of January 1,2006.

 

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 January 1,2006.  We have not made any contributionsto the plan during fiscal 2006, as none have been mandated.  Based upon current contribution creditsavailable under pension funding regulations, actuarial projections indicate nomandatory contributions to the plan would be required through fiscal year2007.  Depending upon changes in assetvalues and interest rates, as well as any discretionary contributions made byus in the interim period, required contributions in periods subsequent tofiscal 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 fourth quarter of fiscal 2005, adecision was rendered in a patent infringement action brought against us by Mr. OleK. Nilssen.

 

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In settlement of pending litigation, we agreed to submit the matter tobinding arbitration, and in May 2005, the arbitrator awarded damages toNilssen of $23.4 million, to be paid within 10 days of the award.  Nilssen’s counsel filed a motion to enter theaward in U.S. District Court for the Northern District of Illinois, and wefiled a counter-motion to vacate the award on grounds that it was fraudulentlyobtained.  Our request for oral argument was granted and the hearing washeld on October 19, 2005.  The judgeis expected to render his decision by mail after further consideration.  An unfavorable decision by the Court couldresult in payment of the award by the Company to Nilssen in the amount of $22.6million (the arbitration award of $23.4 million net of previously paid amountsof $0.8 million), which would have a material adverse effect on the Company’scash flows during fiscal 2006.  Based onfunds held in escrow, we have adequate resources to support payment of theaward if payment is required.  However,borrowings associated with the payment of the award would result in higherinterest expense in fiscal 2006 as compared to fiscal 2005.

 

We do not have any off-balance sheet arrangements or variable interestentities as of January 1, 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.

 

CautionRegarding Forward-Looking Statements and Risk Factors

 

This document, including documents incorporated herein by reference,contains “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995.  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 underlyingforward-looking statements.  Forward-looking statements contained in thisdocument speak only as of the date of this document or, in the case of anydocument 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.

 

Our future results of operations and the other forward-lookingstatements contained in this filing, including this section titled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”,involve a number of risks and uncertainties.  In particular, thestatements 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,the outcome 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.  Additionalrisks and 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 our Form 10-Kfiling with the Securities and Exchange Commission for the year ended July 3,2005, under the heading “Risk Factors Affecting the Company’s Financial Outlook”.

 

**Item 3 – Quantitative and QualitativeDisclosures 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 

 

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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 the our Annual Report on Form 10-K forthe fiscal 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 January 1, 2006 or July 3, 2005.

 

***Interest Rates***

 

The fair value of our debt was $46.2 million at January 1, 2006,equal to the carrying value at that date.  The fair value of our debt isequal to the borrowings outstanding from domestic and foreign banks and smallamounts owed under capital lease arrangements.  For our debt outstandingat January 1, 2006, a hypothetical 10% adverse change in interest rateswould increase our annual interest expense by an estimated $0.4 million. Prospectively we expect our interest expense to increase based on higherinterest rates and potentially continued higher outstanding debt levels underour term loan and revolving credit facility (see Liquidity and CapitalResources) in the event that our appeal in the Nilssen patent infringementaward is not successful and we are required to pay the award.

 

***Foreign CurrencyExchange 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.

 

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 loweramount and accordingly, the effect on net income would be mitigated.

 

We had no foreign currency contracts outstanding at January 1,2006 or July 3, 2005.

 

**Item 4 – Controls and Procedures**

 

In connection with this Form 10-Q, under the direction of ourChief Executive Officer and Chief Financial Officer, we evaluated ourdisclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and15d-15(e), and internal control over financial reporting and concluded that (i) ourdisclosure controls and procedures were effective as of January 1,2006, and (ii) no change in internal control over financial reportingoccurred during the quarter ended January 1, 2006, that hasmaterially affected, or is reasonably likely to materially affect, suchinternal control over financial reporting.

 

**PART II – OTHER INFORMATION**

 

**Item1 – Legal Proceedings**

 

In April 1998, Mr. Ole K. Nilssen (“Nilssen”) filed a lawsuitin the 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 countermotion

 

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to vacate the award on grounds that it was fraudulently obtained arepending in the U.S. District Court for the Northern District of Illinois. Magnetek’s request for oral argument was granted and the hearing was held on October 19,2005.  The judge is expected to render his decision by mail after furtherconsideration.  An unfavorable decision by the Court could result inpayment of the award by the Company to Nilssen in the amount of $22.6 million(the arbitration 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 the period such payment would be made.  In November 2005, the Company deposited$22.6 million into an escrow account to ensure that it is able to satisfy theNilssen arbitration award in the event that its appeal of the award is notsuccessful.

 

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 andTrademark Office (“PTO”) has accepted ULT’s request for reexamination of thefour remaining patents.  A motion for summary judgment that various claimsof the patents at issue are invalid and that the accused ULT products do notinfringe a claim of one of the patents was filed on November 1, 2005 butno hearing had been set as of January 5, 2006 when the Court granted ULT’smotion to stay proceedings in the lawsuit pending the PTO reexamination.  The Company will continue to aggressivelydefend the claims against ULT  however, adecision in the lawsuit that is ultimately unfavorable to ULT could have amaterial adverse effect on the Company’s financial position, cash flows andresults of operations as a result of its indemnification obligations.

 

**Item 1A– Risk Factors**

 

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

 

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

 

Therewere no unregistered sales of equity securities and there were no repurchasesof equity securities during the Company’s second fiscal quarter ended January 1,2006.

 

**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     Certificationof the Chief Executive Officer pursuant to Rule 13a-14(a) of theSecurities Exchange Act of 1934. *

 

31.2     Certificationof the Chief Financial Officer pursuant to Rule 13a-14(a) of theSecurities Exchange Act of 1934. *

 

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32.1     Certificationpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002. *

 

10.1     FirstAmendment to Credit Agreement and Waiver dated as of November 29, 2005,among the Company, certain subsidiaries of the Company party thereto, thelenders party thereto and Wells Fargo Foothill, Inc., as administrativeagent.**

 

10.2     AmendmentNo. 1 to Financing Agreement dated as of November 29, 2005, among theCompany, certain subsidiaries of the Company party thereto, the lenders partythereto and Ableco Finance LLC, as collateral agent and administrative agent.**

 

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*              Filedwith this Report on Form 10-Q.

 

**           Incorporatedby reference to the Registrant’s Report on Form 8-K filed December 6,2005, file number 1-10233.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                          |                            | MAGNETEK,  INC.       |
|-------------------------------|---------------------------------|-----------------------|
|                          |                            | (Registrant)          |
|                          |                            |
|                          |                            |
| Date:  February 10, 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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