Overview

Magnetek, Inc. ("Magnetek," "the Company," "we," or "us" ) is a global provider of digital power control systems that are used to control motion and power primarily in material handling, elevator, and energy delivery applications. Our systems consist primarily of programmable motion control and power conditioning systems used in the following applications: overhead cranes and hoists; elevators; coal mining equipment; and alternative energy applications, including wind turbines and photovoltaic systems. Our products are sold directly or through manufacturers' representatives to original equipment manufacturers ("OEMs") for incorporation into their products, to system integrators and value-added resellers for assembly and incorporation into end-user systems, to distributors for resale to OEMs and contractors, and to end-users for repair and replacement purposes. We believe that with our technical and productive resources we are well positioned to respond to increasing demand in our served markets. We operate in a single segment, Digital Power Control Systems. Magnetek was founded in July 1984 and is listed on the New York Stock Exchange (NYSE: MAG). Our operations are located in North America, predominantly in Menomonee Falls, Wisconsin, our Company headquarters.

Product offerings for material handling applications include drive systems, radio remote controls, and braking, collision-avoidance, and electrification subsystems, sold primarily to OEMs of overhead cranes and hoists. We have a significant market share in North America in alternating current ("AC") control systems and believe we have growth opportunities in direct current ("DC") control systems for retrofit applications, wireless remote controls and in automating existing manual material handling processes.

Our product offerings for elevator applications are comprised of highly integrated subsystems and drives used to control motion primarily in high-rise, high speed elevator applications. Our products are sold mainly to elevator OEMs and we have a significant share of the available market for DC drives and subsystems used in high-rise elevators for both new and retrofit projects. We believe we have opportunities for growth in available elevator markets by introducing new energy-saving product offerings for DC applications, expanding the breadth of our product offering to include competitive low-end products for lower performance AC applications, and using our new product offerings to expand geographically.

Our product offerings for energy delivery applications include power inverters for alternative energy applications, including wind turbines and photovoltaic installations, which deliver AC power to the utility grid from generators inside wind turbines or from solar panels, or deliver power for consumption at the source. Both the wind and solar markets have grown rapidly in North America over the past several years as wind and solar power are becoming increasingly competitive from a cost standpoint with more traditional methods of power generation. We believe our product offerings have us well positioned to take advantage of growth in alternative energy markets and expect sales of power inverters for alternative energy applications to be our fastest revenue growth product over the next several years.

Continuing Operations

We focus on a variety of key indicators to monitor our business performance. These indicators include order rates, sales growth, gross profit margin, operating profit margin, net income, earnings per share, and working capital and cash flow measures. These indicators are compared to our operating plans as well as to our prior year actual results, and are used to measure our success relative to our company objectives. Our company objectives are to grow sales at least 10% on a year-over year basis, to achieve 30% gross margins and 10% operating profit margins, and to generate sufficient cash flow to fund our operations and meet our obligations.

During the second quarter of fiscal 2009, we achieved 5% year-over-year sales growth from the second quarter of fiscal 2008 due to continued strong demand for our products as well as successful introduction and acceptance of new products in our served markets. Second quarter fiscal 2009 sales were $26.8 million compared to second quarter fiscal 2008 sales of $25.4 million, as we experienced year-over-year sales growth in our material handling and elevator product lines. Sales of energy delivery products were lower in the second quarter of fiscal 2009, as increased sales of mining products were not enough to offset larger declines in alternative energy products. While we completed production of the remaining units under our initial order for E-Force wind inverters during the first quarter of fiscal 2009, at our customer's request, we have not yet shipped those units. We expect to ship those units during the third quarter of fiscal 2009. Fiscal 2009 second quarter gross margin was 35.1% compared to fiscal 2008 second quarter gross margin of 27.6%, and operating profit margin was 7.3% in the second quarter of fiscal 2009 compared to 7.2% in the second quarter of fiscal 2008. The improvement in gross margin, mainly due to higher volume and favorable sales mix, was largely offset by a management restructuring charge of $0.9 million and an increase in our non-cash pension expense of $0.8 million, and as a result, our operating profit improved only modestly in the second quarter of fiscal 2009 compared to the second quarter of fiscal 2008. In addition, our cash balances increased by $1.0 million during the second quarter of fiscal 2009, even after making a $1.6 million contribution to our defined benefit pension plan, and we have no debt outstanding as of December 28, 2008.

In the fourth quarter of fiscal 2008, we classified the assets and liabilities of our telecom power systems ("TPS") business as held for sale, and the results of operations of the business as discontinued operations. Our TPS product offerings were focused on providing back-up power for wireless applications. We believe we can better achieve our sales growth objectives by redirecting certain resources deployed in the TPS business to our product offerings in the material handling, elevator and energy delivery markets. We completed the divestiture of the TPS business during the first quarter of fiscal 2009 (see Note 2 of Notes to Condensed Consolidated Financial Statements).

We believe that future increased profitability is dependent upon increased sales revenue and continued improvement in gross margins. Our past sales growth has been, and we believe our fiscal 2009 sales growth will continue to be, dependent on continuing strong demand for material handling products, our customers' ability to obtain financing and willingness to invest in the current economic environment, and successful introduction and increasing acceptance of new products, mainly in the elevator and alternative energy markets. Recently introduced product offerings are gaining acceptance with customers in the marketplace, however, the rate of sales growth of new product offerings is slower than we expected. While we believe we can continue to achieve year-over-year sales growth with existing product offerings and new product introductions, we may pursue selective external growth opportunities to enhance or expand our product offerings, market channels or technical resources. In addition, our material handling business is influenced by cyclical forces in the industrial marketplace, and we have recently seen signs of a softening in demand in certain of our served markets, mainly in the automotive and primary metals industries. A cyclical slowdown could negatively impact our sales growth rate, as sales of material handling product offerings comprised nearly 70% of our sales in fiscal 2008.

Gross margins in our continuing operations have historically been near or above 30% and we are targeting this level of gross margin going forward. Improvement in gross margins is mainly dependent upon favorable economic conditions, continued acceptance of recently introduced product offerings by the marketplace, and successful cost reduction actions related to recently introduced elevator and alternative energy product offerings.

We intend to focus our development and marketing efforts on internal sales growth opportunities across all product lines, with an emphasis on energy efficient power products. While we have continued to focus on controlling our operating expenses, these expenses increased in the second quarter of fiscal 2009 over the second quarter of fiscal 2008, mainly due to a management restructuring charge and higher non-cash pension expense. The higher pension expense will recur throughout fiscal 2009 and is mainly due to negative returns on plan assets experienced during fiscal 2008 and continuing through the second quarter of fiscal 2009 (see Note 8 of Notes to Condensed Consolidated Financial Statements).

We expect that fiscal 2009 operating margin as a percent of sales will likely be comparable to fiscal 2008 operating margins of 6.8%, due mainly to higher gross profit offset by higher pension expense. Through utilization of our net operating loss carryforwards for U.S. tax purposes, we believe the majority of our reported operating profit can be realized as net income.

Discontinued Operations

As discussed above, the operating results of the TPS business as well as certain expenses related to previously divested businesses have been classified as discontinued operations in the accompanying condensed consolidated financial statements and footnotes for all periods presented (see Note 2 of Notes to Condensed Consolidated Financial Statements). Expenses related to previously divested businesses have historically included charges for an arbitration award in a patent infringement claim and related legal fees, as well as certain expenses for environmental matters, asbestos claims and product liability claims (see Note 4 of Notes to Condensed Consolidated Financial Statements). All of these issues relate to businesses we no longer own and most relate to indemnification agreements we provided when we divested those businesses.

Going forward, our results of discontinued operations may include additional costs incurred related to businesses no longer owned, and may include additional costs above those currently estimated and accrued related to the divestiture of our TPS business and our power electronics business, divested in October 2006.

Critical Accounting Policies and Estimates

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", included in our Annual Report on Form 10-K for the fiscal year ended June 29, 2008.

Results of Operations - Three Months Ended December 28, 2008 and December 30, 2007

Net Sales and Gross Profit

Net sales for the three months ended December 28, 2008, were $26.8 million, an increase of 5.4% from the three months ended December 30, 2007, sales of $25.4 million. The increase in sales was due to higher sales volumes in our material handling and elevator product lines, offset by lower sales in our energy delivery product line. Net sales by product line were as follows, in millions:

                                       Three Months Ended
                            December 28, 2008       December 30, 2007
Material handling         $      19.7        74 % $      18.1        71 %
Elevator motion control           4.9        18 %         4.3        17 %
Energy delivery                   2.2         8 %         3.0        12 %

Total net sales           $      26.8       100 % $      25.4       100 %

Gross profit for the three months ended December 28, 2008, was $9.4 million, or 35.1% of sales, versus $7.0 million, or 27.5% of sales, for the three months ended December 30, 2007. The increase in gross profit as a percentage of sales for the three months ended December 28, 2008, as compared to the three months ended December 30, 2007, was due to higher sales volume of material handling and elevator products, increased sales of higher margin mining products, and favorable sales mix within our material handling and elevator products.

Research and Development, Selling, General and Administrative

Research and development ("R&D") expense was $0.9 million, or 3.4% of sales, for the three months ended December 28, 2008, comparable to R&D expense of $0.9 million, also 3.4% of sales, for the three months ended December 30, 2007.

Selling, general and administrative ("SG&A") expense was $6.6 million (24.5% of sales) for the three months ended December 28, 2008, versus $4.3 million (17.0% of sales) for the three months ended December 30, 2007. Selling expenses in the three months ended December 28, 2008, were $2.6 million, comparable to $2.6 million in the three months ended December 30, 2007. General and administrative ("G&A") expense was $4.0 million for the three months ended December 28, 2008, compared to $1.7 million for the three months ended December 30, 2007, mainly due to a restructuring charge related to management reorganization of $0.9 million, an increase in pension expense of $0.8 million, and higher incentive compensation provisions.

Income from Operations

Income from operations for the three months ended December 28, 2008, was $1.9 million compared to income from operations of $1.8 million for the three months ended December 30, 2007. The improvement in income from operations for the three months ended December 28, 2008, as compared to the three months ended December 30, 2007, was due to higher gross profit on increased sales volume, partially offset by increased SG&A expense.

Interest Income and Expense

Interest income was $0.1 million for the three months ended December 28, 2008. Interest income was $0.3 million and interest expense was $0.1 million for the three months ended December 30, 2007. The decrease in interest income in the three months ended December 28, 2008, as compared to the three months ended December 30, 2007, was due to lower cash balances held in short-term investments and reduced interest rates earned on cash balances. Interest expense for the three months ended December 30, 2007, was comprised mainly of deferred financing amortization.

Provision for Income Taxes

We recorded an income tax provision of $0.7 million for the three months ended December 28, 2008, and $0.2 million for the three months ended December 30, 2007. The tax provision for the three months ended December 28, 2008, includes $0.5 million for income taxes on our pretax income in Canada (see Note 9 of Notes to Condensed Consolidated Financial Statements). The tax provision in both periods includes non-cash deferred tax provisions of $0.2 million related to changes in deferred tax liabilities from goodwill amortization.

Income from Continuing Operations

We recorded income from continuing operations of $1.3 million for the three months ended December 28, 2008, or $0.04 earnings per share on both a basic and diluted basis, compared to income from continuing operations of $1.8 million for the three months ended December 30, 2007, or $0.06 earnings per share on both a basic and diluted basis.

Income from Discontinued Operations

Income from discontinued operations for the three months ended December 28, 2008, was $0.7 million, or $0.02 earnings per share on both a basic and diluted basis, compared to income from discontinued operations of $0.8 million, or $0.03 earnings per share on both a basic and diluted basis, for the three months ended December 30, 2007. Income from discontinued operations in the three months ended December 28, 2008, includes a settlement gain of $0.5 million from a previous agreement with Federal-Mogul, as well as income of $0.5 million related to previously divested businesses, partially offset by expenses related to previously divested businesses of $0.3 million. Income from discontinued operations for the three months ended December 30, 2007, includes a settlement gain of $1.4 million from a previous agreement with Federal-Mogul, partially offset by losses of $0.4 million in our TPS business and $0.2 million of expenses related to previously divested businesses.

Net Income

Our net income was $1.9 million in the three months ended December 28, 2008, or $0.06 earnings per share, basic and diluted, compared to net income of $2.6 million in the three months ended December 30, 2007, or $0.08 earnings per share on a diluted basis.

Results of Operations - Six Months Ended December 28, 2008 and December 30, 2007

Net Sales and Gross Profit

Net sales for the six months ended December 28, 2008, were $53.1 million, an increase of 10.2% from the six months ended December 30, 2007, sales of $48.2 million. The increase was due to higher sales volume in each of our main product lines, and includes $1.6 million in sales of products from the business we acquired from Enrange LLC ("Enrange") in February 2008. Net sales by product line were as follows, in millions:

                                        Six Months Ended
                            December 28, 2008       December 30, 2007
Material handling         $      38.0        72 % $      35.3        73 %
Elevator motion control          10.3        19 %         8.8        18 %
Energy systems                    4.8         9 %         4.1         9 %

Total net sales           $      53.1       100 % $      48.2       100 %

Gross profit for the six months ended December 28, 2008, was $18.8 million, or 35.5% of sales, versus $13.8 million, or 28.7% of sales, for the six months ended December 30, 2007. The increase in gross profit as a percentage of sales for the six months ended December 28, 2008, as compared to the six months ended December 30, 2007, was due to higher sales volume in our material handling, elevator and mining product lines, favorable sales mix within each of our main product lines, and lower sales of lower margin wind inverters. In addition, gross profit for the six months ended December 30, 2007, was negatively impacted by start-up costs and manufacturing variances related to ramp up of production of our wind inverter products.

Research and Development, Selling, General and Administrative

R&D expense was $1.8 million, or 3.3% of sales, for the six months ended December 28, 2008, comparable to R&D expense of $1.6 million, or 3.4% of sales, for the six months ended December 30, 2007. R&D expense for the six months ended December 28, 2008, reflects higher payroll costs due to headcount additions.

SG&A expense was $13.1 million (24.7% of sales) for the six months ended December 28, 2008, compared to $9.2 million (19.2% of sales) for the six months ended December 30, 2007. Selling expenses for the six months ended December 28, 2008, were $5.2 million, an increase of $0.3 million compared to $4.9 million for the six months ended December 30, 2007, due to higher volume related commissions and trade show expenses. G&A expense was $7.9 million for the six months ended December 28, 2008, compared to $4.3 million for the six months ended December 30, 2007, due to higher pension expense of $1.6 million, restructuring costs related to management reorganization of $1.0 million, higher incentive compensation provisions of $1.0 million, and the inclusion of Enrange operating expenses of $0.4 million

Income from Operations

Our income from operations for the six months ended December 28, 2008, was $4.0 million compared to income from operations of $3.0 million for the six months ended December 30, 2007. The increase in income from operations for the six months ended December 28, 2008, as compared to the six months ended December 30, 2007, was mainly due to higher gross profit on increased sales volume, partially offset by increased SG&A expense.

Interest Income and Expense and Other Expense

Interest income was $0.1 million for the six months ended December 28, 2008. Interest income was $0.7 million and interest expense was $0.3 million for the six months ended December 30, 2007. The decrease in interest income for the six months ended December 28, 2008, as compared to the six months ended December 30, 2007, was due to lower cash balances and reduced interest rates earned on cash balances. Interest expense for the six months ended December 30, 2007, was comprised mainly of deferred financing amortization.

Provision for Income Taxes

We recorded an income tax provision of $1.1 million for the six months ended December 28, 2008, and $0.5 million for the six months ended December 30, 2007. The tax provision for the six months ended December 28, 2008, includes $0.6 million for income taxes on our pretax income in Canada (see Note 9 of Notes to Condensed Consolidated Financial Statements). The tax provision in both periods includes non-cash deferred tax provisions of $0.5 million related to changes in deferred tax liabilities from goodwill amortization.

Income from Continuing Operations

We recorded income from continuing operations of $3.0 million for the six months ended December 28, 2008, or $0.10 earnings per share on both a basic and diluted basis, compared to income from continuing operations of $2.8 million for the six months ended December 30, 2007, or $0.09 earnings per share on both a basic and diluted basis.

Income (Loss) from Discontinued Operations

Our loss from discontinued operations for the six months ended December 28, 2008, was $0.2 million, or a $0.01 loss per share on both a basic and diluted basis, compared income from discontinued operations of $0.2 million, or $0.01 earnings per share on both a basic and diluted basis, for the six months ended December 30, 2007. Our loss from discontinued operations for the six months ended December 28, 2008, includes a loss on the September 2008 disposal of our TPS business of $0.4 million, expenses related to previously divested businesses of $0.2 million, and losses in our TPS business of $0.1 million, partially offset by a settlement gain of $0.5 million from a previous agreement with Federal-Mogul. Income from discontinued operations for the six months ended December 30, 2007, was comprised of a settlement gain of $1.4 million from the Federal-Mogul agreement, offset by losses in our TPS business of $0.6 million and expenses related to previously divested businesses of $0.6 million.

Net Income

Our net income was $2.8 million for the six months ended December 28, 2008, or $0.10 earnings per share, basic and diluted, compared to net income of $3.1 million for the six months ended December 30, 2007, or a $0.10 earnings per share on both a basic and diluted basis.

Liquidity and Capital Resources

Our cash and cash equivalent balance, including restricted cash, increased $1.7 million during the six months ended December 28, 2008, from $15.5 million at June 29, 2008, to $17.2 million at December 28, 2008. Our primary sources of cash during the six months ended December 28, 2008, were income from operations of $4.0 million, $1.25 million from the sale of our TPS business, and a participation payment related to an annuity contract of $0.5 million, and our primary use of cash was for contributions of $4.4 million to our defined benefit pension plan. During the six months ended December 28, 2008, our net inventories increased by $4.1 million, mainly related to an increase in wind inverter inventory; however, accounts receivable decreased by $3.2 million from June 29, 2008. Our capital expenditures in the six months ended December 28, 2008, were $0.4 million. While we may make further investments to increase capacity for and improve efficiency in the production of wind inverters, we do not anticipate capital expenditures in fiscal 2009 will exceed $2.0 million. The expected amount of capital expenditures could change depending upon changes in revenue levels, our financial condition and the general economy.

In November 2007 we entered into an agreement with Associated Bank, N.A. ("Associated Bank") providing for a $10 million revolving credit facility (the "Associated facility"). Borrowings under the Associated facility bear interest at the London Interbank Offering Rate ("LIBOR") plus 1.5%, with borrowing levels determined by a borrowing base formula as defined in the agreement, based on the level of eligible accounts receivable. The Associated facility also supports the issuance of letters of credit, places certain restrictions on our ability to pay dividends or make acquisitions, and includes covenants which require minimum operating profit levels and limit annual capital expenditures. Borrowings under the Associated facility are collateralized by our accounts receivable and inventory. In December 2008, we entered into an amendment to the Associated facility with Associated Bank, the primary purpose of which was to extend the maturity date of the Associated facility to November 1, 2010. There were no amounts outstanding under the Associated facility and the Company is in compliance with all covenants as of December 28, 2008.

Primarily as a result of the decline in interest rates over the past several years and more recent declines in values in equity markets, the accumulated benefit obligation of our defined benefit pension plan currently exceeds plan assets. We have made contributions to the plan aggregating $9.5 million from April 2008 through January 2009, funded by existing cash on hand. Under funding regulations, current actuarial projections indicate that we will be required to make additional contributions to the plan aggregating approximately $2.8 million during the remainder of fiscal 2009 and approximately $14.2 million in fiscal 2010. Required contributions beyond fiscal 2010 could still be significant, and will depend on future interest rate levels, values in equity and fixed income markets, and the level and timing of additional interim contributions we may make to the plan.

Based upon current plans and business conditions, we believe that current cash balances, borrowing capacity under the Associated facility and internally generated cash flows will be sufficient to fund anticipated operational needs, capital expenditures and other commitments over the next 12 months.

Caution Regarding Forward-Looking Statements and Risk Factors

This document, including documents incorporated herein by reference, contains "forward-looking statements" within the meaning of the Private Securities 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-looking . . .