Overview

We provide electrical and mechanical solutions to industrial, commercial and institutional customers primarily in the United States. We currently operate in three business segments:

· Industrial Services - We provide maintenance and repair services to several industries including electric motor and wind power; repairing, manufacturing, and remanufacturing industrial lifting magnets for the steel and scrap industries.

· Construction and Engineering Services - We provide a wide range of electrical and mechanical contracting services, mainly to industrial, commercial, and institutional customers.

· Rail Services - We manufacture and rebuild power assemblies, engine parts, and other components related to large diesel engines and provide locomotive maintenance, remanufacturing, and repair services for the rail industry.

We evaluate the performance of our business segments based on net income or loss. Corporate administrative and support services for MISCOR are not allocated to the segments but are presented separately.

Recent Developments

On July 22, 2009, the Company and Wells Fargo executed a second Fourth Amendment to the Credit Agreement (the "second Fourth Amendment"). The second Fourth Amendment amended the Credit Agreement in the following respects:

· Revised the definition of "Borrowing Base", resulting in lower available borrowings

· Adjusted the interest rate on the revolving credit line and term notes (defined in the Credit Agreement as the "LIBOR Advance Rate") to the Daily Three Month LIBOR (0.56% at July 5, 2009) plus 8.25%, effective June 1, 2009

· Lowered the amount of the minimum EBITDA that the Company is required to achieve in future periods

· Requires the Company to raise $2 million in additional capital by August 31, 2009 through subordinated debt, asset sales or additional cash equity

· Lowered eligible progress accounts advance rates by $50 per week commencing August 3, 2009.

· Lowered the special accounts advanced rate to 35% effective July 22, 2009 further reducing it to 30% effective August 31, 2009 or such lesser rate the lender may determine

· Added conditions regarding marketing assets, the validation of the Company's cash flow forecast and future financial projections

In connection with the second Fourth Amendment, the Company agreed to pay Wells Fargo an accommodation fee equal to $50,000, payable on the date of execution of the second Fourth Amendment.

If we fail to comply with the covenants under the second Fourth Amendment, there can be no assurance that Wells Fargo will consent to a further amendment of the Credit Agreement. In this event, the lenders could cause the related indebtedness to become due and payable prior to maturity or it could result in the Company having to refinance this indebtedness under unfavorable terms. If our debt were accelerated, our assets might not be sufficient to repay our debt in full. Further, if current unfavorable credit market conditions were to persist throughout the remainder of 2009, there can be no assurance that we will be able to refinance any or all of this indebtedness.

While we explore asset sales, divestitures and other types of capital raising alternatives in order to reduce indebtedness under the Credit Agreement prior to expiration of the Amendment, there can be no assurance that such activities will be successful or generate cash resources adequate to retire or sufficiently reduce this indebtedness.

Beginning in October 2008 and continuing throughout the first half of 2009, the Industrial Services and Rail Services segments have experienced a decline in backlog and revenues driven by the downturn in the current US economy.

We initiated a number of actions beginning in the fourth quarter of 2008 to mitigate the impact on the Company of the unprecedented deterioration of market conditions. These actions have produced the following outcomes:

· The elimination of approximately 200 positions or approximately 27% of our work force has reduced our payroll expense by almost 20% from the fourth quarter of 2008 to the second quarter of 2009. Our 2009 second quarter payroll expense is approximately 6% less than our 2009 first quarter payroll expense.

· Our investment in the start up of the Construction and Engineering's Traffic Division has lead to new backlog of approximately $8.1 million and the division has begun to deliver positive contributions beginning with June 2009.

· Our cost cutting initiatives in the Industrial Services segment lead to a 2.1% improvement in the segment's results in the second quarter of 2009 compared to the first quarter of 2009.

We are continuing to assess the strategic fit of our various businesses and are considering additional divestitures where businesses do not align with our long-term vision. We will explore a number of strategic alternatives for under-performing or non-strategic businesses including possible divestures. We generally announce publicly divesture and acquisition transactions only when we have entered into definitive agreements relative to those transactions.

Critical Accounting Policies and Estimates

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Principles of consolidation. The consolidated financial statements for the three and six months ended July 5, 2009 and June 29, 2008 include our accounts and those of our wholly-owned subsidiaries, Magnetech Industrial Services, Inc., Martell Electric, LLC, Ideal Consolidated, Inc., HK Engine Components, LLC, American Motive Power, Inc. ("AMP") and Magnetech Power Services LLC. All significant intercompany balances and transactions have been eliminated.

Use of estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Significant estimates are required in accounting for inventory costing, asset valuations, costs to complete and depreciation. Actual results could differ from those estimates.

Revenue recognition. Revenue in our Industrial Services segment consists primarily of product sales and service of industrial magnets, and electric motors. Product sales revenue is recognized when products are shipped and both title and risk of loss transfer to the customer. Service revenue is recognized when all work is completed and the customer's property is returned. For services to a customer's property provided at our site, property is considered returned when the customer's property is shipped back to the customer and risk of loss transfers to the customer. For services to a customer's property provided at the customer's site, property is considered returned upon completion of work. We provide for an estimate of doubtful accounts based on specific identification of customer accounts deemed to be uncollectible and historical experience. Our revenue recognition policies are in accordance with Staff Accounting Bulletin No. 101 and No. 104.

Revenues from the Rail Services and Construction and Engineering Services segments are recognized on the percentage-of-completion method, measured by the percentage of costs incurred to date to estimated total costs to complete for each contract. Costs incurred on contracts in excess of customer billings are recorded as part of other current assets. Amounts billed to customers in excess of costs incurred on contracts are recorded as part of other current liabilities.

Cash Equivalents. The Company considers all highly liquid investments with maturities of three months or less from the purchase date to be cash equivalents.

Concentration of credit risk. The Company maintains its cash and cash equivalents primarily in bank deposit accounts. The Federal Deposit Insurance Corporation insures these balances up to $250,000 per bank. The Company has not experienced any losses on its bank deposits and management believes these deposits do not expose the Company to any significant credit risk.

Earnings per share. We account for earnings (loss) per common share under the provisions of SFAS No. 128, Earnings Per Share, which requires a dual presentation of basic and diluted earnings (loss) per common share. Basic earnings (loss) per common share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the year. Diluted earnings (loss) per common share is computed assuming the conversion of common stock equivalents, when dilutive.

Foreign Currency Translation. The assets and liabilities of the Company's Canadian operations are translated into U.S. dollars at the rate of exchange in effect at the balance sheet date, except for non-monetary assets and liabilities, which are translated using the historical exchange rate. Income and expense accounts are translated into U.S. dollars at the year-to-date average rate of exchange, except for expenses related to those balance sheet accounts that are translated using historical exchange rates. The impact of foreign currency translation on the Company's financial statements was not material for the three and six months ended July 5, 2009.

Segment information. We report segment information in accordance with Statement of Financial Accounting Standards ("SFAS") No. 131, Disclosures about Segments of an Enterprise and Related Information.

Goodwill and Intangibles. We account for goodwill and other intangible assets in accordance with FASB Statement No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets." Goodwill represents the excess of the cost of acquired businesses over the fair market value of their net assets at the dates of acquisition. Goodwill, which is not subject to amortization, is tested for impairment annually during the fourth quarter. We test goodwill and other intangible assets for impairment on an interim basis if an event occurs that might reduce the fair value of a reporting unit below its carrying value. Recoverability of goodwill is evaluated using a two-step process. The first step involves a comparison of the fair value of a reporting unit with its carrying value. If the carrying amount of the reporting unit exceeds its fair value, then the second step of the process involves a comparison of the implied fair value and carrying value of the goodwill of that reporting unit. If the carrying value of the goodwill of a reporting unit exceeds the fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess. Reporting units are determined based on our operating segments. The AMP, MIS, and Ideal operating segments, which were also determined to be reporting units under SFAS 142, contain goodwill and are thus tested for impairment. We re-evaluate our reporting units and the goodwill and intangible assets assigned to the reporting units annually, prior to the completion of the impairment testing. The fair value of our reporting units is determined based upon management's estimate of future discounted cash flows and other factors. Management's estimates of future cash flows include assumptions concerning future operating performance and economic conditions and may differ from actual future cash flows.

Other intangible assets consisting mainly of customer relationships, a technical library, and non-compete agreements were all determined to have a definite life and are amortized over the shorter of the estimated useful life or contractual life of the these assets, which range from 1 to 20 years. Intangible assets with definite useful lives are periodically reviewed to determine if facts and circumstances indicate that the useful life is shorter than originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances do exist, the recoverability of intangible assets is assessed by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairments, if any, are based on the excess of the carrying amount over the fair value of those assets (See Note E, Goodwill and Other Intangible Assets).

Inventory. We value inventory at the lower of cost or market. Cost is determined by the first-in, first-out method. We periodically review our inventories and make adjustments as necessary for estimated obsolescence and excess goods. The amount of any markdown is equal to the difference between cost of inventory and the estimated market value based upon assumptions about future demands, selling prices and market conditions.

Property, plant and equipment. Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed over the estimated useful lives of the related assets using the straight-line method. Useful lives of property, plant and equipment are as follows:

                 Buildings                             30 years
                 Leasehold                             Shorter of lease term or useful life
                 improvements
                 Machinery and                         5 to 10 years
                 equipment
                 Vehicles                              3 to 5 years
                 Office and computer equipment         3 to 10 years

Long-lived assets. We assess long-lived assets for impairment whenever events or changes in circumstances indicate that an asset's carrying amount may not be recoverable.

Debt issue costs. We capitalize and amortize costs incurred to secure senior debt financing and revolving notes over the term of the financing, which is three years. Modifications related to the Company's revolving note and term notes are accounted for under the provisions of EITF 98-14 "Debtors Accounting for Changes in Line-of-Credit or Revolving-Debt Arrangements" and EITF 96-19 "Debtors Accounting for a Modification or Change of Debt Instruments".

Advertising costs. Advertising costs consist mainly of product advertisements and announcements published in trade publications, and are expensed when incurred.

Warranty costs. We warrant workmanship after the sale of our products. We record an accrual for warranty costs based upon the historical level of warranty claims and our management's estimates of future costs.

Income taxes. We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes and FASB Interpretation No. 48.

Stock-based compensation. Effective January 1, 2006, we adopted SFAS No. 123R, Share-Based Payments (revised 2004), using the Modified Prospective Approach. SFAS No. 123R revises SFAS No. 123, Accounting for Stock-Based Compensation and supersedes Accounting Principles Opinion ("APB") No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires the cost of all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based upon their fair values at grant date, or the date of later modification, over the requisite service period. In addition, SFAS No. 123R requires unrecognized cost (based on the amounts previously disclosed in our pro forma footnote disclosure) related to options vesting after the initial adoption to be recognized in the financial statements over the remaining requisite service period.

Under the Modified Prospective Approach, the amount of compensation cost recognized includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Prior to the adoption of SFAS No. 123R, we accounted for our stock-based compensation plans under the recognition and measurement provisions of APB No. 25.

New Accounting Standards.

SFAS No. 168

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No. 162 ("SFAS No. 168"). SFAS No. 168 establishes the FASB Accounting Standards Codification (the "Codification") as the single official source of authoritative U.S. GAAP (other than guidance issued by the Securities and Exchange Commission), and supersedes existing FASB, American Institute of Certified Public Accountants, Emerging Issues Task Force, and related literature. The Codification did not change GAAP, but reorganizes the literature. SFAS No. 168 is effective for interim and annual reporting periods ending after September 15, 2009. The Company will apply the Codification beginning with its third quarter ending October 4, 2009, and does not expect SFAS No. 168 to have material impact on its consolidated financial statements.

SFAS No. 167

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) ("SFAS No. 167"). SFAS No. 167 amends certain requirements of FASB Interpretation 46 (revised December 2003), Consolidation of Variable Interest Entities, to change the process for how an enterprise determines which party consolidates a variable interest entity ("VIE") to a primary qualitative analysis. SFAS No. 167 defines the party that consolidates the VIE as the party with (1) the power to direct activities of the VIE that most significantly affect the VIE's economic performance and (2) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE. Upon adoption of SFAS No. 167, reporting entities must reconsider their conclusions on whether an entity should be consolidated and, should a change result, the effect on net assets will be recorded as a cumulative effect adjustment to retained earnings. SFAS No. 167 is effective for reporting periods beginning after November 15, 2009. The Company is currently evaluating the impact that the adoption of SFAS No. 167 will have on its consolidated financial statements.

SFAS No. 166

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140 ("SFAS No. 166"). SFAS No. 166 limits the circumstances in which a financial asset may be de-recognized when the transferor has not transferred the entire financial asset or has continuing involvement with the transferred asset. The concept of a qualifying special-purpose entity, which had previously facilitated sale accounting for certain asset transfers, is removed by SFAS No. 166. SFAS No. 166 is effective for annual reporting periods beginning after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The Company does not expect the adoption of SFAS No. 166 to have a material impact on its consolidated financial statements.

SFAS No. 165

In June 2009, the FASB issued SFAS No. 165, Subsequent Events ("SFAS No. 165"). SFAS No. 165 establishes general standards of accounting for disclosure of events that occur after the balance sheet date but before financial statements are issued. In particular, SFAS No. 165 sets forth the period after the balance sheet date during which management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS No. 165 is effective for interim or annual financial periods ending after June 15, 2009. The adoption of SFAS No. 165 by the Company in the second quarter of 2009 did not have a material impact on the Company's consolidated financial statements.

FSP FAS 157-4

In April 2009, the FASB issued FSP FAS 157-4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly" ("FSP 157-4"), which provides guidance on determining fair value when there is no active market or where the price inputs being used represent distressed sales. FSP 157-4 is effective for interim and annual periods ending after June 15, 2009. The adoption of FSP FAS 157-4 by the Company in the second quarter of 2009 did not have a material impact on the Company's consolidated financial statements.

FSP FAS 107-1 and APB 28-1

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1 "Interim Disclosures about Fair Value of Financial Instruments". ("FSP FAS 107-1 and APB 28-1"). FSP FAS 107-1 and APB 28-1 requires fair value disclosures of financial instruments for interim reporting periods for publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion no. 28-1, "Interim Financial Reporting", to require those disclosures in summarized financial information at interim reporting periods and is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of FSP FAS 107-1 and APB 28-1 by the Company in the second quarter of 2009 did not have a material impact on the Company's consolidated financial statements.

Results of Operations

Three Months Ended July 5, 2009 Compared to Three Months Ended June 29, 2008

Revenues. Total revenues decreased by $11.2 million or 36% to $19.4 million for the three months ended July 5, 2009 from $30.6 million for the three months ended June 29, 2008. The decrease in revenues resulted from decreases in the Industrial Services ("IS") segment revenue of $6.9 million or 50%, the Construction and Engineering Services ("CES") segment revenues of $.6 million or 7%, and the Rail Services ("RS") segment revenue of $3.6 million or 48%.

The decline in revenue is generally related to the ongoing challenging global economic conditions as well as our continuing liquidity pressures (see liquidity and capital resources section below). Specifically, the decrease in IS segment revenue resulted from decline in the steel industry and the decrease in RS segment revenue resulted from the decline in the railroad industry.

Gross Profit. Total gross profit for the three months ended July 5, 2009 was $1.5 million or 7.6% of total revenues compared to $5.1 million or 16.6% of total revenues for the three months ended June 29, 2008. The decrease of $3.6 million or 71% was due to decreased consolidated revenues and the company's level of fixed costs. Gross profit on IS segment revenue declined 77%, due mainly to unabsorbed overhead costs. Gross profit on CES revenue declined 53%, due to cost overruns on certain large electrical contracts. Gross profit on RS segment revenue declined 78% due to unabsorbed overhead costs.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $4.2 million for the three months ended July 5, 2009 compared to $4.1 million for the three months ended June 29, 2008. Costs have been reduced during 2009; however, the reductions have been offset by a non recurring charge for AMP NY booked in the quarter ended June 29, 2009 and operations that didn't exist during the three months ended June 29, 2008 (AMP Montreal and the Traffic division of Martell Electric, LLC).

Interest Expense and Other Income. Interest expense and other income did not significantly change from the three months ended June 29, 2008 to the three months ended July 5, 2009.

Provision for Income Taxes. We have experienced net operating losses in each year since we commenced operations. In January 2007, an ownership change occurred that will limit the amount of net operating loss that we will be able to use in future periods in accordance with Section 382 of the Internal Revenue Code, as amended. We are uncertain as to whether we will be able to utilize these tax losses before they expire. Accordingly, we provided a valuation allowance for the income tax benefits associated with these net future tax assets that primarily relate to cumulative net operating losses, until such time profitability is reasonably assured and it becomes more likely than not that we will be able to utilize such tax benefits.

Net Income. Net loss for the three months ended July 5, 2009 was $2.8 million compared to net income of $0.6 million for the three months ended June 29, 2008. The $3.4 million decrease was due to the decline in revenues and cost levels as discussed in the revenue, gross profit and selling, general, and administrative sections above.

Six Months Ended July 5, 2009 Compared to Six Months Ended June 29, 2008

Revenues. Total revenues decreased by $17.5 million or 29% to $42.8 million for the six months ended July 5, 2009 from $60.3 million for the six months ended June 29, 2008. The decrease in revenues resulted from decreases in the Industrial Services ("IS") segment revenue of $12.1 million or 41%, the Construction and Engineering Services ("CES") segment revenues of $1.3 million or 8%, and the Rail Services ("RS") segment revenue of $4 million or 28%.

The decline in revenue is generally related to the ongoing challenging global economic conditions as well as our continuing liquidity pressures (see liquidity and capital resources section below). Specifically, the decrease in IS segment revenue resulted from decline in the steel industry and the decrease in RS segment revenue resulted from the decline in the railroad industry.

Gross Profit. Total gross profit in the six months ended July 5, 2009 was $3.2 million or 7.4% of total revenues compared to $9.8 million or 16.3% of total revenues in the six months ended June 29, 2008. The decrease of $6.6 million or 67.8% was due to decreased consolidated revenues and the level of fixed costs. Gross profit on IS segment revenue declined 78%, due mainly to unabsorbed overhead costs. Gross profit on CES revenue declined 50%, due to cost overruns on certain larger electrical contracts. Gross profit on RS segment revenue declined 49% due to unabsorbed overhead costs.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $9.3 million in the six months ended July 5, 2009 compared to $8.1 million in the six months ended June 29, 2008. Costs have been reduced during the six months ended July 5, 2009; however, the reductions have been offset by fees related to Wells Fargo, a non recurring fee for AMP NY and operations that didn't exist during the six months ended June 29, 2008 (AMP Montreal and the Traffic division of Martell Electric, LLC).

Interest Expense and Other Income. Interest expense and other income did not significantly change from the six months ended June 29, 2008 to the six months ended July 5, 2009.

Provision for Income Taxes. We have experienced net operating losses in each year since we commenced operations. In January 2007, an ownership change occurred that will limit the amount of net operating loss that we will be able to use in future periods in accordance with Section 382 of the Internal Revenue . . .