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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-K


(Mark One)

 

 

ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

or

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from                                    to                                     

Commission File Number 0-15760



HARDINGE INC.
(Exact name of registrant as specified in its charter)

New York   16-0470200
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

One Hardinge Drive, Elmira, New York

 

14902-1507
(Address of principal executive offices)   Zip Code

(607) 734-2281
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)



Securities pursuant to section 12(b) of the Act: None

Securities pursuant to section 12(g) of the Act:

Common Stock, $0.01 par value per share
Preferred stock purchase rights
  NASDAQ Stock Exchange
(Name of exchange on which registered)

         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No ý

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d). Yes o    No ý

         Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definite proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. ý

         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company o

         Indicate by check mark whether registrant is a shell company (as defined by Exchange Act Rule 12b-2). Yes o    No ý

         The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2008 was $143.8 million, based on the closing price of common stock on the NASDAQ Global Select Market on June 30, 2008.

         There were 11,527,990 shares of Hardinge stock outstanding as of February 28, 2009.

DOCUMENTS INCORPORATED BY REFERENCE

         Portions of Hardinge Inc.'s Proxy Statement for its 2009 Annual Meeting of Shareholders to be filed with the Commission on or about March 31, 2009 are incorporated by reference to Part III of this Form 10-K.

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PART I

ITEM 1.—BUSINESS

General

        Hardinge Inc.'s principal executive office is located at One Hardinge Drive, Elmira, New York 14902-1507; telephone (607) 734-2281. The principal executive office is located in Chemung County, New York, which is on the south-central border of upstate New York.

        Our website, www.hardinge.com, provides links to all of the Company's filings with the Securities and Exchange Commission. A copy of the 10-K is available on the website or can be obtained free of charge by contacting the Investor Relations Department at our principal executive office. Alternatively, such reports may be accessed at the Internet address of the SEC, which is www.sec.gov, or at the SEC's Public Reference Room at 10 F Street, NE, Washington, DC 20549. Information about the operation of the SEC's Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

        We are a global designer, manufacturer and distributor of machine tools, specializing in precision computer numerically controlled metal-cutting machines. The Company has the following wholly owned subsidiaries:

Canadian Hardinge Machine Tool, Ltd
Hardinge Technology Systems, Inc.
Hardinge Holdings, GmbH
Hardinge GmbH
Hardinge Machine Tools, Ltd.
Hardinge Machine Tools B.V.
L. Kellenberger & Co. AG
Hardinge China, Limited
Hardinge Machine (Shanghai) Co., Ltd.
Hardinge Taiwan Precision Machinery Limited
Hardinge Machine Tools B.V., Taiwan Branch ("Hardinge Taiwan")
  Toronto, Ontario, Canada
Elmira, New York
St. Gallen, Switzerland
Krefeld, Germany
Leicester, England
Raamsdonksveer, Netherlands
St. Gallen, Switzerland
Hong Kong, People's Republic of China
Shanghai, People's Republic of China
Nan Tou City, Taiwan, Republic of China
Nan Tou City, Taiwan, Republic of China

        We have manufacturing facilities located in Chemung County, New York; St. Gallen, Switzerland; Biel, Switzerland; Nan Tou City, Taiwan; and Shanghai, People's Republic of China. We manufacture the majority of the products we sell.

        Unless otherwise mentioned or unless the context requires otherwise, all references to "Hardinge," "we," "us," "our," "the Company" or similar references mean Hardinge Inc. and its predecessors together with its subsidiaries.

Products

        We supply high precision computer controlled metal-cutting turning machines, grinding machines, vertical machining centers, and accessories related to those machines. We believe our products are known for accuracy, reliability, durability and value.

        We have been a manufacturer of industrial-use high precision and general precision turning machine tools since 1890. Turning machines, or lathes, are power-driven machines used to remove material from either bar stock or a rough-formed part by moving multiple cutting tools against the surface of a part rotating at very high speeds in a spindle mechanism. The multi-directional movement of the cutting tools allows the part to be shaped to the desired dimensions. On parts produced by our machines, those dimensions are often measured in millionths of an inch. We consider Hardinge to be a

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leader in the field of producing machines capable of consistently and cost-effectively producing parts to very close dimensions.

        Grinding is a machining process in which a part's surface is shaped to closer tolerances with a rotating abrasive wheel or tool. Grinding machines can be used to finish parts of various shapes and sizes. The grinding machines of our Kellenberger subsidiary are used to grind the inside and outside diameters of cylindrical parts. Such grinding machines are typically used to provide a more exact finish on a part that has been partially completed on a lathe. The grinding machines of Kellenberger, which are manufactured in both computer and manually controlled models, are generally purchased by the same type of customers as other Hardinge equipment and further our ability to be a primary source for our customers.

        Our Kellenberger precision grinding technology is complemented by the Hauser, Tripet and Tschudin grinding brands. Hauser machines are jig grinders used to make demanding contour components, primarily for tool and mold-making applications. Tripet and Tschudin product technology is focused on the specialized grinding of cylindrical parts when the customer requires high volume production. Our Tschudin and Tripet machines are generally equipped with automatic loading and unloading mechanisms for the part being machined. These loading and unloading mechanisms significantly reduce the level of involvement a machine operator has to perform in the production process.

        Machining centers cut material differently than a turning machine. These machines are designed to remove material from stationary, prismatic or box-like parts of various shapes with rotating tools that are capable of milling, drilling, tapping, reaming and routing. Machining centers have mechanisms that automatically change tools based on commands from a built-in computer control without the assistance of an operator. Machining centers are generally purchased by the same customers who purchase other Hardinge equipment. We supply a broad line of machining centers addressing a range of sizes, speeds and powers.

        Our machines are generally computer controlled and use commands from an integrated computer to control the movement of cutting tools, grinding wheels, part positioning, and in the case of turning and grinding machines, the rotation speeds of the part being shaped. The computer control enables the operator to program operations such as part rotation, tooling selection and tooling movement for a specific part and then store that program in memory for future use. The machines are able to produce parts while left unattended when connected to automatic bar-feeding, robotics equipment, or other material handling devices designed to supply raw materials and remove machined parts from the machine.

        New products are critical to our growth plans. We gain access to new products through internal product development, acquisitions, joint ventures, license agreements and partnerships. Products are introduced each year to both broaden our product offering and to take advantage of new technologies available to us. These technologies generally allow our machines to run at higher speeds and with more power, thus increasing their efficiency. Customers routinely replace old machines with newer machines that can produce parts faster and with less time to set up the machine when converting from one type of part to another. Generally, our machines can be used to produce parts from all of the standard ferrous and non-ferrous metals, as well as plastics, composites and exotic materials.

        During 2008 we discontinued product lines which target less demanding manufacturing applications. Products in this category, referred to as baseline machines, are typically sold on price and delivery, with minimal technical differentiation from a multitude of producers around the world, and are used in less demanding applications. This strategic change will allow us to focus our efforts on products and solutions for companies making parts from hard to machine materials with hard to sustain close tolerances and hard to achieve surface finishes and which also may be hard to hold in the machine. We believe that with our high precision and super precision lathes, our grinding machines,

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and our rugged machining centers, combined with our work holding products and our technical expertise, we are uniquely qualified to be the supplier of choice for customers manufacturing to demanding specifications.

        On many of our machines, multiple options are available which allow customers to customize their machines to their specific operating performance and cost objectives. We produce machines for stock with popular option combinations for immediate delivery, as well as design and produce machines to specific customer requirements. In addition to our machines, we provide the necessary tooling, accessories and support services to assist customers in maximizing their return on investment.

        The sale of repair parts is important to our business. Certain parts on machines wear over time or break through misuse. Customers will buy parts from us throughout the life of the machine, which is generally measured in multiple years. There are thousands of machines in operation in the world for which we provide those repair parts and in many cases the parts are available exclusively from us.

        In addition, we offer an extensive line of workholding, toolholding and other industrial support products, which may be used on both our machines and those produced by others. We consider our company to be a worldwide leader in the design and manufacture of workholding devices for turning equipment. In addition to our traditional products, we are expanding our range of industrial products that are utilized on milling machines. With our growth in milling over the last few years, milling accessories and industrial products fit well in our product offering.

        A key component in milling accessory growth is our family of rotary indexing systems and high-speed direct-drive rotary table indexers, which are available in single, dual, triple and quad spindle configurations. These indexing systems and indexers are ideal for difficult, high-precision machining or jig grinding applications that require 4- or 5-axis interpolated machining, or for parts that require extremely accurate angular positioning. These products are workhorses for high speed and high accuracy contouring applications. Many of these products can be used as a standalone unit with Hardinge controls, or integrated as a true 4th axis.

        We offer various warranties on our equipment and consider post-sale support to be a critical element of our business. Warranties on machines typically extend for twelve months after purchase. Services provided include operation and maintenance training, in-field maintenance, and in-field repair. We offer these post sales support services on a paid basis throughout the life of the machine.

Sales, Markets and Distribution

        We sell our products in most industrialized countries of the world through a combination of distributors, agents and manufacturers' representatives. In certain areas of the United States, China, Germany, and the United Kingdom, we also use a direct sales force. Generally, distributors have exclusive rights to sell our products in a defined geographic area.

        Our distributors operate independent businesses and purchase products from us at discounted prices for their customers, while agents and representatives sell products on our behalf and receive commissions on sales. Our discount schedule is adjusted to reflect the level of marketing and aftermarket support offered by our distributors. Our direct sales personnel earn a fixed salary plus commission.

        Sales through distributors are made only on standard commercial open account terms or through letters of credit. Distributors take title to products upon shipment from our facilities and do not have any special return privileges.

        Our non-machine products are sold in the United States mainly through telephone orders to a toll-free "800" telephone number, which is linked to an on-line computer order entry system maintained by the Company at its Elmira, N.Y. headquarters. In most cases, we are able to package

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and ship in-stock tooling and repair parts within 24 hours of receiving orders. We can package and ship items with heavy demand within several hours. In other parts of the world, these products are sold on either a direct sales basis or through distributor arrangements associated with machine sales.

        We promote recognition of our products in the marketplace through advertising in trade publications and participation in industry trade shows. In addition, we market our non-machine products through publication of general catalogues and other targeted catalogues, which we distribute to existing and prospective customers. We have a substantial presence on the internet at www.hardinge.com where customers can obtain information about our products and place orders for workholding, rotary, and kneemill products.

        A substantial portion of our sales are to small and medium-sized independent job shops, which in turn sell machined parts to their industrial customers. Industries directly and indirectly served by us include aerospace, automotive, construction equipment, defense, energy, farm equipment, medical equipment, recreational equipment, telecommunications, and transportation.

        No single customer accounted for more than 5% of consolidated sales in 2008 or 2007. While valuing our relationship with each customer, we do not believe that the loss of any single customer, or any few customers, would have an adverse material effect on our business.

        Hardinge Inc. operates in a single business segment, industrial machine tools.

Competitive Conditions

        In our industry, the barriers to entry for competition vary based on the level of product performance required. For the products with the highest performance in terms of accuracy and productivity, the barriers are generally technical in nature. For basic products, often the barriers are not technical; they are tied to effective sales, distribution and support required by customers. Another significant barrier in the global machine tool industry is the high level of working capital that is required to operate the business.

        We compete in the various segments of the machine tool market within the products of turning, milling, grinding and workholding. We compete with numerous vendors in each market segment we serve. The primary competitive factors in the marketplace for our machine tools are reliability, price, delivery time, service and technological characteristics. Our management considers our segment of the industry to be extremely competitive. There are many manufacturers of machine tools in the world. They can be categorized by the size of material their products can machine and the precision level they can achieve. For our high precision, multi-tasking turning and milling equipment, competition comes primarily from companies such as Mori-Seiki, Mazak, Nakamura Tome, and Okuma, which are based in Japan, and DMG, which is based in Germany. Competition in our more standard turning and milling equipment comes to some degree from those companies as well as Hyundai, Kia, and Daewoo, which are based in South Korea, Haas and Fadal, which are based in the U.S., and several smaller Taiwanese and Korean companies. Our cylindrical grinding machines compete primarily with Studer, a Swiss Company owned by the Korber Group from Germany, Voumard, based in Switzerland, and Toyoda and Shigia, which are based in Japan. Our Hauser jig grinding machines compete primarily with Moore, which is based in the U.S., and some Japanese suppliers. Our accessories products compete with many smaller companies.

        The overall number of our competitors providing product solutions serving our market segments may increase. Also, the composition of competitors may change as we broaden our product offerings and the geographic markets we serve. As we expand into new market segments, we will face competition not only from our existing competitors but from other competitors as well, including existing companies with strong technological, marketing and sales positions in those markets. In

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addition, several of our competitors may have greater resources, including financial, technical and engineering resources, than we do.

Sources and Availability of Components

        We manufacture and assemble our lathes, machining centers, knee-mills, and related products at our Elmira, New York plant. The Kellenberger grinding machines and related products are manufactured at our St. Gallen, Switzerland plant and Hauser, Tripet and Tschudin products are produced at our Biel, Switzerland facility. We produce machining centers and lathes at both Hardinge Taiwan in Nan Tou, Taiwan and Hardinge Machine (Shanghai) Co., Ltd. in Shanghai, China. We manufacture products from various raw materials, including cast iron, sheet metal, and bar steel. Although a number of our operations are highly integrated, we purchase a number of components, sub-assemblies and assemblies from outside suppliers, including the computer and electronic components for our computer controlled lathes, grinding machines, and machining centers. There are multiple suppliers for virtually all of our raw material, components, sub-assemblies and assemblies and we have not experienced a serious supply interruption in past years.

        A major component of our computer controlled machines is the computer and related electronics package. We purchase these components for our lathes and machining centers primarily from Fanuc Limited, a large Japanese electronics company and Heidenhain, a Germany control supplier. We utilize controls from Siemens, another German control manufacturer, on certain machine models in our line of machining centers. We also offer Heidenhain and Fanuc controls on our grinding machines. While we believe that design changes could be made to our machines to allow sourcing from several other existing suppliers, and we occasionally do so for special orders, a disruption in the supply of the computer controls from one of our suppliers could cause us to experience a substantial disruption of our operations, depending on the circumstances at the time. We purchase parts from these suppliers under normal trade terms. There are no agreements with these suppliers to purchase minimum volumes per year.

Research and Development

        Our ongoing research and development program involves creating new products, modifying existing products to meet market demands, and redesigning existing products, both to add new functionality and to reduce the cost of manufacturing. The research and development departments throughout the world are staffed with experienced design engineers with varying levels of education, from technical through doctoral degrees.

        The worldwide cost of research and development, all of which has been charged to cost of goods sold, amounted to $9.8 million, $10.6 million and $9.8 million, in 2008, 2007, and 2006, respectively.

Patents

        Although Hardinge Inc. holds several patents with respect to certain of its products, we do not believe that our business is dependent to any material extent upon any single patent or group of patents.

Seasonal Trends and Working Capital Requirements

        Hardinge's business, and that of the machine tool industry in general, is cyclical. It is not subject to significant seasonal trends. However, our quarterly results are subject to fluctuation based on the timing of our shipments of machine tools, which are largely dependent upon customer delivery requirements. Traditionally, we have experienced reduced activity during the third quarter of the year, largely as a result of vacations scheduled at our U.S. and European customers' plants and our policy of closing our U.S. and Switzerland facilities for two weeks during the third quarter. While not reflective of 2008, due

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to the economic crisis (discussed further in Item 1A-Risk Factors), our third-quarter net sales, income from operations and net income typically have been the lowest of any quarter during the year.

        The ability to deliver products within a short period of time is an important competitive criterion. We must have inventory on hand to meet customers' delivery expectations, which for standard machines are typically from immediate to eight weeks delivery. Meeting this requirement is especially difficult with products made in Taiwan, where delivery is extended due to ocean travel times, depending on the location of the customer. This creates a situation where we must have inventory of finished machines available in our major markets.

        We deliver many of our machine products within one to two months after the order. Some orders, especially multiple machine orders, are delivered on a turnkey basis with the machine or group of machines configured to make certain parts for the customer. This type of order often includes the addition of material handling equipment, tooling and specific programming. In those cases the customer usually observes and inspects the parts being made on the machine at the Company's facility before it is shipped and the timing of the sale is dependent upon the customer's schedule and acceptance. Therefore, sales from quarter-to-quarter can vary depending upon the timing of those customers' acceptances and the significance of those orders.

        We feel it is important, where practical, to provide readily available workholding and replacement parts for the machines we sell and we carry inventory at levels sufficient to meet these customer requirements.

Governmental Regulations

        We believe that our current operations and our current uses of property, plant and equipment conform in all material respects to applicable laws and regulations.

Governmental Contracts

        No material portion of our business is subject to government contracts.

Environmental Matters

        Our operations are subject to extensive federal, state, local and foreign laws and regulations relating to environmental matters.

        Certain environmental laws can impose joint and several liability for releases or threatened releases of hazardous substances upon certain statutorily defined parties regardless of fault or the lawfulness of the original activity or disposal. Activities at properties we own or previously owned and on adjacent areas have resulted in environmental impacts.

        In particular, our Elmira, New York manufacturing facility is located within the Kentucky Avenue Wellfield on the National Priorities List of hazardous waste sites designated for cleanup by the United States Environmental Protection Agency ("EPA") because of groundwater contamination. The Kentucky Avenue Wellfield site encompasses an area of approximately three square miles which includes sections of the Town of Horseheads and the Village of Elmira Heights in Chemung County, New York. In February 2006, we received a Special Notice Concerning a Remedial Investigation/Feasibility Study ("RI/FS") for the Koppers Pond (the "Pond") portion of the Kentucky Avenue Wellfield site. The EPA has documented the release and threatened release of hazardous substances into the environment at the Kentucky Avenue Wellfield Superfund site, including releases into and in the vicinity of the Pond. The hazardous substances, including metals and polychlorinated biphenyls, have been detected in sediments in the Pond.

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        A substantial portion of the Pond is located on our property. We, along with Beazer East, Inc., the Village of Horseheads, the Town of Horseheads, the County of Chemung, CBS Corporation, and Toshiba America, Inc., the Potentially Responsible Parties (the"PRPs") have agreed to voluntarily participate in the Remedial Investigation and Feasibility Study ("RI/FS") by signing an Administrative Settlement Agreement and Order on Consent on September 29, 2006. On September 29, 2006, the Director of Emergency and Remedial Response Division of the U.S. Environmental Protection Agency, Region II, approved and executed the Agreement on behalf of the EPA. The PRPs also signed a PRP Member Agreement, agreeing to share the cost of the RI/FS study on a per capita basis. The cost of the RI/FS was estimated to be between $0.7 million and $0.8 million. We estimated our portion of the study to be $0.1 million for which we established a reserve. As of December 31, 2008 we have incurred expenses of $0.08 million, thus the remaining reserve balance at year end was $0.02 million. The PRPs developed a Draft RI/FS with their consultants and, following EPA comments, submitted a Revised RI/FS on December 6, 2007. In April 2008, the PRPs were notified that the EPA approved the RI/FS Work Plan which now includes the PRPs' responses to EPA's comments on their December 6th submission.

        The PRPs commenced field work in the spring of 2008 and completed the field investigations that June. In the fall of 2008, the PRPs forwarded the results of the investigation to the EPA and the New York State Department of Environmental Conservation. The PRPs are currently working with the EPA to respond to and resolve EPA's comments on these results.

        Until receipt of this notice, we had never been named as a PRP at the site or received any requests for information from the EPA concerning the site. Environmental sampling on our property within this site under supervision of regulatory authorities has identified off-site sources for such groundwater contamination and sediment contamination in the Pond and has found no evidence that our operations or property have or are contributing to the contamination. The Company has not established, other than as discussed above, a reserve for any potential costs relating to this site, as it is too early in the process to determine our responsibility, if any, or to estimate any potential costs to remediate. We have notified all appropriate insurance carriers and are actively cooperating with them, but whether coverage will be available has not yet been determined and possible insurance recovery cannot now be estimated with any degree of certainty.

        Although we believe, based upon information currently available, that, except as described in the preceding paragraphs, we will not have material liabilities for environmental remediation, it is possible that future remedial requirements or changes in the enforcement of existing laws and regulation, which are subject to extensive regulatory discretion, will result in material liabilities to us.

Employees

        As of December 31, 2008 Hardinge Inc. employed 1,427 persons, 536 of whom were located in the United States. None of our U.S. employees are covered by collective bargaining agreements. Management believes that relations with its employees are good.

Foreign Operations and Export Sales

        Information related to foreign and domestic operations and sales is included in Note 7 to the Consolidated Financial Statements contained in this Annual Report.

        Our strategy has been to diversify our sales and operations geographically so that the impact of economic trends in different regions can be balanced.

        The risks associated with conducting business on an international basis are discussed further in Item 1A-Risk Factors.

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Item 1A.—RISK FACTORS

        The various risks related to the Company's business include the risks described below. The business, financial condition or results of operations of Hardinge Inc. could be materially adversely affected by any of these risks. The risks and uncertainties described below or elsewhere in the Form 10-K are not the only ones to which we are exposed. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also adversely affect our business and operations. If any of the matters included in the following risks were to occur, our business, financial condition, results of operations, cash flows or prospects could be materially adversely affected.

Our customers' activity levels and spending for our products and services have been impacted by the current global economic conditions, especially deterioration in the credit markets.

        Many of our customers finance their purchases of our products through cash flow from operations, the incurrence of debt or from the proceeds received in connection with an issuance of equity. Commencing in the fourth quarter of 2008, the global financial markets have been experiencing significant losses due to failures of many dominant financial institutions. The governments of the United States and several foreign countries have instituted or are contemplating bailout plans to assist many banks and others impacted by the economic crisis. This crisis has resulted in, among other things, a significant decline in the credit markets and the availability of credit. Additionally, many of our customers' equity values have substantially declined. The combination of a reduction in borrowing bases under asset based credit facilities and the lack of availability of debt or equity financing may result in a significant reduction in our customers' spending for our products and may impact the ability of our customers to pay amounts owed to us. In addition, this crisis and economic uncertainty has resulted in an overall decrease in consumer and business spending, which may reduce the need our customers have for our products. Slow or negative growth in the global economy may materially and adversely affect our business, financial condition and results of operations for the foreseeable future.

Changes in general economic conditions and the cyclical nature of our business could harm our operating results.

        Our business is cyclical in nature, following the strength and weakness of the manufacturing economies in the geographic markets in which we serve. As a result of this cyclicality, we have experienced, and in the future, we can be expected to experience, significant fluctuations in sales and operating income, which may affect our business, operating results, financial condition and the market price of our common shares.

        The following factors, among others, significantly influence demand for our products:

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Our competitive position and prospects for growth may be diminished if we are unable to develop and introduce new and enhanced products on a timely basis that are accepted in the market.

        The machine tool industry is subject to technological change, rapidly evolving industry standards, changing customer requirements and improvements in and expansion of product offerings, especially with respect to computer-controlled products. Our ability to anticipate changes in technology, industry standards, customer requirements and product offerings by competitors, and to develop and introduce new and enhanced products on a timely basis that are accepted in the market, will be significant factors in to our ability to compete and grow. Moreover, if technologies or standards used in our products become obsolete or fail to gain widespread commercial acceptance, our business would be materially adversely affected. Developments by others may render our products or technologies obsolete or noncompetitive. Failure to effectively introduce new products or product enhancements on a timely basis could materially adversely affect our business, operating results and financial condition.

We rely on a single supplier or a limited number of suppliers to obtain certain components, sub-assemblies, assemblies and products. The loss of any of these suppliers may cause us to incur additional costs, result in delays in manufacturing and delivering our products or cause us to carry excess or obsolete inventory.

        Some components, sub-assemblies or assemblies we use in the manufacturing of our products are purchased from a single supplier or a limited number of suppliers. For example, a large Japanese company and two European companies supply the computer and related electronics package used in our CNC machines. In addition, some of the products we sell are purchased by us from a single supplier. Our purchases from these suppliers are generally not made pursuant to long-term contracts and are subject to additional risks associated with purchasing products internationally, including risks associated with potential import restrictions and exchange rate fluctuations, as well as changes in tax laws, tariffs and freight rates. Although we believe that our relationships with these suppliers are good, there can be no assurance that we will be able to obtain these products from these suppliers on satisfactory terms indefinitely. The present economic environment could also pose the risk of one of these key suppliers going out of business.

        We believe that design changes could be made to our machines to allow sourcing of components, sub-assemblies, assemblies or products from several other suppliers; however, a disruption in the supply from any of our suppliers could cause us to experience a material adverse effect on our operations.

Our business, financial condition and results of operations could be adversely affected by the political and economic conditions of the countries in which we conduct business and other factors related to our international operations.

        We manufacture a substantial portion of our products overseas and sell our products throughout the world. In 2008, approximately 69% of our products were sold in countries outside of North America. In addition, a majority of our employees are located outside of the United States. Multiple factors relating to our international operations and to particular countries in which we operate could have a material adverse effect on our business, financial condition, results of operations and cash flows. These factors include:

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        Moreover, international conflicts are creating many economic and political uncertainties that are affecting the global economy. Escalation of existing international conflicts or the occurrence of new international conflicts could severely affect our operations and demand for our products.

We may face trade barriers that could have a material adverse effect on our results of operations and result in a loss of customers or suppliers.

        Trade barriers established by the United States or other countries may interfere with our ability to offer our products in those markets. We manufacture a substantial portion of our products overseas and sell our products throughout the world. We cannot predict whether the United States or any other country will impose new quotas, tariffs, taxes or other trade barriers upon the importation or exportation of our products or supplies, any of which could have a material adverse effect on our results of operations and financial condition. Competition and trade barriers in those countries could require us to reduce prices, increase spending on marketing or product development, withdraw or not enter certain markets or otherwise take actions adverse to us.

        In addition, our subsidiaries may require future equity-related financing, and any capital contributions to certain of our subsidiaries may require the approval of the relevant authorities in the jurisdiction in which the subsidiary is incorporated. Those approvals may be required from the investment commissions or similar agencies of the particular jurisdiction and relate to any initial or additional equity investment by foreign entities in local corporations.

        In all jurisdictions in which we operate, we are also subject to the laws and regulations that govern foreign investment and foreign trade, which may limit our ability to repatriate cash as dividends or otherwise.

Our business is highly competitive, and increased competition could reduce our sales, earnings and profitability.

        The markets in which our machines and other products are sold are extremely competitive and highly fragmented. In marketing our products, we compete primarily with other businesses on quality, reliability, price, value, delivery time, service and technological characteristics. We compete with a number of U.S., European and Asian competitors, many of which are larger, have greater financial and other resources and are supported by governmental or financial institution subsidies. Increased

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competition could force us to lower our prices or to offer additional product features or services at a higher cost to us, which could reduce our earnings.

        The greater financial resources or the lower amount of debt of certain of our competitors may enable them to commit larger amounts of capital in response to changing market conditions. Certain competitors may also have the ability to develop product innovations that could put us at a disadvantage. If we are unable to compete successfully against other manufacturers in our marketplace, we could lose customers, and our sales may decline. There can also be no assurance that customers will continue to regard our products favorably, that we will be able to develop new products that appeal to customers, that we will be able to improve or maintain our profit margins on sales to our customers or that we will be able to continue to compete successfully in our core markets. While we believe our product lines compete effectively in their markets, we may not continue to do so.

Acquisitions could disrupt our operations and harm our operating results.

        We may elect to increase our product offerings and the markets we serve through acquisitions of other companies, product lines, technologies and personnel. Acquisitions involve numerous risks, including the following:

        Acquisitions may also cause us to:

        Acquisitions are inherently risky, and no assurance can be given that our future acquisitions will be successful and will not materially adversely affect our business, operating results or financial condition. Failure to manage and successfully integrate acquisitions we make could harm our business and operating results in a material way. Prior acquisitions have resulted in a wide range of outcomes, from successful introduction of new products, technologies, facilities and personnel to an inability to do so.

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Even when an acquired business has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that pre-acquisition due diligence will have identified all possible issues that might arise with respect to such products.

If we are unable to access additional capital on favorable terms, our liquidity, business and results of operations could be adversely affected.

        The ability to raise financial capital, either in public or private markets or through commercial banks, is critical to our current business and future growth. Our business is generally working capital intensive requiring a long cash-out to cash-in cycle. In addition, we will rely on the availability of longer-term debt financing or equity financing to make investments in new opportunities. Our access to the financial markets could be adversely impacted by various factors including the following:

We are subject to significant foreign exchange and currency risks that could adversely affect our operations and our ability to reinvest earnings from operations.

        Our international operations generate sales in a number of foreign currencies including Swiss Francs, Chinese Renminbi, British Pound Sterling, Canadian Dollars, New Taiwanese Dollars, and Euros. Therefore, our results of operations and financial condition are affected by fluctuations in exchange rates between these currencies and the U.S. Dollar. In addition, our purchases of components in Yen, Euros, New Taiwan Dollars, Swiss Francs, and Chinese Renminbi are affected by inter-currency fluctuations in exchange rates.

        We prepare our financial statements in U.S. Dollars in accordance with U.S. GAAP, but a sizable portion of our revenue and operating expenses are in foreign currencies. As a result, we are subject to significant risks, including:

        Changes in exchange rates will result in increases or decreases in our costs and earnings, and may also affect the book value of our assets located outside of the United States and the amount of our invested equity. Although we may seek to decrease our currency exposure by engaging in hedges against significant transactions and balance sheet currency exposures where we deem it appropriate, we do not hedge against translation risks. We cannot assure you that any efforts to minimize our risk to currency movements will be successful. To the extent we sell our products in markets other than the market in which they are manufactured, currency fluctuations may result in our products becoming too expensive for customers in those markets.

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Prices of some raw materials, especially steel and iron, fluctuate, which can adversely affect our sales, costs, and profitability.

        We manufacture products with a relatively high iron castings or steel content, commodities for which worldwide prices fluctuate. The availability of and prices for these and other raw materials are subject to volatility due to worldwide supply and demand forces, speculative actions, inventory levels, exchange rates, production costs, and anticipated or perceived shortages. In some cases, those cost increases can be passed on to customers in the form of price increases; in other cases, they cannot. If raw material prices increase and we are not able to charge our customers higher prices to compensate, it would adversely affect our business, results of operations and financial condition.

Our quarterly results may fluctuate based on customer delivery requirements.

        Our quarterly results are subject to significant fluctuation based on the timing of our shipments of machine tools, which are largely dependent upon customer delivery requirements. With individual machines priced as high as $750,000 and several machines frequently sold together as a package, a request by a customer to delay shipment at quarter end could significantly affect our quarterly results. Historically, we have experienced reduced activity during the third quarter of the year, largely as a result of vacations scheduled at our customers' plants and our policy of closing our U.S. and Swiss facilities during two weeks in July or August. As a result, our third-quarter net sales, income from operations and net income typically have been the lowest of any quarter during the year.

Our expenditures for post-retirement pension obligations could be materially higher than we have predicted if our underlying assumptions prove to be incorrect or we are required to use different assumptions.

        We provide defined benefit pension plans to eligible employees. Our pension expense, the funding status of our plans and related charges to equity for the amount of under funding, and our required contributions to our pension plans are directly affected by the value of plan assets, the projected rate of return on plan assets, the actual rate of return on plan assets and the actuarial assumptions we use to measure our defined benefit pension plan obligations, including the rate at which future obligations are discounted to a present value, or the discount rate.

        As provided for in the Financial Accounting Standards Board Statement of Financial Accounting Standards ("SFAS") No. 87, "Employers' Accounting for Pensions," the market-related value of assets recognizes asset losses and gains over a five-year period, which we believe is consistent with the long-term nature of pension obligations. As a result, the effect of changes in the market value of assets on our pension expense may be experienced in future years rather than fully reflected in the expense for the year immediately following the year in which the fluctuations actually occurred.

        For the year ended December 31, 2008, the value of our Pension Plan Assets decreased by $34.7 million due to declines in market value as a result of the global economic recession. The lower investment performance of our pension plan assets could significantly impact the plan assets and future growth of the plan assets. Should the assets earn a return less than the assumed rate of return over time, it is likely that future pension expenses and funding requirements would increase. Investment earnings in excess of the assumed rate of return may reduce future pension expenses and funding requirements.

        The discount rate used to determine the present value of the projected and accumulated benefit obligation at the end of each year is based upon the available market rates for high quality, fixed income investments. A change in the discount rate would impact the funded status of our plans. An increase to the discount rate would reduce the pension liability and future pension expense and conversely, a lower discount rate would raise pension liability and the future pension expense.

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        For pension accounting purposes in our U.S. based plan, which is the largest of our plans, an 8.50% rate of return was assumed on the market-related value of plan assets for determining pension expense. The discount rate was 6.60% at December 31, 2008 compared to 6.77% at December 31, 2007.

        In our Swiss subsidiary, we have three defined benefit plans, which when taken as a whole are about as large as the U.S. defined plan. The rate of return on plan assets was between 4.75% and 5.25%. The discount rate was 2.75% at December 31, 2008 compared to 3.50% at December 31, 2007.

        Based on current guidelines, assumptions and estimates, including stock market prices and interest rates, we anticipate that we may be required to make a cash contribution of approximately $3.4 million to our U.S. pension plan in 2009 and approximately $2.5 million to the foreign plans in 2009. If our current assumptions and estimates are not correct, a contribution in years beyond 2009 may be more or less than the projected 2009 contribution.

        In addition, we cannot predict whether changing market or economic conditions, regulatory changes or other factors will increase our pension expenses or our funding obligations, diverting funds we would otherwise apply to other uses. At December 31, 2008, the excess of consolidated projected benefit obligations over plan assets was $47.1 million and the excess of consolidated accumulated benefit obligations over plan assets was $34.2 million.

        Employees hired by our U.S. operating company on or after March 1, 2004 are no longer eligible for the defined benefit plan. The United Kingdom's defined benefit plan was closed to new entrants in April 2005. These employees are provided a defined contribution plan instead.

If we are unable to attract and retain skilled employees to work at our manufacturing facilities our operations and growth prospects would be adversely impacted.

        We conduct substantially all of our manufacturing operations in relatively small urban areas, with the exception of our Shanghai facility. Our continued success depends on our ability to attract and retain a skilled labor force at these locations. If we are not able to attract and retain the personnel we require, we may be unable to develop, manufacture and market our products and expand our operations in a manner that best exploits market opportunities and capitalizes on our investment in our business. This would materially adversely affect our business, operating results and financial condition.

Due to future technological changes, changes in market demand, or changes in market expectations, portions of our inventory may become obsolete or excessive.

        The technology within our products change and generally new versions of machines are brought to market in three to five year cycles. The phasing out of an old product involves both estimating the amount of inventory to hold to satisfy the final demand for those machines as well as to satisfy future repair part needs. Based on changing customer demand and expectations of delivery times for repair parts, we may find that we have either obsolete or excess inventory on hand. Because of unforeseen changes in technology, market demand, or competition, we may have to write off unusable inventory at some time in the future, which may adversely affect our results of operations and financial condition. In 2008, we recorded $7.6 million in impairment charges associated with discontinued product lines and the review of other expected inventory usage patterns.

Major changes in the economic situation of our customer base could require us to write off significant parts of our receivables from customers.

        In difficult economic periods, our customers lose work and find it difficult if not impossible to pay for products purchased from us. Although appropriate credit reviews are done at the time of sale, rapidly changing economic conditions can have sudden impacts on customers' ability to pay. We run the

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risk of bad debt on existing time payment contracts and open accounts. If we write off significant parts of our customer accounts or notes receivable because of unforeseen changes in their business condition, it would adversely affect our results of operations, financial condition, and cash flows.

If we suffer loss to our factories, facilities or distribution system due to catastrophe, our operations could be seriously harmed.

        Our factories, facilities and distribution system are subject to catastrophic loss due to fire, flood, terrorism or other natural or man-made disasters. In particular, several of our facilities could be subject to a catastrophic loss caused by earthquake due to their locations. Our facilities in Southeast Asia are located in areas with above average seismic activity. If any of our facilities were to experience a catastrophic loss, it could disrupt our operations, delay production, shipments and revenue and result in large expenses to repair or replace the facility.

We rely in part on independent distributors and the loss of these distributors could adversely affect our business.

        In addition to our direct sales force, we depend on the services of independent distributors and agents to sell our products and provide service and aftermarket support to our customers. We support an extensive distributor and agent network worldwide. In 2008, approximately 31% of our sales were through distributors. Rather than serving as passive conduits for delivery of product, many of our distributors are active participants in the sale and support of our products. Many of the distributors with whom we transact business offer competitive products and services to our customers. In addition, the distribution agreements we have are typically cancelable by the distributor after a relatively short notice period. The loss of a substantial number of these distributors or an increase in the distributors' sales of our competitors' products to our customers could reduce our sales and profits.

We rely on estimated forecasts of our customers' needs and inaccuracies in such forecasts could adversely affect our business.

        We generally sell our products pursuant to individual purchase orders instead of long-term purchase commitments. Therefore, we rely on estimated demand forecasts, based upon input from our customers and the general economic environment, to determine how much material to purchase and product to manufacture. Because our sales are based on purchase orders, our customers may cancel, delay or otherwise modify their purchase commitments with little or no consequence to them and with little or no notice to us. For these reasons, we generally have limited visibility regarding our customers' actual product needs. The quantities or timing required by our customers for our products could vary significantly. Whether in response to changes affecting the industry or a customer's specific business pressures, any cancellation, delay or other modification in our customers' orders could significantly reduce our revenue, cause our operating results to fluctuate from period to period and make it more difficult for us to predict our revenue. In the event of a cancellation or reduction of a customer order, we may not have enough time to reduce inventory purchases or labor hired to minimize the effect of the lost revenue on our business. During the fourth quarter of 2008, orders and sales were impacted by $9 million in order cancellations and $11 million in shipment deferrals primarily due to the current global economic conditions.

We could face potential product liability claims relating to products we manufacture, which could result in us having to expend significant time and expense to defend these claims and to pay material settlement amounts.

        We face a business risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in injury or other adverse effects. We currently maintain product liability insurance coverage; however, we may not be able to obtain such insurance on acceptable terms in the future, if at all, or obtain insurance that will provide adequate coverage against potential claims.

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Product liability claims can be expensive to defend and can divert the attention of management and other personnel for long periods of time, regardless of the ultimate outcome. An unsuccessful product liability defense could have a material adverse effect on our business, financial condition, results of operations or prospects. In addition, we believe our business depends on the strong brand reputation we have developed. In the event that our reputation is damaged, we may face difficulty in maintaining our pricing positions with respect to some of our products, which would reduce our sales and profitability.

Current employment laws or changes in employment laws could increase our costs and may adversely affect our business.

        Various federal, state and foreign labor laws govern the relationship with our employees and affect operating costs. These laws include minimum wage requirements, overtime, unemployment tax rates, workers' compensation rates, citizenship requirements and costs to terminate or layoff employees. Significant additional government-imposed increases in the following areas could materially affect our business, financial condition, operating results or cash flow:

We are subject to environmental laws that could impose significant costs on us and the failure to comply with such laws could subject us to sanctions and material fines and expenses.

        Our operations are subject to extensive federal, state, local and foreign laws and regulations relating to environmental matters.

        Certain environmental laws can impose joint and several liability for releases or threatened releases of hazardous substances upon certain statutorily defined parties regardless of fault or the lawfulness of the original activity or disposal. Activities at properties we own or previously owned and on adjacent areas have resulted in environmental impacts.

        In particular, our Elmira, New York manufacturing facility is located within the Kentucky Avenue Wellfield on the National Priorities List of hazardous waste sites designated for cleanup by the United States Environmental Protection Agency ("EPA") because of groundwater contamination. The Kentucky Avenue Wellfield site encompasses an area of approximately three square miles which includes sections of the Town of Horseheads and the Village of Elmira Heights in Chemung County, New York. In February 2006, we received a Special Notice Concerning a Remedial Investigation/Feasibility Study ("RI/FS") for the Koppers Pond (the "Pond") portion of the Kentucky Avenue Wellfield site. The EPA has documented the release and threatened release of hazardous substances into the environment at the Kentucky Avenue Wellfield Superfund site, including releases into and in the vicinity of the Pond. The hazardous substances, including metals and polychlorinated biphenyls, have been detected in sediments in the Pond.

        A substantial portion of the Pond is located on our property. We, along with Beazer East, Inc., the Village of Horseheads, the Town of Horseheads, the County of Chemung, CBS Corporation, and Toshiba America, Inc., the Potentially Responsible Parties (the "PRPs") have agreed to voluntarily participate in the Remedial Investigation and Feasibility Study ("RI/FS") by signing an Administrative Settlement Agreement and Order on Consent on September 29, 2006. On September 29, 2006, the Director of Emergency and Remedial Response Division of the U.S. Environmental Protection Agency,

A-17



Region II, approved and executed the Agreement on behalf of the EPA. The PRPs also signed a PRP Member Agreement, agreeing to share the cost of the RI/FS study on a per capita basis. The cost of the RI/FS was estimated to be between $0.7 million and $0.8 million. We estimated our portion of the study to be $0.1 million for which we established a reserve. As of December 31, 2008 we have incurred expenses of $0.08 million, thus the remaining reserve balance at year end was $0.02 million. The PRPs developed a Draft RI/FS with their consultants and, following EPA comments, submitted a Revised RI/FS on December 6, 2007. In April 2008, the PRPs were notified that the EPA approved the RI/FS Work Plan which now includes the PRPs' responses to EPA's comments on their December 6th submission.

        The PRPs commenced field work in the spring of 2008 and completed the field investigations that June. In the fall of 2008, the PRPs forwarded the results of the investigation to the EPA and the New York State Department of Environmental Conservation. The PRPs are currently working with the EPA to respond to and resolve EPA's comments on these results.

        Until receipt of this notice, we had never been named as a PRP at the site or received any requests for information from the EPA concerning the site. Environmental sampling on our property within this site under supervision of regulatory authorities has identified off-site sources for such groundwater contamination and sediment contamination in the Pond and has found no evidence that our operations or property have or are contributing to the contamination. The Company has not established, other than discussed above, a reserve for any potential costs relating to this site, as it is too early in the process to determine our responsibility, if any, or to estimate any potential costs to remediate. We have notified all appropriate insurance carriers and are actively cooperating with them, but whether coverage will be available has not yet been determined and possible insurance recovery cannot now be estimated with any degree of certainty.

        Although we believe, based upon information currently available, that, except as described in the preceding paragraphs, we will not have material liabilities for environmental remediation, it is possible that future remedial requirements or changes in the enforcement of existing laws and regulation, which are subject to extensive regulatory discretion, will result in material liabilities to us.

The loss of current members of our senior management team and other key personnel may adversely affect our operating results.

        The loss of senior management and other key personnel could impair our ability to carry out our business plan. We believe our future success will depend in part on our ability to attract and retain highly skilled and qualified personnel. The loss of senior management and other key personnel may adversely affect our operating results as we incur costs to replace the departing personnel and potentially lose opportunities in the transition of important job functions.

If we fail to maintain an effective system of internal controls, we may not be able to report our financial results accurately or prevent fraud.

        Effective internal controls are necessary for us to provide reliable financial reports, to prevent fraud and to operate successfully as a publicly traded company. Our efforts to maintain an effective system of internal controls may not be successful, and we may be unable to maintain adequate controls over our financial processes and reporting in the future. Ineffective internal controls subject us to regulatory scrutiny and a loss of confidence in our reported financial information, which could have an adverse effect on our business and would likely have a negative effect on the trading price of our common stock.

Item 1B.—UNRESOLVED STAFF COMMENTS

        None.

A-18



ITEM 2.—PROPERTIES

        Pertinent information concerning the principal properties of the Company and its subsidiaries is as follows:

Location   Type of Facility   Acreage (Land)
Square Footage
(Building)
 
Owned Properties:            

Horseheads, New York

 

Manufacturing, Engineering, Turnkey Systems, Marketing, Sales, Demonstration, Service, and Administration

 

 

80 acres
515,000 sq. ft.

 

St. Gallen, Switzerland

 

Manufacturing, Engineering, Turnkey Systems, Marketing, Sales, Demonstration, Service, and Administration

 

 

8 acres
162,924 sq. ft.

 

Nan Tou, Taiwan

 

Manufacturing, Engineering, Marketing, Sales, Demonstration, Service, and Administration

 

 

3 acres
123,204 sq. ft.

 

Biel, Switzerland

 

Manufacturing, Engineering, and Turnkey Systems

 

 

4 acres
41,500 sq. ft.

 

 

Location   Type of Facility   Acreage (Land)
Square Footage
  Lease
Expiration
Date
 
Leased Properties:                  

Horseheads, New York

 

Warehouse

 

 

64,480 sq. ft.

 

 

12/31/09

 

Elmira, New York

 

Warehouse

 

 

55,999 sq. ft.

 

 

3/31/09

 

Shanghai, People's Republic of China

 

Product Assembly, Marketing, Engineering, Turnkey Systems, Sales, Service, Demonstration, and Administration

 

 

68,620 sq. ft.

 

 

2/29/12

 

Leicester, England

 

Sales, Marketing, Engineering, Turnkey Systems, Demonstration, Service, and Administration

 

 

30,172 sq. ft.

 

 

1/31/15

 

Biel, Switzerland

 

Sales, Marketing, Engineering, Turnkey Systems, Demonstration, Service, and Administration

 

 

19,375 sq. ft.

 

 

6/30/09

 

St. Gallen, Switzerland

 

Manufacturing

 

 

14,208 sq. ft.

 

 

8/01/11

 

Raamsdonksveer, Netherlands

 

Sales, Service, and Demonstration

 

 

10,226 sq. ft.

 

 

9/15/11

 

Krefeld, Germany

 

Sales, Service, Demonstration, and Administration

 

 

10,172 sq. ft.

 

 

7/31/10

 

Exeter, England

 

Administration

 

 

3,460 sq. ft.

 

 

12/20/09

 

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ITEM 3.—LEGAL PROCEEDINGS

        The Company is from time to time involved in routine litigation incidental to its operations. None of the litigation in which we are currently involved, individually or in the aggregate, is anticipated to be material to our financial condition, results of operations, or cash flows.

        On October 28, 2008, a putative class-action lawsuit was filed in the United States District Court for the Western District of New York against the Company and certain of our officers and former officers. This complaint alleges that during the period from February 22, 2007 to February 21, 2008 the defendants made misleading statements and/or omissions relating to our business and operating results in violation of the Federal securities laws. The complaint seeks unspecified compensatory damages in favor of the class, together with interest, attorney fees and other expenses. The Company has not yet responded to the complaint. While the Company believes the lawsuit to be without merit and intends to vigorously defend itself, the impact of the lawsuit on the Company cannot be assessed at this time.


ITEM 4.—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        During the fourth quarter of 2008, no matters were submitted to a vote of security holders.

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PART II

ITEM 5.—MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

        The following table reflects the highest and lowest values at which the stock traded in each quarter of the last two years. Hardinge Inc. common stock trades on The Nasdaq Global Select Market under the symbol "HDNG." The table also includes dividends per share, by quarter.

 
  2008   2007  
 
  Values   Values  
 
  High   Low   Dividends   High   Low   Dividends  

Quarter Ended

                                     
 

March 31,

  $ 18.90   $ 11.95   $ 0.05   $ 28.35   $ 14.32   $ 0.05  
 

June 30,

    18.25     12.28     0.05     36.68     22.32     0.05  
 

September 30,

    17.45     11.29     0.05     40.13     25.07     0.05  
 

December 31,

    13.77     3.37     0.01     38.48     12.67     0.05  

        At March 9, 2009, there were 3,028 holders of record of common stock.

Issuer Purchases of Equity Securities

        The following table provides information about issuer repurchases of our common stock by month for the quarter ended December 31, 2008:

Issuer Purchases of Equity Securities
  Total Number
of Shares
Purchased
  Average Price
Paid Per Share
 

October 1 – October 31, 2008

         

November 1 – November 30, 2008

         

December 1 – December 31, 2008

    3,710   $ 4.04  
             

Total

    3,710        
             

        The above shares repurchased in December were part of the Company's Incentive Compensation Plan to satisfy tax withholding obligations.

Share Repurchase Program

        At the February 19, 2008 Board of Directors meeting, the Board approved a share repurchase program for up to $10.0 million of our common stock to be purchased through February 28, 2010. As of December 31, 2008, we have repurchased 45,500 shares of our common stock at an average price of $12.72.

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Performance Graph

        The graph below compares the five-year cumulative total return for Hardinge Inc. Common Stock with the comparable returns for the NASDAQ Stock Market (U.S.) Index and a group of eight peer issuers. Our peer group includes Circor International Inc., Flow International Corp., Hurco Companies Inc., Kadant Inc., Kaydon Corp., Magnetek Inc., NN Inc., and Sun Hydraulics Corp. Cumulative total return represents the change in stock price and the amount of dividends received during the indicated period, assuming reinvestment of dividends. The graph assumes an investment of $100 on December 31, 2003. The stock performance shown in the graph is included in response to SEC requirements and is not intended to forecast or to be indicative of future performance.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Hardinge Inc., The NASDAQ Composite Index
And A Peer Group

GRAPHIC


*
$100 invested on 12/31/03 in stock or index, including reinvestment of dividends.
Fiscal year ending December 31.
  12/03   12/04   12/05   12/06   12/07   12/08  

Hardinge, Inc. 

    100.00     115.34     151.23     132.69     149.13     36.38  

NASDAQ Composite

    100.00     110.06     112.92     126.61     138.33     80.65  

Peer Group

    100.00     117.69     124.26     158.95     197.14     108.09  

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ITEM 6.—SELECTED FINANCIAL DATA

        The following selected financial data is derived from the audited consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes and other information included herein (dollar amounts in thousands except per share data).

 
  2008   2007   2006   2005   2004  

STATEMENT OF OPERATIONS DATA

                               

Net sales

  $ 345,006   $ 356,322   $ 326,621   $ 289,925   $ 232,054  

Cost of sales

    252,741     248,911     226,470     199,642     162,376  
                       

Gross profit

    92,265     107,411     100,151     90,283     69,678  

Selling, general and administrative expense

    97,796     84,520     77,054     74,723     57,184  

Impairment charges(1)

    24,351                  
                       

Operating (loss) income

    (29,882 )   22,891     23,097     15,560     12,494  

(Gain) on sale of assets

    (54 )   (1,372 )            

Interest expense

    1,714     3,051     5,294     4,284     2,660  

Interest (income)

    (285 )   (224 )   (713 )   (569 )   (533 )
                       

(Loss) income before income taxes, minority interest in (profit) of consolidated subsidiary

    (31,257 )   21,436     18,516     11,845     10,367  

Income taxes

    3,048     6,510     4,566     2,373     3,542  

Minority interest in (profit) of consolidated subsidiary

                (2,466 )   (2,433 )
                       

Net (loss) income(1)

  $ (34,305 ) $ 14,926   $ 13,950   $ 7,006   $ 4,392  
                       

PER SHARE DATA:

                               

Weighted average number of Common shares outstanding—basic

    11,309     10,442     8,770     8,761     8,745  

Basic (loss) earnings per share

  $ (3.03 ) $ 1.43   $ 1.59   $ 0.80   $ 0.50  
                       

Weighted average number of Common shares outstanding—diluted

    11,309     10,562     8,809     8,822     8,773  

Diluted (loss)earnings per share

  $ (3.03 ) $ 1.41   $ 1.58   $ 0.79   $ 0.50  
                       

Cash dividends declared per share

  $ 0.16   $ 0.20   $ 0.14   $ 0.12   $ 0.03  
                       

BALANCE SHEET DATA

                               

Working capital

  $ 151,613   $ 189,464   $ 156,994   $ 126,421   $ 122,181  

Total assets

    309,825     361,828     330,660     300,276     286,311  

Total debt

    28,121     27,819     77,861     67,114     42,868  

Shareholders' equity

    168,127     255,145     157,109     138,993     150,000  

(1)
2008 results include a non-cash charge for impairment of goodwill and intangible assets of $24.3 million due to the diminished value of goodwill and intangible assets in our Canadian, English, and Swiss entities as required by FAS 142.

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ITEM 7.—MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        Overview.    Our primary business is designing, manufacturing, and distributing high-precision computer controlled metal-cutting turning, grinding and milling machines and related accessories. We are geographically diversified with manufacturing facilities in the U.S., Switzerland, Taiwan, and China and with sales to most industrialized countries. Approximately 69% of our 2008 sales were to customers outside of North America, 70% of our 2008 products were manufactured outside of North America, and 62% of our employees were outside of North America.

        Our machine products are considered to be capital goods and are part of what has historically been a highly cyclical industry. Our management believes that a key performance indicator is our order level as compared to industry measures of market activity levels.

        The global economic recession, which intensified in the fourth quarter of 2008, has impacted the industries in which we conduct business. The reduced availability of credit has impacted our customers' ability to obtain financing. As a result we have experienced order cancellations, a softening of incoming orders, and a reduction of sales primarily beginning in the fourth quarter of 2008. In conjunction with these economic trends, we recorded an impairment charge on our goodwill. We also were not in compliance with a financial covenant under our multi-currency secured credit facility as of December 31, 2008. As a result of all of these conditions, management has implemented cost reduction initiatives throughout the Company to preserve cash flow, including reducing our quarterly dividend. On March 16, 2009, we entered into a new $10.0 million term loan. Refer to Liquidity and Capital Resources for a description of our new financing arrangements. Management believes these actions will provide the required cash flow to enable the Company to meet its financial commitments throughout 2009.

        The U.S. market activity metrics most closely watched by our management have been: reporting of metal-cutting machine orders as reported by the Association of Manufacturing Technology (AMT), the primary industry group for U.S. machine tool manufacturers; and machine tool consumption as reported annually by Gardner Publications in the Metalworking Insiders Report. In 2008, industry-wide orders for metal-cutting machine tools reported by the AMT declined 3.1% versus 2007. The 2008 decrease compared to 2007 was primarily related to a sharp decline in world-wide order activity during the fourth quarter brought on by the global economic conditions. Year to date orders as of September 2008, increased 11% compared to the same period in 2007, while the 2008 fourth quarter orders declined 41% compared to the same period in 2007. In 2007 orders increased by 6.9% over 2006. The AMT's statistics are reported on a voluntary basis from member companies. The report includes metal-cutting machines of all types and sizes, including segments where we do not compete.

        World machine tool consumption data (domestic production plus imports, less exports) as reported by the Metalworking Insiders Report, an annual report on machine-tool output and consumption, shows an increase in consumption of 12% in 2008 despite worldwide economic conditions. As this report is an annual consumption report it does not fully illustrate the downturn in orders the industry experienced during the fourth quarter of 2008. This report indicates that consumption in China, the world's largest market, increased by 11% in 2008 versus 2007, and 17% in 2007 versus 2006. Consumption in Germany, the world's second largest market increased by 25% in 2008 versus 2007 as measured in local currencies, and 29% in 2007 compared to 2006. In the United Kingdom, machine tool consumption measured in Pound Sterling increased by 16% in 2008 versus 2007, and 6% in 2007 versus 2006. Machine tool consumption in the U.S. increased by 15% in 2008 compared to 2007, recovering from a decline of 3% in 2007 compared to 2006.

        Other closely followed U.S. market indicators are tracked to determine activity levels in U.S. manufacturing plants that might purchase the our products. One such measurement is the PMI (formerly called the Purchasing Manager's Index), as reported by the Institute for Supply Management.

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Another measurement is capacity utilization for manufacturing companies, as reported by the Federal Reserve Board. We are not aware of comparably reliable measures of foreign demand or customer activity.

        Non-machine sales which include collets, accessories, repair parts, and service revenue have typically accounted for approximately 25% of overall sales and are an important part of our business, especially in the U.S. where Hardinge has an installed base of thousands of machines. Sales of these products do not vary on a year-to-year basis as significantly as capital goods, but demand does typically track the direction of the related machine metrics.

        Other key performance indicators are geographic distribution of net sales and orders, gross profit as a percent of net sales, income from operations, working capital changes, and debt level trends. In an industry where constant product technology development has led to an average model life of three to five years, effectiveness of technological innovation and development of new products are also key performance indicators.

        Our management believes currency exchange rate changes are significant to reported results for several reasons. Our primary competitors, particularly for the most technologically advanced products, are now largely manufacturers in Japan, Germany, and Switzerland, which causes the worldwide valuation of the Yen, Euro, and Swiss Franc to be central to competitive pricing in all of our markets. Also, we translate the results of our Swiss, Taiwanese, Chinese, British, German, Dutch and Canadian subsidiaries into U.S. Dollars for consolidation and reporting purposes. Period to period changes in the exchange rate between their local currency and the U.S. Dollar may affect comparative data significantly. We also purchase computer controls and other components from suppliers throughout the world, with purchase costs reflecting currency changes.

        At December 31, 2008, the Company was not in compliance with the minimum EBITDA minus cash taxes and capital expenditures to fixed charge ratio required under our multi-currency secured credit facility. On March 16, 2009, the Company entered into a new agreement with a bank for a 366 day $10.0 million term loan. This term loan replaced a multi-currency secured credit facility which as of March 15, 2009 had an outstanding balance of $8.0 million. Refer to Liquidity and Capital Resources for a description of our new financing arrangements.

        On April 25, 2007, the Company completed a public offering of 2,553,000 shares of common stock, including a 330,000 share over-allotment option exercised in full by the underwriters, with net proceeds of approximately $55.9 million after deducting underwriting discounts and commissions, and offering expenses. We used these funds to repay indebtedness under our U.S. overdraft and revolving line of credit facilities. On December 31, 2008 and 2007, we had 11,469,169 and 11,479,916 shares of common stock outstanding, respectively.

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Results of Operations

2008 Compared to 2007

        The following table summarizes certain financial data for 2008 and 2007:

 
  2008   2007   Change   % Change  
 
  (dollars in thousands)
 

Net sales

  $ 345,006   $ 356,322   $ (11,316 )   (3.2 )%

Gross profit

    92,265     107,411     (15,146 )   (14.1 )%

Selling, general and administrative expenses

    97,796     84,520     13,276     15.7 %

Impairment charges

    24,351         24,351        

(Loss) income from operations

    (29,882 )   22,891     (52,773 )   (230.5 )%

Net (loss)income

    (34,305 )   14,926     (49,231 )   (329.8 )%

Diluted (loss) earnings per share

  $ (3.03 ) $ 1.41   $ (4.44 )   (314.9 )%

Weighted average shares outstanding (in thousands)

    11,309     10,562     747     7.1 %

Gross profit as % of net sales

    26.7 %   30.1 %   (3.4) pts        

Selling, general and administrative expenses as % of net sales

    28.3 %   23.7 %   4.6   pts        

(Loss) income from operations as % of net sales

    (8.7 )%   6.4 %   (15.1) pts        

Net (loss) income as % of net sales

    (9.9 )%   4.2 %   (14.1) pts        

        Net Sales.    Net sales for 2008 were $345.0 million, a $11.3 million or 3% decline compared to 2007 net sales of $356.3 million. Net sales for the year increased in 'Asia and Other' offset by a declines in Europe and North America. On a full year basis, net sales were favorably impacted by approximately $14.5 million in foreign currency translation. Without the currency impact, sales for the year would have declined $25.8 million or 7% compared to 2007. The following table presents 2008 and 2007 sales by region:

Sales to Customers in:
  2008   2007   Change   % Change  
 
  (dollars in thousands)
 

North America

  $ 108,501   $ 121,520   $ (13,019 )   (11 )%

Europe

    158,947     165,144     (6,197 )   (4 )%

Asia & Other

    77,558     69,658     7,900     11 %
                     

Total

  $ 345,006   $ 356,322   $ (11,316 )   (3 )%
                     

        The decline in net sales for the year was primarily the result of the global economic and financial crisis which began late in the third quarter of 2008. For the year, net sales declined in Milling and Turning Products 7% and 20%, respectively, which was offset by a 19% increase in Grinding Products, with 'Asia and Other' representing the strongest overall market. For 2008, approximately 69% of total net sales were to customers outside of North America.

        The geographic mix of sales as a percentage of total net sales is shown in the table below:

Sales to Customers in:
  2008   2007   Percentage
Point
Change
 

North America

    31.4 %   34.1 %   (2.7 )

Europe

    46.1 %   46.4 %   (0.3 )

Asia & Other

    22.5 %   19.5 %   3.0  
                 
 

Total

    100.0 %   100.0 %      
                 

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        Machine sales represented 74.4% of 2008 net sales, as compared to 74.8% of 2007 net sales. Sales of non-machine products and services, primarily repair parts and accessories, made up the balance.

        Orders.    The Company's new orders declined 5% to $341.2 million in 2008 compared to $360.5 million in 2007. On a full year basis, new orders were favorably impacted by approximately $16.7 million in foreign currency translation. Without the currency impact, new orders for the year would have declined $36.1 million or 10% compared to 2007. The following table presents 2008 and 2007 new orders by region:

Orders from Customers in:
  2008   2007   Change   % Change  
 
  (dollars in thousands)
 

North America

  $ 103,249   $ 117,532   $ (14,283 )   (12 )%

Europe

    156,320     170,916     (14,596 )   (9 )%

Asia & Other

    81,605     72,092     9,513     13 %
                     
 

Total

  $ 341,174   $ 360,540   $ (19,366 )   (5 )%
                     

        The decline in net orders for the year was driven by reduced levels of business activity and $9.0 million in order cancellations primarily the result of the global economic and financial crisis which began late in the third quarter of 2008.

        North American orders were down 12% compared to the prior year. North American orders averaged in excess of $28.0 million per quarter through September 30, 2008 with the fourth quarter declining to $18.1 million, a $9.9 million or 35% decrease. The decline in North American orders can be attributed to the economic and financial crisis.

        European orders for the full year decreased $14.6 million or 9% for 2008. European orders averaged over $44.9 million in new orders through September 30, 2008 with the fourth quarter declining to $21.1 million, a $23.8 million or 53% decrease. At $156.3 million, European orders, particularly from Germany, United Kingdom, Switzerland, and Italy, accounted for nearly half of our total order activity during 2008.

        'Asia and Other' order activity for the full year increased 13% despite the reduction in fourth quarter activity. New orders averaged over $24.5 million in new orders through September 30, 2008 with the fourth quarter declining to $7.3 million, a $17.2 million or 70% decrease. The growth in 2008 was primarily in China which had new orders in excess of $53.8 million, or 66% of the total region's orders.

        Gross Profit.    Gross profit was $92.3 million, or 26.7% of net sales in 2008, compared to $107.4 million, or 30.1% of net sales in 2007. The reduction in gross profit can be attributed to $8.8 million in reduced sales volume, a $4.7 million year over year increase in inventory obsolescence reserves (the obsolescence reserve increase is primarily due to the discontinuance of certain product lines during 2008), approximately $3.9 million in reduced margin due to product and channel mix as well as the impact of discounts on discontinued product lines and approximately $3.0 million related to lower capacity utilization in the U.S. and Taiwan. These increases were offset by approximately $4.6 million related to the impact of translating foreign subsidiary financial statements into U.S. Dollars.

        Selling, General, and Administrative Expense.    Selling, general and administrative ("SG&A") expense for the year 2008 was $97.8 million, or 28.3% of net sales, compared to $84.5 million, or 23.7% of net sales, in 2007. SG&A expense as a percentage of net sales increased over 2007 as a result of $2.3 million related to severance expense in the U.S. and Europe, $1.4 million due to increased sales and marketing efforts, including trade shows, and $1.0 million related to a voluntary early retirement program offered in the U.S. during the fourth quarter of 2008. In addition to the severance, marketing, and early retirement costs, 2008 SG&A expense increased by approximately $3.6 million due to foreign

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currency transaction losses which were primarily related to our New Taiwanese Dollar—U.S. Dollar exposure and approximately $3.3 million related to the impact of translating foreign subsidiary financial statements into U.S. Dollars.

        Impairment Charge.    We recorded non-cash impairment charges of $24.4 million related to goodwill and intangible assets during 2008. $2.7 million of this charge was related to our Canadian operations. During the third quarter, as a result of changes to the Company's planned product strategy and method of delivering support to our Canadian customers, as well as an analysis of historical cash flows, we determined that the goodwill and intangible assets associated with the Canadian operations were impaired and recorded a non-cash charge, to reflect the diminished value of goodwill of $2.1 million and $0.6 million of intangible assets. During the fourth quarter of 2008, we performed our annual impairment testing for recorded goodwill and indefinite lived intangible assets. As a result of the current projected business levels and market cap of the company and industry peers, it was determined that the $21.7 million in goodwill was impaired.

        (Loss)/Income from Operations.    Loss from operations in 2008 was ($29.9) million compared to income of $22.9 million in 2007. This $52.8 million change was primarily due to: the 2008 goodwill and intangible asset impairment charges of $24.4 million; $7.6 million in impairment charges associated with the discontinuance of certain product lines and other expected inventory usage patterns; $3.2 million related to severance charges associated with our restructuring activities, and a net change of $3.6 million in currency transaction losses, in addition to the dramatic worldwide decline in business in the fourth quarter of 2008.

        Gain on Sale of Assets.    During 2007, we sold a facility in Exeter, England as part of integrating the Bridgeport operation into the existing business, and recorded a $1.4 million gain as a result of the sale.

        Interest Expense & Interest Income.    Interest expense includes interest payments under our credit facility and amortization of deferred financing costs associated with our credit facility.

        Interest expense for the year 2008 was $1.7 million, a decrease of $1.4 million, or 45% from 2007. The decrease is the result of overall lower interest rates during 2008 as well as lower average borrowings due to the use of our 2007 stock offering proceeds to pay down debt. Interest income was $0.3 million in 2008 compared to $0.2 million in 2007.

        Income Tax/Benefit.    Income tax expense in 2008 was $3.0 million compared to $6.5 million in 2007. The effective tax rate was 9.8% in 2008 and 30.4% in 2007. The 2008 effective rate was negatively impacted by a significant amount of the goodwill impairment charges, which were non-deductible, resulting in a negative impact of 16.0%. Other changes from 2007 include an increase in our valuation allowance due to not recording a tax benefit on losses in the U.S., U.K., German, and Canadian operations. In addition, we experienced a net increase in 2008 in our liability for uncertain tax benefits due to foreign tax positions and settlements, as well as a change in the mix of profits by country. The income tax expense fundamentally represents tax expense on profits in certain of the Company's foreign subsidiaries.

        We continue to maintain a full valuation allowance on the tax benefits of our U.S. net deferred tax assets and we expect to continue to record a full valuation allowance on future tax benefits until an appropriate level of profitability in the U.S. is sustained. We also maintain a valuation allowance on our U.K., German, and Canadian deferred tax assets related to tax loss carryforwards in those jurisdictions, as well as all other deferred tax assets of those entities.

        In 2008, the valuation allowance increased by $20.0 million. This was due to an increase of $7.2 million due to not recording a tax benefit on losses in the U.S., Canada, U.K., and Germany, an increase of $10.7 million due to the increase in minimum pension liabilities in the U.S. and the U.K. (and other items also recorded in Other Comprehensive Income), an increase of $2.2 million for state

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tax credits, and a decrease of $.1 million due a reduction and a reversal of tax assets in accordance with FIN 48.

        As specified in SFAS 109, the Company regularly reviews recent results and projected future results of its operations, as well as other relevant factors, to reconfirm the likelihood that existing deferred tax assets in each tax jurisdiction would be fully recoverable. In the case of the U. S. operations, this recoverability had been based largely on the likelihood of future taxable income.

        Net (Loss) Income.    Net loss for 2008 was ($34.3) million or (9.9%) of net sales, compared to $14.9 million net income, or 4.2% of net sales in 2007. Basic and diluted loss per share for 2008 were ($3.03), compared to basic and diluted earnings per share of $1.43 and $1.41 in 2007. Earnings per share are impacted by the increase in average shares outstanding as a result of our stock offering in April 2007.

Results of Operations

2007 Compared to 2006

        The following table summarizes certain financial data for 2007 and 2006:

 
  2007   2006   Change   % Change  
 
  (dollars in thousands)
 

Net sales

  $ 356,322   $ 326,621   $ 29,701     9.1 %

Gross profit

    107,411     100,151     7,260     7.2 %

Selling, general and administrative expenses

    84,520     77,054     7,466     9.7 %

Income from operations

    22,891     23,097     (206 )   (.9 )%

Net income

    14,926     13,950     976     7.0 %

Diluted earnings per share

  $ 1.41   $ 1.58   $ (0.17 )   (10.8 )%

Weighted average shares outstanding (in thousands)

    10,562     8,809     1,753     19.9 %

Gross profit as % of net sales

    30.1 %   30.7 %   (0.6) pts        

Selling, general and administrative expenses as % of sales

    23.7 %   23.6 %   0.1   pts        

Income from operations as % of net sales

    6.4 %   7.1 %   (0.7) pts        

Net income as % of net sales

    4.2 %   4.3 %   (0.1) pts        

        Net Sales.    Net sales for 2007 were $356.3 million, a $29.7 million or 9% increase over 2006 sales of $326.6 million. Net sales increased in North America and Europe offset by a decline in Asia, as shown below:

Sales to Customers in:
  2007   2006   Change   % Change  
 
  (dollars in thousands)
 

North America

  $ 121,520   $ 118,157   $ 3,363     2.8 %

Europe

    165,144     127,507     37,637     29.5 %

Asia & Other

    69,658     80,957     (11,299 )   (14.0 )%
                     

Total

  $ 356,322   $ 326,621   $ 29,701     9.1 %
                     

        Under U.S. Accounting Standards, income statement items of foreign subsidiaries are translated into U.S. dollars at the average exchange rate during the periods presented. The net of these foreign currency transactions had a favorable impact on sales of $13.1 million. Without the currency impact, sales for the year would have increased $16.6 million or 5% compared to 2006.

        For 2007, net sales growth was driven by increases in sales of all products: Grinding—16%, Milling—7%, Turning—2%, with continental Europe being the strongest market in all product lines. For the year, two-thirds of total net sales were to customers outside of North America.

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        The reduction in net sales for "Asia & Other' was due to specialty grinding and automotive grinding applications that did not recur in 2007.

        The geographic mix of sales as a percentage of total net sales is shown in the table below:

Sales to Customers in:
  2007   2006   Percentage
Point
Change
 

North America

    34.1 %   36.2 %   (2.1 )

Europe

    46.4 %   39.0 %   7.4  

Asia & Other

    19.5 %   24.8 %   (5.3 )
                 
 

Total

    100.0 %   100.0 %      
                 

        Machine sales represented 74.8% of 2007 net sales, as compared to 73.3% of 2006 net sales. Sales of non-machine products and services, primarily repair parts, and accessories, made up the balance.

        Orders.    The Company's new orders rose 4% to $360.5 million in 2007 compared to $347.8 million in 2006, as shown in the table below:

Orders from Customers in:
  2007   2006   Change   % Change  
 
  (dollars in thousands)
   
 

North America

  $ 117,532   $ 124,652   $ (7,120 )   (5.7 )%

Europe

    170,916     146,924     23,992     16.3 %

Asia & Other

    72,092     76,265     (4,173 )   (5.5 )%
                     
 

Total

  $ 360,540   $ 347,841   $ 12,699     3.7 %
                     

        North American orders were down 6% compared to the prior year. This was driven by a weaker economy, and flat machine tool market. The result of these market conditions were further influenced in the short term by the Company's restructuring of its distribution channels which serve North American end users to a more direct sales organization.

        European orders for the full year increased $24.0 million or 16% for 2007 and remained strong throughout the year averaging more than $42 million per quarter. The company was particularly strong in its order performance in Germany, Switzerland, and Italy. Approximately $5.6 million of the full year growth in European orders is attributable to foreign currency translation changes. At $170.9 million, European orders accounted for nearly half of the Company's total order activity during 2007.

        'Asia and Other' order activity for the full year was down by 5% reflecting the impact of several large orders for automotive and turbine blade grinding applications from 2006 that did not recur in 2007.

        Order activity was excellent in the fourth quarter with increases across all of our markets in comparison to the fourth quarter 2006. Our order performance was driven by the strengthening of our global sales network coupled with a series of new product introductions during 2007. We anticipate growth in orders in 2008 will be more difficult with certain economies softening.

        Gross Profit.    Gross profit was $107.4 million, or 30.1% of net sales in 2007, compared to $100.2 million, or 30.7% of net sales in 2006. The reduction in gross margin for 2007 was the result of a combination of factors: prior period accounting adjustments related to intercompany profits in inventory elimination and accounts payable which were recorded in the fourth quarter of 2007; the rebalancing of production volumes in our U.S. and Taiwan production facilities to address current market demand for certain products; higher price discounting related to plans to reduce our finished machine inventories and accelerate the phase-out of older product lines, and product and channel mix changes. Gross margin would have been approximately 30.6% without the impact of the

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aforementioned adjustments for prior years. The impact on net income after adjustments related to prior periods was not significant.

        Selling, General, and Administrative Expense.    Selling, general and administrative ("SG&A") expense for the year 2007 was $84.5 million, or 23.7% of net sales, compared to $77.1 million, or 23.6% of net sales, in 2006. SG&A expense as a percentage of net sales remained essentially flat in 2007 from 2006,reflecting our increased sales volume. The primary drivers for the $7.5 million increase in SG&A expense in 2007 are: $2.9 million related to the translation of foreign subsidiary financial statements into US Dollars, $0.3 million in volume-related commission expenses, $0.5 million in additional provisions for bad debt expense, and the balance for increased selling and marketing expenses in support of our strategy to invest in and strengthen our sales channels.

        Income from Operations.    Income from operations in 2007 was relatively flat at $22.9 million compared to 2006, but declined to 6.4% of net sales in 2007 from 7.1% in 2006.

        Gain on Sale of Assets.    During 2007, the company sold a facility in Exeter, England as part of integrating the Bridgeport operation into the existing business, and recorded a $1.4 million gain as a result of the sale.

        Interest Expense & Interest Income.    Interest expense includes interest payments under the Company's credit facility, unrealized and realized gains or losses on our interest rate swap agreement, and amortization of deferred financing costs associated with our credit facility.

        Interest expense for the year 2007 was $3.1 million, a decrease of $2.2 million, or 42% from 2006. The decrease reflects our decision to use the proceeds from the sale of $55.9 million of common stock in April 2007 to substantially reduce our long-term debt. Interest income was $0.2 million in 2007 compared to $0.7 million in 2006.

        Income Tax/Benefit.    Income tax expense in 2007 was $6.5 million compared to $4.6 Million in 2006. The effective tax rate was 30.4% in 2007 and 24.7% in 2006. The increase in the effective rate is due to the non-reoccurrence of the 2006 favorable reduction in the tax rate at one of the Company's Swiss entities, a net increase in 2007 in our liability for uncertain tax benefits due to foreign tax positions and settlements, as well as a change in the mix of profits by country. The income tax expense fundamentally represents tax expense on profits in the Company's foreign subsidiaries.

        We continue to maintain a full valuation allowance on the tax benefits of our U.S. net deferred tax assets and we expect to continue to record a full valuation allowance on future tax benefits until an appropriate level of profitability in the U.S. is sustained. We also maintain a valuation allowance on our U.K. deferred tax asset for minimum pension liabilities and maintain a valuation allowance on our Canadian deferred tax asset for net operating loss carryforwards. Additionally, until an appropriate level of profitability is reached, we do not expect to recognize any significant tax benefits in future results of our U.S. operations.

        In 2007, the valuation allowance decreased by $8.3 million. This was due to an increase of $0.9 million due to not recording a tax benefit on losses in the U.S. and Canada, a decrease of $5.5 million due to the reduction in minimum pension liabilities in the U.S. and the U.K. (recorded in Other Comprehensive Income), a decrease of $3.1 million due to a reduction in tax assets as a result of a decrease in applicable U.S. state tax rates, and a decrease of $0.6 million due to a reduction and a reversal of tax assets in accordance with FIN 48.

        Net Income.    Net income for 2007 was $14.9 million or 4.2% of net sales, compared to $14.0 million, or 4.3% of net sales in 2006. Basic and diluted earnings per share for 2007 were $1.43 and $1.41, respectively, compared to basic and diluted earnings per share of $1.59 and $1.58 in 2006. Earnings per share are impacted by the increase in average shares outstanding as a result of our stock offering in April 2007.

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Liquidity and Capital Resources

        The Company's principal capital requirements are to fund its operations, including working capital, to purchase and fund improvements to its facilities, machines and equipment, and to fund acquisitions.

        At December 31, 2008, cash and cash equivalents were $18.4 million, compared to $16.0 million at December 31, 2007. The current ratio at December 31, 2008 was 2.80:1 compared to 3.81:1 at December 31, 2007.

        As shown in the Consolidated Statements of Cash Flows, cash provided by operating activities was $9.7 million in 2008 compared to $7.3 million in 2007. This represents an increase in cash provided by operations of $2.4 million.

        The table below shows the changes in cash flows from operating activities by component:

 
  Cash Flow from Operating Activities  
 
  2008   2007   Change in
Cash Flow
 
 
  (dollars in thousands)
 

Cash provided by/(used in):

                   

Net (loss) income

  $ (34,305 ) $ 14,926   $ (49,231 )

Non-cash inventory write down

    7,560         7,560  

Impairment charge

    24,351         24,351  

Provision for deferred taxes

    1,278     250     1,028  

Depreciation and amortization

    9,439     9,446     (7 )

(Gain) on sale of assets

    (54 )   (1,372 )   1,318  

Accounts receivable

    8,503     5,560     2,943  

Inventories

    2,909     (21,448 )   24,357  

Notes receivable

    1,512     2,495     (983 )

Prepaids/Other assets

    (4,009 )   2,537     (6,546 )

Accrued expenses

    (3,162 )   1,262     (4,424 )

Accounts payable

    (6,036 )   (4,857 )   (1,179 )

Other

    1,753     (1,494 )   3,247  
               

Cash provided by operating activities

  $ 9,739   $ 7,305   $ 2,434  
               

        In 2008, cash was provided primarily by adding non cash expenses including depreciation and amortization, inventory write down, impairment charge and provision for deferred taxes to the net loss. Cash was also provided by changes in accounts receivable, notes receivable, inventories, and other operating activities. Cash was used for prepaid and other assets, accrued expenses and accounts payable. The decrease in accounts receivable is due to lower sales levels during the fourth quarter of 2008. The decrease in inventory levels is due to special customer incentive programs, decreased production levels, and concentrated inventory reduction efforts.

        In 2007, cash was provided primarily by net income after adding non-cash expenses including depreciation and amortization, accounts receivable, notes receivable and other assets. Cash was used for inventories, accounts payable and other operating activities. The increased inventory levels were due to increased production levels.

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        The table below shows the changes in cash flows from investing activities by component:

 
  Cash Flow from Investing Activities  
 
  2008   2007   Change in
Cash Flow
 
 
  (dollars in thousands)
 

Cash (used in)/provided by:

                   

Capital expenditures

  $ (4,693 ) $ (5,582 ) $ 889  

Proceeds from sale of assets

    106     3,629     (3,523 )

Purchase of technical information

    (175 )       (175 )

Purchase of Canadian entity

        (240 )   240  
               

Cash (used in) investing activities

  $ (4,762 ) $ (2,193 ) $ (2,569 )
               

        Cash used in investing activities was $4.8 million for 2008, compared to $2.2 million in 2007. Capital expenditures for 2008 were $4.7 million. Capital expenditures in 2008 included upgrades to our overall information technology infrastructure, investment in manufacturing equipment and general maintenance. Capital expenditures for 2007 were $5.6 million. Capital expenditures in 2007 included upgrades to our grinding assembly facility, updates to our overall information technology infrastructure and modest investment in manufacturing equipment.

        Cash used in investing activities during 2008 was primarily related to capital expenditures. Cash used in investing activities during 2007 was primarily related to capital expenditures offset by $3.6 million proceeds on the sale of a building in the U.K.

        Cash (used in)/provided by financing activities for 2008 and 2007 are summarized in the table below:

 
  Cash Flow from Financing Activities  
 
  2008   2007   Change in
Cash Flow
 
 
  (dollars in thousands)
 

Cash (used in)/ provided by:

                   

Borrowings (repayments) on long-term debt

  $ 3,129   $ (48,724 ) $ 51,853  

Borrowings on short term notes payable

    49,010     84,484     (35,474 )

Repayments on short term notes payable

    (51,810 )   (86,026 )   34,216  

Net proceeds from issuance of common stock

        55,946     (55,946 )

Net (purchases) of treasury stock

    (585 )   (89 )   (496 )

Payments of dividends

    (1,833 )   (2,164 )   331  
               

Cash (used in)/ provided by financing activities

  $ (2,089 ) $ 3,427   $ (5,516 )
               

        Cash used in financing activities was $2.1 million for 2008, compared to cash provided by financing activities of $3.4 million for 2007. In April of 2007, the Company completed a public offering of 2,553,000 shares of common stock, with net proceeds of approximately $55.9 million after deducting underwriting discounts and commissions, and offering expenses. We used these funds to repay indebtedness under our U.S. overdraft and revolving line of credit facilities. In 2008, we capitalized $1.0 million in fees for the new credit facility. 2008 dividend payments decreased by $0.3 million over 2007 as a result of our decreasing the dividend payout to $0.01 per share in December 2008.

        On June 13, 2008, we entered into a new five-year $100.0 million multi-currency secured credit facility ("Credit Facility"). The Credit Facility replaced a $70.0 million revolving credit and a term loan agreement which was due to mature January 2011 as well as several other credit facilities in place in

A-33



our foreign subsidiaries. The Credit Facility is secured by substantially all of the Company's and its domestic subsidiaries' assets, other than real estate, and a pledge of (i) 100% of the Company's investments in its domestic subsidiaries and (ii) 662/3% of the Company's investment in Hardinge Holdings GmbH ("Hardinge Holdings") the parent corporation of our significant foreign subsidiaries. In addition, if certain conditions are met, Hardinge Holdings may be required to pledge its investment in certain of its material foreign subsidiaries. The obligations of the Company and Hardinge Holdings are also guaranteed by all of the Company's domestic subsidiaries and, under certain conditions, by certain of the Company's material foreign subsidiaries. Interest is based on London Interbank Offered Rates plus a spread which varies depending on the Company's debt to EBITDA (earnings before interest, taxes, depreciation and amortization) ratio. A variable commitment fee of 0.20% to 0.375%, based on the Company's debt to EBITDA ratio, is payable on the unused portion of the Credit Facility. We have the option, subject to certain conditions, to increase the facility by $50.0 million. At December 31, 2008, borrowings under this agreement were $24.0 million.

        In November 2006, we amended and restated a Revolving Credit and Term Loan Agreement with a group of U.S. banks. The amendment and restated agreement provided for a revolving loan facility of $70.0 million and a term loan of $30.0 million with quarterly principal payments of $1.2 million through December 2006 and quarterly principal payments of $1.3 million from March 2007 through March 2011. These loans were secured by substantially all of our domestic assets, other than real estate, and a pledge of 65% of our investment in the Company's major subsidiaries. The amendment increased the permitted debt to EBITDA ratio for certain portions of the term of the facility, lowered the variable commitment fee and borrowing rates at certain debt to EBITDA ratios, and provided for permitted annual acquisitions up to a certain amount. Interest charged on this debt was based on LIBOR plus a spread that varied depending on our debt to EBITDA ratio. A variable commitment fee of 0.15% to 0.375%, based on the Company's debt to EBITDA ratio, was payable on the unused portion of the revolving loan facility. At December 31, 2007, the outstanding balance on the amended revolving loan facility was $8.0 million. At December 31, 2007, the outstanding balance on the term loan was $12.3 million. This Revolving Credit and Term Loan Agreement was replaced by the Credit Facility entered into on June 13, 2008.

        We have a $3.0 million unsecured short-term line of credit from a bank with interest based on the prime rate. There was no balance outstanding at December 31, 2008. At December 31, 2007, the outstanding balance on this line was $2.8 million. The agreement is negotiated annually and requires no commitment fee.

        In December 2008, our Kellenberger AG ("Kellenberger") subsidiary replaced their existing credit facilities and loan agreements with two new unsecured loan facilities with banks providing for borrowing of up to 11.5 million Swiss Francs, which is equivalent to approximately $10.8 million at December 31, 2008. These lines provide for interest at competitive short-term interest rates and carry no commitment fees on unused funds. At December 31, 2008 there were no borrowings under these facilities.

        Previously, Kellenberger maintained a loan agreement with a Swiss bank providing for borrowing of up to 7.3 million Swiss Francs, which was equivalent to approximately $6.4 million at December 31, 2007. This agreement was secured by the real property owned by Kellenberger. At December 31, 2007, there were no borrowings under this facility. This loan agreement was replaced by the new unsecured loan facilities in December 2008.

        Kellenberger also previously maintained an unsecured overdraft facility with a commercial bank that permitted borrowings of up to 7.5 million Swiss Francs, which was equivalent to approximately $6.6 million at December 31, 2007. These lines provided for interest at competitive short-term interest rates and carried no commitment fees on unused funds. At December 31, 2007 there was no outstanding balance under this facility. This overdraft facility was replaced by the new unsecured loan facilities in December 2008.

A-34


        Our HTT subsidiary (which is now part of Kellenberger) previously maintained a loan agreement with a Swiss bank that provided for borrowings of up to 4.0 million Swiss Francs, which was equivalent to approximately $3.5 million at December 31, 2007. This agreement was secured by real property owned by HTT. There were no borrowings under this agreement at December 31, 2007. This loan agreement was replaced by the new unsecured loan facilities in December 2008.

        The former HTT also maintained an unsecured overdraft facility with a commercial bank that permitted borrowings of up to 8.5 million Swiss Francs, which was equivalent to approximately $7.5 million at December 31, 2007. These lines provided for interest at competitive short-term interest rates and carried no commitment fees on unused funds. There were no borrowings under this overdraft line at December 31, 2007. This overdraft facility was replaced by the new unsecured loan facilities in December 2008.

        Our Hardinge Machine Tools, Ltd. subsidiary previously maintained an overdraft facility for borrowing 0.4 million Pounds Sterling, equivalent to approximately $0.7 million in 2007. The facility was closed in 2007.

        In June 2006, our Taiwan subsidiary negotiated a mortgage loan with a bank secured by the real property owned by the Taiwan subsidiary which initially provided borrowings of 153.0 million New Taiwanese Dollars which was equivalent to approximately $4.7 million. At December 31, 2008 and 2007 borrowings under this agreement were $4.1 million and $4.7 million, respectively. Principal on the mortgage loan is repaid quarterly in the amount of 4.5 million New Taiwanese Dollars, which is equivalent to approximately $0.1 million.

        We maintain a $1.6 million standby letter of credit, which expires March 31, 2009, for potential liabilities pertaining to self-insured workers compensation exposure. This standby letter of credit is renewed annually. In total, we had various letters of credit totaling $9.1 million and $5.6 million at December 31, 2008 and 2007, respectively.

        Certain of these debt agreements require, among other things, that we maintain specified ratios of debt to EBITDA and EBITDA minus capital expenditures to fixed charges, as well as, minimum equity. At December 31, 2008, the Company was not in compliance with the minimum EBITDA minus cash taxes and capital expenditures to fixed charges required under our Credit Facility.

        On March 16, 2009, we entered into an agreement with a bank for a 366 day $10.0 million term loan. This term loan replaced a multi-currency secured credit facility which as of March 15, 2009 had an outstanding balance of $8.0 million. The term loan is secured by substantially all of the Company's assets, a negative pledge on the Company's headquarters in Elmira, NY and a pledge of 66 and 2/3% of the Company's investment in Hardinge Holdings GmbH. Interest is based on one-month London Interbank Offered Rates ("LIBOR") plus 5.0%. The interest rate will increase by 1.0% to LIBOR plus 6.0% on September 30, 2009, with a minimum interest rate of 5.5% at all times.

        In addition to the term loan agreement we entered into on March 16, 2009, we also entered into a commitment with a bank for a three-year revolving line of credit ("Line of Credit") for up to $25.0 million to be secured by substantially all of the Company's U.S. assets and a pledge of 66 and 2/3% of the Company's investment in Hardinge Holdings GmbH. We anticipate that we will close the Line of Credit on or before April 30, 2009. The Line of Credit will replace the term loan entered into on March 16, 2009.

        Excluding amounts associated with the multi-currency secured credit facility, with which we were not in compliance as of December 31, 2008, the Company had access of up to $17.9 million at December 31, 2008. At December 31, 2008 and March 15, 2009, the Company had borrowings of $24.0 million and $8.0 million, respectively, outstanding under the multi-currency secured credit facility. Total consolidated outstanding borrowings at December 31, 2008 and 2007 were $28.1 million and $27.8 million, respectively. Interest expense in 2008, 2007, and 2006 totaled $1.7 million, $3.1 million, and $5.3 million, respectively.

A-35


        We conduct some of our manufacturing, sales and service operations from leased space, with lease terms up to 10 years, and use certain data processing equipment under lease agreements expiring at various dates. Rent expense under these leases totaled $2.5 million, $2.0 million, and $2.2 million, during the years ended December 31, 2008, 2007, and 2006, respectively.

        The following table shows our future commitments in effect as of December 31, 2008 (in thousands):

 
  2009   2010   2011   2012   2013   Thereafter   Total  

Notes payable and debt payments

  $ 24,549   $ 549   $ 550   $ 549   $ 549   $ 1,375   $ 28,121  

Operating lease obligations

    1,357     815     536     246     212     230     3,396  

Purchase commitments

    25,848                         25,848  

Standby letters of credit

    9,098                         9,098  

        We have not included the liabilities for uncertain tax positions in the above table as we can not make a reliable estimate of the period of cash settlement. At December 31, 2008, we classified $24.0 million in long-term debt outstanding under our multi-currency credit facility as current as a result of our not being in compliance with our required debt covenants.

        We believe that the currently available funds and credit facilities, along with internally generated funds, will provide sufficient financial resources for ongoing operations throughout 2009.

Off Balance Sheet Arrangements

        We do not have any off balance sheet arrangements.

Market Risk

        The following information has been provided in accordance with the Securities and Exchange Commission's requirements for disclosure of exposures to market risk arising from certain market risk sensitive instruments.

        Our earnings are affected by changes in short-term interest rates as a result of our floating interest rate debt. If market interest rates on debt subject to floating interest rates were to have increased by 2% over the actual rates paid in that year, interest expense would have increased by $0.6 million in 2008 and $0.8 million in 2007, after considering the effect of the interest rate swap agreements. These amounts are determined by considering the impact of hypothetical interest rates on the Company's borrowing cost and interest rate swap agreements.

        Our operations include manufacturing and sales activities in foreign jurisdictions. We currently manufacture our products in the United States, Switzerland, Taiwan and China using production components purchased internationally, and we sell our products in those markets as well as other worldwide markets. Our U.S. company purchases grinding machines manufactured in Switzerland by its Swiss subsidiary. Likewise, we purchase machining centers and other machines manufactured in Taiwan by our Taiwanese subsidiary and other Taiwanese manufacturers. Our subsidiaries in the U.K., Germany, the Netherlands, Switzerland and Canada sell products in local currency to customers in those countries. These subsidiaries also transact business in currencies other than their functional currency outside of their home country. Our Taiwanese subsidiary sells products to foreign purchasers in U.S. Dollars. As a result of these sales in various currencies and in various countries of the world, our financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we distribute our products. Our operating results are exposed to changes in exchange rates between the U.S. Dollar, Canadian Dollar, British Pound Sterling, Swiss Franc, Euro, New Taiwanese Dollar, Chinese Renminbi and Japanese Yen. As a result of having sales, purchases and certain intercompany transactions denominated in currencies other than the functional currencies of our subsidiaries, we are exposed to the effect of currency exchange rate changes on our cash flows, earnings and balance sheet. To mitigate this currency risk we enter into currency forward exchange contracts to hedge significant non-functional

A-36



currency denominated transactions for periods consistent with the terms of the underlying transactions. Contracts generally have maturities that do not exceed one year.

Discussion of Critical Accounting Policies

        The preparation of our financial statements requires the application of a number of accounting policies which are described in the notes to the financial statements. These policies require the use of assumptions or estimates, which, if interpreted differently under different conditions or circumstances, could result in material changes to the reported results. Following is a discussion of those accounting policies, which were reviewed with our audit committee, and which we feel are most susceptible to such interpretation.

        Accounts and Notes Receivable.    We assess the collectibility of our trade accounts and notes receivable using a combination of methods. We review large individual accounts for evidence of circumstances that suggest a collection problem might exist. Such situations include, but are not limited to, the customer's past history of payments, its current financial condition as evidenced by credit ratings, financial statements or other sources, and recent collection activities. On a case by case basis, we offer long-term customer financing in the form of notes receivable at some of our foreign operations. Our notes receivable in North America are limited to machine sales to end-user customers for years prior to 2003, and a security interest is normally maintained in the equipment sold under terms of those notes. In cases where repossession may be likely, we estimate the probable resale potential of the assets to be repossessed net of repossession, refurbishment and resale costs, and provide a reserve for the remaining receivable balance after realization of such proceeds. We provide a reserve for losses based on current payment trends in the economies where we hold concentrations of receivables and provide a reserve for what we believe to be the most likely risk of uncollectibility. In order to make these allowances, we rely on assumptions regarding economic conditions, equipment resale values, and the likelihood that previous performance will be indicative of future results.

        Inventories.    We use a number of assumptions and estimates in determining the value of our inventory. An allowance is provided for the value of inventory quantities of specific items that are deemed to be excessive based on an annual review of past usage and anticipated future usage. While we feel this is the most appropriate methodology for determining excess quantities, the possibility exists that customers will change their buying habits in the future should their own requirements change. Changes in metal-cutting technology can render certain products obsolete or reduce their market value. We continually evaluate changes in technology and adjust our products and inventories accordingly, either by write-off or by price reductions. However, the possibility exists that a future technological development, currently unanticipated, might affect the marketability of specific products produced by the company.

        We include in the cost of our inventories a component to cover the estimated cost of manufacturing overhead activities associated with production of our products.

        We believe that being able to offer immediate delivery on many of our products is critical to our competitive success. Likewise, we believe that maintaining an inventory of service parts, with a particular emphasis on purchased parts, is especially important to support our policy of maintaining serviceability of our products. Consequently, we maintain significant inventories of repair parts on many of our machine models, including some which are no longer in production. Our ability to accurately determine which parts are needed to maintain this serviceability is critical to our success in managing this element of our business.

A-37


        Intangible Assets.    We have acquired other machine tool companies or assets of companies. When doing so, we have used outside specialists to assist in determining the value of assets acquired, and have used traditional models for establishing purchase price based on EBITDA multiples and present value of future cash flows. Consequently, the value of goodwill and other purchased intangible assets on our balance sheet have been affected by the use of numerous estimates of the value of assets purchased and of future business opportunity. During 2008, the Company recorded non-cash impairment charges of $24.4 million. See Note 3 to the Company's consolidated financial statements for additional information on these non-cash charges.

        Net Deferred Tax Assets.    As specified in Statement of Financial Accounting Standards No. 109 (SFAS 109), we annually review the recent results and projected future results of our operations, as well as other relevant factors, to reconfirm the likelihood that existing deferred tax assets in each tax jurisdiction would be fully recoverable. We continue to record a valuation allowance against deferred tax assets in the U.S., Canada, U.K., and Germany.

        Retirement Plans.    We sponsor various defined benefit pension plans, defined contribution plans, and one postretirement benefit plan, all as described in Note 9 of the Consolidated Financial Statements. The calculation of our plan expenses and liabilities require the use of a number of critical accounting estimates. Changes in the assumptions can result in different plan expense and liability amounts, and actual experience can differ from the assumptions. We believe that the most critical assumptions are the discount rate and the expected rate of return on plan assets.

        We annually review the discount rate to be used for retirement plan liabilities, using a bond pricing model based on high grade U.S. corporate bonds constructed to match the projected liability benefit payments on select discount rate. We discounted our future plan liabilities for our U.S. plan using a rate of 6.60% and 6.77% at our plan measurement date of December 31, 2008 and 2007, respectively. We discounted our future plan liabilities for our foreign plans using rates appropriate for each country, which resulted in a blended rate of 3.13% and 3.93% at their measurement dates of December 31, 2008 and 2007, respectively.

        The expected rate of return on plan assets varies based on the investment mix of each particular plan and reflects the long-term average rate of return expected on funds invested or to be invested in each pension plan to provide for the benefits included in the pension liability. We review our expected rate of return annually based upon information available to us at that time, including the historical returns of major asset classes, the expected investment mix of the plans' assets, and estimates of future long-term investment returns. We used an expected rate of return of 8.50% at our measurement dates of December 31, 2008 and 2007 for our domestic plan. We used rates of return appropriate for each country for our foreign plans which resulted in a blended expected rate of return of 5.24% and 5.05% at their measurement dates of December 31, 2008 and 2007, respectively. A change in the expected return on plan assets can also have a significant effect on retirement plan expense. For example, a decrease of a quarter of a percentage point would increase U.S. pension expense by approximately $0.2 million and would change foreign pension plan expenses by lesser amounts.

New Accounting Standards

        In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in applying generally accepted accounting principles, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. We adopted SFAS 157 effective January 1, 2008 for all financial assets and liabilities. The adoption of this statement did not have a significant impact on our financial statements in 2008. Refer to Note 11

A-38



(Fair Value of Financial Instruments) to the consolidated financial statements for additional information.

        In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an amendment of FASB Statement No. 115 (SFAS 159). This Statement allows all entities a one-time election to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value (the "fair value option"). SFAS 159 is effective for fiscal years beginning after November 15, 2007, and the adoption is optional. We have not elected the fair value measurement for any existing financial instrument other than those that are already being measured at fair value.

        In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (revised—2007) (SFAS 141(R)). SFAS 141(R) is a revision to previously existing guidance on accounting for business combinations. The statement retains the fundamental concept of the purchase method of accounting, and introduces new requirements for the recognition and measurement of assets acquired, liabilities assumed, and noncontrolling interests. The statement is effective for fiscal years beginning after December 15, 2008 and impacts business combinations after that date. This standard will impact our future financial statements if we conduct significant acquisitions in the future.

        In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. This Statement is effective for financial statements issued for periods beginning after November 15, 2008, with early application encouraged. This statement amends and expands the disclosure requirements in SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", and other related literature. We believe that the updated disclosures will not have a material impact on our consolidated financial statements.

        In April 2008, the FASB issued FSP No. FAS 142-3, "Determination of the Useful Life of Intangible Assets." This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). The objective of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R), and other U.S. Generally Accepted Accounting Principles (GAAP). This FSP applies to all intangible assets, whether acquired in a business combination or otherwise and shall be effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years and applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. We do not believe the new statement will have a material impact on our financial statements.

        In November 2008, the FASB issued EITF Abstract 08-6 "Equity Method Investment Accounting Considerations" (EITF 08-6). EITF 08-6 applies to all investments accounted for under the equity method and clarifies the accounting for certain transactions and impairment considerations involving equity method investments. This standard is required to be applied prospectively and is effective for fiscal years beginning after December 15, 2008. We believe that the adoption of this EITF will not have a material impact on our consolidated results of operations and financial condition.

        In December 2008, the FASB issued FSP FAS 132(R)-1, "Employer's Disclosures about Postretirement Benefit Plan Assets" (FSP FAS 132(R)-1). FSP FAS 132(R)-1 amends FASB Statement No. 132 (Revised 2003), Employers' Disclosures about Pensions and Other Postretirement Benefits, to provide guidance on an employer's disclosures about plan assets of a defined benefit pension or other postretirement plan. Required disclosures address: how investment allocation decisions are made; the major categories of plan assets; the inputs and valuation techniques used to measure the fair value of plan assets; the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period; and significant concentrations of risk within plan assets. Disclosures required by this FSP shall be provided for fiscal years ending after December 15, 2009, and are not required for earlier periods presented for comparative purposes. Hardinge expects to comply with the disclosure requirements of FSP FAS 132(R)-1 as required.

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        Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words "believes," "project," "expects," "anticipates," "estimates," "intends," "strategy," "plan," "may," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Accordingly, there can be no assurance that our expectations will be realized. Such statements are based upon information known to management at this time. The Company cautions that such statements necessarily involve uncertainties and risk and deal with matters beyond the Company's ability to control, and in many cases the Company cannot predict what factors would cause actual results to differ materially from those indicated. Among the many factors that could cause actual results to differ from those set forth in the forward-looking statements are fluctuations in the machine tool business cycles, changes in general economic conditions in the U.S. or internationally, the mix of products sold and the profit margins thereon, the relative success of the Company's entry into new product and geographic markets, the Company's ability to manage its operating costs, actions taken by customers such as order cancellations or reduced bookings by customers or distributors, competitors' actions such as price discounting or new product introductions, governmental regulations and environmental matters, changes in the availability and cost of materials and supplies, the implementation of new technologies and currency fluctuations. Any forward-looking statement should be considered in light of these factors. The Company undertakes no obligation to revise its forward-looking statements if unanticipated events alter their accuracy.

ITEM 7A.—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        The information required by this item is incorporated herein by reference to the section entitled "Market Risk" in Item 7, Management's Discussion and Analysis of Results of Operations and Financial Condition, of this Form 10-K.

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ITEM 8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

HARDINGE INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
December 31, 2008

Audited Consolidated Financial Statements

   

Report of Independent Registered Public Accounting Firm

 
A-42

Consolidated Balance Sheets

  A-43

Consolidated Statements of Operations

  A-45

Consolidated Statements of Cash Flows

  A-46

Consolidated Statements of Shareholders' Equity

  A-47

Notes to Consolidated Financial Statements

  A-48

Schedule II—Valuation and Qualifying Accounts is included in Item 15(a) of this report.

        All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Hardinge Inc.

        We have audited the accompanying consolidated balance sheets of Hardinge Inc. and Subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hardinge Inc. and Subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

        As discussed in Notes 1, 5, and 9 to the consolidated financial statements, on January 1, 2006, the Company changed its method of accounting for stock based compensation, on December 31, 2006, the Company changed its method of accounting for defined benefit pension and other postretirement benefits, and on January 1, 2007, the Company changed its method of accounting for uncertainty in income taxes.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Hardinge Inc.'s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2009 expressed an unqualified opinion thereon.

    /s/ Ernst & Young LLP

Buffalo, New York
March 16, 2009

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HARDINGE INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 
  December 31,  
 
  2008   2007  
 
  (In Thousands)
 

Assets

             

Current assets:

             
 

Cash and cash equivalents

  $ 18,430   $ 16,003  
 

Accounts receivable, net

    60,110     71,228  
 

Notes receivable, net

    994     1,555  
 

Inventories, net

    144,957     158,617  
 

Deferred income tax

    398     1,032  
 

Prepaid expenses

    10,964     8,573  
           

Total current assets

    235,853     257,008  

Property, plant and equipment:

             
 

Land and buildings

    63,957     63,890  
 

Machinery, equipment and fixtures

    109,595     108,193  
 

Office furniture, equipment and vehicles

    9,835     8,344  
           

    183,387     180,427  
 

Less accumulated depreciation

    123,790     118,896  
           

Net property, plant and equipment

    59,597     61,531  

Non-current assets:

             
 

Notes receivable, net

    923     1,847  
 

Deferred income taxes

    1,406     306  
 

Other intangible assets

    10,725     11,927  
 

Goodwill

        22,841  
 

Other long-term assets

    1,321     6,368  
           

    14,375     43,289  
           

Total assets

 
$

309,825
 
$

361,828
 
           

See accompanying notes to the consolidated financial statements

A-43



HARDINGE INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Continued)

 
  December 31,  
 
  2008   2007  
 
  (In Thousands, Except
Share and Per Share Data)

 

Total liabilities and shareholders' equity

             

Current liabilities:

             
 

Accounts payable

  $ 20,059   $ 27,266  
 

Notes payable to bank

        2,801  
 

Accrued expenses

    33,255     26,873  
 

Accrued income taxes

    2,911     2,574  
 

Deferred income taxes

    3,466     2,375  
 

Current portion of long-term debt

    24,549     5,655  
           

Total current liabilities

    84,240     67,544  

Other liabilities:

             
 

Long-term debt

    3,572     19,363  
 

Accrued pension expense

    44,962     8,145  
 

Deferred income taxes

        4,361  
 

Accrued postretirement benefits

    2,528     2,199  
 

Accrued income taxes

    2,153     1,054  
 

Other liabilities

    4,243     4,017  
           

Total other liabilities

    57,458     39,139  

Shareholders' equity:

             
 

Preferred stock, Series A, par value $.01 per share; Authorized 2,000,000; issued—none

             
 

Common stock, $.01 par value:

             
   

Authorized shares—20,000,000;
Issued shares—12,472,992 at December 31, 2008 and December 31, 2007

   
125
   
125
 
 

Additional paid-in capital

    114,841     114,971  
 

Retained earnings

    92,700     128,838  
 

Treasury shares—1,003,828 at December 31, 2008 and 993,076 shares at December 31, 2007

    (13,037 )   (13,023 )
 

Accumulated other comprehensive (loss) income

    (26,502 )   24,234  
           

Total shareholders' equity

    168,127     255,145  
           

Total liabilities and shareholders' equity

  $ 309,825   $ 361,828  
           

See accompanying notes to the consolidated financial statements

A-44



HARDINGE INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 
  Year Ended December 31,  
 
  2008   2007   2006  
 
  (In Thousands Except Per Share Data)
 

Net sales

  $ 345,006   $ 356,322   $ 326,621  

Cost of sales

    252,741     248,911     226,470  
               

Gross profit

    92,265     107,411     100,151  

Selling, general and administrative expense

    97,796     84,520     77,054  

Impairment charge

    24,351          
               

(Loss) income from operations

    (29,882 )   22,891     23,097  

(Gain) on sale of assets

    (54 )   (1,372 )    

Interest expense

    1,714     3,051     5,294  

Interest (income)

    (285 )   (224 )   (713 )
               

(Loss) income before income taxes

    (31,257 )   21,436     18,516  

Income taxes

    3,048     6,510     4,566  
               

Net (loss) income

  $ (34,305 ) $ 14,926   $ 13,950  
               

Per share data:

                   

Basic (loss) earnings per share:

                   
 

Weighted average number of common shares outstanding

    11,309     10,442     8,770  
               
 

Basic (loss) earnings per share

  $ (3.03 ) $ 1.43   $ 1.59  
               

Diluted (loss) earnings per share:

                   
 

Weighted average number of common shares outstanding

    11,309     10,562     8,809  
               
 

Diluted (loss) earnings per share

  $ (3.03 ) $ 1.41   $ 1.58  
               

Cash dividends declared per share

  $ 0.16   $ 0.20   $ 0.14  
               

See accompanying notes to the consolidated financial statements

A-45



HARDINGE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 
  Year Ended December 31,  
 
  2008   2007   2006  
 
  (In Thousands)
 

Operating activities

                   

Net (loss) income

  $ (34,305 ) $ 14,926   $ 13,950  

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

                   
 

Non-cash—inventory write down

    7,560          
 

Impairment charge

    24,351          
 

Depreciation and amortization

    9,439     9,446     9,545  
 

Provision for deferred income taxes

    1,278     250     (43 )
 

(Gain) on sale of asset

    (54 )   (1,372 )    
 

Unrealized intercompany foreign currency transaction loss (gain)

    1,673     (1,062 )   (1,229 )
 

Changes in operating assets and liabilities:

                   
   

Accounts receivable

    8,503     5,560     (3,698 )
   

Notes receivable

    1,512     2,495     869  
   

Inventories

    2,909     (21,448 )   (10,471 )
   

Prepaids/other assets

    (4,009 )   2,537     (2,516 )
   

Accounts payable

    (6,036 )   (4,857 )   4,254  
   

Accrued expenses

    (3,162 )   1,262     (3,362 )
   

Accrued postretirement benefits

    80     (432 )   (575 )
               

Net cash provided by operating activities

    9,739     7,305     6,724  

Investing activities

                   

Capital expenditures

    (4,693 )   (5,582 )   (3,591 )

Proceeds on sale of assets

    106     3,629      

Purchase of Canadian entity net of cash acquired

        (240 )   (2,043 )

Purchase of U-Sung, net of cash acquired and minority interest in Hardinge Taiwan

            (5,181 )

Purchase of technical information

    (175 )       (5,000 )
               

Net cash (used in) investing activities

    (4,762 )   (2,193 )   (15,815 )

Financing activities

                   

Borrowings under short-term notes payable to bank

    49,010     84,484     105,625  

Repayments to short-term notes payable to bank

    (51,810 )   (86,026 )   (105,198 )

Increase (decrease) in long-term debt

    3,129     (48,724 )   9,651  

Net proceeds from issuance of common stock

        55,946      

Net (purchases) of treasury stock

    (585 )   (89 )   (40 )

Dividends paid

    (1,833 )   (2,164 )   (1,237 )
               

Net cash (used in) provided by financing activities

    (2,089 )   3,427     8,801  

Effect of exchange rate changes on cash

    (461 )   702     500  
               

Net increase in cash

    2,427     9,241     210  

Cash and cash equivalents at beginning of year

    16,003     6,762     6,552  
               

Cash and cash equivalents at end of year

  $ 18,430   $ 16,003   $ 6,762  
               

See accompanying notes to the consolidated financial statements

A-46



HARDINGE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

 
  Common
Stock
  Additional
Paid-in
Capital
  Retained
Earnings
  Treasury
Stock
  Accumulated
Other
Comp.
Income
(Loss)
  Deferred
Employee
Benefits
  Total
Shareholders'
Equity
 
 
  (Dollars in thousands)
 

Balance at December 31, 2005

  $ 99   $ 60,387   $ 104,219   $ (13,697 ) $ (11,029 ) $ (986 ) $ 138,993  

Comprehensive Income

                                           

Net income

                13,950                       13,950  
 

Other comprehensive income (loss)

                                           
   

Postretirement plans

                            8,800           8,800  
   

Foreign currency translation adjustment

                            9,764           9,764  
   

Unrealized (loss) on cash flow hedge

                            (48 )         (48 )
   

Unrealized (loss) on net investment hedge

                            (796 )         (796 )
   

Comprehensive income

                                        31,670  
   

Cumulative effect of adoption of SFAS 123R

          (986 )                     986     0  

Dividends declared

                (1,237 )                     (1,237 )

Change in measurement date for U.S. Pension Plan

                (494 )                     (494 )

Cumulative effect of implementing SFAS 158 (net of tax)

                            (11,944 )         (11,944 )

Shares issued pursuant to long-term incentive plan

          (45 )         45                 0  

Shares forfeited pursuant to long-term incentive plan

          167           (266 )               (99 )

Amortization (long-term incentive plan)

          259                             259  

Net purchase of treasury stock

          (41 )         2                 (39 )
   

Balance at December 31, 2006

  $ 99   $ 59,741   $ 116,438   $ (13,916 ) $ (5,253 )       $ 157,109  

Comprehensive Income

                                           

Net income

                14,926                       14,926  
 

Other comprehensive income (loss)

                                           
   

Postretirement plans

                            20,469           20,469  
   

Foreign currency translation adjustment

                            9,229           9,229  
   

Unrealized gain on cash flow hedge

                            67           67  
   

Unrealized (loss) on net investment hedge

                            (278 )         (278 )
   

Comprehensive income

                                        44,413  
   

Dividends declared

                (2,164 )                     (2,164 )

Adoption of FIN48

                (362 )                     (362 )

Secondary Equity Offering

    26     55,920                             55,946  

Shares issued pursuant to long-term incentive plan

          (847 )         847                 0  

Shares forfeited pursuant to long-term incentive plan

          65           (105 )               (40 )

Amortization (long-term incentive plan)

          333                             333  

Net purchase of treasury stock

          (241 )         151                 (90 )
   

Balance at December 31, 2007

  $ 125   $ 114,971   $ 128,838   $ (13,023 ) $ 24,234         $ 255,145  

Comprehensive Income

                                           

Net income

                (34,305 )                     (34,305 )
 

Other comprehensive income (loss)

                                           
   

Postretirement plans

                            (46,767 )         (46,767 )
   

Foreign currency translation adjustment

                            (3,050 )         (3,050 )
   

Unrealized (loss) on cash flow hedge

                            (654 )         (654 )
   

Unrealized (loss) on net investment hedge

                            (265 )         (265 )
   

Comprehensive income

                                        (85,041 )
   

Dividends declared

                (1,833 )                     (1,833 )

Shares issued pursuant to long-term incentive plan

          (1,225 )         1,225                 0  

Shares forfeited pursuant to long-term incentive plan

          381           (622 )               (241 )

Amortization (long-term incentive plan)

          682                             682  

Net purchase of treasury stock

          32           (617 )               (585 )
   

Balance at December 31, 2008

  $ 125   $ 114,841   $ 92,700   $ (13,037 ) $ (26,502 )       $ 168,127  
   

See accompanying notes to the consolidated financial statements

A-47



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2008

1. Significant Accounting Policies

Nature of Business

        Hardinge Inc. (the "Company") is a machine tool manufacturer, which designs and manufactures computer-numerically controlled cutting lathes, machining centers, grinding machines, collets, chucks, index fixtures and other industrial products. Sales are to customers in North America, Europe, and "Asia and Other." A substantial portion of our sales are to small and medium-sized independent job shops, which in turn sell machined parts to their industrial customers. Industries directly and indirectly served by the Company include: aerospace, automotive, construction equipment, defense, energy, farm equipment, medical equipment, recreational equipment, telecommunications, and transportation.

Principles of Consolidation

        The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation.

Recent Developments

        The global economic recession, which intensified in the fourth quarter of 2008, has impacted the industries in which we conduct business. The reduced availability of credit has impacted our customers' ability to obtain financing. As a result we have experienced order cancellations, a softening of incoming orders, and a reduction of sales primarily beginning in the fourth quarter of 2008. In conjunction with these economic trends, we recorded an impairment charge on our goodwill. We also were not in compliance with a financial covenant under our multi-currency secured credit facility as of December 31, 2008. As a result of all of these conditions, management has implemented cost reduction initiatives throughout the Company to preserve cash flow, including reducing our quarterly dividend. On March 16, 2009, we entered into a new $10.0 million term loan (See Note 15). Management believes these actions will provide the required cash flow to enable the Company to meet its financial commitments throughout 2009.

Reclassifications

        Certain prior year amounts have been reclassified to conform to the current-year presentation. These reclassifications had no impact on our results of operations, financial position, or changes in shareholders' equity.

Use of Estimates

        The accompanying consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles ("GAAP") which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

        We identified adjustments related to intercompany profit in inventory elimination and accounts payable which have been recorded in 2007. While these adjustments related to years 2003-2006, the effect of the adjustments was not material to net income for any of the prior periods and not significant in the aggregate to net income in 2007. The impact in 2007 was a reduction to net income of approximately $0.7 million.

A-48



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

1. Significant Accounting Policies (Continued)

Cash and Cash Equivalents

        Cash and cash equivalents are highly liquid investments with an original maturity of three months or less at the date of purchase. The fair value of the Company's cash and cash equivalents approximates carrying amounts due to the short maturities.

Accounts Receivable

        We perform periodic credit evaluations of the financial condition of our customers. No collateral is required for sales made on open account terms. Letters of credit from major banks back the majority of sales in the Asian region. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers comprising our customer base. We consider trade accounts receivable to be past due when in excess of 30 days past terms, and charge off uncollectible balances when all collection efforts have been exhausted.

        We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts was $1.9 million and $1.3 million at December 31, 2008 and 2007, respectively. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would result in additional expense to the Company.

Notes Receivable

        In the past, we provided long-term financing for the purchase of our equipment by qualified end-user customers in North America. In 2002, we replaced the internal program by offering lease programs from selected established equipment lease financing companies in the U.S. and Canada. Before that change, customer financing was generally offered for a term of up to seven years, with the Company retaining a security interest in the purchased equipment and filing appropriate liens. The amount of notes receivable outstanding was $1.9 million and $3.4 million at December 31, 2008, and December 31, 2007, respectively. These amounts are net of bad debt allowances of $1.8 million and $1.5 million at December 31, 2008 and 2007, respectively. In the event of a customer default and foreclosure, it is our practice to recondition and resell the equipment. It has been our experience that such equipment resales have realized most, but not all, of the remaining contract value. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments on notes.

Prepaid Expenses and Other Current Assets

        Prepaid expenses and other current assets consist of prepaid insurance, prepaid real estate taxes, prepaid software license agreements, prepaid income taxes and security deposits on certain inventory purchases, as well as a pension asset for one of our Swiss plans. Prepayments are expensed on a straight-line basis over the corresponding life of the underlying asset.

Inventories

        Inventories are stated at the lower of cost (computed in accordance with the first-in, first-out method) or market. Elements of cost include materials, labor and overhead.

A-49



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

1. Significant Accounting Policies (Continued)

        We assess the valuation of our inventories and reduce the carrying value of those inventories that are obsolete or in excess of our forecasted usage to their estimated net realizable value. We estimate the net realizable value of such inventories based on analyses and assumptions including, but not limited to, historical usage, future demand and market requirements. Reductions to the carrying value of inventories are recorded in cost of goods sold. If future demand for our products is less favorable than our forecasts, inventories may be required to be reduced, which would result in additional expense.

 
  Years Ended December 31  
Reserve for Excess and Obsolete Inventory
  2008   2007   2006  
 
  (in thousands)
 

Balance at Beginning of Period

  $ 13,375   $ 13,456   $ 14,391  
 

Additions to provision

    11,725     2,858     2,600  
 

Less deductions

    7,987     2,939     3,535  
               

Balance at End of Period

  $ 17,113   $ 13,375   $ 13,456  
               

Property, Plant and Equipment

        Property, plant and equipment are recorded at cost. Major additions, renewals or betterments are capitalized to property accounts. Maintenance and repairs are expensed to operations as incurred. The cost of assets retired, sold or otherwise disposed of and the related accumulated depreciation is eliminated from the accounts at the time of disposal and any resultant gain or loss is credited or included as a component of income from operations.

        Depreciation expense is computed on the straight-line and accelerated methods over the assets' estimated useful lives. Total depreciation expense on property, plant and equipment was $8.1 million, $8.3 million, and $8.5 million for 2008, 2007 and 2006, respectively. The depreciable lives of our fixed assets vary according to their estimated useful lives and generally are: 40 years for buildings, 12 years for machinery, 10 years for patterns, tools, jigs, and furniture and fixtures, and 5 years for office and computer equipment.

Goodwill and Intangibles

        We account for goodwill and intangibles in accordance with Statements of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 provides that goodwill and other separately recognized intangible assets with indefinite lives are no longer amortized, but reviewed at least annually for impairment or will be reviewed for impairment between annual tests if an event occurs or circumstances change that more likely than not would indicate the carrying amount may be impaired. Intangible assets that are determined to have a finite life will continue to be amortized over their estimated useful lives and are also subject to review for impairment.

        Other intangible assets include the value of the name, trademarks and copyrights associated with the former worldwide operations of Bridgeport, which were acquired in November 2004. We use the Bridgeport brand name on all of our machining center lines, and therefore, the asset has been determined to have an indefinite useful life.

A-50



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

1. Significant Accounting Policies (Continued)

        During 2008, we conducted impairment testing and noted that the implied fair value of our remaining goodwill and a portion of our intangible assets were less than its carrying value, accordingly we recorded a goodwill impairment charge of $23.7 million in 2008 as well as $0.6 million impairment on other intangible assets. No instances of impairment were noted on our goodwill and other intangible assets for the years ended December 31, 2007 and 2006. Footnote 3 provides additional detail on our impairment of goodwill and a summary of intangible assets segregated into amortizable and nonamortizable amounts.

Income Taxes

        We account for income taxes using the liability method in accordance with SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred tax assets and liabilities are recognized based on differences between financial reporting and tax bases of assets and liabilities. These deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. In addition, the amount of any future tax benefits is reduced by a valuation allowance until it is more likely than not those benefits will be realized.

        The Company recorded a full valuation allowance for its U.S. net deferred tax assets in 2003. SFAS 109 requires that a valuation allowance be established when it is "more likely than not" that all or a portion of deferred tax assets will not be realized. A review of all available positive and negative evidence needs to be considered, including a company's current and past performance, the market conditions in which the company operates, the utilization of past tax credits, the length of carryback and carryforward periods, sales backlogs, etc. that will result in future profits. It further states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Therefore, cumulative losses weigh heavily in the overall assessment and are a major consideration in our decision to establish a valuation allowance.

        We continue to maintain a full valuation allowance on the tax benefits of our U.S. net deferred tax assets and we expect to continue to record a full valuation allowance on future tax benefits until an appropriate level of profitability in the U.S. is sustained. We also maintain a valuation allowance on our U.K., Germany, and Canadian deferred tax assets related to tax loss carryforwards in those jurisdictions, as well as all other deferred tax assets of those entities.

        The determination of our provision for income taxes requires significant judgment, the use of estimates and the interpretation and application of complex tax laws. Our provision for income taxes reflects a combination of income earned and taxed in the U.S. and the various states, as well as Switzerland, U.K., Canada, Germany, China and Taiwan federal and provincial jurisdictions. Jurisdictional tax law changes, increases or decreases in permanent differences between book and tax items, accruals or adjustments of accruals for tax contingencies or valuation allowances, and our change in the mix of earnings from these taxing jurisdictions all affect the overall effective tax rate. Accordingly, these substantial judgment items impacted the effective tax rate for 2008.

        On January 1, 2007, the Company adopted FIN 48, and thus accounts for its uncertain tax positions in accordance with the provisions of FIN 48 guidance. Refer to Note 5, Income Taxes, for information related to the effect of adoption of FIN 48, and the accounting for the Company's uncertain tax positions.

A-51



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

1. Significant Accounting Policies (Continued)

Revenue Recognition

        Revenue from product sales is generally recognized upon shipment, provided persuasive evidence of an arrangement exists, the sales price is fixed or determinable, collectibility is reasonably assured and the title and risk of loss have passed to the customer. Sales are recorded net of discounts, customer sales incentives and returns. Transfer of ownership and risk of loss are generally not contingent upon contractual customer acceptance. Prior to shipment, each machine is tested to ensure the machine's compliance with standard operating specifications as listed in our promotional literature. On an exception basis, where larger multiple machine installations are delivered which require run-offs and customer acceptance at their facility, revenue is recognized in the period of customer acceptance.

        Revenue from extended warranties are deferred and recognized on a pro-rata basis across the term of the warranty contract.

Sales Tax/VAT

        We collect and remit taxes assessed by different governmental authorities that are both imposed on and concurrent with revenue producing transactions between the Company and its customers. These taxes may include sales, use and value-added taxes. We report the collection of these taxes on a net basis (excluded from revenues).

Shipping and Handling Costs

        Shipping and handling cost are recorded as part of cost of goods sold.

Warranties

        We offer warranties for our products. The specific terms and conditions of those warranties vary depending upon the product sold and the country in which we sold the product. We generally provide a basic limited warranty, including parts and labor, for a period of one year. We estimate the costs that may be incurred under our basic limited warranty, based largely upon actual warranty repair cost history, and record a liability for such costs in the month that product revenue is recognized. The resulting accrual balance is reviewed during the year. Factors that affect our warranty liability include the number of installed units, historical and anticipated rates of warranty claims, and cost per claim.

        We also sell extended warranties for some of our products. These extended warranties usually cover a 12-24 month period that begins up to 12 months after time of sale. Revenues for these extended warranties are recognized monthly as a portion of the warranty expires.

        These liabilities are reported in accrued expenses on our consolidated balance sheet.

A-52



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

1. Significant Accounting Policies (Continued)

        Changes in our product warranty accrual are as follows:

 
  Year Ended December 31,  
 
  2008   2007  
 
  (in thousands)
 

Balance at beginning of period

  $ 2,469   $ 1,957  

Provisions for warranties

    3,440     3,165  

Warranties settlement costs

    (3,129 )   (2,751 )

Other—currency translation impact

    92     98  
           

Balance at end of period

  $ 2,872   $ 2,469  
           

Research and Development Costs

        The costs associated with research and development programs for new products and significant product improvements are expensed as incurred as a component of cost of goods sold. Research and development expenses totaled $9.8 million, $10.6 million, and $9.8 million, in 2008, 2007, and 2006, respectively.

Foreign Currency Translation

        In accordance with SFAS No. 52 "Foreign Currency Translation", we translate foreign currencies into U.S. Dollars. The functional currency for translating the accounts of our operations outside the U.S. is the currency of the country in which the subsidiary is geographically located. The translation from the applicable foreign currencies is performed for all balance sheet accounts of foreign subsidiaries using exchange rates in effect at the balance sheet date and income statement items are translated at an average exchange rate for the period. The gain or loss resulting from translating subsidiary financial statements is recorded as a separate component of the consolidated statement of shareholders' equity as other comprehensive income. Gains and losses resulting from foreign currency denominated transactions are included as a component of selling, general and administrative expense in our Consolidated Statement of Operations.

Impairment of Long Lived Assets

        In accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets", we review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such events or changes in circumstances are present, a comparison is made of the carrying value of the asset to the estimated undiscounted cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds its fair value. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell and are no longer depreciated. Impairment testing in 2008 on long-lived assets resulted in a charge of $0.6 million.

A-53



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

1. Significant Accounting Policies (Continued)

Fair Value of Financial Instruments

        Financial Instruments are disclosed in accordance with SFAS No. 157, "Fair Value Measurements", which defines fair value and establishes a framework for measuring fair value in applying Generally Accepted Accounting Principles, and expands disclosures about fair value measurement. We used the following methods and assumptions in estimating our fair value disclosure for financial instruments:

        Cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable and accrued expenses: The carrying value of these items approximates fair value because of the relatively short maturities of these instruments.

        Notes receivable:    At December 31, 2008 and 2007, the carrying value of these notes approximated the fair value.

        Long-term debt:    The fair value of variable interest rate debt is approximately equal to its carrying value, as the underlying interest rate is variable.

        Interest rate swap and foreign currency swap agreement: At December 31, 2007, the fair value of the swap agreement was based on quoted market prices for similar instruments.

        Related to our term loan, we entered into a cross-currency swap agreement and an interest rate swap agreement (see Note 4). The term loan and both currency and rate swaps were terminated during 2008. At December 31, 2007 the fair market value of the currency swap was a liability of $0.6 million and the market value on the interest rate swap was immaterial. The notional amount of the cross currency swap at December 31, 2007 was $1.2 million.

Derivative Financial Instruments

        As a multinational Company, we are exposed to market risk from changes in foreign currency exchange rates and interest rates that could affect our results of operations and financial condition.

        Derivative instruments that are not qualifying hedges must be adjusted to fair value through earnings. If the derivative is a qualifying hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in accumulated other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value is immediately recognized in earnings.

        We enter into derivative instruments, including interest rate swaps and foreign currency forwards to manage our interest rate and foreign currency risks. Our derivative instruments are held to hedge economic exposures, such as fluctuations in foreign currency exchange rates on balance sheet exposures of both trade and intercompany assets and liabilities.

        We enter into foreign currency forwards to hedge fluctuations in foreign currency cash flows due to certain trade and intercompany accounts receivable and accounts payable. We hedge this exposure with contracts settling in less than a year and designate these forward contracts as fair value hedges. Gains or losses resulting from the changes in the fair value of these hedging contracts are recognized in earnings.

        At December 31, 2008 and 2007, we had notional principal amounts of approximately $22.1 million and $3.8 million, respectively, in contracts to purchase or sell currency in the future from and to major commercial banks. At December 31, 2008, we recognized fair value asset amounts of approximately $.7 million. At December 31, 2007, the fair value of these contracts was not material.

A-54



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

1. Significant Accounting Policies (Continued)

Earnings Per Share

        We calculate earnings per share in accordance with SFAS No. 128 "Earnings Per Share". Basic earnings per share are computed by using the weighted average number of shares of common stock outstanding during the year. For diluted earnings per share, the weighted average number of shares includes common stock equivalents related primarily to restricted stock and stock options.

        The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations required by SFAS No. 128:

 
  Year Ended December 31,  
 
  2008   2007   2006  
 
  (in thousands except for
per share amounts)

 

Net (loss) income

  $ (34,305 ) $ 14,926   $ 13,950  

Numerator for basic (loss) earnings per share

    (34,305 )   14,926     13,950  

Numerator for diluted (loss) earnings per share

    (34,305 )   14,926     13,950  

Denominator for basic earnings per share
—weighted average shares

    11,309     10,442     8,770  

Effect of diluted securities:
restricted stock and stock options

        120     39  
               

Denominator for diluted earnings per share
—adjusted weighted average shares

    11,309     10,562     8,809  
               

Basic (loss) earnings per share

  $ (3.03 ) $ 1.43   $ 1.59  
               

Diluted (loss) earnings per share

  $ (3.03 ) $ 1.41   $ 1.58  
               

        There is no dilutive effect of the restrictive stock and stock options for the year ended December 31, 2008 since the impact would be anti-dilutive.

Stock-Based Compensation

        On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), "Share-Based Payment" (SFAS 123R), which requires all equity-based payments to employees, including grants of employee stock options, to be recognized in the statement of earnings based on the grant date fair value of the award. This was adopted using the modified perspective method.

        We issued 46,000 stock options in December of 2008. The 2008 expense recognized on these new options was immaterial. All of the previously awarded stock option grants were fully vested at the date of the adoption of SFAS 123R, thus, we did not recognize any share-based compensation expense in 2008, 2007, or 2006, related to those stock options.

        For restricted stock awards issued, the cost is equal to the fair value of the award at the date of grant and compensation expense is recognized for those awards earned over the service period of the grant. During 2008, the Company awarded 83,000 shares of restricted stock with a value of $0.7 million and awarded 13,000 units (a unit is equivalent to a share) with a value of $0.05 million. In 2008, 47,150 restricted shares vested with a market value of $0.6 million and 46,367 restricted shares/units were

A-55



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

1. Significant Accounting Policies (Continued)


forfeited. Amortization expense in 2008 for restricted stock shares and units was $0.7 million, offset by $0.3 million in forfeitures of previously amortized awards. Amortization expense in 2007 for restricted stock shares and units was $0.3 million, amortization expense in 2006 was $0.3 million offset by $0.1 million in forfeitures. There were a total of 155,483 restricted shares and 24,000 units outstanding at December 31, 2008. We amortize compensation expense for restricted stock and units over the vesting period of the grant. The compensation cost not yet recognized on these shares is $1.3 million, which will be amortized over a weighted average term of 2.7 years.

        The following characteristics apply to the Plan stock options that were fully vested, as of December 31, 2008:

Number of options outstanding that are currently exercisable

    36,490  

Weighted-average exercise price of options currently exercisable

    $12.04  

Aggregate intrinsic value of options currently exercisable (in millions)

    $  0.2  

Weighted-average contractual term of options currently exercisable

    5.38 years  

        We use shares of stock held in treasury to fulfill restricted stock awards or shares earned from the exercise of stock options.

        Additional information related to the Company's Incentive Stock Plans is detailed in Note 6 of the Notes to Consolidated Financial Statements.

Comprehensive Income

        We report comprehensive income in accordance with SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes rules for the reporting of comprehensive income and its components and requires the components to be listed in the financial statements. Comprehensive income consists of net income, postretirement plan adjustments, foreign currency translation adjustments and unrealized gains or losses on hedging, net of tax, and is presented in the Consolidated Statements of Shareholders' Equity.

2. Inventories

        Inventories are stated at the lower of cost (computed in accordance with the first-in, first-out method) or market. Elements of cost include materials, labor and overhead and are as follows:

 
  December 31,  
 
  2008   2007  
 
  (in thousands)
 

Finished products

  $ 74,287   $ 85,453  

Work-in-process

    32,827     32,502  

Raw materials and purchased components

    37,843     40,662  
           

  $ 144,957   $ 158,617  
           

        During 2008, we conducted a comprehensive evaluation of our operations, products, and worldwide markets. As a result of this strategic review, we decided to focus on products which are in the higher

A-56



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

2. Inventories (Continued)


end of the product spectrum. As a result of this change, we have discontinued certain product lines which target less demanding manufacturing applications. Additionally, due to the actions taken to reposition our product mix, as well as a review of other expected inventory usage patterns, we recognized a non-cash charge of approximately $7.6 million in 2008 for the impairment of inventory.

3. Goodwill and Intangibles

        The Company accounts for goodwill and intangible assets in accordance with Statements of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. The statement requires that these assets be reviewed for impairment at least annually and reviewed if an event or conditions change that would more likely than not reduce the fair value of a reporting unit below its carrying value. The determination of fair value used in the impairment evaluation is based on a combination of the income approach, utilizing the discounted cash flow method, and the public company comparables approach, utilizing multiples of profit measures in order to estimate fair value.

        The changes in the carrying amount of goodwill are as follows:

 
  Year Ended
December 31,
 
 
  2008   2007  
 
  (in thousands)
 

Balance at beginning of period

  $ 22,841   $ 19,110  

Canadian purchase—goodwill

        2,099  

Write off—impairment

    (23,777 )    

Currency translation adjustment

    936     1,632  
           

Balance at end of period

  $   $ 22,841  
           

        Due to recurring losses at our Canadian entity, during the third quarter of 2008 we performed a discounted cash flow analysis which indicated that the goodwill and intangible assets related to our Canadian entity were impaired. Accordingly, the Company recorded a non-cash charge of $2.1 million to reflect the impairment of the goodwill.

        During the fourth quarter of 2008 we conducted our annual impairment testing. As a result of the global economic conditions and the dramatic decreases in our equity value and the equity value of our industry peers, we determined that the carrying value of reporting units with goodwill exceeded their fair value, indicating that goodwill was potentially impaired. As a result, we initiated the second step of the goodwill impairment test which involves calculating the implied fair value of our goodwill by allocating the fair value of the related reporting unit to all of the reporting unit's assets and liabilities other than goodwill and comparing it to the carrying amount of goodwill. We determined that the implied fair value of our remaining goodwill was $0.0 which resulted in a further $21.6 million impairment charge in 2008.

A-57



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

3. Goodwill and Intangibles (Continued)

Intangible Assets

        The major components of other intangible assets are as follows:

 
  December 31,  
 
  2008   2007  
 
  (in thousands)
 

Amortizable intangible assets:

             

Technical information, patents, and other items

  $ 8,961   $ 9,370  

Nonamortizable intangible assets:

             

Trade name, trademarks & copyrights

    6,500     6,582  
           

    15,461     15,952  

Less accumulated amortization

    (4,736 )   (4,025 )
           

Other Intangible Assets, net

  $ 10,725   $ 11,927  
           

        Other intangible assets include $6.5 million representing the value of the name, trademarks and copyrights associated with the former worldwide operations of Bridgeport, which were acquired in 2004. The Company uses this recognized brand name on all of its machining center lines, and therefore, the asset has been determined to have an indefinite useful life. These assets are reviewed annually for impairment under the provisions of SFAS 142.

        At December 31, 2008 amortizable intangible assets of $4.2 million include the technical information, patents, distribution agreements, customer lists and other items. These assets are reviewed annually for impairment under the provisions of SFAS 144. Due to recurring losses at our Canadian entity, during the third quarter of 2008 we performed a cash flow analysis which indicated that the intangible assets related to our Canadian entity were impaired: accordingly, intangible assets of $0.6 million were written off.

        Our intangible asset amortization expense for the years ended December 31, 2008 and 2007 was $0.9 million and $0.9 million. The estimated amortization expense on existing intangible assets for each of the next five years is approximately $0.7 million, $0.7 million, $0.6 million, $0.6 million, and $0.5 million, respectively. The estimated useful life of the intangible assets ranges from five to ten years.

A-58



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

4. Financing Arrangements

        Long-term debt consists of:

 
  December 31,  
 
  2008   2007  
 
  (in thousands)
 

Note payable under revolving credit facility, with an effective interest rate of 2.22% at December 31, 2008

  $ 24,000   $  

Note payable under revolving credit agreement, with an effective interest rate of 6.07% at December 31, 2007

        8,000  

Note payable under term loan agreement, with an effective interest rate of 5.93% at December 31, 2007

        12,300  

Real estate secured loan payable under terms of loan agreement, with interest rates of 1.48% at December 31, 2008 and 2.92% at December 31, 2007

    4,121     4,718  
           

    28,121     25,018  

Less: current portion

    (24,549 )   (5,655 )
           

  $ 3,572   $ 19,363  
           

        On June 13, 2008, we entered into a new five-year $100.0 million multi-currency secured credit facility ("Credit Facility"). The Credit Facility replaced a $70.0 million revolving credit and a term loan agreement which was due to mature January 2011 as well as several other credit facilities in place in our foreign subsidiaries. The Credit Facility is secured by substantially all of the Company's and its domestic subsidiaries' assets, other than real estate, and a pledge of (i) 100% of the Company's investments in its domestic subsidiaries and (ii) 66 and 2/3% of the Company's investment in Hardinge Holdings GmbH ("Hardinge Holdings"). In addition, if certain conditions are met, Hardinge Holdings may be required to pledge its investment in certain of its material foreign subsidiaries. The obligations of the Company and Hardinge Holdings are also guaranteed by all of the Company's domestic subsidiaries and, under certain conditions, by certain of the Company's material foreign subsidiaries. Interest is based on London Interbank Offered Rates plus a spread which varies depending on the Company's debt to EBITDA (earnings before interest, taxes, depreciation and amortization) ratio. A variable commitment fee of 0.20% to 0.375%, based on the Company's debt to EBITDA ratio, is payable on the unused portion of the Credit Facility. We have the option, subject to certain conditions, to increase the facility by $50.0 million. At December 31, 2008, borrowings under this agreement were $24.0 million which we have classified in current portion of long-term debt outstanding as a result of our not being in compliance with our required debt covenants.

        In November 2006, we amended and restated a Revolving Credit and Term Loan Agreement with a group of U.S. banks. The amended and restated agreement provided for a revolving loan facility of $70.0 million and a term loan of $30.0 million with quarterly principal payments of $1.2 million through December 2006 and quarterly principal payments of $1.3 million from March 2007 through March 2011. These loans were secured by substantially all of our domestic assets, other than real estate, and a pledge of 65% of our investment in the Company's major subsidiaries. The amendment increased the permitted debt to EBITDA ratio for certain portions of the term of the facility, lowered the variable commitment fee and borrowing rates at certain debt to EBITDA ratios, and provided for permitted annual acquisitions up to a certain amount. Interest charged on this debt was based on LIBOR plus a

A-59



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

4. Financing Arrangements (Continued)


spread that varied depending on our debt to EBITDA ratio. A variable commitment fee of 0.15% to 0.375%, based on the Company's debt to EBITDA ratio, was payable on the unused portion of the revolving loan facility. At December 31, 2007, the outstanding balance on the amended revolving loan facility was $8.0 million. At December 31, 2007, the outstanding balance on the term loan was $12.3 million. This Revolving Credit and Term Loan Agreement was replaced by the Credit Facility entered into on June 13, 2008.

        Maturities of long-term debt under the long-term financing agreements in place are as follows for the years ended December 31 (in thousands):

 

2009

  $ 24,549  
 

2010

    549  
 

2011

    550  
 

2012

    549  
 

2013

    549  
 

Thereafter

    1,375  

        We have a $3.0 million unsecured short-term line of credit from a bank with interest based on the prime rate. There was no balance outstanding at December 31, 2008. At December 31, 2007, the outstanding balance on this line was $2.8 million. The agreement is negotiated annually and requires no commitment fee.

        In December 2008, our Kellenberger AG ("Kellenberger") subsidiary replaced their existing credit facilities and loan agreements with two new unsecured loan facilities with banks providing for borrowing of up to 11.5 million Swiss Francs, which is equivalent to approximately $10.8 million at December 31, 2008. These lines provide for interest at competitive short-term interest rates and carry no commitment fees on unused funds. At December 31, 2008 there were no borrowings under these facilities.

        Kellenberger previously maintained a loan agreement with a Swiss bank providing for borrowing of up to 7.3 million Swiss Francs, which was equivalent to approximately $6.4 million at December 31, 2007. This agreement was secured by the real property owned by Kellenberger. At December 31, 2007, there were no borrowings under this facility. This loan agreement was replaced by the new unsecured loan facilities in December 2008.

        Kellenberger also previously maintained an unsecured overdraft facility with a commercial bank that permitted borrowings of up to 7.5 million Swiss Francs, which was equivalent to approximately $6.6 million at December 31, 2007. These lines provided for interest at competitive short-term interest rates and carried no commitment fees on unused funds. At December 31, 2007 there was no outstanding balance under this facility. This overdraft facility was replaced by the new unsecured loan facilities in December 2008.

        Our HTT subsidiary (which is now part of Kellenberger) previously maintained a loan agreement with a Swiss bank which provided for borrowings of up to 4.0 million Swiss Francs, which was equivalent to approximately $3.5 million at December 31, 2007. This agreement was secured by real property owned by HTT. There were no borrowings under this agreement at December 31, 2007. This loan agreement was replaced by the new unsecured loan facilities in December 2008.

A-60



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

4. Financing Arrangements (Continued)

        The former HTT also previously maintained an unsecured overdraft facility with a commercial bank that permitted borrowings of up to 8.5 million Swiss Francs, which was equivalent to approximately $7.5 million at December 31, 2007. These lines provided for interest at competitive short-term interest rates and carried no commitment fees on unused funds. There were no borrowings under this overdraft line at December 31, 2007. This overdraft facility was replaced by the new unsecured loan facilities in December 2008.

        Our Hardinge Machine Tools, Ltd. subsidiary previously maintained an overdraft facility that allowed for borrowing up to 0.4 million Pounds Sterling, which was equivalent to approximately $0.7 million in 2007. The facility was closed in 2007.

        In June 2006, our Taiwan subsidiary negotiated a mortgage loan with a bank secured by the real property owned by the Taiwan subsidiary which initially provided borrowings of 153.0 million New Taiwanese Dollars which was equivalent to approximately $4.7 million. At December 31, 2008 and 2007 borrowings under this agreement were $4.1 million and $4.7 million, respectively. Principal on the mortgage loan is repaid quarterly in the amount of 4.5 million New Taiwanese Dollars, which is equivalent to approximately $0.1 million.

        We maintain a $1.6 million standby letter of credit, which expires March 31, 2009, for potential liabilities pertaining to self-insured workers compensation exposure. This standby letter of credit is renewed annually. In total, we had various letters of credit totaling $9.1 million and $5.6 million at December 31, 2008 and 2007, respectively.

        Certain of these debt agreements require, among other things, that we maintain specified ratios of debt to EBITDA and EBITDA minus capital expenditures to fixed charges, as well as, minimum equity. At December 31, 2008 the Company was not in compliance with the minimum EBITDA minus capital expenditures to fixed charges required under our multi-currency secured credit facility. As further described in Note 15, Subsequent Events, we entered into a new $10 million term loan on March 16, 2009.

        Excluding amounts associated with the multi-currency secured credit facility, with which we were not in compliance as of December 31, 2008, the Company had access of up to $17.9 million at December 31, 2008. At December 31, 2008 and March 15, 2009, the Company had borrowings of $24.0 million and $8.0 million respectively, outstanding under the multi-currency secured credit facility. Total consolidated outstanding borrowings at December 31, 2008 and 2007 were $28.1 million and $27.8 million, respectively. Interest expense in 2008, 2007, and 2006 totaled $1.7 million, $3.1 million, and $5.3 million, respectively.

A-61



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

5. Income Taxes

        The Company's pre-tax income for domestic and foreign sources is as follows:

 
  Year Ended December 31,  
 
  2008   2007   2006  
 
  (in thousands)
 

Domestic

  $ (16,712 ) $ (4,081 ) $ (1,290 )

Foreign

    (14,545 )   25,517     19,806  
               
 

Total

  $ (31,257 ) $ 21,436   $ 18,516  
               

        Significant components of the Company's deferred tax assets and liabilities are as follows:

 
  December 31,  
 
  2008   2007  
 
  (in thousands)
 

Deferred tax assets:

             

Federal, state, and foreign net operating losses

  $ 20,778   $ 9,707  
 

State tax credit carryforwards

    6,683     4,329  
 

Postretirement benefits

    1,072     733  
 

Deferred employee benefits

    1,894     1,596  
 

Accrued pension

    13,424     1,360  
 

Inventory valuation

    582     432  
 

Other

    2,016     2,819  
           

    46,449     20,976  
 

Less valuation allowance

    (38,001 )   (17,956 )
           
     

Total deferred tax assets

    8,448     3,020  
           

Deferred tax liabilities:

             
 

Tax over book depreciation

    (3,978 )   (4,597 )
 

Inventory valuation

    (3,118 )   (2,375 )
 

Other

    (3,014 )   (1,446 )
           
   

Total deferred tax liabilities

    (10,110 )   (8,418 )
           
   

Net deferred tax liabilities

  $ (1,662 ) $ (5,398 )
           

        We continue to maintain a full valuation allowance on the tax benefits of our U.S. net deferred tax assets and we expect to continue to record a full valuation allowance on future tax benefits until an appropriate level of profitability in the U.S. is sustained. We also maintain a valuation allowance on our U.K., Germany, and Canadian deferred tax assets related to tax loss carryforwards in those jurisdictions, as well as all other deferred tax assets of those entities.

        In 2008, the valuation allowance increased by $20.0 million. This was due to an increase of $7.2 million due to not recording a tax benefit on losses in the U.S., Canada, U.K., and Germany, an increase of $10.7 million due to the increase in minimum pension liabilities in the U.S. and the U.K. (and other items also recorded in Other Comprehensive Income), an increase of $2.2 million for state

A-62



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

5. Income Taxes (Continued)


tax credits, and a decrease of $.1 million due a reduction and a reversal of tax assets in accordance with FIN 48.

        In 2007, the valuation allowance decreased by $8.3 million. This was due to an increase of $0.9 million due to not recording a tax benefit on losses in the U.S. and Canada, a decrease of $5.5 million due to the reduction in minimum pension liabilities in the U.S. and the U.K. (recorded in Other Comprehensive Income), a decrease of $3.1 million due to a reduction in tax assets as a result of decrease in applicable U.S. state tax rates, and a decrease of $0.6 million due a reduction and a reversal of tax assets in accordance with FIN 48.

        At December 31, 2008 and 2007, we had state investment tax credits of $6.6 million and $4.3 million, respectively, expiring at various dates through the year 2016. In addition, we have U.S. and state net operating loss carryforwards of $45.7 million and $74.9 million, respectively, which expire from 2021 through 2028. We also have foreign net operating loss carryforwards of $14.0 million. The U.S. net operating loss includes approximately $1.5 million of the net operating loss carryforward for which a benefit will be recorded in Additional Paid in Capital when realized.

        Significant components of income tax expense (benefit) attributable to continuing operations are as follows:

 
  Year Ended December 31,  
 
  2008   2007   2006  
 
  (in thousands)
 

Current:

                   
 

Federal and state

  $   $ 92   $  
 

Foreign

    3,463     6,337     4,486  
               
   

Total current

    3,463     6,429     4,486  
               

Deferred:

                   
 

Federal and state

    (634 )        
 

Foreign

    219     81     80  
               
   

Total deferred

    (415 )   81     80  
               

  $ 3,048   $ 6,510   $ 4,566  
               

        There were no income tax refunds in 2008, 2007 or 2006. Income tax payments primarily related to foreign locations totaled $5.6 million, $5.9 million, and $4.6 million, in 2008, 2007, and 2006, respectively.

A-63



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

5. Income Taxes (Continued)

        The following is a reconciliation of income tax expense computed at the United States statutory rate to amounts shown in the Consolidated Statements of Income:

 
  2008   2007   2006  

Federal income taxes at statutory rate

    (35.0 )%   35.0 %   35.0 %

Taxes on foreign income which differ from the U.S. statutory rate

    4.0     (11.8 )   (9.9 )

Effect of change in the enacted rate in Swiss jurisdiction

    (1.0 )   (0.5 )   (3.7 )

Increase in valuation allowance

    29.7     4.5     2.6  

Recognition of state tax credits

    (7.1 )        

Change in estimated liabilities

    3.3     3.0      

Tax effect of goodwill impairment

    16.0          

Other

    (0.1 )   .2     .7  
               

    9.8 %   30.4 %   24.7 %
               

        At the end of 2008, we concluded that we no longer plan to indefinitely reinvest all of our non-U.S. subsidiaries' earnings outside the U.S., due to capital overseas in excess of current and projected future needs. As a result, we recorded a deferred tax liability of $2.0 million at the end of 2008 to reflect the net additional U.S. tax due upon the ultimate repatriation of approximately $5.8 million of the previously undistributed earnings of our non-U.S. subsidiaries. Because of our tax loss carryforwards in the U.S., we reduced the deferred tax asset related to this item, and decreased our valuation allowance by a corresponding amount.

        The remaining undistributed earnings of the foreign subsidiaries, which amounted to approximately $109.1 million at December 31, 2008, are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries.

        We had been granted a tax holiday in China. For 2008, our tax rate for our Chinese subsidiary was 9.0%, which is 50% of the normal 18% tax rate for the jurisdiction in which we operate. As a result of new legislation effective for 2007, our tax rate in China will be phased in until ultimately reaching a rate of 25% in 2012.

        On January 1, 2007, we adopted the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes: An interpretation of FASB Statement No. 109" ("FIN 48"). As a result of the adoption of FIN 48 and recognition of the cumulative effect of adoption of a new accounting principle, the Company recorded a $0.4 million increase in the liability for uncertain income tax benefits, with an offsetting reduction in retained earnings. This adjustment reflects the net difference between related balance sheet accounts before applying FIN 48, and then as measured pursuant to the provisions of FIN 48. In addition, we derecognized $1.46 million of deferred tax assets, for which a full valuation allowance had previously been provided. The valuation allowance was also reduced by $1.46 million as part of the adoption of FIN 48. Additionally, the adoption of FIN 48 resulted in the accrual for uncertain tax positions being reclassified from accrued income taxes to other liabilities in our Consolidated Balance Sheet.

A-64



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

5. Income Taxes (Continued)

        A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

Balance at January 1, 2008

  $ 1,086  

Additions for tax positions related to the current year

    677  

Additions for tax positions of prior years

    748  

Reductions for tax positions of prior years

    (132 )

Reductions due to lapse of applicable statute of limitations

    (155 )

Settlements

    (32 )
       

Balance at December 31, 2008

    2,192  
       

        If recognized, essentially all of the uncertain tax benefits and related interest at December 31, 2008 would be recorded as a benefit to income tax expense on the Consolidated Statement of Operations.

        We record interest and penalties on tax reserves as income tax expense in the financial statements. For the year ended December 31, 2008 interest expense of $.06 million was recorded and penalties of $.05 million were reduced, and there was $.3 million of accrued interest and $.2 million of accrued penalties related to uncertain tax positions included in the liability for uncertain tax positions at December 31, 2008.

        For the year ended December 31, 2008, we recognized $.1 million of deferred tax assets that had previously been reversed, due to the lapse of applicable statutes of limitations. We determined that the deferred tax assets should be subject to a full valuation allowance, and the valuation allowance was also increased by $.1 million.

        The tax years 2005 to 2008 remain open to examination by United States taxing authorities, and for our other major jurisdictions (Switzerland, U.K., Taiwan, Germany, Canada, and China), the tax years between 2003 to 2008 generally remain open to routine examination by foreign taxing authorities, depending on the jurisdiction.

        On April 1, 2007, legislation was enacted in New York State that changed the apportionment methodology for corporate income from a "three factor formula" comprised of payroll, property, and sales, to one which uses only sales. The law also provides for a lowering of the general corporate income tax rate. These changes are fully effective for the tax year 2007 and thereafter. As a result of this significant change in expected state income tax rates to the company, we reduced our net deferred tax assets by $3.1 million during 2007. Concurrently with this action, we also reduced our valuation allowance by $3.1 million due to this item.

6. Incentive Stock Plans

        We have an Incentive Stock Plan which allows the Board of Directors to issue restricted stock, performance share awards, stock options, and stock appreciation rights. Under the 2002 Plan, an aggregate of 450,000 shares of common stock can be awarded.

A-65



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

6. Incentive Stock Plans (Continued)

        The Company recognizes share-based compensation expense in relation to restricted stock awards. A summary of the restricted stock activity under the Incentive Stock Plan is as follows:

 
  Year Ended December 31,  
 
  2008   2007   2006  

Shares at beginning of period

    177,000     143,000     193,750  

Shares granted

    83,000     56,000     3,000  

Units granted

    13,000     14,500      

Shares vested

    (47,150 )   (29,000 )   (29,815 )

Shares cancelled, forfeited or exercised

    (46,367 )   (7,500 )   (23,935 )
               

Shares and units at end of period

    179,483     177,000     143,000  
               

Intrinsic value of shares vested (in millions)

  $ 0.1   $ 0.5   $ 0.5  

        A total of 179,483 and 177,000 restricted shares/units of common stock were outstanding under the plans at December 31, 2008 and December 31, 2007, respectively. All shares of restricted stock are subject to forfeiture and restrictions on transfer. Unconditional vesting occurs upon the completion of a specified period ranging from three to eight years from date of grant.

        Deferred compensation associated with these restricted stock awards is measured by the market value of the stock on the date of grant and totaled $0.7 million, $1.6 million, and $0.1 million, related to awards in 2008, 2007, and 2006, respectively. This deferred compensation is being amortized on a straight-line basis over the specified service period, which ranges from three to eight years. The unamortized deferred compensation at December 31, 2008, 2007 and 2006 totaled $1.3 million, $1.8 million and $0.6 million, respectively, and is included in additional paid in capital as a reduction of shareholders' equity.

        A summary of the stock option activity under the Incentive Stock Plans is as follows:

 
  Year Ended December 31,  
 
  2008   2007   2006  

Options at beginning of period

    36,490     136,119     184,288  

Options granted

    46,000          

Weighted average grant price per share

  $ 3.84          

Market value per share at date of grant

  $ 3.84          

Options canceled or forfeited

    (2,250 )   (29,250 )   (41,917 )

Weighted average price per share

  $ 25.11   $ 17.19   $ 17.27  

Options exercised

    (1,500 )   (70,379 )   (6,252 )

Weighted average price per share

  $ 7.81   $ 11.04   $ 9.00  
               

Options at end of period

    78,740     36,490     136,119  
               

        During 2008 and 2007, the Company received cash of $0.01 million and $0.8 million, respectively for 1,500 and 70,379 options that were exercised. The aggregate intrinsic value of options exercised during the year ended December 31, 2008 and 2007 was $0.01 million and $1.5 million, respectively.

A-66



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

6. Incentive Stock Plans (Continued)

        The following table summarizes information about the stock options outstanding as of December 31, 2008:

Range of exercise prices
  Number
Outstanding
and exercisable
at 12/31/08
  Number
Outstanding
and non-exercisable
at 12/31/08
  Weighted
average
remaining life
in years
  Weighted
average
exercise price
 

$3.84

          46,000     9.92   $ 3.84  

$6.71 to $7.81

    10,490         5.09   $ 7.57  

$10.50 to $12.65

    14,000         4.40   $ 12.02  

$13.51 to $17.44

    8,250         4.88   $ 14.93  
                   

Total

    32,740     46,000     7.77   $ 6.95  
                   

        The aggregate intrinsic value of exercisable options as of December 31, 2008 was $0.

7. Industry Segment and Foreign Operations

        We operate in one business segment—industrial machine tools.

        Domestic and foreign operations consist of:

 
  Year ended December 31,  
 
  2008   2007   2006  
 
  North
America
  Europe   Asia/
Other
  North
America
  Europe   Asia/
Other
  North
America
  Europe   Asia/
Other
 
 
  (in thousands)
 

Sales

                                                       

Domestic

  $ 114,207   $ 150,672   $ 62,193   $ 120,755   $ 158,349   $ 52,413   $ 124,403   $ 124,507   $ 38,598  

Export

    17,773     37,094     30,411     25,931     39,269     41,908     25,959     43,413     33,846  
                                       

    131,980     187,766     92,604     146,686     197,618     94,321     150,362     167,920     72,444  

Less interarea eliminations

    18,336     20,810     28,198     23,641     17,967     40,695     17,521     13,261     33,323  
                                       

Total Net Sales

  $ 113,644   $ 166,956   $ 64,406   $ 123,045   $ 179,651   $ 53,626   $ 132,841   $ 154,659   $ 39,121  
                                       

Identifiable Assets

  $ 112,755   $ 142,826   $ 54,244   $ 135,595   $ 172,564   $ 53,669   $ 135,295   $ 154,402   $ 40,963  
                                       

        Sales attributable to European Operations and Asian Operations are based on those sales generated by subsidiaries located in Europe and Asia.

        Interarea sales are accounted for at prices comparable to normal, unaffiliated customer sales, reduced by estimated costs not incurred on these sales.

        No single customer accounted for more than 5% of consolidated sales in 2008 and 2007.

        Machine sales accounted for 74.4% and 74.8% of 2008 and 2007 net sales, respectively. Sales on non-machine products and services, primarily workholding, repair parts, and accessories made up the balance.

A-67



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

7. Industry Segment and Foreign Operations (Continued)

Revenues from external customers by country:

 
  Year Ended December 31,  
 
  2008   % of
Total
  2007   % of
Total
  2006   % of
Total
 
 
  (in thousands)
 

U.S. Sales

  $ 99,193     28.8 % $ 113,423     31.8 % $ 109,288     33.4 %

Germany

    51,850     15.0 %   45,295     12.7 %   32,631     10.0 %

China

    51,503     14.9 %   43,455     12.3 %   45,581     14.0 %

England

    26,595     7.7 %   35,312     9.9 %   25,037     7.7 %

Other Foreign

    115,865     33.6 %   118,837     33.3 %   114,084     34.9 %
                           

Total Foreign

    245,813     71.2 %   242,899     68.2 %   217,333     66.6 %
                           

Total Sales

  $ 345,006     100.0 % $ 356,322     100.0 % $ 326,621     100.0 %
                           

Total Property, Plant and Equipment by country:

 
  Year Ended December 31,  
 
  2008   % of
Total
  2007   % of
Total
  2006   % of
Total
 
 
  (in thousands)
 

U.S. 

  $ 19,748     33.1 % $ 21,569     35.0 % $ 23,763     37.1 %

Switzerland

    30,077     50.5 %   29,306     47.6 %   27,202     42.5 %

Taiwan

    7,638     12.8 %   7,791     12.7 %   7,937     12.4 %

Other Foreign

    2,134     3.6 %   2,865     4.7 %   5,150     8.0 %
                           

Total Foreign

    39,849           39,962           40,289        
                                 

Total PP&E

  $ 59,597     100.0 % $ 61,531     100.0 % $ 64,052     100.0 %
                           

8. Shareholders' Equity

Stock Offering

        On April 25, 2007, the Company completed its public offering of 2,553,000 shares of common stock, including a 330,000 share over-allotment option exercised in full by the underwriters, with net proceeds of approximately $55.9 million after deducting underwriting discounts and commissions, and offering expenses. We used these funds to repay indebtedness under our U.S. overdraft and revolving line of credit facilities. On December 31, 2008 and 2007, we had 11,469,164 and 11,479,916 shares of common stock outstanding, respectively.

A-68



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

8. Shareholders' Equity (Continued)

Treasury Shares

        The number of shares of common stock in treasury was as follows:

 
  Year Ended December 31,  
 
  2008   2007   2006  

Shares—beginning of year

    993,076     1,083,117     1,063,287  

Shares distributed/exercised

    (94,252 )   (135,031 )   (16,767 )

Shares purchased

    62,137     37,490     12,662  

Shares forfeited

    42,867     7,500     23,935  
               

Shares—end of year

    1,003,828     993,076     1,083,117  
               

Share Repurchase Program

At the February 19, 2008 Board of Directors meeting, the Board approved a share repurchase program for up to $10.0 million of our common stock to be purchased through February 28, 2010. As of December 31, 2008, we have repurchased 45,500 shares of our common stock at an average price of $12.72.

9. Employee Benefits

Pension and Postretirement Plans

        We account for defined benefit pension and other postretirement benefits in accordance with Statement of Financial Accounting Standards No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)" (SFAS 158). We adopted all provisions of SFAS 158 as of December 31, 2006, which resulted in an increase of $11.9 million to accumulated other comprehensive loss, net of taxes.

        Hardinge provides a qualified defined benefit pension plan covering all eligible domestic employees hired before March 1, 2004. The Plan bases benefits upon both years of service and earnings. Our policy is to fund at least an amount necessary to satisfy the minimum funding requirements of ERISA. For each of our foreign plans, contributions are made on a monthly basis and are governed by their governmental regulations. Also, each of these plans requires employee and employer contributions except Hardinge Taiwan, which requires only employer contributions.

        Domestic employees hired after March 1, 2004 have retirement benefits under our 401k defined contribution plan. After one year of service, Hardinge will contribute 4% of the employee's pay and will further match, at a rate of 25%, the employee's contributions up to 4% of their salary. Those employees, as well as domestic employees hired prior to March 1, 2004, are eligible to contribute additional funds to the plan for which there is no required Company match. We made contributions of $0.3 million and $0.2 million in 2008 and 2007, respectively.

        Hardinge provides a contributory retiree health plan covering all eligible domestic employees who retired at normal retirement age prior to January 1, 1993 and all retirees who will retire at normal retirement age after January 1, 1993 with at least 10 years of active service. Employees who elect early retirement on or after reaching age 55 are eligible for the plan benefits if they have 15 years of active service at retirement. Benefit obligations and funding policies are at the discretion of management. We also provide a non-contributory life insurance plan to retirees who meet the same eligibility criteria as required for retiree health insurance. Because the amount of liability relative to this plan is insignificant, it is combined with the health plan for purposes of this disclosure.

A-69



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

9. Employee Benefits (Continued)

        Increases in the cost of the retiree health plan are paid by the participants with the exception of premium costs for eligible employees who retired under a voluntary early retirement program. We pay the premium in excess of a scheduled amount for these retirees until they reach Medicare eligibility or for a period not to exceed five years at which point the retirees assume responsibility for any premium increases.

        The discount rate for determining benefit obligations in the Postretirement Benefits Plan was 6.50% and 6.56% at December 31, 2008 and 2007, respectively. The change in the discount rate decreased the accumulated postretirement benefit obligation as of December 31, 2008 by less than $0.1 million.

        A summary of the components of net periodic pension cost and postretirement benefit costs for the consolidated company is presented below. The prior year schedules have been restated to include a domestic executive supplemental pension plan.

 
  Pension Benefits
Year Ended December 31,
  Postretirement Benefits
Year Ended December 31,
 
 
  2008   2007   2006   2008   2007   2006  
 
  (in thousands)
  (in thousands)
 

Service cost

  $ 3,468   $ 4,271   $ 3,695   $ 26   $ 31   $ 33  

Interest cost

    8,948     8,306     7,756     150     144     155  

Expected return on plan assets

    (11,042 )   (9,904 )   (9,228 )            

Amortization of prior service cost

    (105 )   (44 )   (41 )   (505 )   (505 )   (505 )

Amortization of transition asset

    (355 )   (372 )   (365 )            

Special termination benefits

    582             725          

Settlement/Curtailment

    296     130                  

Amortization of loss

    91     1,028     1,009         7     42  
                           

Net periodic benefit cost

  $ 1,883   $ 3,415   $ 2,826   $ 396   $ (323 ) $ (275 )
                           

        The net periodic benefit cost for the foreign pension plans included in the amounts above was $0.3 million, $0.8 million, and $0.5 million, for the years ended December 31, 2008, 2007, and 2006, respectively.

A-70



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

9. Employee Benefits (Continued)

        A summary of the Pension and Postretirement Plans' funded status and amounts recognized in our consolidated balance sheets is as follows:

 
  Pension Benefits
December 31,
  Postretirement Benefits
December 31,
 
 
  2008   2007   2008   2007  
 
  (in thousands)
  (in thousands)
 

Change in benefit obligation:

                         

Benefit obligation at beginning of period

  $ 170,236   $ 179,390   $ 2,369   $ 2,595  

Service cost

    3,468     4,271     26     31  

Interest cost

    8,948     8,306     150     144  

Plan participants' contributions

    1,889     1,870     653     624  

Actuarial (gain) loss

    8,046     (18,929 )   (256 )   (292 )

Foreign currency impact

    (67 )   5,650          

Special termination benefits/curtailment

    (1,367 )       726      

Benefits and administrative expenses paid

    (8,740 )   (10,322 )   (770 )   (733 )
                   

Benefit obligation at end of period

    182,413     170,236     2,898     2,369  
                   

Change in plan assets:

                         

Fair value of plan assets at beginning of period

    165,537     151,341          

Actual return on plan assets

    (34,700 )   13,228          

Employer contribution

    9,825     4,271     117     109  

Plan participants' contributions

    1,889     1,870     653     624  

Foreign currency impact

    1,462     5,149          

Benefits and administrative expenses paid

    (8,740 )   (10,322 )   (770 )   (733 )
                   

Fair value of plan assets at end period

    135,273     165,537          
                   

Reconciliation of funded status:

                         

Funded status

    (47,140 )   (4,699 )   (2,898 )   (2,369 )

Unrecognized net actuarial loss

    32,047     8,028          

Unrecognized transition (asset)

    (1,888 )   (1,927 )        

Unrecognized prior service cost

    (693 )   (730 )        
                   

Net amount recognized

  $ (17,674 ) $ 672   $ (2,898 ) $ (2,369 )
                   

 

 
  Pension Benefits
December 31,
  Postretirement Benefits
December 31,
 
 
  2008   2007   2008   2007  
 
  (in thousands)
  (in thousands)
 

Amounts recognized in the balance sheet consist of:

                         

Prepaid benefit cost

  $ 436   $ 5,498   $   $  

Accrued benefit liability

    (47,576 )   (10,197 )   (2,898 )   (2,369 )

Accumulated other comprehensive (income) loss

    29,466     5,371     (2,540 )   (2,789 )
                   

Net amount recognized

  $ (17,674 ) $ 672   $ (5,438 ) $ (5,158 )
                   

A-71



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

9. Employee Benefits (Continued)

        The projected benefit obligation for the foreign pension plans included in the amounts above was $89.0 million and $80.0 million at December 31, 2008 and 2007, respectively. The plan assets for the foreign pension plans included above was $71.1 million and $82.3 million at December 31, 2008 and 2007, respectively.

        Prepaid benefit cost is included in other assets on the balance sheet.

        The accumulated benefit obligation is $169.5 million and $157.2 million at December 31, 2008 and 2007, respectively.

        The following information is presented for pension plans where the projected benefit obligations exceeded the fair value of plan assets (all plans except Kellenberger Stiftung in 2008 and all plans except Kellenberger Stiftung, Kellenberger Pensionskasse and Personalstiftung HTT in 2007):

 
  Pension Benefits
December 31,
 
 
  2008   2007  
 
  (in thousands)
 

Projected benefit obligations

  $ 177,249   $ 105,640  

Plan assets

    129,673     94,651  
           

Excess of projected benefit obligations over plan assets

  $ 47,576   $ 10,989  
           

        The following information is presented for pension plans where the accumulated benefit obligations exceeded the fair value of plan assets (all plans except Hardinge Taiwan and Kellenberger Stiftung in 2008 and all plans except Hardinge U.S., Hardinge Taiwan, Kellenberger Stiftung, Kellenberger Pensionskasse, and Personalstiftung HTT for 2007):

 
  Pension Benefits
December 31,
 
 
  2008   2007  
 
  (in thousands)
 

Accumulated benefit obligations

  $ 168,891   $ 14,118  

Plan assets

    134,613     10,818  
           

Excess of accumulated benefit obligations over plan assets

  $ 34,278   $ 3,300  
           

A-72



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

9. Employee Benefits (Continued)

        Actuarial assumptions used to determine pension costs and other postretirement benefit costs include:

 
  Pension Benefits   Postretirement
Benefits
 
 
  2008   2007   2008   2007  

For the domestic pension plan:

                         

Assumptions at January 1

                         

Discount rate

    6.77 %   6.02 %            

Expected return on plan assets

    8.50 %   8.50 %            

Rate of compensation increase

    3.50 %   3.50 %            

For the foreign pension plans and the domestic post-retirement benefit plans:

                         

Weighted average assumptions at January 1,

                         

Discount rate

    3.75 %   3.19 %   6.56 %   5.75 %

Expected return on plan assets

    5.24 %   5.05 %   N/A     N/A  

Rate of compensation increase

    2.72 %   2.79 %   N/A     N/A  

        Actuarial assumptions used to determine pension obligations and other postretirement obligations include:

 
  Pension Benefits   Postretirement
Benefits
 
 
  2008   2007   2008   2007  

For the domestic pension plan:

                         

Assumptions as of December 31,

                         

Discount rate

    6.60 %   6.77 %            

Rate of compensation increase

    3.50 %   3.50 %            

For the foreign pension plans and the domestic post-retirement benefit plans:

                         

Weighted average assumptions as of December 31,

                         

Discount rate

    3.13 %   3.93 %   6.50 %   6.56 %

Rate of compensation increase

    2.65 %   2.86 %   N/A     N/A  

        We used a bond pricing model based on high grade U.S. corporate bonds constructed to match the projected liability benefit payments to select a discount rate.

        To develop the expected long-term rate of return on assets assumption, we considered the current level of expected returns on risk free investments (primarily government bonds), the historical level of the risk premium associated with the other asset classes in which the portfolio is invested, and the expectations for future returns of each asset class. The expected return for each asset class was then weighted based on the asset allocation to develop the expected long-term rate of return on assets assumption.

A-73



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

9. Employee Benefits (Continued)

        Our pension plan weighted-average asset allocations at December 31, 2008 and December 31, 2007 by asset category are as follows:

 
  Domestic
Plan Assets
  Foreign
Plan Assets
 
 
  December 31,   December 31,  
 
  2008   2007   2008   2007  

Asset Category

                         

Equity securities

    49 %   63 %   34 %   44 %

Debt securities

    48 %   32 %   48 %   44 %

Cash and equivalents

    3 %   5 %   1 %   1 %

Other

    0 %   0 %   17 %   11 %
                   

    100 %   100 %   100 %   100 %
                   

        Domestic pension plan assets did not include any shares of Hardinge Inc. common stock at December 31, 2008 or December 31, 2007. Dividends paid on company stock were less than $0.1 million for the year ended December 31, 2007.

Investment Policies and Strategies

        For the United States defined benefit plan, the plan targets an asset allocation of 40-70% equity securities, 21-51% debt securities, and 0-8% other. The plan's expected long-term rate of return is primarily based on historical returns of similarly diversified passive portfolios and expected results from active investment management.

        Given the relatively long horizon of our aggregate obligation, our investment strategy is to improve and maintain the funded status of our U.S. and non-U.S. plans over time without exposure to excessive asset value volatility. We manage this risk primarily by maintaining actual asset allocations between equity and fixed income securities for the plans within a specified range of its target asset allocation. In addition, we ensure that diversification across various investment subcategories within each plan are also maintained within specified ranges.

        All of our pension assets are managed by outside investment managers and held in trust by third-party custodians. The selection and oversight of these outside service providers is the responsibility of management, investment committees and their advisors. The selection of specific securities is at the discretion of the investment manager and is subject to the provisions set forth by written investment management agreements and related policy guidelines and applicable governmental regulations regarding permissible investments and risk control practices.

        Our funding policy is to contribute to defined benefit plans when pension laws and economics either require or encourage funding. Of our defined benefit plans, the U.S. plan covering the parent company is the largest. The contributions to the U.S. defined benefit plan for the year ended December 31, 2008 totaled $6.3 million.

A-74



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

9. Employee Benefits (Continued)

Cash flows

Contributions

        The expected contributions to be paid during the year ending December 31, 2009 to the domestic defined benefit plan are approximately $3.4 million. We also provide defined benefit pension plans or defined contribution pension plans for our foreign subsidiaries. The expected contributions to be paid during the year ending December 31, 2009 to the foreign defined benefit plans are $2.5 million. For each of our foreign plans, contributions are made on a monthly basis and are determined by their governmental regulations. Also, each of the foreign plans requires employee and employer contributions, except for Taiwan, which has only employer contributions.

Estimated Future Benefit Payments

        The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:

 
  Pension Benefits   Postretirement Benefits  
 
  (in thousands)
 

2009

  $ 7,808   $ 369  

2010

    8,617     368  

2011

    9,275     374  

2012

    8,873     329  

2013

    10,225     288  

Years 2014-2018

    58,092     971  

Retirement Savings Plan

        We maintain a 401(k) plan that covers all eligible domestic employees subject to minimum employment period requirements. In addition to the contribution provisions described previously for employees hired after March 1, 2004, provisions of the plan allow employees to defer from 1% up to 100% of their pre-tax salary to the plan. Those contributions may be invested at the option of the employees in a number of investment alternatives, one being Hardinge Inc. common stock. We did not make a voluntary or discretionary matching contribution in 2008, 2007, or 2006. Management has the ability to reinstate a matching contribution at any future date. We may also make a discretionary contribution to the plan to be distributed among all participants.

A-75



HARDINGE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DECEMBER 31, 2008

9. Employee Benefits (Continued)

Foreign Operations

        Hardinge also has employees in certain foreign countries that are covered by defined contribution pension plans and other employee benefit plans. Related obligations and costs charged to operations for these are not material. The foreign entities with defined benefit plans are included in the consolidated pension plan described earlier within this Employee Benefits Note.

10. Accumulated Other Comprehensive Income (Loss)

        The components of other comprehensive income, net of tax, for the year ended December 31, 2008 and 2007 are as follows:

 
  For the Year Ended
December 31,
 
 
  2008   2007  
 
  (in thousands)
 

Other Comprehensive (Loss) Income:

             

Retirement related plans adjustments (net of tax of $4,710 in 2008 and ($1,360) in 2007)

  $ (46,767 ) $ 20,469  

Foreign currency translation adjustments

    (3,050 )   9,229  

Unrealized gain (loss) on derivatives:

             
 

Cash flow hedges (net of tax of $634 in 2008 and $0 2007)