SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

 

For the transition period from                  to                 

Commission File Number 0-15760

HARDINGE INC.

(Exact name of registrant as specified in its charter)

 

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

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

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

 

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 x

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

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 and 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 x   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 definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o   Accelerated Filer x   Non-accelerated Filer o

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

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2005 was $108,993,941, based on the closing price of common stock on the NASDAQ stock exchange on June 30, 2005. Shares of common stock held by each officer and director and by the Company’s benefit plans have been excluded in that such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.

The number of shares outstanding of the issuer’s common stock as of February 1, 2006:  Common Stock, $.01 par value 8,849,041 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Hardinge Inc.’s Proxy Statement for its 2006 Annual Meeting of Shareholders to be filed with the Commission on or about March 31, 2006 are incorporated by reference to Part III of this Form.

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.

The Company’s website is www.hardinge.com. Hardinge’s website 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 by contacting the Investor Relations Department at the Company’s 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 450 Fifth Street, NW, 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.

The Company has eight wholly owned subsidiaries.

 

The Company has manufacturing facilities located in Chemung County, New York; St. Gallen, Switzerland; Biel, Switzerland; Nan Tou City, Taiwan; and Shanghai, Peoples Republic of China. Hardinge manufactures the majority of the products it sells.

References to Hardinge Inc., the “Company”, or “Hardinge” are to Hardinge Inc. and its predecessors and subsidiaries, unless the context indicates otherwise. The Company changed its name in 1995 from Hardinge Brothers, Inc. to Hardinge Inc.

Products

The Company’s primary business is designing, manufacturing and distributing high-precision computer controlled metal-cutting turning, grinding and milling machines, and accessories related to those machines. It considers its products to be among the world’s best in terms of accuracy, reliability, durability and value. The wide variety of machines manufactured by the Company allows it to be a sole source supplier for its customers.

The Company has been a manufacturer of industrial-use Super-Precision® and general precision turning machine tools since 1890. Turning machines, or lathes, are power-driven machines used to remove material from 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 Hardinge machines, those dimensions are often measured in millionths of inches. Hardinge considers itself to be a leader in the field of producing machines capable of consistently and cost-effectively producing parts to those dimensions.

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Grinding is a machining process where a surface is shaped to closer tolerances or a finer surface finish with a rotating abrasive wheel or tool moving against a part. Grinding machines can be used to finish parts of various shapes and sizes. The grinding machines of the Company’s Kellenberger subsidiary are used to grind the outside and inside diameters of cylindrical parts. Such grinding machines are typically used to provide a more exact finish on a part, which has been partially completed on a lathe. Kellenberger machines are generally purchased by the same type of customers as other Hardinge equipment and further the ability of the Company to be a sole source supplier for its customers.

Hardinge acquired HTT Hauser Tripet Tschudin AG in 2000 to expand its grinding machine product line. Hauser jig grinding machines are used to make demanding contour components, primarily for tool and mold making applications. Tripet and Tschudin product technology is focused on the specialized internal and external cylindrical grinding needs of high volume production customers.

Machining centers or milling machines are designed to remove material from stationary, prismatic (box-like) parts of various shapes with rotating tools that are capable of milling, drilling, tapping, reaming and routing. The multi-directional movement of the spindle holding the cutting tool and the table holding the part allows the part to be shaped to the desired dimension. Machining centers have mechanisms that automatically change tools based on commands from a built-in computer control without the assistance of an operator. The Company produces a broad line of machining centers addressing a range of sizes, speeds and powers.

Most models of Hardinge’s machines are computer numerically controlled (“CNC”) 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.

On November 3, 2004, the Company acquired the name, trademarks, copyrights, designs, patents, know-how, and all other intangibles associated with the former Bridgeport Machine company throughout the world. Hardinge also acquired certain operating assets from the court appointed receiver of the former Bridgeport operations in the U.K. to allow it to carry on Bridgeport’s sales, service and support operations in Europe.

The Bridgeport name has long been associated with a full range of quality machining centers. The Company uses this brand name for all of its machining center lines. The products of Bridgeport, which are being sourced from Taiwan, expanded the line of machines available from the Company in this segment to include horizontal machining centers and 5-axis machining capabilities. Also, the operations in the U.K. have been combined with the Company’s U.K. subsidiary to provide sales and service support for the complete line of Hardinge company products.

Hardinge obtained the rights to manufacture and distribute Bridgeport manually controlled milling machines (called knee mills) in 2002, and parts and support services functions for both knee mills and vertical machining centers previously produced by the Connecticut operations of Bridgeport Machines, Inc. under a licensing arrangement with BPT IP, LLC.

In January 2006, the Company executed its option to purchase the technical information of the Bridgeport knee-mill machine tools, related accessories and spare parts from BPT IP, LLC (“BPT”). BPT had granted the Company the exclusive right to manufacture and sell certain versions of the knee-mill machine tools, accessories and spare parts under Alliance Agreements dated October 29, 2002 and November 3, 2004. Per the Alliance Agreements, the Company had agreed to pay to BPT royalties based on a percentage of net sales attributable to the products, accessories and spare parts.

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The purchase price for the technical information was $5.0 million and it will be amortized over a ten-year period. The technical information purchased includes, but is not limited to, blueprints, designs, schematics, drawings, specifications, computer source and object code, customer lists and proprietary rights and assets of a similar nature. Subsequent to the purchase, no further royalties will be paid to BPT for products shipped thereafter. Royalty expense under these agreements was $1.3 million, $1.2 million, and $0.8 million during the years ended December 31, 2005, 2004, and 2003, respectively.

On December 27, 2005, the Company entered into a Share Purchase Agreement with a group of selling shareholders pursuant to which those selling shareholders agreed to sell their shares in Hardinge Taiwan Limited (“Hardinge Taiwan”) to the Company. Pursuant to a Joint Venture Agreement dated March 16, 1999, the Company owned 51% of Hardinge Taiwan and the Selling Shareholders owned 49% of Hardinge Taiwan. The Company now owns 100% of Hardinge Taiwan, making it a wholly-owned subsidiary of the Company.

The purchase price of the shares was NT$298.8 million, which was equivalent to approximately $9.0 million at December 28, 2005. The purchase price is subject to adjustment based on the final audited balance sheet of Hardinge Taiwan as of December 31, 2005. The purchase price has been primarily recorded against the liability for equity of minority interest on the balance sheet. Based on the final audited balance sheet of Hardinge Taiwan, the purchase price adjustment will be a NT$3.9 million increase, which is equivalent to approximately $0.1 million and must be paid by March 31, 2006.

On December 28, 2005, the Company entered into a Share Sale and Purchase Agreement with Paul Ling and J.R. Ho (the two key managers of Hardinge Taiwan). The agreement grants the Company an irrevocable option exercisable in whole or part to sell up to 1,623,580 shares or approximately 16% of Hardinge Taiwan back to the two key managers on or before March 31, 2006, at an approximate share price of NT$57.83, which was equivalent to approximately $1.76 per share at December 31, 2005.

On December 27, 2005, Hardinge Taiwan entered into a Share Purchase Agreement with U-Sung Co. Ltd. (“U-Sung”), a company in the Republic of China pursuant to which Hardinge Taiwan purchased 100% of the shares of U-Sung. U-Sung owns the land and building in Nan Tou City, Taiwan, Republic of China that is occupied and leased by Hardinge Taiwan. The purchase price of U-Sung was NT$234.8 million, which is equivalent to approximately $7.0 million, which substantially reflects the fair market value of the land and building acquired. No goodwill was recorded. Under an operating lease agreement, Hardinge Taiwan previously paid rent to U-Sung. Rent expense under that lease was $0.9 million, $0.6 million, and $0.5 million during the years ended December 31, 2005, 2004, and 2003, respectively.

The purchase price was comprised of the purchase of the shares in the amount of NT$132.7 million, which was equivalent to approximately $4.0 million at December 31, 2005 and the repayment of U-Sung loans in the amount of NT$102.1 million, which was equivalent to approximately $3.0 million at December 31, 2005. Per the terms of the Agreement, 30% was paid at closing. This amounted to NT$70.4 million, which was equivalent to approximately $2.1 million. The remaining 70% is due on March 31, 2006. This amounts to NT$164.3 million, which is equivalent to approximately $5.0 million. The purchase price is subject to adjustment based on the final audited balance sheet of U-Sung as of December 31, 2005.

New product development is important to the Company’s growth. Products are introduced each year to take advantage of new technologies available to the Company. These technologies generally allow the machine 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.

Multiple options are available on the broad range of the Company’s machines, which allow customers to customize their machines for the specific purpose, and cost objective they require. The Company produces machines for stock with popular option combinations for immediate delivery, as well as machines

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made to specific customer orders. In addition to its machines, the Company provides the necessary computer programming and tooling, as well as robotics and other parts handling equipment manufactured by it or others.

Generally Hardinge 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.

The sale of repair parts is important to the business of the Company. Certain parts on machines wear over time or break through misuse. Customers will buy parts from the Company through the life of the machine, which is several years. There are thousands of machines in operation in the world for which the Company provides those repair parts, in many cases exclusively.

In addition to its machine lines, the Company offers the most extensive line of workholding devices available in the industry, which may be used on both its machines and those produced by others. The Company considers itself to be a worldwide leader in the design and manufacture of workholding devices for equipment.

The Company offers various warranties on its equipment and considers post-sales support to be a critical element of its 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. The Company, where practical, provides readily available replacement parts. The Company offers these post sales support services on a paid basis throughout the life of the machine.

Markets and Distribution

The Company markets its products in most industrialized countries of the world through a combination of distributors, agents and manufacturers’ representatives. In certain areas of the United States, Canada, China, Germany, and the United Kingdom, the company also uses a direct sales force. Generally, distributors have exclusive rights to sell the Company’s products in a defined geographic area.

Certain of the Company’s distributors operate independent businesses, purchase products from the Company at discounted prices and maintain inventories of these products for their customers, while agents and representatives sell products on behalf of the Company and receive commissions on sales. The Company’s commission schedule is adjusted to reflect the level of marketing and aftermarket support offered by its distributors. The Company’s direct sales personnel earn a fixed salary plus commission based upon a percentage of net sales.

Sales through distributors are made only on standard commercial open account terms or through letters of credit and are not included in the Company’s financing programs discussed below. Distributors take title to products upon shipment from the Company’s facilities and do not have any special return privileges.

In the past the Company provided financing terms of up to seven years for qualified end user customers to purchase equipment, primarily in the United States and Canada. These contracts were backed by liens and security agreements.

The Company discontinued providing financing itself in 2002 and began outsourcing long-term customer financing to third party leasing companies. The Company occasionally offers special interest rates to customers as part of its marketing efforts. The amount of the charge from the third party financing company for these special programs is treated as a discount to sales at the time of the contract. There are no repurchase or remarketing agreements with these third parties.

The Company’s non-machine products are mainly sold in the United States 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 headquarters. In most cases, the Company is able to package and

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

The Company promotes recognition of its products in the marketplace through advertising in trade publications and participation in industry trade shows. In addition, the Company markets its non-machine products through publication of general catalogues and other targeted catalogues, which it distributes to existing and prospective customers. The Company has a substantial presence on the internet at www.hardinge.com where customers can obtain information about the Company’s products and place orders for workholding products.

A substantial portion of the Company’s 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.

In 2005, one customer accounted for approximately 6% of our consolidated sales. In 2004 and 2003, no single customer accounted for more than 5% of our consolidated sales.

The Company operates in a single business segment, industrial machine tools.

Competitive Conditions

The primary competitive factors in the marketplace for the Company’s machine tools are reliability, price, delivery time, service and technological characteristics. 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. In the size and precision level the Company addresses with its turning machines and machining centers, the primary competition comes from several Japanese, German, Taiwanese and Korean manufacturers. Kellenberger, Hauser, Tripet and Tschudin grinding machines compete with machines from Japanese, German and other Swiss manufacturers. Management considers its segment of the industry to be extremely competitive. The Company believes that it brings superior quality, reliability, value, availability, capability and support to its customers.

Sources and Availability of Raw Materials

The Company manufactures and assembles its lathes and related products at its Elmira, New York plant. Kellenberger grinding machines and related products are manufactured at its St. Gallen, Switzerland plant and HTT products are produced at its Biel, Switzerland facility. Hardinge produces machining centers and a line of lathes at its plants in Taiwan and China. Some of the machining center products are sourced from manufacturers in Taiwan. Products are manufactured by the Company from various raw materials, including cast iron, sheet metal, and bar steel. The Company purchases a number of components from outside suppliers, including the computer and electronic components for its CNC lathes, grinding machines and machining centers. There are multiple suppliers for virtually all of the Company’s raw material and components and the Company has not experienced a supply interruption in past years.

A major component of the Company’s CNC machines is the computer and related electronics package. The Company purchases a majority of these components from Fanuc Limited, a large Japanese electronics company. The Company also purchases those components from Siemens and Heidenhain, both substantial German manufacturers, for some of its machine lines. A disruption in supply of the computer controls from one of its suppliers could cause the Company to experience a substantial disruption of its operations, depending on the circumstances at the time. The Company purchases parts from these suppliers under normal trade terms. There are no agreements with these suppliers to purchase minimum volumes per year.

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Research and Development

The Company’s ongoing research and development program involves creating new products, modifying existing products to meet market demands and redesigning existing products to add both new functionality and 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 $9.1 million, $7.9 million and $8.2 million, in 2005, 2004, and 2003, respectively.

Patents

Although the Company holds several patents with respect to certain of its products, it does not believe that its business is dependent to any material extent upon any single patent or group of patents.

Seasonal Trends and Working Capital Requirements

The Company’s business and that of the machine tool industry in general is cyclical. It is not subject to significant seasonal trends. However, the Company’s quarterly results are subject to fluctuation based on the timing of its shipments of machine tools, which are largely dependent upon customer delivery requirements. Traditionally, the Company has experienced reduced activity during the third quarter of the year, largely as a result of vacations scheduled at its U.S. and European customers’ plants and the Company’s policy of closing its New York and Switzerland facilities for two weeks during the third quarter. As a result, the Company’s 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. The Company must have inventory on hand to meet customers’ delivery expectations, which for standard machines typically are between immediate to four weeks deliveries. 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 the Company must have inventory of finished machines available in its major markets, including the U.S., China, the U.K. and Germany, as well as finished or nearly finished machines in Taiwan.

The Company delivers many of its 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 schedule of the customer. Therefore, sales from quarter to quarter can vary depending upon the timing of those customers’ acceptances and the significance of those orders.

The Company feels it is important, where practical, to provide readily available workholding and replacement parts for the machines it sells. The Company carries inventory at levels to meet these customer requirements.

Backlog

The Company’s order backlog was $66.8 million at December 31, 2005, compared to $66.3 million at December 31, 2004.

Orders for most products are subject to cancellation by the customer prior to shipment. On large orders for specialized equipment, there are generally cancellation charges associated. The level of unfilled orders at any given date during the year may be materially affected by the timing of the Company’s receipt of orders, the speed with which those orders are filled and the timing of customer acceptance of specialized equipment. Accordingly, the Company’s backlog is not necessarily indicative of actual shipments or sales for any specific future quarterly period, and period-to-period comparisons may not be meaningful.

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Governmental Regulations

The Company believes that its current operations and its current uses of property, plant and equipment conform in all material respects to applicable laws and regulations.

Environmental Matters

The Company’s operations are subject to extensive federal and state legislation and regulation 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 owned by the Company and on adjacent areas have resulted in environmental impacts.

In particular, the Company’s New York manufacturing facility is located within the Kentucky Avenue Well Field 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 Well Field 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, the Company received a Special Notice Concerning Remedial Investigation/Feasibility Study for the Koppers Pond portion of the Kentucky Avenue Well Field site from the EPA. Koppers Pond (the “Pond”) is located on the Company’s property. The Company is among several potentially responsible parties being asked by the EPA to voluntarily participate in the remedial investigation and feasibility study to evaluate the nature and extent of the hazardous substances that have been detected in the Pond. The EPA has documented the release and threatened release of hazardous substances into the environment at the Kentucky Avenue Well Field 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.

Until receipt of this notice, the Company had never been named as a potentially responsible party at the site or received any requests for information from EPA concerning the site. Environmental sampling on the Company’s 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 the Company’s property is contributing to the contamination. Since the remedial investigation and feasibility study has not commenced, the Company has not established a reserve for any potential costs relating to this site, as it is too early in the process to determine the Company’s responsibility as well as to estimate any potential costs to remediate.

Employees

As of December 31, 2005 the Company employed 1,429 persons, 616 of who were located in the United States. None of the Company’s employees are covered by collective bargaining agreements. Management believes that relations with the Company’s 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. The Company believes that its major manufacturing subsidiaries operate in countries in which the economic climate is relatively stable.

The strategy of the Company has been to diversify its sales and operations geographically so that the impact of economic trends in different regions can be balanced. The rapid growth in the manufacturing activity in Asia has been significant to the Company’s growth over the past few years.

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Item 1A.—RISK FACTORS

The various risks related to our 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 Hardinge Inc. is 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.

The cyclical nature of our business could cause fluctuations in our operating results.

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

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, 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 our competitive position and prospects for growth. 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. Although we believe that we have the technological capabilities to remain competitive, 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 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 erected 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 we 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 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 to the United States.

We compete with larger companies that have greater financial resources, and our business could be harmed by competitive inroads.

The markets in which our machine and non-machine products are sold are extremely competitive and highly fragmented. In marketing our products, we compete with other manufacturers primarily on quality, reliability, price, value, delivery time, service and technological characteristics. We compete with a number

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of U.S., European and Asian competitors, many of which are larger, have substantially greater financial resources than us, and are supported by governmental or financial institution subsidies. While we believe our product lines compete effectively in their markets, they may not continue to do so.

If we were unable to access financial markets on favorable terms, our liquidity, businesses 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 fairly long cash out to cash in cycle. Also, we will rely on the availability of longer term 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:

·       Changes in credit markets that reduce available credit or the ability to renew existing facilities on acceptable terms;

·       A deterioration in our financial situation that would violate current covenants and/or prohibit us from obtaining capital from banks, financial institutions, or investors;

·       Extreme volatility in credit markets that increase margin or credit requirements; or

·       Volatility in our results that would substantially increase the cost of our overall capital.

In December 2005, the Company executed an amendment to its credit facilities which provide the Company with an additional $20.0 million on the revolving credit facility. This amendment is a temporary facility and expires on June 30, 2006. It is the Company’s intention to refinance this facility before it expires, however, no assurances can be made that this will occur.

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

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.

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

We manufacture products with a high iron castings or steel content, commodities for which worldwide prices have increased significantly. 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 materials prices increase and we are not able to charge our customers higher prices to compensate, it would adversely affect our business, financial condition and results of operations.

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

The technology within our products changes 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

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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.

We have made and expect to continue to make acquisitions that could disrupt our operations and harm our operating results.

Our strategy involves increasing 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:

·       Difficulties in integrating the operations, technologies, products and personnel of the acquired companies;

·       Diversion of management’s attention from normal daily operations of the business;

·       Potential difficulties in completing projects associated with in-process research and development

·       Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;

·       Initial dependence on unfamiliar supply chains or relatively small supply partners;

·       Insufficient revenues to offset increased expenses associated with acquisitions; and

·       The potential loss of key employees of the acquired companies.

Acquisitions may also cause us to:

·       Issue common stock that would dilute our current shareholders’ percentage ownership;

·       Assume liabilities;

·       Record goodwill and non-amortizable intangible assets that will be subject to impairment testing on a regular basis and potential periodic impairment charges;

·       Incur amortization expenses related to certain intangible assets;

·       Incur large and immediate write-offs, and restructuring and other related expenses; or

·       Become subject to litigation.

Mergers and acquisitions of companies are inherently risky, and no assurance can be given that our previous or 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. Even when an acquired company 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.

Risks related to new product development also apply to acquisitions. Please see the risk factor above entitled, “Due to future technological changes, changes in market demand, or changes in market expectations, portions of our inventory may become obsolete or excess” for additional information.

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Fluctuations in the exchange rates between the U.S. dollar and any of several foreign currencies could increase our costs or decrease our revenue.

Our international operations generate sales in a number of foreign currencies, particularly Swiss Francs, Chinese RMB, English pounds sterling, Canadian dollars, Taiwanese dollars, and the Euro. 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, Euro, Taiwanese dollars, Swiss francs, and Chinese RMB are affected by inter-currency fluctuations in exchange rates.

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 were especially exposed to this bad debt risk when we sold a substantial percentage of our products on time payment contracts supported by Hardinge. Since 2003, we have begun to use third party finance companies, but still run the risk of bad debts 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 and financial condition.

Some components and products are purchased from a single supplier or a limited number of suppliers. 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.

While components and supplies are generally available from a variety of sources, we currently depend on a limited number of suppliers for certain components for our products. Some components 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 the Company’s CNC machines. The Company’s purchases from these suppliers are not made pursuant to long-term contracts and are subject to the 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 the Company believes that its relationship with these suppliers is good, there can be no assurance that the Company will be able to obtain these products from these suppliers on satisfactory terms indefinitely.

The Company believes that design changes could be made to its machines to allow sourcing from several other suppliers, however, a disruption in the supply of the components from any of these three suppliers could cause the Company to experience a material adverse effect on its operations.

Our quarterly results are seasonal and 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 $0.6 million and several machines sold together as a package, a request by a customer to delay shipment at quarter end could significantly affect our quarterly results. Traditionally, 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 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.

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

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

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 funded 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. For pension accounting purposes in our U.S. based plan, which is the largest of our plans, we assumed an 8.50% rate of return on pension plan assets for consideration of contributions for future years. We decreased the discount rate to 5.85% at September 30, 2005, the plan measurement date,  from 6.00% at September 30, 2004, and at September 30, 2003.

Lower investment performance of our pension plan assets resulting from a decline in the stock market could significantly impact the plan assets and future growth of the plan assets. Should the assets earn an average return less than 8.50% over time, it is likely that future pension expenses and funding requirements would increase. Investment earnings in excess of 8.50% may reduce future pension expenses.

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

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 $2.4 million to our U.S. pension plan in 2006. If our current assumptions and estimates are not correct, a contribution in years beyond 2006 may be greater than the projected 2006 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, 2005, the excess of projected benefit obligations over plan assets was $32.1 million and the excess of accumulated benefit obligations over plan assets was $21.0 million.

In 2004, the company made the decision that people hired by the U.S. company after March 1, 2004 will no longer be eligible for the defined benefit plan. They will instead be provided a company subsidized 401(k) plan.

Item 1B.—UNRESOLVED STAFF COMMENTS

None.

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ITEM 2.—PROPERTIES

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

				Acreage (Land)
				Square Footage
Location		Type of Facility		(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, Service, Demonstration and Administration		3 acres 123,204 sq. ft.
Biel, Switzerland		Manufacturing, Engineering, Turnkey Systems		4 acres 41,500 sq. ft.
Exeter, England		Sales, Marketing, Demonstration, Service, Turnkey Systems and Administration		2 acres 27,500 sq. ft.

 

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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 the Company is currently involved, individually or in the aggregate, is anticipated to be material to its financial condition or results of operations.

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

During the fourth quarter of 2005, 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 Stock Market under the symbol “HDNG.” The table also includes dividends per share, by quarter.

		2005											2004
		Values											Values
		High			Low			Dividends					High			Low			Dividends
Quarter Ended
March 31		$	15.27		$	13.00			$	0.03			$	13.35		$	9.25			$	0.00
June 30		16.75			12.30				0.03				13.17			11.59				0.01
September 30		17.00			12.65				0.03				12.55			9.95				0.01
December 31		19.00			14.01				0.03				13.71			10.10				0.01

 

At March 7, 2006, there were 2812 holders of record of common stock.

The following tables provides information about issuer repurchases of our common stock by month for the quarter ended December 31, 2005:

Issuer Purchases of Equity Securities

 

The above shares were repurchased as part of the Company’s Incentive Compensation Plan to satisfy tax withholding obligations in connection with the exercise of stock options by employees.

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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).

 

(1)          2003 results include a non-cash charge for income tax expense of $12,905 to provide a valuation allowance for the Company’s U.S. deferred tax assets as required by FAS 109.

(2)          2001 results include an unusual charge of $27,237 for inventory write-downs for underperforming product lines; a one time additional provision for doubtful accounts of $5,200; and $5,519 for impairment of goodwill and other underutilized assets. The after tax impact of those unusual items was $26,455 in aggregate.

(3)          2001 SG&A included amortization of goodwill of $826, whereas 2005, 2004, 2003 and 2002 had no amortization expense due to the adoption of Statement of Financial Accounting Standards No. 142.

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

Overview.   The Company’s primary business is designing, manufacturing, and distributing high-precision computer controlled metal-cutting turning, grinding and milling machines and related accessories. The Company is geographically diversified with manufacturing facilities in the U.S., Switzerland, Taiwan, and China and with sales to most industrialized countries. Approximately 63% of its 2005 sales were to customers outside of  North America, 61% of its 2005 products were manufactured outside of North America, and 57% of its employees are outside of North America.

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

The U.S. market activity metric most closely watched by management has been metal-cutting machine orders as reported by the Association of Manufacturing Technology (AMT), the primary industry group for U.S. machine tool manufacturers. In 2005, industry-wide orders for metal cutting machine tools increased 9% versus 2004. In 2004, orders increased by 48% versus 2003. The AMT’s statistics include metal-cutting machines of all types and sizes, including segments where the Company does not compete. The Company does use this metric as an indication of overall market trends. While more detailed information regarding types of machines is not publicly available, the Company is able to obtain more detailed information because of its membership in the organization to determine market trends for the types of machines it distributes.

Similar information regarding machine tool consumption in foreign countries is published in various trade journals. In Germany, the Company’s second largest market, consumption measured in local currencies increased by 6% in 2005 versus 2004, and it was flat when comparing 2004 to 2003. In China, the Company’s third largest market, consumption increased by 15% in 2005 versus 2004, and increased by 37% in 2004 versus 2003. In the United Kingdom, the fourth largest market for the Company, machine tool consumption measured in pound sterling decreased by 1% in 2005 versus 2004, and increased by 19% in 2004 versus 2003.

Other closely followed U.S. market indicators are tracked to determine activity levels in U.S. manufacturing plants that might purchase the Company’s products. One such measurement is the PMI (formerly called the Purchasing Manager’s Index), as reported by the Institute for Supply Management. This measurement has been at a good level during the past two years. Another measurement is capacity utilization for manufacturing companies, as reported by the Federal Reserve Board. This measurement has been on an upward trend, but has not yet reached the levels that have historically preceded a strong level of capital spending by manufacturers. The Company’s management is not aware of comparably reliable measures of foreign demand or customer activity.

Non-machine sales which includes accessories, repair parts, and service revenue have typically accounted for between 28% to 32% of overall sales and are an important part of the Company’s 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.

The Company’s management believes currency exchange rate changes are significant to reported results for several reasons. The Company’s primary competitors, particularly for the most technologically

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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 the Company’s markets. Also, the Company translates the results of its Swiss, Taiwanese, Chinese, English, German 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. The Company also purchases computer controls and other components from suppliers throughout the world, with purchase costs reflecting currency changes.

In the past few years, pension liabilities have represented another significant uncertainty for the Company. The Company provides defined benefit pension plans for eligible employees in the U.S., Switzerland, England, and Taiwan. Recent declines in interest rates used to calculate the present value of future pension obligations and historically poor U.S. and UK equity market investment returns in recent years have resulted in deferred pension charges to equity of $4.8 million in 2005 and $1.1 million in 2004. Although these are non-cash charges that do not affect net income, the underlying economic causes reflect a risk of increased future pension expense. U.S. employees hired after March 1, 2004 will receive retirement benefits under the Company’s 401k defined contribution plan and will not be entitled to benefits under the defined benefit pension plan.

On November 3, 2004, the Company completed the acquisition of certain assets of the former Bridgeport Machine operations from Bridgeport International, a portfolio company of American Capital Strategies Ltd., and from the court appointed receiver of the former Bridgeport operations in the U.K. for a total cost of $12.3 million. The acquisition of the worldwide name, trademark, copyrights and other miscellaneous intangibles related to the operations of Bridgeport was recorded as an intangible asset of $6.8 million. Goodwill of $0.5 million was recorded resulting from the acquisition of a sales and service operation in Europe. The Company also purchased approximately $5.0 million of finished machine inventory at the time of the purchase.

The Bridgeport name has long been associated with a full range of quality machining centers. The Company uses this brand name for all of its machining center lines. The products of Bridgeport expanded the line of machines available in this segment. Also, the operations in the UK have been combined with the Company’s U.K. subsidiary to provide sales and service support for the complete line of Hardinge company products.

In January 2006, the Company executed its option to purchase the technical information of the Bridgeport knee-mill machine tools, related accessories and spare parts from BPT IP, LLC (“BPT”). BPT had granted the Company the exclusive right to manufacture and sell certain versions of the knee-mill machine tools, accessories and spare parts under an Alliance Agreement dated November 3, 2004. Per the Alliance Agreement, the Company had agreed to pay to BPT royalties based on a percentage of net sales attributable to the products, accessories and spare parts.

The purchase price for the technical information was $5.0 million and it will be amortized over a ten-year period. The technical information purchased includes, but is not limited to, blueprints, designs, schematics, drawings, specifications, computer source and object code, customer lists and proprietary rights and assets of a similar nature. Subsequent to the purchase, no further royalties will be earned by BPT. Royalty expense under this agreement was $1.3 million, $1.2 million, and $0.8 million during the years ended December 31, 2005, 2004, and 2003, respectively.

On December 27, 2005, the Company entered into a Share Purchase Agreement with a group of selling shareholders pursuant to which those selling shareholders agreed to sell their shares in Hardinge Taiwan Limited (“Hardinge Taiwan”) to the Company. Pursuant to a Joint Venture Agreement dated March 16, 1999, the Company owned 51% of Hardinge Taiwan and the Selling Shareholders owned 49% of Hardinge Taiwan. The Company now owns 100% of Hardinge Taiwan, making it a wholly-owned subsidiary of the Company.

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The purchase price of the shares was NT$298.8 million, which was equivalent to approximately $9.0 million at December 28, 2005. The purchase price is subject to adjustment based on the final audited balance sheet of Hardinge Taiwan as of December 31, 2005. The purchase price has primarily been recorded against the liability for equity of minority interest on the balance sheet. Based on the final audited balance sheet of Hardinge Taiwan, the purchase price adjustment will be a NT$3.9 million increase, which is equivalent to approximately $0.1 million and must be paid by March 31, 2006.

On December 28, 2005, the Company entered into a Share Sale and Purchase Agreement with Paul Ling and J.R. Ho (the two key managers of Hardinge Taiwan). The agreement grants the Company an irrevocable option exercisable in whole or part to sell up to 1,623,580 shares or approximately 16% of Hardinge Taiwan back to the two key managers on or before March 31, 2006, at an approximate share price of NT$57.83, which was equivalent to approximately $1.76 per share at December 31, 2005.

On December 27, 2005, Hardinge Taiwan entered into a Share Purchase Agreement with U-Sung Co. Ltd. (“U-Sung”), a company in the Republic of China pursuant to which Hardinge Taiwan purchased 100% of the shares of U-Sung. U-Sung owns the land and building in Nan Tou City, Taiwan, Republic of China that is occupied and leased by Hardinge Taiwan. The purchase price of U-Sung was NT$234.8 million, which is equivalent to approximately $7.0 million, which substantially reflects the fair market value of the land and building acquired. No goodwill was recorded. Under an operating lease agreement, Hardinge Taiwan previously paid rent to U-Sung. Rent expense under that lease was $0.9 million, $0.6 million, and $0.5 million during the years ended December 31, 2005, 2004, and 2003, respectively.

The purchase price was comprised of the purchase of the shares in the amount of NT$132.7 million, which was equivalent to approximately $4.0 million at December 31, 2005 and the repayment of U-Sung loans in the amount of NT$102.1 million, which was equivalent to approximately $3.0 million at December 31, 2005. Per the terms of the Agreement, 30% was paid at closing. This amounted to NT$70.4 million, which was equivalent to approximately $2.1 million. The remaining 70% is due on March 31, 2006. This amounts to NT$164.3 million, which is equivalent to approximately $5.0 million. The purchase price is subject to adjustment based on the final audited balance sheet of U-Sung as of December 31, 2005.

Results of Operations

2005 Compared to 2004

The following table summarizes certain financial data for 2005 and 2004:

		2005			2004			Change			% Change
		(dollars in thousands)
Net sales		$	289,925		$	232,054		$	57,871			24.9	%
Gross profit		90,283			69,678			20,605				29.6	%
Income from operations		15,560			12,494			3,066				24.5	%
Income before income taxes		11,845			10,367			1,478				14.3	%
Net income		7,006			4,392			2,614				59.5	%
Gross profit as % of net sales		31.1		%	30.0		%	1.1% pts
Income from operations as % of net sales		5.4		%	5.4		%	0.0% pts
Net income as % of net sales		2.4		%	1.9		%	0.5% pts

 

Net Sales.   Net sales were $289.9 million in 2005, an increase of $57.9 million or 24.9% compared to $232.1 million in 2004. Sales increased due to the addition of Bridgeport products, which were acquired in November 2004, and due to increased shipments of the Company’s other product lines. Sales of Bridgeport products were approximately $48.3 million in 2005 and $3.1 million in the part of 2004 following the Acquisition.

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The table below summarizes our 2005 net sales by geographical region, with comparisons to 2004. Net sales in all three geographical regions increased in 2005 as compared to 2004.

Sales to Customers in:				2005				2004				Change				% Change
				(dollars in thousands)
North America				$		105,851		$		93,272		$		12,579			13.5	%
Europe				116,723				93,017				23,706					25.5	%
Asia & Other				67,351				45,765				21,586					47.2	%
Total				$	289,925			$	232,054			$	57,871				24.9	%

 

Sales to customers in North America, Europe and Asia and Other increased due to sales of the Bridgeport products in addition to increased sales of the Company’s other product lines.

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 translations relative to the U.S. dollar had a favorable impact on sales of $0.5 million. Excluding the impact of foreign currency translation, sales for 2005 increased $57.4 million or 24.7%.

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

 

Sales of machines accounted for approximately 71.3% of net sales for 2005, as compared to 70.2% of net sales in 2004. Sales of non-machine products and services, consist of workholding, repair parts, services and accessories.

Orders and Backlog:   The Company’s orders by geographical region is below:

 

Orders for 2005 were $290.4 million, an increase of $34.7 million or 13.6% compared to $255.7 million in 2004.        The increase is primarily due to orders for our new Bridgeport products, which were acquired in November 2004. Orders for the new Bridgeport products were $55.0 million in 2005 and $21.7 million in 2004.

The increase in orders in North America and Europe are due to the Bridgeport products. Orders in the Asia and Other region decreased due to the acquisition of Bridgeport in November 2004. That acquisition resulted in the conversion of $13.6 million in orders from Bridgeport to Hardinge for the Asia and Other region, resulting in a one-time increase in new orders for 2004. Our consolidated backlog at December 31, 2005 was $66.8 million, an increase of $0.5 million or 0.8% compared to $66.3 million at December 31, 2004.

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Gross Profit.   Gross profit for 2005 was $90.3 million, an increase of $20.6 million or 29.6% compared to $69.7 million in 2004. The increased gross profit is primarily due to the increased net sales. In addition, gross profit percentage for 2005 was 31.1% of net sales compared to 30.0% of net sales in 2004. The increased gross profit percentage reflects changes in product mix and better utilization of manufacturing operations.

Selling, General, and Administrative Expense.   Selling, general and administrative (“SG&A”) expense was $72.6 million, or 25.0% of net sales for 2005, an increase of $16.1 million or 28.5% compared to $56.5 million, or 24.3% of net sales, in 2004. The increase in SG&A for the full year includes the following:  $8.8 million was due to the addition of two new sales, service and technical centers located in the U.K. and Holland to support the Bridgeport acquisition, $0.8 million resulted from increased commission expense due to higher sales, $1.9 million was driven by increased promotional and support costs in China. The remainder of the expense increase resulted primarily from expansion of the Company’s sales and support functions to manage the growth in worldwide operations.

Provision for Doubtful Accounts.   Bad debt expense was $2.2 million for 2005 compared to $0.7 million in 2004. The increase is due to additional reserves for the Company’s customer notes receivables. Each quarter, the Company reviews the sufficiency of its allowance for bad debts, based upon its recent experience, prior years experience and the makeup and aging of its current accounts and notes receivables, and adjusts the allowance for bad debts accordingly.  The Company discontinued issuing notes in 2002.

Income from Operations.   Income from operations was $15.6 million, or 5.4% of net sales for 2005, compared to $12.5 million, or 5.4% of net sales in 2004. The increase in income from operations is primarily due to the increase in net sales.

Interest Expense & Interest Income.   Interest expense includes interest payments under the Company’s credit facilities, realized gains or losses on the interest rate swap agreement and amortization of deferred financing costs associated with the Company’s credit facilities. Interest expense was $4.3 million for 2005 compared to $2.7 million in 2004. The increase was due to higher average borrowings, which is primarily attributable to the acquisition of the Bridgeport business, and an increase in working capital to support the increase in net sales.   Interest income was $0.6 million in 2005 and $0.5 million in 2004.

Income Tax Expense/Benefit.   Income tax expense was $2.4 million in 2005, compared to $3.5 million in 2004. The effective tax rate was 20.0% in 2005 and 34.2% in 2004. The decrease in the effective rate is due to non-cash reductions in certain income tax valuation allowances, primarily in the U.K., and accruals in the amount of $1.1 million and to changes in the mix of profits in various countries, offset by not recording a tax benefit for losses in the U.S. which resulted in an increase in our valuation allowance of $0.3 million. Our income tax expense primarily represents tax expense on profits in the Company’s foreign subsidiaries. There is no tax benefit recorded on losses in the U.S. in accordance with the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 109). 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.

Minority Interest In (Profit) of Consolidated Subsidiary.   Until December 27, 2005, the Company had a 51% interest in Hardinge Taiwan Precision Machinery Limited, an entity that is recorded as a consolidated subsidiary. In 2005, $2.5 million of reductions in consolidated net income were recorded, compared to $2.4 million in 2004. This represents the minority stockholders’ 49% share in the joint venture’s net income. This elimination of the minority interest in this consolidated subsidiary was consistent in both years due to the comparable profits at that subsidiary’s operations.

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Net Income.   Net income for 2005 was $7.0 million or 2.4% of net sales, compared to $4.4 million, or 1.9% of net sales in 2004. Basic earnings per share was $0.80 and diluted earnings per share was $0.79 for 2005, compared to $0.50 per basic and diluted earnings per share for 2004.

Results of Operations

2004 Compared to 2003

Orders and Backlog:   The Company’s new orders rose 37% to $255.7 million in 2004 compared to $186.4 million in 2003, as shown in the table below:

 

This $69.2 million increase in new orders included $7.6 million due to the decline in the exchange rate of the dollar against the operational currencies of some of the Company’s subsidiaries. This represents the increased dollar value of the orders originally recorded in the Swiss franc, British pound sterling, and the New Taiwanese dollars when those orders are translated into U.S. dollars for reporting purposes. The remaining $61.7 million increase in orders represents a 33.0% increase over 2003 orders.

The Company’s North American orders increased as market conditions improved. The increase in orders from European customers included $5.5 million of currency exchange impact and approximately $6.8 million of new Bridgeport products.   Without these two impacts, European orders increased by $15.0 million, or 23.3%, which reflects improved market conditions in Europe for the Company’s grinding operations and growing acceptance of the Company’s baseline machining center and turning products.

Orders in 2004 from Asia and Other regions includes a $13.6 million order for specialty grinding machines the Company was able to obtain after it purchased the assets of Bridgeport. The machines under this order will ship beginning in the later part of the first quarter and are anticipated to be completed by the fourth quarter of 2005. Translation affects of the currency rate changes added $2.1 million to the Asian orders when comparing the two years. Excluding these two items, orders increased by $13.4 million, or 39.3% reflecting growth in China as that market continues to expand.

The Company’s December 31, 2004 backlog of $66.3 million was 55.1% above the December 31, 2003 backlog of $42.7 million. The previously described currency exchange rate changes increased the dollar value of the backlogs of the Company’s foreign subsidiaries by $2.1 million. Excluding those impacts, the Company’s backlog increased by 50.3%.

The following table summarizes certain financial data for 2004 and 2003:

 

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Net Sales.   Net sales were $232.1 million in 2004, compared to $185.3 million in 2003. The increase in net sales of $46.8 million, or 25.2%, included increases in all three sales regions, as shown below:

 

The previously discussed decline in the exchange rate of the dollar against the foreign currencies resulted in $7.9 million of the overall increase in sales. Excluding exchange rate impacts, sales increased by $38.9 million or 21.0%.

Sales to customers in North America increased as market conditions improved. Sales to European customers in 2004 were 25.9% above 2003 sales. Currency exchange rates impacted this number by $5.8 million and sales of the new Bridgeport products added approximately $3.1 million. Excluding these items, 2004 European sales increased by 13.5%, reflecting better market conditions and market acceptance of new products.

Sales in the Asia and Other region increased 46.0% to $45.8 million. This reflects the growing market in China and the Company’s continuing initiatives to expand its sales and support capabilities within that region.

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

 

Machine sales represented 70.2% of 2004 net sales, as compared to 68.3% of 2003 net sales. Sales of non-machine products and services, primarily repair parts and accessories, made up the balance.

Gross Profit.   Gross profit was $69.7 million, or 30.0% of net sales in 2004, compared to $54.6 million, or 29.5% of net sales in 2003. The slightly higher gross profit percentage reflects better utilization of manufacturing fixed overhead as production levels increased in each of the Company’s manufacturing plants. Part of these benefits were offset by reduced gross profits caused by exchange rate changes for machines manufactured in Switzerland and Taiwan and sold in U.S. dollars, primarily in the U.S. and China.

Selling, General, and Administrative Expense.   Selling, general and administrative (“SG&A”) expense for the year 2004 were $56.5 million, or 24.3% of net sales, compared to $47.6 million, or 25.7% of net sales, in 2003. Overall, the expense increased due to commission expenses, which increased by $2.2 million on the higher volume, currency translation impacts of $2.1 million, addition of the sales and service operations of Bridgeport of $1.3 million and additional audit and other outside expenses associated with Sarbanes Oxley compliance of $0.7 million. The remainder of the expense increases results primarily from expansion of the Company’s sales and support functions to manage the growth in worldwide operations. SG&A expenses as a percentage of sales decreased due to the impact of comparing the fixed portions of these expenses against a larger sales volume.

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Provision for Doubtful Accounts.   Bad debt expense was $0.7 million for the year 2004, compared to $0.1 million incurred during 2003. Each quarter, the Company reviews the sufficiency of its allowance for bad debts, based upon its recent experience, prior year’s experience and the makeup and aging of its current receivables, and adjusts the allowance for bad debts accordingly. In 2003, these reviews led to reduced expense as less additional provision was warranted. In addition, certain foreign entities, based on several years of minimal bad debt write-offs, recorded reductions to allowances for bad debts, which exceeded 2003 year charges by $0.4 million.

Income from Operations.   Income from operations increased to $12.5 million, or 5.4% of net sales, in 2004 from $6.9 million, or 3.7% of net sales in 2003 largely due to the increased sales level.

Interest Expense & Interest Income.   Interest expense for the year 2004 was $2.7 million, a reduction from $2.9 million in 2003 caused by reduced average borrowings. Interest income, primarily derived from previous years’ internally financed customer sales, was $0.5 million in 2004 and $0.5 million in 2003.

Income Taxes/Benefits.   Income tax expense in 2004 was $3.5 million and primarily represents taxes payable on profits in the Company’s operations in Switzerland and Asia. There is no tax benefit recorded on losses in the U.S. and the U.K, in accordance with the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 109). The 2003 income tax expense of $14.7 million included a charge of $12.9 million to provide a valuation allowance for the Company’s U.S. deferred tax assets. 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.

During the third quarter of 2003, it was determined that it was unlikely that the Company’s U.S. operations would return to profitability by the end of the year, as had been previously expected. SFAS 109 stipulates that when a Company is relying largely on future taxable income and also has a three year cumulative pre-tax loss, considerably greater positive evidence is necessary to conclude that deferred tax assets do not warrant a valuation allowance. The Company did not feel that this high standard for positive evidence could be fully met and the valuation allowance was established. Also, under the provisions of SFAS 109, no current year tax benefit is recognized for net operating loss carryforwards generated.

Minority Interest In (Profit) of Consolidated Subsidiary.   The Company has a 51% interest in Hardinge Taiwan Precision Machinery Limited, an entity that is recorded as a consolidated subsidiary. In 2004 and 2003, respectively, $2.4 million and $1.3 million of reductions in consolidated net income represent the minority stockholders’ 49% share in the joint venture’s net income.

Profit In Investment of Equity Company.   The Company was a 50% owner of Hardinge EMAG GmbH, a joint venture with a German machine tool manufacturer, until the Company sold this investment in December 2003. The Company’s 50% share generated profits for Hardinge of $0.2 million in 2003.

Net Income (Loss).   Operations in 2004 generated net income of $4.4 million, or $0.50 per basic and diluted shares outstanding compared to a net loss of $(11.3 million) for the year 2003, or $(1.30) per basic and diluted share. As previously described, the 2003 loss included a $12.9 million charge for a valuation allowance against the Company’s U.S. deferred tax assets.

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Liquidity and Capital Resources

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

At December 31, 2005, cash and cash equivalents were $6.6 million, compared to $4.2 million at December 31, 2004. The current ratio at December 31, 2005 was 2.65:1 compared to 3.00:1 at December 31, 2004.

Cash Flows from Operating Activities:

As shown in the Consolidated Statements of Cash Flows, cash used in operating activities was $5.8 million in 2005 compared to $6.6 million in 2004. This represents a decrease in cash used of $0.7 million.

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