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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 ____________________________________________
FORM 10-Q
 ____________________________________________
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 29, 2013
 
Commission file number 0-21835
 
  ____________________________________________
SUN HYDRAULICS CORPORATION
(Exact Name of Registration as Specified in its Charter)
 
  ____________________________________________
 
FLORIDA
 
59-2754337
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
1500 WEST UNIVERSITY PARKWAY
SARASOTA, FLORIDA
 
34243
(Address of Principal Executive Offices)
 
(Zip Code)
941/362-1200
(Registrant’s Telephone Number, Including Area Code)
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  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
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 “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
 
o
 
Accelerated filer
 
x
 
 
 
 
Non-accelerated filer
 
o
 
Smaller Reporting Company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
The Registrant had 26,246,499 shares of common stock, par value $.001, outstanding as of July 26, 2013.

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Sun Hydraulics Corporation
INDEX
For the quarter ended June 29, 2013
 
 
 
 
Page
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
Item 5.
 
 
 
 
 
Item 6.

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PART I: FINANCIAL INFORMATION
Item  1.
Sun Hydraulics Corporation
Consolidated Balance Sheets
(in thousands, except share data)
 
 
June 29, 2013
 
December 29, 2012
 
(unaudited)
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
41,686

 
$
34,478

Restricted cash
308

 
329

Accounts receivable, net of allowance for doubtful accounts of $95 and $124
20,536

 
13,754

Inventories
12,441

 
12,559

Income taxes receivable
—

 
728

Deferred income taxes
429

 
248

Short-term investments
36,815

 
37,700

Other current assets
3,326

 
2,649

Total current assets
115,541

 
102,445

Property, plant and equipment, net
70,555

 
64,672

Goodwill
5,082

 
4,472

Other assets
3,803

 
3,532

Total assets
$
194,981

 
$
175,121

Liabilities and shareholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
5,470

 
$
4,606

Accrued expenses and other liabilities
5,478

 
7,641

Income taxes payable
1,430

 
—

Dividends payable
2,362

 
—

Total current liabilities
14,740

 
12,247

Deferred income taxes
7,397

 
7,230

Other noncurrent liabilities
370

 
371

Total liabilities
22,507

 
19,848

Commitments and contingencies
—

 
—

Shareholders’ equity:
 
 
 
Preferred stock, 2,000,000 shares authorized, par value $0.001, no shares outstanding
—

 
—

Common stock, 40,000,000 shares authorized, par value $0.001, 26,239,642 and 26,094,580 shares outstanding
26

 
26

Capital in excess of par value
63,064

 
57,402

Retained earnings
111,535

 
97,242

Accumulated other comprehensive income (loss)
(2,151
)
 
603

Total shareholders’ equity
172,474

 
155,273

Total liabilities and shareholders’ equity
$
194,981

 
$
175,121


The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.
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Sun Hydraulics Corporation
Consolidated Statements of Operations
(in thousands, except per share data)
 
 
Three months ended
 
June 29, 2013
 
June 30, 2012
 
(unaudited)
 
(unaudited)
Net sales
$
55,788

 
$
57,031

Cost of sales
32,387

 
34,062

Gross profit
23,401

 
22,969

Selling, engineering and administrative expenses
6,640

 
6,505

Operating income
16,761

 
16,464

Interest income, net
(242
)
 
(294
)
Foreign currency transaction gain, net
(29
)
 
(66
)
Miscellaneous (income) expense, net
(484
)
 
(39
)
Income before income taxes
17,516

 
16,863

Income tax provision
5,726

 
5,616

Net income
$
11,790

 
$
11,247

Basic net income per common share
$
0.45

 
$
0.43

Weighted average basic shares outstanding
26,236

 
25,937

Diluted net income per common share
$
0.45

 
$
0.43

Weighted average diluted shares outstanding
26,236

 
25,975

Dividends declared per share
$
0.090

 
$
0.090


The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.
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Sun Hydraulics Corporation
Consolidated Statements of Operations
(in thousands, except per share data)
 
 
Six months ended
 
June 29, 2013
 
June 30, 2012
 
(unaudited)
 
(unaudited)
Net sales
$
106,848

 
$
112,305

Cost of sales
62,943

 
67,118

Gross profit
43,905

 
45,187

Selling, engineering and administrative expenses
13,212

 
13,459

Operating income
30,693

 
31,728

Interest income, net
(438
)
 
(635
)
Foreign currency transaction gain, net
(149
)
 
(77
)
Miscellaneous (income) expense, net
(390
)
 
(164
)
Income before income taxes
31,670

 
32,604

Income tax provision
10,305

 
10,734

Net income
$
21,365

 
$
21,870

Basic net income per common share
$
0.82

 
$
0.85

Weighted average basic shares outstanding
26,185

 
25,861

Diluted net income per common share
$
0.82

 
$
0.84

Weighted average diluted shares outstanding
26,185

 
25,905

Dividends declared per share
$
0.270

 
$
0.300


 



 


The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.
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Sun Hydraulics Corporation
Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
 
 
Three months ended
 
Six months ended
 
June 29, 2013
 
June 30, 2012
 
June 29, 2013
 
June 30, 2012
 
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Net income
$
11,790

 
$
11,247

 
$
21,365

 
$
21,870

Other comprehensive income (loss)
 
 
 
 
 
 

Foreign currency translation adjustments
57

 
(1,812
)
 
(2,530
)
 
(200
)
Unrealized gain (loss) on available-for-sale securities
(388
)
 
(408
)
 
(224
)
 
(15
)
Total other comprehensive income (loss)
(331
)
 
(2,220
)
 
(2,754
)
 
(215
)
Comprehensive income
$
11,459

 
$
9,027

 
$
18,611

 
$
21,655


The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.
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Sun Hydraulics Corporation
Consolidated Statement of Changes in Shareholders’ Equity (unaudited)
(in thousands)
 
 
Preferred
shares
 
Preferred
stock
 
Common
shares
 
Common
stock
 
Capital in excess of
par value
 
Retained
earnings
 
Accumulated
other
comprehensive
income
 
Total
Balance, December 29, 2012
—

 
$
—

 
26,095

 
$
26

 
$
57,402

 
$
97,242

 
$
603

 
$
155,273

Shares issued, other comp

 

 
19

 

 
 
 

 

 
—

Shares issued, ESPP

 

 
20

 

 
466

 

 

 
466

Shares issued, shared distribution

 

 
106

 

 
3,486

 

 

 
3,486

Stock-based compensation

 

 

 

 
1,710

 

 

 
1,710

Dividends declared

 

 

 

 

 
(7,072
)
 

 
(7,072
)
Net income

 

 

 

 

 
21,365

 

 
21,365

Other comprehensive income (loss)

 

 

 

 

 

 
(2,754
)
 
(2,754
)
Balance, June 29, 2013
—

 
$
—

 
26,240

 
$
26

 
$
63,064

 
$
111,535

 
$
(2,151
)
 
$
172,474


The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.
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Sun Hydraulics Corporation
Consolidated Statements of Cash Flows
(in thousands)
 
Six months ended
 
June 29, 2013
 
June 30, 2012
 
(unaudited)
 
(unaudited)
Cash flows from operating activities:
 
 
 
Net income
$
21,365

 
$
21,870

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
3,565

 
3,576

(Gain)Loss on disposal of assets
15

 
(21
)
Gain on investment in business
(528
)
 
—

Unrealized foreign exchange gain
—

 
15

Provision for deferred income taxes
(14
)
 
1

Allowance for doubtful accounts
(29
)
 
(15
)
Stock-based compensation expense
1,416

 
1,157

(Increase) decrease in:
 
 
 
Accounts receivable
(6,740
)
 
(5,442
)
Inventories
186

 
(890
)
Income taxes receivable
728

 
120

Other current assets
(677
)
 
(356
)
Other assets
258

 
181

Increase (decrease) in:
 
 
 
Accounts payable
864

 
403

Accrued expenses and other liabilities
1,617

 
2,834

Income taxes payable
1,430

 
342

Other noncurrent liabilities
(1
)
 
25

Net cash provided by operating activities
23,455

 
23,800

Cash flows from investing activities:
 
 
 
Investment in business, net of cash acquired
(923
)
 
—

Capital expenditures
(9,518
)
 
(4,752
)
Proceeds from dispositions of equipment
—

 
21

Purchases of short-term investments
(11,888
)
 
(12,251
)
Proceeds from sale of short-term investments
11,744

 
3,130

Net cash used in investing activities
(10,585
)
 
(13,852
)
Cash flows from financing activities:
 
 
 
Proceeds from stock issued
466

 
333

Dividends to shareholders
(4,710
)
 
(7,769
)
Change in restricted cash
21

 
2

Net cash used in financing activities
(4,223
)
 
(7,434
)
Effect of exchange rate changes on cash and cash equivalents
(1,439
)
 
(311
)
Net increase (decrease) in cash and cash equivalents
7,208

 
2,203

Cash and cash equivalents, beginning of period
34,478

 
51,262

Cash and cash equivalents, end of period
$
41,686

 
$
53,465

Supplemental disclosure of cash flow information:
 
 
 
Cash paid:
 
 
 
Income taxes
$
8,161

 
$
10,272

Supplemental disclosure of noncash transactions:
 
 
 
Common stock issued for shared distribution through accrued expenses and other liabilities
$
3,486

 
$
4,407

Common stock issued for deferred director’s compensation through other noncurrent liabilities
$
294

 
$
930


The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.
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SUN HYDRAULICS CORPORATION
NOTES TO THE CONSOLIDATED, UNAUDITED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)
 
1. BASIS OF PRESENTATION AND SUMMARY OF BUSINESS
Sun Hydraulics Corporation, and its wholly-owned subsidiaries, design, manufacture, and sell screw-in cartridge valves and manifolds used in hydraulic systems. The Company has facilities in the United States, the United Kingdom, Germany, Korea, France, China, and India. Sun Hydraulics Corporation (“Sun Hydraulics”), with its main offices located in Sarasota, Florida, designs, manufactures, and sells its products primarily through distributors. Sun Hydraulik Holdings Limited (“Sun Holdings”), a wholly-owned subsidiary of Sun Hydraulics, was formed to provide a holding company for the European market operations; its wholly-owned subsidiaries are Sun Hydraulics Limited (a British corporation, “Sun Ltd.”) and Sun Hydraulik GmbH (a German corporation, “Sun GmbH”). Sun Ltd. operates a manufacturing and distribution facility located in Coventry, England, and Sun GmbH operates a manufacturing and distribution facility located in Erkelenz, Germany. Sun Hydraulics Korea Corporation (“Sun Korea”), a wholly-owned subsidiary of Sun Hydraulics, located in Inchon, South Korea, operates a manufacturing and distribution facility. In 2012, Sun Korea acquired Seungwon Solutions Corporation (“Seungwon”), also located in Inchon, South Korea, a component supplier to Sun Korea and third parties. Sun Hydraulics, SARL (“Sun France”), a wholly-owned subsidiary of Sun Hydraulics was dissolved in November 2011. Concurrently, Sun Hydraulics opened a liaison office in Bordeaux, France to service the French market. Sun Hydraulics established Sun Hydraulics China Co. Ltd, a representative office in Shanghai in January 2011, to develop new business opportunities in the Chinese market. Sun Hydraulics (India) a liaison office in Bangalore, India is used to develop new business opportunities in the Indian market. On September 27, 2011, Sun Hydraulics purchased the outstanding shares of High Country Tek, Inc. (“HCT”) it did not already own. HCT, now a wholly-owned subsidiary of Sun Hydraulics, is located in Nevada City, California, and designs and manufactures ruggedized electronic/hydraulic control solutions for mobile equipment markets. WhiteOak Controls, Inc. (“WhiteOak”), a 40% equity method investment, located in Mediapolis, Iowa, designs and produces complementary electronic control products. On April 1, 2013, Sun Hydraulics purchased the remaining 60% of WhiteOak, which was merged into HCT (see note 7).
The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Accordingly, certain information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements are not included herein. The financial statements are prepared on a consistent basis (including normal recurring adjustments) and should be read in conjunction with the consolidated financial statements and related notes contained in the Annual Report on Form 10-K for the fiscal year ended December 29, 2012, filed by Sun Hydraulics Corporation (together with its subsidiaries, the “Company”) with the Securities and Exchange Commission on March 12, 2013. In Management’s opinion, all adjustments necessary for a fair presentation of the Company’s financial statements are reflected in the interim periods presented. Operating results for the six month period ended June 29, 2013, are not necessarily indicative of the results that may be expected for the period ending December 28, 2013.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Earnings per share
The following table represents the computation of basic and diluted earnings per common share (in thousands, except per share data):
 
 
Three Months Ended
 
Six Months Ended
 
June 29, 2013
 
June 30, 2012
 
June 29, 2013
 
June 30, 2012
Net income
$
11,790

 
$
11,247

 
$
21,365

 
$
21,870

Weighted average basic shares outstanding
26,236

 
25,937

 
26,185

 
25,861

Basic net income per common share
$
0.45

 
$
0.43

 
$
0.82

 
$
0.85

Effect of dilutive stock options
—

 
38

 
—

 
44

Weighted average diluted shares outstanding
26,236

 
25,975

 
26,185

 
25,905

Diluted net income per common share
$
0.45

 
$
0.43

 
$
0.82

 
$
0.84

Reclassification
Certificates of deposit classified as cash in the prior period were reclassified to marketable securities to conform to the current year presentation. Non-trade receivables classified as accounts receivable in the prior period were reclassified to other current assets to conform to the current year presentation.

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3. STOCK-BASED COMPENSATION
The Company’s 2006 Stock Option Plan (“2006 Plan”) provides for the grant of incentive stock options and nonqualified stock options for the purchase of up to an aggregate of 1,125,000 shares of the Company’s common stock by officers, employees and directors of the Company. Under the terms of the plan, incentive stock options may be granted to employees at an exercise price per share of not less than the fair value per common share on the date of the grant (not less than 110% of the fair value in the case of holders of more than 10% of the Company’s voting stock). Nonqualified stock options may be granted at the discretion of the Company’s Board of Directors. The maximum term of an option may not exceed 10 years, and options become exercisable at such times and in such installments as determined by the Board of Directors. No awards have been granted under the 2006 Plan.
The Company’s 2001 Restricted Stock Plan provides for the grant of restricted stock of up to an aggregate of 928,125 shares of the Company’s common stock to officers, employees, consultants and directors of the Company. Under the terms of the plan, the minimum period before any shares become non-forfeitable may not be less than six months. The 2001 Restricted Stock Plan expired in 2011 and was replaced in September 2011 with the 2011 Equity Incentive Plan (“2011 Plan”). The 2011 Plan provides for the grant of up to an aggregate of 1,000,000 shares of restricted stock, restricted share units, stock appreciation rights, dividend or dividend equivalent rights, stock awards and other awards valued in whole or in part by reference to or otherwise based on the Company’s common stock, to officers, employees and directors of the Company. The 2011 Plan was approved by the Company’s shareholders at the 2012 Annual Meeting. At June 29, 2013, 823,712 shares remained available to be issued through the 2011 Plan. Compensation cost is measured at the date of the grant and is recognized in earnings over the period in which the shares vest. Restricted stock expense for the six months ended June 29, 2013, and June 30, 2012, totaled $1,038 and $835 respectively.

The following table summarizes restricted stock activity from December 29, 2012, through June 29, 2013:
 
 
Number
of shares
 
Weighted
average
grant-date
fair value
Nonvested balance at December 29, 2012
169

 
25.81

Granted
—

 
—

Vested
—

 
—

Forfeitures
—

 
—

Nonvested balance at June 29, 2013
169

 
—

The Company has $2,613 of total unrecognized compensation cost related to restricted stock awards granted under the two plans as of June 29, 2013. That cost is expected to be recognized over a weighted average period of 1.11 years.
The Company maintains an Employee Stock Purchase Plan (“ESPP”), in which most employees are eligible to participate. Employees in the United States who choose to participate are granted an opportunity to purchase common stock at 85 percent of market value on the first or last day of the quarterly purchase period, whichever is lower. Employees in the United Kingdom, under a separate plan, are granted an opportunity to purchase common stock at market value, on the first or last day of the quarterly purchase period, whichever is lower, with the Company issuing one additional free share of common stock for each six shares purchased by the employee under the ESPP. The ESPP authorizes the issuance, and the purchase by employees, of up to 1,096,875 shares of common stock through payroll deductions. No U.S. employee is allowed to buy more than $25 of common stock in any year, based on the market value of the common stock at the beginning of the purchase period, and no U.K. employee is allowed to buy more than the lesser of £1.5 or 10% of his or her annual salary in any year. Employees purchased 20,203 shares at a weighted average price of $23.08, and 17,593 shares at a weighted average price of $18.92, under the ESPP during the six months ended June 29, 2013, and June 30, 2012, respectively. The Company recognized $112 and $101 of compensation expense during the six months ended June 29, 2013 and June 30, 2012, respectively. At June 29, 2013, 693,081 shares remained available to be issued through the ESPP and the U.K. plan.

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The Nonemployee Director Equity and Deferred Compensation Plan (the “Plan”) originally was adopted by the Board of Directors and approved by the shareholders in 2004, and amended in 2008. Under the Plan, Directors who were not officers of the Company were paid 375 shares of Company common stock and $3 in cash fees for attendance at each meeting of the Board of Directors, as well as each meeting of each Board Committee on which they served when the committee meeting was not held within one day of a meeting of the Board of Directors. Committee Chairmen received additional fees equal to 25% of normal compensation and the Chairman of the Board was paid twice the amount of normal compensation, with such additional compensation payable in Company common stock. Prior to June 7, 2011, Directors were able to elect under the Plan to receive all or part of their cash fees in Company stock and to defer receipt of their fees until a subsequent year. When so deferred, the shares of stock were converted to deferred stock units. Deferred stock units are treated as liabilities. At June 29, 2013, there were zero deferred stock units outstanding. The Plan has now been terminated, and no further issuance of shares will be made under the Plan.
In March 2012, the Board reviewed its non-employee director compensation policy and determined that compensating Directors solely in Company stock would further align the interests of the Board and the shareholders. Accordingly, the Board of Directors adopted the Sun Hydraulics Corporation 2012 Nonemployee Director Fees Plan (the “2012 Directors Plan”), which was approved by the shareholders of the Company at its 2012 annual meeting.
Under the 2012 Directors Plan, as compensation for attendance at each Board meeting and each meeting of each committee of the Board on which he or she serves when the committee meeting is not held within one day of a meeting of the Board, each Nonemployee Director will be paid 500 shares of Common Stock. The Chairman’s fee is twice that of a regular director, and the fee for the chairs of each Board committee is 125% that of a regular director. The Board has the authority to change from time to time, in any manner it deems desirable or appropriate, the share compensation to be awarded to all or any one or more Nonemployee Directors, provided that, with limited exceptions, such changes are subject to prior shareholder approval. The aggregate number of Shares which may be issued during any single calendar year is limited to 25,000 Shares. The 2012 Directors Plan authorizes the issuance of up to 270,000 shares of common stock. At June 29, 2013, 248,249 shares remained available for issuance under the 2012 Directors Plan.
Directors were granted 8,500 and 8,266 shares for the six months ended June 29, 2013, and June 30, 2012, respectively. The Company recognized director stock compensation expense of $288 and $218 for the six months ended June 29, 2013, and June 30, 2012, respectively.

4. RESTRICTED CASH
On June 29, 2013, the Company had restricted cash of $308. A restricted cash reserve for customs and excise taxes in the U.K. operation was $46 at June 29, 2013. The restricted amount was calculated as an estimate of two months of customs and excise taxes for items coming into the Company’s U.K. operations and is held with Lloyds TSB in the U.K. Restricted cash of $262 at June 29, 2013, represents the holdback of the purchase price associated with the acquisition of Seungwon on October 18, 2012.

5. INVENTORIES
 
June 29, 2013
 
December 29, 2012
Raw materials
$
5,619

 
$
5,564

Work in process
3,766

 
3,695

Finished goods
3,726

 
3,980

Provision for slow moving inventory
(670
)
 
(680
)
Total
$
12,441

 
$
12,559


6. GOODWILL AND INTANGIBLE ASSETS
A summary of changes in goodwill at June 29, 2013 is as follows:
Balance, December 29, 2012
$
4,472

Acquisitions
726

Currency translation
(116
)
Balance, June 29, 2013
$
5,082

Goodwill is made up of amounts relating to the acquisitions of Sun Korea, HCT, Seungwon, and WhiteOak. Valuation models reflecting the expected future cash flow projections are used to value reporting units. A valuation of the reporting unit at December 29, 2012, indicated that there was no impairment of the carrying value of the goodwill at Sun Korea. A valuation of

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the reporting unit at September 29, 2012 indicated that there was no impairment of the carrying value of the goodwill at HCT. As of June 29, 2013, no factors were identified that indicated impairment of the carrying value of goodwill.

The Company recognized $2,658 and $746 in identifiable intangible assets as a result of the acquisitions of HCT and WhiteOak, respectively. Intangible assets are held in other assets on the balance sheet. At June 29, 2013, and December 29, 2012, intangible assets consisted of the following: 
 
June 29, 2013

December 29, 2012
 
Gross  carrying
amount
 
Accumulated
amortization
 
Net carrying
amount
 
Gross  carrying
amount
 
Accumulated
amortization
 
Net carrying
amount
Definite-lived intangibles:











Trade Name
$
774


$
(136
)

$
638


$
756


$
(95
)

$
661

Non-compete agreement
11


(2
)

9


—


—


—

Technology
868


(86
)

782


697


(256
)

441

Customer Relationships
1,751


(134
)

1,617


1,475


(92
)

1,383


$
3,404


$
(358
)

$
3,046


$
2,928


$
(443
)

$
2,485

Technology associated with our original equity method investment in WhiteOak is included in the prior year numbers above. As a result of the acquisition, our original investment is eliminated upon consolidation. This includes gross technology of $270 and $209 of accumulated amortization through March 30, 2013.
Total estimated amortization expense for the years 2014 through 2018 is presented below. The remaining amortization for 2013 is approximately $139.
Year:

2014
264

2015
256

2016
255

2017
255

2018
255

Total
$
1,285

Intangible assets are evaluated for impairment whenever events or circumstances indicate that the undiscounted net cash flows to be generated by their use over their expected useful lives and eventual disposition may be less than their net carrying value. No such events or circumstances occurred during the six months ended June 29, 2013.

7. ACQUISITIONS
On April 1, 2013, the Company acquired the remaining 60% of the capital stock of WhiteOak that it did not already own for $1,000. WhiteOak has been merged into HCT and relocated to HCT's facility in California. HCT will manufacture, market, sell and have design control for all current WhiteOak products. The combination of HCT and WhiteOak gives Sun full ownership of the technology to develop the next generation of Sun's electronic control products.
The Company recorded approximately $726 in goodwill, $746 in definite lived intangible assets, and $12 in transaction costs related to the acquisition. Of the $746 of acquired intangible assets, $18 was assigned to the WhiteOak trade name (1 year useful life), $11 was assigned to non-compete agreements (2 year useful life), $276 was assigned to customer relationships (15 year useful life), and $441 was assigned to technology (10 year useful life). Additionally, the Company recorded a gain of $528 as a result of remeasuring to fair value its 40% equity interest in WhiteOak held before the business combination.
On October 18, 2012, the Company, through Sun Korea, purchased all of the outstanding stock of Seungwon Solutions Corporation (“Seungwon”) for approximately $1,458. Seungwon is a component supplier, and approximately 80% of its sales are to Sun Korea.
The Company recorded approximately $1,731 in goodwill and approximately $80 in transaction costs related to the acquisition.

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The results of operations of WhiteOak and Seungwon have been included in the Company’s consolidated results since the dates of acquisition. Supplemental pro forma information and disclosure of acquired assets and liabilities have not been provided as these acquisitions did not have a material impact on the consolidated financial statements individually or in the aggregate.

8. LONG-TERM DEBT
Effective August 1, 2011, the Company completed a credit and security agreement in the U.S. with Fifth Third Bank (the “Bank”). The agreement provides for three separate credit facilities totaling $50,000.
Facility A is a $15,000 unsecured revolving line of credit and requires monthly payments of interest. Facility A has a floating interest rate of 1.45% over the 30-day LIBOR Rate (as defined).
Facility B is an accordion feature to increase the revolving line of credit to a $35,000 secured revolving line of credit. Facility B will be secured by the Company’s U.S. assets, including its manufacturing facilities, and requires monthly payments of interest. Facility B will bear interest at the 30-day LIBOR Rate or the Bank’s Base Rate (as defined), at the Company’s discretion, plus a margin based on the Borrower’s Funded Debt to EBITDA Leverage Ratio (as defined). The LIBOR Margin ranges from 1.45% to 2.25% and the Bank’s Base Rate ranges from (0.25)% to 0.00%.
Facility C is a $15,000 construction and term loan. Facility C requires monthly payments of interest for the first 24 months and monthly payments of principal plus accrued interest for 60 months based upon a 15 year amortization schedule. The Construction Loan bears interest at the 30-day LIBOR Rate or the Bank’s Base Rate, at the Company’s discretion, plus a margin based on the Borrower’s Funded Debt to EBITDA Leverage Ratio. The LIBOR Margin ranges from 1.65% to 2.45% and the Bank’s Base Rate ranges from (0.05)% to 0.20%.
Facility A or Facility B (if activated) is payable in full on August 1, 2016. Facility C (if activated) is payable seven years after the closing of the facility. Maturity may be accelerated by the Bank upon an Event of Default (as defined). Prepayment may be made without penalty or premium at any time upon the required notice to the Bank.
Facility A is subject to debt covenants (capitalized terms are defined therein) including: 1) Minimum Tangible Net Worth of not less than $92,000, increased annually by 50% of Net Income, and 2) Minimum EBITDA of not less than $5,000; and requires the Company to maintain its primary domestic deposit accounts with the bank.
If Facility B or Facility C are activated, covenant 2 above will automatically terminate and two additional covenants will be required: 1) Funded Debt to EBITDA ratio equal to or less than 3.0:1.0, and 2) EBIT to Interest Expense ratio of not less than 2.5:1.0.
The Company did not have any amounts drawn on Facilities A, B, or C for the periods ended June 29, 2013, and June 30, 2012.

9. INCOME TAXES
At June 29, 2013, the Company had an unrecognized tax benefit of $1,195 including accrued interest. If recognized, the unrecognized tax benefit would have a favorable effect on the effective tax rate in future periods. The Company recognizes interest and penalties related to income tax matters in income tax expense. Interest accrued as of June 29, 2013, is not considered material to the Company’s consolidated financial statements.
The Company files U.S. federal income tax returns as well as income tax returns in various states and foreign jurisdictions. The Company is no longer subject to income tax examinations by tax authorities for years prior to 2004 for the majority of tax jurisdictions.
The Company’s federal returns are currently under examination by the Internal Revenue Service (IRS) in the United States for the periods 2004 through 2011. To date, there have not been any significant proposed adjustments that have not been accounted for in the Company’s consolidated financial statements.
Audit outcomes and the timing of audit settlements are subject to significant uncertainty. It is reasonably possible that within the next twelve months the Company will resolve some or all of the matters presently under consideration for 2004 through 2011 with the IRS and that there could be significant increases or decreases to unrecognized tax benefits.

10. SEGMENT REPORTING
Historically, the Company had four operating and reportable segments, which were based on the geographic location of its subsidiaries. In 2012, the Company re-evaluated its operating and reportable segments, resulting in a change to a single reportable segment in manufacturing, marketing, selling and distributing its products worldwide. This change was made because, increasingly, the Company is shipping products directly from the factory of origin to end-customers worldwide.

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Management believes the discrete financial information of the Company’s individual foreign subsidiaries is no longer representative of the business level in those locations, and management no longer makes decisions or assesses performance based on this information. Management believes the investment community will have a better understanding, with less confusion, when reviewing our results as one operating segment. The additional information related to the region to which our products are sold, as opposed to the region where the sale was recorded, is more aligned with managerial decision-making and will best inform all interested parties.
The individual subsidiaries comprising the Company operate predominantly in a single industry as manufacturers and distributors of hydraulic components. Given the similar nature of products offered for sale, the type of customers, the methods of distribution and how the Company is managed, the Company determined that it now has only one operating and reporting segment for both internal and external reporting purposes. Prior period financial information included herein has been restated to reflect the financial position and results of operations as one segment.
Geographic Region Information:
Net sales are measured based on the geographic destination of sales. Total and long-lived assets are shown based on the physical location of the assets. Long-lived assets primarily include net property, plant and equipment:
 
 
Three Months Ended 
 June 29, 2013
 
Three Months Ended 
 June 30, 2012
 
Six Months Ended 
 June 29, 2013
 
Six Months Ended 
 June 30, 2012
Net sales

 

 

 

Americas
27,422

 
28,875

 
51,981

 
55,399

Europe/Africa/ME
16,293

 
16,347

 
31,862

 
33,503

Asia/Pacific
12,073

 
11,809

 
23,005

 
23,403

Total
55,788

 
57,031

 
106,848

 
112,305

 
 
June 29, 2013
 
December 29, 2012
Total assets

 

Americas
129,599

 
110,392

Europe/Africa/ME
50,221

 
50,054

Asia/Pacific
15,161

 
14,675

Total
194,981

 
175,121

Long-lived assets

 

Americas
67,137

 
60,240

Europe/Africa/ME
8,307

 
8,085

Asia/Pacific
3,996

 
4,351

Total
79,440

 
72,676



11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company applies fair value accounting guidelines for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Under these guidelines, fair value is defined as the price that would be received for the sale of an asset or paid to transfer a liability (i.e. an exit price) in an orderly transaction between market participants at the measurement date. The guidance establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.
Level 3 - Unobservable inputs that are supported by little, infrequent, or no market activity and reflect the Company’s own assumptions about inputs used in pricing the asset or liability.

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The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company’s valuation techniques used to measure the fair value of marketable equity securities, mutual funds, and phantom stock units were derived from quoted prices in active markets for identical assets or liabilities. The valuation techniques used to measure the fair value of all other financial instruments were valued based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data.
The Company’s investments have been classified and accounted for as available-for-sale. Management determines the appropriate classification of its investments at the time of purchase and reevaluates the designation at each balance sheet date. The Company may or may not hold securities with stated maturities greater than 12 months until maturity. As management views these securities as available to support current operations, the Company classifies securities with maturities beyond 12 months as current assets under the caption short-term investments in the accompanying Consolidated Balance Sheets. These investments are carried at fair value, with the unrealized gains and losses reported as a component of shareholder’s equity. Realized gains and losses on sales of investments are generally determined using the specific identification method, and are included in miscellaneous (income) expense in the Consolidated Statements of Operations.
The following tables provide information regarding the Company’s assets and liabilities measured at fair value on a recurring basis at June 29, 2013, and December 29, 2012. 
 
June 29, 2013
 
Adjusted Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Assets

 

 

 

Level 1:

 

 

 

Equity securities
788

 
25

 
(143
)
 
670

Mutual funds
2,039

 
1

 
(23
)
 
2,017

Subtotal
2,827

 
26

 
(166
)
 
2,687

Level 2:

 

 

 

Corporate fixed income
18,792

 
66

 
(272
)
 
18,586

Municipal bonds
4,357

 
3

 
(16
)
 
4,344

Certificates of deposit and time deposits
10,111

 
1

 
—

 
10,112

Asset backed securities
1,118

 
—

 
(32
)
 
1,086

Subtotal
34,378

 
70

 
(320
)
 
34,128

Total
37,205

 
96

 
(486
)
 
36,815

Liabilities

 

 

 

Level 1:

 

 

 

Phantom stock units
59

 
—

 
—

 
59

Total
59

 
—

 
—

 
59



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December 29, 2012
 
Adjusted Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Assets
 
 
 
 
 
 
 
Level 1:
 
 
 
 
 
 
 
Equity securities
602

 
6

 
(86
)
 
522

Mutual funds
1,936

 
—

 
(28
)
 
1,908

Subtotal
2,538

 
6

 
(114
)
 
2,430

Level 2:
 
 
 
 
 
 
 
Corporate fixed income
18,270

 
48

 
(105
)
 
18,213

Government securities
195

 
14

 
—

 
209

Municipal bonds
4,525

 
4

 
(15
)
 
4,514

Certificates of deposit and time deposits
10,891

 
1

 
—

 
10,892

Asset backed securities
1,447

 
—

 
(5
)
 
1,442

Subtotal
35,328

 
67

 
(125
)
 
35,270

Total
37,866

 
73

 
(239
)
 
37,700

Liabilities
 
 
 
 
 
 
 
Level 1:
 
 
 
 
 
 
 
Deferred director stock units
263

 
—

 
—

 
263

Phantom stock units
30

 
—

 
—

 
30

Total
293

 
—

 
—

 
293

The Company recognized a net realized loss on investments during the six months ended June 29, 2013 of $5 and a net realized gain of $14 during the six months ended June 30, 2012. As of June 29, 2013, gross unrealized losses related to individual securities that had been in a continuous loss position for 12 months or longer were not significant. The Company considers these unrealized losses in market value of its investments to be temporary in nature. When evaluating an investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell, the investment before recovery of the investment’s cost basis. During the six months ended June 29, 2013, the Company recognized an impairment charge of $61, which is included in the net realized loss for the period. This resulted from the deterioration of the financial condition of an issuer of a corporate bond security.
Maturities of investments at June 29, 2013 are as follows:
 

Adjusted Cost

Fair Value
Due in less than one year
$
20,604


$
20,598

Due after one year but within five years
9,701


9,528

Due after five years but within ten years
304


304

Due after ten years
3,769


3,698

Equity securities
788


670

Mutual Funds
2,039


2,017

Total
$
37,205


$
36,815

The Company reports deferred director stock units and phantom stock units as a liability. All remaining deferred stock units were issued in 2013. The Company recognized expense relating to these liabilities of $29 and $35, for the periods ended June 29, 2013, and June 30, 2012. Phantom stock units vest over a period of three years.
The Company did not have any fair value adjustments for assets and liabilities measured at fair value on a nonrecurring basis during the period ended June 29, 2013.

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12. ACCUMULATED OTHER COMPREHENSIVE INCOME
Changes in Accumulated Other Comprehensive Income by Component
Six Months Ended June 29, 2013
 
 
Unrealized
Gains and
Losses on
Available-for-
Sale
Securities
 
Foreign
Currency
Items
 
Total
Balance at December 29, 2012
$
(166
)
 
$
769

 
$
603

Other comprehensive income (loss) before reclassifications
(228
)
 
(2,530
)
 
(2,758
)
Amounts reclassified from accumulated other comprehensive income
4

 
—

 
4

Net current period other comprehensive income (loss)
(224
)
 
(2,530
)
 
(2,754
)
Balance at June 29, 2013
$
(390
)
 
$
(1,761
)
 
$
(2,151
)
Reclassifications out of Accumulated Other Comprehensive Income
Six Months Ended June 29, 2013
 

 
Amount 
Reclassified
from AOCI
 

Details about Accumulated Other
Comprehensive Income Components
 
Three Months Ended 
 June 29, 2013
 
Six Months Ended 
 June 29, 2013
 
Affected Line 
Item in the 
Consolidated
Statements of Operations
Unrealized gains and losses on available-for-sale securities
 

 

 

Realized gain/(loss) on sale of securities
 
$
47

 
$
56

 
Miscellaneous (income) expense, net
Other than temporary impairment
 
—

 
(61
)
 
Miscellaneous (income) expense, net

 
47

 
(5
)
 
Total before tax

 
(16
)
 
1

 
Tax benefit

 
$
31

 
$
(4
)
 
Net of tax
Total reclassifications for the period
 
$
31

 
$
(4
)
 


13. NEW ACCOUNTING PRONOUNCEMENTS
In July 2013, the FASB issued guidance on the Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. Under the guidance, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, noting several exceptions. This guidance is effective for fiscal and interim reporting periods beginning after December 15, 2013. The Company has determined that this new guidance will not have a material impact on its consolidated financial statements.
In February 2013, the FASB issued guidance on the Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income. The guidance requires that companies present either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source (e.g., the release due to cash flow hedges from interest rate contracts) and the income statement line items affected by the reclassification (e.g., interest income or interest expense). If a component is not required to be reclassified to net income in its entirety (e.g., the net periodic pension cost), companies would instead cross reference to the related footnote for additional information (e.g., the pension footnote). This guidance is effective for fiscal and interim reporting periods beginning after December 15, 2012. The Company adopted this guidance in the first quarter of 2013. There was no material impact as a result of this.


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14. COMMITMENTS AND CONTINGENCIES
The Company is not a party to any legal proceedings other than routine litigation incidental to its business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the results of operations, financial position or cash flows of the Company.
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Sun Hydraulics Corporation is a leading designer and manufacturer of high-performance screw-in hydraulic cartridge valves and manifolds, which control force, speed and motion as integral components in fluid power systems. The Company sells its products globally through wholly-owned subsidiaries and independent distributors. Sales outside the United States for the year ended December 29, 2012, were approximately 60% of total net sales.
Approximately two-thirds of Sun’s products are used by the mobile market, which is characterized by applications where the equipment is not fixed in place, the operating environment is often unpredictable, and duty cycles are generally moderate to low. Some examples of the mobile market include equipment used in off-road construction, agriculture, fire and rescue, utilities, oil fields, and mining.
The remaining one-third of products sold are used by industrial markets, which are characterized by equipment that is fixed in place, typically in a controlled environment, and which operates at higher pressures and duty cycles. Power units, automation machinery, metal cutting machine tools and plastics machinery are some examples of industrial equipment. The Company sells to both markets with a single product line.
Industry conditions
Demand for the Company’s products is dependent on demand for the capital goods into which the products are incorporated. The capital goods industries in general, and the fluid power industry specifically, are subject to economic cycles. According to the National Fluid Power Association (the fluid power industry’s trade association in the United States), the United States index of shipments of hydraulic products increased 1% and 24% in 2012 and 2011. The index of shipments of hydraulic products decreased 7% for the three-month period ending June 29, 2013, compared to the same period of the prior year.
The Company’s order trend has historically tracked closely to the United States Purchasing Managers Index (PMI). When PMI is over 50, it indicates economic expansion in the manufacturing sector; when it is below 50, it indicates contraction. The index increased to 50.9 in June 2013 compared to 50.2 in June 2012. In July 2013, the index increased to 55.4, the highest reading since June 2011. The index was largely driven by New Orders, Production and Employment. This is encouraging and bodes well for the manufacturing environment and Sun.

Results for the second quarter
(in millions except net income per share)
 
June 29, 2013
 
June 30, 2012
 
Increase/(Decrease)
Three Months Ended
 
 
 
 
 
Net sales
$
55.8

 
$
57.0

 
(2
)%
Net income
$
11.8

 
$
11.2

 
5
 %
Net income per share:
 
 
 
 
 
Basic
$
0.45

 
$
0.43

 
5
 %
Diluted
$
0.45

 
$
0.43

 
5
 %
Six Months Ended
 
 
 
 
 
Net sales
$
106.8

 
$
112.3

 
(5
)%
Net income
$
21.4

 
$
21.9

 
(2
)%
Net income per share:
 
 
 
 
 
Basic
$
0.82

 
$
0.85

 
(4
)%
Diluted
$
0.82

 
$
0.84

 
(2
)%

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Table of Contents

The second quarter was strong with better than expected earnings due to higher revenues and a $0.01 per share gain resulting from the acquisition of White Oak. On a year-over-year basis, second quarter sales were off a bit in the Americas, flat in Europe and up slightly in Asia.
The Company's new factory in Sarasota is progressing as planned and management expects to be operational in the third quarter. An important part of the Company's value proposition is delivery reliability. The new factory ensures it will continue to offer the industry's best delivery. With the new factory coming online, the Company is closing its Kansas facility. The Kansas operation was started in 2003 to manufacture both ductile iron and larger aluminum manifolds used in integrated packages. The added space the new factory provides now makes it possible to consolidate these operations in Sarasota.
The White Oak acquisition is complete and fully integrated into HCT. Integrated solutions continue to represent the evolution of the cartridge valve industry and management believes these electronic additions to the Company's product portfolio enhance its position in the market place. As HCT and White Oak become more fully assimilated under the Sun brand, including representation by Sun's global distribution network, the Company improves its ability to develop differentiated, integrated solutions for its customers.
Outlook
The third quarter should follow the Company's normal seasonal pattern. Global capital goods leading indicators are more positive than negative, as evidenced by PMI. With its new factory, management believes the Company is in position to take full advantage of the next growth cycle. Sun will continue to offer the industry's best delivery reliability and remain engaged in product and market development activities, while continuing to deliver strong financial results.
Third quarter 2013 revenues are expected to be approximately $49-50 million, up approximately 1% from the third quarter of 2012. Earnings per share are estimated to be $0.32 to $0.34 compared to $0.34 in the same period a year ago. The Kansas relocation will cost approximately $0.02 per share, $0.01 of which is included in the third quarter estimate.
COMPARISON OF THE THREE MONTHS ENDED JUNE 29, 2013 AND JUNE 30, 2012
Historically the Company had four operating and reportable segments, which were based on the geographic location of its subsidiaries. In 2012, the Company re-evaluated its operating and reportable segments, resulting in a change to a single reportable segment in manufacturing, marketing, selling and distributing its products worldwide. Prior period financial information included herein has been restated to reflect the financial position and results of operations as one segment.
Net Sales
Net sales were $55.8 million, a decrease of $1.2 million, or 2.2%, compared to $57.0 million in 2012. The decrease in net sales was driven by weaker demand in our North American end market, which primarily includes capital goods equipment. A price increase, effective July 1, 2012, contributed approximately 3%, or $1.7 million to sales. Changes in exchange rates had a positive impact on sales of approximately $0.1 million. New product sales (defined as products introduced within the last five years) continue to make up 10 - 15% of total sales.

Sales to the Americas decreased 5.0% or $1.5 million, to $27.4 million in the second quarter of 2013, driven by weaker North American demand. Asian/Pacific sales increased 2.2% or $0.3 million, to $12.1 million in the second quarter of 2013, primarily related to demand from Korea and China. This was partially offset by weaker demand in Australia. Exchange rates had a $0.2 million positive impact on Asia/Pacific sales in the second quarter of 2013. EAME sales decreased 0.3% or $0.1 million, to $16.3 million in the second quarter of 2013. Sales to Europe stabilized during the second quarter, after a general economic downturn experienced in this region over the past year. There was a minimal negative impact from currency to EAME sales in the second quarter of 2013.
Gross Profit
Gross profit increased $0.4 million or 1.9% to $23.4 million in the second quarter of 2013, compared to $23.0 million in the second quarter last year. Gross profit as a percentage of net sales increased to 41.9% in the second quarter of 2013, compared to 40.3% in the second quarter last year.
The increase in gross profit was primarily attributable to a price increase in July 2012 of approximately $1.7 million. This amount was partially offset by lower sales volume, which reduced gross profit by approximately $1.2 million. Additionally during the quarter, material and labor increased approximately $0.6 million as a percent of sales. Overhead expenses decreased $0.5 million as a percent of sales during the quarter, primarily related to reduced retirement benefits.

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Table of Contents

Selling, Engineering and Administrative Expenses
Selling, engineering and administrative expenses increased 2.1%, or $0.1 million, to $6.6 million in the second quarter of 2013, compared to $6.5 million last year. There was nothing significant that contributed to the current year change.
Operating Income
Operating income increased $0.3 million or 1.8% to $16.8 million in the second quarter of 2013, compared to $16.5 million in the second quarter last year, with operating margins of 30.0% and 28.9% for the second quarters of 2013 and 2012, respectively. This increase was primarily related to better pricing and reduced retirement benefits in the current year.
Interest Income, Net
Net interest income was $0.2 million for the quarter ended June 29, 2013, compared to $0.3 million for the quarter ended June 30, 2012. The Company currently has no outstanding debt. Total average cash and investments for the quarter ended June 29, 2013, was $77.5 million compared to $81.9 million for the quarter ended June 30, 2012.
Miscellaneous (Income) Expense, Net
There was net miscellaneous income of $0.5 million for the quarter ended June 29, 2013, compared to a minimal amount for the quarter ended June 30, 2012. The current period amount includes a gain of $0.5 million as a result of remeasuring to fair value our 40% equity interest in WhiteOak Controls held before the business combination.
Income Taxes
The provision for income taxes for the quarter ended June 29, 2013, was 32.7% of pretax income compared to 33.3% for the quarter ended June 30, 2012. This effective rate relates to the relative levels of income and different tax rates in effect among the countries in which the Company sells its products.

COMPARISON OF THE SIX MONTHS ENDED JUNE 29, 2013 AND JUNE 30, 2012
Net Sales
Net sales were $106.8 million in 2013, a decrease of $5.5 million, or 4.9%, compared to $112.3 million in 2012. The decrease in net sales was primarily driven by weaker demand in our North American and European end markets, which primarily include capital goods equipment. A price increase, effective July 1, 2012, contributed approximately 3%, or $3.3 million to sales. Changes in exchange rates had a positive impact on sales of approximately $0.4 million. New product sales (defined as products introduced within the last five years) continue to make up 10 - 15% of total sales.

Sales to the Americas decreased 6.2% or $3.4 million, to $52.0 million in 2013, driven by weaker North American demand. Asian/Pacific sales decreased 1.7% or $0.4 million, to $23.0 million in 2013, primarily related to demand from Korea and Australia. For the year, sales to China are up 8.2%. Exchange rates had a $0.4 million positive impact on Asia/Pacific sales in 2013. EAME sales decreased 4.9% or $1.6 million, to $31.9 million in 2013, resulting from the general economic slowdown in Europe. However, this decline was mostly attributable to the first quarter with second quarter sales improving sequentially and essentially level with the comparable period last year. There was minimal impact from currency to EAME sales in 2013.
Gross Profit
Gross profit decreased $1.3 million or 2.8% to $43.9 million in 2013, compared to $45.2 million last year. Gross profit as a percentage of net sales increased to 41.1% in 2013, compared to 40.2% last year.

Lower sales volume reduced gross profit by approximately $3.5 million. Increases in material and labor as a percent of sales reduced gross profit by approximately $0.4 million and $0.5 million, respectively. Overhead expenses as a percent of sales reduced gross profit by approximately $0.2 million. These decreases in gross profit were partially offset by a price increase in July 2012 of approximately $3.3 million.
Selling, Engineering and Administrative Expenses
Selling, engineering and administrative expenses decreased 1.8%, or $0.2 million, to $13.2 million in 2013, compared to $13.5 million last year. The change for 2013 was primarily related to reduced retirement benefits.


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Table of Contents

Operating Income
Operating income decreased $1.0 million or 3.3% to $30.7 million in 2013, compared to $31.7 million last year, with operating margins of 28.7% and 28.3% for 2013 and 2012, respectively. This decrease was primarily related to the reduced sales volume in the current year.
Interest Income, Net
Net interest income was $0.4 million in 2013, compared to $0.6 million in 2012. The Company currently has no outstanding debt. Total average cash and investments for the six months ended June 29, 2013, was $75.7 million compared to $78.8 million for the six months ended June 30, 2012.
Miscellaneous (Income) Expense, Net
There was net miscellaneous income of $0.4 million in 2013, compared to net miscellaneous income of $0.2 million in 2012. The current period income includes a gain of $0.5 million as a result of remeasuring to fair value our 40% equity interest in WhiteOak Controls held before the business combination, and the prior period includes an incentive received for our thermal storage energy building.
Income Taxes
The provision for income taxes for the six months ended June 29, 2013, was 32.5% of pretax income compared to 32.9% for the six months ended June 30, 2012. The change was primarily due to the relative levels of income and different tax rates in effect among the countries in which the Company sells its products.

LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company’s primary source of capital has been cash generated from operations, although fluctuations in working capital requirements have from time to time been met through borrowings under revolving lines of credit. The Company’s principal uses of cash have been to pay operating expenses, make capital expenditures, pay dividends to shareholders, and service debt.
Cash from operations for the six months ended June 29, 2013, was $23.5 million, a decrease of $0.3 million, compared to $23.8 million for the six months ended June 30, 2012. Net income was down approximately $0.5 million from the prior period. Changes in working capital relating to increases in accounts receivable were $6.7 million during 2013, compared to $5.4 million during 2012. There was a decrease in inventory of $0.2 million during 2013 compared to an increase of $0.9 million during 2012. Increases in accounts payable and accruals were $2.5 million during 2013, compared to $3.2 million during 2012. These working capital changes are typical of improved business conditions in the first half of the year compared to those experienced in the Company’s fourth quarter. However, the Company did not see an increase in inventory in 2013, as would be expected, due to better management of inventory levels. Cash on hand increased $7.2 million from $34.5 million at the end of 2012 to $41.7 million at June 29, 2013. Days sales outstanding (DSO) were 33 at June 29, 2013, and 35 at June 30, 2012. Inventory turns were 10.4 as of June 29, 2013, and 9.9 as of June 30, 2012.
In 2012, the Company began construction on a third facility in Sarasota, Florida. The new facility has 58,000 square feet of manufacturing and 17,000 square feet of office space. The total investment is approximately $16.0 million. The Company will begin moving manufacturing operations into the facility during the third quarter of 2013 and expects to occupy the office space in the fourth quarter. As part of this transition, the Company has announced that it will close its Kansas location and move those operations to this new facility. Total one-time costs to relocate this operation are estimated to be $0.7 million, which will be incurred over the remainder of the year. Fixed costs associated with the new facility, net of the savings realized from relocating the Kansas facility, are estimated to be $1.0 million annually.
Capital expenditures were $9.5 million for the six months ended June 29, 2013. Approximately $6.8 million related to the Company’s new facility in Sarasota, Florida, and $0.8 million related to the renovation of its UK facility. The remainder is made up primarily of purchases of machinery and equipment. Capital expenditures, consisting primarily of machinery and equipment, were $4.8 million for the six months ended June 30, 2012. Capital expenditures for the current year are projected to be approximately $15.0 million, which includes approximately $9.0 million related to the new facility.
The Company declared a quarterly cash dividend of $0.09 per share payable on July 15, 2013, to shareholders of record as of June 30, 2013. The declaration and payment of future dividends is subject to the sole discretion of the Board of Directors, and any determination as to the payment of future dividends will depend upon the Company’s profitability, financial condition, capital needs, future prospects and other factors deemed pertinent by the Board of Directors.

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The Company believes that cash generated from operations and its borrowing availability under its revolving line of credit will be sufficient to satisfy the Company’s operating expenses and capital expenditures for the foreseeable future. In the event that economic conditions were to severely worsen for a protracted period of time, the Company would have several options available to ensure liquidity in addition to increased borrowing. Capital expenditures could be postponed since they primarily pertain to long-term improvements in operations. Additional operating expense reductions also could be made. Finally, the dividend to shareholders could be reduced or suspended.
Off Balance Sheet Arrangements
The Company does not engage in any off balance sheet financing arrangements. In particular, the Company does not have any material interest in variable interest entities, which include special purpose entities and structured finance entities.
Through the first quarter, the Company used the equity method of accounting to account for its investment in WhiteOak. The Company did not have a majority ownership in or exercise control over the entity. The investment was not material to the financial statements of the Company at March 30, 2013. On April 1, 2013, Sun Hydraulics purchased the remaining 60% of WhiteOak (see note 7).

Seasonality
The Company generally has experienced increased sales during the second quarter of the year, largely as a result of the order patterns of our customers. The Company’s second quarter net sales, income from operations and net income historically are the highest of any quarter during the year.
Inflation
The impact of inflation on the Company’s operating results has been moderate in recent years, reflecting generally lower rates of inflation in the economy. While inflation has not had, and the Company does not expect that it will have, a material impact upon operating results, there is no assurance that the Company’s business will not be affected by inflation in the future.
Critical Accounting Policies and Estimates
The Company currently applies judgment and estimates which may have a material effect on the eventual outcome of assets, liabilities, revenues and expenses for impairment of long-lived assets, inventory, goodwill, accruals, and income taxes. The Company’s critical accounting policies and estimates are included in its Annual Report on Form 10-K for the year ended December 29, 2012, and did not change during the first six months of 2013.
FORWARD-LOOKING INFORMATION
Certain oral statements made by management from time to time and certain statements contained herein that are not historical facts are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and, because such statements involve risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements, including those in Management’s Discussion and Analysis of Financial Condition and Results of Operations, are statements regarding the intent, belief or current expectations, estimates or projections of the Company, its Directors or its Officers about the Company and the industry in which it operates, and assumptions made by management, and include among other items, (i) the Company’s strategies regarding growth, including its intention to develop new products; (ii) the Company’s financing plans; (iii) trends affecting the Company’s financial condition or results of operations; (iv) the Company’s ability to continue to control costs and to meet its liquidity and other financing needs; (v) the declaration and payment of dividends; and (vi) the Company’s ability to respond to changes in customer demand domestically and internationally, including as a result of standardization. Although the Company believes that its expectations are based on reasonable assumptions, it can give no assurance that the anticipated results will occur.
Important factors that could cause the actual results to differ materially from those in the forward-looking statements include, among other items, (i) the economic cyclicality of the capital goods industry in general and the hydraulic valve and manifold industry in particular, which directly affect customer orders, lead times and sales volume; (ii) conditions in the capital markets, including the interest rate environment and the availability of capital; (iii) changes in the competitive marketplace that could affect the Company’s revenue and/or costs, such as increased competition, lack of qualified engineering, marketing, management or other personnel, and increased labor and raw materials costs; (iv) changes in technology or customer requirements, such as standardization of the cavity into which screw-in cartridge valves must fit, which could render the Company’s products or technologies noncompetitive or obsolete; (v) new product introductions, product sales mix and the geographic mix of sales nationally and internationally; and (vi) changes relating to the Company’s international sales, including changes in regulatory requirements or tariffs, trade or currency restrictions, fluctuations in exchange rates, and tax

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and collection issues. Further information relating to factors that could cause actual results to differ from those anticipated is included but not limited to information under the headings Item 1. “Business,” and Item 1A. “Risk Factors” in the Company’s Form 10-K for the year ended December 29, 2012, and “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” in this Form 10-Q for the quarter ended June 29, 2013. The Company disclaims any intention or obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates on borrowed funds, which could affect its results of operations and financial condition. The Company’s interest rate on its debt financing remains variable based upon the Company’s leverage ratio. The Company had no variable-rate debt outstanding at June 29, 2013. Therefore, a 1% change in interest rates up or down would not have a material effect on the Company’s income statement on an annual basis.
The Company’s exposure to foreign currency exchange fluctuations relates primarily to the direct investment in its facilities in the United Kingdom, Germany and Korea. The Company does not use financial instruments to hedge foreign currency exchange rate changes.

Item 4. CONTROLS AND PROCEDURES
As of June 29, 2013, the Company’s management, under the direction of its Chief Executive Officer and the Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in our SEC reports is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based upon that evaluation, the Company’s Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level as of June 29, 2013, in timely alerting them to material information required to be included in the Company’s periodic SEC filings.
There were no changes in the Company’s internal controls over financial reporting during the period ended June 29, 2013, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II
OTHER INFORMATION


Item 1. Legal Proceedings.
None.

Item 1A. Risk Factors.
For information regarding risk factors, please refer to Part I, Item 1A in the Company’s Annual Report on Form 10-K for the year ended December 29, 2012.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.

Item 3. Defaults Upon Senior Securities.
None.

Item 4. Mine Safety Disclosure
Not applicable.

Item 5. Other Information.
None.


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Item 6.
Exhibits.
Exhibits:
 
Exhibit
Number
 
Exhibit Description
 
 
31.1

 
CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2

 
CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1

 
CEO Certification pursuant to 18 U.S.C. § 1350.
 
 
32.2

 
CFO Certification pursuant to 18 U.S.C. § 1350.
 
 
Exhibit 101.1
 
Interactive Data File
 
 
101.INS
 
XBRL Instance Document
 
 
101.SCH
 
XBRL Schema Document
 
 
101.CAL
 
XBRL Calculation Linkbase Document
 
 
101.DEF
 
XBRL Definition Linkbase Document
 
 
101.LAB
 
XBRL Label Linkbase Document
 
 
101.PRE
 
XBRL Presentation Linkbase Document


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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Sarasota, State of Florida on August 6, 2013.
 
 
 
 
SUN HYDRAULICS CORPORATION
 
 
By:
 
/s/ Tricia L. Fulton
 
 
Tricia L. Fulton
 
 
Chief Financial Officer (Principal Financial and Accounting Officer)

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