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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 October 2, 2010

Commission file number 0-21835

SUN HYDRAULICS CORPORATION

(Exact Name of Registration as Specified in its Charter)

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  ¨

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  ¨    No  ¨

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):

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

The Registrant had 17,013,962 shares of common stock, par value $.001, outstanding as of October 29, 2010.

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Sun Hydraulics Corporation

INDEX

For the quarter ended October 2, 2010

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PART I: FINANCIAL INFORMATION

Item 1.

Sun Hydraulics Corporation

Consolidated Balance Sheets

(in thousands, except share data)

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)

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)

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 and Comprehensive Income (unaudited)

(in thousands)

The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of this financial statement.

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Sun Hydraulics Corporation

Consolidated Statements of Cash Flows

(in thousands)

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)

Sun Hydraulics Corporation, and its wholly-owned subsidiaries and joint ventures, 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. Sun Hydraulics, SARL (“Sun France”), a wholly-owned subsidiary of Sun Hydraulics, located in Bordeaux, France, operates a sales and engineering support facility. Sun Hydraulics Systems (Shanghai) Co., Ltd. (“Sun China”), a 50/50 joint venture between Sun Hydraulics and Links Lin, the owner of Sun Hydraulics’ Taiwanese distributor, is located in Shanghai, China, and operates a manufacturing and distribution facility. WhiteOak Controls, Inc. (“WhiteOak”), a 40% equity method investment, is located in Mediapolis, Iowa, and designs and produces complementary electronic control products. High Country Tek, Inc. (“HCT”), a 48% equity method investment, is located in Nevada City, California, and designs and manufacturers ruggedized electronic/hydraulic control solutions for mobile equipment markets. Sun Hydraulics also has a sales office in Bangalore, India, to develop new business opportunities in the Indian market.

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 January 2, 2010 filed by Sun Hydraulics Corporation (together with its subsidiaries, the “Company”) with the Securities and Exchange Commission on March 15, 2010. 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 three and nine month periods ended October 2, 2010, are not necessarily indicative of the results that may be expected for the period ending January 1, 2011.

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Earnings per share

The following table represents the computation of basic and diluted earnings per common share (in thousands, except per share data):

During 1996, the Company adopted the 1996 Stock Option Plan (“1996 Plan”), which provides for the grant of incentive stock options and nonqualified stock options for the purchase of up to an aggregate of 2,250,000 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.

A summary of activity under the 1996 Plan for the nine months ended October 2, 2010, is as follows:

All options listed above vest over three to five years with a maximum term of seven to ten years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model using weighted average assumptions. Stock option compensation expense for both of the nine month periods ended October 2, 2010, and September 26, 2009, was $5. There were no options granted during these periods.

In September 2006, the Company adopted the 2006 Stock Option Plan (“2006 Plan”), which provides for the grant of incentive stock options and nonqualified stock options for the purchase of up to an aggregate of 750,000 shares of the Company’s common stock by officers, employees and directors of the Company. The Company adopted the 2006 Plan due to the expiration of the Company’s 1996 Stock Option Plan in 2006. 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.

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During 2001, the Company adopted the 2001 Restricted Stock Plan, which provides for the grant of restricted stock of up to an aggregate of 618,750 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. 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 nine months ended October 2, 2010, and September 26, 2009, totaled $612 and $582 respectively.

The following table summarizes restricted stock activity from January 2, 2010, through October 2, 2010:

The Company has $738 of total unrecognized compensation cost related to restricted stock awards granted under the Plan as of October 2, 2010. That cost is expected to be recognized over a weighted average period of .90 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 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 731,250 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 their annual salary in any year. Employees purchased 15,361 shares at a weighted average price of $19.73, and 22,270 shares at a weighted average price of $13.92, under the ESPP during the nine months ended October 2, 2010, and September 26, 2009, respectively. The Company recognized $79 and $55 of compensation expense during the nine months ended October 2, 2010, and September 26, 2009, respectively. At October 2, 2010, 524,345 shares remained available to be issued through the ESPP.

The Company has a Nonemployee Director Equity and Deferred Compensation Plan (the “Plan”), which originally was adopted by the Board of Directors and approved by the shareholders in 2004. The Plan was amended on March 1, 2008 and was approved by the shareholders at the 2008 Annual Meeting. Under the Plan, Directors who are not officers of the Company are paid 250 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 serve when the committee meeting is not held within one day of a meeting of the Board of Directors. Additionally, the Board of Directors has the authority to increase from time to time, as it deems desirable or appropriate, the number of shares of stock awarded to all or any one or more of the Nonemployee Directors. No more than 25,000 shares of stock, in the aggregate, may be issued under the Plan during any single calendar year. Committee Chairmen currently receive additional

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fees equal to 25% of normal compensation and the Chairman of the Board is paid twice the amount of normal compensation, with such additional compensation payable in Company common stock. Prior to June 2, 2008, under the Plan Nonemployee Directors were paid $5 of which half was paid in Company common stock.

Directors may 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 are converted to deferred stock units. Deferred stock units are treated as liabilities. At October 2, 2010, there were 29,738 deferred stock units outstanding.

Directors were granted 7,892 and 7,971 shares for the nine months ended October 2, 2010, and September 26, 2009, respectively. The Company recognized director stock compensation expense of $277 and $213 for the nine months ended October 2, 2010, and September 26, 2009, respectively. The Plan authorizes the issuance of up to 180,000 shares of common stock. At October 2, 2010, 135,160 shares remained available to be issued through the Plan.

The restricted cash balance at October 2, 2010, consisted of $48 in reserves as a required deferment for customs in the U.K. operation. The restricted amount was calculated as an estimate of two months of customs for items coming into the Company’s U.K. operations and is held with Lloyd’s TSB in the U.K. The remaining amount of $86 relates to a guarantee of VAT in our France operation. The guarantee is held with Crédit Agricole Bank in France.

On October 2, 2010, the Company had $715 of goodwill, related to its acquisition of Sun Korea. Goodwill is held in other assets on the balance sheet. Valuation models reflecting the expected future cash flow projections were used to value Sun Korea at January 2, 2010. The analysis indicated that there was no impairment of the carrying value of the goodwill. As of October 2, 2010, no factors were identified that indicated impairment of the carrying value of the goodwill.

The Company has a $35,000 revolving line of credit, collateralized by U.S. assets, with an interest rate of Libor plus 1.5% (1.757% at October 2, 2010), that comes due August 1, 2011. The Company did not have any debt outstanding for the periods ending October 2, 2010 and January 2, 2010.

The revolving line of credit is subject to debt covenants (capitalized terms are defined therein) including: 1) Debt to Tangible Net Worth ratio of not more than 1.5:1.0, 2) Funded Debt to EBITDA ratio of not more than 2.5:1.0, and 3) EBIT to Interest Expense ratio of not less than 1.1:1.0; and requires the Company to maintain its primary domestic deposit accounts with the Bank. As of October 2, 2010, the Company was in compliance with all debt covenants.

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At October 2, 2010, the Company had an unrecognized tax benefit of $506 including accrued interest for uncertain tax positions related to previous years. 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 October 2, 2010, 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 2007. The IRS proposed a significant adjustment to the Company’s research and development tax credit position. Management has disagreed with the proposed adjustment and believes sufficient evidence is available to defend the position. To date, there have not been any other significant proposed adjustments that have not been accounted for in the Company’s 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 2007 with the IRS, and that there could be significant increases or decreases to unrecognized tax benefits.

The individual subsidiaries comprising the Company operate predominantly in a single industry as manufacturers and distributors of hydraulic components. The Company is multinational with operations in the United States, and subsidiaries in the United Kingdom, Germany, Korea, and France. Amounts for France, due to their immateriality, are included with the U.S. In computing operating profit for the foreign subsidiaries, no allocations of general corporate expenses have been made. Management bases its financial decisions by the geographical location of its operations.

Identifiable assets of the foreign subsidiaries are those assets related to the operation of those companies. United States assets consist of all other operating assets of the Company.

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Segment information is as follows:

Sales to unaffiliated customers represent sales from each of the individual subsidiaries. For information on sales to geographic locations, see the Comparison of the Three and Nine Month Periods Ended October 2, 2010, and September 26, 2009, in Management’s Discussion and Analysis of Financial Condition and Results of Operations. Operating income is total sales and other operating income less operating expenses. Segment operating income does not include interest income/expense, foreign currency transaction gain/loss, and net miscellaneous income/expense.

The Company uses the three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

Level 1. Observable inputs such as quoted prices in active markets;

Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

The Company held available-for-sale securities with an aggregate fair value of $12,042 and $765 at October 2, 2010, and September 26, 2009, respectively. The Company, on a recurring basis, measures available-for-sale securities at fair value using quoted prices in active markets. The net unrealized holding

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gain amounted to $105 at October 2, 2010, and a loss of $2 at September 26, 2009. In addition, the Company reports deferred director stock units and phantom stock units as a liability. These liabilities, on a recurring basis, are measured at fair value using quoted prices in the active market. The Company’s liability was $907 and $604, at October 2, 2010, and September 26, 2009, respectively. The Company recognized expense related to those liabilities of $228 and $150, for the quarters ended October 2, 2010 and September 26, 2009, respectively.

The Company did not have any fair value adjustments for assets and liabilities measured at fair value on a nonrecurring basis during the nine months ended October 2, 2010 and September 26, 2009.

Assets measured at fair value on a recurring basis include the following as of October 2, 2010:

The carrying amounts of cash and cash equivalents, restricted cash, accounts receivable, other current assets, accounts payable, accrued expenses and other liabilities approximate fair value based on their short-term status.

In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance amending the existing fair value measurements and disclosures guidance. The amendment requires new disclosures regarding the transfers in and out of level 1 and 2 fair value measurements and activity in level 3 fair value measurements. The amendment also clarifies existing disclosures regarding the level of disaggregated information as well as more disclosure around valuation techniques and inputs to fair value measurements. The guidance was effective for interim and annual reporting periods commencing after December 15, 2009, with a portion effective for fiscal years beginning after December 15, 2010. The adoption of this guidance has not had a material impact on the Company’s Consolidated Financial Statements, nor is the remaining guidance expected to have a material impact.

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.

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On October 28, 2010, the Company announced that its Board of Directors had elected to issue a $0.50 per share dividend to shareholders. The dividend is payable on November 30, 2010 to shareholders of record as of November 15, 2010. The special dividend totals approximately $8.5 million.

Sun’s strong financial position and ability to generate cash allowed it to reward its shareholders with this one-time special dividend. In consideration of the timing of this declaration, the Board took into account potential upcoming changes in dividend tax rates.

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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 January 2, 2010, were approximately 59% of total net sales.

Approximately two-thirds of product sales 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 sales 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 twelve-month shipments of hydraulic products decreased 40% and increased 8% in 2009 and 2008, respectively. The index of shipments of hydraulic products increased 68% for the three-month period ending October 2, 2010, 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 in the economy. The index increased to 54.4 in September 2010 compared to 52.6 in September 2009. In October 2010, the index was 56.9, which represents the fifteenth consecutive month of expansion in the manufacturing sector. New orders and production made significant gains during the month. The PMI index, solidly above 50, indicates continued expansion in the manufacturing sector.

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Results for the third quarter

(Dollars in millions except net income per share)

Business continued to rebound in all geographic regions in the third quarter. Sun continues to service new customers in all regions, which is great for its long-range outlook. Traditional segments that have been slow to recover appear to be regaining momentum, which bolsters the Company’s short- and mid-term outlook. The moderate softening experienced in the third quarter was normal seasonal demand.

Management is extremely pleased with how quickly the Company regained its operating leverage in 2010. This is the result of actions taken in late 2008 and throughout 2009 to retain and educate our workforce and invest in capabilities as well as prospecting for customers. Sun is currently operating at a level similar to 2006, but 2010 earnings will be 25% better than 2006. Management expects 2011 to look a lot like 2007, also with the potential for stronger operational results. Third quarter 2010 earnings included a year-to-date retirement benefit adjustment which was not planned for in our previous third quarter estimates. Without this adjustment, earnings per share would have been 38 cents.

The long-term outlook remains bright for Sun Hydraulics. The core business drivers are unchanged with an emphasis on delivery reliability and superior product and customer service performance. Management expects to continue to outgrow the industry by both creating new markets and gaining market share. Management believes the result will be better than average returns for shareholders.

Outlook

Fourth quarter 2010 revenues are expected to be approximately $38 million, up approximately 39% from the fourth quarter of 2009. Earnings per share are estimated to be $0.34 to 0.36 compared to $0.08 in the same period a year ago.

2010 year-end sales are estimated to be approximately $147 million, an approximately 51% increase over 2009 sales. Earnings per share for 2010 are estimated to be $1.23 to $1.25, compared to $0.11 in 2009.

Sun’s prior year fourth quarter results were based on a 14-week quarter resulting in a 53-week year for 2009.

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COMPARISON OF THE THREE MONTHS ENDED OCTOBER 2, 2010 AND SEPTEMBER 26, 2009

Net Sales

Net sales were $38.1 million, an increase of $14.8 million, or 63.3%, compared to $23.3 million in 2009. The increase in net sales was primarily driven by increased demand in our end markets, which primarily include capital goods equipment. A price increase, effective July 1, 2010, contributed approximately 2 to 3% to sales. The change in exchange rates had a negative impact on sales of approximately $0.6 million. New product sales (defined as products introduced within the last five years) generally make up 10 - 15% of total sales.

North American sales increased 62.6% or $6.6 million, to $17.1 million, Asian sales increased 54.7% or $2.4 million, to $6.8 million, and European sales increased 67.1% or $5.1 million, to $12.7 million.

The U.S. reporting segment had sales of $23.7 million in the third quarter of 2010, up $9.8 million or 70.4%, compared to sales of $13.9 million during the third quarter last year. The increase was driven by demand in our end markets and the general upturn in the global economy. International sales out of the U.S. were $8.6 million during the third quarter of 2010, up 104.0% or $4.4 million, compared to $4.2 million during the third quarter last year. Significant increases in sales were noted in almost all geographic regions.

The Korean reporting segment had sales of $3.3 million during the third quarter of 2010, up $0.7 million or 26.5%, compared to sales of $2.6 million during the third quarter last year. Currency effect increased 2010 third quarter sales by approximately $0.1 million. The remaining increase was the result of efforts to expand and diversify the customer base, in addition to increased demand from existing customers.

The German reporting segment had sales of $5.4 million during the third quarter of 2010, up $2.0 million or 57.6%, compared to sales of $3.4 million during the third quarter last year. Currency effect decreased 2010 third quarter sales by approximately $0.6 million. The increase in sales was primarily related to demand within Germany and from Austria and Italy.

The U.K. reporting segment had sales of $5.7 million during the third quarter of 2010, up $2.3 million or 68.5%, compared to sales of $3.4 million during the third quarter last year. Currency effect decreased 2010 third quarter sales by approximately $0.2 million. The increase in sales was primarily related to demand within the U.K. and from Sweden, Finland, and France.

Gross Profit

Gross profit increased $8.2 million or 153.2% to $13.6 million in the third quarter of 2010, compared to $5.4 million in the third quarter last year. Gross profit as a percentage of net sales increased to 35.6% in the third quarter of 2010, compared to 22.9% in the third quarter last year.

During the downturn of the prior year, the Company maintained its workforce and labor and variable overhead costs became essentially fixed. By maintaining its workforce, the Company has been able to respond to the increasing demand. As sales increased across all segments, the Company has experienced productivity improvements and was able to leverage its overhead costs to generate higher gross profit.

Higher sales volume in the third quarter of 2010 contributed $3.2 million of the increase. Decreases in overhead expenses as a percentage of sales added approximately $3.3 million to gross profit, which occurred primarily in the U.S. The remaining increase in gross profit was attributed to a price increase in July 2010, of approximately $1.0 million and productivity improvements of approximately $0.6 million. The increase in gross profit was partially offset by additional retirement benefit costs of approximately $1.0 million.

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In June 2009, the Company initiated rolling furloughs for the production workforce and a 3% salary reduction for non-production personnel. Production employees were brought back throughout the first quarter of 2010 as demand increased. In April 2010, the Company ended its employee furlough program and restored the 3% salary decrease for all U.S. employees. The prior year period includes cost savings of approximately $0.7 million in the third quarter.

Selling, Engineering and Administrative Expenses

Selling, engineering and administrative expenses increased 8.9%, or $0.4 million, to $5.4 million in 2010, compared to $4.9 million last year. The change is related to additional retirement benefits primarily in the U.S. and marketing efforts in Asia.

Operating Income

Operating income increased $7.8 million or 1,834.3% to $8.2 million in the third quarter of 2010, compared to $0.4 million in the third quarter last year, with operating margins of 21.5% and 1.8% for the third quarters of 2010 and 2009, respectively. Based on the Company’s structure and decisions made during the downturn, the increase in sales during the third quarter of 2010 has improved operating margins across all segments. During the downturn of the prior year, the Company maintained its workforce and labor and variable overhead costs became essentially fixed. By maintaining its workforce, the Company has been able to respond to the increasing demand. As sales increase across all segments, the Company is experiencing productivity improvements and is able to leverage its overhead costs to generate higher operating income.

The U.S. reporting segment contributed $5.6 million to our consolidated operating income during the third quarter of 2010, compared to an operating loss of $0.3 million during the third quarter of 2009. This increase of $5.9 million in the U.S. operating segment was primarily related to productivity gains and leverage of its overhead costs. Productivity gains contributed $0.6 million and decreases in variable and fixed overhead costs added $3.6 million to operating income. The remaining increases in operating income were from the absorption of selling, engineering, and administrative expenses which decreased $2.0 million as a percent of sales.

The Korean reporting segment contributed $0.4 million to our consolidated operating income during the third quarter of 2010 compared to $0.2 million during the third quarter last year, an increase of $0.2 million. The increase in operating income was primarily related to material costs due to the strength of the Korean Won against the U.S. Dollar for material purchases made in U.S. Dollars of $0.2 million.

The German reporting segment contributed $1.1 million to our consolidated operating income during the third quarter of 2010 compared to $0.5 million during the third quarter last year, an increase of $0.6 million. The increase was primarily related to absorption of fixed costs which added $0.4 million to operating income. The increase in sales volume resulted in $0.3 million of additional operating income.

These amounts were offset by material costs, due to the weakening of the Euro against the U.S. Dollar for material purchases made in U.S. Dollars of $0.2 million.

The U.K. reporting segment contributed $1.0 million to our consolidated operating income during the third quarter of 2010 compared to minimal income during the third quarter last year, an increase of $1.0 million. The increase was primarily related to absorption of fixed costs adding $0.8 million to operating income, and productivity improvements of $0.3 million. These amounts were partially offset by increased material costs of $0.2 million.

Interest Income, Net

Net interest income was $0.2 million and $0.1 million for the quarters ended October 2, 2010, and September 26, 2009, respectively. The Company currently has no outstanding debt. Total average cash and investments for the quarter ended October 2, 2010, was $45.1 million compared to $35.7 million for the quarter ended September 26, 2009.

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Foreign Currency Transaction Loss (Gain), Net

Foreign currency loss was minimal for the quarter ended October 2, 2010 compared to a gain of $0.1 million for the quarter ended September 26, 2009. The current year loss is primarily related to the revaluation of assets and liabilities held in U.S. Dollars at our U.K. subsidiary.

Miscellaneous (Income) Expense, Net

There was net miscellaneous income of $0.1 million for the quarter ended October 2, 2010, compared to a net miscellaneous expense of $0.1 million for the quarter ended September 26, 2009, reflecting primarily earnings and losses from joint ventures.

Income Taxes

The provision for income taxes for the quarter ended October 2, 2010, was 32.1% of pretax income compared to 2.8% for the quarter ended September 26, 2009. 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. The prior year provision included a tax benefit recognized in the U.S.

COMPARISON OF THE NINE MONTHS ENDED OCTOBER 2, 2010 AND SEPTEMBER 26, 2009

Net Sales

Net sales were $108.9 million in 2010, an increase of $38.8 million, or 55.3%, compared to $70.1 million in 2009. Net sales increased 54.4% excluding the effect of exchange rates. The increase in net sales was primarily driven by increased demand in our end markets, which primarily include capital goods equipment. A price increase, effective July 1, 2010, contributed less than 1% to sales for the year. New product sales (defined as products introduced within the last five years) generally make up 10 - 15% of total sales.

North American sales increased 53.0% or $16.8 million, to $48.5 million, Asian sales increased 84.4% or $10.2 million, to $22.3 million, and European sales increased 40.5% or $9.8 million, to $34.0 million.

The U.S. reporting segment had sales of $67.9 million in 2010, up $25.8 million or 61.4%, compared to sales of $42.1 million last year. The increase was driven by demand in our end markets and the general upturn in the global economy. International sales out of the U.S. were $25.2 million in 2010, up 89.1% or $11.9 million, compared to $13.3 million last year. Significant increases in sales were noted in almost all geographic regions.

The Korean reporting segment had sales of $12.2 million in 2010, up $5.2 million or 74.4%, compared to sales of $7.0 million last year. Currency effect increased 2010 sales by approximately $1.3 million. The remaining increase is a result of efforts to expand and diversify its customer base, in addition to increased demand from existing customers.

The German reporting segment had sales of $14.8 million in 2010, up $3.8 million or 33.8%, compared to sales of $11.0 million last year. The increase was primarily related to demand within Germany. Currency effect decreased 2010 sales by approximately $0.6 million.

The U.K. reporting segment had sales of $14.1 million in 2010, up $4.1 million or 40.4%, compared to sales of $10.0 million last year. The increase was primarily related to demand within the U.K. and to Sweden. Currency effect decreased 2010 sales by approximately $0.2 million.

Gross Profit

Gross profit increased $22.5 million or 148.3% to $37.7 million, compared to $15.2 million. Gross profit as a percentage of net sales increased to 34.6% in 2010, compared to 21.6% last year.

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During the downturn of the prior year, the Company maintained its workforce and labor and variable overhead costs became essentially fixed. By maintaining its workforce, the Company has been able to respond to the increasing demand. As sales increase across all segments, the Company is experiencing productivity improvements and is able to leverage its overhead costs to generate higher gross profit.

Higher sales volume in 2010 contributed $8.1 million of the increase. The remaining increase in gross profit was attributed to productivity improvements of approximately $3.8 million, and decreases in overhead expenses as a percentage of sales of approximately $10.5 million, both of which occurred primarily in the U.S. A price increase in July 2010 added approximately $1.0 million to gross profit. The increase in gross profit was partially offset by higher material costs as a percent of sales of approximately $0.9 million and additional retirement benefit costs of approximately $1.0 million.

In June 2009, the Company initiated rolling furloughs for the production workforce and a 3% salary reduction for non-production personnel. Production employees were brought back throughout the first quarter of 2010 as demand increased. In April 2010, the Company ended its employee furlough program and restored the 3% salary decrease for all U.S. employees. There was no material impact from the furlough program during 2010. The prior year period includes cost savings of approximately $0.9 million in the third quarter.

Selling, Engineering and Administrative Expenses

Selling, engineering and administrative expenses increased 5.5%, or $0.8 million, to $15.4 million in 2010, compared to $14.6 million last year. The increase is primarily related to marketing efforts in Asia, and fringe benefit costs related to self-funded health plans in the U.S. and additional retirement benefits primarily in the U.S.

Operating Income

Operating income increased $21.7 million or 3,657.8% to $22.3 million in 2010, compared to $0.6 million last year, with operating margins of 20.5% and 0.8% for 2010 and 2009, respectively. Based on the Company’s structure and decisions during the downturn, the increase in sales during 2010 has improved operating margins across all segments. During the downturn of the prior year, the Company maintained its workforce and labor and variable overhead costs became essentially fixed. By maintaining its workforce, the Company has been able to respond to the increasing demand. As sales increase across all segments, the Company is experiencing productivity improvements and is able to leverage its overhead costs to generate higher operating income.

The U.S. reporting segment contributed $15.5 million to our consolidated operating income during 2010, compared to an operating loss of $2.4 million during 2009, an increase of $17.9 million. The increase in the U.S. operating segments is primarily related to productivity gains and leverage of its overhead costs. Productivity gains contributed $3.7 million and decreases in variable and fixed overhead costs added $10.5 million to operating income. The remaining increases in operating income were primarily from absorption of selling, engineering, and administrative expenses.

The Korean reporting segment contributed $1.7 million to our consolidated operating income during 2010 compared to $0.4 million last year, an increase of $1.3 million. The increase in operating income was primarily related to material costs due to the strength of the Korean Won against the U.S. Dollar for material purchases made in U.S. Dollars, and productivity improvements totaling $0.7 million. The increase in sales volume resulted in $0.3 million of additional operating income.

The German reporting segment contributed $3.1 million to our consolidated operating income during 2010 compared to $1.8 million last year, an increase of $1.3 million. The increase was primarily due to the absorption of selling, engineering, and administrative expenses which were down $0.1 million in whole dollars. The increase in sales volume resulted in $0.6 million of additional operating income. These amounts were offset by material costs, due to the weakening of the Euro against the U.S. Dollar for material purchases made in U.S. Dollars of $0.3 million.

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The U.K. reporting segment contributed $2.1 million to our consolidated operating income during 2010 compared to $0.6 million last year, an increase of $1.5 million. The increase was primarily related to productivity improvement of $0.5 million and decreased variable and fixed costs of $1.0 million. The increase in sales volume resulted in $0.2 million of additional operating income. These amounts were partially offset by increased material costs of $0.6 million.

Interest Income, Net