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EX-32 - EXHIBIT 32 - HARDINGE INChdng-6302017x10qxex32.htm
EX-31.2 - EXHIBIT 31.2 - HARDINGE INChdng-6302017x10qxex312.htm
EX-31.1 - EXHIBIT 31.1 - HARDINGE INChdng-6302017x10qxex311.htm
EX-10.6 - EXHIBIT 10.6 - HARDINGE INCexh106simonsconsultagreeme.htm
EX-10.5 - EXHIBIT 10.5 - HARDINGE INCexh105schedulerequiredbyin.htm
EX-10.4 - EXHIBIT 10.4 - HARDINGE INCexh104nonqualifiedoptiondo.htm
EX-10.3 - EXHIBIT 10.3 - HARDINGE INCexh103nonqualifiedoptiondo.htm
EX-10.2 - EXHIBIT 10.2 - HARDINGE INCexh102bahrofferletter.htm
EX-10.1 - EXHIBIT 10.1 - HARDINGE INCexh101hdngemploymentagrmt-.htm
EX-3.1 - EXHIBIT 3.1 - HARDINGE INCexh31hardingeinc-xconforme.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2017
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
 
Commission File Number: 000-15760
hardingehoriz646a04a12.jpg 
Hardinge Inc.
(Exact name of registrant as specified in its charter) 
New York
 
16-0470200
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
One Hardinge Drive
Elmira, NY
 
14902
(Address of principal executive offices)
 
(Zip Code)
(607) 734-2281
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 
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.                                      ýYes  oNo
 
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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                      ýYes  oNo
 
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 definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o  (Do not check if a smaller reporting company)
 
Smaller reporting company o
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     oYes  ýNo

 As of July 31, 2017 there were 12,949,525 shares of Common Stock of the registrant outstanding.
 

1



HARDINGE INC. AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
 
 
PAGE
 
 
 
 
 
 
Consolidated Balance Sheets at June 30, 2017 and December 31, 2016 (Audited)
 
 
Consolidated Statements of Operations for the three and six months ended June 30, 2017 and 2016
 
 
Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2017 and 2016
 
 
Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certifications
 
 
 
 
 
 


2


PART I — FINANCIAL INFORMATION
 
Item 1. Financial Statements.


HARDINGE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
 
June 30,
2017
 
December 31,
2016
 
(Unaudited)
 
 
Assets
 

 
 

Cash and cash equivalents
$
26,369

 
$
28,255

Restricted cash
2,509

 
2,923

Accounts receivable, net
55,071

 
55,573

Inventories, net
118,478

 
107,018

Other current assets
11,321

 
6,926

Total current assets
213,748

 
200,695

 
 
 
 
Property, plant and equipment, net
57,192

 
56,961

Goodwill
6,658

 
6,579

Other intangible assets, net
26,698

 
26,730

Other non-current assets
6,047

 
6,585

Total non-current assets
96,595

 
96,855

Total assets
$
310,343

 
$
297,550

 
 
 
 
Liabilities and shareholders’ equity
 

 
 

Notes payable to bank
$
99

 
$
703

Accounts payable
25,982

 
24,217

Accrued expenses
27,140

 
25,629

Customer deposits
23,063

 
18,215

Accrued income taxes
671

 
1,160

Current portion of long-term debt
4,636

 
2,923

Total current liabilities
81,591

 
72,847

 
 
 
 
Long-term debt

 
2,970

Pension and postretirement liabilities
57,635

 
58,840

Deferred income taxes
4,343

 
3,800

Other liabilities
1,669

 
3,152

Total non-current liabilities
63,647

 
68,762

Commitments and contingencies (see Note 10)


 


Common stock ($0.01 par value, 20,000,000 authorized; shares issued 12,943,789 and 12,903,037)
129

 
129

Additional paid-in capital
121,489

 
121,015

Retained earnings
89,510

 
89,557

Treasury shares (at cost, 0 and 9,243)

 
(104
)
Accumulated other comprehensive loss
(46,023
)
 
(54,656
)
Total shareholders’ equity
165,105

 
155,941

Total liabilities and shareholders’ equity
$
310,343

 
$
297,550

 
See accompanying notes to the unaudited consolidated financial statements.


3


HARDINGE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
 
(Unaudited)
 
(Unaudited)
Sales
$
78,197

 
$
70,186

 
$
142,754

 
$
138,007

Cost of sales
51,568

 
46,633

 
94,738

 
91,711

Gross profit
26,629

 
23,553

 
48,016

 
46,296

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
20,081

 
19,637

 
38,103

 
40,230

Research & development
3,777

 
3,369

 
7,335

 
6,656

Restructuring
542

 
226

 
1,978

 
426

Other expense (income), net
37

 
20

 
192

 
(72
)
Income (loss) from operations
2,192

 
301

 
408

 
(944
)
 
 
 
 
 
 
 
 
Interest expense
104

 
132

 
210

 
285

Interest income
(38
)
 
(69
)
 
(79
)
 
(136
)
Income (loss) before income taxes
2,126

 
238

 
277

 
(1,093
)
Income tax (benefit) expense
(396
)
 
93

 
(198
)
 
8

Net Income (loss)
$
2,522

 
$
145

 
$
475

 
$
(1,101
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Per share data:
 

 
 

 
 

 
 

Basic earnings (loss) per share:
$
0.20

 
$
0.01

 
$
0.04

 
$
(0.09
)
 
 
 
 
 
 
 
 
Diluted earnings (loss) per share:
$
0.20

 
$
0.01

 
$
0.04

 
$
(0.09
)
 
 
 
 
 
 
 
 
Cash dividends declared per share:
$
0.02

 
$
0.02

 
$
0.04

 
$
0.04

 
See accompanying notes to the unaudited consolidated financial statements.


4


HARDINGE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
 
(Unaudited)
 
(Unaudited)
Net income (loss)
$
2,522

 
$
145

 
$
475

 
$
(1,101
)
Other comprehensive income (loss):
 

 
 

 
 

 
 

Foreign currency translation adjustments
4,675

 
(2,840
)
 
8,933

 
899

Retirement plans related adjustments
(527
)
 
1,575

 
(251
)
 
1,302

Unrealized (loss) gain on cash flow hedges
(299
)
 
(33
)
 
(68
)
 
132

Other comprehensive income (loss) before tax
3,849

 
(1,298
)
 
8,614

 
2,333

Income tax (benefit) expense
(438
)
 
282

 
(19
)
 
105

Other comprehensive income (loss), net of tax
4,287

 
(1,580
)
 
8,633

 
2,228

Total comprehensive income (loss)
$
6,809

 
$
(1,435
)
 
$
9,108

 
$
1,127

 
See accompanying notes to the unaudited consolidated financial statements.


5


HARDINGE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
(Unaudited)
Operating activities
 

 
 

Net income (loss)
$
475

 
$
(1,101
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 

 
 

Impairment
1,401

 

Depreciation and amortization
4,411

 
4,098

Debt issuance costs amortization
65

 
66

Deferred income taxes
132

 
(119
)
Gain on sale of assets
(16
)
 
(4
)
Unrealized foreign currency transaction gain
(819
)
 
(116
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable
2,261

 
11,826

Restricted cash
499

 
(331
)
Inventories
(8,251
)
 
(7,720
)
Other assets
(2,893
)
 
(1,330
)
Accounts payable
745

 
(2,170
)
Customer deposits
4,132

 
(3,886
)
Accrued expenses
(2,381
)
 
(5,211
)
Accrued pension and postretirement liabilities
(19
)
 
(41
)
Net cash used in operating activities
(258
)
 
(6,039
)
 
 
 
 
Investing activities
 

 
 

Capital expenditures
(968
)
 
(992
)
Proceeds from sales of assets
16

 
37

Net cash used in investing activities
(952
)
 
(955
)
 
 
 
 
Financing activities
 

 
 

Proceeds from short-term notes payable to bank
12,418

 
28,871

Repayments of short-term notes payable to bank
(13,062
)
 
(28,643
)
Repayments of long-term debt
(1,456
)
 
(2,271
)
Dividends paid
(516
)
 
(536
)
Net cash used in financing activities
(2,616
)
 
(2,579
)
 
 
 
 
Effect of exchange rate changes on cash
1,940

 
167

Net decrease in cash
(1,886
)
 
(9,406
)
 
 
 
 
Cash and cash equivalents at beginning of period
28,255

 
32,774

 
 
 
 
Cash and cash equivalents at end of period
$
26,369

 
$
23,368


See accompanying notes to the unaudited consolidated financial statements.

6


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2017



NOTE 1.  BASIS OF PRESENTATION
 
In these notes, the terms “Hardinge,” “the Company,” "we," "us," "our," or similar references mean Hardinge Inc. and its predecessors together with its subsidiaries.
 
The Company operates through two reportable segments, Metalcutting Machine Solutions (“MMS”) and Aftermarket Tooling and Accessories (“ATA”). The MMS segment includes high precision computer controlled metalcutting turning machines, vertical machining centers, horizontal machining centers, grinding machines, and repair parts related to those machines. The ATA segment includes products, primarily collets and chucks that are purchased by manufacturers throughout the lives of their Hardinge or other branded machines.
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements and, therefore, should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the timing and amount of assets, liabilities, equity, revenue, and expenses reported and disclosed. Actual amounts could differ from these estimates. All adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of the results for the interim periods have been presented and recorded. Due to differing business conditions and some seasonality, operating results for the three and six months ended June 30, 2017 are not necessarily indicative of the results that may be expected in subsequent quarters or for the full year ended December 31, 2017.

Certain amounts in the June 30, 2016 consolidated financial statements have been reclassified to conform to the current presentation.

NOTE 2.  FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The inputs to the valuation techniques used to measure fair value are classified into the following categories:
 
Level 1 — Quoted prices in active markets for identical assets and liabilities.
 
Level 2 — Observable inputs other than quoted prices in active markets for similar assets and liabilities.
 
Level 3 — Inputs for which significant valuation assumptions are unobservable in a market and therefore value is based on the best available data, some of which is internally developed and considers risk premiums that a market participant would require.


7


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

The following table presents the carrying amount, fair values, and classification level within the fair value hierarchy of financial instruments measured or disclosed at fair value on a recurring basis (in thousands):
 
June 30, 2017
 
December 31, 2016
 
Level of Fair Value Hierarchy
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
 
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
26,369

 
$
26,369

 
$
28,255

 
$
28,255

 
Level 1
Restricted cash
2,509

 
2,509

 
2,923

 
2,923

 
Level 1
Foreign currency forward contracts
373

 
373

 
308

 
308

 
Level 2
Liabilities:
 
 
 
 
 
 
 
 
 
Notes payable to bank
99

 
99

 
703

 
703

 
Level 2
Variable interest rate debt
4,696

 
4,696

 
5,986

 
5,986

 
Level 2
Foreign currency forward contracts
725

 
725

 
566

 
566

 
Level 2
 
The fair value of cash and cash equivalents and restricted cash are based on the fair values of identical assets in active markets. Due to the short period to maturity or the nature of the underlying liability, the fair value of notes payable to bank and variable interest rate debt approximates their respective carrying amounts. The fair value of foreign currency forward contracts is measured using models based on observable market inputs such as spot and forward rates. Based on the Company’s continued ability to enter into forward contracts, the markets for the fair value instruments are considered to be active. As of June 30, 2017 and December 31, 2016, there were no significant transfers in and/or out of Level 1 and Level 2.
 
NOTE 3.  INVENTORIES
 
Net inventories are stated at the lower of cost (computed in accordance with the first-in, first-out method) or net realizable value. Elements of the cost include materials, labor and overhead.
 
Net inventories consist of the following (in thousands):
 
June 30,
2017
 
December 31,
2016
Raw materials and purchased components
$
32,867

 
$
33,822

Work-in-process
37,624

 
31,799

Finished products
47,987

 
41,397

Inventories, net
$
118,478

 
$
107,018


NOTE 4.  DERIVATIVE FINANCIAL INSTRUMENTS
 
Foreign currency forward contracts are utilized to mitigate the impact of currency fluctuations on assets and liabilities denominated in foreign currencies as well as on forecasted transactions denominated in foreign currencies. These contracts are considered derivative instruments and are recognized as either assets or liabilities and measured at fair value. For contracts that are designated and qualify as cash flow hedges, the gain or loss on the contracts is reported as a component of other comprehensive income (“OCI”) and reclassified from accumulated other comprehensive income (“AOCI”) into the “Sales” or “Cost of sales” line item on the Consolidated Statements of Operations when the underlying hedged transaction affects earnings, or “Other expense (income), net” when the hedging relationship is deemed to be ineffective. As of June 30, 2017 and December 31, 2016, the notional amounts of the derivative financial instruments designated to qualify for cash flow hedges were $35.7 million and $45.5 million, respectively. The Company expects that approximately $0.1 million of expense, net of income tax effect, to be reclassified from AOCI to earnings within the next 12 months. 

As of June 30, 2017 and December 31, 2016, the notional amounts of the derivative financial instruments not qualifying or otherwise designated as hedges were $26.3 million and $35.4 million, respectively. For the three months ended June 30, 2017 and 2016, losses of $0.2 million and gains of $0.4 million, respectively, were recorded related to this type of derivative financial instrument. For the six months ended June 30, 2017 and 2016, gains of $0.4 million and losses of $0.02 million,

8


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

respectively, were recorded related to this type of derivative financial instrument. For contracts that are not designated as hedges, the gain or loss on the contract is recognized in current earnings in the “Other expense (income), net” line item on the Consolidated Statements of Operations.
 
The following table presents the fair value on the Consolidated Balance Sheets of the foreign currency forward contracts (in thousands):
 
June 30,
2017
 
December 31,
2016
Foreign currency forwards designated as hedges:
 

 
 

Other current assets
$
196

 
$
153

Accrued expenses
(370
)
 
(264
)
Foreign currency forwards not designated as hedges:
 

 
 

Other current assets
177

 
155

Accrued expenses
(355
)
 
(302
)
Foreign currency forwards, net
$
(352
)
 
$
(258
)
 
NOTE 5.  PROPERTY, PLANT AND EQUIPMENT
 
Property, plant and equipment consists of the following (in thousands): 
 
June 30,
2017
 
December 31,
2016
Land, buildings and improvements
$
84,651

 
$
81,311

Machinery, equipment and fixtures
77,541

 
75,177

Office furniture, equipment and vehicles
23,204

 
22,471

Construction in progress
212

 
272

 
185,608

 
179,231

Accumulated depreciation
(128,416
)
 
(122,270
)
Property, plant and equipment, net
$
57,192

 
$
56,961


NOTE 6.  GOODWILL AND INTANGIBLE ASSETS
 
Detail and activity of goodwill by segment is presented below (in thousands):
 
MMS
 
ATA
 
Total
Goodwill
$
32,434

 
$
6,579

 
$
39,013

Accumulated impairment losses
(32,434
)
 

 
(32,434
)
Balance at December 31, 2016

 
6,579

 
6,579

 
 
 
 
 
 
Goodwill
32,434

 
6,579

 
39,013

Currency translation adjustments

 
79

 
79

Accumulated impairment losses
(32,434
)
 

 
(32,434
)
Balance at June 30, 2017
$

 
$
6,658

 
$
6,658


    

9


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

The major components of intangible assets other than goodwill are as follows (in thousands):
 
June 30,
2017
 
December 31,
2016
Gross amortizable intangible assets:
 

 
 

Technical know-how
$
12,985

 
$
12,944

Customer lists
9,016

 
8,981

Land rights
2,559

 
2,498

Patents, trade names, drawings, and other
4,391

 
4,356

Total gross amortizable intangible assets
28,951

 
28,779

 
 
 
 
Accumulated amortization:
 

 
 

Technical know-how
(7,758
)
 
(7,438
)
Customer lists
(1,976
)
 
(1,744
)
Land rights
(337
)
 
(304
)
Patents, trade names, drawings, and other
(3,587
)
 
(3,490
)
Total accumulated amortization
(13,658
)
 
(12,976
)
Amortizable intangible assets, net
15,293

 
15,803

 
 
 
 
Indefinite lived intangible assets:
 

 
 

Trade names
11,405

 
10,927

 
 
 
 
Intangible assets other than goodwill, net
$
26,698

 
$
26,730


Amortization expense related to the definite-lived intangible assets are as follows (in thousands):
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Amortization expense
$
312

 
$
320

 
$
624

 
$
640


NOTE 7.  WARRANTIES
 
A reconciliation of the changes in the product warranty accrual, which is included in "Accrued expenses" in the Consolidated Balance Sheets, is as follows (in thousands):
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Balance at the beginning of period
$
3,266

 
$
3,521

 
$
3,556

 
$
3,802

Warranties issued
473

 
709

 
845

 
1,081

Warranty settlement costs
(479
)
 
(557
)
 
(852
)
 
(1,147
)
Changes in accruals for pre-existing warranties
(36
)
 
62

 
(381
)
 
64

Currency translation adjustments
100

 
89

 
156

 
24

Balance at the end of period
$
3,324

 
$
3,824

 
$
3,324

 
$
3,824



10


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

NOTE 8.  RESTRUCTURING CHARGES
 
In March 2017, management initiated a strategic restructuring program (the "Program") in our MMS segment with the goals of streamlining the Company's cost structure, increasing operational efficiencies, generating cash and improving shareholder returns. This Program consists of rationalizing certain product lines, consolidating certain European manufacturing operations, and the sale of assets. The Program, which is projected to be substantially complete by mid-2018, is expected to generate annual pre-tax savings in the range of approximately $2.0 million to $2.5 million once fully implemented. Of the total costs estimated below, we expect approximately $1.6 million will be non-cash costs.

Restructuring charges are included in the "Restructuring" line item in the Consolidated Statements of Operations. The table below presents the total costs expected to be incurred in connection with the Program, the amount of costs that have been recognized during the three and six months ended June 30, 2017 and the cumulative costs recognized to date by the Program (in thousands):
 
Total Costs Expected to be Incurred
 
Cost Recognized for Three Months Ended June 30, 2017
 
Cost Recognized for Six Months Ended June 30, 2017 (Cumulative costs recognized to date)
Restructuring:
 
 
 
 
 
Employee termination costs
$
1,010

 
$
393

 
$
393

Inventory Impairment
1,401

 

 
1,401

Facility related costs
1,373

 
105

 
115

Other related costs
492

 
44

 
69

Total Restructuring Activity
$
4,276

 
$
542

 
$
1,978


The amounts accrued associated with the Program are included in "Accrued expenses" and "Inventory" in the Consolidated Balance Sheets. A rollforward of the accrued restructuring costs is presented below (in thousands):
Balance at December 31, 2016
$

Restructuring charges:
 
Employee termination costs
393

Inventory Impairment
1,401

Facility related costs
115

Other related costs
69

Total restructuring charges for the period
1,978

 
 
Cash expenditures
(373
)
Other adjustments to accrual

Foreign currency translation adjustment
80

Balance at June 30, 2017
$
1,685


NOTE 9.  INCOME TAXES
 
A valuation allowance is recorded against all or a portion of the deferred tax assets in the U.S., Canada, U.K., Germany, and the Netherlands.
 
Each quarter, a full year tax rate is estimated for jurisdictions not subject to valuation allowances based upon the most recent forecast of full year anticipated results and the year-to-date tax expense is adjusted to reflect the full year anticipated tax rate. The rate is an estimate based upon projected results for the year, estimated annual permanent differences, the statutory tax rates in the various jurisdictions in which the Company operates, and the non-recognition of tax benefits for entities with full valuation allowances. The overall effective tax rate was (18.6)% and (71.5)% for the three and six months ended June 30, 2017. The tax benefit recorded during the three months ended June 30, 2017 is mainly driven by the release of an uncertain tax position due to the lapsing of the statute of limitations resulting in a tax benefit of $0.6 million.


11


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017


The tax years 2013 through 2016 remain open to examination by the U.S. federal taxing authorities. The tax years 2011 through 2016 remain open to examination by the U.S. state taxing authorities. For other major jurisdictions (Switzerland, U.K., Taiwan, France, Germany, Netherlands, China and India), the tax years between 2009 and 2016 generally remain open to routine examination by foreign taxing authorities, depending on the jurisdiction.
 
At June 30, 2017, a liability of $1.4 million is recorded with respect to uncertain income tax positions, which includes related interest of $0.1 million. If recognized, essentially all of the uncertain tax positions and related interest at June 30, 2017 would be recorded as a benefit to income tax expense on the Consolidated Statements of Operations. It is reasonably possible that some of the uncertain tax positions pertaining to foreign operations may change within the next 12 months due to audit settlements and statute of limitations expirations. The change in uncertain tax positions for these potential settlements is estimated to be up to $1.2 million.

NOTE 10.  COMMITMENTS AND CONTINGENCIES
 
The Company is a defendant in various lawsuits as a result of normal operations and in the ordinary course of business. Management believes the outcome of these lawsuits will not have a material effect on the financial position or results of operations.

The Company’s operations are subject to extensive federal, state, local and foreign laws and regulations relating to environmental matters. Certain environmental laws can impose joint and several liability for releases or threatened releases of hazardous substances upon certain statutorily defined parties regardless of fault or the lawfulness of the original activity or disposal. Hazardous substances and adverse environmental effects have been identified with respect to real property owned by the Company, and on adjacent parcels of real property.

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

Until receipt of this Special Notice in February 2006, the Company had never been named as a potentially responsible party (“PRP”) at the Site nor had the Company received any requests for information from the EPA concerning the Site. Environmental sampling on the Company’s property within this Site under supervision of regulatory authorities had identified off-site sources for such groundwater contamination and sediment contamination in the Pond, and found no evidence that the Company’s operations or property have contributed or are contributing to the contamination. All appropriate insurance carriers have been notified, and the Company is actively cooperating with them, but whether coverage will be available has not yet been determined and possible insurance recovery cannot be estimated with any degree of certainty at this time.

A substantial portion of the Pond is located on the Company’s property. The Company, along with Beazer East, Inc., the Village of Horseheads, the Town of Horseheads, the County of Chemung, CBS Corporation and Toshiba America, Inc., (collectively, the "PRP's"), agreed to voluntarily participate in the RI/FS by signing an Administrative Settlement Agreement and Order of Consent on September 29, 2006. On September 29, 2006, the Director of Emergency and Remedial Response Division of the EPA, Region II, approved and executed the Agreement on behalf of the EPA. The PRP's also signed a PRP Member Agreement, agreeing to share the costs associated with the RI/FS study on a per capita basis. In June 2017, the EPA notified the PRP’s that two additional parties had been added to the group of PRP’s (Eaton Corporation and Elmira Water Board). The impact of these new parties to the cost sharing agreement has not yet been determined.

The EPA approved the RI/FS Work Plan in May of 2008. In July of 2012 the PRP's submitted a Remedial Investigation (RI) to respond to EPA issues raised in the initial draft RI. In January 2016, the PRP's submitted a draft Feasibility Study (FS), also to respond to issues raised by the EPA about previous drafts of the FS. In July 2016, the EPA announced its proposed

12


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

remediation plan based on an alternative put forth in a July 2016 Woodruff & Curran FS with an estimated total clean-up phase cost of $1.9 million. The preferred remedy consists of the placement of a continuous six-inch thick soil and sand cap, including a geotextile membrane to act as a demarcation layer, over Koppers Pond. The preferred remedy includes long-term monitoring and institutional controls. After a public comment period, on December 13, 2016, the EPA issued a Certificate of Completion confirming that the RI/FS was complete, confirming that all PRP obligations related to the RI/FS had been performed in accordance with the provisions of the Administrative Settlement Agreement and Order on Consent, and approving the remedy selected in the FS as the final response action for Koppers Pond.

The company has $0.3 million as of June 30, 2017 as a reserve for its estimated related liability, assuming all of the original PRP's would continue to share costs equally in the clean-up phase of the project. Based on our understanding including discussions with our experts, it is possible that the PRP's may change, the total clean-up liability may change, and/or the relative split of costs may be different for this final phase of the project. This reserve is reported in Accrued expenses in the Consolidated Balance Sheets.
    
Based upon information currently available, except as described in the preceding paragraphs, the Company does not have material liabilities for environmental remediation. Though the foregoing reflects the Company’s current assessment as it relates to environmental remediation obligations, it is possible that future remedial requirements or changes in the enforcement of existing laws and regulations, which are subject to extensive regulatory discretion, will result in material liabilities to the Company.

NOTE 11.  PENSION AND POSTRETIREMENT PLANS
 
A summary of the components of net periodic pension and postretirement benefit costs for the three and six months ended June 30, 2017 and 2016 is presented below (in thousands):
 
Pension Benefits
 
Postretirement Benefits
 
Three Months Ended 
 June 30,
 
Three Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Service cost
$
487

 
$
569

 
$
3

 
$
3

Interest cost
1,504

 
1,676

 
18

 
19

Expected return on plan assets
(2,126
)
 
(2,328
)
 

 

Amortization of prior service credit
(78
)
 
(64
)
 

 

Amortization of transition asset

 
(79
)
 

 

Amortization of actuarial loss (gain)
935

 
957

 
(11
)
 
(14
)
Settlement loss (gain)
30

 

 

 

Net periodic cost
$
752


$
731


$
10


$
8

 
 
 
 
 
 
 
 
 
Pension Benefits
 
Postretirement Benefits
 
Six Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Service cost
$
974

 
$
1,128

 
$
6

 
$
6

Interest cost
3,002

 
3,348

 
36

 
38

Expected return on plan assets
(4,236
)
 
(4,637
)
 

 

Amortization of prior service credit
(154
)
 
(127
)
 

 

Amortization of transition asset

 
(156
)
 

 

Amortization of actuarial loss (gain)
1,867

 
1,900

 
(22
)
 
(28
)
Settlement loss (gain)
30

 

 

 

Net periodic cost
$
1,483

 
$
1,456

 
$
20

 
$
16



13


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

NOTE 12.  STOCK BASED COMPENSATION
 
The Company's 2011 Incentive Stock Plan (the "Plan"), as amended on May 6, 2014, permits the grant of several types of incentives, including share options, non-qualified stock options, stock appreciation rights, restricted stock awards/ units (“RSAs”) and performance share incentives (“PSIs”).

Stock Options

There were 225,000 non-qualified stock options granted in the three months ended June 30, 2017. There were no other vested or unvested stock options outstanding at the time of these grants. The fair market value of stock options is estimated using the Black Scholes valuation model using the following assumptions:

 
Three Months ended June 30, 2017
Expected volatility
38.50%
Expected dividend yield
0.66%
Risk free rate
1.32% - 1.45%
Expected term (in years)
6.0 - 6.5
Weighted average grant date fair value
$4.48
Weighted average exercise price
$12.04

Stock options vest over a two or three-year period based on either a service period or a combination of service period and performance measures. Deferred compensation for stock options is amortized on a straight-line basis for stock options, which vest over a specified service period, and is recognized ratably for stock options which also have a performance requirement to the extent that it is probable that the performance target will be met. All stock options granted have a ten-year contractual term.

The intrinsic value of stock options at June 30, 2017 was $0.1 million, which is calculated as the difference between the stock price as of June 30, 2017 and the exercise price of the option.

Restricted Stock/ Unit Awards ("RSAs")

There were 42,350 RSAs granted during the six months ended June 30, 2017, and no awards in the same period of 2016. The deferred compensation for RSAs is amortized on a straight-line basis over the specified service period, which ranges from three to four years.

Performance Share Incentives ("PSIs")

There were 42,350 Performance Share Incentives ("PSIs") granted during the six months ended June 30, 2017, and no awards in the same period of 2016. The deferred compensation with respect to the PSIs is being recognized into earnings based on the passage of time and achievement of performance targets.     
    
Compensation Costs

Stock based compensation costs are based on estimated fair values. The fair value of service and performance based stock awards are based on the market value on the date of the grant. The fair value of stock options are estimated using a Black-Scholes valuation model. All stock based compensation to employees is recorded as "Selling, general and administrative expenses" in the Consolidated Statements of Operations. These non-cash compensation costs are included in the depreciation and amortization amounts in the Consolidated Statements of Cash Flows.
 

14


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

A summary of stock based compensation expense is as follows (in thousands):
 
Three Months Ended 
 June 30,
Six Months Ended 
 June 30,
 
2017
 
2016
2017
 
2016
Stock Options
$
31

 
$

$
31

 
$

Restricted stock/unit awards (“RSA”)
66

 
58

107

 
123

Performance share incentives (“PSI”)
32

 

39

 

Total stock based compensation
$
129

 
$
58

$
177

 
$
123

    
Unrecognized compensation and the expected weighted-average recognition periods with respect to the outstanding RSAs and PSIs as of June 30, 2017 and December 31, 2016, are as follows:
 
June 30,
2017
 
December 31,
2016
 
Stock Options
 
RSAs
 
PSIs
 
Stock Options
 
RSAs
 
PSIs
Unrecognized compensation cost (in thousands)
$
976

 
$
464

 
$
904

 
$

 
$
113

 
$
520

Expected weighted-average recognition period for unrecognized compensation cost (in years)
2.67

 
1.65

 
1.51

 
N/A

 
0.92

 
0.97


NOTE 13.  CHANGES IN ACCUMULATED OTHER COMPREHENSIVE LOSS
 
Changes in AOCI by component for the three and six months ended June 30, 2017 and 2016 are as follows (in thousands):
 
Three Months ended June 30, 2017
 
Foreign
currency
translation
adjustments
 
Retirement
plans related
adjustments
 
Unrealized
gain (loss) on
cash flow
hedges
 
Accumulated
other
comprehensive
loss
Beginning balance, net of tax
$
19,324

 
$
(69,816
)
 
$
182

 
$
(50,310
)
Other comprehensive income (loss) before reclassifications
4,675

 
(1,403
)
 
(261
)
 
3,011

Less: (Loss) income reclassified from AOCI

 
(876
)
 
38

 
(838
)
Net other comprehensive income (loss)
4,675

 
(527
)
 
(299
)
 
3,849

Income taxes
(229
)
 
(155
)
 
(54
)
 
(438
)
Ending balance, net of tax
$
24,228

 
$
(70,188
)
 
$
(63
)
 
$
(46,023
)
 
Three Months Ended June 30, 2016
 
Foreign
currency
translation
adjustments
 
Retirement
plans related
adjustments
 
Unrealized
gain (loss) on
cash flow
hedges
 
Accumulated
other
comprehensive
loss
Beginning balance, net of tax
$
24,312

 
$
(69,221
)
 
$
4

 
$
(44,905
)
Other comprehensive (loss) income before
reclassifications
(2,840
)
 
775

 
(96
)
 
(2,161
)
Less: (loss) income reclassified from AOCI

 
(800
)
 
(63
)
 
(863
)
Net other comprehensive (loss) income
(2,840
)
 
1,575

 
(33
)
 
(1,298
)
Income taxes
113

 
169

 

 
282

Ending balance, net of tax
$
21,359

 
$
(67,815
)
 
$
(29
)
 
$
(46,485
)

15


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

 
Six Months Ended June 30, 2017
 
Foreign
currency
translation
adjustments
 
Retirement
plans related
adjustments
 
Unrealized
gain (loss) on
cash flow
hedges
 
Accumulated
other
comprehensive
loss
Beginning balance, net of tax
$
15,483

 
$
(70,102
)
 
$
(37
)
 
$
(54,656
)
Other comprehensive income (loss) before reclassifications
8,933

 
(1,972
)
 
(179
)
 
6,782

Less: (loss) income reclassified from AOCI

 
(1,721
)
 
(111
)
 
(1,832
)
Net other comprehensive income (loss)
8,933

 
(251
)
 
(68
)
 
8,614

Income taxes
188

 
(165
)
 
(42
)
 
(19
)
Ending balance, net of tax
$
24,228

 
$
(70,188
)
 
$
(63
)
 
$
(46,023
)

 
Six Months Ended June 30, 2016
 
Foreign
currency
translation
adjustments
 
Retirement
plans related
adjustments
 
Unrealized
gain (loss) on
cash flow
hedges
 
Accumulated
other
comprehensive
loss
Beginning balance, net of tax
$
20,529

 
$
(69,100
)
 
$
(142
)
 
$
(48,713
)
Other comprehensive income (loss) before reclassifications
899

 
(287
)
 
116

 
728

Less: (loss) income reclassified from AOCI

 
(1,589
)
 
(16
)
 
(1,605
)
Net other comprehensive income (loss)
899

 
1,302

 
132

 
2,333

Income taxes
69

 
17

 
19

 
105

Ending balance, net of tax
$
21,359

 
$
(67,815
)
 
$
(29
)
 
$
(46,485
)

16


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017


Details about reclassification out of AOCI for the three and six months ended June 30, 2017 and 2016 are as follows (in thousands):
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
Affected line item on the Consolidated Statements of Operations
Details of AOCI components
 
2017
 
2016
 
2017
 
2016
 
Unrealized gain (loss) on cash flow hedges: 
 
 

 
 

 
 
 
 
 
 
 
 
$
18

 
$
(53
)
 
$
(120
)
 
$
23

 
Sales
 
 
20

 
(10
)
 
9

 
(39
)
 
Other expense (income), net
 
 
38

 
(63
)
 
(111
)
 
(16
)
 
Total before tax
 
 
15

 
(10
)
 
(9
)
 
(3
)
 
Income taxes
 
 
$
53

 
$
(73
)
 
$
(120
)
 
$
(19
)
 
Net of tax
Retirement plans related adjustments:
 
 

 
 

 
 
 
 
 
 
Amortization of prior service credit
 
$
78

 
$
64

 
$
154

 
$
127

 
(a)
Amortization of transition asset
 

 
79

 

 
156

 
(a)
Amortization of actuarial loss
 
(924
)
 
(943
)
 
(1,845
)
 
(1,872
)
 
(a)
Settlement loss
 
(30
)
 

 
(30
)
 

 
(a)
 
 
(876
)

(800
)

(1,721
)

(1,589
)
 
Total before tax
 
 
96

 
85

 
184

 
168

 
Income taxes
 
 
$
(780
)
 
$
(715
)
 
$
(1,537
)
 
$
(1,421
)
 
Net of tax
 
(a)  These AOCI components are included in the computation of net periodic pension and post retirement costs. See Note 11. "Pension and Postretirement Plans" for details.
 
NOTE 14.  EARNINGS (LOSS) PER SHARE
 
Basic earnings per share is computed using the weighted average number of shares of common stock outstanding during the period. In periods of earnings, the weighted average number of shares used in the diluted calculation includes common stock equivalents related to stock options and restricted stock. The following table presents the basis of the earnings per share computation (in thousands):
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Numerator for basic and diluted loss per share:
 

 
 

 
 
 
 
Net earnings (loss) applicable to common shareholders
$
2,522

 
$
145

 
$
475

 
$
(1,101
)
 
 
 
 
 
 
 
 
Denominator for basic and diluted loss per share:
 

 
 

 
 
 
 
Denominator for basic and diluted loss per share — weighted average shares
12,894

 
12,812

 
12,887

 
12,804

Assumed exercise of stock options
1

 
22

 
1

 

Assumed satisfaction of restricted stock conditions
37

 
67

 
33

 

Denominator for diluted earnings per share — adjusted weighted average shares
12,932

 
12,901

 
12,921

 
12,804

 
Common stock equivalents of certain stock-based awards totaling 81,233 and 5,384 were excluded from the calculation of diluted earnings per share for the three months ended June 30, 2017 and June 30, 2016, respectively, as they were anti-dilutive. Common stock equivalents of certain stock-based awards totaling 41,681 were excluded from the calculation of diluted earnings per share for the six months ended June 30, 2017, as they were anti-dilutive. There is no dilutive effect of the

17


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

restricted stock and stock options for six months ended June 30, 2016 due to the net loss in this period. There would have been 94,666 of these shares included in the diluted calculation for the six months ended June 30, 2016 had there been earnings in this period.

NOTE 15. SEGMENT INFORMATION
 
Segment income (loss) is measured for internal reporting purposes by excluding corporate expenses, impairment charges, interest income, interest expense, and income taxes. Corporate expenses consist primarily of executive employment costs, certain professional fees, and costs associated with the Company’s global headquarters. Financial results for each reportable segment are as follows (in thousands):
 
Three Months ended June 30, 2017
 
MMS
 
ATA
 
Inter-Segment
Eliminations
 
Total
Sales
$
62,016

 
$
16,302

 
$
(121
)
 
$
78,197

Depreciation and amortization
1,429

 
495

 

 
1,924

Segment income
1,928

 
2,745

 


 
4,673

Capital expenditures
433

 
55

 

 
488

 
Three Months Ended June 30, 2016
 
MMS
 
ATA
 
Inter-Segment
Eliminations
 
Total
Sales
$
54,359

 
$
15,883

 
$
(56
)
 
$
70,186

Depreciation and amortization
1,494

 
526

 

 
2,020

Segment income
276

 
1,641

 


 
1,917

Capital expenditures
394

 
163

 

 
557

 
Six Months Ended June 30, 2017
 
MMS
 
ATA
 
Inter-Segment
Eliminations
 
Total
Sales
$
110,848

 
$
32,161

 
$
(255
)
 
$
142,754

Depreciation and amortization
2,829

 
1,003

 
0

 
3,832

Segment (loss) income
(741
)
 
5,031

 
 

 
4,290

Capital expenditures
768

 
200

 
 

 
968

Segment assets(1)
233,613

 
46,153

 
 

 
279,766

 
Six Months Ended June 30, 2016
 
MMS
 
ATA
 
Inter-Segment
Eliminations
 
Total
Sales
$
106,630

 
$
31,504

 
$
(127
)
 
$
138,007

Depreciation and amortization
2,921

 
1,064

 
 

 
3,985

Segment (loss) income
(880
)
 
3,495

 
 

 
2,615

Capital expenditures
685

 
307

 
 

 
992

Segment assets(1)
222,098

 
48,440

 
 

 
270,538

____________________
(1) 
Segment assets primarily consist of restricted cash, accounts receivable, inventories, prepaid and other assets, property, plant and equipment, and intangible assets. Unallocated assets primarily include, cash and cash equivalents, corporate property, plant and equipment, deferred income taxes, and other non-current assets.
 

18


HARDINGE INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
JUNE 30, 2017

A reconciliation of segment income to consolidated income (loss) before income taxes for the three and six months ended June 30, 2017 and 2016 are as follows (in thousands):
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Segment income
$
4,673

 
$
1,917

 
$
4,290

 
$
2,615

Unallocated corporate expense
(2,481
)
 
(1,616
)
 
(3,882
)
 
(3,559
)
Interest expense, net
(66
)
 
(63
)
 
(131
)
 
(149
)
Income (loss) before income taxes
$
2,126

 
$
238

 
$
277

 
$
(1,093
)
 
A reconciliation of segment assets to consolidated total assets follows (in thousands):
 
June 30,
2017
 
December 31,
2016
Total segment assets
$
279,766

 
$
265,279

Unallocated assets
30,577

 
32,271

Total assets
$
310,343

 
$
297,550


Unallocated assets include cash of $26.4 million and $28.3 million at June 30, 2017 and December 31, 2016, respectively.

NOTE 16.  NEW ACCOUNTING STANDARDS

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. establishing a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. This update provides a five-step analysis in determining when and how revenue is recognized. The new model will require revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration a company expects to receive in exchange for those goods or services and will supersede most of the existing revenue recognition guidance, including industry-specific guidance. We have the option of using either a full retrospective or modified approach to adopt this guidance. Between August 2015 and May 2016, the FASB issued four additional updates to 1) ASU No. 2015-14, Deferral of the Effective Date, 2) ASU No. 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), 3) ASU No. 2016-10, Identifying Performance Obligations and Licensing, and 4) ASU No. 2016-12, Narrow-Scope Improvements and Practical Expedients to provide further guidance and clarification in accounting for revenue arising from contracts with customers. The new guidance is effective for annual reporting periods beginning after December 15, 2017, and all annual and interim periods thereafter. In the first quarter 2017 the Company developed a project plan and timeline to complete a diagnostic assessment to begin developing solutions. This assessment has progressed in the second quarter of 2017 and has included an initial training of key personnel, sampling of contracts, and revenue stream evaluation. The Company has not determined the impact this standard may have on the financial statements, nor decided on the method of adoption. In the second half of 2017, the Company expects to implement and test any changes in policy, processes, systems and internal controls and compute required transition adjustments and disclosures.     
    

19


Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.
 
Overview.  The following Management’s Discussion and Analysis (“MD&A”) contains information that the Company believes is necessary to attain an understanding of the Company’s financial condition and associated matters, including the Company’s liquidity, capital resources and results of operations. The MD&A is provided as a supplement to, and should be read in conjunction with, our unaudited financial statements, the accompanying notes to the financial statements (“Notes”) appearing elsewhere in this report and our Annual Report on Form 10-K for the year ended December 31, 2016.
 
We supply high precision computer controlled metalcutting turning machines, grinding machines, vertical and horizontal machining centers, and repair parts related to those machines. The Company also engineers and supplies high precision, standard and specialty workholding devices, and other machine tool accessories. We believe our products are known for accuracy, reliability, durability and value. We are geographically diversified with manufacturing facilities in China, France, Germany, India, Switzerland, Taiwan, the United States (“U.S.”), and the United Kingdom (“U.K.”), with sales to most industrialized countries. Approximately 68% of our 2016 sales were to customers outside of North America, 71% of our 2016 products sold were manufactured outside of North America, and 68% of our employees as of December 31, 2016 were employed outside of North America. In the first half of 2017, approximately 69% of our sales were to customers outside of North America, 73% of our products sold were manufactured outside of North America, and, as of June 30, 2017, 68% of our employees were outside of North America.
 
Metrics on machine tool market activity monitored by our management include world machine tool shipments, as reported annually by Gardner Publications in the Metalworking Insiders Report, and metal-cutting machine orders, as reported by the Association of Manufacturing Technology, the primary industry group for U.S. machine tool manufacturers. Other closely followed U.S. market indicators are tracked to determine activity levels in U.S. manufacturing plants that are prospective customers for our products. One such measurement is the Purchasing Managers Index, as reported by the Institute for Supply Management. Another measurement is capacity utilization of U.S. manufacturing plants, as reported by the Federal Reserve Board. Similar information regarding machine tool shipments and economic indicators in foreign countries is published by trade associations, government agencies, and economic services in those countries.
 
Non-machine sales, which include collets, chucks, accessories, repair parts and service revenue, accounted for approximately 35% of overall sales through the second quarter of 2017 and are an important part of our business due to an installed base of thousands of machines, and the growing needs demanded by specialty workholding applications. In the past, sales of these products and services have not fluctuated on a year-to-year basis as significantly as the sales of our machines have from time to time, but demand for these products and services typically track the direction of the related machine metrics.
 
Other key performance indicators are geographic distribution of net sales (“sales”) and net orders (“orders”), gross profit as a percent of sales, income from operations, working capital changes, and debt level trends. In an industry where constant product technology development has led to an average model life of three to five years, effectiveness of technological innovation and development of new products are also key performance indicators.
 
We are exposed to financial market risk resulting from changes in interest and foreign currency rates. Global economic conditions and related disruptions within the financial markets have also increased our exposure to the possible liquidity and credit risks of our counterparties. We believe we have sufficient liquidity to fund our foreseeable business needs, including cash and cash equivalents, cash flows from operations, our bank financing arrangements, and equity financing arrangements.
 
We monitor the third-party depository institutions that hold our cash and cash equivalents. Our emphasis is primarily on safety of principal. Our cash and cash equivalents are diversified among counterparties to minimize exposure to any one of these entities.
 
We are subject to credit risks relating to the ability of counterparties of hedging transactions to meet their contractual payment obligations. The risks related to creditworthiness and non-performance has been considered in the fair value measurements of our foreign currency forward exchange contracts.
 
We expect that some of our customers and vendors may experience difficulty in maintaining the liquidity required to buy inventory or raw materials. We continue to monitor our customers’ financial condition in order to mitigate the risk associated with our ability to collect on our accounts receivable.
 

20


Foreign currency exchange rate changes can be significant to reported results for several reasons. Our primary competitors, particularly for the most technologically advanced products, are now largely manufacturers in Japan, Germany, Switzerland, Korea, and Taiwan, which causes the worldwide valuation of their respective currencies to be central to competitive pricing in all of our markets. The major functional currencies of our subsidiaries are the British Pound Sterling (“GBP”), Chinese Renminbi (“CNY”), Euro (“EUR”), New Taiwanese Dollar (“TWD”), and Swiss Franc (“CHF”). Under U.S. generally accepted accounting principles, results of foreign subsidiaries are translated into U.S. Dollars (“USD”) at the average exchange rate during the periods presented. Period-to-period changes in the exchange rate between their local currency and the USD may affect comparative data significantly. We also purchase computer controls and other components from suppliers throughout the world, with purchase costs reflecting currency changes.
 
For the three and six months ended June 30, 2017, foreign currency fluctuations resulted in unfavorable currency translation impact of approximately $1.5 million and $3.0 million on sales when compared to the same periods in 2016.

Results of Operations
 
Presented below is summarized selected financial data for the three and six months ended June 30, 2017 and 2016 (in thousands): 
 
 
Three Months Ended 
 June 30,
 
$
Change
 
%
Change
 
Six Months Ended 
 June 30,
 
$
Change
 
%
Change
 
 
2017
 
2016
 
 
 
2017
 
2016
 
 
Sales
 
$
78,197

 
$
70,186

 
$
8,011

 
11
 %
 
$
142,754

 
$
138,007

 
$
4,747

 
3
 %
Gross profit
 
26,629

 
23,553

 
3,076

 
13
 %
 
48,016

 
46,296

 
1,720

 
4
 %
% of sales
 
34.1
%
 
33.6
%
 
0.5

pts.
 
33.6
%
 
33.5
 %
 
0.1

pts.
Selling, general and administrative expenses
 
20,081

 
19,637

 
444

 
2
 %
 
38,103

 
40,230

 
(2,127
)
 
(5
)%
% of sales
 
25.7
%
 
28.0
%
 
(2.3
)
pts.
 
26.7
%
 
29.2
 %
 
(2.5
)
pts.
Research & development
 
3,777

 
3,369

 
408

 
12
 %
 
7,335

 
6,656

 
679

 
10
 %
Restructuring
 
542

 
226

 
316

 
140
 %
 
1,978

 
426

 
1,552

 
364
 %
Other expense (income), net
 
37

 
20

 
17

 
85
 %
 
192

 
(72
)
 
264

 
(367
)%
Income (loss) from operations
 
2,192

 
301

 
1,891

 
628
 %
 
408

 
(944
)
 
1,352

 
(143
)%
% of sales
 
2.8
%
 
0.4
%
 
2.4

pts.
 
0.3
%
 
(0.7
)%
 
1.0

pts.
Interest expense, net
 
66

 
63

 
3

 
5
 %
 
131

 
149

 
(18
)
 
(12
)%
Income (loss) before income taxes
 
2,126

 
238

 
1,888

 
793
 %
 
277

 
(1,093
)
 
1,370

 
(125
)%
Income tax (benefit) expense
 
(396
)
 
93

 
(489
)
 
(526
)%
 
(198
)
 
8

 
(206
)
 
(2,575
)%
Net income (loss)
 
$
2,522

 
$
145

 
$
2,377

 
1,639
 %
 
$
475

 
$
(1,101
)
 
$
1,576

 
(143
)%
% of sales
 
3.2
%
 
0.2
%
 
3.0

pts.
 
0.3
%
 
(0.8
)%
 
1.1

pts.

Sales.  The table below summarizes sales by each corresponding geographical region for the three and six months ended June 30, 2017 compared to the same period in 2016 (in thousands): 
 
Three Months Ended 
 June 30,
 
$
 
%
 
Six Months Ended 
 June 30,
 
$
 
%
 
2017
 
2016
 
Change
 
Change
 
2017
 
2016
 
Change
 
Change
Sales to customers in:
North America
$
24,220

 
$
20,694

 
$
3,526

 
17%
 
$
43,803

 
$
38,144

 
$
5,659

 
15%
Europe
22,240

 
22,242

 
(2
)
 
—%
 
39,942

 
46,084

 
(6,142
)
 
(13)%
Asia and other
31,737

 
27,250

 
4,487

 
16%
 
59,009

 
53,779

 
5,230

 
10%
Total
$
78,197

 
$
70,186

 
$
8,011

 
11%
 
$
142,754

 
$
138,007

 
$
4,747

 
3%
 
Sales for the three months ended June 30, 2017 were $78.2 million, an increase of $8.0 million, or 11%, compared to the same period in 2016. The increase in sales was driven by higher demand in Asia and North America, partially offset by unfavorable foreign currency translation of approximately $1.5 million. Excluding the translation impact, the increase in sales would have been 14%.
 

21


Sales for the six months ended June 30, 2017 were $142.8 million, an increase of $4.7 million, or 3%, compared to the same period in 2016. The increase in sales was driven by increases in North America and Asia machine sales, partially offset by decreases in machine sales in Europe and an unfavorable foreign currency translation of approximately $3.0 million. Excluding the translation impact, the increase in sales would have been 6%.
 
North America sales were $24.2 million and $43.8 million during the three and six months ended June 30, 2017, respectively, an increase of $3.5 million, or 17%, and $5.7 million, or 15%, when compared to the same periods in 2016.

Europe sales were $22.2 million and $39.9 million during the three and six months ended June 30, 2017, respectively. Sales for the three months ended June 30, 2017 were flat compared to the prior year period. Sales for the six-month period ended June 30, 2017 decreased by $6.1 million or 13% due to first quarter weakness in the European industrial markets. Sales for the three and six months ended June 30, 2017 had unfavorable foreign currency translation of approximately $0.6 and $1.1 million, respectively.
 
Asia and other sales were $31.7 million and $59.0 million during the three and six months ended June 30, 2017, respectively, an increase of $4.5 million, or 16%, and $5.2 million, or 10%, when compared to the same periods in 2016. The sales increases over prior year in both three and six month comparative periods was due to a significant increase in machine sales which was partially offset by unfavorable foreign currency translation of approximately $0.9 million and $1.9 million, respectively.
 
Sales of machines accounted for approximately 67% and 65% of the consolidated sales for the three and six months ended June 30, 2017 and 66% for the three and six months ended June 30, 2016, respectively. Sales of non-machine products and services, primarily consisting of collets, chucks, accessories, repair parts, and service revenue, accounted for approximately 33% and 35% of the consolidated sales for the three and six months ended June 30, 2017 and 34% for the three and six months ended June 30, 2016.
 
Gross Profit.  Gross profit was $26.6 million, or 34% of sales for the three months ended June 30, 2017, compared to $23.6 million, or 34% of sales for the same period in 2016. The increase in gross profit was attributable to higher sales volume for the three months ended June 30, 2017 as compared to the same period in 2016 and a $0.2 million improvement due to incremental savings generated by the restructuring program initiated in late 2015.
 
Gross profit was $48.0 million or 34% of sales for the six months ended June 30, 2017, compared to $46.3 million or 34% of sales for the same period in 2016. The increase in gross profit was attributable to higher sales volume for the six months ended June 30, 2017 as compared to the same period in 2016 and a $0.5 million improvement due to incremental savings generated by the restructuring program initiated in late 2015.

Selling, General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses were $20.1 million, or 26% of sales for the three months ended June 30, 2017, an increase of $0.4 million, or 2%, compared to $19.6 million, or 28% of sales for the three months ended June 30, 2016. We incurred $1.2 million of unusual charges in the current quarter, primarily associated with our change in Chief Executive Officer (CEO). The prior year quarter included $0.4 million in costs associated with the Company’s strategic review process. Without the impact of these unusual costs, SG&A would have decreased by $0.4 million in the current quarter compared to the prior-year quarter.

SG&A expenses were $38.1 million, or 27% of sales for the six months ended June 30, 2017, compared to $40.2 million, or 29% of sales for the six months ended June 30, 2016. We incurred $1.3 million of unusual charges in the current six-month period, primarily associated with our change in CEO. The prior year six-month period included $1.1 million in costs associated with the Company