FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

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

For the quarterly period ended September 30, 2005

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

Hardinge Inc.

(Exact name of Registrant as specified in its charter)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined by Exchange Act Rule 12b-2).  Yes ý  No o

As of September 30, 2005 there were 8,862,012 shares of Common Stock of the Registrant outstanding.

HARDINGE INC. AND SUBSIDIARIES

INDEX

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PART I.  ITEM 1

HARDINGE INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In Thousands, except preferred and common share and per share amounts)

See accompanying notes.

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See accompanying notes.

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HARDINGE INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(In Thousands, Except Per Share Data)

See accompanying notes.

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HARDINGE INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In Thousands)

See accompanying notes.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2005

NOTE A—BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States 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 accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three month period and the nine month period ended September 30, 2005, are not necessarily indicative of the results that may be expected for the year ended December 31, 2005.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2004.  The Company operates in only one business segment – industrial machine tools.

The consolidated balance sheet at December 31, 2004 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

Certain amounts in the September 30, 2004 consolidated financial statements have been reclassified to conform with the September 30, 2005 presentation.

NOTE B—STOCK-BASED COMPENSATION

The Company grants restricted shares of common stock and stock options to certain officers, directors and other key employees.  The Company accounts for restricted share grants and stock option grants in accordance with Accounting Principles Board Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees.  The stock options issued to employees under the 1996 and 2002 Incentive Stock Plans expire 10 years from the date of grant and are exercisable one-third after the first year, two-thirds after the second year, and 100 percent exercisable after the third year.

In accordance with the provisions of Statement of Financial Accounting Standard No. 123 (SFAS No. 123) Accounting for Stock Based Compensation, the Company has elected to continue applying the provisions of APB No. 25 and related interpretations in accounting for its stock-based compensation plans.  The Company amortizes compensation expense for restricted stock over the vesting period of the grant.  The Company does not recognize compensation expense for stock options when the stock option price at the grant date is equal to or greater than the fair market value of the stock at that date.

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

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There are 204,750 and 230,750 shares of restricted common stock outstanding as of September 30, 2005 and 2004, respectively, which are subject to the satisfaction of the vesting requirements.

The following illustrates the pro forma effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123:

NOTE C—WARRANTIES

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

The Company also sells extended warranties for some of its products.  These extended warranties usually cover a 12-24 month period that begins 0-12 months after time of sale.  Revenues for these extended warranties are recognized monthly on a prorated basis until the warranty expires.

These liabilities are reported as accrued expenses on the Company’s consolidated balance sheet.

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A reconciliation of the changes in the Company’s product warranty liability during the three month and nine month periods ended September 30, 2005 and 2004 is as follows:

NOTE D—INVENTORIES

Inventories are summarized as follows (dollars in thousands):

NOTE E—INCOME TAXES

The Company continues to maintain a full valuation allowance on the tax benefits of its U.S. and U.K. net deferred tax assets and the Company expects to continue to record a full valuation allowance on future tax benefits until an appropriate level of profitability in those countries is sustained.  Additionally, until an appropriate level of profitability is reached, the Company does not expect to recognize any significant tax benefits in future results of operations.

Each quarter, the Company estimates its full year tax rate based upon its most recent forecast of full year anticipated results and adjusts year to date tax expense to reflect its full year anticipated tax rate.

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NOTE F— DERIVATIVE FINANCIAL INSTRUMENTS

The Company accounts for derivative financial instruments in accordance with Financial Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.  The statement requires the Company to recognize all its derivative instruments on the balance sheet at fair value.  Derivatives that are not qualifying hedges must be adjusted to fair value through income.  If the derivative is a qualifying hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings.  The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings.

NOTE G—EARNINGS PER SHARE AND WEIGHTED AVERAGE SHARES OUTSTANDING

Earnings per share are computed in accordance with Statement of Financial Accounting Standards No. 128 (SFAS No. 128) Earnings per Share.   Basic earnings per share are computed using the weighted average number of shares of common stock outstanding during the period.  For diluted earnings per share, the weighted average number of shares includes common stock equivalents related primarily to restricted stock.

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

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September 30, 2005

NOTE H—REPORTING COMPREHENSIVE INCOME (LOSS)

During the three and nine month periods ended September 30, 2005 and 2004, the components of total comprehensive income (loss) consisted of the following (dollars in thousands):

Accumulated balances of the components of other comprehensive income (loss) consisted of the following at September 30, 2005 and December 31, 2004  (dollars in thousands):

NOTE I—GOODWILL AND OTHER INTANGIBLE ASSETS

The Company accounts for goodwill and intangibles in accordance with Statements of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and No. 142 (SFAS 142), Goodwill and Other Intangible Assets.  SFAS 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. The statement requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives are amortized over their estimated useful lives.

The total carrying amount of goodwill was $18.1 million as of September 30, 2005 and $20.4 million as of December 31, 2004.  The majority of this asset resulted from the acquisition of HTT Hauser Tripet Tschudin AG in 2000.  The acquisition of the European sales and service operations of Bridgeport in 2004

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added $0.5 million to goodwill.  The asset value of the goodwill decreased by $2.3 million during the nine month period ended September 30, 2005, with the entire change caused by the decreased dollar value of the functional currency of the Company’s subsidiaries whose balance sheets include the goodwill.

The Company completed annual impairment testing during the fourth quarter of 2004 and 2003 and determined that there has been no impairment of goodwill.

Other intangible assets include $6.7 million representing the value of the name, trademarks and copyrights associated with the former worldwide operations of Bridgeport, which were acquired in 2004.  The Company will be using this brand name on all of its machining center lines in the future, and therefore, the asset has been determined to have an indefinite useful life. The asset will be reviewed annually for impairment under the provisions of SFAS 142.

NOTE J—PENSION AND POST RETIREMENT PLANS

 The Company accounts for the pension plans and postretirement benefits in accordance with Statements of Financial Accounting Standards No. 87, Employers’ Accounting for Pensions and No. 106, Employers’ Accounting for Postretirement Benefits Other than Pensions.  The following disclosures related to the pension and postretirement benefits are presented in accordance with Statements of Financial Accounting Standards No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits as revised.

A summary of the components of net periodic pension costs for the consolidated company for the three and nine months ended September 30, 2005 and 2004 is presented below:

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A summary of the components of net postretirement benefits costs for the consolidated company for the three and nine months ended September 30, 2005 and 2004 is presented below:

The expected contributions to be paid during the year ending December 31, 2005 to the domestic defined benefit plan are $0.9 million.  As of September 30, 2005 and 2004, $0.9 million and $3.8 million of contributions have been made to the domestic plan, respectively.  The Company also provides defined benefit pension plans or defined contribution pension plans for its foreign subsidiaries.  The expected contributions to be paid during the year ending December 31, 2005 to the foreign defined benefit plans are $2.0 million.  For each of the Company’s foreign plans, employer and employee contributions are made on a monthly basis and are determined by applicable governmental regulations.  As of September 30, 2005 and 2004, $1.6 million and $1.3 million of contributions have been made to the foreign plans, respectively.

On December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was passed which expands Medicare to include an outpatient prescription drug benefit beginning in 2006.  To encourage employers to retain or provide postretirement drug benefits, beginning in 2006 the federal government will provide non-taxable subsidy payments to employers that sponsor prescription drug benefits to retirees that are “actuarially equivalent” to the Medicare benefit.  In May 2004, the FASB issued Staff Position (FSP) No. FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”, which provides guidance on how companies should account for the impact of the Act on its postretirement health care plans.  Based on guidance available at this time, the plan is not expected to be actuarially equivalent to the Medicare benefit due to the fact that the employer’s premiums are capped at the level paid in 2001.  Based on that assumption, there would be no change in the plans’ accumulated postretirement benefit obligation or annual expense.

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NOTE K—NEW ACCOUNTING STANDARDS

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (SFAS No. 151) Inventory
Costs - An Amendment of ARB No. 43, Chapter 4.  This statement amends ARB No. 43, Chapter 4, Inventory Pricing, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current-period charges.  Additionally, SFAS 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  The Company is required to adopt SFAS 151 effective January 1, 2006.  Hardinge does not expect the adoption of SFAS 151 to have a material impact on the consolidated financial statements of the Company.

In December 2004, the FASB issued FASB Staff Position No. 109-1, (FSP 109-1) “Application of FASB Statement No. 109 (SFAS 109), ‘Accounting for Income Taxes,’ to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004”.  FSP 109-1 provides that the manufacturer’s deduction created in the American Jobs Creation Act of 2004 (the Act) should be accounted for as a special deduction in accordance with SFAS 109 and not as a tax rate reduction.  The Company is currently evaluating the effect that the manufacturer’s deduction will have on future results.

In December 2004, the FASB issued FASB Staff Position No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision Within the American Jobs Creation Act of 2004” (FSP 109-2). The Act introduced a temporary incentive for U.S. multinationals to repatriate earnings accumulated outside the U.S. by providing a one-time tax deduction of 85 percent for certain foreign earnings from controlled foreign corporations. FSP 109-2 provides accounting and disclosure guidance for the repatriation provision. The Company did not elect to apply this provision in 2004 and may elect to apply this provision to qualifying repatriations in 2005. Due to the complexity of the repatriation provision, the Company has not yet completed its evaluation of the impact the Act may have on its decision regarding repatriation of earnings, including a definitive calculation of qualifying dividends and the effect of any repatriation on the Company’s tax provision. The Company expects to complete its evaluation in the fourth quarter of 2005.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which replaces SFAS No. 123, and supercedes APB Opinion No. 25.  SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements at fair value.  On April 14, 2005, the SEC issued a new rule that amends the required effective dates for SFAS 123R.  SFAS 123R will now be effective beginning with the first fiscal year that begins after June 15, 2005.  As a result of the SEC amendment, the Company intends to adopt SFAS 123R in the first quarter of 2006.  The SEC amendment does not change the accounting required under SFAS 123R.

Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost, and the transition method to be used at date of adoption.  The Company is currently evaluating the impact that SFAS 123R will have on Hardinge’s consolidated results of operations and financial condition, which in part will be dependent on the transition and amortization methods used to adopt the new rules in 2006.

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In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143, “(FIN 47) which clarifies the term “conditional asset retirement obligation” used in FASB No. 143 “Accounting for Asset Retirement Obligations” and specifically when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation.  The Company is required to adopt FIN 47 no later than December 31, 2005.  The Company does not expect the adoption of FIN 47 to have a material impact on its consolidated results of operations and financial condition.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (SFAS 154), which replaces APB Opinion No. 20, “Accounting Changes,” (APB 20) and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.”  SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle.  SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.  The Company does not expect the adoption of SFAS 154 will have a material impact on the consolidated financial statements of the Company.

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview.              The following Management’s Discussion and Analysis (“MD&A”) is written to help the reader understand our company.  The MD&A is provided as a supplement to, and should be read in conjunction with, our unaudited condensed financial statements, the accompanying condensed financial notes (“Notes”) appearing elsewhere in this report and our annual report on Form 10-K for the year ended December 31, 2004.

Our primary business is manufacturing high-precision computer controlled metal cutting and grinding machines and related accessories. We are geographically diversified with manufacturing facilities in the U.S., Switzerland, Taiwan, and China and with sales to most industrialized countries. Over 60% of our net sales are to customers outside North America, and approximately half of our employees are located outside of North America.

Our machine products are considered to be capital goods and are part of what has historically been a highly cyclical industry. The U.S. market activity metric most closely watched by our management has been metal-cutting machine orders as reported by the Association of Manufacturing Technology (AMT), the primary industry group for U.S. machine tool manufacturers.  Similar information regarding machine tool consumption in foreign countries is published in various trade journals.

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

Other key performance indicators are geographic distribution of sales and orders, gross margin as percent of sales, income from operations, working capital changes and debt level trends.

Because our U.S. operations have experienced net losses since 2001, we recorded a deferred tax charge in September 2003 and established a valuation allowance offsetting our entire U.S. deferred tax asset in accordance with Statement of Financial Accounting Standards No. 109.  Our management team continues to believe that ultimately these deferred tax assets will be fully utilized as credits against tax expense on future taxable income well before the assets would expire, since our U.S. operations historically averaged $10.0 million annual pretax profit in the years 1990-2000 and the current tax law provides for a lengthy carry-forward period, which for our current deferred tax assets extends until 2021-2023; however the recovery of these tax assets is currently uncertain.

Foreign currency exchange rate changes can besignificant to our reported financial results for several reasons.  Our primary competitors, particularly for the most technologically advanced products are now, largely, manufacturers in Japan, Germany, and Switzerland, which causes the worldwide valuation of the Japanese yen, Euro, and Swiss franc to be central to competitive pricing in all of our markets.  Also, we translate the financial results of our Swiss, Taiwanese, Chinese, English, German and Canadian subsidiaries into U.S. dollars for consolidation and financial reporting purposes.  Period to period changes in the exchange rate between their local currency and the U.S. dollar may significantly affect comparative data.  We also purchase computer controls and other components from suppliers throughout the world, and our purchase costs reflect these foreign currency exchange rate changes.

In the past three years, pension liabilities have represented another significant uncertainty for us. We provide defined benefit pension plans for eligible employees in the U.S., Switzerland, England, and Taiwan.  Declines in interest rates used to calculate the present value of future pension obligations and negative equity market investment returns in the U.S. and UK in 2002 resulted in our recording a deferred pension charge to equity of $3.9 million in 2003 and $5.1 million in 2002.  This deferred pension charge was

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reduced by $2.3 million in 2004 due to improved returns on investments.  These non-cash charges were recorded in “other comprehensive income” in the equity section of the consolidated balance sheets.  The underlying economic causes for these charges reflect a risk of increased future pension expense.  As discussed later, further large pension charges driven by declines in interest rates or lower than assumed investment returns may require us to negotiate changes to our current borrowing arrangements.

In November 2004, we acquired the name, trademarks, copyrights, designs, patents, know-how, and all other intangibles associated with the former Bridgeport Machine Company throughout the world.  We also acquired certain operating assets from the court appointed receiver of the former Bridgeport operations in the U.K. to allow us to carry on Bridgeport’s sales, service and support operations.  The products of Bridgeport, which are sourced from Taiwan, expanded the line of machines available.  Also, the operations in the U.K. were combined with our U.K. subsidiary to provide sales and service support for our complete line of products.

Results of Operations

Summarized selected financial data for the three and nine months ended September 30, 2005 and 2004, respectively: