Table of Contents

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

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 [   ]

     The Registrant had 6,430,594 shares of common stock, par value $.001, outstanding as of August 9, 2002.

Table of Contents

Sun Hydraulics Corporation
INDEX
For the quarter ended June 29, 2002

2

Table of Contents

PART I: FINANCIAL INFORMATION
Item 1.

Sun Hydraulics Corporation
Consolidated Balance Sheets
(in thousands, except share data)

3

Table of Contents

Sun Hydraulics Corporation
Consolidated Statements of Operations
(in thousands, except per share data)

The accompanying Notes to the Consolidated Financial Statements are an integral part of these financial statements.

4

Table of Contents

Sun Hydraulics Corporation
Consolidated Statements of Operations
(in thousands, except per share data)

5

Table of Contents

Sun Hydraulics Corporation
Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income (unaudited)
(in thousands)

The accompanying Notes to the Consolidated Financial Statements are an integral part of these financial statements.

6

Table of Contents

Sun Hydraulics Corporation
Consolidated Statements of Cash Flows
(in thousands)

7

Table of Contents

SUN HYDRAULICS CORPORATION
NOTES TO THE CONSOLIDATED, UNAUDITED FINANCIAL STATEMENTS
(in thousands except per share data)

1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS

     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 generally accepted accounting principles for complete financial statements are not included herein. The financial statements are prepared on a consistent basis (including normal recurring adjustments) and should be read in conjunction with the consolidated financial statements and related notes contained in the Annual Report on Form 10-K for the fiscal year ended December 29, 2001, filed by Sun Hydraulics Corporation (the “Company”) with the Securities and Exchange Commission on March 15, 2002. 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 six month periods ended June 29, 2002, are not necessarily indicative of the results that may be expected for the period ended December 28, 2002.

     Certain amounts shown in the 2001 consolidated financial statements have been reclassified to conform with the 2002 presentation. These reclassifications did not have any effect on total assets, total liabilities, shareholders' equity or net income.

2. NEW ACCOUNTING PRONOUNCEMENTS

     In June 2001, Statement of Financial Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), was issued. SFAS 142 applies to all goodwill and identified intangible assets acquired in a business combination. Under the new standard, all goodwill and indefinite-lived intangible assets, including those acquired before initial application of the standard, will not be amortized but will be tested for impairment at least annually. The new standard is effective for fiscal years beginning after December 15, 2001. The Company’s adoption of FAS 142 effective January 1, 2002, results in the elimination of approximately $60 of annual amortization. The Company completed the initial impairment testing as of January 1, 2002 as required under FAS 142 and no impairment of goodwill was recognized upon adoption of FAS 142 since the fair market value of the underlying asset exceeded its carrying value. The current carrying value of goodwill at June 29, 2002, is $714. There were no additions, impairments, or write offs of goodwill during the three and six months ended June 29, 2002.

     In July 2001, Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143), which requires the recognition of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the carrying amount of the related long-lived asset is correspondingly increased. Over time, the liability is accreted to its present value and the related capitalized charge is depreciated over the useful life of the asset. SFAS 143 is effective for fiscal years beginning after June 15, 2002. Management expects that there will be no impact on the Company’s reported operating results, financial position and existing financial statement disclosure from the adoption of SFAS 143.

     In August 2001, Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), was issued. This statement addresses the financial accounting and reporting for the impairment or disposal of long-lived assets and broadens the definition of what constitutes a discontinued operation and how results of a discontinued operation are to be measured and presented. The provisions of SFAS 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001. At June 29, 2002, there was no impact on the Company’s reported operating results, financial position, and existing financial statement disclosure from the adoption of SFAS 144.

     In June 2002, the Financial Accounting Standards Board (FASB) issued FAS 146, “Accounting for Exit or Disposal Activities.” FAS 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance that the Emerging Issues Task Force (EITF) has set forth in EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other

8

Table of Contents

Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring”. The scope of FAS 146 also includes (1) costs related to terminating a contract that is not a capital lease and (2) termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. FAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002. Early application is encouraged. The Company is in the process of analyzing any potential effect of applying this new standard.

3. BUSINESS

     Sun Hydraulics Corporation and its wholly-owned subsidiaries (the “Company”) 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, and China. Sun Hydraulics Corporation (“Sun Hydraulics”), with its main offices located in Sarasota, Florida, designs, manufactures and sells through independent distributors, primarily in the United States. 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 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.

4. INVENTORY

9

Table of Contents

5. LONG-TERM DEBT

     The Company has three revolving lines of credit agreements totaling $9,666 with various banks. Interest rates on these credit facilities are variable based on the prime rate in the U.S. and the equivalent rate in the U.K. and Germany, respectively. Lines of credit in Germany and the U.K. totaling $2.0 million expire in 2002, while the line of credit in the U.S. expires in 2004. None of these arrangements contain pre-payment penalties. There were no outstanding balances on these credit facilities at June 29, 2002, or December 29, 2001.

     Certain of these debt instruments are subject to debt covenants including 1) consolidated net working capital of not less than $2,000 and a current ratio not less than 1.2:1.0 at all times during the term of the loan, 2) tangible net worth at a minimum of $35,000 for the fiscal year 2001, with tangible net worth increases of at least 50% of net income for the immediately preceding fiscal year, and 3) consolidated debt service coverage ratio throughout the term of the loan at a minimum of 1.25:1.0 on a calendar year basis.

6. REDEEMABLE COMMON STOCK

     On June 22, 2002, the Company entered into a standby Stock Repurchase Agreement with the Koski Family Limited Partnership, which owns approximately 36% of the outstanding shares of the Company’s common stock. Under the Agreement, the Company agreed to purchase up to $2,250 worth of Sun common stock from the Koski Partnership at its request one time during the next two years. The repurchase would be at a per share price of either (i) $7.00 per share, or (ii) 15% less than the average closing price per share of the common stock for the 15 full trading days immediately preceding the closing date, whichever is lower.

     At June 29, 2002, the average closing price of Sun’s common stock for the previous 15 full trading days was $8.06 per share. A 15% discount from this price would result in a repurchase price per share of $6.85. At this price, Sun would repurchase 328 shares from the Koski Partnership for $2,250 in cash, if requested to do so. $2,250 has been transferred from Capital in excess of par into Redeemable common stock.

7. SEGMENT REPORTING

     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, and Korea. In computing operating

10

Table of Contents

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.

     Segment information is as follows:

     Net foreign currency gains (losses) reflected in results of operations were ($14) and ($73), for the quarter ended June 29, 2002, and June 30, 2001, respectively. Operating income (loss) is total sales and other operating income less operating expenses. In computing segment operating income/(loss), interest expense and net miscellaneous income (expense) have not been deducted (added).

     Included in U.S. sales to unaffiliated customers were export sales, principally to Canada and Asia, of $1,963 and $1,424 during the three months ended June 29, 2002, and June 30, 2001, respectively.

11

Table of Contents

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, primarily though independent distributors. Approximately 66% of product sales are used by the mobile market, 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. The remaining 34% of sales are used by industrial markets, which are characterized by equipment that is fixed in place, typically in a controlled environment, with higher pressures and duty cycles. The Company sells to both markets with a single product line.

     Orders for the three months ended June 29, 2002, were $18.2 million. This was a $1.8 million, or 11.1%, increase from the three months ended June 30, 2001, and a $1.5 million, or 9.4%, increase compared to the previous quarter ended March 30, 2002. The 9.4% increase from the previous quarter included a 7.7% increase in domestic orders, and an 11.4% increase in international orders as follows: Korean orders increased 30.1%, German orders increased 5.7% and United Kingdom orders remained the same.

     Historically, the Company’s order trends have tracked to the manufacturing capacity utilization index in the United States. This percentage increased in March 2002 for the first time in approximately two years and continued to increase slowly each month through June.

     The Company’s net sales for the three months ended June 29, 2002, were essentially the same as the three months ended June 30, 2001. Net sales increased $1.8 million or 11.5% compared to the previous quarter ended March 30, 2002.

     Net income for the quarter ended June 29, 2002, was $0.8 million, or 4.4%, of net sales, compared to $0.4 million, or 2.5%, of net sales for the same quarter last year. The increase in net income was primarily a result of improved productivity, and lower marketing and compensation costs in the United States operations. Basic and diluted net income per share for the quarter ended June 29, 2002, were both $0.12, compared to $0.07 for the quarter ended June 30, 2001.

     The Company’s $2.2 million expansion of its plant in the United Kingdom is substantially complete. Internal moves of equipment and furnishings are in process and the project is planned to be complete by the end of August. This investment will double the manufacturing space and improve productivity, and is key to the growth of the Company in Europe.

Outlook

     Order rates in June and July slowed from the order rate increases experienced since the beginning of the year. Based on recent order rates, the third quarter net sales forecast is $16.0 million. The Company predicts this level of sales will result in net income per share for the third quarter ending September 28, 2002, of between $0.06 and $0.08 per share.

     Most key manufacturing economic indicators remain positive and management believes an early fall upturn in customer demand is necessary in order to meet our forecasted earnings per share of $0.40 for the year. Distributor inventories are at historically low levels and Sun has demonstrated the ability to react to increases in customer demand by rapidly turning orders into shipments.

12

Table of Contents

COMPARISON OF THREE MONTHS ENDED JUNE 29, 2002 AND JUNE 30, 2001

     Net sales decreased $0.1 million, or 0.7%, to $17.4 million for the quarter ended June 29, 2002, compared to the quarter ended June 30, 2001. Sales of the Korean operation increased 27.7% and the rest of Asia increased 35.1%. North American sales were flat and European sales decreased 13.4%.

     On slightly lower net sales, gross profit increased $0.3 million to $4.5 million for the quarter ended June 29, 2002, compared to $4.2 million for the quarter ended June 30, 2001. Gross profit as a percentage of net sales increased to 26.0% compared to 24.0% for the second quarter of 2001. The increase in gross profit as a percent of net sales was due to an increase in productivity in the United States operation and lower material costs in Korea and Germany due to strengthening of the euro and the won against the U.S. dollar.

     Selling, engineering and administrative expenses decreased 6.9%, or $0.3 million, to $3.1 million in the quarter ended June 29, 2002, compared to $3.4 million in the quarter ended June 30, 2001. This decrease was due to lower compensation costs, catalogue costs, and professional fees in the United States operations.

     Interest expense was $0.1 million for the quarter ended June 29, 2002 compared with $0.2 million for the quarter ended June 30, 2001. The $0.1 million decrease was due to a decrease in total debt of $1.3 million, coupled with lower interest rates on the two outstanding loans in the United States.

     Other expense was $0.1 million for the quarter ended June 29, 2002, a $0.1 million increase over the same period last year. The increase was due primarily to losses on disposal of assets in the United States and lower interest income in the United Kingdom. Transaction based exchange gains in Germany and Korea were offset by a revaluation of United States dollar denominated accounts on the United Kingdom balance sheet.

     The provision for income taxes for the quarter ended June 29, 2002, was 34.9% of pretax income, compared to 30.8% of pretax income for the quarter ended June 30, 2001. The increase was due to a change in the relative levels of income and different tax rates in effect among the countries in which the Company sells its products.

COMPARISON OF SIX MONTHS ENDED JUNE 29, 2002 AND JUNE 30, 2001

     Net sales decreased $3.5 million, or 9.5%, to $33.0 million for the six months ended June 29, 2002, compared to the six months ended June 30, 2001. Domestic net sales decreased $3.0 million due to the overall decline in the manufacturing sector of the United States economy. Net sales in Europe decreased $1.8 million while Asian sales increased $1.3 million.

     Gross profit decreased $1.3 million to $8.2 million for the six months ended June 29, 2002, compared to $9.5 million for the six months ended June 30, 2001. Gross profit as a percentage of net sales decreased to 24.9% for the six months ended June 29, 2002, compared to 26.2% for the six months ended June 30, 2001. The decrease in gross profit as a percent of net sales was primarily due to the decrease in net sales.

     Selling, engineering and administrative expenses decreased 5.6%, or $0.4 million, to $6.4 million in the six months ended June 29, 2002, compared to $6.8 million in the six months ended June 30, 2001. This decrease was due to lower compensation costs, catalogue costs, and reduced spending on outside contracted labor and professional fees in the United States operations.

     Interest expense was $0.3 million for the six months ended June 29, 2002 compared with $0.5 million for the six months ended June 30, 2001. The $0.2 million decrease was due to a decrease in total debt of $1.3 million, coupled with lower interest rates on the two outstanding loans in the United States.

     Other expense was $0.1 million for the six months ended June 29, 2002, a $0.1 million increase over the same period last year. The increase was due primarily to losses on disposal of assets in the United States

13

Table of Contents

and lower interest income in the United Kingdom. Transaction based exchange gains in Germany and Korea were offset by exchange losses in the United Kingdom operation.

     The provision for income taxes for the six months ended June 29, 2002, was 35.1% of pretax income, compared to 33.7% of pretax income for the six months ended June 30, 2001. The increase was due to a change in the relative levels of income and different tax rates in effect among the countries in which the Company sells its products.

LIQUIDITY AND CAPITAL RESOURCES

     Historically, the Company’s primary source of capital has been cash generated from operations, although fluctuations in working capital requirements have been met through borrowings under revolving lines of credit. The Company’s principal uses of cash have been to pay operating expenses, make capital expenditures, pay dividends to shareholders, and service debt.

     Cash from operations for the six months ended June 29, 2002, was $3.9 million. This compares with $3.8 million for the six months ended June 30, 2001. The $0.1 million increase was due to better utilization of working capital, offset by lower net income. Days sales outstanding (DSO) were 35 at June 29, 2002, which was the same as DSO at June 30, 2001. Inventory turns improved across all business segments to 7.1 at June 29, 2002, up from 6.0 at June 30, 2001.

     Capital expenditures, consisting primarily of purchases of machinery and equipment and the building expansion in the United Kingdom, were $3.4 million for the six months ended June 29, 2002, compared to $1.6 million for the six months ended June 30, 2001. Increased spending is attributed mainly to the building addition in the U.K. Capital expenditures for the year are expected to be $6.0 million, which includes approximately $1.7 million for the building addition in the United Kingdom. Cash from operations for the year is projected to be sufficient to fund all but approximately $0.7 million of working capital needs, capital expenditures, debt service, and dividends.

     On June 22, 2002, the Company entered into a standby Stock Repurchase Agreement with the Koski Family Limited Partnership, which owns approximately 36% of the outstanding shares of the Company’s common stock. Under the Agreement, the Company agreed to purchase up to $2.25 million worth of Sun common stock from the Koski Partnership at its request one time during the next two years. The repurchase would be at a per share price of either (i) $7.00 per share, or (ii) 15% less than the average closing price per share of the common stock for the 15 full trading days immediately preceding the closing date, whichever is lower.

     The repurchase agreement came at the request of Robert Koski, founder, former chairman and present board member of Sun Hydraulics, to help secure a $2.25 million loan from a financial institution to the Koski Partnership. The Koski Partnership has pledged shares of Sun common stock owned by it, as well as its rights under the Agreement, to the bank as collateral for the loan.

     The terms of the Agreement were negotiated and approved by a special committee of the Sun Hydraulics Board of Directors, made up of five independent directors who were not employees of Sun. The special committee determined that it was in Sun’s interest to enter into an agreement to repurchase a portion of the control block of Sun common stock currently held by the Koski Partnership, given that the repurchase would be at a substantial discount, 15%, to the trading price of Sun stock. Sun received a fee for entering into the agreement and the Koski Partnership paid all expenses associated with the special committee’s negotiation and consideration of the agreement.

     The Company believes that cash on hand, cash generated from operations and its borrowing availability under its revolving lines of credit will be sufficient to satisfy the Company’s operating expenses and capital expenditures for the foreseeable future.

     The Company declared a quarterly dividend of $0.04 per share to shareholders of record on June 30, 2002, which was paid on July 15, 2002.

14

Table of Contents

SEASONALITY AND INFLATION

     The Company, historically, has experienced reduced activity during the fourth quarter of the year, largely as a result of fewer working days due to holiday shutdowns. The Company does not believe that inflation had a material effect on its operations for the periods ended June 29, 2002, and June 30, 2001. There can be no assurance, however, that the Company’s business will not be affected by inflation in the future.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Company is exposed to market risk from changes in interest rates on borrowed funds, which could affect its results of operations and financial condition. At June 29, 2002, the Company had approximately $0.1 million in variable-rate debt outstanding and, as such, the market risk is immaterial. The Company manages this risk by selecting debt financing at its lenders’ prime rate less 1%, or the Libor rate plus 2.0%, whichever is more advantageous.

FORWARD-LOOKING INFORMATION

     Certain oral statements made by management from time to time and certain statements contained herein that are not historical facts are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and, because such statements involve risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements, including those in Management’s Discussion and Analysis of Financial Condition and Results of Operations are statements regarding the intent, belief or current expectations, estimates or projections of the Company, its Directors or its Officers about the Company and the industry in which it operates, and assumptions made by management, and include among other items, (i) the Company’s strategies regarding growth, including its intention to develop new products; (ii) the Company’s financing plans; (iii) trends affecting the Company’s financial condition or results of operations; (iv) the Company’s ability to continue to control costs and to meet its liquidity and other financing needs; (v) the declaration and payment of dividends; and (vi) the Company’s ability to respond to changes in customer demand domestically and internationally, including as a result of standardization. Although the Company believes that its expectations are based on reasonable assumptions, it can give no assurance that the anticipated results will occur.

     Important factors that could cause the actual results to differ materially from those in the forward-looking statements include, among other items, (i) the economic cyclicality of the capital goods industry in general and the hydraulic valve and manifold industry in particular, which directly affect customer orders, lead times and sales volume; (ii) conditions in the capital markets, including the interest rate environment and the availability of capital; (iii) changes in the competitive marketplace that could affect the Company’s revenue and/or cost bases, such as increased competition, lack of qualified engineering, marketing, management or other personnel, and increased labor and raw materials costs; (iv) changes in technology or customer requirements, such as standardization of the cavity into which screw-in cartridge valves must fit, which could render the Company’s products or technologies noncompetitive or obsolete; (v) new product introductions, product sales mix and the geographic mix of sales nationally and internationally; and (vi) changes relating to the Company’s international sales, including changes in regulatory requirements or tariffs, trade or currency restrictions, fluctuations in exchange rates, and tax and collection issues. Further information relating to factors that could cause actual results to differ from those anticipated is included but not limited to information under the headings “Business” (including under the subheading “Business Risk Factors”) in the Company’s Form 10-K for the year ended December 29, 2001, and “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” in this Form 10-Q for the quarter ended June 29, 2002. The Company disclaims any intention or obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise.

15

Table of Contents

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

	None.

Item 2. Changes in Securities.

	None.

Item 3. Defaults upon Senior Securities.

	None.

Item 4. Submission of Matters to a Vote of Security Holders.

     The Annual Meeting of Shareholders of the Company was held on May 19, 2002. At the meeting, the following actions were taken by the shareholders:

     Marc Bertoneche was elected as a Director to serve until the Annual Meeting in 2004; and Christine L. Koski, Taco van Tijn, and David N. Wormley were reelected as Directors until the Annual Meeting in the year 2005; until their respective successors are elected and qualified or until their earlier resignation, removal from office or death. The votes cast for and against each were as follows:

     The appointment of PricewaterhouseCoopers, LLP, as the Company’s independent certified public accountants for the year 2002 was ratified and approved. The voting on the proposal was as follows:

Item 5. Other Information.

	None.

Item 6. Exhibits and Reports on Form 8-K

     (a)  Exhibits:

16

Table of Contents

17

Table of Contents

18

Table of Contents

     (b)  Reports on Form 8-K

19

Table of Contents

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Sarasota, State of Florida on August 8, 2002.

20

Table of Contents

EXHIBIT INDEX

21

Table of Contents

22

Table of Contents

23