Overview. Our primary business is designing, manufacturing, and distributing high-precision computer controlled metal-cutting turning, grinding and milling 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. Approximately 69% of our 2008 sales were to customers outside of North America, 70% of our 2008 products were manufactured outside of North America, and 62% of our employees were 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. Our management believes that a key performance indicator is our order level as compared to industry measures of market activity levels.

The global economic recession, which intensified in the fourth quarter of 2008, has impacted the industries in which we conduct business. The reduced availability of credit has impacted our customers' ability to obtain financing. As a result we have experienced order cancellations, a softening of incoming orders, and a reduction of sales primarily beginning in the fourth quarter of 2008. In conjunction with these economic trends, we recorded an impairment charge on our goodwill. We also were not in compliance with a financial covenant under our multi-currency secured credit facility as of December 31, 2008. As a result of all of these conditions, management has implemented cost reduction initiatives throughout the Company to preserve cash flow, including reducing our quarterly dividend. On March 16, 2009, we entered into a new $10.0 million term loan. Refer to Liquidity and Capital Resources for a description of our new financing arrangements. Management believes these actions will provide the required cash flow to enable the Company to meet its financial commitments throughout 2009.

The U.S. market activity metrics most closely watched by our management have been: reporting of metal-cutting machine orders as reported by the Association of Manufacturing Technology (AMT), the primary industry group for U.S. machine tool manufacturers; and machine tool consumption as reported annually by Gardner Publications in the Metalworking Insiders Report. In 2008, industry-wide orders for metal-cutting machine tools reported by the AMT declined 3.1% versus 2007. The 2008 decrease compared to 2007 was primarily related to a sharp decline in world-wide order activity during the fourth quarter brought on by the global economic conditions. Year to date orders as of September 2008, increased 11% compared to the same period in 2007, while the 2008 fourth quarter orders declined 41% compared to the same period in 2007. In 2007 orders increased by 6.9% over 2006. The AMT's statistics are reported on a voluntary basis from member companies. The report includes metal-cutting machines of all types and sizes, including segments where we do not compete.

World machine tool consumption data (domestic production plus imports, less exports) as reported by the Metalworking Insiders Report, an annual report on machine-tool output and consumption, shows an increase in consumption of 12% in 2008 despite worldwide economic conditions. As this report is an annual consumption report it does not fully illustrate the downturn in orders the industry experienced during the fourth quarter of 2008. This report indicates that consumption in China, the world's largest market, increased by 11% in 2008 versus 2007, and 17% in 2007 versus 2006. Consumption in Germany, the world's second largest market increased by 25% in 2008 versus 2007 as measured in local currencies, and 29% in 2007 compared to 2006. In the United Kingdom, machine tool consumption measured in Pound Sterling increased by 16% in 2008 versus 2007, and 6% in 2007 versus 2006. Machine tool consumption in the U.S. increased by 15% in 2008 compared to 2007, recovering from a decline of 3% in 2007 compared to 2006.

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

Another measurement is capacity utilization for manufacturing companies, as reported by the Federal Reserve Board. We are not aware of comparably reliable measures of foreign demand or customer activity.

Non-machine sales which include collets, accessories, repair parts, and service revenue have typically accounted for approximately 25% of overall sales and are an important part of our business, especially in the U.S. where Hardinge has an installed base of thousands of machines. Sales of these products do not vary on a year-to-year basis as significantly as capital goods, but demand does typically track the direction of the related machine metrics.

Other key performance indicators are geographic distribution of net sales and orders, gross profit as a percent of net 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.

Our management believes currency exchange rate changes are significant to reported 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 Yen, Euro, and Swiss Franc to be central to competitive pricing in all of our markets. Also, we translate the results of our Swiss, Taiwanese, Chinese, British, German, Dutch and Canadian subsidiaries into U.S. Dollars for consolidation and reporting purposes. Period to period changes in the exchange rate between their local currency and the U.S. Dollar may affect comparative data significantly. We also purchase computer controls and other components from suppliers throughout the world, with purchase costs reflecting currency changes.

At December 31, 2008, the Company was not in compliance with the minimum EBITDA minus cash taxes and capital expenditures to fixed charge ratio required under our multi-currency secured credit facility. On March 16, 2009, the Company entered into a new agreement with a bank for a 366 day $10.0 million term loan. This term loan replaced a multi-currency secured credit facility which as of March 15, 2009 had an outstanding balance of $8.0 million. Refer to Liquidity and Capital Resources for a description of our new financing arrangements.

On April 25, 2007, the Company completed a public offering of 2,553,000 shares of common stock, including a 330,000 share over-allotment option exercised in full by the underwriters, with net proceeds of approximately $55.9 million after deducting underwriting discounts and commissions, and offering expenses. We used these funds to repay indebtedness under our U.S. overdraft and revolving line of credit facilities. On December 31, 2008 and 2007, we had 11,469,169 and 11,479,916 shares of common stock outstanding, respectively.

2008 Compared to 2007

    The following table summarizes certain financial data for 2008 and 2007:

                                      2008         2007           Change      % Change
                                                  (dollars in thousands)
   Net sales                        $ 345,006    $ 356,322     $    (11,316 )      (3.2 )%
   Gross profit                        92,265      107,411          (15,146 )     (14.1 )%
   Selling, general and
   administrative expenses             97,796       84,520           13,276        15.7 %
   Impairment charges                  24,351            -           24,351
   (Loss) income from operations      (29,882 )     22,891          (52,773 )    (230.5 )%
   Net (loss)income                   (34,305 )     14,926          (49,231 )    (329.8 )%
   Diluted (loss) earnings per
   share                            $   (3.03 )  $    1.41     $      (4.44 )    (314.9 )%
   Weighted average shares
   outstanding (in thousands)          11,309       10,562              747         7.1 %
   Gross profit as % of net sales        26.7 %       30.1 %      (3.4) pts
   Selling, general and
   administrative expenses as %
   of net sales                          28.3 %       23.7 %       4.6  pts
   (Loss) income from operations
   as % of net sales                     (8.7 )%       6.4 %     (15.1) pts
   Net (loss) income as % of net
   sales                                 (9.9 )%       4.2 %     (14.1) pts

Net Sales. Net sales for 2008 were $345.0 million, a $11.3 million or 3% decline compared to 2007 net sales of $356.3 million. Net sales for the year increased in 'Asia and Other' offset by a declines in Europe and North America. On a full year basis, net sales were favorably impacted by approximately $14.5 million in foreign currency translation. Without the currency impact, sales for the year would have declined $25.8 million or 7% compared to 2007. The following table presents 2008 and 2007 sales by region:

          Sales to Customers in:     2008        2007       Change     % Change
                                              (dollars in thousands)
          North America            $ 108,501   $ 121,520   $ (13,019 )       (11 )%
          Europe                     158,947     165,144      (6,197 )        (4 )%
          Asia & Other                77,558      69,658       7,900          11 %

          Total                    $ 345,006   $ 356,322   $ (11,316 )        (3 )%

The decline in net sales for the year was primarily the result of the global economic and financial crisis which began late in the third quarter of 2008. For the year, net sales declined in Milling and Turning Products 7% and 20%, respectively, which was offset by a 19% increase in Grinding Products, with 'Asia and Other' representing the strongest overall market. For 2008, approximately 69% of total net sales were to customers outside of North America.

The geographic mix of sales as a percentage of total net sales is shown in the table below:

                                                              Percentage
                                                                 Point
               Sales to Customers in:      2008      2007       Change
               North America                 31.4 %    34.1 %        (2.7 )
               Europe                        46.1 %    46.4 %        (0.3 )
               Asia & Other                  22.5 %    19.5 %         3.0

                    Total                   100.0 %   100.0 %

Orders. The Company's new orders declined 5% to $341.2 million in 2008 compared to $360.5 million in 2007. On a full year basis, new orders were favorably impacted by approximately $16.7 million in foreign currency translation. Without the currency impact, new orders for the year would have declined $36.1 million or 10% compared to 2007. The following table presents 2008 and 2007 new orders by region:

        Orders from Customers in:       2008        2007       Change     % Change
                                                 (dollars in thousands)
        North America                 $ 103,249   $ 117,532   $ (14,283 )       (12 )%
        Europe                          156,320     170,916     (14,596 )        (9 )%
        Asia & Other                     81,605      72,092       9,513          13 %

              Total                   $ 341,174   $ 360,540   $ (19,366 )        (5 )%

The decline in net orders for the year was driven by reduced levels of business activity and $9.0 million in order cancellations primarily the result of the global economic and financial crisis which began late in the third quarter of 2008.

North American orders were down 12% compared to the prior year. North American orders averaged in excess of $28.0 million per quarter through September 30, 2008 with the fourth quarter declining to $18.1 million, a $9.9 million or 35% decrease. The decline in North American orders can be attributed to the economic and financial crisis.

European orders for the full year decreased $14.6 million or 9% for 2008. European orders averaged over $44.9 million in new orders through September 30, 2008 with the fourth quarter declining to $21.1 million, a $23.8 million or 53% decrease. At $156.3 million, European orders, particularly from Germany, United Kingdom, Switzerland, and Italy, accounted for nearly half of our total order activity during 2008.

'Asia and Other' order activity for the full year increased 13% despite the reduction in fourth quarter activity. New orders averaged over $24.5 million in new orders through September 30, 2008 with the fourth quarter declining to $7.3 million, a $17.2 million or 70% decrease. The growth in 2008 was primarily in China which had new orders in excess of $53.8 million, or 66% of the total region's orders.

Gross Profit. Gross profit was $92.3 million, or 26.7% of net sales in 2008, compared to $107.4 million, or 30.1% of net sales in 2007. The reduction in gross profit can be attributed to $8.8 million in reduced sales volume, a $4.7 million year over year increase in inventory obsolescence reserves (the obsolescence reserve increase is primarily due to the discontinuance of certain product lines during 2008), approximately $3.9 million in reduced margin due to product and channel mix as well as the impact of discounts on discontinued product lines and approximately $3.0 million related to lower capacity utilization in the U.S. and Taiwan. These increases were offset by approximately $4.6 million related to the impact of translating foreign subsidiary financial statements into U.S. Dollars.

Selling, General, and Administrative Expense. Selling, general and administrative ("SG&A") expense for the year 2008 was $97.8 million, or 28.3% of net sales, compared to $84.5 million, or 23.7% of net sales, in 2007. SG&A expense as a percentage of net sales increased over 2007 as a result of $2.3 million related to severance expense in the U.S. and Europe, $1.4 million due to increased sales and marketing efforts, including trade shows, and $1.0 million related to a voluntary early retirement program offered in the U.S. during the fourth quarter of 2008. In addition to the severance, marketing, and early retirement costs, 2008 SG&A expense increased by approximately $3.6 million due to foreign

currency transaction losses which were primarily related to our New Taiwanese Dollar-U.S. Dollar exposure and approximately $3.3 million related to the impact of translating foreign subsidiary financial statements into U.S. Dollars.

Impairment Charge. We recorded non-cash impairment charges of $24.4 million related to goodwill and intangible assets during 2008. $2.7 million of this charge was related to our Canadian operations. During the third quarter, as a result of changes to the Company's planned product strategy and method of delivering support to our Canadian customers, as well as an analysis of historical cash flows, we determined that the goodwill and intangible assets associated with the Canadian operations were impaired and recorded a non-cash charge, to reflect the diminished value of goodwill of $2.1 million and $0.6 million of intangible assets. During the fourth quarter of 2008, we performed our annual impairment testing for recorded goodwill and indefinite lived intangible assets. As a result of the current projected business levels and market cap of the company and industry peers, it was determined that the $21.7 million in goodwill was impaired.

(Loss)/Income from Operations. Loss from operations in 2008 was ($29.9) million compared to income of $22.9 million in 2007. This $52.8 million change was primarily due to: the 2008 goodwill and intangible asset impairment charges of $24.4 million; $7.6 million in impairment charges associated with the discontinuance of certain product lines and other expected inventory usage patterns; $3.2 million related to severance charges associated with our restructuring activities, and a net change of $3.6 million in currency transaction losses, in addition to the dramatic worldwide decline in business in the fourth quarter of 2008.

Gain on Sale of Assets. During 2007, we sold a facility in Exeter, England as part of integrating the Bridgeport operation into the existing business, and recorded a $1.4 million gain as a result of the sale.

Interest Expense & Interest Income. Interest expense includes interest payments under our credit facility and amortization of deferred financing costs associated with our credit facility.

Interest expense for the year 2008 was $1.7 million, a decrease of $1.4 million, or 45% from 2007. The decrease is the result of overall lower interest rates during 2008 as well as lower average borrowings due to the use of our 2007 stock offering proceeds to pay down debt. Interest income was $0.3 million in 2008 compared to $0.2 million in 2007.

Income Tax/Benefit. Income tax expense in 2008 was $3.0 million compared to $6.5 million in 2007. The effective tax rate was 9.8% in 2008 and 30.4% in 2007. The 2008 effective rate was negatively impacted by a significant amount of the goodwill impairment charges, which were non-deductible, resulting in a negative impact of 16.0%. Other changes from 2007 include an increase in our valuation allowance due to not recording a tax benefit on losses in the U.S., U.K., German, and Canadian operations. In addition, we experienced a net increase in 2008 in our liability for uncertain tax benefits due to foreign tax positions and settlements, as well as a change in the mix of profits by country. The income tax expense fundamentally represents tax expense on profits in certain of the Company's foreign subsidiaries.

We continue to maintain a full valuation allowance on the tax benefits of our U.S. net deferred tax assets and we expect to continue to record a full valuation allowance on future tax benefits until an appropriate level of profitability in the U.S. is sustained. We also maintain a valuation allowance on our U.K., German, and Canadian deferred tax assets related to tax loss carryforwards in those jurisdictions, as well as all other deferred tax assets of those entities.

In 2008, the valuation allowance increased by $20.0 million. This was due to an increase of $7.2 million due to not recording a tax benefit on losses in the U.S., Canada, U.K., and Germany, an increase of $10.7 million due to the increase in minimum pension liabilities in the U.S. and the U.K. (and other items also recorded in Other Comprehensive Income), an increase of $2.2 million for state

tax credits, and a decrease of $.1 million due a reduction and a reversal of tax assets in accordance with FIN 48.

As specified in SFAS 109, the Company regularly reviews recent results and projected future results of its operations, as well as other relevant factors, to reconfirm the likelihood that existing deferred tax assets in each tax jurisdiction would be fully recoverable. In the case of the U. S. operations, this recoverability had been based largely on the likelihood of future taxable income.

Net (Loss) Income. Net loss for 2008 was ($34.3) million or (9.9%) of net sales, compared to $14.9 million net income, or 4.2% of net sales in 2007. Basic and diluted loss per share for 2008 were ($3.03), compared to basic and diluted earnings per share of $1.43 and $1.41 in 2007. Earnings per share are impacted by the increase in average shares outstanding as a result of our stock offering in April 2007.

Results of Operations

2007 Compared to 2006

    The following table summarizes certain financial data for 2007 and 2006:

                                        2007        2006        Change       % Change
                                                   (dollars in thousands)
   Net sales                          $ 356,322   $ 326,621   $    29,701          9.1 %
   Gross profit                         107,411     100,151         7,260          7.2 %
   Selling, general and
   administrative expenses               84,520      77,054         7,466          9.7 %
   Income from operations                22,891      23,097          (206 )        (.9 )%
   Net income                            14,926      13,950           976          7.0 %
   Diluted earnings per share         $    1.41   $    1.58   $     (0.17 )      (10.8 )%
   Weighted average shares
   outstanding (in thousands)            10,562       8,809         1,753         19.9 %
   Gross profit as % of net sales          30.1 %      30.7 %   (0.6) pts
   Selling, general and
   administrative expenses as % of
   sales                                   23.7 %      23.6 %    0.1  pts
   Income from operations as % of
   net sales                                6.4 %       7.1 %   (0.7) pts
   Net income as % of net sales             4.2 %       4.3 %   (0.1) pts

Net Sales. Net sales for 2007 were $356.3 million, a $29.7 million or 9% increase over 2006 sales of $326.6 million. Net sales increased in North America and Europe offset by a decline in Asia, as shown below:

         Sales to Customers in:     2007        2006       Change      % Change
                                              (dollars in thousands)
         North America            $ 121,520   $ 118,157   $   3,363          2.8 %
         Europe                     165,144     127,507      37,637         29.5 %
         Asia & Other                69,658      80,957     (11,299 )      (14.0 )%

         Total                    $ 356,322   $ 326,621   $  29,701          9.1 %

Under U.S. Accounting Standards, income statement items of foreign subsidiaries are translated into U.S. dollars at the average exchange rate during the periods presented. The net of these foreign currency transactions had a favorable impact on sales of $13.1 million. Without the currency impact, sales for the year would have increased $16.6 million or 5% compared to 2006.

For 2007, net sales growth was driven by increases in sales of all products:
Grinding-16%, Milling-7%, Turning-2%, with continental Europe being the strongest market in all product lines. For the year, two-thirds of total net sales were to customers outside of North America.

The geographic mix of sales as a percentage of total net sales is shown in the table below:

                                                              Percentage
                                                                 Point
               Sales to Customers in:      2007      2006       Change
               North America                 34.1 %    36.2 %        (2.1 )
               Europe                        46.4 %    39.0 %         7.4
               Asia & Other                  19.5 %    24.8 %        (5.3 )

                    Total                   100.0 %   100.0 %

Machine sales represented 74.8% of 2007 net sales, as compared to 73.3% of 2006 net sales. Sales of non-machine products and services, primarily repair parts, and accessories, made up the balance.

Orders. The Company's new orders rose 4% to $360.5 million in 2007 compared to $347.8 million in 2006, as shown in the table below:

        Orders from Customers in:       2007        2006       Change     % Change
                                           (dollars in thousands)
        North America                 $ 117,532   $ 124,652   $ (7,120 )       (5.7 )%
        Europe                          170,916     146,924     23,992         16.3 %
        Asia & Other                     72,092      76,265     (4,173 )       (5.5 )%

              Total                   $ 360,540   $ 347,841   $ 12,699          3.7 %

North American orders were down 6% compared to the prior year. This was driven by a weaker economy, and flat machine tool market. The result of these market conditions were further influenced in the short term by the Company's restructuring of its distribution channels which serve North American end users to a more direct sales organization.

European orders for the full year increased $24.0 million or 16% for 2007 and remained strong throughout the year averaging more than $42 million per quarter. The company was particularly strong in its order performance in Germany, Switzerland, and Italy. Approximately $5.6 million of the full year growth in European orders is attributable to foreign currency translation changes. At $170.9 million, European orders accounted for nearly half of the Company's total order activity during 2007.

'Asia and Other' order activity for the full year was down by 5% reflecting the impact of several large orders for automotive and turbine blade grinding applications from 2006 that did not recur in 2007.

Order activity was excellent in the fourth quarter with increases across all of our markets in comparison to the fourth quarter 2006. Our order performance was driven by the strengthening of our global sales network coupled with a series of new product introductions during 2007. We anticipate growth in orders in 2008 will be more difficult with certain economies softening.

Gross Profit. Gross profit was $107.4 million, or 30.1% of net sales in 2007, compared to $100.2 million, or 30.7% of net sales in 2006. The reduction in gross margin for 2007 was the result of a combination of factors: prior period accounting adjustments related to intercompany profits in inventory elimination and accounts payable which were recorded in the fourth quarter of 2007; the rebalancing of production volumes in our U.S. and Taiwan production facilities to address current market demand for certain products; higher price discounting related to plans to reduce our finished machine inventories and accelerate the phase-out of older product lines, and product and channel mix changes. Gross margin would have been approximately 30.6% without the impact of the

Selling, General, and Administrative Expense. Selling, general and administrative ("SG&A") expense for the year 2007 was $84.5 million, or 23.7% of net sales, compared to $77.1 million, or 23.6% of net sales, in 2006. SG&A expense as a percentage of net sales remained essentially flat in 2007 from 2006,reflecting our increased sales volume. The primary drivers for the . . .