OVERVIEW

Sun Hydraulics Corporation is a leading designer and manufacturer of high-performance screw-in hydraulic cartridge valves and manifolds, which control force, speed and motion as integral components in fluid power systems. The Company sells its products globally through wholly owned subsidiaries and independent distributors. Sales outside the United States for the year ended December 27, 2008, were approximately 58% of total net sales.

Approximately two-thirds of product sales are used by the mobile market, which is characterized by applications where the equipment is not fixed in place, the operating environment is often unpredictable, and duty cycles are generally moderate to low. Some examples of the mobile market include equipment used in off-road construction, agriculture, fire and rescue, utilities, oil fields, and mining.

The remaining one-third of sales are used by industrial markets, which are characterized by equipment that is fixed in place, typically in a controlled environment, and which operates at higher pressures and duty cycles. Power units, automation machinery, metal cutting machine tools and plastics machinery are some examples of industrial equipment. The Company sells to both markets with a single product line.

Industry conditions

Demand for the Company's products is dependent on demand for the capital goods into which the products are incorporated. The capital goods industries in general, and the fluid power industry specifically, are subject to economic cycles. According to the National Fluid Power Association (the fluid power industry's trade association in the United States), the United States index of shipments of hydraulic products increased 8% and 1% in 2008 and 2007, respectively. The index of shipments of hydraulic products is down 45% for the three-month period ending June 2009, compared to the same period of the prior year.

The Company's order trend has historically tracked closely to the United States Purchasing Managers Index (PMI). The index decreased to 44.8 in June 2009 compared to 50.2 in June 2008. In July 2009, the index increased to 48.9. When PMI is over 50, it indicates economic expansion; when it is below 50, it indicates contraction in the economy. PMI reached a low point in December 2008, at 32.9. It has since increased in seven consecutive months, up nearly 49% in July 2009 compared to December 2008. The portion of the index that represents production has been above 50, indicating a growth phase, for the last two months.

Results for the second quarter

(Dollars in millions except net income per share)

                                          June 27,     June 28,
                                            2009         2008      Decrease

          Three Months Ended
          Net Sales                      $     21.6   $     51.6        -58 %
          Net Income                     $     -0.5   $      8.9       -106 %
          Net Income (Loss) per share:
          Basic                          $    -0.03   $     0.54       -106 %
          Diluted                        $    -0.03   $     0.54       -106 %

          Six Months Ended
          Net Sales                      $     46.8   $    100.6        -53 %
          Net Income                     $      0.0   $     16.6       -100 %
          Net Income per share:
          Basic                          $     0.00   $     1.00       -100 %
          Fully Diluted                  $     0.00   $     1.00       -100 %

Second quarter results were consistent with the Company's expectations. Despite the 53% drop in sales for the first half of the year, the Company operated at breakeven and generated strong cash flow. The Company's order rates remain stable, leading management to believe they have seen the bottom of the cycle. The Company is continuing to invest for the future while maintaining its workforce readiness in preparation for the upturn.

In June, Sun initiated rolling furloughs for the production workforce and a 3% salary reduction for non-production personnel. The furloughs allow the Company to balance its capacity with current business levels without compromising its ability to respond when demand increases. While management expects to see some cost benefit in the third quarter, keeping its workforce intact is the primary goal. Under the furlough model, it is relatively simple to return to normal work schedules as demand recovers.

Sun's distributors throughout the world continue to bring their inventory levels in line with demand. Sun's North American distributor inventory decreased 18% from the beginning of the year as distributors and customers remain reluctant to add inventory. Expedite orders continued to be strong throughout the second quarter. The expedite activity and decreasing distributor inventory leads management to believe that Sun is getting closer to seeing actual customer demand levels.

The Company's strong financial position and ability to generate cash has allowed it to continue to invest in its facilities and people. In June, the Company purchased land that gives it 27 contiguous acres which includes one of its existing facilities, and installed a new heat treat furnace that enhances capacity and improves the quality of its products. Since the end of the first quarter, more than 100 employees have been engaged in the Manufacturing Fundamentals and Essentials Training program offered by the State of Florida. The program develops employability skills and provides training in production processes, maintenance, quality assurance, and safety.

Management believes the actions it has taken and the Company's strong financial position provides it flexibility to manage the business regardless of future demand. However, management is encouraged by the strong uptick in the Purchasing Managers Index in July and the seven months of upward momentum. The portion representing production has been in a growth phase for the last two months. These external indices coupled with stable internal order rates and decreased distributor inventory, leads management to believe the economy is in the early stages of recovery. When it does, management believes Sun is ideally positioned to respond to customer demand with superior product and service performance, and take advantage of market share gains in the beginning phases of the business cycle.

Outlook

The Company's 2009 third quarter sales are expected to be in the range of $22 to $23 million, a 50% decrease in revenue compared to last year, and earnings are expected to be around breakeven compared to earnings of $0.40 per share in the same period of the prior year.

COMPARISON OF THE THREE MONTHS ENDED JUNE 27, 2009 AND JUNE 28, 2008

Net Sales

Net sales were $21.6 million, a decrease of $30 million, or 58.1%, compared to $51.6 million in 2008. Net sales decreased 54.3% excluding the effect of exchange rates. The decrease in net sales was primarily driven by decreased demand in our end markets, which primarily include capital goods equipment. Price increases in October 2008 accounted for approximately 2% of sales. New product sales (defined as products introduced within the last five years) generally make up 15% of total sales.

North American sales decreased 61.4% or $14.5 million, to $9.2 million, Asian sales decreased 56.2% or $5.4 million, to $4.2 million, and European sales decreased 55.7% or $9.5 million, to $7.5 million.

The U.S. reporting segment had sales of $12.6 million in the second quarter of 2009, down $19.1 million or 60.4%, compared to sales of $31.7 million during the second quarter last year. The decrease was driven by demand in our end markets and the general downturn in the global economy. International sales out of the U.S. were $4.4 million during the second quarter of 2009, down 59.6% or $6.5 million, compared to $10.9 million during the second quarter last year. Significant decreases in sales were noted in almost all geographic regions.

The Korean reporting segment had sales of $2.4 million during the second quarter of 2009, down $3.1 million or 56.4%, compared to sales of $5.5 million during the second quarter last year. Currency effect reduced 2009 second quarter sales by approximately $0.6 million. The remaining decrease was related to a slowdown in sales to four major Korean customers that are in the construction equipment industry.

The German reporting segment had sales of $3.4 million during the second quarter of 2009, down $4.4 million or 56.2%, compared to sales of $7.9 million during the second quarter last year. Currency effect reduced 2009 second quarter sales by approximately $0.5 million. The remaining decrease is primarily related to demand within Germany however, sales were down in almost all geographic markets.

The U.K. reporting segment had sales of $3.2 million during the second quarter of 2009, down $3.3 million or 50.9%, compared to sales of $6.5 million during the second quarter last year. Currency effect reduced 2009 second quarter sales by approximately $0.4 million. The largest reduction of sales was to customers within the U.K. however, sales were down in almost all geographic markets.

Gross Profit

Gross profit decreased $14.8 million or 77.8% to $4.2 million in the second quarter of 2009, compared to $19.1 million in the second quarter last year. Gross profit as a percentage of net sales decreased to 19.6% in the second quarter of 2009, compared to 37.0% in the second quarter last year. The Company experienced a sharp decline in sales during the fourth quarter of 2008, which began the downward trend in gross profit margins. Sales continued to decline in the first and second quarters of 2009, resulting in further reductions in the gross profit margin.

Second quarter gross profit decreases compared to the same period of the prior year, were primarily related to lower sales volume, which contributed $11.1 million of the decrease. The remaining decreases in gross profit were attributed to productivity declines of approximately $1.0 million, and increases in overhead expenses as a percentage of sales of approximately $3.2 million, both of which occurred primarily in the U.S. In periods of sharp declining sales, the Company cannot reduce costs at the same pace. However, the decrease in gross profit was partially offset by lower material costs as a percent of

sales of approximately $0.4 million, the elimination of overtime premiums of approximately $0.4 million, reduced retirement benefits related to the shared distribution of approximately $0.5 million that was included in the prior year results, and a one-time reduction in health benefit costs of approximately $0.4 million. These reductions were all primarily in the U.S.

In June, the Company initiated rolling furloughs for the production workforce and a 3% salary reduction for non-production personnel. While the decision was not cost driven, the Company had approximately $0.1 million of benefit in the second quarter, and expects a benefit of approximately $0.8 million in the third quarter.

Selling, Engineering and Administrative Expenses

Selling, engineering and administrative expenses decreased 16.0%, or $0.9 million, to $4.9 million compared to the same quarter last year. The change is primarily a result of decreases in compensation of $0.4 million, resulting primarily from salary freezes and reductions that began in January, fringe benefit costs of $0.2 million, primarily related to retirement benefits associated with the shared distribution that was included in the prior year results, and travel of $0.1 million.

Operating Income (Loss)

Operating income decreased $13.9 million or 104.8% to a loss of $0.6 million in the second quarter of 2009, compared to income of $13.3 million in the second quarter last year, with operating margins of (2.9%) and 25.8% for the second quarters of 2009 and 2008, respectively. The sharp decline in sales is the primary cause for the operating loss. While all reporting segments were able to reduce fixed costs, as sales fall sharply, the Company cannot decrease costs at the same pace.

The U.S. reporting segment experienced an operating loss of $1.5 million in the second quarter of 2009, compared to operating income of $9.4 million during the second quarter of 2008, a decrease of $10.9 million. The sharp decline in sales volume reduced operating income $5.7 million. Decreases in operating income occurred from productivity declines as a result of keeping its workforce intact, and increased variable and fixed overhead costs as a percent of sales. Decreases in operating income were partially offset by decreases in material costs, fringe benefits, and overtime premiums. The Company continues to monitor and reduce fixed costs where it is deemed appropriate.

The Korean reporting segment contributed $0.1 million to our consolidated operating income during the second quarter of 2009 compared to $0.4 million during the second quarter last year, a decrease of $0.3 million. The reduction in sales volume was responsible for $0.2 million of the decrease in operating income.

The German reporting segment contributed $0.6 million to our consolidated operating income during the second quarter of 2009 compared to $2.3 million during the second quarter last year, a decrease of $1.8 million. Reduction in sales volume resulted in a decrease of $1.3 million to operating income. The remaining decrease was primarily related to material costs due to the strength of the U.S. Dollar against the Euro for material purchases made in U.S. Dollars.

The U.K. reporting segment contributed $0.1 million to our consolidated operating income during the second quarter of 2009 compared to $1.1 million during the second quarter last year, a decrease of $1.0 million. The reduction in sales volume was responsible for $0.5 million of the decrease in operating income. The remaining decrease was primarily related to increases in overhead costs as a percent of sales.

Interest Income, Net

Net interest income was $0.2 million for the quarters ended June 27, 2009, and June 28, 2008. The Company currently has no outstanding debt compared to a minimal amount the prior year. Total average cash and investments for the quarter ended June 27, 2009, was $35.3 million compared to $25.7 million for the quarter ended June 28, 2008. Although average cash increased, interest income remained relatively flat due to lower interest rates compared to the prior year.

Foreign Currency Transaction Loss, Net

Foreign currency transaction loss increased to $0.3 million for the quarter ended June 27, 2009, from $0.1 million for the quarter ended June 28, 2008. The British Pound, Euro and Korean Won all made gains against the U.S. Dollar during the period. The current period loss was due to the revaluation of assets and liabilities held in U.S. Dollars at our U.K. subsidiary.

Miscellaneous (Income)/Expense, Net

There was net miscellaneous expense of $0.1 for the quarter ended June 27, 2009, compared to a minimal expense for the quarter ended June 28, 2008. The net miscellaneous expense is primarily made up of earnings and losses from joint ventures.

Income Taxes

The provision for income taxes for the quarter ended June 27, 2009, was 40.6% of pretax loss compared to 33.2% of pretax income for the quarter ended June 28, 2008. The change was primarily due to the relative levels of income and different tax rates in effect among the countries in which the Company sells its products, particularly from the tax benefit recognized in the U.S.

COMPARISON OF THE SIX MONTHS ENDED JUNE 27, 2009 AND JUNE 28, 2008

Net Sales

Net sales were $46.8 million, a decrease of $53.8 million, or 53.5%, compared to $100.6 million in 2008. Net sales decreased 48.6% excluding the effect of exchange rates. The decrease in net sales was primarily driven by decreased demand in our end markets, which primarily include capital goods equipment. Price increases in October 2008 accounted for approximately 2% of sales. New product sales (defined as products introduced within the last five years) generally make up 15% of total sales.

North American sales decreased 52.7% or $23.6 million, to $21.2 million, Asian sales decreased 60.4% or $11.8 million, to $7.7 million, and European sales decreased 51.0% or $17.3 million, to $16.6 million.

The U.S. reporting segment had sales of $28.2 million in the period ended June 27, 2009, down $31.8 million or 53.0%, compared to sales of $60.0 million during the period ended June 28, 2008. The decrease was driven by demand in our end markets and the general downturn in the global economy. International sales out of the U.S. were $9.1 million during 2009, down 55.3% or $11.2 million, compared to $20.3 million during the prior year. Significant decreases in sales were noted in all geographic regions.

The Korean reporting segment had sales of $4.3 million during the period ended June 27, 2009, down $7.5 million or 63.2%, compared to sales of $11.8 million during period ended June 28, 2008. Currency effect reduced 2009 sales by approximately $1.5 million. The remaining decrease was related to a slowdown in sales to four major Korean customers that are in the construction equipment industry.

The German reporting segment had sales of $7.6 million during the period ended June 27, 2009, down $8.2 million or 51.9%, compared to sales of $15.8 million during the period ended June 28, 2008. Currency effect reduced 2009 sales by approximately $1.2 million. The remaining decrease is primarily related to demand within Germany however, sales were down in all geographic markets.

The U.K. reporting segment had sales of $6.7 million during the period ended June 27, 2009, down $6.2 million or 48.3%, compared to sales of $12.9 million during the period ended June 28, 2008. Currency effect reduced 2009 sales by approximately $1.2 million. The largest reduction of sales was to customers within the U.K. however, sales were down in all geographic markets.

Gross Profit

Gross profit decreased $26.4 million or 72.9% to $9.8 million in the period ended June 27, 2009, compared to $36.2 million in the period ended June 28, 2008. Gross profit as a percentage of net sales decreased to 21.0% in the period ended June 27, 2009, compared to 36.0% in the period ended June 28, 2008. The Company experienced a sharp decline in sales during the fourth quarter of 2008, which resulted in gross profit margins of 24.9%. Sales continued to decline during the first half of 2009, resulting in further reductions in the gross profit margin.

The 2009 gross profit decreases were primarily related to lower sales volume, which contributed $19.3 million of the decrease. The remaining decreases in gross profit were attributed to productivity declines of approximately $2.1 million, and increases in overhead expenses as a percentage of sales of approximately $5.9 million, both of which occurred primarily in the U.S. In periods of sharp declining sales, the Company cannot reduce costs at the same pace. However, the decrease in gross profit was partially offset by lower material costs as a percent of sales of approximately $1.0 million, primarily in the U.S. and U.K. Additionally, the Company eliminated overtime premiums equal to approximately $0.8 million, reduced retirement benefits related to the shared distribution of approximately $1.5 million that was included in the prior year results, and experienced a one-time reduction in health benefit costs of $0.4 million. These reductions were all primarily in the U.S.

In June, the Company initiated rolling furloughs for the production workforce and a 3% salary reduction for non-production personnel. While the decision was not cost driven, the Company had approximately $0.1 million of benefit in the first half of 2009, and expects a benefit of approximately $0.8 million in the third quarter.

Selling, Engineering and Administrative Expenses

Selling, engineering and administrative expenses decreased 17.9%, or $2.1 million, to $9.6 million compared to the same period last year. The change is primarily a result of decreases in compensation of $0.7 million, resulting primarily from salary freezes and reductions that began in January, fringe benefit costs of $0.5 million, primarily related to retirement benefits associated with the shared distribution that was included in the prior year results, and travel of $0.2 million.

Operating Income

Operating income decreased $24.3 million or 99.3% to $0.2 million in the period ended June 27, 2009, compared to $24.4 million in the period ended June 28, 2008, with operating margins of 0.4% and 24.3% for 2009 and 2008, respectively. The sharp decline in sales is the primary cause for the reduction in operating income margins. While all reporting segments were able to reduce fixed costs, as sales fall sharply, the Company cannot decrease costs at the same pace. Therefore, at the current sales levels, it is difficult for all reporting segments to absorb their fixed costs.

The U.S. reporting segment experienced an operating loss of $2.1 million in the period ended June 27, 2009, compared to operating income of $16.6 million during the period ended June 28, 2008, a decrease of $18.7 million. The sharp decline in sales volume reduced operating income $8.8 million. Additional decreases in operating income occurred from productivity declines as a result of keeping its workforce intact, and increased variable and fixed overhead costs as a percent of sales. Decreases in operating income were partially offset by decreases in material costs. The Company continues to monitor and reduce fixed costs where it is deemed appropriate.

The Korean reporting segment contributed $0.2 million to our consolidated operating income during the period ended June 27, 2009 compared to $1.1 million during the period ended June 28, 2008, a decrease of $0.9 million. The reduction in sales volume was responsible for $0.7 million of the decrease in operating income.

The German reporting segment contributed $1.3 million to our consolidated operating income during the period ended June 27, 2009 compared to $4.7 million during the period ended June 28, 2008, a decrease

of $3.5 million. Reduction in sales volume resulted in a decrease of $2.5 million to operating income. The remaining decrease was primarily related to material costs due to the strength of the U.S. Dollar against the Euro for material purchases made in U.S. Dollars, and increased fixed overhead costs as a percent of sales.

The U.K. reporting segment contributed $0.6 million to our consolidated operating income during the period ended June 27, 2009 compared to $2.1 million during the period ended June 28, 2008, a decrease of $1.5 million. The reduction in sales volume was responsible for $1.0 million of the decrease in operating income. The remaining decrease was primarily related to increased fixed overhead costs as a percent of sales.

Interest Income, Net

Net interest income was $0.3 million for the periods ended June 27, 2009, and June 28, 2008. The Company currently has no outstanding debt compared to a minimal amount the prior year. Total average cash and investments for the six months ended June 27, 2009, was $34.5 million compared to $23.7 million for the six months ended June 28, 2008. Although average cash increased, interest income remained relatively flat due to lower interest rates compared to the prior year.

Foreign Currency Transaction Loss, Net

Foreign currency transaction loss increased to $0.3 million for the period ended June 27, 2009, from $0.1 million for the period ended June 28, 2008. The British Pound, Euro and Korean Won all made gains against the U.S. Dollar during the second quarter of 2009. The current period loss was due to the revaluation of assets and liabilities held in U.S. Dollars at our U.K. subsidiary in the second quarter.

Miscellaneous (Income)/Expense, Net

There was net miscellaneous expense of $0.3 million for the period ended June 27, 2009, compared to $0.2 million of net miscellaneous income for the period ended June 28, 2008. Net miscellaneous (income)/expense is primarily made up of earnings and losses from joint ventures. The prior year income includes proceeds from an insurance claim.

Income Taxes

The provision for income taxes for the period ended June 27, 2009, was 108.4% of pretax loss compared to 33.1% for the quarter ended June 28, 2008. The change was primarily due to the relative levels of income and different tax rates in effect among the countries in which the Company sells its products, particularly from the tax benefit recognized in the U.S.

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 from time to time 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, repurchase Company common stock and service debt.

Cash from operations for the six months ended June 27, 2009, was $5.5 million, compared to $20.1 million for the six months ended June 28, 2008. The $14.7 million decrease in the Company's net cash flow from operations during the period was due primarily to the decrease in net income of $16.6 million, change in taxes payable/receivable of $3.7 million, and lower cash inflow from accumulation of accounts payable and accrued expenses compared to the prior year. Decreases in accounts receivable and inventory totaling $3.6 million compared to increases in the prior year totaling $6.0 million partially offset the reduction in operating cash flows. Cash on hand decreased $9.2 million from $35.3 million in 2008 to $26.1 million in 2009. However, this decrease was largely the result of net purchases of marketable securities totaling $7.7 million. Days sales outstanding (DSO) were 44 and 39 at June 27, 2009, and June 28, 2008, respectively. Customer payments have not been an issue thus far and the Company does not anticipate collectability issues even in this difficult economic environment. Inventory turns decreased to 8.3 as of June 27, 2009, compared to 10.6 as of June 28, 2008.

Capital expenditures were $3.5 million for the six months ended June 27, 2009, compared to $6.9 million for the six months ended June 28, 2008. The current year includes purchases of machinery and equipment of $1.8 million and a land purchase of $1.7 million. The prior year includes purchases of machinery and equipment of $4.4 million and a land purchase of $2.5 million. The parcels of land along with already owned property that includes one of the Companies existing facilities combine to provide the Company with 27 contiguous acres. It provides the Company with excellent options if it determines that additional bricks and mortar are needed. Capital expenditures for the year are projected to be approximately $7.0 million.

The Company declared a quarterly dividend of $0.09 per share to shareholders of record as of June 30, 2009, payable on July 15, 2009. The declaration and . . .