HELIOS TECHNOLOGIES, INC. - Annual Report: 2016 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL 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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ☐    No  ☒

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

The aggregate market value of the shares of voting common stock held by non-affiliates of the Registrant, computed by reference to the closing sales price of such shares on the Nasdaq Stock Market, LLC, as of the last business day of the Registrant’s most recently completed second fiscal quarter was $686,152,559.

The Registrant had 26,940,399 shares of common stock, par value $.001, outstanding as of February 17, 2017.

PART 1

ITEM 1. BUSINESS

Our Business

Sun Hydraulics Corporation (“Sun,” the “Company,” “we,” “our” or “us”), founded in 1970, in Sarasota, FL, is an industrial technology leader that develops and manufactures solutions for both the hydraulics and electronics markets.  In the hydraulics market, we are a leading manufacturer of high-performance screw-in hydraulic cartridge valves, electro-hydraulics, manifolds, and integrated package solutions for the worldwide industrial and mobile hydraulics markets operating under the brand Sun Hydraulics. In the electronics market, we are a global provider of innovative electronic control, display and instrumentation solutions for both recreational and off-highway vehicles, as well as stationary and power generation equipment; these are offered under the brands of Enovation Controls, Murphy and Zero Off.  Additionally, High Country Tek (“HCT”) is an independent designer and producer of modular, robust, reliable digital and analog electronic controller products for the fluid power industry sold under the brand of HCT.  

Sun has operated in the North American market for over 47 years.  We have expanded our global footprint over the past 30 years to include operations in the UK, Germany and Korea, as well as sales offices in China and India.  Enovation Controls, LLC, (“Enovation Controls”) which was acquired by Sun on December 5, 2016 and is a wholly owned subsidiary of Sun, was formed in 2009 in connection with the reorganization of Murphy Group, Inc. and EControls Group, Inc. which were founded in 1939 and 1994, respectively.  Enovation Controls operates the majority of its manufacturing in Tulsa, OK with sales and engineering capabilities in San Antonio, TX, the UK, China and India.  HCT has been a wholly owned subsidiary of Sun Hydraulics Corporation since 2011 and operates in Nevada City, CA.

Until 2016, Sun operated primarily in the hydraulics market with a small presence in the electronics market through HCT.   On December 5, 2016, Sun purchased two of the four lines of business of Enovation Controls, namely the Power Controls and Vehicle Technologies businesses, retaining the legal entity and related brands.  The remaining non-acquired lines of business will continue to operate as a newly formed company not owned by Sun.  The expansion of Sun’s electronic and digital capabilities through the acquisition of Enovation Controls is a significant step towards achieving our long term strategic vision.  The acquisition further diversifies Sun, granting us access to new, highly specialized markets and customers seeking complete machine control.  Enovation Controls brings a strong talent pool with a proven track record of new product development and technical innovation, complementing our current competencies.  

A primary focus of our strategic thinking is the identification of megatrends, such as globalization, which will impact the future capital and industrial goods markets.  We believe global population growth and urbanization, driven predominantly by Asian mega-cities, will generate ongoing demand for infrastructure projects, resources and food production, all of which require equipment and machinery from our key end markets.  Sophistication of safe machinery and equipment is the second megatrend we recognize.  Today’s machine users demand safety, productivity, efficiency, and even automated control. Advancements in the design of these machines require continuous evolution of critical components such as hydraulic and electronic functionality control.  The final relevant megatrend is computing power.  In this electronic and digital age, what used to be manual or mechanical, is now driven by electrical power.  Information is converted into a form that allows it to be processed, stored and transmitted digitally, saving both time and energy required.  

As a result of these megatrends, we developed our 2025 Vision which is focused on growth and reaching a critical mass of one billion dollars in sales.  There are two significant components to reaching this goal: organic growth and acquisitions.  By 2025, we expect up to half of the one billion dollars in revenue to result from organic growth of our existing products and geographic markets, and the other half to be derived from acquisitions of companies that advance our technology position with adjacent products for the industrial goods sector.  Product innovations are well underway to aid the organic growth and fill the demand resulting from the megatrends.  The acquisition of Enovation Controls is the first important step toward achieving global technology leadership.  All growth initiatives are intended to preserve Sun’s history of superior profitability and financial strength.

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We have been profitable every year since 1972 and Sun has paid a dividend every quarter since going public in January 1997.

The Company’s executive offices are located at 1500 West University Parkway, Sarasota, Florida 34243, and our telephone number is (941) 362-1200. Our websites include www.sunhydraulics.com, www.enovationcontrols.com, www.zerogps.com and www.highcountrytek.com.

Business Segments

Beginning with the fourth quarter of 2016, we are now organized into two operating and reporting segments: Hydraulics and Electronics.  The Hydraulics segment consists of all of the historical Sun Hydraulics companies globally.  Nearly all of the Electronics segment consists of the recently acquired Enovation Controls business. Financial information about our business segments is presented in Note 17 of the Notes to the Consolidated Financial Statements included in this Annual Report.  

Hydraulics

Over the past 47 years, the Hydraulics segment has provided global capital goods industries with hydraulic components and systems used to transmit power and control force, speed and motion. Our products typically add a fine degree of precision and safety to the machinery and equipment in which they are used.

Sun’s hydraulics products are sold globally through a combination of wholly-owned companies, representative sales offices and independent, authorized distributors.  Activities at Sun companies and sales offices include technical support, inventory warehousing, distributor management and custom manifold design and manufacturing. Our global distribution network includes representation in almost all industrialized markets. Distributors are the local experts in our products.  They typically hold local inventory and transact all business with customers.

On a component level, the Hydraulics segment designs and manufactures screw-in hydraulic cartridge valves, manifolds, and integrated fluid power packages and subsystems. Our products provide an important function within a hydraulic system: to control rates and direction of fluid flow and to regulate and control pressures.

Our screw-in hydraulic cartridge valves use a fundamentally different design platform compared to most other competitive product offerings, which are often referred to as industry common products. The floating construction that we pioneered results in a self-alignment characteristic that provides performance and reliability advantages compared to most competitors’ product offerings. This floating construction differentiates our products from those of most of our competitors, who design and manufacture rigid screw-in cartridge valves that fit a common cavity.  Our cartridge valves, offered in five size ranges and including both electrically actuated and non-electrically actuated products, were designed to be able to operate reliably at higher pressures, making them equally suitable for both industrial and mobile applications.  Sun’s product development approach yields a product line of extreme breadth and depth compared to our competitors.  Our broad scope of product offering, coupled with the high performance characteristics of our cartridge valves, makes Sun a leader in our industry.

To fully leverage our cartridge product family, we routinely compete in the manifold and custom integrated package market. A manifold is a solid block of metal, usually aluminum or ductile iron, which is machined to create threaded cavities and channels into which screw-in cartridge valves can be installed and through which the hydraulic fluid flows.  These products allow customers to easily integrate our screw-in cartridge valves into their machinery and equipment. Once designed, standard manifolds require minimal, if any, maintenance engineering over the life of the product and can be manufactured at each of our manufacturing operations. An integrated package consists of multiple cartridge valves assembled into a custom designed manifold for a specific customer to provide the specific operating characteristics of a customer’s circuit.  Because of the unique nature of our cartridge valve designs, manifolds may be designed and machined to make them up to 50% smaller when compared to manifolds that use only industry common cartridge valves.  

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Additionally, we have internally-developed proprietary expert system software that we use to manufacture custom manifolds efficiently in low volumes. Integrated packages provide many benefits to end users and equipment manufacturers, including reduced assembly time, order simplification, reduced leakage points, aesthetics, potentially fewer hose and fitting connections, and more control functions in a single location.

In recent years, we have aggressively expanded our offering of electrically-actuated cartridge valves with design technology developed by HCT.  Our design approach has allowed us to quickly offer a full range of electrically-actuated cartridge valves, helping to increase the competiveness of our integrated package offerings. Because hydraulics systems are increasingly taking signals from on-board electronic control systems, it is necessary for hydraulic products to be capable of digital communication.  

We do not warrant our products for use in any of the following applications, (i) any product that comes under the Federal Highway Safety Act, such as steering or braking systems for passenger-carrying vehicles or on-highway trucks, (ii) aircraft or space vehicles, (iii) ordnance equipment, (iv) life support equipment, and (v) any product that, when sold, would be subject to the rules and regulations of the United States Nuclear Regulatory Commission.

Electronics

Sun, through our HCT brand, designs and manufactures electronic controllers, which manage the function of electrically actuated hydraulic components. HCT’s products range from simple one valve, manually adjusted controllers to fully integrated hydraulic control systems managing multiple hydraulic valves as well as other input and output products such as joysticks and displays. All controllers are potted and therefore impervious to outside influence, making them ideal for mobile, industrial and marine applications.

In 2016 we acquired Enovation Controls to further develop our digital and electronic capabilities in accordance with our strategy.  A portion of the product portfolio offered by Enovation Controls serves end markets also served by our Hydraulics segment such as off-highway vehicles including construction, agricultural and utility vehicles as well as material handling equipment.  However, the majority of Enovation’s products are sold into end markets not historically served by our Hydraulics segment such as marine, power generation and recreational vehicles.  This provides additional diversification of Sun’s customer base.

Globally, electronics products are sold primarily direct to customers, with a small portion sold through independent, authorized distributors.  End markets within the Electronics segment are divided into two lines of business: Power Controls (“PC”) and Vehicle Technologies (“VT”).  PC serves a variety of end markets, some of which are outlined below, with products such as displays, panels, gauges, controllers, battery chargers and various end devices.  VT serves the recreational vehicles end market with products such as electronic controls, displays and instrumentation.

Power Controls

For the off-highway market, Enovation Controls offers rugged and reliable instruments, coupled with expertise in J1939 engine protocol, to produce an industry-leading array of easy-to-read displays and gauges for controller area network (CAN) transmitted engine data and faults. Our PowerView™ system goes a step further with even more focus on the operator interface: larger, full-graphic displays; flexible hardware configurations; multi-language support; class-leading environmental protection; and software tools that deliver the ultimate solution for OEM display customization and CAN control.  Product categories include traditional mechanical and electronic gauge instrumentation, plug and go CAN-based instruments, after-market support through global distribution, complete, custom panel and console offerings, engineering and application specialists, 3D solid modeling, proprietary hardware and software development and wiring harness design and manufacturing.

For the agricultural market, Enovation provides a compact, customizable, all-in-one unit that meets the needs of engine-driven pumping equipment applications. Using dedicated microprocessor-based, single engine controllers, we offer field-adjustable operating parameters that can be changed without the need for a computer. Enovation Controls' controllers are built tough with the ability to withstand a wide ambient temperature range. Some of them come standard in a National Electrical Manufacturers Association (NEMA) 4 rated enclosure secured by four rubber shock mounts.  Enovation Controls' products are a tested solution for pumps and irrigation.

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For the panel solutions market, we offer top-quality design and simple, turnkey solutions. Our Industrial Panel Division offers engineers dedicated to applications, wire harnesses, panels and software development. Engineers focus entirely on custom and standard solutions built to desired specifications.  Our services go beyond design and development including on-site installation and testing with reviews to ensure the solution works with the application out of the box.  

Enovation Controls consistently sets and meets specification standards that are rarely matched by our competitors. Our solutions are designed to work in a variety of harsh environments: wet or dry, hot or cold, dirt or mud. Many of our products offer protection for extreme heat and cold, environmental sealing and water resistance.  In order to ensure durability across a wide range of environmental conditions, we perform extensive testing on each instrument that comes off our assembly lines so they are ready to meet the most demanding applications.

We also offer a full line of products for the commercial marine market as boat builders move towards a more integrated solution approach. We provide instrumentation and control solutions for applications in the commercial marine market from fishing vessels and tugboats to offshore drilling workboats.

Vehicle Technologies

Enovation Controls is a leader in display and control integration solutions for the recreational vehicle markets which include watercraft, all-terrain vehicles, snowmobiles and motorcycles. We offer our customers the ability to customize screens for our PowerView™ line of displays. Our displays offer easy-to-read, bonded LCD graphical views with the industry's best readability even in direct sunlight or harsh water conditions.  In addition, our Zero Off brand provides GPS-based speed control for waterski and wakeboard boats. We offer industry leading integrated solutions by combining high-quality displays with controls and instrumentation.  

Vehicle Technologies group enables Marine and Recreational Vehicle OEM’s to create solutions that outpace automotive and give end users the best of the consumer electronics world, with hardware that can withstand the environmental challenges.  Transforming the vehicles with cutting-edge technology, we connect users and their recreational vehicle more elegantly and seamlessly than the competition, in less man months.  

Custom engineered solutions include processors with enough memory to allow products to stay current, even years after launch, best-in-class sunlight viewability and touch screen technology that is adaptable for specific use, whether it be on the water, in a boat or with gloves on a motorcycle.  Our technology reaches beyond the cockpit and into the users’ environment, by integrating virtually every function into a customized infotainment interface.  This allows the Vehicle Technologies group to target large customers or industries who see value in this level of integration and ruggedness, thus our customer list contains a wide variety of OEM applications. Our unmatched commitment to testing and quality ensures that our components thrive in the rugged environments which provides us with the ability to develop products for use in any outdoor environment.  

The growth of the Vehicle Technology group is driven by developing application expertise in targeted industries by immersing ourselves in the world of our customers to create a truly customized solution in less time than our competitors.  Ongoing revenue is achieved with the current customer base by continued advancements in software and hardware which increases the overall Enovation Controls content, and new customers are evaluated for fit and long term viability before being pursued.    

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Strategy

In November of 2016, we announced our 2025 Vision for Sun.  We believe we can reach sales of $1 billion by 2025 with $500 million achieved organically and $500 million from acquisitions.  We will seek acquisition targets which will bring us advanced technologies in the industrial goods sector.  Targets must contribute to maintaining Sun’s superior profitability and financial strength long-term.  This is imperative to creating lasting shareholder value.  Our current initiatives for organic growth include new product development to expand our electro-hydraulic product offering, penetrating new geographic markets, expanding sales and marketing efforts in existing geographies and developing new channels to market to reach customers not currently in Sun’s purview.

Sun’s strategic roadmap includes product and service differentiation, disciplined and thoughtful leadership throughout our global organization and ensuring that all processes and activities consider the view of the customer.  We have identified and have begun applying several tactics to execute our strategies which include capitalizing on our unique and deeply rooted values, structured human capital development and differentiated engineering for both products and processes.  Internal key performance indicators are used on a daily basis to align our short-term actions with our long-term strategy.

Engineering

Engineers play an important role in all aspects of our business, including design, manufacturing, sales, marketing and technical support. Engineers work within a disciplined set of design parameters that encourage the repeated incorporation of existing parts into new products. Engineers work closely with manufacturing personnel to define the processes required to manufacture products reliably and consistently.

Both of our segments have manufacturing engineers who are responsible for evaluating and changing manufacturing processes as well as implementing lean initiatives throughout global operations.  

Hydraulics

Our Hydraulics segment engineers are comprised of two distinct groups: sustaining and innovation.  The sustaining engineering group focuses on improving existing products, both from a design as well as a manufacturing perspective including optimizing manufacturing costs.  The innovation engineering group is responsible for new product development and evaluating future needs, from a product perspective, of the hydraulics industry.

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Electronics

Our Electronics segment engineers are comprised of four distinct groups: R&D, application, software and sales.  Engineering of new products is often very fast paced and is completed in a collaborative manner with each original equipment manufacturer (“OEM”) based on product release date.  All engineering groups have significant interface with the customer which enables them to understand market demands and identify opportunities for technological advancement, driving market share gains.  

New product development generally starts in the VT line of business, driven by the need for innovative products by VT customers.  Once products are released and in use by VT customers, they become available for sale to PC customers as well.  

Manufacturing

Hydraulics

We utilize a process intensive manufacturing operation that makes extensive use of automated handling and assembly technology (including robotics) where possible to perform repetitive tasks, thus promoting manufacturing efficiencies and workplace safety. We are somewhat vertically integrated and have the capability to manufacture many of the parts that go into our products, although the majority of unfinished parts are purchased from trusted suppliers.  We control most critical finishing processes in-house but rely on a small network of outside manufacturers to machine cartridge parts to varying degrees of completeness. Many high-volume machining operations are performed exclusively at outside suppliers. We are selective in establishing our supplier base and attempts to develop and maintain long-term relationships with suppliers.

At our U.S. manufacturing plants, we have extensive testing facilities that allow us to test fully all cartridge valve products. Smaller testing facilities are also available in our manufacturing plants located in the UK, Germany and Korea.  A metallurgist and complete metallurgical laboratory support our design engineers and in-house heat treatment.

We hold minimal finished goods inventory, typically at our overseas facilities, and rely on our distributors to purchase and maintain sufficient inventory to meet customers’ demands. Most raw materials, including aluminum and steel, are delivered on a just-in-time basis. These and other raw materials are commercially available from multiple sources.

We continually review all of our suppliers to improve the quality of incoming parts and to assess opportunities for better control of both price and quality. Our quality systems at our U.S. facilities are in compliance with ISO 9001:2008 for design, manufacture, and distribution of high performance screw-in hydraulic cartridge valves and manifolds used to control force, speed and motion in fluid power systems. Those in the U.K. are certified to ISO 9001:2008 for the design and manufacture of aluminum and ferrous manifold bodies, hydraulic control valves and cartridge valves.  Quality systems in Germany are certified to ISO 9001:2008 for the design, distribution and manufacturing of hydraulic components for mobile and industrial applications.  Finally, quality systems in Korea are certified to ISO 9001:2008 and 14001:2004 for the design, development, production and servicing of hydraulic valves.

Electronics

We offer a wide range of advanced manufacturing and engineering capabilities, including mechanical and electronic hardware design, software design, product testing, in-house LCD bonding, panel and harness engineering and more.  State-of-the-art manufacturing capabilities include surface mount technology, x-ray inspection and LCD bonding. Multipoint functional testing delivers higher quality products for our customers.  We are a project-based organization, backed by vertically integrated manufacturing capabilities.

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A global integrated operating system, which utilizes intelligent approaches like lean manufacturing and six sigma for maximum productivity, allows us to identify and remove variables in our manufacturing and business processes. By pinpointing areas for improvement, we are able to provide our customers with faster delivery time and higher quality products.  

Our facilities feature focused in-house cells dedicated to specific product production, such as Surface-mount Technology (SMT), Panel, Wire and Sheet Metal.  Testing on a product specific basis is performed in these cells before manufacturing can be completed.  LCD bonding is performed in-house and allows for complete bonding of the LCD to the glass in order to provide long-term durability without yellowing, delamination or degradation.

We hold significant raw materials and finished goods inventory in our Tulsa, OK facility.  Finished goods inventory contains high demand items which require quick delivery.  Raw materials inventory generally has fairly significant lead times, therefore raw material inventory is held in significant quantities to enable us to fulfill orders based on customer request dates which are often less than three weeks.  

Enovation Controls is an ISO9001:2008 certified company.  The business encompasses the design, manufacture and sale of rugged instrumentation, panels, displays, and electronic control solutions for engines and engine-driven equipment serving the commercial, industrial and recreational markets.

Sales and Marketing

Hydraulics

Hydraulic products are sold globally, primarily through independent fluid power distributors. Technical support is provided by experts based at each of our operations (U.S., England, Germany, Korea, India and China).

We currently have 86 distributors, 55 of which are located outside the United States and a majority of which have strong technical backgrounds or capabilities, which enable them to develop practical, efficient, and cost-effective fluid power systems for their customers. In 2016, sales to our largest distributor represented less than 6% of the consolidated net sales of our Hydraulics segment.  We sell approximately 20% of our products directly to OEMs, primarily located outside the US.

In addition to distributors, we sell directly to other companies within the hydraulics industry, including competitors, which incorporate our products into their hydraulic products or systems. We believe that making it easy for other manufacturers to buy our products provides them with a better alternative than developing competing products themselves.  

We provide end users with technical information through Sun’s website and catalogues in multiple languages, including all information necessary to specify and obtain our products. We believe this approach helps stimulate demand for our products.  

Electronics

Electronic products are sold globally, primarily to OEM customers.  Building strong partnerships with OEMs is a priority.  24-hour customer service support and an in-house technical service department is available before, during and after the initial sale to create sustainable partnerships with our customers.  

Our VT line of business sells products to a small group of large OEM’s, whereas the PC line of business sells products to a large number of customers of varying sizes.  Overall, approximately 10% of total VT & PC sales are derived from independent, authorized distributors.

We rely on direct customer contacts to stimulate demand for our products.  We work closely with our customers to design and deliver innovative reliable products for specific applications.  

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Competition

Hydraulics

Competitors in the hydraulics market are broken down into three categories:  full-line hydraulics system producers, cartridge valve only producers, and low cost producers. Most competitors market globally.  Full-line producers have the ability to provide complete hydraulic systems to their customers, including component functionally similar to those manufactured by Sun.  Cartridge valve only producers are like Sun in that they only offer cartridge valves and integrated packages, while additional parts of the hydraulics system are obtained from other manufacturers.  Low cost producers are competitors who have emerged in low cost production areas such as Asia and Eastern Europe. These competitors will typically copy both our products and like products designed by competitors to fit industry common cavities. Low cost producers typically have a limited product range compared to full line or cartridge valve only producers which also limits the opportunities for which they can attack competitors.

We believe that we compete based upon the quality, reliability, price, value, speed of delivery and technological characteristics of our products and services.

Electronics

Competition within the electronics market is very broad with competitors ranging from large multi-national companies with a full electronics offering to small niche companies who specialize in one product type.  Enovation is a niche player in the displays, gauges and instrumentation panel markets.

The market for Power Controls and Vehicle Technologies is relatively fragmented with the top 4-6 companies comprising 70% of the market, mostly servicing the automotive space.  Enovation differentiates itself through product quality, customization ability and service with a focus on low volume niche markets which are not well served by the large competitors.

Our overall position in our key markets is defensible due to high barriers to switching suppliers, such as up front engineering and programming costs, and positive perceptions among core customers on key selection criteria, including quality and service.

Employees

As of December 31, 2016, we had approximately 1,100 full-time employees with 930 in the Americas, 120 in Europe, the Middle East and Africa (“EMEA”) and 50 in Asia Pacific.  No employees are represented by a union in any of our operating units, and we believe that relations with our employees are good.

Patents and Trademarks

In addition to trade secrets, unpatented know-how, and other intellectual property rights, we own a number of patents, trademarks and copyrights relating to certain of our products and businesses.  We believe that the growth of our business is dependent upon the quality and functional performance of our products and our relationship with the marketplace, rather than on any single patent, trademark, copyright, or other item of intellectual property or group of patents, trademarks or copyrights.  

Available Information

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as well as our proxy statements and other materials which are filed with or furnished to the Securities and Exchange Commission (“SEC”) are made available, free of charge, on or through the Sun website under the heading “Investor Relations - SEC Filings,” as soon as reasonably practicable after they are filed with, or furnished to, the SEC.

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ITEM 1A. - RISK FACTORS

FACTORS INFLUENCING FUTURE RESULTS - FORWARD-LOOKING STATEMENTS This Annual Report contains “forward-looking statements” (within the meaning of the Private Securities Litigation Reform Act of 1995) that are based on current expectations, estimates, forecasts, and projections, our beliefs, and assumptions made by us, including (i) our strategies regarding growth, including our intention to develop new products; (ii) our financing plans; (iii) trends affecting our financial condition or results of operations; (iv) our ability to continue to control costs and to meet our liquidity and other financing needs; (v) the declaration and payment of dividends; and (vi) our ability to respond to changes in customer demand domestically and internationally, including as a result of standardization.  In addition, we may make other written or oral statements, which constitute forward-looking statements, from time to time.  Words such as “may,” “expects,” “projects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” variations of such words, and similar expressions are intended to identify such forward-looking statements.  Similarly, statements that describe our future plans, objectives or goals also are forward-looking statements.  These statements are not guarantees of future performance and are subject to a number of risks and uncertainties, including those discussed below and elsewhere in this report.  Our actual results may differ materially from what is expressed or forecasted in such forward-looking statements, and undue reliance should not be placed on such statements.  All forward-looking statements are made as of the date hereof, and we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Factors that could cause actual results to differ materially from what is expressed or forecasted in such forward-looking statements include, but are not limited to: (i) conditions in the capital markets, including the interest rate environment and the availability of capital; (ii) changes in the competitive marketplace that could affect our 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; (iii) new product introductions, product sales mix and the geographic mix of sales nationally and internationally; and the following risk factors:

General global economic trends and industry trends may affect sales.  The capital goods industry in general, and the Hydraulics segment in particular, are subject to economic cycles, which directly affect customer orders, lead times and sales volume. Economic downturns generally have a material adverse effect on our business and results of operations, as they did in 2009. Cyclical economic expansions such as those of 2014, provide a context where demand for capital goods is stimulated, creating increased demand for the products we produce.  In the Electronics segment, our business and widespread adoption of advanced digital control solutions which integrate technologies such as high resolution displays, configurable software GPS navigation telematics, vehicle management systems, and diagnostics to improve engine safety, energy efficiency, performance, and reliability with less dependence on operator skill, is dependent on the general economy, but also favorable industry trends of the many industries our products serve. If one or more of these expected industry trends fails to occur, or occurs at a slower rate than expected, our sales growth will be negatively impacted and our business will be adversely affected. In the future, continued weakening or improvement in the economy will directly affect orders and influence results of operations.

Our business could be harmed by adverse global and regional economic and political conditions. In June 2016, voters in the U.K. approved the exit of that country from the E.U. (“Brexit”), and the British government has indicated that it intends to negotiate the withdrawal of the U.K. from the E.U. based on the results of this vote. The Brexit vote has created significant economic uncertainty in the U.K. and in EMEA, which may negatively impact our business results in those regions. In addition, the terms of the U.K.’s withdrawal from the E.U., once negotiated, could potentially disrupt the markets we serve and the tax jurisdictions in which we operate and adversely change tax benefits or liabilities in these or other jurisdictions, and may cause us to lose customers, suppliers, and employees. In addition, Brexit could lead to legal uncertainty and potentially divergent national laws and regulations as the U.K. determines which E.U. laws to replace or replicate.

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We are subject to intense competition.  

Hydraulics

The hydraulic segment is intensely competitive, and competition comes from a large number of companies, some of which are full-line producers and others that are niche suppliers like us. Full-line producers have the ability to provide total hydraulic systems to customers, including components functionally similar to those manufactured by us. We believe that we compete based upon quality, reliability, price, value, speed of delivery and technological characteristics. Many screw-in cartridge valve competitors are owned by corporations that are significantly larger and have greater financial resources than we have. A new class of competitor has recently emerged in low cost production areas such as Asia and Eastern Europe with look-alike products. We cannot assure that we will continue to be able to compete effectively with these companies.

Most competitors either manufacture manifolds or have sources that they use on a regular basis. In addition, there are many independent manifold suppliers that produce manifolds incorporating various manufacturers’ screw-in cartridge valves, including those made by us. Finally, there are many small, independent machine shops that produce manifolds at very competitive prices. We believe that competition in the manifold and integrated package business is based upon quality, price, performance, proximity to the customer and speed of delivery. Many competitors have very low overhead structures and we cannot assure that we will be able to continue to compete effectively with these companies.

In addition, we compete in the sale of hydraulic valves, manifolds and integrated packages with certain of our customers, who also may be competitors. Generally, these customers purchase cartridge valves from us to meet a specific need in a system that cannot be filled by any valve they make themselves. To the extent that we introduce new products in the future that increase competition with such customers, it may have an adverse effect on our relationships with them.

Electronics

In the Electronics segment, our products face, and will continue to face, significant competition, including from incumbent technologies. New developments in technology may negatively affect the development or sale of some or all of our products or make our products uncompetitive or obsolete. Other companies, many of which have substantially longer operating histories and larger customer bases, name recognition, and financial and marketing resources than we do, are currently engaged in the development of products and technologies that are similar to, or may compete with, certain of our products and technologies.

We sell products into competitive markets. Within our primary markets, we compete with a range of companies that offer certain individual components of our full system solutions. The components of our overall systems most commonly include displays, panels, sensors, valves, and other end-devices. These competitors include, but are not limited to, LOFA, Controls Inc., Medallion, and Faria.

We also face competition from customers developing products internally. Customers for our products generally have substantial technological capabilities and financial resources. Some customers have traditionally used these resources to develop their own products internally. The future prospects for our products are dependent upon our customers’ acceptance of our products as an alternative to their internally developed products. Future sales prospects also are dependent upon acceptance of third-party sourcing for products as an alternative to in-house development. Customers may in the future continue to use internally developed components. They also may decide to develop or acquire products that are similar to, or that may be substituted for, our products. If our customers fail to accept our products as an alternative, if they develop or acquire the technology to develop such products internally rather than purchase our products, or if we are otherwise unable to develop or maintain strong relationships with them, our business, financial condition and results of operations would be materially and adversely affected.

Competitive actions, such as price reductions, consolidation in the industry, improved delivery and other actions, could adversely affect our revenue and earnings. We could experience a material adverse effect to the extent that our competitors are successful in reducing our customers’ purchases of products and services from us. Competition could also cause us to lower our prices, which could reduce our margins and profitability.

11

We are subject to risks relating to international sales. International sales represent a significant proportion of our consolidated sales. In 2016, approximately 59% of our net sales were outside of the United States. We will continue to expand the scope of operations outside the United States, both through direct investment and distribution, and expect that international sales will continue to account for a substantial portion of net sales in future periods.

Our future results could be harmed by a variety of factors, including:

Our international operations and sales also expose us to different local political, regulatory, and business risks and challenges. For example, we are faced with potential difficulties in staffing and managing local operations and we have to design local solutions to manage credit and legal risks of local customers and distributors, which may not be effective. In addition, because some of our international sales are to suppliers that perform work for foreign governments, we are subject to the political risks associated with foreign government projects. For example, certain foreign governments may require suppliers for a project to obtain products solely from local manufacturers or may prohibit the use of products manufactured in certain countries.

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International growth and expansion into markets such as Europe, Asia, and Latin America may cause us difficulty due to greater regulatory barriers than in the United States, the necessity of adapting to new regulatory systems, problems related to entering new markets with different economic, social and political systems and conditions, and significant competition from the primary participants in these markets, some of which may have substantially greater resources and political influence than we do. For example, unstable political conditions or civil unrest could negatively impact our order levels and sales in a region or our ability to collect receivables from customers or operate or execute projects in a region.

Our international operations and transactions also depend upon favorable trade relations between the United States and those foreign countries in which our customers and suppliers have operations. A protectionist trade environment in either the United States or those foreign countries in which we do business or sell products, such as a change in the current tariff structures, export compliance, government subsidies, or other trade policies, may adversely affect our ability to sell our products or do business in foreign markets. Our overall success as a global business depends, in part, upon our ability to succeed in differing economic, social, and political conditions. We may not succeed in developing and implementing policies and strategies to counter the foregoing factors effectively in each location where we do business and the foregoing factors may cause a reduction in our sales, profitability, or cash flows, or cause an increase in our liabilities.

Fluctuations in exchange and interest rates may affect our operating results and impact our financial condition.  Fluctuations in the value of the U.S. dollar may increase or decrease our sales or earnings. Because our consolidated financial results are reported in U.S. dollars, when we generate sales or earnings in other currencies, or we pay expenses in other currencies, the translation of those results into U.S. dollars can result in a significant increase or decrease in the amount of those sales or earnings. If the U.S. dollar strengthens relative to the value of the local currency, we may be less competitive. In addition, our debt service requirements are in U.S. dollars and a portion of our cash flow is generated in British Pounds, Euros or other foreign currencies. Significant changes in the value of the foreign currencies relative to the U.S. dollar could impair our cash flow, results of operations, and financial condition.

In addition, fluctuations in currencies relative to the U.S. dollar may make it more difficult to perform period-to-period comparisons of our reported results of operations. For purposes of accounting, the assets and liabilities of our foreign operations, where the local currency is the functional currency, are translated using period-end exchange rates, and the revenues and expenses of our foreign operations are translated using average exchange rates during each period.

In addition to currency translation risks, we incur currency transaction risk whenever we enter into either a purchase or a sales transaction using a currency other than U.S. dollars. Given the volatility of exchange rates, we may not be able to effectively manage our currency or translation risks. Volatility in currency exchange rates may decrease our sales and profitability and impair our financial condition. Though we periodically evaluate our need to hedge our exposures to foreign currencies, we have not hedged any such exposures to date.

Our existing indebtedness could adversely affect our business and growth prospects.  As of December 31, 2016, we had total indebtedness (including the current portion) of approximately $140 million. Our indebtedness, or any additional indebtedness we may incur, could require us to divert funds identified for other purposes for debt service and impair our liquidity position. If we cannot generate sufficient cash flow from operations to service our debt, we may need to refinance our debt, dispose of assets or issue equity to obtain necessary funds. We do not know whether we will be able to take any of these actions on a timely basis, on terms satisfactory to us or at all.

Our indebtedness, the cash flow needed to satisfy our debt and the covenants contained in our senior credit facility have important consequences, including:

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More specifically, under the terms of our senior credit facility, we have agreed to certain financial covenants. In addition, our senior credit facility places limitations on our ability to make capital expenditures and to acquire other companies. Any failure by us to comply with the financial or other covenants set forth in our senior credit facility in the future, if not cured or waived, could result in our senior lender accelerating the maturity of our indebtedness or preventing us from accessing availability under our senior credit facility. See “Description of Certain Indebtedness.” If the maturity of our indebtedness is accelerated, we may not have sufficient cash resources to satisfy our debt obligations and we may not be able to continue our operations as planned.

We may need additional capital in the future, and it may not be available on acceptable terms, or at all.  We may require additional capital in the future to:

We can give no assurance that additional financing will be available on terms favorable to us, or at all. The terms of available financing may place limits on our financial and operating flexibility. If adequate funds are not available on acceptable terms, we may be forced to reduce our operations or to delay, limit or abandon expansion opportunities. Moreover, even if we are able to continue our operations, the failure to obtain additional financing could reduce our competitiveness. Our senior credit facility limits our ability to incur additional debt and therefore we likely would have to issue additional equity to raise additional capital. If we issue additional equity, your interest in us will be diluted.

We are subject to various risks relating to our growth strategy.  In pursuing our growth strategy and Vision 2025, we intend to expand our presence in existing markets, enter new markets, and pursue acquisitions and joint ventures to complement our business. Many of the expenses arising from expansion efforts may have a negative effect on operating results until such time, if at all, that these expenses are offset by increased revenues. We cannot assure that we will be able to improve our market share or profitability, recover our expenditures, or successfully implement our growth strategy.

The expansion strategy also may require substantial capital investment for the construction of new facilities and their effective operation. We may finance the acquisition of additional assets using cash from operations, bank or institutional borrowings, or through the issuance of debt or equity securities. We cannot assure that we will be able to obtain financing from bank or institutional sources or through the equity or debt markets or that, if available, such financing will be on acceptable terms.

Our culture, by encouraging initiative, and both individual and collaborative responsibility, has substantially contributed to our success and operating results. Because our employees are able to readily shift their job functions to accommodate the demands of the business and changes in the market, we are a nimble, creative and innovative organization.  As we increase the number of our employees and grow into new geographic markets, our culture will likely shift and evolve in new ways. Because our culture promotes the drivers of our success, our inability to protect and align our core values and culture with the evolving needs of the business could adversely affect our continued success.

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We may fail to successfully acquire or integrate companies that provide complementary products or technologies.  We may seek to acquire businesses that complement our existing products and services. Such a strategy involves the potential risks inherent in assessing the value, strengths, weaknesses, contingent or other liabilities, and potential profitability of acquisition candidates and in integrating the operations of acquired companies. In addition, any acquisitions of businesses with foreign operations or sales may increase our exposure to risks inherent in doing business outside the United States. From time to time, we may have acquisition discussions with potential target companies both domestically and internationally. If a large acquisition opportunity arises and we proceed, a substantial portion of our cash and surplus borrowing capacity could be used for the acquisition or we may seek additional debt or equity financing. Any acquisition may or may not occur and, if an acquisition does occur, it may not be successful in enhancing our business for one or more of the following reasons:

Inherent in any future acquisition is the risk of transitioning company cultures and facilities. The failure to efficiently and effectively achieve such transitions could increase our costs and decrease our profitability.

If we are unable to continue our technological innovation and successful introduction of new commercial products, our business will be adversely affected.  The industries we serve in the Electronics segment experience ongoing technological change and product improvement. Manufacturers periodically introduce new generations of products or require new technological capacity to develop customized products or to respond to industry developments or needs. Our future growth will depend on our ability to gauge the direction of the commercial and technological progress in our markets, as well as our ability to acquire new product technologies or to fund and successfully develop, manufacture and market products in this constantly changing environment. We must continue to identify, develop, manufacture and market innovative products on a timely basis to replace existing products in order to maintain our profit margins and competitive position. We may not be successful in acquiring and developing new products or technologies and any of our new products may not be accepted by our customers. If we fail to keep pace with evolving technological innovations in the markets we serve, our business will be adversely affected.  Technology does not advance as quickly in the Hydraulics segment and therefore has a lower threat than electronics relative to continued technological innovation.

Our product development activities may not be successful or may be more costly than currently anticipated, or we may not be able to produce newly developed products at a cost that meets the anticipated product cost structure.  Our business involves a significant level of product development activities, generally in connection with our customers’ development activities. Industry standards, customer expectations, or other products may emerge that could render one or more of our products or services less desirable or obsolete. Maintaining our market position requires continued investment in research and development. During an economic downturn or a subsequent recovery, we may need to maintain our investment in research and development, which may limit our ability to reduce these expenses in proportion to a sales shortfall. In addition, increased investments in research and development may divert resources from other potential investments in our business, such as acquisitions or investments in our facilities, processes and operations. If these activities are not as successful as currently anticipated, are not completed on a timely basis, or are more costly than currently anticipated, or if we are not able to produce newly developed products at a cost that meets the anticipated product cost structure, then our future sales, margins and/or earnings could be lower than expected, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

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If we are unable to protect the confidentiality of our trade secrets, our business and competitive position would be harmed.  In the Electronics segment, we rely significantly on trade secrets, including unpatented software algorithms, know-how, technology, and other proprietary information, to maintain our competitive position. We seek to protect software algorithms through encryption mechanisms in the distribution of our binary files used in programming our engine control products. However, we cannot guarantee that these encryption techniques can protect all or any portion of these binary files. In practice, we seek to protect our trade secrets by entering into non-disclosure and confidentiality agreements with parties who have access to them, such as our employees, corporate collaborators, outside scientific collaborators, contract manufacturers, consultants, advisors and other third parties. In practice, we also enter into confidentiality and noncompetition agreements with certain of our employees and consultants that obligate them to assign to us any inventions developed in the course of their work for us. However, we cannot guarantee that we have executed these agreements with each party that may have or have had access to our trade secrets or that the agreements we have executed will provide adequate protection. Despite these efforts, any of these parties may breach the agreements and disclose our proprietary information, including our trade secrets, and we may not be able to obtain adequate remedies for such breaches. As a result, we may be forced to bring claims against third parties, or defend claims that they bring against us, to determine ownership of what we regard as our intellectual property. Monitoring unauthorized disclosure is difficult and we do not know whether the procedures we have followed to prevent such disclosure are, or will be, adequate. Enforcing a claim that a party illegally disclosed or misappropriated a trade secret is difficult, expensive and time-consuming, and the outcome is unpredictable. In addition, some courts inside and outside the U.S. may be less willing or unwilling to protect trade secrets. If any of our trade secrets were to be disclosed to, or independently developed by, a competitor, our competitive position would be harmed.

The inability to protect our intellectual property and know-how could reduce or eliminate any competitive advantage and reduce our sales and profitability, and the cost of protecting our intellectual property may be significant. In the Electronics segment, we have obtained and applied for some U.S. and foreign trademark and patent registrations and will continue to evaluate the registration of additional trademarks and patents, as appropriate. The key issued patents in our patent portfolio are scheduled to expire between 2025 and 2033. We cannot guarantee that any of our pending patent and trademark applications will be approved. Moreover, even if the applications are approved, third parties may seek to oppose or otherwise challenge them. An inability to obtain registrations in the United States or elsewhere could limit our ability to protect our trademarks and technologies and could impede our business. Further, the protection of our intellectual property rights may require expensive investment in protracted litigation and substantial management time, and there is no assurance we ultimately would prevail or that a successful outcome would lead to an economic benefit that is greater than the investment in the litigation. Recent patent reform legislation could increase the uncertainties and costs surrounding the prosecution of patent applications and the enforcement or defense of our issued patents. On September 16, 2011, the Leahy-Smith America Invents Act, or the Leahy-Smith Act, was signed into law. The Leahy-Smith Act includes a number of significant changes to U.S. patent law. These include provisions that affect the way patent applications are prosecuted and may also affect patent litigation. The USPTO recently developed new regulations and procedures to govern administration of the Leahy-Smith Act, and many of the substantive changes to patent law associated with the Leahy-Smith Act, and in particular, the first to file provisions, only became effective on March 16, 2013. Accordingly, it is not clear what, if any, impact the Leahy-Smith Act will have on the operation of our business. However, the Leahy-Smith Act and its implementation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents, all of which could have a material adverse effect on our business and financial condition.

We may also face difficulties protecting our intellectual property rights in foreign countries. The laws of foreign countries in which our products are sold or manufactured may not protect our intellectual property rights to the same extent as the laws of the U.S. For example, we are increasing our technical capabilities and sales in China, where laws may not afford the same intellectual property protections.

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Our use of open source software may expose us to additional risks.  In the Electronics segment, we use open source software in our business, including in some of our products. While we try to monitor all use of open source software in our business to ensure that no open source software is used in such a way as to require us to disclose the source code to critical or fundamental elements of our software or technology, we cannot be certain that such use may not have inadvertently occurred in deploying our solutions. Furthermore, the terms of many open source licenses have not been interpreted by U.S. courts. As a result, there is a risk that these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our products. The risks associated with usage of open source software cannot be eliminated and could potentially have a material adverse effect on our business, financial condition, and results of operations.

If we are alleged to have infringed upon the intellectual property rights owned by others, our business and results of operations could be materially adversely affected.  In the Electronics segment, competitors or other third parties may allege that we, or consultants or other third parties retained or indemnified by us, infringe on their intellectual property rights. We also may face allegations that our employees have misappropriated intellectual property rights of their former employers or other third parties. From time to time, we receive notices from other companies that allege we may be infringing certain of their patents or other rights. If we are unable to resolve these matters satisfactorily, or to obtain licenses on acceptable terms, we may face litigation. Given the potential risks and uncertainties of intellectual property-related litigation, the assertion of an infringement claim against us may cause us to spend significant amounts to defend the claim (even if we ultimately prevail), pay significant money damages, lose significant revenues, be prohibited from using the relevant technologies or other intellectual property rights, cease offering certain products or services, or incur significant license, royalty, or technology development expenses. Even in instances where we believe that claims and allegations of intellectual property infringement against us are without merit, defending against such claims is time consuming and expensive and could result in the diversion of time and attention of our management and employees. In addition, although in some cases a third party may have agreed to indemnify us for such costs, such indemnifying party may refuse or be unable to uphold its contractual obligations.

We are dependent upon key employees and skilled personnel.  Our success depends, to some extent, upon a number of key individuals. The loss of the services of one or more of these individuals could have a material adverse effect on our business. Future operating results depend to a significant degree upon the continued contribution of key management, technical personnel and the skilled labor force. As the Company continues to expand internationally, additional management and other key personnel will be needed.  Competition for management and engineering personnel is intense and other employers may have greater financial and other resources to attract and retain these employees. We conduct a substantial part of our operations in Sarasota, Florida, and Tulsa, Oklahoma. Continued success is dependent on our ability to attract and retain a skilled labor force at these locations. There are no assurances that we will continue to be successful in attracting and retaining the personnel required to develop, manufacture and market our products and expand our operations.

We are subject to fluctuations in the prices of parts and raw materials, and dependent on our suppliers of these parts.  We are dependent upon suppliers for parts and raw materials used in the manufacture of components that we sell to our customers, and some of our raw material costs are subject to commodity market fluctuations. We may experience an increase in costs for parts or raw materials that we source from our suppliers, or we may experience a shortage of parts or raw materials for various reasons, such as the loss of a significant supplier, high overall demand creating shortages in parts and supplies we use, financial distress, work stoppages, natural disasters, fluctuations in commodity prices, or production difficulties that may affect one or more of our suppliers. In particular, current or future global economic uncertainty may affect our key suppliers in terms of their operating cash flow and access to financing. This may, in turn, affect their ability to perform their obligations to us. In addition, quality and sourcing issues that our suppliers may experience can also adversely affect the quality and effectiveness of our products and services and may result in liability or reputational harm to us. Our customers rely on us to provide on-time delivery and have certain rights if our delivery standards are not maintained. A significant increase in our supply costs, including for raw materials that are subject to commodity price fluctuations, or a protracted interruption of supplies for any reason, could result in the delay of one or more of our customer contracts, or could damage our reputation and relationships with our customers. Any of these events could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

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Some of our products contain magnets that use rare earth metals, and unavailability or limited supply of these metals could delay production of our products or increase our production costs. In the Electronics segment, some of our products contain magnets that use rare earth metals sourced from China. Although such rare earth metals are available from other sources, these alternative sources may be more costly. Reduced availability of such rare earth metals from China through additional export regulations or restrictions, export quotas, tariffs, or for other reasons could impact our ability to obtain magnets that use the required rare earth metals in sufficient quantities, in a timely manner, or at a commercially reasonable cost. In the event that China’s actions cause our suppliers to seek alternate sources of supply for rare earth metals, it could cause a delay in the production of our products that contain magnets using rare earth metals and increase the cost to us of such magnets, thereby reducing or eliminating our profit margin on certain of our products if we are unable to pass the increase in our production costs on to our customers. Increasing prices to our customers due to escalating costs of rare earth metals may reduce demand for our products.

Increased IT security threats and more sophisticated and targeted computer crime could pose a risk to our systems, networks, products, solutions and services.  We are dependent on various information technologies throughout our company to administer, store and support multiple business activities. Increased global IT security threats and more sophisticated and targeted computer crime pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data. While we attempt to mitigate these risks by employing a number of measures, including employee training, comprehensive monitoring of our networks and systems, and maintenance of backup and protective systems, our systems, networks, products, solutions, and services remain potentially vulnerable to advanced persistent threats. Depending on their nature and scope, such threats could potentially lead to the compromising of confidential information, improper use of our systems and networks, manipulation and destruction of data, defective products, production downtimes, and operational disruptions, which in turn could adversely affect our reputation, competitiveness, and results of operations.

Hurricanes could cause a disruption in our operations which could adversely affect our business, results of operations, and financial condition.   A significant portion of our operations are located in Florida, a region that is susceptible to hurricanes. Such weather events can cause disruption to our operations and could have a material adverse effect on our overall results of operations.  While we have property insurance to partially reimburse us for wind losses resulting from a named storm, such insurance would not cover all possible losses.

We are subject to risks relating to changes in our tax rates, unfavorable resolution of tax contingencies, or exposure to additional income tax liabilities. We are subject to income taxes in the United States and various non-U.S. jurisdictions. Domestic and international tax liabilities are subject to the allocation of income among various tax jurisdictions. Our effective tax rate could be affected by changes in the mix among earnings in countries with differing statutory tax rates or changes in tax laws. We are subject to on-going tax audits in various jurisdictions.  If these audits result in assessments different from amounts reserved, future financial results may include unfavorable adjustments to our tax liabilities, which could have a material adverse effect on our results of operations.

We are subject to the cost of environmental compliance and the risk of failing to comply with environmental laws.  Our operations involve the handling and use of substances that are subject to federal, state and local environmental laws and regulations that impose limitations on the discharge of pollutants into the soil, air and water and establish standards for their storage and disposal.  We believe that our current operations are in substantial compliance with applicable environmental laws and regulations, and have not suffered any material adverse effects due to compliance with environmental laws and regulations in the past. However, new laws and regulations, or stricter interpretations of existing laws or regulations, could have a material adverse effect on our business, financial condition and results of operations.

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Our business is subject to a variety of governmental regulations that may restrict our business and may result in costs and penalties.  We are subject to a variety of federal, state, and local laws and regulations relating to foreign business practices, labor and employment, construction, land use, and taxation, among others. These laws and regulations are complex, change frequently and have tended to become more stringent over time. Failure to comply with these laws and regulations may result in a variety of administrative, civil and criminal enforcement measures, including assessment of monetary penalties and the imposition of corrective requirements. From time to time, as part of the regular overall evaluation of our operations, including newly acquired operations, we may be subject to compliance audits by regulatory authorities. In addition, any failure to comply with regulations related to the government procurement process at the federal, state, or local level or restrictions on political activities and lobbying may result in administrative or financial penalties including being barred from providing services to governmental entities.

Our operations expose us to risks of non-compliance with numerous countries’ import and export laws and regulations.  Due to our significant foreign sales, we are subject to trade and import and export regulations in multiple jurisdictions, including the U.S. Treasury Department’s Office of Foreign Assets Control’s regulations. As a result, compliance with multiple trade sanctions and embargoes and import and export laws and regulations pose a constant challenge and risk to us. Furthermore, the laws and regulations concerning import activity, export recordkeeping and reporting, export control and economic sanctions are complex and constantly changing. Any failure to comply with applicable legal and regulatory trading obligations could result in criminal and civil penalties and sanctions, such as fines, imprisonment, debarment from governmental contracts, seizure of shipments, loss of import and export privileges, reputational damage, and a reduction in the value of our common stock.

Regulations related to “conflict minerals” may force us to incur additional expenses and may result in damage to our reputation. We are subject to SEC regulations applicable to companies that use certain minerals and metals, known as conflict minerals, in their products or in the production of their products, whether or not these products are manufactured by third parties. These requirements require us to conduct an inquiry into the country of origin of the conflict minerals used, and if it is determined that the conflict minerals used may have originated in the Democratic Republic of Congo or other covered countries, conduct due diligence on the source and chain of custody of the conflict minerals. These requirements could adversely affect the sourcing, availability and pricing of minerals used in the manufacture of our products. In addition, we incur additional costs to comply with the disclosure requirements, including costs related to determining the source of any of the relevant minerals and metals used in our products or in the manufacturing process. Since our supply chain is complex, we may not be able to sufficiently verify the origins for these minerals and metals used in our products through the due diligence procedures that we implement, which may harm our reputation. In such event, we may also face difficulties in satisfying customers who require that all of the components of our products be conflict mineral free.

Due to the nature of our business and products, we may be liable for damages based on product liability, other tort, and warranty claims.  We face an inherent risk of exposure to claims in the event that the failure, use or misuse of our products results, or is alleged to result, in death, bodily injury, property damage, or economic loss. In the past we have been subject to product liability claims relating to our products, and we may be subject to additional product liability claims in the future for both past and current products.

Although we currently maintain product liability coverage, which we believe to be adequate for the continued operation of our business, such insurance may become difficult or impossible to obtain in the future on terms acceptable to us. Moreover, our insurance coverage includes customary exclusions and conditions, may not cover certain specialized applications, and generally does not cover warranty claims. A successful product liability claim or series of claims against us, including one or more consumer claims purporting to constitute class actions or claims resulting from extraordinary loss events, in excess of or outside our insurance coverage, or a significant warranty claim or series of claims against us, could materially decrease our liquidity, impair our financial condition and adversely affect our results of operations. Furthermore, regardless of the outcome, product liability claims can be expensive to defend, can divert the attention of management and other personnel for significant periods of time, and can cause reputational damage.

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We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws and regulations.  The U.S. Foreign Corrupt Practices Act, or the FCPA, and similar anti-bribery laws and regulations in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to non-U.S. government officials for the purpose of obtaining or retaining business or securing an improper business advantage. Our policies mandate compliance with these anti-bribery laws. We operate in certain countries that have experienced corruption to some degree. If we are found to be liable for FCPA or other similar anti-bribery law or regulatory violations, whether due to our or others’ actions or inadvertence, we could be subject to civil and criminal penalties or other sanctions that could have a material adverse impact on our business, financial condition, results of operations, and cash flows.

We may decide to reduce or eliminate dividends.  Although we have paid a cash dividend each quarter since our common stock began publicly trading in 1997, we cannot assure that funds will be available for this purpose in the future.  The declaration and payment of dividends is subject to the sole discretion of our board of directors and will depend upon our profitability, financial condition, capital needs, acquisition opportunities, future prospects and other factors deemed relevant by the board, and may be restricted by the terms of our credit facilities.

Certain anti-takeover provisions may hinder or prevent a change in control.  Our Articles of Incorporation provide for a classified board of directors.  In addition, the Articles give the board of directors the authority, without further action by the shareholders, to issue and fix the rights and preferences of a new class, or classes, of preferred stock.  These and other provisions of the Articles and our Bylaws may deter or delay changes in control, including transactions in which shareholders might otherwise receive a premium for their shares over then current market prices.  In addition, these provisions may limit the ability of shareholders to approve transactions that they may deem to be in their best interests.

We are subject to control by certain shareholders and management.  Christine L. Koski, the daughter of the deceased founder of the Company, Robert E. Koski, is a member of the board of directors. She, along with other family members, own or control approximately 12% of the outstanding shares of our common stock.  Accordingly, the members of the Koski family have the ability to influence significantly the election of our directors and the outcome of certain corporate actions requiring shareholder approval, and to influence our business.  Such influence could preclude any acquisition of the Company and could adversely affect the price of our common stock.  Our directors and executive officers as a group beneficially own or control approximately 10% of the outstanding shares of our common stock

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2.  PROPERTIES

We own major facilities in the United States, United Kingdom, and Germany, as set forth below.

We own a 69,000 square foot facility in Sarasota, Florida, which houses manufacturing, design, marketing and other administrative functions.  The Sarasota facility is well suited for the design, testing and manufacture of the Company’s products.

We own a 77,000 square foot manufacturing facility in Manatee County, Florida.  This facility, constructed in 1997, has a production capacity similar to the Sarasota facility.

In 2013, we opened our third U.S. manufacturing facility.  This facility, in Manatee County, is located adjacent to our existing Manatee County facility.  The facility provides an additional 58,000 square feet of production space and 17,000 square feet of office space, dedicated to the design and manufacturing of our integrated package business.

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The close proximity of the Florida facilities allows us to quickly shift resources, including machinery and people, to effectively meet changing business requirements.

We also own vacant land in Manatee County, Florida, adjacent to our existing facilities for future expansion requirements.  In total, we own 27 acres of contiguous property.

We lease a property consisting of two buildings totaling 174,000 square feet in Tulsa, OK.  One of the buildings is used primarily for manufacturing and distribution while the other is utilized for design and application engineering and corporate functions such as sales, customer service and other administrative functions.

We own a 37,000 square foot facility in Coventry, England.  This operation, while primarily acting as a distributor, is also involved in manifold design and manufacturing.

We own an 18,000 square foot facility in Salisbury, England.  This location is primarily involved in sales, application engineering, distribution and assembly.

We own a 45,000 square foot distribution and manufacturing facility in Erkelenz, Germany.  This facility is well suited to house equipment used for manufacturing and testing of our products.  Currently, a small portion of the manufacturing area is utilized and the remainder is leased on an annual basis to an outside company.

We lease an 11,500 square foot distribution and manufacturing facility in Incheon, Korea. In 2015, we sold our 10,000 square foot distribution and manufacturing facility in Incheon, Korea.

We lease 14,000 square feet of office space in Shanghai, China. The operations of this location are primarily related to sales and administrative activities.

We lease approximately 650 square feet of office space in Pune, India. The operations of this location are primarily related to sales and administrative activities.

We lease approximately 1,000 square feet of office space in Bangalore, India. The operations of this location are primarily related to sales and administrative activities.

We believe that our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business as presently conducted.  The extent of utilization of our properties varies from time to time and among its facilities.

ITEM 3.  LEGAL PROCEEDINGS

From time to time we are involved in routine litigation incidental to the conduct of our business.  We do not believe that any pending litigation will have a material adverse effect on our consolidated financial position or results of operations.

ITEM 4.  MINE SAFETY DISCLOSURE

Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY,

RELATED STOCKHOLDER MATTERS AND

ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our Common Stock has been trading publicly under the symbol SNHY on the Nasdaq Global Select Market since our initial public offering on January 9, 1997.  The following table sets forth the high and low closing sale prices of our Common Stock as reported by the Nasdaq Global Select Market and the dividends declared for the periods indicated.

Holders

There were 165 shareholders of record of Common Stock on February 17, 2017.  The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of Common Stock whose shares are held in the names of securities brokers, dealers, and registered clearing agencies.  We believe that there are approximately 12,500 beneficial owners of Common Stock.

Dividends

Quarterly dividends of $0.09 per share were paid on the 15^th day of each month following the date of declaration.

In addition to the regular quarterly dividends, we declared shared distribution cash dividends in 2016 equal to $0.04 per share, and in 2015 equal to $0.09 per share.  The 2016 dividend was paid on March 31, 2016, to shareholders of record on March 15, 2016 and the 2015 dividend was paid on March 31, 2015, to shareholders of record on March 15, 2015.

In February 2017, the Company’s board of directors declared a shared distribution cash dividend of $0.02 per share, payable on March 31, 2017, to shareholders of record as of March 15, 2017.

Our board of directors currently intends to continue to pay a quarterly dividend of $0.09 per share during 2017.  However, the declaration and payment of future dividends is subject to the sole discretion of the board of directors, and any determination as to the payment of future dividends will depend upon our profitability, financial condition, capital needs, acquisition opportunities, future prospects and other factors deemed pertinent by the board of directors.

Equity Compensation Plans

Information called for by Item 5 is provided in Note 13 of our 2016 Audited Financial Statements (Item 8 of this report).

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Issuer Purchases of Equity Securities

We did not repurchase any of our stock during the years ended December 31, 2016 and January 2, 2016.

Five-Year Stock Performance Graph

The following graph compares cumulative total return among Sun, the Russell 2000 Index and the Value Line Machinery Industry Group, from December 31, 2011, to December 31, 2016, assuming $100 invested in each on December 31, 2011.  Total return assumes reinvestment of any dividends for all companies considered within the comparison. The stock price performance shown in the graph is not necessarily indicative of future price performance.

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ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA

The following summary should be read in conjunction with the consolidated financial statements and related notes contained herein.  See "Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 1.  Business."

We report on a fiscal year that ends on the Saturday closest to December 31st.  Each quarter generally consists of thirteen weeks. The 2015 fiscal year ended January 2, 2016, as a result the quarter ended January 2, 2016 consisted of fourteen weeks, resulting in a 53-week year. The 2016 fiscal year ended December 31, 2016.

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ITEM 7. MANAGEMENT'S DISCCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. The words "expects," "anticipates," "believes," "intends," "plans" and similar expressions identify forward-looking statements. In addition, any statements which refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We undertake no obligation to publicly disclose any revisions to these forward-looking statements to reflect events or circumstances occurring subsequent to filing this Form 10-K with the Securities and Exchange Commission. These forward-looking statements are subject to risks and uncertainties, including, without limitation, those discussed in this section and in Item 1A, "Risk Factors." In addition, new risks emerge from time to time and it is not possible for management to predict all such risk factors or to assess the impact of such risk factors on our business. Accordingly, our future results may differ materially from historical results or from those discussed or implied by these forward-looking statements. Given these risks and uncertainties, the reader should not place undue reliance on these forward-looking statements.

OVERVIEW

We are an industrial technology leader that develops and manufactures solutions for both the hydraulics and electronics markets, each of which serve as reportable segments.  The Hydraulics segment, which consists of the historical Sun Hydraulics companies, 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 Electronics segment, which consists primarily of Enovation Controls, is a global provider of innovative electronic control, display and instrumentation solutions for both recreational and off-highway vehicles, as well as stationary and power generation equipment.  

Enovation Controls was acquired on December 5, 2016.  Due to the acquisition occurring late in the year in 2016, our consolidated operating results for the year ended December 31, 2016 have been minimally impacted, 2.1% of net sales and an 8.4% impact on net income.  

We sell our products globally through wholly owned subsidiaries and independent distributors.  Sales outside the United States for the year ended December 31, 2016, were approximately 59% of total net sales.

Vision 2025

In 2016 we introduced our vision of the company for the next decade.  We believe it is important to reach a critical mass of $1 billion in sales by 2025 while remaining a technology leader in the industrial goods sector.  To achieve our target, we anticipate organic sales will reach up to $500 million and acquisitions will add another $500 million in revenue.  Through this growth, our decision making process must consider our desire to maintaining superior profitability and financial strength.

The acquisition of Enovation Controls was the first step to realizing our vision.  Enovation Controls improves and expands our technology offering, allows us to market integrated solutions of electronics and hydraulics, and, most importantly, advances our electrification and digitization initiatives across our product portfolio.  The acquisition brings Sun new end markets, diversification of our technology platform, and provides entry into highly sophisticated, specialized markets.  Enovation Controls provides us with a large team of over 100 electronic and software engineers with a track record of new product development and technical innovation. In addition, the sales team has grown strong customer relationships from which market insight can be drawn.  

Product development is a key factor to organic growth in both the hydraulic and electronic segments, as well as joint development between the two segments.  In the Hydraulics segment, our most recent new product introductions have been electrically actuated valves.  We expect this trend to continue as capital goods markets move toward further electrification and digitalization of machines.  Product development in the Electronics segment is generally completed in conjunction with the customer, specifically in the VT line of business.  The technology is then transferred to PC products after implementation in VT.

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Mergers and acquisitions of companies that advance our technology capabilities will be critical to achieving our 2025 Vision.  Cultivating target lists and relationships with potential M&A targets can often be a lengthy process, but we believe it is key to creating successful acquisitions with sustainable business results.  We have an established list of potential targets at any given time and entertain reviewing other opportunities for acquisition as they become known to us.

Management utilizes financial and operational results by segment and at the consolidated level for decision making purposes as well as evaluation.  Within each segment, global leaders are responsible for the coordination of their functional area as well as cross-functional initiatives.   Small teams have been identified to work across both segments in areas of product management, sales, operations and finance.  Key performance indicators are utilized by each global functional area, segment and at the consolidated level.

Industry Conditions

Demand for our products is dependent on demand for the industrial goods markets into which the products are incorporated.  The capital goods industries in general, and the hydraulics and electronics segments 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 decreased 9% in 2016, after decreasing 16% in 2015 and increasing 6% in 2014. The Institute of Printed Circuits Association reports that North American electronics business indicators are strengthening but still mixed.  Electronics manufacturing services (EMS) and semiconductor industries saw solid growth in December, while printed circuit board (PCB) sales remain negative but are improving.  Other industry reports are forecasting single digit growth in 2017 in the EMS, PCB, display and semiconductor markets.

We utilize industry trend reports from various sources, as well as feedback from customers and distributors, to evaluate economic trends.  We also rely on global government statistics such as Gross Domestic Product and Purchasing Managers Index to understand higher level economic conditions.

Results for the 2016 and 2015 fiscal years

Fourth quarter sales were in line with our expectation, with $45.8 million attributable to the Sun Hydraulics Group and HCT and an additional $4.1 million from Enovation Controls. Total fourth quarter sales were up 13% from the fourth quarter of 2015, primarily due to the acquisition of Enovation Controls.

2016 sales fell slightly over 2015 which was primarily attributable to decreased demand in the Hydraulics segment in the US and EMEA markets of 7% and 5%, respectively. We continue to grow our footprint in the Asia/Pacific region with sales increasing 4% over 2015. M&A efforts, including the acquisition of Enovation Controls in December 2016, CEO transition costs, currency exchange and increased sales and marketing initiatives led to a reduction in profitability during the year.

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During 2016 we succeeded in our initial efforts towards our 2025 Vision by investing in strong talent, implementing several new initiatives to drive future profitability, such as lean manufacturing and sales and marketing and we completed the acquisition of Enovation Controls, a valuable addition to our team.  

Recognizing both Sun’s performance in a difficult year and the importance of our employees and shareholders, the Board has again declared a shared distribution for 2016. The 2016 shared distribution totals approximately $1.3 million. It consists of a contribution to employees equal to 2% of wages, most of which will be paid into retirement plans in the form of Sun Hydraulics stock, and a $0.02 per share cash dividend to be paid to all shareholders. The shared distribution is in addition to the normal quarterly dividend and is payable on March 31, 2017, to shareholders of record as of March 15, 2017.

Results of Operations

The following table sets forth, for the periods indicated, certain items in our statements of operations as a percentage of net sales.

Comparison of Years Ended December 31, 2016 and January 2, 2016

Net Sales

Net sales were $196.9 million, a decrease of $3.8 million, compared to $200.7 million in 2015. Demand for our products in 2016 decreased in most major global end markets, which primarily include capital goods equipment. Exchange rates had a negative impact on sales in 2016 of approximately $2.7 million and a negative impact in 2015 of approximately $6.4 million.

Asian/Pacific sales increased 4.1% or $1.7 million, to $43.4 million in 2016, primarily related to increased demand in China. Exchange rates had a $0.5 million negative impact on Asia/Pacific sales in 2016. EMEA sales decreased 4.2% or $2.6 million, to $58.7 million in 2016, primarily related to decreased demand in the United Kingdom, Germany, Finland and Norway. Exchange rates had a negative impact on EMEA sales of approximately $2.2 million in 2016.  Sales to the Americas decreased 3% or $2.9 million, to $94.8 million in 2016, driven by weakened U.S. demand.

Gross Profit

Gross profit decreased $5.8 million or 7.5% to $71.3 million in 2016, compared to $77.1 million in 2015. Gross profit as a percentage of net sales decreased to 36.2% in 2016, compared to 38.4% in 2015.

The decrease in gross profit was primarily attributable to reduced sales volume in the Hydraulics segment negatively impacting gross profit by approximately $3.0 million and increased overhead costs of $2.3 million related to increased compensation and employee benefits.

Selling, Engineering, and Administrative Expenses

Selling, engineering and administrative expenses in 2016 were $36.9 million, a $6.7 million, or 22.2%, increase, compared to $30.2 million in 2015. The change for 2016 was primarily related to transaction costs for the acquisition of Enovation Controls totaling $1.5 million, $3.0 million related to increased professional fees, CEO transition costs and compensation costs and Enovation Controls’ selling, engineering and administrative costs of $2.5 million, which included approximately $1 million of amortization expense on acquired intangible assets.

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Operating Income

Operating income decreased $12.4 million or 26.4% to $34.5 million in 2016, compared to $46.9 million in 2015, with operating margins of 17.5% and 23.4% for 2016 and 2015, respectively.

We derive our operating income based on the consolidated results of our legal entities. We have made the decision to consolidate engineering and manufacturing for the most part in the U.S. Our foreign subsidiaries primarily act as part of our sales and distribution channel. This structure results in different operating margins among the legal entities due to the mix of products, channels to market, and industries present in different geographic regions.

Products manufactured in the U.S. are sold worldwide. Pricing, operations and cost structure are the primary reasons that operating income in the U.S. is higher than foreign subsidiary operating income, which we expect will continue. Our European entities act as value add distributors. These entities sell to end use customers in their respective regions, as well as to third party distributors in certain parts of Europe. Korea, more than any other subsidiary, sells direct to large OEM customers. A significant number of products are sold into both Europe and Asia/Pacific directly from the U.S.  This eliminates foreign currency issues for Sun and gets the product to the customer in the most efficient manner.

Hydraulics Segment

Our U.S. legal entity contributed $32.7 million to our consolidated operating income during 2016 compared to $45.6 million during 2015, a decrease of $12.9 million. The decrease is related to factors discussed above.  Third party export sales from the US were $62.7 million in 2016 compared to $58.2 million in 2015.

Our Korean subsidiary contributed $0.2 million to our consolidated operating income during 2016 compared to an operating loss of $1.1 million during 2015, an increase of $1.3 million. Margins increased from -6.4% in 2015 to approximately 1.1% in 2016. The increase was primarily related to cost reduction efforts.

Our German subsidiary contributed $2.7 million to our consolidated operating income during 2016 compared to a minimal operating loss during 2015, an increase of $2.7 million, relating primarily to decreased material costs. Operating margins were 11.7% and -0.1%, in 2016 and 2015, respectively.

Our U.K. subsidiary contributed $1.1 million to our consolidated operating income during 2016 compared to $2.4 million during 2015, a decrease of $1.3 million, primarily due to lower sales volume and negative impacts of exchange rates. Margins decreased from 13.5% in 2015 to 7.4% in 2016.

Enovation Controls and its U.K. and China subsidiaries experienced a consolidated operating loss of $2.2 million during 2016. Approximately $2 million of this loss is related to amortization of the purchase accounting effects of inventory step-up to fair value and amortization of acquisition-related intangible assets.

Interest Income, Net

Net interest income for 2016 was $0.8 million compared to net interest income of $1.4 million for 2015.  Current year interest expense totaled $0.5 million compared to minimal interest expense in 2015. Total average cash and short-term investments for 2016 was $103.6 million compared to total average cash and short-term investments for 2015 of $113.3 million. Interest derived from investments in corporate and municipal bonds, mutual funds, certificates of deposit, and money market funds decreased approximately $0.1 million in 2016.  Acquisition activity was the driver for the increase in interest expense and decrease in cash and short-term investments over 2016.  

Foreign Currency Transaction (Gain) Loss, Net

Net foreign currency transaction gain was $0.4 million in 2016 compared to a gain of $1.1 million in 2015. The current year gain was primarily derived from a strengthening U.S. Dollar against the Pound. The decrease in the 2016 gain compared to 2015 is due to fewer assets held in U.S. Dollars at our German subsidiary.

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Miscellaneous (Income) Expense, Net

Net miscellaneous expense was $0.7 million in 2016 compared to net miscellaneous expense of $0.2 million in 2015. The current year expense was primarily related to net losses on short term investments of $0.4 million. The prior year amount included a gain on the sale of our Korean facility of approximately $1.3 million, partially offset by impairment of marketable securities of $0.8 million.

Income Taxes

The provision for income taxes for the year ended December 31, 2016, was 33.2% of pretax income compared to a provision of 32.7% for the year ended January 2, 2016. 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. The provisions were affected by discrete items related to a reserve for uncertain tax positions from previous years. Excluding these discrete items, the effective rate would have been approximately 34.0% and 32.3% for the years ended December 31, 2016, and January 2, 2016, respectively.

Comparison of Years Ended January 2, 2016 and December 27, 2014

Net Sales

Net sales were $200.7 million, a decrease of $26.9 million, compared to $227.7 million in 2014. Demand for our products in 2015 decreased in all major global end markets, which primarily include capital goods equipment. A price increase, effective December 1, 2014, contributed approximately 2.6% to sales. Exchange rates had a negative impact on sales in 2015 of approximately $6.4 million and a positive impact in 2014 of approximately $1.6 million. New product sales (defined as products introduced within the last five years) continue to make up 10%-12% of total sales.

Asian/Pacific sales decreased 9.3% or $4.3 million, to $41.7 million in 2015, primarily related to demand from Korea. Exchange rates had a $1.2 million negative impact on Asia/Pacific sales in 2015. EMEA sales decreased 11.5% or $7.9 million, to $61.3 million in 2015, primarily related to demand in Germany and the United Kingdom. Significant decreases were also noted in Finland, Norway, and Ireland. Additionally, currency had a $5.1 million negative impact to EMEA sales in 2015.  Sales to the Americas decreased 13.1% or $14.8 million, to $97.8 million in 2015, driven by weakened U.S. demand.

Gross Profit

Gross profit decreased $16.8 million or 17.9% to $77.1 million in 2015, compared to $93.9 million in 2014. Gross profit as a percentage of net sales decreased to 38.4% in 2015, compared to 41.2% in 2014.

The decrease in gross profit was primarily attributable to decreased sales volume in the current period of approximately $13.3 million. Pricing added approximately $5.2 million to gross profit.

Selling, Engineering, and Administrative Expenses

Selling, engineering and administrative expenses in 2015 were $30.2 million, a $0.4 million, or 1.3%, increase, compared to $29.8 million in 2014. The change for 2015 was related to increases in outside services of $0.2 million and computer expense of $0.2 million.

Operating Income

Operating income decreased $17.2 million or 26.8% to $46.9 million in 2015, compared to $64.1 million in 2014, with operating margins of 23.4% and 28.1% for 2015 and 2014, respectively.

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We derive our operating income based on the consolidated results of our legal entities. We have made the decision to consolidate engineering and manufacturing for the most part in the U.S. Our foreign subsidiaries primarily act as part of our sales and distribution channel. This structure results in different operating margins among the legal entities due to the mix of products, channels to market, and industries present in different geographic regions.

Products manufactured in the U.S. are sold worldwide. Pricing, operations and cost structure are the primary reasons that operating income in the U.S. is higher than foreign subsidiary operating income, which we expect will continue. Our German and UK entities act as value add distributors. These entities sell to both end use customers in their respective regions, as well as to third party distributors in certain parts of Europe. UK margins have historically been lower than margins in Germany. This is due to the fact that, in the UK, we manufacture iron manifolds for the European market. This results in higher overhead costs primarily related to machinery and equipment, and the employment of nearly twice as many people as in Germany. Margins are lowest in our Korean entity. Korea, more than any other subsidiary, sells direct to large OEM customers where pricing pressure is most pronounced.

The U.S. legal entity contributed $45.6 million to our consolidated operating income during 2015 compared to $52.3 million during 2014, a decrease of $6.7 million. A decline in sales volume contributed to a decrease in operating income of $4.8 million. Third party export sales from the US were $58.2 million in 2015 compared to $60.1 million in 2014.

Our Korean subsidiary experienced an operating loss of $1.1 million during 2015 compared to operating income of $1.2 million during 2014, a decrease of $2.3 million. Margins contracted from 5.6% in 2014 to approximately -6.4% in 2015. The decrease was primarily related to a decrease in sales volume.

Our German subsidiary experienced a minimal operating loss during 2015 compared to contributing $6.6 million to operating income during 2014, a decrease of $6.6 million, relating to a decrease in sales volume. Operating margins were -0.1% and 23.2%, in 2015 and 2014, respectively.

Our U.K. subsidiary contributed $2.4 million to our consolidated operating income during 2015 compared to $3.9 million during 2014, a decrease of $1.5 million, contributed to lower volume. Margins decreased from 19.8% in 2014 to 13.5% in 2015.

Interest Income, Net

Net interest income for 2015 was $1.4 million compared to net interest income of $1.6 million for 2014.  Total average cash and marketable securities for 2015 was $113.3 million compared to total average cash and marketable securities for 2014 of $97.2 million. Interest derived from investments in corporate and municipal bonds, mutual funds, certificates of deposit, and money market funds decreased approximately $0.2 million in 2015.

Foreign Currency Transaction (Gain) Loss, Net

Net foreign currency transaction gain was $1.1 million in 2015 compared to a gain of $0.8 million in 2014. The current year gain was primarily derived from a strengthening U.S. Dollar against the Euro and assets held in U.S. Dollars at our German subsidiary.

Miscellaneous (Income) Expense, Net

Net miscellaneous expense was $0.2 million in 2015 compared to net miscellaneous expense of $0.7 million in 2014. The current year amount included a gain on the sale of our Korean facility of approximately $1.3 million, partially offset by impairment of marketable securities of $0.8 million. The prior year period included losses on the disposal of assets.

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Income Taxes

The provision for income taxes for the year ended January 2, 2016, was 32.7% of pretax income compared to a provision of 33.4% for the year ended December 27, 2014. 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. The provisions were affected by discrete items related to a reserve for uncertain tax positions from previous years. Excluding these discrete items, the effective rate would have been approximately 32.3% and 33.1% for the years ended January 2, 2016, and December 27, 2014, respectively.

Liquidity and Capital Resources

Historically, our primary source of capital has been cash generated from operations, although short-term fluctuations in working capital requirements have been met through borrowings under revolving lines of credit as needed. Our principal uses of cash have been paying operating expenses, paying dividends to shareholders, making capital expenditures, and servicing debt. During 2016, we paid cash of approximately $61 million and assumed debt totaling $140 million related to the acquisition of Enovation Controls.

Net cash flow from operations in 2016 was $38.5 million, compared to $49.9 million in 2015 and $62.8 million in 2014. The $11.4 million decrease in our net cash flow from operations in 2016 was due primarily to decreased net income of $9.8 million. Changes in inventory and accounts receivable decreased cash $4.5 million in the current year compared to an increase in cash of $5.2 million in the prior year. Days sales outstanding increased to 34 days in 2016 compared to 28 days in 2015. Inventory turns decreased to 5.8 in 2016 from 9.2 in 2015. Cash on hand decreased $7.7 million from $81.9 million in 2015 to $74.2 million in 2016. Short-term investments decreased $37.4 million from $44.2 million in 2015 to $6.8 million in 2016. The $12.9 million decrease in our net cash flow from operations in 2015, compared to 2014, was due primarily to decreased net income of $10.6 million.  

Capital expenditures were $6.2 million in 2016, compared to $6.1 million in 2015 and $10.7 million in 2014. In 2014 approximately $3.2 million was for improvements to, and reconfiguring of, our Manatee County facility originally constructed in 1997. Capital expenditures made during 2016 and 2015 were primarily for purchases of machinery and equipment.

Capital expenditures for 2017 are estimated to be between $8 million and $10 million, primarily consisting of purchases of machinery and equipment.

On July 29, 2016 we entered into a new credit agreement (the “Prior Credit Agreement”), with PNC Bank, National Association (the “Bank”), as administrative agent, and the lenders party thereto.

On November 22, 2016, the Company entered into an amended and restated credit agreement (the “2016 Credit Agreement”), with the Bank, as administrative agent, and the lenders party thereto.  The 2016 Credit Agreement amends and restates the Prior Credit Agreement.

The 2016 Credit Agreement provides the Company with a revolving line of credit (the "line of credit”) of up to $300 million that is available through November 22, 2021. The 2016 Credit Agreement includes an accordion feature to increase the line of credit by up to an additional $100 million in the form of additional revolving credit loans or in the form of term loans. Interest is payable quarterly for loans under the Base Rate Option (as defined), and interest is payable on the last day of the applicable Interest Period (as defined) (and, if such Interest Period is longer than three months, interest is also payable on the 90th day of such Interest Period) for loans under the Euro Rate Option (as defined). The loans under the line of credit will bear interest at the Euro Rate (as defined) or the Base Rate (as defined), at the Company’s option, plus the Applicable Margin (as defined) based on the Borrower’s Leverage Ratio (as defined). The Applicable Margin ranges from 1.25% to 2.25% for the Euro Rate and ranges from 0.25% to 1.25% for the Base Rate. Subject to customary breakage fees for loans under the Euro Rate Option that are prepaid on a day other than the last day of the applicable Interest Period, prepayment may be made without penalty or premium at any time upon the required notice to the Bank.

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The 2016 Credit Agreement requires the Company (together with its subsidiaries) to comply with certain financial tests, including a minimum Interest Coverage Ratio (as defined) of 3.0 to 1.0 and a maximum Leverage Ratio (as defined) of 3.75 to 1.0 for the first year and 3.5 to 1.0 thereafter. As of the date of this filing, the Company was in compliance with all debt covenants related to the line of credit.

The 2016 Credit Agreement also requires the Company to comply with a number of restrictive covenants. These covenants limit, in certain circumstances, the Company’s ability to take a variety of actions, including but not limited to: incur indebtedness; create or maintain liens on its property or assets; make investments, loans and advances; repurchase shares of its Common Stock; engage in acquisitions, mergers, joint ventures, consolidations and asset sales; and pay dividends and distributions.

The 2016 Credit Agreement contains customary default provisions and has various non-financial covenants, both requiring the Company to refrain from taking certain future actions (as described above) and requiring the Company to take certain affirmative actions, such as maintaining its corporate existence, paying liabilities timely, maintaining insurance, and providing its bank lending group with financial information on a timely basis. Maturity of the line of credit may be accelerated by the Bank upon an Event of Default (as defined).

The line of credit is guaranteed by our U.S. domestic subsidiaries and requires any future U.S. domestic subsidiaries to join as guarantors.  In addition, the line of credit is required to be secured by substantially all of the assets of the Company and its current and any future U.S. domestic subsidiaries of the Company.  Accordingly, (i) the Company entered into a Security Agreement with the Bank, for the benefit of the lenders, granting a security interest in substantially all of their respective assets, (ii) the Company entered into a Pledge Agreement with the Bank, for the benefit of the lenders, granting a security interest in certain equity ownership in certain of its subsidiaries, and (iii) the Company and/or certain of its subsidiaries entered into certain other additional agreements further granting security interests in certain specific assets, including intellectual property rights, in each case to secure amounts borrowed under the 2016 Credit Agreement.

The 2016 Credit Agreement incorporates sub-facilities for swing loans up to $20 million and issuances of letters of credit up to $10 million. Swing loans and letters of credit issued under the 2016 Credit Agreement decrease availability under the $300 million revolving line of credit on a dollar for dollar basis.

At December 31, 2016 the balance on the line of credit was $140,000 with $160,000 of additional credit available, subject to pro forma compliance with debt covenants.

The 2016 Credit Agreement amends, restates, supersedes and replaces the Prior Credit Agreement in its entirety.  

The 2016 Credit Agreement replaced a credit and security agreement with Fifth Third Bank that had been in place since August 1, 2011 (the “Fifth Third Agreement”). The Fifth Third Agreement initially provided for three separate credit facilities totaling $50,000. These included a $15,000 unsecured revolving line of credit, an accordion feature to increase the revolving line of credit to a $35,000 secured revolving line of credit, and a $15,000 construction and term loan (originally obtained to provide financing for the construction of the Company’s third factory in Sarasota). The construction and term loan was never activated, nor did the Company make any borrowings under the other facilities provided by the Fifth Third Agreement.  Accordingly, there were no amounts drawn under the Fifth Third Agreement for the period ended December 31, 2016, and January 2, 2016. At December 31, 2016, the facilities with Fifth Third Bank are no longer available.

Except as noted below, we declared the following regular quarterly dividends to shareholders of record on the last calendar day of the respective quarter, paid on the 15^th day of each month following the date of declaration:

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In addition to the regular quarterly dividends, we declared shared distribution cash dividends in 2016, 2015 and 2014, equal to $0.04, $0.09 and $0.09, respectively.  The 2016 dividend was paid on March 31, 2016, to shareholders of record on March 15, 2016, the 2015 dividend was paid on March 31, 2015, to shareholders of record on March 15, 2015, and the 2014 dividend was paid on March 31, 2014, to shareholders of record on March 15, 2014.  In February 2017, the Board of Directors also declared a shared distribution cash dividend of $0.02 per share, payable on March 31, 2017, to shareholders of record as of March 15, 2017.  

The Board of Directors in 2014, declared a special one-time cash dividend of $1.00 per share, payable October 24, 2014 to shareholders of record as of October 10, 2014. In declaring the special dividend, the Board of Directors cited our strong cash position, ability to generate on-going cash, and strong financial performance in the first half of 2014 as reasons for its decision.

We paid dividends totaling $10.8 million, $12.0 million, and $38.4 million for the years ended December 31, 2016, January 2, 2016, and December 27, 2014, respectively.

The declaration and payment of future dividends is subject to the sole discretion of the Board of Directors, and any determination as to the payment of future dividends will depend upon our profitability, financial condition, capital needs, acquisition opportunities, future prospects and other factors deemed pertinent by the board of directors.

We believe that cash generated from operations and our borrowing availability under the revolving line of credit will be sufficient to satisfy our operating expenses and capital expenditures for the foreseeable future. In the event that economic conditions were to severely worsen for a protracted period of time, we would have several options available to ensure liquidity in addition to increased borrowing. Capital expenditures could be postponed since they primarily pertain to long-term improvements in operations. Additional operating expense reductions also could be made. Finally, the dividend to shareholders could be reduced or suspended.

OTHER MATERIAL COMMITMENTS. Our contractual obligations and debt obligations as of December 31, 2016, are summarized in the table below (in thousands):

Critical Accounting Policies and Estimates

We currently apply judgment and estimates which may have a material effect on the eventual outcome of assets, liabilities, revenues and expenses for impairment of long-lived assets, inventory, goodwill, accruals, income taxes, and fair value of short-term investments. The following explains the basis and the procedure for each account where judgment and estimates are applied.

Revenue Recognition

We report revenues, net of sales incentives, when title passes and risk of loss transfers to the customer.

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Short-term Investments

Our short-term investments have been classified and accounted for as available-for-sale.  We determine the appropriate classification of our investments at the time of purchase and re-evaluate the designation at each balance sheet date.  We may or may not hold securities with stated maturities greater than 12 months until maturity. As we view these securities as available to support current operations, we classify securities with maturities beyond 12 months as current assets under the caption short-term investments in the accompanying Consolidated Balance Sheets.  Our short-term investments are carried at fair value, with the unrealized gains and losses, net of tax, reported as a component of shareholder’s equity.  Realized gains and losses on sales of short-term investments are generally determined using the specific identification method, and are included in miscellaneous (income) expense in the Consolidated Statements of Operations.

Fair Value Measurements

We apply fair value accounting guidelines for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Under these guidelines, fair value is defined as the price that would be received for the sale of an asset or paid to transfer a liability (i.e. an exit price) in an orderly transaction between market participants at the measurement date. The guidance establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.

Level 3 - Unobservable inputs that are supported by little, infrequent, or no market activity and reflect the Company’s own assumptions about inputs used in pricing the asset or liability.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Our valuation techniques used to measure the fair value of marketable equity securities were derived from quoted prices in active markets for identical assets or liabilities. Contingent consideration and newly acquired intangible assets are measured at fair value using level 3 inputs. The valuation techniques used to measure the fair value of all other financial instruments were valued based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data.

Business Combinations

Business combinations are accounted for under the acquisition method of accounting, which requires recognition separately from goodwill, the assets acquired and the liabilities assumed at their acquisition date fair values. While best estimates and assumptions are used to accurately value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, the estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, adjustments are recorded to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recognized in the Consolidated Statements of Operations.

Impairment of Long-Lived Assets

Long-lived assets, such as property and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of the asset is measured by comparison of its carrying amount to undiscounted future net cash flows the asset is expected to generate. If such assets are considered impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds its fair value.

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Inventory

We offer a wide variety of standard products and as a matter of policy do not discontinue products. On an ongoing basis, component parts found to be obsolete through design or process changes are disposed of and charged to material cost. We review on-hand balances of products and component parts against specific criteria. Products and component parts without usage or that have excess quantities on hand are evaluated. An inventory reserve is then established for the full inventory carrying value of those products and component parts deemed to be obsolete or slow moving. See Note 6 to the Financial Statements for inventory reserve amounts.

Goodwill

Goodwill, which represents the excess of the purchase price of acquisition over the fair value of the net assets acquired, is carried at cost. Goodwill is tested for impairment annually or more often if events or circumstances indicate a reduction in the fair value below the carrying value. The carrying value of assets is calculated at the reporting unit. An impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than its carrying value.

We completed our annual goodwill impairment testing and determined that the carrying amount of goodwill was not impaired. See Note 8 to the Financial Statements for goodwill amounts.

Accrued Expenses and Other Liabilities

We make estimates related to certain employee benefits and miscellaneous accruals. Estimates for employee benefit accruals are based on management’s assessment of estimated liabilities related to workers’ compensation, health care benefits and annual contributions to an employee stock ownership plan (“ESOP”) established in 2004 as part of our retirement plan. Estimates for miscellaneous accruals are based on our assessment of estimated liabilities for costs incurred.

We accrue for health care benefit costs under two self-funded plans, one for Sun Hydraulics US employees and one for Enovation Controls US employees. We purchase re-insurance for both specific and aggregate stop losses on claims. The individual stop loss basis is $225 thousand and $250 thousand for Sun and Enovation, respectively and the aggregate stop loss limit for the Sun plan is approximately $6.6 million. The Enovation Controls plan has no aggregate stop loss limit.

Income Taxes

Our income tax policy provides for a liability approach under which deferred income taxes are provided for based upon enacted tax laws and rates applicable to the periods in which the taxes become payable. These differences result from items reported differently for financial reporting and income tax purposes, primarily depreciation, accrued expenses and reserves.

We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. We recognize potential interest and penalties related to our unrecognized tax benefits in income tax expense. We file U.S. federal income tax returns as well as income tax returns in various states and foreign jurisdictions. We are no longer subject to income tax examinations by tax authorities for years prior to 2007 for the majority of tax jurisdictions.

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Our federal returns are currently under examination by the Internal Revenue Service (IRS) in the United States for the periods 2007 through 2012. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. It is reasonably possible that within the next twelve months we will resolve some or all of the matters presently under consideration for 2007 through 2012 with the IRS and that there could be significant increases or decreases to unrecognized tax benefits. See Note 12 to the Financial Statements for income tax amounts, including reserves.

Off Balance Sheet Arrangements

We do not engage in any off balance sheet financing arrangements. In particular, we do not have any material interest in variable interest entities, which include special purpose entities and structured finance entities.

Inflation

The impact of inflation on our operating results has been moderate in recent years, reflecting generally lower rates of inflation in the economy. While inflation has not had, and we do not expect that it will have, a material impact upon operating results, there is no assurance that our business will not be affected by inflation in the future.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to interest rate risk results from variable debt outstanding under our revolving credit facility.  We pay interest on outstanding borrowings at interest rates that fluctuate based upon changes in various base rates. As of December 31, 2016, we had $140 million in borrowings outstanding under the revolving credit facility. Based on our level of variable rate debt outstanding during the year ended December 31, 2016, a one percentage point increase in the weighted average interest rate, which generally equals 2.77%, would have had an insignificant impact on our results of operations.  We have not historically used derivative instruments to manage exposure to changes in interest rates.

Our exposure to foreign currency exchange fluctuations relates primarily to the direct investment in our facilities in the United Kingdom, Germany, and Korea. The Company does not use financial instruments to hedge foreign currency exchange rate changes. A 10% decrease in the 2016 average exchange rate of the Euro, Pound and Won collectively would have caused a decrease in EPS of greater than 10%, which we deem to be material.

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ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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Report of Independent Registered Public Accounting Firm – Grant Thornton LLP

Board of Directors and Shareholders

Sun Hydraulics Corporation

We have audited the accompanying consolidated balance sheet of Sun Hydraulics Corporation (a Florida Corporation) and subsidiaries (the “Company”) as of December 31, 2016, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for the year ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sun Hydraulics Corporation and subsidiaries as of December 31, 2016, and the results of their operations and their cash flows for the year ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2017 expressed an unqualified opinion.

/s/ GRANT THORNTON LLP

Tampa, Florida

February 28, 2017

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Report of Independent Registered Public Accounting Firm – Grant Thornton LLP

Board of Directors and Shareholders

Sun Hydraulics Corporation

We have audited the internal control over financial reporting of Sun Hydraulics Corporation (a Florida corporation) and subsidiaries (the “Company”) as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting (“Management’s Report”). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. Our audit of, and opinion on, the Company’s internal control over financial reporting does not include the internal control over financial reporting of Enovation Controls, LLC, a wholly-owned subsidiary, whose financial statements reflect total assets and revenues constituting 55 and 2 percent, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2016. As indicated in Management’s Report, Enovation Controls, LLC was acquired during 2016. Management’s assertion on the effectiveness of the Company’s internal control over financial reporting excluded internal control over financial reporting of Enovation Controls, LLC.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2016, and our report dated February 28, 2017 expressed an unqualified opinion on those financial statements.

/s/ GRANT THORNTON LLP

Tampa, Florida

February 28, 2017

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Report of Independent Registered Public Accounting Firm - Mayer Hoffman McCann P.C.

To the Board of Directors and

Stockholders of Sun Hydraulics Corporation:

We have audited the consolidated balance sheet of Sun Hydraulics Corporation (a Florida Corporation) and subsidiaries (collectively, the “Company”) as of January 2, 2016, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the two years in the period ended January 2, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements referred to above, present fairly, in all material respects, the financial position of Sun Hydraulics Corporation (a Florida Corporation) and subsidiaries as of January 2, 2016, and the results of its operations and its cash flows for each of the years in the two year period then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ Mayer Hoffman McCann P.C.

Clearwater, Florida

March 1, 2016

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Sun Hydraulics Corporation

Consolidated Balance Sheets

(in thousands, except share data)

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

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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.

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Sun Hydraulics Corporation

Consolidated Statements of Comprehensive Income

(in thousands)

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

43

Sun Hydraulics Corporation

Consolidated Statement of Shareholders’ Equity

(in thousands)

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

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Sun Hydraulics Corporation

Consolidated Statements of Cash Flows

(in thousands)