Here's the culprit - needle bearing. I can't figure that one out.
I have heard about that kind of failure a number of times, even read a few McCulloch service bulletins describing the same thing, but haven't done it myself so far anyway.
There was one service bulleting that chronicled a kart engine failure, dealer claimed it to be a needle dropped in at the factory, factory analyzed the failed parts and discovered the needle came from some other bearing entirely, dropped in accidentally at the dealer doing the work.
When you put one back together, you need to count the needle elements carefully and make sure they all end up where they belong. I am going to grab a copy of that photo for my records as well.
Depending on how badly the cylinder is scored, it might still be possible to make that saw run again; since it had pretty low compression to begin with a bit of scoring may not hurt as much as you think. Many of the old time McCulloch documents indicated a minimum of 90 PSI for compression was acceptable.
Mark