TMCnet News
HURCO COMPANIES INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) EXECUTIVE OVERVIEW Hurco Companies, Inc. is an industrial technology company operating in a single segment. We design and produce computerized machine tools, featuring our proprietary computer control systems and software, for sale through our own distribution network to the worldwide metal cutting market. We also provide software options, control upgrades, accessories and replacement parts for our products, as well as customer service and training support. The following overview is intended to provide a brief explanation of the principal factors that have contributed to our recent financial performance. This overview is intended to be read in conjunction with the more detailed information included in our audited financial statements that appear elsewhere in this report. The market for machine tools is international in scope. We have both significant foreign sales and significant foreign manufacturing operations. During fiscal 2012, 59% of our revenues were attributable to customers in Europe, where we typically sell more of our higher-performance, higher-priced VMX series machines. Additionally, 11% of our revenues were attributable to customers in Asia, where we sell more of our entry-level, lower-priced machines, but where we also encounter greater price pressures. We sell our products through more than 100 independent agents and distributors in countries throughout North America, Europe and Asia. We also have our own direct sales and service organizations in China, France, Germany, India, Italy, Poland, Singapore, South Africa, the United Kingdom and certain parts of the United States. The vast majority of our machine tools are manufactured to our specifications primarily by our wholly owned subsidiary in Taiwan, Hurco Manufacturing Limited (HML). Machine castings and components to support HML's production are manufactured at our facility in Ningbo, China. We also manufacture machine tools for the Chinese market atthe Ningbo plant. Our sales to foreign customers are denominated, and payments by those customers are made, in the prevailing currencies-primarily the Euro, Pound Sterling and Chinese Yuan-in the countries in which those customers are located. Our product costs are incurred and paid primarily in the New Taiwan Dollar and the U.S. Dollar. Changes in currency exchange rates may have a material effect on our operating results and consolidated balance sheets as reported under U.S. Generally Accepted Accounting Principles. For example, when the U.S. Dollar weakens in value relative to a foreign currency, sales made, and expenses incurred, in that currency when translated to U.S. Dollars for reporting in our financial statements, are higher than would be the case when the U.S. Dollar is stronger. In the comparison of our period-to-period results, we discuss the effect of currency translation on those results including the increases or decreases in those results as reported in our financial statements (which reflect translation to U.S. Dollars at exchange rates prevailing during the period covered by those financial statements) and also the effect that changes in exchange rates had on those results. Our high levels of foreign manufacturing and sales also subject us to cash flow risks due to fluctuating currency exchange rates. We seek to mitigate those risks through the use of various derivative instruments - principally foreign currency forward exchange contracts. During fiscal 2012, we continued to focus on our core competencies and strategic priorities, which we believe have a positive impact on our financial performance and our ability to remain competitive in a very diverse global market for machine tools. We continued to invest in China, the largest machine tool market in the world. Unit sales of our products in China in fiscal 2012 increased by more than 50% on a year-over-year basis. In addition, we expanded our product line of five-axis and high speed machines, as well as multi-axis lathes and other specialty equipment that simplifies complex operations with an intuitive, user-friendly interface allowing our customers to increase productivity and profitability. Our overall results reflected a strong improvement in sales of approximately 13% over fiscal 2011 and a 27% improvement in operating income resulting from more effective management of our operating costs. 16 Results of Operations The following table presents, for the fiscal years indicated, selected items from the Consolidated Statements of Operations expressed as a percentage of our worldwide sales and service fees and the year-to-year percentage changes in the dollar amounts of those items. Percentage of Revenues Year-to-Year % Change 2012 2011 2010 Increase (Decrease) '12 vs. '11 '11 vs. '10Sales and service fees 100.0 % 100.0 % 100.0 % 12.6 % 70.4 % Gross profit 31.1 % 31.0 % 20.6 % 13.1 % 156.3 % Selling, general and administrative expenses 20.3 % 21.3 % 28.2 % 6.9 % 29.0 % Operating income (loss) 10.8 % 9.6 % (7.6 )% 26.7 % 316.2 % Other income (expense) (0.1 )% (1.0 )% (0.8 )% 91.1 % (115.4 )% Net income (loss) 7.7 % 6.2 % (5.4 )% 40.6 % 293.7 % Fiscal 2012 Compared to Fiscal 2011 Sales and Service Fees. Annual sales and service fees for fiscal 2012 were $203.1 million, an increase of $22.7 million, or 12.6%, from fiscal 2011. A stronger U.S. Dollar when translating foreign sales to U.S. Dollars had an unfavorable impact of approximately 4%, or $7.6 million, on the year-to-year comparison. Net Sales and Service Fees by Geographic Region The following table sets forth net sales and service fees by geographic region for the fiscal years ended October 31, 2012 and 2011 (in thousands): October 31, Increase (Decrease) 2012 2011 Amount % North America $ 60,527 29.8 % $ 49,637 27.5 % $ 10,890 21.9 % Europe 119,359 58.8 % 111,080 61.6 % 8,279 7.5 % Asia Pacific 23,231 11.4 % 19,683 10.9 % 3,548 18.0 % Total $ 203,117 100.0 % $ 180,400 100.0 % $ 22,717 12.6 % The increase in sales during fiscal 2012 was primarily the result of higher customer demand in all regions. The 7.5% increase in Europe was actually 13.3% when adjusted to exclude the adverse impact of foreign currency translation due to a weaker Euro relative to the U.S. Dollar. In fiscal 2012, unit shipments increased 14% in North America, 4% in Europe and 16% in Asia compared to fiscal 2011. Net Sales and Service Fees by Product Category The following table sets forth net sales and service fees by product category for the years ended October 31, 2012 and 2011 (in thousands): October 31, Increase 2012 2011 Amount % Computerized Machine Tools $ 179,337 88.3 % $ 156,736 86.9 % $ 22,601 14.4 % Service Fees, Parts and Other 23,780 11.7 % 23,664 13.1 % 116 0.5 % Total $ 203,117 100.0 % $ 180,400 100.0 % $ 22,717 12.6 % 17 Orders and Backlog. New order bookings in fiscal 2012 were $198.1 million, an increase of $1.2 million, or 0.6%, over the prior year. Orders in fiscal 2012 increased over fiscal 2011 in North America by $11.6 million (or 23%), but decreased in Europe by $6.1 million (or 5%), and $4.4 million (or 17%) in the Asia Pacific region. The effect of a stronger U.S. Dollar in 2012 when translating foreign orders to U.S. Dollars had an unfavorable impact of $7.0 million, or 4%, on the year-to-year comparison. Unit orders increased 22% in North America, but decreased in Europe by 9% and in the Asia Pacific region by 22%. Backlog was $25.8 million at October 31, 2012, compared to $31.9 million at October 31, 2011. We do not believe backlog is a useful measure of past performance or indicative of future performance. Backlog orders as of October 31, 2012 are expected to be fulfilled in fiscal 2013. Gross Profit. Gross profit for fiscal 2012 was $63.2 million, or 31.1% of sales, compared to $55.9 million, or 31.0% of sales for fiscal 2011. The year-over-year improvement in gross profit was primarily related to an increase in volumeof sales year-over-year. Operating Expenses. Selling, general and administrative expenses were $41.2 million for fiscal 2012, an increase of $2.7 million, or 6.9%, from fiscal 2011. The increase consisted primarily of higher sales and marketing expense, and higher commissions as a result of the increase in sales. Despite the dollar increase, selling, general and administrative expenses as a percentage of sales and service fees declined to 20.3% as compared to 21.3% for fiscal 2011 dueto the increased sales in 2012. Operating Income (Loss). Operating income for fiscal 2012 was $22.0 million, or 10.8% of sales, compared to an operating income of $17.4 million, or 9.6% of sales, in fiscal 2011. The improvement in operating income year-over-year was primarily due to the increase in sales. Other (Income) Expense. Other expense for fiscal 2012 decreased by $1.6 million from fiscal 2011 due to lower foreign currency losses experienced in fiscal 2012. Provision (Benefit) for Income Taxes. Our effective tax rate for fiscal 2012 was 28.5%, which reflected minimal change compared to the effective tax rate for fiscal 2011 of 28.8%. Net Income (Loss). Net income for fiscal 2012 was $15.6 million, or $2.40 per diluted share, which is an increase of $4.5 million from fiscal 2011 net income of $11.1 million, or $1.71 per diluted share. Fiscal 2011 Compared to Fiscal 2010 Sales and Service Fees. Annual sales and service fees for fiscal 2011 were $180.4 million, an increase of $74.5 million, or 70.4%, from fiscal 2010. A weaker U.S. Dollar when translating foreign sales to U.S. Dollars had a favorable impact of approximately 4%, or $4.3 million, on the year-to-year comparison. Net Sales and Service Fees by Geographic Region The following table sets forth net sales and service fees by geographic region for the fiscal years ended October 31, 2011 and 2010 (in thousands): October 31, Increase (Decrease) 2011 2010 Amount % North America $ 49,637 27.5 % $ 27,818 26.3 % $ 21,819 78.4 % Europe 111,080 61.6 % 65,678 62.0 % 45,402 69.1 % Asia Pacific 19,683 10.9 % 12,397 11.7 % 7,286 58.8 % Total $ 180,400 100.0 % $ 105,893 100.0 % $ 74,507 70.4 % The significant percentage increase in sales during fiscal 2011 was primarily the result of higher customer demand as a result of a rebound in industrial manufacturing activity and our ability to increase production to meet demand. In fiscal 2011, unit shipments increased 72% in North America, 51% in Europe and 46% in Asia compared to fiscal 2010. 18 Net Sales and Service Fees by Product Category The following table sets forth net sales and service fees by product category for the years ended October 31, 2011 and 2010 (in thousands): October 31, Increase 2011 2010 Amount % Computerized Machine Tools $ 156,736 86.9 % $ 88,184 83.3 % $ 68,552 77.7 % Service Fees, Partsand Other 23,664 13.1 % 17,709 16.7 % 5,955 33.6 % Total $ 180,400 100.0 % $ 105,893 100.0 % $ 74,507 70.4 % Orders and Backlog. New order bookings in fiscal 2011 were $197.0 million, an increase of $81.7 million, or 70.8%, over the prior year. Orders in fiscal 2011 increased over fiscal 2010 by $17.9 million (or 56%) in North America, by $53.0 million (or 77%) in Europe, and $10.8 million (or 73%) in the Asia Pacific region. The effect of a weaker U.S. Dollar in 2011 when translating foreign orders to U.S. Dollars had a favorable impact of $3.7 million, or 3.2%, on the year-to-year comparison. Unit orders increased 41% in North America, 57% in Europe and 66% in the Asia Pacific region. Backlog was $31.9 million at October 31, 2011, compared to $15.6 million at October 31, 2010. We do not believe backlog is a useful measure of past performance or indicative of future performance. Backlog orders as of October 31, 2011 were fulfilled in fiscal 2012. Gross Profit. Gross profit for fiscal 2011 was $55.9 million, or 31.0% of sales, compared to $21.8 million, or 20.6% of sales for fiscal 2010. The year-over-year improvement in gross profit was primarily related a general increase in volume of sales year-over-year, particularly in Europe, the primary market for our higher-performance VMX series machines, and the increased cost efficiencies realized from higher production levels during fiscal 2011. However, gross profit for fiscal 2011 was adversely impacted by higher raw material costs, primarily for metals, as well as the appreciation of the New Taiwanese Dollar relative to the U.S. Dollar. We increased selling prices across all product offerings at the end of the second quarter of fiscal 2011 to offset these higher costs. Operating Expenses. Selling, general and administrative expenses were $38.5 million for fiscal 2011, an increase of $8.7 million, or 29.0%, from fiscal 2010. The increase consisted primarily of higher sales commissions due to increased sales volume, higher global sales and marketing expense, and increased wages and compensation paid to employees who had experienced wage reductions when cost containment measures were implemented during fiscal 2009 and 2010. Despite the dollar increase, selling, general and administrative expenses as a percentage of the sales and service fees declined to 21.8% in fiscal 2012 as compared to 28.2% for fiscal 2010 due to increased sales in 2011. Operating Income (Loss). Operating income for fiscal 2011 was $17.4 million, or 9.6% of sales, compared to an operating loss of $8.0 million, or 7.6% of sales, in fiscal 2010. The substantial improvement in operating income year-over-year was primarily due to the significant increase in sales in fiscal 2011. Other (Income) Expense. Other income for fiscal 2011 decreased by $1.1 million in comparison to fiscal 2010 due primarily to net realized and unrealized losses from foreign currency fluctuations on payables and receivables, net of foreign currency forward exchange contracts. Provision (Benefit) for Income Taxes. Our effective tax rate for fiscal 2011 was an expense of 28.8%, compared to a benefit of 35.2% for fiscal 2010. The reduction in the effective tax rate for the year was primarily due to changes in the geographic mix of income or loss between tax jurisdictions with statutory tax rates ranging from 17% to 37%. 19 Net Income (Loss). Net income for fiscal 2011 was $11.1 million, or $1.71 per diluted share, which is an increase of $16.8 million from fiscal 2010 net loss of $5.7 million, or $0.89 per diluted share. Liquidity and Capital Resources At October 31, 2012, we had cash and cash equivalents of $35.8 million compared to $45.0 million at October 31, 2011. Approximately 72.1% of our $35.8 million of cash and cash equivalents is held in the U.S. The remaining balances are denominated in various foreign currencies and held by our foreign subsidiaries. These balances are associated with our permanent reinvestment strategy and are subject to fluctuations in currency exchange rates. We do not believe that the indefinite reinvestment of these funds offshore impairs our ability to meet our domestic working capital needs. Working capital, excluding cash, was $88.2 million at October 31, 2012, compared to $61.9 million at October 31, 2011. The increase in working capital, excluding cash, was primarily due to increased inventory resulting from higher production levels and increased accounts receivable due to higher sales volumes. Inventories were $91.3 million at October 31, 2012, compared to $81.1 million at October 31, 2011. The $10.2 million increase was due to increased finished goods inventory to support the 13% increase in sales. Inventory turns remained relatively stable from 1.6 turns as of October 31, 2011 to 1.5 turns as of October 31, 2012. Capital expenditures were $3.7 million in fiscal 2012 and $2.8 million in fiscal 2011. Capital expenditures for 2012 were primarily for purchase of factory equipment for production facilities in Taiwan, software development costs, and implementation of operating systems. We funded these expenditures with cashflow from operations. On December 7, 2012, we entered into a new credit agreement to replace our prior credit agreement. Under the prior credit agreement, we had a $15.0 million unsecured revolving credit facility, a letter of credit facility with a maximum amount for outstanding letters of credit of $3.0 million and a backup letter of credit facility in the amount of 100 million New Taiwan Dollars or approximately $3.5 million. Pursuant to the new credit agreement, the lenders will provide us with a $12.5 million unsecured revolving credit and letter of credit facility, with a $3.0 million maximum amount for outstanding letters of credit. The scheduled maturity date of the new credit agreement is December 7, 2014. Given our current cash position, we determined that a $12.5 million revolving credit facility was sufficient to meet our needs during the term of the new credit agreement; moreover, the reduction in the size of the line from the prior credit agreement facilitated more favorable pricing and covenants. Borrowings under the new credit agreement will bear interest at a LIBOR-based rate or a floating rate of 1% above the prevailing prime rate. The floating rate will not be less than the greatest of (a) a one month LIBOR-based rate plus 1.00% per annum, (b) the federal funds effective rate plus 0.50% per annum, and (c) the prevailing prime rate. The rate we must pay for that portion of the new credit agreement which is not utilized is 0.05% per annum. The new credit agreement permits us to make investments in subsidiaries of up to $5.0 million, an increase from the amount permitted in the prior credit agreement. Further, the new credit agreement replaces the financial covenants that were in the prior credit agreement with a minimum working capital requirement of $90.0 million and a minimum tangible net worth requirement of $120.0 million. The new credit agreement will permit us to pay cash dividends in an amount not to exceed $1.0 million per calendar year so long as we are not in default before and after giving effect to such dividends. The remaining covenants in the new credit agreement are substantially the same as those that were in the prior credit agreement. 20 We also have credit facilities in the United Kingdom, Germany, Taiwan and China. At October 31, 2012, our only outstanding borrowings were in China, where we had $3.2 million outstanding. At October 31, 2012, we were in compliance with those covenants contained in all of our credit facilities and had $25.2 million of available borrowing capacity under those facilities. We believe our cash position and borrowing capacity under our credit facilities provide adequate liquidity to fund our operations over the next twelve months and keep us committed to our strategic plan for product innovation and targeted penetration of developing markets. Although we have not made any significant acquisitions in the recent past, we continue to receive and review information on businesses and assets, including intellectual property assets, which may be available for purchase. Contractual Obligations and Commitments The following is a table of contractual obligations and commitments as of October 31, 2012 (all amounts in thousands): Payments Due by Period More Less than 1-3 3-5 than 5 Total 1 Year Years Years Years Short-term debt $ 3,206 $ 3,206 $ - $ - $ - Operating Leases 6,978 3,037 3,788 153 - Other 1,244 - - - 1,244 Total $ 11,428 $ 6,243 $ 3,788 $ 153 $ 1,244 In addition to the contractual obligations and commitments disclosed above, we also have a variety of other obligations for the procurement of materials and services, none of which subject us to any material non-cancelable commitments. While some of these obligations arise under long-term supply agreements, we are not committed under these agreements to accept or pay for requirements that are not needed to meet our production needs. We have no material minimum purchase commitments or "take-or-pay" type agreements or arrangements. Unrecognized tax benefits in the amount of approximately $118,000, excluding any interest and penalties, have been excluded from the table above because we are unable to determine a reasonably reliable estimate of the timing of future payment. We expect capital spending in fiscal 2013 to be approximately $4.6 million, which includes investments for capitalized software, capital equipment and costs to continue implementation of our integrated computer system. We expect to fund these commitments with cash on hand and cash generated from operations. Off Balance Sheet Arrangements From time to time, our subsidiaries guarantee third party payment obligations in connection with the sale of machines to customers that use financing. As of October 31, 2012, we had 19 outstanding third party payment guarantees totaling approximately $1.1 million. The terms of these guarantees are consistent with the underlying customer financing terms. Upon shipment of a machine, the customer has the risk of ownership. The customer does not obtain title, however, until it has paid for the machine. A retention of title clause allows us to recover the machine if the customer defaults on the financing. We accrue for potential liabilities under these guarantees when we believe a loss is probable and can be estimated. 21 We provide warranties on our products with respect to defects in material and workmanship. The terms of these warranties are generally one year for machines and shorter periods for service parts. We recognize a reserve with respect to this obligation at the time of product sale, with subsequent warranty claims recorded against the reserve. The amount of the warranty reserve is determined based on historical trend experience and any known warranty issues that could cause future warranty costs to differ from historical experience. Critical Accounting Policies and Estimates Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles. The preparation of financial statements in conformity with those accounting principles require us to make judgments and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Those judgments and estimates have a significant effect on the financial statements because they result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Actual results could differ from those estimates. Our accounting policies, including those described below, are frequently evaluated as our judgment and estimates are based upon historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Revenue Recognition - We recognize revenue from sales of our machine tool systems upon delivery of the product to the customer, which is normally at the time of shipment, because persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed and determinable and collectability is reasonably assured. In certain foreign locations, we retain title after shipment under a "retention of title" clause solely to protect collectability. The retention of title is similar to Uniform Commercial Code ("UCC") filings in the United States and provides the creditor with additional rights to the machine if the customer fails to pay. Revenue recognition at the time of shipment is appropriate in this instance as long as all risks of ownership have passed to the buyer. Our computerized machine tools are general-purpose computer controlled machine tools that are typically used in stand-alone operations. Transfer of ownership and risk of loss are not contingent upon contractual customer acceptance. Prior to shipment, we test each machine to ensure the machine's compliance with standard operating specifications as listed in our sales literature. Depending upon geographic location, after shipment, a machine may be installed at the customer's facilities by a distributor, independent contractor or by one of our service technicians. In most instances where a machine is sold through a distributor, we have no installation involvement. If sales are direct or through sales agents, we will typically complete the machine installation, which consists of the reassembly of certain parts that were removed for shipping and the re-testing of the machine to ensure that it is performing within the standard specifications. We consider the machine installation process to be inconsequential and perfunctory. Service fees from maintenance contracts are deferred and recognized in earnings on a pro rata basis over the term of the contract. Sales related to software products are recognized when shipped in conformity with U.S. Generally Accepted Accounting Principles as promulgated by Financial Accounting Standards Board or its predecessor (FASB guidance) related to software revenue recognition that requires at the time of shipment, persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed and determinable and collectability is reasonably assured. The software does not require production, modification or customization. Inventories - We determine at each balance sheet date how much, if any, of our inventory may ultimately prove to be unsalable or unsalable at its carrying cost. Reserves are established to effectively adjust the carrying value of such inventory to net realizable value. To determine the appropriate level of valuation reserves, we evaluate current stock levels in relation to historical and expected patterns of demand for all of our products. We evaluate the need for changes to valuation reserves based on market conditions, competitive offerings and other factors on a regular basis. 22 Income Taxes - We account for income taxes in accordance with FASB guidance. Deferred tax assets and liabilities are measured using enacted income tax rates in each jurisdiction in effect for the year in which the temporary differences are expected to be recovered or settled. These deferred tax assets are reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Our judgment regarding the realization of deferred tax assets may change due to future profitability and market conditions, changes in U.S. or foreign tax laws and other factors. These changes, if any, may require material adjustments to these deferred tax assets and an accompanying reduction or increase in net income in the period when such determinations are made. The determination of our provision for income taxes requires judgment, the use of estimates and the interpretation and application of complex tax laws. Our provision for income taxes reflects a combination of income earned and taxed at the federal and state level in the U.S., as well as in various foreign jurisdictions. We have not provided for any U.S. income taxes on the undistributed earnings of our foreign subsidiaries based upon our determination that such earnings will be indefinitely reinvested abroad. In addition to the risks to the effective tax rate described above, the future effective tax rate reflected in forward-looking statements is based on currently effective tax laws. Significant changes in those laws could materially affect these estimates. We recognize uncertain tax positions when it is more likely than not that the tax position will be sustained upon examination by relevant taxing authorities, based on the technical merits of the position. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Capitalized Software Development Costs - Costs incurred to develop computer software products and significant enhancements to software features of existing products are capitalized as required by FASB guidance relating to accounting for the costs of computer software to be sold, leased, or otherwise marketed, and amortized over the estimated product life of the related software. The determination as to when in the product development cycle technological feasibility has been established, and the expected product life, require judgments and estimates by management and can be affected by technological developments, innovations by competitors and changes in market conditions affecting demand. We periodically review the carrying values of these assets and make judgments as to ultimate realization considering the above-mentioned risk factors. Derivative Financial Instruments - Critical aspects of our accounting policy for derivative financial instruments that we designate as hedging instruments include conditions that require that critical terms of a hedging instrument are essentially the same as a hedged forecasted transaction. Another important element of our policy demands that formal documentation be maintained as required by FASB guidance relating to accounting for derivative instruments and hedging activities. Failure to comply with these conditions would result in a requirement to recognize changes in market value of hedge instruments in earnings. We routinely monitor significant estimates, assumptions, and judgments associated with derivative instruments, and compliance with formal documentation requirements. Stock Compensation - We account for share-based compensation according to FASB guidance relating to share based payments, which requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors based on estimated fair values on the grant date. This guidance requires that we estimate the fair value of share-based awards on the date of grant and recognize as expense the value of the portion of the award that is ultimately expected to vest over the requisite service period. 23 |