Business context and reporting period
Hurco Companies, Inc. designs, manufactures and sells CNC machine tools, controls, software, parts and related services to the global metal-cutting industry. This Form 10-K covers the fiscal year ended October 31, 2016; fiscal 2016 fourth-quarter figures are separately noted below. Hurco operates as one industrial automation equipment segment. The Milltronics and Takumi product lines, acquired in July 2015, were included for a full year in fiscal 2016 versus approximately three months in fiscal 2015.
Financial performance and position
- Revenue: Full-year sales and service fees were $227.3 million, up 4% from $219.4 million. Currency translation reduced fiscal 2016 reported revenue by $6.4 million. Computerized machine tools generated $195.6 million (86% of revenue); parts and service fees were $21.9 million and $7.7 million, respectively.
- Profitability: Gross profit was $70.4 million, with a 31.0% gross margin, compared with $69.1 million and 31.5% in fiscal 2015. Operating income fell 18% to $19.6 million (8.6% margin) from $23.8 million (10.9%). Net income declined 18% to $13.3 million; diluted EPS was $1.99 versus $2.44. The effective tax rate was 30%, versus 31%.
- Fourth quarter: Revenue was $66.4 million versus $65.7 million in Q4 2015. Operating income was $5.1 million versus $6.7 million, and net income was $3.0 million versus $4.8 million; diluted EPS was $0.45 versus $0.72. Gross margin was 30% versus 29%.
- Cash flow and investment: Operating cash flow was negative $6.9 million, compared with positive $28.5 million in fiscal 2015. The filing attributes the cash use principally to working-capital movements, including higher receivables and inventory. Capital expenditures were $4.2 million; capitalized software development was $2.2 million.
- Liquidity and debt: Cash and cash equivalents were $41.2 million, down from $55.2 million. Working capital was $160.4 million and the current ratio was 3.8. Total debt was $1.5 million, all under the China facility; the company reported $19.8 million of available borrowing capacity and compliance with credit covenants.
- Balance sheet: Total assets were $251.9 million and shareholders’ equity was $185.5 million. Inventory increased to $117.0 million from $106.3 million; inventory turns declined to 1.4 from 1.6.
Material changes versus the prior comparable period
- Revenue increased 4%, but orders declined 2% to $219.2 million. Backlog fell to $32.3 million from $41.2 million; management expects the October 2016 backlog to be fulfilled in fiscal 2017 and cautions that backlog is not a reliable performance indicator.
- Regional revenue growth was strongest in Asia Pacific, up 45%, mainly reflecting a full year of Takumi sales versus a partial year. Americas revenue rose 6%, supported by Milltronics and year-end promotions. Europe declined 4% as reported, including a 5% adverse currency impact.
- SG&A rose 12% to $50.8 million, or 22% of revenue, from $45.3 million, or 21%. Management cited trade-show spending, global sales support costs and annualized costs associated with Milltronics and Takumi. Gross margin was broadly stable, but higher operating expenses reduced operating and net income.
- Cash declined by $14.0 million. Working capital increased, but the increase in inventory and negative operating cash flow merit attention.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no formal revenue or earnings guidance. Management expects fiscal 2017 capital spending of approximately $5.9 million, funded by cash on hand and operating cash flow, and says liquidity is adequate for operations, dividends and its strategic plan.
- Credit facility: On December 6, 2016, after year-end, the company amended its U.S. facility, increasing the revolving commitment from $12.5 million to $15.0 million, extending maturity to December 31, 2018, and increasing the annual dividend allowance to $5.0 million, subject to covenant conditions.
- Business risks: Machine-tool demand is cyclical and can change abruptly; the company notes that its typical order backlog is only about 45 days. Other material exposures include international economic and political conditions, foreign-exchange movements, competition from larger manufacturers, reliance on a limited number of manufacturing and component sources, raw-material costs, product-development and acquisition execution, and inventory obsolescence.
- Currency and concentration: Approximately 69% of fiscal 2016 revenue came from outside the U.S. The company uses foreign-exchange forwards but states that hedges may not fully offset currency exposure. Europe represented 54% of revenue, increasing sensitivity to conditions there.
- Contingencies and other items: The company reported ordinary-course claims and lawsuits that it does not expect to have a material adverse effect, and 26 customer-financing guarantees totaling approximately $1.2 million, with insignificant accrued fair-value liabilities. It recorded no goodwill or intangible-asset impairment in fiscal 2016. Foreign subsidiary earnings of approximately $79.7 million are considered indefinitely reinvested; U.S. tax may arise if repatriated.
- Controls and audit: Management and Ernst & Young concluded internal control over financial reporting was effective as of October 31, 2016. The auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether orders and backlog stabilize or improve, particularly given fiscal 2016 orders fell while reported sales rose partly due to the acquisitions’ longer inclusion.
- Whether elevated inventory converts to sales and operating cash flow, and whether inventory turns recover.
- Whether SG&A growth moderates and operating margins improve after acquisition-related and trade-show costs.
- The impact of currency movements, especially in Europe, and the effectiveness and counterparty exposure of foreign-exchange hedges.
- Compliance with amended credit-facility covenants, dividend limits, and the company’s ability to fund planned fiscal 2017 capital spending while sustaining cash generation.
- Potential tax consequences of foreign earnings, the realization of deferred tax assets, and the outcome of ordinary-course claims and customer guarantees.