Item 2. Management’s Discussion and Analysis
Item 2 . MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains information intended to help provide an understanding of our financial condition and other related matters, including our liquidity, capital resources and results of operations. The MD&A is provided as a supplement to, and should be read in conjunction with, our unaudited financial statements and the notes accompanying our unaudited financial statements appearing elsewhere in this report, as well as our audited financial statements, the accompanying notes and the MD&A included in our Annual Report on Form 10-K for the year ended October 31, 2020.
EXECUTIVE OVERVIEW
Hurco Companies, Inc. is an international, industrial technology company operating in a single segment. We design, manufacture and sell computerized (i.e., CNC) machine tools, consisting primarily of vertical machining centers (mills) and turning centers (lathes), to companies in the metal cutting industry through a worldwide sales, service and distribution network. Although the majority of our computer control systems and software products are proprietary, they predominantly use industry standard personal computer components. Our computer control systems and software products are primarily sold as integral components of our computerized machine tool products. We also provide machine tool components, automation integration equipment and solutions for job shops, software options, control upgrades, accessories and replacement parts for our products, as well as customer service, training and applications 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 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 the first three months of fiscal 2021, approximately 45% of our revenues were attributable to customers in Europe, where we typically sell more of our higher-performance, higher-priced VMX series machines. Additionally, approximately 12% of our revenues were attributable to customers in the Asia Pacific region, where we encounter greater pricing pressures.
We have three brands of CNC machine tools in our product portfolio: Hurco is the technology innovation brand for customers who want to increase productivity and profitability by selecting a brand with the latest software and motion technology. Milltronics is the value-based brand for shops that want easy-to-use machines at competitive prices. The Takumi brand is for customers that need very high speed, high efficiency performance, such as that required in the production, die and mold, aerospace, and medical industries. Takumi machines are equipped with industry standard controls instead of the proprietary controls found on Hurco and Milltronics machines. These three brands of CNC machine tools are responsible for the vast majority of our revenue. However, we have added other non-Hurco branded products to our product portfolio that have contributed product diversity and market penetration opportunity. These non-Hurco branded products are sold by our wholly-owned distributors and are comprised primarily of other general-purpose vertical milling centers and lathes, laser cutting machines, waterjet cutting machines, CNC grinders, compact horizontal machines, metal cutting saws and CNC swill lathes. ProCobots LLC (“ProCobots”) is our wholly-owned subsidiary that provides automation solutions that can be integrated with any machine tool. In addition, through our wholly-owned subsidiary in Italy, LCM Precision Technology S.r.l. (“LCM”), we produce high value machine tool components and accessories.
We principally sell our products through more than 200 independent agents and distributors throughout the Americas, Europe, and Asia. Although some distributors carry competitive products, we are the primary line for the majority of our distributors globally. We also have our own direct sales and service organizations in China, France, Germany, India, Italy, the Netherlands, Poland, Singapore, Taiwan, the United Kingdom, and certain parts of the United States, which are among the world's principal machine tool consuming markets. The vast majority of our machine tools are manufactured to our specifications primarily by our wholly-owned subsidiary in Taiwan, HML. Machine castings to support HML’s production are manufactured at our wholly-owned subsidiary in Ningbo, China, NHML. Components to support our SRT line of five-axis machining centers, such as the direct drive spindle, swivel head, and rotary table, are manufactured by our wholly-owned subsidiary in Italy, LCM.
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Our sales to foreign customers are denominated, and payments by those customers are made, in the prevailing currencies in the countries in which those customers are located (primarily the Euro, Pound Sterling, and Chinese Yuan). 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 financial statements 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, which reflect translation to U.S. Dollars at exchange rates prevailing during the period covered by those financial statements.
We operate in the industrial equipment industry and have a global footprint that subjects us to various business risks in many different countries. The COVID-19 pandemic has had a significant impact on our business and industry. We cannot predict the duration or scope of impact of the COVID-19 pandemic and the negative financial impact to our results cannot be reasonably estimated, but we believe the impact has been material thus far and could continue to be material in the near future. To date, we have not experienced material disruptions in our supply chain and have not completely ceased operations at any of our global facilities, but have implemented remote working capabilities, as appropriate or otherwise required under local law. We will continue to evaluate and disclose any trends and uncertainties that have had or are reasonably expected to have, a material effect on our consolidated financial position, results of operations, changes in shareholders’ equity and cash flows for and at the end of each interim period.
Our high levels of foreign manufacturing and sales also expose us to cash flow risks due to fluctuating currency exchange rates. We seek to mitigate those risks through the use of derivative instruments – principally foreign currency forward exchange contracts.
RESULTS OF OPERATIONS
Three Months Ended January 31, 2021 Compared to Three Months Ended January 31, 2020
Sales and Service Fees. Sales and service fees for the first quarter of fiscal 2021 were $54.1 million, an increase of $10.5 million, or 24%, compared to the corresponding prior year period, and included a favorable currency impact of $1.6 million, or 4%, when translating foreign sales to U.S. dollars for financial reporting purposes.
During fiscal 2020, our operating results were adversely affected by the international business disruption due to the outbreak of coronavirus and the ongoing economic slowdown in Europe, uncertainty surrounding the U.K. Brexit activities, and political friction in the U.S. Many of our customers deferred or eliminated investments in capital equipment last year, which we attributed largely to the uncertainty these events created. During the first quarter of fiscal 2021, our sales increased year-over-year in all regions, particularly in the Americas and Europe, our primary markets for our higher-performance, higher-priced machines. We also saw global machine tool manufacturers price their excess inventories aggressively to compete in the market recovery.
Sales and Service Fees by Geographic Region
The following table sets forth net sales and service fees by geographic region for the first quarter ended January 31, 2021 and 2020 (dollars in thousands):
Three Months Ended
January 31,
2021
2020
$ Change
% Change
Americas
$
23,248
43
%
$
17,479
40
%
$
5,769
33
%
Europe
24,246
45
%
20,085
46
%
4,161
21
%
Asia Pacific
6,621
12
%
6,096
14
%
525
9
%
Total
$
54,115
100
%
$
43,660
100
%
$
10,455
24
%
Sales in the Americas for the first quarter of fiscal 2021 increased by 33%, compared to the corresponding period in fiscal 2020, primarily due to an increased volume of shipments of Hurco machines. The increased machine shipments reflected higher sales volumes of lathes and VM and VMX machines, particularly in the southeast and midwest regions of the U.S.
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European sales for the first quarter of fiscal 2021 increased by 21%, compared to the corresponding period in fiscal 2020, and included a favorable currency impact of 7%, when translating foreign sales to U.S. dollars for financial reporting purposes. The increase in European sales for the first quarter of fiscal 2021 was primarily attributable to an increased volume of shipments of Hurco machines in the United Kingdom and Germany, partially offset by reduced volumes in France and Italy.
Asian Pacific sales for the first quarter of fiscal 2021 increased by 9%, compared to the corresponding period in fiscal 2020, and included a favorable currency impact of 5%, when translating foreign sales to U.S. dollars for financial reporting purposes. The year-over-year increase in Asian Pacific sales primarily resulted from an increased volume of shipments of Hurco vertical milling machines in China and Southeast Asia, partially offset by reduced volume of shipments of Hurco machines in India and Takumi machines in China.
Sales and Service Fees by Product Category
The following table sets forth net sales and service fees by product category for the first quarter ended January 31, 2021 and 2020 (dollars in thousands):
Three Months Ended
January 31,
2021
2020
$ Change
% Change
Computerized Machine Tools
$
45,450
84
%
$
35,214
81
%
$
10,236
29
%
Computer Control Systems and Software †
523
1
%
558
1
%
(35)
(6)
%
Service Parts
6,269
12
%
5,901
13
%
368
6
%
Service Fees
1,873
3
%
1,987
5
%
(114)
(6)
%
Total
$
54,115
100
%
$
43,660
100
%
$
10,455
24
%
† Amounts shown do not include computer control systems and software sold as an integrated component of computerized machine systems.
Sales of computerized machine tools and service parts for the first quarter of fiscal 2021 increased by 29% and 6%, respectively, compared to the corresponding prior year period, and each included a favorable currency impact of 4%, when translating foreign sales to U.S. dollars for financial reporting purposes. The increases in machine tools and service parts were primarily due to increased shipments of Hurco-branded products across all regions where our customers are located. Sales of computer control systems and software and service fees decreased by 6% each, compared to the corresponding prior year period, and each included a favorable currency impact of 4%, when translating foreign sales to U.S. dollars for financial reporting purposes. The decreases in control systems and software and service fees primarily resulted from decreased demand in aftermarket software and services in North America.
Orders. Orders for the first quarter of fiscal 2021 were $57.3 million, an increase of $11.7 million, or 26%, compared to the corresponding period in fiscal 2020, and included a favorable currency impact of $2.1 million, or 5%, when translating foreign orders to U.S. dollars.
The following table sets forth new orders booked by geographic region for the first quarter ended January 31, 2021 and 2020 (dollars in thousands):
Three Months Ended
January 31,
2021
2020
$ Change
% Change
Americas
$
23,845
42
%
$
18,162
40
%
$
5,683
31
%
Europe
25,795
45
%
21,746
48
%
4,049
19
%
Asia Pacific
7,683
13
%
5,672
12
%
2,011
35
%
Total
$
57,323
100
%
$
45,580
100
%
$
11,743
26
%
Orders in the Americas for the first quarter of fiscal 2021 increased by 31%, compared to the corresponding period in fiscal 2020, primarily due to increased customer demand for Hurco machines. The increased order levels, similar to the increased sales levels, reflected a higher demand for lathes and VM and VMX machines.
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European orders for the first quarter of fiscal 2021 increased by 19%, compared to the corresponding prior year period, and included a favorable currency impact of 8%, when translating foreign orders to U.S. dollars. The year-over-year increase in orders was driven primarily by increased customer demand for Hurco machines in Germany, France and the United Kingdom.
Asian Pacific orders for the first quarter of fiscal 2021 increased by 35%, compared to the corresponding prior year period, and included a favorable currency impact of 7%, when translating foreign orders to U.S. dollars. The year-over-year increase in Asian Pacific orders was driven primarily by an increase in customer demand for Hurco vertical milling machines in China and Southeast Asia, partially offset by decreased demand for Takumi machines in China.
Gross Profit . Gross profit for the first quarter of fiscal 2021 was $11.5 million, or 21% of sales, compared to $9.2 million, or 21% of sales, for the corresponding prior year period. Gross profit as a percentage of sales remained relatively unchanged year-over-year on a higher level of sales, as global excess inventory levels continue to apply competitive pricing pressure on the machine tool industry. Additionally, similar to fiscal 2020, the first quarter of fiscal 2021 gross profit continued to be impacted by the allocation of fixed costs on lower production volumes year-to-date.
Operating Expenses . Selling, general, and administrative expenses for the first quarter of fiscal 2021 were $10.6 million, or 20% of sales, compared to $10.8 million, or 25% of sales, in the corresponding fiscal 2020 period, and included an unfavorable currency impact of $0.3 million, when translating foreign expenses to U.S. dollars for financial reporting purposes. The year-over-year reduction in selling, general, and administrative expenses was primarily due to operating cost reduction measures implemented in the first two quarters of fiscal 2020, partially offset by increases in incentive compensation.
Operating Income (Loss) . Operating income for the first quarter of fiscal 2021 was $1.0 million compared to an operating loss of $1.7 million for the corresponding period in fiscal 2020. The increase in operating income was primarily driven by the increased volume of sales.
Other Income, Net . Other income, net in the first quarter of fiscal 2021 was $0.1 million compared to $0.1 million for the corresponding period in fiscal 2020.
Income Taxes . The effective tax rate for the first quarter of fiscal 2021 was 45%, compared to 40% in the corresponding prior year period. The year-over-year increase in the effective tax rate was primarily due to changes in geographic mix of income and loss which includes jurisdictions with differing tax rates and other events that are not consistent from period to period, such as changes in income tax laws to address the unfavorable impact of the COVID-19 pandemic and a discrete income tax expense related to unvested stock awards in the first quarter of fiscal 2021.
LIQUIDITY AND CAPITAL RESOURCES
At January 31, 2021, we had cash and cash equivalents of $66.6 million, compared to $57.9 million at October 31, 2020. Approximately 15% of the $66.6 million of cash and cash equivalents was denominated in U.S. dollars. The balance was attributable to our foreign operations and is held in the local currencies of our various foreign entities, 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 was $204.0 million at January 31, 2021 compared to $201.0 million at October 31, 2020. The increase in working capital was primarily driven by an increase in prepaid expenses, offset by a reduction in inventory and an increase in accounts payable.
Capital expenditures of $0.6 million during the first three months of fiscal 2021 were primarily for capital improvements in existing facilities and software development costs. We funded these expenditures with cash on hand.
In addition, during the three months ended January 31, 2021, we paid cash dividends to our shareholders of $0.9 million. Future dividends are subject to approval of our Board of Directors and will depend upon many factors, including our results of operations, financial condition, capital requirements, regulatory and contractual restrictions, our business strategy and other factors deemed relevant by our Board of Directors from time to time.
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On December 31, 2018, we and our subsidiary Hurco B.V. entered into a Credit Agreement with Bank of America, N.A., as the lender, which was subsequently amended on each of March 13, 2020 and December 23, 2020 (as amended, the “2018 Credit Agreement”). The 2018 Credit Agreement provides for an unsecured revolving credit and letter of credit facility in a maximum aggregate amount of $40.0 million. The 2018 Credit Agreement provides that the maximum amount of outstanding letters of credit at any one time may not exceed $10.0 million, the maximum amount of outstanding loans made to our subsidiary Hurco B.V. at any one time may not exceed $20.0 million, and the maximum amount of all outstanding loans denominated in alternative currencies at any one time may not exceed $20.0 million. Under the 2018 Credit Agreement, we and Hurco B.V. are borrowers, and certain of our other subsidiaries are guarantors. The scheduled maturity date of the 2018 Credit Agreement is December 31, 2021.
Borrowings under the 2018 Credit Agreement bear interest at floating rates based on, at our option, either (i) a LIBOR-based rate, or other alternative currency-based rate approved by the lender, plus 1.25% per annum, or (ii) a base rate (which is the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate or (c) the one month LIBOR-based rate plus 1.00%), plus 0.00% per annum. Outstanding letters of credit will carry an annual rate of 1.25%.
The 2018 Credit Agreement contains customary affirmative and negative covenants and events of default, including covenants (1) restricting us from making certain investments, loans, advances and acquisitions (but permitting us to make investments in subsidiaries of up to $10.0 million); (2) restricting us from making certain payments, including (a) cash dividends, except that we may pay cash dividends as long as immediately before and after giving effect to such payment, the sum of the unused amount of the commitments under the 2018 Credit Agreement plus our cash on hand is not less than $10.0 million, and as long as we are not in default before and after giving effect to such dividend payments and (b) payments made to repurchase shares of our common stock, except that we may repurchase shares of our common stock as long as we are not in default before and after giving effect to such repurchases and the aggregate amount of payments made by us for all such repurchases during any fiscal year does not exceed $10.0 million; (3) requiring that we maintain a minimum working capital of $125.0 million; (4) requiring that we maintain a minimum tangible net worth of $170.0 million; and (5) providing that if the total amount of indebtedness outstanding owed by the Company and its Taiwanese and Chinese subsidiaries to the lender or its affiliates (the “Specified Outstanding Amount”) exceeds $25.0 million, then the Company will not permit the amount of unrestricted cash-on-hand of the Company and its subsidiaries to be less than the Specified Outstanding Amount. We may use the proceeds from advances under the 2018 Credit Agreement for general corporate purposes.
In March 2019, our wholly-owned subsidiaries in Taiwan, HML, and China, NHML, closed on uncommitted revolving credit facilities with maximum aggregate amounts of 150 million New Taiwan Dollars and 32.5 million Chinese Yuan, respectively. As uncommitted facilities, both the Taiwan and China credit facilities are subject to review and termination by the respective underlying lending institution from time to time.
As of January 31, 2021, our existing credit facilities consisted of our €1.5 million revolving credit facility in Germany, the 150 million New Taiwan Dollars Taiwan credit facility, the 32.5 million Chinese Yuan China credit facility and the $40.0 million revolving credit facility under the 2018 Credit Agreement. We had no debt or borrowings under any of our credit facilities at January 31, 2021.
At January 31, 2021, we had an aggregate of $52.2 million available for borrowing under our credit facilities and were in compliance with all covenants relating thereto.
We have an international cash pooling strategy that generally provides access to available cash deposits and credit facilities when needed in the U.S., Europe or Asia Pacific. We believe our access to cash pooling and our borrowing capacity under our credit facilities provide adequate liquidity to fund our global operations over the next twelve months and allow us to remain committed to our strategic plan of product innovation, acquisitions, targeted penetration of developing markets, payment of dividends and our stock repurchase program.
We continue to receive and review information on businesses and assets for potential acquisition, including intellectual property assets that are available for purchase.
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CRITICAL ACCOUNTING POLICIES
Our accounting policies, which are described in our Annual Report on Form 10-K for the fiscal year ended October 31, 2020, require management to make significant estimates and assumptions using information available at the time the estimates are made. These estimates and assumptions significantly affect various reported amounts of assets, liabilities, revenues, and expenses. If our future experience differs materially from these estimates and assumptions, our results of operations and financial condition would be affected. There were no material changes to our critical accounting policies during the first three months of fiscal 2021.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
There have been no material changes related to our contractual obligations and commitments from the information provided in our Annual Report on Form 10-K for the fiscal year ended October 31, 2020.
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. We follow FASB guidance for accounting for guarantees (codified in ASC 460). As of January 31, 2021, we had 15 outstanding third party payment guarantees totaling approximately $0.8 million. The terms of these guarantees are consistent with the underlying customer financing terms. Upon shipment of a machine, the customer assumes the risk of ownership. The customer does not obtain title, however, until the customer 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 liabilities under these guarantees at fair value, which amounts are insignificant.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
Certain statements made in this report constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the statements. These risks, uncertainties and other factors include, but are not limited to:
● The impact of the COVID-19 pandemic and other public health epidemics on the global economy, our business and operations, our employees and the business, operations and economies of our customers and suppliers;
● The cyclical nature of the machine tool industry;
● Uncertain economic conditions, which may adversely affect overall demand, in the Americas, Europe and Asia Pacific markets;
● The risks of our international operations;
● Governmental actions, initiatives and regulations, including import and export restrictions, duties and tariffs and changes to tax laws;
● The effects of changes in currency exchange rates;
● Competition with larger companies that have greater financial resources;
● The United Kingdom’s withdrawal from the European Union (Brexit);
● Our dependence on new product development;
● The need and/or ability to protect our intellectual property assets;
● The limited number of our manufacturing and supply chain sources;
● Increases in the prices of raw materials, especially steel and iron products;
● The effect of the loss of members of senior management and key personnel;
● Our ability to integrate acquisitions;
● Acquisitions that could disrupt our operations and affect operating results;
● Failure to comply with data privacy and security regulations;
● Breaches of our network and system security measures;
● Possible obsolescence of our technology and the need to make technological advances;
● Impairment of our assets;
● Negative or unforeseen tax consequences;
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● Uncertainty concerning our ability to use tax loss carryforwards; and
● Changes in the LIBOR rate.
We discuss these and other important risks and uncertainties that may affect our future operations in Part I, Item 1A – Risk Factors in our most recent Annual Report on Form 10-K and may update that discussion in Part II, Item 1A – Risk Factors in this report or in a Quarterly Report on Form 10-Q we file hereafter.
Readers are cautioned not to place undue reliance on these forward-looking statements. While we believe the assumptions on which the forward-looking statements are based are reasonable, there can be no assurance that these forward-looking statements will prove to be accurate. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. This cautionary statement is applicable to all forward-looking statements contained in this report.
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