Analyzing Hurco

Hurco Companies, Inc. (Public, NASDAQ:HURC)

Sales

Sales for the quarter increased 15.28% to $42.49 million from $36.86 million in the year-ago quarter. At the same time, sales slipped 9.35% from the first quarter of fiscal 2007 and 1.55% from the fourth quarter of fiscal 2006. It is important to note that the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007 benefited from the IMTS, the largest U.S. trade show, which was held in September of 2006.

Based on my conversation with Hurco’s CFO, quarterly sales are largely driven by the release of new products. To the best of my knowledge Hurco did not release any new products in the quarter. While the management mentioned the release of the much anticipated Winmax control software and the introduction of Hurco’s largest vertical machining center, the VMX84, it is my understanding that these products were not available for shipment until after the close of the quarter. The release of these two products bodes well for future quarters. The new Winmax control system, with 25 new features, will increase the competitiveness of all Hurco’s machine tools. The VMX84, with its ability to machine large parts, will open Hurco to a new group of customers.

Aside from the new products mentioned above, future quarters should continue to benefit from a weaker U.S. dollar and growing demand in Europe and Asia. While machine tool consumption has been on the decline in the U.S. since the IMTS last year, the most recent machine tool consumption report showed a nice rebound in March after several months of declines. For the full year, industry experts are looking for “steady growth” in the U.S. during 2007. Furthermore, the current quarter is likely to see some benefit from Eastec, a smaller regional U.S. trade show being held next week.

Bookings

If you think the lower sequential sales in the second quarter are a sign of a slowdown…think again. Order bookings increased 31.05% to $48.47 million from the year-ago quarter. If my history is correct, this was the fourth consecutive quarter of record bookings.

As I compare the consecutive quarter of record bookings to sales in the last couple of quarters (book-to-bill ratios), I am led to believe that bookings in the last couple quarter included orders for the VMX84 and the Winmax control system, which were not available for shipment until the current quarter.

Margins

Gross margins improved to 38.47% in the current quarter compared to 36.96% in the prior quarter and 35.75% in the year-ago quarter. Once again, I believe the 38.47% represents a record for Hurco. According to management, gross margins are largely driven by product mix and volume. Hurco’s continued improvement in gross margins demonstrates Hurco’s ability to focus on and compete with its higher margin products. The higher gross margins also demonstrate managements’ ability to manage costs. To this regard, Hurco management is expecting future margin improvement from the manufacturing facility in China.

Operating expenses as a percent of sales increased to 22.13% from 19.37% in the year-ago quarter. Operating expenses as a percent of sales were in the range of recent quarters but on the higher end of the range. Management attributed the higher operating expenses to incremental variable expenses related to market expansion, commissions and compensation expense. Considering Hurco’s recent expansion efforts in China and India, managements’ explanation is reasonable.

Higher gross margins for the quarter were offset by the higher operating expenses as a percent of sales resulting in relatively flat operating margins of 16.34%. Nonetheless, at 16.34%, operating margins were in the upper end of the recent range.

The increase in interest income offset somewhat by a higher tax rate in the quarter, resulted in higher net margins of 11.01% compared to 10.66% in the second quarter of 2006.

Future margin improvement can be expected once the sales and manufacturing operations in China become fully functional and sales in the region increase. Additionally, the VMX84 is likely a higher margin product. With the availability of the VMX84 in the current quarter, there will likely be continued improvement in gross margins.

Earnings

Earnings increased 19.11% from the year-ago quarter but slipped 13.25% sequentially for the reasons mentioned above. EPS for the quarter was $0.73 per diluted share putting the trailing 12-month EPS at $2.89 per diluted share. At a current price of $42.50, I calculate a trailing PE of 14.71. At the now higher price of $43.00 (share continue to rise during the day), I get am calculating an EV/EBITDA of 9.05.

Balance Sheet

Hurco is now free of long-term debt and the cash position increased over $2.1 million to $34.5 million or $5.40 per share. Hurco’s balance sheet remains exceptionally strong.

Cash Flow Statement

While a cash flow statement was not provided, it is reasonable to assume the $2.13 million increase in cash and the elimination of nearly $4 million in long-term debt was the result of another strong quarter of operational cash flows.

Looking Ahead to Next Quarter

I have put together my long-term argument for Hurco in previous blog posts (here). As for now, I will make a few positive bullet points for next quarter:

Expecting continued strength in Europe and Asia along with continued benefit from weaker U.S. dollar.

Expecting more of a rebound in U.S. machine tool consumption and I will be monitoring the U.S. Machine Tool Consumption Survey

Potential boost to U.S. sales as a result of Eastec

Higher book-to-bill ratios in recent quarters suggest some pent up orders for both Winmax and VMX84

Successive record bookings indicates that demand remains strong

Shipping of VMX84 and Winmax should result in continued margin improvement and will help expand customer base

Higher cash position and elimination of debt will result in higher net interest income

Slightly more favorable year-ago comparables

Conclusion

Despite the markets reaction today to missing estimates, Hurco once again reported a very solid quarter and the story remains the same. I continue to have faith in the long-term prospect for Hurco and at this point I am especially excited about the prospects for next quarter. Since I started writing, Hurco shares are already up a couple of dollars. Looks like smart investors are taking advantage of a discount.

Regards,
Tuff

Earnings Release