Wednesday, August 22, 2007

Hurco Train Keeps Chugging

Last week, Hurco Companies, Inc., ("Hurco" or Ticker Symbol: HURC), a designer and producer of computerized machine tools, reported results for its third fiscal quarter of 2007, ending July 31, 2007. Given the spike in Hurco’s share price following the release of earnings, the market clearly liked the results. Looking at the details of the report, the market reaction was seemingly well justified.

Sales & Service Revenue

Revenues increased 14.3% sequentially and 32.7% year-over-year. In my financial model for Hurco, I have quarterly data going back to the second fiscal quarter of 2004. Looking at my model, I noticed that this was the first time Hurco reported a sequential increase in revenues for its fiscal third quarter. Sequential revenues decreased 0.72%, 4.63% and 2.1%, in the third fiscal quarter of 2006, 2005, and 2004, respectively. Given the historical weakness in the third quarter relative to the second quarter, the sequential jump in revenues was somewhat surprising. At the same time, I should note that revenue growth in the second quarter was a little below normal. The below average growth in the second quarter and the above average growth in the third quarter was likely the result of the timing of orders, shipments and the availability of new products.

Again, looking at the quarterly data available in my model, I noticed that Hurco increased revenues on a year-over-year basis at the second highest rate next to the 47.0% in the first fiscal quarter of 2007. The next fastest rate came in the second quarter of 2005 when revenues grew 27.8% year-over-year. With the high level of revenue growth in the first and third quarters, Hurco is in a position to exceed the high level mark for annual sales growth set in 2004.

Over the past few years, Hurco’s annual revenue growth has decelerated. In 2004, Hurco reported annual revenue growth of 31.8%. In 2005 and 2006, revenue growth slowed to 26.1% and 18.3%, respectively. Through the first nine months of fiscal 2007, revenues are up 30.9%. With the upcoming EMO in Hannover, Germany, the high level of order bookings in recent quarters, and the release of exciting new products, Hurco’s sales growth in 2007 should easily exceed 2005 growth and potentially 2004 growth.

Gross Margins

Gross margin for the third quarter of 37.9% was in-line with the last few quarters but up 286 basis points from the year-ago quarter. Management attributed the higher margins to increased volume and product mix. With the recent release of VMX84 and WinMax along with higher sales volume coming off the EMO, I expect gross margins to increase next quarter and potentially hit new record highs. Longer-term, I expect gross margins to experience further improvement as a result of the manufacturing facility in China.

Selling, General & Administrative Expenses

Selling, general and administrative expenses increased to $10.2 million from $7.4 million in the year-ago quarter. Management attributed the dollar increase in SG&A to foreign currency translation of foreign operating expenses and expenses related to market expansion, commissions, and other administrative expenses. As a percentage of sales, SG&A expenses were largely in-line with historical levels.

Operating Margins

Hurco’s operating margin in the quarter was 16.87%, up 53 bps from last quarter and 200 bps from the year-ago quarter. Operating margins were higher for the reasons mentioned above.

Income Tax

Hurco’s income tax provision on the quarter was $3.7 million or 41.5%. The tax rate was higher than last quarters 37.1% and the year-ago quarters 30.21%. The higher rate in the quarter was likely a result of annual adjustments. I expect the tax provision next quarter to be back around 35-37%.

Net Income

Hurco reported earnings of $5.2 million or $0.80 per diluted share. Despite the higher tax rate in the quarter, earnings were up 10.3% from the prior quarter and 35.8% from the year ago quarter.

Order Bookings

New booking in the quarter were a record $48.6 million. With the upcoming EMO show and Hurco’s product offering going into the show, I expect Hurco to report another record quarter for bookings in the fourth quarter. On the year, bookings are up 28% over last year.

Balance Sheet

Hurco has over $37.2 million in cash (+$2.8 million on the quarter) and no long-term debt. On the balance sheet, Investments of $2.1 million, was a new line item. We will have to wait for the 10Q for information relating to this line item. The only other item worth noting on the balance sheet was the 19% sequential increase in inventories. With the high level and growing number of quarterly order bookings along with the upcoming EMO, the increase in inventory seems reasonable. In the second quarter of fiscal 2006, inventories also increased by a similar amount and for similar reasons.

Valuation

Hurco’s trailing EPS is $3.11. As I write, Hurco is trading at $48.62 yielding a PE of 15.63. At the same time, Hurco has nearly $6 in net cash (cash less LT debt). While I don’t have all of the information necessary from the most recent quarter to calculate the EV/EBITDA, I estimate Hurco to be trading at a EV/EBITDA of 8.6.

Year-to-date revenues have grown 30.9% and earnings have grown 41.6%. At the end of the fiscal year, revenue growth and earnings growth will, at the very least, exceed the growth rates of fiscal 2006. Analysts expect earnings to increase 20.4% in 2008 and 28% over the next 5 years. If I assume an annual growth rate of 20%, below historical and estimated growth rates, and a reasonable PEG of 1, Hurco should be trading at a price of $62.20. At $62.20 the EV/EBITDA would be a reasonable 11.5.

Conclusion

Quarter-after-quarter, Hurco has exceeded my expectations. Furthermore, Hurco has continued to increase its new order bookings, rollout new and innovative products, expand its global footprint, and increase operational efficiencies. While management does not issue a lot, if any, press releases, host conference calls or do a whole lot to update the investment community, their ability to manage the company is self-evident. While I consider Hurco shares to be cheap, I am confident that Hurco will continue to post strong results and the share price will appreciate accordingly. Going forward, I expect shares to move higher from both earnings expansion and PE expansion.

Good luck,
Tuff


Disclaimer

Long Hurco since it was introduced to me in the Motley Fools’ Hidden Gem newsletter in 2004.

Other Links

SeekingAlpha Article


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

Thursday, August 9, 2007

BOOM Q2 2007 - Beyond the Numbers

On Thursday, July 26, Dynamic Materials Corporation (“DMC”) (Ticker Symbol: BOOM), reported second quarter net income of $5.7 million, or $0.46 per share, on revenues of $34.5 million. Revenues were up 24% and net income was up 13% compared to the second quarter of 2006. Looking at the numbers alone and the year-over-year growth rates, I would call it a good quarter. I wouldn’t call it a blowout quarter but it was a good quarter nonetheless. If it was just a good quarter, then why, you may ask, did shares of DMC close $5, or 12.85%, higher on the day following the company's earnings release and conference call?

In the post that follows, I have highlighted a number of factors that I believe contributed to the jump in DMC’s share price. While all of the factors likely contributed to the jump in DMC's share price, some of the factors are more relevant than others in terms of analyzing the future potential of DMC.

If anyone is interested, my conference call notes can be found at the end of this post.

Analyst Estimates

Last quarter, management said they expected results for the second quarter to be in-line with results from the first quarter. In the first quarter, DMC reported net income of $4.9 million, or $0.40 per share, on revenues of $33.10 million. Given management's guidance, average estimates for the second quarter were for revenues of $33.0 million and net income per share of $0.42. While analysts were expecting revenues in-line with the first quarter they were expecting an improvement in margins that would in-turn lead to higher net income per share. This was a reasonable expectation considering margins were on the low end of the range in the first quarter due to product mix. In the end, DMC handily beat top and bottom line estimates by 5% and 10%, respectively. Sales topped estimates and margins did indeed show solid improvement from the first quarter (167 basis points). On a side note, management is optomistic that margins in the second half of the year will be as as strong or stronger than the margins in the second quarter.

While it was nice to see DMC beat estimates, this factor has the least or no significance when looking at DMC going forward.

Management Guidance

Management does not provide specific earnings guidance. Nonetheless, in the fourth quarter 2006 earnings release, management said, “We are looking to achieve revenue growth in the 20% range during fiscal 2007.” In the most recent earnings announcement management updated their statement saying, “In light of our strong-performance through the first half of the year, as well as the growth in our order backlog, we are optimistic we will exceed our targeted top-line growth estimate of 20%.” On the conference call, management was more specific and said they are now expecting top-line revenue growth in the range of 20-30%.

I first covered DMC in a post back in March of 2007. In that post, I gave several reasons as to why I thought it was reasonable to assume revenues would grow 30-35% in 2007. In May, after DMC announced it received an $8.3 million contract that would ship in the fourth quarter of 2007, I reiterated my belief, in this post, that revenues were likely to increase 30-35% in 2007.

Through the first two quarters of 2007, revenues are up 27.6%. With the relatively lackluster results reported in the third quarter of 2006, year-to-date revenue growth should ratchet-up over the 30% mark when DMC reports its third quarter results.

By raising guidance, management is obviously more optimistic now than they were at the beginning of 2007. What is behind management's optomism?

Backlog and Bookings

At the end of the second and third quarter of 2006, DMC’s reported that its explosive backlog increased 24% and 31%, respectively, on a sequential basis. The next two quarters, DMC’s backlog remained relatively flat and stood at $67.9 million at the end of the first quarter of 2007. At the end of the second quarter, DMC’s reported backlog jumped 25% sequentially and 62% year-over-year to $84.7 million. What made the increase in the explosive backlog even more impressive was the fact that the increase came in a quarter of near record revenues. This would imply that bookings for the quarter were exceptional.

In order to arrive at an estimate of quarterly bookings, I take the change in the explosive backlog this quarter from last quarter and then add explosive revenues for the quarter.

Q2 backlog – Q1 backlog + Q2 explosive revenues = explosive bookings

$84.7 mil - $67.9 mil + $33.1 mil = $49.9 mil

Using this formula, DMC had record quarterly bookings for its explosive division. The next best quarter for bookings, using the same formula, came in the third quarter of 2006 when bookings were $39.7 million.

The jump in DMC’s backlog and the implied record bookings is solid evidence of growing demand for DMC’s explosive clad.

New Opportunity

In May, DMC announced an $8.3 million contract it received from a U.S. based customer for explosive clad plates. According to DMC, the customer plans to utilize the plates in the construction of equipment being put into service on an alternative energy project.

Due to a confidentiality agreement with the customer, DMC management could not provide many details about the contract on the conference call. At the same time, management said that they are, “intrigued with the longer-term opportunity this emerging industry represents to DMC.”

While the alternative energy contract is not the largest contract DMC has booked, it is significant in that it represents the growing number of industrial applications utilizing explosion clad plates in the construction of associated plant equipment.

With the growing backlog, record bookings and prospects for new uses of explosion clad, the demand equation for DMC appears very favorable. The question now is whether or not DMC has the ability to meet the rising demand. With respect to DMC, investors should direct their attention to the availability of raw materials and operational capacity.

Supply Chain Relief

Supply chain constraints have plagued DMC since the beginning of 2006. While tightness in the supply chain has not resulted in lost revenues, it has extended the book-to-bill cycle and exacerbated the normal lumpiness in quarterly results. For instance, in the second quarter of 2006, DMC’s net income from continuing operations jumped nearly 21% on a sequential basis. The subsequent quarter net income from continuing operations fell over 26% on a sequential basis. The sequential jump and subsequent decline in net income was attributable to the timing of shipments of raw materials.

Supply chain concerns have largely been centered on the high-alloy carbon steel plates that function as the clad backer plates. There are a limited number of suppliers of these carbon steel plates, six mills worldwide, and Arcelor Mittal is the primary supplier in North America. While supplies have been tight worldwide, the situation has been more severe in North America due in large part to planned and unplanned outages at the Arcelor Mittal plant in Coatesville, PA. With a limited number of suppliers, it is extremely difficult for DMC management to overcome general tightness and/or specific outages. Nonetheless, management has been diligent in working with existing suppliers, expanding its supplier network to smaller mills, and increasing the amount of finish work done in-house.

Earlier in the year, management indicated that they expected some improvement in the supply chain towards the second half of 2007. Sure enough, there have been some signs of improvement. Mid-way through the first quarter, DMC booked an $8.3 million contract for clad plates. In a press release, management said they expected to ship the order in the fourth quarter of 2007. Without some improvement in the supply chain, management wouldn’t have been able to promise this type of a turnaround. Further evidence of improvement came in a July 3rd article posted on Purchasing.COM.

“The availability of high-alloy carbon steel plate has improved slightly, buyers report, moving from ‘extreme shortage’ to ‘relatively tight.’”

Finally, the most significant sign of improvement came when DMC management raised their guidance for top-line growth. On the conference call, management highlighted their favorable assessment of metal supplies for near-term order fulfillment as one of the reasons they were raising guidance.

Tightness in the supply chain will likely continue to be the primary constraint on DMC’s growth. Nonetheless, it is very encouraging to see modest improvement in this area.

Capacity Expansion

In its earnings release, DMC announced that the Mt. Braddock expansion is nearly complete and management is expecting to receive the remaining equipment in the third quarter. On the conference call, management said the company is already benefiting from the enhanced production efficiencies associated with this expansion project.

In addition to the Mt. Braddock expansion, DMC is in the process of modernizing its European operations. With the combination of the Mt. Braddock expansion and the European modernization program, it is reasonable to assume that the explosive division has the capacity to generate annual revenues easily in excess of $200 million.

To the knowledge of DMC management, DMC is the only player in the industry that is undergoing substantial capacity expansion. As such, DMC is in a position to improve upon its already very impressive global market share.

The AMK expansion is also near completion. According to management, the AMK division is setting up equipment to meet the ramp-up in production associated with its contract with GE for work on the H System. While H System work has been growing at a slower pace than expected, management was upbeat about the future ramp-up.

Conclusion

In looking at the numbers and comparing year-over-year results, DMC reported a good quarter. But there was so much more to the second quarter earnings report than just the numbers. Demand for DMC’s explosion clad is exceptionally strong and growing. At the same time, management has positioned the company to take advantage of this growth. As an investor in DMC since 2004, I am as optimistic now as I have ever been about the future prospects of the company.

Good Luck,
Tuff


Other Useful Links

10Q

Recent IBD Article


Conference Call Notes

Below are my conference call notes. By notes, I really mean notes.

CEO – Yvon Cariou

Explosive business awarded an array of new contracts bringing backlog to an all time high of $84.7 million, +25% over end of last Q

Quoting activity was strong in Q2 & strength continued in weeks since the close of the quarter

Good indication of persistent strong demand across a broad spectrum of end markets served by DMC

Alternative energy contract – intrigued w/ long-term opportunities this emerging industry represents to DMC

Pleased with progress of capacity expansion efforts. Facilities are operating smoothly & already benefiting from enhanced production efficiencies. Anticipate final equipment by end of Q3.

Supply of carbon steel plates remain “fairly tight” but the interaction w/suppliers has improved predictability of shipments. This is a timing issue and has not impacted ability to attract new orders

CFO – Richard Santa

SG&A increase from higher stock comp expense, annual salary adjustments, staffing changes, increased legal & consulting

Selling expenses up from higher commissions due to increased sales levels

Cash at $10.4 million down as a result of build in WIP inventory & capital expenditures from expansion projects (my note, increase in WIP inventory supported by jump in backlog)

Working capital $43.8 million vs $38.6 million end of 2006

Given progress in first half of year, backlog, assessment of metal supply for near-term order fulfillment, we now expect top-line growth in range of 20-30%

Q&A (notes only and not full questions and answers)

Mix of order in the Q consistent with prior Qs

Management has heard comments from customer about holding back order due to price volatility of metals but not seeing an impact on booking activity

Inventory increase result of increased backlog and expect to see inventories level-off/reverse in next couple of quarters

Capex might be a little higher in second half of year because of work in Europe and final payment on Mount B equipment

AMK margins lower because of adjustment related to change in leadership and associated severance payment. While AMK growing at slower pace than we would like the outlook is extremely good & we are not changing view on prospects. AMK sales down sequentially because of flow of work but stronger second half.

G&A expenses - has stabilized

D&A expense – will move up a little w/new equipment coming on-line. Some projects did not begin to depreciate until late in Q2.

Gross margins – Q1 margins lower from product mix and one large titanium order. Looking at backlog and prospects for increased sales and management hopeful second half margins will be like Q2 or perhaps slightly better

AMK – GE actively working to develop H System line. Prospects look good. AMK actively setting up equipment to meet ramp-up in production

Caller asked if explosion clad something that would be used for poly silicone (used in semi-conductors), apparently caustic. (my note…research this more)

Overall refinery shutdowns have had net positive impact on order rate. Refining is DMC’s leading market segment. Some talk of some projects on hold but overall demand is very active….patching, debottlenecking, changing refineries to make different fuels all good for DMC

US & Europe projects – doubling U.S. capacity at time US = two-thirds of $110 in revenue but an elastic concept. Close to having achieved that. Europe modernization program will lead to added capacity. Looking out over a couple of years DMC has capacity to serve market demand. U.S. was two-thirds of capacity. We have doubled that but that is a nominal doubling so could become bigger than that by pushing walls beyond that.

Hot list strong, number of significant projects out there

Competition – Japanese competition man competitor one-third size of DMC. No real changes. Compete with couple of companies in Europe. DMC only company expanding capacity. Group of Chinese companies but what they are doing is really a competitive product of roll-bond. Some are advancing technique and will compete some day.

No orders from coal-to-liquid projects. Still a little ways out. (I thought this might have been the alternative energy contract. Apparently not)

H System is important to AMK but can’t forget other generators and aircraft engines

Oil & gas might make-up 40%+ of backlog

Carbon steel supply pushing back orders and taking longer to fill an order. Situation is steady, not degrading, somewhat improving & expect to remain tight for some time

Operating 3 shifts, 2 shifts and 1 shift depending on the particular operation


Dynamic Materials Corporation (Public, NASDAQ:BOOM)