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.

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