Just Another Great Q

I have to admit that I was pleasantly surprised by the results that Hurco reported on February 28, 2008. Congrats to all the longs that stayed long despite all the market volatility.

Sales and Bookings

Sales in Q1 of fiscal 2008 increased $20 million, or 30%, to $60.9 million from $46.9 million in the year-ago quarter. Sequentially, sales increased 21.6%. In my Hurco financial model, I have quarterly results going back 15 quarters. Looking at my model, the 21.6% sequential in sales was the largest sequential increase.

In Q4 2007, Hurco’s bookings were a record $54.8 million and that set the stage for the strong sales in Q1 2008. Bookings in Q1 2008 set another record of $61.2 million and would seemingly set the stage for strong sales in Q2. Again looking at my model, the sequential increase in bookings the last two quarters were the best back-to-back quarters for sequential increases going back to the same two quarters two years ago. The sequential increases in both instances can likely be attributed to the EMO.

Here are my list of reasons behind Hurco’s recent growth in sales and bookings:

1) The Exposition Mondiale de la Machine Outil, or EMO, is the largest trade fair for the machine tool industry. It is held every other year around the end of September in Hannover, Germany. Aside from giving Hurco the opportunity to demonstrate new products, the EMO has historically accelerated Hurco’s sales and bookings in subsequent quarters.

2) Over the past couple of years, Hurco has been expanding its geographic footprint with both sales offices and manufacturing facilities. In the Q4 press release, Mr. Doar, Hurco’s CEO, highlighted the importance of the company’s global strategy and how it has contributed to the company’s recent success. About a year-ago we heard the first rumblings about India. Today, we heard some rumblings about Eastern Europe. Despite the slowdown in the U.S., Hurco is reaping the benefits of its global strategy and footprint. International sales were at their highest level this quarter than any other quarter in my model.

In my conversation with Mr. Oblazney, Hurco’s CFO, a couple of quarters back, I asked him about Hurco’s activity in China and India.

Given the difficulty in establishing a business in India, Mr. Oblazney was a little reserved with his expectations for near-term growth in India. As such, it was nice to see that India added to sales in the APAC region. Note that APAC sales were up 29% YoY but down 24% from the prior quarter. As the APAC region only accounts for a few million in sales per quarter, the quarterly fluctuations are to be expected and investors should look for a long-term trend.

3) Hurco released the Winmax control system in 2007. Prior to the release of Winmax, management was seemingly pretty excited about this new control system and made specific mention of it in a couple of press releases. For Hurco management, any press release is a big deal. Management very rarely issues press releases so when they issue a press release and show a hint of excitement, investor take notice. Around the time Winmax was released, Royce and Associates bought a large number of Hurco shares. I speculated that this purchase was at least partially tied to Royce’s expectations for Winmax to boost sales.

Going back to my conversation with Mr. Oblazney, Winmax wasn’t expected to directly boost revenues but it was expected to significantly improve the competitiveness of all Hurco’s products. While Wimnax was released in the U.S. sometime around early May, the EMO marked the global rollout. Based on Hurco’s recent success, Winmax seems to be living up to management’s expectations.

4) In 2007, Hurco also introduced its VMX84, the largest vertical machining center in its product lineup. I am pretty sure this was one of the products on display at the EMO. Note that management recognized sales of higher-end VMX machines as a driver of sales and margins on the quarter.

5) About a year-ago, I wrote my first blog entry on Hurco. In that blog entry, I highlighted the weak U.S. dollar as having a favorable impact on Hurco’s financial results. I also highlighted the weakening dollar as one of the reasons I expected sales to continue to accelerate. In the last few quarters, we have been seeing the benefits of our poor beaten down dollar. In the most recent quarter, the dollar had a favorable impact on sales of $4.6 million. Keep in mind that the favorable impact on sales is offset somewhat by foreign operating and manufacturing expenses.

Margins

Gross margins increased to 40.8% from 37.9% in the prior quarter and 37.0% the year-ago quarter. Management credited the nearly 400 basis point improvement in gross margins to increased sales of higher margin VMX sales in Europe and the favorable impact on the dollar.

SG&A as a percent of sales was 20.31% compared to 22.43% last quarter and 19.43% in the year-ago quarter. The percentage decrease from last quarter was likely the result of fixed costs being spread over a higher level of sales. The dollar increase in SG&A spending of $3.1 million over the year-ago level was the result of increased spending on sales, development and market expansion. Translation of foreign operations back to USD also contributed to the dollar increase in earnings.

Operating margins increased to 20.5% from 15.5% in the prior quarter and 17.22% in the year-ago quarter. Is that right, did they really increase operation margins 500 basis points over Q4 2007? While Q4 2007 operating margins were abnormally low, Q1 2008 operating margins still represent a very nice sequential increase. The improvement in operating margins were the result of the factors listed above.

Hurco’s profit margin of 12.81% for the quarter was an increase of 150 basis points over the prior quarter and 130 basis points over the year-ago quarter. The less drastic jump in sequential profit margins compared to operating margins was due to the higher tax rate in Q1 2008 relative to Q4 2007. The implied tax rate in Q1 was 36.7% compared to 30.3% in Q4.

According to my data, the gross and operating margins for the quarter were records. The profit margin for the quarter was not a record because of the benefit of loss carry-forward in Q4 of 2005.

EPS

I am calculating $3.62 in EPS over the trailing twelve months.

Balance Sheet

The balance sheet looks strong so I won’t go into a lot of detail. Hurco has no long-term debt and $35 million in cash and investments, or nearly $5 per share. Hurco’s strong balance sheets puts it in a healthy position to weather a downturn in the global economy.

DSOs increased to 43 days from 33 days in Q4. While the increase in DSOs might be a bit of concern for some, the 33 days in Q4 was an anomaly and likely a matter of timing of sales, billings and receipts. Looking over the past 15 quarters, the 43 days was easily on the low end of the historical range.

Inventory turns remained flat a 2.00.

Cash Flow Statement

Operational cash flow in the quarter was negative by about $3.7 million. The negative operational cash flow was largely due to the increase in receivables and to a lesser extent the increase in inventories. Given the acceleration of sales in the quarter, I am not overly concerned about either of these items. The increase in receivables was likely the result of both the jump in sales and the timing of shipments, billings, and receipts. Nonetheless, this is something worth watching in the coming quarters.

Other Thoughts

Hurco would seemingly make a nice acquisition for a foreign machine tool manufacturer for a number of reasons:

1) Strong balance sheet
2) High level of international sales
3) Winmax could be leveraged across the acquirer’s products
4) Strength of foreign currency relative to the dollar would make Hurco cheaper
5) Progress already being made in emerging markets (China, India, Eastern Europe, etc.)

I am not sure a buyout would be in the best interest of long-term shareholders but the prospect is at least interesting.

As an alternative to being acquired, Hurco could be on the prowl for an acquisition. The recently announced mixed shelf and the language in the recent 10Q suggest that an acquisition is a very real possibility.

Here is the language from the Executive Overview section of the 10Q:

“Our introduction of new, technologically advanced products, combined with our expansion into new markets, has resulted in our significant growth over the last several years. In addition to this strong organic growth, our recent performance and current financial strength also provide us with the capability to pursue opportunistic acquisitions that are consistent with our strategic focus on expanding our product line and entering new markets.”

And, from the Liquidity and Capital Resources section of the 10Q:

“Although we have not made any significant acquisitions in the recent past, we continue to receive information on businesses and assets, including intellectual property assets that are being sold. Should attractive opportunities arise, we believe that our earnings, cash flow from operations, borrowings under our bank credit facilities, and the sale of securities from our shelf registration would provide sufficient resources to finance any such possible acquisitions.”

Disclosure

I am a long-term holder of Hurco. As always do your own DD and don’t rely on my BS as a basis for making investment decision.

Good luck!
Tuff