HURCO COMPANIES, INC.
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 consolidated
financial statements and the notes thereto included elsewhere in this report.
The following MD&A generally focuses on the operating results and year-over-year
comparisons between fiscal years 2022 and 2021. Discussion of fiscal year 2020
results and year-over-year comparisons between fiscal years 2021 and 2020 that
are not included in this Annual Report on Form 10-K can be found in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal
year ended October 31, 2021 , filed with the SEC on January 7, 2022 .
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, and notes thereto, that appear elsewhere in this report.
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The market for machine tools is international in scope. We have both significant
foreign sales and significant foreign manufacturing operations. During fiscal
year 2022, approximately 50% 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 is our
wholly-owned subsidiary that provides automation solutions. In addition, through
our wholly-owned subsidiary LCM, we produce high value machine tool components
and accessories.
We principally sell our products through approximately 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 , the Czech Republic , 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.
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.
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.
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We operate in the industrial equipment industry and have a global footprint that subjects us to various business risks in many different countries. As a result of the global COVID-19 pandemic, beginning in early 2020, governmental authorities in many of the major global machine tool markets implemented mandatory stay-at-home or shelter orders requiring most businesses to close or to significantly limit operations, resulting in a sudden decrease in demand for many goods and services. Although the mandatory stay-at-home or shelter orders in many jurisdictions permitted our local operations to continue as an essential business or a supplier to critical infrastructure industries or otherwise with remote work capabilities, many of our customers experienced, and continue to experience, significant disruptions in their business operations and normal purchasing cycles. 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 with regard to revenues, income from operations, and cash flow from operations and could continue to be material in the near future. To date, we have experienced some delays 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 have also implemented adjustments in headcount and discretionary spending, delayed capital expenditures, and monitored production activities closely in an effort to weather the adverse business climate. We also received stimulus in various countries to support operations and implemented tax deferrals and provisions that were available to us. We also experienced inflationary pressures and input cost increases in our supply chains on components for our products. We have also seen capacity for transportation and freight services limited significantly by container or vessel availability and delays at departing and receiving ports, all of which have contributed to significantly increased costs and prices associated with the global shipment of our products. The COVID-19 pandemic did not have as significant an impact on our business and industry during fiscal year 2022 as it did in fiscal years 2020 and 2021. However, intermittent lockdowns and similar restrictions in certain markets from time to time continue to impact our business, including those inChina pursuant to its zero- tolerance COVID policy. 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.
Results of Operations
The following table presents, for the fiscal years indicated, selected items
from the Consolidated Statements of Operations expressed as a percentage of our
worldwide sales and service fees and the year-to-year percentage changes in the
dollar amounts of those items.
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Percentage of Revenues Year-to-Year % Change
2022 2021 2020 Increase/Decrease
'22 vs. '21 '21 vs. '20
Sales and service fees 100 % 100 % 100 % 7 % 38 %
Gross profit 26 % 24 % 21 % 15 % 54 %
Selling, general and
administrative expenses 21 % 20 % 24 % 12 % 11 %
Goodwill impairment - - 3 % - (100) %
Operating income (loss) 5 % 4 % (6) % 24 % 204 %
Net income (loss) 3 % 3 % (4) % 22 % 208 %
Fiscal Year 2022 Compared to Fiscal Year 2021
Sales and Service Fees. Sales and service fees for fiscal year 2022 were$250.8 million , an increase of$15.6 million , or 7%, compared to fiscal year 2021, and included an unfavorable currency impact of$13.9 million , or 6%, when translating foreign sales toU.S. Dollars for financial reporting purposes.
The following table sets forth net sales and service fees by geographic region for the fiscal years endedOctober 31, 2022 and 2021 (dollars in thousands): Fiscal Year Ended October 31, Increase/Decrease 2022 2021 Amount % Americas$ 95,964 38 %$ 86,301 37 %$ 9,663 11 % Europe 126,050 50 % 117,522 50 % 8,528 7 % Asia Pacific 28,800 12 % 31,372 13 % (2,572) (8) % Total$ 250,814 100 %$ 235,195 100 %$ 15,619 7 % Sales in theAmericas for fiscal year 2022 increased by 11%, compared to fiscal year 2021, primarily due to inflationary price increases and an increased volume of shipments of VM and higher-performance five-axisHurco machines. European sales for fiscal year 2022 increased by 7%, compared to fiscal year 2021, and included an unfavorable currency impact of 11%, when translating foreign sales toU.S. Dollars for financial reporting purposes. This increase was primarily driven by inflationary price increases, an increased volume of shipments of higher-performanceHurco , Takumi, and Milltronics machines across the European region, as well as increased sales of electro-mechanical components and accessories manufactured by LCM. Asian Pacific sales for fiscal year 2022 decreased by 8%, compared to fiscal year 2021, and included an unfavorable currency impact of 3%, when translating foreign sales toU.S. Dollars for financial reporting purposes. The year-over-year decrease in Asian Pacific sales primarily resulted from a reduced volume of shipments ofHurco and Takumi machines inChina andSoutheast Asia , partially offset by an increased volume of shipments ofHurco machines inIndia . The reduced volume of shipments ofHurco and Takumi machines inChina was primarily due to recent COVID-19 lockdowns and similar restrictions in major Chinese markets pursuant to China's zero-tolerance COVID-19 policy. 35
The following table sets forth net sales and service fees by product group and
services for the fiscal years ended
Fiscal Year Ended October 31, Increase/Decrease
2022 2021 Amount %
Computerized Machine
Tools $ 211,804 85 % $ 198,602 85 % $ 13,202 7 %
Computer Control Systems
and Software † 2,634 1 % 2,528 1 % 106 4 %
Service Parts 28,219 11 % 26,425 11 % 1,794 7 %
Service Fees 8,157 3 % 7,640 3 % 517 7 %
Total $ 250,814 100 % $ 235,195 100 % $ 15,619 7 %
† 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 computer control systems and software for fiscal year 2022 increased by 7% and 4%, respectively, compared to fiscal year 2021, primarily due to inflationary price increases and an increased volume of shipments of VM and higher-performance five-axisHurco machines inNorth America andEurope . Sales of service parts for fiscal year 2022 increased by 7%, compared to fiscal year 2021, due mainly to inflationary price increases and an increased volume of aftermarket sales inNorth America and theUnited Kingdom . Service fees increased by 7% during fiscal year 2022, compared to fiscal year 2021, primarily due to increased aftermarket service forHurco and Takumi machines throughoutEurope . During fiscal year 2022, sales for all product categories included an unfavorable currency impact of 6%, when translating foreign sales toU.S. Dollars for financial reporting purposes. Orders and Backlog. Orders for fiscal year 2022 were$240.9 million , a decrease of$24.5 million , or 9%, compared to fiscal year 2021, and included an unfavorable currency impact of$14.3 million , or 5%, when translating foreign orders toU.S. Dollars.
The following table sets forth new orders booked by geographic region for the
fiscal years ended
Fiscal Year Ended October 31, Increase/Decrease
2022 2021 Amount %
Americas $ 92,268 38 % $ 95,767 36 % $ (3,499) (4) %
Europe 122,556 51 % 133,802 50 % (11,246) (8) %
Asia Pacific 26,107 11 % 35,852 14 % (9,745) (27) %
Total $ 240,931 100 % $ 265,421 100 % $ (24,490) (9) %
Orders in the Americas for fiscal year 2022 decreased by 4%, compared to fiscal
year 2021, primarily due to decreased customer demand for Hurco and Milltronics
machines, partially offset by inflationary price increases implemented during
fiscal year 2022. Despite the year-over-year decrease in total machine order
volume, machine orders for Hurco lathes and higher-performance five-axis
machines increased during the fiscal year.
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European orders for fiscal year 2022 decreased by 8%, compared to fiscal year
2021, and included an unfavorable currency impact of 10%, when translating
foreign orders to U.S. Dollars. This decrease was primarily attributable to the
negative impact of currency and decreased customer demand for electro-mechanical
components manufactured by LCM and for Hurco machines in the United Kingdom ,
France , and Italy , partially offset by inflationary price increases implemented
during fiscal year 2022 and increased demand for Hurco and Takumi machines in
Germany and for Milltronics machines across the region.
Asian Pacific orders for fiscal year 2022 decreased by 27%, compared to fiscal
year 2021, and included an unfavorable currency impact of 4%, when translating
foreign orders to U.S. Dollars. The decrease in Asian Pacific orders
year-over-year was driven primarily by decreased customer demand for Hurco and
Takumi machines in China and Southeast Asia due to recent COVID-19 lockdowns and
similar restrictions, partially offset by increased demand for Hurco machines in
India .
Backlog at October 31, 2022 decreased to $44.8 million from $60.0 million at
October 31, 2021 , primarily due to decreased customer demand during fiscal year
2022 for all product brands and in all regions where our customers are located.
We do not believe backlog is a useful measure of past performance or indicative
of future performance. Backlog orders as of October 31, 2022 are expected to be
fulfilled in fiscal year 2023.
Gross Profit. Gross profit for fiscal year 2022 was $64.5 million , or 26% of
sales, compared to $56.2 million , or 24% of sales, for fiscal year 2021. During
fiscal year 2021, we recorded approximately $1.2 million , or 1% of sales, for
the employee retention credit extended to companies under the Economic Aid to
Hard-Hit Small Businesses, Nonprofits, and Venues Act and the American Rescue
Plan Act of 2021 (the "employee retention credit"). While the employee retention
credit did not recur in fiscal year 2022, gross profit as a percentage of sales
benefited from increased sales of higher-performance machines, improved leverage
of fixed overhead costs and inflationary price increases implemented during
fiscal year 2022.
Operating Expenses. Selling, general, and administrative expenses for fiscal
year 2022 were $51.7 million , or 21% of sales, compared to $46.0 million , or 20%
of sales, for fiscal year 2021, and included a favorable currency impact of $2.2
million , when translating foreign expenses to U.S. Dollars for financial
reporting purposes. The year-over-year increase in selling, general, and
administrative expenses was driven primarily by increases in marketing and
tradeshow expenses (particularly related to the International Manufacturing
Technology Show in September 2022 ), sales commissions, and employee benefit and
compensation costs, as well as increased one-time costs for administrative
services. The increase in selling, general, and administrative expenses
year-over-year also reflected the employee retention credit recorded in those
expenses in fiscal year 2021 of $1.7 million , or 1% of sales.
Operating Income (Loss). Operating income for fiscal year 2022 was $12.7
million , or 5% of sales, compared to an operating income of $10.2 million , or 4%
of sales, for fiscal year 2021. The year-over-year increase in operating income
for fiscal year 2022 was primarily due to increased sales of higher-performance
machines and inflationary price increases implemented during fiscal year 2022.
Operating income for fiscal year 2021 included a benefit of $2.9 million related
to the employee retention credit.
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Other Expense, Net. Other expense, net for fiscal year 2022 increased by $1.3
million from fiscal year 2021, due mainly to an increase in foreign currency
exchange losses.
Provision for Income Taxes. We recorded an income tax expense of $3.7 million
for fiscal year 2022, compared to income tax expense of $3.4 million for fiscal
year 2021. Our effective tax rate for fiscal year 2022 was 31%, compared to 33%
for fiscal year 2021. The year-over-year change in the effective tax rate was
primarily due to changes in geographic mix of income and loss that includes
jurisdictions with differing tax rates, various discrete tax items, and changes
in income tax laws to address the unfavorable impact of the COVID-19 pandemic.
Net Income (Loss). Net income for fiscal year 2022 was $8.2 million , or $1.23
per diluted share, compared to $6.8 million , or $1.01 per diluted share, for
fiscal year 2021. The year-over-year increase in net income was primarily due
to increased sales of higher-performance machines and inflationary price
increases implemented during fiscal year 2022.
Liquidity and Capital Resources
AtOctober 31, 2022 , we had cash and cash equivalents of$63.9 million , compared to$84.1 million atOctober 31, 2021 . The decrease in cash and cash equivalents was primarily a result of increases in inventories. Approximately 31% of our$63.9 million of cash and cash equivalents is held in theU.S. The balance is 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 (including cash and cash equivalents) was$194.7 million atOctober 31, 2022 , compared to$208.7 million atOctober 31, 2021 . The decrease in working capital was primarily driven by decreases in cash and cash equivalents, prepaid assets, and accounts receivable, partially offset by an increase in inventories and decreases in accounts payable and customer deposits. Inventories, net were$156.2 million atOctober 31, 2022 , compared to$148.2 million atOctober 31, 2021 . Inventory turns atOctober 31, 2022 of 1.2 remained the same as that atOctober 31, 2021 . Capital expenditures were$2.2 million in fiscal year 2022, compared to$2.4 million in fiscal year 2021. Capital expenditures for fiscal year 2022 were primarily for software development costs, purchases of factory equipment for production facilities, and purchases of general software and equipment for sales and service divisions. We funded these expenditures with cash flows from operations. OnMarch 12, 2021 , we announced that our Board of Directors approved a share repurchase program in an aggregate amount of up to$7.0 million . Repurchases under the program may be made in the open market or through privately-negotiated transactions from time to time throughMarch 10, 2023 , subject to applicable laws, regulations and contractual provisions. The program may be amended, suspended or discontinued at any time and does not commit us to repurchase any shares of our common stock. During fiscal year 2022, we repurchased$2.9 million in shares of our common stock, and$4.1 million remained available under the program as ofJanuary 6, 2023 . 38 OnJanuary 6, 2023 , we announced that our Board of Directors approved an additional share repurchase program in an aggregate amount of up to$25.0 million . Repurchases under the program may be made in the open market or through privately negotiated transactions from time to time throughNovember 10, 2024 , subject to applicable laws, regulations and contractual provisions. The program may be amended, suspended, or discontinued at any time and does not commit us to repurchase any shares of our common stock. In addition, during fiscal year 2022, we paid cash dividends to our shareholders equal to$3.9 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. OnDecember 31, 2018 , we and our subsidiaryHurco B.V. entered into a credit agreement withBank of America, N.A ., as the lender, which was subsequently amended on each ofMarch 13, 2020 ,December 23, 2020 ,December 17, 2021 , andJanuary 4, 2023 (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 subsidiaryHurco 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 andHurco B.V. are borrowers, and certain of our other subsidiaries are guarantors. The scheduled maturity date of the 2018 Credit Agreement isDecember 31, 2023 . Borrowings under the 2018 Credit Agreement bear interest at floating rates based on, at our option, either (i) a rate based upon the secured overnight financing rate ("SOFR"), the Sterling Overnight Index Average Reference Rate, the Euro Interbank Offering Rate, or another alternative currency-based rate approved by the lender, depending on the term of the loan and the currency in which such loan is denominated, plus 1.00% 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 SOFR-based rate plus 1.00%), plus 0.00% per annum. Outstanding letters of credit will carry an annual rate of 1.00%. 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$25.0 million ; (3) requiring that we maintain a minimum working capital of$125.0 million ; and (4) requiring that we maintain a minimum tangible net worth of$176.5 million . We may use the proceeds from advances under the 2018 Credit Agreement for general corporate purposes. InMarch 2019 , our wholly-owned subsidiaries inTaiwan , HML, and China, NHML, closed on uncommitted revolving credit facilities with maximum aggregate amounts of150 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.
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As of October 31, 2022 , our existing credit facilities consisted of the €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 October 31,
2022 .
At
We have an international cash pooling strategy that generally provides access to available cash deposits and credit facilities when needed in theU.S. ,Europe , orAsia 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 beyond 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 remain committed to a balanced capital allocation strategy that prioritizes a strong balance sheet and liquidity position while recognizing the importance of accretive growth and returning value to shareholders through dividends and stock repurchases, where appropriate. As such, we continue to actively evaluate acquisition opportunities that support our long-term strategic plan.
Contractual Obligations and Commitments
The following is a table of contractual obligations and commitments as of
Payments Due by Period
More
Less than than
Total 1 Year 1-3 Years 3-5 Years 5 Years
Operating leases $ 9,092 $ 4,132 $ 3,477 $ 986 $ 497
Accrued and deferred taxes and
credits 5,444 38 802 509 4,095
Total $ 14,536 $ 4,170 $ 4,279 $ 1,495 $ 4,592 In addition to the contractual obligations and commitments disclosed above, we also have a variety of other obligations for the procurement of materials and services, none of which subject us to any material non-cancelable commitments. While some of these obligations arise under long-term supply agreements, we are not committed under these agreements to accept or pay for requirements that are not needed to meet our production needs. We have no material minimum purchase commitments or "take-or-pay" type agreements or arrangements. Unrecognized tax benefits in the amount of approximately$0.1 million , excluding any interest and penalties, have been excluded from the table above because we are unable to determine a reasonably reliable estimate of the timing of future payment. We expect capital spending in fiscal year 2023 to be approximately$3.7 million , which includes investments for software development, leasehold improvement, factory equipment, and production facilities, as well as general software and equipment for selling facilities. We expect to fund these commitments with cash on hand and cash generated from operations. 40
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 followFinancial Accounting Standards Board ("FASB") guidance for accounting for guarantees (codified in Accounting Standards Codification ("ASC") 460). As ofOctober 31, 2022 , we had nine outstanding third party payment guarantees totaling approximately$0.7 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.
Critical Accounting Estimates
Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance withU.S. Generally Accepted Accounting Principles. The preparation of financial statements in conformity with those accounting principles requires us to make judgments and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Our accounting policies are frequently evaluated as our judgment and estimates are based upon historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Our judgments and estimates have a significant effect on the financial statements because they result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Actual results could differ from those estimates and such differences could be material to our financial condition and results of operations. Critical accounting estimates are those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition and results of operations. While our significant accounting policies are more fully described in Note 1 to our consolidated financial statements included elsewhere in this report, we believe the following discussion addresses our most critical accounting estimates, which involve significant subjectivity and judgment, and changes to such estimates or assumptions could have a material impact on our financial condition or operating results. Therefore, we consider an understanding of the variability and judgment required in making these estimates and assumptions to be critical in fully understanding and evaluating our reported financial results.Goodwill and Intangible Assets.Goodwill and indefinite-lived intangibles arising from a business combination are reviewed for impairment annually as of the last day of our third fiscal quarter, or more frequently, if circumstances arise indicating potential impairment. We have no goodwill as ofOctober 31, 2022 . Other indefinite-lived intangible assets primarily consist of trademarks and trade names and are not material to our consolidated financial statement. Finite-lived intangible assets are amortized over their estimated useful lives and are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount may not be recovered through future net cash flows generated by the assets. We are not aware of any events or changes in circumstances that indicate the carrying value of its finite-lived assets may not be recoverable. Impairment of Long-Lived Assets - We are required periodically to review the recoverability of certain assets, including property, plant, and equipment, intangible assets, and goodwill, based on projections of anticipated future cash flows, including future profitability assessments of various product lines. We estimate cash flows using internal budgets based on recent sales data. We are not aware of any events or changes in circumstances that indicate the carrying value of our long-lived assets may not be recoverable. 41 Inventories and Related Reserves - We determine at each balance sheet date how much, if any, of our inventory may ultimately prove to be either unsalable or unsalable at its carrying cost. Reserves are established to effectively adjust the carrying value of such inventory to lower of cost (first-in, first-out method) or net realizable value. To determine the appropriate level of valuation reserves, we evaluate current stock levels in relation to historical and expected patterns of demand for all of our products. We evaluate the need for changes to valuation reserves based on market conditions, competitive offerings, and other factors on a regular basis. We have not experienced substantive write-offs due to obsolescence. Income Taxes - We account for income taxes and the related accounts under the asset and liability method. Deferred tax assets and liabilities are measured using enacted income tax rates in each jurisdiction in effect for the year in which the temporary differences are expected to be recovered or settled. These deferred tax assets are reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. We operate in multiple jurisdictions through wholly-owned subsidiaries, and our global structure is complex. The estimates of our uncertain tax positions involve judgments and assessment of the potential tax implications. We recognize uncertain tax positions when it is more likely than not that the tax position will be sustained upon examination by relevant taxing authorities, based on the technical merits of the position. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Accordingly, the ultimate outcome with respect to taxes we may owe may differ from the amounts recognized. Our judgment regarding the realization of deferred tax assets may change due to future profitability and market conditions, change inU.S. or foreign tax laws, and other factors. These changes, if any, may require material adjustments to these deferred tax assets and an accompanying reduction or increase in net income in Capitalized Software Development Costs - Costs incurred to develop computer software products and significant enhancements to software features of existing products are capitalized as required by FASB guidance relating to accounting for the costs of computer software to be sold, leased, or otherwise marketed, and such capitalized costs are amortized over the estimated product life of the related software. The determination as to when in the product development cycle technological feasibility has been established, and the expected product life, require judgments and estimates by management and can be affected by technological developments, innovations by competitors, and changes in market conditions affecting demand. We periodically review the carrying values of these assets and make judgments as to ultimate realization considering the above-mentioned risk factors. Derivative Financial Instruments - Critical aspects of our accounting policy for derivative financial instruments that we designate as hedging instruments include conditions that require that critical terms of a hedging instrument are essentially the same as a hedged forecasted transaction. Another important element of our policy demands that formal documentation be maintained as required by FASB guidance relating to accounting for derivative instruments and hedging activities. Failure to comply with these conditions would result in a requirement to recognize changes in market value of hedge instruments in earnings. We routinely monitor significant estimates, assumptions, and judgments associated with derivative instruments and compliance with formal documentation requirements. Stock Compensation - We account for share-based compensation according to FASB guidance relating to share-based payments, which requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors based on estimated fair values on the grant date. This guidance requires that we estimate the fair value of share-based awards on the date of grant and recognize as expense the value of the portion of the award that is ultimately expected to vest over the requisite service period. 42
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