HURCO COMPANIES, INC. 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 and 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 that appear elsewhere in this report. The market for machine tools is international in scope. We have both significant foreign sales and significant foreign manufacturing operations. During fiscal 2019, approximately 51% of our revenues were attributable to customers inEurope , 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 theAsia Pacific region, where we encounter greater price 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/mold, aerospace and medical industries. Takumi machines are equipped with industry standard controls instead of the proprietary controls found onHurco and Milltronics machines. ProCobots is our wholly-owned subsidiary that provides automation solutions that can be integrated with any machine tool. In addition, through our wholly-owned subsidiary LCM, we produce high value machine tool components and accessories. We principally sell our products through more than 190 independent agents and distributors throughout theAmericas ,Europe andAsia . 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 inChina ,France ,Germany ,India ,Italy ,Poland ,Singapore , Taiwan, theUnited Kingdom and certain parts ofthe 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 inTaiwan , HML. Machine castings to support HML's production are manufactured at our wholly-owned subsidiary inNingbo, 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 inItaly , 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 NewTaiwan Dollar and theU.S. Dollar. Changes in currency exchange rates may have a material effect on our operating results and consolidated financial statements as reported underU.S. Generally Accepted Accounting Principles. For example, when theU.S. Dollar weakens in value relative to a foreign currency, sales made, and expenses incurred, in that currency when translated toU.S. Dollars for reporting in our financial statements, are higher than would be the case when theU.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 toU.S. Dollars at exchange rates prevailing during the period covered by those financial statements. 26 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. Results of Operations The following table presents, for the fiscal years indicated, selected items from the Consolidated Statements of Income 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. Percentage of Revenues Year-to-Year % Change 2019 2018 2017 Increase/Decrease '18 vs. '19 vs. '18 '17 Sales and service fees 100 % 100 % 100 % -12 % 23 % Gross profit 29 % 31 % 29 % -16 % 30 % Selling, general and administrative expenses 21 % 19 % 20 % -6 % 17 % Operating income 9 % 11 % 9 % -33 % 62 % Net income 7 % 7 % 6 % -19 % 42 %
Fiscal 2019 Compared to Fiscal 2018
Sales and Service Fees. Sales and service fees for fiscal 2019 were
The following table sets forth net sales and service fees by geographic region for the fiscal years endedOctober 31, 2019 and 2018 (dollars in thousands): Fiscal Year Ended October 31, Increase/Decrease 2019 2018 Amount % Americas$ 99,064 37 %$ 90,902 30 %$ 8,162 9 % Europe 133,675 51 % 166,202 55 % (32,527 ) -20 % Asia Pacific 30,638 12 % 43,567 15 % (12,929 ) -30 % Total$ 263,377 100 %$ 300,671 100 %$ (37,294 ) -12 % Sales in theAmericas for fiscal 2019 increased by 9%, compared to fiscal 2018, primarily attributable to sales of vertical milling machines from aU.S. machine tool distributor inCalifornia acquired byHurco in the fourth quarter of fiscal 2018. European sales for fiscal 2019 decreased by 20%, compared to fiscal 2018, and included an unfavorable currency impact of 4%, when translating foreign sales toU.S. Dollars for financial reporting purposes. The decrease in European sales for fiscal 2019 was primarily attributable to a reduced volume of shipments ofHurco machines inGermany and theUnited Kingdom , as well as a decrease in sales of electro-mechanical components and accessories manufactured by our wholly-owned subsidiary inItaly , LCM. Asian Pacific sales for fiscal 2019 decreased by 30%, compared to fiscal 2018, and included an unfavorable currency impact of 2%, when translating foreign sales toU.S. Dollars for financial reporting purposes. The decrease in Asian Pacific sales for fiscal 2019 was primarily attributable to decreased shipments ofHurco vertical milling machines and Takumi bridge mill machines inChina , partially offset by increased shipments ofHurco vertical milling machines inIndia . 27
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
2019 2018 Amount %
Computerized Machine Tools $ 223,735 85 % $ 261,710 87 % $ (37,975 ) -15 %
Computer Control Systems
and Software † 2,818 1 % 2,870 1 % (52 ) -2 %
Service Parts 27,854 11 % 27,501 9 % 353 1 %
Service Fees 8,970 3 % 8,590 3 % 380 4 %
Total $ 263,377 100 % $ 300,671 100 % $ (37,294 ) -12 %
† 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 2019 decreased by 15% and 2%, respectively, and each included an unfavorable currency impact of 3%, compared to fiscal 2018. The year-over-year decrease in sales of computerized machine tools and computer control systems and software were mainly due to decreased sales ofHurco and Takumi machines inGermany , theUnited Kingdom and China, as well as a decrease in sales of electro-mechanical components and accessories manufactured by LCM, partially offset by an increase in sales of vertical milling machines from theU.S. machine tool distributor inCalifornia acquired byHurco in the fourth quarter of fiscal 2018. Sales of service parts and service fees for fiscal 2019 increased by 1% and 4%, respectively, compared to fiscal 2018, due primarily to an increase in aftermarket sales and aftermarket service ofHurco products
inNorth America .
Orders and Backlog. Orders for fiscal 2019 were$241.1 million , a decrease of$64.7 million , or 21%, compared to fiscal 2018, and included an unfavorable currency impact of$8.5 million , or 3%, when translating foreign orders to
U.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
2019 2018 Amount %
Americas $ 89,136 37 % $ 94,160 31 % $ (5,024 ) -5 %
Europe 120,191 50 % 170,366 56 % (50,175 ) -29 %
Asia Pacific 31,779 13 % 41,319 13 % (9,540 ) -23 %
Total $ 241,106 100 % $ 305,845 100 % $ (64,739 ) -21 %
Orders in theAmericas for fiscal 2019 decreased by 5%, compared to fiscal 2018, primarily due to the fact that fiscal 2018 reflected orders resulting from year-end promotional activities following theSeptember 2018 International Manufacturing Technology Show ("IMTS"), which is held every two years. The decrease in orders for fiscal 2019, compared to fiscal 2018, was partially offset by increased customer demand for vertical milling machines from the distributor inCalifornia acquired in the fourth quarter of fiscal 2018 and increased customer demand for automation and integration systems from ProCobots, aU.S. -based automation integration company acquired byHurco in the fourth quarter of fiscal 2019. European orders for fiscal 2019 decreased by 29%, compared to fiscal 2018, and included an unfavorable currency impact of 4%, when translating foreign orders toU.S. Dollars. The year-over-year decrease in orders was driven primarily by decreased customer demand forHurco and Takumi machines inGermany andItaly , as well as a decrease in customer demand for electro-mechanical components and accessories manufactured by LCM. Asian Pacific orders for fiscal 2019 decreased by 23%, compared to fiscal 2018, and included an unfavorable currency impact of 3%, when translating foreign orders toU.S. Dollars, due mainly to decreased customer demand forHurco and Takumi machines inChina andIndia . 28 Backlog atOctober 31, 2019 decreased to$32.7 million from$55.0 million atOctober 31, 2018 , primarily due to a reduction in customer demand during fiscal 2019. We do not believe backlog is a useful measure of past performance or indicative of future performance. Backlog orders as ofOctober 31, 2019 are expected to be fulfilled in fiscal 2020. Gross Profit. Gross profit for fiscal 2019 was$77.2 million , or 29% of sales, compared to$91.8 million , or 31% of sales, for fiscal 2018. The year-over-year decrease in gross profit as a percentage of sales was primarily due to lower sales of more complex, higher-performance machines in the European sales region, the impact of fixed costs on lower sales and production volume, and competitive pricing pressures on a global basis. Operating Expenses. Selling, general and administrative expenses for fiscal 2019 were$54.7 million , or 21% of sales, compared to$58.0 million , or 19% of sales, in fiscal 2018, and included a favorable currency impact of$1.5 million , when translating foreign expenses toU.S. Dollars for financial reporting purposes. The year-over-year reduction in selling, general and administrative expenses were primarily due to a decrease in tradeshow expenses associated with theSeptember 2018 IMTS, decreased variable employee compensation and other operating expense reductions implemented during fiscal 2019, partially offset by increased operating expenses associated with theU.S. companies we acquired in the fourth quarter of fiscal 2018 and the fourth quarter of fiscal 2019. Operating Income. Operating income for fiscal 2019 was$22.5 million , or 9% of sales, compared to$33.8 million , or 11% of sales, in fiscal 2018. The year-over-year decrease in operating income was due to an overall reduction in sales volume year-over-year, particularly inEurope where our more complex, higher performance machines are primarily sold, as well as increased operating expenses associated with theU.S. companies we acquired in the fourth quarter of fiscal 2018 and the fourth quarter of fiscal 2019, partially offset by a reduction in other selling, general and administrative expenses . Other Expense, Net. Other expense, net for fiscal 2019 decreased by$1.8 million from fiscal 2018, due mainly to a reduction in foreign currency exchange losses in fiscal 2019, compared to fiscal 2018. Provision for Income Taxes. Our effective tax rate for fiscal 2019 was 25%, compared to 34% in fiscal 2018. The year-over-year decrease in the effective tax rate for fiscal 2019 principally resulted from the favorable impact of certainU.S. tax reform provisions available in the current fiscal year, including the full year impact of a lowerU.S. corporate tax rate from 35% to 21%, a new deduction attributable to Foreign-Derived Intangible Income ("FDII") and the benefit of foreign tax credits included in these tax reform provisions. In addition, the year-over year changes in the effective tax rates included a shift in geographic mix of income and loss among tax jurisdictions. The effective tax rate for fiscal 2018 included one-time charges of$2.9 million related to theU.S. Tax Cuts and Jobs Act that was enacted inDecember 2017 . Net Income. Net income for fiscal 2019 was$17.5 million , or$2.55 per diluted share, a decrease of$4.0 million , or 19%, from fiscal 2018 net income of$21.5 million , or$3.15 per diluted share.
Fiscal 2018 Compared to Fiscal 2017
Sales and Service Fees. Sales and service fees for fiscal 2018 were
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The following table sets forth net sales and service fees by geographic region for the fiscal years endedOctober 31, 2018 and 2017 (dollars in thousands): Fiscal Year Ended October 31, Increase/Decrease 2018 2017 Amount % Americas$ 90,902 30 %$ 75,540 31 %$ 15,362 20 % Europe 166,202 55 % 133,671 55 % 32,531 24 % Asia Pacific 43,567 15 % 34,456 14 % 9,111 26 % Total$ 300,671 100 %$ 243,667 100 %$ 57,004 23 %
Sales in theAmericas for fiscal 2018 increased by 20%, compared to fiscal 2017, due primarily to improved U.S. market conditions and increased demand fromU.S. customers for theHurco and Milltronics product lines. The increase in sales year-over-year was attributable to an increased sales volume of vertical milling and lathe machines from all product lines (Hurco , Milltronics and Takumi). European sales for fiscal 2018 increased by 24%, compared to fiscal 2017, and included a favorable currency impact of 7%, when translating foreign sales toU.S. Dollars for financial reporting purposes. The increase in European sales for fiscal 2018 resulted mainly from increased customer demand forHurco and Takumi machines inGermany ,France and theUnited Kingdom , as well as increased customer demand for electro-mechanical components and accessories manufactured by our wholly-owned subsidiary, LCM. Asian Pacific sales for fiscal 2018 increased by 26%, compared to fiscal 2017, and included a favorable currency impact of 3%, when translating foreign sales toU.S. Dollars for financial reporting purposes. The increase in Asian Pacific sales for fiscal 2018 was primarily attributable to increased customer demand forHurco and Takumi machines in all Asian Pacific countries where our customers are located, particularly inChina , the largest market for consumption of machines tools
in the world.
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
2018 2017 Amount %
Computerized Machine Tools $ 261,710 87 % $ 209,311 86 % $ 52,399 25 %
Computer Control Systems
and Software † 2,870 1 % 2,324 1 % 546 23 %
Service Parts 27,501 9 % 24,255 10 % 3,246 13 %
Service Fees 8,590 3 % 7,777 3 % 813 10 %
Total $ 300,671 100 % $ 243,667 100 % $ 57,004 23 %
† 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 2018 increased by 25% and 23%, respectively, and each included a favorable currency impact of 4%, compared to fiscal 2017. The year-over-year increase in sales of computerized machine tools and computer control systems and software reflected increased machine sales across all three regions and product lines. Sales of service parts and service fees for fiscal 2018 increased by 13% and 10%, respectively, compared to fiscal 2017, due primarily to an increase in aftermarket sales and aftermarket service ofHurco products inNorth America ,France and theUnited Kingdom .
Orders and Backlog. Orders for fiscal 2018 were a record
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The following table sets forth new orders booked by geographic region for the
fiscal years ended
Fiscal Year Ended October 31, Increase/Decrease
2018 2017 Amount %
Americas $ 94,160 31 % $ 85,070 33 % $ 9,090 11 %
Europe 170,366 56 % 137,622 53 % 32,744 24 %
Asia Pacific 41,319 13 % 37,917 14 % 3,402 9 %
Total $ 305,845 100 % $ 260,609 100 % $ 45,236 17 %
Orders in theAmericas for fiscal 2018 increased by 11%, compared to fiscal 2017. The increase was largely attributable to improved customer demand forHurco and Takumi vertical milling and lathe machines. European orders for fiscal 2018 increased by 24%, compared to fiscal 2017, and included a favorable currency impact of 9%, when translating foreign orders toU.S. Dollars. The year-over-year increase in European orders was largely driven by increased customer demand forHurco and Takumi vertical milling and lathe machines inGermany andFrance , as well as increased demand for electro-mechanical components and accessories manufactured by LCM. Asian Pacific orders for fiscal 2018 increased by 9%, compared to fiscal 2017, and included a favorable currency impact of 3%, when translating foreign orders toU.S. Dollars. The year-over-year increase in Asian Pacific orders was largely due to increased customer demand forHurco vertical milling machines inIndia , China andSoutheast Asia .
Backlog at
Gross Profit. Gross profit for fiscal 2018 was$91.8 million , or 31% of sales, compared to$70.6 million , or 29% of sales, for fiscal 2017. The year-over-year increase in gross profit as a percentage of sales reflected increased machine sales across all three regions and product lines and the favorable impact of foreign currency translation compared to fiscal 2017. Operating Expenses. Selling, general and administrative expenses for fiscal 2018 were$58.0 million , or 19% of sales, compared to$49.7 million , or 20% of sales, in fiscal 2017, and included an unfavorable currency impact of$1.3 million , when translating foreign expenses toU.S. Dollars for financial reporting purposes. The year-over-year increase in selling, general and administrative expenses was driven by increased expenses for tradeshows, global sales and marketing, employee incentive compensation and the unfavorable impact of foreign currency translation compared to fiscal 2017.
Operating Income. Operating income for fiscal 2018 was
Other Income (Expense). Other income (expense) for fiscal 2018 increased by
Provision for Income Taxes. Our effective tax rate for fiscal 2018 was 34%, compared to 27% for fiscal 2017. The year-over-year increase in the effective tax rate for fiscal 2018 was primarily attributable to one-time charges of$2.8 million related to theU.S. Tax Cuts and Jobs Act that was enacted inDecember 2017 . The impact of these one-time charges increased the effective tax rate by approximately 39% for the first quarter of fiscal 2018. Excluding the impact of these charges, earnings per diluted share would have been$0.41 higher than the earnings per diluted share we reported for fiscal 2018. 31 Net Income. Net income for fiscal 2018 was$21.5 million , or$3.15 per diluted share, an increase of$6.4 million , or 42%, from fiscal 2017 net income of$15.1 million , or$2.25 per diluted share.
Liquidity and Capital Resources
AtOctober 31, 2019 , we had cash and cash equivalents of$56.9 million , compared to$77.2 million atOctober 31, 2018 . The decrease in cash and cash equivalents was primarily a result of a decrease in accounts receivable, partially offset by an increase in inventories year-over-year. Approximately 44% of our$56.9 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$207.2 million atOctober 31, 2019 , compared to$194.6 million atOctober 31, 2018 . The increase in working capital was mostly driven by an increase in inventories and a reduction in accounts payable. Inventories were$148.9 million atOctober 31, 2019 , compared to$137.6 million atOctober 31, 2018 . Inventory turns atOctober 31, 2019 were 1.3, compared to 1.6 turns atOctober 31, 2018 . Capital expenditures were$4.9 million in fiscal 2019, compared to$5.9 million in fiscal 2018. Capital expenditures for fiscal 2019 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.
The purchase price for the ProCobots acquisition has been preliminarily
allocated to the assets acquired and the liabilities assumed based on their fair
values, which approximated
OnDecember 7, 2012 , we entered into a credit agreement, which was subsequently amended onMay 9, 2014 ,June 5, 2014 ,December 5, 2014 andDecember 6, 2016 (as amended, the "2012 Credit Agreement") withJP Morgan Chase Bank , N.A that provided us with an unsecured revolving credit and letter of credit facility. The 2012 Credit Agreement terminated on its scheduled maturity date ofDecember 31, 2018 .
OnDecember 31, 2018 , we and our subsidiary,Hurco B.V. , entered into a new credit agreement (the "2018 Credit Agreement") withBank of America, N.A ., as the lender. The 2018 Credit Agreement replaced the 2012 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, 2020 . Borrowings under the 2018 Credit Agreement bear interest at floating rates based on, at our option, either (i) a LIBOR-based rate, or other alternative currency-based rate approved by the lender, plus 0.75% 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 LIBOR-based rate plus 1.00%), plus 0.00% per annum. Outstanding letters of credit will carry an annual rate of 0.75%. 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 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; (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$170.0 million .
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We may use the proceeds from advances under the 2018 Credit Agreement for general corporate purposes.
InDecember 2018 , in connection with our entry into the 2018 Credit Agreement, (1) using cash on hand, we repaid in full the$1.4 million outstanding under, and terminated, our credit facility inChina and (2) we terminated ourUnited Kingdom credit facility. 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 (the "Taiwan credit facility") and 32.5 million Chinese Yuan (the "China credit facility"), respectively. Both the Taiwan and China credit facilities have a final maturity date ofMarch 5, 2020 .
As a result, as ofOctober 31, 2019 , our existing credit facilities consist of our €1.5 million revolving credit facility inGermany , the150 million New Taiwan Dollars Taiwan credit facility, the 32.5 million ChineseYuan China credit facility and the$40.0 million revolving credit facility under the 2018 Credit Agreement. There were no borrowings under any of our credit facilities as ofOctober 31, 2019 , and we had$1.4 million of borrowings as ofOctober 31, 2018 . As ofOctober 31, 2019 , we were in compliance with the covenants contained in all of our credit facilities, and there was$51.2 million of available borrowing capacity thereunder. We believe our cash position and borrowing capacity under our credit facilities provide adequate liquidity to fund our operations over the next twelve months and allow us to remain committed to our strategic plan of product innovation and targeted penetration of developing markets. In the last six years, we have implemented a strategic plan to expand our market reach to more customers with more products on a global basis. While theHurco -branded computer control systems have been and continue to be our premium flagship product line, we have added other products to our portfolio that provide product diversity and market penetration opportunity, while minimizing the impact of geographic cyclicality, with products priced from entry-level to high performance serving a variety of different industries. We have not changed our overall strategy to design, manufacture and sell a comprehensive line of computerized machine tools; rather, we have enhanced this strategy through growth both organically and through acquisitions to ensure long-term stability and overall profitability.
We continue to receive and review information on businesses and assets for potential acquisition, including intellectual property assets that are available for purchase.
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Contractual Obligations and Commitments
The following is a table of contractual obligations and commitments as of
Payments Due by Period
Less than More than
Total 1 Year 1-3 Years 3-5 Years 5 Years
Operating leases $ 13,401 $ 4,015 $ 5,373 $ 2,213 $ 1,800 Accrued and deferred taxes and credits 6,188 133
639 506 4,911 Total$ 19,589 $ 4,148 $ 6,012 $ 2,719 $ 6,711
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$0.2 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 2020 to be approximately$12.4 million , which includes investments for real estate development, software development, 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.
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, 2019 , we had 21 outstanding third party payment guarantees totaling approximately$0.5 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 Policies and 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. Those 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. Our accounting policies, including those described below, 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. 34
Revenue Recognition - We recognize revenues from the sale of machine tools, components and accessories and services and reflect the consideration to which we expect to be entitled. We record revenues based on a five-step model in accordance with FASB guidance codified in ASC 606. In accordance with ASC 606, we have defined contracts as agreements with our customers and distributors in the form of purchase orders, packing or shipping documents, invoices, and, periodically, verbal requests for components and accessories. For each contract, we identify our performance obligations, which is delivering goods or services, determine the transaction price, allocate the contract transaction price to each of the performance obligations (when applicable), and recognize the revenue when (or as) the performance obligation to the customer is fulfilled. A good or service is transferred when the customer obtains control of that good or service. Our computerized machine tools are general purpose computer-controlled machine tools that are typically used in stand-alone operations. Prior to shipment, we test each machine to ensure the machine's compliance with standard operating specifications. We deem that the customer obtains control upon delivery of the product and that obtaining control is not contingent upon contractual customer acceptance. Therefore, we recognize revenue from sales of our machine tool systems upon delivery of the product to the customer or distributor, which is normally at the time of shipment. Depending upon geographic location, after shipment, a machine may be installed at the customer's facilities by a distributor, independent contractor or by one of our service technicians. In most instances, where a machine is sold through a distributor, we have no installation involvement. If sales are direct or through sales agents, we will typically complete the machine installation, which consists of the reassembly of certain parts that were removed for shipping and the re-testing of the machine to ensure that it is performing within the standard specifications. We consider the machine installation process for our three-axis machines to be inconsequential and perfunctory. For our five-axis machines that we install, we estimate the fair value of the installation performance obligation and recognize that installation revenue on a prorata basis over the period of the installation process. From time to time, and depending upon geographic location, we may provide training or freight services. We consider these services to be perfunctory within the context of the contract, as the value of these services typically does not rise to a material level as a component of the total contract value. Service fees from maintenance contracts are deferred and recognized in earnings on a prorata basis over the term of the contract and are generally sold on a stand-alone basis. Customer discounts and estimated product returns are considered variable consideration and are recorded as a reduction of revenue in the same period that the related sales are recorded. We have reviewed the overall sales transactions for variable consideration and have determined that these amounts are not significant. Inventories -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. 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. Net deferred tax assets and liabilities are classified as non-current in the consolidated financial statements. Our judgment regarding the realization of deferred tax assets may change due to future profitability and market conditions, changes 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 the period when such determinations are made. The determination of our provision for income taxes requires judgment, the use of estimates and the interpretation and application of complex federal, state and foreign tax laws. Our provision for income taxes reflects a combination of income earned and taxed at the federal and state level in theU.S. , as well as in various foreign jurisdictions. In addition to the risks to the effective tax rate described above, the future effective tax rate reflected in forward-looking statements is based on currently effective tax laws. Significant changes in those laws could materially affect these estimates. 35
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. Our tax positions are subject to audit by
taxing authorities across multiple global jurisdictions and the resolution of
such audits may span multiple years. Tax law is complex and often subject to
varied interpretations, accordingly, the ultimate outcome with respect to taxes
we may owe may differ from the amounts recognized.
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.
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.
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