SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

12 Months Ended

Oct. 31, 2016

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation. The consolidated financial statements include the accounts of Hurco Companies, Inc. (an Indiana corporation) and its wholly-owned subsidiaries. We have a 35% ownership interest in a Taiwan affiliate that is accounted for using the equity method. Our investment in that affiliate was approximately $3.6 million and $3.0 million as of October 31, 2016 and 2015, respectively. That investment is included in Investments and other assets, net on the accompanying Consolidated Balance Sheets. Intercompany accounts and transactions have been eliminated.

Statements of Cash Flows. We consider all highly liquid investments with a stated maturity at the date of purchase of three months or less to be cash equivalents. Cash flows from hedges are classified consistent with the items being hedged.

Translation of Foreign Currencies. All balance sheet accounts of non-U.S. subsidiaries are translated at the exchange rate as of the end of the year and translation adjustments of foreign currency balance sheets are recorded as a component of Accumulated other comprehensive loss in shareholders' equity. Income and expenses are translated at the average exchange rates during the year. Cumulative foreign currency translation adjustments, net of gains related to our net investment hedges, as of October 31, 2016 were a net loss of $12.3 million and are included in Accumulated other comprehensive loss. Foreign currency transaction gains and losses are recorded as income or expense as incurred and are recorded in Other expense, net.

Hedging. We are exposed to certain market risks relating to our ongoing business operations, including foreign currency risk, interest rate risk and credit risk. We manage our exposure to these and other market risks through regular operating and financing activities. Currently, the only risk that we manage through the use of derivative instruments is foreign currency risk.

We operate on a global basis and are exposed to the risk that our financial condition, results of operations and cash flows could be adversely affected by changes in foreign currency exchange rates. To reduce the potential effects of foreign exchange rate movements on our net equity investment in one of our foreign subsidiaries, and the gross profit and net earnings of certain of our foreign subsidiaries, we enter into derivative financial instruments in the form of foreign exchange forward contracts with a major financial institution. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in Euros, Pounds Sterling, Indian Rupee, South African Rand, Singapore Dollars, Chinese Yuan, Polish Zloty, and New Taiwan Dollars.

We account for derivative instruments as either assets or liabilities and carry them at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as a fair value hedge, the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the risk being hedged. For a derivative instrument designated as a cash flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of Accumulated other comprehensive loss in shareholders’ equity and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.

For derivative instruments that are not designated as accounting hedges under the Derivatives and Hedging Topic of the Financial Accounting Standards Board (FASB guidance), changes in fair value are recognized in earnings in the period of change. We do not hold or issue derivative financial instruments for speculative trading purposes. We only enter into derivatives with one counterparty, which is among one of the largest U.S. banks (ranked by assets), in order to minimize credit risk and, to date, that counterparty has not failed to meet its financial obligations under such contracts.

Derivatives Designated as Hedging Instruments

We enter into foreign currency forward exchange contracts periodically to hedge certain forecasted inter-company sales and purchases denominated in foreign currencies (the Pound Sterling, Euro and New Taiwan Dollar). The purpose of these instruments is to mitigate the risk that the U.S. Dollar net cash inflows and outflows resulting from sales and purchases denominated in foreign currencies will be adversely affected by changes in exchange rates. These forward contracts have been designated as cash flow hedge instruments, and are recorded in the Consolidated Balance Sheets at fair value in Derivative assets and Derivative liabilities. The effective portion of the gains and losses resulting from the changes in the fair value of these hedge contracts are deferred in Accumulated other comprehensive loss and recognized as an adjustment to Cost of sales and service in the period that the corresponding inventory sold that is the subject of the related hedge contract is recognized, thereby providing an offsetting economic impact against the corresponding change in the U.S. Dollar value of the inter-company sale or purchase being hedged. The ineffective portion of gains and losses resulting from the changes in the fair value of these hedge contracts is reported in Other (income) expense, net immediately. We perform quarterly assessments of hedge effectiveness by verifying and documenting the critical terms of the hedge instrument and determining that forecasted transactions have not changed significantly. We also assess on a quarterly basis whether there have been adverse developments regarding the risk of a counterparty default.

We had forward contracts outstanding as of October 31, 2016, in Euros, Pounds Sterling and New Taiwan Dollars with set maturity dates ranging from November 2016 through October 2017. The contract amount at forward rates in U.S. Dollars at October 31, 2016 for Euros and Pounds Sterling was $27.6 million and $6.1 million, respectively. The contract amount at forward rates in U.S. Dollars for New Taiwan Dollars was $21.8 million at October 31, 2016. At October 31, 2016, we had approximately $1.3 million of gains, net of tax, related to cash flow hedges deferred in Accumulated other comprehensive loss. Of this amount, $1.0 million represented unrealized gains, net of tax, related to cash flow hedge instruments that remain subject to currency fluctuation risk. The majority of these deferred gains will be recorded as an adjustment to Cost of sales and service in periods through October 2017, in which the corresponding inventory that is the subject of the related hedge contract is sold, as described above.

We are exposed to foreign currency exchange risk related to our investment in net assets in foreign countries. To manage this risk, we entered into a forward contract with a notional amount of €3.0 million in November 2015. We designated this forward contract as a hedge of our net investment in Euro denominated assets. We selected the forward method under the FASB guidance related to the accounting for derivatives instruments and hedging activities. The forward method requires all changes in the fair value of the contract to be reported as a cumulative translation adjustment in Accumulated other comprehensive loss, net of tax, in the same manner as the underlying hedged net assets. This forward contract matured in November 2016 and we entered into a new forward contract for the same notional amount that is set to mature in November 2017. As of October 31, 2016, we had a realized gain of $803,000 and an unrealized loss of $39,000, net of tax, recorded as cumulative translation adjustments in Accumulated other comprehensive loss, related to these forward contracts.

Derivatives Not Designated as Hedging Instruments

We enter into foreign currency forward exchange contracts to protect against the effects of foreign currency fluctuations on receivables and payables denominated in foreign currencies. These derivative instruments are not designated as hedges under FASB guidance and, as a result, changes in their fair value are reported currently as Other expense, net in the Consolidated Statements of Income consistent with the transaction gain or loss on the related receivables and payables denominated in foreign currencies.

We had forward contracts outstanding as of October 31, 2016, in Euros, Pounds Sterling, South African Rand and New Taiwan Dollars with set maturity dates ranging from November 2016 through April 2017. The contract amounts at forward rates in U.S. Dollars at October 31, 2016 for Euros, Pounds Sterling and South African Rand totaled $39.5 million. The contract amount at forward rates in U.S. Dollars for New Taiwan Dollars was $26.6 million at October 31, 2016.

Fair Value of Derivative Instruments

We recognize the fair value of derivative instruments as assets and liabilities on a gross basis on our Consolidated Balance Sheets. As of October 31, 2016 and October 31, 2015, all derivative instruments were recorded at fair value on the balance sheets as follows (in thousands):

	2016			2015
	Balance Sheet	Fair		Balance Sheet	Fair
Derivatives	Location	Value		Location	Value

Designated as Hedging Instruments:
Foreign exchange forward contracts	Derivative assets	$	1,721	Derivative assets	$	1,079
Foreign exchange forward contracts	Derivative liabilities	$	173	Derivative liabilities	$	1,027

Not Designated as Hedging Instruments:
Foreign exchange forward contracts	Derivative assets	$	4	Derivative assets	$	149
Foreign exchange forward contracts	Derivative liabilities	$	365	Derivative liabilities	$	44

Effect of Derivative Instruments on the Consolidated Balance Sheets, Statements of Changes in Shareholders’ Equity and Statements of Income

Derivative instruments had the following effects on our Consolidated Balance Sheets, Statements of Changes in Shareholders’ Equity and Statements of Income, net of tax, during the fiscal years ended October 31, 2016 and 2015 (in thousands):

					Location of Gain
	Amount of Gain (Loss)				(Loss) Reclassified	Amount of Gain (Loss)
	Recognized in Other				from Other	Reclassified from Other
	Comprehensive Income				Comprehensive	Comprehensive Income
Derivatives	(Loss)				Income (Loss)	(Loss)
	2016		2015			2016		2015
Designated as Hedging Instruments: (Effective Portion)

Foreign exchange forward contracts – Intercompany sales/purchases	$	1,431	$	1,291	Cost of sales and service	$	1,647	$	784

Foreign exchange forward contract – Net Investment	$	28	$	304

We recognized a gain of $18,000 during the fiscal year ended October 31, 2016 and a gain of $14,000 during the fiscal year ended October 31, 2015 as a result of contracts closed early that were deemed ineffective for financial reporting and did not qualify as cash flow hedges.

	Location of Gain (Loss)	Amount of Gain (Loss)
Derivatives	Recognized in Operations	Recognized in Operations
		2016		2015
		(in thousands)
Not Designated as Hedging Instruments:
Foreign exchange forward contracts	Other expense, net	$	536	$	2,571

The following table presents the changes in the components of Accumulated other comprehensive loss, net of tax, for the fiscal years ended October 31, 2016 and 2015 (in thousands):

	Foreign
	Currency Translation		Cash Flow Hedges		Total

Balance, October 31, 2014		(4,551)		991		(3,560)
Other comprehensive income (loss) before reclassifications		(6,333)		1,291		(5,042)
Reclassifications		—		(784)		(784)
Balance, October 31, 2015	$	(10,884)	$	1,498	$	(9,386)
Other comprehensive income (loss) before reclassifications		(1,441)		1,431		(10)
Reclassifications		—		(1,647)		(1,647)
Balance, October 31, 2016	$	(12,325)	$	1,282	$	(11,043)

Inventories. Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out method. Provisions are made to reduce excess or obsolete inventories to their estimated realizable value.

Property and Equipment. Property and equipment are carried at cost. Depreciation and amortization of assets are provided primarily under the straight-line method over the shorter of the estimated useful lives or the lease terms as follows:

		Number of Years
Land		Indefinite
Building		40
Machines		7 – 10
Shop and office equipment		3 – 7
Leasehold improvements		3 – 40

Total depreciation and amortization expense recognized for property and equipment for the fiscal years ended October 31, 2016, 2015 and 2014 was $2.5 million, $2.2 million, and $2.2 million, respectively.

Revenue Recognition. We recognize revenue from sales of our machine tool systems upon delivery of the product to the customer, which is normally at the time of shipment, because persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed and determinable and collectability is reasonably assured. Our computerized machine tools are general-purpose computer controlled machine tools that are typically used in stand-alone operations. Transfer of ownership and risk of loss are not contingent upon contractual customer acceptance. Prior to shipment, we test each machine to ensure the machine’s compliance with standard operating specifications.

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 to be inconsequential and perfunctory.

Service fees from maintenance contracts are deferred and recognized in earnings on a pro rata basis over the term of the contract.

Sales related to software products are recognized when shipped in conformity with U.S. Generally Accepted Accounting Principles as promulgated by FASB guidance related to software revenue recognition that requires at the time of shipment, persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed and determinable and collectability is reasonably assured. The software does not require production, modification or customization.

Allowance for Doubtful Accounts. The allowance for doubtful accounts is based on our best estimate of probable credit issues and historical experience. We perform credit evaluations of the financial condition of our customers. No collateral is required for sales made on open account terms. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers comprising our customer base and their dispersion across many geographic areas. We consider trade accounts receivable to be past due when payment is not made by the due date as specified on the customer invoice, and charge off uncollectible balances when all reasonable collection efforts have been exhausted.

Product Warranty. Expected future product warranty claims are recorded to expense when the product is sold. Product warranty estimates are established using historical information about the nature, frequency, and average cost of warranty claims. Warranty claims are influenced by factors such as new product introductions, technological developments, the competitive environment, and the costs of component parts. Actual payments for warranty claims could differ from the amounts estimated requiring adjustments to the liabilities in future periods. See Note 12 of Notes to Consolidated Financial Statements for further discussion of warranties.

Research and Development Costs. The costs associated with research and development programs for new products and significant product improvements, other than software development costs which are eligible for capitalization per FASB guidance, are expensed as incurred and are included in Selling, general and administrative expenses. Research and development expenses totaled $4.9 million, $3.9 million, and $3.4 million, in fiscal 2016, 2015, and 2014, respectively.

Software Development Costs. Costs incurred to develop computer software products and significant enhancements to software features of existing products to be sold or otherwise marketed are capitalized, after technological feasibility is established. Software development costs are amortized on a straight-line basis over the estimated product life of the related software, which ranges from three to five years. We capitalized costs of $2.2 million in fiscal 2016, $1.4 million in fiscal 2015, and $1.0 million in fiscal 2014 related to software development projects. Amortization expense for software development costs was $1.2 million, $1.0 million, and $1.2 million, for the fiscal years ended October 31, 2016, 2015, and 2014, respectively. Accumulated amortization at October 31, 2016 and 2015 was $16.5 million and $15.3 million, respectively. Estimated amortization expense for the remaining unamortized software development costs for the fiscal years ending October 31, is as follows (in thousands):

	Amortization
Fiscal Year	Expense
2017	$	1,200
2018		1,275
2019		750
2020		700
2021		625

Goodwill and Intangible Assets. Goodwill and other separately recognized intangible assets with indefinite lives are not subject to amortization. At least once annually or when indicators of impairment exist, we perform an impairment test for goodwill. Goodwill is allocated to various reporting units. We use a qualitative approach to test goodwill and indefinite-lived assets for impairment. Intangible assets that are determined to have a finite life are amortized over their estimated useful lives and are also subject to review for impairment, if indicators of impairment are identified. For fiscal years 2016 and 2015, using the qualitative approach to test for impairment, we concluded that goodwill and other intangible assets were not impaired.

As of October 31, 2016, the balances of intangible assets, other than goodwill, were as follows (in thousands):

	Weighted
	Average	Gross				Net
	Amortization	Intangible		Accumulated		Intangible
	Period	Assets		Amortization		Assets

Tradenames and trademarks	13 years	$	231	$	(59)	$	172
Tradenames and trademarks	indefinite		60		—		60
Customer relationships	15 years		254		(114)		140
Technology	13 years		672		(172)		500
Patents	6 years		2,972		(2,741)		231
Other	8 years		373		(326)		47
Total		$	4,562	$	(3,412)	$	1,150

As of October 31, 2015, the balances of intangible assets, other than goodwill, were as follows (in thousands):

	Weighted
	Average	Gross
	Amortization	Intangible		Accumulated		Net Intangible
	Period	Assets		Amortization		Assets

Tradenames and trademarks	13 years	$	231	$	(41)	$	190
Tradenames and trademarks	indefinite		60		—		60
Customer relationships	15 years		254		(97)		157
Technology	13 years		674		(121)		553
Patents	6 years		2,972		(2,717)		255
Other	8 years		373		(299)		74
Total		$	4,564	$	(3,275)	$	1,289

Intangible asset amortization expense was $137,000, $207,000, and $412,000 for fiscal 2016, 2015 and 2014, respectively. Annual intangible asset amortization expense is estimated to be $115,000 per year for fiscal years 2017 through 2021.

Impairment of Long-Lived Assets. We periodically evaluate the carrying value of long-lived assets to be held and used, including property and equipment, software development costs and intangible assets, including goodwill, when events or circumstances warrant such a review. The carrying value of a long-lived asset (or group of assets) to be held and used is considered impaired when the anticipated separately identifiable undiscounted cash flows from such an asset (or group of assets) are less than the carrying value of the asset (or group of assets) in accordance with FASB guidance related to accounting for the impairment or disposal of long-lived assets.

Earnings Per Share. Basic earnings per share is calculated by dividing net income by the weighted-average number of common shares actually outstanding during the period. Diluted earnings per share assumes the issuance of additional shares of common stock upon exercise of all outstanding stock options and contingently issuable securities if the effect is dilutive, in accordance with the treasury stock method discussed in FASB guidance on “Earnings Per Share”.

The following table presents a reconciliation of our basic and diluted earnings per share computation:

	Fiscal Year Ended October 31,
	2016				2015				2014
(in thousands, except per share amounts)	Basic		Diluted		Basic		Diluted		Basic		Diluted

Net income	$	13,292	$	13,292	$	16,214	$	16,214	$	15,143	$	15,143
Undistributed earnings allocated to participating shares		(76)		(76)		(93)		(93)		(121)		(121)
Net income applicable to common shareholders	$	13,216	$	13,216	$	16,121	$	16,121	$	15,022	$	15,022
Weighted average shares outstanding		6,569		6,569		6,543		6,543		6,497		6,497
Stock options and contingently issuable securities		—		73		—		59		—		41
		6,569		6,642		6,543		6,602		6,497		6,538
Income per share	$	2.01	$	1.99	$	2.46	$	2.44	$	2.31	$	2.30

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. Our judgment regarding the realization of deferred tax assets may change due to future profitability and market conditions, changes in U.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 tax laws. Our provision for income taxes reflects a combination of income earned and taxed at the federal and state level in the U.S., as well as in various foreign jurisdictions. We have not provided for any U.S. income taxes on the undistributed earnings of our foreign subsidiaries based upon our determination that such earnings will be indefinitely reinvested abroad. Undistributed earnings of our wholly-owned foreign subsidiaries at October 31, 2016 were approximately $79.7 million. In the event these earnings are later distributed to the U.S., such distributions would likely result in additional U.S. tax that may be offset, at least in part, by associated foreign tax credits.

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.

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.

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.

Estimates. The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles requires us to make estimates and assumptions that affect the reported amounts presented and disclosed in our consolidated financial statements. Significant estimates and assumptions in these consolidated financial statements require the exercise of judgment and are used for, but not limited to, allowance for doubtful accounts, estimates of future cash flows and other assumptions associated with goodwill, intangible and long-lived asset impairment tests, useful lives for depreciation and amortization, warranty programs, stock compensation, income taxes and deferred tax valuation allowances, and contingencies. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be different from these estimates.