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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

12 Months Ended

Oct. 31, 2018

. 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 $4.0 million and $3.6 million as of October 31, 2018 and 2017, respectively. That investment is included in Investments and other assets, net on the accompanying Consolidated Balance Sheets. Intercompany accounts and transactions have been eliminated.

Reclassifications

Reclassifications.

Certain prior year amounts have been reclassified to conform to current year presentation. This reclassification has no impact on previously reported net income or shareholders’ equity.

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, 2018 were a net loss of $10.6 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

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 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, 2018, in Euros, Pounds Sterling and New Taiwan Dollars with set maturity dates ranging from November 2018 through October 2019. The contract amount at forward rates in U.S. Dollars at October 31, 2018 for Euros and Pounds Sterling was $32.9 million and $9.6 million, respectively. The contract amount at forward rates in U.S. Dollars for New Taiwan Dollars was $34.3 million at October 31, 2018. At October 31, 2018, we had approximately $156,000 of gains, net of tax, related to cash flow hedges deferred in Accumulated other comprehensive loss. Of this amount, $605,000 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 2019, 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 2017. 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, net of tax, in Accumulated other comprehensive loss in the same manner as the underlying hedged net assets. This forward contract matured in November 2018 and we entered into a new forward contract for the same notional amount that is set to mature in November 2019. As of October 31, 2018, we had a realized gain of $

652

,000 and an unrealized gain of $

153

,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, 2018, in Euros, South African Rand and New Taiwan Dollars with set maturity dates ranging from November 2018 through July 2019. The contract amounts at forward rates in U.S. Dollars at October 31, 2018 for Euros and South African Rand totaled $22.4 million. The contract amount at forward rates in U.S. Dollars for New Taiwan Dollars was $37.6 million at October 31, 2018.

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, 2018 and October 31, 2017, all derivative instruments were recorded at fair value on the balance sheets as follows (in thousands):

	2018			2017
	Balance Sheet	Fair		Balance Sheet	Fair
Derivatives	Location	Value		Location	Value
Designated as Hedging Instruments:
Foreign exchange forward contracts	Derivative assets	$	2,654	Derivative assets	$	305
Foreign exchange forward contracts	Derivative liabilities	$	1,616	Derivative liabilities	$	1,508

Not Designated as Hedging Instruments:
Foreign exchange forward contracts	Derivative assets	$	431	Derivative assets	$	291
Foreign exchange forward contracts	Derivative liabilities	$	404	Derivative liabilities	$	224

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, 2018, 2017, and 2016 (in thousands):

	Amount of Gain (Loss)							Location of Gain (Loss)		Amount of Gain (Loss)
	Recognized in							Reclassified from		Reclassified from
	Other Comprehensive							Other Comprehensive		Other Comprehensive
Derivatives	Income (Loss)							Income (Loss)		Income (Loss)
	2018		2017			2016				2018			2017		2016
Designated as Hedging Instruments:
(Effective Portion)
Foreign exchange forward contracts									Cost of sales Cost of sales
– Intercompany sales/purchases	$	155	$	(709	)	$	1,431		and service	$	(1,355	)	$	1,354	$	1,647
Foreign exchange forward contract
– Net Investment	$	136	$	(96	)	$	28

We did not recognize any gains or losses as a result of hedges deemed ineffective during fiscal 2018. We recognized a gain of $18,000 during the fiscal

year ended October 31, 2017 and a gain of $18,000 during the fiscal year ended October 31, 2016 as a result of contracts closed early that were deemed ineffective for financial reporting and did not qualify as cash flow hedges.

We recognized the following gains and losses in our Consolidated Statements of Income during the fiscal years ended October 31, 2018, 2017, and 2016 on derivative instruments not designated as hedging instruments (in thousands):

	Location of Gain (Loss)	Amount of Gain (Loss)
Derivatives	Recognized in Operations	Recognized in Operations
		2018			2017			2016
Not Designated as Hedging Instruments:
Foreign exchange forward contracts	Other expense, net	$	(963	)	$	(1,001	)	$	536

The following table presents the changes in the components of Accumulated other comprehensive loss, net of tax, for the fiscal years ended October 31, 2018 and 2017 (in thousands):

	Foreign			Cash
	Currency			Flow
	Translation			Hedges			Total
Balance, October 31, 2016	$	(12,325	)	$	1,282		$	(11,043	)
Other comprehensive income (loss) before reclassifications		4,916			(709	)		4,207
Reclassifications		–			(1,354	)		(1,354	)
Balance, October 31, 2017	$	(7,409	)	$	(781	)	$	(8,190	)
Other comprehensive income (loss) before reclassifications		(3,183	)		155			(3,028	)
Reclassifications		–			1,355			1,355
Balance, October 31, 2018	$	(10,592	)	$	729		$	(9,863	)

Inventories

. Inventories are stated at the lower of cost or net realizable value, 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 carri

ed 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
Building & leasehold improvements	3 – 40

Total depreciation and amortization expense recognized for propert

y and equipment was $2.5 million for each of the fiscal years ended October 31, 2018, 2017 and 2016.

Revenue Recognition

Revenue Recognition.

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, 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 for our three–axis machines to be inconsequential and perfunctory. We allocate the transaction prices and recognize revenue associated with the installation process for our five–axis machines on a prorata basis over the period of the installation process.

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.

Sales related to software upgrades 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 we 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 11 of Notes to Consolidated Financial Statements for further discussion of warranties.

Research and Development Costs

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 $4.7 million, $4.2 million, and $4.9 million, in fiscal 2018, 2017, and 2016, respectively.

Software Development Costs

Software Development Costs.

We sell software products that are essential to our machine tools. 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 $2.3 million in fiscal 2018, $2.3 million in fiscal 2017, and $2.2 million in fiscal 2016 related to software development projects. Amortization expense for software development costs was $1.1 million, $1.0 million, and $1.2 million, for the fiscal years ended October 31, 2018, 2017, and 2016, respectively. Accumulated amortization at October 31, 2018 and 2017 was $18.5 million and $17.4 million, respectively.

Estimated amortization expense for the remaining unamortized software development costs for the fiscal years ending October 31, is as follows (in thousands):

Fiscal Year	Amortization Expense
2019		1,000
2020		1,300
2021		1,500
2022		1,400
2023		1,050

Goodwill and Intangible Assets

Goodwill and Intangible Assets.

Goodwill and indefinite-lived intangibles arising from a business combination are not amortized and charged to expense over time. Instead, goodwill and indefinite-lived intangibles must be reviewed annually for impairment, or more frequently, if circumstances arise indicating potential impairment. This impairment review was most recently completed as of July 31, 2018. For goodwill, if the carrying amount of the reporting unit containing the goodwill exceeds the fair value of that reporting unit, an impairment loss is recognized to the extent the “implied fair value” of the reporting unit goodwill is less than the carrying amount of the goodwill. For indefinite-lived intangible assets, if the carrying amount exceeds the fair value, an impairment loss is recognized in an amount equal to that excess. 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.

There were no impairments recognized with respect to the carrying value of goodwill or intangible assets for the years ended October 31, 2018, 2017 or 2016.

As of October 31, 2018, the balances of intangible assets, other than goodwill, were as follows (in thousands):

	Weighted Average Amortization Period	Gross Intangible Assets		Accumulated Amortization			Net Intangible Assets
Tradenames and trademarks	indefinite	$	60	$	–		$	60
Tradenames and trademarks	13 years		238		(98	)		140
Customer relationships	15 years		255		(148	)		107
Technology	13 years		692		(284	)		408
Patents	6 years		2,973		(2,790	)		183
Other	8 years		377		(337	)		40
Total		$	4,595	$	(3,657	)	$	938

As of October 31, 2017, the balances of intangible assets, other than goodwill, were as follows (in thousands):

	Weighted Average Amortization Period	Gross Intangible Assets		Accumulated Amortization			Net Intangible Assets
Tradenames and trademarks	indefinite	$	60	$	–		$	60
Tradenames and trademarks	13 years		245		(81	)		164
Customer relationships	15 years		257		(132	)		125
Technology	13 years		713		(239	)		474
Patents	6 years		2,973		(2,765	)		208
Other	8 years		378		(333	)		45
Total		$	4,626	$	(3,550	)	$	1,076

Intangible asset amortization expense was $107,000, $136,000, and $137,000 for fiscal 2018, 2017 and 2016, respectively. Annual intangible asset amortization expense is estimated to be $117,000 per year for fiscal years 2019 through 2023.

Impairment of Long-Lived Assets

Impairment of Long

–

Lived Assets.

Annually, or when there are indicators of impairment, we 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

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,
(in thousands, except per share amounts)	2018						2017						2016
	Basic			Diluted			Basic			Diluted			Basic			Diluted
Net income	$	21,490		$	21,490		$	15,115		$	15,115		$	13,292		$	13,292
Undistributed earnings allocated to participating shares		(132	)		(132	)		(100	)		(100	)		(76	)		(76	)
Net income applicable to common Shareholders	$	21,358		$	21,358		$	15,015		$	15,015		$	13,216		$	13,216
Weighted average shares outstanding		6,700			6,700			6,615			6,615			6,569			6,569
Stock options and contingently issuable securities		–			71			–			65			–			73
		6,700			6,771			6,615			6,680			6,569			6,642
Income per share	$	3.19		$	3.15		$	2.27		$	2.25		$	2.01		$	1.99

Income Taxes

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.

In December 2017, the Tax Cuts and Jobs Act (the “Tax Reform Act”) was enacted. The Tax Reform Act, among other things, lowered the U.S. corporate tax rate from 35% to 21%, implemented a territorial tax system from a worldwide system and imposed a one–time tax on deemed repatriation of earnings of foreign subsidiaries.

As a result of the reduction in the federal corporate income tax rate, we were required to revalue our net deferred tax asset to account for the future impact of lower corporate tax rates on this deferred amount and record any change in the value of such asset as a one–time non–cash charge on its income statement. This resulted in additional expense of $0.6 million. Additionally, the Tax Reform Act required a transition tax on any net accumulated earnings and profits generated by foreign subsidiaries as of the two required measurement dates, November 2, 2017 and December 31, 2017 while providing for future tax–free repatriation of such earnings through a 100% dividends–received deduction. This resulted in a one–time transition tax on the deemed repatriation of net accumulated foreign earnings and profits of $2.2 million, for a total impact of $2.8 million. As such, as of December 31, 2017, all of the Company’s accumulated earnings and profits are deemed repatriated. We have not provided for any U.S. income taxes on the undistributed earnings of our foreign subsidiaries beginning January 1, 2018 based upon our determination that such earnings will be indefinitely reinvested abroad.

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

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

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.