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

Derivative instruments had the following effects on our Condensed Consolidated Balance Sheets, Condensed Consolidated Statements of Changes in Shareholders’ Equity and Condensed Consolidated Statements of Income,Operations, net of tax, during the three months ended January 31, 20182020 and 20172019 (in thousands):

We did not recognize any gains or losses as a result of hedges deemed ineffective for either of the three months ended January 31, 2018. We recognized a loss of $136,000 as a result of hedges deemed ineffective for the three months ended January 31, 2017.2020 or 2019. We recognized the following losses and gains in our Condensed Consolidated Statements of IncomeOperations during the three months ended January 31, 20182020 and 20172019 on derivative instruments not designated as hedging instruments (in thousands):

The following table presents the changes in the components of Accumulated other comprehensive loss, net of tax, for the three months ended January 31, 20182020 (in thousands):

In March 2016, we adopted the Hurco Companies, Inc. 2016 Equity Incentive Plan (the “2016 Equity Plan”), which allows us to grant awards of stock options, stock appreciation rights, restricted stock, stock units and other stock-based awards. The 2016 Equity Plan replaced the Hurco Companies, Inc. 2008 Equity Incentive Plan (the “2008 Plan”) and is the only active plan under which equity awards may be made by us to our employees and non-employee directors. No further awards will be made under our 2008 Plan. The total number of shares of our common stock that may be issued pursuant to awards under the 2016 Equity Plan is 856,048, which includes 386,048 shares remaining available for future grants under the 2008 Plan as of March 10, 2016, the date our shareholders approved the 2016 Equity Plan.

The Compensation Committee of our Board of Directors has the authority to determine the officers, directors and key employees who will be granted awards under the 2016 Equity Plan; designate the number of shares subject to each award; determine the terms and conditions upon which awards will be granted; and prescribe the form and terms of award agreements. We have granted restricted shares and performance units under the 2016 Equity Plan that are currently outstanding, and we have granted stock options restricted shares and performance shares under the 2008 Plan that are currently outstanding. No stock option may be exercised more than ten years after the date of grant or such shorter period as the Compensation Committee may determine at the date of grant. The market value of a share of our common stock, for purposes of the 2016 Equity Plan, is the closing sale price as reported by the Nasdaq Global Select Market on the date in question or, if not a trading day, on the last preceding trading date.

A summary of stock option activity for the three-month period ended January 31, 2018,2020, is as follows:

The total intrinsic value of stock options exercised during the three months ended January 31, 2018 was approximately $492,000.

Summarized information about outstanding stock options as of January 31, 2018,2020, that have already vested and are currently exercisable, are as follows:

The intrinsic value of an outstanding stock option is calculated as the difference between the stock price as of January 31, 20182020 and the exercise price of the option.

On March 9, 2017,November 13, 2019, the Compensation Committee granted a total of 14,920 shares of time-based restricted stock to our non-employee directors. The restricted shares vest in full one year from the date of grant provided the recipient remains on the board of directors through that date. The grant date fair value of the restricted shares was based on the closing sales price of our common stock on the grant date, which was $26.80 per share.

On November 15, 2017, the Compensation Committee granted a total of 2,3648,052 shares of time-based restricted stock to our non-executive employees. The restricted shares vest in thirds over three years from the date of grant provided the recipient remains employed through that date. The grant date fair value of the restricted shares was based upon the closing sales price of our common stock on the date of grant, which was $42.30$35.75 per share.

On January 3, 2018,2, 2020, the Compensation Committee determined the degree to which the long-term incentive compensation arrangement approved for the fiscal 2015-20172017-2019 performance period was attained, and the resulting payout level relative to the target amount for each of the metrics that were established by the Compensation Committee in 2015.2017. As a result, the Compensation Committee determined that a total of 23,299 performance shares28,979 PSUs were earned by our executive officers, which performance sharesshare units (“PSUs”) vested on January 3, 2018.2, 2020. The vesting date fair value of the performance sharesPSUs was based on the closing sales price of our common stock on the vesting date, which was $42.20$37.79 per share.

On January 3, 2018,2, 2020, the Compensation Committee also approved a long-term incentive compensation arrangement for our executive officers in the form of restricted shares and performance stock units (“PSUs”)PSUs under the 2016 Equity Plan, which will be payable in shares of our common stock if earned and vested. The awards were approximately 25% time-based vesting and approximately 75% performance-based vesting. The three-year performance period for the PSUs is fiscal 20182020 through fiscal 2020.2022.

On that date, the Compensation Committee granted a total of 14,81020,837 shares of time-based restricted stock to our executive officers. The restricted shares vest in thirds over three years from the date of grant provided the recipient remains employed through that date. The grant date fair value of the restricted shares was based upon the closing sales price of our common stock on the date of grant, which was $42.20$37.79 per share.

On January 3, 2018,2, 2020, the Compensation Committee also granted a total target number of 20,73426,918 PSUs to our executive officers designated as “PSU – TSR”. These PSUs were weighted as approximately 40% of the overall 20182020 executive long-term incentive compensation arrangement and will vest and be paid based upon the total shareholder return of our common stock over the three-year period of fiscal 2018-2020,2020-2022, relative to the total shareholder return of the companies in a specified peer group over that period. Participants will have the ability to earn between 50% of the target number of the PSUs – TSR for achieving threshold performance and 200% of the target number of the PSUs – TSR for achieving maximum performance. The grant date fair value of the PSUs – TSR was $45.68$46.81 per PSU and was calculated using the Monte Carlo approach.

On January 3, 2018,2, 2020, the Compensation Committee also granted a total target number of 21,89129,174 PSUs to our executive officers designated as “PSU – ROIC”. These PSUs were weighted as approximately 35% of the overall 20182020 executive long-term incentive compensation arrangement and will vest and be paid based upon the achievement of pre-established goals related to our average return on invested capital over the three-year period of fiscal 2018-2020.2020-2022. Participants will have the ability to earn between 50% of the target number of the PSUs - ROIC for achieving threshold performance and 200% of the target number of the PSUs - ROIC for achieving maximum performance. The grant date fair value of the PSUs – ROIC was based on the closing sales price of our common stock on the grant date, which was $42.20$37.79 per share.

A reconciliation of the Company’sour restricted stock performance share and PSU activity and related information for the three-month period ended January 31, 20182020 is as follows:

During the first three months of fiscal 20182020 and 2017,2019, we recorded $549,000approximately $136,000 and $351,000,$709,000, respectively, asof stock-based compensation expense related to grants under our equity plans.the 2016 Equity Plan. As of January 31, 2018,2020, there was an estimated $4.2$4.3 million of total unrecognized stock-based compensation cost that we expect to recognize by the end of the first quarter of fiscal 2021.2023.

On August 5, 2019, we (through a newly-formed subsidiary, ProCobots, LLC (“ProCobots”)) acquired substantially all of the assets of a U.S.-based automation integration company for approximately $4.4 million.  This acquired business provides automation solutions that can be integratedwith any machine tool.The purchase price has been preliminarily allocated to the assets acquired and the liabilities assumed based on their fair values, and approximated $4.4 million. The allocation of the opening balance sheet of ProCobots as of August 5, 2019 is as follows (in thousands):

The acquisition was accounted for in accordance with ASC Topic 805, Business Combinations. Accordingly, the total purchase price was allocated to tangible assets and liabilities based on their fair value and the intangibles and goodwill were allocated on a provisional basis at the date of acquisition. These allocations reflected various provisional estimates that were available at the time and are subject to change during the purchase price allocation period as valuations are in the process of being finalized.

The results of operations of ProCobots have been included in the consolidated financial statements from the date of acquisition.

Per share results have been computed based on the average number of common shares outstanding over the period in question. The computation of basic and diluted net income (loss) per share is determined using net income (loss) applicable to common shareholders as the numerator and the number of shares outstanding as the denominator as follows (in thousands, except per share amounts):

Accounts receivable are net of allowances for doubtful accounts of $797,000$879,000 as of January 31, 20182020 and $639,000$891,000 million as of October 31, 2017.2019.

6. INVENTORIES

In July 2015, the FASB issued guidance on simplifying the measurement of inventory. The guidance, which applies to inventory that is measured using any method other than the last-in, first-out (“LIFO”) or retail inventory method, requires that entities measure inventory at the lower of cost or net realizable value. The Company adopted the provisions of this guidance prospectively in the first quarter of fiscal 2018. The adoption of this guidance did not have a material impact on the Company’s consolidated results of operations, financial position, or cash flows.

Inventories, priced at the lower of cost (first-in, first-out method) or net realizable value, are summarized below (in thousands):

7. SEGMENT INFORMATIONWe adopted Accounting Standards Update (“ASU”) No. 2016-02, “Leases” (“ASC 842”) on November 1, 2019, the start of our 2020 fiscal year, and utilized the transition method allowed. Accordingly, comparative period financial information was not adjusted for the effects of adopting ASC 842 and no cumulative-effect adjustment was required to the opening balance of retained earnings on the adoption date.

Upon adoption of ASC 842, we utilized the following elections and practical expedients:

Our lease portfolio includes leased production and assembly facilities, warehouses and distribution centers, office space, vehicles, material handling equipment utilized in our production and assembly facilities, laptops and other information technology equipment, as well as other miscellaneous leased equipment. Most of the leased production and assembly facilities have lease terms ranging from two to five years, although the terms and conditions of our leases can vary significantly from lease to lease. We have assessed the specific terms and conditions of each lease to determine the amount of the lease payments and the length of the lease term, which includes the minimum period over which lease payments are required plus any renewal options that are both within our control to exercise and reasonably certain of being exercised upon lease commencement. In determining whether or not a renewal option is reasonably certain of being exercised, we assessed all relevant factors to determine if sufficient incentives exist as of lease commencement to conclude renewal is reasonably certain. There are no material residual value guarantees provided by us, nor any restrictions or covenants imposed by the leases to which we are a party. In determining the lease liability, we utilize our incremental borrowing rate to discount the future lease payments over the lease term to present value.

We record a right-of-use asset and lease liability on our Condensed Consolidated Balance Sheets for all leases for which we are a lessee, in accordance with ASC 842. We have no lease agreements in place for which we are a lessor, and all our leases for which we are a lessee are classified as operating leases under the guidance in Topic 840.

We recorded total operating lease expense of $1.3 million and $1.2 million for the three months ended January 31, 2020 and 2019, respectively, which is classified within Cost of sales and service and Selling, general and administrative expenses within the Condensed Consolidated Statements of Operations. Operating lease expense includes short-term leases and variable lease payments which are immaterial. There have been no lease costs capitalized on the Condensed Consolidated Balance Sheets as of January 31, 2020.

The following table summarizes supplemental cash flow information and non-cash activity related to operating leases for the three months ended January 31, 2020 (in thousands):

The following table summarizes the maturities of lease commitments as of October 31, 2019, prior to the adoption of the new lease guidance, as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended October 31, 2019 (in thousands):

The following table summarizes the maturities of undiscounted cash flows of lease commitments reconciled to the total lease liability as of January 31, 2020 (in thousands):

As of January 31, 2020, the weighted-average remaining term of our lease portfolio was approximately 4.0 years and the weighted-average discount rate was approximately 1.5%

We operate in a single segment: industrial automation equipment. 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 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.

8. GUARANTEES AND PRODUCT WARRANTIES

From time to time, our subsidiaries guarantee third party payment obligations in connection with the sale of machines to customers that use financing. We follow FASB guidance for accounting for guarantees (codified in ASC 460). As ofJanuary 31, 2018,2020, we had 2723 outstanding third party payment guarantees totaling approximately $1.0$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 customerit 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.

We provide warranties on our products with respect to defects in material and workmanship. The terms of these warranties are generally one year for machines and certain components and shorter periods for service parts. We recognize a reserve with respect to this obligation at the time of product sale, with subsequent warranty claims recorded against the reserve. The amount of the warranty reserve is determined based on historical trend experience and any known warranty issues that could cause future warranty costs to differ from historical experience. A reconciliation of the changes in our warranty reserve is as follows (in thousands):

The year-over-year increasedecrease in our warranty reserve was primarily due to an increasea decrease in unit sales volume, as well as an increase in average warranty cost per machine as our product mixthe number of machines under warranty shifted to more complex, higher-performance machines.resulting from decreased sales volume.

On December 7, 2012,31, 2018, we and our subsidiary Hurco B.V. entered into ana new credit agreement which was subsequently amended on May 9, 2014, June 5, 2014, December 5, 2014 and December 6, 2016 (as amended, the “U.S. credit agreement”(the “2018 Credit Agreement”) with a financial institution that provided us withBank of America, N.A., as the lender. The 2018 Credit Agreement provides for an unsecured revolving credit and letter of credit facility.facility in a maximum aggregate amount of $40.0 million. The U.S.2018 Credit Agreement provides that the maximum amount of outstanding letters of credit agreementat any one time may not exceed $10.0 million, the maximum amount of outstanding loans made to our subsidiary Hurco 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 and Hurco B.V. are borrowers, and certain of our other subsidiaries are guarantors. The scheduled maturity date of the 2018 Credit Agreement is December 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 financialaffirmative 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 $5.0$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 (3)(4) requiring that we maintain a minimum tangible net worth. The U.S. credit agreement permits us to pay certain cash dividends, so long as we are not in defaultworth of $170.0 million. We may use the proceeds from advances under the U.S. credit agreement before and after giving effect to such dividends.2018 Credit Agreement for general corporate purposes.

Borrowings underIn March 2019, our U.S. credit agreement bear interest either at a LIBOR-based rate or a floating rate,wholly-owned subsidiaries in each case with an interest rate floor of 0.00%. The floating rate equals the greatest of (a) a one month LIBOR-based rate plus 1.00% per annum, (b) the federal funds effective rate plus 0.50% per annum, (c) the prevailing prime rateTaiwan, Hurco Manufacturing Limited. (“HML”), and (d) 0.00%. The rate we must pay for that portion of the U.S. credit agreement which is not utilized is 0.05% per annum.

On December 6, 2016, we entered into a fourth amendment to our U.S. credit agreement to, among other things, increase the unsecuredChina, Ningbo Hurco Machine Tool Co. Ltd. (“NHML”), closed on uncommitted revolving credit facility from $12.5facilities with maximum aggregate amounts of 150 million to $15.0 million, to increase the cash dividend allowance from $4.0 million per calendar year to $5.0 million per calendar year,New Taiwan Dollars (the “Taiwan credit facility”) and to extend the scheduled maturity date to December 31, 2018. The U.S. credit agreement, as amended, provides for the issuance of up to $5.0 million in letters of credit. We also amended the U.S. credit agreement to increase the minimum working capital and minimum tangible net worth requirements from $90.0 million to $105.0 million and $120.0 million to $125.0 million, respectively.

On February 16, 2017, we amended our credit facility in China to decrease the credit facility from 40.032.5 million Chinese Yuan to 20.0 million Chinese Yuan (approximately $3.2 million). On February 14, 2018, we renewed this facility with an expiration date of February 13, 2019. We had $1.6 million(the “China credit facility”), respectively. As uncommitted facilities, both the Taiwan and $1.5 million of borrowings under our China credit facility atfacilities are subject to review and termination by the respective underlying lending institutions from time to time.

As of January 31, 2018 and October 31, 2017, respectively, which bears interest at variable rates2020, our existing credit facilities consist of 4.4% and 4.4% annually, respectively. We also have a £1.0 million revolving credit facility in the United Kingdom and aour €1.5 million revolving credit facility in Germany. We hadGermany, the 150 million New Taiwan Dollars Taiwan credit facility, the 32.5 million Chinese Yuan China credit facility and the $40.0 million revolving credit facility under the 2018 Credit Agreement. There were no other debt or borrowings under any of our other credit facilities at eitherand there was $51.3 million of those dates.available borrowing capacity thereunder.

All of our credit facilities are unsecured. At January 31, 2018, we had unutilized credit facilities of $19.9 million.

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 tax on deemed repatriation of earnings of foreign subsidiaries all of which were effective for our first quarter of fiscal 2018. Otherand added provisions related to theGlobal Intangible Low Taxed Income (“GILTI”) and Foreign-Derived Intangible Income (“FDII”), among other provisions.

The Tax Reform Act such as eliminationcreated a new requirement that GILTI income earned by Controlled Foreign Corporations (“CFCs”) must be included in the gross income of domestic production deductions and limitation on other business deductions, will be effectivethe CFC’s U.S. shareholder. We have elected the period cost method to account for us beginning in fiscal 2019. We recognized the income tax effects of theGILTI tax. The Tax Reform Act also created the FDII for U.S. companies that derive income from the export of tangible and intangible property and services. We have included an estimate for the GILTI and FDII in our 2018 financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidanceannualized effective tax rate used to determine tax expense (benefit) for the application of ASC Topic 740,Income Taxes, in the reporting period in which the 2017 Tax Act was signed into law. As such, our financial results reflect the income tax effects of the Tax Reform Act for which the accounting under ASC Topic 740 is complete and provisional amounts for those specific income tax effects of the Tax Reform Act for which the accounting under ASC Topic 740 is incomplete but a reasonable estimate could be determined.three months ended January 31, 2020.

We recorded an income tax expensebenefit during the first three months of fiscal 20182020 of $4.5 million$597,000 compared to $0.5income tax expense of $2.5 million for the same period in fiscal 2017.2019. Our effective tax rate for the first three months of fiscal 20182020 was 61%40% in comparison to 38%27% for the same period in fiscal 2017.2019. The increase in effective tax rate forwas primarily due to a shift in geographic mix of income and loss among tax jurisdictions. The shift in geographic mix of income and loss during the three months ended January 31, 2018 is a blended rate reflectingquarter created an unfavorable impact of certain U.S. tax reform provisions in the estimated benefit of approximately one month of the federal tax rate reductions forcurrent fiscal 2018, a one-time provisional adjustment of $2.5 millionyear related to the transitiondeductions for FDII and minimal tax on deemed repatriation of accumulated foreign income and a one-time non-cash tax charge of $0.4 million related to the revaluation of net deferred tax assets.

The $2.5 million transition tax on deemed repatriation of accumulated foreign income is subject to adjustment during the measurement period of up to one year following the December 2017 enactment date, as provided by recent SEC guidance. We measure deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, our deferred tax assets and liabilities were re-measured to reflect the reduction in the U.S. corporate income tax rate from 35% to 21%, resulting in an increase of $0.4 million in income tax expenseprovisions for the first quarter ended January 31, 2018 and a corresponding decrease of $0.4 million in net deferred tax assets as of January 31, 2018.

Both of these tax adjustments represent provisional amounts based upon our current interpretation of the Tax Reform Act and may change as we receive additional clarification and implementation guidance. We will continue to analyze the effects of the Tax Reform Act on our financial statements and operations. Any additional impacts from the enactment of the Tax Reform Act will be recorded as they are identified during the measurement period as provided for in accordance with Staff Accounting Bulletin No. 118.GILTI.

Our unrecognized tax benefits were $1.2 million$228,000 as of January 31, 20182020 and $225,000 as of October 31, 2017,2019, and in each case included accrued interest.

We recognize accrued interest and penalties related to unrecognized tax benefits as components of income tax expense. As of January 31, 2018,2020, the gross amount of interest accrued, reported in Accrued expenses, and other, was approximately $58,000,$35,000, which did not include the federal tax benefit of interest deductions.

We file U.S. federal and state income tax returns, as well as tax returns in several foreign jurisdictions. The statutes of limitations with respect to unrecognized tax benefits will expire between July 20182020 and July 2020.August 2023.

FASB fair value guidance establishedestablishes a three-tier fair value hierarchy, which categorizes the inputs used in measuring fair value.  These tiers include: Level 1, defined as observable inputs, such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exist, therefore requiring an entity to develop its own assumptions.

In accordance with this guidance, the following table represents the fair value hierarchy for our financial assets and liabilities measured at fair value as of January 31, 20182020 and October 31, 20172019 (in thousands):

Included in Level 1 assets are mutual fund investments under a nonqualified deferred compensation plan. We estimate the fair value of these investments on a recurring basis using market prices that are readily available.

Included in Level 2 fair value measurements are derivative assets and liabilities related to gains and losses on foreign currency forward exchange contracts entered into with a third party. We estimate the fair value of these derivatives on a recurring basis using foreign currency exchange rates obtained from active markets. Derivative instruments are reported in the accompanying condensed consolidated financial statementsCondensed Consolidated Financial Statements at fair value. We have derivative financial instruments in the form of foreign currency forward exchange contracts as described in Note 23 of Notes to the Condensed Consolidated Financial Statements. The U.S. Dollar equivalent notional amounts of these contracts was $149.1$87.9 million and $134.3$108.6 million at January 31, 20182020 and October 31, 2017,2019, respectively.

The fair value of our foreign currency forward exchange contracts and the related currency positions are subject to offsetting market risk resulting from foreign currency exchange rate volatility. The counterpartycounterparties to the forward exchange contracts is aare substantial and creditworthy financial institution.institutions. We do not consider either the risk of counterpartycounterparties’ non-performance or the economic consequences of counterpartycounterparties’ non-performance to be material risks.

From time to time, we are involved in various claims and lawsuits arising in the normal course of business.  Pursuant to applicable accounting rules, we accrue the minimum liability for each known claim when the estimated outcome is a range of possible loss and no one amount within that range is more likely than another.  We maintain insurance policies for such matters, and we record insurance recoveries when we determine such recovery to be probable.  We do not expect any of these claims, individually or in the aggregate, to have a material adverse effect on our consolidated financial position or results of operations.  We believe that the ultimate resolution of claims for any losses will not exceed our insurance policy coverages.

Recently Adopted Accounting Pronouncements:

In August 2014, the FASB issued ASU No. 2014-15,Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and provide related footnote disclosures. ASU No. 2014-15 is effective for our fiscal year 2018, including interim periods within the fiscal year. As such, we adopted this standard in the first quarter of fiscal 2018. This standard did not have a significant effect on our accounting policies or on our condensed consolidated financial statements and related disclosures.